<PAGE>
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934 (Amendment No. )
Filed by the Registrant /X/
Filed by a Party other than the Registrant / /
Check the appropriate box:
/ / Preliminary Proxy Statement
/ / Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
/ / Definitive Proxy Statement
/X/ Definitive Additional Materials
/ / Soliciting Material Pursuant to Section 240.14a-11(c) or Section
240.14a-12
FHP INTERNATIONAL CORPORATION
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
/ / $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1), 14a-6(i)(2) or
Item 22(a)(2) of Schedule 14A.
/ / $500 per each party to the controversy pursuant to Exchange Act Rule
14a-6(i)(3).
/ / Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
1) Title of each class of securities to which transaction applies:
------------------------------------------------------------------------
2) Aggregate number of securities to which transaction applies:
------------------------------------------------------------------------
3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
------------------------------------------------------------------------
4) Proposed maximum aggregate value of transaction:
------------------------------------------------------------------------
5) Total fee paid:
------------------------------------------------------------------------
/X/ Fee paid previously with preliminary materials.
/X/ Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
The aggregate fee of $1,097,837.74 was paid with two prior filings. A fee of
$931,903.15 was paid by PacifiCare Health Systems, Inc. with its preliminary
proxy materials filed under Schedule 14A on September 18, 1996. A fee of
$165,934.59 was paid by N-T Holdings, Inc. as a registration fee for its
Registration Statement 333-16271 filed on November 18, 1996.
<PAGE>
FHP INTERNATIONAL CORPORATION
3120 LAKE CENTER DRIVE
SANTA ANA, CALIFORNIA 92704
[LOGO] December 12, 1996
TO HOLDERS OF
FHP INTERNATIONAL CORPORATION
COMMON AND SERIES A PREFERRED STOCK
Enclosed is a preliminary prospectus relating to the rights offering of
shares of Talbert Medical Management Holdings Corporation. This preliminary
prospectus is provided to you as supplemental information with respect to the
proposed merger transaction involving PacifiCare Health Systems, Inc. and FHP
International Corporation as described in the Joint Proxy Statement/Prospectus
dated November 21, 1996, with respect to a meeting of stockholders to be held on
December 31, 1996. In the FHP Merger described therein, holders of FHP common
and preferred stock would receive in the FHP Merger, in addition to cash and
shares of PacifiCare Holding, rights to subscribe to shares of Talbert presently
owned by FHP.
The preliminary prospectus relating to the Talbert rights is intended to
provide supplemental information about Talbert.
The offering of the Talbert rights will be made only by means of a
prospectus following consummation of the FHP Merger. The preliminary prospectus
is subject to completion and amendment. A registration statement with respect to
the rights offering has been filed with the Securities and Exchange Commission.
The securities described in the Preliminary Prospectus may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. The preliminary prospectus shall not constitute an offer to sell or a
solicitation of an offer to buy nor shall there be any sale of the securities
offered thereby in any state in which such offer or solicitation or sale would
be unlawful prior to registration or qualification under the securities laws of
any such state.
FHP INTERNATIONAL CORPORATION
<PAGE>
SUBJECT TO COMPLETION, DATED DECEMBER 12, 1996
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
PROSPECTUS
2,767,500 SHARES
TALBERT MEDICAL MANAGEMENT HOLDINGS
CORPORATION
[LOGO]
COMMON STOCK
--------------------------
In connection with the merger of FHP International Corporation ("FHP") and
PacifiCare Health Systems, Inc. ("PacifiCare"), transferable rights ("Rights")
to subscribe for 92.25% of the shares of Common Stock of Talbert Medical
Management Holdings Corporation, a Delaware corporation ("TMMHC" and, together
with its subsidiaries and affiliated medical groups, the "Company", unless
otherwise noted), for $21.50 per share (the "Subscription Price") are being
delivered to the common and preferred stockholders of FHP (the "Offering") as
part of the consideration payable in the merger. FHP stockholders will receive
Rights based on the number of shares of FHP Common Stock and FHP Preferred Stock
held of record at the effective time of the merger (the "Effective Time"), which
is currently anticipated to be on or about January , 1997. Based on current
expectations concerning the number of shares of FHP Common Stock that will be
outstanding as of the Effective Time, FHP stockholders are expected to receive
one Right for every 21.34381 shares of FHP Common Stock and one Right for every
26.46474 shares of FHP Preferred Stock. Rights holders may purchase one share of
the Company's Common Stock with each Right and also may subscribe for additional
shares of the Company's Common Stock in accordance with the Additional
Subscription Privilege described under "The Offering--Additional Subscription
Privilege." The Rights will be evidenced by transferable subscription
certificates. Prior to the Offering, there has not been a public market for the
Common Stock of the Company. See "The Offering" for factors that were considered
in determining the Subscription Price. Proceeds of the Offering will be used to
repay indebtedness to FHP incurred in the Company's acquisition of FHP's equity
interest in Talbert Medical Management Corporation and Talbert Health Services
Corporation.
The Rights will be exercisable only during the subscription period, which
will expire at 5:00 P.M., Eastern Standard Time, on the thirtieth day after the
Effective Time or such other time as the commencement of the Offering is legally
permissible (the "Expiration Date"), which is currently anticipated to be on or
about February , 1997. The Rights will be valueless thereafter. Holders of
Rights are encouraged to consider carefully with their tax and financial
advisors the exercise or sale of the Rights prior to their expiration, since
they become valueless once they expire. Failure to take any action with respect
to the Rights could have adverse tax and financial consequences. See "The
Offering--Certain Federal Income Tax Consequences."
The Company has applied to have the Rights and the Common Stock approved for
quotation on the Nasdaq National Market under the symbols "TMMCR" and "TMMC,"
respectively. Trading in the Rights will cease on the Expiration Date.
AN INVESTMENT IN THE COMMON STOCK IS SUBJECT TO SUBSTANTIAL RISK OF LOSS.
SEE "RISK FACTORS" BEGINNING ON PAGE 12 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PROCEEDS TO
PRICE TO PUBLIC COMPANY(1)
<S> <C> <C>
Per Share............................................................... $21.50 $21.50
Total................................................................... $59,501,250 $59,501,250
</TABLE>
(1) Does not include expenses of the Offering payable by FHP estimated at
$ .
------------------------
The date of this Prospectus is , 1997
<PAGE>
TALBERT MEDICAL CENTERS
The following maps indicate the location of each medical center currently
operated by the Company:
[MAP] OF SOUTHERN CALIFORNIA MEDICAL CENTERS
[MAP] OF UTAH MEDICAL CENTERS
[MAP] OF ARIZONA MEDICAL CENTERS
[MAP] OF NEW MEXICO MEDICAL CENTERS
[MAP] OF NEVADA MEDICAL CENTERS
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS AND
NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS.
THE COMPANY
The Company, through its wholly-owned subsidiary, Talbert Medical Management
Corporation, a Delaware corporation ("TMMC"), organizes and manages physician
and dentist practice groups that contract with health maintenance organizations
("HMOs") and other payors to provide health care services to their members. As
of September 30, 1996, TMMC had management services agreements with ten
affiliated practice groups and directly operated one practice group
(collectively, the "Talbert Medical Groups") employing approximately 360
physicians and 80 dentists and providing care through 52 medical, dental and/or
vision centers (the "Medical Centers") located in southern California, Utah,
Arizona, New Mexico and Nevada. Together with the Talbert Medical Groups, TMMC
managed over 303,000 capitated enrollees as of September 30, 1996, and
generated, for the year ended December 31, 1995, revenues of more than $495
million.
Under a managed care system, HMOs and other payors arrange to provide health
care for their members either by employing physicians and other health care
professionals directly (the "staff model") or by contracting with independent
groups (the "contracted care model"). Under the contracted care model, HMOs
often use "capitation" payments (i.e., payments based solely on the number of
members enrolled with the medical group) to control costs and minimize risk.
However, most physicians practice individually or in small groups that often do
not have the administrative capacity, risk management expertise or information
systems necessary to manage capitation arrangements with multiple payors.
Physician practice management companies ("PPMCs"), such as TMMC, have
evolved recently to provide these services, freeing physicians to focus on the
practice of medicine. TMMC provides a broad range of practice management
services to the Talbert Medical Groups, including (i) provider contract
negotiation and administration, (ii) Medicare risk management, (iii) management
information systems (development, implementation and maintenance), (iv) medical
management (claims administration, utilization and case management, quality
assurance and risk management, and physician credentialing and recruitment), and
(v) support services (including nursing, billing, collection and accounting).
Ancillary clinical services (including pharmacy, radiology, optometry,
laboratory, home health, hospice, rehabilitation and physical therapy) are
provided by Talbert Health Services Corporation, a Delaware corporation
("THSC"), which is also a wholly-owned subsidiary of the Company. TMMC provides
services under a management services agreement with each Talbert Medical Group,
and in return is reimbursed for certain clinic operating expenses and receives a
management fee based on the Talbert Medical Group's revenues after deducting
certain reimbursed clinic operating expenses (except in California, where the
management fee is based on the Talbert Medical Group's gross revenues, and in
New Mexico, where TMMC directly employs the physicians in the Talbert Medical
Group). TMMC currently has management services agreements with four physician
practice groups and six dental practice groups. All of the present Talbert
Medical Groups were formerly a part of FHP's staff model operations. Over time,
the Company intends to seek acquisitions of or affiliations with additional
practice groups in new and existing markets.
TMMC represents the Talbert Medical Groups in obtaining and negotiating
provider agreements with HMOs and other payors. Under a typical provider
agreement, a Talbert Medical Group is responsible for managing all
physician-related covered medical care for each member of the HMO enrolled with
the Talbert Medical Group, in exchange for a prepaid monthly capitation payment
for each such enrollee. Provider agreements generally include shared risk
arrangements and other financial incentives designed to encourage the provision
of high-quality, cost-effective health care. The Talbert Medical Groups and TMMC
currently have a total of 11 provider agreements with FHP, which accounted for
nearly 100% of the Company's revenues for the nine months ended September 30,
1996. The financial results of the Talbert
3
<PAGE>
Medical Groups are combined with those of the Company for financial reporting
purposes because the assets and non-medical operations of the Talbert Medical
Groups are substantially controlled by TMMC. See "Consolidated Financial
Statements--Note 1." TMMC has recently entered into provider agreements with a
number of other payors on behalf of certain of the Talbert Medical Groups, and
expects to further diversify its payor base following its separation from FHP
(as described below).
The following table sets forth the number of Medical Centers, affiliated
physicians, and capitated enrollees for each of the states in which TMMC does
business:
<TABLE>
<CAPTION>
CAPITATED
MEDICAL AFFILIATED ENROLLEES
CENTERS PHYSICIANS (1) (1)
------------- ----------------- ------------
<S> <C> <C> <C>
California.............................. 24 206 132,463
Utah.................................... 7 80 109,652
Arizona................................. 14 41 31,460
New Mexico.............................. 5 27 25,504
Nevada.................................. 2 6 4,706
--
--- ------------
Total................................. 52 360 303,785
--
--
--- ------------
--- ------------
</TABLE>
- ------------------------
(1) As of September 30, 1996.
SEPARATION FROM FHP
The Company's predecessor businesses formed a part of the staff model
operations of FHP, and had been active in managed care since 1961. Since January
1, 1996, TMMC and THSC have operated as subsidiaries of FHP, providing practice
management and ancillary clinical services to the medical groups that formerly
were a part of FHP's staff model operations and that provide health care to
approximately 15.7% of FHP's members. In July 1996, FHP determined to pursue a
tax-free spin-off of TMMC and THSC in the belief that they would be more
attractive to other payors if they operated independently from FHP.
Soon after FHP's decision to spin off TMMC and THSC, FHP agreed to merge
with PacifiCare. FHP and PacifiCare have agreed to abandon the tax-free spin-off
of TMMC and THSC, and instead to proceed with the separation of TMMC and THSC
from FHP concurrent with the merger of FHP and PacifiCare (the "FHP Merger"). To
effect this separation, FHP has agreed to sell its 92.25% equity interest in
both TMMC and THSC to the Company at the closing of the FHP Merger (the
"Acquisition"). In exchange, FHP will receive rights to purchase 92.25% of the
Company's Common Stock, plus a note (the "Talbert Note") for $59,501,250, the
estimated proceeds of the Offering if fully subscribed. By virtue of the FHP
Merger, shares of FHP Common Stock and FHP Preferred Stock will be converted, in
part, into the Rights, which confer upon the holders, collectively, the right to
purchase 92.25% of the Company's Common Stock. The Company will sell to FHP any
shares of Common Stock unsubscribed in the Offering in exchange for cancellation
of any remaining indebtedness under the Talbert Note.
If the Offering is not fully subscribed, the unsubscribed portion of the
Common Stock will be reacquired by FHP (and, therefore indirectly by the holding
company that will own 100% of FHP and PacifiCare as a result of the FHP Merger
("PacifiCare Holdings")). The Company and FHP have entered into a standstill
agreement with respect to any Common Stock obtained by FHP following the
Acquisition (the "Standstill Agreement"). The Standstill Agreement provides,
among other restrictions, that if FHP reacquires 20% or less of the Company's
outstanding Common Stock after the consummation of the Offering, FHP (i) will
vote its shares of Common Stock in accordance with the votes of the non-FHP
stockholders, (ii) will not acquire additional shares of Common Stock, (iii)
will be subject to certain restrictions with respect to its ability to solicit
proxies, make acquisition proposals, become a member of a "group" (as defined in
federal securities laws), or otherwise use its holdings of Common Stock to seek
to exercise control over the Company's management, and (iv) will be entitled to
certain registration rights.
4
<PAGE>
TMMC will continue to provide practice management services to the Talbert
Medical Groups following the Acquisition. The Talbert Medical Groups will
continue to provide care to enrolled members of FHP under their existing
provider agreements until the Effective Time. Pursuant to the terms of the FHP
Merger, FHP and the Talbert Medical Groups were required to renegotiate their
existing provider agreements to reflect rates based on market capitation rates.
New provider agreements covering FHP members (the "New FHP Provider Agreements")
will take effect as of the Effective Time. The New FHP Provider Agreements do
not provide the subsidies included in the existing provider agreements with FHP
and are expected to adversely affect the Company's per enrollee revenue and
expenses. See "Relationship with FHP and PacifiCare Following the
Offering--Provider Agreements."
FHP will provide certain administrative services to the Company on an
interim basis. FHP also will continue to lease to the Company certain Medical
Center facilities and equipment. See "Relationship with FHP and PacifiCare
Following the Offering."
Prior to the Acquisition, TMMC will receive, in connection with the FHP
Merger, a capital contribution sufficient to increase its net worth to
approximately $59 million (the "Capital Contribution"). The amount of the
Capital Contribution is currently anticipated to be approximately $68 million,
but will not exceed $70 million.
THE OFFERING
<TABLE>
<S> <C>
Subscription Price................ $21.50 per share of Common Stock.
Basic Subscription Privilege...... Based on current expectations concerning the number of
shares of FHP Common Stock that will be outstanding as
of the Effective Time, FHP stockholders are expected to
receive one Right for every 21.34381 shares of FHP
Common Stock and one Right for every 26.46474 shares of
FHP Preferred Stock held of record at the Effective Time
(currently anticipated to be on or about January ,
1997). Each holder of Rights will be entitled to
purchase one share of Common Stock for each Right held.
The Rights are evidenced by transferable subscription
certificates (the "Subscription Certificates").
Additional Subscription
Privilege....................... Persons who exercise their Basic Subscription Privilege
may purchase additional shares (subject to proration and
the limits on exercise described below) from any shares
remaining unsubscribed after the exercise of the Basic
Subscription Privilege.
Exercise Cap...................... Rights may not be exercised to the extent that the
holder would become the beneficial owner of more than 8%
of the shares of Common Stock outstanding. However,
holders of FHP Common Stock or FHP Preferred Stock who
are the beneficial owners of FHP Common Stock (on an
as-if-converted basis) in excess of 8% of the
outstanding shares of FHP Common Stock (on an as-
if-converted basis) as of the Effective Time (the "FHP
Ownership Percentage") may exercise Rights to the extent
that their beneficial ownership of Common Stock does not
exceed their FHP Ownership Percentage.
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
Subscription Procedure............ Rights may be exercised by delivery of the related
Subscription Certificate properly completed and
accompanied by full payment for all shares of Common
Stock subscribed for pursuant to the Basic Subscription
Privilege and the Additional Subscription Privilege to
American Stock Transfer & Trust Company (the
"Subscription Agent"), on or before the Expiration Date.
In the event of a proration of shares of Common Stock to
persons exercising the Additional Subscription
Privilege, the Subscription Agent will promptly refund,
without interest, the amount of any overpayment.
Expiration Date................... The thirtieth day following the Effective Time or such
other time as the commencement of the Offering may be
legally permissible (currently anticipated to be on or
about February , 1997), at 5:00 P.M., Eastern Standard
Time.
Transferability of Rights......... The Rights are transferable, but no assurance can be
given that an active trading market will develop, or if
a market develops, that it will continue until the
expiration of the Rights.
Proceeds of the Offering.......... If fully subscribed, the Offering will result in
proceeds of approximately $59.5 million. The proceeds of
the Offering will be used entirely to repay indebtedness
to FHP incurred in the Acquisition. Prior to the
Acquisition, TMMC will receive, in connection with the
FHP Merger, the Capital Contribution, to increase its
net worth to approximately $59 million.
Listing........................... Application has been made for quotation of the Rights
and the Common Stock on the Nasdaq National Market under
the symbols "TMMCR" and "TMMC," respectively. Trading in
the Rights will cease on the Expiration Date.
Fractional Rights................. No fractional Rights will be issued to FHP stockholders.
The Subscription Agent will determine the aggregate
number of fractional Rights that would have been issued
to FHP stockholders had fractional Rights been issued.
The Subscription Agent will sell, if practicable, the
nearest whole number of Rights and remit the net
proceeds, if any, to FHP stockholders based on the
number of fractional Rights they would have received.
</TABLE>
6
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The following summary consolidated financial data sets forth, for the
periods and dates indicated, summary consolidated financial data of the Company
and its subsidiaries (including the Talbert Medical Groups) derived from the
historical consolidated financial statements of its predecessors. The
consolidated statement of operations data presented below for the years ended
December 31, 1993, 1994 and 1995, and the consolidated balance sheet data at
December 31, 1994 and 1995 are derived from, and are qualified by reference to,
the audited consolidated financial statements included elsewhere in this
Prospectus. The consolidated statement of operations data for the years ended
December 31, 1991 and 1992, and the nine months ended September 30, 1995 and
1996, and the consolidated balance sheet data at December 31, 1991, 1992 and
1993, and September 30, 1995 and 1996 are derived from unaudited consolidated
financial statements of the Company and its subsidiaries that are not included
herein. The summary consolidated financial data presented below are qualified by
reference to the consolidated financial statements included elsewhere in this
Prospectus and should be read in conjunction with such financial statements and
related notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------------------- -------------------------
1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996
----------- ----------- ----------- ----------- ----------- ----------- -----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenue (2)(3).............. $ 352,553 $ 402,599 $ 470,883 $ 503,338 $ 495,699 $ 379,365 $ 351,235
Expenses
Affiliated medical
services................ 128,224 153,387 170,690 173,230 173,417 132,051 103,504
Purchased medical
services................ 69,459 84,307 110,582 124,083 121,570 94,133 85,851
Dental services........... 13,970 16,128 20,129 28,955 31,379 24,544 20,443
Optometry, pharmacy and
other primary health
care services........... 52,999 70,702 86,985 96,275 102,412 77,395 80,181
Clinic operations......... 76,992 78,662 80,853 87,253 85,585 68,235 49,207
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total cost of health
care.................. 341,644 403,186 469,239 509,796 514,363 396,358 339,186
Marketing, general and
administrative.......... 20,606 22,569 24,002 26,675 29,698 22,188 19,622
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss.............. (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (7,573)
Interest income (4)......... -- -- -- -- -- -- 1,199
----------- ----------- ----------- ----------- ----------- ----------- -----------
Loss before income tax
benefit................... (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (6,374)
Income tax benefit.......... (3,873) (9,244) (8,924) (13,553) (19,754) (16,005) (2,604)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss (5)................ $ (5,824) $ (13,912) $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Loss per common and common
equivalent share (6)...... $ (1.94) $ (4.64) $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------------------- -------------------------
1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996
----------- ----------- ----------- ----------- ----------- ----------- -----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET
DATA:
Working capital (5)......... $ (18,105) $ (17,937) $ (18,087) $ (18,742) $ (18,638) $ (18,101) $ (10,779)
Total assets (5)............ 10,614 14,003 18,926 23,087 23,178 19,779 51,731
Long-term obligations....... -- -- -- -- -- -- --
Stockholders' deficit
(5)(7).................... (17,425) (17,276) (17,475) (18,113) (17,886) (17,519) (3,670)
</TABLE>
- ------------------------
(1) Reflects financial information relating to the historical staff model
operations of FHP prepared in part from separate records maintained by
subsidiaries of FHP. This information also reflects certain assumptions
regarding the allocation of certain revenue and expense items and certain
balance sheet accounts, many of which could be material, where separate
records were not utilized. See "Consolidated Financial Statements--Note 2."
(2) Revenue is derived from prepaid capitation fees for ambulatory services,
plus patient co-payments and fee-for-service payments. The Company did not
incur any hospital risk for the periods presented.
(3) Nearly 100% of revenue is received pursuant to existing provider agreements
with FHP. The New FHP Provider Agreements will take effect as of the
Effective Time. The pro forma financial data presented elsewhere herein
reflect, in part, the effects of the New FHP Provider Agreements as if such
agreements had been in effect for the periods indicated.
(4) Prior to January 1, 1996, all available cash balances, and the interest
income on such cash balances, were retained by FHP.
(5) Does not reflect the Capital Contribution to be made prior to the
Acquisition and the resulting compensation expense, nor the compensation
expense related to the options granted by the Board of Directors in November
1996, as reflected in the pro forma financial data presented elsewhere
herein.
(6) Loss per common and common equivalent share is computed based on 3,000,000
common shares outstanding at September 30, 1996 for all periods presented.
Options to acquire shares of Common Stock granted in September 1996 were not
dilutive.
(7) Prior to January 1, 1996, stockholders' deficit fluctuated as a result of
various intercompany transactions with FHP. On January 1, 1996, FHP
recapitalized TMMC, resulting in the elimination of a deficit of
$17,886,000.
8
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
The following unaudited pro forma condensed consolidated financial data for
the year ended December 31, 1995 and the nine months ended September 30, 1996,
and the pro forma condensed consolidated balance sheet data at September 30,
1996, present the results of operations and financial position of the Company
for and as of the periods indicated as if the following events had occurred, on
January 1, 1995 with respect to the unaudited consolidated statement of
operations data, or on September 30, 1996 with respect to the unaudited
consolidated balance sheet data: (i) the New FHP Provider Agreements had taken
effect; (ii) the Capital Contribution had been received and certain related
compensation expense had been recognized; and (iii) stock options granted to
management in November 1996 (the "November 1996 Options") had been granted and
certain related compensation expense had been recognized. These developments are
described further below.
In November 1996, the Company renegotiated the Talbert Medical Groups'
provider agreements with FHP. The New FHP Provider Agreements, which become
effective as of the Effective Time, will result in significantly lower revenues
and higher expenses per enrollee based on assumed capitation rates reflected in
the historical financial statements included elsewhere in this Prospectus. The
accompanying unaudited pro forma condensed consolidated statement of operations
data includes the pro forma effect of the New FHP Provider Agreements as if they
had been in effect during the year ended December 31, 1995 and the nine months
ended September 30, 1996. See "Relationship with FHP and PacifiCare Following
the Offering."
Just prior to the Offering, FHP is expected to contribute approximately $68
million to TMMC, which is expected to result in a stockholders' equity balance
of approximately $59 million. In connection with the Capital Contribution, the
Company will recognize as stock compensation expense approximately $5.3 million
(assuming a Capital Contribution of $68 million) relating to the shares of
Common Stock owned by management and others who will not be making a capital
contribution. This expense will be recognized ratably over the vesting period of
the restricted shares of Common Stock held by management and others.
Approximately 25% of such restrictions lapsed in July 1996 and the remainder are
assumed to lapse ratably each July through 1999. Approximately $1.3 million of
the stock compensation expense is expected to be recognized on the date of the
Capital Contribution in connection with previously issued restricted shares for
which restrictions have already lapsed. See "Certain Transactions."
In November 1996, the Board of Directors authorized the issuance of options
with respect to 39,636 shares of the Company's Common Stock to management at an
exercise price of $10.00 per share. The November 1996 Options vest 40% on
December 31, 1996 and 15% each January 1 from 2000 to 2003. Based on an assumed
fair value of the Common Stock of $29.17 per share on the date of grant, the
grant of the November 1996 Options gives rise to deferred compensation expense
of approximately $760,000, of which approximately $304,000 will be recognized in
December 1996. The accompanying unaudited pro forma condensed consolidated
financial data assume the granting of these options on January 1, 1995. See
"Management--Stock Incentive Plan."
The accompanying unaudited pro forma condensed consolidated financial data
is provided for informational purposes only and does not purport to present the
consolidated financial position or results of operations of the Company had the
New FHP Provider Agreements, the Capital Contribution and the grant of the
November 1996 Options occurred on the dates specified, nor are they necessarily
indicative of the results of operations that may be expected in the future.
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<PAGE>
The unaudited pro forma condensed consolidated financial data should be read
in conjunction with the historical consolidated financial statements, and the
notes thereto, included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 NINE MONTHS ENDED SEPTEMBER 30, 1996
--------------------------------------------- ----------------------------------------
HISTORICAL (1) ADJUSTMENTS AS ADJUSTED HISTORICAL ADJUSTMENTS AS ADJUSTED
-------------- ------------ ----------- ----------- ------------ -----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenue................... $ 495,699 $ (36,258)(4) $ 459,441 $ 351,235 $ (26,284)(4) $ 324,951
Expenses
Affiliated medical
services.............. 173,417 -- 173,417 103,504 -- 103,504
Purchased medical
services.............. 121,570 6,887(4) 128,457 85,851 5,287(4) 91,138
Dental services......... 31,379 -- 31,379 20,443 -- 20,443
Optometry, pharmacy and
other primary health
care services......... 102,412 10(4) 102,422 80,181 6(4) 80,187
Clinic operations....... 85,585 -- 85,585 49,207 -- 49,207
-------------- ------------ ----------- ----------- ------------ -----------
Total cost of health
care.............. 514,363 6,897 521,260 339,186 5,293 344,479
Marketing, general and
administrative........... 29,698 1,622(5)(6) 31,320 19,622 988(5) 20,610
-------------- ------------ ----------- ----------- ------------ -----------
Operating loss............ (48,362) (44,777) (93,139) (7,573) (32,565) (40,138)
Interest income........... -- 1,870(7) 1,870 1,199 -- 1,199
-------------- ------------ ----------- ----------- ------------ -----------
Loss before income
taxes.................... (48,362) (42,907) (91,269) (6,374) (32,565) (38,939)
Income tax provision
(benefit) (2)............ (19,754) 19,754 -- (2,604) 2,604 --
-------------- ------------ ----------- ----------- ------------ -----------
Net loss.................. $ (28,608) $ (62,661) $ (91,269) $ (3,770) $ (35,169) $ (38,939)
-------------- ------------ ----------- ----------- ------------ -----------
-------------- ------------ ----------- ----------- ------------ -----------
Loss per common and common
equivalent share (3)..... $ (9.54) $ (20.88) $ (30.42) $ (1.26) $ (11.72) $ (12.98)
-------------- ------------ ----------- ----------- ------------ -----------
-------------- ------------ ----------- ----------- ------------ -----------
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
----------------------------------------
HISTORICAL ADJUSTMENTS AS ADJUSTED
----------- ------------ -----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
PRO FORMA CONSOLIDATED BALANCE SHEET DATA(8):
Working capital................................................. $ (10,779) $ 68,000 $ 57,221
Total assets.................................................... 51,731 68,000 119,731
Long-term obligations........................................... -- -- --
Stockholders' equity (deficit).................................. (3,670) 62,730 59,060
</TABLE>
- --------------------------
(1) Reflects financial information relating to the historical staff model
operations of FHP prepared in part from separate records maintained by
subsidiaries of FHP. This information also reflects certain assumptions
regarding the allocation of certain revenue and expense items and certain
balance sheet accounts, many of which could be material, where separate
records were not utilized. See "Consolidated Financial Statements--Note 2."
(2) No pro forma income tax benefit has been provided because it is not certain
when the Company will generate sufficient taxable income to realize such
benefit. Historically, the Company's tax losses were utilized in FHP's
consolidated tax returns.
(3) Loss per common and common equivalent share is computed based on 3,000,000
common shares outstanding at September 30, 1996 for all periods presented.
Options to acquire Common Stock granted in September 1996 were not dilutive.
(4) Adjusted to reflect the effect of the New FHP Provider Agreements. The new
capitation rates established in the New FHP Provider Agreements are expected
to result in significantly lower revenues and higher expenses per enrollee.
(5) Adjusted to reflect the amortization of stock compensation expense as if the
Capital Contribution of $68,000,000 had been made at January 1, 1995. The
actual Capital Contribution by FHP will be the amount necessary to
10
<PAGE>
eliminate the Company's deficit at the Effective Time and to provide a
stockholders' equity of approximately $59,000,000, but will not exceed
$70,000,000. Amortization of deferred stock compensation expense assumes the
restrictions on the shares issued to management lapse ratably over the
four-year period starting January 1, 1995.
(6) Adjusted to reflect compensation expense of $304,000 arising from the grant
of the November 1996 Options at an exercise price of $10.00 per share for
shares whose fair market value on the date of grant was assumed to be $29.17
per share. Assumes the options were granted on January 1, 1995 and that
options with respect to 40% of the shares vested during 1995.
(7) Adjusted to reflect assumed interest earnings, at an assumed average
investment return of 5.5% of the Capital Contribution of $68,000,000, as if
made on January 1, 1995.
(8) Adjusted to reflect the assumed impact on balance sheet data as if the
Capital Contribution of $68,000,000 was made and the related stock
compensation expense of $1,318,000 and deferred stock compensation expense
of $3,952,000 were recognized as of September 30, 1996.
11
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS,
PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE FACTORS LISTED BELOW IN
EVALUATING AN INVESTMENT IN THE COMMON STOCK.
SUBSTANTIAL OPERATING LOSSES; CAPITAL REQUIREMENTS
FHP's staff model operations, which comprise the Company's predecessor
businesses, have experienced substantial operating losses over the last five
years arising, in part, from the increased competition of contracted care model
HMOs. For the nine months ended September 30, 1996, the Company incurred losses
before income tax benefit of $6.4 million, compared to $39.2 million for the
nine months ended September 30, 1995. The Company incurred losses before income
tax benefit of $48.4 million for the year ended December 31, 1995, and $33.1
million for the year ended December 31, 1994. Subsidies from FHP have offset
losses incurred in these and in prior periods, but FHP will not provide such
subsidies following the Offering. The renegotiation of the New FHP Provider
Agreements, required pursuant to the terms of the FHP Merger, will result in a
material decrease in revenues per enrollee for the year ending December 31,
1997. See "Prospectus Summary--Unaudited Pro Forma Condensed Consolidated
Financial Data." Although management believes this decrease will be offset, in
part, by continuing operating improvements, management nevertheless believes
that it is likely that the Company will incur substantial losses during 1997 and
1998, and will not generate positive cash flow for those periods. Future
operating results will depend on the Company's ability to attract and retain
substantial numbers of additional enrollees and physician practice groups and to
control costs. There can be no assurance that the Company will generate positive
cash flows or profits in the future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Prior to the Company's acquisition of TMMC, TMMC will receive, in connection
with the FHP Merger, the Capital Contribution to increase its net worth to
approximately $59 million. The Company intends to use these funds to fund
operating losses and for working capital and other general corporate purposes.
However, there can be no assurance that these funds will be sufficient for the
Company's capital requirements. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
DEPENDENCE ON FHP
The Company and the Talbert Medical Groups derive nearly all of their
revenues from provider agreements with payors, such as HMOs. Prior to 1996, FHP
was the only payor to have contracts with the Talbert Medical Groups. For the
years ended December 31, 1993, 1994 and 1995, and for the nine months ended
September 30, 1996, FHP members accounted for nearly 100% of the Company's
revenue. The Company intends to reduce its dependence on FHP by seeking payors
for the Talbert Medical Groups in addition to those already served, but there
can be no assurance that additional provider agreements can be obtained or if
obtained, would result in significant numbers of additional enrollees. Moreover,
the loss of any FHP contracts, subsequent renegotiation of the terms of FHP's
contracts, or the failure to regain or retain FHP's members, could have a
material adverse effect on the Company. See "Business--The Company." In
addition, the loss by FHP of a significant number of the members who are
enrolled with the Talbert Medical Groups, including, without limitation, any
loss of members resulting from the FHP Merger, could have a material adverse
effect on the Company. In that regard, FHP has indicated that its competitors
may use the announcement of the FHP Merger to solicit employer groups currently
served by FHP. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
The Company has historically relied upon FHP to provide certain
administrative and other services. FHP will provide certain information services
on an interim basis following the Offering. The Company will rely on third
parties to provide other services formerly received from FHP, which services may
not be available at comparable rates. See "Relationship with FHP and PacifiCare
Following the Offering."
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<PAGE>
CONTRACTED RATE DECREASE
FHP's existing provider agreements with the Talbert Medical Groups provide a
subsidy to offset, in part, the Talbert Medical Groups' operating losses. As of
the Effective Time, these provider agreements will be replaced with the New FHP
Provider Agreements that do not provide for this support. Management therefore
anticipates that the Company will incur substantial operating losses in 1997 and
1998. Although the Capital Contribution in connection with the FHP Merger is
intended, in part, to offset the projected shortfall in cash flows from the
change to the New FHP Provider Agreements, there can be no assurance that this
amount will be sufficient for the Company's capital requirements. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Relationship with FHP and PacifiCare Following the
Offering--Provider Agreements."
CAPITATED NATURE OF REVENUE
For the nine months ended September 30, 1996, approximately 100% of the
Company's revenue related to provider agreements under which the Talbert Medical
Groups received a prepaid monthly capitation fee for each member enrolled with
the Group and certain utilization-based incentive payments, in exchange for
assuming the responsibility to provide specified medical services to enrollees.
Because the Company's revenue is derived from these fees, its success depends in
large part on the effective management of health care costs, including
controlling utilization of specialty care physicians and other ancillary
providers and purchasing services from third-party providers at competitive
prices. In addition, as capitation fees are based on a percentage of premiums
received by payors such as HMOs, any decreases in premiums could result in lower
capitation fees being paid to the Talbert Medical Groups. An unusually high
number of catastrophic claims (such as organ transplants and costly premature
births) in a given period may cause substantial additional health care costs.
Although management believes that the Company's cost control measures, which
include risk-sharing arrangements between the Talbert Medical Groups and the
payors with which they contract, as well as with administrative and medical
review of health care delivery services, will help mitigate these effects, such
costs may periodically affect the Company's results of operations. Changes in
health care practices, Medicare reimbursements, revised treatment protocols, new
technologies, inflation, epidemics, disasters and other factors affecting the
delivery and cost of health care that are or may be beyond the Company's control
may adversely affect the Company's operating results. See "Business."
LIMITED OPERATING HISTORY; NEW BUSINESS STRATEGY
Although FHP's staff model operations have been in existence since 1961, the
Company did not begin operating as a separate entity until January 1996. The
Company therefore has a very limited operating history as a PPMC. The Company,
TMMC, THSC and the Talbert Medical Groups are seeking to transform themselves
from a captive staff model operation to an independent contracted care business.
The success of this new business strategy will depend on the Company's ability
to adapt its practices and culture to the contracted care environment. Among
other challenges, the Company must attract and retain substantial numbers of
capitated enrollees to the Talbert Medical Groups from additional payors, manage
the delivery of health care to enrollees in a cost-efficient manner under
market-based contracts, and respond to developments in a highly competitive and
rapidly changing industry. There can be no assurance that the Company will be
able to address these challenges successfully.
DEPENDENCE ON PRIMARY CARE PHYSICIANS
Primary care physicians are an integral part of the Talbert Medical Groups,
as they provide and manage medical services offered to enrollees. The Company's
growth depends, in part, on its ability to retain existing primary care
physicians and attract additional ones. Beginning in January 1997, the Company
intends to implement a revised physician compensation program that will include
a greater emphasis on performance-based incentives. As a result of the revised
compensation system, the New FHP
13
<PAGE>
Provider Agreements, or other developments, there can be no assurance that
physicians presently in the Talbert Medical Groups will not leave, that the
Company will be able to attract additional primary care physicians into the
Talbert Medical Groups or that the Company will not have to increase or
guarantee the payments receivable by affiliated physicians. To the extent that
primary care physicians leave, or additional primary care physicians do not
join, the Talbert Medical Groups or payments to physicians are increased, the
Company's results of operations may be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
OPEN ENROLLMENT PERIODS; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's operating results are subject to seasonal fluctuations. HMOs
typically have "open enrollment" periods from time to time for commercial
customers, during which new members may enroll or existing members may renew or
leave the HMO. Transfers of enrollees from one payor to another, particularly
during open enrollment periods, could impact quarterly results. A substantial
portion of FHP's current commercial membership is subject to open enrollment
programs occurring in January and February 1997. Any failure by FHP to maintain
or increase commercial enrollment in the Company's markets during this period
could have a significant adverse effect on the Company's future revenues,
earnings, cash flows and financial position.
The Company's costs fluctuate quarterly, based on the overall health of its
patient population. Enrollees, particularly seniors, typically require more care
during the winter months. Because capitation payments are not adjusted on a
seasonal basis to account for fluctuations in required care, the Company's costs
may increase in proportion to its revenues during such periods. Quarterly
results also may be affected by significant differences between actual and
estimated amounts receivable or payable for payor "shared risk" arrangements and
provider "incurred but not yet reported" claims ("IBNR"), that are adjusted
periodically, in the case of "shared risk" arrangements, as settlements are made
and, in the case of IBNR, as actual claims adjustments occur.
DEPENDENCE UPON KEY PERSONNEL
The Company is dependent upon the services of certain of its executive
officers for management and implementation of strategy. The loss to the Company
of the services of any of these executive officers could have a material adverse
effect upon the Company's future operations. The Company has entered into change
of control employment agreements with certain of its key personnel to provide
compensation assurances to such officers in the event of a change of control of
the Company. See "Management-- Change of Control Employment Agreements." The
Company has not purchased key-man life insurance with respect to such
individuals.
COMPOSITION OF BOARD OF DIRECTORS AND MANAGEMENT; POTENTIAL CONFLICTS OF
INTEREST
The Company's Board of Directors includes eight current directors of FHP,
including Jack R. Anderson and Joseph F. Prevratil. Messrs. Anderson and
Prevratil have been designated by FHP to be directors of PacifiCare Holdings
following the FHP Merger. Most of the Company's senior management is also
comprised of former FHP executives. All of the Company's directors and executive
officers will receive PacifiCare Holdings common or preferred stock in exchange
for their FHP Common Stock or FHP Preferred Stock in the FHP Merger. These
individuals may encounter conflicts of interest to the extent that the interests
of the Company diverge from those of FHP, PacifiCare or PacifiCare Holdings. See
"Management."
ABSENCE OF PRIOR PUBLIC MARKET AND POSSIBLE PRICE VOLATILITY
Prior to the Offering there has been no public market for the Rights or the
Common Stock, and there can be no assurance that an active trading market will
develop or be sustained in the future, or that the
14
<PAGE>
market price of the Common Stock will not decline below the Subscription Price.
The Subscription Price was determined through negotiation between FHP and
PacifiCare, and may not be indicative of the market price of the Common Stock
after the Offering. See "The Offering." From time to time after the Offering,
the market price of the Common Stock could be subject to significant
fluctuations in response to such factors as quarterly operating results, general
trends in the economy, the financial markets or the health care industry,
changes in estimates of the Company's earnings or financial position, the impact
of health care reform proposals and other developments affecting the Company or
its competitors, many of which are beyond the Company's control.
MANAGEMENT OF GROWTH
The Company's strategy involves growth through the development of practice
groups in existing and new markets, as well as selected acquisitions and
affiliations in such markets. There can be no assurance that the Company will be
able to grow in existing or new markets or successfully identify, complete and
integrate future acquisitions. Further, there can be no assurance that the
Company will be able to maintain and develop an adequate infrastructure to
support future growth. See "Business."
POSSIBLE DILUTIVE EFFECT OF USING COMMON STOCK FOR FUTURE ACQUISITIONS OR
AFFILIATIONS
The Company's expansion strategy includes acquisitions of, and affiliations
with, additional practice groups and practice management companies. Such
acquisitions or affiliations may be consummated using newly issued shares of
Common Stock as consideration. The issuance of additional shares of Common Stock
may have a dilutive effect on the Company's tangible net book value or earnings
per share following such issuance.
COMPETITION
The managed care industry is highly competitive. The industry also is
subject to continuing changes in the ways services are provided and providers
are selected and paid. As prepaid medical care continues to grow, the Company
may encounter increased competition, including competition for enrollees,
primary care physicians, community health care resources and management
personnel. This competition also may have the effect of reducing capitated
payments received by providers from payors. FHP, the Company's principal source
of capitated enrollees, has experienced significant competition with respect to
its staff model commercial enrollment programs in California in recent periods,
which has been responsible, in part, for declines in the Company's capitated
enrollment. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Certain companies are expanding their presence in the physician practice
management industry. A number of companies provide broad management services to
primary, multi-specialty and specialty physician groups, while other companies
provide claims processing, utilization review and other more focused management
services. Certain of the Company's competitors are significantly larger, have
access to greater resources, have greater experience in providing administrative
services and have longer established relationships with buyers of these
services. No assurance can be given that the Company's strategy will allow it to
compete favorably in obtaining payor contracts for its affiliated medical groups
or expanding or maintaining its position in existing or new markets. See
"Business--Competition."
GOVERNMENT REGULATION
The health care industry is subject to extensive federal and state
regulation. Changes in the regulations or reinterpretations of existing
regulations may significantly affect the Company.
The laws of certain states in which the Company operates or may operate in
the future do not permit general business corporations to practice medicine,
exercise control over physicians who practice medicine or engage in certain
business practices such as fee-splitting with physicians. The Talbert Medical
Groups
15
<PAGE>
currently operate in certain states through professional corporations. The
Company believes that it neither engages in the corporate practice of medicine
in states where it is prohibited from doing so, nor controls the practice of
medicine by physicians within the Talbert Medical Groups. See "Business." The
Company believes that it is in compliance with applicable regulatory
requirements. No assurance can be given, however, that regulatory authorities,
courts or parties with which the Company does business will not assert that the
Company is engaged in the corporate practice of medicine and seek relief
prohibiting the Company or its affiliates from carrying on their respective
businesses or voiding existing contractual relationships. If such assertions are
made, the Company may be required to sever or restructure payor contracts or its
management services agreements with the Talbert Medical Groups. Any such
severing or restructuring could have a material adverse effect on the Company.
The Company is subject to federal legislation regulating certain activities
to induce Medicare or Medicaid business and restricting referrals of business to
entities in which physicians have a financial interest. The laws of all of the
states in which the Company offers its services also regulate the business of
insurance. The Company believes it is in compliance with the laws governing
Medicare, Medicaid, physician referrals and insurance, but if it were determined
to be in violation of any such law, the Company could be subject to significant
fines or other penalties and could be required to restructure its operations in
a material manner. "See Business--Government Regulation."
HEALTH CARE REFORM
Diverse legislative and regulatory initiatives have been proposed at both
the federal and state levels to address both the continuing increases in health
care costs and the lack of health care insurance for many people. Among other
legislation, Congress has considered major reductions in the rate of increase of
Medicare and Medicaid spending as part of efforts to balance the federal budget.
State legislatures also have discussed restructuring Medicaid programs and
adopting "any willing provider" legislation. Certain of the proposals, if
adopted, could have a material adverse effect on the Company. See "Business--
Government Regulation."
POTENTIAL CLAIMS AFFECTING THE COMPANY'S INDUSTRY; INSURANCE
In recent years physicians, hospitals and other participants in the health
care industry have become subject to an increasing number of lawsuits alleging
medical malpractice, bad faith denial of services and other claims for recovery
in connection with alleged injuries or misconduct. Many of these lawsuits
involve large claims and substantial defense costs. The Company maintains
professional malpractice and general liability insurance on behalf of itself and
the Talbert Medical Groups in amounts deemed appropriate by management based on
the nature and risks of the Company's business. Although the Company currently
is not a party to any material litigation relating to the practice of medicine,
there can be no assurance that the Company will not become involved in such
litigation in the future, that claims arising from such litigation will not
exceed the Company's insurance coverage or that such coverage will continue to
be available. See "Business--Risk Management Program."
CLASSIFICATION OF PHYSICIANS AS INDEPENDENT CONTRACTORS
Physicians and other health care professionals not employed directly by the
Talbert Medical Groups are regarded as independent contractors. The Talbert
Medical Groups and the Company do not withhold federal or state income taxes,
make federal or state unemployment tax payments or provide workers' compensation
insurance with respect to these independent contractors. The payment of
applicable taxes is regarded as the responsibility of each independent
contractor. The Company believes that its classification of these health care
professionals as independent contractors is proper for federal and state tax
purposes. A contrary determination by federal taxing authorities, or a change in
existing law, could have a material adverse effect on the Company's operating
results. Congress is considering, in connection with health care
16
<PAGE>
reform, certain measures that would modify the rules for classifying workers as
independent contractors. The Company cannot predict the impact of such measures
on the Company.
ANTI-TAKEOVER CONSIDERATIONS
Certain provisions of the Rights, the Company's Certificate of Incorporation
and Bylaws, Delaware law and the agreements to which the Company is a party
could, together or separately, discourage potential acquisition proposals, delay
or prevent a change in control of the Company and limit the price that certain
investors might be willing to pay in the future for shares of the Common Stock.
See "Description of Capital Stock--Certain Anti-Takeover Effects" and
"Relationship with FHP and PacifiCare Following the Offering--Provider
Agreements."
POSSIBLE CONTROLLING INTEREST OF FHP
FHP may acquire a controlling interest in the Company if the Company is
unable to raise sufficient funds through the Offering to repay a significant
portion of its indebtedness under the Talbert Note. If FHP retains a substantial
equity interest in the Company following consummation of the Offering, other
payors may be discouraged from contracting with the Company. If FHP holds in
excess of 20% of the Company's outstanding Common Stock, certain restrictions
otherwise applicable to FHP's activities as a stockholder of the Company will
cease. If FHP holds in excess of 50% of the Company's outstanding Common Stock,
certain agreements between the Company and FHP will be null and void. Under the
New FHP Provider Agreements, the consent of FHP and PacifiCare is required for a
proposed change in control of TMMC or a Talbert Medical Group for a period of
two years from the Effective Time, which consent cannot be unreasonably
withheld. See "Relationship with FHP and PacifiCare Following the Rights
Offering."
17
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THE COMPANY
The Company was incorporated in Delaware in November 1996 to serve as a
holding company for TMMC and THSC in connection with their separation from FHP
as a result of the FHP Merger. The Company's principal executive offices are
located at 3540 Howard Way, Costa Mesa, California 92626-1417 and its telephone
number at that address is (714) 436-4800.
BACKGROUND
The Company's predecessor businesses formed a part of the staff model
operations of FHP, which had been active in managed care since 1961. In June
1995, FHP announced a plan to restructure its operations, which included the
transformation of its staff model operations into a PPMC, an ancillary clinical
services provider and a number of affiliated professional corporations. TMMC and
THSC were formed as subsidiaries of FHP to provide physician practice management
and ancillary clinical services, respectively, to the practice groups. A number
of professional corporations were organized in California, Utah, Arizona and
Nevada to succeed to FHP's staff model provider practice and become the Talbert
Medical Groups in those states. In New Mexico, TMMC directly employs the former
FHP physicians and acts as the Talbert Medical Group for that state.
SEPARATION FROM FHP
In July 1996, FHP determined to pursue a tax-free spin-off of TMMC and THSC
in the belief that they would be more attractive to other payors if they
operated independently from FHP. Soon after this decision, FHP agreed to merge
with PacifiCare. FHP and PacifiCare have agreed to abandon the tax-free spin-off
of TMMC and THSC, and instead to proceed with the separation of TMMC and THSC
from FHP concurrent with the FHP Merger. To effect this separation, the
following transactions will occur:
- The management and other investors will exchange their aggregate 7.75%
equity interests in TMMC and THSC for an equivalent interest in the
Company.
- TMMC will receive the Capital Contribution (currently anticipated to be
approximately $68 million) to increase its net worth to approximately $59
million, pursuant to the FHP Merger. The Capital Contribution will not
exceed $70 million.
- The Company will purchase from FHP its 92.25% equity interest in TMMC and
THSC in exchange for Rights to purchase 92.25% of the Company's Common
Stock, plus the Talbert Note.
- By virtue of the FHP Merger, shares of FHP Common Stock and FHP Preferred
Stock will be converted, in part, into the Rights, which confer upon the
holders, collectively, the right to purchase 92.25% of the Company's
Common Stock.
- Rights holders may, through the exercise of their Rights, purchase the
Company's Common Stock through the Offering.
- The Company will use the proceeds of the Offering to repay indebtedness
under the Talbert Note. If the Offering is not fully subscribed, the
Company will sell to FHP any unsubscribed shares of Common Stock in
exchange for cancellation of any remaining indebtedness under the Talbert
Note.
Following the separation from FHP as described above, TMMC and THSC will
continue to provide practice management and ancillary clinical services to the
Talbert Medical Groups. The Talbert Medical Groups will continue to provide
health care to FHP members under the New FHP Provider Agreements that will take
effect as of the Effective Time. FHP will continue to have various ongoing
relationships with the Company and its subsidiaries and affiliates. See
"Relationship with FHP and PacifiCare Following the Offering."
18
<PAGE>
THE OFFERING
BASIC SUBSCRIPTION PRIVILEGE
Upon the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock
outstanding as of the Effective Date will be converted, in part, into the
Rights. Based upon current expectations concerning the number of shares of FHP
Common Stock that will be outstanding as of the Effective Date, FHP stockholders
are expected to receive one Right for every 21.34381 shares of FHP Common Stock
and one Right for every 26.46474 shares of FHP Preferred Stock held on the
Effective Date. These exchange ratios assume that options with respect to
approximately 888,000 shares of FHP Common Stock will be exercised prior to the
Effective Time. Pursuant to the Amended and Restated Agreement and Plan of
Reorganization among FHP, PacifiCare, PacifiCare Holdings, and the other parties
thereto with respect to the FHP Merger (the "FHP Merger Agreement"), PacifiCare
may offer to cash out these options, and if any FHP option holder accepts such
offer, these exchange ratios would be adjusted accordingly. The Rights are
evidenced by transferable Subscription Certificates. Each Right entitles the
holder to purchase one share of Common Stock for $21.50 per share. Rights
holders are entitled to subscribe for all, or any whole number of, the shares of
Common Stock underlying their Rights (the "Basic Subscription Privilege").
ADDITIONAL SUBSCRIPTION PRIVILEGE
Each Rights holder who subscribes in full for all shares of Common Stock
that the holder is entitled to purchase pursuant to the Basic Subscription
Privilege will be entitled to purchase additional shares of Common Stock at the
Subscription Price from any unsubscribed shares remaining after the exercise,
sale or expiration of all Basic Subscription Privileges (the "Additional
Subscription Privilege"). However, if the total number of shares of Common Stock
subscribed for pursuant to the Basic Subscription Privilege and the Additional
Subscription Privilege exceeds the total number of shares underlying the Rights,
the number of shares available for subscription pursuant to the Additional
Subscription Privilege will be allocated, on a pro rata basis, to the nearest
whole share, among those exercising the Additional Subscription Privilege on the
basis of their relative subscriptions pursuant to the Additional Subscription
Privilege.
EXERCISE CAP
Rights may not be exercised to the extent that the holder would become the
beneficial owner of more than 8% of the shares of Common Stock outstanding.
However, holders of FHP Common Stock or FHP Preferred Stock with an FHP
Ownership Percentage in excess of 8% as of the Effective Time may exercise
Rights to the extent that their beneficial ownership of Common Stock does not
exceed their FHP Ownership Percentage.
SUBSCRIPTION EXPIRATION DATE
The Rights will expire at 5:00 P.M., Eastern Standard Time, on the
Expiration Date. After the Expiration Date, the Rights will be void and
valueless. The Company is not obligated to honor any subscriptions received by
the Subscription Agent after the Expiration Date, regardless of when such
subscriptions were sent.
19
<PAGE>
SUBSCRIPTION AGENT
The Subscription Agent is American Stock Transfer & Trust Company. The
address to which Subscription Certificates and payment of the Subscription Price
should be delivered, whether by hand, by mail or by overnight courier, is:
American Stock Transfer & Trust Company
40 Wall Street, 46th Floor
New York, New York 10005
Attention: Carolyn O'Neill
Any questions or requests for assistance concerning the method of
subscribing for shares of Common Stock should be directed to the Subscription
Agent at (718) 921-8200.
HOW TO EXERCISE RIGHTS
Rights holders may exercise the Basic Subscription Privilege and the
Additional Subscription Privilege by delivering to the Subscription Agent at its
offices listed under "Subscription Agent," prior to 5:00 P.M., Eastern Standard
Time, on the Expiration Date, a properly completed and executed Subscription
Certificate, together with full payment of the aggregate Subscription Price in
U.S. dollars, by check or bank draft drawn upon a U.S. bank, or postal,
telegraphic or express money order, payable to American Stock Transfer & Trust
Company, as Subscription Agent. However, if at or prior to 5:00 P.M., Eastern
Standard Time, on the Expiration Date, the Subscription Agent has received full
payment of the Subscription Price for shares of Common Stock subscribed for
pursuant to the Basic Subscription Privilege and the Additional Subscription
Privilege, together with a written guarantee from a bank, a trust company, or a
member firm of the New York Stock Exchange, Inc., other national securities
exchanges, or the National Association of Securities Dealers, Inc. that a
Subscription Certificate with respect to the shares of Common Stock will be
delivered to the Subscription Agent prior to 5:00 P.M., Eastern Standard Time,
on the third day following the Expiration Date, the subscription will be
accepted, subject to timely receipt of the duly completed Subscription
Certificates. In the event of a proration of shares of Common Stock to persons
exercising the Additional Subscription Privilege, the Subscription Agent will
promptly refund, without interest, the amount of any overpayment. The
instructions that accompany the Subscription Certificate should be read
carefully and followed in detail.
COMPLETED SUBSCRIPTION CERTIFICATES AND THE RELATED PAYMENT SENT TO THE
OFFICE OF THE SUBSCRIPTION AGENT MUST BE RECEIVED BEFORE 5:00 P.M., EASTERN
STANDARD TIME, ON THE EXPIRATION DATE. DO NOT SEND SUBSCRIPTION CERTIFICATES OR
PAYMENTS TO THE COMPANY OR FHP. SUBSCRIBERS WILL NOT HAVE ANY RIGHT TO REVOKE
THE EXERCISE OF THEIR RIGHTS AFTER DELIVERY OF THEIR SUBSCRIPTION CERTIFICATES
TO THE SUBSCRIPTION AGENT, UNLESS IN THE SOLE JUDGMENT OF FHP, THERE IS A
MATERIAL AMENDMENT TO THE OFFERING AND THE RIGHT IS EXERCISED BEFORE SUCH
AMENDMENT.
THE METHOD OF DELIVERY OF SUBSCRIPTION CERTIFICATES AND PAYMENT OF THE
SUBSCRIPTION PRICE TO THE SUBSCRIPTION AGENT WILL BE AT THE ELECTION AND RISK OF
THE RIGHTS HOLDER, NOT THE COMPANY, FHP OR THE SUBSCRIPTION AGENT. IF SENT BY
MAIL, IT IS RECOMMENDED THAT THEY BE SENT BY REGISTERED MAIL, PROPERLY INSURED,
WITH RETURN RECEIPT REQUESTED, AND THAT A SUFFICIENT NUMBER OF DAYS BE ALLOWED
TO ENSURE RECEIPT BY THE SUBSCRIPTION AGENT PRIOR TO 5:00 P.M., EASTERN STANDARD
TIME, ON THE EXPIRATION DATE.
Record holders of shares of FHP Common Stock and FHP Preferred Stock, such
as brokers, trusts or depositaries for securities, who hold the shares for the
account of others, should notify the respective beneficial owners of the shares
as soon as possible to ascertain the beneficial owners' intentions and
instructions with respect to the related Rights. Based upon the instructions
received from the beneficial
20
<PAGE>
holders, the record holders should complete the Subscription Certificates and
submit them with the applicable payment.
All questions regarding the timeliness, validity, form and eligibility of
any exercise of Rights will be determined by FHP, in its sole discretion, whose
determination will be final and binding. FHP reserves the absolute right to
reject any subscription if such subscription is not in proper form or if the
acceptance thereof or the issuance of shares of Common Stock pursuant thereto
could be deemed unlawful. FHP in its sole discretion may waive any defect or
irregularity, permit a defect or irregularity to be corrected within such time
as it may determine or reject the purported exercise of any Rights.
Subscriptions will not be deemed to have been received or accepted until all
irregularities have been waived or cured within such time as FHP determines in
its sole discretion. FHP, the Company and the Subscription Agent will not be
under any duty to give notification of any defect or irregularity in connection
with the submission of Subscription Certificates nor will any of them incur any
liability for failure to give such notification.
DELIVERY OF CERTIFICATES
Certificates for shares of Common Stock issuable on exercise of the Basic
Subscription Privilege and the Additional Subscription Privilege will be mailed
as soon as practicable after the subscriptions have been accepted by the
Subscription Agent, but not prior to the Expiration Date. Certificates for
shares of Common Stock issued pursuant to the exercise of the Basic Subscription
Privilege and the Additional Subscription Privilege will be registered in the
name of the Rights holder exercising such privilege.
PURCHASE, SALE OR TRANSFER OF RIGHTS
Rights may be purchased or sold through ordinary investment channels,
including brokers. Application has been made for the quotation of the Rights on
the Nasdaq National Market under the symbol "TMMCR."
If any Rights represented by the Subscription Certificate received by the
Subscription Agent are not used in the exercise of the Basic Subscription
Privilege, the Subscription Agent will, if practicable, sell such excess Rights
and will remit the net proceeds, if any, to the subscriber, provided appropriate
instructions are received.
FRACTIONAL RIGHTS
No fractional Rights will be issued to FHP stockholders. The Subscription
Agent will determine the aggregate number of fractional Rights that would have
been issued to FHP stockholders had fractional Rights been issued. The
Subscription Agent will sell, if practicable, the nearest whole number of Rights
and remit the net proceeds, if any, to FHP stockholders based on the number of
fractional Rights they would have received.
FOREIGN AND CERTAIN OTHER STOCKHOLDERS
Subscription Certificates will not be mailed to stockholders whose addresses
are outside the United States and Canada or who have an A.P.O. or F.P.O.
address, but will be held by the Subscription Agent for their account. To
exercise such Rights, stockholders must notify the Subscription Agent by 11:00
A.M., Eastern Standard Time, on the third day prior to the Expiration Date, at
which time (if no instructions have been received) the Rights represented
thereby will be sold, if feasible, and the net proceeds if any, remitted to such
stockholders.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The initial holders of the Rights will have a tax basis in the Rights equal
to their fair market value as of the Effective Time, and the holding period (for
determination of short-term or long-term gains and
21
<PAGE>
losses) of the Rights will commence as of the Effective Time. Upon a sale of the
Rights, the selling holder will recognize short-term gain or loss equal to the
difference between the selling price and the basis, and that gain or loss will
be capital in nature if the Rights are (and the Common Stock obtainable on
exercise of the Rights would be) a capital asset in the hands of the seller. If
the Rights are not exercised or sold, the holder will have a short-term loss
equal to the basis in the Rights.
No gain or loss will be recognized on exercise of the Rights. The tax basis
of the Common Stock obtained on exercise of the Rights will equal (i) the
exercise price under the Rights plus (ii) the basis of the Rights in the hands
of the exercising holder (either the fair market value as of the Effective Time,
or the amount paid to purchase the Rights after the Effective Time). The holding
period of the Common Stock will commence on the exercise of the Rights. Upon a
subsequent sale of the Common Stock, the seller will recognize gain or loss
equal to the difference between the selling price and the basis of the Common
Stock. The gain or loss will be capital in nature if the Common Stock represents
a capital asset in the hands of the holder, and will be long-term if the sale
occurs more than one year after exercise of the Rights.
Under current federal income tax law, the highest tax rate on ordinary
income and short-term capital gains is 39.6%, and long-term capital gains are
subject to a maximum tax rate of 28%. A sale of Common Stock acquired as a
result of exercise of the Rights generally should constitute long-term capital
gain if the stock is held for more than one year after exercise. However,
because of certain provisions in the law relating to the "phase-out" of personal
exemptions and certain limitations on itemized deductions, the federal income
tax consequences to a particular taxpayer of receiving additional amounts of
ordinary income or capital gain may be greater than would be indicated by
application of the stated tax rates to the additional amount of income or gain.
A separate discussion of certain federal income tax consequences associated
with the receipt of the Rights is included in the joint proxy
statement/prospectus filed by FHP and PacifiCare on Schedule 14A with respect to
the FHP Merger and certain other matters. See "Additional Information."
OTHER MATTERS
The Offering is not being made in any states or other jurisdictions in which
it is unlawful to do so, nor are FHP or the Company selling or accepting any
offers to purchase any shares of the Common Stock from Rights holders who are
residents of such states or other jurisdictions. FHP may delay the commencement
of the Offering in certain states or other jurisdictions in order to comply with
the securities law requirements of such states or other jurisdictions. It is not
anticipated that there will be any changes in the terms of the Offering. FHP
may, if it so determines in its sole discretion, decline to make modifications
to the terms of the Offering requested by certain states or other jurisdictions,
in which event Rights holders resident in such states or other jurisdictions
will not be eligible to participate in the Offering.
22
<PAGE>
FINANCIAL STATEMENTS
The consolidated financial data for the Company set forth in this Prospectus
include the accounts of TMMC, THSC and the Talbert Medical Groups. Consolidation
of the Talbert Medical Groups is considered necessary to present fairly the
financial position and results of operations of the Company because the Company
has direct or indirect unilateral and perpetual control over the assets and
non-medical operations of the Talbert Medical Groups. See "Business--The
Company." Financial data provided in this Prospectus for periods and dates prior
to January 1, 1996 is presented for FHP's staff model operations. The financial
statements of the staff model operations have been prepared in part from
separate records maintained by subsidiaries of FHP, and reflect certain
assumptions regarding the allocation of certain revenue and expense items and
certain balance sheet accounts, many of which could be material, where separate
records were not utilized. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
USE OF PROCEEDS
Assuming the Rights are fully exercised, the proceeds to the Company from
the sale of the Common Stock pursuant to the Rights are estimated to be
approximately $59.5 million. FHP will pay the expenses of the Offering, which
are currently estimated to be approximately $ . All of the proceeds of the
Offering will be used to repay indebtedness to FHP incurred in the Acquisition.
See "Relationship with FHP and PacifiCare Following the Offering--Acquisition
Agreement."
DIVIDEND POLICY
The declaration and payment of dividends by the Company are subject to the
discretion of its Board of Directors. It is the current policy of the Company to
retain earnings, if any, to finance the operations and expansion of the
Company's business. Any determination as to the payment of dividends in the
future will depend upon, among other things, general business conditions, the
Company's earnings, financial condition, capital needs and other factors deemed
pertinent by the Company's Board of Directors, including the limitations, if
any, on the payment of dividends under state law and under any then-existing
agreements with others. The Company does not anticipate paying any dividends in
the near future.
23
<PAGE>
CAPITALIZATION
The following table sets forth the actual capitalization of the Company and
its subsidiaries as of September 30, 1996, and as adjusted to give effect to the
Acquisition and the Offering. This table should be read in conjunction with the
consolidated financial statements of the Company and its subsidiaries and the
notes thereto included in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
---------------------------
ACTUAL AS ADJUSTED(1)
--------- ----------------
(IN THOUSANDS)
<S> <C> <C>
Stockholders' equity (deficit):
The Company's Preferred Stock, par value $.01 per share;
1,200,000 shares authorized; no shares issued and
outstanding.................................................. $ -- $ --
The Company's Common Stock, par value $.01 per share;
15,000,000 shares authorized; 3,000,000 shares issued and
outstanding.................................................. 30 30
Additional paid-in capital (1)................................. 70 68,070
Retained earnings (deficit) (1)(2)............................. (3,770) (5,267)
Deferred stock compensation expense (1)........................ -- (3,952)
--------- -------
Total stockholders' equity (deficit)......................... $ (3,670) $ 58,881
--------- -------
--------- -------
</TABLE>
- ------------------------
(1) Adjusted to reflect the recognition of deferred stock compensation expense
of approximately $5,270,000 assuming a Capital Contribution of $68,000,000
and the amortization of $1,318,000 of the deferred stock compensation
expense relating to the vesting of certain of the restricted shares of
Common Stock held by management.
(2) Adjusted to reflect the recognition of stock compensation expense of
approximately $179,000, net of tax benefit of $125,000, as a result of the
grant of the November 1996 Options.
24
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data sets forth, for the
periods and dates indicated, selected consolidated financial data of the Company
and its subsidiaries (including the Talbert Medical Groups) derived from the
historical consolidated financial statements of its predecessors. The
consolidated statement of operations data presented below for the years ended
December 31, 1993, 1994, and 1995, and the consolidated balance sheet data at
December 31, 1994 and 1995 are derived from, and are qualified by reference to,
the audited consolidated financial statements included elsewhere in this
Prospectus. The consolidated statement of operations data for the years ended
December 31, 1991 and 1992 and the nine months ended September 30, 1995 and
1996, and the consolidated balance sheet data at December 31, 1991, 1992 and
1993, and September 30, 1995 and 1996 are derived from unaudited consolidated
financial statements of the Company and its subsidiaries that are not included
herein. The summary consolidated financial data presented below are qualified by
reference to the consolidated financial statements included elsewhere in this
Prospectus and should be read in conjunction with such financial statements and
related notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------------------- -------------------------
1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996
----------- ----------- ----------- ----------- ----------- ----------- -----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenue (2)(3).............. $ 352,553 $ 402,599 $ 470,883 $ 503,338 $ 495,699 $ 379,365 $ 351,235
Expenses
Affiliated medical
services................ 128,224 153,387 170,690 173,230 173,417 132,051 103,504
Purchased medical
services................ 69,459 84,307 110,582 124,083 121,570 94,133 85,851
Dental services........... 13,970 16,128 20,129 28,955 31,379 24,544 20,443
Optometry, pharmacy and
other primary health
care services........... 52,999 70,702 86,985 96,275 102,412 77,395 80,181
Clinic operations......... 76,992 78,662 80,853 87,253 85,585 68,235 49,207
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total cost of health
care.................. 341,644 403,186 469,239 509,796 514,363 396,358 339,186
Marketing, general and
administrative.......... 20,606 22,569 24,002 26,675 29,698 22,188 19,622
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss.............. (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (7,573)
Interest income (4)......... -- -- -- -- -- -- 1,199
----------- ----------- ----------- ----------- ----------- ----------- -----------
Loss before income tax
benefit................... (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (6,374)
Income tax benefit.......... (3,873) (9,244) (8,924) (13,553) (19,754) (16,005) (2,604)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss (5)................ $ (5,824) $ (13,912) $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Loss per common and common
equivalent share (6)...... $ (1.94) $ (4.64) $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------------------- -------------------------
1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996
----------- ----------- ----------- ----------- ----------- ----------- -----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET
DATA:
Working capital (5)......... $ (18,105) $ (17,937) $ (18,087) $ (18,742) $ (18,638) $ (18,101) $ (10,779)
Total assets (5)............ 10,614 14,003 18,926 23,087 23,178 19,779 51,731
Long-term obligations....... -- -- -- -- -- -- --
Stockholders' deficit
(5)(7).................... (17,425) (17,276) (17,475) (18,113) (17,886) (17,519) (3,670)
</TABLE>
- ------------------------
(1) Reflects financial information relating to the historical staff model
operations of FHP prepared in part from separate records maintained by
subsidiaries of FHP. This information also reflects certain assumptions
regarding the allocation of certain revenue and expense items and certain
balance sheet accounts, many of which could be material, where separate
records were not utilized. See "Consolidated Financial Statements--Note 2."
(2) Revenue is derived from prepaid capitation fees for ambulatory services,
plus patient co-payments and fee-for-service payments. The Company did not
incur any hospital risk for the periods presented.
(3) Nearly 100% of revenue is received pursuant to existing provider agreements
with FHP. The New FHP Provider Agreements will take effect as of the
Effective Time. The pro forma financial data presented elsewhere herein
reflect, in part, the effects of the New FHP Provider Agreements as if such
agreements had been in effect for the periods indicated.
(4) Prior to January 1, 1996, all available cash balances, and the interest
income on such cash balances, were retained by FHP.
(5) Does not reflect the Capital Contribution to be made prior to the
Acquisition and the resulting compensation expense, nor the compensation
expense related to the options granted by the Board of Directors in November
1996, as reflected in the pro forma financial data presented elsewhere
herein.
(6) Loss per common and common equivalent share is computed based on 3,000,000
common shares outstanding at September 30, 1996 for all periods presented.
Options to acquire shares of Common Stock granted in September 1996 were not
dilutive.
(7) Prior to January 1, 1996, stockholders' deficit fluctuated as a result of
various intercompany transactions with FHP. On January 1, 1996, FHP
recapitalized TMMC, resulting in the elimination of a deficit of
$17,886,000.
26
<PAGE>
The following table sets forth, for the periods indicated, the percentage of
revenue represented by the following items:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------- ------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenue...................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses
Affiliated medical services................ 36.2 34.4 35.0 34.8 29.5
Purchased medical services................. 23.5 24.7 24.5 24.8 24.4
Dental services............................ 4.3 5.8 6.3 6.5 5.8
Optometry, pharmacy, and other primary
health care services..................... 18.5 19.1 20.7 20.4 22.8
Clinic operations.......................... 17.2 17.3 17.3 18.0 14.0
----------- ----------- ----------- ----------- -----------
Total cost of health care................ 99.7 101.3 103.8 104.5 96.6
Marketing, general and administrative...... 5.1 5.3 6.0 5.8 5.6
----------- ----------- ----------- ----------- -----------
Operating loss............................... (4.7) (6.6) (9.8) (10.3) (2.2)
Interest income.............................. 0.3
----------- ----------- ----------- ----------- -----------
Loss before income tax benefit............... (4.7) (6.6) (9.8) (10.3) (1.8)
Income tax benefit........................... (1.9) (2.7) (4.0) (4.2) (0.7)
----------- ----------- ----------- ----------- -----------
Net loss..................................... (2.9)% (3.9)% (5.8)% (6.1)% (1.1)%
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
</TABLE>
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
TMMC, THSC and the Talbert Medical Groups, subsidiaries and affiliates of
the Company, commenced operations on January 1, 1996, and were formed as part of
a plan announced by FHP in June 1995, to restructure its operations (the
"Restructuring Plan"). The Restructuring Plan included the transformation of
FHP's staff model operations (except for FHP's staff model operations in Guam)
into a PPMC (now known as TMMC), an ancillary clinical services provider (now
known as THSC) and a number of affiliated medical and dental provider practice
groups (now known as the Talbert Medical Groups). TMMC and THSC were originally
formed as subsidiaries of FHP. The Talbert Medical Groups comprise a number of
new professional corporations organized in California, Utah, Arizona and Nevada
to succeed to FHP's staff model business in each of those states. In New Mexico,
TMMC directly employs physicians and effectively acts as the Talbert Medical
Group in that state. Approximately 4,000 of FHP's employees, including health
care professionals, became employees of TMMC, THSC or the Talbert Medical
Groups.
FHP's staff model operations had no separate legal status prior to the
organization of TMMC, THSC and the Talbert Medical Groups. However, through its
subsidiaries FHP had offered health care services to FHP members as a staff
model HMO since 1961. Effective January 1, 1996, and pursuant to its management
services agreements with the Talbert Medical Groups, TMMC began providing a
broad range of practice management services in return for a management fee. At
the same time, the Talbert Medical Groups became responsible for managing all
physician-related covered medical care for each FHP member enrolled with a
Talbert Medical Group in exchange for a prepaid monthly capitation payment for
each such member. The Talbert Medical Groups are not limited to serving only FHP
members. However, they have continuously served FHP members who received their
health care in the former FHP staff model operations.
The consolidated financial statements for the Company include the financial
statements of TMMC, THSC and the Talbert Medical Groups. The Company effectively
controls the Talbert Medical Groups by means other than equity ownership and
consolidation of the Talbert Medical Groups is necessary to present fairly the
financial position and results of operations of the Company. Control of the
Talbert Medical Groups by TMMC is perpetual rather than temporary by virtue of:
(i) the length of the original terms of the relevant management and other
agreements; (ii) the successive extension period provided by the agreements;
(iii) the continuing investment of capital by TMMC; (iv) the employment of the
majority of nonphysician personnel by TMMC; (v) the nature of the services
provided to the Talbert Medical Groups by TMMC; and (vi) the provisions of a
share control agreement entered into by each Talbert Medical Group stockholder
and TMMC. The financial statements of the former FHP staff model operations have
been prepared, in part, from separate records maintained by subsidiaries of FHP,
and reflect certain assumptions regarding the allocation of certain revenue and
expense items and certain balance sheet accounts, many of which could be
material, where separate records were not utilized. See "Consolidated Financial
Statements--Note 2."
RESULTS OF OPERATIONS
REVENUE
The Company derives substantially all of its revenue from capitated provider
agreements, with the balance derived from enrollee co-payments and
fee-for-service revenue. Revenues are net of an allowance for doubtful accounts.
Nearly all revenues are generated from payments under existing provider
agreements with FHP. Pursuant to these agreements, every month FHP pays each
Talbert Medical Group a fixed percentage of FHP's premium revenue, based on the
number of commercial and senior enrollees covered by the Talbert Medical Group.
Unlike capitated revenue, co-payments and fee-for-service revenue represent
payments received directly from patients for services rendered.
28
<PAGE>
The Company believes FHP will continue to be the primary source of capitated
revenue for the forseeable future. The Talbert Medical Groups currently have
four capitated physician agreements and six capitated dental agreements with
FHP. TMMC also has a capitated physician agreement with FHP for New Mexico. The
Talbert Medical Groups also have recently established contractual relationships
with a total of nine other HMOs in California, Arizona, New Mexico and Utah. The
Company will seek to diversify the Talbert Medical Groups' payor base following
separation from FHP. Management believes new payor contracts are essential to
future revenue growth.
The Talbert Medical Groups' senior enrollee revenue is generated from
premiums paid to FHP by the Health Care Financing Administration ("HCFA"). Under
FHP's agreement with HCFA, seniors enroll and disenroll individually throughout
the year. FHP seniors served by the Talbert Medical Groups have individually
selected the Talbert Medical Groups for their health care. FHP receives senior
premium rate increases from HCFA on January 1 of each year and the contracted
percentage of the increase is passed to the Talbert Medical Groups pursuant to
their provider agreements with FHP. Revenue per senior enrollee is substantially
higher than revenue per commercial enrollee because senior enrollees use
substantially more health care services, thereby incurring a higher cost for
services provided. In September of each year, HCFA announces the annual Medicare
rate increases that will become effective on January 1 of the subsequent year.
These rate increases vary geographically and become the basis for determining
the amounts that HCFA will pay to HMOs that provide coverage to Medicare
recipients. For 1996 FHP received an average rate increase of 5.1%. Based upon
HCFA's September 1996 announcement, the Company currently estimates that FHP
will receive an average senior premium rate increase of 5.7% effective January
1, 1997 in the Company's markets. There can be no assurance that such annual
rate increases will continue.
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
REVENUE. Revenue decreased $28.1 million, or 7.4%, to $351.2 million for
the nine months ended September 30, 1996, from $379.4 million for the nine
months ended September 30, 1995. This decrease primarily reflects a 5.4% decline
in capitated enrollment, from 321,128 at September 30, 1995 to 303,785 at
September 30, 1996. Reductions in capitated enrollment in California during this
period were responsible for approximately $13.3 million of the decline in
revenue. Arizona's average monthly capitated enrollment also declined between
these periods as a result of a restructuring of FHP's health care delivery
systems in Arizona. Effective July 1, 1995, approximately 36,100 enrollees in
Arizona were no longer capitated by FHP to the Talbert Medical Group in Arizona
(the "Arizona Group"), although the enrollees continued to receive their health
care from the Arizona Group. In lieu of receiving a monthly capitation payment
for these enrollees, the Arizona Group billed FHP for medical services on a
fee-for-service basis. The change reduced the Arizona Group's average monthly
capitated enrollment by 19.9%, and reduced net revenue by approximately $11.7
million. However, the restructuring also reduced the Arizona Group's liability
for services provided outside its Medical Centers, resulting in a decline of
approximately $14.6 million in the total cost of health care for the Arizona
Group for the nine months ended September 30, 1996.
AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense
consists of expenses related to staff physicians, nursing, laboratory and x-ray
services, and malpractice insurance, that are provided by the Company.
Affiliated medical services expense declined $28.5 million, or 21.6%, to $103.5
million (29.5% of revenues) for the nine months ended September 30, 1996 from
$132.1 million (34.8% of revenues) for the nine months ended September 30, 1995.
This decline primarily reflected lower physician and malpractice costs resulting
from reductions in physician staffing levels. In California and Arizona,
affiliated medical services expense was reduced by $19.1 million and $2.8
million, respectively, through reductions in physician staffing, outsourcing of
certain physician specialist services, and corresponding reductions in
associated support services. In Utah, physician staffing was reduced in
accordance with declines in enrollment, resulting in a $6.6 million reduction in
physician costs.
PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense
consists of expenses related to physician specialists and related services that
are provided outside the Company's Medical Centers. Purchased medical services
expense declined $8.3 million, or 8.8%, to $85.8 million for the nine months
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ended September 30, 1996, compared to $94.1 million for the nine months ended
September 30, 1995. As a percentage of revenues, purchased medical services
expense decreased to 24.4% from 24.8%. The restructuring in Arizona contributed
approximately $7.2 million toward the reduction, while declines in enrollment in
Utah resulted in a further reduction of $4.6 million. These favorable reductions
were partially offset by a $2.7 million increase in purchased medical services
expense in California, attributable principally to the expansion of home health
services and increased outsourcing of certain physician specialty services.
DENTAL SERVICES EXPENSE. Dental services expense declined $4.1 million, or
16.7%, to $20.4 million (5.8% of revenues) for the nine months ended September
30, 1996, from $24.5 million (6.5% of revenues) for the nine months ended
September 30, 1995. The reduction was largely attributable to declines in
enrollment in California and Arizona.
OPTOMETRY, PHARMACY AND OTHER PRIMARY HEALTH CARE SERVICES
EXPENSE. Optometry, pharmacy and other primary health care services expense
increased $2.8 million, or 3.6%, to $80.2 million (22.8% of revenues) for the
nine months ended September 30, 1996, from $77.4 million (20.4% of revenues) for
the nine months ended September 30, 1995. Higher utilization of these services
in California was responsible for $3.9 million of the increase, which was
partially offset by a reduction of $1.9 million resulting from lower utilization
in Arizona.
CLINIC OPERATIONS EXPENSE. Clinic operations expense declined $19.0
million, or 27.9%, to $49.2 million (14.0% of revenues) for the nine months
ended September 30, 1996, from $68.2 million (18.0% of revenues) for the nine
months ended September 30, 1995. Closures of clinics in California accounted for
$10.6 million of the decline. Also, clinic operations expense in Utah and
Arizona declined by $3.2 million and $1.3 million, respectively, reflecting
primarily reductions in physician support staff.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSE. Marketing, general and
administrative ("MG&A") expense declined $2.6 million, or 11.7%, to $19.6
million (5.6% of revenues) for the nine months ended September 30, 1996, from
$22.2 million (5.8% of revenues) for the nine months ended September 30, 1995.
The decline was attributable primarily to reductions in administrative personnel
undertaken as part of the Company's cost savings efforts.
YEARS ENDED DECEMBER 31, 1995 AND 1994
REVENUE. Revenue declined $7.6 million, or 1.5%, to $495.7 million for the
year ended December 31, 1995, from $503.3 million for the year ended December
31, 1994. The decrease was primarily attributable to reductions in capitated
enrollment, which declined by 37,305, or 10.4%, to 321,588 at December 31, 1995
from 358,893 at December 31, 1994. California and Utah experienced revenue
reductions of $15.2 million and $5.6 million, respectively, primarily resulting
from declines in enrollment. These reductions were partially offset by revenue
increases in Nevada and New Mexico of $6.6 million and $3.3 million,
respectively. Revenue in Arizona increased by a net $3.3 million. This reflected
a $7.4 million increase in revenue attributable to an increase in senior
enrollment in proportion to other enrollees of the Arizona Group. Capitation
rates received for senior enrollees are higher than for commercial enrollees.
This revenue increase was partially offset by a revenue reduction of $4.1
million attributable to a decline in the average monthly capitated enrollment of
17.2% that was generated principally by the restructuring of FHP's health care
delivery system in Arizona.
AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense
increased slightly to $173.4 million for the year ended December 31, 1995, from
$173.2 million for the prior year, reflecting primarily increased malpractice
premiums and higher utilization of affiliated laboratory and x-ray services. As
a percentage of revenue, affiliated medical services expense increased to 35.0%
in 1995 from 34.4% in 1994.
PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense
declined to $121.6 million (24.5% of revenues) for the year ended December 31,
1995, from $124.1 million (24.7% of revenues) for the year ended December 31,
1994. Reductions in California and Arizona of approximately $4.1 million
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and $2.1 million, respectively, were attributable primarily to lower enrollment
levels. Enrollment growth in New Mexico and Nevada produced an increase of $4.4
million, while higher utilization in Utah resulted in an increase of $1.5
million.
DENTAL SERVICES EXPENSE. Dental services expense increased to $31.4 million
for the year ended December 31, 1995, compared to $29.0 million for the year
ended December 31, 1994, reflecting expanded benefit coverage in California and
Utah. As a percentage of revenue, dental services expense increased slightly to
6.3% from 5.8%.
OPTOMETRY, PHARMACY AND OTHER PRIMARY HEALTH CARE SERVICES
EXPENSE. Optometry, pharmacy and other primary health care services expense
increased to $102.4 million (20.7% of revenues) for the year ended December 31,
1995, compared to $96.3 million (19.1% of revenues) for the year ended December
31, 1994. Pharmacy costs in Arizona, New Mexico and Nevada increased by a total
of $3.7 million, primarily resulting from higher prescription utilization due to
increased enrollment. Behavioral health expense increased $1.3 million,
primarily due to expanded benefit coverage in California and Utah. Optometry
costs increased by $1.9 million, reflecting increased enrollment in New Mexico
and expanded optometry benefits in Arizona.
CLINIC OPERATIONS EXPENSE. Clinic operations expense declined to $85.6
million for the year ended December 31, 1995, from $87.3 million for the year
ended December 31, 1994, reflecting closures of clinics and associated staff
reductions due to lower enrollment. As a percentage of revenues, clinic
operations expense remained flat at 17.3% of revenues in 1995 and 1994.
MG&A EXPENSE. MG&A expense increased to $29.7 million (6.0% of revenues)
for the year ended December 31, 1995, from $26.7 million (5.3% of revenues) for
the year ended December 31, 1994, reflecting the first full year of
administrative costs incurred in 1995 for the new Nevada operations.
YEAR ENDED DECEMBER 31, 1994 AND 1993
REVENUE. Revenue increased $32.4 million, or 6.9%, to $503.3 million for
the year ended December 31, 1994, compared to $470.9 million for the year ended
December 31, 1993. The increase largely resulted from an increase in capitated
enrollment of 29,851 enrollees, or 9.1%, to 358,893 at December 31, 1994 from
329,042 at December 31, 1993. Revenue in Arizona increased by $25.5 million,
primarily due to the addition of 14,600 new enrollees. Increased enrollment in
California also was primarily responsible for $7.1 million of increased revenue.
The commencement of operations in Nevada in November 1994 also generated $1.1
million of incremental revenue.
AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense
increased to $173.2 million for the year ended December 31, 1994, from $170.7
million for the year ended December 31, 1993, reflecting higher physician costs
in California and Utah. As a percentage of revenue, affiliated medical services
expenses decreased to 34.4% in 1994 from 36.2% in 1993.
PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense
increased $13.5 million, or 12.2%, to $124.1 million (24.7% of revenue) for the
year ended December 31, 1994, compared to $110.6 million (23.5% of revenue) for
the year ended December 31, 1993. The increase reflects higher utilization of
outside specialty services primarily attributable to increased enrollment in
Arizona, California and Nevada.
DENTAL SERVICES EXPENSE. Dental services expense increased $8.9 million, or
44.3%, to $29.0 million for the year ended December 31, 1994, from $20.1 million
for the year ended December 31, 1993, reflecting higher enrollment as well as
the expansion of dental services in Arizona. As a percentage of revenue, dental
services expense increased to 5.8% in 1994 compared to 4.3% in 1993.
OPTOMETRY, PHARMACY AND OTHER PRIMARY CARE HEALTH SERVICES
EXPENSE. Optometry, pharmacy and other primary care health services expense
increased $9.3 million, or 10.7%, to $96.3 million (19.1% of revenues) for the
year ended December 31, 1994, from $87.0 million (18.5% of revenues) for the
year ended December 31, 1993. Pharmacy and optometry costs increased $6.8
million and $2.7 million, respectively, primarily attributable to increased
enrollment.
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CLINIC OPERATIONS EXPENSE. Clinic operations expense increased $6.4
million, or 7.9%, to $87.3 million (17.3% of revenues) for the year ended
December 31, 1994, from $80.9 million (17.2% of revenues) for the year ended
December 31, 1993. The increase primarily resulted from the establishment of a
new Medical Center in Nevada.
MG&A EXPENSE. MG&A expense increased to $26.7 million (5.3% of revenues)
for the year ended December 31, 1994, from $24.0 million (5.1% of revenues) for
the year ended December 31, 1993, largely due to additional enrollment
administration costs.
LIQUIDITY AND CAPITAL RESOURCES
LIMITED FUTURE CASH FLOWS AND CAPITAL CONTRIBUTION
The Company generates cash flow principally from monthly capitation payments
from HMOs for their members who are serviced by the Talbert Medical Groups.
FHP's staff model operations, which comprise the Company's predecessor
businesses, experienced substantial operating losses over the last five years.
Subsidies from FHP have offset losses incurred in these periods, but FHP will
not provide such subsidies following the Offering. The New FHP Provider
Agreements, executed pursuant to the terms of the FHP Merger, will result in
lower revenues and higher expenses per enrollee. Management therefore
anticipates that the Company will incur substantial losses in 1997 and 1998 and
will not generate positive cash flow for those periods.
Management plans to stabilize the Company's financial condition through
revenue enhancements and cost reductions. Enhancing revenues is believed by
management to be essential, even if cost reductions are successfully
implemented. The Company's revenue enhancement plans focus on attracting new
capitated Medicare and commercial enrollees by entering into provider agreements
with payors other than FHP. Declining enrollment has created excess health care
service capacity, and the Company believes additional revenue opportunities can
be achieved with relatively lower associated incremental costs. Management
anticipates that independence from FHP will make the Talbert Medical Groups more
accessible to other payors and new capitated enrollees. However, there can be no
assurance that the Talbert Medical Groups will be able to secure additional
payor contracts or to attract new capitated enrollees. Continued enrollment
decline would adversely impact operating results. The Company's cost reduction
plans focus primarily on continuing improvements in the cost of health care and
controlling general and administrative expenses. Effective January 1, 1997, the
Talbert Medical Groups will implement a new physician compensation program
designed to be competitive with compensation programs in effect in other
independent physician group practices. Physicians will no longer receive only
fixed salaries. Instead, approximately 20% of each physician's salary (based on
current salary levels) will be placed at risk. Funds derived from pharmacy and
hospital risk pools, as well as from reductions in purchased medical services,
will be included in an incentive pool. The incentive pool will be distributed to
physicians based on their individual performance. Performance criteria include
quality of care, patient satisfaction, cost-effectiveness and other factors.
Management believes the revised physician compensation program will align
physician incentives with the provision of quality medical care.
Prior to the Acquisition, TMMC will receive, in connection with the FHP
Merger, the Capital Contribution to increase its net worth to approximately $59
million. The amount of the Capital Contribution is currently anticipated to be
approximately $68 million, but will not exceed $70 million. The Company intends
to use the Capital Contribution to fund operating losses and for working capital
and other general corporate purposes.
The Company does not have a credit facility in place and there can be no
assurance that the Company will be able to obtain such a facility in the future.
The Company also does not have significant tangible assets, other than computer
equipment and tenant improvements. It therefore does not anticipate that credit
facilities would be readily available to it without significant improvements in
its results of operations and cash flows.
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CAPITAL REQUIREMENTS
The Company has budgeted approximately $5 million for information systems
capital expenditures and related activities in 1997. The Company believes that
its existing cash resources, together with the Capital Contribution, will be
sufficient to meet the Company's anticipated expansion and working capital needs
for the next several years, based on current projections. However, this belief
assumes that the Company's enrollment trends do not worsen, that expenses do not
increase in excess of anticipated amounts and that competitive pressures or
other factors do not further depress revenues. In addition, there are other
factors that individually or collectively may have a significant adverse effect
on the Company and impair its ability to operate successfully in the future. For
a discussion of certain of these other factors, see "Risk Factors."
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BUSINESS
OVERVIEW
The Company, through TMMC, organizes and manages physician and dentist
practice groups that contract with HMOs and other payors to provide health care
services to their members. As of September 30, 1996, TMMC had management
services agreements with four physician groups representing approximately 333
primary and specialty care physicians operating in southern California, Utah,
Arizona and Nevada. TMMC also directly employed 27 primary and specialty care
physicians operating in New Mexico. In addition, TMMC had management services
agreements with six dental groups representing approximately 80 dentists in
southern California, Utah and Arizona. In support of these Talbert Medical
Groups, TMMC operates 52 Medical Centers and employs a health care staff of more
than 3,000 individuals. Through its management services agreements with the
Talbert Medical Groups, TMMC managed over 303,000 capitated enrollees as of
September 30, 1996.
The Company believes that HMOs and other payors see primary care physicians
as increasingly important participants in the delivery of managed health care.
Payors rely on primary care physicians to assume more responsibility for the
cost-effective management of patient care, including optimizing the amount of
care provided on an out-patient basis, ensuring efficient utilization of
specialists and hospitals, encouraging preventive care practices and monitoring
the progress of patients throughout their course of treatment.
The Company, through TMMC, uses its experience in managed care to advise the
Talbert Medical Groups in managing their patient populations. TMMC offers a
broad range of practice management services, including (i) provider contract
negotiation and administration, (ii) Medicare risk management, (iii) management
information systems (development, implementation and maintenance), (iv) medical
management (claims administration, utilization and case management, quality
assurance and risk management, and physician credentialing and recruitment), and
(v) support services (including nursing, billing, collection and accounting).
Ancillary clinical services (including pharmacy, radiology, optometry,
laboratory, home health, hospice, rehabilitation and physical therapy) are
provided through THSC. The provision of these services enables physicians to
focus on the practice of medicine.
THE MANAGED HEALTH CARE INDUSTRY
BACKGROUND
Medical services traditionally have been provided on a fee-for-service
basis, with insurance companies paying all or a portion of the fees. Over the
past decade, the cost of medical services generally has risen at a higher rate
than the consumer price index. HCFA estimated health care expenditures in the
United States for 1995 at approximately $1 trillion, representing more than 15%
of gross national product ("GNP"), up from approximately $665 billion, or 12.2%
of GNP, in 1990.
HEALTH MAINTENANCE ORGANIZATIONS
As a result of escalating health care costs, employers, insurers and
governmental entities have sought cost-effective approaches to the delivery of
and payment for health care services. HMOs and other managed health care
organizations have emerged as integral components in this effort. Like
traditional indemnity health care plans, HMOs and other managed health care
organizations typically assume most of the financial risk for the delivery of
medical care. Unlike traditional indemnity health care plans, however, HMOs seek
to reduce the cost of medical services through volume discounts from their
provider networks and through the management of medical services, including the
implementation of techniques such as utilization and technology reviews and
quality assurance programs.
HMOs enroll members by entering into contracts with employer groups or
directly with individuals to provide a broad range of health care services for a
fixed monthly premium, with minimal or no deductibles
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<PAGE>
or co-payments required of the members. HMOs, in turn, typically contract
directly with physicians, hospitals and other health care providers to deliver
medical care to their members. These contracts provide for payment to the
provider on either a discounted fee-for-service or per diem basis, or through
capitation based on the number of members covered, regardless of the amount of
necessary medical care required within the covered benefits.
By capitating payments to physicians, HMOs effectively have begun to shift
to physicians a significant portion of the economic risk of providing health
care. These shared risk arrangements exert more pressure on the physician to
manage medical treatments without diminishing the quality of medical care.
Payors also are shifting administrative responsibilities to physicians,
including requiring physicians to obtain authorization for tests and surgical
procedures and respond to additional oversight from payors. These administrative
burdens are exacerbated by the proliferation of HMOs, which has forced
physicians to comply with multiple formats for claims processing, credentialing
and other administrative reporting requirements. As a result, physicians'
operating expenses and the number of hours devoted to non-medical activities
have increased. In order to relieve these economic and administrative burdens,
physicians have turned to third parties, such as PPMCs, to manage economic risk
and perform non-medical management tasks associated with the practice of
medicine.
PHYSICIAN PRACTICE MANAGEMENT COMPANIES
PPMCs were created to relieve certain of the economic and administrative
burdens imposed on physicians by payors. PPMCs provide management, claims
payment and other administrative services to physicians. PPMCs also help
physician groups by negotiating capitation rates and other incentive
arrangements with payors. These arrangements can take a number of forms, but
often separate payments to the medical group into two categories: (i) a
capitation payment to cover certain services; and (ii) participation in budgeted
shared risk pool to cover other services (such as pharmacy or hospital
services). The capitation payment remains the same regardless of utilization,
and thus the medical group has an incentive to optimize utilization,
particularly with respect to specialty care or other services provided outside
the medical group. The budgeted shared risk pool also provides incentives to the
medical group to optimize utilization of particular services. For example, a
budgeted shared risk pool for hospitalization would allow the medical group to
share in the savings that result from improved utilization of hospital services.
THE COMPANY
The Company anticipates that managed care will continue to play an important
role in the delivery of and payment for health care services. In particular, the
Company believes that to deliver high-quality, cost-effective health care,
primary care physicians must have incentives to manage patient care, including
referrals to specialty care physicians and other medical care service providers.
The Company expects that as the importance of the primary care physician's role
is recognized, more HMOs will embrace the management of health care services
through these physicians. As primary care physicians expand their role in not
only providing medical care, but also in managing its delivery, the Company
believes that these physicians will require the assistance of PPMCs like TMMC to
help them manage their practices and negotiate payor contracts.
THE TALBERT MEDICAL GROUPS
The Company's affiliated practice groups currently consist of four physician
groups and six dental groups. TMMC also directly employs physicians in New
Mexico. All of the Talbert Medical Groups were formerly part of FHP's staff
model operations. TMMC provides practice management services to each of the
Talbert Medical Groups pursuant to a management services agreement. TMMC's
management services agreements generally provide for TMMC to be reimbursed for
certain clinic operating expenses and to receive a management fee based on the
revenues of each Talbert Medical Group after deducting certain reimbursed clinic
operating expenses. In California, TMMC's management fee is based on the gross
revenues of the Talbert Medical Groups in California.
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THE MEDICAL CENTERS. TMMC operates 52 Medical Centers located in five
states. The Medical Centers are staffed largely by primary care physicians, who
practice family, internal and pediatric medicine, and obstetrics-gynecology.
Most of the Medical Centers offer a broad range of outpatient health care
services, including medical, dental, vision, pharmacy, radiology and/or
laboratory services.
The following table sets forth the number of Medical Centers and affiliated
physicians for each of the states in which the Company does business.
THE TALBERT MEDICAL GROUPS
<TABLE>
<CAPTION>
MEDICAL AFFILIATED
CENTERS PHYSICIANS (1)
------------- -----------------
<S> <C> <C>
California........................................................... 24 206
Utah................................................................. 7 80
Arizona.............................................................. 14 41
New Mexico........................................................... 5 27
Nevada............................................................... 2 6
--
---
Total.............................................................. 52 360
--
--
---
---
</TABLE>
- ------------------------
(1) As of September 30, 1996.
OUTSIDE PROVIDERS. Covered health care benefits that are unavailable at the
Medical Centers are provided through contracts with outside providers on a
discounted fee-for-service, sub-capitated, or fixed monthly fee basis. Members
are referred to these providers in accordance with the pre-authorization
guidelines of the relevant payor.
PAYOR RELATIONSHIPS
The Company's revenue is largely dependent on the number of enrollees for
whom the Talbert Medical Groups receive monthly capitation payments. The table
below sets forth the number of capitated enrollees for each of the states in
which the Company does business:
CAPITATED ENROLLEES
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
---------------------------------- --------------------------
1993 1994 1995 1995 1996
--------- --------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
California................... 145,667 150,125 145,986 146,117 132,463
Utah......................... 131,273 138,588 122,596 126,800 109,652
Arizona...................... 29,132 43,748 21,954(1) 17,579(1) 31,460(1)
New Mexico................... 22,970 23,472 26,738 26,389 25,504
Nevada....................... -- 2,960 4,314 4,243 4,706
--------- --------- ------------ ------------ ------------
Total...................... 329,042 358,893 321,588 321,128 303,785
--------- --------- ------------ ------------ ------------
--------- --------- ------------ ------------ ------------
</TABLE>
- ------------------------
(1) Reflects the restructuring of approximately 36,100 capitated enrollees of
the Arizona Group to a fee-for-service basis effective July 1, 1995. The
Company subsequently undertook a program to reconvert such enrollees from a
fee-for-service to a capitated basis.
Currently, FHP is the primary payor for the Talbert Medical Groups,
accounting for nearly 100% of capitated enrollees and revenues for the nine
months ended September 30, 1996 and 1995, and for the years ended December 31,
1995, 1994 and 1993. The Company believes FHP will continue to be the primary
source of capitated revenue for the forseeable future. See "Risk
Factors--Contracted Rate Decrease."
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TMMC has, however, recently established contractual relationships with the
following payors on behalf of one or more of the Talbert Medical Groups:
- Blue Cross Blue Shield (Arizona)
- BPS HMO Inc. (California)
- Foundation Health Corporation (California)
- HMO California (California)
- Health Net (California)
- Maxicare (California)
- PacifiCare California (California)
- Blue Cross (New Mexico)
- United Health Plan (Utah)
In addition, TMMC is currently negotiating contracts with a number of other
payors. TMMC has negotiated 18 preferred provider organization ("PPO") contracts
on behalf of one or more of the Talbert Medical Groups. Under a typical PPO
contract, the payor agrees to list one of the Talbert Medical Groups on its
panel of authorized practice groups. PPO arrangements provide a wider choice of
practice groups to the payor's members, and thus often do not result in as
consistent a revenue stream as capitated agreements. These new payor
relationships do not yet constitute a significant source of revenues for TMMC.
TMMC expects to continue to diversify the Talbert Medical Groups' payor base
following its separation from FHP. TMMC believes its prior diversification
efforts were impeded by its subsidiary relationship with FHP, which a number of
other payors regarded as a direct competitor.
MANAGEMENT SERVICES
TMMC provides a wide array of management services to the Talbert Medical
Groups. TMMC's services include: (i) provider contract negotiation and
administration; (ii) Medicare risk management; (iii) comprehensive management
information systems; (iv) medical management (claims administration, utilization
and case management, quality assurance and risk management, and physician
credentialing and recruitment); and (v) support services (including nursing,
billing, collection and accounting). Ancillary clinical services (including
pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation
and physical therapy) are provided through THSC.
PROVIDER CONTRACTING. TMMC represents the Talbert Medical Groups in
obtaining and negotiating provider agreements with HMOs and other payors. Under
a typical capitation agreement with one of the Talbert Medical Groups, the Group
is responsible for managing all physician-related covered medical care for each
enrollee in exchange for a prepaid monthly capitation payment per member
enrolled with the Talbert Medical Group. Capitation agreements generally include
shared risk arrangements and other financial incentives designed to encourage
the provision of high-quality, cost-effective health care. TMMC has also
represented the Talbert Medical Groups in negotiating discounted fee-for-service
agreements. Under these arrangements, the Talbert Medical Groups bill the payor
for services rendered rather than receive a monthly capitation payment.
When negotiating or renewing payor contracts, TMMC analyzes a number of
specific factors that affect capitated rates, the shared risk pool and the
breadth of covered benefits. These factors include, but are not limited to, the
demographic risk profile of the member pool, its cost history, the existence of
ceilings on required coverage, and fee-for-service equivalent charges. TMMC
undertakes these analyses in order to assess the economic opportunity and risk
exposure associated with the contract, and then conducts the negotiations on
behalf of its affiliated medical group.
MEDICARE RISK MANAGEMENT. Many payors have contracted with the federal
government to provide health care for Medicare beneficiaries under full risk
capitation arrangements. Under these types of
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contracts, the payor receives a monthly per capita payment for each enrollee
that is equal to 95% of HCFA's adjusted average per capita cost. TMMC benefits
from 13 years of experience and expertise in implementing and managing Medicare
risk programs. TMMC's Medicare contracting expertise helps assess the Talbert
Medical Groups' economic opportunity and exposure under such contracts. TMMC's
administrative expertise provides the Talbert Medical Groups with the design and
implementation of clinical systems capable of meeting the needs of the Medicare
population.
MANAGEMENT INFORMATION SYSTEMS. TMMC maintains a comprehensive, on-line
database that provides inpatient and outpatient utilization statistics and
patient encounter reporting and tracking. The Company believes that the
availability of timely information on utilization patterns improves primary care
physician productivity and effectiveness. Medical management information systems
("MIS") play an integral role in TMMC's management of specialty care physicians
and hospital utilization by enabling TMMC's medical directors and utilization
nurses to monitor encounter data, case management decisions and patient
outcomes. In addition, MIS help TMMC perform various administrative functions,
including insurance verification, accounts payable and receivable, financial
reporting and claims payment. The MIS also include a customer service
documentation system that helps TMMC resolve patient concerns and evaluate
patient and physician satisfaction.
CLAIMS ADMINISTRATION. TMMC's claims processing capabilities include
determination of eligibility, identification of appropriate benefits and
assurance of prior authorization. TMMC also provides critical elements of most
effective economic claim adjudication and medical claims review. In addition,
TMMC performs fee-for-service billing and ensures coordination of benefits for
recoveries from primary and secondary insurers.
UTILIZATION MANAGEMENT. TMMC has established a utilization management
program that assists physicians in the Talbert Medical Groups in providing
high-quality, cost-effective care. All referrals to specialty care physicians
and all hospital admissions, with the exception of emergencies, require prior
approval by utilization management committees. TMMC provides information to the
utilization management committees, but does not participate in their
deliberations, nor does TMMC directly engage in the practice of medicine or
exert control over decisions regarding medical care. Utilization management
committees also establish guidelines for routine referrals that can be
authorized by committee staff. The committees help ensure that all necessary
pre-approvals are obtained, benefits are fulfilled, "best medical practice"
alternatives are followed, appropriate providers are used and hospitalization is
properly utilized. A case manager coordinates with hospital nurses and primary
care physicians for discharge planning and the use of alternatives to
hospitalization. The program also focuses on preventive medicine and the
development of alternatives to more costly tests, procedures, surgeries,
hospitalizations or referrals to specialty care physicians.
CASE MANAGEMENT. Case management is a clinical and administrative process
by which health care services are identified, coordinated, implemented and
evaluated on an ongoing basis for members experiencing health problems. These
problems include chronic disability, complex medical issues or problems
involving long-term care or disease management. Case management involves the
coordination of a variety of services, including, in many instances, home
nursing, home infusion and the provision of durable medical equipment. This
approach is intended to provide coordinated and comprehensive care for patients
throughout the course of treatment, while reducing hospitalization referrals.
QUALITY ASSURANCE AND RISK MANAGEMENT. The Talbert Medical Groups maintain,
as a service to both physicians and payors, a comprehensive quality assurance
program designed to assess patient outcomes. The quality assurance program
incorporates peer review, patient satisfaction surveys, medical records
auditing, continuing medical staff development and regular continuing medical
education seminars to meet or exceed the requirements of accrediting
organizations and state law. Medical staff development also includes training
and support programs to encourage the application of identified "best medical
practices."
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TMMC has an established risk management program to oversee the management of
malpractice claims. See "--Risk Management Program."
PHYSICIAN CREDENTIALING AND RECRUITMENT. As a service to payors, TMMC
verifies that the credentials of physicians in the Talbert Medical Groups meet
the minimum requirements specified in payor contracts. In addition, TMMC assists
the Talbert Medical Groups in recruiting physicians. The recruitment process
includes a lengthy series of interviews and reference checks incorporating a
number of credentialing and competency protocols. All of the Talbert Medical
Groups' physicians are licensed to practice medicine in the state where they
provide medical services and are generally either board certified or board
eligible.
SUPPORT SERVICES. The Company provides support services covering all
aspects of ambulatory clinic management, including nursing, reception,
scheduling, billing, collection, accounting, enrollment information management
and licensing maintenance.
ANCILLARY CLINICAL SERVICES. THSC provides pharmacy, radiology, optometry,
laboratory, home health, hospice, rehabilitation and physical therapy services
in many of the Medical Centers.
EXPANSION STRATEGY
The Company's strategy is to develop high quality, cost efficient health
care delivery systems by acquiring or contracting with additional primary and
specialty care physicians in selected geographic markets. The Company's strategy
in its existing markets focuses on three elements: contracting with new payors,
developing additional fee-for-service business and expanding its physician
practice base.
NEW PAYORS. The Company believes that after its separation from FHP, third
party payors previously deterred by its subsidiary affiliation with FHP will be
more willing to contract with the Talbert Medical Groups. This would diversify
the Talbert Medical Groups payor base as well as increase their capitated
enrollment.
INCREASED FEE-FOR-SERVICE. Prior to the separation from FHP, the Talbert
Medical Groups provided little or no fee-for-service business. Through increased
marketing activities and promotional events undertaken by each Medical Center,
the Company believes it can develop greater fee-for-service business at the
Talbert Medical Groups.
NEW PHYSICIAN PRACTICES. The Company intends to expand its physician base
in existing markets through the acquisition of, or affiliation with, individual
physicians or groups in those markets.
The Company also has identified other geographic markets for expansion,
based on internally developed criteria. The Company may expand into these
markets through the acquisition of, or affiliation with, individual and group
primary and specialty care physicians.
CONTRACTUAL RELATIONSHIPS
PROVIDER AGREEMENTS. TMMC represents the Talbert Medical Groups in
obtaining and negotiating provider agreements with payors, such as FHP. Under
most provider agreements, the Talbert Medical Group receives a prepaid monthly
capitation payment for each payor member who selects a primary care physician
employed by the Talbert Medical Group. These capitation payments are
administered by TMMC pursuant to a management services agreement with the
Talbert Medical Group. To encourage efficient utilization of hospital and
related services as well as to maintain the quality of care, the Talbert Medical
Groups are obligated to comply with the utilization management policies and
quality management programs of the payor.
MANAGEMENT SERVICES AGREEMENTS. Under TMMC's contracts to manage the
Talbert Medical Groups (the "Management Services Agreements"), TMMC is obligated
to provide a range of practice management services, including facilities,
non-professional personnel and support staff, billing and collection, and
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negotiation of managed care and provider contracts. As compensation for its
services, TMMC is entitled to reimbursement of certain clinic operating
expenses, as well as a percentage of each Talbert Medical Group's revenues net
of reimbursed clinic operating expenses (except in California, where the
management fee is based on the Talbert Medical Group's gross revenues). The
Talbert Medical Groups are solely and exclusively in control of and responsible
for all aspects of the practice of medicine and the delivery of medical
services. TMMC receives a limited power of attorney from the Talbert Medical
Groups for ease of administration, but each Talbert Medical Group retains full
authority of approval over all provider and payor contracts and credentialing.
The Management Services Agreements generally have terms of twenty years, with
two automatic renewals of ten years each (at TMMC's option), and may be
terminated by either party for cause upon written notice of between 30 to 180
days.
PHYSICIAN EMPLOYMENT AGREEMENTS. The Talbert Medical Groups generally enter
into employment agreements with their physicians (the "Physician Employment
Agreements") for their professional medical services. The physicians also may
provide medical services outside the Talbert Medical Groups if such services do
not interfere with their full commitment to the Talbert Medical Group. The
Physician Employment Agreements typically have terms of approximately one year,
and are automatically renewed for one year. After the one year automatic
renewal, further renewals must be mutually agreed by the parties. The contracts
generally can be terminated upon 60 days written notice by either party. To
date, the Physician Employment Agreements have provided for fixed salaries,
subject to negotiation on an annual basis. Effective January 1, 1997, the
Talbert Medical Groups will adopt a new physician compensation system that
places a certain portion of physician compensation at risk and includes other
financial incentives to encourage high-quality, cost-effective care. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
SHARE CONTROL AGREEMENTS. TMMC has entered into agreements with the sole
shareholder (in each case also the chief of staff) of each of the Talbert
Medical Groups (the "Share Control Agreements") that provide for the sole
shareholder to vote the shares of the Talbert Medical Group as to matters other
than those affecting the delivery of medical care, in a manner approved by TMMC.
COMPETITION
The health care industry is highly competitive and is subject to continuing
changes in the way services are provided and providers are selected and paid.
The Company competes with other companies, including PPMCs, that provide
management services to health care providers. The Talbert Medical Groups compete
with any provider entity in their markets that contracts with payors for the
provision of prepaid physician health care services. Certain competitors are
significantly larger and better capitalized than the Company, and have longer
established relationships with buyers of such services than does the Company.
GOVERNMENT REGULATION
The health care industry is highly regulated, and there can be no assurance
that the regulatory environment in which the Company operates will not change
significantly in the future. Generally, regulation of health care companies is
increasing.
There have been diverse legislative and regulatory initiatives at both the
federal and state levels to address, among other things, the continuing
increases in health care costs and the lack of health care coverage for many
people. Several bills have been introduced in Congress to reform the nation's
health care system. These bills include elements such as guaranteed issuance and
renewability of health insurance; subsidies for individuals who are uninsured or
underinsured; mandates on employers to provide health coverage for their
employees; medical savings accounts; mandatory or voluntary regional health
alliances or purchasing cooperatives; minimum or standardized health benefit
packages; limitations on premiums; medical liability reforms; amendment of the
antitrust laws to benefit providers; mandatory or optional single-payor systems
for all or part of the population; and changes in federal tax, Medicare and
Medicaid
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laws and the Employee Retirement Income Security Act of 1974. To varying
degrees, many of the bills contemplate the involvement of state governments in
the regulation and implementation of federal health care reform legislation.
Various states are considering forms of single-payor systems, restructuring
of Medicaid programs and the adoption of "any willing provider" legislation that
could require managed care companies to contract with any medical provider who
agrees to the terms of the company's standard provider contract and payment
schedule. Any legislation along these lines that becomes law could adversely
affect the Company's business.
The Company is unable to predict how existing federal or state laws and
regulations may be changed or interpreted, what additional laws or regulations
affecting its businesses may be enacted or proposed, when and which of the
proposed laws will be adopted or what effect the new laws and regulations will
have on its businesses. However, certain of the proposals, if adopted, could
have a material adverse effect on the Company's business, while others, if
adopted, could potentially benefit the Company's business. Although the effects
of many proposals cannot yet be determined, the Company remains committed to
participate in the debate over health care reform and in the restructuring of
the health care system.
The laws of the states where the Company currently operates generally
specify who may practice medicine and limit the scope of relationships between
medical practitioners and other parties. Under these laws, the Company is
prohibited from practicing medicine or exercising control over the provision of
medical services. In order to comply with these laws, the Talbert Medical Groups
are organized so that all physician services are offered by physicians employed
by or under contract with the professional corporations affiliated with the
Company. Other than in New Mexico, the Company itself does not employ practicing
physicians as practitioners. The Company does not, in any state, exert control
over physician decisions regarding medical care or represent to the public that
it offers medical services. The Company believes that the services it provides
to the Talbert Medical Groups do not constitute the practice of medicine under
applicable laws.
Every state imposes licensing requirements on individual physicians and on
facilities and services operated by physicians. In addition, federal and state
laws regulate HMOs and other managed care organizations with which the physician
groups may have contracts. Many states require regulatory approval, including
certificates of need, before establishing or expanding certain types of health
care facilities, offering certain services or making expenditures in excess of
statutory thresholds for health care equipment, facilities or programs. Some
states also require licensing of third party administrators. In connection with
its existing operations and its expansion into new markets, the Company believes
it is in compliance with all applicable laws, regulations and interpretations,
but there can be no assurance that they will not change in the future or that
additional laws and regulations will not be enacted. The ability of the Company
to operate profitably will depend in part upon the Company and its affiliated
physician groups obtaining and maintaining all necessary licenses, certificates
of need and other approvals and operating in compliance with applicable health
care regulations.
The laws of all states prohibit physicians from splitting fees with
non-physicians and many states prohibit non-physician entities (such as the
Company) from practicing medicine and, in certain circumstances, from employing
physicians directly. The Company believes its current and planned activities do
not constitute fee-splitting, the practice of medicine or the direct employment
of physicians as contemplated by these laws. There can be no assurance, however,
that interpretations or enforcement of these laws will not force changes in the
Company's relationships with its facilities and physicians. In addition,
statutes in some states could restrict expansion of the Company's operations to
those jurisdictions.
Federal law prohibits the offer, payment, solicitation or receipt of any
form of remuneration in return for, or in order to induce (i) the referral of a
person for services, (ii) the furnishing or arranging for the furnishing of
items or services, or (iii) the purchase, lease or order or arranging or
recommending purchasing, leasing or ordering of any item or service, in each
case, reimbursable under Medicare or Medicaid. Pursuant to this anti-kickback
law, the federal government has recently announced a policy of
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increased scrutiny for joint ventures and other transactions among health care
providers in an effort to reduce potential fraud and abuse relating to Medicare
costs. In addition, federal legislation currently restricts the ability of
physicians to refer patients for clinical laboratory or certain other designated
health services to entities in which they have an ownership interest or other
compensation arrangement. Many states, including those in which the Company
presently does business, have similar anti-kickback and anti-referral laws.
A violation of the federal anti-kickback statute generally requires several
elements: (i) the offer, payment, solicitation, or receipt of remuneration; (ii)
the intent to induce referrals; and (iii) the ability of the parties to make or
influence referrals of patients for services reimbursable under Medicare or
Medicaid programs or to provide items or services reimbursable under such
programs. Noncompliance with, or violation of, the federal anti-kickback
legislation can result in exclusion from Medicare and Medicaid programs and
civil and criminal penalties. With respect to the self-referral prohibition, the
entity and the referring physician are prohibited from receiving Medicare or
Medicaid reimbursement for services rendered. Similar penalties are provided for
violation of state anti-kickback and anti-referral laws. The federal government
has promulgated "safe harbor" regulations that identify certain business and
payment practices deemed not to violate the federal anti-kickback statute.
Although the Company's business does not fall within certain of the current or
proposed safe harbors, the Company believes that its operations substantially
comply with such statutes and regulations.
The Company believes that its business arrangements do not involve the
referral of patients to entities with whom referring physicians have an
ownership interest or compensation arrangement within the meaning of federal and
state anti-referral laws, because referrals are made directly to other providers
rather than to entities in which referring physicians have an ownership or
compensation arrangement. The Company further believes its compensation
arrangements with physicians fall within various exceptions to state and federal
anti-referral laws, including exceptions for ownership or compensation
arrangements with certain managed care organizations and for physician incentive
plans that limit referrals. In addition, the Company believes that the methods
used to acquire existing physician practices and to recruit new physicians do
not violate anti-kickback and anti-referral laws and regulations.
If any of the Company's business arrangements were found to violate
anti-kickback or anti-referral laws, it could have a material adverse effect on
the Company's results of operations. The Company does not believe that its
operations generally are likely to be challenged or, if challenged, are likely
to be subject to an enforcement action.
Laws in all states regulate the business of insurance. Generally, the
business of insurance is defined to include the acceptance of financial risk.
Certain of the shared risk arrangements entered into by the Company could
possibly be characterized by some states as the business of insurance. The
Company, however, believes that the acceptance of capitation payments by a
health care provider does not constitute the conduct of the business of
insurance. Many states also regulate the establishment and operation of networks
of health care providers. Generally, these laws do not apply to the hiring and
contracting of physicians by other health care providers. There can be no
assurance that regulators of the states in which the Company operates would not
apply these laws to require licensing of the Company's operations as an insurer
or provider network. The Company believes that it is in compliance with these
laws in the states in which it does business, but there can be no assurance that
future interpretations of insurance laws and health care network laws by the
regulatory authorities in these states will not require licensing or a
restructuring of some or all of the Company's operations.
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RISK MANAGEMENT PROGRAM
The Company's management services include the provision of professional
liability insurance coverage for its affiliates. The Company maintains
professional liability insurance on a claims-made basis in amounts deemed
appropriate by management, based upon historical claims and the nature and risk
of its business. The Company's policy currently provides this coverage to the
Talbert Medical Groups through a professional liability policy in the amount of
$2 million per claim, and $12 million in the aggregate per policy year. The
Company has renewed its policy through February 15, 1997. However, there can be
no assurance that a future claim or claims will not exceed the limits of
available insurance coverage, that any insurer will remain solvent and able to
meet its obligations to provide coverage for any claim or claims, or that
coverage will continue to be available or available with sufficient limits on a
commercially reasonable basis to insure adequately the Company's operations.
Since January 1, 1996, substantially all claims have been made within 12 months
of incurrence, and no settlements have exceeded policy limits.
Physicians not directly employed by the Talbert Medical Groups are required
by contract to carry certain minimum amounts of professional liability insurance
coverage. These amounts generally correspond to statutory or customary minimums
in the physician's practice area.
In recent years, participants in the health care industry have become
subject to an increasing number of lawsuits alleging medical malpractice, bad
faith denial of services and other claims for recovery in connection with
alleged injuries or misconduct. Many of these lawsuits involve large claims and
substantial defense costs. The Company has significant operations in California,
where very large jury awards have been sustained by other companies for claims
alleging negligent or fraudulent withholding of approval for necessary medical
services. The Company monitors these kinds of cases in each jurisdiction and
considers litigation possibilities in the review and implementation of its risk
management programs.
Due to the nature of its business, the Company and some of its physicians
and officers from time to time may become involved as defendants in medical
malpractice lawsuits, and are subject to the attendant risk of substantial
damage awards. A significant source of potential liability in this regard is the
negligence of health care professionals employed or contracted by the Company
and its affiliates. See "Risk Factors-- Potential Claims Affecting the Company's
Industry; Insurance."
EMPLOYEES
At September 30, 1996, the Company had approximately 3,500 full-time
equivalent employees, including approximately 470 employees of the Talbert
Medical Groups. None of the Company's or the Talbert Medical Groups' employees
are subject to collective bargaining agreements. Management believes that its
employee relations are good.
PROPERTIES
The Company leases the facilities for its 52 Medical Centers, which range in
size from approximately 2,000 to 75,000 square feet. Monthly payments range from
$1,000 to $75,000. The facilities for 49 of the 52 Medical Centers are leased or
sub-leased under the Master Lease Agreement with FHP. See "Relationship with FHP
and PacifiCare Following the Offering--Master Lease Agreement." The Company
leases approximately 60,000 square feet in Costa Mesa, California for its
corporate headquarters and California regional office. Monthly rental payments
are approximately $51,700. The Company's other regional offices are contained in
the Medical Centers, except in Phoenix, Arizona, where a separate 12,600
square-foot regional office is leased for monthly payments of $5,040.
LEGAL PROCEEDINGS
During the ordinary course of business, the Company and its subsidiaries
have become a party to pending and threatened legal actions and proceedings.
Management of the Company is of the opinion, taking into account its insurance
coverage, that the outcome of the currently known legal actions and proceedings
will not, singly or in the aggregate, have a material effect on the consolidated
financial position of the Company and its subsidiaries.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information about the executive
officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- ------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Jack D. Massimino................................ 47 President, Chief Executive Officer and Director
Gloria L. Austin................................. 42 Senior Vice President
Becky J. Behlendorf.............................. 48 Vice President, Information Systems
Jennifer M. Gutzmore, M.D........................ 45 Vice President, Health Care Services
Regina B. Lightner............................... 46 Vice President, Marketing
Walter R. Stone.................................. 45 Vice President, Finance and Treasurer
Jack R. Anderson................................. 71 Chairman and Director
Richard M. Burdge, Sr............................ 69 Director
Warner Heineman.................................. 74 Director
Van B. Honeycutt................................. 52 Director
Robert W. Jamplis, M.D........................... 76 Director
Robert C. Maxson, Ed.D........................... 60 Director
Joseph F. Prevratil.............................. 58 Director
Westcott W. Price III............................ 57 Director
</TABLE>
JACK D. MASSIMINO has been President, Chief Executive Officer and a director
of the Company since November, 1996, and has held the same positions with TMMC
since December 1995. Mr. Massimino previously served FHP as Executive Vice
President since 1993, and added the responsibility of Chief Operating Officer in
1994. He also served in other executive positions since joining FHP in 1988,
including Senior Vice President and Vice President for Corporate Development.
Mr. Massimino is a director of the American Graduate School for International
Business World Business Advisory Council, and the Orange County Business
Committee for the Arts.
GLORIA L. AUSTIN has been Senior Vice President of the Company since
November 1996, and has held the same position with TMMC since December 1995. Ms.
Austin previously served as Senior Vice President of FHP's former staff model
operations from July 1995, and Senior Vice President, Health Care Delivery from
February 1995. She has also served in several executive capacities in FHP's
California and Utah regional operations, including Associate Vice President,
Utah Region Administration and Regional Vice President, Los Angeles. Ms. Austin
joined FHP in 1978.
BECKY J. BEHLENDORF has been Vice President, Information Systems of the
Company since November 1996, and has held the same position with TMMC since
January 1996. Ms. Behlendorf previously served as a strategic information
systems consultant to Beverly Enterprises, an owner and operator of skilled
nursing facilities, from July 1995 to January 1996. She was Associate Vice
President of Strategic Systems of Tenet Health Care from July 1993 to July 1995.
Prior to July 1993, Ms. Behlendorf spent 12 years with IBM in a variety of
technical and marketing positions, including three years as a health care
marketing manager, most notably as Brand Manager of Enterprise Systems.
JENNIFER M. GUTZMORE, M.D. has been Vice President, Health Care Services of
the Company since November 1996, and has held the same position at TMMC since
July 1995. Dr. Gutzmore previously served in a number of senior medical
management positions at FHP, including Senior Medical Director for Utilization
Management from February to July 1995, Senior Medical Director of Fountain
Valley Hospital from September 1994 to February 1995, Senior Medical Director of
Medicare from September 1992 to September 1994, and Senior Medical Director for
Health Care Delivery for FHP's southern California staff model operations from
March 1991 to September 1992. Dr. Gutzmore joined FHP in 1985.
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REGINA B. LIGHTNER has been Vice President, Marketing of the Company since
November 1996, and has held the same position with TMMC since April 1996. Ms.
Lightner served as Vice President of Government Health Care programs at CIGNA
Health Care from July 1994. She was Associate Vice President Region Sales and
Marketing at FHP from March 1990. She was Corporate Associate Vice President of
Sales at FHP from April 1988, and Director of Commercial Sales from February
1986. Ms. Lightner joined FHP in 1985.
WALTER R. STONE has been Vice President, Finance and Treasurer of the
Company since November 1996, and has held the same positions with TMMC since
December 1995. Mr. Stone was previously Corporate Vice President, Finance at FHP
since August 1992. He was Regional Vice President for FHP's staff model
operations from 1990 to 1992, and Regional Vice President for FHP's California
contracted care operations from 1988 to 1990. Mr. Stone joined FHP in 1980.
JACK R. ANDERSON has been Chairman and a director of the Company since
November 1996. Mr. Anderson will be appointed a director of PacifiCare in
connection with the FHP Merger. He has been a director of FHP since June 1994
and Chairman of the FHP Board of Directors since June 1995. He previously served
as Chairman of the Board of Directors of TakeCare, Inc. from 1988 to June 1994.
He has been President of Calver Corporation, a health care consulting and
investing firm, and a private investor since 1982. Mr. Anderson is a director of
Horizon Mental Health Management, Inc. and United Dental Care, Inc.
RICHARD M. BURDGE, SR. has been a director of the Company since November
1996. Mr. Burdge serves as the Chairman of the Compensation Committee. He has
been a director of FHP since July 1994. Mr. Burdge retired in 1984 as Executive
Vice President of CIGNA Corporation, a position he held from 1982 to 1984. He
served as Senior Executive Vice President of INA Corporation from 1980 to 1982
and as Executive Vice President of INA Corporation from 1975 to 1980. He also
served as President and Chief Operating Officer of the American Stock Exchange
from 1972 to 1975. Mr. Burdge is a director of First Commonwealth, Inc.
WARNER HEINEMAN has been a director of the Company since November 1996. Mr.
Heineman serves as the Chairman of the Audit Committee and as a member of the
Finance Committee. He has been a director of FHP since 1990. He has been a
senior advisor to First Business Bank since 1992. From 1989 to 1992, he served
as senior vice president of Bank of Los Angeles. Mr. Heineman also served as a
Senior Vice President of City National Bank from 1981 to 1988. In 1981 he
retired as Vice Chairman and Director of Union Bank after 38 years of service.
Mr. Heineman is a trustee of Southwestern University School of Law, a member of
the Board of Advisors of UCLA Medical Center and the Board of Visitors of UCLA
School of Medicine, a director of the FHP Foundation, Alexander Haagen
Properties, Inc. and the Countrybaskets Index Funds, Inc.
VAN B. HONEYCUTT has been a director of the Company since November 1996. Mr.
Honeycutt serves as a member of the Audit Committee. He has been a director of
FHP since November 1995. He has been President and Chief Executive Officer of
Computer Sciences Corporation since April 1995, and served as president and
chief operating officer of Computer Sciences Corporation from 1993 to 1995.
Computer Sciences Corporation is a publicly-traded company listed on the New
York Stock Exchange that provides information technology consulting, systems
integration and outsourcing services to industry and government. From 1987 to
1993, he served as corporate vice president and president of Computer Sciences
Corporation's Industry Services Group.
ROBERT W. JAMPLIS, M.D. has been a director of the Company since November
1996. Dr. Jamplis serves as a member of the Compensation Committee. He has been
a director of FHP since August 1995. Dr. Jamplis served as a director of
TakeCare, Inc. and two of its HMO subsidiaries prior to FHP's acquisition of
TakeCare, Inc. in 1994. He has been President and Chief Executive Officer of the
Palo Alto Medical Foundation since 1981, was named Executive Director of the
Palo Alto Clinic in 1966 and joined the Clinic in 1954. Dr. Jamplis has written
extensively and held leadership positions with numerous
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medical, academic and business organizations. He is a director of the Children's
Hospital at Stanford, the Santa Barbara Medical Foundation Clinic and the
American Cancer Society-California Division.
ROBERT C. MAXSON, ED.D. has been a director of the Company since November
1996. Dr. Maxson serves as a member of the Audit Committee. He has been a
director of FHP since August 1995. Dr. Maxson is a director of the FHP
Foundation, a position he is obligated to resign if he becomes a stockholder of
FHP. He has been president of California State University, Long Beach since
1994. Dr. Maxson served as the President of the University of Nevada, Las Vegas,
from 1984 to 1994. He has also served on the corporate boards of Bank of America
Nevada and Houston Security Bank.
JOSEPH F. PREVRATIL has been a director of the Company since November 1996.
Mr. Prevratil serves as Chairman of the Finance Committee and as a member of the
Compensation Committee. He will be appointed a director of PacifiCare in
connection with the FHP Merger. He has been a director of FHP since 1991. Mr.
Prevratil is a director and Chief Executive Officer of the FHP Foundation. From
1982 to 1988, Mr. Prevratil served as President of Wrather Port Properties,
Inc., an entertainment and hotel complex that included the Queen Mary oceanliner
in Long Beach, California. In 1988 and 1989 he served as Executive Director of
the Port of Long Beach. From 1989 to 1993, Mr. Prevratil was President of his
own business, providing contracted consulting and management services to the
leisure-time industry and the Redevelopment Agency of the City of Long Beach. In
1993, Mr. Prevratil became President of the RMS Foundation, Inc., a nonprofit
corporation operating the Queen Mary oceanliner attraction. Mr. Prevratil has
been the President of J&P Riverside Hotel Corp., the general partner in
Riverside Hotel Partners, Ltd., a limited partnership that owned and operated
the Sheraton Riverside Hotel. In February 1996, Riverside Hotel Partners, Ltd.
filed a petition under Chapter 11 of the federal bankruptcy laws.
WESTCOTT W. PRICE III has been a director of the Company since November
1996, and has held the same position at TMMC since December 1995. Mr. Price
serves as a member of the Finance Committee. He has been a member of the Board
of Directors of FHP since 1984 and its Vice Chairman since 1986. He became
President of FHP in 1989 and Chief Executive Officer of FHP in 1990. Mr. Price
is a director of the FHP Foundation.
CLASSIFIED BOARD OF DIRECTORS
Pursuant to the terms of the Certificate of Incorporation of the Company,
the Board of Directors is divided into three classes, designated Class I, Class
II and Class III. Class I, consisting of Messrs. Anderson, Burdge and Heineman,
will hold office initially for a term expiring at the annual meeting of
stockholders to be held in 1997, Class II, consisting of Mr. Honeycutt, Dr.
Jamplis and Mr. Massimino, will hold office initially for a term expiring at the
annual meeting of the stockholders to be held in 1998 and Class III, consisting
of Dr. Maxson, Mr. Prevratil and Mr. Price, will hold office initially for a
term expiring at the annual meeting of stockholders to be held in 1999. Each
director will hold office until the annual meeting for the year in which his
term expires and until his successor is duly elected and qualified. At each
annual meeting of the stockholders of the Company, the successors to the class
of directors whose terms expire at such meeting will be elected to hold office
for a term expiring at the annual meeting of stockholders held in the third year
following the year of their election. See "Description of Capital Stock--Certain
Anti-Takeover Effects." The Board of Directors elects officers annually and such
officers serve at the discretion of the Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has established a Finance Committee, an Audit
Committee and a Compensation Committee.
FINANCE COMMITTEE. The Finance Committee has the responsibility to review
the Company's capital resources and financing needs.
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AUDIT COMMITTEE. The Audit Committee has the responsibility to review and
supervise the financial controls of the Company. The Audit Committee makes
recommendations to the Board of Directors of the Company with respect to the
Company's financial statements and the appointment of independent auditors,
reviews significant audit and accounting policies and practices, meets with the
Company's independent public accountants concerning, among other things, the
scope of audits and reports, and reviews the performance of overall accounting
and financial controls of the Company.
COMPENSATION COMMITTEE. The Compensation Committee has the responsibility
to review the performance of the officers of the Company and recommend to the
Board of Directors annual salary and bonus amounts for all officers of the
Company. The Compensation Committee also has the responsibility for oversight
and administration of the Company's 1996 Stock Incentive Plan and other
compensatory plans.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Burdge (Chairman), Dr. Jamplis and Mr. Prevratil have served as members
of the Compensation Committee since the Company's organizational meeting in
November 1996. Each of the members of the Compensation Committee is a
non-employee Director of the Company. No executive officer of the Company during
the last fiscal year served as a member of a compensation committee or director
of another for-profit entity in a situation in which an executive officer of
such other entity served as a member of the Compensation Committee or Director
of the Company.
EXECUTIVE OFFICER AND DIRECTOR COMPENSATION
DIRECTOR COMPENSATION. The Company's 1996 Stock Incentive Plan provides
for initial and subsequent annual grants of nonqualified stock options to
non-employee directors. See "Stock Incentive Plan-- Non-Employee Director
Options." Except for reimbursement of expenses, directors are not otherwise
compensated for attending meetings of the Board of Directors or its committees.
EXECUTIVE OFFICER COMPENSATION. The following table presents certain
information concerning compensation paid by the Company or FHP for services
rendered during the year ended December 31, 1995, for the Chief Executive
Officer and the next four most highly compensated executive officers of the
Company (collectively, the "Named Executive Officers"). The Company did not have
its own executive compensation or employee benefit plans prior to September
1996. Certain of the amounts shown below reflect the participation of the Named
Executive Officers in plans administered by FHP. The table does not reflect
options to purchase FHP Common Stock awarded to the Named Executive Officers by
FHP.
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SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION(1)
--------------------------------------------------
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(2) BONUS(3) COMPENSATION(4)
- --------------------------------------------------------------- --------- ---------- --------- ----------------
<S> <C> <C> <C> <C>
Jack D. Massimino.............................................. 1995 $ 411,925(6) $ -- $ 13,560
President and Chief Executive Officer
Gary E. Goldstein, M.D.(5)..................................... 1995 249,995 1,549 13,050
Former Senior Vice President
Gloria L. Austin............................................... 1995 205,502 20,000 12,263
Senior Vice President
Jennifer M. Gutzmore, M.D...................................... 1995 175,036 3,000 12,325
Vice President, Health Care Services
Walter R. Stone................................................ 1995 148,627 -- 12,074
Vice President, Finance and Treasurer
</TABLE>
- ------------------------
(1) The dollar value of perquisites and other personal benefits did not exceed
the lesser of $50,000 or 10% of the Named Executive Officer's salary and
bonus.
(2) Includes the base salary earned by the Named Executive Officer during the
year and any voluntary salary reduction resulting from contributions for the
year by the Named Executive Officer to (a) the FHP ESOP under Section 401(k)
of the Code and (b) the FHP Deferred Compensation Plan.
(3) Includes the cash value of any bonus earned by the Named Executive Officer
during FHP's fiscal year ended June 30, 1995 and the cash value of any
voluntary bonus reductions resulting in contributions to (a) the FHP ESOP
under Section 401(k) of the Code and (b) the FHP Deferred Compensation Plan.
Does not include the cash value of bonuses earned with respect to FHP's
fiscal year ended June 30, 1996 as follows: Mr. Massimino--$591,700; Ms.
Austin--$645,280; Dr. Gutzmore--$156,806; and Mr. Stone--$258,833.
(4) Includes the dollar value of taxable income from group term life insurance
coverage in excess of $50,000 purchased by FHP as follows: Mr.
Massimino--$1,560; Dr. Goldstein--$1,050; Ms. Austin-- $263; Dr.
Gutzmore--$325; and Mr. Stone--$183. Also includes FHP contributions under
the FHP Money Purchase Plan as follows: Mr. Massimino--$9,000; Dr.
Goldstein--$9,000; Ms. Austin-- $9,000; Dr. Gutzmore--$9,000; and Mr.
Stone--$8,918. Also includes FHP contributions under the FHP ESOP as
follows: Mr. Massimino--$3,000; Dr. Goldstein--$3,000; Ms. Austin--$3,000;
Dr. Gutzmore--$3,000; and Mr. Stone--$2,973. Also includes FHP contributions
under the 401(k) portion of the FHP ESOP Plan as follows: Dr.
Goldstein--$500; and Mr. Stone--$500.
(5) Dr. Goldstein has not been employed by TMMC since July 12, 1996.
(6) Mr. Massimino's annual salary was reduced from $450,000 to $350,000
effective July 1, 1995.
OPTION GRANTS
The Company did not grant any options with respect to its Common Stock
during the fiscal year ended December 31, 1995. The Company has granted options
with respect to its Common Stock on two occasions in its current fiscal year,
including grants to the Named Executive Officers. See "--Stock Incentive Plan."
As of December 12, 1996, the Named Executive Officers held options with respect
to shares of Common Stock as follows: Mr. Massimino--26,082 (all of which are
November 1996 Options); Ms. Austin--5,353 (all of which are November 1996
Options); Dr. Gutzmore--7,500; and Mr. Stone-- 5,353 (all of which are November
1996 Options). There were no option exercises as of December 6, 1996.
48
<PAGE>
CHANGE IN CONTROL EMPLOYMENT AGREEMENTS
The Company will enter into agreements (the "Change in Control Employment
Agreements") providing for benefits in the event of a "Change of Control" of the
Company with the following executives: Jack D. Massimino, Gloria L. Austin,
Becky J. Behlendorf, Jennifer M. Gutzmore, M.D., Regina B. Lightner and Walter
R. Stone. Pursuant to the Change of Control Employment Agreements, certain
officers agree to forego any payments or benefits to which they were entitled
under similar agreements with FHP. For the purposes of the Change of Control
Employment Agreements, a Change of Control occurs when: (i) another party, other
than a Company-sponsored employee benefit plan, acquires (other than directly
from the Company) beneficial ownership of 20% or more of the Company's stock or
voting securities; (ii) there is a change in a majority of the current Board of
Directors (the "Incumbent Board") (excluding any persons approved by a vote of
the Incumbent Board other than in connection with an actual or threatened proxy
contest); or (iii) there is a consummation of a complete liquidation or
dissolution of the Company or a merger, consolidation or sale of all or
substantially all of the Company's assets (collectively, a "Business
Combination") other than a Business Combination in which: (a) all or
substantially all of the stockholders of the Company receive 70% or more of the
stock of the Company resulting from the Business Combination; (b) no party,
other than a Company sponsored employee benefit plan, beneficially owns,
directly or indirectly, 20% or more of the Company's stock or voting securities
except to the extent any such ownership existed prior to the Business
Combination; and (c) at least a majority of the board of directors of the
resulting corporation were members of the Incumbent Board.
The Change of Control Employment Agreements provide that the executive's
employment will continue for three years following a Hostile Change of Control
and for two years following a Change of Control that is not Hostile, in each
case on equivalent terms (including position, duties, compensation and benefits)
to those existing immediately prior to the Change of Control. A Change in
Control is "Hostile" if it results from an unsolicited proposal that is approved
by a majority of the disinterested directors prior to disclosure of the Change
in Control or if such disclosure is made without the prior approval of a
majority of the disinterested directors. If during the relevant period the
executive's employment is terminated other than for "Cause," death or
disability, or if the executive terminates his employment for "Good Reason" (as
defined in the Employment Agreements), the executive is entitled to receive an
accrued salary and annual incentive payment through the date of termination and,
except in the event of death or disability, payments and benefits including the
continuation of bi-weekly salary payments and certain medical, dental and life
insurance coverage for the relevant period, payment of accrued vacation, holiday
and personal leave time, and a lump sum payment equal to additional
contributions that would have been allocated to the executive's accounts under
the Company's 1996 Employee Stock Ownership Plan and 1996 Money Purchase Pension
Plan if the executive had remained employed for the relevant period and deferred
the maximum pretax deferral allowed under the terms of these plans and the
amount of any benefits under the 1996 Employee Stock Ownership Plan that were
forfeited upon termination of employment but that would have vested if the
executive remained employed for the relevant period. All of the executive's
outstanding option rights under the Company's 1996 Stock Incentive Plan will
immediately become exercisable and all restrictions on Restricted Stock will be
eliminated on the date of termination of employment, unless prohibited by law.
The Change of Control Employment Agreements also contain provisions with
respect to the acceleration of options. Upon termination of employment other
than voluntary or for Cause, death or Disability, after a Change of Control and
prior to the end to the relevant period, all outstanding options held by the
executive vest, except to the extent such vesting would result in an "excess
parachute payment" nondeductible by the Company or would prevent accounting for
the Change of Control as a "pooling-of-interest." Options that do not vest by
reason of the exception become exercisable in accordance with their original
vesting schedule and remain exercisable until 90 days thereafter (or, if
earlier, until the original expiration date), provided that within 30 days of
the executive's date of termination the executive satisfies the following two
requirements: (i) the executive executes and delivers to the Company a
Settlement and
49
<PAGE>
Release Agreement waiving all the claims against the Company and its affiliates
(other than obligations under the Change of Control Employment Agreement and
vested employee benefits); and (ii) the executive executes and delivers to the
Company a Covenant Not to Compete for the period through the end of the
Employment Period, imposing certain restrictions upon the executive conducting
the same business in the same cities and counties as carried on by the Company
at the effective date of a Change of Control.
STOCK INCENTIVE PLAN
The Company's 1996 Stock Incentive Plan (the "Stock Incentive Plan") was
adopted by the Board of Directors and approved by FHP as of September 1996. The
purpose of the Stock Incentive Plan is to provide long-term incentives to those
key employees (including executive officers), significant agents and consultants
responsible for the continued success and growth of the Company. In addition,
the Stock Incentive Plan is intended to enable the Company to attract, motivate
and retain experienced and knowledgeable independent directors.
The Stock Incentive Plan is administered by a committee (the "Committee"),
comprised of the Board of Directors or a committee consisting of two or more of
its members, each of whom is an "outside" director within the meaning of Section
162(m) of the Internal Revenue Code (the "Code"). The Committee may grant
discretionary awards to any officer, non-employee director, key employee, or
significant consultant or advisor to the Company. In addition, the Stock
Incentive Plan provides for the automatic grant of nonqualified stock options to
non-employee directors.
SHARES THAT MAY BE ISSUED UNDER THE STOCK INCENTIVE PLAN. A maximum of
180,000 shares of Common Stock, or approximately 5.7% of the issued and
outstanding shares of Common Stock (on a fully diluted basis), has been reserved
for issuance under the Stock Incentive Plan and may be issued upon the exercise
of stock options ("Options") or stock appreciation rights ("SARs") or pursuant
to awards of restricted stock ("Restricted Stock Awards") or performance share
awards ("Performance Awards") and stock bonuses ("Stock Bonuses") or
non-employee director options ("Non-Employee Director Options") (Options, SARs,
Restricted Stock Awards, Performance Awards, Stock Bonuses and Non-Employee
Director Options are collectively referred to as "Awards"). The maximum number
of shares of Common Stock that may be delivered pursuant to incentive stock
options is 50,000 shares. The maximum number of shares of Common Stock that may
be delivered as Non-Employee Director Options is 60,000. The maximum number of
shares subject to Options and SARs that are granted during any calendar year to
any individual is limited to 50,000. The 180,000 shares available under the
Stock Incentive Plan will be registered under a Form S-8 registration statement
expected to be filed with the Securities and Exchange Commission (the
"Commission") within 12 months of the effective date of the registration
statement relating to the Rights and the Common Stock offered hereby (the
"Registration Statement"). As is customary in incentive plans of this nature,
the number and kind of shares available under the Stock Incentive Plan are
subject to adjustment in the event of any extraordinary dividend or any
extraordinary distribution in respect of the Common Stock, or any
reclassification, recapitalization, stock split (including a stock split in the
form of a stock dividend), reverse stock split, reorganization, merger,
combination, consolidation, split-up, spin-off, combination, repurchase or
exchange of Common Stock or other securities of the Company, or there shall
occur any other like corporate transaction or event in respect of the Common
Stock or a sale of substantially all the assets of the Company. Shares relating
to Awards which expire or for any reason are cancelled, terminated, forfeited,
fail to vest, or are reacquired, will again become available for grant purposes
in the Stock Incentive Plan to the extent permitted by law.
Awards are not transferable by an Award holder other than as expressly
provided for under the Stock Incentive Plan or by law, and are exercisable,
during his or her lifetime, only by the Award holder. The Committee determines
the terms of Awards, including the number of shares subject to the Award,
exercise price, term and exercisability. Unless the Committee otherwise
expressly provides, no Award is exercisable or will vest prior to twelve months
after its grant date. In the case of Options or other rights to acquire
50
<PAGE>
Common Stock, an Award will expire not later than ten years after its grant date
(five years in the case of Incentive Stock Options granted to Option holders who
own more than 10% of the voting power of the Company's outstanding voting
stock).
STOCK OPTIONS. An Option is the right to purchase shares of Common Stock at
a future date at a specified price (the "Option Price"). The Option Price is
generally the closing price for a share of Common Stock on a national securities
exchange or quotation system on the date of the grant. An Option may either be
an incentive stock option, as defined in the Code, or a non-qualified stock
option. An incentive stock option may not be granted to a person who owns more
than 10% of the total combined voting power of all classes of stock of the
Company unless the Option Price is at least 110% of the fair market value of
shares of Common Stock subject to the Option. The aggregate fair market value of
shares of Common Stock (determined at the time the Option is granted) for which
incentive stock options may be first exercisable by an Option holder during any
calendar year under the Stock Incentive Plan or any other plan of the Company
may not exceed $100,000. A non-qualified stock option is not subject to any of
these limitations.
STOCK APPRECIATION RIGHTS. In its discretion, the Committee may grant a
SAR either concurrently with the grant of an another Award (the SAR may extend
to all or a portion of the shares covered by such other Awards), or
independently from another Award. Upon exercise of a SAR, the holder receives,
for each share with respect to which the SAR is exercised, an amount equal to
the excess of the fair market value of a share of Common Stock on the date of
exercise of the SAR over the exercise price per share of Common Stock under the
related Award.
RESTRICTED STOCK AWARDS. A Restricted Stock Award is an award for a fixed
number of shares of Common Stock subject to restrictions. The Committee will
specify the price, if any, the participant must pay for the shares and the
restrictions imposed on the shares, which will not terminate earlier than twelve
months after the award date, except to the extent the Committee may otherwise
provide. Restricted Stock awarded to a participant may not be voluntarily or
involuntarily sold, assigned, transferred, pledged or otherwise disposed of or
encumbered during the restricted period.
PERFORMANCE SHARE AWARDS AND STOCK BONUSES. A Performance Award is an award
of a right to receive shares of Common Stock or other compensation (including
cash), the issuance or payment of which is contingent upon the attainment of
performance objectives, among other things. The Committee may, in its discretion
grant Performance Awards based upon factors the Committee deems relevant in
light of the specific type and terms of the award. The Committee may provide for
full or partial credit for the completion of such performance objectives in the
event of death, or total disability, a change in control or certain other
circumstances. A Stock Bonus is an award of shares of Common Stock for no
consideration other than past services and without restriction other than
transfer restrictions set by the Committee.
Without limiting the generality of the foregoing, the Stock Incentive Plan
permits the Committee to grant certain other types of awards ("Performance-Based
Awards") that are intended to qualify as "performance based compensation" under
Section 162(m) of the Code. Under Section 162(m), the Company may not deduct
certain compensation of over $1,000,000 paid in any year to the Chief Executive
Officer or one of the four other most highly compensated executive officers of
the Company ("Executive Officers") unless, among other things, this compensation
qualifies as performance-based compensation under Section 162(m), and the
material terms of the plan for such compensation are approved by stockholders.
Options and SAR's that are granted under that Plan at a fair market value
exercise price are intended to qualify as performance-based compensation. In
addition, other share-based awards (such as restricted stock or performance
awards) that may be granted under the Stock Incentive Plan may qualify as
performance-based compensation under Section 162(m). The Stock Incentive Plan
also provides for the grant of Performance-Based Awards that are not denominated
nor payable in and do not have a value
51
<PAGE>
derived from the value of a price related to shares of Common Stock and are
payable only in cash ("Cash-Based Awards") that are intended to satisfy the
requirements for performance-based compensation under Section 162 (m).
The maximum amount payable to any participant under all Cash-Based Awards
that are intended to be Performance-Based Awards during any calendar year under
the Plan will be $1,000,000. The maximum number of shares of the Company's
Common Stock that may be subject to all Performance-Based Awards, including
stock options and stock appreciation rights, that are granted to any participant
during any calendar year will not exceed 100,000 shares, either individually or
in the aggregate.
ACCELERATION OF AWARDS; POSSIBLE EARLY TERMINATION OF AWARDS. Unless prior
to a Change in Control Event (as described below) the Committee determines that
upon its occurrence there will be no acceleration, then upon the occurrence of a
Change in Control Event, each Option and SAR will become immediately
exercisable, Restricted Stock will vest free of restrictions, and Performance
Shares will become payable. In general, a Change in Control Event includes: (i)
approval by the stockholders of the Company of the dissolution or liquidation of
the Company; (ii) any acquisition by a person or group (subject to certain
exceptions) of 20% or more of either the outstanding Common Stock or the
combined voting power of the Company's outstanding securities; (iii) a change in
the majority of the Company's directors; or (iv) consummation of a
reorganization, merger, consolidation, sale or other disposition of all or
substantially all of the assets of the Company under certain circumstances;
provided that no award will be accelerated as to any person subject to Section
16 of the Securities Act to a date less than six months after its applicable
date of grant. Options or other Awards not exercised prior to the dissolution of
the Company or a merger or other corporate event where the Company is not the
surviving corporation and where no provision is made for the assumption,
conversion, substitution or exchange of the Options or Awards, will terminate
upon the occurrence of such event.
TERMINATION OF OR CHANGES TO THE STOCK INCENTIVE PLAN. The Board of
Directors may terminate or amend the Stock Incentive Plan. Any amendment, to the
extent then required by the Code or as required by any other applicable law,
must be approved by the stockholders of the Company. Unless previously
terminated by the Board of Directors, the Stock Incentive Plan will terminate
ten years after the effective date.
NON-EMPLOYEE DIRECTOR OPTIONS. The Stock Incentive Plan provides for
automatic initial and subsequent annual grants of non-qualified stock options to
non-employee directors. Under the initial grant, made as of September 17, 1996,
the Chairman of the Board of Directors received options to purchase 6,000 shares
of Common Stock, the chairmen of the Audit, Compensation and Finance Committees
each received options to purchase 5,000 shares of Common Stock, and each other
non-employee director received options to purchase 3,000 shares of Common Stock.
Each person who subsequently becomes a non-employee director will receive an
initial grant of options to purchase 3,000 shares of Common Stock. Under the
subsequent automatic grant, each non-employee director then in office will be
granted options to purchase 1,000 shares on each anniversary of the director's
initial option grant. The September 17, 1996 grants to non-employee directors
will vest at the rate of 25% on the later of 90 days after the Award date or 60
days after the date of commencement of trading of the Common Stock on a national
securities exchange or quotation system (the "Initial Award Date") and 25% per
year on the first three anniversaries of the Initial Award Date. Each other
Non-Employee Director Option will vest at the rate of 25% per year commencing on
the first anniversary of the Award date and each of the next three anniversaries
thereof. Upon the occurrence of a Change in Control Event, each Non-Employee
Director Option will become immediately exercisable in full, provided that no
Non-Employee Director Option will be accelerated to a date prior to six months
after its grant date. To the extent any Non-Employee Director Option is not
exercised prior to (i) dissolution of the Company or (ii) a merger or other
corporate event that the Company does not survive, and no provision is made for
the assumption, conversion, substitution or exchange of the Non-Employee
Director Option, the Non-Employee Director Option will terminate upon the
occurrence of the Change in Control Event.
52
<PAGE>
GRANTS TO DATE. As of December 12, 1996, the Company had granted options
to purchase a total of 109,986 shares of Common Stock under the Stock Incentive
Plan. Employees received grants with respect to 76,986 shares, and non-employee
directors received grants with respect to 33,000 shares. Options with respect to
70,350 shares, including all of the non-employee director options, were granted
as of September 17, 1996, with an exercise price of $29.17 per share, and
options with respect to 39,636 shares were granted as of November 21, 1996, with
an exercise price of $10 per share. Options with respect to 37,350 shares
granted to employees as of September 17, 1996 will vest at the rate of 20% per
year on each of the first five anniversaries of the date of the grant. The
November 1996 Options provide for vesting of 40% of the total number of shares
awarded as of December 31, 1996 and 15% each January 1 from 2000 to 2003.
EMPLOYEE STOCK OWNERSHIP PLAN
The Talbert Medical Management Holdings Corporation Employee Stock Ownership
Plan (the "ESOP") is intended to be a tax-qualified retirement plan that
satisfies the requirements of Sections 401(a), 401(k), 501(a) and 4975 of the
Code. The Company's ESOP will have substantially the same terms as FHP's ESOP.
The account balances of Company employees (together with employees of the
Talbert Medical Groups) will be transferred from FHP's ESOP to the Company's
ESOP. The ESOP will provide for a discretionary employer stock bonus
contribution that can be made each year and allocated to the employer
contribution accounts of participants. The employer contribution account of each
participant will be subject to a five-year "cliff" vesting schedule.
Participants formerly employed by FHP will receive credit for their service at
FHP.
In addition, the ESOP will permit employees to elect to reduce their
salaries and make 401(k) contributions to the ESOP. The 401(k) account of each
participant will be 100% vested. The ESOP will also provide for matching
contributions in the same manner as the FHP ESOP. Accordingly, if a participant
has completed less than five years of service, the employer matching
contribution rate will equal 50% of the participant's 401(k) deferrals up to six
percent of the participant's compensation. If the participant has completed at
least five years of service, the employer matching contributions rate will equal
100% of the participant's 401(k) deferrals up to six percent of the
participant's compensation.
The ESOP will permit participants to direct the investment of their 401(k)
and employer matching accounts on a monthly basis. One of the available
investment funds under the ESOP will be a Company Common Stock fund. The ESOP
administrator may establish such rules and procedures as it deems necessary in
its sole discretion to ensure that the participants' investments in the Company
Common Stock fund will satisfy the requirements of all applicable law. Such
rules and procedures may include a prohibition on certain participants' ability
to invest in the Company Common Stock fund.
DEFERRED COMPENSATION PLAN
The Talbert Medical Management Holdings Corporation Deferred Compensation
Plan (the "Deferred Compensation Plan") will be virtually identical to FHP's
Deferred Compensation Plan. Accordingly, the Deferred Compensation Plan will be
a nonqualified deferred compensation plan and will permit the Company's
non-employee directors and a select group of management or highly compensated
employees to elect to defer compensation under the Deferred Compensation Plan.
The Deferred Compensation Plan will permit a minimum deferral of 3% with respect
to salaries (or, with respect to bonuses, 1%) and a maximum deferral of 50% with
respect to salaries (or, with respect to bonuses, 100%). The Deferred
Compensation Plan will also permit discretionary employer contributions. Amounts
deferred under the Deferred Compensation Plan will be credited to bookkeeping
accounts established and maintained for each participant.
The compensation deferral account of each participant will be 100% vested.
The employer contribution account of each participant will be subject to a
five-year "cliff" vesting schedule, but will become 100% vested in the event of
a Change-of-Control (as defined under the Deferred Compensation Plan).
53
<PAGE>
The Company's Deferred Compensation Plan will provide for the same
distribution options as under FHP's Deferred Compensation Plan including: (i)
short-term payout option; (ii) retirement benefit; (iii) termination
distribution (iv) survivor benefit; and (v) withdrawal election.
MONEY PURCHASE PENSION PLAN
The Talbert Medical Management Holdings Corporation Money Purchase Pension
Plan (the "Money Purchase Pension Plan") is intended to be a tax-qualified
retirement plan that satisfies the requirements of Sections 401(a) and 501(a) of
the Code. The Money Purchase Pension Plan will be virtually identical to FHP's
Money Purchase Pension Plan. Accordingly, the Money Purchase Pension Plan will
be frozen both as to contributions as well as to participation. The account
balances of Company employees and the employees of the Talbert Medical Groups
will be transferred from FHP's Money Purchase Pension Plan to the Money Purchase
Pension Plan. The accounts of each participant under the Money Purchase Pension
Plan will be 100% vested. In general, accounts will be distributable upon a
participant's termination from employment.
LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS
The Company's Certificate of Incorporation contains a provision eliminating
or limiting director liability for monetary damages arising from a breach of
fiduciary duty as a director, except for liability of a director (i) for any
breach of such director's duty of loyalty to the Company or its stockholders;
(ii) for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law; (iii) under the Delaware statutory
provision making directors personally liable, under a negligence standard, for
unlawful dividends or unlawful stock purchases or redemptions; or (iv) for any
transaction from which the director derived an improper personal benefit. As a
result of this provision, the ability of the Company or a stockholder thereof to
successfully prosecute an action against a director for a breach of his or her
duty of care is limited. However, the provision does not affect the availability
of equitable remedies such as an injunction or rescission based upon a
director's breach of his duty of care.
In addition, the Certificate of Incorporation and the Company's Bylaws
provide for mandatory indemnification rights, subject to limited exceptions, to
any person who by reason of the fact that he or she is a director or officer of
the Company, is involved in a legal proceeding of any nature if he or she acted
in good faith and in a manner he or she reasonably believed to be in and not
opposed to the best interests of the Company. If such legal proceeding is
brought by or in the right of the Company, no indemnification will be made if
the person is adjudged to be liable for negligence or misconduct in the
performance of his duty to the Company, unless a court finds such person to be
entitled to indemnity despite adjudication of liability. Such indemnification
rights include reimbursement for expenses incurred by such director or officer
in advance of the final disposition of such proceeding in accordance with the
applicable provisions of Delaware General Corporation Law.
The Company will enter into separate indemnification agreements with its
directors and executive officers. Each indemnification agreement provides for,
among other things: (i) indemnification against any and all expenses, judgments,
fines, penalties, and amounts paid in settlement of any claim that an indemnitee
was, is, or is threatened to be made a party to or witness or other participant
to unless it is determined, as provided in the indemnification agreement, that
indemnification is not permitted under law; and (ii) prompt advancement of
expenses to any indemnitee.
The Company also maintains directors' and officers' liability insurance. The
Company believes that the provisions of its Certificate of Incorporation,
Bylaws, indemnification agreements and insurance are necessary to attract and
retain qualified persons as directors and officers. At present, there is no
pending litigation or proceeding involving any director, officer, employee or
agent of the Company where indemnification would be required or permitted. The
Company is not aware of any threatened litigation or proceeding that might
result in a claim for such indemnification.
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CERTAIN TRANSACTIONS
In connection with the reorganization of the staff model operations of FHP
and the creation of TMMC and THSC, in March 1996 twelve individuals, then all
FHP or TMMC executives (the "Management Investors"), purchased shares of TMMC's
common stock (the "TMMC Management Shares") and shares of THSC's Common Stock
(the "THSC Management Shares") for an aggregate consideration of approximately
$8,000 pursuant to a Stock Purchase Agreement among FHP, TMMC, THSC and the
Management Investors (the "Management Stock Purchase Agreement").
In connection with the Acquisition, pursuant to a Management Stock Exchange
Agreement with the Company, the Management Investors will exchange their TMMC
and THSC Management Shares for an equivalent number of shares of the Company's
Common Stock, on equivalent terms and conditions as are provided in the
Management Stock Purchase Agreement (the "Company Management Shares"). See
"Relationship with FHP and PacifiCare Following the Offering--Management Stock
Exchange Agreement."
The Company Management Shares will be issued as follows:
<TABLE>
<CAPTION>
NAME NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
Jack D. Massimino.......................................................... 150,000(2)
Westcott W. Price III...................................................... 20,250
Gloria L. Austin........................................................... 15,000
Kathryn M. Adair........................................................... 7,500
Richard D. Jacobs.......................................................... 7,500
Larry L. Georgopolous...................................................... 6,000
Walter R. Stone............................................................ 6,000
Margaret Van Meter (1)..................................................... 6,000
Barbara C. McNutt.......................................................... 4,500
Gary E. Goldstein, M.D..................................................... 3,750
Kenneth S. Ord............................................................. 3,000
Michael J. Weinstock....................................................... 3,000
-------
Total: 232,500
-------
-------
</TABLE>
- ------------------------
(1) Ms. Van Meter has notified the Company that she intends to terminate her
employment in the first quarter of 1997. On July 1, 1996, 1,500 of her
Company Management Shares vested, and the remaining 4,500 will be
repurchased by FHP pursuant to its buy-back rights under the Management
Stock Purchase Agreement.
(2) Includes 15,000 shares held under an irrevocable trust for the benefit of
Mr. Massimino's children.
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RELATIONSHIP WITH FHP AND PACIFICARE FOLLOWING THE OFFERING
To govern certain of the ongoing relationships between the Company, FHP and
PacifiCare after the Offering and to provide mechanisms for an orderly
transition, the parties will enter into the various agreements described in this
section.
THE FOLLOWING SUMMARIES OF THE VARIOUS AGREEMENTS DO NOT PURPORT TO BE
COMPLETE AND ARE QUALIFIED IN THEIR ENTIRETY BY REFERENCE TO THEIR TEXT, COPIES
OF WHICH ARE FILED AS EXHIBITS TO THE REGISTRATION STATEMENT AND ARE
INCORPORATED HEREIN BY REFERENCE.
PROVIDER AGREEMENTS
Pursuant to the terms of the FHP Merger, TMMC, on behalf of the Talbert
Medical Groups, has entered into the New FHP Provider Agreements with various
HMO subsidiaries of FHP to provide medical and dental services to FHP plan
members. The New FHP Provider Agreements will become effective upon the
completion of the FHP Merger. Under the New FHP Provider Agreements TMMC, as
manager of the Talbert Medical Groups, unconditionally guarantees the
performance of each Talbert Medical Group. The New FHP Provider Agreements have
ten-year terms, except for Utah, which has a 15-year term. Capitation rates
established in the New FHP Provider Agreements are subject to renegotiation one
year after the Effective Time. If the parties are unable to agree upon new
rates, the existing rates will remain in effect.
The Talbert Medical Groups will be responsible for providing or arranging
all covered medical services to members of various FHP HMO subsidiaries in
accordance with professional standards. FHP will provide administration of the
health plan, marketing, enrollment, benefit design and interpretation, medical
management (including quality and utilization management) and claims processing.
The Talbert Medical Groups will receive compensation in two components: monthly
capitation payments (which are a percentage of premiums) and incentive
compensation, disbursed semi-annually, related to controlling hospital or
pharmacy costs, where applicable.
The New FHP Provider Agreements provide that the consent of FHP and
PacifiCare is required for any proposed sale or change in control of TMMC or a
Talbert Medical Group during the first two years of their term, which consent
will not be unreasonably withheld. The Talbert Medical Groups have agreed not to
seek or obtain a Medicare-risk contract with HCFA. The New FHP Provider
Agreements anticipate that FHP systems, compensation mechanisms and
administrative procedures will initially be followed, but will eventually
convert to PacifiCare systems, compensation mechanisms and administrative
procedures.
Unlike previous provider agreements with FHP, the New FHP Provider
Agreements do not contain any subsidies from FHP, and therefore will result in
lower revenues and higher costs per enrollee to the Company. See "Risk
Factors--Contracted Rate Decrease."
The Company also has recently entered into a provider agreement with
PacifiCare's California HMO subsidiary to provide medical and dental services to
its members. The terms of this agreement are substantially similar to those of
the New FHP Provider Agreements, but have already taken effect.
ACQUISITION AGREEMENT
The Company and FHP have entered into a Stock Purchase Agreement pursuant to
which the Company will acquire FHP's interest in TMMC and THSC (the "Acquisition
Agreement"). Under the Acquisition Agreement, the Company will purchase all of
the shares of the common stock held by FHP in exchange for the Rights and the
Talbert Note. The Talbert Note will be payable in an amount equal to the
proceeds of the Offering if fully subscribed. If the Offering is not fully
subscribed, the Company will sell to FHP any of its shares of Common Stock
unsubscribed in the Offering in exchange for the cancellation of any remaining
indebtedness under the Talbert Note. As a condition precedent to the Company's
obligations under the Acquisition Agreement, FHP will make the Capital
Contribution to TMMC.
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<PAGE>
MANAGEMENT STOCK EXCHANGE AGREEMENT
The Company and the Management Investors have entered into a Management
Stock Exchange Agreement, in the form of an amendment to the Management Stock
Purchase Agreement, pursuant to which the Management Investors will exchange
their TMMC and THSC Management Shares for Company Management Shares effective as
of the Closing Date of the FHP Merger. Transfer of Company Management Shares is
restricted; restrictions lapsed as to 25% of each Management Investor's shares
on July 1, 1996, and will lapse as to an additional 25% on July 1 of 1997, 1998
and 1999. FHP has the right to repurchase Company Management Shares: (i) in the
event of termination of employment and prior to the lapse of restrictions for
$.03 per share (other than the shares owned by Messrs. Ord, Price and
Weinstock); (ii) at any time before October 1, 1999 for $100 per share; or (iii)
in certain amounts if the Company fails to meet specified financial goals. These
prices are subject to adjustment by the Compensation Committee of the board of
directors of PacifiCare Holdings, plus one member of the Company's Board of
Directors. The Company Management Shares that are no longer restricted have the
registration rights discussed under "Description of Capital Stock--Registration
Rights."
STANDSTILL AGREEMENT
The Company and FHP have entered into a Standstill Agreement to define the
relationship between the Company and FHP with respect to the Common Stock and
voting securities of the Company held by FHP ("FHP Shares") following the
Acquisition. The Standstill Agreement provides that FHP (i) will vote the FHP
Shares in accordance with the votes of the non-FHP stockholders, (ii) will not
acquire additional shares of Common Stock, (iii) will be subject to certain
restrictions with respect to its ability to solicit proxies, make acquisition
proposals, become a member of a "group" (as defined in the federal securities
laws), or otherwise use its holdings of Common Stock to seek to exercise control
over the Company's management, and (iv) will be entitled to certain registration
rights. See "Description of Capital Stock-- Registration Rights." The Standstill
Agreement has a seven-year term. The Standstill Agreement will be null and void
if FHP reacquires shares of Common Stock unsubscribed for in the Offering in
excess of 20% of the total number of outstanding shares of Common Stock.
MASTER LEASE AGREEMENT
The Company and FHP have entered into the Master Lease Agreement to provide
for the lease, sublease or assignment by the Company of facilities and equipment
used by the Talbert Medical Groups that are either owned or leased by FHP. The
Master Lease Agreement will expire on December 31, 2000. The Master Lease
Agreement originally contained an option whereby FHP could require the Company
to purchase, and the Company could require FHP to sell, the real estate and
equipment subject to the Master Lease Agreement at its book value. The Master
Lease Agreement was amended in December 1996 to remove this option effective as
of January 1, 1996. Accordingly, the Company's consolidated financial statements
reflect the Master Lease Agreement as an operating lease. The Master Lease
Agreement, as amended, also provides that the parties will enter into individual
leases with respect to the real estate and equipment subject to the Master Lease
Agreement. The Company and FHP have agreed to certain additional amendments of
the Master Lease Agreement pursuant to a letter agreement. These amendments
include (i) the extension, at prevailing market rates, of the existing terms of
the individual leases to December 31, 2005, with the exception of leases with
respect to up to 90,000 square feet (of a total of approximately 472,000 square
feet) that the Company may elect not to renew; (ii) two five-year extension
options at prevailing market rates, exercisable solely at the Company's
discretion; (iii) a right of first offer for the Company to purchase the
furniture, fixtures and equipment subject to the Master Lease Agreement
("FF&E"). The parties have also agreed to enter into a separate lease agreement
with respect to FF&E that will expire in December 31, 2000.
ADMINISTRATIVE SERVICES AGREEMENT
The Company and FHP have entered an Administrative Services Agreement
pursuant to which FHP will provide information systems services to the Company
after the Expiration Date for up to one year. The Administrative Services
Agreement may be terminated earlier by: (i) 120 days written notice; (ii) 30
days written notice of a material breach, subject to cure; or (iii) mutual
agreement of the Company and FHP.
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<PAGE>
EMPLOYEE BENEFITS AND COMPENSATION ALLOCATION AGREEMENT
The Company and FHP have entered into an Employee Benefits and Compensation
Allocation Agreement (the "Benefits Agreement"), addressing certain employee
compensation and benefits matters. The Benefits Agreement provides for, among
other things: (i) effective as of the Expiration Date, the assumption by the
Company of all liabilities of FHP for benefits under certain nonqualified
deferred compensation plans with respect to employees who on or after the
Offering will be employees of the Company ("the Employees"); (ii) the transfer
of assets and liabilities from the FHP Money Purchase Pension Plan attributable
to the accounts of the Employees and the employees of the Talbert Medical Groups
(collectively with the Employees, the "Talbert Individuals") into a separate
tax-qualified pension plan and trust to be established by the Company; and (iii)
the transfer of assets and liabilities attributable to the accounts of the
Talbert Individuals under the FHP ESOP into a separate tax-qualified plan and
trust to be established by the Company.
The Benefits Agreement also provides that immediately prior to the Offering
the Company will establish a medical and dental plan that provides benefits to
the Employees similar to those provided by FHP. Coverage will be effective
immediately and the plan will not impose any pre-existing condition limitations
or exclusions with respect to the Employees. The Company will continue to
maintain the medical and dental plan (or comparable plans) for a period of at
least one year following the Offering.
The Benefits Agreement provides for certain adjustments to outstanding
employee stock options under FHP's Executive Incentive Plan (the "EIP").
Pursuant to Section 4.8 of the FHP Merger Agreement, options under the EIP that
are outstanding as of the date of merger of FHP with PacifiCare Holdings will
either be (i) cashed out in accordance with Section 4.8(a) of the FHP Merger
Agreement or (ii) exchanged for options (the "Exchange Options") to purchase
shares of Class B Common Stock, par value of $.01 per share, of PacifiCare
Holdings.
The Benefits Agreement provides that no severance benefits will be payable
to the Employees as a result of the Offering. The Benefits Agreement will become
effective only if, upon completion of the Offering, FHP owns less than 50% of
the outstanding shares of Common Stock.
TAX ALLOCATION AGREEMENT
The Company and FHP have entered into a Tax Allocation Agreement that
provides for FHP, among other things, to file all tax returns with respect to,
and to pay all taxes imposed upon or attributable to, FHP and its affiliates for
all taxable periods, including the taxes incurred in connection with the
Offering. The Company generally has agreed, among other things, to file all tax
returns with respect to the Company for all taxable periods beginning after the
expiration of the Rights and to pay all taxes imposed upon or attributable to
the Company for all taxable periods ending after the Acquisition. The Company
will indemnify FHP against any adverse adjustment, or receive from FHP the
benefit of any favorable adjustment, of an FHP return to the extent that the
adjustment (i) relates to a taxable period prior to the Acquisition, (ii) arises
out of the Company's activities, and (iii) when combined with all other such
adjustments that have occurred, exceeds $2 million, but does not exceed $4
million. The Company and FHP will share equally the liability for, or the
benefit of, such an adjustment to the extent any such adjustment, when combined
with all other such adjustments that have occurred, exceeds $4 million. The Tax
Allocation Agreement will become effective only if, upon completion of the
Offering, FHP owns less than 50% of the outstanding shares of Common Stock.
ALLOCATION OF LIABILITIES AND INDEMNIFICATION AGREEMENT
The Company and FHP have entered into an Allocation of Liabilities and
Indemnification Agreement ("the Assumption Agreement") to provide for
assumptions of liabilities and cross-indemnities designed to allocate between
them financial responsibility for certain liabilities. Under the Assumption
Agreement, the Company will assume, to the extent they arose from the nature of
the business of TMMC or THSC: (i) any liabilities that are known and reserved
against, from January 1, 1996; and (ii) any liabilities that are unknown and not
reserved against (other than malpractice liabilities), from January 1, 1994. All
other liabilities will be assumed by FHP. The Assumption Agreement will become
effective only if, upon completion of the Offering, FHP owns less than 50% of
the outstanding shares of Common Stock.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Common Stock as of October 31, 1996 (except as
otherwise indicated), and as adjusted to give effect to the Offering, in each
case by (a) FHP, (b) each stockholder who would have the opportunity to
beneficially own 5% or more of the outstanding shares of Common Stock based on
ownership of FHP Common or Preferred Stock, (c) each director and Named
Executive Officer of the Company, and (d) all directors and executive officers
of the Company as a group. The adjustments to give effect to the Offering assume
that each Rights holder fully exercises his or her Basic Subscription Privilege.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP PRIOR BENEFICIAL OWNERSHIP AFTER
TO OFFERING(2) OFFERING(2)(3)
--------------------------- NUMBER OF -----------------------------
NUMBER OF SHARES BEING NUMBER OF
NAME OF BENEFICIAL OWNER(1) SHARES PERCENT OFFERED SHARES PERCENT
- ----------------------------------- ----------- ------- ------------ --------- -------
<S> <C> <C> <C> <C> <C>
FHP International Corporation ..... 2,767,500 92.25% 2,767,500 -- --
3120 Lake Center Drive
Santa Ana, California 92704
Jack D. Massimino.................. 160,433(4)(5)(6) 5.3% -- 166,619(7)(8) 5.5%
Gloria L. Austin................... 17,141(4)(6) * -- 18,516(7)(8) *
Jennifer M. Gutzmore, M.D.......... -- * -- 188(7)(8) *
Walter R. Stone.................... 8,141(4)(6) * -- 10,464(7)(8) *
Gary E. Goldstein, M.D............. 3,750(4) * -- 6,573 *
Heine Securities Corporation ...... -- -- -- 285,172(9) 9.5%
51 John F. Kennedy Parkway
Short Hills, New Jersey 07078
Neuberger & Berman L.P. ........... -- -- -- 196,918(10) 6.6%
605 Third Avenue
New York, New York 10158
The Capital Group Companies, Inc. . -- -- -- 192,692(11) 6.4%
333 South Hope Street
Los Angeles, California 90071
Jack R. Anderson................... -- -- -- 143,600(7)(12) 4.8%
Richard M. Burdge, Sr.............. -- -- -- 41,517(7)(13) 1.4%
Warner Heineman.................... -- -- -- 1,167(7)(14) *
Van B. Honeycutt................... -- -- -- -- --
Robert W. Jamplis, M.D............. -- -- -- 234(7)(15) *
Robert C. Maxson, Ed.D............. -- -- -- -- --
Joseph F. Prevratil................ -- -- -- 1,827(7)(16) *
Westcott W. Price III.............. 20,250(4) * -- 45,142(7)(17) 1.5%
All executive officers and
directors as
a group (15 persons)............. 205,965(4) 6.8% -- 429,087(7) 14.2%
</TABLE>
- --------------------------
* Less than one percent.
(1) Unless otherwise indicated, the address of each of the stockholders named in
this table is: c/o Talbert Medical Management Holdings Corporation, 3540
Howard Way, Costa Mesa, California 92626.
(2) Unless otherwise indicated in the footnotes to this table and subject to the
community property laws where applicable, each of the stockholders named in
this table has sole voting authority and investment discretion with respect
to the shares shown as beneficially owned.
(3) Based on an estimated 42,101,000 shares of FHP Common Stock and 21,039,058
shares of FHP Preferred Stock outstanding as of the Effective Date.
(4) Transfer of these shares is restricted pursuant to the Management Stock
Purchase Agreement dated as of March 15, 1996 between the Management
Investors, the Company and FHP.
(5) Includes 15,000 shares held under an irrevocable trust for the benefit of
Mr. Massimino's children.
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<PAGE>
(6) Based on beneficial ownership of Common Stock that includes stock options
exercisable within 60 days after December 6, 1996.
(7) Based on beneficial ownership of FHP Common Stock that includes stock
options exercisable 60 days after October 31, 1996.
(8) Based on beneficial ownership of FHP Common Stock that includes shares held
by the trustee under the FHP ESOP. As of December 31, 1995, the approximate
number of shares of FHP Common Stock allocated to the ESOP accounts of the
individuals named above were as follows: Mr. Price--5,297 shares; Mr.
Massimino--3,291 shares; Ms. Austin--2,108 shares; Dr. Gutzmore--2,313; and
Mr. Stone--2,784.
(9) Based on beneficial ownership of 5,694,226 shares of FHP Common Stock and
486,592 shares of FHP Preferred Stock, as reported on Schedule 13F for the
period ended June 30, 1996.
(10) Based on beneficial ownership of a total of 4,001,346 shares of FHP Common
Stock and 250,000 shares of FHP Preferred Stock, as reported on Schedule 13F
for the period ended June 30, 1996. Schedule 13F states that (i) Neuberger &
Berman L.P. has shared investment discretion and sole voting authority with
respect to 568,046 shares of FHP Common Stock; (ii) Neuberger & Berman
Institutional Asset Management Division has shared investment discretion and
no voting authority with respect to 1,075,400 shares of FHP Common Stock;
and (iii) Neuberger & Berman Management Incorporated has shared investment
discretion and no voting authority with respect to 2,357,900 shares of FHP
Common Stock and 250,000 shares of FHP Preferred Stock.
(11) Based on beneficial ownership of a total of 3,238,300 shares of FHP Common
Stock and 1,084,300 shares of FHP Preferred Stock, as reported on Schedule
13F for the period ended June 30, 1996. Schedule 13F states that (i) Capital
Guardian Trust Company has shared investment discretion with respect to
1,862,900 shares of FHP Common Stock and 299,300 shares of FHP Preferred
Stock, sole voting authority with respect to 1,653,900 shares of FHP Common
Stock and 293,300 shares of FHP Preferred Stock and no voting authority with
respect to 209,000 shares of FHP Common Stock and 6,000 shares of FHP
Preferred Stock; (ii) Capital Research and Management Company has shared
investment discretion and no voting authority with respect to 1,375,400
shares of FHP Common Stock and 785,000 shares of FHP Preferred Stock; and
(iii) Capital Group Companies, Inc. exercises investment discretion over
both Capital Guardian Trust Company and Capital Research and Management
Company.
(12) Based on beneficial ownership of 829,518 shares of FHP Common Stock and
2,771,794 shares of FHP Preferred Stock as of October 31, 1996, including
(i) 137,202 shares of FHP Common Stock and 457,340 shares of FHP Preferred
Stock held by Mr. Anderson's wife, and (ii) 271,200 shares of Common Stock
and 904,000 shares of FHP Preferred Stock held by trusts of which Mr.
Anderson's relatives are beneficiaries. Mr. Anderson disclaims beneficial
ownership of these shares.
(13) Based on beneficial ownership of 287,630 shares of FHP Common Stock and
742,104 shares of FHP Preferred Stock as of October 31, 1996, including
25,030 shares of FHP Common Stock and 83,438 shares of FHP Preferred Stock
held by Mr. Burdge's wife. Also includes 48,000 shares of FHP Common Stock
held by a trust of which Mr. Burdge's relatives are beneficiaries. Mr.
Burdge disclaims beneficial ownership of these shares.
(14) Based on beneficial ownership of 24,900 shares of FHP Common Stock as of
October 31, 1996.
(15) Based on beneficial ownership of 5,000 shares of FHP Common Stock as of
October 31, 1996.
(16) Based on beneficial ownership of 37,000 shares of FHP Common Stock as of
October 31, 1996.
(17) Based on beneficial ownership of 531,297 shares of FHP Common Stock as of
October 31, 1996, including shares held under a revocable trust controlled
by Mr. Price.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company's Certificate of Incorporation provides that the Company may
issue up to 15 million shares of common stock, par value $0.01 per share (the
"Common Stock"), and 1.2 million shares of preferred stock, par value $0.01 per
share (the "Preferred Stock"). Immediately preceding the Offering, there will be
232,500 shares of Common Stock and no shares of Preferred Stock issued and
outstanding, held by 13 stockholders of record.
COMMON STOCK
The holders of Common Stock are entitled to one vote for each share held of
record on all matters to be submitted to a vote of stockholders and do not have
preemptive rights. The holders of Common Stock do not have cumulative voting
rights. Subject to any preferential rights of any outstanding series of
Preferred Stock, the holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by the Board of
Directors of the Company from funds legally available therefor. In the event of
the liquidation, dissolution or winding up of the Company, the holders of Common
Stock are entitled to share ratably in all assets remaining after payment of
liabilities.
PREFERRED STOCK
The Company's Board of Directors has the authority, without any vote or
action by stockholders, to issue Preferred Stock in one or more series and to
fix the designations, preferences, rights, qualifications, limitations and
restrictions thereof, including dividend rights, dividend rates, conversion
rights and terms, voting rights, redemption rights, prices and terms (including
any sinking fund provisions), liquidation preferences and the number of shares
constituting any series. In connection with the Stockholders Rights Agreement,
the Board of Directors has authorized a series of Preferred Stock designated as
"Junior Participating Preferred Stock" that may be issued upon the exercise of
rights distributed to all holders of Common Stock. See "Description of Capital
Stock--Certain Anti-Takeover Effects." Although the Company has no present plans
to issue any shares of Preferred Stock following the consummation of the
Offering, the issuance of shares of Preferred Stock, or the issuance of rights
to purchase such shares, may have the effect of delaying, deferring or
preventing a change in control of the Company or an unsolicited acquisition
proposal.
CERTAIN ANTI-TAKEOVER EFFECTS
Certain provisions of the Rights, the Company's Certificate of
Incorporation, Bylaws and other agreements to which the Company is a party
summarized in the following paragraphs may be deemed to have anti-takeover
effects and may delay, defer or prevent a tender offer or takeover attempt that
a stockholder might favor, including those attempts that might result in a
premium over the market price for the shares held by stockholders.
EXERCISE CAP. The Rights may not be exercised to the extent that the holder
would become the beneficial owner of more than 8% of the shares of Common Stock
outstanding, subject to certain exceptions. See "The Offering--Exercise Cap."
This exercise cap may hinder efforts to accumulate Rights to purchase Common
Stock prior to the Expiration Date.
CLASSIFIED BOARD OF DIRECTORS. The Company's Certificate of Incorporation
and Bylaws provide for the Board of Directors to be divided into three classes
of directors, as nearly equal in number as possible, serving staggered terms so
that directors' initial terms will expire at the 1997, 1998 or 1999 annual
meeting of stockholders. Starting with the 1997 annual meeting of stockholders,
one class of directors will be elected each year for a three-year term. A
director may be removed by the stockholders of the Company only for cause. See
"Management--Classified Board of Directors."
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<PAGE>
The Company believes that a classified Board of Directors will help to
assure the continuity and stability of the Board of Directors and the Company's
business strategies and policies as determined by the Board of Directors, since
a majority of the directors at any given time will have had prior experience as
directors of the Company. The Company believes that this, in turn, will permit
the Board of Directors to more effectively represent the interests of
stockholders.
With a classified Board of Directors, at least two annual meetings of the
Company's stockholders, instead of one, would generally be required to effect a
change in the majority of the Board of Directors. As a result, a provision
relating to a classified Board of Directors may discourage proxy contests for
the election of directors or purchases of a substantial block of the Common
Stock because this provision could operate to prevent obtaining control of the
Board of Directors in a relatively short period of time. The classification
provision could also have the effect of discouraging a third party from making a
tender offer to otherwise attempt to obtain control of the Company.
ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER PROPOSALS AND STOCKHOLDER
NOMINATIONS OF DIRECTORS. The Company's Bylaws establish an advance notice
procedure with regard to the nomination, other than by or at the direction of
the Board of Directors or a committee thereof, of candidates for election as
directors (the "Nomination Procedure") and with regard to other matters to be
brought by stockholders before an annual meeting of stockholders of the Company
(the "Business Procedure"). The Nomination Procedure requires that a stockholder
give prior written notice, in proper form, of a planned nomination for the Board
of Directors to the Secretary of the Company. The requirements as to the form
and timing of that notice are specified in the Bylaws. If the Chairman of the
Board of Directors determines that a person was not nominated in accordance with
the Nomination Procedure, the person will not be eligible for election as a
director. Under the Business Procedure, a stockholder seeking to have any
business conducted at an annual meeting must give prior written notice, in
proper form, to the Secretary of the Company. The requirements as to the form
and timing of that notice are specified in the Bylaws.
Although the Bylaws do not give the Board of Directors any power to approve
or disapprove stockholder nominations for the election of directors or of any
other business desired by stockholders to be conducted at an annual or any other
meeting, the Bylaws: (i) may have the effect of precluding a nomination for the
election of directors or precluding the conduct of business at a particular
annual meeting if the proper procedures are not followed; or (ii) may discourage
a deter a third party from conducting a solicitation of proxies to elect its own
slate of directors or otherwise attempting to obtain control of the Company,
even if the conduct of such solicitation or such attempt might be beneficial to
the Company and its stockholders.
LIMITATIONS ON STOCKHOLDER ACTION BY WRITTEN CONSENT. The Company's
Certificate of Incorporation prohibits stockholder action by written consent in
lieu of a meeting, and provides that stockholder action can be taken only at an
annual or special meeting of stockholders. Special meetings of stockholders may
be called only by the Board of Directors, but if FHP acquires in excess of 20%
of the outstanding Common Stock from unsubscribed shares in the Offering, a
special meeting of stockholders may be called at the written request of
stockholders entitled to cast in excess of 20% of the votes entitled to be cast
at the special meeting. These provisions may have the effect of delaying
consideration of a stockholder proposal until the next annual meeting, unless a
special meeting is called by the Board of Directors.
SUPERMAJORITY VOTE FOR BUSINESS COMBINATIONS. The Company's Certificate of
Incorporation provides that the affirmative vote of at least 66 2/3% of the
outstanding shares of the Company then entitled to vote is required for certain
business combinations, including a merger, or disposition of substantially all
the assets, of the Company. This requirement is not applicable if the Board of
Directors approves the transaction by a resolution adopted by 66 2/3% of its
members. These provisions will not take effect if FHP acquires in excess of 20%
of the outstanding Common Stock from unsubscribed shares in the Offering.
62
<PAGE>
AMENDMENT OF CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION AND
BYLAWS. The Company's Certificate of Incorporation and the Bylaws provide that
the affirmative vote of the holders of at least 66 2/3% of the outstanding
shares of the Company then entitled to vote on the matter is required to amend
the Bylaws and certain provisions of the Certificate of Incorporation, including
those provisions relating to the number of directors, the filling of vacancies
on the Board of Directors, the prohibition on stockholder action without a
meeting, indemnification of directors, officers and others, the limitation on
liability of directors and the supermajority voting requirements in the
Certificate of Incorporation and Bylaws. The Certificate of Incorporation
further provides that the Bylaws may be amended by the Board of Directors,
except that if FHP does not acquire in excess of 20% of the outstanding Common
Stock solely through the transfer of shares unsubscribed in the Offering, the
authorized number of directors may not be amended without the affirmative vote
of the holders of at least 75% of the outstanding shares of the Company then
entitled to vote on the matter. These voting requirements will have the effect
of making more difficult any amendment by stockholders, even if a majority of
the Company's stockholders believes that the amendment would be in its best
interests.
DELAWARE TAKEOVER STATUTE. The Company is subject to Section 203 of the
Delaware General Corporation Law which, subject to certain exceptions, prohibits
a Delaware corporation from engaging in any of a broad range of business
combinations with any "interested stockholder" for a period of three years
following the date that the stockholder became an interested stockholder,
unless: (i) prior to such date, the Board of Directors of the corporation
approved either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder; (ii) upon consummation of the
transaction that resulted in the stockholder becoming an interested stockholder,
the interested stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced, excluding for
purposes of determining the number of shares outstanding those shares owned (a)
by persons who are directors and also officers and (b) by employee stock plans
in which employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or exchange
offer; or (iii) on or after to such date, the business combination is approved
by the Board of Directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at least
66 2/3% of the outstanding voting stock that is not owned by the interested
stockholder. An "interested stockholder" is defined as any person that is (a)
the owner of 15% or more of the outstanding voting stock of the corporation or
(b) an affiliate or associate of the corporation and was the owner of 15% or
more of the outstanding voting stock of the corporation at any time within the
three-year period immediately prior to the date on which it is sought to be
determined whether such person is an interested stockholder.
RIGHTS AGREEMENT. As of the Expiration Date, pursuant to a Stockholder
Rights Agreement between the Company and American Stock Transfer & Trust
Company, as Rights Agent, the Company has declared a dividend distribution to
all holders of Common Stock of a right to purchase a unit initially consisting
of one one-hundredth of a share of Junior Participating Preferred Stock upon the
terms and conditions set forth in that agreement. The Stockholder Rights
Agreement is designed to give the Board of Directors the time and opportunity to
protect stockholder interests and encourage equal treatment of all stockholders
in a takeover situation. In the event of a takeover attempt, the holders of the
rights may exercise them to purchase Common Stock at a 50% discount, or, in the
event of a "squeeze-out" transaction where the Company would not be the
surviving entity, the acquiring company's common stock at a 50% discount. The
issuance of these rights may have the effect of delaying, deferring or
preventing a change in control of the Company or an unsolicited acquisition
proposal.
The Stockholder Rights Agreement provides for a trigger percentage of 8% for
the 90-day period following the Expiration Date, and 15% thereafter. Certain
persons who acquire Common Stock in excess of the trigger percentage will not
trigger the rights, including, with certain limitations, (i) persons who acquire
such Common Stock solely as a result of the exercise of Rights distributed to
them in the Offering, (ii) FHP, if it acquires such Common Stock solely through
the transfer of shares unsubscribed in the
63
<PAGE>
Offering, and (iii) transferees of FHP, if FHP acquires in excess of 20% of the
outstanding Common Stock solely through the transfer of shares unsubscribed in
the Offering.
REGISTRATION RIGHTS
The Management Investors have certain piggyback registration rights.
Accordingly, if the Company proposes to register any of its Common Stock,
whether or not for sale for its own account, with certain exceptions, the
Company is required to notify the Management Investors and use its best efforts
to include the shares of Common Stock requested to be included by them, provided
that the Company may determine for any reason not to register such securities
and shall be relieved of its obligation to use best efforts to effect
registration of such securities. These registration rights are subject to
rejection of such shares under certain circumstances by the underwriter of an
underwritten offering and to a lock-up period to be determined by the Company
and the underwriters, except as part of such underwritten offering.
Under the Standstill Agreement, FHP has certain shelf registration rights
whereby at any time following one year after the Expiration Date, FHP may
require the Company to file and maintain a shelf registration statement to
effect the registration of Common Stock, if any, owned by FHP. FHP will also
have registration rights to participate in certain underwritten public offerings
by the Company.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is American Stock
Transfer & Trust Company.
LEGAL MATTERS
Certain matters with respect to the validity of the issuance of Common Stock
offered hereby are being passed upon for the Company by O'Melveny & Myers LLP,
Los Angeles, California.
EXPERTS
The financial statements as of December 31, 1995 and 1994 and for each of
the three years in the period ended December 31, 1995 included in this
prospectus have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their report appearing herein, and have been so included in reliance
upon the report of such firm given upon their authority as experts in accounting
and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a registration statement on Form
S-1 (the "Registration Statement," which term encompasses all amendments,
exhibits and schedules thereto), under the Securities Act, with respect to the
Rights and the Common Stock offered hereby. This Prospectus, which constitutes a
part of the Registration Statement, does not contain all the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission, and to which
reference hereby is made. Statements made in this Prospectus as to the contents
of any contract, agreement or other document referred to are not necessarily
complete. With respect to each such contract, agreement or other document filed
as an exhibit to the Registration Statement, reference hereby is made to the
exhibit for a more complete description of the matter involved, and each such
statement shall be deemed qualified in its entirety by such reference. The
Registration Statement filed by the Company with the Commission, as well as such
reports and other information filed by the Company with the Commission, may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and at the regional offices of the Commission located at 7 World
Trade Center, 13th Floor, New York, New York 10048, and at Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of
such material, when filed, may also be obtained from the Public
64
<PAGE>
Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549 at prescribed rates.
Upon consummation of the Offering, the Company will become subject to the
informational requirements of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), and, in accordance therewith, will file reports and other
information with the Commission in accordance with the Commission's rules. Such
reports and other information concerning the Company may be inspected and copied
at the public reference facilities and regional offices of the Commission
referred to above.
The Company intends to furnish its stockholders annual reports containing
audited consolidated financial statements and an opinion thereon expressed by
independent auditors, and quarterly reports for the first three quarters of each
fiscal year containing unaudited interim financial information.
FHP and PacifiCare have filed a joint proxy statement/prospectus on Schedule
14A (the "FHP Merger Proxy Statement," which term encompasses all amendments,
exhibits, and schedules thereto), under Section 14(a) of the Exchange Act, with
respect to the FHP Merger and certain other matters. PacifiCare is, and prior to
the FHP Merger FHP will be, subject to the information requirements of the
Exchange Act, and, in accordance therewith, will file reports and information
with the Commission in accordance with the Commission's rules which may be
obtained as described above.
The Commission maintains a World Wide Web site that contains reports, proxy
and information statements and other information regarding registrants that file
electronically with the Commission. The address of the site is
http://www.sec.gov.
65
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
REFERENCE
-------------
<S> <C>
Independent Auditors' Report........................................................................... F-2
Consolidated Balance Sheets, as of December 31, 1994 and 1995 (audited), and September 30, 1996
(unaudited).......................................................................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1993, 1994 and 1995 (audited),
and the nine months ended September 30, 1995 and 1996 (unaudited).................................... F-4
Consolidated Statements of Stockholders' Deficit for the years ended December 31, 1993, 1994 and 1995
(audited), and the nine months ended September 30, 1996 (unaudited).................................. F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995 (audited),
and the nine months ended September 30, 1995 and 1996 (unaudited).................................... F-6
Notes to Consolidated Financial Statements............................................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Talbert Medical Management Holdings Corporation
We have audited the accompanying consolidated balance sheets of Talbert
Medical Management Holdings Corporation and its subsidiaries ("the Company") as
of December 31, 1994 and 1995, and the related consolidated statements of
operations, stockholders' deficit, and cash flows for each of the three years in
the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Talbert Medical Management
Holdings Corporation and its subsidiaries as of December 31, 1994 and 1995, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1995, in conformity with generally accepted
accounting principles.
As more fully described in Note 1, the Company is part of FHP International
Corporation ("FHP") and had no separate legal status or existence through
December 31, 1995. The Company had various transactions with FHP, including
various expense allocations and reimbursements, that are material in amount. The
financial statements of the Company have been prepared from separate records
maintained by the Company as well as from the combined records of FHP, and may
not necessarily be indicative of the conditions that would have existed if the
Company had operated as an independent entity.
Costa Mesa, California
December 11, 1996 (January , 1997 as to the effects
of the acquisition described in Note 1)
The accompanying consolidated financial statements have been prepared as if
the acquisition of Talbert Medical Management Corporation and Talbert Health
Services Corporation by Talbert Medical Management Holdings Corporation,
anticipated to occur in January 1997, had been completed on the basis
substantially identical to that described herein. The above opinion is in the
form which will be signed by Deloitte & Touche LLP upon the consummation of the
acquisition, which is described in Note 1 to the consolidated financial
statements, and assuming that, from December 11, 1996 to the date of such
acquisition no other events will have occurred that would affect the
accompanying consolidated financial statements and notes thereto.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
December 12, 1996
F-2
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1994 1995
---------- ---------- SEPTEMBER 30,
-------------
1996
-------------
(UNAUDITED)
<S> <C> <C> <C>
Cash and cash equivalents (Notes 1 and 2).................................. $ -- $ -- $ 14,291
Accounts receivable, net of allowance for doubtful accounts of $5,386,
$5,478 and $8,040 at December 31, 1994 and 1995, and September 30, 1996
(unaudited), respectively (Notes 1 and 2)................................ 3,629 4,976 10,108
Inventories (Notes 1 and 2)................................................ 7,826 7,414 6,979
Deferred income taxes (Notes 1, 2 and 6)................................... 5,788 6,434 5,568
Prepaid expenses and other current assets (Note 2)......................... 5,215 3,602 6,507
---------- ---------- -------------
Total current assets................................................... 22,458 22,426 43,453
Property and equipment, net (Note 3)....................................... -- -- 5,186
Deferred rent.............................................................. -- -- 2,552
Other assets (Note 2)...................................................... 629 752 540
---------- ---------- -------------
Total assets........................................................... $ 23,087 $ 23,178 $ 51,731
---------- ---------- -------------
---------- ---------- -------------
</TABLE>
LIABILITIES AND STOCKHOLDERS' DEFICIT
<TABLE>
<S> <C> <C> <C>
Accounts payable (Note 2)................................... $ 6,669 $ 8,693 $ 6,123
Medical claims payable (Notes 1, 2 and 4)................... 11,776 12,831 14,497
Accrued salaries and employee benefits (Notes 2 and 7)...... 21,957 19,055 16,708
Other current liabilities (Note 2).......................... 798 485 1,447
Advances from FHP........................................... -- -- 15,457
--------- --------- -----------
Total current liabilities............................... 41,200 41,064 54,232
Deferred income taxes (Note 6).............................. -- -- 1,110
Other liabilities........................................... -- -- 59
--------- --------- -----------
Total liabilities....................................... 41,200 41,064 55,401
--------- --------- -----------
Commitments and contingencies (Note 8)
Stockholders' deficit (Notes 2, 7, 9, 10, and 12):
Preferred Stock, $0.01 par value; 1,200,000 shares
authorized; no shares outstanding at September 30,
1996....................................................
Common Stock, $0.01 par value; 15,000,000 shares
authorized; issued and outstanding 3,000,000 shares at
September 30, 1996...................................... -- -- 30
Paid in capital........................................... -- -- 70
Retained deficit (Note 9)................................. (18,113) (17,886) (3,770)
--------- --------- -----------
Total stockholders' deficit............................. (18,113) (17,886) (3,670)
--------- --------- -----------
Total liabilities and stockholders' deficit............. $ 23,087 $ 23,178 $ 51,731
--------- --------- -----------
--------- --------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-3
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1993 1994 1995
---------- ---------- ---------- NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue (Notes 1 and 2)........................... $ 470,883 $ 503,338 $ 495,699 $ 379,365 $ 351,235
Expenses (Notes 1, 2 and 7):
Affiliated medical services..................... 170,690 173,230 173,417 132,051 103,504
Purchased medical services...................... 110,582 124,083 121,570 94,133 85,851
Dental services................................. 20,129 28,955 31,379 24,544 20,443
Optometry, pharmacy, and other primary health
care services................................. 86,985 96,275 102,412 77,395 80,181
Clinic operations............................... 80,853 87,253 85,585 68,235 49,207
---------- ---------- ---------- ----------- -----------
Total cost of health care..................... 469,239 509,796 514,363 396,358 339,186
Marketing, general and administrative........... 24,002 26,675 29,698 22,188 19,622
---------- ---------- ---------- ----------- -----------
Operating loss.............................. (22,358) (33,133) (48,362) (39,181) (7,573)
Interest income................................... -- -- -- -- 1,199
---------- ---------- ---------- ----------- -----------
Loss before income tax benefit.................... (22,358) (33,133) (48,362) (39,181) (6,374)
Income tax benefit (Notes 1 and 6)................ (8,924) (13,553) (19,754) (16,005) (2,604)
---------- ---------- ---------- ----------- -----------
Net loss.................................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770)
---------- ---------- ---------- ----------- -----------
---------- ---------- ---------- ----------- -----------
Loss per common and common equivalent share (Note
2).............................................. $ (4.48) $ (6.53) $ (9.54) $ (7.73) $ (1.26)
---------- ---------- ---------- ----------- -----------
---------- ---------- ---------- ----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-4
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF COMMON SHARES)
<TABLE>
<CAPTION>
NUMBER OF RETAINED TOTAL
COMMON COMMON PAID IN EARNINGS STOCKHOLDERS'
SHARES STOCK CAPITAL (DEFICIT) DEFICIT
------------ ----------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1993 (NOTE 2)................ -- $ -- $ -- $ (17,276) $ (17,276)
Net change in stockholders' deficit arising from
intercompany transactions (Note 2)............... -- -- -- 13,235 13,235
Net loss........................................... -- -- -- (13,434) (13,434)
------------ ----- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1993....................... -- -- -- (17,475) (17,475)
Net change in stockholders' deficit arising from
intercompany transactions (Note 2)............... -- -- -- 18,942 18,942
Net loss........................................... -- -- -- (19,580) (19,580)
------------ ----- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1994....................... -- -- -- (18,113) (18,113)
Net change in stockholders' deficit arising from
intercompany transactions (Note 2)............... -- -- -- 28,835 28,835
Net loss........................................... -- -- -- (28,608) (28,608)
------------ ----- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1995....................... -- -- -- (17,886) (17,886)
Issuance of Common Stock (Note 10)................. 10,000,000 100 -- -- 100
Retroactive restatement of the effect of one-
for-3.33 reverse stock split (Note 10)........... (7,000,000) (70) 70 -- --
Capital contribution by FHP (Note 9)............... -- -- 5,055 -- 5,055
Assumption of liabilities by FHP (Note 9).......... -- -- 12,831 -- 12,831
Recapitalization of the Company by FHP (Note 9).... -- -- (17,886) 17,886 --
Net loss........................................... -- -- -- (3,770) (3,770)
------------ ----- ---------- ---------- ------------
BALANCE AT SEPTEMBER 30, 1996 (UNAUDITED).......... 3,000,000 $ 30 $ 70 $ (3,770) $ (3,670)
------------ ----- ---------- ---------- ------------
------------ ----- ---------- ---------- ------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-5
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1993 1994 1995
--------- --------- --------- NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss........................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization.... -- -- -- -- 627
Increase in allowance for
doubtful accounts.............. 3,024 368 92 800 2,562
Deferred income taxes............ (1,342) (632) (646) 984 1,976
Effect on cash of changes in
operating assets and
liabilities
Accounts receivable............ (4,800) (1,212) (1,439) (1,143) (7,694)
Inventories.................... (692) (1,983) 412 1,983 435
Prepaid expenses and other
current assets............... (1,162) (685) 1,613 637 (2,905)
Deferred rent.................. (2,552)
Other assets................... 49 (17) (123) 47 212
Accounts payable............... (942) 2,014 2,024 2,831 (2,570)
Medical claims payable......... 1,313 256 1,055 (135) 14,497
Accrued salaries and employee
benefits..................... 4,647 2,156 (2,902) (6,252) (2,347)
Other liabilities.............. 104 373 (313) (346) 1,021
--------- --------- --------- ----------- -----------
Net cash used in operating
activities......................... (13,235) (18,942) (28,835) (23,770) (508)
--------- --------- --------- ----------- -----------
INVESTING ACTIVITIES--Purchase of
property and equipment............. -- -- -- -- (5,813)
--------- --------- --------- ----------- -----------
FINANCING ACTIVITIES:
Issuance of common stock........... -- -- -- -- 100
Advances from FHP.................. 13,235 18,942 28,835 23,770 15,457
Capital contribution by FHP........ -- -- -- -- 5,055
--------- --------- --------- ----------- -----------
Net cash provided by financing
activities......................... 13,235 18,942 28,835 23,770 20,612
--------- --------- --------- ----------- -----------
Net increase in cash and cash
equivalents........................ -- -- -- -- 14,291
Cash and cash equivalents, at
beginning of period................ -- -- -- -- --
--------- --------- --------- ----------- -----------
Cash and cash equivalents, at end of
period............................. $ -- $ -- $ -- $ -- $ 14,291
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Supplemental cash flow information:
Non-cash transactions:
Recapitalization of the Company by
FHP -- Assumption of medical
claims payable by FHP (Note 9)... $ 12,831
-----------
-----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-6
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Talbert Medical Management Holdings Corporation ("TMMHC", and with its
subsidiaries, the "Company") through its subsidiaries Talbert Medical Management
Corporation ("TMMC") and Talbert Health Services Corporation ("THSC"), organizes
and manages physician and dentist practice groups that contract with HMOs and
other payors to provide health care services to their members. Under long-term
management services agreements with its affiliated practice groups (the "Talbert
Medical Groups"), the Company provides management systems and services,
nonphysician health care personnel, facilities and equipment to the Talbert
Medical Groups in return for a reimbursement of certain clinic operations costs,
plus a management fee based on the Talbert Medical Groups' revenues net of
certain reimbursed clinic operations costs, except for the California Medical
Group, where TMMC receives a management fee based on gross revenues. Pharmacy,
radiology, optometry, laboratory, home health, hospice, rehabilitation and
physical therapy services are also available through contracts with THSC.
TMMC, THSC and the Talbert Medical Groups were organized in 1995 in
connection with the restructuring of FHP International Corporation ("FHP"),
which included the transformation of FHP's staff model operations into a
contracted care model operation. The Talbert Medical Groups were organized as
professional corporations in the various states (except in New Mexico) in which
FHP's staff model operations were located to employ the physicians, dentists and
other health care professionals formerly employed by FHP. TMMC was formed to
provide management services to the Talbert Medical Groups, and THSC was
organized to provide certain ancillary clinical services. TMMC and THSC were
incorporated on September 15, 1995 and December 6, 1995, respectively. TMMC,
THSC and the Talbert Medical Groups effectively commenced their operations on
January 1, 1996. TMMHC was organized in November 1996 to serve as a holding
company for TMMC and THSC following their separation from FHP in connection with
the merger of FHP and PacifiCare Health Systems, Inc., et. al. ("PacifiCare") as
discussed below.
FHP's staff model operations had no separate legal status prior to the
organization of TMMC, THSC and the Talbert Medical Groups. FHP has, however,
offered health care services as a staff model HMO through other subsidiaries
since 1961. In the normal course of business, the staff model operations had
various transactions with FHP and its direct subsidiaries that are material in
amount. The accompanying consolidated financial statements of the staff model
operations have been prepared in part from separate records maintained by
subsidiaries of FHP. These statements also reflect key assumptions regarding the
allocation of certain revenue and expense items and certain balance sheet
accounts, many of which could be material, where separate records were not
utilized (Note 2). The accompanying consolidated historical financial statements
of the staff model operations may not necessarily be indicative of the
conditions that would have existed if the staff model operations had operated as
an independent entity.
MERGER OF FHP AND PACIFICARE HEALTH SYSTEMS, INC.
On August 4, 1996, FHP entered into an Agreement and Plan of Reorganization,
as amended and restated, (the "Merger Agreement"), by and among FHP and
PacifiCare. Pursuant to the Merger Agreement, PacifiCare will acquire all of the
outstanding stock of FHP. The transaction is expected to close in January 1997
(the "Effective Time").
In connection with the proposed merger between FHP and PacifiCare, FHP will
sell its 92.25% of the common stock of TMMC and THSC to the Company in exchange
for transferable rights to acquire 92.25%
F-7
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
of the common shares of the Company for $21.50 per share, plus a note for
$59,501,250 (the "Talbert Note"). The rights are expected to be distributed to
the stockholders of FHP. Based on current expectations concerning the number of
shares of FHP common stock that will be outstanding at the Effective Time, FHP
stockholders are expected to receive one right for every 21.34381 shares of FHP
common stock and one right for every 26.46474 shares of FHP preferred stock.
Rights holders may purchase one share of the Company's Common Stock with each
right and also may subscribe for additional shares of the Company's Common Stock
under certain circumstances (the "Offering"). The maximum number of shares to be
issued is 2,767,500. If fully subscribed, the Company expects to receive
$59,501,250 from the Offering, which will be used to retire the Talbert Note.
The Company will sell to FHP any shares of common stock unsubscribed in the
offering in exchange for cancellation of any remaining indebtedness under the
Talbert Note. The holders of the remaining 7.75% of common stock of TMMC and
THSC will exchange their shares in TMMC and THSC for 7.75% of the Common Stock
of the Company.
If the Offering is not fully subscribed, the unsubscribed portion of the
Common Stock will be reacquired by FHP (and, therefore indirectly by the holding
company that will own 100% of FHP and PacifiCare as a result of the FHP Merger
("PacifiCare Holdings")). The Company and FHP have entered into a standstill
agreement with respect to any Common Stock obtained by FHP following the
Acquisition (the "Standstill Agreement"). The Standstill Agreement provides,
among other restrictions, that if FHP reacquires 20% or less of the Company's
outstanding Common Stock in exchange for cancellation of indebtedness under the
Talbert Note, FHP (i) will vote its shares of Common Stock in accordance with
the votes of the non-FHP stockholders, (ii) will be subject to certain
restrictions with respect to its ability to solicit proxies, make acquisition
proposals, become a member of a "group" (as defined in federal securities laws),
or otherwise use its holdings of Common Stock to seek to exercise control over
the Company's management, and (iii) will be entitled to certain shelf
registration rights and the right to participate in future registrations by the
Company. These provisions of the Standstill Agreement, among others, will not
apply if FHP reacquires more than 20% of the Common Stock of the Company after
the consummation of the Offering.
The Talbert Medical Groups will continue to provide care to enrolled members
of FHP under their existing provider agreements until the Effective Time. In
November 1996, the Company renegotiated its provider contract with FHP pursuant
to the terms of the FHP Merger Agreement. This resulted in a decrease in
capitated rates which, if such rates had been in effect during the year ended
December 31, 1995 and the nine months ended September 30, 1996, would, on an
unaudited pro forma basis, have resulted in reducing the Company's revenue by
$36,258,000 and $26,284,000, respectively, and increasing total cost of health
care by $6,897,000 and $5,293,000, respectively.
Just prior to the Offering , FHP is expected to contribute approximately
$68,000,000 to TMMC which is expected to result in a stockholders' equity
balance of approximately $59,000,000 (the "Capital Contribution"). In connection
with the Capital Contribution, the Company will recognize as stock compensation
expense approximately $5,270,000 relating to the Common Stock of the Company
owned by management and others who will not be making a capital contribution.
This expense will be recognized ratably over the vesting period of the
restricted common shares held by management and others. Approximately 25% of
such restrictions lapsed in July 1996 and the remainder are assumed to lapse
ratably each July through 1999. Approximately $1,318,000 of the stock
compensation expense is expected to be recognized on the date of the Capital
Contribution in connection with previously issued restricted shares on which
restrictions have already lapsed.
F-8
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As a result of the foregoing transactions, TMMC and THSC will become
wholly-owned subsidiaries of the Company in a transaction accounted for similar
to a pooling of interests.
BASIS OF PRESENTATION
The accompanying consolidated financial statements for the Company include
the accounts of TMMC, THSC and the Talbert Medical Groups. TMMC has direct or
indirect unilateral and perpetual control over the assets and non-medical
operations of the Talbert Medical Groups by means other than owning the majority
of voting stock. TMMC and the Talbert Medical Groups have entered into 20-40
year practice management agreements with provisions for extensions under certain
circumstances. Because of control by means other than equity ownership,
consolidation of the Talbert Medical Groups is necessary to present fairly the
financial position and results of operations of TMMC. Control by TMMC is
perpetual rather than temporary because of: (i) the length of the original terms
of the management and other agreements; (ii) the successive extension period
provided by the agreements; (iii) the continuing investment of capital by TMMC;
(iv) the employment of the majority of nonphysician personnel by TMMC; (v) the
nature of the services provided to the Talbert Medical Groups by TMMC and (vi)
the provisions of a Share Control Agreement entered into by each Talbert Medical
Group shareholder and TMMC. The terms of the Share Control Agreement require the
shareholder: (i) to elect to the board of directors of the Talbert Medical
Groups only persons approved by TMMC; (ii) to obtain written consent from TMMC
to approve or authorize any merger, consolidation or other reorganization, sale
of assets, or sale of common stock of the Talbert Medical Groups; and (iii) to
give a right to purchase any or all shares of the Talbert Medical Groups to a
person designated by TMMC.
All significant intercompany accounts and transactions have been eliminated
in consolidation.
The Company has elected a fiscal year ending December 31.
REVENUE RECOGNITION AND HEALTH CARE COSTS
The Talbert Medical Groups have contracts with various managed care
organizations to provide physician services based on negotiated fee schedules.
Under various contracts with HMOs, capitation payments are received to cover all
physician services needed by the HMO members. During the years ended December
31, 1993, 1994 and 1995, and the nine months ended September 30, 1995 and 1996,
the Company received nearly all of its capitated revenue from FHP's
subsidiaries. Capitation payments are recognized as revenue on the accrual
basis, and represent approximately 90%, 90%, 88%, 89% (unaudited) and 81%
(unaudited) of the Company's net revenue for the years ended December 31, 1993,
1994 and 1995, and for the nine months ended September 30, 1995 and 1996,
respectively. The Company's remaining revenues are largely derived from
co-payments and fee-for-service from such capitated enrollees.
Net revenue is reported at the estimated realizable amounts from patients,
third-party payors and others for services rendered. Revenue under certain
third-party payor agreements is subject to future audit and retroactive
adjustments. Provisions for estimated third-party payor settlements and
adjustments are estimated in the period the related services are rendered and
are adjusted in future periods as final settlements are determined.
Health care costs are recorded in the period when services are provided to
HMO members, including estimates for contracted medical specialists costs that
have been incurred as of the balance sheet date but not yet paid. The estimates
for medical claims payable are based on historical studies of claims paid. The
F-9
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
methods of making such estimates and for establishing the resulting reserves are
continually reviewed and updated, and any adjustments resulting therefrom are
reflected in current operations. While the ultimate amount of claims and the
related expenses paid are dependent on future developments, management is of the
opinion that the liability for medical claims payable is adequate to cover such
medical claims and expenses. The Company's medical malpractice liability
coverage currently provides professional liability insurance in the amount of
$2,000,000 per claim, and $12,000,000 in the aggregate per policy year.
CASH EQUIVALENTS
The Company considers all highly-liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The carrying value of cash
and cash equivalents approximates fair value based on their short-term maturity.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of premiums receivable from FHP.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's consolidated balance sheet includes the following financial
instruments: cash and cash equivalents, accounts receivable and accounts
payable. The Company considers the carrying amounts of current assets and
liabilities in the consolidated financial statements to approximate the fair
value for these financial instruments because of the relatively short period of
time between origination of the instruments and their expected realization.
RECEIVABLES FROM FHP
Included in accounts receivable at September 30, 1996 is approximately
$7,200,000 (unaudited) due from FHP for health care services provided and
estimated accrued incentives.
ADVERTISING COSTS
Advertising costs, which have not been significant, are expensed when
incurred.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
principally under the average cost method. The principal components of
inventories are as follows (amounts in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
--------- --------- SEPTEMBER 30,
1996
-------------
(UNAUDITED)
<S> <C> <C> <C>
Pharmacy................................................... $ 5,042 $ 5,400 $ 4,472
Optometry.................................................. 2,089 1,368 1,619
Other...................................................... 695 646 888
--------- --------- ------
$ 7,826 $ 7,414 $ 6,979
--------- --------- ------
--------- --------- ------
</TABLE>
F-10
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company utilizes the asset and liability method of accounting for income
taxes. Under this method, income taxes are recognized for (a) the amount of
taxes payable or refundable for the current year and (b) deferred tax
liabilities and assets for the future tax consequences of events that have been
recognized in the Company's financial statements or tax returns. The effects of
income taxes are measured based on enacted tax law and rates. Deferred tax
assets and liabilities are established for temporary differences between the
financial reporting basis and tax basis of the Company's assets and liabilities
at tax rates expected to be in effect when such assets or liabilities are
realized or settled.
The results of the operations of the Company, TMMC, THSC and the Talbert
Medical Groups are included in the consolidated federal and state income tax
returns of FHP. A tax allocation has been made to the Company based primarily on
an estimated separate return basis, including the recording of benefits for tax
losses utilized in FHP's consolidated returns. Upon separation from FHP, the
Company will likely not be able to recognize tax benefits from losses because it
is not certain when the Company will generate sufficient taxable income to
realize such benefits.
The Company and FHP have entered into a Tax Allocation Agreement that
provides for FHP, among other things, to file all tax returns with respect to,
and to pay all taxes imposed upon or attributable to, FHP and its affiliates for
all taxable periods, including the taxes incurred in connection with the
Offering. The Company generally has agreed, among other things, to file all tax
returns with respect to the Company for all taxable periods beginning after the
expiration of the Rights and to pay all taxes imposed upon or attributable to
the Company for all taxable periods ending after the Acquisition. The Company
will indemnify FHP against any adverse adjustment, or receive from FHP the
benefit of any favorable adjustment, of an FHP return to the extent that the
adjustment (i) relates to a taxable period prior to the Acquisition, (ii) arises
out of the Company's activities, and (iii) when combined with all other such
adjustments that, in the aggregate, exceed $2 million, but does not exceed $4
million. The Company and FHP will share equally the liability for, or the
benefit of, such adjustments to the extent they exceed $4 million. The Tax
Allocation Agreement will become effective only if, upon completion of the
Offering, FHP owns less than 50% of the outstanding shares of Common Stock.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation and amortization,
are provided principally by the straight-line method over the estimated useful
lives of the respective classes of assets (three to ten years). Routine
maintenance and repairs are charged to expense as incurred, while costs of
betterments and renewals are capitalized.
ACCOUNTING FOR LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of." As permitted by SFAS 121, the Company elected to adopt the statement as of
December 31, 1995. In accordance with SFAS 121, long-lived assets to be held
will be reviewed for events or changes in circumstances that would indicate that
the carrying value may not be recoverable. The adoption of SFAS 121 had no
effect on the consolidated financial statements for fiscal year 1995.
F-11
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING FOR STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation" provides an alternative to APB Opinion
No. 25 ("APB 25"). SFAS 123 encourages, but does not require, recognition
against earnings of compensation expense for grants of stock, stock options and
other equity instruments by employers (collectively, "options"), based on fair
value at the date of grant. SFAS 123 provides a methodology for the
determination of fair value; however, SFAS 123 also allows companies to continue
to measure compensation cost using the intrinsic value method of accounting
provided by APB 25. SFAS 123 requires companies that choose not to adopt the new
fair value accounting rules to disclose pro forma net income and earnings per
share under the new method as if it had been adopted. The Company intends to
continue with the intrinsic value method prescribed in APB 25 and make pro froma
disclosures of net income and earnings per share as if the fair value method of
accounting (as defined in SFAS 123) had been applied for 1996.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Principal
areas requiring the use of estimates include: the allocation of financial
statement amounts between the Company and FHP (Note 2), determination of
allowances for doubtful accounts receivable, and determination of medical claims
payable.
MANAGEMENT PLANS
The Company has experienced operating losses, negative cash flows and a
working capital deficiency. Management plans to stabilize the Company's
financial condition through revenue enhancement plans and cost reduction
efforts. Management's revenue enhancement plans focus on attracting new Medicare
and commercial enrollees by entering into provider agreements with payors other
than FHP. In addition, management intends to continue its efforts to reduce
operating and overhead costs. Management believes that these plans will provide
sufficient additional cash flow to maintain the Company's operations over a
reasonable period of time.
NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE
COMPANY
The accompanying consolidated financial statements as of and for the periods
prior to January 1, 1996 reflect the assets, liabilities, revenues and expenses
that were directly related to the continuing operations of the Company as they
were operated by FHP. FHP's historical cost basis of the assets and liabilities
has been carried over to the Company. In cases involving assets, liabilities,
revenues, and expenses not specifically identifiable to any particular business
of FHP, certain allocations were made to reflect the future and ongoing
operations of the Company. These allocations were based on a variety of factors
which management believes provide a reliable basis for the accompanying
consolidated financial statements and include the following:
1. No cash balances are recorded as part of these historical financial
statements as it was the practice of FHP not to maintain separate cash
balances for the businesses.
F-12
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE
COMPANY (CONTINUED)
2. The Company estimated its proportionate share of expenses incurred by
FHP on a company-wide basis and used such estimates as a basis to
allocate certain liabilities, principally accounts payable and accrued
salaries and benefits.
3. Capitated enrollee statistics were utilized as a basis to allocate
certain historical revenue and expense items.
4. The net change in stockholders' deficit arising from intercompany
transactions, as reflected in the consolidated statements of
stockholder's deficit, includes (i) the aggregate intercompany
allocations of costs and expenses incurred by the Company and paid by FHP
and (ii) cash generated by the Company and collected by FHP, during the
periods presented. The net change in stockholders' deficit arising from
intercompany transactions also includes all liabilities of the Company
that are not separate legal obligations of the Company, such as income
taxes payable and employee benefit plan obligations that are legal
obligations of FHP, but have been charged to the Company. The amounts
advanced to FHP by the Company were offset primarily against retained
earnings on January 1, 1996 in conjunction with the recapitalization of
the Company. (Note 9)
5. Effective January 1, 1996 the Company bears no risk for the cost of
services related to the hospitalization of members, which risk is
retained by FHP for all prior periods. The historical consolidated
financial statements assume the existence of agreements whereby such
hospital risk is retained by FHP and, accordingly, such costs have been
omitted from the accompanying financial statements.
6. Management information services and certain administrative and overhead
activities are provided to the Company by FHP under a management services
arrangement. The historical financial statements include estimates of
such costs assuming that such arrangement had been in place during the
periods presented.
7. The historical retained earnings of the FHP staff model at December 31,
1990 was utilized in the preparation of the Company's historical balance
sheet at that date. Such balance has been adjusted annually to reflect
the net change in stockholders' deficit arising from intercompany
transactions and the net loss of the Company since that date.
8. The historical financial statements assume that the Real Estate and
Equipment Master Transfer Agreement entered into as of January 1, 1996
between TMMC and FHP had been in effect during all periods presented.
(Note 5)
9. Loss per common and common equivalent share was computed assuming that
the Company's capital structure subsequent to the Offering was in place
for the years ended December 31, 1993, 1994 and 1995, and the nine months
ended September 30, 1995 and 1996. As such, the loss per share
calculation assumes 3,000,000 common shares outstanding for each of the
periods presented.
F-13
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--PROPERTY AND EQUIPMENT
Property and equipment consist of the following (amounts in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
(UNAUDITED)
<S> <C>
Furniture, fixtures and equipment.................................................................. $ 2,670
Computer equipment................................................................................. 1,931
Leasehold improvements............................................................................. 1,212
------
5,813
Less accumulated depreciation and amortization..................................................... (627)
------
Property and equipment, net.................................................................... $ 5,186
------
------
</TABLE>
NOTE 4--MEDICAL CLAIMS PAYABLE
Activity in the liability for medical claims payable is summarized below
(amounts in thousands):
<TABLE>
<CAPTION>
BALANCE CLAIMS INCURRED CLAIMS PAID BALANCE
BEGINNING DURING THE DURING THE END OF
OF PERIOD PERIOD PERIOD PERIOD
----------- ---------------- ---------------- ---------
<S> <C> <C> <C> <C>
Year ended December 31, 1993................ $ 10,207 44,911 (43,598) $ 11,520
Year ended December 31, 1994................ $ 11,520 55,205 (54,949) $ 11,776
Year ended December 31, 1995................ $ 11,776 51,803 (50,748) $ 12,831(1)
Nine months ended September 30, 1996
(unaudited)............................... $ -- (1) 34,259 (19,762) $ 14,497
</TABLE>
- ------------------------
(1) The unpaid balance of $12,831 at December 31, 1995 was assumed by FHP as
part of the recapitalization of the Company on January 1, 1996 (Note 9).
NOTE 5--LEASES
TMMC and FHP have entered into a Real Estate and Equipment Master Transfer
Agreement (the "Master Lease Agreement") to provide for the lease or sublease by
TMMC of facilities and equipment used by the Talbert Medical Groups that are
either owned or leased by FHP. The leases are accounted for as operating leases.
The Master Lease Agreement will expire on December 31, 2000. The Company and FHP
have agreed to certain amendments of the Master Lease Agreement pursuant to a
letter agreement. These amendments include (i) the extension, at prevailing
market rates, of the existing terms of the individual leases to December 31,
2005, with the exception of leases with respect to up to 90,000 square feet (of
a total of approximately 472,000 square feet) that the Company may elect not to
renew; (ii) two five-year extension options at prevailing market rates,
exercisable solely at the Company's discretion; (iii) a right of first offer for
the Company to purchase the furniture, fixtures and equipment subject to the
Master Lease Agreement ("FF&E"). The parties have also agreed to enter into a
separate lease agreement with respect to FF&E that will expire on December 31,
2000. The Company has also entered into leases with
F-14
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--LEASES (CONTINUED)
third parties and has assumed the obligations of FHP under certain other leases
with third parties. Future minimum annual rental commitments under lease
obligations are as follows (amounts in thousands):
<TABLE>
<CAPTION>
MASTER LEASE OTHER LEASES TOTAL
------------ ------------ ----------
<S> <C> <C> <C>
Years ending December 31:
1996............................................... $ 21,454 $ 6,916 $ 28,370
1997............................................... 19,603 7,097 26,700
1998............................................... 17,577 6,809 24,386
1999............................................... 16,272 6,121 22,393
2000............................................... 15,352 4,926 20,278
Remainder.......................................... 28,125 15,269 43,394
------------ ------------ ----------
Total operating lease commitments.................... $ 118,383 $ 47,138 $ 165,521
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
NOTE 6--INCOME TAX BENEFIT
The components of the income tax benefit are summarized as follows (amounts
in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------- ------------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current:
Federal........................................... $ (5,875) $ (10,160) $ (14,899) $ (13,246) $ (3,571)
State............................................. (1,707) (2,761) (4,209) (3,743) (1,009)
---------- ---------- ---------- ---------- ------------
Total current benefit............................... (7,582) (12,921) (19,108) (16,989) (4,580)
---------- ---------- ---------- ---------- ------------
Deferred:
Federal and state................................. (1,342) (632) (646) 984 1,976
---------- ---------- ---------- ---------- ------------
Total income tax benefit............................ $ (8,924) $ (13,553) $ (19,754) $ (16,005) $ (2,604)
---------- ---------- ---------- ---------- ------------
---------- ---------- ---------- ---------- ------------
</TABLE>
The income tax benefit differs from the amount of tax determined by applying
the federal statutory rate to loss before income taxes. The components of this
difference are summarized as follows (amounts in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER
YEAR ENDED DECEMBER 31, 30,
---------------------------------------------------------------------------- ----------------------------
1993 1994 1995 1995 (UNAUDITED)
------------------------ ------------------------ ------------------------ ----------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- ------------- --------- ------------- --------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tax benefit from net
losses at federal
statutory tax rate... $ (7,602) 34% $ (11,597) 35% $ (16,926) 35% $ (13,713) 35%
State tax benefit, net
of federal tax....... (1,322) 6% (1,956) 6% (2,828) 6% (2,292) 6%
-- -- -- --
--------- --------- --------- -----------
Total income tax
benefit.............. $ (8,924) 40% $ (13,553) 41% $ (19,754) 41% $ (16,005) 41%
-- -- -- --
-- -- -- --
--------- --------- --------- -----------
--------- --------- --------- -----------
<CAPTION>
1996 (UNAUDITED)
------------------------------
AMOUNT PERCENT
----------- -----------------
<S> <C> <C>
Tax benefit from net
losses at federal
statutory tax rate... $ (2,231) 35%
State tax benefit, net
of federal tax....... (373) 6%
--
-----------
Total income tax
benefit.............. $ (2,604) 41%
--
--
-----------
-----------
</TABLE>
F-15
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--INCOME TAX BENEFIT (CONTINUED)
The tax effects of significant items comprising the Company's net deferred
tax assets are as follows (amounts in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
--------- --------- SEPTEMBER 30,
-------------
1996
-------------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets-reserves and accruals not currently deductible... $ 5,788 $ 6,434 $ 5,568
Valuation allowance.................................................. -- -- --
--------- --------- ------
Total deferred tax assets............................................ 5,788 6,434 5,568
Deferred tax liabilities-difference between book and tax deduction
allowable under operating leases................................... (1,110)
--------- --------- ------
Net deferred tax assets.......................................... $ 5,788 $ 6,434 $ 4,458
--------- --------- ------
--------- --------- ------
</TABLE>
Management believes that it is more likely than not that sufficient future
taxable income will be generated to recover its deferred tax assets.
Accordingly, no valuation allowance is deemed necessary.
NOTE 7--EMPLOYEE BENEFITS
FHP has certain benefit plans in which the Company's employees are currently
participating. FHP has two tax-qualified retirement plans: a Money Purchase
Pension Plan ("MPPP") and an Employee Stock Ownership Plan with Code section
401(k) and employer matching contribution features ("ESOP"). Following the
separation from FHP, the Company intends to establish a money purchase pension
plan that will be virtually identical to FHP's MPPP. The Company's Money
Purchase Pension Plan (the "Money Purchase Pension Plan") is intended to be a
tax-qualified retirement plan that satisfies the requirements of Sections 401(a)
and 501(a) of the Internal Revenue Code. The Money Purchase Pension Plan will be
frozen both as to contributions as well as to participation. The account
balances under the FHP MPPP attributable to employees of the Company will be
transferred to the Money Purchase Pension Plan. The accounts of each participant
under the Plan will be 100% vested. In general, accounts will be distributable
upon a participant's termination from employment. With respect to the ESOP, the
Company will establish its own plan and trust which are substantially the same
as FHP's ESOP and its related trust. Following the separation from FHP, the
account balances under FHP's ESOP which are attributable to employees of the
Company will be transferred to the new plan and trust to be established by the
Company.
Under the provisions of the FHP plans, FHP contributed into trusts for the
benefit of employees an amount equal to 12% of eligible annual compensation, as
defined, of all plan participants. Effective January 1, 1995, the contribution
rate was reduced to 8% of eligible annual compensation, as defined. Effective
January 1, 1996 the contribution rate was further reduced to 2% of eligible
annual compensation. Participants do not vest until they have completed five
years of service with the Company. Nonvested contributions, which are forfeited
upon an employee's termination, are treated as a reduction in the amount of
FHP's contribution. The combined contribution expenses for the Company's
employees for the MPPP and ESOP were $16,411,000, $15,611,000, and $10,246,000,
for the years ended December 31, 1993, 1994 and 1995 and $7,871,000, and
$3,951,000 for the nine months ended September 30, 1995 and 1996, respectively
(unaudited).
F-16
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--EMPLOYEE BENEFITS (CONTINUED)
Following the separation from FHP, the Company intends to establish a
Deferred Compensation Plan (the "Deferred Compensation Plan") that will be
virtually identical to FHP's deferred compensation plan. Accordingly, the
Deferred Compensation Plan will be a nonqualified deferred compensation plan and
will permit the Company's non-employee directors and a select group of
management or highly compensated employees to elect to defer compensation under
the Deferred Compensation Plan. The Deferred Compensation Plan will permit a
minimum deferral of 3% with respect to salaries (or, with respect to bonuses,
1%) and a maximum deferral of 50% with respect to salaries (or, with respect to
bonuses, 100%). The Deferred Compensation Plan will also permit discretionary
employer contributions. Amounts deferred under the Deferred Compensation Plan
will be credited to bookkeeping accounts established and maintained for each
participant.
The compensation deferral account of each participant will be 100% vested.
The employer contribution account of each participant will be subject to a
five-year "cliff" vesting schedule, but will become 100% vested in the event of
a change-of-control (as defined under the Deferred Compensation Plan).
The Company's Deferred Compensation Plan will provide for the same
distribution options as under FHP's Deferred Compensation Plan including: (i)
short-term payout option, (ii) retirement benefit, (iii) termination
distribution, (iv) survivor benefit and (v) withdrawal election.
The 1996 Stock Incentive Plan (the "Plan") was adopted by the Board of
Directors and approved by FHP in November 1996. The Plan replaces the
substantially similar plan established by TMMC. Under the Plan, the Company is
authorized to grant up to 180,000 shares of common stock options, stock
appreciation rights, restricted stock awards, performance share awards, stock
bonuses, or non-employee director options to any officer, non-employee director
or key employee of the Company. The Board of Directors granted 70,350 options to
employees and non-employee directors under the TMMC plan as of September 17,
1996 with an exercise price of $29.17 per share. These options have been
converted into Plan options. The Plan options granted to management vest at the
rate of 20% per year beginning on the first anniversary the grant date. The
non-employee director stock options vest at the rate of 25% on the later of
ninety days after the award date or sixty days after the Effective Time, and 25%
on each anniversary of the grant date for the first three anniversaries of the
grant date. Additional grants were made in November 1996 (Note 12). The
following is a summary of the activity in the Plan for the nine months ended
September 30, 1996:
<TABLE>
<CAPTION>
SHARES
---------
<S> <C>
Shares subject to options outstanding -- January 1, 1996............................. 0
Granted ($29.17 per share)........................................................... 70,350
Exercised............................................................................ 0
Cancelled............................................................................ 0
---------
Shares subject to options outstanding -- September 30, 1996 (unaudited).............. 70,350
---------
---------
</TABLE>
NOTE 8--COMMITMENTS AND CONTINGENCIES
LITIGATION
During the ordinary course of business, the Company and its subsidiaries
have become a party to pending and threatened legal actions and proceedings.
Management of the Company is of the opinion, taking into account its insurance
coverage, that the outcome of the currently known legal actions and
F-17
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--COMMITMENTS AND CONTINGENCIES (CONTINUED)
proceedings will not, singly or in the aggregate, have a material effect on the
consolidated financial position of the Company and its subsidiaries.
REGULATED OPERATIONS
The health care industry is highly regulated, and there can be no assurance
that the regulatory environment in which the Company operates will not change
significantly in the future. The Company believes that its operations as
described herein are in substantial compliance with applicable law. The ability
of the Company to operate profitably will depend in part upon the Talbert
Medical Groups and their affiliated physicians obtaining and maintaining all
necessary licenses, certificates of need and other approvals and operating in
compliance with applicable health care regulations.
NOTE 9--RECAPITALIZATION
FHP initially capitalized and incorporated TMMC and THSC on September 15,
1995 and December 6, 1995, respectively, with a combined cash contribution of
$91,000. On January 1, 1996, TMMC and THSC assumed the operations and certain
assets and liabilities that had previously been recorded on the books of FHP's
staff model. As part of this assumption, FHP retained certain medical claims
payable ($12,831,000) and contributed cash of $5,055,000 to the Company. As a
result, the Company's retained deficit of $17,886,000 was eliminated.
NOTE 10--STOCKHOLDERS' DEFICIT
The Company's Certificate of Incorporation provides for the issuance of
1,200,000 shares of preferred stock, par value $0.01 per share, and 15,000,000
shares of common stock, par value $0.01 per share. Dividends may be declared and
paid to the holders in cash, property or other securities out of any net profits
or net assets available therefor.
On September 17, 1996 the Board of Directors approved a one-for-3.33 reverse
split of TMMC's Common Stock. All share and per share information in the
accompanying consolidated financial statements have been retroactively restated
to reflect this reverse stock split.
FHP currently owns approximately 92.25% of TMMC and THSC. Management and
other investors (the "Management Investors") own the remaining percentage of
outstanding shares ("Management Shares"). Transfer of the Management Shares is
restricted. The Management Investors will not have the ability to sell or
transfer Management Shares until such restrictions lapse. Twenty-five percent of
the shares issued to each Management Investor vested on July 1, 1996 and the
remainder will vest each July 1 until July 1, 1999 beginning July 1, 1997. With
certain exceptions, if a Management Investor terminates his or her employment
relationship with his or her respective employer before certain shares vest, the
restricted shares will be repurchased from the management for their original
purchase price. In addition, pursuant to certain performance purchase options,
if certain financial goals are not met at the vesting dates, up to 20% of the
otherwise then-vesting shares become subject to repurchase at the original
purchase price.
RIGHTS AGREEMENT. As of the expiration of the Rights Offering (the
"Expiration Date"), pursuant to a Stockholder Rights Agreement between the
Company and American Stock Transfer & Trust Company, as Rights Agent, the
Company has declared a dividend distribution to all holders of Common Stock of a
right to purchase a unit initially consisting of one one-hundredth of a share of
Junior Participating Preferred Stock upon the terms and conditions set forth in
that agreement. The Stockholder Rights Agreement is
F-18
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCKHOLDERS' DEFICIT (CONTINUED)
designed to give the Board of Directors the time and opportunity to protect
stockholder interests and encourage equal treatment of all stockholders in a
takeover situation. In the event of a takeover attempt, the holders of the
rights may exercise them to purchase Common Stock at a 50% discount, or, in the
event of a "squeeze-out" transaction where the Company would not be the
surviving entity, the acquiring company's common stock at a 50% discount. The
issuance of these rights may have the effect of delaying, deferring or
preventing a change in control of the Company or an unsolicited acquisition
proposal.
The Stockholder Rights Agreement provides for a trigger percentage of 8% for
the 90-day period following the Expiration Date, and 15% thereafter. Certain
persons who acquire Common Stock in excess of the trigger percentage will not
trigger the rights, including, with certain limitations, (i) persons who acquire
such Common Stock solely as a result of the exercise of Rights distributed to
them in the Offering, (ii) FHP, if it acquires such Common Stock solely through
the transfer of shares unsubscribed in the Offering, and (iii) transferees of
FHP, if FHP acquires in excess of 20% of the outstanding Common Stock solely
through the transfer of shares unsubscribed in the Offering.
NOTE 11--UNAUDITED QUARTERLY INFORMATION
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
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(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Year ended December 31, 1994:
Revenue.................................................... $ 122,977 $ 122,581 $ 127,898 $ 129,882
Operating loss............................................. (3,988) (7,915) (11,930) (9,300)
Loss before income tax benefit............................. (3,988) (7,915) (11,930) (9,300)
Net loss................................................... (2,357) (4,677) (7,050) (5,496)
Loss per common and common equivalant share................ (0.79) (1.56) (2.35) (1.83)
Year ended December 31, 1995:
Revenue.................................................... $ 133,719 $ 132,167 $ 113,479 $ 116,334
Operating loss............................................. (10,558) (12,730) (15,894) (9,180)
Loss before income tax benefit............................. (10,558) (12,730) (15,894) (9,180)
Net loss................................................... (6,244) (7,530) (9,402) (5,432)
Loss per common and common equivalant share................ (2.08) (2.51) (3.14) (1.81)
Nine Months Ended September 30, 1996:
Revenue.................................................... $ 115,209 $ 121,283 $ 114,743
Operating loss............................................. (4,570) (1,172) (1,831)
Loss before income tax benefit............................. (4,339) (752) (1,283)
Net loss................................................... (2,566) (445) (759)
Loss per common and common equivalant share................ (0.86) (0.15) (0.25)
</TABLE>
F-19
<PAGE>
TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--SUBSEQUENT EVENTS
MERGER OF FHP AND PACIFICARE HEALTH SYSTEMS, INC.--SEE NOTE 1
STOCK OPTION GRANTS
On November 21, 1996, the Company issued options to acquire 39,636 shares of
common stock to certain officers with an exercise price of $10.00 per share. The
options vest 40% on December 31, 1996 and 15% each on January 1 from 2000
through 2003. Based on an assumed fair market value of $29.17 per share on the
date of grant, the Company will recognize approximately $760,000 of stock
compensation expense (before income tax benefit) as the related options vest.
Accordingly, 40% of the $760,000 compensation expense, or $304,000, will be
recognized in December 1996.
F-20
<PAGE>
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NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFER OF ANY SECURITIES OTHER THAN TO THOSE TO WHICH IT RELATES OR AN OFFER TO
SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION
WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE AN IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 12
The Company............................................................... 18
The Offering.............................................................. 19
Financial Statements...................................................... 23
Use of Proceeds........................................................... 23
Dividend Policy........................................................... 23
Capitalization............................................................ 24
Selected Consolidated Financial Data...................................... 25
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 28
Business.................................................................. 34
Management................................................................ 44
Certain Transactions...................................................... 55
Relationship with FHP and PacifiCare Following the Offering............... 56
Principal Stockholders.................................................... 59
Description of Capital Stock.............................................. 61
Legal Matters............................................................. 64
Experts................................................................... 64
Additional Information.................................................... 64
Index to Consolidated Financial Statements................................ F-1
</TABLE>
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UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
2,767,500 SHARES
[logo]
TALBERT MEDICAL
MANAGEMENT
HOLDINGS
CORPORATION
COMMON STOCK
---------------------
PROSPECTUS
, 1997
---------------------
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