<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ____________
Commission file number 0-14796
FHP INTERNATIONAL CORPORATION
a Delaware Corporation
I.R.S. Employer Identification No. 33-0072502
3120 Lake Center Drive, Santa Ana, CA 92704
(Address of principal executive offices) (Zip Code)
(714) 825-6600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes __X__ No ____.
The registrant had 41,719,977 shares of common stock, par value $0.05 per
share, outstanding at February 11, 1997.
The Exhibit Index Appears on Page 21
1
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PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FHP INTERNATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
ASSETS
<TABLE>
<CAPTION>
(amounts in thousands, December 31, June 30,
except share data) 1996 1996
------------ ------------
<S> <C> <C>
Cash and cash equivalents $ 297,815 $ 166,873
Short-term investments 226,598 187,919
Accounts receivable, net 165,367 141,537
Prepaid expenses and other
current assets 27,488 33,736
Deferred income taxes 49,165 49,162
---------- ----------
Total current assets 766,433 579,227
Property and equipment, net 231,764 231,428
Assets held for sale (Note 6) 15,752 16,470
Long-term investments 49,985 36,470
Restricted investments 96,650 90,499
Goodwill and other intangibles,
net 1,013,510 1,028,374
Other assets, net 36,731 31,411
---------- ----------
Total assets $2,210,825 $2,013,879
---------- ----------
---------- ----------
</TABLE>
- ----------
See accompanying Notes to Consolidated Financial Statements.
2
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FHP INTERNATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
(amounts in thousands, December 31, June 30,
except share data) 1996 1996
------------ ------------
<S> <C> <C>
Current portion of long-term obligations $ 19,104 $ 30,097
Accounts payable 46,571 50,979
Medical claims payable 388,565 367,872
Accrued salaries and employee benefits 62,299 71,986
Unearned premiums 207,930 24,713
Restructuring reserve (Note 6) 14,615
Income taxes payable and other
current liabilities 77,790 79,132
---------- ----------
Total current liabilities 802,259 639,394
Long-term obligations 100,195 104,184
Other liabilities 88,596 102,672
---------- ----------
Total liabilities 991,050 846,250
---------- ----------
Commitments and contingencies (Note 4)
Stockholders' equity: (Note 7)
Series A Convertible
Preferred Stock, $0.05 par value;
40,000,000 shares authorized (Note 3) 1,052 1,052
Common Stock, $0.05 par value;
100,000,000 shares authorized;
issued and outstanding 41,569,417
and 40,789,528 shares at December 31,
1996 and June 30, 1996, respectively 2,078 2,039
Paid-in capital 953,756 938,478
Unrealized holding losses on
available-for-sale investments, net of
tax effect of $562 at December 31,
1996 and $1,602 at June 30, 1996 (844) (2,306)
Retained earnings 263,733 228,366
---------- ----------
Total stockholders' equity 1,219,775 1,167,629
---------- ----------
Total liabilities and
stockholders' equity $2,210,825 $2,013,879
---------- ----------
---------- ----------
</TABLE>
- ----------
See accompanying Notes to Consolidated Financial Statements.
3
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FHP INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
For The
Three Months Ended
(amounts in thousands, December 31,
except per share data) 1996 1995
------------ ------------
<S> <C> <C>
Revenues $1,108,343 $1,015,746
---------- ----------
Expenses:
Primary health care 907,596 831,071
Other health care 31,242 29,865
General, administrative and
marketing 129,961 127,751
Provision for restructuring 3,900
---------- ----------
Total expenses 1,068,799 992,587
---------- ----------
Operating income 39,544 23,159
Interest income 9,152 9,163
Interest expense (2,451) (5,963)
---------- ----------
Income before income taxes 46,245 26,359
Provision for income taxes 21,272 12,438
---------- ----------
Net income 24,973 13,921
Preferred Stock dividends 6,575 6,608
---------- ----------
Net income attributable to
Common Stock $ 18,398 $ 7,313
---------- ----------
---------- ----------
Earnings per share
attributable to Common Stock (Note 2) $ 0.44 $ 0.18
---------- ----------
---------- ----------
Weighted average number of common
shares and common share equivalents 42,268 41,289
---------- ----------
---------- ----------
Fully diluted earnings per share (Note 2) $ 0.42 -
---------- ----------
---------- ----------
Fully diluted weighted average number of
common shares and common share equivalents 59,293 -
---------- ----------
---------- ----------
</TABLE>
- ----------
See accompanying Notes to Consolidated Financial Statements.
4
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FHP INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
For The
Six Months Ended
(amounts in thousands, December 31,
except per share data) 1996 1995
------------ ------------
<S> <C> <C>
Revenues $2,207,042 $2,020,379
---------- ----------
Expenses:
Primary health care 1,805,136 1,650,042
Other health care 63,397 60,710
General, administrative and
marketing 261,971 252,877
Provision for restructuring 9,659
---------- ----------
Total expenses 2,130,504 1,973,288
---------- ----------
Operating income 76,538 47,091
Interest income 18,251 18,299
Interest expense (4,944) (12,387)
---------- ----------
Income before income taxes 89,845 53,003
Provision for income taxes 41,328 25,155
---------- ----------
Net income 48,517 27,848
Preferred Stock dividends 13,150 13,215
---------- ----------
Net income attributable to
Common Stock $ 35,367 $ 14,633
---------- ----------
---------- ----------
Earnings per share
attributable to Common Stock (Note 2) $ 0.84 $ 0.36
---------- ----------
---------- ----------
Weighted average number of common
shares and common share equivalents 42,203 41,146
---------- ----------
---------- ----------
Fully diluted earnings per share (Note 2) $ 0.82 -
---------- ----------
---------- ----------
Fully diluted weighted average number of
common shares and common share equivalents 59,318 -
---------- ----------
---------- ----------
</TABLE>
- ----------
See accompanying Notes to Consolidated Financial Statements.
5
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FHP INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
For The
Six Months Ended
December 31,
(amounts in thousands) 1996 1995
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 48,517 $ 27,848
Adjustments to reconcile
net income to net cash
provided by operating activities:
Provision for restructuring 9,659
Depreciation and amortization 35,941 36,714
Increase in allowance for
doubtful accounts 3,188 1,782
Loss on disposal of assets 2,968 48
Gain on sale of available-for-sale
investments (47) (999)
Loss on sale of available-for-sale
investments 52 258
Effect on cash of changes in
operating assets and liabilities:
Accounts receivable (27,018) (9,441)
Prepaid expenses and other
current assets 6,248 3,784
Other assets (6,746) (2,621)
Accounts payable (4,408) 1,687
Medical claims payable 20,693 28,975
Accrued salaries and
employee benefits (9,687) 908
Unearned premiums 183,217 1,700
Other liabilities (30,033) (5,668)
---------- ----------
Net cash provided by operating activities 222,885 94,634
---------- ----------
INVESTING ACTIVITIES
Purchases of available-for-sale investments (385,758) (112,706)
Proceeds from sales/maturities
of available-for-sale investments 329,910 154,216
Purchases of property and equipment (27,113) (28,747)
Proceeds from sales of property and
equipment 3,910 1,228
---------- ----------
Net cash (used in) provided by investing activities (79,051) 13,991
---------- ----------
</TABLE>
6
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FHP INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(unaudited)
<TABLE>
<CAPTION>
For The
Six Months Ended
December 31,
(amounts in thousands) 1996 1995
------------ ------------
<S> <C> <C>
FINANCING ACTIVITIES
Payments on long-term obligations (15,059) (45,088)
Exercise of stock options 14,457 1,753
Redemption of Series B Preferred Stock (1,980)
Issuance of Common Stock through Employee
Stock Purchase Plan 860 2,044
Cash dividends paid to preferred shareholders (13,150) (13,215)
---------- ----------
Net cash used in financing activities (12,892) (56,486)
---------- ----------
Increase in cash and cash equivalents 130,942 52,139
Cash and cash equivalents at beginning of period 166,873 299,144
---------- ----------
Cash and cash equivalents at end of period $ 297,815 $ 351,283
---------- ----------
---------- ----------
Supplemental cash flow information:
Interest payments $ 4,270 $ 10,603
Income tax payments (net of refunds) $ 34,597 $ 27,072
</TABLE>
- ----------
See accompanying Notes to Consolidated Financial Statements.
7
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FHP INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. ORGANIZATION AND ACCOUNTING POLICIES
FHP International Corporation (the "Company"), through its direct and
indirect subsidiaries, delivers managed health care services and sells
indemnity medical, group life, and workers' compensation insurance.
The accompanying unaudited interim Consolidated Financial Statements have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") for reporting on Form 10-Q and do not include all
of the information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles. Interim periods are viewed as an integral part of the annual
period of the Company. The accompanying unaudited interim Consolidated
Financial Statements should be read in conjunction with the audited
Consolidated Financial Statements and Notes to Consolidated Financial
Statements contained in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1996. Certain reclassifications have been made in
the Consolidated Financial Statements and Notes to conform to fiscal year
1997 presentations.
The preparation of the Company's Consolidated Financial Statements in
conformity with generally accepted accounting principles necessarily require
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the balance sheet dates and the reported amounts of revenue and expense
during the reporting periods. Actual results could differ from these
estimates and assumptions.
NOTE 2. EARNINGS PER SHARE
Primary earnings per share attributable to Common Stock for the three and
six month periods ended December 31, 1996 and 1995 are computed by dividing
net income attributable to Common Stock by the weighted average number of
outstanding common shares and common share equivalents during the respective
periods. Common share equivalents include the effect of dilutive stock
options calculated using the treasury stock method.
Fully diluted earnings per share for the three and six month periods
ended December 31, 1996 and 1995 assume the conversion of the Series A
Cumulative Convertible Preferred Stock ("Series A Preferred Stock"), the
elimination of the related Preferred Stock dividend requirement and market
price as of the end of the quarter for dilutive Common Stock options. Fully
diluted earnings per share for the three and six month periods ended December
31, 1995 were anti-dilutive.
NOTE 3. PREFERRED STOCK
The authorized capital stock of the Company includes 40,000,000 shares of
Preferred Stock, par value $0.05 per share. Preferred Stock is designated
either Series A Preferred Stock or Series B Adjustable Rate Cumulative
Preferred Stock ("Series B Preferred Stock"). At December 31, 1996 and June
30, 1996 there was no Series B Preferred Stock outstanding.
8
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The issued and outstanding, and aggregate liquidation preference of the
Company's Series A Preferred Stock is as follows:
December 31, 1996 June 30, 1996
----------------- ---------------
Issued and outstanding 21,039,795 21,040,307
Aggregate liquidation preference $526,027,000 $526,033,000
NOTE 4. COMMITMENTS AND CONTINGENCIES
During the ordinary course of business, the Company and its subsidiaries
have become a party to pending and threatened legal actions and proceedings,
a significant number of which involve alleged claims of medical malpractice.
Management is of the opinion, taking into account its insurance coverage and
reserves that have been established, 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 or results of
operations or cash flows of the Company and its subsidiaries.
On November 19, 1996, Memorial Health Services, a California nonprofit
benefit corporation ("Memorial"), filed a Demand for Arbitration against FHP,
Inc. ("FHP"), a subsidiary of the Company, with the American Arbitration
Association (the "Demand"). The Demand alleges that the Company fraudulently
and/or negligently misrepresented and failed to disclose certain information
in connection with Memorial's purchase of a hospital in Fountain Valley,
California from FHP and its entry into a Capitation Contract with FHP.
Memorial alleges that it paid approximately $87 million for the hospital and
the right to exclusively serve FHP senior and commercial member populations
at such hospital and other Memorial facilities. Memorial claims that but for
FHP's alleged misrepresentations and nondisclosures, Memorial would not have
purchased the hospital nor entered into the Capitation Contract without a
material decrease in purchase price and an increase in the Capitation Fee for
each FHP member served. Memorial's claims for relief include claims for
compensatory damages in excess of $275 million, punitive damages in an amount
to be determined, and rescission of the hospital purchase contract and
Capitation Contract (together with compensatory and punitive damages up to
the date of rescission), plus, in each case, attorneys fees and costs
incurred in arbitration. By letter, dated November 2, 1996, Memorial also
made a claim against FHP alleging that FHP failed to transfer certain assets
to Memorial when Memorial purchased the hospital. Memorial alleges that the
assets are worth approximately $1.3 million. The Company disputes the
arbitrability of Memorial's claims and believes that Memorial's claims are
without merit. The Company intends to vigorously defend against such claims.
Based on discussions to date with Memorial, management believes that
resolution of the claims will not have a material adverse effect on the
consolidated financial position or results of operations or cash flows of the
Company.
NOTE 5. OPM
The Company's HMO subsidiaries have contracts with the United States
Office of Personnel Management ("OPM") to provide or arrange managed health
care services under the Federal Employees Health Benefits Program ("FEHBP")
for federal employees, annuitants and their dependents. Periodically, the
Company's HMO subsidiaries are subject to audits by the government to, among
other things, verify that premiums charged under OPM contracts are
established in compliance with community rating and other requirements under
the FEHBP. Final reports from such audits may recommend that OPM seek
monetary recoveries from the Company for amounts that may be substantial.
9
<PAGE>
The Company increased reserves in the third quarter of fiscal year 1996,
by recording a pretax charge of $45 million ($28.7 million, net of tax), to
address a draft audit report arising from OPM audits for the years 1987
through 1991 at certain of the Company's HMO subsidiaries and potential
governmental claims for the years 1987 through 1991, which have been or may
be asserted in relation to other of the Company's contracts with OPM and for
possible other OPM claims through 1996. The addition to reserves resulted in
a charge to net earnings of $0.68 per share.
On October 7, 1996, the Company reached an agreement with The United
States Department of Justice (the "DOJ") which resolved claims arising from
the draft audit report covering the years 1987 to 1991. The DOJ had notified
the Company that, based on the OPM draft audit report, the DOJ believed the
Company may have violated the False Claims Act. The DOJ believed actual
damages to be approximately $15 million, before consideration of interest or
penalties. The Company paid $12 million to the FEHBP Contingency Reserve
Funds for the regions covered by the draft audit report. The Company paid no
fines or penalties as part of the agreement. Also, the DOJ released the
Company from all claims under the contracts for the years covered by the
draft audit report.
OPM has opened two additional audits for years as far back as 1990 at two
of the Company's other HMO subsidiaries. In October 1996, OPM sent a draft
audit report to the Company for these two additional audits. The draft
report alleges certain defects in the Company's rating practices. The
Company has responded to the draft report and is awaiting further response
from OPM. Based on management's understanding of the government's current
interpretation of the community rating standard requirements, management
currently believes it has established adequate reserves to settle any claims
that have arisen or may arise from present or future FEHBP rate audits for
years between and including 1987 through 1996, or that amounts in excess of
reserves, if any, necessary to settle any such claims would not be such as to
have a material adverse effect on the consolidated financial position or
results of operations or cash flows of the Company.
NOTE 6. RESTRUCTURING CHARGE
In June 1995, the Company's Board of Directors approved a restructuring
plan involving the discontinuance of services and programs that did not meet
the Company's strategic and economic return objectives, including: 1) a
reduction in workforce; 2) the creation of a subsidiary physician practice
management company, Talbert Medical Management Corporation ("Talbert"); and
3) the sale of the Company's two acute care hospitals and other nonproductive
real estate. Talbert began operations as a subsidiary of the Company on
January 1, 1996. Talbert operates in all of FHP's formerly Company operated
medical facilities in California, Utah, Arizona, New Mexico and Nevada. The
restructuring plan was substantially completed in fiscal year 1996.
Restructuring charges in fiscal years 1995 and 1996 were based on the
Company's estimates and were refined throughout fiscal year 1996. The Company
believes it has made adequate provision for matters such as final settlement
of purchase price adjustments and health care services contracts related to
the sales of the hospitals and other facilities. During the six months ended
December 31, 1996, there was no significant change in the aggregate in
estimates with respect to accruals previously established.
10
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NOTE 7. AGREEMENT AND PLAN OF REORGANIZATION
On August 4, 1996, the Company entered into an Agreement and Plan of
Reorganization, as amended and restated, (the "Merger Agreement"), by and
among the Company and PacifiCare Health Systems, Inc., et. al.
("PacifiCare"). Pursuant to the Merger Agreement, a new holding company that
has been formed by PacifiCare will acquire all of the outstanding stock of
the Company. The transaction is expected to close in February, 1997 (the
"Effective Time"). See Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Pursuant to the Merger Agreement, holders of the Company's Common Stock
will receive consideration through a combination of $17.50 in cash and a mix
of shares of Class A Common Stock and Class B Common Stock of PacifiCare,
plus rights to purchase stock of Talbert. The consideration at the date of
the Merger Agreement equated to $35.00 per share without attributing value to
the Talbert Rights. The number of PacifiCare shares to be delivered in the
merger is based on the price of PacifiCare stock during the twenty day
trading period prior to the Company's stockholders' meeting which was held on
December 31, 1996. Each outstanding share of the Company's Series A Preferred
Stock will be converted into the right to receive $14.113 in cash and 0.50
shares of PacifiCare Preferred Stock.
As soon after the Effective Time as legally possible, the shares of the
Company's Common and Preferred Stock will receive rights to purchase, in the
aggregate, all of the Company's approximate 92% holding in Talbert (the
"Talbert Rights"). The Talbert Rights will be exercisable for a period of 30
days upon SEC approval of Talbert's S-1 registration statement filed in
December, 1996, as subsequently amended.
The Company and Talbert entered into a Real Estate and Equipment Master
Transfer Agreement (the "Master Lease Agreement") to provide for the lease,
sublease or assignment by Talbert of facilities and equipment used by Talbert
that are either owned or leased by the Company. The Master Lease Agreement,
as amended, provides that the parties will enter into individual leases with
respect to the real estate and equipment subject to the Master Lease
Agreement. The Master Lease Agreement, as amended, also provides for an
original term of the individual leases ending December 31, 2005, with certain
exceptions. Talbert has a right of first offer to purchase the furniture,
fixtures and equipment subject to the Master Lease Agreement. The Master
Lease Agreement represents approximately $95 million net book value of the
Company's assets at December 31, 1996. The Master Lease Agreement accounted
for as an operating lease and currently eliminates within the Company's
Consolidated Financial Statements.
Talbert has entered into new capitated provider agreements (the "New
Agreements") with FHP for the continued provision of health care and related
services to FHP members. The New Agreements will become effective at the
Effective Time. The New Agreements extend for ten-year terms except in Utah,
which extends for a 15-year term. The capitated rates contained in the New
Agreements will be mutually re-negotiated after a period of one year.
PacifiCare has informed the Company that it has entered into a credit
agreement with Bank of America as Agent, and a syndicate of financial
institutions for an aggregate amount of $1.5 billion to finance the cash
portion of the transaction. The closing of the transaction is subject to
customary closing conditions, including regulatory approvals. (See also
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Proposed Acquisition of the Company by PacifiCare and the form
S-4 SEC registration statement, as amended, filed by PacifiCare in November,
1996.)
11
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FHP International Corporation and its subsidiaries (the "Company") is a
federally qualified health maintenance organization, deriving almost all of
its revenues from premiums received for health care services to approximately
1.9 million HMO members. The Company operates in three business segments: 1)
the Company's contract model operations (the "HMO"); 2) a physician practice
management company, Talbert Medical Management Corporation and related
entities (collectively, "Talbert"), operating since January 1, 1996, in
almost all of the Company's owned and operated medical centers; and 3) the
Company's group life, health and accident and workers' compensation insurance
and related products (collectively, the "Insurance Group").
PROPOSED ACQUISITION OF THE COMPANY BY PACIFICARE
On August 4, 1996, the Company entered into an Agreement and Plan of
Reorganization (the "Merger Agreement") with PacifiCare Health Systems, Inc.
("PacifiCare"), N-T Holdings, Inc. ("PacifiCare Holding"), Neptune Merger
Corp. ("PacifiCare Merger Sub") and Tree Acquisition Corp. ("Company Merger
Sub"). Consummation of the transaction (the "Effective Time") is expected to
occur in February, 1997. The Merger Agreement, as amended and restated,
provides for, among other things, an acquisition transaction involving
PacifiCare and the Company by means of the merger of PacifiCare Merger Sub
with and into PacifiCare and the merger of the Company Merger Sub with and
into the Company (collectively, the "Mergers"). As a result, PacifiCare and
the Company will become wholly-owned subsidiaries of PacifiCare Holding. At
the Effective Time: (i) each outstanding share of PacifiCare Class A Common
Stock will be converted into the right to receive one share of PacifiCare
Holding Class A Common Stock; (ii) each share of PacifiCare Class B Common
Stock will be converted into the right to receive one share of PacifiCare
Holding Class B Common Stock; (iii) each outstanding share of Company Common
Stock will be converted into the right to receive $17.50 in cash and a mix of
PacifiCare Holding Class A Common Stock and PacifiCare Holding Class B Common
Stock; and (iv) each outstanding share of Company Series A Cumulative
Convertible Preferred Stock ("Series A Preferred") will be converted into the
right to receive $14.113 in cash and 0.50 shares of PacifiCare Holding
Preferred Stock. The Mergers, approved by the respective stockholders of the
Company and PacifiCare at their separate meetings on December 31, 1996, are
subject to customary closing conditions, including state regulatory
approvals. See also the S-4 registration statement, as amended, submitted to
the Securities and Exchange Commission jointly by the Company and PacifiCare
in November, 1996.
At the Effective Time, each outstanding share of Company Common Stock and
Series A Preferred will be converted, in part, into rights to purchase a
proportionate share (on an as-if-converted basis) of all of the Company's
approximate 92% holding in Talbert (the "Talbert Rights"). The Talbert
Rights will be exercisable during a subscription period of 30 days,
commencing upon SEC approval (the "Talbert Effective Time") of Talbert's S-1
registration statement filed in December, 1996, as subsequently amended. The
subscription period will expire on the thirtieth day after the Talbert
Effective Time or such other time as the exercise of the Rights is legally
permissible.
12
<PAGE>
The Company and Talbert entered into a Real Estate and Equipment Master
Transfer Agreement (the "Master Lease Agreement") to provide for the lease,
sublease or assignment by Talbert of facilities and equipment used by Talbert
that are either owned or leased by the Company. The Master Lease Agreement,
as amended, provides that the parties will enter into individual leases with
respect to the real estate and equipment subject to the Master Lease
Agreement. The Master Lease Agreement, as amended, also provides for an
original term of the individual leases ending December 31, 2005, with certain
exceptions. Talbert has a right of first offer to purchase the furniture,
fixtures and equipment subject to the Master Lease Agreement. The Agreement
represents approximately $95 million net book value of the Company's assets
at December 31, 1996.
Talbert has entered into new capitated provider agreements (the "New
Agreements") with FHP for the continued provision of health care and related
services to FHP members. The New Agreements will become effective at the
Effective Time. The New Agreements extend for ten-year terms except in Utah,
which extends for a 15-year term. The capitated rates contained in the New
Agreements will be mutually re-negotiated after a period of one year.
The Company's competitors may have used the announcement of the Merger
Agreement as an opportunity to encourage employer groups currently enrolled
with the Company to enroll their employees in other plans. Provider groups
currently affiliated with the Company also may be encouraged to seek other
affiliations. Recently, the Company has begun to experience the loss of
employees due to the potential transaction. In the event that the transaction
is delayed or not completed, losses of significant numbers of members,
providers and/or employees are likely to have a material adverse impact on
the Company's future results of operations in certain geographic areas.
THREE MONTHS ENDED DECEMBER 31, 1996, COMPARED TO THE
THREE MONTHS ENDED DECEMBER 31, 1995
REVENUE AND MEMBERSHIP
The Company generates substantially all of its revenue from premiums
received for health care services provided to the HMO members of its
wholly-owned subsidiaries. Revenue for the three month period ended December
31, 1996, totaled $1,108 million, increasing 9.1% over revenue of $1,016
million for the same period in the previous fiscal year. Total HMO
membership grew 6.2% to approximately 1,939,000 at December 31, 1996, from
approximately 1,825,000 at December 31, 1995. During fiscal year 1996, the
Company experienced modest membership growth, due primarily to intense
competition in all its key markets. This trend continued into the first half
of fiscal year 1997 and may continue throughout the balance of fiscal year
1997. In addition, during the three month period ended December 31, 1996,
the Company experienced a small decline in its commercial membership,
probably due to the pending merger with PacifiCare.
From December 31, 1995, to December 31, 1996, total commercial membership
increased by 86,000 or 6.0% from approximately 1,439,000 to approximately
1,525,000. The Company generates approximately half of its HMO revenue from
sales to the commercial market. The Company's ability to increase its
commercial membership and commercial premium rates during the second quarter
of fiscal year 1997 was adversely impacted by intense competition in all the
Company's major markets, particularly in California, and by the pending
merger with PacifiCare. Downward pressure on commercial premium rates in
California has eased in recent months; however, overall commercial premium
rates are expected to remain relatively flat in fiscal year 1997 over fiscal
year 1996. A substantial portion of the Company's HMO commercial premium
rate increases becomes effective in January of each year.
13
<PAGE>
Senior membership grew by 28,000 or 7.3% to approximately 414,000 at
December 31, 1996, from approximately 386,000 at December 31, 1995. Almost
all of the Company's senior HMO revenue is generated from premiums paid to
the Company by the federal government's Health Care Financing Administration
("HCFA"). Revenue per senior member is substantially higher than revenue per
commercial plan member because senior members use substantially more health
care services. The Company receives senior premium rate increases from HCFA
on January 1 of each year and these rate increases vary geographically. The
Company received an average 5.7% rate increase for calendar year 1997.
During fiscal year 1996 and the first half of fiscal year 1997, the
Company experienced a decline in its membership, both senior and commercial,
at certain medical facilities operated by Talbert. For the Company, the
decline has been more than offset by enrollment gains in the Company's HMO
operations.
COST OF HEALTH CARE
Health care costs increased by $78 million or 9.1% to $939 million for
the three months ended December 31, 1996, from $861 million for the three
months ended December 31, 1995, due to operational growth and cost increases.
Health care costs as a percentage of revenue improved slightly to 84.7% from
84.8% for the same period in the prior year.
During the last three years and the first half of fiscal year 1997,
certain medical centers in California now operated by Talbert have
experienced high operating costs relative to declining enrollment. The
decline has created excess capacity and, therefore, higher health care costs
as a percentage of revenue. Talbert began reducing costs in fiscal year
1996, continuing into fiscal 1997, by reducing administrative overhead and
excess staffing.
GENERAL, ADMINISTRATIVE AND MARKETING COSTS
General, administrative and marketing ("G & A") expenses increased by $2
million or 1.6% to $130 million for the three month period ended December 31,
1996, from $128 million for the three month period ended December 31, 1995.
G & A expenses for the three month period ended December 31, 1996, decreased
as a percentage of revenue to 11.7% from 12.6% for the same period in the
prior fiscal year, primarily due to workforce reductions that took place
during fiscal year 1996, and to recent employee losses associated with the
pending merger with PacifiCare.
INTEREST INCOME
Net interest income was $7 million for the three month period ended
December 31, 1996, as compared to $3 million for the three month period ended
December 31, 1995. Net interest income increased year-over-year primarily
because of lower debt levels.
14
<PAGE>
SIX MONTHS ENDED DECEMBER 31, 1996, COMPARED TO THE
SIX MONTHS ENDED DECEMBER 31, 1995
REVENUE AND MEMBERSHIP
Revenue for the six month period ended December 31, 1996, totaled $2,207
million, increasing 9.3% over revenue of $2,020 million for the same period
in the previous fiscal year. The Company's ability to increase its
commercial membership and commercial premium rates during the first half of
fiscal year 1997 has been adversely impacted by intense competition in all
the Company's major markets and by the pending merger with PacifiCare.
Senior membership growth has continued steadily, increasing at a 7.3% growth
rate (annualized) during the first half of fiscal year 1997.
COST OF HEALTH CARE
Health care costs increased by $158 million or 9.2% to $1,869 million for
the six month period ended December 31, 1996, from $1,711 million for the
comparable six month period ended December 31, 1995. Health care costs as a
percentage of revenue remained flat at 84.7% for both six month periods.
GENERAL, ADMINISTRATIVE AND MARKETING COSTS
General, administrative and marketing ("G & A") expenses increased by $9
million or 3.6% to $262 million for the six month period ended December 31,
1996, from $253 million for the same period in the previous year, primarily
due to cost increases. G & A expenses for the six month period ended
December 31, 1996, decreased as a percentage of revenue to 11.9% from 12.5%
for the same period in the prior fiscal year, primarily due to workforce
reductions in fiscal year 1996, other cost control measures and recent
employee losses associated with the pending merger with PacifiCare.
INTEREST INCOME
Net interest income was $13 million for the six month period ended
December 31, 1996, as compared to $6 million for the six month period ended
December 31, 1995. Net interest income increased year-over-year primarily
due to lower debt levels.
OPM AUDITS
The Company's HMO subsidiaries have contracts with the United States
Office of Personnel Management ("OPM") to provide or arrange managed health
care services under the Federal Employees Health Benefits Program ("FEHBP")
for federal employees, annuitants and their dependents. These contracts with
OPM and applicable government regulations establish premium rating
requirements for the FEHBP. Periodically, the Company's HMO subsidiaries are
subject to audits by the government to, among other things, verify that
premiums charged under OPM contracts are established in compliance with
community rating and other requirements under the FEHBP. In the third
quarter of fiscal year 1996, the Company increased reserves by recording a
pretax charge of $45 million ($28.7 million net of tax), in anticipation of
negotiations to address existing and potential governmental claims arising
from OPM audits for the years 1987 through 1996, as discussed below. The
Company's reserves reflect management's recognition that FEHBP rate audits
and claims based thereon are being handled differently by the government than
in the past and reflect the extent of business the Company's subsidiaries
have conducted with OPM over many years.
15
<PAGE>
In October 1996, the Company reached an agreement with the government to
resolve claims arising from the draft audit report covering the years 1987
through 1991 at certain of the Company's HMO subsidiaries. The United States
Department of Justice had notified the Company that, based on the OPM draft
audit report, the government believed the Company may have violated the False
Claims Act and that it believed the government's actual damages to be
approximately $15 million before consideration of any interest or penalties.
The agreement caused the Company to pay $12 million, which amount was
allocated by OPM to FEHBP Contingency Reserve Funds for the regions covered
by the Company's contracts. The Company did not pay any fine or penalty under
the agreement. Under the terms of the agreement, the government released the
Company from all claims under the subject contracts for the years covered by
the draft audit report.
OPM has opened two additional audits for years as far back as 1990 at two
of the Company's other HMO subsidiaries. In October 1996, OPM sent a draft
audit report with respect to a subsidiary acquired as part of the Company's
purchase of TakeCare, Inc. ("TakeCare") in June, 1994, alleging certain
defects in the subsidiary's rating practices for the years 1990 through 1994,
and requesting that the Company comment on the draft findings. The Company
has responded to the draft report and is awaiting further response from OPM.
It is likely the final TakeCare audit report will recommend that OPM seek
a monetary recovery from the Company and that such recommended recovery will
be for a substantial amount. Based on positions taken by the government with
respect to the 1987-1991 draft audit report discussed above, management
believes that the other open audit and other possible future audits may
allege defective rating practices and result in claims for adjustments from
OPM. Management cannot determine if such claims will result in further
referrals to the Department of Justice and further False Claims Act claims.
Based on management's understanding of the government's current
interpretation of the community rating standard requirements, management
currently believes it has established adequate reserves to settle any claims
that may arise from present or future FEHBP rate audits for years between and
including 1987 through 1996, or that amounts in excess of reserves, if any,
necessary to settle any such claims would not be such as to have a material
adverse effect on the consolidated financial position or results of
operations or cash flows of the Company. In addition, the Company's
management currently does not believe the OPM audits will have a material
effect on future relations with OPM.
The preceding two paragraphs in this subsection headed "OPM Audits"
consist of forward looking statements. The actual outcome of any OPM audits,
claims for adjustments and/or False Claims Act claims, the manner in which
and amounts for which any such claims will be resolved, and the adequacy of
reserves may differ materially from management's current expectation.
Factors that could cause the resolution of these matters to differ materially
from management's current expectation include the presentation by the
government of new interpretations of FEHBP requirements, the presentation of
new data relating to the determination of applicable rate changes or in the
manner in which the government seeks to apply the False Claims Act to such
situations, and/or a change in the government's position toward negotiated
settlements of OPM audits and/or False Claims Act claims.
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's consolidated cash, cash equivalents and short-term
investments increased by $169 million to $524 million at December 31, 1996,
from $355 million at June 30, 1996, due primarily to the early receipt from
HCFA of $186 million for January, 1997, health care services to senior
members. The other material source of cash during the first half of fiscal
year 1997 was $37 million from operations (net of the early receipt of HCFA
premiums). Uses of cash during the period included $27 million for capital
expenditures, $13 million for Preferred Stock dividends, and $15 million of
debt repayment.
In September, 1993, the Company issued $100 million of ten-year Senior
Notes (the "Notes") which carry interest at 7%. In March, 1994, the Company
entered into a $350 million Credit Agreement. The Credit Agreement, as
amended, provides for a $200 million Revolving Credit Loan and a $150 million
Term Loan. The Company borrows at rates based on LIBOR rate borrowings which
currently approximate 5.9%. The Term Loan is repayable at the rate of $15
million every six months, with the final repayment due March 31, 2000. The
Credit Agreement contains financial and other covenants, including
limitations on indebtedness, liens, dividends, sale and lease-back
transactions, and certain other transactions. As of December 31, 1996,
borrowings of $19 million were outstanding under the Credit Agreement.
The Company's ability to make a payment on, or repayment of, its
obligations under the Credit Agreement, the Notes and its Preferred Stock is
significantly dependent upon the receipt of funds by the Company from the
Company's direct and indirect subsidiaries. These subsidiary payments
represent: (a) fees for management services rendered by the Company to the
subsidiaries; and (b) cash dividends by the subsidiaries to the Company.
Nearly all of the subsidiaries are subject to HMO regulations or insurance
regulations (the "Regulated Subsidiaries"). Each of the Regulated
Subsidiaries must meet or exceed various fiscal standards imposed by HMO
regulations or insurance regulations. These fiscal standards may, from time
to time, impact the amount of funds paid by one or more of the Regulated
Subsidiaries to the Company. The Company believes the payments referred to
above by the Regulated Subsidiaries, together with other financing sources,
including the Credit Agreement, should be sufficient to enable the Company to
meet its payment obligations under the Notes, the Credit Agreement and the
Company's Preferred Stock. The Company believes that cash flow from
operations, the Credit Agreement and existing cash balances will be
sufficient to continue to fund operations and capital expenditures for the
foreseeable future.
Under the Merger Agreement, PacifiCare agreed to acquire all of the
outstanding Common and Preferred Stock of the Company. At the Effective Time
of the PacifiCare transaction, each outstanding share of Company Common Stock
and Series A Preferred will be converted in part into rights to purchase a
proportionate share (on an as-if-converted basis) of all of the Company's
holdings in Talbert (the "Rights"). The Rights will be delivered promptly
after the Talbert Effective Time and will be exercisable for 30 days after
the Talbert Effective Time. On or before the Talbert Effective Time, Talbert
will be capitalized to a net worth of approximately $60 million.
The Company currently expects that PacifiCare will assume the Company's
obligation under the Notes. It is expected that outstanding balances under
the Company's Credit Agreement will be paid in full and the Credit Agreement
terminated upon consummation of the merger. In addition, all of the preceding
statements about the Company's expectations or intentions are subject to
changes that might result from the acquisition of the Company by PacifiCare.
17
<PAGE>
EFFECTS OF REGULATORY CHANGES AND INFLATION
Effective January 1, 1996, the Company received an average premium rate
increase from HCFA of approximately 5.1% for its senior HMO members.
Effective January 1, 1997, the Company received an average 5.7% rate increase
for calendar year 1997. The Company evaluates the effects of HCFA premium
adjustments on its liquidity and capital resources, and incorporates the
actual and anticipated impact of such adjustments into its planning process.
The Company has been experiencing significant downward pressures on
commercial HMO premium rates, due to intense competition and counter-
inflationary measures by large commercial employers attempting to hold their
costs down. The Company has experienced competitive pressures in both its
commercial and senior markets in California and this is continuing into
fiscal year 1997. These downward pressures may continue throughout fiscal
year 1997. There can be no assurances that the Company will be able to
obtain premium rate increases in the commercial sector in the short term.
In recent years health care costs have been rising at a rate higher than
that for consumer goods as a whole, as a result of inflation, new technology
and medical advances. The Company believes that internal cost control
measures and financial risk-sharing arrangements with its contract medical
providers help to mitigate the effects of inflation on its operations;
however, there can be no assurance that the Company's efforts to reduce the
impact of the increasing cost of health care will be as successful in the
future as they have been in the past.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
The statements in this Management's Discussion and Analysis of Financial
Condition and Results of Operations concerning future events, activities,
conditions and any and all statements that are not historical facts are
forward-looking statements. Actual results may differ materially from those
projected. Forward-looking statements involve risks and uncertainties. The
Company's ability to expand has been and may continue to be affected by
increasing competition, product choices and competitors in the Company's
service areas. There has been recent discussion in the public arena that HCFA
may reduce premiums paid to HMOs relative to Medicare rates, effective for
years beyond 1997; also, many commercial employer groups want minimal premium
increases or even decreases. Both issues may affect the Company's ability to
increase revenue. In addition, it is often difficult to contract with
physicians and this affects the Company's ability to control health care
costs. There are numerous external factors including but not limited to
government regulation, natural disasters, health care reform, new technology,
epidemics and hospital costs which affect the Company. A change in any one
or a combination thereof could affect the Company's future financial
performance. Also, the Company's past performance is not necessarily
evidence of or an indication of the Company's future financial performance.
18
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Information relating to certain litigation, Commitments and
Contingencies, as set forth in Note 4 and OPM as set forth in Note 5, of
Notes to Consolidated Financial Statements in Part I of this report is
incorporated herein by this reference.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Annual Meeting of Stockholders of the Company held on
December 31, 1996, the holders of the Registrant's common stock
voted on each of the matters listed below. In addition, the holders
of the Registrant's Series A Preferred Stock voted on the Amendment
to the Company's Certificate of Incorporation listed in item (b)
below.
(a) The Amended and Restated Agreement and Plan of Reorganization
(the "Reorganization Agreement"), dated as of November 11,
1996 by and among the Registrant, PacifiCare Health Systems,
Inc., N-T Holdings, Inc., Neptune Merger Corp., and Tree
Acquisition Corp. and the transactions contemplated thereby.
(b) An Amendment to the Registrant's Certificate of Incorporation
as described in the Registrant's proxy statement dated
November 21, 1996 (the "Amendment").
(c) Election of three members to the Registrant's Board of Directors
to serve three year terms ending in 1999.
(d) The ratification of the appointment of Deloitte & Touche LLP as
independent auditors of the Registrant for the fiscal year
ending June 30, 1997.
The stockholders approved the Reorganization Agreement by a vote of
33,220,538 for, 515,292 against, 30,742 abstaining, and 3,630,760
broker non-votes. The Amendment was approved by the common
stockholders by a vote of 31,230,282 for, 2,478,863 against, 96,329
abstaining, and 3,591,858 broker non-votes. The Amendment was approved
by the holders of the Registrant's Series A Preferred Stock by a vote
of 15,721,014 for, 244,885 against and 89,891 abstaining.
The stockholders elected Jack R. Anderson as director by a vote of
36,864,178 for and 533,154 authority withheld. The stockholders
elected Burke F. Gumbiner by a vote of 36,780,945 for and 616,387
authority withheld. The stockholders elected Warner Heineman by a
vote of 36,754,734 for and 642,598 authority withheld. The
stockholders approved the ratification of the appointment of
Deloitte & Touche LLP by a vote of 37,121,015 for, 187,475 against,
and 88,842 abstaining.
ITEM 5. OTHER INFORMATION.
On December 11, 1996, the Registrant entered into Amendment No. 3 to
that certain Stock Purchase Agreement (the "Agreement"), dated as of
March 15, 1996, as amended, by and among the Registrant, Talbert
Medical Management Corporation, Talbert Health Services Corporation,
Talbert Medical Management Holdings Corporation and certain
management investors. Amendment No. 3 to the Agreement is filed as
Exhibit 10.1 to this Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. See Index to Exhibits at page 21 of this report.
(b) Reports on Form 8-K.
None
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FHP INTERNATIONAL CORPORATION
Dated: February 13, 1997 By: /s/ KENNETH S. ORD
---------------------------------
Senior Vice President and
Chief (Principal) Financial Officer
20
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number
- -------
<S> <C>
4.1 Registrant agrees to furnish to the Commission upon request a copy of each
instrument with respect to issues of long-term debt of the Registrant, the
authorized principal amount of which does not exceed 10% of total assets of
Registrant.
10.1 Amendment No. 3 to the Stock Purchase Agreement, dated March 15, 1996, by
and among the Registrant, Talbert Medical Management Corporation, Talbert
Health Services Corporation, Talbert Medical Management Holdings Corporation,
and certain management investors.
11.1 Statement re: Computation of Earnings Per Share.
27.1 Financial Data Schedule.
</TABLE>
21
<PAGE>
MANAGEMENT STOCK EXCHANGE AGREEMENT
[AMENDMENT NO. 3 TO STOCK PURCHASE AGREEMENT]
This Amendment No. 3 to Stock Purchase Agreement ("Amendment") is made
and entered into as of December 11, 1996, by and among FHP International
Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Holdings
Corporation, a Delaware corporation ("Holdings"), Talbert Medical Management
Corporation, a Delaware corporation (the "Company"), Talbert Health Services
Corporation, a Delaware corporation ("THSC"), Kathryn M. Adair, Gloria L.
Austin, Larry L. Georgopolous, Gary E. Goldstein, M.D., Richard D. Jacobs, Jack
D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter
R. Stone, Margaret Van Meter, and Michael J. Weinstock. Defined terms not
defined herein shall have the meanings assigned to them in the Stock Purchase
Agreement (as defined below).
WHEREAS, FHP, the Company, THSC and the Management Investors are
parties to that certain Stock Purchase Agreement dated as of March 15, 1996, as
amended on May 31, 1996 and September 17, 1996 (the "Stock Purchase Agreement").
WHEREAS, in connection with FHP's merger (the "FHP Merger") with
PacifiCare Health Systems, Inc., FHP intends to sell its holdings of common
stock of the Company and THSC to Holdings, which has been formed by FHP for the
purpose of acquiring all of the capital stock of the Company and THSC.
WHEREAS, concurrently with the FHP Merger, Holdings will distribute
rights to purchase common stock of Holdings (the "Holdings Stock") to the common
and preferred stockholders of FHP pursuant to a registration statement on Form
S-1 (the "Offering").
WHEREAS, the Management Investors collectively own 232,500 shares of
TMMC Stock and 42.75 shares of THSC Stock.
WHEREAS, the Management Investors desire to sell their TMMC Stock and
THSC Stock for the consideration described herein, including the Holdings Stock.
WHEREAS, the FHP, the Company, THSC and the Management Investors
desire to amend the Stock Purchase Agreement in these and certain other respects
as set forth below.
NOW, THEREFORE, in consideration of the mutual promises contained
herein and for other good and valuable consideration, the parties hereby agree
as follows:
<PAGE>
1. EXCHANGE OF TMMC STOCK AND THSC STOCK FOR HOLDINGS STOCK.
The Management Investors hereby exchange, assign, transfer and convey
to FHP all of their right, title and interest in and to, and their ownership of,
the TMMC Stock and THSC Stock in exchange for 232,500 shares of Holdings Stock,
distributed as to each Management Investor in a ratio of one (1) share of
Holdings Stock for one (1) share of TMMC Stock plus 42.75/232,500 share of THSC
Stock owned by each such Management Investor as set forth in the Management
Investor Schedules (as such Management Investor Schedules have been adjusted to
reflect the reverse stock-split of the Company effected on September 17, 1996).
The Holdings Stock received by each such Management Investor will be referred to
as "Holdings Management Stock."
2. CLOSING.
The exchange of TMMC Stock and THSC Stock for Holdings Stock as
contemplated by this Amendment (the "Closing") will take place at the same place
and on the same day as the closing of the FHP Merger.
3. CLOSING DELIVERIES.
(a) BY THE MANAGEMENT INVESTORS. At the Closing, the Management
Investors will deliver to Holdings certificates evidencing the TMMC Stock and
THSC Stock. Each certificate will be properly endorsed for transfer to or
accompanied by a duly executed stock power in favor of Holdings and will be in a
form acceptable for transfer on the books of TMMC and THSC.
(b) BY HOLDINGS. At the Closing, the Holdings will deliver to the
Management Investors certificates evidencing the Holdings Stock. Each
certificate will be properly endorsed for transfer to or accompanied by a duly
executed stock power in favor of each Management Investor and will be in a form
acceptable for transfer on the books of Holdings.
4. AMENDMENTS TO STOCK PURCHASE AGREEMENT.
a. Section 2 of the Stock Purchase Agreement is hereby amended as
follows:
i. The second sentence of Section 2.1 of the Stock Purchase
Agreement is hereby amended by deleting the phrase "(the "THSC Management
Stock", with the TMMC Management Stock and the THSC Management Stock
collectively referred to herein as the "Management Stock")" and replacing
it with the phrase "(the "THSC Management Stock", with the TMMC Management
Stock exchanged for 232,500 shares of the common stock ("Holdings Common
Stock") of Talbert Medical Management Holdings Corporation ("Holdings")
(the "Holdings Management Stock"))."
2
<PAGE>
ii. The third sentence of Section 2.1 of the Stock Purchase
Agreement is hereby amended to read as follows:
"Stock certificates evidencing the Holdings Management Stock, in
addition to blank stock powers executed by each Management Investor, shall
be held by the Assistant Secretary of Holdings (the "Escrow Holder"), and
shall continue to be held by the Escrow Holder for the periods set forth in
Section 3 below, subject to the rights and limitations set forth in this
Agreement."
b. All references to "Management Stock" in the Stock Purchase
Agreement are hereby amended to read "Holdings Management Stock."
c. Section 5 of the Stock Purchase Agreement is amended as follows:
i. All references to "the Company" in section 5.1 are hereby
amended to also be references to Holdings.
ii. Section 5.3(a) of the Stock Purchase Agreement is hereby
amended to read as follows:
"If Holdings fails to meet the Financial Goal, as adjusted, for
the fiscal year 1996, as approved by the Audit Committee of the FHP
Board of Directors in accordance with the procedures outlined in
Section 5.3(d) below, FHP shall have the option to purchase from each
Management Investor that portion of the Management Stock with respect
to which the Restrictions lapsed on July 1, 1996 comprising 20% of the
total amount of such Management Stock."
iii. Section 5.3(b) of the Stock Purchase Agreement is hereby
amended to read as follows:
"If Holdings fails to meet the Financial Goal, as adjusted, for
the fiscal year 1997, as approved by the Audit Committee of FHP's
Board of Directors (the "Audit Committee") in accordance with the
procedures outlined in Section 5.3(d) below, FHP shall have the option
to purchase from each Management Investor that portion of the
Management Stock with respect to which the Restrictions lapsed on
July 1, 1997 comprising 20% of the total amount of such Management
Stock."
iv. All references to "the Company" in Section 5.3 are hereby
amended to be read "Holdings."
d. All references to "TMMC Common Stock or THSC Common Stock" in
Sections 6 and 7 of the Stock Purchase Agreement are hereby amended to read
"Holdings Common Stock."
3
<PAGE>
e. Section 8 of the Stock Purchase Agreement is hereby amended to
read as follows:
"8. WITHHOLDING. The Management Investors acknowledge that
Holdings, the Company, FHP or THSC, as appropriate, may withhold
compensation (in cash, or, at the option of Holdings, the Company, FHP
or THSC, as appropriate, in stock) to satisfy all applicable federal,
state and local income, employment and other tax withholding
requirements."
f. All references to "the Company" in section 12 are hereby amended
to be references to Holdings. All references to "Outstanding Company Common
Stock" are hereby amended to be references to "Outstanding Holdings Common
Stock" and all references to "Outstanding Company Voting Securities" are hereby
amended to be references to "Outstanding Holdings Voting Securities."
5. OTHER AGREEMENTS REGARDING THE STOCK PURCHASE AGREEMENT.
a. The parties to this agreement hereby agree that the Holdings Stock
acquired herein by the Management Investors falls within the definition of
"Additional Securities" as such term is defined in the Stock Purchase Agreement,
and is subject to the same conditions as the TMMC Stock and THSC Stock with
respect to which they were exchanged.
b. The parties hereby agree that the Offering is a distribution to
the public which triggers the expiration of the "Drag-Along Rights" and "Tag-
Along Rights" contained in Section 6 of the Stock Purchase Agreement and the
"Right of First Refusal" contained in Section 10.1 of the Stock Purchase
Agreement.
c. The parties hereby agree that the Registration Rights in Section 7
of the Stock Purchase Agreement will not be exercisable in connection with the
Offering or in connection with an offering by FHP pursuant to its shelf
registration rights.
d. The parties hereby agree that the restrictions on transfer of the
Management Stock contained in Section 10 of the Stock Purchase Agreement will
not prevent any transactions contemplated by this Amendment.
6. NOTICES. Notices and other communications provided for herein or in the
Stock Purchase Agreement shall be in writing (including wire, telex, telecopy or
similar writing) and shall be sent, delivered, telexed or telecopied, if to
Holdings, to:
Talbert Medical Management Holdings Corporation
3540 Howard Way
Costa Mesa, CA 92626-1417
Attn: President
Telecopier: (714) 436-4860
4
<PAGE>
with copies to:
O'Melveny & Myers LLP
400 South Hope Street
Los Angeles, CA 90071
Attn: C. James Levin, Esq.
Telecopier: (213) 669-6407
7. GOVERNING LAW. This Amendment shall be governed by and construed in
accordance with the law of the State of Delaware, without reference to its
conflicts of law rules.
8. NO OTHER AMENDMENTS. The Stock Purchase Agreement, as amended previously
and by this Amendment, is and shall continue to be in full force and effect and
is hereby in all respects ratified and confirmed. Except as provided herein,
nothing in this Amendment shall waive or be deemed to waive or modify (except as
expressly set forth herein) any rights or obligations of any of the parties
under the Stock Purchase Agreement.
9. COUNTERPARTS. This Amendment may be executed in any number of
counterparts, each of which will be deemed to be an original but all of which
together will constitute but one instrument.
[remainder of page intentionally left blank]
5
<PAGE>
IN WITNESS WHEREOF, the parties have duly executed this Amendment as
of the date first written above.
FHP International Corporation,
a Delaware corporation
By: /s/ Burke F. Gumbiner
------------------------------
Burke F. Gumbiner
Senior Vice President
Talbert Medical Management Corporation,
a Delaware corporation
By: /s/ Michael A. Montevideo
------------------------------
Name: Michael A. Montevideo
Title: Assistant Treasurer
Talbert Health Services Corporation,
a Delaware corporation
By: /s/ Michael A. Montevideo
------------------------------
Name: Michael A. Montevideo
Title: Assistant Treasurer
Talbert Medical Management Holdings Corporation
a Delaware corporation
By: /s/ Michael A. Montevideo
------------------------------
Name: Michael A. Montevideo
Title: Assistant Treasurer
S-1
<PAGE>
/s/ Kathryn M. Adair /s/ Jack D. Massimino
- ----------------------------- ----------------------------
Kathryn M. Adair Jack D. Massimino
/s/ Gloria L. Austin /s/ Barbara C. McNutt
- ----------------------------- ----------------------------
Gloria L. Austin Barbara C. McNutt
/s/ Larry L. Georgopolous /s/ Westcott W. Price III
- ----------------------------- ----------------------------
Larry L. Georgopolous Westcott W. Price III
/s/ Gary E. Goldstein, M.D. /s/ Walter R. Stone
- ----------------------------- ----------------------------
Gary E. Goldstein, M.D. Walter R. Stone
/s/ Richard D. Jacobs /s/ Margaret Van Meter
- ----------------------------- ----------------------------
Richard D. Jacobs Margaret Van Meter
/s/ Kenneth S. Ord /s/ Michael J. Weinstock
- ----------------------------- ----------------------------
Kenneth S. Ord Michael J. Weinstock
S-2
<PAGE>
EXHIBIT 11.1
FHP INTERNATIONAL CORPORATION
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
(unaudited)
<TABLE>
<CAPTION>
For The
Three Months Ended
(amounts in thousands, December 31,
except share data) 1996 1995
------------ ------------
<S> <C> <C>
Primary earnings per share
attributable to Common Stock:
Net income attributable to
Common Stock $ 18,398 $ 7,313
-------- --------
-------- --------
Weighted average number of
common shares and common
share equivalents:
Common Stock 41,266 40,324
Assumed exercise of options 1,002 965
-------- --------
Total shares 42,268 41,289
-------- --------
-------- --------
Primary earnings per share
attributable to Common Stock $ 0.44 $ 0.18
-------- --------
-------- --------
Fully diluted earnings per share:
Net income attributable to
Common Stock assuming
conversion of Series A
Cumulative Convertible
Preferred Stock $ 24,973 $ 13,888
-------- --------
-------- --------
Weighted average number of
common shares and common
share equivalents:
Common Stock 41,266 40,324
Assumed exercise of options 1,059 1,242
Assumed conversion of
Series A Cumulative
Convertible Preferred Stock 16,968 16,968
-------- --------
Total shares, assuming
full dilution 59,293 58,534
-------- --------
-------- --------
Fully diluted earnings per share $ 0.42 $ 0.24(1)
-------- --------
-------- --------
</TABLE>
(1) This computation is submitted in accordance with Regulation S-K, Item 601
(b)(11) although it is contrary to paragraph 40 of Accounting Principles
Board Opinion No. 15 because it produces an anti-dilutive result.
22
<PAGE>
EXHIBIT 11.1
FHP INTERNATIONAL CORPORATION
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
(unaudited)
<TABLE>
<CAPTION>
For The
Six Months Ended
(amounts in thousands, December 31,
except share data) 1996 1995
------------ ------------
<S> <C> <C>
Primary earnings per share
attributable to Common Stock:
Net income attributable to
Common Stock $ 35,367 $ 14,633
-------- --------
-------- --------
Weighted average number of
common shares and common
share equivalents:
Common Stock 41,101 40,287
Assumed exercise of options 1,102 859
-------- --------
Total shares 42,203 41,146
-------- --------
-------- --------
Primary earnings per share
attributable to Common Stock $ 0.84 $ 0.36
-------- --------
-------- --------
Fully diluted earnings per share:
Net income attributable to
Common Stock assuming
conversion of Series A
Cumulative Convertible
Preferred Stock $ 48,517 $ 27,785
-------- --------
-------- --------
Weighted average number of
common shares and common
share equivalents:
Common Stock 41,101 40,287
Assumed exercise of options 1,249 1,242
Assumed conversion of
Series A Cumulative
Convertible Preferred Stock 16,968 16,968
-------- --------
Total shares, assuming
full dilution 59,318 58,497
-------- --------
-------- --------
Fully diluted earnings per share $ 0.82 $ 0.48(1)
-------- --------
-------- --------
</TABLE>
(1) This computation is submitted in accordance with Regulation S-K, Item 601
(b)(11) although it is contrary to paragraph 40 of Accounting Principles
Board Opinion No. 15 because it produces an anti-dilutive result.
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENTS OF INCOME, BALANCE SHEETS AND CASH FLOWS OF FHP
INTERNATIONAL AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH DECEMBER 31,
1996 QUARTERLY REPORT ON FORM 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 297,815
<SECURITIES> 226,598
<RECEIVABLES> 165,367
<ALLOWANCES> 22,027
<INVENTORY> 8,913
<CURRENT-ASSETS> 766,433
<PP&E> 396,082
<DEPRECIATION> 164,318
<TOTAL-ASSETS> 2,210,825
<CURRENT-LIABILITIES> 802,259
<BONDS> 100,195
0
525,793
<COMMON> 431,093
<OTHER-SE> 262,889
<TOTAL-LIABILITY-AND-EQUITY> 2,210,825
<SALES> 2,207,042
<TOTAL-REVENUES> 2,207,042
<CGS> 2,130,504
<TOTAL-COSTS> 2,130,504
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,188
<INTEREST-EXPENSE> 4,944
<INCOME-PRETAX> 89,845
<INCOME-TAX> 41,328
<INCOME-CONTINUING> 48,517
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 48,517
<EPS-PRIMARY> 0.84
<EPS-DILUTED> 0.82
</TABLE>
