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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended 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 1-11538
HEALTHSOURCE, INC.
(Exact name of registrant as specified in its charter)
New Hampshire 02-0387748
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Two College Park Drive, Hooksett, NH 03106
(Address of principal executive offices)
(603) 268-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.10 par value
5% Convertible Subordinated Notes Due 2003
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ].
State the aggregate market value of the voting stock held by non-affiliates
of the registrant: $1,227,749,676(based upon the reported closing price of $20
5/8 on the New York Stock Exchange on March 24, 1997).
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Title of Each Class: Common Stock, $.10 par value
Number of Shares Outstanding at March 24, 1997: 63,860,017 shares
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DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's 1996 Annual Report are incorporated by
reference in Part II of this Form 10-K.
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HEALTHSOURCE, INC.
FORM 10-K
TABLE OF CONTENTS AND CROSS-REFERENCE SHEET
Reference by Page
to Information
Page of Incorporated
Item No. in Form 10-K Report by Reference
- --------------------- ------ ------------
PART I
1. Business.................................... 4 N/A
2. Properties.................................. 19 N/A
3. Legal Proceedings........................... 20 N/A
4. Submission of Matters to a Vote of Security
Holders..................................... 20 N/A
PART II
5. Market for Registrant's Common Equity and
Related Shareholder Matters................. 21 1996 Annual
Report, p. 25
6. Selected Financial Data..................... 21 1996 Annual
Report, p. 2
7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 21 1996 Annual
Report, p. 3
8. Financial Statements and Supplementary Data. 21 1996 Annual
Report, p. 8
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure...... 22 N/A
PART III
10. Directors and Executive Officers of the
Registrant.................................. 22 N/A
11. Executive Compensation...................... 27 N/A
12. Security Ownership of Certain Beneficial
Owners and Management....................... 34 N/A
13. Certain Relationships and Related Transactions 36 N/A
PART IV
14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K......................... 37 N/A
Exhibit Index..................................... 45 N/A
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PART I
ITEM 1. BUSINESS
(a) General Development of Business. See (c) below.
(b) Financial Information about Industry Segments. Not Applicable.
(c) Narrative Description of Business.
General
Healthsource, a New Hampshire corporation established in 1985
("Healthsource" or the "Company"), is a geographically diversified provider of a
broad range of managed healthcare services. Healthsource is a leading managed
care provider with health maintenance organizations ("HMOs") in North Carolina,
South Carolina, New Hampshire, Massachusetts, Indiana, Maine, Tennessee,
Arkansas, Syracuse, New York, Louisville, Kentucky, Georgia, north central
Texas, southwestern Ohio, New York City, northern New Jersey, and Connecticut.
Healthsource acquired the group health, HMO and third party administration
("TPA") business of Provident Life and Accident Insurance Company of America
("Provident") of Chattanooga, Tennessee in May 1995 (the "Provident
Transaction"). The national indemnity insurance and TPA business acquired from
Provident (collectively referred to as "Healthsource Provident") is concentrated
in the Southeast and serves a total of over 1.7 million members. On January 6,
1997, the Company completed the acquisition (effective December 31, 1996) of the
remaining 85% interest in ChubbHealth, Inc., a 68,000 member HMO in the greater
New York City area. On January 1, 1997 Healthsource provided or administered
healthcare benefits for over 3.1 million members. Healthsource also offers point
of service ("POS") plans, preferred provider organization ("PPOs") plans,
insured and self-insured dental plans, utilization review ("UR") services,
managed workers' compensation services, pharmacy benefit management services and
other managed care consulting and administrative services to other healthcare
payors including Provident and Liberty Mutual Insurance Company. The Company's
executive offices are located at Two College Park Drive, Hooksett, New Hampshire
03106; telephone number (603) 268-7000.
Recent Development - Announced CIGNA Merger Agreement
On February 28, 1997, the Company announced that it had signed an Agreement
and Plan of Merger (the "CIGNA Merger Agreement") with CIGNA Corporation
("CIGNA") under which CIGNA agreed to acquire, through a wholly-owned
subsidiary, all of the outstanding Common Stock of the Company for a price of
$21.75 in cash per share, through a public tender offer (the "Tender Offer") for
all outstanding shares which was commenced on March 6, 1997, to be followed by a
statutory merger (the "Merger") cashing-out the remaining public shareholders at
the same price per share. The consummation of the Tender Offer and Merger are
subject to regulatory and other approvals and conditions; there is no assurance
that such approvals will be obtained or that such conditions will be satisfied.
The CIGNA Merger Agreement has been filed as an exhibit to the Company's Report
on Form 8-K filed March 4, 1997, and the terms of the CIGNA Merger Agreement are
incorporated herein by reference. The Company has agreed to redeem the Rights
issued under the Rights Agreement dated as of July 29, 1996 with The Bank of New
York prior to the consummation
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of the Tender Offer. In connection with the Merger, CIGNA has agreed to fund the
repurchase of the Company's $247,250,000 principal amount 5% Convertible
Subordinated Notes Due 2003 (the "Notes"), the holders of which will have the
right to require that the Company repurchase such Notes at a purchase price in
cash of 101% of the principal amount of such Notes, plus interest to the date
such Notes are accepted for payment by the Company, following the consummation
of the Tender Offer.
In connection with the CIGNA Merger Agreement, CIGNA entered into a Tender
Agreement and Irrevocable Proxy (the "Shareholder Agreement") with Norman C.
Payson, M.D., the Company's President and Chief Executive Officer and a member
of the Company's Board, with respect to the 4,332,760 shares of the Company's
Common Stock owned by Dr. Payson. Pursuant to the Shareholder Agreement, Dr.
Payson has agreed to tender all shares owned by him in the Tender Offer and
CIGNA has agreed to accept for payment and pay for such shares, subject to the
terms of the Tender Offer. See Item 12 "Security Ownership of Certain Beneficial
Owners and Management" for additional information regarding the Shareholder
Agreement.
The Managed Care Industry
The managed care industry has grown substantially in recent years.
Healthsource expects industry growth to continue because of continued pressure
from employers and state and federal governments to control healthcare costs and
the failure of unmanaged indemnity products to provide such controls.
Healthsource believes that managed care will continue to be a major mechanism to
control, finance and deliver healthcare in the United States in the future and
may largely replace the indemnity healthcare financing system.
Healthsource's Business Strategy
Healthsource seeks to enhance its position as a leader in providing quality
and affordable healthcare in an expanding set of local markets. Healthsource's
business strategy has three components: (i) to increase HMO enrollment in its
existing markets by capitalizing on the historically low HMO penetration rate in
many of those markets, emphasizing the conversion to HMO membership of members
currently being served in the Company's indemnity and self-funded plans
(especially those acquired in the Provident Transaction) and continuing to
develop and offer new products for different segments of the population such as
Medicare, (ii) to continue positioning its HMOs to be less vulnerable to
declining average premiums by linking a portion of healthcare costs to premiums
through global capitation arrangements or other suitable arrangements with
healthcare providers, and (iii) to reorient the Company's start-up activities in
new markets with the goal of reducing the Company's losses in such markets below
the levels experienced in 1996. In seeking to convert existing indemnity and
self-funded plan members to HMO membership, Healthsource continues to maintain
working relationships with local physicians and hospitals and, in certain
markets, to provide operating and financial support to primary care practices in
order to enhance the access to, and quality and cost effectiveness of, its
managed care products.
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Healthsource Health Plans
Healthsource owns fifteen (15) operating HMOs as well as two (2) other
major operating subsidiaries: (i) Healthsource Provident Administrators, Inc.
("HPA"), which operates the 1.5 million member TPA business acquired in the
Provident Transaction and (ii) Healthsource Insurance Company ("HIC"), which
operates the 222,000 member indemnity group health insurance business acquired
in the Provident Transaction. HPA and HIC are headquartered in Chattanooga,
Tennessee and service a national client base.
The following table shows the membership by the Company's plans at January
1, 1997:
<TABLE>
<CAPTION>
Membership as of January 1, 1997
HMO/Other
Fully
Insured Indemnity Self-Insured
HMO Products Insurance TPA POS PPO Other Total
- --------------------------- ------------ --------- --------- ------- --------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Leading Plans:
Healthsource North Carolina.......... 212,200 --- --- 62,300 --- --- 274,500
Healthsource South Carolina.......... 141,400 300 --- 7,800 --- 11,200 160,700
Healthsource New Hampshire........... 136,300 900 75,700 44,100 30,900 90,700 378,600
Healthsource Maine................... 70,700 --- --- 37,900 2,400 700 111,700
Subtotal Leading Plans............... ------------ --------- ------- ----- -------- ------ --------
560,600 1,200 75,700 152,100 33,300 102,600 925,500
Other Plans:
Healthsource CMHC.................... 77,100 --- --- --- --- 1,600 78,700
Healthsource Indiana................. 36,500 --- --- --- --- 16,300 52,800
Healthsource New York/New Jersey
New York City...................... 33,600 --- --- --- --- --- 33,600
New Jersey......................... 34,200 --- --- --- --- --- 34,200
Healthsource HMO of New York
(Syracuse NY)...................... 19,000 --- --- 700 10,200 --- 29,900
Healthsource Kentucky................ 12,400 --- --- --- --- --- 12,400
Healthsource Ohio.................... 2,500 --- --- --- --- 400 2,900
Healthsource Connecticut............. 1,600 --- --- --- --- --- 1,600
Healthsource Tennessee............... 92,600 --- --- 27,500 6,500 --- 126,600
Healthsource Arkansas (1)............ 34,600 --- 54,500 1,000 1,100 --- 91,200
Healthsource Georgia ................ 24,800 --- --- --- --- --- 24,800
Healthsource North Texas (1)......... 13,000 --- --- --- 100 --- 13,100
HIC (Chattanooga) (2)................ --- 43,900 --- --- --- 178,700 222,600
HPA (Chattanooga) (2)................ --- --- 1,524,500 --- --- --- 1,524,500
----------- --------- --------- ------- --------- ------- ---------
Subtotal Other Plans................. 381,900 43,900 1,579,000 29,200 17,900 197,000 2,248,900
Total All Plans............. 942,500 45,100 1,654,700 181,300 51,200 299,600 3,174,400
</TABLE>
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- ---------
(1) 70% owned.
(2) Totals only -- Not separately categorized into POS and PPO plans, although
many of these members are in such plans.
Managed Care Products
With the rise in healthcare costs, many private employers are encouraging
their employees to enroll in HMOs or other managed care options. Responding to
similar cost pressures, various federal and state government healthcare programs
are adding more managed care options to their healthcare plans. Healthsource
seeks to meet these needs of employers and government programs not only through
its core offerings of traditional HMO plans, but with a spectrum of other
managed care options, including POS plans, PPO plans and managed workers'
compensation. Healthsource also offers UR services, third-party claims
administration and pharmacy benefit management services to assist self-insured
employers. Healthcare providers typically participate in each of the
Healthsource managed care plans that cover their geographic area.
HMO Products
Healthsource offers a variety of HMO products, enabling it to modify its
benefit structure and pricing to appeal to the varying needs of employers and
their employees. In an HMO plan, the HMO bears the underwriting risk that the
covered medical expenses of its members will exceed related premium revenues in
return for charging pre-determined premiums to employers.
Healthsource's HMOs consist of individual practice association plans in
which each HMO maintains a network of primary care and specialist physicians,
most of whom contract directly with the HMO. Independent physicians are
generally reimbursed for their services by each HMO according to a fee schedule
(also known as fee-for-service) or under fixed fee per member per month ("PMPM")
arrangements (also known as capitation). Both methodologies provide various
incentives for quality and cost-effective care. The Company is emphasizing its
global capitation arrangements with hospitals (discussed at greater length
below) under which variations in the costs of physicians serving Healthsource
members are borne by the hospitals at risk for such members' healthcare costs.
HMO Global Capitation Hospital Contracts
The Company's contracts with hospital providers are a key element in its
efforts to control healthcare costs. While the Company routinely contracts with
hospitals on a discounted fee-for-service, per diem and other fixed payment
bases, the primary focus of the Company's current contracting policy is to have
global capitation arrangements with major hospital providers. In such
arrangements, the hospital generally accepts as full payment for its services
all monies remaining from the global capitation amount after payment of all
other covered medical and healthcare expenses of assigned members; this global
capitation amount is generally linked to a fixed dollar amount PMPM or a
percentage of the Company's premiums collected for assigned members with certain
negotiated variations. Through these global capitation arrangements,
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hospitals and their affiliated providers, such as owned physician practices, are
incentivized to mitigate inappropriate utilization and otherwise strive for
efficiencies in patient care. Generally, the global capitation rate in these
contracts varies directly with premium pricing, which provides incentives for
hospitals that are parties to global capitation arrangements to assist in
enhancing the quality, value and perception of the Company's HMOs in the
marketplace and allows the Company more predictability in its medical loss ratio
("MLR") and less financial exposure if there are reductions in premium pricing
since reductions in premium pricing are generally absorbed pro-rata by the
globally-capitated hospitals. Various protections including premium floors,
catastrophic stop-loss, risk sharing and reimbursement arrangements have been
negotiated by hospitals which can further increase the Company's healthcare
costs during periods of unfavorable healthcare experience.
The Company has in excess of 100 globally-capitated hospital provider
contracts. During 1996, due primarily to premium contraction, healthcare cost
deterioration and various specific local factors, the reimbursement experience
of some globally-capitated hospitals was less than such hospitals had expected
and, in some cases, resulted in minimal or no reimbursement to the hospital. In
many if not most cases, however, the hospital also had a substantial volume of
non-capitated business with the Company on which it received negotiated levels
of reimbursement and which tempered the impact of the global capitation
arrangement on the Company's provider relationships.
During 1996, a number of hospitals commenced arbitration proceedings,
indirectly threatened arbitration or complained orally or in writing to the
Company's local HMOs that they are unhappy with the terms of their contracts.
The Company has renegotiated the terms of several of such capitated hospital
provider contracts on terms which it considers favorable. It is also possible
that other hospitals may, among other things, request arbitration seeking to
renegotiate or terminate these long-term contracts. There can be no assurance of
a favorable result in any arbitration proceeding.
Despite the adverse healthcare costs experienced in 1996 and the
unhappiness of certain globally capitated hospitals, the Company has been able
to conclude a substantial number of new global capitation contracts effective
January 1, 1997 and has additional potential contracts in negotiation. The goal
of the Company is to obtain as many global capitation arrangements as reasonably
possible.
Point of Service Plans
A POS plan incorporates greater flexibility than a traditional HMO plan,
typically containing some of the favored provider pricing and utilization
controls of an HMO while permitting the member to use providers outside the
prescribed network at an increased cost to the member. These plans may be
offered to employers on a fully-insured or self-insured basis depending upon the
preferences of the employer. The availability of the POS option has enabled
Healthsource to service various large national employers who have requested this
option. In most cases, the Company's global capitation provider contracts cover
its POS products.
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Preferred Provider Organizations
A PPO is an indemnity healthcare plan which relies on a network of
physicians, hospitals and other providers to provide care on negotiated
financial terms (including discounts or other favorable pricing methodologies)
and which provides members with a greater level of coverage for using network
providers. In markets where the Company has its own HMO, it typically uses the
HMO providers as the preferred providers in the PPO network. To serve the
broader geographic base of members acquired in the Provident Transaction and
other national and regional accounts in other markets, the Company contracts
with third-party PPO providers for access to their networks. The Company
believes PPOs are a transitional product since health plans such as HMOs and POS
plans allow better utilization management and are more easily supported by
global capitation arrangements.
Third-Party Administration Services
Through its TPA services, Healthsource processes claims for medical and
dental services to members of employer-sponsored, self-funded plans and
reimburses the provider or member according to the terms of each plan. Employers
often purchase TPA services which are bundled with UR services and selected PPO
networks in an effort to apply managed care techniques to their self-funded
plans. Under its TPA arrangements, Healthsource does not generally bear any
healthcare cost risk and, accordingly, is not paid an underwriting premium.
Instead, Healthsource's TPA arrangements typically provide for the payment of
administrative fees which generally vary by the number of members covered.
Certain of these contracts contain performance guarantees as to timeliness and
accuracy and certain other features which can place compensation under such
contracts at risk. Of the total of 1.6 million members being provided TPA
services, more than 1.5 million are serviced by HPA from its headquarters in
Chattanooga, Tennessee, seven regional claims centers, and field sales offices
in 13 states. Other significant TPA operations are administered by affiliates of
the New Hampshire and Arkansas plans.
Medicare Risk Products
The Company is actively developing HMO products for the Medicare market
using a task force headquartered in New Hampshire. The task force is designing
provider contracts, creating marketing materials and strategies and preparing
the Health Care Financing Administration ("HCFA") applications and documentation
on a centralized basis with the expectation that Medicare risk contracts would
eventually be sought in most of the Company's markets. The Company expects to
support the offering of Medicare HMO products in each market typically with a
global capitation arrangement with one or more local hospitals. The Company has
found that its hospital providers are often interested in providing care to
Medicare HMO plans and willing to consider healthcare risk assumption under
global capitation arrangements. The degree of customer acceptance of these
products is unknown and will depend upon various policy decisions by Congress
and HCFA, as well as upon successful marketing in each market inasmuch as
Medicare HMO membership is sold on an individual rather than a group basis. The
Company is presently marketing Medicare risk products in Arkansas and New
Hampshire.
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Indemnity Insurance Products
Prior to the Provident Transaction, the Company owned three small indemnity
insurance companies. With the Provident Transaction, the Company chartered a new
Tennessee insurance company -- HIC, headquartered in Chattanooga, Tennessee. HIC
currently reinsures the indemnity insurance portion of the Provident group
health business, which consisted of approximately 222,000 members on January 1,
1997, through Experience-Rated Refundable Premium Insurance and Other Insurance
Products. Healthsource expects that the bulk of these indemnity insurance
policies will be novated by HIC during 1997.
Experience Rated Refundable Premium Insurance
Approximately 178,000 persons are covered under Experience Rated Refundable
Premium policies in which the employer generally bears most of the healthcare
claims risk and can receive a refund when claims experience is favorable.
Premiums for this coverage are based on the actual claims experience of the
employer in prior periods, adjusted for projected future experience, plus a
charge for administrative expenses, certain risks and profit. At the end of each
policy year, an employer's account will show a surplus or deficit balance
depending on defined claims experience. Surplus balances for a current year are
first applied to prior deficits, if any, and then, at the employer's election,
either held in reserve to offset future deficits or refunded. In years with
deficit balances, premiums for future periods are sought to be adjusted so that
Healthsource may recover the deficit, provided the employer maintains its
relationship with Healthsource. There is no assurance that any such deficit can
ultimately be recovered. Operating results fluctuate with claims experience
since all claims are expensed, whether or not currently recoverable from
employers.
Other Insurance Products
In the Provident Transaction, Healthsource also acquired a book of
fully-insured group health policies which are marketed to small and medium sized
employers and which covered 43,900 members on January 1, 1997. The current
market for this business is primarily employers located in the southeastern
United States and having less than 150 employees, although in some cases larger
employers may choose these types of plans. The majority of this business
includes the use of contracted PPO networks with premiums actuarially based on
the expected claims experience of pools of similar risks, together with
provision for administrative expenses and profit. Profitability of this business
is affected by premium pricing competition, deviations of actual claims
experience from expected claims experience and the ability to control
administrative expenses. Claims experience for this product is primarily a
function of healthcare costs, morbidity rates and the effectiveness of
utilization controls and provider discounts available through contracted PPO
networks. Healthcare expenses increased more rapidly than expected during 1996
resulting in losses in these products; while rates for such products have been
increased in 1997, there can be no assurance such increases will cover future
increases in costs.
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Other Managed Care Services
Utilization Review Services
UR services are provided to certain self-funded and insured plans by
Healthsource's healthcare professionals and may include pre-admission
certification and concurrent review of inpatient care, as well as other
utilization management services. As with TPA services, Healthsource does not
typically bear utilization risk in providing UR services; rather it receives
fees which are based on the level of services provided.
Managed Workers' Compensation
Healthsource also applies its managed care expertise to workers'
compensation programs of insurers and employers, both in the residual and
voluntary markets. Under these managed workers' compensation arrangements, the
insurer or employer retains the underwriting risk for healthcare and disability
costs while Healthsource furnishes access to provider networks and renders TPA
and case management services for a fee. Healthsource currently has a managed
workers' compensation program in New England including the residual market in
New Hampshire and Vermont but also for commercial accounts in New Hampshire,
Maine and Massachusetts.
Pharmacy Benefit Management Services
Through its subsidiary, Healthsource Rx, Healthsource provides pharmacy
benefit management services to its affiliated plans and to self-insured
employers. These services include network and claims administration services and
discount arrangements.
Physician Relationships
Healthsource believes that physicians are a critical factor in managing
healthcare costs through their ability to control the quality and utilization of
services from hospitals, specialists and other providers. Therefore,
Healthsource has structured its business on the premise that physicians need to
be actively involved in its HMOs. Healthsource's HMOs typically have quality
assurance and UR committees comprised of local physicians, and physicians
currently constitute a majority of the Board of Directors of Healthsource and
several of Healthsource's majority-owned HMOs. Healthsource has also found that
its policy of involving physicians is helpful as it seeks to enlist physician
support in new markets. Healthsource currently contracts with over 40,000
physicians.
Quality Management
The Company promotes quality healthcare for its members. Most initiatives
are performed at the local HMO level. Typical initiatives include programs to
increase preventive screening such as mammography testing, primary care
physician profiling for quality indicators ("report cards"), disease management
programs to improve certain disease outcomes (such as for asthma treatment),
consumer satisfaction surveys to assess member perceptions, and quality of
service indicators such as telephone waiting time.
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The Company operates an organ transplant provider network from its
Chattanooga headquarters for the benefit of its HMOs and various other managed
care subsidiaries. The providers in this network are among the nation's leading
organ transplant centers, although individual HMOs and other subsidiaries are
not required to use it exclusively.
The Company is obtaining voluntary accreditations for its health plans from
the National Committee of Quality Assurance (NCQA), an independent organization
which reviews HMOs. The Company's HMOs in New Hampshire, New York and Maine have
received three-year accreditation - the highest level of accreditation available
from NCQA. The North Carolina plan currently has a provisional status pending
the results of their renewal survey which was done January 1997. The South
Carolina plan also has provisional status and is scheduled for resurvey in June
1997. The HMOs in Tennessee and Massachusetts are both scheduled for their
initial NCQA survey in March 1997. The Company is planning to have its other
HMOs reviewed as soon as practical.
Marketing
The Company uses a variety of marketing strategies to sell its managed care
products. The Company, as with most HMOs, has historically relied upon an
internal sales force to pursue local markets. With expanded small group market
sales, many of the Company's HMOs have established relationships with
independent insurance brokers in their local markets. The Company's national TPA
business (centered in Chattanooga) has provided it with substantial contacts
with both national and regional brokerage firms.
The Company has established an integrated marketing program under a Senior
Vice President of Marketing, who is developing a coordinated approach for
national and regional accounts. The Company has a focused marketing effort on a
cross-plan basis to seek HMO conversions from its TPA membership. The Company's
sales force also cross-sells HMO, POS, TPA, and indemnity products so as to seek
total replacement coverage for customer accounts.
Management Information Services
All of the Company's HMOs and other products use extensive computer-based
management information systems ("MIS") for various purposes, including claims
processing, billing, utilization management and precertification of selected
healthcare services, underwriting, marketing and sales tracking, general
accounting, medical cost trending, managed care reporting and financial
planning. The MIS systems provide on-line support to member, group and provider
service functions. The Company's MIS systems and supporting hardware are
continually being enhanced and upgraded in order to increase efficiency,
capacity and flexibility of the system.
The Company maintains two major MIS centers in Hooksett, New Hampshire
(120 employees) and Raleigh, North Carolina (70 employees) to service its HMOs
and related products. HIC and HPA receive data processing services from
Provident's main computer system in Chattanooga under a comprehensive Computer
Services Agreement with a term through May 1, 1999 and containing early
termination provisions. The Company has 140 MIS employees in Chattanooga
primarily working on software maintenance and development to support the
business needs of HIC and HPA.
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The Company has made substantial investments in MIS for healthcare cost,
utilization and quality management reporting. Assisting its healthcare providers
with their data needs is a major priority of the Company's MIS Department and
involves a large commitment of resources by the Company. The claims history of
managed care members is available on a separate computer system, the "Data
Warehouse," which utilizes a relational database to accomplish data analysis and
report generation by MIS personnel, financial analysts and plan personnel.
Healthsource's medical management subsidiary, Healthsource Innovative Medical
Management, Inc., is developing a proprietary set of reports, the Diagnostic
Medical Management Information System. Two components of this system are (i) the
Network Performance Package which provides an analysis of the healthcare
utilization of members associated with the particular capitated hospital group
to support the development of customized, effective, medical management
improvement initiatives, and (ii) the Primary Source which profiles a primary
care physician on the utilization of medical services associated with members
under the physician's care.
Competition
The managed healthcare industry is highly competitive at both the local HMO
level and in the regional and national employer markets. The principal
competitive factors affecting the Company's products are premium rates and fees,
plan design and flexibility, and physician/hospital network and reputation. In
many historically under-penetrated markets such as the Carolinas, many new HMOs
have been recently licensed which is reflected in premium pressure for new and
renewal business. In part as a result of this competition, the Company
experienced a 4.5% decline in average premium yield per member during 1996. The
Company has attempted to increase premiums where competitively practicable for
January account renewals and will likely continue to do so during 1997. As a
result the Company expects an increase in average premium yield per-member
during 1997.
The Company competes with Blue Cross plans, indemnity insurers, HMOs, TPAs,
PPOs and other managed care companies, some of which have greater financial
resources than the Company. The Company also faces competition in many of its
markets from hospitals and other provider groups who have organized their own
networks to contract directly with employer groups. As managed care has expanded
generally, many more employers are offering both HMO and indemnity options; thus
the ability to offer a wide variety of HMO, POS, PPO and other services has
become an important competitive factor. The Company uses its healthcare provider
relationships to enhance its competitive position. The Company expects that
competition will remain intense and could become even more so.
In connection with start-up HMOs developed with strategic provider partners
and certain consulting arrangements and in certain other circumstances, the
Company may agree to restrict its activities in a defined area; the Company has
made such agreements in connection with Healthsource Arkansas, Healthsource
North Central Texas, and Vermont Blue Cross, among others. As part of the
Provident Transaction, the Company entered into a non-competition agreement with
Provident under which the Company agreed not to write for its own account
certain types of medical stop-loss insurance, group long- and short-term
disability insurance or group life insurance for certain
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accounts and areas and for certain restricted periods ending between 1998 and
2000 as specified in the agreement. The non-competition agreement is subject to
various exceptions.
Governmental Regulation
General. State and federal regulation of HMOs, managed care products and
indemnity insurance varies from jurisdiction to jurisdiction, is subject to
frequent change and generally gives responsible administrative agencies broad
discretion. Laws and regulations relating to Healthsource's businesses are
subject to amendment or interpretation in each jurisdiction and any such
amendments or interpretations could adversely affect Healthsource's operations,
products, profitability or business prospects or require Healthsource to change
some of its products, services, contracting policies or marketing plans.
Healthsource is unable to forecast which additional laws or regulations, if any,
affecting its business might be enacted in the future or how existing or future
regulations might be interpreted.
New Restrictive Laws. Recent federal legislation concerning maternity stay,
mental health coverage and benefit portability will affect the Company's HMOs. A
number of states have enacted small group insurance and rating reforms which
generally limit the ability of insurers or HMOs to use risk selection or
pre-existing condition exclusions as methods of controlling costs. In addition,
many states are considering (or have enacted) specific limitations on the
ability of insurers or HMOs to control admissions and length of stay, to affect
the provision of healthcare services through UR procedures, to use certain
capitation or other payment methodologies, to expend less than a certain
percentage of premium on healthcare costs, to contract exclusively with
physicians or other providers or to exclude certain providers and other
measures. The effect of widespread enactment of such laws might be to reduce the
Company's ability to control some major elements of its healthcare expenses.
HMOs. All of the states in which the Company owns HMOs have enacted
comprehensive statutes regulating the activities of HMOs. Most states require
periodic financial reports from licensed HMOs and impose minimum capital and
specific reserve requirements. These capital requirements impose significant
restrictions on the ability of any affiliated HMO to pay dividends to the
Company and could require the Company to make additional capital contributions
to its HMOs. A significant portion of the Company's cash, marketable securities
and other assets is held by HIC, Healthsource New Hampshire, Healthsource North
Carolina, Healthsource South Carolina, and other HMOs, and is restricted to use
within the operations of each of those entities. In addition, certain of the
Company's HMOs are required to maintain segregated cash reserves in
interest-bearing instruments held by bank trustees or state regulators. Some
regulations also enable state agencies to review all material contracts entered
into by HMOs, including management contracts, for reasonableness of fees charged
and other issues.
Governmental Programs. The Company currently has two approved Medicare risk
contracts (Arkansas and New Hampshire). The Company's HMOs which obtain Medicare
risk contracts are subject to regulation by the HCFA, an agency of the United
States Department of Health and Human Services. HCFA has the right to audit HMOs
operating under Medicare risk contracts to determine compliance
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with HCFA contracts and regulations as well as the quality of care rendered to
plan members. Medicare risk contracts require an HMO to comply with requirements
for independent review of member services by contracted peer review
organizations. The Company's HMOs which have Medicaid contracts are subject to
both federal and state regulation regarding services to be provided to Medicaid
enrollees and payment for those services. Both Medicare and Medicaid have
extensive laws and regulations relating to physician incentive plans and
provider referrals which may affect the Company's operations. Some of the
Company's HMOs have contracts with the Office of Personnel Management ("OPM")
for the Federal Employees Health Benefits Program; these contracts are subject
to extensive regulation, including complex rules relating to permissible
premiums that may be charged to employees. OPM has the authority to audit the
rates charged and often seeks refunds and other sanctions against participating
HMOs where premiums are claimed to have exceeded permissible levels. Many of the
Company's HMOs also have contracts with states permitting HMO products to be
offered to a broad range of governmental employees in such states and are
subjected to various operating and financial requirements as a condition of such
contracts.
Indemnity Insurance Regulation. The Company's indemnity insurance
subsidiaries are subject to regulation by the Department of Insurance in each
state in which the entity is licensed. Regulatory authorities exercise extensive
supervisory power over insurance companies with respect to the licensing of new
companies and products, the level of required capital and reserves, required
benefits, the approval of policy forms, limitations on investments, and periodic
examination of operations. The Company's insurance company subsidiaries are also
required to file periodic statutory financial statements in each licensed
jurisdiction and are restricted in their ability to pay dividends to, or
contract with, the Company and its affiliates in a similar manner as HMOs.
Insurance Holding Company Regulation. The Company, by virtue of its
ownership of HMOs and insurance subsidiaries, is subject to various state
insurance holding company laws; such insurance holding company laws and related
regulations generally require registration with the state Department of
Insurance and the filing of certain periodic reports describing the capital
structure, ownership, financial condition, certain intercompany transactions and
general business operations of the holding company system. Changes to the
capital structure of the Company and its subsidiaries or material inter-company
transfers or agreements may trigger notice or prior approval requirements,
depending on the size and nature of the transactions.
ERISA. The provision of goods and services to or through certain types of
employee health benefit plans is subject to the Employee Retirement Income
Security Act of 1974 ("ERISA") and regulations promulgated thereunder. ERISA is
administered by the United States Department of Labor ("DOL") and provides
various restrictions on the Company's administration of most self-funded and
other ERISA-governed plans exclusive of governmental plans. The DOL is engaged
in an active ERISA enforcement program, including litigation surrounding the
calculation of percentage co-insurance provisions on discounted services, which
enforcement activities may expand the potential liabilities associated with
administering ERISA plans. The provisions of ERISA have generally been
considered to preempt state regulation (other than insurance regulation) of
plans governed by ERISA and the Company thereby has been exempt from most
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state-law based claims arising from the administration of ERISA plans; recent
judicial decisions, however, have weakened the ERISA preemption doctrine. There
have also been recent legislative attempts to limit ERISA's preemptive effect.
As a result, the Company could be exposed to greater threat of state law-based
claims relating to ERISA plans and services.
TPAs. HPA and certain other subsidiaries of the Company are also licensed
as TPAs in states where such licensing is required for their activities. TPA
regulations generally contain certain required claims procedures, periodic
reporting obligations and minimum financial requirements which vary by state.
PPOs. Certain of the Company's subsidiaries that offer PPO panels or
arrangements may be subject to regulation in various states. Such PPO
regulations generally contain certain network, contracting, financial and
reporting requirements which vary by state.
UR. A number of states have enacted laws or adopted regulations governing
the provision of UR activities. Generally, these laws and regulations require
compliance with specific standards for the delivery of services,
confidentiality, staffing and policies and procedures of private review
entities. Some of these laws and regulations may affect certain operations of
the Company's subsidiaries.
Personnel
As of February 1, 1997, Healthsource and its majority-owned subsidiaries
employed approximately 5,500 employees. None of Healthsource's employees are
subject to collective bargaining agreements. Healthsource believes its
relationship with its employees is good.
Provident Transaction
Effective May 1, 1995, Healthsource acquired the group health, HMO and TPA
business of Provident for $231 million in cash and securities. The business
acquired in such transaction had $76 million in tangible net equity. The Company
paid $131 million in cash, subject to certain post-closing adjustments, and
issued to Provident 1,000,000 shares of non-voting, non-convertible Class A
Cumulative Preferred Stock (the "Preferred Stock") with an aggregate face value
of $100,000,000. The Preferred Stock was redeemed in March 1996.
In conjunction with the Provident Transaction, the Company and Provident
entered into an agreement expiring in December 1997 under which the Company
provides certain administrative services relating to Provident's retained
stop-loss business and Provident's disability products. The Company also entered
into a Computer Services Agreement having a minimum term of two years by which
the services of Provident's main computer center are provided to the operations
of HPA and HIC.
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Recent Acquisition
On January 6, 1997, the Company purchased from Chubb Life Insurance Company
of America the remaining 85% interest in ChubbHealth, Inc., a 68,000 member HMO
operating in the Metropolitan New York City area. The purchase price for such
interest was $25.6 million in cash. The Company may be required to contribute an
additional $6 million to ChubbHealth under terms of the agreeement. ChubbHealth
has been renamed Healthsource New York/New Jersey, Inc. and offers HMO and POS
products in both New York and New Jersey.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995.
The statements contained in the description of the Company's Business as
well as those in the Management's Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this Annual Report on
Form 10-K concerning future profitability, premium pricing levels, future
levels of medical-loss ratios, the Company's ability to control healthcare
and SG&A costs, the Company's success in obtaining global capitation
contracts, and all other statements that are not historical facts are
forward looking statements. Because such statements involve risks and
uncertainties, the following factors, among others, could affect the
Company's actual results and could cause actual future results to differ
materially from those expressed in any forward looking statements made by
the Company or its representatives including those made herein or in other
SEC filings, press releases, presentations to securities analysts or
investors or other communications by the Company:
Control and Predictability of Health Care Costs. The Company's
profitability depends in large part on predicting and maintaining effective
control of the healthcare costs of its HMOs. The future profitability of
the Company's HMOs is dependent upon controlling future healthcare costs in
part through appropriate benefit design, utilization control and
negotiation of favorable provider contracts, including global capitation
arrangements with hospitals which generally link healthcare costs for
assigned members to the premiums received for such members. The Company may
be unable to predict accurately or to control healthcare costs because of
many factors, including the inherent unpredictability of rates of
utilization of services in any given period and the volatility of such use
particularly in quarterly periods; major epidemics; undetected increases in
costs of units of services (in some cases implemented by providers without
prior notice); changes in risk profile of a rapidly increasing membership;
pre-existing medical conditions; changing demographics and other factors;
and increased utilization driven by changes in physician practice patterns
and new techniques (e.g., use of bone marrow transplants for an increasing
number of diagnostic categories)and new or more costly pharmaceutical
products and by consumer demand for these pharmaceuticals. There can be no
assurance that the Company will be successful in predicting or mitigating
the effect of any of these factors nor that its global capitation
agreements will be able to totally buffer these factors or costs for
assigned members, especially since the Company expects that certain
provider disputes will require it to pay higher than originally anticipated
costs for health care services in 1997 and beyond.
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Competition and Premium Pricing. The managed healthcare industry is highly
competitive at both the local HMO level and in the regional and national
employer markets. The principal competitive factors affecting the Company's
products are premium rates and fees, plan design and flexibility, and
physician/hospital network and reputation. The Company competes with Blue
Cross plans, indemnity insurers, HMOs, TPAs, PPOs and other managed care
companies. The Company also faces competition in many of its markets from
hospitals and other provider groups who have organized their own networks
to contract directly with employer groups.
The price charged for providing benefits is in many instances the
controlling factor in obtaining and retaining employer groups, and in
certain markets some competitors are underpricing the Company's products.
In many historically under-penetrated markets such as the Carolinas and
upper New England, many new HMOs have been recently licensed which is
reflected in premium pressure for new and renewal business. Partially as a
result of this competition, the Company experienced a 4.5% decline in
average premium yield per member during fiscal 1996. The Company expects
the difficult premium pricing environment to continue.
Accounting; MIS; Network Disruption Issues. Reserves for incurred but not
reported claims ("IBNR") are a large component of the Company's medical
claims payable reserve and are based upon an estimation of future claims
using traditional actuarial techniques heavily influenced by historical
claims experience; rapid growth and changing risk profiles could render the
Company's IBNR estimates inaccurate and there can be no assurance as to the
ultimate accuracy of such estimates or that subsequent adjustments will not
cause fluctuations in the Company's operating results. The ability to
predict IBNR, control healthcare costs in general and to manage
increasingly complicated global capitation arrangements depends upon the
use of sophisticated customized MIS systems; there can be no assurance that
such systems can be developed quickly enough to effectively manage the
increasing complexity of the Company's contractual arrangements nor that
facility or equipment problems will not disrupt the Company's ability to
effectively provide such MIS support. The increasing complexity of
contractual arrangements and adverse experience in periods of premium
contraction and increasing costs create the potential for disagreements
with major hospital providers over the reimbursement under such contracts,
which disagreements (if not resolved) could disrupt relations with
affiliated hospital or physician providers, could potentially affect the
perception of the Company's plans in the affected markets and has
contributed to the Company's election to invest in certain of these
long-term arrangements to smooth the affiliated providers' transition to
global risk arrangements.
New Products. A significant part of the Company's long-term business
strategy is to develop new products. Until start-up HMOs reach a critical
mass of membership, they generally produce operating losses (despite
capitated provider contracts) and failure to generate sufficient membership
in start-up markets could adversely affect operating results. The Company
is expanding its product offerings, most
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notably by developing and seeking a license for Medicare risk products in
certain of its markets. The Company expended approximately $5 million in
1996 in developing such Medicare products. Such products, once developed,
require a substantial marketing program before the Company generates
revenues from such products in any market; the failure to achieve Medicare
membership quickly in various markets may further impact operating results
as such development expenses are relatively fixed. There can be no
assurance that the Company will successfully mitigate any of the foregoing
risks.
Impact of Healthcare Reform. Many federal and state proposals have been
made in the past to reform the healthcare system. Federal legislation
covering minimum maternity stay and enhanced mental health benefits has
been recently passed and will affect the Company's HMOs. The Company
anticipates that federal and state legislatures will continue to assess
alternative healthcare systems and payment methodologies as well as other
mandated coverages, capitation limits, underwriting constraints and other
measures that could affect the Company's business. The Company is unable to
predict which, if any, of these healthcare reform or other proposals may be
adopted and the Company could be materially adversely impacted by certain
proposals; for example the imposition of a single-payor system in any state
could potentially eliminate the Company's business in that state. See
"Business - Governmental Regulation".
Governmental Regulation. The Company's HMOs, insurance companies and
certain of its other subsidiaries are licensed by and subject to periodic
examination and extensive regulation by the states in which they operate
and by the federal government. Such state and federal statutes and
regulations are subject to change and such changes could adversely impact
the Company's operations in the future. There can be no assurance that the
Company will be able to obtain any regulatory approvals required to enter
new markets or to offer new products. See "Business - Governmental
Regulation".
Volatility of the Company's Stock. The existence of the CIGNA Merger
Agreement largely controls the trading price of the Company's Common Stock
and Notes. In the absence of the CIGNA Merger Agreement, the price of the
Company's Common Stock would likely decrease and, thereafter, the market
price for the Company's stock may be affected by investor perception of the
Company, by general economic and market conditions, by fluctuations in
quarterly earnings, by general trends in the healthcare market, by adverse
news coverage of the HMO industry and by regulatory developments especially
at the federal level.
ITEM 2. PROPERTIES
Healthsource's principal executive offices are located at Two College Park
Drive, Hooksett, New Hampshire 03106, where Healthsource owns and occupies a
97,600 square foot office building.
Healthsource's health plans and other affiliates own or lease office space
in the following major locations, among others, to support their operations:
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Facility Monthly
Location (Sq. Ft.) Leased/Owned Base Rent
- -------- --------- ------------ ---------
Chattanooga, TN........................ 196,400 Leased $227,000
Raleigh, NC............................ 185,000 Leased $133,000
Concord, NH (2 bldgs.)................. 100,000 Leased $ 55,000
Chattanooga, TN........................ 100,000 Owned N/A
Charleston, SC......................... 70,000 Owned N/A
Freeport, ME........................... 60,000 Leased $ 50,700
Worcester, MA.......................... 55,000 Leased $ 67,400
Indianapolis, IN....................... 36,800 Leased $ 44,000
Little Rock, AK........................ 33,300 Leased $ 37,000
Healthsource also maintains sales offices in 20 cities in leased
facilities.
Healthsource believes that the facilities which it currently owns or
leases, together with the expansion plans and options which it has arranged,
will be adequate to meet its current needs.
ITEM 3. LEGAL PROCEEDINGS
On March 7, 1997, Betty Grayson Kurzweil and Robert Grayson, as trustees
under the will of Florence Rosenman (together, the "Plaintiffs"), filed a
putative class action in the Superior Court of Merrimack County, New Hampshire
(the "Complaint") in connection with the CIGNA Merger Agreement. See Item 1,
"Business - Recent Development - Announced CIGNA Merger Agreement" for a
description of the CIGNA Merger Agreement. The Complaint asserts one cause of
action sounding in breach of fiduciary duty against the Company, each of the
Company's directors (the "Director Defendants") and CIGNA. The Complaint alleges
that the Company's February 28, 1997 announcement of the CIGNA Merger Agreement
failed to indicate whether the Company had engaged a financial advisor to
evaluate the Company or had made any attempt to "seek out other potential
suitors for the Company." As a result, the Plaintiffs allege that the Director
Defendants failed to adequately evaluate the Company's value as a potential
merger or acquisition candidate and/or did not act to enhance the Company's
value as such a candidate. The Complaint further alleges that CIGNA disregarded
the alleged breach of fiduciary duty and thus aided and abetted the alleged
breach. The Complaint seeks unspecified monetary damages. The Company believes
that the lawsuit is without merit.
In the ordinary course of business, Healthsource is a party to pending
legal and arbitration proceedings with providers, members and other parties.
Other than as described above, none of such proceedings is believed to have any
material impact on Healthsource's financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
On March 8, 1996, the Company completed the sale of $247,250,000 principal
amount of its 5% Convertible Subordinated Notes Due 2003, which are convertible
into shares of Common Stock at a price of $46.965 per share. The Notes were sold
pursuant to Section 4(2) of the Securities Act to a group of initial purchasers
comprised of Bear, Stearns & Co. Inc., Goldman, Sachs & Co., Merrill Lynch &
Co., Morgan Stanley & Co. Incorporated, Robertson, Stephens & Company and Smith
Barney Inc., in connection with an offering by such initial purchasers to
"qualified institutional buyers" and institutional "accredited investors" under
Rule 144A and outside of the U.S. pursuant to Regulation S under the Securities
Act. In connection with the offering, the initial purchasers realized an
aggregate underwriting discount of $5,563,125. The public resale of the Notes
and the shares of Common Stock into which the Notes are convertible was
registered with the Securities and Exchange Commission on the Company's Form S-3
Registration Statement dated June 5, 1996, as amended by Amendment No. 1 dated
August 16, 1996 (No. 333-5223).
On April 11, 1996, the Company issued 33,002 shares of its Common Stock to
Candler Health System, Inc.("Candler"), a Savannah, Georgia hospital provider,
pursuant to Section 4(2) of the Securities Act. Such shares were issued in
exchange for Candler's 5% interest in Healthsource Savannah and a rearrangement
of certain provider agreements.
Other than as described above, the Company has not engaged in any sales of
securities which were not registered under the Securities Act since January 1,
1994.
Except as set forth above the information required for this item is
incorporated by reference to p. 25 of Healthsource's 1996 Annual Report to
Shareholders.
ITEM 6. SELECTED FINANCIAL DATA
The information required for this item is incorporated by reference to p. 2
of Healthsource's 1996 Annual Report to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required for this item is incorporated by reference to p. 3
of Healthsource's 1996 Annual Report to Shareholders.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required for this item is incorporated by reference to p. 8
of Healthsource's 1996 Annual Report to Shareholders.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors of the Company
The following table sets forth certain information with respect to the
current directors of the Company as of March 28, 1997.
Merwyn Bagan, M.D., M.P.H.
Director since 1985
Age 61
Dr. Bagan has served as the Chairman of the Board of the Company since
1985. Dr. Bagan served as President of Healthsource New Hampshire, Inc. from
1985 until July 1993. He is a board certified neurosurgeon and practiced for
23 years in Concord and Manchester, New Hampshire prior to his retirement in
July 1993. He subsequently earned an M.P.H. degree and presently works as a
consultant in international health. Dr. Bagan is a past President of both
the New Hampshire Medical Society and the American Association of
Neurological Surgeons.
Paul D. Baron, M.D.
Director since 1985
Age 56
Dr. Baron has served as a director of the Company since 1985. He is a board
certified anatomic and clinical pathologist and has practiced for 22 years, the
last 17 at Concord Hospital in Concord, New Hampshire. Dr. Baron is the Chairman
of the Department of Pathology at Concord Hospital.
Robert H. Bilbro, M.D.
Director since 1994
Age 56
Dr. Bilbro has served as a director of the Company since May 1994 and since
1987 has served as President and Chairman of the Board of Directors of
Healthsource Health Plans, Inc. ("HSHP"). Dr. Bilbro is engaged in the practice
of internal medicine and cardiology with Raleigh Medical Group, P.A., Raleigh,
North Carolina, where he has practiced for 24 years. He was nominated by the
Company Board pursuant to the agreement under which the Company acquired HSHP in
March 1994.
Robert S. Cathcart, III, M.D.
Director since 1993
Age 58
Dr. Cathcart has served as a director of the Company since May 1993 and
served as President of Healthsource South Carolina, Inc. from May 1992 to
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October 1996. Dr. Cathcart is a board certified general surgeon with
Surgical Associates of Charleston, South Carolina, P.A. and has practiced for
25 years in Charleston, South Carolina.
J. Harold Chandler
Director since 1995
Age 48
Mr. Chandler has served as a director of the Company since June 1995. Mr.
Chandler is President and Chief Executive Officer and a director of Provident
Companies, Inc. ("Provident") and various of its subsidiaries. Prior to joining
Provident in 1993, he served as President of NationsBank MidAtlantic Banking
Group. Mr. Chandler currently serves as a director of AmSouth Bancorporation and
Herman Miller Inc.
Daniel F. Eubank, M.D.
Director since 1985
Age 49
Dr. Eubank has served as a director of the Company since 1985. Since
January 1995, Dr. Eubank has been the Director of the Residency Program at
Concord Hospital. Dr. Eubank was a partner in Concord Family Medicine from 1983
to 1995. He is board certified in family medicine and has practiced for 17 years
in the Concord, New Hampshire area.
Robert A. Leipold, M.D.
Director since 1985
Age 46
Dr. Leipold has served as a director of the Company since 1985 and as
President of Healthsource New Hampshire, Inc. from 1993 to 1996. Dr. Leipold is
a board certified obstetrician/gynecologist with Garrison Medical Professional
Association and has practiced for 17 years in Dover, New Hampshire.
Francis G. Middleton, M.D.
Director since 1989
Age 57
Dr. Middleton has served as President and Chief Executive Officer of
Healthsource South Carolina, Inc. since October 1996 and as President of
Healthsource South, Inc. since January 1995. He previously served as Medical
Director of Healthsource South Carolina, Inc. from 1986 to January 1995. Until
July 1991, Dr. Middleton practiced medicine in Charleston, South Carolina as a
specialist in internal medicine and infectious disease.
Norman C. Payson, M.D.
Director since 1985
Age 48
Dr. Payson has served as President and Chief Executive Officer of the
Company since 1985. Dr. Payson has been in the HMO field since 1975, first as a
practicing physician and director of an HMO quality program. By 1980, Dr.
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Payson had assumed a full-time position as Chief Executive Officer of a large
physician group practice and as Medical Director for a related HMO company.
David W. Schall, M.D.
Director since 1989
Age 53
Dr. Schall has been a director of the Company since September 1989 and the
President of Healthsource Maine, Inc. since 1986. Since January 1994, Dr. Schall
has been employed as President, Chief Executive Officer and Chief Operating
Officer and a Director of Bowdoin Medical Group and as Managing Partner of
Bowdoin Medical Group Associates. He is board certified in family medicine and
practiced for 25 years in Brunswick, Maine prior to his retirement from private
practice in November 1996.
Right to Designate Directors; The CIGNA Designees
The CIGNA Merger Agreement provides that, subject to compliance with
applicable law, promptly upon the purchase of and payment by CIGNA for shares of
the Company's Common Stock pursuant to the Tender Offer which represent at least
a majority of such outstanding shares (on a fully diluted basis), CIGNA will be
entitled to designate such number of directors (the "CIGNA Designees"), rounded
up to the next whole number, on the Company Board as is equal to the product of
the total number of directors on the Company Board (determined after giving
effect to the directors elected pursuant to this sentence) multiplied by the
percentage that the aggregate number of Shares beneficially owned by CIGNA and
any of its affiliates bears to the total number of shares then outstanding. The
Company will promptly, upon the request of CIGNA, use its best efforts to cause
the CIGNA Designees to be so elected, including, if necessary, increasing the
size of the Company Board or seeking the resignations of one or more existing
directors. Notwithstanding the foregoing, until the effective time of the
Merger, the Company Board will have at least two directors who are directors on
the date of execution of the CIGNA Merger Agreement.
Set forth below is certain information with respect to the initial CIGNA
Designees:
William M. Pastore
Age 48
Senior Vice President, National Service Organization, CIGNA HealthCare
since December 1995. Prior to that, Mr. Pastore served as Vice President,
Director of National Servicing for Citicorp from 1971 until 1995.
W. Alen Schaffer, M.D.
Age 45
Senior Vice President, Managed Care Operations, CIGNA HealthCare since
November 1994. Prior to that, Dr. Schaffer served as Senior Vice President and
National Medical Director, CIGNA HealthCare beginning in May 1993. Dr. Schaffer
also served as the Vice President, Professional Affairs for Aetna Life and
Casualty from 1992 until 1993 and the Vice President, Quality Management &
Training from 1990 until 1992.
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Joseph M. Fitzgerald
Age 52
Senior Vice President, Underwriting Operations, CIGNA HealthCare since May
1992. Prior to that, Mr. Fitzgerald served as Senior Vice President and Chief
Financial Officer, Employee Benefits Division from February 1991 until May 1992
and Senior Vice President National Accounts, Employee Benefits Division from
June 1990 until February 1991.
H. Edward Hanway
Age 45
President of CIGNA HealthCare since February 1996. Prior to that, Mr.
Hanway served as President of CIGNA International from March 1994 until February
1996 and President of CIGNA International, Property & Casualty from February
1989 until March 1994.
CIGNA has informed the Company that each of the individuals listed above
has consented to act as a director, if so designated. If necessary, CIGNA may
choose additional or other CIGNA Designees, subject to the requirements of Rule
14f-1.
Based solely on the information set forth in CIGNA's Offer to Purchase,
none of the CIGNA Designees (i) is currently a director of, or holds any
position with, the Company, (ii) has a familial relationship with any directors
or executive officers of the Company, or (iii) to the best knowledge of CIGNA,
beneficially owns any securities (or any rights to acquire such securities) of
the Company. The Company has been advised by CIGNA that, to the best of CIGNA's
knowledge, none of the CIGNA Designees has been involved in any transactions
with the Company or any of its directors, officers, or affiliates which are
required to be disclosed pursuant to the rules and regulations of the Securities
and Exchange Commission (the "SEC"), except as may be disclosed herein or in the
Company's related Schedule 14D-9.
Executive Officers of the Company
The following table sets forth certain information with respect to the
current executive officers of the Company as of March 28, 1997.
Norman C. Payson, M.D.
President and Chief Executive Officer
Age 48
Dr. Payson has served as President and Chief Executive Officer of the
Company since 1985. Dr. Payson has been in the HMO field since 1975, first as a
practicing physician and director of an HMO quality program. By 1980, Dr. Payson
had assumed a full-time position as Chief Executive Officer of a large physician
group practice and as Medical Director for a related HMO company.
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Charles M. Schneider
Executive Vice President and Chief Operating Officer
Age 51
Mr. Schneider has served as Chief Operating Officer of the Company since
January 1997 and as Executive Vice President since October 1993. Prior thereto,
he served as Vice President for Development of the Company from February 1991 to
October 1993 and as Director of Business Development of Healthsource New
Hampshire, Inc. from April 1990 to February 1991. Before joining the Company in
April 1990, Mr. Schneider served as Chief Executive Officer of a New England
hospital, and previously held several senior healthcare management positions.
Joseph M. Zubretsky
Chief Financial Officer
Age 40
Mr. Zubretsky has served as Chief Financial Officer since July 1996. Prior
to joining the Company, Mr. Zubretsky was with Coopers & Lybrand LLP's National
Insurance Practice based in Hartford, Connecticut from 1981 through July 1996,
where he had been a partner since 1990.
Francis G. Middleton, M.D.
President and Chief Executive Officer,
Healthsource South Carolina, Inc. and
President, Healthsource South, Inc.
Age 57
Dr. Middleton has served as President and Chief Executive Officer of
Healthsource South Carolina, Inc. since October 1996 and as President of
Healthsource South, Inc. since January 1995. He previously served as Medical
Director of Healthsource South Carolina, Inc. from 1986 to January 1995. Until
July 1991, Dr. Middleton practiced medicine in Charleston, South Carolina as a
specialist in internal medicine and infectious disease.
Richard B. Salmon, M.D., Ph.D.
Senior Vice President for Medical Affairs
Age 47
Dr. Salmon has served as corporate medical director of the Company since
October 1994 and served as Medical Director for Healthsource New Hampshire, Inc.
from 1991 to 1994. Dr. Salmon is responsible for medical management issues on a
company-wide basis. Before joining the Company, Dr. Salmon served as medical
director for another New Hampshire HMO and was a family practice physician.
Robert Chin
Chief Information Officer
Age 37
Mr. Chin has served as Chief Information Officer of the Company since
August 1993. Mr. Chin is responsible for the Company's information services and
technology development functions. Prior to joining the Company, Mr. Chin served
as Chief Information Officer at Tufts Associated Health Plan from 1985
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<PAGE> 27
to 1993 and as Systems Manager at Harvard Community Health Plan from 1977 to
1985.
There are no family relationships existing between or among any of the
above listed officers, nor is there any involvement in certain legal proceedings
for which disclosure is required under Item 401 of Regulation S-K. The term of
office of each of the foregoing officers extends until the organizational
meeting of the Board following the annual meeting of shareholders or until
removed by the Board. See Item 11, "Employment Contracts and Termination of
Employment and Change-in-Control Arrangements" for a description of agreements
under which certain executive officers serve as such.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company's directors and
executive officers, and persons who own more than ten percent of the issued and
outstanding shares of Common Stock, to file with the SEC and the New York Stock
Exchange initial reports of ownership and reports of changes in beneficial
ownership of Common Stock and other equity securities of the Company. Officers,
directors and greater than ten percent shareholders are required by SEC
regulations to furnish the Company with copies of all Section 16(a) forms they
file.
To the Company's knowledge, based solely on review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, all Section 16(a) filing requirements applicable to the
officers, directors and greater than ten percent beneficial owners were complied
with during 1996, other than with respect to one late report regarding one sale
transaction by Dr. Bilbro, with respect to one late report regarding one option
award transaction to Dr. Schall, and with respect to one late report regarding
one purchase transaction by Dr. Salmon.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following Summary Compensation Table sets forth for the fiscal years
ended December 31, 1996, 1995 and 1994 information as to the total compensation
received by each of the Chief Executive Officer and the four highest paid
executive officers who received total compensation in excess of $100,000 in all
capacities.
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<PAGE> 28
SUMMARY COMPENSATION TABLE
Long-Term
Compensation
Annual Compensation Awards
------------------- ------
Securities
Underlying
Name and Other Annual Stock
Principal Position Year Salary(1) Bonus Compensation Options(2)
------------------ ---- --------- ----- ------------ ----------
Norman C. Payson, M.D..... 1996 $ 548,754 --(3) $ 25,550(4) 200,000
President and Chief 1995 483,081 --(3) 10,000(4) 200,000
Executive Officer 1994 387,604 --(3) 10,000(4) 2,200,000(5)
Sally W. Crawford(6)...... 1996 349,531 $65,000 10,000(7) --
Former Chief Operating 1995 324,233 65,000 42,063(7) 100,000
Officer 1994 289,530 28,500 10,000(7) 100,000
Charles M. Schneider...... 1996 360,968 206,743 62,484(9) 250,000(10)
Executive Vice President 1995 322,884 165,000(8) 26,127(9) 150,000
and Chief Operating Officer 1994 210,865 21,500 -- 150,000(10)
Francis G. Middleton, M.D. 1996 348,133 65,000 1,412 110,000
President and Chief 1995 305,384 25,000 -- 100,000
Executive Officer,
Healthsource South
Carolina, Inc. and
President, Healthsource
South, Inc.(11)
Joseph M. Zubretsky (12).. 1996 143,750 150,000 47,089(13) 250,000(14)
Chief Financial Officer
- ----------
(1) Includes amounts deferred pursuant to the Company's 401(k) Plan.
(2) Includes options granted in 1997 for services rendered in 1996.
(3) Dr. Payson declined a cash bonus.
(4) Includes $15,500 for personal use of the Company airplane in 1996 and
$10,000 for automobile expenses in 1996, 1995 and 1994.
(5) Includes options to purchase 2,000,000 shares granted to Dr. Payson in May
1994 in connection with the adoption of the 1994 Stock Option Plan by
shareholders at the 1994 Annual Meeting of Shareholders.
(6) Ms. Crawford resigned effective December 31, 1996.
(7) Includes $10,000 for automobile expenses in 1996, 1995 and 1994 and
$32,063 for unused vacation time in 1995.
(8) Includes $100,000 for relocation bonus.
(9) Includes $51,890 for relocation expenses, $4,850 for personal use of the
Company airplane, $1,160 for country club dues and $4,583 for automobile
expenses in 1996. Also includes $11,577 for unused vacation time and
$14,550 for relocation expenses in 1995.
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<PAGE> 29
(10) Includes options to purchase 50,000 shares granted to defray relocation
expenses in each of 1996 and 1994.
(11) Dr. Middleton was initially designated an executive officer in 1995.
(12) Mr. Zubretsky joined the Company in July 1996.
(13) Relocation expenses.
(14) Includes options to purchase 50,000 shares granted to defray relocation
expenses.
Shown in the table below is information on stock options granted to the
President and Chief Executive Officer and to the four other named executive
officers shown in the Summary Compensation Table who received options to
purchase shares of the Company's Common Stock for fiscal year 1996.
OPTION GRANTS FOR FISCAL YEAR 1996
<TABLE>
<CAPTION>
% of
Total
Options
Number of Granted
Shares to Grant
Underlying Employees Date Grant Date
Options for 1996 Closing Exercise Expiration Present
Name Granted (1,721,794) Price Price Date Value(1)
- ---- ------- ----------- ----- ----- ---- --------
<S> <C> <C> <C> <C> <C> <C>
Norman C. Payson, M.D ....... 200,000(2) 11.6% $12.87 $14.16(3) 2/9/07 $1,161,800
President and Chief
Executive Officer
Sally W. Crawford (4) -- -- -- -- -- --
Former Chief Operating
Officer
Charles M. Schneider ........ 200,000(2) 11.6% 12.87 14.16(3) 2/9/07 1,161,800
Executive Vice President 50,000(5) 2.9% 13.37 14.71(6) 7/16/06 273,650
and Chief
Operating Officer
Francis G. Middleton, M.D. .. 110,000(2) 6.4% 12.87 14.16(3) 2/9/07 638,990
President and Chief
Executive Officer,
Healthsource South
Carolina, Inc. and
President, Healthsource
South, Inc.
Joseph M. Zubretsky (7) ..... 200,000(2) 11.6% 12.87 14.16(3) 2/9/07 1,161,800
Chief Financial Officer 50,000(8) 2.9% 13.37 14.71(6) 7/16/06 273,650
</TABLE>
- ----------
(1) Based on the Black-Scholes option pricing model adapted for use in valuing
employee stock options. Assumptions made for the named executives are for
grants expiring on February 9, 2007: expected option term of six years;
risk-free interest rate of 6.25%; annual dividend rate of zero; and
annualized volatility of 38.2%. Assumptions for grants expiring on July
16, 2006 are; expected option term of six years; risk-free interest rate
of 6.57%; annual dividend rate of zero; and annualized volatility of
31.5%.
(2) Options granted on February 9, 1997 for services rendered in fiscal year
1996. Options are exercisable after February 9, 1999.
(3) Exercise price is 110% of the closing price of the Company's Common Stock
on February 7, 1997.
(4) Ms. Crawford resigned effective December 31, 1996.
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<PAGE> 30
(5) Options granted on July 16, 1996 which become exercisable after July
16, 1998.
(6) Exercise price is 110% of the closing price of the Company's Common Stock
on July 16, 1996.
(7) Mr. Zubretsky joined the Company in July 1996.
(8) Options granted on July 16, 1996 which become exercisable as to half on
July 16, 1997 and the remaining half on July 16, 1998.
Shown in the table below, with respect to the President and Chief
Executive Officer and the four other named executive officers shown in the
Summary Compensation Table, are exercised and unexercised options to purchase
shares of the Company's Common Stock granted in fiscal year 1996 and prior years
pursuant to the Company's stock option plans.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1996
AND 1996 FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Shares
Shares Underlying Value of Unexercised
Acquired Unexercised Options at In-The-Money Options at
On Value December 31, 1996(1) December 31, 1996($)(2)
Exercise Realized($) Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C> <C> <C>
Norman C. Payson, M.D... -- -- 1,240,000 1,560,000 $521,000 --
President and Chief
Executive Officer
Sally W. Crawford (3)... -- -- 80,000 180,000 -- --
Former Chief Operating
Officer
Charles M. Schneider.... -- -- 122,000 320,000 83,360 --
Executive Vice President
and Chief Operating
Officer
Francis G. Middleton, M.D. -- -- 140,000 180,000 337,800 --
President and Chief
Executive Officer,
Healthsource South
Carolina, Inc. and
President, Healthsource
South, Inc.
Joseph M. Zubretsky(4).. -- -- -- 50,000 -- --
Chief Financial Officer
</TABLE>
- ----------
(1) Does not include options granted in 1997 for services rendered in 1996.
(2) Based upon the closing share price of $13.125 for the Company's Common
Stock on December 31, 1996. Does not include options granted in 1997 for
services rendered in 1996.
(3) Ms. Crawford resigned effective December 31, 1996.
(4) Mr. Zubretsky joined the Company in July 1996.
Compensation of Directors
Each director of the Company (except Drs. Payson and Middleton)
currently receives a $25,000 annual director's fee plus $1,000 per meeting of
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<PAGE> 31
the Company Board and $1,000 for each committee meeting attended. The Company
also reimbursed the directors for their travel expenses and Drs. Schall,
Cathcart and Bilbro for lost practice time in travel to meetings.
Pursuant to the Company's 1996 Non-Employee Director Stock Option Plan
(the "1996 Director Plan"), each non-employee director of the Company received,
at no cost, options to purchase 45,000 shares of the Common Stock of the Company
after the 1996 Annual Meeting of Shareholders. Each set of options granted under
the 1996 Director Plan is exercisable for a period of ten (10) years and vests
and becomes exercisable as to 15,000 shares on the date of each succeeding
annual meeting during which the director continues to serve as such with the
Company.
The exercise price of options granted under the 1996 Director Plan was set
at one hundred ten percent (110%) of the fair market value of the shares on the
date of grant ($25.16) and no option granted thereunder may be exercised after
the expiration of ten years from the date of grant. Vested options are
exercisable provided that the option holder remains a director of the Company.
In the event of the death, retirement or permanent and total disability of a
director, such director may exercise vested options through the date of
expiration of the option. In the event of termination of a director's service on
the Company Board for other reasons, such director's options will terminate
within 30 days of the date of termination of service and all then outstanding
options that have been vested will be exercisable during such period. Pursuant
to the CIGNA Merger Agreement, all options held by the Company's directors and
executive officers (among others) will be converted to CIGNA options based on a
formula set forth therein, at the effective time of the Merger.
Employment Contracts and Termination of Employment and Change-in-Control
Arrangements
Dr. Payson. In connection with the execution of the CIGNA Merger
Agreement, CIGNA entered into a consulting agreement (the "Consulting
Agreement") with Dr. Payson. The Consulting Agreement has a term of nine months,
commencing on the date of the consummation of the Tender Offer. During the term,
Dr. Payson will perform such services relating to the business of CIGNA as he
and the President of CIGNA HealthCare mutually agree. The Consulting Agreement
requires Dr. Payson to provide up to 120 hours of consulting services per month
during the first six months of the term of the Consulting Agreement and up to 80
hours per month for the remainder of the term. For a nine month period following
the consummation of the Tender Offer, Dr. Payson will be subject to a covenant
not to compete against CIGNA or the Company or their respective subsidiaries.
Dr. Payson has also agreed that during the term of the Consulting Agreement and
for a period of one year following the termination of the Consulting Agreement,
he will not (i) induce any employee of CIGNA, the Company or any of their
respective affiliates to leave such employment or to accept any other employment
or position, or (ii) assist any other person in hiring any such employee.
Pursuant to the Consulting Agreement, Dr. Payson will receive $100,000 per month
for the nine month term of the Consulting Agreement and is entitled to
reimbursement of ordinary and appropriate business expenses. The Consulting
Agreement further provides that Dr. Payson is entitled to welfare benefits
generally available to senior executive officers of CIGNA and access to a
corporate airplane, with
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<PAGE> 32
the right to purchase such airplane at the book value thereof. Dr. Payson will
also receive a cash payment of $25,000 to purchase office equipment as well as
reimbursement of office and staffing expenses up to $200,000 per year. The
Consulting Agreement further provides that, notwithstanding anything to the
contrary, CIGNA will take all necessary action to cause any Company stock
options held by Dr. Payson or his successors to remain freely exercisable until,
and expire no earlier than, the tenth anniversary of the grant of such options
without regard to the termination of the Consulting Agreement, termination of
Dr. Payson's employment with the Company, Dr. Payson's death or disability or
the cessation of Dr. Payson's services to CIGNA.
Severance Agreements. The CIGNA Merger Agreement provides that the Company
will enter into severance agreements with 29 of the Company's officers (the
"Severance Agreements"), including the executive officers of the Company for
which disclosure is provided herein, prior to the Merger. The Severance
Agreements will provide that severance benefits will be paid to the officer if
his or her employment is terminated by the officer for good reason or by the
Company other than for cause, in either case within two years following the
consummation of the Tender Offer. Dr. Payson will receive severance benefits
upon the consummation of the Tender Offer since his employment with the Company
will be terminated at such time. Severance benefits under the Severance
Agreements will include a lump sum cash payment equal to the sum of the
officer's current base salary plus maximum annual incentive bonus, multiplied by
a factor of three for Dr. Payson, Mr. Schneider and Mr. Zubretsky and a factor
of two for Mr. Chin and Dr. Salmon. Severance benefits also include the payment
of a pro rata portion of the officer's target bonus for the current year,
continuation of medical and welfare benefits for a number of years following
termination of employment equal to the multiple described above, office and
secretarial services for the same period of time, outplacement and financial
planning services for one year following termination of employment, a cash
payment reimbursing the officer for any liabilities in respect of any taxes or
excise taxes in respect of Section 4999 of the Internal Revenue Code (the
"Parachute Tax"), if applicable, and reimbursement of legal fees reasonably
incurred by the officer in connection with enforcing his or her rights under a
Severance Agreement or in respect of the Parachute Tax. Assuming that the
following officers of the Company are terminated from employment immediately
following the Merger, and assuming the Merger occurs on June 30, 1997, each such
officer would be entitled to a lump sum cash payment (excluding from such amount
any reimbursements in respect of the Parachute Tax, if any) equal to the
following: Dr. Payson, $2,475,000; Mr. Schneider, $1,677,000; Mr. Zubretsky,
$1,500,000; Dr. Middleton, $946,890; and Dr. Salmon, $643,750.
Dr. Middleton. In January 1995, Dr. Middleton entered into a five year
employment agreement with the Company pursuant to which he serves as President
of Healthsource South, Inc., and more recently as President and Chief Executive
Officer of Healthsource South Carolina, Inc., at a current annual salary
(including stipend) of $350,700 and is also eligible to receive an annual
performance bonus. Under this agreement, Dr. Middleton conducts development
activities for the Company throughout the southern United States and manages the
operations of the Company's South Carolina HMO. The employment agreement is
terminable by the Company or Dr. Middleton without cause on 60 days' notice and
provides for a severance benefit of $300,000 plus two months' base pay for each
year completed under the agreement, up to a maximum of 12 months, in the event
of termination without cause by the Company, or $500,000 plus two months' base
pay for each year since 1991, up to a
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<PAGE> 33
maximum of 12 months, in the event Dr. Middleton terminates his employment
within 90 days following a change of control of the Company. Dr. Middleton is
also eligible to receive stock options under the Company's employee stock option
plans.
Mr. Zubretsky. In June 1996, Mr. Zubretsky entered into an employment
agreement with the Company under which he serves as the Chief Financial Officer
of the Company, at a current annual salary of $375,000 and is eligible to
receive a performance bonus. The agreement expires December 31, 1997, subject to
annual renewal. If Mr. Zubretsky's employment is terminated by the Company
without cause or if the Company does not renew the agreement, Mr. Zubretsky
becomes entitled to continue to receive his base salary for a two year period,
so long as he complies with noncompetition and nondisclosure provisions
contained in the agreement. Further, if Mr. Zubretsky's employment is terminated
by the Company (or by Mr. Zubretsky if his authority or status with the Company
is reduced) within 180 days following a change in control of the Company, then
Mr. Zubretsky becomes entitled to continue to receive his base salary for a
three year period.
Other Agreements. Mr. Schneider has a severance arrangement with the
Company. Mr. Schneider's arrangement provides that if his employment is
terminated by the Company without cause or by Mr. Schneider if, following a
change in control of the Company, his duties or compensation are adversely
altered, he becomes entitled to receive his base salary for a two year
period. Mr. Chin has a severance arrangement with the Company pursuant to
which Mr. Chin becomes entitled to receive six months of base salary if his
employment is terminated for cause, and one year of base salary if his
employment is terminated without cause. Dr. Salmon has a severance
arrangement with the Company providing that if his employment is terminated
by the Company with or without cause, or if his duties and responsibilities
are materially altered, he becomes entitled to one year of salary
continuation, plus an additional month of salary continuation for each year
of employment with the Company, plus an amount equal to his eligible bonus.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee determines the compensation of executive
officers and stock options to be granted to employees of the Company. Messrs.
Bagan, Baron, Chandler and Leipold serve on the Compensation Committee. Mr.
Chandler serves as President and Chief Executive Officer of Provident. Effective
May 1, 1995, the Company purchased the assets of the group health, HMO and third
party administration business of Provident for a purchase price of $131 million
in cash and $100 million face amount of 6.25% cumulative preferred stock (the
"Provident Transaction"). In conjunction with the Provident Transaction, the
Company and Provident entered into agreements under which the Company provides
certain administrative services to Provident's retained stop-loss business and
Provident's disability products; the Company also agreed to obtain computer
services from Provident's Chattanooga, Tennessee data processing center for the
acquired Provident business for a minimum of two years. In September 1996, the
Company and Provident settled for approximately $2.8 million certain claims and
accounting issues arising out of the Provident Transaction and amended the
stop-loss servicing agreement
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<PAGE> 34
between them. In October 1996, the Company also purchased approximately 72 acres
of land in Chattanooga from Provident for a purchase price of $2.8 million. Mr.
Chandler joined the Company's Board of Directors pursuant to the Provident
Transaction agreements after the completion of the Provident Transaction. On
March 6, 1996, the Company redeemed the $100 million face amount of preferred
stock issued in the Provident Transaction and the Company no longer has an
obligation to nominate a Provident representative to the Company's Board of
Directors.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 24, 1997, certain information
as to those persons who were beneficial owners of more than 5% of the 63,860,017
shares of Common Stock issued and outstanding as of such date and as to the
shares of Common Stock beneficially owned by each of the executive officers and
by all the Company's executive officers and directors as a group.
Number of
Shares Percentage
Beneficially of Class
Name of Beneficial Owner Owned (1) Outstanding
------------------------ --------- -----------
Norman C. Payson, M.D.
President and Chief Executive Officer
Two College Park Drive
Hooksett, NH 03106.................................. 6,012,760 9.2
Franklin Resources, Inc.
777 Mariners Island Blvd.
San Mateo, CA 94403-7777(2)......................... 6,838,466 10.7
Massachusetts Financial Services Company
500 Boylston Street
Boston, MA 02116-3741(4)............................ 7,609,466 11.9
Southeastern Asset Management, Inc.
6075 Poplar Avenue, Suite 900
Memphis, TN 38119(4)................................ 3,350,900 5.3
Charles M. Schneider.................................. 152,000 *
Joseph M. Zubretsky................................... -- *
Francis G. Middleton, M.D............................. 271,000 *
Robert Chin........................................... 36,000 *
Richard B. Salmon, M.D., Ph.D......................... 107,000 *
All Executive Officers and Directors as a Group (14 7,919,737 11.9
persons) (5)
- ----------
* Less than 1%.
(1) The listed figures include options exercisable within 60 days to
purchase 1,680,000, 152,000, 160,000, 36,000, 80,000 and 2,515,000,
shares held by Dr. Payson, Mr. Schneider, Dr. Middleton, Mr. Chin, Dr.
34
<PAGE> 35
Salmon, and all directors and executive officers as a group,
respectively.
(2) Franklin Resources, Inc. ("FRI") is considered a "beneficial owner" of the
Company's Common Stock through its ownership of all of the outstanding
capital stock of Templeton Global Advisors Limited, Templeton Management
Limited, Templeton Investment Management Limited and Franklin Advisers,
Inc., registered investment advisers. The Company is advised, FRI, its
principal shareholders and each advisory subsidiary disclaim any economic
or beneficial ownership in any of the Company securities.
(3) Massachusetts Financial Services Company ("MFS"), a registered investment
advisor, is considered the "beneficial owner" of the Company's Common
Stock. As sponsor of various mutual fund entities, the Company is advised
that 4,397,110 (6.9%) shares and 3,051,930 (4.8%) shares of Company Common
Stock are held by MFS Series Trust II -MFS Emerging Growth Fund and other
non-reporting entities, respectively.
(4) Southeastern Asset Management, Inc. ("Southeastern"), a registered
investment advisor and its Chairman of the Board, in the event he could be
deemed to be a controlling person of Southeastern, advise the Company that
all of the Company Common Stock reported herein are owned by
Southeastern's investment advisory clients and none are owned directly or
indirectly by Southeastern or its Chairman as to which both parties
disclaim any beneficial ownership in any of the Company's securities.
(5) Includes 145,629 shares owned by spouses and minor children of directors
and executive officers and shares held or owned by custodians for the
benefit of such minors, officers or directors, as to which beneficial
ownership may be disclaimed.
In connection with the CIGNA Merger Agreement, CIGNA entered into a Tender
Agreement and Irrevocable Proxy (the "Shareholder Agreement") with Norman C.
Payson, M.D., the Company's President and Chief Executive Officer and a member
of the Company Board, with respect to the 4,332,760 shares of the Company's
Common Stock owned by Dr. Payson. Pursuant to the Shareholder Agreement, Dr.
Payson has agreed to tender all shares owned by him in the Tender Offer and
CIGNA has agreed to accept for payment and pay for such shares subject to the
terms and conditions of the Tender Offer. Pursuant to the Shareholder Agreement,
Dr. Payson has also granted to CIGNA an irrevocable proxy to vote his shares in
connection with any meeting of the Company's shareholders, or in connection with
any written consent of the Company's shareholders, (i) in favor of the Merger,
the execution and delivery by the Company of the CIGNA Merger Agreement and the
approval and adoption of the Merger and the terms thereof and each of the other
actions contemplated by the CIGNA Merger Agreement and the Shareholder Agreement
and any actions required in furtherance thereof; (ii) against any action or
agreement that would impede, interfere with, or prevent the Tender Offer or the
Merger; and (iii) except as otherwise agreed to in writing in advance by CIGNA,
against the following actions (other than the Tender Offer, the Merger and the
transactions contemplated by the CIGNA Merger Agreement and the Shareholder
Agreement): (I) any extraordinary corporate transaction, such as a merger,
consolidation or other business combination involving the Company or any of
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<PAGE> 36
its subsidiaries; (II) any sale, lease or transfer of a material amount of the
assets or business of the Company or its subsidiaries, or any reorganization,
restructuring, recapitalization, special dividend, dissolution, liquidation or
winding up of the Company or its subsidiaries; and (III) any change in the
present capitalization of the Company including any proposal to sell any
material equity interest in the Company or any amendment of the Articles of
Incorporation of the Company. Such irrevocable proxy shall terminate on the
termination of the Shareholder Agreement.
During the term of the Shareholder Agreement, Dr. Payson has agreed that
he will not (i) transfer to any person any or all of his shares (except to CIGNA
pursuant to the Tender Offer; or (ii) except for the proxy granted to CIGNA,
grant any proxies or powers of attorney, deposit any of his shares into a voting
trust or enter into a voting agreement, understanding or arrangement with
respect to such shares. The Shareholder Agreement does permit Dr. Payson to
transfer his shares to any family member, certain entities owned by or formed
for the benefit of Dr. Payson or his family members, and certain of his
successors, provided, that in the case of any such transfer, the transferee
executes an agreement to be bound by the terms of the Shareholder Agreement, or
terms substantially identical thereto.
Until the termination of the Shareholder Agreement, Dr. Payson has agreed
to comply with the provisions in the CIGNA Merger Agreement prohibiting the
Company from initiating, soliciting, or encouraging, directly or indirectly, any
inquiries or the making of a proposal regarding an alternative transaction,
engaging in negotiations or discussions with or furnishing any information with
respect to any alternative transaction, or entering into any agreement with
respect to or approving an alternative transaction, except for taking action in
connection with certain unsolicited offers in pursuance of the Board's fiduciary
duties.
The Shareholder Agreement, and all rights and obligations of the parties
thereunder, terminates upon the earlier of (a) the date upon which CIGNA shall
have purchased and paid for all of Dr. Payson's shares in accordance with the
Tender Offer and (b) the date on which the CIGNA Merger Agreement is terminated.
See Item 1, "Business - Recent Developments Announced CIGNA Merger Agreement"
for additional information regarding the Tender Offer.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Dr. Leipold. In May 1995, the Company made a 7-year term loan in the
principal amount of $1,547,910 to Garrison Medical Professional Association
("Garrison"), the group with which Dr. Leipold practices medicine and is a
shareholder. The loan currently bears interest at a rate of 7.25% which is
adjustable on each anniversary of the loan to a rate one percent below the
reported prime rate of interest. The loan is secured by certain real estate and
accounts receivable of Garrison. The maximum principal amount of the loan
outstanding at any time during 1996 was $1,471,442. As of December 31, 1996,
$1,353,416 in principal amount remained outstanding under the loan.
Mr. Schneider. In June 1996, the Company loaned $400,000 to Mr.
Schneider to temporarily cover the cost of relocating from Chattanooga,
Tennessee to Company headquarters in Hooksett, New Hampshire. The loan bears
interest at 6% per annum and remained outstanding at December 31, 1996.
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<PAGE> 37
Mr. Chandler/Provident Transaction. Mr. Chandler serves as President
and Chief Executive Officer of Provident. For a description of certain
transactions between the Company and Provident, see Item 11, "Executive
Compensation - Compensation Committee Interlocks and Insider Participation."
Participating Physician Agreements. Each physician director of the
Company, other than Drs. Payson, Bagan and Middleton, provided medical services
as a participating physician to one of the Company`s HMOs during 1996. Each such
director's participating physician agreement conformed with the standard
agreements for all participating physicians in the respective HMOs.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents Filed as Part of This Report.
(1) Financial Statements. The following financial statements are filed
herewith and appear in Item 8:
Independent Auditors Report
Consolidated balance sheets as of December 31, 1996 and 1995
Consolidated statements of operations for the years ended December 31,
1996, 1995 and 1994
Consolidated statements of cash flows for the years ended December 31,
1996, 1995 and 1994
Consolidated statements of changes in shareholders' equity for the years
ended December 31, 1996, 1995 and 1994
Notes to consolidated financial statements
(2) Financial Statement Schedules. Not applicable.
(3) Exhibits. Pursuant to Rule 12b-32 and General Instruction G, the following
Exhibits are required to be filed with this Report under Item 14 and are
incorporated by reference from the reference source cited in the Exhibit
Index below, are filed herewith, or are not applicable.
37
<PAGE> 38
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
- ----------- -------- -------------------
(2) Plan of Acquisition
2.1 Agreement and Plan of Merger Exhibit 2 to Schedule
dated as of February 27, 1997 14D-9 dated March 6, 1997
among Healthsource, Inc., CIGNA
Corporation and CHC Acquisition
Corp.
2.2 Confidentiality Agreement dated Exhibit 1 to Schedule
January 31, 1997 between 14D-9 dated March 6, 1997
Healthsource, Inc. and CIGNA
Corporation
(3) Articles of Incorporation and By-Laws
3.1 Articles of Incorporation of Exhibit 3.1 to Form 10-K
Healthsource, Inc., as amended for the Fiscal Year Ended
December 31, 1994 filed on
March 19, 1995
3.2 Articles of Amendment to the Exhibit 4.1 to Form 8-K
Articles of Incorporation of dated June 14, 1995
Healthsource, Inc. designating
the rights of the Class A
Cumulative Preferred Stock
3.3 Articles of Amendment to the Filed herewith
Articles of Incorporation of
Healthsource, Inc. increasing
the authorized Common Stock to
800,000,000 shares
3.4 By-Laws of Healthsource, Inc., Exhibit 3.2 to Amendment
as amended No. 2 to Form S-4
Registration Statement No.
33-56446 dated February
19, 1993
(4) Instruments Defining the Rights of
Security Holders
38
<PAGE> 39
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
- ----------- -------- -------------------
4.1 Indenture dated as of March 6, Exhibit 4.1 to Form S-3
1996 by and between Registration Statement No.
Healthsource, Inc. and The Bank 333-5223 dated June 4, 1996
of New York, as Trustee, and
the form of First Supplemental
Indenture dated as of June 3,
1996
4.2 Note Resale Registration Rights Exhibit 4.2 to Form S-3
Agreement dated as of March 6, Registration Statement No.
1996 by and between 333-5223 dated June 4, 1996
Healthsource, Inc. and Bear,
Stearns & Co., Inc. for itself
and on behalf of the Initial
Purchasers
4.3 Rights Agreement dated as of Exhibit 1 to Form 8-A
July 29, 1996 between Registration Statement
Healthsource, Inc. and The Bank dated August 2, 1996
of New York, as Rights Agent
(10) Material Contracts
10.1 Indemnity Agreement (form) Exhibit 10.7 to Form S-1
dated September 11, 1989 Registration Statement No.
between Healthsource, Inc. and 33-31165 dated September
each of its directors and 20, 1989
executive officers
(compensatory contract)
10.2 Healthsource, Inc. 1991 Exhibit 10.21 to Form 10-K
Non-Qualified Stock Option Plan for the Fiscal Year Ended
(compensatory plan) December 31, 1990 filed on
March 28, 1991
10.3 Healthsource, Inc. 1992 Exhibit 10.2 to Form 10-Q
Director Stock Option Plan for the Quarter Ended June
(compensatory plan) 30, 1992 filed on August
12, 1992
10.4 Healthsource, Inc. 1994 Stock Exhibit to Proxy Statement
Option Plan (compensatory plan) for the Annual Meeting of
Shareholders held on May
11, 1994 filed on April 11,
1994
39
<PAGE> 40
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
- ----------- -------- -------------------
10.5 Employment Agreement dated as Exhibit 8 to Schedule
of July 30, 1993 between 14D-9 dated March 6, 1997
Healthsource, Inc. and Robert
Chin (compensatory contract)
10.6 Employment Agreement dated as Exhibit 10 to Schedule
of June 25, 1996 between 14D-9 dated March 6, 1997
Healthsource, Inc. and Joseph
M. Zubretsky (compensatory
contract)
10.7 Employment Agreement dated as Exhibit 11 to Schedule
of July 19, 1996 between 14D-9 dated March 6, 1997
Healthsource, Inc. and Charles
M. Schneider (compensatory
contract)
10.8 Employment Agreement dated as Exhibit 12 to Schedule
of February 14, 1997 between 14D-9 dated March 6, 1997
Healthsource, Inc. and Richard
B. Salmon, M.D., Ph.D.
(compensatory contract)
10.9 Employment Agreement dated as Exhibit 10.7 to Form 10-K
of January 1, 1995 between for the Fiscal Year Ended
Healthsource, Inc. and Francis December 31, 1994 dated
G. Middleton, M.D. March 17, 1995
(compensatory contract)
10.10 Healthsource, Inc. Deferred Exhibit 13 to Schedule
Compensation Plan for Selected 14D-9 dated March 6, 1997
Employees
10.11 Formation Agreement dated July Exhibit 10 to Form 8-K
28, 1993 between Healthsource, dated July 30, 1993
Inc. and St. Vincent Infirmary
Medical Center
40
<PAGE> 41
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
- ----------- -------- -------------------
10.12 Asset and Stock Purchase Exhibit 2.1 to Form 10-K
Agreement dated as of December for the Fiscal Year Ended
20, 1994 among Provident Life December 31, 1994 dated
and Accident Insurance Company March 17, 1995
of America, Provident Life
Capital Corporation, Provident
Life and Accident Insurance
Company, Provident Life and
Casualty Insurance Company,
Provident Health Care Plans,
Inc. and Healthsource, Inc.
10.13 Third Closing Amendment to Exhibit 10.1 to Form 8-K
Asset and Stock Purchase dated June 14, 1995
Agreement dated May 31, 1995
among Provident Life and
Accident Insurance Company of
America, et al. and
Healthsource, Inc.
10.14 Non-Competition Agreement dated Exhibit 10.3 to Form 8-K
May 31, 1995 between dated June 14, 1995
Healthsource, Inc. and Provident
Life and Accident Insurance
Company of America
10.15 Lease dated as of May 1, 1995 Exhibit 10.4 to Form 8-K
between Provident Life and dated June 14, 1995
Accident Insurance Company and
Healthsource Provident
Administrators, Inc. relating to
a certain property located at
One Fountain Square,
Chattanooga, Tennessee
(11) Computation of Per Share Earnings Filed herewith
(12) Computation of Historical Financial Filed herewith
Ratios
(13) Annual Report to Security Holders
13.1 Healthsource, Inc. 1996 Annual Filed herewith
Report
(21) Subsidiaries of Healthsource, Inc. Filed herewith
(23) Consents of Experts and Counsel
41
<PAGE> 42
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
- ----------- -------- -------------------
23.1 Consent of Deloitte & Touche Filed herewith
LLP
(27) Financial Data Schedule Filed herewith
(b) Reports on Form 8-K.
The following reports on Form 8-K were filed with the Securities and
Exchange Commission during the quarter ended December 31, 1996 and subsequently.
(i) On March 4, 1997 Healthsource filed a Form 8-K reporting the signing
of a definitive agreement with CIGNA Corporation providing for the
acquisition of Healthsource by CIGNA through a cash tender offer for
all outstanding shares of Healthsource common stock for $21.75 per
share, to be followed by a statutory merger which will cash-out all
remaining shares, other than shares held by dissenters, at the same
cash price.
(ii) On January 10, 1997 Healthsource filed a Form 8-K reporting the
closing on January 6, 1997 of its previously-announced agreement to
acquire the remaining 85% interest in ChubbHealth, Inc., an HMO
joint venture with Chubb Life Insurance Company of America located
in Metropolitan New York City, for $25.3 million in cash.
42
<PAGE> 43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 28, 1997 HEALTHSOURCE, INC.
By: /s/ Norman C. Payson, M.D.
----------------------------------------
Norman C. Payson, M.D.
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Joseph M. Zubretsky
----------------------------------------
Joseph M. Zubretsky
Chief Financial Officer
(Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Merwyn Bagan, M.D.
- ----------------------------------- Chairman of the Board of March 28, 1997
Merwyn Bagan, M.D. Directors
/s/ Paul D. Baron, M.D.
- ----------------------------------- Director March 22, 1997
Paul D. Baron, M.D.
/s/ Robert A. Leipold, M.D.
- ----------------------------------- Director March 21, 1997
Robert A. Leipold, M.D.
/s/ Francis G. Middleton, M.D.
- ----------------------------------- Director March 28, 1997
Francis G. Middleton, M.D.
/s/ Robert H. Bilbro, M.D.
- ----------------------------------- Director March 21, 1997
Robert H. Bilbro, M.D.
/s/ Norman C. Payson, M.D.
- ----------------------------------- President, Chief March 28, 1997
Norman C. Payson, M.D. Executive Officer and
Director
43
<PAGE> 44
/s/ Daniel F. Eubank, M.D.
- ----------------------------------- Director March 23, 1997
Daniel F. Eubank, M.D.
/s/ David W. Schall, M.D.
- ----------------------------------- Director March 21, 1997
David W. Schall, M.D.
/s/ Robert S. Cathcart III, M.D.
- ----------------------------------- Director March 21, 1997
Robert S. Cathcart III, M.D.
/s/ J. Harold Chandler
- ----------------------------------- Director March 28, 1997
J. Harold Chandler
44
<PAGE> 45
EXHIBIT INDEX
<TABLE>
<CAPTION>
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
----------- -------- -------------------
<S> <C> <C>
(2) Plan of Acquisition
2.1 Agreement and Plan of Merger dated as Exhibit 2 to Schedule 14D-9
of Exhibit 2 to Schedule 14D-9 dated dated March 6, 1997
February 27, 1997 among Healthsource, Inc.,
March 6, 1997 CIGNA Corporation and CHC
Acquisition Corp.
2.2 Confidentiality Agreement dated January 31, Exhibit 1 to Schedule 14D-9 dated
1997 between Healthsource, Inc. and CIGNA March 6, 1997
Corporation
(3) Articles of Incorporation and By-Laws
3.1 Articles of Incorporation of Healthsource, Exhibit 3.1 to Form 10-K for the
Inc., as amended Fiscal Year Ended December 31, 1994
filed on March 19, 1995
3.2 Articles of Amendment to the Articles of Exhibit 4.1 to Form 8-K dated June 14,
Incorporation of Healthsource, Inc. 1995
designating the rights of the Class A
Cumulative Preferred Stock
3.3 Articles of Amendment to the Articles of Filed herewith
Incorporation of Healthsource, Inc.
increasing the authorized Common Stock to
800,000,000 shares
3.4 By-Laws of Healthsource, Inc., as amended Exhibit 3.2 to Amendment No. 2 to Form
S-4 Registration Statement No.
33-56446 dated February 19, 1993
(4) Instruments Defining the Rights of Security Holders
</TABLE>
45
<PAGE> 46
<TABLE>
<CAPTION>
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
----------- -------- -------------------
<S> <C> <C>
4.1 Indenture dated as of March 6, 1996 by and Exhibit 4.1 to Form S-3 Registration
between Healthsource, Inc. and The Bank of New Statement No. 333-05223 dated June 4,
York, as Trustee, and the form of First 1996
Supplemental Indenture dated as of June 3, 1996
4.2 Note Resale Registration Rights Agreement dated Exhibit 4.2 to Form S-3 Registration
as of March 6, 1996 by and between Statement No. 333-05223 dated June 4,
Healthsource, Inc. and Bear, Stearns & Co., 1996
Inc. for itself and on behalf of the Initial
Purchasers
4.3 Rights Agreement dated as of July 29, 1996 Exhibit 1 to Form 8-A Registration
between Healthsource, Inc. and The Bank of New Statement dated August 2, 1996
York, as Rights Agent
(10) Material Contracts
10.1 Indemnity Agreement (form) dated September 11, Exhibit 10.7 to Form S-1 Registration
1989 between Healthsource, Inc. and each of Statement No. 33-31165 dated September
its directors and executive officers 20, 1989
(compensatory contract)
10.2 Healthsource, Inc. 1991 Non-Qualified Stock Exhibit 10.21 to Form 10-K for the
Option Plan (compensatory plan) Fiscal Year Ended December 31, 1990
filed on March 28, 1991
10.3 Healthsource, Inc. 1992 Director Stock Option Exhibit 10.2 to Form 10-Q for the
Plan (compensatory plan) Quarter Ended June 30, 1992 filed on
August 12, 1992
10.4 Healthsource, Inc. 1994 Stock Option Plan Exhibit to Proxy Statement for the
(compensatory plan) Annual Meeting of Shareholders held on
May 11, 1994 filed on April 11, 1994
</TABLE>
46
<PAGE> 47
<TABLE>
<CAPTION>
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
----------- -------- -------------------
<S> <C> <C>
10.5 Employment Agreement dated as of July 30, 1993 Exhibit 8 to Schedule 14D-9 dated March
between Healthsource, Inc. and Robert Chin 6, 1997
(compensatory contract)
10.6 Employment Agreement dated as of June 25, 1996 Exhibit 10 to Schedule 14D-9 dated
between Healthsource, Inc. and Joseph M. March 6, 1997
Zubretsky (compensatory contract)
10.7 Employment Agreement dated as of July 19, 1996 Exhibit 11 to Schedule 14D-9 dated
between Healthsource, Inc. and Charles M. March 6, 1997
Schneider (compensatory contract)
10.8 Employment Agreement dated as of February 14, Exhibit 12 to Schedule 14D-9 dated
1997 between Healthsource, Inc. and Richard B. March 6, 1997
Salmon, M.D., Ph.D. (compensatory contract)
10.9 Employment Agreement dated as of January 1, Exhibit 10.7 to Form 10-K for the
1995 between Healthsource, Inc. and Francis G. Fiscal Year Ended December 31, 1994
Middleton, M.D. (compensatory contract) dated March 17, 1995
10.10 Healthsource, Inc. Deferred Compensation Plan Exhibit 13 to Schedule 14D-9 dated
for Selected Employees March 6, 1997
10.11 Formation Agreement dated July 28, 1993 between Exhibit 10 to Form 8-K dated July 30,
Healthsource, Inc. and St. Vincent Infirmary 1993
Medical Center
</TABLE>
47
<PAGE> 48
<TABLE>
<CAPTION>
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
----------- -------- -------------------
<S> <C> <C>
10.12 Asset and Stock Purchase Agreement dated as of Exhibit 2.1 to Form 10-K for the Fiscal
December 20, 1994 among Provident Life and Year Ended December 31, 1994 dated
Accident Insurance Company of America, March 17, 1995
Provident Life Capital Corporation, Provident
Life and Accident Insurance Company, Provident
Life and Casualty Insurance Company, Provident
Health Care Plans, Inc. and Healthsource, Inc.
10.13 Third Closing Amendment to Asset and Exhibit 10.1 to Form 8-K dated June 14,
Stock Purchase Agreement dated May 31, 1995 1995
among Provident Life and Accident Insurance
Company of America, et al. and Healthsource,
Inc.
10.14 Non-Competition Agreement dated May 31, 1995 Exhibit 10.3 to Form 8-K dated June 14,
between Healthsource, Inc. and Provident Life 1995
and Accident Insurance Company of America
10.15 Lease dated as of May 1, 1995 between Provident Exhibit 10.4 to Form 8-K dated June 14,
Life and Accident Insurance Company and 1995
Healthsource Provident Administrators, Inc.
relating to a certain property located at One
Fountain Square, Chattanooga, Tennessee
(11) Computation of Per Share Earnings Filed herewith
(12) Computation of Historical Financial Ratios Filed herewith
(13) Annual Report to Security Holders
13.1 Healthsource, Inc. 1996 Annual Report Filed herewith
(21) Subsidiaries of Healthsource, Inc. Filed herewith
(23) Consents of Experts and Counsel
</TABLE>
48
<PAGE> 49
<TABLE>
<CAPTION>
Reg. S-K
Item 601 Source or Consecutive
Exhibit No. Document Page of this Report
----------- -------- -------------------
<S> <C> <C>
23.1 Consent of Deloitte & Touche LLP Filed herewith
(27) Financial Data Schedule Filed herewith
</TABLE>
49
<PAGE> 1
EXHIBIT 3.3
STATE OF NEW HAMPSHIRE
Filing fee: $35.00 Form No. 14
Use black print or type RSA 293-A:10.06
Leave 1" margins both sides
ARTICLES OF AMENDMENT
to the
ARTICLES OF INCORPORATION
of
HEALTHSOURCE, INC.
PURSUANT TO THE PROVISIONS OF THE NEW HAMPSHIRE BUSINESS CORPORATION ACT, THE
UNDERSIGNED CORPORATION ADOPTS THE FOLLOWING ARTICLES OF AMENDMENT TO ITS
ARTICLES OF INCORPORATION:
FIRST: The name of the corporation is: HEALTHSOURCE, INC.
SECOND: The text of each amendment adopted is:
To amend ARTICLE FIFTH, Paragraph A by replacing it in its entirety with
the following:
A. Authorized Shares: The total authorized capital stock of the
Corporation shall consist of eight hundred ten million (810,000,000)
shares of which (i) eight hundred million (800,000,000) shares shall be
Common Stock of $.10 par value per share; and, (ii) ten million
(10,000,000) shares shall be Preferred Stock of $.10 per value per share.
THIRD: If the amendment provides for an exchange, reclassification, or
cancellation of issued shares, the provisions for implementing the amendment(s)
if not contained in the above amendment are:
Not applicable.
FOURTH: The amendment(s) were adopted on (date): May 14, 1996.
[If more space is needed, attach additional sheet(s)]
Page 1 of 3
<PAGE> 2
ARTICLES OF AMENDMENT TO THE Form No. 14
ARTICLES OF INCORPORATION (Cont.)
OF HEALTHSOURCE, INC.
FIFTH: (Check one)
A. |_| The amendment(s) were adopted by the incorporators or board of
directors without shareholder action and shareholder action was
not required.
B. |X| The amendment(s) were approved by the shareholders. (Note 1)
Number of votes
Designation Number of indisputably
(class or series) Number of votes entitled represented at
of voting group shares outstanding to be cast the meeting
- --------------- ------------------ ---------- -----------
Common Stock 63,677,955 63,677,955 53,932,776
Designation
(class or series) Total number of votes cast: OR Total number of undisputed
of voting group FOR AGAINST -- votes cast FOR
- --------------- --- ------- --------------
Common Stock 37,149,560 16,488,787 --
SIXTH: The number cast for the amendment(s) by each voting group was
sufficient for approval by each voting group.
Dated: May 20, 1996
HEALTHSOURCE, INC. (Note 2)
By /s/ Norman C. Payson (Note 3)
---------------------------------
Signature of its President
Norman C. Payson, M.D.
---------------------------------
Print or type name
Page 2 of 3
<PAGE> 3
Notes:
1. All sections under "B." must be completed. If any voting group is entitled
to vote separately, give respective information for each voting group.
(See RSA 293-A:1.40 for definition of voting group.)
2. Exact corporate name of corporation adopting articles of amendment.
3. Signature and title of person signing for the corporation. Must be signed
by the chairman of the board of directors, president or another officer;
or see RSA 293-A:1.20(f) for alternative signatures.
Mail fee and ORIGINAL and ONE EXACT OR CONFORMED COPY to: Secretary of State,
State House, Room 204, 107 North Main Street, Concord, NH 03301-4989
7/93
Page 3 of 3
<PAGE> 1
EXHIBIT 11
HEALTHSOURCE, INC.
COMPUTATION OF NET INCOME PER SHARE
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
1. Net income (loss).......................................... $(3,940) $56,271 $39,044
2. Preferred dividends........................................ (1,128) (4,167) --
------- ------- -------
3. Net income (loss) applicable to common shareholders........ (5,068) 52,104 39,044
======= ======= =======
COMPUTATION OF SHARES OUTSTANDING
4. Average weighted common shares outstanding................. 63,725 62,983 61,696
5. Dilutive effect of stock options issued.................... -- 1,212 1,122
------- ------- -------
6. Average weighted common shares and share equivalents
outstanding................................................. 63,725 64,195 62,818
======= ======= =======
NET INCOME PER SHARE (3/6):................................... $ (0.08) $ 0.81 $ 0.62
</TABLE>
<PAGE> 1
EXHIBIT 12
HEALTHSOURCE, INC.
COMPUTATION OF HISTORICAL FINANCIAL RATIOS
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
AVERAGE ANNUAL HMO HOSPITAL BED DAYS PER 1000
MEMBERS (A):
Northern Region:
(1) Hospital Bed Days................... 82,000 47,700 42,600 37,500 33,800
(2) Average Number of Members........... 349,900 211,100 174,500 147,700 121,500
------- ------- ------- ------- -------
(3) Average (1/2) X 1,000............... 234 226 244 254 278
======= ======= ======= ======= =======
Southern Region:
(1) Hospital Bed Days................... 113,000 64,000 42,700 34,600 23,500
(2) Average Number of Members........... 453,000 257,900 172,500 122,300 81,800
------- ------- ------- ------- -------
(3) Average (1/2) X 1,000............... 249 248 248 283 287
======= ======= ======= ======= =======
MEDICAL LOSS RATIO (A):
Northern Region:
(1) Cost of Medical Premium Revenue..... 478,114 304,475 250,527 205,754 168,763
(2) Medical Premium Revenue............. 581,484 391,703 325,813 275,058 220,199
------- ------- ------- ------- -------
(3) Medical Loss Ratio (1/2)............ 82.2% 77.7% 76.9% 74.8% 76.6%
======= ======= ======= ======= =======
Southern Region:
(1) Cost of Medical Premium Revenue..... 521,888 317,414 203,615 128,689 85,142
(2) Medical Premium Revenue............. 657,452 419,941 267,440 166,487 109,683
------- ------- ------- ------- -------
(3) Medical Loss Ratio (1/2)............ 79.4% 75.6% 76.1% 77.3% 77.6%
======= ======= ======= ======= =======
</TABLE>
- ---------------
(A) The Northern Region includes New Hampshire, Indiana, Syracuse, N.Y.,
Louisville, KY, Maine, Massachusetts and Ohio. The Southern Region includes
South Carolina, North Carolina, Tennessee, Arkansas, Georgia and North
Central Texas. Indiana and Massachusetts are included since their
acquisition or investment in May 1992 and February 1996, respectively.
Arkansas, Georgia, North Central Texas, Louisville, KY and Ohio are included
since Commencement of Operations in January 1994, November 1994, January
1995, July 1995 and January 1996, respectively.
<PAGE> 1
EXHIBIT 13.1
[HEALTHSOURCE, INC. LOGO]
HEALTHSOURCE, INC. 1996 ANNUAL REPORT
<PAGE> 2
To Our Shareholders:
1996 was a challenging year for Healthsource and the industry. Difficult
premium pricing conditions combined with greater than expected health care
costs, for example for pharmaceuticals, significantly compressed operating
margins. We continued to grow at a rapid pace with revenue up 47 percent.
Ironically, our investment in rapid growth functionally made it even more
challenging to respond to these industry wide conditions. It is more challenging
to be assertive on premium pricing and provider contracts when you are in the
first year of a relationship. That notwithstanding, by the end of 1996 we put
into place a comprehensive plan to address these conditions and position us for
the future. The plan included premium price changes, enhanced employer account
selectivity, health care cost control initiatives and extensive efforts to
reduce administrative costs.
Although we believe our plan will be successful, given the challenges and
risks for the industry and our company, we also kept an open mind on strategic
alternatives. When CIGNA approached us and we were able to negotiate a fair
price for our company, given the inherent risks and uncertainties, we decided to
recommend the merger to our shareholders.
It is now a bittersweet time for Healthsource. It is admittedly difficult
for our committed, enthusiastic employees to easily pass the baton. That being
said, we hold CIGNA in the highest regard and believe they will capture the
value of the combined companies.
We think back about what we have built with a great deal of pride. From our
company's inception in rural New Hampshire, with literally no resources, we were
able to reach the public market in just four years. Our initial public offering
price on a split adjusted basis was $2.50 per share. We were then a very small
managed care company with revenue of $47.3 million; now, less than 7 1/2 years
later, we have become a major force in the industry with annual revenues that
will likely exceed $2 billion in 1997. The all cash tender offer price of $21.75
represents an over 30 percent compounded annual rate of return from our initial
public offering price. When someone writes the book on entrepreneurism and
success in the development of managed care we are confident that there will be a
fine chapter about Healthsource. We appreciate your support.
/s/ Norman C. Payson /s/ Merwyn Bagan
--------------------- -------------------------
Norman C. Payson, M.D. Merwyn Bagan, M.D., M.P.H.
President and Chief Chairman of the Board
Executive Officer
------------------------
Healthsource, Inc., through its subsidiaries, is a geographically
diversified provider of a broad range of managed healthcare services.
Healthsource owns HMOs operating primarily in the Northeast, the Midwest and the
South which offer traditional HMO plans, point-of-service plans, preferred
provider organizations and utilization review and managed care services to other
healthcare payors including former members of Provident Life and Accident
Insurance Company.
1
<PAGE> 3
HEALTHSOURCE, INC. AND SUBSIDIARIES
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
---------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND MEMBERSHIP DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA(1):
Revenue:
HMO medical premiums.......................................... $1,238,936 $811,645 $515,639 $239,600 $135,861
Other insured medical premiums................................ 242,535 184,819 16,837 21,190 19,894
Administrative and managed care fees.......................... 232,492 170,233 51,767 30,045 21,831
---------- -------- -------- -------- --------
Total operating revenue................................... 1,713,963 1,166,697 584,243 290,835 177,586
Expenses:
Cost of HMO medical premiums.................................. 1,000,002 621,888 394,173 178,241 104,003
Cost of other insured medical premiums........................ 202,525 149,396 14,020 17,142 14,980
Selling, general and administrative:
HMO and other insured services.............................. 240,945 153,326 82,550 39,902 20,855
Administrative and managed care services.................... 194,641 146,340 40,107 23,300 17,874
---------- -------- -------- -------- --------
Total selling, general and administrative................. 435,586 299,666 122,657 63,202 38,729
Other charges 53,411 -- -- -- --
Depreciation and amortization................................. 38,721 24,129 11,254 6,028 3,913
---------- -------- -------- -------- --------
Operating income(loss)........................................ (16,282) 71,618 42,139 26,222 15,961
Interest income................................................. 24,305 20,823 13,004 6,648 4,646
Interest expense................................................ (12,629) (5,392)
Equity in income of unconsolidated affiliates................... 1,670 3,544 3,006
Net income(loss)................................................ (3,940) 56,271 39,044 26,064 16,987
Preferred stock dividends(2).................................... (1,128) (4,167) -- -- --
Net income(loss) applicable to common shareholders.............. (5,068) 52,104 39,044 26,064 16,987
Net income(loss) per common share (3)........................... (0.08) 0.81 0.62 0.48 0.35
Shares used in calculating net income(loss) per common share
(3)........................................................... 63,725 64,195 62,818 54,332 48,888
OPERATING STATISTICS-FULLY INSURED HMO(4):
Membership:
Northern region............................................... 386,200 273,000 200,300 175,800 152,900
Southern region............................................... 494,800 332,200 197,500 124,000 88,200
---------- -------- -------- -------- --------
Total..................................................... 881,000 605,200 397,800 299,800 241,100
Average annual hospital bed days per 1,000 members (5):
Northern region............................................... 234 226 244 254 278
Southern region............................................... 249 248 248 283 287
Medical loss ratio (6):
Northern region............................................... 82.2% 77.7% 76.9% 74.8% 76.6%
Southern region............................................... 79.4% 75.6% 76.1% 77.3% 77.6%
BALANCE SHEET DATA:
Working capital................................................. 63,706 144,470 100,411 127,388 51,772
Total assets.................................................... 1,006,900 873,039 424,275 294,924 146,568
Long-term debt.................................................. 247,250 95,000 -- -- --
Total shareholders' equity...................................... 385,425 488,082 322,484 241,642 119,480
</TABLE>
- ---------------
(1) Acquisitions in all years presented affect the comparability of these
amounts. See Note 4 to the financial statements.
(2) The Company paid cash dividends relating to its preferred stock in 1996 and
1995. No cash dividends were paid in any previous periods presented.
(3) Healthsource declared a two-for-one stock split in the form of a 100% stock
dividend effective December 15, 1995, a two-for-one stock split in the form
of a 100% stock dividend effective March 14, 1994, and a three-for-two stock
split in the form of a 50% stock dividend effective December 15, 1992. All
share and per share amounts have been restated for the stock splits.
(4) The Northern region includes HMOs operating in New Hampshire, Indiana,
Syracuse, NY, Louisville, KY, Maine, Ohio and Massachusetts. The Southern
region includes HMOs operating in South Carolina, Tennessee, North Carolina,
Arkansas, Georgia and north central Texas. Indiana and Massachusetts are
included since the ownership of investments therein were acquired in May
1992 and February 1996, respectively. Arkansas, Georgia, north central
Texas, Louisville, KY and Ohio are included since commencement of operations
in January 1994, November 1994, January 1995, July 1995 and January 1996,
respectively.
(5) Calculated on the basis of average members during the period, excluding
mental health and substance abuse days.
(6) Cost of HMO medical premiums for the plans in each region divided by HMO
medical premium revenue.
2
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
GENERAL--The Company has experienced substantial growth since its formation
in New Hampshire in 1985. Revenue growth has been accomplished through
increasing membership and medical premiums per member and administrative and
managed care fees from self-insured employers and through acquisitions. The
Company has made acquisitions of health maintenance organization ("HMO")
companies resulting in wholly-owned subsidiaries in South Carolina, Tennessee,
Maine, Indiana, North Carolina, Syracuse, New York, and Massachusetts. The
Company has formed strategic alliances with hospitals to operate HMOs in
Arkansas, Georgia, north central Texas, and southwestern Ohio and has formed
start-up HMOs in Connecticut, Louisville, Kentucky and Austin, Texas. It also
formed a strategic alliance with Chubb Life Insurance Company to operate an HMO
("ChubbHealth") in the metropolitan New York City and northern New Jersey areas.
Effective May 1, 1995, the Company acquired the group health, third-party
administration and HMO business ("the Provident Transaction") from Provident
Life and Accident Insurance Company of America, Inc. for $231 million in cash
and preferred stock. To conduct the acquired businesses, the Company organized
and capitalized Healthsource Provident Insurance Company to assume the insured
business and Healthsource Provident Administrators, Inc. to administer the
self-insured business. The Company experienced a decline in average premium
yield during 1996 of 4.5% as compared to 1995. 1996 and 1995 average premium
yields were as follows:
<TABLE>
<CAPTION>
REGION 12/31/96 12/31/95 % CHANGE
------ -------- -------- --------
<S> <C> <C> <C>
North............................................... $137.47 $140.94 (2.5%)
South............................................... 117.45 122.63 (4.2%)
Total............................................... 124.94 130.84 (4.5%)
</TABLE>
The Company continues to experience very strong resistance to premium
increases by employers and intense price competition from payors, including new
entrants. Nonetheless, the Company has generally increased premium yield on its
1997 renewal business whenever practicable to reflect higher underlying
healthcare costs. In addition, the Company's overall premium yield is affected
by the mix of business volume between its higher yielding Northern Plans and the
lower yielding Southern Plans that historically have grown more rapidly. Given
the difficult premium pricing environment, the Company's medical loss ratio, and
ultimately its profitability, will largely depend upon its ability to control
healthcare and administrative costs.
ACQUISITION DEVELOPMENTS--In February 1997, the Company signed an agreement
of merger with CIGNA Corporation providing for the acquisition of the Company at
a cash price of $21.75 per share, subject to regulatory and other approvals and
conditions. In February, 1996, the Company acquired Central Massachusetts Health
Care ("CMHC"), an 80,000 member HMO headquartered in Worcester, Massachusetts.
The Massachusetts market is highly penetrated and competitive and CMHC may
likely experience financial losses until it can obtain better health care cost
controls or better premium pricing. In January 1997, the Company completed its
previously announced agreement with Chubb Life Insurance Company of America to
acquire the remaining 85% interest in ChubbHealth, a 68,000 member HMO operating
in the metropolitan New York/New Jersey market. In June, 1996, the Company
acquired Security Assurance Company, a Delaware insurance company licensed in 49
states, at a net cost of $3 million in order to fulfill commitments made in the
Provident Transaction and to enable the Company to write its national insured
business directly rather than through Provident entities.
RECENT REDUCTION IN PROFITABILITY; ENROLLMENT LEVELS; REVIEW OF
OPERATIONS--The Company's profitability in 1996, exclusive of the non-recurring
charges discussed below, is dramatically lower than the similar period in 1995,
as a result of the continuing deterioration in health care costs during a period
of premium pricing contraction. The Company has sought increases in 1997 premium
pricing which has contributed to its reduced enrollment growth rates and sought
to strategically exit from certain employer accounts which contributed to its
reduced absolute enrollment level as of January 1, 1997. The Company will also
attempt to improve its medical loss ratio through initiatives to reduce
inappropriate or excessive health care costs. Such
3
<PAGE> 5
initiatives (which may include lower payment levels to providers, new
contracting methodologies, and steerage of members more aggressively to more
efficient providers, and other measures) may cause the Company's relationship
with health care providers to be strained in certain markets. In some markets,
however, the Company may have to increase payment levels to providers over 1996
levels. The Company is exploring other methodologies to contain health care
costs and reassessing various lines of business and operating units in a review
of operations in an attempt to improve profitability in 1997. No assurance can
be given that such initiatives will be successful or that health care costs will
not continue to increase to even more unacceptable levels.
FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995--During 1996, the operating
results of the Company included $53.4 million in pre-tax non-recurring charges.
Of the total, $11.2 million resulted from restructuring charges which include
severance, lease buy-outs, and other personnel reduction related charges related
to the consolidation and realignment of certain Company operations. In addition,
the Company recorded a non-recurring charge of approximately $38 million on a
pre-tax basis to cover costs of lower than expected conversion of self-insured
lives to HMO membership and estimated costs of investments in certain long-term
strategic alliances to provide assistance to hospitals for network start-up
inefficiencies. The remaining charges relate to the write-down of certain
intangible assets in accordance with FAS 121 which the Company believes were
impaired at December 31, 1996.
Revenue increased 47% to $1.7 billion from $1.2 billion. This increase was
largely the result of a 53% increase in HMO medical premium revenue to $1.2
billion from $812 million. The change in HMO medical premium revenue was
attributable to: (1) the combined effect of a 42% increase in average membership
and a 4.5% decrease in average medical premium yield to $125 per member per
month (pmpm) from $131 pmpm at Healthsource New Hampshire (HSNH), Healthsource
Tennessee (HSTN), Healthsource Indiana (HSIN), Healthsource South Carolina
(HSSC), Healthsource Maine (HSME), Healthsource North Carolina (HSNC),
Healthsource Arkansas (HSAR), Healthsource Savannah (HSSV), and Healthsource New
York (HSNY) (collectively "Existing Plans"); (2) a $114 million increase due to
the acquisition of Healthsource CMHC ("HSCMHC"); and (3) the commencement of
operations of Healthsource North Texas (HSNTX) and Healthsource Ohio (HSOH).
Additionally, other insured medical premium and administrative and managed
care fees increased 31% and 37%, respectively, as a result of the inclusion of
the Provident Transaction for an entire year in 1996.
Cost of HMO medical premiums (health care costs) increased 61% to $1
billion from $622 million. This increase was due to: (1) the combined effect of
the 42% increase in average membership with a 1.2% increase in the average cost
of medical premiums to $101 pmpm from $100 pmpm at Existing Plans; (2) a $88
million increase due to the acquisition of HSCMHC; and (3) the commencement of
operations at HSNTX and HSOH. This 1.2% increase in costs resulted principally
from higher outpatient hospital, diagnostic and pharmaceutical costs.
The cost of HMO medical premiums as a percent of HMO medical premiums (the
"medical loss ratio" or "MLR") increased to 80.7% from 76.6% primarily because
of the 4.5% decrease in average medical premium yield and the 1.2% increase in
average cost of medical premiums at Existing Plans. The divergence between
premium pricing (which significantly declined) and health care costs (which
increased) was primarily responsible for the Company's significant reduction in
profitability. While the difficult premium pricing environment is expected to
continue, the Company believes it has generally reversed the premium yield
decline for renewals in January of 1997.
The cost of other insured medical premiums increased to $203 million from
$149 million as a result of the Provident Transaction being included for an
entire year in 1996.
Total selling, general and administrative (SG&A) expenses increased to $436
million from $300 million due to acquisitions and the development of existing
operations and new businesses. As a percent of total operating revenue, SG&A
expenses decreased to 25.4% from 25.7% as a result of a number of factors
including change in mix of business where SG&A levels as a percentage of revenue
are far lower in fully-insured business than self-insured business where revenue
does not include health care expenses.
4
<PAGE> 6
SG&A expenses related to HMO, fully-insured medical business and corporate
administration increased 57% to $241 million from $153 million. This increase
resulted primarily from the SG&A expense associated with the acquisition of
HSCMHC, the membership increases at existing HMOs, the commencement of
operations at HSNTX and HSOH, development expenses at start-up HMOs and other
business development activities. SG&A expenses related to administration and
managed care fees increased 33% to $195 million from $146 million due to the
inclusion of the Provident Transaction for the entire year in 1996.
Depreciation and amortization expense increased 60% to $39 million from $24
million primarily due to the amortization expense associated with HSCMHC which
was acquired in the first quarter of 1996 and depreciation associated with
increased capital purchases.
Interest expense increased 134% to $12.6 million from $5.4 million as a
result of the convertible subordinated notes issued in March 1996.
FISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994--Revenue increased 100% to
$1.17 billion from $584 million. The majority of the increase was the result of
a 57% increase in HMO medical premium revenue to $812 million from $516 million.
The change in HMO medical premium revenue was attributable to: (1) a $131
million increase due to the effect of the acquisition of the remaining interests
in HSNC and HSNY, and the acquisition of HMO members in the Provident
Transaction ("PHCP"), (2) the combined effect of a 44% increase in average
membership and a 3.5% decrease in average medical premium yield to $130 pmpm
from $135 pmpm at its subsidiaries HSNH, HSTN, HSME, HSSC, HSAR, and HSIN
(collectively "Existing Plans"); and (3) from the commencement of operations of
HSSV and Healthsource Kentucky ("HSKY").
In addition, there was a significant increase in other insured medical
premiums to $185 million from $17 million as a result of the acquisition of
Provident's fully-insured managed indemnity products and experience rated
refundable premium products.
The remaining revenue increase was due to a 229% increase in administrative
and managed care fee revenue to $170 million from $52 million which resulted
from the Provident Transaction, continued growth of the Company's self-funded
point-of-service ("POS") business in various states, workers' compensation
healthcare administration fees in New Hampshire, and the effect of the
acquisition of the remaining interest in Healthsource North Carolina
Administrators, Inc. ("HSNCA") during 1994.
Cost of HMO medical premiums increased 58% to $622 million from $394
million. This increase was due to the effect of the acquisition of the remaining
interests in HSNC and HSNY, the combined effect of the 44% increase in average
membership with a 3.7% decrease in average cost of medical premiums to $99 pmpm
from $103 pmpm at Existing Plans, and the commencement of operations of HSSV and
HSKY. This 3.7% decrease in costs resulted from lower inpatient and outpatient
hospital costs as a result of favored hospital pricing arrangements and global
capitation arrangements offsetting increases in diagnostic testing and
pharmaceutical costs.
The Company's medical loss ratio increased to 76.6% from 76.4%. Although
the 3.5% decrease in the average premium yield was less than the 3.7% decrease
in average cost of medical premiums at Existing Plans, this positive effect was
offset by HSNC, HSNY, PHCP, HSSV, and HSKY which combined had higher MLRs than
the Existing Plans.
The cost of other insured medical premiums increased to $149 million from
$14 million as a result of the acquisition of Provident's fully-insured managed
indemnity products and experience rated refundable premium products.
Total selling, general and administrative expenses increased to $300
million from $123 million due to acquisitions and the development of existing
and new businesses. As a percent of total revenue, SG&A increased to 25.7% from
21.0% as a result of the self-funded business acquired in the Provident
Transaction which has inherently higher levels of SG&A expense.
SG&A expenses related to HMO, fully-insured medical business and corporate
administration increased 86% to $153 million from $83 million. This increase was
primarily due to the effect of the acquisition of the
5
<PAGE> 7
remaining interests in HSNC and HSNY and the Provident Transaction, the
membership increases at Existing Plans and start up of operations at HSSV and
HSKY, and other business development activities. SG&A expenses related to
administrative and managed care fees increased 265% to $146 million from $40
million due to the Provident Transaction, the effect of the acquisition of the
remaining interest in HSNCA and increases in the Company's administrative
service businesses serving self-insured POS and managed workers' compensation
membership.
Depreciation and amortization expense increased 114% to $24 million from
$11 million due to amortization expense associated with the acquisitions of
Provident and the remaining interests in HSNC and HSNY and depreciation
associated with increased capital purchases.
Interest and other income increased 60% to $21 million from $13 million.
This increase resulted primarily from the increase in cash, cash equivalents and
marketable securities associated with the Provident Transaction, the acquisition
of HSNC and continued increases in cash available from operations. The Company
incurred interest expense of $5 million in 1995 as a result of borrowings
associated with the Provident Transaction.
The Company had no equity in the income of unconsolidated affiliates for
the year ended December 31, 1995 as compared to $1.7 million in the same period
in 1994. This decrease occurred because of the Company's acquisition of the
remaining interests in HSNC and HSNY which were previously accounted for using
the equity method.
The Company's effective tax rate increased to 35.4% from 31.3% due to the
decline of non-taxable interest income as a percentage of total interest income
and as a percentage of total operating income.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, cash, cash equivalents and marketable securities
totaled approximately $260 million, of which $229 million was held by regulated
operating companies and, except for permissible dividends, was largely
restricted to use in those companies.
During 1996, the Company generated $74 million of cash from operations and
invested approximately $48 million in additional facilities and information
technology. The acquisition of HSCMHC resulted in a net cash expenditure of
approximately $46 million which was funded from borrowings under the Chase
Facility described below.
On March 8, 1996, the Company completed the sale (through a private
offering to institutional investors) of $247 million principal amount of 5%
Convertible Subordinated Notes (the "Notes") due 2003. The Notes are convertible
into Common Stock of the Company at a price of $46.965 per share. The Company
used the net proceeds of the offering to redeem the $100 million face amount of
the Company's outstanding 6.25% Class A Cumulative Preferred Stock. The balance
of the net proceeds of the offering was used to repay a portion of the
outstanding principal balance under the Company's $200 million unsecured
revolving credit agreement with Chase Manhattan Bank N.A. as agent ("Chase
Facility").
The Chase Facility is committed through March 15, 2000. At December 31,
1996, the Company had no amount outstanding. Due to certain covenants taking
effect in March 1998, the effective availability of the Chase Facility is
approximately $100 million.
The principal and interest on the Notes is by their terms subordinated in
right of payment to principal and interest on substantially all existing and
future debt (including debt under the Chase Facility) incurred by the Company
("Senior Debt"). As of December 31, 1996, the Company had no Senior Debt. As of
such date, the Company's subsidiaries had aggregate liabilities of approximately
$342 million, to which the Notes are also structurally subordinated.
In January 1997, the Company completed the acquisition of the 85% interest
in ChubbHealth, Inc. which it did not already own in exchange for a cash payment
of $25.3 million. The Company may be required to contribute an additional $6
million to ChubbHealth under terms of the agreement. The Company funded the
purchase with cash from operations.
6
<PAGE> 8
The Company believes that its existing cash balances and cash flow
generated by its wholly-owned plans coupled with the amounts available for
borrowing under the Chase Facility are adequate to fund its existing operations
and commitments.
EFFECTS OF INFLATION
Medical premiums and the costs of medical premiums (healthcare costs)
generally increase at higher rates than the overall rates of inflation in the
economy. Accordingly, the Company must use strong utilization management
techniques and tight provider contracting strategies to counteract inflationary
trends in healthcare costs and, given the recent phenomenon of declining premium
levels, any failure to adequately control healthcare costs could substantially
increase the Company's medical loss ratio and decrease the Company's net income.
Safe Harbor Statement under the Private Securities
Litigation Reform Act of 1995: The statements contained in this
Management's Discussion and Analysis of Financial Condition and
Results of Operations concerning future premium pricing levels,
future MLR levels, the Company's ability to control healthcare
and SG&A costs and all other statements that are not historical
facts are forward looking statements; actual results may differ
materially from those projected in the forward looking
statements which statements involve risks and uncertainties,
including but not limited to, the following: that increased
regulation will increase healthcare expenses; that increased
competition in the Company's markets, changes in product mix or
other factors will unexpectedly reduce premium yield; that the
Company will be unable to close sufficient global capitation
arrangements with key providers; that healthcare costs in any
given period may be greater than expected due to unexpected
incidence of major cases, natural disasters, epidemics, changes
in physician practices, and new technologies; and that the
Company will be unable to close acquisitions of other HMOs and
healthcare financing companies on satisfactory terms in key
markets. Shareholders are also directed to the other risks
discussed in the Company's Annual Report on Form 10-K and in
other documents filed by the Company with the Securities and
Exchange Commission.
7
<PAGE> 9
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Healthsource, Inc.
Hooksett, New Hampshire
We have audited the accompanying consolidated balance sheets of
Healthsource, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, cash flows and changes in
shareholders' equity for each of the three years in the period ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Healthsource, Inc. and
subsidiaries at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1996 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
February 26, 1997
(February 28, 1997 as to Note 15)
8
<PAGE> 10
HEALTHSOURCE, INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
---------- --------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ 125,017 $121,467
Marketable securities (Notes 3 and 12)............................. 25,135 34,301
Premiums and administrative fees receivable (Note 12).............. 55,984 66,103
Self-insured claims payments receivable (Note 12).................. 52,237 51,768
Restricted investments (Notes 3, 9, and 12)........................ 108,136 123,871
Other current assets............................................... 62,361 29,986
---------- --------
Total current assets............................................ 428,870 427,496
Long-term marketable securities (Notes 3 and 12)..................... 110,049 68,357
Property and leasehold improvements--net (Note 5).................... 130,795 103,611
Restricted investments (Notes 3, 9, and 12).......................... 11,072 8,099
Intangible assets (Note 4)........................................... 301,704 254,886
Other assets......................................................... 24,410 10,590
---------- --------
Total assets.................................................... $1,006,900 $873,039
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable (Note 12)................................... $ 175,481 $152,649
Accounts payable and accrued expenses.............................. 137,639 85,678
Estimated liability under retrospective refund agreements.......... 33,463 35,623
Deferred revenue................................................... 16,158 7,489
Other current liabilities.......................................... 2,423 1,587
---------- --------
Total current liabilities....................................... 365,164 283,026
Revolving note payable (Note 6)...................................... -- 95,000
Convertible subordinated notes (Notes 7 and 15)...................... 247,250 --
Other liabilities.................................................... 9,061 6,931
---------- --------
Total liabilities............................................... 621,475 384,957
Commitments and contingencies (Note 9)
Shareholders' equity (Note 11):
Preferred stock--10,000 shares authorized, 0 and 1,000 issued and
outstanding--$100 stated value (Note 4)......................... -- 100,000
Common stock--$.10 par value--800,000 shares authorized, 63,795 and
63,581 issued and outstanding................................... 6,380 6,358
Additional paid-in capital......................................... 224,778 221,048
Retained earnings.................................................. 154,479 159,547
Unrealized gain (loss) on marketable securities (Note 3)........... (212) 1,129
---------- --------
Total shareholders' equity........................................... 385,425 488,082
---------- --------
Total liabilities and shareholders' equity........................... $1,006,900 $873,039
========= ========
</TABLE>
See notes to consolidated financial statements
9
<PAGE> 11
HEALTHSOURCE, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenue:
HMO medical premiums.................................. $1,238,936 $ 811,645 $515,639
Other insured medical premiums........................ 242,535 184,819 16,837
Administrative and managed care fees.................. 232,492 170,233 51,767
---------- ---------- --------
Total operating revenue.......................... 1,713,963 1,166,697 584,243
---------- ---------- --------
Expenses:
Cost of HMO medical premiums.......................... 1,000,002 621,888 394,173
Cost of other insured medical premiums................ 202,525 149,396 14,020
Selling, general and administrative:
HMO and other insured services..................... 240,945 153,326 82,550
Administrative and managed care services........... 194,641 146,340 40,107
---------- ---------- --------
Total selling, general and administrative........ 435,586 299,666 122,657
---------- ---------- --------
Other charges (Note 13)............................... 53,411 -- --
Depreciation and amortization......................... 38,721 24,129 11,254
---------- ---------- --------
Total operating expenses........................... 1,730,245 1,095,079 542,104
---------- ---------- --------
Operating income (loss)............................ (16,282) 71,618 42,139
Interest income.................................... 24,305 20,823 13,004
Interest expense................................... (12,629) (5,392) --
---------- ---------- --------
Interest income, net............................. 11,676 15,431 13,004
Income (loss) before equity in income of unconsolidated
affiliates and provision for income taxes............. (4,606) 87,049 55,143
Equity in income of unconsolidated affiliates........... -- -- 1,670
---------- ---------- --------
Income (loss) before provision for income taxes......... (4,606) 87,049 56,813
Provision (benefit) for income taxes (Note 8)........... (666) 30,778 17,769
---------- ---------- --------
Net income (loss).................................. $ (3,940) $ 56,271 $ 39,044
========== ========== ========
Preferred stock dividends............................... (1,128) (4,167) --
---------- ---------- --------
Net income (loss) applicable to common shareholders..... $ (5,068) $ 52,104 $ 39,044
========== ========== ========
Net income (loss) per common share:..................... $ (0.08) $ 0.81 $ 0.62
Weighted average number of common and common equivalent
shares outstanding:................................... 63,725 64,195 62,818
</TABLE>
See notes to consolidated financial statements
10
<PAGE> 12
HEALTHSOURCE, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................................... $ (3,940) $ 56,271 $ 39,044
Adjustment to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.................. 38,721 24,129 11,254
Changes in assets and liabilities net of the effects of
acquisitions:
Premiums and administrative fees receivable.... 12,797 (20,316) (3,778)
Other current assets........................... (32,095) (9,156) (7,244)
Medical claims payable......................... 963 (5,062) 6,004
Accounts payable and accrued expenses.......... 49,374 2,247 8,541
Deferred revenue............................... 8,146 2,456 (1,570)
--------- --------- --------
Net cash provided by operating
activities.............................. 73,966 50,569 52,251
--------- --------- --------
Cash flows from investing activities:
Decrease (increase) in marketable securities........ (16,721) 119,448 (29,545)
Investment in affiliates, net of cash acquired...... (60,433) (159,165) 7,831
Additions to property and leasehold improvements.... (48,357) (55,357) (23,253)
Decrease (increase) in other assets and restricted
investments....................................... (1,058) 2,162 (5,742)
--------- --------- --------
Net cash used for investing activities............ (126,569) (92,912) (50,709)
--------- --------- --------
Cash flows from financing activities:
Issuance of convertible subordinated notes............. 247,250 -- --
Net borrowings (repayment) under revolving note
payable............................................. (95,000) 95,000 --
Redemption of preferred stock.......................... (100,000) -- --
Issuance of common stock............................... 2,901 5,727 1,642
Preferred stock dividends.............................. (1,128) (4,167) --
Increase (decrease) in other liabilities............... 2,130 57 (299)
Investment by minority shareholder..................... -- -- 79
--------- --------- --------
Net cash provided by financing activities......... 56,153 96,617 1,422
--------- --------- --------
Increase in cash and cash equivalents.................... 3,550 54,274 2,964
Balance, beginning of year............................... 121,467 67,193 64,229
--------- --------- --------
Balance, end of year..................................... $ 125,017 $ 121,467 $ 67,193
========= ========= ========
Supplemental disclosure of cash flow information:
Income taxes paid...................................... $ 16,911 $ 23,955 $ 16,537
Interest paid.......................................... 8,569 5,331 --
</TABLE>
Supplemental disclosure of non-cash transactions:
In 1995, the Company issued $100 million in 6.25% cumulative preferred stock
in connection with the Provident acquisition (See Note 4).
In 1994, the Company issued 1,242,000 shares of the Company's common stock,
which were valued at $39.2 million, in connection with the Healthsource Health
Plans, Inc. acquisition (See Note 4).
See notes to consolidated financial statements
11
<PAGE> 13
HEALTHSOURCE, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
UNREALIZED
PREFERRED STOCK COMMON STOCK ADDITIONAL GAIN (LOSS) ON
-------------------- ---------------- PAID-IN RETAINED MARKETABLE SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SECURITIES EQUITY
------- --------- ------ ------ ---------- -------- --------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1994................... -- -- 29,736 $2,974 $170,269 $ 68,399 -- $ 241,642
Stock issued in
connection with HSHP
acquisition............ -- -- 1,242 124 39,098 -- -- 39,222
Exercise of stock
options................ -- -- 302 30 4,096 -- -- 4,126
Unrealized loss on
marketable
securities............. -- -- -- -- -- -- (1,550) (1,550)
Net income............... -- -- -- -- -- 39,044 -- 39,044
------ --------- ------ ------ -------- -------- ------- ---------
Balance, December 31,
1994................... -- -- 31,280 3,128 213,463 107,443 (1,550) 322,484
Stock issued in
connection with
Provident
acquisition............ 1,000 100,000 -- -- -- -- -- 100,000
Preferred stock
dividends.............. -- -- -- -- -- (4,167) -- (4,167)
Exercise of stock
options................ -- -- 511 51 10,764 -- -- 10,815
Unrealized gain on
marketable
securities............. -- -- -- -- -- -- 2,679 2,679
Stock split.............. -- -- 31,790 3,179 (3,179) -- -- --
Net income............... -- -- -- -- -- 56,271 -- 56,271
------ --------- ------ ------ -------- -------- ------- ---------
Balance, December 31,
1995................... 1,000 100,000 63,581 6,358 221,048 159,547 1,129 488,082
Preferred stock
dividends.............. -- -- -- -- -- (1,128) -- (1,128)
Preferred stock
redemption............. (1,000) (100,000) -- -- -- -- -- (100,000)
Exercise of stock
options................ -- -- 214 22 3,730 -- -- 3,752
Unrealized loss on
marketable
securities............. -- -- -- -- -- -- (1,341) (1,341)
Net income (loss)........ -- -- -- -- -- (3,940) -- (3,940)
------ --------- ------ ------ -------- -------- ------- ---------
Balance,
December 31, 1996........ -- $ -- 63,795 $6,380 $224,778 $154,479 $ (212) $ 385,425
====== ========= ====== ====== ======== ======== ======= =========
</TABLE>
See notes to consolidated financial statements
12
<PAGE> 14
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF BUSINESS
Healthsource, Inc. and its subsidiaries (together referred to as the
"Company") operate in a single business segment, managed healthcare, and provide
a broad range of managed healthcare products and services through various
subsidiaries. The Company owns health maintenance organizations ("HMOs") in New
England, upstate New York, and the Central, Southeastern and South Central
United States and acquired the group health, HMO and third-party administration
business of Provident Life and Accident Insurance Company of America
("Provident") of Chattanooga, Tennessee in May 1995 (the Provident Transaction).
The Company also provides managed care and administration services directly to
other health care payors.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of Healthsource, Inc. and its majority-owned subsidiaries.
All significant intercompany accounts and transactions are eliminated in
consolidation. Investments in entities in which ownership interests range from
20% to 50% and in which the Company exercises significant influence are
accounted for by the equity method. Interests of other investors in the
Company's majority-owned entities are accounted for as minority interests and
are included in other liabilities for financial reporting purposes.
CASH AND CASH EQUIVALENTS -- The Company considers all money market
deposits and instruments, repurchase agreements, remarketed preferred stock,
certificates of deposit and U.S. Government obligations with original maturities
of three months or less to be cash equivalents.
MARKETABLE SECURITIES -- The Company has adopted the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("FAS 115"). The Company's investment
portfolio is comprised principally of debt securities. The Company classifies
its securities as "available-for-sale" and records them at market value. The
difference between cost and market, net of the related tax effect, has been
reflected as a separate component of shareholders' equity. The carrying value of
investments sold is determined on a specific identification basis.
PROPERTY AND LEASEHOLD IMPROVEMENTS -- Property and leasehold improvements
are stated at cost. Depreciation of property is computed using straight-line and
accelerated methods over the estimated useful lives of the related assets,
principally five to seven years. Depreciation of building and improvements is
computed using the straight-line method over the estimated useful life of forty
years. Amortization of leasehold improvements and assets under capital leases is
computed using the straight-line method over the shorter of the estimated useful
lives or the related lease terms.
INTANGIBLE ASSETS -- Intangible assets consist of costs in excess of net
assets acquired, covenants not to compete, hospital services agreements,
physician networks and acquired membership lists. The costs in excess of net
assets acquired are amortized over various periods not exceeding forty years
using a straight-line method. The other intangible assets are amortized using a
straight-line method over their estimated useful lives ranging from three to
fifteen years. The Company continually evaluates the recoverability of goodwill
using methods consistent with the provisions of Statement of Financial
Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of" ("FAS 121").
MEDICAL CLAIMS PAYABLE -- Reported claims expected to be paid after the
balance sheet date for services provided to members prior to the balance sheet
date are recorded as liabilities. Claims for services provided to members during
the financial reporting period which are unreported at the balance sheet date
are also recorded as liabilities based on the Company's claims experience. The
amounts are based upon estimates of the ultimate net cost of such services
provided.
13
<PAGE> 15
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
RETROSPECTIVE REFUND AGREEMENTS -- The liability for retrospective refund
agreements and the retrospective refund credits due and accrued represent
estimated amounts to be either refunded to group contract holders or used to
stabilize future premiums based on formulas which compare a group's claims
experience to premiums paid.
PHYSICIAN RISK WITHHOLDING -- The cost of medical premiums (including the
portion of the physicians' fees withheld) are charged to expense as incurred,
and amounts withheld from physicians are recorded as liabilities. Amounts to be
returned to physicians are reviewed periodically, and any amounts not returned
under the risk-sharing arrangement are recorded as reductions of the cost of
medical premiums and corresponding reductions of the related liability for
physician risk withholding.
REVENUE -- HMO medical premium revenue and other insured medical premium
revenue are recognized in the month in which members are entitled to receive
health care services; other insured medical premiums are reported net of
retrospective refunds. Medical premiums collected in advance are recorded as
deferred revenue. Administrative and managed care fees are recognized in the
period that claims processing and other managed care services are provided to
self-funded clients. Revenue from management service agreements is recognized in
the period for which the Company performs the services.
COST OF HMO MEDICAL PREMIUMS -- Cost of HMO medical premiums includes the
costs of all medical services delivered to enrolled members of the Company's
majority-owned HMOs and for whom the entities have recorded HMO medical premium
revenue during the reporting period. These costs include payments for specific
medical services and for capitation. The cost of specific medical services
include those paid to physicians, hospitals, and other health care providers on
a fee-for-service basis. These costs include claims paid, claims in process and
pending, estimates of unreported claims, estimates of contractual adjustments
pursuant to hospital and other provider contracts, and charges at the balance
sheet date for which the Company will be responsible. Adjustments to prior
period estimates are reflected in the current period and are not significant.
The costs of capitation (fixed monthly payments per member) include payments to
certain physicians, hospitals, laboratories, pharmaceutical and mental health
care providers.
COST OF OTHER INSURED MEDICAL PREMIUMS -- Cost of other insured medical
premiums includes the costs of all medical services delivered to enrolled
members of the Company's non-HMO medical plans for whom the entities have
recorded medical premium revenue during the reporting period. These costs
include claims paid, claims in process and claims pending, and estimates of
unreported claims and charges at the balance sheet date for which the Company
will be responsible. Adjustments to prior period estimates are reflected in the
current period and are not significant.
REINSURANCE -- The Company's operating subsidiaries are covered under
medical reinsurance agreements that provide partial coverage for medical
services in excess of certain amounts. Reinsurance premiums, net of recoveries
are included in the cost of medical premiums.
SELLING, GENERAL & ADMINISTRATIVE (SG&A) EXPENSE -- HMO and other insured
SG&A expense includes the costs recognized by the Company and its majority-owned
entities: (1) to market and administer the delivery of medical services for
which the Company is at risk; (2) to develop and administer its management
services agreements and (3) to develop new product offerings, negotiate new
provider agreements and costs incurred to enter new markets. Administrative and
managed care fees SG&A expense includes the costs recognized by the Company and
its majority-owned entities to market and administer the delivery of medical
services for self-insured clients. Corporate SG&A is included within HMO and
other insured SG&A expense.
INCOME TAXES -- The Company and its majority-owned subsidiaries file
consolidated federal, New Hampshire, and Maine income tax returns. All other
state income tax returns are filed on a separate company basis.
14
<PAGE> 16
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company accounts for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards No. 109. Deferred income tax assets
and liabilities are computed for differences between the financial statement and
tax bases of assets and liabilities that will result in taxable or deductible
amounts in the future based on enacted tax laws and rates applicable to the
periods in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. Income tax expense is the tax
payable or refundable for the period plus or minus the change during the period
in deferred tax assets and liabilities.
NET INCOME (LOSS) PER COMMON SHARE -- Net income (loss) per common share
for all periods presented was computed by dividing net income (loss) less
preferred dividends by the weighted average number of shares outstanding during
each respective period after giving effect to a two-for-one stock split effected
in the form of a 100% stock dividend payable to shareholders December 15, 1995.
Stock options, if dilutive, are included as common stock equivalents.
RISKS AND UNCERTAINTIES -- The Company's business could be impacted by
continuing price pressure on new and renewal business, the Company's ability to
effectively control healthcare costs, additional competitors entering the
Company's markets, federal and state legislation in the area of healthcare
reform and governmental licensing regulations of HMOs and insurance companies.
Changes in these areas could adversely impact the Company's operations in the
future.
USE OF ESTIMATES -- 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. Estimates also affect the reported amounts of revenue
and expenses during the reporting period. Actual results could differ from those
estimates.
IMPAIRMENT OF LONG-LIVED ASSETS -- The Company has adopted Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121").
SFAS 121 establishes accounting standards for the impairment of long-lived
assets, certain identifiable intangibles, and goodwill related to those assets.
See Note 13.
STOCK-BASED COMPENSATION -- Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123") became effective in
1996. As permitted by SFAS 123, the Company has elected to continue to account
for stock-based compensation to employees under APB Opinion No. 25. See Note 11.
RECLASSIFICATIONS -- Acquisitions in all years presented affect the
comparability of amounts, most notably in 1995, where other insured medical
premiums, cost of other insured medical premiums and a significant portion of
administrative and managed care fees SG&A are impacted and relate primarily to
the Provident Transaction. Accordingly, certain prior year amounts have been
reclassified to conform with the current presentation.
15
<PAGE> 17
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. MARKETABLE SECURITIES AND RESTRICTED INVESTMENTS
The Company's investment portfolio consisted of the following securities
which were classified as "available for sale" at December 31, 1996:
<TABLE>
<CAPTION>
MARKET UNREALIZED UNREALIZED AMORTIZED
VALUE GAIN LOSS COST
-------- ---------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Current Assets:
Marketable Securities:
Municipal Tax Exempt Bonds.......... $ 18,386 $ 84 $ -- $ 18,302
Other............................... 6,749 -- 38 6,787
-------- ------ ----- ---------
Total............................. 25,135 84 38 25,089
-------- ------ ----- ---------
Restricted Investments:
Municipal Tax Exempt Bonds.......... 87,110 412 -- 86,698
US Government and Agencies.......... 11,099 -- 203 11,302
Other............................... 9,927 -- 145 10,072
-------- ------ ----- ---------
Total............................. 108,136 412 348 108,072
-------- ------ ----- ---------
Non-current assets:
Marketable Securities:
US Government and Agencies.......... 12,449 -- 67 12,516
Municipal Tax Exempt Bonds.......... 87,996 295 -- 87,701
Other............................... 9,604 -- 112 9,716
-------- ------ ----- ---------
Total............................. 110,049 295 179 109,933
-------- ------ ----- ---------
Restricted Investments:
US Government and Agencies.......... 7,746 52 -- 7,694
Municipal Tax Exempt Bonds.......... 2,188 23 -- 2,165
Other............................... 1,138 -- -- 1,138
-------- ------ ----- ---------
Total............................. 11,072 75 -- 10,997
-------- ------ ----- ---------
Total Available for Sale............... $254,392 $ 866 $565 $ 254,091
======== ====== ===== =========
</TABLE>
The Company's investment portfolio consisted of the following securities
which were classified as "available for sale" at December 31, 1995:
<TABLE>
<CAPTION>
MARKET UNREALIZED UNREALIZED AMORTIZED
VALUE GAIN LOSS COST
-------- ---------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Current Assets:
Marketable Securities:
Municipal Tax Exempt Bonds.......... $ 23,992 $ 136 $ 32 $ 23,888
Other............................... 10,309 -- 119 10,428
-------- ----- ----- --------
Total............................. 34,301 136 151 34,316
-------- ----- ----- --------
Restricted Investments:
Taxable Municipal Bonds............. 45,187 2 15 45,200
Municipal Tax Exempt Bonds.......... 48,208 579 -- 47,629
Other............................... 30,476 -- -- 30,476
-------- ----- ----- --------
Total............................. 123,871 581 15 123,305
-------- ----- ----- --------
</TABLE>
16
<PAGE> 18
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
MARKET UNREALIZED UNREALIZED AMORTIZED
VALUE GAIN LOSS COST
-------- ---------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Non-current assets:
Marketable Securities:
US Government and Agencies.......... 2,852 7 -- 2,845
Municipal Tax Exempt Bonds.......... 62,072 1,104 57 61,025
Other............................... 3,433 -- 44 3,477
-------- ------ ----- ---------
Total............................. 68,357 1,111 101 67,347
-------- ------ ----- ---------
Restricted Investments:
US Government and Agencies.......... 4,503 119 2 4,386
Municipal Tax Exempt Bonds.......... 1,248 -- -- 1,248
Other............................... 2,348 16 -- 2,332
-------- ------ ----- ---------
Total............................. 8,099 135 2 7,966
-------- ------ ----- ---------
Total Available for Sale............... $234,628 $1,963 $ 269 $ 232,934
======== ====== ===== =========
</TABLE>
Proceeds from sales of "available-for-sale" securities during 1996 and 1995
were $608.4 million and $27.5 million, respectively. Realized gains (losses) on
these sales totaled ($0.6) and $0.4 million for 1996 and 1995, respectively.
Maturities of investments are as follows at December 31, 1996 (in
thousands):
<TABLE>
<CAPTION>
MARKET AMORTIZED
VALUE COST
-------- ---------
<S> <C> <C>
Available-for-Sale:
Within One Year............................................ $ 41,537 $ 41,406
One Through Five Years..................................... 110,867 110,918
After Five Through Ten Years............................... 95,334 95,054
After Ten Years............................................ 6,654 6,713
-------- ---------
$254,392 $ 254,091
======== =========
</TABLE>
4. ACQUISITIONS
The Company's intangible assets were acquired as the result of various
acquisitions. At December 31, 1996 and 1995, the Company's intangible assets
consisted of the following:
<TABLE>
<CAPTION>
1996 1995
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Identifiable intangible assets............................... $ 67,325 $ 20,053
Cost in excess of net assets acquired........................ 268,159 255,191
-------- --------
Total intangible assets...................................... 335,484 275,244
Less accumulated amortization................................ (33,780) (20,358)
-------- --------
Intangible assets, net....................................... $301,704 $254,886
======== ========
</TABLE>
Identifiable intangible assets consist of covenants not to compete,
membership lists, hospital services agreements and physician networks which are
being amortized over estimated useful lives ranging from three to fifteen years
based on formal valuation studies. The final valuation study for Healthsource
CMHC is not yet complete. Amortization expense for the years ended December 31,
1996, 1995, and 1994 was $14.3 million, $9.3 million, and $4.7 million,
respectively.
17
<PAGE> 19
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1996 ACQUISITION -- Effective February 1, 1996, the Company acquired
substantially all of the HMO assets of Central Massachusetts Health Care, Inc.
(now called "Healthsource CMHC" ("HSCMHC")) for approximately $46.5 million in
cash, subject to post closing purchase price adjustments.
1995 ACQUISITION -- Effective May 1, 1995, the Company acquired the group
health, HMO and third party administration business of Provident for $231
million in cash and securities. The Company paid cash of $131 million and issued
to Provident non-convertible cumulative preferred stock with a face value of
$100 million. The Company redeemed the preferred stock in March 1996. The
transaction was accounted for as a purchase. See Note 7.
1994 ACQUISITIONS -- On January 13, 1994, the Company acquired the
remaining 60.2% interest in Healthsource Maine, Inc. ("HSME"). Under the terms
of the agreement, the Company made a cash payment of $11.5 million in exchange
for all of the shares of HSME which it did not already own. The transaction was
accounted for as a purchase.
On March 31, 1994, the Company acquired the remaining 69.9% of Healthsource
Health Plans, Inc. ("HSHP"), the parent company of Healthsource North Carolina,
Inc. ("HSNC"). Under the terms of the agreement, HSHP shareholders received
approximately 1.24 million shares of the Company's common stock. In addition,
certain existing options held by HSHP management were converted at the same
ratio to options to purchase approximately 153,000 shares of Healthsource common
stock with an exercise price of approximately $4.60 per share. The transaction
was accounted for as a purchase. The number of shares and option price per share
have not been adjusted for subsequent stock splits.
In November 1994, the Company completed a cash tender offer to purchase the
remaining 60% interest in Healthsource New York, Inc. (formerly CNY Patient's
Network, Inc.), the parent company of Healthsource HMO of New York ("HSNY")
which resulted in a total purchase price of approximately $11 million. The
transaction was accounted for as a purchase.
The following unaudited pro forma consolidated statement of operations
information assumes the Provident Transaction and the HSCMHC acquisition had
occurred on January 1, of each year.
<TABLE>
<CAPTION>
1996 1995
---------- ----------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C>
Revenue................................................... $1,724,386 $1,439,687
Operating income (loss)................................... (17,579) 69,720
Net income (loss)......................................... (4,787) 55,267
Net income (loss) per common share:....................... $ (0.09) $ 0.76
</TABLE>
5. PROPERTY AND LEASEHOLD IMPROVEMENTS
Property and leasehold improvements at December 31, 1996 and 1995 consisted
of the following:
<TABLE>
<CAPTION>
1996 1995
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Land......................................................... $ 10,516 $ 5,913
Building and improvements.................................... 23,530 13,886
Furniture, fixtures and equipment............................ 111,210 85,271
Purchased computer software.................................. 31,290 21,314
Leasehold improvements....................................... 5,360 6,065
-------- --------
Total................................................... 181,906 132,449
Less accumulated depreciation and amortization............... (51,111) (28,838)
-------- --------
Property and leasehold improvements--net................ $130,795 $103,611
======== ========
</TABLE>
Depreciation and amortization expense for the years ended December 31,
1996, 1995, and 1994 was $24.4 million, $14.9 million, and $6.5 million,
respectively.
18
<PAGE> 20
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. REVOLVING NOTE PAYABLE
The Company has a $200 million unsecured revolving credit agreement with a
bank syndicate which is committed through March 15, 2000. Interest under this
revolving credit facility may range between LIBOR plus .2% and LIBOR plus .45%
depending upon the Company's ratio of indebtedness to total capital. In
connection with the agreement, the Company is required to maintain certain
minimum financial ratios and other covenants. Management believes the Company to
be in compliance with all covenants under this agreement. At December 31, 1996
the Company had no amount outstanding under this facility. The interest rate at
December 31, 1996 was approximately 6.0%.
7. CONVERTIBLE SUBORDINATED NOTES
On March 8, 1996, the Company completed the sale (through a private
offering to institutional investors) of $247 million principal amount of 5%
Convertible Subordinated Notes due 2003. The notes may be converted into common
stock at a conversion price of $46.965 per share and are redeemable, in whole or
in part, at the option of the Company at any time after March 1, 1999. The
proceeds of the sale were used to redeem the outstanding $100 million preferred
stock issued in conjunction with the Provident Transaction and to repay a
portion of the amount owed under the revolving note payable. See Note 4.
8. INCOME TAXES
The provision (benefit) for income taxes was comprised of the following:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal............................................ $ 7,302 $25,190 $17,000
State.............................................. 532 2,862 2,613
-------- ------- -------
Total current................................... 7,834 28,052 19,613
-------- ------- -------
Deferred:
Federal............................................ (7,490) 2,640 (1,651)
State.............................................. (1,010) 86 (193)
-------- ------- -------
Total deferred.................................. (8,500) 2,726 (1,844)
-------- ------- -------
Total provision (benefit)....................... $ (666) $30,778 $17,769
======== ======= =======
</TABLE>
Deferred income tax expense arose from differences between the reported
amounts of assets and liabilities and their tax bases provided for in accordance
with FAS 109.
Deferred tax assets and liabilities were not material individually or in
the aggregate and are included in other current assets, other assets, other
current liabilities, and other liabilities for financial reporting purposes.
The difference between the Company's effective income tax rate and the
federal statutory rate is reconciled below:
<TABLE>
<CAPTION>
1996 1995 1994
----- ---- ----
<S> <C> <C> <C>
Federal statutory rate................................. (35.0)% 35.0% 35.0%
State income taxes..................................... 5.2 2.1 1.6
Net operating losses of majority-owned affiliates not
currently available for benefit...................... 42.2 -- --
Non-taxable income..................................... (48.4) (3.9) (6.6)
Non-deductible expenses and other...................... 21.5 2.2 1.3
----- ---- ----
Effective income tax rate.............................. (14.5)% 35.4% 31.3%
===== ==== ====
</TABLE>
19
<PAGE> 21
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. COMMITMENTS AND CONTINGENCIES
ACQUISITIONS -- In January 1997, the Company acquired the remaining 85%
interest in ChubbHealth, Inc. Under the terms of the agreement, the Company made
a cash payment of $25.3 million in exchange for all of the shares of
ChubbHealth, Inc. which it did not already own. The Company may be required to
contribute an additional $6 million to ChubbHealth, Inc. under terms of the
agreement. The transaction was accounted for as a purchase.
REGULATORY REQUIREMENTS -- The Company's affiliated HMOs and insurance
companies are subject to various regulatory requirements including maintenance
of minimum statutory net worth. At December 31, 1996 the Company believes that
it was in compliance with all such requirements. Certain wholly-owned and
majority-owned subsidiaries are required to maintain restricted investments in
the amount of approximately $119 million which includes approximately $108
million placed in a temporary trust to cover claims payments associated with the
Provident Transaction until such time as the policies acquired are novated to
the Company from the Provident.
LEGAL PROCEEDINGS -- The Company is involved in legal actions in the
ordinary course of business. Although the outcome of any such legal actions
cannot be predicted, in the opinion of management there are no legal proceedings
pending against or involving the Company, the outcome of which is likely to have
a material adverse effect upon the consolidated financial position or results of
operations of the Company.
SHAREHOLDER RIGHTS -- During 1996, the Company adopted a Rights Agreement
pursuant to which each shareholder upon any person or group acquiring ownership
of 20% or greater of the outstanding Common Stock may purchase additional shares
of Common Stock at half of market value.
EMPLOYEE BENEFIT PLANS -- The Company sponsors various defined contribution
retirement plans covering substantially all full-time employees. The Company
matches employee contributions to a maximum of 3% of compensation. Expense
related to these plans amounted to $2.1 million, $1.7 million, and $0.4 million
in 1996, 1995 and 1994, respectively.
LEASES -- The Company leases certain equipment and premises under
noncancellable operating leases. Rent expense under all operating leases was
$13.5 million, $10.9 million, and $3.4 million for the years ended December 31,
1996, 1995 and 1994, respectively.
At December 31, 1996, future minimum annual lease payments under
noncancellable operating leases are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
--------------
(IN THOUSANDS)
<S> <C>
1997........................................................ $13,534
1998........................................................ 12,483
1999........................................................ 9,251
2000........................................................ 5,757
2001........................................................ 3,677
2002 and thereafter......................................... 12,383
</TABLE>
10. RELATED PARTY TRANSACTIONS
Under the terms of various management services agreements, the Company
provided services to previously unconsolidated affiliates. Additionally, several
members of the Board of Directors are also physicians who provide services to a
wholly-owned subsidiary under a standard agreement used for all physicians, and
two hospitals who are minority shareholders of each of two of the Company's
consolidated subsidiaries also provide services under standard provider
agreements.
20
<PAGE> 22
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. STOCK OPTION PLANS
The Company, with the approval of the shareholders, has three Non-Qualified
Stock Option Plans for employees and two Non-Qualified Stock Option Plans for
non-employee directors (the "Plans"). Options granted to employees may be
designated by the Company as qualified or non-qualified at the date of grant.
Under the provisions of the employee plan, the Company is entitled to grant
annually an amount equal to 1 1/2% of the number of outstanding shares on the
preceding December 31 plus any unused amounts from prior periods. Each option is
convertible into one share of common stock of the Company and may be awarded to
employees of the Company and its subsidiaries and non-employee directors of the
Company at a purchase price of at least 110% of the fair market value of the
stock as of the date of grant. Options may be exercised in accordance with the
terms and conditions of each grant. Information concerning options outstanding
for 1996, 1995 and 1994, is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------ -------- ------ --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year.......... 4,951 $18.38 4,542 $14.09 2,753 $ 8.35
Granted................................. 1,888 35.52 1,458 22.35 2,517 17.55
Exercised............................... (181) 10.10 (1,034) 5.17 (604) 2.72
Forfeited............................... (452) 29.67 (15) 17.36 (124) 12.31
----- ------ ------ ------ ----- ------
Outstanding, end of year................ 6,206 22.81 4,951 $18.38 4,542 $14.09
===== ====== ====== ====== ===== ======
Options exercisable at year end......... 2,334 1,884 946
Weighted average fair value of options
granted during the year............... $12.37 $ 8.41
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- ---------------------------------
RANGE OF NUMBER WEIGHTED AVG. NUMBER
EXERCISE OUTSTANDING REMAINING WEIGHTED AVG. EXERCISABLE WEIGHTED AVG.
PRICE AT 12/31/96 CONTRACT LIFE EXERCISE PRICE AT 12/31/96 EXERCISE PRICE
- -------------- -------------- ------------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Less than $10 150 6 years $ 5.20 150 $ 5.20
$10-$14 567 7 11.59 407 10.54
$15-$19 2,931 8 18.66 1,486 17.93
$20-$26 1,455 9 22.94 291 22.89
$32-$42 1,103 9 41.81 -- --
-------
----- ------ ----- ------
6,206 8 years $22.81 2,334 $16.65
===== ======= ====== ===== ======
</TABLE>
21
<PAGE> 23
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company applies APB Opinion 25 and related Interpretations in
accounting for its stock option plans. Accordingly, no compensation cost has
been recognized for these plans. Had compensation cost for these plans been
determined based upon fair value at the date of grant in accordance with FAS
123, the Company's net income and earnings per share would have been as follows:
<TABLE>
<CAPTION>
1996 1995
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Net income (loss)
As Reported.............................................. $ (3,940) $56,271
Proforma................................................. (11,532) 54,780
Earnings (loss) per share
As Reported.............................................. $ (0.08) $ 0.81
Proforma................................................. (0.20) 0.79
</TABLE>
The proforma effect on net income for 1996 and 1995 is not representative
of the proforma effect on net income in future years because it does not take
into effect proforma compensation expense related to grants made prior to 1995.
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1996 1995
-------- ---------
<S> <C> <C>
Risk-free Interest Rate...................................... 6.0% 6.9%
Expected Lives 5 years 5.7 years
Volatility................................................... 36.8% 33.1%
Dividend Yield............................................... N/A N/A
</TABLE>
12. CONCENTRATIONS OF CREDIT RISK
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of investments in marketable
securities, premiums and administrative fees receivable, self-insured claims
payment receivables, and hospital settlement receivables. The Company's
investments in marketable securities are managed by internal and external
investment managers within the guidelines established by the Board of Directors,
which, as a matter of policy, limit the amounts which may be invested in any one
issuer. Concentrations of credit risk with respect to premiums and other
receivables and hospital settlements receivable are limited due to the large
number of employer groups and hospital providers comprising the Company's
customer base and provider networks, respectively. Additionally, the Company has
a right of offset with respect to amounts due from and to the hospitals. As of
December 31, 1996, management believes that the Company had no significant
concentrations of credit risk.
13. OTHER CHARGES
During 1996, the operating results of the Company included $53.4 million in
pre-tax non-recurring charges. Of the total, $11.2 million resulted from
restructuring charges which included severance, lease buyouts, and other
personnel reduction related charges related to the consolidation and realignment
of certain Company operations. In addition, the Company recorded a non-recurring
charge of approximately $38 million on a pre-tax basis to cover costs of lower
than expected conversion of self-insured lives to HMO membership and estimated
costs of investments in certain long-term strategic alliances to provide
assistance to hospitals for network start-up inefficiencies. The remaining
charges relate to the write-down of certain intangible assets in accordance with
FAS 121 which the Company believes were impaired at December 31, 1996.
22
<PAGE> 24
HEALTHSOURCE, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents selected quarterly financial information for
each of the four quarters of 1996 and 1995. Such information includes all
adjustments the Company considers necessary for a fair presentation thereof.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1996
Revenue......................................... $419,092 $430,120 $426,414 $438,337
Operating income (loss)......................... 19,896 7,685 (7,253) (36,610)
Net income (loss)............................... 15,562 6,498 (3,399) (22,601)
Net income (loss) per share..................... 0.22 0.10 (0.05) (0.35)
1995
Revenue......................................... $208,107 $286,744 $328,211 $343,635
Operating income................................ 14,057 15,942 18,853 22,766
Net income...................................... 11,771 13,622 15,023 15,855
Net income per share............................ 0.19 0.20 0.21 0.22
</TABLE>
The sum of the above quarterly amounts may not equal reported year to date
amounts due to rounding.
Operating results for the last three quarters of 1996 were impacted by
premium yield decreases coupled with higher than expected health care costs.
Additionally, results for the third and fourth quarters reflect the impact of
other changes. See Note 13.
15. SUBSEQUENT EVENT
On February 28, 1997, the Company announced that it had entered into a
definitive merger agreement under which CIGNA Corporation has agreed to acquire
the Company. Pursuant to the agreement, CIGNA has commenced a tender offer for
any and all outstanding Company shares at a price of $21.75 per share in cash.
Following consummation of the tender offer, the Company will merge with a
subsidiary of CIGNA under which all remaining Company shareholders will receive
the same per share price. As a result of the merger, the holders of the
Company's convertible subordinated notes will have the right to require the
Company to repurchase the notes at a purchase price in cash in an amount equal
to 101% of the principal amount plus accrued interest. In connection with such
repurchase, CIGNA has agreed to contribute to the Company an amount in cash
necessary to repurchase all such notes.
23
<PAGE> 25
OFFICERS
<TABLE>
<S> <C> <C>
Norman C. Payson, M.D. Charles M. Schneider Richard B. Salmon, M.D., Ph.D.
President and Chief Executive Executive Vice President and Senior Vice President for
Officer Chief Operating Officer Medical Affairs
Joseph M. Zubretsky Francis G. Middleton, M.D. Robert Chin
Chief Financial Officer President and Chief Executive Chief Information Officer
Officer, Healthsource South
Carolina, Inc. and President,
Healthsource South, Inc.
</TABLE>
DIRECTORS
<TABLE>
<S> <C> <C>
Merwyn Bagan, M.D., M.P.H. Robert S. Cathcart, III, M.D. Robert A. Leipold, M.D.
Chairman of the Board General Surgeon, Surgical President, Healthsource New
Neurosurgeon, Retired Associates of Charleston, Hampshire, Inc., Shareholder,
South Carolina, Professional Garrison Medical Professional
Association Association
Paul D. Baron, M.D. J. Harold Chandler Francis G. Middleton, M.D.
Director, Pathways President and Chief Executive President and Chief Executive
Professional Association Officer, Provident Companies, Officer, Healthsource South
Inc. Carolina, Inc.; President,
Healthsource South, Inc.
Robert H. Bilbro, M.D. Daniel F. Eubank, M.D. Norman C. Payson, M.D.
President and Chairman of the Director of Residency Program, President and Chief Executive
Board, Healthsource Health Concord Hospital (NH) Officer
Plan, Inc.; Shareholder,
Raleigh Medical Group,
Professional Association
David W. Schall, M.D.
Chairman of the Board and
President, Healthsource Maine,
Inc.; President, Chief
Executive Officer, Chief
Operating Officer and
Director, Bowdoin Medical
Group
</TABLE>
24
<PAGE> 26
CORPORATE INFORMATION
Corporate Headquarters:
Healthsource, Inc.
Two College Park Drive
Hooksett, NH 03106-1636
(603) 268-7000
SHAREHOLDER INFORMATION
<TABLE>
<S> <C> <C>
Legal Counsel: Certified Public Accountants: Transfer Agent:
Sheehan Phinney Bass + Green, Deloitte & Touche LLP The Bank of New York
Professional Association 125 Summer Street 101 Barclay Street
1000 Elm Street Boston, MA 02110 New York, NY 10286
Manchester, NH 03101 (617) 261-8000 (800) 524-4458
(603) 668-0300
</TABLE>
STOCK MARKET DATA
The Company's Common Stock is traded on the New York Stock Exchange under
the symbol "HS." The approximate number of holders of record of the Company's
Common Stock as of March 24, 1997 was 2,260 . This number does not reflect the
number of persons or entities who hold their stock in nominee or "street" name
through various brokerage firms.
The following table shows the range of high and low closing sales prices
for the Company's Common Stock as reported on the New York Stock Exchange
Corporate Tape for the calendar periods indicated. The prices have been restated
to reflect the effect of a two-for-one stock split effective December 15, 1995.
<TABLE>
<CAPTION>
1995 HIGH LOW
---- ----- -----
<S> <C> <C>
First Quarter.............................................. 23 5/8 19 1/4
Second Quarter............................................. 23 15 1/8
Third Quarter.............................................. 24 1/2 17 1/4
Fourth Quarter............................................. 36 21
</TABLE>
<TABLE>
<CAPTION>
1996 HIGH LOW
---- ----- -----
<S> <C> <C>
First Quarter.............................................. 40 1/8 29 1/4
Second Quarter............................................. 40 17 3/8
Third Quarter.............................................. 17 3/4 11
Fourth Quarter............................................. 14 3/4 10 7/8
</TABLE>
DIVIDEND POLICY
The Company has not paid cash dividends since its inception and does not
expect to pay cash dividends on its Common Stock in the foreseeable future. The
payment of cash dividends by the Company is subject to contractual restrictions
under its $200 million revolving credit facility with Chase Manhattan Bank and a
syndicate of other banks.
FORM 10-K AND OTHER REPORTS.
THE COMPANY HAS FILED AN ANNUAL REPORT ON FORM 10-K FOR ITS MOST RECENT
FISCAL YEAR WITH THE SECURITIES AND EXCHANGE COMMISSION. COPIES OF THE FORM
10-K, AND QUARTERLY REPORTS ON FORM 10-Q, MAY BE OBTAINED WITHOUT CHARGE UPON
WRITTEN REQUEST TO:
TRACEY TURNER
VICE PRESIDENT-CORPORATE COMMUNICATIONS
HEALTHSOURCE, INC.
TWO COLLEGE PARK DRIVE
HOOKSETT, NH 03106
25
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF HEALTHSOURCE, INC.
Name/Doing Business As State of
(if applicable) Incorporation Ownership
- --------------- ------------- ---------
Healthsource New Hampshire, Inc. NH 100%
Healthsource Indiana Insurance Company IN 100%
Healthsource Indiana Managed Care Plan, Inc. IN 100%
Healthsource Insurance Group, Inc. NH 100%
Healthsource South Carolina, Inc. SC 100%
Healthsource Insurance Services, Inc. SC 100%
Healthsource Tennessee Preferred, Inc. TN 100%
Healthsource Tennessee, Inc. TN 100%
Healthsource North Carolina Administrators, Inc. NC 100%
Healthsource North Carolina, Inc. NC 100%
Healthsource HMO of New York, Inc. NY 100%
Healthsource Preferred, Inc. NH 100%
Healthsource Maine, Inc. ME 100%
Healthsource Maine Preferred, Inc. ME 100%
Employee Benefit Plan Administration, Inc. NH 100%
Healthsource Massachusetts, Inc./Healthsource CMHC MA 100%
Healthsource Preferred of NY, Inc. NY 100%
Healthsource Health Plans, Inc. NC 100%
Healthsource South, Inc. NH 100%
Healthsource Management, Inc. NH 100%
Healthsource Indiana, Inc. NH 100%
Physicians Health Systems, Inc. SC 100%
Healthsource Syracuse, Inc. NH 100%
Healthsource Metropolitan New York Holding NH 100%
Company, Inc.
<PAGE> 2
Healthsource New York/New Jersey, Inc. NY 100%
Healthsource Arkansas, Inc. AR 70%
Healthsource Arkansas Preferred, Inc. AR 70%
Spradley & Coker, Inc. AR 70%
Healthsource Provident Administrators, Inc. TN 100%
Healthsource Insurance Company TN 100%
Healthsource North Texas, Inc. TX 70%
Provident Health Care Plan, Inc. of Tennessee TN 100%
Healthsource Ohio, Inc. OH 100%
Healthsource Kentucky, Inc. KY 100%
Healthsource Georgia, Inc. GA 100%
Healthsource Connecticut, Inc. CT 100%
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-05223 of Healthsource, Inc. on Form S-3 and Registration Statements No.
33-43242, No. 33-49856, No. 33-76910 and No. 33-80456 of Healthsource, Inc. on
Form S-8 of our report dated February 26, 1997 (February 28, 1997 as to Note 15)
appearing in this Annual Report on Form 10-K of Healthsource, Inc. for the
year ended December 31, 1996.
/s/ DELOITTE & TOUCHE LLP
Boston, Massachusetts
March 28, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 125,017
<SECURITIES> 133,271
<RECEIVABLES> 108,221
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 428,870
<PP&E> 130,795
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,006,900
<CURRENT-LIABILITIES> 365,164
<BONDS> 247,250
0
0
<COMMON> 6,380
<OTHER-SE> 379,045
<TOTAL-LIABILITY-AND-EQUITY> 1,006,900
<SALES> 1,713,963
<TOTAL-REVENUES> 1,738,268
<CGS> 1,202,527
<TOTAL-COSTS> 1,730,245
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12,629
<INCOME-PRETAX> (4,606)
<INCOME-TAX> (666)
<INCOME-CONTINUING> (3,940)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,940)
<EPS-PRIMARY> (.08)
<EPS-DILUTED> 0
</TABLE>
