<PAGE>
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES EXCHANGE ACT OF
1934
Filed by the Registrant [X]
Filed by a party other than the Registrant [_]
Check the appropriate box:
[_]Preliminary Proxy Statement [_]CONFIDENTIAL, FOR USE OF THE
COMMISSION ONLY (AS PERMITTED BY
[X]Definitive Proxy Statement RULE 14A-6(E)(2))
[_]Definitive Additional Materials
[_]Soliciting Material Pursuant to (S)240.14a-
11(c) or (S)240.14a-12
PHYSICIANS HEALTH SERVICES, INC.
-----------------------------------------------------
(Name of Registrant as Specified in Its Charter)
-----------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of filing fee (Check the appropriate box):
[_]No fee required
[_]Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11
1) Title of each class of securities to which transaction applies:
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2) Aggregate number of securities to which transaction applies:
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3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11
(Set forth the amount on which the filing fee is calculated and state how
it was determined):
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4) Proposed maximum aggregate value of transaction:
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5) Total fee paid:
----------------------------------------------------------------------------
[X]Fee paid previously with preliminary materials.
[_]Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
1) Amount Previously Paid:
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2) Form, Schedule or Registration Statement No.:
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3) Filing Party:
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4) Date Filed:
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<PAGE>
[LOGO] PHYSICIANS
HEALTH SERVICES
December 10, 1997
Dear Stockholder:
You are cordially invited to attend the Annual Meeting of Stockholders (the
"Meeting") of Physicians Health Services, Inc. (the "Company") to be held on
December 31, 1997, at 9:00 a.m., local time, at the Company's principal
executive offices at One Far Mill Crossing, Shelton, Connecticut 06484-0944.
At the Meeting you will be asked to consider and vote upon a proposal to
approve and adopt the Agreement and Plan of Merger, dated as of May 8, 1997, as
amended by Amendment No. 1 thereto, dated as of October 19, 1997 (as so
amended, the "Merger Agreement"), a composite copy of which is attached as
Appendix A to the enclosed Proxy Statement, pursuant to and subject to the
terms and conditions of which PHS Acquisition Corp. ("Merger Sub"), a Delaware
corporation and a wholly-owned subsidiary of Foundation Health Systems, Inc.
("FHS"), will be merged with and into the Company (the "Merger"). Upon
consummation of the Merger, the Company will become a wholly-owned subsidiary
of FHS, and each outstanding share of the Company's Class A Common Stock and
Class B Common Stock (other than shares owned by FHS or Merger Sub or by any
direct or indirect subsidiary of FHS or Merger Sub or which are held in the
treasury of the Company or by any of its subsidiaries, all of which will be
cancelled, or which are held by any dissenting stockholder) will be cancelled
and converted into the right to receive $28.25 in cash, without interest (the
"Merger Consideration"), provided that, if certain waivers and consents are
obtained from The Guardian Life Insurance Company of America, Inc. ("The
Guardian") prior to the time that the Merger becomes effective, each such share
will be cancelled and converted into the right to receive $29.25 in cash,
without interest. See "PROPOSAL ONE--THE MERGER--The Guardian Condition." The
affirmative vote of the holders of a majority of the voting power of the
Company's outstanding Class A Common Stock and Class B Common Stock, voting
together as a single class, is required for the approval and adoption of the
Merger Agreement.
In connection with the execution of the Merger Agreement, the Greater
Bridgeport Individual Practice Association, Inc. ("GBIPA"), the Company and
American Stock Transfer & Trust Company as voting trustee (the "Voting
Trustee"), entered into a Voting Trust Agreement, dated as of May 8, 1997 and
attached as Appendix C to the enclosed Proxy Statement (the "Voting Trust
Agreement"). Pursuant to the Voting Trust Agreement, among other things, GBIPA
has transferred 2,401,021 shares of the Company's Class B Common Stock
(representing approximately 63.2% of the combined voting power of the Company's
outstanding Class A Common Stock and Class B Common Stock) to the Voting
Trustee, and the Voting Trustee has agreed to vote all of such shares in favor
of the approval and adoption of the Merger Agreement, which vote will assure
that the Merger Agreement will be approved and adopted by the Company's
stockholders. See "PROPOSAL ONE--THE MERGER--The Voting Trust Agreement."
Immediately prior to the Merger, the Company will also pay to its employees
who hold stock options under the Company's 1992 Stock Option Plan or 1995 Stock
Option Plan, in cancellation of their respective options and subject to their
prior consent, an amount in cash (less applicable withholding taxes) equal to
the product of the number of shares of the Company's Common Stock subject to
each such option multiplied by the excess, if any, of the Merger Consideration
over the exercise price for each share of the Company's Common Stock subject to
such option, all as more fully set forth in the accompanying Proxy Statement.
The Company is required to deliver the consent of each of its directors and
officers to such cancellation and cash-out at or prior to the effective time of
the Merger and to use its reasonable best efforts to obtain similar consents
from each other holder of such options.
<PAGE>
You should be aware that FHS, the Company, Physicians Health Services of
Connecticut, Inc. ("PHS/CT") and GBIPA have entered into an agreement
providing for an amendment to the Service Agreement between GBIPA and PHS/CT
and a payment to GBIPA by the Company upon consummation of the Merger in
consideration for such amendment. See "PROPOSAL ONE--THE MERGER--Amendment to
GBIPA Service Agreement". Also, certain officers and directors of the Company
have certain interests in the Merger that are different from, or in addition
to, the interests of the stockholders of the Company. See "PROPOSAL ONE--THE
MERGER--Conflicts of Interest and Interests of Certain Persons in the Merger"
and "PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS--Summary Compensation
Table."
The Merger Agreement provides that the Merger shall be consummated within
two business days following the satisfaction or waiver of the closing
conditions pertaining to the Merger, including approval by the requisite vote
of the Company's stockholders and receipt of all regulatory approvals. In the
event such date occurs prior to January 6, 1998, then, at the request of FHS,
the Merger will be consummated on a business day (no later than January 6,
1998) selected by FHS.
The Board of Directors has received an opinion from its financial advisor,
Morgan Stanley & Co. Incorporated, to the effect that, on the date of such
opinion, and based on assumptions made, procedures followed, matters
considered and limitations on the review undertaken, as set forth in such
opinion, the Merger Consideration pursuant to the Merger Agreement was fair
from a financial point of view to the holders of Class A Common Stock and
Class B Common Stock.
THE BOARD OF DIRECTORS HAS CAREFULLY CONSIDERED AND APPROVED THE PROPOSED
MERGER AND THE MERGER AGREEMENT AS BEING IN THE BEST INTERESTS OF THE COMPANY
AND ITS STOCKHOLDERS. THE BOARD OF DIRECTORS, BY THE UNANIMOUS VOTE OF ALL
DIRECTORS, RECOMMENDS THAT THE STOCKHOLDERS OF THE COMPANY VOTE "FOR" THE
APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AT THE MEETING.
Stockholders of the Company are entitled to appraisal rights under Section
262 of the Delaware General Corporation Law ("Section 262"). Stockholders
electing such rights must carefully follow the procedures set forth in Section
262. See "PROPOSAL ONE--THE MERGER--Appraisal Rights." These steps include,
but are not limited to, such stockholder not voting in favor of the Merger and
delivering to the Company a written demand for appraisal.
At the Meeting you will also be asked to elect one Class A and three Class B
Directors to serve until the 2000 Annual Meeting. THE BOARD OF DIRECTORS
UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF THE COMPANY VOTE "FOR"
ELECTION OF THE COMPANY'S NOMINEES FOR CLASS A AND CLASS B DIRECTORS.
The accompanying Proxy Statement provides a detailed description of the
proposals regarding the Merger and the election of directors. You are urged to
read the accompanying materials so that you may be informed about the business
to come before the Meeting.
Please sign, date and return the enclosed proxy card in the envelope
provided. You may vote by signing the enclosed proxy card, whether or not you
plan to attend the Meeting. If you attend the Meeting, you may vote in person,
even if you have previously mailed in your proxy.
We look forward to seeing you at the Meeting.
Sincerely,
/s/ David I. Grayer, M.D.
David I. Grayer, M.D.
Chairman
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
ONE FAR MILL CROSSING
P.O. BOX 904
SHELTON, CONNECTICUT 06484-0944
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NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD DECEMBER 31, 1997
----------------
To the Stockholders of Physicians Health Services, Inc.:
NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders (the
"Meeting") of Physicians Health Services, Inc. (the "Company") will be held on
December 31, 1997 at 9:00 a.m., local time, at the Company's principal
executive offices at One Far Mill Crossing, Shelton, Connecticut 06484-0944,
for the following purposes:
1. To consider and vote upon a proposal to approve and adopt the Agreement
and Plan of Merger, dated as of May 8, 1997, as amended by Amendment No.
1 thereto, dated as of October 19, 1997 (as so amended, the "Merger
Agreement"), a composite copy of which is attached as Appendix A to the
accompanying Proxy Statement, providing for the merger (the "Merger") of
PHS Acquisition Corp. ("Merger Sub"), a Delaware corporation and a
wholly-owned subsidiary of Foundation Health Systems, Inc. ("FHS"), with
and into the Company and which, among other things, provides that each
outstanding share of the Company's Class A and Class B Common Stock
(other than shares of Class A and Class B Common Stock owned by FHS or
Merger Sub or any direct or indirect subsidiary of FHS or Merger Sub, or
which are held in the treasury of the Company or by any of its
subsidiaries, which will be cancelled, or which are held by dissenting
stockholders) will be cancelled and converted into the right to receive
$28.25 (or, under certain limited circumstances, $29.25) per share in
cash, without interest, all as more fully described in the accompanying
Proxy Statement and Appendix A thereto.
2. To elect one Class A Director to serve as a director of the Company for
a term ending at the 2000 Annual Meeting.
3. To elect three Class B Directors to serve as directors of the Company
for respective terms ending at the 2000 Annual Meeting.
4. To transact such other business as may properly come before the Meeting
or any adjournment or postponement thereof.
Only holders of record of outstanding shares of Class A and Class B Common
Stock of the Company at the close of business on November 13, 1997 will be
entitled to notice of, and to vote at, the Meeting or any adjournment or
postponement thereof. A list of stockholders entitled to vote at the Meeting
will be available for examination by any stockholder, for any purpose relevant
to the Meeting, on and after December 19, 1997, during ordinary business hours
at the Company's principal executive offices at One Far Mill Crossing,
Shelton, Connecticut 06484-0944.
<PAGE>
THE BOARD OF DIRECTORS OF THE COMPANY, BY THE UNANIMOUS VOTE OF ALL
DIRECTORS, RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" THE PROPOSAL TO APPROVE AND
ADOPT THE MERGER AGREEMENT. IN ADDITION, THE BOARD OF DIRECTORS UNANIMOUSLY
RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" THE PROPOSALS TO ELECT THE COMPANY'S
NOMINEES AS CLASS A AND CLASS B DIRECTORS, WHICH ARE DESCRIBED IN THE
ACCOMPANYING PROXY STATEMENT.
By Order of the Board of Directors,
/s/ Bernard Sherlip, M.D.
Bernard Sherlip, M.D.
Secretary
Shelton, Connecticut
December 10, 1997
YOUR VOTE IS IMPORTANT. TO VOTE YOUR SHARES, PLEASE MARK, SIGN AND DATE THE
ENCLOSED PROXY CARD AND MAIL IT PROMPTLY IN THE ENCLOSED RETURN ENVELOPE,
WHICH REQUIRES NO POSTAGE IF MAILED IN THE UNITED STATES.
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
ONE FAR MILL CROSSING
P.O. BOX 904
SHELTON, CONNECTICUT 06484-0944
----------------
PROXY STATEMENT FOR ANNUAL MEETING
TO BE HELD DECEMBER 31, 1997
----------------
INTRODUCTION
This Proxy Statement is being furnished to stockholders of Physicians Health
Services, Inc., a Delaware corporation (the "Company"), in connection with the
solicitation of proxies by the Board of Directors of the Company for use at
the Annual Meeting of Stockholders to be held on December 31, 1997, at 9:00
a.m., local time, at the Company's principal executive offices at One Far Mill
Crossing, Shelton, Connecticut 06484-0944, and any adjournment or postponement
thereof (the "Meeting"). Only holders of record of outstanding shares of the
Company's Class A Common Stock, $0.01 par value per share (the "Class A Common
Stock"), and Class B Common Stock, $0.01 par value per share (the "Class B
Common Stock," and collectively with the Class A Common Stock, the "Common
Stock") of the Company at the close of business on November 13, 1997, will be
entitled to vote at the Meeting.
At the Meeting, stockholders will be asked to consider and vote upon a
proposal to approve and adopt the Agreement and Plan of Merger, dated as of
May 8, 1997 (the "Original Merger Agreement"), as amended by Amendment No. 1
thereto, dated as of October 19, 1997 (referred to herein as "Amendment No.
1", and the Original Merger Agreement, as so amended, being referred to herein
as the "Merger Agreement"), among Foundation Health Systems, Inc., a Delaware
corporation ("FHS"), PHS Acquisition Corp., a Delaware corporation and a
wholly-owned subsidiary of FHS ("Merger Sub") and the Company providing for
the merger of Merger Sub with and into the Company (the "Merger"). The
affirmative vote of the holders of a majority of the voting power of the
Company's outstanding Common Stock, voting together as a single class, is
required for the approval and adoption of the Merger Agreement. See "PROPOSAL
ONE--THE MERGER."
If the Merger Agreement is approved and adopted, the Merger will be
consummated on the terms and subject to the conditions set forth in the Merger
Agreement. Upon consummation of the Merger, the Company will become a wholly-
owned subsidiary of FHS, and each outstanding share of Common Stock (other
than shares of Common Stock owned by FHS or Merger Sub or by any direct or
indirect subsidiary of FHS or Merger Sub or which are held in the treasury of
the Company or by any of its subsidiaries, all of which will be cancelled, or
which are held by dissenting stockholders) will be cancelled and converted
into the right to receive $28.25 per share in cash, without interest (the
"Merger Consideration") provided that, if certain waivers and consents are
obtained from The Guardian Life Insurance Company of America, Inc. ("The
Guardian") prior to the time that the Merger becomes effective (the "Effective
Time"), the cash amount to be received by such stockholders will be increased
to $29.25 per share, without interest. While it is possible, the Company
believes it unlikely that the required items will be forthcoming prior to the
Effective Time or that the Merger Consideration will be increased. See
"PROPOSAL ONE--THE MERGER--The Guardian Condition."
In connection with the execution of the Original Merger Agreement, the
Greater Bridgeport Individual Practice Association, Inc. ("GBIPA"), the
Company and American Stock Transfer & Trust Company, as voting trustee (the
"Voting Trustee"), entered into a Voting Trust Agreement, dated as of May 8,
1997 and attached as Appendix C to the enclosed Proxy Statement (the "Voting
Trust Agreement"). Pursuant to the Voting Trust Agreement, among other things,
GBIPA has transferred 2,401,021 shares of the Company's Class B Common Stock
(representing approximately 63.2% of the combined voting power of the
Company's outstanding Class A Common Stock and Class B Common Stock) to the
Voting Trustee, and the Voting Trustee has agreed to vote all of such shares
in favor of the approval and adoption of the Merger Agreement, which vote will
assure that the Merger Agreement will be approved and adopted by the Company's
stockholders. See "PROPOSAL ONE--THE MERGER--The Voting Trust Agreement."
GBIPA has consented to Amendment No. 1.
<PAGE>
Immediately prior to the Merger, the Company will also pay to its employees
who hold stock options ("Employee Options") under the Company's 1992 Stock
Option Plan or 1995 Stock Option Plan, in cancellation of their respective
options and subject to their prior consent, an amount in cash (less applicable
withholding taxes) equal to the product of the number of shares of the
Company's Common Stock subject to each such Employee Option multiplied by the
excess, if any, of the Merger Consideration over the exercise price for each
share of the Company's Common Stock subject to such option. See "PROPOSAL
ONE--THE MERGER--The Merger Agreement--Employee Options." The Company is
required to deliver the consent of each of its directors and officers to such
cancellation and cash-out at or prior to the effective time of the Merger and
to use its reasonable best efforts to obtain similar consents from each other
holder of such options.
Stockholders of the Company are entitled to appraisal rights under Section
262 of the Delaware General Corporation Law ("Section 262"). See "PROPOSAL
ONE--THE MERGER--Appraisal Rights."
On May 7, 1997, the last full trading day prior to the announcement of the
execution of the Original Merger Agreement, the closing sales price per share
of Class A Common Stock as reported on the National Association of Securities
Dealers Automated Quotation ("NASDAQ") National Market System was $26.94. The
highest sales price per share on such date was $27.00 and the lowest sales
price per share on such date was $26.13. On October 17, 1997, the last full
trading day prior to the announcement of the execution of Amendment No. 1, the
closing sales price per share of Class A Common Stock as reported on the
NASDAQ National Market System was $25.63. The highest sales price per share on
such date was $25.63 and the lowest sales price per share on such date was
$25.50. STOCKHOLDERS ARE URGED TO OBTAIN CURRENT QUOTATIONS FOR THE CLASS A
COMMON STOCK.
A composite copy of the Merger Agreement is attached to this Proxy Statement
as Appendix A. See "PROPOSAL ONE--THE MERGER--The Merger Agreement." A copy of
the Voting Trust Agreement is attached to this Proxy Statement as Appendix C.
See "PROPOSAL ONE--THE MERGER--The Voting Trust Agreement."
At the Meeting, stockholders will also be asked to consider and vote upon
(i) a proposal to elect one Class A Director to serve as a director of the
Company until the 2000 Annual Meeting, and (ii) a proposal to elect three
Class B Directors to serve as directors of the Company until the 2000 Annual
Meeting. See "PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS."
THE ABOVE MATTERS AND OTHER MATTERS RELATING TO THE MERGER AND THE ELECTION
OF DIRECTORS ARE DISCUSSED IN MUCH GREATER DETAIL IN THE REMAINDER OF THIS
PROXY STATEMENT. THE PROPOSED MERGER IS A COMPLEX TRANSACTION. STOCKHOLDERS
ARE STRONGLY URGED TO READ AND CONSIDER CAREFULLY THIS PROXY STATEMENT IN ITS
ENTIRETY.
This Proxy Statement is dated December 10, 1997 and is first being mailed to
stockholders along with the related form of proxy on or about December 11,
1997.
AVAILABLE INFORMATION
The Company is subject to the periodic reporting and other information
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission").
Such reports, proxy statements and other information filed by the Company may
be inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and at the Regional Offices at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such material can be obtained
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
2
<PAGE>
Washington, D.C. 20549, at prescribed rates. In addition, the Commission
maintains a Web site that contains reports, proxy and information statements
and other information regarding issuers, such as the Company, that file
electronically with the Commission, at http://www.sec.gov.
Following the Merger, the Company will become a wholly-owned subsidiary of
FHS, and there will be no public trading of shares of Class A Common Stock.
Accordingly, upon application to the Commission following the Merger,
registration of the Class A Common Stock, and the Company's obligation to file
periodic reports, proxy statements and other information with the Commission,
will be terminated.
3
<PAGE>
FORWARD-LOOKING STATEMENTS
Cautionary Statement for Purposes of
Private Securities Litigation Reform Act of 1995
This Proxy Statement, information included in filings by the Company with
the Commission, and information contained in written material, press releases
and oral statements issued by or on behalf of the Company contain, or may
contain, certain "forward-looking statements" including statements concerning
plans, objectives and future events or performance, and other statements which
are other than statements of historical fact. Forward-looking statements also
include the information concerning possible or assumed future results of
operations of the Company and FHS set forth under "PROPOSAL ONE--THE MERGER--
Background of the Merger," "--Reasons for the Merger and Board of Directors'
Recommendation," "--Opinion of the Company's Financial Advisor" and Appendix E
and F and those preceded by, followed by or that include the words "believes,"
"expects," "anticipates" or similar expressions. For those statements, the
Company claims protection of the safe harbor provisions for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995.
It should be understood that the following important factors, in addition to
those discussed elsewhere in this document and in the documents incorporated
by reference, could affect the future results of the Company, and could cause
those results to differ materially from those expressed in such forward-
looking statements. Factors that may cause actual results to differ materially
from those contemplated by such forward-looking statements include, but are
not limited to, the following: (i) business disruption related to the Merger
(both before and after completion); (ii) greater than expected costs or
difficulties related to the integration of management; (iii) litigation costs
and delays; (iv) higher than anticipated costs in completing the Merger; (v)
unanticipated regulatory delays or constraints or changes in the proposed
transaction required by regulatory authorities; (vi) poorer than expected
general economic conditions, including acquisition and growth opportunities,
either nationally or in the states in which the combined company will be doing
business; (vii) legislation or regulatory changes which adversely affect the
business in which the combined company would be engaged; and (viii) other
unanticipated occurrences which may delay or prevent the consummation of the
Merger, increase the costs related to the Merger or decrease the expected
financial benefits of the Merger. Additional information concerning factors
that could cause actual results to differ materially from those contemplated
by forward-looking statements is contained in Appendix E to this Proxy
Statement, which reproduces the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1996, in Item 7 under the caption "Cautionary
Statement."
4
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION..................................................... 2
FORWARD-LOOKING STATEMENTS................................................ 4
SUMMARY................................................................... 6
SELECTED FINANCIAL DATA................................................... 13
CERTAIN INFORMATION REGARDING THE COMPANY................................. 14
THE MEETING............................................................... 15
Meeting Date; Location; Solicitation.................................... 15
Matters Considered...................................................... 15
Voting; Revocation of Proxies........................................... 15
Record Date; Outstanding Securities; Quorum; Votes Required............. 16
PROPOSAL ONE--THE MERGER.................................................. 17
General................................................................. 17
Background of the Merger................................................ 18
Reasons for the Merger and Board of Directors' Recommendation........... 25
Opinion of the Company's Financial Advisor.............................. 30
The Guardian Condition.................................................. 34
Conflicts of Interest and Interests of Certain Persons in the Merger.... 34
Certain Tax Consequences to Stockholders................................ 35
The Merger Agreement.................................................... 36
The Voting Trust Agreement.............................................. 46
Amendment to GBIPA Service Agreement.................................... 47
The Medical Management Agreement........................................ 48
Accounting Treatment.................................................... 48
Regulatory Matters...................................................... 48
Price Range of Class A Common Stock; Dividends.......................... 49
Appraisal Rights........................................................ 50
Certain Effects of the Merger........................................... 52
Security Ownership of Certain Beneficial Owners and Executive Officers
and Directors.......................................................... 52
PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS............................ 55
Proposal Two--Election of Class A Director.............................. 55
Proposal Three--Election of Class B Directors........................... 55
Directors and Nominees.................................................. 57
Non-Director Executive Officers......................................... 59
Committees of the Board of Directors.................................... 59
Section 16(a) Beneficial Ownership Reporting Compliance................. 60
Summary Compensation Table.............................................. 60
Compensation Pursuant to Plans.......................................... 62
Director Compensation................................................... 64
Compensation Committee Report on Executive Compensation................. 64
Performance Graph....................................................... 68
INDEPENDENT PUBLIC ACCOUNTANTS.......................................... 69
STOCKHOLDER PROPOSALS................................................... 69
MISCELLANEOUS........................................................... 69
</TABLE>
Appendices
Appendix A--Composite Agreement and Plan of Merger
Appendix B--Fairness Opinion of Morgan Stanley & Co. Incorporated
Appendix C--Voting Trust Agreement
Appendix D--Section 262 of the Delaware General Corporation Law
Appendix E--Parts I, II and IV of the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1996, as amended by Amendment No.
1 thereto, filed April 30, 1997 and Amendment No. 2 thereto, filed
July 25, 1997.
Appendix F--Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 1997.
5
<PAGE>
SUMMARY
The following summary is intended to highlight certain information included
elsewhere in this Proxy Statement. This summary does not purport to be complete
and is qualified in its entirety by the more detailed information contained
elsewhere in this Proxy Statement and the Appendices hereto. Stockholders are
urged to read this Proxy Statement and the Appendices hereto.
The Parties
The Company, which conducts substantially all of its operations through its
subsidiaries, is a full-service health plan serving more than 500,000 members
in Connecticut, New York and New Jersey, through approximately 24,000 providers
and 194 hospitals in the tri-state area. The Company's managed care products
include traditional health maintenance organization products, in both open
access and gatekeeper models, point of service products, administrative
services only plans and Medicare and Medicaid plans. Consolidated revenues for
the Company for the fiscal year ended December 31, 1996 were $488 million. The
principal executive offices of the Company are located at One Far Mill
Crossing, Shelton, Connecticut 06484-0944, and its telephone number is (203)
381-6400.
Merger Sub is a wholly-owned subsidiary of FHS that was formed by FHS in May
1997 for the sole purpose of acquiring the Common Stock of the Company. FHS,
the fourth-largest publicly traded managed health care company in the United
States, is the result of the merger of Foundation Health Corporation and Health
Systems International, Inc. on April 1, 1997. Through its subsidiaries, FHS
offers group, Medicaid, individual and Medicare health maintenance organization
and preferred provider organization plans; government sponsored managed care
plans; and managed care products related to workers' compensation insurance,
administration and cost-containment, behavioral health, dental, vision and
pharmaceutical products and services. Currently, FHS provides health benefits
to nearly five million individuals in 17 states. The principal executive
offices of FHS and Merger Sub are located at 225 North Main, Pueblo, Colorado
81003, telephone number (719) 542-0500, and at 21600 Oxnard Street, Woodland
Hills, California 91367, telephone number (818) 719-6775.
The Meeting; Voting; Vote Required for Approval
The Meeting will be held on December 31, 1997 at 9:00 a.m., local time, at
the Company's principal executive offices. At the Meeting, stockholders will be
asked to consider and vote upon: (i) a proposal to approve and adopt the Merger
Agreement; (ii) a proposal to elect one Class A Director to serve as a director
of the Company for a term ending at the 2000 Annual Meeting; (iii) a proposal
to elect three Class B Directors to serve as directors of the Company for
respective terms ending at the 2000 Annual Meeting; and (iv) such other matters
as may properly come before the Meeting or any adjournment or postponement
thereof. See "THE MEETING-- Matters Considered."
The Company has fixed the close of business on November 13, 1997 as the
record date (the "Record Date") for determining holders of outstanding shares
of Class A Common Stock and Class B Common Stock who are entitled to notice of
and to vote at the Meeting. As of the Record Date, there were 287 stockholders
of record (with 211 stockholders of record of shares of Class A Common Stock
and 76 stockholders of record of shares of Class B Common Stock), 6,163,054
shares of Class A Common Stock issued and outstanding, each of which shares is
entitled to one vote, and 3,185,671 shares of Class B Common Stock issued and
outstanding, each of which shares is entitled to ten votes. The holders of a
majority in voting power of the Company's outstanding shares of Common Stock,
which are present in person or by proxy at the Meeting, will constitute a
quorum. The approval and adoption of the Merger Agreement requires the
affirmative vote of the holders of a majority of the voting power of the
Company's outstanding shares of Common Stock, voting together as a single
class. The Class A Director will be elected by a plurality of the shares of
Class A Common Stock present and voting (in
6
<PAGE>
other words, the individual receiving the largest number of votes of shares of
Class A Common Stock will be elected as the Class A Director). The three Class
B Directors will be elected by a plurality of the shares of Class A and Class B
Common Stock, voting together as a single class (in other words, the three
individuals receiving the largest number of votes of shares of Class A and
Class B Common Stock will be elected as the Class B Directors). See "THE
MEETING--Record Date; Outstanding Securities; Quorum; Votes Required."
Only record holders or their duly authorized proxies will be entitled to cast
ballots at the Meeting. Proxy holders who wish to vote by ballot at the Meeting
must provide the Secretary of the Company with evidence of their authority to
act at least 30 minutes prior to the commencement of the Meeting. See "THE
MEETING--Voting; Revocation of Proxies."
The Merger
Pursuant to and subject to the terms and conditions set forth in the Merger
Agreement and in accordance with applicable provisions of the Delaware General
Corporation Law, upon the effectiveness of the Merger the Company will become a
wholly-owned subsidiary of FHS and each outstanding share of Common Stock
(other than shares of Common Stock owned by FHS or Merger Sub or by any direct
or indirect subsidiary of FHS or Merger Sub or which are held in the treasury
of the Company or by any of its subsidiaries, all of which will be cancelled,
or which are held by dissenting stockholders) will be cancelled and converted
into the right to receive $28.25 per share in cash, without interest; provided
that, if certain waivers and consents are obtained from The Guardian prior to
the Effective Time, then each such share will be cancelled and converted into
the right to receive $29.25 in cash, without interest. See "PROPOSAL ONE--THE
MERGER--The Guardian Condition."
Voting Trust Agreement
In connection with the execution of the Original Merger Agreement, GBIPA, the
Company and American Stock Transfer & Trust Company, as Voting Trustee, entered
into the Voting Trust Agreement attached as Appendix C to this Proxy Statement.
Pursuant to the Voting Trust Agreement, among other things, GBIPA has
transferred 2,401,021 shares of the Company's Class B Common Stock
(representing approximately 63.2% of the combined voting power of the Company's
outstanding Class A Common Stock and Class B Common Stock) to the Voting
Trustee, and the Voting Trustee has agreed to vote all of such shares in favor
of the approval and adoption of the Merger Agreement, which vote will assure
that the Merger Agreement will be approved and adopted by the Company's
stockholders. See "PROPOSAL ONE--THE MERGER--The Voting Trust Agreement." GBIPA
has consented to Amendment No. 1.
Background of the Merger; Reasons for the Merger and Board of Directors'
Recommendation
After a comprehensive reexamination of the Company's five year strategic plan
and a careful exploration of the Company's strategic alternatives (see
"PROPOSAL ONE--THE MERGER--Background of the Merger"), the Board of Directors
of the Company has determined that the Merger, the Merger Agreement, the Voting
Trust Agreement and the transactions contemplated thereby are in the best
interests of the Company and its stockholders and has, by the unanimous vote of
all directors, recommended that the stockholders of the Company vote "FOR" the
approval and adoption of the Merger Agreement at the Meeting. In reaching its
decision to approve the Merger Agreement and the Voting Trust Agreement, as
well as the transactions contemplated thereby, and to recommend that the
Company's stockholders approve and adopt the Merger Agreement, the Board of
Directors considered a number of factors, including the opinion of Morgan
Stanley & Co. Incorporated ("Morgan Stanley") that the Merger Consideration was
fair to the stockholders of the Company from a financial point of view. See
"PROPOSAL ONE--THE MERGER--Reasons for the Merger and Board of Directors'
Recommendation."
7
<PAGE>
Opinion of the Company's Financial Advisor
Morgan Stanley has delivered its written opinion to the Board of Directors of
the Company, dated October 19, 1997, which opinion has been confirmed in
writing as of December 10, 1997, to the effect that, on the date of such
opinion, and based on assumptions made, procedures followed, matters considered
and limitations on the review undertaken, as set forth in the opinion, the
Merger Consideration pursuant to the Merger Agreement was fair from a financial
point of view to the holders of the Common Stock. See "PROPOSAL ONE--THE
MERGER--Opinion of the Company's Financial Advisor." Morgan Stanley's written
opinion dated December 10, 1997 is attached as Appendix B to this Proxy
Statement. The Company's stockholders are urged to, and should, read the Morgan
Stanley opinion carefully and in its entirety.
Conflicts of Interest and Interests of Certain Persons in the Merger
In considering the recommendation of the Board of Directors that the
stockholders of the Company approve and adopt the Merger Agreement,
stockholders of the Company should be aware that certain officers and directors
of the Company have certain interests in the Merger that are different from, or
in addition to, the interests of the stockholders of the Company. In
particular, stockholders should be aware that Robert L. Natt, the President and
Co-Chief Executive Officer of the Company, who participated extensively in the
negotiations with FHS with respect to the terms and conditions of the Merger
Agreement, and Paul M. Philpott, Senior Vice President and Chief Marketing
Officer of the Company, will be entering into new employment agreements with
FHS and will, in addition, receive additional compensation in the form of
signing and retention bonuses by reason of the consummation of the Merger.
Under Mr. Natt's new employment agreement, he will serve as chief executive
officer of FHS' Greater New York City operations, reporting directly to the
President of FHS, and will receive an annual salary of $320,000. Mr. Natt will
also receive a $46,500 signing bonus and will participate in FHS' bonus plan
and stock-based incentive programs. Mr. Natt will receive a special 150,000
share option grant in respect of the initial term of the agreement and will
receive a $500,000 retention bonus, payable in equal installments, on the first
and second anniversaries of the Effective Time. Under Mr. Philpott's new
employment agreement, he will receive an annual salary of $250,000. Mr.
Philpott will receive a $350,000 retention bonus payable in equal installments
on the first and second anniversaries of the Effective Time. Mr. Philpott will
participate in FHS' bonus plan and stock-based incentive programs. Mr. Philpott
will receive a special 50,000 share option grant in respect of the initial term
of the agreement. FHS has agreed to recommend to the Compensation and Stock
Option Committee (the "FHS Committee") of FHS' Board of Directors that the
special option grants to Messrs. Natt and Philpott be on terms (with respect to
the exercise price, term and exercisability) that are identical to similar
special grants which may be made by FHS in 1997. FHS has agreed to recommend to
the FHS Committee that the special options granted to Messrs. Natt and Philpott
will become immediately exercisable if such executive's employment is
involuntarily terminated by FHS without "cause" or if such executive terminates
employment for "good reason." It is currently anticipated that the special
option grants to Messrs. Natt and Philpott will be made under FHS's stock
option plan, pursuant to which the exercise price of options may not be less
than 100% of the fair market value of the shares subject to such options on the
date of grant. Similarly, James L. Elrod, Jr., Executive Vice President and
Chief Financial Officer of the Company, and Regina M. Campbell, Senior Vice
President and Chief Administrative Officer of the Company, who also
participated in the negotiations with FHS, will receive compensation in
connection with the termination of their employment contracts with the Company.
In satisfaction of their existing employment agreements and conditional
employment agreements with the Company, Mr. Elrod and Ms. Campbell will receive
a net cash payment, which after payment of all applicable taxes will be
$1,500,000 and $1,250,000, respectively, and lifetime medical benefits. The
foregoing amounts include the after tax amount of the value of any stock
options held by Mr. Elrod and Ms. Campbell, respectively, that will vest as a
result of the Merger. See "PROPOSAL ONE--THE MERGER--The Merger Agreement--
Benefit Plans and Employment Arrangements." Stockholders of the Company should
also be aware that Michael E. Herbert, Co-Chief Executive Officer and a
director of the Company, who voted in favor of the Merger, will be entitled to
be employed by the Company following the consummation of the Merger pursuant to
his employment agreements with the Company. Moreover, Employee
8
<PAGE>
Options (including those granted to Messrs. Natt, Philpott and Herbert) which
have been granted but have not yet vested will become immediately vested upon,
and will be cashed out in connection with, the consummation of the Merger.
Under the terms of the Merger Agreement, Messrs. Natt, Philpott and Herbert
will receive amounts of $1,138,875, $305,617, and $799,460, respectively, in
respect of all Employee Options granted to them. See "PROPOSAL ONE--THE
MERGER--The Merger Agreement--Employee Options." In addition, Mr. Natt has
discussed with FHS the possibility that FHS might employ Dr. David I. Grayer,
Chairman of the Board of Directors, who voted in favor of the Merger and who
also participated in the negotiations with FHS, as a provider and marketing
consultant to FHS. In this connection, it has been suggested that Dr. Grayer
might be paid a consultant fee of up to $10,000 per month for 35 months;
however, neither FHS nor Dr. Grayer has any obligation to agree to such a
consulting arrangement. In addition, following the execution of the Original
Merger Agreement, the Compensation Committee of the Board of Directors of the
Company agreed to pay Dr. Grayer $25,000 upon consummation of the Merger in
consideration for his services to the Company in connection with the Merger and
the transactions contemplated thereby. See "PROPOSALS TWO AND THREE--ELECTION
OF DIRECTORS--Summary Compensation Table." See "PROPOSAL ONE--THE MERGER--
Conflicts of Interest and Interests of Certain Persons in the Merger."
In addition, stockholders of the Company should also be aware that FHS, the
Company, Physicians Health Services of Connecticut, Inc. and GBIPA entered into
an agreement (the "GBIPA Agreement"), prior to GBIPA's execution of the Voting
Trust Agreement, which specifies that, upon consummation of the Merger, (a) the
service agreement between GBIPA and PHS/CT will be amended so as to (i) extend
its term for one year, to December 31, 1998, and (ii) adopt utilization
management, quality assurance and credentialing standards as well as capitation
rates, fees schedules and other economic terms and conditions that are
equivalent to those presently in effect under the Provider Agreement between
M.D. Health Plan, a subsidiary of FHS, and the Connecticut State Medical
Society-IPA, Inc., and (b) the Company will pay GBIPA $6,500,000 in
consideration for such amendment. See "PROPOSAL ONE--THE MERGER--Amendment to
GBIPA Service Agreement."
Certain Tax Consequences to Stockholders
The receipt of cash in exchange for Common Stock pursuant to the Merger will
be a taxable transaction for federal income tax purposes and may also be a
taxable transaction under applicable state, local and foreign tax laws. A
stockholder will generally recognize gain or loss for federal income tax
purposes in an amount equal to the difference between such stockholder's
adjusted tax basis in such stockholder's Common Stock and the Merger
Consideration received by such stockholder. Such gain or loss will be a capital
gain or loss if such Common Stock is held as a capital asset and will be long-
term capital gain or loss if, at the effectiveness of the Merger, such Common
Stock has been held for more than one year. EACH STOCKHOLDER IS URGED TO
CONSULT HIS, HER OR ITS TAX ADVISOR WITH RESPECT TO THE TAX CONSEQUENCES OF THE
MERGER, INCLUDING THE EFFECTS OF APPLICABLE STATE, LOCAL OR OTHER TAX LAWS. See
"PROPOSAL ONE--THE MERGER--Certain Tax Consequences to Stockholders."
Employee Options
Pursuant to the Merger Agreement, as of the effectiveness of the Merger, each
Employee Option issued, awarded or granted pursuant to the Company's 1992 Stock
Option Plan or the Company's 1995 Stock Option Plan to purchase shares of
Common Stock will be cancelled by the Company, subject to obtaining the prior
consent of the holders of Employee Options, and each holder of a cancelled
Employee Option will be entitled to receive from the Company (or, at FHS'
option, any subsidiary of the Company) in consideration for the cancellation of
such Employee Option an amount in cash (less applicable withholding taxes)
equal to the product of (i) the number of shares of Common Stock previously
subject to such Employee Option and (ii) the excess, if any, of the Merger
Consideration over the exercise price per share of Common Stock previously
subject to such Employee Option. The Company is required to deliver the consent
of its officers and directors to such cancellation and cash-out at or prior to
the effective time of the Merger and to use its reasonable best efforts to
obtain similar consents from each holder of such options. See "PROPOSAL ONE--
THE MERGER--The Merger Agreement--Employee Options."
9
<PAGE>
Conditions to the Merger
The consummation of the Merger is subject to a number of conditions,
including, but not limited to, the following:
(a) the approval and adoption of the Merger Agreement by the requisite
vote of the stockholders of the Company;
(b) there shall have been no law enacted or injunction entered which
prohibits the Merger or which imposes material conditions with respect
thereto; and
(c) the approval of certain governmental authorities and the expiration
or termination of the waiting period (and any extension thereof) applicable
to the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended (the "HSR Act").
See "PROPOSAL ONE--THE MERGER--The Merger Agreement--Conditions to
Obligations of FHS and Merger Sub," "--Conditions to Obligations of the
Company" and "--Conditions to Obligations of Each Party."
Termination of Merger Agreement
The Merger Agreement may be terminated at any time prior to the effectiveness
of the Merger whether before or after the approval by the stockholders of the
Company by mutual written consent of FHS and the Company, or by either FHS or
the Company if any of the following occurs:
(a) the Merger is not consummated by March 31, 1998;
(b) any governmental entity whose approval is required in order to
consummate the Merger determines not to grant such approval and all appeals
have been taken and have been unsuccessful;
(c) a court permanently prohibits the Merger;
(d) the requisite approval of the Company's stockholders is not obtained
at the Meeting; or
(e) provided that the terminating party is not then in material breach of
the Merger Agreement, the other party breaches any of its representations
or warranties set forth in the Merger Agreement or fails to comply with any
of its covenants or agreements under the Merger Agreement, which breach or
failure has not been cured within 15 business days following receipt by the
breaching party of written notice of such breach and such breach or failure
would give rise to the failure of certain conditions set forth in the
Merger Agreement.
In addition, subject to certain requirements regarding notice to FHS, the
Company has the right to terminate the Merger Agreement if the Board of
Directors of the Company has failed to recommend or has withdrawn, modified or
changed in a manner adverse to FHS its approval or recommendation of the Merger
Agreement in order to permit the Company to execute a definitive agreement
providing for the transaction or transactions contemplated by a proposal that
the Board of Directors of the Company determines in good faith (based on the
advice of a financial advisor of nationally recognized reputation) is more
favorable and provides greater value to all the Company's stockholders than the
Merger Agreement and the Merger.
FHS also has the right to terminate the Merger Agreement if the Board of
Directors of the Company has failed to recommend or has withdrawn, modified or
changed in a manner adverse to the Company or FHS its
10
<PAGE>
approval or recommendation of the Merger Agreement or has recommended or
entered into a definitive agreement providing for the merger of the Company
with another entity or the acquisition of the Company by another entity, or if,
subject to certain notice provisions, FHS has been notified by the Company that
it has received a proposal from another entity regarding the merger with or
acquisition of the Company.
See "PROPOSAL ONE--THE MERGER--The Merger Agreement--Termination."
Termination Fees
The Company has agreed to pay FHS a termination fee of $9 million plus up to
an aggregate of $2.5 million in costs and expenses in the event of a
termination of the Merger Agreement under certain circumstances. See "PROPOSAL
ONE--THE MERGER--The Merger Agreement--Termination Fees."
Regulatory Matters
Under the HSR Act, and the rules promulgated thereunder by the Federal Trade
Commission (the "FTC"), the Merger may not be consummated until notifications
have been given and certain information has been furnished to the FTC and the
Antitrust Division of the Department of Justice and specified waiting period
requirements have been satisfied. The Company and FHS filed their respective
notification and report forms under the HSR Act on May 27, 1997, and jointly
requested early termination of the waiting period, which request was granted
effective June 4, 1997.
The Merger is also subject to review and approval by the Commissioner of the
Connecticut Department of Insurance, the Superintendent of the Insurance
Department of the State of New York, the Commissioner of Health of the State of
New York, the New Jersey Department of Health and Senior Services, the New
Jersey Department of Banking and Insurance and the Bermuda Monetary Authority.
Applications for such approvals have been filed.
See "PROPOSAL ONE--THE MERGER--Regulatory Matters."
Price Range of Class A Common Stock
The Company's Class A Common Stock is traded in the over-the-counter market
on the NASDAQ National Market System under the symbol "PHSV." There is no
market for the Company's Class B Common Stock. During the period between
January 1, 1995, and December 9, 1997, the highest sales price per share was
$43.25 and the lowest sales price per share was $14.00. On May 7, 1997, the
last full trading day prior to the announcement of the execution of the
Original Merger Agreement, the closing sales price per share of Class A Common
Stock as reported on the NASDAQ National Market System was $26.94. The highest
sales price per share on such date was $27.00, and the lowest sales price per
share on such date was $26.13. On October 17, 1997, the last full trading day
prior to the announcement of the execution of Amendment No. 1, the closing
sales price per share of Class A Common Stock as reported on the NASDAQ
National Market System was $25.63. The highest sales price per share on such
date was $25.63 and the lowest sales price per share on such date was $25.50.
STOCKHOLDERS ARE URGED TO OBTAIN CURRENT QUOTATIONS FOR THE CLASS A COMMON
STOCK. See "PROPOSAL ONE--THE MERGER--Price Range of Class A Common Stock;
Dividends."
Appraisal Rights
Stockholders of the Company are entitled to appraisal rights under Section
262. The full text of Section 262 is reprinted in its entirety as Appendix D to
this Proxy Statement.
Under Section 262, stockholders who follow the procedures set forth in
Section 262 and who have not voted in favor of the Merger will be entitled to
have their shares of Common Stock appraised by the Court of Chancery of the
State of Delaware and to receive, instead of the Merger Consideration, an
amount determined by such court to be the "fair value" of their shares of
Common Stock, exclusive of any element of value arising from
11
<PAGE>
the accomplishment or expectation of the Merger, together with a fair rate of
interest. This right is known as an "appraisal right." If a stockholder wishes
to exercise his or her appraisal right he or she must not vote in favor of the
Merger and must meet certain other conditions. These conditions are set out in
full in Appendix D. Delaware law requires that the Company notify stockholders
not less than 20 days prior to the Meeting that they have a right of appraisal
and provide stockholders with a copy of Section 262. This Proxy Statement
constitutes that notice. If a stockholder does not follow the procedures set
out below and in Appendix D, he or she will lose his or her appraisal right.
See "PROPOSAL ONE--THE MERGER--Appraisal Rights."
Certain Effects of the Merger
If the Merger is consummated, holders of shares of Common Stock will not have
an opportunity to continue their common equity interest in the Company as an
ongoing operation and therefore will not have the opportunity to share in its
future earnings and potential growth, if any. If the Merger is consummated, the
Company plans to take all necessary actions (i) to de-register shares of Class
A Common Stock under the Exchange Act and (ii) to terminate inclusion of the
shares of Class A Common Stock in the NASDAQ National Market System. See
"PROPOSAL ONE--THE MERGER--Certain Effects of the Merger."
Election of Directors
The Company's Nominations and Bylaws Revision Committee has nominated Robert
L. Natt to serve as a Class A Director and has nominated David I. Grayer, M.D.,
Edward Sawicki, M.D. and Bernard Sherlip, M.D. to serve as Class B Directors
for respective terms of three years and until the election and qualification of
each person's respective successor. The Board of Directors has unanimously
recommended that stockholders vote "FOR" the proposals to elect the Company's
nominees as Class A and Class B Directors. Pursuant to the Company's Amended
and Restated Certificate of Incorporation, unless waived by the Board of
Directors, no person not already a director is eligible to be elected a
director unless nominated to the Board of Directors at least 75 days prior to
the corresponding date that had been the record date of the previous year's
annual meeting. See "PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS."
12
<PAGE>
SELECTED FINANCIAL DATA
Set forth below is certain selected consolidated financial information
relating to the Company and its subsidiaries which has been excerpted or
derived from the audited consolidated financial statements contained in the
Company's Annual Reports on Form 10-K for the fiscal years ended December 31,
1996, 1995, 1994 and 1993, as amended (the "Form 10-Ks"), and the unaudited
consolidated financial statements contained in the Company's Quarterly Report
on Form 10-Q for the fiscal quarter ended September 30, 1997 (the "Form
10-Q"). More comprehensive financial information is included in the Form 10-
Ks, the Form 10-Q and other documents filed by the Company with the
Commission. The financial information that follows is qualified in its
entirety by reference to such reports and other documents, including the
financial statements and related notes contained therein. Such reports and
other documents may be examined and copies may be obtained from the offices of
the Commission in the manner set forth above under "Available Information."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ ------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
REVENUES:
Premiums................. $488,714 $353,442 $481,534 $342,975 $289,784 $274,795 $265,436
Investment and other in- 5,872 4,806 6,574 6,968 4,160 5,435 3,459
come.................... -------- -------- -------- -------- -------- -------- --------
Total revenues.......... 494,586 358,248 488,108 349,943 293,944 280,230 268,895
-------- -------- -------- -------- -------- -------- --------
Health care expenses:
<CAPTION>
Hospital services........ 172,299 130,435 178,059 111,947 94,934 105,592 107,638
<S> <C> <C> <C> <C> <C> <C> <C>
Physicians and related
health care services.... 195,461 143,284 198,591 131,019 117,393 110,599 106,617
Other health care servic-
es...................... 49,301 30,486 42,382 18,707 12,943 9,741 9,724
Indemnity costs.......... -- 7,008 7,008 2,157 -- -- --
-------- -------- -------- -------- -------- -------- --------
Total health care ex- 417,061 311,213 426,040 263,830 225,270 225,932 223,979
penses................. -------- -------- -------- -------- -------- -------- --------
<CAPTION>
Selling, general and
administrative............ 72,126 62,934 85,919 60,802 44,089 33,730 28,590
<S> <C> <C> <C> <C> <C> <C> <C>
Proxy defense costs....... -- -- -- 892 -- -- --
Interest.................. -- 295 388 -- -- 378 875
-------- -------- -------- -------- -------- -------- --------
Total expenses.......... 489,187 374,442 512,347 325,524 269,359 260,040 253,444
-------- -------- -------- -------- -------- -------- --------
<CAPTION>
Income (loss) before
income taxes.............. 5,399 (16,194) (24,239) 24,419 24,585 20,190 15,451
<S> <C> <C> <C> <C> <C> <C> <C>
Income tax expense (bene- 1,997 (7,519) (11,275) 8,449 10,451 8,299 6,890
fit)..................... -------- -------- -------- -------- -------- -------- --------
Net income (loss)......... $ 3,402 $ (8,675) $(12,964) $ 15,970 $ 14,134 $ 11,891 $ 8,561
======== ======== ======== ======== ======== ======== ========
Net income (loss) per Com-
mon Share................ $ 0.36 $ (0.93) $ (1.39) $ 1.70 $ 1.52 $ 1.31 $ 1.36
Weighted average shares
outstanding (000's)...... 9,482 9,298 9,301 9,403 9,307 9,101 6,283
BALANCE SHEET DATA (1):
Working Capital.......... $ 14,975 $ 26,449 $ 16,744 $ 62,585 $ 64,037 $ 58,714 $ 13,091
Total Assets............. 291,176 235,597 238,310 211,068 207,148 171,456 120,031
Total long term debt..... -- -- -- -- -- -- 5,000
Stockholders' equity..... 100,469 100,314 96,286 108,881 91,206 77,968 25,586
OPERATING STATISTICS:
Enrollment (1)........... 496,502 355,402 400,021 267,116 179,550 158,984 136,832
Enrollment (monthly aver-
age).................... 459,864 331,668 342,576 219,475 173,523 153,251 135,506
Hospital days per thou-
sand (2)................ 259 277 272 281 327 360 403
Medical loss ratio (3)... 86.2% 89.4% 89.8% 78.2% 79.0% 82.9% 84.4%
</TABLE>
- --------
(1) At end of period.
(2) On an annualized basis for commercial products only.
(3) Health care expenses as a percentage of premium revenues excluding self-
funded product revenues.
13
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
Selected unaudited data reflecting the Company's results of operations for
each of the last 11 fiscal quarters are shown in the following table. This
information is taken from the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997, and the Company's Quarterly Reports on
Form 10-Q for the quarters ended March 31, 1997, June 30, 1997, and September
30, 1997. The operating results for the first three quarters of 1997 are not
necessarily indicative of results that may be expected for the entire year
ending December 31, 1997.
<TABLE>
<CAPTION>
1995
-------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(DOLLARS IN MILLIONS EXCEPT PER
SHARE DATA)
<S> <C> <C> <C> <C>
Premium revenues................................ $ 79.6 $ 78.7 $ 85.7 $ 99.0
Total health care expenses...................... 62.5 60.8 63.7 76.8
Selling, general and administrative............. 12.6 14.0 15.4 18.8
Net income...................................... 3.1 3.7 5.2 4.0
Net income per share............................ $ 0.33 $ 0.39 $ 0.55 $ 0.42
Enrollment at end of period (000's)............. 197.3 203.1 240.5 267.1
</TABLE>
<TABLE>
<CAPTION>
1996
---------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(DOLLARS IN MILLIONS EXCEPT PER
SHARE DATA)
<S> <C> <C> <C> <C>
Premium revenues............................. $111.8 $118.4 $123.2 $128.1
Total health care expenses................... 92.9 108.9 109.6 114.6
Selling, general and administrative.......... 19.4 20.0 23.4 23.2
Net income................................... 0.9 (5.0) (4.5) (4.4)
Net income per share......................... $ 0.09 $(0.54) $(0.49) $(0.46)
Enrollment at end of period (000's).......... 320.7 346.9 355.4 400.0
</TABLE>
<TABLE>
<CAPTION>
1997
-----------------------
FIRST SECOND THIRD
QUARTER QUARTER QUARTER
------- ------- -------
(DOLLARS IN MILLIONS
EXCEPT
PER SHARE DATA)
<S> <C> <C> <C> <C>
Premium revenues................................... $149.2 $162.2 $177.3
Total health care expenses......................... 127.2 137.8 152.1
Selling, general and administrative................ 22.9 24.9 24.8
Net income......................................... 0.6 1.1 1.6
Net income per share............................... $ 0.07 $ 0.12 $ 0.17
Enrollment at end of period (000's)................ 441.3 468.4 496.5
</TABLE>
CERTAIN INFORMATION REGARDING THE COMPANY
Information regarding the Company's (i) business, (ii) properties, (iii)
legal proceedings, (iv) financial statements for the two fiscal years ended
December 31, 1996, and the nine months ended September 30, 1997, and (iv)
management's discussion and analysis of such financial statements, are
contained in Appendix E to this Proxy Statement, which reproduces Parts I, II
and IV of the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997, and in Appendix F to this Proxy Statement, which reproduces
the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 1997. The full Annual Report on Form 10-K is also included in
the Company's Annual Report to Stockholders for the fiscal year ended December
31, 1996, which accompanies this Proxy Statement.
14
<PAGE>
THE MEETING
MEETING DATE; LOCATION; SOLICITATION
Each copy of this Proxy Statement mailed to a holder of Common Stock is
accompanied by a form of proxy solicited by the Board of Directors of the
Company for use at the Meeting. The Meeting will be held at the Company's
principal executive offices at One Far Mill Crossing, Shelton, Connecticut
06484-0944, on December 31, 1997, at 9:00 a.m. local time. All expenses
associated with soliciting proxies will be borne by the Company.
MATTERS CONSIDERED
At the Meeting, stockholders will consider and vote upon the following
matters:
1. A proposal to approve and adopt the Merger Agreement. See "PROPOSAL
ONE--THE MERGER."
2. A proposal to elect one Class A Director to serve as a director of the
Company for a term ending at the 2000 Annual Meeting. See "PROPOSALS TWO
AND THREE--ELECTION OF DIRECTORS."
3. A proposal to elect three Class B Directors to serve as directors of the
Company for respective terms ending at the 2000 Annual Meeting. See
"PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS."
4. Such other matters as may properly come before the meeting or any
adjournment or postponement thereof.
The Board of Directors has carefully considered the terms of the proposed
Merger and believes that the Merger, the Merger Agreement and the transactions
contemplated thereby are fair to and in the best interests of the Company and
its stockholders. THE BOARD, BY THE UNANIMOUS VOTE OF ALL DIRECTORS,
RECOMMENDS THAT THE STOCKHOLDERS OF THE COMPANY VOTE "FOR" THE APPROVAL AND
ADOPTION OF THE MERGER AGREEMENT. IN ADDITION, THE BOARD OF DIRECTORS
UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF THE COMPANY VOTE "FOR" THE
ELECTION OF ALL OF THE COMPANY'S NOMINEES FOR CLASS A AND CLASS B DIRECTORS AT
THE MEETING. See "PROPOSAL ONE--THE MERGER--Reasons for the Merger and Board
of Directors' Recommendation" and "PROPOSALS TWO AND THREE--ELECTION OF
DIRECTORS."
VOTING; REVOCATION OF PROXIES
Voting by those present at the Meeting will be by ballot. Only record
holders or their duly authorized proxies will be entitled to cast ballots at
the Meeting. Proxy holders who wish to vote by ballot at the Meeting must
provide the Secretary of the Company with evidence of their authority to act
at least 30 minutes prior to the commencement of the Meeting.
If a proxy in the accompanying form is properly executed and submitted to
the Company no later than 30 minutes prior to the commencement of the Meeting
and is not revoked prior to the time it is exercised, the shares represented
by the proxy will be voted in accordance with the directions specified therein
for the matters listed on the proxy card. Unless the proxy specifies that it
is to be voted against or that voting authority is to be withheld on a
proposal, proxies will be voted FOR approval of Proposal One regarding the
approval and adoption of the Merger Agreement and FOR Proposals Two and Three
regarding the election of the Company's nominees as directors and otherwise in
the discretion of the proxy holders as to any other matter that may come
before the Meeting. See "PROPOSAL ONE--THE MERGER" and "PROPOSALS TWO AND
THREE--ELECTION OF DIRECTORS."
The persons named as proxies may propose and vote for one or more
adjournments or postponements of the Meeting; provided, however, that no proxy
that is voted against the proposal to approve and adopt the Merger Agreement
will be voted in favor of any such adjournment or postponement, and no
adjournment or postponement will be acted on for the purpose of permitting
further solicitations of proxies.
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Any stockholder of the Company who is entitled to vote at the Meeting and
who has given a proxy has the power to revoke such proxy at any time before it
is voted by (i) filing a written revocation with Bernard Sherlip, M.D.,
Secretary of the Company, at Physicians Health Services, Inc., One Far Mill
Crossing, P.O. Box 904, Shelton, Connecticut 06484-0944, (ii) executing a
later-dated proxy relating to the same shares and delivering it to the
Secretary of the Company at the address set forth above no later than 30
minutes prior to the commencement of the Meeting, or (iii) appearing at the
Meeting and voting in person. Attendance at the Meeting will not in and of
itself constitute the revocation of a proxy.
The tellers of the Meeting will canvas the stockholders present at the
Meeting, count their votes and count the votes represented by proxies which
have been submitted to the Secretary of the Company no later than 30 minutes
prior to the commencement of the Meeting. Abstentions and broker non-votes
will be counted for purposes of determining the number of shares represented
at the Meeting, but will be deemed not to have voted on any proposal. Broker
non-votes occur when a broker nominee (which has voted on one or more matters
at the Meeting) does not vote on one or more other matters at the Meeting
because it has not received instructions to so vote from the beneficial owner
of the shares and does not have discretionary authority to vote such shares.
While abstentions and broker non-votes do not affect the election of
directors, since such election is decided by plurality vote, such abstentions
and non-votes are equivalent to a vote against the approval and adoption of
the Merger Agreement.
RECORD DATE; OUTSTANDING SECURITIES; QUORUM; VOTES REQUIRED
The Company has fixed the close of business on November 13, 1997 as the
record date (the "Record Date") for determining holders of outstanding shares
of Class A Common Stock and Class B Common Stock who are entitled to notice of
and to vote at the Meeting. As of the Record Date, there were 287 stockholders
of record (with 211 stockholders of record of shares of Class A Common Stock
and 76 stockholders of record of shares of Class B Common Stock), 6,163,054
shares of Class A Common Stock issued and outstanding, each of which shares is
entitled to one vote, and 3,185,671 shares of Class B Common Stock issued and
outstanding, each of which shares is entitled to ten votes.
The holders of a majority in voting power of the Company's outstanding
shares of Common Stock, which are present in person or by proxy at the
Meeting, will constitute a quorum. The approval and adoption of the Merger
Agreement requires the affirmative vote of the holders of a majority of the
voting power of the Company's outstanding shares of Common Stock, voting
together as a single class. The Class A Director will be elected by a
plurality of the shares of Class A Common Stock present and voting (in other
words, the individual receiving the largest number of votes of shares of Class
A Common Stock will be elected as the Class A Director). The three Class B
Directors will be elected by a plurality of the shares of Class A and Class B
Common Stock, voting together as a single class (in other words, the three
individuals receiving the largest number of votes of shares of Class A and
Class B Common Stock will be elected as the Class B Directors).
The stockholders of the Company have dissenters' appraisal rights in
connection with the proposal to approve and adopt the Merger Agreement. See
"PROPOSAL ONE--THE MERGER--Appraisal Rights." The stockholders of the Company
have no dissenters' appraisal rights in connection with the election of
directors.
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PROPOSAL ONE--THE MERGER
GENERAL
The Board of Directors of the Company has carefully considered and approved
the Merger and the Merger Agreement as being in the best interests of the
Company and its stockholders and has, by the unanimous vote of all directors,
recommended that the stockholders of the Company vote "FOR" the approval and
adoption of the Merger Agreement at the meeting. This section of the Proxy
Statement describes the proposed Merger, the Merger Agreement and certain
other related matters.
Structure
Pursuant to and subject to the terms and conditions of the Merger Agreement,
and in accordance with applicable provisions of the Delaware General
Corporation Law (the "DGCL"), at the Effective Time Merger Sub will merge with
and into the Company, whereupon the separate corporate existence of Merger Sub
will cease and the Company will continue as the surviving corporation in the
Merger (the "Surviving Corporation") and a wholly-owned subsidiary of FHS.
Merger Consideration
At the Effective Time, by virtue of the Merger and without any action on the
part of FHS, Merger Sub, the Company or the holders of any shares of Common
Stock or capital stock of Merger Sub, each share of Common Stock that is
issued and outstanding prior to the Effective Time (as defined below) (other
than shares of Common Stock owned by FHS or Merger Sub or by any direct or
indirect subsidiary of FHS or Merger Sub or which are held in the treasury of
the Company or by any of its subsidiaries, all of which will be cancelled, or
which are held by dissenting stockholders) will be cancelled and converted
into the right to receive $28.25 in cash, without interest thereon (the
"Merger Consideration"); provided that, in the event that certain waivers and
consents are obtained from The Guardian prior to the Effective Time, then each
such share will be cancelled and converted into the right to receive $29.25 in
cash, without interest. See "--The Guardian Condition."
Effective Time
Pursuant to the Merger Agreement, the Merger will be consummated through the
filing of a certificate of merger (the "Certificate of Merger"), in accordance
with the requirements of the DGCL, as promptly as practicable (and in any
event within two business days) after satisfaction or waiver (to the extent
permitted by the Merger Agreement) of all conditions to each party's
obligation to consummate the Merger contained in the Merger Agreement;
provided, however, that if such date occurs prior to January 6, 1998, then, at
the request of FHS, the filing of the Certificate of Merger shall occur on a
business day (no later than January 6, 1998) selected by FHS. The Merger will
be effective at such time as the Certificate of Merger is duly filed with the
Secretary of State of the State of Delaware in accordance with the DGCL or at
such later time agreed to by the parties as specified in the Certificate of
Merger (the "Effective Time"). The date on which the Effective Time will occur
is referred to herein as the "Effective Date."
Parties
The Company. The principal executive offices of the Company are located at
One Far Mill Crossing, Shelton, Connecticut 06484-0944, and its telephone
number is (203) 381-6400. The Company, which conducts substantially all of its
operations through its subsidiaries, is a full-service health plan serving
more than 500,000 members in Connecticut, New York and New Jersey, through
approximately 24,000 providers and 194 hospitals in the tri-state area. The
Company's managed care products include traditional health maintenance
organization ("HMO") products, in both open access and gatekeeper models,
point of service products, administrative services only plans and Medicare and
Medicaid plans. The HMO subsidiaries of the Company contract for medical and
related services with individual practice associations, physician hospital
organizations, physicians, physician groups, hospitals and other health care
providers. The Company arranges for health care coverage for its members for a
fixed monthly payment, generally without regard to the frequency or extent of
health care
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services actually furnished, although small copayments may apply, and members
pay a deductible and coinsurance in connection with the out-of-network
benefits in point of service plans. Consolidated revenues for the Company for
the fiscal year ended December 31, 1996 were $488 million.
FHS and Merger Sub. The principal executive offices of FHS and Merger Sub
are located at 225 North Main, Pueblo, Colorado 81003, telephone number (719)
542-0500, and at 21600 Oxnard Street, Woodland Hills, California 91367,
telephone number (818) 719-6775. Merger Sub is a wholly-owned subsidiary of
FHS that was formed by FHS in May 1997 for the sole purpose of effecting the
Merger. FHS, the fourth-largest publicly traded managed health care company in
the United States, administers the delivery of managed care services. FHS was
formed by the April 1, 1997 merger of Foundation Health Corporation and Health
Systems International, Inc. Through its subsidiaries, FHS offers group,
Medicaid, individual and Medicare health maintenance organization and
preferred provider organization plans; government sponsored managed care
plans; and managed care products related to workers' compensation insurance,
administration and cost-containment, behavioral health, dental, vision and
pharmaceutical products and services. Currently, FHS provides health benefits
to nearly five million individuals in 17 states.
BACKGROUND OF THE MERGER
The managed health care industry has experienced a number of significant
changes during the past several years, including intensified competition,
consolidation of industry participants, expanded governmental regulation, the
implementation of premium reduction programs by employers and increased
resistance by medical service providers to cost reduction efforts of HMOs.
Such changes have tended to favor larger HMOs, since they may be able to
negotiate more favorable contracts with service providers and to reduce costs
through economies of scale. As a consequence, larger HMOs may be in a better
position to offer more attractive premiums to their present and prospective
members.
In light of these changes, the Company adopted a new five year strategic
plan in early 1994 under which the Company would endeavor to increase its
membership substantially and rapidly through an expansion of its Connecticut
operations and through entry into the New York metropolitan area. Shortly
after the new strategic plan was adopted, the Company began to explore the
possibility of some form of marketing alliance with The Guardian. The Guardian
was looking to establish for its client base a more cost effective managed
care alternative to its existing indemnity product. The Company was in a
position to offer such an alternative, and The Guardian's client base,
predominately small group, was in an area in which the Company had not been
strong traditionally. The discussions between the Company and The Guardian led
to the execution in December 1994 of a joint marketing agreement for
Connecticut that called for marketing, through the sales forces of both
companies, of The Guardian's indemnity products and the Company's point of
service and closed panel managed care products under the name HealthCare
Solutions ("HCS"), with the profits to be shared between them.
Shortly thereafter, The Guardian and the Company began to explore an
expansion of the joint marketing arrangements into New York. In connection
with its expansion into the New York metropolitan market, the Company was at
that time building a network of physicians, hospitals and other providers,
seeking regulatory approvals and planning an expensive marketing effort. The
idea of entering metropolitan New York jointly with The Guardian was
attractive, since it would give the Company considerable market strength in
contracting with its New York network providers, would create the possibility
of reducing its current expense burden and would improve the likelihood of
success because of The Guardian's existing client base. In May 1995, the
Company agreed with The Guardian to expand the joint marketing arrangements to
New York, with both profits and losses to be shared between them on a 50-50
basis pursuant to reinsurance agreements.
In the meantime, while the Company was still in the first year of its new
five year strategic plan, GBIPA had notified the Company of its intention to
nominate candidates for election as directors at the Company's May 1995 Annual
Meeting on a platform seeking an exploration of a sale of the Company. At the
Company's May 1995 Annual Meeting, two directors were to be elected by the
holders of Class A Common Stock, and four directors were to be elected by the
holders of Class A and Class B Common Stock, voting together as a single
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class. Because it was the largest owner of shares of Class B Common Stock, and
because the shares of Class B Common Stock have 10 votes per share, the
candidates for the four directorships for which GBIPA could vote were assured
of election. GBIPA could not vote for the two directors to be elected by the
Class A stockholders alone, but commenced soliciting proxies for its nominees
for election as Class A Directors.
Since a number of the members of the Company's Board of Directors were
members of GBIPA, a subcommittee of the Board of Directors was formed to make
recommendations with respect to GBIPA's initiative. The subcommittee, which
was comprised of directors who were not members of GBIPA or representatives of
GBIPA, and the then Chairman of the Board of Directors, Dr. A. Thomas
Licciardello (who was a member of GBIPA), recommended that the Company adopt a
Stockholder Rights Plan, pursuant to which the Company would become obligated
to issue to its stockholders rights to acquire additional equity interests in
the Company at a significant discount in the event that some person or entity,
other than GBIPA, acquired 15% or more of any class of the Company's Common
Stock without the prior approval of the Company's Board of Directors. Based
upon such recommendation, as well as that of the subcommittee's special
counsel, the Board of Directors adopted the Company's Stockholder Rights Plan
on February 21, 1995, in order to protect the ability of the Board of
Directors to act in the interest of all stockholders. The subcommittee also
attempted to arrange a meeting with representatives of GBIPA in order to
ascertain its objectives and rationale, but was initially unsuccessful.
Subsequently, however, in March 1995, the Chairman of the Board, the Vice
Chairman of the Board and the President of GBIPA, together with its financial
advisors, did meet with the Company's Board of Directors. At this meeting
GBIPA and its advisors explained that they wanted the Company to explore a
sale because they believed that the Company did not have the size or the
financial or managerial strength to succeed in its expansion into New York,
that the Company had a "scarcity value," since potential entrants to New York
would pay a premium to acquire the Company and its licenses as a means of
entry, and that such scarcity value would be short-lived since these potential
purchasers would not be interested in an acquisition of the Company once they
had entered New York on their own.
During this period, the Compensation Committee of the Company's Board of
Directors also met to consider the employment terms of the Company's senior
management and the efficacy of the Company's existing change in control
agreements in allaying management's concern over the GBIPA initiative and any
potential changes in control. As a result of this review, the Compensation
Committee approved new conditional employment agreements for Michael E.
Herbert, then President and Chief Executive Officer of the Company; Robert L.
Natt, then Executive Vice President and Chief Operating Officer of the
Company; James L. Elrod, Jr., then Senior Vice President and Chief Financial
Officer of the Company; Regina M. Campbell, Senior Vice President and Chief
Administrative Officer of the Company; and Paul M. Philpott, Senior Vice
President and Chief Marketing Officer of the Company. The new conditional
employment agreements provide that after a change in control of the Company
has occurred the employment of such person shall be continued for three years
from the change in control, with limited ability on the part of the Company to
terminate the employment or alter the nature of the employee's duties. After a
change in control, the compensation of such employee will be converted to a
cash-equivalent basis. If the Company breaches the agreement, the employee is
entitled to damages plus full salary, unused accrued vacation and applicable
bonus through the date of termination, plus a severance amount equal to 2.99
times the highest compensation (including base salary, bonuses, incentive
compensation and other taxable and nontaxable benefits) paid to such person by
the Company with respect to any twelve consecutive month period during the
three years ending with the date of termination, subject to certain
limitations. See "PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS--Summary
Compensation Table."
At the May 1995 Annual Meeting, GBIPA's six candidates were elected. The
holders of the Company's Class A Common Stock voted for GBIPA's candidates
over the Company's nominees by a significant margin.
In light of the change in Board membership and the results of the May 1995
Annual Meeting, the Company's Board of Directors embarked upon a review of the
Company's strategic plan in June of 1995. In addition to a review of revised
projections, the Board of Directors heard presentations by the Company's
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insurance brokerage consultants, by representatives of The Guardian and by an
investment banker not previously associated with either the Company or GBIPA.
During the course of this review, the Board of Directors was advised by
representatives of The Guardian that the exploration of a sale would disrupt
the marketing effort associated with the expansion of the joint marketing
arrangement into New York, just then beginning, and that, in light of the
uncertainty generated by the GBIPA initiative, The Guardian had decided to
pursue a strategic alliance with a different managed care company for New
Jersey. The Board of Directors was also advised by the insurance brokerage
consultant that an exploration of a sale would cause significant damage to the
ability of the Company to market its products, since brokers, including the
consultant's firm, would be disinclined to include the Company's products
among the alternatives recommended to their clients while the Company's future
remained unclear. In addition, a representative of the investment banking firm
advised that exploring a sale was not, in their view, as good a course of
action as exploring some form of recapitalization that would both allow the
Company to pursue its strategic plan and allow GBIPA to have its interests
purchased. At the conclusion of the presentations and discussions, one of
GBIPA's nominees moved to explore a sale of the Company. The motion failed to
carry by a 9 to 9 vote. Following this action, a resolution to confirm the
Company's strategic plan was approved by a 17 to 1 vote, with one abstention.
In the first quarter of 1996, GBIPA suggested to the Nominating and Bylaws
Revision Committee of the Board of Directors (the "Nominating Committee") a
slate of four Class B directors, including three nominees new to the Company.
These nominees met with the Nominating Committee, as a result of which the
Committee nominated six directors, including the four candidates suggested by
GBIPA. This slate was elected at the June 1996 Annual Meeting. At about the
same time, it became clear that the Company's strategic plan was producing
unsatisfactory results. The Company's medical loss ratio had increased to
89.1% in the first six months of 1996 compared to 78.2% in 1995. In addition,
the Company's joint marketing arrangement with The Guardian was generating
substantial losses. As the amount of business written under the joint
marketing arrangement increased, the overall contribution to income of this
business changed from approximately $1.3 million of pretax income in 1995 to
approximately $16.2 million of pretax losses in 1996. As a consequence, in the
summer of 1996, the Company commenced a thorough reexamination of the
Company's strategic plan and its implementation, utilizing the services of a
management consulting firm as well as those of a medical management consulting
firm.
The reexamination of the strategic plan, which continued throughout the
remainder of 1996 and into January 1997, indicated that while the Company's
earlier decision to increase membership substantially and rapidly,
particularly through an expansion into New York, may have been well conceived,
the Company's long term competitive position was nonetheless subject to
substantial risks. In particular, the ability of the Company to increase
premiums over time was limited, especially in New York. Moreover, there was a
significant possibility that the Company would be forced to reduce its
premiums throughout the Tri-State area due to competitive pressures,
particularly in light of the on-going consolidation of the HMO industry. Thus,
the ability of the Company to achieve and maintain profitability while
maintaining growth would depend upon its ability to reduce its selling,
general and administrative costs and to reduce its medical loss ratio. At the
same time, however, it was apparent that it would be difficult to achieve
substantial reductions in overhead expenditures while simultaneously seeking
substantially to expand the Company's membership because of the continuing
need to invest significant amounts in market development. Similarly, while
renegotiations of provider contracts might be possible by reason of the
Company's successful membership growth in New York and Connecticut and might
generate improvement in the Company's medical loss ratio in the short term,
the ability of the Company to achieve and maintain a satisfactory medical loss
ratio in the longer term required a significant augmentation of the Company's
capabilities in medical utilization management. Such augmentation would
include hiring a significant number of new clinical staff, including a number
of additional medical directors, who would have the ability to more closely
monitor medical utilization. In addition, the Company would need to develop
additional information systems applications that would enable it to evaluate
physician and other health care provider practice patterns, identify potential
sources of unnecessary medical spending and identify other cost savings
opportunities.
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While the reexamination of the Company's strategic plan was in progress, the
Board of Directors initiated a number of measures that were designed to
reverse the serious deterioration in the Company's results of operations. One
of those initiatives was the appointment, in August 1997, of Mr. Natt as
President and Co-Chief Executive Officer of the Company with responsibility
for the day-to-day operations of the Company and the assignment to Mr. Natt of
the responsibility for developing a plan for turning around the Company's
financial situation. In this connection, and as part of that turn-around
effort, in November 1996, the Board of Directors authorized a restructuring of
the joint marketing relationship with The Guardian in order to reduce or
eliminate the substantial losses that the Company was concerned that it would
otherwise have continued to suffer in connection with such joint marketing
arrangements. As part of this restructuring, the Company entered into revised
joint marketing agreements with The Guardian pursuant to which 100% of all
premiums and risks related to indemnity insurance sold pursuant to the joint
marketing arrangements and 50% of all other premiums and risks related to the
joint marketing arrangements were ceded to The Guardian. Otherwise, the
revised agreements, which now govern the joint marketing arrangements in
Connecticut, New York and New Jersey, are similar to the agreement that was
executed in 1995 in connection with the expansion of the joint marketing
arrangements to New York. In particular, the revised joint marketing
agreements are terminable by either company in the event of a change in
control, as defined in the joint marketing agreements, of the other.
On January 14, 1997, the Company's Board of Directors authorized a
Subcommittee--comprised of Drs. David Grayer, Lewis Bader and Kenneth Sacks
and Messrs. Richard F. Freeman, Andrew Lozyniak, Robert L. Natt, Arthur H.
Sheer and John C. Washburn--to explore further the Company's strategic
alternatives. Drs. Bader and Sacks and Mr. Freeman had been elected to the
Board of Directors as GBIPA nominees in May 1995, and Messrs. Lozyniak, Sheer
and Washburn had been suggested to the Nominating Committee by GBIPA and
elected in 1996. This Subcommittee met on January 16, 1997, at which time it
directed management to prepare analyses of the potential values that might be
achieved for stockholders through a sale of the Company, through continued
implementation of the Company's strategic plan or through other possible
strategies. Earlier, representatives of FHS had advised the Company in
November 1996, on an unsolicited basis, that FHS might have an interest in
acquiring the Company if it were available for purchase, and Messrs. Natt and
Elrod had met with Jay M. Gellert, President and Chief Operating Officer of
FHS, and B. Curtis Westen, Senior Vice President, General Counsel and
Secretary of FHS, on December 16, 1996, at which time Mr. Natt advised Messrs.
Gellert and Westen that the Company was not then in a position to discuss an
acquisition proposal. On February 23, 1997, while attending an industry
conference in Washington, D.C., Messrs. Natt and Elrod met with Messrs.
Gellert and Westen, who reiterated the interest of FHS in acquiring the
Company. Mr. Natt again advised the representatives of FHS that he was not
authorized to discuss a proposal.
Management presented an analysis of the Company's strategic alternatives to
the members of the Subcommittee on February 25, 1997, at which time particular
attention was focused upon the results that might be obtained, alternatively,
from a continued implementation of the Company's strategic plan, or a
variation thereof, assuming achievement of the then projected turn-around in
the Company's results of operations, and from a possible sale of the Company.
Other alternatives, such as a "merger of equals," were considered, but they
were subject to substantial uncertainties by reason of the Company's recent
poor financial performance and its inability to use the pooling of interests
accounting method, due to the status of the Company as a "subsidiary" of GBIPA
for accounting purposes. After consideration of the alternatives, the
Subcommittee decided to authorize management to explore further the
possibility of a sale. The Subcommittee's decision stemmed from its concern
that the Company's long term viability as an independent company in the New
York metropolitan area was subject to serious risks due to the highly
competitive nature of the managed care industry coupled with the ongoing
consolidation in the industry that was expected to result in larger
competitors. Given the adverse effect on stockholder value that could result
from failure to effectively compete in its service area, the Subcommittee
considered that a sale of the company in the immediate or intermediate term
was likely to be in the stockholders' best interests. The Subcommittee
considered the risks associated with remaining an independent company for the
intermediate term, including the possibility that its forecasted financial
turn around would not be realized, the volatility of the stock market which
could affect the ability to successfully consummate a sale at some future time
and the uncertainties with respect to how long the period of market
consolidation
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would continue in its service area. The premium that the Subcommittee believed
the Company could obtain in connection with a sale during the period of market
consolidation could be jeopardized once the New York metropolitan market
became more stabilized. It was recognized that any such exploration of a sale
would have to be conducted on a discreet basis since a more extensive
exploration process, such as a public sale or auction of the Company, was
likely to expose the Company to substantial business risks. In this
connection, the Subcommittee was advised by management of the Company that if
the Company were to undertake a public sale or auction process, the Company's
competitors could and would be expected to use the process to undermine the
Company's marketing efforts and insurance brokers and consultants would be
reluctant to recommend the Company to current and potential clients in light
of the Company's uncertain future. Moreover, some of the Company's competitors
might profess an interest in acquiring the Company in order to draw out the
exploration process, during which the Company's ability to compete for
business would be impaired. At the same time, the Subcommittee recognized that
unless indications of interest were solicited from at least some potential
acquirors, it would be difficult to assess whether there was any interest in
an acquisition at values that would warrant a departure from the Company's
existing strategic plan. At the conclusion of the meeting, the Subcommittee
authorized management to approach four potential acquirors whom it believed
were the most likely to have the capability and interest to make an
acquisition proposal that would be acceptable to the Company's Board of
Directors. These candidates were selected from the possible acquirors
identified by management, based on management's familiarity with the
consolidation occurring in the industry. Other possible acquirors were judged
unlikely to be able to acquire the Company in the near term because they were
engaged in the process of consolidating other acquisitions into their
operations, because they were pursuing other significant opportunities or
because they did not appear to have the financial resources to acquire the
Company at values that might warrant consideration.
Members of senior management approached the four possible acquirors in late
February and March of 1997 to ascertain whether discussions with any of them
might prove fruitful. Of the four possible acquirors, two indicated that they
did not have any interest in making an acquisition proposal that would involve
the payment of a substantial premium and, in any event, would not consider
pursuing a possible acquisition until the Company's first quarter results had
been published. A meeting with the president of one of these potential
acquirors was eventually scheduled for May 13, 1997. A third potential
acquiror did not express any interest in pursuing a possible acquisition. None
of these approaches led to either ongoing discussions or the prospect of
fruitful discussions. The fourth potential acquiror, FHS, indicated that it
might have such an interest, and, on March 3, 1997, FHS and the Company
entered into a Confidentiality Agreement pursuant to which each company agreed
that it would not make an unsolicited acquisition proposal to the other prior
to December 31, 1997, subject to certain exceptions.
On March 18, 1997, Dr. Grayer and Messrs. Natt and Elrod met with Dr. Malik
M. Hasan, Chairman of the Board and Chief Executive Officer of FHS, and
advised him that the Company would entertain an acquisition proposal from FHS
only if the offering price equaled or exceeded $30 per share. At a subsequent
meeting between Mr. Natt and Mr. Gellert that was held on April 1, 1997, Mr.
Gellert indicated that FHS was prepared to consider an acquisition in the
range of such an offering price, subject to its review of the possible cost
savings that could be generated in a combination of the Company's operations
with its own and its evaluation of the ability of the Company to achieve its
projected financial turn-around.
On April 2, 1997, the Subcommittee authorized management to engage in
further discussions with FHS with a view towards developing a possible
acquisition proposal to be presented to the Company's Board of Directors. The
following day, management retained Morgan Stanley & Co. Incorporated ("Morgan
Stanley") as the Company's financial advisor, subject to approval by the
Company's Board of Directors.
Throughout the month of April and into early May, members of the Company's
management met with members of FHS's management to develop the terms of a
possible acquisition proposal, during which time both companies exchanged
financial and other information with one another, subject to the terms of the
confidentiality agreement. The information shared with FHS included financial
projections prepared by management. These
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projections, which did not give effect to the Merger or the expenses
associated with the Merger, indicated a return to profitability in 1997,
continuing in 1998, and projected earnings per share of $0.51 in 1997,
increasing to $1.15 in 1998. While management believes that the estimates and
assumptions relating to the projections were reasonable when prepared, there
could and can be no assurance that such projections will be realized. The
Company does not as a matter of course make public any projections as to
future performance or earnings and the Company and its financial advisors
assume no responsibility for the accuracy of the projected information. The
Company's independent accountants have not examined or compiled the
projections and, accordingly, do not express an opinion or any other form of
assurance with respect thereto. The projections were based on estimates and
assumptions that are inherently subject to significant economic and
competitive uncertainties, all of which are difficult or impossible to predict
accurately and many of which are beyond the Company's control. The projections
were not prepared with a view to public disclosure or compliance with
published guidelines of the Commission or of the American Institute of
Certified Public Accountants. Reference to the projections is included herein
solely because such information was provided to FHS.
In addition, GBIPA was informed on April 12, 1997 that the Company was
engaged in discussions with FHS, and GBIPA advised the Company that it
intended to negotiate directly with FHS with respect to certain matters
involving GBIPA, including a request that FHS pay certain expenses of GBIPA
arising out of the disposition of GBIPA's interest in the Company, including
the fees of GBIPA's investment bankers, and agree to a two-year extension of
the service agreement between PHS/CT and GBIPA dated January 1, 1997 (the
"Service Agreement").
On May 2, 1997, FHS advised the Company that it would be prepared to offer
to acquire all of the outstanding common stock of the Company, pursuant to a
merger transaction, at a price of $30 per share, subject to certain
conditions, with such price dependent upon the resolution of certain
outstanding issues. These issues included reaching mutually satisfactory
agreements with GBIPA concerning a proposed Voting Trust Agreement and the
Service Agreement. They also included reaching mutually satisfactory
agreements with certain executives of the Company relating to proposed
employment arrangements and the completion of further investigation of the
termination obligations existing with respect to certain other executives of
the Company. This offer was subject also to the approval of FHS's Board of
Directors. The following day, the Subcommittee determined to recommend that
the Board of Directors of the Company approve such a proposed merger between
the Company and Merger Sub, subject to satisfactory resolution of various
issues, including the reported requirement of FHS that one of the conditions
to a closing of the merger would be the obtaining of certain waivers and
consents by The Guardian. Immediately thereafter, the Subcommittee met with
the Executive Committee of the GBIPA Board of Directors. Dr. Grayer met with
Mr. Gellert on Sunday, May 4, 1997, to discuss further the proposed terms of a
merger, including the severance arrangements for two senior executives, Mr.
Elrod and Ms. Campbell.
An industry publication dated May 5, 1997, reported that FHS had made an
informal offer to purchase the Company for about $27.00 per share but that a
committee of the Company's Board of Directors wanted at least $30 per share. A
reporter from The Wall Street Journal advised the Company and FHS on Monday,
May 5, 1997, that he had obtained a copy of FHS's merger proposal and intended
to publish a story with respect to the proposed merger on May 6. Accordingly,
FHS and the Company issued a joint press release announcing that they were
engaged in merger discussions, involving a merger consideration of
"approximately but not more than $30 per share." During this period,
representatives of the Company and FHS continued to negotiate the terms of the
documentation relating to the proposed transaction.
On May 7, 1997, the Board of Directors of the Company held a special meeting
to consider FHS's merger proposal. At that time, it was reported that
preliminary agreements had been reached between FHS and GBIPA to extend the
Service Agreement between the Company and GBIPA (see "--Conflicts of Interest
and Interests of Certain Persons in the Merger") and among FHS, the Company
and the concerned employees, with respect to certain of the Company's
employment arrangements. See "--The Merger Agreement--Benefit Plans and
Employment Arrangements." The Board was then presented with FHS' firm offer
for a merger consideration of $29.25 per share. It was reported that the offer
of $29.25 per share, rather than $30 per share, was arrived at as a
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result of final price negotiations between FHS and the Company's
representatives and financial advisors. Morgan Stanley advised the Board that
following the announcement of merger negotiations at a price of "approximately
but not more than $30 per share" a number of institutional shareholders of FHS
had reacted negatively to the possible price being offered, creating pressure
on FHS to secure a price as much below $30 per share as possible. The Board
was further advised that FHS was unwilling to offer more than $29.25 per share
in light of (i) the conclusion of FHS's due diligence investigations of the
Company, (ii) adverse market reaction to public disclosures about the possible
transaction between FHS and the Company, as described above, and (iii) the
resolution of the various open issues. FHS's offer was conditioned, among
other things, upon obtaining certain waivers and consents from The Guardian
with respect to the joint venture agreements (referred to hereinafter as the
"Guardian Condition"). The Guardian Condition is described below under "--The
Guardian Condition." At the special meeting, the Company's Board of Directors
received presentations by the Company's management, financial advisors and
legal advisors with respect to its strategic alternatives, the progress of the
negotiations with FHS, and the terms and conditions of the proposed Merger
Agreement and the proposed Voting Trust Agreement. During the course of the
meeting, Morgan Stanley rendered its oral opinion (which was confirmed in
writing on the following day) that, as of the date of the special meeting, the
merger consideration of $29.25 was fair to the holders of the Company's Common
Stock from a financial point of view. Thereafter, because FHS had agreed to an
extension of the Service Agreement, the directors of the Company who were not
members of GBIPA and who had not been nominated in 1995 as part of the slate
committed to exploring a sale of the Company, met in executive session. These
directors consisted of Drs. Coletti and Sawicki and Messrs. Herbert, Lozyniak,
Nechasek, Sheer and Washburn. These directors discussed and considered the
factors described below (see "Reasons for the Merger and Recommendation of the
Board"), and voted unanimously to recommend that the full Board of Directors
approve the Original Merger Agreement and the Voting Trust Agreement and the
transactions contemplated thereby. The full Board then met, and upon further
discussion and consideration of such factors, concluded that the Original
Merger Agreement and the transactions contemplated thereby were in the best
interests of the stockholders of the Company and, by the unanimous vote of the
directors present, approved the Merger Agreement, the Voting Trust Agreement
and the transactions contemplated thereby. Dr. Bader had terminated his
telephonic participation in the meeting shortly before the vote for reasons
unrelated to the vote. The Board was aware at the time of its vote that FHS
had suggested to Morgan Stanley that it was prepared to consider a transaction
at a merger consideration of $1.50 to $2.00 per share less than $29.25 that
would not be conditioned upon satisfaction or waiver of the Guardian Condition
and that Morgan Stanley believed that such a reduced consideration was within
the range within which it would be able to render its opinion that the merger
consideration was fair to the Company's stockholders from a financial point of
view. While the Board considered the possibility of a transaction without the
Guardian Condition at a reduced consideration, the Board, as a business
decision, judged that the risk that the Guardian Condition might not be
satisfied or waived was not so great as to warrant, at that time, entertaining
a transaction with a reduction in the Merger Consideration from that which was
then being offered by FHS.
The Company and FHS executed the Original Merger Agreement and the Company,
GBIPA and the Voting Trustee executed the Voting Trust Agreement on May 8,
1997. On the same day, FHS, the Company, PHS/CT and GBIPA entered into an
agreement (the "GBIPA Agreement") which specifies that, upon consummation of
the Merger, (a) the Service Agreement would be amended so as to (i) extend its
term for one year and (ii) adopt certain standards and economic terms and
conditions that are equivalent to those presently in effect under the Provider
Agreement between M.D. Health Plan, a subsidiary of FHS, and the Connecticut
State Medical Society-IPA, Inc., and (b) the Company will pay GBIPA $6,500,000
in consideration for such amendment. See "--Amendment to GBIPA Service
Agreement."
For several months following the execution of the Original Merger Agreement,
members of senior management of the Company, FHS and The Guardian engaged in
discussions with a view toward entering into an agreement that would satisfy,
or result in the waiver of, the Guardian Condition but were unable to reach
such an agreement. By early October, 1997, representatives of the Company and
FHS began to discuss alternatives to consummating the Merger pursuant to the
Original Merger Agreement. By October 17, 1997, the Company and FHS determined
that satisfying the Guardian Condition, while still possible, was unlikely,
and
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began negotiating a specific proposal under which the Guardian Condition would
be eliminated as a condition to consummation of the Merger and the Merger
Consideration would be reduced to $28.25 unless the Guardian Condition was
satisfied prior to consummation of the Merger. Representatives of FHS advised
that FHS's offer was subject to the condition that the closing not take place,
if FHS so elected, until January 6, 1998, even if the conditions to the Merger
were otherwise satisfied prior to that time. Representatives of the Company
and FHS continued to work on finalizing the revised proposal in anticipation
of a meeting of the Company's Board of Directors called for October 19, 1997.
On October 19, 1997, the Company's Board of Directors met and considered the
revised proposal. After considering the events that had occurred since the
execution of the Original Merger Agreement, and reviewing the Company's
strategic position and results of operations, and other factors, see "--
Reasons for the Merger and the Board of Directors' Recommendation", the Board
unanimously approved the execution of Amendment No. 1, incorporating the
revised proposal, subject to GBIPA's consent. The Board also authorized the
execution of a medical management agreement with FHS under which FHS provides
medical management services to the Company during the period following
execution of the Original Merger Agreement. Under the medical management
agreement, FHS may receive a payment of $5 million if certain utilization
targets are achieved. The payment of such amounts is subject to the
consummation of the Merger. A public announcement of the approval was made on
October 20, 1997.
On October 23, 1997 the Board of Directors of GBIPA approved Amendment No. 1
by unanimous written consent and executed a consent thereto.
REASONS FOR THE MERGER AND BOARD OF DIRECTORS' RECOMMENDATION
The Board of Directors of the Company acted on the Original Merger Agreement
at its meeting on May 7, 1997, and acted on the amended Merger Agreement at
its meeting on October 19, 1997. At its meeting on May 7, 1997, the Board
considered the possibility of a transaction that would not be subject to the
Guardian Condition but would include a merger consideration of up to $2.00 per
share less than $29.25. For the reasons described below, the Board initially
made a business decision to proceed on the basis of a merger consideration of
$29.25 per share, conditioned upon satisfying the Guardian Condition. At its
meeting on October 19, 1997, in light of the judgment that the Guardian
Condition was unlikely to be satisfied, for the reasons described below, the
Board revisited this decision and decided to support a transaction that was
not subject to the Guardian Condition at a reduced consideration of $28.25 per
share.
In reaching its decision on May 7, 1997 to approve the Original Merger
Agreement and the Voting Trust Agreement, as well as the transactions
contemplated thereby, and to recommend that the Company's stockholders approve
and adopt the Merger Agreement, the following are the material factors
considered by the Board of Directors:
(i) the consideration to be received by stockholders in the Merger, and
the premium over market represented thereby;
(ii) the strategic alternatives available to the Company, including the
continued implementation of the Company's strategic plan, possible
acquisitions or other business combinations, the divestiture or
discontinuance of certain operations, and the Board's belief that the
Merger was the preferable alternative for the Company's stockholders;
(iii) the inability of the Company to enter into business combinations
using the pooling of interests accounting method, due to the status of the
Company as a "subsidiary" of GBIPA for accounting purposes;
(iv) the risks associated with a continuation of the Company's strategic
plan or a variation thereof and other uncertainties with respect to the
Company's ability to achieve and maintain substantial profitability in the
future, including the on-going consolidation of the health care industry,
intensifying competition, increased governmental regulation, deficiencies
in the Company's medical utilization management systems, the need for
additional capital to finance continued expansion, the difficulty of
expanding upon the Company's already strong position in Connecticut, the
relative weakness of the Company's position in New York and New Jersey and
the Company's recent unsatisfactory results of operations;
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(v) the Company's results of operations for the first quarter of 1997,
and management's projections with respect to the profitability of the
Company during the near and longer term;
(vi) the repeatedly professed desire of GBIPA for the Company to enter
into a sale transaction;
(vii) the recommendation of the proposed Merger by the management of the
Company;
(viii) the presentation made by Morgan Stanley at the meeting of the
Board of Directors held on May 7, 1997;
(ix) the opinion of Morgan Stanley that the merger consideration of
$29.25 per share was fair to the stockholders of the Company from a
financial point of view;
(x) the risks that The Guardian might not agree to certain waivers and
consents relating to its joint marketing agreements with the Company as
required by FHS as a condition to the consummation of the Merger at a
merger consideration of $29.25 per share;
(xi) the terms and conditions of the Voting Trust Agreement, obligating
the Voting Trustee to vote GBIPA's shares in favor of the approval and
adoption of the Merger Agreement, thereby eliminating the risk that the
Company's business might be adversely affected by any uncertainty as to
whether the Merger would be approved by the stockholders of the Company;
(xii) the regulatory approvals needed to consummate the Merger, including
antitrust approvals and insurance and HMO regulatory approvals, and the
likelihood that such approvals would be obtained in a timely manner;
(xiii) the terms and conditions of the Original Merger Agreement,
including a merger consideration of $29.25 per share, the parties'
representations, warranties and covenants, the conditions to their
respective obligations, the amount of the Termination Fees and Termination
Expenses and the circumstances under which such fees and expenses would be
payable;
(xiv) the lack of interest that was shown by certain other potential
acquirors in entering into discussions with the Company with a view toward
acquiring the Company, even after the public announcement of the
discussions relating to the proposed Merger;
(xv) the possibility that a public sale or auction process might have
resulted in a higher per share price than a merger consideration of $29.25
per share and the risk that the conduct of such a public sale or auction
could have materially and adversely affected the Company's ability to
compete for members without resulting in a transaction;
(xvi) the agreements reached with GBIPA (see "--Amendment to GBIPA
Service Agreement");
(xvii) the arrangements for terminating the employment contracts between
the Company and Messrs. Natt, Elrod and Philpott and Ms. Campbell and the
arrangements for continuing the employment of Messrs. Natt and Philpott on
different terms; and
(xviii) the fact that the Merger will result in a taxable transaction to
the stockholders of the Company.
Following consideration of the information and factors described above
(including reliance on the opinion of Morgan Stanley that a merger
consideration of $29.25 per share was fair to the stockholders of the Company
from a financial point of view), the Company's Board of Directors concluded
that the Merger was in the best interests of the Company and its stockholders.
In reaching this conclusion, the Company's Board of Directors did not assign
relative or specific weights to the above information and factors or determine
that any particular information or factor was of unique importance. Instead,
the Company's Board of Directors based its recommendation upon the totality of
the information and factors presented to it or otherwise known to its members.
The discussions among the members of the Board of Directors evidenced the
general view that the factors set forth in paragraphs (i)-(ix), (xi), (xii)
and (xiv)-(xvii) supported the Board's determination to approve the Original
Merger Agreement, the factor set forth in paragraph (x) was an unfavorable
factor and the factors set forth in paragraphs (xiii) and (xviii) contained
both favorable and unfavorable aspects. The factors discussed above were
considered by the Company's Board in the manner set forth below.
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(a) The discussions among the members of the Company's Board evidenced
the general view that the factors set forth in paragraph (i) above strongly
supported the Board's determination to approve the Merger Agreement. The
Board reviewed, among other things, a 12-month daily trading history for
the Common Stock. It was noted that a merger consideration of $29.25 per
share represented a significant premium over the historical trading price
of the Common Stock and was well in excess of the market price of the
Company's Common Stock earlier in the year.
(b) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factors set forth in paragraph
(ii) above supported the Board's determination to approve the Merger
Agreement. While the results to be achieved by continued implementation of
the strategic plan looked promising, the stockholder value expected to be
achieved by implementing the strategic plan was not significantly better
than a merger consideration of $29.25 per share in light of the Company's
recent financial performance and the risks of not achieving such values
were far greater. Furthermore, due to the Company's inability to account
for an acquisition on a pooling basis, it was not considered realistic for
the Company to expect to pursue acquisitions or other business
combinations.
(c) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factor set forth in paragraph
(iii) above supported the Board's determination to approve the Merger
Agreement. The maximum price that could be paid by an acquiror in a
business combination without being dilutive could be higher in a pooling of
interests transaction than could be achieved under the purchase method.
Thus a future transaction might be structured in a way that might result in
a higher consideration. However, given GBIPA's unwillingness to sell down
its stock ownership position so that the Company was no longer controlled
by GBIPA, there was no reasonable prospect that the Company would ever be
able to enter into a transaction using such accounting method.
(d) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the risks set forth in paragraph
(iv) associated with continuation of the Company's strategic plan were
significant and that the existence of those risks supported the Board's
determination to approve the Merger Agreement. The Company had recently
experienced significant adverse financial results to its strategic plan
resulting from only some of the recognized risks. Thus, there were
significant risks associated with the Company's strategic plan, and the
expected results of the plan, under the best of circumstances, were not
significantly different from a merger consideration of $29.25 per share.
(e) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factors set forth in paragraph
(v) supported the Board's determination to approve the Merger Agreement.
While management's projections showed that the Company would return to
profitability during the near and longer term, such profitability was still
subject to significant risks.
(f) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factor set forth in paragraph
(vi) supported the Board's determination to approve the Merger Agreement.
The Company had undergone significant expense and disruption as a result of
GBIPA's actions seeking to cause the Company to explore a sale transaction,
and the uncertainty engendered by such actions could be expected to have an
adverse effect on the Company's marketing efforts, thereby intensifying the
risks that were associated with the Company's strategic plan.
(g) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the recommendation of the merger by
the management of the Company, identified in paragraph (vii), strongly
supported the Board's determination to approve the Merger Agreement. The
management of the Company had significant equity interests in the Company
and the recommendation by management was given significant weight.
(h) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factors set forth in paragraphs
(viii) and (ix) strongly supported the Board's determination to approve the
Merger Agreement. In particular, the analysis presented by Morgan Stanley
indicated that a merger consideration of $29.25 per share was at the high
end of the range that might be
27
<PAGE>
considered fair to the stockholders from a financial point of view, and was
an excellent outcome from the standpoint of stockholder value, and this was
given great weight.
(i) The discussions among the members of the Board of Directors evidenced
the general view that the factors discussed in paragraph (x) above were
unfavorable with respect to the Board's determination to approve the
Original Merger Agreement. At the time the Board adopted the Original
Merger Agreement, the Board was concerned that any significant uncertainty
about whether the Merger would be consummated would adversely affect the
Company's competitive position. The fact that the Original Merger Agreement
was conditioned upon the obtaining of waivers and consents from a third
party, which was not within the control of the Company and was significant,
was considered a negative factor in the decision to approve the Original
Merger Agreement. However, the Board judged that the risk that the Guardian
Condition would not be satisfied or waived was not so great, as to warrant,
at the time, entertaining a reduction in the merger consideration from
$29.25 per share.
(j) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factors set forth in paragraphs
(xi) and (xii) strongly supported the Board's determination to approve the
Merger Agreement. Because the risk that stockholder approval would not be
obtained was effectively eliminated by virtue of the Voting Trust Agreement
and because the Directors did not see evidence that the several approvals
required by regulatory authorities at the federal and state level would be
problematic, the likelihood that the Merger would be consummated was
increased.
(k) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factors set forth in paragraph
(xiii) contained both favorable and unfavorable aspects. A merger
consideration of $29.25 per share was viewed favorably and the conditions
to the obligations of each side were not significant (except for the risks
considered in paragraph (x)). The amount of Termination Fees and
Termination Expenses were substantial, although the possibility that such
fees and expenses would be payable did not appear to be great.
(l) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the factors set forth in paragraph
(xiv) and (xv) strongly supported the Board's determination to approve the
Merger Agreement. While a public sale or auction process could
theoretically have resulted in a higher per share price than a merger
consideration of $29.25 per share, such a public sale or auction would have
had material adverse effects on the Company's competitive position and
would have impaired the pursuit by the Company of its strategic plan. In
addition, because the Company did not receive any interest by any other
potential acquirors, even after the public announcement of the discussions
relating to the proposed merger, the possibility that a public sale or
auction process would have resulted in a higher per share price than a
merger consideration of $29.25 per share was considered remote.
(m) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the agreements reached with GBIPA
supported the Board's determination to approve the Merger Agreement. The
Directors were aware that no transaction such as the Merger could be
accomplished without the approval of GBIPA and the agreements reached with
GBIPA, as part of GBIPA's agreement to participate in the transaction,
significantly reduced the risk that the Merger would not be consummated.
The Board was aware that the agreements with GBIPA might appear to have
resulted in some reduction in the Merger Consideration. However, Morgan
Stanley had advised that the reduction was primarily due to other factors.
See the description of Morgan Stanley's advice on this point enunciated at
the May 7, 1997 meeting of the Board of Directors of the Company under "--
Background of the Merger." The Board concluded that a merger consideration
of $29.25 per share was highly attractive and was the greatest amount
achievable.
(n) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the arrangements for terminating
the employment contracts between the Company and Mr. Elrod and Ms. Campbell
fulfilled the Company's contractual obligations to such executives, and the
arrangements with respect to Messrs. Natt and Philpot were not
unreasonable.
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(o) The discussions among the members of the Board of Directors of the
Company evidenced the general view that the fact that the merger was a
taxable transaction contained both favorable and unfavorable aspects. Given
the trading range of the Company's Common Stock over the last several
years, a significant number of stockholders might have had a relatively
high basis, reducing the taxable impact of the transaction, and a
transaction that could not be accounted for on a pooling basis would in all
likelihood be done as a taxable transaction in any case. On the other hand,
a transaction done on a tax-free basis would have allowed certain
stockholders to continue their participation in an ongoing company without
a tax impact.
At its meeting on October 19, 1997, the Board deliberated upon a revised
proposal that would reduce the merger consideration to $28.25 per share but
would not be subject to the Guardian Condition. The following are the material
factors that were considered by the Board of Directors:
(1) the consideration to be received by stockholders in the Merger;
(2) the elimination of the risk that The Guardian might not agree to
certain waivers and consents required by the terms of the Original Merger
Agreement;
(3) the Company's results of operations for the first two quarters of
1997, and management's projections with respect to the profitability of the
Company during the near and longer term;
(4) the opinion of Morgan Stanley that the Merger Consideration was fair
to the stockholders of the Company from a financial point of view.
Following consideration of the information and factors described above in
items (1) through (4) (including reliance on the opinion of Morgan Stanley
that the Merger Consideration was fair to the stockholders of the Company from
a financial point of view), the Company's Board of Directors concluded that
the Merger was in the best interests of the Company and its stockholders. In
reaching this conclusion, the Company's Board of Directors did not assign
relative or specific weights to the above information and factors or determine
that any particular information or factor was of unique importance. Instead,
the Company's Board of Director based its recommendation upon the totality of
the information and factors presented to it or otherwise known to its members.
The discussions among the members of the Board of Directors evidenced the
general view that the factors set forth in paragraphs (1) through (4)
supported the Board's determination to approve the Merger Agreement. The
factors discussed above were considered by the Company's Board of Directors in
the manner set forth below.
(A) The discussions among the members of the Company's Board evidenced the
general view that the factor set forth in paragraph (1) strongly supported the
Board's determination to approve the Merger Agreement. The Board noted that
the Merger Consideration was still within the range it had considered at the
May 7, 1997 meeting and the Morgan Stanley had then advised would be fair to
the stockholders from a financial point of view.
(B) The discussions among the members of the Company's Board evidenced the
general view that the factor set forth in paragraph (2) strongly supported the
Board's determination to approve the Merger Agreement. At the time the Board
adopted the Original Merger Agreement, the Board was concerned that any
significant uncertainty about whether the Merger would be consummated would
adversely affect the Company's competitive position. It did not judge, at that
time, that this risk was so great as to warrant proceeding with a transaction
that was not conditioned upon the obtaining of waivers and consents from a
third party but at a reduced merger consideration. Since its approval of the
Original Merger Agreement, the Board had been informed of the status of the
discussions among FHS, the Company and The Guardian with respect to such
waivers and consents. These discussions, taking place over months and
involving concerted effort by all parties, caused the Board to question
whether this condition would be satisfied prior to the date that FHS would be
released from its obligation to consummate the Merger. The Board was concerned
that continued uncertainty about whether the Merger would be consummated would
adversely affect the Company's competitive position, and that the Company
might be left in a considerably worse position than if it had adhered to its
strategic plan if the Merger were not consummated. Consequently, the Board
judged that the elimination of the Guardian Condition effected by
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Amendment No. 1 outweighed the associated reduction in the Merger
Consideration. At the same time, the Board recognized that stockholders
retained the possibility of receiving the additional $1 per share if the
Guardian Condition were satisfied or waived prior to the consummation of the
Merger, but did not give any significant weight to this possibility.
(C) The discussions among the members of the Company's Board evidenced the
general view that the factors set forth in paragraph (3) supported the Board's
determination to approve the Merger Agreement. The results of operations for
the first two quarters of the year and management's projections for the near
and longer term remained consistent with the results of the first quarter and
projections considered by the Board at the May 7, 1997 meeting.
(D) The discussions among the members of the Company's Board evidenced the
general view that the factor set forth in paragraph (4) strongly supported the
Board's determination to approve the Merger Agreement. Morgan Stanley advised
the Board that the Merger Consideration was still within the range considered
by it at the time of the approval of the Original Merger Agreement to be fair
from a financial point of view and was still an excellent outcome from the
standpoint of stockholder value, and this was given great weight.
FOR THE REASONS DESCRIBED ABOVE, AND TAKING INTO CONSIDERATION THE
INFORMATION AND FACTORS SET FORTH ABOVE, THE COMPANY'S BOARD OF DIRECTORS, BY
THE UNANIMOUS VOTE OF ALL DIRECTORS PRESENT, APPROVED THE MERGER AGREEMENT AND
THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING THE MERGER, AT A MEETING ON
OCTOBER 19, 1997, AND RECOMMENDS THAT THE STOCKHOLDERS OF THE COMPANY VOTE
"FOR" APPROVAL AND ADOPTION OF THE MERGER AGREEMENT.
OPINION OF THE COMPANY'S FINANCIAL ADVISOR
Morgan Stanley has delivered written opinions to the Board of Directors of
the Company, dated May 8, 1997, with respect to the Original Merger Agreement
and October 19, 1997 with respect to the Merger Agreement, to the effect that,
on the date of such opinion, and based on assumptions made, procedures
followed, matters considered and limitations on the review undertaken, as set
forth in the opinion, the Merger Consideration pursuant to the Merger
Agreement was fair from a financial point of view to the holders of the Common
Stock. Morgan Stanley subsequently confirmed its earlier opinion by delivery
of its written opinion, dated December 10, 1997.
In rendering its December 10, 1997 opinion to the Board, attached hereto as
Appendix B, Morgan Stanley was not asked to update its presentation to the
Board of Directors at its May 7, 1997 meeting, or to update its analysis as
presented to the Board of Directors, other than to confirm its opinion that
the Merger Consideration was fair to the Company's stockholders from a
financial point of view. In rendering its opinion, Morgan Stanley considered
that the Merger Consideration continued to be in the range within which it was
prepared to give its opinion at the time of the May 7, 1997 meeting.
THE FULL TEXT OF MORGAN STANLEY'S WRITTEN OPINION DATED DECEMBER 10, 1997,
WHICH SETS FORTH, AMONG OTHER THINGS, ASSUMPTIONS MADE, PROCEDURES FOLLOWED,
MATTERS CONSIDERED AND LIMITATIONS ON THE REVIEW UNDERTAKEN, IS ATTACHED AS
APPENDIX B TO THIS PROXY STATEMENT. THE COMPANY'S STOCKHOLDERS ARE URGED TO,
AND SHOULD, READ THE MORGAN STANLEY OPINION CAREFULLY AND IN ITS ENTIRETY.
MORGAN STANLEY'S OPINION IS DIRECTED TO THE BOARD OF DIRECTORS OF THE COMPANY
AND THE FAIRNESS OF THE MERGER CONSIDERATION PURSUANT TO THE MERGER AGREEMENT
FROM A FINANCIAL POINT OF VIEW TO THE HOLDERS OF THE COMMON STOCK, AND IT DOES
NOT ADDRESS ANY OTHER ASPECT OF THE MERGER AND DOES NOT CONSTITUTE A
RECOMMENDATION TO ANY COMPANY STOCKHOLDER AS TO HOW TO VOTE AT THE MEETING.
ALL MATERIAL ANALYSES PERFORMED BY MORGAN STANLEY IN CONNECTION WITH THE
MERGER ARE DISCLOSED IN THE SUMMARY OF THE OPINION OF MORGAN STANLEY SET FORTH
HEREIN, WHICH IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF
SUCH OPINION.
In connection with rendering its opinion, Morgan Stanley, among other
things, (i) reviewed certain publicly available financial statements and other
information of the Company; (ii) reviewed certain internal financial
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statements and other financial and operating data concerning the Company
prepared by the management of the Company; (iii) analyzed certain financial
projections prepared by the management of the Company; (iv) discussed the past
and current operations and financial condition and the prospects of the
Company with senior executives of the Company; (v) reviewed the reported
prices and trading activity for the Class A Common Stock; (vi) compared the
financial performance of Company and the prices and trading activity of the
Class A Common Stock with that of certain other comparable publicly-traded
companies and their securities; (vii) reviewed the financial terms, to the
extent publicly available, of certain comparable acquisition transactions;
(viii) participated in discussions and negotiations among representatives of
the Company and FHS and their financial and legal advisors; (ix) reviewed the
Merger Agreement, the Voting Trust Agreement and certain related documents;
and (x) performed such other analyses and considered such other factors as it
deemed appropriate.
In rendering its opinion, Morgan Stanley assumed and relied upon without
independent verification the accuracy and completeness of the information
reviewed by Morgan Stanley for purposes of its opinion. With respect to
financial projections, Morgan Stanley assumed that they were reasonably
prepared on bases reflecting the best currently available estimates and
judgments of the future financial performance of the Company. Morgan Stanley
did not make any independent valuation or appraisal of the assets or
liabilities of the Company, nor was it furnished with any such appraisals.
Morgan Stanley's opinion was based on economic, market and other conditions as
in effect on, and the information made available to Morgan Stanley as of, the
date of its opinion.
In arriving at its opinion, Morgan Stanley was not authorized to solicit,
and did not solicit, interest from any party with respect to the acquisition
of the Company or any of its assets, nor did Morgan Stanley negotiate with any
parties, other than FHS.
The following is a brief summary of certain analyses performed by Morgan
Stanley and reviewed with the Board of Directors of the Company on May 7,
1997, in connection with Morgan Stanley's May 8, 1997 opinion.
Comparable Companies Trading Analysis. As part of its analysis, Morgan
Stanley compared certain financial information of the Company with the
corresponding publicly available financial information of certain other
managed care and other companies similar to the Company, including Coventry
Corporation, Mid Atlantic Medical Services, Inc., Physician Corporation of
America, and WellCare Management Group Inc. (the "Comparable Companies"). For
each of the Comparable Companies, Morgan Stanley calculated (based on market
information as of April 29, 1997, the latest publicly available 10-Ks and 10-
Qs, and estimates of earnings per share and five-year projected growth rates
based on First Call Corporation ("First Call") estimates as of April 29, 1997)
(i) aggregate value per member enrolled, which ranged from $336 to $995, with
a mean of $720 and a median of $775, (ii) price to next twelve months earnings
ratio, which ranged from 7.9x to 44.0x, with a mean of 21.4x and a median of
16.9x, and (iii) price to estimated 1998 earnings ratio, which ranged from
7.0x to 17.7x, with a mean of 11.5x and a median of 10.6x.
Morgan Stanley calculated that a price of $29.25 per share of Common Stock
implied a $1,009 aggregate value per member (which includes proprietary,
Medicaid and Medicare members and half value for HCS members); 70.2x price to
next twelve months earnings ratio, using the mean estimates of First Call as
of April 29, 1997 and 40.0x price to next twelve months earnings ratio, using
management estimates; and a 34.0x price to estimated 1998 earnings ratio,
using First Call mean estimates as of April 29, 1997 and 25.3x price to
estimated 1998 earnings ratio, using management estimates.
No company utilized in the comparable companies analysis as a comparison is
identical to the Company. In evaluating the Comparable Companies, Morgan
Stanley made judgments and assumptions with regard to industry performance,
general business, economic, market and financial conditions and other matters,
many of which are beyond the control of the Company, such as the impact of
competition on the business of the Company and the industry generally,
industry growth and the absence of any adverse material change in the
financial condition and prospects of the Company or the industry or in the
financial markets in general. Mathematical analysis (such as determining the
average or median) is not in itself a meaningful method of using comparable
company data.
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Precedent Transactions Analysis. Morgan Stanley reviewed certain publicly
available information regarding 17 selected business combinations in the
managed care and health insurance industries announced since July 14, 1992
(the "Comparable Transactions"). The Comparable Transactions were the
acquisition of Healthsource, Inc. by Cigna Corporation; the acquisition of
John Hancock Mutual Life Insurance Company's Group-Benefits Division by
WellPoint Health Networks Inc.; the acquisition of Foundation Health
Corporation by Health Systems International, Inc.; the acquisition of FHP
International by PacifiCare Health Systems, Inc.; the pending acquisition of
U.S. Healthcare, Inc. by Aetna Life & Casualty (Bermuda) Ltd.; the acquisition
of HealthWise of America, Inc. by United HealthCare Corporation; the
acquisition of Massachusetts Mutual Life Insurance Company (Life and Health
Benefits Management Division) by WellPoint Health Networks Inc.; the
acquisition of EMPHESYS Financial Group Inc. by Humana Inc.; the acquisition
of The MetraHealth Companies, Inc. by United HealthCare Corporation; the
acquisition of Provident Life Capital Corporation by Healthsource, Inc.; the
acquisition of GenCare Health Systems, Inc. by United HealthCare Corporation;
the acquisition of Intergroup Healthcare Corporation by Foundation Health
Corporation; the acquisition of CareFlorida Health Systems, Inc. by Foundation
Health Corporation; the acquisition of TakeCare, Inc. by FHP International;
the acquisition of Ramsay-HMO, Inc. by United HealthCare Corporation; the
acquisition of HMO America, Inc. by United HealthCare Corporation; and the
acquisition of Century Medicorp, Inc. by Foundation Health Corporation. For
each of the Comparable Transactions, Morgan Stanley calculated, among other
things, equity value as a multiple of next twelve months estimated earnings
per share (using the latest Institutional Broker Estimate System, Inc. or
First Call mean estimates), which ranged from 8.7x to 31.8x.
Morgan Stanley calculated that a price of $29.25 per share of Common Stock
implied a 70.2x price to next twelve months earnings ratio, using First Call
mean estimates as of April 29, 1997 and 40.0x price to next twelve months
earnings ratio, using management estimates.
No transaction utilized in the comparable transactions analysis is identical
to the Merger. In evaluating the precedent transactions, Morgan Stanley made
judgments and assumptions with regard to industry performance, general
business, economic, market and financial conditions and other matters, many of
which are beyond the control of the Company, such as the impact of competition
on the business of the Company and the industry generally, industry growth and
the absence of any adverse material change in the financial condition and
prospects of the Company or the industry or in the financial markets in
general. Mathematical analysis (such as determining the average or median) is
not in itself a meaningful method of using comparable transaction data.
Discounted Cash Flow Analysis. Morgan Stanley performed discounted cash flow
analyses of the Company to determine a range of present values per share of
the Company's Common Stock based on certain financial projections prepared by
the management of the Company and based on a sensitivity case, which provided
for a 1997 medical loss ratio of 84.7% versus the 84.6% in management's
projections and a 1998 medical loss ratio of 86.2% versus the 85.3% in
management's projections. Unlevered free cash flow was calculated as the
after-tax operating earnings of the Company (excluding any interest income or
expense) plus depreciation and amortization, plus (or minus) net changes in
non-cash working capital, minus projected capital expenditures. Morgan Stanley
calculated terminal value by applying a range of multiples to net income in
fiscal 2001 from 10.0x to 14.0x, representing estimated long-term net income
trading multiples. The unlevered free cash flows and terminal value were then
discounted to the present value using a range of discount rates from 13.0% to
15.0%, representing an estimated range of the weighted cost of capital for the
Company. Based on this analysis and the assumptions set forth above, Morgan
Stanley calculated a per share value for the Common Stock ranging from $24.86
to $37.66 using management's projections and $21.61 to $33.35 in the
sensitivity case.
Equity Market Trading Analysis. Morgan Stanley reviewed the performance,
over the period from January 1, 1995 through April 29, 1997, of the closing
prices of the Class A Common Stock compared to the Morgan Stanley HMO Payor
Index and the S&P 400. This analysis showed that during this period, the Class
A Common Stock underperformed both the Morgan Stanley HMO Payor Index and the
S&P 400.
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Pro Forma Merger Analysis. Morgan Stanley analyzed the pro forma effects of
the Merger on FHS' estimated earnings per share for the fiscal years 1997 and
1998. This analysis was based on First Call mean estimates for FHS and
management estimates for the Company, in each case as of April 29, 1997. This
analysis indicated that if the Merger were consummated, it would result in
approximately 5.4% dilution in FHS' fiscal year 1997 earnings per share and
approximately 2.8% dilution in FHS' fiscal year 1998 earnings per share, in
each case assuming no synergies in the Merger are achieved, and approximately
$15.6 million of pre-tax synergies would be required in order to have no
earning per share dilution in fiscal year 1998.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to a partial analysis or summary description. In
arriving at its opinion, Morgan Stanley considered the results of all of its
analyses as a whole and did not attribute any particular weight to any
analysis or factor considered by it. Furthermore, selecting any portion of its
analyses, without considering all analyses, could create an incomplete view of
the process underlying its opinion. In addition, Morgan Stanley may have given
various analyses and factors more or less weight than other analyses and
factors, and may have deemed various assumptions more or less probable than
other assumptions, so that the ranges of valuations resulting from any
particular analysis described above should not be taken to be Morgan Stanley's
view of the actual value of the Company.
In performing its analyses, Morgan Stanley made numerous assumptions with
respect to industry performance, general business and economic conditions and
other matters, many of which are beyond the control of the Company or FHS. The
analyses performed by Morgan Stanley are not necessarily indicative of actual
value, which may be significantly more or less favorable than suggested by
such analyses. Such analyses were prepared solely as a part of Morgan
Stanley's analysis of the fairness from a financial point of view of the
Merger Consideration pursuant to the Merger Agreement to the holders of the
shares of Common Stock and were provided to the Board of Directors of the
Company in connection with the delivery of Morgan Stanley's opinion dated May
8, 1997. In addition, as described above, Morgan Stanley's opinion and
presentations to the Board of Directors of the Company was one of many factors
taken into consideration by the Board of Directors of the Company in making
its determination to approve the Merger Agreement and the transactions
contemplated thereby. The consideration to be received by the stockholders of
the Company pursuant to the Merger was determined through negotiations between
the Company and FHS and was approved by the Board of Directors of the Company.
Morgan Stanley provided advice to the Company during the course of such
negotiations; however, the decision to enter into the Merger Agreement and to
accept the Merger Consideration was solely that of the Board of Directors of
the Company. Consequently, the Morgan Stanley analyses described above should
not be viewed as determinative of the opinion of the Board of Directors of the
Company with respect to the value of the Merger Consideration.
The Board of Directors of the Company retained Morgan Stanley based upon its
experience and expertise. Morgan Stanley is an internationally recognized
investment banking and advisory firm. Morgan Stanley, as part of its
investment banking business, is regularly engaged in the valuation of
businesses and securities in connection with mergers and acquisitions,
negotiated underwritings, competitive biddings, secondary distributions of
listed and unlisted securities, private placements, financings and valuation
for estate, corporate and other purposes. In the ordinary course of Morgan
Stanley's trading and brokerage activities, Morgan Stanley or its affiliates
may, from time to time, have a long or short position in, and buy and sell,
securities of the Company or FHS, for their own accounts or for the accounts
of customers. There has been no material relationship between the Company and
Morgan Stanley during the past two years.
Pursuant to a letter agreement dated as of April 7, 1997, between the
Company and Morgan Stanley, the Company agreed to pay Morgan Stanley a fee of
$1.75 million for delivering its opinion, payable upon consummation of the
Merger. The Company has also agreed to reimburse Morgan Stanley for its out-
of-pocket expenses. In addition, the Company has agreed to indemnify Morgan
Stanley and its affiliates, their respective directors, officers, agents and
employees and each other person, if any, controlling Morgan Stanley or any of
its affiliates against certain liabilities and expenses related to Morgan
Stanley's engagement, including liabilities under the federal securities laws.
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THE GUARDIAN CONDITION
The Merger Consideration is subject to upward adjustment to $29.25 if, prior
to the Effective Time, the Company receives certain waivers and consents, set
forth in a schedule to the Merger Agreement, in respect of the Guardian joint
venture agreements. Specifically, as a condition to such increase in the
Merger Consideration the following waivers and consents must be obtained:
1. The Company would agree to obtain an appropriate waiver from The
Guardian to the effect that The Guardian would agree not to exercise any
rights of termination it may have under the joint venture agreements as a
result of the transactions provided for in the Merger Agreement.
2. In addition, the Company would agree to enter into amendments to the
joint venture agreements in a form reasonably acceptable to FHS, which
amendments would reflect Guardian's agreements that:
a. The Company will obtain a clarification of the joint venture
agreements to the effect that the agreements do not restrict the
ability of the Company to sell any and all products of its affiliates,
including without limitation products of FHS following the Merger.
b. FHS would have the right to approve all rates for insurance
contracts and other insurance products for which The Guardian develops
rates and for which risk is shared by the Company and The Guardian
under the joint venture agreements.
c. As of the Effective Time, The Guardian's right to market HMO plans
under the joint venture agreements shall be limited to existing and
prospective customers of 200 or less employees on a total replacement
basis.
While it is possible that the foregoing waivers and amendments will be
forthcoming prior to the Effective Time, the Company believes it unlikely that
the required items will be forthcoming prior to the Effective Time or that the
Merger Consideration will be increased.
CONFLICTS OF INTEREST AND INTERESTS OF CERTAIN PERSONS IN THE MERGER
In considering the recommendation of the Board of Directors that the
stockholders of the Company approve and adopt the Merger Agreement,
stockholders of the Company should be aware that certain officers and
directors of the Company have certain interests in the Merger that are
different from, or in addition to, the interests of the stockholders of the
Company. In particular, stockholders should be aware that Mr. Natt, who
participated extensively in the negotiations with FHS with respect to the
terms and conditions of the Merger Agreement, and Mr. Philpott will be
entering into new employment agreements with FHS and will, in addition,
receive additional compensation in the form of signing and retention bonuses
by reason of the consummation of the Merger. Under Mr. Natt's new employment
agreement, he will serve as chief executive officer of FHS' Greater New York
City operations, reporting directly to the President of FHS, and will receive
an annual salary of $320,000. Mr. Natt will also receive a $46,500 signing
bonus and will participate in FHS' bonus plan and stock-based incentive
programs. Mr. Natt will receive a special 150,000 share option grant in
respect of the initial term of the agreement and will receive a $500,000
retention bonus, payable in equal installments, on the first and second
anniversaries of the Effective Time. Under Mr. Philpott's new employment
agreement, he will receive an annual salary of $250,000. Mr. Philpott will
receive a $350,000 retention bonus payable in equal installments on the first
and second anniversaries of the Effective Time. Mr. Philpott will participate
in FHS' bonus plan and stock-based incentive programs. Mr. Philpott will
receive a special 50,000 share option grant in respect of the initial term of
the agreement. FHS has agreed to recommend to the FHS Committee that the
special option grants to Messrs. Natt and Philpott be on terms (with respect
to the exercise price, term and exercisability) that are identical to similar
special grants which may be made by FHS in 1997. FHS has agreed to recommend
to the FHS Committee that the special options granted to Messrs. Natt and
Philpott will become immediately exercisable if such executive's employment is
involuntarily terminated by FHS without "cause" or if such executive
terminates employment for "good reason." It is currently anticipated that the
special option grants to Messrs. Natt and Philpott will be made under FHS's
stock option plan, pursuant to which the exercise price of
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options may not be less than 100% of the fair market value of the shares
subject to such options on the date of grant. Similarly, Mr. Elrod and Ms.
Campbell, who also participated in the negotiations with FHS, will receive
compensation in connection with the termination of their employment contracts
with the Company. See "--The Merger Agreement--Benefit Plans and Employment
Arrangements." In satisfaction of their existing employment agreements and
conditional employment agreements with the Company, Mr. Elrod and Ms. Campbell
will receive a net cash payment, which after payment of all applicable taxes
will be $1,500,000 and $1,250,000, respectively, and lifetime medical
benefits. The foregoing amounts include the after tax amount of the value of
any stock options held by Mr. Elrod and Ms. Campbell, respectively, that will
vest as a result of the Merger. See "--The Merger Agreement--Benefit Plans and
Employment Arrangements." Stockholders of the Company should also be aware
that Mr. Herbert, Co-Chief Executive Officer and a director of the Company who
voted in favor of the Merger, will be entitled to be employed by the Company
following the consummation of the Merger pursuant to his employment agreements
with the Company. Moreover, Employee Options (including those granted to
Messrs. Natt, Philpott and Herbert) which have been granted but have not yet
vested will become immediately vested upon, and will be cashed out in
connection with, the consummation of the Merger. Under the terms of the Merger
Agreement, Messrs. Natt, Philpott and Herbert will receive amounts of
$1,138,875, $305,617, and $799,460, respectively, in respect of all Employee
Options granted to them. See "-- The Merger Agreement--Employee Options." In
addition, Mr. Natt has discussed with FHS the possibility that FHS might
employ Dr. Grayer, who also participated in the negotiations with FHS, as a
provider and marketing consultant to FHS. In this connection, it has been
suggested that Dr. Grayer might be paid a consultant's fee of up to $10,000
per month for 35 months; however, neither FHS nor Dr. Grayer has any
obligation to agree to such a consulting arrangement. In addition, following
the execution of the Original Merger Agreement, the Compensation Committee of
the Board of Directors of the Company agreed to pay Dr. Grayer $25,000 upon
consummation of the Merger in consideration for his services to the Company in
connection with the Merger and the transactions contemplated thereby. See
"PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS--Summary Compensation Table."
In light of the foregoing interests, Morgan Stanley took on an increased role
in the negotiations with respect to the Merger from the time those matters
were initially raised. See "--Background of the Merger."
In considering the recommendation of the Board of Directors, stockholders of
the Company should also be aware that FHS, the Company, PHS/CT and GBIPA
entered into the GBIPA Agreement, prior to GBIPA's execution of the Voting
Trust Agreement which specifies that, upon consummation of the Merger, (a) the
service agreement between GBIPA and the Company will be amended so as to (i)
extend its term for one year, to December 31, 1998, and (ii) adopt utilization
management, quality assurance and credentialing standards as well as
capitation rates, fees schedules and other economic terms and conditions that
are equivalent to those presently in effect under the Provider Agreement
between M.D. Health Plan, a subsidiary of FHS, and the Connecticut State
Medical Society-IPA, Inc., and (b) the Company will pay GBIPA $6,500,000 in
consideration for such amendment. See "--Amendment to GBIPA Service
Agreement."
In considering adoption and approval of the Merger Agreement, the Voting
Agreement and the transactions contemplated thereby, the Board recognized that
certain members of the Board may be deemed to have interests in such
transactions that are different from, or in addition to, the interests of the
non-affiliated stockholders of the Company by virtue of such members' direct
or indirect affiliation with GBIPA. Accordingly, the Board directed the Board
members who are not members of GBIPA and who had not been nominated in 1995 by
GBIPA as part of the slate of nominees committed to exploring a sale of the
Company to meet in executive session to consider approval of the Merger
Agreement, the Voting Agreement and the transactions contemplated thereby. As
previously discussed, such directors voted unanimously to recommend that the
full Board approve such agreements and the transactions contemplated thereby.
See "--Background of the Merger."
CERTAIN TAX CONSEQUENCES TO STOCKHOLDERS
The following is a summary of the material United States federal income tax
consequences of the Merger to stockholders.
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The receipt of cash in exchange for Common Stock pursuant to the Merger will
be a taxable transaction for federal income tax purposes and may also be a
taxable transaction under applicable state, local and foreign tax laws. A
stockholder will generally recognize gain or loss for federal income tax
purposes in an amount equal to the difference between such stockholder's
adjusted tax basis in such stockholder's Common Stock and the Merger
Consideration received by such stockholder. Such gain or loss will be a
capital gain or loss if such Common Stock is held as a capital asset and will
be long-term capital gain or loss if, at the Effective Time, such Common Stock
has been held for more than one year.
The foregoing discussion may not apply to stockholders who acquired their
Common Stock pursuant to the exercise of employee stock options or other
compensation arrangements with the Company, who are not citizens or residents
of the United States or who are otherwise subject to special tax treatment.
EACH STOCKHOLDER IS URGED TO CONSULT HIS, HER OR ITS TAX ADVISOR WITH RESPECT
TO THE TAX CONSEQUENCES OF THE MERGER, INCLUDING THE EFFECTS OF APPLICABLE,
STATE, LOCAL OR OTHER TAX LAWS.
THE MERGER AGREEMENT
The description of the Merger Agreement contained in this Proxy Statement
does not purport to be complete and is qualified in its entirety by reference
to the Merger Agreement, a copy of which is attached hereto as Appendix A.
Effective Time
Pursuant to the Merger Agreement, the Merger will be consummated through the
filing of the Certificate of Merger in accordance with the requirements of the
DGCL, as promptly as practicable (and in any event within two business days)
after satisfaction or waiver (to the extent permitted by the Merger Agreement)
of all conditions to each party's obligation to consummate the Merger
contained in the Merger Agreement, provided, however, that if such date occurs
prior to January 6, 1998, then, at the request of FHS, the filing of the
Certificate of Merger shall occur on a business day (no later than January 6,
1998) selected by FHS. The Merger shall be effective at such time as the
Certificate of Merger is duly filed with the Secretary of State of the State
of Delaware in accordance with Delaware law, or at such later time agreed to
by the parties as is specified in the Certificate of Merger.
Certificate of Incorporation and Bylaws
The Merger Agreement provides that the certificate of incorporation of
Merger Sub, as in effect immediately prior to the Effective Time, will be
amended to change the name of Merger Sub to "Physicians Health Services,
Inc.", and, as so amended, the certificate of incorporation of Merger Sub will
be the certificate of incorporation of the Surviving Corporation until
thereafter changed or amended. The Merger Agreement further provides that the
bylaws of Merger Sub will become the bylaws of the Surviving Corporation until
thereafter changed or amended.
Directors and Officers
The directors of Merger Sub at the Effective Time will, from and after the
Effective Time, become the initial directors of the Surviving Corporation
until their successors have been duly elected or appointed and qualified or
until their earlier death, resignation or removal in accordance with the
Surviving Corporation's certificate of incorporation and bylaws. The directors
of Merger Sub currently are Jay M. Gellert and B. Curtis Westen. The officers
of the Company at the Effective Time will, from and after the Effective Time,
become the initial officers of the Surviving Corporation until their
successors have been duly elected or appointed and qualified or until their
earlier death, resignation or removal in accordance with the Surviving
Corporation's certificate of incorporation and bylaws. As a result, Robert L.
Natt will be the Chief Executive Officer of the Surviving Corporation.
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Employee Options
Pursuant to the Merger Agreement, as of the Effective Time, each Employee
Option issued, awarded or granted pursuant to the Company's 1992 Stock Option
Plan or the Company's 1995 Stock Option Plan (the "Company Stock Plans") to
purchase shares of Common Stock will be cancelled by the Company, subject to
obtaining the consents of directors, officers and other holders discussed
below, and each holder of a cancelled Employee Option will be entitled to
receive from the Company (or, at FHS' option, any subsidiary of the Company)
in consideration for the cancellation of such Employee Option an amount in
cash (less applicable withholding taxes) equal to the product of (i) the
number of shares of Common Stock previously subject to such Employee Option
and (ii) the excess, if any, of the Merger Consideration over the exercise
price per share of Common Stock previously subject to such Employee Option. At
or prior to the closing of the Merger (x) the Company will deliver to FHS
agreements (in a form reasonably acceptable to FHS) executed by each member of
the Board of Directors and each officer of the Company acknowledging that the
payment described above is being made in full satisfaction of such
individual's rights under the applicable Company Stock Plans and any option
awards granted thereunder, and (y) the Company will use its reasonable best
efforts to obtain executed agreements of the type described in clause (x) from
each other holder of an option to purchase shares of Common Stock awarded
under the Company Stock Plans.
Exchange of Certificates
The Merger Agreement provides that the exchange of shares of Common Stock
for the Merger Consideration will be effected as follows:
(a) Prior to the Effective Time, FHS will designate a bank or trust company
reasonably acceptable to the Company to act as paying agent (the "Paying
Agent") in effecting the exchange for the Merger Consideration of certificates
(the "Certificates") that, prior to the Effective Time, represented shares of
Common Stock. Upon the surrender of each such Certificate formerly
representing shares of Common Stock, together with a properly completed letter
of transmittal, the Paying Agent will pay the holder of such Certificate the
Merger Consideration multiplied by the number of shares of Common Stock
formerly represented by such Certificate, in exchange therefor, and such
Certificate will forthwith be cancelled. Until so surrendered and exchanged,
each such Certificate (other than Certificates representing shares of Common
Stock owned by FHS or Merger Sub or by any direct or indirect subsidiary of
FHS or Merger Sub or which is held in the treasury of the Company or by any of
its subsidiaries, all of which will be cancelled, or which is held by
dissenting stockholders) will represent solely the right to receive the Merger
Consideration. No interest will be paid or accrue on the Merger Consideration.
If the Merger Consideration (or any portion thereof) is to be delivered to any
person other than the person in whose name the Certificate formerly
representing shares of Common Stock surrendered in exchange therefor is
registered, it will be a condition to such exchange that the Certificate so
surrendered will be properly endorsed or otherwise be in proper form for
transfer and that the person requesting such exchange will pay to the Paying
Agent any transfer or other taxes required by reason of the payment of the
Merger Consideration to a person other than the registered holder of the
Certificate surrendered, or will establish to the satisfaction of the Paying
Agent that such tax has been paid or is not applicable.
(b) Prior to the Effective Time, FHS or Merger Sub will deposit, or cause to
be deposited, in trust with the Paying Agent for the benefit of the holders of
shares of Common Stock the aggregate Merger Consideration to which holders of
shares of Common Stock will be entitled at the Effective Time.
(c) Promptly after the Effective Time, the Paying Agent will mail to each
record holder of Certificates that immediately prior to the Effective Time
represented shares of Common Stock a form of letter of transmittal and
instructions for use in surrendering such Certificates and receiving the
Merger Consideration in exchange therefor.
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Representations and Warranties
The Merger Agreement includes various representations and warranties of the
parties thereto. The Merger Agreement includes representations and warranties
by the Company (except as disclosed) as to, among other things: (i) the
organization and qualification of the Company and its Significant Subsidiaries
(as defined in the Merger Agreement); (ii) the Company's capitalization; (iii)
the interest or investment of the Company and its subsidiaries in other
entities; (iv) the authorization, execution, delivery, performance and
enforceability of the Merger Agreement and the Voting Trust Agreement and the
transactions contemplated thereby; (v) the fairness opinion of Morgan Stanley;
(vi) the absence of the need (except as specified) for governmental or other
filings or actions with respect to the Merger Agreement and the transactions
contemplated thereby; (vii) the Merger Agreement not (a) contravening or
conflicting with the charter or bylaws of the Company or any of its
Significant Subsidiaries; (b) contravening or conflicting with any law,
regulation, judgment, injunction, order or decree binding upon or applicable
to the Company, its subsidiaries or any of their respective properties or
assets; (c) conflicting with (1) any agreement, contract or other instrument
binding upon the Company or any of its subsidiaries or, (2) any license,
franchise, permit or other similar authorization held by the Company or any of
its subsidiaries; or (d) resulting in the creation or imposition of any Lien
(as defined in the Merger Agreement) on any asset of the Company or any of its
subsidiaries; except with respect to clauses (b), (c) and (d) for
contraventions or conflicts which would not have a Material Adverse Effect (as
defined below) on the Company or the Surviving Corporation or impair the
ability of the Company to consummate the transactions contemplated by the
Merger Agreement or prevent or materially delay the consummation of any of the
transactions contemplated by the Merger Agreement; (viii) documents filed by
the Company with the Commission and the Company's financial statements and the
accuracy of information contained therein since January 1, 1995; (ix) the
absence of certain changes or events since December 31, 1996 which would have
a Material Adverse Effect on the Company; (x) the absence of pending or
threatened litigation which would have a Material Adverse Effect on the
Company and the absence of any writ, order, judgment, injunction or decree
which would have a Material Adverse Effect on the Company; (xi) the accuracy
of this Proxy Statement; (xii) filing of tax returns, payment of taxes and
other tax matters; (xiii) compliance with applicable laws; (xiv) the terms,
existence, operations, liabilities and compliance with applicable laws of the
Company's benefit plans and certain other matters relating to the Employee
Retirement Income Security Act of 1974, as amended; (xv) labor matters; (xvi)
certain environmental matters; (xvii) the adequacy of the Company's computer
systems; (xviii) intangible property; (xix) filings with insurance and HMO
regulatory bodies; (xx) the number of members covered under the Company's
various managed health care plans and the number of persons covered by self-
funded and other plans for which the Company provided ASO services; (xxi)
certain material contracts; (xxii) brokers' and finders' fees and expenses;
(xxiii) amendment of the Rights Agreement, dated as of February 21, 1995,
between the Company and American Stock Transfer & Trust Company, as rights
agent (the "Rights Agreement"); and (xxiv) certain real property. "Material
Adverse Effect" means any adverse change in or effect on the financial
condition, business or results of operations of the Company or any of its
subsidiaries or FHS or any of its subsidiaries, as the case may be, which is
material to the Company and its subsidiaries, taken as a whole, or FHS and its
subsidiaries, taken as a whole, as the case may be, other than any change or
effect relating to the United States economy in general or to the health care
industry in general and not specifically relating to the Company and its
subsidiaries or to FHS and its subsidiaries, as the case may be.
The Merger Agreement also includes joint and several representations and
warranties by FHS and Merger Sub (except as disclosed) as to, among other
things: (i) the organization and qualification of FHS and each of its
Significant Subsidiaries; (ii) the authorization, execution, delivery,
performance and enforceability of the Merger Agreement and related matters;
(iii) the absence of the need (except as specified) for governmental or other
filings or actions with respect to the Merger Agreement and the transactions
contemplated thereby; (iv) the Merger Agreement not (a) contravening or
conflicting with their charters or bylaws; (b) contravening or conflicting
with any law, regulation, judgment, injunction, order or decree binding upon
or applicable to FHS or any subsidiary of FHS or any of their respective
properties or assets; (c) conflicting with (1) any agreement, contract or
other instrument binding upon FHS or any of its subsidiaries or, (2) any
license, franchise, permit or other similar authorization held by FHS or any
of its subsidiaries; or (d) resulting in the creation or imposition
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of any Lien on any material asset of FHS or any of its subsidiaries; except
with respect to clauses (b), (c) and (d) for contraventions or conflicts which
would not have a Material Adverse Effect on FHS or impair the ability of FHS
and Merger Sub to consummate the transactions contemplated by the Merger
Agreement or prevent or materially delay the consummation of any of the
transactions contemplated by the Merger Agreement; (v) documents filed by FHS
with the Commission and FHS' financial statements and the accuracy of
information contained therein since January 1, 1995; (vi) the accuracy of
information supplied by FHS or Merger Sub for inclusion in this Proxy
Statement; (vii) operations of Merger Sub; and (viii) brokers' and finders'
fees and expenses.
Business of the Company Pending the Merger
The Company has agreed that, except as disclosed, from the date of the
Merger Agreement to the Effective Time or earlier termination of the Merger
Agreement, it will, and it will cause each of its subsidiaries to, conduct its
operations according to its ordinary and usual course of business consistent
with past practice and, to the extent consistent therewith, use its reasonable
best efforts to preserve intact its current business organizations, keep
available the service of its current officers and employees and preserve its
relationships with customers, suppliers and others having business dealings
with it to the end that goodwill and ongoing businesses will not be impaired.
The Company has agreed that, except as disclosed and except as otherwise
expressly permitted in the Merger Agreement prior to the Effective Time,
neither it nor any of its subsidiaries will: (a) except for shares of Class A
Common Stock to be issued or delivered in connection with the exercise of
Employee Options outstanding on the date of the Merger Agreement in accordance
with their current terms, issue, deliver, sell, dispose of, pledge or
otherwise encumber, or authorize or propose the issuance, sale, disposition or
pledge or other encumbrance of (A) any additional shares of capital stock of
any class (including the shares of Common Stock), or any securities or rights
convertible into, exchangeable for, or evidencing the right to subscribe for
any shares of capital stock, or any rights, warrants, options, calls,
commitments or any other agreements of any character to purchase or acquire
any shares of capital stock, or (B) any other securities in respect of, in
lieu of, or in substitution for, shares of Common Stock outstanding on the
date of the Merger Agreement; (b) except pursuant to the Plans (as defined in
the Merger Agreement) as in effect on the date of the Merger Agreement,
redeem, purchase or otherwise acquire, or propose to redeem, purchase or
otherwise acquire, any shares of capital stock of the Company or any of its
subsidiaries; (c) split, combine, subdivide or reclassify any of its capital
stock or declare, set aside for payment or pay any dividend, or make any other
actual, constructive or deemed distribution in respect of any of its capital
stock or otherwise make any payments to stockholders of the Company in their
capacity as such, except for dividends payable to the Company declared by any
wholly owned subsidiary of the Company; (d) adopt or propose to adopt a plan
of complete or partial liquidation, dissolution, merger, consolidation,
restructuring, recapitalization or other reorganization of the Company or any
of its subsidiaries (other than the Merger); (e) adopt or propose to adopt any
amendments to its Amended and Restated Certificate of Incorporation or Amended
and Restated Bylaws; (f) waive, amend or otherwise alter the Rights Agreement
or redeem the Rights (as defined in the Rights Agreement); (g) acquire or
agree to acquire by merging or consolidating with, or by purchasing a
substantial portion of the assets of or equity in, or by any other manner, any
business or any corporation, partnership, association or other business
organization or division thereof or otherwise acquire or agree to acquire any
assets, in each case, that are material, individually or in the aggregate, to
the Company and its subsidiaries taken as a whole; (h) sell (including by
sale-leaseback), lease or otherwise dispose of, or agree to sell, lease or
otherwise dispose of, any of its assets that are material, individually or in
the aggregate, to the Company and its subsidiaries taken as a whole; (i) make
or agree to make any capital expenditure or expenditures which, individually,
is in excess of $100,000 or, in the aggregate, are in excess of $500,000
(except as disclosed); (j) enter into any non-competition or other agreement
which may restrict in any way the conduct of the respective businesses of the
Company or any of its subsidiaries; (k) modify its existing provider fee or
rate schedules, the result of which modifications would be, based upon 1996
utilization, an increase in either (i) the aggregate reimbursements to all
physician, hospital and ancillary providers, taken together, or (ii)
reimbursements to any individual physician, hospital or ancillary provider
representing at least $1,000,000 or more in annual payments for services
during 1996; (l) except as required by law, effect material changes to rating
plans or issue new business or renewal quotations to groups of more than 1,000
employees or
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enter into any amendment or modification of any of its agreements with
providers, other than amendments expressly contemplated by the Merger
Agreement, without reasonable evidence that doing so would be in the economic
interests of the Company and would not adversely affect the Company's rights
to medically manage the provision of healthcare except in immaterial respects;
(m) other than in the ordinary course of business consistent with past
practice, incur any indebtedness for borrowed money or guarantee any such
indebtedness or issue or sell any debt securities or guarantee any debt
securities of others, or make any loans, advances or capital contributions to,
or investments in, any other person, other than to the Company or any wholly
owned subsidiary of the Company; (n) except as may be required as a result of
a change in law or in generally accepted accounting principles, change any of
the accounting principles or practices used by it; (o) settle or compromise
any pending or threatened material suit, action or claim relating to the
transactions contemplated by the Merger Agreement; (p) pay, discharge or
satisfy any claims, liabilities or obligations (absolute, accrued, asserted or
unasserted, contingent or otherwise), other than the payment, discharge or
satisfaction in the ordinary course of business consistent with past practice,
or as required by their terms, of liabilities reflected or reserved against
in, or contemplated by, the Company Balance Sheet (as defined in the Merger
Agreement) or the notes thereto or incurred in the ordinary course of business
consistent with past practice or immaterial liabilities not incurred in the
ordinary course of business consistent with past practice; (q) increase in any
manner the compensation or fringe benefits of any of its directors, officers
or other employees receiving an annual salary in excess of $40,000, or pay any
pension or retirement allowance not required by any existing plan or agreement
to any such employees, or become a party to, amend or commit itself to any
pension, retirement, profit-sharing or welfare benefit plan or agreement or
employment agreement with or for the benefit of any employee (other than
increases in the compensation of employees who are not officers or directors
of the Company made in the ordinary course of business consistent with past
practice) or voluntarily accelerate the vesting of any compensation or
benefit; (r) waive, amend or allow to lapse any term or condition of any
confidentiality or "standstill" agreement to which the Company is a party; or
(s) take, or agree in writing or otherwise to take, any of the foregoing
actions.
Stockholder Meeting
The Merger Agreement provides that the Board of Directors of the Company
will be permitted to (i) not recommend to the Company's stockholders that they
vote in favor of the approval and adoption of the Merger Agreement or (ii)
withdraw or modify in a manner adverse to FHS its recommendation to the
Company's stockholders that they vote in favor of the approval and adoption of
the Merger Agreement, but in each of cases (i) and (ii) only if and to the
extent that the Company has complied with the requirements set forth in "--No
Solicitation" below, a Superior Proposal (as defined below) is pending at the
time the Company's Board of Directors determines to take any such action or
inaction and the Company's Board of Directors determines in good faith, based
upon the advice of its outside legal counsel, that such action or inaction is
necessary for such Board of Directors to comply with its fiduciary duties
under applicable law; provided that no such failure to recommend, withdrawal
or modification will be made unless the Company has delivered to FHS a written
notice advising FHS that the Board of Directors of the Company has received a
Superior Proposal and identifying the person making such Superior Proposal;
provided, further, that nothing contained in the Merger Agreement will prevent
the Board of Directors of the Company from complying with Rule 14e-2 under the
Exchange Act with regard to an Acquisition Proposal (as defined below).
"Superior Proposal" means any bona fide written Acquisition Proposal for all
of the outstanding shares of Common Stock or all or substantially all of the
assets of the Company and its subsidiaries on terms that the Board of
Directors of the Company determines in good faith (based on the advice of a
financial advisor of nationally recognized reputation) are more favorable and
provide greater value to all the Company's stockholders than the Merger
Agreement and the Merger. "Acquisition Proposal" means any offer or proposal
for, or any indication of interest in, a merger or other business combination
involving the Company or any Significant Subsidiary of the Company or the
acquisition of any equity interest in, or a substantial portion of the assets
of, the Company or any Significant Subsidiary of the Company, other than the
transactions contemplated by the Merger Agreement.
No Solicitation
The Merger Agreement provides that the Company will not directly or
indirectly, through any officer, director, employee, investment banker,
attorney, representative or agent of the Company or any of its
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subsidiaries, (i) solicit, initiate, or encourage any inquiries or proposals
that constitute, or could reasonably be expected to lead to, an Acquisition
Proposal, (ii) engage in negotiations or discussions concerning, or provide
any non-public information or data to any person or entity relating to, any
Acquisition Proposal, or (iii) agree to, approve or recommend any Acquisition
Proposal, or otherwise facilitate any effort or attempt to make or implement
an Acquisition Proposal; provided, however, that nothing contained in the
Merger Agreement will prevent the Company or its Board of Directors from (A)
furnishing non-public information or data to, or entering into discussions or
negotiations with, any person in connection with an unsolicited Acquisition
Proposal, if and only to the extent that the Board of Directors of the Company
determines in good faith, based upon the advice of its outside legal counsel,
that such action is necessary for such Board of Directors to comply with its
fiduciary duties under applicable law and prior to furnishing such non-public
information to, or entering into discussions or negotiations with, such person
or entity, the Company or its Board of Directors receives from such person or
entity an executed customary confidentiality agreement, provided, that in the
event that any term of such confidentiality agreement is more favorable to
such person or entity than the Confidentiality Agreement dated March 3, 1997
between the Company and FHS (the "Confidentiality Agreement") is to FHS, (x)
the Company will promptly (and in no event later than 24 hours after execution
thereof) notify FHS of the more favorable provisions of such confidentiality
agreement and (y) the Confidentiality Agreement will automatically be deemed
to have been amended to provide FHS with the benefit of the more favorable
term(s); or (B) complying with Rule 14e-2 promulgated under the Exchange Act
with regard to an Acquisition Proposal.
Under the terms of the Merger Agreement, the Company is required to (i)
promptly (and in no event later than 24 hours after receipt of any Acquisition
Proposal) notify FHS after receipt by it (or its advisors) of any Acquisition
Proposal or any inquiries indicating that any person is considering making or
wishes to make an Acquisition Proposal, identifying such person, (ii) promptly
notify FHS after receipt of any request for non-public information relating to
it or any of its subsidiaries or for access to its or any of its subsidiaries'
properties, books or records by any person, identifying such person and the
information requested by such person, that may be considering making, or has
made, an Acquisition proposal and promptly provide FHS with any non-public
information which is given to such person described above and (iii) keep FHS
advised of the status and principal financial terms of any such Acquisition
Proposal, indication or request. The Company must give FHS at least 24 hours'
advance notice of any information to be supplied to any person making such
Acquisition Proposal.
Indemnification of Directors and Officers
The Merger Agreement provides that from and after the Effective Time, FHS
will, and will cause the Surviving Corporation to, indemnify and hold harmless
all past and present officers, directors, employees and agents (the
"Indemnified Parties") of the Company and of its subsidiaries to the full
extent such persons may be indemnified by the Company pursuant to the
Company's Amended and Restated Certificate of Incorporation and Amended and
Restated Bylaws (or similar charter documents of any of its subsidiaries), in
each case as in effect as of the date of the Merger Agreement, for acts and
omissions occurring at or prior to the Effective Time and will advance
reasonable litigation expenses incurred by such persons in connection with
defending any action arising out of such acts or omissions, provided that such
persons provide the requisite undertaking, as set forth in the Company's
Amended and Restated Bylaws prior to the Effective Time. In addition, the
Merger Agreement provides that FHS will provide, or cause the Surviving
Corporation to provide, for a period of not less than six years after the
Effective Time, the Company's current directors and officers with an insurance
and indemnification policy that provides coverage for events occurring at or
prior to the Effective Time (the "D&O Insurance") that is no less favorable
than the existing policy or, if substantially equivalent insurance coverage is
unavailable, the best available coverage; provided, however, that FHS and the
Surviving Corporation will not be required to pay an annual premium for the
D&O Insurance in excess of one and one-half times the last annual premium paid
prior to the date of the Merger Agreement, but in such case will purchase as
much of such coverage as possible for such amount.
Benefit Plans and Employment Arrangements
The Merger Agreement provides that, except as may be otherwise agreed to by
FHS and the Company, the Company Stock Plans will terminate as of the
Effective Time. Prior to the Effective Time, the Board of Directors
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of the Company (or, if appropriate, any committee thereof) will adopt such
resolutions or take such other actions as are required to (i) effect the
transactions contemplated by "--Employee Options" above and (ii) with respect
to any stock option, stock appreciation or other stock benefit plan of the
Company or any of its subsidiaries not addressed by the preceding clause (i),
ensure that, following the Effective Time, no participant therein will have
any right thereunder to acquire any capital stock of the Surviving Corporation
or any subsidiary thereof.
FHS has agreed that, for the period from the Effective Time through December
31, 1997, FHS will maintain employee compensation and benefit plans and
arrangements that will provide benefits comparable to those provided to
similarly situated employees of FHS and its subsidiaries. FHS shall also
provide severance pay and benefits no less favorable than those provided under
its severance plans and practices as in effect on the date of execution of the
Merger Agreement. The Company's employees will be given credit for all service
with the Company and its subsidiaries under all employee benefit plans and
arrangements of FHS or any of its subsidiaries in which such employees become
participants for purposes of eligibility and vesting to the same extent as if
rendered to FHS or any of its subsidiaries. The Company's employees shall also
be given credit for any deductible or co-payment amounts paid in respect of
the Plan (as defined in the Merger Agreement) year in which the Effective Time
occurs, to the extent that, following the Effective Time, such employees
participate in any employee benefit plan of FHS for which deductibles or co-
payments are required. FHS will also cause each of its employee benefit plans
to waive (i) any preexisting condition restriction which was waived under the
terms of any analogous Plan immediately prior to the Effective Time or (ii)
waiting period limitation which would otherwise be applicable to an employee
of the Company on or after the Effective Time to the extent such employee had
satisfied any similar waiting period limitation under an analogous Plan prior
to the Effective Time. FHS shall assume the Company's obligations to its
employees with respect to accrued vacation, sick and personal days to the
extent reflected on the Company Balance Sheet.
Robert L. Natt, Co-Chief Executive Officer and President of the Company, and
Paul M. Philpott, Senior Vice President and Chief Marketing Officer of the
Company, each will enter into new employment agreements with FHS, which will
become effective as of the Effective Time, with an initial term through
December 31, 2000. Under Mr. Natt's new employment agreement, he will serve as
chief executive officer of FHS' Greater New York City operations, reporting
directly to the President of FHS, and will receive an annual salary of
$320,000. Mr. Natt will also receive a $46,500 signing bonus and will
participate in FHS' bonus plan and stock-based incentive programs. Mr. Natt
will receive a special 150,000 share option grant in respect of the initial
term of the agreement and will receive a $500,000 retention bonus, payable in
equal installments, on the first and second anniversaries of the Effective
Time. Under Mr. Philpott's new employment agreement, he will receive an annual
salary of $250,000. Mr. Philpott will receive a $350,000 retention bonus
payable in equal installments on the first and second anniversaries of the
Effective Time. Mr. Philpott will participate in FHS' bonus plan and stock-
based incentive programs. Mr. Philpott will receive a special 50,000 share
option grant in respect of the initial term of the agreement. FHS has agreed
to recommend to the FHS Committee that the special option grants to Messrs.
Natt and Philpott be on terms (with respect to the exercise price, term and
exercisability) that are identical to similar special grants which may be made
by FHS in 1997. FHS has agreed to recommend to the FHS Committee that the
special options granted to Messrs. Natt and Philpott will become immediately
exercisable if such executive's employment is involuntarily terminated by FHS
without "cause" or if such executive terminates employment for "good reason."
It is currently anticipated that the special option grants to Messrs. Natt and
Philpott will be made under FHS's stock option plan, pursuant to which the
exercise price of options may not be less than 100% of the fair market value
of the shares subject to such options on the date of grant. The retention
bonus for each of Messrs. Natt and Philpott is payable sooner, if such
executive's employment is involuntarily terminated by FHS without "cause" or
if such executive terminates employment for "good reason." In addition, if
during the two years immediately following the Effective Time Mr. Natt or Mr.
Philpott is involuntarily terminated by FHS without "cause" or if either
executive terminates employment for "good reason", he will be entitled to
severance in a lump sum equal to 1.5 to 2.99 times (depending upon when, and
the circumstances under which, the termination occurs) his then current salary
and he shall receive medical benefits for one year (offset by medical benefits
provided to him by a subsequent employer). Following the initial two-year
period, each of Messrs. Natt and Philpott is entitled to receive severance in
a lump-sum
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amount equal to 18 months' salary (at the rate then in effect) if he is
terminated or if his employment agreement is not renewed at the end of its
term. Messrs. Natt and Philpott are also entitled to receive certain fringe
benefits commensurate with their positions. FHS will make each executive whole
for any excise tax imposed under Section 4999 of the Internal Revenue Code of
1986, as amended (the "Code"), which arises from the transactions contemplated
by the Merger Agreement and will provide each executive with additional
severance benefits consistent with those provided to similarly situated
executives of FHS following a change in control of FHS, subject to golden
parachute limitations under Section 280G of the Code.
The employment of James L. Elrod, Jr., Executive Vice President and Chief
Financial Officer, and Regina M. Campbell, Senior Vice President and Chief
Administrative Officer, will be terminated as of the Effective Time. In
satisfaction of their existing employment agreements and conditional
employment agreements with the Company, Mr. Elrod and Ms. Campbell will
receive a net cash payment, which after payment of all applicable taxes will
be $1,500,000 and $1,250,000, respectively, and lifetime medical benefits. The
foregoing amounts include the after tax amount of the value of any stock
options held by Mr. Elrod and Ms. Campbell, respectively, that will vest as a
result of the Merger.
Conditions to Obligations of FHS and Merger Sub
The obligations of FHS and Merger Sub under the Merger Agreement to
consummate the Merger are subject to the satisfaction or waiver by FHS, at or
prior to the Effective Time, of each of the following conditions: (a)(i) the
Company shall have performed in all material respects all of its material
obligations and complied in all material respects with all of its material
agreements and covenants to be performed or complied with by it under the
Merger Agreement at or prior to the Effective Time; (ii) the representations
and warranties of the Company shall be true and accurate at the date of the
Merger Agreement and as of the Effective Time with the same force and effect
as if they had been made as of the Effective Time (except to the extent a
representation or warranty speaks specifically as of an earlier date and
except as contemplated by the Merger Agreement), except, in each case, for
inaccuracies in any such representations and warranties that would not,
individually or in the aggregate, have or reasonably be expected to have a
Material Adverse Effect on the Company and the Surviving Corporation; and
(iii) the Company shall have provided FHS with a certificate executed by two
executive officers of the Company, dated as of the Effective Date, to such
effect.
Conditions to Obligations of the Company
The obligation of the Company under the Merger Agreement to consummate the
Merger is subject to the satisfaction or waiver by the Company, at or prior to
the Effective Time, of the following conditions: (i) FHS shall have performed
in all material respects all of its material obligations and complied in all
material respects with all of its material agreements and covenants to be
performed or complied with by it under the Merger Agreement at or prior to the
Effective Time; (ii) the representations and warranties of FHS shall be true
and accurate at the date of the Merger Agreement and as of the Effective Time
with the same force and effect as if they had been made as of the Effective
Time (except to the extent a representation or warranty speaks specifically as
of an earlier date and except as contemplated by the Merger Agreement) except,
in each case, for inaccuracies in any such representations and warranties that
would not, individually or in the aggregate, have or reasonably be expected to
have a Material Adverse Effect on FHS; and (iii) FHS shall have provided the
Company with a certificate executed by two executive officers of FHS, dated as
of the Effective Date, to such effect.
Conditions to Obligations of Each Party
The respective obligations of the Company, on the one hand, and FHS and
Merger Sub, on the other hand, to consummate the Merger are further subject to
the satisfaction or waiver, at or prior to the Effective Time, of each of the
following conditions: (a) the Company's Stockholders shall have approved and
adopted the Merger Agreement (the "Company Stockholder Approval"); (b) no
statute, rule, regulation, executive order, decree, injunction or restraining
order shall have been enacted, promulgated or enforced (and not repealed,
superseded or otherwise made inapplicable) by any court of competent
jurisdiction or other governmental entity which
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prohibits the consummation of the transactions contemplated by the Merger
Agreement or imposes material conditions with respect thereto (collectively,
"Restraints"); provided, however, that the party asserting the failure of this
condition will have used reasonable best efforts to prevent the entry of any
such Restraint and, if applicable to such party, to appeal promptly any such
Restraints that may be entered; (c) the parties to the Merger Agreement shall
have made the requisite filings with all governmental entities as required
pursuant to applicable laws, rules and regulations, and such governmental
entities (including, but not limited to, the Insurance Departments of the
States of Connecticut, New Jersey and New York, to the extent required by
applicable law, will have approved the transactions contemplated by the Merger
Agreement, except where the failure to obtain any such approval would not,
individually or in the aggregate, have a Material Adverse Effect on FHS and
the Surviving Corporation, taken as a whole, or upon the consummation of the
transactions contemplated thereby; and (d) the waiting period (and any
extension thereof) applicable to the Merger under the Hart-Scott-Rodino Act of
1976, as amended (the "HSR Act"), shall have expired or been terminated.
Termination
The Merger Agreement may be terminated at any time prior to the Effective
Time whether before or after the approval by the stockholders of the Company:
(a) by mutual written consent of FHS and the Company;
(b) by either FHS or the Company (i) if the Effective Date has not
occurred on or before March 31, 1998, subject to the two business day
period as set forth in the Merger Agreement (ii) if any governmental
entity, the approval of which is a condition to the obligations of FHS,
Merger Sub and the Company to consummate the Merger, has determined not to
grant its approval and all appeals of such determination have been taken
and have been unsuccessful or (iii) if any court of competent jurisdiction
has issued an order, judgment or decree (other than a temporary restraining
order or temporary injunction) restraining, enjoining or otherwise
prohibiting the Merger and such order, judgment or decree has become final
and nonappealable; provided, however, that the right to terminate the
Merger Agreement pursuant to clause (i) will not be available to any party
whose failure to fulfill any obligation under the Merger Agreement has been
the cause of, or resulted in, the failure of the Effective Date to occur on
or before such date;
(c) by either FHS or the Company, if, at the Meeting (including any
adjournment or postponement thereof), the Company Stockholder Approval has
not been obtained;
(d) by FHS (i) if there has been a breach by the Company of any
representation or warranty set forth in the Merger Agreement, which breach
would give rise to the failure of certain conditions set forth in the
Merger Agreement, which has not been cured within 15 business days
following receipt by the Company of written notice of such breach; (ii) if
there has been a breach by the Company of any covenant or agreement set
forth in the Merger Agreement, which breach would give rise to the failure
of certain conditions set forth in the Merger Agreement, which has not been
cured within 15 business days following receipt by the Company of written
notice of such breach; or (iii) if the Board of Directors of the Company
has failed to recommend or withdrawn or modified or changed in a manner
adverse to FHS its approval or recommendation of the Merger Agreement, or
recommended an Acquisition Proposal or has entered into a definitive
agreement providing for the transaction or transactions contemplated by an
Acquisition Proposal (or the Board of Directors of the Company has resolved
to do any of the foregoing); provided, however, that the right to terminate
the Merger Agreement pursuant to subsections (i) or (ii) of this paragraph
(d) will not be available to FHS if it, at such time, is in breach of any
representation, warranty, covenant or agreement set forth in the Merger
Agreement, which breach would give rise to the failure of certain
conditions set forth in the Merger Agreement, which has not been cured
within 15 business days following receipt by FHS of written notice of such
breach;
(e) by the Company (i) if there has been a breach by FHS of any
representation or warranty set forth in the Merger Agreement, which breach
would give rise to the failure of certain conditions set forth in the
Merger Agreement, which has not been cured within 15 business days
following receipt by FHS of written notice of such breach; (ii) if there
has been a breach by FHS of any covenant or agreement set forth in the
Merger Agreement, which breach would give rise to the failure of certain
conditions set forth in the Merger
44
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Agreement, which has not been cured within 15 business days following
receipt by FHS of written notice of such breach; or (iii) subject to the
provisions set forth in "--Certain Actions Prior to Termination" below, if
the Board of Directors of the Company has failed to recommend or withdrawn
or modified or changed in a manner adverse to FHS its approval or
recommendation of the Merger Agreement in order to permit the Company to
execute a definitive agreement providing for the transaction or
transactions contemplated by a Superior Proposal; provided, however, that
the right to terminate the Merger Agreement pursuant to subsections (i) or
(ii) of this paragraph (e) will not be available to the Company if it, at
such time, is in breach of any representation, warranty, covenant or
agreement set forth in the Merger Agreement, which breach would give rise
to the failure of certain conditions set forth in the Merger Agreement,
which has not been cured within 15 business days following receipt by the
Company of written notice of such breach;
(f) by FHS at any time following the date 30 days after notice is
delivered by the Company as required in the Merger Agreement concerning the
receipt of an Acquisition Proposal unless, prior to termination under this
paragraph (f), the Company provides written notice to FHS that such
Acquisition Proposal has been rejected or withdrawn or the Company is no
longer engaged in negotiations or discussions with such other person
concerning the Acquisition Proposal; provided that the 30-day time period
will be reduced with respect to any subsequent Acquisition Proposal made by
a person whose Acquisition Proposal was previously rejected or withdrawn as
provided in this paragraph (f) to a number of days equal to the greater of
(i) 30 minus the number of days lapsed from the receipt of any notice of
any prior Acquisition Proposal from such person until the rejection or
withdrawal of any such prior Acquisition Proposal(s) and (ii) 10.
Certain Actions Prior to Termination
Pursuant to the Merger Agreement, the Company is required to provide FHS the
written notice required by paragraph (b) under "--No Solicitation" above prior
to any termination of the Merger Agreement pursuant to paragraph (e)(iii)
under "--Termination" above advising FHS that the Board of Directors of the
Company has received a Superior Proposal. At any time after the third business
day following such notice, the Company may terminate the Merger Agreement as
provided in paragraph (e)(iii) under "--Termination" above only if (i) the
Board of Directors of the Company determines that such Superior Proposal
remains more favorable and provides greater value to the Company's
stockholders than the Merger Agreement and the Merger (which determination
will be made in light of any revised proposal made by FHS prior to the
expiration of such three business day period) and (ii) the termination fee
contemplated by "--Termination Fees" below has been paid to FHS.
Termination Fees
The Merger Agreement provides that (a) notwithstanding any other provision
of the Merger Agreement, so long as the Company is not entitled to terminate
the Merger Agreement by reason of paragraph (e)(ii) under "--Termination"
above, (i) if the Merger Agreement is terminated pursuant to paragraphs
(d)(iii) or (e)(iii) under "Termination" above, then the Company will promptly
pay to FHS a fee of $9 million (the amount of such fee being hereinafter
referred to as the "Termination Fee"), plus an amount equal to all of the
costs and expenses incurred by FHS and Merger Sub in connection with the
Merger Agreement and the transactions contemplated thereby (upon receipt of
reasonable documentation in respect thereto) up to an aggregate of $2.5
million (the "Termination Expenses"); (ii) if the Merger Agreement is
terminated pursuant to paragraph (c) under "--Termination" above, then the
Company will promptly pay to FHS an amount equal to the Termination Expenses;
(iii) if within 12 months of a termination of the Merger Agreement pursuant to
paragraph (c) under "--Termination" above, the Company or any of its
subsidiaries accepts a written offer for, or otherwise enters into an
agreement to consummate or consummates, a Transaction Proposal (as defined
below) with another person, upon the signing of a definitive agreement
relating to such Transaction Proposal, or, if no such agreement is signed,
then upon consummation of any such Transaction Proposal, the Company will pay
to FHS an amount equal to the Termination Fee; or (iv) if within 12 months of
the termination of the Merger Agreement pursuant to paragraph (f) under "--
Termination" above, the Company or any of its subsidiaries accepts a written
offer for, or otherwise enters into an agreement to consummate or consummates,
a Transaction Proposal with another person, upon the signing of a definitive
agreement relating to such Transaction Proposal, or, if no such agreement
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<PAGE>
is signed, then upon consummation of any such Transaction Proposal, the
Company will pay to FHS an amount equal to the Termination Fee. "Transaction
Proposal" means a proposal or offer (other than by another party to the Merger
Agreement) (i) to acquire beneficial ownership (as defined under Rule 13(d) of
the Exchange Act) of 50% or more of the outstanding capital stock of the
Company or any of its subsidiaries holding substantially all of the assets of
the Company and its subsidiaries pursuant to a merger, consolidation or other
business combination, sale of shares of capital stock, tender offer or
exchange offer or similar transaction, including, without limitation, any
single or multi-step transaction or series of related transactions which is
structured to permit such third party to acquire beneficial ownership of 50%
or more of the outstanding capital stock of the Company or any of its
subsidiaries holding substantially all of the assets of the Company and its
subsidiaries, (ii) to purchase all or substantially all of the business or
assets of the Company and its subsidiaries or (iii) to otherwise effect a
business combination involving the Company or any of its subsidiaries holding
substantially all of the assets of the Company and its subsidiaries.
Expenses
The Merger Agreement provides that except as otherwise provided therein
regarding termination fees and expenses and in addition to the amounts that
may be owed pursuant to the Merger Agreement regarding termination fees and
expenses, all costs and expenses incurred in connection with the Merger
Agreement and the transactions contemplated thereby will be paid by the party
incurring such expenses, except that the liability, if any, for New York State
Real Estate Transfer Tax, New York City Real Property Transfer Tax and
Connecticut Controlling Interest Transfer Tax, if and to the extent applicable
and due with respect to the Merger, will be borne by the Surviving
Corporation.
Amendment and Waivers
Any term or provision of the Merger Agreement may be amended, and the
observance of any term of the Merger Agreement may be waived (either generally
or in a particular instance and either retroactively or prospectively) only by
a writing signed by the party to be bound thereby. The waiver by a party of
any breach thereof or default in the performance thereof will not be deemed to
constitute a waiver of any other default or any succeeding breach or default,
unless such waiver so expressly states. At any time before or after the
Company Stockholder Approval and prior to the Effective Time, the Merger
Agreement may be amended or supplemented by the parties thereto with respect
to any of the terms contained in the Merger Agreement, except that following
the Company Stockholder Approval there will be no amendment or change to the
provisions thereof with respect to the Merger Consideration without further
approval by the stockholders of the Company, and no other amendment will be
made which by law requires further approval by such stockholders without such
further approval.
THE VOTING TRUST AGREEMENT
The description of the Voting Trust Agreement contained in this Proxy
Statement does not purport to be complete and is qualified in its entirety by
reference to the Voting Trust Agreement, a copy of which is attached hereto as
Appendix C.
In connection with the execution of the Merger Agreement, the Company, the
Voting Trustee and GBIPA entered into the Voting Trust Agreement. Pursuant to
the Voting Trust Agreement, (a) GBIPA transferred to the Voting Trustee
2,401,021 shares of Class B Common Stock (such shares, together with the
associated Rights, the "GBIPA Class B Common Stock"), of a total of 2,501,021
shares of Class B Common Stock owned by GBIPA, by delivering to the Company
certificates representing such GBIPA Class B Common Stock together with an
executed stock power transferring such certificates to the Voting Trustee, (b)
the Company cancelled the certificate representing the GBIPA Class B Common
Stock, issued a new certificate therefor in the name of "American Stock
Transfer & Trust Company, as Voting Trustee" (such GBIPA Class B Common Stock,
the "Voting Trust Stock") and delivered such new certificate to the Voting
Trustee; (c) the Voting Trustee accepted the trust created by the Voting Trust
Agreement and holds the Voting Trust Stock as stockholder of record,
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subject to the terms and conditions of the Voting Trust Agreement, for the
benefit of GBIPA as the beneficial owner thereof; and (d) the Voting Trustee
issued to GBIPA, in exchange for the GBIPA Class B Common Stock, a voting
trust certificate (the "Trust Certificate").
Pursuant to the Voting Trust Agreement, the Voting Trustee has agreed to (i)
appear at any annual or special meeting of the stockholders of the Company for
the purpose of obtaining a quorum; (ii) vote all of the Voting Trust Stock in
favor of the approval and adoption of the Merger Agreement, and (iii) vote all
of the Voting Trust Stock against (A) any extraordinary corporate transaction
(other than the Merger), such as a merger, consolidation, business
combination, reorganization, recapitalization or liquidation involving the
Company or any of its subsidiaries, including, but not limited to, any
Transaction Proposal (as defined in "PROPOSAL ONE--THE MERGER--The Merger
Agreement--Termination Fees"), and (B) any sale or transfer of a material
amount of the assets or securities of the Company or any of its subsidiaries
(other than pursuant to the Merger). The Voting Trustee agreed to vote on all
issues other than those specified in the preceding sentence that come before
any meeting of stockholders of the Company as directed by GBIPA.
At the Record Date, the Voting Trust Stock represented approximately 58.3%
of the combined voting power of the outstanding Common Stock, and therefore
the approval and the adoption of the Merger Agreement is assured.
Pursuant to the terms of the Voting Trust Agreement, (i) the Voting Trustee
has agreed not to transfer, directly or indirectly, any Voting Trust Stock or
any interest therein, and (ii) GBIPA has agreed (a) not to transfer, directly
or indirectly, any Trust Certificate or the Voting Trust Stock or any interest
therein or (b) exercise, or cause the Voting Trustee to exercise, the option
to convert any Voting Trust Stock into Class A Common Stock.
Pursuant to the Voting Trust Agreement, the Company has agreed that it will
not amend or otherwise modify any provision of the Merger Agreement the effect
of which would result in a reduction of the Merger Consideration without the
prior written consent of GBIPA. GBIPA has given its consent to Amendment No.
1.
The Company has agreed to indemnify the Voting Trustee from any loss, cost
or expense of any kind in connection with the Voting Trust Agreement, except
those losses, expenses and costs, if any, resulting from the gross negligence,
willful misconduct or bad faith of the Voting Trustee, and has agreed to pay
all costs and expenses of any suit or litigation with respect to the Voting
Trust Stock or the Voting Trust Agreement, and if the Voting Trustee is made a
party thereto, the Company has agreed to pay all costs and expenses, including
counsel fees, to which the Voting Trustee may be subject by reason thereof.
The Company has also agreed to pay the Voting Trustee reasonable and customary
compensation for all services rendered by it as Voting Trustee.
The Voting Trust Agreement will terminate upon the earliest to occur of (i)
60 days after the termination of the Merger Agreement in accordance with its
terms (see "--The Merger Agreement--Termination"), (ii) the Effective Time,
(iii) June 1, 1998 and (iv) a breach by the Company of its obligation not to
amend or otherwise modify any provision in the Merger Agreement the effect of
which would result in a reduction of the Merger Consideration without the
prior written consent of GBIPA; provided, that the Company's obligation to
indemnify the Voting Trustee pursuant to the Voting Trust Agreement will
survive any termination of the Voting Trust Agreement.
AMENDMENT TO GBIPA SERVICE AGREEMENT
GBIPA, which prior to entering into the Voting Trust Agreement owned
approximately 70.5% of the outstanding Class B Common Stock representing
approximately 60.5% of the combined voting power of the Common Stock,
currently provides service for approximately 30% of the Company's enrollees
pursuant to the Service Agreement. The Service Agreement is currently set to
expire on December 31, 1997. In contemplation of the Merger, and in order to
integrate the existing Connecticut provider networks of the Company and FHS,
GBIPA, FHS, the Company and PHS/CT have entered into the GBIPA Agreement which
specifies that, upon
47
<PAGE>
consummation of the Merger, (a) the Service Agreement will be amended so as to
provide for, among other things, (i) the extension of the term of the Service
Agreement for an additional year to December 31, 1998 and (ii) the adoption of
utilization management, quality assurance and credentialing standards as well
as capitation rates, fee schedules and other economic terms in order to make
such terms equivalent to those contained in the provider agreement between
M.D. Health Plan, FHS' Connecticut HMO subsidiary, and Connecticut State
Medical Society IPA, Inc., M.D. Health Plan's current physician provider, and
(b) the Company will pay $6,500,000 to GBIPA in consideration for such
amendment.
THE MEDICAL MANAGEMENT AGREEMENT
FHS began providing medical management services to the Company following
execution of the Original Merger Agreement under an informal arrangement. On
December 10, 1997, the Company executed a formal Medical Management Agreement
with FHS confirming the informal arrangement and the agreements reached
between FHS and the Company at the time of execution of Amendment No. 1. Under
the Medical Management Agreement, if certain medical utilization targets are
met, as measured at the time of consummation of the Merger, FHS will receive a
payment of $5 million, subject to consummation of the Merger. If, as
anticipated, the Merger is consummated promptly after the Meeting, the Company
expects that the targets will be met and the payment will be made.
ACCOUNTING TREATMENT
The Merger will be accounted for as a purchase under generally accepted
accounting principles. Under this method of accounting, all identifiable
assets and liabilities of the Company will be adjusted to fair value at the
effective date of the Merger and any excess of the Merger Consideration over
the fair value of the underlying net assets of the Company is recorded as
goodwill. Accordingly, a determination of the fair value of the Company's
assets and liabilities will be made in order to allocate the purchase price to
the assets acquired and the liabilities assumed.
REGULATORY MATTERS
Federal
Under the HSR Act, and the rules promulgated thereunder by the Federal Trade
Commission (the "FTC"), the Merger may not be consummated until notifications
have been given and certain information has been furnished to the FTC and the
Antitrust Division of the Department of Justice and specified waiting period
requirements have been satisfied. The Company and FHS filed their respective
notification and report forms under the HSR Act on May 27, 1997, and jointly
requested early termination of the waiting period, which request was granted
effective June 4, 1997.
Federal and state antitrust enforcement authorities frequently scrutinize
the legality under the antitrust laws of mergers such as the Merger. At any
time before or after the effectiveness of the Merger, and notwithstanding that
the HSR Act waiting period has expired, any such agency could take any action
under the antitrust laws that it deems to be in the public interest. Such
action could include seeking to enjoin the consummation of the Merger or
seeking divestiture of businesses of the Company and FHS acquired as a result
of the Merger. Private parties may also bring legal actions under the
antitrust laws under certain circumstances.
Based on information available to it, the Company believes that the Merger
can be effected in compliance with federal and state antitrust laws. However,
there can be no assurance that a challenge to the consummation of the Merger
on antitrust grounds will not be made or that, if such a challenge were made,
the Company and FHS would prevail or would not be required to accept certain
conditions in order to consummate the Merger. The Company and FHS are
obligated to complete the Merger unless there is an order of a court of
competent jurisdiction enjoining them from doing so.
Connecticut
PHS Insurance of Connecticut, Inc., a wholly-owned subsidiary of the
Company, is licensed in Connecticut as an insurance company, and Physicians
Health Services of Connecticut, Inc., also a wholly-owned subsidiary
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of the Company, is licensed in Connecticut as a health care center
(Connecticut's statutory term for a health maintenance organization)
(collectively, the "Connecticut Subsidiaries"). Because the Merger will result
in a change of control of the Connecticut Subsidiaries, the Merger is subject
to review and approval by the Commissioner of the Connecticut Department of
Insurance. FHS filed applications for such approval on June 12, 1997. A
hearing on such applications was held on August 29, 1997.
New York
Physicians Health Services Insurance of New York, Inc., a wholly-owned
subsidiary of the Company, holds an insurance license in the State of New
York, and Physicians Health Services of New York, Inc. is licensed in New York
as a health maintenance organization (collectively, the "New York
Subsidiaries"). Because the Merger will result in a change in control of the
New York Subsidiaries, the Merger is subject to (i) review and approval by the
Superintendent of the Insurance Department of the State of New York, and (ii)
review and approval by the Commissioner of Health of the State of New York.
FHS filed applications for such approval on June 12, 1997, and such
applications are currently under review.
New Jersey
Physicians Health Services of New Jersey, Inc., a wholly-owned subsidiary of
the Company, is licensed in New Jersey as a health maintenance organization
(the "New Jersey Subsidiary"). Because the Merger will result in a change in
control of the New Jersey Subsidiary, the Merger will require the filing of an
application with, and the approval of, the New Jersey Department of Health and
Senior Services and the New Jersey Department of Banking and Insurance for an
amended Certificate of Authority. The Company filed such application on June
12, 1997, and such application was approved on October 28, 1997.
Approvals are not expected to be obtained from Connecticut and New York
authorities until, at the earliest, late in the fourth quarter of 1997.
Bermuda
Physicians Health Services (Bermuda) Ltd., a wholly-owned subsidiary of the
Company, is licensed as an insurer in Bermuda (the "Bermuda Subsidiary").
Because the Merger will result in a change in control of the Bermuda
Subsidiary, the Company must file a Share Transfer Permission Form with and
receive the approval of the Bermuda Monetary Authority. The Company filed such
form on May 20, 1997.
PRICE RANGE OF CLASS A COMMON STOCK; DIVIDENDS
The Company's Class A Common Stock is traded in the over-the-counter market
on the NASDAQ National Market System under the symbol "PHSV." There is no
market for the Company's Class B Common Stock. The following table sets forth
the range of high and low sale prices for the Class A Common Stock for each of
the periods indicated as reported on the NASDAQ National Market System.
Quotations represent prices between dealers and do not reflect retail mark-
ups, mark-downs or commissions.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
January 1, 1995 through March 31, 1995..................... $33.75 $26.75
<S> <C> <C>
April 1, 1995 through June 30, 1995........................ $34.25 $24.50
July 1, 1995 through September 30, 1995.................... $28.75 $22.00
October 1, 1995 through December 31, 1995.................. $43.25 $27.25
January 1, 1996 through March 31, 1996..................... $40.75 $29.50
April 1, 1996 through June 30, 1996........................ $34.50 $19.75
July 1, 1996 through September 30, 1996.................... $25.50 $14.50
October 1, 1996 through December 31, 1996.................. $20.00 $14.00
January 1, 1997 through March 31, 1997..................... $27.25 $14.75
April 1, 1997 through June 30, 1997........................ $27.64 $17.75
July 1, 1997 through September 30, 1997.................... $28.69 $25.50
October 1, 1997 through December 9, 1997................... $27.88 $25.12
</TABLE>
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<PAGE>
There were an aggregate of 287 holders of record of the Company's Common
Stock as of November 13, 1997 (with 211 stockholders of record of shares of
Class A Common Stock and 76 stockholders of record of shares of Class B Common
Stock). The Company has not paid any dividends on its Common Stock since its
issuance. The Company does not intend to pay any cash dividends in the
foreseeable future. Rather, the Company intends to retain its earnings to
provide for the operation and expansion of its business. The Company's ability
to declare and pay dividends to its stockholders may be dependent upon its
ability to obtain cash distributions from its operating subsidiaries. The
ability to pay dividends is also restricted by insurance and health
regulations applicable to its subsidiaries, as more thoroughly discussed in
its Form 10-K for the fiscal year ended December 31, 1996.
On May 7, 1997, the last full trading day prior to the announcement of the
execution of the Original Merger Agreement, the closing sales price per share
of Class A Common Stock as reported on the NASDAQ National Market System was
$26.94. The highest sales price per share on such date was $27.00, and the
lowest sales price per share on such date was $26.13. On October 17, 1997, the
last full trading day prior to the announcement of the execution of Amendment
No. 1, the closing sales price per share of Class A Common Stock as reported
on the NASDAQ National Market System was $25.63. The highest sales price per
share on such date was $25.63 and the lowest sales price per share on such
date was $25.50.
STOCKHOLDERS ARE URGED TO OBTAIN CURRENT QUOTATIONS FOR THE CLASS A COMMON
STOCK.
APPRAISAL RIGHTS
Stockholders of the Company are entitled to appraisal rights under Section
262. The following discussion is not a complete statement of the law
pertaining to appraisal rights under the DGCL, but rather is only a guide for
a stockholder who wishes to exercise his or her appraisal right, and is
qualified in its entirety by reference to the full text of Section 262 which
is reprinted in its entirety as Appendix D to this Proxy Statement.
Under Section 262, stockholders who follow the procedures set forth in
Section 262 and who have not voted in favor of the Merger will be entitled to
have their shares of Common Stock appraised by the Court of Chancery of the
State of Delaware and to receive, instead of the Merger Consideration, an
amount determined by such court to be the "fair value" of their shares of
Common Stock, exclusive of any element of value arising from the
accomplishment or expectation of the Merger, together with a fair rate of
interest. This right is known as an "appraisal right." If a stockholder wishes
to exercise his or her appraisal right he or she must not vote in favor of the
Merger and must meet certain other conditions. These conditions are set out in
full in Appendix D. Delaware law requires that the Company notify stockholders
not less than 20 days prior to the Meeting that they have a right of appraisal
and provide stockholders with a copy of Section 262. This Proxy Statement
constitutes that notice. If a stockholder does not follow the procedures set
out below and in Appendix D, he or she will lose his or her appraisal right.
ALL REFERENCES IN THIS SUMMARY AND IN SECTION 262 TO A "STOCKHOLDER" OR TO A
"HOLDER" OF SHARES OF COMMON STOCK ARE TO THE RECORD HOLDER OF THE SHARES OF
COMMON STOCK AS TO WHICH AN APPRAISAL RIGHT IS ASSERTED. A PERSON HAVING A
BENEFICIAL INTEREST IN SHARES OF COMMON STOCK HELD OF RECORD IN THE NAME OF
ANOTHER PERSON, SUCH AS A BROKER OR NOMINEE, MUST ACT PROMPTLY TO CAUSE THE
RECORD HOLDER TO FOLLOW THE STEPS SUMMARIZED BELOW PROPERLY AND IN A TIMELY
MANNER TO PERFECT HIS OR HER APPRAISAL RIGHT.
A holder of shares of Common Stock wishing to exercise his or her appraisal
right must deliver to the Company, before the vote on the Merger at the
Meeting, a written demand for appraisal of his or her shares of Common Stock
and must either (i) abstain from voting with respect to the Merger and not
consent thereto in writing, or (ii) vote against the Merger. Because a fully
executed proxy which does not contain voting instructions will, unless
revoked, be voted for the Merger, a holder of shares of Common Stock who votes
by proxy and who wishes to exercise his or her appraisal right must (i) vote
against the Merger, or (ii) abstain from voting on the Merger. A vote against
the Merger, in person or by proxy, will not in and of itself constitute a
written demand for appraisal satisfying the requirements of Section 262, and a
separate written demand for appraisal is required. In addition, a holder of
shares of Common Stock wishing to exercise his or her appraisal right must be
the record holder of such shares on the date the written demand for appraisal
is made and must continue to hold such shares of record until the Effective
Time.
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A demand for appraisal should be executed by or on behalf of the holder of
record, fully and correctly, as his or her name appears on his or her stock
certificates, and must state that the stockholder intends thereby to demand
appraisal of his or her shares of Common Stock in connection with the Merger.
If the shares are owned of record in a fiduciary capacity, such as by a
trustee, guardian or custodian, execution of the demand should be made in that
capacity, and if the shares are owned of record by more than one person, as in
a joint tenancy and tenancy in common, the demand should be executed by or on
behalf of all joint owners. An authorized agent, including two or more joint
owners, may execute a demand for appraisal on behalf of a holder of record;
however, the agent must identify the record owner or owners and expressly
disclose the fact that, in executing the demand, the agent is agent for such
owner or owners. A record holder such as a broker who holds shares of Common
Stock as nominee for several beneficial owners may exercise appraisal rights
with respect to the shares held for one or more beneficial owners while not
exercising such rights with respect to the shares held for other beneficial
owners; in such case, however, the written demand should set forth the number
of shares as to which appraisal is sought and where no number of shares is
expressly mentioned the demand will be presumed to cover all shares of Common
Stock held in the name of the record owner. Stockholders who hold their shares
of Common Stock in brokerage accounts or other nominee forms and who wish to
exercise appraisal rights are urged to consult with their brokers to determine
the appropriate procedures for the making of a demand for appraisal by such a
nominee.
All written demands for appraisal pursuant to Section 262 should be sent or
delivered to the Company at One Far Mill Crossing, P.O. Box 904, Shelton,
Connecticut 06484-0944, attn: Bernard Sherlip, M.D. Written demands for
appraisal pursuant to Section 262 must be received by Company before the
taking of the vote on the Merger, scheduled for December 31, 1997.
Within ten days after the Effective Time, the surviving corporation of the
Merger must notify each holder of shares of Common Stock who has complied with
Section 262 and has not voted in favor of or consented to the Merger of the
date that the Merger has become effective. Within 120 days after the Effective
Time, but not thereafter, the surviving corporation or any holder of shares of
Common Stock who has so complied with Section 262 and is entitled to an
appraisal right under Section 262 may file a petition in the Court of Chancery
of the State of Delaware demanding a determination of the fair value of his or
her shares of Common Stock. The surviving corporation will have no obligation
to file such a petition, and neither the Company nor FHS has any present
intention to cause the surviving corporation to file such a petition.
Accordingly, it is the obligation of the holder of shares of Common Stock to
initiate all necessary action to perfect his or her appraisal right within the
time prescribed in Section 262.
Any holder of shares of Common Stock who has complied with the requirements
for exercise of his or her appraisal rights will be entitled, upon written
request, to receive from the surviving corporation a statement setting forth
the aggregate number of shares of Common Stock not voted in favor of the
Merger and with respect to which demands for appraisal have been received and
the aggregate number of holders of such shares.
If a petition for an appraisal is timely filed by a holder of shares of
Common Stock, the Court of Chancery is empowered to conduct a hearing on such
petition to determine those holders of shares of Common Stock who have
complied with Section 262 and who have become entitled to appraisal rights
thereunder. The Court of Chancery may require the holders of shares of Common
Stock who demanded appraisal of their shares to submit their stock
certificates to the Register in Chancery for notation thereon of the pendency
of the appraisal proceeding; and if any stockholder fails to comply with such
direction, the Court of Chancery may dismiss the proceedings as to such
stockholder.
After determining the holders entitled to appraisal, the Court of Chancery
will appraise the "fair value" of their shares of Common Stock, exclusive of
any element of value arising from the accomplishment or expectation of the
Merger, together with a fair rate of interest, if any, to be paid upon the
amount determined to be the fair value. Stockholders considering seeking
appraisal should be aware that the fair value of their shares of Common Stock
as determined in an appraisal proceeding under Section 262 could be more than,
the same as or less than the Merger Consideration they would receive pursuant
to the Merger if they did not seek appraisal of their shares, and that
investment banking opinions as to fairness from a financial point of view are
not necessarily opinions as
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to fair value under Section 262. The Delaware Supreme Court has stated that
"proof of value by any techniques or methods which are generally considered
acceptable in the financial community and otherwise admissible in court"
should be considered in the appraisal proceeding. In addition, Delaware courts
have decided that the statutory appraisal remedy, depending on factual
circumstances, may or may not be a dissenter's exclusive remedy. The Court of
Chancery will also determine the amount of interest, if any, to be paid upon
the amounts to be received by persons whose shares of Common Stock have been
appraised.
The costs of the appraisal action may be determined by the Court and taxed
upon the parties as the Court deems equitable. Each party must bear his or her
own other expenses of the proceeding, although the Court may order that all or
a portion of the expenses incurred by any stockholder in connection with an
appraisal, including, without limitation, reasonable attorneys' fees and the
fees and expenses of experts utilized in the appraisal proceeding, be charged
against the value of all of the shares of Common Stock entitled to be
appraised.
Any holder of shares of Common Stock who duly demands appraisal in
compliance with Section 262 will not, after the Effective Time, be entitled to
vote his or her shares for any purpose or be entitled to the payment of
dividends or other distributions on those shares (except dividends or other
distributions payable to holders of record as of a record date prior to the
Effective Time).
If any stockholder who demands appraisal of his or her shares of Common
Stock under Section 262 fails to perfect, or effectively withdraws or loses,
his or her right to appraisal, the shares of such stockholder will be
converted into the right to receive the Merger Consideration pursuant to the
Merger Agreement as described herein (without interest). A stockholder will
fail to perfect, or will effectively lose or withdraw, his or her right to
appraisal if no petition for appraisal is filed within 120 days after the
Effective Time, or if the stockholder delivers to the surviving corporation a
written withdrawal of his or her demand for appraisal and an acceptance of the
Merger, except that any such attempt to withdraw made more than 60 days after
the Effective Time will require the written approval of the surviving
corporation and, once a petition for appraisal is filed, the appraisal
proceeding may not be dismissed as to any holder absent court approval.
FAILURE TO FOLLOW THE STEPS REQUIRED BY SECTION 262 OF THE DGCL FOR
PERFECTING APPRAISAL RIGHTS MAY RESULT IN THE LOSS OF SUCH RIGHTS.
CERTAIN EFFECTS OF THE MERGER
If the Merger is consummated, holders of shares of Common Stock will not
have an opportunity to continue their common equity interest in the Company as
an ongoing operation and therefore will not have the opportunity to share in
its future earnings and potential growth, if any. If the Merger is
consummated, the Company plans to take all necessary actions (i) to de-
register shares of Class A Common Stock under the Exchange Act and (ii) to
terminate inclusion of the shares of Class A Common Stock in the NASDAQ
National Market System.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND EXECUTIVE OFFICERS AND
DIRECTORS
The following table sets forth certain information with regard to the
beneficial ownership of the Common Stock of the Company as of October 15, 1997
by (i) each stockholder who is known by the Company to beneficially own in
excess of 5% of the outstanding shares of Class A or Class B Common Stock,
(ii) each director and each nominee for director, (iii) each executive officer
of the Company named in the table under "Executive Compensation," and (iv) all
officers and directors as a group. Except as otherwise indicated, each
stockholder listed below has sole voting and investment power with respect to
shares beneficially owned by him or her. Class A Common Stock and Class B
Common Stock are identical except for voting and conversion rights. Holders of
Class A Common Stock are entitled to one vote per share and holders of Class B
Common Stock are entitled to ten votes per share on all matters submitted to a
vote of the stockholders. Each share of Class B Common Stock is convertible
into one share of Class A Common Stock.
52
<PAGE>
<TABLE>
<CAPTION>
CLASS A CLASS B
AMOUNT AND AMOUNT
NATURE OF PERCENT AND NATURE PERCENT
NAME AND ADDRESS OF BENEFICIAL OF OF BENEFICIAL OF
BENEFICIAL OWNER OWNERSHIP CLASS A OWNERSHIP CLASS B
------------------- ---------- ------- ------------- -------
<S> <C> <C> <C> <C>
Greater Bridgeport Individual
Practice Association, Inc.
("GBIPA") ................................................ 2,501,021(/2/) 28.9%(/2/) 2,501,021 78.5%
3180 Main Street
Bridgeport, CT 06606
The Guardian Life Insurance
Company of America(/3/)................................... 1,394,200 22.6% -- --
201 Park Avenue South
New York, NY 10003
Michael E. Herbert(/3/)
Physicians Health Services, Inc........................... 600,158(/2/)(/4/) 9.3%(/2/) 278,500(/5/) 8.7%
One Far Mill Crossing
Shelton, CT 06484-0944
Peter M. Schoenfeld(/6/)
P. Schoenfeld Asset Management LLC........................ 339,500 5.5% -- --
1330 Avenue of the Americas
34th Floor
New York, New York 10019
Colonial Individual Practice
Association, Inc. ("CIPA")(/7/)........................... 258,000(/2/) 4.0%(/2/) 258,000 8.1%
Shaws' Cove Six
New London, CT 06320
Heritage Individual Practice
Association, Inc. ("HIPA")................................ 201,700(/2/) 3.2%(/2/) 201,700 6.3%
803 Wooster Heights Road
Bldg 301
Danbury, CT 06810
Lewis Bader, M.D(/8/)..................................... -- -- -- --
Regina M. Campbell........................................ 28,633(/9/) * -- --
Larry Coletti, M.D.(/10/)............................... 3,500(/2/) * 3,000 *
Melvin Coolidge, M.D.(/8/)................................ -- -- -- --
Arnold DoRosario, M.D.(/8/)............................... 500 * -- --
James L. Elrod, Jr........................................ 18,789(/11/) * -- --
Santiago Escobar, M.D.(/8/)............................... -- -- -- --
Richard Freeman........................................... 300 * -- --
David I. Grayer, M.D.(/8/)................................ -- -- -- --
A. Thomas Licciardello, M.D.(/8/)......................... 2,000(/12/) * -- --
Andrew Lozyniak........................................... -- -- -- --
Murray Morrison, M.D.(/8/)................................ -- * -- --
Robert L. Natt............................................ 105,125(/2/)(/13/) 1.7%(/2/) 42,200(/14/) 1.3%
Joseph E. Nechasek........................................ -- * -- --
Noel Newman............................................... -- -- -- --
Richard C. O'Connor, M.D.................................. 50,846(/15/) * -- --
Kenneth Sacks, M.D.(/7/).................................. -- -- -- --
Edward Sawicki, M.D.(/16/).............................. -- -- -- --
Arthur H. Sheer........................................... -- -- -- --
Bernard Sherlip, M.D.(/7/)................................ -- -- -- --
John C. Washburn.......................................... -- -- -- --
All directors and executive officers as a group
(23 persons)(/2/)(/4/)(/5/)(/8/)(/9/)(/10/)(/11/)(/12/)
(/13/)(/14/)(/15/)(/16/)(/17/)........................... 809,851 12.5% 323,700 10.2%
<CAPTION>
PERCENT
OF TOTAL
NAME AND ADDRESS OF VOTING
BENEFICIAL OWNER POWER
------------------- --------
<S> <C>
Greater Bridgeport Individual
Practice Association, Inc.
("GBIPA") ................................................ 65.8%
3180 Main Street
Bridgeport, CT 06606
The Guardian Life Insurance
Company of America(/3/)................................... 3.7%
201 Park Avenue South
New York, NY 10003
Michael E. Herbert(/3/)
Physicians Health Services, Inc........................... 8.2%
One Far Mill Crossing
Shelton, CT 06484-0944
Peter M. Schoenfeld(/6/)
P. Schoenfeld Asset Management LLC........................ *
1330 Avenue of the Americas
34th Floor
New York, New York 10019
Colonial Individual Practice
Association, Inc. ("CIPA")(/7/)........................... 6.8%
Shaws' Cove Six
New London, CT 06320
Heritage Individual Practice
Association, Inc. ("HIPA")................................ 5.3%
803 Wooster Heights Road
Bldg 301
Danbury, CT 06810
Lewis Bader, M.D(/8/)..................................... --
Regina M. Campbell........................................ *
Larry Coletti, M.D.(/10/)................................. *
Melvin Coolidge, M.D.(/8/)................................ --
Arnold DoRosario, M.D.(/8/)............................... *
James L. Elrod, Jr........................................ *
Santiago Escobar, M.D.(/8/)............................... --
Richard Freeman........................................... *
David I. Grayer, M.D.(/8/)................................ --
A. Thomas Licciardello, M.D.(/8/)......................... *
Andrew Lozyniak........................................... --
Murray Morrison, M.D.(/8/)................................ *
Robert L. Natt............................................ 1.3%
Joseph E. Nechasek........................................ *
Noel Newman............................................... --
Richard C. O'Connor, M.D.................................. *
Kenneth Sacks, M.D.(/7/).................................. --
Edward Sawicki, M.D.(/16/)................................ --
Arthur H. Sheer........................................... --
Bernard Sherlip, M.D.(/7/)................................ --
John C. Washburn.......................................... --
All directors and executive officers as a group
(23 persons)(/2/)(/4/)(/5/)(/8/)(/9/)(/10/)(/11/)(/12/)
(/13/)(/14/)(/15/)(/16/)(/17/)........................... 9.8%
</TABLE>
53
<PAGE>
- --------
(1) Based on a total of 6,163,054 shares of Class A Common Stock and
3,185,671 shares of Class B Common Stock as of November 13, 1997. Does
not assume conversion of Class B Common Stock to Class A Common Stock.
(2) Assumes conversion of Class B Common Stock held by such stockholder to
Class A Common Stock, but does not assume conversion of any shares of
Class B Common Stock held by other stockholders.
(3) Based upon information set forth in a Schedule 13D or Schedule 13G filed
by such beneficial owner with the Securities and Exchange Commission.
(4) Includes 9,500 shares of Class A Common Stock owned by Anastacia Herbert,
former spouse of Mr. Herbert, as to which Mr. Herbert has voting control.
Includes 4,670 shares of Class A Common Stock owned by Jacqueline
Herbert, spouse of Mr. Herbert, as trustee, as to which Mr. Herbert
disclaims beneficial ownership. Assumes exercise of 106,269 stock options
currently exercisable into shares of Class A Common Stock. Includes
11,146 shares of Class A Common Stock held in the Company's retirement
plans as of September 30, 1997, the most recent date available.
(5) Includes 7,500 shares of Class B Common Stock owned by Jacqueline
Herbert, spouse of Mr. Herbert, as trustee, as to which Mr. Herbert
disclaims beneficial ownership.
(6) Based upon a Schedule 13D filed with the Commission on September 26, 1997
by Mr. Schoenfeld.
(7) Includes 24,000 shares of Class B Common Stock held directly by members
of CIPA, which shares were subject to a voting trust agreement that
expired on August 16, 1995 and which shares have not yet been distributed
to the individual owners. Under this agreement, CIPA is the voting
trustee with the exclusive right to vote all the shares or to give
written consent in lieu thereof.
(8) Excludes an undivided ownership interest as a member of GBIPA in
2,501,021 shares of Class B Common Stock owned by GBIPA.
(9) Assumes exercise of 24,653 stock options currently exercisable for shares
of Class A Common Stock. Includes 3,580 shares of Class A Common Stock
held in the Company's retirement plans as of September 30, 1997, the most
recent date available.
(10) Excludes an undivided ownership interest as a member of CIPA in 234,000
shares of Class B Common Stock owned by CIPA and 30,000 shares of Common
Stock for which CIPA was voting trustee, not beneficially owned by Dr.
Coletti.
(11) Assumes exercise of 18,789 stock options currently exercisable for shares
of Class A Common Stock.
(12) Includes 2,000 shares of Class A Common Stock owned by Gertrude
Licciardello, spouse of Dr. Licciardello, as to which Dr. Licciardello
disclaims beneficial ownership.
(13) Includes 700 shares of Class A Common Stock owned by Helen Natt, spouse
of Mr. Natt, as custodian, as to which Mr. Natt disclaims beneficial
ownership. Includes 12,592 shares of Class A Common Stock held in the
Company's retirement plans as of September 30, 1997, the most recent date
available. Assumes exercise of 34,633 stock options currently exercisable
for shares of Class A Common Stock.
(14) Includes 1,800 shares of Class B Common Stock owned by Helen Natt, spouse
of Mr. Natt, as custodian, as to which Mr. Natt disclaims beneficial
ownership.
(15) Includes 4,500 shares of Class A Common Stock held by Sheila O'Connor,
spouse of Dr. O'Connor, as to which Dr. O'Connor disclaims beneficial
ownership. Assumes exercise of 39,515 stock options currently exercisable
for shares of Class A Common Stock. Includes 4,789 shares of Class A
Common Stock held in the Company's retirement plans as of September 30,
1997, the most recent date available.
(16) Excludes an undivided ownership interest as a member of CIPA in 234,000
shares of Class B Common Stock owned by CIPA and 30,000 shares of Class B
Common Stock for which CIPA was voting trustee, not beneficially owned by
Dr. Sawicki.
(17) Does not include shares owned by GBIPA, CIPA and HIPA, of which certain
directors have an undivided ownership interest.
* Less than 1%
54
<PAGE>
PROPOSALS TWO AND THREE--ELECTION OF DIRECTORS
The Company's Amended and Restated Certificate of Incorporation provides for
a Board of Directors divided into three classes, as nearly equal in number as
the then total number of Directors constituting the entire Board permits, with
the term of office of one class expiring each year at the Annual Meeting. Each
class of Directors is elected for a term of three years except in the case of
elections to fill vacancies or newly created directorships. Holders of the
Company's Class A Common Stock are entitled to elect 25% of the Company's
Board of Directors (the "Class A Directors").
The Board of Directors presently consists of 18 persons, of whom five are
Class A Directors. The Class A Directors currently are Lewis Bader, M.D.,
Larry Coletti, M.D., Michael E. Herbert, Joseph E. Nechasek, PhD, and Kenneth
Sacks, M.D. The 13 Class B Directors are Melvin Coolidge, M.D., Arnold
DoRosario, M.D., Santiago Escobar, M.D., Richard Freeman, David I. Grayer,
M.D., A. Thomas Licciardello, M.D., Andrew Lozyniak, Murray A. Morrison, M.D.,
Noel R. Newman, Edward Sawicki, M.D., Arthur Sheer, Bernard Sherlip, M.D., and
John Washburn. All of the Directors hold office until the expiration of their
terms and the election and qualification of their successors. The terms of
Drs. Escobar, Grayer, Licciardello, Nechasek, Sawicki and Sherlip expire at
this Meeting. The remaining Directors of the Company are not standing for re-
election because their terms as Director extend past the Meeting. The terms of
Drs. Bader, Coolidge, Morrison and Sacks and Messrs. Freeman and Newman expire
in 1998. The terms of Drs. Coletti and DoRosario and Messrs. Herbert and
Lozyniak, Sheer and Washburn expire in 1999.
Pursuant to the Company's Amended and Restated Certificate of Incorporation,
unless waived by the Board of Directors, no person not already a director is
eligible to be elected a director unless nominated to the Board of Directors
at least 75 days prior to the corresponding date that had been the record date
of the previous year's annual meeting. Such nomination must contain all of the
information concerning such person which would be required to be included in a
proxy statement pursuant to the rules and regulations under the Exchange Act.
The Nominating Committee is responsible for reviewing the qualifications of
all potential nominees as directors of the Company.
The Board of Directors has established the size of the Board of Directors at
16 as of the Meeting.
PROPOSAL TWO--ELECTION OF CLASS A DIRECTOR
The Nominating Committee has nominated Robert L. Natt to serve as a Class A
Director for a term of three years and until the election and qualification of
his successor. Mr. Natt has been President of the Company since August 1996
and was its Chief Operating Officer from 1985 until such date. The Nominating
Committee believes that Mr. Natt has consistently served the interests of the
Company's stockholders and has demonstrated the level of commitment required
by the Nominating Committee in order to justify election to the Board of
Directors.
THE BOARD OF DIRECTORS URGES THAT YOU VOTE FOR MR. NATT FOR ELECTION AS A
CLASS A DIRECTOR BY FILLING OUT THE PROXY CARD AND RETURNING IT IN THE
ENCLOSED STAMPED ENVELOPE.
Unless a stockholder WITHHOLDS AUTHORITY, the holders of proxies contained
on the proxy cards representing shares of Class A Common Stock will vote FOR
the election of Mr. Natt to serve as a Class A Director. Mr. Natt has
consented to serve as a Class A Director of the Company. If he shall be
unavailable for any reason, then the proxies may be voted for the election of
such person as Class A Director as may be recommended by the Board of
Directors.
PROPOSAL THREE--ELECTION OF CLASS B DIRECTORS
The Nominating Committee has nominated David I. Grayer, M.D., Edward
Sawicki, M.D. and Bernard Sherlip, M.D. to serve as Class B Directors for
respective terms of three years and until the election and
55
<PAGE>
qualification of each person's respective successor. The Nominating Committee
believes Drs. Grayer, Sawicki and Sherlip have consistently served the
interests of the Company's stockholders and have demonstrated the level of
commitment required by the Nominating Committee in order to satisfy re-
election to the Board of Directors.
THE BOARD OF DIRECTORS URGES THAT YOU VOTE FOR DRS. GRAYER, SAWICKI AND
SHERLIP FOR ELECTION AS CLASS B DIRECTORS BY FILLING OUT THE PROXY CARD AND
RETURNING IT IN THE ENCLOSED STAMPED ENVELOPE.
Unless a stockholder WITHHOLDS AUTHORITY, the holders of proxies contained
on the proxy cards representing shares of Class A Common Stock and Class B
Common Stock will vote FOR the election of Drs. Grayer, Sawicki and Sherlip on
the proxy card representing shares as Class B Directors. Each of the Nominees
has consented to serve as Class B Directors of the Company. If any such
nominee shall be unavailable for any reason, then the proxies may be voted for
the election of such persons as Class B Directors as may be recommended by the
Board of Directors.
* * * * * * * * * * * * * * * *
The following table sets forth the age and title of each director and each
executive officer of the Company who is not a director, followed by
descriptions of such person's additional business experience during the past
five years.
NOMINEES FOR ELECTION AS DIRECTOR
<TABLE>
<CAPTION>
TERM
NAME AGE POSITION EXPIRES
- ---- --- -------- -------
<S> <C> <C> <C>
David I. Grayer, M.D. .. 58 Chairman and Class B Director 2000
Edward Sawicki, M.D. ... 54 Class B Director 2000
Bernard Sherlip, M.D. .. 68 Class B Director 2000
Robert L. Natt.......... 49 President and Co-Chief Executive Officer 2000
DIRECTORS WHOSE TERMS HAVE NOT EXPIRED
<CAPTION>
TERM
NAME AGE POSITION EXPIRES
- ---- --- -------- -------
<S> <C> <C> <C>
Lewis Bader, M.D. ...... 55 Class A Director 1998
Larry Coletti, M.D. .... 67 Class A Director 1999
Melvin Coolidge, M.D. .. 60 Class B Director 1998
Arnold DoRosario, M.D. . 50 Class B Director 1999
Richard Freeman......... 63 Class B Director 1998
Michael E. Herbert...... 52 Co-Chief Executive Officer and 1999
Class A Director
Andrew Lozyniak......... 65 Class B Director 1999
Murray A. Morrison, 1998
M.D. .................. 57 Class B Director
Noel R. Newman, Esq. ... 65 Class B Director 1998
Kenneth L. Sacks, M.D. . 53 Class A Director 1998
Arthur H. Sheer......... 54 Class B Director 1999
John C. Washburn........ 67 Class B Director 1999
</TABLE>
56
<PAGE>
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C> <C>
James L. Elrod, Jr. .... 43 Executive Vice President and Chief Financial Officer
Regina M. Campbell...... 48 Senior Vice President and Chief Administrative Officer
Paul M. Philpott........ 50 Senior Vice President and Chief Marketing Officer
Carlos S. Beharie,
M.D. .................. 45 Chief Medical Officer
</TABLE>
DIRECTORS AND NOMINEES
Lewis Bader, M.D. has been a director of the Company since 1982 and has
served as the Company's First Vice Chairman since 1986. Dr. Bader has been a
radiologist in private medical practice since 1973 and is associated with
Robert Russo & Associates P.C. Dr. Bader is the past President of the Greater
Bridgeport Medical Association and the past President of Park City Hospital
Medical Staff. Dr. Bader is a member of GBIPA.
Larry Coletti, M.D. has been a director of the Company since 1984. Dr.
Coletti has been in private medical practice in Norwich, Connecticut since
1962 and is an Attending Physician at W. William Backus Hospital, Norwich and
Uncas on the Thames Hospital. Dr. Coletti is a member of CIPA.
Melvin Coolidge, M.D. has been a director of the Company since 1995. Dr.
Coolidge has been a dermatologist in private medical practice in Fairfield,
Connecticut since 1968. Dr. Coolidge is also an Assistant Professor of
Dermatology at Yale University and is also an Attending Physician at
Bridgeport Hospital and is a member of GBIPA.
Arnold DoRosario, M.D. has been a director of the Company since 1992. Dr.
DoRosario has been in private medical practice since 1979. He is the Medical
Director of Maefair Health Care Center and an attending physician at St.
Vincent's Medical Center. Dr. DoRosario is a member of GBIPA.
Santiago Escobar, M.D. has been a director of the Company since 1991. Dr.
Escobar has been in private medical practice in Bridgeport, Connecticut since
1976 and is an Attending Physician at St. Vincent's Medical Center,
Bridgeport, Connecticut. He has been the Medical Director at Roncalli Health
Center since 1980. Dr. Escobar is a member of GBIPA.
Richard F. Freeman has been a director of the Company since 1995. Mr.
Freeman has been the President and Chief Executive Officer of the Greater
Bridgeport Area Foundation, a community non-profit charitable organization in
Bridgeport, Connecticut since 1992 and a principal since 1991 in Freeman &
Associates, Fairfield, Connecticut, which is a consulting firm in the field of
utilities and banking. From May 1978 through December 1991, Mr. Freeman was
the President, Chief Executive Officer and a director of The Bank Mart, then a
savings bank in Bridgeport, Connecticut. Mr. Freeman is a director of
Connecticut Energy Corporation and the Southern Connecticut Gas Company.
David I. Grayer, M.D. has been a director of the Company since 1991 and has
served as Chairman since 1996. Dr. Grayer has been in private medical practice
since 1971 and is associated with the Bridgeport Medical Group, Bridgeport,
Connecticut. Dr. Grayer is an Attending Physician at Bridgeport Hospital and
an Assistant Professor at the Yale School of Medicine. Dr. Grayer is a member
of GBIPA.
Michael E. Herbert served as President of the Company or its predecessor
from 1976 until August 1996 when he became Co-Chief Executive Officer and
Third Vice Chairman. He has served on its Board of Directors since 1984. Mr.
Herbert is the Chairman of the American Association of Health Plans, the
national HMO industry trade association. He also serves on the boards of
directors of numerous civic and charitable organizations. Mr. Herbert is a
director of Urocor Inc., a urological disease state management company.
57
<PAGE>
A. Thomas Licciardello, M.D. has been a director of the Company or its
predecessor since 1978 and served as Chairman of the Board of Directors from
1984 until 1996. Dr. Licciardello has been in private medical practice since
1953 and is associated with Pri-Med in Stratford, Connecticut. He is an
Attending Physician at Bridgeport Hospital and an Assistant Clinical Professor
at Yale University School of Medicine. Dr. Licciardello is a member of GBIPA.
Andrew Lozyniak has been a director of the Company since 1996. Mr. Lozyniak
has been the Chairman of the Board of Directors and President of Dynamics
Corporation of America for more than the past five years. Mr. Lozyniak is also
a Director of CTS Corporation.
Murray A. Morrison, M.D. has been a director of the Company since 1995. Dr.
Morrison as been an orthopaedic surgeon in private practice in Fairfield,
Connecticut with Orthopaedic Specialty Group, P.C., since 1970. Dr. Morrison
is an Attending Physician at Bridgeport Hospital and is a member of GBIPA.
Robert L. Natt has been President and Co-Chief Executive Officer of the
Company since August 1996. From March 1994 through August 1996, Mr. Natt was
Executive Vice President and Chief Operating Officer. He was Senior Vice
President and Chief Operating Officer of the Company from 1985 through March
1994. Mr. Natt is also a certified public accountant.
Joseph E. Nechasek, Ph.D. has been a director of the Company, or its
predecessor corporation, since 1978. He is currently Director of the Division
of Counseling and Human Resources at the University of Bridgeport. Mr.
Nechasek is President of Huntington Health Plans, Inc., a health insurance
consulting firm.
Noel R. Newman, Esq. has been a director of the Company since 1995. Mr.
Newman has been in private legal practice in Fairfield, Connecticut since
1956.
Kenneth L. Sacks, M.D. has been a director of the Company since 1991 and
Second Vice Chairman since 1996. Dr. Sacks has been in private medical
practice in Fairfield, Connecticut since 1975. He is Associate Professor of
Medicine at Yale University and an Attending Physician at St. Vincent's
Medical Center. Dr. Sacks is a member of GBIPA.
Edward S. Sawicki, M.D. has been a director of the Company since 1991. Dr.
Sawicki has been in private medical practice in Willimantic, Connecticut since
1975. He is an Attending Physician at Windham Community Memorial Hospital. Dr.
Sawicki is a member of CIPA.
Arthur H. Sheer has been a director and Treasurer of the Company since 1996
and has been President of Sheer Asset Management Company for more than the
past five years.
Bernard Sherlip, M.D. has been a director of the Company, or its
predecessor, since 1979 and Secretary since 1996. Dr. Sherlip has been in
private medical practice in Bridgeport, Connecticut since 1958 and is an
Attending Physician at Bridgeport Hospital. He is past President of the
Medical Staff at Bridgeport Hospital. Dr. Sherlip is a member of GBIPA.
John C. Washburn has been a director of the Company since 1996. Mr. Washburn
retired in January 1996 as Vice President of GenRad, Inc. where he had been
employed since 1994. Prior to that he was Chief Operating Officer of Mott
Metallurgical Corporation.
Mr. Sheer and Sheer Asset Management Inc. ("SAM"), an investment adviser
registered with the Securities and Exchange Commission (the "Commission")
under the Investment Advisers Act of 1940 (the "1940 Act"), of which Mr. Sheer
is the sole shareholder, consented, without admitting or denying the
allegations of the Commission, to the issuance of an order of the Commission
in 1994, File No. 3-8585 (the "Order"). The Order involved SAM's purchase in
1991 of assets from another investment advisor, for a purchase price which
included SAM agreeing to direct brokerage customers to the seller. In the
Order, the Commission determined that such directed brokerage arrangement was
required to be disclosed in Form ADV filed with the Commission by SAM
58
<PAGE>
under the 1940 Act. Under the Order, SAM paid a civil penalty of $10,000, SAM
and Sheer agreed to cease and desist from committing or causing any violations
of the 1940 Act, SAM agreed to retain a consultant to recommend procedures
designed to ensure compliance with the 1940 Act and SAM was required to file
an affidavit with the Commission within ninety (90) days after entering of the
Order detailing SAM's compliance with its undertakings under the Order. Such
affidavit was timely filed and all other requirements of the Order have been
complied with.
NON-DIRECTOR EXECUTIVE OFFICERS
James L. Elrod, Jr. has been Executive Vice President and Chief Financial
Officer since December 1995. From December 1994 to December 1995, Mr. Elrod
served as Senior Vice President and Chief Financial Officer. From September
1980 through December 1994, Mr. Elrod was an investment banker with Dillon,
Read & Co. Inc., most recently as Managing Director of Dillon Read's Health
Care Group.
Regina M. Campbell has been Senior Vice President and Chief Administrative
Officer since April 1995 and had been Senior Vice President of Legal Affairs
and Human Resources since December 1993. Prior to that time, Ms. Campbell was
with the law firm of Robinson & Cole from 1983 to 1993, first as an associate
and then as a partner.
Paul M. Philpott has been Senior Vice President and Chief Marketing Officer
since March 1996 and had been Senior Vice President, Marketing since May 1994.
From April 1993 through May 1994, he was Vice President, Marketing and Sales
for New York Life/Sanus in New York, New York and from 1990 through April 1993
he was Assistant Vice President, National Sales for FHP Healthcare in Costa
Mesa, California.
Carlos S. Beharie, M.D. has been Chief Medical Officer since April 1997.
From January 1997 through March 1997, he was Acting Chief Medical Officer of
the Company. Prior to that he was Chief Medical Officer, Acting President and
CEO of Physicians HealthCare Plan of New Jersey from October 1995 to December
1996. From June 1982 to September 1995, he was employed by FHP Inc., where he
was Medical Director responsible for Southern California, including Los
Angeles.
The executive officers serve until their successors are elected by the Board
of Directors.
There are no family relationships between any existing director, executive
officer, or person nominated or chosen by the Company to become a director or
executive officer.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has established a Finance Committee, an Audit
Committee, a Nominations Committee, a Compensation Committee and an Executive
Committee.
The members of the Finance Committee are Drs. DoRosario, Grayer and Sawicki
and Messrs. Freeman, Lozyniak, Nechasek, Newman and Washburn. The functions of
the Finance Committee are to monitor the Company's financial performance,
including operating and investment portfolio performance, and review potential
acquisitions or other transactions having a potential material effect on the
Company's financial operations.
The members of the Audit Committee are Drs. Grayer and Sherlip and Messrs.
Freeman, Nechasek and Washburn. The functions of the Audit Committee are to
review contracts with major vendors, including contracts with individual
practice associations ("IPAs") who are stockholders of the Company, recommend
annually to the Board of Directors the appointment of the independent
certified public accountants for the Company, discuss and review the scope and
the fees of the prospective annual audit and review the results thereof with
the independent certified public accountants, review and approve non-audit
services of the independent certified public accountants and review the
results of the Company's internal audits. The physician members of the Audit
Committee will not vote on matters pertaining to an IPA with which they are
associated.
59
<PAGE>
The members of the Nominating Committee are Drs. Coletti, Coolidge, Grayer,
Morrison and Sacks and Messrs. Herbert and Sheer. The purpose of the
Nominating Committee is to review proposed amendments to the Company's Bylaws
for recommendation to the Board of Directors and to nominate persons to be
directors of the Company. Pursuant to the Company's Amended and Restated
Certificate of Incorporation, unless waived by the Board of Directors, no
person not already a director is eligible to be a director unless nominated to
the Board of Directors at least 75 days prior to the corresponding date that
had been the record date of the previous year's annual meeting. Such
nomination must contain all of the information concerning such person which
would be required to be included in a proxy statement pursuant to the rules
and regulations under the Exchange Act. The Nominating Committee has not
adopted formal procedures for considering nomination submissions by
stockholders but will consider nominations if made. Submissions should be sent
to the Chairman of the Board, c/o Physicians Health Services, Inc., One Far
Mill Crossing, P.O. Box 904, Shelton, Connecticut 06484. Submissions will be
subject to the above eligibility requirement.
The members of the Compensation Committee are Drs. Bader, Coolidge, Escobar,
Grayer and Sacks and Mr. Washburn. The purpose of the Compensation Committee
is to establish a compensation policy for the Company's officers and
employees.
The members of the Executive Committee are Drs. Bader, Grayer, Licciardello,
Sacks and Sherlip and Messrs. Freeman, Herbert, Lozyniak and Sheer. The
purpose of the Executive Committee is to act between meetings of the Board of
Directors.
The Company has also established a Continuous Quality Improvement Committee
(the "CQI Committee"). The director members of the CQI Committee are Edward
Sawicki, M.D. and Joseph Nechasek. The CQI Committee was developed to direct,
monitor and report on Company quality improvement activity.
During 1996, the Board of Directors held nine meetings, the Finance
Committee held nine meetings, the Audit Committee held four meetings, the
Executive Committee held three meetings, the Nominating Committee held two
meetings and the Compensation Committee held seven meetings. During 1996, each
Director of the Company, other than Messrs. Newman and Sheer, attended at
least 75% of the meetings of the Board of Directors and any committee upon
which he served.
In 1996, the Board appointed a Subcommittee to consider certain strategic
issues. The members of the Subcommittee are Drs. Bader, Grayer and Sacks and
Messrs. Freeman, Lozyniak, Natt, Sheer and Washburn. The Subcommittee held
four meetings in 1996.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's officers and
directors, and persons who own more than ten percent of its Common Stock, to
file reports of ownership and changes in ownership with the Securities and
Exchange Commission (the "Commission") and the National Association of
Securities Dealers, Inc. Officers, directors and greater than ten percent
stockholders are required by the Commission to furnish the Company with copies
of all Section 16(a) forms that they file.
Based solely on its review of the copies of such forms received by it, the
Company believes that during 1996, its officers, directors and greater than
10% stockholders complied with all applicable filing requirements.
SUMMARY COMPENSATION TABLE
The following Summary Compensation Table sets forth the cash compensation
and certain other components of the compensation of Robert L. Natt, the
President and Co-Chief Executive Officer of the Company, and the other four
most highly compensated executive officers of the Company in 1996.
60
<PAGE>
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
-----------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
----------------------------- --------------------- -------
(I)
(E) (F) (G) ALL
OTHER RESTRICTED SECURITIES (H) OTHER
ANNUAL STOCK UNDERLYING LTIP COMPEN-
(A) (B) (C) (D) COMPEN- AWARD(S) OPTIONS PAYOUTS SATION
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) SATION ($) ($) (#) ($) ($)/1/
- --------------------------- ---- --------- -------- ---------- ---------- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Robert L. Natt,
President and 1996 $261,899 $ 62,878 -- -- 98,809 -- $21,000
Co-Chief Executive 1995 $250,858 $133,841 -- -- 25,741 -- $19,125
Officer............... 1994 $222,000 $ 78,859 -- -- 13,700 -- $16,703
Michael E. Herbert, Co- 1996 $363,181 $108,940 -- -- 44,244 -- $19,883
Chief Executive 1995 $345,835 $234,431 -- -- 65,552 -- $18,159
Officer............... 1994 $310,921 $151,729 -- -- 27,100 -- $18,545
Richard C. O'Connor, 1996 $217,284 $ 45,189 -- -- 18,769 -- $21,790
M.D., Senior Medical 1995 $211,153 $ 96,526 -- -- 17,784 -- $18,850
Director.............. 1994 $196,654 $ 70,575 -- -- 13,700 -- $16,563
James L. Elrod, Jr., -- -- 57,476 -- $20,723
Executive Vice 1996 $233,654 $ 56,070 17,784 $ 3,703
President and Chief 1995 $196,780 $ 90,794
Financial Officer..... 1994 -- --
Regina M. Campbell, -- -- --
Senior -- -- --
Vice President and 1996 $197,308 $ 41,034 38,109 $21,582
Chief Administrative 1995 $184,557 $ 83,450 17,784 $18,618
Officer............... 1994 $159,827 $ 57,359 8,200 $ 837
</TABLE>
- --------
1. Consists of pension and 401(k) contributions for each employee on behalf of
the Company, group term life insurance and other non-cash fringe benefits.
The Company's 1996 contributions under the pension plan were $8,916 for
each named executive officer. The Company's 1996 contributions under the
401(k) plan were $6,000 for each named executive officer. Amounts paid for
group term life insurance represent $1,440 for Mr. Herbert, $870 for Mr.
Natt, $2,250 for Dr. O'Connor, $510 for Mr. Elrod, and $870 for Ms.
Campbell. Other non-cash fringe benefits represent $3,527, $5,214, $4,624,
$5,297 and $5,796, respectively.
The Company has entered into employment agreements with Messrs. Natt,
Herbert, and Elrod and Dr. O'Connor and Ms. Campbell. The employment
agreements terminate, in the case of Mr. Natt, on December 31, 2000, in the
case of Mr. Herbert, on January 31, 1999 and in the case of Mr. Elrod and Ms.
Campbell, on December 31, 1998. The employment agreement between the Company
and Dr. O'Connor was terminated by Dr. O'Connor on April 15, 1997. The
agreements provide for base salaries, subject to annual increases, commencing
November 1, 1995, for Messrs. Herbert and Natt of $360,550 and $260,000,
respectively, and for Mr. Elrod and Ms. Campbell, commencing January 1, 1995,
of $200,000 and $180,000, respectively. The employment agreements set forth
the basic terms of employment for each executive, including base salary,
benefits and severance benefits which are payable if the executive's
employment is terminated. In addition, the employment agreements provide for
incentive compensation determined each year by the Compensation Committee in
accordance with annual performance objectives. In the event that the Company
terminates the employment of Mr. Herbert or Mr. Natt (other than for cause, as
defined in the agreements), the employment agreements provide for the payment
of, in the case of Mr. Natt, the amount due for the remainder of the
employment agreement, and in the case of Mr. Herbert, the amount due until
December 31, 2000, but for either person no less than the amount due for 18
months, at the annual rate in effect on the date of termination. In the event
that the Company terminates the employment of Ms. Campbell or Mr. Elrod, the
employment agreements provide for the payment of then current salary for 18
months.
Non-cash personal benefits payable to executive officers during the year
ended December 31, 1996 did not exceed, in the aggregate, the lesser of
$50,000 or 10% of the cash compensation for any individual officer.
The Company has entered into conditional employment agreements with Messrs.
Natt, Herbert and Elrod and Ms. Campbell. For each person, the conditional
employment agreements terminate on the last day of the later of (i) the sixth
calendar month following termination of employment of such person with the
Company, or
61
<PAGE>
(ii) the thirty-sixth month following a "change in control" (as defined in the
agreements). The conditional employment agreements provide that after a change
in control of the Company has occurred, the employment of such person shall be
continued for three years from the change in control, with limited ability on
the part of the Company to terminate the employment or alter the nature of the
employee's duties. After a change in control, the compensation of such
employee is converted to a cash-equivalent basis. If the Company breaches the
agreement, the employee is entitled to damages plus full salary, unused
accrued vacation and applicable bonus through the date of termination, plus a
severance amount equal to 2.99 times the highest compensation (including base
salary, bonuses, incidental compensation and other taxable and nontaxable
benefits) paid to such person by the Company with respect to any twelve
consecutive month period during the three years ending with the date of
termination, subject to certain limitations. The Company has entered into
similar agreements with Dr. O'Connor and Paul Philpott. Dr. O'Connor
terminated his active employment with the Company on April 15, 1997, and was
on a paid leave of absence until October 15, 1997, at which time his
employment terminated. Mr. Philpott's Agreement will be terminated as of the
Effective Time, and Mr. Philpott will enter into a new employment agreement at
such time. Mr. Natt will also enter into a new employment effective as of the
Effective Time. See "PROPOSAL ONE--THE MERGER--The Merger Agreement--Benefit
Plans and Employment Arrangements."
The Company had previously entered into change in control agreements with
Messrs. Natt, Herbert, Elrod and Ms. Campbell. These change in control
agreements are superseded by the conditional employment agreements described
above. However, in the event that the conditional employment agreements are
declared invalid, these change in control agreements would prevail. For each
person the change in control agreement terminates on the last day of the sixth
calendar month following termination of employment of such person with the
Company. The change in control agreements provide for certain benefits to be
paid upon termination by the Company, other than for specific reasons
enumerated in the agreements, after a change in control of the Company has
occurred. The benefits payable under such circumstances are equal to full base
salary, plus unused accrued vacation and applicable bonus through the date of
termination plus a severance amount equal to 2.99 times the highest
compensation (including base salary, bonuses, incidental compensation and
other taxable and nontaxable benefits) paid to such person by the Company with
respect to any twelve consecutive month period during the three years ending
with the date of termination, subject to certain limitations. Change in
control agreements had also been entered into with Dr. O'Connor and Mr.
Philpott.
COMPENSATION PURSUANT TO PLANS
Pension Plan. The Company contributes 5% of its total aggregate eligible
compensation for eligible employees annually to a defined contribution pension
plan covering all of the employees who have met certain age and service
requirements. Employees become eligible for participation when they have
completed six months of service and have attained the age of 20. Such
contributions vest at 50% after three years of service, 75% after four years
of service, and 100% after five years of service. Employees are eligible to
receive distribution of vested contributions from the plan upon retirement on
or after age 65, upon death or disability, or upon termination of employment.
The contribution to the plan for 1996 was 5% of eligible wages, or
approximately $1,198,000.
Savings and Retirement Plan. The Company maintains a 401(k) savings and
retirement plan (the "401(k) Plan") pursuant to which full-time employees may
currently reduce their salaries by up to 10% of their compensation and have
the salary reduction amounts contributed to the 401(k) Plan. Such
contributions are 75% matched by the Company, up to a maximum of 4% of the
employee's compensation. Participants are fully vested at all times in their
salary reduction and matching contributions. Participants may withdraw their
own contribution and the Company's matching contribution upon retirement, upon
death or disability, upon termination of employment or upon financial
necessity. Participants may elect to make voluntary contributions and may
elect to withdraw such amounts twice in any year. The Company's contributions
in respect of Messrs. Herbert, Natt and Elrod, Dr. O'Connor and Ms. Campbell
are included in the compensation table.
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<PAGE>
Management Incentive Plan. The Company maintains a management incentive plan
for its salaried employees. Pursuant to the plan, each participant is assigned
a target incentive award (expressed as a percentage of such participant's
annual base salary) that becomes payable if the Company achieves certain
operating goals.
The following table sets forth certain information regarding stock options
granted in 1996 to the five individuals named in the Summary Compensation
Table. In addition, in accordance with the Commission's rules, the table also
shows a hypothetical potential realizable value of such options based on
assumed rates of annual compounded stock price appreciation of 5% and 10% from
the date the options were granted over the full option term. The assumed rates
of growth were selected by the Commission for illustration purposes only, and
are not intended to predict future stock prices, which will depend upon market
conditions and the Company's future performance and prospects.
OPTIONS GRANTED IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PERCENT OF POTENTIAL REALIZABLE VALUE
NUMBER OF TOTAL AT ASSUMED ANNUAL RATES
SECURITIES OPTIONS OF STOCK PRICE
UNDERLYING GRANTED TO APPRECIATION FOR
OPTIONS EMPLOYEES EXERCISE OPTION TERM
NAME GRANTED IN FISCAL PRICE ---------------------------
- ---- (#)1 YEAR ($/SH) EXPIRATION DATE 5%($) 10%($)
---------- ---------- -------- --------------- ------------- -------------
Robert L. Natt.......... 78,008 13.81% $17.00 12/05/2006 $ 834,000 $ 2,112,944
20,801 3.68% $38.75 1/30/2006 $ 506,910 $ 1,284,616
Michael E. Herbert...... 44,244 7.83% $38.75 1/30/2006 $ 1,078,203 $ 2,732,395
James L. Elrod, Jr...... 36,675 6.49% $17.00 12/05/2006 $ 392,100 $ 993,659
20,801 3.68% $38.75 1/30/2006 $ 506,910 $ 1,284,616
Richard C. O'Connor..... 8,152 1.44% $17.00 12/05/2006 $ 87,155 $ 220,867
10,617 1.88% $38.75 1/30/2006 $ 258,731 $ 655,679
Regina M. Campbell...... 24,317 4.30% $17.00 12/05/2006 $ 259,978 $ 658,836
13,792 2.44% $38.75 1/30/2006 $ 336,104 $ 851,758
</TABLE>
- --------
1 All options granted and reported in this table are made pursuant to the
Company's 1992 and 1995 Stock Option Plans and have the following material
terms: options may be either (i) "incentive stock options" under Section
422 of the Code, or (ii) non-qualified stock options; all options expire
not more than ten years from the date of grant, or not more than five years
from the date of grant in the case of incentive stock options granted to an
employee holding 10% or more of the voting stock of the Company; the
aggregate fair market value (determined at the time of grant) of shares
issuable pursuant to incentive stock options which become exercisable in
any calendar year by any employee may not exceed $100,000. All options
granted under the 1992 Plan (which are the options listed above with a
$38.75 per share exercise price) vest in equal installments in the three
years following grant. Options granted under the 1995 Plan (which are the
options listed above with a $17.00 per share exercise price) to the
individuals named in the table vest in six years; provided, however, there
is accelerated vesting in the event certain financial performance criteria
are satisfied.
The following table sets forth certain information concerning stock option
exercises by the five individuals named in the summary compensation table
during 1996, including the aggregate value of gains on the date of exercise.
In addition, this table includes the number of shares covered by both
exercisable and non-exercisable stock options as of December 31, 1996. Also
reported are the values for in the money options which represents a positive
spread between the exercise price of any such existing stock options and the
closing market price of the common stock at December 31, 1996 ($14.75).
63
<PAGE>
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND OPTION VALUES AT DECEMBER
31, 1996
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT DECEMBER 31, IN-THE-MONEY OPTIONS
ACQUIRED VALUE 1996 AT DECEMBER 31, 1996($)
NAME ON EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ---- ----------- -------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Robert L. Natt.......... 13,580 $183,090 34,633/100,457 $0/$0
Michael E. Herbert...... 0 0 106,269/51,347 $0/$0
Richard C. O'Connor..... 0 0 39,515/21,158 $0/$0
James L. Elrod, Jr...... 0 0 18,789/56,471 $0/$0
Regina M. Campbell...... 0 0 24,653/39,440 $0/$0
</TABLE>
DIRECTOR COMPENSATION
In 1996, non-employee Directors were entitled to receive an annual retainer
of $4,000 and fees of $500 for each Board or committee meeting attended. The
Chairman of the Board and Committee Chairmen receive $750 for each meeting
they chair, in lieu of the $500 meeting fee. In 1996, Dr. Licciardello and Dr.
Grayer were compensated Chairmen's fees of $5,000 and $34,333 respectively.
The annual retainer for non-employee Directors was increased to $28,000 as of
January 1, 1997.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
Executive Compensation Philosophy
The Compensation Committee of the Board is responsible for reviewing the
Company's executive compensation program and policies each year and
determining the compensation of the Company's executive officers. The
Compensation Committee's decisions are made within parameters established by
the Company's Board of Directors in the form of an overall executive
compensation philosophy.
The Company's compensation program and policies are designed to help the
Company attract, motivate and retain individuals of outstanding ability in key
positions in order to maximize return to stockholders. The primary objectives
of the Company's executive compensation program are to provide total
compensation opportunities that are competitive with opportunities provided to
executives within comparably sized managed care organizations at comparable
levels of performance; to ensure that executives' total compensation levels
vary based on the Company's short-term financial performance, and growth in
stockholder value over time; to focus and motivate executives on the
achievements of defined objectives; and to reward executives in accordance
with their relative contributions to achieving strategic milestones and
upholding key mission-related objectives.
In designing and administering its executive compensation program, the
Company attempts to strike an appropriate balance among these various
objectives. It believes that its executive compensation program includes
elements which, taken together, constitute a flexible and balanced method of
establishing total compensation for senior management. The Company uses the
services of a national compensation consulting firm to develop marketplace
data and assess PHSs practices against such data; assess the overall
effectiveness of the Company's pay program; assess PHSs compensation
philosophy and its alignment with its strategic business needs; and finally,
develop recommendations regarding compensation levels, incentive pay programs
and its ongoing compensation philosophy. For purposes of establishing
compensation for 1996, the market analysis included data from the following
sectors: managed care, for profit health care companies and combined profit
and not-for-profit health care companies.
Based upon a previous review and the recommendations of its consultants, the
Committee has identified base salary and incentive compensation ranges based
on the 50th percentile and 75th percentile, respectively, of competitive data
for similarly sized managed care organizations. The Committee has concluded
that its most direct competitors for executive talent are for-profit health
maintenance organizations and, accordingly, although
64
<PAGE>
it reviewed information from all of the sectors identified above, it
principally compares its actions to a self-selected group of for-profit
managed care companies of comparable size (the "Compensation Comparable
Group") and uses the other data compiled by its consultants as a reference
point. The Compensation Comparable Group is not the same group as the peer
performance group used in calculating the cumulative total return discussed
under "Performance Graph" below.
Base Compensation
Generally, in establishing compensation, the Committee believes that
positions are competitively paid if the executive's salary falls within 20% of
the 50th percentile for base salary. In establishing base compensation for
1996, the Committee reviewed updated competitive salary and total compensation
information for executive staff. The Committee concluded that most senior
management positions fell within 20% of median competitive levels for the
Compensation Comparable Group. Based upon their review of the competitive data
and the financial performance of the Company, as well as the responsibilities
of senior managers, the Committee authorized a 4.7% aggregate increase for
senior managers, other than executive officers, and 9.4% aggregate increase
for executive officers. Individual adjustments were determined within the
total executive compensation budget as approved by the Committee and were
based upon individual achievement and contribution. Individual salary
decisions are recommended by the President to the Committee.
Short-Term Incentive Compensation
The Company's compensation philosophy emphasizes incentive pay to leverage
both individual and organizational performance and to raise the Company's
total compensation position in the marketplace. The Company's short-term
incentive compensation program rewards executives for accomplishing annual
performance objectives. The program provides varied award opportunities that
correspond to each participant's level of responsibility and impact on
strategic initiatives of the Company. The short-term incentive compensation
program for 1996 allowed executives to participate in the incentive
compensation program at levels established by reference to their grade level
(Tier I being the President of the Company, Tier II being Executive Vice
Presidents, Tier III being Senior Vice Presidents and Tier IV being Vice
Presidents). Incentive compensation opportunities, as a percentage of base
salaries, ranged between 12% (threshold, Tier IV) and 75% (maximum, Tier I).
For 1996, the Committee established weighted performance measures based upon
net income (60%) and year end membership (40%). The program assigned levels of
threshold, target and maximum bonuses with corresponding performance
expectations for each category of participants. At threshold, 50% or the
target amount was funded. Target performance resulted in funding of the full
target amount, where superior performance paid 150% of the target amount. The
Company failed to achieve threshold performance with respect to the net income
goal, but achieved superior performance in membership growth. Accordingly,
eligible executives received bonuses for 1996 (as a percentage of base
salaries) of 30% for Tier I, 24% for Tier II, 20.8% for Tier III, and 15.2%
for Tier IV. The Compensation Committee has revised the short-term incentive
compensation program for 1997 to provide that the Company must achieve
profitability objectives before any bonuses are payable to management.
Long-Term Incentive Compensation
The Company's stock option plans are designed to reward employees for long-
term growth consistent with stockholder return. In 1996, senior management was
awarded stock options in amounts designed to deliver a percentage of their
base salaries over the term of the stock option. Values for senior management
are targeted at 120% of base salary for Tier I, 75% of base salary for Tier
II, 60% of base salary for Tier III and 30% of base salary for Tier IV. The
ultimate value of the long-term incentive compensation awards will be
determined by the actual performance of the Company's stock price over time.
CEO Compensation
The Company underwent a change in its most senior position in mid-1996.
Through August 27, 1996, the President and Chief Executive Officer of the
Company was Michael E. Herbert. Robert L. Natt was elected
65
<PAGE>
President and Co-Chief Executive Officer on August 27, 1996 and Mr. Herbert
became Co-Chief Executive Officer and Third Vice Chairman of the Board of
Directors.
In establishing Mr. Herbert's compensation for the period November 1, 1995
through August 1996, the Committee had assessed Mr. Herbert's performance in
the prior year and reviewed competitive market data on salary levels within
the Compensation Comparable Group. Mr. Herbert's salary was increased 8% over
1995 levels, which resulted in his base pay being approximately 8% less than
the median competitive data for similar positions. Following the management
change in August 1996, Mr. Herbert's salary was not adjusted to reflect his
reduced responsibilities. Mr. Herbert's employment agreement, entered into
before the management change, requires the Company to maintain his salary
through the term of the agreement, subject to annual increases. Mr. Herbert's
employment agreement also requires the Company to pay Mr. Herbert annual
bonuses of up to 75% of his base salary, for achieving goals mutually
established by Mr. Herbert and the Committee. Accordingly, Mr. Herbert's base
salary is currently governed solely by the contractual agreements between the
Company and Mr. Herbert and is not subject to performance assessment or
competitive review. Mr. Herbert's bonus in 1996 was at the Tier 1 level and
was equal to 30% of his base salary for 1996. Mr. Herbert's bonus in future
years will be based upon performance objectives established by the Committee
and Mr. Herbert.
Until his promotion, Mr. Natt had served as Executive Vice President and
Chief Operating Officer of the Company, and his salary had been established
for 1996 in accordance with the above criteria. Mr. Natt's salary was adjusted
approximately 19% effective November 1, 1996 to reflect his new
responsibilities. This adjustment resulted in his salary being approximately
20.5% less than the median competitive data for similar positions. At Mr.
Natt's request, his salary increase has been delayed until certain 1997
profitability objectives have been achieved, at which time the increase will
become effective, retroactive to November 1, 1997. Mr. Natt's bonus in 1996
was at the Tier II level and was equal to 24% of his base salary for 1996.
The Committee has not awarded compensation in excess of $1 million. However,
in the event of outstanding performance, it may decide to exceed the $1
million compensation deduction cap.
It is the opinion of the Committee that the aforementioned compensation
structures provide features which properly align the Company's executive
compensation with corporate performance and the interests of its stockholders
and which offer competitive opportunities in the marketplace.
The Compensation Committee
Lewis Bader, M.D., Chairman
Melvin Coolidge, M.D.
Santiago Escobar, M.D.
David I. Grayer, M.D.
Kenneth Sacks, M.D.
John Washburn
Compensation Committee Interlocks and Insider Participation
Drs. Bader, Coolidge, Escobar, Grayer and Sacks and Mr. Washburn served as
members of the Compensation Committee of the Board of Directors during the
fiscal year ended December 31, 1996. As described above, each Director
received an annual retainer of $4,000 and a fee of $500 for each Board or
committee meeting attended in 1996. In addition, Dr. Grayer was compensated
$34,333 in 1996 for additional services provided to the Company in his
capacity as Chairman of the Board of Directors.
Drs. Bader, Coolidge, Escobar, Grayer and Sacks are members of GBIPA. GBIPA,
CIPA and HIPA are both stockholders of and suppliers to the Company. GBIPA
owns 70.5% of the outstanding Class B Common Stock, representing 60.7% of the
combined voting power of the Common Stock and provides service for
approximately 19.3% of the Company's enrollees. CIPA owns 7.4% of the
outstanding Class B Common Stock (including shares held by CIPA as voting
trustee, pursuant to a voting trust which expired on August 16, 1995,
66
<PAGE>
which shares have not yet been distributed to individual holders),
representing 6.4% of the combined voting power of the Common Stock and
provides service for approximately 14.3% of the Company's enrollees. HIPA owns
5.7% of the outstanding Class B Common Stock, representing 4.9% of the
combined voting power of the Common Stock, and provides service for
approximately 7.1% of the Company's enrollees. The IPA stockholders, as
suppliers to the Company, have interests with respect to the Company which
diverge from those of the public stockholders. The IPAs could seek to use
their voting control to reject proposals presented for stockholders approval
that were not considered by them to be in their own best interests.
The current IPA service agreements between the Company and GBIPA, HIPA and
CIPA were approved by the Audit Committee, a majority of whom were not members
of any IPA. All other material transactions between a stockholder IPA and the
Company, including any advance of funds to an IPA to pay excess costs, require
the approval of the Audit Committee. Pursuant to the Company's service
agreements with its IPAs, the Company also provides certain administrative and
support services to the IPAs. Management believes that the terms of these
contracts are as favorable to the Company as those that could have been
obtained from unaffiliated parties.
The following table incorporates information relating to certain material
business transactions to which the Company is a party with IPAs that own 5% or
more of any class of the Company's Common Stock.
<TABLE>
<CAPTION>
LENGTH OF
ORIGINAL EXPIRATION/ YEARS IN PAYMENTS
CONTRACT RENEWAL CURRENT ($ IN MILLIONS)
IPA DATE(1) DATE EXTENSION 1996
--- -------- ----------- --------- ---------------
<S> <C> <C> <C> <C>
CIPA....................... 4/26/84 12/31/97 1 19.9
GBIPA...................... 10/1/80 12/31/97 1 53.8
HIPA....................... 11/12/84 12/31/97 1 15.1
</TABLE>
- --------
(1) The Company entered into contracts with its IPAs on the dates shown above.
These contracts have been extended pursuant to certain amendment
agreements that establish capitation payment increases over the term of
the amendment or replaced by certain agreements entered into, from time to
time, with each of the IPAs.
In 1989, the Company began negotiations with GBIPA to renew its service
agreement, which until then had been renewed annually. Due to difficulties
encountered in finalizing the terms of the service agreement the Company
endeavored to contract with GBIPA's member physicians individually. In 1990,
the U.S. Justice Department commenced a civil investigation under the
antitrust laws with respect to certain actions of GBIPA in connection with the
1989 contract renewal, specifically GBIPA's conduct with respect to the
Company's efforts to contract directly with GBIPA's member physicians. In
September 1992, the Justice Department and GBIPA agreed to the terms of a
consent decree, effective as of January 7, 1993. Without admitting or denying
the Justice Department's allegations, GBIPA agreed not to discourage its
members from entering into direct contracts with any HMO for ten years and
agreed to conduct a compliance program for that period.
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PERFORMANCE GRAPH
The following graph compares the change in the Company's cumulative total
return on its Class A Common Stock to (a) the change in the cumulative total
return on the stocks included in the NASDAQ Composite Index for U.S. Companies
and (b) the change in the cumulative total return on the stocks included in the
NASDAQ Health Services Index assuming an investment of $100 made on January 21,
1993 (the date the Company's Common Stock became listed on the NASDAQ National
Market System under the symbol PHSV) and comparing relative values on January
21, 1993, December 30, 1993, December 29, 1994, December 31, 1995, and December
31, 1996. All of these cumulative total returns are computed assuming the
reinvestment of dividends at the frequency with which dividends were paid
during the period. Note that the price performance of the Company's Class A
Common Stock shown below should not be viewed as being indicative of future
performance.
[GRAPH]
21-Jan-93 100 100 100
31-Dec-93 135 111.62 107.16
30-Dec-94 181.67 109.1 114.98
29-Dec-95 246.67 154.29 146.04
31-Dec-96 98.33 189.79 146.24
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INDEPENDENT PUBLIC ACCOUNTANTS
Ernst & Young LLP is the Company's independent accounting firm and has been
since 1980. Representatives of Ernst & Young LLP are expected to be present at
the Meeting. They will be given the opportunity to make a statement if they
desire to do so and will be available to respond to appropriate questions.
STOCKHOLDER PROPOSALS
Any proposals of holders of Common Stock intended to be presented at the
annual meeting of stockholders to be held in 1998 must be received by the
Company at its principal offices in Shelton, Connecticut on or before August
23, 1998. A proponent of such proposal must comply with the proxy rules under
the Exchange Act.
MISCELLANEOUS
The Company will bear the cost of preparing, assembling and mailing the
proxy, this Proxy Statement and other material that may be sent to
stockholders in connection with this solicitation. The Company may reimburse
persons holding shares in their names or in the names of nominees for their
reasonable expenses in sending proxies and proxy materials to their
principals.
The Annual Report of the Company for its fiscal year ended December 31, 1996
is enclosed.
BY ORDER OF THE BOARD OF DIRECTORS,
/s/ Bernard Sherlip, M.D.
BERNARD SHERLIP, M.D.
SECRETARY
DECEMBER 10, 1997
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APPENDIX A
AGREEMENT AND PLAN OF MERGER
<PAGE>
COMPOSITE AGREEMENT AND PLAN OF MERGER
AGREEMENT AND PLAN OF MERGER (this "Agreement"), dated as of May 8, 1997, as
amended by Amendment No. 1 thereto, dated as of October 19, 1997, by and among
Foundation Health Systems, Inc., a Delaware corporation ("Parent"), PHS
Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of
Parent ("Merger Sub"), and Physicians Health Services, Inc., a Delaware
corporation (the "Company").
RECITALS
WHEREAS, the Boards of Directors of Parent, Merger Sub and the Company have
each approved the acquisition of the Company by Parent upon the terms and
subject to the conditions set forth in this Agreement; and
WHEREAS, in furtherance thereof, upon the terms and subject to the
conditions set forth in this Agreement, (i) Merger Sub would be merged (the
"Merger") with and into the Company in accordance with the General Corporation
Law of the State of Delaware ("Delaware Law") and (ii) each share of Class A
Common Stock, par value $.01 per share, together with the associated Right (as
defined in Section 3.2) (collectively, "Class A Common Stock"), and Class B
Common Stock, par value $.01 per share, together with the associated Right
(collectively, "Class B Common Stock"), of the Company issued and outstanding
(the "Shares") immediately prior to the Effective Time (as defined in Section
1.2) would, except as otherwise expressly provided herein, be converted into
the right to receive the Merger Consideration (as defined in Section 1.8); and
WHEREAS, concurrently herewith and as a condition and inducement to Parent's
and Merger Sub's willingness to enter into this Agreement, the Company,
Greater Bridgeport Individual Practice Association, Inc., a stockholder of the
Company, and American Stock Transfer & Trust Company, as voting trustee, have
entered into a Voting Trust Agreement (the "Voting Trust Agreement"),
substantially in the form of Exhibit A hereto; and
WHEREAS, Parent, Merger Sub and the Company desire to make certain
representations, warranties, covenants and agreements in connection with the
Merger.
NOW, THEREFORE, in consideration of the foregoing and the representations,
warranties, covenants and agreements set forth herein, Parent, Merger Sub and
the Company hereby agree as follows:
ARTICLE I
THE MERGER
1.1 The Merger. At the Effective Time and upon the terms and subject to the
conditions hereof and in accordance with the provisions of Delaware Law,
Merger Sub will be merged with and into the Company, whereupon the separate
corporate existence of Merger Sub shall cease and the Company shall continue
as the surviving corporation in the Merger (the "Surviving Corporation"). The
Company and Merger Sub are sometimes hereinafter referred to collectively as
the "Constituent Corporations."
1.2 Effective Time. Subject to the provisions of this Agreement, the Merger
shall be consummated as promptly as practicable (and in any event within two
business days) after satisfaction or, to the extent permitted hereunder,
waiver of all of the conditions to each party's obligation to consummate the
Merger contained in Article VI (the "First Available Effective Date"), by duly
filing an appropriate certificate of merger (the "Certificate of Merger"), in
such form as is required by, and executed in accordance with, the relevant
provisions of Delaware Law; provided, that in the event that the First
Available Effective Date occurs prior to January 6, 1998, then at the request
of Parent upon notice provided pursuant to Section 8.4 hereof, the Effective
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Date shall occur on a business day thereafter selected by Parent no later than
January 6, 1998: provided, further, that in the event, pursuant to the request
of Parent, the Effective Time (as defined below) does not occur on the First
Available Effective Date, Section 3.8 of the Merger Agreement shall not be
deemed to be breached as a result of any event occurring or arising after the
First Available Effective Date. The Merger shall be effective at such time as
the Certificate of Merger is duly filed with the Secretary of State of the
State of Delaware in accordance with Delaware Law or at such later time agreed
to by the parties as is specified in the Certificate of Merger (the "Effective
Time"). The date on which the Effective Time shall occur is referred to herein
as the "Effective Date." This Agreement is intended by the parties to
constitute the agreement of merger contemplated by Section 251 of Delaware
Law.
1.3 Effects of the Merger; Subsequent Actions. (a) The separate corporate
existence of the Company, as the Surviving Corporation, shall continue
unimpaired by the Merger. The Surviving Corporation shall succeed to all the
properties and assets of the Constituent Corporations and to all debts, causes
of action and other interests due or belonging to the Constituent Corporations
and shall be subject to, and responsible for, all the debts, liabilities and
duties of the Constituent Corporations with the effect set forth in Section
259 of Delaware Law.
(b) If, at any time after the Effective Time, the Surviving Corporation
shall consider or be advised that any deeds, bills of sale, assignments,
assurances or any other actions or things are necessary or desirable to vest,
perfect or confirm of record or otherwise in the Surviving Corporation its
right, title or interest in, to or under any of the rights, properties or
assets of the Company or Merger Sub acquired or to be acquired by the
Surviving Corporation as a result of or in connection with the Merger, or
otherwise to carry out this Agreement, the officers and directors of the
Surviving Corporation shall be authorized to execute and deliver, in the name
and on behalf of the Company or Merger Sub, all such deeds, bills of sale,
assignments, assumption agreements and assurances and to take and do, in the
name and on behalf of each of such corporations or otherwise, all such other
actions and things as may be necessary or desirable to vest, perfect or
confirm any and all right, title and interest in, to and under such rights,
properties or assets of the Surviving Corporation or otherwise to carry out
this Agreement.
1.4 Time and Place of Closing. The closing (the "Closing") of the Merger
shall take place at the offices of Skadden, Arps, Slate, Meagher & Flom LLP,
919 Third Avenue, New York, New York, as promptly as practicable (and in any
event within two business days) after satisfaction or, to the extent permitted
hereunder, waiver of all of the conditions to each party's obligation to
consummate the Merger contained in Article VI, or at such other place or time
as Parent and the Company may agree.
1.5 Certificate of Incorporation and Bylaws. (a) The Certificate of
Incorporation of Merger Sub, as in effect immediately prior to the Effective
Time, shall be amended to change the name of Merger Sub to "Physicians Health
Services, Inc." and, as so amended, the Certificate of Incorporation of Merger
Sub shall be the Certificate of Incorporation of the Surviving Corporation
until thereafter changed or amended as provided therein or under applicable
law.
(b) The Bylaws of Merger Sub, as in effect immediately prior to the
Effective Time, shall be the Bylaws of the Surviving Corporation until
thereafter changed or amended as provided therein or under applicable law.
1.6 Directors. The directors of Merger Sub at the Effective Time shall, from
and after the Effective Time, be the initial directors of the Surviving
Corporation until their successors have been duly elected or appointed and
qualified or until their earlier death, resignation or removal in accordance
with the Surviving Corporation's Certificate of Incorporation and Bylaws.
1.7 Officers. The officers of the Company at the Effective Time shall, from
and after the Effective Time, be the initial officers of the Surviving
Corporation, and as a result Robert L. Natt will be the Chief Executive
Officer of the Surviving Corporation, until their successors have been duly
elected or appointed and qualified or until their earlier death, resignation
or removal in accordance with the Surviving Corporation's Certificate of
Incorporation and Bylaws.
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1.8 Consideration for the Merger; Conversion or Cancellation of Shares in
the Merger. At the Effective Time, by virtue of the Merger and without any
action on the part of Parent, Merger Sub, the Company or the holders of any
Shares or capital stock of Merger Sub:
(a) Each Share issued and outstanding immediately prior to the Effective
Time (other than Shares to be cancelled pursuant to Section 1.8(b) and
Dissenting Shares (as defined in Section 2.1)) shall be cancelled and
extinguished and converted into the right to receive $28.25 in cash,
without interest thereon (the "Merger Consideration"), subject to Section
1.10.
(b) Each Share issued and outstanding immediately prior to the Effective
Time and owned by Parent or Merger Sub or any direct or indirect subsidiary
of Parent or Merger Sub, or which is held in the treasury of the Company or
by any of its subsidiaries, shall cease to be outstanding, be cancelled and
retired without payment of any consideration therefor and cease to exist.
(c) Each share of common stock, par value $.01 per share, of Merger Sub
issued and outstanding immediately prior to the Effective Time shall be
converted into and become one validly issued, fully paid and nonassessable
share of common stock, par value $.01 per share, of the Surviving
Corporation.
1.9 Company Stock Plans. As of the Effective Time, each outstanding option
(including any related stock appreciation right) (an "Employee Option")
issued, awarded or granted pursuant to the Company's 1992 Stock Option Plan or
the Company's 1995 Stock Option Plan (the "Company Stock Plans") to purchase
Shares shall be cancelled to the Company, subject to obtaining the consents
discussed below, and each holder of a cancelled Employee Option shall be
entitled to receive from the Company (or, at Parent's option, any subsidiary
of the Company) in consideration for the cancellation of such Employee Option
an amount in cash (less applicable withholding Taxes (as defined in Section
3.11)) equal to the product of (i) the number of Shares previously subject to
such Employee Option and (ii) the excess, if any, of the Merger Consideration
over the exercise price per Share previously subject to such Employee Option.
At or prior to the Closing (x) the Company shall deliver to Parent agreements
(in a form reasonably acceptable to Parent) executed by each director and
officer of the Company acknowledging that the payment made pursuant to this
Section 1.9 is being made in full satisfaction of such individual's rights
under the applicable Company Stock Plans and any option awards granted
thereunder, and (y) the Company shall use its reasonable best efforts to
obtain executed agreements of the type described in clause (x) from each other
holder of an option to purchase Shares awarded under the Company Stock Plans.
1.10 Adjustment of Merger Consideration. Notwithstanding anything to the
contrary set forth in Section 1.8(a) hereof, in the event that, at or prior to
the Effective Time, the Company obtains each of the waivers and amendments
described on Schedule 6.1 (in a form or forms reasonably satisfactory to
Parent), then the Merger Consideration shall be increased by an amount equal
to $1.00 to a total of $29.25.
ARTICLE II
DISSENTING SHARES; EXCHANGE OF SHARES
2.1 Dissenting Shares. Notwithstanding anything in this Agreement to the
contrary, Shares outstanding immediately prior to the Effective Time and held
by a holder who has not voted to approve and adopt this Agreement or consented
thereto in writing and who has demanded appraisal for such Shares in
accordance with Section 262 of Delaware Law ("Dissenting Shares") shall not be
converted into the right to receive the Merger Consideration unless such
holder fails to perfect or withdraws or otherwise loses his right to
appraisal. If, after the Effective Time, such holder fails to perfect or
withdraws or loses his right to appraisal, such Shares shall no longer be
considered Dissenting Shares for the purposes of this Agreement and shall be
treated as if they had been converted as of the Effective Time into the right
to receive the Merger Consideration without interest thereon. The Company
shall give Merger Sub prompt notice of any demands received by the Company for
appraisal of Shares, and, prior to the Effective Time, Merger Sub shall have
the right to participate in all
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negotiations and proceedings with respect to such demands. Prior to the
Effective Time, the Company shall not, except with the prior written consent
of Merger Sub, make any payment with respect to, or settle or offer to settle,
any such demands.
2.2 Exchange of Certificates. (a) Prior to the Effective Time, Parent shall
designate a bank or trust company reasonably acceptable to the Company to act
as paying agent (the "Paying Agent") in effecting the exchange for the Merger
Consideration of certificates (the "Certificates") that, prior to the
Effective Time, represented Shares. Upon the surrender of each such
Certificate formerly representing Shares, together with a properly completed
letter of transmittal, the Paying Agent shall pay the holder of such
Certificate the Merger Consideration multiplied by the number of Shares
formerly represented by such Certificate, in exchange therefor, and such
Certificate shall forthwith be cancelled. Until so surrendered and exchanged,
each such Certificate (other than Certificates representing Dissenting Shares
or Shares held by Parent, Merger Sub or the Company, or any direct or indirect
subsidiary thereof) shall represent solely the right to receive the Merger
Consideration. No interest shall be paid or accrue on the Merger
Consideration. If the Merger Consideration (or any portion thereof) is to be
delivered to any Person (as defined in Section 8.8) other than the Person in
whose name the Certificate formerly representing Shares surrendered in
exchange therefor is registered, it shall be a condition to such exchange that
the Certificate so surrendered shall be properly endorsed or otherwise be in
proper form for transfer and that the Person requesting such exchange shall
pay to the Paying Agent any transfer or other Taxes (as defined in Section
3.11) required by reason of the payment of the Merger Consideration to a
Person other than the registered holder of the Certificate surrendered, or
shall establish to the satisfaction of the Paying Agent that such Tax has been
paid or is not applicable.
(b) Prior to the Effective Time, Parent or Merger Sub shall deposit, or
cause to be deposited, in trust with the Paying Agent for the benefit of the
holders of Shares the aggregate Merger Consideration to which holders of
Shares shall be entitled at the Effective Time pursuant to Section 1.8(a);
provided that no such deposit shall relieve Parent of its obligation to pay
the Merger Consideration pursuant to Section 1.8(a).
(c) The Merger Consideration shall be invested by the Paying Agent, as
directed by Parent, provided such investments shall be limited to direct
obligations of the United States of America, obligations for which the full
faith and credit of the United States of America is pledged to provide for the
payment of principal and interest, commercial paper rated of the highest
quality by Moody's Investors Services, Inc. or Standard & Poor's Corporation,
or certificates of deposit issued by a commercial bank having at least
$1,000,000,000 in assets; provided, that no loss on investments made pursuant
to this Section 2.2(c) shall relieve Parent of its obligation to pay the
Merger Consideration pursuant to Section 1.8(a).
(d) Promptly following the date which is six months after the Effective
time, the Paying Agent shall deliver to Parent all cash and documents in its
possession relating to the transactions described in this Agreement, and the
Paying Agent's duties shall terminate. Thereafter, each holder of a
Certificate formerly representing a Share may surrender such Certificate to
the Surviving Corporation and (subject to applicable abandoned property,
escheat and similar laws) receive in exchange therefor the Merger
Consideration, without any interest thereon.
(e) Promptly after the Effective Time, the Paying Agent shall mail to each
record holder of Certificates that immediately prior to the Effective Time
represented Shares a form of letter of transmittal and instructions for use in
surrendering such Certificates and receiving the Merger Consideration in
exchange therefor.
(f) After the Effective Time, there shall be no transfers on the stock
transfer books of the Surviving Corporation of any Shares. If, after the
Effective Time, Certificates formerly representing Shares are presented to the
Surviving Corporation or the Paying Agent, they shall be cancelled and
exchanged for the Merger Consideration, as provided in this Article II,
subject to applicable law in the case of Dissenting Shares.
(g) If any Certificate shall have been lost, stolen or destroyed, upon the
making of an affidavit of that fact by the Person claiming such Certificate to
be lost, stolen or destroyed and, if required by the Surviving Corporation,
the posting by such Person of a bond in such reasonable amount as the
Surviving Corporation may direct as indemnity against any claim that may be
made against it with respect to such Certificate, the Paying Agent will pay in
exchange for such lost, stolen or destroyed Certificate the Merger
Consideration deliverable in respect therefor pursuant to this Agreement.
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ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company hereby represents and warrants to Parent and Merger Sub that,
except as set forth with respect to a specifically identified representation
and warranty on the Disclosure Schedule delivered by the Company to Parent
prior to the execution of this Agreement (the "Company Disclosure Schedule"):
3.1 Corporate Organization and Qualification. Each of the Company and each
of its Significant Subsidiaries (as defined in Section 8.8) is a corporation
duly organized, validly existing and in good standing under the laws of its
respective jurisdiction of incorporation and is qualified and in good standing
as a foreign corporation in each jurisdiction where the properties owned,
leased or operated, or the business conducted, by it require such
qualification, except where the failure to so qualify or be in good standing
would not have a Material Adverse Effect (as defined in Section 8.8) on the
Company. Each of the Company and each of its Significant Subsidiaries has all
requisite power and authority (corporate or otherwise) to own its properties
and to carry on its business as it is now being conducted, except where the
failure to have such power and authority would not have a Material Adverse
Effect on the Company. The Company has heretofore made available to Parent
complete and correct copies of its Amended and Restated Certificate of
Incorporation and Amended and Restated Bylaws as in effect on the date hereof.
3.2 Capitalization. The authorized capital stock of the Company consists of
(i) 13,000,000 shares of Class A Common Stock of which, as of the close of
business on May 7, 1997, 5,767,196 shares were issued and outstanding, (ii)
6,369,789 shares of Class B Common Stock of which, as of the close of business
on May 7, 1997, 3,542,921 shares were issued and outstanding and (iii) 500,000
shares of preferred stock, par value $.01 per share, none of which is issued
or outstanding. All of the outstanding shares of capital stock of the Company
have been duly authorized and validly issued and are fully paid and
nonassessable and are not subject to preemptive rights. As of May 7, 1997, (i)
1,348,272 shares of Class A Common Stock were reserved for issuance upon
exercise of outstanding Employee Options pursuant to the Company Plans and
(ii) 200,000 shares of Series A Junior Participating Preferred Stock, par
value $.01 per share ("Junior Preferred Stock"), were reserved for issuance in
connection with the rights (the "Rights") to purchase shares of Junior
Preferred Stock issued pursuant to the Rights Agreement, dated as of February
21, 1995, between the Company and American Stock Transfer & Trust Company, as
rights agent (as amended from time to time, the "Rights Agreement"). Except as
set forth above and except for or as a result of the exercise of Employee
Options outstanding as of May 7, 1997, there are outstanding (i) no shares of
capital stock or other voting securities of the Company, (ii) no securities of
the Company convertible into or exchangeable for shares of capital stock or
voting securities of the Company, (iii) no options, subscriptions, warrants,
calls or other rights to acquire from the Company, and no obligation of the
Company to issue, deliver or sell, any capital stock, voting securities or
securities convertible into or exchangeable for capital stock or voting
securities of the Company and (iv) no equity equivalents (including any
phantom stock or SAR rights, whether cash or other), performance shares,
interests in the ownership or earnings of the Company or any of its
Subsidiaries or other similar rights issued by the Company (collectively,
"Company Securities"). There are no outstanding obligations of the Company or
any of its Subsidiaries to repurchase, redeem or otherwise acquire any Company
Securities. Each of the outstanding shares of capital stock of each of the
Company's Subsidiaries is duly authorized, validly issued, fully paid and
nonassessable and is directly or indirectly owned by the Company, free and
clear of all security interests, liens, claims, pledges, charges, voting
agreements or other encumbrances of any nature whatsoever (collectively,
"Liens"). There are no existing options, subscriptions, warrants, calls or
commitments of any character relating to the issued or unissued capital stock
or other equity securities of any Subsidiary of the Company. The execution,
delivery and performance of the Voting Trust Agreement by the parties thereto,
and the transactions contemplated thereby, will not be deemed to be a transfer
of beneficial ownership of the Class B Common Stock subject to the Voting
Trust Agreement and will not cause the shares of Class B Common Stock subject
to the Voting Trust Agreement to be converted into shares of Class A Common
Stock pursuant to the provisions of the Company's Amended and Restated
Certificate of Incorporation or applicable law.
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3.3 Other Interests. Except for the Company's interests in its Subsidiaries,
neither the Company nor any of its Subsidiaries owns directly or indirectly
any interest or investment (whether equity or debt) in, nor is the Company or
any of its Subsidiaries subject to any obligation or requirement to provide
for or to make any investment (whether equity or debt) in, any corporation,
limited liability company, partnership, joint venture, business, trust or
other entity.
3.4 Authority Relative to this Agreement; Fairness Opinion. The Company has
all necessary corporate power and authority to execute and deliver this
Agreement and the Voting Trust Agreement and (other than, with respect to the
Merger, the approval and adoption of this Agreement by the holders of a
majority of the total outstanding voting power of the Shares, voting as a
single class, as required by Delaware Law (the "Company Stockholder
Approval")) to perform its obligations hereunder and thereunder and to
consummate the transactions contemplated hereby and thereby. The Board of
Directors of the Company, at a meeting duly called and held on May 7, 1997,
(i) determined that this Agreement and the transactions contemplated hereby,
including the Merger, are in the best interests of the stockholders of the
Company, (ii) approved this Agreement and the Voting Trust Agreement and the
transactions contemplated hereby and thereby, including the Merger, and (iii)
resolved, subject to Section 5.6, to recommend that the stockholders of the
Company approve and adopt this Agreement. Morgan Stanley & Co. Incorporated
(the "Company Financial Advisor") has delivered to the Board of Directors of
the Company its written opinion dated May 8, 1997 to the effect that, as of
the date of such opinion, the consideration to be received by the holders of
Shares pursuant to the Merger Agreement is fair from a financial point of view
to such holders, a copy of which opinion has been delivered to Parent. The
execution, delivery and performance of this Agreement and the Voting Trust
Agreement by the Company and the consummation by the Company of the
transactions contemplated hereby and thereby have been duly and validly
authorized by the Board of Directors of the Company and no other corporate
proceedings on the part of the Company are necessary to authorize this
Agreement and the Voting Trust Agreement or to consummate the transactions
contemplated hereby and thereby (other than, with respect to the Merger, the
Company Stockholder Approval and the filing of the appropriate merger
documents as required by Delaware Law). The Board of Directors of the Company
has taken all action necessary with respect to the transactions contemplated
hereby and by the Voting Trust Agreement so as to render inapplicable to such
transactions, including, without limitation, the Merger, the restrictions on
business combinations contained in Section 203 of the Delaware Law. Each of
this Agreement and the Voting Trust Agreement has been duly and validly
executed and delivered by the Company and, assuming it constitutes a valid and
binding agreement of the other parties hereto or thereto, as the case may be,
constitutes a legal, valid and binding agreement of the Company enforceable
against the Company in accordance with its terms, except that the enforcement
hereof or thereof may be limited by (i) bankruptcy, insolvency,
reorganization, moratorium or other similar laws now or hereafter in effect
relating to creditors' rights generally and (ii) general principles of equity
(regardless of whether enforceability is considered in a proceeding in equity
or at law).
3.5 Governmental Authorization. The execution, delivery and performance of
this Agreement by the Company and the consummation by the Company of the
transactions contemplated hereby require no action by or in respect of, or
filing with, any court, administrative agency or commission or other
governmental authority or instrumentality, domestic or foreign ("Governmental
Entity") other than:
(a) the filing of the Certificate of Merger in accordance with Delaware
Law;
(b) compliance with any applicable requirements of the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended (the "HSR Act");
(c) compliance with any applicable requirements of the Securities
Exchange Act of 1934, as amended, and the rules and regulations promulgated
thereunder (the "Exchange Act");
(d) compliance with any applicable foreign or state securities or "blue
sky" laws, rules or regulations;
(e) compliance with Federal, foreign and state laws, rules and
regulations governing insurance, health maintenance organizations, health
care services plans, third party administrators, hospitals or other managed
health care organizations or antitrust; and
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(f) such other filings or registrations with, or authorizations, consents
or approvals of, Governmental Entities, the failure of which to be made or
obtained would not, individually or in the aggregate, (i) have a Material
Adverse Effect on the Company or the Surviving Corporation or (ii) impair
the ability of the Company to consummate the transactions contemplated by
this Agreement.
3.6 Non-Contravention. The execution, delivery and performance of this
Agreement by the Company do not, and the consummation by the Company of the
transactions contemplated hereby will not:
(a) contravene or conflict with any provision of the respective charters
or bylaws (or similar governing documents) of the Company or any of its
Significant Subsidiaries;
(b) assuming compliance with the matters referred to in Section 3.5 and
assuming the Company Stockholder Approval has been obtained, contravene or
conflict with or constitute a violation of any provision of any law,
regulation, judgment, injunction, order or decree binding upon or
applicable to the Company or any Subsidiary of the Company or any of their
respective properties or assets;
(c) conflict with or result in a breach or violation of, or constitute a
default (or an event that with notice or lapse of time or both would become
a default) under, or result in any third party having any right of
termination, amendment, acceleration or cancellation of, or loss of a
material benefit under, (i) any agreement, contract or other instrument
binding upon the Company or any Subsidiary of the Company or, (ii) assuming
compliance with the matters referred to in Section 3.5, any license,
franchise, permit or other similar authorization held by the Company or any
Subsidiary of the Company; or
(d) result in the creation or imposition of any Lien on any asset of the
Company or any Subsidiary of the Company;
except, with respect to clauses (b), (c) and (d) above, for contraventions,
defaults, losses, Liens and other matters referred to in such clauses that
would not, individually or in the aggregate, (i) have a Material Adverse
Effect on the Company or the Surviving Corporation, (ii) impair the ability of
the Company to consummate the transactions contemplated by this Agreement or
(iii) prevent or materially delay the consummation of any of the transactions
contemplated by this Agreement.
3.7 SEC Reports; Financial Statements. Each periodic report, registration
statement, definitive proxy statement and other document filed by the Company
with the Securities and Exchange Commission (the "SEC") since January 1, 1995
(as such documents have since the time of their filing been amended, the
"Company SEC Reports"), as of their respective dates, complied in all material
respects with the requirements of the Securities Act of 1933, as amended, and
the rules and regulations promulgated thereunder (the "Securities Act") or the
Exchange Act, as the case may be, applicable to such Company SEC Reports and
none of the Company SEC Reports contained any untrue statement of a material
fact or omitted to state a material fact required to be stated therein or
necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading, except for such
statements, if any, as have been modified by subsequent filings prior to the
date hereof. The Company SEC Reports include all the documents (other than
preliminary material) that the Company was required to file with the SEC since
January 1, 1995. The financial statements of the Company included in the
Company SEC Reports, as of their respective filing dates with the SEC,
complied as to form in all material respects with applicable accounting
requirements and with the published rules and regulations of the SEC with
respect thereto, have been prepared in accordance with generally accepted
accounting principles applied on a consistent basis during the periods
involved (except as may be indicated in the notes thereto or, in the case of
the unaudited statements, as permitted by Form 10-Q of the SEC) and present
fairly the consolidated financial position of the Company and its consolidated
Subsidiaries as of the dates thereof and the consolidated results of their
operations and cash flows for the periods then ended (subject in the case of
the unaudited statements, to normal, year-end audit adjustments). Since
December 31, 1996, neither the Company nor any of its Subsidiaries has
incurred any liabilities or obligations, whether absolute, accrued, fixed,
contingent, liquidated, unliquidated or otherwise and whether due or to become
due, except (i) as and to the extent set forth on the audited balance sheet of
the Company and its Subsidiaries as of December 31, 1996 (including the notes
thereto) (the "Company Balance Sheet"), (ii) for liability under this
Agreement, (iii) as incurred after December 31, 1996
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in the ordinary course of business and consistent with past practices, (iv) as
described in the Company SEC Reports filed and publicly available prior to the
date hereof or (v) as would not, individually or in the aggregate, have a
Material Adverse Effect on the Company.
3.8 Absence of Certain Changes or Events. Except as disclosed in the Company
SEC Reports filed and publicly available prior to the date hereof, since
December 31, 1996, the Company and its Subsidiaries have conducted their
respective business only in the ordinary course, consistent with past
practice, and there has not occurred or arisen any event which would,
individually or in the aggregate, have a Material Adverse Effect on the
Company.
3.9 Litigation. There is no action, suit, proceeding, claim or investigation
pending or, to the knowledge of the Company, threatened against or affecting
the Company or any of its Subsidiaries or any of their assets or against or
involving any of its officers, directors or employees in connection with the
business or affairs of the Company, including, without limitation, any claims
for indemnification arising under any agreement to which the Company or any of
its Subsidiaries is a party, which would, individually or in the aggregate,
have a Material Adverse Effect on the Company. The Company is not subject to
or in default with respect to any writ, order, judgment, injunction or decree
which would, individually or in the aggregate, have a Material Adverse Effect
on the Company. The parties agree that this representation and warranty shall
not cover any actions, suits, proceedings, claims, investigations, writs,
orders, judgments, injunctions or decrees, pending or threatened, which seek
to prevent or materially delay the consummation of the transactions
contemplated by this Agreement or impose material conditions with respect
thereto.
3.10 Proxy Statement. The proxy or information statement or similar
materials distributed to the Company's stockholders in connection with the
Merger, including any amendments or supplements thereto (the "Proxy
Statement"), will not, at the time of mailing to stockholders of the Company
or at the time of the special meeting of the Company's stockholders called for
the purpose of considering and taking action upon this Agreement (the "Special
Meeting"), contain any untrue statement of a material fact or omit to state
any material fact required to be stated therein or necessary in order to make
the statements therein, in light of the circumstances under which they are
made, not misleading. The Proxy Statement will comply as to form in all
material respects with the provisions of the Exchange Act. Notwithstanding the
foregoing two sentences, the Company makes no representation or warranty with
respect to information supplied by Parent or Merger Sub specifically for
inclusion in the Proxy Statement.
3.11 Taxes.
(a) The Company and each of its Subsidiaries (i) has filed (or the Company
has had timely filed on their behalf) when due (taking into account
extensions) with the appropriate Federal, state, local, foreign and other
governmental agencies, all material tax returns, estimates, reports and
documents of a similar nature relating to taxes required to be filed by it,
and all such returns, estimates and reports are or will be at the time of
filing true, correct and complete in all material respects and (ii) has either
paid when due and payable or has established adequate reserves (including
Taxes (as defined below) being contested in good faith) or otherwise accrued
on the Company Balance Sheet, all material Federal, state, local or foreign
taxes, levies, imposts, duties, licenses and registration fees and charges of
any nature whatsoever, and unemployment and social security taxes and income
tax withholding, including interest and penalties thereon ("Tax" or "Taxes").
There are no Tax liens upon any property of the Company or any of its
Subsidiaries except liens for current Taxes not yet due, and there are no
material Taxes, interest, penalties, assessments or deficiencies claimed in
writing by any Taxing authority and received by the Company or any such
Subsidiary that, in the aggregate, would result in any Tax liability in excess
of the amount of the reserves or accruals, and the Company and each of its
Subsidiaries has or will establish in accordance with its normal accounting
practices and procedures accruals and reserves that are adequate for the
payment of all material Taxes not yet due and payable and attributable to any
period preceding the Closing. The Company has not filed a consent to the
application of Section 341(f)(2) of the Code.
(b) No audit, assessment or other examination relating to Taxes by any
Taxing authority is pending with respect to any material Taxes due by the
Company or any of its Subsidiaries.
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(c) Neither the Company nor any predecessor corporation, nor any of their
respective Subsidiaries, has executed or filed with the Internal Revenue
Service or any other governmental authority or any other Taxing authority any
agreement or other document extending, or having the effect of extending, the
period of assessment or collection of any material Taxes.
(d) Neither the Company nor any of its Subsidiaries is a party to or is
bound by (or will prior to the Closing become a party to or bound by) any Tax
indemnity, Tax sharing or Tax allocation agreement or other similar
arrangement which includes a party other than the Company and its
Subsidiaries. Neither the Company nor any of its Subsidiaries has been a
member of an affiliated group other than one of which Company was the common
parent, or filed or been included in a combined, consolidated or unitary Tax
return other than one filed by the Company (or a return for a group consisting
solely of its Subsidiaries and predecessors).
(e) The Company has not agreed, nor is it required, to make any adjustment
under section 481(a) of the Code by reason of a change in accounting method or
otherwise.
(f) Neither the Company nor any of its Subsidiaries has entered into a
transaction which is being accounted for as an installment obligation under
section 453 of the Code, nor has the Company or any of its Subsidiaries
entered into an interest rate swap, currency swap or other similar
transaction.
3.12 Compliance with Applicable Law. Section 3.12 of the Company Disclosure
Schedule contains a true and complete list of all regulatory undertakings,
orders or other commitments of any nature not embodied in applicable statutes
or regulations or specifically disclosed in the Company SEC Reports filed and
publicly available prior to the date of this Agreement entered into by the
Company or any of its Subsidiaries with any regulatory entity, including any
insurance or HMO regulatory bodies, which undertakings, orders or other
commitments limit or purport to limit the business of the Company or any of
its Significant Subsidiaries as presently conducted or as the same may be
conducted in the future. The Company and its Subsidiaries hold, and at all
times since January 1, 1995 have held, all permits, licenses, variances,
exemptions, orders and approvals of all Governmental Entities necessary for
the lawful conduct of their respective businesses (the "Company Permits"),
except for failures to hold such permits, licenses, variances, exemptions,
orders and approvals which would not, individually or in the aggregate, have a
Material Adverse Effect on the Company. The Company and its Subsidiaries are,
and at all times since January 1, 1995 have been, in compliance with the terms
of the Company Permits, except where the failure so to comply would not,
individually or in the aggregate, have a Material Adverse Effect on the
Company. Except as specifically disclosed in the Company SEC Reports filed and
publicly available prior to the date of this Agreement, the conduct of the
respective businesses of the Company and its Subsidiaries is, and at all times
has been, in conformity with all applicable federal, state and other
governmental and regulatory requirements, except where nonconformity or
noncompliance would not, individually or in the aggregate, have a Material
Adverse Effect on the Company. No investigation or review by any Governmental
Entity with respect to the Company or any of its Subsidiaries is pending or,
to the knowledge of the Company, threatened, other than those which would not,
individually or in the aggregate, have a Material Adverse Effect on the
Company.
3.13 Employee Benefit Plans.
(a) Section 3.13(a) of the Company Disclosure Schedule contains a true and
complete list of each deferred compensation and each bonus or other incentive
compensation, stock purchase, stock option and other equity compensation plan,
program, agreement or arrangement; each severance or termination pay, medical,
surgical, hospitalization, life insurance and other "welfare" plan, fund or
program (within the meaning of section 3(1) of the Employee Retirement Income
Security Act of 1974, as amended ("ERISA"); each "pension" plan, fund or
program (within the meaning of section 3(2) of ERISA); each employment,
termination or severance agreement; and each other employee benefit plan,
fund, program, agreement or arrangement, in each case, that is sponsored,
maintained or contributed to or required to be contributed to by the Company
or by any trade or business, whether or not incorporated (an "ERISA
Affiliate"), that together with the Company would be deemed a "single
employer" within the meaning of section 4001(b) of ERISA, or to which the
Company or an ERISA Affiliate is party, whether written or oral, for the
benefit of any employee or former employee of the Company or any Subsidiary of
the Company (the "Plans"). Neither the Company, any Subsidiary of the Company
nor any ERISA
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Affiliate has any legal commitment to create any additional employee benefit
plan or modify or change any existing Plan that would affect any employee (an
"Employee") or former employee of the Company or any Subsidiary of the
Company.
(b) With respect to each Plan, the Company has heretofore delivered or made
available to Buyer true and complete copies of each of the following
documents:
(i) a copy of the Plan and any amendments thereto (or if the Plan is not
a written Plan, a description thereof);
(ii) a copy of the two most recent annual reports and actuarial reports,
if required under ERISA, and the most recent report prepared with respect
thereto in accordance with Statement of Financial Accounting Standards No.
87;
(iii) a copy of the most recent Summary Plan Description required under
ERISA with respect thereto;
(iv) if the Plan is funded through a trust or any third party funding
vehicle, a copy of the trust or other funding agreement and the latest
financial statements thereof; and
(v) the most recent determination letter received from the Internal
Revenue Service with respect to each Plan intended to qualify under section
401 of the Code.
(c) No Plan is subject to Title IV of ERISA. No Title IV Plan is a
"multiemployer pension plan," as defined in section 3(37) of ERISA, nor is any
Title IV Plan a plan described in section 4063(a) of ERISA.
(d) All contributions required to be made with respect to any Plan on or
prior to the Closing Date have been or will be timely made on or prior to the
Closing Date.
(e) Neither the Company or any Subsidiary of the Company nor, to the
knowledge of the Company, any trustee or administrator thereof, has engaged in
a transaction in connection with which the Company or any Subsidiary of the
Company or any trustee or administrator thereof could reasonably be expected
to be subject to either a material civil penalty assessed pursuant to section
409 or 502(i) of ERISA or a material tax imposed pursuant to section 4975 or
4976 of the Code.
(f) Each Plan has been operated and administered in all material respects in
accordance with its terms and applicable law, including but not limited to
ERISA and the Code.
(g) Each Plan intended to be "qualified" within the meaning of section
401(a) of the Code has received a favorable determination letter to the effect
that the Plan is so qualified and that its related trust maintained thereunder
is exempt from taxation under section 501(a) of the Code.
(h) No Plan provides medical, surgical, hospitalization, death or similar
benefits (whether or not insured) for employees or former employees of the
Company or any Subsidiary for periods extending beyond their retirement or
other termination of service, other than (i) coverage mandated by applicable
law, (ii) death benefits under any "pension plan," or (iii) benefits the full
cost of which is borne by the current or former employee (or his beneficiary).
(i) Except as previously disclosed in writing to Parent, no amounts payable
under the Plans will fail to be deductible for federal income tax purposes by
virtue of section 280G of the Code.
(j) Except as set forth in Section 3.13(j) of the Company Disclosure
Schedule or as expressly provided in this Agreement, the consummation of the
transactions contemplated by this Agreement will not (i) entitle any current
or former employee or officer of the Company or any ERISA Affiliate to
severance pay, unemployment compensation or any other payment, or (ii)
accelerate the time of payment or vesting, or increase the amount of
compensation due any such employee or officer.
(k) There are no pending or, to the knowledge of the Company, threatened or
anticipated claims by or on behalf of any Plan, by any employee or beneficiary
covered under any such Plan, or otherwise involving any such Plan (other than
routine claims for benefits).
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3.14 Labor Matters. Neither the Company nor any of its Subsidiaries is a
party to any collective bargaining agreement or other labor union contract
applicable to persons employed by the Company or any such Subsidiary and, to
the knowledge of the Company, there are no activities or proceedings of any
labor union to organize any such employees.
3.15 Environmental Laws and Regulations.
(a) No written notice, notification, demand, request for information,
citation, summons, complaint or order has been received by the Company or any
of its Subsidiaries, no complaint has been served on the Company or any of its
Subsidiaries, no penalty has been assessed and, to the knowledge of the
Company, no investigation is pending or has been threatened (each, an
"Action") by any Governmental Entity or other party with respect to any (i)
alleged violation by the Company or any of its Subsidiaries of any
Environmental Law, (ii) alleged failure by the Company or any such Subsidiary
to have any environmental permit, certificate, license, approval, registration
or authorization required in connection with the conduct of its business or
(iii) Regulated Activity, in each case where such Action has had or would
have, individually or in the aggregate, a Material Adverse Effect on the
Company.
(b) Neither the Company nor any of its Subsidiaries has any Environmental
Liabilities that has had, or would have, individually or in the aggregate, a
Material Adverse Effect on the Company. There has been no release of Hazardous
Substances into the environment or violation of any Environmental Law in
either case by the Company or any such Subsidiary which in either case has
had, or would have, individually or in the aggregate, a Material Adverse
Effect on the Company.
(c) For the purposes of this Agreement, the following terms have the
following meanings:
"Environmental Laws" shall mean any and all Federal, state, local and
foreign statutes, laws, regulations, ordinances, rules, judgments, orders,
decrees, codes, injunctions and governmental restrictions relating to the
environment or to emissions, discharges or releases of Hazardous Substances
into the environment or otherwise relating to the manufacture, processing,
distribution, use, treatment, storage, disposal, transport or handling of
Hazardous Substances or the clean-up or other remediation thereof.
"Environmental Liabilities" shall mean all liabilities which (i) arise
under Environmental Laws and (ii) relate to Regulated Activities occurring
or conditions existing on or prior to the Effective Time.
"Hazardous Substances" shall mean any pollutants, contaminants, toxic,
radioactive, caustic or otherwise hazardous substance or waste, including
petroleum, its derivatives, by-products and other hydrocarbons and medical
or infectious waste that is regulated under or by any applicable
Environmental Law.
"Regulated Activity" shall mean any generation, treatment, storage,
recycling, transportation, disposal or release of any Hazardous Substances.
3.16 Computer Systems; Intangible Property.
(a) Except as set forth on Section 3.16 of the Company Disclosure Schedule,
the Company's computer systems, including all hardware and software
(collectively, the "Computer Systems"), are presently serving the Company's
needs adequately. There are no infringement suits, actions or proceedings
pending or, to the Company's knowledge, threatened, with respect to the
Computer Systems.
(b) The Company or one of its Subsidiaries is the owner of, or a licensee
under a valid license for, all items of intangible property which are material
to the business of the Company and its Subsidiaries as currently conducted,
taken as a whole, including, without limitation, trade names, unregistered
trademarks and service marks, brand names, patents and copyrights. There are
no claims pending or, to the Company's knowledge, threatened, that the Company
or any of its Subsidiaries is in violation of any such intangible property of
any third party which would, individually or in the aggregate, have a Material
Adverse Effect on the Company. No
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material infringement of any proprietary right owned by or licensed by or to
the Company or any of its Subsidiaries is known to the Company.
3.17 DOI Reports. The Company has made available to Parent at the Company's
offices true, correct and complete copies of all material reports filed by the
Company or any of its Subsidiaries regarding the activities of the Company and
its Subsidiaries in the States of Connecticut, New Jersey and New York with,
and any license applications filed by the Company in such States with, and all
material correspondence regarding such activities and license applications
sent to, or received by the Company or any of its Subsidiaries from,
applicable insurance and HMO regulatory bodies since January 1, 1995. Each
material report required to be filed by the Company or any of its Subsidiaries
with applicable insurance and HMO regulatory bodies since January 1, 1995 (as
such documents have since the time of their filing been amended, the "DOI
Reports") has been filed. As of their respective dates, the DOI Reports
complied in all material respects with the requirements of the laws, rules and
regulations applicable to such DOI Reports, and none of the DOI Reports
contained any untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary in order to make the
statements therein, in light of the circumstances under which they were made,
not misleading, except for such statements, if any, as have been modified by
subsequent filings prior to the date hereof.
3.18 Covered Lives/Subscribers. As of April 30, 1997, (i) the Company had a
total of 379,026 at-risk members covered under its various managed health care
plans, including 339,742 commercial HMO members, 15,254 Medicare members,
24,030 Medicaid members, and no commercial PPO members, and (ii) there were
68,844 persons covered by self-funded and other plans for which the Company
provided ASO services.
3.19 Contracts. Neither the Company nor its Subsidiaries is a party to, or
has any obligation under, any contract or agreement, written or oral, which
contains any covenants currently or prospectively limiting the freedom of the
Company, any of its Subsidiaries or any of their respective affiliates to
engage in any line of business or to compete with any entity. All contracts
and agreements to which the Company or any of its Subsidiaries is a party or
by which any of their respective assets are bound are valid and binding, in
full force and effect and enforceable against the parties thereto in
accordance with their respective terms, subject to applicable bankruptcy,
insolvency, reorganization, moratorium or other similar laws relating to
creditors' rights generally and general principles of equity, other than such
failures to be so valid and binding, in full force and effect or enforceable
which would not, individually or in the aggregate, have a Material Adverse
Effect on the Company. There is not under any such contract or agreement any
existing default, or event which, after notice or lapse of time, or both,
would constitute a default, by the Company or any of its Subsidiaries or, to
the Company's knowledge, any other party, except to the extent such default
would not, individually or in the aggregate, have a Material Adverse Effect on
the Company.
3.20 Brokers and Finders. Except for the fees and expenses payable to the
Company Financial Advisor, which fees and expenses are reflected in its
agreements with the Company, true and complete copies of which have been
furnished to Parent, the Company has not engaged any investment banker,
broker, finder, consultant or intermediary in connection with the transactions
contemplated by this Agreement which would be entitled to any investment
banking, brokerage, finder's or similar fee or commission in connection with
this Agreement or the transactions contemplated hereby.
3.21 Company Rights Plan. The Rights Agreement has been amended to (i)
render the Rights Agreement inapplicable to the Merger and the other
transactions contemplated by this Agreement and (ii) ensure that (y) neither
Parent nor any of its wholly owned Subsidiaries is an Acquiring Person (as
defined in the Rights Agreement) pursuant to the Rights Agreement and (z) a
Stock Acquisition Date or Distribution Date (in each case as defined in the
Rights Agreement) does not occur solely by reason of the execution of this
Agreement or the consummation of the Merger or the other transactions
contemplated by this Agreement.
3.22 Certain Real Property. The Company does not directly own any real
property located in the State of Connecticut.
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ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF PARENT
AND MERGER SUB
Each of Parent and Merger Sub represent and warrant jointly and severally to
the Company that, except as set forth with respect to a specifically
identified representation and warranty on the Disclosure Schedule delivered by
Parent to the Company prior to the execution of this Agreement (the "Parent
Disclosure Schedule"):
4.1 Corporate Organization and Qualification. Each of Parent and each of its
Significant Subsidiaries is a corporation duly organized, validly existing and
in good standing under the laws of its respective jurisdiction of
incorporation and is qualified and in good standing as a foreign corporation
in each jurisdiction where the properties owned, leased or operated, or the
business conducted, by it require such qualification, except where the failure
to so qualify or be in good standing would not have a Material Adverse Effect
on Parent. Each of Parent and each of its Subsidiaries has all requisite power
and authority (corporate or otherwise) to own its properties and to carry on
its business as it is now being conducted, except where the failure to have
such power and authority would not have a Material Adverse Effect on Parent.
Parent and Merger Sub have heretofore made available to the Company complete
and correct copies of their respective Certificates of Incorporation and
Bylaws as in effect on the date hereof.
4.2 Authority Relative to This Agreement. Each of Parent and Merger Sub has
all necessary corporate power and authority to execute and deliver this
Agreement, to perform its obligations hereunder and to consummate the
transactions contemplated hereby. The execution, delivery and performance of
this Agreement by Parent and Merger Sub and the consummation by Parent and
Merger Sub of the transactions contemplated hereby have been duly and validly
authorized by the respective Boards of Directors of Parent and Merger Sub and
by Parent as sole stockholder of Merger Sub, and no other corporate
proceedings on the part of Parent and Merger Sub are necessary to authorize
this Agreement or to consummate the transactions contemplated hereby. This
Agreement has been duly and validly executed and delivered by each of Parent
and Merger Sub and, assuming this Agreement constitutes the valid and binding
agreement of the Company, constitutes a legal, valid and binding agreement of
each of Parent and Merger Sub, enforceable against each of them in accordance
with its terms, except that the enforcement hereof may be limited by (i)
bankruptcy, insolvency, reorganization, moratorium or other similar laws now
or hereafter in effect relating to creditors' rights generally and (ii)
general principles of equity (regardless of whether enforceability is
considered in a proceeding in equity or at law).
4.3 Governmental Authorization. The execution, delivery and performance of
this Agreement by Parent and Merger Sub and the consummation by Parent and
Merger Sub of the transactions contemplated hereby require no action by or in
respect of, or filing with, any Governmental Entity other than:
(a) the filing of the Certificate of Merger in accordance with Delaware
Law;
(b) compliance with any applicable requirements of the HSR Act;
(c) compliance with any applicable requirements of the Exchange Act;
(d) compliance with any applicable foreign or state securities or "blue
sky" laws, rules or regulations;
(e) compliance with Federal, foreign and state laws, rules and
regulations governing insurance, health maintenance organizations, health
care services plans, third party administrators, hospitals or other managed
health care organizations or antitrust; and
(f) such other filings or registrations with, or authorizations, consents
or approvals of, Governmental Entities, the failure of which to be made or
obtained would not, individually or in the aggregate, (i) have a Material
Adverse Effect on Parent or (ii) impair the ability of Parent and Merger
Sub to consummate the transactions contemplated by this Agreement.
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4.4 Non-Contravention. The execution, delivery and performance of this
Agreement by Parent and Merger Sub do not, and the consummation by Parent and
Merger Sub of the transactions contemplated hereby will not:
(a) contravene or conflict with any provisions of the respective charters
or bylaws (or similar governing documents) of Parent or any of its
Significant Subsidiaries;
(b) assuming compliance with the matters referred to in Section 4.3,
contravene or conflict with or constitute a violation of any provision of
any law, regulation, judgment, injunction, order or decree binding upon or
applicable to Parent or any Subsidiary of Parent or any of their respective
properties or assets;
(c) conflict with or result in a breach or violation of, or constitute a
default (or an event that with notice or lapse of time or both would become
a default) under, or result in any third party having any right of
termination, amendment, acceleration or cancellation of or loss of a
material benefit under, (i) any agreement, contract or other instrument
binding upon Parent or any Subsidiary of Parent or (ii) assuming compliance
with the matters referred to in Section 4.3, any license, franchise, permit
or other similar authorization held by Parent or any Subsidiary of Parent;
or
(d) result in the creation or imposition of any Lien on any material
asset of Parent or any Subsidiary of Parent;
except, with respect to clauses (b), (c) and (d) above, for contraventions,
defaults, losses, Liens and other matters referred to in such clauses that
would not, individually or in the aggregate, (i) have a Material Adverse
Effect on Parent, (ii) impair the ability of Parent and Merger Sub to
consummate the transactions contemplated by this Agreement or (iii) prevent or
materially delay the consummation of any of the transactions contemplated by
this Agreement.
4.5 SEC Reports; Financial Statements. Each periodic report, registration
statement, definitive proxy statement and other document filed by the Parent
with the SEC since January 1, 1995 (as such documents have since the time of
their filing been amended, the "Parent SEC Reports"), as of their respective
dates, complied in all material respects with the requirements of the
Securities Act or the Exchange Act, as the case may be, applicable to such
Parent SEC Reports and none of the Parent SEC Reports contained any untrue
statement of a material fact or omitted to state a material fact required to
be stated therein or necessary in order to make the statements therein, in
light of the circumstances under which they were made, not misleading, except
for such statements, if any, as have been modified by subsequent filings prior
to the date hereof. The Parent SEC Reports include all the documents (other
than preliminary material) that Parent was required to file with the SEC since
January 1, 1995. The financial statements of Parent included in the Parent SEC
Reports, as of their respective filing dates with the SEC, complied as to form
in all material respects with applicable accounting requirements and with the
published rules and regulations of the SEC with respect thereto, have been
prepared in accordance with generally accepted accounting principles applied
on a consistent basis during the periods involved (except as may be indicated
in the notes thereto or, in the case of the unaudited statements, as permitted
by Form 10-Q of the SEC) and present fairly the consolidated financial
position of Parent and its consolidated Subsidiaries as of the dates thereof
and the consolidated results of their operations and cash flows for the
periods then ended (subject in the case of the unaudited statements, to
normal, year-end audit adjustments).
4.6 Information Supplied. None of the information supplied or to be supplied
by Parent or Merger Sub specifically for inclusion in the Proxy Statement
will, at the time of mailing to stockholders of the Company or at the time of
the Special Meeting, contain any untrue statement of a material fact or omit
to state any material fact required to be stated therein or necessary in order
to make the statements therein, in light of the circumstances under which they
are made, not misleading.
4.7 Interim Operations of Merger Sub. Merger Sub was formed solely for the
purpose of engaging in the transactions contemplated hereby and has not
engaged in any business activities or conducted any operations other than in
connection with the transactions contemplated hereby.
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4.8 Brokers and Finders. Except for the fees and expenses payable to Credit
Suisse First Boston, which fees and expenses are reflected in its agreements
with Parent, Parent has not engaged any investment banker, broker, finder,
consultant or intermediary in connection with the transactions contemplated by
this Agreement which would be entitled to any investment banking, brokerage,
finder's or similar fee or commission in connection with this Agreement or the
transactions contemplated hereby.
ARTICLE V
ADDITIONAL COVENANTS AND AGREEMENTS
5.1 Conduct of Business of the Company. Except as set forth in Section 5.1
of the Company Disclosure Schedule or Section 5.8 hereof, the Company agrees
that during the period from the date of this Agreement to the Effective Time,
the Company shall, and shall cause each of its Subsidiaries to, conduct its
operations according to its ordinary and usual course of business consistent
with past practice and, to the extent consistent therewith, use its reasonable
best efforts to preserve intact its current business organizations, keep
available the service of its current officers and employees and preserve its
relationships with customers, suppliers and others having business dealings
with it to the end that goodwill and ongoing businesses shall not be impaired.
Except as set forth in Section 5.1 of the Company Disclosure Schedule or
Section 5.8 hereof, without limiting the generality of the foregoing, and
except as otherwise expressly permitted in this Agreement prior to the
Effective Time, neither the Company nor any of its Subsidiaries shall:
(a) except for shares of Class A Common Stock to be issued or delivered
in connection with the exercise of Employee Options outstanding on the date
hereof in accordance with their current terms, issue, deliver, sell,
dispose of, pledge or otherwise encumber, or authorize or propose the
issuance, sale, disposition or pledge or other encumbrance of (A) any
additional shares of capital stock of any class (including the Shares), or
any securities or rights convertible into, exchangeable for, or evidencing
the right to subscribe for any shares of capital stock, or any rights,
warrants, options, calls, commitments or any other agreements of any
character to purchase or acquire any shares of capital stock, or (B) any
other securities in respect of, in lieu of, or in substitution for, Shares
outstanding on the date hereof;
(b) except pursuant to the Plans as in effect on the date hereof, redeem,
purchase or otherwise acquire, or propose to redeem, purchase or otherwise
acquire, any shares of capital stock of the Company or any of its
Subsidiaries;
(c) split, combine, subdivide or reclassify any of its capital stock or
declare, set aside for payment or pay any dividend, or make any other
actual, constructive or deemed distribution in respect of any of its
capital stock or otherwise make any payments to stockholders of the Company
in their capacity as such, except for dividends payable to the Company
declared by any wholly owned subsidiary of the Company;
(d) adopt or propose to adopt a plan of complete or partial liquidation,
dissolution, merger, consolidation, restructuring, recapitalization or
other reorganization of the Company or any of its Subsidiaries (other than
the Merger);
(e) adopt or propose to adopt any amendments to its Amended and Restated
Certificate of Incorporation or Amended and Restated Bylaws;
(f) waive, amend or otherwise alter the Rights Agreement or redeem the
Rights;
(g) acquire or agree to acquire by merging or consolidating with, or by
purchasing a substantial portion of the assets of or equity in, or by any
other manner, any business or any corporation, partnership, association or
other business organization or division thereof or otherwise acquire or
agree to acquire any assets, in each case that are material, individually
or in the aggregate, to the Company and its Subsidiaries taken as a whole;
(h) sell (including by sale-leaseback), lease or otherwise dispose of, or
agree to sell, lease or otherwise dispose of, any of its assets that are
material, individually or in the aggregate, to the Company and its
Subsidiaries taken as a whole;
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(i) make or agree to make any capital expenditure or expenditures which,
individually, is in excess of $100,000 or, in the aggregate, are in excess
of $500,000, except as set forth in Section 5.1(i) of the Company
Disclosure Schedule;
(j) enter into any non-competition or other agreement which may restrict
in any way the conduct of the respective businesses of the Company or any
of its Subsidiaries;
(k) modify its existing provider fee or rate schedules, the result of
which modifications would be, based upon 1996 utilization, an increase in
either (i) the aggregate reimbursements to all physician, hospital and
ancillary providers, taken together, or (ii) reimbursements to any
individual physician, hospital or ancillary provider representing at least
$1,000,000 or more in annual payments for services during 1996;
(l) except as required by law, effect material changes to rating plans or
issue new business or renewal quotations to groups of more than 1,000
employees or enter into any amendment or modification of any of its
agreements with providers, other than amendments expressly contemplated
hereby, without reasonable evidence that doing so would be in the economic
interests of the Company and would not adversely affect the Company's
rights to medically manage the provision of healthcare except in immaterial
respects;
(m) other than in the ordinary course of business consistent with past
practice, incur any indebtedness for borrowed money or guarantee any such
indebtedness or issue or sell any debt securities or guarantee any debt
securities of others, or make any loans, advances or capital contributions
to, or investments in, any other Person, other than to the Company or any
wholly owned Subsidiary of the Company;
(n) except as may be required as a result of a change in law or in
generally accepted accounting principles, change any of the accounting
principles or practices used by it;
(o) settle or compromise any pending or threatened material suit, action
or claim relating to the transactions contemplated hereby;
(p) pay, discharge or satisfy any claims, liabilities or obligations
(absolute, accrued, asserted or unasserted, contingent or otherwise), other
than the payment, discharge or satisfaction in the ordinary course of
business consistent with past practice, or as required by their by terms,
of liabilities reflected or reserved against in, or contemplated by, the
Company Balance Sheet (or the notes thereto) or incurred in the ordinary
course of business consistent with past practice or immaterial liabilities
not incurred in the ordinary course of business consistent with past
practice;
(q) increase in any manner the compensation or fringe benefits of any of
its directors, officers or other employees receiving an annual salary in
excess of $40,000, or pay any pension or retirement allowance not required
by any existing plan or agreement to any such employees, or become a party
to, amend or commit itself to any pension, retirement, profit-sharing or
welfare benefit plan or agreement or employment agreement with or for the
benefit of any employee (other than increases in the compensation of
employees who are not officers or directors of the Company made in the
ordinary course of business consistent with past practice) or voluntarily
accelerate the vesting of any compensation or benefit;
(r) waive, amend or allow to lapse any term or condition of any
confidentiality or "standstill" agreement to which the Company is a party;
or
(s) take, or agree in writing or otherwise to take, any of the foregoing
actions.
5.2 Reasonable Best Efforts. Upon the terms and subject to the conditions
set forth in this Agreement, each of the parties agrees to use its reasonable
best efforts to take, or cause to be taken, all actions, and to do, or cause
to be done, and to assist and cooperate with the other parties in doing, all
things necessary, proper or advisable to consummate and make effective, in the
most expeditious manner practicable, the Merger, and the other transactions
contemplated by this Agreement, including (a) the prompt making of their
respective filings
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and thereafter the making of any other required submission under the HSR Act
with respect to the Merger, (b) the obtaining of all additional necessary
actions or non-actions, waivers, consents and approvals from Governmental
Entities and the making of all necessary registrations and filings (including
filings with Governmental Entities) and the taking of all reasonable steps as
may be necessary to obtain an approval or waiver from any Governmental Entity,
(c) the obtaining of all necessary consents, approvals or waivers from third
parties, (d) the defending of any lawsuits or other legal proceedings, whether
judicial or administrative, challenging this Agreement or the consummation of
the transactions contemplated hereby, including seeking to have any stay or
temporary restraining order entered by any court or other Governmental Entity
vacated or reversed, and (e) the execution and delivery of any additional
instruments necessary to consummate the transactions contemplated by this
Agreement.
5.3 Access to Information. The Company shall, and shall cause each of its
Subsidiaries to, afford to Parent, and to Parent's accountants, counsel and
other representatives, reasonable access and permit them to make such
inspections as they may reasonably require during normal business hours during
the period from the date of this Agreement through the Effective Time to all
their respective properties, books, contracts, commitments and records and,
during such period, the Company shall, and shall cause each of its
Subsidiaries to, furnish promptly to Parent (i) copy of each report, schedule,
registration statement and other document filed by it during such period
pursuant to the requirements of Federal or state laws other than product and
product-related filings with departments of insurance and (ii) all other
information concerning its business, properties and personnel as Parent may
reasonably request. The financial and operating data requested pursuant to
this Section 5.3 shall specifically include, but shall not be limited to, all
correspondence and reports reasonably relating to any actual or threatened
adverse actions, denials or revocations of accreditation, sanctions or
investigations by the National Committee on Quality Assurance, the Joint
Commission on Hospital Accreditation, the Health Care Financing Administration
or any other state or federal agency and any notice of termination from any
employee group or program representing five percent or more of the revenue of
any Subsidiary of the Company. Parent and each of its Subsidiaries will hold,
and will cause its respective affiliates, associates and representatives to
hold, any nonpublic information in accordance with the terms of the
Confidentiality Agreement, dated as of March 3, 1997, between Parent and
Company (the "Confidentiality Agreement").
5.4 Publicity. The parties will consult with each other and will mutually
agree upon any press releases or public announcements pertaining to this
Agreement and the transactions contemplated hereby and shall not issue any
such press releases or make any such public announcements prior to such
consultation and agreement, except as may be required by applicable law or by
obligations pursuant to any listing agreement with any national securities
exchange, in which case the party proposing to issue such press release or
make such public announcement shall use its reasonable best efforts to consult
in good faith with the other party before issuing any such press releases or
making any such public announcements.
5.5 Notices of Certain Events. The Company shall, upon obtaining knowledge
of any of the following, promptly notify Parent in writing of: (i) any
Material Adverse Effect with respect to the Company; (ii) any change which
makes it likely that any representation or warranty set forth in this
Agreement regarding the Company or any of its Subsidiaries will not be true in
any material respect at the Closing and which would be likely to cause any
condition to the obligations of any party to effect the Merger not to be
satisfied; (iii) the occurrence or non-occurrence of any event the occurrence
or non-occurrence of which would be likely to cause any condition to the
obligations of any party to effect the Merger not to be satisfied; (iv) the
failure of the Company to comply with or satisfy any covenant, condition or
agreement to be complied with or satisfied by it pursuant to this Agreement
which would be likely to cause any condition to the obligations of any party
to effect the Merger not to be satisfied; (v) any notice or other
communication from any Governmental Entity in connection with the Merger; or
(vi) any actions, suits, claims, investigations or other proceedings (or
communications indicating that the same may be contemplated) commenced or
threatened against the Company or any of its Subsidiaries which, if pending on
the date of this Agreement, would have resulted in any of the representations
and warranties set forth in Section 3.9 being untrue or inaccurate or which
relate to the
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consummation of the Merger; provided, however, that the delivery of any notice
pursuant to this Section 5.5 shall not cure any breach of any representation
or warranty or otherwise limit or affect the remedies available to Parent.
5.6 Stockholder Meeting; Proxy Materials; Opinion of Financial Advisor.
(a) Unless the Board of Directors of the Company shall take any action
permitted by the third sentence of this Section 5.6(a), the Company shall
cause the Special Meeting to be duly called and held as soon as practicable
after the date of this Agreement for the purpose of voting on the approval and
adoption of this Agreement (the "Company Stockholder Approval"). Except as
provided in the next sentence, the Board of Directors of the Company shall
recommend approval and adoption of this Agreement by the Company's
stockholders. The Board of Directors of the Company shall be permitted to (i)
not recommend to the Company's stockholders that they vote in favor of the
approval and adoption of this Agreement or (ii) withdraw or modify in a manner
adverse to Parent its recommendation to the Company's stockholders that they
vote in favor of the approval and adoption of this Agreement, but in each of
cases (i) and (ii) only if and to the extent that the Company has complied
with Section 5.7, a Superior Proposal (as defined in Section 5.6(b)) is
pending at the time the Company's Board of Directors determines to take any
such action or inaction and the Company's Board of Directors determines in
good faith, based upon the advice of its outside legal counsel, that such
action or inaction is necessary for such Board of Directors to comply with its
fiduciary duties under applicable law; provided that no such failure to
recommend, withdrawal or modification shall be made unless the Company shall
have delivered to Parent a written notice advising Parent that the Board of
Directors of the Company has received a Superior Proposal and identifying the
Person making such Superior Proposal; provided, further, that nothing
contained in this Agreement shall prevent the Board of Directors of the
Company from complying with Rule 14e-2 under the Exchange Act with regard to
an Acquisition Proposal (as defined in Section 5.6(b)).
(b) For purposes of this Agreement, "Superior Proposal" means any bona fide
written Acquisition Proposal for all of the outstanding Shares or all or
substantially all of the assets of the Company and its Subsidiaries on terms
that the Board of Directors of the Company determines in good faith (based on
the advice of a financial advisor of nationally recognized reputation) are
more favorable and provide greater value to all the Company's stockholders
than this Agreement and the Merger. For purposes of this Agreement,
"Acquisition Proposal" means any offer or proposal for, or any indication of
interest in, a merger or other business combination involving the Company or
any Significant Subsidiary of the Company or the acquisition of any equity
interest in, or a substantial portion of the assets of, the Company or any
Significant Subsidiary of the Company, other than the transactions
contemplated by this Agreement.
(c) In connection with such Special Meeting, the Company (i) will promptly
prepare and file with the SEC, will use its reasonable best efforts to have
cleared by the SEC as promptly as practicable and will promptly thereafter
mail to its stockholders the Proxy Statement and all other proxy materials for
such meeting, (ii) will use its reasonable best efforts, subject to the
immediately preceding sentence, to obtain the Company Stockholder Approval and
(iii) will otherwise comply with all legal requirements applicable to such
meeting. The Company shall notify Parent promptly of the receipt of comments
from the SEC and of any request by the SEC for amendments or supplements to
the Proxy Statement or for additional information, and shall supply Parent
with copies of all correspondence between the Company or its representatives,
on the one hand, and the SEC or members of its staff, on the other hand, with
respect to the Proxy Statement. If at any time prior to the Special Meeting,
any event should occur relating to the Company or its officers or directors
which should be described in an amendment of, or a supplement to, the Proxy
Statement, the Company shall promptly inform Parent. Whenever any event occurs
which should be described in an amendment of, or a supplement to, the Proxy
Statement, the Company shall, upon learning of such event, prepare promptly,
file and clear with the SEC and mail to the Company's stockholders such
amendment or supplement; provided, however, that prior to such mailing, to the
extent practicable (i) the Company shall consult with Parent with respect to
such amendment or supplement and (ii) the Company shall afford Parent
reasonable opportunity to comment thereon, it being understood that the
Company will not mail any Proxy Statement, or any amendment or supplement
thereto, to which Parent reasonably objects.
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(d) The Company shall use its reasonable best efforts to cause the Company
Financial Advisor to provide its opinion to the effect that, as of a date no
earlier than three business days prior to the date that the Proxy Statement is
mailed to stockholders of the Company, the consideration to be received by the
holders of Shares pursuant to the Merger is fair to such holders from a
financial point of view, and shall include such updated opinion in the Proxy
Statement.
5.7 No Solicitation.
(a) The Company shall not, directly or indirectly, through any officer,
director, employee, investment banker, attorney, representative or agent of
the Company or any of its Subsidiaries, (i) solicit, initiate, or encourage
any inquiries or proposals that constitute, or could reasonably be expected to
lead to, an Acquisition Proposal, (ii) engage in negotiations or discussions
concerning, or provide any non-public information or data to any Person or
entity relating to, any Acquisition Proposal, or (iii) agree to, approve or
recommend any Acquisition Proposal, or otherwise facilitate any effort or
attempt to make or implement an Acquisition Proposal; provided, however, that
nothing contained in this Agreement shall prevent the Company or its Board of
Directors from (A) furnishing nonpublic information or data to, or entering
into discussions or negotiations with, any Person in connection with an
unsolicited Acquisition Proposal, if and only to the extent that the Company's
Board of Directors determines in good faith, based upon the advice of its
outside legal counsel, that such action is necessary for such Board of
Directors to comply with its fiduciary duties under applicable law and prior
to furnishing such non-public information to, or entering into discussions or
negotiations with, such Person or entity, the Company or its Board of
Directors receives from such Person or entity an executed customary
confidentiality agreement, provided, that in the event that any term of such
confidentiality agreement is more favorable to such Person or entity than the
Confidentiality Agreement is to Parent, (x) the Company shall promptly (and in
no event later than 24 hours after execution thereof) notify Parent of the
more favorable provisions of such confidentiality agreement and (y) the
Confidentiality Agreement shall automatically be deemed to have been amended
to provide Parent with the benefit of the more favorable term(s); (B)
complying with Rule 14e-2 promulgated under the Exchange Act with regard to an
Acquisition Proposal. The Company will immediately cease and cause to be
terminated any existing activities, discussions or negotiations with any
parties conducted heretofore with respect to any of the foregoing.
(b) The Company shall (i) promptly (and in no event later than 24 hours
after receipt of any Acquisition Proposal) notify Parent after receipt by it
(or its advisors) of any Acquisition Proposal or any inquiries indicating that
any Person is considering making or wishes to make an Acquisition Proposal,
identifying such Person, (ii) promptly notify Parent after receipt of any
request for nonpublic information relating to it or any of its Subsidiaries or
for access to its or any of its Subsidiaries' properties, books or records by
any Person, identifying such Person and the information requested by such
Person, that may be considering making, or has made, an Acquisition Proposal
and promptly provide Parent with any nonpublic information which is given to
such Person pursuant to this Section 5.7(b), and (iii) keep Parent advised of
the status and principal financial terms of any such Acquisition Proposal,
indication or request. The Company shall give Parent at least 24 hours'
advance notice of any information to be supplied to any Person making such
Acquisition Proposal.
5.8 Termination of Company Stock Plans. Except as may be otherwise agreed to
by Parent and the Company, the Company Stock Plans shall terminate as of the
Effective Time. Prior to the Effective Time, the Board of Directors of the
Company (or, if appropriate, any committee thereof) shall adopt such
resolutions or take such other actions as are required to (i) effect the
transactions contemplated by Section 1.9 and (ii) with respect to any stock
option, stock appreciation or other stock benefit plan of the Company or any
of its Subsidiaries not addressed by the preceding clause (i), ensure that,
following the Effective Time, no participant therein shall have any right
thereunder to acquire any capital stock of the Surviving Corporation or any
subsidiary thereof.
5.9 Indemnification of Directors and Officers.
(a) From and after the Effective Time, Parent agrees to, and to cause the
Surviving Corporation to, indemnify and hold harmless all past and present
officers, directors, employees and agents (the "Indemnified
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Parties") of the Company and of its Subsidiaries to the full extent such
Persons may be indemnified by the Company pursuant to the Company's Amended
and Restated Certificate of Incorporation and Amended and Restated Bylaws (or
similar charter documents of any of its Subsidiaries), in each case as in
effect as of the date hereof, for acts and omissions occurring at or prior to
the Effective Time and shall advance reasonable litigation expenses incurred
by such Persons in connection with defending any action arising out of such
acts or omissions, provided that such Persons provide the requisite
undertaking, as set forth in the Company's Amended and Restated Bylaws prior
to the Effective Time.
(b) Parent will provide, or cause the Surviving Corporation to provide, for
a period of not less than six years after the Effective Time, the Company's
current directors and officers with an insurance and indemnification policy
that provides coverage for events occurring at or prior to the Effective Time
(the "D&O Insurance") that is no less favorable than the existing policy or,
if substantially equivalent insurance coverage is unavailable, the best
available coverage; provided, however, that Parent and the Surviving
Corporation shall not be required to pay an annual premium for the D&O
Insurance in excess of one and one-half times the last annual premium paid
prior to the date hereof, but in such case shall purchase as much of such
coverage as possible for such amount.
5.10 Expenses. Except as otherwise provided in Section 7.4 and in addition
to the amounts that may be owed pursuant to Section 7.4, all costs and
expenses incurred in connection with this Agreement and the transactions
contemplated hereby shall be paid by the party incurring such expenses, except
that the liability, if any, for New York State Real Estate Transfer Tax, New
York City Real Property Transfer Tax and Connecticut Controlling Interest
Transfer Tax, if and to the extent applicable and due with respect to the
Merger, will be borne by the Surviving Corporation.
5.11 Employee Matters. Parent shall maintain (or cause its Subsidiaries to
maintain), without interruption, through December 31, 1997, employee
compensation and benefit plans and arrangements that will provide benefits to
those provided to similarly situated employees of Parent and its Subsidiaries.
Notwithstanding the foregoing, Parent shall provide, or cause it Subsidiaries
to provide, to each Employee severance pay and benefits that are no less
favorable than those provided under the employee benefit plans and current
practices of Parent as in effect on the date of this Agreement.
5.12 Participation in Benefit Plans. Employees shall be given credit for all
service with the Company and its Subsidiaries under all employee benefit plans
and arrangements of Parent or any of its Subsidiaries in which they become
participants for purposes of eligibility and vesting to the same extent as if
rendered to Parent or any of its Subsidiaries. Employees shall also be given
credit for any deductible or co-payment amounts paid in respect of the Plan
year in which the Effective Time occurs, to the extent that, following the
Effective Time, they participate in any employee benefit plan of the Parent
for which deductibles or co-payments are required. Parent shall also cause
each of its employee benefit plans to waive (i) any preexisting condition
restriction which was waived under the terms of any analogous Plan immediately
prior to the Effective Time or (ii) waiting period limitation which would
otherwise be applicable to an Employee on or after the Effective Time to the
extent such Employee had satisfied any similar waiting period limitation under
an analogous Plan prior to the Effective Time.
5.13 Accrued Vacation/Sick/Personal Days. Parent shall assume the Company's
obligations to Employees with respect to accrued but untaken vacation and sick
and personal days, to the extent such obligations are reflected on the
Company's balance sheet.
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ARTICLE VI
CONDITIONS TO CONSUMMATION OF THE MERGER
6.1 Conditions to Obligations of Parent and Merger Sub. The obligations of
Parent and Merger Sub hereunder to consummate the Merger are subject to the
satisfaction or waiver by Parent, at or prior to the Effective Time, of each
of the following conditions:
(a) Covenants; Accuracy of Representations and Warranties. (i) The
Company shall have performed in all material respects all of its material
obligations and complied in all material respects with all of its material
agreements and covenants to be performed or complied with by it under this
Agreement at or prior to the Effective Time; (ii) the representations and
warranties of the Company contained in Article III shall be true and
accurate at the date of this Agreement and as of the Effective Time with
the same force and effect as if they had been made as of the Effective Time
(except to the extent a representation or warranty speaks specifically as
of an earlier date and except as contemplated by this Agreement), except,
in each case, for inaccuracies in any such representations and warranties
that would not, individually or in the aggregate, have or reasonably be
expected to have a Material Adverse Effect on the Company and the Surviving
Corporation; and (iii) the Company shall have provided Parent with a
certificate executed by two executive officers of the Company, dated as of
the Effective Date, to such effect.
(b) Intentionally Omitted.
6.2 Conditions to Obligations of the Company. The obligation of the Company
hereunder to consummate the Merger is subject to the satisfaction or waiver by
the Company, at or prior to the Effective Time, of the following condition:
(a) Covenants; Accuracy of Representations and Warranties. (i) Parent
shall have performed in all material respects all of its material
obligations and complied in all material respects with all of its material
agreements and covenants to be performed or complied with by it under this
Agreement at or prior to the Effective Time; (ii) the representations and
warranties of Parent contained in Article IV shall be true and accurate at
the date of this Agreement and as of the Effective Time with the same force
and effect as if they had been made as of the Effective Time (except to the
extent a representation or warranty speaks specifically as of an earlier
date and except as contemplated by this Agreement) except, in each case,
for inaccuracies in any such representations and warranties that would not,
individually or in the aggregate, have or reasonably be expected to have a
Material Adverse Effect on Parent; and (iii) Parent shall have provided the
Company with a certificate executed by two executive officers of Parent,
dated as of the Effective Date, to such effect.
6.3 Conditions to Obligations of Each Party. The respective obligations of
the Company, on the one hand, and Parent and Merger Sub, on the other hand, to
consummate the Merger are further subject to the satisfaction or waiver, at or
prior to the Effective Time, of each of the following conditions:
(a) Stockholder Approval. The Company Stockholder Approval shall have
been obtained.
(b) Illegality or Legal Constraint. No statute, rule, regulation,
executive order, decree, injunction or restraining order shall have been
enacted, promulgated or enforced (and not repealed, superseded or otherwise
made inapplicable) by any court of competent jurisdiction or other
Governmental Entity which prohibits the consummation of the transactions
contemplated by this Agreement or imposes material conditions with respect
thereto (collectively, "Restraints"); provided, however, that the party
asserting the failure of this condition shall have used reasonable best
efforts to prevent the entry of any such Restraint and, if applicable to
such party, to appeal promptly any such Restraints that may be entered.
(c) Governmental Approvals. The parties hereto shall have made the
requisite filings with all Governmental Entities as shall be required
pursuant to applicable laws, rules and regulations, and such Governmental
Entities (including, but not limited to, the Insurance Departments of the
States of New York,
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New Jersey and Connecticut), to the extent required by applicable law,
shall have approved the transactions contemplated by this Agreement, except
where the failure to obtain any such approval would not, individually or in
the aggregate, have a Material Adverse Effect on Parent and the Surviving
Corporation, taken as a whole, or upon the consummation of the transactions
contemplated hereby.
(d) HSR Act. The waiting period (and any extension thereof) applicable to
the Merger under the HSR Act shall have expired or been terminated.
ARTICLE VII
TERMINATION OF AGREEMENT
7.1 Termination. This Agreement may be terminated at any time prior to the
Effective Time whether before or after the approval by the stockholders of the
Company:
(a) by mutual written consent of Parent and the Company;
(b) by either Parent or the Company (i) if the Effective Date shall not
have occurred on or before March 31, 1998, subject to the two business day
period set forth in Section 1.4, (ii) if any Governmental Entity, the
approval of which is a condition to the obligations of Parent, Merger Sub
and the Company to consummate the Merger, shall have determined not to
grant its approval and all appeals of such determination shall have been
taken and have been unsuccessful or (iii) if any court of competent
jurisdiction shall have issued an order, judgment or decree (other than a
temporary restraining order or temporary injunction) restraining, enjoining
or otherwise prohibiting the Merger and such order, judgment or decree
shall have become final and nonappealable; provided, however, that the
right to terminate this Agreement pursuant to clause (i) shall not be
available to any party whose failure to fulfill any obligation under this
Agreement has been the cause of, or resulted in, the failure of the
Effective Date to occur on or before such date;
(c) by either Parent or the Company, if, at the Special Meeting
(including any adjournment or postponement thereof) called pursuant to
Section 5.6, the Company Stockholder Approval shall not have been obtained;
(d) by Parent (i) if there has been a breach by the Company of any
representation or warranty set forth in this Agreement, which breach would
give rise to the failure of a condition set forth in Section 6.1 or 6.3,
which has not been cured within 15 business days following receipt by the
Company of written notice of such breach; (ii) if there has been a breach
by the Company of any covenant or agreement set forth in this Agreement,
which breach would give rise to the failure of a condition set forth in
Section 6.1 or 6.3, which has not been cured within 15 business days
following receipt by the Company of written notice of such breach; or (iii)
if the Board of Directors of the Company shall have failed to recommend or
withdrawn or modified or changed in a manner adverse to Parent its approval
or recommendation of this Agreement, or recommended an Acquisition Proposal
or shall have entered into a definitive agreement providing for the
transaction or transactions contemplated by an Acquisition Proposal (or the
Board of the Directors of the Company shall have resolved to do any of the
foregoing); provided, however, that the right to terminate this Agreement
pursuant to this Section 7.1(d)(i) or (ii) shall not be available to Parent
if it, at such time, is in breach of any representation, warranty, covenant
or agreement set forth in this Agreement, which breach would give rise to
the failure of a condition set forth in Section 6.2 or 6.3, which has not
been cured within 15 business days following receipt by Parent of written
notice of such breach;
(e) by the Company (i) if there has been a breach by Parent of any
representation or warranty set forth in this Agreement, which breach would
give rise to the failure of a condition set forth in Section 6.2 or 6.3,
which has not been cured within 15 business days following receipt by
Parent of written notice of such breach; (ii) if there has been a breach by
Parent of any covenant or agreement set forth in this Agreement, which
breach would give rise to the failure of a condition set forth in Section
6.2 or 6.3, which has not been
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cured within 15 business days following receipt by Parent of written notice
of such breach; or (iii) subject to Section 7.2, if the Board of Directors
of the Company shall have failed to recommend or withdrawn or modified or
changed in a manner adverse to Parent its approval or recommendation of
this Agreement in order to permit the Company to execute a definitive
agreement providing for the transaction or transactions contemplated by a
Superior Proposal; provided, however, that the right to terminate this
Agreement pursuant to this Section 7.1(e)(i) or (ii) shall not be available
to the Company if it, at such time, is in breach of any representation,
warranty, covenant or agreement set forth in this Agreement, which breach
would give rise to the failure of a condition set forth in Section 6.1 or
6.3, which has not been cured within 15 business days following receipt by
the Company of written notice of such breach.
(f) by Parent at any time following the date 30 days after notice is
delivered by the Company as required in Section 5.7(b)(i) concerning the
receipt of an Acquisition Proposal unless, prior to termination under this
subsection (f), the Company provides written notice to Parent that such
Acquisition Proposal has been rejected or withdrawn or the Company is no
longer engaged in negotiations or discussions with such other Person
concerning the Acquisition Proposal; provided that the 30-day time period
shall be reduced with respect to any subsequent Acquisition Proposal made
by a Person whose Acquisition Proposal was previously rejected or withdrawn
as provided in this subsection (f) to a number of days equal to the greater
of (i) 30 minus the number of days lapsed from the receipt of any notice of
any prior Acquisition Proposal from such Person until the rejection or
withdrawal of any such prior Acquisition Proposal(s) and (ii) 10.
7.2 Certain Actions Prior to Termination. The Company shall provide to
Parent the written notice required by Section 5.7(b) prior to any termination
of this Agreement pursuant to Section 7.1(e)(iii) advising Parent that the
Board of Directors of the Company has received a Superior Proposal. At any
time after the third business day following such notice, the Company may
terminate this Agreement as provided in Section 7.1(e)(iii) only if (i) the
Board of Directors of the Company determines that such Superior Proposal
remains more favorable and provides greater value to the Company's
stockholders than this Agreement and the Merger (which determination shall be
made in light of any revised proposal made by Parent prior to the expiration
of such three-business day period) and (ii) the termination fee contemplated
by Section 7.4(a) shall have been paid to the Parent.
7.3 Effect of Termination. In the event of termination of this Agreement by
either Parent or the Company as provided in Section 7.1, this Agreement shall
forthwith become void (except as set forth in the last sentence of Section 5.3
and in Sections 5.10 and 7.4 and Article VIII) and there shall be no liability
on the part of Parent, Merger Sub or the Company or their respective officers
or directors, except (i) as set forth in this Section 7.3, the last sentence
of Section 5.3 or Sections 5.10 or 7.4 or Article VIII and (ii) nothing herein
shall relieve any party from liability for (x) any willful or intentional
breach of any representations or warranties contained in this Agreement or (y)
any breach of any covenant or agreement contained in this Agreement.
7.4 Termination Fees.
(a) Notwithstanding any other provision of this Agreement, so long as the
Company is not entitled to terminate this Agreement by reason of Section
7.1(e)(ii), (i) if this Agreement is terminated pursuant to Section
7.1(d)(iii) or Section 7.1(e)(iii), then the Company shall promptly pay to
Parent a fee of $9 million (the amount of such fee being hereinafter referred
to as the "Termination Fee"), plus an amount equal to all of the costs and
expenses incurred by Parent and Merger Sub in connection with this Agreement
and the transactions contemplated hereby (upon receipt of reasonable
documentation in respect thereto) up to an aggregate of $2.5 million (the
"Termination Expenses"); (ii) if this Agreement is terminated pursuant to
Section 7.1(c), then the Company shall promptly pay to Parent an amount equal
to the Termination Expenses; (iii) if within 12 months of a termination of
this Agreement pursuant to Section 7.1(c), the Company or any of its
Subsidiaries accepts a written offer for, or otherwise enters into an
agreement to consummate or consummates, a Transaction Proposal (as defined in
Section 7.4(b)) with another Person, upon the signing of a definitive
agreement relating to such Transaction Proposal, or, if no such agreement is
signed, then upon consummation of any such Transaction
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Proposal, the Company shall pay to Parent an amount equal to the Termination
Fee; or (iv) if within 12 months of the termination of this Agreement pursuant
to Section 7.1(f) the Company or any of its Subsidiaries accepts a written
offer for, or otherwise enters into an agreement to consummate or consummates,
a Transaction Proposal with another Person, upon the signing of a definitive
agreement relating to such a Transaction Proposal, or, if no such agreement is
signed, then upon consummation of any such Transaction Proposal, the Company
shall pay to Parent an amount equal to the Termination Fee.
(b) As used in this Section 7.4 "Transaction Proposal" shall mean a proposal
or offer (other than by another party hereto) (i) to acquire beneficial
ownership (as defined under Rule 13(d) of the Exchange Act) of 50% or more of
the outstanding capital stock of the Company or any of its Subsidiaries
holding substantially all of the assets of the Company and its Subsidiaries
pursuant to a merger, consolidation or other business combination, sale of
shares of capital stock, tender offer or exchange offer or similar
transaction, including, without limitation, any single or multi-step
transaction or series of related transactions which is structured to permit
such third party to acquire beneficial ownership of 50% or more of the
outstanding capital stock of the Company or any of its Subsidiaries holding
substantially all of the assets of the Company and its Subsidiaries, (ii) to
purchase all or substantially all of the business or assets of the Company and
its Subsidiaries or (iii) to otherwise effect a business combination involving
the Company or any of its Subsidiaries holding substantially all of the assets
of the Company and its Subsidiaries.
(c) The obligation to pay the Termination Fee or Termination Expenses
pursuant to Section 7.4(a) shall be in addition to the expenses to be paid by
the Company pursuant to Section 5.10. The Company shall make all such payments
promptly (and in any event within two days of receipt by the Company of
written notice from Parent) by wire transfer of immediately available funds to
an account designated by Parent.
ARTICLE VIII
MISCELLANEOUS AND GENERAL
8.1 Survival. The representations and warranties made herein shall not
survive the termination of this Agreement or the Effective Time. This Section
8.1 shall not limit any covenant or agreement of the parties hereto which by
its terms contemplates performance after termination of this Agreement or the
Effective Time.
8.2 Counterparts. For the convenience of the parties hereto, this Agreement
may be executed in any number of counterparts, each such counterpart being
deemed to be an original instrument, and all such counterparts shall together
constitute the same agreement.
8.3 Governing Laws and Consent to Jurisdiction. The laws of the State of
Delaware (irrespective of its choice of law principles) shall govern all
issues concerning the validity of this Agreement, the construction of its
terms, and the interpretation and enforcement of the rights and duties of the
parties. Each of the parties hereto irrevocably submits to the exclusive
jurisdiction of the courts of the State of Delaware and the Federal courts of
the United States of America located in the State of Delaware (and the
Delaware State and Federal courts having jurisdiction over appeals therefrom)
in respect of the transactions contemplated by this Agreement, the other
agreements and documents referred to herein and the transactions contemplated
by this Agreement and such other documents and agreements.
8.4 Notices. Any notice, request, instruction or other document to be given
hereunder by any party to the other parties shall be in writing and delivered
personally or sent by registered or certified mail, postage prepaid, or by
facsimile transmission (with a confirming copy sent by overnight courier), as
follows:
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(a) If to the Company, to:
Robert L. Natt
Physicians Health Services, Inc.
One Far Mill Crossing
P.O. Box 904
Shelton, CT 06484
(203) 225-8254 (telephone)
(203) 225-4001 (telecopier)
with a copy to:
Robert A. Kindler, Esq.
Cravath, Swaine & Moore
Worldwide Plaza
825 Eighth Avenue
38th Floor
New York, NY 10019-7475
(212) 474-1640 (telephone)
(212) 765-1047 (telecopier)
(b) If to Parent or Merger Sub, to:
Foundation Health Systems, Inc.
225 North Main
Pueblo, CO 81003
Attn: General Counsel
(719) 585-8077 (telephone)
(719) 585-8175 (telecopier)
with a copy to:
Charles W. Mulaney, Jr., Esq.
Gary P. Cullen, Esq.
Skadden, Arps, Slate, Meagher & Flom (Illinois)
333 West Wacker Drive
Suite 2100
Chicago, IL 60606
(312) 407-0700 (telephone)
(312) 407-0411 (telecopier)
or to such other Persons or addresses as may be designated in writing by the
party to receive such notice.
8.5 Entire Agreement. This Agreement and the Confidentiality Agreement
constitute the entire agreement among the parties with respect to the subject
matter hereof and supersede all other prior agreements and understandings,
both written and oral, among the parties or any of them with respect to the
subject matter hereof.
8.6 Parties in Interest. This Agreement shall be binding upon and inure
solely to the benefit of each party hereto and their respective permitted
successors and assigns. Nothing in this Agreement, express or implied, is
intended to or shall confer upon any other Person any rights, benefits or
remedies of any nature whatsoever under or by reason of this Agreement;
provided, however, that the provisions of Section 5.9 shall inure to the
benefit of and be enforceable by the Indemnified Parties.
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8.7 Amendment and Waivers. Any term or provision of this Agreement may be
amended, and the observance of any term of this Agreement may be waived
(either generally or in a particular instance and either retroactively or
prospectively) only by a writing signed by the party to be bound thereby. The
waiver by a party of any breach hereof or default in the performance hereof
shall not be deemed to constitute a waiver of any other default or any
succeeding breach or default, unless such waiver so expressly states. At any
time before or after the Company Stockholder Approval and prior to the
Effective Time, this Agreement may be amended or supplemented by the parties
hereto with respect to any of the terms contained in this Agreement, except
that following the Company Stockholder Approval there shall be no amendment or
change to the provisions hereof with respect to the Merger Consideration
without further approval by the stockholders of the Company, and no other
amendment shall be made which by law requires further approval by such
stockholders without such further approval.
8.8 Certain Definitions. As used herein:
(a) "Material Adverse Effect" shall mean any adverse change in or effect
on the financial condition, business or results of operations of the
Company or any of its Subsidiaries or Parent or any of its Subsidiaries, as
the case may be, which is material to the Company and its Subsidiaries,
taken as a whole, or Parent and its Subsidiaries, taken as a whole, as the
case may be, other than any change or effect relating to the United States
economy in general or to the health care industry in general and not
specifically relating to the Company and its Subsidiaries or to Parent and
its Subsidiaries, as the case may be.
(b) "Person" shall mean any individual, partnership, firm, corporation,
association, joint venture, trust or other entity.
(c) "Significant Subsidiary" shall mean, when used with reference to any
entity, any subsidiary of such entity that constitutes a "significant
subsidiary" within the meaning of Rule 1-02 of Regulation S-X promulgated
by the SEC and any Subsidiary that is subject to regulation by any
insurance or HMO regulatory authority.
(d) "Subsidiary" shall mean, when used with reference to any entity, any
corporation a majority of the outstanding voting securities of which are
owned directly or indirectly by such former entity.
8.9 Validity. The invalidity or unenforceability of any provision of this
Agreement shall not affect the validity or enforceability of any other
provisions of this Agreement, each of which shall remain in full force and
effect.
8.10 Captions. The Article, Section and paragraph captions herein are for
convenience of reference only, do not constitute part of this Agreement and
shall not be deemed to limit or otherwise affect any of the provisions hereof.
8.11 Assignment. Neither this Agreement nor any of the rights, interests or
obligations under this Agreement shall be assigned, in whole or in part, by
operation of law or otherwise, by any of the parties without the prior written
consent of the other parties; provided, however, that Parent may assign its
rights hereunder to any of its Subsidiaries, provided that no such assignment
shall relieve Parent of its obligations hereunder. Any assignment in violation
of the preceding sentence shall be void.
8.12 Disclosure Schedules. Matters reflected on the Company Disclosure
Schedule and the Parent Disclosure Schedule are not necessarily limited to
matters required by this Agreement to be reflected therein and the inclusion
of such matters shall not be deemed an admission that such matters were
required to be reflected on the Company Disclosure Schedule or the Parent
Disclosure Schedule, as the case may be. Such additional matters are set forth
for informational purposes only and do not necessarily include other matters
of a similar nature.
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8.13 Specific Performance. The parties agree that irreparable damage would
occur and that the parties would not have any adequate remedy at law in the
event that any of the provisions of this Agreement were not performed in
accordance with their specific terms or were otherwise breached. It is
accordingly agreed that the parties shall be entitled to an injunction or
injunctions to prevent breaches of this Agreement and to enforce specifically
the terms and provisions of this Agreement in any Federal court located in the
State of Delaware or in Delaware state court, this being in addition to any
other remedy to which they are entitled at law or in equity.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed by their respective duly authorized officers as of the date first
above written.
PHYSICIANS HEALTH SERVICES, INC.
/s/ Robert L. Natt
By:__________________________________
Name:Robert L. Natt
Title:Executive Vice President and
Chief
Operating Officer
FOUNDATION HEALTH SYSTEMS, INC.
/s/ Jay M. Gellert
By:__________________________________
Name:Jay M. Gellert
Title:President and Chief
Operating Officer
PHS ACQUISITION CORP.
/s/ B. Curtis Westen
By:__________________________________
Name:B. Curtis Westen
Title:Vice President, General
Counsel and Secretary
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APPENDIX B
FAIRNESS OPINION OF MORGAN STANLEY & CO. INCORPORATED
<PAGE>
MORGAN STANLEY
MORGAN STANLEY & CO.
INCORPORATED
1585 BROADWAY
NEW YORK, NEW YORK 10036
(212) 761-4000
December 10, 1997
Board of Directors
Physicians Health Services, Inc.
One Far Mill Crossing
Shelton, Connecticut 06484
Members of the Board:
We understand that Physicians Health Services, Inc. (the "Company"), Foundation
Health Systems, Inc. ("Parent") and PHS Acquisition Corp., a wholly owned
subsidiary of Parent ("Merger Sub"), have entered into an Agreement and Plan of
Merger, dated as of May 7, 1997 (the "Merger Agreement"), which provides, among
other things, for the merger (the "Merger") of Merger Sub with and into the
Company. As a result of the Merger, the Company will become a wholly owned
subsidiary of Parent and each outstanding share of Class A Common Stock, par
value $.01 per share ("Class A Common Stock"), and Class B Common Stock, par
value $.01 per share ("Class B Common Stock" and together with the Class A
Common Stock, the "Common Stock"), of the Company, other than shares held in
the treasury of the Company or any of its subsidiaries, held by Parent or any
of its subsidiaries or dissenting shares, will be converted into the right to
receive $28.25 per share in cash ("the Merger Consideration"). The terms and
conditions of the Merger are more fully set forth in the Merger Agreement.
You have asked for our opinion as to whether the Merger Consideration to be
received by the holders of shares of Common Stock pursuant to the Merger
Agreement is fair from a financial point of view to such holders of Common
Stock.
For purposes of the opinion set forth herein, we have:
(i)
reviewed certain publicly available financial statements and other
information of the Company;
(ii)
reviewed certain internal financial statements and other financial and
operating data concerning the Company prepared by the management of
the Company;
(iii)
analyzed certain financial projections prepared by the management of
the Company;
(iv)
discussed the past and current operations and financial condition and
the prospects of the Company with senior executives of the Company;
(v)
reviewed the reported prices and trading activity for the Class A
Common Stock;
(vi)
compared the financial performance of the Company and the prices and
trading activity of the Class A Common Stock with that of certain
other comparable publicly-traded companies and their securities;
(vii)
reviewed the financial terms, to the extent publicly available, of
certain comparable acquisition transactions;
(viii)
participated in discussions and negotiations among representatives of
the Company and Parent and their financial and legal advisors;
(ix)
reviewed the Merger Agreement, the Voting Trust Agreement and certain
related documents; and
(x)
performed such other analyses and considered such other factors as we
have deemed appropriate.
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We have assumed and relied upon without independent verification the accuracy
and completeness of the information reviewed by us for the purposes of this
opinion. With respect to the financial projections, we have assumed that they
have been reasonably prepared on bases reflecting the best currently available
estimates and judgments of the future financial performance of the Company. We
have not made any independent valuation or appraisal of the assets or
liabilities of the Company, nor have we been furnished with any such
appraisals. Our opinion is necessarily based on economic, market and other
conditions as in effect on, and the information made available to us as of,
the date hereof.
In arriving at our opinion, we were not authorized to solicit, and did not
solicit, interest from any party with respect to the acquisition of the
Company or any of its assets, nor did we negotiate with any parties, other
than Parent.
We have acted as financial advisor to the Board of Directors of the Company in
connection with this transaction and will receive a fee for our services,
which is contingent upon the closing of the Merger. In the past, Morgan
Stanley & Co. Incorporated and its affiliates have provided financial advisory
and financing services for Parent and have received fees for the rendering of
these services.
It is understood that this letter is for the information of the Board of
Directors of the Company and may not be used for any other purpose without our
prior written consent, except that this opinion may be referred to and
included in its entirety in any filing with the Securities and Exchange
Commission in connection with the Merger. In addition, we express no opinion
nor recommendation as to how the holders of Common Stock should vote at the
stockholder's meeting held in connection with the Merger.
Based on the foregoing, we are of the opinion that as of the date hereof the
consideration to be received by the holders of shares of Common Stock pursuant
to the Merger Agreement is fair from a financial point of view to such
holders.
Very truly yours,
MORGAN STANLEY & CO.INCORPORATED
/s/ Mary Anne Citrino
By: _________________________________
Mary Anne Citrino
Principal
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APPENDIX C
VOTING TRUST AGREEMENT
<PAGE>
VOTING TRUST AGREEMENT
VOTING TRUST AGREEMENT, dated as of May 8, 1997 (this "Agreement"), by and
among Greater Bridgeport Individual Practice Association, Inc., a Connecticut
nonstock corporation (the "Stockholder"), Physicians Health Services, Inc., a
Delaware corporation (the "Company"), and American Stock Transfer & Trust
Company (the "Voting Trustee").
WHEREAS, the Company, Foundation Health Systems, Inc., a Delaware
corporation ("Parent"), and PHS Acquisition Corp., a Delaware corporation and
a wholly owned subsidiary of Parent ("Merger Sub"), have, substantially
contemporaneously with the execution of this Agreement, entered into an
Agreement and Plan of Merger, dated as of the date hereof (as the same may be
amended or supplemented, the "Merger Agreement"), which provides, among other
things, that Merger Sub shall be merged with and into the Company (the
"Merger"), upon the terms and subject to the conditions set forth in the
Merger Agreement;
WHEREAS, as a condition to the willingness of Parent to enter into the
Merger Agreement, Parent has required that the Company and the Stockholder
agree, and in order to induce Parent to enter into the Merger Agreement, the
Company and the Stockholder have agreed, to enter into this Agreement;
WHEREAS, as of the date hereof, the Stockholder is the record owner of
2,501,021 shares of Class B Common Stock, par value $.01 per share (the "Class
B Common Stock"), together with the associated Rights, of the Company of which
the Stockholder shall transfer to the Voting Trustee, in accordance with and
subject to the terms and conditions of this Agreement, 2,401,021 shares of
Class B Common Stock (the shares of Class B Common Stock being transferred
hereby, together with associated Rights, being collectively referred to herein
as the "Company Common Stock"); and
WHEREAS, the Voting Trustee is willing to act as voting trustee of the
Voting Trust (as defined below) in accordance with the terms and subject to
the conditions of this Agreement.
NOW, THEREFORE, in consideration of the foregoing and the mutual covenants
and agreements contained herein, a voting trust with respect to the Company
Common Stock is hereby created and established (the "Voting Trust"), subject
to the following terms and conditions to which the parties hereto expressly
agree (capitalized terms used but not defined herein having the respective
meanings ascribed to them in the Merger Agreement):
Section 1. Registration of Voting Trust Stock.
(a) The Stockholder is hereby depositing with the Voting Trustee the Company
Common Stock by delivering to the Company certificates representing such
Company Common Stock, together with an executed stock power transferring such
certificates to the Voting Trustee, with any requisite stock transfer stamps
annexed thereto. The Company and the Stockholder shall take such action as is
necessary to effect the transfer of such Company Common Stock to, and the
registration of such Company Common Stock in the name of, the Voting Trustee
on the books and records of the Company, and file a duplicate of this
Agreement with the Secretary of the Company.
(b) The Company shall cancel the certificates representing the Company
Common Stock, issue a new certificate therefor and deliver such new
certificate to the Voting Trustee in the name of "American Stock Transfer &
Trust Company, as Voting Trustee" (such Company Common Stock being referred to
herein as the "Voting Trust Stock").
(c) On the certificate representing the Voting Trust Stock, as well as in
the stock ledger of the Company, the following legend shall conspicuously
appear:
"THE CLASS B COMMON STOCK EVIDENCED BY THIS CERTIFICATE IS SUBJECT TO
CERTAIN RESTRICTIONS CONTAINED IN THE VOTING TRUST AGREEMENT, DATED AS
OF MAY 8, 1997, BY AND AMONG GREATER BRIDGEPORT INDIVIDUAL PRACTICE
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ASSOCIATION, INC., PHYSICIANS HEALTH SERVICES, INC. AND AMERICAN STOCK
TRANSFER & TRUST COMPANY, AS SUCH AGREEMENT MAY BE AMENDED,
SUPPLEMENTED OR OTHERWISE MODIFIED FROM TIME TO TIME. THE HOLDER OF
THIS STOCK CERTIFICATE, BY SUCH HOLDER'S ACCEPTANCE HEREOF, AGREES TO
BE BOUND BY ALL THE PROVISIONS OF SUCH AGREEMENT, WHICH AGREEMENT IS
AVAILABLE FOR INSPECTION BY THE OWNER HEREOF AT THE REGISTERED OFFICE
OF PHYSICIANS HEALTH SERVICES, INC. IN THE STATE OF DELAWARE."
(d) The Voting Trustee accepts the trust created hereby and upon the
transfer of the Voting Trust Stock into the name of the Voting Trustee and
receipt by the Voting Trustee of the certificate for the Voting Trust Stock,
the Voting Trustee shall hold the Voting Trust Stock as stockholder of record,
subject to the terms and conditions of this Agreement, and for the benefit of
the Stockholder as the beneficial owner thereof.
Section 2. Filing of the Agreement. The Company shall, on behalf of itself,
the Stockholder and the Voting Trustee, file a copy of this Agreement (and any
amendments, supplements or modifications hereto) in the registered office of
the Company in the State of Delaware, which copy the Company shall cause to be
open to the inspection of any stockholder of the Company any business day
during business hours.
Section 3. Issuance and Loss or Destruction of Trust Certificate.
(a) Upon the execution of this Agreement, the Voting Trustee shall issue to
the Stockholder, in exchange for the Company Common Stock delivered hereunder,
a voting trust certificate substantially in the form of Exhibit A attached
hereto (such voting trust certificate or any subsequent voting trust
certificate issued pursuant to this Agreement, the "Trust Certificate").
(b) If a Trust Certificate is lost, stolen, mutilated or destroyed, the
Voting Trustee will issue a replacement certificate for such Trust Certificate
upon receipt of (i) an affidavit of the Stockholder of such fact, or other
evidence of such fact reasonably satisfactory to the Voting Trustee, (ii) an
indemnity agreement reasonably satisfactory to the Voting Trustee and (iii)
the existing Trust Certificate, if mutilated.
Section 4. Restrictions on Transfer and Conversion.
(a) The Stockholder hereby covenants and agrees that the Stockholder shall
not, prior to the termination of this Agreement, (i) either directly or
indirectly, offer or otherwise sell, assign, pledge, hypothecate, transfer,
exchange or dispose of any Trust Certificate or the Voting Trust Stock or any
interest therein or (ii) exercise, or cause the Voting Trustee to exercise,
the option to convert any Voting Trust Stock as provided in Section 7 of
Article Fourth of the Company's Amended and Restated Certificate of
Incorporation (the "Certificate of Incorporation").
(b) The Voting Trustee hereby covenants and agrees that the Voting Trustee
shall not, prior to the termination of this Agreement, either directly or
indirectly, offer or otherwise sell, assign, pledge, hypothecate, transfer,
exchange or dispose of any Voting Trust Stock or any interest therein.
(c) No sale, assignment, pledge, hypothecation, transfer, exchange or
disposition in violation of the foregoing provisions of this Section 4 shall
operate to terminate this Agreement or the Voting Trust.
Section 5. Stockholder's Rights.
(a) The Stockholder shall, as to the Voting Trust Stock, possess and be
entitled to exercise all stockholder's rights and powers of every kind as the
beneficial owner thereof, including the right to direct the vote of the Voting
Trust Stock and the right to take part in, or give or withhold consent to, any
corporate or stockholders' action with respect to which such Voting Trust
Stock is entitled to be voted, except as such rights are limited by this
Agreement.
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(b) The Voting Trustee shall not have any rights, with respect to the Voting
Trust Stock, including the right to vote such Voting Trust Stock or to take
part in or consent to any corporate or stockholders' action with respect to
which such Voting Trust Stock is entitled to be voted, except as such rights
are specifically provided for in this Agreement.
Section 6. Voting Agreement.
(a) The Voting Trustee may vote the Voting Trust Stock in person or by such
duly authorized person or persons as the Voting Trustee may select in its good
faith reasonable judgment as the Voting Trustee's proxy. The Voting Trustee or
such proxy shall: (i) appear at any annual or special meeting of stockholders
of the Company for the purpose of obtaining a quorum; (ii) vote all of the
Voting Trust Stock in favor of the adoption and approval of the Merger
Agreement; and (iii) vote all of the Voting Trust Stock against: (A) any
extraordinary corporate transaction (other than the Merger), such as a merger,
consolidation, business combination, reorganization, recapitalization or
liquidation involving the Company or any of its subsidiaries, including, but
not limited to, any Transaction Proposal, and (B) any sale or transfer of a
material amount of the assets or securities of the Company or any of its
subsidiaries (other than pursuant to the Merger). The Voting Trustee
acknowledges receipt and review of a copy of the Merger Agreement.
(b) The Voting Trustee shall vote on all issues other than those specified
in Section 6(a) that come before any meeting of stockholders of the Company as
directed by the Stockholder.
Section 7. Certain Covenants of the Company.
(a) For any corporate action with respect to which the Voting Trustee is
entitled to vote, whether at a meeting of the stockholders of the Company or
by the written consent of the stockholders of the Company, the Company shall
give the Voting Trustee and the Stockholder written notice in the same manner
in which notice is required to be given with respect to such corporate action
to stockholders of the Company in accordance with applicable law and the
Certificate of Incorporation and Amended and Restated Bylaws, each as such may
be amended or supplemented from time to time.
(b) The Company shall not amend or otherwise modify any provision of the
Merger Agreement the effect of which would result in a reduction of the Merger
Consideration without the prior written consent of the Stockholder.
Section 8. Dividends. The Voting Trustee shall, immediately following the
receipt of each dividend (other than stock dividends) as may be declared and
paid upon the Voting Trust Stock, pay the same over to or as directed by the
Stockholder. The Voting Trustee shall receive and hold stock dividends upon
the same terms and conditions as the Voting Trust Stock and shall issue Trust
Certificates representing such new or additional shares to the Stockholder.
Section 9. Representations and Warranties.
(a) Representations and Warranties of the Stockholder. The Stockholder
hereby represents and warrants to the other parties hereto, and for the
benefit of Parent, as follows:
(i) The Stockholder is a nonstock corporation, duly organized, validly
existing and in good standing under the laws of the State of Connecticut.
The Stockholder has all necessary corporate power and authority to execute
and deliver this Agreement and to perform its obligations hereunder and to
consummate the transactions contemplated hereby. The execution, delivery
and performance of this Agreement by the Stockholder and the consummation
by the Stockholder of the transactions contemplated hereby have been duly
and validly authorized by the Board of Directors of the Stockholder, do not
and will not require the approval of the members of the Stockholder and no
other corporate proceedings on the part of the Stockholder are necessary to
authorize this Agreement or to consummate the transactions contemplated
hereby. This Agreement has been duly and validly executed and delivered by
the Stockholder and, assuming it constitutes a valid and binding agreement
of the other parties hereto, constitutes a legal, valid and binding
agreement of the Stockholder enforceable against the Stockholder in
accordance with its terms, except that
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the enforcement hereof may be limited by (i) bankruptcy, insolvency,
reorganization, moratorium or other similar laws now or hereafter in effect
relating to creditors' rights generally and (ii) general principles of
equity (regardless of whether enforceability is considered in a proceeding
in equity or at law).
(ii) The execution and delivery of this Agreement by the Stockholder does
not, and the performance of this Agreement by the Stockholder will not,
result in any breach of or constitute a default (or an event that with
notice or lapse of time or both would become a default) under, or give to
others any rights of termination, amendment, acceleration or cancellation
of, or result in the creation of a lien or encumbrance on any of the Voting
Trust Stock pursuant to, any note, bond, mortgage, indenture, contract,
agreement, lease, license, permit, franchise or other instrument or
obligation to which the Stockholder is a party or by which the Stockholder
or the Company Common Stock are bound or affected, except, in the case of
each of the foregoing, for any such conflicts, violations, breaches,
defaults or other occurrences which would not prevent or materially delay
the performance by the Stockholder of its obligations under this Agreement
or the transactions contemplated hereby.
(iii) As of the date hereof, the Stockholder is the record owner of the
Company Common Stock. The Company Common Stock is owned free and clear of
all security interests, liens, claims, pledges, options, rights of first
refusal, agreements, limitations on the Stockholder's voting rights,
charges and other encumbrances of any nature whatsoever. The Stockholder
has not appointed or granted any proxy, which appointment or grant is still
effective, with respect to the Company Common Stock.
(b) Representations and Warranties of the Company. The Company hereby
represents and warrants to the other parties hereto, and for the benefit of
Parent, as follows:
(i) The Company is a corporation, duly organized, validly existing and in
good standing under the laws of the State of Delaware. The Company has all
necessary corporate power and authority to execute and deliver this
Agreement and to perform its obligations hereunder and to consummate the
transactions contemplated hereby. The execution, delivery and performance
of this Agreement by the Company and the consummation by the Company of the
transactions contemplated hereby have been duly and validly authorized by
the Board of Directors of the Company and no other corporate proceeding on
the part of the Company are necessary to authorize this Agreement or to
consummate the transactions contemplated hereby. This Agreement has been
duly and validly executed and delivered by the Company and, assuming it
constitutes a valid and binding agreement of the other parties hereto,
constitutes a legal, valid and binding agreement of the Company enforceable
against the Company in accordance with its terms, except that the
enforcement hereof may be limited by (i) bankruptcy, insolvency,
reorganization, moratorium or other similar laws now or hereafter in effect
relating to creditors' rights generally and (ii) general principles of
equity (regardless of whether enforceability is considered in a proceeding
in equity or at law).
(ii) The execution and delivery of this Agreement by the Company does
not, and the performance of this Agreement by the Company will not, result
in any breach of or constitute a default (or an event that with notice or
lapse or time or both would become a default) under any note, bond,
mortgage, indenture, contract, agreement, lease, license, permit, franchise
or other instruments or obligation to which the Company is a party or by
which the Company or any of its properties are bound or affected, except,
in the case of each of the foregoing, for any such conflicts, violations,
breaches, defaults or other occurrences which would not prevent or
materially delay the performance by the Company of its obligations under
this Agreement or the transactions contemplated hereby.
(iii) As of the date hereof, the Voting Trust Stock constitutes at least
56% of the total outstanding voting power of the issued and outstanding
voting securities, on a fully diluted basis, of the Company. The execution,
delivery and performance of this Agreement by the parties hereto, and the
transactions contemplated hereby, will not be deemed to be a transfer of
beneficial ownership of the Company Common Stock and will not cause the
shares of Company Common Stock subject to this Agreement to be converted
into shares of Class A Common Stock, par value $.01 per share, of the
Company pursuant to the provisions of the Certificate of Incorporation.
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(c) Representations and Warranties of the Voting Trustee. The Voting Trustee
hereby represents and warrants to the other parties hereto, and for the
benefit of Parent, as follows:
(i) The Voting Trustee is a corporation, duly organized, validly existing
and in good standing under the laws of the State of New York. The Voting
Trustee has all necessary corporate power and authority to execute and
deliver this Agreement and to perform its obligations hereunder and to
consummate the transactions contemplated hereby. The execution, delivery
and performance of this Agreement by the Voting Trustee and the
consummation by the Voting Trustee of the transactions contemplated hereby
have been duly and validly authorized and no other corporate proceedings on
the part of the Voting Trustee are necessary to authorize this Agreement or
to consummate the transactions contemplated hereby. This Agreement has been
duly and validly executed and delivered by the Voting Trustee and, assuming
it constitutes a valid and binding agreement of the other parties hereto,
constitutes a legal, valid and binding agreement of the Voting Trustee
enforceable against the Voting Trustee in accordance with its terms, except
that the enforcement hereof may be limited by (i) bankruptcy, insolvency,
reorganization, moratorium or other similar laws now or hereafter in effect
relating to creditors' rights generally and (ii) general principles of
equity (regardless of whether enforceability is considered in a proceeding
in equity or at law).
(ii) The execution and delivery of this Agreement by the Voting Trustee
does not, and the performance of this Agreement by the Voting Trustee will
not, result in any breach of or constitute a default (or an event that with
notice or lapse of time or both would become a default) under, or give to
others any rights of termination, amendment, acceleration or cancellation
of, any note, bond, mortgage, indenture, contract, agreement, lease,
license, permit, franchise or other instrument or obligation to which the
Voting Trustee is a party or by which the Voting Trustee is bound or
affected, except, in the case of each of the foregoing, for any such
conflicts, violations, breaches, defaults or other occurrences which would
not prevent or materially delay the performance by the Voting Trustee of
its obligations under this Agreement or the transactions contemplated
hereby.
Section 10. Termination. This Agreement shall terminate upon the earliest to
occur of (i) 60 days after the termination of the Merger Agreement in
accordance with its terms pursuant to Article VII of the Merger Agreement,
(ii) the Effective Time, (iii) June 1, 1998 and (iv) a breach by the Company
of its obligation pursuant to Section 7(b); provided, that the Company's
obligation to indemnify the Voting Trustee pursuant to Section 12 shall
survive any termination of this Agreement. The Company shall give written
notice to the Voting Trustee of any termination of this Agreement.
Section 11. Termination Procedure. Upon termination of this Agreement and of
the Voting Trust pursuant to Section 10, the certificate representing the
Voting Trust Stock will be deemed, automatically and without any further
action, cancelled and the Voting Trust Stock will be deemed, automatically and
without any further action, transferred to the Stockholder. Except as
otherwise set forth in Section 2.2(f) of the Merger Agreement, the Company
shall promptly after such termination (but in no event later than five
business days thereafter) indicate such cancellation on its books and records,
shall issue a new certificate representing the Company Common Stock formerly
deposited in the Voting Trust to the Stockholder and shall register such new
certificate on its books in the name of the Stockholder.
Section 12. Voting Trustee Matters.
(a) The duties and responsibilities of the Voting Trustee shall be limited
to those expressly set forth in this Agreement. The Voting Trustee shall not
be responsible for the sufficiency or accuracy of the form, execution,
validity or genuineness of the Voting Trust Stock, or of any documents, or of
any endorsement thereon, or for any lack of endorsement thereof, or for any
description therein, nor shall the Voting Trustee be responsible or liable in
any respect on account of the identity, authority or rights of the persons
executing or delivering, or purporting to execute or deliver, any such Voting
Trust Stock or document or endorsement on this Agreement, except for the
execution and delivery of this Agreement by the Voting Trustee, so long as the
Voting Trustee at all times acts in good faith and without gross negligence or
willful misconduct. The Company shall at all times protect, indemnify and save
harmless the Voting Trustee from any loss, cost or expense of any kind or
character
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whatsoever in connection with this Agreement except those losses, expenses and
costs, if any, resulting from the gross negligence, willful misconduct or bad
faith of the Voting Trustee, and will at all times undertake, assume full
responsibility for and pay all costs and expenses of any suit or litigation of
any character, with respect to the Voting Trust Stock or this Agreement, and
if the Voting Trustee shall be made a party thereto, the Company will pay all
costs and expenses, including counsel fees, to which the Voting Trustee may be
subject by reason thereof.
(b) The Voting Trustee may consult with counsel, which may be counsel to the
Company, and the Voting Trustee shall be entitled to rely on the written
opinion of such counsel in respect of any action taken or omitted by the
Voting Trustee hereunder in good faith and in accordance with such opinion. If
requested by the Company, the Stockholder or Parent, any written opinion of
such counsel with respect to the matters covered by this Agreement shall be
provided to the Company, the Stockholder or Parent, as the case may be.
(c) The Voting Trustee, or any successor voting trustee hereafter appointed,
may at any time resign by giving 60 days' prior written notice of resignation
to the Stockholder and the Company. In the event (i) of the incapacity or
insolvency of the Voting Trustee, (ii) of the material violation of this
Agreement by the Voting Trustee or (iii) of the resignation of the Voting
Trustee as hereinabove provided, then the Company shall within three business
days thereafter appoint a successor voting trustee reasonably acceptable to
the Stockholder. The Company shall be responsible for paying the Voting
Trustee and any successor voting trustee reasonable and customary compensation
for all services rendered by it as Voting Trustee under the terms hereof.
(d) Upon written assumption by the successor voting trustee of the Voting
Trustee's power and duties hereunder, a copy of the assumption shall be
delivered by the Voting Trustee to the Stockholder and the Company, and Parent
shall be notified of such assumption, whereupon the Voting Trustee shall be
discharged of its powers and duties hereunder and the successor trustee shall
become vested therewith.
Section 13. Notices. All notices and other communications given or made
pursuant hereto shall be in writing and shall be deemed to have been duly
given or made and shall be effective upon receipt of delivery, if delivered
personally, mailed by registered or certified mail (postage prepaid, return
receipt requested) or delivered by a recognized national overnight courier to
the parties at the following addresses (or at such other address for a party
as shall be specified by like changes of address) or sent by electronic
transmission (provided that a confirmation copy is sent by another approved
means): (i) if to the Company, to the address set forth in Section 8.4 of the
Merger Agreement; (ii) if to the Voting Trustee, to American Stock Transfer &
Trust Company, 6201 15th Ave., 3rd Floor, Brooklyn, NY 11219 (telecopier no.
(718) 331-1852), Attn: Herbert Lewmer; and (iii) if to the Stockholder,
Greater Bridgeport Individual Practice Association, Inc., 3180 Main Street,
Suite 204, Bridgeport, CT 06606 (telecopier no. (203) 374-8413), Attn: Nancy
S. Watters.
Section 14. Entire Agreement. This Agreement constitutes the entire
agreement among the parties with respect to the subject matter hereof and
supersedes all other prior agreements and understandings, both written and
oral, among the parties or any of them with respect to the subject matter
hereof.
Section 15. Parties in Interest. All covenants and agreements contained
herein shall be binding upon, and inure to the benefit of, the Stockholder,
the Company or the Voting Trustee, whichever is applicable under the terms
hereof, and Parent, as a third party beneficiary hereof. Nothing in this
Agreement, whether express or implied, shall be construed to give to any
Person, other than the Stockholder, the Company, the Voting Trustee or Parent,
any legal or equitable right, remedy or claim under or in respect of this
Agreement (and any covenants, conditions or provisions contained herein).
Section 16. Assignment. Neither this Agreement nor any of the rights,
interests or obligations under this Agreement shall be assigned, in whole or
in part, by operation of law or otherwise, by any of the parties hereto
without the prior written consent of each of the other parties hereto and
Parent.
Section 17. Amendment and Waivers. This Agreement may be amended,
supplemented or otherwise modified, and compliance with any provision hereof
may be waived, only in a writing signed by or on behalf of
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the parties hereto and consented to in writing by Parent. A copy of any such
amendment, supplement or modification shall be filed in the registered office
of the Company in the State of Delaware. Neither the failure nor delay on the
part of any party to exercise any right, remedy, power or privilege under this
Agreement shall operate as a waiver thereof.
Section 18. Severability. If any term or other provision of this Agreement
is invalid, illegal or incapable of being enforced by any rule of law, or
public policy, all other conditions and provisions of this Agreement shall
nevertheless remain in full force and effect. Upon such determination that any
term or other provision is invalid, illegal or incapable of being enforced,
the parties hereto shall negotiate in good faith to modify this Agreement so
as to effect the original intent to the parties as closely as possible to the
fullest extent permitted by applicable law in a mutually acceptable manner in
order that the terms of this Agreement remain as originally contemplated to
the fullest extent possible.
Section 19. Voidability. If prior to the execution hereof, (i) the Board of
Directors of the Company shall not have duly and validly authorized and
approved by all necessary corporate action, this Agreement, the Merger
Agreement and the transactions contemplated hereby and thereby, so that by the
execution and delivery hereof Parent or Merger Sub would become, or could
reasonably be expected to become, an "interested stockholder" with whom the
Company would be prevented for any period pursuant to Section 203 of the
Delaware General Corporation Law (the "DGCL") or the Certificate of
Incorporation of the Company from engaging in any "business combination" (as
such terms are defined in Section 203 of the DGCL) or (ii) the Rights
Agreement shall not have been amended as provided in Section 3.21 of the
Merger Agreement, then this Agreement shall be void and unenforceable,
automatically and without any further action, until such time as such
authorization and approval shall have been duly and validly obtained and the
Rights Agreement shall have been so amended.
Section 20. Governing Law. The laws of the State of Delaware (irrespective
of its choice of law principles) shall govern all issues concerning the
validity of this Agreement, the construction of its terms, and the
interpretation and enforcement of the rights and duties of the parties.
Section 21. Enforcement of Agreement. The parties agree that irreparable
damage would occur and that the parties would not have any adequate remedy at
law in the event that any of the provisions of this Agreement were not
performed in accordance with their specific terms or were otherwise breached.
It is accordingly agreed that the parties shall be entitled to an injunction
or injunctions to prevent breaches of this Agreement and to enforce
specifically the terms and provisions of this Agreement in any Federal court
located in the State of Delaware or in Delaware state court, this being in
addition to any other remedy to which they are entitled at law or in equity.
Each of the parties hereto (i) consents to submit to the personal jurisdiction
of any Federal court located in the State of Delaware or any Delaware state
court in the event any dispute arises out of this Agreement or any of the
transactions contemplated hereby, (ii) agrees that such party will not attempt
to deny or defeat such personal jurisdiction by motion or other request for
leave from any such court and (iii) agrees that such party will not bring any
action relating to this Agreement or any of the transactions contemplated
hereby in any court other than a Federal court sitting in the State of
Delaware or a Delaware state court.
Section 22. Counterparts. For the convenience of the parties hereto, this
Agreement may be executed in any number of counterparts, each such counterpart
being deemed to be an original instrument, and all such counterparts shall
together constitute the same agreement.
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IN WITNESS WHEREOF, each of the parties hereto have caused this Agreement to
be duly executed on the date hereof.
GREATER BRIDGEPORT INDIVIDUAL
PRACTICE ASSOCIATION, INC.
/s/ Nancy S. Watters
By:__________________________________
Name:Nancy S. Watters
Title: President and Chief
Executive Officer
PHYSICIANS HEALTH SERVICES, INC.
/s/ Robert L. Natt
By:__________________________________
Name:Robert L. Natt
Title: Executive Vice President
AMERICAN STOCK TRANSFER & TRUST
COMPANY
/s/ Herbert Lemmer
By:__________________________________
Name:Herbert Lemmer
Title:Vice President
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EXHIBIT A
[FORM OF VOTING TRUST CERTIFICATE]
Registered Holder: Certificate No. 1
THE SALE, ASSIGNMENT, TRANSFER, PLEDGE, HYPOTHECATION OR OTHER ENCUMBRANCE
OF THIS VOTING TRUST CERTIFICATE OR THE CLASS B COMMON STOCK REFERRED TO
HEREIN IS SUBJECT TO THE RESTRICTIONS, TERMS AND CONDITIONS SET FORTH IN THE
VOTING TRUST AGREEMENT DESCRIBED IN THIS CERTIFICATE AND PURSUANT TO WHICH
THIS CERTIFICATE IS ISSUED. THIS CERTIFICATE AND SUCH CLASS B COMMON STOCK ARE
SUBJECT TO AND MAY BE TRANSFERRED OR ENCUMBERED ONLY IN ACCORDANCE WITH SUCH
AGREEMENT, A DUPLICATE OF WHICH IS ON FILE WITH THE SECRETARY OF THE COMPANY.
Voting Trust Certificate
for
2,401,021 shares of Class B Common Stock,
par value $.01 per share,
of
Physicians Health Services, Inc.,
a Delaware corporation
This is to certify that, upon the termination of a certain Voting Trust
established by a Voting Trust Agreement, dated as of May 8, 1997 (the
"Agreement"), by and among Greater Bridgeport Individual Practice Association,
Inc., a Connecticut nonstock corporation (the "Stockholder"), Physicians
Health Services, Inc., a Delaware corporation (the "Company"), and American
Stock Transfer & Trust Company, as Voting Trustee, pursuant to which this
certificate has been issued, the Stockholder, as registered holder of this
certificate, will be entitled to receive a certificate for the shares
hereinabove specified (the "Voting Trust Stock") and, for the duration of such
Agreement, to receive distributions equal to the dividends, property,
securities, cash or other distributions, if any, received by the Voting
Trustee upon the Voting Trust Stock standing in its name. Prior to the
termination of the Agreement, the Voting Trustee, with respect to the Voting
Trust Stock, shall possess and be entitled to exercise, only in the manner and
to the extent provided in the Agreement, all the rights of the holder of this
certificate to vote and to take part in, or to consent to any corporate or
stockholders' action, it being expressly stipulated that no right to vote, or
take part in, or to consent to any corporate or stockholders' action, shall
pass to the registered holder hereof by, or under, this certificate, in each
case subject to or in accordance with the Agreement.
This certificate is not transferable, as set forth in the Agreement, and is
not valid unless signed by the Voting Trustee. The holder hereof, by accepting
this certificate, manifests its consent that the Company may treat the
registered holder hereof as the true owner of this certificate for all
purposes.
IN WITNESS WHEREOF, the undersigned, Voting Trustee has caused this
certificate to be signed as of the day of 1997.
American Stock Transfer & Trust
Company
By:__________________________________
Name:
Title:
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APPENDIX D
SECTION 262 OF THE DELAWARE GENERAL CORPORATION LAW
<PAGE>
APPENDIX D--SECTION 262 OF THE DELAWARE GENERAL CORPORATION LAW
(a) Any stockholder of a corporation of this State who holds shares of stock
on the date of the making of a demand pursuant to subsection (d) of this
section with respect to such shares, who continuously holds such shares
through the effective date of the merger or consolidation, who has otherwise
complied with subsection (d) of this section and who has neither voted in
favor of the merger or consolidation nor consented thereto in writing pursuant
to s 228 of this title shall be entitled to an appraisal by the Court of
Chancery of the fair value of the stockholder's shares of stock under the
circumstances described in subsections (b) and (c) of this section. As used in
this section, the word "stockholder" means a holder of record of stock in a
stock corporation and also a member of record of a nonstock corporation; the
words "stock" and "share" mean and include what is ordinarily meant by those
words and also membership or membership interest of a member of a nonstock
corporation; and the words "depository receipt" mean a receipt or other
instrument issued by a depository representing an interest in one or more
shares, or fractions thereof, solely of stock of a corporation, which stock is
deposited with the depository.
(b) Appraisal rights shall be available for the shares of any class or
series of stock of a constituent corporation in a merger or consolidation to
be effected pursuant to (S)251 (other than a merger effected pursuant to
(S)251(g) of this title), (S)252, (S)254, (S)257, (S)258, (S)263 or (S)264 of
this title:
(1) Provided, however, that no appraisal rights under this section shall
be available for the shares of any class or series of stock, which stock,
or depository receipts in respect thereof, at the record date fixed to
determine the stockholders entitled to receive notice of and to vote at the
meeting of stockholders to act upon the agreement of merger or
consolidation, were either (i) listed on a national securities exchange or
designated as a national market system security on an interdealer quotation
system by the National Association of Securities Dealers, Inc. or (ii) held
of record by more than 2,000 holders; and further provided that no
appraisal rights shall be available for any shares of stock of the
constituent corporation surviving a merger if the merger did not require
for its approval the vote of the stockholders of the surviving corporation
as provided in subsection (f) of (S)251 of this title.
(2) Notwithstanding paragraph (1) of this subsection, appraisal rights
under this section shall be available for the shares of any class or series
of stock of a constituent corporation if the holders thereof are required
by the terms of an agreement of merger or consolidation pursuant to
(S)(S)251, 252, 254, 257, 258, 263 and 264 of this title to accept for such
stock anything except:
a. Shares of stock of the corporation surviving or resulting from
such merger or consolidation, or depository receipts in respect
thereof;
b. Shares of stock of any other corporation, or depository receipts
in respect thereof, which shares of stock or depository receipts at the
effective date of the merger or consolidation will be either listed on
a national securities exchange or designated as a national market
system security on an interdealer quotation system by the National
Association of Securities Dealers, Inc. or held of record by more than
2,000 holders;
c. Cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs (a) and (b) of this
paragraph; or
d. Any combination of the shares of stock, depository receipts and
cash in lieu of fractional shares or fractional depository receipts
described in the foregoing subparagraphs a., b. and c. of this
paragraph.
(3) In the event all of the stock of a subsidiary Delaware corporation
party to a merger effected under (S)253 of this title is not owned by the
parent corporation immediately prior to the merger, appraisal rights shall
be available for the shares of the subsidiary Delaware corporation.
(c) Any corporation may provide in its certificate of incorporation that
appraisal rights under this section shall be available for the shares of any
class or series of its stock as a result of an amendment to its certificate of
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incorporation, any merger or consolidation in which the corporation is a
constituent corporation or the sale of all or substantially all of the assets
of the corporation. If the certificate of incorporation contains such a
provision, the procedures of this section, including those set forth in
subsections (d) and (e) of this section, shall apply as nearly as is
practicable.
(d) appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which appraisal rights are
provided under this section is to be submitted for approval at a meeting of
stockholders, the corporation, not less than 20 days prior to the meeting,
shall notify each of its stockholders who was such on the record date for
such meeting with respect to shares for which appraisal rights are
available pursuant to subsection (b) or (c) hereof that appraisal rights
are available for any or all of the shares of the constituent corporations,
and shall include in such notice a copy of this section. Each stockholder
electing to demand the appraisal of his shares shall deliver to the
corporation, before the taking of the vote on the merger or consolidation,
a written demand for appraisal of his shares. Such demand will be
sufficient if it reasonably informs the corporation of the identity of the
stockholder and that the stockholder intends thereby to demand the
appraisal of his shares. A proxy or vote against the merger or
consolidation shall not constitute such a demand. A stockholder electing to
take such action must do so by a separate written demand as herein
provided. Within 10 days after the effective date of such merger or
consolidation, the surviving or resulting corporation shall notify each
stockholder of each constituent corporation who has complied with this
subsection and has not voted in favor of or consented to the merger or
consolidation of the date that the merger or consolidation has become
effective; or
(2) If the merger or consolidation was approved pursuant to (S)228 or
(S)253 of this title, each constituent corporation, either before the
effective date of the merger or consolidation or within ten days
thereafter, shall notify each of the holders of any class or series of
stock of such constituent corporation who are entitled to appraisal rights
of the approval of the merger or consolidation and that appraisal rights
are available for any or all shares of such class or series of stock of
such constituent corporation, and shall include in such notice a copy of
this section; provided that, if the notice is given on or after the
effective date of the merger or consolidation, such notice shall be given
by the surviving or resulting corporation to all such holders of any class
or series of stock of a constituent corporation that are entitled to
appraisal rights. Such notice may, and, if given on or after the effective
date of the merger or consolidation, shall, also notify such stockholders
of the effective date of the merger or consolidation. Any stockholder
entitled to appraisal rights may, within 20 days after the date of mailing
of such notice, demand in writing from the surviving or resulting
corporation the appraisal of such holder's shares. Such demand will be
sufficient if it reasonably informs the corporation of the identity of the
stockholder and that the stockholder intends thereby to demand the
appraisal of such holder's shares. If such notice did not notify
stockholders of the effective date of the merger or consolidation, either
(i) each such constituent corporation shall send a second notice before the
effective date of the merger or consolidation notifying each of the holders
of any class or series of stock of such constituent corporation that are
entitled to appraisal rights of the effective date of the merger or
consolidation or (ii) the surviving or resulting corporation shall send
such a second notice to all such holders on or within 10 days after such
effective date; provided, however, that if such second notice is sent more
than 20 days following the sending of the first notice, such second notice
need only be sent to each stockholder who is entitled to appraisal rights
and who has demanded appraisal of such holder's shares in accordance with
this subsection. An affidavit of the secretary or assistant secretary or of
the transfer agent of the corporation that is required to give either
notice that such notice has been given shall, in the absence of fraud, be
prima facie evidence of the facts stated therein. For purposes of
determining the stockholders entitled to receive either notice, each
constituent corporation may fix, in advance, a record date that shall be
not more than 10 days prior to the date the notice is given, provided, that
if the notice is given on or after the effective date of the merger or
consolidation, the record date shall be such effective date. If no record
date is fixed and the notice is given prior to the effective date, the
record date shall be the close of business on the day next preceding the
day on which the notice is given.
(e) Within 120 days after the effective date of the merger or
consolidation, the surviving or resulting corporation or any stockholder
who has complied with subsections (a) and (d) hereof and who is otherwise
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entitled to appraisal rights, may file a petition in the Court of Chancery
demanding a determination of the value of the stock of all such stockholders.
Notwithstanding the foregoing, at any time within 60 days after the effective
date of the merger or consolidation, any stockholder shall have the right to
withdraw his demand for appraisal and to accept the terms offered upon the
merger or consolidation. Within 120 days after the effective date of the
merger or consolidation, any stockholder who has complied with the
requirements of subsections (a) and (d) hereof, upon written request, shall be
entitled to receive from the corporation surviving the merger or resulting
from the consolidation a statement setting forth the aggregate number of
shares not voted in favor of the merger or consolidation and with respect to
which demands for appraisal have been received and the aggregate number of
holders of such shares. Such written statement shall be mailed to the
stockholder within 10 days after his written request for such a statement is
received by the surviving or resulting corporation or within 10 days after
expiration of the period for delivery of demands for appraisal under
subsection (d) hereof, whichever is later.
(f) Upon the filing of any such petition by a stockholder, service of a copy
thereof shall be made upon the surviving or resulting corporation, which shall
within 20 days after such service file in the office of the Register in
Chancery in which the petition was filed a duly verified list containing the
names and addresses of all stockholders who have demanded payment for their
shares and with whom agreements as to the value of their shares have not been
reached by the surviving or resulting corporation. If the petition shall be
filed by the surviving or resulting corporation, the petition shall be
accompanied by such a duly verified list. The Register in Chancery, if so
ordered by the Court, shall give notice of the time and place fixed for the
hearing of such petition by registered or certified mail to the surviving or
resulting corporation and to the stockholders shown on the list at the
addresses therein stated. Such notice shall also be given by 1 or more
publications at least 1 week before the day of the hearing, in a newspaper of
general circulation published in the City of Wilmington, Delaware or such
publication as the Court deems advisable. The forms of the notices by mail and
by publication shall be approved by the Court, and the costs thereof shall be
borne by the surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall determine the
stockholders who have complied with this section and who have become entitled
to appraisal rights. The Court may require the stockholders who have demanded
an appraisal for their shares and who hold stock represented by certificates
to submit their certificates of stock to the Register in Chancery for notation
thereon of the pendency of the appraisal proceedings; and if any stockholder
fails to comply with such direction, the Court may dismiss the proceedings as
to such stockholder.
(h) After determining the stockholders entitled to an appraisal, the Court
shall appraise the shares, determining their fair value exclusive of any
element of value arising from the accomplishment or expectation of the merger
or consolidation, together with a fair rate of interest, if any, to be paid
upon the amount determined to be the fair value. In determining such fair
value, the Court shall take into account all relevant factors. In determining
the fair rate of interest, the Court may consider all relevant factors,
including the rate of interest which the surviving or resulting corporation
would have had to pay to borrow money during the pendency of the proceeding.
Upon application by the surviving or resulting corporation or by any
stockholder entitled to participate in the appraisal proceeding, the Court
may, in its discretion, permit discovery or other pretrial proceedings and may
proceed to trial upon the appraisal prior to the final determination of the
stockholder entitled to an appraisal. Any stockholder whose name appears on
the list filed by the surviving or resulting corporation pursuant to
subsection (f) of this section and who has submitted his certificates of stock
to the Register in Chancery, if such is required, may participate fully in all
proceedings until it is finally determined that he is not entitled to
appraisal rights under this section.
(i) The Court shall direct the payment of the fair value of the shares,
together with interest, if any, by the surviving or resulting corporation to
the stockholders entitled thereto. Interest may be simple or compound, as the
Court may direct. Payment shall be so made to each such stockholder, in the
case of holders of uncertificated stock forthwith, and the case of holders of
shares represented by certificates upon the surrender to the corporation
of the certificates representing such stock. The Court's decree may be
enforced as other decrees in the Court of
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Chancery may be enforced, whether such surviving or resulting corporation be a
corporation of this State or of any state.
(j) The costs of the proceeding may be determined by the Court and taxed
upon the parties as the Court deems equitable in the circumstances. Upon
application of a stockholder, the Court may order all or a portion of the
expenses incurred by any stockholder in connection with the appraisal
proceeding, including, without limitation, reasonable attorney's fees and the
fees and expenses of experts, to be charged pro rata against the value of all
the shares entitled to an appraisal.
(k) From and after the effective date of the merger or consolidation, no
stockholder who has demanded his appraisal rights as provided in subsection
(d) of this section shall be entitled to vote such stock for any purpose or to
receive payment of dividends or other distributions on the stock (except
dividends or other distributions payable to stockholders of record at a date
which is prior to the effective date of the merger or consolidation);
provided, however, that if no petition for an appraisal shall be filed within
the time provided in subsection (e) of this section, or if such stockholder
shall deliver to the surviving or resulting corporation a written withdrawal
of his demand for an appraisal and an acceptance of the merger or
consolidation, either within 60 days after the effective date of the merger or
consolidation as provided in subsection (e) of this section or thereafter with
the written approval of the corporation, then the right of such stockholder to
an appraisal shall cease. Notwithstanding the foregoing, no appraisal
proceeding in the Court of Chancery shall be dismissed as to any stockholder
without the approval of the Court, and such approval may be conditioned upon
such terms as the Court deems just.
(l) The shares of the surviving or resulting corporation to which the shares
of such objecting stockholders would have been converted had they assented to
the merger or consolidation shall have the status of authorized and unissued
shares of the surviving or resulting corporation.
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APPENDIX E
PARTS I, II AND IV OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL
YEAR ENDED DECEMBER 31, 1997, AS AMENDED TO JULY 25, 1997.
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Physicians Health Services, Inc., a Delaware corporation ("PHS" or the
"Company"), is the parent of three health maintenance organizations ("HMOs"):
(1) Physicians Health Services of Connecticut, Inc., a Connecticut corporation
("PHS/CT"), operating in Connecticut; (2) Physicians Health Services of New
York, Inc., a New York corporation ("PHS/NY"), operating in New York's
Westchester, Dutchess, Orange, Putnam, Rockland, Nassau and Suffolk Counties,
and the five boroughs of New York City; and (3) Physicians Health Services of
New Jersey, Inc., a New Jersey corporation ("PHS/NJ"), operating in New
Jersey. In addition, the Company is the parent of Physicians Health Insurance
Services, Inc. ("PHIS"), which is licensed in Connecticut as an insurance
broker to offer various insurance products, PHS Investments, Inc. ("PHSI"),
the Company's investment subsidiary, PHS Insurance of Connecticut, Inc.
("Insurance/CT"), which holds a health insurance license in the State of
Connecticut, Physicians Health Services Insurance of New York, Inc.
("Insurance/New York"), which holds a health insurance license in the State of
New York, Physicians Health Services (Bermuda), Ltd. ("Bermuda"), an insurance
company licensed as a reinsurer in Bermuda, and PHS Real Estate, Inc.
("PHSRE"), a Delaware corporation which owns all of the outstanding stock of
the Company's one indirect subsidiary, PHS Real Estate II, Inc. ("PHSREII"), a
Delaware corporation which owns the Company's corporate headquarters in
Shelton, Connecticut. All of the aforementioned subsidiaries are wholly-owned,
either directly or indirectly, by the Company, except for PHS/NJ, in which
MasterCare Companies, Inc. ("MasterCare") holds a 20% minority interest. The
Company is federally qualified as an HMO throughout its Connecticut and New
York service areas.
The Company conducts substantially all of its operations through its
subsidiaries. Unless the context otherwise requires, the terms "Company" and
"PHS" refer to Physicians Health Services, Inc. and its subsidiaries. Its
principal offices are located at One Far Mill Crossing, Shelton, Connecticut
06484 , and its telephone number is (203) 381-6400.
The Company's managed care products include traditional HMO products, in
both open access and gatekeeper models, point of service ("POS") products,
administrative services only ("ASO") plans and Medicare and Medicaid plans.
The Company's HMO subsidiaries contract for medical and related services with
individual practice associations ("IPAs"), physician hospital organizations
("PHOs"), physicians, physician groups, hospitals and other health care
providers. The Company arranges for health care coverage for its members for a
fixed monthly payment, generally without regard to the frequency or extent of
health care services actually furnished, although small copayments may apply
and members pay a deductible and coinsurance in connection with the out-of-
network benefits in POS plans.
As of January 1997, the Company had contracted with 23,298 providers and 183
hospitals throughout its tri-state service area. It had enrolled 400,021
members as of December 31, 1996 (424,940 as of January 1, 1997).
PRODUCTS
The Company offers a broad assortment of managed care products. Its POS
products enable members to choose health care providers from the Company's
network of 23,298 providers and 183 hospitals or to obtain covered services
outside its network. The POS products combine the features of an HMO with the
features of an indemnity-type benefit for out-of-network utilization. Under
the POS plans, a member who obtains benefits outside of the PHS network pays a
deductible and coinsurance. As used herein, a plan with a POS out-of-network
benefit is referred to as a POS plan. The Company's traditional HMO plans
include a gatekeeper model HMO plan, which requires prior approval by a
member's primary care physician before the member may obtain the services of
specialists (the "Passport" plan), and an open access HMO plan in which
members can obtain services from all PHS participating physicians without the
need for a referral (the "Charter" plan). The Charter and Passport plans can
be obtained as traditional HMO plans or as the underlying HMO product for a
POS plan.
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Under the Company's traditional HMO plans, a member who selects a hospital or
physician from outside the network bears the entire cost of such services,
unless the care is related to an emergency or the member has received prior
approval from the Company.
The Company sells its products both on a proprietary basis and through a
joint marketing arrangement with The Guardian Life Insurance Company of
America ("The Guardian"). See "Business--Joint Marketing Arrangement with The
Guardian." Proprietary products are sold to medium and large size groups,
typically as one of several health care plans made available by the employer
to its employees ("alternative products"). Under the agreements with The
Guardian, jointly developed managed care products are marketed to existing
customers of The Guardian, as well as to new customers, under the tradename
"Healthcare Solutions". The Healthcare Solutions products are offered
principally in the small employer group market on a total replacement basis.
Under this arrangement, employees are offered the choice of traditional HMO
products, POS products, and, in certain cases, The Guardian indemnity
products. Through the first nine months of 1996, PHS and The Guardian shared
profits and losses on the Healthcare Solutions products through a combination
of reinsurance and profit sharing arrangements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations". Effective
October 1, 1996, the Company and The Guardian converted all of the Healthcare
Solutions products to a reinsurance basis. As of October 1, 1996, the Company
no longer shared profits and losses with The Guardian with respect to
indemnity products sold under the joint marketing arrangement. The joint
marketing arrangement covers PHS's New York, New Jersey and Connecticut
service areas.
The Company offers third party administrator ("TPA") services for
administrative services only ("ASO") plans, Medicare risk and cost plans,
Medicaid plans, and individual plans in the New York service area. The Company
has a contract with the Mashantucket Pequot Tribe Employee Benefit Plan to
provide access to the Company's network of health care providers and
utilization management programs. In 1995, the Company began marketing plans to
the small group market through the Connecticut Business and Industry
Association ("CBIA"). The Company is one of only four participants in the CBIA
program. The Company has a three-year contract with the Electric Boat Division
of General Dynamics to provide managed health care services to all of its
salaried employees in Connecticut. This contract was effective January 1, 1995
and has been recently expanded to include the members of the Metal Trades
Council Union. The Company has a three-year contract to provide services to
General Electric Company for its employees in Connecticut. The General
Electric plan, which was effective January 1, 1996, combines elements of a
fully insured HMO plan and an ASO plan. Effective December, 1996, the Company
initiated coverage for the New York State Nurses Association Benefits Fund and
its almost 29,000 members under a Charter POS Plan.
HMO PLANS
The Company's traditional HMO plans provide comprehensive health care
services to enrollees for a fixed monthly premium per enrollee, typically
charged to the enrollee's employer group, that does not vary with the nature,
frequency, or cost of services provided, although, where allowed by
regulation, premiums are age/sex adjusted according to the demographic
characteristics of the employer group. Adjusted community rating, which
includes factors related to a specific employer's claims experience, is used
with some of the Company's larger accounts in certain of its service areas.
The Company is also able to experience rate certain groups insured under its
Healthcare Solutions products. See "Business--Enrollment, Employer Groups and
Marketing." Under the traditional HMO plans, the Company does not cover health
care services provided by non-participating physicians or other health care
providers unless pre-approval for an out-of-plan referral has been obtained or
such services are the result of a medical emergency. Members are required to
receive hospital care at participating hospitals except for preauthorized out-
of-plan referrals or emergency admissions. The traditional HMO benefit plans
range from a plan with limited copayments to a plan combining lower monthly
premiums with higher copayments paid by the member. The plans provide coverage
for physicians' services, surgery, hospital care, x-ray and laboratory
services, emergency care, maternity services, well baby and other preventive
health services and, to a limited extent, skilled nursing, home health care,
alcohol and drug rehabilitation and mental health services. The traditional
HMO plans are marketed to employer groups of all sizes, generally as
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alternative products. As of December 31, 1996, 33% of total membership was
enrolled in traditional HMO products (23.2% commercial enrollees, 1.6% ASO
enrollees and 8.2% government enrollees).
The Company's traditional HMO plans are the Charter and Passport plans. The
Charter plan is an open access model which permits members to use PHS
participating physicians, generally without a referral or pre-authorization.
The Passport plan is a gatekeeper plan that the Company developed in response
to employer interest in such plans. Under the Passport plan, each member
selects or is assigned to a primary care provider, typically a family practice
physician, who is responsible for seeing that the member's medical needs are
met. Use by the Passport member of specialists for treatment typically
requires a referral by the primary care provider in order for the services to
be covered.
POS PLANS
POS Plans are marketed to all size employer groups as either a total
replacement or alternative product. Under a POS Plan, an enrollee chooses, at
the time of services, whether to use participating providers and hospitals, or
non-participating providers and hospitals. If the enrollee chooses to use out-
of-network services, the enrollee is subject to deductibles, coinsurance and
claim forms. The POS products have become increasingly popular because of the
freedom of choice afforded enrollees under such plans. The POS plans are
wrapped around the Company's traditional HMO plans so that an enrollee has the
in-network benefits of the Charter or Passport HMO plan. An enrollee who has a
POS Passport plan can elect to see participating or non-participating
providers without the customary prior referrals required in the Passport plan,
in which event such non-referred services are treated as out-of-network
services.
A significant portion of the Company's recent growth in membership has
occurred in its POS plans. As of December 31, 1996, 60.7% of total membership
was enrolled in POS products (51.1% commercial enrollees, 9.6% ASO enrollees).
Only 36% of total membership was enrolled in such plans at December 31, 1995.
The Company expects this trend to continue for the foreseeable future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Cautionary Statement".
ASO PRODUCTS
Under self-funded medical plans, the employer self-insures its health care
expenses and pays for health claims only as they are incurred, rather than
paying monthly premiums for insurance which covers the cost of medical
services as well as administrative expenses. The Company, as a TPA, typically
provides claims processing and health care cost containment services through
its provider network and utilization management programs, and is paid a fee
only in conjunction with these administrative services. The Company's ASO
products enable employers to access the Company's provider network and to
realize savings through certain of the Company's discounted fee arrangements
and medical cost containment capabilities, while allowing employers to design
custom health benefit plans in accordance with their own requirements and
objectives. Certain of the Company's ASO products include performance
guarantees. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Cautionary Statement." As of December 31, 1996,
16.9% of total membership was enrolled in ASO products (9.6% in POS plans,
1.6% in HMO plans and 5.7% in the Mashantucket Peqout plan).
MEDICARE/MEDICAID PRODUCTS
The Company offers PHS/SmartChoice, a federal Medicare program, to Medicare
eligible individuals under the terms of risk contracts with the Health Care
Financing Administration ("HCFA"). PHS/SmartChoice is typically marketed
directly to individuals. The Company also offers PHS/SmartChoice as a POS
product in the group market. It is currently offered in New York and
Connecticut. Enrollees in PHS/SmartChoice have limited copayments as long as
they use health care providers within the Company's network. PHS/SmartChoice
replaces both Medicare Part A and Part B coverage for enrollees and extends
coverage for preventive care, acute hospitalization and skilled nursing care.
In the PHS/SmartChoice gatekeeper product, in the event an enrollee chooses to
receive health care from a non-participating physician, neither
PHS/SmartChoice nor Medicare will cover the costs of such care absent an
emergency or urgent situation.
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Under its risk contracts with HCFA, the Company is paid a fixed per member
per month capitation amount by HCFA based upon a formula established by HCFA
establishing the projected cost to provide the covered services to each
Medicare member. The Company bears the risk that the actual costs of health
care services may exceed the per member per month capitation amount.
Medicare risk contracts provide revenues that are generally higher per
member than those for non-Medicare members, and thus provide an opportunity
for increased profits and cash flow. Such risk contracts, however, also carry
certain risks such as higher comparative medical costs, government regulatory
and reporting requirements, the possibility of reduced or insufficient
government reimbursement in the future, and higher marketing and advertising
costs per member as the result of marketing to individuals rather than to
groups.
In Connecticut the PHS/SmartChoice product is intended to replace another
Medicare product (PHS/Carefree) formerly offered by the Company pursuant to a
cost contract with HCFA. As of December 31, 1996, the Company had 9,638
members enrolled in PHS/Carefree. The Company anticipates that almost all of
these members will convert to the PHS/SmartChoice product by the end of 1997.
The Company participates in Connecticut's Medicaid managed care program
pursuant to a contract with the Connecticut Department of Social Services. PHS
had enrolled 20,781 members in this program as of December 31, 1996. The
Company receives fixed monthly premiums per member under the contract with the
Connecticut Department of Social Services and bears the risk that the actual
costs of health care may exceed the per member per month capitation amounts
received by the Company. Medicaid plans also involve the risk of reduced or
insufficient government reimbursement and higher marketing and advertising
costs per member as a result of marketing to individuals rather than to
groups. PHS has participated in the New York Medicaid managed care program in
Westchester County since February, 1994. It contracts with Westchester Prepaid
Health Service Plans, Inc. for the provision of services under this program.
As of December 31, 1996, 9% of total membership was enrolled in a government
program, almost all in HMO plans.
OTHER PRODUCTS
The Company has entered into marketing arrangements with three prominent HMO
networks, UltraLink SM, HMO National Network SM and National Managed Care,
Inc., to facilitate cooperative marketing efforts focusing on national
employer groups with employees in the Company's service area. The Company's
affiliations with national networks allow it to compete with national managed
care companies for employers desiring a national managed care network. In
1996, the Company generated almost $7 million in premium revenues from
employer groups accessing these national networks. The Company has a multi-
year contract with Dental Benefit Providers, Inc. to market managed dental
products in New York and Connecticut. These managed dental products offer
different levels of dental benefits through a selected panel of dentists at a
cost that is below average indemnity plan prices. These products are designed
to increase the Company's managed care product market penetration and to
promote retention of its enrollee base. The Company also offers prescription
drug riders to its HMO and POS plans. The prescription drug riders are offered
through PCS, Inc., an unaffiliated company that has established contracts with
most of the local pharmacies in the Company's service area. The prescription
drug rider pays the cost of all covered prescriptions, less, in some
instances, a deductible or copayment. The Company also offers a Connecticut
small employer plan to groups of fewer than 50 employees. The Company also
offers an individual HMO and an individual POS plan throughout its New York
State service area. The Company's insurance brokerage subsidiary, PHIS,
markets various insurance products of unaffiliated companies such as dental
and life insurance, short-term disability and stop-loss coverage available
from other insurers. PHIS's insurance activities are solely as an agent and
represented less than 0.1% of the Company's total revenues in 1996 . The
Company contracts with Davis Vision of Plainview, New York for provision of
certain routine and non-routine vision services to both commercial and
government product members.
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OTHER INVESTMENTS
In 1995, the Company invested $2.3 million in MasterCare Companies, Inc.
("MasterCare"), a company offering workers compensation managed care services
in New Jersey and Connecticut. See "Business--Arrangement with MasterCare."
PROVIDER ARRANGEMENTS
PHYSICIANS AND OTHER HEALTH CARE PROVIDERS
The Company contracts with physician groups, such as IPAs, PHOs, and multi-
specialty groups (collectively, "Physician Groups"), individual physicians and
other health care providers for a defined range of health services, including
primary and specialty care. As of January 1, 1997, the Company had agreements
with 23,298 providers and 183 hospitals in its tri-state service area. The
Company's contracts with providers include discounted fee for service
arrangements as well as capitated group arrangements in which the contracting
Physician Group assumes a significant amount of the risk of overutilization.
The Company currently has contracts with four IPAs, three PHOs and one large
physician group ("Group") that provide for most of its physician services in
its Connecticut service area. In New York and New Jersey, the Company
generally contracts directly with physicians and other health care providers.
Under the typical Physician Group arrangements, the Physician Group receives a
fixed monthly capitation payment for each member selecting a primary care
physician from that Physician Group. Capitation payments may be for all
members selecting a primary care physician in the Physician Group or only as
to members in certain commercial HMO and POS plans, depending upon the
negotiated arrangement with the Physician Group. Capitation rates and any
increases thereto are negotiated for the term of the contract. The capitation
payment is designed to cover not only the professional medical services
(including ancillary tests and services) rendered by the physicians and other
providers associated with that Physician Group but also includes payments for
certain other services rendered to the enrollee by providers who are not
members of the Physician Group. Services covered by the capitation payment
include, among other things, virtually all physician claims (whether inpatient
or outpatient, including authorized out-of-plan care) and care rendered by
other professionals such as physical therapists and psychologists. In certain
of the contracts, the Physician Groups also are at risk for hospital, pharmacy
and other facility expenses. The Company does not capitate physicians
directly.
Three of the Company's four Connecticut IPA contracts expire on December 31,
1997; the Company has reached an agreement in principle with the fourth IPA to
extend its present arrangements through December 31, 1997 on slightly
different terms. In the event that the Company was unable or chose not to
renew any Physician Group contract, it would seek alternative arrangements to
ensure the continuation of health care services to its enrollees. However, if
the Company failed to renew any Physician Group contract covering a
significant number of its enrollees and the Company was unable to obtain
satisfactory alternative arrangements, there could be a significant disruption
in the Company's business.
Each Physician Group reimburses its member physicians and other providers
out of the capitation payment paid to it by the Company according to a maximum
fee-for-service schedule for claims submitted by those physicians and
providers affiliated with the Physician Group. A portion of each physician's
and provider's payment is withheld and is contributed to the Physician Group's
risk pool to cover those expenses that exceed the Physician Group's budget for
health care expenses. The withheld portion is returned to providers if the
Physician Group operates within its prescribed budget for services. Because in
most instances the capitation payments received by the Physician Group are
fixed amounts unrelated to the services provided, the provision of excessive
services would obligate the Physician Group to pay more to its physicians than
the Physician Group receives from the Company. The principal exception is the
Greater Bridgeport IPA, where overruns are shared equally between the Company
and IPA. The Company's capitation system is designed to place upon the
Physician Group and its member physicians the responsibility for managing the
use of hospital and other medical services. In the event that the Physician
Group is required to pay more to its physicians than it receives from the
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Company, the Physician Group must continue to cover ongoing expenses and will
be required to take corrective action to restore its financial position.
Corrective action may include, among other things, lowering its fee-for-
service schedule or increasing its withhold percentage. The Company believes
that the member physicians of its Physician Groups have an interest in
supporting the financial condition of their Physician Group through temporary
reductions in fee schedules and increases in withhold. In 1996, each Physician
Group received a return of all or a portion of its withhold account. Physician
Groups may incur an operating loss which would result in the Physician Group
having a retained earnings deficit. If such deficit were not eliminated
through corrective action, the Company might find it necessary to advance
funds to cover such deficit, although it would not be obligated to do so.
Certain of the Company's IPA stockholders, through their ownership of Company
stock or through members who serve on the Company's Board of Directors, may
seek to have the Company fund such deficits in the future and failure by the
IPAs to eliminate such future deficits, if any, could result in unrecovered
cash advances. Any such funding is subject to approval by the Board's Audit
Committee, a majority of which is composed of independent directors. If any
Physician Group with which the Company contracts for services became
insolvent, such insolvency could have a material adverse effect on the
business of the Company.
The capitation payments to Physician Groups other than the PHOs typically do
not cover hospital and other facility expenses, although the Physician Groups
are partially at risk for non-Medicare and non-Medicaid hospital utilization.
The Company establishes an annual per member, per month target for hospital
expenses. The amount varies by benefit plan and Physician Group, and
encompasses both inpatient and outpatient costs. If total hospital expenses
generated by the Physician Group exceed the applicable hospital expense
target, the Company withholds from amounts owed by it to the Physician Group
all or a portion of the excess over budget, in most cases one-half of the
excess over budget. If actual costs are less than budgeted targets, the
Physician Group receives from the Company an incentive credit typically equal
to forty to fifty percent of the amount by which actual costs are less than
budgeted targets.
In its New York and New Jersey expansion areas and in areas in Connecticut
not served through Physician Group contracts, the Company contracts for
services principally through direct contracts with individual physicians and
other health care providers. In addition, the Company contracts with two IPAs
in the northern counties of its New York service area. The Company withholds a
percentage of reimbursement for services rendered pursuant to its direct
physician contracts against budgeted amounts to manage excessive utilization.
The Company provides services to enrollees in PHS/SmartChoice pursuant to a
combination of direct physician agreements, and, in New York, risk sharing
agreements with the aforementioned IPAs. In Connecticut, the Company has
contracted with and is in negotiations with PHOs and other risk entities for
its Medicare risk product to shift the risk of all medical costs to the risk
entity in return for a fixed percentage of the Medicare premium received by
the Company. The Company's agreements in connection with its Medicare risk
products are subject to compliance with new risk sharing regulations adopted
by HCFA, which require disclosure and reinsurance for specified levels of risk
sharing, and proposed state regulations that could affect physician risk
sharing.
HOSPITALS
The Company maintains contracts with 30 acute care hospitals in its
Connecticut service area. In New York, the Company contracts with 83 hospitals
in its service area. The Company has direct and indirect (through MasterCare)
arrangements with 70 hospitals in New Jersey. The Company generally negotiates
contracts with hospitals that include compensation on a per diem basis (at a
daily rate, without regard to the scope of services actually provided). Other
compensation arrangements with hospitals include charged-based discounts
(negotiated discounts from the hospital's billed charges) and all inclusive
case rates. In the case of non-participating hospitals, the Company pays
either hospital billed charges or negotiated discounted charges. Additionally,
some hospital contracts include per case, all-inclusive, payment arrangements
for select procedures such as maternity care.
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OTHER HEALTH CARE PROVIDERS
PHS maintains contracts with outside vendors to provide certain ancillary
services. Laboratory services are provided in Connecticut through an exclusive
arrangement with Diagnostic Medical Laboratory, Inc. Laboratory services in
New York and New Jersey are provided through arrangements with Quest
Diagnostics. Both are capitated arrangements that are effective through
December 31, 1999 and December 31, 1997, respectively. Mental health,
substance abuse and detoxification services are provided in New York City and
Long Island through a capitated arrangement with CMG Health, Inc. ("CMG").
This agreement is now in a renewal period and may be terminated by either
party with at least 120 days notice. CMG also provides these services for the
Company's Medicaid members in Connecticut under a fully capitated arrangement,
which began on August 1, 1995 for a period of 27 months and is automatically
renewable thereafter for one year periods unless terminated by either party on
120 days notice. In Westchester, Dutchess, Orange, Putnam, and Rockland
Counties, New York, CMG provides case management services only. This agreement
is in a renewal period and may be terminated by either party on at least 120
days notice.
MEDICAL COST CONTROLS
Control of health care expenses is critical to the profitability of a
managed care company. Expansion into new areas, introduction of new products,
changes in health care practices, medical cost inflation, new technologies,
government regulation, major epidemics, natural disasters and numerous other
factors affecting the delivery and costs of health care may adversely affect
the Company's operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Cautionary Statement."
Physician Costs. The Company has developed several integrated mechanisms and
procedures for the control of health care costs. The Company's health care
programs are designed around primary care physicians who assume overall
responsibility for the care of enrollees and determine or recommend the nature
and extent of services provided to enrollees. In the case of enrollees
enrolled in Passport products, primary care physicians are also responsible
for making referrals to contracted specialist physicians and hospitals.
Although the primary care physician's prior approval for most specialist
services is not required in the Company's Charter products, it is recommended.
Prior approval is required in the Company's Charter products for the
enrollee's use of certain services such as home health care, hospice care,
cardiac rehabilitation, private duty nurses, skilled nursing care, drug and
alcohol rehabilitation and, except for enrollees in a POS plan, elective
services rendered out-of-network. In addition to the prior approval process
for certain services, the Company monitors services rendered to enrollees and
provides utilization review information to its Physician Groups. In cases of
possible excessive utilization, the Company counsels the enrollee with respect
to the possible duplication of services or medications.
With respect to physicians who contract with PHS through Physician Groups,
costs are also controlled through contracts that provide for payment to the
Physician Group on a capitation basis. The capitation method of payment,
together with the withhold provisions in its contracts, transfers much of the
Company's risk of excessive physician utilization to the Physician Group.
Physicians who contract with PHS directly are not capitated, although
withholds apply in order to mitigate the risk to PHS of excessive utilization.
The Company also endeavors to monitor the practice patterns of all
participating physicians and providers in order to identify inappropriate or
excessive utilization. Each physician's utilization pattern is reviewed
against other physicians within the relevant specialty area in the physician's
Physician Group or relevant geographic area to determine whether average costs
per patient are consistent with utilization generally. In the event there are
insufficient aggregate data in a particular area, the Company's Medical
Directors review utilization data on a specific case basis. If inappropriate
utilization is determined, PHS will typically institute corrective measures
including, if necessary, financial sanctions or, in rare instances,
termination of the physician's membership as a participating physician.
The Company has developed a measurement tool called the "practice profile"
to evaluate and promote the quality of care being provided to the Company's
members. The practice profile compares providers to their peers
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in relation to specific quality indicators that measure quality across a broad
spectrum of areas. The practice profile also provides feedback to providers to
assist them in assessing and enhancing their performance.
Hospital Costs; Utilization Review. The control of the use of hospital and
other medical services by a member is primarily the responsibility of the
member's primary care physician. The Company requires preadmission
notification of non-emergency hospital admissions and stays, pre-certification
of selected inpatient and outpatient procedures, and retrospective review of
ambulatory health services. The Company also maintains nurse coordinators who
are assigned to certain participating hospitals to conduct concurrent reviews
of hospital admissions. In the event that the nurse coordinator believes that
utilization is inappropriate, the nurse coordinator first addresses his/her
concerns with the attending physician, then consults with a physician advisor,
who reviews admission information and patient records. Physician advisors as
well as PHS Medical Directors are available to assist the attending physician
in determining whether it is appropriate for a patient to remain hospitalized.
The physician advisor, Medical Director and/or nurse coordinator works with
the responsible physician to arrange alternative health care where
appropriate, thereby reducing the length of hospital stays. The Company
performs telephonic reviews at certain hospitals where it is not practical to
perform on-site concurrent reviews.
The Company has implemented special review procedures for pharmaceutical
usage and the treatment of mental health and substance abuse conditions. In
addition to the foregoing controls, the Company has adopted certain policies
relating to the timing of admissions and the use of ambulatory facilities for
certain surgical procedures, among other services, in order to reduce costs
associated with hospital utilization.
For catastrophic cases, the Company uses case management techniques to work
with the attending physician, facility, patient and his/her family, to provide
care in a cost-efficient manner consistent with the medical needs of the
patient.
The Company has a pre-certification program for selected elective inpatient
and outpatient procedures to determine the medical necessity of those
services. The pre-certification program requires the physicians performing the
designated procedures to obtain advance authorization, and permits appeal if
the procedure is initially denied. Procedures that are denied through this
program are ineligible for coverage by the Company. As a pre-certification
tool, the Company utilizes the Value Health Sciences Medical Review System.
Since implementation of this program in March 1993, the program has achieved
an overall 21% decrease in the utilization of procedures subject to the
program.
Hospital inpatient costs are also controlled through several contractual
mechanisms. The Company's contracts with Physician Groups contain risk sharing
mechanisms designed to provide incentives to control utilization of hospital
services and its contracts with PHOs include both professional/physician and
hospital/facility services within the capitation payment to the PHO. In
addition, the Company maintains insurance coverage that reimburses the Company
for hospital expenses incurred above certain levels, limiting the risk to the
Company of an individual enrollee's inpatient hospital expense exceeding
specified amounts. See "Business--Stop Loss and Other Insurance."
MANAGEMENT INFORMATION SYSTEMS
The Company believes that timely and relevant information is critical to the
success of its managed health care business. The Company utilizes its
management information systems to process claims on an accurate and timely
basis; to analyze health care utilization; to support provider, member and
employer requirements; and to control administrative costs. The Company's
claims operation is supported by staff and manager training, adherence to
performance standards (for both productivity and accuracy), auditing of claims
for claims processing accuracy, and adequate staffing and system programming
to ensure adherence to all benefit provisions of the Company's provider
policies. Currently, approximately 30% of physician/provider (non-facility)
claims and approximately 20% of institutional claims are received
electronically from the Company's providers. The Company intends to increase
the amount of claims that it processes electronically. The Company's imaging
system enables further automation of the claims process. The Company believes
that its electronic claims
E-8
<PAGE>
capabilities combined with the Company's imaging system have enabled the
Company to establish highly efficient claims processing and information
retrieval systems. The Company has in place a disaster recovery plan that
provides for a back-up of its management information system in case of an
emergency.
The Company is in the process of completing a significant upgrade of its
management information systems. The new systems are expected to begin to come
on line during the second quarter of 1997. At December 31, 1996, the costs
associated with this project included capital expenditures of approximately
$18.6 million, including enhancements beyond the original scope of the
project. The capital expenditures are expected to be amortized over five years
commencing with fiscal year 1997. When completed, the conversion to the new
system is expected to yield significant gains in productivity, accuracy and
speed as well as permit more significant information evaluation. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Cautionary Statement. "
QUALITY ASSURANCE AND CUSTOMER SERVICE
Prior to a physician's acceptance for participation in the Company's network
of providers, the Company reviews the physician's credentials and background.
Each physician must be board certified in his/her specialty, or become board
certified within five years of becoming credentialled. PHS has a rigorous
credentialling process that consists of primary verification of all
credentials; query of the National Practitioner Data Base, state medical
boards and admitting hospitals for malpractice history, disciplinary actions
and/or restrictions of hospital privileges; and on-site office evaluations
including a review of medical records to determine compliance with PHS's
standards. The Company biennially recredentials all its providers.
Recredentialing includes repeating the initial credentialling process as well
as reviewing the provider's practice history with PHS. After acceptance, the
Company monitors various aspects of the physician's performance on an ongoing
basis, including the quality and appropriateness of care delivered. The
Company evaluates the quality and appropriateness of medical care provided to
its enrollees by performing medical care evaluation and member satisfaction
studies, by reviewing utilization of certain services and by responding to
enrollee and physician questions and concerns.
In August 1995, the Company was awarded full three-year accreditation in its
then current service areas from the National Committee for Quality Assurance
("NCQA"), an independent organization that reviews HMOs for compliance with
their quality standards. This accreditation is effective from May, 1994
through May, 1997. In connection with the re-accreditation process, the NCQA
staff made an on-site visit in late March, 1997.
The Company has also established a formal system for documenting and
responding to customer grievances. The Company had no grievances upheld
against it during 1993, 1994 and 1995 by the New York Insurance Department.
The Company also had no complaints upheld against it during 1994 and only one
complaint upheld against it in 1995 by the Connecticut Department of
Insurance. The Company anticipates similarly good results for 1996. The
Company believes that it has established a reputation for high standards of
service.
ENROLLMENT, EMPLOYER GROUPS AND MARKETING
As of December 31, 1996, the Company provided managed health care coverage
to 400,021 enrollees. The Company offers its products to small groups,
generally on a total replacement basis, and to medium and large groups on both
a total replacement as well as alternative bases. The small group market
segment is currently marketed throughout the Company's tri-state service area
through its alliance with The Guardian and, in Connecticut, also through CBIA.
In the large group market, the Company sells both its proprietary HMO and POS
products, as well as ASO products. The Company's enrollee base is diverse and
includes federal and state employees and employees of banks, hospitals and
major industries. The Company's five largest fully insured employer groups
represent approximately 17% of its 332,363 fully insured enrollees and 14% of
its total enrollees. The New York State Nurses Association Benefits Fund,
which constitutes the largest fully insured employer group, represents 7.2% of
the Company's total enrollees and 8.6% of its fully insured enrollees.
Employer groups of 50 or less are subject to community rating restrictions
throughout the Company's service area. In these areas, the Company uses
underwriting guidelines and rating practices that comply with
E-9
<PAGE>
state mandated community rating regulations. In Connecticut and New Jersey,
groups of over 50 members are not subject to community rating regulation. For
these groups, the Company employs rating techniques and underwriting
guidelines designed to price its products according to expected health care
utilization based on group experience.
In New York, all groups written on the Company's HMO license are subject to
community rating regulations. The Company uses underwriting guidelines and
rating practices that comply with New York mandated community rating
regulations. See "Business--Competition." The Company expects to begin
marketing an experience rated POS product in the over 50 employee group market
in mid-1997. In addition, the Company currently experience rates certain of
its Healthcare Solutions products offered in the over 50 employee group market
in New York.
Subject to underwriting guidelines, the Company solicits new employer groups
for its proprietary products through its marketing staff and employee benefits
consultants. Most larger employer groups are represented by brokers and
consultants, who are typically paid by the employers, and work with the
employer to recommend or design employee benefit packages. The Company
utilizes an internal staff of sales and account service representatives and
managers to market its benefit plans to employers. Healthcare Solutions
products are sold through the Company's and The Guardian's respective
marketing staffs, as well as through independent brokers.
Marketing the Company's benefit plans in the alternative carrier market is
typically a two-step process in which presentations are first made to
employers and, after the employer selects the Company as one of its health
care providers, to its employees. In the total replacement market, sales are
made solely at the employer levels and employees then can select from a number
of PHS products, or in the case of Healthcare Solutions, PHS or The Guardian
products.
The marketing process is continuous because contracts with employers are
typically renewed annually, employees are permitted to change plans annually
and employer groups experience regular employee turnover.
JOINT MARKETING ARRANGEMENT WITH THE GUARDIAN
The Company has a joint marketing arrangement with The Guardian throughout
its tri-state service area. The products that are subject to the joint
marketing arrangement are distributed through the brokerage community in an
integrated marketing effort. The products are generally sold on a total
replacement basis, which eliminates the need for marketing to employees once
the products are sold to the employer group. Products are marketed under the
trade name "Healthcare Solutions" and employees are able to choose among PHS's
traditional HMO and POS products as well as, in certain instances, The
Guardian's indemnity products. The Company and The Guardian target groups that
are currently enrolled in The Guardian's indemnity products. Because of the
higher premiums associated with indemnity insurance generally, such groups are
often receptive to conversion to the Healthcare Solutions products. The
Company and The Guardian also market to new groups.
The joint marketing arrangements with The Guardian are for an unlimited term
but can be terminated by either party either with or without cause, subject to
potentially significant payments upon termination in the event of a
termination without cause, by the party electing to terminate, and in the
event of certain for cause terminations, by the party breaching the agreement.
The agreements can also be terminated by either party with respect to new
business following a change in control of the other party, in which event the
parties would continue to share profits and losses on business in effect on
the date of the change in control for a period of up to ten years. For a
description of the Company's financial arrangements with The Guardian in
connection with the Healthcare Solutions business, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 10 to the Consolidated Financial Statements.
As of December 31, 1996, there were 112,566 members enrolled in Healthcare
Solutions products (43,773 in Connecticut, 53,153 in New York and 15,640 in
New Jersey).
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<PAGE>
STOP-LOSS AND OTHER INSURANCE
The Company maintains reinsurance coverage for its existing business to
limit the risk of an individual member's inpatient hospital expense exceeding
specified amounts. The Company believes that its reinsurance coverage
substantially limits its risk of incurring catastrophic costs at a reasonable
premium cost. Beginning January 1, 1996 and continuing throughout 1997, the
reinsurance arrangement for the Company's HMO products throughout its entire
service area covers 80% of the next $400,000 of any member's inpatient
hospital expense and emergency out-of-area services (up to a stated daily
maximum) in excess of a $600,000 deductible. The reinsurance agreement
provides a limit of $1,000,000 per member, per contract period (12 months) and
$2,000,000 per member, per lifetime. The Company also maintains general
liability, property, fidelity and contingent malpractice insurance coverage in
amounts it believes to be adequate. Such insurance may become increasingly
important if plaintiffs prove successful in recent efforts to expand the
liability of a managed health care company for the negligence of providers
with whom the Company directly or indirectly contracts. The Company also
requires contracting Physician Groups and hospitals to maintain malpractice
insurance coverage.
ARRANGEMENT WITH MASTERCARE
The Company has entered into a marketing relationship with MasterCare and
its affiliates. In addition, the parties have network access agreements with
each other stemming from their respective expansion activities. In connection
with the formation of PHS/NJ, the Company used the MasterCare network of
providers to help it develop a network in New Jersey. As consideration, the
Company issued a 20% interest in PHS/NJ to MasterCare. In addition, at
December 31, 1996 PHS owned an interest in MasterCare Companies, Inc. and its
subsidiary, MasterCare of Connecticut, formerly Total Employee Care, a workers
compensation company formerly wholly-owned by the Company. See Note 11 to the
Consolidated Financial Statements.
GOVERNMENT REGULATION
FEDERAL REGULATION
The Company is subject to the Health Maintenance Organization Act of 1973,
as amended, and the rules and regulations promulgated thereunder ("HMO Act"),
which prescribe the manner in which an HMO must be organized and operated in
order to meet and maintain federal qualification and to be eligible to enter
into Medicare contracts with the federal government. PHS/CT and PHS/NY are
federally qualified under the HMO Act. In order to maintain this status the
Company must file periodic reports with, and is subject to periodic review by,
the Department of Health and Human Services through HCFA and the Office of
Prepaid Health Care. In addition, HCFA has the right to audit the Company to
determine compliance with HCFA's regulations and to monitor the quality of
care rendered to PHS/CT's and PHS/NY's Medicare enrollees. Reimbursements
payable to PHS/CT and PHS/NY under the Medicare risk contracts are subject to
periodic unilateral revision by the federal government. Future levels of such
payments may be affected by federal government efforts to contain health care
costs and cannot be predicted with certainty. Each of the Company's Medicare
contracts are renewable on an annual basis. Health plans which offer a
Medicare risk product must also comply with requirements established by peer
review organizations, which are organizations which contract with HCFA to
monitor the quality of health care received by Medicare beneficiaries. These
requirements relate to quality assurance and utilization review procedures.
Recent requirements of HCFA impose requirements relating to physician
incentive plans, which place physicians participating in Medicaid and Medicare
HMO plans at substantial financial risk. Enrollment under the Medicare risk
program cannot exceed 50% of a health plan's total enrollment. Termination of
the Company's Medicare program could have a material adverse effect on its
business.
As a result of its Medicaid contract, PHS/CT is subject to both federal and
state regulation regarding services provided to Medicaid enrollees, payment
for those services and other aspects of the Medicaid program. Medicaid
regulations require that enrollment of Medicaid and other federal government
program beneficiaries cannot exceed 25% of a health plan's total enrollment.
The Company is also required by federal and state regulatory agencies to
maintain restricted cash reserves and/or a minimum net worth. To remain
licensed, it may be necessary for the Company to make changes from
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<PAGE>
time to time in its services, procedures, structure and marketing methods.
Such changes may be required as a result of amendment to, or other significant
modification of, federal and state laws and regulations controlling the
Company's operations. Any changes in federal or state government regulation
could affect the Company's operations, profitability and business prospects.
STATE REGULATION
The Company's HMO and insurance subsidiaries are subject to substantial
state government regulation. PHS/CT is licensed by the Insurance Commissioner
of Connecticut to be a health maintenance organization and is subject to
regulation by the Connecticut Department of Insurance. PHS/NY is also licensed
as a health maintenance organization by the Commissioner of Health of the
State of New York and is subject to regulation by the Department of Health of
the State of New York and the Department of Insurance of the State of New
York. PHS/NJ is licensed as a health maintenance organization by the
Commissioner of Health and Senior Services and Commissioner of Banking and
Insurance of the State of New Jersey and is subject to regulation by the
Department of Health and Senior Services of the State of New Jersey and the
Department of Banking and Insurance of the State of New Jersey. State
regulatory authorities exercise oversight regarding the Company's provider
networks, medical care delivery and quality assurance programs, contract forms
and their provisions, and financial condition, including reserve and cash flow
requirements. Applicable state law requires periodic financial reports,
imposes minimum standards for investments, capital, deposits and reserves, and
regulates marketing, rates, medical benefits, payment of dividends and
affiliate transactions. In addition, the premiums charged by the Company are
subject to review and changes in rates must be approved in advance by state
regulatory authorities. The Company's HMOs are also subject to periodic
examination by the relevant state regulatory authorities.
Insurance/CT is an accident and health company licensed by the Connecticut
Department of Insurance, Insurance/NY is a property and casualty company
licensed by the New York Department of Insurance and Bermuda is an insurance
company licensed as a reinsurer in Bermuda. Applicable laws contain
requirements relating to Insurance/CT's, Insurance/NY's and Bermuda's
financial condition, reserve requirements, premium rates and contracts and
require periodic filings and examinations.
Applicable Connecticut, New York and New Jersey statutes and regulations
require the prior approval of the Connecticut Commissioner of Insurance, New
York Commissioner of Health and New Jersey Commissioner of Health,
respectively, for any acquisition of control of the Company or its
subsidiaries. For purposes of these statutes and regulations, "control" means
the direct or indirect possession of the power to direct or cause the
direction of the management and policies of an entity. Control is presumed to
exist when a person, group of persons or entity acquires the power to vote 10%
or more of the voting securities of another entity.
New York law requires health insurers to accept all individuals and small
groups (between three and fifty employees or group members) without regard to
their age, sex, occupation or medical condition at a "community rated" premium
based on the experience of the entire pool of risks covered by the insurer.
The New York community rating law establishes a pooling mechanism providing
for payments to insurers writing such policies for a disproportionate share of
individuals with certain demographic characteristics and catastrophic medical
expenses. Depending on the age and sex characteristics of an insurer's members
and the incidence of certain high-cost medical conditions among members, an
insurer will either make payments to or receive payments from the state pooled
fund. To date, the Company has incurred expenses related to this fund
amounting to $1,152,000 in 1994, $1,483,000 in 1995 and $3,180,000 in 1996.
The New York community rating law also provides, among other things, for
portability of health insurance, thereby facilitating continued coverage for
those wishing to seek new employment or insurers, and allows members of a
small group to continue their coverage after their membership is terminated.
New York law requires all HMOs to offer an individual HMO plan and an
individual POS plan. The benefits available under these plans are mandated by
law and do not differ between health plans.
Connecticut law also regulates health insurance for employer groups of fifty
and fewer employees. The Connecticut small employer insurance law includes
guaranteed issue, pre-existing condition restrictions and
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<PAGE>
guaranteed renewability provisions. Connecticut applies adjusted community
rating restrictions to all small employer medical plans. Under adjusted
community rating, the only factors that may be used are age, gender,
geographic area, industry, group size and family composition. Such factors are
further limited by applicable Connecticut law.
New Jersey regulates health insurance for employer groups of two to forty-
nine employees through the New Jersey Small Employer Health Benefits Program.
The law sets out six standard plans, only one of which is an HMO plan (the
others are all indemnity plans). The law also mandates the benefits to be
offered under such plans and sets out the participation and contribution
requirements, applies a preexisting condition restriction, guaranteed
renewability and rating restrictions.
The Company's HMO subsidiaries are subject to statutory regulations that
restrict the payment of dividends. Connecticut law imposes a 1.75% premium tax
on the Company's fully insured business written in Connecticut. All HMOs in
Connecticut are now assessed for the costs of the HRA (Health Reinsurance
Association), which offers individual coverage to any person residing in
Connecticut and special health care plans to low income groups of ten or less.
The assessments are used to cover the losses incurred by the program. In
addition, all Connecticut HMOs are now assessed a portion of the cost of
funding the Connecticut Department of Insurance, which until recently had been
funded entirely by assessments only on insurers operating in the state.
If the Company acquires or establishes HMOs in states where it does not
presently operate, it will have to comply with the applicable state statutes
which vary from state to state.
RECENT REGULATORY DEVELOPMENTS AND INITIATIVES
Federal
The recently enacted Federal Health Insurance Portability and Accountability
Act of 1996 (i) insures portability of health insurance to individuals
changing jobs or moving to individual coverage by limiting application of pre-
existing condition exclusions, (ii) guarantees availability of health
insurance to employees in the small group market and (iii) prevents exclusion
of individuals from coverage under group plans based on health status. The Act
also permits offering Medical Savings Account plans on a pilot basis and
includes programs targeting fraud and abuse. The provisions are effective
beginning July 1, 1997. The Company is currently subject to similar state law
provisions in New York limiting pre-existing conditions for new group and
individual enrollees who had continuous prior coverage and requiring issuance
of group coverage to small group employers. Recently enacted federal
legislation mandates coverage for minimum hospital stays after childbirth
(consistent with many new state law requirements) and parity between any
lifetime limits imposed on mental health benefits and those for other medical
benefits. In addition, HCFA adopted rules in 1996 imposing reinsurance,
disclosure and other reporting requirements relating to physician incentive
plans which place physicians participating in Medicare and Medicaid HMO plans
at substantial financial risk.
Congress is also considering significant changes to both Medicare and
Medicaid programs, including changes that would significantly reduce
reimbursement to HMOs. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Cautionary Statement". In addition,
proposed Medicare reform bills contain provisions that would facilitate entry
of competing HMOs in the Company's service area by repealing the rule that
Medicare risk contractors have one commercial enrollee for each Medicare or
other government program enrollee and creating permissive licensure for HMOs
sponsored by provider networks. In Connecticut, the Department of Social
Services is expected to request HMOs participating in its Medicaid program to
resubmit bids in 1997. It is expected that Connecticut will mandate additional
reporting requirements and other changes that will reduce the number of
companies willing to participate.
State
There is a national trend among state governments to enact legislation which
increases regulation of HMOs and managed care companies and to mandate certain
policies and procedures. Each state that the Company does
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<PAGE>
business in is considering or has implemented wide-ranging "Patient
Protection" and "Consumer Disclosure" bills and regulations.
The New York State legislature enacted the Health Care Reform Act of 1996
("HCRA"), effective January 1, 1997, that eliminated regulation of hospital
rates and adopted surcharges and covered lives assessments to fund various
public programs. This deregulation allows all private health care payors to
negotiate payment rates for inpatient hospital services. Previously, only HMOs
could negotiate rates for these services. As a result of the enactment of
HCRA, non-HMOs who compete with the Company may be able to negotiate better
rates with hospitals in New York because of the volume of patients they
represent, which would have an adverse effect on the Company's ability to
compete effectively in New York. Also, effective January 1, 1997, the Company
is required to make payments to state funding pools to finance hospital bad
debt and charity care, graduate medical education, and other state programs
under HCRA. Previously, hospital bad debt and charity care and graduate
medical education were financed by surcharges on payments to hospitals for
inpatient services. The Company has renegotiated many of its hospital
contracts in New York to reflect the surcharges. These adjustments are
generally effective as of January 1, 1997, but they are not expected to result
in savings equal to the cost of the surcharges. The New York legislature also
recently passed legislation related to operation of managed care plans, which
contains provisions relating to, among other things, utilization review,
consumer disclosure and the right of a physician to a hearing on termination
from a health plan network.
In addition, the New Jersey Department of Health and Senior Services
recently issued a comprehensive revision to its existing HMO regulations,
which encompasses many of the same features as the aforementioned New York
law, but also includes a non-binding external appeals process. Connecticut is
considering increased regulation which, like New York and New Jersey, includes
extensive new reporting and data collection requirements. These regulatory
developments are likely to increase the Company's medical and administrative
costs.
COMPETITION
The health care industry in the Company's market area is highly competitive.
The Company has numerous competitors, including for-profit and not-for-profit
HMOs, preferred provider organizations ("PPOs") and indemnity insurance
carriers, and certain of the Company's competitors have substantially greater
enrollment and financial resources than the Company. The Company's major
competitors include independent HMOs, such as Oxford Health Plans, Inc., and
United Health Care, which have significant enrollment in the New York
metropolitan area, and HMOs and managed care plans sponsored by large health
insurance companies, such as Aetna/U.S. Healthcare, Inc., Blue Cross/Blue
Shield, The New York Life Insurance Company and CIGNA. Additional competitors
may enter the Company's market in the future. In addition, the managed care
industry has experienced significant consolidation recently, and such
consolidation is expected to continue, possibly resulting in fewer but larger
competitors in the Company's service area. The Company competes on the basis
of price, quality and scope of services provided, including the extent of its
provider network. The Company believes the quality of its service and
physicians, as well as its reputation, are important competitive factors.
However, the cost of providing benefits is in many instances the controlling
factor in obtaining and retaining employer groups and certain of PHS's
competitors have set premium rates at levels below PHS's rates for comparable
products. The Company anticipates that premium pricing will continue to be
highly competitive.
TRADEMARKS AND TRADENAMES
The Company has a number of registered trademarks. The Company believes that
its trademarks and tradenames are important to its marketing efforts. Any
challenge to the use of a material tradename, trademark or service mark could
have an adverse effect upon the Company's business.
EMPLOYEES
As of December 31, 1996, the Company had 971 full-time employees. The
Company is not a party to any collective bargaining agreement and has not
experienced any work stoppage since its organization. The Company believes its
relations with its employees to be good.
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<PAGE>
ITEM 2. PROPERTIES
The Company's corporate headquarters offices were relocated to Shelton,
Connecticut in early 1997 and comprise 327,195 square feet, located in three
adjacent buildings, which the Company purchased in June, 1996 for $16.6
million. The Company presently occupies approximately 65% of the available
space in this facility. The Company expects that the remainder of the
available space will require renovation before it can be occupied by the
Company's employees. The Company continues to own and occupy its former
headquarters in Trumbull, Connecticut which comprises 74,350 square feet.
PHS/CT leases properties at three locations, for an aggregate of 97,488 square
feet. PHS/NY leases 11,752 square feet of property in White Plains, New York,
18,415 square feet in New York City and 3,415 square feet in Lake Success, New
York. PHS/NJ leases 12,895 square feet of space in Paramus, New Jersey.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation arising in the ordinary course of its
business, a significant portion of which involves claims for coverage or
payment of medical services rendered to enrollees. In the opinion of the
Company's management, based upon discussions with legal counsel, existing
litigation will not have a material adverse effect on the Company's financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter.
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company completed its initial public offering of 2,975,000 shares of
Class A Common Stock in January, 1993. The Company's Class A Common Stock is
traded in the over-the-counter market on the National Association of
Securities Dealers Automated Quotation ("NASDAQ") National Market System under
the symbol "PHSV." There is no market for the Company's Class B Common Stock.
The following table sets forth the range of high and low sale prices for the
Class A Common Stock for each of the periods indicated as reported on the
NASDAQ National Market System. Quotations represent prices between dealers and
do not reflect retail mark-ups, mark-downs or commissions. There was no market
for the Company's Class A Common Stock prior to its initial public offering in
January, 1993.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
January 1, 1995 through March 31, 1995...................... $33.75 $26.75
April 1, 1995 through June 30, 1995......................... $34.25 $24.50
July 1, 1995 through September 30, 1995..................... $28.75 $22.00
October 1, 1995 through December 31, 1995................... $43.25 $27.25
January 1, 1996 through March 31, 1996...................... $40.75 $29.50
April 1, 1996 through June 30, 1996......................... $34.50 $19.75
July 1, 1996 through September 30, 1996..................... $25.50 $14.50
October 1, 1996 through December 31, 1996................... $20.00 $14.00
</TABLE>
There were an aggregate of 390 holders of record of the Company's Class A
and Class B Common Stock (the "Common Stock") as of March 25, 1997. The
Company has not paid any dividends on its Common Stock since its issuance. The
Company does not intend to pay any cash dividends in the foreseeable future.
Rather, the Company intends to retain its earnings to provide for the
operation and expansion of its business. The Company's ability to declare and
pay dividends to its stockholders may be dependent upon its ability to obtain
cash distributions from its operating subsidiaries. The ability to pay
dividends is also restricted by insurance and health regulations applicable to
its subsidiaries. See "Business--Government Regulation."
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<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The income statement data and balance sheet data set forth below have been
derived from the audited consolidated financial statements of the Company. The
information below is qualified by reference to and should be read in
conjunction with the consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included herein.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND OPERATING STATISTICS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
REVENUES:
Premiums.............. $ 481,534 $ 342,975 $ 289,784 $ 274,795 $ 265,436
Investment and other
income............... 6,574 6,968 4,160 5,435 3,459
------------- ------------- ------------- ------------- -------------
Total revenues...... 488,108 349,943 293,944 280,230 268,895
------------- ------------- ------------- ------------- -------------
Health care expenses:
Hospital services..... 178,059 111,947 94,934 105,592 107,638
Physicians and related
health care services. 198,591 131,019 117,393 110,599 106,617
Other health care
services............. 42,382 18,707 12,943 9,741 9,724
Indemnity costs....... 7,008 2,157 -- -- --
------------- ------------- ------------- ------------- -------------
Total health care
expenses........... 426,040 263,830 225,270 225,932 223,979
------------- ------------- ------------- ------------- -------------
Selling, general and
administrative......... 86,728 58,504 44,089 33,730 28,590
Guardian joint marketing
(income) expense, net.. (809) 2,298 -- -- --
Proxy defense costs..... 892
Interest................ 388 -- -- 378 875
------------- ------------- ------------- ------------- -------------
Total expenses...... 512,347 325,524 269,359 260,040 253,444
------------- ------------- ------------- ------------- -------------
Income (loss) before
income taxes........... (24,239) 24,419 24,585 20,190 15,451
Income tax expense
(benefit).............. (11,275) 8,449 10,451 8,299 6,890
------------- ------------- ------------- ------------- -------------
Net income (loss)....... $ (12,964) $ 15,970 $ 14,134 $ 11,891 $ 8,561
============= ============= ============= ============= =============
Net income (loss) per
Common Share........... $ (1.39) $ 1.70 $ 1.52 $ 1.31 $ 1.36
Weighted average shares
outstanding............ 9,301 9,403 9,307 9,101 6,283
BALANCE SHEET DATA:
Working capital....... $ 16,744 $ 62,585 $ 64,037 $ 58,714 $ 13,091
Total assets.......... 238,310 211,068 207,148 171,456 120,031
Total long term debt.. -- -- -- -- 5,000
Stockholders' equity.. 96,286 108,881 91,206 77,968 25,586
OPERATING STATISTICS:
Enrollment (1)........ 400,021 267,116 179,550 158,984 136,832
Enrollment (monthly
average)............. 342,576 219,475 173,523 153,251 135,506
Hospital days per
thousand (2)......... 272 281 327 360 403
Medical loss ratio
(3).................. 89.8% 78.2% 79.0% 82.9% 84.4%
</TABLE>
- --------
(1) At end of period.
(2) On an annualized basis for commercial products only.
(3) Health care expenses as a percentage of premium revenues excluding self-
funded product revenues.
E-16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table shows certain income statement data expressed as a
percentage of total revenues for the years indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Revenues:
Premiums.......................................... 98.7% 98.0% 98.6%
Investment and other income....................... 1.3 2.0 1.4
------- ------- -------
Total revenues.................................. 100.0 100.0 100.0
------- ------- -------
Health care expenses:
Hospital services................................. 36.5 32.0 32.3
Physicians and related health care services....... 40.7 37.5 39.9
Other health care services........................ 8.7 5.3 4.4
Indemnity costs................................... 1.4 0.6
------- ------- -------
Total health care expenses...................... 87.3 75.4 76.6
------- ------- -------
Selling, general and administrative expenses........ 17.8 16.7 15.0
Guardian joint marketing (income) expense, net...... (0.2) 0.7 0.0
Proxy defense costs................................. -- 0.2 --
Interest............................................ 0.1 0.0 0.0
------- ------- -------
Total expenses.................................. 105.0 93.0 91.6
------- ------- -------
Income (loss) before taxes.......................... (5.0) 7.0 8.4
Income tax expense (benefit)........................ (2.3) 2.4 3.6
------- ------- -------
Net income (loss)................................... (2.7)% 4.6% 4.8%
======= ======= =======
</TABLE>
The Company's subsidiaries, PHS/CT, PHS/NY, PHS/NJ and Bermuda, have entered
into several marketing and reinsurance agreements with The Guardian. Under
these agreements, jointly developed managed care and indemnity products are
offered to existing Guardian insureds as well as to new prospects. The Company
and The Guardian have implemented different ways to share profits and losses
under these agreements which vary among the particular states and time periods
as described below.
In Connecticut, PHS/CT wrote 100% of the managed care business and The
Guardian wrote 100% of the indemnity business. The parties shared profits and
losses through September 30, 1996 pursuant to a "selection adjustment payment"
mechanism. Under this arrangement, each party calculated its quarterly profit
or loss (net premiums earned, minus claims payments, capitation payments and
withholds paid with respect to managed care plans, reserve increases or
decreases, administrative charges, commissions and premium taxes, plus
investment income). The selection adjustment payment, which was designed to
mitigate the effect of potential adverse selection in groups which selected
Healthcare Solutions products and enable the parties to share in any long-term
profits or loses, then provided that if both parties had losses, no adjustment
would be made from one to the other, and each would retain its respective
loss. If both parties had profits, the amounts were combined, and the party
with the greater profit would make a selection adjustment payment to the
other, in an amount equal to half of the profit differential. If only one
party had a profit, the profitable party made a selection adjustment payment
equal to that party's reported profit, thereby partially or fully reimbursing
the other party's loss. If the result was a combined profit, the profitable
party would make a selection adjustment payment equal to the other party's
loss, increased by half of the combined profit. Selection adjustment
calculations were done on a cumulative basis, and accordingly, losses are
carried forward to offset against future profits. Because both PHS and The
Guardian incurred losses in Connecticut in 1996, no selection adjustment
payment was made, and the Company reported 100% of the cumulative losses on
the managed care products sold under the Healthcare Solutions product line.
E-17
<PAGE>
The parties entered into new agreements with respect to the Connecticut
Healthcare Solutions business that were effective as of October 1, 1996. The
selection adjustment methodology was replaced with a reinsurance agreement
pursuant to which the Company cedes 50% of the risk on the managed care
portion of the Healthcare Solutions products to The Guardian. In connection
with the conversion to reinsurance, the parties agreed that 50% of the
cumulative losses in Connecticut would be offset from amounts otherwise due to
The Guardian under the reinsurance agreement when profits, if any, are
generated.
In New York, The Guardian cedes 50% of its risk for the out-of-network
portion of the POS Healthcare Solutions products to Bermuda and the Company
cedes 50% of its risk for HMO products and the in-network portion of the POS
Healthcare Solutions products to The Guardian. In New Jersey, the Company
cedes 100% of the risk of the out-of-network portion of the POS Healthcare
Solutions products and 50% of the risk on the other HMO Healthcare Solutions
products to The Guardian and The Guardian retrocedes 50% of the risk for the
out-of-network portion of the POS Healthcare Solutions products back to
Bermuda. The reinsurance agreements were amended in 1996 to reduce the
Company's risk for indemnity Healthcare Solutions products. In New York, the
Company was responsible for 10% of the associated losses on the indemnity
business between January 1 and June 30, 1996 and did not share risk with
respect to the indemnity portion of the Healthcare Solutions business after
June 30, 1996. In Connecticut, the agreements were amended effective October
1, 1996 so that the Company will not share risk with respect to the indemnity
business in those states following September 30, 1996.
As a result of its arrangements with The Guardian, the Company's percentage
growth in its aggregate premium revenue has lagged its percentage growth in
enrollment, since a portion of the Healthcare Solutions revenues and expenses
that were ceded to The Guardian are omitted from the Company's Statement of
Operations. The Company expects that this trend will continue if its
Healthcare Solutions products continue to be successful and the enrollment mix
between its proprietory products and the Healthcare Solutions products shifts
to a greater percentage in Healthcare Solutions. The aggregate revenue is
impacted by this mix due to the fact that for its proprietary products the
Company retains 100% of the revenue and related health care expenses while
under the Healthcare Solutions product, 50% of the revenue and related health
care expenses are ceded to The Guardian, therefore impacting the aggregate
revenue growth compared to aggregate membership growth. Per member, per month
("PMPM") amounts are similarly impacted by this mix due to the fact Healthcare
Solutions membership is reflected at 100% and revenue and related health care
expenses are reflected at 50%.
The marketing and reinsurance agreements with the Guardian have had a
significant impact on the Company's results of operations. In 1996, the
arrangements with the Guardian resulted in approximately $14.6 million of
pretax losses while in 1995, the arrangements resulted in approximately $1.3
million of pretax income.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Premium revenue increased 40.4% to $481.5 million in 1996 from $343.0
million in 1995, while enrollment at December 31, 1996 increased 49.8% over
1995 to 400,021. As of December 31, 1996, fully-insured enrollees increased
59.9% to 332,363 members up from 207,856 as of December 31, 1995, while self-
funded enrollees increased 14.2% to 67,658 members as of December 31, 1996, up
from 59,260 at December 31, 1995. The aggregate premium revenue increase
lagged the membership growth due primarily to the growth of membership in the
Healthcare Solutions product where 50% of the premium revenue and related
healthcare costs are ceded to The Guardian pursuant to the agreement and a
membership shift in the fully insured product mix to lower benefit, lower PMPM
revenue products. Also, enrollee statistics include 100% of the approximately
112,000 members enrolled in Healthcare Solution products at December 31, 1996,
while premium revenue includes only the Company's 50% share of the Healthcare
Solutions revenues derived from the New York arrangements which became
effective July 1, 1995, the New Jersey arrangements effective January 1, 1996,
and the Connecticut arrangements effective October 1, 1996.
E-18
<PAGE>
Investment and other income declined 5.6% in 1996 from $7.0 million for the
year ended December 31, 1995 to $6.6 million for the year ended December 31,
1996. The decline in investment income is due primarily to a decline in
invested assets and lower investment yields due to lower interest rates.
Health care expenses as a percentage of premium revenue (medical loss ratio)
increased to 89.8% for 1996 from 78.2% for 1995. The increase in the medical
loss ratio resulted from a 7.4% increase in medical costs on a PMPM basis
(primarily hospital and prescription drug costs as discussed below) and a
decline of 6.5% in the PMPM premium revenue.
Hospital services expenses increased 59.1% to $178.1 million in 1996 from
$111.9 million in 1995. The increase is due primarily to an increase in fully-
insured membership. On a PMPM basis, however, hospital services increased 5.7%
from 1995 to 1996. This increase is attributable primarily to the recent trend
to perform certain lower cost services, which historically had been performed
in an in-patient setting, in an out-patient setting. This results in a higher
average cost for those services which are still performed in an in-patient
setting. Inpatient hospital utilization for fully-insured commercial enrollees
decreased 3.2% to 272 days per thousand members, per year for the year ending
December 31, 1996 from 281 days per thousand members, per year for the same
1995 period. This decrease was primarily due to the continued trend towards
less expensive treatment being provided in the out-patient setting and more
effective medical management techniques.
Physician and related health care expenses increased 51.6% in 1996 from
1995. The increase is primarily due to the 59.9% increase in fully insured
membership as well as increases in non-capitated expenses, including costs for
out-of-network physicians' services.
Other health care expenses increased by $23.7 million from 1995 to 1996 due
primarily to higher prescription drug costs resulting from an increase in the
number of members covered by prescription drug riders. Additionally, there was
a shift in membership to drug riders which offered greater benefits. At the
same time, fewer generic drugs were prescribed resulting in increased pharmacy
costs.
Indemnity costs reflect the medical costs associated with the indemnity
revenue assumed in connection with The Guardian reinsurance arrangement in New
York which began in 1995. The Company's net indemnity costs for 1996 were $7.0
million, up from $2.2 million for 1995. As a result of continuing adverse
experience related to this business, the Company amended the New York
reinsurance agreement to reduce the Company's share of the indemnity business
assumed from 50% to 10%, for the period from January 1, 1996 to June 30, 1996.
The impact of this adjustment reduced the after tax loss associated with the
indemnity business by approximately $900 thousand, which was recorded in the
second quarter of 1996. The amendment also provided that the Company will
assume no further indemnity risk in the New York market for claims incurred
after June 30, 1996. As noted above, after September 30, 1996 the Company did
not share risk in connection with the Healthcare Solutions indemnity business
in the Connecticut market. Selling, general and administrative expenses
increased 48.2% to $86.7 million in 1996 from $58.5 million in 1995. The
increase was principally due to additional staffing, outside services and
other costs needed to support geographic expansion, product diversification
and enrollment growth.
The Company's effective tax benefit rate was 46.5% for the year ended
December 31, 1996, as compared to an effective tax provision rate of 34.6% for
the comparable 1995 period. The 1996 effective tax rate resulted primarily
from the favorable effect of the income from tax exempt securities which
increases the tax benefit when there are losses.
The Company has undertaken a number of actions intended to restore
profitability in 1997. It increased its premiums an average of 4.4% at the end
of 1996 for groups renewing in 1997 and may make further adjustments subject
to competitive conditions. It has moved to introduce enhanced medical
management, which is intended to result in reduced health care expenses on a
PMPM basis in 1997. In addition, its contracts with risk entities shift a
greater amount of the risk of overutilization to the risk entities, which will
provide further protection against rising health care costs. Moreover, the
Company has shifted a portion of the Healthcare Solutions membership to
capitation arrangements with the Physician Groups. Although there can be no
assurance that these changes, among others, will enable the Company to be
profitable in 1997, the Company expects to see significant improvement in its
financial results in 1997. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Cautionary Statement."
E-19
<PAGE>
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Premium revenue increased 18.4% to $343.0 million in 1995 from $289.8
million in 1994 while enrollment at December 31, 1995 increased 48.8% over
1994 to 267,116. As of December 31, 1995, fully-insured enrollees increased
55.5% to 207,856 members from 133,676 as of December 31, 1994, while self-
funded enrollees increased 29.2% to 59,260 members as of December 31, 1995, up
from 45,874 as of December 31, 1994. The premium revenue increase lagged the
membership growth due to more aggressive pricing and a shift in fully insured
product mix to lower revenue yielding products. Also, enrollee statistics
include 100% of the enrollees in New York, while premium revenue includes only
the Company's 50% share of revenues derived from the New York Guardian
arrangements which become effective July 1, 1995.
Investment and other income was up 67.5% in 1995 from $4.2 million for the
year ended December 31, 1994 to $7.0 million for the year ended December 31,
1995. The increase in investment income was due to improved portfolio yields
and a reduction in realized losses.
Health care expenses as a percentage of premium revenue (medical loss ratio)
decreased to 78.2% for 1995 from 79.0% for 1994. The decrease in the medical
loss ratio resulted from a 7.0% decline in medical costs on a per member per
month basis which was partially offset by a 6.4% decline in the per member per
month premium revenue. Total health care expenses increased 17.1% to $263.8
million in 1995 from $225.3 million for 1994.
Hospital services expenses increased 17.9% to $111.9 million in 1995 from
$94.9 million in 1994. On a PMPM basis, hospital services declined 6.8% from
1994 to 1995. The decline was due primarily to a reduction in in-patient
hospital utilization which was partially offset by higher out-patient
utilization. In-patient hospital utilization for fully-insured enrollees,
excluding Medicare cost contract enrollees, decreased 14.1% to 281 days per
thousand members per year for the year ending December 31, 1995 from 327 days
per thousand members for the same 1994 period.
Physician and related health care expenses increased 11.6% in 1995 from 1994
despite a 55.5% increase in fully insured enrollees. As a result, physician
expense declined 11.8% on a per member per month basis for the year ended
December 31, 1995 as compared to the same 1994 period. The decrease is largely
due to more favorable capitation arrangements with providers and a shift in
membership to lower cost capitated products.
Other health care expenses increased by $5.8 million from 1994 to 1995 due
primarily to higher prescription drug expense resulting from an increase in
prescription drug benefit coverage and increased utilization. Additionally, in
1995, other health care expenses includes the Healthcare Solutions profit
sharing expense which resulted from The Guardian reinsurance arrangement in
Connecticut.
Indemnity costs reflect the medical costs associated with the indemnity
revenue assumed in connection with The Guardian reinsurance arrangement in New
York which began in 1995.
Selling, general and administrative expenses increased 32.7% to $58.5
million in 1995 from $44.1 million in 1994. The increase was principally due
to continuing resource commitments to support enrollment growth and the
expansion into the Connecticut, New York and New Jersey tri-state region.
Additionally, the related administrative infrastructure was also expanded to
accommodate the increased growth.
The Company's effective tax rate declined to 34.6% for the year ended
December 31, 1995 from 42.5% for the comparable 1994 period. The decline in
the effective tax rate resulted primarily from the shift of much of the
Company's investment portfolio into tax exempt municipal bonds and to a slight
decline in the statutory state income tax rates. Additionally, the effective
tax rate for 1995 was favorably affected by the reconciliation of prior
provisions.
E-20
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
PHS has historically financed its operations primarily through internally
generated funds. The Company's primary capital requirements are for working
capital, principally to fund geographic and product expansion, and to maintain
necessary regulatory capital. In addition, the Company's HMO subsidiaries,
PHS/CT, PHS/NY and PHS/NJ, and its insurance subsidiaries, are subject to
statutory regulations that restrict the payment of dividends.
Net cash flows for the year ended December 31, 1996 resulted in an increase
in cash and cash equivalents of $31.7 million. Although operating cash flows
were unfavorably affected by the Company's 1996 loss of $13.0 million, net
cash was provided by operating activities of $24.6 million for the year ended
December 31, 1996. The difference between the net loss and the net cash
provided from operating activities resulted primarily from a $22.3 million
increase in hospital incurred but not reported ("IBNR") claims, which was
generated from the increase in the volume of claims activity due to the rise
in membership and the timing of the related claims payments and from the
collection of outstanding advances to hospitals which totalled $5.5 million.
Additionally, the amounts due to IPAs, physicians and other providers
increased $15.3 million in 1996, reflecting an increase in the amounts payable
to non-capitated providers, such as out of network providers, and the timing
of those related payments. These items were offset in part by the net increase
in receivables of approximately $10.0 million which occurred due to the growth
in enrollment from both the Company's proprietary business and from its
arrangements with The Guardian. Approximately $44.0 million of net cash was
provided by the sales and maturities of marketable securities, of which $34.6
million was used to fund the enhancement of the Company's computer
infrastructure and to purchase the Company's new corporate headquarters .
PHS's net cash used in operations amounted to $9.5 million in 1995. Since
The Guardian holds the funds generated by Healthcare Solutions, on which the
Company earns interest, and since the funds were not released by year end,
operating cash flows in 1995 were unfavorably affected by the arrangements
with The Guardian. In addition, IPA withhold percentages were generally
decreased in 1995, and as a result, the amounts owed to the IPAs tended to be
paid over on a more rapid schedule. Further, accelerated payments related to
income taxes and the Medicare cost contract decreased operating cash flows.
These items were partially offset by the net income of $16.0 million generated
during the year. Cash used for investing activities was $11.7 million for the
year ended December 31, 1995, primarily due to capital expenditures of $15.2
million which represented investments in optical imaging technology and other
improvements in the computer infrastructure needed to support the Company's
expansion.
Net cash flow during 1994 resulted in an increase in cash and investments to
$139.8 million at December 31, 1994 from $112.2 million at December 31, 1993.
Cash provided by operating activities totaled $39.3 million, resulting
primarily from net income of $14.1 million generated during the period, the
timing of the receipt of medical claims and the timing of payments related to
other liabilities.
At December 31, 1994, PHS was no longer required to maintain a restricted
cash reserve to comply with the requirement of the Office of Prepaid
Healthcare in connection with the Medicare cost contract. In New York, the
Company is required to maintain an escrow reserve equal to 5% of estimated
health care expenses for the current year, for the protection of enrollees,
which, as of December 31, 1996 was $9.0 million. In Connecticut, the Company
is required to maintain a statutory minimum unimpaired capital surplus of $1.0
million. The Company is currently in compliance with all applicable statutory
capital requirements. The Company is subject to various laws and regulations
which, at December 31, 1996, caused the aggregate amount of its restricted net
assets to be approximately $38.8 million.
The Company's expenditures for capital equipment, primarily for computers
and related equipment, and in 1996 for the purchase of the Company's new
headquarters, totaled $34.6 million, $15.2 million and $9.7 million for the
years ended December 31, 1996, 1995 and 1994, respectively. The Company
expects to spend additional capital, principally in computer and technology
systems enhancements, over the next several years. The Company expects to
require additional capital over the next several years and, although it can
provide no assurances in this regard, believes that in addition to its current
capital resources and internally generated funds, it will be able to obtain
financing, if necessary, sufficient for its continued operations.
E-21
<PAGE>
EFFECT OF INFLATION
Health care industry costs have been rising annually at rates higher than
the Consumer Price Index. To offset this trend, PHS has been able to achieve
premium rate increases for its 1997 business which should help mitigate the
effect of medical cost inflation on its operations. The Company's premiums are
higher than many of its competitors, however, and there can be no assurance
that the Company will be able to increase premiums sufficiently to offset the
rise in health care costs without jeopardizing the Company's competitive
position. In addition, PHS contracts with several major hospitals on a multi-
year basis with fixed annual increases. The Company's risk sharing
arrangements with its Physician Groups and other cost control measures, such
as its utilization review program, also help to mitigate the effects of price
increases on operations. There can be no assurance that the Company's efforts
to reduce the impact of inflation will be successful.
CAUTIONARY STATEMENT
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby making cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements made by or on behalf of the Company.
The Company wishes to caution readers that the following important factors,
among others, could cause the Company's actual financial or enrollment results
to differ materially from those expressed in any projected, estimated or
forward-looking statements relating to the Company.
Premium Structure; Unpredictability of Medical Costs. A substantial amount
of the Company's revenues are generated by premiums which represent fixed
monthly payments for each person enrolled in the Company's plans. If the
Company is unable to obtain adequate premiums because of competitive or
regulatory considerations, the Company could incur decreased margins or
significant losses. The Company believes that commercial premium pricing will
continue to be highly competitive. The Company's revenues from its Medicare
and Medicaid programs could be adversely affected if reimbursement rates do
not keep pace with rising medical costs. Historically, these rates have been
subject to wide variations from year to year. In the event reimbursement were
to decline from projected amounts, the Company would attempt to renegotiate
its contracts with its health care providers. There can be no assurance that
it could successfully renegotiate these financial arrangements and failure to
reduce the health care costs associated with such programs could have a
material adverse effect upon the Company's business.
The Company's profitability is also dependent, in large part, upon its
ability to accurately project and manage health care costs, including without
limitation, appropriate benefit design, utilization review and case management
programs, and its risk sharing arrangements with providers, while providing
members with quality health care. Health care costs are affected by a variety
of factors that are difficult to predict and are not entirely within the
Company's control, including the severity and frequency of claims. Medical
cost inflation, mandated benefits and other regulatory changes, new
technologies, natural disasters, epidemics and other external factors relating
to the delivery of health care services, inability to establish acceptable
risk sharing arrangements with providers and other factors may adversely
affect the Company's ability to manage the costs of providing health care
services. In addition, the Company experienced high out-of-network utilization
in connection with its POS products in 1996 in New York, which resulted in
medical costs for the POS products exceeding budgeted amounts. The Company is
seeking to expand its network in New York and institute other measures to
limit the risk of high out-of-network utilization. The Company is implementing
a variety of measures to help it manage health care costs better. However,
there can be no assurance that the Company will be able to continue to reduce
its medical costs sufficiently to restore profitability in all its product
lines. In light of the expected continuing growth of the POS products, failure
to reduce out-of-network utilization could adversely affect the Company's
profitability.
Accrued health care expenses payable in the Company's financial statements
include reserves for incurred but not reported claims ("IBNR"), the amount of
which is estimated by the Company. The Company estimates the amount of such
reserves using standard actuarial methodologies based upon historical data
including the
E-22
<PAGE>
average interval between the date services are rendered and the date claims
are paid, expected medical cost inflation, seasonality patterns and increases
in membership. The Company believes that its reserves for IBNR are adequate in
order to satisfy its ultimate claims liability. However, there can be no
assurances as to the ultimate accuracy or completeness of such estimates or
that adjustments to reserves will not cause volatility in the Company's
results of operations.
Dependence upon Key Employer Agreements. The Company's ability to obtain and
maintain favorable group benefit agreements with employer groups affects the
Company's profitability. Currently, 17% of its total commercial enrollment
(those groups which are fully insured, which includes 332,363 enrollees) is
derived from its largest five fully insured accounts. Fully insured groups
produce the highest PMPM revenues for the Company. Although during the
Company's most recent fiscal year, no employer group accounted for more than
7.5% of total revenues, the loss of one or more of the larger employer group
accounts could have a material adverse effect upon the Company's business.
Although only 8% of the Company's total membership in 1996 was enrolled in
Medicare and Medicaid programs, that percentage is expected to increase in the
future. Loss of one or more of the contracts the Company currently has or
expects to have to serve Medicaid or Medicare participants could have a
material adverse effect upon the Company's business. Finally, the Company has
agreed to certain performance guarantees for certain of the large employer
groups with which it contracts. Failure to satisfy such guarantees could
result in financial penalties.
Key Partnership. The Company's contracts with The Guardian are expected to
represent a significant percentage of the Company's revenue and enrollment in
future years. See "Business--Joint Marketing Arrangement with The Guardian."
The loss of this relationship could have a material adverse effect on the
Company's business.
Competition. Managed care companies and HMOs operate in a highly competitive
environment. The Company has numerous types of competitors, both local and
national, including, among others, HMOs, PPOs, self-insured employer plans and
traditional indemnity carriers, many of which have substantially larger total
enrollments, greater financial resources and other characteristics that give
them an advantage in competing with the Company. Additional competitors with
needs or desires for immediate market share or those with greater financial
resources than the Company have entered or may enter the Company's market. The
Company also believes that the addition of new competitors can occur
relatively easily. In addition, certain of the Company's customers may decide
to perform for themselves certain administrative services currently provided
by the Company, which could adversely affect the Company's revenues.
Significant merger and acquisition activity has occurred in the managed care
industry as well as in industries which are suppliers to the Company. This
activity may result in stronger competitors or increased health care costs.
Increased competitive pressures may limit the Company's ability to increase,
or in some instances, maintain premiums, reduce membership levels or decrease
profit margins, and there can be no assurance that the Company will not incur
increased pricing and enrollment pressure from local and national competitors.
Any such pressures could materially affect the Company's results of
operations.
Government Regulation. The Company's business is subject to extensive
federal and state laws and regulations, including, but not limited to,
financial requirements, licensing requirements, enrollment requirements and
periodic examinations by governmental agencies. The laws and regulations
governing the Company's business and the interpretation of those laws and
regulations are subject to frequent change. Existing or future laws or
regulations could force the Company to change the way it does business and may
restrict the Company's revenue or enrollment growth or increase its health
care and/or administrative costs. In particular, the Company's HMO and
insurance subsidiaries are subject to regulations relating to cash reserves,
minimum net worth, premium rates and approval of policy language and benefits.
Although such regulations have not significantly impeded the growth of the
Company's business to date, there can be no assurance that the Company will be
able to continue to obtain or maintain required governmental approvals or
licenses or that regulatory changes will not have a material adverse effect on
the Company's business. In addition, delays in obtaining regulatory approvals
or moratoriums imposed by regulatory authorities could adversely effect the
Company's ability to bring new products to market as forecasted. The Company
is also subject to various governmental audits and investigations.
E-23
<PAGE>
Such activities could result in the loss of required licenses or the right to
participate in certain programs, or the imposition of penalties and/or other
sanctions. In addition, disclosure of any adverse investigation or audit
results or sanctions could negatively affect the Company's reputation in
various markets and make it more difficult for the Company to sell its
products and services.
Management Information System. The Company's management information system
is critical to its current and future operations. The information gathered and
processed by the Company's management information system assists the Company
in, among other things, pricing its services, monitoring utilization and other
cost factors, processing provider claims, providing bills on a timely basis
and identifying accounts for collection. Any difficulty associated with or
failure to successfully implement the current conversion of its management
information system, or any inability to expand processing capability in the
future in accordance with its business needs, could result in a loss of
existing customers and difficulty in attracting new customers, customer and
provider disputes, regulatory problems, increases in administrative expenses
or other adverse consequences.
New Service Areas and Products. The Company recently undertook a significant
expansion of its geographic market area. In addition, it recently introduced
several new products, including Medicare risk and Medicaid products. The
success of its geographic and product expansion efforts depends in large part
on its ability to develop market share in a highly competitive market and to
develop the infrastructure necessary to support the forecasted enrollment
growth. The Company believes that it has budgeted sufficient amounts to meet
its growth expectations; however, there can be no assurance that it will not
require greater resources than expected or that it will be successful in its
marketing efforts. Furthermore, although it believes it has introduced
programs to effectively manage its new products, there can be no assurance
that the health care and other costs associated with such programs will not be
greater than revenues. Medicare risk contracts provide revenues which are
generally higher per member than those for non-Medicare members, and thus
provide an opportunity for increased profits and cash flow. Such risk
contracts, however, also carry certain risks such as higher comparative
medical costs, government regulatory and reporting requirements, the
possibility of reduced or insufficient government reimbursement in the future,
and higher marketing and advertising costs per member as the result of
marketing to individuals as opposed to groups.
Possible Volatility of Common Stock Price. Recently, there has been
significant volatility in the market prices of securities of companies in the
health care industry, including the price of the Company's Common Stock. Many
factors, including medical cost increases, analysts' comments, speculation
about a possible merger or acquisition, announcements of new legislative
proposals or laws relating to health care reform, the performance of, and
investor expectations for, the Company, the trading volume of the Company's
Common Stock and general economic and market conditions, may influence the
trading price of the Company's Common Stock. Accordingly, there can be no
assurance as to the price at which the Company's Common Stock will trade in
the future.
Negative Publicity. The managed care industry has recently received a
significant amount of negative publicity. Such general publicity, or any
negative publicity regarding the Company in particular, could adversely affect
the Company's ability to sell its products or services or could create
regulatory problems for the Company. Recently, the managed care industry has
experienced significant merger and acquisition activity. Speculation or
uncertainty about the Company's future could adversely affect the ability of
the Company to market its products.
Accreditation. Certain of the Company's customers or potential customers
consider rating, accreditation or certification of the Company by various
private or governmental bodies or rating agencies as necessary and/or
important. The Company currently has three year accreditation from the
National Committee on Quality Assurance ("NCQA") which will expire in May,
1997. NCQA visited the Company's offices in connection with its
reaccreditation in late March 1997. Should the Company fail to maintain three-
year NCQA accreditation, or obtain any other certification or accreditation as
may be deemed to be necessary and/or important by customers, it may adversely
affect the Company's ability to obtain or retain the business of such
customers.
Administrative Expense. The level of administrative expense is a partial
determinant of the Company's profitability. While the Company attempts to
effectively manage such expenses, increases in staff-related and
E-24
<PAGE>
other administrative expenses may occur as a result of business or product
expansion, changes in business, acquisitions, regulatory requirements or other
reasons. Such expense increases are not clearly predictable and increases in
administrative expenses may adversely affect financial results.
The Company currently believes that it has a relatively experienced, capable
management staff. Loss of certain managers or a number of such managers could
adversely affect the Company's ability to administer and manage its business.
Litigation and Insurance. The Company is subject to a variety of legal
actions to which any corporation may be subject. In addition, because of the
nature of its business, the Company incurs and likely will continue to incur
potential liability for claims related to its business, such as failure to pay
for or provide health care, poor outcomes for care delivered or arranged,
provider disputes and claims related to self-funded business. It is possible
that punitive or substantial non-economic damages may be sought in cases of
this nature. While the Company currently has insurance coverage for some of
these potential liabilities, others may not be covered by insurance, the
insurers may dispute coverage or the amount of insurance may not be enough to
cover the damages awarded. In addition, certain types of damages, such as
punitive damages, may not be covered by insurance and insurance coverage for
all or certain forms of liability may become unavailable or prohibitively
expensive in the future.
Provider Relations. One of the significant techniques that the Company uses
to manage health care costs and utilization is contracting with physicians,
hospitals and other providers. Because of the large number of providers with
which the Company contracts, the Company currently believes that it has a
limited exposure to provider relations issues. In any particular market,
however, providers could refuse to contract with the Company, demand higher
payments or take other actions which could result in higher health care costs,
less desirable products for customers and members or difficulty in meeting
regulatory or accreditation requirements. In some markets, certain providers,
particularly hospitals, physician/hospital organization or multi-speciality
physician groups, may have significant market positions. Such groups may also
compete directly with the Company. If such providers refuse to contract with
the Company or utilize their market position to negotiate favorable contacts
or place the Company at a competitive disadvantage, the Company's ability to
market products or to be profitable in those areas could be adversely
affected.
In addition, the Company has recently entered into a number of contracts
with physician/hospital organizations and other physician groups that place a
significant percentage of the risk of overutilization on those groups.
Although this technique is believed to be advantageous to the Company insofar
as it limits the Company's risk, failure of one or more of the
physician/hospital or other physician groups to successfully manage the risk
could have a material adverse effect on the Company's business and results of
operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this Item is submitted in Item 14 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
E-25
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)1. All financial statements--see Index to Consolidated Financial
Statements and Schedules attached hereto.
2. Financial statement schedules--see Index to Consolidated Financial
Statements and Schedules attached hereto.
3. Exhibits--see Exhibit Index on page E-1.
(b) Reports on Form 8-K
None
E-26
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................ E-28
Consolidated Balance Sheets as of December 31, 1996 and 1995.............. E-29
Consolidated Statements of Operations for the years ended December 31,
1996, 1995 and 1994...................................................... E-30
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1996,
1995 and 1994............................................................ E-31
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1995 and 1994...................................................... E-32
Notes to Consolidated Financial Statements................................ E-33
Schedule I--Condensed Financial Information of Registrant ................ E-45
Schedule II--Valuation and Qualifying Accounts............................ E-48
</TABLE>
E-27
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Physicians Health Services, Inc.
We have audited the consolidated balance sheets of Physicians Health
Services, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the three years in the period ended December 31, 1996. Our audits
also included the financial statement schedules listed in the Index at Item
14(a). 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Physicians
Health Services, Inc. and subsidiaries at December 31, 1996 and 1995, and the
consolidated 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. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly, in all material
respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 1994 the
Company changed its method of accounting for certain investments in debt and
equity securities.
Ernst & Young LLP
Stamford, Connecticut
March 14, 1997
E-28
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 39,213 $ 7,536
Investments available for sale, at fair value:
Fixed maturity securities............................. 59,115 102,130
Equity securities..................................... -- 1,355
Accounts receivable, less allowances (1996-$1,781 and
1995-$1,050)......................................... 38,028 31,548
Other receivables..................................... 19,696 14,815
Advances to participating hospitals................... 400 5,903
Prepaid expenses and other............................ 1,154 204
----------- -----------
Total Current Assets................................. 157,606 163,491
Property, plant and equipment:
Land.................................................. 8,822 3,322
Building and improvements............................. 26,938 14,645
Furniture and equipment............................... 46,559 29,817
----------- -----------
82,319 47,784
Less accumulated depreciation and amortization......... 15,273 11,028
----------- -----------
67,046 36,756
Other assets (including restricted investments)........ 13,658 10,821
----------- -----------
Total Assets......................................... $ 238,310 $ 211,068
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accrued hospital and other health care expenses....... $ 46,153 $ 23,878
Unearned premiums..................................... 27,757 25,022
Amounts due to IPAs, physicians and other providers... 53,103 37,806
Accounts payable and accrued expenses................. 13,849 14,199
----------- -----------
Total Current Liabilities............................ 140,862 100,905
Excess of net assets over cost of company acquired..... 1,162 1,282
----------- -----------
Total Liabilities.................................... 142,024 102,187
Stockholders' equity:
Preferred Stock, par value $0.01 per share--authorized
500 shares, none issued.............................. -- --
Class A Common Stock, par value $0.01 per share--
authorized 13,000,000 shares; issued and outstanding
1996--5,566,023 shares; 1995--5,310,347 shares;
voting rights--1 per share........................... 56 53
Class B Common Stock, par value $0.01 per share; non-
transferable; authorized and issued 1996--3,829,880
shares; 1995--4,052,974 shares; voting rights--10 per
share................................................ 38 41
Additional paid-in capital............................. 41,360 40,760
Net unrealized gains on marketable securities, net of
tax................................................... 279 510
Retained earnings...................................... 54,554 67,518
----------- -----------
96,287 108,882
Less cost of Class B Common Stock (86,400 shares) in
Treasury.............................................. 1 1
----------- -----------
Total Stockholders' Equity........................... 96,286 108,881
----------- -----------
Total Liabilities and Stockholders' Equity............ $ 238,310 $ 211,068
=========== ===========
</TABLE>
See notes to consolidated financial statements.
E-29
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS,
EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
REVENUES:
Premiums......................................... $481,534 $342,975 $289,784
Investment and other income...................... 6,574 6,968 4,160
-------- -------- --------
488,108 349,943 293,944
Costs and expenses:
Hospital services................................ 178,059 111,947 94,934
Physicians and related health care services...... 198,591 131,019 117,393
Other health care services....................... 42,382 18,707 12,943
Indemnity costs.................................. 7,008 2,157 --
Selling, general and administrative expenses..... 86,728 58,504 44,089
Guardian joint marketing expense (income), net... (809) 2,298 --
Proxy defense costs.............................. -- 892 --
Interest expense................................. 388 -- --
-------- -------- --------
512,347 325,524 269,359
Income (loss) before income taxes.................. (24,239) 24,419 24,585
Income tax expense (benefit)....................... (11,275) 8,449 10,451
-------- -------- --------
Net income (loss).................................. $(12,964) $ 15,970 $ 14,134
======== ======== ========
Net income (loss) per common share................. $ (1.39) $ 1.70 $ 1.52
======== ======== ========
Weighted average number of common and common
equivalent shares outstanding..................... 9,301 9,403 9,307
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
E-30
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
-------- -------- -------
(DOLLARS IN THOUDANDS)
<S> <C> <C> <C>
CLASS A COMMON STOCK
Balance at beginning of period..................... $ 53 $ 49 $ 45
Conversion of Class B Common Stock into Class A
Common Stock:
1996--223,094 shares, 1995--437,537 shares, 1994--
435,228 shares................................... 3 4 4
Options exercised:
1996--32,582 shares, 1995--14,974 shares, 1994--
3,558 shares.....................................
-------- -------- -------
Balance at end of period........................... $ 56 $ 53 $ 49
======== ======== =======
CLASS B COMMON STOCK
Balance at beginning of period..................... $ 41 $ 45 $ 49
Conversion of Class B Common Stock into Class A
Common Stock:
1996--223,094 shares, 1995--437,537 shares, 1994--
435,228 shares................................... (3) (4) (4)
-------- -------- -------
Balance at end of period........................... $ 38 $ 41 $ 45
======== ======== =======
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period..................... $ 40,760 $ 40,514 $40,461
Exercise of stock options.......................... 600 246 53
-------- -------- -------
Balance at end of period........................... $ 41,360 $ 40,760 $40,514
======== ======== =======
NET UNREALIZED GAINS (LOSSES) ON MARKETABLE SECURI-
TIES, NET OF TAX
Balance at beginning of period..................... $ 510 $ (949) $ --
Net unrealized gain at date of adoption of SFAS
115, net of tax................................... -- -- 184
Net unrealized gain (loss)......................... (231) 1,459 (1,133)
-------- -------- -------
Balance at end of period........................... $ 279 $ 510 $ (949)
======== ======== =======
RETAINED EARNINGS
Balance at beginning of period..................... $ 67,518 $ 51,548 $37,414
Net income (loss).................................. (12,964) 15,970 14,134
-------- -------- -------
Balance at end of period........................... $ 54,554 $ 67,518 $51,548
======== ======== =======
TREASURY STOCK
Balance at beginning and end of period............. $ (1) $ (1) $ (1)
TOTAL STOCKHOLDERS' EQUITY
Balance at beginning of period..................... $108,881 $ 91,206 $77,968
Exercise of stock options.......................... 600 246 53
Net income (loss).................................. (12,964) 15,970 14,134
Net unrealized gain (loss) on marketable
securities, net of tax............................ (231) 1,459 (949)
-------- -------- -------
Balance at end of period........................... $ 96,286 $108,881 $91,206
======== ======== =======
</TABLE>
See notes to consolidated financial statements.
E-31
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)............................... $(12,964) $ 15,970 $ 14,134
Adjustments to reconcile net income (loss) to
net cash provided by (used for) operating
activities:
Depreciation and amortization.................. 4,302 3,064 2,364
Provision for doubtful accounts................ 1,485 103 1,423
Amortization of excess of net assets over cost
of company acquired........................... (120) (120) (120)
Deferred income tax expense (benefit).......... 690 1,421 (233)
Changes in assets and liabilities:
Accounts receivable........................... (7,965) (4,453) (3,273)
Other receivables............................. (4,881) (13,043) (1,217)
Advances to participating hospitals........... 5,503 1,619 3,794
Prepaid expenses and other.................... (950) 708 (114)
Accrued health care expenses.................. 22,275 (1,232) (4,028)
Unearned premiums............................. 2,735 631 2,233
Due to IPAS, Physicians and other providers... 15,297 (5,793) 8,076
Accounts payable and accrued expenses......... (856) (8,367) 16,292
-------- -------- --------
Net cash provided by (used for) operating
activities..................................... 24,551 (9,492) 39,331
INVESTING ACTIVITIES
Purchases of property, plant and equipment...... (34,633) (15,168) (9,711)
Disposals of property, plant and equipment...... 41 14 226
Net increase in other assets.................... (2,837) (6,916) (674)
Purchases of marketable securities.............. (242,451) (324,877) (340,176)
Proceeds from sales of marketable securities.... 286,406 335,262 332,629
-------- -------- --------
Net cash provided from (used for) investing
activities..................................... 6,526 (11,685) (17,706)
FINANCING ACTIVITIES
Proceeds from revolving credit line............. 18,000 -- --
Repayment of revolving credit line.............. (18,000) -- --
Exercise of stock options....................... 600 246 53
-------- -------- --------
Net cash provided by financing activities....... 600 246 53
-------- -------- --------
Increase (decrease) in cash and cash
equivalents.................................... 31,677 (20,931) 21,678
Cash and cash equivalents at beginning of year.. 7,536 28,467 6,789
-------- -------- --------
Cash and cash equivalents at end of year........ $ 39,213 $ 7,536 $ 28,467
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
E-32
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. ORGANIZATION AND BUSINESS
Physicians Health Services, Inc. (the "Company" or "PHS") is a holding
company which owns nine subsidiary corporations: Physicians Health Services of
Connecticut, Inc. (PHS/CT), Physicians Health Services of New York, Inc.
(PHS/NY), Physicians Health Insurance Services, Inc. (PHIS), PHS Investments,
Inc., Physicians Health Services (Bermuda), Ltd. (PHS/Bermuda), Physicians
Health Services of New Jersey, Inc. (PHS/NJ), (which was licensed in January
1996), PHS Insurance of Connecticut, Inc. (PHS Insurance CT), Physicians
Health Services Insurance of New York, Inc. (PHS Insurance NY), and PHS Real
Estate, Inc. (PHS RE). PHS/CT and PHS/NY have been designated by the
Department of Health and Human Services (DHHS) as federally qualified Health
Maintenance Organizations (HMOs).
PHS/CT, PHS/NY and PHS/NJ operate as health maintenance organizations in
Connecticut, New York and New Jersey, respectively, and are regulated by their
respective state insurance departments. PHS/NY and PHS/NJ are also regulated
by the Department of Health and Human Services and New Jersey Department of
Health and Senior Services, respectively. State regulations include reserve
and cash flow requirements and restrictions on the ability to pay dividends.
Subscribers pay monthly premiums which entitle them to comprehensive health
services as needed, according to the terms of their contracts.
PHIS, which is licensed as an insurance broker, was formed to market
insurance products to enrollees. The operations of PHIS for all years
presented were not significant.
PHS Insurance CT and PHS Insurance NY operate in and are regulated by the
Insurance Departments of Connecticut and New York, respectively. These
companies are licensed to write accident and health indemnity insurance
although no business has yet been written.
PHS/Bermuda is an offshore property and casualty reinsurer that was formed
to support the business needs of the Company. This includes an agreement to
reinsure certain business with The Guardian Life Insurance Company of America
(see Note 10).
PHS/CT operates throughout most of Connecticut with a significant portion of
its enrollees currently located in Fairfield County. PHS/NY operates only in
New York's Westchester, Putnam, Dutchess, Rockland and Orange Counties, and
the metropolitan New York City and Long Island regions. PHS/NJ operates
throughout New Jersey. The Company's membership consists of commercial,
government and self-funded members.
PHS RE has a wholly owned subsidiary, PHS Real Estate II, Inc. (PHS RE II),
which owns the Company's new corporate headquarters. The operations of PHS RE
and PHS RE II were not significant.
The Company's managed care products include traditional HMO products, in
both open access and gatekeeper models, point of service ("POS") products,
administrative services only ("ASO") plans and Medicare and Medicaid plans.
The Company contracts with physician groups, such as IPAs, PHOs, and multi-
specialty groups (collectively, "Physician Groups"), individual physicians and
other health care providers for a defined range of health services, including
primary and specialty care. The Company's contracts with providers include
discounted fee for service arrangements as well as capitated group
arrangements in which the contracting Physician Group assumes a significant
amount of the risk of overutilization. The Company currently has contracts
with four IPAs, three PHOs and one large physician group ("Group") that
provide for most of its physician services in its Connecticut service area. In
New York and New Jersey, the Company generally
E-33
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
contracts directly with physicians and other health care providers. Under the
typical Physician Group arrangements, the Physician Group receives a fixed
monthly capitation payment for each member selecting a primary care physician
from that Physician Group. Capitation rates and any increases thereto are
negotiated for the term of the contract. The capitation payment is designed to
cover not only the professional medical services (including ancillary tests
and services) rendered by the physicians and other providers associated with
that Physician Group but also includes payments for certain other services
rendered to the enrollee by providers who are not members of the Physician
Group. Services covered by the capitation payment include, among other things,
virtually all physician claims (whether inpatient or outpatient, including
authorized out-of-plan care) and care rendered by other professionals such as
physical therapists and psychologists. In certain of the contracts, the
Physician Groups also are at risk for hospital, pharmacy and other facility
expenses. The Company does not capitate physicians directly.
The capitation payments to Physician Groups other than the PHOs typically do
not cover hospital and other facility expenses, although the Physician Groups
are partially at risk for non-Medicare and non-Medicaid hospital utilization.
The Company establishes an annual per member, per month target for hospital
expenses. The amount varies by benefit plan and Physician Group, and
encompasses both inpatient and outpatient costs. If total hospital expenses
generated by the Physician Group exceed the applicable hospital expense
target, the Company withholds from amounts owed by it to the Physician Group
all or a portion of the excess over budget, in most cases one-half of the
excess over budget. If actual costs are less than budgeted targets, the
Physician Group receives from the Company an incentive credit typically equal
to forty to fifty percent of the amount by which actual costs are less than
budgeted targets.
In its New York and New Jersey expansion areas and in areas in Connecticut
not served through Physician Group contracts, the Company contracts for
services principally through direct contracts with individual physicians and
other health care providers. In addition, the Company contracts with two IPAs
in the northern counties of its New York service area. The Company withholds a
percentage of reimbursement for services rendered pursuant to its direct
physician contracts against budgeted amounts to manage excessive utilization.
The Company generally negotiates contracts with hospitals that include
compensation on a per diem basis (at a daily rate, without regard to the scope
of services actually provided). Other compensation arrangements with hospitals
include charged-based discounts (negotiated discounts from the hospital's
billed charges) and all inclusive case rates. In the case of non-participating
hospitals, the Company pays either hospital billed charges or negotiated
discounted charges. Additionally, some hospital contracts include per case,
all-inclusive payment arrangements for select procedures such as maternity
care.
At December 31, 1996, three of the IPA's own common stock of the Company
aggregating approximately 32% (which entitle them to 68% of the vote on
matters submitted to the Stockholders), with one IPA (Greater Bridgeport
Individual Practice Association) owning approximately 27% (58% of the vote).
Capitation expenses incurred relating to these three IPA's which are included
in physician and related healthcare expenses in the accompanying statements of
operations amounted to $55,019,000, $68,523,000 and $65,091,000 for the years
ended December 31, 1996, 1995 and 1994 respectively. At December 31, 1996 and
1995 amounts payable to these IPA's were $21,622,000 and $10,388,000,
respectively.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries, all of which are wholly-owned except for PHS/NJ which is
80% owned by the Company with a 20% minority interest owned
E-34
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
by Mastercare Companies, Inc. (See Note 11). Such minority interest was not
material to the accompanying consolidated financial statements. Significant
intercompany accounts and transactions have been eliminated in consolidation.
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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
REVENUE RECOGNITION
Premiums from subscribers and assumed or ceded under reinsurance agreements
are reflected in operations as earned on a pro-rata basis over the period of
coverage. Premiums for periods extending beyond year-end are classified as
unearned premiums. The Company maintains an allowance for doubtful accounts at
a level management believes is sufficient to cover potentially uncollectible
amounts.
PHYSICIANS AND RELATED HEALTH CARE SERVICES
The costs of physicians and related health care services are accrued for in
the period they are provided to enrollees. For the services provided for by
individually contracted physicians, the accrual for the incurred but not
reported claims represent the estimated liability on outstanding claims, based
upon an evaluation of reported claims. Such estimates are continually
monitored and, as estimates are adjusted, they are reflected in current
operations. The amounts accrued under capitation arrangements with IPA's are
increased or decreased based on a comparison of the HMO's hospitalization
costs to contractual targets.
HOSPITAL AND OTHER HEALTH CARE SERVICES
The cost of health care services is accrued in the period they are provided
to enrollees. The amounts accrued for hospital and other health care expenses
represent the estimated liabilities for reported and unreported claims. The
reserves for incurred but not reported claims represent the estimated
liability on outstanding claims, based on an evaluation of reported claims.
The estimates are continually monitored and reviewed and, as settlements are
made or estimates adjusted, the resulting differences are reflected in current
operations. Although considerable variability is inherent in such estimates,
management believes that reported reserves are adequate in the aggregate to
cover the ultimate resolution of incurred claims.
CONTRACTS WITH HEALTH CARE FINANCING ADMINISTRATION
Prior to 1996, the Company had entered into a "cost based" contract with the
Health Care Financing Administration ("HCFA"). Under this contract, HCFA pays
the Company a fixed per member per month amount for physician services, while
HCFA pays the costs for inpatient and outpatient services. During 1996, the
Company entered into a "risk based" contract with HCFA. Under the risk-based
contract the Company is paid a fixed per member, per month amount by HCFA for
all services provided. The Company bears the risk that the actual costs of
health care services may exceed the per member, per month amount. The risk
based contract is intended to replace the cost based contract for new
enrollees.
PROPERTY, PLANT AND EQUIPKMENT
Property, plant and equipment are stated at cost, less accumulated
depreciation and amortization. Provisions for depreciation and amortization
are computed using the straight-line method over the estimated useful lives of
E-35
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the assets or the terms of the leases, if shorter. Included in property, plant
and equipment are the costs related to the development of a new managed care
information system, approximately $18,600,000 at December 31, 1996. This new
system is expected to be implemented in late 1997. Amortization of the cost of
the new system will begin upon its implementation and continue on a straight-
line basis over its estimated useful life.
EXCESS OF NET ASSETS OVER COST OF COMPANY ACQUIRED
The excess of net assets over the cost of company acquired is being
amortized by the straight-line method over a 20 year period ending August 31,
2006. Accumulated amortization was $1,240,000 and $1,120,000 at December 31,
1996 and 1995, respectively.
PER SHARE DATA
Per share data are based on the weighted average number of common and common
equivalent shares outstanding during the period. Common stock equivalents
consist of stock options. Fully diluted per share data are not presented as
they are not materially different from primary earnings per share data.
STOCK BASED COMPENSATION
In 1996, the Company implemented the supplemental pro forma provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). SFAS 123, if adopted, requires
companies to recognize compensation expense for grants of restricted stock,
stock options and similar equity instruments to employees and directors based
on their respective fair values at the date of grant. However, the provisions
of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25") may still be utilized with supplemental pro
forma disclosures of net income and earnings per share being made in the
footnotes as if the accounting provisions of SFAS 123 had been adopted. SFAS
123 is effective for fiscal years beginning after December 15, 1995. The
Company continues to apply the requirements of APB 25 in the accompanying
financial statements with supplemental pro forma disclosures provided in the
notes to the consolidated financial statements (See note 8).
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of highly liquid investments with a
maturity of three months or less at the time of purchase.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and cash equivalents, accounts receivable, other receivables, advances
to participating hospitals and all current liabilities have fair values that
approximate their carrying amounts.
INVESTMENTS
In May 1993, the Financial Accounting Standards Board issued SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." The
Company adopted the provisions of the new standard as of January 1, 1994, and
categorizes its investments in fixed maturity and equity securities as
"available for sale." Accordingly, such investments are reported at fair value
with changes in unrealized gains and losses disclosed separately, net of
taxes, in stockholders' equity. Fair values are based primarily on quoted
market prices.
Investment income includes realized investment gains and losses on the sale
or maturity of investments, determined by the specific identification method,
and dividends and interest, which are recognized when earned. The amortization
of premium and accretion of discount for fixed maturities is computed
utilizing the interest method.
INCOME TAXES
Income taxes have been provided using the liability method in accordance
with SFAS 109, "Accounting for Income Taxes."
E-36
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
IMPAIRMENT OF LONG-LIVED ASSETS
In March 1995 the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of." At December 31, 1996, the Company had no
long-lived assets held for disposal. In accordance with SFAS No. 121, the
Company monitors its long-lived assets for any indicators of impairment. To
the extent such indicators are present, a comparison is made of the asset's
carrying value to the estimated undiscounted cash flows related to the asset.
If the undiscounted cash flows of the asset are less than its carrying value,
the Company would recognize an impairment loss equal to the amount by which
the asset's carrying value exceeds its fair value. At December 31, 1996, the
Company noted no indicators of impairment related to its long-lived assets.
RECLASSIFICATIONS
Certain reclassifications were made to conform prior year amounts to current
year presentation.
3. EXCESS OF LOSS REINSURANCE AGREEMENT
During 1996 the Company limited the amount of its risk on eligible hospital
claims for any one member in a contract year by acquiring reinsurance coverage
for claims in excess of $600,000 per member, per year for PHS/CT, PHS/NY and
PHS/NJ. The reinsurance contracts allow the Company to transfer to the
reinsurer 80% of the next $400,000 of claims per member per year. The contract
limits covered claims to $2 million per member per lifetime (including the
deductible). During 1995 and 1994, the Company acquired reinsurance coverage
for claims in excess of $250,000 per member, per year for PHS/CT and $100,000
per member, per year for PHS/NY. Those reinsurance policies allowed the
Company to transfer to the reinsurer 80% of the next $750,000 (PHS/CT) and
$900,000 (PHS/NY) of the amount of claims in excess of the aforementioned
annual retentions. Reinsurance expense and recoveries are included in other
health care services.
Reinsurance expense was $910,000, $1,300,000, and $636,000, for 1996, 1995
and 1994, respectively. Recoveries were $311,000, $60,000, and $106,000 for
1996, 1995, and 1994, respectively.
4. INVESTMENTS AND OTHER INCOME
The amortized cost, gross unrealized gains and losses, and estimated fair
values of investments are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
U.S. Government and its agencies....... $ 5,598 $-- $ 15 $ 5,583
Corporate securities................... 12,803 5 20 12,788
Municipals............................. 40,242 503 1 40,744
-------- ---- ---- --------
Total fixed securities................. $ 58,643 $508 $ 36 $ 59,115
======== ==== ==== ========
<CAPTION>
DECEMBER 31, 1995
----------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
U.S. Government and its agencies....... $ 10,629 $ 22 $-- $ 10,651
Corporate securities................... 1,535 14 -- 1,549
Municipals............................. 89,017 936 23 89,930
-------- ---- ---- --------
Fixed securities..................... 101,181 972 23 102,130
Equity securities...................... 1,417 -- 62 1,355
-------- ---- ---- --------
Total................................ $102,598 $972 $ 85 $103,485
======== ==== ==== ========
</TABLE>
E-37
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1996, the contractual maturities of investments in fixed
maturities are as follows (in thousands):
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- -------
<S> <C> <C>
Due in one year or less................................... $25,037 $25,131
Due after one year through five years..................... 33,106 33,485
Due after ten years....................................... 500 499
------- -------
$58,643 $59,115
======= =======
</TABLE>
Major sources of and related amounts of net investment and other income are
as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Dividends and interest
income from investments.. $ 5,444 $ 7,099 $ 5,091
Realized gains............ 139 385 290
Realized losses........... (99) (366) (1,170)
Investment expenses....... (132) (193) (258)
-------- ------- -------
Net investment income..... 5,352 6,925 3,953
Interest on Guardian
Receivable............... 866 -- --
Other income.............. 356 43 207
-------- ------- -------
Net investment and other
income................... $ 6,574 $ 6,968 $ 4,160
======== ======= =======
5. INCOME TAXES
Significant components of income tax expense (benefit) were as follows (in
thousands):
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Current income tax expense
(benefit):
Federal................. $(10,004) $ 5,428 $ 7,720
State................... (1,961) 1,600 2,964
-------- ------- -------
(11,965) 7,028 10,684
Deferred income tax
expense (benefit)........ 690 1,421 (233)
-------- ------- -------
Income tax expense
(benefit)................ $(11,275) $ 8,449 $10,451
======== ======= =======
The following is a reconciliation of federal income tax expense computed at
statutory rates to the amount of income tax expense reflected in the
consolidated statements of operations (in thousands):
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Federal income tax
(benefit) at statutory
rates.................... $ (8,484) $ 8,547 $ 8,605
State income taxes (net of
federal tax benefit)..... (1,750) 1,773 1,938
Tax exempt interest....... (1,239) (1,790) --
Other..................... 198 (81) (92)
-------- ------- -------
Income tax expense
(benefit)................ $(11,275) $ 8,449 $10,451
======== ======= =======
</TABLE>
E-38
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Net deferred tax liabilities, which are included in accounts payable and
accrued expenses, reflect the tax effect of temporary differences between the
carrying amounts of assets and liabilities for financial reporting and income
tax purposes. Significant components of the Company's net deferred tax
liabilities as of December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
------ ------
<S> <C> <C>
Deferred tax assets:
Provision for bad debts........................................ $ 748 $ 444
Nondeductible hospitalization accruals......................... 968 643
Accrued vacation............................................... 611 428
State net operating loss carryforward.......................... 1,864 --
Other.......................................................... 370 --
------ ------
Total deferred tax assets........................................ 4,561 1,515
Deferred tax liabilities:
Unrealized gains on investments................................ 193 377
Depreciation................................................... 1,075 1,090
Tax credit for research activities............................. 4,242 751
Prepaid expenses............................................... 240 --
Accrued market discount on bonds held.......................... 443 423
------ ------
Total deferred tax liabilities................................... 6,193 2,641
------ ------
Net deferred tax liability....................................... $1,632 $1,126
====== ======
</TABLE>
As a result of current year losses, approximately $27.0 million of state tax
loss carryforwards will be available for use to offset future state taxable
income through 2001.
The Company paid income taxes of $904,000 in 1996, $10,754,000 in 1995, and
$7,059,000 in 1994.
6. LEASES
The Company leases office space for ten branch locations.
Future minimum lease payments under noncancelable operating leases with
remaining terms of one year or more consisted of the following at December 31,
1996 (in thousands):
<TABLE>
<S> <C>
1997................................................................. $ 2,530
1998................................................................. 2,573
1999................................................................. 2,465
2000................................................................. 2,264
2001................................................................. 1,779
2002 and thereafter.................................................. 5,094
-------
$16,705
=======
</TABLE>
Total rent expense was $2,784,000 in 1996, $1,423,000 in 1995, and $420,000
in 1994.
7. COMMITMENTS AND CONTINGENCIES
The Company is involved in various litigation and claims arising in the
normal course of business which management believes, based upon discussions
with legal counsel, will not have a material adverse effect on the
accompanying financial statements.
E-39
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
During 1996, the Company entered into a revolving credit agreement under
which it borrowed $18 million to provide short-term financing for the purchase
of the Company's new headquarters. In the fourth quarter the Company repaid
amounts due under the credit agreement and terminated the credit line. Total
interest expense paid in connection with this agreement was approximately
$388,000.
The Health Reinsurance Association ("HRA") provides for otherwise
unavailable health insurance coverage to uninsured or underinsured Connecticut
residents. All health insurers, including HMOs, licensed in Connecticut are
subject to assessment by the HRA to the extent the HRA incurs net losses.
Assessments are based on premiums written and amounted to $1,018,000,
$692,000, and $800,000 in 1996, 1995 and 1994, respectively.
PHS/NY is subject to a community rating law which establishes a pooling
mechanism providing for payments to insurers writing policies for a
disproportionate share of individuals with certain demographic characteristics
and catastrophic medical expenses. Depending on the age and sex
characteristics of an insurer's members, an insurer will either make payments
to or receive payments from the state pooled fund. Expenses related to the
demographic pool were $3,180,000 in 1996, $1,483,000 in 1995 and $1,152,000 in
1994.
For further commitments, refer to Note 11.
8. EMPLOYEE BENEFIT AND STOCK OPTION PLANS
The Company sponsors a defined contribution pension plan covering all full-
time eligible employees (as defined). Contributions are based on a percentage
of eligible salaries as determined by the Board of Directors. This plan also
allows for additional voluntary contributions by covered full-time employees.
Pension cost was approximately $1,061,000 in 1996, $853,000 in 1995 and
$696,000 in 1994. The Company also has a 401(k) plan which covers
substantially all eligible employees (as defined). This plan allows for
voluntary employee contributions and a corporate match of 75% up to 4% of each
employee's compensation. In addition, the Company contributes 1% of each
eligible employee's compensation (as defined) to the plan. Expense related to
the 401(k) plan was $858,000 in 1996, $654,000 in 1995, and $519,000 in 1994.
The Company's Board of Directors, on November 17, 1992, and subsequently on
November 21, 1995, adopted two Stock Option Plans (the "Plans") under which
the Company may grant to certain officers and key employees (and, under the
1995 Plan, directors) incentive and nonqualified stock options for up to an
aggregate maximum of 1,400,000 shares of Class A Common Stock. Under the
Plans, the Board or Compensation Committee sets the exercise price for such
options, but for incentive stock options, the exercise price shall not be less
than the fair market value of the stock at the date of grant. Under the Plans,
options may be exercised only at such times and under such conditions as
determined by the Board or the Compensation Committee, but in no event more
than ten years after the date of grant. The options that have been granted to
date become exerciseable in equal installments over a period of three years
and expire after ten years except for ten percent shareholders for which such
options expire five years after the grant dates and certain performance based
options granted in 1996, whose vesting may be accelerated based upon
achievement of certain earnings targets.
E-40
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Information relating to stock options during 1996, 1995, and 1994 is as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------------- ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year................ 574,478 $24.78 187,514 $18.40 86,848 $15.00
Granted................. 565,040 22.09 413,098 27.45 111,950 20.86
Exercised............... (32,582) 18.43 (14,974) 16.73 (3,558) 15.00
Canceled................ (37,153) 29.29 (11,160) 27.05 (7,726) 17.36
--------- ------ ------- ------ ------- ------
Outstanding at end of
year................... 1,069,783 $23.40 574,478 $24.78 187,514 $18.40
========= ====== ======= ====== ======= ======
Exercisable at end of
year................... 317,478 $22.90 73,364 $17.55 25,318 $15.00
Available for grant, at
end of year............ 279,103 -- 506,990 -- 408,928 --
</TABLE>
Supplemental and Pro Forma Disclosure:
The following pro forma information regarding net income (loss) and net
income (loss) per share, required by SFAS 123, has been determined as if the
Company had accounted for its stock-based compensation plans under the fair
value methods described in that statement. The fair value of options granted
under the Company's stock-based compensation plans was estimated at the date
of grant using a Black-Scholes option pricing model. The Black-Scholes option
pricing model was developed for use in estimating the fair value of traded
options which have no vesting restrictions and are fully transferable. In
addition, option pricing models require the input of highly subjective
assumptions including the expected dividend yield, the expected life of the
options, the expected price volatility and the risk free interest rate. The
weighted averages of the assumptions used are set forth in the following
paragraph.
The weighted average dividend yield for stock option grants during 1996 and
1995 was 0%. The weighted average expected life for 1996 and 1995 was 5 years.
The weighted average volatility for 1996 and 1995 was .46%. The weighted
average risk-free interest rate for 1996 and 1995 was 5.87% and 6.99%,
respectively.
For purposes of pro forma disclosure, the estimated fair values of the
options awarded are amortized to expense over the options' vesting period and
do not include grants prior to January 1, 1995. As such, the pro forma
information is not indicative of future years. The Company's pro forma
information was as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
1996 1995
-------- -------
<S> <C> <C>
Net income (loss):
As reported................................................ $(12,964) $15,970
Pro forma.................................................. (14,379) 15,535
Net income (loss) per common share:
As reported................................................ $ (1.39) $ 1.70
Pro forma.................................................. (1.54) 1.65
</TABLE>
9. DIVIDEND AND INVESTMENT RESTRICTIONS OF SUBSIDIARIES
The Company's HMO and insurance subsidiaries are subject to statutory
regulations that restrict the payment of dividends. Based on laws currently in
effect, PHS/CT generally may not pay dividends in excess of the greater of (1)
the net gain from operations for the preceding calendar year, or (2) 10% of
capital and surplus as of the preceding year end, both as determined in
accordance with statutory accounting practices, without
E-41
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
receiving approval of the Connecticut Insurance Commissioner. The maximum
amount of cash dividends that PHS/CT could pay in 1997 without regulatory
approval is approximately $2,800,000.
The Company is required by the State of New York to maintain an escrow
reserve, currently held in U.S. government obligations, equal to 5% of
PHS/NY's estimated health care expenses for the upcoming year. The escrow
reserve was approximately $9,113,000 and $7,087,000 at December 31, 1996 and
1995, respectively.
The Company is required by the New Jersey State Insurance Department to
maintain an escrow reserve of $300,000 in the event of insolvency. The escrow
reserve was approximately $322,000 at December 31, 1996.
Based on statutory rules and restrictions, the amount of restricted net
assets of consolidated subsidiaries at December 31, 1996 was approximately
$38.8 million.
10. ARRANGEMENT WITH THE GUARDIAN LIFE INSURANCE COMPANY OF AMERICA
In 1995, the Company's subsidiaries, PHS/CT, PHS/NY and PHS/Bermuda, entered
into several marketing and reinsurance agreements with The Guardian Life
Insurance Company of America ("Guardian") and, together, the "companies".
Under these agreements, jointly developed managed care and indemnity products
are marketed to existing insureds of Guardian. In addition, the companies
distributed these products through the brokerage community and an integrated
marketing effort by the companies under the trade name "Healthcare Solutions."
In 1995 and for the first nine months of 1996, PHS/CT, under the terms of
the marketing agreement, wrote 100% of the HMO/POS business and Guardian wrote
100% of the indemnity business in Connecticut. Under the terms of the profit
sharing agreement, a profit or loss was determined for each line of business.
If both lines were profitable, profits, after provisions for related expenses,
as defined, were shared equally. If neither line were profitable, each company
retained losses, after provisions for related expenses, for its line of
business written. If one line was profitable and the other unprofitable,
payments, as defined, were to be made by the company writing the profitable
line to the company with the unprofitable line, before net profits, if any,
were shared. The Company reported the profits, if any, which inure to Guardian
under this agreement as a component of Guardian joint marketing expenses net.
In connection with this agreement, PHS/CT reported income of $574,000 in 1995,
which represented 50% of the net income in accordance with the terms of the
agreement. In 1996, PHS/CT reported losses after operating expenses of $7.6
million for the HMO/POS business, which represented 100% of the losses in
accordance with the terms of the agreement.
As of October 1, 1996, PHS/CT writes 100% of the HMO/POS business and, under
the terms of a quota share reinsurance agreement, cedes 50% of it to Guardian.
Accordingly, profits and losses, after provisions for related expenses, as
defined, are shared equally. Additionally, 50% of losses previously reported
under the agreement discussed in the preceeding paragraph are recoverable from
future profits, if any, under the reinsurance agreement. Since there is no
assurance that there will be future profits under this agreement, the Company
has not recorded a receivable from Guardian or recognized income for any
future profits. After September 30, 1996, PHS/CT no longer participates in the
indemnity business.
In 1995, PHS/NY wrote the HMO/POS In-Network business and, under the terms
of a quota share reinsurance agreement, ceded 50% of it to Guardian, while
Guardian wrote 100% of the Indemnity/POS Out-of-Network business and, under
the terms of a quota share reinsurance agreement with PHS/Bermuda, ceded 50%
of it to PHS/Bermuda. As such, profits and losses, after provisions for
related expenses, as defined, were shared equally.
From January 1, 1996 to June 30, 1996, PHS/NY's participation in the
Indemnity business was reduced from 50% to 10%. Indemnity costs that appear on
the Statements of Operations represent the Company's
E-42
<PAGE>
PHYSICIANS HEALTH SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
proportionate share of medical costs assumed from Guardian associated with the
New York indemnity business. After June 30, 1996, PHS/NY no longer
participates in the Indemnity business.
In 1996, PHS/NJ entered into marketing and reinsurance agreements with
Guardian. PHS/NJ writes the HMO/POS In-Network business and, under the terms
of the quota share reinsurance agreement, cedes 50% of it to Guardian PHS/NJ
writes the HMO/POS out-of-network business and under the terms of a quota
share reinsurance agreement, ceded 100% of it to Guardian, who retrocedes 50%
of it back to PHS. As such, profits and losses, after provisions for related
expenses, as defined, are shared equally.
In 1996, approximately $114.5 million of total revenues and $129.1 million
of medical costs and other expenses for PHS were generated under the various
marketing and reinsurance arrangements with Guardian described above.
In 1995, approximately $21.5 million of total revenues and $20.2 million of
medical costs and other expenses for PHS were generated under the various
marketing and reinsurance arrangements with Guardian described above.
Other receivables at December 31, 1996 and 1995 includes amounts due from
Guardian under profit sharing and reinsurance agreements of approximately
$18.4 million and $11.8 million, respectively.
As part of the arrangements, the Company recovers from Guardian, a specified
portion of the administrative expenses related to the Healthcare Solutions
activity. Additionally, the direct costs for marketing the Healthcare
Solutions products are shared equally. Both of these expenses as well as the
profits, if any, that inure to Guardian under the profit sharing arrangement
with PHS/CT as described above are included in Guardian joint marketing
expense, net. The components of this line item are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1996 1995
----------- -----------
<S> <C> <C>
Administrative recovery......................... ($ 1,998) ($ 542)
Direct marketing expense........................ 1,189 1,494
Profit sharing expense.......................... -- 1,346
----------- ----------
($ 809) $ 2,298
=========== ==========
</TABLE>
In October 1996, Guardian canceled its warrant that was issued by the
Company in 1995, which originally provided for the purchase of one million
shares of the Company's Class A common stock, once certain operating
conditions had been met. Based upon a subsequent agreement with Guardian, the
number of shares available for purchase under the warrant at the time it was
canceled had been substantially reduced as a result of the Guardian's purchase
of shares of the Company's Class A common stock on the open market. The
Company had not recognized any expense related to the warrant as the
conditions to its exercisability had not been met, nor was it deemed probable
that they would be met up to the date of cancellation.
11. SALE OF TEC AND INVESTMENT IN MASTERCARE COMPANIES, INC.
In September 1995, the Company sold 81% of its wholly-owned subsidiary Total
Employee Care, Inc. to Mastercare Companies, Inc. (Mastercare) for 625,000
voting shares of Mastercare common stock. There was no gain or loss recognized
on the transaction since the estimated fair value of the Mastercare stock
received approximated the book value of the TEC stock sold. In addition, the
Company purchased additional shares of Mastercare voting stock in the amount
of 1,250,000 shares at $1.20 per share. The Company owns less than 20% of the
voting stock and does not have the ability to exercise significant influence
over the operating and financial policies of Mastercare and, accordingly has
reported this investment at cost which approximates fair value.
E-43
<PAGE>
12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Selected unaudited data reflecting the Company's results of operations for
each of the last eight fiscal quarters are shown in the following table
(dollars in millions):
<TABLE>
<CAPTION>
1996
-----------------------------
1ST 2ND 3RD 4TH
------ ------ ------ ------
<S> <C> <C> <C> <C>
Premium revenues................................. $111.8 $118.4 $123.2 $128.1
Total health care expenses....................... 92.9 108.9 109.6 114.6
Selling general and administrative expenses...... 19.4 20.0 23.4 23.2
Net income (loss)................................ .9 (5.0) (4.5) (4.4)
Net income (loss) per share...................... 0.09 (0.54) (0.49) (0.46)
</TABLE>
<TABLE>
<CAPTION>
1995
-----------------------
1ST 2ND 3RD 4TH
----- ----- ----- -----
<S> <C> <C> <C> <C>
Premium revenues....................................... $79.6 $78.7 $85.7 $99.0
Total health care expenses............................. 62.5 60.8 63.7 76.8
Selling general and administrative expenses............ 12.6 14.0 15.4 18.8
Net income............................................. 3.1 3.7 5.2 4.0
Net income per share................................... 0.33 0.39 0.55 0.42
</TABLE>
Note: The sum of the quarters' net income (loss) per share does not equal
the full year per share amount due to rounding.
E-44
<PAGE>
SCHEDULE I
PHYSICIANS HEALTH SERVICES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(DOLLARS IN THOUSANDS)
BALANCE SHEETS
(PARENT COMPANY)
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Cash....................................................... $ 15,572 $ 187
Other receivables.......................................... 219 192
Prepaid expenses and other................................. 1,128 99
-------- --------
TOTAL CURRENT ASSETS................................... 16,919 478
-------- --------
Property, plant and equipment.............................. 408 250
Other assets............................................... 2,319 2,306
Investment in and advances to wholly-owned subsidiaries.... 86,603 106,206
-------- --------
TOTAL ASSETS........................................... $106,249 $109,240
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses...................... $ 9,963 $ 359
-------- --------
TOTAL CURRENT LIABILITIES.............................. 9,963 359
-------- --------
Stockholders' equity
Common Stock............................................. 94 94
Additional paid-in capital............................... 41,360 40,760
Net unrealized gains on marketable securities of
subsidiaries, net of tax................................ 279 510
Retained earnings........................................ 54,554 67,518
-------- --------
96,287 108,882
Less treasury stock........................................ (1) (1)
-------- --------
TOTAL STOCKHOLDERS' EQUITY............................. 96,286 108,881
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............... $106,249 $109,240
======== ========
</TABLE>
The condensed financial information should be read in conjunction with the
consolidated financial information and the accompanying notes thereto.
E-45
<PAGE>
SCHEDULE I
PHYSICIANS HEALTH SERVICES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(DOLLARS IN THOUSANDS)
STATEMENTS OF OPERATIONS
(PARENT COMPANY)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Revenue:
Investment income................................ $ 92 $ 8 $ --
-------- ------- -------
Costs and expenses:
General and administrative expenses.............. -- 2,188 1,243
Interest expense................................. 381 -- --
-------- ------- -------
381 2,188 1,243
-------- ------- -------
LOSS BEFORE INCOME TAXES........................... (289) (2,180) (1,243)
Income tax expense (benefit)....................... 249 505 (154)
-------- ------- -------
Loss before equity in net income (loss) of wholly-
owned subsidiaries................................ (538) (2,685) (1,089)
Equity in net income (loss) of wholly-owned
subsidiaries, net of taxes........................ (12,426) 18,655 15,223
-------- ------- -------
NET INCOME (LOSS).................................. $(12,964) $15,970 $14,134
======== ======= =======
</TABLE>
The condensed financial information should be read in conjunction with the
consolidated financial information and the accompanying notes thereto.
E-46
<PAGE>
SCHEDULE I
PHYSICIANS HEALTH SERVICES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(DOLLARS IN THOUSANDS)
STATEMENTS OF CASH FLOWS
(PARENT COMPANY)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................ $(12,964) 15,970 $ 14,134
Plus equity in net loss (income) of subsidiaries. 12,426 (18,655) (15,223)
Adjustments to reconcile net income (loss) to
cash provided by (used for) operating
activities...................................... 8,377 2,382 1,271
-------- -------- --------
Net cash provided by (used for) operating
activities...................................... 7,839 (303) 182
FINANCING ACTIVITIES
Advances to subsidiaries......................... (40,198) (9,000) (10,000)
Dividends and return of capital from
subsidiaries.................................... 47,144 9,000 10,000
Exercise of stock options........................ 600 246 53
-------- -------- --------
Net cash provided by financing activities........ 7,546 246 53
Increase (decrease) in cash...................... 15,385 (57) 235
Cash at beginning of year........................ 187 244 9
-------- -------- --------
Cash at end of year.............................. $ 15,572 $ 187 $ 244
======== ======== ========
</TABLE>
The condensed financial information should be read in conjunction with the
consolidated financial information and the accompanying notes thereto.
E-47
<PAGE>
SCHEDULE II
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
DECEMBER 31, 1996
VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGE TO BALANCE AT
BEGINNING COST AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1994
Allowance for doubtful accounts.... $ 926 $1,423 $(549) $1,800
====== ====== ===== ======
Year ended December 31, 1995
Allowance for doubtful accounts.... $1,800 $ 103 $(853) $1,050
====== ====== ===== ======
Year ended December 31, 1996
Allowance for doubtful accounts.... $1,050 $1,485 $(754) $1,781
====== ====== ===== ======
</TABLE>
E-48
<PAGE>
APPENDIX F
THE COMPANY'S QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL QUARTER ENDED
SEPTEMBER 30, 1997.
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997.
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-21098.
PHYSICIANS HEALTH SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 06-1116976
(IRS EMPLOYER
(STATE OR OTHER JURISDICTION OF IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
ONE FAR MILL CROSSING 06484
SHELTON, CONNECTICUT (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (203) 381-6400
120 HAWLEY LANE
TRUMBULL, CONNECTICUT 06611
------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by a 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
There were 6,163,054 shares of Class A Common Stock ($0.01 par value) and
3,185,671 shares of Class B Common Stock ($0.01 par value outstanding as of
November 11, 1997.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
F-1
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1.Financial Statements
Condensed Consolidated Balance Sheets at September 30, 1997 and
December 31, 1996................................................ 3
Condensed Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 1997 and 1996.................... 4
Condensed Consolidated Statements of Stockholders' Equity for the
Nine Months Ended September 30, 1997 and 1996.................... 5
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1997 and 1996......................... 6
Notes to Condensed Consolidated Financial Statements.............. 7-8
Item 2.Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 9-11
PART II. OTHER INFORMATION
Item 6.Exhibits and Reports on Form 8-K............................... 12
Signatures........................................................ 13
Exhibit Index..................................................... 14
</TABLE>
F-2
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Current Assets
Cash and Cash Equivalents.......................... $ 14,144 $ 39,213
Fixed Maturity Securities, Available for Sale--
(amortized cost--1997--$84,468 and 1996--
$58,643).......................................... 85,339 59,115
Accounts Receivable Less Allowances (1997--$1,787
and 1996--$1,781)................................. 45,546 37,152
Other Receivables.................................. 58,688 32,157
Advances to Participating Hospitals................ 51 400
Prepaid Expenses and Other......................... 843 1,154
-------- --------
Total Current Assets............................... 204,611 169,191
Property, Plant, and Equipment
Land............................................... 8,822 8,822
Building and Improvements.......................... 28,724 26,938
Furniture and Equipment............................ 54,248 46,559
-------- --------
91,794 82,319
Less Accumulated Depreciation and Amortization..... 19,524 15,273
-------- --------
Total Property, Plant, and Equipment............... 72,270 67,046
-------- --------
Other Assets (including restricted investments)..... 14,295 13,658
-------- --------
Total Assets........................................ $291,176 $249,895
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities
Accrued Health Care Expenses....................... $ 74,489 $ 51,757
Unearned Premiums.................................. 29,253 27,757
Amounts Due to IPA's, Physicians and other
Providers......................................... 53,852 59,084
Accounts Payable and Accrued Expenses.............. 32,042 13,849
-------- --------
Total Current Liabilities.......................... 189,636 152,447
Excess of Net Assets Over Cost of Company Acquired.. 1,071 1,162
Stockholders' Equity
Class A Common Stock, Par Value $0.01 per Share--
Authorized 13,000,000 Shares, Issued and
Outstanding; 1997--5,887,454 shares; 1996--
5,566,023 shares.................................. 59 56
Class B Common Stock, Par Value $0.01 per Share;
Non-transferable--Authorized and Issued 1997--
3,532,671 shares; 1996--3,829,880 shares; Voting
Rights--10 per share.............................. 35 38
Additional Paid-In Capital......................... 41,886 41,360
Net Unrealized Gains (Losses) on Fixed Maturity
Securities Available for Sale, Net of Tax......... 534 279
Retained Earnings.................................. 57,956 54,554
-------- --------
100,470 96,287
Less Cost of Class B Common Stock (86,400) Shares
in Treasury....................................... 1 1
-------- --------
Total Stockholders' Equity.......................... 100,469 96,286
-------- --------
Total Liabilities and Stockholders' Equity.......... $291,176 $249,895
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
F-3
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1997 1996 1997 1996
--------- --------- -------- --------
<S> <C> <C> <C> <C>
REVENUES:
Premiums............................ $ 177,289 $ 123,190 $488,714 $353,442
Investment and Other Income......... 2,150 1,545 5,872 4,806
--------- --------- -------- --------
179,439 124,735 494,586 358,248
COSTS AND EXPENSES:
Hospital Services................... 67,904 46,649 172,299 130,435
Physicians and Related Health Care
Services........................... 67,297 52,726 195,461 143,284
Other Health Care Services.......... 16,912 10,336 49,301 30,486
Indemnity Costs..................... -- -- -- 7,008
--------- --------- -------- --------
Total Health Care Costs........... 152,113 109,711 417,061 311,213
--------- --------- -------- --------
Selling, General and Administrative
Expenses........................... 24,756 23,196 72,126 62,934
--------- --------- -------- --------
176,869 132,907 489,187 374,147
--------- --------- -------- --------
Interest Expense.................... -- 295 -- 295
Income (Loss) before Income Taxes..... 2,570 (8,467) 5,399 (16,194)
Income Tax Expense (Benefit).......... 951 (3,931) 1,997 (7,519)
--------- --------- -------- --------
NET INCOME (LOSS)..................... $ 1,619 $ (4,536) $ 3,402 $ (8,675)
========= ========= ======== ========
Net Income (Loss) Per Common Share.... $ 0.17 $ (0.49) $ 0.36 $ (0.93)
========= ========= ======== ========
Weighted Average Number of Common and
Common Equivalent Shares
Outstanding.......................... 9,588 9,306 9,482 9,298
========= ========= ======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
F-4
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1997 1996
-------- --------
<S> <C> <C>
Class A Common Stock
Balance at Beginning of Period........................... $ 56 $ 53
Conversion of Class B Common Stock into Class A Common
Stock................................................... 3 2
-------- --------
Balance at End of Period................................. $ 59 $ 55
======== ========
Class B Common Stock
Balance at Beginning of Period........................... $ 38 $ 41
Conversion of Class B Common Stock into Class A Common
Stock................................................... (3) (2)
-------- --------
Balance at End of Period................................. $ 35 $ 39
======== ========
Additional Paid-In Capital
Balance at Beginning of Period........................... $ 41,360 $ 40,760
Exercise of Stock Options................................ 526 600
-------- --------
Balance at End of Period................................. $ 41,886 $ 41,360
======== ========
Net Unrealized Gains (Losses) on Fixed Maturity Securities,
Net of Tax
Balance at Beginning of Period........................... $ 279 $ 510
Unrealized Appreciation (Depreciation)................... 255 (492)
-------- --------
Balance at End of Period................................. $ 534 $ 18
======== ========
Retained Earnings
Balance at Beginning of Period........................... $ 54,554 $ 67,518
Net Income (Loss)........................................ 3,402 (8,675)
-------- --------
Balance at End of Period................................. $ 57,956 $ 58,843
======== ========
Treasury Stock
-------- --------
Balance at Beginning and End of Period................... ($1) ($1)
======== ========
Total Stockholders' Equity
Balance at Beginning of Period........................... $ 96,286 $108,881
Exercise of Stock Options................................ 526 600
Net Income (Loss)........................................ 3,402 (8,675)
Net Unrealized Appreciation (Depreciation) on Fixed
Maturity Securities..................................... 255 (492)
-------- --------
Balance at End of Period................................. $100,469 $100,314
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
F-5
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Operating Activities
Net Income (Loss)...................................... $ 3,402 $ (8,675)
Adjustments to Reconcile Net Income to Net Cash
Provided by (Used for) Operating Activities:
Depreciation and Amortization........................ 4,280 3,011
Provision for Doubtful Accounts...................... 492 1,035
Amortization of Excess of Net Assets over Cost of
Company Acquired.................................... (91) (90)
Deferred Income Tax Expense (Benefit)................ 2,700 --
Changes in Assets and Liabilities:
Accounts Receivable................................ 6,057 (7,930)
Other Receivables.................................. (41,474) (13,300)
Advances to Participating Hospitals................ 349 4,649
Prepaid Expenses and Other......................... 311 (979)
Accrued Health Care Expenses....................... 22,732 15,304
Unearned Premiums.................................. 1,496 1,743
Due to IPA's, Physicians and Other Providers....... (5,232) 5,585
Accounts Payable and Accrued Expenses.............. 15,350 (7,802)
--------- ---------
Net Cash Provided by (Used for) Operating Activities..... 10,372 (7,449)
Investing Activities
Purchases of Property, Plant, and Equipment............ (9,527) (29,642)
Proceeds from Disposal of Equipment.................... 23 16
Increase in Other Assets............................... (637) (953)
Purchases of Fixed Maturity Securities................. (281,117) (186,802)
Proceeds from Sales and Maturities of Fixed Maturity
Securities............................................ 255,291 205,759
--------- ---------
Net Cash Used for Investing Activities................... (35,967) (11,622)
Financing Activities
Proceeds from Revolving Credit Line.................... -- 18,000
Exercise of Stock Options.............................. 526 600
--------- ---------
Net Cash Provided by Financing Activities................ 526 18,600
--------- ---------
Decrease in Cash and Cash Equivalents.................... (25,069) (471)
Cash and Cash Equivalents at Beginning of Period......... 39,213 7,536
--------- ---------
Cash and Cash Equivalents at End of Period............... $ 14,144 $ 7,065
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
F-6
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting solely of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for
the nine month period ended September 30, 1997 are not necessarily indicative
of the results that may be expected for the year ended December 31, 1997. For
further information, refer to the consolidated financial statements and
footnotes thereto included in the Physicians Health Services, Inc. and
Subsidiaries Annual Report on Form 10-K for the year ended December 31, 1996.
2. STOCKHOLDERS' EQUITY AND PER SHARE DATA
Pursuant to the Company's Certificate of Incorporation, upon conversion of
Class B shares to Class A shares, such Class B shares are canceled and cannot
be reissued. Per share data are based upon the weighted average number of
common and common equivalent shares outstanding during the period. Common
stock equivalents are excluded to the extent they have an antidilutive effect
on per share data.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method
currently used to compute earnings per share and to restate all prior periods.
Under the new requirements for calculating primary earnings per share, the
dilutive effect of stock options will be excluded. The impact of Statement 128
on the calculation of primary and fully diluted earnings per share for the
quarter and nine months ended September 30, 1997 and September 30, 1996 is not
expected to be material.
3. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130") and Statement of
Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information," ("SFAS 131"). SFAS 130 establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements.
Comprehensive income is defined as the change in equity during the financial
reporting period of a business enterprise resulting from non-owner sources.
SFAS 131 establishes standards for the reporting of operating segment
information in both annual financial reports and interim financial reports
issued to shareholders. An operating segment is a component of an entity for
which separate financial information is available and is evaluated regularly
by the entity's chief operating management. Both Statements are effective for
fiscal years beginning after December 15, 1997 and are not expected to have a
material impact on the Company.
4. TAX PROVISION
The Company is currently under examination by the Internal Revenue Service
(IRS) for certain prior tax years. Management does not expect any proposed
adjustments which may result from the IRS' audit to have a material adverse
impact on the Company's financial position or results of operations.
The Company's effective tax rate is lower than the statutory rate due
primarily to tax exempt interest generated from much of the Company's
investment portfolio.
F-7
<PAGE>
PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SEPTEMBER 30, 1997
(UNAUDITED)
5. RECLASSIFICATIONS
Certain reclassifications were made to conform the 1996 amounts to current
presentations in 1997.
6. NON-MONETARY EXCHANGE
On May 2, 1997, the Company acquired 200 shares of Physicians Health
Services of New Jersey, Inc. ("PHS NJ") from MasterCare Companies, Inc.
("MasterCare"). In exchange for the receipt of the shares of PHS NJ the
Company gave up 1,250,000 shares of Series B Convertible Preferred Stock of
MasterCare Companies, Inc. and 190 shares of Common Stock of MasterCare of
Connecticut, Inc. Since the common stock of MasterCare and PHS NJ are not
publicly traded, fair values of the shares exchanged were estimated.
MasterCare shares were valued based on prices obtained in a recent private
placement while the fair value of PHS NJ shares were derived from a valuation
of membership. The purchase price paid (fair value of MasterCare's shares held
by the Company) exceeded the fair value of MasterCare's proportionate interest
in the net assets of PHS NJ acquired from MasterCare by approximately $1.8
million. Such excess will be amortized over 10 years. As a result of this
transaction, PHS NJ became a wholly-owned subsidiary of the Company. This
transaction resulted in a net gain of $348 thousand which is reflected in
selling, general and administrative expenses.
7. MERGER AGREEMENT
On May 8, 1997, the Company and Foundation Health Systems, Inc. ("FHS")
executed a merger agreement pursuant to which FHS would acquire all of the
shares of common stock of the Company for $29.25 per share in cash, or a total
consideration to the Company's stockholders of approximately $280 million. On
October 19, 1997, the Company and FHS agreed to a new acquisition price of
$28.25 per share in cash or a total consideration of approximately $271
million and eliminated as a condition of the consummation of the merger the
obtaining of certain waivers and consents from The Guardian Life Insurance
Company of America ("The Guardian") in connection with the Company's joint
marketing arrangements with The Guardian. Should the Company obtain such
waivers and consents prior to consumation of the merger, the price would
return to $29.25 per share. FHS announced that it intends to finance the
purchase with a combination of cash and bank debt. As part of the transaction,
the Company has entered into a voting trust agreement with the Greater
Bridgeport Individual Practice Association ("GBIPA"), which owns shares
constituting approximately 61% of the voting power of the Company. The
agreement stipulates that such shares will be voted in favor of the
transaction by GBIPA. The transaction is subject to certain closing
conditions, including receipt of regulatory approvals.
F-8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT
OF OPERATIONS
RESULTS OF OPERATIONS
Quarter Ended September 30, 1997 Versus September 30, 1996
Nine Months Ended September 30, 1997 Versus September 30, 1996
Premium revenue increased 43.9% to $177.3 million in the third quarter of
1997 from $123.2 million for the comparable 1996 quarter. For the nine months
ended September 30, 1997, premium revenue increased 38.3% to $488.7 million
from $353.4 million for the comparable 1996 period. Enrollment at September
30, 1997 was 496,502, an increase of 39.7% from enrollment of 355,402 at
September 30, 1996. As of September 30, 1997, fully insured enrollees
increased 49.5% to 426,152 members up from 285,059 members as of September 30,
1996, while self-funded enrollees remained essentially unchanged at 70,350
members as of September 30, 1997. The aggregate premium revenue increase
lagged the fully insured membership growth due primarily to the growth of
membership in the Healthcare Solutions product where 50% of all the premium
revenue and related health care costs related to this business for 1997 are
ceded to The Guardian pursuant to reinsurance agreements with the Company's
subsidiaries. Until October 1, 1996, the Healthcare Solutions activity in
Connecticut was reported under a profit sharing arrangement. According to the
provisions of the profit sharing arrangement, the Company recorded 100% of the
premium revenue from Connecticut Healthcare Solutions activity until
October 1, 1996. After October 1, 1996, the profit sharing agreement was
replaced by the reinsurance agreement as in effect for 1997. The effect was to
reduce the percentage premium increase as compared to what such increase would
have been if the reinsurance agreement had been in effect throughout 1996.
This effect was offset by an increase in revenue from Medicare products
resulting from a shift in membership from cost to risk products which carry
higher revenue yields and an increase in the pricing of some of the commercial
products.
Investment and other income increased 39.2% to $2.2 million for the third
quarter of 1997 from $1.5 million for the third quarter of 1996. On a year-to-
date basis, investment and other income increased 22.2% to $5.9 million from
$4.8 million for the nine months ended September 30, 1996. The increase is due
primarily to an increase in investable assets.
Health care expenses as a percentage of premium revenues (medical loss
ratio) declined to 86.6% for the third quarter of 1997 as compared to 90.3%
for the third quarter of 1996. For the nine months ended September 30, 1997,
the medical loss ratio was 86.2% down from 89.4% for the first nine months of
1996. Total health care expenses increased 38.6% to $152.1 million in the
third quarter of 1997 from $109.7 million for the comparable 1996 quarter. On
a year-to-date basis, total health care expenses increased 34.0% to $417.1
million for the first nine months of 1997 from $311.2 million for the same
1996 period. The improvement in the medical loss ratios for both the quarter
and year-to-date periods is the result of an increase in fully insured revenue
that exceeded the rise in total medical expenses.
Hospital services expenses increased 45.6% to $67.9 million in the third
quarter of 1997 from $46.7 million for the third quarter of 1996. Hospital
services expenses for the first nine months of 1997 totaled $172.3 million up
32.1% from $130.4 million in the first nine months of 1996. The rise in
hospital services expenses was due, in part, to the 49.5% increase in fully
insured enrollees. Additionally, an overall reduction in commercial hospital
rates for both inpatient and outpatient services was somewhat mitigated by a
new claims assessment in New York from the implementation of the Hospital Care
Reform Act of 1996 ("HCRA"), which became effective on January 1, 1997. The
New York State legislature enacted HCRA, which requires the Company to make
payments to state funding pools to finance hospital bad debt and charity care,
graduate medical education, and other state programs. The claims assessment
under HCRA is equal to 8.18% of qualified New York hospital costs and is
expected to continue to increase the Company's hospital costs in the future.
Commercial inpatient utilization for the third quarter of 1997 decreased
8.4% from the third quarter of 1996 with commercial bed days per thousand
members at 251 days for the third quarter of 1997 versus 274 days for
F-9
<PAGE>
the same 1996 period. On a year-to-date basis, commercial bed days per
thousand members decreased 6.5% from 277 days per thousand members for the
nine months ended September 30, 1996 to 259 days per thousand members for the
nine months ended September 30, 1997. The improvement in the commercial
product line was offset by a 182% and 138% increase in the per member per
month hospital expenses for government products for the quarter and nine
months ended September 30, 1997, respectively. The increase is primarily due
to the introduction of the Medicare risk products and the resulting shift in
membership from the Medicare cost product (for which the Company does not
carry full risk on hospital services) to the Medicare risk products for which
the Company carries substantially more of the hospital risk. The Company
expects hospital costs for the Medicare products to continue to rise as
membership (and related revenue) in this product increases.
Physician and related health care expenses increased by 27.6% from $52.7
million for the third quarter of 1996 to $67.3 million for the third quarter
of 1997. For the nine months ended September 30, 1997, physician and related
health care expenses increased 36.4% to $195.5 million from $143.3 million for
the same 1996 period. The increase in physician and related health care
expenses is primarily due to the increase in fully insured membership and
increases in certain non-capitated services. Additionally, the introduction of
the Medicare risk products have contributed to the rise in physician costs.
Other health care expenses increased by $6.6 million or 63.6% in the third
quarter of 1997 and by $18.8 million or 61.7% on a year-to-date basis. The
increase is primarily due to the increase in fully insured membership and due
to the inclusion of the covered lives assessment in New York as a result of
HCRA. This assessment is expected to continue to increase other health care
expenses in the future. Additionally, prescription drug expenses continue to
increase across all product lines.
Indemnity costs reflect the medical costs associated with the indemnity
revenue assumed in connection with The Guardian reinsurance arrangement in New
York under which the Company shared risk for indemnity business with The
Guardian until June 30, 1996.
Selling, general and administrative expenses increased 6.7% or $1.6 million
in the third quarter of 1997 from the comparable 1996 period. For the nine
months ended September 30, 1997, selling, general and administrative expenses
rose 14.6% or $9.2 million over the prior year. The increase is due primarily
to increased personnel and facilities expenses needed to support the
enrollment growth and product diversity. The increase was partially offset by
increases in the recovery of operating expenses from The Guardian under the
terms of the reinsurance agreements related to the Healthcare Solutions
product. The selling, general and administrative expenses as a percentage of
premium revenues improved to 14.0% for the third quarter of 1997 down from
18.8% for the third quarter of 1996. On a year-to-date basis, selling, general
and administrative expenses as a percentage of premium revenues totaled 14.8%
down from 17.8% for the comparable 1996 period.
LIQUIDITY AND CAPITAL RESOURCES
PHS has historically financed its operations primarily through internally
generated funds. The Company's primary capital requirements are for working
capital, principally to fund geographic and product expansion, and to maintain
necessary regulatory capital. The Company's HMO and insurance subsidiaries are
subject to statutory regulations that restrict the payment of dividends.
Cash and cash equivalents decreased $25.1 million to $14.1 million at
September 30, 1997 from $39.2 million at December 31, 1996.
Cash provided by operations increased primarily due to a combination of
growth in business, a return to profitability, and timing of claims payments
and other disbursements in the ordinary cause of business. Cash provided by
operations also includes a federal tax refund related to prior tax years.
The Company expects to require additional capital, over the next several
years, principally for computer and technology system enhancements and to
maintain necessary regulatory capital. The Company's spending on
F-10
<PAGE>
the computer and technology system enhancements has been temporarily suspended
pending the merger. Therefore, the additional capital requirements may be less
than originally estimated. If the system enhancements are reinstated, the
capital requirements will be restored and could be in excess of amounts
originally anticipated. The Company believes that in addition to its current
capital resources and internally generated funds, it will be able to obtain
financing, if necessary, sufficient for its continued operations, although it
can provide no assurances in this regard.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" includes certain forward looking statements (including statements
identified by the use of such words as "expects", "believes" or similar
expressions). Actual results could differ materially from those discussed.
Additional information concerning factors that could cause actual results to
differ materially from those in forward looking statements is contained in
Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1996 under the caption "Cautionary Statement".
F-11
<PAGE>
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT
- -------------- -----------------------
<S> <C>
27 Financial data schedule
</TABLE>
(b) Reports on Form 8-K
There were no reports filed on Form 8-K for the quarter ended September 30,
1997.
F-12
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
PHYSICIANS HEALTH SERVICES, INC.
_____________________________________
(Registrant)
SIGNATURE TITLE DATE
/s/ James L. Elrod, Jr. Chief Financial November 13,
- ------------------------------------- Officer 1997
JAMES L. ELROD, JR.
/s/ Robert L. Natt President November 13,
- ------------------------------------- 1997
ROBERT L. NATT
F-13
<PAGE>
APP G-1
PHYSICIANS HEALTH SERVICES, INC.
PROXY FOR ANNUAL MEETING
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned, revoking all previous proxies, hereby appoints David I. Grayer,
M.D. and Robert L. Natt, or either of them (the "Proxies"), as attorneys and
proxies, each with full power of substitution and all of the powers which the
undersigned would possess, if present in person, to represent and vote, as
designated on the reverse side of this proxy, all of the shares of Class A
Common Stock of Physicians Health Services, Inc. (the "Company") registered in
the name of the undersigned at the Annual Meeting of Stockholders of the Company
to be held on December 31, 1997, and at any adjournment thereof.
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS DIRECTED BY THIS PROXY. IF NO
DIRECTION IS MADE, THE PROXIES WILL VOTE SUCH SHARES FOR THE APPROVAL AND
ADOPTION OF THE AGREEMENT AND PLAN OF MERGER DESCRIBED IN PROPOSAL ONE AND FOR
THE ELECTION OF ALL OF THE COMPANY'S NOMINEES AS DIRECTORS DESCRIBED IN
PROPOSALS TWO AND THREE, AND SUCH PROXIES WILL VOTE IN ACCORDANCE WITH THEIR
DISCRETION ON SUCH OTHER MATTERS AS MAY PROPERLY COME BEFORE THE MEETING.
(IMPORTANT -- TO BE MARKED, SIGNED AND DATED ON REVERSE SIDE)
<PAGE>
[X] PLEASE MARK
YOUR VOTES AS
IN THIS EXAMPLE
- --------------------------------------------------------------------------------
2. ELECTION OF FOR WITHHELD
CLASS A such from such
DIRECTORS nominee nominee
[_] [_]
CLASS A DIRECTOR NOMINEE: Robert L. Natt
1. Proposal to approve and adopt the Agreement and Plan of Merger, dated as of
May 8, 1997, as amended by Amendment No. 1 thereto, dated as of October 19,
1997 (the "Merger Agreement"), among Foundation Health Systems, Inc. ("FHS"),
PHS Acquisition Corp., a wholly-owned subsidiary of FHS ("Merger Sub"), and
the Company, with respect to the merger of Merger Sub with and into the
Company as provided for in the Merger Agreement, with the Company surviving
as a wholly-owned subsidiary of FHS.
FOR AGAINST ABSTAIN
[_] [_] [_]
3. ELECTION OF CLASS B DIRECTORS
CLASS B DIRECTOR NOMINEES:
David I. Grayer, M.D., Edward Sawicki, M.D. and Bernard Sherlip, M.D.
FOR WITHHELD
all from all
nominees nominees
[_] [_]
For, except vote withheld from the following nominee(s)
-------------------------------------------------------
4. In their discretion, the Proxies are authorized to vote upon such other
business as may properly come before the meeting.
PLEASE MARK, SIGN, DATE AND RETURN THIS PROXY
PROMPTLY USING THE ENCLOSED ENVELOPE.
__________________________________ Date: ____, 1997
Signature of Stockholder
__________________________________ Date: ____, 1997
Signature if held jointly
Note: Please sign exactly as name appears hereon. When shares are held by joint
tenants, both should sign. Executors, administrators, trustees and other
fiduciaries should so indicate when signing. If a corporation, please sign
in full corporate name by president, or other authorized officer. If a
partnership, please sign in partnership name by authorized person.
<PAGE>
APP G-2
PHYSICIANS HEALTH SERVICES, INC.
PROXY FOR ANNUAL MEETING
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned, revoking all previous proxies, hereby appoints David I. Grayer,
M.D. and Robert L. Natt, or either of them (the "Proxies"), as attorneys and
proxies, each with full power of substitution and all of the powers which the
undersigned would possess, if present in person, to represent and vote, as
designated on the reverse side of this proxy, all of the shares of Class B
Common Stock of Physicians Health Services, Inc. (the "Company") registered in
the name of the undersigned at the Annual Meeting of Stockholders of the Company
to be held on December 31, 1997, and at any adjournment thereof.
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS DIRECTED BY THIS PROXY. IF NO
DIRECTION IS MADE, THE PROXIES WILL VOTE SUCH SHARES FOR THE APPROVAL AND
ADOPTION OF THE AGREEMENT AND PLAN OF MERGER DESCRIBED IN PROPOSAL ONE AND FOR
THE ELECTION OF ALL OF THE COMPANY'S NOMINEES AS DIRECTORS DESCRIBED IN PROPOSAL
TWO, AND SUCH PROXIES WILL VOTE IN ACCORDANCE WITH THEIR DISCRETION ON SUCH
OTHER MATTERS AS MAY PROPERLY COME BEFORE THE MEETING.
(IMPORTANT -- TO BE MARKED, SIGNED AND DATED ON REVERSE SIDE)
<PAGE>
[X] PLEASE MARK
YOUR VOTES AS
IN THIS EXAMPLE
- --------------------------------------------------------------------------------
1. Proposal to approve and adopt the Agreement and Plan of Merger, dated as of
May 8, 1997, as amended by Amendment No. 1 thereto, dated as of October 19,
1997 (the "Merger Agreement"), among Foundation Health Systems, Inc. ("FHS"),
PHS Acquisition Corp., a wholly-owned subsidiary of FHS ("Merger Sub"), and
the Company, with respect to the merger of Merger Sub with and into the
Company as provided for in the Merger Agreement, with the Company surviving
as a wholly-owned subsidiary of FHS.
FOR AGAINST ABSTAIN
[_] [_] [_]
2. ELECTION OF CLASS B DIRECTORS
CLASS B DIRECTOR NOMINEES:
David I. Grayer, M.D., Edward Sawicki, M.D. and Bernard Sherlip, M.D.
FOR WITHHILD
all from all
nominees nominees
[_] [_]
For, except vote withheld from the following nominee(s)
- -------------------------------------------------------
3. In their discretion, the Proxies are authorized to vote upon such other
business as may properly come before the meeting.
PLEASE MARK, SIGN, DATE AND RETURN THIS PROXY PROMPTLY
USING THE ENCLOSED ENVELOPE.
__________________________________ Date: ____, 1997
Signature of Stockholder
__________________________________ Date: ____, 1997
Signature if held jointly
Note: Please sign exactly as name appears hereon. When shares are held by joint
tenants, both should sign. Executors, administrators, trustees and other
fiduciaries should so indicate when signing. If a corporation, please sign
in full corporate name by president, or other authorized officer. If a
partnership, please sign in partnership name by authorized person.
