<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: June 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to .
Commission file number: 1-12718
HEALTH SYSTEMS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 95-42288333
- ------------------------------------------------ ------------------------------------
(State or other jurisdiction of incorporation or (I.R.S. Employer identification No.)
organization)
</TABLE>
21600 Oxnard Street, Woodland Hills, CA 91367
225 North Main Street, Pueblo, CO 81003
- ----------------------------------------- -----------
(Address of principal executive offices) (Zip Codes)
Registrant's telephone numbers, including area code: (818) 719-6978 (California)
(719) 542-0500 (Colorado)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date.
As of August 1, 1996, 29,028,935 shares of Class A Common Stock, $.001
par value per share, were outstanding (exclusive of 3,194,374 shares held as
treasury stock) and 19,297,642 shares of Class B Common Stock, $.001 par value
per share, were outstanding.
<PAGE> 2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Health Systems International, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
----------- ------------
<S> <C> <C>
ASSETS
Current assets
Cash and equivalents $ 103,787 $ 225,932
Marketable securities held for sale 387,689 366,629
Premiums receivable, net 91,575 91,106
Prepaid expenses and other 49,433 34,849
Deferred income taxes 10,689 18,902
----------- -----------
Total current assets 643,173 737,418
Property and equipment, net 80,260 84,743
Goodwill and other intangible assets, net 339,010 336,365
Deferred income taxes 1,651 1,958
Other assets 55,406 53,227
----------- -----------
Total assets $ 1,119,500 $ 1,213,711
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Estimated claims payable $ 245,986 $ 310,392
Shared risk and other settlements 12,921 30,664
Unearned subscriber premiums 27,834 91,596
Accounts payable and accrued expenses 94,810 120,161
Federal and state income taxes payable 13,975 13,196
Notes payable, current portion 2,299 2,340
----------- -----------
Total current liabilities 397,825 568,349
Notes payable 362,769 354,080
Other 12,385 5,755
----------- -----------
Total liabilities 772,979 928,184
----------- -----------
</TABLE>
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<TABLE>
<S> <C> <C>
Stockholders' equity
Preferred stock, $.001 par value
Authorized shares - 10,000,000
Issued and outstanding shares - none -- --
Class A common stock, $.001 par value
Authorized shares - 135,000,000
Issued and outstanding shares - 32,194,194 in 1996
and 22,643,030 in 1995 32 23
Class B nonvoting convertible common stock, $.001 par value
Authorized shares - 30,000,000
Issued and outstanding shares - 19,297,642 in 1996 and
25,684,152 in 1995 19 26
Additional paid-in capital 185,461 66,147
Retained earnings 259,073 233,711
Advance to repurchase 574,869 shares of Class A common stock in 1995 (16,330)
Treasury Stock 3,194,374 shares of Class A common stock in 1996 (95,831)
Unrealized gain/(loss) on marketable securities held for sale, net (2,233) 1,950
----------- -----------
Total stockholders' equity 346,521 285,527
----------- -----------
Total liabilities and stockholders' equity $ 1,119,500 $ 1,213,711
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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Health Systems International, Inc. and Subsidiaries
Condensed Consolidated Statements of Income (Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three-Months Ended June 30, Six-Months Ended June 30,
------------------------------- -------------------------------
1996 1995 1996 1995
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Premium revenue $ 777,524 $ 649,930 $ 1,560,647 $ 1,268,868
Administrative services and
other revenue 20,435 10,782 38,661 19,340
----------- ----------- ----------- -----------
Total revenue 797,959 660,712 1,599,308 1,288,208
----------- ----------- ----------- -----------
Operating Expenses:
Health care expenses:
Physician 311,447 240,439 609,151 486,988
Hospital 257,853 215,488 536,086 414,535
Pharmacy and other 78,661 67,177 151,646 120,499
----------- ----------- ----------- -----------
Total health care expenses 647,961 523,104 1,296,883 1,022,022
Marketing, general and administrative 79,901 74,351 160,021 145,971
Depreciation and amortization 13,208 11,870 26,674 22,757
Administrative services and
other expenses 17,229 10,166 33,562 18,138
Merger-related costs 2,185 11,112
----------- ----------- ----------- -----------
Total operating expenses 758,299 621,676 1,517,140 1,220,000
----------- ----------- ----------- -----------
Operating income 39,660 39,036 82,168 68,208
Investment income 9,956 7,671 18,779 15,103
Interest expense (6,000) (4,877) (11,932) (9,246)
----------- ----------- ----------- -----------
Income before income taxes
and minority interest 43,616 41,830 89,015 74,065
Income taxes 19,201 18,947 38,591 32,281
Minority interest in loss of
subsidiary 33 83 64 93
=========== =========== =========== ===========
Net Income $ 24,448 $ 22,966 $ 50,488 $ 41,877
=========== =========== =========== ===========
Earnings per share:
Primary and fully diluted $ 0.51 $ 0.47 $ 1.05 $ 0.85
=========== =========== =========== ===========
Weighted average common
shares outstanding:
Primary 48,388 49,035 48,260 49,225
=========== =========== =========== ===========
Fully diluted 48,388 49,073 48,265 49,257
=========== =========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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Health Systems International, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Six-Months Ended June 30,
---------------------------
1996 1995
--------- ---------
OPERATING ACTIVITIES
<S> <C> <C>
Net income $ 50,488 $ 41,877
Adjustments to reconcile net income to net
cash used by operating activities:
Depreciation and amortization of fixed and intangible assets 26,674 22,757
Deferred income taxes 8,653 15,575
Changes in operating assets and liabilities net of acquisition:
Premiums receivable and unearned subscriber premiums (64,231) 8,460
Prepaid expenses and other (14,730) (15,005)
Estimated claims payable, shared risk and other settlements (82,149) (31,199)
Accounts payable and accrued expenses (20,404) (38,583)
Federal and state income taxes payable 4,389 (4,141)
--------- ---------
Net cash used by operating activities (91,310) (259)
INVESTING ACTIVITIES
Sale or redemption of marketable securities held for sale 127,129 119,101
Purchases of marketable securities held for sale (154,462) (170,765)
Purchases of property and equipment (14,568) (18,814)
Acquisition of subsidiaries, net of cash acquired (4,114) (90,639)
--------- ---------
Net cash used by investing activities (46,015) (161,117)
FINANCING ACTIVITIES
Proceeds from exercise of stock options and
employee stock plan purchases 15,719 2,288
Proceeds from sale of stock 96,230 --
Borrowings 9,000 235,000
Purchase of treasury stock (105,417) (13,302)
Advances to repurchase shares of Class A common stock (12,997)
Repayment of debt and other non current liabilities (352) (144,716)
--------- ---------
Net cash provided by financing activities 15,180 66,273
--------- ---------
Decrease in cash and equivalents (122,145) (95,103)
Cash and equivalents, beginning of period 225,932 267,877
--------- ---------
Cash and equivalents, end of period $ 103,787 $ 172,774
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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HEALTH SYSTEMS INTERNATIONAL, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements of Health Systems International, Inc. and its wholly and majority
owned subsidiaries (collectively, the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information, and 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 of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the six month period ended June 30, 1996 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1996. For further information, reference is made to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1995, and
to certain "Cautionary Factors" included elsewhere in this quarterly report on
Form 10-Q.
2. CREDIT FACILITY
On April 26, 1996, the Company replaced its $400 million revolving
credit facility obtained on April 12, 1995 with a $700 million revolving credit
facility. Under the new credit facility, the Company may incur permitted
subordinated indebtedness in a maximum aggregate amount not to exceed $150
million which is available for acquisition purposes and to provide short-term
financing to repurchase shares of stock. The Company may elect from various
short-term interest rates based upon a spread above the LIBOR rate; or the
greater of the bank's reference rate or the federal funds rate plus 1/2%. In
addition, the Company may elect a "competitive bid auction" in which
participating banks are offered an opportunity to bid alternative rates. The
credit facility is for a term of five years from the date of execution, with two
one year extension options. At June 30, 1996, $319 million had been borrowed
against the new $700 million credit facility.
3. CONTINGENCIES
In January 1995, two purported class action lawsuits were filed against
the Company and the members of its Board of Directors alleging breach of
fiduciary duties to its public stockholders by refusing to seriously consider
certain acquisition bids for the Company. These lawsuits were subsequently
consolidated into a single action. On April 19, 1996, such single, consolidated
action was dismissed without prejudice.
The Company is also involved in various other legal proceedings, most
of which are routine to its business. In the opinion of management, based in
part on advice from litigation counsel to the
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Company, the resolution of these matters should not have a material adverse
effect on the financial condition or results of operations of the Company.
4. STOCKHOLDER'S EQUITY
During the first quarter of 1996, the Company repurchased 303,879
shares of its Class A Common Stock from certain current and former management
employees of the Company and HN Management Holdings, Inc., a predecessor to the
Company, at a price of $31.55 per share. The repurchased shares were held
pursuant to the Amended and Restated Health Net Associate Trust Agreement dated
as of May 1, 1994 (the "Associate Trust Agreement"), on behalf of certain
founding stockholders of the Company at the date of the conversion of Health Net
to for-profit status (the "Class A Stockholders"). The repurchased shares,
having an aggregate value of $9,587,000, were immediately canceled and netted
against Class A Common Stock, Additional Paid-in-Capital and Retained Earnings.
On May 15, 1996, the Company completed a public offering in which the
Company sold 3,194,374 shares of Class A Common Stock and the California
Wellness Foundation (the "Foundation") sold 6,386,510 shares of Class A Common
Stock (constituting 6,386,510 shares of Class B Common Stock which automatically
converted into shares of Class A Common Stock upon the sale) for a per share
purchase price to the public of $30.00 (the "Offering"). The net proceeds
received by the Company from the sale of the 3,194,374 shares of Class A Common
Stock were approximately $92.4 million after deducting underwriting discounts
and commissions and estimated expenses of the Offering payable by the Company.
The Company used its net proceeds from the Offering to repurchase 3,194,374
shares of Class A Common Stock held pursuant to the Associate Trust Agreement
from certain Class A Stockholders. The Company repurchased these shares of Class
A Common Stock from the Class A Stockholders at $30.00 per share less
transaction costs associated with the offering, amounting to $1.08 per share.
All of these 3,194,374 shares of Class A Common Stock repurchased are currently
held in treasury. The Company did not receive any of the proceeds from the sale
of shares of Class A Common Stock in the Offering by the Foundation.
5. RELATED PARTY TRANSACTION
On April 14, 1995, a member of the Company's Board of Directors, who is
also a Class A Stockholder, was provided a loan by the Company in the amount of
$1.0 million, which was secured by shares of the Company's Class A Common Stock
owned by such board member and held pursuant to the Associate Trust Agreement.
On May 15, 1996, the note evidencing this loan was paid back in full by the
board member as part of his stock sale during the Company's repurchase of Class
A Common Stock held pursuant to the Associate Trust Agreement described above.
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6. ACQUISITION
On May 14, 1996, the Company announced that it had reached a definitive
agreement with the St. Francis Health System to acquire Advantage Health, Inc.,
a managed care company headquartered in Pittsburgh, Pa., with approximately
60,000 members for approximately $12.5 million in cash. The transaction is
subject to approvals from regulatory authorities, and other customary conditions
of closing. The transaction is expected to close in the third quarter of 1996.
7. RESTRUCTURING CHARGE
On April 10, 1996, the Company announced its intention to take a
pre-tax one-time restructuring charge of approximately $34.2 million or $.41 per
share after tax, during the second quarter of 1996. The charge was to cover
non-recurring costs of a comprehensive restructuring of the Company's Health Net
subsidiary, computer software and hardware write-offs, and the consolidation of
certain operational functions of other subsidiaries.
The Company subsequently put in place a new management team consisting
of a new president and chief operating officer, and a new president and chief
executive officer for both its Health Net and QualMed subsidiaries. To allow
this new management team time to fully assess the impact of the proposed
restructuring and consolidations of the Company's primary subsidiaries, the
Company has postponed the restructuring charge until the third quarter of 1996.
The restructuring of Health Net will include the reorganization of its
management and operating structure and staff reductions. The software write-offs
are related to abandoned development projects at Health Net, while the computer
hardware write-offs recognize the obsolescence of certain equipment in the
anticipation of significant system upgrades. A portion of the charge will also
cover the Company's centralization of claims processing and certain other
functions in its non-California health plans in Pueblo, Colorado. Since the
restructuring of Health Net and the centralization of functions in Pueblo will
occur throughout 1996, it is anticipated that savings from the restructuring
charges, if any, will not become estimable or be realized until 1997.
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<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
Health Systems International, Inc. (the "Company") is one of the
largest health maintenance organizations ("HMOs") in the United States,
providing health care and administrative services to more than 1.9 million
full-risk HMO and administrative services only ("ASO") members in California,
Colorado, Connecticut, Idaho, New Jersey, New Mexico, Oregon, Pennsylvania and
Washington. Through its operating subsidiaries, the Company provides a wide
range of managed health care services through Network Model and Individual
Practice Association Model HMOs. The Company also provides various tailored
managed health care products, operates a preferred provider organization network
and owns two health and life insurance companies.
The following discussion should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1995.
RESULTS OF OPERATIONS
The following table sets forth certain selected operating statistics
and membership data of the Company for the three and six month periods ended
June 30, 1996.
SUMMARY OF OPERATING STATISTICS AND MEMBERSHIP DATA
OPERATING STATISTICS
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
-------------------------- ------------------------
1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
Medical loss ratio (health care expense as a
percentage of premium revenue) 83.3% 80.5% 83.1% 80.5%
Marketing, general and administrative expense
including depreciation and amortization
as a percentage of premium revenue 12.0% 13.3% 12.0% 13.3%
Net income as a percentage of total revenue 3.1% 3.5% 3.2% 3.3%
Primary and fully diluted earnings per share
(before net merger-related costs in 1995) $ 0.51 $ 0.51 $ 1.05 $ 1.00
====== ====== ====== ======
Primary and fully diluted earnings per share $ 0.51 $ 0.47 $ 1.05 $ 0.85
====== ====== ====== ======
</TABLE>
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<PAGE> 10
Enrollment Data
<TABLE>
<CAPTION>
June 30,
--------------------------
1996 1995
---- ----
<S> <C> <C>
Members by Product Type
Commercial 1,594,849 1,497,891
Medicare 141,334 102,178
Medicaid 61,794 11,567
--------- ---------
Full Risk Members 1,797,977 1,611,636
ASO 114,525 150,407
Managed 4,551 4,202
--------- ---------
Total 1,917,053 1,766,245
========= =========
Members by State
California 1,323,926 1,317,928
Colorado 70,522 48,582
New Mexico 28,535 27,096
Washington/Idaho 113,415 123,960
Oregon 49,014 39,894
Connecticut 162,318 133,785
Pennsylvania 169,323 75,000
--------- ---------
Total 1,917,053 1,766,245
========= =========
</TABLE>
The Company added 150,808 new full-risk and ASO members since the
second quarter of 1995. Of this increase, 85,223 members resulted from the
acquisition of Greater Atlantic Health Services, Inc., an HMO operating in
Pennsylvania and New Jersey. Internal growth accounted for the remaining
increase in enrollment of 65,585.
For the period ended June 30, 1996, enrollment decreased by
approximately 22,000 (1%) compared to December 31, 1995. The bulk of the
enrollment decrease occurred during the first quarter of 1996. The decrease was
due to the Company's efforts to maintain pricing discipline in the current
competitive environment and marketplace uncertainty caused by the abandoned
merger involving the Company and WellPoint Health Networks Inc. The decrease
resulted from a 52,000 member reduction in commercial enrollment, partially
offset by increases of 8,000, 12,000 and 10,000 in the Company's Medicare,
Medicaid and ASO lines of business, respectively. Enrollment remained relatively
stable throughout the second quarter of 1996.
THREE MONTHS ENDED JUNE 30, 1996 COMPARED TO THREE MONTHS ENDED JUNE 30, 1995
Net income increased 6.5% to $24.4 million for the three months ended
June 30, 1996, compared to $23.0 million, after net merger-related costs of $2.2
million, for the comparable period in 1995. The increase in net income
reflected the Company's higher investment income, growth in membership and
premium revenue, and a decrease in
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administrative expenses as a percentage of revenue, offset in part by an
increase in the Company's medical loss ratio (i.e., health care expenses as a
percentage of premium revenue, or "MLR") from 80.5% in the three months ended
June 30, 1995 to 83.3% in the three months ended June 30, 1996.
Premium Revenue
Premium revenue, excluding ASO revenue, increased $127.6 million or
19.6% in the second quarter of 1996 compared to the second quarter of 1995. The
increase in premium revenue was reflective of increased membership and premium
rate increases in the Medicare line of business. The Company's Northeast
operations contributed $53.9 million of acquired premium growth and $35.7
million of post-acquisition internal premium growth between the second quarter
of 1996 and the second quarter of 1995. On a same store basis, premium revenue
(including post-acquisition internal premium growth in the Northeast)
increased by $73.7 million or 11.3%, between the three month periods ended
June 30, 1996 and June 30, 1995.
Change in Net Premium Revenue
(In Millions)
Second Quarter 1996 Compared to Second Quarter 1995
<TABLE>
<S> <C>
Change in revenue due to
premium change (same store):
Commercial $ (1.9)
Medicare 9.8
------
7.9
Change in revenue due to
membership change (same store):
Commercial 30.6
Medicare 35.2
------
65.8
Change in revenue due to
acquisitions:
Commercial 31.2
Medicare 22.7
------
53.9
Total change in revenue:
Commercial 59.9
Medicare 67.7
------
$127.6
</TABLE>
Total member months (cumulative number of member service months during
the period) increased by 12.5% to 5,397,000 during the second quarter of 1996
compared to the same period in 1995, and the combined per member per month
("PMPM") premium revenue increased by 6.3% to $144.07.
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On a same store basis, total member months increased by 7.1% to
5,139,000 during the second quarter of 1996 compared to the same period in 1995,
and total PMPM premium revenue increased by 3.9% to $140.80.
Commercial member months increased by 10.6% to 4,974,000 during the
second quarter of 1996 compared to the same period in the prior year. For the
quarter ended June 30, 1996, commercial premium revenue PMPM increased by .6% to
$119.35, compared to the same period last year. Excluding the effects of
Northeast acquisitions, commercial member months for the quarter ended
June 30, 1996 increased by 5.7% to 4,757,000 compared to the prior year
period. Commercial premium revenue PMPM, excluding the effects of Northeast
acquisitions, decreased by .3% to $118.25, compared to the same period
last year. The decrease was due mainly to pricing pressures in the highly
competitive California marketplace.
Medicare member months increased by 41.3% to 422,000 during the first
quarter of 1996 compared to the same period in the prior year. For the quarter
ended June 30, 1996, Medicare premium revenue PMPM increased by 12.0% to
$435.13, compared to the same period last year. Excluding the effects of
Northeast acquisitions, Medicare member months for the quarter ended June 30,
1996 increased by 27.9% to 383,000. Medicare premium revenue PMPM, excluding the
effects of Northeast acquisitions, increased by 8.4% to $421.19 compared to the
same period last year. Increases in Medicare PMPM are principally a result of
rate increases by the Federal Health Care Financing Administration.
Health Care Expenses
Health care expenses increased by 23.9% from $523.1 million in the
second quarter of 1995 to $648.0 million in the second quarter of 1996. On a
PMPM basis, health care expenses for the quarter ended June 30, 1996 rose by
10.1% to $120.06 PMPM, versus $109.05 PMPM during the equivalent period in the
prior year. During the same period, the Company's overall MLR increased to 83.3%
as compared to 80.5% during the prior year's three-month period. The increase in
the Company's MLR was principally a result of increases in pharmacy costs
compared to the second quarter in 1995 and higher utilization of services
coupled with premium rate reductions in the Company's Medicaid line of
business in the Philadelphia market. In addition, flat PMPM growth in the
California commercial market contributed to the increase in the Company's
overall MLR.
Commercial health care expenses on a PMPM basis in the quarter ended
June 30, 1996 increased by 4.6% to $97.34 compared to $93.09 during the same
period last year. The Commercial MLR increased to 81.6% from 78.4% for the
comparable period in 1995. As previously described, the increase reflects higher
pharmacy costs, increased utilization, higher medical costs for the Company's
Philadelphia Medicaid business and flat PMPM revenue growth in the California
commercial market.
Medicare health care expenses on a PMPM basis in the quarter ended June
30, 1996 increased by 11.0% to $387.58, compared to $349.11 during the same
period last year. The Medicare MLR decreased to 89.1% from 89.9% for the second
quarter of 1995. The reduction in this overall
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<PAGE> 13
Medicare MLR is primarily a result of an 82% MLR for the Company's Philadelphia
Medicare business offset, in part, by higher pharmacy costs in the Company's
California Medicare business.
Marketing, General and Administrative Expenses
Marketing, general and administrative expenses, excluding the effects
of the Company's ASO business, decreased to 10.3% of premium revenue in the
second quarter of 1996 as compared to 11.4% during the second quarter of the
prior year. The decrease in marketing, general and administrative expenses
reflects the Company's ongoing efforts to aggressively control its
administrative costs.
Depreciation and Amortization Expenses
Depreciation and amortization expenses remained relatively static as a
percentage of premium revenue for the three months ended June 30, 1996, compared
to the same period in 1995. These expenses were $13.2 million (1.7% of premium
revenue) in the second quarter of 1996 compared to $11.9 million (1.8% of
premium revenue) in the second quarter of 1995.
SIX MONTHS ENDED JUNE 30, 1996 COMPARED TO SIX MONTHS ENDED JUNE 30, 1995
Net income increased 20.6% to $50.5 million for the six months ended
June 30, 1996, compared with $41.9 million, after merger related costs net of
tax of $7.5 million, for the comparable period in 1995. The increase in net
income reflected the Company's growth in membership and premium rates, and a
decrease in administrative expenses as a percentage of revenue, offset in part
by an increase in the Company's MLR from 80.5% for the six months ended June
30, 1995 to 83.1% for the six months ended June 30, 1996.
Premium Revenue
Premium revenue, excluding ASO revenue, increased $291.8 million or 23%
in the first six months of 1996 compared to the first six months of 1995.
The Company's Northeast acquisitions contributed $129.5 million of acquired
premium growth and $69.2 million of post-acquisition internal premium growth
between the first six months of 1996 and the first six months of 1995. On a same
store basis, premium revenue (including post-acquisition internal premium growth
in the Northeast) increased by $162.3 million or 12.8%, between the six month
periods ended June 30, 1996 and June 30, 1995.
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<PAGE> 14
Change in Net Premium Revenue
(In Millions)
Six Months Ended 1996 Compared to Six Months Ended 1995
<TABLE>
<S> <C>
Change in revenue due to
premium change (same store):
Commercial $ (8.2)
Medicare 18.2
------
10.0
Change in revenue due to
membership change (same store):
Commercial 69.8
Medicare 82.5
------
152.3
Change in revenue due to
acquisitions:
Commercial 84.6
Medicare 44.9
------
129.5
Total change in revenue:
Commercial 146.2
Medicare 145.6
------
$291.8
</TABLE>
Total member months increased by 15.2% to 10,827,000 during the first
six months of 1996 compared to the same period in 1995, and the combined
PMPM premium revenue increased by 6.8% to $144.15.
On a same store basis, total member months increased by 8.4% to
10,186,000 during the first six months of 1996 compared to the same period in
1995, and total PMPM premium revenue increased by 4.1% to $140.51.
Commercial member months increased by 13.1% to 9,986,000 during the
first six months of 1996 compared to the same period in the prior year. For the
six months ended June 30, 1996, commercial premium revenue PMPM increased by .8%
to $119.71, compared to the same period the prior year. Excluding the effects
of Northeast acquisitions, commercial member months for the six months ended
June 30, 1996 increased by 6.7% to 9,425,000 compared to the prior year period.
Commercial premium revenue PMPM, excluding the effects of Northeast
acquisitions, decreased by .8% to $117.85, compared to the same period last
year. The decrease was due mainly to pricing pressures in the highly
competitive California marketplace.
Medicare member months increased by 48.8% to 841,000 during the first
six months of 1996 compared to the same period in the prior year. For the six
months ended June 30, 1996,
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<PAGE> 15
Medicare premium revenue PMPM increased by 11.7% to $434.37, compared to the
same period last year. Excluding the effects of Northeast acquisitions,
Medicare member months for the six months ended June 30, 1996 increased by
34.7% to 761,000. Medicare premium revenue PMPM, excluding the effects of
Northeast acquisitions, increased by 8.3% to $421.01 compared to the same
period last year. Increases in Medicare PMPM are principally a result of rate
increases by the Federal Health Care Financing Administration.
Health Care Expenses
Health care expenses increased by 26.9% from $1.0 billion in the first
six months of 1995 to $1.3 billion in the first six months of 1996. On a PMPM
basis, health care expenses for the first six months ended June 30, 1996 rose by
10.1% to $119.79 PMPM, versus $108.75 PMPM during the equivalent period in the
prior year. During the same period, the Company's MLR increased to 83.1% as
compared to 80.5% during the prior year's six month period. The increase in the
Company's MLR was principally a result of increases in pharmacy costs compared
to the first six months of 1995 and higher utilization of services coupled
with premium rate reductions in the Company's Medicaid line of business in the
Philadelphia market. In addition, flat PMPM growth in the California commercial
market contributed to the increase in the Company's overall MLR.
Commercial health care expenses on a PMPM basis for the six month
period ended June 30, 1996 increased by 3.4% to $96.93 compared to $93.78 during
the same period in 1995. The Commercial MLR increased to 81.0% for the first six
months of 1996 from 78.9% for the comparable period in 1995. The increase
reflects higher pharmacy and outpatient costs in certain of the Company's
markets, the previously described higher medical costs for the Company's
Philadelphia Medicaid business and flat PMPM revenue growth in the California
commercial market.
Medicare health care expenses on a PMPM basis in the six months ended
June 30, 1996 increased by 14.1% to $391.19, compared to $342.77 during the same
period last year. The Medicare MLR increased to 90.1% from 88.2% for the first
six months of 1995. The increase in this overall Medicare MLR is primarily a
result of unusually high Medicare fee for service claims volumes during the
first quarter of 1996.
Marketing, General and Administrative Expenses
Marketing, general and administrative expenses, excluding the effects
of the Company's ASO business, decreased to 10.3% of premium revenue in the
first six months of 1996 as compared to 11.5% during the first six months of the
prior year. The decrease in marketing, general and administrative expenses
reflects the Company's ongoing efforts to aggressively control its
administrative costs.
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<PAGE> 16
Depreciation and Amortization Expenses
Depreciation and amortization expenses remained relatively static as a
percentage of premium revenue in the first six months of 1996 as compared to the
first six months of 1995. These expenses were $26.7 million (1.7% of premium
revenue) in the first six months of 1996 as compared to $22.8 million (1.8% of
premium revenue) in the first six months of 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of cash is premium revenue. Its primary
uses of cash are claims and capitation payments. Estimates of future cash flows
include a component to account for the delay between providing health care
services and reporting their cost. The estimate is based on actuarial
projections of claims and other costs, claims paid history, membership growth,
inflation, seasonality, claims inventory and reserves.
The Company's capital resources are managed according to certain
guidelines intended to ensure liquidity and maximize total return by assuming
prudent investment risks. The Company's liquidity requirements consist of the
need to service medical claims in a timely manner and to satisfy shared risk and
other obligations. Such requirements are the principal factors in determining
the appropriate investment portfolio mix. The Company presently invests
primarily in a variety of fixed-income obligations according to established
investment guidelines.
During the first six months of 1996, cash used by operating activities
was $91.3 million, compared with cash used of $.3 million in the comparable
prior year period. This increase in cash used by operating activities is due
primarily to payments of claims payable, shared risk settlement, accounts
payable and accrued expenses, and the timing of receipts of unearned
subscriber premiums. Increased efficiencies in the Company's claims processing
areas allowed accelerated handling of claims, as well as reductions in claims
inventories.
Cash used by investing activities decreased from $161.1 million in the
six months ended June 30, 1995 to $46.0 million in the six months ended June 30,
1996, while cash provided by financing activities also decreased from $66.3
million to $15.2 million during such periods. Decreases in these cash flow
categories resulted from limited acquisition activity during the first six
months of 1996, as compared to the comparable prior year period.
The Company's current ratios at June 30, 1996 and December 31, 1995
were 1.62 to 1 and 1.30 to 1, respectively. The increase in the Company's
current ratio is primarily attributable to decreased current liabilities
resulting from increased payments of claims, accounts payable and accrued
expenses, as well as reductions in unearned premiums as of June 30, 1996.
Outstanding notes payable amounted to $365.1 million at June 30, 1996,
an increase of $8.7 million from December 31, 1995, resulting primarily from
additional borrowings relating to the stock repurchases during the first quarter
of 1996 (see note 4 of the Notes to Condensed Consolidated Financial
Statements). Principal and interest requirements of notes payable are
-15-
<PAGE> 17
scheduled at between $19 and $25 million per year through 2006. The Company
believes that cash from operations and existing working capital are adequate to
fund existing obligations, introduce new products and services and continue to
develop health care-related businesses. The Company regularly evaluates its cash
requirements for current operations and commitments, and for capital
acquisitions and other strategic transactions. The Company may elect to raise
additional funds for these purposes, either through additional debt or equity,
the sale of investment securities or otherwise, as appropriate.
On April 26, 1996, the Company obtained an unsecured $700 million
revolving line of credit from a lending syndicate led by Bank of America and
co-agented by Industrial Bank of Japan and Citibank. The new credit facility
replaced the Company's previous $400 million credit facility. Under the credit
facility the Company may incur permitted subordinated indebtedness in
a maximum aggregate amount not to exceed $150 million which is available for
acquisition and other purposes, and to provide short-term financing to
repurchase shares of stock. As of June 30, 1996, $319 million was outstanding
under the Company's new credit facility.
Under the terms of the five-year Credit Facility, the Company pays
interest at a variable rate (See note 2 of the Notes to Condensed Consolidated
Financial Statements).
The Company's subsidiaries must comply with certain minimum capital
requirements under applicable state laws and regulations. The long-term portion
of principal and interest payments under the notes payable to the Foundation is
subordinated to Health Net meeting its tangible net equity ("TNE") requirements
under applicable California laws and regulations. As of June 30, 1996, each of
the Company's subsidiaries was in compliance with its minimum capital
requirements.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit
margin is low. Hence, it is especially sensitive to inflation. Increases in
medical expenses without corresponding increases in premiums could have a
material adverse effect on the Company.
Various federal and state legislative initiatives regarding the health
care industry have been proposed during recent legislative sessions, and health
care reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or operations of the Company.
Reference is also made to the disclosures contained under the heading
"Cautionary Factors" included elsewhere in this Quarterly Report on Form 10-Q,
which could cause the Company's actual results to differ from those projected in
forward looking statements of the Company made by or on behalf of the Company.
In addition, certain of these factors may have affected the Company's past
results and may affect future results.
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<PAGE> 18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Class Action Lawsuits
On January 4, 1995, a purported class action lawsuit was filed in the
Delaware Court of Chancery under the caption Philip Laufer v. Roger F. Greaves,
et al., C.A. No. 13952 (the "Laufer Complaint"), against the Company and the
members of its Board of Directors. The Laufer Complaint alleged that the
individual directors breached their fiduciary duties to the Company's public
stockholders by allegedly refusing to seriously consider certain acquisition
bids for the Company. The Laufer Complaint further alleged that the individual
directors had put their own interest before the interests of the Company's
public stockholders and deprived the public stockholders of the opportunities to
operate competitively in the HMO marketplace and maximize the value of their
investment. The Laufer Complaint requested an injunction ordering the Company's
directors: to evaluate alternatives to maximize shareholder value; to ensure
that no conflicts exist between the individual directors' interests and their
fiduciary obligations to the public stockholders; and to account for all damages
allegedly suffered by the class members. The Laufer Complaint also requested
that the Court order the defendants to pay plaintiffs' costs and disbursements
including attorneys' and expert fees.
On January 5, 1995, a second purported class action lawsuit was brought
in the Delaware Court of Chancery under the caption, John E. Kovalchick v.
Health Systems International, Inc. et al., C.A. No. 13953 (the "Kovalchick
Complaint"), against the Company and the members of its Board of Directors. The
Kovalchick Complaint made allegations similar to those in the Laufer Complaint
and sought similar relief. By order of the Court of Chancery dated March 6,
1995, the Laufer and Kovalchick actions were consolidated under the caption In
re Health Systems International, Inc. Shareholders Litigation, Consolidated C.A.
No. 13952 (the "Consolidated Action"). On March 31, 1995, all defendants filed
answers in the Consolidated Action. On April 19, 1996, the Court entered a
Stipulation and Order of Dismissal dismissing the Consolidated Action without
prejudice.
Restricted Stock Dispute
Following the conversion of Health Net to a for-profit subsidiary of
the Company (the "Conversion"), a restricted stock plan (the "Restricted Stock
Plan") was adopted and restricted shares were issued to certain management
employees of Health Net. In February 1993, the California Department of
Corporations (the "DOC") informed Health Net that it believed the issuance of
such restricted shares ("Restricted Shares") of the Company to persons who were
stockholders of the Company as of the date of the Conversion (the "Restricted
Share Recipients") violated certain provisions and terms imposed by the DOC in
connection with the Conversion. In March 1993, the DOC insisted that such
restricted shares be rescinded and stated that the DOC would take steps
necessary to revoke the approval of the Conversion if the issuance of the
Restricted Shares was not rescinded (the "Conditional Revocation Order"). In
April 1993 the Restricted Share Recipients agreed to rescind all of the
Restricted Shares issued to them, under express protest to the DOC.
Subsequently, a formal protest was filed with the DOC which requested a hearing
regarding the correctness of the decision.
<PAGE> 19
On September 14, 1994, Health Net, the Company and certain of the
Restricted Stock Recipients, on behalf of all the Restricted Stock Recipients
(the "Petitioners"), filed a Petition for Writ of Administrative Mandamus in the
Superior Court of the County of Los Angeles (Case No. BS030426) (the "Writ
Proceeding"). The Writ Proceeding seeks to overturn the Conditional Revocation
Order and to require the Commissioner of the DOC to follow procedures set forth
in the Administrative Procedures Act which would result in an administrative
hearing regarding the correctness of the Conditional Revocation Order or, in the
alternative, to treat the Conditional Revocation Order as a final agency action
and to have the Court order the Commissioner of the DOC to rescind the
Conditional Revocation Order.
On May 25, 1995, the Petitioners filed an amended petition expanding
the original claims and adding a new cause of action for a declaratory judgment
that would revoke the rescission of the issuance of the Restricted Shares. The
DOC and The California Wellness Foundation (the "Foundation") filed new
demurrers to the amended petition on July 3, 1995. At a hearing on July 28,
1995, the Court sustained the demurrers without leave to amend. On August 7,
1995, the Petitioners filed objections to the Court's Statement of Decision. On
August 15, 1995, the Court overruled the objections of the Petitioners to the
Court's Statement of Decision. On September 8, 1995, the Court entered an Order
of Dismissal, and the Amended Petition for Writ of Mandate and Complaint for
Declaratory Relief of the Petitioners was dismissed. On September 19, 1995, the
DOC served notice of the entry of the Order of Dismissal. On October 18, 1995,
the Petitioners filed a Notice of Appeal. The opening brief was filed on March
15, 1996, and the Respondents' briefs were filed on or around June 13, 1996. The
Reply Briefs are due August 19, 1996.
Under the terms of the Agreement and Plan of Merger relating to the
merger involving QualMed, Inc. and Health Net which created the Company, in the
event that the Petitioners are successful and the Restricted Shares are
permitted to be issued to the Original Shareholders, shares of common stock
would be transferred from the Foundation to the Restricted Stock Recipients and
the Company would not suffer any adverse effect other than the payment of legal
fees and related costs of the Writ Proceeding which the Company is obligated to
fund.
Miscellaneous Proceedings
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Based upon information presently available,
management of the Company is of the opinion, based in part on advice from
litigation counsel to the Company, that the final outcome of all such
proceedings should not have a material adverse effect upon the Company's results
of operations or financial condition.
<PAGE> 20
ITEM 2. CHANGES IN SECURITIES
Revolving Credit Facility
On April 26, 1996, the Company entered into an Amended and Restated
Credit Agreement among the Company, Bank of America National Trust and Savings
Association ("Bank of America"), as agent, and certain financial institutions
which are parties thereto (the "Credit Agreement") pursuant to which the Company
obtained an unsecured five-year $700 million revolving credit facility. The
Credit Agreement replaced the Company's prior credit agreement providing for an
unsecured $400 million revolving credit facility, which prior agreement was also
entered into by the Company with Bank of America, as agent.
Specifically, Section 7.11 of the Credit Agreement provides that the
Company and its subsidiaries may, so long as no event of default exists (i)
declare and distribute stock as a dividend; (ii) purchase, redeem or acquire its
stock, options and warrants with the proceeds of concurrent public offerings and
(iii) declare and pay dividends or purchase, redeem or otherwise acquire its
capital stock, warrants, options or similar rights with cash so long as the sum
of such acquisitions does not exceed $150 million plus 25% of the net income of
the Company and its subsidiaries in fiscal 1995 plus 50% of the net income of
the Company and its subsidiaries in fiscal 1996 and subsequent years (calculated
on a cumulative consolidated basis).
In addition, under the Credit Agreement as originally executed the
Company was allowed to incur Subordinated Indebtedness (as defined in the Credit
Agreement) to repurchase its Class A Common Stock, but was limited to
repurchasing not more than 50% of the Class A Common Stock held by certain
designated stockholders (the "50% Repurchase Limitation"). The Credit Agreement
was amended by Amendment No. 1 thereto on May 10, 1996 to eliminate the 50%
Repurchase Limitation.
On May 28, 1996, the Credit Agreement was further amended by Amendment
No. 2 thereto to clarify the definition of the term "LIBOR Base Rate," a copy of
which Amendment No. 2 to the Credit Agreement is filed herewith.
Shareholder Rights Plan
On May 20, 1996, the Board of Directors of the Company declared a
dividend distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights and the expiration of the Rights and in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then outstanding and no separate Rights Certificates will be distributed.
Subject to certain exceptions contained in the Rights Agreement dated as of June
1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights
Agent (the "Rights Agreement"), the Rights will separate from the Common Stock
in the event any person acquires 15% or more of the
<PAGE> 21
outstanding Class A Common Stock, the Board of Directors of the Company declares
a holder of 10% or more of the outstanding Class A Common Stock to be an
"Adverse Person," or any person commences a tender offer for 15% of the Class A
Common Stock (each event causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock, at a price of $170.00
per one-thousandth share. However, in the event any person acquires 15% or more
of the outstanding Class A Common Stock, or the Board of Directors of the
Company declares a holder of 10% or more of the outstanding Class A Common Stock
to be an "Adverse Person," the Rights (subject to certain exceptions contained
in the Rights Agreement) will instead become exercisable for Class A Common
Stock having a market value at such time equal to $340.00. The Rights are
redeemable under certain circumstances at $.01 per Right and will expire, unless
earlier redeemed, on July 31, 2006.
A copy of the Rights Agreement has been filed with the Securities and
Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on
Form 8-A (File No. 001-12718), and is available free of charge from the Company.
This summary description of the Rights does not purport to be complete and is
qualified in its entirety by reference to the Rights Agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
<PAGE> 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 20, 1996, the Company held its 1996 Annual Meeting of
Stockholders (the "Annual Meeting"). At the Annual Meeting, the Company's
stockholders voted upon proposals to (1) elect five directors for a term of
three years ("Proposal 1"); and (2) ratify the selection of Deloitte & Touche
LLP as the Company's independent public accountants for the year ended December
31, 1996 ("Proposal 2").
The following provides voting information for all matters voted upon at
the Annual Meeting, and includes a separate tabulation with respect to each
nominee for director:
Proposal 1
<TABLE>
<CAPTION>
Director Nominee Votes For Votes Against Votes Withheld
- ---------------- --------- ------------- --------------
<S> <C> <C> <C>
Malik M. Hasan, M.D. 20,096,641 0 114,646
Lawrence E. Austin, M.D. 20,097,124 0 114,163
Dale T. Berkbigler, M.D. 20,091,173 0 120,114
Roger F. Greaves 20,096,248 0 115,039
Kenneth W. Kizer 20,097,324 0 113,963
</TABLE>
Each of Drs. Hasan, Austin, Berkbigler and Kizer and Mr. Greaves was
elected as a Class III director for a three-year term at the Annual Meeting.
Other directors whose term of office as directors continued after the Annual
Meeting were: J. Thomas Bouchard, Charles T. Braden, George Deukmejian, Thomas
T. Farley, Michael E. Gallagher, E. Keith Hovland, Robert L. Montgomery, Douglas
M. Mancino and J. Kevin Murphy. Mr. Hovland resigned as a director effective May
15, 1996 in connection with his retirement from the Company. Jay M. Gellert was
elected as a director of the Company as of July 1, 1996.
Proposal 2
With respect to the ratification of the selection of Deloitte & Touche
LLP as the Company's independent public accountants for the year ended December
31, 1996, 20,201,358 votes were cast in favor, 3,498 votes were cast against and
6,431 votes were withheld for such proposal.
In total, 22,329,678 shares of Class A Common Stock were eligible to
vote at the Annual Meeting, 20,211,287 shares were voted at the Annual Meeting
and 2,118,391 shares were unvoted at the Annual Meeting.
<PAGE> 23
ITEM 5. OTHER INFORMATION
Public Offering
On May 15, 1996, the Company completed a public offering (the
"Offering") in which the Company sold 3,194,374 shares of Class A Common Stock
and the Foundation sold 6,664,964 shares of Class A Common Stock (constituting
6,664,964 shares of Class B Common Stock which automatically converted into
shares of Class A Common Stock upon the sale) for a per share purchase price to
the public of $30.00. The proceeds received by the Company from the sale of the
3,194,374 shares of Class A Common Stock were approximately $92.4 million after
deducting underwriting discounts and commissions and estimated expenses of the
Offering payable by the Company. The Company used its net proceeds from the
Offering to repurchase 3,194,374 shares of Class A Common Stock held pursuant to
the Amended and Restated Health Net Associate Trust Agreement dated as of May 1,
1994 (the "Associate Trust Agreement"), on behalf of certain founding
stockholders of the Company at the date of the conversion of Health Net to
for-profit status (the "Class A Stockholders"). The repurchase price per share
paid by the Company to repurchase these shares of Class A Common Stock from the
Class A Stockholders was $28.92, which represented the net proceeds per share
received by the Company in the Offering. All 3,194,374 of such shares
repurchased by the Company are currently held as treasury stock. The Company did
not receive any of the proceeds from the sale of shares of Class A Common Stock
by the Foundation.
Revolving Credit Facility
As indicated in Item 2 above, on April 26, 1996 the Company executed
the Credit Agreement which provides an unsecured five-year $700 million
revolving credit facility. A copy of the Credit Agreement was attached as
Exhibit 10.1 to the Company's Current Report on Form 8-K dated April 26, 1996.
Amendment No. 1 to the Credit Agreement was attached as Exhibit 10.33 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996 and
Amendment No. 2 to the Credit Agreement is attached as Exhibit 10.33 to this
Quarterly Report on Form 10-Q. Capitalized terms used but not defined herein
have the meanings set forth in the Credit Agreement.
Approximately $319 million which was borrowed under the Company's prior
$400 million credit facility was rolled into the new facility under the Credit
Agreement. The new facility is available to the Company and its subsidiaries for
general corporate purposes including Permitted Acquisitions and Joint Ventures
and, if the Company should elect, to repurchase or redeem the Company's capital
stock to the extent allowed by the Federal Reserve Board Regulations and other
requirements of law and as set forth in the Credit Agreement. As of June 30,
1996, the Company had drawn approximately $319 million under the facility of
which approximately $135 million had been applied to pay a portion of the notes
payable to the Foundation, approximately $100 million had been drawn to fund the
Company's acquisition of M.D. Enterprises of Connecticut, Inc., approximately
$75 million had been drawn to fund the Company's acquisition of G.H. Holding
Corporation and approximately $9 million had been drawn to fund certain stock
repurchases from the Class A Stockholders in February of 1996.
<PAGE> 24
Bank of America is the lead bank and agent for the other participating
banks named in the Credit Agreement. At the election of the Company, and subject
to customary covenants, loans can be initiated on a bid or committed basis and
will carry interest at offshore or domestic rates, but subject to the applicable
LIBOR Rate or the Base Rate, of .50% above the Federal Funds Rate or the Bank of
America "reference rate." Actual rates on borrowings under the facility will
vary based on competitive bidding, sources of funds and the Company's senior
leverage ratio at the time of the borrowing. The facility is available for five
years, until April 2001, but may be extended, under certain circumstances, for
two additional years until April 2003.
Loans under the facility are unsecured but the Company and its
subsidiaries are subject to affirmative and negative covenants. As described in
Item 2 above, these include limitations on the payment of cash dividends on the
Company's capital stock and, in certain cases, the redemption or repurchase of
capital stock or securities. In addition to obligations incurred under the
facility, the Company and its subsidiaries are entitled to incur Permitted
Subordinated Indebtedness for seller financing of Permitted Acquisitions and
certain other items in an aggregate amount of up to $150 million and to incur
unsecured indebtedness to repurchase the Company's Class A Common Stock.
Under the Credit Agreement, the Company is (i) obligated to maintain at
all times a Total Leverage Ratio not to exceed 3 to 1, a Fixed Charge Coverage
of not less than 2.75 to 1 and to preserve its combined net worth and Permitted
Class A Subordinated Indebtedness (as defined in the Credit Agreement) at not
less than $100 million plus 50% of net income after December 31, 1994 on a
cumulative consolidated basis, (ii) obligated to limit liens on its assets to
those incurred in the normal course and for taxes and other similar obligations,
and (iii) subject to customary covenants to dispose of assets only in the
ordinary course and generally at fair value, to restrict mergers and
consolidations to those permitted under the Credit Agreement, and to limit
loans, leases, joint ventures and contingent obligations and certain
transactions with affiliates. Upon the occurrence of a default or an event of
default, the Company and its subsidiaries would be subject to further
restrictions, including with respect to the operating HMO subsidiaries, an
obligation to advance to the parent company reserves in excess of those held to
comply with state and similar administrative requirements.
Cautionary Statements
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, the Company is hereby filing
cautionary statements identifying important risk factors that could cause the
Company's actual results to differ materially from those projected in
forward-looking statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that the following 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. The following factors should
be considered in conjunction with any discussion of operations or results by the
Company or its representatives, including any forward-looking discussion, as
well as comments contained in press releases, presentations to securities
analysts or investors, or other communications by the Company.
<PAGE> 25
In making these statements, the Company is not undertaking to address
or update each factor in future filings or communications regarding the
Company's business or results, and is not undertaking to address how any of
these factors may have caused changes to discussions or information contained in
previous filings or communications. In addition, certain of the matters
discussed below may have affected the Company's past results and may affect
future results.
Health Care Costs. A large portion of the revenue received by the
Company is expended to pay the costs of health care services or supplies
delivered to its members. The total health care costs incurred by the Company
are affected by the number of individual services rendered and the cost of each
service. Much of the Company's premium revenue is set in advance of the actual
delivery of services and the related incurring of the cost, usually on a
prospective annual basis. While the Company attempts to base the premiums it
charges at least in part on its estimate of expected health care costs over the
fixed premium period, competition, regulations and other circumstances may limit
the Company's ability to fully base premiums on estimated costs. In addition,
many factors may and often do cause actual health care costs to exceed those
costs estimated and reflected in premiums. These factors may include increased
utilization of services, increased cost of individual services, catastrophes,
epidemics, seasonality, general inflation, new mandated benefits or other
regulatory changes and insured population characteristics.
Marketing. The Company markets its products and services through both
employed sales people and independent sales agents. Although the Company has a
number of such sales employees and agents, if certain key sales employees or
agents or a large subset of such individuals were to leave the Company, its
ability to retain existing customers and members could be impaired. In addition,
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 necessary or important. Certain of the Company's
health plans or other business units may not have obtained or may not desire or
be able to obtain or maintain such accreditation or certification which could
adversely affect the Company's ability to obtain or retain business with such
customers.
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.
Competition. The Company competes with a number of other entities in
the geographic and product markets in which it operates, some of which other
entities may have certain characteristics or capabilities which give them an
advantage in competing with the Company. The Company believes there are few
barriers to entry in these markets, so that the addition of new competitors can
occur relatively easily. Certain of the Company's customers may decide to
perform for themselves functions or services formerly provided by the Company,
which should result in a decrease in the Company's revenues. Certain of the
Company's providers may decide to market products and services to Company
customers in competition with the Company. In addition, significant merger and
acquisition activity has occurred in the industry in which the Company operates
as well as in industries which act as suppliers to the Company such as the
hospital, physician, pharmaceutical and medical device industries. This activity
may create
<PAGE> 26
stronger competitors and/or result in higher health care costs. To the extent
that there is strong competition or that competition intensifies in any market,
the Company's ability to retain or increase customers, its revenue growth, its
pricing flexibility, its control over medical cost trends and its marketing
expenses may all be adversely affected.
Provider Relations. One of the significant techniques the Company uses
to mange health care costs and utilization and monitor the quality of care being
delivered is contracting with physicians, hospitals and other providers. Because
of the large number of providers with which the Company's health plans contract,
the Company currently believes 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 organizations or multi-specialty physician groups, may have
significant market positions or even monopolies. Many of these providers may
compete directly with the Company. If such providers refuse to contract with the
Company or utilize their market position to negotiate favorable contracts 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.
Administration and Management. 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 other
administrative expenses may occur from time-to-time due to business or product
start-ups or expansions, growth or changes in business, acquisition, regulatory
requirements or other reasons. Such expense increases are not clearly
predictable and increases in administrative expenses may adversely affect
results.
The Company's business is significantly dependent on effective
information systems. The Company has many different information systems for its
various businesses. The Company is in the process of attempting to reduce the
number of systems and also upgrade and expand its information systems
capabilities. Failure to maintain an effective information system could result
in loss of existing customers and difficulty in attracting new customers,
customer and provider disputes, regulatory problems, increases in administrative
expenses or other adverse consequences. In addition, the Company may, from
time-to-time, obtain significant portions of its systems-related or other
services or facilities from independent third parties which may make the
Company's operations vulnerable to such third parties' failure to perform
adequately.
The Company currently believes 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.
Management of Growth. The Company has made several large acquisitions
in recent years, and has an active ongoing acquisition program. Failure to
effectively integrate acquired operations could result in increased
administrative costs or customer confusion or dissatisfaction. The Company may
also not be able to manage this growth effectively, including not being able
<PAGE> 27
to continue to develop processes and systems to support its growing operations.
There can be no assurance that the Company will be able to maintain its
historical growth rate.
Government Programs and Regulation. The Company's business is heavily
regulated. The laws and rules governing the Company's business and
interpretations of those laws and rules are subject to frequent change. Existing
or future laws and rules could force the Company to change how it does business
and may restrict the Company's revenue and/or enrollment growth and/or increase
its health care and administrative costs. Regulatory approvals must be obtained
and maintained to market many of the Company's products and services. Delays in
obtaining or failure to obtain or maintain such approvals could affect the
Company's revenue or the number of its members, or could increase costs.
A significant portion of the Company's revenues relate to federal,
state and local government health care coverage programs. These types of
programs, such as Medicare and Medicaid programs, are generally subject to
frequent change including changes which may reduce the number of persons
enrolled or eligible, reduce the revenue received by the Company or increase the
Company's administrative or health care costs under such programs. Such changes
may in the future adversely affect the Company's results and its willingness to
participate in such programs.
The Company is also subject to various governmental audits and
investigations. Such activities could result in the loss of licensure or the
right to participate in certain programs, or the imposition of fines, penalties
and 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.
Loss Reserves. The Company's loss reserves are estimates of future
costs based on various assumptions. The accuracy of these estimates may be
affected by external forces such as changes in the rate of inflation, the
regulatory environment, the judicial administration of claims, medical costs and
other factors. Included in the loss reserves are estimates for incurred but not
reported ("IBNR") claims which are established for unreported claims and adverse
loss developments relating to current and prior years. On a quarterly basis, the
Company and an independent actuary review the adequacy of its loss reserves
using generally accepted actuarial methods, and annually, an opinion is used by
the actuary as to the adequacy of the reserves. If the assumptions on which the
estimates are based prove to be incorrect and reserves are inadequate to cover
the Company's actual experience, the Company's profitability could be adversely
affected.
Litigation and Insurance. The Company is subject to a variety of legal
actions to which any corporation may be subject, including employment and
employment discrimination-related suits, employee benefit claims, breach of
contract actions, tort claims, shareholder suits, including for securities
fraud, and intellectual property related litigation. 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, including disputes over withheld compensation and claims
related to self-funded business. In some cases, substantial non-economic or
punitive damages may be sought. While the Company currently has insurance
coverage for some of these
<PAGE> 28
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.
Stock Market. Recently, the market prices of the securities of certain
of the publicly-held companies in the industry in which the Company operates
have shown volatility and sensitivity in response to many factors, including
public communications regarding managed care, legislative or regulatory actions,
health care cost trends, pricing trends, competition, earning or membership
reports of particular industry participants, and acquisition activity. There can
be no assurances regarding the level of stability of the Company's share price
at any time or the impact of these or any other factors on the share price.
<PAGE> 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this Quarterly Report on
Form 10-Q or are incorporated herein by reference:
2.1 Agreement and Plan of Merger, dated August 28, 1993, between
and among HN Management Holdings, Inc., QualMed, Inc. and QM
Merger Sub, Inc. (included as Annex A to the HSI Proxy
Statement/Prospectus filed with HSI's Registration Statements
on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
2.1.1 Amendment No. 1 to the Agreement and Plan of Merger, dated
August 29, 1993, between and among HN Management Holdings,
Inc., QualMed, Inc. and QM Merger Sub, Inc. (included in Annex
A to the HSI Proxy Statement/Prospectus filed with HSI's
Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated
by reference herein).
2.1.2 Letter Agreement re: Split Ratio, dated December 6, 1993, by
and among HN Management Holdings, Inc., QualMed, Inc. and QM
Merger Sub, Inc. (included in Annex A to the HSI Proxy
Statement/Prospectus filed with HSI's Registration Statements
on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
2.2 Agreement and Plan of Merger, dated September 14, 1994, by and
among Health Systems International, Inc., M.D. Enterprises of
Connecticut, Inc., M.D. Health Plan, Inc. and MDE Merger Sub,
Inc., (included in Annex A to the Proxy Statement/Prospectus
with HSI's Registration Statement on Form S-4 (File No.
33-86524) which is incorporated by reference herein).
2.2.1 Amendment No. 1 to the Agreement and Plan of Merger, dated
November 14, 1994, by and among Health Systems International,
Inc., M.D. Enterprises of Connecticut, Inc., M.D. Health Plan,
Inc. and MDE Merger Sub, Inc. (included in Annex A to the
Proxy Statement/Prospectus with HSI's Registration Statement
on Form S-4 (File No. 33-86524) which is incorporated by
reference herein).
2.2.2 Amended and Restated Agreement and Plan of Merger dated
January 13, 1995 by and among Health Systems International,
Inc., M.D. Enterprises of Connecticut, Inc., M.D. Health Plan,
Inc. and MDE Merger Sub, Inc., (included in Annex A to the
Proxy Statement/Prospectus, filed with Amendment No. 1 to
HSI's Registration Statement on Form S-4 (File No. 33-86524)
which is incorporated by reference herein).
2.3 Purchase Agreement, dated as of June 13, 1995, between Health
Systems International, Inc. and G.H. Holding Corporation
(including the Addendum
<PAGE> 30
thereto dated as of July 10, 1995) (filed as Exhibit 2.1 to
HSI's Current Report on Form 8-K dated July 10, 1995, which is
incorporated by reference herein).
3.1 Third Amended and Restated Certificate of Incorporation of HSI
(included as Exhibit 4.1 to the HSI Registration Statement on
Form S-8 (File no. 33-74780) which is incorporated by
reference herein).
3.2 Third Amended and Restated By-Laws of HSI (included as Exhibit
4.1 to HSI's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1995, which is incorporated by reference
herein).
4.1 Form of Class A Common Stock Certificate of HSI (included as
Exhibit 4.2 to HSI's Registration Statements on Forms S-1 and
S-4 (File nos. 33-72892 and 33-72892-01, respectively which is
incorporated by reference herein).
4.2 Form of Class B Common Stock Certificate of HSI (included as
Exhibit 4.3 to HSI's Registration Statements on Forms S-1 and
S-4 (File nos. 33-72892 and 33-72892-01, respectively) which
is incorporated by reference herein).
4.3.1 Nonnegotiable Senior Secured Promissory Note in the original
principal amount of $150,000,000, dated January 28, 1992, made
by Health Net in favor of The California Wellness Foundation
(filed as Exhibit 4.8 to HSI's Registration Statements on
Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
4.3.2 Nonnegotiable Subordinated Secured Promissory Note in the
original principal amount of $75,000,000, dated January 28,
1992, made by Health Net in favor of The California Wellness
Foundation (filed as Exhibit 4.9 to HSI's Registration
Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference
herein).
4.3.3 Senior Security Agreement, dated January 28, 1992, between
Health Net and The California Wellness Foundation (filed as
Exhibit 4.10 to HSI's Registration Statements on Forms S-1 and
S-4 (File nos. 33-72892 and 33-72892-01, respectively) which
is incorporated by reference herein).
4.3.4 Subordinated Security Agreement, dated January 28, 1992,
between Health Net and The California Wellness Foundation
(filed as Exhibit 4.11 to HSI's Registration Statements on
Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
4.3.5 Cash Pledge Agreement, dated January 28, 1992, by and between
Health Net and The California Wellness Foundation (filed as
Exhibit 4.12 to HSI's Registration Statements on Forms S-1 and
S-4 (File nos. 33-72892 and 33-72892-01, respectively) which
is incorporated by reference herein).
<PAGE> 31
4.3.6 Sinking Fund Agreement, dated as of January 28, 1992, by and
between Health Net and The California Wellness Foundation
(filed as Exhibit 4.13 to HSI's Registration Statements on
Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
4.3.7 Charitable Contribution Grant and Subordination Agreement,
dated January 28, 1992, between Health Net and The California
Wellness Foundation (filed as Exhibit 4.14 to HSI's
Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated
by reference herein).
4.3.8 Guaranty Agreement, dated January 28, 1992, between Health Net
and The California Wellness Foundation (filed as Exhibit 4.15
to HSI's Registration Statements on Forms S-1 and S-4 (File
nos. 33-72892 and 33-72892-01, respectively) which is
incorporated by reference herein).
9.1.1 Amended and Restated Trust Agreement, dated as of May 1, 1994,
among Roger F. Greaves, Gerald M. Cooper and Stephen D. Vogt,
as Trustees, and the shareholders on Exhibit 1 therein (filed
as Exhibit 9.1 to HSI's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1994) which is incorporated by
reference herein).
9.1.2 Letter Agreement, dated March 31, 1995, among Health Systems
International, Inc., WellPoint Health Networks Inc. and Roger
F. Greaves, Stephen D. Vogt and Gerald M. Cooper, as Trustees
of the Trust created pursuant to the Amended and Restated
Trust Agreement dated as of May 1, 1994 (filed as Exhibit 10.3
to HSI's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1995, which is incorporated by reference herein).
9.1.3 Letter Agreement dated as of January 26, 1995, among Health
Systems International, Inc., The California Wellness
Foundation and the founding stockholders of Health Systems
International, Inc. (filed as Exhibit 28.1 to HSI's Current
Report on Form 8-K dated January 26, 1995, which is
incorporated by reference herein).
9.1.4 Letter Agreement, dated March 9, 1995, among Health Systems
International, Inc. and Roger F. Greaves, Stephen D. Vogt and
Gerald M. Cooper, as Trustees of the Trust created pursuant to
the Amended and Restated Trust Agreement dated as of May 1,
1994 (filed as Exhibit 10.1 to HSI's Current Report on Form
8-K dated March 9, 1995, which is incorporated by reference
herein).
10.1 Amended Foundation Shareholder Agreement, dated as of January
28, 1992, among HN Management Holdings, Inc., the California
Wellness Foundation and the stockholders of HN Management
Holdings, Inc. named therein (filed as Exhibit 10.1 to HSI's
Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated
by reference herein).
<PAGE> 32
10.2 Officers' Agreement, dated August 28, 1993, by and among HN
Management Holdings, Inc., QualMed, Inc., Roger F. Greaves,
Stephen D. Vogt and Gerald M. Cooper (filed as Exhibit 10.2 to
HSI's Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated
by reference herein).
10.3 Employment Agreement, dated August 28, 1993, by and among HN
Management Holdings, Inc., Health Net and Joe V. Criscione
(filed as Exhibit 10.16 to HSI's Registration Statements on
Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
10.4 Employment Agreement, dated August 28, 1993, by and among
QualMed, Inc., HN Management Holdings, Inc. and Malik M.
Hasan, M.D. (filed as Exhibit 10.18 to HSI's Registration
Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference
herein).
10.5 Employment Agreement, dated August 28, 1993, by and among
QualMed, Inc., HN Management Holdings, Inc., Health Net and E.
Keith Hovland (filed as Exhibit 10.19 to HSI's Registration
Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference
herein).
10.6 Employment Agreement, dated August 28, 1993, by and among
QualMed, Inc., HN Management Holdings, Inc. and Dale T.
Berkbigler, M.D. (filed as Exhibit 10.20 to HSI's Registration
Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference
herein).
10.7 Employment Agreement, dated August 28, 1993, by and among
QualMed, Inc., HN Management Holdings, Inc. and Walter G.
Woodbury (filed as Exhibit 10.22 to HSI's Registration
Statements on Forms S-1 and S-4 (file nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference
herein).
10.8 Severance Payment Agreement, dated as of April 25, 1994, among
HSI, Health Net and James J. Wilk (filed as Exhibit 10.9 to
HSI's Annual Report on Form 10-K for the year ended December
31, 1994, which is incorporated by reference herein).
10.9 Severance Payment Agreement, dated as of April 25, 1994, among
HSI, QualMed, Inc. and B. Curtis Westen (filed as Exhibit
10.10 to HSI's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
10.10 Severance Payment Agreement, dated as of April 25, 1994, among
HSI, QualMed, Inc. and Terry Fouts, M.D. (filed as Exhibit
10.11 to HSI's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
<PAGE> 33
10.11 Amendment No. 1 to Employment Agreement dated as of April 27,
1994, by and among HSI, Health Net and Joe Criscione (filed as
Exhibit 10.12 to HSI's Annual Report on Form 10-K for the year
ended December 31, 1994, which is incorporated by reference
herein).
10.12 Amendment No. 1 to Employment Agreement dated as of April 27,
1994, by and among HSI, QualMed, Inc. and Walter G. Woodbury
(filed as Exhibit 10.15 to HSI's Annual Report on Form 10-K
for the year ended December 31, 1994, which is incorporated by
reference herein).
10.13 Amendment No. 1 to Employment Agreement dated as of April 25,
1994, by and among HSI, QualMed, Inc. and Malik Hasan, M.D.
(filed as Exhibit 10.16 to HSI's Annual Report on Form 10-K
for the year ended December 31, 1994, which is incorporated by
reference herein).
10.14 Amendment No. 1 to Employment Agreement dated as of April 27,
1994, by and among HSI, QualMed, Inc. and Dale T. Berkbigler,
M.D. (filed as Exhibit 10.17 to HSI's Annual Report on Form
10-K for the year ended December 31, 1994, which is
incorporated by reference herein).
10.15 Amendment No. 1 to Employment Agreement dated as of April 27,
1994, by and among HSI, QualMed, Inc. and E. Keith Hovland
(filed as Exhibit 10.18 to HSI's Annual Report on Form 10-K
for the year ended December 31, 1994, which is incorporated by
reference herein).
10.16 Office Lease, dated as of January 1, 1992, by and between
Warner Properties III and Health Net (filed as Exhibit 10.23
to HSI's Registration Statements on Forms S-1 and S-4 (File
Nos. 33-72892 and 33-72892-01, respectively) which is
incorporated by reference herein).
10.17 Health Systems International, Inc. Second Amended and Restated
1991 Stock Option Plan (filed as Exhibit 10.30 to Registration
Statement on Form S-4 (File No. 33-86524) which is
incorporated by reference herein).
10.18 Health Systems International, Inc. Second Amended and Restated
Non-Employee Director Stock Option Plan (filed as Exhibit
10.31 to Registration Statement on Form S-4 (File No.
33-86524) which is incorporated by reference herein).
10.19 Health Systems International, Inc. Employee Stock Purchase
Plan (filed as Exhibit 10.33 to HSI's Registration Statements
on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01
respectively) which is incorporated by reference herein).
10.20 Health Systems International, Inc. 1994 Optional Stock
Repurchase Program (filed as Exhibit 10.1 to HSI's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1994,
filed May 13, 1994, which is incorporated by reference
herein).
<PAGE> 34
10.21 Health Systems International, Inc. Performance-Based Annual
Bonus Plan (filed as Exhibit 10.35 to Registration Statement
on Form S-4 (File No. 33-86524) which is incorporated by
reference herein).
10.22 Deferred Compensation Agreement dated as of March 3, 1995, by
and among Malik M. Hasan, M.D., HSI and the Compensation and
Stock Option Committee of the Board of Directors of HSI (filed
as Exhibit 10.31 to HSI's Annual Report on Form 10-K for the
year ended December 31, 1994, which is incorporated by
reference herein).
10.23 Trust Agreement for Deferred Compensation Arrangement for
Malik M. Hasan, M.D., dated as of March 3, 1995, by and
between HSI and Norwest Bank Colorado N.A. (filed as Exhibit
10.32 to HSI's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
10.24 Registration Rights Agreement dated as of March 2, 1995
between HSI and the Foundation (filed as Exhibit No. 28.2 to
HSI's Current Report on Form 8-K dated March 2, 1995, which is
incorporated by reference herein).
10.25 Description of Retention Payment Arrangement between Health
Systems International, Inc. and Andrew Wang (filed as Exhibit
10.10 to HSI's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1995, which is incorporated by reference
herein).
10.26 Health Systems International, Inc. 1995 Stock Appreciation
Right Plan (filed as Exhibit 10.12 to HSI's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1995, which
is incorporated by reference herein).
10.27 Letter Agreement Re: Temporary Warehouse/Mail Center
Operations Support, dated October 16, 1995, between Health Net
and CBS Associates, Inc. (an affiliate of Charles Braden, a
director of HSI) (filed as Exhibit 10.15 to HSI's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1995,
which is incorporated by reference herein).
10.28 Employment Letter, dated June 9, 1995, between Philip Katz,
Ph.D. and Health Net (filed as Exhibit 10.38 to HSI's Annual
Report on Form 10-K for the year ended December 31, 1995,
which is incorporated by reference herein).
10.29 Agreement and accompanying Promissory Note, each dated August
17, 1995, between Philip Katz, Ph.D. and Health Net (filed as
Exhibit 10.39 to HSI's Annual Report on Form 10-K for the year
ended December 31, 1995, which is incorporated by reference
herein).
10.30 Credit Agreement dated as of April 12, 1995 among Health
Systems International, Inc., Bank of America National Trust
and Savings Association, as Agent, and financial institutions
party thereto (filed as Exhibit 10.17 to HSI's Quarterly
<PAGE> 35
Report on Form 10-Q for the quarter ended March 31, 1995,
which is incorporated by reference herein).
10.31 Amended and Restated Credit Agreement dated as of April 26,
1996 among Health Systems International, Inc., Bank of America
National Trust and Savings Association, as Agent, and
financial institutions party thereto (filed as Exhibit 10.1 to
HSI's Current Report on Form 10-K dated May 3, 1996, which is
incorporated by reference herein).
10.32 Amendment No. 1 to Credit Agreement dated as of May 10, 1996
among Health Systems International, Inc., Bank of America
National Trust and Savings Association, as Agent, and
financial institutions party thereto (filed as Exhibit 10.32
to HSI's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1996, which is incorporated by reference herein).
*10.33 Amendment No. 2 to Credit Agreement dated as of May 28, 1996
among Health Systems International, Inc., Bank of America
National Trust and Savings Association, as Agent, and
financial institutions party thereto, a copy of which is filed
herewith.
*10.34 Confidential Settlement and Separation Agreement and General
Release dated as of June 15, 1996 by and between E. Keith
Hovland and HSI, a copy of which is filed herewith.
*10.35 Employment Letter Agreement dated May 28, 1996 between Michael
D. Pugh and QualMed, Inc., a copy of which is filed herewith.
*10.36 Employment Letter Agreement dated June 4, 1996 between Arthur
M. Southam and HSI and Health Net, a copy of which is filed
herewith.
10.37 Rights Agreement dated as of June 1, 1996 by and between the
Company and Harris Trust and Savings Bank, as Rights Agent
(filed as Exhibit 99.1 to the Company's Registration Statement
on Form 8-A (File No. 001-12718) which is incorporated by
reference herein).
*11.1 Statement relative to computation of earnings per share of the
Company, a copy of which is filed herewith.
21.1 Subsidiaries of HSI (filed as Exhibit 21.1 to HSI's Annual
Report on Form 10-K for the year ended December 31, 1995,
which is incorporated by reference herein).
*27.1 Financial Data Schedule, a copy of which is filed herewith.
* A copy of the Exhibit is filed herewith.
<PAGE> 36
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by the Company
during the quarterly period ended June 30, 1996:
1. A report dated April 11, 1996 was filed announcing that the Company
intended to take an approximately $34.2 million pre-tax one-time restructuring
charge in its second quarter ending June 30, 1996, amounting to approximately
$.41 per share after tax, which charge would cover non-recurring costs of a
comprehensive restructuring of the Company's Health Net subsidiary, computer
software and hardware write-offs and the consolidation of certain operational
functions of other subsidiaries.
2. A report dated May 3, 1996 was filed announcing that the Company
had entered into a new Amended and Restated Credit Agreement, dated as of April
26, 1996, providing for a $700 million revolving credit facility with a
consortium of commercial banks.
No other Current Reports on Form 8-K were filed by the Company during
such period.
<PAGE> 37
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.
HEALTH SYSTEMS INTERNATIONAL, INC.
(Registrant)
Date: August 14, 1996 /s/ Malik M. Hasan, M.D.
--------------------------------------
Malik M. Hasan, M.D., Chairman of the
Board of Directors and Chief
Executive Officer
Date: August 14, 1996 /s/ Jay M. Gellert
--------------------------------------
Jay M. Gellert, President and
Chief Operating Officer
<PAGE> 1
Exhibit 10.33
SECOND AMENDMENT TO
AMENDED AND RESTATED CREDIT AGREEMENT
THIS SECOND AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT is made
and dated as of May 28, 1996 (the "SECOND AMENDMENT") among Health Systems
International, Inc. (the "Company"), the Banks party to the Amended and
Restated Credit Agreement referred to below, and BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, a national banking association, as Agent (the
"AGENT"), and amends that certain Amended and Restated Credit Agreement dated
as of April 26, 1996, as amended by that certain First Amendment to Amended and
Restated Credit Agreement dated as of May 10, 1996 (as so amended or modified
from time to time, the "CREDIT AGREEMENT").
RECITALS
WHEREAS, the Company has requested the Agent and the Banks to amend
certain provisions of the Credit Agreement, and the Agent and the Banks are
willing to do so, on the terms and conditions specified herein;
NOW, THEREFORE, for good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereby agree as follows:
1. Terms. All terms used herein shall have the same meanings as
in the Credit Agreement unless otherwise defined herein. All references to the
Credit Agreement shall mean the Credit Agreement as hereby amended.
2. Amendment. The Company, the Agent and the Banks hereby agree
to amend the Credit Agreement by deleting the clause "to the nearest 1/16th of
1%" that appears in the definition of the term "LIBOR Base Rate" in Section
1.01 of the Credit Agreement and replacing it with the clause "to the nearest
1/10,000 of 1%".
3. Representations and Warranties. The Company represents and
warrants to the Agent and the Banks that, on and as of the date hereof, and
after giving effect to this Second Amendment:
3.1 Authorization. The execution, delivery and performance by the
Company of this Second Amendment has been duly authorized by all necessary
corporate action, and this Second Amendment has been duly executed and
delivered by the Company.
-1-
<PAGE> 2
3.2 Binding Obligation. This Second Amendment
constitutes the legal, valid and binding obligations of the Company,
enforceable against it in accordance with its terms, except as enforceability
may be limited by applicable bankruptcy, insolvency, or similar laws affecting
the enforcement of creditors' rights generally or by equitable principles
relating to enforceability.
3.3 No Legal Obstacle to Amendment. The execution,
delivery and performance of this Second Amendment will not (a) contravene the
Organization Documents of the Company; (b) constitute a breach or default under
any contractual restriction or violate or contravene any law or governmental
regulation or court decree or order binding on or affecting the Company which
individually or in the aggregate does or could reasonably be expected to have a
Material Adverse Effect; or (c) result in, or require the creation or
imposition of, any Lien on any of the Company's properties. No approval or
authorization of any governmental authority is required to permit the
execution, delivery or performance by the Company of this Second Amendment, or
the transactions contemplated hereby.
3.4 Incorporation of Certain Representations. The
representations and warranties of the Company set forth in Article V of the
Credit Agreement are true and correct in all respects on and as of the date
hereof as though made on and as of the date hereof, except as to such
representations made as of an earlier specified date.
3.5 Default. No Default or Event of Default under the
Credit Agreement has occurred and is continuing.
4. Conditions, Effectiveness. The effectiveness of this Second
Amendment shall be subject to the compliance by the Company with its agreements
herein contained, and to the delivery of such other evidence with respect to
the Company as the Agent may reasonably request in connection with this Second
Amendment and the compliance with the conditions set forth herein.
5. Miscellaneous.
5.1 Effectiveness of the Credit Agreement and the Notes. Except
as hereby expressly amended, the Credit Agreement and the Notes shall each
remain in full force and effect, and are hereby ratified and confirmed in all
respects on and as of the date hereof.
5.2 Waivers. This Second Amendment is limited solely to the
matters expressly set forth herein and is specific in time and in intent and
does not constitute, nor should it be construed as, a waiver or amendment of
any other term or condition, right, power or privilege under the Credit
Agreement or under any agreement, contract, indenture, document or instrument
mentioned therein; nor does it preclude or prejudice any rights of the Agent or
the Banks thereunder, or any exercise thereof or the exercise of any other
right, power or privilege, nor shall it require the Majority Banks to agree to
an amendment, waiver
-2-
<PAGE> 3
or consent for a similar transaction or on a future occasion, nor shall any
future waiver of any right, power, privilege or default hereunder, or under any
agreement, contract, indenture, document or instrument mentioned in the Credit
Agreement, constitute a waiver of any other right, power, privilege or default
of the same or of any other term or provision.
5.3 Counterparts. This Second Amendment may be executed
in any number of counterparts, and all of such counterparts taken together
shall be deemed to constitute one and the same instrument. This Second
Amendment shall not become effective until the Company, the Agent and the
Majority Banks shall have signed a copy hereof and the same shall have been
delivered to the Agent.
5.4 Governing Law. This Second Amendment shall be
governed by and construed in accordance with the laws of the State of New York.
IN WITNESS WHEREOF, the parties hereto have caused this Second
Amendment to be duly executed and delivered as of the date first written above.
HEALTH SYSTEMS IN INTERNATIONAL, INC.
By: /s/ MICHAEL E. JANSEN
-------------------------------
Name: Michael E. Jansen, Esq.
-----------------------------
Title: Vice President, Assistant
----------------------------
General Counsel and Assistant
Secretary
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, as Agent
By: /s/ RUTH Z. EDWARDS
-------------------------------
Name: Ruth Z. Edwards
-----------------------------
Title: Vice President
----------------------------
-3-
<PAGE> 4
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, as a Bank
By: /s/ WYATT R RITCHIE
-------------------------------
Name: Wyatt R Ritchie
-----------------------------
Title: Managing Director
----------------------------
ABN AMRO BANK, N.V.
By: ABN AMRO North America, Inc.
its agent
By: /s/ DAVID J. STASSEL
-------------------------
Name: David J. Stassel
-----------------------
Title: VP and Director
----------------------
By: /s/ JOHN A. MILLER
-------------------------
Name: John A. Miller
-----------------------
Title: Director
----------------------
BANK OF MONTREAL
By: /s/ IRENE M. GELLER
-------------------------------
Name: Irene M. Geller
-----------------------------
Title: Director
----------------------------
THE BANK OF NEW YORK
By: /s/ REBECCA K. LEVINE
-------------------------------
Name: Rebecca K. Levine
-----------------------------
Title: Assistant Vice President
----------------------------
-4-
<PAGE> 5
THE BANK OF NOVA SCOTIA
By: /s/ ALAN PINDERGAST
-------------------------------
Name: Alan Pindergast
-----------------------------
Title: Relationship Manager
----------------------------
BANQUE NATIONALE DE PARIS
By: /s/ C. BETTLES
-------------------------------
Name: C. Bettles
-----------------------------
Title: Sr. V.P. & Manager
----------------------------
By: /s/ MARGARET MUDD
-------------------------------
Name: Margaret Mudd
-----------------------------
Title: V.P.
----------------------------
BANQUE PARIBAS
By: /s/ CLARE BAILHE
-------------------------------
Name: Clare Bailhe
-----------------------------
Title: V.P.
----------------------------
By: /s/ LB
-------------------------------
Name: Lee S. Buckner
-----------------------------
Title: Group Vice President
----------------------------
-5-
<PAGE> 6
CHEMICAL BANK
By: /s/ DAWN LEE LUM
-------------------------------
Name: Dawn Lee Lum
-----------------------------
Title: Vice President
----------------------------
CITIBANK, N.A., as a Bank and
Co-Agent
By: /s/ MARGARET AU BROWN
-------------------------------
Name: Margaret Au Brown
-----------------------------
Title: Vice President
----------------------------
399 Park Ave./8th Fl./Zn2
(212) 599-0501
COOPERATIEVE CENTRALE RAIFFEISEN-
BOERENIENBANK B.A. "RABOBANK
NEDERLAND" NEW YORK BRANCH
By: /s/ RICHARD J. CERF
-------------------------------
Name: Richard J. Cerf
-----------------------------
Title: Vice President
----------------------------
By: /s/ JOHANNES F. BRUEKHOVEN
-------------------------------
Name: Johannes F. Bruekhoven
-----------------------------
Title: Vice President
----------------------------
CREDIT LYONNAIS NEW YORK BRANCH
By: /s/ F. TAVANGAR
-------------------------------
Name: Farboud Tavanger
-----------------------------
Title: Vice President
----------------------------
-6-
<PAGE> 7
THE DAI-ICHI KANGY0 BANK, LTD.
Los Angeles Agency
By: /s/ T. YAMAGUCHI
-------------------------------
Name: Teruhisa Yamaguchi
-----------------------------
Title: Sr. Vice President &
---------------------------
Joint General Manager
--------------------------
THE FUJI BANK, LIMITED
Los Angeles Agency
By: /s/ NOBUHIRO UMEMURA
-------------------------------
Name: Nobuhiro Umemura
-----------------------------
Title: Joint General Manager
----------------------------
THE INDUSTRIAL BANK OF JAPAN,
LIMITED, Los Angeles Agency,
as a Bank and Co-Agent
By: /s/ TOSHINARI TYODA
-------------------------------
Name: Toshinari Tyoda
-----------------------------
Title: Senior Vice President
----------------------------
THE LONG-TERM CREDIT BANK OF JAPAN,
LTD., Los Angeles Agency
By: /s/ Y. KAMISAWA
-------------------------------
Name: Yutaka Kamisawa
-----------------------------
Title: Deputy General Manager
----------------------------
-7-
<PAGE> 8
THE NORTHERN TRUST COMPANY
By: /s/ MICHELLE D. GRIFFIN
-------------------------------
Name: Michelle D. Griffin
-----------------------------
Title: Vice President
----------------------------
THE SANWA BANK, LIMITED
Los Angeles Branch
By: /s/ KAREN WICKS COLEMAN
-------------------------------
Name: Karen Wicks Coleman
-----------------------------
Title: AVP & Manager
----------------------------
WELLS FARGO BANK N.A.
By: /s/ W.J. BAIRD
-------------------------------
Name: W.J. Baird
-----------------------------
Title:
----------------------------
-8-
<PAGE> 1
EXHIBIT 10.34
E. KEITH HOVLAND
CONFIDENTIAL SETTLEMENT AND SEPARATION
AGREEMENT AND GENERAL RELEASE
This Confidential Settlement and Separation Agreement and General
Release (this "Agreement") is entered into as of the 15th day of June, 1996
(the "Effective Date"), by and between E. Keith Hovland, on the one hand, and
Health Systems International, Inc., a Delaware corporation, and its affiliated
entities, including Health Net and QualMed, Inc. (collectively, the "Company"),
on the other hand, and sets forth the terms upon which (i) Mr. Hovland and the
Company have agreed to terminate the employment of Mr. Hovland with the
Company, (ii) Mr. Hovland and the Company have each agreed to release the
other from any liability arising from their employment relationship and the
termination of that relationship and (iii) Mr. Hovland and the Company have
agreed to settle certain rights, obligations and liabilities arising under that
certain employment agreement, dated August 28, 1993, by and between Mr. Hovland
and the Company (the "Employment Agreement"), the provisions of which, except
as otherwise set forth herein, shall not survive the termination of Mr.
Hovland's employment with the Company.
The parties agree as follows:
1. It is mutually in the best interests of Mr. Hovland and the
Company to terminate their full-time employment relationship in accordance with
the terms hereof as of the close of business on June 15, 1996 (the "Employment
Termination Date"), at which time Mr. Hovland's full-time employment with the
Company shall cease. Mr. Hovland and the Company each acknowledge that the
reasons for such termination are unrelated to any past or prospective business
combination involving the Company. In accordance with the foregoing, as of the
Employment Termination Date, Mr. Hovland hereby resigns from all positions as
an officer, director or employee that he may hold or may have held with the
Company and all subsidiaries and affiliates of the Company (collectively, the
"Affiliates").
2. As consideration for entering into this Agreement, Mr. Hovland
shall receive, in full settlement as of the Employment Termination Date of any
benefits to which Mr. Hovland would otherwise be entitled under the Employment
Agreement or any other compensation or benefits plan, program, policy or
arrangement maintained by the Company in which Mr. Hovland has at any time been
a participant, the following benefits:
1
<PAGE> 2
(a) Beginning on the Employment Termination Date and continuing
for a period of thirty-six (36) months thereafter (the
"Severance Period"), the Company shall continue to pay to Mr.
Hovland his Base Salary (as defined in the Employment
Agreement) at the rate in effect immediately prior to the
Employment Termination date (as adjusted during the Severance
period to include the 7% annual increases provided for in the
Employment Agreement). In addition, the Company shall pay Mr.
Hovland his accrued Base Salary through and including the
Employment Termination Date. As an alternative to such Base
Salary payments during the Severance Period, Mr. Hovland may
elect to receive $755,617 as a one-time lump sum payment
(which represents the present value of such Base Salary
payments during the Severance Period assuming a discount rate
equal to 120% of the February, 1996 short-term Applicable
Federal Rate of 6.4%).
(b) On the Employment Termination Date, the Company shall pay to
Mr. Hovland a lump sum equal to the sum of (i) the value of
Mr. Hovland's accrued benefits (including the 78.5% premium)
as of the Employment Termination Date under the Company's
Supplemental Executive Retirement Program (the "SERP"), which
is comprised of Mr. Hovland's account balances under (x) the
Executive Deferral Plan and (y) the Supplemental Credit Plan,
and (ii) $200,088 which represents an additional retirement
benefit extended to Mr. Hovland in connection with the
termination of his Employment Agreement. In addition, to the
extent provided for under the Company's 401 (k)/Profit Sharing
Plan, Mr. Hovland shall be entitled to receive a rollover
distribution of his entire account balance that has vested
pursuant to the terms of such plan.
(c) The Company shall indemnify Mr. Hovland to the maximum extent
permitted by the Company's Third Amended and Restated By-laws
(the "By-laws") in effect as of the Effective Date, subject,
however, to any other applicable law, with respect to claims
or liabilities arising out of or relating to any acts,
omissions or decisions undertaken by Mr. Hovland in the course
and scope of his positions as an officer, director or employee
of the Company or any Affiliate subject to the conditions
contained in such By-laws.
(d) As of the Employment Termination Date, the Company shall pay
Mr. Hovland for his accrued but unpaid and unused vacation
time.
2
<PAGE> 3
(e) As of the Employment Termination Date, Mr. Hovland shall be
entitled to purchase from the Company all "knickknacks" and
collectibles in his Company office for the sum of one dollar.
(f) The Company shall provide Mr. Hovland with any forms or
applications necessary for him to receive the payments
provided for under this Agreement.
(g) Notwithstanding anything to the contrary herein, none of the
benefits otherwise payable pursuant to subsections (a) through
(e) of this Section 2 shall become payable unless Mr. Hovland
does not revoke this Agreement pursuant to Section 10 hereof,
such that the provisions of Sections 3 and 4 below shall be
effective as of the Employment Termination Date.
(h) Mr. Hovland shall also be entitled to continue to be covered
during the Severance Period by all medical, health and
accident insurance or other such health care arrangements. at
the same coverage level maintained immediately prior to the
date of Mr. Hovland's termination. In the event Mr. Hovland
is ineligible under the terms of such insurance or other such
health care arrangements to continue to be so covered, the
Company shall provide Mr. Hovland with substantially
equivalent coverage through other sources or will provide Mr.
Hovland with a lump sum payment equal to the agreed upon
present value of the continuation of such health insurance or
other such health care arrangements to which Mr. Hovland is
entitled under this section. In addition, as an alternative
to all of the continued coverages during the Severance Period
described above in this Section 2(h), Mr. Hovland may elect to
receive $12,142 as a one-time, lump sum payment (which
represents the present value of such coverages during the
Severance Period assuming a discount rate equal to 120% of the
February, 1996 short-term Applicable Federal Rate of 6.4%).
3. Except for the rights and obligations of the parties set forth
herein, all of which shall survive the execution of this Agreement and the
receipt by the parties of the consideration provided for herein, and as a
material inducement to enter into this Agreement, Mr. Hovland hereby knowingly
and voluntarily, fully and finally releases, acquits, and forever discharges
the Company, any Affiliates, and their past and present officers, directors,
shareholders, partners, trustees, beneficiaries, managers, employees,
attorneys, agents, successors or assigns (collectively, the "Company Released
Parties"), from any and all claims, charges, complaints, liens, demands, causes
of action, obligations, damages and liabilities, known or unknown, that he had,
now has, or may hereafter claim to have against the Company Released Parties as
of the Effective Date arising out of or relating in any way to Mr. Hovland's
relationship with the Company as an employee, officer or director, and the
termination of such employment, or to any other matter, event or cause
3
<PAGE> 4
whatsoever arising on or before the date of this Agreement, whether or not
previously asserted before any state or federal court or before any state,
federal or regulatory agency or governmental entity. This release expressly
extends to without limiting the generality of the foregoing, any claims arising
under Title VII of the Civil Rights Act of 1964, as amended, the Age
Discrimination in Employment Act, as amended, the California Fair Employment
and Housing Act, as amended, the United States Constitution, any state
constitutions and any other federal, state or local statute, regulation or
ordinance governing the employment relationship.
4. Mr. Hovland represents that he has not brought or joined in
any claim, charge or action against the Company Released Parties, or any
of them, and agrees that he shall not bring or join in any claim, charge or
action, arising out of, based upon or relating to the matters released
hereunder.
5. Except for the rights and obligations of the parties set forth
herein, all of which survive the execution of this Agreement and the receipt by
the parties of the consideration provided for herein, and as a material
inducement to enter into this Agreement, the Company, on behalf of itself, the
Affiliates and their Affiliates and their officers and directors (in their
capacity as officers or directors of the Company), agents, employees,
successors and assigns likewise hereby knowingly and voluntarily, fully and
finally releases, acquits, and forever discharges Mr. Hovland and his agents,
attorneys, employees, successors, heirs, beneficiaries or assigns (the
"Employee Released Parties"), to the extent permitted by law, from any and all
claims, charges, complaints, liens, demands, causes of action, obligations,
damages and liabilities, known or unknown, that it had, now has, or may
hereafter claim to have against the Employee Released Parties arising out of or
relating in any way to Mr. Hovland's relationship with the Company as an
employee, officer or director, and the termination of such employment, or any
other matter, event or cause whatsoever arising on or before the date of this
Agreement, whether or not previously asserted before any state or federal court
or before any state, federal or regulatory agency or governmental entity.
Notwithstanding the generality of the foregoing, nothing contained herein shall
release Mr. Hovland from any claim relating to the breach by Mr. Hovland of any
confidentiality agreements with the Company or any Affiliate, or the obligations
set forth herein.
6. The Company represents that it has not brought or joined in
any claim, charge or action against the Employee Released parties, or any of
them, and agrees that it shall not bring or join in any claim, charge or
action, arising out of, based upon or relating to the matters released
hereunder.
7. It is expressly understood and agreed that there are no claims
or provisions or liabilities other than those set forth or otherwise referenced
in this Agreement and that the provision for payment as hereinabove set forth
is not, and shall not be construed to be, an admission of liability of any
person, firm, or corporation; but that Mr. Hovland and the Company
4
<PAGE> 5
Released Parties are settling and compromising all matters and claims in
connection with their employer-employee relationship, as to which each of the
Company Released Parties and the Employee Released Parties denies any
liability. With respect to the said settlement, Mr. Hovland covenants and
agrees (both on behalf of himself and all other parties releasing claims
against the Company under Section 3) that he shall forever refrain from
initiating, prosecuting, maintaining or pressing any action, suit or claim in
any jurisdiction against the Company Released Parties, based on his employment
or holding of any office with the Company or any Affiliate or the termination
thereof, with respect to the matters released hereunder, with the exception of
proceedings to enforce the terms of this Agreement. With respect to the said
settlement, the Company covenants and agrees (both on behalf of itself and all
other parties releasing claims against Mr. Hovland under Section 5) forever to
refrain from initiating, prosecuting, maintaining or pressing any action, suit
or claim in any jurisdiction against Mr. Hovland, based on his employment with
the Company or any Affiliate or the termination thereof, with respect to the
matters released hereunder, with the exception of proceedings to enforce the
terms of this Agreement.
8. The Company (on behalf of itself, the Affiliates and their
officers and directors (in their capacity as officers or directors of the
Company), agents, employees, successors and assigns) and Mr. Hovland each
represent and warrant that there has been no assignment or other transfer of
any interest in any claim they may have against any of the parties released
herein, or any of them, and each agrees to indemnify and hold harmless such
released parties, and each of them, from any liability, claims, demands,
damages, costs, expenses, and attorneys' fees incurred by such released
parties, or any of them, as a result of any such assignment or transfer.
9. Notwithstanding anything to the contrary in the Employment
Agreement, in the event of any action or proceeding of any sort arising from or
relating to this Agreement, the prevailing party shall be entitled to recover
his or its reasonable attorneys' fees and costs incurred therein.
10. Mr. Hovland represents and acknowledges that he is aware that
he has the right to review this Agreement and, specifically, the release
provisions, with legal counsel of his choice prior to signing the Agreement,
and that he has done so. Mr. Hovland further represents and acknowledges that
he is aware that he has twenty-one (21) days during which to consider the
provisions of this Agreement, although he may sign and return the Agreement
sooner, that he has the right to revoke the Agreement for a period of seven (7)
days after signing it, and that the Agreement shall not become effective or
enforceable until such seven (7) day revocation expires without revocation.
Except as otherwise provided herein, neither Mr. Hovland, on the one hand, nor
the Company, on the other hand, shall have any obligation toward the other
under any other agreement relating to the matters described herein; provided,
however, that in the event of a revocation pursuant to this Section 10, Mr.
Hovland shall retain his rights under Section 4(a) of
5
<PAGE> 6
the Employment Agreement with respect to the termination of his employment with
the Company.
11. Each of the parties hereto represents that this Agreement has
been carefully read To by him or it and that he or it knows and understands the
contents hereof. Each of the parties has received independent legal advice
from attorneys of his or its choice with respect to the preparation, review and
advisability of executing this Agreement. Each of the parties further
represents and acknowledges that he or it has freely and voluntarily executed
this Agreement after independent investigation and without fraud, duress, or
undue influence and that in executing this Agreement he or it does not rely and
has not relied upon any representation or statement not set forth herein made
by the other party or by any of the other party's agents, representatives or
attorneys with regard to the subject matter, basis or effect of this Agreement
or otherwise.
12. This Agreement will be governed by and construed and enforced
under the laws of the State of Colorado, without regard to its conflict of laws
rules.
13. While the provisions contained in this Agreement are
considered by the parties to be reasonable in all circumstances, it is
recognized that provisions of the nature in question may fail for technical
reasons and accordingly, it is hereby agreed and declared that if any one or
more of such provisions shall either by itself or themselves or taken with
others, be adjudged to be invalid as exceeding what is reasonable in all
circumstances for the protection of the interests of the Company or Mr.
Hovland, but would be valid if any particular restriction or provisions were
deleted or restricted or limited in a particular manner or if the period or
area thereof were reduced or curtailed, then the said provisions shall apply
with such deletion, restriction, limitation, reduction, curtailment, or
modification as may be necessary to make them valid and effective.
14. This Agreement constitutes the entire agreement relating to
the matters set forth herein between the parties who have executed it and
supersedes any and all other agreements (including but not limited to the
Employment Agreement), understandings, negotiations, or discussions, either
oral or in writing, express or implied, between the parties to this Agreement.
The parties to this Agreement each acknowledge, except as otherwise set forth
herein, that no representations, inducements, promises, agreements or
warranties, oral or otherwise, have been made by them, or anyone acting on
their behalf, which are not embodied in this Agreement, that they have not
executed this Agreement in reliance on any such representation, inducement,
promise, agreement or warranty, and that no representation, inducement,
promise, agreement or warranty not contained in this Agreement including but
not limited to, any purported supplements, modifications, waivers or
termination of this Agreement shall be valid or binding, unless executed in
writing by all of the parties to this Agreement.
6
<PAGE> 7
15. All amounts payable hereunder shall be subject to such
withholding taxes as may be required by law.
16. The provisions of this Agreement shall be binding upon the
Company and Mr. Hovland and their respective successors, assigns, heirs and
legal representatives. The Company shall require any successor (whether direct
or indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company, by agreement on
form and substance satisfactory to Mr. Hovland, to expressly assume and agree
to perform this Agreement in the same manner and to the same extent that the
Company would be required to perform it if no such succession had taken place.
As used in Section 16, "Company" shall mean the Company as hereinbefore defined
and any successor to its business and/or assets as aforesaid which executes and
delivers the agreement provided for in this Section 16 or which otherwise
becomes bound by all the terms and provisions of this Agreement by operation of
law.
17. In the event that any payment received by Mr. Hovland or paid
by the Company on behalf of Mr. Hovland under this Agreement or under any other
plan, arrangement or agreement with the Company or any person whose actions
result in a change in control of the Company or any person affiliated with the
Company or such person (collectively, the "Total Payments") will be subject to
any excise tax (the "Excise Tax") imposed by Section 4999 (or any successor
provision) of the Internal Revenue Code of 1986, as amended (the "Code") or any
similar provisions imposed by applicable state law, or any interest or
penalties with respect to such Excise Tax, the Company shall pay to Mr. Hovland
an additional amount (the "Gross-Up Payment") such that the net amount retained
by Mr. Hovland, after deduction of any Excise Tax or any interest or penalties
with respect to such Excise Tax on the Total Payments and any federal, state
and local income, excise and/or other taxes upon the Gross-Up Payment provided
for by this Section 17, shall be equal to the Total Payments.
For purposes of determining whether any of the Total Payments
will be subject to the Excise Tax and the amount of such Excise Tax, (i) the
Total Payments shall be treated as "parachute payments" within the meaning of
Section 280G(b)(2) of the Code, and all "excess parachute payments" within the
meaning of Section 280G(b)(1) of the Code shall be treated as subject to the
Excise Tax, unless in the opinion of tax counsel selected by the Company's
independent auditors such other payments or benefits (in whole or in part) do
not constitute parachute payments, including by reason of Section 280G(b)(4)(A)
of the Code, or such excess parachute payments (in whole or in part) represent
reasonable compensation for services actually rendered, within the meaning of
Section 280G(b)(4)(B) of the Code, in excess of the Base Amount allocable to
such reasonable compensation, or are otherwise not subject to the Excise Tax,
and (ii) the value of any non-cash benefits or any deferred payment or benefit
shall be determined by the Company's independent auditors in accordance with
the principles of Sections 280G(d)(3) and (4) of the Code.
7
<PAGE> 8
For purposes of determining the amount of the Gross-Up
Payment, Mr. Hovland shall be deemed to pay federal income and other taxes at
the highest applicable marginal rate of taxation in the calendar year in which
the Gross-Up Payment is to be made and state and local income and other taxes
at the highest applicable marginal rate of taxation in the state and locality
of Mr. Hovland's residence on the date the Gross-Up Payment is to be made, net
of the maximum reduction in federal incomes taxes which could be obtained from
deduction of such state and local taxes and any other taxes. In the event that
the Excise Tax is subsequently determined to be less than the amount taken into
account hereunder, Mr. Hovland shall repay to the Company, at the time that the
amount of such reduction in Excise Tax is finally determined, the portion of
the Gross-Up Payment attributable to such reduction (plus that portion of the
Gross-Up Payment attributable to the Excise Tax and federal, state and local
income and other taxes imposed on the Gross-Up Payment being repaid by Mr.
Hovland to the extent that such repayment results in a reduction in Excise Tax
and/or a federal, state or local income tax deduction) plus interest on the
amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the
Code. In the event that the Excise Tax is determined to exceed the amount
taken into account hereunder (including by reason of any payment the existence
or amount of which cannot be determined at the time of the Gross-Up Payment),
the Company shall make an additional Gross-Up Payment in respect of such excess
(plus any interest, penalties or additions payable to Mr. Hovland with respect
to such excess), at the time that the amount of such excess is finally
determined. Mr. Hovland and the Company shall each reasonably cooperate with
the other in connection with any administrative or judicial proceedings
concerning the existence or amount of liability for Excise Tax with respect to
the Total Payments.
The Gross-Up Payment payable pursuant to this Section 17 shall
be payable on the earlier of (i) the date the Company is required to withhold
the Excise Tax pursuant to Section 4999 of the Code or (ii) the date Mr.
Hovland is required to pay the Excise Tax.
Mr. Hovland shall notify the Company of any audit or review by
the Internal Revenue Service of Mr. Hovland's federal income tax return for any
period in which a payment under this Agreement is made within ten (10) days of
Mr. Hovland's receipt of such audit or review. In addition, Mr. Hovland shall
also notify the Company of the final resolution of such audit or review within
ten (10) days of such resolution.
18. Each of the parties covenants and agrees that neither he nor
it nor his or its attorneys or representatives shall reveal to anyone, except
his spouse (if any), accountants and attorneys, any of the terms of this
Agreement, except as may be mutually agreed upon in writing or otherwise
required by law (including requirements of the Securities and Exchange
Commission and stock exchange rules with respect to reporting the termination
of Mr. Hovland's status as an employee, director and officer of the Company or
its Affiliates) or court order.
8
<PAGE> 9
19. This Agreement may be executed in one or more counterparts,
each of which shall be deemed to be an original but all of which together will
constitute one and the same instrument.
IN WITNESS WHEREOF, the parties have set their hand as of the date first
written above.
HEALTH SYSTEMS INTERNATIONAL, INC.
By: /s/ MICHAEL E. JANSEN
---------------------------------
Michael E. Jansen
Vice President, Assistant General
Counsel and Assistant Secretary
/s/ E. KEITH HOVLAND
------------------------------------
E. Keith Hovland
9
<PAGE> 1
EXHIBIT 10.35
May 28, 1996
Mr. Michael D. Pugh
4200 Larchmont
Dallas, TX 75205
Re: Offer of Employment
Dear Michael:
We are pleased to extend to you an offer of employment with QualMed, Inc., a
subsidiary of Health Systems International, Inc. ("HSI") (hereinafter
collectively referred to as the "Company"), for the exempt position of Senior
Vice President of HSI and President and Chief Executive Officer of QualMed at
an annual base salary of $250,000. In this capacity, you will report to Jay M.
Gellert, the President and Chief Operating Officer of HSI. Your office will be
located in Pueblo, Colorado. The start date for your employment is July 1,
1996.
As a senior executive of the Company, your annual base salary will be reviewed
each year by the HSI Compensation and Stock Option Committee. Your first
review for annual salary compensation purposes is scheduled to occur at the
conclusion of the 1997 calendar year, and annually thereafter.
You will also be eligible to participate in the HSI Management Bonus Plan.
Under this plan you can earn up to 50% of your base salary as a bonus, subject
to the discretion of the HSI Compensation and Stock Option Committee, if
certain goals based upon HSI's, QualMed's and your individual performance are
achieved. Your 1996 bonus will be based upon corporate and individual
performance for the number of full months you are employed by the Company
during the year. The goals which will be used to measure your performance for
1996 are attached hereto as Exhibit 1 and it is intended that you will be
provided goals for successive calendar years prior to January 31 of each such
year. As we discussed, you will be leaving your current employer in the middle
of the fiscal year and will forgo any bonus opportunity payable as a result of
your performance for that period. Your bonus for 1996 will be annualized to
account for the award you would have received during the first six months of
1996.
As to any bonus award, you must be actively employed and on the Company payroll
at the time said bonus is to be paid. The HSI Compensation and Stock Option
Committee in its sole discretion will award amounts as it deems appropriate
consistent with the guidelines of the HSI Management Bonus Plan. If you are
deemed to be one of HSI's
<PAGE> 2
Mr. Michael D. Pugh
May 28, 1996
Page 2
five highest paid executive officers for any given year, you will participate
in the HSI Performance-Based Annual Bonus Plan as adopted by HSI shareholders
in 1994, in lieu of the Management Bonus Plan (the HSI Performance-Based Annual
Bonus Plan is designed to address the limitations imposed under federal tax law
on the Company's ability to deduct certain compensation paid to the five
highest paid executive officers.)
In addition to the foregoing, and subject to (1) any applicable prerequisite
length of employment or other eligibility requirements and (2) your continued
employment with the Company, you will be eligible for consideration to receive
and/or participate in the fringe benefits set forth in the Company's applicable
Plan Documents, Associate Handbooks and/or Policy Statement, subject to the
Company's right to enhance, increase, reduce, eliminate or otherwise modify at
any time these or other fringe benefits (including the bonus plans referenced
above). Your Company benefits include:
o Associate 401(k) Savings Plan.
o Employee Stock Purchase Plan.
o Group medical coverage for you and your eligible dependents at
current monthly rates applicable to the Company's employees to
start July 1, 1996.
o Group dental coverage for you and your eligible dependents at
current monthly rates applicable to the Company's employees to
start July 1, 1996.
o Eligibility to elect to designate up to $5,000 of your pay to
be contributed on a pre-tax basis to an account for your
dependent care expenses and up to $2,000 of your pay to be
contributed on a pre-tax basis to an account for your medical
and dental expenses.
o Entitlement to reimbursement of the initial fee to join the
Pueblo Country Club and reimbursement of Pueblo Country Club
expenses, to a maximum of $2,000 annually.
o Group term life insurance in the amount of $500,000
(supplemental term life insurance and term life insurance for
your dependents is also available at your expense).
o Short-term and long-term disability benefits.
o 22 vacation and/or paid-time off days per calendar year.
<PAGE> 3
Mr. Michael D. Pugh
May 28, 1996
Page 3
o An anticipated initial nonqualified stock option grant
effective July 2, 1996 (vesting one third per year, beginning
on the third anniversary of your employment, with a ten year
life) to purchase 18,000 shares of HSI Class A Common Stock at
the market value of such stock at the close of business on the
date granted.
o Eligibility to participate in HSI's profit-sharing stock grant
program, which is based upon the profits of HSI and QualMed.
o Eligibility to participate in the Company's Supplemental
Executive Retirement Plan.
o Reimbursement of reasonable, substantiated monthly business
expenses.
o Company paid holidays (currently nine days per year).
o Education Assistance Program.
o Eligibility to participate in the Decibel Credit Union
(Decibel offers low interest loans, low interest VISA credit
cards, Christmas Club, etc.).
o A car allowance of $1,000 per month plus a corporate VISA
charge card which can be used for Company-related expenses.
o A cellular phone for your vehicle.
o A fax machine to be installed at your home.
o Financial planning allowance for tax advice and financial
counseling subject to a maximum of $5,000 per year beginning
with 1996.
The Company will also provide you with certain benefits to assist you in
relocating to Pueblo, including:
o Payment for all packing, shipping and unloading of all your
reasonable household items upon your move and up to 60 days
storage, including federal and state tax gross-ups as allowed
by law.
o Assistance with the sale of your current home to include
payment of up to a 7% real estate commission, and assistance
in the purchase of a new home to include payment of up to two
points, including federal and state tax gross-ups as allowed
by law.
<PAGE> 4
Mr. Michael D. Pugh
May 28, 1996
Page 4
o An allowance in the amount of $6,000 for additional relocation
expenses.
Should you leave the employ of the Company within one year from your date of
hire, you will be obligated to reimburse the Company for relocation expenses
paid on your behalf, pro-rated by the number of months that have expired since
your employment began.
If you are terminated by the Company for a reason other than just cause, you
will be entitled to receive severance pay equal to six months of your base
salary, at the salary rate in effect immediately prior to your termination of
employment. If you remain unemployed at the end of the six-month period
beginning on your date of termination of employment with the Company, and
provided that you use your best efforts to find employment, the Company will
continue to provide you severance pay until you obtain employment, for a
maximum period of an additional six months.
Should disagreements arise with respect to this offer of employment, you and
the Company agree to submit the matter to binding arbitration. The arbitration
committee shall consist of three individuals. You will select one individual,
the Company will select another, and the third individual will be selected by
The American Arbitration Association. The Company shall also have the right to
pursue an equitable remedy in a Colorado court pursuant to the applicable laws
of Colorado with respect to the noncompete and confidentiality restrictions set
forth below. The prevailing party in either the arbitration and/or the
equitable remedy action shall recover all attorney's fees and costs incurred.
This offer of employment shall remain confidential and, if accepted by you,
will obligate you to the following one-year non-compete agreement.
Accordingly, if you accept this offer you agree that you will not, for a period
of one (1) year after any termination of your employment with the Company,
undertake any employment or activity on behalf of a Competitor (as defined
below) in the geographical area in which you performed services for the Company
or any of its affiliates (the "Market Area"), which employment or activity
could call upon you to reveal, to make judgments on or otherwise use any
confidential business information or trade secrets of the business of the
Company or any of its affiliates to which you had access during your employment
with the Company.
For these purposes, "Competitor" shall refer to any health maintenance
organization, insurance company or similar entity that provides managed health
care or related services similar to those provided by the Company or any of its
affiliates within the Market Area. The Company shall have the reasonable right
to approve your choice of employer. If deemed necessary, the determination of
reasonable right is subject to arbitration. It is hereby further agreed that
if an arbitrator or any court of competent jurisdiction shall determine that
the restrictions imposed in this non-compete agreement are unreasonable,
<PAGE> 5
Mr. Michael D. Pugh
May 28, 1996
Page 5
invalid or unlawful (including, but not limited to, the definition of Market
Area or Competitor or the time period during which this restriction is
applicable), the parties hereto hereby agree to any restrictions that such
arbitrator or court would find to be reasonable under the circumstances. It is
further agreed that the Company shall have all equitable remedies available to
enforce this non-competition restriction and the confidentiality restriction
set forth in the following paragraph.
You acknowledge and agree that, during the period of your employment by the
Company, you will have access to and become acquainted with various
confidential information and practices, confidential customer information, and
pricing methodology. All documents, memoranda, reports, files, correspondence,
lists and other written, electronic and graphic records affecting or relating
to the Company's business that you may prepare, use, observe, possess or
control shall be and remain the Company's sole property, and you shall not
disclose any of these items, except as required in the course of your
employment by the Company. In the event of the termination of your employment,
you shall deliver promptly to the Company all written and/or graphic records
containing such trade secrets or confidential information.
Nothing set forth herein is intended to create any condition or term of
employment other than that of an "at-will" employee. In other words, by
accepting employment with the Company you confirm that you employment is
voluntary and that there is no obligation on your part or on the part of the
Company to continue that employment relationship for any period of time. While
the Company certainly hopes that there will be a long and mutually satisfactory
relationship between you and the Company, it is expressly understood and agreed
that your employment can be terminated by either you or the Company at any
time, for any reason and with or without prior notice of any kind. The only
way in which this "at-will" employment relationship can be changed is by a
written agreement, approved by the HSI Compensation and Stock Option Committee,
which expressly sets forth a specific length of employment and other
appropriate terms and conditions for the employment relationship.
The foregoing describes the terms of this offer of employment. Any prior or
contemporaneous agreements or representations, whether oral or written, which
may have been made or discussed but which are not included herein, are of no
force or effect whatsoever or at all. The HSI Compensation and Stock Option
Committee has approved this offer of employment.
Michael, you should know that both Jay Gellert and Dr. Hasan join me in
extending our warmest wishes. We are both enthusiastic about the prospect of
having you on the Company's "First Team". Wishing you the best of success and
the very
Best of health,
<PAGE> 6
Mr. Michael D. Pugh
May 28,1996
Page 6
JAMES J. WILK
James J. Wilk
Senior Vice President, Human Resources
and Administrative Services of Health Net
JJW/lsm
I hereby accept the terms of this offer of employment as outlined above.
/s/ MICHAEL D. PUGH 5/30/96
- -------------------- --------
Michael D. Pugh Date
Sent by facsimile
5/30/96
SIG
Attachments: Exhibit I
<PAGE> 1
EXHIBIT 10.36
[LETTERHEAD]
[HEALTH SYSTEMS INTERNATIONAL]
June 4, 1996
Dr. Arthur Southam
347 10th Street
Santa Monica, CA 90403
Re: OFFER OF EMPLOYMENT
Dear Artie:
We are pleased to extend to you an offer of employment with Health Systems
International, Inc. ("HSI") and its subsidiary, Health Net (hereinafter
collectively referred to as the "Company"), for the exempt positions of
President and Chief Executive Officer of Health Net and Senior Vice President
of HSI at an annual base salary of $375,000. In these capacities, you will
report to Mr. Jay M. Gellert, President and Chief Operating Officer of HSI.
Your office will be located in Woodland Hills, California. The target start
date for your employment is July 2, 1996, subject to arrangements you are
making with your current employer. In no event will you start work later than
July 9, 1996.
As a senior executive of the Company, your annual base salary will be reviewed
each year by the HSI Compensation and Stock Option Committee. Your first
review for annual salary compensation purposes is scheduled to occur in
December of 1997.
You will also be eligible to participate in the HSI Management Bonus Plan.
Under this plan you can earn up to 65% of your base salary as a bonus at the
100% of target level, subject to the discretion of the HSI Compensation and
Stock Option Committee, if certain goals based upon HSI's, Health Net's and
your individual performance are achieved. If corporate and individual
performance exceed goals, you can earn as much as 97.5% of your base salary as
a bonus. Your total bonus award will be prorated for 1996 based upon the
number of full months you are employed by the Company during the year. For the
1996 Plan year only, the Company will guarantee that your bonus award will not
be less than $62,500. Any additional 1996 bonus award will be based upon
performance that exceeds the targets necessary for you to receive $62,500. For
Plan years beginning on and after 1997, there will be no further bonus
guarantees. The goals that will be used to measure your performance are
attached hereto as Exhibit 1, and it is intended that you will be provided
goals for successive calendar years prior to January 31st of each such year.
<PAGE> 2
Dr. Arthur Southam
June 4, 1996
Page 2
Upon commencement of your employment, the Company will award you a signing
bonus in the amount of $75,000, as reimbursement for the cash bonus you have
indicated you will forego with your current employer.
With respect to any bonus award, you must also be actively employed and on the
Company payroll at the time said bonus is to be paid. The HSI Compensation and
Stock Option Committee in its sole discretion will award amounts as it deems
appropriate consistent with the guidelines of the HSI Management Bonus Plan.
If you are deemed to be one of HSI's five highest paid executive officers for
any given year, you will participate in the HSI Performance-Based Annual Bonus
Plan as adopted by HSI shareholders in 1994, in lieu of the Management Bonus
Plan (the HSI Performance-Based Annual Bonus Plan is designed to address the
limitations imposed under federal tax law on the Company's ability to deduct
certain compensation paid to the five highest paid executive officers).
In addition to the foregoing, and subject to (1) any applicable prerequisite
length of employment or other eligibility requirements and (2) your continued
employment with the Company, you will be eligible for consideration to receive
and/or participate in the fringe benefits set forth in the Company's applicable
Plan Documents, Associate Handbooks and/or Policy Statement, subject to the
Company's right to enhance, increase, reduce, eliminate or otherwise modify at
any time these or other fringe benefits (including the bonus plans referenced
above). Your Company benefits include:
o Associate 401(k) Savings Plan.
o Employee Stock Purchase Plan.
o Group medical coverage for you and your eligible dependents at
current monthly rates applicable to the Company's employees to
start July 2, 1996.
o Group dental coverage for you and your eligible dependents at
current monthly rates applicable to the Company's employees to
start July 2, 1996.
o Group term life insurance in the amount of $500,000
(supplemental term life insurance and term life insurance for
your dependents is also available at your expense).
o Short-term and long-term disability benefits.
o 22 vacation and/or paid-time off days per calendar year.
Additionally, the week of August 2, 1996 through August 8,
1996 will be a paid vacation and will not offset your normal
paid-time off accruals.
<PAGE> 3
Dr. Arthur Southam
June 4, 1996
Page 3
o An anticipated initial nonqualified stock option grant
(vesting one third per year, beginning on the third
anniversary of your employment, with a ten year life) to
purchase 50,000 shares of HSI Class A Common Stock at an
exercise price equal to the closing price of such stock on the
date of grant, and to purchase an additional 15,000 shares of
HSI Class A Common Stock at an exercise price equal to a 20%
premium over such closing price (vesting immediately in each
case with a term subject to the restrictions contained in
HSI's standard form of stock option agreement). Such option
grant is expected to be made at the first meeting of the HSI
Compensation and Stock Option Committee after your hire date.
o Eligibility to participate in HSI's profit-sharing stock grant
program, which is based upon the profits of HSI and Health Net.
o Eligibility to participate in the Company's Supplemental
Executive Retirement Plan.
o Reimbursement of reasonable, substantiated monthly business
expenses.
o Company paid holidays (currently ten days per year).
o Education Assistance Program.
o A car allowance of $1,000 per month plus a corporate VISA
charge card which can be used for Company-related expenses.
o A cellular phone for your vehicle.
o A fax machine to be installed at your home.
o Financial planning allowance for tax advice and financial
counseling subject to a maximum of $5,000 per year beginning
with 1996.
o Dues and expenses associated with membership in the Jonathan
Club and YPO subject to appropriate documentation of said
expenses.
You have agreed to diligently pursue securing the accrued SERP benefit promised
to you by your current employer. Should your efforts prove unsuccessful or
only partially successful, the Company will provide you with a SERP benefit
that compensates you for the difference between the amount you would have
received on an accrued basis July 1, 1996 and the amount you are successful in
securing. As we discussed, the benefit you
<PAGE> 4
Dr. Arthur Southam
June 4, 1996
Page 4
will receive from the Company is approximately $52,000 per year for life
beginning at age 60 and the benefit will not be used as an offset to any
benefit you may accrue under the HSI SERP. You will be 100% vested in this
benefit upon commencement of your employment. Artie, please note that this
benefit award is subject to verification by way of documentation which you will
forward to me and is not intended to provide benefits in addition to SERP
amounts you receive from your current employer.
Additionally, acceptance of this offer of employment will provide you with two
potential severance arrangements. A Change-of-Control severance will protect
you in the unlikely event a Change-of-Control transaction (as defined below)
occurs resulting in termination of your employment. Absent a Change-of-Control
transaction, you may also be eligible for a termination severance benefit, if
your employment is terminated under circumstances described below.
If, during a two-year period following a Change-of-Control transaction, you are
terminated by the Company or voluntarily resign for "good reason" (as defined
below), you will receive severance pay equal to three years of your then
current annual base salary, except that any severance pay will not exceed the
lesser of (i) $1.2 million or (ii) the applicable Internal Revenue Code Section
280G limitations to avoid penalty taxes and deduction limitations on "excess
parachute payments".
Change-of-Control is defined as any one of the following:
o A 51% change in beneficial ownership as a result of a single
transaction of all capital stock of HSI;
o A change in the majority of outside directors of HSI's Board
of Directors over two years, which is unapproved by a majority
of HSI's current directors;
o The sale of substantially all of HSI's assets to an unrelated
third party; or
o The liquidation or dissolution of HSI.
For purposes of your Change-of-Control severance benefit, "good reason" means a
material reduction in the scope of your position, duties or responsibilities,
or of your salary or status with the Company, or your removal from your
positions referred to above as determined by the HSI Compensation and Stock
Option Committee existing as of the date of the Change-of-Control, or if your
principal office is relocated or changed without your consent to a location
more than 50 miles from the Company's current offices located in Woodland
Hills, California except in connection with the termination of your employment
for disability, normal retirement or cause, or by voluntary resignation other
than for good reason.
<PAGE> 5
Dr. Arthur Southam
June 4, 1996
Page 5
If you are terminated by the Company for a reason other than a
Change-of-Control, as defined in the preceding paragraphs, or just cause, or if
you voluntarily resign for "good reason" (as defined below), you will be
entitled to receive a severance payment equal to two years of your then current
annual base salary, except that any severance payment will not exceed $800,000.
"Just cause", for purposes of this paragraph, includes, without limitation,
acts of dishonesty, insubordination, incompetence or moral turpitude,
conviction of a felony which is materially and demonstrably injurious to the
Company, habitual drunkenness, narcotic drug addiction, or other material
misconduct of any kind. Poor performance of the Company shall not be
considered "just cause." Further, actions taken at the direction of the Board,
or actions based on the recommendations of corporate legal counsel or qualified
outside advisors shall be presumed to be taken in good faith and for the best
interest of the Company. "Good reason" for purposes of this paragraph means a
material reduction in the scope of your position, duties or responsibilities,
or of your salary or status with the Company, or your removal from your
positions referred to above or if your principal office is relocated or changed
without your consent to a location more than 50 miles from the Company's
current offices located in Woodland Hills, California.
In the event you voluntarily terminate your employment with the Company, there
shall be no restrictions on your future employment.
Should disagreements arise with respect to this offer of employment, you and
the Company agree to submit the matter to binding arbitration. The Company
shall also have the right to pursue an equitable remedy in a California court
pursuant to the applicable laws of California with respect to the non-compete
and confidentiality restrictions set forth below. The prevailing party in
either the arbitration and/or the equitable remedy action shall recover all
attorney's fees and costs incurred.
This offer of employment shall remain confidential and, if accepted by you,
will obligate you to the following non-compete agreement as a condition of
receipt of any severance payments. Severance payments will be made on a
monthly basis for a period of two (2) years and are contingent upon
verification that you have complied with the non-compete provisions described
below. Accordingly, if you accept this offer, you agree that you will not, as
long as you accept severance payments, undertake any employment or activity on
behalf of a Competitor which employment or activity could call upon you to
reveal, to make judgments on or otherwise use any confidential business
information or trade secrets of the business of the Company or any of its
affiliates to which you had access during your employment with the Company.
For these purposes, "Competitor," shall refer to Kaiser Health Plan, Blue Cross
of California/WellPoint Health Networks, Blue Shield of California, Foundation
Health
<PAGE> 6
Dr. Arthur Southam
June 4, 1996
Page 6
Plans, Aetna Health Plans, PacifiCare, FHP International, Humana, United
Healthcare Corp, CIGNA, Prudential, or any other organization that would
reasonably be categorized as a member of this peer group. It is hereby further
agreed that if an arbitrator or any court of competent jurisdiction shall
determine that the restrictions imposed in this noncompete agreement are
unreasonable, invalid or unlawful (including, but not limited to, the
definition of Market Area or Competitor or the time period during which this
restriction is applicable), the parties hereto hereby agree to any restrictions
that such arbitrator or court would find to be reasonable under the
circumstances. It is further agreed that the Company shall have all equitable
remedies available to enforce this noncompetition restriction and the
confidentiality restriction set forth in the following paragraph.
You acknowledge and agree that, during the period of your employment by the
Company, you will have access to and become acquainted with various
confidential information and practices, confidential customer information, and
pricing methodology. All documents, memoranda, reports, files, correspondence,
lists and other written, electronic and graphic records affecting or relating
to the Company's business that you may prepare, use, observe, possess or
control shall be and remain the Company's sole property, and you shall not
disclose any of these items, except as required in the course of your
employment by the Company. In the event of the termination of your employment,
you shall deliver promptly to the Company all written and/or graphic records
containing such trade secrets or confidential information.
Nothing set forth herein is intended to create any condition or term of
employment other than that of an "at-will" employee. In other words, by
accepting employment with the Company you confirm that your employment is
voluntary and that there is no obligation on your part or on the part of the
Company to continue that employment relationship for any period of time. While
the Company certainly hopes that there will be a long and mutually satisfactory
relationship between you and the Company, it is expressly understood and agreed
that your employment can be terminated by either you or the Company at any
time, for any reason and with or without prior notice of any kind. The only
way in which this "at will" employment relationship can be changed is by a
written agreement, approved by the HSI Compensation and Stock Option Committee,
which expressly sets forth a specific length of employment and other
appropriate terms and conditions for the employment relationship.
The foregoing describes the terms of this offer of employment. Any prior or
contemporaneous agreements or representations, whether oral or written, which
may have been made or discussed but which are not included herein, are of no
force or effect whatsoever or at all. The HSI Compensation and Stock Option
Committee has approved this offer of employment.
<PAGE> 7
Dr. Arthur Southam
June 4, 1996
Page 7
Artie, you should know that both Jay Gellert and Dr. Hasan join me in extending
our warmest wishes. We are both enthusiastic about the prospect of having you
on Company's "First Team". Wishing you the best of success and the very
Best of health,
JAMES J. WILK
James J. Wilk
Senior President, Human Resources
and Administrative Services of Health Net
JJW/lsm
I hereby accept the terms of this offer of employment as outlined above.
/s/ ARTHUR M. SOUTHAM 6/4/96
- ----------------------- ---------
Arthur M. Southam, M.D. Date
Attachment: Exhibit 1
c: Malik M. Hasan, M.D. w/attachments
Jay M. Gellert w/attachments
<PAGE> 1
Exhibit 11.1
Health Systems International, Inc. and Subsidiaries
Computation of Earnings Per Share
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three-Months Ended June 30, Six-Months Ended June 30,
-------------------------------- --------------------------------
1996 1995 1996 1995
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Primary:
Shares outstanding at beginning of
period 48,089 48,826 48,327 48,492
Weighted average shares issued
(repurchased) during period 173 (362) (257) 147
Dilutive shares contingently issuable
upon exercise of stock options,
net of shares assumed to have
been purchased (at average
market price) for treasury with
assumed proceeds from exercise 126 571 190 586
------------ ------------ ------------ ------------
Total primary shares 48,388 49,035 48,260 49,225
============ ============ ============ ============
Net income $ 24,448 $ 22,966 $ 50,488 $ 41,877
============ ============ ============ ============
Net income per share $ 0.51 $ 0.47 $ 1.05 $ 0.85
============ ============ ============ ============
Fully diluted:
Shares outstanding at beginning of
period 48,089 48,826 48,327 48,492
Weighted average shares issued
(repurchased) during period 173 (362) (257) 147
Dilutive shares contingently
issuable upon exercise of stock
options, net of shares assumed to
have been purchased (at the
greater of average or period-end
market price) for treasury with 126 609 195 618
assumed proceeds from exercise ------------ ------------ ------------ ------------
Total fully diluted shares 48,388 49,073 48,265 49,257
============ ============ ============ ============
Net income $ 24,448 $ 22,966 $ 50,488 $ 41,877
============ ============= ============ ============
Net income per share $ 0.51 $ 0.47 $ 1.05 $ 0.85
============ ============= ============ ============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Health Net's
Form 10-Q and is qualified in its entirety by reference to such Form 10-Q
filing.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1996
<CASH> 103,787
<SECURITIES> 378,689
<RECEIVABLES> 102,717
<ALLOWANCES> (11,142)
<INVENTORY> 0
<CURRENT-ASSETS> 643,173
<PP&E> 189,523
<DEPRECIATION> (109,263)
<TOTAL-ASSETS> 1,119,500
<CURRENT-LIABILITIES> 397,825
<BONDS> 362,769
0
0
<COMMON> 51
<OTHER-SE> 346,470
<TOTAL-LIABILITY-AND-EQUITY> 1,119,500
<SALES> 0
<TOTAL-REVENUES> 807,915<F1>
<CGS> 0
<TOTAL-COSTS> 647,961<F2>
<OTHER-EXPENSES> 110,338
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,000
<INCOME-PRETAX> 43,616<F3>
<INCOME-TAX> 19,201
<INCOME-CONTINUING> 24,448
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,448
<EPS-PRIMARY> .51
<EPS-DILUTED> .51
<FN>
<F1>Includes 9,956 million of investment income.
<F2>Includes healthcare expenses only.
<F3>Excludes 33 thousand of minority interest in loss of subsidiary.
</FN>
</TABLE>
