<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(x) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Fee Required)
For the fiscal year ended: December 31, 1996
-----------------
( ) TRANSITION REPORT PURSUANT TO SECTION 13(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(No Fee Required)
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)
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 (818) 719-6978 (California)
code: (719) 542-0500 (Colorado)
Securities registered pursuant to Section 12(b) of
the Act:
</TABLE>
<TABLE>
<CAPTION>
Name of Each Exchange
Title of Each Class On Which Registered
------------------- ---------------------
<S> <C>
Class A Common Stock, $.001 par value New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of
the Act:
None
</TABLE>
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 ( )
<PAGE> 2
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. (x)
The aggregate market value of the voting stock held by non-affiliates
of the registrant at March 24, 1997 was $696,654,299 (which represents
23,817,241 shares of Class A Common Stock held by such non-affiliates
multiplied by $29.25, the closing price of such stock on the New York Stock
Exchange on March 24, 1997).
The number of shares outstanding of the registrant's Class A Common
Stock as of March 24, 1997 was 29,144,331 (excluding 3,194,374 shares held as
treasury stock), and 19,297,642 shares of the registrant's Class B Common Stock
were outstanding as of such date.
DOCUMENTS INCORPORATED BY REFERENCE: None.
<PAGE> 3
HEALTH SYSTEMS INTERNATIONAL, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
Page No.
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<S> <C> <C> <C>
PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . 14
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters . . . . . . . . . . . . . 21
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . 24
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . 55
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . 56
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . 68
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . 72
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . 77
</TABLE>
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PART I
ITEM 1. BUSINESS
Health Systems International, Inc. (the "Company" or "HSI") is one of
the largest managed health care companies in the United States, with more than
1.9 million full-risk and administrative services only ("ASO") members. The
Company provides a comprehensive range of health care services through health
maintenance organizations ("HMOs") located in the following four regions: the
California region, the Northeast region (Connecticut, Pennsylvania and New
Jersey), the Northwest region (Washington, Oregon and Idaho) and the Southwest
region (Colorado and New Mexico). Health Net, the Company's HMO subsidiary in
California, is the second largest provider of managed health care services in
California with approximately 1,340,000 members. The Company also operates a
preferred provider organization ("PPO") network providing access to health care
services to over 4.6 million persons in 48 states and owns two health and life
insurance companies licensed to sell insurance in 33 states and the District of
Columbia.
The Company's HMOs market traditional HMO products to employer groups
and Medicare and Medicaid products directly to individuals. Health care
services that are provided to the Company's commercial and individual members
include primary and specialty physician care, hospital care, laboratory and
radiology services, prescription drugs, dental and vision care, skilled nursing
care, physical therapy and mental health. The Company's HMO service networks
include approximately 19,300 primary care physicians, 42,000 specialists and
554 hospitals. The Company utilizes sophisticated medical management systems
to reduce excess utilization of health care services. The Company continues to
develop a new generation medical management system which utilizes clinical
protocols and triage procedures to direct members to the most appropriate
provider. The Company believes that this new system, which it calls "Fourth
Generation Medical Management," will represent a major advance in applying
sophisticated information systems to the practice of medicine.
The Company's strategy for growth combines revenue and member
increases in existing markets with expansion into new geographic markets
principally through acquisitions. The Company's internal growth has been
achieved through the introduction of Medicare, Medicaid and other products, and
the Company has targeted the Northeastern United States for expansion due to
the relatively low penetration of managed health care in the region and such
region's relatively higher average premiums as compared to the Company's
western regions. In conformance with this strategy, the Company is in the
process of acquiring Advantage Health, a group of managed health care companies
headquartered in Pittsburgh, with operations in West Virginia, Ohio and
Pennsylvania. The Company has also recently entered into definitive agreements
to acquire debentures convertible into 71% of the total equity of First Option
Health Plan, Inc. ("FOHP"), a managed health care company located in Red Bank,
New Jersey. The Company expects to continue to make health-care related
acquisitions in the Northeastern United States and other geographic regions.
On October 1, 1996 the Company entered into an Agreement and Plan of
Merger with Foundation Health Corporation ("FHC"), an integrated managed health
care organization. Under the definitive agreement, FH Acquisition Corp., a
wholly-owned subsidiary of HSI, will merge with and into FHC with FHC surviving
the merger as a wholly-owned subsidiary of HSI (the "FHC Merger"). Each
company's stockholders voted to approve the FHC Merger at their respective
special meetings held on February 12, 1997. Completion of the transaction,
which will be accounted for as a pooling-of-interests, is subject to regulatory
approvals as well as other customary conditions and is expected to be completed
in April of 1997. FHC's stockholders will receive 1.3 shares of HSI Class A
Common Stock for each share of FHC common stock owned resulting in the issuance
of approximately 77 million additional shares of HSI Class A Common Stock.
The Company was incorporated in 1990. The Company is the successor to
the business conducted by Health Net, which became a subsidiary of the Company
in 1992, and the HMO and PPO networks operated by QualMed, Inc. ("QualMed"),
which combined with the Company in 1994 (the "HSI Combination"). The Company
operates and conducts its HMO and other businesses through its wholly and
majority owned subsidiaries. Except as the context otherwise requires, the
term the "Company" refers to HSI and its subsidiaries.
<PAGE> 5
THE MANAGED HEALTH CARE INDUSTRY
In response to the rapid increases in health care costs, employers,
insurers and government entities have sought cost- effective alternatives to
conventional indemnity insurance for the delivery of and payment for quality
health care services. The integration of the delivery of, and payment for,
health care services distinguishes HMOs from conventional health insurance
plans. The goals of HMOs are to provide their members with access to quality
health care, while employing a business strategy and management systems
designed to encourage more cost-effective use of health care delivery systems.
Such cost containment strategies include providing access to primary physician
care and other services on a fixed, prepaid basis, monitoring hospital
admissions and lengths of stay, using a system of specialist referrals, using
non-hospital based medical services, and emphasizing preventive care. To
accomplish these objectives, the following basic HMO models have evolved:
o Network Model HMOs contract with several physician groups and
independent or individual practice associations ("IPAs").
o Individual or Independent Practice Association HMOs ("IPA
Model HMOs") contract through one or more IPAs, which are
physician entities that in turn subcontract with individual
physicians to provide HMO patient services. Those physicians
continue to provide services to non-HMO patients in their
separate private practices, while also providing services to
HMO patients (and often PPO patients as well) through an IPA.
o Staff Model HMOs directly employ physicians and usually own
the offices and clinics utilized by the physician staff.
o Group Model HMOs contract, often on an exclusive basis, with a
physician group practice. In many cases, the HMO also owns the
offices and clinics.
Health Net is a Network Model HMO and the Company's other HMOs
operate under the IPA Model.
MARKETS
As of December 31, 1996, the Company owned and operated HMOs in four
regional areas of the United States: The California region, the Northeast
region (Connecticut, Pennsylvania and New Jersey), the Northwest region
(Washington, Oregon and Idaho) and the Southwest region (Colorado and New
Mexico). The following table contains certain information relating to
commercial HMO members, Medicare members and employer groups under contract as
of December 31, 1996 in each region in which the Company operates:
<TABLE>
<CAPTION>
California Northeast Northwest Southwest
Region Region Region Region
------ ------ ------ ------
<S> <C> <C> <C> <C>
Commercial HMO Members 1,218,562 172,210 146,237 78,920
Medicare Members 117,225 13,659 2,805 12,021
Medicaid Members 0 42,634 16,834 0
ASO 0 156,935 0 11,855
Number of Employer Groups 3,733 5,707 2,243 2,916
Largest Employer Group as
% of enrollment 10% 27% 19% 9%
</TABLE>
2
<PAGE> 6
<TABLE>
<S> <C> <C> <C> <C>
10 largest Employer Groups as
% of enrollment 32% 35% 32% 26%
% of Members in Employer Groups
with fewer than 50 Eligible Members 5% 15% 15% 21%
</TABLE>
California Region. The California market is characterized by a
concentrated population and a relatively high proportion of large employer
groups (over 1,000 employees). Health Net is the second-largest HMO in the
State of California in terms of membership. As of December 31, 1996, Health
Net was licensed to operate its commercial HMO business in 47 of the 58
counties in the State of California, which counties represent over 81% of the
population in California. HMO enrollment represented 43% of the population of
California in 1996. The Company's commercial HMO membership in California at
December 31, 1996 was 1,218,562 which represented a decrease of 3.1% during
1996. The Company's Medicare risk membership in California at December 31,
1996 was 117,225 which represented an increase of 8.7% during 1996.
Northeast Region. The Northeast region currently includes
Connecticut, Pennsylvania and New Jersey. The Company commenced operations in
this region in 1994 with the acquisition of a PPO network and significantly
expanded its operations with the acquisition of M.D. Health Plan of Connecticut
in March 1995 and Greater Atlantic Health Services of Pennsylvania (now named
QualMed Plans for Health, Inc.) in December 1995. HMO enrollment represented
31% and 34% of the population of Connecticut and Pennsylvania, respectively, in
1996. The Company believes its Pennsylvania HMO is the fourth-largest HMO in
terms of membership in the state of Pennsylvania. The Company's commercial HMO
membership in Pennsylvania was 42,217 at December 31, 1996 which represented a
decrease of 17.1% during 1996. The Company's Medicare risk membership in
Pennsylvania was 13,659 at December 31, 1996 which represented an increase of
3.4% during 1996. The Company's Medicaid risk membership in Pennsylvania was
20,317 at December 31, 1996, a 28.3% decrease in 1996. The Company believes
M.D. Health Plan is the fifth-largest HMO in terms of membership in the State
of Connecticut. M.D. Health Plan's commercial HMO membership in Connecticut
was 129,993 at December 31, 1996 which represented an increase of 11.4% during
1996. Medicaid risk membership for M.D. Health Plans was 22,317 at December
31, 1996, an increase of 177% in 1996.
Northwest Region. The Northwest region's population is principally
concentrated in Portland, Oregon and Seattle and Spokane, Washington. The
Company's Washington HMO also services a limited number of residents who reside
in the State of Idaho. Portland, Seattle and Spokane have experienced
population growth rates greater than the national average over the last several
years. In addition, an increasing percentage of the population in each of
these areas has enrolled in HMOs in the last several years. HMO enrollment
represented 43% and 24% of the population of Oregon and Washington,
respectively, in 1996. In Washington and Oregon, the Company believes that it
ranks second and seventh, respectively, with respect to total membership; the
Company believes that it ranks second in Washington and second in Oregon with
respect to the size of its primary care physician and specialist networks. The
Company's commercial HMO membership in Oregon was 50,808 at December 31, 1996
which represented an increase of 20.5% during 1996. The Company's commercial
HMO membership in Washington was 95,429 at December 31, 1996 which represented
a decrease of 16.1% during 1996. The Company's Medicare risk membership in
Washington was 2,805 at December 31, 1996 which represented an increase of
92.8% during 1996. The Company's Medicaid risk membership in Washington was
16,055 at December 31, 1996 which represented an increase of 46.9% during 1996.
Southwest Region. The Southwest region includes the States of
Colorado and New Mexico. The Company's employer groups in the Southwest region
consist predominantly of companies with fewer than 50 employees. HMO
enrollment represented 31% and 17% of the population of Colorado and New
Mexico, respectively, in 1996. The Company believes that it is the
fifth-largest HMO in Colorado as measured by total membership and the seventh
largest as measured by the size of its primary care physician and specialist
provider networks. The Company's commercial HMO membership in Colorado was
51,869 at December 31, 1996 which represented an increase of 16.1% during 1996.
The Company's Medicare membership in Colorado was 9,954 at December 31, 1996
which represented an increase of 11.6% during 1996. In New Mexico, the Company
believes that its ranks fourth, as measured by total membership and the size of
its provider network. The Company's commercial HMO membership in New Mexico
was 27,051 at December 31, 1996 which represented an increase
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<PAGE> 7
of 3.1% during 1996. The Company's Medicare risk membership in New Mexico was
2,067 at December 31, 1996 which represented an increase of 17.0% during 1996.
SERVICES AND PRODUCTS
Commercial Managed Health Care Products. The Company's HMOs, through
their health care providers, offer members a comprehensive range of health care
services, including ambulatory and outpatient physician care, hospital care,
pharmacy services, eye care, mental health and ancillary diagnostic and
therapeutic services. The Company offers a full spectrum of managed health
care products including conventional HMO, managed indemnity, point-of-service
and customized HMO products. The Company's strategy is to offer a wide range
of managed health care products and services to employers to assist employers
in containing health care costs. The pricing of the products offered is
designed to provide incentives to both employers and employees to select and
enroll in the products with greater managed health care and cost containment
elements. While a majority of the Company's members are covered by
conventional HMO products, the Company is continuing to expand its other
product lines, thereby enabling it to offer flexibility to an employer and to
tailor its product to an employer's particular needs.
The integrated health care programs offered by the Company's HMOs
include traditional Network and IPA Model HMO products, which are intended to
offer quality care, cost containment and comprehensive coverage; a matrix
package which allows employees to select their desired coverage from
alternatives that have interchangeable outpatient and inpatient co-payment
levels; point-of- service programs which offer a multi-tier design that
provides both conventional HMO and indemnity-like (in-network and out-of-
network) tiers; a PPO-like tier which allows members to self-refer to the
network physician of their choice; and a managed indemnity plan, which is
provided for employees who reside outside of its HMO service areas.
Medicare Risk. The Company expanded its Medicare risk business in
1996 through the addition of 12,484 Medicare risk enrollees and, as of December
31, 1996, the Company's Medicare risk plans had a combined membership of
approximately 146,000. The Company expects its Medicare risk business to
continue to increase in the future.
The Company offers its Seniority Plus, Senior Security and Wise Choice
Medicare risk products directly to individuals and to employer groups. To
enroll in a Company Medicare risk plan covered persons must be eligible for
Medicare. Health care services normally covered by Medicare are provided or
arranged for by the Company, in conjunction with a broad range of preventive
health care services. The federal Health Care Financing Administration
("HCFA") pays to the Company for each enrolled member a monthly fee based, in
part, upon the "Adjusted Average Per Capita Cost," as determined by HCFA's
analysis of fee-for-service costs related to beneficiary demographics.
Depending on plan design and other factors, the Company may charge a member a
premium or prepaid charge.
The Company's Health Net subsidiary introduced a Medicare risk
point-of-service product in the first half of 1996. The two-tier product
combines features of a standard Medicare risk HMO with an option for the member
to seek health care services outside of the HMO network, which outside services
carry higher co-payments and co-insurance compared with services provided
inside the HMO network. The Company believes that this product will provide
additional marketing opportunities to retirees of large employers, Health Net's
largest market segment.
The Company's California Medicare risk product, Seniority Plus, was
licensed and certified to operate in 31 California counties (20 full counties
and 11 partial counties) as of December 31, 1996. The Company's other HMOs are
licensed and certified to offer Medicare risk plans in 7 counties in Colorado,
5 counties in New Mexico, 6 counties in Washington and 5 counties in
Pennsylvania. The Company is currently applying for a Medicare risk contract
in Oregon and Connecticut. The Company has contracted with more than 7,200
primary care physicians, more than 16,400 specialty physicians and 213 hospitals
to provide services to its Medicare risk members in California, and the
Company's HMOs in the Southwest, Northwest and Northeast regions have
contracted with approximately 3,200 primary care physicians, 8,500 specialty
physicians and 113 hospitals to provide services to its Medicare risk members.
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<PAGE> 8
Medicaid Products. With the acquisitions of M. D. Health Plan and
Greater Atlantic in 1995, the Company significantly expanded its Medicaid
business and, at December 31, 1996, the Company had an aggregate of
approximately 59,000 Medicaid members. To enroll in these Medicaid products,
an individual must be eligible for Medicaid benefits under the appropriate
state regulatory requirements. These HMOs offer, in addition to standard
Medicaid coverage, certain additional services including dental and vision
benefits. The applicable state agency pays the Company's HMOs a monthly fee
for each Medicaid member enrolled on a percentage of fee-for-service costs. As
of December 31, 1996, Greater Atlantic had approximately 20,000 Medicaid
members in Pennsylvania, M.D. Health Plan had approximately 22,000 Medicaid
members in Connecticut, and the Company's HMOs in Washington and Oregon had
approximately 16,000 and 1,000 Medicaid members in their service areas,
respectively. Effective March 1997 the Company has discontinued its
participation in the Pennsylvania Medicaid program.
Administrative Services Only Business. The Company also provides
third party administrative services to large employer groups throughout its
service areas. Under these arrangements, the Company provides claims
processing, customer service, medical management and other administrative
services without assuming the risk for medical costs. The Company is generally
compensated for these services on a fixed per member per month basis.
Workers' Compensation Product. Health Net Comp.24, the Company's
workers' compensation product in California, is an integrated full service
managed care workers' compensation program designed to deliver managed medical
care to reduce workers' compensation medical expenses for insurance carriers
and self-insured employers. Comp.24 combines medical cost-saving techniques
and workers' compensation disability management with the goal of halting
inflationary trends and reducing overall costs in workers' compensation. The
initial strategy of Comp.24, which began operations in July 1994, is to create
multiple alliances with large, well-established regional and national insurance
carriers and to provide administrative services to large self-insured
employers. Consumers of the Comp.24 product will have access to a specialized
provider network and tailored medical management, quality controls, and other
specialized administrative capabilities. Currently, Comp.24 provides
administrative workers' compensation services to American International Group
Claim Services, Republic Indemnity and ITT Hartford. The Company has expanded
its Comp.24 product line by offering a "24 hour" workers' compensation
coverage.
Insurance Products. The Company offers indemnity products as part of
multiple option products in California, Colorado, New Mexico and Washington.
These products are offered by the Company's health and life insurance
subsidiaries which are licensed to sell insurance in 33 states and the District
of Columbia. Through these subsidiaries, the Company also offers HMO members
certain auxiliary non-health products such as group life, accidental death and
disability and short-term disability insurance, in conjunction with its managed
care products.
Specialty Products. The Company's comprehensive product offering also
includes supplemental programs for managed chiropractic care, vision coverage,
a managed mental health/substance abuse program and a prescription drug
program.
Wellness Programs. The Company emphasizes the importance of health
education, disease prevention and adoption of healthier lifestyles through its
"Wellness Programs." Management believes that health awareness can be a factor
in the reduction of health care costs. Wellness Programs are offered directly
to employees at the employees' work site or through primary medical groups
("PMGs"). PMGs are required and encouraged (in the form of increased
capitation payments) to offer educational programs and preventive health care
information. To date, Wellness Programs have focused on topics such as
prenatal care, smoking cessation, weight management, back care, diabetes and
exercise. In addition to the health care benefits, the Company believes that
its Wellness Programs are unique and provide it with a marketing advantage
which differentiates it from its competitors.
PPO Network Services. As of December 31, 1996, the Company's PPO
network subsidiary, Preferred Health Networks, Inc. ("PHN"), provided PPO and
workers' compensation network services to over 4.6 million covered persons in
48 states and the District of Columbia. In January 1996, PHN acquired Midwest
Business Medical Association ("MBMA"), a PPO network operating in the states of
Illinois, Indiana, Nebraska and
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<PAGE> 9
Wisconsin. MBMA included more than 200 hospitals and 9,500 physicians covering
more than one million members. The Company intends to continue to expand such
operations into additional states, as appropriate.
PROVIDER SERVICES AND ARRANGEMENTS
Physician Relationships. Upon enrollment in one of the Company's HMO
plans, each member selects a primary care physician or PMG from the HMO's
provider panel. The primary care physicians and PMGs assume overall
responsibility for the care of members and determine the nature and extent of
services provided to any given member. Medical care provided directly by such
physicians includes the treatment of illnesses not requiring referral, as well
as physical examinations, routine immunizations, maternity and child care and
other preventive health services. In conjunction with medical director review,
the primary care physicians and PMGs are responsible for making referrals to
specialists and hospitals. In Connecticut, the M. D. Health Plan HMO is
offered on an "open panel" basis under which members may access any physician
in the network without first consulting a primary care physician.
The following table sets forth the number of primary care and
specialist physicians with whom the Company's HMOs (and certain of such HMOs'
PMGs) contracted as of December 31, 1996 by its plans in each of the geographic
regions in which it had active HMO operations:
<TABLE>
<CAPTION>
California Northeast Northwest Southwest
Region Region Region Region
------ ------ ------ ------
<S> <C> <C> <C> <C>
Primary Care Physicians 10,370 4,011 3,809 1,129
Specialist Physicians 20,877 8,689 9,493 3,010
Total 31,247 12,700 13,302 4,139
====== ====== ====== =====
</TABLE>
Physician contracts are generally for a period of one year and are
automatically renewable unless terminated, with certain requirements for
maintenance of good professional standing and compliance with the Company's
quality, utilization and administrative procedures. Market pressures have
caused the Company to undertake a review of the financial terms of contracts
with certain of its physician providers. In California, the primary care
physicians and PMGs generally receive a monthly "capitation" fee for every
member served. The capitation fee represents payment in full for all medical
and ancillary services specified in the service agreements. The non-physician
component of all hospital services is covered by a combination of capitation
and/or per diem charges. In such capitated arrangements, in cases where the
capitated provider cannot provide the health care services needed, such
providers generally contract with specialists and other ancillary service
providers to furnish the requisite services pursuant to capitation agreements
or negotiated fee schedules with specialists. The Company's HMOs outside
California generally reimburse physicians according to a discounted
fee-for-service schedule.
Hospital Relationships. The Company's HMOs provide hospital care
primarily under contracts with selected hospitals in their service areas. Such
hospital contracts generally provide for multi-year terms, with limited annual
reimbursement increases, and provide for payments on a variety of bases,
including capitation, per diem rates, case rates and discounted fee-for-service
schedules.
Covered hospital inpatient care for a member is comprehensive; it
includes the services of physicians, nurses and other hospital personnel, room
and board, intensive care, laboratory and x-ray services, diagnostic imaging
and generally all other services normally provided by acute-care hospitals.
Once a member is admitted to a hospital, nurses employed or designated by the
HMO monitor the progress of the member's continued hospitalization by reviewing
medical charts in the hospital, consulting with the attending physician and
reporting back to the physician medical director. The nurse updates the
member's status on a daily basis into the Company's management information
system. In the Company's IPA Model HMOs, a daily hospitalization report is
generated, and the status of each hospitalized member is reviewed by a medical
director on a daily basis. The HMO nurses
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<PAGE> 10
and medical directors are actively involved in discharge planning and case
management, which often involves the coordination of community support
services, including visiting nurses, physical therapy, durable medical
equipment and home intravenous therapy.
Other Medical Services. Certain medical and surgical procedures,
including laboratory tests, diagnostic radiology services and ambulatory
surgery, are performed on an outpatient basis. Other outpatient services
include crisis intervention, group therapy and counseling services,
substance-abuse services, physical therapy and other similar services for which
hospitalization is not medically necessary. These services, as well as optional
riders for pharmaceuticals and eye care, are provided to members through
contracting physicians and other health care providers, who are generally paid
according to a discounted fee-for-service schedule.
MANAGEMENT INFORMATION SYSTEMS
The Company operates a sophisticated management information system
that gathers and stores data on its members and physician and hospital
providers. It contains all of the Company's necessary membership and
claims-processing capabilities as well as marketing and medical utilization
programs. An effective management information system is critical to the
Company's operation. In 1995 the Company commenced the installation of the
AMISYS operating and MACESS document imaging systems at its HMOs outside of
California. These systems provide the Company with an integrated and efficient
system of billing, reporting, member services and claims processing and the
ability to examine member encounter information for the optimization of
clinical outcomes.
In 1995, the Company embarked on a multi-year project to develop and
install a new information system designed to facilitate the seamless management
of patients throughout the entire health care continuum. This "Fourth
Generation Medical Management" project includes regional data repositories
containing clinical and demographic data about each of the Company's health
plan members, which data serves as the basis for enhanced clinical decision
making. Physicians, hospitals and the Company's case managers will have access
to expert systems and an ever-expanding library of clinical protocols which
will help in optimizing the diagnosis and treatment decisions for each health
plan member. In addition, the Company is building regional, comprehensive
member support centers which it believes will strengthen the connection between
members and the Company. These centers will serve as the primary contact for
members 24 hours a day, seven days a week, offering expert triage by nurses and
directing members to the most appropriate provider. Outbound activities of the
call centers include clinical reminder calls to members and consultive support
for self-care protocols. The Fourth Generation Medical Management system has
been undergoing testing since July 1996. In its Philadelphia "beta" site, six
hospitals, two physician practices and a comprehensive Member Support Center
servicing 300,000 of the Company's members are running on a single integrated
"Fourth Generation" system. The Company anticipates that this system will see
expanded use in its health plans by the end of 1997 and will be installed in
all the Company's plans within three years.
COST CONTAINMENT
The primary care physician or PMG is responsible for authorizing all
needed medical care except for emergency medical services. By coordinating
care through such physicians in cases where reimbursement includes risk-sharing
arrangements, the Company believes that inappropriate use of medical resources
is reduced and efficiencies are achieved.
To limit possible abuse in utilization of hospital services, a
certification process precedes the admission of each non- emergency patient
member, followed by continuing review during the patient's hospital stay. In
addition to reviewing the appropriateness of hospital admission and continued
hospital care, the Company plays an active role in evaluating alternative means
of providing care to enrollment members and encourages the use of outpatient
care, when appropriate, to reduce the cost that would otherwise be associated
with an inpatient hospital admission.
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QUALITY ASSURANCE
Quality assurance is a continuing priority for the Company. Each of
the Company's HMOs has a quality assurance plan administered by a committee
comprised of medical directors and primary care and specialist physicians. The
committees' responsibilities include periodic review of medical records,
development and implementation of standards of care based on current medical
literature and community standards and the collection of data relating to
results of treatment. All of the Company's HMOs also have a subscriber
grievance procedure and/or a member satisfaction program designed to respond
promptly to member grievances. Aspects of such member service programs take
place both with the participating physicians and the Company's HMOs. They are
coordinated with other aspects of the Company's operations, including quality
assurance and utilization management, medical policy and marketing. The
following projects and reviews help to access the Company's progress in this
area.
NCQA Accreditation. The National Committee for Quality Assurance
("NCQA") is an independent, non-profit organization that reviews and accredits
HMOs. NCQA assesses an HMOs quality improvement, utilization management,
credentialing process, commitment to members' rights and preventive health
services. HMOs that comply with NCQA's review requirements and quality
standards receive NCQA accreditation. Health Net received full one year
accreditation from the NCQA in 1995. Health Net had its 1996 NCQA site visit
in December 1996 and it is awaiting the results. The Company's Seattle region
of its Washington HMO had its initial NCQA accreditation site visit in July
1995 and received provisional accreditation. The health plan's second visit
from NCQA occurred in January 1997 and is awaiting the results. The Company's
Philadelphia, Pennsylvania HMO was also evaluated in July 1996 and is likewise
awaiting the final determination. The Company's Spokane region of its
Washington HMO is scheduled for its initial accreditation site visit in March
1997. The Company's remaining HMOs have already submitted or are currently
preparing applications for NCQA accreditation, and such HMOs anticipate that
NCQA accreditation site visits will take place in early 1997. See also
"Government Regulation--National Committee for Quality Assurance" herein.
HEDIS. In 1996, the Company's HMOs continued their participation in a
nationwide program known as the Health Plan Employer Data and Information Set
("HEDIS"). The purpose of HEDIS is to test the ability of health plans to
collect and report on a wide variety of measures that point toward quality of
care and service. The project was developed under the auspices of the NCQA.
NCQA modified the required quality measures for the 1996 HEDIS submission which
was filed electronically as part of a voluntary NCQA pilot program called
"Quality Compass", a CD-ROM publication tool for HEDIS results. The results of
these submissions indicated that the quality, performance and member
satisfaction of the Company's HMOs were comparable to or exceeded its major
competing plans.
MARKETING AND SALES
Marketing is a two-step process in which the Company first markets to
employer groups and then provides information directly to employees once the
employer has selected the HMO. The Company typically uses its internal sales
staff to serve the large employer groups while independent brokers work with
the Company's internal sales staff to develop business with smaller employer
groups. Once selected by an employer, the Company solicits enrollees from the
employee base directly. In 1996, the Company marketed its programs and services
primarily through its direct sales staff and independent brokers, agents and
consultants. During "open enrollment" periods when employees are permitted to
change health care programs, the Company uses direct mail, worksite and health
fair presentations, telemarketing, and outdoor, print, radio and television
advertisements to attract new enrollees. The Company's sales efforts are
supported by its marketing division which includes research and product
development, corporate communications, public relations and marketing services.
Premiums for each employer group are generally contracted for on a
yearly basis. Numerous factors are considered by the Company in fixing its
monthly premiums, including employer group needs, and anticipated health-care
utilization rates as forecasted by the Company's management based on the
demographic composition of, and the Company's prior experience in, its service
areas. Premiums are also affected by applicable regulations that
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prohibit experience rating of group accounts (i.e., setting the premium for the
group based on its past use of health care services) and by state regulations
governing the manner in which premiums are structured and the plan's overall
financial viability.
COMPETITION
HMOs operate in a highly competitive environment in an industry
currently subject to significant changes from business consolidations, new
strategic alliances, legislative reform and market pressures brought about by a
better informed and better organized customer base. The Company's HMOs face
substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded
plans (including self-insured employers and union trust funds), Blue Cross/Blue
Shield plans and traditional indemnity insurance carriers, some of which have
substantially larger enrollments and greater financial resources than the
Company. The Company believes that the principal competitive features
affecting its ability to retain and increase membership include the range and
prices of benefit plans offered, provider network, quality of service,
responsiveness to user demands, financial stability, comprehensiveness of
coverage, diversity of product offerings and market presence and reputation.
The relative importance of each of these features and key competitors vary by
market. The Company believes that it competes effectively with respect to all
of these factors.
California Region. Kaiser Foundation Health Plan ("Kaiser") is the
largest HMO in California and in the United States and the Company's principal
competitor in the California HMO industry. In addition to Kaiser, the
Company's other HMO competitors include PacifiCare of California (which
recently purchased FHP Health Plan) California Care (Blue Cross), CIGNA
Healthplans of California, Inc. and Foundation Health Plan. In addition, there
are a number of other types of competitors including self-directed plans,
traditional indemnity insurance plans and other managed care plans.
The Company competes in California for employers and members against
other HMOs, self-funded plans, traditional health insurers and a variety of
PPOs. The establishment of PPOs has been encouraged by legislation in
California that enables insurance companies to negotiate fees with health care
providers and to extend economic incentives to insureds to utilize such
providers without significant legal restrictions. However, the California
Department of Corporations (the "DOC"), which regulates all California HMOs,
has interpreted California law to prohibit California PPOs that lack an HMO
license from compensating providers on a capitated or other prepaid or periodic
basis unless those providers themselves have an HMO license. Thus, only HMOs
may legally enter into such financial arrangements with providers, while PPOs
are limited to fee-for-service arrangements.
Southwest Region. The Company's Colorado HMO competes primarily
against other area HMOs including Kaiser and FHP of Colorado, Inc., as well as
with a Blue Cross/Blue Shield HMO, other commercial carriers and various
hospital or physician-owned HMOs. The Company's largest competitor in New
Mexico is Lovelace Health Plan, an HMO owned by CIGNA Corporation. The
Company's New Mexico HMO also competes with Presbyterian Health Plan, FHP
Healthcare and Blue Cross/Blue Shield.
Northwest Region. The Company's Oregon HMO competes primarily against
other HMOs including Kaiser, PacifiCare of Oregon, The Good Health Plan, PACC
Health Plans and a Blue Cross/Blue Shield HMO, and with various PPOs. The
Company's Washington HMO competes primarily with Group Health Cooperative of
Puget Sound, Kaiser, HealthPlus (Blue Cross), and with commercial carriers,
self-funded plans and other Blue Cross/Blue Shield organizations.
Northeast Region. The Company's HMO in Connecticut competes for
business with commercial insurance carriers, Blue Cross and Blue Shield of
Connecticut and more than ten HMOs. The Company's main competitors in
Pennsylvania and New Jersey are AETNA/U.S. Healthcare, Independence Blue
Cross, Oxford Health Plans, AmeraHealth and Keystone East.
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GOVERNMENT REGULATION
The Company believes it is in compliance in all material respects with
all current state and federal regulatory requirements applicable to the
business to be conducted by its subsidiaries. Certain of these requirements are
discussed below.
Federal HMO Statutes. Under the Federal Health Maintenance
Organization Act of 1973 (the "HMO Act"), services to members must be provided
substantially on a fixed, prepaid basis without regard to the actual degree of
utilization of services. Although premiums established by an HMO may vary from
account to account through composite rate factors and special treatment of
certain broad classes of members, traditional experience rating of accounts
(i.e., retrospective adjustments for a group account based on that group's past
use of health care services) is not permitted under the HMO Act; prospective
rating adjustments are, however, allowed. All of the Company's HMOs (other than
M.D. Health Plan) are federally qualified in certain parts of their respective
service areas under the HMO Act and are therefore subject to the requirements
of such act to the extent federally qualified products are offered and sold.
The Company's Seniority Plus, Senior Security and Wise Choice products
provided under Medicare risk contracts are subject to regulation by HCFA.
Under these contracts and HCFA regulations, if premiums received for
Medicare-covered health care services provided to senior plan members are more
than the premiums received for the same health care services provided to
non-senior plan members, then the Company must provide senior plan members with
additional benefits beyond those required by Medicare, or reduce their
premiums, deductibles or copayments, if any. Such products are not permitted to
account for more than one-half of the Company's total HMO members in each of
their geographic markets. HCFA has the right to audit HMOs operating under
Medicare contracts to determine the quality of care being rendered and the
degree of compliance with HCFA's contracts and regulations.
California HMO Regulations. California HMOs such as Health Net are
subject to state regulation, principally by the DOC under the Knox-Keene Health
Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"). Among the
areas regulated by the Knox-Keene Act are: (i) adequacy of management, (ii) the
scope of benefits required to be made available to members, (iii) the manner in
which premiums are structured, (iv) procedures for review of quality assurance,
(v) enrollment requirements, (vi) composition of policy making bodies to assure
that plan members have access to representation, (vii) procedures for resolving
grievances, (viii) the interrelationship between HMOs and their health care
providers, (ix) adequacy and accessibility of the network of health care
providers, (x) provider contracts and (xi) initial and continuing financial
viability. Any material modifications to the organization or operations of
Health Net are subject to prior review and approval by the DOC. This approval
process can be lengthy and there is no certainty of approval. In addition,
under the Knox-Keene Act, Health Net must file periodic reports with, and is
subject to periodic review by, the DOC.
Other HMO Regulations. In each state in which the Company does
business, HMOs must file periodic reports with, and their operations are
subject to periodic examination by, state licensing authorities. In addition,
each HMO must meet numerous state licensing criteria and secure the approval of
state licensing authorities before implementing certain operational changes,
including the development of new product offerings and, in some states, the
expansion of service areas. To remain licensed, each HMO must continue to
comply with state laws and regulations and may from time to time be required to
change services, procedures or other aspects of its operations to comply with
changes in applicable laws and regulations. HMOs are required by state law to
meet certain minimum capital and deposit and/or reserve requirements in each
state and may be restricted from paying dividends to their parent corporations
under certain circumstances from time to time. Several states have increased
minimum capital requirements, which increases are typically phased in over a
period of time. Regulations in these and other states may be changed in the
future to further increase equity requirements. Such increases could require
the Company to contribute additional capital to its HMOs. Any adverse change in
governmental regulation or in the regulatory climate in any state could
materially impact the HMOs operating in that state. The HMO Act and state laws
place various restrictions on the ability of HMOs to price their products
freely. The Company must comply
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with certain provisions of certain state insurance and similar laws, especially
as it seeks ownership interests in new HMOs, PPOs and insurance companies, or
otherwise expands its geographic markets or diversifies its product lines.
Insurance Regulations. State departments of insurance (the "DOIs")
regulate insurance and third party administrator business conducted by certain
subsidiaries of the Company (the "Insurance Subsidiaries") pursuant to various
provisions of state insurance codes and regulations promulgated thereunder. The
Insurance Subsidiaries are subject to various capital reserve and other
financial requirements established by the DOIs. The Insurance Subsidiaries must
also file periodic reports regarding their activities regulated by the DOIs and
are subject to periodic reviews of those activities by the DOIs. The Company
must also obtain approval from or file with the DOIs for all of its group and
individual policies prior to issuing those policies. The Company does not
believe that the requirements imposed by the DOIs will have a material impact
on the ability of the Insurance Subsidiaries to conduct their business
profitably.
National Committee for Quality Assurance. NCQA, an independent,
non-profit organization that reviews and accredits HMOs, assesses an HMO's
quality improvement, utilization management, credentialing process, commitment
to members' rights and preventive health services. HMOs that comply with NCQA's
review requirements and quality standards receive NCQA accreditation. See also
"Quality Assurance--NCQA Accreditation" herein. After an NCQA review is
completed, NCQA will issue one of four designations. These are (i) full
accreditation for three years; (ii) full accreditation for one year; (iii)
provisional accreditation for twelve to eighteen months to correct certain
problems with a follow-up review to determine qualification for accreditation;
and (iv) not accredited.
RISK MANAGEMENT
The Company currently manages risk through various mechanisms
including premium structure, reinsurance and liability coverage.
Premium Structure. The Company's premiums are based on the estimated
average medical and administrative costs per member for the expected
utilization and cost of services provided to members under the benefit plans
and the benefit riders selected by an employer. These rates are formulated by
the Company with the assistance of outside actuarial consulting firms as
required. The Company also calculates the capitation rate, where applicable,
for the coverage and optional riders chosen by each employer group.
All employer group premium rates generally are contracted for on a
yearly basis unless the Company and the employer agree to adjust the contract
term so that the effective date coincides with the beginning of the group's
health benefit plan year or to accommodate an established open enrollment
period. The Company may, from time to time, guarantee limits on premiums with
employers if contracts are renewed. Based on its marketing experience, the
Company believes that the rates established at the present time are competitive
with rates presently paid by employers in its service areas for similar health
benefit coverage. The Company's methodology for determining premium rates is
in accordance with federal guidelines, which provide for community rating,
community rating by class and adjusted community rating.
Reinsurance. With respect to reinsurance, the Company pursues the
most appropriate approach for each operating HMO subsidiary within the combined
enterprise based on financial considerations and regulatory requirements.
Historically, the Company's HMOs outside of California have obtained
reinsurance to limit the risk for an individual member's hospital expenses in
excess of certain amounts, subject to deductibles per member per contract year.
Each of these HMOs (other than QualMed Plans for Health (PA)) has entered into
a reinsurance agreement with QualMed Health & Life Insurance Company, a wholly
owned second-tier subsidiary of the Company, under which QualMed Health & Life
Insurance Company reinsures each such HMO as described in the preceding
sentence, with the specific reinsurance coverage terms and conditions based
upon the size, loss history and other relevant circumstances of the particular
HMO. Health Net, on the other hand, has historically self-insured for these
risks, and QualMed Plans for Health (PA) obtains such reinsurance through an
unrelated third party.
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Liability Coverage. The Company maintains general liability,
professional liability, workers compensation, property and casualty and
directors' and officers' liability coverage subject to customary deductibles,
limitations and exclusions. The Company also requires participating
physicians, PMGs and participating hospitals to maintain malpractice insurance
coverage. The Company verifies malpractice insurance coverage as part of its
credentialing and recredentialing processes.
SERVICE MARKS
The Company's service marks and/or trademarks include: BabyWell(SM)
Being Well(R), Feetbeat Worksite Walking Program(SM), FLEX NET(SM), Health
Net(R), Health Net ACCESS(SM), Health Net Comp.24(SM), Health Net ELECT(SM),
Health Net INSIGHT(SM), Health Net OPTIONS(SM), Health Net SELECT(SM), Health
Net Seniority Plus(SM), Heart & Soul(SM), M.D. Health Plan Personal Medical
Management(SM), QualAssist(SM), QualAdmit(SM), Qual-Med(R), QualMed(SM), QualMed
Health & Life Insurance Company(R), QualMed Plans for Health(R), Rapid
Access(SM) Senior Security(R), "The Final Piece of the Healthcare Puzzle"(SM)
and "Well Managed Care Right from the Start(R)" and certain designs related to
the foregoing.
The Company utilizes these marks in connection with the marketing and
identification of products and services. The Company believes such marks are
valuable and material to its marketing efforts.
EMPLOYEES
At December 31, 1996, the Company employed approximately 3,700
full-time employees and approximately 125 part-time employees. Such employees
perform a variety of functions, including administrative services for
employers, providers, and members, negotiation of agreements with physician
groups, hospitals, pharmacies and other health care providers, handling claims
for payment of hospital and other services and providing data processing
services. The Company's employees are not unionized and the Company has not
experienced any work stoppage since its organization. The Company considers
its relations with its employees to be very good.
ITEM 2. PROPERTIES
The Company owns its principal executive offices in Pueblo, Colorado
and leases office space for its principal executive offices in Woodland Hills,
California. The Pueblo facility, with approximately 72,000 square feet, is
subject to a mortgage in the aggregate principal amount of approximately $1.4
million. The Company also received three properties in 1996 with approximately
188,400 aggregate square feet and will receive approximately $4.5 million for
such properties' renovation from the City of Pueblo in return for certain
employment commitments. The Woodland Hills facility, with approximately
275,000 square feet, is leased pursuant to a ten year lease expiring in 2001 on
an anchor full-service gross basis with annual rent in 1996 of approximately
$7.8 million. The Company and its subsidiaries also lease an aggregate of
approximately 450,000 square feet of additional office space. The Company's
aggregate rent obligations under these leases were approximately $10.7 million
in 1996. Management believes that its ownership and rental costs are
consistent with those available for similar space in the applicable local area.
The Company's properties are well maintained, considered adequate and are being
utilized for their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
CLASS ACTION LAWSUIT
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
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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 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.
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 sought to overturn the Conditional Revoca-
tion 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 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 to
the Respondents' briefs were timely filed on August 19, 1996 and the Court set
oral arguments on the appeal for November 13, 1996.
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On November 26, 1996, the California Court of Appeals entered an order
affirming the trial court decision. During the first week of January 1997, the
Petitioners filed a petition for review asking the California Supreme Court to
consider the matter. The DOC and the California Wellness Foundation filed
oppositions to the petition for review on January 21, 1997 and January 23,
1997, respectively. On March 12, 1997, the California Supreme Court issued a
ruling denying the petition for review. This case is now resolved.
MEDAPHIS CORPORATION
On November 7, 1996 the Company filed a lawsuit against Medaphis
Corporation ("Medaphis") and its former Chairman and Chief Executive Officer
Randolph G. Brown entitled Health Systems International, Inc. v. Medaphis
Corporation, Randolph G. Brown and Does 1-50, case number BC 160414. Superior
Court of California, County of Los Angeles. The lawsuit arises out of the
acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July
1996, the Company, the owner of 1,234,544 shares (or 77%) of Series F Preferred
Stock of HDS, representing over sixteen percent of the total outstanding equity
of HDS, voted its shares in favor of the acquisition of HDS by Medaphis. The
Company received as the result of the acquisition 976,771 shares of Medaphis
Common Stock in exchange for its Series F Preferred Stock.
In its complaint, the Company alleges that Medaphis was actually a
poorly run company with sagging earnings in its core business, and had
artificially maintained its stock prices through a series of acquisitions and
accounting maneuvers which provided the illusion of growth while hiding the
reality of its weakening financial and business condition. The Company alleges
that Medaphis, Brown and other insiders deceived the Company by failing to
reveal that Medaphis would shortly reveal a "write off" of up to $40 million in
reorganization costs and would lower its earnings estimate for the following
year, thereby more than halving the value of the Medaphis shares received by
the Company. The Company alleges that these false and misleading statements
were contained in oral communications with the Company, as well as in the
prospectus provided by Medaphis to all HDS shareholders in connection with the
HDS acquisition. Further, despite knowing of the Company's discussions to form
a strategic alliance of its own with HDS, Medaphis and the individual
defendants wrongfully interfered with that prospective business relationship by
proposing to acquire HDS using Medaphis stock whose market price was
artificially inflated by false and misleading statements. The Company alleges
that the defendants' actions constitute violations of both federal and state
securities laws, as well as fraud and other torts under state law. The Company
is seeking either rescission of the transaction or damages in excess of $38
million The defendants have denied the allegations in the complaint, and the
Company is vigorously pursuing its claims against Medaphis.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of
the Company, either through solicitation of proxies or otherwise, during the
fourth quarter of the year ended December 31, 1996.
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 6,386,510 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 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
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$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
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, Amendment No. 2 to the Credit
Agreement was attached as Exhibit 10.33 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996 and Amendment No. 3 to the
Credit Agreement is attached hereto as Exhibit 10.33 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996. 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 December 31, 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 has 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 1996 and certain acquisitions.
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. 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 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) 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
15
<PAGE> 19
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.
In connection with the Agreement and Plan of Merger (the "Merger
Agreement") with FHC, the Company entered into Amendment No. 3 to the Credit
Agreement which, among other things, deemed the FHC Merger to be a Permitted
Acquisition and waived certain compliance requirements through June 30, 1997 in
order to enable the Company to negotiate and enter into a new credit agreement
combining the Credit Agreement and the FHC's existing credit agreement.
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 outstanding Class A Common Stock, the Board of Directors of the
Company declares a holder of 10% or more to 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). In connection with its execution of the Merger
Agreement, the Company entered into Amendment No. 1 (the "Rights Amendment") to
the Rights Agreement to exempt the Merger Agreement and related transactions
from triggering the Rights. In addition, the Rights Amendment modifies certain
terms of the Rights Agreement applicable to the determination of certain
"Adverse Persons," which modifications become effective upon consummation of
the transactions provided for under the Merger Agreement. This summary
description of the Rights does not purport to be complete and is qualified in
its entirety by reference to the Rights Agreement.
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 these 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-
16
<PAGE> 20
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.
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 these matters
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 health 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 could 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 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 manage 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
17
<PAGE> 21
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 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
18
<PAGE> 22
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 an
annual basis, the Company and an independent actuary review the adequacy of its
loss reserves using generally accepted actuarial methods, and 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 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.
Recent Developments
Foundation Health Corporation. On October 1, 1996, the Company and FH
Acquisition Corp., a wholly owned subsidiary of the Company ("Merger Sub"),
entered into the Merger Agreement with FHC, whereby Merger Sub will merge with
and into FHC and FHC will survive as a wholly owned subsidiary of the Company.
Pursuant to the Merger Agreement FHC stockholders will receive 1.3 shares of the
Company's Class A Common Stock for every share of FHC common stock held
resulting in the issuance of approximately 77 million additional shares of HSI
Class A Common Stock. The shares of the Company's Class A Common Stock issued to
FHC's stockholders in the Merger will constitute approximately 61% of the
outstanding stock of the Company after the Merger and the Company's current
stockholders will hold approximately 39% of the outstanding stock of the Company
after the Merger.
Pursuant to the Merger Agreement, the Company will amend its
Certificate of Incorporation to change the name of the Company to Foundation
Health Systems, Inc. and to increase the number of authorized shares of the
Company's Common Stock to 380,000,000 shares consisting of 350,000,000 shares
of Class A Common Stock and 30,000,000 shares of Class B Common Stock.
The Merger Agreement also provides for, among other things, amendment
of the Company's By-Laws to effect certain changes to the governance provisions
of the Company following the Merger, including provisions related to the
structure of the Company's Board of Directors and the committees of the
Company's Board of Directors. Except in certain circumstances, during a
transaction period following the consummation of the Merger
19
<PAGE> 23
and up to, but not including, the election of directors at the Company's May
2000 Annual Meeting of Stockholders, the Company's Board of Directors will
consist of 11 members, six of whom (Daniel D. Crowley and five other
independent directors) are to be designated by FHC and five of whom (Malik M.
Hasan, M.D. and four other independent directors) are to be designated by the
Company. Pursuant to such designations the new Company board of directors will
initially be comprised of the following members: J. Thomas Bouchard, Daniel D.
Crowley, George Deukmejian, Thomas T. Farley, Patrick Foley, Earl B. Fowler,
Roger F. Greaves, Richard W. Hanselman, Malik M. Hasan, M.D., Richard J.
Stegmeier and Raymond S. Troubh.
Each company's stockholders voted to approve the FHC Merger at their
respective special meetings held on February 12, 1997. Completion of the
transaction, which will be accounted for as a pooling-of-interests, is subject
to regulatory approvals as well as other customary conditions and is expected
to be completed in April of 1997.
Advantage Health. On May 14, 1996, the Company announced that it had
reached a definitive agreement with the St. Francis Health System to acquire
Advantage Health, a group of managed care companies, headquartered in
Pittsburgh, Pennsylvania, with approximately 60,000 members for approximately
$12.5 million in cash (less the dollar amount of certain investments to be
retained by Advantage Health). The transaction is subject to final approvals
from regulatory authorities, and other customary conditions of closing. The
transaction is expected to close in early 1997.
First Option Health Plan. Pursuant to an Amended and Restated
Securities Purchase Agreement, dated February 10, 1997, as amended, and
effective on March 19, 1997 (the "Amended FOHP Agreement"), among the Company,
FOHP, Inc., a New Jersey corporation ("FOHP") and First Option Health Plan of
New Jersey, Inc., a New Jersey corporation ("FOHP-NJ"), the Company agreed to
invest an initial amount of approximately $43 million in FOHP. FOHP
(headquartered in Red Bank, New Jersey) is owned by physicians, hospitals and
other health care providers and is the sole shareholder of FOHP-NJ, a managed
health care company providing a full line of commercial products for businesses
and individuals, along with Medicare, Medicaid and Workers' Compensation
programs. FOHP-NJ currently has approximately 168,000 HMO members in New
Jersey, 141,000 of which are commercial and 27,000 of which are in Medicare and
Medicaid programs. In addition, FOHP-NJ has more than 70,000 Workers'
Compensation members and 60,000 PPO members. The Company's original agreement
with FOHP contemplated that the Company would infuse $30 million in exchange
for convertible subordinated debentures and an option to buy FOHP stock for $11
million pursuant to a Securities Purchase Agreement dated October 24, 1996 (the
"Original FOHP Agreement")
At closing, the Company will purchase approximately $43 million worth
of FOHP convertible subordinated debentures (the "Initial Principal Amount"). A
portion of the Initial Principal Amount will reflect fees owed to the Company by
FOHP pursuant to a management agreement to be entered into by the Company and
FOHP concurrently with the Amended FOHP Agreement. This portion of the Initial
Principal Amount (estimated to be approximately $1.5 million as of the closing)
will immediately be converted into FOHP stock. The Initial Principal Amount,
and further amounts to be forwarded by the Company to FOHP prior to December 31,
1997 (such further amounts not to exceed $8.4 million), shall be convertible
into 71% of the outstanding equity of FOHP at the Company's discretion. The
timing of payment for these contractual obligations may be subject to revision
pursuant to required regulatory approvals. In 1999, the Company may affect
either a cash offer for shares or a merger, business combination or
consolidation transaction for the remaining shares of FOHP not owned by the
Company.
As part of the transaction the Company will also provide a variety of
management services to FOHP, including utilization review, quality assurance
and strategic planning and, at HSI's option, information systems, among others.
The Company will receive management fees from FOHP for these services.
All of these transactions are subject to FOHP shareholder approval and
other conditions of closing (including certain membership commitments from
FOHP's hospital and other institutional shareholders).
20
<PAGE> 24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the
Company's Class A Common Stock, par value $.001 per share (the "Class A Common
Stock") on The New York Stock Exchange, Inc. ("NYSE") since January 31, 1994,
the day the Class A Common Stock first commenced trading.
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
Calendar Quarter - 1994
First Quarter (commencing January 31, 1994) 29 7/8 20
Second Quarter 36 3/4 24 1/2
Third Quarter 29 1/4 22
Fourth Quarter 30 5/8 20 3/4
Calendar Quarter - 1995
First Quarter 33 7/8 24 7/8
Second Quarter 34 1/8 25
Third Quarter 30 3/8 27 7/8
Fourth Quarter 34 1/4 29 1/4
Calendar Quarter - 1996
First Quarter 37 1/8 30 3/8
Second Quarter 37 1/8 26 7/8
Third Quarter 28 7/8 19 3/8
Fourth Quarter 29 1/8 22 5/8
Calendar Quarter - 1997
First Quarter (through March 24, 1997) 30 3/4 23 1/8
</TABLE>
On March 24, 1997, the last reported sales price per share of the
Class A Common Stock was $29 1/4 per share.
DIVIDENDS
No dividends have been paid by the Company during the preceding two
fiscal years. The Company has no present intention of paying any dividends on
its Common Stock.
The Company is a holding company and, therefore, its ability to pay
dividends depends on distributions received from its subsidiaries, which are
subject to regulatory net worth requirements and certain additional state
regulations which may restrict the declaration of dividends by HMOs, insurance
companies and licensed managed health care plans. The payment of any dividend
is at the discretion of the Company's Board of Directors and depends upon the
Company's earnings, financial position, capital requirements and such other
factors as the Company's Board of Directors deems relevant.
Under a revolving credit agreement initially entered into in 1995 and
amended and restated in 1996 with Bank of America National Trust and Savings
Association, as agent (the "Credit Agreement"), the Company cannot declare or
pay cash dividends to its stockholders or purchase, redeem or otherwise acquire
shares of its capital stock or warrants, rights or options to acquire such
shares for cash in excess, in the aggregate, of the sum of (i) $150 million
plus (ii) 25% of net income of the Company and its subsidiaries arising from
January 1, 1995 through December 31, 1995 plus (iii) 50% of net income of the
Company and its subsidiaries arising after December 31, 1995, in each case,
computed on a cumulative consolidated basis.
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<PAGE> 25
HOLDERS
As of March 24, 1997, there were approximately 1,800 holders of record
of Class A Common Stock. The California Wellness Foundation (the "Foundation")
is the only holder of record of the Company's Class B Common Stock, par value
$.001 per share (the "Class B Common Stock") which constitutes approximately 40%
of the Company's aggregate equity. Under the Restated Certificate, shares of the
Company's Class B Common Stock have the same economic benefits as shares of the
Company's Class A Common Stock, but are non-voting. Upon the sale or other
transfer of shares of Class B Common Stock by the Foundation to an unrelated
third party, such shares automatically convert into Class A Common Stock.
22
<PAGE> 26
ITEM 6. SELECTED FINANCIAL DATA
Health Systems International, Inc. and Subsidiaries
Selected Financial Data
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994 1993 1992(1)
----------------- ------------------- ---------------- ---------------- --------------------
<S> <C> <C> <C> <C> <C>
Revenues:
Premium revenue $ 3,134,014 $ 2,692,335 $ 2,290,601 $ 1,943,730 $ 1,528,500
ASO and other 70,142 39,717 15,561 13,530 9,642
--------------- ------------------- ---------------- ---------------- --------------------
3,204,156 2,732,052 2,306,162 1,957,260 1,538,142
Operating expenses:
Health care 2,611,527 2,180,277 1,838,235 1,567,232 1,245,780
Marketing, general and
administrative 326,401 302,870 266,764 262,927 182,650
Depreciation and amorti- 52,626 48,140 39,692 34,187 32,677
zation
ASO and other 58,447 37,453 15,623 10,837 8,327
Restructuring and other 44,108
charges
Merger-related costs 20,164 672 29,725
--------------- ------------------- ---------------- ---------------- -------------------
Operating income 111,047 143,148 145,176 52,352 68,708
Interest income (expense), net 14,163 13,495 5,592 (114) (679)
Income taxes (51,720) (67,307) (62,759) (28,438) (27,753)
Minority interest in loss of 102 256 66
--------------- ------------------- ---------------- ---------------- -------------------
subsidiary
Net income $ 73,592 $ 89,592 $ 88,075 $ 23,800 $ 40,276
=============== =================== ================ ================ ===================
Primary earnings per share $ 1.52 $ 1.83 $ 1.77 $ 0.48 $ 0.81
=============== =================== ================ ================ ===================
Weighted average common shares
outstanding (primary) 48,332 48,831 49,691 49,517 49,456
=============== =================== ================ ================ ===================
Balance sheet data:
Cash and equivalents and
marketable $ 589,614 $ 592,561 $ 512,372 $ 465,602 $ 351,268
securities
Total assets 1,211,880 1,213,711 894,397 822,221 771,679
Long-term debt 362,465 354,080 158,340 219,922 224,493
Stockholders' equity 364,976 285,527 223,605 154,352 127,316
</TABLE>
__________________________________
(1) All data prior to February 6, 1992 reflects only QualMed data since
Health Net prior to the conversion was not considered a predecessor
company. See Note 1 to the consolidated financial statements.
23
<PAGE> 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
INTRODUCTION
Since the HSI Combination in January 1994, the Company has experienced
significant growth in revenue. Revenue increased to $3.2 billion in 1996, from
$2.7 billion in 1995 and $2.3 billion in 1994. Net income totaled $73.6
million in 1996, compared to $89.6 million in 1995 and $88.1 million in 1994,
after pretax restructuring and other charges of $44.1 million in 1996, and
merger related costs of $20.2 and $.7 million in 1995 and 1994 respectively.
With continued commercial premium rate pressures in California, the Company has
focused on increasing its presence in the Medicare market in California and,
through strategic acquisitions, entering new geographic markets. Medicare
membership grew by 9.4% in 1996 and 69% in 1995. As initial steps in its
Northeast expansion, the Company in 1995 acquired M.D. Health Plan, a managed
health care company operating in the state of Connecticut, and Greater
Atlantic, a managed health care company operating in Pennsylvania and New
Jersey. In addition, the Company has entered into agreements to acquire an
interest in managed care companies operating in Pennsylvania, West Virginia,
Ohio and New Jersey.
Revenue growth in 1996 over 1995 has been due in large part to
full-year revenues contributed by acquisitions in the Northeast during 1995,
accounting for $215.3 million of the $441.7 million premium revenue increase in
1996 as compared to 1995. In 1995, those acquisitions contributed $173 million
in premium revenue. The remaining 1996 increase in premium revenue of $226.4
million was primarily a result of increases in Medicare risk membership, making
up $161.6 million of such increase. The majority of this increase occurred in
the Company's California market, where the Medicare risk product was initially
offered in 1993. The acquisition of M.D. Health Plan initially added 59,000
commercial members, which increased to 117,000 by December 1995, primarily due
to the conversion of approximately 52,000 State of Connecticut employees from
ASO to full risk membership in July 1995. As of December 31, 1996, commercial
membership in M.D. Health Plan totaled 130,000. The Company subsequently
acquired Greater Atlantic, a 90,000 member HMO with operations in Pennsylvania
and New Jersey. Greater Atlantic's business includes a substantial number of
Medicare and Medicaid members. Revenue growth in 1995 was due in large part to
significant increases in Medicare risk membership which accounted for $191
million of increases for that year. The majority of this increase occurred in
the Company's California market. The Company believes that modest commercial
premium rate pressures, particularly in California, will continue in 1997 and,
accordingly, the Company will continue to emphasize the growth of its Medicare
risk business and expansion into other geographic markets.
The Company's overall medical loss ratio (medical expenses as a
percentage of premium revenue) ("MLR"), increased to 83.3% in 1996 from 81.0% in
1995. The increase in MLR is the result of escalating health care costs coupled
with a relatively flat premium environment, particularly in the California
market. The increased health care costs reflect continued high pharmacy cost
trends on a company-wide basis and increased outpatient costs in certain of the
Company's markets outside of California. In addition, a high MLR was
experienced in the Company's Philadelphia Medicaid business in 1996 as a result
of a significant reduction in Medicaid reimbursement rates in February 1996. As
of March 1997, the Company is no longer participating in the Pennsylvania
Medicaid program. In 1995, effective medical management and the recontracting
of its largely capitated provider network in California enabled the Company to
maintain a stable MLR. The Company's overall MLR increased slightly to 81.0% in
1995 from 80.3% in 1994, primarily due to the increased Medicare risk business
in 1995. Medicare risk MLRs typically run higher than commercial ratios due to
the higher utilization of services in the senior population. A stable commercial
MLR of 79.4% was achieved by the Company in 1995 by renegotiating its provider
contracts in California, to offset premium pricing pressures, and quickly
implementing its medical management system in its newly acquired HMO operations
in the Northeast.
Declining marketing, general and administrative expenses (excluding
merger-related costs and ASO business) as a percentage of premium revenue over
the period of 1994 through 1996 (11.6%, 11.2%, and 10.4% respectively) reflect
the realization in part of the benefits of the Company's restructuring of both
California and non-California operations, as well as its ongoing efforts to
control costs and increase its membership growth in the higher premium Medicare
business.
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<PAGE> 28
In 1996, the Company recorded a restructuring charge of approximately $35.6
million and an accrual for anticipated losses on certain customer contracts
amounting to approximately $8.5 million. The restructuring charges relate to the
Company's restructuring of administrative operations and the loss contract
accrual relates primarily to government contracts in the Company's
non-California operations.
SUMMARY OF OPERATING RESULTS
<TABLE>
<CAPTION>
Membership at year end: 1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Commercial 1,615,929 1,647,201 1,392,317
Medicare 145,710 133,226 78,690
Medicaid 59,468 50,120
ASO 168,790 104,010 2,815
----------- ----------- -----------
1,989,897 1,934,557 1,473,822
=========== =========== ===========
Revenues:
Commercial 71.3% 79.5% 86.0%
Medicare 23.2% 18.2% 13.3%
Medicaid 3.3% .8%
ASO 2.2% 1.5% .7%
----------- ----------- -----------
100.0% 100.0% 100.0%
=========== =========== ===========
Medical Loss Ratio:
Commercial 81.4% 79.4% 79.4%
Medicare 89.4% 88.0% 85.6%
----------- ----------- -----------
Total 83.3% 81.0% 80.3%
=========== =========== ===========
Marketing, general and administrative expenses
as a percentage of premium revenue (exclusive of ASO) 10.4% 11.2% 11.6%
Depreciation and amortization as a percentage of
premium revenue (exclusive of ASO) 1.7% 1.8% 1.7%
Net income as a percentage of revenue 2.3% 3.3% 3.8%
- --------------------------
</TABLE>
PREMIUM REVENUE
Premium revenue, excluding administrative services only ("ASO")
revenue, increased by $441.7 million or 16.4% from 1995 to 1996, and by $402
million or 17.5% from 1994 to 1995. The factors that contributed to these
increases included acquisitions completed in 1995 in the Northeast, continued
growth in Medicare risk membership in the Company's existing service areas and
limited premium rate increases in certain markets. Increased membership,
particularly in higher premium Medicare business in California, was offset in
part by premium rate reductions in the California commercial market.
The acquisitions in the Northeast contributed $215.3 million in
premium revenue in 1996, and $173 million in 1995. Premium revenue increases
in the Company's existing markets are attributable to a combination of
membership increases and premium rate changes. Increases in commercial and
Medicare risk membership accounted for $369 million of premium revenue
increases in 1996 from 1995. Commercial membership increases accounted for
$175.8 million of the increase and Medicare risk membership increases accounted
for $193.2 million. Limited premium rate increases in certain markets and
growth in the higher premium Northeast markets resulted in an increase in
commercial premium revenue of $21.7 million in 1996, while increases in
Medicare rates increased premium revenue by $50.9 million in 1996. The Medicare
premium rate increases reflect average overall Medicare reimbursement rate
increases of 10% in 1996. On a per member per month ("PMPM") basis, the
premium rate changes resulted in an increase of 1% in commercial premium
revenue to $119.69 and an increase in Medicare premium revenue of 10.2% to
$434.79 in 1996. Overall, Medicare risk business accounted for an increase of
$244.1 million of premium revenue in 1996 over 1995 and commercial business
accounted for an increase of $197.5 million of premium revenue in 1996 over
1995.
Increases in commercial and Medicare risk membership accounted for
$316 million of premium revenue increases in 1995 from 1994. Of this increase,
$145 million represented commercial membership increases and $171
25
<PAGE> 29
million resulted from Medicare risk membership increases. Changes in premium
rates in both the commercial business and Medicare risk business accounted for
a decrease of $86.5 million of premium revenue in 1995. On an overall PMPM
basis, the premium rate changes resulted in a decrease of 3% in commercial
premium revenue to $118.51 and a increase in Medicare premium revenue of 4.5%
to $394.42 in 1995. Overall, Medicare risk business accounted for an increase
of $191 million of premium revenue in 1995 compared to 1994 and commercial
business accounted for an increase of $211 million of premium revenue in 1995
compared to 1994.
Management of the Company believes that in 1997 there will continue to
be premium pressures on HMOs from increasingly sophisticated consumers,
particularly in the California marketplace. While it is not possible to
predict with certainty the ultimate financial impact of such pressures on
premiums, the Company believes that it is well-positioned to offset such
pressures by increasing its volume and containing costs.
The Company's ASO business accounted for $70.1 million, $39.7 million
and $15.6 million of revenue in 1996, 1995 and 1994, respectively. Included in
ASO revenue in 1996 was revenue totaling $25.1 that relates to certain
businesses providing ancillary healthcare services. These business were
acquired as part of the acquisition of Greater Atlantic in Philadelphia and
were sold in October 1996.
HEALTH CARE EXPENSES
Healthcare expenses increased by $431.3 million, or 19.8%, to $120.39
PMPM in 1996 compared to $110.23 PMPM in 1995. The Company's overall MLR
increased to 83.3% from 81% in 1995. If the $8.5 million loss contract charge,
which was recorded in the fourth quarter of 1996 but not included in the MLR
calculation, had been included in health care expenses, then the MLR for 1996
would have increased by .3%. Impacting the Company's overall PMPM healthcare
expense and MLR was the growth in Medicare business, increased pharmacy costs
and high costs associated with the Company's Medicaid business in Philadelphia.
In addition, the Company's MLR in the Medicare risk business increased to 89.4%
in 1996 from 88% in 1995 due to Medicare risk membership growth in higher cost
areas. Commercial healthcare expenses on a PMPM basis increased from $94.09 in
1995 to $97.48 in 1996 and the Company's commercial MLR increased to 81.4% in
1996 from 79.4% in 1995.
Healthcare expenses increased by $342 million, or 18.6%, to $110.23
PMPM in 1995 compared to $107.82 PMPM in 1994. The Company's overall MLR
increased slightly to 81.0% from 80.3% in 1994. Impacting the Company's
overall healthcare expense PMPM and MLR was the growth in Medicare business and
the associated higher utilization experience. The Company's MLR in the
Medicare risk business increased to 88.0% in 1995 from 85.6% in 1994 due to
Medicare risk membership growth in higher cost areas. Commercial healthcare
expenses on a PMPM basis decreased from $97.03 in 1994 to $94.09 in 1995 and
the Company's commercial MLR remained flat in 1995, at 79.4%, relative to 1994.
The Company's recontracting in 1995 of its largely capitated
commercial provider network in California enabled it to maintain its relatively
consistent MLR despite the reduced commercial premium rates experienced in that
market in 1995. The implementation of the Company's medical management system
in its newly acquired HMO operations in the Northeast also contributed to the
stable 1995 MLR. Significant and ongoing cost savings have been achieved
through effective utilization management in the Company's Connecticut
operations.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Marketing, general and administrative expenses (excluding ASO
expenses) were $326.4 million or 10.4% of premium revenue in 1996, compared to
$302.9 million or 11.2% of premium revenue in the prior year. Marketing,
general and administrative expenses were $266.8 million, or 11.6% of premium
revenue in 1994. The decreases in marketing, general and administrative
expenses as a percentage of premium revenue from 1994 through 1996 reflect
ongoing efforts to streamline operations and maximize efficiencies and the
effects of the Company's restructuring plan.
26
<PAGE> 30
DEPRECIATION AND AMORTIZATION EXPENSES
Depreciation and amortization expenses as a percentage of premium
revenue decreased slightly from 1.8% in 1995 to 1.7% in 1996 ($48.1 million in
1995 and $52.6 million in 1996). The decrease in depreciation and amortization
expenses resulted primarily from write-downs of fixed assets related to the
Company's restructuring of its operations.
RESTRUCTURING, MERGER AND OTHER CHARGES
In the fourth quarter of 1996, the Company recorded $44.1 million or
$.53 per share, in restructuring and other charges. These charges included
restructuring charges of $35.6 million, the components of which are: executive,
workforce and facilities consolidation costs of approximately $11.9 million,
software and hardware write-offs of approximately $15.0 million, and other
components which aggregate approximately $8.7 million. In addition, the
Company recorded $8.5 million in the fourth quarter related to estimated losses
that the Company anticipates will occur through the remaining term of certain
customer contracts.
Throughout 1995, the Company incurred merger-related costs of $20.2
million in connection with the proposed HSI/WellPoint Transaction that was
ultimately terminated. Such costs included legal, accounting and consulting
fees, and certain severance- related costs totaling $12.2 million.
FOUNDATION MERGER
On October 1, 1996 the Company entered into a merger agreement with
Foundation Health Corporation ("FHC"), an integrated managed health care
organization. Under the definitive agreement, FH Acquisition Corp., a
wholly-owned subsidiary of the Company, will merge with and into FHC with FHC
surviving the merger as a wholly-owned subsidiary of the Company. The merger
will be accounted for as a pooling-of-interest transaction and, accordingly,
after the merger, the financial statements of the Company and FHC will be
presented on a combined basis for financial reporting purposes. As previously
announced, negotiation and consummation of the FHC Merger as well as additional
charges associated with and related to integrating the operations of HSI and
FHC will result in material non-recurring costs and expenses to the new
combined company. Such costs cannot be determined until the transition plan
related to the integration of operations is completed, but they are estimated at
this time by the Company to be in the range of $175 million to $225 million.
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 medical
services and reporting their cost. These estimates are 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 maximum 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.
For the year ended December 31, 1996, cash provided by operating
activities decreased to $20.3 million from $111.6 million in the prior year.
In part this decrease is due to normal fluctuations in operating assets and
liabilities from year to year caused by timing differences in the payment of
liabilities and collection of receivables at each respective year end. The
remainder of the decrease in cash provided by operations in 1996 was due to a
significant reduction of claims inventory which had accumulated in late 1995.
Net cash used by investing activities was $74.8 million in 1996, a decrease
over the prior year cash used of $282.3 million. The reduction in cash used by
investing activities was primarily the result of 1995 acquisitions in the
Northeast and a reduction in the purchase of marketable securities in 1996.
Net cash provided by financing activities in 1996 was $16.1 million versus
$128.7 million in 1995. The decrease in 1996 is attributable to reduced
borrowings under the credit facility; in 1995 such borrowings were used to fund
the Northeast acquisitions. The financing of these 1995 acquisitions was
through additional borrowings on the Credit Facility (see below).
27
<PAGE> 31
Management of the Company believes that its 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 cash requirements for current
operations, commitments, development activities and strategic acquisitions.
The Company may elect to raise additional funds for these purposes, either
through the issuance of additional debt or equity, sale of investment
securities or otherwise, as appropriate.
On April 26, 1996, the Company replaced its five-year unsecured $400
million revolving credit facility with a $700 million revolving credit
facility (the "Credit Facility") from a lending syndicate led by Bank of
America. 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 December 31, 1996, $319 million had been
borrowed against the new $700 million Credit Facility. The Company used $310
million of the Credit Facility in 1995 to fund the prepayment by its Health Net
subsidiary of $135 million in debt to the Foundation, and to fund the MDEC and
GHH acquisitions in the amount of $100 million and $75 million, respectively.
In 1996, an additional $9 million was borrowed from the Credit Facility.
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 Foundation Notes is
subordinated to Health Net meeting tangible net equity ("TNE") requirements
under applicable California laws and regulations. As of December 31, 1996, the
Company's subsidiaries were in compliance with 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
health care costs 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 or, 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 Annual Report on Form 10-K,
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.
28
<PAGE> 32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders of
Health Systems International, Inc.
Pueblo, Colorado
Woodland Hills, California
We have audited the accompanying consolidated balance sheets of Health Systems
International, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1996. Our audits
also included the financial statement schedules listed in the index at Item
14(a)(2). These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements and financial statement schedules based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Health Systems International, Inc.
and subsidiaries at December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
Deloitte & Touche LLP
Los Angeles, California
March 21, 1997
29
<PAGE> 33
Health Systems International, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31 December 31
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash and equivalents $ 187,486 $ 225,932
Marketable securities held for sale 402,128 366,629
Premiums receivable, net of allowances of
$11,370 in 1996 and $13,408 in 1995 86,598 91,106
Prepaid expenses and other 52,895 34,849
Deferred income taxes 24,370 18,902
------------ ------------
Total current assets 753,477 737,418
Property and equipment, net 71,786 84,743
Goodwill and other intangible assets, net 328,719 336,365
Deferred income taxes 4,976 1,958
Other assets 52,922 53,227
------------ ------------
TOTAL ASSETS $ 1,211,880 $ 1,213,711
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Estimated claims payable $ 243,144 $ 310,392
Accounts payable and accrued expenses 108,057 120,161
Shared risk and other settlements 27,235 30,664
Unearned subscriber premiums 88,605 91,596
Federal and state income taxes payable 9,689 13,196
Notes payable, current portion 1,608 2,340
------------ ------------
Total current liabilities 478,338 568,349
Notes payable 362,465 354,080
Other 6,101 5,755
------------ ------------
846,904 928,184
Commitments and contingencies (Notes 6, 7 and 8)
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 - 32,329,684 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 187,086 66,147
Treasury Stock, 3,194,374 shares of Class A common stock (95,831)
Advances to repurchase 574,869 shares of Class A common stock (16,330)
Retained earnings 282,091 233,711
Unrealized gain (loss) on marketable securities held for sale, net (8,421) 1,950
------------ ------------
Total stockholders' equity 364,976 285,527
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,211,880 $ 1,213,711
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
30
<PAGE> 34
Health Systems International, Inc. and Subsidiaries
Consolidated Statements of Income
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994
--------------- ----------------- ---------------
<S> <C> <C> <C>
Revenues:
Premium revenue $ 3,134,014 $ 2,692,335 $ 2,290,601
ASO and other 70,142 39,717 15,561
--------------- ----------------- ---------------
Total revenues 3,204,156 2,732,052 2,306,162
--------------- ----------------- ---------------
Operating expenses:
Health care expenses:
Physician 1,195,148 1,053,630 911,476
Hospital 1,079,837 883,100 742,248
Pharmacy and other 336,542 243,547 184,511
--------------- ----------------- ---------------
Total health care expenses 2,611,527 2,180,277 1,838,235
Marketing, general and administrative 326,401 302,870 266,764
Depreciation and amortization 52,626 48,140 39,692
ASO and other 58,447 37,453 15,623
Restructuring and other charges 44,108
Merger-related costs 20,164 672
--------------- ----------------- ---------------
Total operating expenses 3,093,109 2,588,904 2,160,986
--------------- ----------------- ---------------
Operating income 111,047 143,148 145,176
Investment income 38,702 33,170 20,143
Interest expense (24,539) (19,675) (14,551)
--------------- ----------------- ---------------
Income before income taxes and minority interest 125,210 156,643 150,768
Income taxes 51,720 67,307 62,759
Minority interest in loss of subsidiary 102 256 66
--------------- ----------------- ---------------
NET INCOME $ 73,592 $ 89,592 $ 88,075
=============== ================= ===============
Earnings per share:
PRIMARY AND FULLY DILUTED $ 1.52 $ 1.83 $ 1.77
=============== ================= ===============
Weighted average common shares outstanding:
PRIMARY 48,332 48,831 49,691
=============== ================= ===============
FULLY DILUTED 48,338 48,883 49,792
=============== ================= ===============
</TABLE>
See accompanying notes to consolidated financial statements
31
<PAGE> 35
Health Systems International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In Thousands)
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
------------ ---------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 73,592 $ 89,592 $ 88,075
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 52,626 48,140 39,692
Write-down of fixed assets 14,963
Deferred income taxes (2,207) 7,585 70
Changes in operating assets and liabilities:
Premiums receivable and unearned subscriber
premiums 1,517 25,582 1,946
Prepaid expenses and other assets (42,476) (18,523) (7,967)
Estimated claims payable, shared risk and other
settlements (72,242) (30,000) 31,856
Accounts payable and accrued liabilities (5,798) (20,833) 308
Federal and state income taxes payable 357 10,082 6,781
------------ ---------- ---------
Net cash provided by operating activities 20,332 111,625 160,761
INVESTING ACTIVITIES
Sale or redemption of marketable securities held for sale 224,199 249,506 295,943
Purchases of marketable securities held for sale (254,373) (328,957) (235,043)
Purchases of property and equipment, net (37,619) (35,647) (28,883)
Acquisition of subsidiaries, net of cash acquired (4,113) (139,462) (795)
Investment in other companies (4,146) (21,949)
Other 1,205 (5,798)
------------ ---------- ---------
Net cash provided (used) by investing activities (74,847) (282,307) 31,222
FINANCING ACTIVITIES
Purchase of treasury stock (105,419) (24,418) (18,940)
Proceeds from sale of stock 95,831
Advances to repurchase shares of Class A common stock (16,330)
Proceeds from exercise of stock options and employee
stock plan purchases 17,483 4,524 4,686
Borrowings 9,000 310,000
Repayment of debt and other non-current liabilities (826) (145,039) (60,011)
------------ ---------- ---------
Net cash provided (used) by financing activities 16,069 128,737 (74,265)
Increase (decrease) in cash and equivalents (38,446) (41,945) 117,718
Cash and equivalents, beginning of period 225,932 267,877 150,159
------------ ---------- ---------
CASH AND EQUIVALENTS, END OF PERIOD $ 187,486 $ 225,932 $ 267,877
============ ========== =========
</TABLE>
See accompanying notes to consolidated financial statements
32
<PAGE> 36
Health Systems International, Inc. and Subsidiaries
Supplemental Schedule to the Consolidated Statements of Cash Flows
(In Thousands)
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
------------- ------------- ---------------
<S> <C> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Income taxes $ 51,191 $ 39,600 $ 53,335
Interest 24,272 19,472 14,462
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Issuance of notes and assumption of liabilities as
consideration in acquisition of GHH $ $ 28,200 $
Profit sharing plan shares issued (4,558)
DETAILS OF BUSINESSES ACQUIRED IN PURCHASE TRANSACTIONS
Fair value of assets acquired $ 4,634 $ 287,403 $ 5,084
Less liabilities assumed 518 105,787 3,972
------------- ------------- ---------------
Cash paid for acquisitions 4,116 181,616 1,112
Cash acquired in acquisitions 3 42,154 317
------------- ------------- ---------------
NET CASH PAID IN ACQUISITIONS $ 4,113 $ 139,462 $ 795
============= ============= ===============
</TABLE>
See accompanying notes to consolidated financial statements
33
<PAGE> 37
Health Systems International, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(In Thousands)
<TABLE>
<CAPTION>
Common Stock
---------------------------------------------------------
Class A Class B Additional
----------------------- ------------------------ Paid-In
Shares Amount Shares Amount Capital
------ ------------- ------ ------------- -----------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1994 23,007 $ 23 25,684 $ 26 $ 64,488
Exercise of stock options,
including related tax benefit 401 1 5,298
Employee stock purchase plan 54 902
Purchase of treasury stock
Unrealized loss on marketable
securities held for sale, net
Net income
-----------------------------------------------------------------------------------
Balance at December 31, 1994 23,462 24 25,684 26 70,688
Exercise of stock options,
including related tax benefit 629 1 5,234
Employee stock purchase plan 48 1,071
Purchase of treasury stock
Retirement of treasury stock (1,496) (2) (10,846)
Advance to repurchase Class A
shares
Unrealized gain on marketable
securities held for sale
Net income
-----------------------------------------------------------------------------------
Balance at December 31, 1995 22,643 23 25,684 26 66,147
Exercise of stock options,
including related tax benefit 766 1 20,053
Employee stock purchase plan 52 1,204
Employee profit sharing plan 166 4,558
Sale of Common stock 9,581 10 (6,386) (7) 95,828
Purchase of treasury stock
Retirement of treasury stock (878) (2) (704)
Unrealized gain on marketable
securities held for sale
Net income
-----------------------------------------------------------------------------------
Balance at December 31, 1996 32,330 $32 19,298 $ 19 $ 187,086
===================================================================================
</TABLE>
<TABLE>
<CAPTION>
Unrealized
Gain (Loss)
Treasury Stock Advances to on Marketable
------------------- Repurchase Retained Securities
Shares Amount Treasury Stock Earnings Held for Sale Total
------ ------ -------------- -------- ------------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994 $ 88,554 $ 1,261 $ 154,352
Exercise of stock options,
including related tax benefit 5,299
Employee stock purchase plan 902
Purchase of treasury stock (655) $ (18,940) (18,940)
Unrealized loss on marketable
securities held for sale, net (6,083) (6,083)
Net income 88,075 88,075
--------------------------------------------------------------------------------------------
Balance at December 31, 1994 (655) (18,940) 176,629 (4,822) 223,605
Exercise of stock options,
including related tax benefit 5,235
Employee stock purchase plan 1,071
Purchase of treasury stock (841) (24,418) (24,418)
Retirement of treasury stock 1,496 43,358 (32,510)
Advance to repurchase Class A
shares $ (16,330) (16,330)
Unrealized gain on marketable
securities held for sale 6,772 6,772
Net income 89,592 89,592
--------------------------------------------------------------------------------------------
Balance at December 31, 1995 (16,330) 233,711 1,950 285,527
Exercise of stock options,
including related tax benefit 20,054
Employee stock purchase plan 1,204
Employee profit sharing plan 4,558
Sale of Common stock 95,831
Purchase of treasury stock (4,072) (105,419) (105,419)
Retirement of treasury stock 878 9,588 16,330 (25,212)
Unrealized gain on marketable
securities held for sale (10,371) (10,371)
Net income 73,592 73,592
--------------------------------------------------------------------------------------------
Balance at December 31, 1996 (3,194) $ (95,831) $ - $282,091 $ (8,421) $364,976
============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements
34
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization and Basis of Presentation
These consolidated financial statements present the accounts of Health Systems
International, Inc. and its wholly and majority-owned subsidiaries, including
Health Net, QualMed, Inc. ("QualMed"), HN Reinsurance Limited ("HNR"), M.D.
Enterprises of Connecticut, Inc. ("MDEC") and HSI Eastern Holdings, Inc.
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation.
Nature of Operations
The Company provides a wide range of managed health care services through
Health Net, a California health maintenance organization ("HMO"), QualMed, the
parent company of a system of HMOs with operations in various Western states
and through certain Northeast subsidiaries. In March 1995, the Company
acquired MDEC, the parent company of M.D. Health Plan, Inc., an HMO operating
in Connecticut ("M.D. Health Plan"), and in December 1995 the Company acquired
G.H. Holding Corporation (now named HSI Eastern Holdings, Inc.) ("GHH") the
parent company of Greater Atlantic Health Service, Inc. ("Greater Atlantic," now
named QualMed Plans for Health, Inc.), an HMO operating in Pennsylvania and New
Jersey. The Company also owns a preferred provider organization ("PPO")
network with operations in 48 states and the District of Columbia and two
health and life insurance companies with licenses to sell insurance in 33
states and the District of Columbia.
In California, the Company generally provides services to its members by
contract with participating medical groups on a capitated or fixed fee per
member per month ("PMPM") basis. Outside of California, the Company generally
provides services to its members through contracts with individual physicians
and groups of physicians on a discounted fee-for-service basis and in certain
areas through capitation arrangements with physician groups.
HSI Combination
On January 28, 1994, the Company, successor by name change to HN Management
Holdings, Inc. ("HNMH") (which was formed in 1990 for the purpose of acquiring
Health Net) and QualMed completed a merger (the "HSI Combination"). In the HSI
Combination, QualMed stockholders received one share of the Company's Class A
Common Stock for each share of QualMed common stock and, at the same time,
previously outstanding HNMH shares (both Class A voting and Class B nonvoting)
were split in a ratio of 3.3618 shares of the Company's Common Stock for each
previously existing share of HNMH stock. The HSI Combination was accounted for
as a pooling-of-interests.
Terminated WellPoint and Blue Cross of California Business Combination
On March 31, 1995, the Company, WellPoint Health Networks Inc. and Blue Cross
of California entered into a merger agreement which provided for, among other
things, the business combination of the Company, WellPoint and certain
commercial operations of Blue Cross of California. On December 28, 1995, the
Company, WellPoint and Blue Cross of California announced that they had entered
into an agreement that terminated the merger agreement. In connection with the
terminated merger agreement, the Company incurred merger-related costs
totaling approximately $20.2 million in 1995. Such costs include legal,
accounting and consulting fees, as well as severance related costs of $12.2
million resulting from agreements with certain key executives in contemplation
of the proposed merger.
35
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Health Net Conversion
On February 6, 1992, Health Net received approval from the California
Department of Corporations ("DOC") for its conversion from nonprofit to
for-profit status (the "Conversion"). Under the terms of the Conversion as
approved by the DOC, on February 7, 1992, ownership of Health Net was
transferred to the Company, and Health Net contributed $300 million to a
qualifying independent charitable organization, The California Wellness
Foundation (the "Foundation"). In addition, the Foundation received 7,640,000
(25,684,152 after giving effect to the 3.3618:1 stock split) shares of Class B
nonvoting common stock of the Company. The Foundation was established by
Health Net to provide public awareness and educational programs to promote
healthy lifestyles, and other health-related programs. The contribution by
Health Net in connection with the Conversion included $75 million in cash and
$225 million in notes payable to the Foundation. The Conversion was accounted
for under the purchase method of accounting and the excess of the Conversion
price over the fair value of net assets acquired was recorded as goodwill.
During 1995, the Company eliminated approximately $33.0 million of associated
goodwill (See Note 8).
Statutory Accounting Practices
All of the Company's health plans as well as its insurance subsidiaries are
required to periodically file financial statements with regulatory agencies in
accordance with statutory accounting and reporting practices. Under the
California Knox-Keene Health Care Service Plan Act, Health Net must comply with
certain minimum capital or tangible net equity ("TNE") requirements. The
Company's non-California health plans, as well as its health and life insurance
companies, must comply with their respective state's minimum regulatory net
worth requirements generally under the regulation of the respective state's
department of insurance.
The long-term portion of Health Net's debt to the Foundation, as discussed in
Note 5, is subordinated to Health Net satisfying its TNE requirements.
Dividends and loans by Health Net are restricted to the extent that the payment
of such would reduce its TNE below the minimum requirement. As of December 31,
1996 and 1995, all of the Company's health plans exceeded their respective
minimum TNE requirements. On a cumulative basis, the regulatory net worth of
the Company's health plans exceeded the minimum aggregate requirement by
approximately $223 million and $172 million at December 31, 1996 and 1995,
respectively.
Revenue Recognition and Health Care Expenses
Each of the Company's individual HMOs generally provide health care to their
members for a prepaid monthly fee. Premiums for members are recognized as
revenue in the month in which the members are entitled to service. Premiums
collected in advance are deferred and recorded as unearned subscriber premiums.
The cost of health care services is recognized in the period in which it is
provided and includes an estimate of the cost of services which have been
incurred but not yet reported. Such costs include payments to primary care
physicians, specialists, hospitals, out-patient care facilities and the costs
associated with managing the extent of such care. The estimate for accrued
health care costs is based on actuarial projections of hospital and other costs
using historical studies of claims paid. Estimates are continually monitored
and reviewed and, as settlements are made or estimates adjusted, differences
are reflected in current operations.
Capitation and Shared-Risk Arrangements
The Company generally contracts in California with various medical groups to
provide professional care to certain of its members on a capitation or fixed
fee PMPM. Capitation contracts generally include provisions for stop-loss and
non-capitated services for which the Company is liable. Professional capitated
contracts also generally contain provisions for shared risk, whereby the
Company and the medical groups share in the variance between actual hospital
costs and predetermined goals. Additionally, the Company contracts with
certain hospitals to provide hospital care to enrolled members on a capitated
basis.
36
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Cash and Equivalents
Cash equivalents include all highly liquid investments with a maturity of three
months or less when purchased.
The Company and its consolidated subsidiaries are required to set aside certain
funds for restricted purposes. As of December 31, 1996 and 1995, balances of
$0.7 million and $2.0 million, respectively, which are held in financial
depository accounts, are restricted as to use.
Marketable Securities
The Company accounts for investments in accordance with Statement of Financial
Accounting Standards (SFAS) No. 115 "Accounting for Certain Investments in Debt
and Equity Securities" and has determined that all marketable securities (which
are primarily comprised of debt securities) held as of December 31, 1996 and
1995 are held for sale. Accordingly, such securities are carried at fair value
determined using quoted market prices, and unrealized gains or losses, net of
applicable income taxes, are recorded in stockholders' equity. The Company has
also determined that such marketable securities are available for use in
current operations and, accordingly, has classified such securities as current
assets without regard to the securities' contractual maturity dates.
The cost of marketable securities sold is determined in accordance with the
specific identification method and realized gains and losses are included in
investment income.
The Company and its consolidated subsidiaries are required to set aside funds
for the protection of their plan members in accordance with the laws of the
various states in which they operate. Such restricted funds totaled $5.2
million and $9.3 million at December 31, 1996 and 1995, respectively, and are
held in U.S. Treasury bills and certificates of deposit with commercial banks.
These investments are included in marketable securities held for sale.
Interest earned on such investments accrues to the Company and its consolidated
subsidiaries and is not restricted as to use. In addition, $20.3 million of
securities are restricted in connection with a debt agreement at December 31,
1996 and 1995. (See Note 5).
Property and Equipment
Property and equipment are stated at historical cost less accumulated
depreciation. Depreciation is computed using the straight- line method over
the estimated useful lives of the various classes of assets or the lease term,
whichever is less. Lives of the assets range from three to 40 years.
Software Development and System Conversion Costs
With respect to internal costs incurred in the development of computer
software, the Company expenses such costs in the period they are incurred.
External costs incurred in the development of computer software are
capitalized. In addition, certain internal systems conversion costs are
capitalized. The Company capitalized approximately $8.3 million and $12.7
million of computer software development and systems conversion costs in 1996
and 1995, respectively. Such capitalized costs are amortized using the
straight- line method over the remaining estimated economic life of the product
or system. Amortization expense amounted to $4.6 million, $2.2 million and $.6
million in 1996, 1995 and 1994 respectively.
Long-Lived Assets
The Company accounts for certain long-lived assets, identifiable intangibles,
and goodwill in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The standard
requires long lived assets awaiting disposition or with impaired service
potential to be valued at the lower of cost or undiscounted expected cash flows
attributable to the assets.
37
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Goodwill and other intangible assets have resulted from the Conversion, as well
as acquisitions which have been accounted for under the purchase method. Other
intangible assets consist of the value of employer group contracts and provider
networks. The Company routinely evaluates the recoverability of goodwill and
other intangible assets based on estimated future cash flows.
Intangible assets consisted of the following at December 31, 1996 (in
thousands):
<TABLE>
<CAPTION>
BALANCE AT
ACCUMULATED DECEMBER 31 AMORTIZATION
COST AMORTIZATION 1996 PERIOD
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Goodwill $ 296,053 $ 34,718 $ 261,335 27-35 years
Provider network 19,125 2,024 17,101 5-20 years
Employer group contracts 94,951 45,719 49,232 11 years
Other 6,261 5,210 1,051 4-15 years
--------------------------------------------
$ 416,390 $ 87,671 $ 328,719
============================================
</TABLE>
Intangible assets consisted of the following at December 31, 1995 (in
thousands):
<TABLE>
<CAPTION>
BALANCE AT
ACCUMULATED DECEMBER 31 AMORTIZATION
COST AMORTIZATION 1995 PERIOD
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Goodwill $ 279,815 $ 25,041 $ 254,774 27-35 years
Provider network 19,125 1,068 18,057 5-20 years
Employer group contracts 94,951 37,354 57,597 11 years
Other 6,261 324 5,937 4-15 years
--------------------------------------------
$ 400,152 $ 63,787 $ 336,365
============================================
</TABLE>
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of marketable securities as described in Note 2,
cash equivalents and premiums receivable. All cash equivalents and investments
are managed within established guidelines which limit the amounts which may be
invested with one issuer. Concentrations of credit risk with respect to
premiums receivable are limited due to the large number of payers comprising
the Company's customer base. The Company's ten largest employer groups
accounted for 37.4% and 23.9% of receivables and 21.4% and 24.8% of premium
revenue as of December 31, 1996 and 1995, respectively, and for the years then
ended. In addition, the Company has a receivable in the amount of $22.1
million from the State of Connecticut that represents claims paid by the
Company and reimbursable by the State of Connecticut pursuant to a previous ASO
arrangement. Such receivable is included in other assets.
Income Taxes
Deferred income taxes reflect the net effects of temporary differences between
the carrying values of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The differences result in
taxable or deductible amounts for income tax purposes when the reported amount
of the asset or liability in the financial statements is recovered or settled,
respectively. The Company has recorded a deferred tax asset of $29.3 million
as of December 31, 1996. Although realization is not assured, management
believes it is more likely than not that all of the deferred tax asset will be
realized.
Earnings per Share
Earnings per share is calculated based on the weighted average shares of common
stock and common stock equivalents
38
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
outstanding during the periods presented. Common stock equivalents arising
from dilutive stock options are computed using the treasury stock method.
In February 1997, the Financial Accounting Standards Board issued SFAS 128,
"Earnings Per Share" effective for periods ending after December 15, 1997,
including interim periods; earlier adoption is not permitted. This statement
requires restatement of all prior period earnings per share ("EPS") data
presented. The statement establishes standards for computing and presenting
EPS.
Use of Estimates in the Preparation of Financial Statements
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The Company estimates the fair value of financial instruments in accordance
with the requirements of SFAS No. 107, "Disclosures about Fair Value of
Financial Instruments." The estimated fair value amounts of cash equivalents,
marketable securities held for sale and notes payable approximate their
carrying amounts in the financial statements and have been determined by the
Company using available market information and appropriate valuation
methodologies. The carrying amount of cash equivalents approximate fair value
due to the short maturity of those instruments. The fair values of marketable
securities are estimated based on quoted market prices and dealer quotes for
similar investments. The fair value of notes payable is estimated based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities. Considerable
judgment is required to develop estimates of fair value. Accordingly, the
estimates are not necessarily indicative of the amounts the Company could have
realized in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the estimated
fair value amounts.
The fair value estimates are based on pertinent information available to
management as of December 31, 1996 and 1995. Although management is not aware
of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date, and therefore, current estimates of
fair value may differ significantly.
Stock-Based Compensation
During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which encourages but does not
require companies to record stock-based compensation cost at fair value. The
Company has chosen to continue accounting for stock-based compensation under
the intrinsic value method prescribed in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value
method, compensation cost for stock options is measured at the date of grant as
the excess, if any, of the quoted market price of the Company's stock over the
exercise price of the option. See Note 10, Stock Option and Employee Stock
Purchase Plans.
39
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. MARKETABLE SECURITIES HELD FOR SALE
The following is a summary of marketable securities held for sale as of
December 31, 1996 (in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Government securities $ 66,159 $ 45 $ (426) $ 65,778
Asset-backed securities 187,059 487 (972) 186,574
Debt securities 88,576 355 (1,113) 87,818
Securities held by depository 25,019 25,019
Other 48,654 18 (11,733) 36,939
---------------------------------------------------------------------
$ 415,467 $ 905 $ (14,244) $ 402,128
=====================================================================
</TABLE>
Included in other securities is the Company's investment in Medaphis
Corporation. At December 31, 1996, the unrealized loss on such investment was
$11.6 million. See Note 3.
During the year ended December 31, 1996, marketable securities held for sale
with a fair value at the date of sale of $224.2 million were sold. The gross
realized gains on such sales totaled $2.4 million, and the gross realized
losses totaled $270,000.
The following is a summary of marketable securities held for sale as of
December 31, 1995 (in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Government securities $ 99,640 $ 445 $ (136) $ 99,949
Asset-backed securities 146,363 2,194 (214) 148,343
Debt securities 60,093 940 (250) 60,783
Securities held by depository 28,040 (83) 27,957
Other 29,042 640 (85) 29,597
------------------------------------------------------------------------
$ 363,178 $ 4,219 $ (768) $ 366,629
========================================================================
</TABLE>
During the year ended December 31, 1995, marketable securities held for sale
with a fair value at the date of sale of $249.5 million were sold. The gross
realized gains on such sales totaled $618,000, and the gross realized losses
totaled $38,000.
The amortized cost and estimated fair value of marketable securities at
December 31, 1996 by contractual maturity, are shown below (in thousands).
Expected maturities will differ from contractual maturities because the issuers
of the securities may have the right to prepay obligations without prepayment
penalties. Asset-backed securities do not have single maturity dates.
40
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
<TABLE>
<CAPTION>
Estimated
Cost Fair Value
----------------------------------
<S> <C> <C>
Available for sale:
Due in one year or less $ 113,078 $ 112,375
Due after one year through five years 69,140 68,693
Due after five years through ten years 17,613 17,490
Due after ten years 648 654
----------------------------------
200,479 199,212
Asset-backed securities 187,059 186,574
Equity securities 27,929 16,342
----------------------------------
$ 415,467 $ 402,128
==================================
</TABLE>
3. ACQUISITIONS
The following summarizes acquisitions and strategic investments by HSI for the
three years ended December 31, 1996:
GHH - On December 1, 1995, the Company acquired the outstanding stock of GHH
and certain of its for-profit subsidiaries, including Greater Atlantic, an HMO
operating in Pennsylvania and New Jersey, for $114 million in cash and notes
(the "GHH Transaction"). In connection with the GHH Transaction, the Company
also paid an aggregate of $12.5 million to certain affiliated hospitals of
Graduate Health System, Inc. ("GHS"), GHH's previous parent company, in return
for the extension of term and other amendments to such hospitals' provider
contracts with Greater Atlantic. In addition, pursuant to the GHH Transaction,
the Company established a hospital management company to manage GHS's
Philadelphia-area hospitals pursuant to hospital management agreement and
acquired certain other healthcare services businesses that provide services
primarily to the hospitals in the GHS system. The acquisition has been
accounted using purchase accounting and the excess of the purchase price over
the fair value of assets acquired in the amount of $88.4 million was recorded
as goodwill. In the fourth quarter of 1996, the Company sold certain of the
healthcare services businesses for $2 million in cash and recorded revenue of
$3 million in connection with the termination of the hospital management
agreement. No gain or loss was recognized on the sale of such businesses
because the Company's investment in such companies approximated the sales price.
Care Management Sciences Corporation - On September 6, 1996, the Company
purchased shares of preferred stock of Care Management Sciences Corporation
("CMS") for an aggregate purchase price of $4.1 million, which, together with
the shares of CMS preferred stock purchased by the Company in 1995 for $2
million, represent approximately 43.9% of the outstanding capital of CMS. In
connection with its 1995 and 1996 purchases, the Company was issued warrants to
purchase additional shares of CMS preferred stock at the same per share
purchase price of such purchases, which warrants, if fully exercised, would
increase the Company's ownership in CMS to 56.42%. In addition, the Company
(as part of the stock acquisition in 1996) has provided CMS with line of credit
in the amount of $2,684,675, which is in addition to a previously granted $1
million line of credit, under which CMS has borrowed $1 million. CMS develops,
licenses and supports proprietary software related to the health care industry.
The Company has accounted for its investment in CMS using the cost method and
such investment is included in other assets.
HDS - On June 30, 1995, the Company acquired shares of preferred stock of
Health Data Sciences Corporation ("HDS"), representing a minority equity
interest in HDS, for an aggregate purchase price of approximately $15.6
million. In addition, the Company entered into certain software licensing and
development agreements with HDS. HDS develops, licenses and supports
proprietary software and technology related to health care information
management systems. On November 13, 1995 and December 29, 1995, the Company
acquired additional shares of preferred stock of HDS for an aggregate purchase
price of approximately $6.3 million.
In July 1996, HDS was acquired by Medaphis Corporation ("Medaphis") and the
Company's preferred stock in HDS was converted into 976,771 shares of Medaphis
common stock. Since the acquisition of HDS by Medaphis the value of Medaphis
common stock has substantially declined, and the Company has therefore recorded
an unrealized loss of $11.6 million related to its investment in Medaphis
common stock. In connection with the decline in value in
41
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
November 1996, the Company filed a lawsuit against Medaphis claiming, among
other things, that misleading financial performance information was given to the
Company prior to the acquisition. The complaint seeks rescission of the
transaction or damages in excess of $38.0 million. As of December 31, 1996, the
litigation is ongoing.
MDEC - On March 15, 1995, the Company acquired all of the outstanding stock of
M.D. Enterprises of Connecticut, Inc. ("MDEC"), and its wholly-owned
subsidiary, M.D. Health Plan, an HMO operating in Connecticut, for $95.4
million. In addition, the Company assumed certain contractual obligations
related to MDEC stock appreciation rights equal in value to $5.1 million. The
acquisition has been accounted using purchase accounting and the excess of the
purchase price over the fair value of assets acquired totaling $97.1 million
was recorded as goodwill in the amount of $89.1 million and employer group
contracts in the amount of $8.0 million.
QMPHP - In October 1994, the Company purchased 51% of the outstanding stock of
QualMed Plans for Health of Pennsylvania, Inc. ("QMPHP"), a Pennsylvania
managed health care provider, for $1.1 million in cash. HSI subsequently
increased its ownership interest in QMPHP to 83% through additional capital
contributions of approximately $6.5 million. The QMPHP acquisition resulted in
$3 million of provider network intangible assets. QMPHP's accounts are
consolidated with those of the Company, and the minority stockholders' interest
in QMPHP's net assets and income (loss) is included in the Company's financial
statements as minority interest. The Company is also in the process of
purchasing 17,000 shares of preferred stock of QMPHP from its current holder
for $1.7 million.
Advantage Health - On May 14, 1996, the Company announced that it had reached
a definitive agreement with St. Francis Health System to acquire an 80%
interest in Advantage Health, a managed health care company headquartered in
Pittsburgh, Pennsylvania, for approximately $10 million in cash. The
transaction is subject to approvals from regulatory authorities, and other
customary conditions of closing.
First Option Health Plan. Pursuant to an amended purchase agreement, dated
February 10, 1997, as amended, and effective on March 19, 1997 among the
Company, FOHP, Inc., a New Jersey corporation ("FOHP") and First Option Health
Plan of New Jersey, Inc., a New Jersey corporation ("FOHP-NJ"), the Company
agreed to invest an initial amount of approximately $43 million in FOHP. FOHP
is owned by physicians, hospitals and other health care providers and is the
sole shareholder of FOHP-NJ, a managed health care company providing a full
line of commercial products for businesses and individuals, along with
Medicare, Medicaid and Workers' Compensation programs.
At closing, the Company will purchase approximately $43 million worth of FOHP
convertible subordinated debentures, a portion of which will reflect fees owed
to the Company by FOHP pursuant to a management agreement to be entered into by
the Company and FOHP. This portion of the $43 million initial investment
(estimated to be approximately $1.5 million as of the closing) will immediately
be converted into FOHP stock. The initial investment, and further amounts to be
forwarded by the Company to FOHP prior to December 31, 1997 (such further
amounts not to exceed $8.4 million), will be convertible into 71% of the
outstanding equity of FOHP at the Company's discretion. The timing of payment
for these contractual obligations may be subject to revision pursuant to
required regulatory approvals. In 1999, the Company may effect either a cash
offer for shares or a merger, business combination or consolidation transaction
for the remaining shares of FOHP not owned by the Company.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 1996 and 1995
(in thousands):
<TABLE>
<CAPTION>
1996 1995
-----------------------
<S> <C> <C>
Furniture, equipment and software $ 173,653 $170,342
Leasehold improvements 12,308 13,105
Land and building 4,588 4,256
-----------------------
190,549 187,703
Less accumulated depreciation and amortization 118,763 102,960
-----------------------
Total property and equipment $ 71,786 $ 84,743
=======================
</TABLE>
42
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. NOTES PAYABLE
Wellness Note
In connection with the Conversion, Health Net issued two non-negotiable
promissory notes to the Foundation in the aggregate original principal amount
of $225 million. The notes, a $150 million original principal amount senior
secured promissory note and a $75 million original principal amount
subordinated secured promissory note, bore interest at 10.27% in years 1996 and
1995. The rate adjusts to 2.5% above the three-year treasury bill auction rate
on the last business day before December 31, 1997, 2000, and 2003, but will not
be less than 5%. Principal and interest is due in quarterly installments,
currently based on a 25-year amortization schedule; in 1996, the amortization
schedule is changed to 20 years, and in 1997, the amortization schedule is
changed to 15 years. In addition, commencing in 1995, additional payments of
principal becomes due to the extent that Health Net has an "Excess Cash Ratio,"
as defined, in any calendar year. Any remaining unpaid principal and interest
is due on December 31, 2006. In January 1994, the Company made a discretionary
$50 million prepayment to the Foundation on the subordinated secured promissory
note. In April 1995, the Company paid down $135 million of the outstanding
Foundation debt, leaving a remaining principal balance on the senior secured
promissory note of $19.6 million. As of December 31, 1996, the remaining
principal balance was $19.3 million. (See discussion of credit facility
below).
Health Net's performance under the note obligations has been guaranteed by the
Company. In accordance with the provisions of the promissory notes described
above, Health Net has provided the Foundation a security interest in the
following collateral: premiums receivable, property and equipment and debt
securities held by depository (Note 2). Health Net is required to maintain a
minimum of funds in a depository sufficient to cover the total amount
outstanding. These funds totaled $20.3 million and $20.3 million at December
31, 1996 and 1995, and were included in marketable securities held for sale.
In addition, Health Net is required to make payments to a sinking fund,
commencing in 2003, in order to provide funds for the unpaid principal balloon
payment (plus any interest) due in 2006.
The long-term portion of the principal and interest payments under these notes
is subordinated to Health Net meeting its tangible net equity requirements
under the Knox-Keene Health Care Service Plan Act.
Based on the terms of the Conversion as approved by the DOC, Health Net may
treat as a deemed principal payment with respect to the senior secured note
payable to the Foundation any taxes, penalties or interest assessed with
respect to the Conversion (whether resulting from the recently completed
examination or otherwise) up to a maximum of $28 million. In March 1995,
Health Net and the IRS entered into a settlement of all outstanding issues
raised in the audit. The settlements paid were treated as a principal payment
on the notes due to the Foundation. (See Note 8).
Credit Facility
On April 26, 1996, the Company replaced its five-year unsecured $400 million
revolving credit facility obtained on April 12, 1995 with a $700 million
revolving credit facility (the "Credit Facility") from a lending syndicate led
by Bank of America. 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. As of December 31, 1996, $319 million had been
borrowed against the new $700 million Credit Facility.
In 1995, the Company had used $310 million of the Credit Facility to fund the
prepayment by Health Net of $135 million in debt to the Foundation, $100
million to fund the MDEC acquisition, and $75 million to fund the purchase of
GHH. As of December 31, 1996, the Company had used an additional $9 million to
repurchase treasury stock and fund certain acquisitions.
43
<PAGE> 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Other Notes Payable
The Company also has various other notes payable outstanding, both secured and
unsecured, totaling $25.7 million and $26.8 million at December 31, 1996 and
1995, respectively. In connection with its acquisition of GHH in 1995, the
Company issued a promissory note in the amount of $22.5 million to GHS. Such
note bears interest at 7.95% and is payable in 2005.
The weighted average annual interest rate on the Company's long-term debt was
approximately 6.3%, 7.4%, and 8.0% for the years 1996, 1995, and 1994,
respectively.
The following table presents the principal payments due with respect to all of
the above referenced notes for the five years ending December 31 (in
thousands):
<TABLE>
<S> <C>
1997 $ 1,608
1998 848
1999 932
2000 1,025
2001 886
Thereafter 358,774
-------------------
364,073
Less: current portion 1,608
-------------------
Long-term portion $ 362,465
===================
</TABLE>
6. OPERATING LEASES
The Company leases administrative and medical office space under various
operating leases. Certain medical office space is subleased to Participating
Medical Groups doing business with the Company. Certain leases contain renewal
options and rent escalation clauses. Future minimum lease commitments for
noncancelable operating leases at December 31, 1996 are as follows (in
thousands):
44
<PAGE> 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
<TABLE>
<S> <C>
1997 $ 19,755
1998 14,699
1999 12,048
2000 11,027
2001 10,167
Thereafter 3,226
------------------
Total minimum lease commitments $ 70,922
==================
</TABLE>
Rent expense totaled $18.6 million, $17.7 million and $13.8 million in 1996,
1995 and 1994, respectively.
7. EMPLOYEE BENEFIT PLANS
Retirement Plans
In 1995 the Company had five separate 401(k) retirement savings plans. All five
of the 401(k) plans were consolidated into a single plan effective January 1,
1996. The plan is available to substantially all employees of certain
subsidiaries age 21 or older who have completed various periods of continuous
service. Non-highly compensated employees as defined by the Internal Revenue
Code may defer up to a maximum of 15% of their annual compensation under the
401(k) plan, while highly compensated employees are limited to lesser maximums
in compliance with discrimination tests. The Company made certain matching
contributions to the plan in 1996.
Effective April 30, 1994, the Company's defined benefit pension plan in effect
at such time was amended to cease benefit accruals. The plan was subsequently
terminated effective December 31, 1994. This freezing of the plan affects the
comparability of net periodic pension cost and funded status with that of prior
years. In 1994, the Company recorded a $3.1 million gain from the freeze. The
plan covered substantially all Health Net employees. Benefits were based on
years of service and the employee's compensation during the last five years of
employment. The plan's assets consist of investments in a bank's pooled trust
fund. Expenses under the 401(k) and defined benefit pension plans totaled $1.4
million in 1996, $1.3 million in 1995 and $2.9 million in 1994.
The following table sets forth the plans' funded status and the amounts
recognized in the Company's consolidated financial statements at December 31
(in thousands):
<TABLE>
<CAPTION>
1996 1995
-------------------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Accumulated vested benefit obligation $ 946 $ 6,988
Projected benefit obligation $ 946 $ 6,988
Plan assets at fair value 1,080 6,751
-------------------------------
Projected benefit obligation greater than / (less than) plan assets (134) 237
Unrecognized net loss (98) (832)
Additional minimum liability 832
-------------------------------
Net pension liability / (prepaid cost) $ (232) $ 237
===============================
</TABLE>
45
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Net pension costs included the following components for the years ended
December 31 (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------------------------
<S> <C> <C> <C>
Interest cost on projected benefit obligation $ 227 $ 614 $ 644
Actual return on plan assets (209) (749) 123
Net amortization and deferral (487) 644 (1,119)
---------------------------------------------
Total cost / (income) $ (469) $ 509 $ (352)
=============================================
</TABLE>
The projected benefit obligation was determined using a discount rate of 5.25%
for 1996 and 1995 and an assumed rate of compensation increase was not
applicable in 1996 nor 1995. The net pension costs were determined using the
aforementioned assumptions and an expected long-term rate of return on plan
assets of 8% for each of the years 1996, 1995 and 1994.
On December 15, 1992, the Company adopted a Supplemental Executive Retirement
Plan (the "Prior SERP"). Certain key executives were eligible to participate
in the Prior SERP. Under the provisions of the Prior SERP, these executives
could elect to credit amounts to the Prior SERP in lieu of compensation. The
annual amount so credited was equal to 50% of the premium that would be
required to fund a premium variable life insurance policy. The Company then
credited the executive's SERP account with the remaining 50% premium. Upon
death, beneficiaries are entitled to receive the entire death benefit under the
policy plus an additional 78.5% of policy benefits. At retirement or
termination, the executive is entitled to the cash surrender value of the
policy plus an additional 78.5% of such cash surrender value. The termination
or retirement benefit must be paid to the executive in a lump sum. This Prior
SERP was discontinued in December 1995.
A new SERP program (the "Current SERP") was approved effective January 1, 1996.
The new SERP plan ensures that executives who retire at age 62 or later and
have worked for the Company or a predecessor organization for at least 15 years
receive 50% of average pay (salary and bonus) when combined with Social
Security and all other employer provided retirement benefits provided under
current and prior programs including the accumulated value of company
contributions to the Company's 401(k) plan (including the profit sharing
component of such plan) for the account of such individuals, along with
benefits accrued under the prior SERP frozen in 1995. Executives with less
than 15 years of service at age 62 will receive a reduced benefit under this
plan, and executives must accrue at least five years of service to receive a
partial benefit. Those terminating with between 5 and 10 years of service are
entitled to receive a partial benefit, and executives who terminate with 10 or
more years of service will be 100% vested on earned benefits.
The Company also has adopted the Health Net Board of Directors Retirement Plan.
The plan covers all outside members of the Health Net Board of Directors
retiring on or after age 65 for a duration not to exceed the period of service
as a director.
Expense under the SERP programs and Health Net Board of Directors Retirement
Plan totaled $2.7 million in 1996, $1.8 million in 1995 and $2.5 million in
1994.
Post-retirement Health and Life Benefits
The Company sponsors a defined-benefit health care plan for its Health Net
employees that provides post-retirement medical benefits to full-time employees
and their eligible dependents for employees who have worked ten years and
attained age 55. The Company pays 100% of the cost of medical, dental,
prescription and vision benefits for those employees who retired on or before
December 1, 1995; for employees retiring after December 1, 1995, the Company
pays 25% of the cost of medical coverage for those employees with ten years of
service, increasing 5% a year to 25 years or more of service, at which time
100% of the cost is borne by the Company. The health care plan includes
certain cost-sharing features such as deductibles, coinsurance and maximum
annual benefit amounts for certain benefits.
46
<PAGE> 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table presents this plan's funded status and the amounts
recognized in the Company's consolidated financial statements at December 31
(in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------
<S> <C> <C>
Accumulated post-retirement benefit obligations:
Retirees $ 2,345 $ 1,251
Active 1,822 2,800
------------------
4,167 4,051
Plan assets at fair value - -
------------------
Accumulated benefit obligation in excess of plan assets 4,167 4,051
Unrecognized net gain from past experience different from that
assumed and from changes in assumptions 753 328
------------------
Accrued post-retirement benefit cost at year end $ 4,920 $ 4,379
==================
</TABLE>
Net periodic post-retirement cost includes the following for the years ended
December 31 (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------------------
<S> <C> <C> <C>
Service cost $405 $390 $413
Interest cost 266 266 211
Net amortization and deferral (25) (4)
---------------------------------------
Total cost $646 $656 $620
=======================================
</TABLE>
The weighted-average annual assumed rate of increase in the per capita cost of
covered benefits (i.e., health-care cost-trend rate) is 7.75% for 1997, and is
assumed to decrease gradually to 5.5% for 2007 and remain at that level
thereafter. The health-care cost- trend rate assumption has a significant
effect on the amounts reported. To illustrate, increasing the assumed health
care cost- trend rates by one percentage point in each year would increase the
accumulated post-retirement benefit obligation as of December 31, 1996 by
$650,000 and the aggregate of service and interest cost components of net
periodic post-retirement benefit cost for the year then ended by $200,000. The
weighted-average discount rate used in determining the accumulated
post-retirement benefit obligation was 7.5% in 1996 and 1995 and 8.5% in 1994.
The Company also sponsors a life insurance plan, funded entirely by the
Company. The amount of coverage varies with the maximum amount of three times
earnings not to exceed $500,000. The Company's policy is to fund the cost of
benefits for the health care and life insurance plans in amounts determined at
the discretion of management, after consultation with an independent actuary.
Employee Stock Purchase Plan
In 1993 the Company's Board of Directors approved the Health Systems
International Employee Stock Purchase Plan, effective February 15, 1993. See
note 10, Stock-Based Compensation.
Performance-Based Annual Bonus Plan
The Company has a Performance-Based Annual Bonus Plan that qualifies under
Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code").
Under the plan, if the Company meets certain financial and operating targets,
certain executives subject to the limitations of Section 162(m) of the Code
become eligible to receive annual cash bonuses based on a maximum pool of 2.5%
of consolidated operating income and on the executives' salaries in relation to
the pool. Amounts payable to such executives from such pool are subject to
downward adjustment by the Company's Compensation and Stock Option Committee.
47
<PAGE> 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Management Bonus Plan
The Company also has a Management Bonus Plan whereby certain executives become
eligible to receive annual cash bonuses if the Company and such executives meet
certain financial and operating targets.
8. COMMITMENTS AND CONTINGENCIES
Income Tax Examinations
Health Net was under audit by the IRS during 1995 and 1994. The principal
issue during the course of the audit was whether Health Net qualified as a
tax-exempt entity for certain periods prior to the Conversion. In March 1995,
Health Net and the IRS entered into a settlement of all outstanding issues
raised in the audit. The settlement paid was treated as a payment on the notes
due to the Foundation, in accordance with the terms of such notes. A deferred
tax liability account was previously established by the Company to cover
potential liabilities relating to the audit. As a result of this settlement,
the deferred tax liability and associated goodwill of approximately $33.0
million have been eliminated.
Health Net is currently under examination by the California Franchise Tax
Board. Issues under examination include, among other issues, tax ramifications
of the Conversion. Additionally, certain QualMed plans are currently under
examination by the Internal Revenue Service. Issues under examination include,
among other issues, tax treatment of goodwill related to various acquisitions.
Although it is not possible to predict with any certainty the outcome of these
examinations, the Company's management believes, based on advice of legal
counsel, that QualMed and Health Net have substantial bases for their positions
on issues likely to arise during the course of the examinations. The ultimate
resolution of these matters should not have a material adverse effect on the
financial statements of the Company.
Litigation
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 the Company's public stockholders by refusing to seriously consider
certain acquisition bids for the Company. Such lawsuits were dismissed without
prejudice in April 1996.
The Company is involved in various other legal proceedings, which are routine
in its business. In the opinion of management, based upon current facts and
circumstances known by the Company, the resolution of these matters should not
have a material adverse effect on the financial position or results of
operations of the Company.
9. TRANSACTIONS WITH RELATED PARTIES
Three directors of the Company are partners of law firms which received legal
fees totaling $1.0 million, $1.9 million and $1.5 million in 1996, 1995 and
1994, respectively. An officer of a contracted hospital is also a member of
the Company's Board of Directors. Medical costs paid to the provider totaled
$58.7 million, $55.3 million and $14.0 million in 1996, 1995 and 1994,
respectively. Such contracted hospital is also an employer group of the
Company. The Company received annual premium revenues of $3.4 million in 1996
and $3.0 million in 1995 and 1994. A director of the Company was an officer of
an employer group until October 1994. In 1994, the Company received premium
revenues of $17 million from the group. Certain stockholders and directors of
the Company are officers of consulting firms which received approximately
$1,250,000 in 1996 and $140,000 in 1995 and $70,000 in 1994 pursuant to
consulting agreements to pay for certain consulting services provided to the
Company.
In 1995, the Company advanced an aggregate sum of approximately $16.3 million
to three of its former executive officers and directors in connection with the
future repurchase of shares of HSI Class A Common Stock held by such
individuals. This repurchase agreement was entered into in connection with
certain severance agreements between the Company and each such individual in
connection with his or her termination of employment. Such advances were
non-interest bearing and were secured by a pledge of shares of Class A Common
Stock, which shares were ultimately repurchased by the Company in January 1996.
48
<PAGE> 52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
The repurchased shares were held pursuant to the Amended and Restated Health
Net Associate Trust Agreement dated as of May 1, 1994 on behalf of certain
founding stockholders of the Company at the date of the conversion of Health
Net to for-profit status. The repurchased shares, having an aggregate value of
$9.6 million, were immediately canceled and netted against Class A Common
Stock, Additional Paid-in-Capital, and Retained Earnings.
10. STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS
The company has various outstanding stock option and stock purchase plans which
cover certain employees, officers, and non-employee directors. Such plans have
been adopted by the stockholders and options have been granted under such
plans. The Company grants stock options at prices at or above the market value
of the stock on the date of grant. The options generally carry a maximum term
of 10 years and vest either ratably over 5 years or over the 3rd, 4th and 5th
anniversaries of the date of grant. A summary of the plans in existence as of
December 31, 1996 is as follows:
1989 Plan - In 1989, 2,210,000 shares of the Company's Class A Common Stock
were authorized to be issued under future grants to officers, directors and
certain employees of the Company pursuant to the 1989 Stock Option Plan.
1991 Plan - In 1991, 1,000,000 shares of the Company's Class A Common Stock
were authorized to be issued under future grants to officers and employees of
the Company pursuant to the 1991 Stock Option Plan. The authorized number of
shares was subsequently increased to 5,000,000.
Non-Employee Director Plan - In 1991, 100,000 shares of the Company's Class A
Common Stock were authorized to be issued under grants to non-employee
directors of the Company pursuant to the Non-Employee Director Stock Option
Plan. The authorized number of shares was subsequently increased to 300,000.
Employee Stock Purchase Plan - In 1993, 1,000,000 shares of the Company's Class
A Common Stock were reserved for issuance under the Company's Employee Stock
Purchase Plan. The plan provides employees of the Company with an opportunity
to purchase stock through payroll deductions. Eligible employees may purchase
up to $25,000 in fair market value annually of the Company's Common Stock at
85% of the lower of the market price on either the first or the last day of
each offering period.
Stock option activity and weighted average exercise prices for the years ended
December 31, 1996, 1995, and 1994 is present below:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------- ------------------------------- -----------------------------
Exercise Exercise Exercise
Options Price Options Price Options Price
----------- ------------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding
at January 1 1,672,564 $ 24.02 2,617,815 $ 17.71 1,770,264 $ 7.61
Granted 1,445,000 34.56 71,586 28.73 1,297,665 29.32
Exercised (790,200) 21.65 (915,637) 5.96 (401,114) 9.41
Canceled (72,550) 32.49 (101,200) 28.16 (49,000) 18.16
-------------- ------------- -------------
Outstanding
at December 31 2,254,814 $ 31.30 1,672,564 $ 24.02 2,617,815 $ 17.71
============== ============= =============
Exercisable
at December 31 2,202,314 1,618,564 1,280,030
============== ============= =============
</TABLE>
During 1996 and 1995, 51,623 shares and 48,530 shares, respectively, were
issued under the Employee Stock Purchase Plan at a weighted average issuance
price of $23.30 and $22.07, respectively. The shares were issued at prices of
$21.25 and $25.93 in 1996 and $20.93 and $23.06 in 1995.
49
<PAGE> 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The weighted average fair value at date of grant for options granted during
1996 and 1995 was $9.78 and $8.49, respectively. The fair value of options
granted during 1996 and 1995 were estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions: (i)
risk-free interest rate of 6.26%; (ii) expected lives of 2.92 years; (iii)
expected volatility of 38.4%; and (iv) no expected dividend yield.
The following table summarizes the weighted average price and life information
for significant option groups outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------- ----------------------------------
Range of Remaining
Exercise Options Contractual Exercise Options Exercise
Prices Outstanding Life Price Exercisable Price
--------------- ---------------- --------------- ---------------- ---------------- --------------
<S> <C> <C> <C> <C> <C>
11.63 - 14.88 156,699 2.60 13.39 156,699 13.39
18.25 - 26.75 200,365 6.49 23.53 165,365 22.85
27.75 - 31.91 710,500 5.90 28.85 693,000 28.86
34.69 - 44.06 1,187,250 9.00 36.43 1,187,250 36.43
-------------- ---------------
11.63 - 44.06 2,254,814 7.35 31.30 2,202,314 31.39
=============== ==============
</TABLE>
No stock-based compensation cost was recognized for 1996 and 1995. Had the
stock-based compensation cost been determined based on the fair value of
options granted, net income would have decreased by $8.1 million and $381,000,
respectively, and earnings per share would have decreased by $0.16 in 1996 and
would have remained unchanged in 1995. As fair value criteria were not applied
to awards prior to 1995, and additional awards in future years are anticipated,
the effects on net income and earnings per share in this pro forma disclosure
may not be indicative of future amounts.
50
<PAGE> 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. INCOME TAXES
Significant components of the Company's deferred tax liabilities and assets as
of December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
Deferred tax liabilities:
Tax over book amortization $ $ 230
Unrealized gain on marketable securities 1,501
Other 2,130 2,454
------------- -------------
Total deferred tax liabilities 2,130 4,185
------------- -------------
Deferred tax assets:
Unrealized loss on marketable securities 4,918
Estimated book reserves in excess of tax reserves 13,581 12,925
Other post-employment benefit obligations 1,341 1,034
Book over tax depreciation 4,017 1,765
Book over tax amortization 32
Accrued compensation 2,915 1,447
State franchise tax 3,123 3,244
Accrued merger related costs 2,986
Deferred rent 912 1,296
Other 637 348
-------------- -------------
Total deferred tax assets 31,476 25,045
-------------- -------------
Net deferred tax assets $ 29,346 $ 20,860
=============== ===============
</TABLE>
During the years ended December 31, 1996, 1995 and 1994, tax benefits totaling
$3.9 million, $8.7 million and $1.5 million, respectively, were realized as a
result of compensation recognized for tax purposes relating to the exercise of
stock options and were recorded as an increase in additional paid-in capital.
The Company has utilized pre-acquisition operating losses of subsidiaries
acquired which could differ from amounts allowed by the tax authorities.
Management believes it has adequately provided for any increases in taxes that
might result from any reduction of the realization of net operating loss
carryforwards.
Significant components of the provision for income taxes are as follows for the
three years ended December 31 (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------
<S> <C> <C> <C>
Current:
Federal $44,013 $ 39,273 $49,641
State 10,032 11,552 12,971
-----------------------------------
Total current 54,045 50,825 62,612
-----------------------------------
Deferred:
Federal (2,095) 12,596 (27)
State (230) 3,886 174
-----------------------------------
Total deferred (2,325) 16,482 147
-----------------------------------
$51,720 $ 67,307 $ 62,759
===================================
</TABLE>
51
<PAGE> 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Following is a reconciliation of income tax computed at the U.S. federal
statutory tax rates to income tax expense for the three years ended December 31
(in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------
<S> <C> <C> <C>
Income taxes at the federal statutory rate $43,850 $54,825 $52,769
State income taxes, net of federal tax benefit 6,371 10,035 8,544
Merger-related expenses 262
Goodwill amortization 3,546 2,099
Other, net 348 1,184
(2,047)
-------------------------------------------
$51,720 $67,307 $62,759
===========================================
</TABLE>
12. COMMON STOCK
The Company has two classes of Common Stock. The Company's Class B Common Stock
has the same economic benefits as the Company's Class A Common Stock but is
non-voting. Upon the sale or transfer of shares of Class B Common Stock by the
Foundation to an unrelated third party, such shares automatically convert to
Class A Common Stock. The Foundation is the only holder of record of the
Company's Class B Common Stock.
Public Offering
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 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.
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. The Rights will separate from the Common
Stock in the event any person acquires 15% or more of the 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
52
<PAGE> 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
13. RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 1996, the Company recorded $44.1 million, or $.53 per
share, in restructuring and other charges. These charges included
restructuring charges of $35.6 million, the components of which were:
executive, workforce and facilities consolidation costs of approximately $11.9
million; software and hardware write-offs of approximately $15.0 million; and
other components which aggregated approximately $8.7 million.
In addition, the Company provided loss reserves totaling $8.5 million relating
primarily to contracts with governmental employer groups in the Company's
non-California markets. The Company expects to utilize these reserves over the
remaining lives of these contracts, which expire at varying dates through 1999.
14. FOUNDATION MERGER
On October 1, 1996 the Company and FH Acquisition Corp., a wholly owned
subsidiary of the Company ("Merger Sub"), entered into a Agreement and Plan of
Merger (the "Merger Agreement") with FHC, whereby Merger Sub will merge (the
"Merger") with and into FHC and FHC will survive as a wholly owned subsidiary
of the Company. Pursuant to the Merger Agreement FHC stockholders will receive
1.3 shares of the Company's Class A Common Stock for every share of FHC common
stock held. The shares of the Company's Class A Common Stock issued to FHC's
stockholders in the Merger will constitute approximately 61% of the outstanding
stock of the Company after the Merger, and the Company's current stockholders
will hold approximately 39% of the outstanding stock of the Company after the
Merger.
Pursuant to the Merger Agreement, the Company will amend its Certificate of
Incorporation to change the name of the Company to Foundation Health Systems,
Inc. and to increase the number of authorized shares of the Company's Common
Stock to 380,000,000 shares consisting of 350,000,000 shares of Class A Common
Stock and 30,000,000 shares of Class B Common Stock. The transaction is
structured to be a tax-free combination accounted for as a pooling of
interests. The new company will operate on a calendar year for financial
reporting purposes.
On February 12, 1996, shareholders of the Company and FHC approved the Merger
Agreement at separate special meetings. The transaction is anticipated to be
completed in April 1997 subject to regulatory approvals and other customary
conditions.
53
<PAGE> 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
15. QUARTERLY INFORMATION (UNAUDITED)
The following interim financial information presents the 1996 and 1995 results
of operations on a quarterly basis (in thousands except per share data):
<TABLE>
<CAPTION>
1996
Quarter Ended
March 31 June 30 September 30 December 31
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 801,349 $ 797,959 $ 802,818 $ 802,030
Restructuring and other charges 44,108
Income (loss) from operations 42,508 39,660 43,084 (14,205)
Net income (loss) 26,040 24,448 25,314 (2,210)
Earnings (loss) per share 0.54 0.51 0.52 (0.05)
</TABLE>
<TABLE>
<CAPTION>
1995
Quarter Ended
March 31 June 30 September 30 December 31
<S> <C> <C> <C> <C>
-----------------------------------------------------------------
Revenues $ 627,497 $ 660,712 $ 702,882 $ 740,961
Merger-related costs 8,927 2,185 2,328 6,724
Income from operations 29,173 39,036 38,955 35,984
Net income 18,911 22,966 24,284 23,431
Earnings per share 0.38 0.47 0.50 0.48
</TABLE>
54
<PAGE> 58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not Applicable.
55
<PAGE> 59
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The Third Amended and Restated Certificate of Incorporation of the Company
(the "Restated Certificate") provides that the Board of Directors shall consist
of not less than three nor more than twenty members, the exact number to be
determined in accordance with the Company's Third Amended and Restated By-Laws
(the "By-Laws"). In accordance with the By-Laws, the number of members of the
Board of Directors has currently been set at fourteen (14). The Restated
Certificate provides for the Board of Directors to be divided into three
classes, each class to serve for staggered three-year terms. Each class is to
consist, as nearly as possible, of one-third of the total number of directors
constituting the entire Board of Directors.
The following sets forth certain information with respect to the directors
of the Company, which are divided by the class in which they serve. It should
be noted that pursuant to the documents evidencing the FHC Merger, all
directors other than Dr. Hasan and Messrs. Deukmejian, Bouchard, Farley and
Greaves will resign effective upon consummation of the FHC Merger.
<TABLE>
<CAPTION>
Term to
Name of Director Principal Occupation Age Expire
- ---------------- -------------------- --- ------
<S> <C> <C> <C>
CLASS I
Charles T. Braden President, CBS Associates, Inc. 53 1997
Gov. George Deukmejian Partner of Sidley & Austin 68 1997
Michael E. Gallagher General Partner of Shamrock 47 1997
Investments
Robert L. Montgomery President and Chief Executive Officer 60 1997
of Alta Bates Health System
J. Kevin Murphy Business Consultant 70 1997
CLASS II
J. Thomas Bouchard Senior Vice President, Human 56 1998
Resources of International
Business Machines Corporation
Thomas T. Farley Senior Partner of Petersen, Fonda, 62 1998
Farley, Mattoon, Crockenberg
and Garcia, P.C.
Jay M. Gellert President and Chief Operating 43 1998
Officer of the Company
Douglas M. Mancino Partner of McDermott, Will & Emery 47 1998
</TABLE>
56
<PAGE> 60
<TABLE>
<S> <C> <C> <C>
CLASS III
Malik M. Hasan, M.D. Chairman of the Board of Directors, 58 1999
Treasurer and Chief Executive
Officer of the Company
Lawrence E. Austin, M.D. Retired Northwest Vice President of 62 1999
Medical Affairs of the Company
Dale T. Berkbigler, M.D. Vice Chairman of the Board, 47 1999
Executive Vice President and Chief
Medical Officer of the Company
Roger F. Greaves Previous Co-Chairman of the Board 59 1999
of Directors, Co-President and
Co-Chief Executive Officer of the Company
Kenneth W. Kizer, M.D. Health Care Consultant 45 1999
</TABLE>
Dr. Hasan became Chairman of the Board of Directors and Chief Executive
Officer of the Company on March 31, 1995. Dr. Hasan also assumed the position
of President of the Company on March 31, 1995, an office he held until June
1996. In addition, Dr. Hasan was elected Treasurer in November 1996. Dr.
Hasan was the Co-Chairman, Co-President and Co-Chief Executive Officer of the
Company from January 1994 (upon consummation of the HSI Combination) until
March 31, 1995. Dr. Hasan has served as Chairman of the Board of Directors of
QualMed since its formation in 1985. Dr. Hasan assumed the additional position
of Chief Executive Officer of QualMed in June 1990. Effective March 2, 1991,
Dr. Hasan also became President of QualMed, an office he held until February
1995. A board- certified neurologist in Pueblo, Colorado since June 1975, Dr.
Hasan maintained a limited practice until July 1992. From 1980 to 1984, Dr.
Hasan was a director of the Colorado Medical Society and Parkview Episcopal
Medical Center. In 1989, he was appointed by the Governor of Colorado to the
Colorado Health Data Commission, on which he continued to serve until 1993.
Dr. Hasan served as a Clinical Assistant Professor of Neurology at the
University of Colorado from 1976 until 1990 and has been a member of the London
Royal College of Physicians since 1964.
Dr. Austin became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Dr. Austin served as a director of
QualMed from 1986 until February 1995 and served as Northwest Vice President of
Medical Affairs of QualMed from July 1989 until May 1993. Dr. Austin was a
founding principal, director and president of Pueblo Physicians, Inc. He
served as Medical Director for the Pueblo HMO service area from December 1986
to June 1989. Dr. Austin was a practicing board-certified psychiatrist in
Pueblo, Colorado from 1968 to 1989. Dr. Austin served as the Chief of Staff of
Parkview Episcopal Hospital in Pueblo, Colorado and as a member of the Board of
Parkview Episcopal Medical Center from 1978 to 1980.
Dr. Berkbigler became Executive Vice President of Medical Affairs of the
Company and a director of the Company in January 1994 (upon consummation of the
HSI Combination). Dr. Berkbigler has been a director of QualMed since July
1987 and has served as the Executive Vice President of Medical Affairs of
QualMed since July 1989. Dr. Berkbigler became President of QualMed in
February 1995, an office he held until July 1996. He was appointed Vice
Chairman of the Board, Executive Vice President and Chief Medical Officer of
the Company in July 1996. Prior to 1986, Dr. Berkbigler served as the
President of San Luis Valley Physicians Service Corporation, and from August
1986 to March 1991 held the position of San Luis Valley HMO Medical Director.
He was promoted to QualMed Medical Director in April 1987, and assumed the
title of Vice President of Medical Affairs of QualMed in January 1988. He also
served as a member of the Board of Directors of St. Joseph Hospital, Del Norte,
Colorado, from September 1983 through September 1989 and as its Chairman of the
Board from October 1986 through September 1988. Dr. Berkbigler was a
practicing internist in Del Norte, Colorado from 1979 until 1991.
57
<PAGE> 61
Mr. Bouchard became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Bouchard served as a director of
QualMed from May 1991 until February 1995. Since October 1994, Mr. Bouchard
has served as Senior Vice President, Human Resources of International Business
Machines Corporation. From June 1989 until October 1994, Mr. Bouchard served
as Senior Vice President & Chief Human Resources Officer of U.S. West, Inc., a
diversified global communications company, and prior to that time he was Senior
Vice President--Human Resources and Organization for United Technologies Corp.
Mr. Bouchard has served on the Board of Directors of the Labor Policy
Association since March 1991 and Nordstrom National Credit Bank since April
1991.
Mr. Braden became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Braden was elected to the Health Net
Board of Directors in September 1987. Mr. Braden is President of CBS
Associates, Inc., a real estate advisory group. Prior to his association with
CBS Associates, Inc., Mr. Braden provided business consulting services
primarily to the real estate and financial industries. Mr. Braden served as
Executive Vice President at Fidelity Federal Savings and Loan from 1977 to
1991.
Mr. Deukmejian became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Deukmejian has served as a director
of QualMed from April 1992 until February 1995 and, since February 1991, has
been a partner in the law firm of Sidley & Austin, Los Angeles, California.
Mr. Deukmejian served as Governor of the State of California for two terms,
from January 1983 to January 1991. Mr. Deukmejian also served the State of
California as Attorney General from 1979 to 1982, as a State Senator from 1967
to 1978 and as a State Assemblyman from 1963 to 1966. Mr. Deukmejian became a
director of Burlington Northern Santa Fe Corporation ("BNSF"), a railroad
company, in September 1995 upon consummation of the BNSF merger. Mr.
Deukmejian served as a director of Santa Fe Pacific Corporation from January
1991 through September 1995 and he became a director of Whittaker Corporation
in January 1997.
Mr. Farley became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Farley served as a director of
QualMed from February 1991 until February 1995, and is a senior partner in the
law firm of Petersen, Fonda, Farley, Mattoon, Crockenberg and Garcia, P.C.,
Pueblo, Colorado. Mr. Farley was formerly President of the governing board of
Colorado State University, the University of Southern Colorado and Ft. Lewis
College and Chairman of the Colorado Wildlife Commission. He served as
Minority Leader of the Colorado House of Representatives from 1967 to 1975.
Mr. Farley has been a director of the Public Service Company of Colorado, a
public gas and electric company, since 1983 and a director/advisor of Norwest
Banks of Pueblo and Sunset since 1985. Mr. Farley has been a member of the
Board of Regents of Santa Clara University, a Jesuit institution, since 1987.
Mr. Gallagher has been a director of the Company since January 1994 (upon
consummation of the HSI Combination). Mr. Gallagher was a director of QualMed
from November 1993 until February 1995. Mr. Gallagher has been a general
partner of Shamrock Investments, a financial advisory firm specializing in the
health care service industry, since 1987. From May 1995 to May 1996, Mr.
Gallagher served as President and Chief Executive Officer of Health Net. From
1980 to 1987, Mr. Gallagher was an officer of American Medical International,
Inc. ("AMI"), where he most recently served as Group Vice President. Before
joining AMI, his professional career included various positions with the
accounting firm of Coopers & Lybrand in Los Angeles and service as an officer
in the U.S. Marine Corps.
Mr. Gellert became a director and President and Chief Operating Officer of
the Company in June 1996. Mr. Gellert also holds the position of Chairman of
the Board of Directors for the Company's principal operating subsidiaries,
Health Net and QualMed. Prior to joining the Company, Mr. Gellert directed
Shattuck Hammond Partners Inc.'s strategic advisory engagements in the area of
integrated delivery systems development, managed care network formation and
physician group practice integration. Prior to joining Shattuck Hammond
Partners, Mr. Gellert was an independent consultant, and from 1988 to 1991, he
served as President and Chief Executive Officer of Bay Pacific Health
Corporation. From 1985 to 1988 Mr. Gellert was Senior Vice President and Chief
Operating Officer for California Healthcare System.
58
<PAGE> 62
Mr. Greaves, who serves as a consultant to the Company, served as
Co-Chairman of the Board of Directors, Co-President and Co- Chief Executive
Officer of the Company from January 1994 (upon consummation of the HSI
Combination) until March 31, 1995. Prior to January 1994, Mr. Greaves served
as Chairman of the Board of Directors, President and Chief Executive Officer of
H.N. Management Holdings, Inc. (a predecessor of the Company) since its
incorporation in June 1990. Mr. Greaves is also a past Chairman of the Board
of Directors, President and Chief Executive Officer of Health Net. Prior to
joining Health Net, Mr. Greaves held various management roles at Blue Cross of
Southern California, including Vice President of Human Resources and Assistant
to the President, and held various management positions at Allstate Insurance
Company from 1962 until 1968. Mr. Greaves currently serves as a Commissioner
on the California Senate Advisory Commission on Life and Health Insurance, as a
member of the Board of Directors of the Group Health Association of America and
as a member of the Board of Directors of Quidel Corporation.
Dr. Kizer became a director of the Company in August 1994. He has been a
director of the Foundation since 1992 and was Chairman of the Board of the
Foundation from December 1993 through December 1995. Dr. Kizer was Chairman of
the Department of Community and International Health and Professor of Emergency
Medicine and Clinical Toxicology in the Department of Internal Medicine at the
University of California, Davis from July 1991 through October 1994. Dr. Kizer
is also currently an adjunct professor of public policy at the University of
Southern California. From 1985 to 1991, Dr. Kizer was the Director of the
California Department of Health Services. Since October 1994, Dr. Kizer has
been the Chief Executive Officer Under Secretary for Health, U.S. Department of
Veterans Affairs of the veterans health care system of the United States .
Mr. Mancino became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Mancino has been a partner in the
Los Angeles office of the law firm McDermott, Will & Emery since 1987. Mr.
Mancino also is a past President of the American Academy of Healthcare
Attorneys of the American Hospital Association.
Mr. Montgomery became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Montgomery served as a director of
QualMed from May 1991 until February 1995, and since January 1989 has served as
the President and Chief Executive Officer of Alta Bates Health System, a
holding company consisting of acute care hospitals, long-term care facilities,
home care services and a management service company for physician practice
groups and independent practice associations. Mr. Montgomery served as
Executive Vice President for VHA Enterprises, Inc., a subsidiary of Voluntary
Hospitals of America, Inc., from 1986 to 1988. Mr. Montgomery was a director
of Blue Cross of Northern California from December 1972 to April 1984, and from
1989 to April 1991 was a director of Bay Pacific Health Plan. Mr. Montgomery
has been a director of Health Risk Management, Inc., a managed care information
system company, since October 1993.
Mr. Murphy became a director of the Company in January 1994 (upon
consummation of the HSI Combination). Mr. Murphy served as a director of
QualMed from August 1990 until February 1995 and as Vice Chairman of the Board
of Directors of QualMed during such service from July 1991. Since January
1992, Mr. Murphy has been self-employed as a business consultant, from November
1985 until December 1991 he was employed as the President of 655 Associates,
Inc., a crisis management firm, and from August 1985 to January 1989 he was a
Managing Director and a Senior Vice President of the Gabelli Group, Inc., a New
York-based financial services company. Prior to 1985 Mr. Murphy was President
of Purolator Courier Corp. and Trailways, Inc. Mr. Murphy has been a director
of Pinkerton's, Inc., a security services company, since October 1990 and a
member of the St. Mary College Board of Trustees since November 1995.
59
<PAGE> 63
EXECUTIVE OFFICERS
The following sets forth certain information with respect to the current
executive officers of the Company. Please refer to the information contained
above under the heading "Directors" for biographical information of executive
officers who are also directors of the Company.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Malik M. Hasan, M.D. 58 Director and Chairman of the Board of Directors, Treasurer and Chief Executive
Officer
Jay M. Gellert 43 Director, President and Chief Operating Officer
Dale T. Berkbigler, M.D. 47 Director, Vice Chairman of the Board, Executive Vice President and Chief Medical
Officer
Michael D. Pugh 43 Senior Vice President of the Company and President and Chief Executive Officer of
QualMed
Arthur M. Southam, M.D. 40 Senior Vice President of the Company and President and Chief Executive Officer of
Health Net
Andrew Wang 55 Senior Vice President and Chief Actuary
Douglas C. Werner 52 Senior Vice President of Planning and Business Development
B. Curtis Westen, Jr. 36 Senior Vice President, General Counsel and Secretary
Terry Fouts, M.D. 53 Senior Vice President for Medical Affairs and Chief Medical Officer of QualMed
James J. Wilk 46 Senior Vice President of Human Resources and Administrative Services of Health Net
Philip A. Katz, Ph.D. 54 Vice President and Chief Information Officer
</TABLE>
Mr. Pugh became Senior Vice President of the Company and the President
and Chief Executive Officer of QualMed in July 1996. Mr. Pugh is responsible
for all of the Company's western operations outside the state of California.
He currently serves as a Commissioner of the Joint Commission on Accreditation
of Health Care Organizations. Prior to 1996, Mr. Pugh was President/CEO of
Columbia Hospital at Medical City Dallas in Dallas, Texas. From June 1984 to
July 1995 he was President/CEO of Parkview Health System, Pueblo, Colorado and
from September 1979 to June 1984 he was Administrator/CEO of United General
Hospital, Sedro Woolley, Washington.
Dr. Southam became Senior Vice President of the Company and the
President and Chief Executive Officer of Health Net in July 1996. Prior to
accepting this position, Dr. Southam was President and Chief Executive Officer
for CareAmerica Health Plans. He currently serves as Chairman of the
California Association of HMOs, an organization representing 32 health plans
throughout the State of California. Dr. Southam earned his medical degree from
the University of California at Los Angeles School of Medicine and served his
residency in internal medicine at Cedars-Sinai Medical Center in Los Angeles.
60
<PAGE> 64
Mr. Wang joined Health Net in April 1992 as Vice President and Chief
Actuary. In September 1994 he assumed the title of Senior Vice President and
Chief Actuary for Health Net, the Company and QualMed. Mr. Wang was a
consulting actuary with Milliman & Robertson, Inc. from 1974 to 1992 prior to
joining Health Net. From 1972 to 1974 he was a Professor of Mathematics at the
University of Colorado in Boulder, Colorado. Mr. Wang is a Fellow of the
Society of Actuaries and is a Member of the American Academy of Actuaries.
Mr. Werner became Senior Vice President, Strategic Planning and
Business Development of the Company in October 1996. Mr. Werner is also the
acting executive responsible for all of the Company's eastern operations.
Since 1987, Mr. Werner was employed by Aetna Health Plans in several regional
vice president positions, most recently as Regional Vice President, western
region, for Aetna Health Plans, where he developed and led commercial and
government health plan operations. He has also served in executive positions
at Western Health Plans, National Medical Enterprises, Healthcare Affiliates,
Inc. and CIGNA Healthplans.
Mr. Westen has served as Senior Vice President of the Company since
January 1995, and as Senior Vice President, General Counsel and Secretary of
the Company since April 1995. Mr. Westen also serves as a director of certain
subsidiaries of the Company. Mr. Westen has served as Senior Vice President,
General Counsel and Secretary of QualMed since February 1994, and has served as
Vice President of Administration of QualMed from August 1993 until February
1994. Since February 1995, he has served as a director of QualMed. Mr. Westen
served as Assistant General Counsel and Assistant Secretary of QualMed since
joining QualMed in March 1992. From September 1986 until March 1992, Mr. Westen
was an attorney with the firm of Lord, Bissell & Brook in Chicago, Illinois.
Dr. Fouts became Senior Vice President of Medical Affairs of the
Company in January 1994 upon consummation of the HSI Combination. In July 1996
Dr. Fouts was appointed Chief Medical Officer of QualMed. Dr. Fouts has been
Senior Vice President of Medical Affairs of QualMed since November 1991, and
served as QualMed's Associate Vice President of Medical Affairs from August
1990 to November 1991. He served as medical director for the Company's
Colorado Springs/Pueblo service areas from November 1989 through June 1992.
From April 1986 until November 1989, he served as a regional medical director
for a competitor of the Company. Prior to such time, Dr. Fouts was a
practicing physician in Pueblo, Colorado.
Mr. Wilk has served as Senior Vice President or Vice President, Human
Resources and Administrative Services of Health Net since March 1992 and has
functioned as the chief human resources officer since he joined Health Net in
September 1990. Mr. Wilk is currently the executive in charge of the Company's
developing "Customer Rewards Initiative" business. From time to time during
the period 1973 to 1990, Mr. Wilk was responsible for the Human Resources
functions at Allied-Signal, Johnson & Johnson, Bell Atlantic Corporation and
CitiCorp.
Dr. Katz has served as Vice President and Chief Information Officer of
the Company since July 1995. Prior to joining the Company, Dr. Katz was Vice
President, Planning and Technology at Graduate Health System from March 1990
until July 1995. His other past positions include President of Integrated
Technologies Resources Corporation and Associate Vice President, Technology and
Information Management at Thomas Jefferson University.
61
<PAGE> 65
ITEM 11. EXECUTIVE COMPENSATION
The following tables and descriptive materials set forth separately,
for the fiscal years indicated, each component of compensation paid or awarded
to, or earned by, (i) Dr. Hasan, the Chief Executive Officer of the Company,
and (ii) each of the four other most highly compensated executive officers
serving as of the end of the 1996 fiscal year (collectively, the "Named
Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation Long Term Compensation
------------------- ----------------------
Awards Payout
------------ ----------
Securities All Other
Name and Principal Underlying LTIP Compen-
------------------ Salary Bonus Options/ Payout sation
Position with HSI Year ($) ($) SARs(#) ($) ($)(1)
----------------- ---- ------- ------ ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C>
Malik M. Hasan, M.D. 1996 937,417 0 300,000 - 825,343(2)
Chairman of the 1995 910,441 800,000 - - 181,274(3)
Board of Directors, 1994 833,221 585,000 350,000 - 1,237,120(4)
Treasurer and Chief Executive Officer
Dale T. Berkbigler, M.D. 1996 360,000 0 92,000 - 2,633(5)
Vice Chairman of the Board, Executive 1995 359,099 115,000 - - 79,478(6)
Vice President and Chief Medical Officer 1994 304,558 208,234 25,000 - 382,524(7)
James J. Wilk 1996 273,535 0 22,000 - 3,941(8)
Senior Vice President, 1995 279,804 69,999 - - 38,455(9)
Human Resources of Health Net 1994 247,546 101,250 12,000 - 43,008(10)
Andrew Wang 1996 258,060 0 18,000 - 6,086(11)
Senior Vice President and Chief Actuary 1995 265,100 66,300 - - 20,345(12)
1994 229,309 97,500 6,000 - 24,039(13)
Arthur M. Southam, M.D. 1996 174,519(14) 137,500(15) 65,000 - 459(16)
Senior Vice President of the Company and 1995 - - - - -
President and CEO of Health Net 1994 - - - -
-
</TABLE>
(1) The figures contained in this column do not include the value of the
following number of shares of the Company's Class A Common Stock which were
awarded to the named individuals for the 1995 plan year under the Company's
profit sharing component of its 401(k) plan: Dr. Hasan (265 shares), Dr.
Berkbigler (172 shares), Mr. Wilk (254 shares), Mr. Wang (254 shares) and
Dr. Southam (no shares). No such shares were awarded for the 1996 plan
year to any of the named individuals.
(2) This amount includes $818,918 in accrued employer contributions under the
Company's prior SERP, $2,375 in matching contributions under the Company's
401(k) plan and $4,050 in premiums paid by the Company on life insurance
policies.
(3) This amount includes $178,046 in accrued employer contributions under the
Company's prior SERP, $2,310 in matching contributions under the Company's
401(k) plan and $918 in premiums paid by the Company on a life insurance
policy.
(4) This amount includes $1,232,500 paid to Dr. Hasan in connection with the
HSI Combination with respect to the termination of a change in control
agreement.
(5) This amount includes $1,067 in matching contributions under the Company's
401(k) plan and $1,566 in premiums paid by the Company on a life insurance
policy.
(6) This amount includes $75,486 in accrued employer contributions under the
Company's prior SERP, $2,310 in employer matching contributions made under
the Company's 401(k) plan and $1,682 in premiums paid by the Company on a
life insurance policy.
62
<PAGE> 66
(7) This amount includes $377,730 paid to Dr. Berkbigler with respect
to the termination of a change in control agreement in connection
with the HSI Combination.
(8) This amount includes $2,375 in matching contributions under the
Company's 401(k) plan and $1,566 in premiums paid by the Company
on a life insurance policy.
(9) This amount includes $35,337 in accrued employer contributions
under the Company's prior SERP, $2,310 in employer matching
contributions made under the Company's 401(k) plan and $808 in
premiums paid by the Company on a life insurance policy.
(10) This amount includes $35,337 in accrued employer contributions
under the Company's prior SERP, $6,930 in employer matching
contributions made under the Company's 401(k) plan and $741 in
premiums paid by the Company on a life insurance policy.
(11) This amount includes $2,036 in matching contributions under the
Company's 401(k) plan and $4,050 in premiums paid by the Company
on a life insurance policy.
(12) This amount includes $16,083 in accrued employer contributions
under the Company's prior SERP, $1,980 in employer matching
contributions made under the Company's 401(k) plan and $2,282 in
premiums paid by the Company on a life insurance policy.
(13) This amount includes $16,083 in accrued employer contributions
under the Company's prior SERP, $5,940 in employer matching
contributions made under the Company's 401(k) plan and $2,016 in
premiums paid by the Company on a life insurance policy.
(14) Dr. Southam became an officer of Health Net in July 1996 and this
base salary therefore represents only the six months of 1996
during which he was so employed.
(15) This amount includes $75,000 paid to Dr. Southam as a signing
bonus upon his hire and $62,500 as a guaranteed bonus earned in
1996.
(16) This amount represents premiums paid by the Company on a life
insurance policy.
OPTION GRANTS IN 1996
The following table summarizes option grants in 1996 to the Named Executive
Officers.
<TABLE>
<CAPTION>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
Number of % of Total
Securities Options/SARs Granted Potential Realizable Value
Underlying to Employees in Exercise or at Assumed Annual Rates of
Options/SARs Fiscal Base Price(a) Expiration Stock Price Appreciation
Name Granted(#)(a) Year ($/Share) Date for Option Term(d)
---- ---------------- -------------- --------- ----------- ------------------------
5%($) 10%($)
----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Malik M. Hasan, M.D.(b ) 100,000 6.9% $35.25 02/23/06 $2,216,854 $5,617,942
100,000 6.9% $40.54 02/23/06 $1,688,104 $5,089,192
100,000 6.9% $44.06 02/23/06 $1,335,604 $4,736,692
Arthur Southam, M.D.(c) 50,000 3.5% $21.75 07/15/06 $683,923 $1,733,195
15,000 1.0% $26.10 07/15/06 $139,927 $454,708
James J. Wilk 22,000 1.5% $35.25 02/23/06 $487,709 $1,235,947
Dale T. Berkbigler, M.D. 92,000 6.4% $35.25 02/23/06 $2,039,505 $5,168,507
Andrew Wang 18,000 1.2% $35.25 02/23/06 $399,034 $1,011,230
</TABLE>
(a) All options granted in 1996 were non-qualified stock options pursuant
to the Health Systems International, Inc. Second Amended and Restated
1991 Stock Option Plan. All grants in 1996 to the Named Executive
Officers (except for the grant to Dr. Southam (see note (c)) provide
for vesting of 33 1/3% of the options during each of the third, fourth
and fifth years of the term of the options. Except for grants to Dr.
Hasan (see note (b)) and Dr. Southam (see note (c)), all 1996 grants
to the Named Executive Officers were at an exercise price equal to the
closing price of Class A Common Stock on the NYSE on the date on which
such grants were made. Under the terms of the Health Systems
International, Inc. Second Amended and Restated 1991 Stock Option
Plan, all options became exercisable on October 1, 1996 as a result of
approval by the Board of Directors of the FHC Merger.
(b) Dr. Hasan was granted stock options on February 23, 1996 to purchase
(1) 100,000 shares at an exercise price equal to the fair market value
of Class A Common Stock on the date on which the options were granted,
(2) an additional 100,000 shares at an exercise price set equal to
115% of the fair market value of Class A Common Stock on the date on
which the options were granted and (3) as
63
<PAGE> 67
additional incentive, an additional 100,000 shares at an exercise
price equal to 125% of the fair market value of Class A Common Stock
on the date on which the options were granted.
(c) Dr. Southam was granted stock options on July 15, 1996 to purchase (1)
50,000 shares at an exercise price equal to the fair market value of
Class A Common Stock on the date on which the options were granted
which were subject to the 33 1/3% vesting schedule described in note
(a) above and (2) 15,000 shares at an exercise price equal to 120% of
the fair market value of Class A Common Stock on the date on which the
options were granted which were immediately exercisable.
(d) The potential gains shown are net of the option exercise price and do
not include the effect of any taxes associated with exercise. The
amounts shown are the assumed rates of appreciation only, do not
constitute projections of future stock price performance, and may not
necessarily be realized. Actual gains, if any, on stock option
exercises depend on the future performance of Class A Common Stock,
continued employment of the optionee through the term of the option,
and other factors.
OPTION EXERCISES IN 1996
The following table summarizes the number and value of options
exercised during 1996, as well as the number and value of unexercised options
as of December 31, 1996, held by the Named Executive Officers.
<TABLE>
<CAPTION>
AGGREGATE OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION/SAR VALUES
Number of Securities
Shares Underlying Unexercised Value of Unexercised
Acquired on Value Options/SARs as of In-the-Money Options/SARs
Name Exercise (#) Realized($) December 31, 1996(b) as of December 31, 1996(d)
---- ------------ ----------- ----------------- -----------------------
Exercisable Unexercisable(c) Exercisable Unexercisable(c)
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Malik M. Hasan, M.D. 5,367(a) $240,000(a) 710,000 0 $757,500 $0
Dale T. Berkbigler, M.D. 1,742(a) $84,768(a) 137,000 0 $197,500 $0
James J. Wilk 0 0 34,000 0 $0 $0
Andrew Wang 0 0 24,000 0 $0 $0
Arthur M. Southam, M.D. 0 0 65,000 0 $150,000 $0
</TABLE>
(a) An aggregate of 14,633 shares and 3,258 shares otherwise issuable were
withheld from the exercises by Dr. Hasan and Dr. Berkbigler,
respectively, of non-qualified stock options to purchase 20,000 shares and
5,000 shares, respectively, of the Company's Class A Common Stock at
exercise prices of $12.125 (in the case of Dr. Hasan) and $14.875 (in the
case of Dr. Berkbigler) per share (all of which exercise prices were
equal to the fair market value of the underlying shares on the date of
grant) to satisfy exercise price and tax withholding obligations, with the
result that 5,367 net shares of Class A Common Stock were issued to Dr.
Hasan and 1,742 net shares of Class A Common Stock were issued to Dr.
Berkbigler in these exercises.
(b) The exercise price of outstanding options at December 31, 1996 ranges from
$12.125 to $44.06 per share. Options to purchase an aggregate of 400,000
shares held by Dr. Hasan have an exercise price of either 115% or 125% of
the fair market value of the underlying shares on the date of grant,
options to purchase an aggregate of 15,000 shares held by Dr. Southam have
an exercise price of 120% of the fair market value of the underlying
shares on the date of grant and all other options held by Dr. Hasan, Dr.
Southam and the other Named Executive Officers have exercise prices equal
to the fair market value of the underlying shares on the date of grant.
(c) Under the terms of the Health Systems International, Inc. Second Amended
and Restated 1991 Stock Option Plan, all outstanding options became
exercisable on October 1, 1996 as a result of approval by the Board of
Directors of the FHC Merger.
(d) Based on the difference between the closing price of $24.75 of Class A
Common Stock on the NYSE on December 31, 1996 (the last trading day in
1996) and the option exercise price.
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<PAGE> 68
SUPPLEMENTAL EXECUTIVE RETIREMENT PROGRAMS
The Company had in effect through December 31, 1995 a Supplemental
Executive Retirement Plan ("SERP") program that allowed executives to defer
income on a non-qualified pre-tax basis. The Company matched 100% of the
deferral amounts up to a pre-set limit. These amounts accumulate earnings
based upon executive investment elections. Under the program the executive
receives an additional 78.5% of the accumulated deferral and Company match
amounts upon termination. Contributions, including executive deferral and
company match, were terminated December 31, 1995 and participating executives
will be eligible for a payment equal to their account value as of December 31,
1995 upon termination of employment. The total value under this plan as of
December 31, 1996 for Drs. Hasan and Berkbigler, and Messrs. Wilk and Wang,
including deferral amounts, matching amounts and the 78.5% termination award,
is approximately $1,185,000, $109,000, $420,000 and $192,000, respectively.
Dr. Southam is not a participant in this prior SERP.
A new SERP program was approved effective January 1, 1996. The new SERP
plan ensures that executives who retire at age 62 or older and have worked for
HSI or a predecessor organization for at least 15 years receive 50% of average
pay (salary and bonus) when combined with Social Security and all other
employer provided retirement benefits provided under current and prior programs
including the accumulated value of Company contributions to the Company's
401(k) Plan (and the profit sharing component of such plan) for the account of
such individuals, along with benefits accrued under the SERP frozen in 1995.
Executives with less than 15 years of service at age 62 will receive a reduced
benefit under this plan, and executives must accrue at least five years of
service to receive a partial benefit. Those terminating with between 5 and 10
years of service are entitled to receive a partial benefit, and executives who
terminate with 10 or more years of service will be 100% vested on earned
benefits.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
Employment Agreements With Drs. Hasan and Berkbigler. Each of Drs. Hasan
and Berkbigler has an Employment Agreement with the Company (collectively, the
"Employment Agreements"). Each of the Employment Agreements became effective
or, was assumed by the Company, on consummation of the HSI Combination. Each
of the Employment Agreements has a five-year term, with an automatic one-year
extension on each anniversary of the agreement.
The Employment Agreements provide for a minimum 7% increase in annual
salary each year. During the term of their employment, each of Drs. Hasan and
Berkbigler is eligible to participate in the various insurance, stock option,
pension, incentive compensation and other fringe benefit plans and programs of
the Company. Each of Drs. Hasan and Berkbigler also is reimbursed for
reasonable business expenses in performing his duties.
If the Company terminates the employment of either of Drs. Hasan or
Berkbigler without "cause" or such an executive terminates his or her
employment for "good reason" (each as defined in the Employment Agreements),
during the period commencing on the effective date of such termination and
ending 36 months after the date of such termination, the Company will pay such
executive his base salary and shall continue such executive's medical, health
and accident insurance at the same coverage level maintained for such
executive's benefit immediately prior to the date of termination. In the event
that payments to Dr. Hasan were subject to the "golden parachute" excise tax
under section 4999 of the Internal Revenue Code of 1986, as amended (the
"Code"), the Company would provide them with a tax gross-up payment in an
amount sufficient to offset the effects of such excise tax.
On March 10, 1997, in connection with the FHC Merger, Dr Hasan's
Employment Agreement was amended and restated effective as of January 1, 1997
(the "Amended Employment Agreement"). The Amended Employment Agreement has a
five-year term beginning on the Effective Date, with an automatic one-year
extension on each anniversary of the agreement. The Amended Employment
Agreement provides for a three year stay bonus to be paid for the fiscal years
ending in 1997, 1998 and 1999 in the event that the FHC Merger is consummated.
The stay bonus is subject to certain performance objectives as set forth in the
Amended Employment Agreement. In addition, the Amended Employment Agreement
provides that the base amount of the 36-month severance benefit
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<PAGE> 69
provided for in the Employment Agreement will include an amount equal to the
average of the annual bonus paid to Dr. Hasan (excluding the stay bonus
referred to above) for the three fiscal years ending before the date of his
resignation or termination.
Employment Agreement with Dr. Southam. Dr. Southam has an Employment
Letter Agreement with the Company dated June 4, 1996 (the "Employment Letter
Agreement"). During the term of Dr. Southam's employment, he is eligible to
participate in various insurance, stock option, pension, incentive compensation
and other fringe benefit plans and programs of the Company. Dr. Southam also
is reimbursed for reasonable business expenses in performing his duties and is
provided with a monthly automobile allowance.
The Employment Letter Agreement provides Dr. Southam with two potential
severance arrangements. If during a two-year period following a
change-of-control transaction, the Company terminates the employment of Dr.
Southam or he voluntarily resigns for "good reason" (each as defined in the
Employment Letter Agreement) he will receive severance pay equal to three years
of his then current annual base salary. Such severance pay will not exceed the
lessor of (i) $1.2 million or (ii) the applicable Code Section 280G limitations
to avoid penalty taxes and deduction limitations on "excess parachute
payments."
If the Company terminates the employment of Dr. Southam other than
following a change-of control or for "just cause" or if Dr. Southam terminates
his employment for "good reason" (each as defined in the Employment Letter
Agreement) he will be entitled to receive a severance payment equal to two
years of his then current annual base salary. Such severance payment will not
exceed $800,000.
Each of the severance payments described above will be made to Dr. Southam
on a monthly basis for a two-year period. Such severance payments are
contingent upon Dr. Southam's compliance with the non-compete provisions set
forth in the Employment Letter Agreement.
Severance Payment Agreement with Mr. Wilk. Mr. Wilk has a Severance
Payment Agreement (the "Severance Agreement") with the Company and Health Net,
effective as of May 1, 1995. The Severance Agreement has a two-year term.
If during the term of the Severance Agreement, the Company terminates the
employment of Mr. Wilk without "cause" or Mr. Wilk terminates his employment
for "good reason" within 12 months after a change of control (each as defined
in the Severance Agreement), for a period of six months from the date of
termination Mr. Wilk will be entitled to a continuation of his base salary and
all medical, health, disability, life and accident insurance maintained for his
benefit immediately prior to the date of termination. In addition, in the
event that Mr. Wilk has not been employed at any time during such six month
period, Mr. Wilk will be entitled to an additional continuation of his salary
and benefits for a period of six months, provided that such payments for such
additional continuance of salary and benefits shall only be made until the
earlier of (i) the date he is so employed and (ii) a date 12 months after his
termination of employment with the Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Decisions regarding the Company's executive compensation are made by the
Compensation and Stock Option Committee of the Board of Directors (the
"Compensation Committee"), which in 1996 consisted of: (i) until February 26,
1996, Dr. Austin and Messrs. Bouchard (Chairman), Mancino and Montgomery and
(ii) commencing February 26, 1996 (at which time the Compensation Committee was
reconstituted), Messrs. Bouchard (Chairman), Farley and Murphy, each of whom
was a non-employee director of the Company and a "disinterested person" as such
term is defined in Rule 16b-3 adopted under the Securities Exchange Act of
1934, as amended, with respect to the plans administered by the Compensation
Committee at the time of service on such committee.
The composition of the Compensation Committee was modified effective
February 23, 1996 to comply with certain requirements of Section 162 (a) of the
Code.
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<PAGE> 70
Mr. Mancino is a partner in the law firm of McDermott, Will & Emery. The
Company paid McDermott, Will & Emery approximately $302,000 in fees for legal
services rendered to the Company and certain of its subsidiaries in 1996.
Mr. Montgomery is the President and Chief Executive Officer of Alta Bates
Health System, a health system holding company. Subsidiaries of Alta Bates
Health System have provided hospital and other services to a Company subsidiary
since December 1990. Payments by such subsidiary for such services totaled
approximately $58.7 million in 1996. In addition, Alta Bates Health System was
an employer group of a Company subsidiary in 1996 and continues to be such an
employer group. Premiums paid by Alta Bates Health System to such subsidiary
totaled approximately $3.4 million in 1996.
Mr. Farley, a director of the Company, is a partner in the law firm of
Petersen, Fonda, Farley, Mattoon, Crockenberg and Garcia, P.C. The Company and
certain of its subsidiaries paid to Petersen, Fonda, Farley, Mattoon,
Crockenberg and Garcia, P.C. approximately $13,000 in fees for legal services
in 1996. In addition, Petersen, Fonda, Farley, Mattoon, Crockenberg and
Garcia, P.C. was an employer group of a Company subsidiary in 1996 and
continues to be such an employer group. Premiums paid by such firm to this
Company subsidiary totaled approximately $27,000 in 1996.
DIRECTORS' COMPENSATION FOR 1996
No fees are paid to employees of the Company for service as a director of
the Company. In 1996, the annual retainer payable to non-employee directors of
the Company was $20,000 per year, and each non-employee director who chairs a
committee of the Company's Board is eligible to receive an annual additional
retainer of $4,000. Such non-employee directors also receive a $1,000 fee for
each meeting of the board or committee thereof attended.
In addition, non-employee directors of the Company participate in the
Health Systems International, Inc. Second Amended and Restated Non-Employee
Director Stock Option Plan (the "Director Plan"), which provides for initial
grants and automatic annual grants of nonqualified stock options to such
directors. Each such grant entitles the optionee to purchase up to 5,000
shares of Class A Common Stock at an exercise price equal to the fair market
value of Class A Common Stock on the date of grant. Each grant vests as to 20%
of the shares each year on the anniversary of the date of grant, provided, that
the options become immediately exercisable in the event of a "change in
control" of the Company, as defined in the Director Plan. Under the Director
Plan, 300,000 shares of HSI Class A Common Stock have been reserved for grant.
Under the terms of the Director Plan, all options granted prior to October 1,
1996 became fully exercisable on such date as a result of approval by the Board
of Directors of the proposed business combination involving the Company and
FHC.
On each of February 26, 1996 and May 21, 1996, options to purchase 5,000
shares at an exercise price of $34.25 per share and $28.875 per share,
respectively, were granted to each of Drs. Austin and Kizer and to each of
Messrs. Bouchard, Braden, Deukmejian, Farley, Greaves, Mancino, Montgomery and
Murphy pursuant to the formula provisions of the Director Plan.
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<PAGE> 71
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Set forth below is a tabulation indicating those persons or groups who are
known to the Company to be beneficial owners of more than 5% of the outstanding
shares of HSI Class A Common Stock as of March 24, 1997. The following
information is based on reports on Schedules 13D or 13G filed with the
Securities and Exchange Commission or other reliable information.
<TABLE>
<CAPTION>
Amount and Nature of
Percentage of Beneficial Percentage of
Name and Address of Beneficial Owner Ownership(1) Class
------------------------------------ ------------ -----
<S> <C> <C>
Malik M. Hasan, M.D.
225 North Main Street
Pueblo, Colorado 81003 5,014,6372 16.8%
FMR Corp.
82 Devonshire Street
Boston, Massachusetts 02109 1,703,9003 5.9%
Sanford C. Bernstein & Co., Inc.
767 Fifth Avenue
New York, New York 10153 2,664,9804 9.1%
Franklin Resources, Inc.
777 Mariners Island Blvd.
San Mateo, California 94403 3,884,5005 13.3%
</TABLE>
______________
1 The nature of beneficial ownership for shares shown in this column is
sole voting and investment power unless otherwise indicated herein,
subject to community property laws where applicable.
2 Includes 710,000 shares of Class A Common Stock with respect to which
Dr. Hasan has the right to acquire beneficial ownership by virtue of
outstanding vested options, 265 shares under the profit sharing plan
component of the Company's 401(k) plan and an aggregate of 82,815
shares owned by Dr. Hasan's wife (982 shares) or held by the Hasan
Family Foundation (a private charitable foundation of which Mrs. Hasan
is the chairperson) (81,833 shares), as to which shares Dr. Hasan
disclaims beneficial ownership. This number of shares does not
include 138,036 shares held by three trusts, the beneficiaries of
which are the three children of Dr. and Mrs. Hasan and the sole
trustee of which is an unrelated third party.
3 FMR Corp. owns and controls Fidelity Management and Research Company,
an investment company, which directly owns 1,394,900 shares of the
Company's Class A Common Stock. FMR Corp. has sole power to dispose
of all such shares. The sole power to vote or direct the voting of
these 1,394,900 shares resides with the Board of Trustees of Fidelity
Management and Research Company. This amount also includes 309,000
shares that are owned by Fidelity Management Trust Company, a
subsidiary of FMR Corp.
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<PAGE> 72
4 Sanford C. Bernstein & Co., Inc. ("SBC") is a registered investment
advisor/broker dealer. An aggregate of 2,664,980 of the Company's
Class A Common Stock are held for the accounts of one or more
discretionary clients of SBC. SBC has sole power to dispose of all
such shares. SBC has sole voting authority with respect to 1,331,434
of such shares. In addition, one or more of SBC's clients have
appointed an independent voting agent with instructions to vote an
additional 381,875 of such shares in the same manner as SBC. SBC's
clients have the right to receive dividends from and the proceeds of
the sale of such shares.
5 Franklin Resources, Inc. ("FRI") is a parent holding company whose
wholly-owned subsidiaries Franklin Mutual Advisers, Inc. ("FMAI") and
Franklin Advisers, Inc. ("FAI") are investment advisors registered
under the Investment Advisors Act of 1940. One or more of FMAI's
advisory clients is the legal owner of an aggregate of 3,597,000
shares of the Company's Class A Common Stock and one or more of FAI's
advisory clients is the legal owner of 287,000 shares of the Company's
Class A Common Stock. Pursuant to investment advisory agreements
with its respective advisory clients, each of FMAI and FAI has sole
investment discretion and voting authority with respect to such
shares. Charles B. Johnson and Rupert H. Johnson, Jr. (the
"Principal Stockholders") each own in excess of 10% of the outstanding
common stock of FRI and are the principal shareholders of FRI. Each
of the Principal Stockholders, therefore, may be deemed to have
indirect beneficial ownership over such shares. Neither the Principal
Stockholders, FRI, FMAI nor FAI has any interest in dividends or
proceeds from the sale of such shares, owns any such shares for his or
its own account, and disclaims beneficial ownership of all the shares
owned by FMAI's and FAI's advisory clients. The address of each of
the Principal Stockholders and FRI is as set forth in the table above.
The address for FMAI is: 51 John F. Kennedy Parkway, Short Hills, NJ
94404.
The foregoing information relates only to the ownership of the
Company's Class A Common Stock. In addition, the Foundation holds 19,297,642
shares of the Company's Class B Common Stock, constituting all of the shares of
that class and approximately 40% of the Company's aggregate equity. Under the
Restated Certificate, the shares held of record by the Foundation are entitled
to the same economic benefits as all shares of Class A Common Stock, but are
non-voting in nature. Upon the sale or other transfer of any such shares by
the Foundation to an unrelated third party, such shares are automatically
converted on a one-to-one basis into fully voting shares of Class A Common
Stock. Until 1998, transfer of such shares is subject to certain restrictions
imposed by the DOC.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth the number of shares of Class A Common
Stock beneficially owned by each of the current directors of the Company, by
each Named Executive Officer and by all directors and executive officers as a
group as of March 24, 1997, and the percentage that these shares bear to the
total number of shares of Class A Common Stock outstanding as of such date:
<TABLE>
<CAPTION>
Name of Individual or Number Amount of Shares Percentage of
of Persons in Group Beneficially Owned(1) Class
------------------------------- --------------------- -----
<S> <C> <C>
Malik M. Hasan, M.D. 5,014,637 2 16.8%
Dale T. Berkbigler, M.D. 509,292 3 1.7%
Lawrence E. Austin, M.D. 420,115 4 1.4%
J. Thomas Bouchard 25,000 5 *
Charles T. Braden 108,550 6 *
George Deukmejian 26,399 7 *
</TABLE>
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<PAGE> 73
<TABLE>
<CAPTION>
Name of Individual or Number Amount of Shares Percentage of
of Persons in Group Beneficially Owned(1) Class
------------------------------- --------------------- -----
<S> <C> <C>
Thomas T. Farley 63,000 8 *
Michael E. Gallagher 12,6039 *
Jay M. Gellert 100,00010 *
Roger F. Greaves 38,94311 *
Kenneth M. Kizer, M.D. 15,50012 *
Douglas M. Mancino 20,78113 *
Robert L. Montgomery 21,44614 *
J. Kevin Murphy 35,50015 *
James Wilk 53,37416 *
Andrew Wang 25,15317 *
Arthur Southam, M.D. 65,30018 *
All executive officers and directors
as a group (21 persons) 6,734,95419 22.0%
</TABLE>
_________________
* The amount shown is less than 1% of the outstanding shares of each
class.
1 The information contained in this table is based upon information
furnished to the Company by the persons named above or obtained from
records of the Company. The nature of beneficial ownership for shares
shown in this column is sole voting and investment power unless
otherwise indicated herein, subject to community property laws where
applicable.
2 Includes 710,000 shares of Class A Common Stock with respect to which
Dr. Hasan has the right to acquire beneficial ownership by virtue of
outstanding vested options, 265 shares under the profit sharing plan
component of the Company's 401(k) plan and an aggregate of 82,815
shares owned by Dr. Hasan's wife (982 shares) or held by the Hasan
Family Foundation (a private charitable foundation of which Mrs. Hasan
is the chairperson) (81,833 shares), as to which shares Dr. Hasan
disclaims beneficial ownership. This number of shares does not include
138,036 shares held by three trusts, the beneficiaries of which are the
three children of Dr. and Mrs. Hasan and the sole trustee of which is
an unrelated third party.
3 Includes 132,000 shares with respect to which Dr. Berkbigler has the
right to acquire beneficial ownership by virtue of outstanding vested
options, 373,086 shares held by Berkbigler Family Partners, Ltd., of
which Dr. Berkbigler is the general partner, and 172 shares held by Dr.
Berkbigler under the profit sharing component of the Company's 401(k)
Plan.
4 Includes 20,000 shares with respect to which Dr. Austin has the right
to acquire beneficial ownership by virtue of outstanding vested options
and 49,882 shares owned by Dr. Austin's wife, as to which shares Dr.
Austin disclaims beneficial ownership.
5 Includes 25,000 shares with respect to which Mr. Bouchard has the right
to acquire beneficial ownership by virtue of outstanding vested
options.
6 Includes 17,781 shares with respect to which Mr. Braden has the right
to acquire beneficial ownership by virtue of outstanding vested
options.
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7 Includes 25,699 shares with respect to which Mr. Deukmejian has the
right to acquire beneficial ownership by virtue of outstanding vested
options. Such amount also includes 700 shares held in the C. George
Deukmejian Defined Benefit Pension Plan, of which Mr. Deukmejian is a
trustee.
8 Includes 30,000 shares with respect to which Mr. Farley has the right
to acquire beneficial ownership by virtue of outstanding vested
options. Such amount also includes 10,000 shares held by the Farley
Family Trust over which trust Mr. Farley has investment power. Mr.
Farley disclaims beneficial ownership of the shares held by the Farley
Family Trust.
9 Includes 8,603 shares with respect to which Mr. Gallagher has the right
to acquire beneficial ownership by virtue of outstanding vested
options. This amount does not include 50,000 SARs held by MR.
Gallagher and described in Item 13 below.
10 Include 100,000 shares with respect to which Mr. Gellert has the right
to acquire beneficial ownership by virtue of outstanding vested
options.
11 Includes 10,000 shares with respect to which Mr. Greaves has the right
to acquire beneficial ownership by virtue of outstanding vested
options.
12 Excludes all of the 19,297,642 shares of Class B Common Stock held by
the Foundation of which Dr. Kizer is a director. Dr. Kizer disclaims
any beneficial interest in the Class B Common Stock. Includes 15,000
shares with respect to which Dr. Kizer has the right to acquire
beneficial ownership by virtue of outstanding vested options.
13 Includes 2,700 shares held by the McDermott, Will & Emery Profit
Sharing Trust, of which trust Mr. Mancino is a beneficiary, and 17,781
shares with respect to which Mr. Mancino has the right to acquire
beneficial ownership by virtue of outstanding vested options.
14 Includes 20,000 shares with respect to which Mr. Montgomery has the
right to acquire beneficial ownership by virtue of outstanding vested
options.
15 Includes 30,000 shares with respect to which Mr. Murphy has the right
to acquire beneficial ownership by virtue of outstanding vested
options.
16 Includes 34,000 shares with respect to which Mr. Wilk has the right to
acquire beneficial ownership by virtue of outstanding vested options
and 254 shares held by Mr. Wilk under the profit sharing component of
the Company's 401(k) plan.
17 Includes 24,000 shares with respect to which Mr. Wang has the right to
acquire beneficial ownership by virtue of outstanding vested options
and 254 shares held by Mr. Wang under the profit sharing component of
the Company's 401(k) plan.
18 Includes 65,000 shares with respect to which Mr. Southam has the right
to acquire beneficial ownership by virtue of outstanding vested
options.
19 Includes an aggregate of 1,407,864 shares with respect to which all
executive officers and directors as a group have the right to acquire
beneficial ownership by virtue of outstanding vested options.
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<PAGE> 75
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following information relates to transactions by the Company with
certain directors and executive officers of the Company.
On April 14, 1995, the Company loaned Mr. Braden, a director of the
Company, $1 million in consideration for a Secured Promissory Note in the
principal amount of $1 million made by Mr. Braden in favor of the Company (the
"Braden Note"). The principal of the Braden Note and accrued interest thereon
were due on the earlier of (a) December 31, 1996 or (b) the date on which the
Company repurchases shares of its Class A Common Stock of which Mr. Braden
holds a beneficial interest pursuant to the terms of the Trust Agreement (as
defined and described below) or otherwise and bear interest at a rate per
annum, adjusted on the first day of each month, equal to the lesser of (i) the
most favorable rate then available to the Company under the Company's revolving
credit facility (or such other revolving credit facility as shall then be in
effect) or (ii) the applicable Federal rate under Section 1274(d) of the Code,
compounded semiannually, in effect on April 14, 1995. The Braden Note was
secured by 188,000 shares of Class A Common Stock pursuant to a security and
pledge agreement. On February 29, 1996, the Company repurchased 15,540 shares
of Class A Common Stock from Mr. Braden for an aggregate purchase price of
$490,240, $313,754 of which was used to pay-down outstanding interest and
principal pursuant to the terms of such note. In addition, on May 15, 1996 in
connection with the Offering, the Company repurchased 75,278 shares of Class A
Common Stock from Mr. Braden for an aggregate purchase price of $2,175,594,
$805,324 of which was used to pay down all remaining principal and interest on
such note. As of such time the Braden Note was fully paid. See "Other
Information--Public Offering."
Mr. Braden is President of CBS Associates, Inc. The Company paid CBS
Associates, Inc. approximately $242,000 in 1996 for certain warehouse,
printing, purchasing and real estate services. Mr. Braden has also provided
consulting services to a Company subsidiary. Such subsidiary paid Mr. Braden
fees of $27,000 for such consulting services rendered in 1996.
Gov. Deukmejian, a director of the Company, is a partner in the law
firm of Sidley & Austin. The Company and certain of its subsidiaries paid
Sidley & Austin approximately $733,000 in fees for legal services in 1996.
Mr. Farley, a director of the Company, is a partner in the law firm of
Petersen, Fonda, Farley, Mattoon, Crockenberg and Garcia, P.C. The Company and
certain of its subsidiaries paid to Petersen, Fonda, Farley, Mattoon,
Crockenberg and Garcia, P.C. approximately $13,000 in fees for legal services
in 1996. In addition, Petersen, Fonda, Farley, Mattoon, Crockenberg and
Garcia, P.C. was an employer group of a Company subsidiary in 1996 and
continues to be such an employer group. Premiums paid by such firm to this
Company subsidiary totaled approximately $27,000 in 1996.
Mr. Gallagher, a director of the Company, is a general partner of
Shamrock Investments. The Company paid Shamrock Investments approximately
$900,000 in fees for financial advisory services in connection with potential
business transactions in 1996. Mr. Gallagher served as Chairman, President and
Chief Executive Officer of Health Net from May 1995 until May 1996, during
which time the Company and Health Net had in place an arrangement with Shamrock
Investments (a financial advisory firm of which Mr. Gallagher is a general
partner) pursuant to which Mr. Gallagher was retained to serve in such
capacity. Pursuant to such arrangement, during such service Mr. Gallagher and
Shamrock Investments received a fee of approximately $67,390 per month. During
such time, Mr. Gallagher was also eligible to participate in all insurance,
pension and other fringe benefit plans and programs of the Company, and
receives certain other perquisites.
On May 21, 1995, the Company adopted the Health Systems International,
Inc. 1995 Stock Appreciation Rights Plan and granted Mr. Gallagher a stock
appreciation right (the "SAR") thereunder with respect to 50,000
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<PAGE> 76
shares of Class A Common Stock. The SAR entitles Mr. Gallagher to receive,
upon exercise thereof, an amount in cash equal to (i) the excess of (A) the
fair market value of one share of Class A Common Stock over (B) $26.75 (the
"Base Price," which is equal to the fair market value of Class A Common Stock
on May 21, 1995), multiplied by (ii) the number of shares with respect to
which the SAR is being exercised. The term of the SAR will expire on May 21,
2000. The SAR became fully exercisable on December 27, 1995. The number and
class of shares to which the SAR relates and the Base Price are each subject to
adjustment in the event of any change in the capital stock of the Company.
Prior to his employment by the Company, Mr. Gellert directed Shattuck
Hammond's strategic advisory engagements in the area of integrated delivery
systems development, managed care network formation and physician group
practice integration. The Company paid financial advisory and consulting fees
to Shattuck Hammond in 1996 in connection with certain of its acquisitions
and proposed transactions.
In connection with Mr. Greaves's resignation as Co-Chairman of the
Board of Directors, Co-President and Co-Chief Executive Officer of the Company
on March 31, 1995, in settlement of any benefits to which Mr. Greaves would
otherwise have been entitled under his employment agreement dated August 28,
1993 with the Company (the "Greaves Employment Agreement"), Mr. Greaves and the
Company entered into a Confidential Settlement Agreement and General Release
dated as of March 31, 1995 (the "Greaves Settlement Agreement"). Concurrently
with the execution of the Greaves Settlement Agreement, the Company and Mr.
Greaves entered into a Consulting Agreement (the "Greaves Consulting
Agreement").
Pursuant to the Greaves Settlement Agreement, Mr. Greaves received the
following benefits: (a) a lump sum payment of $2,517,299, which represents the
present value of Mr. Greaves' Base Salary (as defined in the Greaves Employment
Agreement) payable to Mr. Greaves during the 36-month period commencing on
March 31, 1995 at the rate of Base Salary in effect immediately prior to March
31, 1995, as adjusted to give effect to the minimum 7% annual increase set
forth in the Greaves Employment Agreement; (b) the right to require the Company
to repurchase within 30 days of March 31, 1995 up to 50% of the shares of Class
A Common Stock held by Mr. Greaves as of March 31, 1995, which repurchase was
completed on April 11, 1995, (i) at a price per share equal to the average
closing prices of Class A Common Stock on the NYSE for each trading day during
the month of March 1995 (which was approximately $29.36 per share) and (ii)
subject to transaction costs, payable to the Company, equal to 2 1/2% of the
aggregate repurchase price as so determined; (c) all stock options granted to
Mr. Greaves under the Company's stock option plans became immediately vested
and exercisable in full, and remained exercisable until March 31, 1996; (d) a
lump sum payment in the amount of $125,000, representing the prorated portion
of the estimated bonus Mr. Greaves would have earned during 1995 under the
Company's Performance-Based Annual Bonus Plan; (e) a lump sum payment equal to
Mr. Greaves' aggregate accrued benefits under certain of the Company's
retirement benefit plans and programs; (f) free lifetime medical benefits for
Mr. Greaves and his spouse at the level provided from time to time for the
Company's senior executives; and (g) certain other benefits.
Mr. Greaves and the Company agreed in the Greaves Settlement Agreement
to a mutual general release of each other and their respective affiliates,
representatives, successors and assigns from any and all claims, charges,
complaints, liens, demands, causes of action, obligations, damages and
liabilities, known or unknown, that either had, now has, or may thereafter
claim to have against the released parties arising out of or relating in any
way to Mr. Greaves' relationship with the Company as an employee, and the
termination of such employment, or to any other matter, event or cause arising
on or before March 31, 1995.
Pursuant to the Greaves Consulting Agreement, Mr. Greaves will serve
the Company as an independent consultant for the three- year period commencing
March 31, 1995 (the "Greaves Consulting Period"). Pursuant to the Greaves
Consulting Agreement, Mr. Greaves will perform such services on a limited-time
basis, and will not be required to devote more than (a) 50% of his time to the
performance of such services during the first 12 months of the Greaves
Consulting Period, (b) 25% of his time to the performance of such services
during the second 12
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months of the Greaves Consulting Period and (c) such time as may be reasonably
necessary during the last 12 months of the Greaves Consulting Period.
The Greaves Consulting Agreement provides that the Company will pay Mr.
Greaves a consulting fee (i) during the first 12 months of the Greaves
Consulting Period, at the rate of $800,000 per year, (ii) during the second 12
months of the Greaves Consulting Period, at the rate of $700,000 per year and
(iii) during the third 12 months of the Greaves Consulting Period, at the rate
of $500,000 per year. Mr. Greaves will also accrue certain retirement and
fringe benefits, as specified in the Greaves Consulting Agreement, and the
Company will transfer ownership or otherwise assign to Mr. Greaves the
split-dollar life insurance policy maintained by the Company on Mr. Greaves'
life. In addition, in the event that any payment received by Mr. Greaves
pursuant to the Greaves Settlement Agreement and the Greaves Consulting
Agreement will be subject to the "golden parachute" excise tax imposed under
section 4999 of the Code, the Company will pay to Mr. Greaves an additional
amount to offset the effects of such excise tax. The Company believes,
however, that none of such payments will be subject to the excise tax under
section 4999 of the Code.
Pursuant to the Greaves Consulting Agreement, Mr. Greaves has agreed to
keep confidential certain nonpublic information regarding the Company. Mr.
Greaves has also agreed to certain provisions that do not allow him to compete
with the Company during the Greaves Consulting Period. The Company and Mr.
Greaves are currently negotiating a final settlement and termination of the
Greaves Consulting Agreement in connection with the FHC Merger in order for Mr.
Greaves to qualify as an independent director under the terms of the documents
evidencing the FHC Merger.
Dr. Kizer, a director of the Company, served as a director of the
Foundation since 1992 and, since December 1993, Dr. Kizer has been Chairman of
the Board of the Foundation. Under the relevant provisions of California law,
when a corporation converts from nonprofit to for-profit corporate status, the
equivalent of the fair market value of the nonprofit corporation must be
contributed to a successor charity that has a charitable purpose consistent
with the purposes of the nonprofit entity. The Foundation was formed to be the
charitable recipient of the conversion settlement when Health Net effected a
conversion from nonprofit to for- profit status, which occurred in February
1992 (the "Conversion"). In connection with the Conversion, Health Net issued
to the Foundation promissory notes in the original principal amount of $225
million and shares of Class B Common Stock, which immediately prior to the HSI
Combination were split to become the 25,684,152 shares of Class B Common Stock
then held by the Foundation. While such shares are held by the Foundation,
they are entitled to the same economic benefit of Class A Common Stock, but are
non-voting in nature. If the Foundation sells or transfers such shares to an
unrelated third party, they automatically convert to Class A Common Stock. In
connection with the Offering in May 1996, the Foundation sold 6,386,510 shares
of Class B Common Stock which were automatically converted to Class A Common
Stock. The Foundation now holds 19,297,642 shares of Class B common Stock and
as of December 31, 1996, approximately $19.4 million in principal of such notes
remained outstanding.
Pursuant to the Amended Foundation Shareholder Agreement, dated as of
January 28, 1992 (the "Foundation Shareholder Agreement") by and among the
Company, the Foundation and certain stockholders of HN Management Holdings,
Inc. named therein, the Foundation is subject to various volume and manner of
sale restrictions specified in the Foundation Shareholder Agreement which limit
the number of shares that the Foundation may dispose of prior to December 31,
1998. In addition, the Foundation Shareholder Agreement, in conjunction with
the Letter Agreement executed by the Company and the Trustees of the Trust
(each as defined below) on March 9, 1995 and ratified by the Company's Board of
Directors on March 16, 1995 (the "Letter Agreement") requires the Foundation to
offer its shares of Class B Common Stock to the Company prior to selling such
shares to any other person. In this respect, the Foundation Shareholder
Agreement permits the Foundation to offer and sell up to 80% of the
Foundation's interest in the Class B Common Stock (or all but 5,136,830 of such
shares) to the Company prior to December 31, 1998 (including up to 3,852,623
shares in 1997 and up to the balance of the 80% not previously sold in 1998).
The Foundation Shareholder Agreement, in conjunction with the Letter Agreement,
requires the
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Foundation to provide the Company with notice on or before January 31 of each
year setting forth the number of shares, if any, being offered to the Company.
The Company then has 45 days following receipt of such notice to notify the
Foundation of its intention to purchase such number of shares. On January 27,
1997, the Foundation provided the Company with notice of its offer to sell
3,852,653 shares of Class B Common Stock, provided that at the Company's option
the number of shares may be increased to not more than 5,000,000 shares.
Pursuant to such offer to sell, the Foundation agreed to extend until May 31,
1997 the time in which the Company must notify the Foundation of its intention
to purchase or redeem such number of shares of Class B Common Stock. The
Company has no current intention to purchase or redeem such shares consistent
with the pooling of interest accounting rules and any such decision to purchase
or redeem such shares will be made by the full Board of Directors of the
Company.
Mr. Mancino, a director of the Company, is a partner in the law firm of
McDermott, Will & Emery. The Company paid McDermott, Will & Emery
approximately $302,000 for legal services rendered to the Company and certain
of its subsidiaries in 1996.
Mr. Montgomery, a director of the Company, is the President and Chief
Executive Officer of Alta Bates Health System, a health system holding company.
Subsidiaries of Alta Bates Health System have provided hospital and other
services to a Company subsidiary since December 1990. Payments by such
subsidiary for such services totaled approximately $58.7 million in 1996. In
addition, Alta Bates Health System was an employer group of a Company
subsidiary in 1996 and continues to be such an employer group. Premiums paid
by Alta Bates Health System to such subsidiary totaled approximately $3.4
million in 1996.
On March 9, 1995, the Company and Roger F. Greaves, Stephen D. Vogt and
Gerald M. Cooper (in their capacities as such, the "Trustees") as Trustees of
the trust (the "Trust") created pursuant to an Amended and Restated Trust
Agreement dated as of May 1, 1994 (the "Trust Agreement"), on behalf of the
founding stockholders of HNMH who were stockholders as of the Conversion (the
"Original Stockholders"), executed a Letter Agreement (the "Letter Agreement"),
which agreement was ratified by the Board of Directors of the Company on March
16, 1995. The following persons are directors or Executive Officers of the
Company and are among the Original Stockholders: Roger F. Greaves, Charles T.
Braden and James Wilk. Pursuant to the Letter Agreement, the Original
Stockholders agreed to waive their right to purchase shares of Class B Common
Stock from the Foundation pursuant to the Amended Foundation Shareholder
Agreement dated as of January 28, 1992 (the "Foundation Shareholder Agreement")
among the Company, the Foundation and the Original Stockholders through the
term of the Foundation Shareholder Agreement. The Letter Agreement provides
that, during the 10-day period commencing immediately after the 120-day period
following Board approval of the Letter Agreement, the Original Stockholders
could have elected to sell to the Company a number of shares of Class A Common
Stock up to the entire number of shares of Class A Common Stock owned by such
stockholder under the Trust at a purchase price equal to the average closing
price of Class A Common Stock on the NYSE over the last 20 trading days
occurring in the 120-day period. However, the Company currently has no such
obligation to repurchase shares from the Original Stockholders pursuant to the
terms of the Letter Agreement because, prior to the end of the 120-day period,
the Board of Directors of the Company approved a proposed business combination
(the "HSI/WellPoint Transaction") with WellPoint Health Networks Inc.
("WellPoint") and certain commercial operations of Blue Cross of California
("BCC"). Nevertheless, the Letter Agreement also provided that, because the
proposed HSI/WellPoint Transaction was not ultimately consummated, the Company
and the Original Stockholders were to commence good faith discussions to
determine a procedure, consistent with the terms and conditions of the Letter
Agreement, whereby each such Original Stockholder may elect to sell to the
Company a number of shares of Class A Common Stock up to the entire number of
such shares beneficially owned by such Original Stockholder under the Trust.
In accordance with such good faith discussions, in February 1996 the Company
repurchased an aggregate of 303,879 shares of Class A Common Stock from the
Original Stockholders. Pursuant to the terms of the Trust Agreement the Trust
was terminated effective February 7, 1997.
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On September 30, 1996 the Board of Directors terminated all of the
Company's stock repurchase programs in connection with the FHC Merger. Prior to
such termination, in February of 1996 the Company repurchased an aggregate of
303,879 shares at a price of $31.547 per share (or $9,586,470 in the aggregate)
pursuant to the Letter Agreement. In this transaction the Company repurchased
15,540 shares from Mr. Braden for an aggregate purchase price of $490,240, and
3,108 shares from Mr. Wilk for an aggregate purchase price of 98,048. In
addition, in connection with the Offering in May 1996, the Company repurchased
an aggregate of 3,194,374 shares of the Company's Class A Common Stock at a
price of $28.92, including 425,000 shares from Mr. Greaves, 75,228 shares from
Mr. Braden and 15,000 shares from Mr. Wilk.
In August 1995, the Company loaned to Philip Katz, Ph.D., a Vice
President and the Chief Information Officer of the Company, an amount of
$125,000 to facilitate the relocation of Dr. Katz from the Philadelphia,
Pennsylvania area to the Company's Woodland Hills, California office. The loan
did not bear interest and was due upon the sale of Dr. Katz's home in
Philadelphia. Accordingly, such loan was paid off in full in March 1996.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM
8-K
(a) Financial Statements, Schedules and Exhibits
1. Financial Statements
The following consolidated financial statements are included in this
Annual Report on Form 10-K:
Report of Deloitte & Touche LLP
Consolidated balance sheets at December 31, 1996 and 1995
Consolidated statements of income for each of the three years
in the period ended December 31, 1996
Consolidated statements of stockholders' equity for each of
the three years in the period ended December 31, 1996
Consolidated statements of cash flows for each of the three
years in the period ended December 31, 1996.
Notes to consolidated financial statements
2. Financial Statement Schedules
The following financial statement schedules are filed as a part of
this Annual Report on Form 10-K:
Schedule I-Condensed Financial Information of the Company
Schedule II-Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the
consolidated financial statements or notes thereto.
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3. Exhibits
The following exhibits are filed as part of this Annual Report on Form
10-K or are incorporated herein by reference:
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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).
2.4 Purchase Agreement, dated as of June 13, 1995, between Health Systems International, Inc. and G.H. Holding
Corporation (including the Addendum 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).
2.5 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International, Inc., FH
Acquisition Corp. and Foundation Health Corporation (included in Appendix I to the Joint Proxy Statement/Prospectus
filed with HSI's Registration Statement on Form S-4 (File No. 333-19273) which is incorporated by referenced
herein).
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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).
3.2.1 Amendment to Third Amended and Restated Bylaws of HSI (included as Exhibit 3.2.1 to HSI's Quarterly Report on Form
10-Q for the quarter ended September 30, 1996, 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).
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
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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).
9.2 Voting Agreement, dated October 1, 1996 between Malik M. Hasan, M.D. and Foundation Health Corporation (filed as
Exhibit 9.1 to HSI's Registration Statement on Form S-4 (File No. 333-19273) 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).
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 Amended and Restated Employment Agreement, dated March 10, 1997, by and between HSI and Malik M. Hasan, M.D, a copy
of which is filed herewith.
* 10.4 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
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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 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).
* 10.6 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).
* 10.7 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).
* 10.8 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).
* 10.9 The Health Net Supplemental Executive Retirement Program, which includes The Health Net Executive Deferred Plan,
The Health Net Supplemental Credit Plan and The Health Net Frozen Accrued Benefit Plan (filed as Exhibit 10.24 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).
10.10 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).
* 10.11 The Health Net Supplemental Executive Retirement Program (filed as Exhibit 10.24 to HSI's Registration Statements
on Form S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein).
* 10.12 Health Net Annual Management Incentive Compensation Plan (filed as Exhibit 10.25 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).
* 10.13 Health Net Long-Term Executive Incentive Compensation Plan (filed as Exhibit 10.26 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).
* 10.14 HN Management Holdings, Inc. Restricted Stock Plan (filed as Exhibit 10.27 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).
* 10.15 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).
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* 10.16 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).
* 10.17 Health Systems International, Inc. Second Amended and Restated 1989 Stock Option Plan (filed as Exhibit 10.32 to
Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein).
* 10.18 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).
* 10.19 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).
* 10.20 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).
* 10.21 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).
* 10.22 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).
* 10.23 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).
* 10.24 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).
* 10.25 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).
10.26 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).
* 10.27 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).
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* 10.28 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)
10.29 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 Report on Form 10-Q for the quarter ended March 31, 1995, which is incorporated by reference herein).
10.30 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).
10.31 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).
10.32 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 (filed as
Exhibit 10.33 to HSI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by
reference herein).
+ 10.33 Amendment No. 3 to Credit Agreement dated as of January 31, 1997 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 (filed as Exhibit 10.34 to HSI's Quarterly Report on Form 10-Q for the quarter ended June 30,
1996 which is incorporated by reference herein).
* 10.35 Employment Letter Agreement dated May 28, 1996 between Michael D. Pugh and QualMed, Inc. (filed as Exhibit 10.35 to
HSI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference
herein).
* 10.36 Employment Letter Agreement dated June 4, 1996 between Arthur M. Southam and HSI and Health Net (filed as Exhibit
10.36 to HSI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by
reference herein).
* 10.37 Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and HSI (filed as Exhibit 10.37 to HSI's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which is incorporated by reference herein).
* 10.38 Employment Letter Agreement dated September 30, 1996 between Douglas C. Werner and HSI (filed as Exhibit 10.38 to
HSI's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which is incorporated by reference
herein).
</TABLE>
83
<PAGE> 87
<TABLE>
<S> <C>
10.39 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).
10.40 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between the Company and Harris Trust
and Savings Bank, as Rights Agent (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed October
9, 1996, which is incorporated by reference herein).
+ 11.1 Statement relative to computation of per share earnings of the Company, a copy of which is filed herewith.
+ 21.1 Subsidiaries of HSI, a copy which is filed herewith.
+ 23.1 Consent of Deloitte & Touche LLP, a copy of which is filed herewith.
+ 27 Financial Data Schedule, a copy of which has been filed with the EDGAR version of this filing.
</TABLE>
_______________________
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Annual Report on Form 10-K pursuant to
Item 14(c) of Form 10-K.
+ A copy of the Exhibit is filed herewith.
84
<PAGE> 88
(b) Reports on Form 8-K
A Current Report on Form 8-K dated October 1, 1996 was filed by the
Company announcing that:
(a) On October 1, 1996 the Company entered into an
Agreement and Plan of Merger (the "Merger Agreement")
with Foundation Health Corporation ("FHC") and FH
Acquisition Corp., a wholly-owned subsidiary of the
Company ("Merger Sub"), pursuant to which Merger Sub
will be merged with and into FHC, subject to
regulatory and stockholder approvals.
(b) On October 1, 1996 the Company entered into and
Amendment to its Rights Agreement with Harris Trust
and Savings Bank to exempt the Merger Agreement with
FHC from the Rights Agreement and modify the
circumstances under which the Company's Board of
Directors can terminate the Rights Agreement.
No other Current Reports on Form 8-K were filed by the Company during
the quarterly period ended December 31, 1996.
85
<PAGE> 89
Supplemental Schedule I - Condensed Financial Information of Registrant
Health Systems International, Inc.
Condensed Balance Sheets
(In Thousands)
<TABLE>
<CAPTION>
December 31 December 31
1996 1995
------------------- -----------------
<S> <C> <C>
Assets:
Current assets:
Cash and equivalents $ 9,460 $ 12,661
Marketable securities held for sale 24,130 15,866
Other current assets 23,197 2,428
------------------- -----------------
Total current assets 56,787 30,955
Property and equipment, net 3,515 720
Intangibles, net 203,309 185,771
Investment in subsidiaries 561,450 496,556
Other assets (1,179) (3,104)
---------------- ---------------
Total assets $ 823,882 $ 710,898
=================== =================
Liabilities and stockholders' equity
Current liabilities:
Due to subsidiaries 106,907 78,302
Other current liabilities 9,984 13,952
------------------- -----------------
Total current liabilities 116,891 92,254
Notes payable 342,373 333,373
Other liabilities (358) (256)
Stockholders' equity:
Common stock 187,137 66,196
Retained earnings 282,091 233,711
Interest in unrealized (loss) gain on marketable securities held
for sale by subsidiaries, net (8,421) 1,950
Treasury stock (95,831) -
Advance to repurchase Class A common stock - (16,330)
------------------- -----------------
Total stockholders' equity 364,976 285,527
------------------- -----------------
Total liabilities and stockholders' equity $ 823,882 $ 710,898
=================== =================
</TABLE>
See accompanying notes
86
<PAGE> 90
Supplemental Schedule I - Condensed Financial Information of Registrant
(continued)
Health Systems International, Inc.
Condensed Statements of Income
(In Thousands)
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994
------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Investment income $ 1,571 $ 2,966 $ 598
Miscellaneous income 3,600
------------------ ------------------ ------------------
5,171 2,966 598
Expenses:
Interest 22,063 13,234 1,470
Depreciation and amortization 7,217 1,899 -
Restructuring/Merger-related costs 2,500 20,164 672
Other 11,879 4,811 153
------------------ ------------------- ------------------
Loss before income taxes and equity in
net income of subsidiaries (38,488) (37,142) (1,697)
Income tax benefit 11,861 14,596 652
Equity in net income of subsidiaries 100,219 112,138 89,120
---------------- ----------------- ----------------
Net income $ 73,592 $ 89,592 $ 88,075
================= ================= ================
</TABLE>
See accompanying notes
Condensed Statements of Cash Flows
(In Thousands)
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994
------------- ---------------- ---------------
<S> <C> <C> <C>
Operating activities
--------------------
Net income $ 73,592 $ 89,592 $ 88,075
Equity in net income of subsidiaries (100,219) (112,138) (89,120)
Changes in operating assets and liabilities 37,018 (90,808) (4,923)
------------- --------------- --------------
Net cash provided (used) by operating activities
10,391 (113,354) (5,968)
Investing activities
--------------------
Sales or redemption of marketable securities held for sale - - 8,146
Purchases of marketable securities held for sale (20,160) (15,574) -
Purchases of property and equipment, net (3,273) (743)
Investment in other companies (4,146)
Acquisition of companies (4,113)
(139,462) -
Other 1,205
-------------- -------------- ------------
Net cash (used) provided by investing activities
(30,487) (155,779) 8,146
Financing activities
--------------------
Purchase of treasury stock (105,419) (24,418) (18,940)
Proceeds from sale of stock 95,831
Advances to repurchase shares of Class A common stock - (16,330)
Proceeds from exercise of stock options and employee stock
plan purchases 17,483 4,524 4,686
Net subsidiary activity - - -
Borrowings 9,000 310,000 -
-------------- ---------------- ---------------
Net cash (used) provided by financing activities 16,895 273,776 (14,254)
--------------- ---------------- ----------------
Increase (decrease) in cash and equivalents (3,201) 4,643 (12,076)
Cash and equivalents, beginning of period 12,661 8,018 20,094
--------------- -------------- ----------------
Cash and equivalents, end of period $ 9,460 $ 12,661 $ 8,018
================ ================ ===============
</TABLE>
See accompanying notes
87
<PAGE> 91
Supplemental Schedule I - Condensed Financial Information of Registrant
(continued)
Health Systems International, Inc.,
Notes to Supplemental Schedule I - Condensed Financial Statements
1. BASIS OF PRESENTATION
HSI's investment in subsidiaries is stated at cost plus equity in undistributed
earnings of subsidiaries. HSI's share of net income of its unconsolidated
subsidiaries is included in consolidated income using the equity method.
Parent company only financial statements should be read in conjunction with
HSI's consolidated financial statements.
2. GUARANTEES
Health Net, the principal subsidiary of HSI, has $19.3 million of long-term
debt outstanding as of December 31, 1996 due to The California Wellness
Foundation. Such debt was incurred in connection with the conversion of Health
Net to a for-profit enterprise. In connection with the issuance of the
original debt totaling $225 million, HSI has guaranteed the performance of
Health Net under the debt agreements, including payment of all principal and
interest.
88
<PAGE> 92
Supplemental Schedule II - Valuation and Qualifying Accounts
Health Systems International, Inc.
(In Thousands)
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
Description Balance at ADDITIONS Deductions- Balance at End
Beginning of Describe of Period
Period
Charged to Costs Charged to Other
and Expenses Accounts-Describe
<S> <C> <C> <C> <C> <C>
ALLOWANCE FOR RETROACTIVITY
Year ended December 31, 1996 $ 13,408 $ 12,894 $ - $ (14,932) $ 11,370
Year ended December 31, 1995 $ 11,235 $ 14,575 $ 2,168 (1) $ (14,570) $ 13,408
Year ended December 31, 1994 $ 13,367 $ 6,432 $ - $ (8,564) $ 11,235
</TABLE>
(1) Additional balance due to acquisitions of MDEC and Greater Atlantic
89
<PAGE> 93
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this Report to be
signed on its behalf by the undersigned thereunto duly authorized on March 31,
1997.
HEALTH SYSTEMS INTERNATIONAL, INC.
By: /s/ Malik M. Hasan, M.D.
----------------------------------
Malik M. Hasan, M.D.
Chairman of the Board of Directors,
Treasurer (Principal Accounting and
Financial Officer) and Chief Executive
Officer (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf
of the Company and in the capacities indicated on March 31, 1997.
<TABLE>
<CAPTION>
Signature Title
- --------- -----
<S> <C>
/s/ Lawrence E. Austin, M.D. Director
- ----------------------------
Lawrence E. Austin, M.D.
/s/ Dale T. Berkbigler, M.D. Director, Vice Chairman of the Board, Executive
- ----------------------------
Dale T. Berkbigler, M.D. Vice President and Chief Medical Officer
/s/ Charles T. Braden Director
- ---------------------
Charles T. Braden
/s/ J. Thomas Bouchard Director
- ----------------------
J. Thomas Bouchard
/s/ George Deukmejian Director
- ---------------------
George Deukmejian
/s/ Thomas T. Farley Director
- --------------------
Thomas T. Farley
/s/ Michael E. Gallagher Director
- ------------------------
Michael E. Gallagher
</TABLE>
<PAGE> 94
<TABLE>
<S> <C>
/s/ Jay M. Gellert Director, President and Chief Operating Officer
- ------------------
Jay M. Gellert
/s/ Roger F. Greaves Director
- --------------------
Roger F. Greaves
/s/ Malik M. Hasan, M.D. Director, Chairman of the Board of Directors, Treasurer
- ------------------------
Malik M. Hasan, M.D. (Principal Financial and Accounting Officer) and Chief
Executive Officer (Principal Executive Officer)
/s/ Kenneth W. Kizer, M.D. Director
- --------------------------
Kenneth W. Kizer, M.D.
/s/ Douglas Mancino Director
- -------------------
Douglas Mancino
/s/ Robert L. Montgomery Director
- ------------------------
Robert L. Montgomery
/s/ Kevin Murphy Director
- --------------------------
J. Kevin Murphy
</TABLE>
<PAGE> 95
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
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).
2.4 Purchase Agreement, dated as of June 13, 1995, between Health Systems International, Inc. and G.H. Holding
Corporation (including the Addendum 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).
2.5 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International, Inc., FH
Acquisition Corp. and Foundation Health Corporation (included in Appendix I to the Joint Proxy Statement/Prospectus
filed with HSI's Registration Statement on Form S-4 (File No. 333-19273) which is incorporated by referenced
herein).
</TABLE>
<PAGE> 96
<TABLE>
<S> <C>
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).
3.2.1 Amendment to Third Amended and Restated Bylaws of HSI (included as Exhibit 3.2.1 to HSI's Quarterly Report on Form
10-Q for the quarter ended September 30, 1996, 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).
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
</TABLE>
<PAGE> 97
<TABLE>
<S> <C>
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).
9.2 Voting Agreement, dated October 1, 1996 between Malik M. Hasan, M.D. and Foundation Health Corporation (filed as
Exhibit 9.1 to HSI's Registration Statement on Form S-4 (File No. 333-19273) 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).
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 Amended and Restated Employment Agreement, dated March 10, 1997, by and between HSI and Malik M. Hasan, M.D, a copy
of which is filed herewith.
* 10.4 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
</TABLE>
<PAGE> 98
<TABLE>
<S> <C>
Statements on Forms S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively) which is incorporated by refer-
ence herein).
* 10.5 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).
* 10.6 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).
* 10.7 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).
* 10.8 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).
* 10.9 The Health Net Supplemental Executive Retirement Program, which includes The Health Net Executive Deferred Plan,
The Health Net Supplemental Credit Plan and The Health Net Frozen Accrued Benefit Plan (filed as Exhibit 10.24 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).
10.10 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).
* 10.11 The Health Net Supplemental Executive Retirement Program (filed as Exhibit 10.24 to HSI's Registration Statements
on Form S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein).
* 10.12 Health Net Annual Management Incentive Compensation Plan (filed as Exhibit 10.25 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).
* 10.13 Health Net Long-Term Executive Incentive Compensation Plan (filed as Exhibit 10.26 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).
* 10.14 HN Management Holdings, Inc. Restricted Stock Plan (filed as Exhibit 10.27 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).
* 10.15 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).
</TABLE>
<PAGE> 99
<TABLE>
<S> <C>
* 10.16 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).
* 10.17 Health Systems International, Inc. Second Amended and Restated 1989 Stock Option Plan (filed as Exhibit 10.32 to
Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein).
* 10.18 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).
* 10.19 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).
* 10.20 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).
* 10.21 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).
* 10.22 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).
* 10.23 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).
* 10.24 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).
* 10.25 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).
10.26 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).
* 10.27 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).
</TABLE>
<PAGE> 100
<TABLE>
<S> <C>
* 10.28 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)
10.29 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 Report on Form 10-Q for the quarter ended March 31, 1995, which is incorporated by reference herein).
10.30 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).
10.31 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).
10.32 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 (filed as
Exhibit 10.33 to HSI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by
reference herein).
+ 10.33 Amendment No. 3 to Credit Agreement dated as of January 31, 1997 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 (filed as Exhibit 10.34 to HSI's Quarterly Report on Form 10-Q for the quarter ended June 30,
1996 which is incorporated by reference herein).
* 10.35 Employment Letter Agreement dated May 28, 1996 between Michael D. Pugh and QualMed, Inc. (filed as Exhibit 10.35 to
HSI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference
herein).
* 10.36 Employment Letter Agreement dated June 4, 1996 between Arthur M. Southam and HSI and Health Net (filed as Exhibit
10.36 to HSI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by
reference herein).
* 10.37 Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and HSI (filed as Exhibit 10.37 to HSI's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which is incorporated by reference herein).
* 10.38 Employment Letter Agreement dated September 30, 1996 between Douglas C. Werner and HSI (filed as Exhibit 10.38 to
HSI's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which is incorporated by reference
herein).
</TABLE>
<PAGE> 101
<TABLE>
<S> <C>
10.39 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).
10.40 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between the Company and Harris Trust
and Savings Bank, as Rights Agent (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed October
9, 1996, which is incorporated by reference herein).
+ 11.1 Statement relative to computation of per share earnings of the Company, a copy of which is filed herewith.
+ 21.1 Subsidiaries of HSI, a copy which is filed herewith.
+ 23.1 Consent of Deloitte & Touche LLP, a copy of which is filed herewith.
+ 27 Financial Data Schedule, a copy of which has been filed with the EDGAR version of this filing.
</TABLE>
_______________________
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Annual Report on Form 10- K pursuant to
Item 14(c) of Form 10-K.
+ A copy of the Exhibit is filed herewith.
<PAGE> 1
EXHIBIT 10.3
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
THIS AMENDED AND RESTATED AGREEMENT is made and entered into
this 10th day of March, 1997 effective as of the Effective Date, by and among
Health Systems International, Inc. (the "Company") (which shall become
Foundation Health Systems, Inc. upon the consummation of the merger (the
"Merger") contemplated by that certain Agreement and Plan of Merger (the
"Merger Agreement"), dated as of October 1, 1996, by and among Health Systems
International, Inc., FH Acquisition Corp. and Foundation Health Corporation)
and Malik M. Hasan, M.D. ("Executive").
W I T N E S S E T H:
WHEREAS, the Executive entered into an employment agreement
with QualMed, Inc., a Delaware corporation ("QM") and HN Management Holdings,
Inc., a Delaware corporation ("HNMH"), dated as of August 28, 1993, as amended
as of April 25, 1994 (the "Prior Agreement") providing for the employment of
Executive pursuant to the terms thereof, which terms include, among others,
provisions for salary payments and death, disability, retirement, and severance
benefits to be paid to Executive or his designated beneficiaries;
WHEREAS, the Company has approved (contingent on consummation
of the Merger) the payment to Executive of a "Stay Bonus," as set forth herein;
WHEREAS, Executive and the Company deem it to be in their
respective best interests to amend and restate the Prior Agreement; and
WHEREAS, the Company has succeeded to the rights and
obligations of QM and HNMH under the Prior Agreement;
NOW, THEREFORE, in consideration of the premises and the
mutual promises and agreements contained herein, it is hereby agreed as
follows:
<PAGE> 2
1. Effective Date. This Agreement shall be effective as of
January 1, 1997, which date shall be referred to herein as the "Effective
Date."
2. Duties.
(a) The Company hereby agrees to employ Executive
(i) from the Effective Date to the Effective Time (as defined in the Merger
Agreement), as Chairman of the Board of Directors and Chief Executive Officer
of the Company; (ii) from the Effective Time (as defined in the Merger
Agreement) until the Crowley Termination Date (as defined below), as Chief
Executive Officer and President of the Company (in accordance with Section
2.01(h) of the Merger Agreement); and (iii) for the period commencing upon the
Crowley Termination Date (as defined below), as Chief Executive Officer and
Chairman of the Board of the Company. For purposes of this Agreement, the
"Crowley Termination Date" shall be the earlier to occur of (a) the date one
year following the Effective Time (as defined in the Merger Agreement) and (b)
the date of Mr. Crowley's death, resignation or removal as Chairman of the
Board of the Company. Executive acknowledges that Daniel D. Crowley will be
Chairman of the Board of the Company for the period beginning at the Effective
Time and ending upon the Crowley Termination Date. Executive hereby agrees to
waive any and all rights he might otherwise have under Section 5(e) as a result
of the changes to his position, status, title, duties and responsibilities
prior to the Effective Date set forth in Section 1 of this Employment
Agreement, or which are contemplated under the Merger Agreement.
(b) Executive in these capacities agrees to use his
best efforts during the Term of Employment to protect, encourage and promote
the interests of the Company. During the Term of Employment (as hereinafter
defined), Executive shall also perform such other duties consistent with the
offices held by Executive as may be reasonably assigned to him from time to
time by the Board of Directors, and will devote substantial time and attention
to such duties, except for sick leave, vacations, and excused leaves of
absence. During such period, Executive may also be required to perform
services for one or more affiliates of the Company. In addition, Executive
may, in his discretion, perform such duties at
2
<PAGE> 3
any one of his residence(s) or at the office facilities made available to him
pursuant to this Agreement.
3. Compensation. The Company agrees to pay to Executive as a
minimum annual salary during the Term of Employment the sum of nine-hundred
eighty-three thousand, ninety-seven dollars ($983,097) per calendar year,
payable in semi-monthly installments on the first and fifteenth day of each
month or otherwise in accordance with such normal payroll procedures of the
Company to which Executive may consent. Such annual salary shall increase a
minimum of 7% per year on the first day of each succeeding calendar year
commencing after the Effective Date. Such annual salary, as adjusted, shall be
subject to periodic review by the Board of Directors any may be increased by
the Board of Directors, or an appropriate committee thereof, from time to time,
provided, however, such annual salary in effect from time to time (without
consideration of any bonus or incentive compensation that may be awarded to
Executive) may not be decreased without the consent of Executive. If Executive
changes his residence to another location at the Company's request, Executive's
annual salary shall be increased to reflect the relative increase in his cost
of living, if any, based on the most recent index of relative living costs as
determined by the most recently published American Chamber of Commerce Research
Association Inter-City Cost of Living Index by multiplying (i) Executive's then
current annual salary by (ii) the percentage derived by dividing (A) the cost
of living index for such new residence location, by (B) the cost of living
index for Pueblo, Colorado. (The amount of Executive's annual salary, as
adjusted from time to time pursuant to this paragraph, shall be referred to as
"Base Salary.")
4. Benefits. During the Term of Employment:
(a) The Company shall furnish Executive with, and
Executive shall be allowed full use, at both of in Woodland Hills, California,
and Pueblo, Colorado, of office facilities, automobiles (as provided in Section
4(e) of this Agreement), secretarial and clerical assistance and other Company
property and services of a quality, nature and to the extent made available to
senior executive employees of the Company from time to time. If Executive
changes his residence at the Company's request, Executive's relocation expenses
incurred in such move
3
<PAGE> 4
shall be reimbursed. Such reimbursement shall not be less than that which
would have been paid under the more generous of the Company's relocation policy
in effect on the date this Agreement was executed or in effect on the date the
expenses are incurred.
(b) Executive shall be eligible to participate in
life, health and long-term disability insurance programs, stock purchase
programs, stock option plans, pension programs, incentive compensation programs
and other fringe benefit programs, if any, available to senior executive
employees of the Company from time to time. Notwithstanding the immediately
preceding sentence, Executive hereby expressly waives any rights Executive may
have, under this Agreement or otherwise, to participate in (1) the Company's
Annual Management Incentive Compensation Plan for any fiscal year during which
the Company's Performance-Based Annual Bonus Plan ("162(m) Plan") is effective
and covers Executive as a participant therein for such fiscal year; or (2) the
Company's Long-Term Incentive Plan. (Each reference to a plan in the preceding
sentence also shall refer to any successor to such plan). The Company shall
provide Executive with a pension retirement program containing benefits and
future entitlement under no less favorable terms than as contemplated under the
pension retirement program applicable to him on December 31, 1996.
(c) Executive shall be allowed vacations and leaves
of absence with pay on the same basis as senior executive employees of the
Company.
(d) The Company will reimburse Executive for
reasonable business expenses in performing Executive's duties and promoting the
business of the Company; including but not limited to reasonable entertainment
expenses, automobile expenses, and travel and lodging, when incurred.
Executive is encouraged and is expected from time to time to incur reasonable
expenses for the promotion of the business of the Company, including expenses
for social, professional, civic and country club memberships, including but
limited to, initiation fees, maintenance fees, dues, entertainment and similar
items. The cost of these items shall be borne by the Company upon presentation
of an itemized expense voucher. In addition, an annual home business expense
allowance shall also be made available in an amount equal to the
4
<PAGE> 5
allowance made available to Executive at the Effective Date or such other
amount as determined thereafter from time to time by the Board or an
appropriate committee thereof.
(e) The Company shall provide Executive with the use
of an automobile of Executive's choice (comparable to the automobiles provided
for the use of Executive as of the Effective Date of this Agreement) at each of
the Company's offices of Woodland Hills, California and Pueblo, Colorado, and
each such automobile shall at no time be older than three (3) years or 50,000
miles. In addition, the Company shall continue to furnish Executive use of the
limousines owned by or on order by the Company on the Effective Date for their
remaining useful lives (or, if earlier, until Executive terminates employment
with the Company), such usage to be in accordance with the practices in effect
immediately before the Effective Date; however, the Company shall not be
obligated to provide a limousine to Executive after the end of such limousines'
useful lives. The Company shall pay all operating expenses of such automobiles
as related to the Company's business and shall procure and maintain an
automobile liability insurance policy of such automobiles, which coverage
includes Executive and Executive's spouse and those of his children who qualify
as Executive's dependents under Section 152 of the Internal Revenue Code in the
minimum amounts of one million dollars ($1,000,000) for bodily injury or death
to one person in one accident, and three-hundred-thousand dollars ($300,000)
for property damage in one accident.
(f) The Company shall reimburse Executive for
reasonable expenses incurred in connection with the relocation of Executive's
place of residence, provided such relocation is required by the Company.
5. Term; Termination of Employment. As used herein, the
phrase "Term of Employment" shall mean the period commencing on the Effective
Date and ending five years from the Effective Date; provided, however, that on
any anniversary of the Effective Date at which time the then remaining Term of
Employment is four years, the Term of Employment shall automatically be
extended by an additional year so that as a result of such extension the then
remaining Term of Employment will be five years.
5
<PAGE> 6
Notwithstanding the foregoing, the Term of Employment shall expire on the first
to occur of the following:
(a) Termination Without Cause. Notwithstanding
anything to the contrary in this Agreement, whether express or implied, the
Company may at any time terminate Executive's employment for any reason other
than Cause (as defined below) by giving Executive at least 60 days' prior
written notice of the effective date of termination. In the event of such
termination, Executive shall receive the Contract Payments (as hereinafter
defined) and, for the period commencing on the effective date of such
termination and ending 36 months thereafter, the Severance Payments (as
hereinafter defined).
(i) For purposes of this Agreement,
"Severance Payments" shall mean one-twelfth (1/12) of the sum of (i)
Base Salary (at the rate in effect immediately prior to notice of
termination) plus (ii) an amount equal to the average annual bonus
(excluding Stay Bonuses under Section 11) earned by Executive during
the three most recent fiscal years of the Company completed prior to
the effective date of such termination. Severance Payments shall also
include Executive's right to continue to be covered by all medical,
health and accident insurance or other such health care arrangements,
at the same coverage level maintained for Executive's benefit
immediately prior to the date on which notice of Executive's
termination is given, at no greater cost to Executive than the cost to
Executive immediately prior to the date on which notice of Executive's
termination is given. In the event Executive is ineligible under the
terms of such insurance or other such health care arrangements to
continue to be so covered, the Company shall provide Executive with
substantially equivalent coverage through other sources or will
provide Executive 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 Executive is entitled under
this Section 5(a).
6
<PAGE> 7
(ii) For purposes of this Agreement,
"Contract Payments" shall mean (1) an accrued but unpaid base salary
due Executive through termination, (2) other unpaid amounts then due
under Company benefit plans or programs (including the retirement
benefits described in Section 4(b)), and (3) a cash lump sum equal to
the value of the Executive's accrued but unused vacation days, to the
extent such payment is provided under applicable Company policies.
(b) Termination for Cause. The Company shall have
the right to terminate Executive's employment at any time for Cause by giving
Executive written notice of the effective date of termination (which effective
date may, except as other- wise provided below, be the date of such notice).
For purposes of this Agreement, Cause shall only mean felony conviction for
fraud, misappropriation, or embezzlement.
If the Company terminates Executive's employment for Cause,
the Company shall have no further obligation hereunder from and after the
effective date of termination, except to make Contract Payments. If
Executive's employment is terminated for Cause and Executive does not consent
to such termination, such termination shall not be considered effective and
Executive's rights under this Agreement during the Term of Employment
(including but not limited to, the provisions of Sections 3 and 4 hereof, but
excluding, during the pendency of any contest over the existence of Cause, the
right to voluntarily terminate for Good Reason (as defined below) under Section
5(e) hereof) shall continue until the existence of such Cause has been
determined by an independent arbitrator appointed by the American Arbitration
Association and either party's rights to petition a court of law for a decision
in the matter have been exhausted. In connection with the appointment of an
arbitrator, both parties agree to submit the question to final and binding
arbitration by an appointee of the American Arbitration Association and to
cooperate with the arbitrator, with all costs of arbitration paid by the
Company.
(c) Termination on Account of Death. In the event
of Executive's death while in the employ of the Company, the Company shall pay
to Executive's Designated
7
<PAGE> 8
Beneficiaries (as defined below) Contract Payments and 100% of Executive's
monthly Base Salary as in effect immediately prior to Executive's death, at the
beginning of each month for a period of 12 months following Executive's death.
In addition, Executive's surviving spouse, if any, shall continue to be covered
by all medical, health and accident insurance or other such health care
arrangement, and for the same coverage, maintained for Executive's benefit
immediately prior to the date of Executive's death, for a period of 18 months
thereafter. In the event Executive's surviving spouse is ineligible under the
terms of such insurance or other such health care arrangement to continue to be
so covered, the Company shall provide substantially equivalent coverage through
other sources or will provide Executive's surviving spouse with the lump sum
payment equal to the agreed upon present value of the continuation of such
health insurance or other such health care arrangement under this Section 5(c).
In addition, or up to one year following Executive's death, the Company without
charge shall make Executive's assistant (currently George Evans) available to
assist in settling Executive's estate affairs to the extent it is inconvenient,
impractical, or unwise or Executive's estate to handle such matters without
such assistance.
(d) Voluntary Termination by Executive Without Good
Reason. Notwithstanding anything to the contrary in this Agreement, whether
express or implied, Executive may at any time terminate his employment for any
reason by giving the Company 14 days prior written notice of the effective date
of termination. In the event that Executive's employment with the Company is
voluntarily terminated by Executive without Good Reason (as defined below),
neither Executive nor the Company shall have any further obligations hereunder
from and after the effective date of such termination, except that the Company
shall make Contract Payments to Executive.
(e) Voluntary Termination by Executive With Good
Reason. In the event that Executive's employment with the Company is
voluntarily terminated by Executive in accordance with the preceding Section
5(d) but with Good Reason, in addition to receiving Contract Payments, for the
period commencing on the effective date of such termination and ending 36
months thereafter, Executive also shall receive Severance Payments. For
8
<PAGE> 9
purposes of this Agreement, Good Reason shall mean any of the following which
occurs subsequent to the Effective Date:
(i) a reduction in Executive's position,
duties, responsibilities or status with the Company, or any removal of
Executive from or any failure to reelect Executive to any of the
positions referred to in paragraph 2 hereof, except in connection with
the termination of his employment for disability, normal retirement or
Cause or by Executive voluntarily other than for Good Reason;
(ii) a reduction by the Company in
Executive's Base Salary or a material reduction by the Company to
Executive's employee benefit package as in effect immediately prior to
such reduction, in either case, without Executive's consent;
(iii) a requirement that Executive travel on
the Company's business to an extent materially greater than
Executive's normal business travel obligations, or a relocation of
Executive to a location more than 25 miles from Executive's residence
at the date of such proposed relocation (other than a relocation to
Woodland Hills, California, pursuant to Executive's choice);
(iv) any breach by the Company of any
provision of this Agreement or any other agreement with Executive;
(v) any failure by the Company to obtain
the assumption of this Agreement by any successor or assign of the
Company; or
(vi) Executive's permanent disability,
which for purposes of this Agreement shall mean Executive's inability
to perform his duties under this Agreement for 90 days during any
twelve-month period due to illness, accident or other incapacity (as
determined in good faith by a physician mutually acceptable to the
Company and Executive) or if the physician
9
<PAGE> 10
selected by Executive and the Company examines Executive and advises
the Company that it is likely that Executive will be unable to perform
such duties for 90 days during the succeeding twelve-month period.
(f) Notwithstanding any other provisions of this
Section 5, in accordance with Item 5(c) of Section 6.01(b)(ii) of the
Disclosure Schedule to the Merger Agreement, Executive acknowledges that he
shall not be entitled to receive Severance Payments under this Section 5 on
account of the Merger with Foundation Health Corporation unless and until he is
no longer employed by the Company.
(g) Acceptance by Executive of Severance Payments,
Contract Payments, or other payments under this Section 5 shall constitute
Executive's release of any claims he may have against the Company or any
related person or entity for severance benefits, salary or bonus payments,
benefit plan coverages, and vacation pay cashouts.
6. Expenses. The Company will promptly pay or reimburse
Executive for all costs and expenses (including court costs, arbitration costs
and reasonable attorneys' fees) incurred by Executive as a result of any good
faith claim, action or proceeding arising out or, or challenging the validity,
enforceability or interpretation of, this Agreement or any provision hereof.
Any dispute concerning such reimbursement of costs and expenses shall, at
Executive's election, be resolved through the arbitration procedures as set
forth in Section 5(b) hereof (pertaining to disputes arising from a termination
of Executive's employment for Cause).
7. Mitigation. In the event of a termination of Executive's
employment for any reason, Executive shall not be required to seek other
employment; in addition, no amount payable under Section 5 of this Agreement
shall be reduced by any compensation earned by Executive as a result of
employment by another employer after such termination of employment with the
Company.
8. Designated Beneficiary. In the event of the death of
Executive while in the employ of the Company, or at any time thereafter during
which amounts remain
10
<PAGE> 11
payable to Executive under Section 4(c), 5(a), 5(c) or 5(e) hereof, such
payments shall thereafter be made to such person or persons as Executive may
specifically designate (successively or contingently) to receive payments under
this Agreement following Executive's death by filing a written beneficiary
designation with the Company during Executive's lifetime. Such beneficiary
designation shall be in such form as may be prescribed by the Company and may
be amended from time to time or may be revoked by Executive pursuant to written
instruments filed with the Company during his lifetime. Beneficiaries
designated by Executive may be any natural or legal person or persons,
including a fiduciary, such as a trustee or a trust or the legal representative
of an estate. Unless otherwise provided by the beneficiary designation filed
by Executive, if all of the persons so designated die before Executive on the
occurrence of a contingency not contemplated in such beneficiary designation,
then the amount payable under this Agreement shall be paid to Executive's
estate.
9. Gross-Up Payment. In the event that any payment received
by Executive under this Agreement (including any payments under Section 5
hereof following Executive's termination of employment with the Company), 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 the tax (the "Excise Tax") imposed by Section 4999 of the
Internal Revenue Code (or any successor provision of the Code), the Company
shall pay to Executive, not later than thirty (30) days following the date of
any payment giving rise to an Excise Tax liability, an additional amount (the
"Gross-Up Payment") such that the net amount retained or to be retained by
Executive after deduction of any Excise Tax on the Total Payments and any
federal and state and local income tax, employment tax, and Excise Tax upon the
Gross-Up Payment provided for by this Section 9, 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, (A) when
requested to do so by Executive, Total Payments shall be treated as "parachute
payments" within the meaning of Section 280G(b)(2) of the
11
<PAGE> 12
Code, and all "parachute payments" in excess of the base amount within the
meaning of Section 280G(3) shall be treated as subject to the Excise Tax,
unless in the opinion of tax counsel selected by the Company's independent
auditors and acceptable to Executive such Total Payments (in whole or in part)
do not constitute "parachute payments," or such parachute payments in excess of
the base amount (in whole or in part) are otherwise not subject to the Excise
Tax and (B) the value of any non-cash benefit or any deferred payment or
benefit shall be determined by the Company's independent auditors in accordance
with the principles of Section 280G(d)(3) and (4) of the Code. Notwithstanding
the foregoing, if the Company withholds Excise Tax pursuant to Section 4999 of
the Code prior to Executive's termination of employment, the Gross-Up Payment
shall be made on that date.
For purposes of determining the amount of the Gross-Up
Payment, Executive shall be deemed to pay federal income taxes at the highest
marginal rate of federal income taxation in the calendar year in which the
Gross-Up Payment is to be made and state and local income taxes at the highest
marginal rate of taxation in the state and locality of his residence on the
date of termination or the date any Excise Tax is withheld by the Company, net
of the maximum reduction in federal income taxes which would be obtained from
deduction of such state and local taxes. In the event that the Excise Tax is
subsequently determined to be less than the amount originally taken into
account hereunder, Executive 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 interest on the amount
of such repayment at the rate provided in Section 1274(b)(2)(B) or the Code.
In the event that the Excise Tax is determined to exceed the amount originally
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 payable with respect to such excess) at the time that the
amount of such excess is finally determined. Executive shall notify the
Company of any audit or review by the Internal Revenue Service of Executive's
federal income tax return for the year in which a payment under this Agreement
is made within ten (10) days of Executive's
12
<PAGE> 13
receipt of notification of such audit or review. In addition, Executive shall
also notify the Company of the final resolution of such audit or review within
ten (10) days of such resolution.
10. Miscellaneous. This Agreement shall also be subject to
the following miscellaneous considerations:
(a) The Company represents and warrants to Executive
that it has the authorization, power and right to deliver, execute and fully
perform its obligations under this Agreement in accordance with its terms.
(b) Except with respect to the Indemnification
Agreement entered into as of August 10, 1996, between Executive and the Company
(the "Indemnification Agreement"), and other agreements, plans or arrangements
specifically excepted or otherwise referred to herein, this Agreement contains
a complete statement of all the arrangements between the parties with respect
to Executive's employment by the Company and supersedes all prior and existing
negotiations and agreements between them concerning Executive's employment,
including, but not limited to, the Prior Agreement. This Agreement can only be
changed or modified pursuant to a written instrument duly executed by each of
the parties hereto.
(c) If any provision of this Agreement or any
portion thereof is declared invalid, illegal or incapable of being enforced by
any court of competent jurisdiction, the remainder of such provisions and all
of the remaining provisions of this Agreement shall continue in full force and
effect.
(d) This Agreement shall be governed by and
construed in accordance with the internal laws of the State of Delaware, except
to the extent governed by federal law.
(e) All compensation payable hereunder shall be
subject to such withholding taxes as may be required by law.
(f) This Agreement shall be binding upon and inure
to the benefit of the successors and assigns of the Company. Except as
expressly provided herein, Execu-
13
<PAGE> 14
tive may not sell, transfer, assign, or pledge any of his rights or interests
pursuant to this Agreement.
(g) Except as otherwise provided in Section 5(b)
hereof, in the event of any dispute between the Company and Executive with
respect to any of the provisions of this Agreement, the Company and Executive
agree that either party may request that the dispute be resolved by submitting
the issue to arbitration or such other form of alternative dispute resolution
as the parties may agree upon (collectively, "Alternative Dispute Resolution").
The parties expressly agree and acknowledge, however, that, except as otherwise
provided in Section 5(b) hereof, nothing in this Agreement (whether express or
implied) shall under any circumstances require either party to consent to
Alternative Dispute Resolution.
(h) Any rights of Executive hereunder shall be in
addition to any rights Executive may otherwise have under benefit plans or
agreements of the Company to which he is a party or in which he is a
participant, including, but not limited to, any Company sponsored employee
benefit plans. Except as set forth in this second sentence of Section 4(b)
hereof, this Agreement shall not in any way abrogate Executive's rights under
such other plan and agreements.
11. Stay Bonus and Related Provisions.
(a) In the event that the Merger is consummated,
this Section 11 shall become effective and Executive shall be eligible for a
special bonus in respect of each fiscal year of the Company ending in 197, 1998
and 1999 (each such bonus, a "Stay Bonus").
(b) Each Stay Bonus shall be paid under the
Company's Performance-Based Annual Bonus Plan (the "162(m) Plan"). The award
of a Stay Bonus to Executive in respect of a fiscal year shall not, by itself,
preclude Executive from being awarded an additional bonus under the 162(m)
Plan.
(c) If the performance targets and other
requirements set forth below in subsection (d) are satisfied for a fiscal year,
the Company's Compensation and Stock Option Committee shall exercise its
negative dis-
14
<PAGE> 15
cretion under the 162(m) Plan so as to pay a $1.33 million Stay Bonus to
Executive, or if less, the maximum amount that can be awarded to Executive
under the 162(m) Plan.
(d) A Stay Bonus only shall be paid in respect of a
fiscal year if all of the following conditions are satisfied as to that year
(except to the extent partial payment is authorized by Section 11(d)(ii) hereof
for certain partial years of employment and Section 11(d)(iii) hereof with
respect to fiscal years ending in 1997 and 1998):
(i) The Merger would not be precluded from
qualifying for "pooling of interests" accounting treatment because of
this Stay Bonus provision (this determination shall be made by the
accounting firm whose pooling of interests accounting opinion is
required as a condition of the consummation of the Merger).
(ii) Executive is an employee of the
Company on the last day of such fiscal year (provided that a pro rata
portion of a Stay Bonus would be paid if Executive's employment is
terminated without Cause, for Good Reason or on account of death
during such fiscal year if the specific performance targets for that
fiscal year are achieved).
(iii) A Stay Bonus is payable after
application (as determined by the Compensation and Stock Option
Committee by its sole discretion and ratified by the Board of
Directors) of the special performance targets applicable to such
fiscal year, as follows:
Fiscal Year ending in 1997: 50% of the Stay
Bonus will be paid if Merger-related synergies result in at
least $55 million increase in pre-tax operating income; 50% of
the Stay Bonus will be paid if Board-approved budgeted net
income (currently $2.50 per share) is achieved.
Fiscal year ending in 1998: 50% of the Stay
Bonus will be paid if Merger-related syn-
15
<PAGE> 16
ergies result in at least a cumulative $110 million increase
in pre-tax operating income for fiscal years 1997 and 1998;
50% of the Stay Bonus will be paid if Board-approved budgeted
net income is achieved.
Fiscal year ending in 1999: 100% of the Stay
Bonus will be paid if Board-approved budgeted net income is
achieved.
IN WITNESS WHEREOF, the parties hereto have executed this
Agreement as of the day and year first above written.
EXECUTIVE HEALTH SYSTEMS
INTERNATIONAL, INC.
By
- --------------------------------- --------------------------------
Malik M. Hasan, M.D. B. Curtis Westen, Esq.
Its Senior Vice President, General
Counsel and Secretary
16
<PAGE> 1
EXHIBIT 10.33
THIRD AMENDMENT TO
AMENDED AND RESTATED CREDIT AGREEMENT
THIS THIRD AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT is made
and dated as of January 31, 1997 (the "THIRD 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 and that certain Second
Amendment to Amended and Restated Credit Agreement dated as of May 28, 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.
2. Amendment. The Credit Agreement is hereby amended
as follows:
2.1 Amendment to Section 1.01.
The definition of the term "Subsidiary" in Section 1.01 of the Credit Agreement
is hereby amended by adding the following two sentences at the end thereof:
"Notwithstanding anything to the contrary herein, except as otherwise expressly
provided in Section 8.01 of this Agreement, during the period from the date the
Foundation Acquisition is completed through June 30, 1997, neither Foundation
Health nor any of its Subsidiaries shall be deemed to be a Subsidiary of the
Company or any of the Company's Subsidiaries. After June 30, 1997, the
determination of whether Foundation Health and its Subsidiaries are
Subsidiaries of the Company shall be made by reference to the first two
sentences of this definition."
2.2 Addition of New Definitions.
Section 1.01 of the Credit Agreement is further amended by adding the following
definition thereto in appropriate alphabetic order:
<PAGE> 2
"Foundation Health" means Foundation Health Corporation, a
Delaware corporation.
"Foundation Acquisition" means the acquisition by the Company
of all of the outstanding common stock of Foundation Health pursuant
to the terms of that certain Agreement and Plan of Merger dated
October 1, 1996 among the Company, FH Acquisition Corp., a
wholly-owned Subsidiary of the Company, and Foundation Health.
2.3 Amendment to Section 8.01.
Section 8.01 of the Credit Agreement is hereby amended by adding the following
sentence at the end thereof: "For purposes of clauses (e), (f), (g) and (i) of
this Section 8.01 (but only for purposes of clauses (e), (f), (g) and (i) of
Section 8.01), from and after completion of the Foundation Acquisition,
Foundation Health and each of its Subsidiaries shall be deemed to be
Subsidiaries of the Company."
3. Acknowledgement. By their execution hereof, the
Company, the Agent and the Banks acknowledge that upon the Company's compliance
with clauses (ii) and (iii) of Section 6.13, the Foundation Acquisition will be
a Permitted Acquisition for purposes of the Credit Agreement.
4. 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 Third Amendment:
4.1 Authorization. The
execution, delivery and performance by the Company of this Third Amendment has
been duly authorized by all necessary corporate action, and this Third
Amendment has been duly executed and delivered by the Company.
4.2 Binding Obligation. This
Third 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.
4.3 No Legal Obstacle to
Amendment. The execution, delivery and performance of this Third 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 or 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 Third Amendment or the transactions contemplated hereby.
2
<PAGE> 3
4.4 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.
4.5 Default. No Default or
Event of Default under the Credit Agreement has occurred and is continuing.
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 Third
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 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 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 Third
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 Third 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 Third
Amendment shall be governed by and construed in accordance with the laws of the
State of California.
3
<PAGE> 4
IN WITNESS WHEREOF, the parties hereto have caused this Third
Amendment to be duly executed and delivered as of the date first written above.
HEALTH SYSTEMS INTERNATIONAL, INC.
By:
------------------------------------
Name:
----------------------------------
Title:
---------------------------------
BANK OF AMERICA NATIONAL TRUST AND SAVINGS
ASSOCIATION, AS Agent
By:
------------------------------------
Name:
----------------------------------
Title:
---------------------------------
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, as a Bank
By:
------------------------------------
Name:
----------------------------------
Title:
---------------------------------
4
<PAGE> 5
ABN AMRO BANK, N.V.
By: ABN AMRO North America, Inc.
its agent
By:
-----------------------------------------
Name:
----------------------------------------
Title:
---------------------------------------
By:
-----------------------------------------
Name:
----------------------------------------
Title:
---------------------------------------
BANK OF MONTREAL
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
THE BANK OF NEW YORK
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
THE BANK OF NOVA SCOTIA
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
5
<PAGE> 6
BANQUE NATIOANALE DE PARIS
By:
-------------------------------------------
Name:
-----------------------------------------
Title:
----------------------------------------
By:
-------------------------------------------
Name:
-----------------------------------------
Title:
----------------------------------------
BANQUE PARIBAS
By:
-------------------------------------------
Name:
-----------------------------------------
Title:
----------------------------------------
CHEMICAL BANK
By:
-------------------------------------------
Name:
-----------------------------------------
Title:
----------------------------------------
CITIBANK, N.A., as a Bank and Co-Agent
By:
-------------------------------------------
Name:
-----------------------------------------
Title:
----------------------------------------
6
<PAGE> 7
COOPERATIEVE CENTRALE RAIFFEISEN-
BOERENIEENBANK B.A. "RABOBANK
NEDERLAND" NEW YORK BRANCH
By:
---------------------------------------------
Name:
-------------------------------------------
Title:
------------------------------------------
By:
---------------------------------------------
Name:
-------------------------------------------
Title:
------------------------------------------
CREDIT LYONNAIS NEW YORK BRANCH
By:
---------------------------------------------
Name:
-------------------------------------------
Title:
------------------------------------------
THE DAI-ICHI KANGYO BANK, ltd.
Los Angeles Agency
By:
---------------------------------------------
Name:
-------------------------------------------
Title:
------------------------------------------
THE FUJI BANK, LIMITED
Los Angeles Agency
By:
---------------------------------------------
Name:
-------------------------------------------
Title:
------------------------------------------
7
<PAGE> 8
THE INDUSTRIAL BANK OF JAPAN,
LIMITED, Los Angeles Agency, as a Bank and
CO-Agent
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
THE LONG-TERM CREDIT BANK OF JAPAN
LTD., Los Angeles Agency
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
THE NORTHERN TRUST COMPANY
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
THE SANWA BANK, LIMITED
Los Angeles Branch
By:
---------------------------------------------------
Name:
-------------------------------------------------
Title:
------------------------------------------------
8
<PAGE> 9
WELSS FARGO BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
9
<PAGE> 1
Exhibit 11.1
Health Systems International, Inc. and Subsidiaries
Computation of Earnings Per Share
(In thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended
-----------------------------------------------------------
1996 1995 1994
------------ ------------ -------------
<S> <C> <C> <C>
Primary:
Shares outstanding at beginning of period 48,327 48,491 48,691
Weighted average shares issued (repurchased)
during period (97) 21 (95)
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 102 319 1,095
------------ ------------ -------------
Total primary shares 48,332 48,831 49,691
============ ============ =============
Net income $ 73,592 $ 89,592 $ 88,075
============ ============ =============
Net income per share $ 1.52 $ 1.83 $ 1.77
============ ============ =============
Fully diluted:
Shares outstanding at beginning of period 48,327 48,491 48,691
Weighted average shares issued
(repurchased) during period (97) 21 (95)
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 assumed
proceeds from exercise 108 371 1,196
------------ ------------ -------------
Total fully diluted shares 48,338 48,883 49,792
============ ============ =============
Net income $ 73,592 $ 89,592 $ 88,075
============ ============ =============
Net income per share $ 1.52 $ 1.83 $ 1.77
============ ============ =============
</TABLE>
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF HEALTH SYSTEMS INTERNATIONAL, INC.
(ALL SUBSIDIARIES WHOLLY OWNED UNLESS OTHERWISE INDICATED)
HEALTH SYSTEMS INTERNATIONAL, INC. (DE)
- Health Net (CA)
- Health Net Life Insurance Company (CA)
- PCA of California Insurance Agency (CA)
- QualMed, Inc. (DE)
- Preferred Health Network, Inc. (CA)
- Midwest Business Medical Association, Ltd. (IL)
- QualMed Plans for Health of Colorado, Inc. (CO)
- St. Louis Valley Physician Service Corp.
Limited (CO)*
- QualMed Health & Life Insurance Company (CO)
- QualMed Plans for Health, Inc. (NM)
- QualMed Oregon Health Plan, Inc. (OR)
- QualMed Washington Health Plan, Inc. (WA)
- M.D. Health Plan, Inc. (CT)
- HSI Eastern Holdings, Inc. (PA)
- Greater Atlantic Health Service, Inc. (DE)
- QualMed Plans for Health, Inc. (PA)
- Greater Atlantic Preferred Plus, Inc. (PA)
- Employ Better Care, Inc. (PA)
- QualMed Plans for Health of Pennsylvania, Inc. (PA)**
- HN Reinsurance Limited (Cayman Islands)
- National Pharmacy Services, Inc. (DE)
- Integrated Pharmacy Systems, Inc. (PA) ***
* A limited partnership in which QualMed Plans for Health of Colorado,
Inc. is an 83.4% limited partner
** HSI owns approximately 83% of the outstanding common stock.
*** National Pharmacy Services, Inc. owns approximately 90% of the
outstanding common stock.
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-74780 of Health Systems International, Inc. on Form S- 8 of our report dated
March 21, 1997, appearing in this Annual Report on Form 10-K of Health Systems
International, Inc. for the year ended December 31, 1996.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM HEALTH
SYSTEMS INTERNATIONAL, INC., FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FORM 10-K FILING.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 187,486
<SECURITIES> 402,128
<RECEIVABLES> 97,968
<ALLOWANCES> (11,370)
<INVENTORY> 0
<CURRENT-ASSETS> 753,477
<PP&E> 190,549
<DEPRECIATION> 118,763
<TOTAL-ASSETS> 1,211,880
<CURRENT-LIABILITIES> 478,338
<BONDS> 362,465
0
0
<COMMON> 51
<OTHER-SE> 364,925
<TOTAL-LIABILITY-AND-EQUITY> 1,211,880
<SALES> 0
<TOTAL-REVENUES> 3,242,858<F1>
<CGS> 0
<TOTAL-COSTS> 2,611,522<F2>
<OTHER-EXPENSES> 481,582
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 24,539
<INCOME-PRETAX> 125,210<F3>
<INCOME-TAX> 51,720
<INCOME-CONTINUING> 73,592
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 73,592
<EPS-PRIMARY> 1.52
<EPS-DILUTED> 1.52
<FN>
<F1>Includes $38,702 thousand of investment income.
<F2>Includes healthcare expenses only.
<F3>Excludes $102 thousand of minority interest in loss of subsidiary.
</FN>
</TABLE>
