-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JDihpiWtJEm5i6J8tTgNqj6jH8c+DQIPM+s+nafkF58ibMvwa5dFItV8114w+fZn RH7IjgsXJYGSmz2dCuNxhQ== 0000912057-97-002480.txt : 19970203 0000912057-97-002480.hdr.sgml : 19970203 ACCESSION NUMBER: 0000912057-97-002480 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 12 FILED AS OF DATE: 19970131 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: TALBERT MEDICAL MANAGEMENT HOLDINGS CORP CENTRAL INDEX KEY: 0001027131 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SPECIALTY OUTPATIENT FACILITIES, NEC [8093] STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-17679 FILM NUMBER: 97514789 BUSINESS ADDRESS: STREET 1: 3540 HOWARD WAY CITY: COSTA MESA STATE: CA ZIP: 92626-1417 BUSINESS PHONE: 7144364800 S-1/A 1 FORM S-1/A AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 31, 1997 REGISTRATION NO. 333-17679 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 8099 33-0730363 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF CLASSIFICATION CODE NUMBER) IDENTIFICATION INCORPORATION OR ORGANIZATION) NUMBER)
3540 HOWARD WAY COSTA MESA, CALIFORNIA 92626-1417 (714) 436-4800 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) JACK D. MASSIMINO TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 3540 HOWARD WAY COSTA MESA, CALIFORNIA 92626-1417 (714) 436-4800 (NAME AND ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------------ COPY TO: C. JAMES LEVIN, ESQ. O'MELVENY & MYERS LLP 400 SOUTH HOPE STREET LOS ANGELES, CALIFORNIA 90071-2899 (213) 669-6000 -------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT OR, IF LATER, UPON THE EFFECTIVE TIME OF THE FHP MERGER -------------------------- IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE TO BE OFFERED ON A DELAYED OR CONTINUOUS BASIS PURSUANT TO RULE 415 UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), CHECK THE FOLLOWING BOX. /X/ IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT, PLEASE CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFERING. / / IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(C) UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFERING. / / IF DELIVERY OF THE PROSPECTUS IS EXPECTED TO BE MADE PURSUANT TO RULE 434, PLEASE CHECK THE FOLLOWING BOX. / / --------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM AGGREGATE AMOUNT OF TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE OFFERING REGISTRATION SECURITIES TO BE REGISTERED(1) BE REGISTERED PER UNIT(1) PRICE(1)(2) FEE(1) COMMON STOCK, $.01 PAR VALUE(3)............. 2,767,500 $21.50 $59,501,250 $18,031 RIGHTS TO PURCHASE COMMON STOCK............. 2,767,500 -- -- --
(1) CALCULATED PURSUANT TO RULE 457(O). (2) ESTIMATED SOLELY FOR THE PURPOSE OF COMPUTING THE AMOUNT OF THE REGISTRATION FEE PURSUANT TO RULE 457(A). (3) THIS REGISTRATION STATEMENT ALSO INCLUDES RIGHTS IN RESPECT OF SUCH COMMON STOCK PURSUANT TO THE STOCKHOLDER RIGHTS AGREEMENT BETWEEN THE COMPANY AND AMERICAN STOCK TRANSFER & TRUST COMPANY. -------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PROSPECTUS 2,767,500 SHARES TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION [LOGO] COMMON STOCK -------------------------- In connection with the merger of FHP International Corporation ("FHP") and PacifiCare Health Systems, Inc. ("PacifiCare"), transferable rights ("Rights") to subscribe for 92.25% of the shares of Common Stock of Talbert Medical Management Holdings Corporation, a Delaware corporation ("TMMHC" and, together with its subsidiaries and affiliated medical groups, the "Company", unless otherwise noted), for $21.50 per share (the "Subscription Price") are being delivered to the common and preferred stockholders of FHP (the "Offering") as part of the consideration payable in the merger. FHP stockholders will receive Rights based on the number of shares of FHP Common Stock and FHP Preferred Stock held of record at the effective time of the merger (the "Effective Time"), which was on February , 1997. FHP stockholders will receive one Right for every 21.40635 shares of FHP Common Stock and one Right for every 26.54228 shares of FHP Preferred Stock. Rights holders may purchase one share of the Company's Common Stock with each Right and also may subscribe for additional shares of the Company's Common Stock in accordance with the Additional Subscription Privilege described under "The Offering--Additional Subscription Privilege." The Rights will be evidenced by transferable subscription certificates. Prior to the Offering, there has not been a public market for the Common Stock of the Company. See "The Offering" for factors that were considered in determining the Subscription Price. If fully subscribed, the proceeds of the Offering will be approximately $59.5 million. Proceeds of the Offering will be used to repay indebtedness to FHP of approximately $59.5 million incurred in the Company's acquisition of FHP's equity interest in Talbert Medical Management Corporation and Talbert Health Services Corporation. The Company will sell to FHP any shares of Common Stock unsubscribed for in the Offering in exchange for the cancellation of any remaining such indebtedness. The Company and FHP have entered into an agreement with respect to certain aspects of FHP's ownership of any Common Stock it acquires. See "Relationship with FHP and PacifiCare Following the Offering--Standstill Agreement." The Rights will be exercisable only during the subscription period, which will expire at 5:00 P.M., Eastern Standard Time, on March , 1997 (the "Expiration Date"). The Rights will be valueless thereafter. Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the Common Stock outstanding or the holder's FHP Ownership Percentage (as defined herein), whichever is greater. See "The Offering--Exercise Cap." Holders of Rights are encouraged to consider carefully with their tax and financial advisors the exercise or sale of the Rights prior to their expiration, since they become valueless once they expire. Failure to take any action with respect to the Rights could have adverse tax and financial consequences, including the recognition of short-term loss equal to the basis in the Rights. See "The Offering--Certain Federal Income Tax Consequences." The Rights and the Common Stock have been approved for quotation on the Nasdaq National Market under the symbols "TMMCR" and "TMMC," respectively. Trading in the Rights will cease on the Expiration Date. AN INVESTMENT IN THE COMMON STOCK IS SUBJECT TO SUBSTANTIAL RISK OF LOSS. SEE "RISK FACTORS" BEGINNING ON PAGE 12 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. --------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
PROCEEDS TO PRICE TO PUBLIC COMPANY(1) Per Share............................................................... $21.50 $21.50 Total................................................................... $59,501,250 $59,501,250
(1) Does not include expenses of the Offering payable by FHP estimated at $ . ------------------------ The date of this Prospectus is February , 1997 TALBERT MEDICAL CENTERS The following maps indicate the location of each medical center currently operated by the Company: [MAP] OF SOUTHERN CALIFORNIA MEDICAL CENTERS [MAP] OF UTAH MEDICAL CENTERS [MAP] OF ARIZONA MEDICAL CENTERS [MAP] OF NEW MEXICO MEDICAL CENTERS [MAP] OF NEVADA MEDICAL CENTERS 2 PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. THE COMPANY The Company, through its wholly-owned subsidiary, Talbert Medical Management Corporation, a Delaware corporation ("TMMC"), organizes and manages physician and dentist practice groups that contract with health maintenance organizations ("HMOs") and other payors to provide health care services to their members. As of September 30, 1996, TMMC had management services agreements with ten affiliated practice groups and directly employed the physicians in one practice group (collectively, the "Talbert Medical Groups") employing approximately 360 physicians and 80 dentists and providing care through 52 medical, dental and/or vision centers (the "Medical Centers") located in southern California, Utah, Arizona, New Mexico and Nevada. Together with the Talbert Medical Groups, TMMC managed over 303,000 capitated enrollees as of September 30, 1996, and generated, for the year ended December 31, 1995, revenues of more than $495 million. Under a managed care system, HMOs and other payors arrange to provide health care for their members either by employing physicians and other health care professionals directly (the "staff model") or by contracting with independent groups (the "contracted care model"). Under the contracted care model, HMOs often use "capitation" payments (i.e., payments based solely on the number of members enrolled with the medical group) to control costs and minimize risk. However, most physicians practice individually or in small groups that often do not have the administrative capacity, risk management expertise or information systems necessary to manage capitation arrangements with multiple payors. Physician practice management companies ("PPMCs"), such as TMMC, have evolved recently to provide these services, freeing physicians to focus on the practice of medicine. TMMC provides a broad range of practice management services to the Talbert Medical Groups, including (i) provider contract negotiation and administration, (ii) Medicare risk management, (iii) management information systems (development, implementation and maintenance), (iv) medical management (claims administration, utilization and case management, quality assurance and risk management, and physician credentialing and recruitment), and (v) support services (including nursing, billing, collection and accounting). TMMC provides services under a management services agreement with each Talbert Medical Group, and in return is reimbursed for certain clinic operating expenses and receives a management fee based on the Talbert Medical Group's revenues after deducting certain reimbursed clinic operating expenses (except in California, where the management fee is based on the Talbert Medical Group's gross revenues, and in New Mexico, where TMMC directly employs the physicians in the Talbert Medical Group). TMMC currently has management services agreements with four physician practice groups and six dental practice groups. All of the present Talbert Medical Groups were formerly a part of FHP's staff model operations. Over time, the Company intends to seek acquisitions of or affiliations with additional practice groups in new and existing markets. TMMC represents the Talbert Medical Groups in obtaining and negotiating provider agreements with HMOs and other payors. Under a typical provider agreement between a Talbert Medical Group and an HMO, a Talbert Medical Group is responsible for managing all physician-related covered medical care for each member of the HMO enrolled with the Talbert Medical Group, in exchange for a prepaid monthly capitation payment for each such enrollee. Provider agreements generally include shared risk arrangements and other financial incentives designed to encourage the provision of high-quality, cost-effective health care. See "Business--The Company." TMMC and THSC facilitate the provision of such care by providing practice management and ancillary clinical services, respectively, to the Talbert Medical Groups. Capitation payments, copayments and fee-for-service payments provide revenues to the Talbert Medical Groups and provide the basis for TMMC's management fees. The Talbert Medical Groups and TMMC currently have a total of 11 provider agreements with FHP, which accounted for nearly 100% of the 3 Company's revenues for the nine months ended September 30, 1996. The financial results of the Talbert Medical Groups are combined with those of the Company for financial reporting purposes because the assets and non-medical operations of the Talbert Medical Groups are substantially controlled by TMMC. See "Consolidated Financial Statements--Note 1." TMMC has recently entered into provider agreements with a number of other payors on behalf of certain of the Talbert Medical Groups, and expects to further diversify its payor base following its separation from FHP (as described below). Provider agreements with other payors do not currently constitute a significant source of revenue. See "Business--The Company-- Payor Relationships." The Company, through its other wholly-owned subsidiary, Talbert Health Services Corporation, a Delaware corporation ("THSC"), provides ancillary clinical services (including pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physicial therapy) that are entirely dependent upon, and largely integrated with, the business of TMMC. The following table sets forth the number of Medical Centers, affiliated physicians, and capitated enrollees for each of the states in which the Company does business:
CAPITATED MEDICAL AFFILIATED ENROLLEES CENTERS PHYSICIANS (1) (1) ------------- ----------------- ------------ California.............................. 24 206 132,463 Utah.................................... 7 80 109,652 Arizona................................. 14 41 31,460 New Mexico.............................. 5 27 25,504 Nevada.................................. 2 6 4,706 -- --- ------------ Total................................. 52 360 303,785 -- -- --- ------------ --- ------------
- ------------------------ (1) As of September 30, 1996. SEPARATION FROM FHP The Company's predecessor businesses formed a part of the staff model operations of FHP, and had been active in managed care since 1961. Since January 1, 1996, TMMC and THSC have operated as subsidiaries of FHP, providing practice management and ancillary clinical services to the medical groups that formerly were a part of FHP's staff model operations and that provide health care to approximately 15.7% of FHP's members. In July 1996, FHP determined to pursue a tax-free spin-off of TMMC and THSC in the belief that they would be more attractive to other payors if they operated independently from FHP. Soon after FHP's decision to spin off TMMC and THSC, FHP agreed to merge with PacifiCare. FHP and PacifiCare have agreed to abandon the tax-free spin-off of TMMC and THSC, and instead to proceed with the separation of TMMC and THSC from FHP concurrent with the merger of FHP and PacifiCare (the "FHP Merger"). To effect this separation, FHP has agreed to sell its 92.25% equity interest in both TMMC and THSC to the Company at the closing of the FHP Merger (the "Acquisition"). In exchange, FHP will receive rights to purchase 92.25% of the Company's Common Stock, plus a note (the "Talbert Note") for $59,501,250, the estimated proceeds of the Offering if fully subscribed. By virtue of the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock will be converted, in part, into the Rights, which confer upon the holders, collectively, the right to purchase 92.25% of the Company's Common Stock. The Company has agreed to sell to FHP any shares of Common Stock unsubscribed in the Offering in exchange for cancellation of any remaining indebtedness under the Talbert Note. See "Relationship with FHP and PacifiCare Following the Offering--Acquisition Agreement." A diagram and timeline describing these transactions is provided under "The Company--Separation from FHP." 4 If the Offering is not fully subscribed, the unsubscribed portion of the Common Stock will be reacquired by FHP (and, therefore indirectly by the holding company that will own 100% of FHP and PacifiCare as a result of the FHP Merger ("PacifiCare Holdings")). Depending upon the number of shares of Common Stock subscribed for in the Offering, FHP could acquire in excess of 20% of the outstanding Common Stock. The Company and FHP have entered into an agreement with respect to any Common Stock obtained by FHP following the Acquisition (the "Standstill Agreement"). The Standstill Agreement provides, among other restrictions, that if FHP reacquires 20% or less of the Company's outstanding Common Stock after the consummation of the Offering, FHP (i) will vote its shares of Common Stock in accordance with the votes of the non-FHP stockholders, (ii) will not acquire additional shares of Common Stock, (iii) will be subject to certain restrictions with respect to its ability to solicit proxies, make acquisition proposals, become a member of a "group" (as defined in federal securities laws), or otherwise use its holdings of Common Stock to seek to exercise control over the Company's management, and (iv) will be entitled to certain registration rights. See "Description of Capital Stock--Registration Rights." TMMC will continue to provide practice management services to the Talbert Medical Groups following the Acquisition. The Talbert Medical Groups will continue to provide care to enrolled members of FHP under their existing provider agreements until the Effective Time. Pursuant to the terms of the FHP Merger, FHP and the Talbert Medical Groups were required to renegotiate their existing provider agreements to reflect rates based on market capitation rates. New provider agreements covering FHP members (the "New FHP Provider Agreements") will take effect as of the Effective Time. The New FHP Provider Agreements do not provide the subsidies included in the existing provider agreements with FHP and are expected to adversely affect the Company's per enrollee revenue and expenses. See "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." FHP will provide certain administrative services to the Company on an interim basis. FHP also will continue to lease to the Company certain Medical Center facilities and equipment. See "Relationship with FHP and PacifiCare Following the Offering." Prior to the Acquisition, TMMC received, in connection with the FHP Merger, a capital contribution of approximately $68 million, sufficient to increase its net worth to approximately $59 million (the "Capital Contribution"). RISK FACTORS An investment in the Common Stock is subject to substantial risk of loss. See "Risk Factors." THE OFFERING Subscription Price................ $21.50 per share of Common Stock. Basic Subscription Privilege...... FHP stockholders will receive one Right for every 21.40635 shares of FHP Common Stock and one Right for every 26.54228 shares of FHP Preferred Stock held of record at the Effective Time. Each holder of Rights will be entitled to purchase one share of Common Stock for each Right held. The Rights are evidenced by transferable subscription certificates (the "Subscription Certificates"). Additional Subscription Privilege....................... Persons who exercise their Basic Subscription Privilege may purchase additional shares (subject to proration and the limits on exercise described below) from any shares remaining unsubscribed after the exercise of the Basic Subscription Privilege.
5 Exercise Cap...................... Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the shares of Common Stock outstanding. However, holders of FHP Common Stock or FHP Preferred Stock who are the beneficial owners of FHP Common Stock (on an as-if-converted basis) in excess of 8% of the outstanding shares of FHP Common Stock (on an as- if-converted basis) as of the Effective Time (the "FHP Ownership Percentage") may exercise Rights to the extent that their beneficial ownership of Common Stock does not exceed their FHP Ownership Percentage. Subscription Procedure............ Rights may be exercised by delivery of the related Subscription Certificate properly completed and accompanied by full payment for all shares of Common Stock subscribed for pursuant to the Basic Subscription Privilege and the Additional Subscription Privilege to American Stock Transfer & Trust Company (the "Subscription Agent"), on or before the Expiration Date. In the event of a proration of shares of Common Stock to persons exercising the Additional Subscription Privilege, the Subscription Agent will promptly refund, without interest, the amount of any overpayment. Expiration Date................... March , 1997 at 5:00 P.M., Eastern Standard Time. Transferability of Rights......... The Rights are transferable, but no assurance can be given that an active trading market will develop, or if a market develops, that it will continue until the expiration of the Rights. Proceeds of the Offering.......... If fully subscribed, the Offering will result in proceeds of approximately $59.5 million. The proceeds of the Offering will be used entirely to repay indebtedness to FHP incurred in the Acquisition. Prior to the Acquisition, TMMC will receive, in connection with the FHP Merger, the Capital Contribution, to increase its net worth to approximately $59 million. Listing........................... The Rights and the Common Stock have been approved for quotation on the Nasdaq National Market under the symbols "TMMCR" and "TMMC," respectively. Trading in the Rights will cease on the Expiration Date. Fractional Rights................. No fractional Rights will be issued to FHP stockholders. The Subscription Agent will determine the aggregate number of fractional Rights that would have been issued to FHP stockholders had fractional Rights been issued. The Subscription Agent will sell, if practicable, the nearest whole number of Rights and remit the net proceeds, if any, to FHP stockholders based on the number of fractional Rights they would have received. Information Agent................. Georgeson & Company Inc. will serve as Information Agent for the Offering. Any questions or requests for assistance concerning the method of subscribing for Common Stock or additional copies of this Prospectus can be directed to the Information Agent. The Information Agent's telephone number is (800) 223-2064.
6 SUMMARY CONSOLIDATED FINANCIAL DATA The following summary consolidated financial data sets forth, for the periods and dates indicated, summary consolidated financial data of the Company and its subsidiaries (including the Talbert Medical Groups) derived from the historical consolidated financial statements of its predecessors. The consolidated statement of operations data presented below for the years ended December 31, 1993, 1994 and 1995, and the consolidated balance sheet data at December 31, 1994 and 1995 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Prospectus. The consolidated statement of operations data for the years ended December 31, 1991 and 1992, and the nine months ended September 30, 1995 and 1996, and the consolidated balance sheet data at December 31, 1991, 1992 and 1993, and September 30, 1995 and 1996 are derived from unaudited consolidated financial statements of the Company and its subsidiaries that are not included herein. The summary consolidated financial data presented below are qualified by reference to the consolidated financial statements included elsewhere in this Prospectus and should be read in conjunction with such financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue (2)(3).............. Capitation................ $ 322,233 $ 366,911 $ 425,141 $ 450,964 $ 437,493 $ 339,070 $ 293,085 Copayments, fee-for-service and other................... 30,320 35,688 45,742 52,374 55,206 40,295 58,150 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total revenue........... 352,553 402,599 470,883 503,338 495,699 379,365 351,235 Expenses Affiliated medical services................ 128,224 153,387 170,690 173,230 173,417 132,051 103,504 Purchased medical services................ 69,459 84,307 110,582 124,083 121,570 94,133 85,851 Dental services........... 13,970 16,128 20,129 28,955 31,379 24,544 20,443 Optometry, pharmacy and other primary health care services........... 52,999 70,702 86,985 96,275 102,412 77,395 80,181 Clinic operations......... 76,992 78,662 80,853 87,253 85,585 68,235 49,207 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total cost of health care.................. 341,644 403,186 469,239 509,796 514,363 396,358 339,186 Marketing, general and administrative.......... 20,606 22,569 24,002 26,675 29,698 22,188 19,622 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Operating loss.............. (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (7,573) Interest income (4)......... -- -- -- -- -- -- 1,199 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit................... (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (6,374) Income tax benefit.......... (3,873) (9,244) (8,924) (13,553) (19,754) (16,005) (2,604) ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net loss (5)................ $ (5,824) $ (13,912) $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss per common and common equivalent share (6)...... $ (1.94) $ (4.64) $ (4.48) $ (6.54) $ (9.55) $ (7.74) $ (1.26) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
7
DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Working capital (5)......... $ (18,105) $ (17,937) $ (18,087) $ (18,742) $ (18,638) $ (18,101) $ (10,779) Total assets (5)............ 10,614 14,003 18,926 23,087 23,178 19,779 51,731 Long-term obligations....... -- -- -- -- -- -- -- Stockholders' deficit (5)(7).................... (17,425) (17,276) (17,475) (18,113) (17,886) (17,519) (3,670)
- ------------------------ (1) Reflects financial information relating to the historical staff model operations of FHP prepared in part from separate records maintained by subsidiaries of FHP. This information also reflects certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." (2) Revenue is derived from prepaid capitation fees for ambulatory services, plus patient co-payments and fee-for-service payments. The Company did not incur any hospital risk for the periods presented. (3) Nearly 100% of revenue is received pursuant to existing provider agreements with FHP. The New FHP Provider Agreements will take effect as of the Effective Time. The pro forma financial data presented elsewhere herein reflect, in part, the effects of the New FHP Provider Agreements as if such agreements had been in effect for the periods indicated. (4) Prior to January 1, 1996, all available cash balances, and the interest income on such cash balances, were retained by FHP. (5) Does not reflect the Capital Contribution to be made prior to the Acquisition and the resulting compensation expense, nor the compensation expense related to the options granted by the Board of Directors in November 1996, as reflected in the pro forma financial data presented elsewhere herein. (6) Loss per common and common equivalent share is computed based on 2,996,104 common equivalent shares outstanding for all periods presented. Equivalent shares of Common Stock include the effect of options to purchase 70,350 shares of Common Stock granted in September 1996 and options to purchase 39,636 shares of Common Stock granted in November 1996. Pursuant to the Commission Staff Account Bulletin Topic 4:D, stock options granted during the twelve-month period prior to the date of the initial filing of the Registration Statement have been included in the calculation of common equivalent shares using the treasury stock method (considering the assumed proceeds from the stock options and the number of shares that could have been repurchased using the estimated initial public price) as if the shares were outstanding for all periods presented, even if the impact of the incremental shares is anti-dilutive. (7) Prior to January 1, 1996, stockholders' deficit fluctuated as a result of various intercompany transactions with FHP. On January 1, 1996, FHP recapitalized TMMC, resulting in the elimination of a deficit of $17,886,000. 8 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA The following unaudited pro forma condensed consolidated financial data for the year ended December 31, 1995 and the nine months ended September 30, 1996, and the pro forma condensed consolidated balance sheet data at September 30, 1996, present the results of operations and financial position of the Company for and as of the periods indicated as if the following events had occurred, on January 1, 1995 with respect to the unaudited consolidated statement of operations data, or on September 30, 1996 with respect to the unaudited consolidated balance sheet data: (i) the New FHP Provider Agreements had taken effect; (ii) the Capital Contribution had been received and certain related compensation expense had been recognized; and (iii) stock options granted to management in November 1996 (the "November 1996 Options") had been granted and certain related compensation expense had been recognized. These developments are described further below. In November 1996, the Company renegotiated the Talbert Medical Groups' provider agreements with FHP. The New FHP Provider Agreements, which become effective as of the Effective Time, will result in significantly lower revenues and higher expenses per enrollee based on assumed capitation rates reflected in the historical financial statements included elsewhere in this Prospectus. The accompanying unaudited pro forma condensed consolidated statement of operations data includes the pro forma effect of the New FHP Provider Agreements as if they had been in effect during the year ended December 31, 1995 and the nine months ended September 30, 1996. See "Relationship with FHP and PacifiCare Following the Offering." Just prior to the Offering, FHP is expected to contribute approximately $68 million to TMMC, which is expected to result in a stockholders' equity balance of approximately $59 million. In connection with the Capital Contribution, the Company will recognize as stock compensation expense approximately $5.3 million (assuming a Capital Contribution of $68 million) relating to the shares of Common Stock owned by management and others who will not be making a capital contribution. As management and others who own 7.75% of the outstanding shares of the Company will not be making a capital contribution, the Company will recognize stock compensation expense representing the portion of the contribution made by FHP that could be deemed to accrue to those investors. Total compensation expense of $5.3 million (7.75% of the total Capital Contribution of $68 million) will be recognized ratably over the vesting period of the restricted shares of Common Stock held by management and others. Approximately 25% of such restrictions lapsed in July 1996 and the remainder are assumed to lapse ratably each July through 1999. Approximately $1.3 million of the stock compensation expense is expected to be recognized on the date of the Capital Contribution in connection with previously issued restricted shares for which restrictions have already lapsed. See "Certain Transactions." In November 1996, the Board of Directors authorized the issuance of options with respect to 39,636 shares of the Company's Common Stock to management at an exercise price of $10.00 per share. The November 1996 Options vest 40% on December 31, 1996 and 15% each January 1 from 2000 to 2003. Based on an assumed fair value of the Common Stock of $29.17 per share on the date of grant, the grant of the November 1996 Options gives rise to deferred compensation expense of approximately $760,000, of which approximately $304,000 will be recognized in December 1996. The accompanying unaudited pro forma condensed consolidated financial data assume the granting of these options on January 1, 1995. See "Management--Stock Incentive Plan." The accompanying unaudited pro forma condensed consolidated financial data is provided for informational purposes only and does not purport to present the consolidated financial position or results of operations of the Company had the New FHP Provider Agreements, the Capital Contribution and the grant of the November 1996 Options occurred on the dates specified, nor are they necessarily indicative of the results of operations that may be expected in the future. 9 The unaudited pro forma condensed consolidated financial data should be read in conjunction with the historical consolidated financial statements, and the notes thereto, included elsewhere in this Prospectus.
YEAR ENDED DECEMBER 31, 1995 NINE MONTHS ENDED SEPTEMBER 30, 1996 --------------------------------------------- ---------------------------------------- HISTORICAL (1) ADJUSTMENTS AS ADJUSTED HISTORICAL ADJUSTMENTS AS ADJUSTED -------------- ------------ ----------- ----------- ------------ ----------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue Capitation................... $ 437,493 $ (36,258)(4a) $ 401,235 $ 293,085 $ (26,284)(4a) $ 266,801 Copayments, fee-for-service and other.................... 58,206 58,206 58,150 58,150 -------------- ------------ ----------- ----------- ------------ ----------- Total revenue.............. 495,699 459,441 351,235 324,951 Expenses Affiliated medical services................... 173,417 -- 173,417 103,504 -- 103,504 Purchased medical services... 121,570 6,887(4b) 128,457 85,851 5,287(4b) 91,138 Dental services.............. 31,379 -- 31,379 20,443 -- 20,443 Optometry, pharmacy and other primary health care services................... 102,412 10(4b) 102,422 80,181 6(4b) 80,187 Clinic operations............ 85,585 -- 85,585 49,207 -- 49,207 -------------- ------------ ----------- ----------- ------------ ----------- Total cost of health care................... 514,363 6,897 521,260 339,186 5,293 344,479 Marketing, general and 1,318(5) administrative................ 29,698 304(6) 31,320 19,622 988(5) 20,610 -------------- ------------ ----------- ----------- ------------ ----------- Operating loss................. (48,362) (44,777) (93,139) (7,573) (32,565) (40,138) Interest income................ -- 1,870(7) 1,870 1,199 -- 1,199 -------------- ------------ ----------- ----------- ------------ ----------- Loss before income taxes....... (48,362) (42,907) (91,269) (6,374) (32,565) (38,939) Income tax provision (benefit) (2)........................... (19,754) 19,754 -- (2,604) 2,604 -- -------------- ------------ ----------- ----------- ------------ ----------- Net loss....................... $ (28,608) $ (62,661) $ (91,269) $ (3,770) $ (35,169) $ (38,939) -------------- ------------ ----------- ----------- ------------ ----------- -------------- ------------ ----------- ----------- ------------ ----------- Loss per common and common equivalent share (3).......... $ (9.55) $ (20.91) $ (30.46) $ (1.26) $ (11.74) $ (13.00) -------------- ------------ ----------- ----------- ------------ ----------- -------------- ------------ ----------- ----------- ------------ -----------
SEPTEMBER 30, 1996 ---------------------------------------- HISTORICAL ADJUSTMENTS AS ADJUSTED ----------- ------------ ----------- (AMOUNTS IN THOUSANDS) PRO FORMA CONSOLIDATED BALANCE SHEET DATA(8): Working capital................................................. $ (10,779) $ 68,000 $ 57,221 Total assets.................................................... 51,731 68,000 119,731 Long-term obligations........................................... -- -- -- Stockholders' equity (deficit).................................. (3,670) 61,970 58,300
- -------------------------- (1) Reflects financial information relating to the historical staff model operations of FHP prepared in part from separate records maintained by subsidiaries of FHP. This information also reflects certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." (2) Adjusted to eliminate the historical tax benefit of the Company that was utilized in FHP's consolidated return. No pro forma tax benefit has been provided because it is not likely that the Company will generate sufficient taxable income to realize its deferred tax assets. Assuming the Company were separated from FHP as of January 1, 1996, its pro forma deferred tax assets would have been $19,754,000 and $22,358,000, as of December 31, 1995 and September 30, 1996, respectively, with a corresponding valuation allowance of the same amount. (3) Loss per common and common equivalent share is computed based on 2,996,104 common equivalent shares for all periods presented. Equivalent common shares include the effect of options to purchase 70,350 shares of Common Stock granted in September 1996 and options to purchase 39,636 shares of Common Stock granted in November 1996. Pursuant to the Commission Staff Account Bulletin Topic 4:D, stock options granted during the twelve-month period prior to the date of the initial filing of the Registration Statement have been included in the calculation of 10 common equivalent shares using the treasury stock method (considering the assumed proceeds from the stock options and the number of shares that could have been repurchased using the estimated initial public price) as if the shares were outstanding for all periods presented, even if the impact of the incremental shares is anti-dilutive. (4) Adjusted to reflect the effect of the New FHP Provider Agreements: a. Revenue. The New FHP Provider Agreements reduce the Company's monthly capitation fee for each member enrolled with the Talbert Medical Groups. The effective rate decrease is estimated to yield an aggregate 7.3% reduction in the monthly capitation received by the Company for each of the periods presented. The revenue adjustment was calculated by multiplying the actual enrollees served within each of the periods reported by the 7.3% net monthly capitation fee reduction. b. Health care expense. Adjustments reflect the estimated costs attributable to specific additional medical services that the Talbert Medical Groups have agreed to provide with the capitation fee. Expense adjustment is based upon each added health care service multiplied by the actual per enrollee cost for the service multiplied by the actual number of enrollees served within the periods presented. Costs of these added health care services were formerly paid by FHP. (5) Adjusted to reflect the amortization of stock compensation expense as if the Capital Contribution of $68,000,000 had been made at January 1, 1995. The actual Capital Contribution by FHP will be the amount necessary to eliminate the Company's deficit at the Effective Time and to provide a stockholders' equity of approximately $59,000,000, but will not exceed $70,000,000. Amortization of deferred stock compensation expense assumes the restrictions on the shares issued to management lapse ratably over the four-year period starting January 1, 1995. Accordingly, stock compensation expense of approximately $1,318,000 (25% of the total stock compensation expense of $5,270,000) was recognized on a pro forma basis for the year ended December 31, 1995 and stock compensation expense of $988,000 (representing nine months amortization of the annual expense of $1,318,000) was recognized on a pro forma basis during the nine months ended September 30, 1996. (6) Adjusted to reflect compensation expense of $304,000 arising from the grant of the November 1996 Options at an exercise price of $10.00 per share for shares whose fair market value on the date of grant was determined by the Board of Directors to be $29.17 per share. Assumes the options were granted on January 1, 1995 and that options with respect to 40% of the shares vested during 1995. (7) Adjusted to reflect assumed interest earnings, at an assumed average investment return of 5.5% of the Capital Contribution of $68,000,000, as if made on January 1, 1995. (8) Adjusted to reflect the assumed impact on balance sheet data as if the Capital Contribution of $68,000,000 was made and the related stock compensation expense of $1,318,000 and deferred stock compensation expense of $3,952,000 were recognized as of September 30, 1996. Also adjusted to reflect the assumed impact of compensation expense arising from the grant of options to acquire 39,636 shares of Common Stock in November 1996 at an exercise price of $10.00 per share. Based on an assumed fair market value of $29.17 per share on the date of grant, compensation expense of approximately $760,000 will be recognized, of which 40% or $304,000 is deemed recognized as of September 30, 1996 and the remaining $456,000 will be recognized as the remaining options vest beginning in 2000. 11 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE FACTORS LISTED BELOW IN EVALUATING AN INVESTMENT IN THE COMMON STOCK. SUBSTANTIAL OPERATING LOSSES; CAPITAL REQUIREMENTS FHP's staff model operations, which comprise the Company's predecessor businesses, have experienced substantial operating losses over the last five years arising, in part, from the increased competition of contracted care model HMOs. For the nine months ended September 30, 1996, the Company incurred losses before income tax benefit of $6.4 million, compared to $39.2 million for the nine months ended September 30, 1995. The Company incurred losses before income tax benefit of $48.4 million for the year ended December 31, 1995, and $33.1 million for the year ended December 31, 1994. Subsidies from FHP have offset losses incurred in these and in prior periods, but FHP will not provide such subsidies following the Offering. The renegotiation of the New FHP Provider Agreements, required pursuant to the terms of the FHP Merger, will result in a material decrease in revenues per enrollee for the year ending December 31, 1997. See "Prospectus Summary--Unaudited Pro Forma Condensed Consolidated Financial Data." Although management believes this decrease will be offset, in part, by continuing operating improvements, management nevertheless believes that it is likely that the Company will incur substantial losses during 1997 and 1998, and will not generate positive cash flow for those periods. Future operating results will depend on the Company's ability to attract and retain substantial numbers of additional enrollees and physician practice groups and to control costs. There can be no assurance that the Company will generate positive cash flows or profits in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Prior to the Company's acquisition of TMMC, TMMC will receive, in connection with the FHP Merger, the Capital Contribution to increase its net worth to approximately $59 million. The Company intends to use these funds to fund operating losses and for working capital and other general corporate purposes. However, there can be no assurance that these funds will be sufficient for the Company's capital requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON FHP The Company and the Talbert Medical Groups derive nearly all of their revenues from provider agreements with payors, such as HMOs. Prior to 1996, FHP was the only payor to have contracts with the Talbert Medical Groups. For the years ended December 31, 1993, 1994 and 1995, and for the nine months ended September 30, 1996, FHP members accounted for nearly 100% of the Company's revenue. The Company intends to reduce its dependence on FHP by seeking payors for the Talbert Medical Groups in addition to those already served, but there can be no assurance that additional provider agreements can be obtained or if obtained, would result in significant numbers of additional enrollees. Moreover, the loss of any FHP contracts, subsequent renegotiation of the terms of FHP's contracts, or the failure to regain or retain FHP's members, could have a material adverse effect on the Company. See "Business--The Company." In addition, the loss by FHP of a significant number of the members who are enrolled with the Talbert Medical Groups, including, without limitation, any loss of members resulting from the FHP Merger, could have a material adverse effect on the Company. In that regard, FHP has indicated that its competitors may use the announcement of the FHP Merger to solicit employer groups currently served by FHP. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company has historically relied upon FHP to provide certain administrative and other services. FHP will provide certain information services on an interim basis following the Offering. The Company will rely on third parties to provide other services formerly received from FHP, which services may not be available at comparable rates. See "Relationship with FHP and PacifiCare Following the Offering." 12 CONTRACTED RATE DECREASE FHP's existing provider agreements with the Talbert Medical Groups provide a subsidy to offset, in part, the Talbert Medical Groups' operating losses. As of the Effective Time, these provider agreements will be replaced with the New FHP Provider Agreements that do not provide for this support. Management therefore anticipates that the Company will incur substantial operating losses in 1997 and 1998. On a pro forma basis, the New FHP Provider Agreements would have resulted in an additional operating loss of approximately $31.6 million for the nine months ended September 30, 1996, and approximately $43.1 million for the year ended December 31, 1995. Although the Capital Contribution in connection with the FHP Merger is intended, in part, to offset the projected shortfall in cash flows from the change to the New FHP Provider Agreements, there can be no assurance that this amount will be sufficient for the Company's capital requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." CAPITATED NATURE OF REVENUE For the nine months ended September 30, 1996, approximately 100% of the Company's revenue related to provider agreements under which the Talbert Medical Groups received a prepaid monthly capitation fee for each member enrolled with the Group and certain utilization-based incentive payments, in exchange for assuming the responsibility to provide specified medical services to enrollees. Because a significant portion of the Company's revenue is derived from these fees, and because the Company has in certain cases guaranteed the ability of the Talbert Medical Groups to perform their contractual obligations, its success depends in large part on the effective management of health care costs, including controlling utilization of specialty care physicians and other ancillary providers and purchasing services from third-party providers at competitive prices. In addition, as capitation fees are based on a percentage of premiums received by payors such as HMOs, any decreases in premiums could result in lower capitation fees being paid to the Talbert Medical Groups. An unusually high number of catastrophic claims (such as organ transplants and costly premature births) in a given period may cause substantial additional health care costs. Although management believes that the Company's cost control measures, which include risk-sharing arrangements between the Talbert Medical Groups and the payors with which they contract, as well as with administrative and medical review of health care delivery services, will help mitigate these effects, such costs may periodically affect the Company's results of operations. Changes in health care practices, Medicare reimbursements, revised treatment protocols, new technologies, inflation, epidemics, disasters and other factors affecting the delivery and cost of health care that are or may be beyond the Company's control may adversely affect the Company's operating results. See "Business." LIMITED OPERATING HISTORY; NEW BUSINESS STRATEGY Although FHP's staff model operations have been in existence since 1961, the Company did not begin operating as a separate entity until January 1996. The Company therefore has a very limited operating history as a PPMC. The Company, TMMC, THSC and the Talbert Medical Groups are seeking to transform themselves from a captive staff model operation to an independent contracted care business. The success of this new business strategy will depend on the Company's ability to adapt its practices and culture to the contracted care environment. Among other challenges, the Company must attract and retain substantial numbers of capitated enrollees to the Talbert Medical Groups from additional payors, manage the delivery of health care to enrollees in a cost-efficient manner under market-based contracts, and respond to developments in a highly competitive and rapidly changing industry. Although in the past the Company has relied nearly exclusively on FHP to generate revenues, the Company anticipates that its future operating results will be dependent upon additional sources of revenue. See "Business--The Company--Payor Relationships." There can be no assurance that the Company will be able to address these challenges successfully. 13 POSSIBLE CONTROLLING INTEREST OF FHP FHP may acquire a controlling interest in the Company if the Company is unable to raise sufficient funds through the Offering to repay a significant portion of its indebtedness under the Talbert Note. If FHP retains a substantial equity interest in the Company following consummation of the Offering, other payors may be discouraged from contracting with the Company. If FHP holds in excess of 20% of the Company's outstanding Common Stock, certain restrictions otherwise applicable to FHP's activities as a stockholder of the Company will cease. If FHP holds in excess of 50% of the Company's outstanding Common Stock, certain agreements between the Company and FHP will be null and void. Under the New FHP Provider Agreements, the consent of FHP and PacifiCare is required for a proposed change in control of TMMC or a Talbert Medical Group for a period of two years from the Effective Time, which consent cannot be unreasonably withheld. See "Relationship with FHP and PacifiCare Following the Rights Offering." DEPENDENCE ON PRIMARY CARE PHYSICIANS Primary care physicians are an integral part of the Talbert Medical Groups, as they provide and manage medical services offered to enrollees. The Company's growth depends, in part, on its ability to retain existing primary care physicians and attract additional ones. Beginning in January 1997, the Company intends to implement a revised physician compensation program that will include a greater emphasis on performance-based incentives. As a result of the revised compensation system, the New FHP Provider Agreements, or other developments, there can be no assurance that physicians presently in the Talbert Medical Groups will not leave, that the Company will be able to attract additional primary care physicians into the Talbert Medical Groups or that the Company will not have to increase or guarantee the payments receivable by affiliated physicians. To the extent that primary care physicians leave, or additional primary care physicians do not join, the Talbert Medical Groups or payments to physicians are increased, the Company's results of operations may be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Although physicians in the Talbert Medical Groups enter into employment agreements that include non-competition provisions, there can be no assurance that physicians who leave a Talbert Medical Group will not attempt to compete with that group. See "Business--The Company--Contractual Relationships." OPEN ENROLLMENT PERIODS; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company's operating results are subject to seasonal fluctuations. HMOs typically have annual "open enrollment" periods for commercial customers, during which new members may enroll or existing members may renew or leave the HMO. Transfers of enrollees from one payor to another, particularly during open enrollment periods, could impact quarterly results. A substantial portion of FHP's current commercial membership is subject to open enrollment programs occurring in January and February 1997. Any failure by FHP to maintain or increase commercial enrollment in the Company's markets during this period could have a significant adverse effect on the Company's future revenues, earnings, cash flows and financial position. The Company's costs fluctuate quarterly, based on the overall health of its patient population. Enrollees, particularly seniors, typically require more care during the winter months. Because capitation payments are not adjusted on a seasonal basis to account for fluctuations in required care, the Company's costs may increase in proportion to its revenues during such periods. Quarterly results also may be affected by significant differences between actual and estimated amounts receivable or payable for payor "shared risk" arrangements and provider "incurred but not yet reported" claims ("IBNR"), that are adjusted periodically, in the case of "shared risk" arrangements, as settlements are made and, in the case of IBNR, as actual claims adjustments occur. 14 DEPENDENCE UPON KEY PERSONNEL The Company is dependent upon the services of certain of its executive officers for management and implementation of strategy. The loss to the Company of the services of any of these executive officers could have a material adverse effect upon the Company's future operations. The Company has entered into change of control employment agreements with certain of its key personnel to provide compensation assurances to such officers in the event of a change of control of the Company. See "Management-- Change of Control Employment Agreements." The Company has not purchased key-man life insurance with respect to such individuals. COMPOSITION OF BOARD OF DIRECTORS AND MANAGEMENT; POTENTIAL CONFLICTS OF INTEREST The Company's Board of Directors includes eight current directors of FHP, including Jack R. Anderson and Joseph F. Prevratil. Messrs. Anderson and Prevratil have been designated by FHP to be directors of PacifiCare Holdings following the FHP Merger. Most of the Company's senior management is also comprised of former FHP executives. All of the Company's directors and executive officers have received PacifiCare Holdings common or preferred stock in exchange for their FHP Common Stock or FHP Preferred Stock in the FHP Merger. These individuals may encounter conflicts of interest to the extent that the interests of the Company diverge from those of FHP, PacifiCare or PacifiCare Holdings. See "Management." The Company has entered into transactions with certain of its executives with respect to the purchase of Common Stock, the grant of options to purchase Common Stock, and employment agreements in the event of a change of control of the Company. See "Certain Transactions," "Management--Stock Incentive Plan," and "--Change of Control Employment Agreements." ABSENCE OF PRIOR PUBLIC MARKET AND POSSIBLE PRICE VOLATILITY Prior to the Offering there has been no public market for the Rights or the Common Stock, and there can be no assurance that an active trading market will develop or be sustained in the future, or that the market price of the Common Stock will not decline below the Subscription Price. The Subscription Price was determined through negotiation between FHP and PacifiCare, and may not be indicative of the market price of the Common Stock after the Offering. See "The Offering." From time to time after the Offering, the market price of the Common Stock could be subject to significant fluctuations in response to such factors as quarterly operating results, general trends in the economy, the financial markets or the health care industry, changes in estimates of the Company's earnings or financial position, the impact of health care reform proposals and other developments affecting the Company or its competitors, many of which are beyond the Company's control. MANAGEMENT OF GROWTH The Company's strategy involves growth through the development of practice groups in existing and new markets, as well as selected acquisitions and affiliations in such markets. There can be no assurance that the Company will be able to grow in existing or new markets or successfully identify, complete and integrate future acquisitions. Further, there can be no assurance that the Company will be able to maintain and develop an adequate infrastructure to support future growth. See "Business." POSSIBLE DILUTIVE EFFECT OF USING COMMON STOCK FOR FUTURE ACQUISITIONS OR AFFILIATIONS The Company's expansion strategy includes acquisitions of, and affiliations with, additional practice groups and practice management companies. Such acquisitions or affiliations may be consummated using newly issued shares of Common Stock as consideration. The issuance of additional shares of Common Stock may have a dilutive effect on the Company's tangible net book value or earnings per share following such issuance. 15 COMPETITION The managed care industry is highly competitive. The industry also is subject to continuing changes in the ways services are provided and providers are selected and paid. As prepaid medical care continues to grow, the Company may encounter increased competition, including competition for enrollees, primary care physicians, community health care resources and management personnel. This competition also may have the effect of reducing capitated payments received by providers from payors. FHP, the Company's principal source of capitated enrollees, has experienced significant competition with respect to its staff model commercial enrollment programs in California in recent periods, which has been responsible, in part, for declines in the Company's capitated enrollment. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Certain companies are expanding their presence in the physician practice management industry and in certain geographic markets in which the Company operates. A number of companies provide broad management services to primary, multi-specialty and specialty physician groups, while other companies provide claims processing, utilization review and other more focused management services. Certain of the Company's competitors are significantly larger, have access to greater resources, have greater experience in providing administrative services and have longer established relationships with buyers of these services. No assurance can be given that the Company's strategy will allow it to compete favorably in obtaining payor contracts for its affiliated medical groups or expanding or maintaining its position in existing or new markets. See "Business--Competition." GOVERNMENT REGULATION The health care industry is subject to extensive federal and state regulation. Changes in the regulations or reinterpretations of existing regulations may significantly affect the Company. CORPORATE PRACTICE OF MEDICINE; INSURANCE. The laws of certain states in which the Company operates or may operate in the future do not permit general business corporations to practice medicine, exercise control over physicians who practice medicine or engage in certain business practices such as fee-splitting with physicians. The Talbert Medical Groups currently operate in certain states through professional corporations. The Company believes that it neither engages in the corporate practice of medicine in states where it is prohibited from doing so, nor controls the practice of medicine by physicians within the Talbert Medical Groups. See "Business." Laws of all states regulate the business of insurance, and certain of the risk arrangements entered into by the Talbert Medical Groups could, in the future, possibly be characterized by some states as the business of insurance. The Company believes that it is in compliance with applicable regulatory requirements. No assurance can be given, however, that regulatory authorities, courts or parties with which the Company does business will not assert that the Company is engaged in the corporate practice of medicine or the business of insurance and seek relief prohibiting the Company or its affiliates from carrying on their respective businesses or voiding existing contractual relationships. If such assertions are made, the Company may be required to sever or restructure payor contracts or its management services agreements with the Talbert Medical Groups. Any such severing or restructuring could have a material adverse effect on the Company. LIMITATIONS ON REFERRALS. The Company is subject to federal legislation regulating certain activities to induce Medicare or Medicaid business and restricting referrals of business to entities in which physicians have a financial interest. The Company believes it is in compliance with the laws governing Medicare, Medicaid, physician referrals and insurance, but if it were determined to be in violation of any such law, the Company could be subject to significant fines or other penalties and could be required to restructure its operations in a material manner. "See Business--Government Regulation." 16 HEALTH CARE REFORM Diverse legislative and regulatory initiatives have been proposed at both the federal and state levels to address both the continuing increases in health care costs and the lack of health care insurance for many people. Among other legislation, Congress has considered major reductions in the rate of increase of Medicare and Medicaid spending as part of efforts to balance the federal budget. State legislatures also have discussed restructuring Medicaid programs and adopting "any willing provider" legislation. Certain of the proposals, if adopted, could have a material adverse effect on the Company. See "Business-- Government Regulation." POTENTIAL CLAIMS AFFECTING THE COMPANY'S INDUSTRY; INSURANCE In recent years physicians, hospitals and other participants in the health care industry have become subject to an increasing number of lawsuits alleging medical malpractice, bad faith denial of services and other claims for recovery in connection with alleged injuries or misconduct. Many of these lawsuits involve large claims and substantial defense costs. The Company maintains professional malpractice and general liability insurance on behalf of itself and the Talbert Medical Groups in amounts deemed appropriate by management based on the nature and risks of the Company's business. Although the Company currently is not a party to any material litigation relating to the practice of medicine, there can be no assurance that the Company will not become involved in such litigation in the future, that claims arising from such litigation will not exceed the Company's insurance coverage or that such coverage will continue to be available. See "Business--Risk Management Program." CLASSIFICATION OF PHYSICIANS AS INDEPENDENT CONTRACTORS Physicians and other health care professionals not employed directly by the Talbert Medical Groups are regarded as independent contractors. The Talbert Medical Groups and the Company do not withhold federal or state income taxes, make federal or state unemployment tax payments or provide workers' compensation insurance with respect to these independent contractors. The payment of applicable taxes is regarded as the responsibility of each independent contractor. The Company believes that its classification of these health care professionals as independent contractors is proper for federal and state tax purposes. A contrary determination by federal taxing authorities, or a change in existing law, could have a material adverse effect on the Company's operating results. Congress is considering, in connection with health care reform, certain measures that would modify the rules for classifying workers as independent contractors. The Company cannot predict the impact of such measures on the Company. ANTI-TAKEOVER CONSIDERATIONS Certain provisions of the Rights, the Company's Certificate of Incorporation and Bylaws, Delaware law and the agreements to which the Company is a party could, together or separately, discourage potential acquisition proposals, delay or prevent a change in control of the Company and limit the price that certain investors might be willing to pay in the future for shares of the Common Stock. Rights may not be exercised to the extent that the holder would become the beneficial holder of more than 8% of the Common Stock outstanding or the holder's FHP Ownership Percentage (as defined herein), whichever is greater. See "The Offering--Exercise Cap." Following the completion of the Offering, the Company's Stockholder Rights Agreement may delay or prevent a change in control of the Company by giving holders of such rights the opportunity to purchase Common Stock at a discount. See "Description of Capital Stock--Certain Anti-Takeover Effects." The New FHP Provider Agreements provide that the consent of FHP and PacifiCare is required for any proposed sale or change in control of TMMC or a Talbert Medical Group during the first two years of their term, which consent will not unreasonably be withheld. See "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." 17 SHARES ELIGIBLE FOR FUTURE SALE FHP has certain registration rights with respect to any Common Stock it may acquire as a result of an undersubscription of the Offering. The number of shares subject to such rights, if any, will depend on the extent to which the Offering is undersubscribed. Certain members of management also have registration rights with respect to their restricted shares of Common Stock. Approximately 232,500 shares of Common Stock are subject to such rights. See "Description of Capital Stock--Registration Rights." 18 THE COMPANY The Company was incorporated in Delaware in November 1996 to serve as a holding company for TMMC and THSC in connection with their separation from FHP as a result of the FHP Merger. The Company's principal executive offices are located at 3540 Howard Way, Costa Mesa, California 92626-1417 and its telephone number at that address is (714) 436-4800. BACKGROUND The Company's predecessor businesses formed a part of the staff model operations of FHP, which had been active in managed care since 1961. In June 1995, FHP announced a plan to restructure its operations, which included the transformation of its staff model operations into a PPMC, an ancillary clinical services provider and a number of affiliated professional corporations. TMMC and THSC were formed as subsidiaries of FHP to provide physician practice management and ancillary clinical services, respectively, to the practice groups. A number of professional corporations were organized in California, Utah, Arizona and Nevada to succeed to FHP's staff model provider practice and become the Talbert Medical Groups in those states. In New Mexico, TMMC directly employs the former FHP physicians and acts as the Talbert Medical Group for that state. SEPARATION FROM FHP In July 1996, FHP determined to pursue a tax-free spin-off of TMMC and THSC in the belief that they would be more attractive to other payors if they operated independently from FHP. Soon after this decision, FHP agreed to merge with PacifiCare. FHP and PacifiCare have agreed to abandon the tax-free spin-off of TMMC and THSC, and instead to proceed with the separation of TMMC and THSC from FHP concurrent with the FHP Merger through the transactions described below: [CHART] 19 Concurrent with the FHP Merger: (1) TMMC received the Capital Contribution of approximately $68 million to increase its net worth to approximately $59 million. (2) The management and other investors ("MIs") exchanged their aggregate 7.75% equity interests in TMMC and THSC for an equivalent interest in the Company. (3) The Company purchased from FHP its 92.25% equity interest in TMMC and THSC in exchange for Rights to purchase 92.25% of the Company's Common Stock, plus the Talbert Note. (4) In connection with the FHP Merger, FHP transferred the Rights to PacifiCare Holdings. (5) By virtue of the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock were converted, in part, into the Rights, which confer upon FHP's stockholders ("FHP SHs"), collectively, the right to purchase 92.25% of the Company's Common Stock. During the Offering: (6) The Rights holders may, through the exercise of their Rights, purchase the Company's Common Stock in the Offering. Immediately After the Offering: (7) The Company will use the proceeds of the Offering to repay indebtedness under the Talbert Note. If the Offering is not fully subscribed, the Company will sell to FHP any unsubscribed shares of Common Stock in exchange for cancellation of any remaining indebtedness under the Talbert Note. Following the separation from FHP as described above, TMMC and THSC will continue to provide practice management and ancillary clinical services to the Talbert Medical Groups. The Talbert Medical Groups will continue to provide health care to FHP members under the New FHP Provider Agreements that will take effect as of the Effective Time. FHP will continue to have various ongoing relationships with the Company and its subsidiaries and affiliates. See "Relationship with FHP and PacifiCare Following the Offering." 20 THE OFFERING BASIC SUBSCRIPTION PRIVILEGE Upon the FHP Merger, shares of FHP Common Stock and FHP Preferred Stock outstanding as of the Effective Date will be converted, in part, into the Rights. FHP stockholders will receive one Right for every 21.40635 shares of FHP Common Stock and one Right for every 26.54228 shares of FHP Preferred Stock held at the Effective Time. The Rights are evidenced by transferable Subscription Certificates. Each Right entitles the holder to purchase one share of Common Stock for $21.50 per share. Rights holders are entitled to subscribe for all, or any whole number of, the shares of Common Stock underlying their Rights (the "Basic Subscription Privilege"). ADDITIONAL SUBSCRIPTION PRIVILEGE Each Rights holder who subscribes in full for all shares of Common Stock that the holder is entitled to purchase pursuant to the Basic Subscription Privilege will be entitled to purchase additional shares of Common Stock at the Subscription Price from any unsubscribed shares remaining after the exercise, sale or expiration of all Basic Subscription Privileges (the "Additional Subscription Privilege"). However, if the total number of shares of Common Stock subscribed for pursuant to the Basic Subscription Privilege and the Additional Subscription Privilege exceeds the total number of shares underlying the Rights, the number of shares available for subscription pursuant to the Additional Subscription Privilege will be allocated, on a pro rata basis, to the nearest whole share, among those exercising the Additional Subscription Privilege on the basis of their relative subscriptions pursuant to the Additional Subscription Privilege. EXERCISE CAP Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the shares of Common Stock outstanding. However, holders of FHP Common Stock or FHP Preferred Stock with an FHP Ownership Percentage in excess of 8% as of the Effective Time may exercise Rights to the extent that their beneficial ownership of Common Stock does not exceed their FHP Ownership Percentage. SUBSCRIPTION EXPIRATION DATE The Rights will expire at 5:00 P.M., Eastern Standard Time, on the Expiration Date. After the Expiration Date, the Rights will be void and valueless. The Company is not obligated to honor any subscriptions received by the Subscription Agent after the Expiration Date, regardless of when such subscriptions were sent. SUBSCRIPTION AGENT The Subscription Agent is American Stock Transfer & Trust Company. The address to which Subscription Certificates and payment of the Subscription Price should be delivered, whether by hand, by mail or by overnight courier, is: American Stock Transfer & Trust Company 40 Wall Street, 46th Floor New York, New York 10005 Attention: Reorganization Department Any questions or requests for assistance concerning the method of subscribing for shares of Common Stock should be directed to the Subscription Agent at (718) 921-8200. 21 INFORMATION AGENT Georgeson & Company Inc. will serve as Information Agent for the Offering. Any questions or requests for assistance concerning the method of subscribing for Common Stock or additional copies of this Prospectus can be directed to the Information Agent. The Information Agent's telephone number is (800) 223-2064. HOW TO EXERCISE RIGHTS Rights holders may exercise the Basic Subscription Privilege and the Additional Subscription Privilege by delivering to the Subscription Agent at its offices listed under "Subscription Agent," prior to 5:00 P.M., Eastern Standard Time, on the Expiration Date, a properly completed and executed Subscription Certificate, together with full payment of the aggregate Subscription Price in U.S. dollars, by check or bank draft drawn upon a U.S. bank, or postal, telegraphic or express money order, payable to American Stock Transfer & Trust Company, as Subscription Agent. However, if at or prior to 5:00 P.M., Eastern Standard Time, on the Expiration Date, the Subscription Agent has received full payment of the Subscription Price for shares of Common Stock subscribed for pursuant to the Basic Subscription Privilege and the Additional Subscription Privilege, together with a written guarantee from a bank, a trust company, or a member firm of the New York Stock Exchange, Inc., other national securities exchanges, or the National Association of Securities Dealers, Inc. that a Subscription Certificate with respect to the shares of Common Stock will be delivered to the Subscription Agent prior to 5:00 P.M., Eastern Standard Time, on the third day following the Expiration Date, the subscription will be accepted, subject to timely receipt of the duly completed Subscription Certificates. In the event of a proration of shares of Common Stock to persons exercising the Additional Subscription Privilege, the Subscription Agent will promptly refund, without interest, the amount of any overpayment. The instructions that accompany the Subscription Certificate should be read carefully and followed in detail. COMPLETED SUBSCRIPTION CERTIFICATES AND THE RELATED PAYMENT SENT TO THE OFFICE OF THE SUBSCRIPTION AGENT MUST BE RECEIVED BEFORE 5:00 P.M., EASTERN STANDARD TIME, ON THE EXPIRATION DATE. DO NOT SEND SUBSCRIPTION CERTIFICATES OR PAYMENTS TO THE COMPANY OR FHP. SUBSCRIBERS WILL NOT HAVE ANY RIGHT TO REVOKE THE EXERCISE OF THEIR RIGHTS AFTER DELIVERY OF THEIR SUBSCRIPTION CERTIFICATES TO THE SUBSCRIPTION AGENT, UNLESS IN THE SOLE JUDGMENT OF FHP, THERE IS A MATERIAL AMENDMENT TO THE OFFERING AND THE RIGHT IS EXERCISED BEFORE SUCH AMENDMENT. THE METHOD OF DELIVERY OF SUBSCRIPTION CERTIFICATES AND PAYMENT OF THE SUBSCRIPTION PRICE TO THE SUBSCRIPTION AGENT WILL BE AT THE ELECTION AND RISK OF THE RIGHTS HOLDER, NOT THE COMPANY, FHP OR THE SUBSCRIPTION AGENT. IF SENT BY MAIL, IT IS RECOMMENDED THAT THEY BE SENT BY REGISTERED MAIL, PROPERLY INSURED, WITH RETURN RECEIPT REQUESTED, AND THAT A SUFFICIENT NUMBER OF DAYS BE ALLOWED TO ENSURE RECEIPT BY THE SUBSCRIPTION AGENT PRIOR TO 5:00 P.M., EASTERN STANDARD TIME, ON THE EXPIRATION DATE. Record holders of shares of FHP Common Stock and FHP Preferred Stock, such as brokers, trusts or depositaries for securities, who hold the shares for the account of others, should notify the respective beneficial owners of the shares as soon as possible to ascertain the beneficial owners' intentions and instructions with respect to the related Rights. Based upon the instructions received from the beneficial holders, the record holders should complete the Subscription Certificates and submit them with the applicable payment. All questions regarding the timeliness, validity, form and eligibility of any exercise of Rights will be determined by FHP, in its sole discretion, whose determination will be final and binding. FHP reserves the absolute right to reject any subscription if such subscription is not in proper form or if the acceptance thereof or the issuance of shares of Common Stock pursuant thereto could be deemed unlawful. FHP in its sole discretion may waive any defect or irregularity, permit a defect or irregularity to be corrected within 22 such time as it may determine or reject the purported exercise of any Rights. Subscriptions will not be deemed to have been received or accepted until all irregularities have been waived or cured within such time as FHP determines in its sole discretion. FHP, the Company and the Subscription Agent will not be under any duty to give notification of any defect or irregularity in connection with the submission of Subscription Certificates nor will any of them incur any liability for failure to give such notification. DELIVERY OF CERTIFICATES Certificates for shares of Common Stock issuable on exercise of the Basic Subscription Privilege and the Additional Subscription Privilege will be mailed as soon as practicable after the subscriptions have been accepted by the Subscription Agent, but not prior to the Expiration Date. Certificates for shares of Common Stock issued pursuant to the exercise of the Basic Subscription Privilege and the Additional Subscription Privilege will be registered in the name of the Rights holder exercising such privilege. PURCHASE, SALE OR TRANSFER OF RIGHTS Rights may be purchased or sold through ordinary investment channels, including brokers. Application has been made for the quotation of the Rights on the Nasdaq National Market under the symbol "TMMCR." If any Rights represented by the Subscription Certificate received by the Subscription Agent are not used in the exercise of the Basic Subscription Privilege, the Subscription Agent will, if practicable, sell such excess Rights and will remit the net proceeds, if any, to the subscriber, provided appropriate instructions are received. FRACTIONAL RIGHTS No fractional Rights will be issued to FHP stockholders. The Subscription Agent will determine the aggregate number of fractional Rights that would have been issued to FHP stockholders had fractional Rights been issued. The Subscription Agent will sell, if practicable, the nearest whole number of Rights and remit the net proceeds, if any, to FHP stockholders based on the number of fractional Rights they would have received. FOREIGN AND CERTAIN OTHER STOCKHOLDERS Subscription Certificates will not be mailed to stockholders whose addresses are outside the United States and Canada or who have an A.P.O. or F.P.O. address, but will be held by the Subscription Agent for their account. To exercise such Rights, stockholders must notify the Subscription Agent by 11:00 A.M., Eastern Standard Time, on the third day prior to the Expiration Date, at which time (if no instructions have been received) the Rights represented thereby will be sold, if feasible, and the net proceeds if any, remitted to such stockholders. CERTAIN FEDERAL INCOME TAX CONSEQUENCES The initial holders of the Rights will have a tax basis in the Rights equal to their fair market value as of the Effective Time, and the holding period (for determination of short-term or long-term gains and losses) of the Rights will commence as of the Effective Time. Upon a sale of the Rights, the selling holder will recognize short-term gain or loss equal to the difference between the selling price and the basis, and that gain or loss will be capital in nature if the Rights are (and the Common Stock obtainable on exercise of the Rights would be) a capital asset in the hands of the seller. If the Rights are not exercised or sold, the holder will have a short-term loss equal to the basis in the Rights. No gain or loss will be recognized on exercise of the Rights. The tax basis of the Common Stock obtained on exercise of the Rights will equal (i) the exercise price under the Rights plus (ii) the basis of the 23 Rights in the hands of the exercising holder (either the fair market value as of the Effective Time, or the amount paid to purchase the Rights after the Effective Time). The holding period of the Common Stock will commence on the exercise of the Rights. Upon a subsequent sale of the Common Stock, the seller will recognize gain or loss equal to the difference between the selling price and the basis of the Common Stock. The gain or loss will be capital in nature if the Common Stock represents a capital asset in the hands of the holder, and will be long-term if the sale occurs more than one year after exercise of the Rights. Under current federal income tax law, the highest tax rate on ordinary income and short-term capital gains is 39.6%, and long-term capital gains are subject to a maximum tax rate of 28%. A sale of Common Stock acquired as a result of exercise of the Rights generally should constitute long-term capital gain if the stock is held for more than one year after exercise. However, because of certain provisions in the law relating to the "phase-out" of personal exemptions and certain limitations on itemized deductions, the federal income tax consequences to a particular taxpayer of receiving additional amounts of ordinary income or capital gain may be greater than would be indicated by application of the stated tax rates to the additional amount of income or gain. O'Melveny & Myers LLP has provided an opinion to the effect that, under current law, the exercise, sale or lapse of the Rights will have the tax consequences set forth above. This opinion has been filed as an exhibit to the Registration Statement, and is subject to the conditions, qualifications and assumptions set forth therein. A separate discussion of certain federal income tax consequences associated with the receipt of the Rights is included in the joint proxy statement/prospectus filed by FHP and PacifiCare on Schedule 14A with respect to the FHP Merger and certain other matters. See "Additional Information." OTHER MATTERS The Offering is not being made in any states or other jurisdictions in which it is unlawful to do so, nor are FHP or the Company selling or accepting any offers to purchase any shares of the Common Stock from Rights holders who are residents of such states or other jurisdictions. FHP may delay the commencement of the Offering in certain states or other jurisdictions in order to comply with the securities law requirements of such states or other jurisdictions. It is not anticipated that there will be any changes in the terms of the Offering. FHP may, if it so determines in its sole discretion, decline to make modifications to the terms of the Offering requested by certain states or other jurisdictions, in which event Rights holders resident in such states or other jurisdictions will not be eligible to participate in the Offering. FINANCIAL STATEMENTS The consolidated financial data for the Company set forth in this Prospectus include the accounts of TMMC, THSC and the Talbert Medical Groups. Consolidation of the Talbert Medical Groups is considered necessary to present fairly the financial position and results of operations of the Company because the Company has direct or indirect unilateral and perpetual control over the assets and non-medical operations of the Talbert Medical Groups. See "Business--The Company." Financial data provided in this Prospectus for periods and dates prior to January 1, 1996 is presented for FHP's staff model operations. The financial statements of the staff model operations have been prepared in part from separate records maintained by subsidiaries of FHP, and reflect certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 24 USE OF PROCEEDS Assuming the Rights are fully exercised, the proceeds to the Company from the sale of the Common Stock pursuant to the Rights are estimated to be approximately $59.5 million. FHP will pay the expenses of the Offering, which are currently estimated to be approximately $ . All of the proceeds of the Offering will be used to repay indebtedness to FHP incurred in the Acquisition. See "Relationship with FHP and PacifiCare Following the Offering--Acquisition Agreement." DIVIDEND POLICY The declaration and payment of dividends by the Company are subject to the discretion of its Board of Directors. It is the current policy of the Company to retain earnings, if any, to finance the operations and expansion of the Company's business. Any determination as to the payment of dividends in the future will depend upon, among other things, general business conditions, the Company's earnings, financial condition, capital needs and other factors deemed pertinent by the Company's Board of Directors, including the limitations, if any, on the payment of dividends under state law and under any then-existing agreements with others. The Company does not anticipate paying any dividends in the near future. 25 CAPITALIZATION The following table sets forth the actual capitalization of the Company and its subsidiaries as of September 30, 1996, and as adjusted to give effect to the Acquisition and the Offering. This table should be read in conjunction with the consolidated financial statements of the Company and its subsidiaries and the notes thereto included in this Prospectus.
SEPTEMBER 30, 1996 --------------------------- ACTUAL AS ADJUSTED(1) --------- ---------------- (IN THOUSANDS) Stockholders' equity (deficit): The Company's Preferred Stock, par value $.01 per share; 1,200,000 shares authorized; no shares issued and outstanding.................................................. $ -- $ -- The Company's Common Stock, par value $.01 per share; 15,000,000 shares authorized; 3,000,000 shares issued and outstanding.................................................. 30 30 Additional paid-in capital (1)................................. 70 68,070 Retained earnings (deficit) (1)(2)............................. (3,770) (5,596) Deferred stock compensation expense (1)........................ -- (3,623) --------- ------- Total stockholders' equity (deficit)......................... $ (3,670) $ 58,881 --------- ------- --------- -------
- ------------------------ (1) Adjusted to reflect the recognition of deferred stock compensation expense of approximately $5,270,000 assuming a Capital Contribution of $68,000,000 and the amortization of $1,647,000 of the deferred stock compensation expense relating to the vesting of certain of the restricted shares of Common Stock held by management. (2) Adjusted to reflect the recognition of stock compensation expense of approximately $179,000, net of tax benefit of $125,000, as a result of the grant of the November 1996 Options. 26 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data sets forth, for the periods and dates indicated, selected consolidated financial data of the Company and its subsidiaries (including the Talbert Medical Groups) derived from the historical consolidated financial statements of its predecessors. The consolidated statement of operations data presented below for the years ended December 31, 1993, 1994, and 1995, and the consolidated balance sheet data at December 31, 1994 and 1995 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Prospectus. The consolidated statement of operations data for the years ended December 31, 1991 and 1992 and the nine months ended September 30, 1995 and 1996, and the consolidated balance sheet data at December 31, 1991, 1992 and 1993, and September 30, 1995 and 1996 are derived from unaudited consolidated financial statements of the Company and its subsidiaries that are not included herein. The summary consolidated financial data presented below are qualified by reference to the consolidated financial statements included elsewhere in this Prospectus and should be read in conjunction with such financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenue (2)(3) Capitation................ $ 322,233 $ 366,911 $ 425,141 $ 450,964 $ 437,493 $ 339,070 $ 293,085 Copayments, fee-for-service and other................... 30,320 35,688 45,742 52,374 58,206 40,295 58,150 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total revenue........... 352,553 402,599 470,883 503,338 495,299 379,365 351,235 Expenses Affiliated medical services................ 128,224 153,387 170,690 173,230 173,417 132,051 103,504 Purchased medical services................ 69,459 84,307 110,582 124,083 121,570 94,133 85,851 Dental services........... 13,970 16,128 20,129 28,955 31,379 24,544 20,443 Optometry, pharmacy and other primary health care services........... 52,999 70,702 86,985 96,275 102,412 77,395 80,181 Clinic operations......... 76,992 78,662 80,853 87,253 85,585 68,235 49,207 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total cost of health care.................. 341,644 403,186 469,239 509,796 514,363 396,358 339,186 Marketing, general and administrative.......... 20,606 22,569 24,002 26,675 29,698 22,188 19,622 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Operating loss.............. (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (7,573) Interest income (4)......... -- -- -- -- -- -- 1,199 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit................... (9,697) (23,156) (22,358) (33,133) (48,362) (39,181) (6,374) Income tax benefit.......... (3,873) (9,244) (8,924) (13,553) (19,754) (16,005) (2,604) ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net loss (5)................ $ (5,824) $ (13,912) $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Loss per common and common equivalent share (6)...... $ (1.94) $ (4.64) $ (4.48) $ (6.54) $ (9.55) $ (7.74) $ (1.26) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
27
DECEMBER 31, SEPTEMBER 30, ------------------------------------------------------------------- ------------------------- 1991 (1) 1992 (1) 1993 (1) 1994 (1) 1995 (1) 1995 (1) 1996 ----------- ----------- ----------- ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Working capital (5)......... $ (18,105) $ (17,937) $ (18,087) $ (18,742) $ (18,638) $ (18,101) $ (10,779) Total assets (5)............ 10,614 14,003 18,926 23,087 23,178 19,779 51,731 Long-term obligations....... -- -- -- -- -- -- -- Stockholders' deficit (5)(7).................... (17,425) (17,276) (17,475) (18,113) (17,886) (17,519) (3,670)
- ------------------------ (1) Reflects financial information relating to the historical staff model operations of FHP prepared in part from separate records maintained by subsidiaries of FHP. This information also reflects certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." (2) Revenue is derived from prepaid capitation fees for ambulatory services, plus patient co-payments and fee-for-service payments. The Company did not incur any hospital risk for the periods presented. (3) Nearly 100% of revenue is received pursuant to existing provider agreements with FHP. The New FHP Provider Agreements will take effect as of the Effective Time. The pro forma financial data presented elsewhere herein reflect, in part, the effects of the New FHP Provider Agreements as if such agreements had been in effect for the periods indicated. (4) Prior to January 1, 1996, all available cash balances, and the interest income on such cash balances, were retained by FHP. (5) Does not reflect the Capital Contribution to be made prior to the Acquisition and the resulting compensation expense, nor the compensation expense related to the options granted by the Board of Directors in November 1996, as reflected in the pro forma financial data presented elsewhere herein. (6) Loss per common and common equivalent share is computed based on 2,996,104 common equivalent shares for all periods presented. Equivalent common shares include the effect of options to purchase 70,350 shares of Common Stock granted in September 1996 and options to purchase 39,636 shares of Common Stock granted in November 1996. Pursuant to the Commission Staff Account Bulletin Topic 4:D, stock options granted during the twelve-month period prior to the date of the initial filing of the Registration Statement have been included in the calculation of common equivalent shares using the treasury stock method (considering the assumed proceeds from the stock options and the number of shares that could have been repurchased using the estimated initial public price) as if the shares were outstanding for all periods presented, even if the impact of the incremental shares is anti-dilutive. (7) Prior to January 1, 1996, stockholders' deficit fluctuated as a result of various intercompany transactions with FHP. On January 1, 1996, FHP recapitalized TMMC, resulting in the elimination of a deficit of $17,886,000. 28 The following table sets forth, for the periods indicated, the percentage of revenue represented by the following items:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------- ------------------------ 1993 1994 1995 1995 1996 ----------- ----------- ----------- ----------- ----------- Revenue Capitation................................. 90.3% 89.6% 88.3% 89.4% 83.4 Copayments, fee-for-service and other...... 9.7 10.4 11.7 10.6 16.6 Total revenue............................ 100.0 100.0 100.0 100.0 100.0 Expenses Affiliated medical services................ 36.2 34.4 35.0 34.8 29.5 Purchased medical services................. 23.5 24.7 24.5 24.8 24.4 Dental services............................ 4.3 5.8 6.3 6.5 5.8 Optometry, pharmacy, and other primary health care services..................... 18.5 19.1 20.7 20.4 22.8 Clinic operations.......................... 17.2 17.3 17.3 18.0 14.0 ----------- ----------- ----------- ----------- ----------- Total cost of health care................ 99.7 101.3 103.8 104.5 96.6 Marketing, general and administrative...... 5.1 5.3 6.0 5.8 5.6 ----------- ----------- ----------- ----------- ----------- Operating loss............................... (4.7) (6.6) (9.8) (10.3) (2.2) Interest income.............................. 0.3 ----------- ----------- ----------- ----------- ----------- Loss before income tax benefit............... (4.7) (6.6) (9.8) (10.3) (1.8) Income tax benefit........................... (1.9) (2.7) (4.0) (4.2) (0.7) ----------- ----------- ----------- ----------- ----------- Net loss..................................... (2.9)% (3.9)% (5.8)% (6.1)% (1.1)% ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
29 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW TMMC, THSC and the Talbert Medical Groups, subsidiaries and affiliates of the Company, commenced operations on January 1, 1996, and were formed as part of a plan announced by FHP in June 1995, to restructure its operations (the "Restructuring Plan"). The Restructuring Plan included the transformation of FHP's staff model operations (except for FHP's staff model operations in Guam) into a PPMC (now known as TMMC), an ancillary clinical services provider (now known as THSC) and a number of affiliated medical and dental provider practice groups (now known as the Talbert Medical Groups). TMMC and THSC were originally formed as subsidiaries of FHP. The Talbert Medical Groups comprise a number of new professional corporations organized in California, Utah, Arizona and Nevada to succeed to FHP's staff model business in each of those states. In New Mexico, TMMC directly employs physicians and effectively acts as the Talbert Medical Group in that state. Approximately 4,000 of FHP's employees, including health care professionals, became employees of TMMC, THSC or the Talbert Medical Groups. FHP's staff model operations had no separate legal status prior to the organization of TMMC, THSC and the Talbert Medical Groups. However, through its subsidiaries FHP had offered health care services to FHP members as a staff model HMO since 1961. Effective January 1, 1996, and pursuant to its management services agreements with the Talbert Medical Groups, TMMC began providing a broad range of practice management services in return for a management fee. At the same time, the Talbert Medical Groups became responsible for managing all physician-related covered medical care for each FHP member enrolled with a Talbert Medical Group in exchange for a prepaid monthly capitation payment for each such member. See "Business--The Company--Contractual Relationships." The Talbert Medical Groups are not limited to serving only FHP members. However, they have continuously served FHP members who received their health care in the former FHP staff model operations. Because a significant portion of the Company's revenue is derived from capitated payments, and because the Company has in certain cases guaranteed the obligations of the Talbert Medical Groups, its success depends in large part on the effective management of health care costs, including controlling utilization of specialty care physicians and other ancillary providers and purchasing services from third-party providers at competitive prices. In addition, as capitation fees are based on a percentage of premiums received by payors such as HMOs, any decrease in premiums could result in lower capitation fees being paid to the Talbert Medical Groups. Although management believes that the Company's cost control measures, which include risk-sharing arrangements between the Talbert Medical Groups and the payors with which they contract, as well as with administrative and medical review of health care delivery services, will help mitigate their effects, such costs may periodically affect the Company's results of operations. A typical payor contract includes a direct professional capitation payment to the Talbert Medical Group as well as a shared risk/incentive program. The hospital shared risk incentive program is based on actual bed-day utilization against a negotiated bed-day budget. If the actual bed-day utilization is favorable to the bed-day budget, a predetermined dollar amount per day is contributed to the hospital incentive fund. The residual in the fund typically is shared equally between the hospital and the Company. When the Talbert Medical Group assumes risk for over-utilization, the Talbert Medical Group's exposure is usually limited to no more than a maximum of 10% of the deficit in the fund. In the future, the Company may take additional hospital risk under certain circumstances when the Company believes it can make sufficient improvements in bed-day utilization to warrant such risk. The consolidated financial statements for the Company include the financial statements of TMMC, THSC and the Talbert Medical Groups. The Company effectively controls the Talbert Medical Groups by means other than equity ownership, and therefore consolidation of the Talbert Medical Groups is necessary to present fairly the financial position and results of operations of the Company. Control of the Talbert Medical Groups by TMMC is perpetual rather than temporary by virtue of: (i) the length of the original terms of the relevant management and other agreements; (ii) the successive extension period 30 provided by the agreements; (iii) the continuing investment of capital by TMMC; (iv) the employment of the majority of nonphysician personnel by TMMC; (v) the nature of the services provided to the Talbert Medical Groups by TMMC; and (vi) the provisions of a share control agreement entered into by each Talbert Medical Group stockholder and TMMC. The financial statements of the former FHP staff model operations have been prepared, in part, from separate records maintained by subsidiaries of FHP, and reflect certain assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized. See "Consolidated Financial Statements--Note 2." RESULTS OF OPERATIONS REVENUE The Company derives substantially all of its revenue from capitated provider agreements, with the balance derived from enrollee co-payments, fee-for-service revenue and other. Revenues are net of an allowance for doubtful accounts. Nearly all revenues are generated from payments under existing provider agreements with FHP. Pursuant to these agreements, every month FHP pays each Talbert Medical Group a fixed percentage of FHP's premium revenue, based on the number of commercial and senior enrollees covered by the Talbert Medical Group. Unlike capitated revenue, co-payments and fee-for-service revenue represent payments received directly from patients for services rendered. The Company believes FHP will continue to be the primary source of capitated revenue for the forseeable future. The Talbert Medical Groups currently have four capitated physician agreements and six capitated dental agreements with FHP. TMMC also has a capitated physician agreement with FHP for New Mexico. The Talbert Medical Groups also have recently established contractual relationships with a total of nine other HMOs in California, Arizona, New Mexico and Utah. The Company will seek to diversify the Talbert Medical Groups' payor base following separation from FHP. Management believes new payor contracts are essential to future revenue growth. The Talbert Medical Groups' senior enrollee revenue is generated from premiums paid to FHP by the Health Care Financing Administration ("HCFA"). Under FHP's agreement with HCFA, seniors enroll and disenroll individually throughout the year. FHP seniors served by the Talbert Medical Groups have individually selected the Talbert Medical Groups for their health care. FHP receives senior premium rate increases from HCFA on January 1 of each year and the contracted percentage of the increase is passed to the Talbert Medical Groups pursuant to their provider agreements with FHP. Revenue per senior enrollee is substantially higher than revenue per commercial enrollee because senior enrollees use substantially more health care services, thereby incurring a higher cost for services provided. In September of each year, HCFA announces the annual Medicare rate increases that will become effective on January 1 of the subsequent year. These rate increases vary geographically and become the basis for determining the amounts that HCFA will pay to HMOs that provide coverage to Medicare recipients. For 1996 FHP received an average rate increase of 5.1%. Based upon HCFA's September 1996 announcement, the Company currently estimates that FHP will receive an average senior premium rate increase of 5.7% effective January 1, 1997 in the Company's markets. There can be no assurance that such annual rate increases will continue. NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 REVENUE. Revenue decreased $28.1 million, or 7.4%, to $351.2 million for the nine months ended September 30, 1996, from $379.4 million for the nine months ended September 30, 1995. This decrease primarily reflects a 5.4% decline in capitated enrollment, from 321,128 at September 30, 1995 to 303,785 at September 30, 1996. Reductions in capitated enrollment in California during this period were responsible for approximately $13.3 million of the decline in revenue. Arizona's average monthly capitated enrollment also declined between these periods as a result of a restructuring of FHP's health care delivery systems in Arizona. Effective July 1, 1995, approximately 36,100 enrollees in Arizona were no longer capitated by FHP to the Talbert Medical Group in Arizona (the "Arizona Group"), although the enrollees continued to 31 receive their health care from the Arizona Group. In lieu of receiving a monthly capitation payment for these enrollees, the Arizona Group billed FHP for medical services on a fee-for-service basis. The change reduced the Arizona Group's average monthly capitated enrollment by 19.9%, and reduced net revenue by approximately $11.7 million. However, the restructuring also reduced the Arizona Group's liability for services provided outside its Medical Centers, resulting in a decline of approximately $14.6 million in the total cost of health care for the Arizona Group for the nine months ended September 30, 1996. AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense consists of expenses related to staff physicians, nursing, laboratory and x-ray services, and malpractice insurance, that are provided by the Company. Affiliated medical services expense declined $28.5 million, or 21.6%, to $103.5 million (29.5% of revenues) for the nine months ended September 30, 1996 from $132.1 million (34.8% of revenues) for the nine months ended September 30, 1995. This decline primarily reflected lower physician and malpractice costs resulting from reductions in physician staffing levels. In California and Arizona, affiliated medical services expense was reduced by $19.1 million and $2.8 million, respectively, through reductions in physician staffing, outsourcing of certain physician specialist services, and corresponding reductions in associated support services. In Utah, physician staffing was reduced in accordance with declines in enrollment, resulting in a $6.6 million reduction in physician costs. PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense consists of expenses related to physician specialists and related services that are provided outside the Company's Medical Centers. Purchased medical services expense declined $8.3 million, or 8.8%, to $85.8 million for the nine months ended September 30, 1996, compared to $94.1 million for the nine months ended September 30, 1995. As a percentage of revenues, purchased medical services expense decreased to 24.4% from 24.8%. The restructuring in Arizona contributed approximately $7.2 million toward the reduction, while declines in enrollment in Utah resulted in a further reduction of $4.6 million. These favorable reductions were partially offset by a $2.7 million increase in purchased medical services expense in California, attributable principally to the expansion of home health services and increased outsourcing of certain physician specialty services. DENTAL SERVICES EXPENSE. Dental services expense declined $4.1 million, or 16.7%, to $20.4 million (5.8% of revenues) for the nine months ended September 30, 1996, from $24.5 million (6.5% of revenues) for the nine months ended September 30, 1995. The reduction was largely attributable to declines in enrollment in California and Arizona. OPTOMETRY, PHARMACY AND OTHER PRIMARY HEALTH CARE SERVICES EXPENSE. Optometry, pharmacy and other primary health care services expense increased $2.8 million, or 3.6%, to $80.2 million (22.8% of revenues) for the nine months ended September 30, 1996, from $77.4 million (20.4% of revenues) for the nine months ended September 30, 1995. Higher utilization of these services in California was responsible for $3.9 million of the increase, which was partially offset by a reduction of $1.9 million resulting from lower utilization in Arizona. CLINIC OPERATIONS EXPENSE. Clinic operations expense declined $19.0 million, or 27.9%, to $49.2 million (14.0% of revenues) for the nine months ended September 30, 1996, from $68.2 million (18.0% of revenues) for the nine months ended September 30, 1995. Closures of clinics in California accounted for $10.6 million of the decline. Also, clinic operations expense in Utah and Arizona declined by $3.2 million and $1.3 million, respectively, reflecting primarily reductions in physician support staff. MARKETING, GENERAL AND ADMINISTRATIVE EXPENSE. Marketing, general and administrative ("MG&A") expense declined $2.6 million, or 11.7%, to $19.6 million (5.6% of revenues) for the nine months ended September 30, 1996, from $22.2 million (5.8% of revenues) for the nine months ended September 30, 1995. The decline was attributable primarily to reductions in administrative personnel undertaken as part of the Company's cost savings efforts. 32 YEARS ENDED DECEMBER 31, 1995 AND 1994 REVENUE. Revenue declined $7.6 million, or 1.5%, to $495.7 million for the year ended December 31, 1995, from $503.3 million for the year ended December 31, 1994. The decrease was primarily attributable to reductions in capitated enrollment, which declined by 37,305, or 10.4%, to 321,588 at December 31, 1995 from 358,893 at December 31, 1994. California and Utah experienced revenue reductions of $15.2 million and $5.6 million, respectively, primarily resulting from declines in enrollment. These reductions were partially offset by revenue increases in Nevada and New Mexico of $6.6 million and $3.3 million, respectively. Revenue in Arizona increased by a net $3.3 million. This reflected a $7.4 million increase in revenue attributable to an increase in senior enrollment in proportion to other enrollees of the Arizona Group. Capitation rates received for senior enrollees are higher than for commercial enrollees. This revenue increase was partially offset by a revenue reduction of $4.1 million attributable to a decline in the average monthly capitated enrollment of 17.2% that was generated principally by the restructuring of FHP's health care delivery system in Arizona. AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense increased slightly to $173.4 million for the year ended December 31, 1995, from $173.2 million for the prior year, reflecting primarily increased malpractice premiums and higher utilization of affiliated laboratory and x-ray services. As a percentage of revenue, affiliated medical services expense increased to 35.0% in 1995 from 34.4% in 1994. PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense declined to $121.6 million (24.5% of revenues) for the year ended December 31, 1995, from $124.1 million (24.7% of revenues) for the year ended December 31, 1994. Reductions in California and Arizona of approximately $4.1 million and $2.1 million, respectively, were attributable primarily to lower enrollment levels. Enrollment growth in New Mexico and Nevada produced an increase of $4.4 million, while higher utilization in Utah resulted in an increase of $1.5 million. DENTAL SERVICES EXPENSE. Dental services expense increased to $31.4 million for the year ended December 31, 1995, compared to $29.0 million for the year ended December 31, 1994, reflecting expanded benefit coverage in California and Utah. As a percentage of revenue, dental services expense increased slightly to 6.3% from 5.8%. OPTOMETRY, PHARMACY AND OTHER PRIMARY HEALTH CARE SERVICES EXPENSE. Optometry, pharmacy and other primary health care services expense increased to $102.4 million (20.7% of revenues) for the year ended December 31, 1995, compared to $96.3 million (19.1% of revenues) for the year ended December 31, 1994. Pharmacy costs in Arizona, New Mexico and Nevada increased by a total of $3.7 million, primarily resulting from higher prescription utilization due to increased enrollment. Behavioral health expense increased $1.3 million, primarily due to expanded benefit coverage in California and Utah. Optometry costs increased by $1.9 million, reflecting increased enrollment in New Mexico and expanded optometry benefits in Arizona. CLINIC OPERATIONS EXPENSE. Clinic operations expense declined to $85.6 million for the year ended December 31, 1995, from $87.3 million for the year ended December 31, 1994, reflecting closures of clinics and associated staff reductions due to lower enrollment. As a percentage of revenues, clinic operations expense remained flat at 17.3% of revenues in 1995 and 1994. MG&A EXPENSE. MG&A expense increased to $29.7 million (6.0% of revenues) for the year ended December 31, 1995, from $26.7 million (5.3% of revenues) for the year ended December 31, 1994, reflecting the first full year of administrative costs incurred in 1995 for the new Nevada operations. YEAR ENDED DECEMBER 31, 1994 AND 1993 REVENUE. Revenue increased $32.4 million, or 6.9%, to $503.3 million for the year ended December 31, 1994, compared to $470.9 million for the year ended December 31, 1993. The increase largely resulted from an increase in capitated enrollment of 29,851 enrollees, or 9.1%, to 358,893 at December 31, 1994 from 329,042 at December 31, 1993. Revenue in Arizona increased by $25.5 million, primarily due to 33 the addition of 14,600 new enrollees. Increased enrollment in California also was primarily responsible for $7.1 million of increased revenue. The commencement of operations in Nevada in November 1994 also generated $1.1 million of incremental revenue. AFFILIATED MEDICAL SERVICES EXPENSE. Affiliated medical services expense increased to $173.2 million for the year ended December 31, 1994, from $170.7 million for the year ended December 31, 1993, reflecting higher physician costs in California and Utah. As a percentage of revenue, affiliated medical services expenses decreased to 34.4% in 1994 from 36.2% in 1993. PURCHASED MEDICAL SERVICES EXPENSE. Purchased medical services expense increased $13.5 million, or 12.2%, to $124.1 million (24.7% of revenue) for the year ended December 31, 1994, compared to $110.6 million (23.5% of revenue) for the year ended December 31, 1993. The increase reflects higher utilization of outside specialty services primarily attributable to increased enrollment in Arizona, California and Nevada. DENTAL SERVICES EXPENSE. Dental services expense increased $8.9 million, or 44.3%, to $29.0 million for the year ended December 31, 1994, from $20.1 million for the year ended December 31, 1993, reflecting higher enrollment as well as the expansion of dental services in Arizona. As a percentage of revenue, dental services expense increased to 5.8% in 1994 compared to 4.3% in 1993. OPTOMETRY, PHARMACY AND OTHER PRIMARY CARE HEALTH SERVICES EXPENSE. Optometry, pharmacy and other primary care health services expense increased $9.3 million, or 10.7%, to $96.3 million (19.1% of revenues) for the year ended December 31, 1994, from $87.0 million (18.5% of revenues) for the year ended December 31, 1993. Pharmacy and optometry costs increased $6.8 million and $2.7 million, respectively, primarily attributable to increased enrollment. CLINIC OPERATIONS EXPENSE. Clinic operations expense increased $6.4 million, or 7.9%, to $87.3 million (17.3% of revenues) for the year ended December 31, 1994, from $80.9 million (17.2% of revenues) for the year ended December 31, 1993. The increase primarily resulted from the establishment of a new Medical Center in Nevada. MG&A EXPENSE. MG&A expense increased to $26.7 million (5.3% of revenues) for the year ended December 31, 1994, from $24.0 million (5.1% of revenues) for the year ended December 31, 1993, largely due to additional enrollment administration costs. LIQUIDITY AND CAPITAL RESOURCES LIMITED FUTURE CASH FLOWS AND CAPITAL CONTRIBUTION The Company's prepaid monthly capitation fees are based on a percentage of premiums received by the HMO payors, and any decrease in premiums could result in lower capitation fees paid to the Talbert Medical Groups. The New FHP Provider Agreements have ten-year terms, except for Utah, which has a 15-year term. Capitation rates established in the New FHP Provider Agreements are subject to renegotiation one year after the Effective Time. If the parties are unable to agree upon new rates, the existing rates will remain in effect. The New Provider Agreements do not contain any subsidies from FHP, and therefore will result in lower revenues and higher health care costs per enrollee to the Company. In addition, HMO's typically have annual "open enrollment" periods for commercial customers, during which new members may enroll or existing members may renew or leave the HMO. Fluctuations in capitated enrollment levels directly impact the Company's recognized capitated revenue. A substantial portion of FHP's current commercial membership is subject to open enrollment programs occurring in January 1997. Any failure by FHP to maintain or increase commercial enrollment in the Company's markets during this period could have a significant adverse effect on the Company's future revenues, earnings, cash flows and financial position. The Company generates cash flow principally from monthly capitation payments from HMOs for their members who are serviced by the Talbert Medical Groups. FHP's staff model operations, which comprise the Company's predecessor businesses, experienced substantial operating losses over the last five years. 34 Subsidies from FHP have offset losses incurred in these periods, but FHP will not provide such subsidies following the Offering. The New FHP Provider Agreements, executed pursuant to the terms of the FHP Merger, will result in lower revenues and higher expenses per enrollee. Management therefore anticipates that the Company will incur substantial losses in 1997 and 1998 and will not generate positive cash flow for those periods. See "Relationship with FHP and PacifiCare Following the Offering--Provider Agreements." The Company's liquidity requirements are generated principally by its need to fund future operating losses, projected capital expenditures and anticipated expansion. Management plans to stabilize the Company's financial condition through revenue enhancements and cost reductions. Enhancing revenues is believed by management to be essential, even if cost reductions are successfully implemented. Declining enrollment has created excess health care service capacity, and the Company believes additional revenue opportunities can be achieved with relatively lower associated incremental costs. Management anticipates that independence from FHP will make the Talbert Medical Groups more accessible to other payors and new capitated enrollees. However, there can be no assurance that the Talbert Medical Groups will be able to secure additional payor contracts or to attract new capitated enrollees. Continued enrollment decline would adversely impact operating results. The Company's revenue enhancement plans focus on attracting new capitated Medicare and commercial enrollees by entering into provider agreements with payors other than FHP. To date, the Company has obtained 13 other provider agreements and in excess of 20 preferred provider organization ("PPO") contracts on behalf of one or more of the Talbert Medical Groups. See "Business--The Company--Payor Relationships." The Company's cost reduction plans focus primarily on continuing improvements in the cost of health care and controlling general and administrative expenses. Effective January 1, 1997, the Talbert Medical Groups implemented a new physician compensation program designed to be competitive with compensation programs in effect in other independent physician group practices. Physicians no longer receive only fixed salaries. Instead, approximately 20% of each physician's salary (based on current salary levels) has been placed at risk. Funds derived from hospital incentives, as well as from reductions in purchased medical services, are included in an incentive pool. The incentive pool will be distributed to physicians based on their individual performance as determined by the Company. Performance criteria include quality of care, patient satisfaction, cost-effectiveness and other factors. Management believes the revised physician compensation program will improve the Company's operating results and align physician incentives with the provision of quality medical care. The Company expects to further reduce costs by converting to self-insurance for employees' health insurance as well as converting the Company's annual contribution under its employee stock ownership plan (equivalent to two percent of salary) from a fixed basis to a performance basis. Contributions will be made only if the Company meets its financial goals. The Company also intends to further reduce its cost of health care by improving its use of outside specialists and by renegotiating its specialty provider contracts. The Company's health care costs fluctuate quarterly based on the overall health of its patient population. Enrollees, particularly seniors, typically require more care during the winter months. Quarterly results also may be affected by significant differences between actual and estimated amounts receivable or payable for payor "shared risk" arrangements and certain estimated medical specialty claims liabilities that are adjusted periodically to reflect actual claims adjustments as they occur. The Company's facilities costs are primarily governed by the Master Lease Agreement (as defined herein) with FHP. The Master Lease Agreement will expire on December 31, 2000, at which time it will be extended at prevailing market rates to December 31, 2005, with the exception of leases with respect to up to 90,000 square feet (of a total of approximately 472,000 square feet) that the Company may elect not to renew. See "Relationship with FHP and PacifiCare following the Offering--Master Lease Agreement." The Company's consolidated financial statements reflect the Master Lease Agreement as an operating lease. See "Consolidated Financial Statements--Note 5." At September 30, 1996, the Company had cash balances of $14.3 million and a stockholders' deficit of approximately $3.7 million. Prior to the Acquisition, the Company will receive a Capital Contribution of 35 approximately $68 million. However, the Company will be required to settle amounts due to FHP to reimburse FHP for medical service costs paid on behalf of the Company. This balance will be paid off in its entirety prior to the Acquisition. The Company's current liabilities consist of amounts for accrued medical claims payable attributable to services provided by specialty care physicians and ancillary provider services. This accrued liability includes claims received by the Company that have not yet been paid as well as an estimate of costs for covered medical benefits incurred by enrollees but not yet reported by the providers. These amounts are not due and payable until after the provider has presented a claim and are typically paid within 30 to 45 business days after their receipt. The Company estimates its medical claims liability based upon the anticipated cost for actual out-of-clinic referrals to the provider specialist authorized by the Company's utilization management program, plus an estimate of unknown provider specialty occurrences based upon historical utilization patterns of the Company's enrollees. See "Risk Factors--Open Enrollment Periods; Fluctuations in Quarterly Results." Prior to the Acquisition, TMMC received, in connection with the FHP Merger, the Capital Contribution of approximately $68 million to increase its net worth to approximately $59 million. The Company intends to use the Capital Contribution to fund operating losses and for working capital and other general corporate purposes. The Company does not have a credit facility in place and there can be no assurance that the Company will be able to obtain such a facility in the future. The Company also does not have significant tangible assets, other than computer equipment and tenant improvements. It therefore does not anticipate that credit facilities would be readily available to it without significant improvements in its results of operations and cash flows. CAPITAL REQUIREMENTS The Company has budgeted approximately $5.0 million for information systems capital expenditures and related activities in 1997. The Company's expansion strategy is to develop high quality, cost efficient health care delivery systems by acquiring or contracting with additional primary and specialty care physicians in selected geographic markets. The Company has not entered into any agreements, understandings, or arrangements with respect to such acquisitions or development. As a result, the amount of any funds required to accomplish such acquisitions or development cannot be accurately predicted. The Company believes that its existing cash resources, together with the Capital Contribution, will be sufficient to meet the Company's anticipated expansion and working capital needs for the next several years. However, this belief assumes that the Company's enrollment trends do not worsen, that expenses do not increase in excess of anticipated amounts and that competitive pressures or other factors do not further depress revenues. In addition, there are other factors that individually or collectively may have a significant adverse effect on the Company and impair its ability to operate successfully in the future. For a discussion of certain of these other factors, see "Risk Factors." 36 BUSINESS OVERVIEW The Company, through TMMC, organizes and manages physician and dentist practice groups that contract with HMOs and other payors to provide health care services to their members. As of September 30, 1996, TMMC had management services agreements with four physician groups representing approximately 333 primary and specialty care physicians operating in southern California, Utah, Arizona and Nevada. TMMC also directly employed 27 primary and specialty care physicians operating in New Mexico. In addition, TMMC had management services agreements with six dental groups representing approximately 80 dentists in southern California, Utah and Arizona. In support of these Talbert Medical Groups, TMMC operates 52 Medical Centers and employs a health care staff of more than 3,000 individuals. Through its management services agreements with the Talbert Medical Groups, TMMC managed over 303,000 capitated enrollees as of September 30, 1996. The Company believes that HMOs and other payors see primary care physicians as increasingly important participants in the delivery of managed health care. Payors rely on primary care physicians to assume more responsibility for the cost-effective management of patient care, including optimizing the amount of care provided on an out-patient basis, ensuring efficient utilization of specialists and hospitals, encouraging preventive care practices and monitoring the progress of patients throughout their course of treatment. The Company, through TMMC, uses its experience in managed care to advise the Talbert Medical Groups in managing their patient populations. TMMC offers a broad range of practice management services, including (i) provider contract negotiation and administration, (ii) Medicare risk management, (iii) management information systems (development, implementation and maintenance), (iv) medical management (claims administration, utilization and case management, quality assurance and risk management, and physician credentialing and recruitment), and (v) support services (including nursing, billing, collection and accounting). Ancillary clinical services (including pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy) are provided through THSC. The provision of these services enables physicians to focus on the practice of medicine. THE MANAGED HEALTH CARE INDUSTRY BACKGROUND Medical services traditionally have been provided on a fee-for-service basis, with insurance companies paying all or a portion of the fees. Over the past decade, the cost of medical services generally has risen at a higher rate than the consumer price index. HCFA estimated health care expenditures in the United States for 1995 at approximately $1 trillion, representing more than 15% of gross national product ("GNP"), up from approximately $665 billion, or 12.2% of GNP, in 1990. HEALTH MAINTENANCE ORGANIZATIONS As a result of escalating health care costs, employers, insurers and governmental entities have sought cost-effective approaches to the delivery of and payment for health care services. HMOs and other managed health care organizations have emerged as integral components in this effort. Like traditional indemnity health care plans, HMOs and other managed health care organizations typically assume most of the financial risk for the delivery of medical care. Unlike traditional indemnity health care plans, however, HMOs seek to reduce the cost of medical services through volume discounts from their provider networks and through the management of medical services, including the implementation of techniques such as utilization and technology reviews and quality assurance programs. HMOs enroll members by entering into contracts with employer groups or directly with individuals to provide a broad range of health care services for a fixed monthly premium, with minimal or no deductibles 37 or co-payments required of the members. HMOs, in turn, typically contract directly with physicians, hospitals and other health care providers to deliver medical care to their members. These contracts provide for payment to the provider on either a discounted fee-for-service or per diem basis, or through capitation based on the number of members covered, regardless of the amount of necessary medical care required within the covered benefits. By capitating payments to physicians, HMOs effectively have begun to shift to physicians a significant portion of the economic risk of providing health care. These shared risk arrangements exert more pressure on the physician to manage medical treatments without diminishing the quality of medical care. Payors also are shifting administrative responsibilities to physicians, including requiring physicians to obtain authorization for tests and surgical procedures and respond to additional oversight from payors. These administrative burdens are exacerbated by the proliferation of HMOs, which has forced physicians to comply with multiple formats for claims processing, credentialing and other administrative reporting requirements. As a result, physicians' operating expenses and the number of hours devoted to non-medical activities have increased. In order to relieve these economic and administrative burdens, physicians have turned to third parties, such as PPMCs, to manage economic risk and perform non-medical management tasks associated with the practice of medicine. PHYSICIAN PRACTICE MANAGEMENT COMPANIES PPMCs were created to relieve certain of the economic and administrative burdens imposed on physicians by payors. PPMCs provide management, claims payment and other administrative services to physicians. PPMCs also help physician groups by negotiating capitation rates and other incentive arrangements with payors. These arrangements can take a number of forms, but often separate payments to the medical group into two categories: (i) a capitation payment to cover certain services; and (ii) participation in budgeted shared risk pools to cover other services (such as pharmacy or hospital services). The capitation payment remains the same regardless of utilization, and thus the medical group has an incentive to optimize utilization, particularly with respect to specialty care or other services provided outside the medical group. The budgeted shared risk pools also provide incentives to the medical group to optimize utilization of particular services. For example, a budgeted shared risk pool for hospitalization would allow the medical group to share in the savings that result from improved utilization of hospital services. THE COMPANY The Company anticipates that managed care will continue to play an important role in the delivery of and payment for health care services. In particular, the Company believes that to deliver high-quality, cost-effective health care, primary care physicians must have incentives to manage patient care, including referrals to specialty care physicians and other medical care service providers. The Company expects that as the importance of the primary care physician's role is recognized, more HMOs will embrace the management of health care services through these physicians. As primary care physicians expand their role in not only providing medical care, but also in managing its delivery, the Company believes that these physicians will require the assistance of PPMCs like TMMC to help them manage their practices and negotiate payor contracts. THE TALBERT MEDICAL GROUPS The Company's affiliated practice groups currently consist of four physician groups and six dental groups. TMMC also directly employs physicians in New Mexico. All of the Talbert Medical Groups were formerly part of FHP's staff model operations. TMMC provides practice management services to each of the Talbert Medical Groups pursuant to a management services agreement. TMMC's management services agreements generally provide for TMMC to be reimbursed for certain clinic operating expenses and to receive a management fee based on the revenues of each Talbert Medical Group after deducting certain reimbursed clinic operating expenses. In California, TMMC's management fee is based on the gross revenues of the Talbert Medical Groups in California. 38 THE MEDICAL CENTERS. TMMC operates 52 Medical Centers located in five states. The Medical Centers are staffed largely by primary care physicians, who practice family, internal and pediatric medicine, and obstetrics-gynecology. Most of the Medical Centers offer a broad range of outpatient health care services, including medical, dental, vision, pharmacy, radiology and/or laboratory services. The following table sets forth the number of Medical Centers and affiliated physicians for each of the states in which the Company does business. THE TALBERT MEDICAL GROUPS
MEDICAL AFFILIATED CENTERS PHYSICIANS (1) ------------- ----------------- California........................................................... 24 206 Utah................................................................. 7 80 Arizona.............................................................. 14 41 New Mexico........................................................... 5 27 Nevada............................................................... 2 6 -- --- Total.............................................................. 52 360 -- -- --- ---
- ------------------------ (1) As of September 30, 1996. OUTSIDE PROVIDERS. Covered health care benefits that are unavailable at the Medical Centers are provided through contracts with outside providers on a discounted fee-for-service, sub-capitated, or fixed monthly fee basis. Members are referred to these providers in accordance with the pre-authorization guidelines of the relevant payor. PAYOR RELATIONSHIPS The Company's revenue is largely dependent on the number of enrollees for whom the Talbert Medical Groups receive monthly capitation payments. The table below sets forth the number of capitated enrollees for each of the states in which the Company does business: CAPITATED ENROLLEES
AS OF DECEMBER 31, AS OF SEPTEMBER 30, ---------------------------------- -------------------------- 1993 1994 1995 1995 1996 --------- --------- ------------ ------------ ------------ California................... 145,667 150,125 145,986 146,117 132,463 Utah......................... 131,273 138,588 122,596 126,800 109,652 Arizona...................... 29,132 43,748 21,954(1) 17,579(1) 31,460(1) New Mexico................... 22,970 23,472 26,738 26,389 25,504 Nevada....................... -- 2,960 4,314 4,243 4,706 --------- --------- ------------ ------------ ------------ Total...................... 329,042 358,893 321,588 321,128 303,785 --------- --------- ------------ ------------ ------------ --------- --------- ------------ ------------ ------------
- ------------------------ (1) Reflects the restructuring of approximately 36,100 capitated enrollees of the Arizona Group to a fee-for-service basis effective July 1, 1995. The Company subsequently undertook a program to reconvert such enrollees from a fee-for-service to a capitated basis. Currently, FHP is the primary payor for the Talbert Medical Groups, accounting for nearly 100% of capitated enrollees and revenues for the nine months ended September 30, 1996 and 1995, and for the years ended December 31, 1995, 1994 and 1993. The Company believes FHP will continue to be the primary source of capitated revenue for the forseeable future. See "Risk Factors--Contracted Rate Decrease." 39 TMMC has, however, recently established contractual relationships with the following payors on behalf of one or more of the Talbert Medical Groups: - Blue Cross/Blue Shield (Arizona) - BPS HMO Inc. (California) - CIGNA (California) - Foundation Health Corporation (California) - HMO California (California) - Health Net (California) - Maxicare (California) - PacifiCare California (California) - Blue Cross (New Mexico) - AMIL International of Nevada (Nevada) - Humana (Nevada) - Blue Cross/Blue Shield of Utah (Utah) - United Health Plan (Utah) In addition, TMMC is currently negotiating contracts with a number of other payors. TMMC has negotiated in excess of 20 PPO contracts on behalf of one or more of the Talbert Medical Groups. Under a typical PPO contract, the payor agrees to list one of the Talbert Medical Groups on its panel of authorized practice groups. PPO arrangements provide a wider choice of practice groups to the payor's members, and thus often do not result in as consistent a revenue stream as capitated agreements. These new payor relationships do not yet constitute a significant source of revenues for TMMC. TMMC expects to continue to diversify the Talbert Medical Groups' payor base following its separation from FHP. TMMC believes its prior diversification efforts were impeded by its subsidiary relationship with FHP, which a number of other payors regarded as a direct competitor. MANAGEMENT SERVICES TMMC provides a wide array of management services to the Talbert Medical Groups. TMMC's services include: (i) provider contract negotiation and administration; (ii) Medicare risk management; (iii) comprehensive management information systems; (iv) medical management (claims administration, utilization and case management, quality assurance and risk management, and physician credentialing and recruitment); and (v) support services (including nursing, billing, collection and accounting). Ancillary clinical services (including pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy) are provided through THSC. PROVIDER CONTRACTING. TMMC represents the Talbert Medical Groups in obtaining and negotiating provider agreements with HMOs and other payors. Under a typical capitation agreement with one of the Talbert Medical Groups, the Group is responsible for managing all physician-related covered medical care for each enrollee in exchange for a prepaid monthly capitation payment per member enrolled with the Talbert Medical Group. Capitation agreements generally include shared risk arrangements and other financial incentives designed to encourage the provision of high-quality, cost-effective health care. TMMC has also represented the Talbert Medical Groups in negotiating discounted fee-for-service agreements. Under these arrangements, the Talbert Medical Groups bill the payor for services rendered rather than receive a monthly capitation payment. When negotiating or renewing payor contracts, TMMC analyzes a number of specific factors that affect capitated rates, the shared risk pool and the breadth of covered benefits. These factors include, but are not limited to, the demographic risk profile of the member pool, its cost history, the existence of ceilings on required coverage, and fee-for-service equivalent charges. TMMC undertakes these analyses in order to assess the economic opportunity and risk exposure associated with the contract, and then conducts the negotiations on behalf of its affiliated medical group. 40 MEDICARE RISK MANAGEMENT. Many payors have contracted with the federal government to provide health care for Medicare beneficiaries under full risk capitation arrangements. Under these types of contracts, the payor receives a monthly per capita payment for each enrollee that is equal to 95% of HCFA's adjusted average per capita cost. TMMC benefits from 13 years of experience and expertise in implementing and managing Medicare risk programs. TMMC's Medicare contracting expertise helps assess the Talbert Medical Groups' economic opportunity and exposure under such contracts. TMMC's administrative expertise provides the Talbert Medical Groups with the design and implementation of clinical systems capable of meeting the needs of the Medicare population. MANAGEMENT INFORMATION SYSTEMS. TMMC maintains a comprehensive, on-line database that provides inpatient and outpatient utilization statistics and patient encounter reporting and tracking. The Company believes that the availability of timely information on utilization patterns improves primary care physician productivity and effectiveness. Medical management information systems ("MIS") play an integral role in TMMC's management of specialty care physicians and hospital utilization by enabling TMMC's medical directors and utilization nurses to monitor encounter data, case management decisions and patient outcomes. In addition, MIS help TMMC perform various administrative functions, including insurance verification, accounts payable and receivable, financial reporting and claims payment. The MIS also include a customer service documentation system that helps TMMC resolve patient concerns and evaluate patient and physician satisfaction. CLAIMS ADMINISTRATION. TMMC's claims processing capabilities include determination of eligibility, identification of appropriate benefits and assurance of prior authorization. TMMC also provides critical elements of most effective economic claim adjudication and medical claims review. In addition, TMMC performs fee-for-service billing and ensures coordination of benefits for recoveries from primary and secondary insurers. UTILIZATION MANAGEMENT. TMMC has established a utilization management program that assists physicians in the Talbert Medical Groups in providing high-quality, cost-effective care. All referrals to specialty care physicians and all hospital admissions, with the exception of emergencies, require prior approval by utilization management committees. TMMC provides information to the utilization management committees, but does not participate in their deliberations, nor does TMMC directly engage in the practice of medicine or exert control over decisions regarding medical care. Utilization management committees also establish guidelines for routine referrals that can be authorized by committee staff. The committees help ensure that all necessary pre-approvals are obtained, benefits are fulfilled, "best medical practice" alternatives are followed, appropriate providers are used and hospitalization is properly utilized. A case manager coordinates with hospital nurses and primary care physicians for discharge planning and the use of alternatives to hospitalization. The program also focuses on preventive medicine and the development of alternatives to more costly tests, procedures, surgeries, hospitalizations or referrals to specialty care physicians. CASE MANAGEMENT. Case management is a clinical and administrative process by which health care services are identified, coordinated, implemented and evaluated on an ongoing basis for members experiencing health problems. These problems include chronic disability, complex medical issues or problems involving long-term care or disease management. Case management involves the coordination of a variety of services, including, in many instances, home nursing, home infusion and the provision of durable medical equipment. This approach is intended to provide coordinated and comprehensive care for patients throughout the course of treatment, while reducing hospitalization referrals. QUALITY ASSURANCE AND RISK MANAGEMENT. The Talbert Medical Groups maintain, as a service to both physicians and payors, a comprehensive quality assurance program designed to assess patient outcomes. The quality assurance program incorporates peer review, patient satisfaction surveys, medical records auditing, continuing medical staff development and regular continuing medical education seminars to meet or exceed the requirements of accrediting organizations and state law. Medical staff development also 41 includes training and support programs to encourage the application of identified "best medical practices." TMMC has an established risk management program to oversee the management of malpractice claims. See "--Risk Management Program." PHYSICIAN CREDENTIALING AND RECRUITMENT. As a service to payors, TMMC verifies that the credentials of physicians in the Talbert Medical Groups meet the minimum requirements specified in payor contracts. In addition, TMMC assists the Talbert Medical Groups in recruiting physicians. The recruitment process includes a lengthy series of interviews and reference checks incorporating a number of credentialing and competency protocols. All of the Talbert Medical Groups' physicians are licensed to practice medicine in the state where they provide medical services and are generally either board certified or board eligible. SUPPORT SERVICES. The Company provides support services covering all aspects of ambulatory clinic management, including nursing, reception, scheduling, billing, collection, accounting, enrollment information management and licensing maintenance. ANCILLARY CLINICAL SERVICES THSC provides pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy services in many of the Medical Centers. EXPANSION STRATEGY The Company's strategy is to develop high quality, cost efficient health care delivery systems by acquiring or contracting with additional primary and specialty care physicians in selected geographic markets. The Company's strategy in its existing markets focuses on three elements: contracting with new payors, developing additional fee-for-service business and expanding its physician practice base. NEW PAYORS. The Company believes that after its separation from FHP, third party payors previously deterred by its subsidiary affiliation with FHP will be more willing to contract with the Talbert Medical Groups. This would diversify the Talbert Medical Groups payor base as well as increase their capitated enrollment. INCREASED FEE-FOR-SERVICE. Prior to the separation from FHP, the Talbert Medical Groups provided little or no fee-for-service business. Through increased marketing activities and promotional events undertaken by each Medical Center, the Company believes it can develop greater fee-for-service business at the Talbert Medical Groups. NEW PHYSICIAN PRACTICES. The Company intends to expand its physician base in existing markets through the acquisition of, or affiliation with, individual physicians or groups in those markets. The Company also has identified other geographic markets for expansion, based on internally developed criteria. The Company may expand into these markets through the acquisition of, or affiliation with, individual and group primary and specialty care physicians. CONTRACTUAL RELATIONSHIPS PROVIDER AGREEMENTS. TMMC represents the Talbert Medical Groups in obtaining and negotiating provider agreements with payors, such as FHP. Under most provider agreements, the Talbert Medical Group receives a prepaid monthly capitation payment for each payor member who selects a primary care physician employed by the Talbert Medical Group. These capitation payments are administered by TMMC pursuant to a management services agreement with the Talbert Medical Group. To encourage efficient utilization of hospital and related services as well as to maintain the quality of care, the Talbert Medical Groups are obligated to comply with the utilization management policies and quality management programs of the payor. 42 A typical payor contract includes a direct professional capitation payment to the Talbert Medical Group as well as a shared risk/incentive program. The hospital shared risk incentive program is based on actual bed-day utilization against a negotiated bed-day budget. If the actual bed-day utilization is favorable to the bed-day budget, a predetermined dollar amount per day is contributed to the hospital incentive fund. The residual in the fund is typically shared equally between the hospital and the Company. When the Talbert Medical Group assumes risk for over-utilization, the Talbert Medical Group's exposure is usually limited to no more than a maximum of 10% of the deficit in the fund. In the future, the Company may take additional hospital risk under certain circumstances when the Company believes it can make sufficent improvements in bed-day utilization to warrant such risk. TMMC typically identifies potential payors for the Talbert Medical Groups, and negotiates and agrees to provider agreements. In certain cases, TMMC has also guaranteed the obligations of the Talbert Medical Groups under provider agreements. MANAGEMENT SERVICES AGREEMENTS. Under TMMC's contracts to manage the Talbert Medical Groups (the "Management Services Agreements"), TMMC is obligated to provide a range of practice management services, including facilities, non-professional personnel and support staff, billing and collection, and negotiation of managed care and provider contracts. As compensation for its services, TMMC is entitled to reimbursement of certain clinic operating expenses, as well as a percentage of each Talbert Medical Group's revenues net of reimbursed clinic operating expenses (except in California, where the management fee is based on the Talbert Medical Group's gross revenues). The Talbert Medical Groups are solely and exclusively in control of and responsible for all aspects of the practice of medicine and the delivery of medical services. TMMC receives a limited power of attorney from the Talbert Medical Groups for ease of administration, but each Talbert Medical Group retains full authority of approval over all provider and payor contracts and credentialing. The Management Services Agreements generally have terms of twenty years, with two automatic renewals of ten years each (at TMMC's option), and may be terminated by either party for cause upon written notice of between 30 to 180 days. PHYSICIAN EMPLOYMENT AGREEMENTS. The Talbert Medical Groups generally enter into employment agreements with their physicians (the "Physician Employment Agreements") for their professional medical services. The physicians also may provide medical services outside the Talbert Medical Groups if such services do not interfere with their full commitment to the Talbert Medical Group. During the term of the Physician Employment Agreement and for a period of one year following termination, physicians agree not to practice medicine within a three-mile radius of their Medical Center. However, there can be no assurance that such physicians will not attempt to compete with the Talbert Medical Group. The Physician Employment Agreements typically have terms of approximately one year, and are automatically renewed for one year. After the one year automatic renewal, further renewals must be mutually agreed by the parties. The contracts generally can be terminated upon 60 days written notice by either party. To date, the Physician Employment Agreements have provided for fixed salaries, subject to negotiation on an annual basis. Effective January 1, 1997, the Talbert Medical Groups will adopt a new physician compensation system that places a certain portion of physician compensation at risk and includes other financial incentives to encourage high-quality, cost-effective care. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." SHARE CONTROL AND CHIEF OF STAFF AGREEMENTS. TMMC has entered into agreements with the sole shareholder (in each case also the chief of staff) of each of the Talbert Medical Groups (the "Share Control Agreements") that provide for the sole shareholder to vote the shares of the Talbert Medical Group, as to matters other than those affecting the delivery of medical care, in a manner approved by TMMC. TMMC and the sole shareholder of each Talbert Medical Group have entered into agreements appointing the chief of staff of each Talbert Medical Group (the "Chief of Staff Agreements") that may be unilaterally terminated by either party upon 10 days notice. The sole shareholder of each Talbert Medical Group is required to serve as chief of staff, and if terminated, is obligated to sell his or her shares to a 43 designee of TMMC. The Share Control Agreements and Chief of Staff Agreements therefore allow TMMC to replace unilaterally the sole shareholder/chief of staff of a Talbert Medical Group. COMPETITION The health care industry is highly competitive and is subject to continuing changes in the way services are provided and providers are selected and paid. The Company competes with other companies, including PPMCs, that provide management services to health care providers in the geographic markets in which the Company operates. Among the PPMCs with which the Company competes are MedPartners/Mullikin, Inc. in California, FPA Medical Management, Inc. in California and Arizona, and Phycor, Inc. in Utah and Arizona. The Talbert Medical Groups compete with any provider entity in their markets that contracts with payors for the provision of prepaid physician health care services, including physician practice groups not affiliated with PPMCs and HMOs with staff model operations. Certain competitors are significantly larger and better capitalized than the Company, and have longer established relationships with buyers of such services than does the Company. GOVERNMENT REGULATION The health care industry is highly regulated, and there can be no assurance that the regulatory environment in which the Company operates will not change significantly in the future. Generally, regulation of health care companies is increasing. There have been diverse legislative and regulatory initiatives at both the federal and state levels to address, among other things, the continuing increases in health care costs and the lack of health care coverage for many people. Several bills have been introduced in Congress to reform the nation's health care system. These bills include elements such as guaranteed issuance and renewability of health insurance; subsidies for individuals who are uninsured or underinsured; mandates on employers to provide health coverage for their employees; medical savings accounts; mandatory or voluntary regional health alliances or purchasing cooperatives; minimum or standardized health benefit packages; limitations on premiums; medical liability reforms; amendment of the antitrust laws to benefit providers; mandatory or optional single-payor systems for all or part of the population; and changes in federal tax, Medicare and Medicaid laws and the Employee Retirement Income Security Act of 1974. To varying degrees, many of the bills contemplate the involvement of state governments in the regulation and implementation of federal health care reform legislation. Various states are considering forms of single-payor systems, restructuring of Medicaid programs and the adoption of "any willing provider" legislation that could require managed care companies to contract with any medical provider who agrees to the terms of the company's standard provider contract and payment schedule. Any legislation along these lines that becomes law could adversely affect the Company's business. The Company is unable to predict how existing federal or state laws and regulations may be changed or interpreted, what additional laws or regulations affecting its businesses may be enacted or proposed, when and which of the proposed laws will be adopted or what effect the new laws and regulations will have on its businesses. However, certain of the proposals, if adopted, could have a material adverse effect on the Company's business, while others, if adopted, could potentially benefit the Company's business. Although the effects of many proposals cannot yet be determined, the Company remains committed to participate in the debate over health care reform and in the restructuring of the health care system. The laws of the states where the Company currently operates generally specify who may practice medicine and limit the scope of relationships between medical practitioners and other parties. Under these laws, the Company is prohibited from practicing medicine or exercising control over the provision of medical services. In order to comply with these laws, the Talbert Medical Groups are organized so that all physician services are offered by physicians employed by or under contract with the professional corporations affiliated with the Company. Other than in New Mexico, the Company itself does not employ 44 practicing physicians as practitioners. The Company does not, in any state, exert control over physician decisions regarding medical care or represent to the public that it offers medical services. The Company believes that the services it provides to the Talbert Medical Groups do not constitute the practice of medicine under applicable laws. Every state imposes licensing requirements on individual physicians and on facilities and services operated by physicians. In addition, federal and state laws regulate HMOs and other managed care organizations with which the physician groups may have contracts. Many states require regulatory approval, including certificates of need, before establishing or expanding certain types of health care facilities, offering certain services or making expenditures in excess of statutory thresholds for health care equipment, facilities or programs. Some states also require licensing of third party administrators. In connection with its existing operations and its expansion into new markets, the Company believes it is in compliance with all applicable laws, regulations and interpretations, but there can be no assurance that they will not change in the future or that additional laws and regulations will not be enacted. The ability of the Company to operate profitably will depend in part upon the Company and its affiliated physician groups obtaining and maintaining all necessary licenses, certificates of need and other approvals and operating in compliance with applicable health care regulations. The laws of all states prohibit physicians from splitting fees with non-physicians and many states prohibit non-physician entities (such as the Company) from practicing medicine and, in certain circumstances, from employing physicians directly. The Company believes its current and planned activities do not constitute fee-splitting, the practice of medicine or the direct employment of physicians as contemplated by these laws. There can be no assurance, however, that interpretations or enforcement of these laws will not force changes in the Company's relationships with its facilities and physicians. In addition, statutes in some states could restrict expansion of the Company's operations to those jurisdictions. Federal law prohibits the offer, payment, solicitation or receipt of any form of remuneration in return for, or in order to induce (i) the referral of a person for services, (ii) the furnishing or arranging for the furnishing of items or services, or (iii) the purchase, lease or order or arranging or recommending purchasing, leasing or ordering of any item or service, in each case, reimbursable under Medicare or Medicaid. Pursuant to this anti-kickback law, the federal government has recently announced a policy of increased scrutiny for joint ventures and other transactions among health care providers in an effort to reduce potential fraud and abuse relating to Medicare costs. In addition, federal legislation currently restricts the ability of physicians to refer patients for clinical laboratory or certain other designated health services to entities in which they have an ownership interest or other compensation arrangement. Many states, including those in which the Company presently does business, have similar anti-kickback and anti-referral laws. A violation of the federal anti-kickback statute generally requires several elements: (i) the offer, payment, solicitation, or receipt of remuneration; (ii) the intent to induce referrals; and (iii) the ability of the parties to make or influence referrals of patients for services reimbursable under Medicare or Medicaid programs or to provide items or services reimbursable under such programs. Noncompliance with, or violation of, the federal anti-kickback legislation can result in exclusion from Medicare and Medicaid programs and civil and criminal penalties. With respect to the self-referral prohibition, the entity and the referring physician are prohibited from receiving Medicare or Medicaid reimbursement for services rendered. Similar penalties are provided for violation of state anti-kickback and anti-referral laws. The federal government has promulgated "safe harbor" regulations that identify certain business and payment practices deemed not to violate the federal anti-kickback statute. Although the Company's business does not fall within certain of the current or proposed safe harbors, the Company believes that its operations substantially comply with such statutes and regulations. The Company believes that its business arrangements do not involve the referral of patients to entities with whom referring physicians have an ownership interest or compensation arrangement within the meaning of federal and state anti-referral laws, because referrals are made directly to other providers 45 rather than to entities in which referring physicians have an ownership or compensation arrangement. The Company further believes its compensation arrangements with physicians fall within various exceptions to state and federal anti-referral laws, including exceptions for ownership or compensation arrangements with certain managed care organizations and for physician incentive plans that limit referrals. In addition, the Company believes that the methods used to acquire existing physician practices and to recruit new physicians do not violate anti-kickback and anti-referral laws and regulations. If any of the Company's business arrangements were found to violate anti-kickback or anti-referral laws, it could have a material adverse effect on the Company's results of operations. The Company does not believe that its operations generally are likely to be challenged or, if challenged, are likely to be subject to an enforcement action. Laws in all states regulate the business of insurance. Generally, the business of insurance is defined to include the acceptance of financial risk. Certain of the shared risk arrangements entered into by the Company could possibly be characterized by some states as the business of insurance. The Company, however, believes that the acceptance of capitation payments by a health care provider does not constitute the conduct of the business of insurance. Many states also regulate the establishment and operation of networks of health care providers. Generally, these laws do not apply to the hiring and contracting of physicians by other health care providers. There can be no assurance that regulators of the states in which the Company operates would not apply these laws to require licensing of the Company's operations as an insurer or provider network. The Company believes that it is in compliance with these laws in the states in which it does business, but there can be no assurance that future interpretations of insurance laws and health care network laws by the regulatory authorities in these states will not require licensing or a restructuring of some or all of the Company's operations. RISK MANAGEMENT PROGRAM The Company's management services include the provision of professional liability insurance coverage for its affiliates. The Company maintains professional liability insurance on a claims-made basis in amounts deemed appropriate by management, based upon historical claims and the nature and risk of its business. The Company's policy currently provides this coverage to the Talbert Medical Groups through a professional liability policy in the amount of $2 million per claim, and $12 million in the aggregate per policy year for each of the Talbert Medical Groups. The Company has renewed its policy through February 15, 1997. However, there can be no assurance that a future claim or claims will not exceed the limits of available insurance coverage, that any insurer will remain solvent and able to meet its obligations to provide coverage for any claim or claims, or that coverage will continue to be available or available with sufficient limits on a commercially reasonable basis to insure adequately the Company's operations. Since January 1, 1996, substantially all claims have been made within 12 months of incurrence, and no settlements have exceeded policy limits. Physicians not directly employed by the Talbert Medical Groups are required by contract to carry certain minimum amounts of professional liability insurance coverage. These amounts generally correspond to statutory or customary minimums in the physician's practice area. In recent years, participants in the health care industry have become subject to an increasing number of lawsuits alleging medical malpractice, bad faith denial of services and other claims for recovery in connection with alleged injuries or misconduct. Many of these lawsuits involve large claims and substantial defense costs. The Company has significant operations in California, where very large jury awards have been sustained by other companies for claims alleging negligent or fraudulent withholding of approval for necessary medical services. The Company monitors these kinds of cases in each jurisdiction and considers litigation possibilities in the review and implementation of its risk management programs. 46 Due to the nature of its business, the Company and some of its physicians and officers from time to time may become involved as defendants in medical malpractice lawsuits, and are subject to the attendant risk of substantial damage awards. A significant source of potential liability in this regard is the negligence of health care professionals employed or contracted by the Company and its affiliates. See "Risk Factors-- Potential Claims Affecting the Company's Industry; Insurance." EMPLOYEES At September 30, 1996, the Company had approximately 3,500 full-time equivalent employees, including approximately 470 employees of the Talbert Medical Groups. None of the Company's or the Talbert Medical Groups' employees are subject to collective bargaining agreements. Management believes that its employee relations are good. PROPERTIES The Company leases the facilities for its 52 Medical Centers, which range in size from approximately 2,000 to 75,000 square feet. Monthly payments range from $1,000 to $75,000. The facilities for 49 of the 52 Medical Centers are leased, sub-leased or assigned under an agreement with FHP. See "Relationship with FHP and PacifiCare Following the Offering--Master Lease Agreement." The Company leases approximately 60,000 square feet in Costa Mesa, California for its corporate headquarters and California regional office. Monthly rental payments are approximately $51,700. The Company's other regional offices are contained in the Medical Centers, except in Phoenix, Arizona, where a separate 12,600 square-foot regional office is leased for monthly payments of $5,040. LEGAL PROCEEDINGS During the ordinary course of business, the Company and its subsidiaries have become a party to pending and threatened legal actions and proceedings. Management of the Company is of the opinion, taking into account its insurance coverage, that the outcome of the currently known legal actions and proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position of the Company and its subsidiaries. 47 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information about the executive officers and directors of the Company.
NAME AGE POSITION WITH THE COMPANY - ------------------------------------------------ --- ------------------------------------------------------ Jack D. Massimino............................... 47 President, Chief Executive Officer and Director Gloria L. Austin................................ 44 Senior Vice President Becky J. Behlendorf............................. 48 Vice President, Information Systems Jennifer M. Gutzmore, M.D....................... 45 Vice President, Health Care Services Regina B. Lightner.............................. 46 Vice President, Marketing Walter R. Stone................................. 46 Vice President, Finance, Treasurer and Secretary Jack R. Anderson................................ 71 Chairman and Director Richard M. Burdge, Sr........................... 69 Director Warner Heineman................................. 74 Director Van B. Honeycutt................................ 52 Director Robert W. Jamplis, M.D.......................... 76 Director Robert C. Maxson, Ed.D.......................... 60 Director Joseph F. Prevratil............................. 58 Director Westcott W. Price III........................... 57 Director
JACK D. MASSIMINO has been President, Chief Executive Officer and a director of the Company since November, 1996, and has held the same positions with TMMC since December 1995. Mr. Massimino previously served FHP as Executive Vice President since 1993, and added the responsibility of Chief Operating Officer in 1994. He also served in other executive positions since joining FHP in 1988, including Senior Vice President and Vice President for Corporate Development. Mr. Massimino is a director of the American Graduate School for International Business World Business Advisory Council, and the Orange County Business Committee for the Arts. GLORIA L. AUSTIN has been Senior Vice President of the Company since November 1996, and has held the same position with TMMC since December 1995. Ms. Austin previously served as Senior Vice President of FHP's former staff model operations from July 1995, and Senior Vice President, Health Care Delivery from February 1995. She has also served in several executive capacities in FHP's California and Utah regional operations, including Associate Vice President, Utah Region Administration and Regional Vice President, Los Angeles. Ms. Austin joined FHP in 1978. BECKY J. BEHLENDORF has been Vice President, Information Systems of the Company since November 1996, and has held the same position with TMMC since January 1996. Ms. Behlendorf previously served as a strategic information systems consultant to Beverly Enterprises, an owner and operator of skilled nursing facilities, from July 1995 to January 1996. She was Associate Vice President of Strategic Systems of Tenet Health Care from July 1993 to July 1995. Prior to July 1993, Ms. Behlendorf spent 12 years with IBM in a variety of technical and marketing positions, including three years as a health care marketing manager, most notably as Brand Manager of Enterprise Systems. JENNIFER M. GUTZMORE, M.D. has been Vice President, Health Care Services of the Company since November 1996, and has held the same position at TMMC since July 1995. Dr. Gutzmore previously served in a number of senior medical management positions at FHP, including Senior Medical Director for Utilization Management from February to July 1995, Senior Medical Director of Fountain Valley Hospital from September 1994 to February 1995, Senior Medical Director of Medicare from September 1992 to September 1994, and Senior Medical Director for Health Care Delivery for FHP's southern California staff model operations from March 1991 to September 1992. Dr. Gutzmore joined FHP in 1985. 48 REGINA B. LIGHTNER has been Vice President, Marketing of the Company since November 1996, and has held the same position with TMMC since April 1996. Ms. Lightner served as Vice President of Government Health Care programs at CIGNA Health Care from July 1994. She was Associate Vice President Region Sales and Marketing at FHP from March 1990. She was Corporate Associate Vice President of Sales at FHP from April 1988, and Director of Commercial Sales from February 1986. Ms. Lightner joined FHP in 1985. WALTER R. STONE has been Vice President, Finance, Treasurer and Secretary of the Company since November 1996, and has held the same positions with TMMC since December 1995. Mr. Stone was previously Corporate Vice President, Finance at FHP since August 1992. He was Regional Vice President for FHP's staff model operations from 1990 to 1992, and Regional Vice President for FHP's California contracted care operations from 1988 to 1990. Mr. Stone joined FHP in 1980. JACK R. ANDERSON has been Chairman and a director of the Company since November 1996. Mr. Anderson will be appointed a director of PacifiCare in connection with the FHP Merger. He has been a director of FHP since June 1994 and Chairman of the FHP Board of Directors since June 1995. He previously served as Chairman of the Board of Directors of TakeCare, Inc. from 1988 to June 1994. He has been President of Calver Corporation, a health care consulting and investing firm, and a private investor since 1982. Mr. Anderson is a director of Horizon Mental Health Management, Inc. and United Dental Care, Inc. RICHARD M. BURDGE, SR. has been a director of the Company since November 1996. Mr. Burdge serves as the Chairman of the Compensation Committee. He has been a director of FHP since July 1994. Mr. Burdge retired in 1984 as Executive Vice President of CIGNA Corporation, a position he held from 1982 to 1984. He served as Senior Executive Vice President of INA Corporation from 1980 to 1982 and as Executive Vice President of INA Corporation from 1975 to 1980. He also served as President and Chief Operating Officer of the American Stock Exchange from 1972 to 1975. Mr. Burdge is a director of First Commonwealth, Inc. WARNER HEINEMAN has been a director of the Company since November 1996. Mr. Heineman serves as the Chairman of the Audit Committee and as a member of the Finance Committee. He has been a director of FHP since 1990. He has been a senior advisor to First Business Bank since 1992. From 1989 to 1992, he served as senior vice president of Bank of Los Angeles. Mr. Heineman also served as a Senior Vice President of City National Bank from 1981 to 1988. In 1981 he retired as Vice Chairman and Director of Union Bank after 38 years of service. Mr. Heineman is a trustee of Southwestern University School of Law, a member of the Board of Advisors of UCLA Medical Center and the Board of Visitors of UCLA School of Medicine, a director of the FHP Foundation, Alexander Haagen Properties, Inc. and the Countrybaskets Index Funds, Inc. VAN B. HONEYCUTT has been a director of the Company since November 1996. Mr. Honeycutt serves as a member of the Audit Committee. He has been a director of FHP since November 1995. He has been President and Chief Executive Officer of Computer Sciences Corporation since April 1995, and served as president and chief operating officer of Computer Sciences Corporation from 1993 to 1995. Computer Sciences Corporation is a publicly-traded company listed on the New York Stock Exchange that provides information technology consulting, systems integration and outsourcing services to industry and government. From 1987 to 1993, he served as corporate vice president and president of Computer Sciences Corporation's Industry Services Group. ROBERT W. JAMPLIS, M.D. has been a director of the Company since November 1996. Dr. Jamplis serves as a member of the Compensation Committee. He has been a director of FHP since August 1995. Dr. Jamplis served as a director of TakeCare, Inc. and two of its HMO subsidiaries prior to FHP's acquisition of TakeCare, Inc. in 1994. He has been President and Chief Executive Officer of the Palo Alto Medical Foundation since 1981, was named Executive Director of the Palo Alto Clinic in 1966 and joined the Clinic in 1954. Dr. Jamplis has written extensively and held leadership positions with numerous 49 medical, academic and business organizations. He is a director of the Children's Hospital at Stanford, the Santa Barbara Medical Foundation Clinic and the American Cancer Society-California Division. ROBERT C. MAXSON, ED.D. has been a director of the Company since November 1996. Dr. Maxson serves as a member of the Audit Committee. He has been a director of FHP since August 1995. Dr. Maxson is a director of the FHP Foundation, a position he is obligated to resign if he becomes a stockholder of FHP. He has been president of California State University, Long Beach since 1994. Dr. Maxson served as the President of the University of Nevada, Las Vegas, from 1984 to 1994. He has also served on the corporate boards of Bank of America Nevada and Houston Security Bank. JOSEPH F. PREVRATIL has been a director of the Company since November 1996. Mr. Prevratil serves as Chairman of the Finance Committee and as a member of the Compensation Committee. He will be appointed a director of PacifiCare in connection with the FHP Merger. He has been a director of FHP since 1991. Mr. Prevratil is a director and Chief Executive Officer of the FHP Foundation. From 1982 to 1988, Mr. Prevratil served as President of Wrather Port Properties, Inc., an entertainment and hotel complex that included the Queen Mary oceanliner in Long Beach, California. In 1988 and 1989 he served as Executive Director of the Port of Long Beach. From 1989 to 1993, Mr. Prevratil was President of his own business, providing contracted consulting and management services to the leisure-time industry and the Redevelopment Agency of the City of Long Beach. In 1993, Mr. Prevratil became President of the RMS Foundation, Inc., a nonprofit corporation operating the Queen Mary oceanliner attraction. Mr. Prevratil has been the President of J&P Riverside Hotel Corp., the general partner in Riverside Hotel Partners, Ltd., a limited partnership that owned and operated the Sheraton Riverside Hotel. In February 1996, Riverside Hotel Partners, Ltd. filed a petition under Chapter 11 of the federal bankruptcy laws. WESTCOTT W. PRICE III has been a director of the Company since November 1996, and has held the same position at TMMC since December 1995. Mr. Price serves as a member of the Finance Committee. He has been a member of the Board of Directors of FHP since 1984 and its Vice Chairman since 1986. He became President of FHP in 1989 and Chief Executive Officer of FHP in 1990. Mr. Price is a director of the FHP Foundation. KENNETH S. ORD will become a consultant to the Company shortly after the Effective Time of the FHP Merger. Shortly after completion of the Offering, the Company anticipates that Mr. Ord will assume the position of Executive Vice President and Chief Financial Officer of the Company. He is 50 and has been Senior Vice President and Chief Financial Officer of FHP since 1994. From 1982 to 1994, Mr. Ord was employed by Kelly Services, Inc. in Troy, Michigan, most recently as Vice President of Finance, Controller and Treasurer. CLASSIFIED BOARD OF DIRECTORS Pursuant to the terms of the Certificate of Incorporation of the Company, the Board of Directors is divided into three classes, designated Class I, Class II and Class III. Class I, consisting of Messrs. Anderson, Burdge and Heineman, will hold office initially for a term expiring at the annual meeting of stockholders to be held in 1997, Class II, consisting of Mr. Honeycutt, Dr. Jamplis and Mr. Massimino, will hold office initially for a term expiring at the annual meeting of the stockholders to be held in 1998 and Class III, consisting of Dr. Maxson, Mr. Prevratil and Mr. Price, will hold office initially for a term expiring at the annual meeting of stockholders to be held in 1999. Each director will hold office until the annual meeting for the year in which his term expires and until his successor is duly elected and qualified. At each annual meeting of the stockholders of the Company, the successors to the class of directors whose terms expire at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. See "Description of Capital Stock--Certain Anti-Takeover Effects." The Board of Directors elects officers annually and such officers serve at the discretion of the Board of Directors. 50 COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors has established a Finance Committee, an Audit Committee and a Compensation Committee. FINANCE COMMITTEE. The Finance Committee has the responsibility to review the Company's budget, capital resources and financing needs. AUDIT COMMITTEE. The Audit Committee has the responsibility to review and supervise the financial controls of the Company. The Audit Committee makes recommendations to the Board of Directors of the Company with respect to the Company's financial statements and the appointment of independent auditors, reviews significant audit and accounting policies and practices, meets with the Company's independent public accountants concerning, among other things, the scope of audits and reports, and reviews the performance of overall accounting and financial controls of the Company. COMPENSATION COMMITTEE. The Compensation Committee has the responsibility to review the performance of the officers of the Company and recommend to the Board of Directors annual salary and bonus amounts for all officers of the Company. The Compensation Committee also has the responsibility for oversight and administration of the Company's 1996 Stock Incentive Plan and other compensatory plans. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Mr. Burdge (Chairman), Dr. Jamplis and Mr. Prevratil have served as members of the Compensation Committee since the Company's organizational meeting in November 1996. Each of the members of the Compensation Committee is a non-employee Director of the Company. No executive officer of the Company during the last fiscal year served as a member of a compensation committee or director of another for-profit entity in a situation in which an executive officer of such other entity served as a member of the Compensation Committee or Director of the Company. See "Certain Transactions." EXECUTIVE OFFICER AND DIRECTOR COMPENSATION DIRECTOR COMPENSATION. The Company's 1996 Stock Incentive Plan provides for initial and subsequent annual grants of nonqualified stock options to non-employee directors. See "Stock Incentive Plan-- Non-Employee Director Options." Except for reimbursement of expenses, directors are not otherwise compensated for attending meetings of the Board of Directors or its committees. EXECUTIVE OFFICER COMPENSATION. The following table presents certain information concerning compensation paid by the Company or FHP for services rendered during the year ended December 31, 1996, for the Chief Executive Officer and the next four most highly compensated executive officers of the Company (collectively, the "Named Executive Officers"). The Company did not have its own executive compensation or employee benefit plans prior to November 1996. Certain of the amounts shown below reflect the participation of the Named Executive Officers in plans administered by FHP. The table does not reflect options to purchase FHP Common Stock awarded to the Named Executive Officers by FHP during the year ended December 31, 1996. 51 SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION(1) --------------------------------------------------- ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY(2) BONUS(3) COMPENSATION(4) - -------------------------------------------------------------- --------- ---------- ---------- ---------------- Jack D. Massimino............................................. 1996 $ 350,000 $ 591,700 $ President and Chief Executive Officer 1995 411,925(6) -- 13,560 Gloria L. Austin.............................................. 1996 210,001 645,280 Senior Vice President 1995 205,502 20,000 12,263 Walter R. Stone............................................... 1996 151,382 258,833 Vice President, Finance, Treasurer and Secretary 1995 148,627 -- 12,074 Jennifer M. Gutzmore, M.D..................................... 1996 200,273 188,578 Vice President, Health Care Services 1995 175,036 3,000 12,325 Gary E. Goldstein, M.D. (5)................................... 1996 191,334 -- Former Senior Vice President 1995 249,995 1,549 13,050
- ------------------------ (1) The dollar value of perquisites and other personal benefits did not exceed the lesser of $50,000 or 10% of the Named Executive Officer's salary and bonus. (2) Includes the base salary earned by the Named Executive Officer during the year and any voluntary salary reduction resulting from contributions for the year by the Named Executive Officer to (a) the FHP ESOP under Section 401(k) of the Code and (b) the FHP Deferred Compensation Plan. (3) 1995 figures include the cash value of any bonus earned by the Named Executive Officer during FHP's fiscal year ended June 30, 1995 and the cash value of any voluntary bonus reductions resulting in contributions to (a) the FHP ESOP under Section 401(k) of the Code and (b) the FHP Deferred Compensation Plan. (4) Includes the dollar value of taxable income from group term life insurance coverage in excess of $50,000 purchased by FHP as follows: Mr. Massimino: 1996--$662, 1995--$1,560; Ms. Austin: 1996-- $386, 1995--$263; Mr. Stone: 1996--$966, 1995--$183; Dr. Gutzmore: 1996--$463, 1995--$325; and Dr. Goldstein: 1996--$281, 1995--$1,050. Also includes FHP contributions under the FHP Money Purchase Plan as follows: Mr. Massimino: 1995--$9,000; Ms. Austin: 1995--$9,000; Mr. Stone: 1995-- $8,918; Dr. Gutzmore: 1995--$9,000; and Dr. Goldstein: 1995--$9,000 (the FHP Money Purchase Plan was discontinued as of December 31, 1995, thus no contributions were made after that date). Also includes FHP contributions under the FHP ESOP as follows: Mr. Massimino: 1996--$ , 1995--$3,000; Ms. Austin: 1996-- , 1995--$3,000; Mr. Stone: 1996--$ , 1995--$2,973; Dr. Gutzmore: 1996-- , 1995--$3,000; and Dr. Goldstein: 1996--0, 1995--$3,000. Also includes FHP contributions under the 401(k) portion of the FHP ESOP Plan as follows: Mr. Massimino: 1996--$ ; Ms. Austin: 1996-- ; Mr. Stone: 1996-- ; 1995--$500; Dr. Gutzmore: 1996-- ; and Dr. Goldstein: 1996-- , 1995--$500. (5) Dr. Goldstein has not been employed by TMMC since July 12, 1996. (6) Mr. Massimino's annual salary was reduced from $450,000 to $350,000 effective July 1, 1995. The Company anticipates that Kenneth Ord will assume the position of Executive Vice President and Chief Financial Officer shortly after completion of the Offering. See "Recent Developments." Mr. Ord served as Senior Vice President and Chief Financial Officer of FHP during 1996, and received from FHP salary of $336,265 (see footnote 2 above); bonus of $59,170 (see footnote 3 above); and other compensation in the amount of $97,724 (representing $95,756 of loan forgiveness by FHP and $1,968 in dollar value of taxable income from group term life insurance coverage in excess of $50,000 purchased by FHP); 52 $ in FHP contributions under the FHP ESOP; and $ in FHP Contributions under the 401(k) portion of the FHP ESOP. OPTION GRANTS OPTION GRANTS IN FISCAL YEAR 1996. The following table sets forth the options granted with respect to the fiscal year ended December 31, 1996 to the Named Executive Officers. The Company has not granted any stock appreciation rights. OPTION GRANTS IN FISCAL YEAR 1996
INDIVIDUAL GRANTS POTENTIAL REALIZABLE --------------------------------------------------------- VALUE AT ASSUMED ANNUAL NUMBER OF PERCENT OF RATES OF STOCK PRICE SHARES TOTAL OPTIONS APPRECIATION FOR UNDERLYING GRANTED TO EXERCISE OR OPTION TERM(4) OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ------------------------ NAME GRANTED(#)(1) FISCAL YEAR ($/SH) DATE 5%($) 10%($) - -------------------------------- ------------- --------------- ----------- ------------ ---------- ------------ Jack D. Massimino............... 26,082(2) 33.9% $ 10.00 11/21/2006 $ 979,303 $ 1,709,683 Gloria L. Austin................ 5,353(2) 7.0% 10.00 11/21/2006 200,990 350,891 Walter R. Stone................. 5,353(2) 7.0% 10.00 11/21/2006 200,990 350,891 Jennifer M. Gutzmore, M.D....... 7,500(3) 9.7% 29.17 09/17/2006 137,828 347,852 Gary E. Goldstein, M.D.......... 0 -- -- -- -- --
- ------------------------ (1) Stock options were granted under the Stock Incentive Plan (see "--Stock Incentive Plan"). (2) The options vest at the rate of (a) 40% on the date of commencement of trading of the Common Stock on Nasdaq and (b) 15% per year on each January 1 of the years 2000 through 2003. (3) The options vest at the rate of (a) 20% on the later of September 17, 1997 or the date of commencement of trading of the Common Stock on Nasdaq and (b) 20% per year on each September 17 of the years 1998 through 2001. (4) This column shows the hypothetical gains or "option spreads" of the options granted based on both the fair market value of the Common Stock for financial reporting purposes and assumed annual compound stock appreciation rates of 5% and 10% over the full 10-year term of the options. The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future Common Stock prices. The gains shown are net of the option exercise price, but do not include deductions for taxes or other expenses associated with the exercise of the option or the sale of the underlying shares. The actual gains, if any, on the exercises of stock options will depend on the future performance of the Common Stock, the option holder's continued employment through the option period, and the date on which the options are exercised. 53 OPTION EXERCISES AND YEAR-END HOLDINGS. None of the options held by the Named Executive Officers were exercisable in 1996. The following table sets forth information regarding the number and value of options held at the end of 1996 by the Named Executive Officers. FISCAL YEAR-END 1996 OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT FISCAL YEAR-END(#) FISCAL YEAR-END($)(1) -------------------------------- -------------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---------------------------------------------------------- ----------------- ------------- ----------------- ------------- Jack D. Massimino......................................... 0 26,082 0 $ 499,992 Gloria L. Austin.......................................... 0 5,353 0 102,617 Walter R. Stone........................................... 0 5,353 0 102,617 Jennifer M. Gutzmore, M.D................................. 0 7,500 0 0 Gary E. Goldstein, M.D.................................... 0 0 0 0
- ------------------------ (1) The amounts set forth represent solely the difference between the estimated fair value of $29.17 per share of the Common Stock underlying those unexercised options that had an exercise price below such price (i.e., "in-the-money options") and the respective exercise prices of the options. No assumptions or representations regarding the "value" of such options are made or intended. CHANGE IN CONTROL EMPLOYMENT AGREEMENTS The Company has entered into agreements (the "Change in Control Employment Agreements") providing for benefits in the event of a "Change of Control" of the Company with the following executives: Jack D. Massimino, Gloria L. Austin, Becky J. Behlendorf, Jennifer M. Gutzmore, M.D., Regina B. Lightner and Walter R. Stone. Pursuant to the Change of Control Employment Agreements, certain officers agree to forego any payments or benefits to which they were entitled under similar agreements with FHP. For the purposes of the Change of Control Employment Agreements, a Change of Control occurs when: (i) another party, other than a Company-sponsored employee benefit plan, acquires (other than directly from the Company) beneficial ownership of 20% or more of the Company's stock or voting securities; (ii) there is a change in a majority of the current Board of Directors (the "Incumbent Board") (excluding any persons approved by a vote of the Incumbent Board other than in connection with an actual or threatened proxy contest); or (iii) there is a consummation of a complete liquidation or dissolution of the Company or a merger, consolidation or sale of all or substantially all of the Company's assets (collectively, a "Business Combination") other than a Business Combination in which: (a) all or substantially all of the stockholders of the Company receive 70% or more of the stock of the Company resulting from the Business Combination; (b) no party, other than a Company sponsored employee benefit plan, beneficially owns, directly or indirectly, 20% or more of the Company's stock or voting securities except to the extent any such ownership existed prior to the Business Combination; and (c) at least a majority of the board of directors of the resulting corporation were members of the Incumbent Board. The Change of Control Employment Agreements provide that the executive's employment will continue for three years following a Hostile Change of Control and for two years following a Change of Control that is not Hostile, in each case on equivalent terms (including position, duties, compensation and benefits) to those existing immediately prior to the Change of Control. A Change in Control is "Hostile" if it results from an unsolicited proposal that is approved by a majority of the disinterested directors prior to disclosure of the Change in Control or if such disclosure is made without the prior approval of a majority of the disinterested directors. If during the relevant period the executive's employment is terminated other than for "Cause," death or disability, or if the executive terminates his employment for "Good Reason" (as defined in the Employment Agreements), the executive is entitled to receive an accrued salary and annual 54 incentive payment through the date of termination and, except in the event of death or disability, payments and benefits including the continuation of bi-weekly salary payments and certain medical, dental and life insurance coverage for the relevant period, payment of accrued vacation, holiday and personal leave time, and a lump sum payment equal to additional contributions that would have been allocated to the executive's accounts under the Company's 1996 Employee Stock Ownership Plan and 1996 Money Purchase Pension Plan if the executive had remained employed for the relevant period and deferred the maximum pretax deferral allowed under the terms of these plans and the amount of any benefits under the 1996 Employee Stock Ownership Plan that were forfeited upon termination of employment but that would have vested if the executive remained employed for the relevant period. All of the executive's outstanding option rights under the Company's 1996 Stock Incentive Plan will immediately become exercisable and all restrictions on Restricted Stock will be eliminated on the date of termination of employment, unless prohibited by law. The Change of Control Employment Agreements also contain provisions with respect to the acceleration of options. Upon termination of employment other than voluntary or for Cause, death or Disability, after a Change of Control and prior to the end to the relevant period, all outstanding options held by the executive vest, except to the extent such vesting would result in an "excess parachute payment" nondeductible by the Company or would prevent accounting for the Change of Control as a "pooling-of-interest." Options that do not vest by reason of the exception become exercisable in accordance with their original vesting schedule and remain exercisable until 90 days thereafter (or, if earlier, until the original expiration date), provided that within 30 days of the executive's date of termination the executive satisfies the following two requirements: (i) the executive executes and delivers to the Company a Settlement and Release Agreement waiving all the claims against the Company and its affiliates (other than obligations under the Change of Control Employment Agreement and vested employee benefits); and (ii) the executive executes and delivers to the Company a Covenant Not to Compete for the period through the end of the Employment Period, imposing certain restrictions upon the executive conducting the same business in the same cities and counties as carried on by the Company at the effective date of a Change of Control. STOCK INCENTIVE PLAN The Company's 1996 Stock Incentive Plan (the "Stock Incentive Plan") was adopted by the Board of Directors as of September 1996. The purpose of the Stock Incentive Plan is to provide long-term incentives to those key employees (including executive officers), significant agents and consultants responsible for the continued success and growth of the Company. In addition, the Stock Incentive Plan is intended to enable the Company to attract, motivate and retain experienced and knowledgeable independent directors. The Stock Incentive Plan is administered by a committee (the "Committee"), comprised of the Board of Directors or a committee consisting of two or more of its members, each of whom is an "outside" director within the meaning of Section 162(m) of the Internal Revenue Code (the "Code"). The Committee may grant discretionary awards to any officer, non-employee director, key employee, or significant consultant or advisor to the Company. In addition, the Stock Incentive Plan provides for the automatic grant of nonqualified stock options to non-employee directors. SHARES THAT MAY BE ISSUED UNDER THE STOCK INCENTIVE PLAN. A maximum of 180,000 shares of Common Stock, or approximately 5.7% of the issued and outstanding shares of Common Stock (on a fully diluted basis), has been reserved for issuance under the Stock Incentive Plan and may be issued upon the exercise of stock options ("Options") or stock appreciation rights ("SARs") or pursuant to awards of restricted stock ("Restricted Stock Awards") or performance share awards ("Performance Awards") and stock bonuses ("Stock Bonuses") or non-employee director options ("Non-Employee Director Options") (Options, SARs, Restricted Stock Awards, Performance Awards, Stock Bonuses and Non-Employee Director Options are collectively referred to as "Awards"). The maximum number of shares of Common Stock that may be delivered pursuant to incentive stock options is 50,000 shares. The maximum number of 55 shares of Common Stock that may be delivered as Non-Employee Director Options is 60,000. The maximum number of shares subject to Options and SARs that are granted during any calendar year to any individual is limited to 50,000. The 180,000 shares available under the Stock Incentive Plan will be registered under a Form S-8 registration statement expected to be filed with the Securities and Exchange Commission (the "Commission") within 12 months of the effective date of the registration statement relating to the Rights and the Common Stock offered hereby (the "Registration Statement"). As is customary in incentive plans of this nature, the number and kind of shares available under the Stock Incentive Plan are subject to adjustment in the event of any extraordinary dividend or any extraordinary distribution in respect of the Common Stock, or any reclassification, recapitalization, stock split (including a stock split in the form of a stock dividend), reverse stock split, reorganization, merger, combination, consolidation, split-up, spin-off, combination, repurchase or exchange of Common Stock or other securities of the Company, or there shall occur any other like corporate transaction or event in respect of the Common Stock or a sale of substantially all the assets of the Company. Shares relating to Awards which expire or for any reason are cancelled, terminated, forfeited, fail to vest, or are reacquired, will again become available for grant purposes in the Stock Incentive Plan to the extent permitted by law. Awards are not transferable by an Award holder other than as expressly provided for under the Stock Incentive Plan or by law, and are exercisable, during his or her lifetime, only by the Award holder. The Committee determines the terms of Awards, including the number of shares subject to the Award, exercise price, term and exercisability. Unless the Committee otherwise expressly provides, no Award is exercisable or will vest prior to twelve months after its grant date. In the case of Options or other rights to acquire Common Stock, an Award will expire not later than ten years after its grant date (five years in the case of Incentive Stock Options granted to Option holders who own more than 10% of the voting power of the Company's outstanding voting stock). STOCK OPTIONS. An Option is the right to purchase shares of Common Stock at a future date at a specified price (the "Option Price"). The Option Price is generally the closing price for a share of Common Stock on a national securities exchange or quotation system on the date of the grant. An Option may either be an incentive stock option, as defined in the Code, or a non-qualified stock option. An incentive stock option may not be granted to a person who owns more than 10% of the total combined voting power of all classes of stock of the Company unless the Option Price is at least 110% of the fair market value of shares of Common Stock subject to the Option. The aggregate fair market value of shares of Common Stock (determined at the time the Option is granted) for which incentive stock options may be first exercisable by an Option holder during any calendar year under the Stock Incentive Plan or any other plan of the Company may not exceed $100,000. A non-qualified stock option is not subject to any of these limitations. STOCK APPRECIATION RIGHTS. In its discretion, the Committee may grant a SAR either concurrently with the grant of an another Award (the SAR may extend to all or a portion of the shares covered by such other Awards), or independently from another Award. Upon exercise of a SAR, the holder receives, for each share with respect to which the SAR is exercised, an amount equal to the excess of the fair market value of a share of Common Stock on the date of exercise of the SAR over the exercise price per share of Common Stock under the related Award. RESTRICTED STOCK AWARDS. A Restricted Stock Award is an award for a fixed number of shares of Common Stock subject to restrictions. The Committee will specify the price, if any, the participant must pay for the shares and the restrictions imposed on the shares, which will not terminate earlier than twelve months after the award date, except to the extent the Committee may otherwise provide. Restricted Stock awarded to a participant may not be voluntarily or involuntarily sold, assigned, transferred, pledged or otherwise disposed of or encumbered during the restricted period. PERFORMANCE SHARE AWARDS AND STOCK BONUSES. A Performance Award is an award of a right to receive shares of Common Stock or other compensation (including cash), the issuance or payment of which 56 is contingent upon the attainment of performance objectives, among other things. The Committee may, in its discretion grant Performance Awards based upon factors the Committee deems relevant in light of the specific type and terms of the award. The Committee may provide for full or partial credit for the completion of such performance objectives in the event of death, or total disability, a change in control or certain other circumstances. A Stock Bonus is an award of shares of Common Stock for no consideration other than past services and without restriction other than transfer restrictions set by the Committee. Without limiting the generality of the foregoing, the Stock Incentive Plan permits the Committee to grant certain other types of awards ("Performance-Based Awards") that are intended to qualify as "performance based compensation" under Section 162(m) of the Code. Under Section 162(m), the Company may not deduct certain compensation of over $1,000,000 paid in any year to the Chief Executive Officer or one of the four other most highly compensated executive officers of the Company ("Executive Officers") unless, among other things, this compensation qualifies as performance-based compensation under Section 162(m), and the material terms of the plan for such compensation are approved by stockholders. Options and SAR's that are granted under that Plan at a fair market value exercise price are intended to qualify as performance-based compensation. In addition, other share-based awards (such as restricted stock or performance awards) that may be granted under the Stock Incentive Plan may qualify as performance-based compensation under Section 162(m). The Stock Incentive Plan also provides for the grant of Performance-Based Awards that are not denominated nor payable in and do not have a value derived from the value of a price related to shares of Common Stock and are payable only in cash ("Cash-Based Awards") that are intended to satisfy the requirements for performance-based compensation under Section 162 (m). The maximum amount payable to any participant under all Cash-Based Awards that are intended to be Performance-Based Awards during any calendar year under the Plan will be $1,000,000. The maximum number of shares of the Company's Common Stock that may be subject to all Performance-Based Awards, including stock options and stock appreciation rights, that are granted to any participant during any calendar year will not exceed 100,000 shares, either individually or in the aggregate. ACCELERATION OF AWARDS; POSSIBLE EARLY TERMINATION OF AWARDS. Unless prior to a Change in Control Event (as described below) the Committee determines that upon its occurrence there will be no acceleration, then upon the occurrence of a Change in Control Event, each Option and SAR will become immediately exercisable, Restricted Stock will vest free of restrictions, and Performance Shares will become payable. In general, a Change in Control Event includes: (i) approval by the stockholders of the Company of the dissolution or liquidation of the Company; (ii) any acquisition by a person or group (subject to certain exceptions) of 20% or more of either the outstanding Common Stock or the combined voting power of the Company's outstanding securities; (iii) a change in the majority of the Company's directors; or (iv) consummation of a reorganization, merger, consolidation, sale or other disposition of all or substantially all of the assets of the Company under certain circumstances; provided that no award will be accelerated as to any person subject to Section 16 of the Securities Act to a date less than six months after its applicable date of grant. Options or other Awards not exercised prior to the dissolution of the Company or a merger or other corporate event where the Company is not the surviving corporation and where no provision is made for the assumption, conversion, substitution or exchange of the Options or Awards, will terminate upon the occurrence of such event. TERMINATION OF OR CHANGES TO THE STOCK INCENTIVE PLAN. The Board of Directors may terminate or amend the Stock Incentive Plan. Any amendment, to the extent then required by the Code or as required by any other applicable law, must be approved by the stockholders of the Company. Unless previously terminated by the Board of Directors, the Stock Incentive Plan will terminate ten years after the effective date. 57 NON-EMPLOYEE DIRECTOR OPTIONS. The Stock Incentive Plan provides for automatic initial and subsequent annual grants of non-qualified stock options to non-employee directors. Under the initial grant, made as of September 17, 1996, the Chairman of the Board of Directors received options to purchase 6,000 shares of Common Stock, the chairmen of the Audit, Compensation and Finance Committees each received options to purchase 5,000 shares of Common Stock, and each other non-employee director received options to purchase 3,000 shares of Common Stock. Each person who subsequently becomes a non-employee director will receive an initial grant of options to purchase 3,000 shares of Common Stock. Under the subsequent automatic grant, each non-employee director then in office will be granted options to purchase 1,000 shares on each anniversary of the director's initial option grant. The September 17, 1996 grants to non-employee directors will vest at the rate of 25% on the later of 90 days after the Award date or 60 days after the date of commencement of trading of the Common Stock on a national securities exchange or quotation system (the "Initial Award Date") and 25% per year on the first three anniversaries of the Initial Award Date. Each other Non-Employee Director Option will vest at the rate of 25% per year commencing on the first anniversary of the Award date and each of the next three anniversaries thereof. Upon the occurrence of a Change in Control Event, each Non-Employee Director Option will become immediately exercisable in full, provided that no Non-Employee Director Option will be accelerated to a date prior to six months after its grant date. To the extent any Non-Employee Director Option is not exercised prior to (i) dissolution of the Company or (ii) a merger or other corporate event that the Company does not survive, and no provision is made for the assumption, conversion, substitution or exchange of the Non-Employee Director Option, the Non-Employee Director Option will terminate upon the occurrence of the Change in Control Event. GRANTS TO DATE. As of December 31, 1996, the Company had granted options to purchase a total of 109,986 shares of Common Stock under the Stock Incentive Plan. Employees received grants with respect to 76,986 shares, and non-employee directors received grants with respect to 33,000 shares. Options with respect to 70,350 shares, including all of the non-employee director options, were granted as of September 17, 1996, with an exercise price of $29.17 per share, and options with respect to 39,636 shares were granted as of November 21, 1996, with an exercise price of $10 per share. Options with respect to 37,350 shares granted to employees as of September 17, 1996 will vest at the rate of 20% per year on each of the first five anniversaries of the date of the grant. The November 1996 Options provide for vesting of 40% of the total number of shares awarded as of December 31, 1996 (or the date on which the Common Stock begins trading on a national securities exchange or quotation system) and 15% each January 1 from 2000 to 2003. EMPLOYEE STOCK OWNERSHIP PLAN The Talbert Medical Management Holdings Corporation Employee Stock Ownership Plan (the "ESOP") is intended to be a tax-qualified retirement plan that satisfies the requirements of Sections 401(a), 401(k), 501(a) and 4975 of the Code. The Company's ESOP will have substantially the same terms as FHP's ESOP. The account balances of Company employees (together with employees of the Talbert Medical Groups) will be transferred from FHP's ESOP to the Company's ESOP. The ESOP will provide for a discretionary employer stock bonus contribution that can be made each year and allocated to the employer contribution accounts of participants. The employer contribution account of each participant will be subject to a five-year "cliff" vesting schedule. Participants formerly employed by FHP will receive credit for their service at FHP. In addition, the ESOP will permit employees to elect to reduce their salaries and make 401(k) contributions to the ESOP. The 401(k) account of each participant will be 100% vested. The ESOP will also provide for matching contributions in the same manner as the FHP ESOP. Accordingly, if a participant has completed less than five years of service, the employer matching contribution rate will equal 50% of the participant's 401(k) deferrals up to six percent of the participant's compensation. If the 58 participant has completed at least five years of service, the employer matching contributions rate will equal 100% of the participant's 401(k) deferrals up to six percent of the participant's compensation. The ESOP will permit participants to direct the investment of their 401(k) and employer matching accounts on a monthly basis. One of the available investment funds under the ESOP will be a Company Common Stock fund. The ESOP administrator may establish such rules and procedures as it deems necessary in its sole discretion to ensure that the participants' investments in the Company Common Stock fund will satisfy the requirements of all applicable law. Such rules and procedures may include a prohibition on certain participants' ability to invest in the Company Common Stock fund. DEFERRED COMPENSATION PLAN The Talbert Medical Management Holdings Corporation Deferred Compensation Plan (the "Deferred Compensation Plan") will be virtually identical to FHP's Deferred Compensation Plan. Accordingly, the Deferred Compensation Plan will be a nonqualified deferred compensation plan and will permit the Company's non-employee directors and a select group of management or highly compensated employees to elect to defer compensation under the Deferred Compensation Plan. The Deferred Compensation Plan will permit a minimum deferral of 3% with respect to salaries (or, with respect to bonuses, 1%) and a maximum deferral of 50% with respect to salaries (or, with respect to bonuses, 100%). The Deferred Compensation Plan will also permit discretionary employer contributions. Amounts deferred under the Deferred Compensation Plan will be credited to bookkeeping accounts established and maintained for each participant. The compensation deferral account of each participant will be 100% vested. The employer contribution account of each participant will be subject to a five-year "cliff" vesting schedule, but will become 100% vested in the event of a Change-of-Control (as defined under the Deferred Compensation Plan). The Company's Deferred Compensation Plan will provide for the same distribution options as under FHP's Deferred Compensation Plan including: (i) short-term payout option; (ii) retirement benefit; (iii) termination distribution (iv) survivor benefit; and (v) withdrawal election. MONEY PURCHASE PENSION PLAN The Talbert Medical Management Holdings Corporation Money Purchase Pension Plan (the "Money Purchase Pension Plan") is intended to be a tax-qualified retirement plan that satisfies the requirements of Sections 401(a) and 501(a) of the Code. The Money Purchase Pension Plan will be virtually identical to FHP's Money Purchase Pension Plan. Accordingly, the Money Purchase Pension Plan will be frozen both as to contributions as well as to participation. The account balances of Company employees and the employees of the Talbert Medical Groups will be transferred from FHP's Money Purchase Pension Plan to the Money Purchase Pension Plan. The accounts of each participant under the Money Purchase Pension Plan will be 100% vested. In general, accounts will be distributable upon a participant's termination from employment. LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS The Company's Certificate of Incorporation contains a provision eliminating or limiting director liability for monetary damages arising from a breach of fiduciary duty as a director, except for liability of a director (i) for any breach of such director's duty of loyalty to the Company or its stockholders; (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; (iii) under the Delaware statutory provision making directors personally liable, under a negligence standard, for unlawful dividends or unlawful stock purchases or redemptions; or (iv) for any transaction from which the director derived an improper personal benefit. As a result of this provision, the ability of the Company or a stockholder thereof to successfully prosecute an action against a director for a breach of 59 his or her duty of care is limited. However, the provision does not affect the availability of equitable remedies such as an injunction or rescission based upon a director's breach of his duty of care. In addition, the Certificate of Incorporation and the Company's Bylaws provide for mandatory indemnification rights, subject to limited exceptions, to any person who by reason of the fact that he or she is a director or officer of the Company, is involved in a legal proceeding of any nature if he or she acted in good faith and in a manner he or she reasonably believed to be in and not opposed to the best interests of the Company. If such legal proceeding is brought by or in the right of the Company, no indemnification will be made if the person is adjudged to be liable for negligence or misconduct in the performance of his duty to the Company, unless a court finds such person to be entitled to indemnity despite adjudication of liability. Such indemnification rights include reimbursement for expenses incurred by such director or officer in advance of the final disposition of such proceeding in accordance with the applicable provisions of Delaware General Corporation Law. The Company has entered into separate indemnification agreements with its directors and executive officers. Each indemnification agreement provides for, among other things: (i) indemnification against any and all expenses, judgments, fines, penalties, and amounts paid in settlement of any claim that an indemnitee was, is, or is threatened to be made a party to or witness or other participant to unless it is determined, as provided in the indemnification agreement, that indemnification is not permitted under law; and (ii) prompt advancement of expenses to any indemnitee. The Company also maintains directors' and officers' liability insurance. The Company believes that the provisions of its Certificate of Incorporation, Bylaws, indemnification agreements and insurance are necessary to attract and retain qualified persons as directors and officers. At present, there is no pending litigation or proceeding involving any director, officer, employee or agent of the Company where indemnification would be required or permitted. The Company is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification. 60 CERTAIN TRANSACTIONS In connection with the reorganization of the staff model operations of FHP and the creation of TMMC and THSC, in March 1996 twelve individuals, then all FHP or TMMC executives (the "Management Investors"), purchased shares of TMMC's common stock (the "TMMC Management Shares") and shares of THSC's Common Stock (the "THSC Management Shares") for an aggregate consideration of approximately $8,000 pursuant to a Stock Purchase Agreement among FHP, TMMC, THSC and the Management Investors (the "Management Stock Purchase Agreement"). In connection with the Acquisition, pursuant to a Management Stock Exchange Agreement with the Company, the Management Investors exchanged their TMMC and THSC Management Shares for an equivalent number of shares of the Company's Common Stock, on equivalent terms and conditions as are provided in the Management Stock Purchase Agreement (the "Company Management Shares"). See "Relationship with FHP and PacifiCare Following the Offering--Management Stock Exchange Agreement." The Company Management Shares will be issued as follows:
NAME NUMBER OF SHARES - --------------------------------------------------------------------------- ----------------- Jack D. Massimino.......................................................... 150,000(2) Westcott W. Price III...................................................... 20,250 Gloria L. Austin........................................................... 15,000 Kathryn M. Adair........................................................... 7,500 Richard D. Jacobs.......................................................... 7,500 Larry L. Georgopolous...................................................... 6,000 Walter R. Stone............................................................ 6,000 Margaret Van Meter (1)..................................................... 6,000 Barbara C. McNutt.......................................................... 4,500 Gary E. Goldstein, M.D..................................................... 3,750 Kenneth S. Ord............................................................. 3,000 Michael J. Weinstock....................................................... 3,000 ------- Total 232,500 ------- -------
- ------------------------ (1) Ms. Van Meter has notified the Company that she intends to terminate her employment in the first quarter of 1997. On July 1, 1996, 1,500 of her Company Management Shares vested, and the remaining 4,500 will be repurchased by FHP pursuant to its buy-back rights under the Management Stock Purchase Agreement. (2) Includes 15,000 shares held under an irrevocable trust for the benefit of Mr. Massimino's children. The Management Investors will not make capital contributions to the Company equivalent to the Capital Contribution by FHP. The Company therefore will recognize stock compensation expense of approximately $5.3 million. See "Prospectus Summary--Unaudited Pro Forma Condensed Consolidated Financial Data." The Company has also entered into certain transactions with FHP. See "Relationship with FHP and PacifiCare Following the Offering." 61 RELATIONSHIP WITH FHP AND PACIFICARE FOLLOWING THE OFFERING To govern certain of the ongoing relationships between the Company, FHP and PacifiCare after the Offering and to provide mechanisms for an orderly transition, the parties have entered into the various agreements described in this section. THE FOLLOWING SUMMARIES OF THE VARIOUS AGREEMENTS DO NOT PURPORT TO BE COMPLETE AND ARE QUALIFIED IN THEIR ENTIRETY BY REFERENCE TO THEIR TEXT, COPIES OF WHICH ARE FILED AS EXHIBITS TO THE REGISTRATION STATEMENT AND ARE INCORPORATED HEREIN BY REFERENCE. PROVIDER AGREEMENTS Pursuant to the terms of the FHP Merger, TMMC, on behalf of the Talbert Medical Groups, has entered into the New FHP Provider Agreements with various HMO subsidiaries of FHP to provide medical and dental services to FHP plan members. The New FHP Provider Agreements became effective upon the completion of the FHP Merger. The New FHP Provider Agreements have ten-year terms, except for Utah, which has a 15-year term. Capitation rates established in the New FHP Provider Agreements are subject to renegotiation one year after the Effective Time. If the parties are unable to agree upon new rates, the existing rates will remain in effect. The Talbert Medical Groups will be responsible for providing or arranging all covered medical services to members of various FHP HMO subsidiaries in accordance with professional standards. FHP will provide administration of the health plan, marketing, enrollment, benefit design and interpretation, medical management (including quality and utilization management) and claims processing. The Talbert Medical Groups will receive compensation in two components: monthly capitation payments (which are a percentage of premiums) and incentive compensation, disbursed semi-annually, related to controlling hospital or pharmacy costs, where applicable. The New FHP Provider Agreements involve several significant differences from previous provider agreements with FHP. The New FHP Provider Agreements do not contain any subsidies from FHP, and therefore will result in lower revenues per enrollee to the Company. See "Risk Factors--Contracted Rate Decrease." They also require the Talbert Medical Group to provide additional physician services, increasing costs per enrollee. See "Prospectus Summary--Unaudited Pro Forma Condensed Consolidated Financial Data." The New FHP Provider Agreements also provide for TMMC, as manager of the Talbert Medical Groups, to guarantee the performance of each of the Talbert Medical Groups. The New FHP Provider Agreements further provide that the consent of FHP and PacifiCare is required for any proposed sale or change in control of TMMC or a Talbert Medical Group during the first two years of their term, which consent will not be unreasonably withheld. The Talbert Medical Groups have agreed not to seek or obtain a Medicare-risk contract with HCFA. The New FHP Provider Agreements anticipate that FHP systems, compensation mechanisms and administrative procedures will initially be followed, but will eventually convert to PacifiCare systems, compensation mechanisms and administrative procedures. The Company also has recently entered into a provider agreement with PacifiCare's California HMO subsidiary to provide medical and dental services to its members. The terms of this agreement are substantially similar to those of the New FHP Provider Agreements. ACQUISITION AGREEMENT The Company and FHP have entered into a Stock Purchase Agreement pursuant to which the Company acquired FHP's interest in TMMC and THSC (the "Acquisition Agreement"). Under the Acquisition Agreement, the Company agreed to purchase all of the shares of the common stock held by FHP in exchange for the Rights and the Talbert Note. The Talbert Note will be payable in an amount equal to the proceeds of the Offering if fully subscribed. If the Offering is not fully subscribed, the Company will sell to FHP any of its shares of Common Stock unsubscribed in the Offering in exchange for the 62 cancellation of any remaining indebtedness under the Talbert Note. As a condition precedent to the Company's obligations under the Acquisition Agreement, FHP made the Capital Contribution to TMMC. MANAGEMENT STOCK EXCHANGE AGREEMENT The Company and the Management Investors have entered into a Management Stock Exchange Agreement, in the form of an amendment to the Management Stock Purchase Agreement, pursuant to which the Management Investors agreed to exchange their TMMC and THSC Management Shares for Company Management Shares effective as of the Closing Date of the FHP Merger. Transfer of Company Management Shares is restricted; restrictions lapsed as to 25% of each Management Investor's shares on July 1, 1996, and will lapse as to an additional 25% on July 1 of 1997, 1998 and 1999. FHP has the right to repurchase Company Management Shares: (i) in the event of termination of employment and prior to the lapse of restrictions for $.03 per share (other than the shares owned by Messrs. Ord, Price and Weinstock); (ii) at any time before October 1, 1999 for $100 per share; or (iii) in certain amounts if the Company fails to meet specified financial goals. These prices are subject to adjustment by the Compensation Committee of the board of directors of PacifiCare Holdings, plus one member of the Company's Board of Directors. The Company Management Shares that are no longer restricted have the registration rights discussed under "Description of Capital Stock--Registration Rights." STANDSTILL AGREEMENT The Company and FHP have entered into a Standstill Agreement to define the relationship between the Company and FHP with respect to the Common Stock and voting securities of the Company held by FHP ("FHP Shares") following the Acquisition. The Standstill Agreement provides that FHP (i) will vote the FHP Shares in accordance with the votes of the non-FHP stockholders, (ii) will not acquire additional shares of Common Stock, (iii) will be subject to certain restrictions with respect to its ability to solicit proxies, make acquisition proposals, become a member of a "group" (as defined in the federal securities laws), or otherwise use its holdings of Common Stock to seek to exercise control over the Company's management, and (iv) will be entitled to certain registration rights. See "Description of Capital Stock-- Registration Rights." The Standstill Agreement has a seven-year term. The Standstill Agreement will be null and void if FHP reacquires shares of Common Stock unsubscribed for in the Offering in excess of 20% of the total number of outstanding shares of Common Stock. MASTER LEASE AGREEMENT The Company and FHP have entered into a Real Estate and Equipment Master Transfer Agreement (the "Master Lease Agreement") to provide for the lease, sublease or assignment by the Company of facilities and equipment used by the Talbert Medical Groups that are either owned or leased by FHP. The Master Lease Agreement originally contained an option whereby FHP could require the Company to purchase, and the Company could require FHP to sell, the real estate and equipment subject to the Master Lease Agreement at its book value. The Master Lease Agreement was amended in December 1996 to remove this option effective as of January 1, 1996. Accordingly, the Company's consolidated financial statements reflect the Master Lease Agreement as an operating lease. The Master Lease Agreement, as amended, provides that the parties will enter into individual leases with respect to the real estate and equipment subject to the Master Lease Agreement. The Master Lease Agreement, as amended, also provides for (i) an original term of the individual leases ending December 31, 2005, with the exception of leases with respect to up to 90,000 square feet (of a total of approximately 472,000 square feet) that the Company may elect not to renew; (ii) lease payments at prevailing market rates; (iii) two five-year extension options at prevailing market rates, exercisable solely at the Company's discretion; (iv) a right of first offer for the Company to purchase the furniture, fixtures and equipment subject to the Master Lease Agreement ("FF&E"). The parties have also entered into a separate lease agreement with respect to FF&E that will expire in December 31, 2000. 63 ADMINISTRATIVE SERVICES AGREEMENT The Company and FHP have entered an Administrative Services Agreement pursuant to which FHP will provide information systems services to the Company after the Expiration Date for up to one year. The Administrative Services Agreement may be terminated earlier by: (i) 120 days written notice; (ii) 30 days written notice of a material breach, subject to cure; or (iii) mutual agreement of the Company and FHP. EMPLOYEE BENEFITS AND COMPENSATION ALLOCATION AGREEMENT The Company and FHP have entered into an Employee Benefits and Compensation Allocation Agreement (the "Benefits Agreement"), addressing certain employee compensation and benefits matters. The Benefits Agreement provides for, among other things: (i) effective as of the Expiration Date, the transfer to the Company of all assets and liabilities (approximately $6.3 million as of November 30, 1996) of FHP for benefits under certain nonqualified deferred compensation plans with respect to employees who on or after the Offering will be employees of the Company ("the Employees"); (ii) the transfer of assets and liabilities (approximately $69 million as of November 30, 1996) from the FHP Money Purchase Pension Plan attributable to the accounts of the Employees and the employees of the Talbert Medical Groups (collectively with the Employees, the "Talbert Individuals") into a separate tax-qualified pension plan and trust to be established by the Company; and (iii) the transfer of assets and liabilities (approximately $69.6 million as of November 30, 1996) attributable to the accounts of the Talbert Individuals under the FHP ESOP into a separate tax-qualified plan and trust to be established by the Company. The Benefits Agreement also provides that immediately prior to the Offering the Company will establish a medical and dental plan that provides benefits to the Employees similar to those provided by FHP. Coverage will be effective immediately and the plan will not impose any pre-existing condition limitations or exclusions with respect to the Employees. The Company will continue to maintain the medical and dental plan (or comparable plans) for a period of at least one year following the Offering. The Benefits Agreement provides for certain adjustments to outstanding employee stock options under FHP's Executive Incentive Plan (the "EIP"). Pursuant to Section 4.8 of the FHP Merger Agreement, options under the EIP that are outstanding as of the date of merger of FHP with PacifiCare Holdings will either be (i) cashed out in accordance with Section 4.8(a) of the FHP Merger Agreement or (ii) exchanged for options (the "Exchange Options") to purchase shares of Class B Common Stock, par value of $.01 per share, of PacifiCare Holdings. The Benefits Agreement provides that no severance benefits will be payable to the Employees as a result of the Offering. The Benefits Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. TAX ALLOCATION AGREEMENT The Company and FHP have entered into a Tax Allocation Agreement that provides for FHP, among other things, to file all tax returns with respect to, and to pay all taxes imposed upon or attributable to, FHP and its affiliates for all taxable periods, including the taxes incurred in connection with the Offering. The Company generally has agreed, among other things, to file all tax returns with respect to the Company for all taxable periods beginning after the expiration of the Rights and to pay all taxes imposed upon or attributable to the Company for all taxable periods ending after the Acquisition. The Company will indemnify FHP against any adverse adjustment, or receive from FHP the benefit of any favorable adjustment, of an FHP return to the extent that the adjustment (i) relates to a taxable period prior to the Acquisition, (ii) arises out of the Company's activities, and (iii) when combined with all other such adjustments that have occurred, exceeds $2 million, but does not exceed $4 million. The Company and FHP will share equally the liability for, or the benefit of, such an adjustment to the extent any such adjustment, when combined with all other such adjustments that have occurred, exceeds $4 million. The 64 Tax Allocation Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. ALLOCATION OF LIABILITIES AND INDEMNIFICATION AGREEMENT The Company and FHP have entered into an Allocation of Liabilities and Indemnification Agreement ("the Assumption Agreement") to provide for assumptions of liabilities and cross-indemnities designed to allocate between them financial responsibility for certain liabilities. Under the Assumption Agreement, the Company will assume, to the extent they arose from the nature of the business of TMMC or THSC: (i) any liabilities that are known and reserved against, from January 1, 1996; and (ii) any liabilities that are unknown and not reserved against (other than malpractice liabilities), from January 1, 1994. All other liabilities will be assumed by FHP. The Assumption Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. 65 PRINCIPAL STOCKHOLDERS The following table sets forth certain information with respect to the beneficial ownership of the Common Stock as of December 31, 1996 (except as otherwise indicated), and as adjusted to give effect to the Offering, in each case by (a) FHP, (b) each stockholder who would have the opportunity to beneficially own 5% or more of the outstanding shares of Common Stock based on ownership of FHP Common or Preferred Stock, (c) each director and Named Executive Officer of the Company, and (d) all directors and executive officers of the Company as a group. The adjustments to give effect to the Offering assume that each Rights holder fully exercises his or her Basic Subscription Privilege.
BENEFICIAL OWNERSHIP PRIOR BENEFICIAL OWNERSHIP AFTER TO OFFERING(2) OFFERING(2)(3) --------------------------- NUMBER OF ----------------------------- NUMBER OF SHARES BEING NUMBER OF NAME OF BENEFICIAL OWNER(1) SHARES PERCENT OFFERED SHARES PERCENT - ----------------------------------- ----------- ------- ------------ --------- ------- FHP International Corporation ..... 2,767,500 92.25% 2,767,500 -- -- 3120 Lake Center Drive Santa Ana, California 92704 Jack D. Massimino.................. 160,433(4)(5)(6) 5.3% -- 166,601(7)(8) 5.5% Gloria L. Austin................... 17,141(4)(6) * -- 18,512(7)(8) * Walter R. Stone.................... 8,141(4)(6) * -- 10,458(7)(8) * Jennifer M. Gutzmore, M.D.......... -- * -- 186(7)(8) * Gary E. Goldstein, M.D............. 3,750(4) * -- 6,573 * Heine Securities Corporation ...... -- -- -- 283,592(9) 9.5% 51 John F. Kennedy Parkway Short Hills, New Jersey 07078 Neuberger & Berman ................ -- -- -- 174,311(10) 6.6% 605 Third Avenue New York, New York 10158 Jack R. Anderson................... -- -- -- 143,180(7)(11) 4.8% Richard M. Burdge, Sr.............. -- -- -- 41,396(7)(12) 1.4% Warner Heineman.................... -- -- -- 1,163(7)(13) * Van B. Honeycutt................... -- -- -- -- -- Robert W. Jamplis, M.D............. -- -- -- 234(7)(14) * Robert C. Maxson, Ed.D............. -- -- -- -- -- Joseph F. Prevratil................ -- -- -- 1,728(7)(15) * Westcott W. Price III.............. 20,250(4) * -- 44,924(7)(16) 1.5% All executive officers and directors as a group (15 persons)............. 205,965(4) 6.8% -- 428,528(7) 14.2%
- -------------------------- * Less than one percent. (1) Unless otherwise indicated, the address of each of the stockholders named in this table is: c/o Talbert Medical Management Holdings Corporation, 3540 Howard Way, Costa Mesa, California 92626. (2) Unless otherwise indicated in the footnotes to this table and subject to the community property laws where applicable, each of the stockholders named in this table has sole voting authority and investment discretion with respect to the shares shown as beneficially owned. (3) Based on an estimated 42,101,000 shares of FHP Common Stock and 21,039,058 shares of FHP Preferred Stock outstanding as of the Effective Date. (4) Transfer of these shares is restricted pursuant to the Management Stock Purchase Agreement dated as of March 15, 1996 between the Management Investors, the Company and FHP. (5) Includes 15,000 shares held under an irrevocable trust for the benefit of Mr. Massimino's children. (6) Based on beneficial ownership of Common Stock that includes stock options exercisable within 60 days after December 31, 1996. 66 (7) Based on beneficial ownership of FHP Common Stock that includes stock options exercisable 60 days after December 31, 1996. (8) Based on beneficial ownership of FHP Common Stock that includes shares held by the trustee under the FHP ESOP. As of December 31, 1995, the approximate number of shares of FHP Common Stock allocated to the ESOP accounts of the individuals named above were as follows: Mr. Price--5,297 shares; Mr. Massimino--3,291 shares; Ms. Austin--2,108 shares; Mr. Stone--2,784; and Dr. Gutzmore--2,313. (9) Based on beneficial ownership of 5,678,226 shares of FHP Common Stock and 486,592 shares of FHP Preferred Stock, as reported on Schedule 13F for the period ended September 30, 1996. (10) Based on beneficial ownership of a total of 3,529,746 shares of FHP Common Stock and 250,000 shares of FHP Preferred Stock, as reported on Schedule 13F for the period ended June 30, 1996. Schedule 13F states that (i) Neuberger & Berman has shared investment discretion and no voting authority with respect to 558,046 shares of FHP Common Stock; (ii) Neuberger & Berman Institutional Asset Management Division has shared investment discretion and no voting authority with respect to 613,800 shares of FHP Common Stock; and (iii) Neuberger & Berman Management Incorporated has shared investment discretion and no voting authority with respect to 2,357,900 shares of FHP Common Stock and 250,000 shares of FHP Preferred Stock. (11) Based on beneficial ownership of 829,518 shares of FHP Common Stock and 2,771,794 shares of FHP Preferred Stock as of December 31, 1996, including (i) 137,202 shares of FHP Common Stock and 457,340 shares of FHP Preferred Stock held by Mr. Anderson's wife, and (ii) 271,200 shares of Common Stock and 904,000 shares of FHP Preferred Stock held by trusts of which Mr. Anderson's relatives are beneficiaries. Mr. Anderson disclaims beneficial ownership of these shares. (12) Based on beneficial ownership of 287,630 shares of FHP Common Stock and 742,104 shares of FHP Preferred Stock as of December 31, 1996, including 25,030 shares of FHP Common Stock and 83,438 shares of FHP Preferred Stock held by Mr. Burdge's wife. Also includes 48,000 shares of FHP Common Stock held by a trust of which Mr. Burdge's relatives are beneficiaries. Mr. Burdge disclaims beneficial ownership of these shares. (13) Based on beneficial ownership of 24,900 shares of FHP Common Stock as of December 31, 1996. (14) Based on beneficial ownership of 5,000 shares of FHP Common Stock as of December 31, 1996. (15) Based on beneficial ownership of 37,000 shares of FHP Common Stock as of December 31, 1996. (16) Based on beneficial ownership of 528,166 shares of FHP Common Stock as of December 31, 1996, including shares held under a revocable trust controlled by Mr. Price. 67 DESCRIPTION OF CAPITAL STOCK GENERAL The Company's Certificate of Incorporation provides that the Company may issue up to 15 million shares of common stock, par value $0.01 per share (the "Common Stock"), and 1.2 million shares of preferred stock, par value $0.01 per share (the "Preferred Stock"). Immediately preceding the Offering, there will be 232,500 shares of Common Stock and no shares of Preferred Stock issued and outstanding, held by 13 stockholders of record. COMMON STOCK The holders of Common Stock are entitled to one vote for each share held of record on all matters to be submitted to a vote of stockholders and do not have preemptive rights. The holders of Common Stock do not have cumulative voting rights. Subject to any preferential rights of any outstanding series of Preferred Stock, the holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the Board of Directors of the Company from funds legally available therefor. In the event of the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities. PREFERRED STOCK The Company's Board of Directors has the authority, without any vote or action by stockholders, to issue Preferred Stock in one or more series and to fix the designations, preferences, rights, qualifications, limitations and restrictions thereof, including dividend rights, dividend rates, conversion rights and terms, voting rights, redemption rights, prices and terms (including any sinking fund provisions), liquidation preferences and the number of shares constituting any series. In connection with the Stockholders Rights Agreement, the Board of Directors has authorized a series of Preferred Stock designated as "Junior Participating Preferred Stock" that may be issued upon the exercise of rights distributed to all holders of Common Stock. See "Description of Capital Stock--Certain Anti-Takeover Effects." Although the Company has no present plans to issue any shares of Preferred Stock following the consummation of the Offering, the issuance of shares of Preferred Stock, or the issuance of rights to purchase such shares, may have the effect of delaying, deferring or preventing a change in control of the Company or an unsolicited acquisition proposal. CERTAIN ANTI-TAKEOVER EFFECTS Certain provisions of the Rights, the Company's Certificate of Incorporation, Bylaws and other agreements to which the Company is a party summarized in the following paragraphs may be deemed to have anti-takeover effects and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might favor, including those attempts that might result in a premium over the market price for the shares held by stockholders. EXERCISE CAP. The Rights may not be exercised to the extent that the holder would become the beneficial owner of more than 8% of the shares of Common Stock outstanding, subject to certain exceptions. See "The Offering--Exercise Cap." This exercise cap may hinder efforts to accumulate Rights to purchase Common Stock prior to the Expiration Date. CLASSIFIED BOARD OF DIRECTORS. The Company's Certificate of Incorporation and Bylaws provide for the Board of Directors to be divided into three classes of directors, as nearly equal in number as possible, serving staggered terms so that directors' initial terms will expire at the 1997, 1998 or 1999 annual meeting of stockholders. Starting with the 1997 annual meeting of stockholders, one class of directors will be elected each year for a three-year term. A director may be removed by the stockholders of the Company only for cause. See "Management--Classified Board of Directors." 68 The Company believes that a classified Board of Directors will help to assure the continuity and stability of the Board of Directors and the Company's business strategies and policies as determined by the Board of Directors, since a majority of the directors at any given time will have had prior experience as directors of the Company. The Company believes that this, in turn, will permit the Board of Directors to more effectively represent the interests of stockholders. With a classified Board of Directors, at least two annual meetings of the Company's stockholders, instead of one, would generally be required to effect a change in the majority of the Board of Directors. As a result, a provision relating to a classified Board of Directors may discourage proxy contests for the election of directors or purchases of a substantial block of the Common Stock because this provision could operate to prevent obtaining control of the Board of Directors in a relatively short period of time. The classification provision could also have the effect of discouraging a third party from making a tender offer to otherwise attempt to obtain control of the Company. ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER PROPOSALS AND STOCKHOLDER NOMINATIONS OF DIRECTORS. The Company's Bylaws establish an advance notice procedure with regard to the nomination, other than by or at the direction of the Board of Directors or a committee thereof, of candidates for election as directors (the "Nomination Procedure") and with regard to other matters to be brought by stockholders before an annual meeting of stockholders of the Company (the "Business Procedure"). The Nomination Procedure requires that a stockholder give prior written notice, in proper form, of a planned nomination for the Board of Directors to the Secretary of the Company. The requirements as to the form and timing of that notice are specified in the Bylaws. If the Chairman of the Board of Directors determines that a person was not nominated in accordance with the Nomination Procedure, the person will not be eligible for election as a director. Under the Business Procedure, a stockholder seeking to have any business conducted at an annual meeting must give prior written notice, in proper form, to the Secretary of the Company. The requirements as to the form and timing of that notice are specified in the Bylaws. Although the Bylaws do not give the Board of Directors any power to approve or disapprove stockholder nominations for the election of directors or of any other business desired by stockholders to be conducted at an annual or any other meeting, the Bylaws: (i) may have the effect of precluding a nomination for the election of directors or precluding the conduct of business at a particular annual meeting if the proper procedures are not followed; or (ii) may discourage a deter a third party from conducting a solicitation of proxies to elect its own slate of directors or otherwise attempting to obtain control of the Company, even if the conduct of such solicitation or such attempt might be beneficial to the Company and its stockholders. LIMITATIONS ON STOCKHOLDER ACTION BY WRITTEN CONSENT. The Company's Certificate of Incorporation prohibits stockholder action by written consent in lieu of a meeting, and provides that stockholder action can be taken only at an annual or special meeting of stockholders. Special meetings of stockholders may be called only by the Board of Directors, but if FHP acquires in excess of 20% of the outstanding Common Stock from unsubscribed shares in the Offering, a special meeting of stockholders may be called at the written request of stockholders entitled to cast in excess of 20% of the votes entitled to be cast at the special meeting. These provisions may have the effect of delaying consideration of a stockholder proposal until the next annual meeting, unless a special meeting is called by the Board of Directors. SUPERMAJORITY VOTE FOR BUSINESS COMBINATIONS. The Company's Certificate of Incorporation provides that the affirmative vote of at least 66 2/3% of the outstanding shares of the Company then entitled to vote is required for certain business combinations, including a merger, or disposition of substantially all the assets, of the Company. This requirement is not applicable if the Board of Directors approves the transaction by a resolution adopted by 66 2/3% of its members. These provisions will not take effect if FHP acquires in excess of 20% of the outstanding Common Stock from unsubscribed shares in the Offering. 69 AMENDMENT OF CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION AND BYLAWS. The Company's Certificate of Incorporation and the Bylaws provide that the affirmative vote of the holders of at least 66 2/3% of the outstanding shares of the Company then entitled to vote on the matter is required to amend the Bylaws and certain provisions of the Certificate of Incorporation, including those provisions relating to the number of directors, the filling of vacancies on the Board of Directors, the prohibition on stockholder action without a meeting, indemnification of directors, officers and others, the limitation on liability of directors and the supermajority voting requirements in the Certificate of Incorporation and Bylaws. The Certificate of Incorporation further provides that the Bylaws may be amended by the Board of Directors, except that if FHP does not acquire in excess of 20% of the outstanding Common Stock solely through the transfer of shares unsubscribed in the Offering, the authorized number of directors may not be amended without the affirmative vote of the holders of at least 75% of the outstanding shares of the Company then entitled to vote on the matter. These voting requirements will have the effect of making more difficult any amendment by stockholders, even if a majority of the Company's stockholders believes that the amendment would be in its best interests. DELAWARE TAKEOVER STATUTE. The Company is subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any "interested stockholder" for a period of three years following the date that the stockholder became an interested stockholder, unless: (i) prior to such date, the Board of Directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned (a) by persons who are directors and also officers and (b) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or after to such date, the business combination is approved by the Board of Directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. An "interested stockholder" is defined as any person that is (a) the owner of 15% or more of the outstanding voting stock of the corporation or (b) an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within the three-year period immediately prior to the date on which it is sought to be determined whether such person is an interested stockholder. RIGHTS AGREEMENT. As of the Expiration Date, pursuant to a Stockholder Rights Agreement between the Company and American Stock Transfer & Trust Company, as Rights Agent, the Company has declared a dividend distribution to all holders of Common Stock of a right to purchase a unit initially consisting of one one-hundredth of a share of Junior Participating Preferred Stock upon the terms and conditions set forth in that agreement. The Stockholder Rights Agreement is designed to give the Board of Directors the time and opportunity to protect stockholder interests and encourage equal treatment of all stockholders in a takeover situation. In the event of a takeover attempt, the holders of the rights may exercise them to purchase Common Stock at a 50% discount, or, in the event of a "squeeze-out" transaction where the Company would not be the surviving entity, the acquiring company's common stock at a 50% discount. The issuance of these rights may have the effect of delaying, deferring or preventing a change in control of the Company or an unsolicited acquisition proposal. The Stockholder Rights Agreement provides for a trigger percentage of 8% for the 90-day period following the Expiration Date, and 15% thereafter. Certain persons who acquire Common Stock in excess of the trigger percentage will not trigger the rights, including, with certain limitations, (i) persons who acquire such Common Stock solely as a result of the exercise of Rights distributed to them in the Offering, (ii) FHP, if it acquires such Common Stock solely through the transfer of shares unsubscribed in the 70 Offering, and (iii) transferees of FHP, if FHP acquires in excess of 20% of the outstanding Common Stock solely through the transfer of shares unsubscribed in the Offering. REGISTRATION RIGHTS The Management Investors have certain piggyback registration rights. Accordingly, if the Company proposes to register any of its Common Stock, whether or not for sale for its own account, with certain exceptions, the Company is required to notify the Management Investors and use its best efforts to include the shares of Common Stock requested to be included by them, provided that the Company may determine for any reason not to register such securities and shall be relieved of its obligation to use best efforts to effect registration of such securities. These registration rights are subject to rejection of such shares under certain circumstances by the underwriter of an underwritten offering and to a lock-up period to be determined by the Company and the underwriters, except as part of such underwritten offering. Approximately 232,500 shares of Common Stock are subject to such rights. Under the Standstill Agreement, FHP has certain shelf registration rights whereby at any time following one year after the Expiration Date, FHP may require the Company to file and maintain a shelf registration statement to effect the registration of Common Stock, if any, owned by FHP. FHP will also have registration rights to participate in certain underwritten public offerings by the Company. The number of shares of Common Stock subject to FHP's registration rights will depend on the number of shares not subscribed for in the Offering. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is American Stock Transfer & Trust Company. LEGAL MATTERS Certain matters with respect to the validity of the issuance of Common Stock offered hereby are being passed upon for the Company by O'Melveny & Myers LLP, Los Angeles, California. EXPERTS The financial statements as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 included in this prospectus and the related financial statement schedule included elsewhere in the Registration Statement have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein, and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Commission a registration statement on Form S-1 (the "Registration Statement," which term encompasses all amendments, exhibits and schedules thereto), under the Securities Act, with respect to the Rights and the Common Stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission, and to which reference hereby is made. Statements made in this Prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference hereby is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. The Registration Statement filed by the Company with the Commission, as well as such reports and other information filed by the Company with the Commission, may be inspected and copied at the public reference facilities 71 maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional offices of the Commission located at 7 World Trade Center, 13th Floor, New York, New York 10048, and at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material, when filed, may also be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. Upon consummation of the Offering, the Company will become subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith, will file reports and other information with the Commission in accordance with the Commission's rules. Such reports and other information concerning the Company may be inspected and copied at the public reference facilities and regional offices of the Commission referred to above. The Company intends to furnish its stockholders annual reports containing audited consolidated financial statements and an opinion thereon expressed by independent auditors, and quarterly reports for the first three quarters of each fiscal year containing unaudited interim financial information. FHP and PacifiCare have filed a joint proxy statement/prospectus on Schedule 14A (the "FHP Merger Proxy Statement," which term encompasses all amendments, exhibits, and schedules thereto), under Section 14(a) of the Exchange Act, with respect to the FHP Merger and certain other matters. PacifiCare is, and prior to the FHP Merger FHP will be, subject to the information requirements of the Exchange Act, and, in accordance therewith, will file reports and information with the Commission in accordance with the Commission's rules which may be obtained as described above. The Commission maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. 72 INDEX TO FINANCIAL STATEMENTS
PAGE REFERENCE ------------- Independent Auditors' Report........................................................................... F-2 Consolidated Balance Sheets, as of December 31, 1994 and 1995 (audited), and September 30, 1996 (unaudited).......................................................................................... F-3 Consolidated Statements of Operations for the years ended December 31, 1993, 1994 and 1995 (audited), and the nine months ended September 30, 1995 and 1996 (unaudited).................................... F-4 Consolidated Statements of Stockholders' Deficit for the years ended December 31, 1993, 1994 and 1995 (audited), and the nine months ended September 30, 1996 (unaudited).................................. F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995 (audited), and the nine months ended September 30, 1995 and 1996 (unaudited).................................... F-6 Notes to Consolidated Financial Statements............................................................. F-7
F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Talbert Medical Management Holdings Corporation We have audited the accompanying consolidated balance sheets of Talbert Medical Management Holdings Corporation and its subsidiaries ("the Company") as of December 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index at Item 16(b). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule 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 Talbert Medical Management Holdings Corporation and its subsidiaries as of December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As more fully described in Note 1, the Company is part of FHP International Corporation ("FHP") and had no separate legal status or existence through December 31, 1995. The Company had various transactions with FHP, including various expense allocations and reimbursements, that are material in amount. The financial statements of the Company have been prepared from separate records maintained by the Company as well as from the combined records of FHP, and may not necessarily be indicative of the conditions that would have existed if the Company had operated as an independent entity. Costa Mesa, California December 11, 1996 (February , 1997 as to the effects of the acquisition described in Note 1) The accompanying consolidated financial statements have been prepared as if the acquisition of Talbert Medical Management Corporation and Talbert Health Services Corporation by Talbert Medical Management Holdings Corporation, anticipated to occur in February 1997, had been completed on the basis substantially identical to that described herein. The above opinion is in the form which will be signed by Deloitte & Touche LLP upon the consummation of the acquisition, which is described in Note 1 to the consolidated financial statements, and assuming that, from January 30, 1997 to the date of such acquisition no other events will have occurred that would affect the accompanying consolidated financial statements and notes thereto. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California January 30, 1997 F-2 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
SEPTEMBER DECEMBER 31, 30, 1994 1995 1996 --------- --------- ----------- (UNAUDITED) Cash and cash equivalents (Notes 1 and 2)................... $ -- $ -- $ 14,291 Accounts receivable, net of allowance for doubtful accounts of $5,386, $5,478 and $8,040 at December 31, 1994 and 1995, and September 30, 1996 (unaudited), respectively (Notes 1 and 2)........................................... 3,629 4,976 5,604 Receivables from FHP........................................ -- -- 4,504 Inventories (Notes 1 and 2)................................. 7,826 7,414 6,979 Deferred income taxes (Notes 1, 2 and 6).................... 5,788 6,434 5,568 Prepaid expenses and other current assets (Note 2).......... 5,215 3,602 6,507 --------- --------- ----------- Total current assets.................................... 22,458 22,426 43,453 Property and equipment, net (Note 3)........................ -- -- 5,186 Deferred rent............................................... -- -- 2,552 Other assets (Note 2)....................................... 629 752 540 --------- --------- ----------- Total assets............................................ $ 23,087 $ 23,178 $ 51,731 --------- --------- ----------- --------- --------- -----------
LIABILITIES AND STOCKHOLDERS' DEFICIT Accounts payable (Note 2)................................... $ 6,669 $ 8,693 $ 6,123 Medical claims payable (Notes 1, 2 and 4)................... 11,776 12,831 14,497 Accrued salaries and employee benefits (Notes 2 and 7)...... 21,957 19,055 16,708 Other current liabilities (Note 2).......................... 798 485 1,447 Advances from FHP........................................... -- -- 15,457 --------- --------- ----------- Total current liabilities............................... 41,200 41,064 54,232 Deferred income taxes (Note 6).............................. -- -- 1,110 Other liabilities........................................... -- -- 59 --------- --------- ----------- Total liabilities....................................... 41,200 41,064 55,401 --------- --------- ----------- Commitments and contingencies (Note 8) Stockholders' deficit (Notes 2, 7, 9, 10, and 12): Preferred Stock, $0.01 par value; 1,200,000 shares authorized; no shares outstanding at September 30, 1996.................................................... Common Stock, $0.01 par value; 15,000,000 shares authorized; issued and outstanding 3,000,000 shares at September 30, 1996...................................... -- -- 30 Paid in capital........................................... -- -- 70 Retained deficit (Note 9)................................. (18,113) (17,886) (3,770) --------- --------- ----------- Total stockholders' deficit............................. (18,113) (17,886) (3,670) --------- --------- ----------- Total liabilities and stockholders' deficit............. $ 23,087 $ 23,178 $ 51,731 --------- --------- ----------- --------- --------- -----------
See accompanying Notes to Consolidated Financial Statements. F-3 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------- 1993 1994 1995 ---------- ---------- ---------- NINE MONTHS ENDED SEPTEMBER 30, ------------------------ 1995 1996 ----------- ----------- (UNAUDITED) (UNAUDITED) Revenue (Notes 1 and 2): Capitation...................................... $ 425,141 $ 450,964 $ 437,493 $ 339,070 $ 293,085 Copayments, fee-for-service and other........... 45,742 52,374 58,206 40,295 58,150 Total revenue............................... 470,883 503,338 495,699 379,365 351,235 Expenses (Notes 1, 2 and 7): Affiliated medical services..................... 170,690 173,230 173,417 132,051 103,504 Purchased medical services...................... 110,582 124,083 121,570 94,133 85,851 Dental services................................. 20,129 28,955 31,379 24,544 20,443 Optometry, pharmacy, and other primary health care services................................. 86,985 96,275 102,412 77,395 80,181 Clinic operations............................... 80,853 87,253 85,585 68,235 49,207 ---------- ---------- ---------- ----------- ----------- Total cost of health care..................... 469,239 509,796 514,363 396,358 339,186 Marketing, general and administrative........... 24,002 26,675 29,698 22,188 19,622 ---------- ---------- ---------- ----------- ----------- Operating loss.............................. (22,358) (33,133) (48,362) (39,181) (7,573) Interest income................................... -- -- -- -- 1,199 ---------- ---------- ---------- ----------- ----------- Loss before income tax benefit.................... (22,358) (33,133) (48,362) (39,181) (6,374) Income tax benefit (Notes 1 and 6)................ (8,924) (13,553) (19,754) (16,005) (2,604) ---------- ---------- ---------- ----------- ----------- Net loss.................................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ---------- ---------- ---------- ----------- ----------- ---------- ---------- ---------- ----------- ----------- Loss per common and common equivalent share (Note 2).............................................. $ (4.48) $ (6.54) $ (9.55) $ (7.74) $ (1.26) ---------- ---------- ---------- ----------- ----------- ---------- ---------- ---------- ----------- -----------
See accompanying Notes to Consolidated Financial Statements. F-4 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF COMMON SHARES)
NUMBER OF RETAINED TOTAL COMMON COMMON PAID IN EARNINGS STOCKHOLDERS' SHARES STOCK CAPITAL (DEFICIT) DEFICIT ------------ ----------- ---------- ---------- ------------ BALANCE AT JANUARY 1, 1993 (NOTE 2)................ -- $ -- $ -- $ (17,276) $ (17,276) Net change in stockholders' deficit arising from intercompany transactions (Note 2)............... -- -- -- 13,235 13,235 Net loss........................................... -- -- -- (13,434) (13,434) ------------ ----- ---------- ---------- ------------ BALANCE AT DECEMBER 31, 1993....................... -- -- -- (17,475) (17,475) Net change in stockholders' deficit arising from intercompany transactions (Note 2)............... -- -- -- 18,942 18,942 Net loss........................................... -- -- -- (19,580) (19,580) ------------ ----- ---------- ---------- ------------ BALANCE AT DECEMBER 31, 1994....................... -- -- -- (18,113) (18,113) Net change in stockholders' deficit arising from intercompany transactions (Note 2)............... -- -- -- 28,835 28,835 Net loss........................................... -- -- -- (28,608) (28,608) ------------ ----- ---------- ---------- ------------ BALANCE AT DECEMBER 31, 1995....................... -- -- -- (17,886) (17,886) Issuance of Common Stock (Note 10)................. 10,000,000 100 -- -- 100 Retroactive restatement of the effect of one- for-3.33 reverse stock split (Note 10)........... (7,000,000) (70) 70 -- -- Capital contribution by FHP (Note 9)............... -- -- 5,055 -- 5,055 Assumption of liabilities by FHP (Note 9).......... -- -- 12,831 -- 12,831 Recapitalization of the Company by FHP (Note 9).... -- -- (17,886) 17,886 -- Net loss........................................... -- -- -- (3,770) (3,770) ------------ ----- ---------- ---------- ------------ BALANCE AT SEPTEMBER 30, 1996 (UNAUDITED).......... 3,000,000 $ 30 $ 70 $ (3,770) $ (3,670) ------------ ----- ---------- ---------- ------------ ------------ ----- ---------- ---------- ------------
See accompanying Notes to Consolidated Financial Statements. F-5 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ---------------------------------- 1993 1994 1995 ---------- ---------- ---------- NINE MONTHS ENDED SEPTEMBER 30, ------------------------------ 1995 1996 -------------- -------------- (UNAUDITED) (UNAUDITED) OPERATING ACTIVITIES: Net loss.................................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............. -- -- -- -- 627 Increase in allowance for doubtful accounts................................ 3,024 368 92 800 2,562 Deferred income taxes..................... (1,342) (632) (646) 984 1,976 Effect on cash of changes in operating assets and liabilities Accounts receivable..................... (4,800) (1,212) (1,439) (1,143) (7,694) Inventories............................. (692) (1,983) 412 1,983 435 Prepaid expenses and other current assets................................ (1,162) (685) 1,613 637 (2,905) Deferred rent........................... (2,552) Other assets............................ 49 (17) (123) 47 212 Accounts payable........................ (942) 2,014 2,024 2,831 (2,570) Medical claims payable.................. 1,313 256 1,055 (135) 14,497 Accrued salaries and employee benefits.............................. 4,647 2,156 (2,902) (6,252) (2,347) Other liabilities....................... 104 373 (313) (346) 1,021 ---------- ---------- ---------- -------------- -------------- Net cash used in operating activities......... (13,235) (18,942) (28,835) (23,770) (508) ---------- ---------- ---------- -------------- -------------- INVESTING ACTIVITIES--Purchase of property and equipment................................... -- -- -- -- (5,813) ---------- ---------- ---------- -------------- -------------- FINANCING ACTIVITIES: Issuance of common stock.................... -- -- -- -- 100 Advances from FHP........................... 13,235 18,942 28,835 23,770 15,457 Capital contribution by FHP................. -- -- -- -- 5,055 ---------- ---------- ---------- -------------- -------------- Net cash provided by financing activities..... 13,235 18,942 28,835 23,770 20,612 ---------- ---------- ---------- -------------- -------------- Net increase in cash and cash equivalents..... -- -- -- -- 14,291 Cash and cash equivalents, at beginning of period...................................... -- -- -- -- -- ---------- ---------- ---------- -------------- -------------- Cash and cash equivalents, at end of period... $ -- $ -- $ -- $ -- $ 14,291 ---------- ---------- ---------- -------------- -------------- ---------- ---------- ---------- -------------- -------------- Supplemental cash flow information: Non-cash transactions: Recapitalization of the Company by FHP--Assumption of medical claims payable by FHP (Note 9)........................... $ 12,831 -------------- --------------
See accompanying Notes to Consolidated Financial Statements. F-6 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Talbert Medical Management Holdings Corporation ("TMMHC", and with its subsidiaries, the "Company") through its subsidiaries Talbert Medical Management Corporation ("TMMC") and Talbert Health Services Corporation ("THSC"), organizes and manages physician and dentist practice groups that contract with HMOs and other payors to provide health care services to their members. Under long-term management services agreements with its affiliated practice groups (the "Talbert Medical Groups"), the Company provides management systems and services, nonphysician health care personnel, facilities and equipment to the Talbert Medical Groups in return for a reimbursement of certain clinic operations costs, plus a management fee based on the Talbert Medical Groups' revenues net of certain reimbursed clinic operations costs, except for the California Medical Group, where TMMC receives a management fee based on gross revenues. Pharmacy, radiology, optometry, laboratory, home health, hospice, rehabilitation and physical therapy services are also available through contracts with THSC. TMMC, THSC and the Talbert Medical Groups were organized in 1995 in connection with the restructuring of FHP International Corporation ("FHP"), which included the transformation of FHP's staff model operations into a contracted care model operation. The Talbert Medical Groups were organized as professional corporations in the various states (except in New Mexico) in which FHP's staff model operations were located to employ the physicians, dentists and other health care professionals formerly employed by FHP. In New Mexico, TMMC directly employs physicians and effectively acts as the Talbert Medical Group for that state. TMMC was formed to provide management services to the Talbert Medical Groups, and THSC was organized to provide certain ancillary clinical services. TMMC and THSC were incorporated on September 15, 1995 and December 6, 1995, respectively. TMMC, THSC and the Talbert Medical Groups effectively commenced their operations on January 1, 1996. TMMHC was organized in November 1996 to serve as a holding company for TMMC and THSC following their separation from FHP in connection with the merger of FHP and PacifiCare Health Systems, Inc., et. al. ("PacifiCare") as discussed below. FHP's staff model operations had no separate legal status prior to the organization of TMMC, THSC and the Talbert Medical Groups. FHP has, however, offered health care services as a staff model HMO through other subsidiaries since 1961. In the normal course of business, the staff model operations had various transactions with FHP and its direct subsidiaries that are material in amount. The accompanying consolidated financial statements of the staff model operations have been prepared in part from separate records maintained by subsidiaries of FHP. These statements also reflect key assumptions regarding the allocation of certain revenue and expense items and certain balance sheet accounts, many of which could be material, where separate records were not utilized (Note 2). The accompanying consolidated historical financial statements of the staff model operations may not necessarily be indicative of the conditions that would have existed if the staff model operations had operated as an independent entity. MERGER OF FHP AND PACIFICARE HEALTH SYSTEMS, INC. On August 4, 1996, FHP entered into an Agreement and Plan of Reorganization, as amended and restated, (the "Merger Agreement"), by and among FHP and PacifiCare. Pursuant to the Merger Agreement, PacifiCare will acquire all of the outstanding stock of FHP. The transaction is expected to close in February 1997 (the "Effective Time"). F-7 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In connection with the proposed merger between FHP and PacifiCare, FHP will sell its 92.25% of the common stock of TMMC and THSC to TMMHC in exchange for transferable rights to acquire 92.25% of the common shares of the Company for $21.50 per share, plus a note for $59,501,250 (the "Talbert Note"). The rights are expected to be distributed to the stockholders of FHP. Based on current expectations concerning the number of shares of FHP common stock that will be outstanding at the Effective Time, FHP stockholders are expected to receive one right for every 21.40635 shares of FHP common stock and one right for every 26.54228 shares of FHP preferred stock. Rights holders may purchase one share of the Company's Common Stock with each right and also may subscribe for additional shares of the Company's Common Stock under certain circumstances (the "Offering"). The maximum number of shares to be issued is 2,767,500. If fully subscribed, the Company expects to receive $59,501,250 from the Offering, which will be used to retire the Talbert Note. The Company will sell to FHP any shares of common stock unsubscribed in the offering in exchange for cancellation of any remaining indebtedness under the Talbert Note. In connection with the creation of TMMC and THSC, twelve individuals, then all FHP or TMMC executives (the "Management Investors"), purchased, at fair market value, 7.75% of the outstanding shares of TMMC's common stock and 7.75% of the outstanding shares of THSC's common stock (the "Management Shares") for an aggregate consideration of $8,000 pursuant to a Stock Purchase Agreement among FHP, TMMC, THSC and the Management Investors (the "Management Stock Purchase Agreement"). The Management Investors have subsequently agreed to exchange their Management Shares in TMMC and THSC for 7.75% of the common shares of TMMHC, in connection with TMMHC's acquisition of 92.25% of the common stock of TMMC and THSC from FHP. As a result of these transactions TMMC and THSC will become wholly-owned subsidiaries of TMMHC. If the Offering is not fully subscribed, the unsubscribed portion of the Common Stock will be reacquired by FHP (and, therefore indirectly by the holding company that will own 100% of FHP and PacifiCare as a result of the FHP Merger ("PacifiCare Holdings")). The Company and FHP have entered into a standstill agreement with respect to any Common Stock obtained by FHP following the Acquisition (the "Standstill Agreement"). The Standstill Agreement provides, among other restrictions, that if FHP reacquires 20% or less of the Company's outstanding Common Stock in exchange for cancellation of indebtedness under the Talbert Note, FHP (i) will vote its shares of Common Stock in accordance with the votes of the non-FHP stockholders, (ii) will be subject to certain restrictions with respect to its ability to solicit proxies, make acquisition proposals, become a member of a "group" (as defined in federal securities laws), or otherwise use its holdings of Common Stock to seek to exercise control over the Company's management, and (iii) will be entitled to certain shelf registration rights and the right to participate in future registrations by the Company. These provisions of the Standstill Agreement, among others, will not apply if FHP reacquires more than 20% of the Common Stock of the Company after the consummation of the Offering. The Talbert Medical Groups will continue to provide care to enrolled members of FHP under their existing provider agreements until the Effective Time. In November 1996, the Company renegotiated its provider contract with FHP pursuant to the terms of the FHP Merger Agreement. This resulted in a decrease in capitated rates which, if such rates had been in effect during the year ended December 31, 1995 and the nine months ended September 30, 1996, would, on an unaudited pro forma basis, have resulted in reducing the Company's revenue by $36,258,000 and $26,284,000, respectively, and increasing total cost of health care by $6,897,000 and $5,293,000, respectively. Just prior to the Offering , FHP is expected to contribute approximately $68,000,000 to TMMC which is expected to result in a stockholders' equity balance of approximately $59,000,000 (the "Capital F-8 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Contribution"). In connection with the Capital Contribution, the Company will recognize as stock compensation expense approximately $5,270,000 relating to the Common Stock of the Company owned by management and others who will not be making a capital contribution. This expense will be recognized ratably over the vesting period of the restricted common shares held by management and others in accordance with the Management Stock Purchase Agreement. Also, in accordance with the Management Stock Purchase Agreement, approximately 25% of such restrictions lapsed in July 1996 and the remainder are assumed to lapse ratably each July through 1999. Approximately $1,318,000 of the stock compensation expense is expected to be recognized on the date of the Capital Contribution in connection with previously issued restricted shares on which restrictions have already lapsed. As a result of the foregoing transactions, TMMC and THSC will become wholly-owned subsidiaries of the Company in a transaction accounted for similar to a pooling of interests. BASIS OF PRESENTATION The accompanying consolidated financial statements for the Company include the accounts of TMMC, THSC and the Talbert Medical Groups. TMMC has direct or indirect unilateral and perpetual control over the assets and non-medical operations of the Talbert Medical Groups by means other than owning the majority of voting stock. TMMC and the Talbert Medical Groups have entered into 20-40 year practice management agreements with provisions for extensions under certain circumstances. Because of control by means other than equity ownership, consolidation of the Talbert Medical Groups is necessary to present fairly the financial position and results of operations of TMMC. Control by TMMC is perpetual rather than temporary because of: (i) the length of the original terms of the management and other agreements; (ii) the successive extension period provided by the agreements; (iii) the continuing investment of capital by TMMC; (iv) the employment of the majority of nonphysician personnel by TMMC; (v) the nature of the services provided to the Talbert Medical Groups by TMMC and (vi) the provisions of a Share Control Agreement entered into by each Talbert Medical Group shareholder and TMMC. The terms of the Share Control Agreement require the shareholder: (i) to elect to the board of directors of the Talbert Medical Groups only persons approved by TMMC; (ii) to obtain written consent from TMMC to approve or authorize any merger, consolidation or other reorganization, sale of assets, or sale of common stock of the Talbert Medical Groups; and (iii) to give a right to purchase any or all shares of the Talbert Medical Groups to a person designated by TMMC. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company has elected a fiscal year ending December 31. REVENUE RECOGNITION AND HEALTH CARE COSTS The Talbert Medical Groups have contracts with various managed care organizations to provide physician services based on negotiated fee schedules. Under various contracts with HMOs, capitation payments are received to cover all physician services needed by the HMO members. During the years ended December 31, 1993, 1994 and 1995, and the nine months ended September 30, 1995 and 1996, the Company received nearly all of its capitated revenue from FHP's subsidiaries. Capitation payments are recognized as revenue on the accrual basis, and represent approximately 90%, 90%, 88%, 89% (unaudited) and 83% (unaudited) of the Company's net revenue for the years ended December 31, 1993, 1994 and 1995, and for the nine months ended September 30, 1995 and 1996, respectively. The Company's F-9 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) remaining revenues are largely derived from co-payments and fee-for-service from such capitated enrollees. Revenues from hospital incentive funds are included in the Statement of Operations under "Copayments, fee-for-service and other." Hospital shared risk incentive programs are based on actual bed-day utilization against a negotiated bed-day budget. If the actual bed-day utilization is favorable to the bed-day budget, a predetermined dollar amount per day is contributed by the hospital to the hospital incentive fund. The residual in the incentive fund typically is shared equally between the hospital and the Company. Net revenue includes reserves for uncollectable accounts and professional fee adjustments and is reported at the estimated realizable amounts from patients, third-party payors and others for services rendered. Non-capitated revenue under certain third-party payor agreements, which is not material in relation to the Company's statement of operations, is subject to future audit and retroactive adjustments. Provisions for estimated third-party payor settlements and adjustments are estimated in the period the related services are rendered and are adjusted in future periods as final settlements are determined. Management believes its reserves for final third-party payor settlements are adequate. Health care costs are recorded in the period when services are provided to HMO members, including the recognition of costs for accrued medical claims attributable to services provided by specialty care physicians and ancillary provider services. The accrued medical claims costs include referrals for outside medical services not provided within the Medical Centers that have been authorized by the Talbert Medical Group's physicians and have not yet been paid, as well as an estimate of costs for covered medical benefits incurred by enrollees but not yet reported by the providers. Medical claims are not due and payable until the outside provider has presented the claim, which may take 30 to 60 business days from the date of service. Upon receipt of the claim the Company typically pays the claim within 30 to 45 business days. Until the actual claim is received and paid, the Company estimates its medical claims liability based upon the anticipated cost for actual out of clinic referrals to the provider specialist authorized by the Company's utilization management program, plus an estimate of unknown provider specialty occurrences based upon historical utilization patterns of the Company's enrollees. The methods of making such estimates and for establishing the resulting reserves are continually reviewed and updated, and any resulting adjustments are reflected in current operations. While the ultimate amount of claims and the related expenses paid are dependent on future developments, management is of the opinion that the liability for medical claims payable is adequate to cover such medical claims and expenses (Note 4). The Company's medical malpractice liability coverage currently provides professional liability insurance in the amount of $2,000,000 per claim, and $12,000,000 in the aggregate per policy year for each of the Talbert Medical Groups. CASH EQUIVALENTS The Company considers all highly-liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value based on their short-term maturity. CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of premiums receivable from FHP. F-10 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's consolidated balance sheet includes the following financial instruments: cash and cash equivalents, accounts receivable and accounts payable. The Company considers the carrying amounts of current assets and liabilities in the consolidated financial statements to approximate the fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. RECEIVABLES FROM FHP Included in accounts receivable at September 30, 1996 is approximately $4,504,000 (unaudited) due from FHP for health care services provided and estimated accrued incentives.
SEPTEMBER 30, 1996 ------------- Hospital incentives............................................................ $ 2,344,000 Earned capitation payments..................................................... 2,160,000 ------------- Total due from FHP........................................................... $ 4,504,000 ------------- -------------
ADVERTISING COSTS Advertising costs, which have not been significant, are expensed when incurred. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined principally under the average cost method. The principal components of inventories are as follows (amounts in thousands):
DECEMBER 31, -------------------- 1994 1995 --------- --------- SEPTEMBER 30, 1996 ------------- (UNAUDITED) Pharmacy................................................... $ 5,042 $ 5,400 $ 4,472 Optometry.................................................. 2,089 1,368 1,619 Other...................................................... 695 646 888 --------- --------- ------ $ 7,826 $ 7,414 $ 6,979 --------- --------- ------ --------- --------- ------
INCOME TAXES The Company utilizes the asset and liability method of accounting for income taxes. Under this method, income taxes are recognized for (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The effects of income taxes are measured based on enacted tax law and rates. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and tax basis of the Company's assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled. The results of the operations of the Company, TMMC, THSC and the Talbert Medical Groups are included in the consolidated federal and state income tax returns of FHP. A tax allocation has been made to the Company based primarily on an estimated separate return basis, including the recording of benefits F-11 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) for tax losses utilized in FHP's consolidated returns. Upon separation from FHP, the Company will likely not be able to recognize tax benefits from losses because it is not certain when the Company will generate sufficient taxable income to realize such benefits. The Company and FHP have entered into a Tax Allocation Agreement that provides for FHP, among other things, to file all tax returns with respect to, and to pay all taxes imposed upon or attributable to, FHP and its affiliates for all taxable periods, including the taxes incurred in connection with the Offering. The Company generally has agreed, among other things, to file all tax returns with respect to the Company for all taxable periods beginning after the expiration of the Rights and to pay all taxes imposed upon or attributable to the Company for all taxable periods ending after the Acquisition. The Company will indemnify FHP against any adverse adjustment, or receive from FHP the benefit of any favorable adjustment, of an FHP return to the extent that the adjustment (i) relates to a taxable period prior to the Acquisition, (ii) arises out of the Company's activities, and (iii) when combined with all other such adjustments that, in the aggregate, exceed $2 million, but does not exceed $4 million. The Company and FHP will share equally the liability for, or the benefit of, such adjustments to the extent they exceed $4 million. The Tax Allocation Agreement will become effective only if, upon completion of the Offering, FHP owns less than 50% of the outstanding shares of Common Stock. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation and amortization, are provided principally by the straight-line method over the estimated useful lives of the respective classes of assets (three to ten years). Routine maintenance and repairs are charged to expense as incurred, while costs of betterments and renewals are capitalized. ACCOUNTING FOR LONG-LIVED ASSETS In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." As permitted by SFAS 121, the Company elected to adopt the statement as of December 31, 1995. In accordance with SFAS 121, long-lived assets to be held will be reviewed for events or changes in circumstances that would indicate that the carrying value may not be recoverable. The adoption of SFAS 121 had no effect on the consolidated financial statements for fiscal year 1995. ACCOUNTING FOR STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" provides an alternative to APB Opinion No. 25 ("APB 25"). SFAS 123 encourages, but does not require, recognition against earnings of compensation expense for grants of stock, stock options and other equity instruments by employers (collectively, "options"), based on fair value at the date of grant. SFAS 123 provides a methodology for the determination of fair value; however, SFAS 123 also allows companies to continue to measure compensation cost using the intrinsic value method of accounting provided by APB 25. SFAS 123 requires companies that choose not to adopt the new fair value accounting rules to disclose pro forma net income and earnings per share under the new method as if it had been adopted. The Company intends to continue with the intrinsic value method prescribed in APB 25 and make pro froma disclosures of net income and earnings per share as if the fair value method of accounting (as defined in SFAS 123) had been applied for 1996. F-12 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PER SHARE CALCULATIONS The per share calculations have been computed by dividing net loss by the weighted average number of common shares and common share equivalents outstanding during the periods. Common share equivalents included in determining loss per share include shares issuable upon exercise of stock options. Pursuant to the Securities and Exchange Commission Staff Accounting Bulletin Topic 4:D, stock options granted during the twelve-month period prior to the date of the initial filing of the Registration Statement have been included in the calculation of common equivalent shares using the treasury stock method (considering the assumed proceeds from the stock options and the number of shares that could have been repurchased using the estimated initial public offering price) as if the shares were outstanding for all periods presented, even if the impact of the incremental shares is anti-dilutive. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal areas requiring the use of estimates include: the allocation of financial statement amounts between the Company and FHP (Note 2), determination of allowances for doubtful accounts receivable, and determination of medical claims payable. MANAGEMENT PLANS The Company has experienced operating losses, negative cash flows and a working capital deficiency. Management plans to stabilize the Company's financial condition through revenue enhancement plans and cost reduction efforts. Management's revenue enhancement plans focus on attracting new Medicare and commercial enrollees by entering into provider agreements with payors other than FHP. Declining enrollment has created excess health care service capacity and the Company believes additional revenue opportunities can be achieved with relatively lower allocated incremental cost. Management anticipates that independence from FHP will make the Talbert Medical Groups more accessible to other payers and new capitaled enrollers. In addition, management intends to continue its efforts to reduce operating and overhead costs. The Company's cost reduction efforts focus primarily on continuing improvements in the cost of health care and controlling general and administrative costs, including through the implementation of a new physician compensation system. Management believes that these plans will provide sufficient additional cash flow to maintain the Company's operations for the next several years. NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE COMPANY The accompanying consolidated financial statements as of and for the periods prior to January 1, 1996 reflect the assets, liabilities, revenues and expenses that were directly related to the continuing operations of the Company as they were operated by FHP. FHP's historical cost basis of the assets and liabilities has been carried over to the Company. In cases involving assets, liabilities, revenues, and expenses not specifically identifiable to any particular business of FHP, certain allocations were made to reflect the future and ongoing operations of the Company. These allocations were based on a variety of factors which management believes provide a reliable basis for the accompanying consolidated financial statements and include the following: F-13 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE COMPANY (CONTINUED) 1. No cash balances are recorded as part of these historical financial statements as it was the practice of FHP not to maintain separate cash balances for the businesses. 2. The Company estimated its proportionate share of expenses incurred by FHP on a company-wide basis and used such estimates as a basis to allocate certain liabilities, principally accounts payable and accrued salaries and benefits. 3. Capitated enrollee statistics were utilized as a basis to allocate certain historical revenue and expense items, as follows: a. Revenue -- Actual revenue was applied for California, Utah and Nevada. For Arizona and New Mexico, the average number of enrollees per physician multiplied by the actual number of physicians multiplied by the average capitation rate per enrollee received by each region respectively was applied to determine the revenue. b. Expenses -- Actual staff model expenses are applied for California, Utah and Nevada. Arizona and New Mexico's actual affiliated services are utilized. Purchased service costs for Arizona and New Mexico are based upon the historical average percentage of revenues for each region. Management believes the amounts allocated to the Company have been computed on a reasonable and consistent basis. 4. The net change in stockholders' deficit arising from intercompany transactions, as reflected in the consolidated statements of stockholder's deficit, includes (i) the aggregate intercompany allocations of costs and expenses incurred by the Company and paid by FHP and (ii) cash generated by the Company and collected by FHP, during the periods presented. The net change in stockholders' deficit arising from intercompany transactions also includes all liabilities of the Company that are not separate legal obligations of the Company, such as income taxes payable and employee benefit plan obligations that are legal obligations of FHP, but have been charged to the Company. The amounts advanced to FHP by the Company were offset primarily against retained earnings on January 1, 1996 in conjunction with the recapitalization of the Company. (Note 9) 5. The Company bears no expense for the cost of services related to the hospitalization of members, which risk is retained by FHP. Accordingly, the Company's financial statements include only physician-related costs, for which it has been and continues to be responsible. 6. The historical financial statements include the Company's best estimates of management information services and certain administrative and overhead activities provided to the Company by FHP. Management believes that such amounts approximate the cost of similar services obtained from an independent party. 7. The historical retained earnings of the FHP staff model at December 31, 1990 was utilized in the preparation of the Company's historical balance sheet at that date. Such balance has been adjusted annually to reflect the net change in stockholders' deficit arising from intercompany transactions and the net loss of the Company since that date. 8. The historical financial statements include the Company's best estimate of the cost of using the Talbert Medical Centers and related equipment, furniture and fixtures owned or leased by FHP during all periods presented. Management believes such usage cost is a reasonable approximation of the cost of renting similar facilities, equipment, furniture and fixtures from an independent party. F-14 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--ASSUMPTIONS RELATED TO THE HISTORICAL FINANCIAL STATEMENTS OF THE COMPANY (CONTINUED) 9. Loss per common and common equivalent share was computed assuming that the Company's capital structure subsequent to the Offering was in place for the years ended December 31, 1993, 1994 and 1995, and the nine months ended September 30, 1995 and 1996. As such, the loss per share calculation assumes 2,996,104 common shares outstanding for each of the periods presented. NOTE 3--PROPERTY AND EQUIPMENT Property and equipment consist of the following (amounts in thousands):
SEPTEMBER 30, 1996 ------------- (UNAUDITED) Furniture, fixtures and equipment.................................................................. $ 2,670 Computer equipment................................................................................. 1,931 Leasehold improvements............................................................................. 1,212 ------ 5,813 Less accumulated depreciation and amortization..................................................... (627) ------ Property and equipment, net.................................................................... $ 5,186 ------ ------
NOTE 4--MEDICAL CLAIMS PAYABLE Activity in the liability for medical claims payable is summarized below (amounts in thousands):
BALANCE CLAIMS INCURRED CLAIMS PAID BALANCE BEGINNING DURING THE DURING THE END OF OF PERIOD PERIOD PERIOD PERIOD ----------- ---------------- ---------------- --------- Year ended December 31, 1993................ $ 10,207 44,911 (43,598) $ 11,520 Year ended December 31, 1994................ $ 11,520 55,205 (54,949) $ 11,776 Year ended December 31, 1995................ $ 11,776 51,803 (50,748) $ 12,831(1) Nine months ended September 30, 1996 (unaudited)............................... $ -- (1) 34,259 (19,762) $ 14,497
- ------------------------ (1) The unpaid balance of $12,831 at December 31, 1995 was assumed by FHP as part of the recapitalization of the Company on January 1, 1996 (Note 9). NOTE 5--LEASES TMMC and FHP have entered into a Real Estate and Equipment Master Transfer Agreement (the "Master Lease Agreement") to provide for the lease, sublease or assignment by FHP to TMMC of facilities and equipment used by the Talbert Medical Groups that are either owned or leased by FHP. The leases are accounted for as operating leases. The Master Lease Agreement will expire on December 31, 2000. The Company and FHP have agreed to certain amendments of the Master Lease Agreement pursuant to a letter agreement. These amendments include (i) the extension, at prevailing market rates, of the existing terms of the individual leases to December 31, 2005, with the exception of leases with respect to up to 90,000 square feet (of a total of approximately 472,000 square feet) that the Company may elect not to renew; (ii) two five-year extension options at prevailing market rates, exercisable solely at the Company's discretion; (iii) a right of first offer for the Company to purchase the furniture, fixtures and F-15 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5--LEASES (CONTINUED) equipment subject to the Master Lease Agreement ("FF&E"). The parties have also agreed to enter into a separate lease agreement with respect to FF&E that will expire on December 31, 2000. The Company has also entered into leases with third parties and has assumed the obligations of FHP under certain other leases with third parties. Future minimum annual rental commitments under lease obligations are as follows (amounts in thousands):
MASTER LEASE OTHER LEASES TOTAL ------------ ------------ ---------- Years ending December 31: 1996............................................... $ 21,454 $ 6,916 $ 28,370 1997............................................... 19,603 7,097 26,700 1998............................................... 17,577 6,809 24,386 1999............................................... 16,272 6,121 22,393 2000............................................... 15,352 4,926 20,278 Remainder.......................................... 28,125 15,269 43,394 ------------ ------------ ---------- Total operating lease commitments.................... $ 118,383 $ 47,138 $ 165,521 ------------ ------------ ---------- ------------ ------------ ----------
NOTE 6--INCOME TAX BENEFIT The components of the income tax benefit are summarized as follows (amounts in thousands):
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------- ------------------------ 1993 1994 1995 1995 1996 ---------- ---------- ---------- ---------- ------------ (UNAUDITED) Current: Federal........................................... $ (5,875) $ (10,160) $ (14,899) $ (13,246) $ (3,571) State............................................. (1,707) (2,761) (4,209) (3,743) (1,009) ---------- ---------- ---------- ---------- ------------ Total current benefit............................... (7,582) (12,921) (19,108) (16,989) (4,580) ---------- ---------- ---------- ---------- ------------ Deferred: Federal and state................................. (1,342) (632) (646) 984 1,976 ---------- ---------- ---------- ---------- ------------ Total income tax benefit............................ $ (8,924) $ (13,553) $ (19,754) $ (16,005) $ (2,604) ---------- ---------- ---------- ---------- ------------ ---------- ---------- ---------- ---------- ------------
F-16 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 6--INCOME TAX BENEFIT (CONTINUED) The income tax benefit differs from the amount of tax determined by applying the federal statutory rate to loss before income taxes. The components of this difference are summarized as follows (amounts in thousands):
NINE MONTHS ENDED SEPTEMBER YEAR ENDED DECEMBER 31, 30, ---------------------------------------------------------------------------- ---------------------------- 1993 1994 1995 1995 (UNAUDITED) ------------------------ ------------------------ ------------------------ ---------------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT --------- ------------- --------- ------------- --------- ------------- ----------- --------------- Tax benefit from net losses at federal statutory tax rate... $ (7,602) 34% $ (11,597) 35% $ (16,926) 35% $ (13,713) 35% State tax benefit, net of federal tax....... (1,322) 6% (1,956) 6% (2,828) 6% (2,292) 6% -- -- -- -- --------- --------- --------- ----------- Total income tax benefit.............. $ (8,924) 40% $ (13,553) 41% $ (19,754) 41% $ (16,005) 41% -- -- -- -- -- -- -- -- --------- --------- --------- ----------- --------- --------- --------- ----------- 1996 (UNAUDITED) ------------------------------ AMOUNT PERCENT ----------- ----------------- Tax benefit from net losses at federal statutory tax rate... $ (2,231) 35% State tax benefit, net of federal tax....... (373) 6% -- ----------- Total income tax benefit.............. $ (2,604) 41% -- -- ----------- -----------
The tax effects of significant items comprising the Company's net deferred tax assets are as follows (amounts in thousands):
DECEMBER 31, 1994 1995 --------- --------- SEPTEMBER 30, 1996 ------------- (UNAUDITED) Deferred tax assets-reserves and accruals not currently deductible... $ 5,788 $ 6,434 $ 5,568 Valuation allowance.................................................. -- -- -- --------- --------- ------ Total deferred tax assets............................................ 5,788 6,434 5,568 Deferred tax liabilities-difference between book and tax deduction allowable under operating leases................................... (1,110) --------- --------- ------ Net deferred tax assets.......................................... $ 5,788 $ 6,434 $ 4,458 --------- --------- ------ --------- --------- ------
Management believes that it is more likely than not that sufficient future taxable income will be generated to recover its deferred tax assets. Accordingly, no valuation allowance is deemed necessary. NOTE 7--EMPLOYEE BENEFITS FHP has certain benefit plans in which the Company's employees are currently participating. FHP has two tax-qualified retirement plans: a Money Purchase Pension Plan ("MPPP") and an Employee Stock Ownership Plan with Code section 401(k) and employer matching contribution features ("ESOP"). Following the separation from FHP, the Company intends to establish a money purchase pension plan that will be virtually identical to FHP's MPPP. The Company's Money Purchase Pension Plan (the "Money Purchase Pension Plan") is intended to be a tax-qualified retirement plan that satisfies the requirements of Sections 401(a) and 501(a) of the Internal Revenue Code. The Money Purchase Pension Plan will be frozen both as to contributions as well as to participation. The account balances under the FHP MPPP attributable to employees of the Company will be transferred to the Money Purchase Pension Plan. The accounts of each participant under the Plan will be 100% vested. In general, accounts will be distributable F-17 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7--EMPLOYEE BENEFITS (CONTINUED) upon a participant's termination from employment. With respect to the ESOP, the Company will establish its own plan and trust which are substantially the same as FHP's ESOP and its related trust. Following the separation from FHP, the account balances under FHP's ESOP which are attributable to employees of the Company will be transferred to the new plan and trust to be established by the Company. Under the provisions of the FHP plans, FHP contributed into trusts for the benefit of employees an amount equal to 12% of eligible annual compensation, as defined, of all plan participants. Effective January 1, 1995, the contribution rate was reduced to 8% of eligible annual compensation, as defined. Effective January 1, 1996 the contribution rate was further reduced to 2% of eligible annual compensation. Participants do not vest until they have completed five years of service with the Company. Nonvested contributions, which are forfeited upon an employee's termination, are treated as a reduction in the amount of FHP's contribution. The combined contribution expenses for the Company's employees for the MPPP and ESOP were $16,411,000, $15,611,000, and $10,246,000, for the years ended December 31, 1993, 1994 and 1995 and $7,871,000, and $3,951,000 for the nine months ended September 30, 1995 and 1996, respectively (unaudited). Following the separation from FHP, the Company intends to establish a Deferred Compensation Plan (the "Deferred Compensation Plan") that will be virtually identical to FHP's deferred compensation plan. Accordingly, the Deferred Compensation Plan will be a nonqualified deferred compensation plan and will permit the Company's non-employee directors and a select group of management or highly compensated employees to elect to defer compensation under the Deferred Compensation Plan. The Deferred Compensation Plan will permit a minimum deferral of 3% with respect to salaries (or, with respect to bonuses, 1%) and a maximum deferral of 50% with respect to salaries (or, with respect to bonuses, 100%). The Deferred Compensation Plan will also permit discretionary employer contributions. Amounts deferred under the Deferred Compensation Plan will be credited to bookkeeping accounts established and maintained for each participant. The compensation deferral account of each participant will be 100% vested. The employer contribution account of each participant will be subject to a five-year "cliff" vesting schedule, but will become 100% vested in the event of a change-of-control (as defined under the Deferred Compensation Plan). The Company's Deferred Compensation Plan will provide for the same distribution options as under FHP's Deferred Compensation Plan including: (i) short-term payout option, (ii) retirement benefit, (iii) termination distribution, (iv) survivor benefit and (v) withdrawal election. The 1996 Stock Incentive Plan (the "Plan") was adopted by the Board of Directors and approved by FHP in November 1996. The Plan replaces the substantially similar plan established by TMMC. Under the Plan, the Company is authorized to grant up to 180,000 shares of common stock options, stock appreciation rights, restricted stock awards, performance share awards, stock bonuses, or non-employee director options to any officer, non-employee director or key employee of the Company. The Board of Directors granted 70,350 options to employees and non-employee directors under the TMMC plan as of September 17, 1996 with an exercise price of $29.17 per share. These options have been converted into Plan options. The Plan options granted to management vest at the rate of 20% per year beginning on the first anniversary the grant date. The non-employee director stock options vest at the rate of 25% on the later of 90 days after the award date or 60 days after the listing of the Common Stock on a national security exchange or quotation system, and 25% on each anniversary of the grant date for the first three F-18 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7--EMPLOYEE BENEFITS (CONTINUED) anniversaries of the grant date. Additional grants were made in November 1996 (Note 12). The following is a summary of the activity in the Plan for the nine months ended September 30, 1996:
SHARES --------- Shares subject to options outstanding -- January 1, 1996............................. 0 Granted ($29.17 per share)........................................................... 70,350 Exercised............................................................................ 0 Cancelled............................................................................ 0 --------- Shares subject to options outstanding -- September 30, 1996 (unaudited).............. 70,350 --------- ---------
NOTE 8--COMMITMENTS AND CONTINGENCIES LITIGATION During the ordinary course of business, the Company and its subsidiaries have become a party to pending and threatened legal actions and proceedings. Management of the Company is of the opinion that the outcome of the currently known legal actions and proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position and operating results of the Company and its subsidiaries. REGULATED OPERATIONS The health care industry is highly regulated, and there can be no assurance that the regulatory environment in which the Company operates will not change significantly in the future. The Company believes that its operations as described herein are in substantial compliance with applicable law. The ability of the Company to operate profitably will depend in part upon the Talbert Medical Groups and their affiliated physicians obtaining and maintaining all necessary licenses, certificates of need and other approvals and operating in compliance with applicable health care regulations. NOTE 9--RECAPITALIZATION FHP initially capitalized and incorporated TMMC and THSC on September 15, 1995 and December 6, 1995, respectively, with a combined cash contribution of $91,000. On January 1, 1996, TMMC and THSC assumed the operations and certain assets and liabilities that had previously been recorded on the books of FHP's staff model. As part of this assumption, FHP retained certain medical claims payable ($12,831,000) and contributed cash of $5,055,000 to the Company. As a result, the Company's retained deficit of $17,886,000 was eliminated. NOTE 10--STOCKHOLDERS' DEFICIT The Company's Certificate of Incorporation provides for the issuance of 1,200,000 shares of preferred stock, par value $0.01 per share, and 15,000,000 shares of common stock, par value $0.01 per share. Dividends may be declared and paid to the holders in cash, property or other securities out of any net profits or net assets available therefor. On September 17, 1996 the Board of Directors approved a one-for-3.33 reverse split of TMMC's Common Stock. All share and per share information in the accompanying consolidated financial statements have been retroactively restated to reflect this reverse stock split. F-19 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10--STOCKHOLDERS' DEFICIT (CONTINUED) Management and other investors (the "Management Investors") own 7.75% of the Company's outstanding shares ("Management Shares"). Transfer of the Management Shares is restricted. The Management Investors will not have the ability to sell or transfer Management Shares until such restrictions lapse. Twenty-five percent of the shares issued to each Management Investor vested on July 1, 1996 and the remainder will vest each July 1 until July 1, 1999 beginning July 1, 1997. With certain exceptions, if a Management Investor terminates his or her employment relationship with his or her respective employer before certain shares vest, FHP has an option, but not the obligation, to repurchase the restricted shares from the Management Investor for their original purchase price. In addition, pursuant to certain performance purchase options, if certain financial goals are not met at the vesting dates, up to 20% of the otherwise then-vesting shares become subject to repurchase by FHP at the original purchase price. RIGHTS AGREEMENT. As of the expiration of the Rights Offering (the "Expiration Date"), pursuant to a Stockholder Rights Agreement between the Company and American Stock Transfer & Trust Company, as Rights Agent, the Company has declared a dividend distribution to all holders of Common Stock of a right to purchase a unit initially consisting of one one-hundredth of a share of Junior Participating Preferred Stock upon the terms and conditions set forth in that agreement. The Stockholder Rights Agreement is designed to give the Board of Directors the time and opportunity to protect stockholder interests and encourage equal treatment of all stockholders in a takeover situation. In the event of a takeover attempt, the holders of the rights may exercise them to purchase Common Stock at a 50% discount, or, in the event of a "squeeze-out" transaction where the Company would not be the surviving entity, the acquiring company's common stock at a 50% discount. The issuance of these rights may have the effect of delaying, deferring or preventing a change in control of the Company or an unsolicited acquisition proposal. The Stockholder Rights Agreement provides for a trigger percentage of 8% for the 90-day period following the Expiration Date, and 15% thereafter. Certain persons who acquire Common Stock in excess of the trigger percentage will not trigger the rights, including, with certain limitations, (i) persons who acquire such Common Stock solely as a result of the exercise of Rights distributed to them in the Offering, (ii) FHP, if it acquires such Common Stock solely through the transfer of shares unsubscribed in the Offering, and (iii) transferees of FHP, if FHP acquires in excess of 20% of the outstanding Common Stock solely through the transfer of shares unsubscribed in the Offering. F-20 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11--UNAUDITED QUARTERLY INFORMATION
QUARTER ENDED -------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ---------- ---------- ------------ ------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Year Ended December 31, 1994: Revenue.................................................... $ 122,977 $ 122,581 $ 127,898 $ 129,882 Operating loss............................................. (3,988) (7,915) (11,930) (9,300) Loss before income tax benefit............................. (3,988) (7,915) (11,930) (9,300) Net loss................................................... (2,357) (4,677) (7,050) (5,496) Loss per common and common equivalant share................ (0.79) (1.56) (2.35) (1.83) Year Ended December 31, 1995: Revenue.................................................... $ 133,719 $ 132,167 $ 113,479 $ 116,334 Operating loss............................................. (10,558) (12,730) (15,894) (9,180) Loss before income tax benefit............................. (10,558) (12,730) (15,894) (9,180) Net loss................................................... (6,244) (7,530) (9,402) (5,432) Loss per common and common equivalant share................ (2.08) (2.51) (3.14) (1.81) Nine Months Ended September 30, 1996: Revenue.................................................... $ 115,209 $ 121,283 $ 114,743 Operating loss............................................. (4,570) (1,172) (1,831) Loss before income tax benefit............................. (4,339) (752) (1,283) Net loss................................................... (2,566) (445) (759) Loss per common and common equivalant share................ (0.86) (0.15) (0.25)
In the opinion of management, all adjustments necessary to fairly present the unaudited quarterly information are included for all quarters presented. NOTE 12--SUBSEQUENT EVENTS MERGER OF FHP AND PACIFICARE HEALTH SYSTEMS, INC.--SEE NOTE 1 STOCK OPTION GRANTS On November 21, 1996, the Company issued options to acquire 39,636 shares of common stock to certain officers with an exercise price of $10.00 per share. The options vest 40% on December 31, 1996 and 15% each on January 1 from 2000 through 2003. Based on an assumed fair market value of $29.17 per share on the date of grant, the Company will recognize approximately $760,000 of stock compensation expense (before income tax benefit) as the related options vest. Accordingly, 40% of the $760,000 compensation expense, or $304,000, will be recognized in December 1996. F-21 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN TO THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 3 Risk Factors.............................................................. 12 The Company............................................................... 19 The Offering.............................................................. 21 Financial Statements...................................................... 24 Use of Proceeds........................................................... 25 Dividend Policy........................................................... 25 Capitalization............................................................ 26 Selected Consolidated Financial Data...................................... 27 Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................. 30 Business.................................................................. 37 Management................................................................ 48 Certain Transactions...................................................... 61 Relationship with FHP and PacifiCare Following the Offering............... 62 Principal Stockholders.................................................... 66 Description of Capital Stock.............................................. 68 Legal Matters............................................................. 71 Experts................................................................... 71 Additional Information.................................................... 71 Index to Consolidated Financial Statements................................ F-1
------------------------ UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. 2,767,500 SHARES [logo] TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION COMMON STOCK --------------------- PROSPECTUS , 1997 --------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the various expenses and costs (other than underwriting discounts and commissions) expected to be incurred in connection with the sale and distribution of the securities being registered. All of the amounts shown are estimated except the registration fee of the Securities and Exchange Commission.
ITEM AMOUNT - --------------------------------------------------------------------------------------------- --------- Securities and Exchange Commission registration fee.......................................... $ 18,031 Printing and engraving expenses.............................................................. Legal fees and expenses...................................................................... Accounting fees and expenses................................................................. Miscellaneous................................................................................ --------- Total.................................................................................... $ --------- ---------
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS See "Management--Limitations on Liability of Officers and Directors," contained in the Prospectus. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES On March 15, 1996, TMMC and THSC entered into an agreement to issue 270,000 shares and 45 shares, respectively, of their common stock to the Management Investors as an inducement for the Management Investors to remain in the service of the companies and as an incentive for increased efforts during their service. The securities were issued with a restrictive legend thereon, and are subject to other restrictions, including buy-back rights of FHP, contained in the Management Stock Purchase Agreement, a copy of which is filed as an exhibit to the Registration Statement and is incorporated herein by reference. See "Certain Transactions." In connection with the formation of TMMC and THSC, FHP purchased 9,187,500 shares of Common Stock of TMMC for $91,875 and 510 shares of Common Stock of THSC for $1,010. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS
EXHIBIT NUMBER DESCRIPTION - --------- ------------------------------------------------------------------------------------------------------- +2.1 Amended and Restated Agreement and Plan of Reorganization dated as of November 11, 1996 among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., Tree Acquisition Corp. and FHP International Corporation. +3.1 Certificate of Incorporation of Talbert Medical Management Holdings Corporation, as amended to date. +3.2 Bylaws of Talbert Medical Management Holdings Corporation, as amended to date. +4.1 Rights Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and American Stock Transfer & Trust Company.
II-1
EXHIBIT NUMBER DESCRIPTION - --------- ------------------------------------------------------------------------------------------------------- +4.2 Management Stock Purchase Agreement dated as of March 15, 1996, as amended, between Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation, FHP International Corporation and the investors who are signatories thereto. *4.3 Specimen form of Subscription Certificate. *4.4 Specimen form of Common Stock Certificate. ++5.1 Opinion of O'Melveny & Myers LLP. +10.1 Form of Provider Agreement dated as of , 1996 between certain HMO subsidiaries of FHP International Corporation and the Talbert Medical Groups. +10.2 Form of Provider Agreement dated as of , 1996 between the California HMO subsidiary of PacifiCare Health Systems, Inc. and the Talbert Medical Groups. +10.3 Stock Purchase Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and FHP International Corporation. +10.4 Standstill Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and FHP International Corporation. +10.5 Amended and Restated Real Estate and Equipment Master Transfer Agreement dated as of , 1997 among Talbert Medical Management Corporation, Inc., FHP, Inc., FHP of Utah, Inc. and FHP of New Mexico, Inc. +10.6 Letter Agreement among Talbert Medical Management Corporation and FHP, Inc., FHP of Utah, Inc. and FHP of New Mexico, Inc. +10.7 Administrative Services Agreement dated as of , 1997 between Talbert Medical Management Corporation and FHP International Corporation. +10.8 Employee Benefits and Compensation Allocation Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and FHP International Corporation. +10.9 Tax Allocation Agreement dated as of , 1997 among Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation and FHP International Corporation. +10.10 Allocation of Liabilities and Indemnification Agreement dated as of , 1997 among Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation and FHP International Corporation. *10.11 Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan. *10.12 Form of Stock Option Agreement between Talbert Medical Management Holdings Corporation and certain members of management. *10.13 Form of Stock Option Agreement between Talbert Medical Management Holdings Corporation and certain non-employee directors. ++10.14 Talbert Medical Management Holdings Corporation Employee Stock Ownership Plan. +10.15 Talbert Medical Management Holdings Corporation Deferred Compensation Plan. ++10.16 Talbert Medical Management Holdings Corporation Money Purchase Pension Plan. *10.17 Form of Indemnification Agreement between Talbert Medical Management Holdings Corporation and its officers and directors. *10.18 Form of Employment Agreement between Talbert Medical Management Holdings Corporation and certain officers who are signatories thereto. *10.19 Form of Chief of Staff Agreement between the Talbert Medical Groups and certain individuals who are signatories thereto. *10.20 Form of Share Control Agreement (non-California) between Talbert Medical Management Corporation and certain individuals who are signatories thereto. *10.21 Form of Share Control Agreement (California) between Talbert Medical Management Corporation and certain individuals who are signatories thereto.
II-2
EXHIBIT NUMBER DESCRIPTION - --------- ------------------------------------------------------------------------------------------------------- +10.22 Form of Management Services Agreement (non-California) between Talbert Medical Management Corporation and the Talbert Medical Groups. +10.23 Form of Management Service Agreement (California) between Talbert Medical Management Corporation and the Talbert Medical Groups. +10.24 Form of Physician Employment Agreement (non-Utah) between the Talbert Medical Groups and certain individuals who are signatories thereto. +10.25 Form of Physician Employment Agreement (Utah) between the Talbert Medical Groups and certain individuals who are signatories thereto. *11.1 Statement re computation of per share earnings +21.1 Subsidiaries of Talbert Medical Management Holdings Corporation ++23.1 Consent of Deloitte & Touche LLP ++23.2 Consent of O'Melveny & Myers LLP (included in Exhibit 5.1) +24.1 Power of attorney (see page II-5)
- ------------------------ * Filed herewith. + Filed previously. ++ To be filed by amendment. II-3 (B) FINANCIAL STATEMENT SCHEDULES TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED 1993, 1994, AND 1995 AND NINE MONTHS ENDED SEPTEMBER 30, 1996
BALANCE AT CHARGED TO BALANCE AT BEGINNING COST AND END OF OF PERIOD EXPENSES WRITE-OFFS PERIOD ----------- ----------- ----------- ----------- (AMOUNTS IN THOUSANDS) YEAR ENDED DECEMBER 31, 1993 Allowance for doubtful accounts: Accounts Receivable............................................ $ 1,994 $ 3,524 $ (500) $ 5,018 YEAR ENDED DECEMBER 31, 1994 Allowance for doubtful accounts: Accounts Receivable............................................ $ 5,018 $ 1,500 $ (1,132) $ 5,386 YEAR ENDED DECEMBER 31, 1995 Allowance for doubtful accounts: Accounts Receivable............................................ $ 5,386 $ 952 $ (860) $ 5,478 NINE MONTHS ENDED SEPTEMBER 30, 1996 (UNAUDITED) Allowance for doubtful accounts: Accounts Receivable............................................ $ 5,478 $ 4,119 $ (1,557) $ 8,040
All other schedules are omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements and notes hereto. ITEM 17. UNDERTAKINGS (a) The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high and of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities II-4 offered therein, and the offering of such securities at that time shall be deemed to be the initial BONA FIDE offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (c) The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) The undersigned Registrant hereby undertakes to supplement the prospectus, after the expiration of the subscription period, to set forth the results of the subscription offer, the transactions by the underwriters during the subscription period, the amount of unsubscribed securities to be purchased by the underwriters, and the terms of any subsequent reoffering thereof. If any public offering by the underwriters is to be made on terms differing from those set forth on the cover page of the prospectus, a post-effective amendment will be filed to set forth the terms of such offering. II-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-1 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Costa Mesa, State of California, on this 30th day of January, 1997. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: /s/ JACK D. MASSIMINO ----------------------------------- Jack D. Massimino PRESIDENT AND CHIEF EXECUTIVE OFFICER POWER OF ATTORNEY KNOWN ALL MEN BY THESE PRESENTS that each individual whose signature appears below constitutes and appoints Jack D. Massimino and Walter R. Stone and each of them, his true and lawful attorneys-in-fact and agents with full power of substitution, for him and in his name, place and stead in any and all capacities, to sign any and all amendments to this Registration Statement, and to file same, with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them full power and authority to do and perform each and every act and thing requisite and necessary to be done to comply with the provisions of the Securities Act of 1933, as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed on January 30, 1997 by the following persons in the capacities indicated.
SIGNATURE TITLE - ------------------------------------------------------ --------------------------------------------------------- /s/ JACK D. MASSIMINO ------------------------------------------- President and Chief Executive Officer (Principal Jack D. Massimino Executive Officer) /s/ WALTER R. STONE ------------------------------------------- Vice President, Finance, Treasurer and Secretary Walter R. Stone (Principal Financial and Accounting Officer) * ------------------------------------------- Director Jack R. Anderson ------------------------------------------- Director Richard M. Burdge, Sr. * ------------------------------------------- Director Warner Heineman ------------------------------------------- Director Van B. Honeycutt
II-6
SIGNATURE TITLE - ------------------------------------------------------ --------------------------------------------------------- * ------------------------------------------- Director Robert W. Jamplis, M.D. * ------------------------------------------- Director Robert C. Maxson * ------------------------------------------- Director Joseph F. Prevratil * ------------------------------------------- Director Westcott W. Price III *By: /s/ JACK D. MASSIMINO ------------------------------------------- Jack D. Massimino ATTORNEY-IN-FACT
II-7 INDEX TO EXHIBITS
EXHIBITS PAGE - --------- --------- +2.1 Amended and Restated Agreement and Plan of Reorganization dated as of November 11, 1996 among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., Tree Acquisition Corp. and FHP International Corporation. +3.1 Certificate of Incorporation of Talbert Medical Management Holdings Corporation, as amended to date. +3.2 Bylaws of Talbert Medical Management Holdings Corporation, as amended to date. +4.1 Rights Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and American Stock Transfer & Trust Company. +4.2 Management Stock Purchase Agreement dated as of March 15, 1996, as amended, between Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation, FHP International Corporation and the investors who are signatories thereto. *4.3 Specimen form of Subscription Certificate. *4.4 Specimen form of Common Stock Certificate. ++5.1 Opinion of O'Melveny & Myers LLP. +10.1 Form of Provider Agreement dated as of , 1996 between certain HMO subsidiaries of FHP International Corporation and the Talbert Medical Groups. +10.2 Form of Provider Agreement dated as of , 1996 between the California HMO subsidiary of PacifiCare Health Systems, Inc. and the Talbert Medical Groups. +10.3 Stock Purchase Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and FHP International Corporation. +10.4 Standstill Agreement dated as of , 1997 between Talbert Medical Management Holdings Corporation and FHP International Corporation. +10.5 Amended and Restated Real Estate and Equipment Master Transfer Agreement dated as of , 1997 among Talbert Medical Management Corporation, Inc., FHP, Inc., FHP of Utah, Inc. and FHP of New Mexico, Inc. +10.6 Letter Agreement among Talbert Medical Management Corporation and FHP, Inc., FHP of Utah, Inc. and FHP of New Mexico, Inc. +10.7 Administrative Services Agreement dated as of , 1997 between Talbert Medical Management Corporation and FHP International Corporation. +10.8 Employee Benefits and Compensation Allocation Agreement dated as of , 1996 between Talbert Medical Management Holdings Corporation and FHP International Corporation. +10.9 Tax Allocation Agreement dated as of , 1997 among Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation and FHP International Corporation. +10.10 Allocation of Liabilities and Indemnification Agreement dated as of , 1997 among Talbert Medical Management Holdings Corporation, Talbert Medical Management Corporation, Talbert Health Services Corporation and FHP International Corporation. *10.11 Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan. *10.12 Form of Stock Option Agreement between Talbert Medical Management Holdings Corporation and certain members of management. *10.13 Form of Stock Option Agreement between Talbert Medical Management Holdings Corporation and certain non-employee directors. ++10.14 Talbert Medical Management Holdings Corporation Employee Stock Ownership Plan.
EXHIBITS PAGE - --------- --------- +10.15 Form of Talbert Medical Management Holdings Corporation Deferred Compensation Plan. ++10.16 Talbert Medical Management Holdings Corporation Money Purchase Pension Plan. *10.17 Form of Indemnification Agreement between Talbert Medical Management Holdings Corporation and its officers and directors. *10.18 Form of Employment Agreement between Talbert Medical Management Holdings Corporation and certain officers who are signatories thereto. *10.19 Form of Chief of Staff Agreement between the Talbert Medical Groups and certain individuals who are signatories thereto. *10.20 Form of Share Control Agreement (non-California) between Talbert Medical Management Corporation and certain individuals who are signatories thereto. *10.21 Form of Share Control Agreement (California) between Talbert Medical Management Corporation and certain individuals who are signatories thereto. +10.22 Form of Management Services Agreement (non-California) between Talbert Medical Management Corporation and the Talbert Medical Groups. +10.23 Form of Management Service Agreement (California) between Talbert Medical Management Corporation and the Talbert Medical Groups. +10.24 Form of Physician Employment Agreement (non-Utah) between the Talbert Medical Groups and certain individuals who are signatories thereto. +10.25 Form of Physician Employment Agreement (Utah) between the Talbert Medical Groups and certain individuals who are signatories thereto. *11.1 Statement re computation of per share earnings +21.1 Subsidiaries of Talbert Medical Management Holdings Corporation ++23.1 Consent of Deloitte & Touche LLP ++23.2 Consent of O'Melveny & Myers LLP (included in Exhibit 5.1) +24.1 Power of attorney (see page II-5)
- ------------------------ * Filed herewith. + Filed previously. ++ To be filed by amendment. EX-4.3 2 EXHIBIT 4.3 SPECIMEN FORM OF SUBSCRIPTION TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION SUBSCRIPTION CERTIFICATE REPRESENTING RIGHTS TO PURCHASE SHARES OF COMMON STOCK, $.01 PAR VALUE, OF TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION ("COMMON STOCK"). VOID IF NOT VALIDLY EXERCISED BEFORE 5:00 P.M. EASTERN STANDARD TIME ON FEBRUARY ___, 1997. THIS SUBSCRIPTION CERTIFICATE IS TRANSFERABLE AND MAY BE COMBINED OR DIVIDED (BUT ONLY INTO CERTIFICATES EVIDENCING A WHOLE NUMBER OF RIGHTS) AT THE OFFICE OF THE SUBSCRIPTION AGENT. CONTROL NUMBER THE TERMS AND CONDITIONS OF THE RIGHTS OFFERING ARE SET FORTH IN THE COMPANY'S PROSPECTUS DATED JANUARY ___, 1997 (THE "PROSPECTUS") AND ARE INCORPORATED HEREIN BY REFERENCE. CAPITALIZED TERMS NOT OTHERWISE DEFINED HEREIN HAVE THE MEANINGS ASSIGNED TO THEM IN THE PROSPECTUS. COPIES OF THE PROSPECTUS ARE AVAILABLE UPON REQUEST FROM AMERICAN STOCK TRANSFER & TRUST COMPANY, THE SUBSCRIPTION AGENT. REGISTERED OWNER: SUBSCRIPTION CERTIFICATE FOR SHARES SUBSCRIPTION PRICE: U.S. $21.50 PER SHARE CUSIP 874121 11 4 The registered owner whose name is inserted hereon, or assigns, is entitled to subscribe for shares of Common Stock upon the terms and subject to the conditions set forth in the Prospectus and instructions relating thereto. The Rights represented by this Subscription Certificate may be exercised by duly completing Form 1; may be transferred, assigned, exercised or sold through a bank or broker by completing Form 2; and may be sold through the Subscription Agent by duly completing Form 3. Special delivery instructions may be specified by completing Form 4. THE RIGHTS EVIDENCED BY THIS SUBSCRIPTION CERTIFICATE MAY NOT BE EXERCISED, TRANSFERRED, ASSIGNED OR SOLD UNLESS THE REVERSE SIDE HEREOF IS SIGNED, WITH A SIGNATURE GUARANTEE, IF APPLICABLE, AND THE APPROPRIATE FORM IS COMPLETED. Date: SECRETARY [SEAL] PRESIDENT COUNTERSIGNED AND REGISTERED: AMERICAN STOCK TRANSFER & TRUST COMPANY SUBSCRIPTION AGENT BY AUTHORIZED SIGNATURE TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION RIGHTS HOLDERS SHOULD BE AWARE THAT IF THEY CHOOSE TO EXERCISE OR TRANSFER LESS THAN ALL OF THE RIGHTS EVIDENCED HEREBY, THEY MAY NOT RECEIVE A NEW SUBSCRIPTION CERTIFICATE IN SUFFICIENT TIME TO EXERCISE THE REMAINING RIGHTS EVIDENCED THEREBY. FORM 1 - EXERCISE AND SUBSCRIPTION. The undersigned hereby irrevocably exercises one or more Rights to subscribe for shares of Common Stock as indicated below, on the terms and subject to the conditions specified in the Prospectus, receipt of which is hereby acknowledged. Rights may only be exercised in whole numbers. (a) Number of shares subscribed for pursuant to the Basic Subscription Privilege (one Right needed to subscribe for each full share): (b) Number of shares subscribed for pursuant to the Additional Subscription Privilege: (c) Total Subscription Price (total number of shares subscribed for pursuant to both the Basic Subscription Privilege and the Additional Subscription Privilege - times the Subscription Price of $21.50): If the amount enclosed or transmitted is not sufficient to pay the Subscription Price for all shares that are stated to be subscribed for, or if the number of shares being subscribed for is not specified, the number of shares subscribed for will be assumed to be the maximum number of whole shares that could be subscribed for upon payment of such amount. If the number of shares to be subscribed for pursuant to the Additional Subscription Privilege is not specified and the amount enclosed or transmitted exceeds the Subscription Price for all shares represented by this Subscription Certificate (the "Subscription Excess"), the person subscribing pursuant hereto shall be deemed to have exercised the Additional Subscription Privilege to purchase, to the extent available, that number of whole shares of Common Stock equal to the quotient obtained by dividing the Subscription Excess by $21.50. Any amount remaining after such division shall be returned to the subscriber without interest or deduction. METHOD OF PAYMENT (CHECK ONE) / / CHECK, BANK DRAFT OR MONEY ORDER PAYABLE TO AMERICAN STOCK TRANSFER & TRUST COMPANY, AS SUBSCRIPTION AGENT. / / WIRE TRANSFER DIRECT TO AMERICAN STOCK TRANSFER & TRUST COMPANY, ACCOUNT NO. 323053793, ABA NO. 021 000 121. (d) If the number of Rights being exercised pursuant to the Basic Subscription Privilege is less than all of the Rights represented by this Subscription Certificate (check only one): / / DELIVER TO ME A NEW SUBSCRIPTION CERTIFICATE EVIDENCING THE REMAINING RIGHTS TO WHICH I AM ENTITLED. / / DELIVER A NEW SUBSCRIPTION CERTIFICATE EVIDENCING THE REMAINING RIGHTS IN ACCORDANCE WITH MY FORM 2 INSTRUCTIONS (which include any required signature guarantees). / / SELL THE REMAINING UNEXERCISED RIGHTS IN ACCORDANCE WITH MY FORM 3 INSTRUCTIONS. Any request to sell shares in accordance with Form 3 instructions must be received by the Subscription Agent by 11:00 a.m. 3 business days prior to the Expiration Date. / / CHECK HERE IF RIGHTS ARE BEING EXERCISED PURSUANT TO A NOTICE OF GUARANTEED DELIVERY DELIVERED TO THE SUBSCRIPTION AGENT PRIOR TO THE DATE HEREOF AND COMPLETE THE FOLLOWING: Name(s) of Registered Owner(s) ____________________________________________ Window Ticket Number (if any) _____________________________________________ Date of Execution of Notice of Guaranteed Delivery ________________________ Name of Institution that Guaranteed Delivery ______________________________ FORM 2 - TO TRANSFER YOUR SUBSCRIPTION CERTIFICATE OR SOME OR ALL OF YOUR RIGHTS OR TO EXERCISE OR SELL RIGHTS THROUGH YOUR BANK OR BROKER: For value received __________________ Rights represented by this Subscription Certificate are hereby assigned to (please print name and address and Social Security No. or Taxpayer ID No. of transferee in full): Name: ________________________________________________________________________ Address: _____________________________________________________________________ ____________________________________________________________ PROVIDE GUARANTEE ____________________________________________________________ OF SIGNATURE(S) ____________________________________________________________ BELOW IF TRANSFEREE IS NOT A BANK OR BROKER Social Security or Taxpayer ID No.: ____________________________________________ / / FORM 3 - CHECK HERE TO SELL YOUR UNEXERCISED RIGHTS THROUGH SUBSCRIPTION AGENT: Check box if the undersigned hereby authorizes the Subscription Agent to sell any Rights represented by this Subscription Certificate but not exercised hereby and to deliver to the undersigned a check for the net proceeds. / / FORM 4 - DELIVERY INSTRUCTIONS: Name and/or address for mailing any stock, new Subscription Certificate or cash payment if other than shown on the reverse hereof: Name: _____________________________________________________ PROVIDE GUARANTEE Address: _________________________________________________ OF SIGNATURE(S) ___________________________________________________________ BELOW ___________________________________________________________ (Including Zip Code) - ------------------------------------------------------------------------------- IMPORTANT RIGHTS HOLDER SIGN HERE AND, IF RIGHTS ARE BEING SOLD OR EXERCISED, COMPLETE SUBSTITUTE FORM W-9 _______________________________________________________________________________ _______________________________________________________________________________ signature(s) of Holder(s) Dated: ________________________________________________________________________ Must be signed by the registered holder(s) exactly as name(s) appear(s) on the Subscription Certificate. If signature by trustee(s), executor(s), administrator(s), guardian(s), attorney(s)-in-fact, officer(s) of a corporation or another acting in a fiduciary or representative capacity, please provide the following information. See instructions for Forms 1-3. Name(s)________________________________________________________________________ _______________________________________________________________________________ (Please Print) Capacity ______________________________________________________________________ Address ______________________________________________________________________________ ______________________________________________________________________________ (including zip code) Area Code and Telephone Number: ___________________________________________________________ (Home) _______________________________________________________________________________ (Business) Tax Identification or Social Security No. _________________________________________________________ (Complete Substitute Form W-9) GUARANTEE OF SIGNATURE(S) See instructions for Forms 2 and 4 Authorized Signature __________________________________________________________ Name: _________________________________________________________________________ Title: _______________________________________________________________________ Name of Firm: _________________________________________________________________ Address: ______________________________________________________________________ Area Code and Telephone Number: ______________________________________________ Dated: ________________________________________________________________________ THE RIGHTS EVIDENCED BY THIS CERTIFICATE EXPIRE AT 5:00 P.M. EASTERN STANDARD TIME ON FEBRUARY ______________, 1997. EX-4.4 3 EXHIBIT 4.4 SPECIMEN FORM OF COMMON STOCK COMMON STOCK COMMON STOCK TM TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION INCORPORATED UNDER THE LAWS OF SEE REVERSE FOR THE STATE OF DELAWARE CERTAIN DEFINITIONS CUSIP 874121 10 6 THIS CERTIFIES THAT is the record holder of FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $.01 PAR VALUE, OF TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this Certificate properly endorsed. This Certificate is not valid unless countersigned and registered by the Transfer Agent and Registrar. WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. Dated: SECRETARY PRESIDENT [SEAL] COUNTERSIGNED AND REGISTERED: AMERICAN STOCK TRANSFER & TRUST COMPANY TRANSFER AGENT AND REGISTRAR BY AUTHORIZED SIGNATURE The Corporation shall furnish without charge to each stockholder who so requests a statement of the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock of the Corporation or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. Such requests shall be made to the Corporation's Secretary at the principal office of the Corporation. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations:
TEN COM -- as tenants in common UNIF GIFT MIN ACT -- ............... Custodian ................. TEN ENT -- as tenants by the entireties (Cust) (Minor) JT TEN -- as joint tenants with right of under Uniform Gifts to Minors survivorship and not as tenants Act....................................... in common (State) UNIF TRF MIN ACT -- ............ Custodian (until age .........) (Cust) ................... under Uniform Transfers (Minor) to Minors Act ............................ (State)
Additional abbreviations may also be used though not in the above list. FOR VALUE RECEIVED, ________________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE ------------------------------------ _______________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE) _______________________________________________________________________________ ______________________________________________________________________ Shares of the common stock represented by the within Certificate, and do hereby irrevocably constitute and appoint _______________________________________________________________________ Attorney to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises. Dated _____________________________________ X_________________________________ X_________________________________ NOTICE: THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER. Signature(s) Guaranteed By _______________________________________ THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. EX-10.11 4 EXHIBIT 10.11 TALBERT 1996 STOCK INCENTIVE PLAN TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN TABLE OF CONTENTS PAGE ---- 1. THE PLAN. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 Purpose. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Administration and Authorization; Power and Procedure. . . . . 1 1.3 Participation. . . . . . . . . . . . . . . . . . . . . . . . . 3 1.4 Shares Available for Awards; Share Limits. . . . . . . . . . . 3 1.5 Grant of Awards. . . . . . . . . . . . . . . . . . . . . . . . 4 1.6 Award Period . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.7 Limitations on Exercise and Vesting of Awards. . . . . . . . . 4 1.8 No Transferability; Limited Exception to Transfer Restrictions . . . . . . . . . . . . . . . . . . . . . . . . 5 2. OPTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.1 Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.2 Option Price . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.3 Limitations on Grant and Terms of Incentive Stock Options. . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.4 Limits on 10% Holders. . . . . . . . . . . . . . . . . . . . . 7 2.5 Cancellation and Regrant/Waiver of Restrictions. . . . . . . . 7 2.6 Options and Rights in Substitution for Stock Options Granted by Other Corporations. . . . . . . . . . . . . . . . 7 3. STOCK APPRECIATION RIGHTS . . . . . . . . . . . . . . . . . . . . . 8 3.1 Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 3.2 Exercise of Stock Appreciation Rights. . . . . . . . . . . . . 8 3.3 Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4. RESTRICTED STOCK AWARDS . . . . . . . . . . . . . . . . . . . . . . 9 4.1 Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 4.2 Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . 9 4.3 Return to the Corporation. . . . . . . . . . . . . . . . . . . 10 5. PERFORMANCE SHARE AWARDS AND STOCK BONUSES. . . . . . . . . . . . . 10 5.1 Grants of Performance Share Awards . . . . . . . . . . . . . . 10 5.2 Special Performance-Based Share Awards . . . . . . . . . . . . 11 5.3 Grants of Stock Bonuses. . . . . . . . . . . . . . . . . . . . 12 5.4 Deferred Payments. . . . . . . . . . . . . . . . . . . . . . . 13 i 6. OTHER PROVISIONS. . . . . . . . . . . . . . . . . . . . . . . . 13 6.1 Rights of Eligible Persons, Participants and Beneficiaries. . . . . . . . . . . . . . . . . . . . . . 13 6.2 Adjustments; Acceleration. . . . . . . . . . . . . . . . . 14 6.3 Effect of Termination of Employment. . . . . . . . . . . . 15 6.4 Compliance with Laws . . . . . . . . . . . . . . . . . . . 15 6.5 Tax Withholding. . . . . . . . . . . . . . . . . . . . . . 16 6.6 Plan Amendment, Termination and Suspension . . . . . . . . 16 6.7 Privileges of Stock Ownership. . . . . . . . . . . . . . . 17 6.8 Effective Date of the Plan . . . . . . . . . . . . . . . . 17 6.9 Term of the Plan . . . . . . . . . . . . . . . . . . . . . 17 6.10 Governing Law/Construction/Severability. . . . . . . . . . 17 6.11 Captions . . . . . . . . . . . . . . . . . . . . . . . . . 18 6.12 Effect of Change of Subsidiary Status. . . . . . . . . . . 18 7. NON-EMPLOYEE DIRECTOR OPTIONS . . . . . . . . . . . . . . . . . 19 7.1 Participation. . . . . . . . . . . . . . . . . . . . . . . 19 7.2 Annual Option Grants . . . . . . . . . . . . . . . . . . . 19 7.3 Option Price . . . . . . . . . . . . . . . . . . . . . . . 19 7.4 Option Period and Exercisability . . . . . . . . . . . . . 20 7.5 Termination of Directorship. . . . . . . . . . . . . . . . 20 7.6 Adjustments. . . . . . . . . . . . . . . . . . . . . . . . 20 7.7 Acceleration Upon a Change in Control Event. . . . . . . . 21 8. DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . 21 8.1 Definitions. . . . . . . . . . . . . . . . . . . . . . . . 21 ii TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN 1. THE PLAN. 1.1 PURPOSE. The purpose of this Plan is to promote the success of the Company by providing an additional means through the grant of Awards to attract, motivate, retain and reward key employees, including officers, whether or not directors, of the Company with awards and incentives for high levels of individual performance and improved financial performance of the Company and to attract, motivate and retain experienced and knowledgeable independent directors through the benefits provided under Article 7. "Corporation" means Talbert Medical Management Holdings Corporation, and "Company" means the Corporation and its Subsidiaries, collectively. These terms and other capitalized terms are defined in Article 8. 1.2 ADMINISTRATION AND AUTHORIZATION; POWER AND PROCEDURE. (a) COMMITTEE. This Plan shall be administered by and all Awards to Eligible Persons shall be authorized by the Committee. Action of the Committee with respect to the administration of this Plan shall be taken pursuant to a majority vote or by unanimous written consent of its members. (b) PLAN AWARDS; INTERPRETATION; POWERS OF COMMITTEE. Subject to the express provisions of this Plan, the Committee shall have the authority: (i) to determine from among those persons eligible the particular Eligible Persons who will receive any Awards; (ii) to grant Awards to Eligible Persons, determine the price at which securities will be offered or awarded and the amount of securities to be offered or awarded to any of such persons, and determine the other specific terms and conditions of such Awards consistent with the express limits of this Plan, and establish the installments (if any) in which such Awards shall become exercisable or shall vest, or determine that no delayed exercisability or vesting is required, and establish the events of termination or reversion of such Awards; (iii) to approve the forms of Award Agreements (which need not be identical either as to type of award or among Participants); (iv) to construe and interpret this Plan and any agreements defining the rights and obligations of the Company and Participants who are granted Awards under Articles 2, 3, 4 or 5 of this Plan, further define the terms used in this Plan, and prescribe, amend and rescind rules and regulations relating to the administration of this Plan; (v) to cancel, modify, or waive the Corporation's rights with respect to, or modify, discontinue, suspend, or terminate any or all outstanding Awards held by Eligible Persons, subject to any required consent under Section 6.6; (vi) to accelerate or extend the exercisability or extend the term of any or all such outstanding Awards within the maximum ten-year term of Awards under Section 1.6; and (vii) to make all other determinations and take such other action as contemplated by this Plan or as may be necessary or advisable for the administration of this Plan and the effectuation of its purposes. Notwithstanding the foregoing, the provisions of Article 7 relating to Non- Employee Director Awards shall be automatic and, to the maximum extent possible, self-effectuating. (c) BINDING DETERMINATIONS. Any action taken by, or inaction of, the Corporation, any Subsidiary, the Board or the Committee relating or pursuant to this Plan shall be within the absolute discretion of that entity or body and shall be conclusive and binding upon all persons. No member of the Board or Committee, or officer of the Corporation or any Subsidiary, shall be liable for any such action or inaction of the entity or body, of another person or, except in circumstances involving bad faith, of himself or herself. Subject only to compliance with the express provisions hereof, the Board and Committee may act in their absolute discretion in matters within their authority related to this Plan. (d) RELIANCE ON EXPERTS. In making any determination or in taking or not taking any action under this Plan, the Committee or the Board, as the case may be, may obtain and may rely upon the advice of experts, including professional advisors to the Corporation. No director, officer or agent of the Company shall be liable for any such action or determination taken or made or omitted in good faith. (e) DELEGATION. The Committee may delegate ministerial, non- discretionary functions to a third-party administrator or to individuals who are officers or employees of the Company. 2 1.3 PARTICIPATION. Awards may be granted by the Committee only to those persons that the Committee determines to be Eligible Persons. An Eligible Person who has been granted an Award may, if otherwise eligible, be granted additional Awards if the Committee shall so determine. 1.4 SHARES AVAILABLE FOR AWARDS; SHARE LIMITS. (a) SHARES AVAILABLE. Subject to the provisions of Section 6.2, the capital stock that may be delivered under this Plan shall be shares of the Corporation's authorized but unissued Common Stock and any shares of its Common Stock held as treasury shares. The shares may be delivered for any lawful consideration. (b) SHARE LIMITS. The maximum number of shares of Common Stock that may be delivered pursuant to all Awards granted under this Plan shall not exceed 180,000 shares (the "SHARE LIMIT"). The maximum number of shares of Common Stock that may be delivered pursuant to Options qualified as Incentive Stock Options granted under Article 2 of this Plan is 50,000 shares. The maximum number of shares of Common Stock that may be delivered to Non-Employee Directors under the provisions of Article 7 shall not exceed 60,000 shares. The maximum number of shares subject to Options and Stock Appreciation Rights that are granted during any calendar year to any individual shall be limited to 50,000. Each of the four foregoing numerical limits shall be subject to adjustment as contemplated by this Section 1.4 and Section 6.2. (c) SHARE RESERVATION; REPLENISHMENT AND REISSUE OF UNVESTED AWARDS. No Award may be granted under this Plan unless, on the date of grant, the sum of (i) the maximum number of shares issuable at any time pursuant to such Award, plus (ii) the number of shares that have previously been issued pursuant to Awards granted under this Plan, other than reacquired shares available for reissue consistent with any applicable legal limitations, plus (iii) the maximum number of shares that may be issued at any time after such date of grant pursuant to Awards that are outstanding on such date, does not exceed the Share Limit. Shares that are subject to or underlie Awards which expire or for any reason are cancelled or terminated, are forfeited, fail to vest, or for any other reason are not paid or delivered under this Plan, as well as reacquired shares, shall again, except to the extent prohibited by law, be available for subsequent Awards under the Plan. Except as limited by law, if an Award is or may be settled only in cash, such Award need not be counted against any of the limits under this Section 1.4. 3 1.5 GRANT OF AWARDS. Subject to the express provisions of this Plan, the Committee shall determine the number of shares of Common Stock subject to each Award, the price (if any) to be paid for the shares or the Award and, in the case of Performance Share Awards, in addition to matters addressed in Section 1.2(b), the specific objectives, goals and performance criteria (such as an increase in sales, market value, earnings or book value over a base period, the years of service before vesting, the relevant job classification or level of responsibility or other factors) that further define the terms of the Performance Share Award. Each Award shall be evidenced by an Award Agreement signed by the Corporation and, if required by the Committee, by the Participant. The Award Agreement shall set forth the material terms and conditions of the Award established by the Committee consistent with the specific provisions of this Plan. 1.6 AWARD PERIOD. Each Award and all executory rights or obligations under the related Award Agreement shall expire on such date (if any) as shall be determined by the Committee, but in the case of Options or other rights to acquire Common Stock not later than ten (10) years after the Award Date. 1.7 LIMITATIONS ON EXERCISE AND VESTING OF AWARDS. (a) PROVISIONS FOR EXERCISE. Unless the Committee otherwise expressly provides, no Award shall be exercisable or shall vest until at least 12 months after the initial Award Date, and once exercisable an Award shall remain exercisable until the expiration or earlier termination of the Award. (b) PROCEDURE. Any exercisable Award shall be deemed to be exercised when the Secretary of the Corporation receives written notice of such exercise from the Participant, together with any required payment made in accordance with Section 2.2(a) or 7.4, as the case may be. (c) FRACTIONAL SHARES/MINIMUM ISSUE. Fractional share interests shall be disregarded, but may be accumulated. The Committee, however, may determine in the case of Eligible Persons that cash, other securities, or other property will be paid or transferred in lieu of any fractional share interests. No fewer than 100 shares may be purchased on exercise of any Award at one time unless the number purchased is the total number at the time available for purchase under the Award. 4 1.8 NO TRANSFERABILITY; LIMITED EXCEPTION TO TRANSFER RESTRICTIONS. (a) LIMIT ON EXERCISE AND TRANSFER. Unless otherwise expressly provided in (or pursuant to) this Section 1.8, by applicable law and by the Award Agreement, as the same may be amended, (i) all Awards are non-transferable and shall not be subject in any manner to sale, transfer, anticipation, alienation, assignment, pledge, encumbrance or charge; Awards shall be exercised only by the Participant; and (ii) amounts payable or shares issuable pursuant to an Award shall be delivered only to (or for the account of) the Participant. (b) EXCEPTIONS. The Committee may permit Awards to be exercised by and paid to certain persons or entities related to the Participant pursuant to such conditions and procedures as the Committee may establish. Any permitted transfer shall be subject to the condition that the Committee receive evidence satisfactory to it that the transfer is being made for estate and/or tax planning purposes or a gratuitous or donative basis and without consideration (other than nominal consideration). Notwithstanding the foregoing, Incentive Stock Options and Restricted Stock Awards shall be subject to any and all applicable transfer restrictions under the Code. (c) FURTHER EXCEPTIONS TO LIMITS ON TRANSFER. The exercise and transfer restrictions in Section 1.8(a) shall not apply to: (i) transfers to the Corporation, (ii) the designation of a beneficiary to receive benefits in the event of the Participant's death or, if the Participant has died, transfers to or exercise by the Participant's beneficiary, or, in the absence of a validly designated beneficiary, transfers by will or the laws of descent and distribution, (iii) transfers pursuant to a QDRO order, (iv) if the Participant has suffered a disability, permitted transfers or exercises on behalf of the Participant by his or her legal representative, or (v) the authorization by the Committee of "cashless exercise" procedures with third parties who provide financing for the purpose of (or who otherwise facilitate) the exercise of Awards consistent with applicable laws and the express authorization of the Committee. Notwithstanding the foregoing, Incentive Stock Options and Restricted Stock Awards shall be subject to all applicable transfer restrictions under the Code. 5 2. OPTIONS. 2.1 GRANTS. One or more Options may be granted under this Article to any Eligible Person. Each Option granted shall be designated in the applicable Award Agreement by the Committee as either an Incentive Stock Option subject to Section 2.3, or a Non-Qualified Stock Option. 2.2 OPTION PRICE. (a) PRICING LIMITS. The purchase price per share of the Common Stock covered by each Option shall be determined by the Committee at the time of the Award, but in the case of Incentive Stock Options shall not be less than 100% (110% in the case of a Participant described in Section 2.4) of the Fair Market Value of the Common Stock on the date of grant. (b) PAYMENT PROVISIONS. The purchase price of any shares purchased on exercise of an Option granted under this Article shall be paid in full at the time of each purchase in one or a combination of the following methods: (i) in cash or by electronic funds transfer; (ii) by check payable to the order of the Corporation; (iii) by notice and third party payment in such manner as may be authorized by the Committee; or (iv) by the delivery of shares of Common Stock of the Corporation already owned by the Participant, PROVIDED, HOWEVER, that the Committee may in its absolute discretion limit the Participant's ability to exercise an Award by delivering such shares. Shares of Common Stock used to satisfy the exercise price of an Option shall be valued at their Fair Market Value on the date of exercise. 2.3 LIMITATIONS ON GRANT AND TERMS OF INCENTIVE STOCK OPTIONS. (a) $100,000 LIMIT. To the extent that the aggregate Fair Market Value of stock with respect to which incentive stock options first become exercisable by a Participant in any calendar year exceeds $100,000, taking into account both Common Stock subject to Incentive Stock Options under this Plan and stock subject to incentive stock options under all other plans of the Company or any parent corporation, such options shall be treated as Nonqualified Stock Options. For this purpose, the Fair Market Value of the stock subject to options shall be determined as of the date the options were awarded. In reducing the number of options treated as incentive stock options to meet the $100,000 limit, the most recently granted options shall be reduced first. To the extent a reduction of simultaneously granted options is necessary to meet the $100,000 limit, the Committee may, in the manner and to the extent permitted by law, designate which shares of Common Stock are to be treated as shares acquired pursuant to the exercise of an Incentive Stock Option. 6 (b) OPTION PERIOD. Each Option and all rights thereunder shall expire no later than ten years after the Award Date. (c) OTHER CODE LIMITS. Incentive Stock Options may only be granted to Eligible Employees who are actually employed by the Corporation or a Subsidiary and that satisfy the other eligibility requirements of the Code. There shall be imposed in any Award Agreement relating to Incentive Stock Options such other terms and conditions as from time to time are required in order that the Option be an "incentive stock option" as that term is defined in Section 422 of the Code. 2.4 LIMITS ON 10% HOLDERS. No Incentive Stock Option may be granted to any person who, at the time the Option is granted, owns (or is deemed to own under Section 424(d) of the Code) shares of outstanding Common Stock possessing more than 10% of the total combined voting power of all classes of stock of the Corporation, unless the exercise price of such Option is at least 110% of the Fair Market Value of the stock subject to the Option and such Option by its terms is not exercisable after the expiration of five years from the date such Option is granted. 2.5 CANCELLATION AND REGRANT/WAIVER OF RESTRICTIONS. Subject to Section 1.4 and Section 6.6 and the specific limitations on Awards contained in this Plan, the Committee from time to time may authorize, generally or in specific cases only, for the benefit of any Eligible Person any adjustment in the exercise or purchase price, the vesting schedule, the number of shares subject to, the restrictions upon or the term of, an Award granted under this Article by cancellation of an outstanding Award and a subsequent regranting of an Award, by amendment, by substitution of an outstanding Award, by waiver or by other legally valid means. Such amendment or other action may result among other changes in an exercise or purchase price which is higher or lower than the exercise or purchase price of the original Award or prior Award, provide for a greater or lesser number of shares subject to the Award, or provide for a longer or shorter vesting or exercise period. 2.6 OPTIONS AND RIGHTS IN SUBSTITUTION FOR STOCK OPTIONS GRANTED BY OTHER CORPORATIONS. Options and Stock Appreciation Rights may be granted to Eligible Persons under this Plan in substitution for employee stock options granted by other entities to persons who are or who will become Eligible Persons in respect of the Company, in connection with a distribution, merger or reorganization by or with the granting entity or an affiliated entity, or the acquisition by the Company, directly or indirectly, of all or a substantial part of the stock or assets of the other entity. 7 3. STOCK APPRECIATION RIGHTS. 3.1 GRANTS. In its discretion, the Committee may grant a Stock Appreciation Right to any Eligible Person either concurrently with the grant of another Award or in respect of an outstanding Award, in whole or in part, or independently of any other Award. Any Stock Appreciation Right granted in connection with an Incentive Stock Option shall contain such terms as may be required to comply with the provisions of Section 422 of the Code and the regulations promulgated thereunder, unless the holder otherwise agrees. 3.2 EXERCISE OF STOCK APPRECIATION RIGHTS. (a) EXERCISABILITY. Unless the Award Agreement or the Committee otherwise provides, a Stock Appreciation Right related to another Award shall be exercisable at such time or times, and to the extent, that the related Award shall be exercisable. (b) EFFECT ON AVAILABLE SHARES. To the extent that a Stock Appreciation Right is exercised, the number of underlying shares of Common Stock theretofore subject to a related Award shall be charged against the maximum amount of Common Stock that may be delivered pursuant to Awards under this Plan. The number of shares subject to the Stock Appreciation Right and the related Option of the Participant shall be reduced by the number of underlying shares as to which the exercise related, unless the Award Agreement otherwise provides. (c) STAND-ALONE SARS. A Stock Appreciation Right granted independently of any other Award shall be exercisable pursuant to the terms of the Award Agreement but in no event earlier than six months after the Award Date, except in the case of death or Total Disability. 3.3 PAYMENT. (a) AMOUNT. Unless the Committee otherwise provides, upon exercise of a Stock Appreciation Right and the attendant surrender of an exercisable portion of any related Award, the Participant shall be entitled to receive payment of an amount determined by multiplying (i) the difference obtained by subtracting the exercise price per share of Common Stock under the related Award (if applicable) or the initial share value specified in the Award from the Fair Market Value of a share of Common Stock on the date of exercise of the Stock Appreciation Right, by 8 (ii) the number of shares with respect to which the Stock Appreciation Right shall have been exercised. (b) FORM OF PAYMENT. The Committee, in its sole discretion, shall determine the form in which payment shall be made of the amount determined under paragraph (a) above, either solely in cash, solely in shares of Common Stock (valued at Fair Market Value on the date of exercise of the Stock Appreciation Right), or partly in such shares and partly in cash, provided that the Committee shall have determined that such exercise and payment are consistent with applicable law. If the Committee permits the Participant to elect to receive cash or shares (or a combination thereof) on such exercise, any such election shall be subject to such conditions as the Committee may impose. 4. RESTRICTED STOCK AWARDS. 4.1 GRANTS. The Committee may, in its discretion, grant one or more Restricted Stock Awards to any Eligible Person. Each Restricted Stock Award Agreement shall specify the number of shares of Common Stock to be issued to the Participant, the date of such issuance, the consideration for such shares (but not less than the minimum lawful consideration under applicable state law) by the Participant, the extent to which the Participant shall be entitled to dividends, voting and other rights in respect of the shares prior to vesting and the restrictions imposed on such shares and the conditions of release or lapse of such restrictions. Such restrictions shall not lapse earlier than 12 months after the Award Date, except to the extent the Committee may otherwise provide. Stock certificates evidencing shares of Restricted Stock pending the lapse of the restrictions ("restricted shares") shall bear a legend making appropriate reference to the restrictions imposed hereunder and shall be held by the Corporation or by a third party designated by the Committee until the restrictions on such shares shall have lapsed and the shares shall have vested in accordance with the provisions of the Award and Section 1.7. Upon issuance of the Restricted Stock Award, the Participant may be required to provide such further assurance and documents as the Committee may require to enforce the restrictions. 4.2 RESTRICTIONS. (a) PRE-VESTING RESTRAINTS. Except as provided in Section 4.1 and 1.8, restricted shares comprising any Restricted Stock Award may not be sold, assigned, transferred, pledged or otherwise disposed of or encumbered, either voluntarily or involuntarily, until the restrictions on such shares have lapsed and the shares have become vested. 9 (b) DIVIDEND AND VOTING RIGHTS. Unless otherwise provided in the applicable Award Agreement, a Participant receiving a Restricted Stock Award shall be entitled to cash dividend and voting rights for all shares issued even though they are not vested, provided that such rights shall terminate immediately as to any restricted shares which cease to be eligible for vesting. (c) CASH PAYMENTS. If the Participant shall have paid or received cash (including any dividends) in connection with the Restricted Stock Award, the Award Agreement shall specify whether and to what extent such cash shall be returned (with or without an earnings factor) as to any restricted shares which cease to be eligible for vesting. 4.3 RETURN TO THE CORPORATION. Unless the Committee otherwise expressly provides, restricted shares that remain subject to restrictions at the time of termination of employment or are subject to other conditions to vesting that have not been satisfied by the time specified in the applicable Award Agreement shall not vest and shall be returned to the Corporation in such manner and on such terms as the Committee shall therein provide. 5. PERFORMANCE SHARE AWARDS AND STOCK BONUSES. 5.1 GRANTS OF PERFORMANCE SHARE AWARDS. The Committee may, in its discretion, grant Performance Share Awards to Eligible Persons based upon such factors as the Committee shall deem relevant in light of the specific type and terms of the award. An Award Agreement shall specify the maximum number of shares of Common Stock (if any) subject to the Performance Share Award, the consideration (but not less than the minimum lawful consideration) to be paid for any such shares as may be issuable to the Participant, the duration of the Award and the conditions upon which delivery of any shares or cash to the Participant shall be based. The amount of cash or shares or other property that may be deliverable pursuant to such Award shall be based upon the degree of attainment over a specified period (a "performance cycle") as may be established by the Committee of such measure(s) of the performance of the Company (or any part thereof) or the Participant as may be established by the Committee. The Committee may provide for full or partial credit, prior to completion of such performance cycle or the attainment of the performance achievement specified in the Award, in the event of the Participant's death, or Total Disability, a Change in Control Event or in such other circumstances as the Committee consistent with Section 6.10(c)(2), if applicable, may determine. 10 5.2 SPECIAL PERFORMANCE-BASED SHARE AWARDS. Without limiting the generality of the foregoing, and in addition to Options and Stock Appreciation Rights granted under other provisions of this Plan which are intended to satisfy the exception for "performance-based compensation" under Section 162(m) of the Code (with such Awards hereinafter referred to as a "Qualifying Option" or a "Qualifying Stock Appreciation Right," respectively), other performance-based awards within the meaning of Section 162(m) of the Code ("PERFORMANCE-BASED AWARDS"), whether in the form of restricted stock, performance stock, phantom stock, Cash-Based Awards, or other rights, the grant, vesting, exercisability or payment of which depends on the degree of achievement of the Performance Goals relative to preestablished targeted levels for the Corporation or the Corporation and one or more of its Subsidiaries, may be granted under this Plan. Any Qualifying Option or Qualifying Stock Appreciation Right shall be subject only to the requirements of subsections (a) and (c) below in order for such Awards to satisfy the requirements for Performance-Based Awards under this Section 5.2. With the exception of any Qualifying Option or Qualifying Stock Appreciation Right, an Award that is intended to satisfy the requirements of this Section 5.2 shall be designated as a Performance-Based Award at the time of grant. (a) ELIGIBLE CLASS. The eligible class of persons for Performance- Based Awards under this Section shall be the executive officers of the Corporation. (b) PERFORMANCE GOAL ALTERNATIVES. The specific performance goals for Performance-Based Awards granted under this Section (other than Qualifying Options and Qualifying Stock Appreciation Rights) shall be, on an absolute or relative basis, one or more of the Performance Goals, as selected by the Committee in its sole discretion. The Committee shall establish in the applicable Award Agreement the specific performance target(s) relative to the Performance Goal(s) which must be attained before the compensation under the Performance-Based Award becomes payable. The specific targets shall be determined within the time period permitted under Section 162(m) of the Code (and any regulations issued thereunder) so that such targets are considered to be preestablished and so that the attainment of such targets is substantially uncertain at the time of their establishment. The applicable performance measurement period may not be less than one nor more than 10 years. (c) MAXIMUM PERFORMANCE-BASED AWARD. Notwithstanding any other provision of the Plan to the contrary, the maximum number of shares of Common Stock which may be delivered pursuant to options, stock appreciation rights, restricted stock or other share-based awards that are granted as Performance- Based Awards to any Participant in any calendar year shall not exceed 100,000 shares, either individually or in the aggregate, subject to 11 adjustment as provided in Section 6.2. Awards that are cancelled during the year shall be counted against this limit to the extent required by Section 162(m) of the Code. In addition, the aggregate amount of compensation to be paid to any Participant in respect of any Cash-Based Awards that are granted during any calendar year as Performance-Based Awards shall not exceed $1,000,000. (d) COMMITTEE CERTIFICATION. Before any Performance-Based Award under this Section 5.2 (other than Qualifying Options or Qualifying Stock Appreciation Rights) is paid, the Committee must certify in writing that the Performance Goal(s) and any other material terms of the Performance-Based Award were satisfied; provided, however, that a Performance-Based Award may be paid without regard to the satisfaction of the applicable Performance Goal in the event of a Change in Control Event in accordance with Section 6.2(d). (e) TERMS AND CONDITIONS OF AWARDS. The Committee will have the discretion to determine the restrictions or other limitations of the individual Awards granted under this Section 5.2 including the authority to reduce Awards, payouts or vesting or to pay no Awards, in its sole discretion, if the Committee preserves such authority at the time of grant by language to this effect in its authorizing resolutions or otherwise. (f) ADJUSTMENTS FOR CHANGES IN CAPITALIZATION AND OTHER MATERIAL CHANGES. In the event of a change in corporate capitalization, such as a stock split or stock dividend, or a corporate transaction, such as a merger, consolidation, spinoff, reorganization or similar event, or any partial or complete liquidation of the Corporation, or any similar event consistent with regulations issued under Section 162(m) of the Code including, without limitation, any material change in accounting policies or practices affecting the Corporation and/or the Performance Goals or targets, then the Committee may make adjustments to the Performance Goals and targets relating to outstanding Performance-Based Awards to the extent such adjustments are made to reflect the occurrence of such an event; provided, however, that adjustments described in this subsection may be made only to the extent that the occurrence of an event described herein was unforeseen at the time the targets for a Performance-Based Award were established by the Committee. 5.3 GRANTS OF STOCK BONUSES. The Committee may grant a Stock Bonus to any Eligible Person to reward exceptional or special services, contributions or achievements in the manner and on such terms and conditions (including any restrictions on such shares) as determined from time to time by the Committee. The number of shares so awarded shall be determined by the Committee. The Award may be granted independently or in lieu of a cash bonus. 12 5.4 DEFERRED PAYMENTS. The Committee may authorize for the benefit of any Eligible Person the deferral of any payment of cash or shares that may become due or of cash otherwise payable under this Plan, and provide for accredited benefits thereon based upon such deferment, at the election or at the request of such Participant, subject to the other terms of this Plan. Such deferral shall be subject to such further conditions, restrictions or requirements as the Committee may impose, subject to any then vested rights of Participants. 6. OTHER PROVISIONS. 6.1 RIGHTS OF ELIGIBLE PERSONS, PARTICIPANTS AND BENEFICIARIES. (a) EMPLOYMENT STATUS. Status as an Eligible Person shall not be construed as a commitment that any Award will be made under this Plan to an Eligible Person or to Eligible Persons generally. (b) NO EMPLOYMENT CONTRACT. Nothing contained in this Plan (or in any other documents related to this Plan or to any Award) shall confer upon any Eligible Person or other Participant any right to continue in the employ or other service of the Company or constitute any contract or agreement of employment or other service, nor shall interfere in any way with the right of the Company to change such person's compensation or other benefits or to terminate the employment of such person, with or without cause, but nothing contained in this Plan or any document related hereto shall adversely affect any independent contractual right of such person without his or her consent thereto. (c) PLAN NOT FUNDED. Awards payable under this Plan shall be payable in shares or from the general assets of the Corporation, and no special or separate reserve, fund or deposit shall be made to assure payment of such Awards. No Participant, Beneficiary or other person shall have any right, title or interest in any fund or in any specific asset (including shares of Common Stock, except as expressly otherwise provided) of the Company by reason of any Award hereunder. Neither the provisions of this Plan (or of any related documents), nor the creation or adoption of this Plan, nor any action taken pursuant to the provisions of this Plan shall create, or be construed to create, a trust of any kind or a fiduciary relationship between the Company and any Participant, Beneficiary or other person. To the extent that a Participant, Beneficiary or other person acquires a right to receive payment pursuant to any Award hereunder, such right shall be no greater than the right of any unsecured general creditor of the Company. 13 6.2 ADJUSTMENTS; ACCELERATION. (a) ADJUSTMENTS. If there shall occur any extraordinary dividend or other extraordinary distribution in respect of the Common Stock (whether in the form of cash, Common Stock, other securities, or other property), or any reclassification, recapitalization, stock split (including a stock split in the form of a stock dividend), reverse stock split, reorganization, merger, combination, consolidation, split-up, spin-off, combination, repurchase, or exchange of Common Stock or other securities of the Corporation, or there shall occur any other like corporate transaction or event in respect of the Common Stock or a sale of substantially all the assets of the Corporation as an entirety, then the Committee shall, in such manner and to such extent (if any) as it deems appropriate and equitable (1) proportionately adjust any or all of (i) the number and type of shares of Common Stock (or other securities) which thereafter may be made the subject of Awards (including the specific numbers of shares set forth elsewhere in this Plan), (ii) the number, amount and type of shares of Common Stock (or other securities or property) subject to any or all outstanding Awards, (iii) the grant, purchase, or exercise price of any or all outstanding Awards, (iv) the securities, cash or other property deliverable upon exercise of any outstanding Awards, or (v) the performance standards appropriate to any outstanding Awards, or (2) in the case of an extraordinary dividend or other distribution, recapitalization, reclassification, merger, reorganization, consolidation, combination, sale of assets, split up, exchange, or spin off, make provision for a cash payment or for the substitution or exchange of any or all outstanding Awards or the cash, securities or property deliverable to the holder of any or all outstanding Awards based upon the distribution or consideration payable to holders of the Common Stock of the Corporation upon or in respect of such event; PROVIDED, HOWEVER, in each case, that with respect to Awards of Incentive Stock Options, no such adjustment shall be made which would cause the Plan to violate Section 424(a) of the Code or any successor provisions thereto without the written consent of holders materially adversely affected thereby. In any of such events, the Committee may take such action sufficiently prior to such event if necessary to permit the Participant to realize the benefits intended to be conveyed with respect to the underlying shares in the same manner as is available to shareholders generally. (b) ACCELERATION OF AWARDS UPON CHANGE IN CONTROL. As to any Participant, unless prior to a Change in Control Event the Committee determines that, upon its occurrence, there shall be no acceleration of benefits under Awards or determines that only certain or limited benefits under Awards shall be accelerated and the extent to which they shall be accelerated, and/or establishes a different time in respect of such Change in Control Event for such acceleration, then upon the occurrence of a Change in Control Event (i) each Option and Stock Appreciation Right shall become immediately exercisable, (ii) Restricted Stock shall immediately vest free of restrictions, and (iii) each Performance Share Award shall become payable to the Participant; provided, however, that in no 14 event shall any Award be accelerated as to any Section 16 Person to a date less than six months after the Award Date of such Award. The Committee may override the limitations on acceleration in this Section 6.2(b) by express provision in the Award Agreement and may accord any Eligible Person a right to refuse any acceleration, whether pursuant to the Award Agreement or otherwise, in such circumstances as the Committee may approve. Any acceleration of Awards shall comply with applicable regulatory requirements, including without limitation Section 422 of the Code. (c) POSSIBLE EARLY TERMINATION OF ACCELERATED AWARDS. If any Option or other right to acquire Common Stock under this Plan (other than under Article 7) has been fully accelerated as permitted by Section 6.2(b) but is not exercised prior to (i) a dissolution of the Corporation, or (ii) an event described in Section 6.2(a) that the Corporation does not survive, or (iii) the consummation of an event described in Section 6.2(a) that results in a Change in Control Event approved by the Board, such Option or right shall thereupon terminate, subject to any provision that has been expressly made by the Committee for the survival, substitution, exchange or other settlement of such Option or right. 6.3 EFFECT OF TERMINATION OF EMPLOYMENT. The Committee shall establish in respect of each Award granted to an Eligible Person the effect of a termination of employment on the rights and benefits thereunder and in so doing may make distinctions based upon the cause of termination. In addition, in the event of, or in anticipation of, a termination of employment with the Company for any reason, other than discharge for cause, the Committee may, in its discretion, increase the portion of the Participant's Award available to the Participant, or Participant's Beneficiary or Personal Representative, as the case may be, or, subject to the provisions of Section 1.6, extend the exercisability period upon such terms as the Committee shall determine and expressly set forth in or by amendment to the Award Agreement. 6.4 COMPLIANCE WITH LAWS. This Plan, the granting and vesting of Awards under this Plan and the offer, issuance and delivery of shares of Common Stock and/or the payment of money under this Plan or under Awards granted hereunder are subject to compliance with all applicable federal and state laws, rules and regulations (including but not limited to state and federal securities law and federal margin requirements) and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Corporation, be necessary or advisable in connection therewith. Any securities delivered under this Plan shall be subject to such restrictions, and the person acquiring such securities shall, if requested by the Corporation, provide such assurances and representations to the 15 Corporation as the Corporation may deem necessary or desirable to assure compliance with all applicable legal requirements. 6.5 TAX WITHHOLDING. Upon any exercise, vesting, or payment of any Award or upon the disposition of shares of Common Stock acquired pursuant to the exercise of an Incentive Stock Option prior to satisfaction of the holding period requirements of Section 422 of the Code, the Company shall have the right at its option to (i) require the Participant (or Personal Representative or Beneficiary, as the case may be) to pay or provide for payment of the amount of any taxes which the Company may be required to withhold with respect to such Award event or payment or (ii) deduct from any amount payable in cash the amount of any taxes which the Company may be required to withhold with respect to such cash payment. In any case where a tax is required to be withheld in connection with the delivery of shares of Common Stock under this Plan, the Committee may in its sole discretion grant (either at the time of the Award or thereafter) to the Participant the right to elect, pursuant to such rules and subject to such conditions as the Committee may establish, to have the Corporation reduce the number of shares to be delivered by (or otherwise reacquire) the appropriate number of shares valued at their then Fair Market Value, to satisfy such withholding obligation. 6.6 PLAN AMENDMENT, TERMINATION AND SUSPENSION. (a) BOARD AUTHORIZATION. The Board may, at any time, terminate or, from time to time, amend, modify or suspend this Plan, in whole or in part. No Awards may be granted during any suspension of this Plan or after termination of this Plan, but the Committee shall retain jurisdiction as to Awards then outstanding in accordance with the terms of this Plan. (b) SHAREHOLDER APPROVAL. Any amendment that would (i) materially increase the benefits accruing to Participants under this Plan, (ii) materially increase the aggregate number of securities that may be issued under this Plan, or (iii) materially modify the requirements as to eligibility for participation in this Plan, shall be subject to stockholder approval only to the extent then required by Section 425 of the Code or applicable law, or deemed necessary or advisable by the Board. (c) AMENDMENTS TO AWARDS. Without limiting any other express authority of the Committee under but subject to the express limits of this Plan, the Committee by agreement or resolution may waive conditions of or limitations on Awards to Eligible Persons that the Committee in the prior exercise of its discretion has imposed, without the consent of a Participant, and may make other changes to the terms and conditions of Awards that do not affect in any manner 16 materially adverse to the Participant, his or her rights and benefits under an Award. (d) LIMITATIONS ON AMENDMENTS TO PLAN AND AWARDS. No amendment, suspension or termination of the Plan or change of or affecting any outstanding Award shall, without written consent of the Participant, affect in any manner materially adverse to the Participant any rights or benefits of the Participant or obligations of the Corporation under any Award granted under this Plan prior to the effective date of such change. Changes contemplated by Section 6.2 shall not be deemed to constitute changes or amendments for purposes of this Section 6.6. 6.7 PRIVILEGES OF STOCK OWNERSHIP. Except as otherwise expressly authorized by the Committee or this Plan, a Participant shall not be entitled to any privilege of stock ownership as to any shares of Common Stock not actually delivered to and held of record by him or her. No adjustment will be made for dividends or other rights as a shareholders for which a record date is prior to such date of delivery. 6.8 EFFECTIVE DATE OF THE PLAN. This Plan shall be effective as of November 21, 1996, the date of Board approval, subject to shareholder approval within 12 months thereafter. 6.9 TERM OF THE PLAN. No Award shall be granted more than ten years after the effective date of this Plan (the "termination date"). Unless otherwise expressly provided in this Plan or in an applicable Award Agreement, any Award granted prior to the termination date may extend beyond such date, and all authority of the Committee with respect to Awards hereunder, including the authority to amend an Award, shall continue during any suspension of this Plan and in respect of outstanding Awards on the termination date. 6.10 GOVERNING LAW/CONSTRUCTION/SEVERABILITY. (a) CHOICE OF LAW. This Plan, the Awards, all documents evidencing Awards and all other related documents shall be governed by, and construed in accordance with the laws of the state of incorporation of the Corporation. (b) SEVERABILITY. If any provision shall be held by a court of competent jurisdiction to be invalid and unenforceable, the remaining provisions of this Plan shall continue in effect. 17 (c) PLAN CONSTRUCTION. (1) RULE 16B-3. It is the intent of the Corporation that transactions in and affecting Awards in the case of Participants who are or may be subject to Section 16 of the Exchange Act satisfy any then applicable requirements of Rule 16b-3 so that such persons (unless they otherwise agree) will be entitled to the benefits of Rule 16b-3 or other exemptive rules under Section 16 of the Exchange Act in respect of these transactions and will not be subjected to avoidable liability thereunder. If any provision of this Plan or of any Award would otherwise frustrate or conflict with the intent expressed above, that provision to the extent possible shall be interpreted so as to avoid such conflict. If the conflict remains irreconcilable, the Committee may disregard the provision if it concludes that to do so furthers the interest of the Corporation and is consistent with the purposes of this Plan as to such persons in the circumstances. (2) SECTION 162(M). It is the further intent of the Company that Options or Stock Appreciation Rights with an exercise or base price not less than Fair Market Value on the date of grant and Performance Share Awards under Section 5.2 of this Plan that are granted to or held by a Section 16 Person shall qualify as performance-based compensation under Section 162(m) of the Code, and this Plan shall be interpreted consistent with such intent. 6.11 CAPTIONS. Captions and headings are given to the sections and subsections of this Plan solely as a convenience to facilitate reference. Such headings shall not be deemed in any way material or relevant to the construction or interpretation of the Plan or any provision thereof. 6.12 EFFECT OF CHANGE OF SUBSIDIARY STATUS. For purposes of this Plan and any Award hereunder, if an entity ceases to be a Subsidiary a termination of employment and service shall be deemed to have occurred with respect to each Eligible Person in respect of such Subsidiary who does not continue as an Eligible Person in respect of another entity within the Company. 6.13 NON-EXCLUSIVITY OF PLAN. Nothing in this Plan shall limit or be deemed to limit the authority of the Board or the Committee to grant awards or authorize any other compensation, with or without reference to the Common Stock, under any other plan or authority. 18 7. NON-EMPLOYEE DIRECTOR OPTIONS. 7.1 PARTICIPATION. Awards under this Article 7 shall be made only to Non-Employee Directors and shall be evidenced by Award Agreements substantially in the form of Exhibit A hereto. 7.2 ANNUAL OPTION GRANTS. (a) TIME OF INITIAL AWARD. Subject to approval by the stockholders of the Corporation, (i) the Chairman of the Board at the date of the Plan's adoption on November 21, 1996 shall be granted without further action a Nonqualified Stock Option dated as of September 17, 1996 to purchase 6,000 shares of Common Stock; (ii) each person who is the chairman of the Audit Committee, Finance Committee or Compensation Committee of the Board at the date of the Plan's adoption on November 21, 1996 shall be granted without further action a Nonqualified Stock Option dated as of September 17, 1996 to purchase 5,000 shares of Common Stock and (iii) each person who is a Non-Employee Director in office on November 21, 1996 and who is not described in clause (i) or (ii) shall be granted without further action a Nonqualified Stock Option dated as of September 17, 1996 to purchase 3,000 shares of Common Stock. After approval of this Plan by the stockholders of the Corporation on November 21, 1996, if any person who is not then an officer or employee of the Company shall become a director of the Corporation, there shall be granted automatically to such person (without any action by the Board or Committee) a Nonqualified Stock Option (the Award Date of which shall be the date such person takes office) to purchase 3,000 shares of Common Stock. (b) SUBSEQUENT ANNUAL AWARDS. With respect to each Non-Employee Director, as of each anniversary of the date of his or her initial option grant under Section 7.2(a), there shall be granted automatically (without any action by the Committee or the Board) a Nonqualified Stock Option (the Award Date of which shall be such anniversary date) to purchase 1,000 shares of Common Stock provided that the Non-Employee Director continues to serve in office on such date. (c) MAXIMUM NUMBER OF SHARES. Annual grants that would otherwise exceed the maximum number of shares under Section 1.4(a) shall be prorated within such limitation. A Non-Employee Director shall not receive more than one Nonqualified Stock Option under this Section 7.2 in any calendar year. 7.3 OPTION PRICE. 19 The purchase price per share of the Common Stock covered by each Option granted pursuant to Section 7.2 hereof shall be 100 percent of the Fair Market Value of the Common Stock on the Award Date. The exercise price of any Option granted under this Article shall be paid in full at the time of each purchase in cash or by check or in shares of Common Stock valued at their Fair Market Value on the date of exercise of the Option, or partly in such shares and partly in cash, PROVIDED THAT any such shares used in payment shall have been owned by the Participant at least six months prior to the date of exercise. 7.4 OPTION PERIOD AND EXERCISABILITY. Each Option granted under this Article 7 and all rights or obligations thereunder shall expire ten years after the Award Date and shall be subject to earlier termination as provided below. Each Option granted under the first sentence of Section 7.2(a) shall become exercisable as follows: (i) at the rate of 25% on the later of 90 days after the Award Date or 60 days after the date of commencement of trading of the Common Stock on a national securities exchange (the "Initial Award Date") and (ii) at the rate of 25% per annum commencing on the first anniversary of the Initial Award Date and each of the next two anniversaries thereof. Each other Option granted under Section 7.2 shall become exercisable at the rate of 20% per annum commencing on the first anniversary of the Award Date and each of the next four anniversaries thereof. 7.5 TERMINATION OF DIRECTORSHIP. If a Non-Employee Director's services as a member of the Board of Directors terminate by reason of death or Total Disability, an Option granted pursuant to this Article held by such Participant shall immediately become and shall remain exercisable for two years after the date of such termination or until the expiration of the stated term of such Option, whichever first occurs. If a Non-Employee Director fails to be renominated or re-elected to the Board of Directors, the Options granted pursuant to this Article shall immediately become vested and shall remain exercisable for ninety (90) days from the date such Non- Employee Director ceases to be renominated or re-elected as a member of the Board of Directors. If a Non-Employee Director's services as a member of the Board of Directors terminate for any other reason, any portion of an Option granted pursuant to this Article which is not then exercisable shall terminate and any portion of such Option which is then exercisable may be exercised for ninety (90) days after the date of such termination or until the expiration of the stated term whichever first occurs. 7.6 ADJUSTMENTS. Options granted under this Article 7 shall be subject to adjustment as provided in Section 6.2, but only to the extent that (a) such adjustment and the 20 Committee's actions in respect thereof satisfy any applicable criteria under Rule 16, (b) such adjustment in the case of a Change in Control Event is effected pursuant to the terms of a reorganization agreement approved by shareholders of the Corporation, and (c) such adjustment is consistent with adjustments to Options held by persons other than executive officers or directors of the Corporation. 7.7 ACCELERATION UPON A CHANGE IN CONTROL EVENT Upon the occurrence of a Change in Control Event, each Option granted under Section 7.2 hereof shall become immediately exercisable in full; provided, however, that none of the Options granted under Section 7.2 shall be accelerated to a date less than six months after the Award Date of such Option. To the extent that any Option granted under this Article 7 is not exercised prior to (i) a dissolution of the Corporation or (ii) a merger or other corporate event that the Corporation does not survive, and no provision is (or consistent with the provisions of Section 7.7 can be) made for the assumption, conversion, substitution or exchange of the Option, the Option shall terminate upon the occurrence of such event. 8. DEFINITIONS. 8.1 DEFINITIONS. (a) "AWARD" shall mean an award of any Option, Stock Appreciation Right, Restricted Stock, Stock Bonus, Performance Share Award, Performance-Based Award, Cash-Based Award, dividend equivalent or deferred payment right or other right or security that would constitute a "derivative security" under Rule 16a- 1(c) of the Exchange Act, or any combination thereof, whether alternative or cumulative, authorized by and granted under this Plan. (b) "AWARD AGREEMENT" shall mean any writing setting forth the terms of an Award that has been authorized by the Committee. (c) "AWARD DATE" shall mean the date upon which the Committee took the action granting an Award or such later date as the Committee designates as the Award Date at the time of the Award or, in the case of Awards under Article 7, the applicable dates set forth therein. (d) "AWARD PERIOD" shall mean the period beginning on an Award Date and ending on the expiration date of such Award. (e) "BENEFICIARY" shall mean the person, persons, trust or trusts designated by a Participant or, in the absence of a designation, entitled by will or 21 the laws of descent and distribution, to receive the benefits specified in the Award Agreement and under this Plan in the event of a Participant's death, and shall mean the Participant's executor or administrator if no other Beneficiary is designated and able to act under the circumstances. (f) "BOARD" shall mean the Board of Directors of the Corporation. (g) "CASH-BASED AWARDS" shall mean Awards that, if paid, must be paid in cash and that are neither denominated in nor have a value derived from the value of, nor an exercise or conversion privilege at a price related to, shares of Common Stock. (h) "CASH FLOW" shall mean cash and cash equivalents derived from either (i) net cash flow from operations or (ii) net cash flow from operations, financings and investing activities, as determined by the Committee at the time an Award is granted. (i) "CHANGE IN CONTROL EVENT" shall mean any of the following: (1) Approval by the shareholders of the Corporation of the dissolution or liquidation of the Corporation; (2) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Corporation (the "Outstanding Corporation Common Stock:) or (ii) the combined voting power of the then outstanding voting securities of the Corporation entitled to vote generally in the election of directors (the "Outstanding Corporation Voting Securities"); provided, however, that for purposes of this subsection (2), the following acquisitions shall not constitute a Change in Control Event: (i) any acquisition directly from the Corporation, (ii) any acquisition by the Corporation, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Corporation or any entity controlled by the Corporation or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (4) below; or (3) Individuals who, as of the effective date of the Plan, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Corporation's stockholders, was 22 approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (4) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Corporation (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Corporation or all or substantially all of the Corporation's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Corporation or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination. (j) "CODE" shall mean the Internal Revenue Code of 1986, as amended from time to time. (k) "COMMISSION" shall mean the Securities and Exchange Commission. 23 (l) "COMMITTEE" shall mean the Board or a committee appointed by the Board to administer this Plan, which committee shall be comprised only of two or more directors or such greater number of directors as may be required under applicable law, each of whom, in respect of any decision at a time when the Participant affected by the decision may be subject to Section 162(m) of the Code, shall be an "outside" director within the meaning of Section 162(m) of the Code. (m) "COMMON STOCK" shall mean the Common Stock of the Corporation and such other securities or property as may become the subject of Awards, or become subject to Awards, pursuant to an adjustment made under Section 6.2 of this Plan. (n) "COMPANY" shall mean, collectively, the Corporation and its Subsidiaries. (o) "CORPORATION" shall mean Talbert Medical Management Holdings Corporation, a Delaware corporation, and its successors. (p) "DISINTERESTED" shall mean disinterested within the meaning of any applicable regulatory requirements, including Rule 16b-3. (q) "ELIGIBLE EMPLOYEE" shall mean an officer (whether or not a director) or key employee of the Company, or, prior to the time that the Corporation's Common Stock is registered on a Registration Statement on Form S- 8, any person who has agreed to commence serving in any such capacity within 120 days of the date of grant. (r) "ELIGIBLE PERSON" means an Eligible Employee, or any Other Eligible Person, as determined by the Committee in its discretion. (s) "EPS" shall mean earnings per common share on a fully diluted basis determined by dividing (i) net earnings, less dividends on preferred stock of the Corporation by (ii) the weighted average number of common shares and common shares equivalents outstanding. (t) "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. (u) "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended from time to time. (v) "FAIR MARKET VALUE" on any date shall mean (i) if the stock is listed or admitted to trade on a national securities exchange, the closing price of the stock on the Composite Tape, as published in the Western Edition of The Wall Street Journal, of the principal national securities exchange on which the 24 stock is so listed or admitted to trade, on such date, or, if there is no trading of the stock on such date, then the closing price of the stock as quoted on such Composite Tape on the next preceding date on which there was trading in such shares; (ii) if the stock is not listed or admitted to trade on a national securities exchange, the last price for the stock on such date, as furnished by the National Association of Securities Dealers, Inc. ("NASD") through the NASDAQ National Market Reporting System or a similar organization if the NASD is no longer reporting such information; (iii) if the stock is not listed or admitted to trade on a national securities exchange and is not reported on the National Market Reporting System, the mean between the bid and asked price for the stock on such date, as furnished by the NASD or a similar organization; or (iv) if the stock is not listed or admitted to trade on a national securities exchange, is not reported on the National Market Reporting System and if bid and asked prices for the stock are not furnished by the NASD or a similar organization, the value as established by the Committee at such time for purposes of this Plan. (w) "INCENTIVE STOCK OPTION" shall mean an Option which is intended, as evidenced by its designation, as an incentive stock option within the meaning of Section 422 of the Code, the award of which contains such provisions (including but not limited to the receipt of shareholder approval of this Plan, if the Award is made prior to such approval) and is made under such circumstances and to such persons as may be necessary to comply with that section. (x) "NONQUALIFIED STOCK OPTION" shall mean an Option that is designated as a Nonqualified Stock Option and shall include any Option intended as an Incentive Stock Option that fails to meet the applicable legal requirements thereof. Any Option granted hereunder that is not designated as an incentive stock option shall be deemed to be designated a nonqualified stock option under this Plan and not an incentive stock option under the Code. (y) "NON-EMPLOYEE DIRECTOR" shall mean a member of the Board of Directors of the Corporation who is not an officer or employee of the Company. (z) "NON-EMPLOYEE DIRECTOR PARTICIPANT" shall mean a Non-Employee Director who holds an outstanding Award under the provisions of Article 7. (aa) "OPTION" shall mean an option to purchase Common Stock granted under this Plan. The Committee shall designate any Option granted to an Eligible Person as a Nonqualified Stock Option or an Incentive Stock Option. Options granted under Article 8 shall be Nonqualified Stock Options. (ab) "OTHER ELIGIBLE PERSON" shall mean any Non-Employee Director or any individual consultant or advisor who renders or has rendered 25 BONA FIDE services (other than services in connection with the offering or sale of securities of the Company in a capital raising transaction) to the Company, and who is selected to participate in this Plan by the Committee. A non- employee agent providing BONA FIDE services to the Company (other than as an eligible advisor or consultant) may also be selected as an Other Eligible Person if such agent's participation in this Plan would not adversely affect (i) the Corporation's eligibility to use Form S-8 to register under the Securities Act of 1933, as amended, the offering of shares issuable under this Plan by the Company or (ii) the Corporation's compliance with any other applicable laws. (ac) "PARTICIPANT" shall mean an Eligible Person who has been granted an Award under this Plan and a Non-Employee Director who has received an Award under Article 7 of this Plan. (ad) "PERFORMANCE-BASED AWARD" shall mean an Award of a right to receive shares of Common Stock or other compensation (including cash) under Section 5.2, the issuance or payment of which is contingent upon, among other conditions, the attainment of performance objectives specified by the Committee. (ae) "PERFORMANCE GOALS" shall mean EPS or ROE or Cash Flow or Total Stockholder Return, and "Performance Goals" means any combination thereof. (af) "PERFORMANCE SHARE AWARD" shall mean an Award of a right to receive shares of Common Stock made in accordance with Section 5.1, the issuance or payment of which is contingent upon, among other conditions, the attainment of performance objectives specified by the Committee. (ag) "PERSONAL REPRESENTATIVE" shall mean the person or persons who, upon the disability or incompetence of a Participant, shall have acquired on behalf of the Participant, by legal proceeding or otherwise, the power to exercise the rights or receive benefits under this Plan and who shall have become the legal representative of the Participant. (ah) "PLAN" shall mean this 1996 Stock Incentive Plan. (ai) "QDRO" shall mean a qualified domestic relations order as defined in Section 414(p) of the Code or Title I, Section 206(d)(3) of ERISA (to the same extent as if this Plan were subject thereto), or the applicable rules thereunder. (aj) "RESTRICTED STOCK AWARD" shall mean an award of a fixed number of shares of Common Stock to the Participant subject, however, to payment of such consideration, if any, and such forfeiture provisions, as are set forth in the Award Agreement. 26 (ak) "RESTRICTED STOCK" shall mean shares of Common Stock awarded to a Participant under this Plan, subject to payment of such consideration, if any, and such conditions on vesting and such transfer and other restrictions as are established in or pursuant to this Plan, for so long as such shares remain unvested under the terms of the applicable Award Agreement. (al) "ROE" shall mean consolidated net income of the Corporation (less preferred dividends), divided by the average consolidated common shareholders equity. (am) "RULE 16b-3" shall mean Rule 16b-3 as promulgated by the Commission pursuant to the Exchange Act, as amended from time to time. (an) "SECTION 16 PERSON" shall mean a person subject to Section 16(a) of the Exchange Act. (ao) "SECURITIES ACT" shall mean the Securities Act of 1933, as amended from time to time. (ap) "STOCK APPRECIATION RIGHT" shall mean a right to receive a number of shares of Common Stock or an amount of cash, or a combination of shares and cash, the aggregate amount or value of which is determined by reference to a change in the Fair Market Value of the Common Stock that is authorized under this Plan. (aq) "STOCK BONUS" shall mean an Award of shares of Common Stock granted under this Plan for no consideration other than past services and without restriction other than such transfer or other restrictions as the Committee may deem advisable to assure compliance with law. (ar) "SUBSIDIARY" shall mean any corporation or other entity a majority of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by the Corporation. (as) "TOTAL DISABILITY" shall mean a "permanent and total disability" within the meaning of Section 22(e)(3) of the Code and (except in the case of a Non-Employee Director) such other disabilities, infirmities, afflictions or conditions as the Committee by rule may include. (at) "TOTAL STOCKHOLDER RETURN" shall mean with respect to the Corporation or other entities (if measures on a relative basis), the (i) change in the market price of its common stock (as quoted in the principal market on which it is traded as of the beginning and ending of the period) plus dividends and other distributions paid, divided by (ii) the beginning quoted market price, all of which 27 is adjusted for any changes in equity structure, including but not limited to stock splits and stock dividends. 28 EXHIBIT A TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION ELIGIBLE DIRECTOR NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT dated as of the _____ day of _____________, 19__, between Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Corporation"), and ________________ (the "Director"). W I T N E S S E T H WHEREAS, the Corporation has adopted and the shareholders of the Corporation have approved a Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Plan"). WHEREAS, pursuant to Article 7 of the Plan, the Corporation has granted an option (the "Option") to the Director upon the terms and conditions evidenced hereby, as required by the Plan, which Option is not intended as and shall not be deemed to be an incentive stock option within the meaning of Section 422 of the Code. NOW, THEREFORE, in consideration of the services rendered and to be rendered by the Director, the Corporation and the Director agree to the terms and conditions set forth herein as required by the terms of the Plan. 1. OPTION GRANT. This Agreement evidences the grant to the Director, as of ___________, ____ (the "Option Date"), of an Option to purchase an aggregate of _____ shares of Common Stock, par value _____ per share, under Article 7 of the Plan, subject to the terms and conditions and to adjustment as set forth herein or in pursuant to the Plan. 2. EXERCISE PRICE. The Option entitles the Director to purchase (subject to the terms of Sections 3 through 5 below) all or any part of the Option shares at a price per share of $_______, which amount represents the Fair Market Value of the shares on the Option Date. 3. OPTION EXERCISABILITY AND TERM. Subject to adjustment pursuant to Section 7.6 of the Plan, the Option shall first become and remain exercisable as to ______________ of the shares on ___________________ and as to an additional _________ shares on each of the following dates: ______________, A-1 199_, __________, 199_ and _____________, 199_, in each case subject to adjustments under Section ____ of the Plan and acceleration under Section 7.7 of the Plan. The Option shall terminate on ____________, 19__, unless earlier terminated in accordance with the terms of Sections 7.7 of the Plan. 4. SERVICE AND EFFECT OF TERMINATION OF SERVICE. The Director agrees to serve as a director in accordance with the provisions of the Corporation's Articles of Incorporation, bylaws and applicable law. If the Director's services as a member of the Board shall terminate, this Option shall terminate at the times and to the extent set forth in Section 7.5 of the Plan. 5. GENERAL TERMS. The Option and this Agreement are subject to, and the Corporation and the Director agree to be bound by, the provisions of the Plan that apply to the Option. Such provisions are incorporated herein by this reference. The Director acknowledges receiving a copy of the Plan and reading its applicable provisions. Capitalized terms not otherwise defined herein shall have the meaning assigned to such terms in the Plan. 6. NONTRANSFERABILITY. The grant of the Option is intended to constitute an exempt transaction under Rule 16b-3. In furtherance thereof, the Option shall be non-transferable to the fullest extent required by Rule 16b- 3(a)(2) as in effect on the date of adoption of this Plan or during the transition period by former Rule 16b-3(d)(1)(ii), incorporated herein by this reference. - -------------------------------------- *insert day before tenth anniversary of date of grant. A-2 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (a Delaware corporation) By: ___________________________ Title: ___________________________ Optionee Director _____________________________ (Signature) _____________________________ (Print Name) _____________________________ (Address) _____________________________ (City, State, Zip Code) In consideration of the execution of the foregoing Stock Option Agreement by Talbert Medical Management Holdings Corporation, I, _________________, the spouse of the Director therein named, do hereby agree to be bound by all of the terms and provisions thereof and of the Plan. DATED: ______________, 19__. ___________________________ Signature of Spouse A-3 EX-10.12 5 EXHIBIT 10.12 EMPLOYEE NONQUAL STOCK OPTION AGMT TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN EMPLOYEE NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT dated as of the 21st day of November, 1996, between TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION, a Delaware corporation (the "Corporation"), and ___________________________ (the "Employee"). W I T N E S S E T H WHEREAS, the Corporation maintains the Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Plan"); and WHEREAS, pursuant to the Plan, the Corporation has granted to the Employee effective as of the 17th day of September, 1996 (the "Award Date") an option to purchase all or any part of _____________ authorized but unissued or treasury shares of Common Stock, par value $.01 per share, of the Corporation upon the terms and conditions set forth herein and in the Plan; NOW, THEREFORE, in consideration of the mutual promises and covenants made herein and the mutual benefits to be derived herefrom, the parties agree as follows: 1. DEFINED TERMS. Capitalized terms used herein and not otherwise defined herein shall have the meaning assigned to such terms in the Plan. 2. GRANT OF OPTION. This Agreement evidences the Corporation's grant to the Employee of the right and option to purchase, on the terms and conditions set forth herein and in the Plan, all or any part of an aggregate of ______ shares of the Common Stock at the price of $29.17 per share (the "Option"), exercisable from time to time, subject to the provisions of this Agreement and the Plan, prior to the close of business on the day before the tenth anniversary of the Award Date (the "Expiration Date"). Such price equals the Fair Market Value of a share of the Corporation's Common Stock as of the Award Date. It is the intent of the Corporation that this Option constitute a nonqualified stock option and such option shall not be deemed an incentive stock option within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended ("Code"). 3. CONTINUANCE OF EMPLOYMENT. As a condition of this Option, the Employee hereby agrees to remain in the employ of the Corporation or one of its Subsidiaries for a period of one year after the Award Date. Nothing contained herein or in the Plan shall confer upon the Employee any right with respect to the continuation of 1 employment by the Corporation or any Subsidiary or interfere in any way with the right of the Corporation or of any Subsidiary at any time to terminate such employment or to increase or decrease the compensation of the Employee from the rate in existence at any time. 4. EXERCISABILITY OF OPTION. Except as earlier permitted by or pursuant to the Plan or by resolution of the Committee adopted AFTER the date hereof, no shares may be purchased by exercise of the Option until the expiration of twelve months after the Award Date. The Option will become exercisable (i) at the rate of 20% on the later of the first anniversary of the Award Date or the date of commencement of trading of the Common Stock on a national securities exchange or quotation system and (ii) at the rate of 20% per annum commencing on the second anniversary of the Award Date and each of the next three anniversaries thereof. Should the Employee die or suffer a Total Disability while employed by the Corporation or any Subsidiary, the Option will become fully exercisable on the later of (i) such date of death or Total Disability, or (ii) the date of commencement of trading of the Common Stock on a national securities exchange or quotation system. To the extent the Employee does not in any year purchase all or any part of the shares to which the Employee is entitled, the Employee has the right cumulatively thereafter to purchase any shares not so purchased and such right shall continue until the Option terminates or expires. Fractional share interests shall be disregarded, but may be cumulated. No fewer than 100 shares may be purchased at any one time, unless the number purchased is the total number at the time available for purchase under the Option. 5. METHOD OF EXERCISE OF OPTION. The Option shall be exercisable by the delivery to the Corporation of a written notice stating the number of shares to be purchased pursuant to the Option and accompanied by payment made in accordance with and in a form permitted in Section 2.2 of the Plan for the full purchase price of the shares to be purchased, subject to such further limitations and rules or procedures as the Committee may from time to time establish as to any non-cash payment and as to the tax withholding requirements of Section 6.5 of the Plan. Shares delivered in payment of the exercise price must have been owned by Employee for at least six months prior to the exercise. In addition, the Employee (or the Employee's Beneficiary or Personal Representative) shall furnish any written statements required pursuant to Section 6.4 of the Plan. 6. EFFECT OF TERMINATION OF EMPLOYMENT OR DEATH; CHANGE IN SUBSIDIARY STATUS. The Option and all other rights hereunder, to the extent not exercised, shall terminate and become null and void at such time as the Employee ceases to be employed by either the Corporation or any Subsidiary, except that (a) if the Employee terminates (i) by reason deemed by the Committee, in its discretion, to be for the convenience of the Corporation, or (ii) under a retirement plan of the Company or any Subsidiary after 2 attainment of normal retirement age as provided for in such retirement plan, or retirement at an earlier age with the consent of the Committee, in its discretion, the Employee may at any time within a period of 90 days after such termination exercise the Option to the extent the Option was exercisable at the date of such termination; (b) if the Employee terminates by reason of death or Total Disability, or if the Employee dies or suffers a Total Disability within 90 days after a termination described in subsection (a), then the Option may be exercised within a period of two years after such date of death or Total Disability (or, if earlier, the Employee's termination from employment), to the extent that the Option was exercisable on such date (or, if such death or Total Disability occurred while the Employee was employed by the Corporation or any Subsidiary, to the extent the Option will become exercisable pursuant to Section 4 hereof); provided, however, that in no event may the Option be exercised by anyone under this Section or otherwise after the Expiration Date. If Employee is employed by an entity which ceases to be a Subsidiary, such event shall be deemed for purposes of this Section 6 to be a termination of employment described in subsection (a) in respect of Employee. Absence from work caused by military service or authorized sick leave shall not be considered as a termination of employment for purposes of this Section. 7. TERMINATION OF OPTION UNDER CERTAIN EVENTS. As permitted by Section 6.2 of the Plan, the Committee retains the right to terminate the Option to the extent not previously exercised upon an event or transaction which the Corporation does not survive. 8. NON-TRANSFERABILITY OF OPTION. The Option and any other rights of the Employee under this Agreement or the Plan are nontransferable as provided in Section 1.8 of the Plan. 9. NOTICES. Any notice to be given under the terms of this Agreement shall be in writing and addressed to the Corporation at its principal office located at 3540 Howard Way, Costa Mesa, California 92626, to the attention of the Corporate Secretary and to the Employee at the address given beneath the Employee's signature hereto, or at such other address as either party may hereafter designate in writing to the other. 10. PLAN. The Option and all rights of Employee thereunder are subject to, and the Employee agrees to be bound by, all of the terms and conditions of Articles 1, 2, 6 and 8 of the Plan, incorporated herein by this reference, to the extent such provisions are applicable to options granted to Eligible Persons. The Employee acknowledges receipt of a copy of the Plan, which is made a part hereof by this reference, and agrees to be bound by the terms thereof. Unless otherwise expressly provided in other Sections of this Agreement, provisions of the Plan that confer discretionary 3 authority on the Committee do not (and shall not be deemed to) create any rights in the Employee unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Committee so conferred by appropriate action of the Committee under the Plan after the date hereof. 11. GRANT CONDITIONAL UPON LISTING OF SHARES. Notwithstanding anything else contained herein to the contrary, this Option is expressly conditioned upon the commencement of trading of the shares of the Corporation's Common Stock on a national securities exchange or quotation system. In the event that the Corporation's Common Stock does not commence trading on a national securities exchange or quotation system within twelve (12) months from the Award Date, this Option shall be null and void. IN WITNESS WHEREOF, the Corporation has caused this Agreement to be executed on its behalf by a duly authorized officer and the Employee has hereunto set his or her hand. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (a Delaware corporation) By: ________________________________ Title: President and Chief Executive Officer EMPLOYEE ____________________________________ (Signature) ____________________________________ (Print Name) ____________________________________ (Address) ____________________________________ (City, State, Zip Code) 4 CONSENT OF SPOUSE In consideration of the execution of the foregoing Nonqualified Stock Option Agreement by Talbert Medical Management Holdings Corporation, I, _____________________________, the spouse of the Employee herein named, do hereby join with my spouse in executing the foregoing Employee Nonqualified Stock Option Agreement and do hereby agree to be bound by all of the terms and provisions thereof and of the Plan. DATED: ______________________, 1997. ____________________________________ Signature of Spouse 5 EX-10.13 6 EXHIBIT 10.13 ELIG DIRECTOR NONQUAL STOCK OPTION A TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION 1996 STOCK INCENTIVE PLAN ELIGIBLE DIRECTOR NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT dated as of the 21st day of November, 1996, between TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION, a Delaware corporation (the "Corporation"), and ___________________________ (the "Director"). W I T N E S S E T H WHEREAS, the Corporation has adopted and the stockholders of the Corporation have approved the Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Plan"). WHEREAS, pursuant to Article 7 of the Plan, the Corporation has granted an option (the "Option") to the Director upon the terms and conditions evidenced hereby, as required by the Plan, which Option is not intended as and shall not be deemed to be an incentive stock option within the meaning of Section 422 of the Code. NOW, THEREFORE, in consideration of the services rendered and to be rendered by the Director, the Corporation and the Director agree to the terms and conditions set forth herein as required by the terms of the Plan. 1. OPTION GRANT. This Agreement evidences the grant to the Director, as of September 17, 1996 (the "Award Date"), of an Option to purchase an aggregate of ______ shares of Common Stock, par value $.01 per share, under Article 7 of the Plan, subject to the terms and conditions and to adjustment as set forth herein or pursuant to the Plan. 2. EXERCISE PRICE. The Option entitles the Director to purchase (subject to the terms of Sections 3 through 6 below) all or any part of the Option shares at a price per share of $29.17, which amount represents the Fair Market Value of the shares on the Award Date. 3. OPTION EXERCISABILITY AND TERM. Subject to adjustment pursuant to Section 7.6 of the Plan, the Option shall become and remain exercisable: (i) at the rate of 25% on the later of 90 days after the Award Date or 60 days after the date of commencement of trading of the Common Stock on a national securities exchange or quotation system (the "Initial Award Date") and (ii) at the rate of 25% per annum commencing on the first anniversary of the Initial Award Date and each of the next two anniversaries thereof. The Option shall terminate on September 16, 2006 unless earlier terminated in accordance with the terms of Section 7.7 of the Plan. 4. SERVICE AND EFFECT OF TERMINATION OF SERVICE. The Director agrees to serve as a director in accordance with the provisions of the Corporation's Articles of Incorporation, bylaws and applicable law. If the Director's services as a member of the Board shall terminate, this Option shall terminate at the times and to the extent set forth in Section 7.5 of the Plan. 5. GENERAL TERMS. The Option and this Agreement are subject to, and the Corporation and the Director agree to be bound by, the provisions of the Plan that apply to the Option. Such provisions are incorporated herein by this reference. The Director acknowledges receiving a copy of the Plan and reading its applicable provisions. Capitalized terms not otherwise defined herein shall have the meaning assigned to such terms in the Plan. 6. GRANT CONDITIONED UPON LISTING OF SHARES. Notwithstanding anything else contained herein to the contrary, this Option is expressly conditioned upon the commencement of trading of the shares of the Corporation's Common Stock on a national securities exchange or quotation system. In the event that the Corporation's Common Stock does not commence trading on a national securities or quotation system exchange within twelve (12) months from the Award Date, this Option shall be null and void. 7. NONTRANSFERABILITY. The Option and any other rights of the Director under this Agreement or the Plan are nontransferable as provided in Section 1.8 of the Plan. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION (a Delaware corporation) By: ________________________________ Title: President and Chief Executive Officer DIRECTOR ____________________________________ (Signature) ____________________________________ (Print Name) ____________________________________ (Address) ____________________________________ (City, State, Zip Code) CONSENT OF SPOUSE In consideration of the execution of the foregoing Stock Option Agreement by Talbert Medical Management Holdings Corporation, I, _____________________________, the spouse of the Director therein named, do hereby agree to be bound by all of the terms and provisions thereof and of the Plan. DATED: ______________________, 1997. ____________________________________ Signature of Spouse EX-10.17 7 EXHIBIT 10.17 FORM OF INDEMNIFICATION INDEMNIFICATION AGREEMENT AGREEMENT, dated as of November 21, 1996, by and between Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Company"), and ________________ (the "Indemnitee"). WHEREAS, it is essential to the Company to retain and attract as directors and officers the most capable persons available; and WHEREAS, the Indemnitee is an officer and/or director of the Company; and WHEREAS, both the Company and the Indemnitee recognize the increased risk of litigation and other claims being asserted against directors and officers of public companies in today's environment; and WHEREAS, the Bylaws of the Company require the Company to indemnify and advance expenses to its directors and officers and to persons who serve at the request of the Company as directors and officers of another corporation to the full extent permitted by law and the Indemnitee has been serving and continues to serve at the request of the Company, as a director and/or officer of the Company in part in reliance on such Bylaws; and WHEREAS, in recognition of the Indemnitee's need for substantial protection against personal liability in order to enhance the Indemnitee's continued service to the Company in an effective manner, the increasing difficulty in obtaining satisfactory director and officer liability insurance coverage and the Indemnitee's reliance on the aforesaid Bylaws, and in part to provide the Indemnitee with specific contractual assurance that the protection promised by such Bylaws will be available to the Indemnitee (regardless of, among other things, any amendment to or revocation of such Bylaws or any change in the composition of the Company's Board of Directors or acquisition transaction relating to the Company), the Company wishes to provide in this Agreement for the indemnification of and the advancing of expenses to the Indemnitee to the fullest extent (whether partial or complete) permitted by law and as set forth in this Agreement, and, to the extent insurance is maintained, for the continued coverage of the Indemnitee under the Company's directors' and officers' liability insurance policies. NOW, THEREFORE, in consideration of the premises and of the Indemnitee continuing to serve the Company directly or, at its request, another enterprise, and intending to be legally bound hereby, the parties hereto agree as follows: 1 1. CERTAIN DEFINITIONS: (a) "CHANGE IN CONTROL" shall be deemed to have occurred if (1) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than (i) a trustee or other fiduciary holding securities under an employee benefit plan of the Company, (ii) a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, or (iii) FHP International Corporation ("FHP"), if FHP as a result of the rights offering to purchase the Company's Common Stock being made in connection with PacifiCare Health Systems, Inc.'s acquisition of FHP and more fully described in the Form S-1 Registration Statement filed with the Securities and Exchange Commission on December 11, 1996, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 20% or more of the total voting power represented by the Company's then outstanding Voting Securities; (2) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period of whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof; or (3) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the Voting Securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into Voting Securities of the surviving entity) at least 80% of the total voting power represented by the Voting Securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of (in one transaction or a series of transactions) all or substantially all the Company's assets. (b) "CLAIM" shall mean any threatened, pending or completed action, suit or proceeding, or any inquiry or investigation, whether instituted by the Company or any other party, that the Indemnitee in good faith believes might lead to the institution of any such action, suit or proceeding, whether civil, criminal, administrative, investigative or other. (c) "EXPENSES" shall include attorneys' fees and all other costs, expenses and obligations paid or incurred in connection with investigating, defending, being a witness in or participating in (including on appeal), or preparing to defend, be a witness in or participate in, any Claim relating to any Indemnifiable Event. (d) "INDEMNIFIABLE EVENT" shall mean any event or occurrence related to the fact that the Indemnitee is or was a director, officer, employee, agent or fiduciary of the Company, or is or was serving at the request of the Company as a director, officer, employee, trustee, agent or fiduciary of another corporation, partnership, joint venture, employee benefit plan, trust or other enterprise, or by reason of anything done or not done by the Indemnitee in any such capacity. 2 (e) "INDEPENDENT LEGAL COUNSEL" shall mean an attorney or firm of attorneys, selected in accordance with the provisions of Section 3, who shall not have otherwise performed services for the Company or the Indemnitee within the last five years (other than with respect to matters concerning the rights of the Indemnitee under this Agreement, or of other indemnities under similar indemnity agreements). (f) "POTENTIAL CHANGE IN CONTROL" shall be deemed to have occurred if (1) the Company enters into an agreement, the consummation of which would result in the occurrence of a Change in Control; (2) any person (including the Company) publicly announces an intention to take or to consider taking actions which if consummated would constitute a Change in Control; (3) any person, other than (i) a trustee or other fiduciary holding securities under an employee benefit plan of the Company, (ii) a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, (iii) FHP, if FHP as a result of the rights offering to purchase the Company's Common Stock being made in connection with PacifiCare Health Systems, Inc.'s acquisition of FHP and more fully described in the Form S-1 Registration Statement filed with the Securities and Exchange Commission on December 11, 1996, is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of the Company's then outstanding Voting Securities, increases by three percentage points (3%) or more over the percentage so owned by such person; or (4) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred. (g) "REVIEWING PARTY" shall mean any appropriate person or body consisting of a member or members of the Company's Board of Directors or any other person or body appointed by the Board who is not a party to the particular Claim for which the Indemnitee is seeking indemnification, or Independent Legal Counsel. (h) "VOTING SECURITIES" shall mean any securities of the Company which vote generally in the election of directors. 2. BASIC INDEMNIFICATION ARRANGEMENT. (a) In the event the indemnitee was, is or becomes a party to or witness or other participant in, or is threatened to be made a party to or witness or other participant in, a Claim by reason of (or arising in part out of) an Indemnifiable Event, the Company shall indemnify the Indemnitee to the fullest extent permitted by law as soon as practicable but in any event no later than thirty days after written demand is presented to the Company, against any and all Expenses, judgments, fines, penalties and amounts paid in settlement (including all interest, assessments and other charges paid or payable in connection with or in respect of such Expenses, judgments, fines, penalties or amounts paid in settlement) of such Claim, except that no indemnification shall be made pursuant to this Agreement for any Claim by reason of the Indemnitee's liability under Section 16(b) of the Exchange Act or under federal or state securities laws for "insider trading," conduct that is finally adjudged as constituting active or deliberate dishonesty or willful fraud or illegality, or conduct that is finally adjudged as producing an unlawful personal benefit. Notwithstanding anything in this Agreement to the contrary, prior to a Change in Control, the Indemnitee shall not be entitled to indemnification pursuant to this Agreement in connection with any Claim initiated by the Indemnitee (other than pursuant to 3 Section 5 hereof) against the Company or any director or officer of the Company unless the Board of Directors has authorized or consented to the initiation of such Claim. If so requested by the Indemnitee, the Company shall advance (within ten (10) business days of such request) any and all Expenses to the Indemnitee (an "Expense Advance"). (b) Notwithstanding the foregoing, (i) the obligations of the Company under Section 2(a) shall be subject to the condition that the Reviewing Party shall not have determined (in a written opinion, in any case in which the Independent Legal Counsel referred to in Section 3 hereof is involved) that the Indemnitee would not be permitted to be indemnified under applicable law, and (ii) the obligation of the Company to make an Expense Advance pursuant to Section 2(a) shall be subject to the condition that, if, when and to the extent that the Reviewing Party determines that the Indemnitee would not be permitted to be so indemnified under applicable law, the Company shall be entitled to be reimbursed by the Indemnitee (who hereby agrees to reimburse the Company) for all such amounts theretofore paid; provided, however, that if the Indemnitee has commenced or thereafter commences legal proceedings in a court of competent jurisdiction to secure a determination that the Indemnitee should be indemnified under applicable law, any determination made by the Reviewing Party that the Indemnitee would not be permitted to be indemnified under applicable law shall not be binding and the Indemnitee shall not be required to reimburse the Company for any Expense Advance until a final judicial determination is made with respect thereto (as to which all rights of appeal therefrom have been exhausted or lapsed). If there has not been a Change in Control, the Reviewing Party shall be selected by the Board of Directors, and if there has been such a Change in Control (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control), the Reviewing Party shall be the Independent Legal Counsel referred to in Section 3 hereof. If there has been no determination by the Reviewing Party or if the Reviewing Party determines that the Indemnitee substantively would not be permitted to be indemnified in whole or in part under applicable law, the Indemnitee shall have the right to commence litigation in any court in the States of California or Delaware having subject matter jurisdiction thereof and in which venue is proper seeking an initial determination by the court or challenging any such determination by the Reviewing Party or any aspect thereof, including the legal or factual bases therefor, and the Company hereby consents to service of process and to appear in any such proceeding. Any determination by the Reviewing Party otherwise shall be conclusive and binding on the Company and the Indemnitee. 3. CHANGE IN CONTROL. The Company agrees that if there is a Change in Control of the Company (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control), then with respect to all matters thereafter arising concerning the rights of the Indemnitee to indemnity payments and Expense Advances under this Agreement or any other agreement or Company Bylaw now or hereafter in effect relating to Claims for Indemnifiable Events, the Company shall seek legal advice only from Independent Legal Counsel selected by the Indemnitee and approved by the Company (which approval shall not be unreasonably withheld). Such counsel, among other things, shall render its written opinion to the Company and the Indemnitee as to whether and to what extent the Indemnitee would be permitted to be indemnified under applicable law. The Company agrees to pay the reasonable fees of the Independent Legal Counsel referred to 4 above and to fully indemnify such counsel against any and all expenses (including attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement or its engagement pursuant thereto. 4. ESTABLISHMENT OF TRUST. In the event of a Potential Change in Control, the Company shall, upon written request by the Indemnitee, create a trust for the benefit of the Indemnitee and from time to time upon written request of the Indemnitee shall fund such trust in an amount sufficient to satisfy any and all Expenses reasonably anticipated at the time of each such request to be incurred in connection with investigating, preparing for and defending any Claim relating to an Indemnifiable Event, and any and all judgments, fines, penalties and settlement amounts of any and all Claims relating to an Indemnifiable Event from time to time actually paid or claimed, reasonably anticipated or proposed to be paid. The amount or amounts to be deposited in the trust pursuant to the foregoing funding obligation shall be determined by the Reviewing Party in any case in which the Independent Legal Counsel referred to above is involved. The terms of the trust shall provide that upon a Change in Control (i) the trust shall not be revoked or the principal thereof invaded, without the written consent of the Indemnitee, (ii) the trustee shall advance, within ten business days of a request by the Indemnitee, any and all Expenses to the Indemnitee (and the Indemnitee hereby agrees to reimburse the trust under the circumstances under which the Indemnitee would be required to reimburse the Company under Section 2(b) of this Agreement), (iii) the trust shall continue to be funded by the Company in accordance with the funding obligation set forth above, (iv) the trustee shall promptly pay to the Indemnitee all amounts for which the Indemnitee shall be entitled to indemnification pursuant to this Agreement or otherwise, and (v) all unexpended funds in such trust shall revert to the Company upon a final determination by the Reviewing Party or a court of competent jurisdiction, as the case may be, that the Indemnitee has been fully indemnified under the terms of this Agreement. The trustee shall be chosen by the Indemnitee; PROVIDED THAT neither the Company nor any of its directors or officers may serve as the trustee. Nothing in this Section 4 shall relieve the Company of any of its obligations under this Agreement. 5. INDEMNIFICATION FOR ADDITIONAL EXPENSES. The Company shall indemnify the Indemnitee against any and all expenses (including attorneys' fees) and, if requested by the Indemnitee, shall (within ten business days of such request) advance such expenses to the Indemnitee which are incurred by the Indemnitee in connection with any action brought by the Indemnitee for (i) indemnification or advance payment of Expenses by the Company under this Agreement or any other agreement or Company Bylaw now or hereafter in effect relating to Claims for Indemnifiable Events and/or (ii) recovery under any directors' and officers' liability insurance policies maintained by the Company, regardless of whether the Indemnitee ultimately is determined to be entitled to such indemnification, advance expense payment or insurance recovery, as the case may be. 6. PARTIAL INDEMNITY, ETC. If the Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of the Expenses, judgments, fines, penalties and amounts paid in settlement of a Claim but not, however, for all of the total amount thereof, the Company shall nevertheless indemnify the Indemnitee for the portion thereof to which the Indemnitee is entitled. Moreover, notwithstanding any other provision of this 5 Agreement, to the extent that the Indemnitee has been successful on the merits or otherwise in defense of any or all Claims relating in whole or in part to an Indemnifiable Event or in defense of any issue or matter therein, including dismissal without prejudice, the Indemnitee shall be indemnified against all Expenses incurred in connection therewith. 7. BURDEN OF PROOF. In connection with any determination by the Reviewing Party or otherwise as to whether the Indemnitee is entitled to be indemnified hereunder the burden of proof shall be on the Company to establish that the Indemnitee is not so entitled. 8. NO PRESUMPTIONS. For purposes of this Agreement, the termination of any claim, action, suit or proceeding, by judgment, order, settlement (whether with or without court approval) or conviction, or upon a plea of nolo contendere, or its equivalent, shall not create a presumption that the Indemnitee did not meet any particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law. In addition, neither the failure of the Reviewing Party to have made a determination as to whether the Indemnitee has met any particular standard of conduct or had any particular belief, nor an actual determination by the Reviewing Party that the Indemnitee has not met such standard of conduct or did not have such belief, prior to the commencement of legal proceedings by the Indemnitee to secure a judicial determination that the Indemnitee should be indemnified under applicable law shall be a defense to the Indemnitee's claim or create a presumption that the Indemnitee has not met any particular standard of conduct or did not have any particular belief. 9. NONEXCLUSIVITY, ETC. The rights of the Indemnitee hereunder shall be in addition to any other rights the Indemnitee may have under the Company's Bylaws or the Delaware General Corporation Law or otherwise. To the extent that a change in the Delaware General Corporation Law (whether by statute or judicial decision) permits greater indemnification by agreement than would be afforded currently under the Company's Bylaws and this Agreement, it is the intent of the parties hereto that the Indemnitee shall enjoy by this Agreement the greater benefits so afforded by such change. 10. LIABILITY INSURANCE. To the extent the Company maintains an insurance policy or policies providing directors' and officers' liability insurance, the Indemnitee shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage available for any Company director or officer. 11. PERIOD OF LIMITATIONS. No legal action shall be brought and no cause of action shall be asserted by or in the right of the Company against the Indemnitee, the Indemnitee's spouse, heirs, executors or personal or legal representatives after the expiration of two years from the date of accrual of such cause of action, and any claim or cause of action of the Company shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such two-year period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action such shorter period shall govern. 12. AMENDMENTS, ETC. No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the 6 provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. 13. SUBROGATION. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of the Indemnitee, who shall execute all papers required and shall do everything that may be necessary to secure such rights, including the execution of such documents necessary to enable the Company effectively to bring suit to enforce such rights. 14. NO DUPLICATION OF PAYMENTS. The Company shall not be liable under this Agreement to make any payment in connection with any Claim made against the Indemnitee to the extent the Indemnitee has otherwise actually received payment (under any insurance policy, Bylaw or otherwise) of the amounts otherwise indemnifiable hereunder. 15. BINDING EFFECT, ETC. This Agreement shall be binding upon and inure to the benefit of and be enforceable by the parties hereto and their respective successors, assigns, including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business and/or assets of the Company, spouses, heirs, executors and personal and legal representatives. The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation, liquidation or otherwise) to all, substantially all, or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to the Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. This Agreement shall continue in effect regardless of whether the Indemnitee continues to serve as an officer or director of the Company or of any other enterprise at the Company's request. 16. SEVERABILITY. The provisions of this Agreement shall be severable in the event that any of the provisions hereof (including any provision within a single section, paragraph or sentence) is held by a court of competent jurisdiction to be invalid, void or otherwise unenforceable in any respect, and the validity and enforceability of any such provision in every other respect and of the remaining provisions hereof shall not be in any way impaired and shall remain enforceable to the fullest extent permitted by law. 17. GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware applicable to contracts made and to be performed in such state without giving effect to the principles of conflicts of laws. 18. EFFECTIVENESS. This Agreement shall become effective only if FHP holds less than 50% of the Company's Common Stock upon completion of the rights offering to purchase the Company's Common Stock being made in connection with PacifiCare Health Systems, Inc.'s acquisition of FHP and more fully described in the Form S-1 Registration Statement filed with the Securities and Exchange Commission on December 11, 1996. 7 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of November 21, 1996. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: ------------------------------------------- Name: Jack D. Massimino Title: President and Chief Executive Officer ----------------------------------------------- Indemnitee 8 EX-10.18 8 EXHIBIT 10.18 FORM OF EMPLOYEE AGREEMENT EMPLOYMENT AGREEMENT AGREEMENT by and between Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Company") and ____________________ (the "Executive"), dated as of the 7th day of January, 1997. For all purposes of this Agreement, employment with the Company shall include employment with any of its affiliated companies. The Board of Directors of the Company (the "Board"), has determined that it is in the best interests of the Company and its shareholders to assure that the Company will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a Change of Control (as defined below) of the Company. NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS: 1. CERTAIN DEFINITIONS. (a) The "Effective Date" shall mean the first date during the Change of Control Period (as defined in Section 1(b)) on which a Change of Control (as defined in Section 2) occurs. Anything in this Agreement to the contrary notwithstanding, if a Change of Control occurs and if the Executive's employment with the Company is terminated prior to the date on which the Change of Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change of Control or (ii) otherwise arose in connection with or anticipation of a Change of Control, then for all purposes of this Agreement the "Effective Date" shall mean the date immediately prior to the date of such termination of employment. (b) The "Change of Control Period" shall mean the period commencing on the date hereof and ending on the second anniversary of the date hereof. (c) A "Hostile Change in Control" shall mean a change of control that results from an unsolicited proposal that is not approved by a majority of the Continuing Directors (as defined below) prior to disclosure of such proposal for a Change in Control or if such disclosure is made without the prior approval of a majority of the disinterested directors. Any reference in this Agreement to a Change in Control includes any Hostile Change in Control unless specifically noted otherwise. (d) A "Continuing Director" shall mean any member of the Board of Directors of the Company (while such Person is a member of the Board) who (i) is not an Acquiring Person, or an Affiliate or Associate of an Acquiring Person, or a representative of an Acquiring Person or of any such Affiliate or Associate, and (ii) either (A) was a member of the Board of Directors prior to the time any person became an Acquiring Person, or (B) became a member of the Board of Directors 1 subsequent to the time any person became an Acquiring Person, if such person's nomination for election, or re-election, to the Board was recommended, or approved, by a majority of the Continuing Directors then in office. (e) "Affiliate" and "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Exchange Act (as defined below), as in effect as of the date hereof. 2. CHANGE OF CONTROL. For the purpose of this Agreement, a "Change of Control" shall mean: (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (an "Acquiring Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 2; or (v) any acquisition by FHP International Corporation ("FHP") as a result of the rights offering to purchase the Company's Common Stock being made in connection with PacifiCare Health Systems, Inc.'s acquisition of FHP and more fully described in the Form S-1 Registration Statement filed with the Securities and Exchange Commission on December 11, 1996, (the "Rights Offering"), or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of an Acquiring Person other than the Board; or (c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company 2 Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. 3. EMPLOYMENT PERIOD. The Company hereby agrees to continue the Executive in its employ, and the Executive hereby agrees to remain in the employ of the Company subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on either (i) the third anniversary of such date if such Effective Date is triggered by a Hostile Change of Control or (ii) the second anniversary of such date if such Effective Date is triggered by a Change in Control that is not hostile (the "Employment Period"). 4. TERMS OF EMPLOYMENT. (a) POSITION AND DUTIES. (i) During the Employment Period, the Executive's position (including status, offices, titles and reporting requirements), authority, duties and responsibilities shall be at least commensurate in all material respects with the most significant of those held, exercised and assigned at any time during the 120-day period immediately preceding the Effective Date. (ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote reasonable attention and time during normal business hours to the business and affairs of the 3 Company and, to the extent necessary to discharge the responsibilities assigned to the Executive hereunder, to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal investments, so long as such activities do not significantly interfere with the performance of the Executive's responsibilities as an employee of the Company in accordance with this Agreement. To the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executive's responsibilities to the Company. (b) COMPENSATION. (i) BASE SALARY. During the Employment Period, the Executive shall receive an annual base salary ("Annual Base Salary"), which shall be paid at a monthly rate, at least equal to twelve times the highest monthly base salary paid or payable, including any base salary which has been earned but deferred, to the Executive by the Company and its affiliated companies in respect of the twelve-month period immediately preceding the month in which the Effective Date occurs. During the Employment Period, the Annual Base Salary shall be reviewed no more than 12 months after the last salary increase awarded to the Executive prior to the Effective Date and thereafter at least annually. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. Annual Base Salary shall not be reduced after any such increase and the term Annual Base Salary as utilized in this Agreement shall refer to Annual Base Salary as so increased. As used in this Agreement, the term "affiliated companies" shall include any company controlled by, controlling or under common control with the Company. (ii) OTHER BENEFITS. During the Employment Period, the Executive shall be entitled to participate in all incentive, savings, retirement, welfare benefit, vacation and sick leave plans, practices, policies and programs applicable generally to other peer executives of the Company and its affiliated companies. 5. TERMINATION OF EMPLOYMENT. (a) DEATH OR DISABILITY. The Executive's employment shall terminate automatically upon the Executive's death during the Employment Period. If the Company determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 12(b) of this Agreement of its intention to terminate the Executive's employment. In 4 such event, the Executive's employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the "Disability Effective Date"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executive's duties. For purposes of this Agreement, "Disability" shall mean the absence of the Executive from the Executive's duties with the Company on a full- time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to the Executive or the Executive's legal representative. (b) CAUSE. The Company may terminate the Executive's employment during the Employment Period for Cause. For purposes of this Agreement, "Cause" shall mean: (i) the willful and continued failure of the Executive to perform substantially the Executive's duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Board or the Chief Executive Officer of the Company which specifically identifies the manner in which the Board or Chief Executive Officer believes that the Executive has not substantially performed the Executive's duties, or (ii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company. For purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered "willful" unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chief Executive Officer or a senior officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. The cessation of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive is guilty of the conduct described in subparagraph (i) or (ii) above, and specifying the particulars thereof in detail. (c) GOOD REASON. The Executive's employment may be terminated by the Executive for Good Reason. For purposes of this Agreement, "Good Reason" shall mean: 5 (i) the assignment to the Executive of any duties inconsistent in any material respect with the Executive's position (including status, offices, titles and reporting requirements), authority, duties or responsibilities as contemplated by Section 4(a) of this Agreement, or any other action by the Company which results in material diminution in such position, authority, duties or responsibilities; (ii) any failure by the Company to comply with any of the provisions of Section 4(b) of this Agreement, other than an isolated insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive; (iii) any purported termination by the Company of the Executive's employment otherwise than as expressly permitted by this Agreement; or (iv) any failure by the Company to comply with and satisfy Section 10(c) of this Agreement. For purposes of this Section 5(c), any controversy or claim arising out of or relating to any determination of "Good Reason" made by the Executive shall be settled by arbitration in Orange County, California, in accordance with the following: (v) Each party shall appoint its own arbitrator and the two arbitrators shall choose a third, impartial arbitrator as umpire before the date set for the hearing. If a party fails to appoint its arbitrator within 30 days after have either received or given the notice requesting arbitration, the other shall appoint the second arbitrator. If the two arbitrators fail to appoint the umpire without 30 days after their appointments, either party may apply to the Orange County Superior Court of the State of California to appoint an impartial umpire. The umpire shall promptly notify all parties to the arbitration of his selection. (vi) The arbitration shall be conducted pursuant to the provisions of the California Code of Civil Procedure, including the rules pertaining to discovery. (vii) Within a reasonable time after completion of the arbitration, the arbitrators shall prepare a written opinion, a copy of which shall be provided to each party. (viii) The parties shall share equally the expenses of arbitration, including the arbitrator's fee, provided, however, that the arbitrators, in their discretion, may award costs to the prevailing party. (d) NOTICE OF TERMINATION. Any termination by the Company for Cause, or by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(c) of this Agreement. For purposes of this Agreement, 6 a "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder. (e) DATE OF TERMINATION. "Date of Termination" means (i) if the Executive's employment is terminated by the Company for Cause, or by the Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if the Executive's employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies the Executive of such termination, and (iii) if the Executive's employment is terminated by reason of Death or Disability, the Date of Termination shall be the date of Death of the Executive or the Disability Effective Date, as the case may be. 6. OBLIGATIONS OF THE COMPANY OR EXECUTIVE UPON TERMINATION. (a) GOOD REASON; OTHER THAN FOR CAUSE, DEATH OR DISABILITY. If, during the Employment Period, the Company shall terminate the Executive's employment other than for Cause, Death or Disability or the Executive shall terminate employment for Good Reason, such termination, for purposes of this Section 6(a), shall constitute separation from, and cessation of duties for, the Company as of the Date of Termination. Under such circumstances, the Company shall pay to the Executive the following payments and benefits: (i) Bi-weekly salary continuation at the Executive's Annual Base Salary as if the Executive had remained employed through the end of the Employment Period; and (ii) Medical and Dental Coverage continuation as if the Executive had remained employed through the end of the Employment Period at the Executive's benefit level as of the Date of Termination; (iii) Life Insurance Coverage continuation through the end of the Employment Period at the Executive's current benefit level as of the Date of Termination; (iv) Outplacement services consistent with the Company's outplacement policy for a person at the Executive's job classification and/or grade level; 7 (v) A payment on the last day of the Employment Period in an amount equal to the sum of (A) the additional contributions that would have been allocated to Executive's accounts under the Talbert Medical Management Holdings Corporation Employee Stock Ownership Plan (the "ESOP") and the Talbert Medical Management Holdings Corporation Money Purchase Pension Plan if the Executive had remained employed through the end of the Employment Period and deferred the maximum pretax deferral allowed under the terms of the ESOP (after the application of the limitations on deferrals set forth in the ESOP) and (B) the amount of any benefits under the ESOP which were forfeited upon termination of employment but which would have become vested if the Executive had remained employed through the end of the Employment Period; (vi) Payment within 30 days of the Date of Termination of all accrued vacation, holiday and personal leave days as of the Date of Termination; and (vii) Payment of any incentive compensation that Executive would have earned if Executive had remained employed through the end of the Employment Period under, and in accordance with the terms of, any applicable incentive compensation plan. The Company reserves the right to deduct from any applicable sum those amounts required by law. Any monies owed to the Company by Executive may be deducted from the Amounts payable pursuant to this Section 6(a). All accruals of vacation, holiday and personal leave days shall end effective the Date of Termination. The payments called for in this Section 6(a) shall be in lieu of and discharge any obligations of Company to Executive for compensation, accrued vacation, accrued personal leave days, accrued holidays, incentive compensation, car allowances or any other expectations of remuneration or benefit on the part of the Executive. (b) DEATH. If the Executive's employment is terminated by reason of the Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than for payment of accrued obligations and the timely payment or provision of other benefits under any plan, program, policy or practice of the Company in accordance with the terms of such plan, program, policy or practice (the "Other Benefits"). Accrued obligations shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. (c) DISABILITY. If the Executive's employment is terminated by reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than for payment of accrued obligations and the timely payment or provision of Other Benefits. Accrued obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. (d) CAUSE; OTHER THAN FOR GOOD REASON. If the Executive's employment shall be terminated for Cause during the Employment Period, this Agreement shall terminate without 8 further obligations to the Executive other than the obligation to pay to the Executive (x) his Annual Base Salary through the Date of Termination, (y) the amount of any compensation previously deferred by the Executive, and (z) Other Benefits, in each case to the extent theretofore unpaid. If the Executive voluntarily terminates employment during the Employment Period, excluding a termination for Good Reason, this Agreement shall terminate without further obligations to the Executive, other than for accrued obligations and the timely payment or provision of Other Benefits. In such case, all accrued obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. (e) ACCELERATION OF OPTIONS. The Board of Directors has determined that the events described in Section 2 hereof will constitute a "Change of Control of the Company" for purposes of Section 6.2(b) of the Incentive Plan (as defined below). Therefore, if the Executive's employment is terminated other than voluntarily or for Cause, Death or Disability prior to the end of the Employment Period, then, subject to Section 11 of this Agreement, all of the Executive's outstanding Options under, and as defined in, the Talbert Medical Management Holdings Corporation 1996 Stock Incentive Plan (the "Incentive Plan") which have not otherwise become exercisable shall become immediately exercisable in full on the Date of Termination, and all substantial risks of forfeiture and restrictions on transfer relating to any of the Executive's shares of Restricted Stock under, and as defined in, the Incentive Plan shall be terminated on the Date of Termination. For purposes of this provision, any termination of the Executive's employment other than voluntarily or for Cause, Death or Disability shall be deemed to be a termination for the convenience of the Board; accordingly, any Option granted to the Executive which are or become exercisable as of the Date of Termination shall terminate 90 days after the Date of Termination. (f) DUTY TO COOPERATE. During the Employment Period and thereafter, Executive agrees to cooperate with and assist the Company, upon reasonable notice, in the defense of any litigation or governmental investigation arising from events which occurred while Executive was employed by the Company. Such cooperation and assistance shall include, but not be limited to, Executive's full participation in locating, producing, collecting, analyzing and preparing documents and other informational materials; in preparing for and participating in depositions, hearings and trials; and in responding to document production requests, interrogatories, and other discovery. If it becomes necessary for Executive to testify in any judicial or administrative proceedings, the Company shall reimburse Executive for any reasonable travel expenses (including transportation, food and lodging) which are incurred (or are to be incurred) in connection with such testimony (including preparation therefor). The Company shall not be required to pay Executive any additional consideration, including, but not limited to, consulting or witness fees, in connection with any cooperation, assistance or testimony required of or provided by Executive pursuant to this Agreement. In addition, from the Date of Termination to the end of the Employment Period, the Executive shall devote a reasonable amount of time cooperating with and assisting the Company in maintaining and improving its relationships with its customers. 9 7. NON-EXCLUSIVITY OF RIGHTS. Nothing in this Agreement shall prevent or limit the Executive's continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify, nor, subject to Section 12(f), shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement. 8. FULL SETTLEMENT. Except as stated herein, the Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and such amounts shall not be reduced whether or not the Executive obtains other employment. 9. CONFIDENTIAL INFORMATION. The Executive shall hold in a fiduciary capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. 10. SUCCESSORS. (a) This Agreement is personal to the Executive and without the prior written consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives. (a) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. (b) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken 10 place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. 11. CERTAIN REDUCTION OF PAYMENTS BY THE COMPANY. (a) Notwithstanding anything to the contrary in Section 6 of this Agreement or the Incentive Plan (as defined in Section 6(e) above), in no event shall (1) Options and Stock Appreciation become immediately exercisable (2) the risks of forfeiture and restrictions relating to Restricted Stock terminate or (3) Performance Share Awards become payable under the Incentive Plan upon the Executive's Date of Termination if such acceleration would (i) cause any payment made to the Executive, whether pursuant to the terms of this Agreement or otherwise (a "Payment") to constitute an "excess parachute payment" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), or (ii) disqualify the transaction constituting the Change of Control from being accounted for as a "pooling of interests" within the meaning of APB No. 16, which would qualify for such accounting treatment in the absence of such acceleration (the "Disqualification"). In the event acceleration of any Options would cause any Payment to constitute an excess parachute payment, or would cause a Disqualification, the Compensation Committee of the Company's Board of Directors shall select the Options which shall remain unexercisable so that no Payment shall constitute an excess parachute payment and/or no Disqualification shall occur. Any Options which remain unexercisable upon the Executive's Date of Termination by reason of this Section 11(a) shall become exercisable as set forth in Section 11(c) below. Any shares of Restricted Stock or Performance Share Awards which do not become vested by reason of this Section 11(a) shall be forfeited upon the Executive's Date of Termination. (b) All determinations required to be made under this Section 11 as to whether a Payment or benefit would be deductible by the Company shall be made by the Company's independent auditors (the "Accounting Firm") which shall provide detailed supporting information both to the Company and the Executive within 30 business days following the Date of Termination or such earlier time as is requested by the Company. A determination as to whether a Disqualification would occur shall be made by the Accounting Firm at least 10 days prior to a Change of Control. Any such determination by the Accounting Firm shall be binding upon the Company and the Executive. (c) PROVIDED that within 30 days after the Date of Termination (i) the Executive shall have executed and delivered to the Company a Covenant Not to Compete during the Employment Period in the form of EXHIBIT "A" hereto and (ii) the Executive shall have executed and delivered to the Company a Settlement and Release Agreement in the form of "EXHIBIT "B" hereto in the manner specified therein, THEN: If the Executive's employment is terminated other than voluntarily or for Cause, Death or Disability prior to the end of the Employment Period, each of the Executive's outstanding Options which shall not otherwise have become exercisable shall become exercisable in such manner and at such times as the Options would have become exercisable if the 11 Executive had not terminated employment and shall remain exercisable until the earlier of the date which is 90 days following the date on which the Options first becomes exercisable or the original expiration date of the Options. Calculation of the number of Options that become immediately exercisable under Section 11(a) shall be made independently of this Section 11(c). 12. MISCELLANEOUS. (a) This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. (b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: IF TO THE EXECUTIVE: ________________________ ________________________ ________________________ IF TO THE COMPANY: Talbert Medical Management Holdings Corporation 3540 Howard Way Costa Mesa, California 92626 Attention: President or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. (c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (d) As stated, the Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. (e) The Executive's or the Company's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may 12 have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 5(c)(i)-(iv) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. (f) The Executive and the Company acknowledge that, except as may otherwise be provided under any other written agreement between the Executive and the Company, the employment of the Executive by the Company is "at will" and, subject to Section 1(a) hereof, prior to the Effective Date, the Executive's employment and/or this Agreement may be terminated by either the Executive or the Company at any time prior to the Effective Date, in which case the Executive shall have no further rights under this Agreement. (g) From and after the Effective Date, this Agreement shall supersede any other agreement between the parties with respect to the subject matter hereof entered into prior to the date hereof. (h) This Agreement shall be void and without further force and effect unless executed and delivered by the Executive to Russell D. Phillips, Jr., Assistant Secretary of the Company, at least 48 hours prior to the Effective Time of the merger contemplated by the Amended and Restated Agreement and Plan of Reorganization among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., Tree Acquisition Corp., and FHP, dated as of November 11, 1996. (i) This Agreement shall be void and without further force and effect if FHP holds in excess of 50% of the Company's Common Stock as a result of the Rights Offering. 13 IN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION ----------------------------------------------- By: Jack D. Massimino Its: President and Chief Executive Officer ------------------------------------------------ Executive COVENANT NOT TO COMPETE This COVENANT NOT TO COMPETE, is entered into as of ____________, 1997 (the "Agreement"), is made by and between Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Company"), and _____________________ ("Executive") pursuant to the Employment Agreement between them dated as of the 7th day of January, 1997 (the "Employment Agreement"). Defined terms not defined herein shall have the meanings assigned to them in the Employment Agreement. WHEREAS, the Company desires the benefits of the continued services of the Executive, and the Executive is willing to render such services, pursuant and subject to the terms and conditions of the Employment Agreement; and WHEREAS, Executive desires the benefits of Section 11(c) of the Employment Agreement and in consideration thereof desires to execute and deliver this Agreement in accordance therewith. NOW, THEREFORE, in consideration of the promises and the covenants and agreements contained herein, the parties hereto agree as follows: 1. COVENANT NOT TO COMPETE. Until the earlier of the expiration of the Employment Period or the expiration of 30 days following Executive's Date of Termination without execution and delivery by Executive of a Settlement and Release Agreement as provided in Section 11(c) of the Employment Agreement, Executive shall not, directly or indirectly, as principal, employee, agent, independent contractor, proprietor, partner, or otherwise, operate, own, manage, control, or participate in conducting the same business in the same cities and counties as carried on by the Company in the State of California at the Effective Date, if in so doing Executive personally carries on activities substantially the same in all material respects as the activities carried on by Executive as an officer and employee of the Company at the Effective Date. 2. REASONABLENESS OF COVENANT. Executive has carefully considered the nature and extent of the restrictions upon Executive and the rights and remedies conferred upon Company under this Agreement, and hereby acknowledges and agrees that such covenants are reasonable, are designed to prevent irreparable damage to Company, are required to protect Company's legitimate interests, and do not confer a benefit upon Company disproportionate to the detriment of Executive. 3. NO WAIVER. No waiver of any of the provisions herein shall be valid unless in writing signed by the party against whom such claimed waiver is sought to be enforced, nor shall a failure to enforce any right hereunder constitute a continuing waiver of the notice or a waiver of any other right hereunder. The failure of the Company at any time or from time "EXHIBIT A" to time to require performance of any of Executive's obligations hereunder shall in no manner affect the Company's right to enforce any provision of this Agreement at a subsequent time. 4. SEVERABILITY. In the event that any provision or portion of this Agreement be found by a court of competent jurisdiction to be invalid or unenforceable, this Agreement shall be deemed to be amended so as to delete only the invalid or unenforceable provision, or the invalid or unenforceable portion thereof, and the remaining provisions hereof shall remain in full force and effect. 5. SUCCESSORS. This Agreement shall inure to the benefit of, and be binding upon the parties, their heirs, executors, administrators, successors and assigns. 6. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the law of the State of California, without reference to principles of conflicts of laws. 7. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date first above mentioned. TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION By: ------------------------------------------ Jack D. Massimino President and Chief Executive Officer --------------------------------------------- Executive SETTLEMENT AGREEMENT AND RELEASE This SETTLEMENT AGREEMENT AND RELEASE ("Agreement") is entered into by and between ____________________ ("Executive") and Talbert Medical Management Holdings Corporation, a Delaware corporation (the "Company"), pursuant to the EMPLOYMENT AGREEMENT between them dated as of the 7th day of January, 1997 (the "Employment Agreement"). WHEREAS, the employment of Executive by the Company terminated __________________ (the "Termination Date"); and WHEREAS, Executive desires the benefits of Section 11(c) of the Employment Agreement and in consideration thereof desires to execute and deliver this Agreement in accordance therewith. NOW, THEREFORE, in consideration of the promises and the covenants and agreements contained herein, the parties hereto agree as follows: 1. RELEASE. In consideration of the above, the sufficiency of which Executive hereby acknowledges, and subject to the proviso hereinafter set forth, Executive hereby agrees not to sue and fully, finally, completely and generally releases, absolves and discharges the Company, its predecessors, successors, subsidiaries, parents, related companies and business concerns, affiliates, partners, trustees, directors, officers, agents, attorneys, servants, representatives and employees, past and present, and each of them (hereinafter collectively referred to as "Releasees") from any and all claims, demands, liens, agreements, contracts, covenants, actions, suits, causes of action, grievances, arbitrations, unfair labor practice charges, wages, vacation payments, severance payments, obligations, commissions, overtime payments, Workers' Compensation claims, debts, profit sharing or bonus claims, expenses, damages, judgments, orders and/or liabilities of whatever kind or nature in law, equity or otherwise, whether known or unknown to Executive, which Executive now owns or holds or has at any time owned or held as against Releasees, or any of them ("Claims"), including specifically but not exclusively and without limiting the generality of the foregoing, any and all Claims arising out of or in any way connected to Executive's employment with or separation of employment from Executive including any Claims based on contract, tort, wrongful discharge, fraud, breach of fiduciary duty, attorneys' fees and costs, discrimination in employment, any and all acts or omissions in contravention of any federal or state laws or statutes (including but not limited to federal or state securities laws and the Racketeer Influenced and Corrupt Organizations Act), and any right to recovery based on state or federal age, sex, pregnancy, race, color, national origin, marital status, religion, veteran status, disability, sexual orientation, medical condition, union affiliation or other anti-discrimination laws, including, without limitation, Title VII, the Age Discrimination in Employment Act, the Americans with Disabilities Act, the National Labor Relations Act, and the California Fair Employment and Housing Act, all as amended, whether such claim be based upon "EXHIBIT B" an action filed by Executive or by a governmental agency; PROVIDED, HOWEVER, the foregoing release shall not affect or diminish any rights of Executive under the Employment Agreement or in respect of vested employee benefits. "Vested employee benefits" means any and all rights of Executive under or in respect of (i) any employee benefit plan of the Company or any corporation or other entity which controlling, controlled by or under common control with the Company or that is a Releasee ("Affiliated Company"), (ii) any option or other agreement relating to any right or interest of Executive in any stock or other securities of the Company or any Affiliated Company, (iii) salary or wages payable for services rendered before the Termination Date, (iv) reimbursement for business expenses or other amounts for which Executive is entitled to reimbursement by the Company immediately before the Termination Date, or (v) indemnification as an agent. (a) Executive acknowledges and agrees that neither anything in this Agreement or the offer, execution, delivery, or acceptance thereof shall be construed as an admission of any kind by the Company, and this Agreement shall not be admissible as evidence in any proceeding except to enforce this Agreement. (b) It is the intention of Executive in executing this instrument that it shall be effective as a bar to each and every claim, demand, grievance and cause of action hereinabove specified as being released. In furtherance of this intention, Executive hereby expressly consents that this Agreement shall be given full force and effect according to each and all of its express terms and provisions, including those relating to unknown and unsuspected claims, demands and causes of action, if any, as well as those relating to any other claims, demand and causes of action hereinabove specified, and elects to assume all risks for claims that now exist in Executive's favor, known or unknown, that are released under this Agreement. Executive acknowledges that Executive may hereafter discover facts different from, or in addition to, those Executive now knows or believes to be true with respect to the claims, demands, liens, agreements, contracts, covenants, actions, suits, causes of action, wages, obligations, debts, expenses, damages, judgments, orders and liabilities herein released, and agrees the release herein shall be and remain in effect in all respects as a complete and general release as to all matters released herein, notwithstanding any such different or additional facts. (c) If any provision of this Agreement or application thereof is held invalid, the invalidity shall not affect other provisions or applications of the Agreement which can be given effect without the invalid provision or application. To this end, the provisions of this Agreement are severable. (d) Executive represents and warrants that Executive has not heretofore assigned or transferred or purported to assign or transfer to any person, firm or corporation any claim, demand, right, damage, liability, debt, account, action, cause of action, or any other matter herein released. (e) NOTICE TO EXECUTIVE: The law requires that Executive be advised and the Company hereby advises Executive to consult with an attorney and discuss this Agreement before executing it. Executive acknowledges that the Company has provided to Executive at least 21 days within which to review and consider this Agreement before signing it. If Executive decides not to use the full 21 days, then Executive knowingly and voluntarily waives any claims that Executive was not in fact given that period of time or did not use the entire 21 days to consult an attorney and/or consider this Agreement. Executive acknowledges that Executive may revoke this Agreement for up to seven calendar days following Executive's execution of this Agreement and that it shall not become effective or enforceable until the revocation period has expired. Executive further acknowledges and agrees that such revocation must be in writing addressed to the Company as follows: Talbert Medical Management Holdings Corporation, 3540 Howard Way, Costa Mesa, California 92626-1417, Attn: President, and received by the Company as so addressed not later than midnight on the seventh day following execution of this Agreement by Executive. If Executive so revokes this Agreement, the Agreement shall not be effective or enforceable and Executive will not receive the benefits described above. If Executive does not revoke this Agreement in the time frame specified above, the Agreement shall become effective at 12:00:01 on the eighth day after it is signed by Executive. (f) Executive represents that Executive has read and understood the foregoing Agreement, has been advised to and has had the opportunity to discuss it with anyone he or she desires, including an attorney of his or her own choice, and Executive accepts and agrees to the terms of this Agreement, acknowledges receipt of a copy of the same and the sufficiency of the benefits described above, and hereby executes this Agreement voluntarily and with full understanding of its consequences. PLEASE READ CAREFULLY. THIS AGREEMENT CONTAINS A GENERAL RELEASE OF ALL KNOWN AND UNKNOWN CLAIMS. Date:_______________, 199__ Executive: ---------------------------------------- Date:_______________, 199__ Talbert Medical Management Holdings Corporation By: ------------------------------------------ Its: ----------------------------------------- EX-10.19 9 EXHIBIT 10.19 FORM OF CHIEF OF STAFF AGREE. CHIEF OF STAFF AGREEMENT THIS AGREEMENT ("Agreement") is effective January 1, 1996, by and between ______________________ hereinafter referred to as "Physician" and Talbert Medical Management Corporation, hereinafter referred to as "TMMC". NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: ARTICLE I. ENGAGEMENT - CHIEF OF STAFF TMMC engages Physician and Physician accepts the engagement of the position of Chief of Staff of Talbert Medical Group, Inc. ("TMG") on the terms and conditions set forth in this Agreement. ARTICLE II. TERM The initial term of this engagement shall commence on January 1, 1996, and shall continue until the earlier of January 1, 2001 or the date on which it is terminated in accordance with Article V. ARTICLE III. COMPENSATION TMMC will compensate Physician for the Chief of Staff duties set forth in this Agreement at the rate of ______________________________ per annum, payable semi-annually on the last business day of June and on the last business day of December. ARTICLE IV. DUTIES As the principal appointed official of the TMG staff, Physician shall: A. Interact with the TMMC administration to aid in coordinating the activities and concerns of the TMG administration and of the patient care services furnished by the TMG staff. 1 B. Communicate and represent the opinions, policies, concerns, needs and grievances of the TMG staff to the Board of Directors of TMG ("Board") and the administration of TMMC. C. Consult with the TMMC Medical Director on matters of special concern to the TMG staff and maintain liaison with TMMC to assist in settling grievances and problems of the TMG staff. D. Provide such other advisory duties as are assigned to Physician by the Board or TMMC. ARTICLE V. TERMINATION OF AGREEMENT This Agreement may be unilaterally terminated by either TMMC or Physician without cause upon ten (10) days written notice. ARTICLE VI. MISCELLANEOUS COVENANTS A. This Agreement constitutes the entire Agreement between the parties and supersedes all prior agreements. No changes in the Agreement will be valid unless made in writing and signed by both parties. B. This Agreement shall be binding upon both parties and upon their respective executors, administrators, successors and assigns. C. This Agreement shall be governed by and construed in accordance with all applicable state ("State") and federal laws. "State" is defined to be the state in which Physician is practicing on behalf of TMG. D. The terms of this Agreement are confidential and shall not be disclosed except as necessary for the performance of this Agreement or as required by law. E. The waiver by either party of a failure to perform as set forth in this Agreement shall not act as a waiver of performance for a subsequent breach of the same or any other provision in this Agreement. F. If any provision of this Agreement is deemed to be invalid or unenforceable by a court of competent jurisdiction or in arbitration, the same shall be deemed severable from the remainder of this Agreement and shall not cause the invalidity or unenforceability of the remainder of the Agreement. 2 G. This Agreement may not be assigned by Physician; it may be assigned by TMMC to a wholly owned subsidiary of TMMC without consent of Physician. TALBERT MEDICAL MANAGEMENT CORPORATION By: ------------------------------------ Name: ---------------------------------- Title: --------------------------------- PHYSICIAN: -------------------------------------- ______________________ 3 EX-10.20 10 EXHIBIT 10.20 FORM OF SHARE CONTROL AGREE. (NONCA) SHARE CONTROL AGREEMENT THIS SHARE CONTROL AGREEMENT ("Agreement") is made and entered into this 7th day of December, 1995, by and among Talbert Medical Group, Ltd., a Nevada professional corporation (the "Corporation"), [Shareholder] an individual residing in the State of __________ (the "Shareholder"), and Talbert Medical Management Corporation ("TMMC"), ____________ Delaware corporation. RECITALS A. For good and valuable consideration, the Shareholder is willing to vote his or her shares of the Corporation's capital stock in accordance with the terms of this Agreement. Such voting obligations shall not apply in those cases, if any, where an issue is presented to the Shareholder of the Corporation that applicable law or ethical provisions mandate be determined by an individual who is duly licensed under applicable state law. In those cases, the Shareholder may vote his or her shares in any manner that he or she deems appropriate, and no approval by TMMC shall be necessary. The parties do not intend that the Shareholder receive any economic benefit (whether dividends, distributions or otherwise) from his or her respective shareholdings. B. The Corporation, the Shareholder and TMMC desire that (i) the Shareholder shall elect only persons approved by TMMC as directors of the Corporation; (ii) the Shareholder shall approve or authorize any merger, consolidation or other reorganization of the Corporation, any sale of the Corporation's assets, any dissolution of the Corporation, or any sale of the Corporation's capital stock only with the prior written consent of TMMC; and (iii) the Shareholder shall give a right of purchase to a person designated by TMMC to purchase any or all shares of the Corporation's capital stock owned by the Shareholder if (A) the Shareholder ceases, as provided herein, to serve as Chief of Staff of the Corporation, or (B) if the Shareholder desires to sell, transfer, or otherwise convey any or all such shares. IN CONSIDERATION of the mutual rights and obligations of the parties hereto, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the Shareholder, and the undersigned Shareholder being and remaining holder of the Corporation's capital stock, the parties hereto agree as follows: 1. OBLIGATIONS CONCERNING THE VOTING OF SHARES. The Shareholder agrees to vote each share of the Corporation's capital stock now or hereafter owned by the Shareholder on any matter submitted for a vote to the Shareholder of such stock, only as approved in advance and in writing by TMMC, including, but not limited to, the matters provided for in this paragraph 1. (a) The Shareholder shall not, without the prior written consent of TMMC, vote his or her shares in such a manner that the Corporation may (i) lease, sell, exchange, transfer or otherwise dispose of all or substantially all of the Corporation's assets, (ii) be merged, consolidated or otherwise reorganized with or into any other corporation or trade or business, (iii) issue any shares of any class of the Corporation's capital stock (whether from treasury or from authorized but unissued shares), (iv) amend or otherwise modify its 1 articles of incorporation, bylaws or code of regulations, if applicable, (v) dissolve, (vi) amend or terminate the Management Services Agreement between TMMC and the Corporation, dated as of January 1, 1996, or (vii) enter into any agreement with any person to do any of the foregoing. (b) The Shareholder shall not elect any person to the Board of Directors of the Corporation without the prior approval of such person by TMMC. (c) Upon the prior written request of TMMC, the Shareholder shall call a special meeting or authorize an action without a meeting for the purpose of voting on such matters. (d) Notwithstanding the foregoing, in the event that an issue is presented to the Shareholder that applicable law or ethical provisions mandate be determined by an individual who is duly licensed as a physician under applicable state law, the Shareholder may vote his or her shares with respect to such issue in any manner that he or she deems appropriate, and no approval by TMMC shall be necessary. 2. OBLIGATIONS CONCERNING THE PROVISION OF PROFESSIONAL SERVICES. The Shareholder shall ensure that the Corporation renders professional services to patients of the Corporation only through officers, employees and agents who are themselves duly licensed or otherwise legally authorized to render professional services within the State of ________. 3. PURCHASE OF SHARES ON TERMINATION OF EMPLOYMENT. In the event that the Shareholder is removed, or ceases to act, as Chief of Staff of the Corporation for any reason, including, without limitation, termination, disability, death, discharge or resignation, the Shareholder or the legal successors of the Shareholder shall transfer the shares held by the Shareholder to a person or persons designated by TMMC, which person or persons must be duly licensed physicians in the State of ________; PROVIDED, HOWEVER, that at all times, one of the transferees must be the Chief of Staff of the Corporation. The closing of the purchase and sale shall take place not later than ninety (90) days after the date of termination or appointment. The price of each such share shall be $1.00. All certificates evidencing the shares being purchased and sold shall be delivered in transferable form against payment of the purchase price thereof evidenced by a check drawn on the designee of TMMC and payable in United States dollars to the order of the Shareholder, or in the case of death, his or her legal representative(s). 4. RIGHT OF FIRST PURCHASE. The Shareholder shall not transfer, encumber, or otherwise dispose of (by sale, pledge, gift, devise, or other disposition) any shares of the Corporation's capital stock now or hereafter held of record or beneficially owned by him or her unless the Shareholder shall have complied with the following procedure: (a) The Shareholder shall give TMMC written notice of his or her intent to dispose of such shares, and such notice shall be deemed to be an offer to sell such shares to a designee of TMMC subject to acceptance and pursuant to the price and terms provided in this paragraph 4. Any such designee of TMMC must be a duly licensed physician in the State of ______. 2 (b) Any offer made pursuant to this paragraph 4 may be accepted by a designee of TMMC by giving written notice of such acceptance to the Shareholder not later than the ninetieth (90th) calendar day after the offer was given. The designee of TMMC may accept the offer only as to all of the shares offered. (c) The price of each share offered and purchased pursuant to this paragraph 4 shall be $1.00. (d) The closing of the shares offered and purchased pursuant to this paragraph 4 shall take place not later than fifteen (15) days after the date for timely acceptance of the offer to sell. A certificate in transferable form for the number of shares offered and purchased shall be delivered against payment of the purchase price thereof. 5. LEGEND. The Shareholder shall deliver to the Corporation all certificates heretofore issued representing shares of the Corporation's capital stock held of record or beneficially owned by the Shareholder, and each certificate hereafter issued representing any share of the Corporation's capital stock shall, have affixed to the back of the certificate a legend substantially as follows: The rights of any holder of any share evidenced by this certificate, including the right to dispose of the securities represented by this certificate or any interest therein, are subject to and restricted by a certain Agreement, dated December 7, 1995, among the issuer, the holder, and Talbert Medical Management Corporation. The issuer will mail without charge to any holder of these shares a copy of such agreement within five (5) days of receipt by the issuer of a written request therefor. 6. TERM, AMENDMENT, TERMINATION. The term of this Agreement shall be into perpetuity. This Agreement may be amended or terminated at any time but only with the written consent of each of the parties hereto. 7. NOTICES. Any and all notices, offers, acceptances, and other communications required to be given hereunder shall be given by and be deemed given when deposited in United States registered or certified mail addressed, in the case of the Corporation or TMMC, to its principal office, and in the case of the Shareholder, to the address last appearing on the books of the Corporation. 8. COUNTERPARTS. This Agreement may be executed in any number of counterparts. Any party may execute the Agreement by executing any such counterpart and all of such executed counterparts shall be taken together to constitute a single instrument. 9. SPECIFIC PERFORMANCE. If the Shareholder or the person so required under this Agreement fails to give notice or to vote his or her shares in accordance herewith, and if the failure continues for five (5) days after notice by the Corporation or TMMC to the party in default, any of the parties to the Agreement may institute and maintain a proceeding to compel the specific performance of this Agreement by the party in default. 3 10. RECOGNITION. The Corporation shall not recognize any share transfer or other action not in compliance with the terms of this Agreement. 11. BENEFIT. This Agreement shall be binding upon and inure to the benefit of the parties hereto and the legal representatives, successors in interest and assigns, respectively, of each such party. 12. CONSTRUCTION. This Agreement shall be governed by and construed in accordance with the law of the State of ________. IN WITNESS WHEREOF, the parties hereto have executed or caused to be executed this Agreement as of the date first written above. TALBERT MEDICAL GROUP, LTD. By: ---------------------------------------------- Name: ------------------------------------------- Title: ------------------------------------------- TALBERT MEDICAL MANAGEMENT CORPORATION By: ---------------------------------------------- Name: -------------------------------------------- Title: ------------------------------------------- -------------------------------------------------- [Shareholder] 4 EX-10.21 11 EXHIBIT 10.21 FORM OF SHARE CONTROL AGREE. (CA) SHARE CONTROL AGREEMENT THIS SHARE CONTROL AGREEMENT ("Agreement") is made and entered into this _____ day of December, 1995, by and among Talbert Medical Group, Inc., a California professional corporation (the "Corporation"), [Shareholder] an individual residing in the State of California (the "Shareholder"), and Talbert Medical Management Corporation ("TMMC"), a Delaware corporation. RECITALS A. For good and valuable consideration, the Shareholder is willing to vote his or her shares of the Corporation's capital stock in accordance with the terms of this Agreement. The parties do not intend that the Shareholder receive any economic benefit (whether dividends, distributions or otherwise) from his or her respective shareholdings. B. The Corporation, the Shareholder and TMMC desire that there be continuity in management and control of the Corporation and that the affairs of the Corporation be managed consistent with the terms of this Agreement. IN CONSIDERATION of the mutual rights and obligations of the parties hereto, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the Shareholder, and the undersigned Shareholder being and remaining holder of the Corporation's capital stock, the parties hereto agree as follows: 1. OBLIGATIONS CONCERNING THE VOTING OF SHARES. The Shareholder shall advise TMMC, at least thirty (30) days in advance, of his or her intention to vote the shares of the Corporation's capital stock now or hereafter owned by the Shareholder on any matter submitted for a vote to the Shareholder: (a) which involves the (i) lease, sale, exchange, transfer or disposal of all or substantially all of the Corporation's assets, (ii) merged, consolidation or reorganization of the Corporation with or into any other corporation or trade or business, (iii) issuance any shares of any class of the Corporation's capital stock, (iv) amendment or modification of the articles of incorporation or bylaws of the Corporation, (v) dissolution of the Corporation, (vi) amendment or termination of the Management Services Agreement between TMMC and the Corporation, dated as of January 1, 1996, or (vii) entry into any agreement with any person to do any of the foregoing; or (b) to elect any person to the Board of Directors of the Corporation. Notwithstanding the foregoing, in the event that an issue is presented to the Shareholder that applicable law or ethical provisions mandate be determined by an individual who is duly licensed as a physician under applicable state law, the Shareholder may vote his or her shares with respect to such issue in any manner that he or she deems appropriate. 1 2. OBLIGATIONS CONCERNING THE PROVISION OF PROFESSIONAL SERVICES. The Shareholder shall ensure that the Corporation renders professional services to patients of the Corporation only through officers, employees and agents who are themselves duly licensed or otherwise legally authorized to render professional services within the State of California. 3. PURCHASE OF SHARES ON TERMINATION OF EMPLOYMENT. In the event that the Shareholder is removed, or ceases to act, as Chief of Staff of the Corporation for any reason, including, without limitation, termination, disability, death, discharge or resignation, the Shareholder or the legal successors of the Shareholder shall transfer the shares held by the Shareholder to a person or persons designated by TMMC, which person or persons must be duly licensed physicians in the State of California; PROVIDED, HOWEVER, that at all times, one of the transferees must be the Chief of Staff of the Corporation. The closing of the purchase and sale shall take place not later than ninety (90) days after the date of termination or appointment. The price of each such share shall be $1.00. All certificates evidencing the shares being purchased and sold shall be delivered in transferable form against payment of the purchase price thereof evidenced by a check drawn on the designee of TMMC and payable in United States dollars to the order of the Shareholder, or in the case of death, his or her legal representative(s). 4. RIGHT OF FIRST PURCHASE. The Shareholder shall not transfer, encumber, or otherwise dispose of (by sale, pledge, gift, devise, or other disposition) any shares of the Corporation's capital stock now or hereafter held of record or beneficially owned by him or her unless the Shareholder shall have complied with the following procedure: (a) The Shareholder shall give TMMC written notice of his or her intent to dispose of such shares, and such notice shall be deemed to be an offer to sell such shares to a designee of TMMC subject to acceptance and pursuant to the price and terms provided in this paragraph 4. Any such designee of TMMC must be a duly licensed physician in the State of California. (b) Any offer made pursuant to this paragraph 4 may be accepted by a designee of TMMC by giving written notice of such acceptance to the Shareholder not later than the ninetieth (90th) calendar day after the offer was given. The designee of TMMC may accept the offer only as to all of the shares offered. (c) The price of each share offered and purchased pursuant to this paragraph 4 shall be $1.00. (d) The closing of the shares offered and purchased pursuant to this paragraph 4 shall take place not later than fifteen (15) days after the date for timely acceptance of the offer to sell. A certificate in transferable form for the number of shares offered and purchased shall be delivered against payment of the purchase price thereof. 5. LEGEND. The Shareholder shall deliver to the Corporation all certificates heretofore issued representing shares of the Corporation's capital stock held of record or beneficially owned by the Shareholder, and each certificate hereafter issued representing any 2 share of the Corporation's capital stock shall, have affixed to the back of the certificate a legend substantially as follows: The rights of any holder of any share evidenced by this certificate, including the right to dispose of the securities represented by this certificate or any interest therein, are subject to and restricted by a certain Agreement, dated __________, 1995, among the issuer, the holder, and Talbert Medical Management Corporation. The issuer will mail without charge to any holder of these shares a copy of such agreement within five (5) days of receipt by the issuer of a written request therefor. 6. TERM, AMENDMENT, TERMINATION. The term of this Agreement shall be into perpetuity. This Agreement may be amended or terminated at any time but only with the written consent of each of the parties hereto. 7. NOTICES. Any and all notices, offers, acceptances, and other communications required to be given hereunder shall be given by and be deemed given when deposited in U.S. registered or certified mail addressed, in the case of the Corporation or TMMC, to its principal office, and in the case of the Shareholder, to the address last appearing on the books of the Corporation. 8. COUNTERPARTS. This Agreement may be executed in any number of counterparts. Any party may execute the Agreement by executing any such counterpart and all of such executed counterparts shall be taken together to constitute a single instrument. 9. SPECIFIC PERFORMANCE. If the Shareholder or the person so required under this Agreement fails to give notice or to vote his or her shares in accordance herewith, and if the failure continues for five (5) days after notice by the Corporation or TMMC to the party in default, any of the parties to the Agreement may institute and maintain a proceeding to compel the specific performance of this Agreement by the party in default. 10. RECOGNITION. The Corporation shall not recognize any share transfer or other action not in compliance with the terms of this Agreement. 11. BENEFIT. This Agreement shall be binding upon and inure to the benefit of the parties hereto and the legal representatives, successors in interest and assigns, respectively, of each such party. 3 12. CONSTRUCTION. This Agreement shall be governed by and construed in accordance with the law of the State of California. IN WITNESS WHEREOF, the parties hereto have executed or caused to be executed this Agreement as of the date first written above. TALBERT MEDICAL GROUP, INC. By: ----------------------------------- Name: ---------------------------------- Title: --------------------------------- TALBERT MEDICAL MANAGEMENT CORPORATION By: ----------------------------------- Name: ---------------------------------- Title: --------------------------------- --------------------------------------- [Shareholder] 4 EX-11.1 12 STATEMENT OF COMPUTATION OF EARNINGS EXHIBIT 11.1 TALBERT MEDICAL MANAGEMENT HOLDINGS CORPORATION COMPUTATION OF EARNINGS PER SHARE
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------- --------------------- 1993 1994 1995 1995 1996 ---------- ---------- ---------- ---------- --------- (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) Primary and fully diluted earnings per common and common equivalent share: Net loss............................................... $ (13,434) $ (19,580) $ (28,608) $ (23,176) $ (3,770) ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------- --------- Weighted average number of common shares and common share equivalents: Common stock......................................... 3,000 3,000 3,000 3,000 3,000 Assumed exercise of options.......................... (4) (4) (4) (4) (4) ---------- ---------- ---------- ---------- --------- Total shares....................................... 2,996 2,996 2,996 2,996 2,996 ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------- --------- Primary and fully diluted loss per common and common equivalent share.................... $ (4.48) $ (6.54) $ (9.55) $ (7.74) $ (1.26) ---------- ---------- ---------- ---------- --------- ---------- ---------- ---------- ---------- ---------
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