-----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, GuTRiuk1ct+H0mWbAtSnUot+0lddV7jcLFlIWNXu4mBG5On+V9gm499bV4Z9zdkD qk62lhFEH/sTxsUCMyrSRg== 0000892569-98-001377.txt : 19980514 0000892569-98-001377.hdr.sgml : 19980514 ACCESSION NUMBER: 0000892569-98-001377 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980513 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFICARE HEALTH SYSTEMS INC /DE/ CENTRAL INDEX KEY: 0001027974 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 954591529 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21949 FILM NUMBER: 98617366 BUSINESS ADDRESS: STREET 1: 5995 PLAZA DR CITY: CYPRESS STATE: CA ZIP: 90630 BUSINESS PHONE: 7149521121 MAIL ADDRESS: STREET 1: 5995 PLAZA DR CITY: CYPRESS STATE: CA ZIP: 90630 FORMER COMPANY: FORMER CONFORMED NAME: N T HOLDINGS INC DATE OF NAME CHANGE: 19961204 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED MARCH 31 1998 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------------ FORM 10-Q ------------------------ (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ------------------------ COMMISSION FILE NUMBER 000-21949 PACIFICARE HEALTH SYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4591529 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3120 LAKE CENTER DRIVE, SANTA ANA, CALIFORNIA 92704 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (714) 825-5200 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of April 30, 1998, there were 14,809,811 shares of the Registrant's Class A Common Stock, par value $0.01 per share, outstanding, and 26,922,062 shares of Class B Common Stock, par value $0.01 per share, outstanding. ================================================================================ 2 PACIFICARE HEALTH SYSTEMS, INC. FORM 10-Q INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997............................ 3 Consolidated Statements of Operations for the three months ended March 31, 1998 and 1997.................. 4 Consolidated Statements of Cash Flows for the three months ended March 31, 1998 and 1997.................. 5 Notes to Condensed Consolidated Financial Statements... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 11 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K.................. 18 SIGNATURES.................................................. 19 INDEX TO EXHIBITS........................................... 20
2 3 PART 1: FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS PACIFICARE HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 DECEMBER 31, (UNAUDITED) 1997 ------------- -------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Assets Current assets: Cash and equivalents...................................... $ 235,693 $ 680,674 Marketable securities..................................... 926,652 864,708 Receivables, net.......................................... 326,343 301,345 Prepaid expenses and other current assets................. 32,213 32,194 Deferred income taxes..................................... 111,401 112,037 ---------- ---------- Total current assets.............................. 1,632,302 1,990,958 ========== ========== Property, plant and equipment, net.......................... 229,145 235,943 Marketable securities -- restricted......................... 157,596 145,989 Goodwill and intangible assets, net......................... 2,440,577 2,458,463 Other assets................................................ 35,261 36,605 ---------- ---------- $4,494,881 $4,867,958 ========== ========== Liabilities and Shareholders' Equity Current liabilities: Medical claims and benefits payable....................... $ 708,700 $ 715,600 Accounts payable and accrued liabilities.................. 460,421 429,524 Unearned premium revenue.................................. 43,034 491,808 Long-term debt due within one year........................ 152 154 ---------- ---------- Total current liabilities......................... 1,212,307 1,637,086 ---------- ---------- Long-term debt due after one year........................... 1,041,195 1,011,234 Deferred income taxes....................................... 103,174 102,793 Other liabilities........................................... 54,155 54,283 Minority interest........................................... 355 375 Shareholders' equity: Preferred shares, par value $0.01 per share; 40,000 shares authorized; 10,517 shares of Series A Convertible Preferred Stock issued and outstanding at March 31, 1998 and December 31, 1997 ($262,926 aggregate liquidation value)..................................... 105 105 Class A common shares, par value $0.01 per share; 100,000 shares authorized; 14,860 and 14,794 issued and outstanding at March 31, 1998 and December 31, 1997, respectively........................................... 148 148 Class B common shares, par value $0.01 per share; 100,000 shares authorized; 27,307 and 27,201 issued and outstanding at March 31, 1998 and December 31, 1997, respectively........................................... 273 272 Additional paid-in capital................................ 1,607,518 1,599,229 Accumulated other comprehensive income.................... 7,832 9,993 Retained earnings......................................... 491,157 452,440 Treasury shares, at cost: Class A common shares -- 42; Class B common shares -- 406........................... (23,338) -- ---------- ---------- Total shareholders' equity........................ 2,083,695 2,062,187 ---------- ---------- $4,494,881 $4,867,958 ========== ==========
See accompanying notes. 3 4 PACIFICARE HEALTH SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, -------------------------------- 1998 1997 -------------- -------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue: Commercial premiums....................................... $ 960,898 $ 756,927 Government premiums (Medicare and Medicaid)............... 1,396,522 1,074,995 Other income.............................................. 24,530 11,681 ---------- ---------- Total operating revenue........................... 2,381,950 1,843,603 ---------- ---------- Expenses: Health care services: Commercial services....................................... 798,452 629,793 Government services....................................... 1,210,049 917,862 ---------- ---------- Total health care services........................ 2,008,501 1,547,655 ---------- ---------- Marketing, general and administrative expenses.............. 282,313 214,514 Amortization of goodwill and intangible assets.............. 18,636 10,319 ---------- ---------- Operating income............................................ 72,500 71,115 Interest income............................................. 25,304 17,685 Interest expense............................................ (17,518) (9,719) ---------- ---------- Income before income taxes.................................. 80,286 79,081 Provision for income taxes.................................. 38,940 35,587 ---------- ---------- Net income.................................................. $ 41,346 $ 43,494 ========== ========== Preferred dividends......................................... (2,629) (904) ---------- ---------- Net income available to common shareholders................. $ 38,717 $ 42,590 ========== ========== Basic earnings per share.................................... $ 0.93 $ 1.17 ========== ========== Diluted earnings per share.................................. $ 0.90 $ 1.12 ========== ==========
See accompanying notes. 4 5 PACIFICARE HEALTH SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ----------------------- 1998 1997 --------- ---------- (IN THOUSANDS) Operating activities: Net income................................................ $ 41,346 $ 43,494 Adjustments to reconcile net income to net cash used in operating activities: Amortization of goodwill and intangible assets......... 18,636 10,319 Depreciation and amortization.......................... 12,627 9,141 Deferred income taxes.................................. 2,368 911 Provision for doubtful accounts........................ 136 1,690 Other noncash items.................................... (22) -- Loss on disposal of property, plant and equipment...... -- 2,966 Changes in assets and liabilities, net of effects from acquisitions: Accounts receivable.................................. (25,134) (27,234) Prepaid expenses and other assets.................... 1,325 (6,205) Medical claims and benefits payable.................. (6,900) (29,000) Accounts payable and accrued liabilities............. 33,017 31,857 Unearned premium revenue............................. (448,774) (213,630) --------- ---------- Net cash flows used in operating activities....... (371,375) (175,691) --------- ---------- Investing activities: Sale (purchase) of marketable securities.................. (65,456) 57,862 Sale (purchase) of marketable securities -- restricted.... (11,607) 393 Purchase of property, plant and equipment................. (5,827) (8,673) Acquisitions, net of cash acquired........................ (750) (980,646) --------- ---------- Net cash flows used in investing activities....... (83,640) (931,064) --------- ---------- Financing activities: Proceeds from long-term borrowing, net of expenses........ 30,000 1,105,639 Repurchase of common stock................................ (23,338) -- Proceeds from issuance of common stock.................... 6,042 29,912 Cash dividends paid to preferred shareholders............. (2,629) (904) Principal payments on long-term debt...................... (41) (99,725) Capitalization of Talbert................................. -- (67,000) --------- ---------- Net cash flows provided by financing activities... 10,034 967,922 --------- ---------- Net decrease in cash and equivalents........................ (444,981) (138,833) Beginning cash and equivalents.............................. 680,674 367,748 --------- ---------- Ending cash and equivalents................................. $ 235,693 $ 228,915 ========= ==========
See accompanying notes. 5 6 PACIFICARE HEALTH SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ---------------------- 1998 1997 ------- ----------- (IN THOUSANDS) Supplemental cash flow information: Cash paid during the period for: Income taxes........................................... $ 360 $ 45,092 Interest............................................... $16,086 $ 2,437 Supplemental schedule of noncash investing and financing activities: Tax benefit realized upon exercise of stock options....... $ 2,216 $ 14,858 Compensation awarded in Class B Common Stock.............. $ 32 $ 721 Details of businesses acquired in purchase transactions: Fair value of assets acquired............................. $ 750 $ 3,384,154 Liabilities assumed or created, including notes to sellers................................................ -- (1,194,988) Preferred and common consideration........................ -- (1,161,893) ------- ----------- Cash paid for acquisitions................................ 750 1,027,273 Cash acquired in acquisitions............................. -- (46,627) ------- ----------- Net cash paid for acquisitions............................ $ 750 $ 980,646 ======= =========== Details of unrealized changes in marketable securities: Decrease in marketable securities......................... $(3,512) $ (7,530) Less decrease in deferred income taxes.................... 1,351 2,882 ------- ----------- Decrease in shareholders' equity.......................... $(2,161) $ (4,648) ======= ===========
See accompanying notes. 6 7 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1998 (UNAUDITED) NOTE 1 -- BASIS OF PRESENTATION PacifiCare Health Systems, Inc. (the "Company" or "PacifiCare") is one of the leading health care services companies in the United States, serving approximately 3.7 million members in the commercial, Medicare and Medicaid lines of business. The interim condensed consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures, normally included in the financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such SEC rules and regulations; nevertheless, management of the Company believes that the disclosures herein are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's December 31, 1997 Annual Report on Form 10-K, filed with the SEC in March 1998. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly the consolidated financial position of the Company with respect to the interim condensed consolidated financial statements, and the consolidated results of its operations and its cash flows for the interim periods then ended, have been included. The results of operations for the interim periods are not necessarily indicative of the results for the full year. NOTE 2 -- ACQUISITIONS AND DISPOSITIONS In February 1997, FHP International Corporation ("FHP") was acquired by the Company (the "FHP Acquisition"), which was accounted for as a purchase. Total consideration of approximately $2.2 billion was allocated to the assets acquired and liabilities assumed based on estimates of their fair values. The fair values of the assets acquired and liabilities assumed were $0.9 billion and $1.1 billion, respectively. A total of $2.4 billion, net of related deferred taxes, representing the excess of the purchase price over the estimated fair values of the net assets acquired, was allocated to goodwill and other acquired intangible assets and is being amortized over a four to 40 year period. In February 1997, the Company sold the outstanding common stock of its Florida subsidiary, at which time the buyer assumed the daily operations. The sales price, which approximated net book value, totaled $9 million. The close of the sale was completed in July 1997 when the Company received regulatory approval from the state of Florida. 7 8 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The pro forma information below presents combined results of operations as if the FHP Acquisition and the sale of the Company's Florida subsidiary had occurred at the beginning of 1997. The pro forma information gives effect to actual operating results prior to the acquisition and adjustments to interest expense, goodwill amortization and income taxes. No adjustment has been made to give effect to synergies that may be realized as a result of the FHP Acquisition.
THREE MONTHS ENDED MARCH 31, 1997 ------------------ (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Total operating revenue............................ $2,396,482 Pretax income...................................... $ 69,501 Net income......................................... $ 35,243 ========== Basic earnings per share........................... $ 0.79 ========== Diluted earnings per share......................... $ 0.77 ==========
NOTE 3 -- LONG-TERM DEBT The Company has a $1.5 billion credit facility under which it had $940 million in borrowings outstanding as of March 31, 1998. The credit facility requires mandatory step-down payments beginning on January 1, 1999 with final maturity on January 1, 2002. The outstanding balance on the credit facility, as of March 31, 1998, would not require a reduction until July 1, 2001. Interest under the credit facility is presently based on the London Interbank Offering Rate ("LIBOR") plus a spread, except for $350 million of the outstanding balance which is covered by interest-rate swap agreements. The average fixed interest rate paid by the Company on the existing swap agreements is approximately six percent. The terms of the credit facility contain various covenants usual for financing of this type, including a minimum net worth requirement, a minimum fixed charge requirement and leverage ratios. At March 31, 1998, the Company was in compliance with all such covenants. In 1997, the Company assumed $100 million in senior notes of FHP which carry an interest rate of seven percent, payable semiannually, and mature on September 15, 2003. NOTE 4 -- SHAREHOLDERS' EQUITY In January 1998, the Company's board of directors approved a plan to repurchase shares of the Company's equity instruments. The Company successfully renegotiated terms of its credit facility to increase the maximum amount of repurchases permitted to $500 million. The Company has and may repurchase its equity instruments using cash flows from operations and additional borrowings under its credit facility. See "Liquidity and Capital Resources." Shares repurchased will be available for reissuance in connection with the Company's employee benefit plans or for other corporate purposes. As of March 31, 1998, the Company had repurchased 42,000 shares of its Class A Common Stock and 406,000 shares of its Class B Common Stock for an aggregate amount of $23 million. The Company's Preferred Stock includes 11,000,000 authorized shares of Series A Preferred Stock. Each share of Series A Preferred Stock entitles its owner to convert it at any time to 0.374 shares of Class B Common Stock, assuming no unpaid accrued dividends in arrears. Series A Preferred Stock shareholders also have a preference of $25.00 per share over the Common Stock in the event of involuntary or voluntary liquidation. Dividends on the Series A Preferred Stock accrue at an annual rate of $1.00 per share, are cumulative and are payable quarterly when, as and if declared by the board of directors. In March 1998, the Company paid $0.25 per share or approximately $3 million in dividends to preferred shareholders of record as of February 27, 1998. Unpaid cumulative dividends earned were $0.4 million on the 10,517,044 Series A Preferred shares outstanding at March 31, 1998. 8 9 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) On or after June 17, 1998, the Series A Preferred Stock may be redeemed at the option of the Company for cash plus unpaid dividends. The redemption price ranges from 103 percent to 100 percent of the stated value of Series A Preferred Stock, or $25.00 per share, in one-half percent decrements for each successive anniversary of June 17, 1998 through 2004. Series A Preferred Stock ranks senior to the Class A and B Common Stock with respect to dividend and liquidation rights. Holders of Series A Preferred Stock generally have no voting rights; however, there are certain exceptions including the right to elect two additional directors if the equivalent of six quarterly dividends payable on the Series A Preferred Stock are in default. NOTE 5 -- CONTINGENCIES OPM. The Company's HMO subsidiaries have commercial contracts with the United States Office of Personnel Management ("OPM") to provide managed health care services to members under the Federal Employees Health Benefit Program ("FEHBP") for federal employees, annuitants and their dependents. In the normal course of business, OPM audits health plans with which it contracts to, among other things, verify that the premiums calculated and charged to OPM are established in compliance with the best price community rating guidelines established by OPM. OPM typically audits plans once every five or six years, and each audit covers the prior five or six year period. Depending on the type of contract the Company has with OPM, OPM will audit one or more health plans at the same time. OPM has notified the Company of its intent to audit or has recently completed an audit of the majority of the Company's health plans. While the government's initial on-site audits are usually followed by a post-audit briefing in which the government indicates its preliminary results, final resolution and settlement of the audits have historically taken a minimum of three to five years. In addition to claims made by the auditors as part of the normal audit process, OPM may also refer their results to the United States Department of Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ has the authority to file a claim under the False Claims Act if it believes that the health plan knowingly overcharged the government or otherwise submitted false documentation or certifications. In False Claims Act actions, the government may impose trebled damages and a civil penalty of not less than $5,000 nor more than $10,000 for each separate alleged false claim. In November 1997, the Company was notified that the 1995 audit of the operations of the Company's Oklahoma HMO subsidiary had been referred to the DOJ. The Company is negotiating to settle this matter with the DOJ. PacifiCare intends to negotiate with OPM and the DOJ on all matters to attain a mutually satisfactory result. There can be no assurance that these negotiations will be concluded satisfactorily, that additional audits will not be referred to the DOJ, or that additional, possibly material, liability will not be incurred. The Company has also entered into discussions with OPM. The Company believes that any ultimate liability in excess of amounts accrued would not materially affect the Company's consolidated financial position. However, such liability could have a material effect on results of operations or cash flows of a future quarter if resolved unfavorably. Legal Proceedings. The Company has been served with several purported class action suits alleging violations of federal securities laws by the Company and by certain of its officers and directors. The complaints relate to the period from the date of the FHP Acquisition through the Company's November 25, 1997 announcement that earnings for the fourth quarter of 1997 would be lower than expected. These complaints primarily allege that the Company previously omitted and/or misrepresented material facts with respect to its costs, earnings and profits. These suits are at a very early stage and no discovery has occurred. The Company believes it has good defenses to the claims in these suits and is contesting them vigorously. The Company is also involved in legal actions in the normal course of business, some of which seek substantial monetary damages, including claims of punitive damages that are not covered by insurance. After review, including consultation with counsel, based on current information, management believes any ultimate liability in excess of amounts accrued that would likely arise from these actions (including the purported class 9 10 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) actions) would not materially affect the Company's consolidated financial position, results of operations or cash flows. NOTE 6 -- EARNINGS PER SHARE In 1997, the Financial Accounting Standards Board issued Statement No. 128 ("SFAS 128"), "Earnings per Share." SFAS 128 replaces the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options and convertible securities. Diluted earnings per share is very similar to the previously reported primary earnings per share. Earnings per share amounts reported for the three months ended March 31, 1997 were restated to conform to the SFAS 128 requirements, and did not vary materially from amounts previously stated. The following table sets forth the computation of the denominator for basic and diluted earnings per share for the periods indicated:
THREE MONTHS ENDED MARCH 31, --------------- 1998 1997 ------ ------ (IN THOUSANDS) Shares outstanding at the beginning of the period........... 41,995 31,301 Weighted average number of shares issued (repurchased): Repurchases............................................... (370) -- Exercise of stock options................................. 58 217 FHP Acquisition........................................... -- 4,842 ------ ------ Denominator for basic earnings per share.................... 41,683 36,360 Assumed conversion of Series A Preferred Stock.............. 3,955 1,987 Employee stock options...................................... 250 634 ------ ------ Denominator for diluted earnings per share.................. 45,888 38,981 ====== ======
NOTE 7 -- COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components; however, its adoption had no impact on the Company's net income or shareholders' equity for the quarter ended March 31, 1998. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities to be included in other comprehensive income. These amounts were reported separately in shareholders' equity prior to adoption. Prior year financial statements have been conformed to the reporting requirements of SFAS 130. During each of the quarters ended March 31, 1998 and 1997, comprehensive income totaled $39 million. 10 11 PART I: FINANCIAL INFORMATION ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table presents HMO membership data by state and by consumer type as of the dates indicated.
AT MARCH 31, 1998 AT MARCH 31, 1997 ------------------------------------ ------------------------------------ GOVERNMENT GOVERNMENT (MEDICARE & (MEDICARE & MEMBERSHIP DATA COMMERCIAL MEDICAID) TOTAL COMMERCIAL MEDICAID) TOTAL --------------- ---------- ----------- --------- ---------- ----------- --------- Arizona.................... 111,100 88,700 199,800 101,700 88,400 190,100 California................. 1,578,000 605,900 2,183,900 1,693,700 633,500 2,327,200 Colorado................... 293,800 53,400 347,200 275,500 47,300 322,800 Guam....................... 42,600 -- 42,600 42,800 -- 42,800 Nevada..................... 44,200 24,400 68,600 40,100 22,800 62,900 Ohio....................... 48,700 14,000 62,700 55,200 8,400 63,600 Oklahoma................... 101,500 26,500 128,000 115,000 24,900 139,900 Oregon..................... 114,100 38,200 152,300 116,100 39,900 156,000 Texas...................... 138,600 68,500 207,100 137,000 68,900 205,900 Utah....................... 120,300 23,100 143,400 155,800 32,600 188,400 Washington................. 95,300 57,600 152,900 96,200 52,700 148,900 --------- --------- --------- --------- --------- --------- Total membership(1)... 2,688,200 1,000,300 3,688,500 2,829,100 1,019,400 3,848,500 ========= ========= ========= ========= ========= =========
THREE MONTHS ENDED MARCH 31, ------------------ OPERATING STATISTICS 1998 1997 -------------------- ------ ------ Medical care ratio (health care services as a percent of premium revenue): Consolidated.............................................. 85.2% 84.5% Commercial................................................ 83.1% 83.2% Government (Medicare and Medicaid)........................ 86.6% 85.4% Marketing, general and administrative expenses as a percent of operating revenue...................................... 11.9% 11.6% Operating income as a percent of operating revenue.......... 3.0% 3.9% Effective tax rate.......................................... 48.5% 45.0%
- --------------- (1) The membership table does not include the members of Illinois and New Mexico at March 31, 1997 because these companies were classified as net assets held for sale, and were subsequently sold during 1997. As of March 31, 1997, Illinois had 59,000 and 3,000 commercial and government members, respectively; and New Mexico had 38,000 and 18,000 commercial and government members, respectively. 11 12 THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THE THREE MONTHS ENDED MARCH 31, 1997 RESULTS OF OPERATIONS For the three months ended March 31, 1998, total operating revenue increased 29 percent as compared to the same period in the prior year. The 1997 results include the results of operations of FHP from February 14, 1997 (see Note 2 of the Notes to the Condensed Consolidated Financial Statements). Enrollment gains, including the increased membership from the acquisition of FHP, in both the government and commercial programs, contributed approximately 81 percent of the increase in revenue. Premium rate increases, mainly in the government programs, contributed 13 percent of the increase. The Company's specialty managed care products and services contributed the remainder of the increase. Other income increased 110 percent as compared to the same period in the prior year, due primarily to increased revenue from the Company's prescription drug benefit management and Secure Horizons USA subsidiaries. Total HMO membership decreased four percent to approximately 3.7 million members at March 31, 1998, from approximately 3.8 million members at March 31, 1997. The membership declines were due, in part, to the exit of certain product lines including Medicaid and geographic markets. Commercial premiums increased 27 percent over the prior year due to a full quarter of FHP Acquisition membership being included in 1998 compared to a half quarter in the prior year. Premium rate increases of approximately two percent contributed to a five percent membership decrease from 1997. The membership decrease was expected, and is the result of the Company shifting its focus from one of rapid growth to improved profit margins through the use of a more disciplined product pricing strategy. Government premiums increased 30 percent for the three months ended March 31, 1998, primarily due to the FHP Acquisition contributing 45 days more of premiums than in the three months ended March 31, 1997. Government per member premium rates increased as a result of the Company's exit of its Medicaid lines of business in certain of the Company's markets. These increases were offset slightly by reductions in member paid supplemental premiums in several of the Company's markets. The commercial medical care ratio (health care services as a percent of premium revenue) decreased slightly for the three months ended March 31, 1998, as compared to the same period of the prior year. The improvement in the commercial medical care ratio was due to the continued renegotiation of provider contracts into capitated arrangements, lower prescription drug costs and an improved pricing environment. The increase in the government programs' medical care ratio for the three months ended March 31, 1998, as compared to the same period of the prior year, was primarily the result of increases in out-of-area emergency costs and provider insolvency reserves. As a percentage of operating revenue, marketing, general and administrative expenses increased from the prior year primarily from the accelerated recognition of discretionary spending including accruals for employee profit sharing plans and other overhead costs. Excluding these accelerated expenses, the administrative ratio in this year would have been comparable to, or slightly below, the ratio recorded in the same period last year. Interest income increased approximately 43 percent for the three months ended March 31, 1998 compared to the same period in the prior year primarily due to gains on sales of marketable securities. Interest expense increased approximately 80 percent for the three months ended March 31, 1998 compared to the same period in the prior year primarily due to increased borrowings under the Company's credit facility for the FHP Acquisition. The effective income tax rate was approximately 49 percent for the three months ended March 31, 1998, which is an increase over the prior year. This increase reflects the additional nondeductible goodwill amortization expense over the prior year related to the acquisition of FHP. 12 13 For the year ended December 31, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." This statement requires a dual presentation of earnings per share, basic and diluted, and restatement of prior years. The adoption of this statement did not have a material affect on the Company's calculation of earnings per share for the reported periods. LIQUIDITY AND CAPITAL RESOURCES The Company's consolidated cash, equivalents and marketable securities decreased by $383 million to $1.2 billion at March 31, 1998 from $1.5 billion at December 31,1997. The decrease reflects the impact of timing differences in receipt of HCFA premiums. Cash flows provided by operations, excluding the impact of the January 1998 advance Medicare payment from HCFA, were $77 million and are primarily attributable to results of operations. Net cash used in investing activities was $84 million and $931 million for the three months ended March 31, 1998 and 1997, respectively. Cash used in 1998 was primarily attributable to the purchase of marketable securities and investments in capital expenditures. Cash used in 1997 was primarily attributable to the FHP Acquisition and investments in capital expenditures which was partially offset by the sale of marketable securities. Net cash provided by financing activities was $10 million and $968 million for the three months ended March 31, 1998 and 1997, respectively. During 1998, net cash provided by financing activities included $30 million in borrowings under the Company's $1.5 billion credit facility to finance the repurchase of common stock. In January 1998, the Company's board of directors approved a plan to repurchase shares of the Company's equity instruments. As of March 31, 1998, the Company had repurchased 42,000 shares of its Class A Common Stock and 406,000 shares of its Class B Common Stock for an aggregate amount of $23 million (see Note 4 of the Notes to the Condensed Consolidated Financial Statements). For the three months ended March 31, 1997, the Company had borrowed $1.1 billion and had repaid $80 million of its borrowings under the credit facility. The issuance of common stock provided cash in 1998 and 1997 of $6 million and $30 million, respectively. The Company paid approximately $3 million and $1 million of preferred stock dividends in 1998 and 1997, respectively. In 1997, the Company made capital contributions to Talbert Medical Management Corporation, a former subsidiary of FHP, in the amount of $67 million. NEW ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") has issued several pronouncements regarding disclosure that the Company will adopt in 1998. SFAS No. 129, "Disclosure of Information about Capital Structure," consolidates the existing guidance relating to an entity's capital structure. The required capital structure disclosures include liquidation preferences of preferred stock, information about the pertinent rights and privileges of the outstanding equity securities and the redemption amounts of all issues of capital stock that are redeemable at fixed or determinable prices on fixed or determinable dates. SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," significantly changes the way public companies report segment information in annual financial statements and also requires those companies to report selected segment information in interim financial reports. Under SFAS 131, public companies will report financial and descriptive information about their operating segments. Operating segments are revenue-producing components of the enterprise for which separate financial information is produced internally and are subject to evaluation by the chief operating decision maker in deciding how to allocate resources to segments. In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed For or Obtained For Internal Use." Under SOP 98-1, effective in 1999, certain computer software costs are required to be capitalized and amortized over the software's estimated useful life. The Company will adopt SOP 98-1 in 1999. 13 14 DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements to encourage companies to provide prospective information about themselves without fear of litigation so long as those statements are identified as forward looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statements. The statements contained in this section, and throughout the document, are based on current expectations. These statements are forward looking and actual results may differ materially from those projected in the forward looking statements, which statements involve risks and uncertainties. In addition, past financial performance is not necessarily a reliable indicator of future performance and investors should not use historical performance to anticipate results or future period trends. Shareholders are also directed to the other risks discussed in other documents filed by the Company with the SEC. FORWARD LOOKING INFORMATION UNDER THE PRIVATE SECURITIES LITIGATION ACT OF 1995 Membership and Premiums. The Company's membership for the year ended December 31, 1998 is expected to decline in the commercial program. In accordance with the Company's strategic focus shifting from one of rapid growth to improved margin performance, the Company's emphasis is on renewing employer contracts with sufficient price increases to improve gross margin. Specifically, the Company has implemented commercial price increases in all markets ranging from zero to over 10 percent, with concentrated efforts in Utah and Washington, which may result in net membership attrition. In addition to pricing increases, the Company has or intends to exit certain geographical areas where the premiums are insufficient to support the cost of health care in that area. Combined with continued increases in competition and the potential disposition of its Utah subsidiary, which currently has approximately 120,000 commercial members, the Company expects to see declines in commercial membership in 1998. The rate of increase in government membership is expected to remain flat or increase minimally in 1998 as compared to 1997 as competition increases and the Company continues the migration of FHP senior members into the Company's benefit structures and the combined provider network. Additionally, if the proposed Utah disposition is completed, government membership will decrease by approximately 23,000 government members. An unforeseen loss of profitable membership could have a material adverse effect on the Company. Factors which could contribute to the loss of membership include issues related to the retention of FHP's members as the Company combines the PacifiCare and FHP health plans, sale of certain managed care operations, failure to obtain new customers or to retain existing customers, effect of premium increases, reductions in workforce by existing customers, adverse publicity and news coverage, inability to carry out marketing and sales plans, or the loss of key executives or key employees. Health Care Provider Contracts. The Company's profitability depends, in part, on its ability to maintain effective control over health care costs while providing members with quality care. Specifically, capitating providers in Utah, Nevada and Washington and recontracting with providers in Oregon will be important to improved results of operations for those markets. Securing cost-effective contracts with existing and new physician groups is more difficult due to increased competition. The negotiation of provider contracts, generally as of January 1, may be impacted by adverse state and federal legislation and regulation discussed below. Failure to secure cost-effective contracts may result in a loss in membership or a higher medical care ratio. The Company's inability to contract with providers, loss of contracts with providers, inability of providers to provide adequate care or insolvency of providers could materially and adversely affect the Company. These contracting and insolvency risks include, among others, a loss of membership; incurring additional expenses to meet the requirement to continue to arrange for health care services, and other services, for members; the inability to obtain reimbursement due the Company from providers; the expenditure of additional funds to maintain adequate provider networks; and assertion of claims by third parties against the Company. The effect of these risks could result in the recognition of a charge in a future period. Commercial Medical Care Ratio. The commercial medical care ratio is expected to increase for the three months ended June 30, 1998 as compared to the three months ended March 31, 1998. For the remainder 14 15 of 1998, the Company expects the commercial medical care ratio to increase from the ratio experienced in the first three months of 1998, but overall, anticipates that the medical care ratio for the full year will be lower than that for the year ended December 31, 1997. The Company expects improvements as it continues to renegotiate provider contracts and implement capitated contracts and price increases. Price increases on a consolidated company basis are expected to increase by an average of four percent, with increases ranging from zero to over 10 percent. Moreover, higher premium rates offered during renewal periods should result in the elimination of some high medical care ratio business. During 1998, the Company will continue to concentrate its efforts on renegotiations with providers, including contracts assumed by the FHP Acquisition. Successful renegotiation of these contracts should reduce the medical care ratio from the prior year. Finally, the commercial medical care ratio should improve if the proposed Utah disposition is completed. Government Medical Care Ratio. For the three months ended June 30, 1998, the medical care ratio for the government programs is expected to be lower than the three months ended March 31, 1998. For the year ended December 31, 1998, the government medical care ratio is expected to be slightly higher than the prior year. The Company believes that a portion of the out-of-area emergency costs experienced in the first quarter of 1998 are one-time in nature and expects that such costs will be improved in future quarters. Competitive pressures in the Medicare market may require enhanced benefits. The implementation of Medicare reform provisions which curtail program spending and allow the entry of new forms of competitor plans could further increase competitive pressures (see Legislation and Regulation below). The 1998 HCFA rate increases and lower FHP government medical care ratio are expected to be offset by these competitive pressures. Medical Care Risk Factors. The commercial and government medical care ratio expectations discussed above could be affected by various uncertainties, including increases in medical and prescription drug costs which have been escalating faster than premium increases in recent years, increases in utilization and costs of medical services and the effect of actions by competitors or groups of providers, termination of provider contracts or renegotiations of such contracts at less cost-effective rates or terms of payment. In addition, the commercial and government medical care ratio expectations for the HMOs acquired in the FHP Acquisition could be impacted by the ongoing conversion to the Company's computer systems which may result in reduced timely visibility of actual claims costs. Other Income. For the quarter ended June 30, 1998, other income is expected to be comparable or slightly less than the quarter ended March 31, 1998 as pharmacy funding from mail service co-payments is expected to decrease slightly. Compared to 1997, other income is expected to increase substantially from the Company's prescription drug benefit management and Secure Horizons USA subsidiaries. Marketing, General and Administrative Support. As a percentage of operating revenue, marketing, general and administrative expenses are expected to decrease for the three months ended June 30, 1998 as compared to the quarter ended March 31, 1998. Marketing, general and administrative expenses as a percentage of operating revenue in 1998 are expected to be comparable to or slightly lower than 1997. The Company expects to experience additional costs associated with the integration of FHP largely related to upgrading and converting information systems to maintain and enhance the Company's competitive edge in information technology. These additional costs are expected to be offset as the Company realizes the benefits of restructuring and a full year of synergies as a result of the FHP Acquisition. Marketing, general and administrative expenses could be adversely impacted by the need for additional advertising, marketing, administrative, or management information systems expenditures and the inability to carry out marketing and sales plans. The ability of the Company to realize the anticipated benefits and synergies related to the FHP Acquisition is subject to the following additional uncertainties, among others: the ability to eliminate duplicative functions while maintaining acceptable performance levels, and the possibility that the continued integration will result in a loss of providers, employers, members or key employees. Future Dispositions. While the Company has previously announced its intention to dispose of its Utah and workers' compensation operations, other dispositions could be announced as the Company continues to evaluate whether certain subsidiaries or products fit within its core business strategy. There is no guarantee that the Company will be successful in selling all or a portion of the Utah or workers' compensation operations at a price sufficient to avoid disposition losses. Such losses could include restructuring expenses for severance, 15 16 lease and contract terminations as well as impairment of long-lived assets. There can be no assurance that the dispositions will not result in additional pretax charges. The Company believes, however, that any disposition operating losses would not materially affect the Company's consolidated financial position. However, the disposition losses could have a material adverse effect on the results of operations or cash flows of a future quarter. Impairment of Long-Lived Assets. The Company assesses the recoverability of its long-lived assets (including goodwill and intangibles) on an annual basis or whenever adverse events or changes in circumstances or the business climate indicate that expected undiscounted future cash flows for individual business units may not be sufficient to support the recorded asset. Based on the 1997 annual analysis, certain of the Company's operations will require more frequent monitoring in 1998. In addition, at March 31, 1998 certain of the Company's property, plant and equipment was determined to be recoverable because of long- term operating lease agreements. Should there be a change in the rental income stream, an impairment for these assets may be necessary. The Company believes that this impairment would not materially affect the Company's consolidated financial position. However, the impairment charges could have a material adverse effect on the results of operations or cash flows. Year 2000. In 1996, the Company developed and began execution of an enterprise-wide plan to ensure application and systems compliance for the Year 2000. This plan's scope includes internal systems and the written confirmation from all systems vendors ensuring Year 2000 compliance in conjunction with the Company's target deadline of fall 1999. The Company is currently assessing the impact, if any, of Year 2000 issues it may encounter with entities with which it electronically interacts, including HCFA. If HCFA or certain other entities experience significant failures or erroneous applications, it could have a material adverse effect on the Company's financial position, results of operations or cash flows. Office of Personnel Management Contingencies. The Company intends to negotiate with OPM and DOJ on all claims to attain a mutually satisfactory result. While there is no assurance that the negotiations will be concluded satisfactorily or that additional liability will not be incurred, management believes that any ultimate liability in excess of amounts accrued, which could arise upon completion of the audits by OPM of the health plans, would not materially affect the Company's consolidated financial position. However, such liability could have a material adverse effect on results of operations or cash flows of a future quarter if resolved unfavorably (see Note 5 of the Notes to Condensed Consolidated Financial Statements). Liquidity and Capital Resources. The Company's credit facility requires mandatory reductions of the outstanding principal balance beginning January 1999 and is required to be paid in full by January 1, 2002. As of March 31, 1998, the outstanding balance on the credit facility would not require a reduction until July 1, 2001. The Company believes cash flows from operations, existing cash equivalents, marketable securities and other financing sources will be sufficient to meet the requirements of the credit facility and should provide sufficient liquidity for operations in the foreseeable future. Cash flows could be adversely affected because the Company is subject to greater operating leverage due to its higher levels of indebtedness as a result of the FHP Acquisition. The Company's plan to repurchase shares of outstanding stock may result in the reduction of cash and equivalents or in additional borrowings on its credit facility. Additional borrowings on the credit facility may result in the Company being subject to earlier mandatory reduction of its outstanding balance. Additionally, should the credit facility be fully drawn, the Company's ability to make a payment on, or repayment of, its future obligations under the credit facility and $100 million of senior notes of FHP assumed by the Company will be significantly dependent upon the receipt of funds from the Company's subsidiaries. These subsidiary payments represent fees for management services rendered by the Company to the subsidiaries and cash dividends by the subsidiaries to the Company. Nearly all of the subsidiaries are subject to HMO regulations or insurance regulations and may be subject to substantial supervision by one or more HMO or insurance regulators. Subsidiaries subject to regulation must meet or exceed various fiscal standards imposed by HMO or insurance regulations, which may from time to time impact the amount of funds that may be paid by subsidiaries to the Company. Additionally, from time to time, the Company advances funds, in the form of a loan or capital contribution, to its subsidiaries to assist them in satisfying federal or state financial requirements. If a federal or state regulator has concerns about the 16 17 financial position of a subsidiary, as a result of costs being incurred by such subsidiary, a regulator may impose additional financial requirements on the subsidiary which may require additional funding from the Company. Legislation and Regulation. The Company's success is significantly impacted by federal and state legislation and regulation. Almost 60 percent of the Company's revenue, and an even greater percentage of its profit, comes from its government programs, the majority of which is Medicare risk business. Actual results may differ materially from expected results discussed throughout this document because of adverse state and federal legislation and regulation. This includes limitations on premium levels; increases in minimum capital and reserves and other financial viability requirements; prohibition or limitation of capitated arrangements or provider financial incentives; benefit mandates (including mandatory length of stay and emergency room coverage, many of which are effective in 1998) and limitations on the ability to manage care and utilization of any willing provider and direct access laws. Legislation and regulation could also include adverse actions of governmental payors, including unilateral reduction of Medicare premiums payable; discontinuance of or limitation on governmentally funded programs and recovery by governmental payors of previously paid amounts; the inability to increase premiums or prospective or retroactive reductions to premium rates for federal employees; adverse regulatory determinations resulting in care or limitations of licensure, and certification or contracts with governmental payors; and consolidation of operations or other efforts to integrate FHP. On August 5, 1997, President Clinton signed into law the Balanced Budget Act of 1997, which enacted numerous revisions to the Medicare program. The law replaces the risk contract program with a new "Medicare+choice" program, which is intended to increase Medicare enrollment in private health plans. During 1998, HCFA is expected to promulgate regulations that will allow participation in the Medicare+choice program by HMOs, preferred provider organizations, point-of-service plans, provider-sponsored organizations and fee-for-service plans and provide for a new medical savings account demonstration project for Medicare beneficiaries. The law also revises the formula used by HCFA to calculate payments to Medicare health plans by establishing minimum payment levels and annual increases and limiting the overall rate of payment growth. Further, the law enacts new requirements for risk adjustment, information disclosure, quality measurement and improvement and beneficiary enrollment, among other provisions. The Company believes that any slowdown in the rate of premium growth may be offset by the effect of this new legislation encouraging managed health care for Medicare beneficiaries. The loss of Medicare contracts or termination or modification of the HCFA risk-based Medicare program could have a material adverse effect on the revenue, profitability and business prospects of the Company. Additionally, recently adopted federal legislation, among other things, repeals the requirement that at least half of a Medicare health plan's enrollment be drawn from commercial contracts (the "50/50 Rule") beginning January 1, 1999, and gives the Department of Health and Human Services broad authority to waive the 50/50 Rule for certain plans beginning January 1, 1998. The Company believes that the repeal of the 50/50 Rule will allow it to develop Medicare risk programs in markets where it does not have operations through expansion of the Secure Horizons programs and affiliations between Secure Horizons USA, its Medicare risk management subsidiary, and health plans or providers in such markets. Legal Proceedings. The Company has been served with several purported class action suits alleging violations of federal securities laws by the Company and by certain of its officers and directors. The complaints relate to the period from the date of the FHP Acquisition through the Company's November 25, 1997 announcement that earnings for the fourth quarter of 1997 would be lower than expected. These complaints primarily allege that the Company previously omitted and/or misrepresented material facts with respect to its costs, earnings and profits. These suits are at a very early stage and no discovery has occurred. The Company believes it has good defenses to the claims in these suits and is contesting them vigorously. The Company is also involved in legal actions in the normal course of business, some of which seek monetary damages, including claims for punitive damages which are not covered by insurance. After review, including consultation with counsel, based on current information, management believes any ultimate liability in excess of amounts accrued which would likely arise from these actions (including the purported class actions) would not materially affect the Company's consolidated financial position, results of operations or 17 18 cash flows. However, management's evaluation of the likely impact of these actions could change in the future and an unfavorable outcome, depending upon the amount and timing, could have a material adverse effect on the Company's results of operations or cash flows of a future quarter. Other. Results may differ materially from those projected, forecast, estimated and budgeted by the Company due to adverse results in ongoing audits or in other reviews conducted by federal or state agencies or health care purchasing cooperatives; adverse results in significant litigation matters; and changes in interest rates causing an increase in interest expense. PART II. OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS No changes. ITEM 2: CHANGES IN SECURITIES None ITEM 3: DEFAULTS UPON SENIOR SECURITIES None ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5: OTHER INFORMATION None ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K a) Exhibit Index Exhibit 10.1 Separation Agreement, dated as of February 3, 1998, between the Company and Wayne B. Lowell. Exhibit 27 Financial Data Schedule (filed electronically).
b) There were no reports on Form 8-K filed by the Registrant or its subsidiaries during the quarter ended March 31, 1998. 18 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PACIFICARE HEALTH SYSTEMS, INC. (Registrant) Date: May 13, 1998 By: /s/ ALAN R. HOOPS ------------------------------------ Alan R. Hoops President, Chief Executive Officer and Director Date: May 13, 1998 By: /s/ WAYNE B. LOWELL ------------------------------------ Wayne B. Lowell Executive Vice President and Chief Financial Officer 19 20 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- Exhibit 10.1 Separation Agreement, dated as of February 3, 1998, between the Company and Wayne B. Lowell. Exhibit 27 Financial Data Schedule (filed electronically).
20 EX-10.1 2 SEPARATION AGREEMENT 1 EXHIBIT 10.1 SEPARATION AGREEMENT This SEPARATION AGREEMENT (this "Agreement"), dated as of February 3, 1998, (the "Effective Date") by and between PACIFICARE HEALTH SYSTEMS, INC., a Delaware corporation (the "Company"), and, Wayne Lowell, an individual ("EXECUTIVE"), with reference to the following facts: RECITALS: WHEREAS, on or about February 22, 1990, the Company and EXECUTIVE entered into an Employment Agreement, pursuant to which the Company engaged EXECUTIVE in the capacity of Chief Financial Officer of the Company (as such agreement heretofore may have been amended, modified, or revised, the "Employment Agreement"); WHEREAS, EXECUTIVE has tendered to the Company his resignation, to be effective on a mutually agreeable date; WHEREAS, the Company and EXECUTIVE mutually desire to terminate the Employment Agreement and to provide for the complete satisfaction and settlement of all obligations arising under the Employment Agreement upon the terms and subject to the conditions set forth in this Agreement; and WHEREAS, in view of EXECUTIVE'S impending separation from the Company, EXECUTIVE desires to resign from the offices, positions, and board memberships that EXECUTIVE currently holds with the Company and with the Company's subsidiaries and affiliates. NOW THEREFORE, in consideration of the above premises and the representations, warranties, conditions, covenants, and promises exchanged by the parties expressed below, the Company and EXECUTIVE agree as follows: ARTICLE I. TERMINATION OF EMPLOYMENT SECTION 1.01 EFFECT OF THIS AGREEMENT. ------------------------- This Agreement shall supersede the Employment Agreement, except to the extent that specific provisions of the Employment Agreement are referenced and incorporated herein. SECTION 1.02 NOTICE OF INTENT TO RESIGN. -------------------------- EXECUTIVE hereby reaffirms his intent to resign from the Company. -1- 2 SECTION 1.03 EFFECT OF RESIGNATION. ---------------------- At the request of the Company, EXECUTIVE has agreed to continue his employment with the Company with the understanding that the final termination date ("Termination Date") will be no sooner than March 15, 1998, and no later than June 15, 1998. Between those dates, EXECUTIVE'S employment shall be terminable at the will of either Company or EXECUTIVE, with or without cause and with or without advance notice. EXECUTIVE'S employment may be extended beyond June 15, 1998, by the mutual agreement of the Company and EXECUTIVE, in which case, EXECUTIVE'S continued employment shall remain terminable at the will of either Company or EXECUTIVE, with or without cause and with or without advance notice. On the Termination Date, at 11:59 p.m., Pacific Standard Time, EXECUTIVE'S Employment Agreement and EXECUTIVE'S employment with the Company, will terminate. Moreover, on the Termination Date and without further action, EXECUTIVE shall resign the offices of Executive Vice President and Chief Financial Officer as well as all other offices, directorships or position he held in the Company or in any of the subsidiaries of the Company. SECTION 1.04 EXECUTIVE'S INTERIM EMPLOYMENT. ------------------------------- During the period prior to the Termination Date, EXECUTIVE will remain employed with the Company as an "at will" employee on a full-time basis. During this interim period, EXECUTIVE'S duties will remain the same as they were prior to the Effective Date except that EXECUTIVE'S duties also will include assistance in management transition and support to all individuals necessary to ensure a smooth and timely transfer of EXECUTIVE responsibilities. The Compensation provisions set forth at Section 3.01 of the Employment Agreement, which describe the salary and benefits to which EXECUTIVE was entitled during the term of that agreement are incorporated herein and govern EXECUTIVE'S salary and benefits during any period between the Effective Date and the Termination Date. ARTICLE II. COMPENSATION SECTION 2.01 CERTIFICATION OF COMPENSATION AT TERMINATION. --------------------------------------------- As of the Termination Date, if the Company owes EXECUTIVE compensation of any kind that is attributable to EXECUTIVE'S services to the Company on or before the Termination Date, EXECUTIVE shall execute a Certificate of Compensation, substantially in the form of Exhibit "A" attached hereto and incorporated in full herein by this reference (the "Certificate of Compensation"). Pursuant to the Certificate of Compensation, EXECUTIVE shall certify to the Company the amount of any cash or non-cash compensation or employee benefits to which EXECUTIVE may be entitled for services rendered through the Termination Date (including those additional benefits, which the EXECUTIVE shall accrue during the Vacation Benefit Period defined below). EXECUTIVE shall deliver the Certificate of -2- 3 Compensation to the Company contemporaneously with the Company's delivery to EXECUTIVE of the Final Gross Compensation defined therein. After the Termination Date, EXECUTIVE shall not be entitled to any compensation for his past employment services to the Company which is not reflected in a Certificate of Compensation that is verified and approved the Company. The above notwithstanding, the Certificate of Compensation shall not include any compensation for accrued paid time off, as such accrued paid time off shall be accounted for in the Vacation Benefit Period described in Section 2.02. SECTION 2.02 BENEFIT PERIOD. --------------- Following the Termination Date, EXECUTIVE shall remain eligible to participate in certain employee benefits for a period of time (the "Benefit Period"). The Benefit Period shall be separated into two parts: the Vacation Benefit Period and the Severance Benefit Period. The benefits available to the EXECUTIVE shall vary depending upon whether they occur during the Vacation Benefit Period or the Severance Benefit Period as set forth in Section 2.03. 2.02.01 Vacation Benefit Period Defined. -------------------------------- The "Vacation Benefit Period" shall last for the number of days of vacation that EXECUTIVE has accrued as of the Termination Date, plus any additional days of paid time off which EXECUTIVE would accrue during the Vacation Benefit Period. The Vacation Benefit Period shall begin on the day after the Termination Date. By agreeing to the terms of the Vacation Benefit Period set forth in this Agreement, EXECUTIVE is waiving his right to accept full compensation for all accrued yet unused vacation pay, which would be due and payable under California law on the Termination Date. 2.02.02 Severance Benefit Period Defined. --------------------------------- The "Severance Benefit Period" shall last for a minimum of fifteen (15) months. PacifiCare shall increase the Benefit Period by one month for each full month (and by one day for each day of a partial month) that EXECUTIVE continues his employment and service to the Company on and after January 1, 1998, such continued at-will employment being at the sole discretion of the Company. However, in no event shall the Severance Benefit Period exceed two years. The Severance Benefit Period begins on the day after the last day of the Vacation Benefit Period. 2.02.03 Examples. --------- 1. If the Company establishes a Termination Date of March 23, 1998, the Vacation Benefit Period shall equal EXECUTIVE'S accrued vacation as of March 23, 1998, and the Severance Benefit Period shall be 17 months and 23 days, which is equal to 15 months plus two additional months for EXECUTIVE'S service to the Company in January and February, plus the 23 days in March. -3- 4 2. If the Company establishes a Termination Date of June 6, 1998, the Vacation Benefit Period shall equal EXECUTIVE'S accrued vacation as of June 6, 1998, and the Severance Benefit Period shall be 20 months and six days, which is equal to 15 months plus five additional months for EXECUTIVE'S service from January through May, plus the six days in June. These examples are for illustration purposes only and do not imply or suggest either (i) that the Company will retain the services of EXECUTIVE for any length of time following the Effective Date or (ii) that the Severance Benefit Period will exceed 15 months. SECTION 2.03 COMPENSATION AND BENEFITS DURING THE VACATION BENEFIT PERIOD. ------------------------------------------------------------- 2.03.01 Salary Continuation. -------------------- During the Vacation Benefit Period, EXECUTIVE'S annual salary as of the Termination Date shall continue payable every other week in equal installments on the Company's regular payroll dates, less standard deductions and withholdings required by law or directed by EXECUTIVE, including, without limitation, state and federal income taxes social security contributions, and all applicable deductions for the benefits described in Subsection 2.03.02 2.03.02 Benefits. --------- During the Vacation Benefit Period, EXECUTIVE shall be entitled to all of the benefits, which he was entitled to as a employee as of the Effective Date including 1. Continued vesting in performance based incentive programs such as the Annual Incentive Program and the Long Term Performance Incentive Program. 2. Continued accrual of paid time off, which shall be added to the Vacation Benefit Period. Notwithstanding the above, all benefits are subject to change to the extent that a change is made for high level executives who remain employed with the Company. SECTION 2.04 COMPENSATION AND BENEFITS DURING THE SEVERANCE BENEFIT PERIOD ------------------------------------------------------------- 2.04.01 Salary Continuation. -------------------- During the Severance Benefit Period, EXECUTIVE's current annual salary as of the Effective Date shall continue payable every other week in equal installments on the Company's regular payroll dates, less standard deductions and withholdings required by law or -4- 5 directed by EXECUTIVE, including, without limitation, state and federal income taxes, social security contributions, and standard amounts deducted for the employee benefits set forth in this Section 2.04. 2.04.02 Health Benefits. ---------------- The Company's portion of the cost of EXECUTIVE'S current medical, dental and life insurance benefits for EXECUTIVE and EXECUTIVE'S dependents shall be paid by the Company though the end of the Severance Benefit Period. EXECUTIVE shall be responsible for paying his portion of the cost of such coverage, which shall be deducted from the payments set forth in Subsection 2.04.01. Thereafter, EXECUTIVE may elect to continue his health care coverage at EXECUTIVE'S expense as permitted under COBRA. 2.04.03 LTPIP and AIP Benefits. ----------------------- EXECUTIVE shall be entitled to payment of benefits under the Long-Term Performance Incentive Plan and the Annual Incentive Plan, which shall be deemed to have accrued as of the end of the Vacation Benefit Period. However, EXECUTIVE shall not be entitled to participate in the Company's Annual Incentive Plan or Long-Term Performance Incentive Plan after the Vacation Benefit Period. 2.04.04 Vesting of Stock Options. ------------------------- EXECUTIVE shall be entitled to vest any unvested stock options which have been granted to the EXECUTIVE under the Company's various Stock Option Plans for Executives and Key Employees, (the "Stock Option Plans"), through December 31, 1998. For the sole purpose of permitting such continued vesting, EXECUTIVE will be deemed an employee of the Company through December 31, 1998. EXECUTIVE agrees that if the Company determines that it is inconsistent with the Stock Option Plans to allow EXECUTIVE'S stock options to vest following the Termination Date, the Company shall make provisions to provide a benefit to the EXECUTIVE, which is identical in monetary terms to the options described in the previous paragraph that would vest following the Termination Date. EXECUTIVE shall not be considered a participant in the Stock Option Plans for purposes of the issuance of any new grants of stock options following the Effective Date. 2.04.05 Exercise of Vested and Unexercised Stock Options. ------------------------------------------------- EXECUTIVE shall have the right to exercise any vested and unexercised options under the Stock Option Plans in accordance with their terms on any day prior to and including December 31, 1999. On December 31, 1999 at 5p.m. Pacific Standard -5- 6 Time all rights to exercise any stock options issued under any of the Company's Stock Option Plans shall terminate. These dates shall also apply to any equivalent benefits which may be provided to EXECUTIVE in accordance with Subsection 2.04.04 of this Agreement. 2.04.06 Benefits Not Available. ----------------------- EXECUTIVE shall not be entitled to any benefits not expressly set forth in this Agreement during the Severance Benefit Period. Without limiting the foregoing, EXECUTIVE'S participation in (i) the accidental death and dismemberment insurance policy, (ii) the disability insurance policy, and (iii) the basic and supplemental life insurance policies shall terminate at the end of the Vacation Benefit Period and shall not be available during the Severance Benefit Period. 2.04.07 Effect of Earnings from Competitors. ------------------------------------ Notwithstanding the foregoing provisions of this Section 2.04, if EXECUTIVE engages in employment with a competitor of the Company during the Severance Benefit Period, the compensation payable to EXECUTIVE under this Section 2.04.01 shall be reduced by the amount of any and all gross earnings EXECUTIVE earns while engaged in employment with any such competitor or competitors. For the purposes of this subsection 2.04.07, a "competitor of the Company" shall include, without limitation, a health maintenance organization, competitive medical plan, preferred provider organization, or health or life insurance company which owns a managed care plan or program. EXECUTIVE agrees to provide immediate written notification to Company upon receipt of any gross earnings, which EXECUTIVE expects to receive, or has received, from any competitor of the Company. For purposes of this subsection, "employment with a competitor" shall any include services which EXECUTIVE provides as an independent consultant to any competitor of the Company. SECTION 2.05 ADDITIONAL CONSIDERATION DURING THE ENTIRE BENEFIT PERIOD. ---------------------------------------------------------- 2.05.01 Automobile Allowance. --------------------- EXECUTIVE shall receive an automobile allowance of $850.00 per month during the Benefit Period; provided, however, that EXECUTIVE shall be responsible for any expenses attributable to usage of his car. 2.05.02 Outplacement Services. ---------------------- The Company shall provide to EXECUTIVE the outplacement services described in Section 3.01.06 of the Employment Agreement. -6- 7 2.05.03 Termination of Employee Benefits. --------------------------------- Except as expressly set forth in this Agreement, EXECUTIVE shall not be entitled to receive any cash, in-kind compensation, or benefits of any kind or nature, for any periods after the Termination Date. The foregoing prohibitions are not intended to limit, restrict, or deny EXECUTIVE any benefits under employee mandatory or fringe benefit plans or programs, in which EXECUTIVE participates on the Effective Date, that are earned by EXECUTIVE on or before the Termination Date while being payable or distributable to EXECUTIVE after the Termination Date. ARTICLE III. RETURN OF THE COMPANY'S PROPERTY On or before the Termination Date, EXECUTIVE shall return all of the Company's property, equipment, keys, credit cards, books, records, and any and all other documents, property, or other items belonging to the Company. ARTICLE IV. CONFIDENTIALITY PROVISIONS SECTION 4.01 TRADE SECRETS. -------------- EXECUTIVE acknowledges that, during the course of his employment with the Company or with any affiliate or subsidiary of the Company, EXECUTIVE has had, and will continue to have through the Termination Date, access to certain Trade Secrets in the form of know-how, trade secrets, or proprietary information of the Company or its subsidiaries or affiliates ("Trade Secrets ") and that such Trade Secrets were acquired, or will be acquired, in confidence and as a fiduciary of the Company or its subsidiaries or affiliates. For the purposes of this Agreement, Trade Secrets shall include, without limitation, any and all cost and expense data, marketing and customer data, sales manuals, underwriting guidelines, case management policies and procedures, utilization review and quality assurance policies and procedures, provider manuals, individual and group subscriber information (including, the name, address, telephone number, or contact person for an individual or group subscriber), subscriber group manuals, processes, designs, devices, compilations of information, operating manuals, symbols, service marks, logos, customer and vendor lists (including, without limitation, lists of subscribers, subscriber groups, clients, brokers, and providers contracting with the Company or any subsidiary or affiliate of the Company), business information, marketing programs, plans, and strategies, contracts and licenses, advertising and promotional materials, financial information and strategies, computer software and other computer-related materials, copyrightable material, and other legally protected information owned by or used in -7- 8 the respective businesses of the Company or its subsidiaries or affiliates which are confidential or proprietary in nature. For the purposes of this Agreement, Trade Secrets shall not include information which: (i) EXECUTIVE can prove became known to him other than through his relationship with the Company through either (a) completely independent development of such information not within the course of his employment with the Company, or (b) a source other than the Company or a subsidiary, affiliate, shareholder, director, officer, employee, consultant, agent, or advisor of the Company, but only if such source did not disclose such information in violation of a duty of nondisclosure owed to the Company or a subsidiary or affiliate of the Company; (ii) is a matter of public knowledge through no fault of EXECUTIVE; (iii) is approved in advance for release or use by the Company's Board of Directors; or (iv) is required to be disclosed by law. SECTION 4.02 CONFIDENTIALITY COVENANT. ------------------------- EXECUTIVE acknowledges and agrees that maintaining the confidentiality of all of the Trade Secrets is integral to the value of the Company and is vital to the successful operations of the Company and its subsidiaries and affiliates. In view of the foregoing, EXECUTIVE agrees to, at all times after the Effective Date, maintain the confidentiality of all Trade Secrets and to not disclose, divulge, exploit, or use, in any manner whatsoever, the Trade Secrets for EXECUTIVE'S own benefit or the benefit of another individual or entity. SECTION 4.03 EQUITABLE RELIEF. ----------------- EXECUTIVE acknowledges and agrees that it would be difficult to measure the damage to the Company (or any subsidiary or affiliate, as the case may be) from any breach of EXECUTIVE'S obligations under this Article IV, that injury to the Company (or to any subsidiary or affiliate, as the case may be) from any such breach would be impossible to calculate, and that money damages would therefore be an inadequate remedy for any such breach. Therefore, EXECUTIVE acknowledges and agrees that the Company, in addition to any of its other rights or remedies, shall be entitled to seek injunctive or other equitable relief without bond or other security in the event of an actual or threatened breach of this Agreement. The obligations of EXECUTIVE and the rights and remedies of the Company under this Agreement are cumulative and in addition to, and not in lieu of, any obligations, rights, or remedies created by applicable patent, copyright, or other laws, including the statutory and common laws governing unfair competition, misappropriation or theft of trade secrets, proprietary rights, or Trade Secrets generally. SECTION 4.04 ATTORNEYS' FEES. ---------------- In the event of any dispute involving the subject matter of this Article IV (including an arbitration if applicable), the substantially prevailing party shall be entitled to his or its reasonable attorneys' fees and court or arbitration costs incurred in resolving or settling the -8- 9 dispute, in addition to any and all other damages or relief which a court or arbitrator may deem proper. With the exception of a resolution of a dispute relating to this Article, the parties agree that the prevailing party does not have a right to collect attorneys' fees, unless specifically provided for by law. ARTICLE V. MUTUAL RELEASE OF ANY AND ALL CLAIMS SECTION 5.01 RELEASE OF ALL CLAIMS BY EXECUTIVE AGAINST COMPANY. --------------------------------------------------- Effective as of the Termination Date, EXECUTIVE irrevocably and unconditionally, fully and forever releases and discharges the Company and the Company's parents, shareholders, successors, assigns, directors, officers, agents, and representatives and subsidiaries (collectively, the "Company Group") from any and all claims, demands, actions, causes of action (whether at law or in equity), suits, and administrative actions or proceedings, of every kind and nature, whether known or unknown, past or present, suspected or unsuspected, foreseeable or unforeseeable, whether or not heretofore asserted, that EXECUTIVE may now have, have ever had, or in the future may have against the Company or any other member of the Company Group for any losses, liabilities, damages (of any kind or nature), obligations, debts, indebtedness, costs, expenses, or fees (including, without limitation, attorneys' fees), which in any way have arisen from or are related to: (I) the Employment Agreement or EXECUTIVE'S employment with the Company; (II) the termination of the Employment Agreement or EXECUTIVE'S separation from the Company; or (III) any discriminatory conduct or consequences, whether arising under (A) Title VII of the Civil Rights Act of 1964, (race, color, religion, sex, and national origin discrimination), (B) 42 U.S.C. Section 1981 (discrimination), (C) 29 U.S.C. Section 621-634 (age discrimination), (D) 29 U.S.C. Section 206(d)(1) (equal pay), (E) The Americans with Disabilities Act (disability discrimination) or (E) The California Fair Employment and Housing Act (discrimination including race, color, national origin, ancestry, physical handicap, medical condition, marital status, sex, or age); (IV) retaliation or constructive or wrongful discharge relating to any allegation of the above claims; (V) any claim that the Company violated any law or public policy, (e.g. "whistle blower" claims or "qui tam" claims); (VI) any past compensation, including regular wages, bonuses, commissions, overtime and liquidated damages, or benefits relating to EXECUTIVE'S employment with the Company Group; (VII) any claim capable of being raised in any complaint filed with the United States Department of Labor ("DOL"), the California Department of Fair Employment and Housing or the California Division of Labor Standards Enforcement against the Company Group; (VIII) any claim that the Company Group has violated any written, oral, or implied release with EXECUTIVE; (IX) any claim of breach of any express or implied covenant of good faith and fair dealing; (X) any claims in tort including, but not limited to, intentional infliction of mental or emotional distress, interference with business or employment relationship, invasion of privacy, defamation of character, slander, libel, negligent supervision, gross negligence, or negligence -9- 10 of any kind; (XI) any claim of personal injury or unreported work-related injury arising from or relating to any act or omission by the Company Group; (XII) any claim that the Company Group has violated EXECUTIVE'S rights, if any, under the Constitutions of the United States or the state of California. SECTION 5.02 INDEMNIFICATION AND RELEASE OF CLAIMS BY COMPANY. ------------------------------------------------- 5.02.01 Release of all Claims by Company against EXECUTIVE. --------------------------------------------------- Effective as of the Termination Date, the Company Group hereby irrevocably and unconditionally, fully and forever releases and discharges EXECUTIVE, from any and all claims, demands, actions, causes of action (whether at law or in equity), suits, and administrative actions or proceedings, of every kind and nature, whether known or unknown, past or present, suspected or unsuspected, foreseeable or unforeseeable, whether or not heretofore asserted, that Company or any member of the Company Group may now have, have ever had, or in the future may have, for any losses, liabilities, damages (of any kind or nature), obligations, debts, indebtedness, costs, expenses, or fees (including, without limitation, attorneys' fees) which in any way have arisen from or are related to: (I) the Employment Agreement or EXECUTIVE'S employment with the Company; (II) EXECUTIVE'S conduct as a officer, director and employee of the Company or any of the subsidiaries of the Company; (III) EXECUTIVE'S conduct outside of the scope of his employment, which occurred prior to the Termination Date. 5.02.02 Indemnification of EXECUTIVE by Company. ---------------------------------------- Company will indemnify EXECUTIVE to the extent required by Labor Code Section 2802, which provides: "An employer shall indemnify his employee for all that the employee necessarily expends or loses in direct consequence of the discharge of his duties as such, or of his obedience to the directions of the employer, even though unlawful, unless the employee, at the time of obeying such directions, believed them to be unlawful." In addition to the above, the Company and EXECUTIVE are currently named as defendants in various law suits alleging violation of the federal securities laws. Company will indemnify EXECUTIVE for any actions in violations of the securities laws to the extent that the Company provides such indemnification to its current officers and directors under its Certificate of Incorporation or to the extent that the Company and its current directors and officers are insured for such liability. If EXECUTIVE is required to sue Company to enforce the terms of this Section 5.02, and EXECUTIVE prevails in the lawsuit, EXECUTIVE shall be entitled to reasonable attorney's fees incurred in bringing such suit. -10- 11 SECTION 5.03 SPECIFIC WAIVER OF ANY UNKNOWN CLAIMS. -------------------------------------- Effective as of the Termination Date, each party expressly waives and relinquishes all rights and benefits afforded by Section 1542 of the Civil Code of the State of California, and does so understanding and acknowledging the significance of such specific waiver of Section 1542. Section 1542 of the Civil Code of the State of California states as follows: A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor. Thus, notwithstanding the provisions of Section 1542, and for the purpose of implementing a full and complete release and discharge of all claims by either party, EXECUTIVE and all members of the Company Group expressly acknowledge that this Agreement is intended to include in its effect, without limitation, all claims which either party does not know or suspect to exist in its favor at the time of execution hereof, and that this Agreement contemplates the extinguishment of any such claim or claims. This waiver, however, does not extend to any actions or claims, which may arise after execution of this Agreement. SECTION 5.04 NO CLAIMS OR ASSIGNMENT OF CLAIMS. ---------------------------------- EXECUTIVE represents and warrants to the Company and to all members of the Company's Group that he has not suffered any workplace injury and that he has not made or commenced, and will not make or commence, any claim with any governmental or administrative agency, department, or other regulatory body, whether federal, state, or local, that in any way relates to his employment with or severance from the Company and from any of its subsidiaries or affiliates. EXECUTIVE further represents and warrants to the Company and to all members of the Company's Group that no portion of any claim, right, demand, action, or cause of action that he has or may have arising out of or relating to his employment with or severance from the Company (or any subsidiary or affiliate thereof), nor any portion of any recovery or settlement to which he might be entitled, has been assigned or transferred to any individual or entity in any manner whatsoever, including by way of subrogation, operation of law, or otherwise. SECTION 5.05 EFFECT OF SETTLEMENT. --------------------- The parties hereto expressly acknowledge and agree that this Agreement pertains to disputed issues or claims and that any settlement discussions, including proposing, negotiating, and entering into this Agreement, neither indicate nor constitute an admission of any liability or wrongdoing of any nature whatsoever by any party hereto. By considering, negotiating, and entering into this Agreement, the parties hereto are simply buying their peace and avoiding any potential legal costs or expenses. Therefore, this Agreement shall not be used as evidence -11- 12 of any liability or wrongdoing for any purpose whatsoever except as may be necessary to enforce the terms and conditions of this Agreement. ARTICLE VI. NOTICES ------- Any and all notices, requests, consents, demands, and/or other communications required or permitted to be given hereunder shall be in writing and shall be deemed to have been duly given (i) when delivered, if sent by United States registered or certified mail (return receipt requested), (ii) when delivered, if delivered personally by commercial courier, or (iii) on the next following business day, if sent by United States Express Mail or overnight courier, in each case to the parties at the following addresses (or at such other addresses as shall be specified by like notice) with postage or delivery charges prepaid: If to the Company: PacifiCare Health Systems, Inc. 3120 Lake Center Drive Santa Ana, California 92799 Attn: President If to EXECUTIVE: Mr. Wayne Lowell 6 Bayside Irvine, California 92714 ARTICLE VII. GENERAL PROVISIONS ------------------ SECTION 7.01 INTEGRATED AGREEMENT. --------------------- This Agreement, together with the Certificate of Compensation, when executed, constitutes the entire and complete understanding and fully integrated agreement between the Company and EXECUTIVE with respect to the termination of EXECUTIVE'S employment with the Company; and this Agreement and the Certificate of Compensation supersede any and all prior or contemporaneous negotiations, agreements, or communications, whether oral or written, between the Company and EXECUTIVE with respect to such matter. -12- 13 SECTION 7.02 AMENDMENTS; WAIVER. ------------------- This Agreement shall not be amended, modified, revised, or supplemented orally unless evidenced by a dated written instrument executed by the Company and EXECUTIVE. No waiver of any provision of this Agreement shall be effective unless evidenced by a dated, written instrument executed by the Company. No waiver of any provision hereof shall be construed as a further or continuing waiver of such provision or of any other provision hereof. SECTION 7.03 SEVERABILITY. ------------- If any provision in this Agreement shall be found by a court of competent jurisdiction to be invalid, illegal, or unenforceable, such provision shall be construed and enforced as if it had been narrowly drawn so as not to be invalid, illegal, or unenforceable, and the validity, legality, and enforceability of the remaining provisions of this Agreement shall not in any way be affected or impaired thereby. SECTION 7.04 GOVERNING LAW. -------------- This Agreement shall be governed by and construed in accordance with the laws of the State of California, withoUt regard to principles of conflicts of law. SECTION 7.05 SUCCESSORS AND ASSIGNS. ----------------------- This Agreement shall be binding upon the parties hereto and their respective successors, transferees, heirs, devisees, assigns, and legal representatives. SECTION 7.06 CONSTRUCTION. ------------- This Agreement has been drafted with the joint participation of each of the parties hereto and shall be construed to be neither against nor in favor of either party hereto, but rather in accordance with the fair meaning hereof. SECTION 7.07 REPRESENTATION BY LEGAL COUNSEL. -------------------------------- Each party has had an opportunity to consult with his or its legal counsel with respect to this Agreement and has entered into this Agreement, after consultation with such counsel, voluntarily, and without duress. Without limiting the generality of the foregoing, EXECUTIVE acknowledges that he is hereby advised in writing that EXECUTIVE should consult an attorney prior to executing this Agreement. EXECUTIVE represents and agrees that he fully understands his right to discuss all aspects of this Agreement with his private attorney and that he has availed himself of this right, that he has carefully read and fully understands all of the provisions of this Agreement, and that he is voluntarily entering into this Agreement after having consulted with his independent legal counsel. -13- 14 SECTION 7.08 TIME TO CONSIDER AGREEMENT. --------------------------- EXECUTIVE acknowledges that Company is giving him a period of forty-five (45) days within which to consider this Agreement, during which the offer of the provisions of this Agreement will not be revoked by Company. EXECUTIVE may accept and sign this Agreement before the expiration of the forty-five (45) day time period, but he is not required to do so and failing to do so will not prejudice him in any way as long as the Agreement is signed prior to the end of the forty-five (45) day time period. For a period of seven (7) days following the signing and submission of this Agreement to the Company, EXECUTIVE may revoke this Agreement. Any such notice of revocation must be in writing to Company's legal counsel. If EXECUTIVE has already received any payment anticipated by this Agreement, the revocation will not be effective unless the written notice is accompanied by a complete refund of all amounts paid. This Agreement shall become effective on the eighth day after EXECUTIVE signs it, if it has not been revoked during the revocation period. SECTION 7.09 SECTION HEADINGS. ----------------- The section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. SECTION 7.10 ARBITRATION. ------------ Except that any party to this Agreement may seek injunctive relief or a prejudgment attachment in a court of competent jurisdiction, and except as otherwise specifically provided for herein, any and all controversies, disputes, or claims arising out of or relating to this Agreement, or any part hereof, including, without limitation, the meaning, applicability, or scope of this Section 7.10 and to the performance, breach, interpretation, meaning, construction, or enforceability of this Agreement, or any portion hereof, and all claims for rescission or fraud in the inducement of this Agreement, shall, at the request of either party, be settled or resolved by binding arbitration. The parties shall mutually agree upon an arbitrator and rules of arbitration. If they are unable to agree on an arbitrator and arbitration rules within 45 days of a written demand for arbitration, then the parties shall arbitrate pursuant to the commercial rules and regulations of the American Arbitration Association (the "AAA") for the resolution of commercial disputes, except as modified hereinbelow. Any party requesting arbitration under this Agreement shall make a demand on the other party by registered or certified mail with a copy to the AAA. The parties consent and agree to have any such arbitration proceedings heard in Los Angeles, California, or in the place closest thereto which the AAA may select for convenience of the arbitrator(s). The arbitration shall take place as noticed by the AAA regardless of whether one side to the dispute or controversy fails or refuses to participate. The arbitrators shall apply California substantive law and federal substantive law where state law is preempted. Civil discovery for use in such arbitration may be conducted in accordance with the California Code of Civil Procedure and the California Evidence Code, and the arbitrator(s) selected shall have the power of discovery -14- 15 by the imposition of the same terms, conditions, and penalties as may be imposed in like circumstances in a civil action by a superior court of the State of California. Without limiting the generality of the foregoing, the provisions of ss.983.05 of the California Code of Civil Procedure, as amended, permitting the taking of depositions and the obtaining of discovery, are hereby incorporated in full herein by this reference. The arbitrators shall have the power to grant all legal and equitable remedies and award compensatory damages provided by California law. The arbitrators shall prepare in writing and provide to the parties an award including factual findings and the legal reasons on which the decision is based. The arbitrators shall not have the power to commit errors of law or legal reasoning and the award may be vacated or corrected pursuant to California Code of Civil Procedure ss.986.2 or ss.986.6 for any such error. Judgment upon any award may be entered in any court having jurisdiction thereof. SECTION 7.11 COUNTERPARTS. ------------- This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original and all of which shall be considered one and the same agreement. IN WITNESS WHEREOF, the Company and EXECUTIVE have executed this Agreement as of the day and year first written above. THE COMPANY: PACIFICARE HEALTH SYSTEMS, INC., a Delaware corporation By: [SIG] ------------------------------ Title: Secretary ------------------------------ EXECUTIVE: [SIG] ------------------------------------- Wayne Lowell EX-27.1 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFICARE HEALTH SYSTEMS, INC.'S UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1998, AND RELATED UNAUDITED CONSOLIDATED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 235,693 926,652 352,579 26,236 0 1,632,302 370,999 141,854 4,494,881 1,212,307 0 0 105 421 2,083,169 4,494,881 0 2,381,950 0 2,008,501 300,813 136 17,518 80,286 38,940 41,346 0 0 0 41,346 0.93 0.90
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