-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, TocZIXxo+nCzPDMlK2NDLY2nd8OXLK0aTYtHUkjgxv8W/6ZoPfNCe+AukLN6No2Y ej0ug/AoQkkIMUZGGXwMjw== 0000912057-94-004016.txt : 19941128 0000912057-94-004016.hdr.sgml : 19941128 ACCESSION NUMBER: 0000912057-94-004016 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19940830 FILED AS OF DATE: 19941123 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFICARE HEALTH SYSTEMS INC CENTRAL INDEX KEY: 0000766456 STANDARD INDUSTRIAL CLASSIFICATION: 6324 IRS NUMBER: 330064895 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-14181 FILM NUMBER: 94561599 BUSINESS ADDRESS: STREET 1: 5995 PLAZA DR CITY: CYPRESS STATE: CA ZIP: 90630 BUSINESS PHONE: 7149521121 MAIL ADDRESS: STREET 1: 5995 PLAZA DRIVE CITY: CYPRESS STATE: CA ZIP: 90630 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1994 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to ____________________________ Commission File Number 0-14181 PACIFICARE HEALTH SYSTEMS, INC. (Exact name of registrant as specified in its Charter) Delaware 33-0064895 (State or other jurisdiction of (IRS Employer Identification Number) incorporation or organization) 5995 Plaza Drive, Cypress, California 90630-5028 (Address of principal executive offices, including zip code) (Registrant's telephone number, including area code) (714) 952-1121 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, par value $0.01 Class B Common Stock, par value $0.01 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ X ]. The aggregate market value of voting stock held by non-affiliates of the Registrant on November 1, 1994, was approximately $446,411,000. The number of shares of Class A Common Stock and Class B Common Stock outstanding at November 1, 1994, was 12,249,033 and 15,291,879, respectively. DOCUMENTS INCORPORATED BY REFERENCE DOCUMENT WHERE INCORPORATED Portions of the Registrant's definitive Proxy Statement to be filed by January 28, 1995 Part III PART I ITEM 1. BUSINESS PacifiCare [REGISTERED TRADEMARK] Health Systems, Inc. (the "Company") is one of the nation's leading managed health care services companies which arranges for the delivery of a comprehensive range of health care services, primarily through its health maintenance organization ("HMO") operations, for more than 1.3 million commercial, Medicare and Medicaid members. The Company serves the group employer market through seven wholly-owned HMOs located in California, Florida, Oklahoma, Oregon, Texas and Washington, which as of September 30, 1994 had a combined commercial membership of approximately 949,000 members. Since 1985, the Company has arranged for health care services to Medicare beneficiaries through its Secure Horizons[REGISTERED TRADEMARK] programs pursuant to capitated risk contracts with the Health Care Financing Administration ("HCFA"). Secure Horizons is the largest Medicare risk program in the nation and the Company believes one of the fastest growing (in terms of membership) Medicare risk programs in the United States. As of September 30, 1994, the Company had approximately 409,000 members enrolled in its government (Medicare and Medicaid) programs. The Company's commercial and government program members are provided some or all of the following health care services, including primary and specialty physician care, hospital care, laboratory and radiology services, prescription drugs, dental and vision care, skilled nursing care, physical therapy and psychological counseling. The Company also offers certain specialty products and services to group purchasers and to other managed care organizations and their beneficiaries, including Medicare risk management services, pharmacy benefit management, military health care management, coordination of managed care products for multi-region employers, health and life insurance, behavioral health, workers' compensation, dental and vision services and health promotion. The Company believes that its ability to provide a wide range of products and services through its commercial and government programs, together with its specialty managed care programs, will enable it to respond effectively to changes and needs in the health care marketplace. THE MANAGED CARE INDUSTRY Health care costs in the United States have risen from $27 billion in 1960, comprising five percent of gross domestic product, to more than $1 trillion in 1994 comprising more than 14 percent of gross domestic product. In response to the rapid increases in health care costs, employers, insurers, government entities and health care providers have sought cost-effective alternatives to conventional indemnity insurance for the delivery of and payment for quality health care services. The integration of the delivery of, and payment for, health care services distinguishes HMOs from conventional health insurance plans. HMOs emerged as an alternative to conventional health insurance plans following enactment of the Federal Health Maintenance Organization Act of 1973 (the "HMO Act"), a statute designed to encourage the establishment and expansion of HMOs. The number of HMOs in the United States grew from 175 in December 1976 to more than 550 in December 1994. Over this period, HMO enrollment increased at an annual compound rate of approximately 13 percent, from approximately 6 million members in December 1976 to an estimated 50 million members in December 1994. The rate of increase in HMO membership has moderated in recent years in response to increased competition from other types of managed health care options, such as preferred provider organizations ("PPOs") and certain employer self-funded programs. In addition, in some geographic markets such as California, large employers have reduced the number of HMO options offered to their employees. The Company believes that the ability to offer broad geographic or statewide service and a wide range of specialty managed health care products and services have become key competitive factors in achieving greater economies of scale in the provision of more cost-effective health care services and in attracting and retaining membership. 2 HEALTH CARE SERVICES There are four basic organizational models of HMOs that are primarily distinguishable by the HMO's relationship with its physician providers and the capital intensiveness of its operations. GROUP HMOs contract with one large multi-specialty medical group practice which typically receives a monthly fixed fee, known as a capitation fee, for each HMO member, regardless of the number of physician visits. NETWORK HMOs contract with more than one physician group to provide services generally on a capitation fee basis. INDIVIDUAL PRACTICE ASSOCIATION ("IPA") HMOs contract with independent physicians who are broadly dispersed throughout a community and who see patients in their own offices in exchange for a monthly capitation fee or on a discounted fee basis. STAFF HMOs employ the physician and, ordinarily, use capital to provide the facility in which the physician sees patients. The physician receives a salary and/or bonus typically based on the performance of the HMO. The Company primarily operates network and group HMOs and, to a lesser extent, IPA and staff model HMOs. In order to enhance cost and quality control, the Company may, in certain instances, expand its current involvement with health care providers by making investments in their operations or in health care facilities. Members of the company's HMOs are offered a range of health care services. These services generally include the following: MEDICAL SERVICES. Primary care and specialist physician services, laboratory and radiology services, family planning, health education and home services, outpatient surgery and certain other outpatient services in which hospitalization is not medically necessary or appropriate. HOSPITAL SERVICES. Inpatient acute care, including room and board, medical and surgical services, and care in skilled nursing facilities. OTHER SERVICES. Emergency room, ambulance and out-of-area emergency services, supplemental benefits for prescription drugs, durable medical equipment and chiropractic, behavioral health, vision and dental services. HMO OPERATIONS The Company's total membership grew to approximately 1,358,000 at September 30, 1994 from approximately 246,000 at September 30, 1987, a compound annual growth rate of approximately 28 percent. The Company anticipates that its future growth will be enhanced by the expansion of its government programs, acquisitions, expansion into new markets, the marketing of a broader range of managed care products and services and the development of nationwide servicing capabilities. The Company has also developed point-of-service plans, which combine the features of an HMO (a defined provider network providing care to members with reduced deductibles and co-payments) with the features of a traditional indemnity insurance product (the freedom to use any physician, with higher deductibles and co-payments). 3 The following table provides a breakdown of the Company's membership at September 30, 1994:
GOVERNMENT (MEDICARE & COMMERCIAL MEDICAID) COMBINED PERCENT OF TOTAL ---------------------------------------------------------------------------- California 627,161 295,123 922,284 67.9% Florida 58,597 10,007 68,604 5.0 Oklahoma 113,117 11,933 125,050 9.2 Oregon 58,512 38,616 97,128 7.2 Texas 62,320 36,834 99,154 7.3 Washington 29,417 16,582 45,999 3.4 ---------------------------------------------------------------------------- Total Membership 949,124 409,095 1,358,219 100.0% ---------------------------------------------------------------------------- ----------------------------------------------------------------------------
COMMERCIAL MEMBERS The Company's commercial membership grew to approximately 949,000 at September 30, 1994 from approximately 175,000 at September 30, 1987, a compound annual growth rate of approximately 27 percent. Commercial members generally join the Company's HMOs through an employer, which typically offers employees a selection of indemnity insurance and managed health care plans, pays for all or part of the monthly costs thereof and makes payroll deductions for any costs payable by the employee. During a designated annual "open enrollment period," employees may select their desired health care coverage. New employees select their health care coverage at the time of their employment. Monthly premium rates are negotiated between the Company and the employer and are typically fixed for a one-year period, although there is generally no requirement that the employer offer the Company's services after the expiration of such period. For the commercial employer market, the Company offers a range of benefit plan options that generally vary only in the level of co-payments required for physician office visits, inpatient hospitalization and certain other services. A co-payment is a nominal charge paid by the member, generally at the time of service. The Company believes that such co-payments are useful in helping contain the costs of health care without providing a barrier to members seeking needed health care services. The Company also offers, at an additional premium, supplemental benefits such as outpatient prescription drug, dental, vision and chemical dependency services. These services are generally provided through subcontracting or referral relationships with other health care providers. The Company's 25 largest employer groups as of September 30, 1994 accounted for approximately 38 percent of total commercial membership, with the largest employer group comprising approximately eight percent of total commercial membership. The Company's five largest employer groups provided, in the aggregate, approximately 23 percent of its commercial revenue for the fiscal year ended September 30, 1994. GOVERNMENT MEMBERS The Company's government membership grew to approximately 409,000 at September 30, 1994 from approximately 71,000 at September 30, 1987, a compound annual growth rate of approximately 28 percent. Since 1985, the Company has provided health care services to Medicare beneficiaries through its Secure Horizons programs pursuant to annual contracts with HCFA. These contracts entitle the Company to a fixed fee-per-member premium (a "risk contract") and are subject to periodic unilateral revisions based on certain demographic information relating to the Medicare population and the cost of providing health care in a particular geographic area. Secure Horizons is the largest Medicare risk program in the nation and the Company believes one of the fastest growing (in terms of membership) Medicare risk programs in the United States. As a risk contractor, in addition to the payment of a fixed fee-per-member premium by the member, Secure Horizons is reimbursed by the federal government for the projected cost of health care services. Members in the Secure Horizons programs are enrolled on an individual basis and may disenroll upon 30 days' notice. The Company believes that its Secure Horizons programs are attractive to Medicare beneficiaries because these programs provide a more comprehensive package of benefits than offered under traditional Medicare, and because these programs substantially reduce the member's administrative responsibilities. 4 The Company's Medicare contracts are automatically renewed every 12 months unless the Company or HCFA elects either not to renew or to terminate them. HCFA may unilaterally terminate the Company's Medicare contracts if the Company fails to continue to meet compliance and eligibility standards. This could have a material adverse effect on the Company. Because the use of health care services by Medicare recipients generally exceeds the use of services by those who are under the age of 65, the Company's Medicare contracts provide for substantially larger revenue per member than do the Company's non-Medicare plans. Premium revenue for each Secure Horizons member is more than three times that of a commercial member, reflecting, in part, the higher medical and administrative costs of serving a Medicare member. As a result, although members in the Secure Horizons programs represented approximately 30 percent of the Company's membership at September 30, 1994, they accounted for approximately 57 percent of the consolidated premium revenue for the fiscal year ended September 30, 1994. Such programs, however, also are subject to certain risks relative to commercial programs, such as higher comparative medical costs, higher levels of utilization, government and regulatory reporting requirements, the possibility of reduced or insufficient government reimbursement in the future and higher marketing and advertising costs associated with selling to individuals rather than to groups. The Company's Secure Horizons programs are not permitted, under federal regulations, to account for more than one-half of the Company's total HMO members in each of the Company's non-contiguous geographic state markets. This limitation may constrain the Company's rate of growth in expansion of markets where the Company is able to add Medicare members at a faster rate than commercial members. In response to employer's needs to provide cost-effective health care coverage for their retired employees who may not be currently eligible for Medicare benefits, the Company developed the Secure Horizons retiree product. This product takes advantage of PacifiCare's expertise developed in its traditional Medicare risk programs. The premium and provider networks are the same as in the Company's Secure Horizons programs. The retiree product provides the Company with access to individuals who, once familiar with the Company's services and delivery system, may enroll in Secure Horizons programs after they become eligible for Medicare benefits. Since 1993, the Company has arranged for health care services to Medicaid eligibles through its HMO subsidiaries pursuant to annual contracts with the Department of Health and Human Services ("HHS"). Currently, the Company has the ability to arrange for health care services to Medicaid eligibles in California, Florida and Oregon and is developing the capacity to enroll Medicaid eligibles in Oklahoma and Texas. The Company receives a capitated payment for each Medicaid member from HHS similar to payments received by the Company from HCFA in connection with the Secure Horizons programs. Although the benefits available to Medicaid eligibles are extensive, the Company believes that its Medicaid programs are attractive to Medicaid eligibles because these programs provide access to quality health care providers, continuity of medical care and an introduction into mainstream managed care. The Company's Medicaid contracts with HHS are renewed on an annual basis. PROVIDER ARRANGEMENTS The Company contracts with more than 330 physician groups for a defined range of health care services. The Company pays for health care services provided by physicians or physician groups by paying a monthly fee, or capitation payment, based on a percentage of premium revenue or per-member-per- month fee for each member assigned to the group. The capitation payment rate is negotiated annually in advance with each physician or physician group and does not subsequently vary with the nature or extent of services provided. Except as provided below, generally, there is no requirement that the provider continue its relationship with the Company upon expiration of the annual period. The Company may make incentive payments to the physician or physician group based on performance relative to budgeted targets. The Company believes that these methods of physician reimbursement encourage efficient utilization of health care services by its providers. To develop more strategic and long term alliances with certain physician groups which currently contract with the Company (the "Groups"), the Company, in September 1994, commenced a public offering of 750,000 shares of the Company's non-voting Class B Common Stock, par value $0.01 per share (the "Class B Common Stock"), to approximately 50 of such Groups. If a Group agrees to purchase shares in the offering, it will enter into an agreement whereby it will be irrevocably obligated to purchase a fixed number of shares of the Class B Common Stock. The 5 purchase price for the shares will be fixed and payable over a five year period. To date, the Company has not entered into any agreements with any of the groups to sell shares under this offering. The Company contracts with 478 hospitals for hospital services under a variety of arrangements including per diem, percentage of premium or per-member- per-month capitation, discounted fee-for-service, flat fee and fee-for-service arrangements. The loss of contracts with certain physician groups and with certain hospitals could have a material adverse effect on the Company's HMO operations. QUALITY ASSURANCE The Company evaluates the quality and appropriateness of medical care provided to its HMO members by performing medical care evaluation and member satisfaction studies, by reviewing the utilization of certain services and by responding to member and physician complaints. These evaluations are based on statistical information compiled by the Company concerning the utilization of various health care services and on-site reviews of medical records at the medical groups. The Company has established a peer review procedure, which is implemented at each HMO by a Quality Assurance Committee chaired by the HMO's Medical Director and comprised of physicians and representatives of the physician groups. When a new physician or physician group is considered by the Company as a potential provider, the Company seeks to evaluate, among other things, the quality of the physician or group's medical facilities, medical records, laboratory and x-ray licenses and the capacity to handle membership demands. Once selected, a physician or group is periodically reviewed to monitor whether members are receiving quality medical care. The Company also has a member services department to respond to membership questions and complaints. The Company's California commercial and Secure Horizons HMO programs are accredited by the National Committee for Quality Assurance ("the "NCQA"), a non- profit institution which represents the interest of health care purchasers and consumers as well as health care organizations. The California commercial and Secure Horizons HMO programs received full accreditation from the NCQA in 1992. PacifiCare's California and Secure Horizons HMO programs were the first HMOs in California to be accredited. CONTROL OF HEALTH CARE COSTS The Company manages health care costs primarily by entering into contractual arrangements with health care providers and by sharing the risk of certain health care costs with the Company's contracting physicians or groups and hospitals. The Company's HMOs arrange for comprehensive health care services for their members principally through capitation, a fixed monthly payment made without regard to frequency, extent or nature of the health care services actually furnished. Benefits are provided to enrolled members generally through the Company's contractual relationships with physician groups and hospitals. For the year ended September 30, 1994, physician and hospital capitation represented 56 percent and 69 percent, respectively, of total health care costs for both the commercial and government programs combined. The focus for medical utilization and cost control in the Company's HMOs is the primary care physician or group (family practice, internal medicine, pediatrics) which directs referrals, hospitalization and other services and is responsible for any related payments to those referral providers. The primary care physician or group is selected by the HMO member as the member's personal physician or group. In order to manage hospital and other health care costs, the Company provides additional incentives to the physicians or groups for appropriate utilization of hospital inpatient, outpatient, surgery, and emergency room services. The Company also operates a utilization review system, under which routine hospital admissions and lengths of stay are reviewed by utilization review committees comprised of several physicians at each physician group. The committees approve non-emergency hospitalizations in advance. After admission, the committees, together with the Company's medical services utilization staff, carefully monitor the member's continued stay. The Company, through its medical services department, becomes actively involved in the utilization review of longer, more costly hospitalizations and emergencies. This department also becomes involved in the field to monitor catastrophic cases in an effort to provide members appropriate medical care and suggest treatment options that may be more appropriate and cost-effective than a long-term hospital stay. 6 The profitability of the Company is dependent on maintaining effective control over health care costs. New technologies, inflation, hospital costs, major epidemics and numerous other external factors may affect the ability of HMOs, including the Company's HMOs, to control health care costs. RISK MANAGEMENT In addition to the Company's cost control systems, the use of underwriting criteria is an integral part of its risk management efforts. Underwriting is the process by which a health plan assesses the risk of enrolling employer groups and establishes appropriate or necessary premium rates. Utilizing underwriting criteria, the Company seeks to avoid contracting with employers whose employees are likely to experience an actuarially higher than expected need for medical care. Underwriting techniques are not employed with small employers (defined as groups with four to 50 employees) or with the government programs because of regulations which require the Company to accept all such employer groups and all Medicare and Medicaid applicants. In addition, the Company shifts part of the risk of catastrophic losses by maintaining reinsurance coverage for hospital costs incurred in the treatment of catastrophic illnesses of its members. The Company also maintains general liability, property, insolvency and medical malpractice insurance coverage in amounts that the Company believes are adequate. The Company requires contracting physicians, physician groups and hospitals to maintain individual malpractice insurance coverage. Such insurance may become increasingly important if plaintiffs prove successful in recent efforts to expand the liability of an HMO for negligence, including the negligence of providers with whom it directly or indirectly contracts. The Company has from time to time been subject to litigation, including claims for punitive or bad faith damages, which are not covered by insurance. MARKETING The Company solicits new employer groups of various sizes through direct, personal selling efforts and through contacts with insurance brokers and consultants. Many employer groups under contract with the Company are represented by insurance brokers and consultants who work with the employer to recommend or design employee benefits packages. Brokers are paid on a commission basis by the Company over the life of the contract, while consultants generally are paid by the employer. In response to increased HMO penetration of employer groups in the southern California service area, the Company has developed a marketing strategy to strengthen and increase its market share by increasing penetration in existing employer groups and by increasing access to new populations through expansion of its delivery network. This strategy includes implementing a telemarketing program and using extensive market research. Marketing efforts are also supported by an advertising program that includes television, radio, billboard and print media. The Company believes that its continued success will be influenced by its ability to offer a diverse set of products and services in its existing markets as well as to new geographic areas and market segments. The Company believes its experience in developing and marketing products to the competitive southern California market and its other current markets should improve its ability to compete successfully in new market areas. Marketing the Company's HMOs to commercial members generally involves a two-part sale. The employer must decide to offer the Company's HMO; then the employee generally must choose from among the Company's HMOs and other health care coverage options, often including other HMOs. The Company utilizes various techniques to attract commercial members during open enrollment periods, including work site presentations, direct mail, medical group tours and local advertising. A significant portion of the Company's commercial membership growth comes from existing employer groups. The Company markets the Secure Horizons program to Medicare beneficiaries through direct mail, telemarketing, television, radio and cooperative advertising with participating medical groups. The Company anticipates further growth opportunities in the Medicare risk program based on the Company's current marketing strategies and the growing senior population in the United States. The Company markets the Medicaid programs directly to Medicaid eligibles as the various state laws permit. In Los Angeles, pursuant to MediCal requirements, presentations of the health care programs, including the Company's Medicaid program, available to Medicaid eligibles are made by independent third parties to Medicaid eligibles. 7 SPECIALTY MANAGED CARE SERVICES In addition to its HMO operations, the Company provides a wide range of specialty managed care products and services. The Company believes that such service diversification complements the Company's core HMO business and, given increasing market demand for greater choice and flexibility in the design of health care products and funding arrangements, will contribute to the Company's competitive position in the health care services marketplace. These services are offered to HMOs, insurers, employers, governmental entities, providers and PPOs through the following affiliated operations: SECURE HORIZONS[REGISTERED TRADEMARK]USA ("SHUSA") was formed in March 1993 to take advantage of the Company's expertise in the Medicare risk area. SHUSA is authorized to license the use of the Secure Horizons service mark, trade name and systems, in exchange for license fees, to qualified HMOs that want to engage in Medicare risk contracting. SHUSA provides consulting, marketing, provider contracting, administrative services and other various services in support of the operation of a Medicare risk program by such HMOs. SHUSA intends to be reimbursed for its expenses and to receive a percentage of the revenue derived from each program in the form of license fees. SHUSA may also enter into joint ventures related to Medicare risk contracting. In September 1993, SHUSA formed an alliance with Tufts Associated Health Maintenance Organization, Inc. ("Tufts") to develop and implement the Secure Horizons Medicare risk program in New England. Through the alliance, Tufts operates Secure Horizons, Tufts Health Plan for Seniors, under a license from and with the assistance of SHUSA. As of October 1, 1994, Tufts began enrolling Medicare beneficiaries in the Boston area in the Medicare risk plan. It is ultimately intended that the Medicare risk plan will be offered throughout Massachusetts and other parts of New England. PRESCRIPTION SOLUTIONS[REGISTERED TRADEMARK] was established in May 1993 as an administrative division of PacifiCare Pharmacy Centers, Inc. to offer pharmacy benefit management services to HMOs, third-party administrators, self- insured companies and union trusts throughout the nation. Clients of Prescription Solutions have access to a pharmacy provider network that features independent and chain pharmacies, as well as a variety of cost and quality management capabilities. The Company estimates that Prescription Solutions currently represents more than two million lives. PACIFICARE LIFE AND HEALTH INSURANCE COMPANY-SM- ("PLHIC"), formerly Columbia General Life Insurance Company, is a health and life insurance company incorporated in Indiana and licensed to operate in 37 states, including California, Florida, Oklahoma, Oregon and Texas and in the District of Columbia. The Company, through PLHIC, offers employer groups managed health care insurance products which have been integrated with its existing HMO products to form multi-option health benefits programs. LIFELINK-SM-, INC. ("LifeLink") is licensed by the California Department of Corporations as a specialized health care service plan. In California, LifeLink provides mental health and chemical dependency benefit programs, on a capitated basis, directly to corporate customers and indirectly through the Company's California HMO to its commercial members. Outside of California, PacifiCare Behavioral Health, Inc. contracts with various HMOs, insurers and employers to manage their respective mental health and chemical dependency benefit programs. CALIFORNIA DENTAL HEALTH PLAN, INC. ("CDHP") and Dental Plan Administrators, an affiliated company ("DPA"), were acquired in November 1993 by the Company. CDHP is a specialized health care service plan which provides prepaid dental and optometric benefits for individuals, including members of PacifiCare's California commercial and Secure Horizons programs, and employer groups. DPA is an affiliated company of CDHP that provides administrative services to CDHP and other companies. The Company will offer CDHP dental and vision plans to its clients in connection with its California commercial and government programs. CDHP will continue to market independently of the Company and to provide dental and vision benefits to its current members. COVANTAGE, INC., formerly HMO National Network, Inc., began operations in October 1990 to facilitate cooperative marketing and client support efforts between HMOs nationwide. In addition, Covantage, Inc. provides centralized marketing, billing and account servicing for multi-state employers who desire the simplicity of contracting with national carriers. PACIFICARE[REGISTERED TRADEMARK] MILITARY HEALTH SYSTEMS, INC. ("PMHS") contracted with Administrator Defense Services, Inc. ("Administrator"), formerly Uniformed Services Benefit Plans, Inc., in July 1993 to provide administrative services, on behalf of Administrator, to the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS"). 8 CHAMPUS is a Department of Defense health care program for family members and other dependents of active, retired or deceased military personnel. PMHS will serve as a managed care subcontractor to Administrator, which will provide administrative services for CHAMPUS' northern region that includes 19 northeastern and midwestern states. This CHAMPUS region encompasses more than 900,000 beneficiaries, a portion of whom will be provided services by PMHS. PMHS is currently pursuing contracts in other geographical areas. COMPREMIER-SM-, INC. ("COMPREMIER") was formed to implement a workers' compensation product designed to help control the high healthcare costs related to workers' compensation cases. COMPREMIER is licensed to operate in Los Angeles and Orange Counties, California and arranges workers' compensation health care services in exchange for a capitated fee in conjunction with self-insured companies and workers' compensation insurance carriers. After an initial phase-in period, it is expected that the Company will expand COMPREMIER in California and other states. PACIFICARE WELLNESS COMPANY ("PacifiCare Wellness"), formerly Execu- Fit[REGISTERED TRADEMARK] Health Programs, Inc., is a health promotion company which provides work-site wellness and health education programs to corporate clients throughout the United States with primary emphasis in California. Founded in 1984 and acquired by the Company in August 1991, PacifiCare Wellness' systematic approach to improving employee health includes medical fitness screenings, individualized health appraisals, wellness education seminars and health enhancement courses for the purpose of reducing employers' health care costs, increasing productivity and reducing absenteeism. TRADEMARKS The federally registered service marks PacifiCare[REGISTERED TRADEMARK] and Secure Horizons[REGISTERED TRADEMARK] are owned by the Company and are material to its business. COMPETITION The health care industry is highly competitive. The Company has many competitors, including insurance carriers, other HMOs, employer self-funded programs and PPOs, many of which have substantially larger enrollments or greater financial resources than the Company. The California market, the largest market in which the Company competes, is served by a large number of HMOs and is one of the most heavily penetrated markets in the United States. Competition for members in the Company's markets has resulted in an increase in benefits and price competition. The Company believes that the most significant factors which distinguish competing health plans, including other HMOs, are health care costs to members and employers, accessibility to health care providers, quality of care and comprehensiveness of coverage. The Company's ability to expand its operations is dependent, in part, on its ability to secure contracts with additional acceptable physician groups or to ensure that existing providers expand their operations. Achieving such objectives with physician groups is becoming more difficult due to increasing competition. Competitive factors include membership volume, fees and incentives, and administrative service capabilities. For a discussion of incentives offered by the Company to providers, see "Provider Arrangements." GOVERNMENT REGULATION The Company's HMOs are licensed and subject to periodic examination by governmental agencies and are subject to state and federal statutes and regulations which extensively regulate the activities and licensing of HMOs. Among the areas regulated by state and federal law are procedures for quality assurance, enrollment requirements, the relationship between the HMO and its health care providers and the HMO's financial condition. To remain licensed, it may be necessary for the Company's HMOs to make changes from time to time in their services, procedures, structure and marketing methods. Such changes may be required as a result of amendments to, or other significant modifications of, federal and state laws and regulations controlling the Company's HMO operations. The Company's HMOs, which are operated as subsidiaries of the Company, are subject to state regulations which require periodic financial reports from HMOs licensed to operate in their state and, in certain cases, impose minimum equity, capital, deposit and/or reserve requirements. Certain federal and/or state regulatory agencies also require the Company's HMOs to maintain restricted cash reserves represented by interest-bearing instruments which are held by trustees or state regulatory agencies. These requirements, which limit the ability of the Company's subsidiaries to transfer 9 funds to the Company, may limit the ability of the Company to pay dividends. From time to time, the Company advances funds, in the form of a loan, to its subsidiaries in order to assist them in satisfying federal or state financial requirements. One of the most significant federal laws affecting the Company is the HMO Act and the regulations promulgated thereunder by the Secretary of Health and Human Services. Among other things, the HMO Act requires federally qualified HMOs to offer a comprehensive benefit program and to have quality assurance and educational programs for both the health care professional utilized by the HMO and its members. Only HMOs that continue to meet federal criteria may retain their qualified status. HCFA requires periodic financial reports from qualified HMOs and imposes net equity, net profitability (or a plan to achieve a net operating profit within available financial resources), reserve and cash flow requirements. The Company's HMO operations, except for its Washington and Florida HMOs and portions of its California and Oklahoma HMO service areas, are federally qualified. HCFA requires that an HMO be federally qualified or meet similar requirements; therefore, the lack of federal qualification does not substantially impact the operations of the Company's HMO subsidiaries or their ability to offer the Company's Medicare risk program. In the past, federally qualified HMOs were required to set their premiums according to principles of "community rating," as established by federal statutes and regulations. Essentially, community rating required that an HMO's premium rates not vary from employer group to employer group on the basis of health services utilization experience. The HMO Act currently allows HMOs more flexibility in setting rates for specific employer groups based upon a comparison of a specific employer group's utilization and the premiums required to profitably provide health care benefits. If the Company acquires or establishes HMOs in states where it does not presently operate, it will have to comply with the applicable state statutes. The time necessary to obtain a license or to comply with state statutes varies from state to state. The Company's Secure Horizons programs provide services under contracts with HCFA and are subject to regulation by HCFA and various state agencies. HCFA requires that an HMO be federally qualified or meet similar requirements as a competitive medical plan in order to be eligible for Medicare fixed-fee-per- member contracts. As a result of HCFA's regulations governing the Company's Medicare fixed-fee-per-member programs, the "medical loss ratio" (health care expenses as a percentage of premium revenue), as determined prospectively through formulas established by HCFA for the Company's Medicare contracts in a particular region, may not be less than the medical loss ratio for the Company's non-Medicare contracts in such region. If the Company were to fall out of compliance with these regulations it would have to provide additional benefits or reduced premiums to its Medicare members, or accept a lower payment from HCFA, in order to increase the medical loss ratio for the Medicare contracts to the level of the medical loss ratio for the non-Medicare contracts. This regulation could affect the operations, profitability or business prospects of the Company. The federal and state statutes and regulations that govern the Company's HMOs are subject to change. Although the Company intends to maintain its HMOs' federal qualifications, state licenses and Medicare contracts, there can be no assurance that it can do so. As a result of the continued escalation of health care costs and the inability of many individuals to obtain health care insurance, numerous proposals relating to health care reform have been, and additional proposals may be introduced in the United States Congress and the legislatures of the states in which the Company operates or may seek to operate. The Company cannot predict what effect, if any, yet to be enacted health care legislation or proposals will have on the Company if, and when enacted. The Company believes that the current political environment in which it operates will result in continued legislative scrutiny of health care reform and may lead to additional legislative initiatives. The Company is unable to predict the ultimate impact upon the Company of any federal or state restructuring of the health care delivery or health care financing systems, but such changes could have a material adverse impact on the operations, financial condition and prospects of the Company. In July 1993, the California legislature passed, and the Governor signed, a comprehensive workers' compensation reform package, consisting of seven pieces of legislation. Some of the enacted legislation took effect immediately, while a portion became effective on January 1, 1994 and the remainder becomes effective on January 1, 1995. The reform package is intended to result in lower insurance premiums to employers and increased benefits to injured workers through changes aimed at controlling the substantial cost, reducing inefficiencies and eliminating certain abusive practices in the workers' compensation system. Specifically, the reform legislation includes provisions which will affect insurance rates paid by employers, benefits payable to disabled workers, the control of medical treatment and employer health plans relating to workplace injuries and the claims and appeals process for compensation awards. 10 Legislation has become effective in California that requires all HMOs and insurers which offer coverage to small employers (defined as groups with four to 50 employees) to guarantee coverage to their employees seeking coverage regardless of their health status. The legislation also requires renewal of these small group employer plans, limits rate renewal increases, mandates community rating and excludes coverage of pre-existing conditions for six months after enrollment. In addition, the legislation requires HMOs and insurers that offer coverage to small employers to accept all small employers who apply for coverage. The Company has in the past considered the health status of all potential enrollees in groups consisting of three to 25 enrollees when determining whether to offer coverage to such groups. EMPLOYEES As of September 30, 1994, the Company had 3,856 full and part-time employees. None of the Company's employees are presently covered by a collective bargaining agreement and the Company has not experienced any work stoppage since its organization. The Company considers its relations with its employees to be good. ITEM 2. PROPERTIES As of September 30, 1994 the Company had leases, in the aggregate, for approximately 760,000 square feet of office space for its corporate headquarters, executive offices, regional offices and subsidiary operations in California, Florida, Oklahoma, Oregon, Texas and Washington. Of this aggregate amount, the Company had leases for its corporate headquarters and executive offices of approximately 105,000 square feet in Cypress, California. The Company owns an office building of approximately 200,000 square feet on approximately 9.2 acres of land in Cypress, California which serves as the executive and administrative offices of its California HMO operation. The Company also owns a fifty percent interest in a parcel of undeveloped land of approximately 8.5 acres in Cypress, California. Additionally, the Company owns a child care facility on one acre of land in Cypress, California and an office building on 1.4 acres on land in Tustin, California. The Company considers its facilities to be in good working condition, well maintained and adequate for its present needs. ITEM 3. LEGAL PROCEEDINGS The Company is involved in legal actions in the normal course of business, some of which seek substantial monetary damages, including claims of punitive damages which are not covered by insurance. After review, including consultation with counsel, management believes any ultimate liability in excess of amounts accrued which could arise from the actions would not materially affect the Company's consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the three months ended September 30, 1994. 11 PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND QUARTERLY INFORMATION The Class A Common Shares, par value $0.01 per share (the "Class A Common Stock"), and the Class B Common Stock are traded on the over-the-counter market and are quoted on the NASDAQ National Market System under the symbols PHSYA and PHSYB, respectively. The following tables set forth, for the indicated periods, the high and low last reported sale prices per share of the Class A and Class B Common Stock as furnished by NASDAQ.
CLASS A CLASS B COMMON STOCK COMMON STOCK -------------------- ------------------------ HIGH LOW HIGH LOW -------------------- ------------------------ 1993 First Quarter 51 38 44 3/4 32 1/2 Second Quarter 56 3/4 30 1/2 49 20 5/8 Third Quarter 44 34 40 28 5/8 Fourth Quarter 43 3/4 31 40 3/4 29 1/2 1994 First Quarter 42 1/4 31 41 1/2 29 7/8 Second Quarter 57 38 1/4 56 3/8 37 3/4 Third Quarter 59 3/4 47 1/2 59 1/2 47 1/2 Fourth Quarter 79 3/16 47 75 46
The Company has never paid any cash dividends on its common stock and presently anticipates that no cash dividends on its common stock will be declared in the foreseeable future and that all of its earnings will be retained for development of the Company's business. Any dividends will depend upon future earnings, the financial condition of the Company and regulatory requirements. As of September 30, 1994 there were approximately 286 and 237 shareholders of record of the Company's Class A Common Stock and Class B Common Stock, respectively. Based upon information available to it, the Company believes that there are at least 23,000 beneficial holders in the aggregate of the Class A and Class B Common Stock. 12 ITEM 6. SELECTED FINANCIAL DATA The following selected financial and operating data are derived from the audited financial statements of the Company and its subsidiaries. The selected financial and operating data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and also with "Item 8. Financial Statements and Supplementary Data."
INCOME STATEMENT DATA YEARS ENDED SEPTEMBER 30 (in thousands, except per share data) 1994(1) 1993 1992 1991 1990 - ------------------------------------------------------------------------------------------------------------------- Operating revenue $ 2,893,252 $ 2,221,073 $ 1,686,314 $ 1,242,357 $ 975,849 - ------------------------------------------------------------------------------------------------------------------- Expenses: Health care services 2,374,258 1,850,469 1,393,645 1,053,239 840,534 Other operating expenses 398,064 283,360 232,120 159,384 120,927 - ------------------------------------------------------------------------------------------------------------------- Operating income 120,930 87,244 60,549 29,734 14,388 Interest income, net 24,538 21,083 14,303 14,787 13,300 Gain on sale of Austin, Texas operations - - - - 1,750 - ------------------------------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of a change in accounting principle 145,468 108,327 74,852 44,521 29,438 Provision for income taxes 60,875 45,631 31,262 18,819 11,800 - ------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of a change in accounting principle 84,593 62,696 43,590 25,702 17,638 Cumulative effect on prior years of a change in accounting principle 5,658 - - - - - ------------------------------------------------------------------------------------------------------------------- Net Income $90,251 $62,696 $43,590 $25,702 $17,638 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Earnings per share(2): Before cumulative effect of a change in accounting principle $3.02 $2.25 $1.78 $1.10 $0.74 Cumulative effect on prior years of a change in accounting principle 0.20 - - - - - ------------------------------------------------------------------------------------------------------------------- Earnings per share $3.22 $2.25 $1.78 $1.10 $0.74 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- OPERATING STATISTICS YEARS ENDED SEPTEMBER 30 1994(1) 1993 1992 1991 1990 - ------------------------------------------------------------------------------------------------------------------- Medical loss ratio (health care services as a percent of premium revenue) 83.1% 84.1% 83.2% 85.4% 86.7% Marketing, general and administrative expenses as a percent of operating revenue 13.6% 12.6% 13.6% 12.8% 12.4% Operating income as a percent of operating revenue 4.2% 3.9% 3.6% 2.4% 1.5% Effective tax rate 41.8% 42.1% 41.8% 42.3% 40.1% Return on average shareholders' equity 24.6% 24.2% 29.2% 29.5% 29.8% - ------------------------------------------------------------------------------------------------------------------- 1 The 1994 results reflect the addition of several acquisitions. See Note 5 of Notes to Consolidated Financial Statements, page 27. 2 Adjusted to reflect the June 1992 Stock Dividend, which had the same effect on the total number of shares of common stock and equivalents outstanding as a two-for-one stock split.
13 FINANCIAL STATEMENT CHANGE STATISTICS
YEARS ENDED SEPTEMBER 30 1994(1) 1993 1992 1991 1990 - ------------------------------------------------------------------------------------------------------------------- Operating revenue 30.3% 31.7% 35.7% 27.3% 50.1% Net income 44.0% 43.8% 69.6% 45.7% 62.4% Earnings per share 43.1% 26.4% 61.8% 48.6% 54.2% Total assets 59.4% 39.3% 54.5% 39.2% 19.6% Total shareholders' equity 29.5% 60.5% 99.5% 33.7% 70.0% - ------------------------------------------------------------------------------------------------------------------- MEMBERSHIP DATA (owned and managed) SEPTEMBER 30 1994(1) 1993 1992 1991 1990 - ------------------------------------------------------------------------------------------------------------------- Commercial 949,124 806,918 742,104 567,422 545,929 Government (Medicare & Medicaid) 409,095 290,149 214,110 159,074 127,430 - ------------------------------------------------------------------------------------------------------------------- Total membership 1,358,219 1,097,067 956,214 726,496 673,359 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Percent change in membership 23.8% 14.7% 31.6% 7.9% 21.7% - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- BALANCE SHEET DATA (in thousands) SEPTEMBER 30 1994(1) 1993 1992 1991 1990 - ------------------------------------------------------------------------------------------------------------------- Cash and equivalents and marketable securities $ 710,608 $ 437,231 $ 272,135 $ 205,846 $ 160,430 Total assets $1,105,548 $ 693,646 $ 498,082 $ 322,328 $ 231,608 Medical claims and benefits payable $ 302,900 $ 255,000 $ 208,000 $ 175,700 $ 127,200 Long-term debt, excluding current maturities $ 101,137 $ 21,821 $ 18,488 $ 2,280 $ 305 Shareholders' equity $ 413,358 $ 319,294 $ 198,884 $ 99,678 $ 74,550 - ------------------------------------------------------------------------------------------------------------------- 1 The 1994 results reflect the addition of several acquisitions. See Note 5 of Notes to Consolidated Financial Statements, page 27. The 1994 results reflect the cumulative effect on prior years of a change in accounting principle. See Note 2j of Notes to Consolidated Financial Statements, page 26. The change in net income and earnings per share before cumulative effect of a change in accounting principle are 34.9 percent and 34.2 percent, respectfully.
14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FISCAL YEAR 1994 COMPARED WITH FISCAL YEAR 1993 Total operating revenue increased 30 percent or $672 million to $2.9 billion for the year ended September 30, 1994 from $2.2 billion for the same period in the prior year. Enrollment gains in both the government (Medicare and Medicaid) and commercial programs provided an increase in total operating revenue of $451 million, while an additional $77 million was derived from higher premium rates in both programs. In addition, approximately $106 million of the increase in total operating revenue represents the incremental operations of acquisitions described in Note 5 of the Notes to Consolidated Financial Statements. The Company's specialty managed care products and services and its joint venture medical groups contributed the remainder of the increase. Commercial premiums increased $191 million to $1.2 billion for the year ended September 30, 1994 from $1 billion in the prior year. Excluding the effects of acquisitions described above, membership growth provided 46 percent of the increase in the commercial HMO program. An additional 21 percent of the increase is attributable to higher premium rates, which rose an average of three percent. Commercial HMO premium rates are expected to remain flat or decrease slightly in the next enrollment period due to increasing competitive pressures in the Company's markets. The remainder of the increase in commercial premiums was derived from commercial specialty managed care products and services and joint venture medical groups. Government premiums rose $464 million to $1.6 billion for the year ended September 30, 1994 from $1.2 billion in the prior year. Excluding the effects of acquisitions described above, enrollment gains predominately in the Secure Horizons program contributed 80 percent of this increase. Average premium rate increases of two percent accounted for nine percent of the increase. The remainder of the change is attributable to acquisitions. In September 1994, the Company was advised by HCFA that effective January 1995, its HMOs will receive a weighted average premium rate increase of approximately 5.4 percent. Total health care service expenses as a percent of premium revenue (the "medical loss ratio"; see Item 6. Selected Financial Data, page 13) for the year ended September 30, 1994, have decreased to 83.1 percent from 84.1 percent for the same period in the prior year. The commercial medical loss ratio decreased to 80.5 percent from 82.5 percent while the government medical loss ratio declined slightly to 85.2 percent from 85.6 percent. The Company expects to experience upward pressure on the consolidated medical loss ratio into fiscal 1995. Because the government program has a higher medical loss ratio and continues to grow at a faster rate than the commercial program, a higher consolidated medical loss ratio is expected. In addition, pricing pressures are expected to result in a higher commercial medical loss ratio. The government medical loss ratio is expected to remain flat because premium increases are expected to be offset by enhanced benefits and increased health care costs in new geographic markets. The decrease in the commercial medical loss ratio is primarily attributable to lower inpatient hospital costs. The decrease in the government medical loss ratio is primarily related to lower hospital expenses and increases in net positive reserve adjustments described below. The health care service expenses for the years ended September 30, 1994 and 1993, reflect the impact of net positive reserve adjustments of approximately $9 million and $6 million, respectively. These net positive reserve adjustments result primarily from the periodic reconciliation of amounts reserved for physician incentive programs and revised estimates for hospital services and other health care costs which have been incurred but not yet reported. The Company periodically makes adjustments to these estimated expenses based on actual calculations and changed expectations. The $4 million increase in net positive reserve adjustments is primarily attributable to increases in members served under hospital capitation arrangements and improved contracting. Commercial net positive reserve adjustments for each of the years ended September 30, 1994 and 1993 totaled $4 million. Government net positive reserve adjustments for year ended September 30, 1994 increased to $5 million compared to $2 million for the same period in the prior year. 15 Marketing, general and administrative expenses increased $115 million to $395 million for the year ended September 30, 1994 from $280 million for 1993. As a percentage of operating revenue, marketing, general and administrative expenses increased to 13.6 percent from 12.6 percent. These increases are primarily attributable to higher costs related to developing markets, products and services in new as well as established geographic areas and incremental expenses to integrate acquisitions. Future marketing, general and administrative expenses as a percentage of operating revenue are expected to be comparable or slightly less than the current year as the Company obtains efficiency through process improvement. Net interest income increased by approximately $3.5 million primarily due to increased cash generated by operations and available for investment purposes offset by interest expense from higher levels of borrowings made throughout the year. Interest expense is expected to increase due to higher levels of borrowings under new credit facilities (see Liquidity and Capital Resources). For the year ended September 30, 1994, before the cumulative effect of a change in accounting principle, earnings per share increased 34 percent to $3.02 compared to $2.25 for 1993. The increase is primarily related to membership growth derived substantially from the government programs. Decreases in health care service expenses were partially offset by increases in marketing, general and administrative expenses. The results for the years ended September 30, 1994 and 1993 include approximately $0.18 and $0.12, respectively, related to the net positive reserve adjustments previously described. Changes in income tax accounting principles (see Note 9 of the Notes to Consolidated Financial Statements) increased earnings per share by approximately $0.20, resulting in earnings per share of $3.22 for the year ended September 30, 1994. The Company's ability to expand is dependent, in part, on competitive premium pricing and its ability to secure cost-effective contracts with additional physicians or to ensure that existing physician groups expand their operations to accommodate the Company's new HMO membership. Achieving such objectives with physicians is becoming difficult due to increasing competition. In addition, the Company's profitability is dependent, in part, on its ability to maintain effective control over health care costs while providing members with quality care. Factors such as health care reform, utilization, new technologies, hospital costs, major epidemics, and numerous other external influences may affect the Company's operating results. Accordingly, past financial performance is not necessarily a reliable indicator of future performance, and investors should not use historical records to anticipate results or future period trends. FISCAL YEAR 1993 COMPARED WITH FISCAL YEAR 1992 Total operating revenue increased 32 percent or $535 million to $2.2 billion for the year ended September 30, 1993 from $1.7 billion for the same period in 1992. The Company's HMOs provided additional operating revenue of $507 million through enrollment gains and higher premium rates. The remaining $28 million increase was attributable to the amounts generated by the Company's specialty managed care products and services and its joint venture medical groups. In the Company's HMOs, enrollment gains in both the commercial and government programs provided an increase in total operating revenue of $345 million while an additional $143 million was derived from higher premium rates for both programs. The government programs contributed 73 percent of the increase in total operating revenue attributable to the Company's HMOs. Approximately $29 million of the increase in operating revenue represents an incremental two months of Health Plan of America's ("HPA") operations because a full year of operations is included in 1993 versus ten months in 1992. Commercial premiums increased $156 million to $1 billion for the year ended September 30, 1993 from $890 million in the prior year. The effects of the HPA acquisition, described above, and membership growth provided 62 percent of the increase in the commercial program. The rate of commercial membership growth improved slightly over the prior year due to our expansion of the Texas and Oregon operations and continued California growth. Higher premium rates, which rose an average of five percent, contributed 33 percent of the increase. The remaining increase was attributable to specialty managed care products and services revenue. Government premiums increased $369 million to $1.2 billion for the year ended September 30, 1993 from $785 million in the prior year. Enrollment gains accounted for 75 percent of this increase. Average premium rate increases of nine percent accounted for the remainder of the change. 16 The medical loss ratio for the year ended September 30, 1993 increased to 84.1 percent from 83.2 percent for the prior year. The health care service expenses for each of the years ended September 30, 1993 and 1992 reflected the impact of net positive reserve adjustments of approximately $6 million comparable to those in 1994 as described above. The commercial medical loss ratio increased to 82.5 percent compared to a ratio of 80.2 percent in 1992 while the government medical loss ratio declined slightly to 85.6 percent from 86.6 percent. The increase in the commercial medical loss ratio was primarily attributable to increased hospital capitation and out-of-area emergency costs related to the Company's HMOs. The increase in hospital capitation reflected changes in the contractual relationship with providers. These increases were partially offset by lower inpatient hospital costs, lower prescription drug costs and higher premium revenue. Government average premium rate increases of nine percent described above were partially offset by increases in hospital capitation expenses and increased benefits provided to members, including prescription drugs. These factors resulted in a decrease in the medical loss ratio for the government program of one percent for the year ended September 30, 1993. Marketing, general and administrative expenses increased $50 million to $280 million for the year ended September 30, 1993 from $230 million for 1992. As a percentage of total operating revenue, marketing, general and administrative expenses decreased to 12.6 percent in 1993 from 13.6 percent in 1992. This decrease was primarily attributable to increased operating revenue, decreased consulting costs and a reduction in one-time costs of approximately $6 million related to the HPA integration included in 1992. Earnings per share rose 26 percent to $2.25 for the year ended September 30, 1993 compared to $1.78 for 1992. Several factors contributed to the increase in earnings per share. Premium increases and membership growth derived substantially from the government program generated higher operating revenue. A decrease in marketing, general and administrative expenses as a percentage of operating revenue was partially offset by an increase in the consolidated medical loss ratio. The earnings per share for the years ended September 30, 1993 and 1992 included approximately $0.12 and $0.14, respectively, related to net positive reserve adjustments previously described. The results for the year ended September 30, 1993 also included the write-off of net intangible assets which reduced earnings per share by approximately $0.03 (see Note 2d of the Notes to Consolidated Financial Statements). LIQUIDITY AND CAPITAL RESOURCES The Company's working capital as of September 30, 1994 was $231 million, an increase of $68 million from the prior year. The increase is primarily attributable to borrowings of long-term debt of $82 million, discussed below, and increases in cash generated from operations partially offset by acquisitions made with cash. The total purchase price for completed acquisitions described in Note 5 of the Notes to Consolidated Financial Statements is expected to be approximately $108 million, $88 million of which has been paid to date. Completed acquisitions have been financed through the sale of certain of the Company's investments in marketable securities and borrowings under its long term line of credit. The remainder of the purchase price will be paid in calendar year 1995 if certain contingent events occur. Cash generated from operations increased by $153 million for the year ended September 30, 1994 as compared to the prior year. The majority of this change is the result of an increase of $151 million in unearned premium revenue which occurred because the advance payment for Medicare premiums for October 1994 was received in September 1994; whereas, in 1993, the October payment was received in October 1993. The decrease in the purchase of marketable securities by the Company is related to the prior year investment of $61 million of offering proceeds received in October 1992. The Company made capital expenditures of $29 million for the year ended September 30, 1994, primarily for computer equipment. These purchases were financed in part by borrowings under capital leases. The Company anticipates that the level of capital expenditures will increase in fiscal year 1995 to support the redesign of information systems. In January, 1994, the Company established a $130 million revolving line of credit with The Chase Manhattan Bank and a syndicate of banks (see Note 6 of the Notes to Consolidated Financial Statements, page 28). The Company is currently negotiating a $250 million revolving line of credit with Bank of America and a syndicate of banks. Most of the 17 banks in the current syndicate will participate in the new syndicate. The Company anticipates that this new credit line will be in place by December 1994. The Company believes that its current capital resources are adequate to fund its existing HMO operations, the introduction of new products and services and the continued development of its health care-related businesses. The Credit Line enhances the Company's ability to introduce new products and services, expand geographic markets and consummate acquisitions. In May 1993, the Financial Accounting Standards Board issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which is effective for fiscal years beginning after December 15, 1993. The Company adopted SFAS No. 115 on October 1, 1994. All current, unrestricted investments in debt securities have been designated as "available-for-sale." Marketable securities - restricted have been designated as "held to maturity" and continue to be stated at amortized cost. The cumulative effect of this change in accounting principle in the first quarter of fiscal year 1995 is a decrease to marketable securities of $6.3 million, a decrease to shareholders' equity of $3.8 million and an increase to deferred tax assets of $2.5 million. 18 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PAGE ---- Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . 20 Consolidated Statements of Income . . . . . . . . . . . . . . . . . . . 21 Consolidated Statements of Shareholders' Equity . . . . . . . . . . . . 22 Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . . 23 Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . 24 Report of Ernst & Young LLP Independent Auditors. . . . . . . . . . . . 34 Quarterly Information for Fiscal Years 1994 and 1993 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 19 CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 (in thousands, except per share data) 1994 1993 - ------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and equivalents $ 192,609 $ 33,262 Marketable securities 517,999 403,969 Receivables, net 73,976 53,674 Prepaid expenses 8,883 10,648 Deferred income taxes 28,415 13,346 - ------------------------------------------------------------------------------------------------------------------- Total current assets 821,882 514,899 - ------------------------------------------------------------------------------------------------------------------- Property, plant and equipment at cost, net of accumulated depreciation and amortization 97,018 79,049 Marketable securities - restricted 15,994 12,964 Goodwill and intangible assets 167,085 79,591 Other assets 3,569 7,143 - ------------------------------------------------------------------------------------------------------------------- $1,105,548 $ 693,646 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Medical claims and benefits payable: Medical claims payable $ 203,900 $ 161,000 Incentives payable to participating medical groups 83,700 76,000 Future life and annuity policy benefits 15,300 18,000 - ------------------------------------------------------------------------------------------------------------------- Total medical claims and benefits payable 302,900 255,000 - ------------------------------------------------------------------------------------------------------------------- Accounts payable 17,000 13,373 Accrued liabilities 47,110 38,774 Accrued compensation and employee benefits 37,737 28,488 Income taxes payable 6,748 4,376 Unearned premium revenue 170,970 8,041 Long-term debt due within one year 8,175 4,066 - ------------------------------------------------------------------------------------------------------------------- Total current liabilities 590,640 352,118 - ------------------------------------------------------------------------------------------------------------------- Long-term debt due after one year 101,137 21,821 Minority interest 413 413 Commitments and contingencies Shareholders' equity: Preferred shares, par value $1.00 per share; 10,000 shares authorized; none issued - - Class A common shares, par value $0.01 per share; 30,000 shares authorized; 12,238 and 12,133 shares issued in 1994 and 1993, respectively 122 121 Class B common shares, par value $0.01 per share; 60,000 shares authorized; 15,290 and 15,123 shares issued in 1994 and 1993, respectively 153 151 Additional paid-in capital 141,955 138,145 Retained earnings 271,128 180,877 - ------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 413,358 319,294 - ------------------------------------------------------------------------------------------------------------------- $1,105,548 $ 693,646 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See accompanying notes. 20 CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30 (in thousands, except per share data) 1994 1993 1992 - ------------------------------------------------------------------------------------------ Revenue: Commercial premiums $1,237,411 $1,046,186 $ 890,330 Government premiums 1,618,145 1,153,964 784,844 Other income 37,696 20,923 11,140 - ------------------------------------------------------------------------------------------ Total operating revenue 2,893,252 2,221,073 1,686,314 Expenses: Health care services: Medical services 1,127,785 867,157 675,607 Hospital services 968,605 766,770 554,532 Other services 277,868 216,542 163,506 - ------------------------------------------------------------------------------------------ Total health care services 2,374,258 1,850,469 1,393,645 Marketing, general and administrative expenses 394,620 279,865 229,881 Amortization of intangibles 3,444 3,495 2,239 - ------------------------------------------------------------------------------------------ Operating income 120,930 87,244 60,549 Interest income 28,588 23,459 17,725 Interest expense (4,050) (2,376) (3,422) - ------------------------------------------------------------------------------------------ Income before income taxes and cumulative effect of a change in accounting principle 145,468 108,327 74,852 Provision for income taxes 60,875 45,631 31,262 - ------------------------------------------------------------------------------------------ Income before cumulative effect of a change in accounting principle 84,593 62,696 43,590 Cumulative effect on prior years of a change in accounting principle 5,658 - - - ------------------------------------------------------------------------------------------ Net income $90,251 $62,696 $43,590 - ------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------ Weighted average common shares and equivalents outstanding used to calculate earnings per share 28,004 27,847 24,509 - ------------------------------------------------------------------------------------------ Earnings per share: Before cumulative effect of a change in accounting principle $3.02 $2.25 $1.78 Cumulative effect on prior years of a change in accounting principle .20 - - - ------------------------------------------------------------------------------------------ Earnings per share $3.22 $2.25 $1.78 - ------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------
See accompanying notes. 21 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 CLASS A COMMON SHARES CLASS B COMMON SHARES ADDITIONAL --------------------- --------------------- PAID-IN RETAINED (in thousands) OUTSTANDING AMOUNT OUTSTANDING AMOUNT CAPITAL EARNINGS TOTAL - ---------------------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1991 11,385 $ 5,693 - $ - $ 19,394 $ 74,591 $99,678 - ---------------------------------------------------------------------------------------------------------------------------------- Change in par value - (5,580) - - 5,580 - - Stock dividend effected as a two-for-one stock split - - 11,921 119 (119) - - Issuance of 1,725,000 shares of common stock in connection with public offering - - 1,725 17 38,082 - 38,099 Issuance of common stock upon exercise of stock options 187 2 21 1 911 - 914 Issuance of common stock upon conversion of convertible debentures 374 4 4 - 14,975 - 14,979 Tax benefit realized upon exercise of stock options - - - - 1,624 - 1,624 Net income - - - - - 43,590 43,590 - ---------------------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1992 11,946 119 13,671 137 80,447 118,181 198,884 - ---------------------------------------------------------------------------------------------------------------------------------- Issuance of 1,600,000 shares of common stock in connection with public offering - - 1,600 16 59,276 - 59,292 Issuance of common stock upon exercise of stock options 186 2 112 1 1,536 - 1,539 Issuance of common stock upon conversion of convertible debentures 1 - 1 - 20 - 20 Tax benefit realized upon exercise of stock options - - - - 5,038 - 5,038 Purchase and retirement of common stock - - (261) (3) (8,172) - (8,175) Net income - - - - - 62,696 62,696 - ---------------------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1993 12,133 121 15,123 151 138,145 180,877 319,294 - ---------------------------------------------------------------------------------------------------------------------------------- Issuance of common stock upon exercise of stock options 105 1 181 2 2,323 - 2,326 Issuance of common stock under incentive plan - - 21 - 849 - 849 Tax benefit realized upon exercise of stock options - - - - 1,715 - 1,715 Purchase and retirement of common stock - - (35) - (1,077) - (1,077) Net income - - - - - 90,251 90,251 - ---------------------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1994 12,238 $122 15,290 $153 $141,955 $271,128 $413,358 - ---------------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes. 22 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30 (in thousands) 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------- Operating activities: Net income $ 90,251 $ 62,696 $ 43,590 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 17,913 11,916 8,405 Deferred income taxes (9,411) 1,275 (10,244) Cumulative effect of a change in accounting principle (5,658) - - Amortization of intangibles 3,444 3,495 2,239 Loss on disposal of property, plant and equipment 642 1,337 - Provision for doubtful accounts 532 1,650 594 Other 45 (407) 1,126 Changes in assets and liabilities net of effects from acquisitions: Accounts receivable (15,607) (16,433) (6,377) Prepaid and other assets 9,774 (5,715) (4,179) Medical claims and benefits payable 29,043 47,000 11,090 Accounts payable (5,819) 1,768 7,784 Accrued liabilities 8,336 18,736 (1,245) Accrued compensation and employee benefits 9,249 994 7,155 Income taxes payable 2,372 4,428 6,889 Unearned premium revenue 153,387 2,378 1,093 - ------------------------------------------------------------------------------------------------------------------- Net cash flows provided by operating activities 288,493 135,118 67,920 - ------------------------------------------------------------------------------------------------------------------- Investing activities: Purchase of marketable securities (113,415) (161,971) (87,982) Acquisition, net of cash acquired (69,589) - 10,177 Purchase of property, plant and equipment (24,979) (19,577) (10,526) Sale (purchase) of marketable securities - restricted 450 (206) (4,867) Proceeds from sale of equipment - 32 16 - ------------------------------------------------------------------------------------------------------------------- Net cash flows used in investing activities (207,533) (181,722) (93,182) - ------------------------------------------------------------------------------------------------------------------- Financing activities: Proceeds from borrowings of long-term debt 82,350 - 506 Principal payments on long-term debt (5,212) (2,927) (35,949) Proceeds from issuance of common stock 2,326 60,831 39,012 Purchase and retirement of common stock (1,077) (8,175) - - ------------------------------------------------------------------------------------------------------------------- Net cash flows provided by financing activities 78,387 49,729 3,569 - ------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and equivalents 159,347 3,125 (21,693) Beginning cash and equivalents 33,262 30,137 51,830 - ------------------------------------------------------------------------------------------------------------------- Ending cash and equivalents $ 192,609 $ 33,262 $ 30,137 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See accompanying notes. 23 CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED SEPTEMBER 30 (in thousands) 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------- Supplemental cash flow information Cash paid during the year for: Income taxes $ 66,510 $ 40,295 $ 34,794 Interest $ 2,466 $ 1,865 $ 1,951 - ------------------------------------------------------------------------------------------------------------------- Supplemental schedule of noncash investing and financing activities: Leases capitalized $ 4,063 $ 8,658 $ 2,540 Tax benefit realized upon exercise of stock options $ 1,715 $ 5,038 $ 1,624 Compensation awarded in Class B Common Stock $ 849 $ - $ - Capital leases terminated $ 1 $ 45 - Conversion of 7.50% subordinated convertible debentures $ - $ 20 $ 14,980 Notes payable from purchase of fixed assets $ - $ - $ 22 - ------------------------------------------------------------------------------------------------------------------- Details of businesses acquired in purchase transactions: Fair value of assets acquired $130,323 $ - $114,990 Less liabilities assumed or created, including notes to seller 42,587 - 93,490 - ------------------------------------------------------------------------------------------------------------------- Cash paid for acquisition 87,736 - 21,500 Cash acquired in acquisition 18,147 - 31,677 - ------------------------------------------------------------------------------------------------------------------- Net cash (paid for) acquired in acquisition $(69,589) $ - $ 10,177 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- See accompanying notes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE REPORTING ENTITY a) Organization and Operations. PacifiCare Health Systems, Inc. (the "Company") owns and operates federally qualified health maintenance organizations ("HMOs"), which provide health care services principally for a predetermined, prepaid periodic fee to enrolled subscriber groups through independent health care organizations under contract. The Company also offers certain specialty products and services to group purchasers and to other managed care organizations and their beneficiaries, including Medicare risk management services, pharmacy benefit management, military health care management, coordination of managed care products for multi-region employers, health and life insurance, behavioral health, workers' compensation, dental and vision services and health promotion. UniHealth America ("UniHealth"), a California non-profit public benefit corporation, owned approximately 48 and 21 percent of the Company's outstanding shares of Class A and Class B Common Stock, respectively, at September 30, 1994. b) Basis of Presentation. The accompanying consolidated financial statements include the accounts of the Company and all significant subsidiaries which are more than 50 percent owned and controlled. All significant intercompany transactions and balances have been eliminated in consolidation. 24 2. SIGNIFICANT ACCOUNTING POLICIES a) Cash and Equivalents. Cash and equivalents are defined as cash, money market funds and certificates of deposit with a maturity of three months or less. b) Marketable Securities. Marketable securities comprise municipal bonds, corporate notes, commercial paper and U.S. Treasury securities. These investments are stated at amortized cost. The market value was $511.7 million and $419.7 million, respectively at September 30, 1994 and 1993. Marketable securities-restricted comprise U. S. Government securities and certificates of deposit held by trustees or state regulatory agencies. These securities are stated at amortized cost which approximates market value. In May 1993, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which is effective for fiscal years beginning after December 15, 1993. The statement addresses the accounting and reporting for investments in equity and debt securities. The Company adopted SFAS No. 115 on October 1, 1994. All current unrestricted investments have been designated as "available for sale." Marketable securities-restricted have been designated as held to maturity and continue to be stated at amortized cost. The cumulative effect of this change in accounting principle in the first quarter of fiscal year 1995 is a decrease to marketable securities of $6.3 million, a decrease to shareholders' equity of $3.8 million and an increase to deferred tax assets of $2.5 million. c) Property, Plant and Equipment. Property, plant and equipment are recorded at cost; replacements and major improvements are capitalized, while repairs and maintenance are charged to expense as incurred. Upon sale or retirement of property, plant and equipment, the costs and related accumulated depreciation are eliminated from the accounts. Any resulting gains and losses are included in the determination of net income. Property, plant and equipment are depreciated using the straight-line method for financial reporting purposes over estimated useful lives ranging from five to twenty-five years. Leasehold improvements are amortized using the straight-line method over the term of the lease or ten years, whichever is shorter. d) Goodwill and Intangible Assets. Goodwill and intangible assets represent principally the unamortized excess of the cost of acquiring subsidiary companies over the fair values of such companies' net tangible assets at the dates of acquisition. Goodwill and intangible assets are amortized on a straight-line basis over periods not exceeding forty years. Net intangible assets totaling $844,000 were written off in 1993, reducing earnings per share by approximately $0.03. These assets, which were related to the Company's health and life insurance subsidiary, were determined to have no continuing value. As of September 30, 1994 and 1993, accumulated amortization totaled $8,798,000 and $5,481,000, respectively. e) Software Costs. Direct costs associated with the development of computer software are expensed as incurred. These costs totaled $9,626,000, $7,047,000 and $6,186,000 in 1994, 1993 and 1992, respectively. f) Premiums and Revenue Recognition. Prepaid health care premiums from the Company's HMOs' enrolled groups are reported as revenue in the month in which enrollees are entitled to receive health care. Premiums received prior to such period are recorded as unearned premium revenue. Approximately 57 percent, 52 percent, and 47 percent of the Company's premium revenue in the years ended September 30, 1994, 1993 and 1992, respectively, were derived from funds received under the Federal Medicare program. g) Health Care Services. The Company's HMOs arrange for comprehensive health care services to their members principally through capitation, a fixed, monthly payment made without regard to the frequency, extent or nature of the health care services actually furnished. Benefits are provided to enrolled members generally through the Company's contractual relationships with physician groups and hospitals. The Company's contracted providers may, in turn, contract with specialists or referral providers for specific services and are responsible for any related payments to those referral providers. The Company's HMOs have various programs that provide incentives to participating medical groups through the use of risk-sharing agreements and other programs. Payments are made to medical groups based on their performance in controlling health care costs while providing quality health care. Expenses related to these 25 programs, which are based in part on estimates, are recorded in the period in which the related services are dispensed. The cost of health care provided is accrued in the period it is dispensed to the enrolled members, based in part on estimates for hospital services and other health care costs which have been incurred but not yet reported. The Company has also recorded reserves, based in part on estimates, to indemnify its members against potential referral claims related to insolvent medical groups. The Company's HMOs have stop-loss insurance to cover unusually high costs of care when incurred beyond a predetermined annual amount per enrollee. h) Utilization Review and Case Management Services. The Company's HMOs conduct utilization review and case management programs to ensure that their providers deliver a consistent quality of care to members. The utilization review program essentially provides patients with second opinions, while the case management program assigns nurses to complicated, high-risk or chronic cases to evaluate and recommend treatment options to the patient and provider. The costs associated with providing these medical services are recorded in general and administrative expenses and totaled $10,856,000, $8,897,000 and $6,999,000 for the fiscal years ended September 30, 1994, 1993 and 1992, respectively. i) Earnings Per Share. Earnings per share are computed on the weighted average number of common shares outstanding each year. Outstanding stock options are common stock equivalents and are included in earnings per share computations. j) Taxes Based on Premiums and Income. Certain states in which the Company does business require the remittance of excise, per capita or premium taxes based upon a specified rate for enrolled members or a percentage of billed premiums. Such taxes may be levied in lieu of a state income tax. These amounts are recorded in general and administrative expenses and totaled $4,033,000, $3,261,000 and $2,808,000 for the fiscal years ended September 30, 1994, 1993 and 1992. As of October 1, 1993, the Company adopted SFAS No. 109, ACCOUNTING FOR INCOME TAXES and recorded a benefit for the cumulative effect prior to October 1, 1993 of the change in accounting principle of $5,658,000 or approximately $0.20 per share. SFAS No. 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, SFAS No. 109 generally considers all expected future events other than enactments of changes in the tax law or rates. Previously, the Company used the SFAS No. 96 asset and liability approach that gave no recognition to future events other than the recovery of assets and settlement of liabilities at their carrying amounts. As permitted by SFAS No. 109, the Company has elected not to restate the financial statements of any prior years. 3. RECEIVABLES Receivables consist of the following components:
SEPTEMBER 30 (in thousands) 1994 1993 - ---------------------------------------------------------------------------------------------------- Premiums receivable: Commercial $132,307 $120,171 Government 5,590 1,292 - ---------------------------------------------------------------------------------------------------- Total premiums receivable 137,897 121,463 Accounts and notes receivable 34,444 21,402 - ---------------------------------------------------------------------------------------------------- 172,341 142,865 Less: Unearned premium revenue included in premiums receivable 97,807 88,036 Allowance for doubtful accounts 558 1,155 - ---------------------------------------------------------------------------------------------------- Receivables, net $ 73,976 $ 53,674 - ---------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------
26 4. PROPERTY, PLANT AND EQUIPMENT The following table summarizes the components of property, plant and equipment:
SEPTEMBER 30 (in thousands) 1994 1993 - ---------------------------------------------------------------------------------------------------- Land $ 14,533 $ 14,242 Buildings and improvements 30,087 24,895 Furniture, fixtures and equipment 74,148 49,949 Leasehold improvements 10,509 7,206 Capital leases 17,526 13,257 Construction in progress 2,717 4,732 - ---------------------------------------------------------------------------------------------------- 149,520 114,281 Less accumulated depreciation and amortization 52,502 35,232 - ---------------------------------------------------------------------------------------------------- Net property, plant and equipment $ 97,018 $ 79,049 - ---------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------
5. ACQUISITIONS The Company completed several acquisitions during the year ended September 30, 1994. In October 1993, the Company acquired certain assets including approximately 14,000 members from Freedom Plan, Inc. In November 1993, the Company acquired all of the issued and outstanding capital stock of each of California Dental Health Plan, Inc. ("CDHP") and Dental Plan Administrators ("DPA"). CDHP is a licensed provider of prepaid dental and optometric benefits for individuals and groups, and DPA is an affiliated company of CDHP that provides administrative services to CDHP and other companies. In December 1993, the Company acquired all of the issued and outstanding capital stock of Advantage Health Plans, Inc., a Miami-based HMO with approximately 20,000 members. In February 1994, the Company acquired all of the issued and outstanding capital stock of Preferred Health Resources, Inc. ("PHRI"), a Seattle-based corporation. PHRI owns all of the issued and outstanding capital stock of Network Health Plan, Inc., a Seattle-based health care services contractor with approximately 28,000 members, and Network Management Incorporated, an affiliated company that provides administrative services to the health plan and other companies. In September 1994, the Company acquired all of the issued and outstanding capital stock of Pasteur Health Plans, Inc. ("PHP"), Pasteur Delivery Systems, Inc. ("PDS") and Interstate Medical Equipment, Inc. ("IME"). PHP is a Miami-based HMO with approximately 50,000 members. PDS and IME are affiliated companies of PHP that provide medical and administrative services to PHP and other companies. The total purchase price for these acquisitions is expected to be approximately $108 million. Of the total purchase price, $88 million has been paid to date. The contingent purchase payments for these acquisitions will be paid in 1995 if certain events occur. Based on the fair values of assets acquired and liabilities assumed in connection with these acquisitions, the preliminary estimate of excess purchase price is approximately $91 million. A final allocation of purchase price will be determined when appraisals and other studies are completed and contingent purchase payments are determined. The transactions have been accounted for as purchases and the operating results of each completed acquisition are included in the consolidated financial statements from the date of purchase. Amortization of the excess purchase price is made over a period not to exceed forty years. The following table summarizes the unaudited pro forma consolidated results of the Company as though the completed acquisitions occurred at the beginning of the periods presented giving effect to the interest income foregone, the costs associated with the integration of the operations into those of the Company and the amortization of the excess of the purchase price over the fair value of the assets acquired. The unaudited pro forma information is not necessarily indicative of the actual consolidated results of operations that would have occurred had the completed acquisitions occurred at the beginning of the period and is not intended to be indicative of results which may occur in the future. 27
YEARS ENDING SEPTEMBER 30 (Unaudited) (Amounts in thousands, except per share amounts) 1994 1993 - ------------------------------------------------------------------------------------ Premium revenue $2,929,887 $2,382,687 Total operating revenue $2,972,114 $2,410,605 Pretax income $ 141,888 $ 99,074 Net income (1) $ 87,445 $ 55,884 Earnings per share (1) $ 3.13 $ 2.01 - ------------------------------------------------------------------------------------ (1) The unaudited pro forma income before cumulative effect of a change in accounting principle for the year ended September 30, 1994 was $81.8 million or $2.93 per share. The unaudited pro forma cumulative effect on prior years of a change in accounting principle for the year ended September 30, 1994 is $5.7 million or $0.20 per share (see Note 2j of the Notes to Consolidated Financial Statements).
6. LONG-TERM DEBT Long-term debt consists of the following components:
SEPTEMBER 30 (in thousands) 1994 1993 - --------------------------------------------------------------------------------------------------------- Revolving line of credit $ 82,350 $ -- 8.80% privately placed senior debt, due in annual installments of $3,750,000 commencing November 1994 15,000 15,000 Capitalized lease obligations 9,745 9,832 Installment notes payable, annual payments of $400,000, non-interest bearing, through December 1995 655 1,024 Other long-term debt 1,562 31 - --------------------------------------------------------------------------------------------------------- 109,312 25,887 Less amounts due within one year 8,175 4,066 - --------------------------------------------------------------------------------------------------------- Long-term debt due after one year $101,137 $21,821 - --------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------
In January 1994, the Company established with The Chase Manhattan Bank ("Chase") and a syndicate of banks, a $130 million revolving line of credit (the "Credit Line"). The Company has and will continue to borrow under the Credit Line during a one-year period commencing January 1994, after which any amount outstanding will be converted into a two year term loan. Interest will be paid over the three year period at a rate per annum equal to the London Interbank Offered Rate plus a spread ranging from 0.3125 percent to 0.6250 percent or the prime rate. At September 30, 1994, the weighted average interest rate was 5.33 percent. Certain subsidiaries guarantee the Credit Line to the extent permitted by regulatory authorities. Advances have been classified as long-term debt because of the Credit Line's conversion feature. Both the debt agreement for $15 million of 8.80 percent privately placed senior debt and the Credit Line include financial covenants requiring a minimum consolidated net worth, a minimum fixed charge coverage ratio and a maximum leverage ratio. Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the aggregate fair value of the Credit Line and 8.80 percent privately placed senior debt is approximately $98 million. The Company is currently negotiating a $250 million revolving line of credit with Bank of America and a syndicate of banks. Most of the banks in the current syndicate will participate in the new syndicate. The Company anticipates that this new credit line will be in place by December 1994. 28 As of September 30, 1994, the maturities of long-term debt for the years following 1994 are as follows:
YEARS ENDING SEPTEMBER 30 (in thousands) - ------------------------------------------------------------------------------- 1995 $ 8,175 1996 8,045 1997 88,024 1998 3,924 1999 34 Thereafter 1,110 - ------------------------------------------------------------------------------- $109,312 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Capitalized leases relate to equipment included in the accompanying consolidated balance sheets at a cost of $17,526,000 and $13,257,000 at September 30, 1994 and 1993, respectively. Accumulated amortization related to this equipment totaled $8,188,000 and $3,368,000 at September 30, 1994 and 1993, respectively. These leases require future payments including interest totaling $10,130,000 at September 30, 1994 through the end of the lease terms. 7. SHAREHOLDERS' EQUITY In September 1994, the Company commenced a public offering of 750,000 shares of the Company's Class B Common Stock to certain physicians groups (the "Groups") which currently contract with the Company. If a Group agrees to purchase shares in this offering, it will enter into an agreement whereby it will be irrevocably obligated to purchase a fixed number of shares of the Class B Common Stock at a fixed price payable over a five year period beginning May 1, 1996. To date, the Company has not entered into any agreements with any of the Groups to sell shares under this offering. On February 23, 1993, the Board of Directors authorized the purchase of a total of up to 500,000 shares of the Company's Class B Common Stock in the open market subject to market conditions; such shares are to be retired upon purchase. This program was formally terminated by the Board of Directors of the Company on April 28, 1994. Through that date, the Company had purchased and retired 295,700 shares at an average price of $31.29 per share. In November 1992, the Company completed a public offering of 3,200,000 shares of Class B Common Stock, of which 1,600,000 shares were sold by the Company and 1,600,000 shares were sold by UniHealth. The net proceeds received by the Company from the sale of the 1,600,000 shares of Class B Common Stock offered by the Company were approximately $59 million after deducting underwriting discounts and commissions, and expenses of the offering In July 1992, the Company completed a public offering of 3,450,000 shares of Class B Common Stock, of which 1,725,000 shares were sold by the Company and 1,725,000 shares were sold by UniHealth. The net proceeds received by the Company from the sale of the 1,725,000 shares of Class B Common Stock offered by the Company were approximately $38 million after deducting underwriting discounts and commissions and expenses of the offering. On June 4, 1992, the shareholders of the Company approved an Amendment (the "Reclassification Amendment") to the Company's Certificate of Incorporation, as amended. The Reclassification Amendment: (a) reclassified the existing common stock as Class A Common Stock; (b) authorized a new class of non-voting common stock designated as non-voting Class B Common Stock (the Class A Common Stock together with the Class B Common Stock shall hereinafter be referred to as the "Common Stock"); (c) increased the total number of authorized shares of Common Stock from 20 million to 90 million, consisting of 30 million shares of Class A Common Stock and 60 million shares of Class B Common Stock; (d) established the rights, powers and limitations of both classes of common stock; and (e) reduced the par value of the Common Stock from $0.50 per share to $0.01 per share. 29 In connection with the Reclassification Amendment, the Company declared a stock dividend to holders of record of the Class A Common Stock on June 5, 1992, payable on June 10, 1992, consisting of one share of Class B Common Stock for each share of Class A Common Stock then outstanding. The stock dividend had the same effect on the total number of shares of common stock and equivalents outstanding as a two-for-one stock split. All earnings per share calculations, as well as share and per share data, have been adjusted to reflect the stock split on a retroactive basis. 8. TRANSACTIONS WITH RELATED PARTIES The Company purchased health care services from hospitals owned and managed by UniHealth totaling $61,497,000, $55,482,000 and, $30,160,000 for the years ended September 30, 1994, 1993 and 1992, respectively. Under the terms of a management arrangement with UniHealth, the Company paid $831,000, $1,221,000 and $832,000 for management fees, payroll processing services and other services in the years ended September 30, 1994, 1993 and 1992, respectively. Amounts payable to UniHealth were $251,000 and $410,000 at September 30, 1994 and 1993, respectively. UniHealth purchased health care coverage from the Company in the amounts of $10,050,000, $7,312,000 and $6,169,000 for the years ended September 30, 1994, 1993 and 1992, respectively. Amounts receivable from UniHealth were $1,000,000 and $729,000 at September 30, 1994 and 1993, respectively. Joseph S. Konowiecki, the secretary and general counsel of the Company, is the sole shareholder of Joseph S. Konowiecki, Inc., a California professional corporation, which is a partner of the law firm of Konowiecki & Rank. The Company purchased legal services from Konowiecki & Rank in the amounts of $3,137,888, $2,251,000 and $2,397,000 for the years ended September 30, 1994, 1993 and 1992, respectively. The amounts payable to Konowiecki & Rank at September 30, 1994 and 1993 were $248,000 and $151,000, respectively. 9. INCOME TAXES Effective October 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, "Accounting for Income Taxes" (See Note 2j - "Taxes Based on Premiums and Income"). As permitted under the new rules, prior years' financial statements have not been restated. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows:
SEPTEMBER 30 (IN THOUSANDS) 1994 - ------------------------------------------------------------------------------- Deferred tax assets: Accrued compensation $ 9,574,000 Accrued health care costs 8,363,000 Accrued expenses 5,644,000 Capital leases 2,974,000 State franchise taxes 2,758,000 Other assets 1,434,000 - ------------------------------------------------------------------------------- Total deferred tax assets 30,747,000 Deferred tax liabilities: Depreciation (1,591,000) Other liabilities (741,000) - ------------------------------------------------------------------------------- Net deferred tax assets $ 28,415,000 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
30 The provision for income taxes for the years ended September 30, 1994, 1993 and 1992, consists of the following components:
YEARS ENDED SEPTEMBER 30 (in thousands) 1994 1993 1992 - ------------------------------------------------------------------------------- CURRENT: Federal $ 58,036 $ 35,324 $ 33,156 State 12,250 9,032 8,350 - ------------------------------------------------------------------------------- Total current 70,286 44,356 41,506 DEFERRED: Federal (9,349) 1,275 (10,244) State (62) -- -- - ------------------------------------------------------------------------------- Total deferred (9,411) 1,275 (10,244) - ------------------------------------------------------------------------------- Provision for income taxes $ 60,875 $ 45,631 $ 31,262 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
The following table summarizes significant differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rates to income before income taxes:
YEARS ENDED SEPTEMBER 30 (in thousands) 1994 1993 1992 - ------------------------------------------------------------------------------- Computed expected provision 35.0% 34.8% 34.0% State taxes, net of federal benefit 5.4 5.4 7.4 Tax exempt interest (1.9) (1.7) (1.6) Amortization of intangibles 0.7 1.0 0.9 Changes in unrecognized (0.3) 2.2 (1.0) deferred tax benefits Insurance company statutory rate -- 0.1 0.5 Other, net 2.9 0.3 1.6 - ------------------------------------------------------------------------------- Provision for income taxes 41.8% 42.1% 41.8% - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
The Company and its subsidiaries file a consolidated Federal income tax return. The Company also files a combined California franchise tax return with its subsidiaries. Prior to the change in accounting principle, the sources of differed tax items and the corresponding tax effects during the fiscal years ended September 30, 1993 and 1992 were as follows:
YEARS ENDED SEPTEMBER 30 (in thousands) 1993 1992 - ------------------------------------------------------------------------------- Depreciation $ 2,803 $ 600 Medical claims and benefits payable 1,482 (6,086) Performance incentives 942 (2,169) State franchise taxes (141) (1,416) Capital leases (2,322) (892) Other, net (1,489) (281) - ------------------------------------------------------------------------------- $ 1,275 $(10,244) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
10. EMPLOYEE BENEFIT PLANS a) Savings and Profit-Sharing Plan. The Company has an employee profit- sharing plan covering substantially all full-time employees, which provides for annual contributions by the Company of two percent of the annual compensation of employees and additional amounts determined by the Board of Directors which are generally 31 based upon a percentage of pretax income. Employees may defer up to twelve percent of their annual compensation under the Plan, with the Company matching one half of the deferred amount, up to a maximum of three percent of annual compensation. Amounts charged to expense applicable to the plan were $10,298,000, $7,774,000 and $4,908,000 for the years ended September 30, 1994, 1993 and 1992, respectively. b) Stock Option Plans. The Company has granted stock options for employees and Directors under various plans including the Stock Option Plan for Executive and Key Employees, as amended (the "1985 Plan"), the Amended and Restated 1989 Stock Option Plan for Officers and Key Employees, as amended (the "1989 Employee Plan"), the 1989 Non-Officer Directors Stock Option Plan (the "1989 Director Plan") and the 1992 Non-Officer Directors Stock Option Plan (the "1992 Director Plan"). Grants under the 1985 Plan and 1989 Director Plan were suspended. The total number of shares of common stock which may be granted as incentive stock options, non-qualified stock options, stock appreciation rights and stock payments ("Awards") under the 1989 Employee Plan is up to (i) 805,558 shares for Awards granted prior to October 1, 1992 and (ii) one and one-half percent of the outstanding shares of Common Stock of the Company as of the last day of the previous fiscal year for Awards granted each fiscal year on and after October 1, 1992. Options may be granted for a term of up to ten years at a price not less than 100 percent of the fair market value of the common shares at the time of grant. The 1992 Director Plan provides for a maximum of 140,000 shares of Class B Common Stock issuable upon the exercise of non-qualified stock options granted to eligible non-officer Directors of the Company. Any non-officer Director of the Company not eligible to receive options under the 1989 Employee Plan shall be eligible to receive options under the 1992 Director Plan. The following table summarizes the activity in non-qualified stock options under the 1985 Plan, the 1989 Employee Plan, the 1989 Director Plan and the 1992 Director Plan for the years ended September 30, 1994 and 1993:
NON-QUALIFIED STOCK OPTIONS - ------------------------------------------------------------------------------------------------------------------------------- YEARS ENDED SEPTEMBER 30, CLASS A CLASS B 1994 AND 1993 STOCK EXERCISE PRICE STOCK EXERCISE PRICE - ------------------------------------------------------------------------------------------------------------------------------- OUTSTANDING AT SEPTEMBER 30, 1992 759,434 $ 1.63 - $19.75 759,434 $ 1.63 - $19.75 Granted -- -- - -- 288,230 $ 29.75 - $44.75 Exercised 186,400 $ 1.63 - $19.75 111,700 $ 1.63 - $19.75 Canceled 12,975 $ 6.88 - $19.75 13,875 $ 6.88 - $37.50 - ------------------------------------------------------------------------------------------------------------------------------- OUTSTANDING AT SEPTEMBER 30, 1993 560,059 $ 1.63 - $19.75 922,089 $ 1.63 - $44.75 Granted -- -- - -- 588,400 $ 37.75 - $53.75 Exercised 104,649 $ 1.63 - $17.25 180,645 $ 1.63 - $40.25 Canceled 4,126 $ 17.25 - $17.25 25,005 $ 17.25 - $40.50 - ------------------------------------------------------------------------------------------------------------------------------- OUTSTANDING AT SEPTEMBER 30, 1994 451,284 $ 1.63 - $19.75 1,304,839 $ 1.63 - $53.75 - ------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------
At September 30, 1994, approximately 1,756,000 shares were reserved for issuance upon the exercise of outstanding options. As of that date, 418,084 options were exercisable for Class A shares at an exercise price of $1.63 - $19.75 per share and 485,705 options were exercisable for Class B shares at an exercise price of $1.63 - $44.75. No stock appreciation rights have been awarded under the 1989 Employee Plan. c) Performance Incentive Programs. The Company has a long-term performance incentive program administered by a subcommittee of the Compensation Committee of the Board of Directors (the "Committee"). Under the terms of the program, all Executive Officers (as defined in Rule 3b-7 of the Exchange Act) of the Company and certain officers and key employees of the Company and its subsidiaries are eligible for participation. Incentive compensation is based on the achievement of objectives established by the Committee and approved by the shareholders of the Company. The performance objectives are based on increases in shareholders' equity and increases in the revenue of non-core businesses, measured over a three-year period. A minimum target for return on equity must be achieved before the measurement for increasing revenue may be applied. A new three-year performance period commences annually and minimum and maximum targets for each measurement objective vary for each performance cycle. Except for Executive Officers, at the end of each performance period, the 32 committee may adjust individual awards to reflect an overall evaluation of performance. For fiscal years ended September 30, 1994, 1993 and 1992, the incentive compensation expense for this program was $2,500,000, $1,854,000 and $3,600,000, respectively. The Company also has an annual incentive compensation program. All Executive Officers of the Company or any subsidiary of the Company are eligible to participate and any officer or full-time employee of the Company or any subsidiary of the Company, determined by the Committee to have a direct, significant and measurable impact on the attainment of the Company's or subsidiary's annual growth and profitability objectives is eligible to participate. Within these parameters, the Committee has total discretion over which participants are eligible to receive awards. Incentive compensation is based on the achievement of objectives established by the Committee and approved by the shareholders of the Company. Performance objectives are based on earnings per share. The Committee may make additional awards to participants who are determined by the Committee to have positively impacted directly on the attainment of the performance objectives established by the Committee. Amounts charged to expense for such programs were $7,048,000, $2,229,000 and $7,400,000 for the years ended September 30, 1994, 1993 and 1992, respectively. 11. COMMITMENTS AND CONTINGENCIES a) Lease Commitments. The Company leases office space under various non- cancelable operating leases. Rental expense for the years ended September 30, 1994, 1993 and 1992 totaled $10,170,000, $8,140,000 and $7,269,000, respectively. Future minimum lease payments under operating leases at September 30, 1994 are as follows:
YEARS ENDING SEPTEMBER 30 (in thousands) - ------------------------------------------------------------------------------- 1995 $ 11,222 1996 10,491 1997 9,201 1998 5,638 1999 3,361 Thereafter 4,563 - ------------------------------------------------------------------------------- $ 44,476 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
b) Employment Agreements. The Company has entered into an employment agreement with the Chairman, the President of the Company and four other officers. The agreements contain provisions that would entitle each to receive severance benefits which are payable if employment is terminated for various reasons, including termination following a change of ownership or control of the Company as defined by the agreements. The maximum contingent liability for severance payments that the Company would be required to make under the employment agreements (excluding amounts which may be payable under incentive plans and the value of certain benefits) would be approximately $3,400,000 at September 30, 1994. c) Litigation. The Company is involved in legal actions in the normal course of business, some of which seek substantial monetary damages, including claims for punitive damages which are not covered by insurance. After review, including consultation with counsel, management believes any ultimate liability in excess of amounts accrued which could arise from the actions would not materially affect the Company's consolidated financial position or results of operations. 12. CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of short-term investments in marketable securities and commercial premiums receivable. The Company's short-term investments in marketable securities are managed by professional investment managers within guidelines established by the Board of Directors, which, as a matter of policy, limit the amounts which may be invested in any one issuer. Concentrations of credit risk with respect to commercial premiums receivable are limited due to the large number of employer groups comprising the Company's customer base. As of September 30, 1994, the Company had no significant concentrations of credit risk. 33 REPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS The Board of Directors and Shareholders PacifiCare Health Systems, Inc. We have audited the accompanying consolidated balance sheets of PacifiCare Health Systems, Inc. as of September 30, 1994 and 1993, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1994. Our audits also included the financial statement schedules listed in the Index at Item 14(a)(2). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PacifiCare Health Systems, Inc. as of September 30, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1994 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 2 to the Consolidated Financial Statements, as of October 1, 1993 the Company changed its method of accounting for income taxes. ERNST & YOUNG LLP Los Angeles, California November 11, 1994 34 QUARTERLY INFORMATION FOR FISCAL YEARS 1994 AND 1993 (UNAUDITED)
THREE MONTHS ENDED (in thousands, except per share amounts) DEC. 31 MARCH 31 JUNE 30 SEPT. 30 - ------------------------------------------------------------------------------------------------------------------------------- YEAR ENDED SEPTEMBER 30, 1994 - ------------------------------------------------------------------------------------------------------------------------------- Operating revenue $645,748 $714,424 $752,259 $780,821 Operating expenses 625,411 683,591 713,234 750,086 Interest income, net 5,603 5,777 6,617 6,541 - ------------------------------------------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of a change in accounting principle 25,940 36,610 45,642 37,276 Provision for income taxes 11,201 15,766 18,846 15,062 - ------------------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of a change in accounting principle 14,739 20,844 26,796 22,214 Cumulative effect on prior years of a change in accounting principle 5,658 - - - - ------------------------------------------------------------------------------------------------------------------------------- Net Income $20,397 $20,844 $26,796 $22,214 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- Earnings per share: Before cumulative effect of a change in accounting principle $0.53 $0.75 $0.95 $0.79 Cumulative effect on prior years of a change in accounting principle 0.20 - - - - ------------------------------------------------------------------------------------------------------------------------------- Earnings per share(1) $0.73 $0.75 $0.95 $0.79 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- Membership(2) 1,149 1,227 1,225 1,358 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- YEAR ENDED SEPTEMBER 30, 1993 - ------------------------------------------------------------------------------------------------------------------------------- Operating revenue $484,757 $555,125 $575,712 $605,479 Operating expenses 470,755 533,911 547,737 581,426 Interest income, net 4,171 5,338 5,917 5,657 - ------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 18,173 26,552 33,892 29,710 Provision for income taxes 7,472 11,376 14,184 12,599 - ------------------------------------------------------------------------------------------------------------------------------- Net income $10,701 $15,176 $19,708 $17,111 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- Earnings per share(1) $0.39 $0.54 $0.71 $0.61 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- Membership(2) 978 1,040 1,059 1,097 - ------------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------------- 1 The results for the quarters ended June 30, 1994 and 1993 include $0.18 and $0.10, respectively, of positive reserve adjustments which are described in Management's Discussion and Analysis on page 16. 2 Membership as of quarter-end.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in the Registrant's independent auditors or disagreements with such auditors on accounting principles or practices or financial statement disclosure within the last two years. 35 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is contained in the Company's 1994 Proxy Statement and is incorporated herein by reference. Such Proxy Statement shall be filed with the Securities and Exchange Commission not later than 120 days subsequent to September 30, 1994. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is contained in the Company's 1994 Proxy Statement and is incorporated herein by reference. Such Proxy Statement shall be filed with the Securities and Exchange Commission not later than 120 days subsequent to September 30, 1994. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is contained in the Company's 1994 Proxy Statement and is incorporated herein by reference. Such Proxy Statement shall be filed with the Securities and Exchange Commission not later than 120 days subsequent to September 30, 1994. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is contained in the Company's 1994 Proxy Statement and is incorporated herein by reference. Such Proxy Statement shall be filed with the Securities and Exchange Commission not later than 120 days subsequent to September 30, 1994. 36 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The following documents are filed as part of this report. Consolidated financial statements and notes thereto are included in Part II, Item 8 of this Report:
PAGE REFERENCE -------------- (a)1. Financial Statements: Consolidated Balance Sheets as of September 30, 1994 and 1993 20 Consolidated Statements of Income for the years ended September 30, 1994, 1993 and 1992 21 Consolidated Statements of Shareholders' Equity for the years ended September 30, 1994, 1993 and 1992 22 Consolidated Statements of Cash Flows for the years ended September 30, 1994, 1993 and 1992 23 Notes to Consolidated Financial Statements 24 Report of Ernst & Young LLP Independent Auditors 34 Quarterly Information for Fiscal Years 1994 and 1993 (Unaudited) 35 2. Financial Statement Schedules: Schedule I - Marketable Securities-Other Investments 41 Schedule II - Amounts Receivable from Related Parties and Underwriters, Promoters and Employees Other Than Related Parties 44 Schedule VIII - Valuation and Qualifying Accounts 45
All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because information required is included in the Financial Statements and related notes. 3. Exhibits: 3.1 Certificate of Incorporation and amendments thereto [incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-2 (File No. 33-31541)]. 3.2 Amendment to the Certificate of Incorporation [incorporated by reference to Exhibit 2.1 to the Company's Registration Statement on Form 8-A, dated May 20, 1992]. 3.3 Amendment to the Certificate of Incorporation [incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q for the quarter ended March 31, 1994]. 3.4 Bylaws of the Company. 3.5 First Amendment to the Bylaws of the Company. 4.1 Specimen of the Company's Class A Common Shares [incorporated by reference to Exhibit 1 to the Company's Form 8, dated May 20, 1992]. 37 4.2 Specimen of the Company's Class B Common Shares [incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A, dated May 20, 1992]. 10.1 Employment Agreement, dated as of April 1, 1993, between the Company and Terry Hartshorn [incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended March 31, 1994]. 10.2 Employment Agreement, dated February 22, 1990, between the Company and Alan Hoops, as amended April 7, 1992 and June 5, 1992 [incorporated by reference to Exhibit 28.2 to the Company's Registration Statement on Form S-3 (File No. 33-52438)].(1) 10.3 Employment Agreement, dated February 22, 1990, between the Company and Wayne Lowell, as amended June 5, 1992 [incorporated by reference to Exhibit 28.3 to the Company's Registration Statement on Form S-3 (File No. 33-52438)].(1) 10.4 Employment Agreement, dated February 22, 1990, between the Company and Richard Lipeles, as amended April 7, 1992 and June 5, 1992 [incorporated by reference to Exhibit 28.5 to the Company's Registration Statement on Form S-3 (File No. 33-52438)].(1) 10.5 Employment Agreement, dated as of October 16, 1992, between the Company and Roger Taylor [incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-3 (File No. 33-72012)].(1) 10.6 Form of contract for the period January 1, 1993 through December 31, 1993 between PacifiCare of California and the Department of Health and Human Services [incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-3 (File No. 33-72012)]. 10.7 Management Consulting Agreement, dated as of October 1, 1991, between the Company and UniHealth America [incorporated by reference to Exhibit 28.6 to the Company's Registration Statement on Form S-3 (File No. 33-52438)]. 10.8 Amended and Restated 1989 Stock Option Plan for Officers and Key Employees, as amended [incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No. 33-82204)].(1) 10.9 1992 Non-Officer Directors Stock Option Plan [incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-8 (File No. 33-48543)].(1) 10.10 Amended Long-Term Performance Incentive Plan, as amended [incorporated by reference to Exhibit 10.4 to the Company's Form 10-Q for the quarter ended March 31, 1994].(1) 10.11 Amended Management Incentive Compensation Plan, as amended [incorporated by reference to Exhibit 10.5 to the Company's Form 10-Q for the quarter ended March 31, 1994].(1) 10.12 $130,000,000 Revolving Credit Agreement, dated as of January 14, 1994, among PacifiCare Health Systems, Inc., the banks named therein and The Chase Manhattan Bank [incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1994]. 38 10.13 Contribution and Indemnification Agreement, dated November 19, 1993, between the Company and UniHealth America [incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-3 (File No. 33-72012)]. 11A Computation of Earnings Per Share - Primary 11B Computation of Earnings Per Share - Fully Diluted 21 List of Subsidiaries 23 Consent of Ernst & Young LLP Independent Auditors 27 Financial Data Schedules (1) Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K. (b) Reports on Form 8-K: None. 39 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) 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. Date: November 23, 1994 By /s/ ALAN HOOPS ---------------------------------------------------- Alan Hoops, President and Chief Executive Officer PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED. SIGNATURE TITLE DATE /s/ TERRY HARTSHORN Chairman of the Board November 23, 1994 - ---------------------------- Terry Hartshorn President and Chief Executive Officer /s/ ALAN HOOPS (Principal Executive Officer) November 23, 1994 - ---------------------------- Alan Hoops Executive Vice President and Chief Financial Officer /s/ WAYNE LOWELL (Principal Financial Officer) November 23, 1994 - ---------------------------- Wayne Lowell Senior Vice President and Corporate Controller /s/ FRED V. RYDER, JR. (Principal Accounting Officer) November 23, 1994 - ---------------------------- Fred V. Ryder, Jr. /s/ ERIC BENVENISTE Director November 23, 1994 - ---------------------------- Eric Benveniste /s/ DAVID R. CARPENTER Director November 23, 1994 - ---------------------------- David R. Carpenter /s/ GARY L. LEARY Director November 23, 1994 - ---------------------------- Gary L. Leary /s/ WARREN E. PINCKERT II Director November 23, 1994 - ---------------------------- Warren E. Pinckert II /s/ DAVID A. REED Director November 23, 1994 - ---------------------------- David A. Reed /s/ LLOYD ROSS Director November 23, 1994 - ---------------------------- Lloyd Ross /s/ DENNIS STRUM Director November 23, 1994 - ---------------------------- Dennis Strum 40 PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE I - MARKETABLE SECURITIES-OTHER INVESTMENTS AS OF SEPTEMBER 30, 1994 (amounts in thousands)
AMOUNT MARKET AT WHICH PRINCIPAL COST VALUE OF CARRIED AMOUNT OF EACH ISSUE IN THE OF BONDS EACH AT BALANCE BALANCE NAME OF ISSUER AND TITLE OF EACH ISSUE AND NOTES ISSUE SHEET DATE SHEET - -------------------------------------------------------------------------------------------------------------------------------- US TREASURY SECURITIES $174,365 $172,516 $168,710 $172,543 COMMERCIAL PAPER AND CORPORATE NOTES American General Finance Medium Term Notes 1,000 1,006 951 1,005 Chesterfiled, Virginia Pollution Control Revenue for Virginia Electric Power & Tax Exempt Commercial Paper 3,000 3,000 3,000 3,000 Connecticut Health and Education Facility Authority Revenue Bond for Yale University 5,500 5,500 5,500 5,500 Ford Motor Credit Corporation Medium Term Notes 1,000 1,000 966 1,000 General Electric Credit Corporation Commercial Paper 280 280 280 280 Intermountain Power Agency Power Supply Revenue Series F2 Tax Exempt Commercial Paper 2,850 2,850 2,850 2,850 Jasper County, Indiana Variable Rate Pollution Control Revenue for Northern Indiana Public Service Tax Exempt Commercial Paper 1,000 1,000 1,000 1,000 John Deere Company Medium Term Notes 1,000 1,000 970 1,000 Maricopa County, Arizona Pollution Control Revenue for Southern California Edison Tax Exempt Commercial Paper 650 650 650 650 Municipal Electric Authority of Georgia Project #3 Tax Exempt Commercial Paper 600 600 600 600 Nuveen Insured Quality Series W 2,500 2,476 2,481 2,497 Nuveen Preferred Plus Municipal Fund Series T 1,000 998 991 999 Nuveen Premier Income Series T 2,500 2,495 2,469 2,497 North Central Texas Health Facilities Development Corporation Hospital Revenue for Methodist Hospitals of Dallas Tax Exempt Commercial Paper 1,200 1,200 1,200 1,200 N.C. Eastern Power Catawba Tax Exempt Commercial Paper 2,100 2,100 2,100 2,100 Royal Bank Of Canada Floating Rate Notes 3,000 3,015 3,011 3,005 Salt Lake Hosp Tax Exempt Commercial Paper 2,100 2,100 2,100 2,100 Salt River AG Imp Dist Tax Exempt Commercial Paper 4,850 4,850 4,850 4,850 Sarasota Pub Hosp Tax Exempt Commercial Paper C 1,600 1,600 1,600 1,600 Security Pacific National Bank Home Equity Loan 1991-2B 1,354 1,354 1,361 1,354 Texas Municipal Power Agt Tax Exempt Commercial Paper 12,750 12,750 12,750 12,750 Vermont Commercial Paper Rans C 5,200 5,200 5,200 5,200 York County Virginia Pollution Control Revenue for Virginia Electric and Power Tax Exempt Commercial Paper 16,350 16,350 16,350 16,350 GOVERNMENT SPONSORED ENTERPRISES(1) Federal Farm Credit Bank Discount Note, 10/20/94 490 489 489 489 Federal Farm Credit Bank Discount Note, 10/31/94 2,500 2,489 2,489 2,489 Federal Home Loan Bank Step-Up Call 5/17/96 5,000 5,000 4,850 5,000 Federal Home Loan Banks Inverse Floater, 5/10/96 5,000 5,000 4,622 5,000 Federal Home Loan Mortgage Corporation 8,266 8,346 8,018 8,345 Federal Home Loan Mortgage Corporation Collateralized Mortgage Obligation Series M Class 6 1,126 1,191 1,133 1,187 Federal Home Loan Mortgage Corporation Collateralized Mortgage Obligation Series 1216-E 1,000 958 959 966 Federal Home Loan Mortgage Corporation Collateralized Mortgage Obligation Series 71 Class E 866 912 883 910 Federal Home Loan Mortgage Corporation Discount Notes, 10/3/94 560 556 556 556 Federal Home Loan Mortgage Corporation Discount Notes, 11/2/94 12,465 12,388 12,387 12,388 Federal Home Loan Mortgage Floating Rate Note 2,300 2,306 2,174 2,305 Federal National Mortgage Association 6,000 6,139 5,916 6,133 Federal National Mortgage Association Adjustable Rate Mortgages 1,378 1,389 1,371 1,389 Federal National Mortgage Association Discount Notes, 10/24/94 36,660 36,543 36,543 36,543 Federal National Mortgage Association Discount Notes, 11/17/94 150 148 148 148 Federal National Mortgage Association Discount Notes, 11/2/94 2,040 2,031 2,030 2,031 Overseas Private Investment Corporation Interest Certificates 2,000 2,000 2,000 2,000 Resolution Fund Corporation Strips 1/15/00 6,500 3,148 3,334 3,148 Resolution Trust Corporation Series 1991-16 Class A-5 899 954 939 952 Resolution Trust Corporation Series 1992-C6 Series B 307 306 304 306
41 PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE I - MARKETABLE SECURITIES-OTHER INVESTMENTS (CONTINUED) AS OF SEPTEMBER 30, 1994 (amounts in thousands)
AMOUNT MARKET AT WHICH PRINCIPAL COST VALUE OF CARRIED AMOUNT OF EACH ISSUE IN THE OF BONDS EACH AT BALANCE BALANCE NAME OF ISSUER AND TITLE OF EACH ISSUE AND NOTES ISSUE SHEET DATE SHEET - -------------------------------------------------------------------------------------------------------------------------------- GOVERNMENT SPONSORED ENTERPRISES(1) (CONTINUED) Resolution Trust Corporation Series 1993-3 Class A-3 $ 1,639 $ 1,718 $ 1,688 $ 1,713 Resolution Trust Corporation Series 1993-C1 Class B 1,500 1,505 1,519 1,504 Student Loan Mortgage Association (French Franc Bull Note) 2,500 2,500 2,447 2,500 MORTGAGE-BACKED SECURITIES Advanta Home Equity Loan Trust Series 93-A3 7,320 7,298 6,983 7,299 Citicorp Mortgage Securities, Incorporated Series 1991-9 Class B 2,000 2,067 2,023 2,066 Citicorp Mortgage Securities, Incorporated Series 1989-B Class A6 2,000 2,110 2,035 2,106 Ryland Mortgage Securities Corporation Series 1993-7 Class A 10,295 90 87 211 Salomon Brothers Mortgage Securities VII Series 1994-2 Class XS1 9,971 486 419 646 The Money Store Home Equity Trust 9,118 9,134 8,782 9,133 POLITICAL SUBDIVISION OF A STATE Anderson County South Carolina Hospital Facilities Revenue Anderson Memorial Hospital Revenue Bonds 5,000 5,759 5,445 5,647 Baltimore County, Maryland Unlimited Tax General Obligation Bonds 2,000 2,028 2,151 2,016 Boise-Kuna, Idaho Irrigation District Lucky Peak Project Revenue Bonds 1,000 997 1,039 998 Chicago Illinois Central Public Library Series-C-Converted Unlimited General Obligation Bonds 3,000 3,334 3,270 3,319 Chicago Illinois Metropolitan Water Unlimited General Obligation Bonds 3,350 3,777 3,601 3,685 Chicago Illinois Water Revenue Refunding Bonds 6,000 6,000 5,978 6,000 City and County of Honolulu General Obligation Bonds 4,415 4,415 4,623 4,415 City of San Antonio, Texas Water and Wastewater System Revenue Refunding Bonds 1,500 1,489 1,555 1,492 Clark County, Nevada Airport Improvement Revenue - Variable Rate Demand Note Series A 10,300 10,300 10,300 10,300 Contra Costa County California Tax & Revenue Anticipated Notes Series A Limited General Obligation Notes 4,000 3,992 3,990 3,993 Georgia State Municipal Electric Authority Revenue Refunding Series Q Revenue Bonds 3,350 3,909 3,681 3,806 Illinois Development Finance Authority Pollution Control Revenue 2,500 2,500 2,413 2,500 Jackson County, Mississippi Pollution Control Revenue for Chevron Daily Demand Note 14,650 14,650 14,650 14,650 Kalamazoo Michigan Hospital Finance Authority Regular Auction Rate Certificates 1,400 1,400 1,400 1,400 Kentucky Development Finance Authority Revenue Bonds 1,875 1,930 1,908 1,899 Le Claire Iowa Electric Revenue Bonds 990 990 980 990 Los Angeles County Transportation Commission Sales Tax Revenue Series 92A 6,000 5,967 6,121 5,973 Massachusetts Health and Education Facility Authority Revenue Capital Assets Program Variable Rate Note 300 300 300 300 Maryland State Health & Higher Educational Facilities Authority Revenue John Hopkins University Issue A Revenue Bonds 2,500 2,670 2,639 2,646 Minnesota State Housing Finance Agency Single Family Mortgage Series Series D Revenue Bonds 6,000 6,000 5,512 6,000 New York State Power Authority Revenue & General Purpose Regular Auction Rate Certificates 3,000 3,000 3,000 3,000 Putnam County, Florida Development Authority Floating Rate Note Seminol Electric 800 800 800 800 Rhode Island Housing & Mortgage Fixed Alternative Minimum Tax Homeownership Opportunity 15-C Revenue Bonds 2,045 2,045 2,080 2,045
42 PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE I - MARKETABLE SECURITIES-OTHER INVESTMENTS (CONTINUED) AS OF SEPTEMBER 30, 1994 (amounts in thousands)
AMOUNT MARKET AT WHICH PRINCIPAL COST VALUE OF CARRIED AMOUNT OF EACH ISSUE IN THE OF BONDS EACH AT BALANCE BALANCE NAME OF ISSUER AND TITLE OF EACH ISSUE AND NOTES ISSUE SHEET DATE SHEET - ----------------------------------------------------------------------------------------------------------------------------- POLITICAL SUBDIVISION OF A STATE (CONTINUED) San Mateo County California Joint Powers Finance Authority Lease Revenue Regular Auction Rate Certificates $ 3,500 $ 3,500 $ 3,500 $ 3,500 Shelby County Tennessee Health Educational & Housing Facilities Board Revenue Bonds 1,000 1,196 1,118 1,133 Southern California Edison -A-CA 1,100 1,100 1,100 1,100 Texas State University System Series A 3,000 2,989 3,157 2,993 Tri-County Metropolitan Transportation, Oregon Revenue Bonds 1,500 1,500 1,497 1,500 Upper Allegheny Pennsylvania Joint Sanitation Authority Revenue Bonds 5,500 5,500 5,486 5,500 Washington Public Power Supply System Revenue Bonds, Nuclear Project 3,000 2,984 3,263 2,988 Western Carolina Regional Sewer Authority South Carolina Sewer System Revenue Bonds 2,000 2,249 2,125 2,203 STATE SECURITIES California Higher Education Loan Authority Auction Rate Certificates Series C-1 2,700 2,700 2,700 2,700 California State Revenue Anticipated Warrants Series C 9,000 9,127 9,111 9,124 Houston Texas Tax & Revenue Certificates Obligation Series F 2,000 1,988 1,897 1,990 New Jersey State Series D Unlimited General Obligation Bonds 1,550 1,579 1,537 1,569 Pennsylvania State Refunding First Series Unlimited General Obligation Bonds 5,000 4,944 4,848 4,944 Portland, Oregon Seattle, Washington Limited General Obligation Bonds 1,000 993 974 993 State of Georgia General Obligation Bonds 4,485 4,440 4,594 4,451 State of Illinois General Obligation Bonds 4,510 4,450 4,750 4,478 State of Minnesota General Obligation Bonds 4,000 4,003 4,000 4,001 State of Washington General Obligation Bonds 6,095 6,073 6,033 6,074 Wisconsin State Transportation Series A Revenue Bonds 1,000 1,087 1,041 1,034 Wisconsin State Series C Unlimited General Obligation Bonds 1,795 1,998 1,904 1,928 OTHER 529 529 529 529 ---------------------------------------------------- TOTAL $ 539,838 $ 518,272 $ 511,668 $ 517,999 ---------------------------------------------------- ---------------------------------------------------- (1) Not guaranteed by the U.S. Government.
43 PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES (amounts in thousands)
BALANCE AT BALANCE AT SEPTEMBER 30, 1994 -------------------------------- NAME OF DEBTOR OCTOBER 1, 1993 ADDITIONS DEDUCTIONS CURRENT NON-CURRENT - ------------------------------------------------------------------------------------------------------------ Terry Hartshorn (1) $240 -- $240 -- -- -------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- BALANCE AT BALANCE AT SEPTEMBER 30, 1993 ----------------------------- NAME OF DEBTOR OCTOBER 1, 1992 ADDITIONS DEDUCTIONS CURRENT NON-CURRENT - ---------------------------------------------------------------------------------------------------------- Terry Hartshorn (1) $255 -- $15 $240 -- -------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- BALANCE AT BALANCE AT SEPTEMBER 30, 1992 ----------------------------- NAME OF DEBTOR OCTOBER 1, 1991 ADDITIONS DEDUCTIONS CURRENT NON-CURRENT - ------------------------------------------------------------------------------------------------------------- Terry Hartshorn (1) $270 -- $15 $15 $240 -------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- Notes: (1) Interest payable monthly at 6 percent per annum. Principal reduced through debt forgiveness in the amount of $15,000 per year for five years commencing March 15, 1990. All remaining principal was paid on March 15, 1994. Secured by trust deed on residence.
44 PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (amounts in thousands)
ADDITIONS -------------------------- BALANCE AT CHARGED TO CHARGED TO BALANCE AT BEGINNING COSTS AND OTHER DEDUCTIONS/ END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS PERIOD - ---------------------------------------------------------------------------------------------------------- Allowance for Doubtful Accounts Year ended September 30, 1994 $1,155 $ 532 $ 263 $1,392 $ 558 --------------------------------------------------------------------------- --------------------------------------------------------------------------- Year ended September 30, 1993 $1,698 $1,650 $ 546 $2,739 $1,155 --------------------------------------------------------------------------- --------------------------------------------------------------------------- Year ended September 30, 1992 $1,221 $ 594 $ -- $ 117 $1,698 --------------------------------------------------------------------------- ---------------------------------------------------------------------------
45 EX-3.4 2 EXHIBIT 3.4 EXHIBIT 3.4 BY-LAWS OF PACIFICARE HEALTH SYSTEMS, INC. TABLE OF CONTENTS SECTION PAGE Article I OFFICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Section 1. Registered Office. . . . . . . . . . . . . . . . . . . 1 Section 2. Other Offices. . . . . . . . . . . . . . . . . . . . . 1 Article II MEETINGS OF STOCKHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Section 1. Place of Meetings. . . . . . . . . . . . . . . . . . . 1 Section 2. Annual Meeting of Stockholders . . . . . . . . . . . . 1 Section 3. Quorum; Adjourned Meetings and Notice Thereof . . . . . . . . . . . . . . . . . . . . . . 1 Section 4. Voting . . . . . . . . . . . . . . . . . . . . . . . . 2 Section 5. Proxies. . . . . . . . . . . . . . . . . . . . . . . . 2 Section 6. Special Meetings . . . . . . . . . . . . . . . . . . . 2 Section 7. Notice of Stockholders' Meetings . . . . . . . . . . . 2 Section 8. Maintenance and Inspection of Stockholder List. . . . . . . . . . . . . . . . . . . . . . . . 3 Section 9. Stockholder Action by Written Consent Without a Meeting . . . . . . . . . . . . . . . . . 3 Article III DIRECTORS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Section 1. Number and Qualification of Directors. . . . . . . . . 3 Section 2. Vacancies. . . . . . . . . . . . . . . . . . . . . . . 4 Section 3. Powers . . . . . . . . . . . . . . . . . . . . . . . . 4 Section 4. Place of Directors' Meetings . . . . . . . . . . . . . 4 Section 5. Regular Meetings . . . . . . . . . . . . . . . . . . . 4 Section 6. Special Meetings . . . . . . . . . . . . . . . . . . . 4 Section 7. Quorum . . . . . . . . . . . . . . . . . . . . . . . . 5 Section 8. Action Without Meeting . . . . . . . . . . . . . . . . 5 Section 9. Telephonic Meetings. . . . . . . . . . . . . . . . . . 5 Section 10. Committees of Directors . . . . . . . . . . . . . . . 5 Section 11. Minutes of Committee Meetings . . . . . . . . . . . . 6 Section 12. Compensation of Directors . . . . . . . . . . . . . . 6 Section 13. Indemnification . . . . . . . . . . . . . . . . . . . 6 Article IV OFFICERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Section 1. Officers . . . . . . . . . . . . . . . . . . . . . . . 9 Section 2. Election of Officers . . . . . . . . . . . . . . . . . 9 Section 3. Subordinate Officers . . . . . . . . . . . . . . . . . 9 Section 4. Compensation of Officers . . . . . . . . . . . . . . . 9 Section 5. Term of Office; Removal and Vacancies. . . . . . . . . 9 Section 6. Chairman of the Board. . . . . . . . . . . . . . . . . 10 Section 7. President. . . . . . . . . . . . . . . . . . . . . . . 10 Section 8. Vice President . . . . . . . . . . . . . . . . . . . . 10 Section 9. Secretary. . . . . . . . . . . . . . . . . . . . . . . 10 Section 10. Assistant Secretary . . . . . . . . . . . . . . . . . 11 Section 11. Treasurer . . . . . . . . . . . . . . . . . . . . . . 11 Section 12. Assistant Treasurer . . . . . . . . . . . . . . . . . 11 Article V CERTIFICATES OF STOCK. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Section 1. Certificates . . . . . . . . . . . . . . . . . . . . . 11 Section 2. Signatures on Certificates . . . . . . . . . . . . . . 12 Section 3. Statement of Stock Rights, Preferences and Privileges. . . . . . . . . . . . . . . . . . . . . 12 Section 4. Lost Certificates. . . . . . . . . . . . . . . . . . . 12 Section 5. Transfers of Stock . . . . . . . . . . . . . . . . . . 13 Section 6. Fixing the Record Date . . . . . . . . . . . . . . . . 13 Section 7. Registered Stockholders. . . . . . . . . . . . . . . . 13 Article VI GENERAL PROVISIONS; DIVIDENDS. . . . . . . . . . . . . . . . . . . . . . . . 13 Section 1. Dividends. . . . . . . . . . . . . . . . . . . . . . . 13 Section 2. Payment of Dividends; Directors' Duties. . . . . . . . 13 Section 3. Checks . . . . . . . . . . . . . . . . . . . . . . . . 14 Section 4. Fiscal Year. . . . . . . . . . . . . . . . . . . . . . 14 Section 5. Corporate Seal . . . . . . . . . . . . . . . . . . . . 14 Section 6. Manner of Giving Notice. . . . . . . . . . . . . . . . 14 Section 7. Waiver of Notice . . . . . . . . . . . . . . . . . . . 14 Section 8. Annual Statement . . . . . . . . . . . . . . . . . . . 14 Article VII AMENDMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Section 1. Amendment by Directors or Stockholders . . . . . . . . 14 -1- BY-LAWS OF PACIFICARE HEALTH SYSTEMS, INC. ARTICLE I OFFICES Section 1. REGISTERED OFFICE. The registered office shall be in the City of Wilmington, County of New Castle, State of Delaware. Section 2. OTHER OFFICES. The Corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the Corporation may require. ARTICLE II MEETINGS OF STOCKHOLDERS Section 1. PLACE OF MEETINGS. All meetings of the stockholders shall be held in the City of Cypress, State of California, at such place as may be fixed from time to time by the Board of Directors, or at such other place either within or without the State of Delaware as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting. Section 2. ANNUAL MEETING OF STOCKHOLDERS. The annual meeting of stockholders shall be held each year on the first Tuesday in November, if not a legal holiday, and if a legal holiday, then on the next secular day following, at 10:00 a.m. or at such other date and time as may be determined from time to time by resolution adopted by the Board of Directors, when they shall elect by a plurality vote a Board of Directors, and transact such other business as may properly be brought before the meeting. At each annual meeting Directors shall be elected and any other proper business may be transacted. Section 3. QUORUM; ADJOURNED MEETINGS AND NOTICE THEREOF. A majority of the stock issued and outstanding and entitled to vote at any meeting of stockholders, the holders of which are present in person or represented by proxy, shall constitute a quorum for the transaction of business except as otherwise provided by law, by the Certificate of Incorporation, or by these By- Laws. A quorum, once established, shall not be broken by the withdrawal of enough votes to leave less than a quorum and the votes present may continue to transact business until adjournment. If, however, such quorum shall not be present or represented at any meeting of the stockholders, a majority of the voting stock represented in person or by proxy may adjourn the -2- meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote thereat. Section 4. VOTING. When a quorum is present at any meeting, the vote of the holders of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes, or the Certificate of Incorporation, or these By-Laws, a different vote is required in which case such express provision shall govern and control the decision of such question. Section 5. PROXIES. At each meeting of the stockholders, each stockholder having the right to vote may vote in person or may authorize another person or persons to act for him by proxy appointed by an instrument in writing subscribed by such stockholder and bearing a date not more than three years prior to said meeting, unless said instrument provides for a longer period. All proxies must be filed with the Secretary of the Corporation at the beginning of each meeting in order to be counted in any vote at the meeting. Each stockholder shall have one vote for each share of stock having voting power, registered in his name on the books of the Corporation on the record date set by the Board of Directors as provided in Article V, Section 6 hereof. All elections shall be had and all questions decided by a plurality vote. Section 6. SPECIAL MEETINGS. Special meetings of the stockholders, for any purpose, or purposes, unless otherwise prescribed by statute or by the Certificate of Incorporation, may be called by the President and shall be called by the President or the Secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of stockholders owning a majority in amount of the entire capital stock of the Corporation issued and outstanding, and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting. Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice. Section 7. NOTICE OF STOCKHOLDERS' MEETINGS. Whenever stockholders are required or permitted to take any action at a meeting, a written notice of the meeting shall be given which notice shall state the place, date and hour of the meeting, and, -3- in the case of a special meeting, the purpose or purposes for which the meeting is called. The written notice of any meeting shall be given to each stockholder entitled to vote at such meeting not less than ten nor more than sixty days before the date of the meeting. If mailed, notice is given when deposited in the United States mail, postage prepaid, directed to the stockholder at his address as it appears on the records of the Corporation. Section 8. MAINTENANCE AND INSPECTION OF STOCKHOLDER LIST. The officer who has charge of the stock ledger of the Corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Section 9. STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING. Unless otherwise provided in the Certificate of Incorporation, any action required to be taken at any annual or special meeting of stockholders of the Corporation, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. ARTICLE III DIRECTORS Section 1. NUMBER AND QUALIFICATION OF DIRECTORS. The number of Directors which shall constitute the whole Board shall be not less than five (5) nor more than nine (9). The first Board shall consist of seven (7). The Directors need not be stockholders. The Directors shall be elected at the annual meeting of the stockholders, except as provided in Section 2 of this Article, and each Director elected shall hold office until -4- his successor is elected and qualified; provided, however, that unless otherwise restricted by the Certificate of Incorporation or By-Law, any Director or the entire Board of Directors may be removed, either with or without cause, from the Board of Directors at any meeting of stockholders by a majority of the stock represented and entitled to vote thereat. Section 2. VACANCIES. Vacancies on the Board of Directors by reason of death, resignation, retirement, disqualification, removal from office, or otherwise, and newly created Directorships resulting from any increase in the authorized number of Directors may be filled by a majority of the Directors then in office, although less than a quorum, or by a sole remaining Director. The Directors so chosen shall hold office until the next annual election of Directors and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no Directors in office, then an election of Directors may be held in the manner provided by statute. If, at the time of filling any vacancy or any newly created Directorship, the Directors then in office shall constitute less than a majority of the whole Board (as constituted immediately prior to any such increase), the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten percent of the total number of the shares at the time outstanding having the right to vote for such Directors, summarily order an election to be held to fill any such vacancies or newly created Directorships, or to replace the Directors chosen by the Directors then in office. Section 3. POWERS. The property and business of the Corporation shall be managed by or under the direction of its Board of Directors. In addition to the power and authorities by these By-Laws expressly conferred upon them, the Board may exercise all such powers of the Corporation and do all lawful acts and things as are not by statute or by the Certificate of Incorporation or by these By-Laws directed or required to be exercised or done by the stockholders. Section 4. PLACE OF DIRECTORS' MEETINGS. The Directors may hold their meetings and have one or more offices, and keep the books of the Corporation outside of the State of Delaware. Section 5. REGULAR MEETINGS. Regular meetings of the Board of Directors may be held without notice at such time and place as shall from time to time be determined by the Board. Section 6. SPECIAL MEETINGS. Special meetings of the Board of Directors may be called by the President on forty-eight hours' notice to each Director, either personally or by mail or by telegram; special meetings shall be called by the President or the Secretary in like manner and on like notice on the written -5- request of two Directors unless the Board consists of only one Director; in which case special meetings shall be called by the President or Secretary in like manner or on like notice on the written request of the sole Director. Section 7. QUORUM. At all meetings of the Board of Directors a majority of the authorized number of Directors shall be necessary and sufficient to constitute a quorum for the transaction of business, and the vote of a majority of the Directors present at any meeting at which there is a quorum, shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute, by the Certificate of Incorporation or by these By-Laws. If a quorum shall not be present at any meeting of the Board of Directors the Directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. If only one Director is authorized, such sole Director shall constitute a quorum. Section 8. ACTION WITHOUT MEETING. Unless otherwise restricted by the Certificate of Incorporation or these By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors or of any Committee thereof may be taken without a meeting, if all members of the Board or Committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or Committee. Section 9. TELEPHONIC MEETINGS. Unless otherwise restricted by the Certificate of Incorporation or these By-Laws, members of the Board of Directors, or any Committee designated by the Board of Directors, may participate in a meeting of the Board of Directors, or any Committee, by means of a conference telephone or similar communications equipment by means of which all persons participating in the meetings can hear each other, and such participation in a meeting shall constitute presence in person at such meeting. Section 10. COMMITTEES OF DIRECTORS. The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more Committees, each such Committee to consist of one or more of the Directors of the Corporation. The Board may designate one or more Director(s) as alternate members of any Committee, who may replace any absent or disqualified member at any meeting of the Committee. In the absence or disqualification of a member of a Committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Any such Committee, to the extent provided -6- in the resolution of the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such Committee shall have the power or authority in reference to amending the Certificate of Incorporation, adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the Corporation's property and assets, recommending to the stockholders a dissolution of the Corporation or a revocation of a dissolution, or amending the By-Laws of the Corporation; and, unless the resolution or the Certificate of Incorporation expressly so provide, no such Committee shall have the power or authority to declare a dividend or to authorize the issuance of stock. Section 11. MINUTES OF COMMITTEE MEETINGS. Each Committee shall keep regular minutes of its meetings and report the same to the Board of Directors when required. Section 12. COMPENSATION OF DIRECTORS. Unless otherwise restricted by the Certificate of Incorporation or these By-Laws, the Board of Directors shall have the authority to fix the compensation of Directors. The Directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as Director. No such payment shall preclude any Director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing Committees may be allowed like compensation for attending Committee meetings. Section 13. INDEMNIFICATION. (a) The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonable incurred by him in connection with such action, suit or proceedings if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by -7- judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. (b) The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and except that no such indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless and only to the extent that the Court of Chancery of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which such Court of Chancery or such other court shall deem proper. (c) To the extent that a Director, officer, employee or agent of the Corporation, shall be successful on the merits or otherwise in defense, of any action, suit or proceeding referred to in paragraphs (a) and (b), or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. (d) Any indemnification under paragraphs (a) and (b) (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the Director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in paragraphs (a) and (b). Such determination shall be made (1) by the Board of Directors by a majority vote of a quorum consisting of Directors who were not parties to such action, suit or proceeding, or (2) if such a quorum is not obtainable, or, even if obtainable a quorum of -8- disinterested Directors so directs, by independent legal counsel in a written opinion, or (3) by the stockholders. (e) Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized by the Board of Directors in the manner provided in paragraph (d) upon receipt of an undertaking by or on behalf of the Director, officer, employee or agent to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation as authorized in this Section 13. (f) The indemnification provided by this Section 13 shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any By-Law, agreement, vote of stockholders or disinterested Directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a Director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. (g) The Board of Directors may authorize, by a vote of a majority of a quorum of the Board of Directors, the Corporation to purchase and maintain insurance on behalf of any person who is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a Director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Section 13. (h) For the purposes of this Section 13, references to "the Corporation" shall include, in addition to the resulting Corporation, any constituent Corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its Directors, officers, and employees or agents, so that any person who is or was a Director, officer, employee or agent of such constituent Corporation, or is or was serving at the request of such constituent Corporation as a Director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Section with respect to the resulting or surviving Corporation as he would have with respect to such constituent Corporation if its separate existence had continued. -9- (i) For purposes of this Section, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "serving at the request of the Corporation" shall include service as a Director, officer, employee or agent of the Corporation which imposes duties on, or involves services by, such Director, officer, employee or agent with respect to an employee benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a manner reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Section. ARTICLE IV OFFICERS Section 1. OFFICERS. The officers of this Corporation shall be chosen by the Board of Directors and shall include a President, a Secretary, and a Treasurer. The Corporation may also have at the discretion of the Board of Directors such other officers as are desired, including a Chairman of the Board, one or more Vice Presidents, one or more Assistant Secretaries and Assistant Treasurers, and such other officers as may be appointed in accordance with the provisions of Section 3 hereof. In the event there are two or more Vice Presidents, then one or more may be designated as Executive Vice President, Senior Vice President, or other similar or dissimilar title. At the time of the election of officers, the Directors may by resolution determine the order of their rank. Any number of offices may be held by the same person, unless the Certificate of Incorporation or these By-Laws otherwise provide. Section 2. ELECTION OF OFFICERS. The Board of Directors, at its first meeting after each annual meeting of stockholders, shall choose the officers of the Corporation. Section 3. SUBORDINATE OFFICERS. The Board of Directors may appoint such other officers and agents as it shall deem necessary who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board. Section 4. COMPENSATION OF OFFICERS. The salaries of all officers and agents of the Corporation shall be fixed by the Board of Directors. Section 5. TERM OF OFFICE; REMOVAL AND VACANCIES. The officers of the Corporation shall hold office until their successors are chosen and qualify in their stead. Any officer -10- elected or appointed by the Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. If the office of any officer or officers becomes vacant for any reason, the vacancy shall be filled by the Board of Directors. Section 6. CHAIRMAN OF THE BOARD. The Chairman of the Board, if such an officer be elected, shall, if present, preside at all meetings of the Board of Directors and exercise and perform such other powers and duties as may be from time to time assigned to him by the Board of Directors or prescribed by these By-Laws. If there is no President, the Chairman of the Board shall in addition be the Chief Executive Officer of the Corporation and shall have the powers and duties prescribed in Section 7 of this Article IV. Section 7. PRESIDENT. Subject to such supervisory powers, if any, as may be given by the Board of Directors to the Chairman of the Board, if there be such an officer, the President shall be the Chief Executive Officer of the Corporation and shall, subject to the control of the Board of Directors, have general supervision, direction and control of the business and officers of the Corporation. He shall preside at all meetings of the stockholders and, in the absence of the Chairman of the Board, or if there be none, at all meetings of the Board of Directors. He shall be an ex-officio member of all Committees and shall have the general powers and duties of management usually vested in the office of President and Chief Executive Officer of Corporations, and shall have such other powers and duties as may be prescribed by the Board of Directors or these By-Laws. Section 8. VICE PRESIDENT. In the absence or disability of the President, the Vice Presidents in order of their rank as fixed by the Board of Directors, or if not ranked, the Vice President designated by the Board of Directors, shall perform all the duties of the President, and when so acting shall have all the powers of and be subject to all the restrictions upon the President. The Vice Presidents shall have such other duties as from time to time may be prescribed for them, respectively, by the Board of Directors. Section 9. SECRETARY. The Secretary shall attend all sessions of the Board of Directors and all meetings of the stockholders and record all votes and the minutes of all proceedings in a book to be kept for that purpose; and shall perform like duties for the standing Committees when required by the Board of Directors. He shall give, or cause to be given, notice of all meetings of the stockholders and of the Board of Directors, and shall perform such other duties as may be prescribed by the Board of Directors or these By-Laws. He shall keep in safe custody the seal of the Corporation, and when -11- authorized by the Board, affix the same to any instrument requiring it, and when so affixed it shall be attested by his signature or by the signature of an Assistant Secretary. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his signature. Section 10. ASSISTANT SECRETARY. The Assistant Secretary or, if there be more than one, the Assistant Secretaries in the order determined by the Board of Directors or, if there be no such determination, the Assistant Secretary designated by the Board of Directors shall, in the absence or disability of the Secretary, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. Section 11. TREASURER. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. He shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements and shall render to the Board of Directors, at its regular meetings, or when the Board of Directors so requires, an account of all his transactions as Treasurer and of the financial condition of the Corporation. If required by the Board of Directors, he shall give the Corporation a bond, in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors, for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation. Section 12. ASSISTANT TREASURER. The Assistant Treasurer or, if there shall be more than one, the Assistant Treasurers in the order determined by the Board of Directors or, if there be no such determination, the Assistant Treasurer designated by the Board of Directors shall, in the absence or disability of the Treasurer, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. ARTICLE V CERTIFICATES OF STOCK Section 1. CERTIFICATES. Every holder of stock of the Corporation shall be entitled to have a certificate signed by, or -12- signed in the name of the Corporation by, the Chairman or Vice Chairman of the Board of Directors, or the President or a Vice President, and by the Secretary or an Assistant Secretary, or the Treasurer or an Assistant Treasurer of the Corporation, certifying the number of shares represented by the certificate owned by such stockholder in the Corporation. Section 2. SIGNATURES ON CERTIFICATES. Any or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent, or registrar at the date of issue. Section 3. STATEMENT OF STOCK RIGHTS, PREFERENCES AND PRIVILEGES. If the Corporation shall be authorized to issue more than one class of stock or more than one series of any class, the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualification, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of the certificate which the Corporation shall issue to represent such class or series of stock, provided that, except as otherwise provided in Section 202 of the General Corporation Law of Delaware, in lieu of the foregoing requirements, there may be set forth in the face or back of the certificate which the Corporation shall issue to represent such class or series of stock, a statement that the Corporation will furnish without charge to each stockholder who so requests the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. Section 4. LOST CERTIFICATES. The Board of Directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed. -13- Section 5. TRANSFERS OF STOCK. Upon surrender to the Corporation, or the transfer agent of the Corporation, of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignation or authority to transfer, it shall be the duty of the Corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. Section 6. FIXING THE RECORD DATE. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of the stockholders, or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix a record date which shall not be more than sixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. Section 7. REGISTERED STOCKHOLDERS. The Corporation shall be entitled to treat the holder of record of any share or shares of stock as the holder in fact thereof and accordingly shall not be bound to recognize any equitable or other claim or interest in such share on the part of any other person, whether or not it shall have express or other notice thereof, save as expressly provided by the laws of the State of Delaware. ARTICLE VI GENERAL PROVISIONS; DIVIDENDS Section 1. DIVIDENDS. Dividends upon the capital stock of the Corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Certificate of Incorporation. Section 2. PAYMENT OF DIVIDENDS; DIRECTORS' DUTIES. Before payment of any dividend there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the Directors from time to time, in their absolute discretion, think proper as a reserve fund to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or for such other purpose as the -14- Directors shall think conducive to the interests of the Corporation, and the Directors may abolish any such reserve. Section 3. CHECKS. All checks or demands for money and notes of the Corporation shall be signed by such officer or officers as the Board of Directors may from time to time designate. Section 4. FISCAL YEAR. The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors. Section 5. CORPORATE SEAL. The corporate seal shall have inscribed thereon the name of the Corporation, the year of its organization and the words "Corporate Seal, Delaware". Said seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. Section 6. MANNER OF GIVING NOTICE. Whenever, under the provisions of the statutes or of the Certificate of Incorporation or of these By-Laws, notice is required to be given to any Director or stockholder, it shall not be construed to mean personal notice, but such notice may be given in writing, by mail, addressed to such Director or stockholder, at his address as it appears on the records of the Corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Notice to Directors may also be given by telegram. Section 7. WAIVER OF NOTICE. Whenever any notice is required to be given under the provisions of the statutes or of the Certificate of Incorporation or of these By-Laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. Section 8. ANNUAL STATEMENT. The Board of Directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the Corporation. ARTICLE VII AMENDMENTS Section 1. AMENDMENT BY DIRECTORS OR STOCKHOLDERS. These By-Laws may be altered, amended or repealed or new By-Laws may be adopted by the stockholders or by the Board of Directors, when such power is conferred upon the Board of Directors by the Certificate of Incorporation, at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors if -15- notice of such alteration, amendment, repeal or adoption of new By-Laws be contained in the notice of such special meeting. If the power to adopt, amend or repeal By-Laws is conferred upon the Board of Directors by the Certificate of Incorporation it shall not divest or limit the power of the stockholders to adopt, amend or repeal By-Laws. -16- EX-3.5 3 EXHIBIT 3.5 EXHIBIT 3.5 FIRST AMENDMENT TO BYLAWS OF PACIFICARE HEALTH SYSTEMS This First Amendment (the "First Amendment"), effective as of September 28, 1994, to the Bylaws (the "Bylaws") of PacifiCare Health Systems, Inc., a Delaware corporation (the "Company") has been adopted by the board of directors of the Company (the "Board"), at a duly held meeting with reference to the following facts: WHEREAS, Article II, Section 2 of the Bylaws of the Company currently provides that the annual meeting of the stockholders shall be held each year on the first Tuesday in November, if not a legal holiday, and if a legal holiday, then on the next secular day following, at 10:00 a.m. or at such other date and time as may be determined from time to time by resolution adopted by the Board of Directors, when they shall elect by a plurality vote of the Board of Directors, and transact such other business as may properly be brought before the meeting. At each annual meeting Directors shall be elected and any other proper business transacted; WHEREAS, the Board deems it to be advisable and in the best interest of the Company to amend Article II Section 2 of the Bylaws to change the date of the annual meeting of shareholders from the first Tuesday in November to the first Wednesday in March; WHEREAS, Section 109(a) of the Delaware General Corporation Law permits the board of directors of a corporation to adopt, amend or repeal the bylaws of such corporation if the certificate of incorporation confers such power on the board of directors; WHEREAS, Article X of the Company's certificate of incorporation, as amended, and Article VII, Section 1, of the Bylaws permits the Board to adopt, amend or repeal the Bylaws; RESOLVED, that the Board deems it advisable and in the best interests of the Company that Article II, Section 2 of the Bylaws be amended and restated to read in its entirety as follows (the "Amendment"): Section 2. The annual meeting of the stockholders shall be held each year on the first Wednesday in March, if not a legal holiday, and if a legal holiday, then on the next secular day following, at 10:00 a.m. or at such other date and time as may be determined from time to time by resolution adopted by the Board of Directors, when they shall elect by a plurality vote of the Board of Directors, and transact such other business as may properly be brought before the meeting. At each annual meeting Directors shall be elected and any other proper business transacted RESOLVED, that the Bylaws shall not be further amended and that the Bylaws, as hereby amended, shall remain in full force and effect and shall be enforced in accordance with their terms, as amended. CERTIFICATE OF SECRETARY I, Joseph Konowiecki, hereby certify that I am the duly elected and acting secretary of PacifiCare Health Systems, Inc., a Delaware corporation (the "Company"), and that the foregoing First Amendment to the Bylaws of PacifiCare Health Systems, Inc., was duly adopted by the board of directors of the Company at a meeting duly held on September 28, 1994. IN WITNESS WHEREOF, I have executed this Certificate of Secretary on October 27, 1994. /s/ Joseph S. Konowiecki ------------------------------------- Joseph S. Konowiecki Secretary EX-11.A 4 EXHIBIT 11A Exhibit 11A PACIFICARE HEALTH SYSTEMS, INC.
COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK - PRIMARY (dollars and shares in thousands, except per share amounts) YEARS ENDED SEPTEMBER 30 ---------------------------- 1994 1993 1992 ---------------------------- Shares outstanding at the beginning of the period 27,256 25,617 22,771 Weighted average number of shares issued during the period in connection with public offerings, for exercise of stock options and conversion of subordinated debentures 155 1,694 1,007 Shares repurchased (weighted) (33) (88) - Dilutive shares contingently issuable upon exercise of stock options, net of shares assumed to have been purchased (at the average market price) for treasury with assumed proceeds from exercise of stock options 626 624 731 ----------------------------- Total primary shares 28,004 27,847 24,509 ----------------------------- ----------------------------- Income before cumulative effect of a change in accounting principle $ 84,593 $ 62,696 $ 43,590 Cumulative effect on prior years of a change in accounting principle 5,658 - - ----------------------------- Net income $ 90,251 $ 62,696 $ 43,590 ----------------------------- ----------------------------- Primary earnings per share: Earnings before cumulative effect of a change in accounting principle $ 3.02 $ 2.25 $ 1.78 Cumulative effect on prior years of a change in accounting principle 0.20 - - ----------------------------- Earnings per share - primary $ 3.22 $ 2.25 $ 1.78 ----------------------------- ----------------------------- All share and per share amounts have been adjusted to reflect the stock dividend, which had the same effect on the total number of shares of common stock and equivalents outstanding as a two-for-one stock split. (See Note 7 of the Notes to Consolidated Financial Statements, page 29.)
46 EX-11.B 5 EXHIBIT 11B EXHIBIT 11B PACIFICARE HEALTH SYSTEMS, INC.
COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK - FULLY DILUTED (dollars and shares in thousands, except per share amounts) YEARS ENDED SEPTEMBER 30 ----------------------------- 1994 1993 1992 ----------------------------- Shares outstanding at the beginning of the period 27,256 25,617 22,771 Weighted average number of shares issued during the period in connection with public offerings, for exercise of stock options and conversion of subordinated debentures 155 1,694 1,007 Shares repurchased (weighted) (33) (88) - Dilutive shares contingently issuable upon conversion of subordinated debentures, and exercise of stock options, net of shares assumed to have been purchased (at the higher of average or ending market price) for treasury with assumed proceeds from exercise of stock options 766 624 944 ----------------------------- Total fully diluted shares 28,144 27,847 24,722 ----------------------------- ----------------------------- Income before cumulative effect of a change in accounting principle $ 84,593 $ 62,696 $ 43,590 Cumulative effect on prior years of a change in accounting principle 5,658 - - ----------------------------- Net income $ 90,251 $ 62,696 $ 43,590 Decrease in interest expense applicable to subordinated convertible debentures, net income of income tax effect - 1 133 ----------------------------- Net income as adjusted $ 90,251 $ 62,697 $ 43,723 ----------------------------- ----------------------------- Fully diluted earnings per share: Earnings before cumulative effect of a change in accounting principle $ 3.00 $ 2.25 $ 1.77 Cumulative effect on prior years of a change in accounting principle 0.20 - - ----------------------------- Earnings per share - fully diluted $ 3.20 $ 2.25 $ 1.77 ----------------------------- ---------------------------- All share and per share amounts have been adjusted to reflect the stock dividend, which had the same effect on the total number of shares of common stock and equivalents outstanding as a two-for-one stock split. (See Note 7 of the Notes to Consolidated Financial Statements, page 29.)
47 EX-21 6 EXHIBIT 21 Exhibit 21 PACIFICARE HEALTH SYSTEMS, INC. LIST OF SUBSIDIARIES NAME OF SUBSIDIARY STATE OF INCORPORATION - ------------------ ---------------------- Advanced Delivery Systems Management Company California Barbis Advertising Florida California Dental Health Plan, Inc. California Clinica Pasteur, Inc. Florida Clinica Pasteur Laguna & Sweetwater, Inc. Florida COMPREMIER, Inc. California Covantage, Inc. Delaware CRM Insurance Services, Inc. California Dental Plan Administrators, Inc. California Health in Dade, Inc. Florida Health in Miami Beach, Inc. Florida Health Managers of Texas, Inc. Texas Interstate Medical Equipment, Inc. Florida Ismael Hernandez, M.D. & Associates, P.A. Florida LifeLink, Inc. Delaware MediCor, Inc. Texas Optica Pasteur, Inc. Florida Oregon Health Management Company California PacifiCare Administrative Services, Inc. California PacifiCare Administrative Services of Florida, Inc. Florida PacifiCare Behavioral Health, Inc. Delaware PacifiCare Benefit Administrators, Inc. Washington PacifiCare Life and Health Insurance Company Indiana PacifiCare Life Insurance Company Arizona PacifiCare Military Health Systems, Inc. Delaware PacifiCare of California California PacifiCare of Florida Florida PacifiCare of Oklahoma, Inc. Oklahoma PacifiCare of Oregon, Inc. Oregon PacifiCare of Texas, Inc. Texas PacifiCare of Washington, Inc. Washington PacifiCare Pharmacy Centers, Inc. California PacifiCare Ventures, Inc. California PacifiCare Wellness Company California PacifiClinic, P.C. Oregon PC-CWD Vista Associates California Pasteur Delivery Systems, Inc. Florida Pasteur Pharmacy, Inc. Florida Pasteur Systems, Inc. Florida Preferred Health Resources, Inc. Washington Secure Horizons USA, Inc. California West Dade Professional Services, Inc. Florida Woodbridge Management Company California 48 EX-23 7 EXHIBIT 23 Exhibit 23 CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (S-8 number 33-82204) and related Prospectus pertaining to the Amended and Restated 1989 Stock Option Plan for Officers and Key Employees, as amended, and in the Registration Statement (S-8 number 48543) and related Prospectus pertaining to the 1992 Non-Officer Directors Stock Option Plan, of PacifiCare Health Systems, Inc. of our report dated November 11, 1994 with respect to the consolidated financial statements and schedules of PacifiCare Health Systems, Inc. included in this Annual Report (Form 10-K) for the year ended September 30, 1994. ERNST & YOUNG LLP Los Angeles, California November 23, 1994 EX-27 8 EXHIBIT 27 FDS
5 1,000 12-MOS 12-MOS 12-MOS SEP-30-1994 SEP-30-1993 SEP-30-1992 OCT-01-1993 OCT-01-1992 OCT-01-1991 SEP-30-1994 SEP-30-1993 SEP-30-1992 192,609 33,262 30,137 517,999 403,969 241,998 74,534 54,829 40,589 558 1,155 1,698 0 0 0 821,882 514,899 329,475 149,520 114,281 89,279 52,502 35,232 25,135 1,105,548 693,646 498,082 590,640 352,118 279,925 101,137 21,821 18,488 275 272 256 0 0 0 0 0 0 413,083 319,022 198,628 1,105,548 693,646 498,082 0 0 0 2,893,252 2,221,073 1,686,314 0 0 0 2,374,258 1,850,469 1,393,645 0 0 0 532 1,650 594 4,050 2,376 3,422 145,468 108,327 74,852 60,875 45,631 31,262 84,593 62,696 43,590 0 0 0 0 0 0 5,658 0 0 90,251 62,696 43,590 3.22 2.25 1.78 3.20 2.25 1.77
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