-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K93GeD1EB1W7fRPJ1egFmgIftJY/Cxk4GcHPaYnMeUpijo17y8L+AVDWBqmNzvfL SHmf4gAcojXl4Tbcmi6YdQ== 0000912057-95-010543.txt : 19951201 0000912057-95-010543.hdr.sgml : 19951201 ACCESSION NUMBER: 0000912057-95-010543 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19950930 FILED AS OF DATE: 19951129 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFICARE HEALTH SYSTEMS INC CENTRAL INDEX KEY: 0000766456 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [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: 95597428 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, 1995 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 - ------------------------------------------------------------------------------- PACIFIC 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 [ ]. The aggregate market value of voting stock held by non-affiliates of the Registrant on November 1, 1995, was approximately $476,352,000. The number of shares of Class A Common Stock and Class B Common Stock outstanding at November 1, 1995, was 12,331,408 and 18,551,697, respectively. DOCUMENTS INCORPORATED BY REFERENCE DOCUMENT WHERE INCORPORATED Portions of the Registrant's definitive Proxy Statement to be filed by January 29, 1996 Part III PART I ITEM 1. BUSINESS PacifiCare-Registered Trademark- Health Systems, Inc. (the "Company" or "PacifiCare") is one of the nation's leading managed health care services companies, serving approximately 1,757,000 commercial, Medicare and Medicaid members. PacifiCare is also a leader in the management, development and marketing of diversified health maintenance organization ("HMO") products and related services. The Company operates HMOs in California, Florida, Oklahoma, Oregon, Texas and Washington, which as of September 30, 1995 had a combined commercial membership of approximately 1,216,000 members. Through internal growth and strategic acquisitions, the Company believes it has built a strong competitive position in California and has expanded operations into new and existing geographic markets. The Company, through its Secure Horizons-Registered Trademark- programs, operates the largest and one of the fastest growing Medicare risk programs in the United States (as measured by membership) with approximately 481,000 members enrolled as of September 30, 1995. The Company believes that its Secure Horizons programs are attractive to Medicare beneficiaries because they provide a more comprehensive package of benefits than offered under traditional Medicare and substantially reduce the member's administrative responsibilities. The Company's commercial and government (Medicare and Medicaid) program members are provided some or all of the following health care services: 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 pharmacy benefit management, life and health insurance, behavioral health, Medicare risk management services, dental and vision services, coordination of managed care products for multi- region employers, military health care management, workers' compensation managed care and health promotion. The Company believes that its ability to provide a comprehensive range of products and services and its long-term relationships with health care providers are the major factors that will enable it to respond effectively to changes and needs in the health care marketplace. The Company believes that it will continue to be among the nation's leading managed health care services companies. 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 1995 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 alternative health care delivery systems, such as HMOs, that provide better controls on rising costs without sacrificing quality. The goal of HMOs is to provide their members with access to quality health care, while employing a business strategy and management systems designed to encourage more cost-effective use of health care delivery systems. To accomplish these objectives, several basic HMO models have evolved. The models are distinguishable by the HMO's relationship with its physician providers and the capital investment required to support its operations. Under the staff model, the HMO employs the physicians and, ordinarily, provides the facility in which the physicians see patients. The physicians receive a salary and/or bonus typically based on the performance of the HMO. Under the group model, the HMO contracts with one large multi-specialty medical group practice which typically receives a monthly fixed fee for each HMO member (capitation), regardless of the medical services provided to each member. The network model is predicated on an HMO contracting with more than one physician group to provide services generally on a capitation fee basis. Under an individual practice association ("IPA") model, the HMO contracts 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. The Company primarily operates network and group HMOs and, to a lesser extent, IPA and staff model HMOs. 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. The rate of increase in HMO membership has moderated in recent years in response to increased competition. Increased managed health care options for commercial, Medicare and Medicaid programs include point of service ("POS"), preferred provider organizations ("PPOs") and certain employer self-funded programs. In addition, in some geographic 2 markets such as California, large employers have reduced the number of HMO options offered to their employees. Potential federal legislation may increase the number of Medicare competitors and various state legislation has changed the Medicaid market potential (See - "Government Regulation" and "Operations, Products and Services - Medicaid HMO Programs"). OPERATIONS, PRODUCTS AND SERVICES HMO Operations The Company's total membership has grown from approximately 673,000 members at September 30, 1990 to approximately 1,757,000 members at September 30, 1995, a 21 percent compound annual growth rate. The Company's membership at September 30, 1995 by state and program is as follows:
GOVERNMENT (MEDICARE & COMMERCIAL MEDICAID) TOTAL PERCENT OF TOTAL - ---------------------------------------------------------------------------------- California 816,554 382,998 1,199,552 68.3% Florida 53,352 10,104 63,456 3.6 Oklahoma 106,436 16,538 122,974 7.0 Oregon 93,318 45,084 138,402 7.9 Texas 77,532 49,186 126,718 7.2 Washington 68,948 37,082 106,030 6.0 ----------------------------------------------------------- Total Membership 1,216,140 540,992 1,757,132 100.0% ----------------------------------------------------------- -----------------------------------------------------------
COMMERCIAL HMO PROGRAMS The Company's commercial membership has grown from approximately 546,000 members at September 30, 1990 to approximately 1,216,000 members at September 30, 1995, a 17 percent compound annual growth rate. The Company offers a comprehensive range of products, including HMOs, PPOs and POS 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 option to use any physician, with higher deductibles and co-payments). The Company has historically focused on the larger employer market, but has recently entered the smaller employer and individual markets. The Company believes that these markets have lower HMO penetration levels than the larger employer market and represent significant growth opportunities. 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 make their selection 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 amount 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 co-payments are useful in helping contain the costs of health care without providing a barrier to members seeking needed health care services. In addition, the Company also offers at an additional premium, specialty managed care products and services, such as prescription pharmacy benefit management, dental and vision care and behavioral health care 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, 1995 accounted for approximately 34 percent of total commercial membership, with the largest employer group accounting for approximately eight percent of total commercial membership. The Company's five largest employer groups, in the aggregate, accounted for approximately 19 percent of its commercial revenue for the fiscal year ended September 30, 1995. 3 SECURE HORIZONS PROGRAMS Through its Secure Horizons-Registered Trademark- programs, the Company operates the largest and one of the fastest growing Medicare risk programs in the United States (as measured by membership). The Company's Medicare membership has grown from approximately 127,000 members at September 30, 1990 to approximately 481,000 members at September 30, 1995, a 31 percent compound annual growth rate. The Company believes the Medicare market offers significant growth opportunities since only approximately eight percent of the country's Medicare beneficiaries are enrolled in at-risk HMO programs such as those offered by the Company. The Company will seek to continue its growth in the Medicare risk arena by entering into new geographic markets with its Secure Horizons programs. The Company has provided health care services to Medicare beneficiaries through its Secure Horizons programs pursuant to annual contracts with the Health Care Financing Administration ("HCFA") since 1985. 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. The Company's Medicare contracts with HCFA 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. Termination of the Company's Medicare contracts could have a material adverse effect on the Company. The Company, however, has no reason to believe that such termination will occur. The Company believes that its Secure Horizons programs are attractive to Medicare beneficiaries because they provide a more comprehensive package of benefits than offered under traditional Medicare and because these programs substantially reduce the member's administrative responsibilities. Secure Horizons members enroll on an individual basis and may disenroll upon 30 days' notice. The Company believes that its Secure Horizons programs have one of the lowest disenrollment rates relative to other Medicare risk plans. Because the use of health care services by Medicare beneficiaries generally exceeds the use of services by those who are under the age of 65, the Company's Medicare contracts generate substantially larger per member revenue than the Company's commercial and Medicaid programs. 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 31 percent of the Company's membership at September 30, 1995, they accounted for 57 percent of the consolidated premium revenue for the fiscal year ended September 30, 1995. The Secure Horizons programs, however, 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 markets where the Company does not currently operate a commercial HMO, it has the ability to develop Medicare risk programs through other arrangements. See - "Specialty Managed Care Products and Services - Secure Horizons USA, Inc." Recent legislation passed by the U.S. House of Representatives may have an impact on the Company's Secure Horizons programs. See "Government Regulation." The Company is unable to predict the effect, if any, this legislation may have on the Company's business. In response to employers' 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. 4 MEDICAID HMO PROGRAMS Since 1993, the Company has arranged for health care services to Medicaid beneficiaries through certain of its HMO subsidiaries pursuant to annual contracts with the Department of Health and Human Services ("HHS"). The Company's Medicaid membership has grown from 1,597 members at September 30, 1993 to 59,586 members at September 30, 1995. Currently, the Company arranges for the provision of health care services to Medicaid beneficiaries in California, Florida, Oklahoma, Oregon and Washington and may enroll Medicaid beneficiaries in other geographic markets. Medicaid is a joint federal and state program designed to provide health care coverage for the indigent. The Company's Medicaid programs generally operate similarly to the Company's Secure Horizons programs with the Company receiving a capitated payment for each Medicaid member from HHS similar to payments received by the Company from HCFA in connection with its Secure Horizons programs. The Company's Medicaid contracts are subject to annual renewal. The Company believes that the risks associated with its Medicaid managed care programs are similar to the risks associated with its Secure Horizons programs. The Company believes that its programs are attractive to Medicaid beneficiaries because these programs provide access to quality health care providers, continuity of medical care and an introduction into mainstream managed care. California's Medicaid ("Medi-Cal") managed care program was recently modified by the California Department of Health Services ("DHS"). Under the new system, Medi-Cal beneficiaries can choose between either a county-run program or a mainstream HMO. Mainstream contracts were awarded by DHS, of which none were awarded to PacifiCare. Consequently, PacifiCare has decided to discontinue marketing to Medi-Cal beneficiaries. PacifiCare will continue serving its approximately 31,000 Medi-Cal members until the members transition to DHS contracted providers. Once this transition occurs, the Company will no longer participate in the Medi-Cal program. In Florida, legislation was recently passed which revised its Medicaid program. This legislation reduced Medicaid premiums, but did not include an automatic enrollment procedure for new Medicaid beneficiaries. Because the costs of marketing to obtain new Medicaid members in Florida is high relative to the premiums received for a Medicaid member, the Company has decided not to actively seek Medicaid members in Florida. The Company expects Medicaid members in Florida to disenroll throughout fiscal 1996. The Company expects to continue to operate Medicaid managed care programs in Oklahoma, Oregon and Washington. SPECIALTY MANAGED CARE PRODUCTS AND SERVICES In addition to its HMO operations, the Company provides a wide range of specialty managed care products and services. These products and services are offered to HMOs, insurers, employers, governmental entities, providers and PPOs through the following affiliated operations: PRESCRIPTION SOLUTIONS-Registered Trademark- was established in May 1993 to offer pharmacy benefit management services. 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. In January 1995, Prescription Solutions acquired Preferred Solutions, a San Jose-based pharmacy benefit management company. The acquisition of Preferred Solutions enables Prescription Solutions to provide fully integrated services, including mail order distribution, an extensive network of retail pharmacies, claims processing and sophisticated drug utilization reporting. In addition, the Company believes the acquisition of Preferred Solutions makes Prescription Solutions one of the industry's 10 largest pharmacy benefit management companies covering more than 3.5 million lives. PACIFICARE LIFE AND HEALTH INSURANCE COMPANY-SM- ("PLHIC") offers employer groups managed health care insurance products which have been integrated with the Company's existing HMO products to form multi-option health benefits programs. PLHIC is a life and health insurance company licensed to operate in 37 states, including California, Florida, Oklahoma, Oregon and Texas. PACIFICARE BEHAVIORAL HEALTH OF CALIFORNIA, INC., formerly LifeLink, Inc., is a licensed specialized health care service plan which provides behavioral health care services, including chemical dependency benefit programs in California 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. 5 SECURE HORIZONS-Registered Trademark-USA, INC. ("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 is reimbursed for its expenses and receives 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"). Through this 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 Secure Horizons, Tufts Health Plan for Seniors in the Boston area and, as of September 30, 1995 has approximately 18,000 members. The Company believes that Secure Horizons, Tufts Health Plan for Seniors will be ultimately offered throughout Massachusetts and other parts of New England. Other specialty products and services offered by the Company through various affiliated operations include: dental and vision care through California Dental Health Plan, Inc.; coordination of managed care products for multi-region employers through Covantage, Inc.; military health care management through PacifiCare Military Health Systems, Inc.; workers' compensation managed care through COMPREMIER, Inc.; and health promotion through PacifiCare Wellness Company. BUSINESS STRATEGY The Company's business strategy is to solidify its position as one of the leading managed health care services companies by: marketing a broader range of managed care products and services; capitalizing on its experience in developing long-term relationships with health care providers; expanding its Secure Horizons Medicare programs and selectively expanding into new markets to further develop its multi-regional servicing capabilities. During its last two fiscal years, the Company has entered into new markets, including South Florida, Houston and Dallas, Texas, Seattle, Washington and Central California. Growth in new markets has resulted from the Company building membership through expansion of its existing HMOs into additional geographic markets within the same state and through acquisitions. The Company believes it can continue to expand its membership through selective acquisitions and by establishing HMOs in new markets. The strategy of growth through acquisitions will be enhanced commencing in December 1995 when, for the first time, the Company will have the ability to use the pooling-of-interests method of accounting in connection with stock-for-stock acquisitions. HEALTH CARE PROVIDER RELATIONSHIPS The Company contracts with more than 381 physician groups for a defined range of health care services. The Company's HMOs arrange for comprehensive health care services for their members principally through a 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 generally negotiated annually in advance with each physician or physician group and does not subsequently vary with the nature or extent of the services provided. Generally, there is no requirement that the provider continue its relationship with the Company upon expiration of the annual period. The Company has, however, entered into provider service contracts with terms up to 10 years. The Company contracts with 560 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. For the year ended September 30, 1995, fixed fee capitated payments to providers and hospitals represented 58 percent and 75 percent of total health care costs for the commercial and government programs, respectively. 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 respect to competitive premium pricing and physician contracts is becoming difficult due to increasing competition. 6 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 primary care physician or group influences medical utilization and cost control in the Company's HMOs through 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 an HMO member as the member's personal physician or group. 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 may also 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. 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. The Company's profitability is dependent, in part, on maintaining effective control over health care costs while providing members with quality care. Factors such as health care reform, levels of utilization of health care services, new technologies, hospital costs, major epidemics, competition and numerous other external factors may affect the ability of the Company to control health care costs. QUALITY ASSURANCE The Company believes that providing access to high quality health care services is an essential ingredient for success. To achieve this goal, the Company has established a peer review procedure at each HMO, which is implemented by a Quality Assurance Committee chaired by the HMO's Medical Director and comprised of physicians and representatives of the physician groups at each HMO. When a new physician or physician group is considered by one of the Company's HMOs as a potential provider, the Quality Assurance Committee of the HMO evaluates, 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 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 questions and 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. In addition, in 1994, the Company began reporting Health Plan Employer Data Information Sets ("HEDIS"), to test the ability of health plans to report on indicators of performance in a quantitative manner. The Company expects that HEDIS will play a larger role in the future as purchases of managed health care services will be able to use them to compare health plans on quality and service. The National Committee for Quality Assurance (the "NCQA") is an independent, non-profit organization that reviews and accredits HMOs. NCQA assesses an HMO's quality improvement, utilization management, credentialing process, commitment to members' rights and preventative health services. HMOs that comply with NCQA's review requirements and quality standards receive NCQA accreditation. At September 30, 1995, the Company's California HMO received one year accreditation and the Company's Oklahoma and Florida HMOs were denied accreditation. The Company's other HMOs have applied for NCQA accreditation and are scheduled for NCQA site review in 1997. Accreditation in Florida is mandatory and is required for licensure but is not required in any other state where the Company operates HMOs. As a result of the accreditation denials in Oklahoma and Florida, the Company has developed a corrective action process, which is intended to address the issues identified by the NCQA, and the Company plans to re- 7 apply for accreditation in the future. The Company believes these denials will not have a material adverse impact on its operations. 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. The setting of premium rates directly affects a health plan's profitability and marketing success. Underwriting techniques are not employed with the government programs because of regulations which require the Company to accept all Medicare and Medicaid applicants. 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 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. MARKETING Marketing the Company's HMOs to commercial members generally involves a two- part sale. The employer must decide to offer the Company's HMO. The employee then generally must choose from among the Company's HMOs and other health care coverage options, often including other HMOs. 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. A significant portion of the Company's commercial membership growth comes from existing employer groups. 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. Marketing efforts are also supported by an advertising program that includes television, radio, billboard and print media. The Company markets the Secure Horizons programs 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 beneficiaries as various state laws permit. MANAGEMENT INFORMATION SYSTEMS The Company uses computer-based management information systems for various purposes, including underwriting, billing, claims processing, utilization management, marketing and sales tracking, and financial and management accounting, reporting, planning and analysis general accounting, medical cost trending, managed care reporting and financial planning. These systems also support member, group and provider service functions, including on-line access to membership verification, claims and referral status and information regarding hospital admissions and lengths of stay. In addition, these systems support extensive analysis of cost and outcome data. The Company's computer information systems which support its managed care operations and specialty managed products are continually being enhanced and upgraded. Information system development efforts relating to increased efficiency, capacity and flexibility are ongoing. The Company is heavily dependent on its information systems and is in the process of integrating the systems of its recently acquired operations. 8 COMPETITION The health care industry is highly competitive, both nationally and in the Company's various markets. 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 Company also faces competition from hospitals, health care facilities and other health care providers who have combined and formed their own networks to contract directly with employer groups and other prospective customers for the delivery of health care services. Pending federal legislation may also increase the number of competitors (See - "Government Regulation"). California, 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, access to health care providers, quality of care, comprehensiveness of coverage and quality of administrative services. In such an increasingly competitive environment, the Company believes that a comprehensive range of products and services, along with a strong provider network, must be provided to remain competitive. GOVERNMENT REGULATION The Company's HMOs are licensed and are subject to state and federal statutes and regulations which extensively control the activities and licensing of HMOs and subject the HMOs to periodic examination by governmental agencies. 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. The Company believes that it is currently in compliance in all material respects with the various federal and state licensing regulations applicable to its current operations. To maintain such compliance, it may be necessary for the Company's HMOs to make changes from time to time in their services, procedures, structure and marketing methods. Some of the changes may be caused by changes in federal and state statutes and regulations that govern the Company's HMOs. 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. Additional governmental regulation or future interpretation of existing regulations could adversely affect the Company's operations, profitability or business prospects. The Company's HMOs 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 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 to assist them in satisfying federal or state financial requirements. California legislation requires all HMOs and insurers which offer small group coverage to accept all small employers who apply for coverage and 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. Compliance with this legislation has required the Company to make certain changes to its small group products in California. One of the most significant federal laws affecting the Company is the Federal Health Maintenance Organization Act of 1973 (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 HMO and portions of its California and Oklahoma HMO service areas, are federally qualified. 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. 9 The Company's Secure Horizons programs 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 to be eligible for Medicare risk contracts. HCFA has the right to audit HMOs operating under Medicare contracts to determine the quality of care being rendered and the degree of compliance with HCFA's contract and regulations. 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, reduce the supplemental premiums charged to its Medicare members or accept a lower payment from HCFA 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. Secure Horizons' premiums are determined through formulas established by HCFA for the Company's Medicare contracts in a particular region. If these premiums are reduced or if premium rate increases in a particular region are lower than the rate of increase in health care service expenses of Secure Horizons members in such region, the Company's operations, profitability or business prospects could be affected. The Company has mitigated this risk by paying approximately 75 percent of the health care service expenses of the Secure Horizons programs for the year ended September 30, 1995 on a capitated basis. The Company believes that any slowdown in the rate of premium growth may be offset by the effect of a proposal encouraging managed health care for Medicare beneficiaries. The loss of Medicare contracts or termination or modification of the HCFA risk-based Medicare program could have a material adverse effect on the revenue, profitability and business prospects of the Company. The Company's HMOs which have Medicaid contracts are subject to both federal and state regulation regarding services to be provided to Medicaid enrollees, payment for those services and other aspects of the Medicaid program. Both Medicare and Medicaid have in force and/or have proposed regulations relating to fraud and abuse, physician incentive plans and provider referrals which may affect the Company's operations. Some of the Company's HMOs contract with the United States Office of Personnel Management ("OPM") to arrange managed health care services under the Federal Employees Health Benefit Program ("FEHBP"). These contracts are subject to extensive regulation, including complex rules related to the premiums charged. OPM has the authority to retroactively audit the rates charged and frequently seeks premium refunds and other sanctions against health plans participating in the program. The Company's HMOs which have contracted with OPM are subject to such audits and may be requested to make such refunds. The Company has two insurance subsidiaries, one domiciled in Indiana and licensed in 37 states and one domiciled in Arizona. The Company's insurance subsidiaries are subject to regulation in each state in which they are licensed. Regulatory authorities exercise extensive supervisory power over insurance companies. The Company's insurance subsidiaries are required to file periodic statutory financial statements in each jurisdiction in which they are licensed. Additionally, such subsidiaries are periodically examined by the insurance departments of the jurisdiction in which they are licensed to do business. Certain of the Company's HMOs and each of the Company's insurance subsidiaries are subject to regulation under state insurance holding company regulations. Such insurance holding company laws and regulations generally require registration with the state department of insurance and the filing of certain reports describing capital structure, ownership, financial condition, certain intercompany transactions and general business operations. Various notice and reporting requirements generally apply to transactions between companies within an insurance holding company system, depending on the size and nature of the transactions. Certain state insurance holding company laws and regulations require prior regulatory approval or, in certain circumstances, prior notice of certain material intercompany transfers of assets as well as certain transactions between the regulated companies, their parent holding companies and affiliates, and acquisitions. 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 made, and additional proposals may be introduced in the United State Congress and the legislatures of the states in which the Company operates or may seek to operate. 10 The United States Congress recently passed a budget reconciliation package (the "Budget Package") that included provisions reforming the Medicare program. Under the Budget Package, Medicare beneficiaries would be offered a variety of new health care options, including the ability to enroll in private plans, such as HMOs, PPOs, POS plans, medical savings accounts and provider-sponsored organizations. A traditional fee-for-service Medicare program would, however, continue to be offered through HCFA. The Budget Package would also amend current laws which prohibit physician self-referral, guard against fraud and abuse and eliminate the requirement that HMOs participating in the Medicare program have membership which is at least 50 percent non-government program beneficiaries. In addition, HMOs would be paid a monthly capitation rate that blends local and national costs with greater weight given to the local component. A floor would be established for payments to rural areas. The Budget Package has been submitted to President Clinton and a presidential veto is expected. Accordingly, the ultimate form in which this legislation will take effect and the impact of this legislation on the Company's business cannot be predicted. It is believed that a portion of the managed care provisions will be included in the final legislation and that programs similar to the Company's Secure Horizons programs would be favorably impacted by Medicare reform. It may, however, result in an increase in the number of competitors. The Budget Package also aims to modify the Medicaid program by converting the existing Medicaid program from a federal entitlement into a block grant payment to the states. In addition, federal standards for nursing homes would be revoked and states would have to establish and maintain their own standards. As stated above, ultimate passage of this legislation and the impact of this legislation on the Company's business cannot be predicted. 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 and financial condition of the Company. 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. EMPLOYEES As of September 30, 1995, the Company had 4,438 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, 1995 the Company had leases, in the aggregate, for approximately 1,094,000 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 leases approximately 105,000 square feet in Cypress, California for its corporate headquarters and executive offices. The Company owns an office building of approximately 216,000 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 child care facility on one acre of land in Cypress, California and an office building of approximately 16,000 square feet on 1.4 acres of land in Tustin, California. The Company considers its facilities to be in good working condition, well maintained and adequate for its present needs. 11 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, results of operations or cash flows. 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, 1995. 12 PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND QUARTERLY INFORMATION The Class A Common Stock, par value $0.01 per share (the "Class A Common Stock"), and the Class B Common Stock, par value $0.01 per share (the "Class B Common Stock"), are traded on the over-the-counter market and are quoted on the Nasdaq National Market 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 ------- ------ ------ ------ 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 1995 First Quarter 79 60 3/4 74 3/4 60 1/2 Second Quarter 76 1/4 61 77 62 Third Quarter 75 1/8 44 1/2 76 1/4 44 Fourth Quarter 68 1/2 49 3/4 71 48 1/2 The Company has never paid any cash dividends on its common stock and presently anticipates for the foreseeable future that no cash dividends on its common stock will be declared 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, 1995 there were approximately 266 and 211 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 22,000 beneficial holders in the aggregate of the Class A and Class B Common Stock. 13 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) 1995(1) 1994(1) 1993 1992 1991 - ---------------------------------------------------------------------------------------------------------------------- Operating revenue $3,731,022 $2,893,252 $2,221,073 $1,686,314 $1,242,357 - ---------------------------------------------------------------------------------------------------------------------- Expenses: Health care services 3,077,135 2,374,258 1,850,469 1,393,645 1,053,239 Other operating expenses 505,644 398,064 283,360 232,120 159,384 - ---------------------------------------------------------------------------------------------------------------------- Operating income 148,243 120,930 87,244 60,549 29,734 Interest income, net 33,857 24,538 21,083 14,303 14,787 - ---------------------------------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of a change in accounting principle 182,100 145,468 108,327 74,852 44,521 Provision for income taxes 74,005 60,875 45,631 31,262 18,819 - ---------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of a change in accounting principle 108,095 84,593 62,696 43,590 25,702 Cumulative effect on prior years of a change in accounting principle -- 5,658 -- -- -- - ---------------------------------------------------------------------------------------------------------------------- Net Income $ 108,095 $ 90,251 $ 62,696 $ 43,590 $ 25,702 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- Earnings per share(2) $ 3.62 $ 3.22 $ 2.25 $ 1.78 $ 1.10 - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
OPERATING STATISTICS
YEARS ENDED SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991 - ---------------------------------------------------------------------------------------------------------------------- Medical loss ratio (health care services as a percent of premium revenue) Consolidated 83.6% 83.1% 84.1% 83.2% 85.4% Commercial 82.5% 80.5% 82.5% 80.2% 84.0% Government 84.3% 85.2% 85.6% 86.6% 87.1% Marketing, general and administrative expenses as a percent of operating revenue 13.4% 13.6% 12.6% 13.6% 12.8% Operating income as a percent of operating revenue 4.0% 4.2% 3.9% 3.6% 2.4% Effective tax rate 40.6% 41.8% 42.1% 41.8% 42.3% Return on average shareholders' equity 18.9% 24.6% 24.2% 29.2% 29.5% - ---------------------------------------------------------------------------------------------------------------------- (1) The 1995 and 1994 results reflect the effect of several acquisitions. See Note 5 of Notes to Consolidated Financial Statements, page 28. (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. Earnings per share before cumulative effect of a change in accounting principle for the year ended September 30, 1994 was $3.02 per share. The cumulative effect of a change in accounting principle for the year ended September 30, 1994 was $0.20 per share.
14 FINANCIAL STATEMENT CHANGE STATISTICS
YEARS ENDED SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991 - ---------------------------------------------------------------------------------------------------------------------- Operating revenue 29.0% 30.3% 31.7% 35.7% 27.3% Net income 19.8% 44.0% 43.8% 69.6% 45.7% Earnings per share 12.4% 43.1% 26.4% 61.8% 48.6% Total assets 25.3% 59.4% 39.3% 54.5% 39.2% Total shareholders' equity 77.1% 29.5% 60.5% 99.5% 33.7% - ----------------------------------------------------------------------------------------------------------------------
MEMBERSHIP DATA (owned and managed)
SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991 - ---------------------------------------------------------------------------------------------------------------------- Commercial 1,216,140 949,124 806,918 742,104 567,422 Government (Medicare & Medicaid) 540,992 409,095 290,149 214,110 159,074 - ---------------------------------------------------------------------------------------------------------------------- Total membership 1,757,132 1,358,219 1,097,067 956,214 726,496 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- Percent change in membership 29.4% 23.8% 14.7% 31.6% 7.9% - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA (in thousands)
SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991 - ---------------------------------------------------------------------------------------------------------------------- Cash and equivalents and marketable securities $ 811,525 $ 710,608 $437,231 $272,135 $205,846 Total assets $1,385,372 $1,105,548 $693,646 $498,082 $322,328 Medical claims and benefits payable $ 288,400 $ 302,900 $255,000 $208,000 $175,700 Long-term debt, excluding current maturities $ 11,949 $ 101,137 $ 21,821 $ 18,488 $ 2,280 Shareholders' equity $ 732,024 $ 413,358 $319,294 $198,884 $ 99,678 - ---------------------------------------------------------------------------------------------------------------------- (1) The 1995 and 1994 results reflect the effect of several acquisitions. See Note 5 of Notes to Consolidated Financial Statements, page 28. 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 1994 changes in net income and earnings per share before cumulative effect of a change in accounting principle are 34.9 percent and 34.2 percent, respectively.
15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FISCAL YEAR 1995 COMPARED WITH FISCAL YEAR 1994 Total operating revenue increased 29.0 percent or $838 million to $3.7 billion for the year ended September 30, 1995 from $2.9 billion for the same period in the prior year. Enrollment gains in both the government (Medicare and Medicaid) and commercial programs, offset slightly by decreases in commercial premium rates, provided an increase in total operating revenue of $659 million. Membership growth is expected to continue in both the commercial and government programs. However, competition for members and the expected Medicaid disenrollment in California and Florida, combined with a larger membership base is expected to cause the rate of the membership growth to decline from the 28 percent and 32 percent increases experienced in the commercial and government programs, respectively, in 1995. Approximately $149 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 remaining $30 million was contributed by the Company's specialty managed care products and services and its joint venture medical groups. Commercial premiums increased $275 million or 22 percent to $1.5 billion for the year ended September 30, 1995 from $1.2 billion in 1994. Commercial HMO membership increased by 267,000 or 28 percent to 1,216,000 due to continued growth in California, Oregon, Texas and Washington. The increase in membership includes the effects of acquisitions in California and Washington of 67,000 and 33,000 members, respectively. The Company expects the 1996 membership growth rate to be lower than 1995 because more competitors are offering consumers more choices with pricing consistent with 1995 rates. Commercial HMO membership growth provided $177 million of the increase, more than offsetting average premium rate decreases of two percent, primarily in California. The effects of acquisitions described above and the commercial specialty managed care products and services and joint venture medical groups provided the remainder of the increase in commercial premiums. Government premiums rose $553 million or 34 percent to $2.2 billion for the year ended September 30, 1995 from $1.6 billion in 1994. Enrollment gains, predominantly in the Secure Horizons programs, accounted for $492 million or 89 percent of the increase. In fiscal 1996, the government membership growth rate is expected to be less than the 32 percent increase experienced in 1995. The remainder of the premium increase is attributable to incremental acquisitions and premium rate increases averaging one percent. In November 1995, the Company was advised by HCFA that effective January 1996, its HMOs will receive a weighted average premium rate increase of approximately 5.6 percent. Because pending federal legislation may change Medicare reimbursement rates, there can be no assurance that these rate increases will be received. Total health care services expenses as a percent of premium revenue (the "medical loss ratio"; See Item 6. Selected Financial Data, page 14) for the year ended September 30, 1995, increased to 83.6 percent from 83.1 percent in 1994. The commercial medical loss ratio increased to 82.5 percent from 80.5 percent while the government medical loss ratio decreased to 84.3 percent from 85.2 percent. The increase in the commercial medical loss ratio has been driven by the Company's entry into new markets, through acquisitions and internal development, with principally traditional fee-for-service delivery systems. Implementing the Company's provider contracting approach, shifting the delivery systems from fee- for-service to capitation and risk-sharing arrangements, and developing the provider network through education in these markets are expected to decrease the commercial medical loss ratio by the end of fiscal 1996. Until health care cost risks are mitigated through contract renewals beginning January 1, 1996 and later, the commercial medical loss ratio may increase slightly in the first and second quarter of fiscal 1996. The decrease in the government medical loss ratio is primarily related to more cost effective physician and hospital contracts. The government medical loss ratio is expected to increase in 1996 as competitive pressures increase health care costs and outpace increases in premium revenue. For the year ended September 30, 1995, the Company made net positive reserve adjustments totaling $12 million. These net positive reserve adjustments have historically been made in the third quarter and result primarily from the periodic reconciliation of amounts reserved for physician and hospital incentive programs. For the year ended September 30, 1995, however, net positive reserve adjustments were made in insignificant amounts throughout the year. For the year ended September 30, 1994, net positive reserve adjustments of $9 million were made in the third quarter. 16 Marketing, general and administrative expenses increased $104 million or 26 percent to $498 million for the year ended September 30, 1995 from $395 million for 1994. As a percentage of operating revenue, marketing, general and administrative expenses decreased to 13.4 percent from 13.6 percent. The decrease is primarily attributable to increased operating revenue and efficiencies due to process improvements which have offset infrastructure investments in new markets. Marketing, general and administrative expenses as a percentage of operating revenue in fiscal 1996 are expected to be comparable to, or slightly higher than, fiscal 1995 as mature market process improvements are offset by investments in new markets. Net interest income increased by approximately $9 million compared to the prior year primarily due to increased cash available for investment purposes at higher interest rates than 1994. For the year ended September 30, 1995, earnings per share increased 20 percent to $3.62 compared to $3.02 for 1994 before the cumulative effect of a change in accounting principle. The increase is primarily related to membership growth derived substantially from the government programs predominantly Secure Horizons. Increases in health care service expenses were partially offset by decreases in marketing, general and administrative expenses. The results for the years ended September 30, 1995 and 1994 included approximately $0.24 and $0.18, respectively, related to the net positive reserve adjustments previously described. Earnings per share for the year ended September 30, 1994 were $3.22 which included approximately $0.20 due to changes in income tax accounting principles (see Note 2j of the Notes to Consolidated Financial Statements). The Company's ability to expand is affected by increasing competition not only in product choices but also in the number of competitors in the Company's service areas. Certain large employer groups and other purchasers of health care services continue to demand minimal premium rate increases or reductions in premium rates while limiting the number of choices offered to employees. In addition, securing cost effective contracts with additional physicians is becoming difficult due to increasing competition among HMOs for physician contracts. The Company's profitability depends, in part, on its ability to maintain effective control over health care costs while providing members with quality care. Factors such as health care reform, levels of utilization of health care services, 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 performance to anticipate results or future period trends. 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 1993. Enrollment gains in both the government 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 represented 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 1993. Excluding the effects of the acquisitions described above, membership growth provided 46 percent of the increase in the commercial HMO program. An additional 21 percent of the increase was attributable to higher premium rates, which rose an average of three percent. 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 1993. Excluding the effects of acquisitions described above, enrollment gains predominantly in the Secure Horizons programs contributed 80 percent of the increase. Average premium rate increases of two percent accounted for nine percent of the increase. The remainder of the change was attributable to acquisitions. The medical loss ratio for the year ended September 30, 1994, decreased to 83.1 percent from 84.1 percent for the same period in 1993. 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 decrease in the commercial 17 medical loss ratio was primarily attributable to lower inpatient hospital costs. The decrease in the government medical loss ratio was 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. The $3 million increase in net positive reserve adjustments was primarily attributable to increases in members served under hospital capitation arrangements and improved contracting. Commercial net positive reserve adjustments for the year ended September 30, 1994 increased to $4 million compared to $1 million for the same period in the prior year. Government net positive reserve adjustments for each of the years ended September 30, 1994 and 1993 totaled $5 million. 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 were 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. 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 was 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 2j 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. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital as of September 30, 1995 was $321 million, an increase of $89 million from September 30, 1994. The increase in working capital is primarily attributable to increases in cash and accounts receivable offset by increases in accounts payable, accrued liabilities and unearned premium revenue resulting from growth in operations. Medical claims and benefits payable decreased from September 30, 1994, reflecting shifting membership, primarily in the Secure Horizons programs, to capitated arrangements, coupled with improvements in claims processing that result in faster payment and fewer claims awaiting adjudication and payment. For the year ended September 30, 1995, payments for physician and hospital capitation represented approximately 68 percent of total health care costs, an increase of four percent over 1994. Redesigned work processes and electronic data interface technologies resulted in more efficient and prompt payment of claims. While the expedited claims payment process is expected to reduce interest income, these operating efficiencies enhance the Company's ability to comply with certain HMO regulations. Cash generated from operations was $147 million, principally from net income and non-cash items including depreciation and amortization. In fiscal 1994, cash generated from operations of $288 million reflected net income, non-cash items and a $153 million increase in unearned premium revenue because October HCFA premiums were received in September. Because fiscal 1995 also reflects October HCFA premiums received in September, unearned premium revenue increased slightly over 1994, decreasing cash generated from operations by $141 million. The Company made acquisitions using $135 million of cash, decreasing the net purchases of marketable securities. The Company made capital expenditures of $25 million for the year ended September 30, 1995 primarily for computer equipment. The Company anticipates that the level of capital expenditures will increase in 1996 in connection with the Company's ongoing program of updating and enhancing its management information systems. In March 1995, the Company completed a public offering of 5,175,000 shares of its Class B Common Stock, of which 3,000,000 shares were sold by the Company and 2,175,000 share were sold by UniHealth. The Company received net proceeds of approximately $198 million for the sale of the 3,000,000 shares of Class B Common Stock after deducting underwriting discounts and commissions and expenses of the offering payable by the Company. The Company used approximately $186 million of the net proceeds to repay the amount outstanding under its line of credit (see Note 6 - 18 "Long Term Debt") and to replenish working capital used to pay for certain of the acquisitions (see Note 5 - "Acquisitions"). The Company believes that its current capital resources, which includes the $250 million line of credit with B of A, are adequate to fund existing HMO operations, the introduction of new products and services and the continued development of its health-care related businesses (see Note 6 - "Long Term Debt" for a summary of the terms of the B of A Credit Line). 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. . . . . . . 25 Report of Ernst & Young LLP Independent Auditors. . . . 35 Quarterly Information for Fiscal Years 1995 and 1994 (Unaudited). . . . . . . . . . . . . . . . . . . . . . 36
19 CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 (in thousands, except per share data) 1995 1994 - ------------------------------------------------------------------------------------------ ASSETS Current assets: Cash and equivalents $ 279,145 $ 192,609 Marketable securities 532,380 517,999 Receivables, net 112,408 73,976 Prepaid expenses 9,469 8,883 Deferred income taxes 28,207 28,415 - ------------------------------------------------------------------------------------------ Total current assets 961,609 821,882 - ------------------------------------------------------------------------------------------ Property, plant and equipment at cost, net of accumulated depreciation and amortization 99,276 97,018 Marketable securities - restricted 23,108 15,994 Goodwill and intangible assets 295,794 167,085 Other assets 5,585 3,569 - ------------------------------------------------------------------------------------------ $1,385,372 $1,105,548 - ------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Medical claims and benefits payable: Medical claims payable $ 192,800 $ 203,900 Incentives payable to participating medical groups 80,600 83,700 Future life and annuity policy benefits 15,000 15,300 - ------------------------------------------------------------------------------------------ Total medical claims and benefits payable 288,400 302,900 - ------------------------------------------------------------------------------------------ Accounts payable 21,699 17,000 Accrued liabilities 74,685 47,110 Accrued compensation and employee benefits 45,415 37,737 Income taxes payable 7,404 6,748 Unearned premium revenue 195,413 170,970 Long-term debt due within one year 7,978 8,175 - ------------------------------------------------------------------------------------------ Total current liabilities 640,994 590,640 - ------------------------------------------------------------------------------------------ Long-term debt due after one year 11,949 101,137 Minority interest 405 413 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; 12,331 and 12,238 shares issued in 1995 and 1994, respectively 123 122 Class B common shares, par value $0.01 per share; 60,000 shares authorized; 18,551 and 15,290 shares issued in 1995 and 1994, respectively 186 153 Additional paid-in capital 347,548 141,955 Unrealized gain on marketable securities net of taxes 4,944 -- Retained earnings 379,223 271,128 - ------------------------------------------------------------------------------------------ Total shareholders' equity 732,024 413,358 - ------------------------------------------------------------------------------------------ $1,385,372 $1,105,548 - ------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------
See accompanying notes. 20 CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30 (in thousands, except per share data) 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------ Revenue: Commercial premiums $1,512,080 $1,237,411 $1,046,186 Government premiums 2,170,885 1,618,145 1,153,964 Other income 48,057 37,696 20,923 - ------------------------------------------------------------------------------------------------------------ Total operating revenue 3,731,022 2,893,252 2,221,073 - ------------------------------------------------------------------------------------------------------------ Expenses: Health care services: Medical services 1,453,289 1,127,785 867,157 Hospital services 1,264,002 968,605 766,770 Other services 359,844 277,868 216,542 - ------------------------------------------------------------------------------------------------------------ Total health care services 3,077,135 2,374,258 1,850,469 Marketing, general and administrative expenses 498,445 394,620 279,865 Amortization of intangibles 7,199 3,444 3,495 - ------------------------------------------------------------------------------------------------------------ Operating income 148,243 120,930 87,244 Interest income 39,406 28,588 23,459 Interest expense (5,549) (4,050) (2,376) - ------------------------------------------------------------------------------------------------------------ Income before income taxes and cumulative effect of a change in accounting principle 182,100 145,468 108,327 Provision for income taxes 74,005 60,875 45,631 - ------------------------------------------------------------------------------------------------------------ Income before cumulative effect of a change in accounting principle 108,095 84,593 62,696 Cumulative effect on prior years of a change in accounting principle -- 5,658 -- - ------------------------------------------------------------------------------------------------------------ Net income $ 108,095 $ 90,251 $ 62,696 - ------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------ Weighted average common shares and equivalents outstanding used to calculate earnings per share 29,864 28,004 27,847 - ------------------------------------------------------------------------------------------------------------ Earnings per share: Before cumulative effect of a change in accounting principle $ 3.62 $ 3.02 $ 2.25 Cumulative effect on prior years of a change in accounting principle -- .20 -- - ------------------------------------------------------------------------------------------------------------ Earnings per share $ 3.62 $ 3.22 $ 2.25 - ------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------
See accompanying notes. 21 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 UNREALIZED CLASS A COMMON SHARES CLASS B COMMON SHARES ADDITIONAL GAIN ON --------------------- --------------------- PAID-IN MARKETABLE RETAINED (in thousands) OUTSTANDING AMOUNT OUTSTANDING AMOUNT CAPITAL SECURITIES EARNINGS TOTAL - --------------------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1992 11,946 $119 13,671 $137 $ 80,447 $ -- $118,181 $198,884 - --------------------------------------------------------------------------------------------------------------------------------- Issuance of 1,600 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 - --------------------------------------------------------------------------------------------------------------------------------- Issuance of 3,000 shares of common stock in connection with public offering -- -- 3,000 30 197,602 -- -- 197,632 Issuance of common stock upon exercise of stock options 93 1 245 3 3,284 -- -- 3,288 Issuance of common stock under incentive plan -- -- 16 -- 1,024 -- -- 1,024 Tax benefit realized upon exercise of stock options -- -- -- -- 3,683 -- -- 3,683 Cumulative effect of a change in accounting principle, net of taxes of $2,474 -- -- -- -- -- (3,808) -- (3,808) Change in unrealized gains (losses), net of taxes of $5,516 -- -- -- -- -- 8,752 -- 8,752 Net income -- -- -- -- -- -- 108,095 108,095 - --------------------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1995 12,331 $123 18,551 $186 $347,548 $4,944 $379,223 $732,024 - --------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------
See accompanying notes. 22 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30 (in thousands) 1995 1994 1993 - ------------------------------------------------------------------------------------------------ Operating activities: Net income $ 108,095 $ 90,251 $62,696 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 21,436 17,913 11,916 Amortization of intangibles 7,199 3,444 3,495 Loss on disposal of property, plant and equipment 2,033 642 1,337 Deferred income taxes (2,834) (9,411) 1,275 Provision for doubtful accounts 530 532 1,650 Cumulative effect of a change in accounting principle -- (5,658) -- Other 114 45 (407) Changes in assets and liabilities net of effects from acquisitions: Accounts receivable (27,458) (15,607) (16,433) Prepaid and other assets (2,489) 9,774 (5,715) Medical claims and benefits payable (19,093) 29,043 47,000 Accounts payable (153) (5,819) 1,768 Accrued liabilities 27,575 8,336 18,736 Accrued compensation and employee benefits 7,678 9,249 994 Income taxes payable 656 2,372 4,428 Unearned premium revenue 23,934 153,387 2,378 - ------------------------------------------------------------------------------------------------ Net cash flows provided by operating activities 147,223 288,493 135,118 - ------------------------------------------------------------------------------------------------ Investing activities: Acquisitions, net of cash acquired (134,971) (69,589) -- Purchase of property, plant and equipment (25,035) (24,979) (19,577) Purchase of marketable securities (6,395) (113,415) (161,971) Purchase) sale of marketable securities -- restricted (7,114) 450 (206) Proceeds from sale of property, plant and equipment 3,056 -- 32 - ------------------------------------------------------------------------------------------------ Net cash flows used in investing activities (170,459) (207,533) (181,722) - ------------------------------------------------------------------------------------------------ Financing activities: Proceeds from issuance of common stock 200,920 2,326 60,831 Principal payments on long-term debt (174,483) (5,212) (2,927) Proceeds from borrowings of long-term debt 83,335 82,350 -- Purchase and retirement of common stock -- (1,077) (8,175) - ------------------------------------------------------------------------------------------------ Net cash flows provided by financing activities 109,772 78,387 49,729 - ------------------------------------------------------------------------------------------------ Net increase in cash and equivalents 86,536 159,347 3,125 Beginning cash and equivalents 192,609 33,262 30,137 - ------------------------------------------------------------------------------------------------ Ending cash and equivalents $ 279,145 $ 192,609 $33,262 - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------
See accompanying notes. 23 CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED SEPTEMBER 30 (in thousands) 1995 1994 1993 - ------------------------------------------------------------------------------------------------ Supplemental cash flow information Cash paid during the year for: Income taxes $ 61,166 $ 66,510 $40,295 Interest $ 2,685 $ 2,466 $ 1,865 - ------------------------------------------------------------------------------------------------ Supplemental schedule of noncash investing and financing activities: Tax benefit realized upon exercise of stock options $ 3,683 $ 1,715 $ 5,038 Compensation awarded in Class B Common Stock $ 1,024 849 $ -- Leases capitalized $ 392 $ 4,063 $ 8,658 Capital leases terminated $ -- $ 1 $ 45 Conversion of 7.50% subordinated convertible debentures $ -- $ -- $ 20 - ------------------------------------------------------------------------------------------------ Details of unrealized gain on marketable securities: Marketable securities $ 7,986 $ -- $ -- Deferred taxes $ 3,042 $ -- $ -- - ------------------------------------------------------------------------------------------------ Increase in shareholders' equity $ 4,944 $ -- $ -- - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------ Details of businesses acquired in purchase transactions: Fair value of assets acquired $ 152,456 $ 130,323 $ -- Less liabilities assumed or created, including notes to seller 15,909 42,587 -- - ------------------------------------------------------------------------------------------------ Cash paid for acquisitions 136,547 87,736 -- Cash acquired in acquisitions 1,576 18,147 -- - ------------------------------------------------------------------------------------------------ Net cash paid for in acquisitions $ 134,971 $ 69,589 $ -- - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------
See accompanying notes. 24 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 arrange 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 pharmacy benefit management, life and health insurance, behavioral health, Medicare risk management services and vision services, coordination of managed care products for multi-region employers, military health care management, workers' compensation managed care and health promotion. UniHealth, a California non- profit public benefit corporation owned approximately 44 percent and two percent of the Company's outstanding shares of Class A and Class B Common Stock, respectively, at September 30, 1995. 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. 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. As of October 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In connection with the adoption of SFAS No. 115, the Company determined that all marketable securities (which are comprised of municipal bonds, corporate notes, commercial paper and U.S. Treasury securities) held as of that date are available for sale. Accordingly, such securities are carried at fair value and unrealized gains or losses, net of applicable income taxes, are recorded in shareholders' equity. The Company also determined that these marketable securities are available for use in current operations and, accordingly, classified such securities as current assets without regard to the securities' contractual maturity dates. Prior to the adoption of SFAS No. 115, the Company carried marketable securities at cost, unless there was a permanent impairment of value. The adoption of SFAS No. 115 had no effect on net income, but decreased marketable securities as of October 1, 1994 by $6.3 million, decreased shareholders' equity by $3.8 million and increased deferred tax assets by $2.5 million. The Company is required by state regulatory agencies to set aside funds for the protection of their plan members in accordance with the laws of the various states in which they operate. Such funds are included in marketable securities- restricted (which are comprised of U.S. government securities and certificates of deposit held by trustees or state regulatory agencies). The Company determined that all marketable securities-restricted are held-to-maturity since the Company has the intent and ability to hold the securities to maturity. Held-to-maturity securities continue to be stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity, and are classified as noncurrent assets. 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 $0.8 million were written off in 1993, reducing earnings per 25 share by approximately $0.03. These assets, which were related to the Company's life and health insurance subsidiary, were determined to have no continuing value. As of September 30, 1995 and 1994, accumulated amortization totaled $16.0 and $8.8 million, respectively. In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. The statement also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt SFAS No. 121 on October 1, 1996 and, based on current circumstances, does not believe the effect of the adoption will be material. e) Software Costs. Direct costs associated with the development of computer software are expensed as incurred. These costs totaled $12.1 million, $9.6 million and $7.0 million in 1995, 1994 and 1993, 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. Funds received under the federal Medicare programs accounted for approximately 57 percent of the Company's premium revenue for each of the years ended September 30, 1995 and 1994 and 52 percent for the year ended September 30, 1993. 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 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 $14.6 million, $10.9 million and $8.9 million for the fiscal years ended September 30, 1995, 1994 and 1993, 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 $4.3 million, $4.0 million and $3.3 million for the fiscal years ended September 30, 1995, 1994 and 1993. 26 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 $5.7 million or approximately $0.20 per share. 3. MARKETABLE SECURITIES The following table summarizes marketable securities as of September 30, 1995:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED (amounts in thousands) COST GAINS LOSSES FAIR VALUE - ---------------------------------------------------------------------------------------------------------- Marketable securities: U.S. Government and agency $120,756 $3,396 $ (63) $124,089 State and state agency 107,483 1,454 (237) 108,700 Municipal and local agency 117,221 3,140 - 120,361 Corporate debt and other securities 178,934 1,498 (1,202) 179,230 - ---------------------------------------------------------------------------------------------------------- Total marketable securities 524,394 9,488 (1,502) 532,380 - ---------------------------------------------------------------------------------------------------------- Marketable securities - restricted: U.S. Government and agency 5,595 11 - 5,606 Corporate debt and other securities 17,513 - - 17,513 - ---------------------------------------------------------------------------------------------------------- Total marketable securities - restricted 23,108 11 - 23,119 - ---------------------------------------------------------------------------------------------------------- Total marketable securities $547,502 $9,499 $(1,502) $555,499 - ---------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------
As of September 30, 1995, the contractual maturities of the Company's marketable securities were as follows:
MARKETABLE SECURITIES- MARKETABLE SECURITIES RESTRICTED AMORTIZED AMORTIZED (amounts in thousands) COST FAIR VALUE COST FAIR VALUE - ------------------------------------------------------------------------------------------------ Due in one year or less $118,332 $118,011 $21,655 $21,661 Due after one year through five years 259,938 261,575 1,453 1,458 Due after five years through ten years 120,301 126,120 - - Due after ten years 25,823 26,674 - - - ------------------------------------------------------------------------------------------------ $524,394 $532,380 $23,108 $23,119 - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------
During the year ended September 30, 1995, proceeds from sales and maturities of marketable securities were $2.7 billion, resulting in gross realized gains of $6.0 million and realized losses of $6.8 million. Realized gains and losses are included in investment income under the specific identification method. 27 4. PROPERTY, PLANT AND EQUIPMENT The following table summarizes the components of property, plant and equipment:
SEPTEMBER 30 (in thousands) 1995 1994 - -------------------------------------------------------------------------- Land $12,060 $14,533 Buildings and improvements 33,994 30,087 Furniture, fixtures and equipment 91,304 74,148 Leasehold improvements 15,620 10,509 Capital leases 18,357 17,526 Construction in progress 1,082 2,717 - -------------------------------------------------------------------------- 172,417 149,520 Less accumulated depreciation and amortization 73,141 52,502 - -------------------------------------------------------------------------- Net property, plant and equipment $ 99,276 $ 97,018 - -------------------------------------------------------------------------- - --------------------------------------------------------------------------
5. ACQUISITIONS The Company completed several acquisitions in the years ended September 30, 1995 and 1994. During fiscal 1995, the Company made the following acquisitions (the "1995 Acquisitions"): (i) Preferred Solutions, a San Jose-based pharmacy benefit management company, in January 1995; (ii) ValuCare, a Fresno, California-based HMO with approximately 67,000 members in March 1995; and (iii) the membership of Pacific Health Plans, a Washington-based HMO, with approximately 33,000 members in March 1995. During fiscal 1994, the Company made the following acquisitions (the "1994 Acquisitions"): (i) Freedom Plan, Inc., a Santa Barbara, California-based HMO, with approximately 14,000 members in October 1993; (ii) California Dental Health Plan, Inc., a southern California-based dental HMO and its affiliate, Dental Plan Administrators, a third party administrator, in November 1993; (iii) Advantage Health Plans, Inc., a southern Florida-based HMO, with approximately 20,000 members in December 1993; (iv) Network Health Plan, Inc., a Washington- based health care service contractor, with approximately 28,000 members in February 1994; and (v) Pasteur Health Plans, Inc., a southern Florida-based HMO, with approximately 50,000 members in August 1994. The 1994 and the 1995 Acquisitions shall together be referred to herein as the "Acquisitions" and the companies acquired through the Acquisitions shall be referred to as the "Acquired Companies." The total purchase price for the Acquisitions, including contingent purchase payments, was approximately $220.0 million. Based on the fair values of the assets and liabilities of the Acquired Companies, the preliminary estimate of excess purchase price is approximately $220.4 million. A final allocation of purchase price will be determined when appraisals and other studies are completed. The Acquisitions 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. The following table summarizes the unaudited pro forma consolidated results of the Company as though the Acquisitions had 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 Acquisitions occurred at the beginning of the period and is not intended to be indicative of results which may occur in the future. 28
YEARS ENDED SEPTEMBER 30 (Unaudited) (Amounts in thousands, except per share amounts) 1995 1994 - ---------------------------------------------------------------------------------------- Premium revenue $3,752,959 $3,067,329 Total operating revenue $3,801,684 $3,112,121 Pretax income $177,925 $ 129,334 Net income (1) $105,100 $ 78,862 Earnings per share (1) $ 3.52 $ 2.82 - ----------------------------------------------------------------------------------------
(1) The unaudited pro forma income before cumulative effect of a change in accounting principle for the year ended September 30, 1994 was $73.2 million or $2.62 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) 1995 1994 - ------------------------------------------------------------------------------------------------------ 8.80% privately placed senior debt, due in annual installments of $3,750 through November 1997 $11,250 $ 15,000 Capitalized lease obligations 5,655 9,745 Revolving line of credit - 82,350 Other long-term debt 3,022 2,217 - ------------------------------------------------------------------------------------------------------ 19,927 109,312 Less amounts due within one year 7,978 8,175 - ------------------------------------------------------------------------------------------------------ Long-term debt due after one year $11,949 $101,137 - ------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------
In November 1994, the Company established a $250.0 million revolving line of credit with Bank of America National Trust and Saving Association and a syndicate of banks (the "B of A Credit Line"). The B of A Credit Line has a five year term with interest payable at a rate per annum equal to the London Interbank Offered Rate plus a margin. The B of A Credit Line is subject to, among other things, certain financial covenants, including a fixed charge ratio and a leverage ratio. The B of A Credit Line may be extended beyond its five year term but not beyond November 30, 2001. In November 1994, the Company borrowed $82.3 million under the B of A Credit Line to pay the balance owed on the syndicated $130.0 million credit line with The Chase Manhattan Bank, N.A. The amount outstanding under the B of A Credit Line was repaid in March 1995 from the proceeds of the sale of the Company's Class B Common Stock, par value $0.01 per share (the "Class B Common Stock") (see Note 7 - "Shareholders' Equity"). As of September 30, 1995, the maturities of long-term debt for the years following 1995 are as follows:
YEARS ENDING SEPTEMBER 30 (in thousands) - ----------------------------------------------------------------------------- 1996 $7,978 1997 6,264 1998 4,112 1999 111 2000 32 Thereafter 1,430 - ----------------------------------------------------------------------------- $19,927 - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
29 Capitalized leases relate to equipment included in the accompanying consolidated balance sheets at a cost of $18.4 million and $17.5 million at September 30, 1995 and 1994, respectively. Accumulated amortization related to this equipment totaled $12.8 million and $8.2 million at September 30, 1995 and 1994, respectively. These leases require future payments including interest totaling $8.4 million at September 30, 1995 through the end of the lease terms. 7. SHAREHOLDERS' EQUITY The authorized capital stock of the Company consists of 30 million shares of the Class A Common Stock, par value $0.01 per share (the "Class A Common Stock"), 60 million shares of the Class B Common Stock and 10 million shares of Preferred Stock, par value $1.00 per share (the "Preferred Stock"). As of November 1, 1995, there were 12,331,408 shares of the Class A Common Stock outstanding, 18,551,697 of the Class B Common Stock outstanding and no shares of Preferred Stock outstanding. Holders of the Class A Common Stock have one vote per share while holders of the Class B Common Stock have no voting rights other than as required by Delaware law. Holders of the Class A Common Stock and Class B Common Stock are entitled to equal per share cash and stock dividends, if any, distributions upon liquidation of the Company and consideration in a merger or consolidation of the Company. In March 1995, the Company completed a public offering of 5,175,000 shares of its Class B Common Stock, of which 3,000,000 shares were issued and sold by the Company and 2,175,000 shares were sold by UniHealth. The sale of 4,500,000 shares of the Class B Common Stock closed on March 23, 1995 with the sale of the additional 675,000 shares of the Class B Common Stock occurring on March 29, 1995 pursuant to the exercise of the underwriters' over-allotment option. The Company received net proceeds of approximately $197.6 million from the sale of the 3,000,000 shares of Class B Common Stock after deducting underwriting discounts and commissions and expenses of the offering payable by the Company. The Company did not receive any of the proceeds from the sale of shares of Class B Common Stock by UniHealth. The Company used approximately $186.0 million of the net proceeds to repay the amount outstanding under its B of A Credit Line and to replenish working capital used to pay for certain of the Acquisitions (see Note 5 - "Acquisitions"). In December 1994, the Company completed a public offering of 90,000 shares of its Class B Common Stock to certain physician groups which currently contract with the Company. Each group has entered into an irrevocable obligation to purchase a fixed number of shares of the Class B Common Stock over a five year period beginning May 1, 1996 at $64.88 per share. On December 13, 1993, UniHealth completed a public offering of 575,000 shares of the Company's Class A Common Stock. The Company did not receive any of the proceeds from this offering. 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 were approximately $59 million after deducting underwriting discounts and commissions, and expenses of the offering. 8. TRANSACTIONS WITH RELATED PARTIES The Company purchased health care services from hospitals owned and managed by UniHealth totaling $70.6 million, $61.5 million and $55.5 million for the years ended September 30, 1995, 1994 and 1993, respectively. Under the terms of a management arrangement with UniHealth, the Company paid $0.7 million, $0.8 million and $1.2 million for management fees, payroll processing services and other services in the years ended September 30, 1995, 1994 and 1993, respectively. UniHealth purchased health care coverage from the Company in the amounts of $12.0 million, $10.0 million and $7.3 million for the years ended September 30, 1995, 1994 and 1993, respectively. Amounts receivable from UniHealth were $0.9 million and $1.0 million at September 30, 1995 and 1994, respectively. 30 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 $3.2 million, $3.1 million and $2.3 million for the years ended September 30, 1995, 1994 and 1993, respectively. The amount payable to Konowiecki & Rank was $0.2 million at September 30, 1995 and 1994. 9. INCOME TAXES 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) 1995 1994 - -------------------------------------------------------------------------------- Deferred tax assets: Accrued health care costs $15,147 $ 8,363 Accrued compensation 8,682 9,574 Accrued expenses 4,761 5,644 State franchise taxes 3,121 2,758 Capital leases 708 2,974 Depreciation 693 -- Other assets 485 1,434 - -------------------------------------------------------------------------------- Total deferred tax assets 33,597 30,747 Deferred tax liabilities: Unrealized gain on marketable securities (3,042) -- Prepaid expense (1,445) -- Other liabilities (903) (741) Depreciation -- (1,591) - -------------------------------------------------------------------------------- Net deferred tax assets $28,207 $28,415 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The provision for income taxes for the years ended September 30, 1995, 1994 and 1993, consists of the following components:
YEARS ENDED SEPTEMBER 30 (in thousands) 1995 1994 1993 Current: Federal $62,912 $58,036 $35,324 State 13,927 12,250 9,032 - --------------------------------------------------------------------------------------- Total current 76,839 70,286 44,356 Deferred: Federal (2,444) (9,349) 1,275 State (390) (62) -- - --------------------------------------------------------------------------------------- Total deferred (2,834) (9,411) 1,275 - --------------------------------------------------------------------------------------- Provision for income taxes $74,005 $60,875 $45,631 - --------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------
31 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) 1995 1994 1993 - -------------------------------------------------------------------------------- Computed expected provision 35.0% 35.0% 34.8% State taxes, net of federal benefit 4.9 5.4 5.4 Tax exempt interest (2.2) (1.9) (1.7) Amortization of intangibles 1.1 0.7 1.0 Changes in unrecognized deferred tax benefits 0.2 (0.3) 2.2 Other, net 1.6 2.9 0.4 - -------------------------------------------------------------------------------- Provision for income taxes 40.6% 41.8% 42.1% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
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 deferred tax items and the corresponding tax effects during the year ended September 30, 1993 were as follows:
YEARS ENDED SEPTEMBER 30 (in thousands) 1993 - -------------------------------------------------------------------------------- Depreciation $ 2,803 Medical claims and benefits payable 1,482 Performance incentives 942 State franchise taxes (141) Capital leases (2,322) Other, net (1,489) - -------------------------------------------------------------------------------- $ 1,275 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
10. EMPLOYEE BENEFIT PLANS a) Savings and Profit-Sharing Plan. The Company has an employee profit- sharing plan (the "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 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 $14.3 million, $10.3 million and $7.8 million for the years ended September 30, 1995, 1994 and 1993, 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 Second 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 ("NQSOs"), stock appreciation rights ("SARs") and stock payments under the 1989 Employee Plan is approximately 653,500. 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 stock 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 NQSQs granted to eligible non-officer Directors of the Company. Non-officer Directors of the Company who are not eligible to receive options under the 1989 Employee Plan are eligible to receive NQSQs under the 1992 Director Plan. 32 The following table summarizes the activity in NQSQs under the 1985 Plan, the 1989 Employee Plan, the 1989 Director Plan and the 1992 Director Plan for the years ended September 30, 1995 and 1994:
NON-QUALIFIED STOCK OPTIONS - ------------------------------------------------------------------------------------------------------------------- YEARS ENDED SEPTEMBER 30, CLASS A CLASS B 1995 AND 1994 STOCK EXERCISE PRICE STOCK EXERCISE PRICE - ------------------------------------------------------------------------------------------------------------------- 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 Granted -- $ -- - $ -- 743,700 $65.56 - $66.75 Exercised 93,375 $ 1.63 - $19.75 245,233 $ 1.63 - $53.75 Canceled 825 $17.25 - $19.75 110,995 $17.25 - $66.75 - ------------------------------------------------------------------------------------------------------------------- OUTSTANDING AT SEPTEMBER 30, 1995 357,084 $ 1.63 - $19.75 1,692,311 $ 1.63 - $66.75 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
At September 30, 1995, approximately 2,049,575 shares were reserved for issuance upon the exercise of outstanding options. As of that date, options were exercisable for 342,984 shares of Class A Common Stock at exercise prices of $1.63 - $19.75 per share and 394,289 shares of Class B Common Stock at exercise prices of $1.63 - $66.75. No SARs have been awarded under the 1989 Employee Plan. c) Performance Incentive Programs. The Company has a long-term performance incentive program, under which all executive officers of the Company and certain officers and key employees of the Company and its subsidiaries are eligible to participate. Incentive compensation is based on the achievement of objectives established by the Compensation Committee (the "Committee") of the Board of Directors and approved by the shareholders of the Company. For fiscal years ended September 30, 1995, 1994 and 1993, the incentive compensation expense for this program was $3.0 million, $2.5 million and $1.9 million, 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. Amounts charged to expense for the annual compensation program were $2.7 million, $7.0 million and $2.2 million for the years ended September 30, 1995, 1994 and 1993, respectively. 11. COMMITMENTS AND CONTINGENCIES a) Lease Commitments. The Company leases office space and equipment under various non-cancelable operating leases. Rental expense for the years ended September 30, 1995, 1994 and 1993 totaled $18.3 million, $10.2 million and $8.1 million, respectively. Future minimum lease payments under operating leases at September 30, 1995 are as follows:
YEARS ENDING SEPTEMBER 30 (in thousands) - ------------------------------------------------------------------------------ 1996 $20,658 1997 17,275 1998 10,359 1999 5,706 2000 4,159 Thereafter 5,169 - ------------------------------------------------------------------------------ $63,326 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
33 b) Employment Agreements. The Company has entered into employment agreements with the President of the Company and certain other executive 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 $7.4 million at September 30, 1995. 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, results of operations or cash flows. 12. INTEREST RATE SWAP AGREEMENTS The Company has entered into interest rate swaps to reduce the impact of changes in interest rates on a portion of its investments in marketable securities. Interest rate swaps are contractual agreements between the Company and third parties to exchange floating interest rate payments periodically over the life of the agreements without the exchange of the underlying principal amounts ("notional amounts"). At September 30, 1995, the total notional amount of such agreements with off-balance sheet risk was $150.0 million. At September 30, 1995, the fair value of such agreements, representing the estimated amount the Company would receive to terminate the agreement based on current interest rates, was not significant. 13. CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of investments in marketable securities, interest rate swap agreements 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. The interest rate swap agreements contain an element of risk that the counter parties may be unable to meet the terms of the agreement. However, the Company minimizes such risk exposure for interest rate swap agreements by limiting the counterparties to major financial institutions. As of September 30, 1995, in Management's opinion, the Company had no significant concentrations of credit risk. 34 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, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, 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, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1995 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 2 to the Consolidated Financial Statements, as of October 1, 1994 the Company changed its method of accounting for marketable securities. ERNST & YOUNG LLP Los Angeles, California November 10, 1995 35 QUARTERLY INFORMATION FOR FISCAL YEARS 1995 AND 1994 (UNAUDITED)
THREE MONTHS ENDED ------------------------------------------------------------ (in thousands, except per share amounts) DEC. 31 MARCH 31 JUNE 30 SEPT. 30 - --------------------------------------------------------------------------------------------------------- YEAR ENDED SEPTEMBER 30, 1995 - --------------------------------------------------------------------------------------------------------- Operating revenue $821,614 $912,766 $981,236 $1,015,406 Operating expenses 790,748 875,318 941,650 975,063 Interest income, net 3,217 8,594 11,281 10,765 - --------------------------------------------------------------------------------------------------------- Income before income taxes 34,083 46,042 50,867 51,108 Provision for income taxes 14,026 18,683 20,619 20,677 - --------------------------------------------------------------------------------------------------------- Net income $20,057 $27,359 $30,248 $30,431 - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- Earnings per share(1) $ 0.71 $ 0.96 $ 0.97 $ 0.98 - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- Membership(2) 1,405 1,526 1,682 1,757 - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- 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 1,255 1,358 - --------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------
(1) The results for the quarter ended June 30, 1994 includes $0.18 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. 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is contained in the Company's 1995 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, 1995. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is contained in the Company's 1995 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, 1995. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is contained in the Company's 1995 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, 1995. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is contained in the Company's 1995 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, 1995. 37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-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, 1995 and 1994...............20 Consolidated Statements of Income for the years ended September 30, 1995, 1994 and 1993.........................................21 Consolidated Statements of Shareholders' Equity for the years ended September 30, 1995, 1994 and 1993...................................22 Consolidated Statements of Cash Flows for the years ended September 30, 1995, 1994 and 1993.........................................23 Notes to Consolidated Financial Statements..................................25 Report of Ernst & Young LLP Independent Auditors............................35 Quarterly Information for Fiscal Years 1995 and 1994 (Unaudited)............36 2. Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts...........................42
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 [ incorporated by reference to Exhibit 3.4 to the Company's Form 10-K for the year ended September 30, 1994]. 3.5 First Amendment to the Bylaws of the Company [incorporated by reference to Exhibit 3.5 to the Company's Form 10-K for the year ended September 30, 1994]. 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]. 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].
38 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 December 1, 1994, between the Company and Alan Hoops [incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended December 31, 1994].(1) 10.3 Employment Agreement, dated December 12, 1994, between the Company and Jeffrey Folick [incorporated by reference to Exhibit 10.3 to the Company's Form 10-Q for the quarter ended December 31, 1994].(1) 10.4 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) 10.5 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 [incorporated by reference to Exhibit 28.6 to the Company's Registration Statement on Form S-3 (File No. 33-52438)]. 10.8 Second Amended and Restated 1989 Stock Option Plan for Officers and Key Employees, as amended [incorporated by reference to Exhibit A to the Company's Proxy Statement, dated January 26, 1992.(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 Credit Agreement, dated as of November 30, 1994, among PacifiCare Health Systems, Inc., the financial institutions named therein, The Chase Manhattan Bank, Citicorp USA, Inc. and Nationsbank of Texas, N.A., as Co-Agents and Bank of America, National Trust and Savings Association, as Administrative Agent [incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended December 31, 1994]. 10.13 Contribution and Indemnification Agreement, dated March 16, 1995 between the Company and UniHealth [incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-3 (File No. 33-57783)].
39 10.14 The PacifiCare Health Systems, Inc. Statutory Restoration Plan.(1) 10.15 PacifiCare Health Systems, Inc. Nonemployee Director Compensation and Retirement Plan.(1) 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. 40 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 22, 1995 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 22, 1995 - ----------------------------------- Terry Hartshorn President, Chief Executive Officer, and Director /s/ ALAN HOOPS (Principal Executive Officer) November 22, 1995 - ----------------------------------- Alan Hoops Executive Vice President, Chief Administrative Officer and Chief Financial Officer /s/ WAYNE LOWELL (Principal Financial Officer) November 22, 1995 - ----------------------------------- Wayne Lowell Senior Vice President and Corporate Controller /s/ FRED V. RYDER, JR. (Principal Accounting Officer) November 22, 1995 - ----------------------------------- Fred V. Ryder, Jr. /s/ JEAN BIXBY SMITH Director November 22, 1995 - ----------------------------------- Jean Bixby Smith /s/ DAVID R. CARPENTER Director November 22, 1995 - ----------------------------------- David R. Carpenter /s/ GARY L. LEARY Director November 22, 1995 - ----------------------------------- Gary L. Leary /s/ WARREN E. PINCKERT II Director November 22, 1995 - ----------------------------------- Warren E. Pinckert II /s/ DAVID A. REED Director November 22, 1995 - ----------------------------------- David A. Reed /s/ LLOYD ROSS Director November 22, 1995 - ----------------------------------- Lloyd Ross
41 PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II - 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, 1995 $ 558 $ 530 $1,498 $1,896 $ 690 ---------------------------------------------------------------------------------- ---------------------------------------------------------------------------------- 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 ---------------------------------------------------------------------------------- ----------------------------------------------------------------------------------
42 EX-10.15 2 STATUATORY RESTORATION PLAN EXHIBIT 10.15 PACIFICARE HEALTH SYSTEMS, INC. _____________________________________________________________________________ RESTORATION PLAN TABLE OF CONTENTS PAGE - ------------------------------------------------------------------ ARTICLE I Definitions. . . . . . . . . . . . . . . . . . . . 1 1.1 Accounts . . . . . . . . . . . . . . . . . . . . . 1 1.2 Administrative Committee . . . . . . . . . . . . . 1 1.3 Beneficiary. . . . . . . . . . . . . . . . . . . . 1 1.4 Board of Directors . . . . . . . . . . . . . . . . 1 1.5 Compensation . . . . . . . . . . . . . . . . . . . 1 1.6 Deferral Account . . . . . . . . . . . . . . . . . 1 1.7 Earnings . . . . . . . . . . . . . . . . . . . . . 2 1.8 Effective Date . . . . . . . . . . . . . . . . . . 2 1.9 Eligible Employee. . . . . . . . . . . . . . . . . 2 1.10 Employer . . . . . . . . . . . . . . . . . . . . . 2 1.11 Matching Account . . . . . . . . . . . . . . . . . 2 1.12 Participant. . . . . . . . . . . . . . . . . . . . 2 1.13 Plan . . . . . . . . . . . . . . . . . . . . . . . 2 1.14 Plan Year. . . . . . . . . . . . . . . . . . . . . 2 1.15 Profit-Sharing Account . . . . . . . . . . . . . . 3 1.16 Qualified Plan . . . . . . . . . . . . . . . . . . 3 1.17 Retirement . . . . . . . . . . . . . . . . . . . . 3 1.18 Statutory Limits . . . . . . . . . . . . . . . . . 3 1.19 Valuation Date . . . . . . . . . . . . . . . . . . 3 ARTICLE II Contributions to the Plan. . . . . . . . . . . . . 4 2.1 Amount of Deferral . . . . . . . . . . . . . . . . 4 2.2 Amount of Profit-Sharing Contribution. . . . . . . 4 2.3 Amount of Matching Contribution. . . . . . . . . . 4 2.4 Amount of Discretionary Company Contribution . . . 4 2.5 Filing of Applications . . . . . . . . . . . . . . 4 2.6 Designation of Beneficiary . . . . . . . . . . . . 5 2.7 Administration . . . . . . . . . . . . . . . . . . 5 ARTICLE III Accrual of Benefits. . . . . . . . . . . . . . . . 6 3.1 Earnings of Accounts . . . . . . . . . . . . . . . 6 3.2 Vesting. . . . . . . . . . . . . . . . . . . . . . 6 (i) TABLE OF CONTENTS PAGE - ------------------------------------------------------------------ ARTICLE IV Distribution of Accounts . . . . . . . . . . . . . 7 4.1 Payment upon Retirement. . . . . . . . . . . . . . 7 4.2 Payment upon Termination of Employment . . . . . . 7 4.3 Amount Distributable . . . . . . . . . . . . . . . 7 ARTICLE V The Administrative Committee . . . . . . . . . . . 8 5.1 Administrative Committee . . . . . . . . . . . . . 8 5.2 Rights and Duties. . . . . . . . . . . . . . . . . 8 5.3 Information. . . . . . . . . . . . . . . . . . . . 10 5.4 Compensation, Indemnity and Liability. . . . . . . 10 ARTICLE VI Amendment and Discontinuance . . . . . . . . . . . 11 6.1 Amendments . . . . . . . . . . . . . . . . . . . . 11 6.2 Discontinuance of Plan . . . . . . . . . . . . . . 11 ARTICLE VII Miscellaneous. . . . . . . . . . . . . . . . . . . 12 7.1 No Interest in Assets. . . . . . . . . . . . . . . 12 7.2 Limitation of Rights of Employees. . . . . . . . . 12 7.3 Restriction against Assignment . . . . . . . . . . 12 7.4 Receipt or Release . . . . . . . . . . . . . . . . 12 7.5 Payment on Behalf of Minor . . . . . . . . . . . . 13 7.6 Forfeiture . . . . . . . . . . . . . . . . . . . . 13 7.7 Withholding. . . . . . . . . . . . . . . . . . . . 13 7.8 California Law Governs . . . . . . . . . . . . . . 13 7.9 Interpretation . . . . . . . . . . . . . . . . . . 13 7.10 Instrument in Counterparts . . . . . . . . . . . . 13 7.11 Successors and Assigns . . . . . . . . . . . . . . 14 (ii) 1. PACIFICARE HEALTH SYSTEMS, INC. RESTORATION PLAN THIS PLAN evidences the terms of the PacifiCare Health Systems, Inc. Restoration Plan for certain executive employees. WITNESSETH: ARTICLE I DEFINITIONS Any terms defined in the Qualified Plan will have the same definition in this Plan unless such term is expressly redefined in this Article I. 1.1 ACCOUNTS. "Accounts" shall mean the accounts maintained by the Administrative Committee for each Participant, which includes the Deferral Account, the Profit- Sharing Account, and the Matching Account. 1.2 ADMINISTRATIVE COMMITTEE. The "Administrative Committee" shall mean the committee of at least three persons appointed by the Employer to perform the duties detailed in Article V. 1.3 BENEFICIARY. "Beneficiary" or "Beneficiaries" shall mean the person or persons (including, without limitation, any trustee) last designated by a Participant to receive the benefits specified hereunder, in the event of the Participant's death, or if there is no designated Beneficiary or surviving Beneficiary, the Participant's estate. 14. BOARD OF DIRECTORS. "Board of Directors" shall mean the Board of Directors of PacifiCare Health Systems, Inc. 1.5 COMPENSATION. "Compensation" shall mean Compensation as defined in the Qualified Plan, without application of the "Pay Cap" defined in Section 1.18(a) of this Plan. 1.6 DEFERRAL ACCOUNT. "Deferral Account" shall mean the Account maintained by the Administrative Committee for each Participant that is to be credited with the 2. amounts of the Participant's Compensation that are deferred pursuant to this Plan, together with the Earnings credited thereon as provided herein. 1.7 EARNINGS. "Earnings" shall mean the amounts credited to a Participant's Accounts as investment growth. The rate of growth credited to the Accounts will be set by, and at the sole discretion of, the Administrative Committee. The rate will be determined for each ensuing quarter and will be communicated to Participants prior to the beginning of such quarter. 1.8 EFFECTIVE DATE. "Effective Date" shall mean January 1, 1993. 1.9 ELIGIBLE EMPLOYEE. "Eligible Employee" shall mean any employee of the Employer whose job classification is Senior Vice President or a higher classification. 1.10 EMPLOYER. "Employer" or "Company" shall mean PacifiCare Health Systems, Inc. and wholly-owned subsidiaries. 1.11 MATCHING ACCOUNT. "Matching Account" shall mean the Account maintained by the Administrative Committee for each Participant that is to be credited with: (a) The amount of Company Matching (50% of deferrals to a maximum of 3% of Compensation) contribution pursuant to this Plan; (b) The amount of discretionary Company contributions contributed pursuant to this Plan; (c) Earnings credited to such contributions as provided herein. 1.12 PARTICIPANT. "Participant" shall mean any Eligible Employee who actually participates in this Plan in any Plan Year and who is entitled to a benefit hereunder. 1.13 PLAN. This Plan shall be known as the "PacifiCare Health Systems, Inc. Restoration Plan," as now adopted or hereafter amended. 1.14 PLAN YEAR. "Plan Year" shall mean the 12-month period commencing on January 1 and ending on December 31. 3. 1.15 PROFIT-SHARING ACCOUNT. "Profit-Sharing Account" shall mean the Account maintained by the Administrative Committee for each Participant which is to be credited with the 2% of Compensation contributions made pursuant to this Plan, together with the earnings credited thereon as provided herein. 1.16 QUALIFIED PLAN. "Qualified Plan" shall mean the PacifiCare Health Systems, Inc. Savings and Profit-Sharing Plan for Employees of PacifiCare Health Systems, Inc. 1.17 RETIREMENT. "Retirement" shall mean the retirement of a Participant under the normal or disability retirement provisions of the Qualified Plan. 1.18 STATUTORY LIMITS. "Statutory Limits" shall mean the following: (a) The maximum recognizable compensation under Internal Revenue Code (IRC) Section 401(a)(17) -- the "Pay Cap;" (b) The maximum contributions or other additions permitted under IRC Section 415(c) -- the "415 Limit;" (c) The exclusion of excess deferrals under IRC Section 402(g)(1) -- the "Deferral Limit" (d) The limit on contributions for highly compensated employees under IRC Sections: 401(k)(3) -- the "ADP Test," and 401(m)(2) -- the "ACP Test." 1.19 VALUATION DATE. "Valuation Date" shall mean the last day of each calendar quarter or, in the Administrative Committee's discretion, such other dates on which the Administrative Committee undertakes to determine the value of each Participant's Accounts. 4. ARTICLE II CONTRIBUTIONS TO THE PLAN 2.1 AMOUNT OF DEFERRAL. A Participant may elect to defer all or a portion of the amount of his Compensation that he could defer under the terms of the Qualified Plan, except for the application of the Statutory Limits. If a Participant so elects, any such excess deferral will be credited to that Participant's Deferral Account under this Plan. 2.2 AMOUNT OF PROFIT-SHARING CONTRIBUTION. Any excess profit-sharing contribution that would be contributed on behalf of a Participant under the terms of the Qualified Plan, except for the application of the Statutory Limits, will be credited to that Participant's Profit-Sharing Account under this Plan. 2.3 AMOUNT OF MATCHING CONTRIBUTION. Any excess Company matching contribution that would be contributed on behalf of a Participant under the terms of the Qualified Plan, except for the application of the Statutory Limits, will be credited to that Participant's Matching Account under this Plan. 2.4 AMOUNT OF DISCRETIONARY COMPANY CONTRIBUTION. Any excess discretionary Company contribution that would be contributed on behalf of a Participant under the terms of the Qualified Plan, except for the application of the Statutory Limits, will be credited to that Participant's Matching Account under this Plan. 2.5 FILING OF APPLICATIONS. To be eligible to defer Compensation that is paid as part of a Participant's regular wages paid during any Plan Year, an Eligible Employee must file a written application with the Administrative Committee no later than December 15 of the preceding Plan Year. The Administrative Committee shall notify each employee of his prospective eligibility to participate in the Plan at least thirty (30) days prior to the time he must file an application for participation. Notwithstanding the foregoing, the Administrative Committee may, in its sole and absolute discretion, permit an Eligible Employee to file an application on or after December 15 if, in its judgment, his failure to do so prior to said date was due to reasonable cause, but in no event may such application be filed after December 31. The application for participation shall signify the Eligible Employee's acceptance of the terms of this Plan and the portion of Compensation that he elects to defer in accordance with Section 2.1 of this Plan. 5. Notwithstanding the above, no further application shall be required from any Eligible Employee who elects to defer Compensation hereunder until such Eligible Employee wishes to change the amount to be deferred in accordance with the next succeeding paragraph. A Participant may elect, with at least fifteen (15) days' advance written notification to the Administrative Committee, to terminate his deferrals under this Plan with respect to Compensation in subsequent years. A Participant shall be permitted to resume participation in the Plan or change his deferral amount subject to the limitation specified in Section 2.1 as of the first day of a Plan year if he files an application pursuant to this Section 2.5. 2.6 DESIGNATION OF BENEFICIARY. The Beneficiary or Beneficiaries under this Plan will be the individual(s) designated as such under the Qualified Plan. The Employer and the Administrative Committee may rely on the designation of the beneficiary or beneficiaries last filed in accordance with the terms of the Qualified Plan. 2.7 ADMINISTRATION. Any amounts credited to a Participant's Accounts under this Plan will be administered by the Administrative Committee. 6. ARTICLE III ACCRUAL OF BENEFITS 3.1 EARNINGS OF ACCOUNTS. There shall be credited to each Participant's Accounts as of the end of each calendar quarter Earnings on the balance(s) credited thereto. Such Earnings, determined pursuant to Section 1.7, shall be credited as though the amount allocated to the hypothetical Participant's Accounts pursuant to Article II was contributed on the date deemed to be the date such amount would have been invested, if the amount were available for contribution under the Qualified Plan. 3.2 VESTING. The interest of each Participant in any benefit accrued hereunder shall be vested in accordance with the vesting provisions of the Qualified Plan. In the event of death or permanent and total disability, the Participant becomes 100% vested. 7. ARTICLE IV DISTRIBUTION OF ACCOUNTS 4.1 PAYMENT UPON RETIREMENT. If a Participant terminates employment due to Retirement (or thereafter), the amount distributable to the Participant (determined pursuant to Section 4.3) as of the date of such Retirement, plus Earnings, shall be paid to the Participant in a single sum as soon as practicable after the Valuation Date following such Retirement. 4.2 PAYMENT UPON TERMINATION OF EMPLOYMENT. If a Participant terminates employment with the Employer by reason of death, or any other reason other than Retirement, the amount distributable to the Participant (determined pursuant to Section 4.3) as of the date of termination shall be distributed to the Participant in a single sum as soon as practicable after the Valuation Date following such termination. 4.3 AMOUNT DISTRIBUTABLE. The amount distributable to a Participant or any designated Beneficiary or Beneficiaries as of any date specified in this Plan shall be an amount equal to the vested balance credited to the Participant's Accounts as of the Valuation Date immediately following said date. 8. ARTICLE V THE ADMINISTRATIVE COMMITTEE 5.1 ADMINISTRATIVE COMMITTEE. The Administrative Committee (appointed by the Board of Directors) shall keep all records and documents pertaining to the Committee's administration of the Plan. Any action of the Administrative Committee shall be taken pursuant to a majority vote, or with the written consent of a majority of its members, and such action shall constitute the action of the Administrative Committee and be binding the same as if all members had joined therein. A quorum of the Administrative Committee shall consist of two members. A member of the Administrative Committee shall not vote or act on any matter that relates solely to such member as a Participant. Any member may execute any certificate or other written direction on behalf of the Administrative Committee. Third persons dealing with the Administrative Committee may conclusively rely on any certificate or other written direction signed by a member that purports to have been duly authorized by the Administrative Committee. 5.2 RIGHTS AND DUTIES. The Administrative Committee, on behalf of the Participants and their Beneficiaries, shall enforce the Plan in accordance with its terms, shall be charged with the general administration of the Plan, and shall have all powers necessary to accomplish those purposes, including, but not by way of limitation, the following: (a) To determine all questions relating to the eligibility of employees to participate; (b) To maintain or to designate any person or entity to maintain all the necessary records for the administration of the Plan; (c) To make and publish such rules for the regulation of the Plan as are not inconsistent with the terms hereof; (d) To provide for disclosure of all information and filing or provision of all reports and statements to Participants or Beneficiaries under this Plan or to governmental bodies as may be required by ERISA; and (e) To establish claims procedures consistent with regulations of the Secretary of Labor for presentation of claims by Participants and Beneficiaries for Plan 9. benefits, consideration of such claims, review of claim denials, and issuance of decisions on review. Such claims procedures at a minimum shall consist of the following: (1) The Administrative Committee shall notify Participants and, where appropriate, Beneficiaries, of their right to claim benefits under the claims procedures, shall make forms available for filing of such claims, and shall provide the name of the person or persons with whom such claims should be filed. (2) The Administrative Committee shall establish procedures for action on claims initially made and the communication of a decision to the claimant promptly and, in any event, not later than sixty (60) days after the date of the claim; the claim may be deemed by the claimant to have been denied for purposes of further review described below in the event a decision is not furnished to the claimant within a 60-day period. Every claim for benefits that is denied shall be denied by written notice setting forth in a manner calculated to be understood by the claimant (1) the specific reason or reasons for the denial, (2) specific reference to any provisions of this Plan on which denial is based, (3) description of any additional material or information necessary for the claimant to perfect his claim with an explanation of why such material or information is necessary, and (4) an explanation of the procedure for further reviewing the denial of the claim under the Plan. (3) The Administrative Committee shall establish a procedure for review of claim denials, with such review to be undertaken by the Committee. The review given after denial of any claim shall be a full and fair review, with the claimant or his duly authorized representative having sixty (60) days after receipt of denial of his claim to request such review, and having the right to review all pertinent documents and the right to submit issues and comments in writing. (4) The Administrative Committee shall establish a procedure for issuance of a decision by the Committee not later than sixty (60) days after receipt of a request for review from a claimant unless special circumstances, such as the need to hold a hearing, require a longer period of time, in which 10. case a decision shall be rendered as soon as possible but not later than one hundred twenty (120) days after receipt of the claimant's request for review. The decision on review shall be in writing and shall include specific reasons for the decision written in a manner calculated to be understood by the claimant, with specific reference to any provision of the Plan on hich the decision is based. All action of the Administrative Committee shall be conclusive on all persons interested in the Plan, except to the extent otherwise specifically indicated herein. The Administrative Committee may appoint a plan administrator and other agents, and delegate thereto such powers and duties in connection with the administration of the Plan as the Administrative Committee may from time to time prescribe. 5.3 INFORMATION. To enable the Administrative Committee to perform its functions, the Employer shall supply full and timely information to such Committee on all matters relating to the payment of Compensation of all Participants, their employment, their retirement, death, or the cause for termination of employment, and such other pertinent facts as the Administrative Committee may require. 5.4 COMPENSATION, INDEMNITY AND LIABILITY. The members of the Administrative Committee shall serve without bond, except as otherwise required by law, and without compensation for their services hereunder. All expenses of the Administrative Committee shall be paid by the Employer, and the Employer shall furnish the Administrative Committee with such clerical and other assistance as is necessary in the performance of its duties. No member of the Administrative Committee shall be liable for any act or omission of any other member of the Administrative Committee nor for any act or omission on his own part, excepting only his own willful misconduct or gross negligence. The Employer shall indemnify and save harmless each member of the Administrative Committee against any and all expenses and liabilities arising out of his membership on the Administrative Committee, excepting only expenses and liabilities arising out of his own willful misconduct or gross negligence. 11. ARTICLE VI AMENDMENT AND DISCONTINUANCE 6.1 AMENDMENTS. The Board of Directors shall have the right to amend this Plan from time to time or to cancel any amendments. 6.2 DISCONTINUANCE OF PLAN. It is the expectation of the Employer that this Plan will be continued indefinitely, but continuance of the Plan is not assumed as a contractual obligation of the Employer, and the right is reserved by the Employer at any time to reduce, suspend, or discontinue this Plan; provided, however, the Employer shall in no event have the power to reduce the amount already paid or credited to a Participant's Deferral Account. 12. ARTICLE VII MISCELLANEOUS 7.1 NO INTEREST IN ASSETS. No Participant or any other person shall have any interest in any fund or in any specific asset of the Employer by reason of any amount credited to him hereunder, nor any right to receive any distribution under the Plan except as and to the extent expressly provided in the Plan. There shall be no funding of any benefits that may become payable hereunder. No trust shall be created in connection with or by the execution or adoption of this Plan. Any benefits that become payable hereunder shall be paid from the general assets of the Employer. Nothing in the Plan shall be deemed to give any officer or any employee of the Employer any right to participate in the Plan, except in accordance with the provisions of the Plan. 7.2 LIMITATION ON RIGHTS OF EMPLOYEES. Neither the adoption nor the amendment of the Plan, nor any action of the Board of Directors of the Employer, shall be held or construed to confer on any person any legal right to be continued as an employee of the Employer, to receive any particular level of compensation, or to be employed in any particular job or job classification. 7.3 RESTRICTION AGAINST ASSIGNMENT. The Employer shall pay all amounts payable hereunder only to the person(s) designated by the Plan and not to any other person or corporation. No part of a Participant's Account shall be liable for the debts, contracts, or engagements of any Participant, his Beneficiaries, or successors in interest, nor shall it be subject to execution by levy, attachment, or garnishment or by any other legal or equitable proceeding, nor shall any such person have any right to alienate, anticipate, commute, pledge, encumber, or assign any benefits or payments hereunder in any manner whatsoever. Notwithstanding the above, nothing herein shall be deemed a waiver of the Employer's right of offset as set forth in the laws of the State of California. 7.4 RECEIPT OR RELEASE. Any payment to any Participant or his Beneficiary in accordance with the provisions of this Plan shall, to the extent thereof, be in full satisfaction of all claims against the Committee and the Employer, and the Committee may require such Participant or Beneficiary, as a condition precedent to such payment, to execute a receipt and release to such effect. 13. 7.5 PAYMENT ON BEHALF OF MINOR. In the event any amount becomes payable under the Plan to a minor or a person who, in the sole judgment of the Committee, is considered by reason of physical or mental condition to be unable to give a valid receipt therefor, the Committee may direct that such payment be made to any person found by the Committee, in its sole judgment, to have assumed the care of such minor or other person. Any payment made pursuant to such determination shall constitute a full release and discharge of the Committee and the Employer. 7.6 FORFEITURE. Any payment or distribution to a Participant under the Plan that is not claimed by the Participant, Beneficiary, or other person entitled thereto within three years after becoming payable shall be forfeited and canceled and shall remain with the Employer, and no other person shall have any right thereto or interest therein. The Employer shall not have any duty to give notice that amounts are payable under the Plan to any person other than the Participant and the designated Beneficiary or Beneficiaries. 7.7 WITHHOLDING. The Employer shall deduct from the amount of all distributions under the Plan any taxes required to be withheld by the federal or any state or local government. 7.8 CALIFORNIA LAW GOVERNS. This Plan shall be construed, regulated, and administered under the laws of the State of California. If any provision of this instrument shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions thereof shall continue to be fully effective. 7.9 INTERPRETATION. Headings and subheadings in the Plan are inserted for convenience only and are not to be considered in the construction of the provisions thereof. Singular nouns may include the plural and plural nouns may include the singular where appropriate. The masculine gender may mean the feminine and/or neuter gender where appropriate. 7.10 INSTRUMENT IN COUNTERPARTS. This Plan has been executed in several counterparts, each of which shall be deemed an original, and said counterparts shall constitute but one and the same instrument, which may be sufficiently evidenced by one counterpart. 14. 7.11 SUCCESSORS AND ASSIGNS. This Plan shall inure to the benefit of, and be binding on, the parties hereto and their successors and assigns. Executed at ____________________, California, on the ____ day of ________________, 1992. PacifiCare Health Systems, Inc. By /s/ SAMUEL J. TIBBETTS ------------------------------- Title CHAIRMAN ------------------------------- By ------------------------------- Title ------------------------------- Approved as to form: ___________________________ Counsel for Employer EX-10.16 3 NONEMPLOYEE DIR. COMPENSATION & RETIREMENT PLAN EXHIBIT 10.16 PACIFICARE HEALTH SYSTEMS, INC. NONEMPLOYEE DIRECTOR COMPENSATION AND RETIREMENT PLAN PacifiCare Health Systems, Inc., a corporation organized under the laws of the State of Delaware (the "Company"), hereby adopts this PacifiCare Health Systems, Inc. Nonemployee Director Compensation and Retirement Plan. 1. PURPOSE OF THE PLAN The purpose of this Plan is to enhance the growth, development and financial success of the Company and its ability to attract and retain the services of qualified and experienced Nonemployee Directors by providing such Nonemployee Directors annual cash compensation, retirement benefits and stock options, subject to the conditions and limitations of the Plan. 2. DEFINITIONS When used herein, the following terms shall have the respective meanings set forth below: (a) "Affiliate" shall mean any corporation or entity which directly, or indirectly through one or more intermediaries, controls, is controlled by or is under common control with the Company. Affiliates of the Company shall include UniHealth America and its affiliates. (b) "Annual Retainer" means the retainer compensation established by the Board and paid to a qualified Nonemployee Director pursuant to Section 4 hereof. (c) "Board" means the Board of Directors of the Company. (d) "Board Meeting Fee" shall mean the fee established by the Board and paid to each Nonemployee Director for attending a meeting of any committee of the Board pursuant to Section 5 hereof. (e) "Committee Meeting Fee" shall mean the fee established by the Board and paid to each Nonemployee Director for attending a meeting of any committee of the Board pursuant to Section 5 hereof. (f) "Company" means PacifiCare Health Systems, Inc., a Delaware corporation, and any successor corporation. (g) "Director" means any person who is duly elected or appointed to the Board. 1 (h) "Employee" means any full-time employee (as defined in Section 31.340(c)-1 of the Internal Revenue Code of 1986, as amended) of the Company or any of its Affiliates. (i) "Meeting Fees" shall mean the Board Meeting Fee and the Committee Meeting Fee. (j) "Nonemployee Director" or "Participant" means any Director who is not an Employee and who is otherwise eligible to accrue or receive benefits under the Plan. (k) "Plan" means the Company's Nonemployee Director Compensation and Retirement Plan as set forth herein, as it may be amended from time to time. (l) "Plan Committee" shall mean the committee of the Board of Directors of the Company as defined in Section 3(a) hereof. (m) "Retire" or "Retirement" shall mean the termination of service of a Nonemployee Director as a Director by resignation, expiration of office without reelection, or for any other reason except death or removal of the Nonemployee Director for "cause." (n) "Retirement Benefits" shall mean the retirement benefits payable to Nonemployee Directors under Section 7 hereof. (o) "Stock Options" shall mean options to purchase shares of the Company's common stock granted to Nonemployee Directors under the Company's 1989 Stock Option Plan for Officers and Key Employees and the 1989 Stock Option Plan for Non-Officer Directors. (p) "Year(s) of Service" shall mean the number of full years (i.e., 365 days) of service of a Director as a Nonemployee Director for the Company and, prior to November, 1983, for the Company's predecessors, PacifiCare Health Systems, a California corporation, PacifiCare, Inc., a California corporation, and PacifiCare, Inc., a California nonprofit corporation. 3. ADMINISTRATION OF THE PLAN (a) GENERAL ADMINISTRATION; POWERS OF ADMINISTRATION. The Plan shall be generally administered by the Board. The Board may delegate the general administration of the Plan to a committee of the Board (the "Plan Committee"). The Company shall pay all costs of administration of the Plan. The Board or, if applicable, the Plan Committee, shall have and may exercise such powers and authority as may be necessary or appropriate to carry out the administration of the Plan. Without limiting the generality of the foregoing, the Board or, if applicable, the Plan Committee shall have full power and authority (i) to 2 determine all questions of fact and law that may arise under the Plan, (ii) to interpret the Plan and to make all other determinations necessary or advisable for the administration of the Plan, and (iii) to prescribe, amend, and rescind rules and regulations relating to the Plan, including, without limitation, any rules which the Board or, if applicable, the Plan Committee determines are necessary or appropriate, as the case may be, to ensure that the Company complies with all applicable provisions of any federal, state, or local law, including laws relating to the withholding of tax, including both prospective and retroactive changes in tax laws. All interpretations, determinations, and actions by the Board or Plan Committee, as the case may be, shall be final, conclusive, and binding upon all Participants. (b) PLAN COMMITTEE. The Plan Committee shall consist of at least three (3) members. The Plan Committee shall only act by a majority vote of its members. The Plan Committee may act either by a vote at a meeting or by memorandum or other written instrument signed by a majority of the Plan Committee members. (c) LIABILITY. All actions taken and all interpretations and determinations made by the Board or the Plan Committee, as the case may be, in good faith shall be final and binding upon all Participants, the Company and all other interested persons. No member of the Board or the Plan Committee, as the case may be, shall be personally liable for damages, costs or expenses resulting from any action, failure to act, determination or interpretation made in good faith with respect to the Plan and all members of the Board and Plan Committee shall be fully protected by the Company in respect to any such action, determination or interpretation. (d) NONAPPLICABILITY TO STOCK OPTIONS. Notwithstanding anything contained herein, any action, determination, or interpretation with respect to Stock Options, including, but not limited to, the administration of or grants of Stock Options under the Company's 1989 Stock Option Plan for Officers and Key Employees and the 1989 Stock Option Plan for Non-Officer Directors, as the case may be, shall be governed exclusively by the terms and conditions of said stock option plans. (e) COMPENSATION AND RETIREMENT AGREEMENTS. The Board or Plan Committee, as the case may be, in its sole and absolute discretion, shall cause the Company to enter into a written compensation and retirement agreement with each eligible Nonemployee Director which agreement shall be executed by the Nonemployee Director and an authorized Officer of the Company and which shall contain such terms and conditions as the Board or Plan Committee, as the case may be, shall determine, consistent with the Plan. Each such agreement shall expressly incorporate 3 by reference the provisions of this Plan (a copy of which shall be made available for inspection by the Participant during normal business hours at the principal office of the Company) and shall state that in the event of any inconsistency between the provisions hereof and the provisions of such agreement, the provisions of this Plan shall govern. 4. ANNUAL RETAINER (a) AMOUNT. The amount of the Annual Retainer payable by the Company to each eligible Nonemployee Director other than the Chairman of the Board of the Company shall be $10,000 per year. In recognition of his additional administrative duties and responsibilities, the amount of the Annual Retainer for an eligible Nonemployee Director who is also the Chairman of the Board of the Company shall be equal to one hundred fifty percent (150%) of the Annual Retainer amount payable to all other eligible Nonemployee Directors. The Board may change the amount of the Annual Retainer at any time by a duly adopted resolution. (b) ELIGIBILITY. A Nonemployee Director shall be eligible to receive the Annual Retainer only if he or she has been duly elected as a Director and serving in such capacity on April 1 of the particular year for which the Annual Retainer is payable by the Company. (c) PAYMENT DATE. Each eligible Nonemployee Director shall be paid the Annual Retainer on April 1 of each year commencing on April 1, 1991. 5. MEETING FEES (1) AMOUNT. (i) The amount of the Board Meeting Fee for eligible Nonemployee Directors other than the Chairman of the Board of the Company shall be $1,000 per Board meeting. In recognition of his additional administrative duties and responsibilities, the amount of the Board Meeting Fee for an eligible Nonemployee Director who is also the Chairman of a Board Committee shall be equal to one hundred fifty percent (150%) of the Board Meeting Fee amount applicable to all other eligible Nonemployee Directors. (ii) The amount of the Committee Meeting Fee for eligible Nonemployee Directors other than the Chairman of each respective committee of the Board shall be $750 per Board committee meeting. In recognition of his or her additional administrative duties and responsibilities, the amount of the Committee Meeting Fee for an eligible committee chairman shall be equal to one hundred fifty percent (150%) of the Board Meeting 4 Fee amount applicable to all other eligible Nonemployee Directors. (iii) The Board may change the amount of the Board Meeting Fee and the Committee Meeting Fee at any time by a duly adopted resolution. (b) ELIGIBILITY. A Nonemployee Director shall be eligible to receive a Board Meeting Fee and/or Committee Meeting Fee only if he or she attends the Board meeting or Board committee meeting, as the case may be, to which the Board Meeting Fee or Committee Meeting Fee, as the case may be, applies. (c) PAYMENT DATE. Each eligible Nonemployee Director shall be paid the applicable Board Meeting Fee or Committee Meeting Fee, as the case may be, at the commencement of the Board meeting or Board committee meeting to which the Board Meeting Fee or Committee Meeting Fee applies. 6. DEFERRAL OF ANNUAL RETAINER AND MEETING FEES A Nonemployee Director may elect to defer all or a portion of the Annual Retainer or Meeting Fees payable to such Nonemployee Director by the Company. In the event that a Nonemployee Director elects to defer all or a portion of the Annual Retainer or Meeting Fees, he or she shall enter into a written agreement with the Company, which agreement shall contain such terms and conditions of the deferral arrangement as the Board or Plan Committee, as the case may be, shall determine, consistent with the Plan. 7. RETIREMENT BENEFITS (a) ELIGIBILITY. (i) Upon Retirement, a Nonemployee Director shall be eligible to receive Retirement Benefits under the Plan if such Nonemployee Director has at least five (5) consecutive Years of Service as a Nonemployee Director (I.E., without any break in service for any reason). The amount and the manner of payment of such Retirement Benefits will be as provided below in Section 7(c). (ii) A Nonemployee Director who serves or has at anytime served (before or after the effective date of the Plan) as any Employee shall not be eligible to receive Retirement Benefits under the Plan if such Nonemployee Director is eligible to receive retirement benefits under a Defined Benefit Plan (as such plans are defined by the Employee Retirement Income Security Act (ERISA)) established by the Company. 5 (b) DISQUALIFICATION. A Nonemployee Director shall not be entitled to receive Retirement Benefits under the Plan if he or she is removed for "cause" from the Board even if such Nonemployee Director otherwise satisfies the requirements for receiving Retirement Benefits and even if Retirement Benefits have already accrued. (c) AMOUNT OF RETIREMENT BENEFITS. (i) If a Nonemployee Director Retires, the Company shall pay the Nonemployee Director Retirement Benefits equal to the average of the Annual Retainer paid to such Nonemployee Director for the three (3) year period immediately preceding Retirement or the average of the Annual Retainer paid to such Nonemployee Director if the Annual Retainer has been paid by the Company for less than three (3) years. Unless an eligible Nonemployee Director becomes ineligible, disqualified or his or her Retirement Benefits terminate as provided herein, the payment of Retirement Benefits by the Company shall be made annually for the number of Years of Service accumulated by an eligible Nonemployee Director at the time of his Retirement. Each Nonemployee Director shall be fully liable for payment of any local, state or federal income or other taxes associated with the receipt of Retirement Benefits. (ii) If a Nonemployee Director Retires and later resumes Nonemployee Director status, payments of Retirement Benefits shall be automatically suspended as of the date of resumption of Nonemployee Director status and until such time as the Nonemployee Director again Retires and is eligible to receive Retirement Benefits. If the Nonemployee Director again Retires, the Company shall pay the Nonemployee Director Retirement Benefits equal to the average Annual Retainer paid to such Nonemployee Director for the immediately preceding three (3) year period, or the average of the Annual Retainer paid to such Nonemployee Director if such has been paid for less than three (3) years, provided such Nonemployee Director remains eligible to receive Retirement Benefits. Unless an eligible Nonemployee Director becomes ineligible, disqualified or his or her Retirement Benefits terminate as provided herein, payment of Retirement Benefits shall be made by the Company annually for the number of Years of Service accumulated by the Nonemployee Director (less any period of time for which payments of Retirement Benefits were previously made under the Plan) at the time of his or her Retirement, including Years of Service which may have accrued since the resumption of Nonemployee Director as a Director or in any other capacity for any period of time or at a particular retainer or other rate of compensation, as conferring upon any Participant any legal or other right to continue as a Director or in any other capacity, or as limiting, interfering with or otherwise affecting the right to terminate a 6 Participant in his or her capacity as a Director or otherwise at any time for any reason, with or without cause, and without regard to the effect that such termination might have upon him or her as a Participant under the Plan. 10. COMPLIANCE WITH GOVERNMENT REGULATIONS Neither the Plan nor the Company shall be obligated to make any payments pursuant to the Plan at any time unless and until all applicable requirements under federal and state laws, rules, and regulations, or by any regulatory agencies, have been fully met. 11. NONTRANSFERABILITY OF RIGHTS No Participant may assign the right to receive Retirement Benefits under the Plan or any other right or interest under the Plan, contingent or otherwise, or to cause or permit any encumbrance, pledge, or charge of any nature to be imposed on any such right or interest. 12. AMENDMENT AND TERMINATION OF PLAN The Board shall have the power, in its discretion, to amend, suspend, or terminate the Plan at any time, provided that no amendment, suspension, or termination of the Plan will, without the consent of the Participant, alter, terminate, or reduce any benefits which have accrued under the Plan, unless such amendment, suspension, or termination is required by applicable law. 13. GOVERNING LAW The laws of the State of Delaware shall govern and control the interpretation and application of the terms of the Plan. 14. EFFECTIVE DATE AND DURATION OF THE PLAN This Plan will become effective as of April 1, 1991. Nonemployee Directors who have Retired prior to such date shall not be entitled to receive Retirement Benefits under the Plan. 7 EX-11.A 4 COMP. OF EARNINGS PER SHARE-PRIMARY 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 --------------------------------------- 1995 1994 1993 --------------------------------------- Shares outstanding at the beginning of the period 27,528 27,256 25,617 Weighted average number of shares issued during the period in connection with a public offering, compensation awarded in stock and exercise of stock options 1,750 155 1,694 Shares repurchased (weighted) - (33) (88) Dilutive shares issuable, net of shares assumed to have been purchased (at the average market price) for treasury with assumed proceeds from contingent exercise of stock options 586 626 624 --------------------------------------- Total primary shares 29,864 28,004 27,847 --------------------------------------- --------------------------------------- Income before cumulative effect of a change in accounting principle $ 108,095 $ 84,593 $ 62,696 Cumulative effect on prior years of a change in accounting principle - 5,658 - --------------------------------------- Net income $ 108,095 $ 90,251 $ 62,696 --------------------------------------- --------------------------------------- Primary earnings per share: Before cumulative effect of a change in accounting principle $ 3.62 $ 3.02 $ 2.25 Cumulative effect on prior years of a change in accounting principle - 0.20 - --------------------------------------- Earnings per share - primary $ 3.62 $ 3.22 $ 2.25 --------------------------------------- ---------------------------------------
EX-11.B 5 COMP. OF EARNINGS PER SHARE-FULLY DILUTED 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 ---------------------------------------- 1995 1994 1993 ---------------------------------------- Shares outstanding at the beginning of the period 27,528 27,256 25,617 Weighted average number of shares issued during the period in connection with a public offering, compensation awarded in stock and exercise of stock options 1,750 155 1,694 Shares repurchased (weighted) - (33) (88) Dilutive shares issuable, net of shares assumed to have been purchased (at the higher of average or ending market price) for treasury with assumed proceeds from: Contingent exercise of stock options 608 766 624 Registered equity purchase contracts 4 - - ---------------------------------------- Total fully diluted shares 29,890 28,144 27,847 ---------------------------------------- ---------------------------------------- Income before cumulative effect of a change in accounting principle $ 108,095 $ 84,593 $ 62,696 Cumulative effect on prior years of a change in accounting principle - 5,658 - ---------------------------------------- Net income $ 108,095 $ 90,251 $ 62,696 Decrease in interest expense applicable to subordinated convertible debentures, net of income tax effect - - 1 ---------------------------------------- Net income as adjusted $ 108,095 $ 90,251 $ 62,697 ---------------------------------------- ---------------------------------------- Fully diluted earnings per share: Earnings before cumulative effect of a change in accounting principle $ 3.62 $ 3.00 $ 2.25 Cumulative effect on prior years of a change in accounting principle - 0.20 - ---------------------------------------- Earnings per share - fully diluted $ 3.62 $ 3.20 $ 2.25 ---------------------------------------- ----------------------------------------
EX-21 6 LIST OF SUBSIDIARIES Exhibit 21 PACIFICARE HEALTH SYSTEMS, INC. LIST OF SUBSIDIARIES NAME OF SUBSIDIARY STATE OF INCORPORATION ------------------ ---------------------- Advanced Delivery Systems Management Company California Barbis Advertising, Inc. Florida California Dental Health Plan 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 California Health in Dade, Inc. Florida Health in Miami Beach, Inc. Florida Health Managers of Oklahoma, Inc. Oklahoma Health Managers of Texas, Inc. Texas Interstate Medical Equipment, Inc. Florida Ismael Hernandez, M.D. & Associates, P.A. Florida 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 Behavioral Health of California, 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, Inc. 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 Secure Horizons USA, Inc. California West Dade Professional Services, Inc. Florida EX-23 7 CONSENT OF ERNST & YOUNG LLP 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 10, 1995 with respect to the consolidated financial statements and schedule of PacifiCare Health Systems, Inc. included in this Annual Report (Form 10-K) for the year ended September 30, 1995. ERNST & YOUNG LLP Los Angeles, California November 21, 1995 EX-27 8 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS SEP-30-1995 OCT-01-1994 SEP-30-1995 279,145 532,380 113,098 690 0 961,609 172,417 73,141 1,385,372 640,994 11,949 309 0 0 732,024 1,385,372 0 3,731,022 0 3,077,135 0 530 5,549 182,100 74,005 108,095 0 0 0 108,095 3.62 3.62
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