-----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, ESZVxBlmA4gEAop1NKqkp9a2xDSGaMJSNTqIPGKj3o9MhNYbFH/rkotg/GEor5sL 4lmsEKd7eyfgqHxN4x9f/w== 0000912057-96-026394.txt : 19961118 0000912057-96-026394.hdr.sgml : 19961118 ACCESSION NUMBER: 0000912057-96-026394 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FHP INTERNATIONAL CORP CENTRAL INDEX KEY: 0000793499 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-OFFICES & CLINICS OF DOCTORS OF MEDICINE [8011] IRS NUMBER: 330072502 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-14796 FILM NUMBER: 96664343 BUSINESS ADDRESS: STREET 1: 9900 TALBERT AVE CITY: FOUNTAIN VALLEY STATE: CA ZIP: 92708 BUSINESS PHONE: 7149637233 FORMER COMPANY: FORMER CONFORMED NAME: FHP CORP DATE OF NAME CHANGE: 19870201 10-Q 1 FORM 10Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _______________________ (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 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 0-14796 FHP INTERNATIONAL CORPORATION a Delaware Corporation I.R.S. Employer Identification No. 33-0072502 3120 Lake Center Drive, Santa Ana, CA 92704 (Address of principal executive offices) (Zip Code) (714) 825-6600 (Registrant's telephone number, including area code) 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 . ----- ---- The registrant had 41,212,804 shares of common stock, par value $0.05 per share, outstanding at November 8, 1996. The Exhibit Index Appears on Page 20 1 PART 1 - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FHP INTERNATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS (unaudited) ASSETS (amounts in thousands, September 30, June 30, except share data) 1996 1996 ------------- -------- Cash and cash equivalents $ 164,295 $ 166,873 Short-term investments 215,571 187,919 Accounts receivable, net 155,043 141,537 Prepaid expenses and other current assets 27,942 33,736 Deferred income taxes 49,165 49,162 ---------- ---------- Total current assets 612,016 579,227 Property and equipment, net 231,057 231,428 Assets held for sale (Note 6) 16,222 16,470 Long-term investments 41,613 36,470 Restricted investments 91,010 90,499 Goodwill and other intangibles, net 1,021,008 1,028,374 Other assets, net 31,292 31,411 ---------- ---------- Total assets $2,044,218 $2,013,879 ---------- ---------- ---------- ---------- - --------- See accompanying notes to consolidated financial statements. 2 FHP INTERNATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS (unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY (amounts in thousands, September 30, June 30, except share data) 1996 1996 ------------- -------- Current portion of long-term obligations $ 19,102 $ 30,097 Accounts payable 55,107 50,979 Medical claims payable 401,657 367,872 Accrued salaries and employee benefits 51,236 71,986 Unearned premiums 22,691 24,713 Restructuring reserve (Note 6) 12,321 14,615 Income taxes payable and other current liabilities 88,668 79,132 ---------- ---------- Total current liabilities 650,782 639,394 Long-term obligations 100,222 104,184 Other liabilities 101,513 102,672 ---------- ---------- Total liabilities 852,517 846,250 ---------- ---------- Commitments and contingencies (Note 4) Stockholders' equity: Series A Convertible Preferred Stock, $0.05 par value; 40,000,000 shares authorized (Note 3) 1,052 1,052 Common Stock, $0.05 par value; 100,000,000 shares authorized; issued and outstanding 41,178,042 and 40,789,528 shares at September 30, 1996 and June 30, 1996, respectively 2,059 2,039 Paid-in capital 945,141 938,478 Unrealized holding losses on available-for-sale investments, net of tax effect of $1,311 at September 30, 1996 and $1,602 at June 30, 1996 (1,886) (2,306) Retained earnings 245,335 228,366 ---------- ---------- Total stockholders' equity 1,191,701 1,167,629 ---------- ---------- Total liabilities and stockholders' equity $2,044,218 $2,013,879 ---------- ---------- ---------- ---------- - ---------- See accompanying notes to consolidated financial statements. 3 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (unaudited) For The (amounts in thousands, Three Months Ended except per share data) September 30, 1996 1995 ---------- ---------- Revenues $1,098,699 $1,004,633 ---------- ---------- Expenses: Primary health care 897,540 818,971 Other health care 32,155 30,845 General, administrative and marketing 132,010 125,126 Provision for restructuring 5,759 ---------- ---------- Total expenses 1,061,705 980,701 ---------- ---------- Operating income 36,994 23,932 Interest income 9,099 9,136 Interest expense (2,493) (6,424) ---------- ---------- Income before income taxes 43,600 26,644 Provision for income taxes 20,056 12,717 ---------- ---------- Net income 23,544 13,927 Preferred Stock dividends 6,575 6,607 ---------- ---------- Net income attributable to Common Stock $ 16,969 $ 7,320 ---------- ---------- ---------- ---------- Earnings per share attributable to Common Stock (Note 2) $ 0.40 $ 0.18 ---------- ---------- ---------- ---------- Weighted average number of common shares and common share equivalents 42,059 41,016 ---------- ---------- ---------- ---------- Fully diluted earnings per share (Note 2) $ 0.40 - ---------- ---------- ---------- ---------- Fully diluted weighted average number of common shares and common share equivalents 59,300 - ---------- ---------- ---------- ---------- - ---------- See accompanying notes to consolidated financial statements. 4 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) For The Three Months Ended (amounts in thousands) September 30, 1996 1995 ------- ------- OPERATING ACTIVITIES Net income $23,544 $13,927 Adjustments to reconcile net income to net cash provided by operating activities: Provision for restructuring 5,759 Depreciation and amortization 17,861 18,372 (Decrease) increase in allowance for doubtful accounts (2,456) 739 Loss on disposal of equipment 314 68 Effect on cash of changes in operating assets and liabilities: Accounts receivable (11,050) (1,774) Prepaid expenses and other current assets 5,794 (2,240) Other assets (343) (161) Accounts payable 4,128 2,851 Medical claims payable 33,785 1,691 Accrued salaries and employee benefits (20,750) (12,335) Unearned premiums (2,022) (9,734) Other liabilities 6,083 10,745 ------- ------- Net cash provided by operating activities 54,888 27,908 ------- ------- INVESTING ACTIVITIES Purchases of available-for-sale investments (184,096) (47,272) Proceeds from sales/maturities of available-for-sale investments 151,498 78,419 Loss on sale of available-for-sale investments 7 161 Gain on sale of available-for-sale investments (4) (486) Purchases of property and equipment (13,121) (13,245) Proceeds from sales of assets held for sale 3,174 236 ------- ------- Net cash (used in) provided by investing activities (42,542) 17,813 ------- ------- 5 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS(continued) (unaudited) For The Three Months Ended (amounts in thousands) September 30, 1996 1995 -------- -------- FINANCING ACTIVITIES Payments on long-term obligations (15,032) (15,048) Exercise of stock options 6,683 1,287 Cash dividends paid to preferred shareholders (6,575) (6,597) -------- -------- Net cash used in financing activities (14,924) (20,358) -------- -------- (Decrease)increase in cash and cash equivalents (2,578) 25,363 Cash and cash equivalents at beginning of period 166,873 299,144 -------- -------- Cash and cash equivalents at end of period $164,295 $324,507 -------- -------- -------- -------- Supplemental cash flow information: Interest payments $ 4,082 $ 5,123 Income tax payments (net of refunds) $ 18,512 $ 9,677 - ---------- See accompanying notes to consolidated financial statements. 6 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1. ORGANIZATION AND ACCOUNTING POLICIES FHP International Corporation (the "Company"), through its direct and indirect subsidiaries, delivers managed health care services and sells indemnity medical, group life, and workers' compensation insurance. Interim periods are viewed as an integral part of the annual period of the Company. Accordingly, the results for the interim periods reported are based on the accounting principles and practices followed by the Company as presented in its Annual Report on Form 10-K for the year ended June 30, 1996. In the opinion of management, all adjustments necessary to fairly present the financial position and the results of operations for the three months ended September 30, 1996 and 1995 are included in these consolidated financial statements. NOTE 2. EARNINGS PER SHARE Primary earnings per share attributable to Common Stock for the three months ended September 30, 1996 and 1995 are computed by dividing net income attributable to Common Stock by the weighted average number of outstanding common shares and common share equivalents during the respective periods. Common share equivalents include the effect of dilutive stock options calculated using the treasury stock method. Fully diluted earnings per share for the three months ended September 30, 1996 assume the conversion of the Series A Cumulative Convertible Preferred Stock, the elimination of the related Preferred Stock dividend requirement and market price as of the end of the quarter for dilutive Common Stock options. Fully diluted earnings per share for the three months ended September 30, 1995 were anti-dilutive. NOTE 3. PREFERRED STOCK The authorized capital stock of the Company includes 40,000,000 shares of Preferred Stock, par value $0.05 per share. Preferred Stock is designated either Series A Cumulative Convertible Preferred Stock ("Series A Preferred Stock") or Series B Adjustable Rate Cumulative Preferred Stock ("Series B Preferred Stock"). At September 30, 1996 and June 30, 1996 there was no Series B Preferred Stock outstanding. The issued and outstanding, and aggregate liquidation preference of the Company's Series A Preferred Stock is as follows: September 30, 1996 June 30, 1996 ------------------ ------------- Issued and outstanding 21,040,307 21,040,307 Aggregate liquidation preference $526,036,000 $526,033,000 7 NOTE 4. COMMITMENTS AND CONTINGENCIES During the ordinary course of business, the Company and its subsidiaries have become a party to pending and threatened legal actions and proceedings, a significant number of which involve alleged claims of medical malpractice. Management is of the opinion, taking into account its insurance coverage and reserves that have been established, that the outcome of the currently known legal actions and proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position or results of operations or cash flows of the Company and its subsidiaries. NOTE 5. OPM The Company's HMO subsidiaries have contracts with the United States Office of Personnel Management ("OPM") to provide or arrange managed health care services under the Federal Employees Health Benefits Program ("FEHBP") for federal employees, annuitants and their dependents. Periodically, the Company's HMO subsidiaries are subject to audits by the government to, among other things, verify that premiums charged under OPM contracts are established in compliance with community rating and other requirements under the FEHBP. Final reports from such audits may recommend that OPM seek monetary recoveries from the Company for amounts that may be substantial. The Company increased reserves in the third quarter of fiscal year 1996, by recording a pretax charge of $45 million ($28.7 million, net of tax), to address existing (as discussed below) and potential governmental claims for the years 1987 through 1991, which have been or may be asserted in relation to the Company's contracts with OPM and for possible other OPM claims through 1996. The addition to reserves resulted in a charge to net earnings of $0.68 per share. In May 1993, OPM sent a draft audit report to the Company covering primarily the years 1987 through 1991, alleging defective rating practices in certain regions. A final audit report was not issued. In the third quarter of fiscal year 1996, the United States Department of Justice (the "DOJ") notified the Company that (based on the OPM draft audit report and discussions with OPM personnel) the DOJ believed the Company may have violated the False Claims Act. The DOJ believed its actual damages to be approximately $15 million. (In False Claims Act actions, the government may seek trebled damages and a civil penalty of not less than $5,000 nor more than $10,000 for each separate alleged false claim.) The DOJ indicated it did not have any information that would lead it to believe that the Company violated any criminal laws. On October 7, 1996, the Company reached an agreement with the DOJ which resolved the claims under the OPM draft audit report for the years 1987 to 1991. The Company agreed to pay $12 million to the FEHBP Contingency Reserve Funds for the regions covered by the draft audit report. The payment will be charged against the $45 million reserve established to cover existing and potential FEHBP audit claims through 1996. The Company paid no fines or penalties as part of the agreement. Also, the DOJ released the Company from all claims under the contracts for the years covered by the draft audit report. 8 OPM has opened two additional audits for years as far back as 1990 at two of the Company's other HMO subsidiaries. In October 1996, OPM sent a draft audit report to the Company for these two additional audits. The draft report alleges certain defects in the Company's rating practices. The Company is evaluating the draft report. Based on management's understanding of the government's current interpretation of the community rating standard requirements, management currently believes it has established adequate reserves to settle any claims that have arisen or may arise from present or future FEHBP rate audits for years between and including 1987 through 1996, or that amounts in excess of reserves, if any, necessary to settle any such claims would not be such as to have a material adverse effect on the consolidated financial position or results of operations or cash flows of the Company. NOTE 6. RESTRUCTURING CHARGE In June 1995, the Company's Board of Directors approved a restructuring plan involving the discontinuance of services and programs that did not meet the Company's strategic and economic return objectives, including: 1) a reduction in workforce; 2) the creation of a subsidiary physician practice management company, Talbert Medical Management Corporation ("Talbert"); and 3) the sale of the Company's two acute care hospitals and other nonproductive real estate. Talbert began operations as a subsidiary of the Company on January 1, 1996. Talbert operates in all of FHP's formerly Company operated medical facilities in California, Utah, Arizona, New Mexico and Nevada. The restructuring plan was substantially completed in fiscal year 1996. Restructuring charges in fiscal years 1995 and 1996 were based on the Company's estimates and were refined throughout fiscal year 1996. During the three months ended September 30, 1996, there was no significant change in the aggregate in estimates with respect to accruals previously established. NOTE 7. AGREEMENT AND PLAN OF REORGANIZATION On August 4, 1996, the Company entered into an Agreement and Plan of Reorganization, as amended and restated, (the "Merger Agreement"), by and among the Company and PacifiCare Health Systems, Inc., et. al. ("PacifiCare"). Pursuant to the Merger Agreement, PacifiCare will acquire all of the outstanding stock of the Company. The transaction is expected to close in January, 1997 (the "Effective Time"). Pursuant to Merger Agreement, holders of the Company's Common Stock will receive consideration through a combination of $17.50 in cash and a mix of shares of Class A Common Stock and Class B Common Stock of PacifiCare, plus rights to purchase stock of Talbert. The consideration at the date of the Merger Agreement equated to $35.00 per share without attributing value to the Talbert Rights. The maximum amount of Class A Common Stock of PacifiCare that will be issued to stockholders of the Company will be 2,350,000 shares. The balance of PacifiCare stock to be issued to the Company's stockholders will be Class B Common Stock. 9 Each outstanding share of the Company's Series A Preferred Stock will be converted into the right to receive either: (a) $14.113 in cash and 0.50 shares of PacifiCare Holding Preferred Stock, assuming approval of the proposed amendment to the Restated Certificate of Incorporation of the Company ("Series A Amendment"); or (b) if the Series A Amendment is not approved, (1) $25.00 in cash, (2) a mix of cash, PacifiCare Class A Common and PacifiCare Class B Common determined by a formula described in the Merger Agreement, or (3) the consideration that would have been received had the Series A Preferred Stock been converted into Company Common Stock immediately prior to the Effective Time of the transaction, including rights to purchase stock of Talbert. At the Effective Time, the shares of the Company's Common and Preferred Stock will have the right to purchase, in the aggregate, all of the Company's approximate 92% interest in Talbert. The number of PacifiCare shares to be delivered in the merger is subject to adjustment based on the price of PacifiCare stock during a twenty day trading period ending prior to the Company's stockholders' meeting. PacifiCare has informed the Company that it has received a commitment from a bank to provide financing for the cash portion of the transaction. The closing of the transaction is subject to customary closing conditions, including the approval of the stockholders of the Company and PacifiCare, various regulatory approvals, and passage of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and is currently expected to occur in early 1997. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations - Proposed Acquisition of the Company by PacifiCare.) 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FHP International Corporation and its subsidiaries (the "Company") is a federally qualified health maintenance organization, deriving almost all of its revenues from premiums received for health care services to approximately 1.9 million HMO members. During fiscal year 1996, the Company separated its operations into three business segments. These segments comprise: 1) the Company's contract model operations (the "HMO"); 2) a physician practice management company, Talbert Medical Management Corporation ("Talbert"), operating almost all of the Company's owned and operated medical centers (collectively formerly known as the "Staff Model"); and 3) the Company's group life, health and accident and workers' compensation insurance and related products (collectively, the "Insurance Group"). PROPOSED ACQUISITION OF THE COMPANY BY PACIFICARE On August 4, 1996, the Company entered into an Agreement and Plan of Reorganization (the "Merger Agreement") with PacifiCare Health Systems, Inc. ("PacifiCare"), N-T Holdings, Inc. ("PacifiCare Holding"), Neptune Merger Corp. ("PacifiCare Merger Sub") and Tree Acquisition Corp. ("Company Merger Sub"). The Merger Agreement, as amended and restated, provides for, among other things, an acquisition transaction involving PacifiCare and the Company by means of the merger of PacifiCare Merger Sub with and into PacifiCare and the merger of the Company Merger Sub with and into the Company. As a result, PacifiCare and the Company will become wholly-owned subsidiaries of PacifiCare Holding. Upon consummation of the transaction (the "Effective Time"): (i) each outstanding share of PacifiCare Class A Common Stock will be converted into the right to receive one share of PacifiCare Holding Class A Common Stock; (ii) each share of PacifiCare Class B Common Stock will be converted into the right to receive one share of PacifiCare Holding Class B Common Stock; (iii) each outstanding share of Company Common Stock will be converted into the right to receive $17.50 in cash and a mix of PacifiCare Holding Class A Common Stock and PacifiCare Holding Class B Common Stock; (iv) each outstanding share of Company Series A Cumulative Convertible Preferred Stock ("Series A Preferred") will be converted into the right to receive either (a) $14.113 in cash and 0.50 shares of PacifiCare Holding Preferred Stock, assuming approval of the proposed amendment to the Restated Certificate of Incorporation of the Company (the "Series A Amendment"), or (b) if the Series A Amendment is not approved, (1) $25.00 in cash, (2) a mix of cash, PacifiCare Class A Common Stock and PacifiCare Class B Common Stock determined by a formula described in the Merger Agreement, or (3) the consideration that would have been received had the Series A Preferred been converted into Company Common Stock immediately prior to the effective time of the transaction. At the Effective Time, each outstanding share of Company Common Stock and Series A Preferred will be converted in part into rights to purchase a proportionate share (on an as-if-converted basis) of all of the Company's holdings in Talbert (the "Talbert Rights"). The Talbert Rights will be delivered promptly after consummation of the mergers and will be exercisable for 30 days after delivery. The transaction is subject to customary closing conditions, including the approval of the stockholders of the Company and PacifiCare, various regulatory approvals and passage of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act"). 11 The United States Federal Trade Commission has requested additional documentation regarding the transaction, pursuant to the HSR Act. The Company's competitors may use the announcement of the Merger Agreement as an opportunity to encourage employer groups currently enrolled with the Company to enroll their employees in other plans. Provider groups currently affiliated with the Company also may be encouraged to seek other affiliations. Recently, the Company has begun to experience the loss of employees in connection with the potential transaction. In the event that the transaction is delayed or not completed, losses of significant numbers of members, providers and/or employees could have a material adverse impact on the Company's future results of operations. THREE MONTHS ENDED SEPTEMBER 30, 1996, COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 1995 REVENUE AND MEMBERSHIP The Company generates substantially all of its revenue from premiums received for health care services provided to the HMO members of its wholly-owned subsidiaries. Revenue for the three month period ended September 30, 1996, totaled $1,099 million, increasing 9.4% over revenue of $1,005 million for the same period in the previous fiscal year. Total HMO membership grew 7.3% to approximately 1,932,000 at September 30, 1996, from approximately 1,800,000 at September 30, 1995. During fiscal year 1996, the Company continued to experience modest membership growth, due primarily to intense competition in all its key markets. This trend continued into the first quarter of fiscal year 1997 and may continue throughout the balance of fiscal year 1997. During fiscal year 1996 and the first quarter of fiscal year 1997, the Company experienced a decline in its membership, both senior and commercial, at certain medical facilities operated by Talbert. For the Company, the decline has been more than offset by enrollment gains in the Company's HMO operations. From September 30, 1995, to September 30, 1996, total commercial membership increased by 109,000 or 7.7% from approximately 1,417,000 to approximately 1,526,000. The Company generates approximately half of its HMO revenue from sales to the commercial market. The Company's ability to increase its commercial membership and commercial premium rates during the last two fiscal years and the first quarter of fiscal year 1997 was adversely impacted by intense competition in all the Company's major markets, particularly in California. Downward pressure on commercial premium rates in California has eased in recent months; however, overall commercial premium rates are expected to remain relatively flat in fiscal year 1997 over fiscal year 1996. A substantial portion of the Company's HMO commercial premium rate increases becomes effective in January of each year. Senior membership grew by 23,000 or 6.0% to approximately 406,000 at September 30, 1996, from approximately 383,000 at September 30, 1995. Almost all of the Company's senior HMO revenue is generated from premiums paid to the Company by the federal government's Health Care Financing Administration ("HCFA"). Revenue per senior member is substantially higher than revenue per commercial plan member because senior members use substantially more health care services. The Company receives senior premium rate increases from HCFA on January 1 of each year. 12 For calendar year 1996, the Company received an average 5.1% rate increase. In September of each year, HCFA announces the annual Medicare rate increases that will become effective on January 1 of the subsequent year. These rate increases vary geographically and become the basis for determining the amounts that HCFA will pay to the Company. Based on HCFA's announcement in September, the Company is anticipating an average 5.7% rate increase for calendar year 1997. COST OF HEALTH CARE Health care costs increased 9.4% to $930 million for the three months ended September 30, 1996, from $850 million for the three months ended September 30, 1995, due to operational growth and cost increases. Health care costs as a percentage of revenue remained flat at 84.6% for both three month periods. In the first quarter of fiscal year 1997, the Company experienced higher hospital costs in certain regions outside of California and higher pharmacy costs across most regions. These higher costs were offset by lower physician costs. During the last three years and the first quarter of fiscal year 1997, certain medical centers in California now operated by Talbert have experienced high operating costs relative to declining enrollment. The decline created excess capacity and, therefore, higher health care costs as a percentage of revenue. During fiscal year 1996, Talbert began reducing costs, by reducing administrative overhead and excess staffing. GENERAL, ADMINISTRATIVE AND MARKETING COSTS General, administrative and marketing ("G & A") expenses increased by $7 million or 5.6% to $132 million for the three month period ended September 30, 1996, from $125 million for the three month period ended September 30, 1995, primarily due to Company growth. G & A expenses for the three month period ended September 30, 1996, decreased as a percentage of revenue to 12.0% from 12.5% for the same period in the prior fiscal year, primarily due to workforce reductions in fiscal year 1996 and other cost control measures. INTEREST INCOME Net interest income was $7 million for the three month period ended September 30, 1996, as compared to $3 million for the three month period ended September 30, 1995. Net interest income increased year-over-year primarily because of lower debt levels. OPM AUDITS The Company's HMO subsidiaries have contracts with the United States Office of Personnel Management ("OPM") to provide or arrange managed health care services under the Federal Employees Health Benefits Program ("FEHBP") for federal employees, annuitants and their dependents. These contracts with OPM and applicable government regulations establish premium rating requirements for the FEHBP. Periodically, the Company's HMO subsidiaries are subject to audits by the government to, among other things, verify that premiums charged under OPM contracts are established in compliance with community rating and other requirements under the FEHBP. In the third quarter of fiscal year 1996, the Company increased reserves by recording a pretax charge of $45 million ($28.7 million net of tax), in anticipation of negotiations to address existing and potential governmental claims arising from OPM audits for the years 1987 through 1996, as discussed below. 13 The Company's reserves reflect management's recognition that FEHBP rate audits and claims based thereon are being handled differently by the government than in the past and reflect the extent of business the Company's subsidiaries have conducted with OPM over many years. In May 1993, OPM sent a draft audit report to the Company alleging certain defective rating practices by one of the Company's HMO subsidiaries in certain regions during the years 1987 through 1991. Following its evaluation of the draft audit report, the Company indicated to OPM certain areas where it believed the report to be inaccurate or based on misconceptions. Although OPM had not issued a final audit report and the Company had received no further correspondence from the government regarding the draft audit report, in the third quarter of fiscal year 1996, the United States Department of Justice notified the Company that, based on the OPM draft audit report and discussions with OPM personnel, the government believed the Company may have violated the False Claims Act in community rate certifications that were the subject of the audit and that it believed the government's actual damages to be approximately $15 million. In October 1996, the Company reached an agreement with the government to resolve these claims. The agreement called for the Company to pay $12 million, which amount the Company understands will be allocated by OPM to the FEHBP Contingency Reserve Funds for the regions covered by the Company's contracts. The Company did not pay any fine or penalty under the agreement. Under the terms of the agreement, the government released the Company from all claims under the subject contracts for the years covered by the draft audit report. OPM has opened two additional audits for years as far back as 1990 at two of the Company's other HMO subsidiaries. In October 1996, OPM sent a draft audit report with respect to the Company's TakeCare subsidiary, alleging certain defects in the subsidiary's rating practices for the years 1990 through 1994, and requesting that the Company comment on the draft findings. The Company currently is evaluating the draft audit report and preparing a response. It is likely the final TakeCare audit report will recommend that OPM seek a monetary recovery from the Company and that such recommended recovery will be for a substantial amount. Based on positions taken by the government with respect to the 1987-1991 draft audit report discussed above, management believes that the other open audit and other possible future audits may allege defective rating practices and result in claims for adjustments from OPM. Management cannot determine if such claims will result in further referrals to the Department of Justice and further False Claims Act claims. Based on management's understanding of the government's current interpretation of the community rating standard requirements, management currently believes it has established adequate reserves to settle any claims that may arise from present or future FEHBP rate audits for years between and including 1987 through 1996, or that amounts in excess of reserves, if any, necessary to settle any such claims would not be such as to have a material adverse effect on the consolidated financial position or results of operations or cash flows of the Company. In addition, the Company's management currently does not believe the OPM audits will have a material effect on future relations with OPM. 14 The preceding two paragraphs in this subsection headed "OPM Audits" consist of forward looking statements. The actual outcome of any OPM audits, claims for adjustments and/or False Claims Act claims, the manner in which and amounts for which any such claims will be resolved, and the adequacy of reserves may differ materially from management's current expectation. Factors that could cause the resolution of these matters to differ materially from management's current expectation include the presentation by the government of new interpretations of FEHBP requirements, the presentation of new data relating to the determination of applicable rate changes or in the manner in which the government seeks to apply the False Claims Act to such situations, and/or a change in the government's position toward negotiated settlements of OPM audits and/or False Claims Act claims. LIQUIDITY AND CAPITAL RESOURCES The Company's consolidated cash, cash equivalents and short-term investments increased by $25 million to $380 million at September 30, 1996, from $355 million at June 30, 1996. The major source of cash during the first quarter of fiscal year 1997 was $55 million from operations. Uses of cash during the quarter included $13 million for capital expenditures, $7 million for Preferred Stock dividends, and $15 million of debt repayment. In September, 1993, the Company issued $100 million of ten-year Senior Notes (the "Notes") which carry interest at 7%. In March, 1994, the Company entered into a $350 million Credit Agreement. The Credit Agreement, as amended, provides for a $200 million Revolving Credit Loan and a $150 million Term Loan. The Company borrows at rates based on LIBOR rate borrowings which currently approximate 5.9%. The Term Loan is repayable at the rate of $15 million every six months, with the final repayment due March 31, 2000. The Credit Agreement contains financial and other covenants, including limitations on indebtedness, liens, dividends, sale and lease-back transactions, and certain other transactions. As of September 30, 1996, borrowings of $19 million were outstanding under the Credit Agreement. The Company's ability to make a payment on, or repayment of, its obligations under the Credit Agreement, the Notes and its Preferred Stock is significantly dependent upon the receipt of funds by the Company from the Company's direct and indirect subsidiaries. These subsidiary payments represent: (a) fees for management services rendered by the Company to the subsidiaries; and (b) cash dividends by the subsidiaries to the Company. Nearly all of the subsidiaries are subject to HMO regulations or insurance regulations (the "Regulated Subsidiaries"). Each of the Regulated Subsidiaries must meet or exceed various fiscal standards imposed by HMO regulations or insurance regulations. These fiscal standards may, from time to time, impact the amount of funds paid by one or more of the Regulated Subsidiaries to the Company. The Company believes the payments referred to above by the Regulated Subsidiaries, together with other financing sources, including the Credit Agreement, should be sufficient to enable the Company to meet its payment obligations under the Notes, the Credit Agreement and the Company's Preferred Stock. The Company believes that cash flow from operations, the Credit Agreement and existing cash balances will be sufficient to continue to fund operations and capital expenditures for the foreseeable future. Under the Merger Agreement, PacifiCare agreed to acquire all of the outstanding Common and Preferred Stock of the Company. At the Effective Time of the PacifiCare transaction, each outstanding share of Company Common Stock and Series A Preferred will be converted in part into rights to purchase a proportionate share (on an as-if-converted basis) of all of the Company's holdings in Talbert (the "Rights"). 15 The Rights will be delivered promptly after the Effective Time and will be exercisable for 30 days after delivery. On or before the Effective Time, Talbert will be capitalized to a net worth of approximately $60 million. The Company anticipates funding the Talbert capitalization through borrowings under its Credit Agreement. The Company currently expects that PacifiCare will assume the Company's obligation under the Notes. It is expected that outstanding balances under the Company's Credit Agreement will be paid in full and the Credit Agreement terminated upon consummation of the merger. In addition, all of the preceding statements about the Company's expectations or intentions are subject to changes that might result from the acquisition of the Company by PacifiCare. EFFECTS OF REGULATORY CHANGES AND INFLATION Effective January 1, 1996, the Company received an average premium rate increase from HCFA of approximately 5.1% for its senior HMO members. Based on HCFA's announcement in September, the Company is anticipating an average 5.7% rate increase for calendar year 1997. The Company evaluates the effects of HCFA premium adjustments on its liquidity and capital resources, and incorporates the actual and anticipated impact of such adjustments into its planning process. The Company has been experiencing significant downward pressures on commercial HMO premium rates, due to intense competition and counter-inflationary measures by large commercial employers attempting to hold their costs down. The Company has experienced competitive pressures in both its commercial and senior markets in California and this is continuing into fiscal year 1997. These downward pressures may continue throughout fiscal year 1997. There can be no assurances that the Company will be able to obtain premium rate increases in the commercial sector in the short term. In recent years health care costs have been rising at a rate higher than that for consumer goods as a whole, as a result of inflation, new technology and medical advances. The Company believes that internal cost control measures and financial risk-sharing arrangements with its contract medical providers help to mitigate the effects of inflation on its operations; however, there can be no assurance that the Company's efforts to reduce the impact of the increasing cost of health care will be as successful in the future as they have been in the past. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations concerning future events, activities, conditions and any and all statements that are not historical facts are forward-looking statements. Actual results may differ materially from those projected. Forward-looking statements involve risks and uncertainties. The Company's ability to expand has been and may continue to be affected by increasing competition, product choices and competitors in the Company's service areas. Many employer groups want minimal premium increases or even decreases, affecting the Company's ability to increase revenue; it is often difficult to contract with physicians which affects the Company's ability to control health care costs. There are numerous external factors including but not limited to government regulation, natural disasters, health care reform, new technology, epidemics and hospital costs which affect the Company. A change in any one or a combination thereof could affect the Company's future financial performance. Also, the Company's past performance is not necessarily evidence of or an indication of the Company's future financial performance. 16 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. Information relating to certain litigation as set forth in Note 4 of Notes to Consolidated Financial Statements in Part I of this report is incorporated herein by this reference. In the third quarter of fiscal year 1996, the United States Department of Justice notified the Registrant that, based on a draft United States Office of Personnel Management ("OPM") audit report of certain of the Registrant's contracts with OPM covering primarily the years 1987 through 1991 and on discussions with OPM personnel, the Government believed that the Registrant may have violated the False Claims Act in community rate certifications that were the subject of the audit and that it believed the Government's damages to be approximately $15 million. In October 1996, the Registrant reached an agreement with the Government to resolve these claims. The agreement called for the Registrant to pay $12 million, which amount the Registrant understands will be allocated by OPM to the FEHBP Contingency Reserve Funds for the regions covered by the Registrant's contracts. The Registrant did not pay any fine or penalty under the agreement. Under the terms of the agreement, the Government released the Registrant from all claims under the subject contracts for the years covered by the draft audit report. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - OPM." ITEM 2. CHANGES IN SECURITIES. None. ITEM 3. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. During the quarter ended September 30, 1996, the Registrant's Board of Directors authorized an amendment to the employment agreements with the following executives: Gloria L. Austin, Robert N. Franklin, Larry D. Gray, Burke F. Gumbiner, Jeffrey H. Margolis, Jack D. Massimino, Roger L. Moseley, Kenneth S. Ord, Westcott W. Price III, Eric D. Sipf and Michael J. Weinstock. The employment agreements are currently in the process of being amended. The form of amendment is filed as Exhibit 10.1 to this Form 10-Q. During the quarter ended September 30, 1996, the Registrant's Board of Directors authorized a second amendment to that certain Stock Purchase Agreement (the "Agreement") dated as of March 15, 1996, as amended, by and among the Registrant, Talbert Medical Management Corporation ("TMMC"), Talbert Health Services Corporation ("THSC") and certain management investors. The Agreement is currently in the process of being amended. The form of Amendment No. 2 to the Agreement is filed as Exhibit 10.2 to this Form 10-Q. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. See Index to Exhibits at page 20 of this report. 17 (b) Reports on Form 8-K. The Registrant filed a report on Form 8-K dated August 19, 1996, which reported that the Registrant entered into an Agreement and Plan or Reorganization (the "Original Merger Agreement") dated August 4, 1996, by and among the Registrant, PacifiCare Health Systems, Inc., a Delaware corporation ("PHS"), N-T Holdings, Inc., a Delaware corporation ("New PacifiCare"), Neptune Merger Corp., a Delaware corporation and a wholly-owned subsidiary of New PacifiCare, and Tree Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of New PacifiCare ("Company Sub"). Pursuant to the Original Merger Agreement, New PacifiCare will acquire all the stock of the Registrant by merger of the Registrant with Company Sub (the "Transaction"). In the Transaction, holders of the Registrant's common stock will receive consideration of an approximate value of $35.00 per share through a combination of $17.50 in cash and shares of Class A common stock and Class B common stock of New PacifiCare, plus rights to purchase stock of two subsidiaries of the Registrant, Talbert Medical Management Corporation and Talbert Health Services Corporation ("Talbert"). The maximum amount of Class A common stock of New PacifiCare that will be issued to stockholders of the Registrant will be 2,350,000 shares. The balance of New PacifiCare stock to be issued to the Registrant's stockholders will be Class B common stock. Holders of the Registrant's Series A Preferred Stock will receive for each such share $14.113 in cash plus one-half share of new Series A Preferred Stock of New PacifiCare which shall be convertible into Class B Common Stock of New PacifiCare. The number of shares to be delivered in the Transaction is subject to adjustment based on the price of PHS stock during a twenty day trading period ending prior to the Registrant's stockholders meeting. The closing of the Transaction is subject to customary closing conditions, including the approval of the stockholders of the Registrant and PHS, various regulatory approvals and passage of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR"). The Registrant filed a report on Form 8-K dated September 24, 1996, which reported that the Registrant, PHS, New PacifiCare, PacifiCare Merger Sub and FHP Merger Sub entered into an Amended and Restated Agreement and Plan of Reorganization (the "Merger Agreement") amending and restating in its entirety the Original Merger Agreement. The principal purpose of the Merger Agreement is to provide that the Transaction may occur whether or not a proposed amendment to the Registrant's Certificate of Incorporation (the "Series A Amendment") is approved. In the event such approval is not obtained, each holder of the Registrant's Series A Cumulative Convertible Preferred Stock ("Series A Preferred Stock") (i) will be entitled to exercise "Special Conversion Rights" (as provided in the Registrant's Certificate of Incorporation), or (ii) in the absence of an exercise of Special Conversion Rights, will be entitled to receive the same consideration in the Transaction that such holder would have received had such holder converted such holder's Series A Preferred Stock into Common Stock immediately prior to the effective time of the Transaction. The Merger Agreement also clarifies the Original Merger Agreement in certain other respects. The September 24, 1996 Form 8-K also reported that on September 20, 1996, the Registrant and PHS jointly announced that the U.S. Federal Trade Commission had, in accordance with the regulations promulgated under HSR, requested additional documentation regarding the Transaction (the "Second Request"). 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FHP INTERNATIONAL CORPORATION Dated: November 13, 1996 By: /s/ Kenneth S. Ord ----------------------------------- Senior Vice President and Chief (Principal) Financial Officer 19 INDEX TO EXHIBITS Exhibit Number *2.1 Agreement and Plan of Reorganization dated August 4, 1996, by and among the Registrant, PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., and Tree Acquisition Corp. (Exhibit 2 to Form 8-K dated August 19, 1996). *2.2 Amended and Restated Agreement and Plan of Reorganization dated September 17, 1996, by and among the Registrant, PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp., and Tree Acquisition Corp. (Exhibit 2 to Form 8-K dated September 24, 1996). 4.1 Registrant agrees to furnish to the Commission upon request a copy of each instrument with respect to issues of long-term debt of the Registrant, the authorized principal amount of which does not exceed 10% of total assets of Registrant. 10.1 Form of Amendment No. 1 to Employment Agreement with the following executives: Gloria L. Austin, Robert N. Franklin, Larry D. Gray, Burke F. Gumbiner, Jeffrey H. Margolis, Jack D. Massimino, Roger L. Moseley, Kenneth S. Ord, Westcott W. Price III, Eric D. Sipf and Michael J. Weinstock. 10.2 Form of Amendment No. 2 to Stock Purchase Agreement dated as of March 15, 1996, as amended, by and among the Registrant, Talbert Medical Management Corporation, Talbert Health Services Corporation, Kathryn M. Adair, Gloria L. Austin, Larry L. Georgopolous, Richard D. Jacobs, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter and Michael J. Weinstock. 11.1 Statement re: Computation of Earnings Per Share. 27.1 Financial Data Schedule. * Previously filed. 20 EX-10.1 2 EXHIBIT 10.1 AMEND #1 TO EMPLOYEE AGREEMENT Exhibit 10.1 AMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT This AMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT, dated as of September 17, 1996 (the "Amendment"), is made by and between FHP International Corporation, a Delaware corporation (the "Company") and ________________ (the "Executive"), for the purpose of amending the EMPLOYMENT AGREEMENT between them dated as of the _____ day of ________________, 1996 (the "Employment Agreement"). Defined terms not defined herein shall have the meanings assigned to them in the Employment Agreement. WHEREAS, the Company has entered into the Agreement and Plan of Reorganization dated as of August 4, 1996 among the Company, PacifiCare Health Systems, Inc., a Delaware corporation, N-T Holdings, Inc., a Delaware corporation ("PacifiCare Holding"), and certain other persons, as amended and restated by the Amended and Restated Agreement and Plan of Reorganization among them dated as of September 17, 1996 (as so amended, the "Reorganization Agreement"); and WHEREAS, the Company desires the benefits of the continued services of the Executive before and after the Effective Date, and the Executive is willing to render such services, pursuant and subject to the terms and conditions of the Employment Agreement as amended hereby; and WHEREAS, Section 4.8(b) of the Reorganization Agreement permits the Employment Agreement to be amended as provided herein. NOW, THEREFORE, in consideration of the promises and the covenants and agreements contained herein, the parties hereto agree as follows: 1. AMENDMENT TO EMPLOYMENT AGREEMENT. The Employment Agreement is hereby amended by revising Section 11(c) of the Employment Agreement to read as follows: "(c) PROVIDED THAT (i) on or before the Effective Date the Executive shall have executed and delivered to the Company a Covenant Not to Compete during the Employment Period in the form of EXHIBIT "A" hereto, (ii) within 30 days after the Date of Termination the Executive shall have executed and delivered to the Company a Settlement and Release Agreement in the form of EXHIBIT "B" hereto in the manner specified therein, and (iii) if and for so long as he or she may have been requested to do so (but not beyond the end of the Employment Period), the Executive shall have served as a director of the Company or any corporation controlling, controlled by or under common control with the Company, on terms and conditions no less favorable than apply to other directors of such corporation except that such service shall be without compensation, THEN: If the Executive's employment is terminated other than voluntarily or for Cause, Death or Disability prior to the end of the Employment 1 Period, each of the Executive's outstanding Option Rights which shall not otherwise have become exercisable shall become exercisable in such manner and at such times as the Option Right would have become exercisable if the Executive had not terminated employment and shall remain exercisable until the earlier of the date which is 90 days following the date on which the Option Right first becomes exercisable or the original expiration date of the Option Right. Calculation of the number of Options Rights that become immediately exercisable under Section 11(a) shall be made independently of this Section 11(c)." 2. GOVERNING LAW. This Amendment shall be governed by and construed in accordance with the internal laws of the State of Delaware. 3. NO OTHER AMENDMENTS. The Agreement, as amended by this Amendment, is and shall continue to be in full force and effect and is hereby in all respects ratified and confirmed. Except as expressly provided herein, nothing in this Amendment shall waive or be deemed to waive or modify any rights or obligations of any of the parties under the Agreement. 4. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. IN WITNESS WHEREOF, the parties have duly executed this Amendment as of the date first above mentioned. FHP International Corporation, a Delaware corporation By:____________________________________________ Name: Westcott W. Price III Title: President and Chief Executive Officer _______________________________________________ Executive 2 COVENANT NOT TO COMPETE This COVENANT NOT TO COMPETE, dated as of September 17, 1996 (the "Agreement"), is made by and between FHP International Corporation, a Delaware corporation (the "Company"), and ________________ ("Executive"). Defined terms not defined herein shall have the meanings assigned to them in the Employment Agreement or the Reorganization Agreement (as defined below). WHEREAS, as of the Effective Time, the Company shall have merged pursuant to the Amended and Restated Agreement and Plan of Reorganization dated as of September 17, 1996 (the "Reorganization Agreement") among the Company, PacifiCare Health Systems, Inc., a Delaware corporation, N-T Holdings, Inc., a Delaware corporation ("PacifiCare Holding"); and WHEREAS, as of the Effective Time and pursuant to the Company Merger, all stock of the Company held by Executive has been converted into stock of PacifiCare Holding and certain other consideration, and all Company Options held by Executive have been replaced by Exchange Options, in accordance with the provisions of the Reorganization Agreement; and WHEREAS, the Company desires the benefits of the continued services of the Executive after the Effective Time, and the Executive is willing to render such services, pursuant and subject to the terms and conditions of the Employment Agreement; and WHEREAS, Executive desires the benefits of Section 11(c) of the Employment Agreement and in consideration thereof desires to execute and deliver this Agreement in accordance therewith. NOW, THEREFORE, in consideration of the promises and the covenants and agreements contained herein, the parties hereto agree as follows: 1. COVENANT NOT TO COMPETE. Until the earlier of the expiration of the Employment Period or the expiration of 30 days following Executive's Date of Termination without execution and delivery by Executive of a Settlement and Release Agreement as provided in Section 11(c) of the Employment Agreement, Executive shall not, directly or indirectly, as principal, employee, agent, independent contractor, proprietor, partner, or otherwise, operate, own, manage, control, or participate in conducting the same business in the same cities and counties as carried on by the Company in the State of California at the Effective Time, if in so doing Executive personally carries on activities substantially the same in all material respects as the activities carried on by Executive as an officer and employee of the Company at the Effective Time. 2. REASONABLENESS OF COVENANT. Executive has carefully considered the nature and extent of the restrictions upon Executive and the rights and remedies conferred upon Company under this Agreement, and hereby acknowledges and agrees that such 3 covenants are reasonable, are designed to prevent irreparable damage to Company, are required to protect Company's legitimate interests, and do not confer a benefit upon Company disproportionate to the detriment of Executive. 3. NO WAIVER. No waiver of any of the provisions herein shall be valid unless in writing signed by the party against whom such claimed waiver is sought to be enforced, nor shall a failure to enforce any right hereunder constitute a continuing waiver of the notice or a waiver of any other right hereunder. The failure of the Company at any time or from time to time to require performance of any of Executive's obligations hereunder shall in no manner affect the Company's right to enforce any provision of this Agreement at a subsequent time. 4. SEVERABILITY. In the event that any provision or portion of this Agreement be found by a court of competent jurisdiction to be invalid or unenforceable, this Agreement shall be deemed to be amended so as to delete only the invalid or unenforceable provision, or the invalid or unenforceable portion thereof, and the remaining provisions hereof shall remain in full force and effect. 5. SUCCESSORS. This Agreement shall inure to the benefit of, and be binding upon the parties, their heirs, executors, administrators, successors and assigns. 6. GOVERNING LAW. This Amendment shall be governed by and construed in accordance with the law of the State of California, without reference to principles of conflicts of laws. 7. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date first above mentioned. FHP INTERNATIONAL CORPORATION By:_______________________________________ Westcott W. Price III President and Chief Executive Officer __________________________________________ Executive 4 SETTLEMENT AGREEMENT AND RELEASE This SETTLEMENT AGREEMENT AND RELEASE ("Agreement") is entered into by and between ________________ ("Executive") and FHP International Corporation, a Delaware corporation (the "Company"), pursuant to the EMPLOYMENT AGREEMENT between them dated as of the _____ day of __________, 1996, as amended (the "Employment Agreement"). WHEREAS, the employment of Executive by the Company terminated __________________ (the "Termination Date"); and WHEREAS, Executive desires the benefits of Section 11(c) of the Employment Agreement and in consideration thereof desires to execute and deliver this Agreement in accordance therewith. NOW, THEREFORE, in consideration of the promises and the covenants and agreements contained herein, the parties hereto agree as follows: 1. RELEASE. In consideration of the above, the sufficiency of which Executive hereby acknowledges, and subject to the proviso hereinafter set forth, Executive hereby agrees not to sue and fully, finally, completely and generally releases, absolves and discharges the Company, its predecessors, successors, subsidiaries, parents, related companies and business concerns, affiliates, partners, trustees, directors, officers, agents, attorneys, servants, representatives and employees, past and present, and each of them (hereinafter collectively referred to as "Releasees") from any and all claims, demands, liens, agreements, contracts, covenants, actions, suits, causes of action, grievances, arbitrations, unfair labor practice charges, wages, vacation payments, severance payments, obligations, commissions, overtime payments, Workers' Compensation claims, debts, profit sharing or bonus claims, expenses, damages, judgments, orders and/or liabilities of whatever kind or nature in law, equity or otherwise, whether known or unknown to Executive, which Executive now owns or holds or has at any time owned or held as against Releasees, or any of them ("Claims"), including specifically but not exclusively and without limiting the generality of the foregoing, any and all Claims arising out of or in any way connected to Executive's employment with or separation of employment from Executive including any Claims based on contract, tort, wrongful discharge, fraud, breach of fiduciary duty, attorneys' fees and costs, discrimination in employment, any and all acts or omissions in contravention of any federal or state laws or statutes (including but not limited to federal or state securities laws and the Racketeer Influenced and Corrupt Organizations Act), and any right to recovery based on state or federal age, sex, pregnancy, race, color, national origin, marital status, religion, veteran status, disability, sexual orientation, medical condition, union affiliation or other anti-discrimination laws, including, without limitation, Title VII, the Age Discrimination in Employment Act, the Americans with Disabilities Act, the National Labor Relations Act, and the California Fair Employment and Housing Act, all as amended, whether such claim be based upon an action 5 filed by Executive or by a governmental agency; PROVIDED, HOWEVER, the foregoing release shall not affect or diminish any rights of Executive under the Employment Agreement or in respect of vested employee benefits. "Vested employee benefits" means any and all rights of Executive under or in respect of (i) any employee benefit plan of the Company or any corporation or other entity which controlling, controlled by or under common control with the Company or that is a Releasee ("Affiliated Company"), (ii) any option or other agreement relating to any right or interest of Executive in any stock or other securities of the Company or any Affiliated Company, (iii) salary or wages payable for services rendered before the Termination Date, (iv) reimbursement for business expenses or other amounts for which Executive is entitled to reimbursement by the Company immediately before the Termination Date, or (v) indemnification as an agent. (a) Executive acknowledges and agrees that neither anything in this Agreement or the offer, execution, delivery, or acceptance thereof shall be construed as an admission of any kind by the Company, and this Agreement shall not be admissible as evidence in any proceeding except to enforce this Agreement. (b) It is the intention of Executive in executing this instrument that it shall be effective as a bar to each and every claim, demand, grievance and cause of action hereinabove specified as being released. In furtherance of this intention, Executive hereby expressly consents that this Agreement shall be given full force and effect according to each and all of its express terms and provisions, including those relating to unknown and unsuspected claims, demands and causes of action, if any, as well as those relating to any other claims, demand and causes of action hereinabove specified, and elects to assume all risks for claims that now exist in Executive's favor, known or unknown, that are released under this Agreement. Executive acknowledges that Executive may hereafter discover facts different from, or in addition to, those Executive now knows or believes to be true with respect to the claims, demands, liens, agreements, contracts, covenants, actions, suits, causes of action, wages, obligations, debts, expenses, damages, judgments, orders and liabilities herein released, and agrees the release herein shall be and remain in effect in all respects as a complete and general release as to all matters released herein, notwithstanding any such different or additional facts. (c) If any provision of this Agreement or application thereof is held invalid, the invalidity shall not affect other provisions or applications of the Agreement which can be given effect without the invalid provision or application. To this end, the provisions of this Agreement are severable. (d) Executive represents and warrants that Executive has not heretofore assigned or transferred or purported to assign or transfer to any person, firm or corporation any claim, demand, right, damage, liability, debt, account, action, cause of action, or any other matter herein released. 6 (e) NOTICE TO EXECUTIVE: The law requires that Executive be advised and the Company hereby advises Executive to consult with an attorney and discuss this Agreement before executing it. Executive acknowledges that the Company has provided to Executive at least 21 days within which to review and consider this Agreement before signing it. If Executive decides not to use the full 21 days, then Executive knowingly and voluntarily waives any claims that Executive was not in fact given that period of time or did not use the entire 21 days to consult an attorney and/or consider this Agreement. Executive acknowledges that Executive may revoke this Agreement for up to seven calendar days following Executive's execution of this Agreement and that it shall not become effective or enforceable until the revocation period has expired. Executive further acknowledges and agrees that such revocation must be in writing addressed to the Company as follows: FHP International Corporation, P.O. Box 25186, Santa Ana, California 92799, Attn: President, and received by the Company as so addressed not later than midnight on the seventh day following execution of this Agreement by Executive. If Executive so revokes this Agreement, the Agreement shall not be effective or enforceable and Executive will not receive the benefits described above. If Executive does not revoke this Agreement in the time frame specified above, the Agreement shall become effective at 12:00:01 on the eighth day after it is signed by Executive. (f) Executive represents that Executive has read and understood the foregoing Agreement, has been advised to and has had the opportunity to discuss it with anyone he or she desires, including an attorney of his or her own choice, and Executive accepts and agrees to the terms of this Agreement, acknowledges receipt of a copy of the same and the sufficiency of the benefits described above, and hereby executes this Agreement voluntarily and with full understanding of its consequences. PLEASE READ CAREFULLY. THIS AGREEMENT CONTAINS A GENERAL RELEASE OF ALL KNOWN AND UNKNOWN CLAIMS. Date:_____________ , 199__ Executive: ____________________________ Date:_____________ , 199__ FHP International Corporation By:_____________________________ Its:____________________________ 7 EX-10.2 3 EXHIBIT 10.2 AMENDMENT #2 TO STOCK PURCH. AGREE. Exhibit 10.2 AMENDMENT NO. 2 TO STOCK PURCHASE AGREEMENT This AMENDMENT No. 2 TO STOCK PURCHASE AGREEMENT, dated as of September 17, 1996 (the "Amendment"), is made by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Talbert Health Services Corporation, a Delaware corporation ("THSC"), Kathryn M. Adair, Gloria L. Austin, Larry L. Georgopolous, Richard D. Jacobs, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter and Michael J. Weinstock. Defined terms not defined herein shall have the meanings assigned to them in the Stock Purchase Agreement. WHEREAS, FHP, the Company and the Management Investors are parties to that certain Stock Purchase Agreement, dated as of March 15, 1996, as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996 (collectively, the "Stock Purchase Agreement"); and WHEREAS, FHP, PacifiCare Health Systems, Inc., a Delaware corporation ("PacifiCare"), N-T Holdings, Inc., a Delaware corporation, Neptune Merger Corp., a Delaware corporation and Tree Acquisition Corp., a Delaware corporation, have entered into that certain Amended and Restated Agreement and Plan of Reorganization, dated September 17, 1996 (the "Reorganization Agreement"); and WHEREAS, the Reorganization Agreement provides that the common and preferred stockholders of FHP will receive transferable rights (the "Rights") to subscribe for 92.25% of the outstanding shares of either TMMC Common Stock or the capital stock of an affiliated entity (the "Rights Offering"); and WHEREAS, prior to the execution of the Stock Purchase Agreement, William P. Bracciodieta ("Bracciodieta"), originally intended to be a party to the Stock Purchase Agreement as a Management Investor, ceased to be in the employ of FHP, and, after the execution of the Stock Purchase Agreement but prior to the issuance of the Management Stock thereunder to the Management Investors, R. Judd Jessup ("Jessup"), a party to the Stock Purchase Agreement as a Management Investor, ceased to be in the employ of FHP, and, accordingly, no shares of Management Stock were issued and sold to either Bracciodieta or Jessup pursuant to the Stock Purchase Agreement; and WHEREAS, in light of the execution of the Reorganization Agreement and the termination of the employment of Bracciodieta and Jessup with the Company and FHP, FHP, THSC, the Company and the Management Investors desire to amend the Stock Purchase Agreement in certain respects as set forth below. NOW, THEREFORE, in consideration of the premises and the representations, warranties, covenants and agreements contained herein, the parties hereto agree as follows: 1 1. AMENDMENTS TO STOCK PURCHASE AGREEMENT. (a) ADJUSTMENT OF NUMBERS AND PERCENTAGES. The second sentence of Section 2.1 of the Stock Purchase Agreement is hereby amended to read as follows: "The aggregate number of shares of TMMC Stock issued to the Management Investors shall be 812,500 (the "TMMC Management Stock"), and the TMMC Stock issued to the Management Investors, collectively, initially shall comprise 8.125% of the total outstanding common stock of the Company (the "TMMC Management Stock"); and the aggregate number of shares of THSC Stock issued to the Management Investors shall be 45, and the THSC Stock issued to the Management Investors, collectively, initially shall comprise approximately 8.125% of the total outstanding common stock of THSC (the "THSC Management Stock", with the TMMC Management Stock and the THSC Management Stock collectively referred to herein as the "Management Stock")." (b) EXPIRATION OF CERTAIN OPTIONS. At the Effective Time (as that term is defined in the Reorganization Agreement), the Stock Purchase Agreement shall be amended to add the following as Section 12: "12. EXPIRATION OF CERTAIN OPTIONS. Notwithstanding anything to the contrary contained in this Agreement (including, without limitation, the provisions of Sections 3.2 and 5.4, above): 12.1 TERMINATION OF FHP MANAGEMENT INVESTORS WITHOUT CAUSE. In the event that the employment with FHP of any of the Management Investors who are officers of FHP (the "FHP Management Investors") is terminated without cause, any Restrictions remaining applicable to the Management Stock owned by such FHP Management Investor shall terminate, and all unvested Management Stock owned by such FHP Management Investor shall vest. Such Restrictions shall be deemed to terminate, and such Management Stock shall be deemed to vest, prior to the time FHP's repurchase option provided for in Section 5.1, above, arises; PROVIDED, HOWEVER, that in such event, the Management Stock owned by such FHP Management Investor shall remain subject to the options provided by Sections 5.2 and 5.3, above, until the first to occur of the expiration of such options pursuant to the terms of Section 5, above, or the expiration of such options pursuant to the terms of Section 12.2, below. 12.2 CHANGE IN CONTROL OF THE COMPANY. Both the option granted under Section 5.1 and the Performance Purchase Option granted under Section 5.3 shall expire as to all Management Investors upon a Change in Control (as herein defined) of TMMC which occurs at any time after the date of the expiration of the subscription period during which the Rights are exercisable under the Rights Offering (the "Expiration Date"). For purposes of this Agreement, "Change in Control" means: (a) The acquisition by any individual entity or group (within the meaning of Section 13(d) or 14(d)(2) of the Exchange Act) (a "Person") of 2 beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of over 50% of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); PROVIDED, HOWEVER, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by FHP or PacifiCare, or (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or PacifiCare, or any corporation controlled by the Company or PacifiCare; or (b) Individuals who, as of the Expiration Date, constitute the Board of Directors of the Company (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board of Directors of the Company; provided, however, that any individual becoming a director subsequent to the Expiration Date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board of Directors of the Company." 2. FHP PURCHASE OF STOCK. The parties hereto consent to the purchase by FHP from, and the issuance, sale and transfer to FHP by, (i) the Company of 87,500 shares of TMMC Common Stock, for consideration in the amount of $.01 per share, and (ii) THSC of 5 shares of THSC Common Stock, for consideration in the amount of $2.00 per share. Such purchases by FHP shall occur as soon as practicable after the execution of this Amendment, and pursuant to a resolution of the Board of Directors of each of the Company and THSC adopted as of September 17, 1996. 3. FHP CAPITALIZATION OF THE COMPANY. The parties hereto consent to any capital contributions which have been or will be made to the Company by FHP pursuant to Section 4.15(b) of the Reorganization Agreement. 4. GOVERNING LAW. This Amendment shall be governed by and construed in accordance with the law of the State of Delaware, without reference to its conflicts of law rules. 5. NO OTHER AMENDMENTS. The Stock Purchase Agreement, as amended by this Amendment, is and shall continue to be in full force and effect and is hereby in all respects ratified and confirmed. Except as provided herein, nothing in this Amendment shall waive or be deemed to waive or modify (except as expressly set forth herein) any rights or obligations of any of the parties under the Stock Purchase Agreement. 3 6. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which will be deemed to be an original but all of which together will constitute but one instrument. IN WITNESS WHEREOF, the parties have duly executed this Amendment as of the date first above mentioned. FHP International Corporation, Talbert Health Services Corporation, a Delaware corporation a Delaware corporation By:_______________________________ By:_________________________________ Name:_____________________________ Name:_______________________________ Title:____________________________ Title:______________________________ Talbert Medical Management Corporation, a Delaware corporation By:_______________________________ Name:_____________________________ ____________________________________ Title:____________________________ Kathryn M. Adair __________________________________ ____________________________________ Gloria L. Austin Larry L. Georgopolous __________________________________ ____________________________________ Richard D. Jacobs Jack D. Massimino __________________________________ ____________________________________ Barbara C. McNutt Kenneth S. Ord __________________________________ ____________________________________ Westcott W. Price III Walter R. Stone __________________________________ ____________________________________ Margaret Van Meter Michael J. Weinstock 4 EX-11.1 4 EXHIBIT 11.1 STATEMENT RE: COMPUTATION OF EARNINGS EXHIBIT 11.1 FHP INTERNATIONAL CORPORATION STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE (unaudited) For The (amounts in thousands, Three Months Ended except per share data) September 30, 1996 1995 --------- -------- Primary earnings per share attributable to Common Stock: Net income attributable to Common Stock $ 16,969 $ 7,320 --------- -------- --------- -------- Weighted average number of common shares and common share equivalents: Common Stock 40,936 40,249 Assumed exercise of options 1,123 767 --------- -------- Total shares 42,059 41,016 --------- -------- --------- -------- Primary earnings per share attributable to Common Stock $ 0.40 $ 0.18 --------- -------- --------- -------- Fully diluted earnings per share: Net income attributable to Common Stock assuming conversion of Series A Cumulative Convertible Preferred Stock $ 23,544 $ 13,878 --------- -------- --------- -------- Weighted average number of common shares and common share equivalents: Common Stock 40,936 40,249 Assumed exercise of options 1,396 772 Assumed conversion of Series A Cumulative Convertible Preferred Stock 16,968 16,968 --------- -------- Total shares, assuming full dilution 59,300 57,989 --------- -------- --------- -------- Fully diluted earnings per share $ 0.40 $ 0.24(1) --------- -------- --------- -------- (1) This computation is submitted in accordance with Regulation S-K, Item 601(b)(11) although it is contrary to paragraph 40 of Accounting Principles Board Opinion No. 15 because it produces an anti-dilutive result. 21 EX-27 5 FDS EXH. 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENTS OF INCOME, BALANCE SHEETS AND CASH FLOWS OF FHP INTERNATIONAL CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH SEPTEMBER 30, 1996 QUARTERLY REPORT ON FORM 10-Q. 1,000 3-MOS JUN-30-1997 JUL-01-1996 SEP-30-1996 164,295 215,571 171,426 16,383 8,800 612,016 389,451 158,394 2,044,218 650,782 100,222 422,459 0 525,793 243,449 2,044,218 1,098,699 1,098,699 1,061,705 1,061,705 0 (2,456) 2,493 43,600 20,056 23,544 0 0 0 23,544 0.40 0.40
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