-----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, AhMRlUX827KGQJ/ZexNy+/EnEJ2W0ALabavBi1QKft5UkkOfQG0GUwVv+tBOtSal V1K5XJ1Jir1GKnjyzrZxhA== 0000912057-96-021502.txt : 19961001 0000912057-96-021502.hdr.sgml : 19961001 ACCESSION NUMBER: 0000912057-96-021502 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960930 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-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-14796 FILM NUMBER: 96636818 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-K405 1 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 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 JUNE 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 (Exact name of Registrant as specified in its charter) DELAWARE 33-0072502 (State or other (I.R.S. Employer jurisdiction of Identification No.) incorporation or organization)
3120 LAKE CENTER DRIVE, SANTA ANA, CA 92704 (Address, including zip code, of principal executive offices) (714) 825-6600 (Registrant's telephone number, including area code) ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $.05 PER SHARE SERIES A CUMULATIVE CONVERTIBLE PREFERRED STOCK, PAR VALUE $.05 PER SHARE ------------------------ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant at September 16, 1996 was $1,444,061,201 based upon the closing sale price on such date of $37.375. The Registrant had 41,079,354 shares of common stock, par value $.05 per share, outstanding at September 16, 1996. DOCUMENTS INCORPORATED BY REFERENCE None. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS PART I
ITEM PAGE ----- ----- 1. Business............................................................................................ 1 2. Properties.......................................................................................... 11 3. Legal Proceedings................................................................................... 11 4. Submission of Matters to a Vote of Security Holders................................................. 12 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters............................... 12 6. Selected Financial Data............................................................................. 12 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 13 8. Financial Statements and Supplementary Data......................................................... 13 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................ 13 PART III 10. Directors and Executive Officers of the Registrant.................................................. 14 11. Executive Compensation.............................................................................. 18 12. Security Ownership of Certain Beneficial Owners and Management...................................... 24 13. Certain Relationships and Related Transactions...................................................... 25 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................... 26 Signatures.......................................................................................... 27
PART I ITEM 1. BUSINESS (A) GENERAL DESCRIPTION OF BUSINESS Through its direct and indirect subsidiaries, FHP International Corporation, a Delaware corporation (the "Company"), delivers managed health care services and sells indemnity health, group life and workers' compensation insurance. The Company's oldest subsidiary, FHP, Inc., a California corporation ("FHP"), is a federally qualified multi-state licensed health maintenance organization ("HMO"), which has been operating managed health care programs since 1961. Unless the context otherwise requires, the term "Company" as used in this Form 10-K Annual Report refers to FHP International Corporation and its direct and indirect subsidiaries. The Company's executive offices are located at 3120 Lake Center Drive, Santa Ana, California 92704; telephone (714) 825-6600. The Company's mailing address is P.O. Box 25186, Santa Ana, California 92799-5186. At June 30, 1996, the Company provided a broad range of managed health care services to more than 1,913,000 HMO members, comprised of commercial and governmental employees and Medicare beneficiaries, in 11 states and Guam. These managed health care services include ambulatory and outpatient physician care, hospital care, pharmacy, dental care, eye care, home health nursing, skilled nursing, physical therapy, psychological counseling and health education. The Company also offers group term life and health insurance products through its insurance subsidiaries. At June 30, 1996, the Company provided group term life insurance coverage for approximately 89,000 insureds and group health and accident indemnity insurance coverage for approximately 47,000 insureds. In its 24 Hour Managed Care Program-SM-, the Company offers in a single package workers' compensation coverage, HMO plans and group indemnity medical, dental and life insurance benefit plans through several of its subsidiaries. The Company also offers third party administration and utilization review services and several preferred provider organization ("PPO") networks. RESTRUCTURING PLAN In June 1995, the Company announced that its Board of Directors had approved a restructuring plan (the "Restructuring Plan") of its business operations. The Restructuring Plan which was formulated in response to the intensely competitive environment in the HMO industry and continued declining membership in the Company's staff model operations included the following: (1) the sale or other disposition of the Company's owned or operated hospitals and other in-patient facilities, certain nonproductive real estate and other assets; (2) a reduction in the Company's workforce; and (3) the creation of three distinct business segments. These business segments are: (1) a contract model HMO; (2) a physician practice management corporation, Talbert Medical Management Corporation ("Talbert"); and (3) the Company's group life, health and accident and workers' compensation insurance and related products (collectively, the "Insurance Group"). Costs associated with the Restructuring Plan, including administrative facility closure costs and employee separation costs, resulted in pretax charges against earnings of approximately $75.1 million and $9.7 million in fiscal years 1995 and 1996, respectively. During fiscal year 1996, as part of the Restructuring Plan, the Company completed the sales of its Fountain Valley, California hospital campus, its Salt Lake City, Utah hospital campus and certain nonproductive real estate. Also, during fiscal year 1996, the Company transferred the operations of two sub-acute in-patient facilities to other operators. As of June 30, 1996, limited amounts of real property scheduled for sale remained unsold. Net proceeds from the sales of assets have been used primarily for the reduction of indebtedness and for various other corporate purposes. Between June 1995 and June 1996, the Company reduced its workforce by approximately 3,000 employees. The reductions included approximately 1,300 employees as a result of the sales of the Company's two hospitals and approximately 200 employees at sub-acute facilities transferred to other 1 operators. The balance of the reduction in workforce consisted of administrative employees primarily located in California. At June 30, 1996, the Company had approximately 10,000 full and part-time employees. The Restructuring Plan included the creation of Talbert, as an operational subsidiary of the Company, together with the creation of ten newly-formed professional corporations (the "PCs"). Approximately 4,300 of the Company's employees, including licensed health care professionals, became employees of Talbert or the PCs on January 1, 1996. Talbert leases or subleases all the Company's medical and dental centers and related assets in California, Arizona, Utah, New Mexico and Nevada. The Company's HMOs contracted with the PCs and directly with Talbert in New Mexico to provide health care services to approximately 16% of the Company's HMO members who were already receiving health care in the medical and dental centers. The PCs have entered into long-term practice management agreements with Talbert. The business structure allows the PCs and Talbert to do business with other payors and HMOs, as well as with the Company's HMOs. These third party arrangements are designed to allow Talbert to utilize excess capacity in the medical and dental centers. Talbert is approximately 92% owned by the Company and approximately 8% owned by a group of management investors. RECENT DEVELOPMENTS 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"). On September 20, 1996, the Company and PacifiCare jointly announced that the U.S. Federal Trade Commission had, in accordance with the regulations promulgated under the HSR Act, requested additional documentation regarding the transaction. 2 The Company's primary business activities consist of three business segments: (1) the contract model HMO; (2) physician practice management operations; and (3) group life, health and accident and workers' compensation insurance. Information concerning revenue, operating profit or loss and identifiable assets of the Company's three business segments is set forth in the financial statements and related notes included in Part II of this Form 10-K. (B) CONTRACT MODEL HMO OPERATIONS The Company delivers health care services through independent practice association and group model HMOs in which the Company contracts with individual medical and dental providers, provider networks and multi-specialty medical groups to provide health care in facilities not operated by the Company. The term "IPA" used hereafter in this Form 10-K Annual Report refers to both of these contract HMO models. Each IPA model centers around one or more contract hospitals where IPA physicians maintain practice privileges. The Company's members receive health care through the offices of approximately 50,000 independent contract providers (excluding Talbert and PC providers) and approximately 650 contract hospitals. COMMERCIAL MEMBERS. As used herein, the term commercial members means all HMO members except Senior Plan-SM- members. The Company acquires most of its commercial members by contracting with employers that offer health benefits to their employees. These employers generally offer a selection of indemnity and managed health care plans, pay for all or part of the monthly costs thereof and make payroll deductions for any costs payable by the employee. Supplemental benefits such as dental and eye care are often included as part of employer health benefit plans. During a designated open enrollment period, employees may select their desired health care coverage. Monthly premiums are negotiated between the Company and the employers, and are typically fixed for a one-year period. Commercial members comprised approximately 79% of the Company's total membership at June 30, 1996. SENIOR PLAN MEMBERS. The Company also delivers managed health care services to Medicare beneficiaries under its Senior Plan pursuant to contracts with the Health Care Financing Administration ("HCFA") of the United States Department of Health and Human Services ("DHHS"). These contracts entitle the Company to a fixed fee per member premium, and are subject to adjustment annually based on certain demographic information relating to the Medicare population, and the cost of providing health care in a particular geographic area. Senior Plan membership comprised approximately 21% of the Company's total membership at June 30, 1996, but accounted for approximately 50% of the Company's total revenue for the fiscal year. The Company receives substantially more revenue for each Senior Plan member than it receives for each commercial member. In addition to physician care, hospitalization and other benefits covered by Medicare, Senior Plan benefits also include prescription drugs, routine physical exams, hearing tests, immunizations, eye examinations, counseling and health education services. Senior Plan members are enrolled on an individual basis and may disenroll with 30 days notice. Medicare beneficiaries also can choose to enroll in the Senior Plan Plus-SM- program which offers more comprehensive medical and dental benefits. Seniors who enroll in this plan pay a monthly premium. The Company anticipates further growth opportunities for its Senior Plan, based in part on demographic trends that show that the senior population is growing faster than any other segment of the nation's population. The Company is currently one of the largest providers of health care services to Medicare beneficiaries in the United States. 3 The following table shows an approximate breakdown of the Company's HMO membership at June 30, 1996:
COMMERCIAL(1) SENIOR PLAN TOTAL % -------------- ----------- ---------- --- California............................................. 718,000 213,000 931,000 49 Colorado............................................... 305,000 42,000 347,000 18 Utah................................................... 175,000 11,000 186,000 10 Arizona................................................ 98,000 87,000 185,000 10 Illinois (2)........................................... 58,000 1,000 59,000 3 Nevada................................................. 33,000 22,000 55,000 3 Ohio (3)............................................... 54,000 54,000 3 New Mexico............................................. 25,000 18,000 43,000 2 Guam (4)............................................... 41,000 0 41,000 2 Texas.................................................. 9,000 3,000 12,000 * -------------- ----------- ---------- --- Total................................................ 1,516,000 397,000 1,913,000 100 -------------- ----------- ---------- --- -------------- ----------- ---------- ---
- ------------------------ * Less than 1%. (1) Includes government employees and Medicaid recipients. (2) Includes approximately 6,000 members located in northwest Indiana. (3) Includes approximately 1,000 members located in southeast Indiana and approximately 22,000 members located in northern Kentucky. (4) Includes 32,000 staff model and 9,000 IPA members. (C) TALBERT OPERATIONS As described above, the Company restructured its staff model operations which resulted in the transfer of substantially all of those operations into Talbert and the PCs. Currently, Talbert and the PCs, which are considered contract providers, deliver health care services through an employed staff of primary health care physicians, physician specialists, dentists, nurses and other health care providers. These providers deliver health care to the Company's HMO members in Talbert-operated facilities, which were formerly the Company's staff model medical centers. At June 30, 1996, Talbert and the PCs employed approximately 390 primary care physicians and physician specialists, 80 dentists and 3,200 other health care professionals. Talbert-operated facilities include 54 medical and dental centers ranging in size from approximately 2,000 to 96,000 square feet. At June 30, 1996, the Company's HMOs were the primary payors for the PCs, accounting for substantially all of the PCs' revenues for the fiscal year ended June 30, 1996. The following table shows an approximate breakdown of the Company's HMO membership receiving health care services at Talbert facilities at June 30, 1996:
COMMERCIAL (1) SENIOR PLAN TOTAL % -------------- ----------- ---------- --- California............................................. 83,000 50,000 133,000 44 Utah................................................... 104,000 11,000 115,000 38 New Mexico............................................. 13,000 13,000 26,000 9 Arizona................................................ 7,000 17,000 24,000 8 Nevada................................................. 2,000 2,000 4,000 1 -------------- ----------- ---------- --- Total................................................ 209,000 93,000 302,000 100 -------------- ----------- ---------- --- -------------- ----------- ---------- ---
- ------------------------ (1) Includes government employees and Medicaid recipients. 4 (D) INSURANCE OPERATIONS The Company also offers group health and life insurance products through its insurance subsidiaries. At June 30, 1996, the Company provided group term life insurance coverage for approximately 89,000 insureds and group health and accident indemnity coverage (including its PPO) for approximately 47,000 insureds. The Company also operates a 24 Hour Managed Care Program, which provides HMO and preferred provider organization/indemnity medical coverage and workers' compensation coverage in one coordinated managed care system. Through this program, both occupational and nonoccupational injuries and illnesses are covered by products offered in a single package and administered on a coordinated basis. As of June 30, 1996, the 24 Hour Managed Care Program provided services to approximately 200 employer groups for approximately 22,000 insured employees. (E) GOVERNMENT REGULATION Most of the Company's HMO subsidiaries are qualified under the federal Health Maintenance Organization Act of 1973, as amended (the "HMO Act"). In addition, each of the states in which the Company does business has enacted statutes regulating or affecting the HMO subsidiaries. As a result, the Company is subject to extensive regulation regarding the scope of benefits provided to HMO members and the terms of group benefit agreements, the Company's financial condition, including minimum tangible net equity, quality assurance and utilization review procedures, enrollment requirements, manner of structuring member premiums, member grievance procedures, provider contracts, marketing and advertising. Changes in governmental regulations could adversely affect the operations, profitability and business prospects of the HMO subsidiaries. An example of such regulations is the Knox-Keene Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"), under which the Company's California HMO is licensed. The Knox-Keene Act mandates that the Company's California HMO satisfy California regulatory authorities that it has fiscally sound operations, adequate provision for the risk of insolvency, and working procedures for the prompt payment or denial of claims for payment by health care providers. In addition, the Knox-Keene Act empowers California regulatory authorities to limit the administrative expense of the Company's California HMO to 15% of total revenue. Nearly all of the Company's HMOs outside of California are subject to state regulation similar to the Knox-Keene Act. California law requires all HMOs and health insurers that offer health care benefit plans to "small groups" in California (employers with 5 to 50 employees) to offer such benefit plans to any small group seeking coverage, and to renew the health coverage of any small group that purchases coverage from the HMO or insurer and desires to renew it, regardless of the health status of the individuals in the group. This legislation also limits the amount by which the premium rates charged to a specific small group by an HMO or insurer can vary from the average community rate charged by such HMO or insurer to other small groups in California. The law also places various other requirements on HMOs and insurers participating in the California small group market, including a requirement to file premium rate information with the state and various restrictions on the terms under which health care coverage can be provided to small groups. Certain minimum tangible net equity and other financial viability requirements are imposed on the Company's HMO and insurance subsidiaries by regulatory authorities in each state in which these subsidiaries operate and restrict the Company's ability to transfer cash and short-term investments from such subsidiaries to the Company. While the Company currently believes its regulated subsidiaries are in compliance with these minimum tangible net equity and other financial viability requirements, a change in these requirements or an adverse determination by one or more regulatory authorities could have a material adverse effect on the Company's ability to make timely payments on preferred stock dividend obligations and principal and interest obligations under its Credit Agreement and its 7% Senior Notes due 5 2003. In order to obtain approvals for HMO and insurance company expansions into additional states, the regulated subsidiaries are required to meet certain minimum capital, surplus and deposit requirements which may require the Company to make additional capital contributions to such subsidiaries. The Company's Senior Plan services are provided under contracts with, and are subject to regulation by, HCFA and certain state agencies. HCFA requires that an HMO be federally qualified in order to be eligible for Medicare fixed fee per member contracts. Under the Company's Medicare contracts and HCFA regulations, if the premiums received for Medicare covered health care services provided to Senior Plan members are more than the premiums received for the same health care services provided to non-Senior Plan members, then the Company must provide its Senior Plan members with additional benefits beyond those required by Medicare or reduce any of the premiums, deductibles or co-payments that it may charge. The Company's Senior Plan is not permitted to account for more than one-half of the Company's total HMO members in each of the Company's geographic markets as those markets are defined by HCFA. 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 contracts and regulations. The Company's Medicare contracts are renewed annually unless the Company or HCFA elects to terminate the contracts. HCFA also may unilaterally terminate the Company's Medicare contracts if the Company fails to continue to meet compliance and eligibility standards. While the federal government may implement changes in the Medicare risk-based program, the Company believes that HMOs will continue to be an important factor in the federal government's overall efforts to control medical costs. However, 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 services reimbursed by Medicare and Medicaid are subject to various requirements and restrictions imposed by contract law and regulation. Non-compliance with government regulations could subject the Company to adverse action by the government. To maintain compliance, the Company will take such action, or modify its practices, as it deems necessary. Section 9313(c) of the Omnibus Budget Reconciliation Act of 1986 ("OBRA '86") prohibits HMOs with Medicare risk contracts from knowingly making incentive payments to a physician as an inducement to reduce or limit services to Medicare beneficiaries. Sections 4204(a) and 4731 of OBRA '90 repealed the prohibition on all such physician incentive plans, and enacted requirements for regulating these plans. Under these sections, an HMO must: (1) not operate a physician incentive plan that directly or indirectly makes specific payments to a physician or physician group as an inducement to limit or reduce medically necessary services to a specific individual enrolled with the organization; (2) disclose to HCFA their incentive plan arrangements in such detail as to allow HCFA to determine compliance of the arrangements with the DHHS regulations; and (3) provide certain protections to physicians and enrollees where a physician incentive plan places a physician or physician group at "substantial financial risk" for services not provided directly by them. The Company's Medicare contracts subject it to numerous other federal regulations governing the Medicare program, including the so-called "Medicare and Medicaid anti-kickback statute". The Medicare and Medicaid anti-kickback statute (Section 1128B of the Social Security Act, as amended) provides both civil and criminal penalties for individuals or entities that knowingly and willfully offer, pay, solicit or receive remuneration in return for referrals of business reimbursed under Medicare or Medicaid. Civil penalties include exclusion from participation in the Medicare or Medicaid programs. In 1991, DHHS promulgated a "safe harbor" regulation that defined certain payment practices between providers of Medicare or Medicaid covered services and entities or individuals in a position to refer patients or business to these providers, which would not constitute violations of the statute. On November 5, 1992, DHHS promulgated interim final regulations establishing two new safe harbors and amending one existing safe harbor to provide protection from criminal prosecution and civil sanctions for certain payment practices engaged in by health care plans, including HMOs. This new regulation provides that certain incentives offered to HMO enrollees, such as a reduction or waiver of Medicare coinsurance or deductible amounts 6 paid by the HMO; the waiver of Part A deductible and coinsurance amounts pursuant to an agreement between a hospital and a Medicare insurer; and price reductions or discounts offered to HMOs by contracting health care providers as part of agreements by those providers to furnish Medicare covered services will be deemed not to violate the anti-kickback statute. The Company believes that its payment practices either come within one or more of the safe harbors promulgated in 1991 and 1992, or are not in violation of the anti-kickback statute in any event. The HMO and insurance subsidiaries of the Company must file periodic reports with, and their operations are subject to periodic examination by, federal and state licensing authorities. To remain licensed and accredited, it is necessary for the Company's HMO and insurance subsidiaries to comply with various fiscal standards imposed by regulatory authorities and to make changes from time to time in their services, procedures, structure and marketing methods. Such changes may be required as a result of amendment to, or other significant modification of, federal and state laws and regulations controlling the subsidiaries' operations. Talbert's operations are predominantly in states that do not permit general business corporations to practice medicine, exercise control over physicians who practice medicine or engage in certain practices such as fee-splitting with physicians. Talbert believes that it neither engages in the practice of medicine nor controls the practice of medicine by physicians within the PCs. Talbert believes that it is in compliance with applicable regulatory requirements. No assurance can be given, however, that regulatory authorities, courts or parties with which Talbert does business will not assert that Talbert is engaged in the corporate practice of medicine and seek relief prohibiting Talbert or its affiliates from carrying on their respective business or voiding existing contractual relationships. If such assertions are made, Talbert might be required to restructure its contracts with payors or the PCs. Any such restructuring could have a material adverse effect on Talbert. The Company's insurance subsidiaries are regulated by the department of insurance in each of the states in which they operate. These regulations relate to, among other things, the terms, administration and marketing of the products offered and the financial condition of these subsidiaries, and subject these subsidiaries to periodic audits and continuing oversight. In addition, the offering of certain new insurance products may require the approval of these regulatory agencies. The Company believes that it is in substantial compliance with all governmental regulations affecting its business, the violation of which could have a material adverse effect on its consolidated financial position or results of operations or cash flows. OPM AUDITS 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 for the years 1987 through 1991, discussed below, which have been and may be asserted in relation to the Company's contracts with the United States Office of Personnel Management ("OPM") and for possible OPM claims for subsequent years through 1996. The addition to reserves resulted in a third quarter charge to net earnings of $0.68 per share. The Company's HMO subsidiaries have contracts with 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. As previously disclosed, in May 1993, after conducting an audit of the Company's FEHBP contracts covering primarily the years 1987 through 1991, OPM sent a draft audit report to the Company alleging certain defective rating practices in certain regions. Following its evaluation of the draft audit 7 report, the Company indicated to OPM certain areas where it believed the report to be inaccurate or based on misconceptions. Also, the Company evaluated the availability of offsets and established reserves pending issuance of a final audit report or further correspondence from OPM. A final audit report has not been issued as of the date hereof and the Company received no further correspondence from the Government regarding the draft audit report until the third quarter of fiscal year 1996. 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 that the Company may have violated the False Claims Act in its certifications to OPM that the FEHBP received community rates for health care services provided in certain regions during 1987 through 1991. No action has been commenced by the Government, although the Government asserted in correspondence with the Company dated April 25, 1996 that, at that time, the Government 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 Government has indicated that it does not have any information that would lead it to believe that the Company violated any criminal laws. The Company intends to negotiate with the Government to determine whether it is possible to resolve these matters without litigation. While there is no assurance that negotiations will be concluded satisfactorily or that additional liability incurred, if any, in excess of reserves established in connection with the ultimate outcome of these matters is likely 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 that the allegations will have a material effect on future relations with OPM. In addition, OPM has opened two audits for years as far back as 1990 at two of the Company's other HMO subsidiaries. Based on positions taken by the Government with respect to the 1987-1991 draft audit report, management believes that the two open audits may allege defective rating practices and result in claims for adjustments from OPM and management believes other possible future audits may allege defective rating practices and result in claims for adjustments from OPM. Such claims could be for substantial amounts. Management cannot determine if such claims would result in further referrals to the Department of Justice and further False Claims Act claims. 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 has conducted with OPM over many years. Based on management's understanding of the Government's current interpretation of the community rating standard requirements in the context of the 1987-1991 draft OPM audit report, the Company believes that 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 if any amount in excess of reserves is necessary to settle any such claims, the amounts 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. The preceding three 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 Claim 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 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 False Claim Act claims. 8 (F) HEALTH CARE REFORM There have been diverse legislative and regulatory initiatives at both the federal and state levels to address, among other aspects of the nation's health care system, the continuing increases in health care costs, the lack of health care coverage for a significant segment of the population, and quality and consumer protection in health care. On August 20, 1996, the President signed into law the "Health Insurance Portability and Accountability Act of 1996," which takes effect beginning January 1, 1997. The bill includes provisions for guaranteed issuance and renewability; limits on pre-existing condition exclusions; non-discrimination requirements; and a demonstration project for medical savings accounts. The Company is analyzing the impact of this new law on its operations. Several other bills have been introduced in Congress to reform elements of the nation's health care system, including parity for mental health coverage; minimum maternity lengths of stay; payment for emergency services; and provider contract regulations. In addition, various states are considering restructuring of Medicaid programs, as well as forms of legislation or regulations that could require managed care companies to alter their health benefit packages or provider contracts. All or any of these legislative or regulatory initiatives could adversely affect the Company's operations. The Company is unable to predict how existing federal or state laws and regulations may be changed or interpreted, what additional laws or regulations affecting its businesses may be enacted or proposed, when and which of the proposed laws will be adopted or what effect the new laws and regulations will have on its businesses. However, certain of the proposals, if adopted, could have a material adverse effect on the Company's business, while others, if adopted, could potentially benefit the Company's business. Although the effects of these activities cannot yet be determined, the Company remains committed to participate in the debate over health care reform and in the restructuring of the health care system. (G) COMPETITION The health care and insurance industries are highly competitive. The Company believes that among the most significant competitive factors in the market are the quality and location of the health care providers, the comprehensiveness of coverage and the pricing of services. The Company has a number of competitors, including commercial insurance carriers and other HMOs, some of which have substantially larger memberships and are better capitalized than the Company. In addition to insurance carriers and other HMOs, the Company also competes with fee-for-service physicians, hospitals, and preferred provider organizations which contract directly with employers, thus by-passing HMOs. The Company's largest HMO competitor in California is Kaiser Foundation Health Plan, Inc. ("Kaiser"), which served approximately 4.7 million members in California at January 1, 1996. In addition to Kaiser, there are at least two other HMOs with more members than the Company in California at January 1, 1996. At June 30, 1996, the Company served approximately 931,000 HMO members in California. At June 30, 1996, the Company served approximately 347,000 and 186,000 HMO members in Colorado and Utah, respectively, more members than any other HMO in these States. The Company believes that Kaiser is its largest competitor in Colorado and that IHC Care, Inc. is its largest competitor in Utah. At June 30, 1996, the Company served approximately 185,000, 59,000 and 55,000 HMO members in Arizona, Illinois and Nevada, respectively. The Company believes that its largest competitors in Arizona are Intergroup of Arizona and CIGNA Health Care of Arizona-Phoenix, that its largest competitor in Nevada is Health Plan of Nevada and that its largest competitor in Illinois is Chicago HMO Ltd. At June 30, 1996, the Company served approximately 54,000 and 43,000 HMO members in Ohio and New Mexico, respectively. The Company believes its largest competitor in Ohio is UHC of Ohio, Inc. and that its largest competitor in New Mexico is Lovelace Health Systems, Inc. At June 30, 1996, the Company served approximately 41,000 HMO members in Guam. The Company believes its largest competitor in 9 Guam is Guam Memorial Health Plan. At June 30, 1996, the Company served approximately 12,000 members in Texas. The Company believes that NYLCare Health Plans of the Southwest, Inc. is its largest competitor in Texas. The Company also believes that Blue Cross and Blue Shield carriers serve a substantial portion of the total health care markets in its service areas. All membership data for other HMOs is obtained from "The InterStudy Competitive Edge, 1996 Volume 6.2, Number 1," published by InterStudy Center for Managed Care Research, a research organization. (H) FACTORS FOR FORWARD LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves without fear of litigation so long as those statements are identified as forward looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. Accordingly, the Company hereby identifies the following important factors which could cause the Company's actual results to differ materially from any such results which might be projected, forecasted, estimated or budgeted by the Company in forward-looking statements: (i) Heightened competition, including specifically the intensification of price competition, the entry of new competitors and the formation of new products by new and existing competitors, especially with respect to Medicare products; (ii) Adverse state and federal legislation and regulation, including limitations on premium levels, increases in minimum capital and reserves and other financial viability requirements, prohibition or limitation of capitated arrangements or provider financial incentives, benefit mandates (including mandatory length of stay and emergency room coverage), limitations on the ability to manage care and utilization and any willing provider or pharmacy laws; (iii) Increases in medical costs, including increases in utilization and costs of medical services and the effects of actions by competitors or groups of providers; (iv) Termination of provider contracts or renegotiation thereof at less cost-effective rates or terms of payment; (v) Price increases in pharmaceuticals, durable medical equipment and other covered items; (vi) Adverse actions of governmental payors, including unilateral reduction of Medicare and Medicaid premiums payable to the Company, discontinuance of or limitations on governmentally-funded programs and recovery by governmental payors of previously paid amounts; (vii) Inability to increase premiums or prospective or retroactive reductions to premium rates for federal employees notwithstanding increases in medical costs due to competition, government regulation or other factors; (viii) Loss of HMO members; (ix) Failure to obtain new customers, retain existing customers or reductions in force by existing customers; (x) Governmental financial assessments or taxes to subsidize uncompensated care, other insurance carriers or academic medical institutions; (xi) Adverse publicity and news coverage; (xii) Inability to carry out marketing and sales plans; (xiii) Loss or retirement of key executives or key employees; 10 (xiv) Denial of accreditation by independent quality accrediting agencies; (xv) Adverse results in ongoing OPM audits or in other reviews conducted by federal or state agencies; (xvi) Adverse results in significant litigation matters; (xvii) Adverse regulatory determinations resulting in loss or limitations of licensure, certification or contracts with governmental payors; (xviii) Higher service, administrative or general expenses occasioned by the need for additional advertising, marketing, administrative or management information systems expenditures; (xix) Changes in interest rates causing an increase in interest expense; and (xx) Increases by regulatory authorities of minimum capital, reserve and other financial viability requirements. ITEM 2. PROPERTIES The Company, through Talbert, currently operates (i) 25 medical and dental centers in southern California, of which 8 are owned and 17 are leased; (ii) 7 medical and dental centers in Utah, of which 5 are owned and 2 are leased; (iii) 15 medical centers in Arizona, of which 4 are owned and 11 are leased; (iv) 3 owned and 2 leased medical centers in New Mexico; and (v) 2 medical centers in Nevada, of which 1 is owned and 1 is leased. FHP continues to operate 1 owned and 3 leased medical centers in Guam and a neighboring island. The medical and dental centers range in size from approximately 2,000 to 96,000 square feet. Talbert has either leased or subleased each of the medical and dental centers and related assets located in California, Utah, Arizona, New Mexico and Nevada from the Company's various HMO subsidiaries. As described in Item 1, the Company sold its Fountain Valley, California and Salt Lake City, Utah hospital campuses during fiscal year 1996. The Fountain Valley, California campus included primary and specialty care medical clinics and the Salt Lake City, Utah campus included a specialty care medical clinic, each of which were leased-back from the new owners by Talbert. In addition, the Company transferred the operations of its two sub-acute in-patient facilities to other operators during the second and third quarter of fiscal year 1996. The Company currently manages a hospital which is licensed for 150 beds located in Hawaiian Gardens, California. The management agreement associated with this facility will expire on January 30, 1997. The Company occupies as its principal executive offices approximately 160,000 square feet of office space located in a three-building office complex in Santa Ana, California under a lease which expires on June 30, 2006. The Company also owns a 58,000 square foot administrative office building in Utah and leases administrative offices in more than one dozen states. On June 30, 1996, the Company owned buildings totaling approximately 516,000 square feet in size, all of which were free of outstanding encumbrances. During the fiscal year ended June 30, 1996, the Company leased approximately 2.5 million square feet of buildings subject to annual lease obligations of approximately $28.1 million. In addition, the Company owns nonproductive acreage in California, Arizona, New Mexico and Nevada, which it is in the process of selling. ITEM 3. LEGAL PROCEEDINGS During the ordinary course of business, the Company has become a party to pending and threatened legal actions and proceedings, a significant number of which involve claims of medical malpractice. Management of the Company is of the opinion, taking into account its insurance coverage and reserves that have been established, that the outcome of 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. 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the three months ended June 30, 1996. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (A) MARKET INFORMATION The Company's Common Stock is traded over-the-counter on the National Association of Securities Dealers Automated Quotation ("NASDAQ") National Market System under the symbol "FHPC." The following table sets forth the range of high and low closing bid prices per share for the fiscal periods indicated, as reported on the NASDAQ National Market System. Quotations represent prices between dealers and do not reflect retail markups, mark-downs or commissions and may not necessarily represent actual transactions.
PRICE RANGE OF COMMON STOCK -------------------- HIGH LOW --------- --------- YEAR ENDED JUNE 30, 1996: First Quarter................................................................. 26 5/8 22 1/2 Second Quarter................................................................ 29 23 1/8 Third Quarter................................................................. 33 1/2 27 3/8 Fourth Quarter................................................................ 31 3/4 26 5/8 YEAR ENDED JUNE 30, 1995: First Quarter................................................................. 30 1/2 21 3/4 Second Quarter................................................................ 29 25 1/4 Third Quarter................................................................. 29 1/2 24 1/4 Fourth Quarter................................................................ 29 1/2 19 3/4
As of September 16, 1996, the reported closing bid price per share was $37.375. (B) HOLDERS The approximate number of holders of record of the Company's Common Stock as of August 31, 1996 was 650. This number did not include individual participants in security position listings. Based on available information, the Company believes there are several thousand beneficial holders of its Common Stock. (C) DIVIDENDS The Company has retained its fiscal year 1996 earnings for use in its business and anticipates, for the foreseeable future, that no cash dividends will be paid on its Common Stock. The Company's Amended Credit Agreement restricts the payment of cash dividends on the Company's Common Stock. ITEM 6. SELECTED FINANCIAL DATA Information with respect to this item is located at page 29 herein. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information with respect to this item is located at pages 30 through 36 herein. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following documents are filed as part of this Form 10-K Annual Report:
PAGE ----- Index to Financial Statements............................................................................ 37 Consolidated Balance Sheets, June 30, 1996 and 1995...................................................... 38 Consolidated Statements of Income for the years ended June 30, 1996, 1995 and 1994....................... 39 Consolidated Statements of Stockholders' Equity for the years ended June 30, 1996, 1995 and 1994......... 40 Consolidated Statements of Cash Flows for the years ended June 30, 1996, 1995 and 1994................... 42 Notes to Consolidated Financial Statements............................................................... 43 Independent Auditors' Report............................................................................. 62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in the Company's independent auditors or disagreements with such auditors on accounting principles or practices or financial statement disclosures. 13 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Directors of the Company are as follows:
NAME AGE POSITION - ------------------------------------------ --- --------------------------------------------------------------- Jack R. Anderson.......................... 71 Chairman of the Board Westcott W. Price III..................... 57 Vice Chairman of the Board, President and Chief Executive Officer Richard M. Burdge, Sr..................... 69 Director Burke F. Gumbiner......................... 45 Director, Senior Vice President and President, Insurance Division Warner Heineman........................... 74 Director Van B. Honeycutt.......................... 51 Director Robert W. Jamplis, M.D.................... 76 Director Robert C. Maxson, Ed.D.................... 60 Director Joseph F. Prevratil....................... 58 Director
The executive officers of the Company, who serve at the discretion of the Board of Directors, are as follows:
NAME AGE POSITION - ------------------------------------------ --- --------------------------------------------------------------- Westcott W. Price III..................... 57 President and Chief Executive Officer Gloria L. Austin.......................... 42 Senior Vice President, Talbert-California Valerie A. Fletcher....................... 49 Vice President, Accounting and Controller Robert N. Franklin........................ 53 Senior Vice President, Public Affairs Larry D. Gray............................. 45 Senior Vice President and President FHP, California Region Burke F. Gumbiner......................... 45 Senior Vice President and President, Insurance Division Jeffrey H. Margolis....................... 33 Senior Vice President and Chief Information Officer Jack D. Massimino......................... 47 President and Chief Executive Officer, Talbert Michael A. Montevideo..................... 42 Vice President and Treasurer Kenneth S. Ord............................ 50 Senior Vice President and Chief Financial Officer Eric D. Sipf.............................. 47 Senior Vice President and President, FHP of Colorado, Inc. Michael J. Weinstock...................... 55 Senior Vice President, General Counsel and Secretary
DIRECTORS JACK R. ANDERSON joined the Board of Directors of the Company in June 1994, pursuant to the terms of an Agreement and Plan of Merger (the "TakeCare Merger Agreement") whereby the Company acquired ownership of TakeCare, Inc. ("TakeCare") and agreed to add Mr. Anderson to the Company's Board of Directors and to renominate him at the Annual Meeting of Stockholders in 1996. He was elected Chairman of the Board of Directors of the Company in June, 1995 and is a member of the Executive Committee of the Board. Mr. Anderson is also a member of the Talbert Board of Directors. Mr. Anderson 14 was Chairman of the Board of Directors of TakeCare from 1988 to June of 1994. He has been President of Calver Corporation, a health care consulting and investing firm and a private investor since 1982. Mr. Anderson currently serves on the Boards of Directors of Horizon Mental Health Management, Inc. and United Dental Care, Inc. WESTCOTT W. PRICE III has been Vice Chairman of the Board of Directors of the Company since 1986 and a Director of the Company since 1984. Mr. Price became President of the Company in 1989 and Chief Executive Officer in 1990. Mr. Price is a member of the Executive Committee of the Board. He also serves as President of two of the Company's HMO subsidiaries. Mr. Price joined FHP in 1981 as a Senior Vice President. Mr. Price is also a member of the Talbert Board of Directors. Mr. Price has been a member of the Board of Directors of FHP Foundation since 1985. RICHARD M. BURDGE, SR. joined the Board of Directors of the Company in July 1994 pursuant to the terms of the TakeCare Merger Agreement whereby the Company agreed to add Mr. Burdge to the Company's Board of Directors and to renominate him at the Annual Meeting of Stockholders in 1995. Mr. Burdge currently serves as Chairman of the Compensation Committee and as a member of the Audit Committee of the Board of Directors. Mr. Burdge is also a member of the Talbert Board of Directors. Mr. Burdge retired in 1984 as Executive Vice President of CIGNA Corporation, a position he held from 1982 to 1984. He served as Senior Executive Vice President of INA Corporation from 1980 to 1982 and as Executive Vice President of INA Corporation from 1975 to 1980. He also served as President and Chief Operating Officer of the American Stock Exchange from 1972 to 1975. BURKE F. GUMBINER has been a Director of the Company since 1984. Mr. Gumbiner is also a member of the Quality Assessment Committee of the Board. He was a Vice President of the Company from 1984 to 1989, and in 1989 he became a Senior Vice President. Mr. Gumbiner joined FHP in 1972 and has served in several executive capacities. In August 1995 Mr. Gumbiner was appointed President of the Company's Insurance Group. WARNER HEINEMAN has been a member of the Board of Directors of the Company since 1990 and is the Chairman of the Company's Audit Committee and a member of the Compensation and Quality Assessment Committees. Mr. Heineman is also a member of the Talbert and FHP Financial Corporation Boards of Directors. Mr. Heineman has served as a Senior Advisor to First Business Bank since 1992. From 1989 to 1992, he served as Senior Vice President of Bank of Los Angeles. He also served as a Senior Vice President of City National Bank from 1981 to 1988. In 1981 he retired as Vice Chairman and Director of Union Bank after 38 years of service with that organization. Mr. Heineman is a trustee of Southwestern University School of Law, a member of the Board of Advisors of UCLA Medical Center, member of the Board of Visitors, UCLA School of Medicine, a member of the Board of Directors of FHP Foundation and a director of Alexander Haagen Properties, Inc. and Countrybaskets Index Fund, Inc. VAN B. HONEYCUTT joined the Board of Directors in November 1995, when the Board was expanded from 8 to 9 members. Mr. Honeycutt also serves as a member of the Audit Committee of the Board. Mr. Honeycutt is also a member of the Talbert Board of Directors. Mr. Honeycutt has been President and Chief Executive Officer of Computer Sciences Corporation since April 1995. Computer Sciences Corporation is a publicly-traded company listed on the New York Stock Exchange which provides information technology consulting, systems integration and outsourcing services to industry and government. From 1993 to 1995, Mr. Honeycutt served as President and Chief Operating Officer of Computer Sciences Corporation. From 1987 to 1993, he served as Corporate Vice President and President of Computer Sciences Corporation's Industry Services Group. ROBERT W. JAMPLIS, M.D. joined the Board of Directors in August 1995, when he filled a vacancy on the Board caused by the resignation of another director. He serves as Chairman of the Quality Assessment Committee of the Board. Dr. Jamplis is also a member of the Talbert Board of Directors. He served on the Boards of Directors of TakeCare and two of its HMO subsidiaries prior to the Company's acquisition of 15 TakeCare in 1994. Dr. Jamplis has been President and Chief Executive Officer of Palo Alto Medical Foundation since 1981, was named Executive Director of the Palo Alto Clinic in 1966, and joined the Clinic in 1954. Dr. Jamplis has written extensively and held leadership positions with numerous medical, academic and business organizations. He presently serves on the Boards of Directors of Children's Hospital at Stanford, Santa Barbara Medical Foundation Clinic, and the American Cancer Society-- California Division. ROBERT C. MAXSON, ED.D. joined the Board of Directors in August 1995, when he filled a vacancy on the Board caused by the resignation of another director. He currently serves on the Compensation Committee of the Board. Dr. Maxson is also a member of the Talbert Board of Directors. Dr. Maxson also serves on the Board of Directors of FHP Foundation. Dr. Maxson has been President of California State University, Long Beach, since 1994. Dr. Maxson served as the President of the University of Nevada, Las Vegas, from 1984 to 1994. He has also served on other corporate boards such as Bank of America Nevada and Houston Security Bank. JOSEPH F. PREVRATIL has been a member of the Board of Directors of the Company since 1991 and is Chairman of the Company's Executive Committee and a member of its Audit and Compensation Committees. Mr. Prevratil is also a member of the Talbert Board of Directors. Mr. Prevratil also serves as a Director and Chief Executive Officer of FHP Foundation. From 1982 to 1988, Mr. Prevratil served as President of Wrather Port Properties, Inc., an entertainment and hotel complex that included the Queen Mary oceanliner in Long Beach, California. In 1988 and 1989 he served as Executive Director of the Port of Long Beach. From 1989 to 1993, Mr. Prevratil was President of his own business, providing contracted consulting and management services to the leisure-time industry and the Redevelopment Agency of the City of Long Beach. In 1993, Mr. Prevratil became President of the RMS Foundation, Inc., a nonprofit corporation operating the Queen Mary oceanliner attraction. The Company's Directors are divided into three classes and serve terms of three years, with one class being elected by the stockholders each year. The terms of Directors expire as follows: Messrs. Anderson, Gumbiner and Heineman in 1996; Messrs. Honeycutt, Price and Prevratil in 1997; and Messrs. Burdge, Jamplis and Maxson in 1998. EXECUTIVE OFFICERS WESTCOTT W. PRICE III has been Vice Chairman of the Board of Directors of the Company since 1986, and has been a Director of the Company since 1984. Mr. Price was a Vice President of the Company from 1987 to 1989 and was elected President in 1989. Mr. Price joined FHP in 1981, first serving as Senior Vice President and later as Executive Vice President, and was elected President in 1987. Mr. Price became Chief Executive Officer of the Company in 1990. GLORIA L. AUSTIN joined FHP in 1978 and served in several executive capacities in FHP's Utah and California regional operations, including Associate Vice President, Utah Region Administration and Regional Vice President, Los Angeles. In February 1995, Ms. Austin became the Company's Senior Vice President, Health Care Delivery. In July 1995, Ms. Austin was appointed Senior Vice President, California of the Company's former staff model operations. Ms. Austin currently serves as Senior Vice President, Talbert-California. VALERIE A. FLETCHER joined FHP in 1989 as Associate Vice President, Finance. In 1992, Mrs. Fletcher was appointed Corporate Vice President, Accounting of FHP and in 1993 was elected Controller of the Company. In 1994, Mrs. Fletcher became Vice President, Accounting of the Company. ROBERT N. FRANKLIN joined FHP in 1990 and served as Vice President, Government Affairs before being appointed Senior Vice President, Public Affairs in 1993. In 1994, Mr. Franklin became Senior Vice President, Public Affairs of the Company. 16 LARRY D. GRAY joined the Company in 1996 as a Senior Vice President and President of FHP's California region. Mr. Gray is also a director of FHP. From 1993 to 1996, Mr. Gray was President and Chief Executive Officer of Health Visions Corporation. From 1987 to 1993, Mr. Gray was President and Chief Executive Officer of CareAmerica Health Plans, Inc. BURKE F. GUMBINER has been a Director of the Company since 1984 and was a Vice President from 1986 to 1989, when he was appointed Senior Vice President. He joined FHP in 1972 and served in several executive capacities before being appointed a Senior Vice President in 1986. In 1994, Burke Gumbiner was appointed Senior Vice President and Chief Operating Officer, Insurance and Support Services of the Company. In August 1995, Mr. Gumbiner was appointed President of the Company's Insurance Group. JEFFREY H. MARGOLIS joined the Company in 1994 as Vice President, Information Services and Chief Information Officer. From 1993 to 1994, Mr. Margolis was Vice President and Chief Information Officer of TakeCare. From 1989 to 1991, Mr. Margolis was Director of Information Services of Comprecare, Inc. and from 1991 to 1993 he was Vice President and Chief Information Officer of Comprecare, Inc. In June 1995, Mr. Margolis was appointed a Senior Vice President of the Company. JACK D. MASSIMINO first joined FHP in 1975 and served in several executive capacities, including Utah Regional General Manager, before leaving FHP in 1979 to join a health care consulting firm. He later served as President, CEO and a Director of Texas Health Plans from 1987 to 1988. In 1988, he returned to FHP as Vice President of Corporate Development and in 1990 was appointed a Senior Vice President of FHP. From 1994 to 1995 he served as the Company's Executive Vice President and Chief Operating Officer. In July 1995, Mr. Massimino was appointed President of the Company's former staff model operations. Mr. Massimino currently serves as a Director, President and Chief Executive Officer of Talbert. MICHAEL A. MONTEVIDEO joined FHP in 1985, became Treasurer of the Company and FHP in 1989 and was appointed an Associate Vice President of FHP in 1990 and a Vice President of FHP in 1993. In 1994, Mr. Montevideo became a Vice President of the Company. KENNETH S. ORD joined the Company in 1994 as Senior Vice President and Chief Financial Officer. From 1982 to 1994, he was employed by Kelly Services, Inc. in Troy, Michigan most recently as Vice President of Finance, Controller and Treasurer. ERIC D. SIPF joined the Company in 1994 as Senior Vice President of Health Plans of the Company's Eastern Division. Mr. Sipf currently serves as a Senior Vice President of the Company and as President of FHP of Colorado, Inc. From 1985 to 1993, he was President and Chief Executive Officer of Comprecare, Inc. and from 1993 to 1994 was President of Comprecare Health Care Services, Inc. and TakeCare of Colorado, Inc. MICHAEL J. WEINSTOCK has been General Counsel and Secretary of the Company and FHP since 1987. He became a Vice President of the Company and FHP in 1989 and a Senior Vice President of the Company and FHP in 1993. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 and the rules thereunder require the Company's officers and directors and persons who own more than 10% of the Company's Common Stock to file reports of ownership and changes in ownership with the Securities and Exchange Commission and to furnish the Company with copies. Based upon its review of the copies of such forms received by it, or written representation from certain reporting persons, the Company believes that, during the last fiscal year, all filing requirements applicable to its officers, directors, and greater than 10% beneficial owners were complied with on a timely basis. 17 ITEM 11. EXECUTIVE COMPENSATION The following table provides information concerning the annual and long-term compensation for services in all capacities to the Company and its subsidiaries for the fiscal years shown of those persons ("Named Executive Officers") who were, during the latest fiscal year (i) the chief executive officer and (ii) the other four most highly compensated executive officers of the Company. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ------------------------------------------ ANNUAL COMPENSATION OPTION ------------------------------- RESTRICTED AWARDS ALL OTHER FISCAL SALARY(1) BONUS(2) OTHER(3) STOCK (NUMBER OF COMPENSATION(4) NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) AWARDS SHARES) ($) - ---------------------------------------- ------ --------- -------- -------- ---------- ------------ --------------- WESTCOTT W. PRICE III 1996 499,990 355,020 -- --(5) 25,000 15,093 Vice Chairman of the Board; President 1995 499,990 -0- -- -0- 275,000 9,582 and CEO 1994 428,922 95,514 -- -0- 50,000 28,301 JACK D. MASSIMINO 1996 361,924 591,700 -- --(5) 25,000 13,683 President and Chief Executive Officer, 1995 450,008 -0- -- -0- 25,000 10,492 Talbert Medical Management Corporation 1994 345,483 151,226 -0- 225,000 29,277 GLORIA L. AUSTIN 1996 209,996 645,280(6) -- --(5) 10,000 12,331 Senior Vice President, California, 1995 184,966 20,000 -- -0- 10,000 9,143 Talbert Medical Management Corporation 1994 151,548 35,266 -- -0- 10,000 23,239 MICHAEL J. WEINSTOCK 1996 249,995 207,020 -- --(5) 10,000 14,282 Senior Vice President, General Counsel 1995 249,995 -0- -- -0- 10,000 10,030 and Secretary 1994 227,288 103,897 -- -0- 60,000 28,301 JEFFREY H. MARGOLIS 1996 244,627 146,874 -- -0- -0- 12,176 Senior Vice President and Chief 1995 227,307 -0- -- -0- -0- 6,878(9) Information Officer 1994 4,821(7) --(8) -- -0- 25,000 --
- ------------------------------ (1) Includes the base salary earned by the Named Executive Officer during the fiscal year covered and any voluntary salary reduction resulting from contributions for the fiscal year by the Named Executive Officer to (a) the Company's Employee Stock Ownership Plan under Internal Revenue Code Section 401(k), and (b) the Company's Deferred Compensation Plan. (2) Includes the cash value of bonus earned by the Named Executive Officer during the fiscal year covered and the cash value of voluntary bonus reductions resulting in contributions to (a) the Company's Employee Stock Ownership Plan under Internal Revenue Code Section 401(k) and (b) the Company's Deferred Compensation Plan. (3) Excludes perquisites and other personal benefits if the value did not exceed the lesser of $50,000 or 10% of both salary and bonus. (4) Includes the dollar value of taxable income from group term life insurance coverage in excess of $50,000 purchased by the Company as follows: Westcott W. Price III--$1,632; Jack D. Massimino--$1,650; Gloria L. Austin--$331, Michael J. Weinstock--$2,244; and Jeffrey H. Margolis--$176. Amount also includes interest credited on deferred compensation in excess of 120% of the applicable federal long-term rate as follows: Westcott W. Price III--$1,461; Jack D. Massimino--$33; and Michael J. Weinstock--$38. Also includes Company contributions under the FHP Money Purchase Pension Plan as follows: Westcott W. Price III--$9,000; Jack D. Massimino--$9,000; Gloria L. Austin--$9,000; Michael J. Weinstock--$9,000; and Jeffrey H. Margolis--$9,000. Also includes Company contributions under the Company's Employee Stock Ownership Plan as follows: Westcott W. Price III--$3,000; Jack D. Massimino--$3,000; Gloria L. Austin--$3,000; Michael J. Weinstock--$3,000; and Jeffrey H. Margolis--$3,000. The foregoing retirement plan contributions are through December 31, 1995. Contributions are made annually on December 31st; therefore, no contributions were made for the six-month period ended June 30, 1996. Jeffrey H. Margolis became a participant in the retirement plans on January 1, 1995. (5) Pursuant to a Stock Purchase Agreement dated as of March 15, 1996, as amended (the "Stock Purchase Agreement"), by and between the Company, Talbert, Talbert Health Services Corporation ("THSC") and certain management investors, Westcott W. Price III, Jack D. Massimino, Gloria L. Austin and Michael J. Weinstock purchased 67,500, 500,000, 50,000 and 10,000 shares, respectively, of Talbert Common Stock for $0.01 per share, the same per share price at which the Company purchased its 9,100,000 shares of Talbert Common Stock. In addition, pursuant to the Stock Purchase Agreement, Westcott W. Price III, Jack D. Massimino, Gloria L. Austin and Michael J. Weinstock purchased four, 27, three and one shares, respectively, of THSC Common Stock for $2.00 per share, the same per share price at which the Company purchased its 500 shares of THSC Common Stock. On July 1, 1996, 1997, 1998 and 1999, 25% of the stock issued to each Named Executive Officer vests. The shares of Talbert and THSC Common Stock are also subject to numerous other restrictions which lapse on specified dates. The Company, however, has a performance purchase option to purchase 80% of the shares of stock that vests on July 1, 1996, 1997 and 1998 for the original purchase prices of $0.01 and $2.00, respectively, if it is determined by the Company's Audit Committee that Talbert 18 did not meet its planned financial goals for the previous fiscal year. The Company's Audit Committee has determined that Talbert met its planned financial goals for the fiscal year ended June 30, 1996. The Stock Purchase Agreement provides that the Company has an option to repurchase from the Named Executive Officers for the original purchase prices of $0.01 and $2.00, respectively, any portion of their Common Stock which remains unvested when and if these Named Executive Officers cease to be an employee of the Company, an affiliate of the Company or Talbert. The Company also has an unrestricted option to purchase from the Named Executive Officers at any time prior to October 1, 1999 any portion of their Common Stock (whether or not vested or otherwise restricted) for $30 per share. The Company proposes to amend the Stock Purchase Agreement to provide that upon the termination of the employment of Westcott W. Price III or Michael J. Weinstock with the Company, all of such Named Executive Officer's Common Stock will vest; however, such common stock would remain subject to both the Company's performance purchase option and the Company's $30-per-share purchase option. The amendment also would provide that upon a change in control (as defined) of Talbert which occurs after the consummation of the transactions contemplated by the Merger Agreement, the options of the Company to purchase the Common Stock at $.01 and $2.00, respectively, per share will expire. The restricted shares of stock are held in escrow by the Assistant Secretary of the Company in the capacity of escrow agent under the Stock Purchase Agreement. The Named Executive Officers have all rights of a shareholder with respect to the stock including the right to vote, to receive dividends and to participate in stock splits or other recapitalizations, and to exchange such shares in a merger, consolidation or other reorganization. The number of shares and repurchase prices are subject to adjustment for a 1-for-3.33 reverse stock split declared by the Talbert Board of Directors on September 17, 1996. (6) Includes total bonus amount awarded and accrued during fiscal year 1996 but subject to payment in the two following fiscal years. (7) Following the acquisition of TakeCare, Inc., Mr. Margolis became an employee of the Company and served as such during the last 13 days during the fiscal year ended June 30, 1994. On an annualized basis, his salary would have been approximately $139,400. (8) Mr. Margolis received a bonus of $90,278 under the TakeCare Incentive Program for the period of January 1, 1994 through June 17, 1994. (9) Includes $6,833 paid to Mr. Margolis in lieu of certain welfare benefits which he was otherwise entitled to as an employee of TakeCare. OPTION GRANTS IN LAST FISCAL YEAR The following table provides details regarding stock options of the Company granted under the Company's Executive Incentive Plan to the Named Executive Officers during the fiscal year ended June 30, 1996. In addition, in accordance with Commission rules, there are shown the hypothetical gains or "option spreads" that would exist for the respective options if they were exercised. These gains are based on assumed rates of compound stock price appreciation of 5% and 10% from the date the options were granted over the full option term. In assessing these values it should be kept in mind that no matter what theoretical value is placed on a stock option, its ultimate value will depend on the market value of the Company's stock at a future date. The Company's Executive Incentive Plan does not provide for the grant of stock appreciation rights.
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE NUMBER OF APPRECIATION FOR SHARES % OF TOTAL OPTION TERM(2) UNDERLYING OPTIONS GRANTED EXERCISE ------------------------ OPTIONS TO EMPLOYEES IN PRICE PER EXPIRATION 5% 10% NAME GRANTED(1) FISCAL YEAR SHARE(1) DATE $(37.6682) $(59.9803) - ------------------------------------------ ----------- --------------- ----------- ----------- ----------- ----------- Westcott W. Price III..................... 25,000(3) 6.3% $ 23.125 07/03/05 $ 363,580 $ 921,383 Jack D. Massimino......................... 25,000(3) 6.3% $ 23.125 07/03/05 $ 363,580 $ 921,383 Gloria L. Austin.......................... 10,000(3) 2.5% $ 23.125 07/03/05 $ 145,432 $ 368,553 Michael J. Weinstock...................... 10,000(3) 2.5% $ 23.125 07/03/05 $ 145,432 $ 368,553 Jeffrey H. Margolis....................... -0- 0.0% N/A N/A N/A N/A
- ------------------------------ (1) All options were granted at an exercise price equal to the fair market value of the Company's Common Stock on the option grant date. In accordance with the terms of the Company's Executive Incentive Plan, options become fully exercisable on the occurrence of a change of control unless such acceleration is nullified by the Company's Board of Directors within 10 business days after the Board of Directors becomes aware of a change in control. In connection with the acquisition of the Company by PacifiCare, the Board of Directors made the determination to nullify the provisions in the Executive Incentive Plan providing for 19 automatic acceleration and has reinstated the existing vesting and forfeiture provisions subject to the terms and conditions of the Merger Agreement. (2) These amounts represent certain assumed rates of appreciation only. Actual gains, if any, on stock option exercises and Common Stock holdings are dependent on the future performance of the Common Stock and overall stock market conditions. There can be no assurance that the amounts reflected in this table will be achieved. (3) Exercisable July 3, 2002, but subject to accelerated incremental vesting as to 10%, 15%, 20%, 25%, and 30% of the total number of option shares granted, respectively, each year subsequent to the date of the grant (i) if the consolidated earnings per share ("EPS") of the Company for the fiscal year ending on the June 30 immediately preceding such accelerated vesting date exceed both EPS for the preceding fiscal year, and the average EPS for the two preceding fiscal years and (ii) if the Optionee shall have been in the continuous employ of the Company or any subsidiary from the date of grant of this option through such accelerated vesting date. If accelerated vesting does not occur, the percentage will be carried forward and added to the percentage which becomes eligible for accelerated vesting with respect to the next anniversary date. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table provides information concerning the exercise of options during the last fiscal year and unexercised options held as of the end of the last fiscal year by the Named Executive Officers.
VALUE OF UNEXERCISED SHARES NUMBER OF UNEXERCISED IN-THE-MONEY OPTION ACQUIRED ON VALUE OPTION SHARES AT FY-END(#) SHARES AT FY-END($) EXERCISE REALIZED ---------------------------- -------------------------- NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ----------------------------------- ------------- ----------- ------------- ------------- ----------- ------------- Westcott W. Price III.............. -0- -0- 30,000 420,000 255,625 1,894,375 Jack D. Massimino.................. -0- -0- 76,250 270,000 208,359 1,236,563 Gloria L. Austin................... 5,250 30,844 9,000 47,750 65,547 272,703 Michael J. Weinstock............... 10,000 137,500 19,000 96,000 39,375 480,000 Jeffrey H. Margolis................ 24,813 724,506 7,500 52,125 40,781 1,005,145
CHANGE IN CONTROL EMPLOYMENT AGREEMENTS The Company has entered into individual employment agreements (the "Employment Agreements") with certain key executive officers, including the Named Executive Officers, providing for benefits in the event of a "Change of Control" of the Company. The Employment Agreements provide that upon the date (the "Effective Date", as defined in the Employment Agreements) upon which a Change of Control occurs, the Company will continue to employ the Named Executive Officers for the period commencing on the Effective Date and ending on the third anniversary of the Effective Date (the "Employment Period"). During the Employment Period, the Named Executive Officer's position, authority, duties and responsibilities shall be at least commensurate in all respects with the most significant of those held, exercised and assigned during any time during the 120-day period immediately preceding the Effective Date. During the Employment Period, the Named Executive Officers shall receive an annual base salary ("Annual Base Salary"), subject to periodic review, at least equal to twelve times the highest monthly base salary paid or payable, including any base salary which has been earned but deferred, to the Named Executive Officers by the Company and its affiliated companies in respect of the twelve-month period immediately preceding the month in which the Effective Date occurs. In addition, the Named Executive Officers shall be entitled to participate in all benefit programs applicable to other peer executives of the Company and its affiliated companies. The Employment Agreements contain provisions for termination of the Named Executive Officer's employment under various circumstances including death, disability, cause or good reason. If, during the Employment Period, the Company shall terminate the Named Executive Officer's Employment other than for cause, death or disability or the Named Executive Officer shall terminate employment for good reason, the Company shall be required to pay to the Named Executive Officer the following payments and benefits: (i) bi-weekly salary continuation at the Named Executive Officer's Annual Base Salary as if the Named Executive Officer had remained employed through the end of the Employment Period; (ii) medical and dental coverage continuation through the end of the Employment Period at the Named Executive 20 Officer's benefit level as of the date of termination; (iii) life insurance coverage continuation through the end of the Employment Period at the Named Executive Officer's current benefit level as of the date of termination; (iv) out-placement services; (v) a payment and other benefits determined by reference to the Named Executive Officer's participation in the Company's ESOP and the FHP Money Purchase Pension Plan and in the manner provided in the Employment Agreements; (vi) payment of all accrued vacation, holiday and personal leave days as of the date of termination; and (vii) payment of any unpaid incentive compensation, all as determined in the manner set forth in the Employment Agreements. The Employment Agreements also contain provisions with respect to the acceleration of options. Upon a termination of employment other than voluntarily or for cause, death or disability, after a Change of Control and prior to the end of the Employment Period, all outstanding options held by the Named Executive Officer vest, except to the extent such vesting would result in an "excess parachute payment" nondeductible by the Company or would prevent accounting for the Change of Control as a "pooling-of-interests." Options that do not vest by reason of an exception become exercisable in accordance with their original vesting schedule and remain exercisable until 90 days thereafter (or, if earlier, until the original expiration date), provided that the Named Executive Officer satisfies all three of the following requirements: (i) the Named Executive Officer must execute and deliver to the Company a settlement and release agreement waiving all claims against the Company and its affiliates (other than obligations under the employment agreements and vested employee benefits) within 30 days after the Named Executive Officer's date of termination; (ii) at or before the Effective Date, the Named Executive Officer must have executed and delivered to the Company a covenant not to compete for the period through the end of the Employment Period, imposing certain restrictions upon the Named Executive Officers conducting the same business in the same cities and counties as carried on by the Company in California at the Effective Date (the nature of the restrictions varies depending on the position of the Named Executive Officers); and (iii) requiring the Named Executive Officers to serve without compensation as a director, after the Effective Date, of any corporation controlling, under common control with or controlled by the Company, if requested to do so and for so long as such corporation may require (but not beyond the end of the Employment Period). The acquisition of the Company by PacifiCare will constitute a Change of Control under the Employment Agreements. NON-EMPLOYEE DIRECTOR COMPENSATION DIRECTORS' FEES In June 1995, the Board restructured the fees paid to its non-employee Directors so as to reduce the initial amount paid to new non-employee Directors, to encourage long-term participation by non-employee Directors and to encourage consistent participation by committee members. As of June 15, 1996, the initial fee paid to non-employee Directors first elected to the Board after June 15, 1996, was reduced to $5,000 per quarter (from $10,000 per quarter) and such fee will be increased at the end of each year of service as a non-employee Director by the sum of $1,250 per quarter up to a maximum per quarter compensation rate of $10,000. The restructured fee schedule was made applicable to Jack R. Anderson and Richard M. Burdge, Sr. based upon the date of commencement of their service as non-employee Directors in 1994. In addition, each non-employee Director who serves as a member of a committee of the Board (other than the Chairmen of the Executive, Audit, Compensation and Quality Assessment Committees) is to receive a fee of $1,000 each for each committee meeting attended. The Chairman of the Executive Committee is paid an annual sum of $50,000 for service in such capacity, the Chairman of the Audit Committee is paid an annual sum of $25,000 for service in such capacity, the Chairman of the Compensation Committee is paid an annual sum of $10,000 for service in such capacity, and the Chairman of the Quality Assessment is paid an annual sum of $10,000 for service in such capacity. Warner Heineman also received $10,000 for serving on the Board of Directors of one of the Company's subsidiaries. Employee Directors receive no fees for service as Board or Committee members. 21 DEFERRED COMPENSATION The Company adopted a Deferred Compensation Plan for non-employee Directors which was terminated as of December 31, 1995. From July 1 through December 31, 1995, an amount equal to 8% of the non-employee Directors' annual director fees was credited to their benefit on the Company's books. Such funds were credited with earnings at the same interest rate that the Company earns on its cash and cash equivalent investments. Effective January 1, 1996, the non-employee Directors' account balances were transferred into the Company's Deferred Compensation Plan. The non-employee Directors may voluntarily elect to defer all or a portion of their fees into the Company's Deferred Compensation Plan. Set forth below are (1) the fees earned during the fiscal year ended June 30, 1996 by the non-employee Directors of the Company for service as directors of the Company and certain of its subsidiaries during the fiscal year ended June 30, 1996 and (2) the deferral amounts (including earnings) which were accrued on the Company's books for non-employee Directors during the six months ended December 31, 1995:
FEES DEFERRAL AMOUNTS --------- ----------------- Jack R. Anderson................................................. $ 25,000 $ 1,170 Richard M. Burdge, Sr............................................ 38,000 1,696 Warner Heineman.................................................. 83,000 3,642 Van B. Honeycutt................................................. 12,000 -0- Robert W. Jamplis................................................ 22,500 680 Robert C. Maxson................................................. 18,000 400 Joseph F. Prevratil.............................................. 95,000 4,584
STOCK OPTIONS The Company's Executive Incentive Plan provides for the automatic award of nonqualified stock options to non-employee Directors according to the formula set forth below. Each person who first becomes a non-employee Director of the Company is awarded a nonqualified option to purchase 10,000 shares of the Company's Common Stock at an option exercise price equal to the market value of the Common Stock on the date that person becomes a non-employee director. This option becomes exercisable in full only after the optionee has completed two years of continuous service as a non-employee Director. Based on the foregoing formula, nonqualified options were granted each to Robert W. Jamplis and Robert C. Maxson on August 7, 1995 to purchase 10,000 shares of the Company's Common Stock at an option exercise price of $23.8125 per share. Similarly, based on the foregoing formula, an option was granted to Van B. Honeycutt on November 16, 1995, to purchase 10,000 shares of the Company's Common Stock at an option exercise price of $25.00 per share. The Executive Incentive Plan further provides that a person who has continuously served as a non-employee Director of the Company for two years and has not received an option award during that period, is awarded a nonqualified option to purchase 10,000 additional shares of the Company's Common Stock. This option becomes exercisable at the rate of 20% of the shares covered thereby for each year thereafter that the optionee completes as a non-employee Director. Based on the foregoing formula, a nonqualified option was granted to Jack R. Anderson on June 17, 1996, to purchase 10,000 shares of the Company's Common Stock at an option exercise price of $27.40625 per share. The Executive Incentive Plan also provides that a person who continuously serves as a non-employee Director of the Company for a period of two years after receiving the option award described in the preceding paragraph, receives an option to purchase 2,000 additional shares of Company's Common Stock annually for each year that the non-employee director continues to serve in that capacity. Each of these options becomes exercisable at the rate of 20% of the shares covered thereby for each year thereafter that the optionee completes as a non-employee Director. Based on the foregoing formula, a nonqualified 22 option was granted to Warner Heineman on October 2, 1995, to purchase 2,000 shares of the Company's Common Stock at an option exercise price of $24.25 per share. In addition, the Executive Incentive Plan provides that each non-employee Director who serves as Chairman of the Executive Committee will be awarded an option to purchase 50,000 shares, each non-employee Director who serves as Chairman of the Audit Committee will be awarded an option to purchase 25,000 shares, each non-employee Director who serves as Chairman of the Compensation Committee and each non-employee Director who serves as Chairman of the Quality Assessment Committee will receive options to purchase 10,000 shares. In each case, the award is granted on the date the non-employee Director is first elected to a committee chairmanship. The exercise price of such options is equal to the market value per share on the date of award. The options are exercisable 25% as of the date of grant and 25% on the first three anniversaries thereof on which such Chairman has continuously served as a non-employee Director of the Company. Based on the foregoing formula, a nonqualified option was granted to Robert W. Jamplis upon his election as Chairman of the Quality Assessment Committee on September 7, 1995, to purchase 10,000 shares of the Company's Common Stock at an option exercise price of $23.00 per share. CONSULTING FEES No consulting fees were paid to any Director during the year ended June 30, 1996. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Richard M. Burdge, Sr. (Chairman), Warner Heineman and Joseph F. Prevratil served as members of the Company's Compensation Committee during the entire fiscal year ended June 30, 1996. Robert C. Maxson was appointed as an additional member of the Compensation Committee in September 1995. Each of the members of the Compensation Committee are non-employee Directors of the Company. Mr. Prevratil is the President of the RMS Foundation, Inc. (the "Foundation") which manages the day-to-day operations of the Queen Mary oceanliner tourist attraction located in Long Beach harbor in California. During the fiscal year ended June 30, 1994, and a portion of fiscal year ended June 30, 1995, the Company's HMO and insurance subsidiaries provided health care coverage to the Foundation's employees. During the fiscal year ended June 30, 1996, the Foundation's largest outstanding account balance was $105,109. However, as of October 6, 1995, the Foundation had paid the account balance, including interest at the rate of 8.5% per annum, in full. Since 1990, Mr. Prevratil has been the President of J&P Riverside Hotel Corp., the general partner in Riverside Hotel Partners, Ltd., which owned and operated the Sheraton Riverside Hotel. In February, 1996, Riverside Hotel Partners, Ltd., a limited partnership, filed a petition under Chapter 11 of the Federal bankruptcy laws. No executive officer of the Company during the last fiscal year served as a member of a compensation committee or director of another for-profit entity in a situation in which an executive officer of such other entity served as a member of the Compensation Committee or Director of the Company. 23 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table and footnotes set forth certain information regarding beneficial ownership of the Company's Common Stock and Series A Preferred Stock: (i) by each person known by the Company to own beneficially more than 5% of the Company's Common Stock; (ii) by each of the current directors and Named Executive Officers (as defined in Item 402(a)(3) of Regulation S-K) of the Company; and (iii) by all of the Company's directors and officers as a group. Unless otherwise noted, the information is as of August 31, 1996:
AMOUNT AND NATURE OF BENEFICIAL PERCENT OF NAME OF BENEFICIAL OWNER(1) CLASS OF STOCK OWNERSHIP(2) CLASS - --------------------------------------------- --------------------- ------------------- ----------- Heine Securities Corporation................. Common 5,694,266(3) 14.0% 51 John F. Kennedy Parkway Short Hills, NJ 07078 Neuberger & Berman L.P....................... Common 4,001,346(3) 9.8% 605 Third Avenue New York, NY 10158 FHP International Corporation Employee Stock Ownership Plan................ Common 3,256,710 7.9% 3120 W. Lake Center Drive Santa Ana, CA 92704 The Capital Group Companies, Inc............. Common 3,238,300(3) 7.9% 333 South Hope Street Los Angeles, CA 90071 Invista Capital Management, Inc.............. Common 2,199,416(3) 5.4% 1500 Hub Tower, 699 Walnut Street Des Moines, IA 50309 Jack R. Anderson............................. Common 829,518(4)(7) 2.0% Series A Preferred 2,771,794(4) 13.2% Westcott W. Price III........................ Common 531,297(5)(6)(7) 1.3% Richard M. Burdge, Sr........................ Common 287,631(7)(8) * Series A Preferred... 742,104(8) 3.5% Burke F. Gumbiner............................ Common 184,353(5)(6)(7) * Warner Heineman.............................. Common 24,900(7) * Van B. Honeycutt............................. Common 0 * Robert W. Jamplis, M.D....................... Common 5,000(7) * Robert C. Maxson............................. Common 0 * Joseph F. Prevratil.......................... Common 37,000(7) * Jack D. Massimino............................ Common 132,041(6)(7) * Gloria L. Austin............................. Common 29,358(6)(7) * Michael J. Weinstock......................... Common 61,306(6)(7) *
24
AMOUNT AND NATURE OF BENEFICIAL PERCENT OF NAME OF BENEFICIAL OWNER(1) CLASS OF STOCK OWNERSHIP(2) CLASS - --------------------------------------------- --------------------- ------------------- ----------- Jeffrey H. Margolis.......................... Common 52,526(6)(7) * 19 directors and executive officers as a group (including those named above)..................................... Common 2,437,265(6)(7) 5.8% Series A Preferred... 3,658,306 17.4%
- ------------------------ * Less than 1.0%. (1) C/O FHP International Corporation, P.O. Box 25186, Santa Ana, California 92799-5186 unless otherwise indicated. (2) Reported in accordance with the beneficial ownership rules of the Securities and Exchange Commission (the "Commission"). Subject to community property laws, where applicable, voting power or investment power with respect to shares reflected in the table is not shared with others. (3) Based upon a Schedule 13F for the quarter ended June 30, 1996. (4) Includes 137,202 shares of Common Stock held by Mr. Anderson's wife and 271,200 shares of Common Stock held by trusts of which Mr. Anderson's relatives are beneficiaries. Includes 457,340 shares of Series A Preferred held by Mr. Anderson's wife and 904,000 shares of Series A Preferred held by trusts of which Mr. Anderson's relatives are beneficiaries. Mr. Anderson disclaims beneficial ownership of these shares. (5) Includes shares held under a revocable trust controlled by the named individual. (6) Includes shares held by the trustee under the ESOP. As of June 30, 1996, the approximate number of shares of Common Stock allocated to the ESOP accounts of the Named Executive Officers were as follows: Westcott W. Price III--5,297 shares; Jack D. Massimino--3,291 shares; Gloria L. Austin-- 2,108 shares; Michael J. Weinstock--2,806 shares; Jeffrey H. Margolis--211 shares; and all executive officers and directors of the Company (19 persons) as a group--23,791 shares. (7) Includes stock options exercisable within 60 days after August 31, 1996, which are reported pursuant to Rule 13d-3(d)(1) under the Securities Exchange Act of 1934, as amended with respect to the following persons: Jack R. Anderson--10,000 shares; Westcott W. Price III--163,750 shares; Richard M. Burdge, Sr.--15,000 shares; Burke F. Gumbiner--80,500 shares; Warner Heineman--24,900 shares; Robert W. Jamplis, M.D.--5,000 shares; Joseph F. Prevratil-- 37,000 shares; Jack D. Massimino--128,750 shares; Gloria L. Austin--27,250 shares; Michael J. Weinstock--47,500 shares; Jeffrey H. Margolis--24,813 shares; and all executive officers and directors of the Company (19 persons) as a group--690,144 shares. (8) Includes 25,030 shares of Common Stock and 83,435 shares of Series A Preferred held by Mr. Burdge's wife. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Robert W. Jamplis, a member of the Company's Board of Directors, serves as President and Chief Executive Officer of the Palo Alto Medical Foundation. During the fiscal year ended June 30, 1996, the Company's HMO subsidiaries made capitation payments totaling approximately $14.8 million to the Palo Alto Medical Foundation for the provision of health care services to approximately 20,000 of the Company's HMO members. In 1995, Robert Franklin, a Senior Vice President of the Company, borrowed $100,000 from the Company for the purpose of purchasing a new residence. The loan, which bears interest at the rate of 25 7.96% per annum, is payable in five annual installments of $20,000 each commencing on December 1, 1995. At June 30, 1996, the principal outstanding balance on this loan was $80,000. In the interim, the loan is secured by a recorded second lien on Mr. Franklin's residence. In 1994, Kenneth S. Ord, Senior Vice President and Chief Financial Officer of the Company, borrowed $100,000 for the purpose of purchasing a residence in California following his relocation from Michigan. The loan, which bears interest at a rate of 8.5% per annum, may be forgiven in installments of $20,000 a year if Mr. Ord remains employed with the Company through February 14, 1999. In the interim, the loan is secured by a recorded second lien on Mr. Ord's residence. At June 30, 1996, the loan had been forgiven, in part, by $40,000 plus accrued interest, and the outstanding principal balance was $60,000. In 1994, Jeffrey H. Margolis, Senior Vice President and Chief Information Officer of the Company, borrowed $150,000 from the Company for the purpose of purchasing a residence in California following his relocation from Colorado. $100,000 of the loan, which bears interest at a rate of 8.5% per annum, may be forgiven in installments of $20,000 per year if Mr. Margolis remains employed with the Company through August 1, 1999. The remaining $50,000 of principal, together with interest thereon, is due and payable on August 1, 1997. At June 30, 1996, the loan had been forgiven, in part, by $20,000 plus accrued interest, and the outstanding principal balance was $130,000. In the interim, the loan is secured by a recorded second lien on Mr. Margolis' residence. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The following documents are filed as part of this Form 10-K Annual Report: (a) Exhibits: See the Exhibit Index on pages 63 through 65 herein. (b) Financial Statement Schedules: None. (c) Reports on Form 8-K: None filed during the three months ended June 30, 1996. 26 SIGNATURES Pursuant to the requirements of 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. FHP INTERNATIONAL CORPORATION By /s/ WESTCOTT W. PRICE III ------------------------------------ Westcott W. Price III, CHIEF EXECUTIVE OFFICER AND PRESIDENT Date: September 30, 1996 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. /s/ JACK R. ANDERSON - ------------------------------ Director and Chairman of September 30, 1996 Jack R. Anderson the Board Director, President, Chief /s/ WESTCOTT W. PRICE III Executive Officer - ------------------------------ (Principal Executive September 30, 1996 Westcott W. Price III Officer), and Vice Chairman of the Board /s/ BURKE F. GUMBINER - ------------------------------ Senior Vice President and September 30, 1996 Burke F. Gumbiner Director /s/ JOSEPH F. PREVRATIL - ------------------------------ Director September 30, 1996 Joseph F. Prevratil /s/ WARNER HEINEMAN - ------------------------------ Director September 30, 1996 Warner Heineman /s/ RICHARD M. BURDGE, SR. - ------------------------------ Director September 30, 1996 Richard M. Burdge, Sr. /s/ ROBERT C. MAXSON - ------------------------------ Director September 30, 1996 Robert C. Maxson
27 /s/ ROBERT W. JAMPLIS - ------------------------------ Director September 30, 1996 Robert W. Jamplis /s/ VAN B. HONEYCUTT - ------------------------------ Director September 30, 1996 Van B. Honeycutt Senior Vice President and /s/ KENNETH S. ORD Chief Financial Officer - ------------------------------ (Principal Financial September 30, 1996 Kenneth S. Ord Officer) /s/ VALERIE A. FLETCHER - ------------------------------ Controller (Principal September 30, 1996 Valerie A. Fletcher Accounting Officer)
28 FHP INTERNATIONAL CORPORATION SELECTED FINANCIAL DATA
YEARS ENDED JUNE 30, -------------------------------------------------------------------- 1996 1995 1994 1993 1992 ------------ ------------ ------------ ------------ ------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA (A): Revenue.................................... $ 4,179,284 $ 3,909,380 $ 2,472,958 $ 2,005,854 $ 1,586,086 Expenses: Primary health care...................... 3,405,588 3,121,529 1,963,112 1,595,231 1,243,020 Other health care........................ 125,340 116,960 94,577 85,913 81,680 General, administrative and marketing.... 510,613 521,702 332,249 269,645 231,916 OPM reserve charge (b)................... 45,000 Provision for restructuring (c).......... 9,659 75,110 ------------ ------------ ------------ ------------ ------------ 4,096,200 3,835,301 2,389,938 1,950,789 1,556,616 ------------ ------------ ------------ ------------ ------------ Operating income........................... 83,084 74,079 83,020 55,065 29,470 Interest income............................ 36,174 32,079 20,365 14,919 22,211 Interest expense........................... (21,141) (25,972) (6,565) (211) (189) ------------ ------------ ------------ ------------ ------------ Income before provision for income taxes... 98,117 80,186 96,820 69,773 51,492 Provision for income taxes................. 53,964 42,894 37,510 25,607 18,602 ------------ ------------ ------------ ------------ ------------ Net income................................. 44,153 37,292 59,310 44,166 32,890 Preferred Stock dividends.................. 26,425 25,337 1,032 ------------ ------------ ------------ ------------ ------------ Net income attributable to Common Stock.... $ 17,728 $ 11,955 $ 58,278 $ 44,166 $ 32,890 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Earnings per share (d)..................... $ 0.43 $ 0.29 $ 1.71 $ 1.33 $ 1.00 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
JUNE 30, ---------------------------------------------------------------- 1996 1995 1994 1993 1992 ------------ ------------ ------------ ---------- ---------- (AMOUNTS IN THOUSANDS) BALANCE SHEET DATA (A): Total assets................................... $ 2,013,879 $ 2,315,816 $ 2,169,269 $ 745,684 $ 615,659 Long-term obligations.......................... 104,184 337,817 377,986 20,802 23,279 Stockholders' equity........................... 1,167,629 1,140,141 1,113,136 364,422 311,381
- ------------------------ (a) The Company acquired all of the outstanding Common Stock of TakeCare on June 17, 1994. The foregoing Selected Financial Data includes the impact of the TakeCare acquisition as of that date. (See Note 12 to the Consolidated Financial Statements.) (b) The Company recorded a charge in fiscal year 1996 relating to the Company's contracts with OPM. (See Note 9 to the Consolidated Financial Statements.) (c) During fiscal years 1995 and 1996, the Company recorded restructuring charges of $75.1 million and $9.7 million, respectively. The charges relate to the costs of employee separations, asset write-downs to net realizable values, and certain other costs associated with the restructuring of the Company's operations. (See Note 13 to the Consolidated Financial Statements.) (d) Earnings per share are computed as explained in Note 11 to the Consolidated Financial Statements. 29 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 ("HMO"), deriving almost all of its revenues from premiums received for health care services to approximately 1.9 million HMO members. 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., ET. AL. ("PacifiCare") under which PacifiCare agreed to acquire all of the outstanding Common and Preferred Stock of the Company. PacifiCare agreed to exchange $17.50 in cash, and a combination of PacifiCare class A Common Stock (voting) and class B Common (non-voting) Stock. The combined consideration equates to $35.00 per share of the Company's Common Stock, assuming a trading value of $68 per share for PacifiCare Class B Common Stock. Final consideration will be determined in part based on the average market closing price of PacifiCare Class B Common Stock during the 20 trading days before the Company's Stockholder Meeting. The Company's Preferred Stock will be exchanged for $14.11 in cash and an equivalent value in PacifiCare class A Common Stock subject to Preferred shareholder approval. (See Item 1. Business (a) General Description of Business -- Recent Developments and Note 14 to the Consolidated Financial Statements for more information on the Merger Agreement with PacifiCare.) The Merger with PacifiCare is contingent upon customary closing conditions, including approval by the stockholders of both companies and regulatory approvals. BUSINESS RESTRUCTURING During fiscal year 1996 the Company substantially completed a plan of restructuring (the "Restructuring Plan") announced at the end of fiscal year 1995. The Restructuring Plan was formulated in response to the intensely competitive environment in the HMO industry and continued declining membership in the Company's owned and operated medical centers and hospitals (collectively, the "staff model"). Prior to the Restructuring Plan, the Company managed its health care delivery network as one health care system, delivering health care to its members through a network of contracted health care providers (the "contract model HMO" or the "IPAs") and through its own staff model. The Restructuring Plan consisted of the creation of three distinct business segments: 1) the contract model HMO; 2) a physician practice management company, Talbert Medical Management Corporation ("Talbert") operating out of most of the Company's former staff model facilities; and 3) the Company's group life, health and accident and workers' compensation insurance and related products (collectively, the "Insurance Group"). The Restructuring Plan also called for the sale or other disposition of the Company's owned and operated hospitals and skilled nursing facilities, certain nonproductive real estate and other assets and a reduction in the Company's work force. Costs associated with the Restructuring Plan, including administrative facility closure costs and employee separation costs, resulted in pretax charges against earnings of approximately $75.1 million ($46.6 million net of tax) in fiscal year 1995, and $9.7 million ($6.0 million net of tax) in fiscal year 1996. Following is a summary of the Company's progress with regard to the Restructuring Plan: - DISPOSITION OF ASSETS The Company sold its acute-care hospitals in southern California and Utah for combined proceeds of approximately $157 million. The proceeds, received in April ($87 million) and May ($70 million) were used primarily to reduce debt. The transactions were recorded in the second and fourth quarters of fiscal year 1996 and had no material effect on operating results. The hospital premises comprised acute-care hospitals, primary and specialty care medical clinics and other buildings. Both transactions included the lease of primary and specialty care clinics to Talbert. 30 The Company transferred the operations of its two skilled nursing facilities to other operators during fiscal year 1996. The Company also completed several sales of other assets and vacant land. Some real estate and undeveloped land remained unsold at year end. - WORK FORCE REDUCTIONS Since the Company announced its Restructuring Plan, the Company has reduced its workforce by approximately 3,000 employees. Approximately 500 of the reductions took place in fiscal year 1995. The reduction of 2,500 employees in fiscal year 1996 included approximately 1,500 employees of the sold hospitals and skilled nursing facilities who transferred to their respective purchasers. - TALBERT The Restructuring Plan included the creation of Talbert which became operational January 1, 1996, as a new subsidiary of the Company and the creation of several new professional corporations (the "PCs"). Talbert is approximately 92% owned by the Company and 8% owned by a group of management investors. Approximately 3,900 of the Company's employees, including health care professionals, are currently employees of Talbert and/or the PCs. Effective January 1, 1996: 1) Talbert leased or subleased all of the Company's medical centers and related assets located in California, Arizona, Utah, New Mexico and Nevada; and 2) the Company's HMO contracted with the PCs to provide health care services to the Company's HMO members who were already receiving health care in the medical centers. Talbert served approximately 302,000 or 16% of the Company's HMO members at June 30, 1996. The contractual arrangements between the Company's HMO and the PCs are financially similar to existing contracts between the HMO and other contract health care providers. The PCs entered into long-term practice management agreements with Talbert. The business structure allows the PCs and Talbert to do business with other payors and HMOs, as well as with the Company's HMOs. 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. The Company experienced significant revenue growth during the three-year period ended June 30, 1996, primarily due to the acquisition of TakeCare, Inc. ("TakeCare") in June, 1994. During fiscal year 1996, revenue growth was slowed by modest enrollment growth and intense pricing competition. Total revenue for the year ended June 30, 1996, was $4,179 million increasing 6.9% over revenue of $3,909 million for the previous year. The Company's commercial and senior enrollment each generate approximately half of the Company's HMO revenue. The Company's ability to increase its commercial HMO premium rates during the last three fiscal years has been adversely impacted by intense competition in all the Company's major markets, particularly in California. Adding to rate pressure, certain large employer groups and other purchasers of health care services continue to demand minimal increases or reductions in premium rates. Downward pressure on premium rates may continue in fiscal year 1997 in all of the Company's major service areas. (A substantial portion of the Company's HMO commercial premium rate increases becomes effective in January of each year.) Total HMO membership grew 104.3%, 3.9% and 7.5% in the years ended June 30, 1994, 1995 and 1996, respectively. Membership growth in fiscal year 1994 was primarily due to the acquisition of TakeCare. Excluding TakeCare membership, total HMO membership growth in fiscal year 1994 was 10.5%. During fiscal years 1995 and 1996, the Company experienced slower membership growth than in prior years, due primarily to intense competition in all its key markets. During fiscal year 1996, HMO membership grew 7.5% to approximately 1,913,000 at June 30, 1996, from approximately 1,779,000 at June 30, 1995. The Company's membership growth rate improved during fiscal year 1996 over fiscal year 1995 but remained slower than the HMO industry in general. 31 During fiscal year 1996, the Company experienced a decline in its membership, both senior and commercial at certain medical facilities operated by Talbert. This decline was more than offset by growth in the Company's contract model HMO. Commercial HMO membership grew 152.6%, 2.9% and 8.0% for the years ended June 30, 1994, 1995 and 1996, respectively. Commercial HMO membership growth in fiscal year 1994 was primarily due to the acquisition of TakeCare. Exclusive of acquired TakeCare commercial membership, commercial growth in fiscal year 1995 was 6.7%, net of a decline of approximately 1.8% (14,000) of former TakeCare members lost as the companies merged in an intensely competitive environment. During fiscal year 1996, total commercial HMO membership increased by 112,000 or 8.0% from approximately 1,404,000 to approximately 1,516,000. The Company's rate of commercial HMO membership growth improved in fiscal year 1996 over the growth rate experienced in fiscal year 1995, but still fell short of the real rate of growth of 10.7% experienced in fiscal year 1994. The Company's ability to increase its commercial membership during the last three fiscal years was adversely impacted by intense competition in all the Company's major markets, particularly in California. This trend may continue into fiscal year 1997. Senior membership grew 16.8%, 7.8% and 5.9% for the years ended June 30, 1994, 1995 and 1996 respectively. Excluding TakeCare senior membership, senior HMO membership growth in fiscal year 1994 was 10.1%. During fiscal year 1995, the Company experienced delays in obtaining regulatory approvals necessary for senior membership expansion in northern California, causing lower than expected senior growth. During fiscal year 1996, senior membership grew by 22,000 or 5.9% to approximately 397,000 at June 30, 1996, from approximately 375,000 at June 30, 1995. The Company continued to experience low growth rates in its senior membership, particularly in California and Utah; however, these were offset by gains in other markets (primarily Arizona, Colorado and Texas). Almost all of the Company's senior HMO revenue is generated from premiums paid to the Company by the Health Care Financing Administration ("HCFA"). Revenue per senior member is substantially higher than revenue per commercial member because senior members use substantially more health care services. 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. For calendar years 1996 and 1995, the Company received an average 5.1% and 5.8% rate increase, respectively. For calendar year 1997, the Company is preliminarily anticipating an average 5.7% rate increase. For the year ended June 30, 1996, the Company generated approximately 2.5% of its revenue from the sale of indemnity health, group life and workers' compensation insurance, and related lines of business. This compares to 3.7% for the previous fiscal year. During fiscal year 1995, the Company was unfavorably impacted by rate deregulation for workers' compensation insurance in California resulting in substantial rate decreases and loss of business in the state. Also, the Company's indemnity health subsidiaries faced an increasingly competitive market. During fiscal year 1996, the Company's group health and life company lost its single largest group accounting for approximately half of its revenues. COST OF HEALTH CARE A significant factor affecting the Company's profitability is its ability to manage and control its health care costs. Since the Company receives fixed monthly premiums, an unusually high number of catastrophic claims (such as organ transplants and costly premature births) could cause substantial additional health care costs. Periodically, the Company's results of operations may be affected by such costs. Management believes that the Company's cost control measures, which include risk-sharing and capitation arrangements with its contract medical providers along with administrative and medical review of its health care delivery services, help to mitigate the effects of rising health care costs. During the last three years, certain medical centers in California now operated by Talbert have experienced high operating costs relative to declining enrollment. The competitive environment and the 32 proliferation of managed care health plan choices contributed to a decline in membership in these medical centers. The decline created excess capacity and therefore, higher health care costs as a percentage of revenue. These were significant factors behind the Company's decision to establish Talbert as part of the Company's Restructuring Plan. The following table sets forth the percentage relationships of various income statement items to revenue for the periods indicated:
YEARS ENDED JUNE 30, ------------------------------- 1996 1995 1994 --------- --------- --------- Revenue.............................................................. 100.0% 100.0% 100.0% Health care costs.................................................... 84.5 82.8 83.2 General, administrative, and marketing expenses...................... 12.2 13.3 13.4 Restructuring and OPM reserves....................................... 1.3 1.9 -- Operating income..................................................... 2.0 1.9 3.4 Interest income, net................................................. 0.4 0.2 0.5 Income before income taxes........................................... 2.3 2.1 3.9 Net income........................................................... 1.1 1.0 2.4
FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995 Revenue increased 6.9% to $4,179 million for fiscal year 1996 from $3,909 million for fiscal year 1995, primarily due to membership growth. Health care costs grew 9.0% to $3,531 million for fiscal year 1996, from $3,239 million for fiscal year 1995, due to operational growth and cost increases. Health care costs for fiscal year 1996 increased as a percentage of revenue by 1.7 percentage points, to 84.5% from 82.8% for the prior fiscal year. The increase as a percent of revenue resulted primarily from lower average commercial premium rates in almost all states in which the Company operates and from higher pharmacy and hospital costs. General, administrative and marketing ("G & A") expenses decreased by $11 million or 2.1% to $511 million for fiscal year from $522 million for the prior fiscal year. The decrease was primarily the result of cost savings from earlier workforce reductions and other cost controls, offset by higher sales and marketing costs. Net interest income was $15 million for fiscal year 1996, compared to $6 million for the previous fiscal year. Net interest income increased $9 million year-over-year primarily as the result of growth in the Company's investment portfolio, lower outstanding debt and higher interest rates earned on investments. FISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994 Revenue increased 58.1% to $3,909 million for fiscal year 1995 from $2,473 million for fiscal year 1994, primarily due to the acquisition of TakeCare. Health care costs increased 57.4% to $3,239 million for fiscal year 1995 from $2,058 million for fiscal year 1994, primarily due to the TakeCare acquisition. Health care costs decreased to 82.8% of revenue in fiscal year 1995 from 83.2% in fiscal year 1994, primarily due to the lower average cost of health care in the former TakeCare health plans. Notwithstanding the year-over-year improvement, the Company's cost of health care was adversely impacted by excess capacity in Company-operated medical centers. General, administrative, and marketing ("G&A") expenses increased 57.0% to $522 million for fiscal year 1995 from $332 million for fiscal year 1994, primarily as a result of the acquisition of TakeCare. G&A expenses as a percentage of revenue were 13.3% in fiscal year 1995, down slightly from 13.4% in fiscal year 1994. Fiscal year 1995 G&A expenses included approximately $27 million of goodwill amortization arising from the TakeCare transaction on June 17, 1994. In fiscal year 1994, goodwill amortization relating to the TakeCare transaction was approximately $1 million. 33 Net interest income was $6 million for fiscal year 1995 as compared to $14 million for the previous year. Net interest income declined year-over-year, primarily because of additional interest expense due to an increase in debt related to the acquisition of TakeCare. OPM BACKGROUND 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 for the years 1987 through 1991, discussed below, which have been and may be asserted in relation to the Company's contracts with the United States Office of Personnel Management ("OPM") and for possible OPM claims for subsequent years through 1996. The addition to reserves resulted in a third quarter charge to net earnings of $0.68 per share. The Company's HMO subsidiaries have contracts with 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. As previously disclosed, in May 1993, after conducting an audit of the Company's FEHBP contracts covering primarily the years 1987 through 1991, OPM sent a draft audit report to the Company alleging certain defective rating practices in certain regions. 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. Also, the Company evaluated the availability of offsets and established reserves pending issuance of a final audit report or further correspondence from OPM. A final audit report has not been issued as of the date hereof and the Company received no further correspondence from the Government regarding the draft audit report until the third quarter of fiscal year 1996. 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 that the Company may have violated the False Claims Act in its certifications to OPM that the FEHBP received community rates for health care services provided in certain regions during 1987 through 1991. No action has been commenced by the Government, although the Government asserted in correspondence with the Company dated April 25, 1996, that, at that time, the Government believed its actual damages to be approximately $15 million. The Government has indicated that it does not have any information that would lead it to believe that the Company violated any criminal laws. OUTLOOK The Company is negotiating with the Government and hopes to resolve these matters without litigation. While there is no assurance that negotiations will be concluded satisfactorily or that additional liability will not be incurred, management does not believe that additional liability incurred, if any, in excess of reserves that have been established in connection with the ultimate outcome of these matters is likely 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 allegations will have a material effect on future relations with OPM. OPM has conducted two audits for years as far back as 1990 at two of the Company's other HMO subsidiaries that were acquired as part of TakeCare. Based on positions taken by the Government with respect to the 1987-1991 draft audit report, management believes that these open audits may allege defective rating practices and result in claims for adjustments from OPM. Management believes other possible future audits may allege defective rating practices and result in claims for adjustments from OPM. 34 Such claims could be for substantial amounts. Management cannot determine if such claims would result in further referrals to the Department of Justice and further False Claims Act claims. 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 has conducted with OPM over many years. Based on management's understanding of the Government's current interpretation of the community rating standard requirements in the context of the 1987-1991 draft OPM audit report, the Company believes that it has established adequate reserves to settle any claims that may arise from present or future FEHBP rate audits for past years, or that if any amount in excess of reserves is necessary to settle any such claims, the amounts 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. The preceding paragraphs in this section headed "OPM--Outlook" consist of forward looking statements. The actual outcome of any OPM audits, claims for adjustments and/or False Claim 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 rates changes 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 False Claim Act claims. LIQUIDITY AND CAPITAL RESOURCES The Company's consolidated cash and cash equivalents and short-term investments decreased by $101 million to $355 million at June 30, 1996, from $456 million at June 30, 1995. The decrease reflects the impact of timing differences in receipt of HCFA premiums. The Company's June 30, 1995, cash balances included the early receipt of approximately $152 million of premiums from HCFA for medical services to be provided to senior members in July, 1995. The Company's cash balances at June 30, 1996, did not include any early receipt of HCFA premiums. Major sources of cash during the fiscal year ended June 30, 1996, included $146 million from operations (excluding the effect of timing differences in receipt of HCFA premiums), and approximately $160 million from the sales of the Company's two hospitals and other assets. Uses of cash during the year included $58 million for capital expenditures, $26 million for Preferred Stock dividends, and $231 million of debt repayment. Funds from the sales of real estate and other assets were used primarily for the reduction of debt. 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 is approximately 5.8%. 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 June 30, 1996, borrowings of $34 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 35 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 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 Talbert Rights will be delivered promptly after consummation of the mergers and will be exercisable for 30 days after delivery. At that time, Talbert will be capitalized to a net worth of approximately $60 million. 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. (See Item 1. Business (a) General Description of Business--Recent Developments and Note 14 to the Consolidated Financial Statements for more on the Merger Agreement with 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. Over calendar years 1994 and 1995, annual senior premium increases from HCFA were approximately 2.0% and 5.8%, respectively. 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. This downward pressure may continue in 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. Also, the Company is experiencing some competitive pressures in its senior markets, particularly in California and this also may continue into fiscal year 1997. 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 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. 36 INDEX TO FINANCIAL STATEMENTS
PAGE REFERENCE --------- Consolidated Balance Sheets, June 30, 1996 and 1995.................................................... 38 Consolidated Statements of Income for the years ended June 30, 1996, 1995 and 1994..................... 39 Consolidated Statements of Stockholders' Equity for the years ended June 30, 1996, 1995 and 1994....... 40 Consolidated Statements of Cash Flows for the years ended June 30, 1996, 1995 and 1994................. 42 Notes to Consolidated Financial Statements............................................................. 43 Independent Auditors' Report........................................................................... 62
37 FHP INTERNATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS ASSETS
JUNE 30, ------------------------ 1996 1995 ----------- ----------- (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) Cash and cash equivalents (Note 1)........................ $ 166,873 $ 299,144 Short-term investments (Notes 1 and 2).................... 187,919 157,220 Accounts receivable (net of allowance for doubtful accounts of $18,839 and $23,617 at June 30, 1996 and 1995, respectively) (Note 1)............................ 141,537 141,840 Prepaid expenses and other current assets................. 33,736 44,091 Deferred income taxes (Notes 1 and 7)..................... 49,162 31,984 ----------- ----------- Total current assets................................ 579,227 674,279 Property and equipment, net (Notes 1 and 3)............... 231,428 229,765 Assets held for sale (Notes 1 and 13)..................... 16,470 138,164 Long-term investments (Notes 1 and 2)..................... 36,470 71,492 Restricted investments (Notes 1 and 2).................... 90,499 105,482 Goodwill and other intangibles, net (Notes 1 and 12)...... 1,028,374 1,059,507 Other assets (Notes 1, 7 and 8)........................... 31,411 37,127 ----------- ----------- Total assets........................................ $ 2,013,879 $ 2,315,816 ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current portion of long-term obligations (Notes 1 and 6)...................................................... $ 30,097 $ 30,168 Accounts payable (Note 1)................................. 50,979 64,762 Medical claims payable (Notes 1 and 4).................... 367,872 341,222 Accrued salaries and employee benefits (Note 8)........... 71,986 77,716 Unearned premiums (Note 1)................................ 24,713 207,961 Restructuring reserve (Note 13)........................... 14,615 15,038 Income taxes payable and other current liabilities (Notes 1, 5 and 7)............................................. 79,132 15,791 ----------- ----------- Total current liabilities........................... 639,394 752,658 Long-term obligations (Notes 1 and 6)..................... 104,184 337,817 Other liabilities (Notes 5 and 8)......................... 102,672 85,200 ----------- ----------- Total liabilities................................... 846,250 1,175,675 ----------- ----------- Commitments and contingencies (Note 9) Stockholders' equity: Series A Convertible and Series B Preferred Stock $0.05 par value; 40,000,000 shares authorized; issued and outstanding 21,040,307 (Series A) at June 30, 1996 and 1995, and 79,218 (Series B) at June 30, 1995; aggregate liquidation preference $526,033 and $526,027 (Series A) at June 30, 1996 and 1995, respectively, and $1,999 (Series B) at June 30, 1995 (Notes 1, 10 and 12)............................................... 1,052 1,056 Common Stock, $0.05 par value; 100,000,000 shares authorized; issued and outstanding 40,789,528 and 40,220,941 shares at June 30, 1996 and 1995, respectively (Notes 1, 8, 10 and 12).................. 2,039 2,011 Paid-in capital......................................... 938,478 927,882 Unrealized holding losses on available-for-sale investments, net of tax effect of $1,602 (1996) and $1,232 (1995) (Note 2)................................ (2,306) (1,446) Retained earnings....................................... 228,366 210,638 ----------- ----------- Total stockholders' equity.......................... 1,167,629 1,140,141 ----------- ----------- Total liabilities and stockholders' equity.......... $ 2,013,879 $ 2,315,816 ----------- ----------- ----------- -----------
See accompanying Notes to Consolidated Financial Statements. 38 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, ---------------------------------------- 1996 1995 1994 ------------ ------------ ------------ (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue (Note 1)........................................................ $ 4,179,284 $ 3,909,380 $ 2,472,958 Expenses (Note 1): Primary health care: Medical services.................................................... 1,617,733 1,553,955 923,560 Hospital services................................................... 1,395,351 1,227,392 839,980 Dental, optometry, pharmacy and other primary health care services.......................................................... 392,504 340,182 199,572 Other health care..................................................... 125,340 116,960 94,577 General, administrative and marketing................................. 510,613 521,702 332,249 OPM reserve charge (Note 9)........................................... 45,000 Provision for restructuring (Note 13)................................. 9,659 75,110 ------------ ------------ ------------ 4,096,200 3,835,301 2,389,938 ------------ ------------ ------------ Operating income.................................................. 83,084 74,079 83,020 Interest income......................................................... 36,174 32,079 20,365 Interest expense (Notes 1 and 6)........................................ (21,141) (25,972) (6,565) ------------ ------------ ------------ Income before provision for income taxes................................ 98,117 80,186 96,820 Provision for income taxes (Notes 1 and 7).............................. 53,964 42,894 37,510 ------------ ------------ ------------ Net income........................................................ 44,153 37,292 59,310 Preferred stock dividends (Note 10)..................................... 26,425 25,337 1,032 ------------ ------------ ------------ Net income attributable to Common Stock................................. $ 17,728 $ 11,955 $ 58,278 ------------ ------------ ------------ ------------ ------------ ------------ Earnings per share attributable to Common Stock (Note 11)............... $ 0.43 $ 0.29 $ 1.71 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying Notes to Consolidated Financial Statements. 39 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NUMBER OF NUMBER OF PREFERRED COMMON PREFERRED COMMON PAID-IN SHARES SHARES STOCK STOCK CAPITAL ----------- ----------- ----------- ----------- ---------- (AMOUNTS IN THOUSANDS) BALANCE AT JULY 1, 1993................................ 32,836 $ -- $ 1,642 $ 222,375 Stock options exercised (Note 8)....................... 356 18 2,697 Income tax benefit from exercise of stock options...... 3,229 Issuance of Series A Convertible Preferred Stock (Notes 10 and 12)........................................... 21,032 1,052 524,741 Issuance of Series B Preferred Stock (Notes 10 and 12).................................................. 33 1 820 Issuance of Common Stock (Notes 10 and 12)............. 6,312 316 161,954 Dividends on Series A Convertible and Series B Preferred Stock (Note 10)............................ Unrealized holding gains (losses), net of taxes (Note 2)................................................... Net income............................................. ----------- ----------- ----------- ----------- ---------- BALANCE AT JUNE 30, 1994............................... 21,065 39,504 1,053 1,976 915,816 Stock options exercised (Note 8)....................... 640 31 6,321 Income tax benefit from exercise of stock options...... 2,530 Issuance of Series A Convertible Preferred Stock (Notes 10 and 12)........................................... 9 213 Issuance of Series B Preferred Stock (Notes 10 and 12).................................................. 46 3 1,156 Issuance of Common Stock (Notes 10 and 12)............. 77 4 1,846 Dividends on Series A Convertible and Series B Preferred Stock (Note 10)............................ Unrealized holding gains (losses), net of taxes (Note 2)................................................... Net income............................................. ----------- ----------- ----------- ----------- ---------- BALANCE AT JUNE 30, 1995............................... 21,120 40,221 1,056 2,011 927,882 Stock options exercised (Note 8)....................... 486 24 6,398 Income tax benefit from exercise of stock options...... 4,132 Redemption of Series B Preferred Stock (Note 10)....... (79) (4) (1,976) Employee Stock Purchase Plan transactions (Note 8)..... 83 4 2,042 Dividends on Series A Convertible and Series B Preferred Stock (Note 10)............................ Unrealized holding gains (losses), net of taxes (Note 2)................................................... Net income............................................. ----------- ----------- ----------- ----------- ---------- BALANCE AT JUNE 30, 1996............................... 21,041 40,790 $ 1,052 $ 2,039 $ 938,478 ----------- ----------- ----------- ----------- ---------- ----------- ----------- ----------- ----------- ----------
See accompanying Notes to Consolidated Financial Statements. 40 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
UNREALIZED TOTAL RETAINED HOLDING STOCKHOLDERS' EARNINGS LOSSES EQUITY ---------- ----------- ---------------- (AMOUNTS IN THOUSANDS) BALANCE AT JULY 1, 1993................................................ $ 140,405 $ -- $ 364,422 Stock options exercised (Note 8)....................................... 2,715 Income tax benefit from exercise of stock options...................... 3,229 Issuance of Series A Convertible Preferred Stock (Notes 10 and 12)..... 525,793 Issuance of Series B Preferred Stock (Notes 10 and 12)................. 821 Issuance of Common Stock (Notes 10 and 12)............................. 162,270 Dividends on Series A Convertible and Series B Preferred Stock (Note 10).................................................................. (1,032) (1,032) Unrealized holding gains (losses), net of taxes (Note 2)............... (4,392) (4,392) Net income............................................................. 59,310 59,310 ---------- ----------- ---------------- BALANCE AT JUNE 30, 1994............................................... 198,683 (4,392) 1,113,136 Stock options exercised (Note 8)....................................... 6,352 Income tax benefit from exercise of stock options...................... 2,530 Issuance of Series A Convertible Preferred Stock (Notes 10 and 12)..... 213 Issuance of Series B Preferred Stock (Notes 10 and 12)................. 1,159 Issuance of Common Stock (Notes 10 and 12)............................. 1,850 Dividends on Series A Convertible and Series B Preferred Stock (Note 10).................................................................. (25,337) (25,337) Unrealized holding gains (losses), net of taxes (Note 2)............... 2,946 2,946 Net income............................................................. 37,292 37,292 ---------- ----------- ---------------- BALANCE AT JUNE 30, 1995............................................... 210,638 (1,446) 1,140,141 Stock options exercised (Note 8)....................................... 6,422 Income tax benefit from exercise of stock options...................... 4,132 Redemption of Series B Preferred Stock (Note 10)....................... (1,980) Employee Stock Purchase Plan transactions (Note 8)..................... 2,046 Dividends on Series A Convertible and Series B Preferred Stock (Note 10).................................................................. (26,425) (26,425) Unrealized holding gains (losses), net of taxes (Note 2)............... (860) (860) Net income............................................................. 44,153 44,153 ---------- ----------- ---------------- BALANCE AT JUNE 30, 1996............................................... $ 228,366 $ (2,306) $ 1,167,629 ---------- ----------- ---------------- ---------- ----------- ----------------
See accompanying Notes to Consolidated Financial Statements. 41 FHP INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, ------------------------------- 1996 1995 1994 --------- --------- --------- (AMOUNTS IN THOUSANDS) Operating Activities: Net income.................................................................... $ 44,153 $ 37,292 $ 59,310 Adjustments to reconcile net income to net cash (used in) provided by operating activities: OPM reserve charge.......................................................... 45,000 Provision for restructuring................................................. 9,659 75,110 Depreciation and amortization............................................... 71,743 80,065 45,271 (Decrease) increase in allowance for doubtful accounts...................... (4,778) 10,169 6,301 Loss on disposal of assets.................................................. 6,292 4,757 4,954 Gain on sale of available-for-sale investments.............................. (1,498) (5,232) Loss on sale of available-for-sale investments.............................. 277 880 Deferred income taxes....................................................... (9,689) (25,118) 2,630 Effect on cash of changes in operating assets and liabilities, net of effects from acquisitions in 1995 and 1994: Accounts receivable..................................................... 5,081 (39,917) (30,051) Prepaid expenses and other current assets............................... 10,355 12,596 (18,099) Other assets............................................................ (2,250) (4,279) 47 Accounts payable........................................................ (13,783) (29,963) 8,060 Medical claims payable.................................................. 26,650 57,610 12,138 Accrued salaries and employee benefits.................................. (5,730) (6,655) 7,931 Unearned premiums....................................................... (183,248) 175,223 (2,815) Other liabilities....................................................... (4,696) (59,907) 6,292 --------- --------- --------- Net cash (used in) provided by operating activities............................. (6,462) 282,631 101,969 --------- --------- --------- Investing Activities: Purchases of available-for-sale investments................................... (314,952) (519,090) Proceeds from sales/maturities of available-for-sale investments.............. 334,249 600,487 1,167 Purchase of TakeCare, Inc., net of cash acquired.............................. (341,602) Purchase of Colorado HMO, net of cash acquired................................ (755) (3,419) Proceeds from sales of property and equipment................................. 159,990 Purchases of property and equipment........................................... (58,117) (72,096) (86,052) --------- --------- --------- Net cash provided by (used in) investing activities............................. 121,170 8,546 (429,906) --------- --------- --------- Financing Activities: Proceeds from issuance of long-term obligations............................... 15,000 400,000 Payments on long-term obligations............................................. (231,174) (50,155) (20,136) Exercise of stock options including tax benefit............................... 10,554 8,882 5,944 Redemption of Series B Preferred Stock........................................ (1,980) Issuance of Common Stock through Employee Stock Purchase Plan................. 2,046 Cash dividends paid to preferred shareholders................................. (26,425) (26,331) --------- --------- --------- Net cash (used in) provided by financing activities............................. (246,979) (52,604) 385,808 --------- --------- --------- Net (decrease) increase in cash and cash equivalents............................ (132,271) 238,573 57,871 Cash and cash equivalents at beginning of year.................................. 299,144 60,571 2,700 --------- --------- --------- Cash and cash equivalents at end of year........................................ $ 166,873 $ 299,144 $ 60,571 --------- --------- --------- --------- --------- --------- Supplemental cash flow information: Interest payments (net of portion capitalized in 1995 and 1994)............... $ 20,130 $ 25,526 $ 4,695 Income tax payments (net of refunds).......................................... $ 34,725 $ 73,751 $ 34,583 Supplemental schedule of noncash investing and financing activities: The Company purchased all of the outstanding common stock of TakeCare, Inc. in exchange for Common Stock, Preferred Stock and cash as follows: Total TakeCare acquisition cost........................................... $1,137,642 Cash acquired............................................................. (60,402) Liabilities accrued....................................................... (46,754) Common and Preferred Stock issued......................................... (688,884) --------- Net cash paid............................................................. $ 341,602 --------- ---------
See accompanying Notes to Consolidated Financial Statements. 42 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION 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. Most of the Company's subsidiaries are federally qualified, licensed health maintenance organizations ("HMO") which provide comprehensive health care to their members for a fixed monthly fee per member. In the course of providing health care services to commercial and governmental employees, the Company extends credit to various federal government agencies and hospitals, independent physician groups, and to other health care providers and intermediaries located in Arizona, California, Colorado, Illinois, Indiana, Kentucky, Nevada, New Mexico, Ohio, Texas, Utah and Guam. During fiscal year 1996, the Company formed a subsidiary, Talbert Medical Management Corporation ("Talbert"), a physician practice management company and formed several professional corporations (the "PCs"). The sole shareholder of each PC is a licensed doctor or dentist. The PCs created by Talbert are located in Arizona, California, Nevada and Utah. Together, Talbert and the PCs represent the reorganization of substantially all of the Company's owned and operated staff model operations. These actions collectively enable the PCs and Talbert to do business with third party payors and other HMOs as well as with the Company's contract model HMO. Talbert, which became operational January 1, 1996, is approximately 92% owned by the Company and 8% owned by a group of management investors. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. Talbert has direct or indirect unilateral and perpetual control over the assets and operations of the PCs by means other than owning the majority of voting stock. Talbert and the PCs have entered into 20 to 40 year practice management agreements. In addition, Talbert through its management agreements with the PCs, has effectively assumed responsibility for all operating expenses in return for the assignment of the revenue of the PCs. As such, because of control by means other than equity ownership, consolidation of the PCs is necessary to present fairly the financial position and results of operations of Talbert. Control by Talbert is perpetual rather than temporary because of: (i) the length of the original terms of the agreements; (ii) the successive extension periods provided by the agreements; (iii) the continuing investment of capital by the Company; (iv) the employment of the majority of the nonphysician personnel; (v) the nature of the services provided to the PCs by Talbert; and (vi) the provisions of a Share Control Agreement entered into by each PC's shareholder and Talbert. The terms of the Share Control Agreement require the shareholder: (i) to elect to the board of directors of the PCs only persons approved by Talbert; (ii) to obtain written consent from Talbert to approve or authorize any merger, consolidation or other reorganization, sale of assets, or sale of common stock of the PCs; and (iii) give a right to purchase any or all shares of the PCs to a person designated by Talbert. All significant intercompany accounts and transactions have been eliminated in consolidation. 43 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) REGULATORY REQUIREMENTS The Company's regulated subsidiaries must comply with certain minimum capital or tangible net equity requirements in each of the states in which they operate. As of June 30, 1996, all of the Company's regulated subsidiaries were in compliance with these requirements. REVENUE RECOGNITION AND HEALTH CARE COSTS Medicare risk contracts with the Health Care Financing Administration ("HCFA") provided 48%, 45% and 63% of revenue in fiscal years 1996, 1995 and 1994, respectively. The Company's HMOs are paid a prospectively determined per capita monthly payment for each Medicare beneficiary enrolled in the HMOs. This capitated payment is the projected actuarial equivalent of 95% of the amount Medicare would have paid for the Medicare beneficiaries if they had received services from a fee for service Medicare provider or supplier. The HMOs must absorb any difference between the Medicare prepaid amounts and the actual costs the HMOs incur for providing services and are, therefore, at risk. Premiums from enrolled groups for prepaid health care are recognized as revenue in the month in which the enrollees are entitled to care. Unearned premiums represent cash received from employer groups and HCFA in advance of the applicable period of coverage. Health care costs are recorded in the period when services are provided to enrolled members, including estimates for contracted medical specialists and hospital costs which have been incurred as of the balance sheet date but not yet reported. The estimates for accrued health care costs are based on historical studies of claims paid. The methods for making such estimates and for establishing the resulting reserves are continually reviewed and updated, and any adjustments resulting therefrom are reflected in current operations. While the ultimate amount of claims and the related expenses paid are dependent on future developments, management is of the opinion that the liability for medical claims payable is adequate to cover such medical claims and expenses. ADVERTISING COSTS Advertising expense was $31,895,000, $37,018,000 and $23,800,000 for the fiscal years ended June 30, 1996, 1995 and 1994, respectively. CASH EQUIVALENTS The Company considers all highly-liquid investments with a maturity of three months or less when purchased to be cash equivalents. SHORT-TERM, LONG-TERM AND RESTRICTED INVESTMENTS The Company accounts for its investments in accordance with Statement of Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities." The Company has classified all of its investment portfolio as "available-for-sale." In accordance with SFAS 115, investments classified as available-for-sale are carried at fair value, and unrealized gains or losses (net of applicable income taxes) are reported in a separate caption of stockholders' equity. Short-term, long-term, and restricted investments consist of U.S. Treasury securities, certificates of deposit, and other marketable debt securities. Long-term investments have maturities in excess of one year. Restricted investments primarily include investments placed on deposit with various state regulatory agencies to comply with regulatory requirements. 44 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of investments in marketable securities and commercial premiums receivable. The Company's short-term investments in marketable securities are managed by professional investment managers within guidelines established by the Board of Directors, which, as a matter of policy, limit the amounts which may be invested in any one issuer. Concentrations of credit risk with respect to commercial premiums receivable are limited due to the large number of employer groups comprising the Company's customer base. In management's opinion, the Company had no significant concentrations of credit risk at June 30, 1996. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's consolidated balance sheet includes the following financial instruments: cash and cash equivalents, trade accounts and notes receivable, trade accounts payable and long-term obligations. The Company considers the carrying amounts of current assets and liabilities in the consolidated financial statements to approximate the fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. The fair value, based on the quoted market price as of June 30, 1996, of the Company's 7% Senior Notes due September 2003, approximates $97,160,000. The Company considers that the carrying value of all other long-term obligations approximates the fair value of such obligations due to the variable nature of interest rates associated with the debt instruments. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the respective classes of assets as follows: buildings, 20 to 40 years; leasehold improvements, lesser of the useful lives (three to ten years) or the lease term; and equipment and fixtures, three to ten years. Property and equipment also includes capitalized interest expense of approximately $471,000 and $596,000 in fiscal years 1995 and 1994, respectively, associated with the Company's major construction projects. There were no significant construction projects in fiscal year 1996. GOODWILL AND OTHER INTANGIBLES Goodwill arose primarily from the purchase of TakeCare, Inc. ("TakeCare") on June 17, 1994. Amortization is provided on a straight-line basis over periods not exceeding 37 years. In addition to goodwill, other intangible assets resulting from business acquisitions consist of the economic value of purchased membership, customer contracts and covenants not-to-compete. Intangibles are amortized on a straight-line basis over their estimated useful lives ranging from 3 to 30 years. The Company periodically evaluates whether events and circumstances have occurred which may affect the estimated useful life or the recoverability of the remaining balance of its intangibles. At June 30, 1996, the Company's management believed that no material impairment of goodwill or other intangible assets existed. Amortization charged to operations amounted to $32,064,000, $31,506,000 and $5,284,000 for fiscal years 1996, 1995 and 1994, respectively. Accumulated amortization was $66,444,000, $34,738,000 and $6,685,000 for the fiscal years ended June 30, 1996, 1995 and 1994, respectively. 45 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) INCOME TAXES The Company utilizes the asset and liability method of accounting for income taxes. Under this method, income taxes are recognized for (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The effects of income taxes are measured based on enacted tax law and rates. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and tax basis of the Company's assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled. ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." In accordance with SFAS 121, long-lived assets to be held are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. In June 1995, the Company adopted a plan of reorganization (the "Restructuring Plan") which included the disposition of long-lived assets (Note 13). Assets held for sale are accounted for at the lower of carrying amount or fair value, less costs to sell, since management has committed to a plan to dispose of the assets. ACCOUNTING FOR STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation" provides an alternative to APB Opinion No. 25 ("APB 25"). SFAS 123 encourages, but does not require, recognition against earnings of compensation expense for grants of stock, stock options and other equity instruments by employers (collectively, "options"), based on fair value at the date of grant. SFAS 123 provides a methodology for the determination of fair value; however, SFAS 123 also allows companies to continue to measure compensation cost using the intrinsic value method of accounting provided by APB 25. SFAS 123 requires companies that choose not to adopt the new fair value accounting rules to disclose pro forma net income and earnings per share under the new method as if it had been adopted. The Company intends to continue with the intrinsic value method prescribed in APB 25 and make pro forma disclosures of net income and earnings per share as if the fair value method of accounting (as defined in SFAS 123) had been applied beginning in fiscal year 1997. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Principal areas requiring the use of estimates include: determination of allowances for doubtful accounts receivable, medical claims payable (Note 4), professional and general liability, reserves relating to OPM contracts (Note 9) and restructuring reserves (Note 13). 46 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) OTHER ASSETS The principal components of other assets are as follows:
JUNE 30, -------------------- 1996 1995 --------- --------- (AMOUNTS IN THOUSANDS) Deferred income taxes (Note 7)....................................... $ 13,836 $ 21,007 Cash surrender value of life insurance policies (Note 8)............. 12,551 6,902 Deposits............................................................. 1,068 3,608 Notes receivable..................................................... 837 2,999 Other................................................................ 3,119 2,611 --------- --------- Total other assets................................................... $ 31,411 $ 37,127 --------- --------- --------- ---------
RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the 1996 financial statement presentation. 47 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--INVESTMENTS Gross unrealized gains and losses and a comparison of amortized cost and estimated fair value are presented in the table below:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE ---------- ----------- ----------- ---------- (AMOUNTS IN THOUSANDS) JUNE 30, 1996: Classified as short-term: U.S. Government and its agencies............................... $ 139,029 $ 91 $ (318) $ 138,802 Corporate obligations.......................................... 40,530 16 (171) 40,375 Municipal obligations.......................................... 7,506 8 (11) 7,503 Other.......................................................... 1,254 1 (16) 1,239 ---------- ----------- ----------- ---------- Total short-term............................................. 188,319 116 (516) 187,919 ---------- ----------- ----------- ---------- Classified as long-term: U.S. Government and its agencies............................... 28,080 2 (733) 27,349 Corporate obligations.......................................... 8,288 18 (190) 8,116 Other.......................................................... 1,006 (1) 1,005 ---------- ----------- ----------- ---------- Total long-term.............................................. 37,374 20 (924) 36,470 ---------- ----------- ----------- ---------- Classified as restricted investments: U.S. Government and its agencies............................... 85,841 46 (2,405) 83,482 Corporate obligations.......................................... 5,948 24 (269) 5,703 Certificates of deposit........................................ 1,025 1,025 Money market funds............................................. 289 289 ---------- ----------- ----------- ---------- Total restricted............................................. 93,103 70 (2,674) 90,499 ---------- ----------- ----------- ---------- Total...................................................... $ 318,796 $ 206 $ (4,114) $ 314,888 ---------- ----------- ----------- ---------- ---------- ----------- ----------- ---------- JUNE 30, 1995: Classified as short-term: U.S. Government and its agencies............................... $ 117,913 $ 382 $ (619) $ 117,676 Corporate obligations.......................................... 22,503 (175) 22,328 Municipal obligations.......................................... 11,605 25 (20) 11,610 Other.......................................................... 5,649 12 (55) 5,606 ---------- ----------- ----------- ---------- Total short-term............................................. 157,670 419 (869) 157,220 ---------- ----------- ----------- ---------- Classified as long-term: U.S. Government and its agencies............................... 49,329 438 (1,493) 48,274 Corporate obligations.......................................... 15,257 74 (114) 15,217 Other.......................................................... 8,072 4 (75) 8,001 ---------- ----------- ----------- ---------- Total long-term.............................................. 72,658 516 (1,682) 71,492 ---------- ----------- ----------- ---------- Classified as restricted investments: U.S. Government and its agencies............................... 103,454 645 (1,722) 102,377 Certificates of deposit........................................ 2,575 9 2,584 Money market funds............................................. 515 6 521 ---------- ----------- ----------- ---------- Total restricted............................................. 106,544 660 (1,722) 105,482 ---------- ----------- ----------- ---------- Total...................................................... $ 336,872 $ 1,595 $ (4,273) $ 334,194 ---------- ----------- ----------- ---------- ---------- ----------- ----------- ----------
48 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Realized gains and (losses) on available-for-sale investments are calculated on the specific identification method and were $1,498,000 and ($277,000), respectively, in fiscal year 1996 and $5,232,000 and ($880,000), respectively, in fiscal year 1995. The contractual maturities of short-term, long-term, and restricted investments at June 30, 1996, were as follows:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (AMOUNTS IN THOUSANDS) Due within one year............................................................. $ 125,342 $ 125,031 Due after one year, but within five years....................................... 145,193 144,101 Due after five years, but within ten years...................................... 32,525 30,387 Due after ten years............................................................. 15,736 15,369 ---------- ---------- Total contractual maturities.................................................... $ 318,796 $ 314,888 ---------- ---------- ---------- ----------
The Company also determined that investments, classified as short-term, are available for use in current operations and, accordingly, classified such investments as current assets without regard to the investments' contractual maturity dates. The fair value of short-term, long-term and restricted investments is estimated based on quoted market prices. NOTE 3--PROPERTY AND EQUIPMENT Property and equipment consist of the following:
JUNE 30, ---------------------- 1996 1995 ---------- ---------- (AMOUNTS IN THOUSANDS) Land............................................................................ $ 28,623 $ 26,002 Buildings....................................................................... 59,049 60,231 Leasehold improvements.......................................................... 49,085 42,779 Equipment and fixtures.......................................................... 245,438 232,250 Construction in progress........................................................ 2,408 9,920 ---------- ---------- 384,603 371,182 Less accumulated depreciation and amortization.................................. 153,175 141,417 ---------- ---------- Total property and equipment, net............................................... $ 231,428 $ 229,765 ---------- ---------- ---------- ----------
Total depreciation and amortization expense related to property and equipment was $39,679,000, $48,559,000 and $39,987,000 for fiscal years 1996, 1995 and 1994, respectively. 49 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4--MEDICAL CLAIMS PAYABLE Activity in the liability for medical claims payable is summarized below:
(AMOUNTS IN THOUSANDS) ------------- BALANCE AT JULY 1, 1993.................................................................. $ 149,060 Incurred related to: Current year--1994................................................................... 610,904 Prior years.......................................................................... 1,561 ------------- Total incurred......................................................................... 612,465 Paid related to: Current year--1994................................................................... (461,122) Prior years.......................................................................... (137,435) ------------- Total paid............................................................................. (598,557) ------------- TakeCare, Inc. medical claims payable (Note 12)........................................ 120,644 ------------- BALANCE AT JUNE 30, 1994................................................................. 283,612 Incurred related to: Current year--1995................................................................... 1,140,842 Prior years.......................................................................... 15,530 ------------- Total incurred......................................................................... 1,156,372 ------------- Paid related to: Current year--1995................................................................... (842,310) Prior years.......................................................................... (256,452) ------------- Total paid............................................................................. (1,098,762) ------------- BALANCE AT JUNE 30, 1995................................................................. 341,222 Incurred related to: Current year--1996................................................................... 1,333,948 Prior years.......................................................................... 18,052 ------------- Total incurred......................................................................... 1,352,000 ------------- Paid related to: Current year--1996................................................................... (1,017,199) Prior years.......................................................................... (308,151) ------------- Total paid............................................................................. (1,325,350) ------------- BALANCE AT JUNE 30, 1996................................................................. $ 367,872 ------------- -------------
NOTE 5--OTHER LIABILITIES From January 1984 through March 1986, the Company maintained commercial insurance on a claims occurrence basis with nominal deductibles. From April 1986 through May 1996, the Company maintained commercial insurance on a claims made basis. For this period, the Company's policy provided $50,000,000 of professional liability insurance with self-insured retention of $2,000,000 per occurrence and $12,000,000 per year in the aggregate. Effective May 31, 1996, the Company procured $50,000,000 of professional liability insurance on a claims made basis with a $100,000 deductible per occurrence. Effective February 15, 50 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1996, Talbert purchased $50,000,000 of separate professional liability insurance with no annual deductibles for coverage on a claims made basis. For the period during which the Company was self-insured, the Company continues to maintain reserves for professional liability claims, including deductibles. These reserves have been actuarially computed on a present value basis using a discount rate of 7% and amount to approximately $37,284,000 and $35,525,000 at June 30, 1996 and 1995, respectively. Such amounts are allocated between other current liabilities and other liabilities based on estimates of the amounts of claims which are expected to be paid during the subsequent fiscal year (Note 9). Other liabilities also include approximately $29,043,000 and $30,001,000 of reserves for losses and loss adjustment expenses at June 30, 1996 and 1995, respectively, associated with the Company's insurance operations. These reserves are estimates based on actuarial computations and industry standards for the eventual costs of claims incurred but not settled, less estimated reinsurance recoverable from policies in effect with third party reinsurers. As claims are settled, as amounts required to settle become known, and as anticipated claims are actuarially revised, the professional liability and loss reserve expenses and liabilities are adjusted accordingly. NOTE 6--LONG-TERM OBLIGATIONS Long-term obligations consist of the following:
JUNE 30, ------------------------- 1996 1995 ------------- ---------- (AMOUNTS IN THOUSANDS) 7% Senior Notes due September 2003, interest payable semi-annually........... $ 100,000 $ 100,000 Term loan under bank credit agreement, due in semi-annual installments of $15,000,000 plus interest, at floating rates averaging 5.8% and 6.5% in 1996 and 1995, respectively................................................ 34,000 150,000 Revolving loan under bank credit agreement................................... 115,000 Other........................................................................ 281 2,985 ------------- ---------- Total.................................................................... 134,281 367,985 Less current portion....................................................... 30,097 30,168 ------------- ---------- Total long-term obligations................................................ $ 104,184 $ 337,817 ------------- ---------- ------------- ----------
Scheduled maturities of long-term obligations are as follows:
(AMOUNTS IN YEARS ENDING JUNE 30: THOUSANDS) - ------------------------------------------------------------------------------- ------------- 1997........................................................................... $ 30,097 1998........................................................................... 4,034 1999........................................................................... 119 2000........................................................................... 31 2001........................................................................... Later years.................................................................... 100,000 ------------- Total scheduled maturities..................................................... $ 134,281 ------------- -------------
51 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company has a $350 million credit agreement, as amended, ("Credit Agreement") with a syndicate of banks which provides a $200 million revolving credit facility and a $150 million term loan facility. The Credit Agreement expires March 31, 2000. Prime rate, London Interbank Offered Rate based, or competitive bid (revolving credit facility only) interest rate options are available for borrowings under the Credit Agreement. In addition, a facility fee of 0.125% is payable, regardless of usage, on the $200 million revolving credit facility portion of the Credit Agreement. The Credit Agreement contains financial and other covenants. The Company was in compliance with these covenants as of June 30, 1996. NOTE 7--INCOME TAXES The components of the provision for income taxes are summarized as follows:
YEARS ENDED JUNE 30, ------------------------------- 1996 1995 1994 --------- --------- --------- (AMOUNTS IN THOUSANDS) Current: Federal.............................................................. $ 52,186 $ 53,965 $ 27,806 State................................................................ 11,110 12,590 5,999 Guam................................................................. 357 1,457 1,075 --------- --------- --------- Total current provision................................................ 63,653 68,012 34,880 --------- --------- --------- Deferred: Federal.............................................................. (8,633) (20,964) 2,201 State................................................................ (1,056) (4,154) 429 --------- --------- --------- Total deferred (benefit) provision..................................... (9,689) (25,118) 2,630 --------- --------- --------- Total provision for income taxes....................................... $ 53,964 $ 42,894 $ 37,510 --------- --------- --------- --------- --------- ---------
The provision for income taxes differs from the amount of tax determined by applying the Federal statutory rate to pretax income. The components of this difference are summarized as follows:
YEARS ENDED JUNE 30, ---------------------------------------------------------------------------- 1996 1995 1994 ------------------------ ------------------------ ------------------------ AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT --------- ------------- --------- ------------- --------- ------------- (AMOUNTS IN THOUSANDS) Taxes on income at Federal statutory tax rate.... $ 34,341 35% $ 28,065 35% $ 33,887 35% State income taxes, net of Federal tax benefit... 6,535 7 5,484 6 4,178 4 Goodwill amortization............................ 9,841 10 8,573 11 Other, net....................................... 3,247 3 772 1 (555) -- -- -- --------- --------- --------- Total provision for income taxes................. $ 53,964 55% $ 42,894 53% $ 37,510 39% -- -- -- -- -- -- --------- --------- --------- --------- --------- ---------
52 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The tax effects of significant items comprising the Company's net deferred tax assets are as follows:
JUNE 30, ---------------------- 1996 1995 ---------- ---------- (AMOUNTS IN THOUSANDS) Deferred tax assets: Reserves not currently deductible............................................. $ 55,649 $ 30,270 Restructuring charges......................................................... 10,275 37,974 Vacation and other deferred compensation...................................... 7,656 6,125 State income taxes............................................................ 403 (99) Other......................................................................... 137 660 ---------- ---------- Total deferred tax assets................................................... 74,120 74,930 Deferred tax liabilities: Difference between book and tax bases of property............................. (11,122) (21,939) ---------- ---------- Net deferred tax assets..................................................... $ 62,998 $ 52,991 ---------- ---------- ---------- ----------
Management believes that no valuation allowance was required as of and for the years ended June 30, 1996 and 1995. NOTE 8--EMPLOYEE BENEFITS The Company has a defined contribution pension plan ("Pension Plan") and an Employee Stock Ownership Plan ("ESOP") covering substantially all employees. Under the provisions of these plans, the Company contributed into trusts for the benefit of employees an amount equal to 12% of eligible annual compensation, as defined, of all plan participants (8% to the Pension Plan and 4% to the ESOP). The Company's ESOP contribution is discretionary. Effective January 1, 1995, the contribution rate was reduced to 8% of eligible annual compensation, as defined (6% to the Pension Plan and 2% to the ESOP). Effective January 1, 1996, the Company ceased to make contributions to the Pension Plan. All participants in the Pension Plan vested as of December 31, 1995. The Company continued to contribute 2% to the ESOP. Participants in the ESOP do not vest until they have completed five years of service with the Company. Nonvested contributions, which are forfeited upon an employee's termination, are treated as a reduction in the amount of the Company's contribution. The Company currently makes quarterly contributions to the ESOP to fund quarterly purchases of Company Common Stock by the ESOP on the open market. For fiscal years 1996, 1995 and 1994, the Company contributed $6,395,000, $9,315,000 and $9,140,000, respectively, for this purpose. The combined contribution expenses for the Pension Plan and ESOP (including the Company 401(k) match discussed below) were $20,954,000, $32,844,000 and $35,020,000 for fiscal years 1996, 1995 and 1994, respectively. The ESOP has a 401(k) feature whereby employees may voluntarily contribute before-tax earnings and receive matching Company contributions. The 401(k) offers several investment choices. Employees vest in the Company match after five years of service. Before January 1, 1996, employees could contribute between 1% and 10% of eligible compensation (1% to 5% for highly compensated employees). Employee contributions invested in the Company's Common Stock were matched by the Company at the rate of $0.25 per $1.00, up to a maximum of $500 per year. Effective January 1, 1996, the maximum employee contribution for highly compensated employees increased to 6%. Also, Company matching contributions increased to $0.50 per $1.00 up to a maximum of 6% of eligible compensation for employees with less than five years of service and increased to $1.00 per $1.00 up to a maximum of 6% of eligible compensation for employees with five or more years of service. 53 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In March 1996, approximately 8% of the stock in Talbert was purchased by certain management employees of Talbert and the Company for $0.01 per share. Shares held by the management employees are restricted and vest incrementally each July 1 until July 1, 1999, conditional upon attaining certain operating results and the passing of certain prospective dates. Also, Talbert established a non-qualified stock option plan for the purpose of retaining certain key employees. Under an Executive Incentive Plan (the "Plan"), the Company is authorized to grant restricted stock awards, incentive stock options, nonqualified stock options, and bonus awards to directors, officers, key employees, consultants, and other agents. Under the terms of the Plan, the exercise price of the stock options must be equal to the fair market value of the Company's Common Stock at the date of grant. All stock options granted by the Company through June 30, 1996, were nonqualified. Beginning July 1, 1992, the first of a series of four annual stock option grants were made to certain executives under the Plan. These grants are intended to provide a strong linkage between long-term incentives and the Company's financial performance. Accelerated vesting of each of these stock options is tied directly to growth in the Company's earnings per share ("EPS"). Stock options for 180,000, 300,000, 435,000 and 1,085,000 shares were granted under this plan on July 1, 1995, 1994, 1993 and 1992, respectively. Each year's stock option grant allows the optionee up to six consecutive annual opportunities for accelerated vesting of portions of the employee's stock options only if the Company's EPS exceeds both: (1) EPS for the previous fiscal year and (2) average EPS for the two previous fiscal years. The terms of accelerated vesting for 70%, 45%, 25% and 10% of the stock options granted on July 1, 1992, 1993, 1994 and 1995 were met. If a stock option in the series does not become subject to accelerated vesting by the sixth anniversary of its grant, the stock option automatically becomes vested on the seventh anniversary of its grant. The Company issued stock options to certain executives under the Plan on July 1, 1996. Upon consummation of the Merger Agreement with PacifiCare (Note 14), all unvested options under the Plan will convert into equivalent options in PacifiCare. The accelerated vesting feature discussed above will be replaced with annual vesting in four equal installments, beginning July 1, 1997. In addition to the options described above, the Company has granted other options. All options granted are included in the following summary of stock option activity for fiscal years 1996, 1995 and 1994:
YEARS ENDED JUNE 30, ---------------------------------------------- 1996 1995 1994 -------------- -------------- -------------- Outstanding at beginning of year....................................... 4,342,000 4,641,000 2,386,000 Granted.............................................................. 394,000 812,000 2,830,000 Cancelled............................................................ (438,000) (471,000) (219,000) Exercised............................................................ (486,000) (640,000) (356,000) -------------- -------------- -------------- Outstanding at end of year............................................. 3,812,000 4,342,000 4,641,000 -------------- -------------- -------------- -------------- -------------- -------------- Exercisable at end of year............................................. 863,000 824,000 390,000 -------------- -------------- -------------- -------------- -------------- -------------- Price range of options outstanding at end of year...................... $1.16-$31.19 $1.16-$29.25 $1.16-$28.25 Price range of options exercised....................................... $1.16-$27.63 $1.16-$27.63 $2.73-$27.63
At June 30, 1996, 1,224,000 shares remained available under the Plan for future grants of stock awards and stock options. Outstanding stock options at June 30, 1996, expire at the earlier of the date the stock option holder ceases to be an employee or a director, or ten years after the date of grant, based on the date of grant of the original stock options. The Company established a deferred compensation plan (the "DCP") effective January 1, 1996 (replacing the FHP, Inc. Deferred Compensation Plan for Executives and Physicians which was terminated 54 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) as of December 31, 1995), for certain of its executives, physicians and non-employee directors, which is designed to provide supplemental retirement income benefits. Employee participants in the DCP may elect to defer receipt of up to 50% of their gross annual salaries and 100% of their gross annual bonuses. Amounts deferred by employees are included in other liabilities and these deferred amounts are deemed to be invested in one or more mutual funds selected by the participants. The DCP provides that non-employee directors may defer 0% to 100% of their annual director fees, retainer fees and committee fees into the DCP. Amounts deferred by employees and non-employee directors earn interest at a stated Crediting Rate. The DCP provides a Crediting Rate for the 1996 plan year equal to the Moody's Corporate Bond Yield Average (currently 7.6%). The DCP Committee has the discretion to provide a Premium Rate in addition to the Crediting Rate. The Crediting Rate, when added to the Premium Rate, equals the Preferred Rate. The Premium Rate and Preferred Rate are declared for the coming year in October prior to the annual deferral elections. The Premium Rate declared for the 1996 plan year is an additional 20% of the Crediting Rate, making the Preferred Rate for the 1996 plan year 9.1%. The Preferred Rate vests after 5 years of service. Upon a change in control of the Company, the participants will immediately be vested in the Preferred Rate. The Company established an Employee Stock Purchase Plan ("ESPP") in January 1995. The ESPP provides employees of the Company with an opportunity to purchase the Company's Common Stock annually with after tax income set aside through payroll deductions. Eligible employees may set aside up to a specified amount from annual compensation to purchase shares of the Company's Common Stock at 85% of the market price on the last day of each annual offering period. In December 1995 and January 1996, 82,845 shares of the Company's Common Stock were issued to participants in the ESPP. NOTE 9--COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company leases certain buildings and equipment under operating leases. Future minimum rental payments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year as of June 30, 1996, are as follows:
(AMOUNTS IN YEARS ENDING JUNE 30: THOUSANDS) - ----------------------------------------------------------------------------------------- ------------- 1997..................................................................................... $ 28,700 1998..................................................................................... 22,641 1999..................................................................................... 16,527 2000..................................................................................... 12,944 2001..................................................................................... 10,693 Later years.............................................................................. 34,576 ------------- Total minimum payments required...................................................... $ 126,081 ------------- -------------
Total rental expense on operating leases aggregated $34,111,000, $34,956,000 and $28,663,000 for fiscal years 1996, 1995 and 1994, respectively. OPM AUDIT 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 55 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. As previously disclosed, in May 1993, after conducting an audit of the Company's FEHBP contracts covering primarily the years 1987 through 1991, OPM sent a draft audit report to the Company alleging certain defective rating practices in certain regions. 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. Also, the Company evaluated the availability of offsets and established reserves pending issuance of a final audit report or further correspondence from OPM. A final audit report has never been issued and the Company received no further correspondence from the Government regarding the draft audit report until the third quarter of fiscal year 1996. In the third quarter of fiscal year 1996, the United States Department of Justice (the "Government") notified the Company that based on the OPM draft audit report and discussions with OPM personnel, the Government believed that the Company may have violated the False Claims Act in its certifications to OPM that the FEHBP received community rates for health care services provided in certain regions during 1987 through 1991. No action has been commenced by the Government, although the Government asserted in correspondence with the Company dated April 25, 1996 that, at that time, the Government 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 Government has indicated that it does not have any information that would lead it to believe that the Company violated any criminal laws. Accordingly, 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 for the years 1987 through 1991, discussed above, which have been and may be asserted in relation to the Company's contracts with OPM and for possible OPM claims for subsequent years through 1996. The addition to reserves resulted in a third quarter charge to net earnings of $0.68 per share. LITIGATION 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 of the Company 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 10--STOCKHOLDERS' EQUITY The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, par value $0.05 per share and 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"). As a result of the acquisition of TakeCare as of June 17, 1994, the Company issued 6,311,781 shares of Common Stock, 21,031,733 shares of Series A Preferred Stock and 32,850 shares of Series B Preferred Stock (Note 12). An additional 5,545 shares of Common Stock, 8,574 shares of Series A Preferred Stock, and 46,368 shares of 56 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Series B Preferred Stock were issued during fiscal year 1995 to TakeCare shareholders for shares which were not presented at the acquisition date. During fiscal year 1996, the Company redeemed all issued and outstanding Series B Preferred Stock for $1,980,000 at $25 per share plus accrued and unpaid dividends through the redemption date. Holders of the Series A Preferred Stock are entitled to receive cumulative cash dividends of 5.0% per annum. Dividends are payable quarterly in arrears when and if declared by the Company's Board of Directors. On or after the fourth anniversary of the TakeCare acquisition, the Company may, at its option, redeem all or part of the outstanding shares of Series A Preferred Stock, at fixed redemption prices per share plus an amount equal to any accrued and unpaid dividends. Each share of Series A Preferred Stock is convertible at the option of the holder into the Company's Common Stock at any time. The conversion price for the Series A Preferred Stock is $31 per share. In June 1990, the Board of Directors of the Company declared a dividend of one common share purchase right (a "Right") for each outstanding share of Common Stock to the holders of record on June 29, 1990, and authorized and directed the issuance of one Right with respect to each share of Common Stock that shall become outstanding prior to the occurrence of certain terminating events. Each Right entitles the registered holder to purchase from the Company one-fourth of a share of Common Stock at a price which varies based on the market price of a share of the Company's stock ($27.375 at June 30, 1996), subject to adjustment (the "Purchase Price"). Upon the occurrence of certain events associated with an unsolicited takeover attempt of the Company, the Rights will become exercisable and will cease to automatically trade with the Common Stock. Thereafter, upon the occurrence of certain further triggering events, each Right will become exercisable, at an adjusted Purchase Price (the "Adjusted Purchase Price") equal to four times the Purchase Price immediately prior to such adjustment, for that number of shares of Common Stock having a market value of two times such Adjusted Purchase Price. The Rights have certain anti-takeover effects that will cause substantial dilution to a person or group that attempts to acquire the Company in a manner which causes the Rights to become exercisable. The terms of the Rights may be amended by the Board of Directors of the Company without the consent of the holders of the Rights. At June 30, 1996, there was one Right outstanding for each share of Common Stock outstanding and a sufficient number of authorized but unissued shares of Common Stock available for issuance upon: (i) the exercise of the Rights; (ii) the issuance of Common Stock (and associated Rights) in connection with the future exercise of outstanding stock options; and (iii) the issuance of Common Stock (and associated Rights) in connection with the future conversion of the Series A Preferred Stock. The Rights will be cancelled on or before consummation of the Merger Agreement with PacifiCare (Note 14). NOTE 11--EARNINGS PER SHARE ATTRIBUTABLE TO COMMON STOCK Earnings per share for fiscal years 1996, 1995 and 1994 were computed by dividing net income attributable to Common Stock by 41,524,000, 41,057,000 and 34,051,000 shares, respectively, which represent 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. Primary and fully diluted earnings per share are the same for each year presented. 57 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12--ACQUISITION OF TAKECARE The Company acquired all of the outstanding Common Stock of TakeCare on June 17, 1994, for a combination of stock and cash in a transaction treated as a purchase for accounting purposes. The consolidated financial statements include the operations of TakeCare beginning June 17, 1994. The purchase price was approximately $1,054.4 million, net of acquisition costs (Note 10). As a result of the purchase, the Company recorded goodwill of approximately $1,078.0 million. NOTE 13--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, a reduction in workforce, and the creation of Talbert, which 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. In addition, the Board of Directors decided to sell the Company's two acute care hospitals and other nonproductive real estate. The restructuring plan included a significant reduction in the Company's workforce, resulting in separation expenses for displaced employees. Accordingly, the Company recorded pretax restructuring charges of $9.7 million ($6.0 million, net of tax) and $75.1 million ($46.6 million, net of tax) in the accompanying Consolidated Statements of Income for the fiscal years ended June 30, 1996 and 1995, respectively. The charges included the expected costs of employee separations ($11.5 million), asset write-downs to estimated net realizable values ($58.9 million), and certain other costs associated with the Company's restructuring of its operations ($14.4 million). Assets identified as those to be sold as part of the restructuring were reclassified as assets held for sale in the accompanying Consolidated Balance Sheets as of June 30, 1996 and 1995. The hospitals and other assets were sold during fiscal year 1996 and the transactions had no material impact on earnings. The Company has made adequate provision for matters such as final settlement of purchase price adjustments related to the sales of the hospitals and other facilities. The restructuring charges were based on the Company's estimates and were refined throughout fiscal year 1996. During fiscal year 1996, the restructuring reserve was increased by the $9.7 million charge described above and decreased by $10.1 million. There was no significant change in the aggregate in estimates with respect to accruals previously established. NOTE 14--SUBSEQUENT EVENT 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"). In the 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. 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. Each outstanding share of the Company's Series A Preferred 58 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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, each share 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 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. The Merger Agreement had no effect on the Company's fiscal year 1996 results. PacifiCare 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. NOTE 15--INFORMATION REGARDING THE COMPANY'S OPERATIONS IN DIFFERENT SEGMENTS The Company offers a wide range of products to achieve its strategic goal of becoming a sole source provider of health care services. These products have been separated into three principal segments of business as a result of the Company's Restructuring Plan: the HMO, Talbert and insurance and related services. Talbert provides primary health care services to HMO members in medical and dental centers formerly operated as a part of the Company's staff model operations. The HMO offers a wide range of related products to consumers and employers in the direct delivery of managed health care services, either through contracted health care providers or through medical centers managed by Talbert. The insurance segment products include traditional indemnity health and life insurance, workers' compensation, and third party administration of self-insured employer programs (collectively, the "Insurance Group"). Often, the products offered by the HMO and insurance segments are sold to the same account; that is, an employer is able to offer a "dual choice" to its employees of enrollment in either the HMO or the indemnity product provided through group health insurance coverage. 59 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Information regarding the three segments is summarized below:
YEARS ENDED JUNE 30, ---------------------------------------------- 1996 1995 1994 -------------- -------------- -------------- (AMOUNTS IN THOUSANDS) Revenue: HMO............................................. $ 4,024,589 $ 3,643,572 $ 1,915,964 Talbert (a)..................................... 458,939 534,855 481,553 Insurance Group................................. 103,895 146,387 109,126 Corporate and eliminations...................... (408,139) (415,434) (33,685) -------------- -------------- -------------- Total revenue..................................... $ 4,179,284 $ 3,909,380 $ 2,472,958 -------------- -------------- -------------- -------------- -------------- -------------- Pretax income (loss): HMO (b)......................................... $ 199,431 $ 219,899 $ 141,996 Talbert (a)(b).................................. (19,249) (29,363) (16,696) Insurance Group (b)............................. (9,171) (10,475) 8,076 Corporate....................................... (87,927) (105,982) (50,356) Interest income, net............................ 15,033 6,107 13,800 -------------- -------------- -------------- Total pretax income............................... $ 98,117 $ 80,186 $ 96,820 -------------- -------------- -------------- -------------- -------------- -------------- Assets: HMO (c)......................................... $ 1,803,785 $ 1,794,423 $ 1,875,075 Talbert (a)(c).................................. 165,575 128,909 141,049 Insurance Group................................. 156,854 181,909 167,092 Corporate and eliminations...................... (112,335) 210,575 (13,947) -------------- -------------- -------------- Total assets...................................... $ 2,013,879 $ 2,315,816 $ 2,169,269 -------------- -------------- -------------- -------------- -------------- -------------- Depreciation and amortization: HMO............................................. $ 46,528 $ 51,486 $ 20,780 Talbert (a)..................................... 12,361 15,790 14,504 Insurance Group................................. 1,410 1,348 1,399 Corporate....................................... 11,444 11,441 8,588 -------------- -------------- -------------- Total depreciation and amortization............... $ 71,743 $ 80,065 $ 45,271 -------------- -------------- -------------- -------------- -------------- -------------- Capital expenditures: HMO (c)......................................... $ 20,939 $ 35,376 $ 72,509 Talbert (a)(c).................................. 3,489 Insurance Group................................. 759 1,684 3,287 Corporate....................................... 32,930 35,036 10,256 -------------- -------------- -------------- Total capital expenditures........................ $ 58,117 $ 72,096 $ 86,052 -------------- -------------- -------------- -------------- -------------- --------------
- ------------------------ (a) Talbert reflects the operation of the physician practice management company and several medical and dental professional corporations located in Arizona, California, Nevada, New Mexico and Utah, from January 1, 1996. Information prior to this date was obtained from the financial records maintained by subsidiaries of the Company responsible for the Company's equivalent staff model operations derived on a consistent basis. (b) Segments include recognition of allocated costs for information services necessary to support operations. (c) All capital expenditures for either HMO operations or Talbert's predecessor staff model operations were attributed to the HMO prior to January 1, 1996. Talbert has entered into a lease agreement with the HMO for medical and dental centers and equipment effective January 1, 1996. The segment data assumes this lease was in effect for all years presented. 60 FHP INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 16--UNAUDITED QUARTERLY INFORMATION
QUARTERS ENDED -------------------------------------------------------------- SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 -------------- -------------- -------------- -------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Year ended June 30, 1996: Revenue......................................... $ 1,004,633 $ 1,015,746 $ 1,061,395 $ 1,097,510 Operating income (loss) (a)(d)(e)............... 23,932 23,159 (5,709) 41,702 Income (loss) before income taxes (a)(d)(e)..... 26,644 26,359 (1,375) 46,489 Net income (loss) (a)(d)(e)..................... 13,927 13,921 (5,132) 21,437 Primary earnings (loss) per share attributable to Common Stock (a)(b)(d)(e).................. $0.18 $0.18 $(0.28) $0.35 Year ended June 30, 1995: Revenue......................................... $ 954,340 $ 954,407 $ 1,001,062 $ 999,571 Operating income (loss) (c)..................... 37,236 38,660 50,960 (52,777) Income (loss) before income taxes (c)........... 38,371 39,494 52,613 (50,292) Net income (loss) (c)........................... 20,720 21,327 28,411 (33,166) Primary earnings (loss) per share attributable to Common Stock (c)........................... $0.37 $0.36 $0.53 $(0.97) Fully diluted earnings per share (b)............ $0.36 $0.49
- ------------------------ (a) The net loss for the third quarter ended March 31, 1996 included an unfavorable adjustment due to a charge of $28.7 million, net of tax, relating to the Company's contracts with OPM (Note 9). (b) Fully diluted earnings per share is not presented if it is anti-dilutive. (c) The net loss for the fourth quarter ended June 30, 1995 included an unfavorable net adjustment due to a restructuring charge of approximately $46.6 million, net of tax, relating primarily to the costs of employee separations, asset write-downs to estimated net realizable values, and certain other costs associated with the restructuring of the Company's operations (Note 13). (d) Net income for the fourth quarter ended June 30, 1996 included an unfavorable net adjustment of $5.0 million due to a claim by HCFA for end stage renal disease reimbursement that the Company had been overpaid for certain services for the three year period then ended. Also in the fourth quarter, the Company recorded approximately $5.2 million, net of tax, for favorable adjustments associated primarily with the collection of additional revenue from OPM and changes of estimates with respect to certain fiscal year 1996 compensation and benefit related accruals and reserves for professional liability claims. (e) Net income for the first and second quarters of fiscal 1996 included an unfavorable adjustment due to restructuring charges of approximately $3.6 million, net of tax, and $2.4 million, net of tax, relating primarily to the cost of employee separations and certain other costs associated with restructuring of the Company's operations (Note 13). 61 INDEPENDENT AUDITORS' REPORT FHP International Corporation: We have audited the accompanying consolidated balance sheets of FHP International Corporation and its subsidiaries as of June 30, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of FHP International Corporation and its subsidiaries at June 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1996 in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP Costa Mesa, California September 4, 1996 62 INDEX TO EXHIBITS
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE - ----------- ---------------------------------------------------------------------------------------- ----------------- *3.1 Restated Certificate of Incorporation of FHP International Corporation (Exhibit 3.1 to Form S-4 No. 33-53431). * *3.2 Amendment to Restated Certificate of Incorporation of FHP International Corporation (Exhibit 3.2 to Form S-4 No. 33-53431). * *3.3 Certificate of Designation for Series A Cumulative Convertible Preferred Stock of FHP International Corporation. (Exhibit 3.3 to Form 8-K, filed with the Commission on July 1, 1994). * *3.4 Bylaws of FHP International Corporation as amended to date. * *4.1 Specimen Common Stock Certificate (Exhibit 4.1 to Form S-3 Registration Statement No. 33-39984). * *4.2 Indenture dated as of September 22, 1993 between Registrant and The Chase Manhattan Bank, N.A. in regard to $100,000,000 7% Senior Notes due 2003. (Exhibit 4.2 to Form 10-K for the Fiscal Year Ended June 30, 1993). * *4.3 Credit Agreement dated as of March 24, 1994, among the Registrant, the Lenders named therein and Chemical Bank as Administrative Agent (Exhibit 10.1 to Form 8-A filed with the Commission on May 9, 1994). * *4.4 First Amendment dated as of March 31, 1995, to Credit Agreement dated as of March 24, 1994. (Exhibit 4.4 to Form 10-K for the Fiscal Year Ended June 30, 1995). * *4.5 Second Amendment dated as of August 29, 1995, to Credit Agreement dated as of March 24, 1994. (Exhibit 4.5 to Form 10-K for the Fiscal Year Ended June 30, 1995). * *4.6 Third Amendment, dated as of May 2, 1996, to Credit Agreement dated March 24, 1994 (Exhibit 10.3 to Form 10-Q for the Quarter Ended March 31, 1996). * 4.7 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 the total assets of Registrant. *10.1 Health Insurance Benefits for the Aged and Disabled Contracts dated January 1, 1992 between FHP, Inc. and the Secretary of Health and Human Services (Exhibit 10.2 to Form 10-K for the Fiscal Year Ended June 30, 1992). * *10.2 Group Health Benefits Contract dated January 1, 1986 between FHP, Inc. and the Federal Office of Personnel Management (Exhibit 10.3 to Form S-1 Registration Statement No. 33-5596). * *10.3 Form of Employment Agreement, dated as of February 1, 1996, by and between the Registrant and Gloria L. Austin, Robert N. Franklin, Larry D. Gray (dated April 8, 1996), Burke F. Gumbiner, Jeffrey H. Margolis, Jack D. Massimino, Roger L. Moseley (dated August 5, 1996), Kenneth S. Ord, Westcott W. Price III, Eric D. Sipf and Michael J. Weinstock (Exhibit 10.1 to Form 10-Q for the Quarter Ended March 31, 1996). *
63
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE - ----------- ---------------------------------------------------------------------------------------- ----------------- *10.4 FHP International Corporation Amended & Restated Executive Incentive Plan (Exhibit A to Definitive Proxy Statement dated October 18, 1995). * *10.5 FHP Money Purchase Pension Plan, as amended and restated June 7, 1993. (Exhibit 10.12 to Form 10-K for the Fiscal Year Ended June 30, 1993). * *10.6 FHP International Corporation Employee Stock Ownership Plan, as amended and restated June 7, 1993. (Exhibit 10.13 to Form 10-K for the Fiscal Year Ended June 30, 1993). * *10.7 FHP, Inc. Deferred Compensation Plan for Executives and Physicians, dated June 28, 1991. (Exhibit 10.14 to Form 10-K for the Fiscal Year Ended June 30, 1993). * *10.8 FHP International Corporation/TakeCare, Inc. Stock Option Plan (successor to the TakeCare, Inc. Amended and Restated 1990 Stock Option Plan and the TakeCare, Inc. 1993 Stock Option Plan) (Exhibit 4 to Form S-8 Registration Statement No. 33-54313). * *10.9 TakeCare Savings and Retirement Plan and Trust Agreement (1992 Restatement) (Exhibit 4.1 to Form S-8 Registration Statement No. 33-55545). * *10.10 Amendment No. 1 to the TakeCare Savings and Retirement Plan and Trust Agreement (1992 Restatement) (Exhibit 4.2 to Form S-8 Registration No. 33-55545). * *10.11 Amendment No. 2 to the TakeCare Savings and Retirement Plan and Trust Agreement (Exhibit 4.3 to Form S-8 Registration Statement No. 33-55545). * *10.12 FHP International Corporation Employee Stock Purchase Plan (Exhibit 4.1 to Form S-8 Registration No. 33-56651). * *10.13 Amended and Restated Rights Agreement evidencing rights to purchase Common Stock of Registrant (Exhibit 1 to Form 8-A/A filed with the Commission on April 5, 1994). * *10.14 Stock Purchase Agreement, dated as of March 15, 1996, by and among the Registrant, Talbert Medical Management Corporation, Kathryn M. Adair, Gloria L. Austin, William P. Bracciodieta, Larry L. Georgopolis, Gary E. Goldstein, Richard D. Jacobs, R. Judd Jessup, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter and Michael J. Weinstock (Exhibit 10.2 to Form 10-Q for the Quarter Ended March 31, 1996). * 10.15 Amendment No. 1 dated May 31, 1996, to Stock Purchase Agreement dated as of March 15, 1996, by and among the Registrant, Talbert Medical Management Corporation, Kathryn M. Adair, Gloria L. Austin, William P. Bracciodieta, Larry L. Georgopolous, Gary E. Goldstein, Richard D. Jacobs, R. Judd Jessup, Jack D. Massimino, Barbara C. McNutt, Kenneth S. Ord, Westcott W. Price III, Walter R. Stone, Margaret Van Meter and Michael J. Weinstock. 10.16 FHP International Corporation Deferred Compensation Plan, dated as of January 1, 1996. 10.17 FHP International Corporation Deferred Compensation Plan Master Trust Agreement, dated as of January 1, 1996, by and between the Registrant and Wells Fargo Bank, N.A.
64
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE - ----------- ---------------------------------------------------------------------------------------- ----------------- *10.18 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). * *10.19 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). * 11.1 Computation of earnings per common share for the years ended June 30, 1996, 1995 and 1994. 21.0 Subsidiaries of the Registrant. 23.1 Independent Auditors' Consent. 27.0 Financial Data Schedule.
- ------------------------ * Document has previously been filed with the Commission and is incorporated by reference and made a part hereof. The Registrant will furnish any of the foregoing exhibits upon the payment of a reasonable fee based upon the Registrant's expenses in furnishing such exhibit(s). Written inquiries should be addressed to FHP International Corporation, Investor Relations Department, P.O. Box 25186, Santa Ana, California 92799-5186. 65 EX-10.15 2 STOCK PURCHASE AGMT. AMENDMENT NO. 1 TO STOCK PURCHASE AGREEMENT This AMENDMENT NO. 1 TO STOCK PURCHASE AGREEMENT, dated as of May 31, 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 , William P. Bracciodieta, Larry L. Georgopolous, Gary E. Goldstein, M.D., Richard D. Jacobs , R. Judd Jessup, Jack D. Massimino ("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 (the "Stock Purchase Agreement"); and WHEREAS, the Management Stock has not yet been issued to the Management Investors pursuant to the Stock Purchase Agreement; and WHEREAS, Bracciodieta is no longer in the employ of the Company; and WHEREAS, FHP, the Company and the Management Investors desire to amend the Stock Purchase Agreement in these and certain other 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. AMENDMENTS TO STOCK PURCHASE AGREEMENT. The Stock Purchase Agreement is hereby amended as follows: (a) PURCHASE OF CLASS A COMMON STOCK AND THSC COMMON STOCK. (1) The recitals on page 1 of the Stock Purchase Agreement are hereby amended to read as follows: "A. WHEREAS, FHP has formed the Company to function as a physician practice management company to provide practice management services to certain professional corporations; and "B. WHEREAS, FHP has formed THSC to provide ancillary medical services; and "C. WHEREAS, FHP has acquired 9,100,000 shares of the Class A Voting Common Stock of the Company, par value $.01 (one cent) per share (the "TMMC Class A Common Stock", with the TMMC Class 1 A Common Stock and the Class B Common Stock of the Company, par value $.01 (one cent) per share, collectively referred to herein as the "TMMC Common Stock"), which shares of TMMC Class A Common Stock comprise all of the issued and outstanding shares of the common stock of the Company, for consideration in the amount of $91,000.00; and "D. WHEREAS, FHP has acquired 500 shares of the Common Stock of THSC, no par value (the "THSC Common Stock"), which shares of THSC Common Stock comprise all of the issued and outstanding shares of the common stock of THSC, for consideration in the amount of $1,000.00; and "E. WHEREAS, the Company, FHP and THSC regard the services provided to the Company by the Management Investors as valuable to the Company, FHP, and THSC and have determined that it would be to the advantage and in the best interests of the Company, FHP and THSC to provide for the issuance of shares of TMMC Class A Common Stock and THSC Common Stock to the Management Investors as provided for in this Agreement (i) as an inducement to remain in the service of the Company, FHP and THSC, and (ii) as an incentive for increased efforts during such service; and "F. WHEREAS, FHP desires to provide for the issuance of shares of TMMC Class A Common Stock and THSC Common Stock to the Management Investors, and the Management Investors wish to acquire such shares from the Company and from THSC, respectively, all on the terms and subject to the conditions set forth in this Agreement." (2) The first two sentences of Section 2.1 of the Stock Purchase Agreement are hereby amended to read as follows: "Subject to the terms and conditions of this Agreement, each of the Management Investors, severally and not jointly, agrees to purchase, and FHP agrees to cause the Company and THSC to, and the Company and THSC, respectively, agree to, issue, sell and transfer to each of the Management Investors, severally and not jointly, at the Closing (as defined below), the following: (i) for consideration in the amount of $.01 (one cent) per share, as to each such Management Investor, the number of shares of the TMMC Class A Common Stock (the "TMMC Stock") set forth in that certain schedule signed by each of FHP, the Company, THSC and such Management Investor (each, a "Management Investor Schedule"), and (ii) for consideration in the amount of $2.00 (two dollars) per share, as to each such Management Investor, the number of shares of the THSC Common Stock (the "THSC Stock", with the TMMC Stock and the THSC Stock collectively referred to herein as the "Stock") set forth 2 in the Management Investor Schedules. The aggregate number of shares of TMMC Stock issued to the Management Investors shall be 880,000 (the "TMMC Management Stock"), and the TMMC Stock issued to the Management Investors, collectively, initially shall comprise approximately 8.8% 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 49, and the THSC Stock issued to the Management Investors, collectively, initially shall comprise approximately 8.8% 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")." (3) Pursuant to this Amendment, (i) all rights and obligations created under the Stock Purchase Agreement between (a) FHP and the Management Investors with respect to the TMMC Management Stock, and (b) the Company and the Management Investors with respect to the TMMC Management Stock, shall hereby also create separate and identical rights and obligations between (x) FHP and the Management Investors with respect to the THSC Management Stock, and (y) THSC and the Management Investors with respect to the THSC Management Stock, respectively, as if two separate and identical sets of such rights and obligations were originally created thereunder, (ii) all other rights and obligations created under the Stock Purchase Agreement between (a) FHP and the Management Investors, and (b) the Company and the Management Investors, shall hereby also create separate and identical rights and obligations between (x) FHP and the Management Investors, and (y) THSC and the Management Investors, respectively, as if two separate and identical sets of such rights and obligations were originally created thereunder, (iii) all references in the Stock Purchase Agreement to "the Company," in so far as such references relate to such rights and obligations created between the Management Investors and the Company described in clauses (i)(b) and (ii)(b), shall also be references to THSC and shall relate to such separate and identical rights and obligations between the Management Investors and THSC as described in clauses (i)(y) and (ii)(y), above, and (iv) all other references to "the Company" in the Stock Purchase Agreement shall also be references to THSC; PROVIDED, HOWEVER, that the foregoing clauses (iii) and (iv) shall not apply to those references to "the Company" contained in Sections 5.1, 5.3, 8 and 11.5 of the Stock Purchase Agreement. (4) All references to "Common Stock" in Section 6 and 7 of the Stock Purchase Agreement are hereby amended to read "TMMC Common Stock or THSC Common Stock, as appropriate". (5) Section 8 of the Stock Purchase Agreement is hereby amended to read as follows: "8. WITHHOLDING. The Management Investors acknowledge that the Company, FHP or THSC, as appropriate, may withhold compensation (in cash, or, at the option of the Company, FHP or THSC, as appropriate, 3 in stock) to satisfy all applicable federal, state, and local income, employment and other tax withholding requirements." (6) The parties hereto acknowledge that there exists the possibility that at some future date, THSC may be merged with or into the Company, and in the event such merger occurs, it is presently contemplated that upon the effective time of such merger (the "Effective Time"), each Management Investor shall receive, in exchange for the shares of THSC Common Stock purchased by such Management Investor pursuant to the Stock Purchase Agreement, as amended by this Amendment (or, in the event that THSC and the Company are merged into a new entity, for the shares of the THSC Common Stock and the shares of the TMMC Common Stock so purchased by such Management Investor), the number of shares of TMMC Common Stock (or shares of the common stock of the new entity) which, when combined with the number of shares of TMMC Common Stock purchased by such Management Investor pursuant to the Stock Purchase Agreement, as amended by this Amendment (or which shares of the common stock of the new entity), would result in the ownership by such Management Investor of the same percentage of the total outstanding common stock of the Company (or of such merged entity) immediately after the Effective Time as the percentage of the total outstanding common stock of the Company owned by such Management Investor immediately prior to the Effective Time. In such event, immediately following the Effective Time: (i) all rights and obligations created under this Amendment between (a) FHP and the Management Investors with respect to the THSC Management Stock, and (b) THSC and the Management Investors with respect to the THSC Management Stock, shall become rights and obligations between (x) FHP and the Management Investors with respect to the TMMC Management Stock, and (y) the Company and the Management Investors with respect to the TMMC Management Stock, respectively, as if the separate and identical obligations created pursuant to Section 1(a)(3)(i), above, had never been created thereunder; (ii) all other rights and obligations created pursuant to this Amendment between (a) FHP and the Management Investors, and (b) THSC and the Management Investors, shall become rights and obligations between (x) FHP and the Management Investors, and (y) the Company and the Management Investors, respectively, as if the separate and identical sets of rights and obligations created pursuant to Section 1(a)(3)(ii), above, had never been created thereunder; (iii) all references in the Stock Purchase Agreement, as amended by this Amendment, to "the Company," in so far as such references relate to such rights and obligations created pursuant to Section 1(3)(a)(iii), above, between the Management Investors and THSC, shall be references only to the Company, and shall no longer be references to THSC, and shall relate only to the rights and obligations between the Management Investors and the Company as described in clauses (i)(y) and (ii)(y) of this Section 1(a)(6); and 4 (iv) all other references to "the Company" in the Stock Purchase Agreement, as amended by this Amendment, shall be references to the Company only. Each Management Investor hereby agrees and consents that the execution of this Amendment by such Management Investor shall constitute an agreement by such Management Investor to (i) consent in writing to a merger of THSC with or into the Company pursuant to Section 228 of the Delaware General Corporation Law, as amended (the "DGCL"), and (ii) refrain from demanding any appraisal rights to which such Management Investor might otherwise be entitled pursuant to Section 262 of the DGCL, or pursuant to any other provision of applicable law, in connection with such a merger. (b) REMOVAL OF PARTY TO STOCK PURCHASE AGREEMENT. The Stock Purchase Agreement is hereby amended to remove all references to "William P. Bracciodieta" and "Bracciodieta" in the Stock Purchase Agreement. Accordingly, William P. Bracciodieta shall not be a party to the Stock Purchase Agreement. 2. NOTICES. Notices and other communication provided for herein or in the Stock Purchase Agreement shall be in writing (including wire, telex, telecopy or similar writing) and shall be sent, delivered, telexed or telecopied, if to THSC, to: Talbert Health Services Corporation 3540 Howard Way Costa Mesa, CA 92626 Attn: President 3. 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. 4. 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. 5. 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. 5 IN WITNESS WHEREOF, the parties have duly executed this Amendment as of the date first above mentioned. FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner Title: Senior Vice President Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo Title: Assistant Treasurer Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo Title: Assistant Treasurer 6 /s/ Kathryn M. Adair /s/ Jack D. Massimino - ------------------------------ ----------------------------------- Kathryn M. Adair Jack D. Massimino /s/ Gloria L. Austin /s/ Barbara C. McNutt - ------------------------------ ----------------------------------- Gloria L. Austin Barbara C. McNutt /s/ William P. Bracciodieta /s/ Kenneth S. Ord - ------------------------------ ----------------------------------- William P. Bracciodieta Kenneth S. Ord /s/ Larry L. Georgopolous /s/ Westcott W. Price III - ------------------------------ ----------------------------------- Larry L. Georgopolous Westcott W. Price III /s/ Gary E. Goldstein /s/ Walter R. Stone - ------------------------------ ----------------------------------- Gary E. Goldstein, M.D. Walter R. Stone /s/ Richard D. Jacobs /s/ Margaret Van Meter - ------------------------------ ----------------------------------- Richard D. Jacobs Margaret Van Meter /s/ Michael J. Weinstock - ------------------------------ ----------------------------------- R. Judd Jessup Michael J. Weinstock 7 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Kathryn M. Adair 25,000 TMMC 7021 Pinebrook Road 1 THSC Park City, UT 84060 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Kathryn M. Adair ------------------------------------------------- Kathryn M. Adair 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Gloria L. Austin 50,000 TMMC 17 Whispering Wind 3 THSC Irvine, CA 92714 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Gloria L. Austin ------------------------------------------------- Gloria L. Austin 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Larry L. Georgopolous 20,000 TMMC 12009 Ibex Avenue N.E. 1 THSC Albuquerque, NM 87111 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Larry L. Georgopolous ------------------------------------------------- Larry L. Georgopolous 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Gary E. Goldstein, M.D. 50,000 TMMC 6 Amber Sky Drive 3 THSC Rancho Palos Verdes, CA 90275 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Gary E. Goldstein ------------------------------------------------- Gary E. Goldstein, M.D. 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Richard D. Jacobs 25,000 TMMC 4176 W. Jasper 1 THSC Chandler, AZ 85226 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Richard D. Jacobs ------------------------------------------------- Richard D. Jacobs 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- R. Judd Jessup 67,500 TMMC 30962 Via Serenidad 4 THSC Coto de Caza, CA 92679 FHP International Corporation, a Delaware corporation By: ---------------------------------------------- Name: -------------------------------------------- Title: ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: ---------------------------------------------- Name: -------------------------------------------- Title: ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: ---------------------------------------------- Name: -------------------------------------------- Title: ------------------------------------------- ------------------------------------------------- R. Judd Jessup 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Jack D. Massimino 500,000 TMMC 25362 Gallup Circle 27 THSC Laguna Hills, CA 92653 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Jack D. Massimino ------------------------------------------------- Jack D. Massimino 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta, ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Barbara C. McNutt 15,000 TMMC 8250 Fox Tail Way 1 THSC Las Vegas, NV 89123 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Barbara C. McNutt ------------------------------------------------- Barbara C. McNutt 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Kenneth S. Ord 10,000 TMMC 11 Emerald Glen 1 THSC Laguna Niguel, CA 92677 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Kenneth S. Ord ------------------------------------------------- Kenneth S. Ord 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Westcott W. Price III 67,500 TMMC 1505 Emerald Bay 4 THSC Laguna Beach, CA 92651 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Westcott W. Price III ------------------------------------------------- Westcott W. Price III 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Walter R. Stone 20,000 TMMC 6492 Doral Drive 1 THSC Huntington Beach, CA 92648 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Walter R. Stone ------------------------------------------------- Walter R. Stone 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Margaret Van Meter 20,000 TMMC #1 Cala Churcha Street 1 THSC Barrigada Heights, GU 96921 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Margaret Van Meter ------------------------------------------------- Margaret Van Meter 8 MANAGEMENT INVESTOR SCHEDULE This Management Investor Schedule has been prepared pursuant to Section 2.1 of that certain Stock Purchase Agreement, dated as of March 15, 1996, by and among FHP International Corporation, a Delaware corporation ("FHP"), Talbert Medical Management Corporation, a Delaware corporation (the "Company"), Kathryn M. Adair ("Adair"), Gloria L. Austin ("Austin"), William P. Bracciodieta ("Bracciodieta"), Larry L. Georgopolous ("Georgopolous"), Gary E. Goldstein, M.D. ("Goldstein"), Richard D. Jacobs ("Jacobs"), R. Judd Jessup ("Jessup"), Jack D. Massimino ("Massimino"), Barbara C. McNutt ("McNutt"), Kenneth S. Ord ("Ord"), Westcott W. Price III ("Price"), Walter R. Stone ("Stone"), Margaret Van Meter ("Van Meter"), and Michael J. Weinstock ("Weinstock"), as amended by that certain Amendment No. 1 to Stock Purchase Agreement, dated as of May 31, 1996, by and among the same parties, and Talbert Health Services Corporation, a Delaware corporation ("THSC"). Management Investor # of Shares ------------------- ----------- Michael J. Weinstock 10,000 TMMC 8 Morning Sun 1 THSC Irvine, CA 92715 FHP International Corporation, a Delaware corporation By: /s/ Burke F. Gumbiner ---------------------------------------------- Name: Burke F. Gumbiner -------------------------------------------- Title: Senior Vice President ------------------------------------------- Talbert Medical Management Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- Talbert Health Services Corporation, a Delaware corporation By: /s/ Michael A. Montevideo ---------------------------------------------- Name: Michael A. Montevideo -------------------------------------------- Title: Assistant Treasurer ------------------------------------------- /s/ Michael J. Weinstock ------------------------------------------------- Michael J. Weinstock 8 EX-10.16 3 DEFERRED COMPENSATION PLAN FHP INTERNATIONAL CORPORATION DEFERRED COMPENSATION PLAN MASTER PLAN DOCUMENT - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- EFFECTIVE JANUARY 1, 1996 TABLE OF CONTENTS Page ---- Purpose. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARTICLE 1 Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARTICLE 2 Selection, Enrollment, Eligibility . . . . . . . . . . . . . . . 9 2.1 Selection by Committee . . . . . . . . . . . . . . . . . . . . . 9 2.2 Enrollment Requirements. . . . . . . . . . . . . . . . . . . . . 9 2.3 Eligibility; Commencement of Participation . . . . . . . . . . . 9 2.4 Termination of Participation and/or Deferrals. . . . . . . . . . 10 ARTICLE 3 Deferral Commitments/Interest Crediting/Taxes. . . . . . . . . . 10 3.1 Minimum Deferral . . . . . . . . . . . . . . . . . . . . . . . . 10 3.2 Maximum Deferral . . . . . . . . . . . . . . . . . . . . . . . . 11 3.3 Election to Defer; Effect of Election Form . . . . . . . . . . . 11 3.4 Withholding of Deferral Amounts. . . . . . . . . . . . . . . . . 12 3.5 Interest Crediting Prior to Distribution . . . . . . . . . . . . 12 3.6 Interest Crediting for Installment Distributions . . . . . . . . 13 3.7 FICA and Other Taxes . . . . . . . . . . . . . . . . . . . . . . 13 3.8 Annual Company Contribution Amount . . . . . . . . . . . . . . . 14 3.9 Vesting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 3.10 Rollovers. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 ARTICLE 4 Short-Term Payout; Withdrawal Election . . . . . . . . . . . . . 15 4.1 Short-Term Payout. . . . . . . . . . . . . . . . . . . . . . . . 15 4.2 Other Benefits Take Precedence Over Short-Term Payout. . . . . . 15 4.3 Withdrawal Election. . . . . . . . . . . . . . . . . . . . . . . 16 ARTICLE 5 Retirement Benefit . . . . . . . . . . . . . . . . . . . . . . . 16 5.1 Retirement Benefit . . . . . . . . . . . . . . . . . . . . . . . 16 5.2 Payment of Retirement Benefit. . . . . . . . . . . . . . . . . . 16 5.3 Death Prior to Completion of Retirement Benefit. . . . . . . . . 17 -i- ARTICLE 6 Pre-Retirement Survivor Benefit. . . . . . . . . . . . . . . . . 17 6.1 Pre-Retirement Survivor Benefit. . . . . . . . . . . . . . . . . 17 6.2 Payment of Pre-Retirement Survivor Benefit . . . . . . . . . . . 17 6.3 Restriction in the Event of Suicide or Falsely Provided Information. . . . . . . . . . . . . . . . . . . . . . . . . . . 18 ARTICLE 7 Termination Benefit. . . . . . . . . . . . . . . . . . . . . . . 18 7.1 Termination Benefit. . . . . . . . . . . . . . . . . . . . . . . 18 7.2 Payment of Termination Benefit . . . . . . . . . . . . . . . . . 18 ARTICLE 8 Disability and Benefit . . . . . . . . . . . . . . . . . . . . . 19 8.1 Disability . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 8.2 Continued Eligibility; Disability Benefit. . . . . . . . . . . . 19 ARTICLE 9 Beneficiary Designation. . . . . . . . . . . . . . . . . . . . . 19 9.1 Beneficiary. . . . . . . . . . . . . . . . . . . . . . . . . . . 19 9.2 Beneficiary Designation; Change; Spousal Consent . . . . . . . . 20 9.3 Acknowledgment . . . . . . . . . . . . . . . . . . . . . . . . . 20 9.4 No Beneficiary Designation . . . . . . . . . . . . . . . . . . . 20 9.5 Doubt as to Beneficiary. . . . . . . . . . . . . . . . . . . . . 20 9.6 Discharge of Obligations . . . . . . . . . . . . . . . . . . . . 21 ARTICLE 10 Leave of Absence . . . . . . . . . . . . . . . . . . . . . . . . 21 10.1 Paid Leave of Absence. . . . . . . . . . . . . . . . . . . . . . 21 10.2 Unpaid Leave of Absence. . . . . . . . . . . . . . . . . . . . . 21 ARTICLE 11 Termination, Amendment or Modification . . . . . . . . . . . . . 21 11.1 Termination. . . . . . . . . . . . . . . . . . . . . . . . . . . 21 11.2 Amendment. . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 11.3 Plan Agreement . . . . . . . . . . . . . . . . . . . . . . . . . 22 11.4 Interest Rate in the Event of a Change of Control. . . . . . . . 22 11.5 Effect of Payment. . . . . . . . . . . . . . . . . . . . . . . . 23 -ii- ARTICLE 12 Administration . . . . . . . . . . . . . . . . . . . . . . . . . 23 12.1 Committee Duties . . . . . . . . . . . . . . . . . . . . . . . . 23 12.2 Agents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 12.3 Binding Effect of Decisions. . . . . . . . . . . . . . . . . . . 23 12.4 Indemnity of Committee . . . . . . . . . . . . . . . . . . . . . 23 12.5 Employer Information . . . . . . . . . . . . . . . . . . . . . . 24 ARTICLE 13 Other Benefits and Agreements. . . . . . . . . . . . . . . . . . 24 13.1 Coordination with Other Benefits . . . . . . . . . . . . . . . . 24 13.2 Offset Under Split-Dollar Life Insurance Agreement . . . . . . . 24 ARTICLE 14 Claims Procedures. . . . . . . . . . . . . . . . . . . . . . . . 25 14.1 Presentation of Claim. . . . . . . . . . . . . . . . . . . . . . 25 14.2 Notification of Decision . . . . . . . . . . . . . . . . . . . . 25 14.3 Review of a Denied Claim . . . . . . . . . . . . . . . . . . . . 26 14.4 Decision on Review . . . . . . . . . . . . . . . . . . . . . . . 26 14.5 Legal Action . . . . . . . . . . . . . . . . . . . . . . . . . . 27 ARTICLE 15 Trust. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 15.1 Establishment of the Trust . . . . . . . . . . . . . . . . . . . 27 15.2 Interrelationship of the Plan and the Trust. . . . . . . . . . . 27 15.3 Distributions From the Trust . . . . . . . . . . . . . . . . . . 27 ARTICLE 16 Miscellaneous. . . . . . . . . . . . . . . . . . . . . . . . . . 28 16.1 Unsecured General Creditor . . . . . . . . . . . . . . . . . . . 28 16.2 Employer's Liability . . . . . . . . . . . . . . . . . . . . . . 28 16.3 Nonassignability . . . . . . . . . . . . . . . . . . . . . . . . 28 16.4 Not a Contract of Employment . . . . . . . . . . . . . . . . . . 28 16.5 Furnishing Information . . . . . . . . . . . . . . . . . . . . . 29 16.6 Terms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 16.7 Captions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 16.8 Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . . 29 16.9 Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 16.10 Successors. . . . . . . . . . . . . . . . . . . . . . . . . . . 30 -iii- 16.11 Spouse's Interest . . . . . . . . . . . . . . . . . . . . . 30 16.12 Validity. . . . . . . . . . . . . . . . . . . . . . . . . . 30 16.13 Incompetent . . . . . . . . . . . . . . . . . . . . . . . . 30 16.14 Court Order . . . . . . . . . . . . . . . . . . . . . . . . 30 16.15 Distribution in the Event of Taxation . . . . . . . . . . . 31 -iv- FHP INTERNATIONAL CORPORATION DEFERRED COMPENSATION PLAN Effective January 1, 1996 PURPOSE The purpose of this Plan is to provide specified benefits to Directors and to a select group of management or highly compensated Employees who contribute materially to the continued growth, development and future business success of FHP International Corporation, a Delaware corporation, and its subsidiaries, if any, that sponsor this Plan. This Plan shall be unfunded for tax purposes and for purposes of Title I of ERISA. ARTICLE 1 DEFINITIONS For purposes hereof, unless otherwise clearly apparent from the context, the following phrases or terms shall have the following indicated meanings: 1.1 "Account Balance" shall mean (i) the Deferral Account balance plus (ii) the vested Company Contribution Account balance. This balance shall be a bookkeeping entry only and shall be utilized solely as a device for the measurement and determination of the amounts to be paid to a Participant, or his or her designated Beneficiary, pursuant to this Plan. 1.2 "Affiliate" shall mean any corporation or other business entity that has entered into a contractual obligation with an Employer to provide professional medical services. If such contractual obligation ends, without renewal or modification, the corporation or business entity shall lose its status as an "Affiliate." 1.3 "Annual Company Contribution Amount" for any one Plan Year shall be the amount determined in accordance with Section 3.8. 1.4 "Annual Deferral Amount" shall mean that portion of a Participant's Base Annual Salary, Bonus and/or Directors Fees that a Participant elects to have, -1- and is deferred, in accordance with Article 3, for any one Plan Year. In the event of a Participant's Retirement, death or a Termination of Employment prior to the end of a Plan Year, such year's Annual Deferral Amount shall be the actual amount withheld prior to such event. 1.5 "Base Annual Salary" shall mean the annual compensation, excluding bonuses, commissions, overtime, fringe benefits, stock options, relocation expenses, incentive payments, non- monetary awards, directors fees and other fees, automobile and other allowances, paid to an Executive for employment services rendered (whether or not such allowances are included in the Executive's gross income). Base Annual Salary shall be calculated before reduction for compensation voluntarily deferred or contributed by the Executive pursuant to all qualified or non-qualified plans and shall be calculated to include amounts not otherwise included in the Participant's gross income under Code Sections 125, 402(e)(3), 402(h) or 403(b) pursuant to plans established by any Employer; provided, however, that all such amounts will be included in compensation only to the extent that, had there been no such plan, the amount would have been payable in cash to the Executive. 1.6 "Beneficiary" shall mean one or more persons, trusts, estates or other entities, designated in accordance with Article 9, that are entitled to receive benefits under this Plan upon the death of a Participant. 1.7 "Beneficiary Designation Form" shall mean the form established from time to time by the Committee that a Participant completes, signs and returns to the Committee to designate one or more Beneficiaries. 1.8 "Board" shall mean the board of directors of the Company. 1.9 "Bonus" shall mean any compensation, in addition to Base Annual Salary, paid to a Participant as an Employee under any Employer's bonus and/or incentive plans. 1.10 "Change of Control" shall mean the first to occur of any of the following events: (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial -2- ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 1.10; or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the -3- corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company of such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. 1.11 "Claimant" shall have the meaning set forth in Section 14.1. 1.12 "Code" shall mean the Internal Revenue Code of 1986, as may be amended from time to time. 1.13 "Committee" shall mean the committee described in Article 12. 1.14 "Company" shall mean FHP International Corporation, a Delaware corporation. 1.15 "Company Contribution Account" shall mean (i) the sum of a Participant's Annual Company Contribution Amounts, plus (ii) interest credited in accordance with all the applicable interest crediting provisions of this Plan that relate to a Participant's Company Contribution Account, less (iii) all distributions made to the Participant or his or her Beneficiary pursuant to this Plan that relate to the Participant's Company Contribution Account. This -4- account shall be a bookkeeping entry only and shall be utilized solely as a device for the measurement and determination of the amounts to be paid to the Participant, or his or her designated Beneficiary, pursuant to this Plan. 1.16 "Crediting Rate" shall mean, for each Plan Year, an interest rate, stated as an annual rate, determined and announced by the Committee before the Plan Year for which it is to be used that is equal to either (i) the applicable "Moody's Rate" or (ii) such other rate as determined by the Committee in its sole discretion. For purposes of the foregoing, the Moody's Rate for a Plan Year shall be an interest rate, stated as an annual rate, that (i) is published in Moody's Bond Record under the heading of "Moody's Corporate Bond Yield Averages -- Av. Corp," and (ii) is equal to the average corporate bond yield calculated for the month of September that immediately precedes the Plan Year for which the rate is to be used. 1.17 "Deduction Limitation" shall mean the following described limitation on a benefit that may otherwise be distributable pursuant to the provisions of this Plan. Except as otherwise provided, this limitation shall be applied to all distributions that are "subject to the Deduction Limitation" under this Plan. If an Employer determines in good faith prior to a Change of Control that there is a reasonable likelihood that any compensation paid to a Participant for a taxable year of the Employer would not be deductible by the Employer solely by reason of the limitation under Code Section 162(m), then to the extent deemed necessary by the Employer to ensure that the entire amount of any distribution to the Participant pursuant to this Plan prior to the Change of Control is deductible, the Employer may defer all or any portion of a distribution under this Plan. Any amounts deferred pursuant to this limitation shall continue to be credited with interest in accordance with Section 3.5 below, even if such amount is an installment payment. The amounts so deferred and interest thereon shall be distributed to the Participant or his or her Beneficiary (in the event of the Participant's death) at the earliest possible date, as determined by the Employer in good faith, on which the deductibility of compensation paid or payable to the Participant for the taxable year of the Employer during which the distribution is made will not be limited by Section 162(m), or if earlier, the effective date of a Change of Control. Notwithstanding anything to the contrary in this Plan, the Deduction Limitation shall not apply to any distributions made after a Change of Control. -5- 1.18 "Deferral Account" shall mean (i) the sum of all of a Participant's Annual Deferral Amounts, plus (ii) the Participant's Rollover Amount, if any, plus (iii) interest credited in accordance with all the applicable interest crediting provisions of this Plan that relate to the Participant's Deferral Account, less (iv) all distributions made to the Participant or his or her Beneficiary pursuant to this Plan that relate to the Participant's Deferral Account. This account shall be a bookkeeping entry only and shall be utilized solely as a device for the measurement and determination of the amounts to be paid to the Participant, or his or her designated Beneficiary, pursuant to this Plan. 1.19 "Director" shall mean any member of the board of directors of any Employer. 1.20 "Directors Fees" shall mean the annual fees paid by any Employer, including retainer fees and meetings fees, as compensation for serving on the board of directors or a committee thereof. 1.21 "Disability" shall be determined by the Committee in its sole discretion. 1.22 "Disability Benefit" shall mean the benefit set forth in Article 8. 1.23 "Election Form" shall mean the form established from time to time by the Committee that a Participant must complete, sign and return to the Committee to make an election under the Plan. 1.24 "Employee" shall mean a person who is employed by any Employer. 1.25 "Employer(s)" shall mean the Company and/or any of its subsidiaries (now in existence or hereafter formed or acquired) that have adopted the Plan as a sponsor. For this purpose, a subsidiary is any corporation in which the Company possesses more than 50% of either (i) the total combined voting power of all classes of stock of such corporation or (ii) the total combined value of shares of all classes of stock of such corporation. 1.26 "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as it may be amended from time to time. 1.27 "Participant" shall mean any Employee or Director (i) who is selected to participate in the Plan, (ii) who elects to participate in the Plan, (iii) who signs a Plan Agreement, an Election Form and a Beneficiary Designation Form, -6- (iv) whose signed Plan Agreement, Election Form and Beneficiary Designation Form are acknowledged by the Committee, (v) who commences participation in the Plan, and (vi) whose Plan Agreement has not terminated. A spouse or former spouse of a Participant shall not be treated as a Participant in the Plan, even if he or she has an interest in the Participant's benefits under the Plan as a result of applicable law or property settlements resulting from legal separation or divorce. 1.28 "Plan" shall mean the Company's Deferred Compensation Plan, which shall be evidenced by this instrument and by each Plan Agreement, as it may be amended from time to time. 1.29 "Plan Agreement" shall mean a written agreement, as may be amended from time to time, which is entered into by and between an Employer and a Participant. Each Plan Agreement executed by a Participant and the Participant's Employer shall provide for the entire benefit to which such Participant is entitled to under the Plan, and the Plan Agreement bearing the latest date of acknowledgement by the Committee shall govern such entitlement. The terms of any Plan Agreement may be varied among Participants, and any Plan Agreement may provide additional benefits not set forth in the Plan or limit the benefits otherwise provided under the Plan; provided, however, that any such additional benefits or benefit limitations must be agreed to by both the Employer and the Participant. 1.30 "Plan Year" shall mean a year that begins on January 1 and ends on December 31. 1.31 "Preferred Rate" shall mean, for each Plan Year, an interest rate that is the sum of the Crediting Rate and the Premium Rate for that Plan Year. 1.32 "Premium Rate" shall mean, for a Plan Year, an interest rate, if any, determined by the Committee, in its sole discretion, which rate shall be determined and announced before the commencement of the Plan Year for which the rate applies. This rate may be zero for any Plan Year. 1.33 "Pre-Retirement Survivor Benefit" shall mean the benefit set forth in Article 6. 1.34 "Retirement", "Retires" or "Retired" shall mean, with respect to an Employee, severance from employment from all Employers for any reason other than a -7- leave of absence, death or Disability on or after the earlier of the attainment of (a) age sixty-five (65) or (b) age fifty-five (55) with ten (10) Years of Service; and shall mean, with respect to a Director who is not an Employee, severance of his or her directorships with all Employers. If a Participant is both an Employee and a Director, Retirement shall be deemed to occur when he or she has severed his or her employment with all Employers, if he or she has then either attained age sixty-five (65) or attained age fifty-five (55) with ten (10) Years of Service, regardless of whether he or she has severed his or her service as a Director. Despite the foregoing, and for purposes of this Plan only, if a Participant (i) transferred his or her employment from all Employers to an Affiliate, or a Participant terminated his or her employment with all Employers and became employed by an Affiliate within 30 days of such termination, and (ii) remains employed by that Affiliate, another Affiliate or any Employer until attaining age sixty-five (65) or age fifty-five (55) with ten (10) Years of Service, he or she shall be treated as having Retired under this Plan as of his or her Termination of Employment. 1.35 "Retirement Benefit" shall mean the benefit set forth in Article 5. 1.36 "Rollover Amount" shall mean the amount determined in accordance with Section 3.10. 1.37 "Short-Term Payout" shall mean the payout set forth in Section 4.1. 1.38 "Termination Benefit" shall mean the benefit set forth in Article 7. 1.39 "Termination of Employment" shall mean the ceasing of employment with all Employers and Affiliates, voluntarily or involuntarily, for any reason other than Retirement, Disability, death or an authorized leave of absence. Despite the foregoing, a severance of a directorship shall be treated as a Retirement in accordance with Section 1.34 above. Further, if an Affiliate ceases to be an Affiliate, the Participant, for purposes of this Plan only, shall be treated as having ceased employment with the Affiliate as of the date that the Affiliate ceases to be an Affiliate. However, for purposes of this Plan only, if a Participant (i) transfers his or her employment from an Employer to an Affiliate, or (ii) terminates his or her employment with all Employers and is employed by an Affiliate within 30 days of such termination, the Participant shall not be treated as having experienced a Termination of Employment. -8- 1.40 "Trust" shall mean the trust established pursuant to that certain Master Trust Agreement, dated as of January 1, 1996, between the Company and the trustee named therein, as amended from time to time. 1.41 "Years of Service" shall mean the total number of full years in which a Participant has been employed by one or more Employers, plus, in the case of a Participant who has transferred his or her employment from all Employers to an Affiliate, or who has terminated his or her employment with all Employers and is employed by an Affiliate within 30 days of such termination, the total number of full years in which a Participant has been employed by one or more Affiliates. For purposes of this definition, a year of employment shall be a 365 day period (or 366 day period in the case of a leap year) that, for the first year of employment, commences on the Employee's date of hiring and that, for any subsequent year, commences on an anniversary of that hiring date. If a Participant terminates employment and later is rehired, any full years of employment for the prior period will be added to any full years of employment for subsequent years. Any partial year of employment shall not be counted. ARTICLE 2 SELECTION, ENROLLMENT, ELIGIBILITY 2.1 SELECTION BY COMMITTEE. Participation in the Plan shall be limited to Directors and a select group of management or highly compensated Employees of the Employers, as determined by the Committee, in its sole discretion. From that group, the Committee shall select, in its sole discretion, Employees and Directors to participate in the Plan. 2.2 ENROLLMENT REQUIREMENTS. As a condition to participation, each selected Employee or Director shall complete, execute and return to the Committee a Plan Agreement, an Election Form and a Beneficiary Designation Form, all before the later of (a) December 1, 1995, or (b) the date which is 30 days after he or she is selected to participate in the Plan. In addition, the Committee shall have the ability to amend and/or establish from time to time such other enrollment requirements as it determines, in its sole discretion, are necessary. 2.3 ELIGIBILITY; COMMENCEMENT OF PARTICIPATION. Provided an Employee or Director selected to participate in the Plan has met all enrollment requirements -9- set forth in this Plan and required by the Committee, including returning all required documents to the Committee within the specified time period, that Employee or Director shall commence participation in the Plan on the first day of the month following the month in which the Employee or Director completes all enrollment requirements. If an Employee or Director fails to meet all such requirements within the required 30 day period (or, if earlier, by December 31, 1995), that Employee or Director shall not be eligible to participate in the Plan until the first day of the Plan Year following the delivery to and acknowledgement by the Committee of the required documents. 2.4 TERMINATION OF PARTICIPATION AND/OR DEFERRALS. If the Committee determines in good faith that a Participant no longer qualifies as a member of a select group of management or highly compensated employees, as membership in such group is determined in accordance with Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, the Committee shall have the right, in its sole discretion, to (i) terminate any deferral election the Participant has made for the Plan Year in which the Participant's membership status changes, (ii) prevent the Participant from making future deferral elections and/or (iii) immediately distribute the Participant's then Account Balance as a Termination Benefit and terminate the Participant's participation in the Plan. If the Committee chooses not to terminate the Participant's participation in the Plan, the Committee may, in its sole discretion, reinstate the Participant to full Plan participation at such time in the future as the Participant again becomes a member of the select group described above. ARTICLE 3 DEFERRAL COMMITMENTS/INTEREST CREDITING/TAXES 3.1 MINIMUM DEFERRAL. (a) MINIMUM. For each Plan Year, a Participant may elect to defer, as his or her Annual Deferral Amount, one or more of the following forms of compensation in the following minimum percentages for each deferral elected: -10- Minimum Deferral Percentage -------- ---------- Base Annual Salary 3% Bonus 1% Directors Fees 0% If an election is made for less than stated minimum amounts, or if no election is made, the amount deferred shall be zero. (b) SHORT PLAN YEAR. If a Participant first becomes a Participant after the first day of a Plan Year, the minimum Base Annual Salary deferral shall be an amount equal to the minimum set forth above, multiplied by a fraction, the numerator of which is the number of complete months remaining in the Plan Year and the denominator of which is 12. 3.2 MAXIMUM DEFERRAL. For each Plan Year, a Participant may elect to defer, as his or her Annual Deferral Amount, Base Annual Salary, Bonus and/or Directors Fees up to the following maximum percentages for each deferral elected: Maximum Deferral Percentage -------- ---------- Base Annual Salary 50% Bonus 100% Directors Fees 100% Notwithstanding the foregoing, if a Participant first becomes a Participant after the first day of a Plan Year, the maximum Annual Deferral Amount shall be limited to the amount of compensation not yet earned by the Participant as of the date the Participant submits a Plan Agreement and Election Form to the Committee for acknowledgement. 3.3 ELECTION TO DEFER; EFFECT OF ELECTION FORM. (a) FIRST PLAN YEAR. In connection with a Participant's commencement of participation in the Plan, the Participant shall make an irrevocable deferral election for the Plan Year in which the Participant commences -11- participation in the Plan, along with such other elections as the Committee deems necessary or desirable under the Plan. FOR THESE ELECTIONS TO BE VALID, THE ELECTION FORM MUST BE COMPLETED AND SIGNED BY THE PARTICIPANT, TIMELY DELIVERED TO THE COMMITTEE (IN ACCORDANCE WITH SECTION 2.3 ABOVE) AND ACKNOWLEDGED BY THE COMMITTEE. (b) SUBSEQUENT PLAN YEARS. For each succeeding Plan Year, an irrevocable deferral election for that Plan Year, and such other elections as the Committee deems necessary or desirable under the Plan, shall be made by timely delivering to the Committee, in accordance with its rules and procedures before the end of the Plan Year preceding the Plan Year for which the election is made, a new Election Form. If no Election Form is timely delivered for a Plan Year, no Annual Deferral Amount shall be withheld for that Plan Year. (c) PERCENTAGE ELECTED. With respect to each deferral election, the percentage of Base Annual Salary, Bonus and/or Directors Fees that is elected to be deferred must be a whole percentage between the allowed minimum and maximum amounts. 3.4 WITHHOLDING OF DEFERRAL AMOUNTS. For each Plan Year, the Base Annual Salary portion of the Annual Deferral Amount shall be withheld from each regularly scheduled Base Annual Salary payroll, as determined by the Committee in its sole discretion. The Bonus and/or Directors Fees portion of the Annual Deferral Amount shall be withheld at the time the Bonus or Directors Fees are or otherwise would be paid to the Participant. 3.5 INTEREST CREDITING PRIOR TO DISTRIBUTION. Prior to any distribution of benefits under Articles 4, 5, 6, 7 or 8, interest shall be credited and compounded annually on (i) a Participant's Deferral Account as though the Annual Deferral Amount for that Plan Year was withheld at the beginning of the Plan Year and (ii) on a Participant's Company Contribution Account as though the Annual Company Contribution Amount, if any, was credited at the beginning of that Plan Year; provided, however, that in either case, if the Plan Year is the first year of Plan participation, the amount withheld and/or credited shall be deemed withheld or credited on the date that the Participant commenced participation in the Plan. The rate of interest for crediting shall be the Preferred Rate, except as otherwise provided in this Plan, which rate shall be -12- treated as the nominal rate for crediting interest. In the event of Retirement, Disability, death or Termination of Employment prior to the end of a Plan Year, the basis for that year's interest crediting will be a fraction of the full year's interest, based on the number of full months that the Participant was employed with the Employer during the Plan Year prior to the occurrence of such event. If a distribution is made under this Plan, for purposes of crediting interest up to the time of the distribution, the Participant's Account Balance shall be reduced as of the first day of the month in which the distribution is made. 3.6 INTEREST CREDITING FOR INSTALLMENT DISTRIBUTIONS. If a Participant's benefits under this Plan are to be paid in equal monthly installments, such payments shall be determined by amortizing the Participant's specified benefit over the number of months elected, with payments made at the beginning of each installment period, using the interest rate specified below and treating the first installment payment as all principal and each subsequent installment payment, first as interest accrued for the preceding installment period on the unpaid Account Balance and second as a reduction in the Account Balance. The interest rate to be used to calculate installment payment amounts shall be a fixed interest rate that is determined by averaging the Preferred Rates for the Plan Year in which installment payments commence and the four (4) preceding Plan Years. This rate shall be treated as the nominal rate for making such calculations. If a Participant has completed fewer than five (5) Plan Years, this average shall be determined using the Preferred Rates for the Plan Years during which the Participant participated in the Plan. 3.7 FICA AND OTHER TAXES. (a) ANNUAL DEFERRAL AMOUNTS. For each Plan Year in which an Annual Deferral Amount is being withheld, the Participant's Employer(s) shall withhold from that portion of the Participant's Base Annual Salary and/or Bonus that is not being deferred, in a manner determined by the Employer(s), the Participant's share of FICA and other employment taxes. If necessary, the Committee may reduce the Annual Deferral Amount in order to comply with this Section 3.7. (b) COMPANY CONTRIBUTION ACCOUNT. When a participant becomes vested in a portion of his or her Company Contribution Account, and, after vesting, when allocations are made of Annual Company Contribution -13- Amounts, the Participant's Employer(s) shall withhold from the Participant's Base Annual Salary and/or Bonus that is not deferred, in a manner determined by the Employer(s), the Participant's share of FICA and other employment taxes. If necessary, the Committee may reduce the vested portion of the Participant's Company Contribution Account in order to comply with this Section 3.7. (c) DISTRIBUTIONS. The Participant's Employer(s), or the trustee of the Trust, shall withhold from any payments made to a Participant under this Plan all federal, state and local income, employment and other taxes required by law to be withheld by the Employer(s), or the trustee of the Trust, in connection with such payments, in amounts and in a manner as required by law. 3.8 ANNUAL COMPANY CONTRIBUTION AMOUNT. For each Plan Year, an Employer, in its sole discretion, may, but is not required to, credit any amount it desires to any Participant's Company Contribution Account under this Plan, which amount shall be for that Participant the Annual Company Contribution Amount for that Plan Year. The amount so credited to a Participant may be smaller or larger than the amount credited to other Participants, and the amount credited to any Participant for a Plan Year may be zero, even though one or more other Participants receive an Annual Company Contribution Amount for that Plan Year. 3.9 VESTING. Except as provided in Sections 6.3 and 7.1, a Participant shall be (i) 100% vested in his or her Deferral Account and (ii) vested in his or her Company Contribution Account in accordance with the following schedule: YEARS OF SERVICE ON DATE VESTED PERCENTAGE OF OF TERMINATION OF EMPLOYMENT COMPANY CONTRIBUTION ACCOUNT Less than 5 years 0% 5 years or more 100% Despite the foregoing, in the event of a Change of Control or the Participant's death, a Participant's Company Contribution Account shall immediately become 100% vested (if it is not so vested in accordance with the above vesting schedule). -14- 3.10 ROLLOVERS. If a Participant was a participant in the FHP, Inc. Deferred Compensation Plan for Executives and Physicians, the FHP Deferred Compensation Plan for Non- Employee Directors and/or the Takecare, Inc. Deferred Compensation Plan, and had a positive account balance in one or more of those plans on December 31, 1995, those positive account balances, as determined as of that date, shall be transferred to and added to the Participant's account balance under this Plan, and shall be governed by the terms and conditions of this Plan and shall be referred to as the "Rollover Amount." In addition, any elections made by the Participant with respect to his or her Account Balance shall apply to the Rollover Amount, except that if the Participant Retires prior to January 1, 1999, that portion of his or her Account Balance that represents the Rollover Amount (including earnings on that amount since the transfer) shall be paid in a lump sum in accordance with Article 5 below, regardless of whether the Participant may have elected to receive his or her Account Balance in installments. ARTICLE 4 SHORT-TERM PAYOUT; WITHDRAWAL ELECTION 4.1 SHORT-TERM PAYOUT. In connection with each election to defer an Annual Deferral Amount, a Participant may elect to receive a future "Short-Term Payout" from the Plan with respect to that Annual Deferral Amount. Subject to the Deduction Limitation, the Short-Term Payout shall be a lump sum payment in an amount that is equal to the Annual Deferral Amount plus interest credited in the manner provided in Section 3.5 above on that amount, but using the applicable interest rate set forth in Section 7.1 below, determined at the time that the Short-Term Payout becomes payable (rather than the date of a Termination of Employment). Subject to the other terms and conditions of this Plan, each Short-Term Payout elected shall be paid, subject to the Deduction Limitation, within 90 days of the first day of the Plan Year that is at least 5 years after the first day of the Plan Year in which the Annual Deferral Amount is actually deferred. 4.2 OTHER BENEFITS TAKE PRECEDENCE OVER SHORT-TERM PAYOUT. Should an event occur that triggers a benefit under Article 5, 6, 7 or 8, any Annual Deferral Amount, plus interest thereon, that is subject to a Short-Term Payout election under Section 4.1 shall not be paid in accordance with Section 4.1, but shall be paid in accordance with the other applicable Article. -15- 4.3 WITHDRAWAL ELECTION. A Participant may elect, at any time, to withdraw all of his or her Account Balance, calculated as if there had occurred a Termination of Employment as of the day of the election, less a withdrawal penalty equal to 10% of such amount (the net amount shall be referred to as the "Withdrawal Amount"). This election can be made at any time before or after Retirement, Disability, death or Termination of Employment, and whether or not the Participant (or Beneficiary) is in the process of being paid pursuant to an installment payment schedule. No partial withdrawals of the Withdrawal Amount shall be allowed. The Participant shall make this election by giving the Committee advance written notice of the election in a form determined from time to time by the Committee. The Participant shall be paid the Withdrawal Amount within 90 days of his or her election. Once the Withdrawal Amount is paid, the Participant's participation in the Plan shall terminate and the Participant shall not be eligible to participate in the Plan in the future. The payment of this Withdrawal Amount shall not be subject to the Deduction Limitation. ARTICLE 5 RETIREMENT BENEFIT 5.1 RETIREMENT BENEFIT. Subject to the Deduction Limitation, a Participant who Retires shall receive, as a Retirement Benefit, his or her Account Balance. 5.2 PAYMENT OF RETIREMENT BENEFIT. A Participant, in connection with his or her commencement of participation in the Plan, shall elect on an Election Form to receive the Retirement Benefit in a lump sum or, if the Participant's Account Balance is at least $25,000 at the time of his or her Retirement, in equal monthly payments (the latter determined in accordance with Section 3.6 above) over a period of 60, 120 or 180 months. The Participant may annually change his or her election to an allowable alternative payout period by submitting a new Election Form to the Committee, provided that any such Election Form is submitted at least 3 years prior to the Participant's Retirement and is acknowledged by the Committee in its sole discretion. The Election Form most recently acknowledged by the Committee shall govern the payout of the Retirement Benefit (provided it was submitted at least 3 years prior to the Participant's Retirement). If a Participant does not make any election with respect to the payment of the Retirement Benefit, then such benefit shall be payable in a lump sum. The lump sum payment shall be made, or installment -16- payments shall commence, no later than 90 days after the date the Participant Retires. Any payment made shall be subject to the Deduction Limitation. 5.3 DEATH PRIOR TO COMPLETION OF RETIREMENT BENEFIT. If a Participant dies after Retirement but before the Retirement Benefit is paid in full, the Participant's unpaid Retirement Benefit payments shall continue and shall be paid to the Participant's Beneficiary (a) over the remaining number of months and in the same amounts as that benefit would have been paid to the Participant had the Participant survived, or (b) in a lump sum, if requested by the Beneficiary and allowed in the sole discretion of the Committee, that is equal to the Participant's unpaid remaining Account Balance. ARTICLE 6 PRE-RETIREMENT SURVIVOR BENEFIT 6.1 PRE-RETIREMENT SURVIVOR BENEFIT. Subject to the Deduction Limitation, and except as provided in Section 6.3 below, the Participant's Beneficiary shall receive a Pre-Retirement Survivor Benefit equal to the Participant's Account Balance, if the Participant dies before he or she Retires, experiences a Termination of Employment or suffers a Disability. 6.2 PAYMENT OF PRE-RETIREMENT SURVIVOR BENEFIT. A Participant, in connection with his or her commencement of participation in the Plan, shall elect on an Election Form whether the Pre-Retirement Survivor Benefit shall be received by his or her Beneficiary in a lump sum or in equal monthly payments (the latter determined in accordance with Section 3.6 above) over a period of 60, 120 or 180 months. The Participant may annually change this election to an allowable alternative payout period by submitting a new Election Form to the Committee, which form must be acknowledged by the Committee in its sole discretion. The Election Form most recently acknowledged by the Committee prior to the Participant's death shall govern the payout of the Participant's Pre- Retirement Survivor Benefit. If a Participant does not make any election with respect to the payment of the Pre- Retirement Survivor Benefit, then such benefit shall be paid in a lump sum. Despite the foregoing, if the Participant's Account Balance at the time of his or her death is less than $25,000, payment of the Pre-Retirement Survivor Benefit may be made, in the sole discretion of the Committee, in a lump sum or in monthly installment payments that do not exceed five years in duration. The lump sum payment shall be made, or -17- installment payments shall commence, no later than 90 days after the date the Committee is provided with proof that is satisfactory to the Committee of the Participant's death. Any payment made shall be subject to the Deduction Limitation. 6.3 RESTRICTION IN THE EVENT OF SUICIDE OR FALSELY PROVIDED INFORMATION. In the event of a Participant's suicide within 2 years after the Participant first becomes a Participant, or in the event the Participant's death is determined to be from a bodily or mental cause or causes, the information about which was withheld, knowingly concealed, or falsely provided by the Participant if requested to furnish evidence of good health, the Pre-Retirement Survivor Benefit shall be equal to the sum of the Participant's Annual Deferral Amounts, without interest, all determined as of his or her date of death and payable in accordance with the provisions of Section 6.2 above. ARTICLE 7 TERMINATION BENEFIT 7.1 TERMINATION BENEFIT. Subject to the Deduction Limitation, the Participant shall receive a Termination Benefit, which shall be equal to the Participant's Account Balance, with interest credited in the manner provided in Section 3.5 above, but using the applicable interest rate set forth in the following schedule, if a Participant experiences a Termination of Employment prior to his or her Retirement, death or Disability: YEARS OF SERVICE ON DATE OF TERMINATION OF EMPLOYMENT APPLICABLE RATE Less than 5 years Crediting Rate 5 or more years Preferred Rate 7.2 PAYMENT OF TERMINATION BENEFIT. The Termination Benefit shall be paid in a lump sum within 90 days of the Termination of Employment. Any payment made shall be subject to the Deduction Limitation. -18- ARTICLE 8 DISABILITY AND BENEFIT 8.1 DISABILITY. (a) NO WAIVER OF DEFERRAL. A Participant who is determined by the Committee to be suffering from a Disability shall be required to fulfill that portion of the Annual Deferral Amount commitment that occurs after his or her Disability to the extent of his or her Base Annual Salary, Bonus and/or Directors Fees paid after such Disability. (b) RETURN TO WORK. If a Participant returns to employment, or service as a Director, with an Employer after a Disability ceases, the Participant may elect to defer an Annual Deferral Amount for the Plan Year following his or her return to employment or service and for every Plan Year thereafter while a Participant in the Plan; provided such deferral elections are otherwise allowed and an Election Form is delivered to and acknowledged by the Committee for each such election in accordance with Section 3.3 above. 8.2 CONTINUED ELIGIBILITY; DISABILITY BENEFIT. A Participant suffering a Disability shall, for benefit purposes under this Plan, continue to be considered to be employed, or in the service of an Employer as a Director, and shall be eligible for the benefits provided for in Articles 4, 5, 6 or 7 in accordance with the provisions of those Articles. Notwithstanding the above, the Committee shall have the right, in its sole and absolute discretion and for purposes of this Plan only, and must in the case of a Participant who is otherwise eligible to Retire, to terminate a Participant's employment or service as a Director at any time (or in the case of a Participant who is eligible to Retire, as soon as practical) after such Participant is determined to be suffering from a Disability. Any payment made shall be subject to the Deduction Limitation. ARTICLE 9 BENEFICIARY DESIGNATION 9.1 BENEFICIARY. Each Participant shall have the right, at any time, to designate his or her Beneficiary(ies) (both primary as well as contingent) to receive any benefits payable under the Plan to a beneficiary upon the death of a -19- Participant. The Beneficiary designated under this Plan may be the same as or different from the Beneficiary designation under any other plan of an Employer in which the Participant participates. 9.2 BENEFICIARY DESIGNATION; CHANGE; SPOUSAL CONSENT. A Participant shall designate his or her Beneficiary by completing and signing the Beneficiary Designation Form, and returning it to the Committee or its designated agent. A Participant shall have the right to change a Beneficiary by completing, signing and otherwise complying with the terms of the Beneficiary Designation Form and the Committee's rules and procedures, as in effect from time to time. If the Participant names someone other than his or her spouse as a Beneficiary, a spousal consent, in the form designated by the Committee, must be signed by that Participant's spouse, notarized and returned to the Committee. Upon the acknowledgement by the Committee of a new Beneficiary Designation Form, all Beneficiary designations previously filed shall be cancelled. The Committee shall be entitled to rely on the last Beneficiary Designation Form filed by the Participant and acknowledged by the Committee prior to his or her death. 9.3 ACKNOWLEDGMENT. No designation or change in designation of a Beneficiary shall be effective until received and acknowledged in writing by the Committee or its designated agent. 9.4 NO BENEFICIARY DESIGNATION. If a Participant fails to designate a Beneficiary as provided in Sections 9.1, 9.2 and 9.3 above or, if all designated Beneficiaries predecease the Participant or die prior to complete distribution of the Participant's benefits, then the Participant's designated Beneficiary shall be deemed to be his or her surviving spouse. If the Participant has no surviving spouse, the benefits remaining under the Plan to be paid to a Beneficiary shall be payable to the executor or personal representative of the Participant's estate. 9.5 DOUBT AS TO BENEFICIARY. If the Committee has any doubt as to the proper Beneficiary to receive payments pursuant to this Plan, the Committee shall have the right, exercisable in its discretion, to cause the Participant's Employer to withhold such payments until this matter is resolved to the Committee's satisfaction. -20- 9.6 DISCHARGE OF OBLIGATIONS. The payment of benefits under the Plan to a Beneficiary shall fully and completely discharge all Employers and the Committee from all further obligations under this Plan with respect to the Participant, and that Participant's Plan Agreement shall terminate upon such full payment of benefits. ARTICLE 10 LEAVE OF ABSENCE 10.1 PAID LEAVE OF ABSENCE. If a Participant is authorized by the Participant's Employer for any reason to take a paid leave of absence from the employment of the Employer, the Participant shall continue to be considered employed by the Employer and the Annual Deferral Amount shall continue to be withheld during such paid leave of absence in accordance with Section 3.4. 10.2 UNPAID LEAVE OF ABSENCE. If a Participant is authorized by the Participant's Employer for any reason to take an unpaid leave of absence from the employment of the Employer, the Participant shall continue to be considered employed by the Employer and the Participant shall be excused from making deferrals until the earlier of the date the leave of absence expires or the Participant returns to a paid employment status. Upon such expiration or return, deferrals shall resume for the remaining portion of the Plan Year in which the expiration or return occurs, based on the deferral election, if any, made for that Plan Year. If no election was made for that Plan Year, no deferral shall be withheld. ARTICLE 11 TERMINATION, AMENDMENT OR MODIFICATION 11.1 TERMINATION. Although the Employers anticipate that they will continue the Plan for an indefinite period of time, there is no guarantee that the Committee will continue the Plan or will not terminate the Plan at any time in the future. Accordingly, the Committee reserves the right to discontinue any Employer's sponsorship of the Plan and/or to terminate the Plan, at any time, with respect to any Employer's participating Employees or Directors. Upon the termination of the Plan with respect to any Employer, the Plan Agreements of the affected Participants who are employed by that Employer, or are in the -21- service of that Employer as Directors, shall terminate and their Account Balances, determined as if they had experienced a Termination of Employment on the date of Plan termination or, if Plan termination occurs after the date upon which a Participant was eligible to Retire, then with respect to that Participant as if he or she had Retired on the date of Plan termination, shall be paid to the Participants as follows. Prior to a Change of Control, the Committee shall have the right, in its sole discretion, and notwithstanding any elections made by the Participant, to pay such benefits in a lump sum or in equal monthly installments for up to 15 years, with interest credited during the installment period as provided in Section 3.6. After a Change of Control, a Participant's benefits shall be paid in a lump sum. The termination of the Plan shall not adversely affect any Participant or Beneficiary who has become entitled to the payment of any benefits under the Plan as of the date of termination; provided however, that the Committee shall have the right to accelerate installment payments by paying the Participant's remaining Account Balance at the time of such acceleration. 11.2 AMENDMENT. The Committee may, at any time, amend or modify the Plan in whole or in part with respect to any Employer; provided, however, that no amendment or modification shall be effective to decrease or restrict the value of a Participant's Account Balance in existence at the time the amendment or modification is made, calculated as if the Participant had experienced a Termination of Employment as of the effective date of the amendment or modification, or, if the amendment or modification occurs after the date upon which the Participant was eligible to Retire, the Participant had Retired as of the effective date of the amendment or modification. The amendment or modification of the Plan shall not affect any Participant or Beneficiary who has become entitled to the payment of benefits under the Plan as of the date of the amendment or modification; provided, however, that the Committee shall have the right to accelerate installment payments by paying the Participant's remaining Account Balance at the time of such acceleration. 11.3 PLAN AGREEMENT. Despite the provisions of Sections 11.1 and 11.2 above, if a Participant's Plan Agreement contains benefits or limitations that are not in this Plan document, the Employer may only amend or terminate such provisions with the consent of the Participant. 11.4 INTEREST RATE IN THE EVENT OF A CHANGE OF CONTROL. If a Change of Control occurs, the applicable interest rate to be used in determining a Participant's -22- benefit in connection with a Termination of Employment after the Change of Control, or a Plan termination, amendment or modification under Sections 11.1 and 11.2, shall be the Preferred Rate. However, the Crediting Rate for the applicable Plan Year, and not the Preferred Rate, shall continue to be used as the discount rate for determining present value. 11.5 EFFECT OF PAYMENT. The full payment of the applicable benefit under Section 4.3 or Articles 5, 6, 7 or 8 of the Plan shall completely discharge all obligations to a Participant and his or her designated Beneficiaries under this Plan and the Participant's Plan Agreement shall terminate. ARTICLE 12 ADMINISTRATION 12.1 COMMITTEE DUTIES. This Plan shall be administered by a Committee which shall consist of the Board, or such committee as the Board shall appoint. Members of the Committee may be Participants under this Plan. The Committee shall also have the discretion and authority to (i) make, amend, interpret, and enforce all appropriate rules and regulations for the administration of this Plan, (ii) decide or resolve any and all questions including interpretations of this Plan, as may arise in connection with the Plan, and (ii) amend or terminate the Plan in accordance with Sections 11.1 and 11.2 above. 12.2 AGENTS. In the administration of this Plan, the Committee may, from time to time, employ agents and delegate to them such administrative duties as it sees fit (including acting through a duly appointed representative) and may from time to time consult with counsel who may be counsel to any Employer. 12.3 BINDING EFFECT OF DECISIONS. The decision or action of the Committee with respect to any question arising out of or in connection with the administration, interpretation and application of the Plan and the rules and regulations promulgated hereunder shall be final and conclusive and binding upon all persons having any interest in the Plan. 12.4 INDEMNITY OF COMMITTEE. All Employers shall indemnify and hold harmless the members of the Committee against any and all claims, losses, damages, expenses or liabilities arising from any action or failure to act with respect to -23- this Plan, except in the case of willful misconduct by the Committee or any of its members. 12.5 EMPLOYER INFORMATION. To enable the Committee to perform its functions, each Employer shall supply full and timely information to the Committee on all matters relating to the compensation of its Participants, the date and circumstances of the Retirement, Disability, death or Termination of Employment of its Participants, and such other pertinent information as the Committee may reasonably require. ARTICLE 13 OTHER BENEFITS AND AGREEMENTS 13.1 COORDINATION WITH OTHER BENEFITS. The benefits provided for a Participant and Participant's Beneficiary under the Plan are in addition to any other benefits available to such Participant under any other plan or program for employees of the Participant's Employer. The Plan shall supplement and shall not supersede, modify or amend any other such plan or program except as may otherwise be expressly provided. 13.2 OFFSET UNDER SPLIT-DOLLAR LIFE INSURANCE AGREEMENT. Notwithstanding anything contained herein to the contrary, those portions of any benefits payable under this Plan which are attributable to Rollover Amounts (including earnings on Rollover Amounts) shall be offset by the value of benefits received by the Participants under certain life insurance policies as set forth in this Section. Participants in this Plan may own life insurance policies (the "Policies") purchased on their behalf by the Company. The ownership of these Policies by each Participant is, however, subject to certain conditions (set forth in a "Split-Dollar Life Insurance Agreement" between each Participant and the Company) and, if the Participant fails to meet the conditions set forth in the Split-Dollar Life Insurance Agreement, the Participant may lose certain rights under the Policy. In the event that a Participant satisfies the conditions specified in Section 5 or 6 of the Split-Dollar Life Insurance Agreement, so that the Participant or his or her beneficiary becomes entitled to benefits under one of those sections, or the Company's security interest in the Policy is otherwise released, the value of those benefits shall constitute an immediate offset to any benefit attributable to the Rollover Amount which is otherwise payable under this Plan. As the case -24- may be, this offset (the "Offset Value") shall be equal to the value of benefits payable under the Split-Dollar Life Insurance Agreement, that is, the cash surrender value of the Policy or, in the case of the Participant's death, the death benefit payable to the beneficiary under the Policy. Effective as of the date that a Participant or his or her beneficiary becomes entitled to benefits under Section 5 or 6 of the Split-Dollar Life Insurance Agreement, or the Company's security interest in the Policy is otherwise released, the Offset Value shall be compared to that portion of the Participant's Deferral Account which is attributable to the Participant's Rollover Amount (including earnings), and the amount credited to the Deferral Account shall be reduced, but not to less than zero, by the lesser of the Offset Value or an amount equal to the Rollover Amount plus earnings to the date of offset. Notwithstanding anything contained in the Plan to the contrary, a Participant who owns a Policy that is subject to a Split-Dollar Life Insurance Agreement with the Company may not make the withdrawal election described in Section 4.3 while such Split-Dollar Life Insurance Agreement is in effect. ARTICLE 14 CLAIMS PROCEDURES 14.1 PRESENTATION OF CLAIM. Any Participant or Beneficiary of a deceased Participant (such Participant or Beneficiary being referred to below as a "Claimant") may deliver to the Committee a written claim for a determination with respect to the amounts distributable to such Claimant from the Plan. If such a claim relates to the contents of a notice received by the Claimant, the claim must be made within 60 days after such notice was received by the Claimant. The claim must state with particularity the determination desired by the Claimant. All other claims must be made within 180 days of the date on which the event that caused the claim to arise occurred. The claim must state with particularity the determination desired by the Claimant. 14.2 NOTIFICATION OF DECISION. The Committee shall consider a Claimant's claim within a reasonable time, and shall notify the Claimant in writing: (a) that the Claimant's requested determination has been made, and that the claim has been allowed in full; or -25- (b) that the Committee has reached a conclusion contrary, in whole or in part, to the Claimant's requested determination, and such notice must set forth in a manner calculated to be understood by the Claimant: (i) the specific reason(s) for the denial of the claim, or any part of it; (ii) specific reference(s) to pertinent provisions of the Plan upon which such denial was based; (iii) a description of any additional material or information necessary for the Claimant to perfect the claim, and an explanation of why such material or information is necessary; and (iv) an explanation of the claim review procedure set forth in Section 14.3 below. 14.3 REVIEW OF A DENIED CLAIM. Within 60 days after receiving a notice from the Committee that a claim has been denied, in whole or in part, a Claimant (or the Claimant's duly authorized representative) may file with the Committee a written request for a review of the denial of the claim. Thereafter, but not later than 30 days after the review procedure began, the Claimant (or the Claimant's duly authorized representative): (a) may review pertinent documents; (b) may submit written comments or other documents; and/or (c) may request a hearing, which the Committee, in its sole discretion, may grant. 14.4 DECISION ON REVIEW. The Committee shall render its decision on review promptly, and not later than 60 days after the filing of a written request for review of the denial, unless a hearing is held or other special circumstances require additional time, in which case the Committee's decision must be rendered within 120 days after such date. Such decision must be written in a manner calculated to be understood by the Claimant, and it must contain: -26- (a) specific reasons for the decision; (b) specific reference(s) to the pertinent Plan provisions upon which the decision was based; and (c) such other matters as the Committee deems relevant. 14.5 LEGAL ACTION. A Claimant's compliance with the foregoing provisions of this Article 14 is a mandatory prerequisite to a Claimant's right to commence any legal action with respect to any claim for benefits under this Plan. ARTICLE 15 TRUST 15.1 ESTABLISHMENT OF THE TRUST. The Company shall establish the Trust, and the Employers shall at least annually transfer over to the Trust such assets as the Employers determine, in their sole discretion, are necessary to provide, on a present value basis, for their respective future liabilities created with respect to the Annual Deferral Amounts, Annual Company Contribution Amounts and interest credits on those amounts for that year. 15.2 INTERRELATIONSHIP OF THE PLAN AND THE TRUST. The provisions of the Plan and the Plan Agreement shall govern the rights of a Participant to receive distributions pursuant to the Plan. The provisions of the Trust shall govern the rights of the Employers, Participants and the creditors of the Employers to the assets transferred to the Trust. Each Employer shall at all times remain liable to carry out its obligations under the Plan. 15.3 DISTRIBUTIONS FROM THE TRUST. Each Employer's obligations under the Plan may be satisfied with Trust assets distributed pursuant to the terms of the Trust, and any such distribution shall reduce the Employer's obligations under this Agreement. -27- ARTICLE 16 MISCELLANEOUS 16.1 UNSECURED GENERAL CREDITOR. Participants and their Beneficiaries, heirs, successors and assigns shall have no legal or equitable rights, interests or claims in any property or assets of an Employer. For purposes of the payment of benefits under this Plan, any and all of an Employer's assets shall be, and remain, the general, unpledged unrestricted assets of the Employer. An Employer's obligation under the Plan shall be merely that of an unfunded and unsecured promise to pay money in the future. 16.2 EMPLOYER'S LIABILITY. An Employer's liability for the payment of benefits shall be defined only by the Plan and the Plan Agreement, as entered into between the Employer and a Participant. An Employer shall have no obligation to a Participant under the Plan except as expressly provided in the Plan and his or her Plan Agreement. 16.3 NONASSIGNABILITY. Neither a Participant nor any other person shall have any right to commute, sell, assign, transfer, pledge, anticipate, mortgage or otherwise encumber, transfer, hypothecate, alienate or convey in advance of actual receipt, the amounts, if any, payable hereunder, or any part thereof, which are, and all rights to which are expressly declared to be, unassignable and non- transferable, except that the foregoing shall not apply to any court order specified in Section 16.14 below. No part of the amounts payable shall, prior to actual payment, be subject to seizure, attachment, garnishment or sequestration for the payment of any debts, judgments, alimony or separate maintenance owed by a Participant or any other person, nor be transferable by operation of law in the event of a Participant's or any other person's bankruptcy or insolvency. 16.4 NOT A CONTRACT OF EMPLOYMENT. The terms and conditions of this Plan shall not be deemed to constitute a contract of employment between any Employer and the Participant. Such employment is hereby acknowledged to be an "at will" employment relationship that can be terminated at any time for any reason, or no reason, with or without cause, and with or without notice, unless expressly provided in a written employment agreement. Nothing in this Plan shall be deemed to give a Participant the right to be retained in the service of any Employer, either as an Employee or a Director, or to interfere with the right of any Employer to discipline or discharge the Participant at any time. -28- 16.5 FURNISHING INFORMATION. A Participant or his or her Beneficiary will cooperate with the Committee by furnishing any and all information requested by the Committee and take such other actions as may be requested in order to facilitate the administration of the Plan and the payments of benefits hereunder, including but not limited to taking such physical examinations as the Committee may deem necessary. 16.6 TERMS. Whenever any words are used herein in the masculine, they shall be construed as though they were in the feminine in all cases where they would so apply; and whenever any words are used herein in the singular or in the plural, they shall be construed as though they were used in the plural or the singular, as the case may be, in all cases where they would so apply. 16.7 CAPTIONS. The captions of the articles, sections and paragraphs of this Plan are for convenience only and shall not control or affect the meaning or construction of any of its provisions. 16.8 GOVERNING LAW. Subject to ERISA, the provisions of this Plan shall be construed and interpreted according to the internal laws of the State of California without regard to its conflicts of laws principles. NOTICE. Any notice or filing required or permitted to be given to the Committee under this Plan shall be sufficient if in writing and either : (a) hand-delivered to: FHP International Corporation Corporate Employee Benefits 3100 Lake Center Drive Santa Ana, California 92704 (b) or, if sent by registered or certified mail, to: FHP International Corporation Corporate Employee Benefits P.O. Box 25186 Santa Ana, California 92799-9859 -29- Such notice shall be deemed given as of the date of delivery or, if delivery is made by mail, as of the date shown on the postmark on the receipt for registration or certification. Any notice or filing required or permitted to be given to a Participant under this Plan shall be sufficient if in writing and hand-delivered, or sent by mail, to the last known address of the Participant. 16.10 SUCCESSORS. The provisions of this Plan shall bind and inure to the benefit of the Participant's Employer and its successors and assigns and the Participant and the Participant's designated Beneficiaries. 16.11 SPOUSE'S INTEREST. The interest in the benefits hereunder of a spouse of a Participant who has predeceased the Participant shall automatically pass to the Participant and shall not be transferable by such spouse in any manner, including but not limited to such spouse's will, nor shall such interest pass under the laws of intestate succession. 16.12 VALIDITY. In case any provision of this Plan shall be illegal or invalid for any reason, said illegality or invalidly shall not affect the remaining parts hereof, but this Plan shall be construed and enforced as if such illegal or invalid provision had never been inserted herein. 16.13 INCOMPETENT. If the Committee determines in its discretion that a benefit under this Plan is to be paid to a minor, a person declared incompetent or to a person incapable of handling the disposition of that person's property, the Committee may direct payment of such benefit to the guardian, legal representative or person having the care and custody of such minor, incompetent or incapable person. The Committee may require proof of minority, incompetency, incapacity or guardianship, as it may deem appropriate prior to distribution of the benefit. Any payment of a benefit shall be a payment for the account of the Participant and the Participant's Beneficiary, as the case may be, and shall be a complete discharge of any liability under the Plan for such payment amount. 16.14 COURT ORDER. The Committee is authorized to make any payments directed by court order in any action in which the Plan or the Committee has been named as a party. In addition, if a court determines that a spouse or former spouse of a Participant has an interest in the Plan as the result of a property -30- settlement or otherwise, the Committee, in its sole discretion, shall have the right, notwithstanding any election made by a Participant to immediately distribute the spouse's or former spouse's interest in the Plan to that spouse or former spouse. 16.15 DISTRIBUTION IN THE EVENT OF TAXATION. (a) GENERAL. If, for any reason, all or any portion of a Participant's benefit under this Plan becomes taxable to the Participant prior to receipt, a Participant may petition the Committee before a Change of Control, or the trustee of the Trust after a Change of Control, for a distribution of that portion of his or her benefit that has become taxable. Upon the grant of such a petition, which grant shall not be unreasonably withheld, a Participant's Employer shall distribute to the Participant immediately available funds in an amount equal to the taxable portion of his or her benefit (which amount shall not exceed a Participant's unpaid Account Balance under the Plan), less taxes withheld in accordance with Section 3.7(c) above. If the petition is granted, the tax liability distribution shall be made within 90 days of the date when the Participant's petition is granted. Such a distribution shall affect and reduce the benefits to be paid under this Plan. (b) TRUST. If the Trust terminates in accordance with Section 3.6(e) of the Trust Agreement and benefits are distributed from the Trust to a Participant in accordance with that Section, the Participant's benefits under this Plan shall be reduced to the extent of such distributions. IN WITNESS WHEREOF, the Company has signed this Plan document as of January 1, 1996. "Company" FHP International Corporation, a Delaware corporation By: /s/ Kenneth S. Ord ------------------------------ Title: Senior Vice President and CFO --------------------------------- -31- EX-10.17 4 MASTER TRUST AGREEMENT FHP INTERNATIONAL CORPORATION MASTER TRUST AGREEMENT - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- EFFECTIVE JANUARY 1, 1996 MASTER TRUST AGREEMENT Table of Contents Article Page - ------- ---- ARTICLE 1 Name, Intentions, Irrevocability, Deposit and Definitions......... 1 1.1 Name............................................................... 1 1.2 Intentions......................................................... 1 1.3 Irrevocability; Creditor Claims.................................... 2 1.4 Initial Deposit.................................................... 2 1.5 Additional Definitions............................................. 2 1.6 Grantor Trust...................................................... 5 ARTICLE 2 General Administration............................................ 5 2.1 Committee Directions and Administration Before Change of Control... 5 2.2 Administration Upon Change of Control.............................. 6 2.3 Contributions...................................................... 7 2.4 Sub-Trust.......................................................... 7 2.5 Distribution of Excess Sub-Trust Funds to Employers................ 7 ARTICLE 3 Powers and Duties of Trustee...................................... 7 3.1 Investment Directions.............................................. 7 3.2 Investment Upon Change of Control.................................. 8 3.3 Management of Investments.......................................... 8 3.4 Securities......................................................... 10 3.5 Substitution....................................................... 11 3.6 Distributions...................................................... 11 3.7 Trustee Responsibility Regarding Payments on Insolvency............ 13 3.8 Costs of Administration............................................ 15 3.9 Trustee Compensation and Expenses.................................. 15 3.10 Professional Advice............................................... 16 3.11 Payment on Court Order............................................ 16 3.12 Protective Provisions............................................. 16 3.13 Indemnifications.................................................. 16 -i- ARTICLE 4 Insurance Contracts.............................................. 17 4.1 Types of Contracts................................................. 17 4.2 Ownership.......................................................... 17 4.3 Restrictions on Trustee's Rights................................... 17 ARTICLE 5 Trustee's Accounts............................................... 18 5.1 Records............................................................ 18 5.2 Annual Accounting; Final Accounting................................ 18 5.3 Valuation.......................................................... 19 5.4 Delegation of Duties............................................... 19 ARTICLE 6 Resignation or Removal of Trustee................................ 19 6.1 Resignation; Removal............................................... 19 6.2 Successor Trustee.................................................. 20 6.3 Settlement of Accounts............................................. 20 ARTICLE 7 Controversies, Legal Actions and Counsel......................... 20 7.1 Controversy........................................................ 20 7.2 Joinder of Parties................................................. 20 7.3 Employment of Counsel.............................................. 21 ARTICLE 8 Insurers......................................................... 21 8.1 Insurer Not a Party................................................ 21 8.2 Authority of Trustee............................................... 21 8.3 Contract Ownership................................................. 21 8.4 Limitation of Liability............................................ 21 8.5 Change of Trustee.................................................. 21 ARTICLE 9 Amendment and Termination........................................ 22 9.1 Amendment.......................................................... 22 9.2 Final Termination.................................................. 23 ARTICLE 10 Miscellaneous................................................... 24 10.1 Directions Following Change of Control............................ 24 10.2 Taxes............................................................. 24 -ii- 10.3 Nonassignability; Nonalienation................................... 24 10.4 The Plan.......................................................... 24 10.5 Applicable Law.................................................... 25 10.6 Notices and Directions............................................ 25 10.7 Successors and Assigns............................................ 25 10.8 Gender and Number................................................. 25 10.9 Headings.......................................................... 25 10.10 Counterparts..................................................... 25 10.11 Beneficial Interest.............................................. 25 10.12 Effective Date................................................... 26 -iii- MASTER TRUST AGREEMENT FOR FHP INTERNATIONAL CORPORATION EXECUTIVE DEFERRAL PLANS THIS MASTER TRUST AGREEMENT ("Master Trust Agreement") is made and entered into as of January 1, 1996, between FHP International Corporation, a Delaware corporation (the "Company"), and Wells Fargo Bank, N. A. (the "Trustee"), to evidence the master trust (the "Trust") to be established, pursuant to those executive deferral plans of the Company now or hereafter existing that require the establishment of a trust, for the benefit of a select group of management, highly compensated employees and Directors who contribute materially to the continued growth, development and business success of the Company and those subsidiaries of the Company, if any, that participate in the Plans. ARTICLE 1 NAME, INTENTIONS, IRREVOCABILITY, DEPOSIT AND DEFINITIONS 1.1 NAME. The name of the Trust created by this Agreement (the "Trust") shall be: MASTER TRUST AGREEMENT FOR FHP INTERNATIONAL CORPORATION EXECUTIVE DEFERRAL PLANS 1.2 INTENTIONS. The Company wishes to establish the Trust and to contribute to the Trust assets that shall be held therein, subject to the claims of the Company's and the Subsidiaries' creditors in the event of their Insolvency (as defined below) until paid to Participants and their Beneficiaries in such manner and at such times as specified in the Plans. It is the intention of the parties that this Trust shall constitute an unfunded arrangement and shall not affect the status of the Plans as unfunded plans maintained for the purpose of providing supplemental compensation for a select group of management, highly compensated employees and/or Directors for purposes of Title I of ERISA (as defined below). In addition, it is the intention of the Company and the Subsidiaries to make contributions to the Trust to provide themselves with a source of funds to assist them in the meeting of their liabilities under the Plans. -1- 1.3 IRREVOCABILITY; CREDITOR CLAIMS. The Trust hereby established shall be irrevocable. Except as otherwise provided in Sections 2.5 and 9.2, the principal of the Trust, and any earnings thereon, shall be held separate and apart from other funds of the Company and the Subsidiaries and shall be used exclusively for the uses and purposes of the Participants and the general creditors of the Company and the Subsidiaries as herein set forth. The Participants and their Beneficiaries shall have no preferred claim on, or any beneficial ownership interest in, any assets of the Trust. Any rights created under the Plans and this Master Trust Agreement shall be mere unsecured contractual rights of the Participants and their Beneficiaries against the Company and the Subsidiaries. Any assets held by the Trust will be subject to the claims of the Company's and the Subsidiaries' general creditors under federal and state law in the event of Insolvency. 1.4 INITIAL DEPOSIT. The Company hereby deposits with the Trustee in trust $100, which shall become the principal of the Trust to be held, administered and disposed of by the Trustee as provided in this Master Trust Agreement. 1.5 ADDITIONAL DEFINITIONS. In addition to the definitions set forth above, for purposes hereof, unless otherwise clearly apparent from the context, the following terms have the following indicated meanings: (a) "Beneficiary" shall mean one or more persons, trusts, estates or other entities, designated in accordance with a Plan, that are entitled to receive benefits under a Plan upon the death of a Participant. (b) "Board" shall mean the board of directors of the Company. (c) "Change of Control" shall mean the first to occur of any of the following events: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the 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"); -2- provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (3) of this Section 1.5(c); or (2) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company s shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (3) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting -3- securities entitled to vote generally in the election of directors, as the case my be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company s assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company of such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. (d) "Committee" shall mean the administrative committee appointed by the Board to administer this Trust. (e) "Director" shall mean any member of the board of directors of the Company or any Subsidiary. (f) "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as it may be amended from time to time. (g) "Insolvent" shall have the meaning set forth in Section 3.7(a) below. -4- (h) "Insolvent Entity" shall have the meaning set forth in Section 3.7(a) below. (i) "IRS" shall mean the Internal Revenue Service. (j) "Participant" shall mean a person who is a participant in one or more of the Plans in accordance with their terms and conditions. (k) "Payment Schedule" shall have the meaning set forth in Section 3.6(b) below. (l) "Plan(s)" shall mean one or more of the executive deferral plans established now or in the future by the Company that require the establishment of a trust. (m) "Plan Year" shall mean the Plan Year chosen for this Master Trust Agreement by the Board. (n) "Subsidiary" or "Subsidiaries" shall mean any corporation (now in existence or hereafter formed or acquired) in which the Company possesses more than 50% of either (i) the total combined voting power of all classes of stock of such corporation or (ii) the total combined value of shares of all classes of stock of such corporation. (o) "Sub-Trust" shall mean a sub-trust established in accordance with Section 2.4 below. 1.6 GRANTOR TRUST. The Trust is intended to be a "grantor trust," of which the Company and the Subsidiaries are the grantors, within the meaning of subpart E, part I, subchapter J, chapter 1, subtitle A of the Internal Revenue Code of 1986, as amended, and the Trust shall be construed accordingly. ARTICLE 2 GENERAL ADMINISTRATION 2.1 COMMITTEE DIRECTIONS AND ADMINISTRATION BEFORE CHANGE OF CONTROL. Until a Change of Control has occurred, this Section 2.1 shall be effective and the Committee shall direct the Trustee as to the administration of the Trust in accordance with the following provisions: -5- (a) The Committee shall be identified to the Trustee by a copy of the resolution of the Board appointing the Committee. In the absence thereof, the Board shall be the Committee. Persons authorized to give directions to the Trustee on behalf of the Committee shall be identified to the Trustee by written notice from the Committee, and such notice shall contain specimens of the authorized signatures. The Trustee shall be entitled to rely on such written notice as evidence of the identity and authority of the persons appointed until a written cancellation of the appointment, or the written appointment of a successor, is received by the Trustee. (b) Directions by the Committee, or its delegate, to the Trustee shall be in writing and signed by the Committee or persons authorized by the Committee, or may be made by such other method as is acceptable to the Trustee. (c) The Trustee may conclusively rely upon directions from the Committee in taking any action with respect to this Master Trust Agreement, including the making of payments from the Trust and the investment of the assets of the Trust pursuant to this Master Trust Agreement. The Trustee shall have no liability for actions taken, or for failure to act, on the direction of the Committee. The Trustee shall have no liability for failure to act in the absence of proper written directions. (d) The Trustee may request instructions from the Committee and shall have no duty to act or liability for failure to act if such instructions are not forthcoming from the Committee. If requested instructions are not received within a reasonable time, the Trustee may, but is under no duty to, act on its own discretion to carry out the provisions of this Master Trust Agreement in accordance with this Master Trust Agreement and the Plans. 2.2 ADMINISTRATION UPON CHANGE OF CONTROL. In the event of a Change of Control, the authority of the Committee to administer the Trust and direct the Trustee, as set forth in Section 2.1 above, shall cease, and the Trustee shall have complete authority to administer the Trust. The president of the Company shall notify the Trustee in writing when a Change of Control has occurred. The Trustee has no duty to inquire whether a Change of Control has occurred and may rely on notification by the president of the Company of a Change of Control; provided, however, that if any officer, former officer, director or former director of the Company or any Subsidiary (other than the president of the Company), or any Participant notifies the Trustee that there has been or there may be a Change of Control, the Trustee shall have the duty to satisfy itself as to whether a Change of Control has in fact occurred. The Company and the Subsidiaries shall indemnify and hold harmless the Trustee for any damages or costs (including -6- attorneys' fees) that may be incurred because of reliance on the president's notice or lack thereof. 2.3 CONTRIBUTIONS. Except as provided in any Plan, the Company and the Subsidiaries, in their sole discretion, may at any time, or from time to time, make additional deposits of cash or other property to their respective Sub-Trust(s) to augment the principal to be held, administered and disposed of by the Trustee as provided in this Master Trust Agreement. Neither the Trustee nor any Participant or Beneficiary shall have any right to compel such additional deposits. The Trustee shall have no duty to collect or enforce payment to it of any contributions or to require that any contributions be made, and shall have no duty to compute any amount to be paid to it nor to determine whether amounts paid comply with the terms of the Plans. 2.4 SUB-TRUST. The Company shall establish a Sub-Trust for the Company and for each Subsidiary, and the contributions made by the Company and each Subsidiary to this Trust, and the earnings thereon, shall be allocated to and held in the Company's or each Subsidiary's Sub-Trust, as the case may be. Within each Sub-Trust, the assets shall be held and administered pursuant to the terms of this Master Trust Agreement without distinction between income and principal and without liability for the payment of interest thereon except as expressly provided in this Master Trust Agreement. During the term of this Trust, all income received by each Sub-Trust, net of expenses and taxes, shall be accumulated and reinvested. 2.5 DISTRIBUTION OF EXCESS SUB-TRUST FUNDS TO EMPLOYERS. In the event that the Committee, prior to a Change of Control, or the Trustee in its sole and absolute discretion, after a Change of Control, determines that the assets of a Sub-Trust of the Company or a Subsidiary exceeds 125 percent of the present value of the anticipated benefit obligations and administrative expenses that are to be paid under the Plans with respect to the Company or the Subsidiary, as the case may be, the Trustee, at the direction of the Committee prior to a Change of Control, or in its sole and absolute discretion after a Change of Control, shall distribute to the Company or that Subsidiary, as the case may be, such excess portion of the assets of the Sub-Trust. ARTICLE 3 POWERS AND DUTIES OF TRUSTEE 3.1 INVESTMENT DIRECTIONS. Except as provided in this Section and Section 3.2 below, the Committee shall provide the Trustee with all investment instructions. The Trustee shall neither affect nor change investments of any Sub-Trust, except as directed in writing by the Committee, and shall have no right, duty or -7- responsibility to recommend investments or investment changes; provided, that the Trustee may but is not required to (i) deposit cash on hand from time to time in any bank savings account, certificate of deposit, or other instrument creating a deposit liability for a bank, including the Trustee's own banking department, if the Trustee is a bank, without such prior direction, or (ii) invest in government securities, bonds with specific ratings, or stock of "Fortune 500" companies, all within broad investment guidelines established by the Committee from time to time. 3.2 INVESTMENT UPON CHANGE OF CONTROL. In the event of a Change of Control, the authority of the Committee to direct investments of the Sub-Trusts shall cease and the Trustee shall have complete authority to direct investments of each Sub-Trust. 3.3 MANAGEMENT OF INVESTMENTS. Subject to Section 3.1 above, the Trustee shall have, without exclusion, all powers conferred on the Trustee by applicable law, unless expressly provided otherwise herein, and all rights associated with assets of the Trust shall be exercised by the Trustee or the person designated by the Trustee, and shall in no event be exercisable by or rest with Participants or their Beneficiaries. The Trustee shall have full power and authority to invest and reinvest the assets held in any Sub-Trust in any investment permitted by law, exercising the judgment and care that persons of prudence, discretion and intelligence would exercise under the circumstances then prevailing, considering the probable income and safety of their capital, including, without limiting the generality of the foregoing, the power: (a) To invest and reinvest the assets held in any Sub-Trust, together with the income therefrom, in common stock, preferred stock, convertible preferred stock, mutual funds, bonds, debentures, convertible debentures and bonds, mortgages, notes, time certificates of deposit, commercial paper and other evidences of indebtedness (including those issued by the Trustee or any of its affiliates), other securities, policies of life insurance, annuity contracts, options to buy or sell securities or other assets, and other property of any kind (personal, real, or mixed, and tangible or intangible); provided, however, that in no event may the Trustee invest in securities (including stock or rights to acquire stock) or obligations issued by the Company or the Subsidiaries, other than a de minimis amount held in common investment vehicles in which the Trustee invests; (b) To deposit or invest all or any part of the assets of any Sub-Trust in savings accounts or certificates of deposit or other deposits which bear a reasonable interest rate in a bank, including the commercial department of the Trustee, if such bank is supervised by the United States or any State; (c) To hold, manage, improve, repair and control all property, real or personal, forming part of any Sub-Trust and to sell, convey, -8- transfer, exchange, partition, lease for any term, even extending beyond the duration of this Trust, and otherwise dispose of the same from time to time in such manner, for such consideration, and upon such terms and conditions as the Trustee shall determine; (d) To have, respecting securities, all the rights, powers and privileges of an owner, including the power to give proxies, pay assessments and other sums deemed by the Trustee to be necessary for the protection of the assets of the Trust, to vote any corporate stock either in person or by proxy, with or without power of substitution, for any purpose; to participate in voting trusts, pooling agreements, foreclosures, reorganizations, consolidations, mergers and liquidations, and in connection therewith to deposit securities with and transfer title to any protective or other committee under such terms as the Trustee may deem advisable; to exercise or sell stock subscriptions or conversion rights; and, regardless of any limitation elsewhere in this instrument relative to investment by the Trustee, to accept and retain as an investment any securities or other property received through the exercise of any of the foregoing powers; (e) To hold in cash, without liability for interest, such portion of the assets of any Sub-Trust which, in its discretion, shall be reasonable under the circumstances, pending investments, or payment of expenses, or the distribution of benefits; (f) To take such actions as may be necessary or desirable to protect the assets of any Sub-Trust from loss due to the default on mortgages held in the Trust including the appointment of agents or trustees in such other jurisdictions as may seem desirable, to transfer property to such agents or trustees, to grant such powers as are necessary or desirable to protect the Trust or its assets, to direct such agents or trustees, or to delegate such power to direct, and to remove such agents or trustees; (g) To employ such agents including custodians and counsel as may be reasonably necessary and to pay them reasonable compensation; to settle, compromise or abandon all claims and demands in favor of or against the Trust assets; (h) To cause title to property of the Trust to be issued, held or registered in the individual name of the Trustee, or in the name of its nominee(s) or agents, or in such form that title will pass by delivery; (i) To exercise all of the further rights, powers, options and privileges granted, provided for, or vested in trustees generally under the laws of -9- the State whose laws are applicable to this Master Trust Agreement, as provided in Section 10.6 below, so that the powers conferred upon the Trustee herein shall not be in limitation of any authority conferred by law, but shall be in addition thereto; (j) To borrow money from any source (including the Trustee) and to execute promissory notes, mortgages or other obligations and to pledge or mortgage any Trust assets as security; (k) To lend certificates representing stocks, bonds, or other securities to any brokerage or other firm selected by the Trustee; (l) To institute, compromise and defend actions and proceedings; to pay or contest any claim; to settle a claim by or against the Trustee by compromise, arbitration, or otherwise; to release, in whole or in part, any claim belonging to the Trust to the extent that the claim is uncollectible; (m) To use securities depositories or custodians and to allow such securities as may be held by a depository or custodian to be registered in the name of such depository or its nominee or in the name of such custodian or its nominee; (n) To invest the assets of any Sub-Trust from time to time in one or more investment funds, which funds may be affiliated with or advised by the Trustee and shall be registered under the Investment Company Act of 1940; and (o) To do all other acts necessary or desirable for the proper administration of all Sub-Trusts, as if the Trustee were the absolute owner thereof. However, nothing in this section shall be construed to mean the Trustee assumes any responsibility for the performance of any investment made by the Trustee in its capacity as trustee under the operations of this Master Trust Agreement. Notwithstanding any powers granted to the Trustee pursuant to this Master Trust Agreement or to applicable law, the Trustee shall not have any power that could give this Trust the objective of carrying on a business and dividing the gains therefrom, within the meaning of section 301.7701-2 of the Procedure and Administrative Regulations promulgated pursuant to the Internal Revenue Code of 1986, as amended. 3.4 SECURITIES. Voting or other rights in securities shall be exercised by the person or entity responsible for directing such investments, and the Trustee shall have no duty to exercise voting or proxy or other rights relating to any investment managed or directed by the Committee. If any foreign securities are purchased pursuant to the -10- direction of the Committee, it shall be the responsibility of the person or entity responsible for directing such investments to advise the Trustee in writing of any laws or regulations, either foreign or domestic, that apply to such foreign securities or to the receipt of dividends or interest on such securities. 3.5 SUBSTITUTION. Notwithstanding any provision of any Plan or the Trust to the contrary, the Company and/or any Subsidiary shall at all times have the power to reacquire the assets of its Sub-Trust by substituting readily marketable securities (other than stock, a debt obligation or other security issued by the Company or any Subsidiary) and/or cash of an equivalent value and such other property shall, following such substitution, constitute the assets of that Sub-Trust. 3.6 DISTRIBUTIONS. (a) The establishment of the Trust and the payment or delivery to the Trustee of money or other property shall not vest in any Participant or Beneficiary any right, title, or interest in and to any assets of the Trust. To the extent that any Participant or Beneficiary acquires the right to receive payments under any of the Plans, such right shall be no greater than the right of an unsecured general creditor of the Company and the Subsidiaries and such Participant or Beneficiary shall have only the unsecured promise of the Company and the Subsidiaries that such payments shall be made. (b) Concurrent with the establishment of this Trust, the Company shall deliver to the Trustee a schedule (the "Payment Schedule") that indicates the amounts payable in respect of each Participant (and his or her Beneficiaries) on a Plan by Plan basis, provides a formula or formulas or other instructions acceptable to the Trustee for determining the amounts so payable, specifies the form in which such amount is to be paid (as provided for or available under the applicable Plans), and the time of commencement for payment of such amounts. The Payment Schedule shall be updated from time to time as is necessary. Except as otherwise provided herein, prior to a Change of Control, the Trustee shall make payments to the Participants and their Beneficiaries in accordance with such Payment Schedule. Despite the foregoing, after a Change of Control, the Trustee shall make payments in accordance with the terms and provisions of each of the Plans and related plan agreements. The Trustee, at the direction of the Committee or, after a Change of Control, on its own volition, may make any distribution required to be made by it hereunder by delivering: (i) Its check payable to the person to whom such distribution is to be made, to the person, or, if prior to a Change of Control, to the Company for redelivery to such person; provided that before -11- a Change of Control, the Committee may direct the Trustee to deliver one or more lump sum checks payable to the Company, and the Company shall prepare and deliver individual checks for each Participant or Beneficiary; or (ii) Its check payable to an insurer for the benefit of such person, to the insurer, or, if prior to a Change of Control, to the Company for redelivery to the insurer; or (iii) Contracts held on the life of the Participant to whom or with respect to whom the distribution is being made, to the Participant or Beneficiary, or, if prior to a Change of Control, to the Company for redelivery to the person to whom such distribution is to be made; or (iv) If a distribution is being made, in whole or in part, of other assets, assignments or other appropriate documents or certificates necessary to effect a transfer of title, to the Participant or Beneficiary, or, if prior to a Change of Control, to the Company for redelivery to such person. (c) If the assets of the Company's or any Subsidiary's Sub- Trust, and any earnings thereon, are not sufficient to make benefit payments, in accordance with the terms of one or more Plans, to the Company's or the Subsidiary Participants in those Plans, the Company or the Subsidiary, as the case may be, shall make the balance of each such payment as it falls due. The Trustee shall notify the Company or the Subsidiary, as the case may be, when principal and earnings are not sufficient. (d) The Company and the Subsidiaries may make payment of benefits directly to Participants or their Beneficiaries as they become due under the terms of the Plans. The Company and the Subsidiaries shall notify the Trustee of their decisions to make payment of benefits directly prior to the time amounts are payable to Participants or their Beneficiaries. (e) Notwithstanding anything contained in this Master Trust Agreement to the contrary, if at any time the Trust is finally determined by the IRS not to be a "grantor trust" with the result that the income of the Trust is not treated as income of the Company or the Subsidiaries pursuant to Sections 671 through 679 of the Internal Revenue Code of 1986, as amended, or if a tax is finally determined by the IRS to be payable by one or more Participants or Beneficiaries with respect to any interest in the Plans or the assets of any Sub-Trust prior to payment of such interest to any such Participant or Beneficiary, the Trustee shall immediately determine each Participant's share of the assets of each -12- Sub-Trust in accordance with the Plans, and the Trustee shall immediately distribute such share in a lump sum to each Participant or Beneficiary entitled thereto, regardless of whether such Participant's employment has terminated (provided such Participant has a vested interest in his or her accrued benefits under the Plans) and regardless of form and time of payments specified in or pursuant to the Plans. Any remaining assets (less any expenses or costs due under Sections 3.8 and 3.9 of this Master Trust Agreement) shall then be paid by the Trustee to the Company and the Subsidiaries in such amounts, and in the manner instructed by the Committee. If the value of the assets of any Sub-Trust is less than the applicable benefit obligations under the Plans, the foregoing described distributions will be limited to a Participant's share of the assets of a Sub-Trust, determined by allocating assets to the Participant based on the ratio of the Participant's benefit obligations under the Plans to the total benefit obligations under the Plans. Prior to a Change of Control, the Trustee shall rely solely on the directions of the Committee with respect to the occurrence of the foregoing events and the resulting distributions to be made, and the Trustee shall not be responsible for any failure to act in the absence of such direction. (f) The Trustee shall make provision for the reporting and withholding of any federal, state or local taxes that may be required to be withheld with respect to the payment of benefits pursuant to the terms of the Plans and shall pay amounts withheld to the appropriate taxing authorities or determine that such amounts have been reported, withheld and paid by the Company and the Subsidiaries. (g) Prior to a Change of Control, payments by the Trustee shall be delivered or mailed to addresses supplied by the Committee and the Trustee's obligation to make such payments shall be satisfied upon such delivery or mailing. Prior to a Change of Control, the Trustee shall have no obligation to determine the identity of persons entitled to benefits or their mailing addresses. After a Change of Control, the Trustee shall have such obligations. (h) Prior to a Change of Control, the entitlement of a Participant or his or her Beneficiaries to benefits under the Plans shall be determined by the Company and the Subsidiaries or such party as they shall designate under the Plans, and any claim for such benefits shall be considered and reviewed under the procedures set out in the Plans. 3.7 TRUSTEE RESPONSIBILITY REGARDING PAYMENTS ON INSOLVENCY. (a) The Trustee shall cease payment of benefits to Participants and their Beneficiaries if, in the event that the Company or any Subsidiary is Insolvent (the -13- "Insolvent Entity"), the Trustee shall cease payments of benefits to the Insolvent Entity's Participants and their Beneficiaries. The Insolvent Entity shall be considered "Insolvent" for purposes of this Master Trust Agreement if: (i) the Insolvent Entity is unable to pay its debts as they become due, or (ii) the Insolvent Entity is subject to a pending proceeding as a debtor under the United States Bankruptcy Code. For purposes of this Section 3.7, if an entity is determined to be Insolvent, each Subsidiary in which such entity has an equity interest shall also be deemed to be an Insolvent Entity. However, the insolvency of a Subsidiary will not cause a parent corporation or another Subsidiary to be deemed Insolvent. (b) At all times during the continuance of this Trust, as provided in Section 1.3 above, the principal and income of the Trust shall be subject to claims of the general creditors of the Company and its Subsidiaries under federal and state law as set forth below: (i) The Board and the president of the Company shall have the duty to inform the Trustee in writing of the Company's or any Subsidiary's Insolvency. If a person claiming to be a creditor of the Company or any Subsidiary alleges in writing to the Trustee that the Company or any Subsidiary has become Insolvent, the Trustee shall determine whether the Company or any Subsidiary is Insolvent and, pending such determination, the Trustee shall discontinue payment of benefits to the Insolvent Entity's Participants or their Beneficiaries. Prior to a Change of Control, the Trustee may conclusively rely on any determination it receives from the Board or the president of the Company with respect to the Insolvency of the Company or any Subsidiary. (ii) Unless the Trustee has actual knowledge of the Company's or a Subsidiary's Insolvency, or has received notice from the Company, a Subsidiary, or a person claiming to be a creditor alleging that the Company or a Subsidiary is Insolvent, the Trustee shall have no duty to inquire whether the Company or any Subsidiary is Insolvent. The Trustee may in all events rely on such evidence concerning the Company's or any Subsidiary's solvency as may be furnished to the Trustee and that provides the Trustee with a reasonable basis for making a determination concerning the Company's or any Subsidiary's solvency. In this regard, the Trustee may rely upon a letter from the Company's or a Subsidiary's auditors as to the Company's or any Subsidiary's financial status. -14- (iii) If at any time the Trustee has determined that the Company or any Subsidiary is Insolvent, the Trustee shall discontinue payments to the Insolvent Entity's Participants or their Beneficiaries, and shall hold that entity's Sub-Trust for the benefit of the Insolvent Entity's general creditors. Nothing in this Master Trust Agreement shall in any way diminish any rights of Participants or their Beneficiaries to pursue their rights as general creditors of the Insolvent Entity with respect to benefits due under the Plans or otherwise. (iv) The Trustee shall resume the payment of benefits to Participants or their Beneficiaries in accordance with this Article 3 of this Master Trust Agreement only after the Trustee has determined that the alleged Insolvent Entity is not Insolvent (or is no longer Insolvent). (c) Provided that there are sufficient assets, if the Trustee discontinues the payment of benefits from the Trust pursuant to Section 3.7(b) hereof and subsequently resumes such payments, the first payment following such discontinuance shall include the aggregate amount of all payments due to Participants or their Beneficiaries under the terms of the Plans for the period of such discontinuance, less the aggregate amount of any payments made to Participants or their Beneficiaries by the Company or any Subsidiary in lieu of the payments provided for hereunder during any such period of discontinuance. Prior to a Change of Control, the Committee shall instruct the Trustee as to such amounts, and after a Change of Control, the Trustee shall determine such amounts in accordance with the terms and provisions of the Plans. 3.8 COSTS OF ADMINISTRATION. The Trustee is authorized to incur reasonable obligations in connection with the administration of the Trust, including attorneys' fees, administrative fees and appraisal fees. Such obligations shall be paid by the Company and the Subsidiaries. If the Company or the Subsidiaries fail to pay them within 60 days of presentation of a statement of the amounts due, the Trustee is authorized to pay such amounts from the Company's and/or Subsidiaries' Sub-Trust(s), by direct allocation or by pro- ration, as the case may be. 3.9 TRUSTEE COMPENSATION AND EXPENSES. The Trustee shall be entitled to reasonable compensation for its services as from time to time agreed upon between the Trustee and the Company. If the Trustee and the Company fail to agree upon a compensation, or following a Change of Control, the Trustee shall be entitled to compensation at a rate equal to the rate charged by the Trustee for similar services rendered by it during the current fiscal year for other trusts similar to this Trust. The Trustee shall be entitled to reimbursement for expenses incurred by it in the performance of its duties as the Trustee, including reasonable fees for legal counsel. The Trustee's compensation and expenses shall be paid by the Company and the Subsidiaries. If the Company or the Subsidiaries fail to pay them within 60 days of presentation of a -15- statement of the amounts due, the Trustee is authorized to pay such amounts from the Company's and/or Subsidiaries' Sub-Trust(s), by direct allocation or by pro- ration, as the case may be. 3.10 PROFESSIONAL ADVICE. Upon notice and consent of the Company, the Trustee may retain legal counsel (who may also be legal counsel for the Company generally) or other professional advisors to advise it in connection with the exercise of any duty under this Master Trust Agreement, including, but not limited to, any matter relating to or following a Change of Control or the Insolvency of the Company or any Subsidiary. The Trustee shall be fully protected in acting upon the advice of such legal counsel or advisors, and shall be entitled to charge the Trust for seeking professional advice under this Section 3.10. 3.11 PAYMENT ON COURT ORDER. To the extent permitted by law, the Trustee is authorized to make any payments directed by court order in any action in which the Trustee has been named as a party. The Trustee is not obligated to defend actions in which the Trustee is named, but shall notify the Company or Committee of any such action and may tender defense of the action to the Company, Committee, Participant or Beneficiary whose interest is affected. The Trustee may in its discretion defend any action in which the Trustee is named, and any expenses incurred by the Trustee shall be paid by the Company and the Subsidiaries. If the Company or the Subsidiaries fail to pay them within 60 days of presentation of a statement of the amounts due, the Trustee is authorized to pay such amounts from the Company's and/or Subsidiaries' Sub- Trust(s), as the case may be. 3.12 PROTECTIVE PROVISIONS. Notwithstanding any other provision contained in this Master Trust Agreement to the contrary, the Trustee shall have no obligation to (i) determine the existence of any conversion, redemption, exchange, subscription or other right relating to any securities purchased of which notice was given prior to the purchase of such securities and shall have no obligation to exercise any such right unless the Trustee is advised in writing by the Committee both of the existence of the right and the desired exercise thereof within a reasonable time prior to the expiration of the right to exercise, or (ii) advance any funds to the Trust. Furthermore, the Trustee is not a party to the Plans. 3.13 INDEMNIFICATIONS. (a) The Company and the Subsidiaries shall indemnify and hold the Trustee harmless from and against all loss or liability (including expenses and reasonable attorneys' fees) to which it may be subject by reason of its execution of its duties under this Trust, or by reason of any acts taken in good faith in accordance with any directions, or acts omitted in good faith due to -16- absence of directions, from the Company, the Committee or a Participant, unless such loss or liability is due to the Trustee's gross negligence or willful misconduct. The indemnity described herein shall be provided by the Company and the Subsidiaries. (b) In the event that the Trustee is named as a defendant in a lawsuit or proceeding involving one or more of the Plans or the Trust, the Trustee shall be entitled to receive on a current basis the indemnity payments provided for in this Section, provided however that if the final judgement entered in the lawsuit or proceeding holds that the Trustee is guilty of gross negligence or willful misconduct with respect to the Trust, the Trustee shall be required to refund the indemnity payments that it has received. (c) All releases and indemnities provided in this Master Trust Agreement shall survive the termination of this Master Trust Agreement. ARTICLE 4 INSURANCE CONTRACTS 4.1 TYPES OF CONTRACTS. To the extent that the Trustee is directed by the Committee prior to a Change of Control to invest part or all of the assets of the Trust in insurance contracts, the type and amount thereof shall be specified by the Committee. The Trustee shall be under no duty to make inquiry as to the propriety of the type or amount so specified. 4.2 OWNERSHIP. Each insurance contract issued shall provide that the Trustee shall be the owner thereof with the power to exercise all rights, privileges, options and elections granted by or permitted under such contract or under the rules of the insurer. The exercise by the Trustee of any incidents of ownership under any contract shall, prior to a Change of Control, be subject to the direction of the Committee. 4.3 RESTRICTIONS ON TRUSTEE'S RIGHTS. The Trustee shall have no power to name a beneficiary of the policy other than the Trust, to assign the policy (as distinct from conversion of the policy to a different form) other than to a successor Trustee, or to loan to any person the proceeds of any borrowing against such policy. Despite the foregoing, the Trustee may (i) loan to the Company or any Subsidiary the proceeds of any borrowing against an insurance policy held in the Company's or Subsidiary's Sub-Trust or (ii) assign all, or any portion, of a policy to the Company or any Subsidiary if under other provisions of this Master Trust Agreement the Company or any Subsidiary is entitled to receive assets from the Trust. -17- ARTICLE 5 TRUSTEE'S ACCOUNTS 5.1 RECORDS. The Trustee shall maintain accurate records and detailed accounts of all investments, receipts, disbursements and other transactions hereunder. Such records shall be available at all reasonable times for inspection by the Company and Subsidiaries or their authorized representative. The Trustee, at the direction of the Committee, shall submit to the Committee and to any insurer such valuations, reports or other information as the Committee may reasonably require and, in the absence of fraud or bad faith, the valuation of the assets of each Sub-Trust by the Trustee shall be conclusive. 5.2 ANNUAL ACCOUNTING; FINAL ACCOUNTING. (a) Within 60 days following the end of each Plan Year and within 60 days after the removal or resignation of the Trustee or the termination of the Trust, the Trustee shall file with the Committee a written account setting forth a description of all properties purchased and sold, all receipts, disbursements and other transactions effected by it during the Plan Year or, in the case of removal, resignation or termination, since the close of the previous Plan Year, and listing the properties held in each Sub-Trust as of the last day of the Plan Year or other period and indicating their values. Such values shall be either cost or market as directed by the Committee in accordance with the terms of the Plans. (b) The Committee may approve such account either by written notice of approval delivered to the Trustee or by its failure to express written objection to such account delivered to the Trustee within 60 days after the date of which such account was delivered to the Committee. (c) The approval by the Committee of an accounting shall be binding as to all matters embraced in such accounting on all parties to this Master Trust Agreement and on all Participants and Beneficiaries, to the same extent as if such accounting had been settled by a judgment or decree of a court of competent jurisdiction in which the Trustee, the Committee, the Company, the Subsidiaries and all persons having or claiming any interest in any Plan or any Sub-Trust were made parties. (d) Despite the foregoing, nothing contained in this Master Trust Agreement shall deprive the Trustee of the right to have an accounting -18- judicially settled, if the Trustee, in the Trustee's sole discretion, desires such a settlement. 5.3 VALUATION. The assets of each Sub-Trust shall be valued at their respective fair market values on the date of valuation, as determined by the Trustee based upon such sources of information as it may deem reliable, including, but not limited to, stock market quotations, statistical valuation services, newspapers of general circulation, financial publications, advice from investment counselors, brokerage firms or insurance companies, or any combination of sources. Prior to a Change of Control, the Committee shall instruct the Trustee as to the value of assets for which market values are not readily obtainable by the Trustee. If the Committee fails to provide such values within 60 days of request by the Trustee, the Trustee may take whatever action it deems reasonable, including employment of attorneys, appraisers, life insurance companies or other professionals, the expense of which shall be an expense of administration of the Trust and payable by the Company and the Subsidiaries. The Trustee may rely upon information from the Company and the Subsidiaries, the Committee, appraisers or other sources and shall not incur any liability for an inaccurate valuation based in good faith upon such information. 5.4 DELEGATION OF DUTIES. The Company or the Committee, or both, may at any time employ the Trustee as their agent to perform any act, keep any records or accounts and make any computations that are required of the Company, any Subsidiary or the Committee by this Master Trust Agreement or the Plans. The Trustee may be compensated for such employment and such employment shall not be deemed to be contrary to the Trust. Nothing done by the Trustee as such agent shall change or increase its responsibility or liability as Trustee hereunder. ARTICLE 6 RESIGNATION OR REMOVAL OF TRUSTEE 6.1 RESIGNATION; REMOVAL. The Trustee may resign at any time by written notice to the Company, which shall be effective 60 days after receipt of such notice unless the Company and the Trustee agree otherwise. Prior to a Change of Control, the Trustee may be removed by the Company on 60 days notice or upon shorter notice accepted by the Trustee. After a Change of Control, the Trustee may be removed by a majority vote of the Participants, and if a Participant is dead, his or her Beneficiaries (who collectively shall have one vote among them and shall vote in place of such deceased Participant), on 60 days notice or upon shorter notice accepted by the Trustee. -19- 6.2 SUCCESSOR TRUSTEE. If the Trustee resigns or is removed, a successor shall be appointed by the Company, in accordance with this Section, by the effective date of the resignation or removal under Section 6.1 above. The successor shall be a bank, trust company, or similar independent third party that is granted corporate trustee powers under state law. After the occurrence of a Change of Control, a successor Trustee may not be appointed without the consent of a majority of the Participants. If no such appointment has been made, the Trustee may apply to a court of competent jurisdiction for appointment of a successor or for instructions. All expenses of the Trustee in connection with the proceeding shall be allowed as administrative expenses of the Trust. 6.3 SETTLEMENT OF ACCOUNTS. Upon resignation or removal of the Trustee and appointment of a successor Trustee, all assets shall subsequently be transferred to the successor Trustee. The transfer shall be completed within 90 days after receipt of notice of resignation, removal or transfer, unless the Company extends the time limit. Upon the transfer of the assets, the successor Trustee shall succeed to all of the powers and duties given to the Trustee in this Master Trust Agreement. The resigning or removed Trustee shall render to the Committee an account in the form and manner and at the time prescribed in Section 5.2. The approval of such accounting and discharge of the Trustee shall be as provided in such Section. ARTICLE 7 CONTROVERSIES, LEGAL ACTIONS AND COUNSEL 7.1 CONTROVERSY. If any controversy arises with respect to the Trust, the Trustee shall take action as directed by the Committee or, in the absence of such direction or after a Change of Control, as it deems advisable, whether by legal proceedings, compromise or otherwise. The Trustee may retain the funds or property involved without liability pending settlement of the controversy. The Trustee shall be under no obligation to take any legal action of whatever nature unless there shall be sufficient property in the Trust to indemnify the Trustee with respect to any expenses or losses to which it may be subjected. 7.2 JOINDER OF PARTIES. In any action or other judicial proceedings affecting the Trust, it shall be necessary to join as parties the Trustee, the Committee, the Company and the Subsidiaries. No Participant or other person shall be entitled to any notice or service of process. Any judgment entered in such a proceeding or action shall be binding on all persons claiming under the Trust. Nothing in this Master Trust Agreement shall be construed as to deprive a Participant or Beneficiary of his or her right -20- to seek adjudication of his or her rights by administrative process or by a court of competent jurisdiction. 7.3 EMPLOYMENT OF COUNSEL. The Trustee may consult with legal counsel (who may be counsel for the Company or any Subsidiary) and shall be fully protected with respect to any action taken or omitted by it in good faith pursuant to the advice of counsel. ARTICLE 8 INSURERS 8.1 INSURER NOT A PARTY. No insurer shall be deemed to be a party to the Trust and an insurer's obligations shall be measured and determined solely by the terms of contracts and other agreements executed by it. 8.2 AUTHORITY OF TRUSTEE. An insurer shall accept the signature of the Trustee to any documents or papers executed in connection with such contracts. The signature of the Trustee shall be conclusive proof to the insurer that the person on whose life an application is being made is eligible to have a contract issued on his or her life and is eligible for a contract of the type and amount requested. 8.3 CONTRACT OWNERSHIP. An insurer shall deal with the Trustee as the sole and absolute owner of any insurance contracts and shall have no obligation to inquire whether any action or failure to act on the part of the Trustee is in accordance with or authorized by the terms of the Plans or this Master Trust Agreement. 8.4 LIMITATION OF LIABILITY. An insurer shall be fully discharged from any and all liability for any action taken or any amount paid in accordance with the direction of the Trustee and shall have no obligation to see to the proper application of the amounts so paid. An insurer shall have no liability for the operation of the Trust or the Plans, whether or not in accordance with their terms and provisions. 8.5 CHANGE OF TRUSTEE. An insurer shall be fully discharged from any and all liability for dealing with a party or parties indicated on its records to be the Trustee until such time as it shall receive at its home office written notice of the appointment and qualification of a successor Trustee. -21- ARTICLE 9 AMENDMENT AND TERMINATION 9.1 AMENDMENT. Subject to the limitations set forth in this Section 9.1, this Master Trust Agreement may be amended by a written instrument executed by the Trustee and the Company. Notwithstanding the foregoing, no such amendment shall conflict with the terms of the Plans or shall make the Trust revocable after it has become irrevocable in accordance with Section 1.3 above. Any amendment, change or modification shall be subject to the following rules: (a) GENERAL RULE. Subject to Sections 9.1(b), (c) and (d) below, this Master Trust Agreement may be amended: (i) By the Company and the Trustee, provided, however, that if an amendment would, in the opinion of the Company, in any way adversely affect the rights accrued under the Plans in the Trust by any Participant or Beneficiary, each and every Participant and Beneficiary whose rights in the Trust would be adversely affected must consent to the amendment before this Master Trust Agreement may be so amended; and (ii) By the Company and the Trustee as may be necessary to comply with laws which would otherwise render the Trust void, voidable or invalid in whole or in part. (b) LIMITATION. Notwithstanding that an amendment may be permissible under Section 9.1(a) above, this Master Trust Agreement shall not be amended by an amendment that would: (i) Cause any of the assets of the Trust to be used for or diverted to purposes other than for the exclusive benefit of Participants and Beneficiaries as set forth in the Plans, except as is required to satisfy the claims of the Company's or a Subsidiary's general creditors; or (ii) In the opinion of the Company, be inconsistent with the terms of any Plan, including the terms of any Plan regarding termination, amendment or modification of the Plan. (c) WRITING AND CONSENT. Any amendment to this Master Trust Agreement shall be set forth in writing and signed by the Company and the Trustee and, if consent of any Participant or Beneficiary is required under Section 9.1(a), the Participant or Beneficiary whose consent is required. Any -22- amendment may be current, retroactive or prospective, in each case as provided therein. (d) THE COMPANY AND TRUSTEE. In connection with the exercise of the rights under this Section 9.1: (i) prior to a Change of Control, the Trustee shall have no responsibility to determine whether any proposed amendment complies with the terms and conditions set forth in Sections 9.1(a) and (b) above and may conclusively rely on the directions of the Committee with respect thereto, unless the Trustee has knowledge of a proposed transaction or transactions that would result in a Change of Control; and (ii) after a Change of Control, the power of the Company to amend this Master Trust Agreement shall cease, and the power to amend that was previously held by the Company shall, instead, be exercised by a majority of the Participants and, if a Participant is dead, his or her Beneficiaries (who collectively shall have one vote among them and shall vote in place of such deceased Participant), with the consent of the Trustee, provided that such amendment otherwise complies with the requirements of Sections 9.1(a), (b) and (c) above. (e) TAXATION. This Master Trust Agreement shall not be amended, altered, changed or modified in a manner that would cause the Participants and/or Beneficiaries under any Plan to be taxed on the benefits under any Plan in a year other than the year of actual receipt of benefits. 9.2 FINAL TERMINATION. The Trust shall not terminate until the date on which Participants and their Beneficiaries are no longer entitled to benefits pursuant to the terms of the Plans, and on such date the Trust shall terminate. Upon termination of the Trust, any assets remaining in each Sub-Trust shall be returned to the Company or the Subsidiaries, as the case may be, whereupon the Trustee shall be released and discharged from all obligations hereunder. From and after the date of termination and until final distribution of the assets of the Trust, the Trustee shall continue to have all of the powers provided herein as are necessary or expedient for the orderly liquidation and distribution of the assets of the Trust. -23- ARTICLE 10 MISCELLANEOUS 10.1 DIRECTIONS FOLLOWING CHANGE OF CONTROL. Despite any other provision of this Master Trust Agreement that may be construed to the contrary, following a Change of Control, all powers of the Committee, the Company and the Board to direct the Trustee under this Master Trust Agreement shall terminate, and the Trustee shall act on its own discretion to carry out the terms of this Master Trust Agreement in accordance with the Plans and this Master Trust Agreement. 10.2 TAXES. The Company and the Subsidiaries shall from time to time pay taxes of any and all kinds whatsoever that at any time are lawfully levied or assessed upon or become payable in respect of the Trust, the income or any property forming a part thereof, or any security transaction pertaining thereto. To the extent that any taxes lawfully levied or assessed upon the Trust are not paid by the Company and the Subsidiaries, the Trustee shall have the power to pay such taxes out of the appropriate Sub-Trusts and shall seek reimbursement from the Company and the Subsidiaries. Prior to making any payment, the Trustee may require such releases or other documents from any lawful taxing authority as it shall deem necessary. The Trustee shall contest the validity of taxes in any manner deemed appropriate by the Company or its counsel, but at the Company's and the Subsidiaries' expense, and only if it has received an indemnity bond or other security satisfactory to it to pay any such expenses. Prior to a Change of Control, and except as provided in Section 3.6(f), the Trustee (i) shall not be liable for any nonpayment of tax when it distributes an interest hereunder on directions from the Committee, and (ii) shall have no obligation to prepare or file any tax return on behalf of the Trust, any such return being the sole responsibility of the Committee. The Trustee shall cooperate with the Committee in connection with the preparation and filing of any such return. After a Change of Control, the Trustee shall have such duties and obligations. 10.3 NONASSIGNABILITY; NONALIENATION. Benefits payable to Participants and their Beneficiaries under this Master Trust Agreement may not be anticipated, assigned (either at law or in equity), alienated, pledged, encumbered or subjected to attachment, garnishment, levy, execution or other legal or equitable process. 10.4 THE PLANS. This Trust, the Plans and each Participant's Plan Agreement are parts of a single, integrated employee benefit plan system and shall be construed together. In the event of any conflict between the terms of this Master Trust Agreement and the agreements that constitute the Plans, such conflict shall be resolved in favor of this Master Trust Agreement. -24- 10.5 APPLICABLE LAW. Except to the extent, if any, preempted by ERISA, this Master Trust Agreement shall be governed by and construed in accordance with the internal laws of the State of California. Any provision of this Master Trust Agreement prohibited by law shall be ineffective to the extent of any such prohibition, without invalidating the remaining provisions hereof. 10.6 NOTICES AND DIRECTIONS. Whenever a notice or direction is given by the Committee to the Trustee, it shall be in the form required by Section 2.1. Actions by the Company shall be by the Board or a duly authorized officer, with such actions certified to the Trustee by an appropriately certified copy of the action taken. The Trustee shall be protected in acting upon any such notice, resolution, order, certificate or other communication believed by it to be genuine and to have been signed by the proper party or parties. 10.7 SUCCESSORS AND ASSIGNS. This Master Trust Agreement shall be binding upon and inure to the benefit of the Company, the Subsidiaries and the Trustee and their respective successors and assigns. 10.8 GENDER AND NUMBER. Words used in the masculine shall apply to the feminine where applicable, and when the context requires, the plural shall be read as the singular and the singular as the plural. 10.9 HEADINGS. Headings in this Master Trust Agreement are inserted for convenience of reference only and any conflict between such headings and the text shall be resolved in favor of the text. 10.10 COUNTERPARTS. This Master Trust Agreement may be executed in an original and any number of counterparts, each of which shall be deemed to be an original of one and the same instrument. 10.11 BENEFICIAL INTEREST. The Company and the Subsidiaries are the true beneficiaries hereunder in that the payment of benefits, directly or indirectly to or for a Participant or Beneficiary by the Trustee, is in satisfaction of the Company's and the Subsidiaries' liability therefor under the Plans. Nothing in this Master Trust Agreement shall establish any beneficial interest in any person other than the Company and the Subsidiaries. -25- 10.12 EFFECTIVE DATE. The effective date of this Master Trust Agreement shall be January 1, 1996 IN WITNESS WHEREOF the Company and the Trustee have signed this Master Trust Agreement as of the date first written above. TRUSTEE: THE COMPANY: Wells Fargo Bank, N.A. FHP International Corporation, a Delaware corporation By: /s/ Janet Greenbaum By: /s/ Kenneth S. Ord ----------------------------- ----------------------------------- Title: Vice President Title: Senior Vice President and CFO --------------------------- -------------------------------- By: /s/ Marvin A. Freedland ---------------------------- Title: Vice President and Compliance Officer ------------------------------------- -26- EX-11.1 5 EXHIBIT 11.1 EXHIBIT 11.1 FHP INTERNATIONAL CORPORATION COMPUTATION OF EARNINGS PER SHARE
YEARS ENDED JUNE 30, ----------------------------------- 1996 1995 1994 ----------- ----------- --------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Primary earnings per share attributable to Common Stock: Net income attributable to Common Stock.................................... $ 17,728 $ 11,955 $ 58,278 ----------- ----------- --------- ----------- ----------- --------- Weighted average number of common shares and common share equivalents: Common Stock............................................................. 40,454 39,915 33,285 Assumed exercise of options.............................................. 1,070 1,142 766 ----------- ----------- --------- Total shares........................................................... 41,524 41,057 34,051 ----------- ----------- --------- ----------- ----------- --------- Primary earnings per share attributable to Common Stock.................... $ 0.43 $ 0.29 $ 1.71 ----------- ----------- --------- ----------- ----------- --------- Fully diluted earnings per share: Net income................................................................. $ 44,153 $ 37,292 $ 59,310 ----------- ----------- --------- ----------- ----------- --------- Weighted average number of common shares and common share equivalents: Common Stock............................................................. 57,422 56,876 33,951 Assumed exercise of options.............................................. 1,070 1,142 766 ----------- ----------- --------- Total shares, assuming full dilution................................... 58,492 58,018 34,717 ----------- ----------- --------- ----------- ----------- --------- Fully diluted earnings per share............................................. $ 0.75(1) $ 0.64(1) $ 1.71 ----------- ----------- --------- ----------- ----------- ---------
- ------------------------ (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 antidilutive result in fiscal years 1996 and 1995. EX-21 6 EXHIBIT 21 EXHIBIT 21.0 SUBSIDIARIES OF THE REGISTRANT There is no parent of the Registrant. The following is a listing of the active subsidiaries of the Registrant, or if indented, subsidiaries of the subsidiary under which they are listed:
JURISDICTION OF INCORPORATION -------------- FHP Financial Corporation..................................................... Delaware Great States Insurance Company.............................................. California Great States Administrators, Inc............................................ Delaware TakeCare, Inc................................................................. Delaware TakeCare Administrative Services Corporation................................ Indiana TakeCare Life Insurance Company........................................... Arizona FHP of Colorado, Inc...................................................... Colorado FHP of Illinois, Inc...................................................... Illinois FHP of Ohio, Inc.......................................................... Ohio TakeCare Insurance Company................................................ Colorado FHP, Inc.................................................................. California FHP Life Insurance Company.............................................. California FHP of Utah, Inc........................................................ Utah FHP of New Mexico, Inc.................................................. New Mexico FHP of Texas, Inc....................................................... Texas Employees Choice Health Option.......................................... Utah Health Maintenance Life, Inc............................................ Guam FHP Reinsurance Limited................................................. Bermuda FHP Administrators...................................................... California Ultra Credentialing, Inc.................................................. California Talbert Medical Management Corporation........................................ Delaware Talbert Health Services Corporation........................................... Delaware
EX-23.1 7 EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements 33-30200, 33-14257, 33-30090, 33-36521, 33-54313 and 33-56651 on Form S-8 of our report with respect to FHP International Corporation's financial statements dated September 4, 1996, appearing in this Annual Report on Form 10-K of FHP International Corporation for the year ended June 30, 1996. /s/ Deloitte & Touche LLP Costa Mesa, California September 30, 1996 EX-27 8 EXHIBIT 27
5 1,000 YEAR JUN-30-1996 JUL-01-1995 JUN-30-1996 166,873 187,919 160,376 18,839 10,184 579,227 384,603 153,175 2,013,879 639,394 104,184 0 526,006 415,563 226,060 2,013,879 4,179,284 4,179,284 4,041,541 4,041,541 54,659 (4,778) 21,141 98,117 53,964 44,153 0 0 0 44,153 .43 .75
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