Since the HSI Combination in January 1994, the Company has experienced significant growth in revenue. Revenue increased to $3.2 billion in 1996, from $2.7 billion in 1995 and $2.3 billion in 1994. Net income totaled $73.6 million in 1996, compared to $89.6 million in 1995 and $88.1 million in 1994, after pretax restructuring and other charges of $44.1 million in 1996, and merger related costs of $20.2 and $.7 million in 1995 and 1994 respectively. With continued commercial premium rate pressures in California, the Company has focused on increasing its presence in the Medicare market in California and, through strategic acquisitions, entering new geographic markets. Medicare membership grew by 9.4% in 1996 and 69% in 1995. As initial steps in its Northeast expansion, the Company in 1995 acquired M.D. Health Plan, a managed health care company operating in the state of Connecticut, and Greater Atlantic, a managed health care company operating in Pennsylvania and New Jersey. In addition, the Company has entered into agreements to acquire an interest in managed care companies operating in Pennsylvania, West Virginia, Ohio and New Jersey.
Revenue growth in 1996 over 1995 has been due in large part to full-year revenues contributed by acquisitions in the Northeast during 1995, accounting for $215.3 million of the $441.7 million premium revenue increase in 1996 as compared to 1995. In 1995, those acquisitions contributed $173 million in premium revenue. The remaining 1996 increase in premium revenue of $226.4 million was primarily a result of increases in Medicare risk membership, making up $161.6 million of such increase. The majority of this increase occurred in the Company's California market, where the Medicare risk product was initially offered in 1993. The acquisition of M.D. Health Plan initially added 59,000 commercial members, which increased to 117,000 by December 1995, primarily due to the conversion of approximately 52,000 State of Connecticut employees from ASO to full risk membership in July 1995. As of December 31, 1996, commercial membership in M.D. Health Plan totaled 130,000. The Company subsequently acquired Greater Atlantic, a 90,000 member HMO with operations in Pennsylvania and New Jersey. Greater Atlantic's business includes a substantial number of Medicare and Medicaid members. Revenue growth in 1995 was due in large part to significant increases in Medicare risk membership which accounted for $191 million of increases for that year. The majority of this increase occurred in the Company's California market. The Company believes that modest commercial premium rate pressures, particularly in California, will continue in 1997 and, accordingly, the Company will continue to emphasize the growth of its Medicare risk business and expansion into other geographic markets.
Declining marketing, general and administrative expenses (excluding merger-related costs and ASO business) as a percentage of premium revenue over the period of 1994 through 1996 (11.6%, 11.2%, and 10.4% respectively) reflect the realization in part of the benefits of the Company's restructuring of both California and non-California operations, as well as its ongoing efforts to control costs and increase its membership growth in the higher premium Medicare business.
In 1996, the Company recorded a restructuring charge of approximately $35.6 million and an accrual for anticipated losses on certain customer contracts amounting to approximately $8.5 million. The restructuring charges relate to the Company's restructuring of administrative operations and the loss contract accrual relates primarily to government contracts in the Company's non-California operations.
The acquisitions in the Northeast contributed $215.3 million in premium revenue in 1996, and $173 million in 1995. Premium revenue increases in the Company's existing markets are attributable to a combination of membership increases and premium rate changes. Increases in commercial and Medicare risk membership accounted for $369 million of premium revenue increases in 1996 from 1995. Commercial membership increases accounted for $175.8 million of the increase and Medicare risk membership increases accounted for $193.2 million. Limited premium rate increases in certain markets and growth in the higher premium Northeast markets resulted in an increase in commercial premium revenue of $21.7 million in 1996, while increases in Medicare rates increased premium revenue by $50.9 million in 1996. The Medicare premium rate increases reflect average overall Medicare reimbursement rate increases of 10% in 1996. On a per member per month ("PMPM") basis, the premium rate changes resulted in an increase of 1% in commercial premium revenue to $119.69 and an increase in Medicare premium revenue of 10.2% to $434.79 in 1996. Overall, Medicare risk business accounted for an increase of $244.1 million of premium revenue in 1996 over 1995 and commercial business accounted for an increase of $197.5 million of premium revenue in 1996 over 1995.
Increases in commercial and Medicare risk membership accounted for $316 million of premium revenue increases in 1995 from 1994. Of this increase, $145 million represented commercial membership increases and $171
Management of the Company believes that in 1997 there will continue to be premium pressures on HMOs from increasingly sophisticated consumers, particularly in the California marketplace. While it is not possible to predict with certainty the ultimate financial impact of such pressures on premiums, the Company believes that it is well-positioned to offset such pressures by increasing its volume and containing costs.
Healthcare expenses increased by $431.3 million, or 19.8%, to $120.39 PMPM in 1996 compared to $110.23 PMPM in 1995. The Company's overall MLR increased to 83.3% from 81% in 1995. If the $8.5 million loss contract charge, which was recorded in the fourth quarter of 1996 but not included in the MLR calculation, had been included in health care expenses, then the MLR for 1996 would have increased by .3%. Impacting the Company's overall PMPM healthcare expense and MLR was the growth in Medicare business, increased pharmacy costs and high costs associated with the Company's Medicaid business in Philadelphia. In addition, the Company's MLR in the Medicare risk business increased to 89.4% in 1996 from 88% in 1995 due to Medicare risk membership growth in higher cost areas. Commercial healthcare expenses on a PMPM basis increased from $94.09 in 1995 to $97.48 in 1996 and the Company's commercial MLR increased to 81.4% in 1996 from 79.4% in 1995.
The Company's recontracting in 1995 of its largely capitated commercial provider network in California enabled it to maintain its relatively consistent MLR despite the reduced commercial premium rates experienced in that market in 1995. The implementation of the Company's medical management system in its newly acquired HMO operations in the Northeast also contributed to the stable 1995 MLR. Significant and ongoing cost savings have been achieved through effective utilization management in the Company's Connecticut operations.
Marketing, general and administrative expenses (excluding ASO expenses) were $326.4 million or 10.4% of premium revenue in 1996, compared to $302.9 million or 11.2% of premium revenue in the prior year. Marketing, general and administrative expenses were $266.8 million, or 11.6% of premium revenue in 1994. The decreases in marketing, general and administrative expenses as a percentage of premium revenue from 1994 through 1996 reflect ongoing efforts to streamline operations and maximize efficiencies and the effects of the Company's restructuring plan.
In the fourth quarter of 1996, the Company recorded $44.1 million or $.53 per share, in restructuring and other charges. These charges included restructuring charges of $35.6 million, the components of which are: executive, workforce and facilities consolidation costs of approximately $11.9 million, software and hardware write-offs of approximately $15.0 million, and other components which aggregate approximately $8.7 million. In addition, the Company recorded $8.5 million in the fourth quarter related to estimated losses that the Company anticipates will occur through the remaining term of certain customer contracts.
Throughout 1995, the Company incurred merger-related costs of $20.2 million in connection with the proposed HSI/WellPoint Transaction that was ultimately terminated. Such costs included legal, accounting and consulting fees, and certain severance- related costs totaling $12.2 million.
On October 1, 1996 the Company entered into a merger agreement with Foundation Health Corporation ("FHC"), an integrated managed health care organization. Under the definitive agreement, FH Acquisition Corp., a wholly-owned subsidiary of the Company, will merge with and into FHC with FHC surviving the merger as a wholly-owned subsidiary of the Company. The merger will be accounted for as a pooling-of-interest transaction and, accordingly, after the merger, the financial statements of the Company and FHC will be presented on a combined basis for financial reporting purposes. As previously announced, negotiation and consummation of the FHC Merger as well as additional charges associated with and related to integrating the operations of HSI and FHC will result in material non-recurring costs and expenses to the new combined company. Such costs cannot be determined until the transition plan related to the integration of operations is completed, but they are estimated at this time by the Company to be in the range of $175 million to $225 million.
The Company's primary source of cash is premium revenue. Its primary uses of cash are claims and capitation payments. Estimates of future cash flows include a component to account for the delay between providing medical services and reporting their cost. These estimates are based on actuarial projections of claims and other costs, claims paid history, membership growth, inflation, seasonality, claims inventory and reserves.
The Company's capital resources are managed according to certain guidelines intended to ensure liquidity and maximum total return by assuming prudent investment risks. The Company's liquidity requirements consist of the need to service medical claims in a timely manner and to satisfy shared risk and other obligations. Such requirements are the principal factors in determining the appropriate investment portfolio mix. The Company presently invests primarily in a variety of fixed income obligations according to established investment guidelines.
On April 26, 1996, the Company replaced its five-year unsecured $400 million revolving credit facility with a $700 million revolving credit facility (the "Credit Facility") from a lending syndicate led by Bank of America. Under the new Credit Facility, the Company may incur permitted subordinated indebtedness in a maximum aggregate amount not to exceed $150 million which is available for acquisition purposes and to provide short-term financing to repurchase shares of stock. The Company may elect from various short-term interest rates based upon a spread above the LIBOR rate or the greater of the bank's reference rate or the federal funds rate plus 1/2%. In addition, the Company may elect a "competitive bid auction" in which participating banks are offered an opportunity to bid alternative rates. The Credit Facility is for a term of five years from the date of execution, with two one year extension options. At December 31, 1996, $319 million had been borrowed against the new $700 million Credit Facility. The Company used $310 million of the Credit Facility in 1995 to fund the prepayment by its Health Net subsidiary of $135 million in debt to the Foundation, and to fund the MDEC and GHH acquisitions in the amount of $100 million and $75 million, respectively. In 1996, an additional $9 million was borrowed from the Credit Facility.
Board of Directors and Stockholders of Health Systems International, Inc. Pueblo, Colorado Woodland Hills, California
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Health Systems International, Inc. and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The Company provides a wide range of managed health care services through Health Net, a California health maintenance organization ("HMO"), QualMed, the parent company of a system of HMOs with operations in various Western states and through certain Northeast subsidiaries. In March 1995, the Company acquired MDEC, the parent company of M.D. Health Plan, Inc., an HMO operating in Connecticut ("M.D. Health Plan"), and in December 1995 the Company acquired G.H. Holding Corporation (now named HSI Eastern Holdings, Inc.) ("GHH") the parent company of Greater Atlantic Health Service, Inc. ("Greater Atlantic," now named QualMed Plans for Health, Inc.), an HMO operating in Pennsylvania and New Jersey. The Company also owns a preferred provider organization ("PPO") network with operations in 48 states and the District of Columbia and two health and life insurance companies with licenses to sell insurance in 33 states and the District of Columbia.
In California, the Company generally provides services to its members by contract with participating medical groups on a capitated or fixed fee per member per month ("PMPM") basis. Outside of California, the Company generally provides services to its members through contracts with individual physicians and groups of physicians on a discounted fee-for-service basis and in certain areas through capitation arrangements with physician groups.
On January 28, 1994, the Company, successor by name change to HN Management Holdings, Inc. ("HNMH") (which was formed in 1990 for the purpose of acquiring Health Net) and QualMed completed a merger (the "HSI Combination"). In the HSI Combination, QualMed stockholders received one share of the Company's Class A Common Stock for each share of QualMed common stock and, at the same time, previously outstanding HNMH shares (both Class A voting and Class B nonvoting) were split in a ratio of 3.3618 shares of the Company's Common Stock for each previously existing share of HNMH stock. The HSI Combination was accounted for as a pooling-of-interests.
On February 6, 1992, Health Net received approval from the California Department of Corporations ("DOC") for its conversion from nonprofit to for-profit status (the "Conversion"). Under the terms of the Conversion as approved by the DOC, on February 7, 1992, ownership of Health Net was transferred to the Company, and Health Net contributed $300 million to a qualifying independent charitable organization, The California Wellness Foundation (the "Foundation"). In addition, the Foundation received 7,640,000 (25,684,152 after giving effect to the 3.3618:1 stock split) shares of Class B nonvoting common stock of the Company. The Foundation was established by Health Net to provide public awareness and educational programs to promote healthy lifestyles, and other health-related programs. The contribution by Health Net in connection with the Conversion included $75 million in cash and $225 million in notes payable to the Foundation. The Conversion was accounted for under the purchase method of accounting and the excess of the Conversion price over the fair value of net assets acquired was recorded as goodwill. During 1995, the Company eliminated approximately $33.0 million of associated goodwill (See Note 8).
All of the Company's health plans as well as its insurance subsidiaries are required to periodically file financial statements with regulatory agencies in accordance with statutory accounting and reporting practices. Under the California Knox-Keene Health Care Service Plan Act, Health Net must comply with certain minimum capital or tangible net equity ("TNE") requirements. The Company's non-California health plans, as well as its health and life insurance companies, must comply with their respective state's minimum regulatory net worth requirements generally under the regulation of the respective state's department of insurance.
The Company and its consolidated subsidiaries are required to set aside certain funds for restricted purposes. As of December 31, 1996 and 1995, balances of $0.7 million and $2.0 million, respectively, which are held in financial depository accounts, are restricted as to use.
The Company and its consolidated subsidiaries are required to set aside funds for the protection of their plan members in accordance with the laws of the various states in which they operate. Such restricted funds totaled $5.2 million and $9.3 million at December 31, 1996 and 1995, respectively, and are held in U.S. Treasury bills and certificates of deposit with commercial banks. These investments are included in marketable securities held for sale. Interest earned on such investments accrues to the Company and its consolidated subsidiaries and is not restricted as to use. In addition, $20.3 million of securities are restricted in connection with a debt agreement at December 31, 1996 and 1995. (See Note 5).
Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight- line method over the estimated useful lives of the various classes of assets or the lease term, whichever is less. Lives of the assets range from three to 40 years.
Intangible assets consisted of the following at December 31, 1996 (in thousands):
Intangible assets consisted of the following at December 31, 1995 (in thousands):
In February 1997, the Financial Accounting Standards Board issued SFAS 128, "Earnings Per Share" effective for periods ending after December 15, 1997, including interim periods; earlier adoption is not permitted. This statement requires restatement of all prior period earnings per share ("EPS") data presented. The statement establishes standards for computing and presenting EPS.
The fair value estimates are based on pertinent information available to management as of December 31, 1996 and 1995. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly.
The following is a summary of marketable securities held for sale as of December 31, 1995 (in thousands):
During the year ended December 31, 1995, marketable securities held for sale with a fair value at the date of sale of $249.5 million were sold. The gross realized gains on such sales totaled $618,000, and the gross realized losses totaled $38,000.
The amortized cost and estimated fair value of marketable securities at December 31, 1996 by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. Asset-backed securities do not have single maturity dates.
Care Management Sciences Corporation - On September 6, 1996, the Company purchased shares of preferred stock of Care Management Sciences Corporation ("CMS") for an aggregate purchase price of $4.1 million, which, together with the shares of CMS preferred stock purchased by the Company in 1995 for $2 million, represent approximately 43.9% of the outstanding capital of CMS. In connection with its 1995 and 1996 purchases, the Company was issued warrants to purchase additional shares of CMS preferred stock at the same per share purchase price of such purchases, which warrants, if fully exercised, would increase the Company's ownership in CMS to 56.42%. In addition, the Company (as part of the stock acquisition in 1996) has provided CMS with line of credit in the amount of $2,684,675, which is in addition to a previously granted $1 million line of credit, under which CMS has borrowed $1 million. CMS develops, licenses and supports proprietary software related to the health care industry. The Company has accounted for its investment in CMS using the cost method and such investment is included in other assets.
QMPHP - In October 1994, the Company purchased 51% of the outstanding stock of QualMed Plans for Health of Pennsylvania, Inc. ("QMPHP"), a Pennsylvania managed health care provider, for $1.1 million in cash. HSI subsequently increased its ownership interest in QMPHP to 83% through additional capital contributions of approximately $6.5 million. The QMPHP acquisition resulted in $3 million of provider network intangible assets. QMPHP's accounts are consolidated with those of the Company, and the minority stockholders' interest in QMPHP's net assets and income (loss) is included in the Company's financial statements as minority interest. The Company is also in the process of purchasing 17,000 shares of preferred stock of QMPHP from its current holder for $1.7 million.
Advantage Health - On May 14, 1996, the Company announced that it had reached a definitive agreement with St. Francis Health System to acquire an 80% interest in Advantage Health, a managed health care company headquartered in Pittsburgh, Pennsylvania, for approximately $10 million in cash. The transaction is subject to approvals from regulatory authorities, and other customary conditions of closing.
First Option Health Plan. Pursuant to an amended purchase agreement, dated February 10, 1997, as amended, and effective on March 19, 1997 among the Company, FOHP, Inc., a New Jersey corporation ("FOHP") and First Option Health Plan of New Jersey, Inc., a New Jersey corporation ("FOHP-NJ"), the Company agreed to invest an initial amount of approximately $43 million in FOHP. FOHP is owned by physicians, hospitals and other health care providers and is the sole shareholder of FOHP-NJ, a managed health care company providing a full line of commercial products for businesses and individuals, along with Medicare, Medicaid and Workers' Compensation programs.
In connection with the Conversion, Health Net issued two non-negotiable promissory notes to the Foundation in the aggregate original principal amount of $225 million. The notes, a $150 million original principal amount senior secured promissory note and a $75 million original principal amount subordinated secured promissory note, bore interest at 10.27% in years 1996 and 1995. The rate adjusts to 2.5% above the three-year treasury bill auction rate on the last business day before December 31, 1997, 2000, and 2003, but will not be less than 5%. Principal and interest is due in quarterly installments, currently based on a 25-year amortization schedule; in 1996, the amortization schedule is changed to 20 years, and in 1997, the amortization schedule is changed to 15 years. In addition, commencing in 1995, additional payments of principal becomes due to the extent that Health Net has an "Excess Cash Ratio," as defined, in any calendar year. Any remaining unpaid principal and interest is due on December 31, 2006. In January 1994, the Company made a discretionary $50 million prepayment to the Foundation on the subordinated secured promissory note. In April 1995, the Company paid down $135 million of the outstanding Foundation debt, leaving a remaining principal balance on the senior secured promissory note of $19.6 million. As of December 31, 1996, the remaining principal balance was $19.3 million. (See discussion of credit facility below).
Health Net's performance under the note obligations has been guaranteed by the Company. In accordance with the provisions of the promissory notes described above, Health Net has provided the Foundation a security interest in the following collateral: premiums receivable, property and equipment and debt securities held by depository (Note 2). Health Net is required to maintain a minimum of funds in a depository sufficient to cover the total amount outstanding. These funds totaled $20.3 million and $20.3 million at December 31, 1996 and 1995, and were included in marketable securities held for sale. In addition, Health Net is required to make payments to a sinking fund, commencing in 2003, in order to provide funds for the unpaid principal balloon payment (plus any interest) due in 2006.
In 1995, the Company had used $310 million of the Credit Facility to fund the prepayment by Health Net of $135 million in debt to the Foundation, $100 million to fund the MDEC acquisition, and $75 million to fund the purchase of GHH. As of December 31, 1996, the Company had used an additional $9 million to repurchase treasury stock and fund certain acquisitions.
The Company also has various other notes payable outstanding, both secured and unsecured, totaling $25.7 million and $26.8 million at December 31, 1996 and 1995, respectively. In connection with its acquisition of GHH in 1995, the Company issued a promissory note in the amount of $22.5 million to GHS. Such note bears interest at 7.95% and is payable in 2005.
The weighted average annual interest rate on the Company's long-term debt was approximately 6.3%, 7.4%, and 8.0% for the years 1996, 1995, and 1994, respectively.
The following table presents the principal payments due with respect to all of the above referenced notes for the five years ending December 31 (in thousands):
Effective April 30, 1994, the Company's defined benefit pension plan in effect at such time was amended to cease benefit accruals. The plan was subsequently terminated effective December 31, 1994. This freezing of the plan affects the comparability of net periodic pension cost and funded status with that of prior years. In 1994, the Company recorded a $3.1 million gain from the freeze. The plan covered substantially all Health Net employees. Benefits were based on years of service and the employee's compensation during the last five years of employment. The plan's assets consist of investments in a bank's pooled trust fund. Expenses under the 401(k) and defined benefit pension plans totaled $1.4 million in 1996, $1.3 million in 1995 and $2.9 million in 1994.
The following table sets forth the plans' funded status and the amounts recognized in the Company's consolidated financial statements at December 31 (in thousands):
Net pension costs included the following components for the years ended December 31 (in thousands):
The projected benefit obligation was determined using a discount rate of 5.25% for 1996 and 1995 and an assumed rate of compensation increase was not applicable in 1996 nor 1995. The net pension costs were determined using the aforementioned assumptions and an expected long-term rate of return on plan assets of 8% for each of the years 1996, 1995 and 1994.
A new SERP program (the "Current SERP") was approved effective January 1, 1996. The new SERP plan ensures that executives who retire at age 62 or later and have worked for the Company or a predecessor organization for at least 15 years receive 50% of average pay (salary and bonus) when combined with Social Security and all other employer provided retirement benefits provided under current and prior programs including the accumulated value of company contributions to the Company's 401(k) plan (including the profit sharing component of such plan) for the account of such individuals, along with benefits accrued under the prior SERP frozen in 1995. Executives with less than 15 years of service at age 62 will receive a reduced benefit under this plan, and executives must accrue at least five years of service to receive a partial benefit. Those terminating with between 5 and 10 years of service are entitled to receive a partial benefit, and executives who terminate with 10 or more years of service will be 100% vested on earned benefits.
Expense under the SERP programs and Health Net Board of Directors Retirement Plan totaled $2.7 million in 1996, $1.8 million in 1995 and $2.5 million in 1994.
The Company sponsors a defined-benefit health care plan for its Health Net employees that provides post-retirement medical benefits to full-time employees and their eligible dependents for employees who have worked ten years and attained age 55. The Company pays 100% of the cost of medical, dental, prescription and vision benefits for those employees who retired on or before December 1, 1995; for employees retiring after December 1, 1995, the Company pays 25% of the cost of medical coverage for those employees with ten years of service, increasing 5% a year to 25 years or more of service, at which time 100% of the cost is borne by the Company. The health care plan includes certain cost-sharing features such as deductibles, coinsurance and maximum annual benefit amounts for certain benefits.
The following table presents this plan's funded status and the amounts recognized in the Company's consolidated financial statements at December 31 (in thousands):
Net periodic post-retirement cost includes the following for the years ended December 31 (in thousands):
In 1993 the Company's Board of Directors approved the Health Systems International Employee Stock Purchase Plan, effective February 15, 1993. See note 10, Stock-Based Compensation.
The Company has a Performance-Based Annual Bonus Plan that qualifies under Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). Under the plan, if the Company meets certain financial and operating targets, certain executives subject to the limitations of Section 162(m) of the Code become eligible to receive annual cash bonuses based on a maximum pool of 2.5% of consolidated operating income and on the executives' salaries in relation to the pool. Amounts payable to such executives from such pool are subject to downward adjustment by the Company's Compensation and Stock Option Committee.
In January 1995, two purported class action lawsuits were filed against the Company and the members of its Board of Directors alleging breach of fiduciary duties to the Company's public stockholders by refusing to seriously consider certain acquisition bids for the Company. Such lawsuits were dismissed without prejudice in April 1996.
Three directors of the Company are partners of law firms which received legal fees totaling $1.0 million, $1.9 million and $1.5 million in 1996, 1995 and 1994, respectively. An officer of a contracted hospital is also a member of the Company's Board of Directors. Medical costs paid to the provider totaled $58.7 million, $55.3 million and $14.0 million in 1996, 1995 and 1994, respectively. Such contracted hospital is also an employer group of the Company. The Company received annual premium revenues of $3.4 million in 1996 and $3.0 million in 1995 and 1994. A director of the Company was an officer of an employer group until October 1994. In 1994, the Company received premium revenues of $17 million from the group. Certain stockholders and directors of the Company are officers of consulting firms which received approximately $1,250,000 in 1996 and $140,000 in 1995 and $70,000 in 1994 pursuant to consulting agreements to pay for certain consulting services provided to the Company.
During the first quarter of 1996, the Company repurchased 303,879 shares of its Class A Common Stock from certain current and former management employees of the Company and HN Management Holdings, Inc., a predecessor to the Company. The repurchased shares were held pursuant to the Amended and Restated Health Net Associate Trust Agreement dated as of May 1, 1994 on behalf of certain founding stockholders of the Company at the date of the conversion of Health Net to for-profit status. The repurchased shares, having an aggregate value of $9.6 million, were immediately canceled and netted against Class A Common Stock, Additional Paid-in-Capital, and Retained Earnings.
The company has various outstanding stock option and stock purchase plans which cover certain employees, officers, and non-employee directors. Such plans have been adopted by the stockholders and options have been granted under such plans. The Company grants stock options at prices at or above the market value of the stock on the date of grant. The options generally carry a maximum term of 10 years and vest either ratably over 5 years or over the 3rd, 4th and 5th anniversaries of the date of grant. A summary of the plans in existence as of December 31, 1996 is as follows:
Non-Employee Director Plan - In 1991, 100,000 shares of the Company's Class A Common Stock were authorized to be issued under grants to non-employee directors of the Company pursuant to the Non-Employee Director Stock Option Plan. The authorized number of shares was subsequently increased to 300,000.
Employee Stock Purchase Plan - In 1993, 1,000,000 shares of the Company's Class A Common Stock were reserved for issuance under the Company's Employee Stock Purchase Plan. The plan provides employees of the Company with an opportunity to purchase stock through payroll deductions. Eligible employees may purchase up to $25,000 in fair market value annually of the Company's Common Stock at 85% of the lower of the market price on either the first or the last day of each offering period.
The following table summarizes the weighted average price and life information for significant option groups outstanding at December 31, 1996:
No stock-based compensation cost was recognized for 1996 and 1995. Had the stock-based compensation cost been determined based on the fair value of options granted, net income would have decreased by $8.1 million and $381,000, respectively, and earnings per share would have decreased by $0.16 in 1996 and would have remained unchanged in 1995. As fair value criteria were not applied to awards prior to 1995, and additional awards in future years are anticipated, the effects on net income and earnings per share in this pro forma disclosure may not be indicative of future amounts.
During the years ended December 31, 1996, 1995 and 1994, tax benefits totaling $3.9 million, $8.7 million and $1.5 million, respectively, were realized as a result of compensation recognized for tax purposes relating to the exercise of stock options and were recorded as an increase in additional paid-in capital.
Significant components of the provision for income taxes are as follows for the three years ended December 31 (in thousands):
The Company has two classes of Common Stock. The Company's Class B Common Stock has the same economic benefits as the Company's Class A Common Stock but is non-voting. Upon the sale or transfer of shares of Class B Common Stock by the Foundation to an unrelated third party, such shares automatically convert to Class A Common Stock. The Foundation is the only holder of record of the Company's Class B Common Stock.
On October 1, 1996 the Company and FH Acquisition Corp., a wholly owned subsidiary of the Company ("Merger Sub"), entered into a Agreement and Plan of Merger (the "Merger Agreement") with FHC, whereby Merger Sub will merge (the "Merger") with and into FHC and FHC will survive as a wholly owned subsidiary of the Company. Pursuant to the Merger Agreement FHC stockholders will receive 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held. The shares of the Company's Class A Common Stock issued to FHC's stockholders in the Merger will constitute approximately 61% of the outstanding stock of the Company after the Merger, and the Company's current stockholders will hold approximately 39% of the outstanding stock of the Company after the Merger.
Pursuant to the Merger Agreement, the Company will amend its Certificate of Incorporation to change the name of the Company to Foundation Health Systems, Inc. and to increase the number of authorized shares of the Company's Common Stock to 380,000,000 shares consisting of 350,000,000 shares of Class A Common Stock and 30,000,000 shares of Class B Common Stock. The transaction is structured to be a tax-free combination accounted for as a pooling of interests. The new company will operate on a calendar year for financial reporting purposes.
On February 12, 1996, shareholders of the Company and FHC approved the Merger Agreement at separate special meetings. The transaction is anticipated to be completed in April 1997 subject to regulatory approvals and other customary conditions.
The following interim financial information presents the 1996 and 1995 results of operations on a quarterly basis (in thousands except per share data):