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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31,JUNE 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBERNUMBER: 1-12718
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FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4288333
(State or other jurisdiction of (I.R.S. Employer
of Identification
incorporation or organization) No.)
21650 OXNARD STREET, WOODLAND 91367 HILLS, CA 91367
(Address of principal executive offices) (Zip Code)
executive offices)
(818) 676-6978
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
The number of shares outstanding of the registrant's Class A Common Stock as
of May 12,August 11, 1999 was 117,215,876117,659,410 (excluding 3,194,374 shares held as treasury
stock), and 5,047,6424,567,442 shares of the registrant's Class B Common Stock were outstanding as of such
date.
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FOUNDATION HEALTH SYSTEMS, INC.
INDEX TO FORM 10-Q
PAGE
-------------
PART I--FINANCIAL INFORMATION
Item 1--Financial Statements
Condensed Consolidated Balance Sheets--March 31,Sheets as of June 30, 1999 and December 31, 1998..................................................................1998.......................... 3
Condensed Consolidated Statements of Operations for the FirstSecond Quarter Ended March 31,June 30, 1999 and 1998.........................................1998...... 4
Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 1999 and 1998.......... 5
Condensed Consolidated Statements of Cash Flows for the First QuarterSix Months Ended March 31,June 30, 1999 and 1998......................................... 51998.......... 6
Notes to Condensed Consolidated Financial Statements.................... 6Statements..................................................... 7
Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 8Operations.............. 11
Item 3--Quantitative and Qualitative Disclosures About Market Risk........ 17Risk......................................... 21
PART II--OTHER INFORMATION
Item 1--Legal Proceedings................................................. 19Proceedings.................................................................................. 22
Item 2--Changes in Securities............................................. 20Securities.............................................................................. 23
Item 3--Defaults Upon Senior Securities................................... 21Securities.................................................................... 24
Item 4--Submission of Matters to a Vote of Security Holders............... 21Holders................................................ 24
Item 5--Other Information................................................. 21Information.................................................................................. 25
Item 6--Exhibits and Reports on Form 8-K.................................. 25
Signatures................................................................ 318-K................................................................... 29
Signatures................................................................................................. 35
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
JUNE 30, DECEMBER 31,
1999 1998
MARCH 31, ------------ 1999
------------------------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents..........................................................equivalents....................... $ 615,574475,755 $ 763,865
Investments--available for sale.................................................... 564,365sale................. 576,849 525,082
Premiums receivable, net........................................................... 222,257net........................ 189,688 230,157
Amounts receivable under government contracts...................................... 292,495contracts... 321,582 321,411
Deferred taxes..................................................................... 145,184taxes.................................. 245,821 160,446
Reinsurance and other receivables.................................................. 153,941receivables............... 149,701 147,827
Other assets....................................................................... 78,268assets.................................... 76,971 91,096
------------ ------------------------------
Total current assets............................................................. 2,072,084assets.......................... 2,036,367 2,239,884
Property and equipment, net........................................................ 334,130net..................... 320,769 345,269
Goodwill and other intangible assets, net.......................................... 960,316net....... 934,399 977,910
Deferred taxes.................................. -- 118,759
Other assets....................................................................... 344,892 366,478assets.................................... 165,083 181,447
------------ ------------------
Total Assets.................................. $ 3,456,618 $ 3,863,269
------------ Total Assets..................................................................... $ 3,711,422 $3,929,541------------------
------------ ------------
------------ ------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Reserves for claims and other settlements..........................................settlements....... $ 1,016,9091,022,953 $ 961,3991,006,799
Unearned premiums.................................................................. 100,091premiums............................... 54,310 288,683
Notes payable and capital leases................................................... 1,569leases................ 2,535 1,760
Amounts payable under government contracts......................................... 78,282contracts...... 85,450 69,792
Accounts payable and other liabilities............................................. 441,836 503,797liabilities.......... 340,398 458,397
------------ ------------------------------
Total current liabilities........................................................ 1,638,687liabilities..................... 1,505,646 1,825,431
Notes payable and capital leases................................................... 1,193,679leases................ 1,089,190 1,254,278
Deferred taxes.................................. 21,121 --
Other liabilities.................................................................. 94,060 105,790liabilities............................... 28,981 39,518
------------ ------------------
Total Liabilities............................. 2,644,938 3,119,227
------------ Total Liabilities................................................................ 2,926,426 3,185,499
------------ ------------------------------
Stockholders' Equity:
Common Stock and additional paid-in capital........................................ 642,355capital..... 642,795 641,945
Treasury Class A common stock, at cost.............................................cost.......... (95,831) (95,831)
Accumulated other comprehensive loss............................................... (8,685)loss............ (10,410) (7,308)
Retained earnings.................................................................. 247,157earnings............................... 275,126 205,236
------------ ------------------------------
Total stockholders' equity....................................................... 784,996equity.................... 811,680 744,042
------------ ------------------------------
Total Liabilities and Stockholders' Equity.......................................Equity.... $ 3,711,422 $3,929,5413,456,618 $ 3,863,269
------------ ------------------
------------ ------------ ------------------------------
See accompanying Notes to Condensed Consolidated Financial Statements.
3
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FIRSTSECOND QUARTER ENDED MARCH 31,JUNE
30,
--------------------------
1999 1998
------------ ------------
REVENUES
Health plan premiums.............................................................. $ 1,743,698 $ 1,783,109
Government contracts/Specialty services........................................... 365,797 360,827
Investment and other income....................................................... 21,976 23,444
Loss on sale of businesses........................................................ (5,810) --
------------ ------------
Total revenues.................................................................. 2,125,661 2,167,380
------------ ------------
EXPENSES
Health plan services.............................................................. 1,474,360 1,493,723
Government contracts/Specialty services........................................... 241,840 233,574
Selling, general and administrative............................................... 314,674 334,856
Depreciation...................................................................... 17,037 20,093
Amortization...................................................................... 10,544 11,412
Interest.......................................................................... 20,657 22,193
Asset impairments and other costs................................................. -- 50,000
------------ ------------
Total expenses.................................................................. 2,079,112 2,165,851
------------ ------------
Income from operations before income taxes.......................................... 46,549 1,529
Income taxes........................................................................ 18,580 573
------------ ------------
Net income.......................................................................... $ 27,969 $ 956
------------ ------------
------------ ------------
Basic and diluted earnings per share................................................ $ 0.23 $ 0.01
------------ ------------
------------ ------------
Weighted average shares outstanding:
Basic............................................................................... 122,279 121,957
Diluted............................................................................. 123,161 122,335
See accompanying Notes to Condensed Consolidated Financial Statements.
4
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
--------------------------
1999 1998
------------ ------------
REVENUES
Health plan premiums................................................................ $ 1,855,4233,516,078 $ 1,844,4843,562,631
Government contracts/Specialty services............................................. 348,352 304,740733,104 668,863
Investment and other income......................................................... 18,657 26,150
Gain40,633 49,594
Net gain on sale of pharmacy benefits management operations............................. 53,558businesses...................................................... 47,748 --
------------ ------------
Total revenues.................................................................... 2,275,990 2,175,3744,337,563 4,281,088
------------ ------------
EXPENSES
Health plan services................................................................ 1,564,777 1,544,0922,974,794 2,976,149
Government contracts/Specialty services............................................. 238,799 191,468480,894 425,042
Selling, general and administrative................................................. 321,915 343,850636,589 678,706
Depreciation........................................................................ 17,739 17,82034,776 37,913
Amortization........................................................................ 10,984 13,02121,528 24,433
Interest............................................................................ 21,938 21,86142,595 44,054
Restructuring, asset impairments and other costs.......................................................costs.................................... 21,059 --50,000
------------ ------------
Total expenses.................................................................... 2,197,211 2,132,1124,212,235 4,236,297
------------ ------------
Income from operations before income taxes and cumulative effect of change in
accounting principle................................................................ 78,779 43,262125,328 44,791
Income tax provision.................................................................. 31,441 17,024taxes.......................................................................... 50,021 17,597
------------ ------------
Income before cumulative effect of change in accounting principle..................... 47,338 26,23875,307 27,194
Cumulative effect of change in accounting principle................................... 5,417 --
------------ ------------
Net income............................................................................ $ 41,92169,890 $ 26,23827,194
------------ ------------
------------ ------------
Basic and diluted earnings per share:
Income before cumulative effect of change in accounting principle..................... $ 0.390.62 $ 0.22
Cumulative effect of change in accounting principle................................... 0.05 --
------------ ------------
Net income............................................................................ $ 0.340.57 $ 0.22
------------ ------------
------------ ------------
Weighted average shares outstanding:
Basic................................................................................. 122,233 121,614122,257 121,786
Diluted............................................................................... 122,233 121,907122,296 122,117
See accompanying Notes to Condensed Consolidated Financial Statements.
45
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
FIRST QUARTERSIX MONTHS ENDED MARCH 31,JUNE
30,
------------------------
1999 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................................................. $ 41,92169,890 $ 26,23827,194
Adjustments to reconcile net income to net cash used in operating activities:
Amortization and depreciation......................................................... 28,723 30,841
Gain56,304 62,346
Net gain on sale of pharmacy benefits management operations............................... (53,558)businesses........................................................ (47,748) --
Net gain on sale of buildings......................................................... (2,482) --
Cumulative effect of change in accounting principle................................... 5,417 --
Changes in net assets of discontinued operations......................................Asset impairments..................................................................... -- (30,324)35,000
Other changes......................................................................... 648 9392,263 (4,286)
Changes in assets and liabilities:liabilities, net of effect of dispositions:
Premiums receivable................................................................. 7,900 (19,086)34,681 (16,744)
Unearned premiums................................................................... (188,592) (111,640)(233,570) (144,432)
Other assets........................................................................ 38,705 29,95767,606 (63,156)
Amounts receivable/payable under government contracts............................... 37,406 20,48815,487 (33,897)
Reserves for claims and other settlements........................................... 55,510 (49,991)22,429 (114,242)
Accounts payable and accrued liabilities............................................ (78,702) (85,520)(137,258) (104,263)
----------- -----------
Net cash used in operating activities................................................... (104,622) (188,098)(146,981) (356,480)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of investments......................................................... 98,232 120,109264,781 428,586
Purchase of investments................................................................. (142,312) (166,712)(320,612) (436,577)
Purchases of property and equipment..................................................... (9,017) (26,450)
Sales(13,591) (77,263)
Net proceeds from the sale of property and equipment......................................................... 2,381businesses................................................ 76,000 --
Net proceeds from the sale of pharmacy benefits management operations................... 65,000buildings................................................. 7,433 --
Other................................................................................... 2,427 --8,323 5,677
----------- -----------
Net cash provided by (used in) investing activities..................................... 16,711 (73,053)22,334 (79,577)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock purchases.................... 410 1,385850 12,349
Proceeds from issuance of notes payable and other financing arrangements................ 20,000 45,000115,560
Repayment of debt and other non-current liabilities..................................... (80,790) (654)(184,313) (526)
----------- -----------
Net cash provided by (used in) financing activities..................................... (60,380) 45,731(163,463) 127,383
----------- -----------
Net decrease in cash and cash equivalents............................................... (148,291) (215,420)(288,110) (308,674)
Cash and cash equivalents, beginning of period.......................................... 763,865 559,360
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................................ $ 615,574475,755 $ 343,940250,686
----------- -----------
----------- -----------
See accompanying Notes to Condensed Consolidated Financial Statements.
56
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following notes should be read in conjunction with the notes to the
consolidated financial statements and the management's discussion and analysis
of financial condition and results of operations for each of the three years in
the period ended December 31, 1998 incorporated by reference in the Foundation
Health Systems, Inc. (the "Company") Annual Report on Form 10-K for the year
ended December 31, 1998.1998 as well as the consolidated operating results presented
in the management's discussion and analysis contained in this Quarterly Report
on Form 10-Q.
NOTE 1--BASIS OF PRESENTATION
In the opinion of management, the accompanying condensed consolidated
financial statements include all normal and recurring adjustments necessary for
a fair presentation of the consolidated financial position of the Company and
the consolidated results of its operations and its cash flows for the interim
periods presented. Although the Company believes that the disclosures in these
financial statements are adequate to make the information presented not
misleading, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission (the "Commission") applicable to
quarterly reports on Form 10-Q. Results of operations for the interim periods
are not indicative of results to be expected for the full year.
Certain prior period amounts have been reclassified to conform with the
current period presentation. TheIn the second quarter ended June 30, 1999, the
Company reclassified and adjusted certain intercompany revenues and expenses
which did not impact net income or earnings per share. In addition, in the first
quarter ended March 31, 1999, the Company reclassified medical management
expenses from health plan services costsmedical expenses to selling, general and
administrative expenses ("SG&A") expenses. The Companyand also reclassifiedrecorded SG&A expenses of its
Specialty Services division from Government Contracts/Specialty Services costs toservices businesses in SG&A, expenses. In conjunction with its segment reporting,rather than in Specialty services costs
as had been the Company is reporting
the revenues and expenses of its Government Contracts/Specialty Services segment
on a combined basiscase in the condensed consolidated statements of operations.prior periods.
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS
During 1998, the Company initiated a formal plan to dispose of certain
Central Division health plans included in the Company's Health Plan Services
segment in accordance with its anticipated divestitures program.strategic plan to focus on core operations. In
this connection, the Company adoptedimplemented a formal plan during the first quarter
ended March 31, 1999 to close the Colorado regional supportprocessing center for these
health plans and transfer its operations to the Company's other administrative
facilities. In August 1999, the Company sold certain of the processing center
facilities and accompanying real estate. See "Item 5. Recent Developments--
Colorado Operations." The closure of the remaining processing center facilities
is expected to be completed for all but the Colorado operations by the end of
the third quarter of 1999. The Company recorded a pretax restructuring charge of
$21.1 million including $18.5during the first quarter of 1999. Of the $21.1 million for severance and $2.6of
restructuring costs, $1.4 million for other expenses associated with the
closing of the facility. As of March 31, 1999, norepresented cash payments have been made
and $21.1$16.5 million is
expected to require future outlays of cash.cash as of June 30, 1999.
During 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection. FPA, through its affiliated medical groups, provided services to the
Company's affiliated members. The Company leased healthcare facilities to FPA
prior to the bankruptcy. As a result, the Company recorded $50.0 million of
charges primarily comprised of real estate asset impairments, notes receivable
impairments, and other items in the second quarter ended June 30, 1998.
7
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS (CONTINUED)
During 1997 and 1998, the Company adopted restructuring plans, the principal
elements of which included a workforce reduction, the consolidation of employee
benefit plans, the consolidation of facilities in certain geographic locations,
the consolidation of overlapping provider networks and the consolidation of
information systems at all locations. Of the $146.8$167.9 million in net restructuring
costs recorded as part of the 1997 and 1998 plans, $93.2 million represented cash
payments and $42.4 million represented non-cash activities through March 31,
1999. Of the remaining amounts, $7.5$9.7 million is expected to
require future outlays of cash and $3.7$3.5 million represents future non-cash
activities. Of the
$21.2 million in restructuring costs recordedactivities as part of the 1998 plan, $15.5
million represented cash payments and $2.0 million represented non-cash
activities through March 31,June 30, 1999. Of the remaining amounts, $3.7 million is
expected to require future outlays of cash.
6
NOTE 3--COMPREHENSIVE INCOME
The Company's comprehensive income for the first quartersthree and six months ended March 31June
30 is as follows (amounts in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Net Income..................................................................................income.............................. $ 41,92127,969 $ 26,238956 $ 69,890 $ 27,194
Other comprehensive income (loss), net
of tax:
Change in unrealized appreciation
(depreciation) on investments........................... (1,377) 3,805investments....... (1,725) (2,629) (3,102) 1,176
--------- --------- --------- ---------
Comprehensive Income........................................................................income (loss)............. $ 40,54426,244 $ 30,043(1,673) $ 66,788 $ 28,370
--------- --------- --------- ---------
--------- --------- --------- ---------
NOTE 4--EARNINGS PER SHARE
Basic earnings per share excludes dilution and reflects income divided by
the weighted average shares of common stock outstanding during the periods
presented. Diluted earnings per share is based upon the weighted average shares
of common stock and dilutive common stock equivalents (all of which are
comprised of stock options) outstanding during the periods presented; no
adjustment to income is required. Common stock equivalents arising from dilutive
stock options are computed using the treasury stock method. There were no such881,000
and 39,000 shares of common stock equivalents for the three and six months ended
March 31,June 30, 1999, respectively, and 293,000378,000 and 331,000 shares of common stock
equivalents for the three and six months ended March 31, 1998.June 30, 1998, respectively.
8
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5--SEGMENT INFORMATION
Presented below are segment data for the first quarterthree and six months ended March 31,June 30,
1999 and 1998 (amounts in thousands):
GOVERNMENT
CONTRACTS/
HEALTH PLAN CONTRACTS/SPECIALTY CORPORATE/
SERVICES SERVICES OTHER TOTAL
------------ ----------- ---------------------------- --------------- ------------
MARCH 31,THREE MONTHS ENDED JUNE 30, 1999
Revenues from external sources..............................sources................... $ 1,855,4231,743,698 $ 348,352365,797 $ 72,21516,166 $ 2,275,9902,125,661
Intersegment revenues....................................... 1,681 40,485 7,946 50,112revenues............................ 89,206 -- 5,902 95,108
Income (loss) before income taxes................ 30,140 23,572 (7,163) 46,549
THREE MONTHS ENDED JUNE 30, 1998
Revenues from external sources................... $ 1,783,109 $ 360,827 $ 23,444 $ 2,167,380
Intersegment revenues............................ 92,609 -- 9,331 101,940
Income (loss) before income taxes................ 36,392 37,361 (72,224) 1,529
SIX MONTHS ENDED JUNE 30, 1999
Revenues from external sources................... $ 3,516,078 $ 733,104 $ 88,381 $ 4,337,563
Intersegment revenues............................ 173,930 -- 13,848 187,778
Income before income taxes and cumulative effect
of change in accounting principle................................... 8,497 32,597 37,685 78,779
MARCH 31,principle.............. 38,637 56,169 30,522 125,328
SIX MONTHS ENDED JUNE 30, 1998
Revenues from external sources..............................sources................... $ 1,844,4843,562,631 $ 304,740668,863 $ 26,15049,594 $ 2,175,3744,281,088
Intersegment revenues....................................... 6,230 31,035 8,246 45,511revenues............................ 163,801 -- 17,578 181,379
Income (loss) before income taxes.................................. 35,621 26,333 (18,692) 43,262taxes................ 72,013 63,694 (90,916) 44,791
NOTE 6--CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1999, the Company adopted Statement of Position 98-5
"Reporting on the Costs of Start-Up Activities" and changed its method of
accounting for start-up and organization costs. The change involved expensing
these costs as incurred, rather than the Company's previous accounting principle
of capitalizing and subsequently amortizing such costs.
The change in accounting principle resulted in the write-off of the costs
capitalized as of January 1, 1999. The cumulative effect of the write-off was
$5.4 million (net of tax benefit of $3.7 million) and has been expensed and
reflected in the condensed consolidated statement of operations for the threesix
months ended March 31,June 30, 1999.
7
NOTE 7--DISPOSITION OF ASSETS
On March 8, 1999, the Company entered into a definitive agreement for the
sale of its HMO operations in the state of New Mexico. Completion of the
transaction is subject to various conditions and certain regulatory approvals.
On March 31, 1999, the Company completed the sale of certain of its pharmacy
benefits managementprocessing operations for net cash proceeds of $65.0 million and
recognized a net gain of $53.6 million.
9
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--DISPOSITION OF ASSETS (CONTINUED)
During the second quarter ended June 30, 1999, the Company completed the
sale of its HMO operations in the states of Texas, Louisiana and Oklahoma and
its preferred provider organization network subsidiary, Preferred Health
Network, Inc. As part of the transactions, the Company received certain cash
proceeds and convertible preferred stock. The Company recognized total losses on
the sales of $5.8 million, before taxes, in the second quarter ended June 30,
1999.
On November 4, 1998,July 2, 1999, the Company entered into a definitive agreement for the
sale of its HMO operations in the statesstate of Texas, Louisiana and Oklahoma to
AmCareco, Inc. The sale was consummated effective April 30, 1999. As partUtah. Completion of the transaction
is subject to various conditions and certain regulatory approvals.
On July 16, 1999, the Company received convertible preferred stockentered into a definitive agreement for the
sale of its two California hospitals. Completion of the buyertransaction is subject
to various conditions and cash in excess of certain statutory surplus and minimum working capital
requirements of the plans sold.
Inregulatory approvals.
On December 1997,10, 1998, the Company adopted a formal plan to sell itscompleted the sale of the workers'
compensation segment which was accounted for as discontinued operations for the
first quarterthree and six months ended March 31,June 30, 1998. The loss on disposition of $99 million
recorded at December 31, 1997 included the anticipated results of discontinued
operations through the disposal date;date of disposition; accordingly, net losses of $4.2
million and $7.9 million related to the operations of the workers' compensation
segment are not reflected on the Company's condensed consolidated statementstatements of
operations for the quarterthree and six months ended March 31, 1998. On December 10,June 30, 1998, the Company completed the sale of
the workers' compensation segment.respectively.
NOTE 8--LEGAL PROCEEDINGS
Complaints have been filed in federal and state courts seeking an
unspecified amount of damages on behalf of an alleged class of persons who
purchased shares of common stock, convertible subordinated debentures and
options to purchase common stock of FPA Medical Management, Inc. ("FPA") at
various times between February 3, 1997 and May 15, 1998. The complaints allege
that the Company and certain former officers violated federal and state
securities laws by misrepresenting and failing to disclose certain information
about a 1996 agreement between the Company and FPA, about FPA's business and
about the Company's 1997 sale of FPA common stock held by the Company.
Subsequent to the Company's filing of a motion to dismiss all claims asserted
against it in the consolidated federal class actions, all claims against the
Company's former officers were voluntarily dismissed from the consolidated class
actions in both federal and state court. Thereafter, all proceedings in the
consolidated federal class actions were stayed and the motion to dismiss was
denied without prejudice to renewal after the expiration of the stay. Management
believes these suits are without merit and intends to vigorously defend the
actions.
The Company is involved inand certain of its subsidiaries are also parties to various
other legal proceedings, many of which are
routineinvolve claims for coverage encountered
in itsthe ordinary course of business. InBased in part on advice from litigation
counsel to the Company and upon information presently available, management of
the Company is of the opinion that the final outcome of management, based upon current facts
and circumstances known by the Company, the resolution of these mattersall such proceedings
should not have a material adverse effect on the financial position or results
of operations of the Company.
10
ITEM 2.2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Foundation Health Systems, Inc. (together with its subsidiaries, the
"Company") is an integrated managed care organization which administers the
delivery of managed health care services. The Company's operations consist of
two operating segments: Health Plan Services and Government Contracts/contracts/ Specialty
Services.services. Through its subsidiaries, the Company offers group, individual,
Medicaid and Medicare health maintenance organization ("HMO") and preferred
provider organization ("PPO") plans; government sponsored managed care plans;
and managed care products related to administration and cost containment,
behavioral health, dental, vision and pharmaceutical products and other
services.
The Health Plan Services segment consists of HMOs organized into four
operational divisions located in the following geographic regions: the
California Division, the Northeast Division, the Central Division and the
Arizona Division. During the first quartersix months ended March 31,June 30, 1999, these health plans
were located in Arizona, California, Colorado, Connecticut, Florida, Idaho, Louisiana, New
Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Utah, Washington and
West Virginia. As discussed above, theThe Company sold its HMO operations in the Statesstates of Louisiana,
Oklahoma and Texas effective April 30, 1999. The Company's health plans provide
a wide range of managed health care services throughout the United States with
approximately 4.14.0 million at risk and administrative services only members. The
Company's HMO subsidiaries contract to provide medical care services to a
defined, 8
enrolled population for a predetermined, prepaid monthly fee for group,
Medicaid, individual Medicare and MedicareMedicaid plans throughout their respective service
areas. All of the HMOs are state licensed and some are also federally qualified.
The Company also operates PPO networks which provide access to health care
services and owns six health and life insurance companies licensed to sell
insurance throughout most of the United States. The financial results include
the results of two hospitals owned by the Company operating in California.
The Government Contracts/contracts/Specialty Servicesservices segment administers large,
multi-year managed health care government contracts. This segment subcontracts
to affiliated and unrelated third parties the administration and health care
risk of parts of these contracts and currently administers health care programs
covering approximately 1.5 million eligible individuals under the Civilian
Health and Medical Program of the Uniformed Services ("CHAMPUS") through the
TRICARE program. Currently, the Company provides these services under three
TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma,
Oregon, Texas, Washington and parts of Arizona, Idaho and Louisiana. This
segment also offers behavioral health, pharmacy management, dental and vision
services and sub-acute hospital unit management as well as managed care and
workers' compensation products related to bill review, administration and cost
containment for hospitals, health plans and other entities.
This discussion and analysis contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve risks and uncertainties which may cause
actual results to differ materially from those projected or implied in these
statements. The risks and uncertainties faced by the Company include, but are
not limited to, those set forth under "Additional Information Concerning the
Company's Business," "Cautionary Statements" and other sections within the
Company's filings with the Securities and Exchange Commission.
CONSOLIDATED OPERATING RESULTS OF OPERATIONS
The Company's net income for the firstsecond quarter ended March 31,June 30, 1999 was
$41.9$28.0 million, or $0.34$0.23 per basic and diluted share, compared to net income for
the comparable period in 1998 of $26.2$1.0 million, or $0.01 per basic and diluted
share. The Company's net income for the six months ended June 30, 1999 was $69.9
million, or $0.57 per basic and diluted share, compared to net income for the
comparable period in 1998 of $27.2 million or $0.22 per basic and diluted share.
Excluding the cumulative effect of the change in accounting principle for
organization and start up costs recorded during the first quarter of 1999, net
income was $47.3$75.3 million or $0.39$0.62 per basic and diluted share for the first quartersix months
ended March 31,June 30, 1999.
911
The table immediately below and the paragraphs whichthat follow provide selected
financial information related to the Company's performance for the 1999 and 1998
periods. The second table below, relating to the three months ended March 31,
June 30, September 30 and December 31, 1998 and March 31, 1999, contains certain
prior period amounts that have been reclassified to conform with the current
period presentation. In the second quarter ended June 30, 1999, the Company
reclassified and adjusted certain intercompany revenues and expenses which did
not impact net income or earnings per share. The reclassifications did result in
higher reported revenues in its Government Contracts/Specialty Services unit and
lower reported revenues and costs in its Health Plan services unit compared with
amounts previously disclosed. FHS believes this more accurately reflects the
performance of its specialty companies as if they were independent entities. In
addition, in the first quarter ended March 31, 1999, the Company reclassified
medical management expenses from health plan medical expenses to selling,
general and 1998 (amountsadministrative expenses ("SG&A") and also recorded SG&A expenses of
its Specialty services businesses in thousands except PMPM data):SG&A, rather than in Specialty services
costs as had been the case in prior periods.
FIRSTSECOND QUARTER ENDED MARCH 31,SIX MONTHS ENDED
-------------------------- --------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER MEMBER
PER MONTH AMOUNTS)
Total revenues........................................................................
REVENUES:
Health plan premiums................................... $ 2,275,9901,743,698 $ 2,175,3741,783,109 $ 3,516,078 $ 3,562,631
Government contracts/Specialty services................ 365,797 360,827 733,104 668,863
Investment and other income............................ 21,976 23,444 40,633 49,594
Net gain (loss) on sale of businesses.................. (5,810) -- 47,748 --
------------ ------------ Expenses:------------ ------------
Total revenues....................................... 2,125,661 2,167,380 4,337,563 4,281,088
------------ ------------ ------------ ------------
EXPENSES:
Health plan services................................................................ 1,564,777 1,544,092services................................... 1,474,360 1,493,723 2,974,794 2,976,149
Government contracts/Specialty services............................................. 238,799 191,468services................ 241,840 233,574 480,894 425,042
Selling, general and administrative................................................. 321,915 343,850
Depreciation........................................................................ 17,739 17,820
Amortization........................................................................ 10,984 13,021
Interest............................................................................ 21,938 21,861administrative.................... 314,674 334,856 636,589 678,706
Depreciation........................................... 17,037 20,093 34,776 37,913
Amortization........................................... 10,544 11,412 21,528 24,433
Interest............................................... 20,657 22,193 42,595 44,054
Restructuring, asset impairment and other costs.......................................................costs........ -- 50,000 21,059 50,000
------------ ------------ ------------ ------------
Total expenses....................................... 2,079,112 2,165,851 4,212,235 4,236,297
------------ ------------ ------------ ------------
Income from operations before income taxes and cumulative
effect of change in accounting principle............... 46,549 1,529 125,328 44,791
Income tax provision..................................... 18,580 573 50,021 17,597
------------ ------------ ------------ ------------
Income before cumulative effect of change in accounting
principle.............................................. 27,969 956 75,307 27,194
Cumulative effect of change in accounting principle...... -- -- 5,417 --
------------ ------------ Total expenses........................................................................ 2,197,211 2,132,112
------------ ------------
Overall MCR........................................................................... 81.8% 80.8%Net income............................................... $ 27,969 $ 956 $ 69,890 $ 27,194
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Administrative (SG&A+depreciation) ratio.............................................. 15.4% 16.8%
HEALTH PLAN SERVICES SEGMENT:&A + Depreciation) Ratio............... 15.72% 16.56% 15.80% 16.94%
Health plan premiums.................................................................. $ 1,855,423 $ 1,844,484
Health plan MCR....................................................................... 84.3% 83.7%MCR.......................................... 84.55% 83.77% 84.61% 83.54%
Government contracts/Specialty services MCR.............. 66.11% 64.73% 65.60% 63.55%
Overall MCR.............................................. 81.36% 80.57% 81.33% 80.38%
Health plan premiums per member per month.............................................month................ $ 143.95137.18 $ 136.33126.30 $ 137.34 $ 126.49
Health plan services per member per month.............................................month................ $ 121.40115.99 $ 114.13
GOVERNMENT CONTRACTS/SPECIALTY SERVICES SEGMENT:105.80 $ 116.20 $ 105.66
12
FIRST SECOND THIRD FOURTH FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER
ENDED ENDED ENDED ENDED ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1998 1998 1998 1998 1999
------------ ------------ ------------- ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER MEMBER PER MONTH AMOUNTS)
REVENUES:
Health plan premiums.................... $ 1,779,522 $ 1,783,109 $ 1,769,291 $1,792,239 $ 1,772,380
Government contracts/Specialty
services.............................. 308,036 360,827 348,732 393,672 367,307
Investment and other income............. 26,150 23,444 20,441 29,006 72,215
------------ ------------ ------------- ------------ ------------
Total revenues........................ 2,113,708 2,167,380 2,138,464 2,214,917 2,211,902
------------ ------------ ------------- ------------ ------------
EXPENSES:
Health plan services.................... 1,482,426 1,493,723 1,539,072 1,563,251 1,500,434
Government contracts/Specialty
services.............................. 191,468 233,574 232,346 266,687 239,054
Selling, general and administrative..... 343,850 334,856 350,406 361,759 321,915
Depreciation............................ 17,820 20,093 20,276 20,762 17,739
Amortization............................ 13,021 11,412 12,323 12,386 10,984
Interest................................ 21,861 22,193 23,626 24,479 21,938
Asset impairment and other costs........ -- 50,000 87,987 136,966 21,059
------------ ------------ ------------- ------------ ------------
Total expenses........................ 2,070,446 2,165,851 2,266,036 2,386,290 2,133,123
------------ ------------ ------------- ------------ ------------
Income (loss) from operations before
income taxes and cumulative effect of
change in accounting principle.......... 43,262 1,529 (127,572) (171,373) 78,779
Income tax provision (benefit)............ 17,024 573 (38,953) (67,640) 31,441
------------ ------------ ------------- ------------ ------------
Income (loss) before cumulative effect of
change in accounting principle.......... 26,238 956 (88,619) (103,733) 47,338
Cumulative effect of change in accounting
principle............................... -- -- -- -- 5,417
------------ ------------ ------------- ------------ ------------
Net income (loss)......................... $ 26,238 $ 956 $ (88,619) $ (103,733) $ 41,921
------------ ------------ ------------- ------------ ------------
------------ ------------ ------------- ------------ ------------
Administrative (SG&A + Depreciation)
Ratio................................... 17.33% 16.56% 17.50% 17.50% 15.87%
Health plan MCR........................... 83.30% 83.77% 86.99% 87.22% 84.66%
Government contracts/Specialty services
revenues......................................MCR..................................... 62.16% 64.73% 66.63% 67.74% 65.08%
Overall MCR............................... 80.18% 80.57% 83.64% 83.72% 81.30%
Health plan premiums per member per
month................................... $ 348,352126.67 $ 304,740
Government contracts/Specialty126.30 $ 128.38 $ 133.89 $ 137.50
Health plan services MCR........................................... 68.6% 62.8%per member per
month................................... $ 105.52 $ 105.80 $ 111.68 $ 116.78 $ 116.40
13
ENROLLMENT INFORMATION
FIRST QUARTER ENDED MARCH 31,
(AMOUNTS IN THOUSANDS)
JUNE 30,
-------------------- PERCENT
1999 1998 CHANGE
--------- --------- --------------------
Health Plan Services:
Commercial........................................................................ 3,141 3,523 (10.8%Services
Commercial............................................................................ 3,073 3,516 (12.6%)
Medicare Risk..................................................................... 283 310 (8.7%Risk......................................................................... 269 318 (15.4%)
Medicaid.......................................................................... 642 488 31.6%Medicaid.............................................................................. 673 550 22.4%
--------- ---------
4,066 4,321 (5.9%4,015 4,384 (8.4%)
--------- ---------
--------- ---------
Government Contracts:
CHAMPUS PPO and Indemnity......................................................... 713 882 (19.2%Indemnity............................................................. 684 782 (12.5%)
CHAMPUS HMO....................................................................... 803 720 11.5%HMO........................................................................... 817 662 23.4%
--------- ---------
1,516 1,602 (5.4%1,501 1,444 (3.9%)
--------- ---------
--------- ---------
10
REVENUES AND HEALTH CARE COSTS
The Company's revenues grewdecreased by $100.6$41.7 million or 4.6%1.9% for the firstsecond
quarter ended March 31,June 30, 1999 and $56.5 million or 1.3% for the six months ended
June 30, 1999 as compared to the comparable periodperiods in 1998. GrowthDecreases in Health
Plan revenues of $10.9$39.4 million wasand $46.6 million for the second quarter and six
months ended June 30, 1999, respectively, as compared to the comparable periods
in 1998 were due primarily to decreases in enrollment partially offset by
increases in premium ratesrates. The sale of the HMO operations in virtually all markets partially offset by decreasesthe states of
Texas, Louisiana and Oklahoma that eliminated approximately $7.0 million in
commercial
enrollment.health plan revenues for the second quarter ended June 30, 1999 also contributed
to the decreases. Growth in Government contracts/Specialty services revenues
totaled $43.6$5.0 million and $64.2 million for the second quarter and six months
ended June 30, 1999, respectively, as compared to the comparable periods in
1998. This growth is primarily due to growthincreases in government contracts and
mental health services and certain revenue
adjustments under government contracts.revenues which were partially offset by decreases in pharmacy
revenue. See "Segment Information" for further discussion of Health Plan
Services and Government Contract/contract/Specialty Services.services.
Included in total revenues for the six months ended June 30, 1999 is a $53.6
million gain on the sale of certain pharmacy benefits processing services of the
Company during the first quarter of 1999 which was partially offset by losses
totaling $5.8 million related to the sale of certain businesses during the
second quarter of 1999.
The overall medical care ratio ("MCR") (medical costs as a percentage of
Health Plan premiums and Government contracts/Specialty services revenues) for
the firstsecond quarter and six months ended March 31,June 30, 1999 was 81.8%81.36% and 81.33%,
respectively, as compared to 80.8%80.57% and 80.38%, respectively, for the comparable
periodperiods in 1998. The increase wasincreases were primarily due to higher pharmacy costs in
all divisions, benefit cost increases which exceeded premium rate
increases, and increased utilizationmost of pharmaceuticals and provider services
throughout the Company's health plans.
On March 31, 1999, the Company completed the sale of certain of its pharmacy
benefits management operations. As a result, the Company recorded $65 million in
net cash proceedsplans and a net gain of $53.6 million.increased costs from higher physician and
hospital costs.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses
decreased by $21.9$20.2 million or 6.4%6.0% for the firstsecond quarter ended March 31,June 30, 1999 as
compared to the comparable period in 1998. The Company's selling, general and
administrative ("SG&A") expenses decreased by $42.1 million or 6.2% for the six
months ended June 30, 1999 as compared to the comparable period in 1998. The
decrease in SG&A expenses during 1999 is primarily attributable to the Company's
ongoing efforts to control its SG&A expenses, and savings associated with the
integration of its 1997 acquisitions.mergers and acquisitions, and reductions in costs
resulting from the sales of certain operations.
14
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense decreased by $2.1$3.9 million and $6.0
million for the firstsecond quarter and six months ended March 31,June 30, 1999, respectively,
as compared to the comparable periodperiods in 1998. The decrease is due to write-downsthe
write-down of goodwill and other long-lived assets to their estimated fair value
during the year ended December 31, 1998.1998 and the write-off of organization and
pre-operating costs during the first quarter ended March 31, 1999.
INTEREST EXPENSE
Interest expense was $21.9decreased by $1.5 million for the first quarterssecond quarter and six
months ended March 31,June 30, 1999 and 1998 as compared to the comparable periods in
1998. DecreasedA decrease in interest expense from the reduction in the revolving credit
facility balance was partially offset by a higher borrowing rate in 1999 as
compared to the comparable period in 1998.
INCOME TAX PROVISION
The effective tax provision rate was 39.9% on income from operations for the firstsecond
quarter and six months ended March 31,June 30, 1999, respectively, compared to the
effective tax provision rate on continuing operations of 39.4%37.5% and 39.3%, respectively,
for the comparable periodperiods in 1998.
RESTRUCTURING AND OTHER COSTS
During 1998, the Company initiated a formal plan to dispose of certain
Central Division health plans included in the Company's Health Plan Services
segment in accordance with its anticipated divestitures program.strategic plan to focus on core operations. In
this connection, the Company adoptedimplemented a formal plan during the first quarter
ended March 31, 1999 to close the Colorado regional supportprocessing center for these
health plans and transfer its operations to the Company's other administrative
facilities. In August 1999, the Company sold certain of the processing center
facilities and accompanying real estate. See "Item 5. Recent Developments--
Colorado Operations." The closure of the remaining processing center facilities
is expected to be completed for all but the Colorado operations by the end of
the third quarter of 1999. The Company recorded a pretax restructuring charge of
$21.1 million including $18.5$18.7 million for severance and $2.6$2.4 million for other
expenses associated with the closing of the facility.
11
facility during the first quarter
ended March 31, 1999. Of the $18.9 million remaining as of June 30, 1999,
approximately $16.5 million is expected to require future cash outlays.
SEGMENT INFORMATION
HEALTH PLAN SERVICES
Health Plan Services revenues increaseddecreased by $10.9$39.4 million or 0.6%2.2% in the firstsecond
quarter ended March 31,June 30, 1999 as compared to the comparable period in 1998 and
decreased by $46.6 million or 1.3% for the six months ended June 30, 1999 as
compared to the comparable period in 1998. These decreases were primarily due to
average premium rate increases of 8.0%an 8.4% decrease in enrollment in the commercial market
whichCompany's health plans. The sale of the
HMO operations in the states of Texas, Louisiana, and Oklahoma eliminated
approximately $7.0 million in health plan revenues for the second quarter ended
June 30, 1999. Of the total membership decline, 65,000 members were enrolled in
plans that have been sold. These decreases were partially offset by an average
increase in premium rates as a 5.9% decrease in enrollment.result of instituting pricing discipline which
yielded a revenue per member per month ("PMPM") increase of 8.6% for the second
quarter and six months ended June 30, 1999.
Health plan health carePlan costs increaseddecreased by $20.7$19.4 million, or 1.3%, for the firstsecond quarter
ended March 31,June 30, 1999 as compared to the comparable period in 1998 and decreased
by $1.4 million or 0.1% for the six months ended June 30, 1999 as compared to
the comparable period in 1998. The health plans MCR increased from 83.7% in83.77% for
the firstsecond quarter ended March 31,June 30, 1998 to 84.3% in84.55% for the comparable period in
1999 due to higher medical costs particularly in physician
and hospital fee for service costs, an increase in pharmacy costs and increased
utilization of pharmaceuticals and provider services.
The Company's commercial business is experiencing lower margins than in 1998
due to health care cost increases outpacing health plan revenue increases in
1999. Premium rate increases in the commercial line of products contributed to
revenue increasesfrom 83.54% for the first quartersix months ended March 31, 1999 as comparedJune 30, 1998 to 84.61% for the
comparable period in 19981999. These increases were primarily due to higher pharmacy
costs in virtually allmost of the Company's health plans but
were partially offset by enrollment decreases in commercial HMO markets.
Commercial health plan revenues and health careincreased costs on a per member per month
basis have increased approximately 8%from higher
physician and 11%, respectively, during the first
quarter ended March 31, 1999 as compared to the comparable period in 1998.
The Company's Medicare business is experiencing higher margins than in 1998,
particularly in the Northeast division. Medicare premium rates have increased in
all markets averaging about 6% due to new premiums charged to members and a
favorable mix shift from exiting unfavorable markets. Medicare health care costs
on a per member per month basis have increased approximately 5% during the first
quarter ended March 31, 1999 as compared to the comparable period in 1998.
The Company's Medicaid business is experiencing lower margins than in 1998.
Medicaid revenues and health care costs on a per member per month basis have
increased approximately 1% and 8%, respectively, during the first quarter ended
March 31, 1999 as compared to the comparable period in 1998. Medicaid enrollment
in the California division has increased significantly resulting in a 42.9%
increase in member months during the first quarter ended March 31, 1999,
compared to the comparable period in 1998. Medicaid premium rates have increased
slightly in all markets except for the Northeast where they have decreased by
1.3%. Medicaid health care costs have increased on a per member per month basis
in all of the Company's markets.hospital costs.
15
GOVERNMENT CONTRACTS/SPECIALTY SERVICES
Government contracts/Specialty services revenue increased by $43.6$5.0 million or
14.3%1.4% during the firstsecond quarter ended March 31,June 30, 1999 as compared to the comparablesame
period in 1998, primarily dueand by $64.2 million or 9.6% for the six months ended June 30,
1999 as compared to certainthe same period in 1998. Favorable revenue adjustments under
government contracts, andcoupled with growth in the Company's managed behavioral health
network and bill review cost containment businesses.
Thebusinesses, were partially offset by
loss of revenues previously generated by certain pharmacy benefits processing
services which were sold during the first quarter ended March 31, 1999.
Government contracts/Specialty services MCR increased to 68.6% for66.11% in the
firstsecond quarter ended March 31,June 30, 1999 compared to 62.8%from 64.73% for the comparable 1998 period
and to 65.60% in 1998. This increasethe six months ended June 30, 1999 from 63.55% for the
first quarter ended March 31, 1999 iscomparable 1998 period. The increase was primarily due to increased pharmacya result of higher 1998
administrative government contract revenue having no associated health care
costs, and increased utilization of provider services.only administrative costs.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit margin is
low; hence, it is especially sensitive to inflation. Increases in medical
expenses or contracted medical rates without corresponding increases in premiums
could have a material adverse effect on the Company.
12
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, regulatory changes, utilization,
new technologies, hospital costs, major epidemics and numerous other external
influences may affect the Company's operating results. Accordingly, past
financial performance is not a reliable indicator of future performance, and
investors should not use historical records to anticipate results or future
period trends.
The Company's HMO and insurance subsidiaries are required to maintain
reserves to cover their estimated ultimate liability for expenses with respect
to reported and unreported claims incurred. These reserves are estimates of
future payments based on various assumptions. Establishment of appropriate
reserves is an inherently uncertain process, and there can be no certainty that
currently established reserves will prove adequate in light of subsequent actual
experience, which in the past has resulted and in the future could result in
loss reserves being too high or too low. The accuracy of these estimates may be
affected by external forces such as changes in the rate of inflation, the
regulatory environment, the judicial administration of claims, medical costs and
other factors. Future loss development or governmental regulators could require
reserves for prior periods to be increased, which would adversely impact
earnings in future periods. In light of present facts and current legal
interpretations, management believes that adequate provisions have been made for
claims and loss reserves.
The Company's HMO subsidiaries contract with providers in California, and to
a lesser degree in other areas, primarily through capitation fee arrangements.
Under a capitation fee arrangement, the Company's subsidiary pays the provider a
fixed amount per member on a regular basis and the provider accepts the risk of
the frequency and cost of member utilization of services. The inability of
providers to
16
properly manage costs under capitation arrangements can result in financial
instability of such providers. Any financial instability of capitated providers
could lead to claims for unpaid health care against the Company's HMO
subsidiaries, even though such subsidiaries have made their regular payments to
the capitated providers. Depending on state law, the Company's HMO subsidiaries
may be liable for such claims.
YEAR 2000
The Company recognizes that the arrival of the year 2000 requires computer
systems to be able to recognize the date change from 1999 to 2000 and, like
other companies, is assessing and modifying its computer applications and
business processes to provide for their continued functionality.
The "Year 2000" issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, prepare invoices or
engage in normal business activities. In addition, the Year 2000 problems of the
Company's providers and customers, including governmental entities, can affect
the Company's operations, which are highly dependent upon information technology
for processing claims, determining eligibility and exchanging information.
13
PROJECT STATUS--The Year 2000 effort for the Company has the highest
priority of technology projects and has the full support of the Company's
management. The project has dedicated resources with multiple teams to address
its unique systems environment. Uniform project management techniques have been
adopted with overall oversight responsibility residing with the Company's Chief
Technology Officer, assisted by a special project manager hired by the Company.
An executive management committee is also actively and directly involved in an
oversight capacity in the Company's Year 2000 project and receives monthly
reports from the project manager. In addition, the project manager regularly
meets with the Company's audit committee to further discuss the Company's Year
2000 issues.
The Company is addressing its Year 2000 issues in several ways. Selected
systems are being retired with the business functions being converted to Year
2000 compliant systems. A number of the Company's systems include packaged
software from large vendors that the Company is closely monitoring to ensure
that these systems are Year 2000 compliant. The Company believes that vendors
will make timely updates available to ensure that all remaining purchased
software is Year 2000 compliant.compliant, and has determined that there are no
significant applications for which the Company does not have adequate ability to
work around in the event of failure. The remaining systems' compliance with Year
2000 will be addressed by internal technical staff. The Company has engaged IBM
Global Services to assist in the program management of the project. In addition,
the Company has assessed its third party relationships with respect to
non-information technology assets and services, has retained IBM's The Wilkerson
Group, and is developinghas developed contingency plans to provide continuity of material
relationships. Legal consultants have been retained to assist with insurance
review and assessment of the Company's obligations and rights.
The Company has divided its internal Year 2000 effort into five phases: (1)
Assessment and Strategy, (2) Detailed Analysis and Planning, (3) Remediation,
(4) Testing and Implementation, and (5) Certification. During the firstsecond quarter
of 1999, the Company made substantial progress in its efforts to address Year
2000 issues. The Company has established the third quarter of 1999 to complete
all phases and is endeavoring to accelerate completion ahead of that time.phases. The
17
following table sets forth the estimated percentage completion of each of the
Company's Year 2000 phases with respect to its Year 2000 project overall.
PHASE 1 PHASE 2 PHASE 3 PHASE 4
PHASE 5
----------- ----------- ----------- ----------- ------------------------
Overall--May 1999................................................Overall--July 1999............................................... 100% 100% 93% 55% 3%
Overall--February100% 88%
Overall--May 1999 (as reported in the Company's AnnualQuarterly Report
on Form 10-K)...........................................10-Q for the first quarter of 1999).................... 100% 83%100% 93% 55%
PHASE 5
-------------
Overall--July 1999............................................... 54%
11% 0%Overall--May 1999 (as reported in the Company's Quarterly Report
on Form 10-Q for the first quarter of 1999).................... 3%
THIRD PARTIES--The Company's inventoryCompany has substantially completed its assessment of
third party relationships and has identified general purpose utility vendors,
care delivery organizations (such as providers), customer service vendors and
certain other entities as strategically important to the Company. The assessment continues and is expected to be
completed withinDuring the
second quarter, of 1999. Thethe assessment was focused on delegated authorities and certain
other providers and the Company is also in the process
of following up with the important third parties identified in the assessmentendeavoring to help ensure that the relationships will not be materially interrupted or
affected by theobtain assurances from those
entities as to their Year 2000 problem.readiness. There can be no assurance that the
systems of other companies on which the Company relies will be compliant on a
timely basis, or that the failure by a third party to be compliant would not
have a material adverse effect on the Company.
COSTS--The Company is evaluating on an on-going basis the related costs to
resolve its potential Year 2000 problems. The Company has reduced its estimate
ofestimates that the total
cost for the project fromwill be approximately $42.7 million to $36-40$34-38 million, excluding the costs
to accelerate the replacement of hardware or software otherwise required to be
purchased by the Company. TheThis represents a decrease is a
result principally of a reduction in the anticipated duration ofexpected overall
cost from $36-40 million, due in part to actual and expected cost-savings from
the employment
of outside consultants and contractors and a shiftshutdown or transfer of certain responsibilities
to internal labor.hardware and software associated with
certain completed divestitures. Through the firstsecond quarter of 1999, the Company
expended approximately $20.2$28.4 million relating to, among other things, the cost
to repair or replace software and related hardware problems, the cost of
assessment, analysis and planning, and internal and external communications. The
Company currently estimates that the percentages of its total expenditures for
Year 2000 issues will be approximately as follows: 35%36% for internal costs, 30%
for outside consultants and contractors and 35%34% for
14
software-related and
hardware-related costs. The Company has established a line-item in its overall
operating budget specifically for Year 2000 costs. The operating subsidiaries
for each line of business of the Company, however, are paying for the costs of
assessment, planning, remediation, testing and testingcertification of Year 2000 issues
for their respective operations.
Notwithstanding the foregoing, the costs of the project and the timetable in
which the Company plans to complete the Year 2000 compliance requirements are
based on estimates derived from utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. There can be no assurances that these
estimates will be achieved and actual results and costs could differ materially
from these estimates.
Certain insurance coverages for defense costs associated with Year 2000
litigation have already been secured under the Company's Directors and Officers
Liability Insurance policy and will be re-evaluated upon renewal of that policy. At this time, it is unclear as to the extent of
existing insurance coverage, if any, the Company may have to cover potential
Year 2000 costs and liabilities under its other insurance policies. The Company
is currently analyzingengaged in ongoing efforts to analyze the availability of such coverage under
other existing and future insurance policies and products.
CONTINGENCY PLANNING--An important part of the Company's Year 2000 project
involves identifying worst case scenarios and seeking to develop contingency
plans. The Company has completed the assessment of its mission critical business
functions and has sought to prioritizeprioritized them in order to address the most critical issues
first in remediation efforts and to develop alternatives to these critical
processes as part of contingency planning. A mission critical business activity
or system is one that cannot be without an automated or functional system for a
period of 21 days without causing significant business impact to the particular
line of business. Among other things, the Company's divisions have assessed
potential negative impacts on a valid member's ability to receive services, the
ability to generate revenue, the need for
18
additional expenditures, compliance with legal, regulatory or accreditation
requirements, meeting contractual obligations and reimbursing providers, vendors
and agents. The Company is in the process of documentinghas documented and validatingtested its contingency plans and expects to complete such process by the end of the second quarter of
1999. The Company currently anticipates that itsplans. Such
contingency plans will include, among other things, the use of manual as well as
on-line files of its members to avoid disruption in the verification of
membership and eligibility for the provision of health care services to its
members. There can be no assurance that the contingency plans of the Company, if
implemented, will adequately address Year 2000 problems that may arise or
prevent such problems from having a material adverse effect on the Company's
operations.
RISKS--The Company is highly dependent upon its own information technology
systems and that of its providers and customers. Failure by the Company or a
third party to correct a material Year 2000 problem could result in a failure of
or an interruption in the Company's business activities and operations. Such
interruptions and failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the readiness of third party providers and customers, the Company
is not able at this time to determine whether the Year 2000 problems will have a
material adverse effect on the Company's results of operations, liquidity or
financial condition. The Company's Year 2000 project is expected to reduce
significantly the Company's level of uncertainty and the possibility of
significant or long-lasting interruptions of the Company's business operations;
however, the Company believes that it is impossible to predict all of the areas
in which material problems may arise.
The Company has been formally communicating with others with whom it does
significant business to determine their Year 2000 issues. The Company is
currently projecting to completehas
substantially completed its assessment of third party risks byand is in the
endprocess of confirming that third parties with whom the second quarterCompany does significant
business have taken substantial steps to address potential Year 2000 problems
and that such parties will undertake additional remediation efforts to
significantly reduce the possibility of 1999.material disruptions to the Company.
There can be no assurances, however, that the systems of other companies on
which the Company's systems rely will be Year 2000 ready, that any Year 2000
problems of such companies will be timely remedied, or that the failure by
another company to be Year 2000 ready would not have a material adverse effect
on the Company.
Forward-looking statements contained in this Year 2000 section should be
read in connection with the Company's cautionary statements identifying
important risk factors that could cause the Company's actual
15
results to differ
materially from those projected in these forward-looking statements, which
cautionary statements are contained in the Company's Annual Report on Form 10-K
for the year ended December 31, 1998. The information contained herein is
intended to be a "Year 2000 Readiness Disclosure" as defined in the Year 2000
Information and Readiness Disclosure Act of 1998 enacted on October 19, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state laws and regulations, and must have
adequate reserves for claims. Certain subsidiaries must maintain ratios of
current assets to current liabilities pursuant to certain government contracts.
The Company believes it is in compliance with these contractual and regulatory
requirements in all material respects.
The Company believes that cash from operations, existing working capital,
lines of credit, and funds from planned divestitures of business are adequate to
fund existing obligations, introduce new products and services, and continue to
develop health care-related businesses. The Company regularly evaluates cash
requirements for current operations and commitments, and for capital
acquisitions and other strategic transactions. The Company may elect to raise
additional funds for these purposes, either through additional debt or equity,
the sale of investment securities or otherwise, as appropriate.
Government health care receivables are best estimates of payments that are
ultimately collectible or payable. Since these amounts are subject to government
audit and negotiation, amounts ultimately
19
collected may vary from current estimates. Additionally, the timely collection
of such receivables is also impacted by government audit and negotiation.
For the first quartersix months ended March 31,June 30, 1999, cash used inby operating activities
was $104.6$147.0 million compared to $188.1$356.5 million in the first quartercomparable period of 1998.
This change was due primarily to increases in reserves for claims and other
settlements and collection of premiums receivable, which were offset by
decreases in unearned premiums, accounts payable and other liabilities. The
timing differences in Medicare and Medicaid payments also affected cash flow
from operations. Excluding these timing differences would have resulted in a
positive cash flow from operations of $32.6 million for the six months ended
June 30, 1999. Net cash provided by investing activities was $16.7$22.3 million
during the first quarter ofsix months ended June 30, 1999 as compared to cash used in investing
activities of $73.1$79.6 million during the comparable period in 1998. This increase
was primarily due to the proceeds from the sale of certain pharmacy benefits
managementprocessing services of the Company and the Company's preferred provider
organization network subsidiary operations. Net cash used in financing
activities was $60.4$163.5 million during the first quarter ofsix months ended June 30, 1999 as
compared to cash provided by financing activities of $45.7$127.4 million during the
comparable period in 1998. The decrease in 1999change was primarily due to the repayment of
funds drawn under the Company's Credit Facility (as defined below), which were partially offset by additional
drawings under the Credit Facility..
The Company has a $1.5 billion credit facility (the "Credit Facility"), with
Bank of America as Administrative Agent for the Lenders thereto, which was
amended by a Letter Agreement dated as of March 27, 1998 and Amendments in
April, July, and November 1998 and in March 1999 with the Lenders (the
"Amendments"). All previous revolving credit facilities were terminated and
rolled into the Credit Facility on July 8, 1997. At the election of the Company,
and subject to customary covenants, loans are initiated on a bid or committed
basis and carry interest at offshore or domestic rates, at the applicable LIBOR
rate plus margin or the bank reference rate. Actual rates on borrowings under
the Credit Facility vary, based on competitive bids and the Company's unsecured
credit rating at the time of the borrowing. As of March 31,June 30, 1999, the Company was
in compliance with the financial covenants of the Credit Facility, as amended by
the Amendments. As of June 30, 1999, the maximum commitment level under the
Credit Agreement was approximately $1.4 billion, of which approximately $340
million remained available. The Credit Facility expires in July 2002, but it may
be extended under certain circumstances for two additional years.
In February 1999, the Company entered into an agreement to sell certain of
its pharmacy benefits management operations to an unrelated third party. On
March 31, 1999, the Company completed the sale. The net proceeds of $65 million
from the sale was used in April 1999 to reduce corporate debt.
16
The Company has initiated a formal plan to dispose of certain non-core
health plans included in the Company's Health Plan Services segment. It is
anticipated that the sales of these health plans will be completed during 1999.
In this regard, the Company adoptedimplemented a formal plan to close the regional
supportprocessing center connected to the health plans in the Central Division. The phase-downIn
August 1999, the Company sold certain of the supportprocessing center facilities and
accompanying real estate. See "Item 5. Recent Development--Colorado Operations."
The closure of the remaining processing center facilities is expected to be
completed for all but the Colorado operations by the end of the third quarter of
1999. During the first quarter ended March 31, 1999, the Company recorded
restructuring and other costs of $21.1 million associated with this facilitythe processing
center closure.
The Company's subsidiaries must comply with certain minimum capital
requirements under applicable state laws and regulations. The long-term portion
of principal and interest payments under the promissory notes issued to The
California Wellness Foundation in connection with the Health Net conversion to
for-profit status is subordinated to Health Net meeting tangible equity
requirements under applicable California statutes and regulations. During the
firstsecond quarter of 1999, the Company contributed $21.7 millionwas not required to make any contributions
to its subsidiaries to meet risk-based or other capital requirements of the regulated
entities. The Company will, however, make contributions to its subsidiaries, as
necessary, to meet risk-based capital requirements under state laws and
regulations during the second half of 1999. The Company contributed $3.0 million
to one of its subsidiaries to meet other capital requirements during the second
quarter ended June 30, 1999. As of March 31,June 30, 1999, the Company's subsidiaries
were in compliance with minimum capital requirements.
20
Legislation has been or may be enacted in certain states in which the
Company's subsidiaries operate imposing substantially increased minimum capital
and/or statutory deposit requirements for HMOs in such states. Such statutory
deposits may only be drawn upon under limited circumstances relating to the
protection of policyholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate and market risk primarily due to its
investing and borrowing activities. Market risk generally represents the risk of
loss that may result from the potential change in the value of a financial
instrument as a result of fluctuations in interest rates and in equity prices.
Interest rate risk is a consequence of maintaining fixed income investments. The
Company is exposed to interest rate risks arising from changes in the level or
volatility of interest rates, prepayment speeds and/or the shape and slope of
the yield curve. In addition, the Company is exposed to the risk of loss related
to changes in credit spreads. Credit spread risk arises from the potential that
changes in an issuer's credit rating or credit perception may affect the value
of financial instruments.
The Company has several bond portfolios to fund reserves. The Company
attempts to manage the interest rate risks related to its investment portfolios
by actively managing the asset/liability duration of its investment portfolios.
The overall goal of the investment portfolios is to support the ongoing
operations of the Company's business units. The Company's philosophy is to
actively manage assets to maximize total return over a multiple-year time
horizon, subject to appropriate levels of risk. Each business unit will have
additional requirements with respect to liquidity, current income and
contribution to surplus. The Company manages these risks by setting risk
tolerances, targeting asset-class allocations, diversifying among assets and
asset characteristics, and using performance measurement and reporting.
The Company uses a value-at-risk model to assess the market risk of its
investments. The estimation of potential losses that could arise from changes in
market conditions is typically accomplished through the use of statistical
models which seek to predict risk of loss based on historical price and
volatility patterns. The Company's measured value at risk for its investments
from continuing operations, using a 95% confidence level, was approximately $4.0$4.5
million at March 31,June 30, 1999.
The Company's calculated value-at-risk exposure represents an estimate of
reasonably possible net losses that could be recognized on its investment
portfolios assuming hypothetical movements in future market rates and are not
necessarily indicative of actual results which may occur. It does not represent
the maximum possible loss nor any expected loss that may occur, since actual
future gains and losses will differ from those estimated, based upon actual
fluctuations in market rates, operating exposures, and the timing thereof, and
changes in the Company's investment portfolios during the year. 17
The Company,
however, believes that any loss incurred would be offset by the effects of
interest rate movements on the respective liabilities, since these liabilities
are affected by many of the same factors that affect asset performance; that is,
economic activity, inflation and interest rates, as well as regional and
industry factors.
In addition, the Company has some interest rate market risk due to its
borrowings. Notes payable, capital leases and other financing arrangements
totaled $1.195$1,091.7 million at March 31,June 30, 1999 and the related average interest rate
was 6.8%6.6% (which interest rate is subject to change pursuant to the terms of the
Credit Facility). SeeFor a description of the Credit Facility undersee "Liquidity and
Capital Resources." The table below presents the expected cash flows of market
risk sensitive instruments at March 31,June 30, 1999. These cash flows include both
expected principal and interest payments consistent with the terms of the
outstanding debt as of March 31,June 30, 1999 (amounts in thousands).
1999 2000 2001 2002 2003 BEYOND TOTAL
--------- --------- --------- ---------- --------- --------- ------------ --------- --------- ----------------------
Long-term Borrowings Floating Rate............... $ 217,090 $ 77,340 $ 77,340 $ 1,139,940 $Rate............. 291,826 69,378 69,378 1,048,658 2,540 $ 13,866 $ 1,528,11617,343 1,499,123
--------- --------- --------- ---------- --------- --------- ------------ --------- --------- ----------------------
1821
PART II--OTHERII. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
On November 7, 1996 the Company's predecessor, HSI,Company (then named Health Systems International,
Inc. ("HSI")) filed a lawsuit against Medaphis Corporation ("Medaphis") and its
former Chairman and Chief Executive Officer Randolph G. Brown, entitled HEALTH
SYSTEMS INTERNATIONAL, INC. V. MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES
1-50, case number BC 160414, Superior Court of California, County of Los Angeles.Angeles
(the "Medaphis Action"). The lawsuit arises out of the acquisition of Health
Data Sciences Corporation ("HDS") by Medaphis. In July 1996, HSI, the owner of
1,234,544 shares of Series F Preferred Stock of HDS, representing over sixteen
percent of the total outstanding equity of HDS, voted its shares in favor of the
acquisition of HDS by Medaphis. HSI received as the result of the acquisition
976,771 shares of Medaphis Common Stockcommon stock in exchange for its Series F Preferred
Stock. Pursuant to the Merger Agreement, the Company
succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has
been substituted for HSI as plaintiff in the suit.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core business, and had artificially
maintained its stock prices through a series of acquisitions and accounting
maneuvers which provided the illusion of growth while hiding the reality of its
weakening financial and business condition. The Company alleges that Medaphis, Brown and other insiders deceived the
Company by presenting materially false financial statements and by failing to
disclose that Medaphis would shortly reveal a "write off" of up to $40 million
in reorganization costs and would lower its earnings estimate for the following
year, thereby more than halving the value of the Medaphis shares received by the
Company.
The Company alleges
that these false and misleading statements were containedMedaphis have reached a tentative agreement in oral communications
withprinciple to
settle their legal disputes related to the Medaphis Action. The broad parameters
of the settlement provide for the Company to receive net proceeds of
approximately $25.0 million consisting of: (i) $4.5 in cash to be funded by
Medaphis' insurers, (ii) proceeds from the sale of the 976,771 shares of
Medaphis common stock currently owned by the Company and (iii) proceeds from the
sale of Medaphis common stock to be issued to the Company as well as in the registration statement and the prospectus
provided by Medaphis to all HDS shareholders in connection with the HDS
acquisition. Further, despite knowingpart of the
Company's discussions to formsettlement. In exchange, the Company and Medaphis will terminate ongoing
litigation and each will grant the other a strategic alliancegeneral release. The settlement
agreement is contingent upon numerous events, including funding of its own with HDS,insurance
proceeds, final documentation and execution of the settlement agreement, and
issuance, registration and sale of the common stock. Accordingly, there can be
no assurance that the Company and Medaphis and the individual defendants
wrongfully interfered with that prospective business relationship by proposing
to acquire HDS using Medaphis stock whose market price was artificially inflated
by false and misleading statements.will reach a final binding settlement
agreement. The Company alleges that the defendants'
actions constitute violations of both federal and state securities laws, as well
as fraud and other torts under state law. The Company is seeking either
rescission of the transaction or damages in excess of $38 million. The
defendantsMedaphis have denied the allegations in the complaint, and the Company is
vigorously pursuing its claims against Medaphis.
The Company movedagreed to disqualify the law firm representing certain of the
individual defendants. The trial court granted the Company's motion, and the law
firm and its clients appealed such decision. In addition, the trial court
grantedstay pending litigation while
they attempt to negotiate a stay of the case in order to permit the law firm to appeal. On
November 30, 1998, the Appellate Court affirmed the trial court's decision. New
counsel has been substituted in as counsel for certain of the individual
defendants. The court ordered stay has been lifted and, therefore, discovery is
now permitted to resume. The case is in the early stages of discovery.binding settlement.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in
federal and state courts seeking an unspecified amount of damages on behalf of
an alleged class of persons who purchased shares of common stock, convertible
into
debentures and options to purchase common stock of FPA Medical Management, Inc.
("FPA") at various times between February 3, 1997 and May 15, 1998. The FPA
Complaints name as defendants FPA, certain of FPA's auditors, the Company and
certain of the Company's former officers. The FPA Complaints allege that the
Company and such former officers violated federal and state securities laws by
misrepresenting and failing to disclose certain information about a 1996
transaction between the Company and FPA, about FPA's business and about the
Company's 1997 sale of FPA common stock held by the Company. The Company has
filed a motion to dismiss all claims asserted against it in the consolidated
federal class actions but has not formally responded to the other complaints.
19
Subsequent to the Company's filing of a motion to dismiss all claims asserted
against it in the consolidated federal class action, all claims against the
Company's former officers were voluntarily dismissed from the consolidated class
actions in both federal and state court. Thereafter, all proceedings in the
consolidated federal class actions were stayed and the motion to dismiss was
denied without prejudice to renewal after the expiration of the stay. Management
believes these suits against the Company and its former officers are without
merit and intends to defend the actions vigorously.
22
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Based in part on advice from litigation counsel
to the Company and upon information presently available, management of the
Company is of the opinion that the final outcome of all such proceedings should
not have a material adverse effect upon the Company's results of operations or
financial condition.
ITEM 2. CHANGES IN SECURITIES
REVOLVING CREDIT FACILITY
The Company has an unsecured, five-year $1.5 billion revolving credit
facility pursuant to a Credit Agreement dated July 8, 1997 (the "Credit
Agreement") with the banks identified in the Credit Agreement (the "Banks") and
Bank of America National Trust and Savings Association ("Bank of America") as
Administrative Agent. All previous revolving credit facilities of the Company were terminated
and rolled into the Credit Agreement. The Credit Agreement contains customary
representations and warranties, affirmative and negative covenants, and events
of default. Specifically, Section 7.11 of the Credit Agreement provides that the
Company and its subsidiaries may, so long as no event of default exists: (i)
declare and distribute stock as a dividend; (ii) purchase, redeem, or acquire
its stock, options, and warrants with the proceeds of concurrent public
offerings; and (iii) declare and pay dividends or purchase, redeem, or otherwise
acquire its capital stock, warrants, options, or similar rights with cash
subject to certain specified limitations.
Under the Credit Agreement, as amended pursuant to a Letter Agreement dated
as of March 27, 1998, the First Amendment and Waiver to Credit Agreement dated
as of April 6, 1998, the Second Amendment to Credit Agreement dated as of July
31, 1998, the Third Amendment to Credit Agreement dated as of November 6, 1998
and the Fourth Amendment toof Credit Agreement dated as of March 26, 1999
(collectively, the "Amendments") with the Banks, the Company is: (i) obligated
to maintain certain covenants keyed to the Company's financial condition and
performance (including a Total Leverage Ratio and Fixed Charge Ratio); (ii)
obligated to limit liens; (iii) subject to customary covenants, including (A)
disposition of assets only in the ordinary course and generally at fair value
and (B) restrictions on acquisitions, mergers, consolidations, loans, leases,
joint ventures, contingent obligations and certain transactions with affiliates;
(iv) permitted to sell the Company's workers' compensation insurance business,
provided that the net proceeds shall be applied towards repayment of the
outstanding loans under the Credit Agreement (which sale the Company completed
on December 10, 1998); and (v) permitted to incur additional indebtedness in an
aggregate amount not to exceed $1,000,000,000 upon certain terms and conditions,
includingconditions.
The Credit Agreement also provides for mandatory prepayment of the outstanding
loans under the Credit Agreement with a certain portion of the proceeds from the
issuance of such indebtedness and from sales of assets, resulting in a permanent
reduction of the aggregate amount of commitments under the Credit Agreement by
the amount so prepaid. As of June 30, 1999, the maximum commitment level
permitted under the Credit Agreement was approximately $1.4 billion, of which
approximately $340 million remained available. The Amendments also provided for
an increase in the interest and facility fees under the Credit Agreement.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend
distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights, and the expiration of the Rights, and 20
in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then
23
outstanding and no separate Rights certificates will be distributed. Subject to
certain exceptions contained in the Rights Agreement dated as of June 1, 1996 by
and between the Company and Harris Trust and Savings Bank, as Rights Agent (the
"Rights Agreement"), the Rights will separate from the Common Stock in the event
any person acquires 15% or more of the outstanding Class A Common Stock, the
Board of Directors of the Company declares a holder of 10% or more to the
outstanding Class A Common Stock to be an "Adverse Person," or any person
commences a tender offer for 15% or more of the Class A Common Stock (each event
causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock at a price of $170.00 per
one-thousandth share. However, in the event any person acquires or commences a
tender offer for 15% or more of the outstanding Class A Common Stock, or the
Board of Directors of the Company declares a holder of 10% or more of the
outstanding Class A Common Stock to be an "Adverse Person," the Rights (subject
to certain exceptions contained in the Rights Agreement) will instead become
exercisable for Class A Common Stock having a market value at such time equal to
$340.00. The Rights are redeemable under certain circumstances at $.01 per Right
and will expire, unless earlier redeemed, on July 31, 2006.
A copy of the Rights Agreement has been filed with the Securities and
Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on
Form 8-A (File No. 001-12718). In connection with its execution of the Merger
Agreement for the merger transaction involving Foundation Health Corporation and
Health Systems International, Inc., the Company's predecessors, the Company
entered into Amendment No. 1 (the "Rights Amendment") to the Rights Agreement to
exempt the Merger Agreement and related transactions from triggering the Rights.
In addition, the Rights Amendment modifies certain terms of the Rights Agreement
applicable to the determination of certain "Adverse Persons," which
modifications became effective upon consummation of the transactions provided
for under the Merger Agreement. This summary description of the Rights does not
purport to be complete and is qualified in its entiretyentirely by reference to the
Rights Agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 6, 1999, the Company held its 1999 Annual Meeting of Stockholders
(the "Annual Meeting"). At the Annual Meeting, the Company's stockholders voted
upon proposals to (i) elect four directors for a term of three years ("Proposal
1") and (ii) ratify the selection of Deloitte & Touche LLP as the Company's
independent public accountants for the year ending December 31, 1999 ("Proposal
2"). The following provides voting information for all matters voted upon at the
Annual Meeting, and includes a separate tabulation with respect to each nominee
for director:
PROPOSAL 1
ELECTION OF DIRECTORS VOTES FOR VOTES AGAINST VOTES WITHHELD
- ------------------------------------------------ ------------- ------------------- --------------
J. Thomas Bouchard.............................. 105,451,415 0 939,635
Thomas T. Farley................................ 105,414,635 0 976,415
Patrick Foley................................... 105,411,109 0 979,941
Richard J. Stegemeier........................... 105,454,244 0 936,806
24
Each of Messrs. Bouchard, Farley, Foley and Stegemeier was elected as a
Class III director for a three-year term at the Annual Meeting. Other directors
whose term of office as directors continued after the Annual Meeting were: Gov.
George Deukmejian, Adm. Earl B. Fowler, Jay M. Gellert, Roger Greaves, Richard
W. Hanselman, and Raymond S. Troubh.
PROPOSAL 2
With respect to the ratification of the selection of Deloitte & Touche LLP
as the Company's independent public accountants for the year ending December 31,
1999, 106,320,573 votes were cast in favor, 44,080 votes were cast against and
26,397 votes were withheld for such proposal.
In total, 117,200,785 shares of Class A Common Stock were eligible to vote
at the Annual Meeting, 106,391,050 shares were voted at the Annual Meeting and
10,809,735 shares were unvoted at the Annual Meeting.
No other matters were submitted to a vote of the Company's security holders
during the quarter ended March 31,June 30, 1999.
ITEM 5. OTHER INFORMATION
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company has previously filed with its Annual
Report on Form 10-K for the year ended December 31, 1998 certain cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others,
could cause the Company's actual financial or enrollment results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to the Company. The factors should be considered in
conjunction with any discussion of operations or results by the Company or its
representatives, including any forward-
21
lookingforward-looking discussion, as well as comments
contained in press releases, presentations to securities analysts or investors,
or other communications by the Company.
In making these statements, the Company was not and is not undertaking to
address or update each factor in future filings or communications regarding the
Company's business or results, and is not undertaking to address how any of
these factors may have caused changes to discussions or information contained in
previous filings or communications. In addition, certain of these matters may
have affected the Company's past results and may affect future results.
RECENT DEVELOPMENTS
FOHP. In 1997, the Company purchased convertible debentures (the "FOHP
Debentures") of FOHP, Inc., a New Jersey corporation ("FOHP"), in the aggregate
principal amount of approximately $80.7 million and converted approximately
$70.6 million principal amount of the FOHP Debentures into shares of Common
Stock of FOHP. As a result, the Company owned approximately 98% of the
outstanding shares of FOHP common stock.
Effective December 31, 1997, the Company purchased nonconvertible debentures
in the amount of $24 million from FOHP. The debentures mature on December 31,
2002. The debentures were issued to the Company in consideration for additional
capital contributions made by the Company pursuant to the Amended and Restated
Securities Purchase Agreement, dated February 10, 1997, and as amended March 13,
1997, among the Company, FOHP, and First Option Health Plan of New Jersey, Inc.
("FOHP-NJ"), a wholly-owned subsidiary of FOHP (collectively, the "Definitive
Agreements"). Pursuant to the Definitive Agreements, at any time during the 1999
calendar year, the Company may acquire any remaining shares of FOHP not owned by
the Company pursuant to a tender offer, merger, combination or other business
combination transaction for consideration (to be paid in cash or stock of the
Company) equal to the value of such FOHP stock based on appraisal
determinations.FOHP.
25
Pursuant to an Agreement and Plan of Merger dated as of October 26, 1998,
Physicians Health Services of New Jersey, Inc., a New Jersey HMO wholly-owned by
the Company, merged with and into FOHP-NJ on January 1, 1999 and FOHP-NJ changed
its name to Physicians Health Services of New Jersey, Inc. ("PHS-NJ"). On
December 31, 1998, the Company converted $1,197,183 principal amount of its
remaining convertible debentures of FOHP into common stock of FOHP. As a result,
the Company now ownsowned approximately 99.6% of the outstanding equity of FOHP. The
minority shareholders of FOHP arewere physicians, hospitals and other health care
providers.
Pursuant to an Agreement and Plan of Merger dated as of November 16, 1998,
which was approved by the stockholders of FOHP at a special meeting held July
29, 1999, a wholly-owned subsidiary of the Company will merge with andmerged into FOHP on July 30,
1999 and FOHP will becomebecame a wholly-owned subsidiary of the Company. The merger is anticipated
to occur in the second quarter of 1999. In connection
with the merger, the currentformer minority shareholders of FOHP will beare entitled to either
the$0.25 per share (the value of
their sharesper FOHP share as of December 31, 1998 as determined
by an appraiseroutside appraiser) or payment rights which entitle the holders to receive
not less than $15.00 per payment right on or about July 1, 2001, provided that,
with respect to the payment rights (i) for provider shareholders, other than
hospitals, such shareholder must remain a provider shareholder, such shareholder agreesof PHS-NJ until July 1, 2001
and agree to remain a provider to PHS-NJ from July 1, 2001 until December 31,
2001, and a specified number of hospital providers in the provider network doesshareholders must not leave the
provider network prior to December 31, 2001 for such provider shareholder to be
eligible to receive such payment, (ii) for a hospital provider shareholder,shareholders, such payment
rights will beare subject to the same foregoing conditions and additional conditions to payment
relating to reimbursement rates, enrollment of hospital employees in PHS-NJ
health plans, and payments of premiums to PHS-NJ for such hospital shareholder
to be eligible to receive such payment and (iii) for a non-provider shareholder,provider shareholders,
other than hospitals, such shareholder will be entitled to receive additional
consideration of $2.25 per payment right and a pro rata portion of a bonus to be
funded by monies forfeited by providerhospital shareholders, provided that PHS-NJ
achieves certain annual returns on common equity.equity and certain of the foregoing
conditions are met.
QUALMED PLANS FOR HEALTH OF PENNSYLVANIA, INC. Effective December 31, 1998,
the Company purchased the minority interests in QualMed Plans for Health of
Pennsylvania, Inc. ("QualMed-PA"), a then majority-owned subsidiary of the
Company, for approximately $2 million. Previously, the Company owned
22
approximately 83% of the common stock of QualMed-PA. In January 1999, the
Company transferred certain of the assets of QualMed-PA, including the assets
relating to its preferred provider organization ("MaxNet(R)MaxNet-Registered Trademark-")
and managed workers' compensation ("CompTek(R)CompTek-Registered Trademark-") business and
operations, to Preferred Health Network, Inc., anothera wholly-owned subsidiary of the
Company.Company that was recently sold as described below.
MEDPARTNERS PROVIDER NETWORK, INC. On March 11, 1999, MedPartners Provider
Network, Inc. ("MPN"), a Knox-Keene licensed entity and a subsidiary of
MedPartners, Inc., a publicly-held physician practice and pharmacy benefit
management company, was placed into conservatorship by the State of California
under Section 1393(C)1393(c) of the California Health and Safety Code. The conservator
immediately filed a petition under Chapter 11 of the Bankruptcy Code on behalf
of MPN. MPN and various provider groups and clinics affiliated with MedPartners,
Inc. provide health care services to approximately 215,000 enrollees of the
Company's Health Net HMO subsidiary.
The Company continues to monitor the situation closely and has been involved
in discussions with various parties to attempt to maintain continuity of care
and to minimize the impact that MPN's conservatorship and bankruptcy could have
on affected Health Net members. The Company understands from various public
statements made by MedPartners, Inc. that it intends to divest its California
clinic operations.
MedPartners, Inc., MPN and the State of California have executed a letteran Amended and
Restated Operations and Settlement Agreement dated as of intentJune 16, 1999 (the "O&S
Agreement"), containing the basic principles for an orderly transition of the
California operations of MedPartners, Inc., and the resolution of unpaid
provider claims. Definitive documentationA Bankruptcy Court Order approving the O&S Agreement was
obtained by MPN
26
on July 19, 1999. Although court approval of this settlementthe O&S Agreement has been
obtained, a number of conditions subsequent and third party consents required by
such agreement are yet to occur or be obtained before the transactions reflected
therein will become effective. MedPartners, Inc. is being drafted and
discussed.also pursuing the sale of
all of its physician management operations in California. As of August 1, 1999,
sales have been consummated on operations covering approximately 32% of the
total number of members of the Company associated with MedPartners, Inc.'s
physician groups. Sales for the remainder of the physician groups are pending.
At this time, no assurances can be given that such a final settlement agreement
on the terms reflected in the O&S Agreement will become effective or be
implemented or that sales for the remainder of MedPartners, Inc.'s physician
groups will be entered into and implemented.consummated. In the event of the execution
anda final implementation of a
settlement on the settlement agreement,terms reflected in the O&S Agreement, the Company believes
that the bankruptcy of MPN will not have a material adverse effect on the
Company's California operations. Failure to execute and implementIf the settlement reflected in the O&S
Agreement is not fully implemented, such a settlement
agreementfailure could have a material adverse
effect on the Company's California operations in the event the Company is
ultimately held liable to pay theunpaid provider claims and/or the Company is
unable to quickly transition its remaining members covered by MPN to alternate
providers. However, the Company has developed and is developingimplementing various
transitional strategies that it believes wouldwill reduce any such adverse impact in
the event such a settlement agreementon the terms reflected in the O&S Agreement is not executed and implemented.fully
implemented on a timely basis or at all.
INSURANCE SUBSIDIARIES. The Company is in the process of restructuring its
insurance subsidiaries to merge Foundation Health National Life Insurance
Company ("FHNL") and Foundation Health Systems Life and Health Insurance Company
("FHS Life") under a holding company subsidiary of the Company, FHS Life
Holdings Company, Inc. The merger has received regulatory approval from each
merging entity's state of incorporation.
LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On April 30, 1999, the
Company completed the sale of its HMO operations in the states of Texas,
Louisiana and Oklahoma to AmCareco, Inc. As part of the transaction, the Company
received convertible preferred stock of the buyer and cash in excess of certain
statutory surplus and minimum working capital requirements of the plans sold.
The transaction is subject to certain post-closing adjustments and affiliates of
the Company will continue to provide certain administrative, behavioral health
and other services to such HMO operations for a transitionary period pursuant to
separate agreements.
PHARMACY BENEFITS MANAGEMENTPROCESSING SERVICES. On March 31, 1999, the Company
completed the sale to Advance Paradigm of the capital stock of Foundation Health
Pharmaceutical Services, Inc., and certain pharmacy benefit processing services
of Integrated Pharmaceutical Services, Inc. for approximately $65.0 million in
cash. In addition, as part of the transaction, Advance Paradigm will provide to
the Company at competitive rates claims processing, retail network management
and payment of claims pharmacy benefits services under a services agreement.
Advance Paradigm will also provide pharmacy mail service to the Company's Health
Plan Divisions. For a period of five years, the Company may not compete with
respect to such services in any market in which Advance Paradigm conducts
business, subject to certain exceptions.
23
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company
("Gem"), a subsidiary of the Company, has implemented a restructuring plan to
reduce operating losses and its in-force insurance risk. In 1997, Gem initiated
a withdrawal from the Nevada insurance markets, and began restructuring its
insurance products in Utah and then in certain other markets. Gem also reduced
commissions to market-level rates and terminated certain general agents. Gem
continued to implement such restructuring plan in 1998. As a result, the number
of Gem's insureds dropped from over 100,000 at the start of 1998 to
approximately 1,3001,100 at AprilJune 30, 1999. Gem has filed notices of intention to
withdraw from Nebraska and the small group market in Colorado. Currently,
Foundation Health Systems Life and Health Insurance Company, a subsidiary of the
Company, services Gem's insureds through an administrative services
27
agreement between the companies. The Company is reviewing the possibility of
winding up the operations of Gem or merging such operations into another
insurance subsidiary of the Company. Upon completion of its current withdrawals,
Gem will be licensed in only five states.
COLORADO OPERATIONS. In March 1999, the Company announced it had entered
into a letter of intent to sell the capital stock of QualMed Plans for Health of
Colorado, Inc., the Company's HMO subsidiary in the state of Colorado, to Wellpoint Health
Networks Inc. The Company anticipates closing the sale by the end of 1999.
Although the Company has entered into a letter of intent for the foregoing sale,Colorado. As
previously disclosed, consummation of the sale iswas subject to executing a
definitive agreement mutually satisfactory to the parties and satisfaction of
all conditions to be set forth therein, including obtaining regulatory
approvals. In addition,No such definitive agreement has yet been executed, and the Company
has
decidedcontinues to closeconsider various alternatives to wind-down its business in
Colorado. In this connection, in August 1999, the Company sold certain of its
regional support centerprocessing facilities and accompanying real estate in Pueblo, Colorado,
including certain equipment and expectsother assets located at the facilities, to complete such closingthe
Pueblo Economic Development Company and The TPA, Inc. The closure of the
remaining processing facilities is expected to occur for all but the Colorado
operations by the end of the third quarter of 1999.
NEW MEXICO OPERATIONS. In March 1999, the Company also entered into a definitive
agreement to sell the capital stock of QualMed Plans for Health, Inc., the
Company's HMO subsidiary in the state of New Mexico, to Health Care Horizons,
Inc. Although the Company has entered into a definitive agreement for the
foregoing sale, consummation of the sale is subject to various conditions and
certain regulatory approvals. A public hearing on the transaction has been set
for August 30 and 31, 1999, and the Company anticipates closing the sale by the
end of the third quarter of 1999.
PREFERRED HEALTH NETWORK, INC. In May 1999, the Company sold the capital
stock of Preferred Health Network, Inc., its PPO network subsidiary ("PHN"), to
Beyond Benefits, Inc. PHN and the Company, or certain affiliates thereof,
entered into agreements at closing to provide each other with certain continued
access to each other's networks.
UTAH OPERATIONS. In July 1999, the Company entered into a definitive
agreement to sell the outstanding capital stock of Intergroup of Utah, Inc., the
Company's HMO subsidiary in the state of Utah, to Altius Health Plans Inc.
Although the Company has entered into a definitive agreement for the foregoing
sale, consummation of the sale is subject to various conditions and certain
regulatory approvals. The Company anticipates closing the sale by the end of
1999.
OTHER POTENTIAL DIVESTITURES
SOUTHERN CALIFORNIA HOSPITALS. TheIn July 1999, the Company is reviewing the possibility of
divesting its ownership of two Southern California hospitals,entered into a
128-bed hospital
located in Los Angeles, California, thedefinitive agreement to sell East Los Angeles Doctors Hospital and a
200-bed hospital located in Gardena, California, the Memorial
Hospital of Gardena.Gardena, two Southern California hospitals, to HealthPlus+ Corp.
Although the Company has entered into a definitive agreement for the foregoing
sale, consummation of the sale is subject to various conditions and certain
regulatory approvals. The Company is presently responding to inquiriesanticipates closing the sale by the end of
parties which have
expressed an interest in1999. Certain subsidiaries of the purchase of such businesses.
CERTAINCompany will maintain contractual arrangements
with the hospitals following the sale.
OTHER OPERATIONS.POTENTIAL DIVESTITURES. The Company continues to evaluate the
profitability realized or likely to be realized by its existing businesses and
operations, and is reviewing from a strategic standpoint which of such
businesses or operations should be divested.
DIRECTOR AND EXECUTIVE OFFICER CHANGES
In February 1999, the Board of Directors of the Company elected Jay M.
Gellert, the Company's President and Chief Executive Officer, to fill a vacancy
on the Board of Directors. Effective March 1, 1999, Malik M. Hasan, M.D.,
resigned from the Company's Board of Directors. Accordingly, there currently
exists a vacancy on the Board of Directors. The Board of Directors is currently
in the process of recruiting an appropriate replacement director to fill the
vacancy pursuant to and in accordance with the Company's
28
Fifth Amended and Restated By-Laws. In May 1999, the Board of Directors elected
Richard W. Hanselman as Chairman of the Board of Directors.
In April 1999, Karin D. Mayhew became Senior Vice President Human Resources
of the Company. In May 1999, Ross D. Henderson, M.D. became Senior Vice
President and Chief Medical Officer of the Company. Dr. Henderson succeeded Dale
T. Berkbigler, M.D. in such position.
24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this Quarterly Report on Form
10-Q or are incorporated herein by reference:
2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems
International, Inc., FH Acquisition Corp. and Foundation Health Corporation
(filed as Exhibit 2.5 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996, which is incorporated by reference herein).
2.2 Agreement and Plan of Merger, dated May 8, 1997, by and among the Company, PHS
Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.2 to
the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997, which is incorporated by reference herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and
among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc.
(filed as Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997, which is incorporated by reference herein).
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant
(filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File
No. 333-24621), which is incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
which is incorporated by reference herein).
*3.3 Certain Amendments to the Fifth Amended and Restated Bylaws of the Registrant, a
copy of which is filed herewith.
4.1 Form of Class A Common Stock Certificate (included as Exhibit 4.2 to the
Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively), which is incorporated by reference herein).
4.2 Form of Class B Common Stock Certificate (included as Exhibit 4.3 to the
Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively), which is incorporated by reference herein).
4.3 Rights Agreement dated as of June 1, 1996 by and between the Company and Harris
Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to the Company's
Registration Statement on Form 8-A (File No. 001-12718), which is incorporated
by reference herein).
4.4 First Amendment to the Rights Agreement dated as of October 1, 1996, by and
between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as
Exhibit 10.40 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, which is incorporated by reference herein).
29
10.1 Letter Agreement dated June 1, 1998 between The California Wellness Foundation
and the Company (filed as Exhibit 10.75 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998, which is incorporated by
reference herein).
*10.210.2 Employment Letter Agreement between the Company and Karin D. Mayhew dated
January 22, 1999 a copy of(filed as Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1999, which is filed herewith.
*10.3incorporated by
reference herein).
10.3 Employment Letter Agreement between the Company and Ross D. Henderson dated
April 29, 1999 a copy of(filed as Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1999, which is filed herewith.
25
incorporated by reference
herein).
10.4 Letter Agreement dated June 25, 1998 between B. Curtis Westen and the Company
(filed as Exhibit 10.73 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998, which is incorporated by reference herein).
10.5 Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and the
Company (filed as Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996, which is incorporated by reference
herein).
10.6 Amended Letter Agreement between the Company and Jay M. Gellert dated as of
August 22, 1997 (filed as Exhibit 10.69 to the Company's Annual Report on Form
10-K for the year ended December 31, 1997, which is incorporated by reference
herein).
10.7 Employment Letter Agreement between the Company and Dale Terrell dated December
31, 1997 (filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, which is incorporated by reference herein).
10.8 Employment Letter Agreement between the Company and Steven P. Erwin dated March
11, 1998 (filed as Exhibit 10.72 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, which is incorporated by reference herein).
10.9 Employment Agreement between the Company and Maurice Costa dated December 31,
1997 (filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997, which is incorporated by reference herein).
10.10 Employment Letter Agreement between the CompanyFoundation Health Corporation and Gary S.
Velasquez dated May 1, 1996 (filed as Exhibit 10.13 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998, which is incorporated
by reference herein).
10.11 Employment Agreement between Foundation Health Corporation and Edward J. Munno
dated November 8, 1993 (filed as Exhibit 10.14 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, which is incorporated by
reference herein).
10.12 Amendment Number One to Employment Agreement between Foundation Health
Corporation and Edward J. Munno dated May 1, 1996 (filed as Exhibit 10.15 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1998, which
is incorporated by reference herein).
10.13 Employment Letter Agreement between the Company and Cora Tellez dated November
16, 1998 (filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998, which is incorporated by reference herein).
10.14 Employment Letter Agreement between the Company and Karen Coughlin dated March
12, 19991998 (filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1998, which is incorporated by reference herein).
10.15 Employment Letter Agreement between the Company and J. Robert Bruce dated September
22, 1998 (filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998, which is incorporated by reference herein).
10.15 Employment Letter Agreement between the Company and J. Robert Bruce dated
September 22, 1998 (filed as Exhibit 10.18 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, which is incorporated by
reference herein).
30
10.16 Waiver and Release of Claims between the Company and Robert Natt (filed as
Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated by reference herein).
10.17 Form of Severance Payment Agreement dated December 4, 1998 by and between the
Com-
panyCompany and various of its executive officers (filed as Exhibit 10.21 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1998, which
is incorporated by reference herein).
26
10.18 Early Retirement Agreement dated August 6, 1998 between the Company and Malik M.
Hasan, M.D. (filed as Exhibit 10.77 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998, which is incorporated by reference
herein).
10.19 Severance Payment Agreement, dated as of April 25, 1994, among the Company,
QualMed, Inc. and B. Curtis Westen (filed as Exhibit 10.10 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1994, which is
incorporated by reference herein).
10.20 Severance Payment Agreement between the Company and J. Robert Bruce dated
September 15, 1998 (filed as Exhibit 10.23 to the Company's Form 10-K for the
year ended December 31, 1998, which is incorporated by reference herein).
10.21 Severance Payment Agreement between the Company and Maurice Costa dated April 6,
1998 (filed as Exhibit 10.24 to the Company's Form 10-K for the year ended
December 31, 1998, which is incorporated by reference herein).
10.22*10.22 Waiver and Release of Claims between the Company and Dale T. Berkbigler, M.D.
dated as of June 30, 1999, a copy of which is filed herewith.
10.23 The Company's Second Amended and Restated 1991 Stock Option Plan (filed as
Exhibit 10.30 to Registration Statement on Form S-4 (File No. 33-86524), which
is incorporated by reference herein).
10.2310.24 The Company's Second Amended and Restated Non-Employee Director Stock Option
Plan (filed as Exhibit 10.31 to Registration Statement on Form S-4 (File No.
33-86524), which is incorporated by reference herein).
10.2410.25 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.33 to the
Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively), which is incorporated by reference herein).
10.2510.26 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35 to
Registration Statement on Form S-4 (File No. 33-86524), which is incorporated by
reference herein).
10.2610.27 Deferred Compensation Agreement dated as of March 3, 1995, by and among Malik M.
Hasan, M.D., the Company and the Compensation and Stock Option Committee of the
Board of Directors of the Company (filed as Exhibit 10.31 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1994, which is
incorporated by reference herein).
10.2710.28 Trust Agreement for Deferred Compensation Arrangement for Malik M. Hasan, M.D.,
dated as of March 3, 1995, by and between the Company and Norwest Bank Colorado
N.A. (filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994, which is incorporated by reference herein).
10.2810.29 The Company's Deferred Compensation Plan Trust Agreement dated as of September
1, 1998 between the Company and Union Bank of California (filed as Exhibit 10.31
to the Company's Form 10-K for the year ended December 31, 1998, which is
incorporated by reference herein).
10.2910.30 The Company's 401(k) Associate Savings Plan (filed as Exhibit 4.5 to the
Company's 401(k) Associate Savings Plan (filed as Exhibit 4.5 to the Company's
Registration Statement on Form S-8 filed on Form S-8 filed on March 31, 1998, which is incorporated by
reference herein).
10.30March 31, 1998, which is
incorporated by reference herein).
31
10.31 The Company's 1997 Stock Option Plan (filed as Exhibit 10.45 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is
incorporated by reference herein).
10.3110.32 The Company's 1998 Stock Option Plan (filed as Exhibit 4.5 to the Company's
Registration Statement on Form S-8 filed on December 4, 1998, Stock Option Plan (filed as Exhibit 4.5 to the Company's
Registration Statement on Form S-8 filed on December 4, 1998, which is incorporated
by reference herein).
27
10.32which is
incorporated by reference herein).
10.33 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.47 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
which is incorporated by reference herein).
10.3310.34 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.48 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
which is incorporated by reference herein).
10.3410.35 The Company's Third Amended and Restated Non-Employee Director Stock Option Plan
(filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997, which is incorporated by reference herein).
10.3510.36 The Company's Supplemental Executive Retirement Plan effective as of January 1,
1996 (filed as Exhibit 10.65 to the Company's Form 10-K for the year ended
December 31, 1998, which is incorporated by reference herein).
10.37 The Company's Deferred Compensation Plan effective as of May 1, 1998 (filed as
Exhibit 10.66 to the Company's Form 10-K for the year ended December 31, 1998,
which is incorporated by reference herein).
10.38 The Company's 1995 Stock Appreciation Rights Plan (filed as Exhibit 10.12 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1995, which is incorporated by reference herein).
10.39 Managed Health Network, Inc. Incentive Stock Option Plan (filed as Exhibit 4.8
to the Company's Registration Statement on Form S-8 (File No. 333-24621), which
is incorporated by reference herein).
10.3610.40 Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan (filed
as Exhibit 4.9 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
10.3710.41 1990 Stock Option Plan of Foundation Health Corporation (filed as Exhibit 4.5 to
the Company's Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
10.3810.42 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for the
year ended June 30, 1994 filed with the Commission on September 24, 1994, which
is incorporated by reference herein).
10.3910.43 Participation Agreement dated as of May 25, 1995 among Foundation Health Medical
Services, as Construction Agent and Lessee, FHC, as Guarantor, First Security
Bank of Utah, N.A., as Owner Trustee, Sumitomo Bank Leasing and Finance, Inc.,
The Bank of Nova Scotia and NationsBank of Texas, N.A., as Holders and
NationsBank of Texas, N.A., as Administrative Agent for the Lenders; and
Guaranty Agreement dated as of May 25, 1995 by FHC for the benefit of First
Security Bank of Utah, N.A. (filed as an exhibit to FHC's Form 10-K for the year
ended June 30, 1995, filed with the Commission on September 27, 1995, which is
incorporated by reference herein).
10.4010.44 FHC's Deferred Compensation Plan, as amended and restated (filed as an exhibitExhibit
10.99 to FHC's Form 10-K for the year ended June 30, 1995, which is incorporated
by reference herein).
32
10.45 FHC's Supplemental Executive Retirement Plan, as amended and restated (filed as
Exhibit 10.100 to FHC's Form 10-K for the year ended June 30, 1995, which is
incorporated by reference herein).
10.4110.46 FHC's Supplemental Executive RetirementRetiree Medical Plan, as amended and restated (filed as an
exhibitExhibit
10.101 to FHC's Form 10-K for the year ended June 30, 1995, which is
incorporated by reference herein).
10.42 FHC's Executive Retiree Medical Plan, as amended and restated (filed as an exhibit
to FHC's Form 10-K for the year ended June 30, 1995, which is incorporated by
reference herein).
10.4310.47 Stock and Note Purchase Agreement by and between FHC, Jonathan H., Schoff, M.D.,
FPA Medical Management, Inc., FPA Medical Management of California, Inc. and FPA
Independent Practice Association dated as of June 28, 1996 (filed as Exhibit
10.109 to FHC's Annual Report on Form 10-K for the year ended June 30, 1996,
which is incorporated by reference herein).
10.4410.48 Credit Agreement dated July 8, 1997 among the Company, the banks identified
therein and Bank of America National Trust and Savings Association in its
capacity as Administrative Agent (providing for an unsecured $1.5 billion
revolving credit facility) (filed as Exhibit 10.23 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1997, among the Company, the banks identified therein
and Bank of America National Trust and Savings Association in its capacity as
Administrative Agent (providing for an unsecured $1.5 billion revolving credit
facility) (filed as Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997, which is incorporated by reference herein).
28
10.45which is incorporated
by reference herein).
10.49 Guarantee Agreement dated July 8, 1997 between the Company and First Security
Bank, National Association (filed as Exhibit 10.24 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1997, which is
incorporated by reference herein).
10.4610.50 First Amendment and Waiver to Credit Agreement dated April 6, 1998 among the
Company, Bank of America National Trust and Savings Association and the Banks
(as defined therein) (filed as Exhibit 10.64 to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1998, which is incorporated by
reference herein).
10.4710.51 Second Amendment to Credit Agreement dated July 31, 1998 among the Company, Bank
of America National Trust and Savings Association and the Banks (as defined
therein) (filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998, which is incorporated by reference herein).
10.4810.52 Third Amendment to Credit Agreement, dated November 6, 1998, among the Company,
Bank of America National Trust and Savings Association and the Banks (as defined
therein) (filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998, which is incorporated by reference
herein).
10.4910.53 Fourth Amendment to Credit Agreement, dated as of March 26, 1999,1998, among the
Company, Bank of America National Trust and Savings Association and the Banks,
as defined therein (filed as Exhibit 10.64 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, which is incorporated by
reference herein).
10.5010.55 Form of Credit Facility Commitment Letter, dated March 27, 1998, between the
Company and the Majority Banks (as defined therein) (filed as Exhibit 10.70 to
the Company's Annual Report on Form 10-K for the year ended December 31, 1997,
which is incorporated by reference herein).
10.5110.56 Registration Rights Agreement dated as of March 2, 1995 between the Company and
theThe California Wellness Foundation (filed as Exhibit No. 28.2 to the Company's
Current Report on Form 8-K dated March 2, 1995, which is incorporated by
reference herein).
10.5210.57 Office Lease, dated as of January 1, 1992, by and between Warner Properties III
and Health Net (filed as Exhibit 10.23 to the Company's Registration Statements
on Forms S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively), which
is incorporated by reference herein).
10.5310.58 Lease Agreement between HAS-First Associates and FHC dated August 1, 1998 and
FHC dated August 1, 1998 and form
of amendment thereto (filed as an exhibit to FHC's Registration Statement on Form
S-1 (File No. 33-34963), which is incorporated by reference herein).
10.54form of amendment thereto (filed as an exhibit to FHC's Registration Statement
on Form S-1 (File No. 33-34963), which is incorporated by reference herein).
33
10.59 Asset Purchase Agreement dated December 31, 1998 by and between the Company and
Access Health, Inc. (filed as Exhibit 10.62 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, which is incorporated by
reference herein).
10.5510.60 Purchase Agreement dated February 26, 199926,1999 by and among the Company, Foundation
Health Pharmaceutical Services, Inc., Integrated Pharmaceutical Services, Inc.,
and Advance Paradigm, Inc. (filed as Exhibit 10.63 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998, which is incorporated by reference herein).
10.56 The Company's Supplemental Executive Retirement Plan effective as of January 1, 1996
(filed as Exhibit 10.65 to the Company's Form 10-K for the year ended December 31,
1998, which is incorporated by reference herein).
10.57 The Company's Deferred Compensation Plan effective as of May 1, 1998 (filed as
Exhibit 10.66 to the Company's Form 10-K for the year ended December 31, 1998, which
is incorporated by reference herein).
29
10.58 The Company's 1995 Stock Appreciation Rights Plan (filed as Exhibit 10.12 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, which is incorporated
by reference herein).
11.1 Statement relative to computation of per share earnings of the Company (included
in the Notes to the Condensed Consolidated Financial Statements contained in
this Quarterly Report on Form 10-Q).
27.1*27.1 Financial Data Schedule for the firstsecond quarter ended March 31,June 30, 1999, a copy of
which has been filed with the EDGAR version of this filing.
- ------------------------
* A copy of the Exhibit is filed herewith.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed by the Company during the
quarterly period ended March 31,June 30, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
FOUNDATION HEALTH SYSTEMS, INC.
(REGISTRANT)
By: /s/ JAY M. GELLERT
-----------------------------------------------------------------------------------
Jay M. Gellert
Date: May 14,August 16, 1999 PRESIDENT AND CHIEF EXECUTIVE OFFICER
By: /s/ STEVEN P. ERWIN
-----------------------------------------------------------------------------------
Steven P. Erwin
Date: August 16, 1999 EXECUTIVE VICE PRESIDENT AND
Date: May 14, 1999 CHIEF FINANCIAL OFFICER
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