SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
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, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ____________.
Commission file number: 1-12718
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 identification No.)
incorporation or organization)
21600 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (818) 719-6978
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:
As of May 9, 1997, 106,133,786 shares of Class A Common Stock, $.001 par
value per share, were outstanding (exclusive of 3,324,374 shares held as
treasury stock) and 19,297,642 shares of Class B Common Stock, $.001 par
value per share, were outstanding.
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Foundation Health Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
March 31, December 31,
1997 1996
---------- ----------
ASSETS
Current assets
Cash and equivalents $ 204,865 $ 187,486
Marketable securities held for sale 377,819 402,128
Premiums receivable, net 98,823 86,598
Prepaid expenses and other 62,612 52,895
Deferred income taxes 25,536 24,370
---------- ----------
Total current assets 769,655 753,477
Property and equipment, net 72,217 71,786
Goodwill and other intangible assets, net 323,994 328,719
Deferred income taxes 4,976 4,976
Other assets 65,261 52,922
---------- ----------
TOTAL ASSETS $1,236,103 $1,211,880
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Estimated claims payable $ 227,304 $ 243,144
Shared risk and other settlements 32,070 27,235
Unearned subscriber premiums 34,643 88,605
Accounts payable and accrued expenses 116,286 108,057
Federal and state income taxes payable 24,820 9,689
Notes payable, current portion 1,488 1,608
---------- ----------
Total current liabilities 436,611 478,338
Notes payable 409,800 362,465
Other 1,485 6,101
---------- ----------
847,896 846,904
Commitments and contingencies
Stockholders' equity
Preferred stock, $.001 par value
Authorized shares - 10,000,000
Issued and outstanding shares - none
Class A common stock, $.001 par value
Authorized shares - 135,000,000
Issued and outstanding shares -
32,338,705 in 1997 and 32,329,684
in 1996 32 32
Class B nonvoting convertible common stock,
$.001 par value
Authorized shares - 30,000,000
Issued and outstanding shares -
19,297,642 in 1997 and 1996 19 19
Additional paid-in capital 187,252 187,086
Retained earnings 306,803 282,091
Treasury Stock, 3,194,374 shares of
Class A common stock (95,831) (95,831)
Unrealized loss on marketable
securities held for sale, net (10,068) (8,421)
---------- ----------
Total stockholders' equity 388,207 364,976
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,236,103 $1,211,880
---------- ----------
---------- ----------
See accompanying notes to consolidated financial statements
2
Foundation Health Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Income (Unaudited)
(In thousands, except per share data)
Three-Months Ended March 31,
----------------------------
1997 1996
-------- --------
Revenues:
Premium revenue $831,264 $783,123
ASO and other 9,701 18,226
-------- --------
Total revenues 840,965 801,349
-------- --------
Operating Expenses:
Health care expenses:
Physician 317,154 297,704
Hospital 292,574 278,233
Pharmacy and other 94,343 72,985
-------- --------
Total health care expenses 704,071 648,922
Marketing, general and administrative 82,553 80,120
Depreciation and amortization 11,176 13,466
ASO and other 5,125 16,333
-------- --------
Total operating expenses 802,925 758,841
-------- --------
Operating income 38,040 42,508
Investment income 9,439 8,823
Interest expense (6,316) (5,932)
-------- --------
Income before income taxes and minority
interest 41,163 45,399
Income taxes 16,589 19,390
Minority interest in (gain)/loss of
subsidiary (2) 31
-------- --------
Net income $ 24,572 $ 26,040
-------- --------
-------- --------
Earnings per share:
Primary and fully diluted $ 0.51 $ 0.54
-------- --------
-------- --------
Weighted average common shares outstanding:
Primary 48,500 48,135
-------- --------
-------- --------
Fully diluted 48,506 48,177
-------- --------
-------- --------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
Foundation Health Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
Three-Months Ended March 31,
----------------------------
1997 1996
-------- --------
OPERATING ACTIVITIES
Net income $ 24,572 $ 26,040
Adjustments to reconcile net income to net
cash used by operating activities:
Depreciation and amortization 11,176 13,466
Deferred income taxes 1,331
Changes in operating assets and
liabilities net of acquisition:
Premiums receivable and unearned
subscriber premiums (66,187) (58,762)
Prepaid expenses and other (7,337) (4,249)
Estimated claims payable, shared risk
and other settlements (11,005) (23,285)
Accounts payable and accrued expenses
and other liabilities 3,610 (16,063)
Federal and state income taxes payable 15,131 15,648
-------- --------
Net cash used by operating activities (30,040) (45,874)
INVESTING ACTIVITIES
Sale or redemption of marketable securities
held for sale 103,657 75,201
Purchases of marketable securities held for
sale (82,161) (80,929)
Purchases of property and equipment (8,892) (5,922)
Investment in subsidiaries (12,566) (4,114)
-------- --------
Net cash provided (used) by investing
activities 38 (15,764)
FINANCING ACTIVITIES
Proceeds from exercise of stock
options and employee stock plan
purchases 166 14,481
Borrowings 47,500 9,000
Purchase of treasury stock (9,586)
Repayment of debt and other non current
liabilities (285) (142)
-------- --------
Net cash provided by financing activities 47,381 13,753
-------- --------
Increase (decrease) in cash and equivalents 17,379 (47,885)
Cash and equivalents, beginning of period 187,486 225,932
-------- --------
Cash and equivalents, end of period $204,865 $178,047
-------- --------
-------- --------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
FOUNDATION HEALTH SYSTEMS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements of Foundation Health Systems, Inc. and its wholly and majority
owned subsidiaries (collectively, the "Company") have been prepared in
accordance with generally accepted accounting principles for interim
financial information, and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three-month
period ended March 31, 1997 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1997. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Annual Report on Form 10-K for the year ended
December 31, 1996 of the Company (formerly known as Health Systems
International, Inc. ("HSI")).
The accompanying unaudited interim condensed consolidated financial
statements of the Company do not include the financial position or results of
operations of Foundation Health Corporation ("FHC") as the companies were not
merged as of March 31, 1997 (see Note 2 below).
2. FOUNDATION HEALTH SYSTEMS MERGER
Effective April 1, 1996, pursuant to the Agreement and Plan of Merger
(the "Merger Agreement") among the Company, FHC and FH Acquisition Corp. (a
wholly-owned subsidiary of the Company), Merger Sub merged (the "Merger")
with and into FHC and FHC became a wholly owned subsidiary of the Company.
Pursuant to the Merger prior FHC stockholders received 1.3 shares of the
Company's Class A Common Stock for every share of FHC common stock held. The
shares of the Company's Class A Common Stock issued to FHC's stockholders in
the Merger constitute approximately 61% of the outstanding stock of the
Company, and the Company's stockholders immediately prior to the Merger hold
approximately 39% of the outstanding stock of the Company.
Pursuant to the Merger Agreement, the Company also amended its
Certificate of Incorporation to change its name to Foundation Health Systems,
Inc. and to increase the number of authorized shares of the Company's Common
Stock to 380,000,000 shares consisting of 350,000,000 shares of Class A
Common Stock and 30,000,000 shares of Class B Common Stock.
The Merger was tax-free and accounted for as a pooling of interests.
5
Summarized below are the unaudited pro forma consolidated results of
operations of the Company for the three month periods ended March 31, 1996
and March 31, 1997 as if the Merger had taken place as of January 1, 1996 (in
millions except earnings per share):
Three Months Ended March 31,
1997 1996
-------- --------
Premium and ASO revenue $1,860.6 $1,652.4
-------- --------
Net income $ 58.5 $ 62.3
-------- --------
Primary and fully diluted earnings
per share $ 0.47 $ 0.50
-------- --------
Also attached as Exhibits 99.1, 99.2, and 99.3 to this report are the following
unaudited pro forma consolidated supplemental schedules for the quarter ended
March 31, 1997: Pro Forma Unaudited Consolidated Balance Sheet, Pro Forma
Unaudited Consolidated Statement of Operations and Pro Forma Medical Covered
Lives.
3. NOTES PAYABLE
On April 26, 1996, the five-year unsecured $400 million revolving credit
facility was replaced with a $700 million revolving credit facility (the
"Credit Facility") from a lending syndicate led by Bank of America. The
Company may elect from various short-term interest rates based upon a spread
above the LIBOR rate, or the greater of the bank's reference rate or the
federal funds rate plus 1/2%. In addition, the Company may elect a
"competitive bid auction" in which participating banks are offered an
opportunity to bid alternative rates. The Credit Facility is for a term of
five years from the date of execution, with two one year extension options.
As of March 31, 1997, $366.5 million had been borrowed against the new $700
million Credit Facility.
4. CONTINGENCIES
LITIGATION
The Company is involved in various other legal proceedings, most of which
are routine to its business. In the opinion of management, based in part on
advice from litigation counsel to the Company, the resolution of these
matters will not have a material adverse effect on the financial condition or
results of operations of the Company.
5. EARNINGS PER SHARE
Earnings per share is calculated based on the weighted average shares of
common stock and common stock equivalents outstanding during the periods
presented. Common stock equivalents arising from dilutive stock options are
computed using the treasury stock method.
In February 1997, the Financial Accounting Standards Board issued SFAS
128, "EARNINGS PER SHARE" effective for periods ending after December 15,
1997, including interim periods; earlier adoption is not permitted. This
statement requires restatement of all prior period earnings per share ("EPS")
data presented. The statement establishes standards for computing and
presenting EPS. The following sets forth the weighted shares and EPS as
calculated under SFAS 128:
6
Three Months Ended March 31,
1997 1996
------ ------
Basic Shares Outstanding 48,437 47,878
------ ------
Basic EPS $.51 $.54
------ ------
Diluted Share Outstanding 48,506 48,177
------ ------
Diluted EPS $.51 $.54
------ ------
6. ACQUISITIONS
PHYSICIANS HEALTH SERVICES
On May 8, 1997 the Company entered into a definitive agreement to acquire
Physicians Health Services, Inc. ("PHS") for $29.25 per share, or a total
consideration to PHS shareholders of approximately $300 million. PHS is a
440,000 member health plan with operations in the New York metropolitan area,
including northern New Jersey, and throughout the state of Connecticut.
Consummation of the transaction is subject to customary conditions, including
approval by PHS's stockholders and the receipt of all necessary governmental
authorizations. In connection with entering into the definitive acquisition
agreement, the Greater Bridgeport Individual Practice Association, Inc.,
holding a majority of the outstanding voting power of PHS stock, agreed to
vote in favor of the transactions. The Company will fund the acquisition with
cash on hand and existing bank credit lines. The Company presently expects
that the transaction will close in the third or fourth quarter of 1997.
PACC
On April 9, 1997, the Company announced that it had reached a definitive
agreement to acquire PACC, a 116,000 member health plan based in Oregon. The
transaction is subject to receipt of all applicable regulatory approvals.
The Company expects the transaction to close in the third quarter of 1997.
ADVANTAGE HEALTH
On April 1, 1997, the Company completed the acquisition of Advantage
Health, a group of managed health care companies based in Pittsburgh, PA.,
for $12.5 million in cash. Advantage Health has approximately 40,000
full-risk members. In 1996, Advantage Health recorded revenues of
approximately $56 million, with about 90 percent from HMO operations. The
Company purchased Advantage Health from St. Francis Health System, which has
a short-term option to re-acquire a 20 percent interest in Advantage Health
for $2.5 million. Advantage Health remains a party to long-term provider
agreements with the St. Francis Health System and a management agreement with
the Company.
7
FIRST OPTION HEALTH PLAN
On April 30, 1997, the Company completed a $51.7 million investment in
FOHP, Inc. ("FOHP") of Red Bank, New Jersey. FOHP is owned by physicians,
hospitals and other health care providers and is the sole shareholder of
First Option Health Plan of New Jersey, Inc. ("FOHP-NJ"), a managed care
company. The Company's investment is in the form of FOHP debentures
convertible into up to 71 percent of FOHP's outstanding equity at the
Company's discretion. In addition to the investment, the Company will provide
a variety of management services to FOHP in return for a percentage of FOHP's
premium revenue. The Company, at its option, may also provide information
systems and claims processing services to FOHP. First Option currently has
more than 250,000 members in New Jersey enrolled in its commercial, Medicare,
Medicaid and PPO programs.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company is one of the largest HMOs in the United States, providing as
of March 31, 1997 health care and administrative services to more than 1.9
million full-risk HMO members in California, Colorado, Connecticut, Idaho,
New Jersey, New Mexico, Oregon, Pennsylvania and Washington. Through its
operating subsidiaries, the Company provides a wide range of managed health
care services and also provides various tailored managed health care
products, operates a preferred provider organization network and owns certain
health and life insurance companies.
The following discussion should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1996, and the notes included elsewhere herein. In
particular, it should be noted that the following information does not
include the financial position or results of operations of FHC which became a
subsidiary of the Company effective April 1, 1997.
RESULTS OF OPERATIONS
The following table sets forth the selected operating statistics and
membership data for the three months ended March 31, 1997.
SUMMARY OF OPERATING STATISTICS AND MEMBERSHIP DATA
OPERATING STATISTICS
Three Months Ended March 31,
---------------------------
1997 1996
-------- --------
Medical loss ratio (health care expense as a
percentage of premium revenue) 84.7% 82.9%
Marketing, general and administrative expense
including depreciation and amortization
as a percentage of premium revenue 11.3% 12.0%
Net income as a percentage of total revenue 2.9% 3.2%
Primary and fully diluted earnings per share $0.51 $0.54
----- -----
----- -----
MEMBERSHIP DATA
March 31,
1997 1996
--------- ---------
Members by Product Type
Commercial 1,702,465 1,606,260
Medicare 151,663 139,787
Medicaid 50,969 59,550
--------- ---------
Total 1,905,097 1,805,597
--------- ---------
--------- ---------
9
March 31,
1997 1996
--------- ---------
Members by State
California 1,391,157 1,340,052
Colorado 76,314 53,649
New Mexico 30,468 27,751
Washington/Idaho 126,538 113,546
Oregon 61,506 48,331
Connecticut 165,898 135,759
Pennsylvania 53,216 86,509
--------- ---------
Total 1,905,097 1,805,597
--------- ---------
--------- ---------
For the period ended March 31, 1997 full risk membership increased by
approximately 99,500 (5.5%) compared to the same period last year. The
increase is comprised of 96,200 commercial members and 11,800 medicare
members, offset by a decrease in Medicaid membership of 8,500.
For the quarter ended March 31, 1997 full risk membership increased by
approximately 84,000 (4.6%) compared to December 31, 1996. A successful open
enrollment period resulted in a significant membership increase during the
first quarter. The increase is comprised of 86,500 commercial members and
6,000 medicare members, offset by a decrease in Medicaid membership of 8,500.
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THREE MONTHS ENDED MARCH 31,
1996
Net income decreased 5.6% to $24.6 million for the first three months of
1997, compared with $26.0 million for the comparable period in 1996. Premium
revenues, excluding ASO revenues, were $831.3 million for the three month
period, a 6.1% increase from the $ 783.1 million reported in 1996.
TOTAL REVENUE
Premium revenue, excluding ASO revenue, increased $48.2 million or 6.1%
in the first quarter of 1997 compared to the first quarter of 1996. The
increase in premium revenue was reflective of overall increased membership
and premium rate increases in the Company's Medicare line of business.
10
CHANGE IN NET PREMIUM REVENUE
(IN MILLIONS)
FIRST QUARTER 1997 COMPARED TO FIRST QUARTER 1996
Change in revenue due to
premium change:
Commercial $ (8.9)
Medicare 11.3
-------
2.4
Change in revenue due to
membership change:
Commercial 30.0
Medicare 15.8
-------
45.8
Total change in revenue:
Commercial 21.1
Medicare 27.1
-------
$ 48.2
-------
-------
Total member months (cumulative number of member service months during
the period) increased by 5.3% to 5,725,000 during the first quarter of 1997
compared to the same period in 1996, and the combined per member per month
("PMPM") premium revenue increased by .8% to $145.21.
COMMERCIAL
Commercial member months increased by 5.1% to 5,272,000 during the first
quarter of 1997 compared to the same period in the prior year. For the
quarter ended March 31, 1997, commercial premium revenue PMPM decreased by
1.5% to $118.13, compared to the same period last year. The decrease was due
mainly to pricing pressures in the Northwest, Northeast and California.
MEDICARE
Medicare member months increased by 8.2% to 453,000 during the first
quarter of 1997 compared to the same period in the prior year. For the
quarter ended March 31, 1997, Medicare premium revenue PMPM increased by 6.2%
to $460.61, compared to the same period last year. Increases in Medicare
PMPM are principally a result of rate increases by the Federal Health Care
Financing Administration.
HEALTH CARE EXPENSES
Health care expenses increased by 8.5% from $648.9 million in the first
quarter of 1996 to $704.1 million in the first quarter of 1997. On a PMPM
basis, health care expenses for the quarter ended March 31, 1997 rose by 3.0%
to $122.99 PMPM, versus $119.37 PMPM during the equivalent period in the
prior year. During the same period, the Company's overall medical loss ratio
(i.e., health care expenses as a percentage of premium revenue, or "MLR"),
increased to 84.7% as compared to 82.9% during the prior year's three-month
period.
COMMERCIAL
Commercial health care expenses on a PMPM basis in the quarter ended
March 31, 1997 increased by .5% to $96.87 compared to $96.40 during the same
period last year. Commercial MLR increased to 82.0% from 80.4% for the
comparable period in 1996. The commercial MLR increase is primarily a result
of lower commercial PMPM revenue, coupled with flat commercial PMPM health
care expenses for the three months ended
11
March 31, 1997 as compared to March 31, 1996.
MEDICARE
Medicare health care expenses on a PMPM basis in the quarter ended March
31, 1997 increased by 8.2% to $427.26, compared to $394.78 during the same
period last year. Medicare MLR increased to 92.8% from 91.1% for the first
quarter of 1996. The increase in Medicare health care expenses and MLR is
mainly due to higher pharmacy costs and increased utilization of services in
all of the Company's markets.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Marketing, general and administrative expenses, excluding the effects of
the Company's ASO business, decreased to 9.9% of premium revenue in the first
quarter of 1997 as compared to 10.2% during the first quarter of the prior
year. The decrease in marketing, general and administrative expenses reflects
the Company's ongoing efforts to aggressively control its administrative
costs.
DEPRECIATION AND AMORTIZATION EXPENSES
Depreciation and amortization expenses decreased as a percentage of
premium revenue in the first quarter of 1997 as compared to the first quarter
of 1996. These expenses were $11.2 million (1.3% of premium revenue) in the
first quarter of 1997 and $13.5 million (1.7% of premium revenue) in the
first quarter of 1996. The decrease in depreciation expense is a direct
result of a portion of assets which became fully depreciated in the first
quarter of 1997, coupled with asset write-offs in late 1996.
FOUNDATION HEALTH SYSTEMS MERGER
On October 1, 1996 the Company entered into a merger agreement with FHC,
an integrated managed health care organization. Pursuant to such merger
agreement, effective April 1, 1997, FH Acquisition Corp., a wholly-owned
subsidiary of the Company, merged with and into FHC with FHC surviving the
merger as a wholly-owned subsidiary of the Company. The merger was accounted
for as a pooling-of-interest transaction and, accordingly, after the merger,
the financial statements of the Company and FHC will be presented on a
combined basis for financial reporting purposes.
As previously announced, negotiation and consummation of the FHC Merger
as well as additional charges associated with and related to integrating the
operations of the Company and FHC will result in material non-recurring costs
and expenses to the new combined company. Such costs cannot be determined
until the transition plan related to the integration of operations is
completed, but they are estimated at this time by the Company to be in the
range of $175 million to $225 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of cash is premium revenue. Its primary
uses of cash are claims and capitation payments. Estimates of future cash
flows include a component to account for the delay between providing health
care services and reporting their cost. The estimate is based on actuarial
projections of claims and other costs, claims paid history, membership
growth, inflation, seasonality, claims inventory and reserves.
The Company's capital resources are managed according to certain
guidelines intended to ensure liquidity and maximize total return by assuming
prudent investment risks. The Company's liquidity requirements consist of
the need to service medical claims in a timely manner and to satisfy shared
risk and other obligations. Such requirements are the principal factors in
determining the appropriate investment portfolio mix. The Company presently
invests primarily in a
12
variety of fixed-income obligations according to established investment
guidelines.
During the first quarter of 1997, cash used by operating activities was
$30.0 million, compared with cash used of $45.9 million in the comparable
prior year period. This decrease compared to 1996 is due, in part, to normal
fluctuations in operating assets and liabilities from year to year caused by
timing differences in the payment of liabilities and collection of
receivables of each respective quarter end. The remaining difference in cash
used by operating activities compared to the prior year was due to a
significant reduction in claims inventory in the first quarter of 1996 which
had accumulated in late 1995.
Cash used for investing activities decreased from $15.8 million in the
quarter ended March 31, 1996 to cash provided by investing activities of
$38,000 in the quarter ended March 31, 1997. Cash provided from financing
activities increased from $13.8 million to $47.4 million during such periods.
Decreases in cash used by investing activities resulted from increased sale
of marketable securities during the first quarter of 1997, as compared to the
comparable prior year quarter. The increase in cash provided from financing
activities was due to additional borrowings against the credit line for
merger related expenses and an acquisition in April of 1997.
The Company's current ratios at March 31, 1997 and December 31, 1996 were
1.76 to 1 and 1.57 to 1, respectively. The increase in the Company's current
ratio is primarily attributable to decreased current liabilities resulting
from increased payments of claims, as well as reductions in unearned premiums
during the first quarter of 1997.
Outstanding notes payable amounted to $411.3 million at March 31, 1997,
an increase of $47.5 million from December 31, 1996, resulting from
additional borrowings relating to the FHC merger described above and the
Company's investment in Advantage Health Plan during the first quarter of
1997 (see note 6 of the Notes to Condensed Consolidated Financial
Statements). The Company believes that cash from operations and existing
working capital 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.
Under the terms of its $700 million five-year Credit Facility, the
Company pays interest at a variable rate (See note 3 of the Notes to
Condensed Consolidated Financial Statements and information contained in Part
II of this report). FHC also currently has in place two credit facilities
providing an aggregate line of credit of up to $500 million (please refer to
the information contained in Part II of this report for additional detail).
The Company's subsidiaries must comply with certain minimum capital
requirements under applicable state laws and regulations. As of March 31,
1997, each of the Company's subsidiaries was in compliance with its minimum
capital requirements.
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 without corresponding increases in premiums could have a
material adverse effect on the Company.
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 operations
of the Company.
Reference is also made to the disclosures contained under the heading
"Cautionary Factors" included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1996, which could cause the
13
Company's actual results to differ from those projected in forward looking
statements of the Company made by or on behalf of the Company. In addition,
certain of these factors may have affected the Company's past results and may
affect future results.
14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
On November 7, 1996 the Company 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. The lawsuit arises out of the
acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In June
1996, the Company, the owner of 1,234,544 shares (or 77%) 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. The Company received as the result of the acquisition
976,771 shares of Medaphis Common Stock in exchange for its Series F
Preferred Stock.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core businesses, 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
failing to reveal that Medaphis would shortly reveal a "write off" of up to
$40,000,000 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 contained in oral communications with the Company,
as well as in the prospectus provided by Medaphis to all HDS shareholders in
connection with the HDS acquisition. Further, despite knowing of the
Company's discussions to form a strategic alliance of its own with HDS,
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. These allegations of the Company constitute violations of both
federal and state securities laws, as well as constituting fraud and other
torts under state law. The Company is seeking either rescission of the
transaction or damages in excess of $38,000,000. The defendants have denied
the allegations in the complaint, and the Company is vigorously pursuing its
claims against Medaphis.
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 upon information presently
available, management of the Company is of the opinion, based in part on
advice from litigation counsel to the Company, 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.
15
ITEM 2. CHANGES IN SECURITIES
REVOLVING CREDIT FACILITY
On April 26, 1996, the Company entered into an Amended and Restated
Credit Agreement among the Company, Bank of America National Trust and
Savings Association ("Bank of America"), as agent, and certain financial
institutions which are parties thereto (the "Credit Agreement") pursuant to
which the Company obtained an unsecured five-year $700 million revolving
credit facility. The Credit Agreement replaced the Company's prior credit
agreement providing for an unsecured $400 million revolving credit facility,
which prior agreement was also entered into by the Company with Bank of
America, as agent.
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 so long as the sum of such acquisitions does not exceed $150 million
plus 25% of the net income of the Company and its subsidiaries in fiscal 1995
plus 50% of the net income of the Company and its subsidiaries in fiscal 1996
and subsequent years (calculated on a cumulative consolidated basis).
Under the Credit Agreement, the Company is (i) obligated to maintain at
all times a Total Leverage Ratio not to exceed 3 to 1, a Fixed Charge
Coverage of not less than 2.75 to 1 and to preserve its combined net worth
and Permitted Class Subordinated Indebtedness (as defined in the Credit
Agreement) at not less than $100 million plus 50% of net income after
December 31, 1994 on a cumulative consolidated basis, (ii) obligated to limit
liens on its assets to those incurred in the normal course and for taxes and
other similar obligations, and (iii) subject to customary covenants to
dispose of assets only in the ordinary course and generally at fair value, to
restrict mergers and consolidations to those permitted under the Credit
Agreement, and to limit loans, leases, joint ventures and contingent
obligations and certain transactions with affiliates. Upon the occurrence of
a default or an event of default, the Company and its subsidiaries would be
subject to further restrictions, including with respect to the operating HMO
subsidiaries, an obligation to advance to the parent company reserves in
excess of those held to comply with state and similar administrative
requirements.
In connection with the Merger (as defined in Item 4 below), the Company
entered into Amendment No. 3 to the Credit Agreement which, among other
things, deemed the Merger to be a Permitted Acquisition and waived certain
compliance requirements through June 30, 1997 in order to enable the Company
to negotiate and enter into a new credit agreement combining the Credit
Agreement and FHC's existing credit agreements.
16
FHC also has two unsecured revolving credit agreements (one with a $300
million credit line and the other with a $200 million credit line) with
Citicorp USA, Inc. as Administrative Agent for the lenders thereto (together,
the "FHC Credit Agreements"). The FHC Credit Agreements contains customary
terms, events of default and affirmative and negative covenants (including
financial covenants related to net worth, fixed charge coverage ratio and
total debt to total capitalization ratio). Principal amounts outstanding
under the FHC Credit Agreements bear interest, at FHC's option, at either
Citibank's base rate or the Eurodollar rate plus a margin depending upon
FHC's level of total debt to total capitalization and other factors. Any
interest payments are due quarterly and principal is due at maturity.
In connection with the Merger, FHC entered into amendments to the Credit
Agreements which, among other things, deemed the Merger to be a permitted
acquisition under the FHC Credit Agreements and waived certain compliance
requirements through June 30, 1997 in order to enable the Company to
negotiate and enter into a new credit agreement combining the FHC Credit
Agreements and the Company's existing 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 in certain other circumstances. Rights will attach to all
Common Stock certificates representing shares then 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
of the outstanding Class A Common Stock to be an "Adverse Person," or any
person commences a tender offer for 15% 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 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
17
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.
In connection with the Merger, the Company entered into Amendment No. 1
(the "Amendment") to the Rights Agreement to exempt the Merger and related
transactions from triggering the Rights. In addition, the Amendment modifies
certain terms of the Rights Agreement applicable to the determination of
certain "Adverse Persons," which modifications became effective upon
consummation of the Merger.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 12, 1997, the Company held a Special Meeting of Stockholders
(the "Special Meeting") at which meeting the Company's stockholders voted
upon the following two proposals:
1. To consider and vote upon a proposal to approve the Agreement and
Plan of Merger, dated as of October 1, 1996 (the "Merger Agreement"), among
the Company, FHC and FH Acquisition Corp., a wholly owned subsidiary of the
Company ("Merger Subsidiary"), the merger of Merger Subsidiary with and into
FHC (the "Merger") and the transactions contemplated thereby, including the
issuance of shares of the Company's Class A Common Stock, par value $.001 per
share ("Proposal 1"); and
2. To consider and vote upon a proposal to amend and restate the
Company's Certificate of Incorporation to (i) increase the number of
authorized shares of common stock of the Company to 380 million shares with
350 million shares designated as Class A Common Stock and 30 million shares
designated as Class B Common Stock and (ii) change the name of the Company to
"Foundation Health Systems, Inc." ("Proposal 2").
18
The following provides voting information for such proposals voted upon
at the Special Meeting:
Proposal Votes For Votes Against Votes Withheld
-------- ---------- -------------- --------------
Proposal 1 22,611,768 26,564 354,187
Proposal 2 22,505,011 127,169 360,339
In total, 29,136,310 shares of Class A Common Stock were eligible to vote
at the Special Meeting, 22,992,519 shares were voted at the Special Meeting
and 6,143,791 shares were unvoted at the Special Meeting.
ITEM 5. OTHER INFORMATION
REVOLVING CREDIT FACILITY
As indicated in Item 2 above, on April 26, 1996 the Company executed the
Credit Agreement which provides an unsecured five-year $700 million revolving
credit facility. The facility is available to the Company and its
subsidiaries for general corporate purposes including Permitted Acquisitions
and Joint Ventures and, if the Company should elect, to repurchase or redeem
the Company's capital stock to the extent allowed by the Federal Reserve
Board Regulations and other requirements of law and as set forth in the
Credit Agreement. As of March 31, 1997, the Company had drawn approximately
$367 million under the facility.
Bank of America is the lead bank and agent for the other participating
banks named in the Credit Agreement. At the election of the Company, and
subject to customary covenants, loans can be initiated on a bid or committed
basis and will carry interest at offshore or domestic rates, but subject to
the applicable LIBOR Rate or the Base Rate, of .50% above the Federal Funds
Rate or the Bank of America "reference rate." Actual rates on borrowings
under the facility will vary based on competitive bidding, sources of funds
and the Company's senior leverage ratio at the time of the borrowing. The
facility is available for five years, until April 2001, but may be extended,
under certain circumstances, for two additional years until April 2003.
19
Loans under the facility are unsecured but the Company and its
subsidiaries are subject to affirmative and negative covenants. As described
in Item 2 above, these include limitations on the payment of cash dividends
on the Company's capital stock and, in certain cases, the redemption or
repurchase of capital stock or securities. In addition to obligations
incurred under the facility, the Company and its subsidiaries are entitled to
incur Permitted Subordinated Indebtedness for seller financing of Permitted
Acquisitions and certain other items in an aggregate amount of up to $150
million and to incur unsecured indebtedness to repurchase the Company's Class
A Common Stock.
Under the Credit Agreement, the Company is (i) obligated to maintain at
all times a Total Leverage Ratio not to exceed 3 to 1, a Fixed Charge
Coverage of not less than 2.75 to 1 and to preserve its combined net worth
and Permitted Class A Subordinated Indebtedness (as defined in the Credit
Agreement) at not less than $100 million plus 50% of net income after
December 31, 1994 on a cumulative consolidated basis, (ii) obligated to limit
liens on its assets to those incurred in the normal course and for taxes and
other similar obligations, and (iii) subject to customary covenants to
dispose of assets only in the ordinary course and generally at fair value, to
restrict mergers and consolidations to those permitted under the Credit
Agreement, and to limit loans, leases, joint ventures and contingent
obligations and certain transactions with affiliates. Upon the occurrence of
a default or an event of default, the Company and its subsidiaries would be
subject to further restrictions, including with respect to the operating HMO
subsidiaries, an obligation to advance to the parent company reserves in
excess of those held to comply with state and similar administrative
requirements.
In connection with the Merger, the Company entered into Amendment No. 3
to the Credit Agreement which, among other things, deemed the Merger to be a
Permitted Acquisition and waived certain compliance requirements through June
30, 1997 in order to enable the Company to negotiate and enter into a new
credit agreement combining the Credit Agreement and the FHC's existing credit
agreements.
As indicated in Item 2 above, FHC also has two unsecured revolving credit
agreements with Citicorp USA, Inc. as Administrative Agent for the lenders
thereto (the "FHC Credit Agreements") in the aggregate amount of $500
million. As of March 31, 1997, FHC had borrowed approximately $405 million
under the FHC Credit Agreements. The FHC Credit Agreements contain customary
terms, events of default and affirmative and negative covenants (including
financial covenants related to net worth, fixed charge coverage ratio and
total debt to total capitalization ratio). Principal amounts outstanding
under the FHC Credit Agreements bear interest, at FHC's option, at either
Citibank's base rate or the Eurodollar rate plus a margin depending upon
FHC's level of total debt to total capitalization and other factors. Any
interest payments are due quarterly and principal is due at maturity.
In connection with the Merger, FHC entered into amendments to the Credit
Agreements which, among other things, deemed the Merger to be a permitted
acquisition under the FHC Credit Agreements, and waived certain compliance
requirements through June 30, 1997 in order to
20
enable the Company to negotiate and enter into a new credit agreement
combining the FHC Credit Agreements and the Company's existing Credit
Agreement.
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, 1996 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-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
FOUNDATION HEALTH CORPORATION
On April 1, 1997, the Company and FH Acquisition Corp., a wholly owned
subsidiary of the Company ("Merger Sub"), completed the Merger with FHC,
whereby Merger Sub merged with and into FHC and FHC survived as a wholly
owned subsidiary of the Company. Pursuant to the Merger Agreement FHC
stockholders received 1.3 shares of the Company's Class A Common Stock for
every share of FHC common stock held. The shares of the Company's Class A
Common Stock issued to FHC's stockholders in the Merger constituted
approximately 61% of the outstanding stock of the Company after the Merger
and the Company's stockholders prior to the Merger now hold approximately 39%
of the outstanding stock of the Company after the Merger.
In connection with the Merger, the Company amended its Certificate of
Incorporation to change the name of the Company to Foundation Health Systems,
Inc. and to increase the number of authorized shares of the Company's Common
Stock to 380,000,000
21
shares consisting of 350,000,000 shares of Class A Common Stock and
30,000,000 shares of Class B Common Stock.
In connection with the Merger, the Company also, among other things,
amended the Company's By-Laws to effect certain changes to the governance
provisions of the Company following the merger, including provisions related
to the structure of the Company's Board of Directors and the committees of
the Company's Board of Directors. Except in certain circumstances, during a
transaction period following the consummation of the Merger and up to, but
not including, the election of directors at the Company's May 2000 Annual
Meeting of Stockholders, the Company's Board of Directors will consist of 11
members, six of whom (Daniel D. Crowley and five other independent directors)
were designated by FHC and five of whom (Malik M. Hasan, M.D. and four other
independent directors) is designated by the Company. Pursuant to such
designations the Company's Board of Directors is comprised of the following
members: J. Thomas Bouchard, Daniel D. Crowley, George Deukmejian, Thomas T.
Farley, Patrick Foley, Earl B. Fowler, Roger F. Greaves, Richard W.
Hanselman, Malik M. Hasan, M.D., Richard J. Stegemeier and Raymond S. Troubh.
RECENT MANAGEMENT CHANGES
On May 8, 1997, the Company announced that Daniel D. Crowley had been
replaced by Malik M. Hasan, M.D. as the Chairman of the Board of Directors of
the Company, and that Mr. Crowley would remain as a director and serve as a
consultant to the Company for three years. It was also announced that Dr.
Hasan would retain the office of Chief Executive Officer of the Company, and
that Jay M. Gellert was elected to the offices of President and Chief
Operating Officer of the Company.
FIRST OPTION HEALTH PLAN
On April 30, 1997, the Company purchased convertible debentures (the
"FOHP Debentures") of FOHP, Inc., a New Jersey corporation ("FOHP"), in the
aggregate principal amount of approximately $51.7 million. The FOHP
Debentures are convertible into up to 71 percent of the outstanding equity of
FOHP at the Company's discretion. At any time during the 1999 calendar year,
the Company may acquire the remaining shares of FOHP not owned thereby
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 appraiser determinations.
FOHP (headquartered in Red Bank, New Jersey) is owned by physicians,
hospitals and other health care providers and is the sole shareholder of
First Option Health Plan of New Jersey, Inc. a New Jersey corporation and a
wholly-owned subsidiary of FOHP ("FOHP-NJ"). FOHP-NJ is a managed health
care company providing commercial products for businesses and individuals,
along with Medicare, Medicaid and Workers' Compensation programs. FOHP-NJ
currently has more than 250,000 members in New Jersey enrolled in its
commercial, Medicare, Medicaid and PPO programs.
As part of the transaction, the Company will also provide a variety of
management services to FOHP, including provider contracting, utilization
review and quality assurance and employee relations, sales and marketing and
strategic planning. The Company will receive monthly management fees from
FOHP for such services in an amount equal to two percent of FOHP's premium
revenue. The Company, at its option, may also provide information systems
and claims processing services to FHP. Approximately $1,700,000 of the $51.7
million principal
22
amount of the FOHP Debentures reflected fees paid to the Company by FOHP for
such management services provided by the Company prior to the closing of the
sale of the FOHP Debentures; such principal amount was immediately converted
into FOHP common stock.
ADVANTAGE HEALTH
On April 1, 1997, the Company completed the acquisition from St. Francis
Health System of Advantage Health, a group of managed health care companies
with approximately 40,000 full-risk members in Western Pennsylvania, Ohio and
West Virginia, for $12.5 million in cash. In 1996 Advantage Health recorded
revenue of approximately $56 million. St. Francis has a short-term option to
reacquire a 20% interest in Advantage Health for $2.5 million.
Advantage Health remains a party to long-term provider agreements with
the St. Francis Health System and a management agreement with the Company.
The Company will operate Advantage Health under combined management with its
Philadelphia-based plan, QualMed Plans for Health, Inc.
PACC
Pursuant to the Agreement and Plan of Reorganization, dated as of March
20, 1997 and effective on April 9, 1997 (the "Reorganization Agreement"),
among the Company, QualMed Health Plan, Inc., an Oregon corporation and an
indirect wholly-owned subsidiary of the Company ("QMO"), and PACC HMO and
PACC Health Plans, each an Oregon non-profit corporation (PACC HMO and PACC
Health Plans being referred to herein, collectively, as "PACC"), the Company
agreed to acquire PACC for an undisclosed amount.
PACC (based in Clackamas, Oregon) has health plan operations in Oregon
and Washington, with approximately 116,000 medical members (approximately
108,000 of which are located in the Portland, Oregon area). Approximately
67,000 of such members are in PACC HMO (a commercial health maintenance
organization), with the balance in PACC Health Plans (primarily a preferred
provider organization). PACC recorded more than $133 million in revenues in
1996.
The transaction is structured as a merger of PACC into QMO, with QMO as
the surviving corporation to be renamed FHS of Oregon, Inc. or a similar-type
name. Such merger will be immediately preceded by an acquisition and
assumption by QualMed Washington Health Plan, Inc. (a Washington corporation
and an indirect wholly-owned subsidiary of the Company) of various contracts
of PACC relating to PACC's health care service contractor business in the
State of Washington and the acquisition and assumption by QualMed Health &
Life Insurance Company (an insurance company domesticated under the laws of
the State of Colorado and an indirect wholly-owned subsidiary of the Company)
of various contracts of PACC relating to PACC's health maintenance
organization business in the State of Washington.
23
The Reorganization Agreement contemplates that PACC will organize
Northwest Health Foundation (the "PACC Foundation") as an Oregon nonprofit
public benefit corporation which will receive the net acquisition
consideration proceeds. The PACC Foundation will assume certain of PACC's
obligations under the Reorganization Agreement (including indemnification
obligations) at closing.
Consummation of the PACC acquisition transaction is subject to approvals
from regulatory authorities and other customary conditions of closing.
PHYSICIANS HEALTH SERVICES, INC.
On May 8, 1977 the Company entered into a definitive agreement to acquire
Physicians Health Services, Inc. ("PHS") for $29.25 per share, or a total
consideration to PHS shareholders of approximately $280 million. PHS is a
440,000-member health plan with operations in the New York metropolitan area,
including northern New Jersey, and throughout the state of Connecticut.
Consummation of the transaction is subject to customary conditions, including
approval by PHS's stockholders and the receipt of all necessary governmental
authorizations. In connection with entering into the definitive acquisition
agreement, the Greater Bridgeport Individual Practice Association, Inc.,
holding a majority of the outstanding voting power of PHS stock, agreed to
vote in favor of the transaction. The Company will fund the acquisition with
cash on hand and existing bank credit lines. The Company presently expects
that the transaction will close in the third quarter or fourth quarter of
1997.
HEALTH NET ASSOCIATE TRUST
Certain founding stockholders of the Company had transferred their shares
(initially 6,548,784) of Class A Common Stock of the Company (the "Class A
Shares") into that certain Amended and Restated Health Net Associate Trust
Agreement dated as of May 1, 1994 (the "Associate
24
Trust Agreement"). Among other things, the Associate Trust Agreement in
general restricted the sale and transfer of the Class A Shares to any entity
other than the Company until February 1997. Effective February 7, 1997 the
trust created pursuant to the Health Net Associate Trust Agreement was
dissolved pursuant to its terms, thereby lifting the transfer restrictions of
the Class A Shares.
25
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., a copy of which is filed herewith.
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 Fourth Amended and Restated Bylaws of the Registrant (filed as
Exhibit 4.2 to the Company's Registration Statement on Form S-8
(File No. 333-24621), which is incorporated by reference herein)).
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 Form of Indenture of Foundation Health Corporation ("FHC") (filed
as an exhibit to FHC's Registration Statement on Form S-3 (File
No. 33-61684), which is incorporated by reference herein).
4.4 Form of Senior Notes of FHC (filed as an exhibit to FHC's
Registration Statement on Form S-3 (File No. 33-61684), which is
incorporated by reference herein).
10.1 Employment Agreement, dated August 28, 1993, by and among
QualMed, Inc., HN Management Holdings, Inc. and Malik M. Hasan,
M.D. (filed as Exhibit 10.18 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).
10.2 Employment Agreement, dated August 28, 1993, by and among
QualMed, Inc., HN Management Holdings, Inc. and Dale T.
Berkbigler, M.D. (filed as Exhibit 10.20 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).
26
10.3 Severance Payment Agreement, dated as of April 25, 1994, among
the Company, Health Net and James J. Wilk (filed as Exhibit 10.9
to the Company's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
*10.4 Severance Payment Agreement dated March 31, 1997 between the
Company and Health Net and James J. Wilk, a copy of which is
filed herewith.
10.5 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).
*10.6 Letter Agreement dated April 23, 1997 between B. Curtis Westen
and the Company, a copy of which is filed herewith.
10.7 Amendment No. 1 to Employment Agreement dated as of April 25,
1994, by and among the Company, QualMed, Inc. and Malik Hasan,
M.D. (filed as Exhibit 10.16 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1994, which is
incorporated by reference herein).
10.8 Amended and Restated Employment Agreement, dated March 10, 1997,
by and between the Company and Malik M. Hasan, M.D. (filed as
Exhibit 10.3 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996, which is incorporated by reference
herein).
10.9 Amendment No. 1 to Employment Agreement dated as of April 27,
1994, by and among the Company, QualMed, Inc. and Dale T.
Berkbigler, M.D. (filed as Exhibit 10.17 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1994, which
is incorporated by reference herein).
10.10 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).
10.11 The Company's Second Amended and Restated 1991 Stock Option Plan
(filed as Exhibit 10.30 to the Company's Registration Statement
on Form S-4 (File No. 33-86524) which is incorporated by
reference herein).
10.12 The Company's Second Amended and Restated Non-Employee Director
Stock Option Plan (filed as Exhibit 10.31 to the Company's
Registration Statement on Form S-4 (File No. 33-86524) which is
incorporated by reference herein).
10.13 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).
27
10.14 The Company's Performance-Based Annual Bonus Plan (filed as
Exhibit 10.35 to the Company's Registration Statement on Form S-4
(File No. 33-86524) which is incorporated by reference herein).
10.15 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).
10.16 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).
10.17 Registration Rights Agreement dated as of March 2, 1995 between
the Company and the 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).
10.18 Description of Retention Payment Arrangement between the Company
and Andrew Wang (filed as Exhibit 10.10 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1995, which is incorporated by reference herein).
10.19 The Company's 1995 Stock Appreciation Right 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).
10.20 Letter Agreement Re: Temporary Warehouse/Mail Center Operations
Support, dated October 16, 1995, between Health Net and CBS
Associates, Inc. (an affiliate of Charles Braden, a director of
the Company) (filed as Exhibit 10.15 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1995,
which is incorporated by reference herein).
28
10.21 Amended and Restated Credit Agreement dated as of April 26, 1996
among the Company, Bank of America National Trust and Savings
Association, as Agent, and financial institutions party thereto
(filed as Exhibit 10.1 to the Company's Current Report on Form
8-K dated May 3, 1996, which is incorporated by reference
herein).
10.22 Amendment No. 1 to Credit Agreement dated as of May 10, 1996
among the Company, Bank of America National Trust and Savings
Association, as Agent, and financial institutions party thereto
(filed as Exhibit 10.32 to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1996, which is incorporated
by reference herein).
10.23 Amendment No. 2 to Credit Agreement dated as of May 28, 1996
among the Company, Bank of America National Trust and Savings
Association, as Agent, and financial institutions party thereto,
(filed as Exhibit 10.33 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996, which is incorporated
by reference herein).
10.24 Amendment No. 3 to Credit Agreement dated as of January 31, 1997
among the Company, Bank of America National Trust and Savings
Association, as Agent, and financial institutions party thereto
(filed as Exhibit 10.33 to the Company's Annual Report on Form
10-K for the year ended December 31, 1996, which is incorporated
by reference herein).
10.25 Employment Letter Agreement dated May 28, 1996 between Michael D.
Pugh and QualMed, Inc., (filed as Exhibit 10.35 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1996, which is incorporated by reference herein).
10.26 Employment Letter Agreement dated June 4, 1996 between Arthur M.
Southam and the Company and Health Net (filed as Exhibit 10.36
to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996, which is incorporated by reference herein).
10.27 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-K for the quarter ended September 30,
1996, which is incorporated by reference herein).
29
10.28 Employment Letter Agreement dated September 30, 1996 between
Douglas C. Werner and the Company (filed as Exhibit 10.38 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996, which is incorporated by reference herein).
10.29 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).
10.30 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).
10.31 Amended and Restated Employment Agreement, dated December 16,
1996, by and among the Company, Foundation Health Corporation and
Daniel D. Crowley (filed as Exhibit 10.1 to the Company's
Registration Statement on Form S-4 (File No. 333-19273), which is
incorporated by reference herein).
*10.32 Employment Agreement Termination Agreement, dated as of May 1,
1997, by and between Daniel D. Crowley, the Company and FHC, a
copy of which is filed herewith.
10.33 Amended and Restated Employment Agreement, dated December 16,
1996, by and among the Company, Foundation Health Corporation and
Kirk A. Benson (filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-4 (File No. 333-19273), which is
incorporated by reference herein).
10.34 Amended and Restated Employment Agreement, dated December 16,
1996, by and among the Company, Foundation Health Corporation and
Jeffrey L. Elder (filed as Exhibit 10.4 to the Company's
Registration Statement on Form S-4 (File No. 333-19273), which is
incorporated by reference herein).
10.35 Amended and Restated Employment Agreement, dated December 16,
1996, by and among the Company, Foundation Health Corporation and
Allen J. Marabito (filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-4 (File No. 333-19273), which is
incorporated by reference herein).
10.36 Foundation Health Corporation Employee Stock Purchase Plan (filed
as Exhibit 4.3 to the Company's Registration Statement on Form S-8
(File No. 333-24621), which is incorporated by reference herein).
10.37 Foundation Health Corporation Profit Sharing and 401(k) Plan
(Amended and Restated effective January 1, 1994) (filed as
Exhibit 4.4 to the Company's Registration Statement on Form S-8
(File No. 333-24621), which is incorporated by reference herein).
30
10.38 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).
10.39 1992 Nonstatutory Stock Option Plan of Foundation Health
Corporation (filed as Exhibit 4.6 to the Company's Registration
Statement on Form S-8 (File No. 333-24621), which is incorporated
by reference herein).
10.40 1989 Stock Plan of Business Insurance Corporation (as Amended and
Restated Effective September 22, 1992) (filed as Exhibit 4.7 to
the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
10.41 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).
10.42 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).
10.43 1993 Nonstatutory Stock Option Plan of Foundation Health
Corporation (as amended and restated September 7, 1995) (filed as
Exhibit 4.10 to the Company's Registration Statement on Form S-8
(File No. 333-24621), which is incorporated by reference herein).
10.44 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).
10.45 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 by herein).
10.46 FHC's Deferred Compensation Plan, as amended and restated
(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).
10.47 FHC's Supplemental Executive Retirement Plan, as amended and
restated (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).
10.48 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, filed with the Commission on September 27, 1995,
which is incorporated by reference herein).
10.49 Agreement and Plan Reorganization dated January 9, 1996 by and
between FHC and Managed Health Network, Inc. (filed as Annex 1 of
Proxy Statement/Prospectus contained in FHC's Registration
Statement on Form S-4 (File No. 333-00517), which is incorporated
by reference herein).
10.50 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).
10.51 $300 Million Revolving Credit Agreement (the "FHC Credit
Agreement") dated as of December 5, 1994, among FHC, as
Borrower, Citicorp USA, Inc., as Administrative Agent, Wells
Fargo Bank, N.A. and NationsBank of Texas, N.A., as Co-Agents
and Citicorp Securities, Inc., as Arranger, and the Other Banks
and Financial Institutions Party thereto (filed as an Exhibit
to FHC's quarterly report on Form 10-Q for the quarter ended
December 31, 1994 filed with the Commission on February 14,
1995, which is incorporated by reference herein).
*10.52 First Amendment Agreement (to the FHC Credit Agreement) dated as
of August 9, 1995 among FHC, as Borrower, the Lenders parties to
the FHC Credit Agreement, Citicorp USA, Inc., as Administrative
Agent, Wells Fargo Bank, N.A. and NationsBank of Texas, N.A.,
as Co-Agents, and Citicorp Securities, Inc., as Arranger, a
copy of which is filed herewith.
*10.53 Second Amendment Agreement (to the FHC Credit Agreement), dated as
of June 28, 1996 among FHC, the Lenders and Citicorp USA, Inc., as
Administrative Agent, a copy of which is filed herewith.
*10.54 Third Amendment Agreement and Waiver (to the FHC Credit Agreement)
dated December 13, 1996 among FHC, the Lenders and Citibank, N.A.,
(as successor to Citicorp USA, Inc.), as Administrative Agent, a
copy of which is filed herewith.
*10.55 Fourth Amendment Agreement and Waiver (to the FHC Credit
Agreement) dated as of January 28, 1997 among FHC, the Lenders
and Citibank, N.A. (as successor to Citicorp USA, Inc.), as
Administrative Agent, a copy of which is filed herewith.
*10.56 Fifth Amendment Agreement (to the FHC Credit Agreement) dated
as of April 1, 1997 among FHC, the Lenders and Citibank, N.A. (as
successor to Citicorp USA, Inc.), as Administrative Agent, a copy
of which is filed herewith.
*10.57 $200 million Revolving Credit Agreement (the "FHC Revolving
Credit Agreement") dated as of December 17, 1996 among FHC, the
Lenders and Citibank, N.A., as Administrative Agent for the
Lenders, a copy of which is filed herewith.
*10.58 First Amendment Agreement and Waiver (to the FHC Revolving Credit
Agreement) dated as of January 28, 1997 among FHC, the Lenders and
Citibank, N.A., as Administrative Agent for the Lenders, a copy of
which is filed herewith.
*10.59 Second Amendment Agreement and Waiver (to the FHC Revolving Credit
Agreement) among FHC, the Lenders and Citibank, N.A., as
Administrative Agent for the Lenders, a copy of which is filed
herewith.
10.60 Lease Agreement between HAS-First Associates 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).
10.61 Agreement and Plan of Reorganization dated as of June 27, 1994 by
and among FHC, CareFlorida Health Systems, Inc., and the other
parties signatory thereto (filed as an exhibit to FHC's Current
Report on Form 8-K filed with the Commission on June 28, 1994,
which is incorporated by reference herein).
10.62 Agreement and Plan of Merger dated as of July 28, 1994 between FHC
and Intergroup Healthcare Corporation (filed as an exhibit to
FHC's Current Report on Form 8-K filed with the Commission on
August 9, 1994, which is incorporated by reference herein).
10.63 Agreement and Plan of Merger dated as of July 28, 1994 between FHC
and Thomas-Davis Medical Centers, P.C. (filed as an exhibit to
FHC's Current Report on Form 8-K filed with the Commission on
August 9, 1994, which is incorporated by reference herein).
*11.1 Statement relative to computation of earnings per share of the
Company, a copy of which is filed herewith.
*21.1 Subsidiaries of the Company, a copy of which is filed herewith.
31
*27.1 Financial Data Schedule, a copy of which is filed with the EDGAR
version of this filing.
*99.1 Pro Forma Unaudited Consolidated Balance Sheet as of March 31,
1997, a copy of which is filed herewith.
*99.2 Pro Forma Unaudited Consolidated Statement of Operations for
the quarters ended March 31, 1996 and 1997, a copy of which is
filed herewith.
*99.3 Pro Forma Medical Covered Lives at March 31, 1997, a copy of
which is filed herewith.
* A copy of the Exhibit is filed herewith.
32
(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, 1997.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FOUNDATION HEALTH SYSTEMS INC.
(Registrant)
Date: May 13, 1997 /s/ JAY M. GELLERT
------------------------
Jay M. Gellert
President and Chief
Operating Officer
Date: May 13, 1997 /s/ JEFFREY L. ELDER
------------------------
Jeffrey L. Elder, Senior Vice President
and Chief Financial Officer
34