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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transaction period from to
Commission File Number: 1-12718
FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4288333
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
21600 Oxnard Street, Woodland Hills, CA 91367
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(Address of principal executive offices) (Zip Code)
(818) 719-6978
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(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:
As of November 11, 1997 111,182,480 shares of Class A Common Stock, $.001
par value per share, were outstanding (exclusive of 3,194,374 shares held as
treasury stock) and 10,297,642 shares of Class B Common Stock, $.001 par value
per share were outstanding.
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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--September 30, 1997 and December 31, 1996......................... 3
Condensed Consolidated Statements of Operations for the Quarters Ended September 30, 1997 and 1996...... 4
Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 1997 and 1996... 5
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1997 and 1996... 6
Notes to Condensed Consolidated Financial Statements.................................................... 7
Item 2-- Management's Discussion and Analysis of Financial Condition and Results of Operations............ 13
PART II--OTHER INFORMATION
Item 1--Legal Proceedings................................................................................. 23
Item 2--Changes in Securities............................................................................. 24
Item 3--Defaults Upon Senior Securities................................................................... 26
Item 4--Submission of Matters to a Vote of Security Holders............................................... 26
Item 5--Other Information................................................................................. 28
Item 6--Exhibits and Reports on Form 8-K.................................................................. 33
Signature................................................................................................. 41
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
ASSETS
Cash and cash equivalents................................. $ 380,772 $ 514,000
Investments............................................... 1,076,882 1,336,801
Premiums receivable, net.................................. 259,975 239,027
Amounts receivable under government contracts............. 250,024 221,787
Property and equipment, net............................... 383,626 346,311
Reinsurance receivable.................................... 201,602 149,582
Goodwill and other intangible assets, net................. 712,334 714,915
Other assets.............................................. 699,085 561,618
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$3,964,300 $4,084,041
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------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Reserves for claims, losses and loss adjustment expense... $1,286,232 $1,362,342
Notes payable and capital leases.......................... 920,784 877,092
Amounts payable under government contracts................ 72,772 44,323
Accounts payable and other liabilities.................... 665,183 616,873
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2,944,971 2,900,630
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Stockholders' Equity:
Common stock and additional paid-in capital............... 633,925 721,610
Retained earnings......................................... 484,732 557,478
Unrealized holding gains and (losses), net of taxes....... (3,497) 3,201
Common stock held in treasury, at cost.................... (95,831) (98,878)
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1,019,329 1,183,411
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$3,964,300 $4,084,041
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See Notes to Condensed Consolidated Financial Statements
3
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
QUARTER ENDED SEPTEMBER 30,
------------------------------
1997 1996
-------------- --------------
Revenues:
Health plan premiums........................................................... $ 1,446,952 $ 1,369,025
Government contracts........................................................... 228,863 248,001
Workers' compensation revenue.................................................. 139,802 120,043
Specialty services revenue..................................................... 70,348 78,955
Investment and other income.................................................... 37,844 27,846
-------------- --------------
1,923,809 1,843,870
-------------- --------------
Expenses:
Health plan services........................................................... 1,224,304 1,155,618
Government health care services................................................ 163,398 180,927
Workers' compensation costs.................................................... 130,799 102,690
Specialty services costs....................................................... 64,097 72,826
Selling, general and administrative............................................ 192,880 198,671
Amortization and depreciation.................................................. 25,168 27,475
Interest expense............................................................... 15,511 12,155
-------------- --------------
1,816,157 1,750,362
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Income before income taxes....................................................... 107,652 93,508
Income tax provision............................................................. 38,751 35,990
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Net income....................................................................... $ 68,901 $ 57,518
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Earnings per share:.............................................................. $ 0.57 $ 0.46
-------------- --------------
-------------- --------------
Weighted average common and common stock equivalent shares outstanding........... 121,907,429 125,219,511
-------------- --------------
-------------- --------------
See Notes to Condensed Consolidated Financial Statements
4
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
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Revenues:
Health plan premiums.......................................................... $ 4,305,976 $ 4,029,928
Government contracts.......................................................... 698,517 648,178
Workers' compensation revenue................................................. 404,942 409,358
Specialty services revenue.................................................... 196,234 203,736
Investment and other income................................................... 114,698 84,264
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5,720,367 5,375,464
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Expenses:
Health plan services.......................................................... 3,611,553 3,341,931
Government health care services............................................... 520,798 484,866
Workers' compensation costs................................................... 384,545 354,322
Specialty services costs...................................................... 173,800 185,191
Selling, general and administrative........................................... 607,641 609,722
Amortization and depreciation................................................. 76,569 82,823
Interest expense.............................................................. 47,770 31,368
Merger, restructuring and other costs......................................... 348,400 --
Gem costs..................................................................... 57,500 --
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5,828,576 5,090,223
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Income (loss) from continuing operations before income taxes.................... (108,209) 285,241
Income tax provision (benefit).................................................. (35,463) 101,868
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Income (loss) from continuing operations........................................ (72,746) 183,373
Gain from discontinued operations, net of tax................................... -- 2,910
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Net income (loss)............................................................... $ (72,746) $ 186,283
----------- -----------
----------- -----------
Earnings (loss) per share:
Continuing operations......................................................... $ (0.58) $ 1.47
Discontinued operations....................................................... -- 0.02
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Net........................................................................... $ (0.58) $ 1.49
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Weighted average common and common stock equivalent shares outstanding.......... 124,448,330 124,842,084
----------- -----------
----------- -----------
See Notes to Condensed Consolidated Financial Statements
5
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1997 1996
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Net cash provided (used) by operating activities........................................ $ (323,607) $ 43,605
INVESTING ACTIVITIES:
Sales or redemption of marketable securities available for sale......................... 692,400 467,863
Purchase of marketable securities available for sale.................................... (436,318) (649,985)
Purchase of property and equipment...................................................... (83,421) (69,689)
Decrease (increase) in other assets..................................................... 90,606 (68,401)
Acquisition of subsidiaries, net of cash acquired....................................... (24,329) 107
----------- -----------
Net cash provided (used) by investing activities........................................ 238,938 (320,105)
FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock purchases.................... 16,036 25,919
Proceeds from sale of stock............................................................. -- 95,828
Borrowings on credit facilities......................................................... 173,937 196,296
Purchase of treasury stock.............................................................. (108,287) (105,417)
Repayment of debt and other non-current liabilities..................................... (130,245) (4,517)
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Net cash provided (used) by financing activities........................................ (48,559) 208,109
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Decrease in cash and cash equivalents................................................... (133,228) (68,391)
Cash and cash equivalents, beginning of period.......................................... 514,000 376,749
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Cash and cash equivalents, end of period................................................ $ 380,772 $ 308,358
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See Notes to Condensed Consolidated Financial Statements
6
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--MERGER
Effective April 1, 1997, Foundation Health Systems, Inc. (the "Company") was
formed pursuant to a merger transaction (the "Merger") involving Health Systems
International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant
to the Merger, FHC merged into a newly created subsidiary of HSI and each
outstanding share of FHC capital stock was converted into 1.3 shares of HSI's
Class A Common Stock. As part of the transaction HSI remained as the ultimate
parent company and changed its name to "Foundation Health Systems, Inc." The
Merger was tax-free and accounted for as a pooling of interests. In accordance
with the pooling of interests method of accounting the Company's consolidated
financial statements as of December 31, 1996 and for the nine months ended
September 30, 1997 and 1996 and the three months ended September 30, 1996 and
the notes thereto have been restated to include the accounts of HSI and FHC for
all periods presented. Although prior to the Merger FHC's final Annual Report
was reported on a fiscal year ended June 30 basis, the condensed consolidated
financial statements have been restated to reflect the Company's calendar year
basis.
NOTE 2--BASIS OF PRESENTATION
In the opinion of management, the accompanying condensed consolidated
financial statements include all 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.
All adjustments presented in these condensed consolidated financial statements
are of a normal recurring nature. 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 "SEC"). For further
information please refer to the consolidated financial statements and notes
thereto in the HSI Annual Report on Form 10-K for the year ended December 31,
1996 and the FHC Annual Report on Form 10-K/A Amendment No. 3 for the year ended
June 30, 1996. Results of operations for the interim periods are not necessarily
indicative of results to be expected for the full year.
NOTE 3--MERGER, RESTRUCTURING AND OTHER COSTS
The Company recorded a charge for merger, restructuring and other costs of
$348.4 million in the quarter ended June 30, 1997. The components of this charge
include merger related costs, restructuring costs and other costs.
MERGER RELATED COSTS
Merger costs totaling $74.0 million were incurred in the quarter ended June
30, 1997 and include $28.8 million of transaction costs, primarily consisting of
investment banking, legal, accounting, filing and printing fees. Integration
costs totaled $25.5 million and directors and officers liability coverage
required by the merger agreement totaled $3.1 million. Costs to consolidate the
debt facilities of the combining companies totaled $9.6 million. All other
merger related costs totaled $7.0 million.
7
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3--MERGER, RESTRUCTURING AND OTHER COSTS (CONTINUED)
RESTRUCTURING COSTS
In connection with the Merger, the Company adopted a restructuring plan
during the quarter ended June 30, 1997, the principal elements of which include:
a workforce reduction of approximately 1,050 employees; the consolidation of
employee benefit plans; the consolidation of facilities in geographic locations
where office space is duplicated; the consolidation of overlapping provider
networks; and the consolidation of information systems at all locations to
standardized systems. The plan, which the Company anticipates will be
substantially completed by the end of the second quarter of 1998, resulted in a
restructuring charge of $188.1 million for the quarter ended June 30, 1997.
The following table summarizes the principal components of the charge in
millions:
Severance and benefit related costs......................... $ 68.1
Provider network consolidation costs........................ 43.2
Real estate lease termination costs......................... 32.6
Asset impairment costs...................................... 44.2
---------
$ 188.1
$143.9 million of this charge is expected to require outlays of cash. As of
September 30, 1997, approximately $45 million of the total accrued restructuring
charge had been paid.
Severance and benefit related costs include a termination benefits plan and
contractually required change of control payments to certain senior executives.
Also included are the costs of settlements of benefit plans being terminated as
a result of the restructuring plan to conform benefits for the combining
companies.
Provider network consolidation costs include costs to consolidate
overlapping provider networks, primarily in California, and the costs of exiting
existing provider contracts as legally, regulatorily or administratively
required.
Real estate lease termination costs include facilities consolidation costs
primarily in geographic regions where there is overlapping office space usage.
Asset impairment costs are primarily a result of the Company's plan to be on
common operating systems and hardware platforms. These costs include impairment
of hardware, software and other systems related assets.
OTHER COSTS
Other costs totaling $86.3 million included non-recurring charges for the
quarter ended June 30, 1997. The primary components of these charges included
$30.5 million for IPA receivables related to provider contracts that will not be
renewed as a result of the Merger; $17.2 million for government receivables
related to prior contracts and adjustments on current contracts being negotiated
with the Department of Defense; $13.4 million for litigation settlement
estimates on claims primarily related to former FHC subsidiaries; $12.6 million
for the loss on disposal of the Company's United Kingdom operations; and $5.2
million related to losses on certain subscriber contracts.
8
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4--GEM COSTS
Gem Insurance Company ("Gem"), a subsidiary of the Company, had previously
reached definitive agreement prior to the end of the second quarter regarding a
reinsurance transaction with The Centennial Life Insurance Company
("Centennial"). Pursuant to this agreement, Centennial was to reinsure,
administer and manage Gem's accident and health, life and annuity policies in
exchange for a reinsurance premium. The cost of the reinsurance along with the
write-off of certain Gem assets that were not recoverable based on the terms of
this agreement totaled $57.5 million. The transaction was not ultimately
consummated due to the unanticipated failure to satisfy certain closing
conditions including the failure to receive certain regulatory approvals. As a
result, Gem established a reserve for the estimated premium deficiency related
to these policies.
NOTE 5--INVESTMENTS
Investments are comprised of the following (in thousands):
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ -----------------
Available for sale..................................... $ 1,048,390 $ 1,306,606
Held to maturity....................................... 28,492 30,195
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Total investments...................................... $ 1,076,882 $ 1,336,801
------------------ -----------------
------------------ -----------------
For purposes of calculating realized gains and losses on sales of
investments available for sale, the amortized cost of each investment sold is
used.
NOTE 6--BUSINESS SEGMENT INFORMATION
The Company operates principally in the following two segments: (i)
providing managed health care services to subscribers and (ii) the writing of
workers' compensation insurance. The following schedule sets forth information
about these two operating segments.
9
FOUNDATION HEALTH SYSTEMS, INC.
SEGMENT REPORTING
QUARTER ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
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(IN MILLIONS)
Net revenue from unaffiliated entities:
Managed health care(1)............................. $ 1,770.8 $ 1,712.7 $ 5,277.2 $ 4,935.9
Managed workers' compensation...................... 153.0 131.2 443.2 439.6
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$ 1,923.8 $ 1,843.9 $ 5,720.4 $ 5,375.5
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Income (loss) from continuing operations before
income taxes:
Managed health care(1)............................. $ 105.9 $ 78.3 $ (102.7) $ 241.9
Managed workers' compensation...................... 17.3 27.4 42.3 74.7
Interest expense................................... (15.5) (12.2) (47.8) (31.4)
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$ 107.7 $ 93.5 $ (108.2) $ 285.2
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Depreciation and amortization:
Managed health care(1)............................. $ 23.3 $ 26.1 $ 71.4 $ 78.4
Managed workers' compensation...................... 1.9 1.4 5.2 4.4
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$ 25.2 $ 27.5 $ 76.6 $ 82.8
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Capital expenditures:
Managed health care(1)............................. $ 36.7 $ 19.9 $ 75.0 $ 63.9
Managed workers' compensation...................... 2.5 1.2 8.4 5.8
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$ 39.2 $ 21.1 $ 83.4 $ 69.7
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AS OF
----------------------------
SEPTEMBER 30, DECEMBER 31,
1997 1996
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TOTAL ASSETS:
Managed health care(1)............................................................ $ 2,735.4 $ 2,933.2
Managed workers' compensation..................................................... 1,228.9 1,150.8
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$ 3,964.3 $ 4,084.0
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(1) Includes general corporate balances net of eliminations.
10
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--STOCKHOLDER'S EQUITY
On June 27, 1997 the Company redeemed 4,550,000 shares of its Class B Common
Stock from The California Wellness Foundation (the "CWF"), the charitable
receipient of the proceeds from the conversion of the Company's Health Net
subsidiary to for-profit status in 1992. The redemption price was approximately
$111.3 million, or $24.47 a share. In addition, during the period from June to
August of 1997, the CWF sold 3,450,000 shares of its Class B Common Stock to
various unrelated third parties, which shares automatically converted into
shares of Class A Common Stock upon such sales.
NOTE 8--ACQUISITIONS
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 35,000 full-risk members. In
1996 Advantage Health recorded revenues of approximately $56 million, with about
90 percent from health plan 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.
PACC
On October 22, 1997 the Company acquired PACC HMO and PACC Health Plans
(collectively, "PACC") for a net purchase price of approximately $43.6 million.
PACC is a 108,000 member health plan with operations in Oregon and Washington
which had more than $133 million in revenues in 1996.
FIRST OPTION HEALTH PLAN
On April 30, 1997 the Company completed a $51.7 million investment in FOHP,
Inc. ("FOHP"). 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
provides a variety of management services to FOHP in return for a percentage of
FOHP's premium revenue. FOHP-NJ currently has more than 205,000 members in New
Jersey enrolled in its commercial, Medicare, Medicaid and PPO programs.
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 of approximately $280 million. PHS is a 426,000 member health plan
with operations in the New York metropolitan area, including northern New
Jersey, and throughout the state of Connecticut. On October 20, 1997, the
Company announced that it had agreed to a new purchase price whereby the Company
would purchase PHS for $28.25 per PHS share, a $1.00 reduction from the
previously announced price of $29.25 per share, pursuant to an amendment to the
definitive agreement entered into between the parties. The new price reduces the
total amount the Company will pay to acquire PHS to approximately $271 million
for the approximately nine million PHS shares outstanding. The consummation of
the transaction is subject to customary conditions, including approval by PHS
stockholders and the receipt of all necessary governmental authorizations.
11
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--ACQUISITIONS (CONTINUED)
The revised purchase price was agreed to by the parties because PHS was
unable to obtain certain waivers from The Guardian Life Insurance Company of
America ("Guardian"). PHS was obligated to provide to FHS such waivers and
amendments prior to closing. Should PHS provide such waivers and amendments
before closing, the price would return to $29.25 per share. 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 December, 1997.
CHRISTIANIA GENERAL INSURANCE CORPORATION
On May 14, 1997 the Business Insurance Group, Inc. ("BIG"), a subsidiary of
the Company, acquired the Christiania General Insurance Corporation of New York
("CGIC"). CGIC was purchased by BIG to more effectively compete in the workers'
compensation and group accident and health markets outside of California. CGIC
is currently licensed in 47 states with 27 workers' compensation licenses and 23
group accident and health licenses.
NOTE 9--REVOLVING CREDIT FACILITY
On July 8, 1997 the Company entered into a $1.5 billion revolving credit
facility with Bank of America as Administrative Agent for the lenders thereto.
All previously existing credit facilities were terminated and rolled into this
new facility. As of September 30, 1997 the amount outstanding on this line was
aproximately $875 million.
NOTE 10--REDEMPTION OF DEBT
FHC, a subsidiary of the Company, consummated a cash tender offer on June
27, 1997 of all of its $125 million outstanding principal amount of 7 3/4%
Senior Notes due 2003 (the "FHC Notes"). As part of this repurchase, FHC and the
trustee for the FHC Notes also executed a supplemental indenture which removed
substantially all of the restrictive covenants contained in the Indenture for
the FHC Notes.
NOTE 11--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February, 1997 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, (EARNINGS PER SHARE) ("SFAS 128")
which requires changes in current earnings per share ("EPS") reporting
requirements. The Company is required to adopt SFAS 128 in the fourth quarter of
1997. Management expects there to be no significant difference in the
calculation and reporting of EPS under the new statement, hence, SFAS 128 is not
expected to significantly affect historical or future EPS.
In June, 1997, the Financial Accounting Standards Board adopted Statements
of Financial Accounting Standards No. 130 (REPORTING COMPREHENSIVE INCOME),
which requires that an enterprise report, by major components and as a single
total, the change in its net assets during the period from nonowner sources; and
No. 131 (DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION),
which establishes annual and interim reporting standards for an enterprise's
business segments and related disclosures about its products, services,
geographic areas, and major customers. Adoption of these statements will not
impact the Company's consolidated financial position, results of operations or
cash flows. Both statements are effective for fiscal years beginning after
December 15, 1997.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Foundation Health Systems, Inc. (the "Company") is an integrated managed
care organization which administers the delivery of managed health care
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 workers' compensation insurance,
administration and cost-containment, behavioral health, dental, vision and
pharmaceutical products and services.
The current operations of the Company are a result of the April 1, 1997
merger transaction (the "Merger") involving Health Systems International, Inc.
("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the Merger, FH
Acquisition Corp., a wholly owned subsidiary of HSI ("Merger Sub"), merged with
and into FHC and FHC survived as a wholly owned subsidiary of HSI, which changed
its name to "Foundation Health Systems, Inc." and thereby became the Company.
Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that
evidenced the Merger, 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 shares held by the Company's stockholders prior to the Merger
(i.e., the prior stockholders of HSI) constituted approximately 39% of the
outstanding stock of the Company after the Merger.
The Merger was accounted for as a pooling of interests for accounting and
financial reporting purposes. The pooling of interests method of accounting is
intended to present, as a single interest, two or more common stockholder
interests which were previously independent and assumes that the combining
companies have been merged from inception. Consequently, in this Quarterly
Report on Form 10-Q, the Company's condensed consolidated financial statements
have been prepared and/or restated as though HSI and FHC always had been
combined.
Commercial HMO and PPO operations are characterized by the assumption of
underwriting risk in return for premium revenue. Government contracts consist of
contractual services to state and federal government programs such as CHAMPUS
and Medicaid in which the Company receives revenues for administrative and
management services and, under most of the contracts, also accepts financial
responsibility for health care costs. Workers' compensation services consist of
operations in which the Company assumes risk in return for premium revenue and
operations in which the Company provides third party administration and bill
review services. Specialty services consists both of operations in which the
Company assumes underwriting risk in return for premium revenue, including
behavioral health, dental and vision HMO products, and operations in which the
Company provides administrative services only, including certain of the
behavioral health and pharmacy benefits management programs.
13
CONSOLIDATED OPERATING RESULTS
The Company's revenues grew by $79.9 million or 4.3% for the quarter ended
September 30, 1997 as compared to the same period in calendar year 1996. Growth
in revenues for the quarter was due to increased health plan premiums including
California and certain states on the east coast as well as increased worker's
compensation premiums. Revenues for the nine months ended September 30, 1997
increased by $344.9 million or 6.4% as compared to revenues for the same period
in 1996. Revenue increases from new government contracts and growth in health
plan premiums and medicaid contracts in California, and commercial growth on the
east coast contributed to this increase. The overall medical loss ratio ("MLR")
for the quarter ended September 30, 1997 of 83.9% and nine months ended
September 30, 1997 of 83.7% increased slightly over the same periods in 1996 due
to continued pricing pressures throughout the Company's health plans and
worker's compensation business as well as an increase in pharmacy costs in the
Company's health plans and higher estimated future costs of the claims reported
and not yet settled in the Company's California workers' compensation business.
The Company's selling, general and administrative ("SG&A") expenses
decreased by $5.8 million or 2.9% for the quarter ended September 30, 1997 as
compared to the same quarter in 1996, and decreased slightly by $2.1 million or
0.3% for the nine months ended September 30, 1997 as compared to the same period
in 1996. The administrative expense ratio (SG&A as a percent of revenue)
decreased from 10.8% for the quarter ended September 30, 1996 to 10.0% for the
quarter ended September 30, 1997. The administrative expense ratio decreased
from 11.3% for the nine months ended September 30, 1996 to 10.6% for the nine
months ended September 30, 1997. Favorable expense reductions have occurred for
the quarter and nine months ended September 30, 1997 as a percent of revenues
due to the Company's ongoing efforts to aggressively control its selling and
administrative expenses and synergy savings associated with the integration of
HSI and FHC after the Merger.
The difference between the statutory combined federal and state income tax
rate of 40.4% and the Company's effective tax rate of 36.0% for the quarter
ended September 30, 1997 is primarily due to health plan and insurance premiums
not subject to income tax in certain states, permanent differences associated
with tax exempt interest income, research and experimental tax credits,
partially offset by nonamortizable goodwill and other nondeductible items.
The difference between the statutory combined federal and state income tax
rate of 40.4% and the Company's effective tax benefit of 32.8% for the nine
months ended September 30, 1997 is primarily due to health plan and insurance
premiums not subject to income tax in certain states, permanent differences
associated with tax exempt interest income, research and experimental tax
credits, more than offset by non-deductible merger and restructuring costs,
non-amortizable goodwill and other non-deductible items.
Income for the quarter ended September 30, 1997 increased by $11.4 million
or 19.8% as compared to the same period in 1996. This was driven by higher
health plan premium revenues, higher investment and other income, and by cost
savings which reduced selling, general and administrative costs as a percentage
of revenue. Merger, restructuring and other costs caused the loss from
continuing operations in the nine months ended September 30, 1997. Gem costs of
$57.5 million recorded in the quarter ended June 30, 1997 also contributed to
the net loss for the nine months ended September 30, 1997. Income from
continuing operations before income taxes for the nine months ended September
30, 1997, excluding the merger, restructuring and other costs, and Gem costs
increased by $12.5 million or 4.3% as compared to the same period a year ago.
In connection with the Merger, the Company adopted a significant
restructuring plan which provides for a workforce reduction of approximately
1,050 employees, the consolidation of employee benefit plans, the consolidation
of certain office locations, the consolidation of overlapping provider networks,
and the consolidation of information systems to standard systems. Management
anticipates that substantial payroll, rent and other cost savings will be
obtained once the plan is fully implemented. The restructuring charge for the
quarter ended June 30, 1997 totaled $188.1 million. The major components of this
charge include
14
$68.1 million for severance and benefit related costs, $43.2 million for
provider network consolidation costs, $32.6 million for real estate lease
termination costs, and $44.2 million for asset impairment costs.
Merger related costs for the quarter ended June 30, 1997 totaling $74.0
million consisted primarily of $28.8 million of transaction costs, $25.5 million
of integration costs, $3.1 million of directors and officers liability insurance
costs, and $9.6 million of debt facilities consolidation costs.
Other charges for the quarter ended June 30, 1997 consist primarily of $30.5
million for IPA receivables related to provider contracts that will not be
renewed, $17.2 for government receivables, $13.4 million for litigation
settlement estimates primarily related to former FHC subsidiaries, $12.6 million
for the loss on the sale of the United Kingdom operations, and $5.2 million for
losses on subscriber contracts.
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 necessarily a reliable indicator of future
performance, and investors should not use historical records to anticipate
results or future period trends.
Certain of 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 costs 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.
LINE OF BUSINESS REPORTING
The Company currently operates in two industry segments, managed health care
and managed workers' compensation. The managed health care segment's continuing
operations are in three primary lines of business (i) health plan operations;
(ii) government contracts; and (iii) specialty services.
The following table presents financial information reflecting the Company's
continuing operations for both segments and its primary lines of business:
15
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
QUARTER ENDED
QUARTER ENDED SEPTEMBER 30, 1997 SEPTEMBER 30, 1996
--------------------------------- --------------------
PERCENT PERCENT
OF PERCENT OF
AMOUNT OR TOTAL INCREASE AMOUNT OR TOTAL
PERCENT REVENUE (DECREASE) PERCENT REVENUE
----------- ------- ---------- ----------- -------
Revenues:
Health plan premiums...................................... $1,446,952 75.2% 5.7% $1,369,025 74.2%
Government contracts...................................... 228,863 11.9 (7.7) 248,001 13.5
Workers' compensation revenue............................. 139,802 7.3 16.5 120,043 6.5
Specialty services revenue................................ 70,348 3.6 (10.9) 78,955 4.3
Investment and other income............................... 37,844 2.0 35.9 27,846 1.5
----------- ------- ----------- -------
1,923,809 100.0 4.3 1,843,870 100.0
----------- ------- ----------- -------
Expenses:
Health plan services...................................... 1,224,304 63.7 5.9 1,155,618 62.6
Government health care services........................... 163,398 8.5 (9.7) 180,927 9.8
Workers' compensation costs............................... 130,799 6.8 27.4 102,690 5.6
Specialty services costs.................................. 64,097 3.3 (12.0) 72,826 3.9
Selling, general and administrative ("SG&A").............. 192,880 10.0 (2.9) 198,671 10.8
Amortization and depreciation............................. 25,168 1.3 (8.4) 27,475 1.5
Interest expense.......................................... 15,511 0.8 27.6 12,155 0.7
----------- ------- ----------- -------
1,816,157 94.4 3.8 1,750,362 94.9
----------- ------- ----------- -------
Income before income taxes.................................. 107,652 5.6 15.1 93,508 5.1
Income tax provision........................................ 38,751 2.0 7.7 35,990 2.0
----------- ------- ----------- -------
Net income.................................................. $ 68,901 3.6% 19.8 $ 57,518 3.1%
----------- ------- ----------- -------
----------- ------- ----------- -------
Earnings per share.......................................... $ 0.57 23.0 $ 0.46
----------- -----------
----------- -----------
Weighted average common and common stock equivalent shares
outstanding............................................... 121,907,429 (2.6) 125,219,511
----------- -----------
----------- -----------
Operating ratios:
Health plan loss ratio.................................... 84.6% 84.4%
Government contracts ratio................................ 71.4 73.0
Workers' compensation ratio............................... 93.6 85.5
Specialty services ratio.................................. 91.1 92.2
SG&A to total revenues.................................... 10.0 10.8
Effective tax rate........................................ 36.0 38.5
16
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996
------------------------------------ ------------------------
PERCENT OF PERCENT PERCENT OF
AMOUNT OR TOTAL INCREASE AMOUNT OR TOTAL
PERCENT REVENUE (DECREASE) PERCENT REVENUE
----------- ----------- ---------- ----------- -----------
REVENUES:
Health plan premiums................................ $ 4,305,976 75.3% 6.8% $ 4,029,928 75.0%
Government contracts................................ 698,517 12.2 7.8 648,178 12.0
Workers' compensation revenue....................... 404,942 7.1 (1.1) 409,358 7.6
Specialty services revenue.......................... 196,234 3.4 (3.7) 203,736 3.8
Investment and other income......................... 114,698 2.0 36.1 84,264 1.6
----------- ----------- ----------- -----------
5,720,367 100.0 6.4 5,375,464 100.0
----------- ----------- ----------- -----------
EXPENSES:
Health plan services................................ 3,611,553 63.2 8.1 3,341,931 62.3
Government health care services..................... 520,798 9.1 7.4 484,866 9.0
Workers' compensation costs......................... 384,545 6.7 8.5 354,322 6.6
Specialty services costs............................ 173,800 3.0 (6.2) 185,191 3.4
Selling, general and administrative ("SG&A")........ 607,641 10.6 (0.3) 609,722 11.3
Amortization and depreciation....................... 76,569 1.3 (7.6) 82,823 1.5
Interest expense.................................... 47,770 0.8 52.3 31,368 0.6
Merger, restructuring and other costs............... 348,400 6.2 -- -- --
GEM costs........................................... 57,500 1.0 -- -- --
----------- ----------- ----------- -----------
5,828,576 101.9 14.5 5,090,223 94.7
----------- ----------- ----------- -----------
Income (loss) from continuing operations before income
taxes............................................... (108,209) (1.9) (137.9) 285,241 5.3
Income tax provision (benefit)........................ (35,463) (0.6) (134.8) 101,868 1.9
----------- ----------- ----------- -----------
Income (loss) from continuing operations.............. $ (72,746) (1.3)% (139.7) $ 183,373 3.4%
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Earnings (loss) per share from continuing
operations.......................................... $ (0.58) (139.8) $ 1.47
----------- -----------
----------- -----------
Weighted average common and common stock equivalent
shares outstanding.................................. 124,448,330 (0.3) 124,842,084
----------- -----------
----------- -----------
Operating ratios:
Health plan loss ratio.............................. 83.9% 82.9%
Government contracts ratio.......................... 74.6 74.8
Workers' compensation ratio......................... 95.0 86.6
Specialty services ratio............................ 88.6 90.9
SG&A to total revenues.............................. 10.6 11.3
Effective tax rate (benefit)........................ (32.8) 35.7
17
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30, 1997
-------------------------- NINE MONTHS ENDED
PERCENT SEPTEMBER 30, 1996
AMOUNT OR INCREASE ---------------------
PERCENT (DECREASE) AMOUNT OR PERCENT
----------- ------------- ---------------------
Enrollment (in thousands):
Health Plan:
Commercial...................................................... 2,812 1.8% 2,761
Medicare risk................................................... 259 11.6 232
Medicaid........................................................ 393 26.8 310
----- -----
3,464 4.9 3,303
----- -----
Government:
CHAMPUS PPO and indemnity....................................... 963 (8.1) 1,048
CHAMPUS HMO..................................................... 684 42.2 481
----- -----
1,647 7.7 1,529
----- -----
Combined........................................................ 5,111 5.8 4,832
----- -----
----- -----
18
MANAGED HEALTH CARE SEGMENT
HEALTH PLAN OPERATIONS
Revenues generated by the Company's health plan operations increased $77.9
million or 5.7% in the quarter ended September 30, 1997 compared to the quarter
ended September 30, 1996 and $276.0 million or 6.8% for the nine months ended
September 30, 1997 compared to the same period in 1996. The increase in revenues
for the quarter and nine months ending September 30, 1997 is primarily due to
enrollment increases in the Medicaid lines of business and enrollment and
premium increases in the Medicare lines of business in California, commercial
enrollment increases in Connecticut, and the acquisition of Advantage Health in
Pennsylvania. The Company expects continued pressure from employer groups and
government agencies to minimize future premium increases.
Health care costs increased for the quarter and nine months ended September
30, 1997 as compared to the quarter and nine months ended September 30, 1996. In
the California market, health care costs increased as a result of higher
pharmacy costs for both the commercial and Medicare lines of business,
percentage of premium provider contracting arrangements, increased hospital
utilization in the Medicare line of business, and increased enrollment in the
Medicaid line of business. The health plans loss ratio increased slightly from
84.4% for the quarter ended September 30, 1996 to 84.6% for the quarter ended
September 30, 1997 and from 82.9% for the nine months ended September 30, 1996
to 83.9% for the nine months ended September 30, 1997. Continued downward
pressure on pricing, coupled with increased pharmacy costs and utilization
contributed to the overall health plan loss ratio increase.
GOVERNMENT CONTRACTS
Government health care revenue decreased by $19.1 million or 7.7% in the
quarter ended September 30, 1997 as compared to the same quarter of 1996 as a
result of improved health care and subcontractor performance on the
California/Hawaii contract which lowered revenues due to the risk sharing
features of these government contracts. The decline in revenues was partially
offset by higher revenues in Washington/Oregon due to retroactive bid price
increases resulting from the economic price adjustment provisions of the
contract. Revenues for the nine months ended September 30, 1997 increased $50.3
million or 7.8% as compared to the same period in 1996 primarily because the
California/Hawaii contract did not commence health care delivery until April,
1996.
Government health care costs as a percentage of government contract revenue
decreased from 73.0% for the quarter ended September 30, 1996 to 71.4% or 1.6%
for the quarter ended September 30, 1997, primarily as a result of improved
health care and subcontractor cost performance on the California/Hawaii and
Washington/Oregon contracts. The cost percentage for the nine months ended
September 30, 1997 declined by .2% to 74.6% due to the impact of lower health
care and subcontractor performance on the California/Hawaii and
Washington/Oregon contracts in the second and third quarters of 1997.
SPECIALTY SERVICES
Specialty services operations are comprised of several companies including
behavioral health, pharmacy benefits management, dental, vision and a third
party health care administrator. Revenues generated by the Company's specialty
services operations decreased in the quarter ended September 30, 1997 by $8.6
million or 10.9% as compared to the same quarter in 1996 primarily due to the
sale of certain ancillary health care service operations in the fourth quarter
of 1996 and revenues which were generated from the Behavioral Health Company's
participation in a medicaid contact in Tennesee in the third quarter of 1996
which was subsequently cancelled. For the nine months ended September 30, 1997,
revenue decreased by $7.5 million or 3.7% as compared to the same periods in
1996 was due to the sale of certain ancillary health care service operations
referenced above and the participation in the medicaid contract in 1996,
partially offset by revenues generated by the acquisition of Managed Health
Network, Inc. ("MHN") in March 1996.
19
The Company expects continued pressure from employer groups to maintain
modest increases in premiums for behavioral health, dental and vision products.
Specialty services costs have decreased as a percent of specialty services
revenue from 92.2% for the quarter ended September 30, 1996 to 91.1% for the
quarter ended September 30, 1997. The decrease is due to the synergies in
operating costs created after the acquisition of MHN which was purchased in the
quarter ended March 31, 1996. Specialty services costs for the nine months ended
September 30, 1997 decreased to 88.6% as a percent of revenue compared to 90.9%
for the same time period in 1996. This decrease was also due to the favorable
benefits of the MHN acquisition.
MANAGED WORKERS' COMPENSATION SEGMENT
Business Insurance Group, Inc. ("BIG") is a leading national managed care
workers' compensation group and a subsidiary of the Company. BIG owns the
following seven affiliated companies: California Compensation Insurance Company,
a specialty workers' compensation carrier writing primarily in California;
Business Insurance Company, a national workers' compensation specialty carrier;
Commercial Compensation Insurance Company, licensed to write multiple lines of
business in approximately 47 states; Combined Benefits Insurance Company,
writing single source workers' compensation and employee health insurance
primarily in California; Reviewco, which provides bill review, utilization
management and PPO network services nationally; FIRM Solutions, a national risk
management and TPA company; and Claims Technical Services, a wholly owned
subsidiary of FIRM Solutions, specializing in providing temporary employees to
the workers' compensation and health insurance industry (collectively referred
to as the "Workers' Compensation Companies").
The Workers' Compensation Companies entered into a quota share reinsurance
agreement ("quota share treaty") with General Reinsurance Corporation, effective
July 1, 1996 and also entered into an aggregate excess of loss treaty
("aggregate treaty") with General Reinsurance Corporation ("the reinsurer")
effective January 1, 1997.
Under the quota share treaty, the percentage of premiums earned, losses and
loss adjustment expenses incurred ceded to the reinsurer was 30% from July 1,
1996 to December 31, 1996 and 7.5% for the period of January 1, 1997 to June 30,
1997. The quota share treaty contained a provisional ceding commission which is
adjustable based upon actual loss experience. The agreement was canceled on July
1, 1997.
The aggregate treaty provided $37.5 million of ceded losses and loss
adjustment expenses for $30 million of ceded premium for the first 6 months of
1997. Effective July 1, 1997 the aggregate treaty was amended to cede $60
million of premium for $75 million of ceded loss coverage for the second six
months of 1997. For the three months ended September 30, 1997, $30.0 million of
premium revenue and $37.5 million of losses and loss adjustment recoveries were
ceded to the reinsurer. For the nine months ended September 30, 1997, $60.0
million of premium revenue and $74.8 million of losses and loss adjustment
recoveries were ceded to the reinsurer.
Workers' compensation revenue increased $19.8 million or 16.5% for the
quarter ended September 30, 1997 and decreased $4.5 million or 1.1% for the nine
months ended September 30, 1997. The increase in revenue in the third quarter is
due to elimination of the quota share reinsurance treaty on July 1, 1997 and an
increase in bill review and service fee revenue in Reviewco, offset partially by
the premium ceded under the aggregate treaty. The decrease in revenue for the
nine months ended September 30, 1997 is due to the revenue ceded under the
aggregate and quota share treaties, offset by growth in bill review and service
fee revenue in Reviewco and earned premium growth in the insurance operations.
The growth in net premiums earned is due primarily to national expansion
through the Companies workers' compensation product in states outside of
California, offset by a reduction in California business. Premiums earned on
workers' compensation policies issued in California continue to be affected by
severe price competition since the start of competitive rating in January, 1995.
20
Net investment income, excluding realized capital gains, increased by $.5
million or 5.8% in the quarter ended September 30, 1997 compared to the
comparable quarter in 1996. For the 9 months ended September 30, 1997 investment
income increased $7.3 million or 33.7%. The growth in investment income is due
to an increase in investable assets from operational cash flow, as well as
capital contributions to the workers' compensation companies of $75 million in
May, 1996 and $55 million in August, 1996 from borrowings BIG made from its
parent.
The primary ratios used to measure underwriting performance of the workers'
compensation companies are the loss and loss adjustment expense ratio and the
underwriting expense ratio, which when added together constitute the combined
ratio. A combined ratio of greater than 100% reflects an underwriting loss,
while a combined ratio of less than 100% indicates an underwriting profit. These
ratios are all calculated as a percentage of net premiums earned.
The following sets forth the workers' compensation companies underwriting
experience as measured by its combined ratio and its components for the quarters
and nine months ended September 30, 1997 and 1996:
The loss and loss adjustment expense ratio for the current quarter decreased
to 67.6% from 74.0% for the comparable quarter in 1996. The decrease in the
ratio is due to utilization of aggregate excess of loss reinsurance during the
quarter. For the nine months ended September 30, 1997 the loss and loss
adjustment expense ratio is 70.2% compared to 66.4% for the same period in 1996.
The increase in the ratio is due to an increase in the estimated ultimate cost
of workers' compensation claims that have not been settled as of September 30,
1997.
The underwriting expense ratio increased in the current quarter to 30.2%
from 16.9% for the comparable quarter in 1996. The increase is due to
cancellation of the quota share treaty. Under the quota share agreement 30% of
third quarter 1996 business was ceded, with a provisional ceding commission and
a sliding scale commission based upon actual loss experience. The treaty was
canceled effective July 1, 1997. For the nine months ended September 30, 1997
the underwriting expense ratio was 27.5% compared to 23.3% for the same period
in 1996 due to the cancellation of the quota share treaty.
LIQUIDITY AND CAPITAL RESOURCES
Cash used by operating activities was $323.6 million for the nine months
ended September 30, 1997 as compared to cash provided by operating activities of
$43.6 million for the comparable period in fiscal year 1996. The Company's cash
and investments decreased from $1,850.8 million at December 31, 1996 to $1,457.7
million at September 30, 1997 primarily due to the repurchase of stock from The
California Wellness Foundation for $111 million, the Company's investment in
FOHP, Inc. in April, 1997 of $51.7 million, the timing of certain government
receipts for health plan services, merger, restucturing, and other charges,
increased reinsurance receivables, claims payments and capital expenditures.
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state HMO and insurance laws and
regulations, and must have adequate reserves for claims incurred but not
reported and claims payments. Certain subsidiaries must maintain ratios of
current assets to current liabilities of 1:1 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 and
lines of credit are adequate to fund existing obligations, introduce new
products and services, complete its pending acquisitions 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.
21
Management of the Company continually evaluates opportunities to expand the
Company's commercial, government, insurance and specialty services operations;
however, the Company currently has no material commitments for future use of its
current or expected levels of available cash resources except as described above
and other than proposed additional capital contributions to FOHP pursuant to the
procedures described in part II below. The Company's expansion options may
include additional acquisitions and internal development of new products and
programs.
On July 8, 1997 the Company entered into a $1.5 billion revolving credit
facility with Bank of America as Administrative Agent for the lenders thereto.
All previously existing credit facilities were terminated and rolled into this
new facility. As of September 30, 1997, the amount outstanding on this line was
$875 million.
On June 16, 1997 FHC, a wholly owned subsidiary of the Company, announced a
tender offer to repurchase all of its $125 million outstanding principal amount
of 7 3/4% Senior Notes due 2003. The purchase price per $1,000 principal amount
of notes was $1,054.77. As of June 30, 1997 $124 million of principal amount had
been tendered and repurchased. On July 15, 1997 the remaining $1 million of
principal amount had been tendered and repurchased.
During the quarter ended June 30, 1997, FHC sold 4,076,087 shares of common
stock of FPA Medical Management, Inc. that it had received as consideration in
its sale of the affiliated physician-owned Medical Practices and its physician
management subsidiary. The proceeds from the sale of stock was approximately $79
million, or an average of $19.45 per share. In addition, as of June 30, 1997 FPA
Medical Management, Inc. prepaid approximately $98.7 million due on a promissory
note received as consideration in the Company's sale of its Medical Practices.
On June 27, 1997 the Company redeemed 4,550,000 shares of its Class B Common
Stock from The California Wellness Foundation, the charitable receipient of the
proceeds from the conversion of the Company's Health Net subsidiary to
for-profit status in 1992. The redemption price was approximately $111.3
million, or $24.47 a share.
SUBSEQUENT EVENT
On October 22, 1997 the Company acquired PACC HMO and PACC Health Plans
(collectively, "PACC") for a net purchase price of approximately $43.6 million.
PACC is a 108,000 member health plan with operations in Oregon and Washington
which generated more than $133 million in revenues in 1996.
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 headings "Risk
Factors" and "Cautionary Statements" included in the Company's various filings
with the Securities and Exchange Commission and the documents incorporated by
reference therein, which could cause the Company's actual results to differ from
those projected in forward looking statements of the Company made on behalf of
the Company. In addition, certain of these factors may have affected the
Company's past results and may affect future results.
22
PART II. OTHER INFORMATION
INTRODUCTION
As referenced in Part I above, the current operations of Foundation Health
Systems, Inc. (the "Company") are a result of the April 1, 1997 merger
transaction (the "Merger") involving Health Systems International, Inc. ("HSI")
and Foundation Health Corporation ("FHC"). Pursuant to the Merger, FH
Acquisition Corp., a wholly owned subsidiary of HSI ("Merger Sub"), merged with
and into FHC and FHC survived as a wholly owned subsidiary of HSI, which changed
its name to "Foundation Health Systems, Inc." and thereby became the Company.
Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that
evidenced the Merger, 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 shares held by the Company's stockholders prior to the Merger (i.e.,
the prior stockholders of HSI) constituted 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 as referenced above 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.
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 transition 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 is to consist of 11 members to be designated as set
forth in the Company's Certificate of Incorporation and By-Laws. Pursuant to
such designations the Company's Board of Directors is currently comprised of the
following ten members (see disclosure below relative to the current vacancy on
the Board of Directors): J. Thomas Bouchard, 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.
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
23
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.
MONACELLI VS. GEM INSURANCE COMPANY
On December 29, 1994, a lawsuit entitled MARIO AND CHRISTIAN MONACELLI V.
GEM INSURANCE COMPANY, ET AL (Case No. CV94-20715) was initiated in Maricopa
County (Arizona) Superior Court against Gem Insurance Company, a subsidiary of
the Company ("Gem"), for bad faith and misrepresentation. Plaintiffs
subsequently asserted claims in the same action against their insurance agent,
Mark Davis, for negligence and misrepresentation. The Plaintiffs' claims arose
from the rescission of their health insurance policy based on their alleged
failure to disclose an X-ray, taken one year before the Plaintiffs filled out
their insurance application, which revealed an undiagnosed mass on Mr.
Monacelli's lung. Plaintiffs incurred approximately $70,000 in medical expenses
in connection therewith. Prior to trial, the agent recanted certain portions of
his deposition testimony and admitted that the Plaintiffs had told him that Mr.
Monacelli had undergone certain tests which were not revealed on the
application. Based on this new information, Gem paid the Plaintiffs' medical
expenses with interest.
The case went to trial in April of 1997 against Gem and the agent. A jury
verdict was ultimately rendered awarding the Plaintiffs $1 million in
compensatory damages and assessing fault 97% to Gem and 3% to the agent, Mark
Davis. In addition, the jury awarded $15 million in punitive damages against
Gem. The Monacellis subsequently filed a motion seeking $4 million in attorneys'
fees. Post-trial motions (including Gem's motion for judgment notwithstanding
the verdict and motion for new trial/motion for remittitur) and the Plaintiffs'
motion for an award of attorneys' fees are currently pending. In addition, on
July 15, 1997 Gem filed a complaint against Mr. Davis and his spouse in Maricopa
County (Arizona) Superior Court (Case No. CV97-13053) asserting a claim for
indemnity against Mr. Davis with respect to the MONACELLI case.
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
On July 8, 1997, the Company entered into a Credit Agreement (the "Credit
Agreement") among the Company, the banks identified therein (the "Banks") and
Bank of America National Trust and Savings Association (the "Bank of America"),
in its capacity as the Administrative Agent, pursuant to which the Company
obtained an unsecured five-year $1.5 billion revolving credit facility. The
Credit Agreement replaced (i) the Company's prior Amended and Restated Credit
Agreement, dated as of April 26, 1996, with Bank of America, as agent, providing
for a $700 million unsecured revolving credit facility and
24
(ii) Foundation Health Corporation's ("FHC's") prior (A) Revolving Credit
Agreement, dated as of December 5, 1994, with Citicorp USA, Inc., as agent,
providing for a $300 million unsecured revolving credit facility (the "Old FHC
Credit Agreement") and (B) Revolving Credit Agreement, dated as of December 17,
1996, with Citibank, N.A., as administrative agent, providing for a $200 million
unsecured revolving credit facility.
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 so long as the sum of such dividends, redemptions and
acquisitions does not exceed $300 million plus 25% of the net income of the
Company and its subsidiaries in fiscal year 1998 plus 50% of the net income of
the Company and its subsidiaries in fiscal year 1999 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 (as such term is defined in the Credit Agreement)
not to exceed 3 to 1, a Fixed Charge Coverage Ratio (as such term is defined in
the Credit Agreement) of not less than 2.75 to 1 and to preserve its combined
net worth at not less than the sum of 85% of the combined net worth on June 30,
1997 plus 50% of the net income of the Company and its subsidiaries arising
after June 30, 1997 (calculated 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 (A) dispose of assets only in the ordinary course and generally at
fair value and (B) restrict acquisitions, mergers, consolidations, loans,
leases, joint ventures, contingent obligations and certain transactions with
affiliates to those permitted under the Credit Agreement.
In connection with entering into the Credit Agreement, FHC obtained a waiver
under a Guaranty Agreement, dated as of May 25, 1997 (the "FHC Guaranty"), until
August 15, 1997 in order to enable the Company to negotiate the replacement by
the Company of FHC as the guarantor under the FHC Guaranty. The FHC Guaranty
incorporates the representations, warranties and covenants of the Old FHC Credit
Agreement, as amended from time to time, and it further provides that to the
extent the Old FHC Credit Agreement is terminated and is replaced with a similar
credit facility, the representations, warranties and covenants of such new
credit facility are automatically incorporated into the FHC Guaranty. Since the
Old FHC Credit Agreement was replaced with a similar credit facility, i.e., the
Credit Agreement, and FHC is not a party to the Credit Agreement, the
replacement by the Company of FHC as the guarantor under the FHC Guaranty was
required. On July 8, 1997, the Company entered into the Guaranty Agreement (the
"New Guaranty") for the benefit of First Security Bank, National Association,
and replaced FHS as the guarantor under the FHC Guaranty. As a result, FHC was
relieved of all of its obligations under the FHC Guaranty and all other
agreements relating thereto.
The Company, as the guarantor under the New Guaranty, guarantees certain
obligations of Foundation Health Facilities, Inc., a California corporation
("FHF"), under: (i) a Lease Agreement, dated as of May 25, 1995, between First
Security Bank, National Association (formerly First Security Bank of Utah, N.A.)
(the "Owner Trustee"), as lessor, and FHF, as lessee, providing for the leasing
of certain real property; (ii) an Agency Agreement, dated as of May 25, 1995,
between the Owner Trustee and FHF, providing for FHF to act as agent for the
Owner Trustee in the acquisition, development and construction of certain real
property; and (iii) any other agreement entered into by FHF in connection with
the Participation Agreement, dated as of May 25, 1997, among FHF, FHC, the
Owners Trustee, and NationsBank of Texas, N.A., as the administrative agent for
certain financial institutions parties to a Credit Agreement, dated as of May
25, 1995, with the Owner Trustee, as the borrower.
25
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 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 August 6, 1997, the Company held its 1997 Annual Meeting of Stockholders
(the "Annual Meeting"). At the Annual Meeting, the Company's stockholders voted
upon proposals to (1) elect three directors for a term of three years ("Proposal
1"); (2) approve the Foundation Health Systems, Inc. 1997 Stock Option Plan
("Proposal 2"); (3) approve the Foundation Health Systems, Inc., Third Amended
and Restated Non-Employee Director Stock Option Plan ("Proposal 3"); (4) approve
the Foundation Health Systems, Inc. Employee Stock Purchase Plan ("Proposal 4");
(5) approve the availability of 650,000 shares of the Company's Class A Common
Stock for purchase under the Foundation Health Corporation Employee Stock
Purchase Plan ("Proposal 5"); (6) approve the material terms of the Foundation
Health Systems, Inc. Performance-Based Annual Bonus Plan ("Proposal 6"); and (7)
ratify the selection of Deloitte & Touche LLP as the Company's independent
public accountants for the year ended December 31, 1997 ("Proposal 7").
26
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
DIRECTOR NOMINEE VOTES FOR VOTES AGAINST VOTES WITHHELD
- ------------------------------------------------- ------------ ------------------- --------------
Malik M. Hasan, M.D. ............................ 86,515,237 0 791,933
Gov. George Deukmejian........................... 86,224,275 0 1,082,895
Adm. Earl B. Fowler.............................. 86,526,973 0 780,197
Each of Dr. Hasan and Messrs. Deukmejian and Fowler were elected as a Class
I director for a three-year term at the Annual Meeting. Other directors whose
term of office as directors continued after the Annual Meeting were: J. Thomas
Bouchard, Thomas T. Farley, Patrick Foley, Roger F. Greaves, Richard W.
Hanselman, Richard J. Stegemeier and Raymond S. Troubh.
PROPOSAL 2
With respect to the approval of the Foundation Health Systems, Inc. 1997
Stock Option Plan, 48,641,193 votes were cast in favor, 27,720,225 votes were
cast against and 163,000 votes were withheld for such proposal.
PROPOSAL 3
With respect to the approval of the Foundation Health Systems, Inc. Third
Amended and Restated Non-Employee Director Stock Option Plan, 73,526,229 votes
were cast in favor, 2,035,060 votes were cast against and 287,389 votes were
withheld for such proposal.
PROPOSAL 4
With respect to the approval of the Foundation Health Systems, Inc. Employee
Stock Purchase Plan, 75,138,882 votes were cast in favor, 562,548 votes were
cast against and 147,248 votes were withheld for such proposal.
PROPOSAL 5
With respect to the approval of the availability of 650,000 shares of the
Company's Class A Common Stock for purchase under the Foundation Health
Corporation Employee Stock Purchase Plan, 74,121,006 votes were cast in favor,
876,197 votes were cast against and 154,185 votes were withheld for such
proposal.
PROPOSAL 6
With respect to the approval of material terms of the Foundation Health
Systems, Inc. Performance-Based Annual Bonus Plan, 71,943,087 votes were cast in
favor, 13,433,118 votes were cast against and 175,112 votes were withheld for
such proposal.
PROPOSAL 7
With respect to the ratification of the selection of Deloitte & Touche LLP
as the Company's independent public accountants for the year ended December 31,
1997, 86,922,114 votes were cast in favor, 61,869 votes were cast against and
79,207 votes were withheld for such proposal.
27
In total 109,444,117 shares of Class A Common Stock were eligible to vote at
the Annual Meeting, 87,307,170 shares were voted at the Annual Meeting and
22,136,947 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 September 30, 1997.
ITEM 5. OTHER INFORMATION
REVOLVING CREDIT FACILITY
As indicated in Item 2 above, on July 8, 1997 the Company executed the
Credit Agreement, which provides for an unsecured five-year $1.5 billion
revolving credit facility, to replace (i) the Company's prior $700 million
unsecured revolving credit facility with Bank of America, as agent and (ii)
FHC's prior (A) $300 million unsecured revolving credit facility with Citicorp
USA, Inc., as agent and (B) $200 million unsecured revolving credit facility
with Citibank, N.A., as administrative agent.
The facility is available to the Company and its subsidiaries for general
corporate purposes, including Permitted Acquisitions and Joint Ventures. As of
October 31, 1997, the Company had drawn approximately $925 million under the
facility.
Bank of America is the administrative agent and co-lead bank with Citibank
N.A. 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 (which
is the higher 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 and the Company's long-term senior unsecured debt rating
and Total Leverage Ratio (as such term is defined in the Credit Agreement) at
the time of the borrowing. The facility is available for five years, until July
2002, but may be extended, under certain circumstances, for two additional years
until July 2004.
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 certain types of Indebtedness
in an aggregate amount of up to $500 million.
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 Ratio
of not less than 2.75 to 1 and to preserve its combined net worth at not less
than the sum of 85% of the combined net worth on June 30, 1997 plus 50% of the
net income of the Company and its subsidiaries arising after June 30, 1997
(calculated 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 (A) dispose of
assets only in the ordinary course and generally at fair value and (B) restrict
acquisitions, mergers, consolidations, loans, leases, joint ventures, contingent
obligations and certain transactions with affiliates to those permitted under
the Credit Agreement.
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, HSI has previously filed with its Annual Report
on Form 10-K for the year ended December 31, 1996 and FHC has previously filed
with its Annual Report on Form 10-K/A Amendment No. 3 for the year ended June
30, 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.
28
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
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.
Effective July 16, 1997, Mr. Crowley resigned as a director of the Company.
As a result, there currently exists a vacancy in the Class I directors which
will be filled pursuant to the Merger Agreement after an appropriate
recommendation from the Committee on Directors. The Committee on Directors is
currently conducting a process of screening qualified individuals for this
vacancy.
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 fully-diluted 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.
Pursuant to the definitive agreements with FOHP, the Company also has the
right to acquire additional FOHP Debentures in return for capital infusions to
the extent that financial projections indicate that FOHP requires additional
capital to meet applicable statutory net worth requirements. Such definitive
agreements afford the Company the right to purchase FOHP Debentures convertible
into an additional 1.42% of FOHP's fully-diluted equity for each additional $1
million of capital infused.
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. 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 205,000 members in New Jersey enrolled in its
commercial, Medicare, Medicaid and PPO programs.
As part of the transaction, the Company also provides 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 receives monthly management fees from FOHP for such
29
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 FOHP. Approximately $1,700,000 of the $51.7 million
principal 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.
PACC
On October 22, 1997 the Company completed its acquisition of 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") pursuant to an
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. For statutory reporting purposes, the
acquisition was effective as of October 1, 1997.
As part of such transaction and as provided for in the Reorganization
Agreement, PACC organized Northwest Health Foundation (the "PACC Foundation") as
an Oregon nonprofit public benefit corporation which received the net
acquisition consideration proceeds. The PACC Foundation also assumed certain of
PACC's obligations under the Reorganization Agreement (including indemnification
obligations) at closing. Although the total purchase price for PACC was $68
million, under the Reorganization Agreement the Company received an
approximately $10.1 million credit for certain physician payment obligations of
PACC it assumed, and was permitted to transfer to the PACC Foundation an
aggregate of $14.3 million in marketable securities previously owned by PACC. As
a result, the Company paid the PACC Foundation a net purchase price of
approximately $43.6 million.
The transaction was structured as a merger of PACC into QMO, with QMO as the
surviving corporation which was renamed QualMed Plans for Health of Oregon, Inc.
The merger was immediately preceded by an acquisition and assumption by QualMed
Washington Health Plan, Inc. (a Washington corporation and 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.
Immediately prior to its acquisition by the Company, PACC (based in
Clackamas, Oregon) had health plan operations in Oregon and Washington, with
approximately 108,000 medical members. Approximately 67,000 of such members were
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.
PHYSICIANS HEALTH SERVICES, INC.
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 of approximately $280 million. PHS is a 426,000-member health plan
with operations in the New York metropolitan area, including northern New
Jersey, and throughout the state of Connecticut.
On October 20, 1997, the Company announced that it had agreed to a new
purchase price whereby the Company would purchase PHS for $28.25 per PHS share,
a $1.00 reduction from the previously announced price of $29.25 per share,
pursuant to an amendment to the definitive agreement entered into between the
parties. The amendment was contingent on the approval of the new purchase price
by Greater Bridgeport Individual Practice Association, Inc. ("GBIPA"), PHS'
majority shareholder, which approval from GBIPA
30
was received on October 23, 1997. The new price reduces the total amount the
Company will pay to acquire PHS to approximately $271 million for the
approximately nine million PHS shares outstanding.
The new purchase price was agreed to by the parties because PHS had
indicated that it was unable to obtain certain waivers and amendments to its
Healthcare Solutions joint venture agreements from The Guardian Life Insurance
Company of America ("Guardian"). PHS was obligated to provide to FHS such
waivers and amendments prior to closing. Should PHS provide such waivers and
amendments before closing, the price would return to $29.25 per share. However,
Guardian and the Company have indicated that, given the current circumstances,
they intend to work cooperatively under the current agreements and to build and
expand Healthcare Solutions products in the tri-state area. The Healthcare
Solutions joint venture markets a number of health insurance products in the New
York City tri-state area.
Consummation of the transaction is subject to customary conditions,
including approval by PHS' stockholders and the receipt of all necessary
governmental authorizations. 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 December of 1997.
GEM INSURANCE COMPANY
Gem Insurance Company ("Gem") was acquired by the Company as a result of
FHC's acquisition of Intergroup Healthcare Corporation and the Thomas Davis
Medical Center in 1994. Gem is a Utah-domiciled life and health insurance
company, admitted to write group and individual medical and life insurance in
nine states and it has policies in force in the following seven states: Arizona,
Colorado, Nebraska, Nevada, New Mexico, Texas and Utah. It is licensed but not
active in Oregon and Washington.
As referenced at Part I above, the Company had previously reached definitive
agreement relating to a reinsurance transaction with The Centennial Life
Insurance Company ("Centennial") involving Gem. In this connection, Gem was to
cede to Centennial on an indemnity basis one hundred percent (100%) of the
policy liabilities of Gem in return for all of Gem's premium income, policy
reserves and a cash payment by the Company.
The transaction was not ultimately consummated due to the nonsatisfaction of
certain closing conditions. As a result, the Company is now in the process of
restructuring certain of Gem's products and consolidating certain markets in
which Gem operates with other FHS affiliates.
THE CALIFORNIA WELLNESS FOUNDATION
Pursuant to the Amended Foundation Shareholder Agreement, dated as of
January 28, 1992 (the "CWF Shareholder Agreement"), by and among the Company,
The California Wellness Foundation (the "CWF") and certain stockholders (the
"HNMH Stockholders") of HN Management Holdings, Inc. (a predecessor to the
Company) ("HNMH") named therein, the CWF is subject to various volume and manner
of sale restrictions specified in the CWF Shareholder Agreement which limit the
number of shares that the CWF may dispose of prior to December 31, 1998.
Under the relevant provisions of California law, when a corporation converts
from nonprofit to for-profit corporate status, the equivalent of the fair market
value of the nonprofit corporation must be contributed to a successor charity
that has a charitable purpose consistent with the purposes of the nonprofit
entity. The CWF was formed to be the charitable recipient of the conversion
settlement when Health Net (a subsidiary of the company) effected a conversion
from nonprofit to for-profit status, which occurred in February 1992 (the
"Conversion"). In connection with the Conversion, Health Net issued to the CWF
promissory notes in the original principal amount of $225 million (the "CWF
Notes") and shares of Class B Common Stock (which immediately prior to the
business combination involving HNMH and QualMed, Inc. were split to become
25,684,152 shares of Class B Common Stock then held by the CWF). While such
shares are held by the CWF, they are entitled to the same economic benefit of
Class A
31
Common Stock, but are non-voting in nature. If the CWF sells or transfers such
shares to an unrelated third party, they automatically convert to Class A Common
Stock.
In addition, the CWF Shareholder Agreement, in conjunction with the Letter
Agreement executed by the Company and the Trustees of a Trust (holding shares on
behalf of the HNMH Stockholders) on March 9, 1995 and ratified by the Company's
Board of Directors on March 16, 1995 (the "Letter Agreement") requires the CWF
to offer its shares of Class B Common Stock to the Company prior to selling such
shares to any other person. In this respect, the CWF Shareholder Agreement
permits the CWF to offer and sell up to 80% of the CWF's interest in the Class B
Common Stock (or all but 5,136,830 of such shares) to the Company prior to
December 31, 1998. The CWF Shareholder Agreement, in conjunction with the Letter
Agreement, requires the CWF to provide the Company with notice on or before
January 31 of each year setting forth the number of shares, if any, being
offered to the Company. The Company then has 45 days following receipt of such
notice to notify the CWF of its intention to purchase such number of shares. On
January 27, 1997, the CWF provided the Company with notice of its offer to sell
3,852,653 shares of Class B Common Stock, provided that at the Company's option
the number of shares could be increased to not more than 5,000,000 shares.
Pursuant to such offer and subsequent letter agreements (collectively, the "1997
Notice Materials") the CWF agreed to extend until June 20, 1997 the time by
which the Company could notify the CWF of its intention to purchase or redeem
such number of shares of Class B Common Stock. Accordingly, after appropriate
notice was given and effective June 27, 1997, the Company redeemed 4,550,000
shares of Class B Common Stock from the CWF at a price of $24.469 per share.
In addition, on June 18, 1997, the Company provided its consent under the
CWF Shareholder Agreement to permit the CWF to sell 3,000,000 shares of Class B
Common Stock to an unrelated third party. Pursuant to the 1997 Notice Materials,
the CWF also retained the right to sell the balance of the 5,000,000 shares not
redeemed by the Company (or up to 450,000 shares) to unrelated third parties.
Sales of such 450,000 shares to unrelated third parties were consummated
throughout August of 1997. On November 6, 1997, the Company also provided its
consent under the CWF Shareholder Agreement to permit the CWF to sell 1,000,000
shares of Class B Common Stock to an unrelated third party. Pursuant to the
Company's Certificate of Incorporation, such 3,000,000 shares, 450,000 shares
and 1,000,000 shares of Class B Common Stock automatically converted into shares
of Class A Common Stock in the hands of such third parties.
As a result of such transactions, the CWF now holds 10,297,642 shares of
Class B Common Stock and, as of September 30, 1997, approximately $19 million in
principal of the CWF Notes remained outstanding.
REDEMPTION OF FHC PUBLIC DEBT
FHC, a subsidiary of the Company, consummated a cash tender offer on June
27, 1997 of all of its $125 million outstanding principal amount of 7 3/4%
Senior Notes due 2003 (the "FHC Notes"). As part of this repurchase, FHC and the
trustee for the FHC Notes also executed a supplemental indenture which removed
substantially all of the restrictive covenants contained in the Indenture for
the FHC Notes.
The price paid for each tendered FHC Note was based on a fixed spread of 25
basis points over the reference yield of the 6 1/4% U.S. Treasury Notes due
February 15, 2003, plus accrued and unpaid interest to the applicable settlement
date. Accordingly, the reference yield was 6.365%, the reference yield plus the
fixed spread was 6.615% and the purchase price per $1,000 principal amount of
the FHC Notes was $1,054.77, plus accrued and unpaid interest.
32
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., 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 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).
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. 33-68684), 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. 33-68684), 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).
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).
33
10.4 Severance Payment Agreement dated March 31, 1997 between the Company and Health Net
and James J. Wilk (filed as Exhibit 10.4 to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997, which is incorporated by reference
herein).
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
(filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, which is incorporated by reference herein).
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 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 Registration Statement on Form S-4 (File No. 33-86524)
which is incorporated by reference herein).
10.13 The Health Systems International, Inc. 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).
10.14 The Health Systems International, Inc. 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).
10.15 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
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).
34
10.18 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).
10.19 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).
10.20 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).
10.21 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).
10.22 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).
10.23 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, which is incorporated by reference herein).
*10.24 Guarantee Agreement dated July 8, 1997 between the Company and First Security Bank,
National Association, a copy of which is filed herewith.
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-Q for
the quarter ended September 30, 1996, which is incorporated by reference herein).
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).
35
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 (filed as Exhibit 10.32 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997).
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 Consulting Agreement, dated as of May 1, 1997, between the Company, FHC and Allen
J. Marabito, (filed as Exhibit 10.35 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, which is incorporated by reference herein).
10.37 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).
10.38 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).
10.39 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).
10.40 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).
10.41 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).
10.42 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).
10.43 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).
10.44 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).
36
10.45 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).
10.46 Foundation Health Systems, Inc. 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).
10.47 Foundation Health Systems, Inc. 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).
10.48 Foundation Health Systems, Inc. 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).
10.49 Foundation Health Systems, Inc. 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).
10.50 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).
10.51 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 Commissionon
September 27, 1995, which is incorporated by reference herein).
10.52 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).
10.53 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).
10.54 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).
10.55 Stock and Note Purchase Agreement by and between FHC, Jonathan H. Scheft, 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).
10.56 $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, 1994, which is incorporated by reference herein).
37
10.57 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 (filed as
Exhibit 10.52 to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997, which is incorporated by reference herein).
10.58 Second Amendment Agreement (to the FHC Credit Agreement), dated as of June 28, 1996
among FHC, the Lenders and Citicorp USA, Inc. (filed as Exhibit 10.53 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which
is incorporated by reference herein).
10.59 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 (filed as Exhibit 10.54 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by
reference herein).
10.60 Fourth Amendment Agreement and Waiver (to the FHC Credit Agreement) dated January
28, 1997 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA,
Inc.), as Administrative Agent (filed as Exhibit 10.55 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by
reference herein).
10.61 Fifth Amendment Agreement (to the FHC Credit Agreement) dated April 1, 1997 among
FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as
Administrative Agent (filed as Exhibit 10.56 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference
herein).
10.62 $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 (filed as Exhibit 10.57 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is
incorporated by reference herein).
10.63 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 (filed as Exhibit 10.58 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference
herein).
10.64 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 (filed
as Exhibit 10.59 to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1997, which is incorporated by reference herein).
10.65 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).
10.66 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).
10.67 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).
10.68 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).
38
*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 (filed as Exhibit 21.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by
reference herein).
*27.1 Financial Data Schedule, a copy of which is filed with the EDGAR version of this
filing.
- ------------------------
* A copy of the Exhibit is filed herewith.
39
(b) Reports on Form 8-K
The following Current Report on Form 8-K was filed by the Company during the
quarterly period ended September 30, 1997:
A report dated July 21, 1997 was filed on August 4, 1997 announcing that:
(i) Daniel D. Crowley had resigned from the Company's Board of Directors
effective July 16, 1997 and (ii) the Company's Board of Directors had withdrawn
the nomination of Mr. Crowley for election at the Company's upcoming 1997 annual
stockholders meeting.
No other Current Reports on Form 8-K were filed by the Company during such
quarter.
40
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)
Date: November 13, 1997 -----------------------------------------
Jay M. Gellert
By: PRESIDENT AND CHIEF OPERATING OFFICER
Date: November 13, 1997
-----------------------------------------
Jeffrey L. Elder
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL
By: OFFICER
41