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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 1-12718
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FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4288333
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
21600 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of principal executive offices) (Zip Codes)
(818) 676-6978
Registrant's telephone number, including area code
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
As of August 10, 1998, 117,083,153 shares of Class A Common Stock, $.001 par
value per share, were outstanding (exclusive of 3,194,374 shares held as
treasury stock) and 5,047,642 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, June 30, 1998 and December 31, 1997............................... 3
Condensed Consolidated Statements of Operations for the Second Quarter Ended June 30, 1998 and 1997...... 4
Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 1998 and 1997.......... 5
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1998 and 1997.......... 6
Notes to Condensed Consolidated Financial Statements..................................................... 7
Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 11
Item 3--Quantitative and Qualitative Disclosures About Market Risk......................................... 21
PART II--OTHER INFORMATION
Item 1--Legal Proceedings.................................................................................. 23
Item 2--Changes in Securities.............................................................................. 25
Item 3--Defaults Upon Senior Securities.................................................................... 26
Item 4--Submission of Matters to a Vote of Security Holders................................................ 27
Item 5--Other Information.................................................................................. 27
Item 6--Exhibits and Reports on Form 8-K................................................................... 31
Signatures................................................................................................. 39
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
JUNE 30, DECEMBER 31,
1998 1997
------------ -------------
(UNAUDITED)
ASSETS
Cash and cash equivalents......................................... $ 250,686 $ 559,360
Securities available for sale..................................... 557,588 553,001
Premiums receivable, net.......................................... 241,127 224,383
Amounts receivable under government contracts..................... 315,636 272,060
Deferred taxes.................................................... 241,748 213,695
Reinsurance and other receivables................................. 131,177 130,875
Other assets...................................................... 214,333 223,900
Net assets of discontinued operations............................. 270,303 267,713
------------ -------------
Total current assets............................................ 2,222,598 2,444,987
Securities held to maturity....................................... 13,447 12,885
Property and equipment, net....................................... 436,344 427,149
Goodwill and other intangible assets, net......................... 1,029,462 1,044,727
Other assets...................................................... 175,011 146,602
------------ -------------
Total Assets.................................................... $ 3,876,862 $ 4,076,350
------------ -------------
------------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Reserves for claims and other settlements......................... $ 853,573 $ 967,815
Unearned premiums................................................. 99,908 244,340
Notes payable and capital leases.................................. 4,741 3,593
Amounts payable under government contracts........................ 88,120 78,441
Accounts payable and other liabilities............................ 361,362 470,483
------------ -------------
Total current liabilities....................................... 1,407,704 1,764,672
Notes payable and capital leases.................................. 1,422,182 1,308,979
Other liabilities................................................. 118,144 106,725
------------ -------------
Total Liabilities............................................... 2,948,030 3,180,376
------------ -------------
Stockholders' Equity:
Common stock and additional paid-in capital....................... 633,223 628,735
Retained earnings................................................. 397,588 370,394
Unrealized investment gains and (losses), net of taxes............ (6,148) (7,324 )
Common stock held in treasury, at cost............................ (95,831) (95,831 )
------------ -------------
Total Stockholders' Equity...................................... 928,832 895,974
------------ -------------
Total Liabilities and Stockholders' Equity...................... $ 3,876,862 $ 4,076,350
------------ -------------
------------ -------------
See Notes To Condensed Consolidated Financial Statements
3
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SECOND QUARTER ENDED
JUNE 30,
------------------------
1998 1997
----------- -----------
Revenues
Health plan premiums............................................... $ 1,869,468 $ 1,438,554
Government contracts premiums...................................... 249,362 223,620
Specialty services................................................. 94,697 77,506
Investment and other income........................................ 23,444 33,742
----------- -----------
Total revenues................................................. 2,236,971 1,773,422
----------- -----------
Expenses
Health plan services............................................... 1,618,093 1,203,695
Government contracts health care services.......................... 192,346 166,488
Specialty services................................................. 72,859 67,307
Selling, general and administrative................................ 248,446 203,442
Amortization and depreciation...................................... 31,505 24,804
Interest........................................................... 22,193 17,185
----------- -----------
2,185,442 1,682,921
----------- -----------
Asset impairments related to FPA Medical Management................ 50,000 --
Merger, restructuring and other costs.............................. -- 346,109
Gem costs.......................................................... -- 57,500
----------- -----------
50,000 403,609
----------- -----------
Total expenses................................................. 2,235,442 2,086,530
----------- -----------
Income (loss) from continuing operations before income taxes......... 1,529 (313,108)
Income tax provision (benefit)....................................... 573 (107,316)
----------- -----------
Income (loss) from continuing operations............................. 956 (205,792)
Income from discontinued operations.................................. -- 5,664
----------- -----------
Net income (loss).................................................... $ 956 $ (200,128)
----------- -----------
----------- -----------
Basic earnings (loss) per share:
Continuing operations.............................................. $ 0.01 $ (1.64)
Discontinued operations............................................ -- 0.04
----------- -----------
Net................................................................ $ 0.01 $ (1.60)
----------- -----------
----------- -----------
Diluted earnings (loss) per share:
Continuing operations.............................................. $ 0.01 $ (1.64)
Discontinued operations............................................ -- 0.04
----------- -----------
Net................................................................ $ 0.01 $ (1.60)
----------- -----------
----------- -----------
Weighted average common and common stock equivalent shares
outstanding:
Basic.............................................................. 121,957 125,306
Diluted............................................................ 122,335 125,777
See Notes To Condensed Consolidated Financial Statements
4
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SIX MONTHS ENDED JUNE
30,
------------------------
1998 1997
----------- -----------
Revenues
Health plan premiums............................................... $ 3,713,952 $ 2,858,299
Government contracts premiums...................................... 462,989 469,654
Specialty services................................................. 185,810 155,536
Investment and other income........................................ 49,594 59,952
----------- -----------
Total revenues................................................. 4,412,345 3,543,441
----------- -----------
Expenses
Health plan services............................................... 3,202,596 2,384,703
Government contracts health care services.......................... 355,637 357,400
Specialty services................................................. 146,067 132,566
Selling, general and administrative................................ 506,854 417,977
Amortization and depreciation...................................... 62,346 49,488
Interest........................................................... 44,054 32,123
----------- -----------
4,317,554 3,374,257
----------- -----------
Asset impairments related to FPA Medical Management................ 50,000 --
Merger, restructuring and other costs.............................. -- 346,109
Gem costs.......................................................... -- 57,500
----------- -----------
50,000 403,609
----------- -----------
Total expenses................................................. 4,367,554 3,777,866
----------- -----------
Income (loss) from continuing operations before income taxes......... 44,791 (234,425)
Income tax provision (benefit)....................................... 17,597 (76,257)
----------- -----------
Income (loss) from continuing operations............................. 27,194 (158,168)
Income from discontinued operations.................................. -- 16,521
----------- -----------
Net income (loss).................................................... $ 27,194 $ (141,647)
----------- -----------
----------- -----------
Basic earnings (loss) per share:
Continuing operations.............................................. $ 0.22 $ (1.26)
Discontinued operations............................................ -- 0.13
----------- -----------
Net................................................................ $ 0.22 $ (1.13)
----------- -----------
----------- -----------
Diluted earnings (loss) per share:
Continuing operations.............................................. $ 0.22 $ (1.26)
Discontinued operations............................................ -- 0.13
----------- -----------
Net................................................................ $ 0.22 $ (1.13)
----------- -----------
----------- -----------
Weighted average common and common stock equivalent shares
outstanding:
Basic.............................................................. 121,786 125,302
Diluted............................................................ 122,117 125,735
See Notes To Condensed Consolidated Financial Statements
5
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................... $ 27,194 $(141,647)
Adjustments to reconcile net income (loss) to net cash used for
operating activities:
Amortization and depreciation..................................... 62,346 49,488
Changes in net assets of discontinued operations.................. (3,575) (31,649)
Asset impairments related to FPA Medical Management............... 45,000 --
Other changes..................................................... (711) 10,610
Change in assets and liabilities
Premiums receivable and unearned subscriber premiums.............. (161,176) (137,690)
Other assets...................................................... (63,156) (141,058)
Amounts receivable/payable under government contracts............. (33,897) (21,470)
Reserves for claims and other settlements......................... (114,242) (57,645)
Accounts payable and accrued liabilities.......................... (114,263) 147,814
--------- ---------
Net cash used for operating activities................................ (356,480) (323,247)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of securities available for sale................... 424,974 452,300
Purchases of securities available for sale.......................... (433,783) (251,119)
Disposition of securities held to maturity.......................... 3,612 1,550
Purchases of securities held to maturity............................ (2,794) (2,274)
Purchases of property and equipment................................. (77,263) (40,451)
Investment in other companies....................................... -- (16,112)
Other............................................................... 5,677 98,128
--------- ---------
Net cash provided by (used for) investing activities.................. (79,577) 242,022
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock
purchases......................................................... 12,349 12,861
Proceeds from issuance of notes payable and other financing
arrangements...................................................... 115,560 262,520
Repayment of debt and other non-current liabilities................. (526) (130,828)
Purchase of treasury stock.......................................... -- (112,179)
--------- ---------
Net cash provided by financing activities............................. 127,383 32,374
--------- ---------
Net decrease in cash and cash equivalents............................. (308,674) (48,851)
Cash and cash equivalents, beginning of period........................ 559,360 487,938
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD.............................. $ 250,686 $ 439,087
--------- ---------
--------- ---------
See Notes To Condensed Consolidated Financial Statements
6
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--MERGER
The current operations of Foundation Health Systems, Inc. (the "Company")
are a result of the April 1, 1997 merger transaction (the "FHS Combination")
involving Health Systems International, Inc. ("HSI") and Foundation Health
Corporation ("FHC"). Pursuant to the FHS Combination, FH Acquisition Corp., a
wholly owned subsidiary of HSI, 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 that evidenced the FHS Combination, FHC stockholders received 1.3
shares of the Company's Class A Common Stock for every share of FHC common stock
held, resulting in the issuance of approximately 76.7 million shares of the
Company's Class A Common Stock to FHC stockholders.
The FHS Combination 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, the Company's
condensed consolidated financial statements have been prepared and/or restated
as though HSI and FHC always had been combined.
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. For further information
please refer to the consolidated financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
Results of operations for the interim periods are not necessarily indicative of
results to be expected for the full year.
NOTE 3--ASSET IMPAIRMENT
On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its
affiliated medical groups, currently provides services to approximately 150,000
of the Company's affiliated members in Arizona and California. FPA has indicated
that it will discontinue its medical group operations in these markets. As a
result, the Company will have to find new tenants for, or sell, the 13
healthcare facilities it currently leases to FPA in these markets and make other
arrangements for provider services to the Company's affiliated members.
Management's analysis of this situation indicates that the likely
replacement lease terms from these properties will be inadequate to enable the
Company to sell the facilities and recover their carrying value. Based on
management's best estimate of recovery for the real estate and the impairment of
notes receivable and other Company assets due to the FPA bankruptcy filing, the
Company has recorded a charge of $50 million in the second quarter of 1998.
Elements of the charge include approximately
7
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3--ASSET IMPAIRMENT (CONTINUED)
$35 million for real estate asset impairments, approximately $10 million for a
note receivable impairment and $5 million for other items.
NOTE 4--MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS
Net restructuring costs of $149.4 million were recorded during the year
ended December 31, 1997 related to the FHS Combination and the restructuring of
the Company's Eastern Division health plans. As of June 30, 1998, $84.0 million
of the net restructuring charge has resulted in cash outlays and $25.3 million
is expected to require future outlays of cash. In addition, $70.4 million of
merger costs, $118.6 million of other costs and $57.5 million of premium
deficiency costs of Gem Insurance Company were recorded during 1997. It is
expected that $10.6 million of these other charges will require future outlays
of cash.
NOTE 5--DISCONTINUED OPERATIONS
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business and thereby adopted a plan to discontinue this
segment of its business through divestiture of its workers' compensation
insurance subsidiaries. As a result, the Company is reporting its workers'
compensation insurance segment as discontinued operations for each period
presented in the condensed consolidated financial statements. Consistent with
the foregoing, on May 5, 1998 the Company entered into a definitive agreement to
sell its workers' compensation insurance operations to Superior National
Insurance Group, Inc. The transaction is expected to yield the Company
approximately $290 million in cash net of tax considerations and the cost of
reinsurance.
The following sets forth the summarized balance sheets as of June 30, 1998
and December 31, 1997 and results of operations for the second quarter and
six-month periods ended June 30, 1998 and 1997 for the workers' compensation
insurance companies to be sold (in thousands):
JUNE 30, DECEMBER 31,
1998 1997
---------- -------------
Total assets........................................................ $1,224,246 $ 1,260,335
Total liabilities................................................... 977,820 1,000,815
---------- -------------
Net assets.......................................................... 246,426 259,520
Amounts to reconcile to net assets from discontinued operations:
Elimination of net notes payable to Parent and other net
receivables from Parent and subsidiaries........................ 110,769 107,193
Loss on disposition............................................... (86,892) (99,000)
---------- -------------
Net assets from discontinued operations............................. $ 270,303 $ 267,713
---------- -------------
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8
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5--DISCONTINUED OPERATIONS (CONTINUED)
SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Total revenues....................................... $ 81,686 $ 135,996 $ 231,665 $ 268,221
Total expenses....................................... 96,742 130,708 256,297 249,657
--------- --------- --------- ---------
Income (loss) before income taxes.................... (15,056) 5,288 (24,632) 18,564
Provision (benefit) for income taxes................. (7,129) (376) (12,524) 2,043
--------- --------- --------- ---------
Net income (loss).................................... (7,927) 5,664 (12,108) 16,521
Loss after measurement date anticipated in loss on
disposition........................................ 7,927 -- 12,108 --
--------- --------- --------- ---------
Net income from discontinued operations.............. $ -- $ 5,664 $ -- $ 16,521
--------- --------- --------- ---------
--------- --------- --------- ---------
The loss on disposition of $99 million recorded at December 31, 1997
included the anticipated results of operations through the disposal date and
therefore the net loss of $7.9 million and $12.1 million for the second quarter
and six-month periods ended June 30, 1998, respectively, are not reflected on
the Company's condensed consolidated statements of operations for those
respective periods.
NOTE 6--COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130 "Reporting
Comprehensive Income." This standard requires that an enterprise report, by
major components and as a single total, the change in its net assets during the
period from non-owner sources which is defined as net income plus direct
adjustments to stockholders' equity such as unrealized investment adjustments
and pension liability adjustments. The Company's comprehensive income pursuant
to such standard is as follows (in thousands):
SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Net income (loss).................................... $ 956 $(200,128) $ 27,194 $(141,647)
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities not
included in net income........................... (2,629) 4,975 1,176 (10,762)
--------- --------- --------- ---------
Comprehensive income (loss).......................... $ (1,673) $(195,153) $ 28,370 $(152,409)
--------- --------- --------- ---------
--------- --------- --------- ---------
NOTE 7--EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share excludes dilution and reflects income or
loss divided by the weighted average shares of common stock outstanding during
the periods presented. Diluted earnings (loss) per share is based upon the
weighted average shares of common stock and dilutive common stock equivalents
(stock options) outstanding during the periods presented; no adjustment to
income is required. Common stock equivalents arising from dilutive stock options
are computed using the treasury stock method.
9
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
During 1997, the Financial Accounting Standards Board issued SFAS 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; and SFAS No. 132 "Employers Disclosures About Pensions and
Other Postretirement Benefits", which revises and standardizes pension and other
benefit plan disclosures. Adoption of these statements will not impact the
Company's consolidated financial position, results of operations or cash flows.
These statements are effective for fiscal years beginning after December 15,
1997. Accordingly, the Company plans to adopt these statements during the fourth
quarter of 1998.
NOTE 9--PRIOR PERIOD RECLASSIFICATION
Certain prior period amounts have been reclassified to conform with the
current period presentation.
10
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 bill review, administration and
cost-containment, behavioral health, dental, vision and pharmaceutical products
and services.
CONSOLIDATED OPERATING RESULTS
The Company's net income from continuing operations for the quarter ended
June 30, 1998 was $1.0 million, or $.01 per diluted share, compared to a net
loss from continuing operations for the quarter ended June 30, 1997 of $205.8
million, or $1.64 per diluted share. Excluding the asset impairments charge
related to FPA Medical Management, Inc. ("FPA") of $50 million in the 1998
quarter, and the merger, restructuring, other costs and Gem costs of $403.6
million in the 1997 quarter, the diluted earnings per share for the quarters
ended June 30, 1998 and June 30, 1997 was $.26 and $.43, respectively.
The Company's net income from continuing operations for the six months ended
June 30, 1998 was $27.2 million, or $.22 per diluted share, compared to a net
loss from continuing operations for the six months ended June 30, 1997 of $158.2
million, or $1.26 per diluted share. Excluding the asset impairments charge of
$50 million in 1998 and the merger, restructuring, other costs and Gem costs of
$403.6 million in 1997, the diluted earnings per share for the six months ended
June 30, 1998 and June 30, 1997 was $.47 and $.81, respectively.
REVENUES AND HEALTH CARE COSTS
The Company's revenues for the quarter and six months ended June 30, 1998 as
compared to the same periods in 1997 grew by $463.5 million and $868.9 million
or 26.1% and 24.5%, respectively. Growth in revenues for the quarter and six
months was due primarily to the acquisitions that occurred in the fourth quarter
of 1997, including Physicians Health Services, Inc. ("PHS"), FOHP, Inc.
("FOHP"), and PACC HMO, Inc. and PACC Health Plans, Inc. (collectively, "PACC").
Excluding these acquisitions, revenues grew by $106.6 million and $160.4 million
for the quarter and six months, respectively. The growth from existing
businesses was due to increases in premium rates in virtually all markets and
significant increases in Medicaid enrollment in the California Division
contributed to the increase in revenue. Specialty Services Division revenue
increased for the quarter and six months ended June 30, 1998 as compared to the
same periods in 1997 by $17.2 million and $30.3 million or 22.2% and 19.5%,
respectively, primarily due to increased revenue from drug manufacturer rebates,
the Company's behavioral health plans, and bill review, cost containment and
administrative services businesses. The increase for the second quarter of 1998
included increased Government Contracts Division revenue resulting from CHAMPUS
contract downward price adjustments occurring in the second quarter of 1997.
Investment and other income for the quarter and six months ended June 30, 1998
was $10.3 million and $10.4 million lower as compared to the same periods in
1997 as a result of 1997 interest income and gain on redemption of the notes
receivable from FPA Medical Management, Inc. ("FPA") and the gain on the sale of
FPA common stock included in the second quarter of 1997.
The Health Plan medical care ratio ("MCR") (medical costs as a percentage of
health plan revenues) for the quarter and six months ended June 30, 1998
increased to 86.6% and 86.2%, respectively, from 83.7% and 83.4% for the
respective periods in 1997. The increase in the MCR was primarily due to higher
pharmacy costs in all divisions and benefit cost increases which exceeded
premium rate increases.
11
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses
increased by $45.0 million and $88.9 million or 22.1% and 21.3% for the quarter
and six months ended June 30, 1998 as compared to the same periods in 1997. The
increase in SG&A expenses is primarily due to additional SG&A expenses
associated with the acquisitions that occurred in 1997. The administrative
expense ratio (SG&A as a percentage of health plan and government contracts
revenue) decreased to 11.7% and 12.1% for the quarter and six months ended June
30, 1998 from 12.2% and 12.6%, respectively, for the comparable periods in 1997.
This lower ratio is the result of continued focus on cost control and continued
benefits of integration synergies from acquisitions.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense increased by $6.7 million and $12.9
million for the quarter and six months ended June 30, 1998 as compared to the
same periods in 1997. This was primarily due to higher levels of intangibles and
fixed assets as a result of the acquisition of companies that occurred in the
fourth quarter of 1997 and increased expenditures on fixed assets primarily
related to consolidation and integration of the Company's administrative
facilities.
ASSET IMPAIRMENTS RELATED TO FPA MEDICAL MANAGEMENT
On July 19, 1998, FPA filed for bankruptcy protection under Chapter 11 of
the federal Bankruptcy Code. FPA, through its affiliated medical groups,
currently provides services to approximately 150,000 of the Company's members in
Arizona and California. FPA has indicated that it will discontinue its medical
group operations in these markets.
The Company recorded a $50 million charge in the second quarter ended June
30, 1998 primarily related to real estate assets currently leased to FPA.
Elements of the charge include approximately $35 million for real estate asset
impairments, approximately $10 million for a note receivable from FPA and
approximately $5 million for other items related to FPA.
INTEREST EXPENSE
Interest expense increased by $5.0 million and $11.9 million for the quarter
and six months ended June 30, 1998, respectively, as compared to the same
periods during the prior year. The increase in interest expense was due to
higher debt levels associated with the Company's revolving lines of credit. The
additional borrowings were incurred for general corporate purposes as well as
the purchase of PHS, FOHP and PACC in the fourth quarter of 1997.
INCOME TAX PROVISION
The tax provision rate on income from continuing operations for the quarter
and six months ended June 30, 1998 of 37.5% and 39.3% increased from the tax
benefit rate of 34.3% and 32.5% for the quarter and six months ended June 30,
1997 because of the charges recorded in 1997 from merger, restructuring, other
costs and Gem costs, portions of which were not deductible for tax purposes. The
tax provision rate differs from the statutory federal rate of 35% due to state
income taxes and tax-exempt income, offset by non-deductible goodwill
amortization.
LINE OF BUSINESS REPORTING
The Company currently operates in the managed health care segment. 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. Discontinued operations include the workers' compensation
insurance segment.
12
CONTINUING OPERATIONS
HEALTH PLANS
Revenues generated by the Company's Health Plan operations increased $430.9
million or 30.0% for the quarter ended June 30, 1998 and $855.7 million or 29.9%
for the six months ended June 30, 1998 compared to the same periods in 1997. The
primary reason for the increase is the acquisitions that occurred in the fourth
quarter of 1997 including PHS, FOHP and PACC which contributed approximately
$384.4 million and $692.6 million, respectively, in revenue during the second
quarter and first six months of 1998. In addition, Medicaid enrollment growth in
the California division and premium rate increases in the aggregate for all
divisions contributed to the overall increase in revenues for the health plans.
The MCR for the Company's Health Plan operations increased to 86.6% and
86.2% for the quarter and six months ended June 30, 1998 as compared to 83.7%
and 83.4% in the same periods in 1997. These increases were primarily a result
of pharmacy cost increases in all divisions and benefit cost increases which
exceeded premium rate increases.
The Company's Commercial product lines are profitable and have been adding
membership in the aggregate for all divisions. Premium rate increases in the
Commercial line of products contributed to revenue increases for the quarter and
six months ended June 30, 1998 compared to the same periods in 1997 in all
divisions of the Company, but were partially offset by enrollment decreases in
Commercial HMO markets in California and the Western health plans. Commercial
health care costs on a per member per month basis have increased 11.5% in the
quarter and six months ended June 30, 1998 as compared to the same periods in
1997.
The Company's Medicare product lines in the California market are
profitable, but are experiencing lower margins than in the prior year. The
Medicare products in the Company's Northeast health plans have shown an
underwriting loss of approximately $11.5 million for the six months ended June
30, 1998. Medicare premium rates and enrollment have increased in the Northeast
markets, but enrollment rates are expected to slow. Medicare health care costs
in the California and Northeast markets continue to increase faster than premium
rates.
Medicaid enrollment in the California division has increased significantly
resulting in a 71% increase in member months in the quarter and six months ended
June 30, 1998 compared to the same periods in 1997. However, Medicaid premium
rates have decreased in all markets. Medicaid health care costs have remained
steady or decreased on a per member per month basis in all of the Company's
markets except for several of its Western health plans, which have experienced
higher costs due to several high cost claims.
GOVERNMENT CONTRACTS
Government Contracts Division revenue increased by $25.7 million or 11.5%
for the quarter ended June 30, 1998 compared to the same period in 1997. The
increase in revenue was primarily due to decreased revenue in the second quarter
of 1997 resulting from retroactive price adjustments and the related risk
sharing provisions of CHAMPUS contracts, while 1998 second quarter revenues were
impacted by positive retroactive adjustments related to estimated final
settlements on CHAMPUS contracts. Government Contracts Division revenue for the
six months ended June 30, 1998 decreased $6.7 million compared to the same
period in 1997 primarily due to activity in the first quarter of 1998 which
reduced contract prices because of lower than anticipated health care costs. The
price adjustment feature of the CHAMPUS contracts results in reduced revenues
when health care costs decline more than anticipated.
Government contracts health care costs as a percentage of government
contracts revenue increased to 77.1% in the second quarter of 1998 from 74.5% in
the second quarter of 1997. This increase was primarily a result of second
quarter 1997 revenues including Medicaid administrative contract revenue
activity with
13
no associated health care costs, only administrative costs. This ratio for the
six months ended June 30, 1998 was 76.8% compared to 76.1% for the six months
ended June 30, 1997.
SPECIALTY SERVICES
Revenues generated by the Company's Specialty Services Division for the
second quarter of 1998 increased by $17.2 million or 22.2% as compared to the
second quarter of 1997 and increased by $30.3 million or 19.5% for the six
months ended June 30, 1998 compared to the same period in 1997. These increases
are primarily the result of higher drug manufacturer rebates and higher pharmacy
cost recovery contract revenue in the current year quarter as well as growth in
service fees by the Company's bill review cost containment and administrative
services businesses, and continued growth in its managed behavioral health
network businesses.
Specialty Services Division costs decreased as a percentage of specialty
services revenue to 76.9% for the second quarter of 1998 as compared to 86.8% in
the second quarter of 1997 and to 78.6% for the six months ended June 30, 1998
compared to 85.2% for the same six month period in 1997. The reduction in this
percentage was primarily due to increased revenues from drug rebates and
manufacturer cost recovery contract revenue coupled with reduced administrative
expenses as a percentage of revenue in the bill review, cost containment and
administrative services businesses, partially offset by slightly higher costs
due to a change in product mix in the managed behavioral health network
businesses.
DISCONTINUED OPERATIONS
WORKERS' COMPENSATION INSURANCE BUSINESS
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business and thereby adopted a plan to discontinue this
segment of its business through divestiture of its workers' compensation
insurance subsidiaries. As a result, the Company is reporting its workers'
compensation insurance segment as discontinued operations. Consistent with the
foregoing, on May 5, 1998 the Company entered into a definitive agreement to
sell its workers' compensation insurance operations to Superior National
Insurance Group, Inc. The transaction is expected to yield the Company
approximately $290 million in cash net of tax considerations and the cost of
reinsurance.
REVENUE
Total workers' compensation revenue in the second quarter of 1998 of $81.7
million is $54.3 million or 39.9% less than the second quarter of 1997. Net
earned premium of $72.7 million in the second quarter of 1998 is $52.2 million
or 41.8% less than the net earned premium of $124.9 million in the second
quarter of 1997. The decrease in premium is due primarily to the implementation
of a quota share reinsurance treaty effective May 1, 1998. Under terms of this
quota share agreement, gross premium earned on all policies with estimated
annual premium in excess of $25,000 at policy inception along with 100% of the
associated net losses and allocated loss adjustment expenses are ceded to the
reinsurer, with a 33.5% ceding commission returned to the Company. In the second
quarter of 1998, $59.8 million of earned premium was ceded under this quota
share reinsurance treaty.
For the six months ended June 30, 1998, total revenue of $231.7 million was
$36.5 million or 13.6% less than the same period in 1997. Net earned premium for
the six months ended June 30, 1998 of $212.3 million is $34.0 million or 13.8%
less than the same period in 1997, primarily as a result of the aforementioned
quota share treaty. In the second quarter of 1998, earned premium of $59.8
million was ceded under the 1998 quota share treaty.
14
COSTS
Workers' compensation costs of $96.7 million, including general and
administrative costs, decreased $34.0 million or 26.0% in the second quarter of
1998 compared to the same period in 1997. The decrease is primarily due to a
ceding commission of $26.6 million under the quota share treaty mentioned above.
For the six months ended June 30, 1998, total workers' compensation costs,
including general and administrative costs, of $256.3 million are $6.6 million
or 2.6% more than the same period in 1997. The ceding commission on the quota
share reinsurance treaty offset higher claims costs in 1998.
NET INCOME (LOSS)
The loss on disposition of $99.0 million recorded at December 31, 1997
included the anticipated results of operations through the disposal date and
therefore, the net loss of $7.9 million and $12.1 million for the quarter and
six months ended June 30, 1998 is not reflected on the Company's condensed
consolidated statement of operations for these periods.
THE FOLLOWING TABLES PRESENT FINANCIAL INFORMATION REFLECTING THE COMPANY'S
CONTINUING OPERATIONS FOR ITS PRIMARY LINES OF BUSINESS:
15
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
CONTINUING OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SECOND QUARTER ENDED SECOND QUARTER ENDED
JUNE 30, 1998 JUNE 30, 1997
----------------------------------- ----------------------
PERCENT PERCENT PERCENT
AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL
PERCENT REVENUE (DECREASE) PERCENT REVENUE
--------- ----------- ----------- --------- -----------
Revenues
Health plan premiums........................... $1,869,468 83.6% 30.0% $1,438,554 81.1%
Government contracts premiums.................. 249,362 11.1 11.5 223,620 12.6
Specialty services............................. 94,697 4.2 22.2 77,506 4.4
Investment and other income.................... 23,444 1.1 (30.5) 33,742 1.9
--------- ----- --------- -----
Total revenues............................. 2,236,971 100.0 26.1 1,773,422 100.0
--------- ----- --------- -----
Expenses
Health plan services........................... 1,618,093 72.3 34.4 1,203,695 67.9
Government contracts health care services...... 192,346 8.6 15.5 166,488 9.4
Specialty services............................. 72,859 3.3 8.2 67,307 3.8
Selling, general and administrative ("SG&A")... 248,446 11.1 22.1 203,442 11.5
Amortization and depreciation.................. 31,505 1.4 27.0 24,804 1.4
Interest....................................... 22,193 1.0 29.1 17,185 1.0
--------- ----- --------- -----
2,185,442 97.7 29.9 1,682,921 95.0
--------- ----- --------- -----
Asset impairments related to FPA Medical
Management................................... 50,000 2.2 100.0 -- --
Merger, restructuring and other costs.......... -- -- (100.0) 346,109 19.5
Gem costs...................................... -- -- (100.0) 57,500 3.2
--------- ----- --------- -----
50,000 2.2 (87.6) 403,609 22.7
--------- ----- --------- -----
Total expenses............................. 2,235,442 99.9 7.1% 2,086,530 117.7
--------- ----- --------- -----
Income (loss) from continuing operations before
income taxes................................... 1,529 0.1 (313,108) (17.7)
Income tax provision (benefit)................... 573 0.0 (107,316) (6.1)
--------- ----- --------- -----
Income (loss) from continuing operations......... $ 956 0.1% $(205,792) (11.6)%
--------- ----- --------- -----
--------- ----- --------- -----
Earnings (loss) per share from continuing
operations:
Basic........................................ $ 0.01 $ (1.64)
Diluted...................................... $ 0.01 $ (1.64)
Weighted average common and common stock
equivalent shares outstanding:
Basic........................................ 121,957 125,306
Diluted...................................... 122,335 125,777
Operating ratios:
Health plan medical care ratio................. 86.6% 83.7%
Government contracts medical care ratio........ 77.1 74.5
Specialty services medical care ratio.......... 76.9 86.8
SG&A as a percent of health plan and government
contracts revenues........................... 11.7 12.2
16
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
CONTINUING OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SIX MONTHS ENDED SIX MONTHS ENDED JUNE
JUNE 30, 1998 30, 1997
----------------------------------- ----------------------
PERCENT PERCENT PERCENT
AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL
PERCENT REVENUE (DECREASE) PERCENT REVENUE
--------- ----------- ----------- --------- -----------
Revenues
Health plan premiums........................... $3,713,952 84.2% 29.9% $2,858,299 80.6%
Government contracts premiums.................. 462,989 10.5 (1.4) 469,654 13.3
Specialty services............................. 185,810 4.2 19.5 155,536 4.4
Investment and other income.................... 49,594 1.1 (17.3) 59,952 1.7
--------- ----- --------- -----
Total revenues............................. 4,412,345 100.0 24.5 3,543,441 100.0
--------- ----- --------- -----
Expenses
Health plan services........................... 3,202,596 72.6 34.3 2,384,703 67.3
Government contracts health care services...... 355,637 8.1 (0.5) 357,400 10.1
Specialty services............................. 146,067 3.3 10.2 132,566 3.7
Selling, general and administrative ("SG&A")... 506,854 11.5 21.3 417,977 11.8
Amortization and depreciation.................. 62,346 1.4 26.0 49,488 1.4
Interest....................................... 44,054 1.0 37.1 32,123 0.9
--------- ----- --------- -----
4,317,554 97.9 28.0 3,374,257 95.2
--------- ----- --------- -----
Asset impairments related to FPA Medical
Management................................... 50,000 1.1 100.0 -- --
Merger, restructuring and other costs.......... -- -- (100.0) 346,109 9.8
Gem costs...................................... -- -- (100.0) 57,500 1.6
--------- ----- --------- -----
50,000 1.1 (87.6) 403,609 11.4
--------- ----- --------- -----
Total expenses............................. 4,367,554 99.0 15.6 3,777,866 106.6
--------- ----- --------- -----
Income (loss) from continuing operations before
income taxes................................... 44,791 1.0 (234,425) (6.6)
Income tax provision (benefit)................... 17,597 0.4 (76,257) (2.1)
--------- ----- --------- -----
Income (loss) from continuing operations......... $ 27,194 0.6% $(158,168) (4.5)%
--------- ----- --------- -----
--------- ----- --------- -----
Earnings (loss) per share from continuing
operations:
Basic........................................ $ 0.22 $ (1.26)
Diluted...................................... $ 0.22 $ (1.26)
Weighted average common and common stock
equivalent shares outstanding:
Basic........................................ 121,786 125,302
Diluted...................................... 122,117 125,735
Operating ratios:
Health plan medical care ratio................. 86.2% 83.4%
Government contracts medical care ratio........ 76.8 76.1
Specialty services medical care ratio.......... 78.6 85.2
SG&A as a percent of health plan and government
contracts revenues........................... 12.1 12.6
17
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS INFORMATION
CONTINUING OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30, 1998 JUNE 30, 1997
------------------------ -------------
PERCENT
INCREASE
ENROLLMENT (DECREASE) ENROLLMENT
----------- ----------- -------------
Health Plan
Commercial............................................. 3,524 23.7% 2,849
Medicare risk.......................................... 319 26.6 252
Medicaid............................................... 550 55.8 353
----- -----
4,393 27.2 3,454
Government
CHAMPUS PPO and indemnity.............................. 821 (12.8) 941
CHAMPUS HMO............................................ 742 19.7 620
----- -----
1,563 0.1 1,561
----- -----
Combined............................................... 5,956 18.8% 5,015
----- -----
----- -----
18
LIQUIDITY AND CAPITAL RESOURCES
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state laws and regulations, and must have
adequate reserves for claims. Certain subsidiaries must maintain ratios of
current assets to current liabilities 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 regularly evaluates cash requirements for current operations and
commitments, and for capital acquisitions and other strategic transactions. The
Company may elect to raise additional funds for these purposes, either through
additional debt or equity, the sale of investment securities or otherwise, as
appropriate.
Government health care receivables and payables are best estimates of
payments that are ultimately collectible or payable. Since these amounts are
subject to government audit and negotiation, amounts ultimately collected may
vary from current estimates. Additionally, the timely collection of such
receivables is also impacted by government audit and negotiation.
For the six months ended June 30, 1998, cash used for operating activities
was $356.5 million compared to $323.2 million in the same six month period of
1997. This use of cash for operating activities in 1998 was due primarily to a
level of operating performance which was below the prior year level, the timing
of receipt of payments under federal and state Medicare and Medicaid contracts,
a reduction of claims inventory, payments for merger, restructuring and other
costs, regulatory deposits required in the Northeast, CHAMPUS contract bid price
adjustment payments and physician risk sharing payments.
Net cash used by investing activities was $79.6 million during the first six
months of 1998 as compared to $242.0 million of net cash provided by investing
activities during the same period in 1997. The change is due primarily to higher
net purchases of securities available for sale and higher capital spending
during the 1998 period as well as FPA's redemption of a note payable in the
June, 1997 quarter carried as an other asset on the Company's balance sheet.
Net cash generated from financing activities was $127.4 million in the six
months ended June 30, 1998 as compared to $32.4 million during the same period
in 1997. The net change in the first six months of 1998 compared to the same
period in 1997 was due primarily to additional borrowings under the revolving
line of credit primarily for capital contributions to acquired subsidiaries in
the Northeast, payments to regulated subsidiaries in the discontinued operations
segment under corporate tax sharing agreements and loan repayments to the
Federal Services subsidiary to cover bid price adjustment payments and other
cash needs of that subsidiary. Additionally, no purchases of treasury stock or
debt repayments were made in 1998 as had occurred in the 1997 period.
The Company has a $1.5 billion credit facility (the "Credit Facility") with
Bank of America as Administrative Agent for the Lenders thereto, which was
amended by Amendments dated April 6 and July 31, 1998 with the Lenders (the
"Amendments"). All previous revolving credit facilities were terminated and
rolled into the Credit Facility on July 8, 1997. At the election of the Company,
and subject to customary covenants, loans are initiated on a bid or committed
basis and carry interest at offshore or domestic rates, at the applicable LIBOR
Rate plus margin or the bank reference rate. Actual rates on borrowings under
the Credit Facility vary, based on competitive bids and the Company's unsecured
credit rating at the time of the borrowing. Under the Amendments, the Company's
public issuer rating becomes the exclusive means of setting the facility fee and
borrowing rates under the Credit Facility. In addition, certain covenants
including financial covenants were amended. The Credit Facility is available for
five years, until July 2002, but it may be extended under certain circumstances
for two additional years. Due to operating and investing requirements, the
outstanding balance under the Credit Facility has increased from $1.265 billion
at December 31, 1997, to $1.31 billion at March 31, 1998, to $1.38 billion at
June 30, 1998. As of August 10, 1998 $1.39 billion was outstanding under the
Credit Facility.
19
The Company's subsidiaries must comply with certain minimum capital
requirements under applicable state laws and regulations. The long-term portion
of principal and interest payments under the California Wellness Foundation
Notes issued by the Company in connection with the Health Net conversion is
subordinated to Health Net meeting tangible equity requirements under applicable
California statutes and regulations. As of June 30, 1998, the Company's
subsidiaries were in compliance with minimum capital requirements.
Legislation has been or may be enacted in certain states in which the
Company's subsidiaries operate imposing substantially increased minimum capital
and/or statutory deposit requirements for HMOs in such states. Such statutory
deposits may only be drawn upon under limited circumstances relating to the
protection of policyholders. The Company's HMO subsidiary operating in New
Jersey was required to increase its statutory deposits by approximately $29
million in 1998 pursuant to such legislation.
The Company believes that cash from operations, existing working capital,
lines of credit and funds from planned divestitures of business are adequate to
fund existing obligations, introduce new products and services, and continue to
develop health care-related businesses, assuming that the Company completes its
previously announced workers' compensation divestiture on schedule and
substantially achieves its financial performance objectives for the balance of
1998. Such cash adequacy also assumes that no substantial additional statutory
deposits are imposed upon the Company's operating subsidiaries prior to
successful completion of these assumptions. In the event these assumptions are
not achieved, the Company may be required to pursue alternate financing
arrangements in order to maintain adequate liquidity.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit margin is
low; hence, it is especially sensitive to inflation. Increases in medical
expenses or contracted medical rates without corresponding increases in premiums
could have a material adverse effect on the Company.
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, regulatory changes, utilization,
new technologies, hospital costs, major epidemics and numerous other external
influences may affect the Company's operating results. Accordingly, past
financial performance is not necessarily a reliable indicator of future
performance, and investors should not use historical records to anticipate
results or future period trends.
The Company's HMO and insurance subsidiaries are required to maintain
reserves to cover their estimated ultimate liability for expenses with respect
to reported and unreported claims incurred. These reserves are estimates of
future payments based on various assumptions. Establishment of appropriate
reserves is an inherently uncertain process, and there can be no certainty that
currently established reserves will prove adequate in light of subsequent actual
experience, which in the past has resulted and in the future could result in
loss reserves being too high or too low. The accuracy of these estimates may be
affected by external forces such as changes in the rate of inflation, the
regulatory environment, the judicial administration of claims, medical costs and
other factors. Future loss development or governmental regulators could require
reserves for prior periods to be increased, which would adversely impact
earnings in future periods. In light of present facts and current legal
interpretations, management believes that adequate provisions have been made for
claims and loss reserves.
20
Reference is also made to the disclosures contained under the heading
"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.
YEAR 2000
The Company recognizes that the arrival of the Year 2000 requires computer
systems to be able to recognize the date change from 1999 to 2000 and, like
other companies, is assessing and modifying its computer applications and
business processes to provide for their continued functionality.
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, prepare invoices or
engage in normal business activities.
The Year 2000 effort for the Company has the highest priority of technology
projects. The project has dedicated resources with multiple teams to address
unique systems environment. Uniform project management techniques are in place
with overall oversight responsibility residing with the Company's Chief
Technology Officer. Emphasis has been placed on business unit involvement and
the use of internal staff enhanced by external specialists. Selected systems
will be retired with the business functions being converted to Year 2000
compliant systems. A number of the Company's systems include packaged software
from large vendors that the Company is closely monitoring to ensure that these
systems are Year 2000 compliant. The Company believes that vendors will make
timely updates available to ensure that all remaining purchased software is Year
2000 compliant. The remaining systems' compliance with Year 2000 will be
addressed by internal technical staff.
The Company has initiated formal communications with others with whom it
does significant business to determine their Year 2000 issues. There can be no
assurances that the systems of other companies on which the Company's systems
rely will be timely converted, or that the failure to convert by another company
would not have a material adverse effect on the Company.
The Company is evaluating on an ongoing basis the related costs to resolve
these potential Year 2000 problems. The total current cost estimate for the Year
2000 project is between $13 and $17 million. These costs will continue to be
incurred during 1998 and 1999 and are expensed as incurred.
However, notwithstanding the foregoing, the costs of the project and the
timetable in which the Company plans to complete the Year 2000 compliance
requirements are based on estimates derived utilizing numerous assumptions of
future events including the continued availability of certain resources, third
party modification plans and other factors. There can therefore be no assurance
that these estimates will be achieved and actual results could differ materially
from these estimates.
At this time it is unclear as to the extent of existing insurance coverage,
if any, the Company may have to cover potential year 2000 liabilities. The
Company is currently analyzing the obtainment of such coverage.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CONTINUING OPERATIONS
The Company is exposed to interest rate and market risk primarily due to its
investing and borrowing activities. Market risk generally represents the risk of
loss that may result from the potential change in the value of a financial
instrument as a result of fluctuations in interest rates and in equity prices.
Interest rate
21
risk is a consequence of maintaining fixed income investments. The Company is
exposed to interest rate risks arising from changes in the level or volatility
of interest rates, prepayment speeds and/or the shape and slope of the yield
curve. In addition, the Company is exposed to the risk of loss related to
changes in credit spreads. Credit spread risk arises from the potential that
changes in an issuer's credit rating or credit perception may affect the value
of financial instruments.
The Company has several bond portfolios to fund reserves. The Company
attempts to manage the interest rate risks related to its investment portfolios
by actively managing the asset/liability duration of its investment portfolios.
The overall goal of the investment portfolios is to support the ongoing
operations of the Company's business units. The Company's philosophy is to
actively manage assets to maximize total return over a multiple-year time
horizon, subject to appropriate levels of risk. Each business unit will have
additional requirements with respect to liquidity, current income and
contribution to surplus. The Company manages these risks by setting risk
tolerances, targeting asset-class allocations, diversifying among assets and
asset characteristics, and using performance measurement and reporting.
The Company uses a value-at-risk model to assess the market risk of its
investments. The estimation of potential losses that could arise from changes in
market conditions is typically accomplished through the use of statistical
models which seek to predict risk of loss based on historical price and
volatility patterns. The Company's measured value at risk for its investments
from continuing operations, using a 95 percent confidence level, was
approximately $4.0 million at June 30, 1998.
The Company's calculated value-at-risk exposure represents an estimate of
reasonably possible net losses that could be recognized on its investment
portfolios assuming hypothetical movements in future market rates and are not
necessarily indicative of actual results which may occur. It does not represent
the maximum possible loss nor any expected loss that may occur, since actual
future gains and losses will differ from those estimated, based upon actual
fluctuations in market rates, operating exposures, and the timing thereof, and
changes in the Company's investment portfolios during the year.
In addition, the Company has some interest rate market risk due to its
borrowings. Notes payable, capital leases and other financing arrangements
totaled $1.4 billion at June 30, 1998 and the related average interest rate was
6.1% (which interest rate is subject to change pursuant to the terms of the
Credit Facility). See a description of the Credit Facility under "Liquidity and
Capital Resources." The table below presents the expected cash flows of market
risk sensitive instruments at June 30, 1998. These cash flows include both
expected principal and interest payments consistent with the terms of the
outstanding debt as of June 30, 1998 (dollars in thousands).
1998 1999 2000 2001 2002 BEYOND TOTAL
--------- --------- ---------- --------- ------------ --------- ------------
Long-term Borrowings
Fixed Rate................ $ 3,695 $ 4,329 $ 26,830 $ 2,540 $ 2,541 $ 19,999 $ 59,934
Floating Rate............. 84,151 82,938 82,938 82,938 1,421,469 -- 1,754,434
--------- --------- ---------- --------- ------------ --------- ------------
Total....................... $ 87,846 $ 87,267 $ 109,768 $ 85,478 $ 1,424,010 $ 19,999 $ 1,814,368
--------- --------- ---------- --------- ------------ --------- ------------
--------- --------- ---------- --------- ------------ --------- ------------
DISCONTINUED OPERATIONS
The Company has entered into a definitive agreement to sell its
risk-assuming workers' compensation insurance businesses which represent a
separate segment of business. Therefore the results of these businesses have
been reported as discontinued operations.
The Company's measured value-at-risk of its investments from discontinued
operations at a 95 percent confidence level, at June 30, 1998 was approximately
$5.5 million.
The discontinued operations businesses do not have any significant interest
rate risk due to debt.
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" or the "FHS Combination") 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.
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 (there currently exists one vacancy on the Board of
Directors which vacancy is in the process of being filled): 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. As set forth under the heading "Recent Developments" below,
Dr. Hasan has agreed that, in connection with his recent retirement, he will
resign from the Board of Directors sometime between September 30, 1998 and March
1, 1999.
ITEM 1. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
On November 7, 1996 the Company's predecessor, HSI, filed a lawsuit against
Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive
Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V.
MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414,
Superior Court of California, County of Los Angeles. The lawsuit arises out of
the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July
1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS,
representing over sixteen percent of the total outstanding equity of HDS, voted
its shares in favor of the acquisition of HDS by Medaphis. HSI received as the
result of the acquisition 976,771 shares of Medaphis Common Stock in exchange
for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company
succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has
been substituted for HSI as plaintiff in the suit.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core business, and had artificially
maintained its stock prices through a series of acquisitions and accounting
maneuvers which provided the illusion of growth while hiding the reality of its
weakening financial and business condition. The Company alleges that Medaphis,
Brown and other insiders deceived the Company by presenting materially false
financial statements and by failing to disclose that Medaphis would shortly
reveal a "write off" of up to $40 million in reorganization costs and would
lower its earnings
23
estimate for the following year, thereby more than halving the value of the
Medaphis shares received by the Company. The Company alleges that these false
and misleading statements were contained in oral communications with the
Company, as well as in the registration statement and 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. The Company alleges that the defendants' actions
constitute violations of both federal and state securities laws, as well as
fraud and other torts under state law. The Company is seeking either rescission
of the transaction or damages in excess of $38 million. The defendants have
denied the allegations in the complaint, and the Company is vigorously pursuing
its claims against Medaphis.
Recently the Company moved to disqualify the law firm representing certain
of the individual defendants. The trial court granted the Company's motion, and
the law firm and its clients have appealed such decision. In addition, the trial
court granted a stay of the case in order to permit the law firm to appeal.
Although the briefing for such appeal has been completed, no date has been set
for orally arguing the appeal. Prior to the stay the case was in the early
stages of discovery, and no trial date has yet been set.
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. Thereafter, the plaintiffs filed a motion seeking to recover an additional
$4 million in attorneys' fees, and Gem filed post-trial motions for judgment
notwithstanding the verdict, for a new trial and for remittitur of the jury
verdict. Gem's motion for judgment notwithstanding the verdict was denied. The
court granted Gem's motion for remittitur and remitted the jury verdict to an
award of $1 million in compensatory damages and $2 million in punitive damages.
The court further ordered that if the plaintiffs did not accept the remittitur
order, Gem's motion for new trial would be granted. The plaintiffs accepted the
court's remittitur. The court also awarded plaintiffs approximately $233,000 in
attorneys' fees and interest.
Notwithstanding the plaintiffs' acceptance of the court's remittitur, Gem
planned to appeal the verdict. However, Gem and the plaintiffs reached agreement
to settle the case in May of 1998 for an undisclosed amount thus avoiding any
further costs associated with an appeal or new trial.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in
federal and state courts seeking an unspecified amount of damages on behalf of
an alleged class of persons who purchased shares of common stock, convertible
subordinated debentures and options to purchase common stock of FPA Medical
Management, Inc. ("FPA") at various times between February 3, 1997 and May 15,
1998. The
24
FPA Complaints name as defendants FPA, certain of FPA's present and former
officers and directors, FPA's auditors, the Company and certain of the Company's
former officers. The FPA Complaints allege that the Company and such former
officers violated federal and state securities laws by misrepresenting and
failing to disclose certain information about a 1996 transaction between the
Company and FPA, about FPA's business and about the Company's 1997 sale of FPA
common stock held by the Company. The Company has not formally responded to
these complaints.
Management believes these suits against the Company and its former officers
are without merit and intends to defend the actions vigorously.
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 with the banks
identified therein (the "Banks") and Bank of America National Trust and Savings
Association ("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 maturing on July 7, 2002. 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 (ii) 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 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 subject to certain specified limitations.
Under the Credit Agreement, as amended pursuant to the First Amendment and
Waiver to Credit Agreement dated as of April 6, 1998 (the "First Amendment") and
the Second Amendment to Credit Agreement dated as of July 31, 1998 (the "Second
Amendment" and, together with the First Amendment, the "Amendments") with the
Banks, the Company is: (i) obligated to maintain certain covenants keyed to the
Company's financial condition and performance (including a Total Leverage Ratio
and Fixed Charge Ratio); (ii) obligated to limit liens; (iii) subject to
customary covenants, including (A) disposition of assets only in the ordinary
course and generally at fair value and (B) restrictions on acquisitions,
mergers, consolidations, loans, leases, joint ventures, contingent obligations
and certain transactions with affiliates; (iv) permitted to sell the Company's
workers' compensation insurance business, provided that the net proceeds shall
be applied towards repayment of the outstanding Loans under the Credit
Agreement; and (v) permitted to incur additional indebtedness in an aggregate
amount not to exceed $1,000,000,000 upon certain terms and conditions, including
mandatory prepayment of the outstanding Loans with a certain portion of the
proceeds from the issuance of such indebtedness, resulting in a permanent
reduction of the
25
aggregate amount of commitments under the Credit Agreement by the amount so
prepaid. The Amendments also provided for an increase in the interest and
facility fees under the Credit Agreement. A copy of the Second Amendment is
included as Exhibit 10.65 to this Quarterly Report on Form 10-Q.
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 to
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.
A copy of the Rights Agreement has been filed with the Securities and
Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on
Form 8-A (File No. 001-12718). In connection with its execution of the Merger
Agreement for the FHS Combination, the Company entered into Amendment No. 1 (the
"Rights Amendment") to the Rights Agreement to exempt the Merger Agreement and
related transactions from triggering the Rights. In addition, the Rights
Amendment modifies certain terms of the Rights Agreement applicable to the
determination of certain "Adverse Persons," which modifications become effective
upon consummation of the transactions provided for under the Merger Agreement.
This summary description of the Rights does not purport to be complete and is
qualified in its entirety by reference to the Rights Agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 7, 1998, the Company held its 1998 Annual Meeting of Stockholders
(the "Annual Meeting"). At the Annual Meeting, the Company's stockholders voted
upon a proposal to elect three directors for a term of three years. 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:
DIRECTOR NOMINEE VOTES FOR VOTES AGAINST VOTES WITHHELD
- ------------------------------------------------ ------------- ------------------- --------------
Roger F. Greaves................................ 107,743,070 0 1,322,632
Richard W. Hanselman............................ 107,702,860 0 1,362,842
Raymond S. Troubh............................... 107,745,813 0 1,319,889
Each of Messrs. Greaves, Hanselman and Troubh were elected as a Class II
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, Gov. George Deukmejian, Thomas T. Farley, Patrick Foley, Adm. Earl B.
Fowler, Malik M. Hasan, M.D. and Richard J. Stegemeier.
In total, 111,308,582 shares of Class A Common Stock were eligible to vote
at the Annual Meeting, 109,065,702 shares were voted at the Annual Meeting and
2,242,880 were unvoted at the Annual Meeting.
No other matters were submitted to a vote of the Company's security holders
during the quarter ended June 30, 1998.
ITEM 5. OTHER INFORMATION
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company has previously filed with its Annual
Report on Form 10-K for the year ended December 31, 1997 certain cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others,
could cause the Company's actual financial or enrollment results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to the Company. The factors should be considered in
conjunction with any discussion of operations or results by the Company or its
representatives, including any forward-looking discussion, as well as comments
contained in press releases, presentations to securities analysts or investors,
or other communications by the Company.
In making these statements, the Company was not and is not undertaking to
address or update each factor in future filings or communications regarding the
Company's business or results, and is not undertaking to address how any of
these factors may have caused changes to discussions or information contained in
previous filings or communications. In addition, certain of these matters may
have affected the Company's past results and may affect future results.
RECENT DEVELOPMENTS
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 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
27
December 31, 1998. The CWF and the Company are also party to a Registration
Rights Agreement dated as of March 2, 1995 (the "CWF Registration Rights
Agreement") pursuant to which the CWF has the right to demand registration for
sale in underwritten public offerings of up to 8,026,298 shares of Class B
Common Stock.
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 as
Class A 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. As of June 30, 1998, approximately $18.4 million in
principal of the CWF Notes remained outstanding.
On February 25, 1998, the CWF notified the Company of its intention to sell
up to 8,026,000 shares of Class B Common Stock pursuant to the CWF Registration
Rights Agreement in an underwritten public offering. Pursuant to the terms of
the CWF Registration Rights Agreement, the Company upon receipt of a
notification under such agreement must prepare and file a registration statement
with respect to such shares with the Securities and Exchange Commission as
expeditiously as possible but in no event later than 90 days following receipt
of the notice, subject to certain exceptions. Pursuant to the terms of a letter
agreement dated June 1, 1998 between the CWF and the Company (the "Letter
Agreement"), the Company provided its consent under the CWF Registration Rights
Agreement to permit the CWF to sell certain shares of Class B Common Stock in
private sales transactions (subject to the terms and conditions set forth in
such Letter Agreement) in lieu of such underwritten public offering. Effective
June 18, 1998, the CWF sold 5,250,000 shares of Class B Common Stock to
unrelated third parties in accordance with the Letter Agreement, which shares of
Class B Common Stock sold by the CWF automatically converted on a one-for-one
basis into shares of Class A Common Stock. Pursuant to the terms of the Letter
Agreement, all of such 5,250,000 shares sold reduced the number of shares
subject to registration under the CWF Registration Rights Agreement on a
one-for-one basis. As a result of such sales, the CWF currently holds 5,047,642
shares of Class B Common Stock.
As of December 31, 1998, the various volume and manner of sale restrictions
contained in the CWF Shareholder Agreement referred to above expire pursuant to
the terms of such agreement.
SALE OF WORKERS' COMPENSATION BUSINESSES
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business as a result of various adverse developments
arising in 1997 in the workers' compensation insurance business, primarily
related to the workers' compensation claims environment in California. As
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, such adverse developments resulted in the need for the
Company to strengthen its workers' compensation reserves at the end of 1997.
These developments also led the Company to adopt a plan to discontinue this
segment of its business, through divestiture of its workers' compensation
risk-assuming insurance subsidiaries.
In this connection, on May 5, 1998 the Company entered into a definitive
agreement (the "Workers' Compensation Sale Agreement") to sell its risk-assuming
workers' compensation insurance operations (the
28
"Workers' Compensation Operations") to Superior National Insurance Group, Inc.
of Calabasas, California ("Superior National"). The transaction, subject to
customary closing conditions including regulatory approvals and a favorable vote
from Superior National's shareholders, is expected to close in the fourth
quarter of 1998 and is expected to yield the Company approximately $290 million
in cash net of tax considerations and the cost of reinsurance.
As required under the terms of the Workers' Compensation Sale Agreement, the
Company has obtained a commitment from a third party reinsurance company to
purchase reinsurance that will cover up to $150 million of adverse loss
development in the Workers' Compensation Operations for losses incurred through
December 31, 1997. Such reinsurance coverage was increased by $25 million for
adverse loss development incurred in 1998 in exchange for additional purchase
price consideration pursuant to the terms of the Workers' Compensation Sales
Agreement at Superior National's request. A copy of the Workers' Compensation
Sale Agreement was filed as Exhibit 10.65 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1998.
In addition to the sale of the Workers' Compensation Operations, the Company
and Superior National have agreed to a contract under which the Company's
administrative services businesses that currently provide certain services to
the Workers' Compensation Operations would continue to provide such services and
additional services to Superior National for a period of five years after
closing. The Company estimates that, based on past results and the expected
contribution from Superior National's operations, this five-year service
agreement will create additional total revenue in the range of $40 to $50
million for the Company's administrative service subsidiaries over such
five-year term.
OTHER POTENTIAL DIVESTITURES
The Company is presently reviewing possible plans to either divest or
wind-down its HMO operations in the states of Texas, Louisiana and Oklahoma due
to inadequate returns on invested capital. The Company is presently reviewing
exit strategies for such states' businesses (including potential sale
transactions).
The Company has decided to review the possibility of divesting its direct
ownership of two Southern California hospitals, a 128-bed hospital located in
Los Angeles, California, the East Los Angeles Doctors Hospital, and a 200-bed
hospital located in Gardena, California, the Memorial Hospital of Gardena.
Direct ownership of these two hospitals is not consistent with the Company's
business philosophy to manage health care through contracts with independent
providers of medical services. The Company is presently responding to inquiries
of parties which have expressed an interest in purchasing these hospitals.
As described in its Annual Report on Form 10-K for the year ended December
31, 1997, the Company continues to evaluate the profitability realized or likely
to be realized by its existing businesses and operations, and is reviewing from
a strategic standpoint which of such businesses or operations should be
divested.
FPA MEDICAL MANAGEMENT, INC.
On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its
affiliated medical groups, currently provides services to approximately 150,000
of the Company's members in Arizona and California. FPA has indicated that it
will discontinue its medical group operations in these markets.
The Company announced on August 5, 1998 that it would record a $50 million
nonrecurring charge in its second quarter ended June 30, 1998, primarily related
to real estate assets currently leased to FPA. Elements of the charge include
approximately $35 million for real estate asset impairment, approximately $10
million for a note from a prior California IPA sale to FPA and approximately $5
million in other items related to FPA.
29
In 1996, Foundation Health Corporation ("FHC"), a predecessor to the
Company, sold certain medical groups and IPAs to FPA for approximately $220
million in total consideration. As part of the transaction, FHC retained
ownership of the related medical clinics and leased them to FPA. FPA was
contractually committed to a deferred purchase of these clinics at a purchase
price equal to the Company's book value in the assets. It is the value of these
clinics that is being written down in connection with the above-referenced
charge. As part of the total consideration for the FPA transaction FHC received
approximately four million shares of FPA common stock and secured notes. The
Company sold all of these shares in the second quarter of 1997 for $79 million
and, during the same period, FPA redeemed all of such notes.
HEADQUARTERS DESIGNATION
On June 25, 1998, the Board of Directors of the Company formally designated
Los Angeles, California as the corporate headquarters of the Company, with the
physical offices of such corporate headquarters to be located in Woodland Hills,
California.
EXECUTIVE OFFICER CHANGES
On August 7, 1998, the Company announced that Malik M. Hasan, M.D. had
retired as Chief Executive Officer of the Company and that Dr. Hasan would
continue as non-executive Chairman of the Board of Directors of the Company
until sometime between September 30, 1998 and March 1, 1999, at which time Dr.
Hasan would resign as Chairman of the Board of Directors and as a director. In
connection with such retirement, the Company and Dr. Hasan entered into an Early
Retirement Agreement which provided for, among other matters, the termination of
Dr. Hasan's Employment Agreement with the Company and for certain payments and
releases, a copy of which agreement has been filed as an exhibit to this
Quarterly Report on Form 10-Q.
Due to Dr. Hasan's retirement, Jay M. Gellert, formerly President and Chief
Operating Officer of the Company, became President and Chief Executive Officer
of the Company as of August 7, 1998. As a result, Mr. Gellert is directly
responsible for the Company's strategic direction with all senior line and staff
management reporting directly to him. The Company also announced that a new
Chairman of the Board of Directors will be named when Dr. Hasan leaves the post
next year.
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this Quarterly Report on Form
10-Q or are incorporated herein by reference:
2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International,
Inc., FH Acquisition Corp. and Foundation Health Corporation (filed as Exhibit 2.5 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is
incorporated by reference herein).
2.2 Agreement and Plan of Merger, dated May 8, 1997, by and among the Company, PHS Acquisition Corp.
and Physicians Health Services, Inc. (filed as Exhibit 2.2 to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and among the
Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.3 to
the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is
incorporated by reference herein).
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant (filed as Exhibit 4.1
to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by
reference herein).
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).
31
10.3 Severance Payment Agreement, dated as of April 25, 1994, among the Company, Health Net and James
J. Wilk (filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
10.4 Severance Payment Agreement dated March 31, 1997 between the Company and Health Net and James J.
Wilk (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 Company's Employee Stock Purchase Plan (filed as Exhibit 10.33 to the Company's Registration
Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is
incorporated by reference herein).
10.14 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35 to Registration
Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein).
32
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).
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 (filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997, which is incorporated by reference herein).
33
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 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).
10.29 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between the Company
and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 10.40 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by
reference herein).
10.30 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).
10.31 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).
10.32 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).
10.33 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).
10.34 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).
10.35 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).
10.36 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).
34
10.37 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation (as amended and restated
September 7, 1995) (filed as Exhibit 4.10 to the Company's Registration Statement on Form S-8
(File No. 333-24621), which is incorporated by reference herein).
10.38 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).
10.39 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).
10.40 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).
10.41 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).
10.42 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).
10.43 Participation Agreement dated as of May 25, 1995 among Foundation Health Medical Services, as
Construction Agent and Lessee, FHC, as Guarantor, First Security Bank of Utah, N.A., as Owner
Trustee, Sumitomo Bank Leasing and Finance, Inc., The Bank of Nova Scotia and NationsBank of
Texas, N.A., as Holders and NationsBank of Texas, N.A., as Administrative Agent for the
Lenders; and Guaranty Agreement dated as of May 25, 1995 by FHC for the benefit of First
Security Bank of Utah, N.A. (filed as an exhibit to FHC's Form 10-K for the year ended June
30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference
herein).
10.44 FHC's Deferred Compensation Plan, as amended and restated (filed as an exhibit to FHC's Form
10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which
is incorporated by reference herein).
10.45 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).
10.46 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).
10.47 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).
10.48 Stock and Note Purchase Agreement by and between FHC, Jonathan H. Schoff, M.D., FPA Medical
Management, Inc., FPA Medical Management of California, Inc. and FPA Independent Practice
Association dated as of June 28, 1996 (filed as Exhibit 10.109 to FHC's Annual Report on Form
10-K for the year ended June 30, 1996, which is incorporated by reference herein).
35
10.49 $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).
10.50 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).
10.51 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).
10.52 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).
10.53 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).
10.54 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).
10.55 $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).
10.56 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).
10.57 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).
36
10.58 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).
10.59 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).
10.60 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).
10.61 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).
10.62 Amended Letter Agreement between the Company and Jay M. Gellert dated as of August 22, 1997
(filed as Exhibit 10.69 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, which is incorporated by reference herein).
10.63 Form of Credit Facility Commitment Letter, dated March 27, 1998, between the Company and the
Majority Banks (as defined therein) (filed as Exhibit 10.70 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein).
10.64 First Amendment and Waiver to Credit Agreement, dated as of April 6, 1998, among the Company,
Bank of America National Trust and Savings Association and the Banks (as defined therein),
(filed as Exhibit 10.64 to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998, which is incorporated by reference herein).
*10.65 Second Amendment to Credit Agreement, dated as of July 31, 1998, among the Company, Bank of
America National Trust and Savings Association and the Banks (as defined therein), a copy of
which is filed herewith.
10.66 Purchase Agreement by and between Foundation Health Corporation and Superior National Insurance
Group, Inc., dated as of May 5, 1998, (filed as Exhibit 10.65 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1998, which is incorporated by reference
herein).
10.67 Employment Letter Agreement between the Company and Dale Terrell dated December 31, 1997 (filed
as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the year ended December 31,
1997, which is incorporated by reference herein).
10.68 Employment Letter Agreement between the Company and Steven P. Erwin dated March 11, 1998 (filed
as Exhibit 10.72 to the Company's Annual Report on Form 10-K for the year ended December 31,
1997, which is incorporated by reference herein).
10.69 Employment Agreement, dated as of December 31, 1997, between the Company and Maurice Costa
(filed as Exhibit 10.73 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, which is incorporated by reference herein).
37
10.70 Employment Agreement, dated as of December 31, 1997, between the Company and Robert L. Natt
(filed as Exhibit 10.74 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, which is incorporated by reference herein).
10.71 Employment Letter Agreement, dated October 10, 1997, between the Company and Alex Labak (filed
as Exhibit 10.75 to the Company's Annual Report on Form 10-K for the year ended December 31,
1997, which is incorporated by reference herein).
10.72 Employment Letter, dated June 9, 1995, between Philip Katz, Ph.D. and Health Net (filed as
Exhibit 10.38 to the Company's Annual Report on Form 10-K for the year ended December 31,
1995, which is incorporated by reference herein).
*10.73 Employment Letter Agreement, dated June 25, 1998, between the Company and B. Curtis Westen, a
copy of which is filed herewith.
*10.74 Employment Letter Agreement, dated July 31, 1998, between the Company and Michael White, a copy
of which is filed herewith.
*10.75 Letter Agreement, dated June 1, 1998, between the Company and The California Wellness
Foundation, a copy of which is filed herewith.
*10.76 Form of Severance Payment Agreement entered into between the Company and various of its
executive officers on April 6, 1998, a copy of which is filed herewith.
*10.77 Early Retirement Agreement, dated as of August 6, 1998, between the Company and Malik M. Hasan,
M.D., a copy of which is filed herewith.
11.1 Statement relative to computation of per share earnings of the Company (included in the notes to
the Financial Statements contained in this Quarterly Report on Form 10-Q).
*21.1 Subsidiaries of the Company, a copy of which is filed herewith.
*27.1 Financial Data Schedule, a copy of which has been filed with the EDGAR version of this filing.
- ------------------------
* A copy of the Exhibit is filed herewith.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed by the Company during the
quarterly period ended June 30, 1998.
38
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: August 14, 1998 By:
-----------------------------------------
Jay M. Gellert
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: August 14, 1998 By:
-----------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
39