<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended DECEMBER 31, 1995
----------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transaction period from to
---------- ------------
Commission File Number 1-10540
---------------
FOUNDATION HEALTH CORPORATION
-------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 68-0014772
- ------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3400 DATA DRIVE, RANCHO CORDOVA, CA 95670
- ----------------------------------- ---------------------------
(Address of principal executive offices) (Zip Code)
(916) 631-5000
- ----------------------------------------------------
(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 January 31, 1996:
COMMON STOCK, $0.01 PAR VALUE 57,568,461
- ----------------------------- -----------------
Class Number of Shares
1
<PAGE>
FOUNDATION HEALTH CORPORATION
INDEX TO FORM 10-Q
PAGE
Part I - Financial Information
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets -
December 31, 1995 and June 30, 1995 3
Condensed Consolidated Statements of Operations for the Quarters
and Six Months Ended December 31, 1995 and 1994 4
Condensed Consolidated Statements of Cash Flows for the Six Months
Ended December 31, 1995 and 1994 5
Notes to Condensed Consolidated Financial Statements 6 - 7
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 8 - 16
Part II - Other Information
Item 1 - Legal Proceedings 17 - 18
Item 4 - Submission of Matters to a Vote of Security Holders 19
Item 6 - Exhibits and Reports on Form 8-K 20
Signature 21
Index to Exhibits 22
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
FOUNDATION HEALTH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, June 30,
------------- --------------
1995 1995
------------- --------------
(Unaudited) (Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 151,180 $ 203,937
Investments 649,460 591,341
Amounts receivable under government contracts 116,186 81,089
Reinsurance receivable 91,109 98,255
Premium and patient receivables, net 116,810 100,727
Property and equipment, net 254,671 230,278
Goodwill and other intangible assets, net 412,835 409,342
Deferred income taxes 56,581 65,673
Other assets 255,396 183,565
------------- --------------
$ 2,104,228 $ 1,964,207
------------- --------------
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Reserves for claims, losses and loss adjustment expenses $ 756,957 $ 700,281
Notes payable and capital leases 213,128 180,054
Amounts payable under government contracts 40,433 47,584
Accrued dividends to policyholders 9,471 16,405
Other liabilities 240,958 262,984
------------- -------------
1,260,947 1,207,308
------------- -------------
Stockholders' Equity
Common stock and additional paid-in capital 519,219 518,671
Retained earnings 325,302 244,249
Unrealized investment gains and losses, net of taxes 1,807 (2,974)
Common stock held in treasury, at cost (3,047) (3,047)
------------ --------------
843,281 756,899
------------ --------------
$ 2,104,228 $ 1,964,207
------------ --------------
------------ --------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
3
<PAGE>
FOUNDATION HEALTH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
Quarter Ended December 31, Six Months Ended December 31,
---------------------------- --------------------------------
1995 1994 1995 1994
------------ ------------ -------------- -----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Commercial premiums $ 477,108 $ 401,788 $ 936,683 $ 792,577
Government contracts 104,815 45,969 185,834 93,947
Specialty services revenue 158,589 127,079 316,013 257,337
Patient service revenue, net 13,255 10,715 24,930 19,964
Investment and other income 14,218 12,998 26,890 29,099
------------ ------------ -------------- -----------
767,985 598,549 1,490,350 1,192,924
------------ ------------ -------------- -----------
Expenses:
Commercial health care services 375,031 312,953 742,429 622,597
Government contracts health care services 64,257 17,236 91,298 29,489
Government contracts subcontractor costs 2,599 15,437 20,815 42,643
Specialty services costs 140,674 108,807 279,126 223,188
Patient service costs 8,560 8,607 17,640 17,256
Selling, general and administrative 97,301 74,393 182,330 146,483
Amortization and depreciation 14,251 10,186 27,692 18,093
Interest expense 3,910 2,953 7,954 5,860
Acquisition and restructuring costs 124,822 124,822
------------ ------------ -------------- -----------
706,583 675,394 1,369,284 1,230,431
------------ ------------ -------------- -----------
Income (loss) before income taxes and
minority interest 61,402 (76,845) 121,066 (37,507)
Provision for income taxes 19,754 (28,070) 40,013 (14,153)
Minority interest 492 2,262
------------ ------------ -------------- -----------
Net income (loss) $ 41,648 $ (49,267) $ 81,053 $ (25,616)
------------ ------------ -------------- -----------
------------ ------------ -------------- -----------
Earnings (loss) per share $ 0.72 $ (0.90) $ 1.40 $ (0.49)
---------- ----------- -------------- -----------
---------- ----------- -------------- -----------
Weighted average common and common
stock equivalent shares outstanding 57,954,054 54,755,405 57,692,110 52,200,075
---------- ---------- -------------- -----------
---------- ---------- -------------- -----------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
<PAGE>
FOUNDATION HEALTH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended December 31,
-----------------------------
1995 1994
-------------- ------------
(Unaudited) (Unaudited)
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 47,936 $ 147,419
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (40,205) (47,862)
Purchases of available for sale investments (310,627) (379,502)
Sales/maturities of available for sale investments 249,702 407,176
Purchases of held to maturity investments (5,278) (27,883)
Maturities of held to maturity investments 14,377 65,160
Increase in goodwill, intangibles and other assets (30,023) (83,645)
Acquisition of businesses, net of cash acquired (6,034) (30,735)
------------- ------------
Net cash used for investing activities (128,088) (97,291)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable and capital leases 40,016 23,048
Principal payments on notes payable and capital leases (11,965) (34,549)
Proceeds and tax benefits from issuance of common stock
and exercise of stock options 16,901 6,694
Stock repurchase and other merger related adjustments (17,557)
------------- ------------
Net cash provided by (used for) financing activities 27,395 (4,807)
------------- ------------
Net (decrease) increase in cash and cash equivalents (52,757) 45,321
Cash and cash equivalents, beginning of period 203,937 165,209
------------- ------------
Cash and cash equivalents, end of period $ 151,180 $ 210,530
------------- ------------
------------- ------------
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid $ 7,437 $ 7,392
------------- ------------
------------- ------------
Income taxes paid $ 1,825 $ 23,959
------------- ------------
------------- ------------
Noncash investing activities:
Transfer of investments from held to maturity to available for sale $ 9,009 $
------------- ------------
------------- ------------
Acquisition of businesses:
Assets acquired $ 7,074 $ 373,422
Liabilities assumed (854) (48,515)
Issuance of notes payable (9,600)
Issuance of common stock (274,017
------------- ------------
Cash paid 6,220 41,290
Fees and expenses 6,553
Less cash acquired (186) (17,108)
------------- ------------
Net cash paid $ 6,034 $ 30,735
------------- ------------
------------- ------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
5
<PAGE>
FOUNDATION HEALTH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited consolidated financial
statements include all adjustments necessary for a fair presentation of the
consolidated financial position of Foundation Health Corporation (the "Company")
and the consolidated results of its operations and its cash flows for the
interim periods presented. Although the Company believes that the disclosures
in these financial statements are adequate to make the information presented not
misleading, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission ("SEC"). For further information
refer to the consolidated financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended June 30, 1995. Results
of operations for the interim periods are not necessarily indicative of results
to be expected for the full year.
NOTE 2 - RESTRUCTURING COSTS
In connection with several mergers in November 1994 the Company recorded a
charge of $124.8 million to operations during the quarter ended December 31,
1994 which represents the costs of acquiring and consolidating the companies'
management information systems and administrative functions and positioning the
Company to take advantage of best practices in health care delivery systems and
managed care techniques after the mergers. As of December 31, 1995, $84.9
million in merger, integration and restructuring costs had been paid or
otherwise charged against the $124.8 million accrual. Management will continue
to review estimates of costs to be incurred during the remainder of the year.
The progress of the Plan and the actual amounts incurred could vary from these
estimates if future developments differ from the underlying assumptions used by
management in developing the recorded accrual.
6
<PAGE>
NOTE 3 - INVESTMENTS
Investments comprised the following (in thousands):
<TABLE>
<CAPTION>
December 31, 1995 June 30, 1995
----------------- -------------
<S> <C> <C>
Available for sale $617,887 $541,596
Held to maturity 31,573 49,745
-------- --------
$649,460 $591,341
-------- --------
-------- --------
</TABLE>
For purposes of calculating realized gains and losses on sales of investments
available for sale, the amortized cost of each investment sold is used.
NOTE 4 - CAPITAL STOCK
The Company has a stock repurchase program to acquire from time to time up to
5.7 million shares of the Company's common stock in the open market. As of
December 31, 1995 the Company had repurchased a total of 1,795,500 shares
pursuant to this program.
NOTE 5 - RECENTLY ISSUED ACCOUNTING STANDARDS
In October 1995, the Financial Accounting Standards Board issued Statement No.
123, "ACCOUNTING FOR STOCK-BASED COMPENSATION". The new standard defines a fair
value method of accounting for stock options and other equity instruments, such
as stock purchase plans. Under this method, compensation cost is measured on
the fair value of the stock award when granted and is recognized as expense over
the service period, which is usually the vesting period. This standard will be
effective for the Company beginning in fiscal 1997, and requires measurement of
awards made on or after December 15, 1995.
The new standard permits companies to continue to account for equity
transactions with employees under existing accounting rules, but requires
disclosure in a note to the financial statements of the pro forma net income and
earnings per share as if the Company had applied the new method of accounting.
The Company intends to follow the disclosure requirements for its employee stock
plans. The new standard will also require that all stock-based transactions
with non-employees be measured in accordance with the fair value method and
recorded as expense. The Company has not determined the effect, if any, of
implementing this standard on its results of operations.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
Foundation Health Corporation (the "Company") is an integrated managed care
organization which administers the delivery of managed health care services.
The Company's operations consist of three primary lines of business: (i)
commercial operations, which includes group, Medicaid, individual and Medicare
health maintenance organization ("HMO") and preferred provider organization
("PPO") plans; (ii) government contracts; and (iii) specialty services, which
includes managed care products related to workers' compensation insurance,
administration and cost-containment, behavioral health, dental, vision and
pharmaceutical products and services.
Commercial HMO and PPO operations are characterized by the assumption of
underwriting risk in return for premium revenue. Government contracts consist
of contractual services to state and federal government programs such as CHAMPUS
and Medicaid in which the Company receives revenues for administrative and
management services and, under most of the contracts, also accepts financial
responsibility for health care costs. Specialty services consists both of
operations in which the Company assumes underwriting risk in return for premium
revenue, including managed care workers' compensation insurance and behavioral
health, dental and vision HMO products, and operations in which the Company
provides administrative services only, including certain of the behavioral
health and pharmacy benefits management programs, workers' compensation third
party administration and bill review services and administrative-only products
and services.
In fiscal year 1995, the Company was awarded two contracts to establish managed
care programs for up to 230,000 eligible CHAMPUS beneficiaries in Washington and
Oregon (the "Washington/Oregon Contract") and up to 590,000 eligible CHAMPUS
beneficiaries in Oklahoma and most of Arkansas, Louisiana and Texas (the "Region
6 Contract"). Implementation of the Washington/Oregon Contract commenced in
September 1994 and the delivery of health care services commenced in March 1995.
Implementation of the Region 6 Contract commenced in April 1995 and the delivery
of health care services commenced in November 1995. Each of these contracts has
a five year term. In August 1995, the Company was awarded a contract to
establish a managed care program for up to 720,000 eligible CHAMPUS
beneficiaries in California and Hawaii (the "California/Hawaii Contract").
Implementation of the contract commenced in September 1995 with the provision of
health care services scheduled to begin in April 1996. Two unsuccessful bidders
have filed independent actions for injunctive relief against the award of the
California/Hawaii Contract to the Company. At the present time, requests for
preliminary injunction have either been denied or withdrawn in both actions;
future hearings on the actions have been set after the April 1, 1996 scheduled
commencement date of the provision of health care services by the Company under
such Contract. The Contract has a term of up to five years. In October 1995,
the Company was awarded four Medicaid contracts to establish a managed care
program to cover up to
8
<PAGE>
approximately 800,000 eligible beneficiaries in four California counties.
Certain of these Medicaid contracts are being protested by unsuccessful
bidders. The Company anticipates that implementation of one of the contracts
will commence in July 1996 with the remainder to be implemented in Fall
1996. The contracts have terms extending through March 2002.
In January 1996 a definitive agreement was reached to acquire Managed Health
Network, Inc. ("MHN"), a privately held company providing employee assistance
and managed behavioral health programs to more than 2.7 million covered lives
through its subsidiaries, in a stock-for-stock, pooling of interests
transaction valued at approximately $45 million. Completion of the transaction
is subject to certain closing conditions, including approval by the California
Department of Corporations. Following the closing, the Company intends to
expense the costs related to the merger and to combining MHN with its existing
businesses, which costs are expected to total approximately $4.2 million in the
quarter in which the transaction is consummated, currently anticipated to be the
quarter ended March 31, 1996.
When used in this Quarterly Report on Form 10-Q and the documents incorporated
herein by reference the words "estimate", " project", "anticipate", "expect"
and similar expressions are intended to identify forward-looking statements.
Such statements are subject to certain risks and uncertainties, including
those discussed below, in the Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Company's Form 10-K for
the fiscal year ended June 30, 1995 and in the Risk Factors section of the
Proxy Statement/Prospectus contained in the Company's recently filed
Registration Statement on Form S-4 (File No. 333-00517) for the acquisition of
MHN (which parts of the Form 10-K and Form S-4 are incorporated herein by
reference) that could cause actual results to differ materially from those
projected. Readers are cautioned not to place undue reliance on these forward-
looking statements which speak only as of the date hereof.
9
<PAGE>
CONSOLIDATED OPERATING RESULTS
The Company achieved significant increases in revenues and earnings for the
quarter and six months ended December 31, 1995 over the same periods in fiscal
year 1995. The growth in revenues was primarily driven by commercial enrollment
gains, especially from the Company's individual and Medicare risk products,
growth in net earned workers' compensation premium revenue due to growth in the
number of policies written and delivery of health care services under the
Washington/Oregon and Region 6 Contracts.
The Company's selling, general and administrative ("SG&A") expenses in the
quarter and six months ended December 31, 1995 increased due primarily to
implementation of the additional government contracts in this period compared to
only the Washington/Oregon contract in the prior period and continued growth in
commercial enrollment in existing service areas and geographic expansion. The
increase in the SG&A ratio for the quarter ended December 31, 1995 compared to
the prior year quarter is due to continued competitive pricing pressures on
commercial products and administrative expenses associated with the additional
government contracts.
The effective tax rate decreased for the quarter and six months ended December
31, 1995 as compared with the corresponding periods in the preceding year
because of the effect of non-deductible acquisition costs in the preceding year.
As of December 31, 1995, $84.9 million in merger, integration and restructuring
costs had been paid or otherwise charged against the $124.8 million accrual
recorded in the quarter ended December 31, 1994. Management will continue to
review estimates of costs to be incurred during the remainder of the year. The
progress of the Plan and the actual amounts incurred could vary from these
estimates if future developments differ from the underlying assumptions used by
management in developing the recorded accrual. The Company expects that this
restructuring will result in operating cost savings in excess of the amount of
the charge.
As a result of the factors described above and the Company's continued focus on
cost containment while increasing revenues, the Company's income before income
taxes and minority interest increased over the same period in fiscal year 1995.
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 and pending legislation affecting the way in which managed care
companies have historically operated, integration of acquired companies,
regulatory changes, health care utilization, new technologies, hospital costs,
evolving theories of recovery, major epidemics and numerous other external
influences
10
<PAGE>
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 performance to anticipate results or
future period trends.
LINE OF BUSINESS REPORTING
The Company operates in a single industry segment, managed health care. The
following table presents financial information reflecting the Company's
operations by its three primary lines of business: (i) commercial operations;
(ii) government contracts; and (iii) specialty services.
11
<PAGE>
FOUNDATION HEALTH CORPORATION
LINE OF BUSINESS FINANCIAL INFORMATION
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Quarter Ended
Quarter Ended December 31, 1995 December 31, 1994
----------------------------------------------------------------------
Percent Percent Percent
Amount or of Total Increase Amount or of Total
Percent Revenue (Decrease) Percent Revenue
------------- --------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Revenues:
Commercial premiums $ 477,108 62.1 % 18.7 % $ 401,788 67.1 %
Government contracts 104,815 13.6 128.0 45,969 7.7
Specialty services revenue 158,589 20.7 24.8 127,079 21.2
Patient service revenue, net 13,255 1.7 23.7 10,715 1.8
Investment and other income 14,218 1.9 9.4 12,998 2.2
------------- ------- ------------ -------
767,985 100.0 28.3 598,549 100.0
------------- ------- ------------ -------
Expenses:
Commercial health care services 375,031 48.8 19.8 312,953 52.3
Government contracts health care services 64,257 8.4 272.8 17,236 2.9
Government contracts subcontractor costs 2,599 0.3 (83.2) 15,437 2.6
Specialty services costs 140,674 18.3 29.3 108,807 18.2
Patient service costs 8,560 1.1 (0.5) 8,607 1.4
Selling, general and administrative ("SG&A") 97,301 12.7 30.8 74,393 12.4
Amortization and depreciation 14,251 1.9 39.9 10,186 1.7
Interest expense 3,910 0.5 32.4 2,953 0.4
Acquisition and restructuring costs (100.0) 124,822 20.9
------------- ------- ------------ --------
706,583 92.0 4.6 675,394 112.8
------------- ------- ------------ --------
Income before income taxes and minority interest 61,402 8.0 n/a (76,845) (12.8)
Provision for income taxes 19,754 2.6 n/a (28,070) (4.7)
Minority interest (100.0) 492 0.1
------------- ------- ------------ --------
Net income $ 41,648 5.4 % n/a $ (49,267) (8.2) %
------------- ------- ------------ --------
------------- ------- ------------ --------
Earnings per share $ 0.72 n/a $ (0.90)
------------- ------------
------------- ------------
Weighted average common and common
stock equivalent shares outstanding 57,954,054 5.8 54,755,405
------------- ------------
------------- ------------
Operating ratios:
Commercial loss ratio 78.6 % 77.9%
Government contracts ratio 63.8 71.1
Specialty services ratio 88.7 85.6
Patient service ratio 64.6 80.3
SG&A to total revenues 12.7 12.4
Effective tax rate 32.2 36.5
Enrollment (in thousands):
Commercial:
Group and individual 1,090 21.9 894
Medicare risk 78 32.2 59
Medicaid 122 (1.6) 124
------------- ------------
1,290 19.8 1,077
------------- ------------
Government:
CHAMPUS PPO and indemnity 668 704.8 83
CHAMPUS HMO 194 618.5 27
------------- ------------
862 683.6 110
------------- ------------
Combined 2,152 81.3 1,187
------------- ------------
------------- ------------
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended
Six Months Ended December 31, 1995 December 31, 1994
------------------------------------------------------------------------
Percent Percent Percent
Amount or of Total Increase Amount or of Total
Percent Revenue (Decrease) Percent Revenue
------------- --------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Commercial premiums $ 936,683 62.8 % 18.2 % $ 792,577 66.4 %
Government contracts 185,834 12.5 97.8 93,947 7.9
Specialty services revenue 316,013 21.2 22.8 257,337 21.6
Patient service revenue, net 24,930 1.7 24.9 19,964 1.7
Investment and other income 26,890 1.8 (7.6) 29,099 2.4
--------------- --------- ----------- --------
1,490,350 100.0 24.9 1,192,924 100.0
-------------- --------- ----------- --------
Expenses:
Commercial health care services 742,429 49.9 19.2 622,597 52.1
Government contracts health care services 91,298 6.1 209.6 29,489 2.5
Government contracts subcontractor costs 20,815 1.4 (51.2) 42,643 3.6
Specialty services costs 279,126 18.7 25.1 223,188 18.7
Patient service costs 17,640 1.2 2.2 17,256 1.4
Selling, general and administrative ("SG&A") 182,330 12.2 24.5 146,483 12.3
Amortization and depreciation 27,692 1.8 53.1 18,093 1.5
Interest expense 7,954 0.6 35.7 5,860 0.5
Acquisition and restructuring costs (100.0) 124,822 10.5
------------- ------- ---------- --------
1,369,284 91.9 11.3 1,230,431 103.1
------------- ------- ---------- --------
Income before income taxes and minority interest 121,066 8.1 n/a (37,507) (3.1)
Provision for income taxes 40,013 2.7 n/a (14,153) (1.2)
Minority interest (100.0) 2,262 0.2
------------- ------- ----------- --------
Net income $ 81,053 5.4 % n/a $ (25,616) (2.1) %
------------- ------- ----------- --------
------------- ------- ----------- --------
Earnings per share $ 1.40 n/a $ (0.49)
------------- -----------
------------- -----------
Weighted average common and common
stock equivalent shares outstanding 57,692,110 10.5 52,200,075
------------- ----------
------------- ----------
Operating ratios:
Commercial loss ratio 79.3 % 78.6 %
Government contracts ratio 60.3 76.8
Specialty services ratio 88.3 86.7
Patient service ratio 70.8 86.4
SG&A to total revenues 12.2 12.3
Effective tax rate 33.1 37.7
</TABLE>
12
<PAGE>
COMMERCIAL OPERATIONS
Revenues generated by the Company's commercial operations increased in the
quarter and six months ended December 31, 1995 over the same periods in the
prior year due in part to an approximate 20% increase in enrollment from
existing lines of business and geographic expansion offset by reductions in
commercial premium revenue per member due to competitive price pressures.
The Company expects continued pressure from employer groups and government
agencies to reduce premiums. Effective July 1, 1995, Medicaid HMO rates in
Florida were reduced by approximately 18%, which have affected commercial
premium revenues. Health care costs on a per member basis increased slightly
for the quarter ended December 31, 1995 as compared to the quarter ended
December 31, 1994. The commercial loss ratio increased from 77.9% for the
quarter and 78.6% for the six months ended December 31, 1994 to 78.6% for the
quarter and 79.3% for the six months ended December 31, 1995. The slight
increase in the ratio for the quarter and six months ended December 31, 1995 was
due to the continued competitive premium pressures in California offset in part
by the greater profitability of the Company's Florida and Arizona HMOs. The
Company believes that the pressures on margins will continue, which may
adversely affect the commercial loss ratio; however, the Company will seek to
mitigate any increase in the loss ratio by the cost management efforts
previously described. In addition, as the Company's Medicare risk business
increases, the loss ratio may increase, as historically this product has a
higher loss ratio than the Company's other HMO and indemnity insurance
businesses.
GOVERNMENT CONTRACTS
Government contracts revenue increased in the quarter and six months ended
December 31, 1995 over the same periods in the prior year primarily due to the
Washington/Oregon, Region 6 and California/Hawaii Contracts offset by decreases
in revenue as a result of expiration of the CHAMPUS Reform Initiative ("CRI")
Contract and the Base Realignment and Closure ("BRAC") Contract.
The government contracts ratio improved during the quarter ended December 31,
1995 compared to the quarter ended December 31, 1994. This was due primarily to
several of the contracts being in the implementation period. Comparability of
the government contracts ratio between periods is dependent on the mix of the
contracts that are in the implementation phase versus contracts that are in the
health care delivery phase. Administrative expenses relating to both phases are
recorded as part of SG&A. Once the delivery of health care services begins the
expenses related to health care services are recorded either as government
contracts health care services or as government contracts subcontractor costs.
The government contracts ratio is expected to increase during the remainder of
fiscal year 1996 as a result of a full year of delivery of health care services
under the Washington/Oregon Contract and delivery of health care services under
the Region 6 Contract which commenced in November 1995 and the California/Hawaii
Contract which is scheduled to commence in April 1996.
13
<PAGE>
SPECIALTY SERVICES
Specialty services revenues increased in the quarter and six months ended
December 31, 1995 over the same periods in the prior year due to increased
workers' compensation insurance premiums generated by California Compensation
Insurance Company and its subsidiaries ("CalComp"), the Company's workers'
compensation insurance subsidiary and to increased revenue generated by the
Company's pharmaceutical subsidiary. CalComp's net premium revenue totaled $112
and $217 million for the quarter and six months ended December 31, 1995 compared
to $90 and $185 million for the same periods in the prior year, with increases
of 24.4% and 17.3%. The increase in CalComp's net premium revenue was a result
of growth in the number of new workers' compensation policies written
predominately in states outside of California. The premium volume increase was
offset in part by a 16% mandatory reduction in the minimum premium rate for all
policies in force effective October 1, 1994 and the effect of deregulation in
the California workers' compensation market, which allowed premium rates to be
set on a competitive basis for new policies written after January 1, 1995.
Revenues generated by the pharmaceutical subsidiary totaled $9.4 and $23.6
million for the quarter and six months ended December 31, 1995 as compared with
$2.2 and $4.3 million for the comparable periods in the preceding year primarily
due to increased pharmaceutical rebate revenue earned. Specialty services
costs, which includes health care and administrative costs, increased $31.9 and
$55.9 million for the quarter and six months ended December 31, 1995 over the
comparable prior year periods principally as a result of an increase in
CalComp's workers' compensation business as discussed below and pharmaceutical
rebate costs corresponding to the increase rebate revenue.
The specialty services ratio (specialty services costs as a percentage of
specialty services revenues) for the quarter and six months ended December 31,
1995 has increased when compared with the same periods in the prior year.
Reasons for this change are discussed below.
Four ratios are traditionally used to measure underwriting performance of
workers' compensation companies: the loss and loss adjustment expense ratio, the
underwriting expense ratio and the policyholder dividend ratio, which when added
together constitute the combined ratio. A combined ratio of greater than 100%
reflects an underwriting loss, while a combined ratio of less than 100%
indicates an underwriting profit.
The following table sets forth CalComp's underwriting experience as measured by
its combined ratio and its components (computed on a generally accepted
accounting principles basis) for the quarters and six months ended December 31,
1995 and 1994:
14
<PAGE>
<TABLE>
<CAPTION>
December 31,
-----------
1995 1994
---------------- ----------------
Six Six
Months Months
Quarter Ended Quarter Ended
------- ----- ------- ------
<S> <C> <C> <C> <C>
Loss and loss adjustment expense ratio 64.8% 65.2% 72.6% 67.0%
Underwriting expense ratio 23.4 22.7 13.4 19.4
Policy holder dividend ratio 1.5 2.1 3.3 2.2
----- ----- ----- -----
Combined ratio 89.7 % 90.0 % 89.3% 88.6%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
CalComp's loss and loss adjustment expense ratio decreased to 64.8% and 65.2%
for the quarter and six months ended December 31, 1995, from 72.6% and 67.0% for
the comparable periods in 1994. During the quarter, the experience for loss and
loss adjustment expenses incurred for accident years 1994 and prior continued to
reflect the same favorable overall claim trends that have emerged during the
fist three calendar quarters of 1995. For accident year 1995, while Cal Comp
has experienced an increase in reported claims, this has been primarily
mitigated by a decrease in the average cost per claim, through the use of
managed care techniques that reduce the medical component of each claim.
During the quarter and six months ended December 31, 1994, a reclassification
was made between losses incurred and underwriting expenses incurred related to
Cal Comp's quota share reinsurance agreement.
The policyholder dividend ratio decreased to 1.5% for the quarter ended
December 31, 1995 from 3.3% for the comparable quarter in 1994. The decrease
in this ratio is due to the pricing changes under California's workers'
compensation competitive rating in 1995, as reforms and increased price
competition have resulted in lower accrued dividends which are estimated to be
paid after a policy expires. This increase in price competition in California
in 1995 has resulted in reduced premiums at policy inception in lieu of
policyholder dividends paid after policy expiration.
LIQUIDITY AND CAPITAL RESOURCES
The net cash provided by operating activities was $47.9 million for the six
months ended December 31, 1995 as compared to net cash provided by operating
activities of $147.4 million for the comparable period in fiscal year 1995.
The change in the net cash provided by operating activities for the six months
ended December 31, 1995 as compared with the same period in the prior year is
principally due to timing of the receipt or payment of amounts under government
contracts. The Company's cash and investments increased from $795.3 million at
June 30, 1995 to $800.6 million at December 31, 1995. The Company invests its
cash in investment grade securities.
15
<PAGE>
During fiscal year 1996, the Company expects capital expenditures to approximate
$67.8 million, primarily consisting of $47.7 million for the purchase of
computer hardware and software systems; $15.3 million for the purchase of
furniture and equipment primarily for health care centers and the hospitals; and
$4.8 million for other requirements. The Company anticipates the net costs of
operating and managing the health care centers for fiscal year 1996 will
approximate $20 million, offset in part by health care cost savings anticipated
to be realized by the Company's HMOs. Other assets increased over the amount at
June 30, 1995 due to increases in pharmacy rebates and trade receivables and the
cash surrender value of life insurance policies related to the non-qualified
defined benefit pension plans.
In January 1996, the Company's four affiliated independent practice associations
("IPAs") (IPAs each owned by Company-affiliated physicians) were sold to a
publicly-traded physician practice management company for a purchase price
consisting of cash and a promissory note payable over 10 years. The Company
collected notes receivable under the Company's credit agreements with the IPAs
in the amount of $10 million in connection with the transaction.
The anticipated level of capital expenditures in fiscal year 1996 for
construction of health care centers and corporate facilities has been impacted
as a result of the Company's $60 million tax-retention operating lease financing
with NationsBank of Texas, N.A., as Administrative Agent for the lenders thereto
and First Security Bank of Utah, N.A., as Owner Trustee (the "TROL" financing).
The Company expects that up to $32 million of the TROL financing will be used
during fiscal year 1996 for the construction of health care centers and
corporate facilities.
In December 1994, the Company established a $300 million unsecured revolving
credit agreement with Citicorp USA, Inc. as Administrative Agent for the lenders
thereto (the "Credit Agreement"). As of December 31, 1995, the Company has
drawn $60 million on the Credit Agreement.
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state HMO and insurance laws and
regulations, and 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 material compliance with these contractual and
regulatory requirements.
Management of the Company continually evaluates opportunities to expand the
Company's commercial and specialty services operations; however, the Company
currently has no material commitments for future use of its current or expected
levels of available cash resources except as described above. The Company's
expansion options may include additional acquisitions and internal development
of new products and programs.
16
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of its business, the Company is a party to claims and
legal actions by enrollees, providers and others. The Company's operations are
subject to extensive state and federal regulation. Such regulation is subject
to change, and the impact of potential changes on the Company's business cannot
be determined. There can be no assurance that the Company will be able to
obtain or maintain any necessary governmental approvals to continue to implement
its business strategy of product growth and geographic expansion. The Company
is in the process of seeking accreditation by the National Committee on Quality
Assurance ("NCQA") of its Florida HMO operations, which accreditation is a
condition of doing business as an HMO in that state. Failure to obtain
accreditation within specific time frames could result in suspension of
enrollment levels or revocation of licensure, which could have a material
adverse effect on the Company's future operations results. Other states and
employer groups are increasingly requiring NCQA accreditation as a condition to
purchasing health care benefits from managed care companies.
Where the Company provides services under government contracts, the respective
federal and state agencies possess significant powers to review, audit and
control the contractual relationship. The Company is subject to and currently
is undergoing extensive governmental audits and investigations with respect to
certain of its Medicaid and Medicare contracts and the operations of its
commercial HMO and insurance subsidiaries, including by the federal Health Care
Financing Administration ("HCFA"), the California Department of Corporations and
various state Departments of Health and Insurance. The Company is subject to
federal and state legislation prohibiting activities and arrangements that
provide economic inducements for the referral of business or other activities
that may be deemed to constitute "fraud or abuse" under government programs.
The Company, like many other government contractors, is subject to
private lawsuits by persons (generally employees or former employees) who may
assert the rights of the government by filing an action under seal if such
person purports to have information that the contractor submitted a claim
to the government that could be false. Upon filing, the government has
the opportunity to intervene and assume control of the case. The Company has
been informed of two such complaints; the Company has not seen the complaints
as they remain subject to seal. These matters are in the very preliminary stages
and the Company is cooperating with, and responding to, the respective
government authorities in these actions.
The results of such government audits, investigations or lawsuits, which may
continue past the termination of such contracts, may result in reimbursement to
the government of amounts previously paid, or the imposition of significant
penalties or limitation of marketing under, or cessation of participation in,
these programs.
17
<PAGE>
After consulting with legal counsel, the Company believes that any liability
that may ultimately be incurred as a result of the claims, legal actions,
investigations or audits described above will not have a material adverse effect
on the consolidated financial position or results of operations of the Company.
See "Government Regulation" and "Legal Proceedings" in the Company's Annual
Report on Form 10-K for the fiscal year ended June 30, 1995, which are
incorporated herein by reference, for a further description of audits,
investigations, claims and legal proceedings to which the Company and certain of
its subsidiaries are subject.
18
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on Tuesday, November
14, 1995. The matters voted upon and the vote obtained with respect to
each matter is as follows:
(i) Election of Directors
<TABLE>
<CAPTION>
<S> <C> <C>
Name Votes For Votes Withheld
----- --------- --------------
Daniel D. Crowley 47,500,799 151,293
David A. Boggs 47,598,607 53,485
Jeffrey L. Elder 47,519,289 132,803
Earl B. Fowler 47,596,246 55,846
Richard W. Hanselman 47,520,031 132,061
Ross D. Henderson, M.D. 47,393,555 258,537
Frank A. Olson 47,598,484 53,608
Richard J. Stegemeier 47,597,499 54,593
Steven D. Tough 47,536,896 115,196
Raymond S. Troubh 47,580,933 71,159
</TABLE>
(ii) Ratification of Appointment of Deloitte & Touche LLP as Foundation
Health Corporation's independent auditors for the fiscal year ended June
30, 1996:
FOR 47,593,349
AGAINST 30,386
ABSTAIN 28,357
19
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.102(1) - Agreement and Plan of Reorganization dated as of January 9,
1996 by and between Foundation Health Corporation and
Managed Health Network, Inc.
11 - Earnings Per Share Computation
(b) Reports on Form 8-K
There were no reports on Form 8-K filed by Foundation Health Corporation
during the quarter ended December 31, 1995.
______________________________________________________________
(1) Incorporated by reference to Annex 1 of the Proxy Statement/
Prospectus contained in the Company's Registration Statement on Form S-4
(File No. 333-00517).
20
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FOUNDATION HEALTH CORPORATION
Dated: February 14, 1996 By: /S/ Jeffrey L. Elder
---------------------
JEFFREY L. ELDER
SENIOR VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
21
<PAGE>
FOUNDATION HEALTH CORPORATION
INDEX TO EXHIBITS
EXHIBIT NO. PAGE
10.102(1) Agreement and Plan of Reorganization dated as of
January 9, 1996 by and between Foundation Health
Corporation and Managed Health Network, Inc. (1) -
11 Earnings Per Share Computation 23
_______________________________________________________________________
(1) Incorporated by reference to Annex 1 of the Proxy Statement/
Prospectus contained in the Company's Registration Statement on Form S-4
(File No. 333-00517).
22
<PAGE>
FOUNDATION HEALTH CORPORATION
EXHIBIT 11
Earnings Per Share Computation
Utilizing the Treasury Stock Method
(Dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
Quarter Ended December 31, Six Months Ended December 31,
--------------------------- -------------------------------
1995 1994 1995 1994
------------ ------------- ------------- ---------------
<S> <C> <C> <C> <C>
Proceeds upon exercise of options outstanding $ 104,499 $ 55,100
----------- ------------
----------- ------------
Average market price of common stock $ 41.83 $ 33.86
----------- ------------
----------- ------------
Weighted average common shares outstanding 57,277,763 54,755,405
Issued shares- exercise of options 3,174,637
Shares assumed to be repurchased with proceeds from exercise (2,498,346)
----------- ------------ ------------- ------------
Weighted average shares outstanding (A) 57,954,054 54,755,405 57,692,110 52,200,075
----------- ------------ ------------- ------------
----------- ------------ ------------- ------------
Net income (loss) for the period (B) $ 41,648 $ (49,267) $ 81,053 $ (25,616)
----------- ------------ --------------- -------------
----------- ------------ --------------- -------------
Earnings (loss) per share (B)/(A) $ 0.72 $ (0.90) $ 1.40 $ (0.49)
----------- ------------ --------------- -------------
----------- ------------ --------------- -------------
</TABLE>
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Form 10-Q filed by Foundation Health Corporation for the quarter ended
December 31, 1995 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> DEC-31-1995
<CASH> 151,180
<SECURITIES> 649,460
<RECEIVABLES> 324,105
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 254,671 <F1>
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,104,228
<CURRENT-LIABILITIES> 0
<BONDS> 213,128
0
0
<COMMON> 519,219
<OTHER-SE> 324,062
<TOTAL-LIABILITY-AND-EQUITY> 2,104,228
<SALES> 753,767
<TOTAL-REVENUES> 767,985
<CGS> 0
<TOTAL-COSTS> 706,583
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,910
<INCOME-PRETAX> 61,402
<INCOME-TAX> 19,754
<INCOME-CONTINUING> 41,648
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 41,648
<EPS-PRIMARY> .72
<EPS-DILUTED> 0
<FN>
<F1> Net PP&E
</FN>
</TABLE>
