<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 March 31, 1996
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 April 30, 1996:
Common Stock, $0.01 par value 58,712,110
- ----------------------------- -----------------
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 -
March 31, 1996 and June 30, 1995 3
Condensed Consolidated Statements of Operations for the Quarters
and Nine Months Ended March 31, 1996 and 1995 4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended March 31, 1996 and 1995 5
Notes to Condensed Consolidated Financial Statements 6 - 8
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 -18
Part II - Other Information
Item 1 - Legal Proceedings 19 - 20
Item 6 - Exhibits and Reports on Form 8-K 21
Signature 22
Index to Exhibits 23
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
March 31, June 30,
--------------- ------------
1996 1995
--------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 99,277 $ 203,937
Investments 690,640 591,341
Amounts receivable under government contracts 138,806 81,089
Reinsurance receivable 100,532 98,255
Premium and patient receivables, net 135,374 100,727
Property and equipment, net 270,555 230,278
Goodwill and other intangible assets, net 413,509 409,342
Deferred income taxes 59,732 65,673
Other assets 266,815 183,565
--------------- ------------
$ 2,175,240 $ 1,964,207
--------------- ------------
--------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Reserves for claims, losses and loss adjustment expenses $ 792,541 $ 700,281
Notes payable and capital leases 215,849 180,054
Amounts payable under government contracts 44,614 47,584
Accrued dividends to policyholders 10,203 16,405
Other liabilities 223,563 262,984
--------------- ------------
1,286,770 1,207,308
--------------- ------------
Stockholders' Equity
Common stock and additional paid-in capital 529,556 518,671
Retained earnings 367,150 244,249
Unrealized investment gains and losses, net of taxes (5,189) (2,974)
Common stock held in treasury, at cost (3,047) (3,047)
--------------- ------------
888,470 756,899
--------------- ------------
$ 2,175,240 $ 1,964,207
--------------- ------------
--------------- ------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
3
<PAGE>
<TABLE>
<CAPTION>
FOUNDATION HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Quarter Ended March 31, Nine Months Ended March 31,
------------------------------ -----------------------------
1996 1995 1996 1995
---------- ----------- ----------- -----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Commercial premiums $ 512,550 $ 427,454 $ 1,449,233 $ 1,220,031
Government contracts 147,347 40,889 333,181 134,836
Specialty services revenue 178,676 121,882 494,689 379,219
Patient service revenue, net 12,185 12,490 37,115 32,454
Investment and other income 17,094 12,914 43,984 42,013
---------- --------- --------- ----------
867,852 615,629 2,358,202 1,808,553
---------- --------- --------- -----------
Expenses:
Commercial health care services 408,515 330,655 1,150,944 953,252
Government contracts health care services 98,665 17,308 189,963 46,797
Government contracts subcontractor costs 4,397 12,859 25,212 55,502
Specialty services costs 156,866 102,335 435,992 325,523
Patient service costs 9,118 9,076 26,758 26,332
Selling, general and administrative 110,397 71,632 292,727 218,115
Amortization and depreciation 15,490 11,096 43,182 29,189
Interest expense 3,602 2,854 11,556 8,714
Acquistion and restructuring costs 124,822
---------- --------- ---------- -----------
807,050 557,815 2,176,334 1,788,246
---------- --------- ---------- -----------
Income before income taxes and
minority interest 60,802 57,814 181,868 20,307
Provision for income taxes 18,954 21,523 58,967 7,370
Minority interest 2,262
---------- ---------- --------- ---------
Net income $ 41,848 $ 36,291 $ 122,901 $ 10,675
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Earnings per share $ 0.72 $ 0.63 $ 2.12 $ 0.20
---------- ---------- --------- ---------
---------- ---------- --------- ---------
Weighted average common and common
stock equivalent shares outstanding 58,412,472 57,358,480 57,972,132 53,892,518
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
<PAGE>
FOUNDATION HEALTH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended March 31,
---------------------------------
1996 1995
(Unaudited) (Unaudited)
--------------- ------------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 59,669 $ 197,359
--------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (61,542) (68,562)
Purchases of available for sale investments (504,408) (582,475)
Sales/maturities of available for sale investments 391,166 591,800
Purchases of held to maturity investments (6,277) (29,627)
Maturities of held to maturity investments 16,270 70,205
Increase in goodwill, intangibles and other assets (32,589) (88,199)
Acquisition of businesses, net of cash acquired (1,813) (41,874)
--------------- ------------
Net cash used for investing activities (199,193) (148,732)
--------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable and capital leases 42,818 44,175
Principal payments on notes payable and capital leases (11,005) (37,701)
Proceeds and tax benefits from issuance of common stock
and exercise of stock options 20,608 12,354
Stock repurchase and other merger related adjustments (17,557) (3,047)
--------------- ------------
Net cash provided by financing activities 34,864 15,781
--------------- ------------
Net (decrease) increase in cash and cash equivalents (104,660) 64,408
Cash and cash equivalents, beginning of period 203,937 165,209
--------------- ------------
Cash and cash equivalents, end of period $ 99,277 $ 229,617
--------------- ------------
--------------- ------------
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid $ 8,603 $ 8,389
--------------- ------------
--------------- ------------
Income taxes paid $ 2,112 $ 24,317
--------------- ------------
--------------- ------------
Noncash investing activities:
Transfer of amounts from held to maturity to available
for sale $ 9,009 $
--------------- ------------
--------------- ------------
Acquisition of businesses:
Assets acquired $ 26,090 $ 392,509
Liabilities assumed (13,239) (49,506)
Issuance of notes payable (7,909)
Issuance of common stock (6,631) (274,017)
--------------- ------------
Cash paid 6,220 61,077
Less cash acquired (4,407) (19,203)
--------------- ------------
Net cash paid $ 1,813 $ 41,874
--------------- ------------
--------------- ------------
</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. The Company is
nearing completion of this restructuring; in the quarter ended March 31,
1996, the Company has re-evaluated the restructuring liabilities as provided
in the acquisition and restructuring plan (the "Plan") as originally
formulated. As of March 31, 1996, $103.3 million in merger, integration and
restructuring costs have been paid or charged against the original $124.8
million accrued in 1994. The Company anticipates that approximately $14.2
million of expenses remain to be incurred, $7.3 million less than the
original estimate. This excess reserve has been offset in the quarter ended
March 31, 1996 by an approximately equivalent amount of restructuring costs
arising from the Company's decision to restructure its operations in the
United Kingdom and acquisition and integration costs associated with the
merger of Managed Health Network, Inc. ("MHN") in March 1996. The resulting
restructuring accrual of $21.5 million at March 31, 1996 is expected to be
substantially incurred during the next 90 days.
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
6
<PAGE>
vary from these estimates if future developments differ from the underlying
assumptions used by management in developing the recorded accrual.
NOTE 3 - INVESTMENTS
Investments comprised the following (in thousands):
March 31, 1996 June 30, 1995
-------------- -------------
Available for sale $660,018 $541,596
Held to maturity 30,622 49,745
-------------- -------------
$690,640 $591,341
-------------- -------------
-------------- -------------
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
March 31, 1996 the Company had repurchased a total of 1,795,500 shares pursuant
to this program. No shares were repurchased during the quarter ended March 31,
1996.
During the quarter ended March 31, 1996 the Company issued 1,055,949 shares for
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. The Company has determined that the impact on prior
years financial statements of restatement of the Company's financial
statements as a result of the MHN merger would not be significant and
therefore, has combined MHN's net assets as of March 6, 1996, the date of
acquisition, and results of operations for the month of March 1996 with the
Company's consolidated financial statements.
7
<PAGE>
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.
8
<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 and 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 contracts to establish managed
care programs for up to 230,000 CHAMPUS eligible beneficiaries in Washington
and Oregon (the "Washington/Oregon Contract") and up to 590,000 CHAMPUS
eligible 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, with annual funding. In
August 1995, the Company was awarded a contract to establish a managed care
program for up to 720,000 CHAMPUS eligible beneficiaries in California and
Hawaii (the "California/Hawaii Contract"). Implementation of the contract
commenced in September 1995 and the delivery of health care services
commenced in April 1996. This contract has a term of five years, with annual
funding. In March 1996, the Company executed the four previously awarded
Medicaid contracts with the California Department of Health Services to
establish a managed care program to cover approximately 500,000 to 700,000
eligible beneficiaries in four California counties. The Company anticipates
that implementation of these contracts will commence in Fall 1996. The
contracts have terms extending through March 2002.
9
<PAGE>
As of March 31, 1996, $103.3 million in merger, integration and restructuring
costs have been paid or charged against the original $124.8 million accrued
in 1994 in connection with several mergers in November 1994. The Company
anticipates that approximately $14.2 million of expenses remain to be
incurred, $7.3 million less than the original estimate. This excess reserve
has been offset in the quarter ended March 31, 1996 by an approximately
equivalent amount of restructuring costs arising from the Company's decision
to restructure its operations in the United Kingdom and acquisition and
integration costs associated with the merger of Managed Health Network, Inc.
("MHN") in March 1996 as discussed below. 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
completion of this restructuring will result in operating cost savings in
excess of the amount of the charge.
In January 1996, the Board of Directors and management approved a plan to
restructure operations of the Company's managed care operations in the United
Kingdom. During the quarter ended March 31, 1996, the Company charged $8.8
million to the restructuring accrual for operating losses incurred during the
quarter and for the write-off of intangible assets related to the operations.
In connection with the restructuring of operations, expected to take up to a
year, the Company anticipates that approximately $3.9 million, net of tax,
will be needed over the next twelve months to complete the process. This
amount is provided for in the Company's restructuring accrual discussed
above.
In March 1996, MHN, a privately held company providing employee assistance and
managed behavioral health programs to more than 2.7 million covered lives
through its subsidiaries, was acquired in a stock-for-stock, pooling of
interests transaction valued at approximately $45 million. The Company
anticipates that costs related to the merger and combination of MHN with its
existing businesses will total approximately $4.6 million. During the quarter
ended March 31, 1996, $1.2 million of the $4.6 million was charged against the
Company's existing restructuring accrual. The remaining amount will be charged
against the restructuring liability over the next two quarters.
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
10
<PAGE>
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. The Company undertakes no obligation to revise or update these
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
CONSOLIDATED OPERATING RESULTS
The Company achieved significant increases in revenues for the quarter and nine
months ended March 31, 1996 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, Medicaid and Medicare risk products,
growth in net earned workers' compensation premium revenue due to growth in the
number of policies written, and increased government contracts revenue related
to 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 nine months ended March 31, 1996 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 March 31, 1996 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 nine months ended March 31,
1996 as compared with the corresponding periods in the preceding year because of
the effect of non-deductible acquisition costs in the preceding year (which
caused a higher than normal rate) and the effect of net operating loss
carryforwards which became available during the current period (which caused a
lower than normal rate). As a result of additional net operating loss
carryforwards that are anticipated to become available in the fourth quarter
management anticipates that a further decrease in the effective tax rate will
occur in the quarter.
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 and maintain adequate
profitability 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
11
<PAGE>
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 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.
12
<PAGE>
FOUNDATION HEALTH CORPORATION
LINE OF BUSINESS FINANCIAL INFORMATION
(Dollars in thousands, except share amounts)
<TABLE>
Quarter Ended
Quarter Ended March 31, 1996 March 31, 1995
---------------------------------------- ---------------------------
Percent Percent Percent
Amount or of Total Increase Amount or of Total
Percent Revenue (Decrease) Percent Revenue
------------ --------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
Commercial premiums $ 512,550 59.1% 19.9% $ 427,454 69.4%
Government contracts 147,347 17.0 260.4 40,889 6.6
Specialty services revenue 178,676 20.6 46.6 121,882 19.8
Patient service revenue, net 12,185 1.4 (2.4) 12,490 2.0
Investment and other income 17,094 2.0 32.4 12,914 2.1
------------ --------- ---------- --------
867,852 100.0 41.0 615,629 100.0
------------ --------- ---------- --------
Commercial health care services 408,515 47.1 23.5 330,655 53.7
Government contracts health care services 98,665 11.4 470.1 17,308 2.8
Government contracts subcontractor costs 4,397 0.5 (65.8) 12,859 2.1
Specialty services costs 156,866 18.1 53.3 102,335 16.6
Patient service costs 9,118 1.1 0.5 9,076 1.5
Selling, general and administrative ("SG&A") 110,397 12.7 54.1 71,632 11.6
Amortization and depreciation 15,490 1.0 39.6 11,096 1.8
Interest expense 3,602 0.4 26.2 2,854 0.5
Acquisiton and restructuring costs - n/a - n/a
------------ --------- ---------- --------
807,050 93.0 44.7 557,815 90.6
------------ --------- ---------- --------
Income before income taxes and minority
interest 60,802 7.0 n/a 57,814 9.4
Provision for income taxes 18,954 2.2 n/a 21,523 3.5
Minority interest n/a -
------------ --------- ---------- --------
Net income $ 41,848 4.8 % n/a $ 36,291 5.9%
------------ --------- ---------- --------
------------ --------- ---------- --------
Earnings per share $ 0.72 n/a $ 0.63
------------ ----------
------------ ----------
Weighted average common and common
stock equilvalant shares outstanding 58,412,472 1.8 57,358,480
------------ ----------
------------ ----------
Operating ratios:
Commercial loss ratio 79.7% 77.4%
Government contracts ratio 69.9 73.8
Specialty services ratio 87.8 84.0
Patient service ratio 74.8 72.7
SG&A to total revenues 12.7 11.6
Effective tax rate 31.2 37.2
Enrollment (in thousands):
Commercial:
Group and individual 1,163 24.4 935
Medicare risk 85 30.8 65
Medicaid 159 32.5 120
------------ ----------
1,407 25.6 1,120
------------ ----------
Government:
CHAMPUS PPO and indemnity 629 657.8 83
CHAMPUS HMO 233 763.0 27
------------ ----------
862 683.6 110
------------ ----------
Combined 2,269 84.5% 1,230
------------ ----------
------------ ----------
Nine Months Ended
Nine Months Ended March 31, 1996 March 31, 1995
-------------------------------------- -----------------------------
Percent Percent Percent
Amount or of Total Increase Amount or of Total
Percent Revenue (Decrease) Percent Revenue
----------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Commercial premiums $ 1,449,233 61.5% 18.8 % $ 1,220,031 67.5%
Government contracts 333,181 14.1 147.1 134,836 7.5
Specialty services revenue 494,689 21.0 30.4 379,219 21.0
Patient service revenue, net 37,115 1.6 14.4 32,454 1.8
Investment and other income 43,984 1.9 4.7 42,013 2.3
----------- --------- ----------- ---------
2,358,202 100.0 30.4 1,808,553 100.0
----------- --------- ----------- ---------
Commercial health care services 1,150,944 48.8 20.7 953,252 52.7
Government contracts health care services 189,963 8.1 305.9 46,797 2.6
Government contracts subcontractor costs 25,212 1.1 (54.6) 55,502 3.1
Specialty services costs 435,992 18.5 33.9 325,523 18.0
Patient service costs 26,758 1.1 1.6 26,332 1.5
Selling, general and administrative ("SG&A") 292,727 12.4 34.2 218,115 12.1
Amortization and depreciation 43,182 1.8 47.9 29,189 1.6
Interest expense 11,556 0.5 32.6 8,714 0.4
Acquisiton and restructuring costs - (100.0) 124,822 6.9
----------- --------- ----------- ---------
2,176,334 92.3 21.7 1,788,246 98.9
----------- --------- ----------- ---------
Income before income taxes and minority
interest 181,868 7.7 n/a 20,307 1.1
Provision for income taxes 58,967 2.5 n/a 7,370 0.4
Minority interest (100.0) 2,262 0.1
----------- --------- ----------- ---------
Net income $ 122,901 5.2% n/a $ 10,675 0.6 %
----------- --------- ----------- ---------
----------- --------- ----------- ---------
Earnings per share $ 2.12 n/a $ 0.20
----------- -----------
----------- -----------
Weighted average common and common
stock equilvalant shares outstanding 57,972,132 7.6 53,892,518
----------- -----------
----------- -----------
Operating ratios:
Commercial loss ratio 79.4% 78.1%
Government contracts ratio 64.6 75.9
Specialty services ratio 88.1 85.8
Patient service ratio 72.1 81.1
SG&A to total revenues 12.4 12.1
Effective tax rate 32.4 36.3
</TABLE>
13
<PAGE>
COMMERCIAL OPERATIONS
The Company achieved significant increases in revenues for the quarter and the
nine months ended March 31, 1996 over the same periods in the prior year due in
part to an approximate 26% increase in enrollment from existing lines of
business and geographic expansion offset by reductions in commercial premium
revenue per member due to continued 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 March 31, 1996 as compared to the quarter ended March
31, 1995. The commercial loss ratio increased from 77.4% for the quarter and
78.1% for the nine months ended March 31, 1995 to 79.7% for the quarter and
79.4% for the nine months ended March 31, 1996. The increase in the ratio
for the quarter and nine months ended March 31, 1996 was due to the continued
competitive premium pressures and increased health care costs. The Company
believes that commercial premiums will continue to increase at lower rates
than it has experienced historically, or will be lower than current rates
which may adversely affect the commercial loss ratio. The Company continues
to seek to mitigate the effects of premium pressures by continued health care
cost containment efforts. 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 commercial products.
GOVERNMENT CONTRACTS
Government contracts revenue increased in the quarter ended March 31, 1996
over the same period in the prior year primarily due to revenues generated
by the Washington/Oregon, Region 6, California/Hawaii, and the previously
expired CHAMPUS Reform Initiative ("CRI") contracts. The CRI increase was
due to revenue adjustments recognized during the quarter ended March 31,
1996. These increases were offset by the expiration of the Base Realignment
and Closure ("BRAC") Contract. Government contracts revenue increased in the
nine months ended March 31, 1996 over the same period in the prior year
primarily due to revenues generated by the Washington/Oregon, Region 6 and
California/Hawaii Contracts offset by decreases in revenue as a result of
expiration of CRI and the BRAC Contracts.
The government contracts ratio improved during the quarter and nine months
ended March 31, 1996 compared to the same periods in the preceding year.
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 selling, general and administrative costs. Once the delivery of health
care services begins, however 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
14
<PAGE>
increase during the remainder of fiscal year 1996 and into fiscal year 1997
as all three CHAMPUS contracts will be delivering health care services during
the entire fiscal year as compared to staggered implementation during the
current fiscal year. Health care services commenced in March 1995 under the
Washington/Oregon Contract, in November 1995 under the Region 6 Contract and
in April 1996 under the California/Hawaii Contract.
SPECIALTY SERVICES
Specialty services revenues increased in the quarter and nine months ended March
31, 1996 over the same periods in the prior year due to increased insurance
premiums generated by California Compensation Insurance Company and its
subsidiaries (collectively "CalComp"), the Company's workers' compensation
insurance subsidiaries and to increased revenue generated by the Company's
pharmaceutical subsidiary. CalComp's net premium revenue totaled $126 million
and $344 million for the quarter and nine months ended March 31, 1996 compared
to $85 million and $270 million for the same periods in the prior year, with
increases of 48% and 27%, respectively. 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
$12.5 million and $36.1 million for the quarter and nine months ended March 31,
1996 as compared with $3.0 million and $7.3 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
services costs, increased $54.5 million and $110.5 million for the quarter and
nine months ended March 31, 1996 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
increased rebate revenue.
The specialty services ratio (specialty services costs as a percentage of
specialty services revenues) for the quarter and nine months ended March 31,
1996 has increased when compared with the same periods in the prior year.
Reasons for this change are primarily related to the workers' compensation
business as discussed below.
15
<PAGE>
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 for the quarters and nine months ended
March 31, 1996 and 1995:
March 31,
1996 1995
------------------------------
Nine Nine
Months Months
Quarter Ended Quarter Ended
------- ------ ------- -------
Loss and loss adjustment expense ratio 63.1% 64.4% 62.4% 65.4%
Underwriting expense ratio 26.5 24.1 19.8 19.4
Policy holder dividend ratio .7 1.6 (0.7) 1.3
------- ------ ------- -------
Combined ratio 90.3% 90.1% 81.5% 86.1%
------- ------ ------- -------
------- ------ ------- -------
The loss and loss adjustment expense ratio for the quarter ended March 31,
1996 was consistent with the ratio for the same period in the prior year.
During the quarter, Cal Comp's loss and loss adjustment expense reserve
estimates for prior accident years decreased by $10.8 million. The amount
represents 8.6% of net premiums earned for the quarter. The 1996 accident
year loss and loss adjustment expense ratio for the quarter was 71.7%. As
premium volume has increased the number of reported claims has increased.
This increase in frequency from higher premium volume has been offset by a
reduction in the average cost of both new as well as closed claims. The
lower severity is attributable to increased utilization of managed care
techniques, specifically medical management, network utilization and return
to work programs which have helped to contribute to an 18% reduction in the
average cost of closed claims for accident year 1996 as compared to accident
year 1995 at the comparable stage of development.
The underwriting ratio has increased for the quarter and nine months ended March
31, 1996 as compared to the same periods in the prior year as a result of the
decrease in the average premium earned due the open rating environment which was
offset by a decrease in the average commissions paid to its brokers on new and
renewal insurance policies in California.
The policy dividend ratio for the quarter continues to be affected by the
decrease in the number of policies written on a participating basis. The
reduction in participating policies written lowers the potential policyholder
dividend liability which is based on claims experience and paid after the policy
has expired.
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The net cash provided by operating activities was $59.7 million for the nine
months ended March 31, 1996 as compared to net cash provided by operating
activities of $197.4 million for the comparable period in fiscal year 1995.
The change is principally due to timing of the receipt or payment of amounts
under government contracts as revenues are received monthly in arrears under
the current CHAMPUS contracts, while previously some contracts were prepaid.
These changes have also significantly increased the current receivables under
government contracts and had the impact of decreasing cash and investments
from $795.3 million at June 30, 1995 to $789.9 million at March 31, 1996.
The Company invests its cash in investment grade securities.
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. For the nine months
ended March 31, 1996, capital expenditures totaled approximately $61.5
million. 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, 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 California affiliated independent practice
associations ("IPAs") (i.e., 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. Notes
receivable under the Company's credit agreements with the IPAs in the amount of
$10 million were repaid to the Company in connection with the transaction.
As of March 31, 1996, the Company has used approximately $24 million 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), for the
construction of four health care centers.
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 March 31, 1996, the Company has drawn
$60 million on the Credit Agreement, $40 million of which was drawn during the
nine months ended March 31, 1996, none of which was drawn in the quarter ended
March 31, 1996.
17
<PAGE>
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state HMO and insurance laws and
regulations, and must have adequate reserves for claims incurred but not yet
reported and claims payments. Certain subsidiaries must maintain ratios of
current assets to current liabilities of 1:1 pursuant to certain government
contracts. The Company believes it is in compliance with these contractual and
regulatory requirements in all material respects.
Certain of the Company's subsidiaries are required to maintain reserves to
cover their estimated ultimate liability for claims, losses and loss
adjustment expenses with respect to reported and unreported claims incurred.
These reserves are estimates of future costs based on various assumptions.
Establishment of appropriate reserves is an inherently uncertain process, and
there can be no certainty that currently established reserves will prove
adequate in light of subsequent actual experience, which in the past has
resulted and in the future could result in loss reserves being too high or
too low. The accuracy of these estimates may be affected by external forces
such as changes in the rate of inflation, the regulatory environment, the
judicial administration of claims, medical costs and other factors. Future
loss development or governmental regulators could require reserves for prior
periods to be increased, which would adversely impact earnings in future
periods. In light of present facts and current legal interpretations,
management believes that adequate provisions have been made for claims and
loss reserves.
Management of the Company continually evaluates opportunities to expand the
Company's commercial, government, insurance and specialty services operations;
however, the Company currently has no material commitments for future use of its
current or expected levels of available cash resources except as described
above. The Company's expansion options may include additional acquisitions and
internal development of new products and programs.
18
<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 operating 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, 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. The Company has been informed that the government will not intervene at
the current time on one such filed complaint. The remaining matter is in the
very preliminary stages and the Company is cooperating with, and responding to,
the respective government authorities in that action.
The results of 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, the imposition of significant
penalties or limitation of marketing under, or cessation of participation in,
these programs.
19
<PAGE>
With respect to the Securities and Exchange Commission ("SEC") investigation
commencing in August 1992 regarding trading in the common stock of Century
Medicorp, Inc. ("CMC") and the Company prior to the announcement of the
merger of CMC with the Company, on April 29, 1996, the SEC staff advised the
Company that it has closed, without recommending any action, its
investigation concerning the CMC merger insofar as it pertains to 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.
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.
20
<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 March 31, 1996.
______________________________________________________________
(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).
21
<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: May 14,1996 By: JEFFREY L. ELDER
JEFFREY L. ELDER
SENIOR VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
22
<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 24
______________________________________________________________________
(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).
23
<PAGE>
FOUNDATION HEALTH CORPORATION
EXHIBIT 11
Earnings Per Share Computation
Utilizing the Treasury Stock Method
(Dollars in thousands, except share amounts)
<TABLE>
Quarter ended Nine months ended
March 31, March 31,
------------------------- ----------------------
1996 1995 1996 1995
---------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Proceeds upon exercise of options outstanding $ 97,055 $ 47,954
---------- -----------
---------- -----------
Average market price of common stock $ 39.57 $ 30.63
---------- -----------
---------- -----------
Weighted average common shares outstanding 57,877,871 57,017,649
Issued shares- exercise of options 2,987,617 1,906,568
Shares assumed to be repurchased with proceeds from exercise (2,453,016) (1,565,737)
---------- ----------- ----------- -----------
Weighted average shares outstanding (A) 58,412,472 57,358,480 57,972,132 53,892,518
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
Net income (loss) for the period (B) $ 41,848 $ 36,291 $ 122,901 $ 10,675
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
Earnings per share (B) / (A) $ 0.72 $ 0.63 $ 2.12 $ 0.20
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
</TABLE>
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FORM 10Q FILED BY FOUNDATION HEALTH CORPORATION FOR THE QUARTER ENDED
MARCH 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 99,277
<SECURITIES> 690,640
<RECEIVABLES> 374,712
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 270,555<F1>
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,175,240
<CURRENT-LIABILITIES> 0
<BONDS> 215,849
0
0
<COMMON> 529,556
<OTHER-SE> 358,914
<TOTAL-LIABILITY-AND-EQUITY> 2,175,240
<SALES> 850,758
<TOTAL-REVENUES> 867,852
<CGS> 0
<TOTAL-COSTS> 803,448
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,602
<INCOME-PRETAX> 60,802
<INCOME-TAX> 18,954
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 41,848
<EPS-PRIMARY> .72
<EPS-DILUTED> 0
<FN>
<F1>NET PPE
</FN>
</TABLE>
