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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 2
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NO. 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) 95670
3400 DATA DRIVE, RANCHO CORDOVA, CA (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code:
(916) 631-5000
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock $.01 par value New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act:
NONE
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. (X)Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in part III of this Form 10-K or any
amendment to this Form 10-K. (X)
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on
November 15,1996 as reported on the New York Stock Exchange Composite Tape was
approximately $1,836,000,500.
As of November 15, 1996, the Registrant had 58,752,016 shares of Common
Stock outstanding and entitled to vote in the election of directors.
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The following Items are amended in their entirety in this Form 10-K/A, Amendment
No. 2.
Item 1. Business
Item 3. Legal Proceedings
Item 6. Selected Consolidated Financial Data
Item 7. Management's discussion and analysis of financial condition
and results of operations
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K (1)
(1) Exhibits amended are as follows:
Exhibit 11.0
Exhibit 12.0
Exhibit 13.1
Exhibit 13.2
Exhibit 13.3
Exhibit 23.1
Exhibit 23.2
Exhibit 23.3
Exhibit 23.4
PART I
ITEM 1. BUSINESS.
Foundation Health Corporation (the "Company") is an integrated managed care
organization which administers the delivery of managed health care services.
Through its subsidiaries, the Company offers group, Medicaid, individual and
Medicare health maintenance organization ("HMO") and preferred provider
organization ("PPO") plans; government sponsored managed care plans; and managed
care products related to workers' compensation insurance, administration and
cost-containment, behavioral health, dental, vision and pharmaceutical products
and services.
The Company has implemented managed care cost-containment programs,
cost-effective medical delivery systems and medical information management to
enable it to meet its business strategies. Over the past several years, the
Company has developed a diversified product line, has established a full range
of medical delivery systems and has achieved geographic expansion throughout the
west, southwest and southeast areas of the United States and in the United
Kingdom.
The Company was incorporated in Delaware in 1984. The Company's executive
offices are located at 3400 Data Drive, Rancho Cordova, California 95670, and
its telephone number is (916) 631-5000. Unless the context otherwise requires,
the term "Company" as used in this Report refers to Foundation Health
Corporation, a Delaware corporation, and its subsidiaries.
BUSINESS STRATEGY
The Company's business strategy is to develop, market and support the
delivery of quality, cost-effective managed care products that address the
health care needs of the Company's commercial, specialty services and government
customers.
The Company's business plan has the following primary objectives:
(i) Increase enrollment of covered medical risk lives (including
Medicare, Medicaid and CHAMPUS lives);
(ii) Achieve significant market share in commercial, government and
specialty services managed care products in the markets the Company serves;
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(iii) Differentiate the Company's products by providing a system of
quality, accessible health care services for the Company's members; and
(iv) Create administrative processes that, when measured against
standards of performance, reflect outstanding service and create satisfied and
long-term provider and customer relationships.
EXPANSION AND DIVESTITURE OF OPERATIONS
The Company continually evaluates opportunities to expand its business and
considers whether to divest or cease offering the products of certain of its
businesses. These opportunities may include acquisitions or dispositions of a
specialty services managed care product, insurance and HMO operations or
affiliated provider relationships. The Company also devotes significant
attention to internal development of new products and techniques for the
containment of health care costs, the measurement of outcomes and
efficiencies of health care delivered and the management of health care delivery
systems.
On August 31, 1995, the Company and Thomas-Davis Medical Centers, P.C.
("TDMC") acquired Tucson Medical Associates, Ltd., an Arizona based physician
group, to enhance the number of physician providers of TDMC to provide greater
access for the Company's HMO members in Arizona.
On March 6, 1996, the Company acquired Managed Health Network, Inc. and its
subsidiaries (collectively, "MHN"), which provide behavioral health managed care
programs, both on an at-risk and administration only basis, including employee
assistance programs. The Company is integrating the operations of MHN with
those of Foundation Health PsychCare Services, Inc., its behavioral health
subsidiary.
In January 1996, FPA Medical Management, Inc. ("FPA"), a national health
care management services organization, purchased three California independent
practice associations ("IPAs") affiliated with the Company. On June 28, 1996,
the Company sold its Florida and Arizona IPAs to FPA. Additionally, on June
28, 1996, the Company executed a Stock and Note Purchase Agreement with FPA
for the purchase by FPA of the Company's physician practice management
operations ("Foundation Health Medical Services" or "FHMS") and affiliated
medical groups in California ("Foundation Health Medical Group, Inc.") and
Arizona ("Thomas-Davis Medical Centers, P.C.") (collectively referred to as
the "Medical Practices"). This transaction is subject to customary closing
conditions, including regulatory and FPA stockholder approval and is expected
to close in the second quarter of fiscal 1997. See discussion of operations
under the caption "Discontinued Physician Practice Management Business".
On June 28, 1996, the Company acquired the minority interest in its
Intergroup of Utah HMO operations. Also, on June 28, 1996 the Company sold its
interest in Premier Medical Networks in Utah.
On October 1, 1996, the Company entered into an Agreement and Plan of
Merger with Health Systems International, Inc. ("HSI"). Under the definitive
agreement approved by both companies' boards of directors, the Company will
merge into a wholly-owned subsidiary of HSI with the Company surviving the
merger as a wholly-owned subsidiary of HSI. HSI will change its name to
Foundation Health Systems, Inc. Completion of the transaction, which will be
a tax-free combination and accounted for as a pooling-of-interests, is
subject to stockholder and regulatory approval as well as other customary
conditions and is expected to be completed in January 1997. The Company's
stockholders will receive 1.3 shares of HSI Class A common stock for each
share of Company common stock owned (the "exchange ratio"). Holders of the
Company's options will receive substitute HSI options based on the same
exchange ratio.
COMMERCIAL MANAGED CARE
MEDICAL HMO AND PPO. The Company owns medical HMO subsidiaries which operate
in Arizona, California, Colorado, Florida, Louisiana, Oklahoma, Texas and Utah.
The HMOs provide comprehensive health care coverage for a fixed fee or premium
that does not vary with the extent or frequency of medical services actually
received by the member. The Company's insurance subsidiaries have established
PPO products. PPOs are generally a network of health care providers which offer
their services to health care purchasers, such as insurers and self-funded
employers. PPO enrollees choose their medical care from among the various
contracting providers or choose a non-contracting provider and are reimbursed on
a traditional indemnity plan basis after reaching an annual deductible. The
Company assumes both underwriting and administrative expense risk in return for
the premium revenue it receives from its medical HMO and PPO products. The HMOs
and PPOs have contractual arrangements with health care providers for the
delivery of health care to the Company's enrollees. Cost-effective delivery of
health care services by such providers is achieved through appropriate use of
health care services, emphasizing preventive health care services and
encouraging the reduction of unnecessary hospitalization and other services.
The Company's California HMO was awarded four Medicaid contracts, and is
subcontractor under two other contracts, in California to deliver managed care
to up to 616,000 Medicaid beneficiaries. Implementation of these programs
commenced in fiscal year 1996 with delivery of health care services currently
anticipated to commence during fiscal year 1997.
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The following chart describes the Company's commercial HMO and insured PPO
membership by state and product:
COMMERCIAL HMO AND INSURED PPO MEDICAL LIVES
JUNE 30, 1996
(IN THOUSANDS)
STATE GROUP AND MEDICARE
INDIVIDUAL RISK MEDICAID TOTAL
Arizona 313 40 7 360
California 577 21 199 797
Colorado 33 0 0 33
Florida 69 26 19 114
Louisiana 23 0 0 23
Oklahoma 2 0 25 27
Texas 24 0 0 24
Utah 87 0 10 97
Other 67 0 0 67
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Total 1,195 87 260 1,542
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PROVIDER ARRANGEMENTS. The Company's medical HMOs arrange for the delivery of
health care services to their enrollees by contracting with physicians, either
directly or through IPAs and medical groups, hospitals and other health care
providers for a defined range of health services, including primary and
specialty care and outpatient diagnostic services. Each enrollee's primary care
physician plays a significant role in cost-control by practicing preventive
medicine and managing the use of specialty physicians, hospitals and ancillary
providers. The Company pays for health care services provided by IPAs and
medical groups on a capitated basis or pursuant to discounted fee-for-service
arrangements. Under capitation arrangements, the Company pays the IPA or medical
group a fixed amount per member per month to cover the payment of all or most
medical services regardless of utilization, which transfers the risk of certain
health care costs to the provider organization. The Company also uses various
risk sharing and incentive arrangements to manage further the cost of providing
health care. The Company contracts for hospital services under a variety of
arrangements including capitation, per diem, discounted fee-for-service and case
rate arrangements.
CONTROL OF HEALTH CARE COSTS. The profitability of the Company depends on its
ability to effectively control health care costs. Advances in medical
technologies, inflation, increasing hospital costs, the occurrence of major
epidemics and numerous other external factors, including the aging of the
population and other demographic characteristics affecting the delivery of
health care, may affect the ability of HMOs, including the Company's HMOs, to
predict and control health care costs.
The Company manages health care costs by entering into payment arrangements
with health care providers and by sharing the risk of certain health care costs
with certain of the Company's contracting providers. The Company continues to
seek capitation arrangements with its physician providers. In addition, several
of the Company's hospital providers are paid pursuant to capitation
arrangements.
Under the Company's utilization review system, certain routine hospital
admissions and lengths of stay require prior authorization and concurrent
review. Post-discharge utilization review procedures are performed to evaluate
the quality and utilization of care. Health professionals also monitor and
become involved in case management of catastrophic cases in an effort to assist
enrollees in obtaining medical care and treatment options that may be more
appropriate and cost-effective than a long-term hospital stay.
RISK MANAGEMENT. In addition to the Company's cost control systems, the use of
medical underwriting criteria is an integral part of its risk management
efforts. In addition, the Company mitigates part of the risk of catastrophic
losses by
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maintaining reinsurance coverage for annual hospital costs incurred in the
treatment of an enrollee's illness. The Company believes that its reinsurance
policies significantly limit, at a reasonable premium cost, the risk of
catastrophic costs incurred by its enrollees. The Company also maintains general
liability, property, fidelity, and managed care professional liability, errors
and omissions and directors and officers insurance coverage in amounts the
Company believes to be adequate. The Company requires contracting physicians,
physician groups, dentists, hospitals and ancillary providers to maintain
malpractice insurance coverage in amounts customary in the industry.
QUALITY MANAGEMENT. The Company's HMOs have programs to evaluate the quality
and appropriateness of care provided to its enrollees. The providers participate
in quality management programs through peer review procedures conducted with the
Company's medical directors. These procedures involve reviews of the tests,
types of treatment and procedures performed for specific diagnoses as well as
reviews of aggregate data. When considering whether to contract with a provider,
the Company's HMOs conduct a credentialling evaluation of the applicant,
including licensure, board certification, residency program completion,
malpractice claims history and ability to accommodate enrollment demands. The
Company's HMOs have customer service departments that work directly with
enrollees to respond to their concerns and have grievance procedures to
investigate and resolve enrollees' complaints. The Company's HMOs also conduct
periodic surveys to assess enrollees' satisfaction with the health care delivery
system, health care received and responsiveness to enrollees' needs.
MANAGED CARE INDEMNITY PRODUCTS. Through the Company's indemnity insurance
subsidiaries, the Company expands the managed care options for enrollees by
making available PPO, point-of-service and other insured managed care products,
including certain specialty services insured products. These companies also
offer group term and dependent life, accidental death and dismemberment and
long-term disability coverage.
SPECIALTY SERVICES MANAGED CARE
The Company is utilizing its experience in managing HMOs to apply managed
care concepts to areas such as dental, vision, prescription drugs, behavioral
health, workers' compensation insurance and administration and ancillary
services. This assists employers and other payers in meeting cost-containment
and integration of benefits goals both on an insured and self-funded basis. The
Company believes that offering a continuum of integrated managed care products
and selling them across broad product lines will result in new sources of
revenue, will increase membership in existing employer groups and will enable
the Company to sell its integrated products to new employer groups. The
Company's specialty services managed care operations consist of the following
groups:
DENTAL. DentiCare of California, Inc. ("DentiCare"), the Company's dental
HMO, offers prepaid commercial and Medicaid dental care services. DentiCare
served approximately 473,000 enrollees as of June 30, 1996.
VISION. Foundation Health Vision Services dba AVP Vision Plans ("AVP"),
the Company's vision HMO, offers prepaid vision services in the major
metropolitan areas of California. AVP served approximately 331,000
enrollees as of June 30, 1996.
BEHAVIORAL HEALTH. Foundation Health PsychCare Services, Inc. and MHN
provide managed care behavioral health, employee assistance and substance
abuse programs on both an insured and self-funded basis to employers,
governmental entities and other payers throughout the United States through
a network of contracted providers. These companies provided services to
approximately 6.6 million eligible beneficiaries as of June 30, 1996.
WORKERS' COMPENSATION SERVICES. The Company applies its managed care
concepts, such as use of specialized preferred provider networks and
utilization review, to the operations of its workers' compensation
subsidiaries, California Compensation Insurance Company ("CalComp"),
Business Insurance Company ("BICO") and Combined Benefits Life Insurance
Company ("CBLIC"), which had estimated aggregate annual premiums in force
at June 30, 1996 of over $585 million. These subsidiaries expand the
Company's workers' compensation products to include insured risk products,
permit the Company to apply its managed care expertise to reduce the
medical costs associated with workers' compensation claims and enable the
Company to develop and market "24
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hour" risk or "Combined Care" products covering employees for medical care
both on and off the job. The Company provides third party administration of
workers' compensation claims primarily to self-insured employers, and
operates a medical review and cost-containment business for the workers'
compensation industry primarily within California.
PHARMACEUTICAL MANAGED CARE SERVICES. Integrated Pharmaceutical Services
("IPS"), the Company's pharmaceutical subsidiary, provides pharmaceutical
managed care services, including a national pharmacy network and formulary,
pharmacy adjudication and claims processing services, to reduce enrollees
and employer groups health care costs. IPS is also developing disease
state management projects with pharmaceutical manufacturers to enable
outcomes research and information to enhance the quality of care provided
to the Company's enrollees.
SELF-FUNDED PRODUCTS. The Company has developed self-funded products,
including a provider network, for employers who desire the cost containment
aspects of an HMO product but who want to self-insure the health care cost
risk. The Company's third party administration subsidiaries provide
administrative only arrangements, including utilization review, managed
care and claims administration services to employer groups and to medical
groups and IPAs that are paid on a capitated, at-risk basis.
GOVERNMENT CONTRACTS
The Company, through Foundation Health Federal Services, Inc. ("FHFS"), its
government contracts subsidiary, administers large, multi-year managed care
government programs. FHFS subcontracts to affiliated and unrelated third parties
the administration and health care risk of parts of these contracts. These
programs include: (i) a CHAMPUS managed care contract in Washington and Oregon
(the "Washington/Oregon Contract") to provide health care services to
approximately 227,000 CHAMPUS-eligible beneficiaries which commenced health care
services in March, 1995, (ii) a similar contract in Texas, Louisiana, Arkansas
and Oklahoma (the "Region 6 Contract") to provide health care services to
approximately 590,000 CHAMPUS-eligible beneficiaries which commenced delivery of
health care services in November 1995, and (iii) the multi-year TRICARE managed
care contract to provide health care services to approximately 720,000
CHAMPUS-eligible beneficiaries in California and Hawaii (the "California/Hawaii
Contract") which commenced delivery of health care services in April 1996. The
Company intends to compete for other managed care contracts as they are
announced by federal and state agencies. There can be no assurance that the
Company will be successful in managing the implementation and delivery of
services under several large, multi-year government managed care contracts or
whether any such contracts will provide the Company with an adequate level of
profitability.
FHFS also administers contracts in Massachusetts, New Jersey, Georgia and
Maine to enroll Medicaid eligible individuals in managed care programs in those
states. FHFS is not at risk for the provision of any health care services under
any of these contracts.
PATIENT SERVICES
The Company owns and operates a 128-bed hospital located in Los Angeles,
California, the East Los Angeles Doctors Hospital, and a 200-bed hospital
located in Gardena, California, the Memorial Hospital of Gardena. Both of these
hospitals are accredited by the Joint Commission on the Accreditation of
Healthcare Organizations. The Company's strategy in maintaining ownership of
these hospitals depends on the continued cost-efficiency of the hospitals,
integration of the hospitals into the Company's Southern California HMO
networks, particularly with respect to the Medicaid population, and development
of subacute or related units which offer less costly care than acute
hospitalization and which contribute to the hospitals' revenues. Through its
wholly owned subsidiaries, American VitalCare, Inc. and Managed Alternative
Care, Inc., the Company is also engaged in the management of hospital subacute
care units serving chronically ill patients.
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DISCONTINUED PHYSICIAN PRACTICE MANAGEMENT BUSINESS
The Company's physician practice management business currently consists of a
healthcare management service organization which provides facilities,
administrative and operations services, including claims processing, accounting
and financial reporting to its affiliated medical practices, Foundation Health
Medical Group, Inc. ("FHMG") located in California, and Thomas-Davis Medical
Centers, P.C.("TDMC"), located in Arizona. FHMG provides primary health care
services and employed 110 providers at 17 health care centers in California as
of June 30, 1996. TDMC provides primary and specialty health care services and
employs 271 providers at 18 health care centers in Arizona as of June 30, 1996.
FHMS employs the administrative and non-professional staff at the care centers.
During fiscal year 1996, the Company revised its strategy of creating
proprietary networks of IPAs, which contract with physicians to provide
medical services to the Company's members, and establishing affiliated
Medical Practices which operate from the Company owned and managed health
care centers. This change in strategy was due to the emergence of large,
competitive physician management companies with the necessary size and
expertise to manage provider networks and the required reporting and
information systems. These changes led the Company to adopt a plan in the
third quarter of fiscal 1996 to completely discontinue the operations of this
segment. In connection with this changed environment and with its plan to
discontinue this segment, the following transactions were entered into with
FPA and certain of its affiliate entities, none of which are affiliated with
the Company.
In January 1996 the Company completed the sale, initiated in the second
quarter of fiscal 1996, of its affiliated California IPAs to FPA for a
purchase price consisting of cash and a promissory note payable over 10
years. Notes receivable under revolving credits agreement with the IPAs in
the amount of $10 million were repaid to the Company and no gain or loss was
recognized in connection with this transaction.
In June 1996, the Company completed the sale, initiated in the third quarter of
fiscal 1996, of its affiliated Florida and Arizona IPAs to FPA for aggregate
consideration of $20 million, consisting of $3 million in cash and a promissory
note in the amount of $17 million which is due and payable six months after
closing and bears a floating interest rate. A gain of $10.4 million was
recognized by the Company and is included in discontinued operations for fiscal
1996.
On June 28, 1996, the Company and the sole shareholder of the Medical
Practices entered into a Stock and Note Purchase Agreement whereby the
Company will sell all the outstanding stock of FHMS, its management services
organization, and the sole shareholder will sell all the outstanding stock of
the holding company for the Medical Practices to FPA. The Medical Practices
and FHMS operations are treated as discontinued operations in the Company's
Consolidated Financial Statements. The aggregate consideration consists of
$2 million cash, $75 million of FPA common stock, $22 million bridge note due
five months after closing and bearing a floating interest rate and a $12
million note to be consolidated with the assumption of the intercompany
indebtedness of FHMS, the holding company and the Medical Practices to the
Company by FPA (estimated to be $80 million as of June 30, 1996) which amount
will be adjusted for liabilities incurred, up to $12 million, between June
30, 1996 and the closing of the transaction, currently anticipated to be the
second quarter of fiscal year 1997. The consolidated note will bear interest
at a floating rate with amortization of principal on a 15 year schedule with
the remaining principal and accrued interest due 54 months after close. FPA
will also assume other liabilities owed by FHMS, the Holding Company and the
Medical Practices to third parties (estimated to be $41 million as of June
30, 1996). The promissory notes will be secured by the assets and stock of
FPA, the purchasing company, FHMS, the holding company, and the Medical
Practices. The promissory notes will be guaranteed by FPA. The Company's
affiliated health plans in Arizona, California and Florida will have agreed
to pay FPA an aggregate of $55 million during the period commencing August
1996 through December 1996 for continued and uninterrupted access as defined
in the Purchase Agreement to the professional providers of the IPAs and the
Medical Practices for the Company's affiliated health plan enrolles. This
transaction will be recorded in the financial statements in the quarter it
closes, presently anticipated to be the second quarter of fiscal 1997.
Operating losses since the measurement date are being deferred because of an
anticipated gain on the sale of the Company's physician practice management
subsidiary and affiliated Medical Practices.
As part of these transactions, the Company's affiliated health plans have
entered into 30-year provider agreements with the IPAs and Medical Practices to
ensure that the Company's enrollees have continued and uninterrupted access to
the providers of the Medical Practices and IPAs. See Note 1 of Notes to
Consolidated Financial Statements.
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INFORMATION TECHNOLOGY
The Company's information technology systems include several computer
systems, each utilizing customized software and a network of on-line terminals.
The Company's operations use its computer-based information technology systems
for various purposes including claims processing, general accounting and health
services reporting. These systems also include enrollment and billing functions,
including membership verification capabilities, and analysis of transactions
relating to providers and enrollees, such as claims status, hospital admissions
and lengths of stay, outpatient care, utilization and various reporting
capabilities required for accreditation, including HEDIS and NCQA, outcomes data
and cost analyses. The Company is heavily dependent on its information
technology systems and is in the process of integrating the systems of its
recently acquired operations. These systems will need to be further enhanced as
the Company's business expands and it offers new products; there is no assurance
the Company will not experience interruptions in service as a result of the
enhancement and integration of its information technology systems.
SALES AND MARKETING
The Company's sales and marketing strategy for its managed care products is
defined and coordinated by its corporate sales staff. Primary responsibility for
the Company's products resides with a direct sales force at both the corporate
and subsidiary levels. In addition, these products are sold through independent
insurance agents and brokers. The Company is emphasizing cross-marketing of its
products to current and prospective customers through its corporate and
subsidiary sales and marketing staff. Medicaid and Medicare risk products are
primarily marketed by the HMOs' sales employees. Sales and marketing efforts are
also supported by advertising programs that employ television, radio,
newspapers, billboard and direct mail.
COMPETITION
The managed health care industry evolved primarily as a result of health
care buyers' concerns regarding rising health care costs. The industry's goal is
to infuse greater cost effectiveness and accountability into the health care
system through the development of managed care products, including HMOs, PPOs,
and specialized services such as mental health or pharmacy benefit programs,
while increasing the accessibility and quality of health care services. The
managed health care industry is highly competitive, both nationally and in the
Company's various service areas.
As HMO and PPO penetration of the health care market and the effects of
health care reforms increase nationwide, the Company expects that competition
for new contracts with large employer and government groups, small employer
groups and individuals will intensify. In addition, employers may choose to
self-insure the health care risk while seeking benefit administration and
utilization review services from third parties to assist them in controlling and
reporting health care costs. In such an environment, the Company believes that
having a broad line of health care programs and products available will be
important in being selected by employers to manage the health care products or
coverage offered to their employees.
The Company's managed care products compete for group and individual
membership with conventional health insurance plans, Blue Cross/Blue Shield
plans, other HMOs, PPOs, third party administrators and health care companies,
and employers or groups who elect to self-insure. The Company also faces
competition from hospitals, health care facilities and other health care
providers who have combined and formed their own networks to contract directly
with employer groups and other prospective customers for the delivery of health
care services, including in California and other states, the trends for provider
groups to accept full risk for the provision of medical services. The Company's
ability to increase the number of persons covered by its products or services or
to increase its premiums and fees can be affected by the Company's level of
competition in any particular area. The Company believes that the principal
competitive factors affecting the Company's business include price, the level
and quality of service provided or arranged for, provider network capabilities,
the offering of innovative products and marketplace reputation.
Further, the Company believes the current factors that generally help it in
regard to competitors are the breadth of its product line, its geographic scope
and diversity, its significant market position in certain geographic areas, the
strength of its provider network and its expertise in managing large government
managed care contracts. In a number of
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markets, the Company may be at a disadvantage with respect to competitors with
larger market shares, broader networks, or more established market place name
and reputation.
GOVERNMENT REGULATION
Substantially all of the Company's businesses are regulated at both the
federal and state level. Government regulation varies from jurisdiction to
jurisdiction and from product to product. Changes in applicable laws and
regulations are continually being considered and the interpretation of existing
laws and rules may also change from time to time. Regulatory agencies generally
have broad discretion in promulgating regulations and in interpreting and
enforcing laws and rules. The Company is unable to predict what regulatory
changes may occur or the impact on the Company of any particular change;
however, the Company's operations and financial results could be negatively
affected by regulatory revisions. See "Cautionary Statements-Health Care
Reform."
Certain minimum tangible net equity, capital and surplus and other
financial viability requirements are imposed on the Company's HMOs and insurance
subsidiaries by regulatory authorities in the states in which these subsidiaries
operate. In addition, certain of the Company's government contracts require the
contracting subsidiaries to maintain specified current ratio or equity levels or
parent guarantees of certain aspects of the financial performance of the
contracts. The Company's HMOs and insurance subsidiaries are required to file
periodic statutory financial statements in each jurisdiction in which they are
licensed and are generally subject to annual financial, medical or other audits.
Additionally, such companies are periodically examined by the supervisory
agencies of the jurisdictions in which they are licensed to do business.
A number of jurisdictions have enacted small group insurance and rating
reforms which generally limit the ability of insurers and HMOs to use risk
selection as a method of controlling costs for small group business. These laws
may generally limit or eliminate use of pre-existing conditions exclusions,
experience rating and industry class rating and may limit the amount of rate
increases from year to year.
The Company is potentially subject to governmental investigations and
audits and enforcement actions related to its businesses. These include
possible government actions relating to the federal Employee Retirement Income
Security Act ("ERISA"), which regulates insured and self-insured health coverage
plans offered by employers and the Company's services to such plans and
employers, provision of services pursuant to the Federal Employees Health
Benefit Plan ("FEHBP"), federal and state fraud and abuse laws and laws relating
to utilization management and the delivery of health care. The Company is
currently involved in various government audits with respect to its government
contracts, Medicare and Medicaid programs and the operations of its insurance
and HMO subsidiaries.
The Company believes that it is currently in compliance in all material
respects with the various federal and state licensing regulations and contract
requirements applicable to its operations. To maintain such compliance, it may
be necessary for the Company to make changes from time to time in its services,
products, capital structure or marketing methods. Non-compliance with
government regulations or contract requirements could subject the Company to
fines, penalties, cease and desist orders, investigations, audits, reimbursement
of funds previously received, lower reimbursement levels and contract or program
termination. 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. The Company's Arizona
HMO received NCQA full accreditation in December 1995 and its California HMO
received provisional NCQA accreditation effective for 15 months in July 1996.
Other states and employer groups are increasingly requiring NCQA or other
similar accreditation as a condition to purchasing health care benefits from
managed care companies.
HMOS. All of the states in which the Company's HMOs offer products have
enacted statutes regulating the activities of those HMOs. As a result, the HMOs
are subject to extensive regulation regarding the scope of benefits provided to
HMO
9
<PAGE>
members and the terms of group benefit agreements, the HMOs financial condition,
including minimum tangible net equity, quality assurance and utilization review
procedures, enrollment requirements, manner of structuring member premiums,
member grievance procedures, provider contracts, marketing and advertising.
The Company's HMOs which have Medicare risk contracts are subject to
regulation by the Health Care Financing Administration ("HCFA"), a branch of the
United States Department of Health and Human Services. HCFA has the right to
audit HMOs operating under Medicare risk contracts to determine each HMO's
compliance with HCFA's contracts and regulations and the quality of care being
rendered to the HMO's enrollees. The Company's Medicare contracts are renewed
annually unless the Company or HCFA elects to terminate the contracts. HCFA
also may unilaterally terminate the Company's Medicare contracts if the Company
fails to continue to meet compliance and eligibility standards. While the
federal government may implement changes in the Medicare risk-based program, the
Company believes that HMOs will continue to be an important factor in the
federal government's overall efforts to control medical costs. However, the
loss of Medicare contracts or termination or modification of the HCFA risk-based
Medicare program could have an adverse effect on the revenue, profitability and
business prospects of the Company as the Company's Medicare business grows. The
services reimbursed by Medicare and Medicaid are subject to various requirements
and restrictions imposed by contract, law and regulation.
The Company's HMOs which have Medicaid contracts are subject to both
federal and state regulation regarding services to be provided to Medicaid
enrollees, payment for those services and other aspects of the Medicaid program.
Both Medicare and Medicaid have in force and/or have proposed regulations
relating to fraud and abuse, physician incentive plans and provider referrals
which may affect the Company's operations.
INSURANCE SUBSIDIARIES. The Company's insurance subsidiaries are subject to
regulation by the Department of Insurance (the "DOI") in each state in which the
entity is licensed. Regulatory authorities exercise extensive supervisory power
over insurance companies with regard to the licensing of insurance companies,
including the nature of, and limitation on, an insurance company's investments,
periodic examination of the operations of insurance companies, and the
establishment of capital and surplus requirements for insurance companies. In
addition, the offering of new products may require the approval of these
regulatory agencies.
INSURANCE HOLDING COMPANY REGULATIONS. Certain of the Company's HMOs and each
of the Company's insurance subsidiaries are subject to regulation under state
insurance holding company regulations. Such insurance holding company laws and
regulations generally require registration with the state DOI and the filing of
certain reports describing capital structure, ownership, financial condition,
certain intercompany transactions and general business activities. Various
notice and reporting requirements generally apply to transactions between
companies within an insurance holding company system, depending on the size and
nature of the transactions. Certain state insurance holding company laws and
regulations require prior regulatory approval or, in certain circumstances,
prior notice of, certain transactions between the regulated companies and their
affiliates.
HOSPITAL REGULATION. The operation of the Company's hospitals is also subject
to federal, state and local government regulation. These facilities are subject
to periodic inspection by state licensing agencies to determine that standards
of medical care and the physical plant necessary for continued licensure are
maintained. The hospitals are subject to environmental legislation by virtue of
the real property owned by the hospitals and by their operations, including
regulation of the disposal of medical waste.
Under the federal reimbursement program for inpatients, Medicare pays a
predetermined rate for each covered hospitalization. Each hospitalization is
classified into one of several hundred diagnosis related groups, which
classification determines the rate paid for the hospitalization. Outpatient
services are reimbursed on the basis of reasonable cost and/or per procedure
price.
The East Los Angeles Doctors Hospital and Memorial Hospital of Gardena have
Medicaid contracts which are subject to cancellation by the state or the
hospital on 120 days' prior notice without cause. If either hospital's Medicare
contract was terminated, the hospital would also be required to cease
participation in Medicaid. For the fiscal year ended
10
<PAGE>
June 30, 1996, the hospitals received approximately 79% of their total revenues
from the Medicare and Medicaid contracts. The termination of participation in
these programs would threaten the hospitals' viability.
EMPLOYEES
As of June 30, 1996, the Company and its subsidiaries employed
approximately 10,500 individuals. None of the Company's employees are presently
covered by a collective bargaining agreement, and the Company believes its
employee relations are good.
ITEM 3. LEGAL PROCEEDINGS
The Company maintains general liability, managed care professional
liability, and directors and officers liability and other insurance coverage
it believes is typical in the industry. In the ordinary course of its
business, the Company is subject to claims and legal actions by enrollees,
providers and others. There can be no assurance that claims in excess of the
Company's insurance coverage will not arise or that all claims would be
covered by such insurance.
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.
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 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.
On October 16, 1996, an alleged stockholder of the Company filed suit in the
Superior Court in Sacramento, California against the Company and individuals
members of the Company's Board. The plaintiff, who purports to represent a
class of all of the Company's stockholders, alleges that the consideration
which the Company's stockholders would receive pursuant to the merger with
Health Systems International Inc. (referred to as the "Merger") is inadequate
and that the directors of the Company have therefore breached their fiduciary
duties to the Company's stockholders. The complaint alleges that the Merger
consideration is below the fair or intrinsic value of the Company and that
the defendants have not considered other potential purchasers of the Company
or explored other strategic alternatives to maximize stockholder value. The
suit seeks an injunction against the Merger, rescission of the Merger if
consummated, unspecified damages, attorney's fees and other relief. The
Company believes, based in part upon discussions with its outside legal
counsel, that the suit is without merit and intends to defend the suit
vigorously.
Two complaints, as previously disclosed, filed under seal against the Company
and certain of its subsidiaries, have been resolved with no material adverse
effect on the Company's financial results. The government informed the
Company that it has declined to intervene in one such filed complaint and in
the other action, the government and the Company have resolved the matter.
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.
11
<PAGE>
CAUTIONARY STATEMENTS
The following discussion contains certain cautionary statements
regarding the Company's business and results of operations which should be
considered by investors and others. These statements discuss matters which
may in part be discussed elsewhere in this Form 10-K/A and which may have been
discussed in other documents prepared by the Company pursuant to federal or
state securities laws. This discussion is intended to take advantage of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. The following factors should be considered in conjunction with any
discussion of operations or results by the Company or its representatives,
including any forward-looking discussion, as well as comments contained in
press releases, presentations to securities analysts or investors, or other
communications by the Company.
In making these statements, the Company is not undertaking to address or
update each factor in future filings or communications regarding the
Company's business or results, and is not undertaking to address how any of
these factors may have caused changes to discussions or information contained
in previous filings or communications. In addition, any of the matters
discussed below may have affected the Company's past results and may affect
future results, so that the Company's actual results for the first fiscal
quarter 1997 and beyond may differ materially from those expressed in prior
communications.
HEALTH CARE COSTS. A large portion of the revenue received by the
Company is expended to pay the costs of health care services or supplies
delivered to its enrollees. Much of the Company's premium revenue is set in
advance of the actual delivery of services and the related incurring of the
cost, usually on a prospective annual basis. While the Company attempts to
base the premiums it charges at least in part on its estimate of expected
health care costs over the fixed premium period, competition, regulations and
other circumstances may limit the Company's ability to fully base premiums on
estimated costs. In addition, many factors may and often do cause actual
health care costs to exceed that estimated and reflected in premiums. These
factors may include increased utilization of services, increased cost of
individual services, catastrophes, epidemics, seasonality, general inflation,
new mandated benefits or other regulatory changes and insured population
characteristics.
WORKERS' COMPENSATION INSURANCE. The Company, primarily through CalComp
in California and BICO in other states, writes managed care workers'
compensation business. For the fiscal year ended June 30, 1996,
approximately 83% of the Company's direct written workers' compensation
premiums were in California. Since January 1995, policies in California have
been issued under "open rating" rules instead of the "minimum rate" laws
which had been in effect. The open rating environment brings uncertainties
to premium revenues and operating profits due to increased price competition.
Although the Company intends to continue to underwrite each account taking
into consideration the insured's risk profile, prior loss experience, loss
prevention plans and other underwriting considerations, there can be no
assurance that the Company will be able to continue to operate profitably in
the California workers' compensation industry or that future workers'
compensation legislation will not be adopted in California or other states
which may adversely affect the Company's results of operations.
A key part of the Company's workers' compensation business strategy is
continued geographic expansion. Future growth of the Company's operations
depends, in part, on its ability to manage workers' compensation programs for
customers in states outside of California. In order to operate effectively
in a new state, the Company must obtain all necessary regulatory approvals,
develop a broker and provider network, achieve acceptance of the Company in
the local market, adapt its procedures to that state's workers' compensation
system and regulation and establish internal controls that enable it to
conduct operations in several locations. Although the Company believes its
managed care approach to workers' compensation will be effective in states
other than California, the Company has limited experience with its techniques
in these other states and there can be no assurance that the Comapny can
successfully use these techniques in other states. Future growth will also
be dependent on the ability of the Company to maintain sufficient capital to
support such growth.
<PAGE>
ADEQUACY OF RESERVES. The Company's HMO and insurance subsidiaries are
requried to maintain reserves to cover their estimated ultimate liability
with respect to reported and unreported claims incurred. These reserves do
not represent an exact calculation of liabilities but rather are estimates
involving judgment and actuarial projections. The accuracy of these
estimates may be affected by external forces such as changes in the rate of
inflation, the regulatory environment, medical costs and other factors. In
particular, because certain workers' compensation claims may not be reported
for several years, estimating reserves for such claims can be more difficult
and uncertain than estimating reserves in other lines of HMO and insurance
businesses in which the period between the occurrence of the claim and final
detemination of the Company's liability is shorter. Establishment of
reserves is an inherently uncertain process and there can be no certainty
that currently established reserves will prove to be adequate to cover actual
ultimate expenses. Subsequent actual experience could result in loss
reserves being too high or too low. Higher than expected claim costs could
require reserves for prior periods to be increased, which would adversely
impact the Company's earnings in future periods.
HEALTH CARE REFORM. There have been numberous legislative and
regulatory initiatives at both the federal and state levels to address, among
other aspects of the nation's health care system, the continuing increases in
health care costs and the lack of health care coverage for a significant
segment of the population. The Health Insurance Portability and
Accountability Act of 1996 (the "1996 Act"), which was recently adopted by
Congress and signed by President Clinton, contains a number of provisions to
reform the nation's health care system. These provisions include guaranteed
insurance coverage and "portability" of health insurance when changing jobs;
limited use of pre-existing conditions as the basis for exclusion from
coverage; creation of medical saving accounts; mandatory or voluntary regional
health alliances or purchasing cooperatives; increase in the deductability of
premiums for the self employed; and numerous fraud and abuse provisions
containing significant criminal and civil law enhancements (some of which
will apply not only to federal health programs, such as Medicare and
Medicaid, but to private health plans as well). To varying degrees, many of
the provisions of the 1996 Act and other pending bills contemplate the
involvement of state governments in the regulation and implementation of
federal health care reform legislation.
Various states are considering forms of single-payer systems, restructur-
ing of Medicaid programs, "any willing provider" legislation that could require
managed care companies to contract with any medical proivder who agrees to
the terms of the company's standard provider contract and payment schedule
and "patient care initiatives" which address consumer protection issues in
the managed care environment. All or any of these potential forms of
legislation could adversely affect the Company's business.
The Company is unable to predict how existing federal or state laws and
regulations may be changed or interpreted, what additional laws or regulations
affecting its businesses may be enacted or proposed, when and which or the
proposed laws will be adopted or what effect the new laws and regulations
will have on its businesses. However, certain of the proposals, if adopted,
could have a material adverse effect on the Company's business, while others,
if adopted, could potentially benefit the Company's business. Although the
effects of these activities cannot yet be detrmined, the Company remains
committed to participate in the debate over health care reform and in the
restructuring of the health care system.
MERGERS, ACQUISITIONS AND EXPANSION. Mergers and acquisitions have
played an important role in the implementation of the Company's business
strategy and are expected to continue to be important to the Company's growth
and development. The Company's product offerings and HMO, PPO and specialty
services enrollment have been expanded through these acquisitions. As a
result, the Company is subject to the uncertainties and risks associated with
any business that has grown rapidly and has expanded into new product and
geographic areas. These mergers and acquisitions have placed substantial
demands on the Company's management and financial resources. The integration
of the acquired companies' operations continues to be slower, more complex and
more costly than originally anticipated, especially in systems and functional
areas such as claims processing, data management and finance. There can be
no assurance that the combined companies will realize the full cost savings
or revenue enhancements the Company expects to realize in connection with the
recent acquisitions or that such savings or enhancements will be realized at
the points in time currently anticipated. Furthermore, there can be no
assurance that any cost savings which are realized will not be
<PAGE>
offset by decreases in revenues or increases in other expenses. The Company
will encounter similar uncertainties and risks with respect to any future
acquisitions it may make.
The Company has start-up HMO and specialty services operations in a
number of states and the United Kingdom thereby exposing the Company to
different methods of operations and management and the effect of varying
state regulations. These operations have required and will continue to incur
significant expenses related to creating the infrastructure for operations,
satisfying net equity or capital and surplus requirements, hiring and
training personnel, obtaining necessary regulatory approvals and operating
until sufficient revenues are achieved to offset the overhead costs. There
can be no assurance that the Company will be successful in managing HMOs at
multiple locations or in obtaining sufficient revenues to be profitable.
The Company's United Kingdom operations are experiencing greater losses
and larger capital requirements than originally anticipated; there can be no
assurance that the critical mass needed for these operations to become
profitable within a reasonable time period will be realized. Failure of the
United Kingdom operations would have an adverse effect on the Company's
operating results.
From time to time the Company engages in the evaluation of potential
acquisitions. No assurance can be given as to the Company's ability to
compete successfully at favorable prices for available acquisition candidates
or to complete future acquisitions, or as to the financial effect on the
Company of any acquisitions. Future acquisitions by the amortization expense
or decreased operating income, which could have an adverse impact on the
Company's future operating result or a dilutive effect on the Company's
earnings per share.
COMPETITION. In many of its geographic or product markets the Company
competes with a number of other entities, some of which may have certain
characteristics or capabilities which give them an advantage in competing
with the Company. The Company believes there are few barriers to entry in
some markets, so that the addition of new competitors can occur relatively
easily. Certain of the Company's customers may decide to perform for
themselves functions or services formerly provided by the Company, which
would result in a decrease in the Company's revenues. Certain of the
Company's providers may decide to market products and services to Company
customers in competition with the Company. In addition, significant merger
and acquisition activity has occurred in the industry in which the Company
operates as well as in industries which act as suppliers to the Company such
as the hospital, physician, pharmaceutical and medical device industries.
This activitity may create stronger competitors and/or result in higher
health care costs. To the extent that there is strong competition or that
competition intensifies in any market, the Company's ability to retain or
increase customers, its revenue growth, its pricing flexibility, its control
over medical cost trends and its marketing expenses may all be adversely
affected.
The media are not generally aware of the high degree of regulatory
oversight of the managed care industry or the degree to which the
industry's health care delivery networks have enhanced the ability to measure,
monitor and improve the quality of health care services. As a result, the
managed care industry has recently been the subject of significant amounts of
negative publicity. Such general publicity, or any negative publicity
regarding the Company in particular, could adversely affect the Company's
ability to sell its product or services or could create regulatory problems
for the Company.
PROVIDER RELATIONS. One of the significant techniques the Company uses
to manage health care costs and utilization and monitor the quality of care
being delivered is contracting with physicans, hospitals and other providers.
Because of the geographic diversity of the Company's HMOs and the large
number of providers with which most of those HMOs contract, the Company
currently believes it has a limited exposure to potential disruption in
relations with sepcific providers. In any particular market, however,
providers could refuse to contract with the Company, demand higher payments
or take other actions which could result in higher health care costs, less
desirable products for customers and members or difficulty meeting regulatory
or accreditation requirements.
<PAGE>
In some markets, certain providers, particularly hospitals,
physician/hospital organizations or multi-specialty physician groups, may
have significant market positions. Many of these providers may compete
directly with the Company. If such providers refuse to contract with the
Company or utilize their market position to negotiate contracts that place
the Company at a competitive disadvantage, the Company's ability to market
products or to be profitable in those areas could be adversely affected.
The Company has recently divested its affiliated IPAs and has pending
transactions to divest its affiliated medical groups in California and
Arizona; although the Company has entered into long-term provider contracts
with the purchaser of these IPAs and medical groups, a significant change in
market conditions, benefits or provider costs or an adverse change in the
financial viability of the purchaser of the IPAs and medical groups, could
adversely affect the cost of health care provided to the Company's enrollees
under these arrangements.
ADMINISTRATION AND MANAGEMENT. The level of administrative expense is a
partial determinant of the Company's profitability. While the Company
attempts to effectively manage such expenses, increases in staff-related and
other administrative expenses may occur from time-to-time due to business or
product start-ups, expansions, growth or changes in business, acquisitions,
regulatory requirements or other reasons. Such cost increases are not
clearly predictable and may adversely affect the Company's financial results.
INFORMATION SYSTEMS. The Company's business is significantly dependent
on effective information systems. The Company has many different information
systems for its various businesses. The Company is in the process of
attempting to reduce the number of systems and also upgrade and expand its
information systems capabilities. Failure to maintain an effective and
efficient information system could result in loss of existing customers and
difficulty in attracting new customers, customer and provider disputes,
regulatory problems, increases in administrative expenses or other adverse
consequences. In addition, the Company may, from time to time, obtain
significant portions of its services or facilities from independent third
parties which may make the Company's operations vulnerable to such third
party's failure to perform adequately. The Company has made several large
acquisitions in recent years. Failure to effectively integrate acquired
operations could result in increased administrative costs and poor customer
relations.
GOVERNMENT PROGRAMS AND REGULATION. The Company's business is heavily
regulated. The laws and rules governing the Company's business and
interpretations of those laws and rules are subject to frequent change.
Existing or future laws and rules could force the Company to change how it
does business and may restrict the Company's revenue and/or enrollment growth
and/or increase its health care and administrative costs. Regulatory
approvals must be obtained and maintained to market many of the Company's
products and services. Delays in obtaining or failure to obtain or maintain
such approvals could adversely affect the Company's revenue or the number of
its enrollees, or could increase costs.
A significant portion of the Company's revenues relate to federal, state
and local government health care coverage programs. These types of programs,
such as the federal CHAMPUS and Medicare programs and the federal and state
Medicaid program, are generally subject to frequent change including changes
which may reduce the number of persons enrolled or eligible, reduce the
revenue received by the Company or increase the Company's administrative or
health care costs under such programs. Such changes have in the past and may
in the future adversely affect the Company's financial results and its
willingness to continue participation in such programs.
The Company is also subject to various governmental audits and
investigations. Adverse findings could result in the loss of licensure or
the right to participate in certain programs, or the imposition of fines,
penalties and other sanctions. In addition, disclosure of any adverse
investigation or audit results or sanctions could negatively affect the
Company's reputation in various markets and make it more difficult for the
Company to sell its products and services.
LITIGATION AND INSURANCE. The Company is subject to a variety of legal
actions to which any corporation may be subject, including employment-related
suits, employee benefit claims, breach of contract actions and tort claims.
In
<PAGE>
addition, because of the nature of its business, the Company incurs and
likely will continue to incur potential liability for claims related to its
business, such as failure to pay for or provide health care, poor outcomes
for care delivered or arranged, provider disputes, including disputes over
withheld compensation and claims related to self-funded business. In some
cases, substantial non-economic or punitive damages may be sought. While the
Company currently has insurance coverage for some of these potential
liabilities, other may not be covered by insurance, the insurers may dispute
coverage or the amount of insurance may not be enough to cover the damages
awarded. In addition, certain types of damages, such as punitive damages,
may not be covered by insurance and insurance coverage for all or certain
forms of liability may become unavailable or prohibitively expensive in the
future.
STOCK MARKET. Recently, the market prices of the securities of certain
of the publicly-held companies in the industry in which the Company operates
have shown volatility and sensitivity in response to many factors, including
public communications regarding managed care, legislative or regulatory
actions, health care cost trends, pricing trends, competition, earnings or
membership reports of particular industry participants, and acquisition
activity. There can be no assurance regarding the level or stability of the
Company's share price at any time or of the impact of these or any other
factors on the share price.
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
FOUNDATION HEALTH CORPORATION
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(RESTATED)
YEARS ENDED JUNE 30,
------------------------------------------------------------------------
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA (1):
Revenues:
Commercial premiums $ 900,660 $ 1,102,392 $ 1,358,616 $ 1,664,509 $ 2,002,695
Government contracts 670,271 746,827 542,726 187,493 586,011
Specialty services 50,627 89,135 380,726 509,807 700,923
Patient service revenue, net 40,612 43,483 41,358 38,604 50,124
Investment and other income 21,603 20,519 37,273 59,010 67,875
------------ ------------ ------------ ------------ ------------
1,683,773 2,002,356 2,360,699 2,459,423 3,407,628
------------ ------------ ------------ ------------ ------------
Expenses:
Commercial health care services 711,735 862,602 1,067,027 1,290,367 1,607,073
Government contracts health care services 171,983 188,139 152,185 67,508 375,480
Government contracts subcontractor costs 419,817 432,903 252,743 66,551 40,572
Specialty services costs 47,950 79,366 355,208 438,124 616,537
Patient service costs 40,973 38,156 37,599 33,561 36,216
Selling, general and administrative 165,259 227,611 282,318 304,850 448,322
Amortization and depreciation 17,079 19,197 25,162 34,831 52,184
Interest Expense 6,035 4,239 11,147 10,796 14,684
Acquisition and restructuring costs (2) - 12,413 - 124,822 -
------------ ------------ ------------ ------------ ------------
1,580,831 1,864,626 2,183,389 2,371,410 3,191,068
------------ ------------ ------------ ------------ ------------
Income from continuing operations before
income taxes and minority interest 102,942 137,730 177,310 88,013 216,560
Provision for income taxes 39,360 57,327 69,954 29,900 64,318
Minority interest 4,042 6,636 7,398 2,262 -
------------ ------------ ------------ ------------ ------------
Income from continuing operations $ 59,540 $ 73,767 $ 99,958 $ 55,851 $ 152,242
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Earnings per share from continuing operations $ 1.49 $ 1.54 $ 2.05 $ 1.02 $ 2.61
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Weighted average common and common stock
equivalent shares outstanding 40,022,322 47,870,576 48,688,221 54,780,162 58,292,971
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
<CAPTION>
JUNE 30,
------------------------------------------------------------------------
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (1)
Cash and investments $ 291,919 $ 481,840 $ 761,593 $ 794,551 $ 941,070
Total assets 632,037 856,711 1,432,025 1,884,689 2,337,653
Notes payable and capital leases 51,688 150,369 149,335 167,483 309,136
Stockholders' equity 263,427 342,398 416,377 707,394 866,926
</TABLE>
- ----------
(1) The Company's consolidated financial statements have been restated to
reflect (a) the results of acquisitions accounted for in accordance with
the pooling of interests method of accounting and (b) reflect the
consolidation of the Company's affiliated physician-owned Medical
Practices which have been treated as discontinued operations for all
periods reported. See Note 1 of Notes to the Consolidated Financial
Statements.
(2) In connection with certain acquisitions the Company recorded charges
for acquisition and restructuring costs. See Note 1 of Notes to the
Consolidated Financial Statements.
12
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CONSOLIDATED OPERATING RESULTS
The Company achieved record revenues and earnings for the fiscal year ended
June 30, 1996. The growth in revenues was primarily driven by (i) commercial
enrollment gains from the Company's individual, Medicaid, and Medicare risk
products, (ii) continued growth in net earned workers' compensation premium due
to growth in premiums written and (iii) revenues related to an entire year of
health care delivery under the Washington/Oregon Contract and commencement of
health care delivery under the Region 6 Contract during the second quarter.
Additionally, in September 1995 implementation of the California/Hawaii Contract
commenced and delivery of health care services began in the fourth quarter.
These results were offset in part by losses from the Company's Gem Insurance
Company ("Gem") PPO operations and HMO operations in Utah. Fiscal year 1995
revenues were primarily driven by commercial enrollment gains, especially from
the Company's individual and Medicare risk products, additional Medicaid
enrollment as a result of the acquisition of the Florida Medicaid HMO, growth in
net earned workers' compensation premium due to sales and recapture of ceded
premium and commencement of health care delivery under the Washington/Oregon
Contract during the third quarter. This growth was offset by the January 31,
1994 expiration of the CHAMPUS Reform Initiative Contract for California and
Hawaii (the "CRI Contract"). Fiscal year 1994 revenues included $431.3 million
in revenues related to the CRI Contract. Revenues in fiscal year 1994 exceeded
revenues in fiscal year 1993 primarily as a result of increased commercial
enrollment and specialty services revenues, including revenues generated from
CalComp which was acquired in August 1993.
Investment and other income, included as a component of the Company's
revenues, increased in fiscal 1996 over fiscal year 1995 primarily due to
investment of excess surplus and reserves generated by operations. Increases in
each of the other years is due primarily to the investment of excess surplus and
reserves generated by operations, a significant part of investments are held by
CalComp and its subsidiaries in tax-exempt securities.
The Company's selling, general and administrative ("SG&A") expenses in
fiscal year 1996 increased due primarily to the implementation costs of the
Region 6 and California/Hawaii Contracts. The Company's SG&A expenses in fiscal
year 1995 increased over 1994 primarily due to the implementation costs of the
Washington/Oregon and Region 6 Contracts and start-up of the New Jersey Medicaid
administrative services only contract. Fiscal year 1994 SG&A expenses were
driven primarily by expenses incurred related to the establishment and operation
of government claims processing as an internal function and inclusion of SG&A
expenses related to Gem, which was acquired January 1, 1994.
The ratio of SG&A expenses to total revenue (the "SG&A ratio") was 13.2%
for fiscal year 1996 compared to 12.4% for fiscal year 1995. This increase
from 1995 to 1996 was primarily due to the implementation costs incurred in
fiscal year 1996 related to the Region 6 and California/Hawaii contracts,
lower revenue from increased pricing pressure on commercial premiums offset
in part by the completion of the wind-down period of the CRI contract during
1995. The SG&A ratio for fiscal year 1995 was 12.4% compared to 12.0% for
fiscal year ended 1994. The increase in the ratio in 1995 over 1994 is
primarily due to implementation costs of the Washington/Oregon and Region 6
contracts and start-up of the New Jersey Medicaid administrative services
contract, during 1995.
Amortization and depreciation expense increased each year primarily due to
increased depreciation as a result of the Company's ownership and construction
of health care centers and increased amortization of intangibles incurred in
connection with the purchase of the Intergroup minority interest and other
business acquisitions during fiscal years 1994, 1995 and 1996.
Interest expense increased in 1996 over 1995 due to increased borrowing
under the Company's unsecured revolving line of credit. Fiscal year 1997
interest expense is expected to increase due to increased borrowings under
the Company's credit agreement. See "Liquidity and Capital Resources".
In connection with the mergers of CareFlorida, TDMC and Intergroup, the
Company recorded a charge for integration, restructuring and pooling costs of
$124.8 million in fiscal year 1995. The acquisition and restructuring charge
13
<PAGE>
represented 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 components of this charge included (in millions):
Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . $21.5
Cancellation of certain contractual obligations and
other settlement costs. . . . . . . . . . . . . . . . . . . . . . 27.1
Write-off of certain redundant hardware, software and
other settlement costs. . . . . . . . . . . . . . . . . . . . . . 17.9
Elimination of duplicate facilities . . . . . . . . . . . . . . . . 13.0
Transition and severance related payments to employees. . . . . . . 36.5
Other integration and restructuring . . . . . . . . . . . . . . . . 8.8
------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $124.8
------
------
These costs satisfy the definition of "exit costs" as set forth in Emerging
Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" that are directly related to the mergers.
During the third quarter of fiscal 1996, the Company re-evaluated the
restructuring liabilities as originally formulated in fiscal 1995. The re-
evaluation resulted in an estimate of $16.7 million less than the original
reserve. This excess reserve was offset 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. in March 1996. The
Company has substantially completed its integration and restructuring of the
combined entities as of June 30, 1996.
As a result of the factors described above, fiscal year 1996 income from
continuing operations before income taxes and minority interest increased to
$216.6 million. In fiscal year 1995, income from continuing operations before
income taxes and the minority interest was $212.8 million (before acquisition
and restructuring costs). After acquisition and restructuring costs, income
from continuing operations before income taxes and minority interest was
$88.0 million in fiscal year 1995. Fiscal year 1994 income from continuing
operations before income taxes and minority interest increased to $177.3 million
as compared to $150.1 million (before acquisition and restructuring costs) for
fiscal year 1993. After acquisition and restructuring costs, income from
continuing operations before income taxes and minority interest was $137.7
million in fiscal year 1993.
The tax provision for fiscal year 1996 decreased to 29.7% as compared to a
rate of 34.0% for fiscal year 1995 as a result of the effect of non-deductible
acquisition costs in fiscal year 1995 (which caused a higher than normal rate)
and the effect of net operating loss carryforwards which became available during
fiscal year 1996 (which caused a lower than normal rate) related to Managed
Health Network, Inc., which was acquired by the Company in March 1996.
Additional net operating loss carryforwards became available in fiscal year 1996
that further decreased the effective tax rate. The tax provision rate for 1995
of 34.0% was lower than the 1994 rate of 39.5% because of the combined effect of
the acquisition and restructuring charge of $124.8 million and the resulting
increased proportion of tax-exempt interest income as a percentage of pre-tax
income. The rate was further reduced by the acquisition of Intergroup, which is
not subject to state franchise or income taxes, and the elimination of a
duplicate tax for undistributed income from Intergroup to its former parent
company. These rate reductions were mitigated by the effects of non-deductible
acquisition expenses. The tax rate is anticipated to increase in fiscal year
1997 as the availability of net operating loss carryforwards is not expected to
recur.
Minority interest in fiscal years 1994 and 1995 represents the allocation
of Intergroup's net income to the holders of the 39.5% portion of Intergroup
common stock not held by TDMC (the "Intergroup Minority Interest"), for the
periods prior to the Company's acquisition of the Intergroup Minority Interest.
Through the combination of the factors described above, income from
continuing operations grew from $99.9 million or $2.05 per share in fiscal year
1994 to income from continuing operations of $138.2 million or $2.52 per
share
14
<PAGE>
in fiscal year 1995 (before the $124.8 million acquisition and restructuring
costs net of related tax-effects). After such charge net of related tax effects,
income from continuing operations for fiscal year 1995 was $55.9 million or
$.1.02 per share. Income from continuing operations increased in fiscal year
1996 to $152.2 million or $2.61 per share over the $138.2 million (before
acquisition and restructuring costs, net of related tax benefits) or $2.52 per
share in fiscal year 1995.
LINE OF BUSINESS REPORTING
The Company currently operates in a single industry segment, managed
health care. The Company's continuing operations are in three primary lines
of business (i) commercial operations, (ii) government contracts; and (iii)
specialty services. Previously, the Company also operated in another
segment, physician practice management and physician-owned Medical Practices
which were discontinued during the third quarter of fiscal year 1996.
Operating losses since the measurement date are being deferred because of an
anticipated gain on the sale of the Company's physician practice management
company and physician-owned Medical Practices, which is scheduled to close in
the second quarter of fiscal 1997. The following table presents financial
information related to discontinued operations.
Year Ended June 30,
-------------------
1994 1995 1996
---- ---- ----
Revenues $109.5 $118.3 $153.8
Operating losses, net
of taxes (1) $ 12.3 $ 49.8 $ 4.0
Loss per share $ 0.25 $ 0.91 $ 0.07
------ ------ ------
------ ------ ------
(1) Deferred losses from measurement date of March 1, 1996 to June 30, 1996
were $17.5 million.
The following table presents financial information reflecting the Company's
continuing operations by the three primary lines of business: (i) commercial
operations; (ii) government contracts; and (iii) specialty services.
15
<PAGE>
LINE OF BUSINESS FINANCIAL INFORMATION
FOUNDATION HEALTH CORPORATION
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(Restated)
YEARS ENDED JUNE 30,
<TABLE>
<CAPTION>
1994 1995 1996
------------------------------- ------------------------------- -------------------------------
PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT
AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL INCREASE
PERCENT REVENUE (DECREASE) PERCENT REVENUE (DECREASE) PERCENT REVENUE (DECREASE)
----------- -------- ---------- ----------- -------- ---------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Commercial premiums $ 1,358,616 57.5% 23.2% $ 1,664,509 67.7% 22.5% $ 2,002,695 58.8% 20.3%
Government contracts 542,726 23.0 (27.3) 187,493 7.6 (65.5) 586,011 17.2 212.6
Specialty services 380,726 16.1 327.1 509,807 20.7 33.9 700,923 20.6 37.5
Patient service revenue, net 41,358 1.8 (4.9) 38,604 1.6 (6.7) 50,124 1.5 29.8
Investment and other income 37,273 1.6 81.7 59,010 2.4 58.3 67,875 2.0 15.0
----------- ---- ----------- ---- ----------- ----
2,360,699 100.0 17.9 2,459,423 100.0 4.2 3,407,628 100.0 38.6
----------- ---- ----------- ---- ----------- ----
Expenses:
Commercial health care
services 1,067,027 45.2 23.7 1,290,367 52.5 20.9 1,607,073 47.2 24.5
Government contracts health
care service 152,185 6.4 (19.1) 67,508 2.7 (55.6) 375,480 11.0 456.2
Government contracts
subcontractor costs 252,743 10.7 (41.6) 66,551 2.7 (73.7) 40,572 1.2 (39.0)
Specialty services costs 355,208 15.0 347.6 438,124 17.8 23.3 616,537 18.1 40.7
Patient service costs 37,599 1.6 (1.5) 33,561 1.4 (10.7) 36,216 1.1 7.9
Selling, general and
administrative (SG&A) 282,318 12.0 24.0 304,850 12.4 8.0 448,322 13.2 47.1
Amortization and depreciation 25,162 1.1 31.1 34,831 1.4 38.4 52,184 1.5 49.8
Interest Expense 11,147 0.5 163.0 10,796 0.4 (3.1) 14,684 0.4 36.0
Acquisition and restructuring
costs - 0.0 N/A 124,822 5.1 N/A - 0.0 N/A
----------- ---- ----------- ---- ----------- ----
2,183,389 92.5 17.1 2,371,410 96.4 8.6 3,191,068 93.6 34.6
----------- ---- ----------- ---- ----------- ----
Income from continuing operations
before income taxes and
minority interest 177,310 7.5 28.7 88,013 3.6 (51.5) 216,560 6.4 146.1
Provision for income taxes 69,954 3.0 22.0 29,900 1.2 (57.3) 64,318 1.9 115.1
Minority interest 7,398 0.3 11.5 2,262 0.1 (69.4) - 0.0 N/A
----------- ---- ----------- ---- ----------- ----
Income from continuing
operations $ 99,958 4.2% 35.5 $ 55,851 2.3% (44.1) $ 152,242 4.5% 172.6
----------- ---- ----------- ---- ----------- ----
----------- ---- ----------- ---- ----------- ----
Earnings per share
from continuing operations $ 2.05 33.1 $ 1.02 (50.3) $ 2.61 156.2
----------- ----------- -----------
----------- ----------- -----------
Weighted average common and
common stock equivalent
shares outstanding 48,688,221 1.7 54,780,162 12.5 58,292,971 6.4
----------- ----------- -----------
----------- ----------- -----------
Operating Ratios
Commercial loss ratio 78.5% 77.5% 80.2%
Government contracts ratio 74.6 71.5 71.0
Specialty services ratio 93.3 85.9 88.0
Patient service ratio 90.9 86.9 72.3
S G & A to total revenues 12.0 12.4 13.2
Effective tax rate 39.5 34.0 29.7
Enrollment
Commercial:
Group and individual 828 25.3 992 19.8 1,195 20.5
Medicare risk 46 64.3 72 56.5 87 20.8
Medicaid 111 33.7 112 0.9 260 132.1
----------- ------ ----------- ------ ----------- ------
985 27.6 1,176 19.4 1,542 31.1
----------- ------ ----------- ------ ----------- ------
Government
CHAMPUS PPO and Indemnity 86 (87.9) 251 191.9 1,072 327.1
CHAMPUS HMO 24 (90.7) 86 258.3 457 431.4
----------- ------ ----------- ------ ----------- ------
110 (88.7) 337 206.4 1,529 353.7
----------- ------ ----------- ------ ----------- ------
Combined 1,095 (37.2%) 1,513 38.2% 3,071 103.0%
----------- ------ ----------- ------ ----------- ------
----------- ------ ----------- ------ ----------- ------
</TABLE>
16
<PAGE>
COMMERCIAL OPERATIONS
Revenues generated by the Company's commercial operations increased in
fiscal year 1996 over fiscal year 1995 due in part to a 31% increase in
enrollment from existing lines of business and geographic expansion offset by
reductions in commercial premium revenue per member due to continued competitive
pricing pressures. Revenues generated by commercial operations in fiscal year
1995 increased over fiscal year 1994 due in part to inclusion of revenues from
the January 1994 purchase of Gem and the November 1994 purchases of the Colorado
HMO and the Florida Medicaid HMO as well as increased enrollment in existing
lines of business. Revenues in fiscal year 1994 increased over fiscal year
1993, reflecting increased enrollment growth and as well as the inclusion of
revenue from Gem for the last six months of fiscal year 1994. The Company
anticipates revenues to increase during fiscal year 1997 primarily as a result
of commercial enrollment growth and revenues related to delivery of health care
services pursuant to the Medicaid Mainstream program in California anticipated
to commence in mid-fiscal year 1997; however, the rate of increase is not
expected to be at the same level as in prior years since, to some extent, prior
year increases have resulted from businesses acquired and the Company
anticipates continued pressure on its ability to increase premium rates.
The Company expects continued pressure from employer groups and government
agencies to reduce premiums. Health care costs on a per member basis increased
slightly for fiscal year 1996 as compared to fiscal year 1995. The commercial
loss ratio increased from 77.5% for fiscal year 1995 to 80.2% for fiscal year
1996. The increase in the ratio was due to the continued competitive premium
pressures, new enrollees in higher loss ratio products and increased health care
costs. The commercial loss ratio decreased slightly to 77.5% in fiscal year
1995 from 78.5% in fiscal year 1994. This decrease was due to the emphasis on
controlling health care costs. The 1994 loss ratio was impacted by competitive
pressures in California offset by greater profitability of the Company's Florida
and Arizona HMOs. The Company believes that commercial premiums will 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 fiscal year 1996 over fiscal
year 1995 primarily due to revenues generated by the Washington/Oregon, Region 6
and California/Hawaii Contracts. These increases were offset by the expiration
of the Base Realignment and Closure ("BRAC") Contract. Government contracts
revenue for fiscal year 1995 decreased from fiscal year 1994 primarily due to
the expiration of the CRI Contract in January 1994. The CRI Contract contributed
revenues of $431.3 million in fiscal year 1994. The Company commenced health
care delivery under its managed care contract in Louisiana and Texas in May 1993
and under the Washington/Oregon Contract in March 1995. Government contracts
revenue is impacted by semi-annual bid price adjustments, annual price increases
or decreases, risk sharing provisions and various other price adjustments
attributable to change orders for additional services, inflation and other
factors.
The government contracts ratio improved in fiscal years 1994 and 1995. The
improvement in those fiscal years was due primarily to lower health care costs
under the CRI Contract attributable to effective managed care techniques,
shifting of claims processing from an outside vendor to an internal function and
increased change order revenue. The government contracts ratio improved slightly
during fiscal year 1996 compared to fiscal year 1995. 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 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 increase
during fiscal year 1997 as health care services will be delivered under all
three CHAMPUS contracts during the fiscal year 1997 as compared to staggered
implementation during the fiscal year 1996. 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.
17
<PAGE>
SPECIALTY SERVICES
Specialty services revenues increased substantially during each of the last
three fiscal years. A significant part of the increases was due to revenues
generated by CalComp, the Company's workers' compensation bill review and third
party administration subsidiaries and the acquisition of BICO by CalComp in
February 1995.
The improvement in the specialty services ratio in fiscal year 1995 over
that of fiscal year 1994 was primarily due to improvement in the workers'
compensation operating ratios, through the successful implementation of managed
care programs, which has lowered worker's compensation medical costs, and to the
addition of the worker's compensation bill review company, which has a lower
administrative component than most of the other specialty services companies.
The increase in the specialty services ratio in fiscal year 1996 over that of
fiscal year 1995 is primarily due to an increase in the combined ratio in the
worker's compensation business as described below.
Commencing in fiscal year 1994, several significant reforms to the
California workers' compensation laws affected CalComp. The reforms address
various aspects of the workers' compensation system, including limitations on
certain types of claims, restrictions on vocational rehabilitation benefits,
additional penalties for fraud and abuse, and reductions in state-mandated
minimum premium rates which culminated in open rating in California effective
January 1, 1995. Since the acquisition of CalComp, the Company has taken
various actions to mitigate the effects of the reforms and the sharp premium
declines as a result of the more competitive pricing environment under open
rating. These actions include development and implementation of its managed
care approach to workers' compensation, continued use of loss prevention and
return to work programs, shifting of the risk profile of CalComp's business,
increased use of the Company's PPO and blended case management systems (which
have reduced the average severity per claim). In addition, to diversify its
underwriting risk as a result of reduced premium levels on policies written in
California and to take advantage of perceived opportunities because of favorable
national workers' compensation reform, the Company started to write workers'
compensation policies in states outside of California through BICO, a subsidiary
of CalComp, licensed to write insurance in 49 states. Since being purchased in
February 1995, BICO has increased its estimated annual premiums inforce to over
$100 million, and recognized direct premiums earned of approximately $42 million
during fiscal 1996. BICO utilizes the same managed workers' compensation
approach as CalComp to manage its claim costs. The Company believes these
strategies should contribute to the continued growth of this part of the
specialty services operations and partially offset the impact from the changes
in the California workers' compensation marketplace.
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 and its subsidiaries underwriting
experience as measured by its combined ratio and its components (computed on a
generally accepted accounting principles basis) for the fiscal years ended June
30, 1996, 1995 and the eleven months from August 1, 1993 (the date of
acquisition) to June 30, 1994:
1996 1995 1994
---- ---- ----
Loss and loss adjustment expense ratio 64.2% 62.8% 62.8%
Underwriting expense ratio 24.5 22.7 24.0
Policyholder dividend ratio 1.1 1.4 7.4
---- ---- ----
Combined ratio 89.8% 86.9% 94.2%
---- ---- ----
---- ---- ----
While average premium rates decreased during fiscal 1996, CalComp's loss
and loss adjustment expense ratio showed a slight increase of 1.4%. CalComp
continues to emphasize writing accounts and classes of business with the
potential for lower than average claim severity and higher claim frequency,
which permits CalComp's loss control staff and managed workers' compensation
programs to reduce the number of reported claims. As a percent of covered
insured payroll, the claims frequency rate decreased by 8% during fiscal year
1996 compared to 1995. In addition to frequency as a percent
18
<PAGE>
of payroll decreasing, the average cost of new reported claims was 7% lower than
new claims reported during fiscal 1995. This reduction in costs is due to the
effective use of managed care techniques, which reduces the medical components
of loss costs, lower allocated loss adjustment expenses by utilizing more cost
efficient hearing representatives, emphasizing returning the injured worker to
some form of modified work, and closing claims more quickly. The reductions in
claim incidence and cost, and reductions in estimates for prior accident year
claims did not fully offset the impact of reductions in premium revenue due to
competitive rating, thereby producing a loss and loss adjustment expense ratio
that increased by 1.4% from fiscal 1995.
The underwriting expense ratio increased by 1.8%, primarily due to the
reduction in premium rates in fiscal year 1996 over fiscal year 1995. The
increase in these costs was greater than the increase in net premiums earned.
This ratio, as a percent of net premiums earned, was significantly impacted by
the reduction to premium rates in California for policies written after
January 1, 1995. Premiums earned in fiscal 1995 included premiums for policies
issued prior to the start of competitive rating. Premiums earned in fiscal
1996 were derived primarily from policies written subsequent to the start of
competitive rating in California. In addition, operating costs were impacted by
the establishment of regional offices for BICO in strategic locations in western
and southern states.
The policyholder dividend ratio for the fiscal year 1996 was 1.1%. In
fiscal year 1996, CalComp issued less than 6% of its California policies on a
participating basis. This resulted in minimal policyholder dividends accrued.
Currently, California policyholders receive the benefit of lower workers'
compensation premiums at the inception of their respective policies, as compared
to policyholder dividends which were paid after policy expiration. Though
CalComp writes participating policies through BICO in states outside of
California, the portion of earned premiums represented by this group is
relatively small in fiscal year 1996.
CalComp was able to maintain a consistent loss and loss adjustment expense
ratio in fiscal year 1995 through the successful implementation of managed care
programs, and the increased use of internal staff to support fair hearing
representatives in the settlement of claims, despite the 16% decrease in the
minimum rates in California effective October 1, 1994, and the abolishment of
minimum rates and the commencement of open rating effective January 1, 1995. The
decrease in the combined ratio from fiscal year 1994 to fiscal year 1995 was
primarily due to the 6.0% decrease in the policyholder dividend ratio and the
1.3% reduction in the underwriting expense ratio. The underwriting expense
ratio decrease is primarily due to the decrease in employee salaries and
benefits to 9.7% of premiums in fiscal year 1995 from 11.0% in fiscal year 1994.
CalComp was able to achieve this decrease during a period when net premiums
earned increased by 20%; however, approximately one-half of such increase was
the result of cancellation of CalComp's quota share reinsurance arrangement
effective July 1, 1994. Workers' compensation reforms and increased price
competition have also resulted in lower policyholder dividends incurred as
policyholders now receive the benefit of lower workers' compensation costs in
the form of reduced premiums at the inception of the policy versus policyholder
dividends paid after the policy expires.
19
<PAGE>
QUARTERLY RESULTS
The following table presents unaudited restated consolidated operating results
for the last eight fiscal quarters, see Note 12 to the Consolidated Financial
Statements. The Company believes that all necessary adjustments, consisting
only of normal recurring adjustments, have been included in the amounts stated
below to present fairly the following quarterly results when read in conjunction
with the Company's consolidated financial statements included elsewhere herein.
Results of operations for any particular quarter are not necessarily indicative
of results of operations for a full fiscal year.
<TABLE>
<CAPTION>
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(RESTATED)
<S> <C> <C> <C> <C>
FISCAL 1995
Total revenues . . . . . . . . . . . . . . . . . . . . $595.2 $599.1 $615.0 $650.1
Income (loss) from continuing operations before
income taxes and minority interest. . . . . . . . . . $41.7 $(68.9)(1) $57.8 $57.5
Income (loss) from continuing operations . . . . . . . $25.0 $(43.8) $36.3 $38.4
Loss from discontinued operations. . . . . . . . . . . $(5.0) $(2.8) $(16.9) $(25.2)
Net income (loss). . . . . . . . . . . . . . . . . . . $20.0 $(46.6) $19.4 $13.2
Earnings (loss) per share from continuing operations . $0.50 $(0.80) $0.63 $0.67
Earnings (loss) per share from discontinued operations $(0.10) $(0.05) $(0.29) $(0.44)
Earnings(loss) per share . . . . . . . . . . . . . . . $0.40 $(0.85) $0.34 $0.23
FISCAL 1996
Total revenues . . . . . . . . . . . . . . . . . . . . $724.0 $770.1 $865.8 $1,047.7
Income from continuing operations before
income taxes and minority interest. . . . . . . . . . $60.3 $53.6 $57.0 $45.7
Income from continuing operations . . . . . . . . . . 39.8 $37.1 $39.6 $35.7
Income (loss) from discontinued operations . . . . . . $(16.1) $9.2 $(3.4) $6.3
Net income . . . . . . . . . . . . . . . . . . . . . . $23.7 $46.3 $36.2 $42.0
Earnings per share from continuing operations. . . . . $0.69 $0.64 $0.68 $0.60
Earnings (loss) per share from discontinued operations $(0.28) $0.16 $(0.06) $0.11
Earnings per share . . . . . . . . . . . . . . . . . . $0.41 $0.80 $0.62 $0.71
</TABLE>
(1) During the second quarter of fiscal year 1995, the Company incurred an
acquisition and restructuring charge of $124.8 million as discussed in
Note 1 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $148.7 million for the year ended
June 30, 1996 as compared to $178.0 million for the prior year. 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. The Company's cash and
investments increased from $794.5 million at June 30, 1995 to $941.1 million at
June 30, 1996. The Company invests its excess cash in investment grade
securities.
During fiscal year 1997, the Company expects capital expenditures to
approximate $85.8 million, primarily consisting of $78.2 million for the
purchase of computer hardware and software systems; $4.1 million for the
purchase of furniture and equipment; and $3.5 million for other requirements.
Other assets increased over the amount at June 30, 1995, which is primarily 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 sold its affiliated California IPAs, which
are treated as discounted operations in the Company's consolidated financial
statements, to FPA for a purchase price consisting of cash and a promissory
note payable over 10 years. See Notes 1 and 12 to the Consolidated Financial
Statements. Notes receivable under the revolving credit agreements with the
IPAs in the amount of $10 million were repaid to the Company and the revolving
credit agreements were terminated in connection with the transaction. No
gain or loss was recognized on this transaction.
20
<PAGE>
In connection with construction of its health care centers and of its
administrative facilities the Company has a $60 million tax-retention operating
lease financing with Nations Bank of Texas, N.A., as Administrative Agent for
the Lenders parties thereto and First Security Bank of Utah, N.A., as Owner
Trustee (the "TROL" financing). As of June 30, 1996, approximately $26 million
of the TROL financing had been used for construction of health care centers.
The Company expects that up to $5 million of the TROL financing will be used
during fiscal year 1997 for the construction of its administrative facilities.
On June 28, 1996, the Company and the sole shareholder of the Medical
Practices entered into a Stock and Note Purchase Agreement whereby the
Company will sell all the outstanding stock of FHMS, its management services
organization, and the sole shareholder will sell all the outstanding stock of
the holding company for the Medical Practices to FPA. The Medical Practices
and FHMS operations are treated as discontinued operations in the Company's
Consolidated Financial Statements. The aggregate consideration consists of
$2 million cash, $75 million of FPA common stock, $22 million bridge note due
five months after closing and bearing a floating interest rate and a $12
million note to be consolidated with the assumption of the intercompany
indebtedness of FHMS, the holding company and the Medical Practices to the
Company by FPA (estimated to be $80 million as of June 30, 1996), which amount
will be adjusted for liabilities incurred, up to $12 million, between June
30, 1996 and the closing of the transaction, currently anticipated for
December, 1996). The consolidated note will bear interest at a floating rate
with amortization of principal on a 15 year schedule with the remaining
principal and accrued interest due 84 months after close. FPA will also
assume other liabilities owed by FHMS, the Holding Company and the Medical
Practices to third parties (estimated to be $41 million as of June 30, 1996).
The promissory notes will be secured by the assets and stock of FPA, the
purchasing company, FHMS, the holding company, and the Medical Practices.
The promissory notes will be guaranteed by FPA. The Company's affiliated
health plans in Arizona, California and Florida will have agreed to pay
FPA an aggregate of $55 million during the period commencing August 1996
through December 1998 for continued and uninterrupted access as defined in
the Purchase Agreement to the professional providers of the IPAs and the
Medical Practices for the Company's affiliated health plan enrollees.
This transaction will be recorded in the financial statements in the quarter
it closes, presently anticipated to be the second quarter of fiscal 1997.
Operating losses since the measurement date are being deferred because of an
anticipated gain on the sale of the Company's physician practice management
subsidiary and affiliated Medical Practices.
In December 1994, the Company established a $300 million unsecured
revolving credit agreement with Citicorp USA, Inc. as Administrative Agent
(the "Credit Agreement") for the lenders parties thereto. As of November 18,
1996, the Company has borrowed $285 million under the Credit Agreement. In
June 1993, the Company issued $125 million of Senior Notes due June 1, 2003,
which bear interest at 7.75% due semiannually (the "Senior Notes"). See
Notes 7 and 13 to the Consolidated Financial Statements for a more detailed
description of the TROL financing, the Credit Agreement and the Senior Notes.
In April 1993, the Company established a stock repurchase program (as
amended) to acquire from time to time up to 5.7 million shares of the
Company's common stock in the open market at prices deemed appropriate by
management and subject to market conditions and other relevant factors. As of
June 30, 1996, the Company had repurchased 1,795,500 shares under the
program, 250,000 of which were repurchased in fiscal year 1996. Effective
September 30, 1996, the stock repurchase program was cancelled.
The Company's regulated subsidiaries are required to maintain minimum
tangible net equity or capital and surplus. As of June 30, 1996, restricted
net assets of the subsidiaries totaled approximately $71.5 million. Certain
subsidiaries must also maintain current ratios of 1:1. During fiscal year
1996, the Company contributed or advanced approximately $115 million to
various of its subsidiaries to allow them to support and expand premium and
revenue growth and to meet rating and regulatory agency requirements. As the
Company's businesses continue to grow, the Company expects to contribute
additional cash to certain subsidiaries to support premium and revenue
growth. Subsequent to June 30, 1996, the Company has borrowed $100 million
on its credit agreement to support premium and revenue growth in its
insurance subsidiaries. Certain of the Company's regulated subsidiaries are
required to keep securities on deposit in various states where they are
licensed. At June 30, 1996, approximately $405 million in securities were
restricted to satisfy various state regulatory and licensing requirements.
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
21
<PAGE>
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.
The Company currently believes its available cash resources will be
sufficient to meet its current operating requirements and internal development
and integration activities. However, external financing sources may be required
to sustain growth in certain of the Company's regulated subsidiaries during
fiscal year 1997. There currently are no other material definitive commitments
for future use of the Company's available cash resources; however management
continually evaluates opportunities to expand its operations, which includes
internal development of new products and programs and may include additional
acquisitions.
On October 1, 1996, the Company entered into an Agreement and Plan of
Merger with Health Systems International, Inc. ("HSI"). Under the definitive
agreement approved by both companies' boards of directors, the Company will
merge into a wholly-owned subsidiary of HSI with the Company surviving the
merger as a wholly-owned subsidiary of HSI. HSI will change its name to
Foundation Health Systems, Inc. Completion of the transaction, which will be
a tax-free combination and accounted for as a pooling-of-interests, is
subject to stockholder and regulatory approval as well as other customary
conditions and is expected to be completed in January 1997. The Company's
stockholders will receive 1.3 shares of HSI Class A common stock for each
share of Company common stock owned (the "exchange ratio"). Holders of
Company options will receive substitute HSI options based on the same
exchange ratio.
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 does not expect that implementation of this Standard will have a
material impact on its results of operations.
In March 1995, the Financial Accounting Standards Board issued Statement
No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed of ("FAS No. 121"). The Statement requires that
long-lived assets and certain identifiable intangibles to be held and used by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. The
Statement also requires that long-lived assets and certain identifiable
intangibles to be disposed of be reported at the lower of carrying amounts or
fair value less cost to sell. This Statement will be effective for the Company
beginning in fiscal 1997. Adoption of FAS No. 121 is not expected to have a
material effect on the Company's consolidated financial Statements.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
1. FINANCIAL STATEMENTS.
The following Consolidated Financial Statements of Foundation Health
Corporation and its subsidiaries and the Independent Auditors' Report therein
are filed as part of this Report:
Independent Auditors' Report (Restated)
Consolidated Balance Sheets as of June 30, 1995 and 1996 (Restated)
Consolidated Statements of Operations for the years ended June 30, 1994,
1995 and 1996 (Restated)
Consolidated Statements of Stockholders' Equity for the years ended June
30, 1994, 1995 and 1996 (Restated)
Consolidated Statements of Cash Flows for the years ended June 30, 1994,
1995 and 1996 (Restated)
Notes to Consolidated Financial Statements (Restated)
22
<PAGE>
The independent auditors' reports for predecessor companies for the year
ended December 31, 1993 are included in Exhibits 13.1, 13.2 and 13.3
The independent auditors consents are included in Exhibits 23.1, 23.2, 23.3
and 23.4
2. FINANCIAL STATEMENT SCHEDULE AND OTHER FINANCIAL INFORMATION. The following
financial statement schedule and other financial information of Foundation
Health Corporation and its subsidiaries are filed as part of this Report and
should be read in conjunction with the Consolidated Financial Statements of
Foundation Health Corporation:
SCHEDULE
Article 5, Schedule I - Condensed Financial Information of Registrant
OTHER FINANCIAL INFORMATION
Section 403.04.b - Reconciliation of Beginning and Ending Class Reserves
and Exhibit of Deficiencies (Redundancies) - Incorporated by reference
from Form 10-K filed September 3, 1996.
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or Notes thereto.
3. EXHIBITS. The Exhibits listed on the accompanying Index to Exhibits
immediately following the financial statement schedule are filed as part of, or
incorporated by reference into, this Report.
Executive Compensation Plans and Arrangements:
A. 1990 Stock Option Plan of Foundation Health Corporation (as amended
and restated effective August 15, 1996) - Exhibit 10.102; Form 10-K filed
September 3, 1996.
B. Foundation Health Corporation Profit Sharing and 401(k) Plan (as
amended and restated effective January 1, 1994) - Exhibit 10.103; Form 10-K
filed September 27, 1995;
C. Executive Incentive Plan of Foundation Health Corporation - Exhibit
10.3; Form 10-K filed September 23, 1994;
D. Employment Agreement between Foundation Health Corporation and Daniel
D. Crowley dated April 30, 1994 - Exhibit 10.84; Registration Statement No.
33-80432;
E. Employment Agreement between Foundation Health Corporation and Steven
D. Tough dated April 22, 1994 - Exhibit 10.86; Registration Statement No. 33-
80432; Amended May 1, 1996 - Exhibit 10.108; Form 10-K filed September 3, 1996.
F. Employment Agreement between Foundation Health Corporation and Allen
J. Marabito dated April 22, 1994 - Exhibit 10.88; Registration Statement No. 33-
80432; Amended May 1, 1996 - Exhibit 10.107; Form 10-K filed September 3, 1996.
G. Employment Agreement between Foundation Health Corporation and Jeffrey
L. Elder dated April 22, 1994 - Exhibit 10.85; Registration Statement No. 33-
80432; Amended May 1, 1996 - Exhibit 10.106; Form 10-K filed September 3, 1996.
H. Employment Agreement between Foundation Health Corporation and Kirk A.
Benson dated April 22, 1994 - Exhibit 10.87; Registration Statement No. 33-
80432; Amended May 1, 1996 - Exhibit 10.105; Form 10-K filed September 3, 1996.
I. Employee Stock Purchase Plan - Exhibit 10.53; Registration Statement
No. 33-38867;
J. Amended and Restated Foundation Health Corporation Deferred
Compensation Plan - Exhibit 10.99; Form 10-K filed September 27, 1995;
K. Foundation Health Corporation Supplemental Executive Retirement Plan,
as amended and restated - Exhibit 10.100; Form 10-K filed September 27, 1995;
23
<PAGE>
L. Foundation Health Corporation Executive Retiree Medical Plan, as
amended and restated - Exhibit 10.101; Form 10-K filed September 27, 1995;
(b) Reports on Form 8-K. The following reports on Form 8-K were filed by
the Company during the fiscal quarter ended June 30, 1996:
May 2, 1996 (related to pooling of interests 30 day combined financial
statements for Managed Health Network, Inc. acquisition)
24
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment to be
signed on its behalf by the undersigned, thereunto duly authorized.
FOUNDATION HEALTH CORPORATION
By /s/ DANIEL D. CROWLEY
---------------------
Daniel D. Crowley
Chairman, President and
Chief Executive Officer
Dated: November 18, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Amendment has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ DANIEL D. CROWLEY
--------------------------
Daniel D. Crowley Director, President and Chief Executive November 18, 1996
Officer (Principal Executive Officer) and
Chairman of the Board
/s/ DAVID A. BOGGS*
-------------------------- Director November 18, 1996
David A. Boggs
/s/ JEFFREY L. ELDER Director, Senior Vice President-Chief Financial November 18, 1996
-------------------------- Officer (Principal Financial and Accounting
Jeffrey L. Elder Officer)
/s/ PATRICK FOLEY* Director November 18, 1996
--------------------------`
Patrick Foley
/s/ EARL B. FOWLER* Director November 18, 1996
--------------------------
Earl B. Fowler
/s/ RICHARD W. HANSELMAN* Director November 18, 1996
--------------------------
Richard W. Hanselman
/s/ ROSS D. HENDERSON, M.D* Director November 18, 1996
---------------------------
Ross D. Henderson, M.D.
/s/ RICHARD J. STEGEMEIER* Director November 18, 1996
---------------------------
Richard J. Stegemeier
/s/ STEVEN D. TOUGH Director November 18, 1996
---------------------------
Steven D. Tough
/s/ RAYMOND S. TROUBH* Director November 18, 1996
---------------------------
Raymond S. Troubh
*By: /s/ DANIEL D. CROWLEY
---------------------------
Daniel D. Crowley
Attorney-In-Fact November 18, 1996
</TABLE>
25
<PAGE>
FOUNDATION HEALTH CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1995 AND 1996
(Restated)
26
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Foundation Health Corporation
We have audited the accompanying consolidated balance sheets of Foundation
Health Corporation and its subsidiaries (the "Company") as of June 30, 1995 and
1996, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended June 30,
1996. Our audits also included the financial statement schedule of Condensed
Financial Information listed in the index at Item 14(a)(2). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. The
consolidated financial statements give retroactive effect to the merger of
CareFlorida Health Systems, Inc. and a wholly-owned subsidiary of Foundation
Health Corporation on October 31, 1994, and to the merger of Foundation Health
Corporation and Thomas-Davis Medical Centers, P.C. on November 1, 1994, both of
which have been accounted for as a pooling of interests as described in Note 1
to the consolidated financial statements. We did not audit the statements of
income, stockholders' equity and cash flows of Thomas-Davis Medical Centers,
P.C., for the year ended December 31, 1993, which statements reflect total
revenues of $419,283,000. We also did not audit the statements of income,
stockholders' equity and cash flows of CareFlorida Health Systems, Inc. for the
year ended December 31, 1993, which statements reflect total revenues of
$154,122,000. Those financial statements were audited by other auditors whose
reports have been furnished to us, and our opinion, insofar as it relates to the
amounts included for Thomas-Davis Medical Centers, P.C. and CareFlorida Health
Systems, Inc. for such period, is based solely on the reports of the other
auditors. As described in Note 1 to the consolidated financial statements,
subsequent to the issuance of the reports of the other auditors, the financial
statements of Thomas-Davis Medical Centers, P.C. and CareFlorida Health Systems,
Inc. were restated to conform to the fiscal year of Foundation Health
Corporation for the year ended June 30, 1994.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Foundation Health Corporation and
its subsidiaries as of June 30, 1995 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 1996 in conformity with generally accepted accounting principles. Also,
in our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
As discussed in Note 12, the accompanying financial statements have been
restated to consolidate the Company's affiliated physician-owned medical
practices.
We also audited the adjustments described in Note 1 that were applied to
restate the 1993 financial statements of Thomas-Davis Medical Centers, P.C. and
CareFlorida Health Systems, Inc. In our opinion, such adjustments are
appropriate and have been properly applied.
DELOITTE & TOUCHE LLP
Sacramento, California
July 25, 1996,
November 18, 1996, as to
Notes 1, 2, 6, 7, 8, 9, 10, 12, 13 and 14
27
<PAGE>
FOUNDATION HEALTH CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(RESTATED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------------
1995 1996
-------------- -------------
<S> <C> <C>
Cash and cash equivalents $ 203,210 $ 226,156
Investments :
Available for sale investments 541,596 683,023
Held to maturity investments 49,745 31,891
Amounts receivable under government contracts 81,089 182,062
Reinsurance receivable 98,255 94,662
Premium and patient receivables, net of allowance for doubtful
accounts of $11,915 and $13,675 at June 30, 1995 and 1996 100,727 139,499
Property and equipment, net 210,535 257,564
Goodwill and other intangible assets, net 406,006 402,015
Deferred income taxes 67,564 45,487
Other assets 125,962 275,294
------------- -------------
$ 1,884,689 $ 2,337,653
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Reserves for claims, losses and loss adjustment expenses $ 700,281 $ 883,911
Notes payable, capital leases and other financing arrangements 167,483 309,136
Amounts payable under government contracts 47,584 52,948
Accrued dividends to policyholders 16,405 9,726
Net liabilities of discontinued operations 9,668 1,483
Other liabilities 235,874 213,523
------------- -------------
1,177,295 1,470,727
------------- -------------
Stockholders' equity:
Common stock and additional paid-in capital, $.01 par value,
100,000,000 shares authorized, 57,142,606 and 58,825,753
shares issued and outstanding at June 30, 1995 and 1996 518,671 533,855
Retained Earnings 194,744 343,026
Unrealized investment gains and losses, net of taxes (2,974) (6,908)
Common stock held in treasury, at cost (3,047) (3,047)
------------- -------------
707,394 866,926
------------- -------------
$ 1,884,689 $ 2,337,653
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements
28
<PAGE>
FOUNDATION HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(RESTATED)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------------------------
1994 1995 1996
-------------- -------------- --------------
<S> <C> <C> <C>
REVENUES:
Commercial premiums $ 1,358,616 $ 1,664,509 $ 2,002,695
Government contracts 542,726 187,493 586,011
Specialty services revenue 380,726 509,807 700,923
Patient service revenue, net 41,358 38,604 50,124
Investment and other income 37,273 59,010 67,875
------------ ------------ ------------
2,360,699 2,459,423 3,407,628
------------ ------------ ------------
EXPENSES:
Commercial health care services 1,067,027 1,290,367 1,607,073
Government contracts health care services 152,185 67,508 375,480
Government contracts subcontractor costs 252,743 66,551 40,572
Specialty services costs 355,208 438,124 616,537
Patient service costs 37,599 33,561 36,216
Selling, general and administrative 282,318 304,850 448,322
Amortization and depreciation 25,162 34,831 52,184
Interest expense 11,147 10,796 14,684
Acquisition and restructuring costs - 124,822 -
------------ ------------ ------------
2,183,389 2,371,410 3,191,068
------------ ------------ ------------
Income from continuing operations before income taxes
and minority interest 177,310 88,013 216,560
Provision for income taxes 69,954 29,900 64,318
Minority interest 7,398 2,262 -
------------ ------------ ------------
Income from continuing operations 99,958 55,851 152,242
Discontinued operations:
Loss, net of income taxes (12,383) (49,841) (3,960)
------------ ------------ ------------
Net income $ 87,575 $ 6,010 $ 148,282
------------ ------------ ------------
------------ ------------ ------------
Earnings (loss) per share:
Continuing operations $ 2.05 $ 1.02 $ 2.61
Discontinued operations (0.25) (0.91) (0.07)
------------ ------------ ------------
Net earnings $ 1.80 $ 0.11 $ 2.54
------------ ------------ ------------
------------ ------------ ------------
Weighted average common and common stock
equivalent shares outstanding 48,688,221 54,780,162 58,292,971
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements
29
<PAGE>
FOUNDATION HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(RESTATED)
<TABLE>
<CAPTION>
COMMON STOCK UNREALIZED
COMMON STOCK HELD IN TREASURY INVESTMENT
------------------------- ------------------------- RETAINED GAINS AND LOSSES,
SHARES AMOUNT SHARES AMOUNT EARNINGS NET OF TAXES TOTAL
---------- ---------- ---------- ---------- ---------- --------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1993 47,219,097 $ 248,911 3,381,713 $ (9,667) $ 103,154 $ - $ 342,398
Issuance of common
stock - net 2,087,971 1,627 - - - - 1,627
Purchase of treasury
stock (1,400,281) 1,400,281 (27,666) - - (27,666)
Exercise of stock options 572,347 8,661 - - - - 8,661
Assumption of stock
options - 367 - - - - 367
Tax benefits related to
stock options exercised - 5,410 - - - - 5,410
Dividends paid by
predecessor company - - - - (1,995) - (1,995)
Net income - - - - 87,575 - 87,575
---------- ---------- --------- ---------- ----------- ------------- ----------
Balance at June 30, 1994 48,479,134 264,976 4,781,994 (37,333) 188,734 - 416,377
Cumulative effect of
adoption of SFAS
No. 115, net of taxes - - - - - (9,019) (9,019)
Issuance of common stock 8,432,676 280,465 - - - - 280,465
Purchase of treasury
stock (100,000) - 100,000 (3,047) - - (3,047)
Retirement of treasury
stock - (37,333) (4,781,994) 37,333 - - -
Exercise of stock options 330,796 5,920 - - - - 5,920
Tax benefits related to
stock options exercised - 4,643 - - - - 4,643
Net unrealized holding -
gains - - - - - 6,045 6,045
Net income - - - - 6,010 - 6,010
---------- ---------- --------- ---------- ----------- ------------- ----------
Balance at June 30, 1995 57,142,606 518,671 100,000 (3,047) 194,744 (2,974) 707,394
Issuance of common
stock - net 875,160 (86) 250,000 (8,384) - - (8,470)
Exercise of stock options 807,987 16,932 - - - - 16,932
Retirement of treasury
stock - (8,384) (250,000) 8,384 - - -
Tax benefits related to
stock options exercised - 6,722 - - - - 6,722
Net unrealized holding
loss - - - - - (3,934) (3,934)
Net income - - - - 148,282 - 148,282
---------- ---------- --------- ---------- ----------- ------------- ----------
Balance at June 30, 1996 58,825,753 $ 533,855 100,000 $ (3,047) $ 343,026 $ (6,908) $ 866,926
---------- ---------- --------- ---------- ----------- ------------- ----------
---------- ---------- --------- ---------- ----------- ------------- ----------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
30
<PAGE>
FOUNDATION HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(RESTATED)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------------------------
1994 1995 1996
-------------- -------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES :
Net income $ 87,575 $ 6,010 $ 148,282
Adjustments to reconcile net income to cash provided by operating
activities:
Amortization and depreciation 25,162 34,831 52,184
Amortization of bond discounts 3,719 5,396 2,769
Noncash restructuring costs - 11,486 -
Cash used by discontinued operations, net (11,076) (33,221) (12,145)
Loss from discontinued operations 12,383 49,841 3,960
Change in assets and liabilities, net of effects from acquisition of businesses:
Premium and patient receivables, net 11,577 (5,376) (35,537)
Reinsurance receivable 7,117 25,583 3,712
Other assets (21,018) (36,971) (94,967)
Amounts receivable/payable under government contracts (10,761) 51,730 (95,609)
Reserves for claims, losses and loss adjustment expenses 18,071 59,645 180,071
Accrued dividends to policyholders 7,115 (13,621) (6,679)
Other liabilities 9,721 41,415 (20,462)
Deferred income taxes, net 1,083 (18,731) 23,116
-------------- -------------- --------------
Net cash from continuing operating activities 140,668 178,017 148,695
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES :
Purchases of available for sale investments - (765,510) (599,302)
Sales and maturities of available for sale investments - 770,673 459,852
Purchases of held to maturity investments - (39,112) (8,970)
Maturities of held to maturity investments - 80,034 17,553
Purchases of short-term investments (367,253) - -
Sales and maturities of short-term investments 435,201 - -
Purchases of fixed maturity investments (731,324) - -
Sales and maturities of fixed maturity investments 641,404 - -
Acquisition of property and equipment (42,471) (117,953) (79,519)
(Increase) decrease in goodwill and other intangible assets 4,223 (34,807) 1,375
Increase in other assets (16,928) (5,001) (52,390)
Acquisition of businesses, net of cash acquired (62,545) (41,874) (1,813)
-------------- -------------- --------------
Net cash used for investing activities (139,693) (153,550) (263,214)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES :
Principal payments on notes payable and capital leases (8,218) (16,451) (17,287)
Proceeds from issuance of notes payable and capital leases 300 20,000 147,401
Proceeds from issuance of common stock - net 1,627 6,448 1,254
Proceeds from exercise of stock options 8,661 5,920 16,932
Tax benefits related to stock options 5,410 4,643 6,722
Stock repurchase and other adjustments related to mergers (27,666) (3,047) (17,557)
Dividends paid by predecessor company (1,995) - -
-------------- -------------- --------------
Net cash from (used for) financing activities (21,881) 17,513 137,465
-------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents (20,906) 41,980 22,946
Cash and cash equivalents, beginning of year 182,136 161,230 203,210
-------------- -------------- --------------
Cash and cash equivalents, end of year $ 161,230 $ 203,210 $ 226,156
-------------- -------------- --------------
-------------- -------------- --------------
SUPPLEMENTAL CASH FLOWS DISCLOSURE :
Interest paid $ 13,994 $ 13,377 $ 14,489
Income taxes paid 64,426 47,792 10,662
Noncash investing and financing activities:
Capital lease obligations 2,378 - 807
Deferred compensation 5,379 5,143 2,530
Transfer of investments from held to maturity to available for sale - - 9,090
Acquisition of businesses :
Assets acquired 532,331 392,509 26,090
Liabilities assumed (439,740) (49,506) (13,239)
Issuance of notes payable held in escrow (4,359) (7,909) -
Issuance of common stock - (274,017) (6,631)
-------------- -------------- --------------
Cash paid 88,232 61,077 6,220
Less cash acquired (25,687) (19,203) (4,407)
-------------- -------------- --------------
Net cash paid $ 62,545 $ 41,874 $ 1,813
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
31
<PAGE>
FOUNDATION HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Restated)
NOTE 1 - DESCRIPTION OF BUSINESS
Foundation Health Corporation (the "Company") operates an integrated
multi-state managed care organization. The Company's operations are focused on
its commercial health maintenance organization ("HMO") and preferred provider
organization ("PPO") operations, government-sponsored managed care programs, and
specialty services operations.
The Company's commercial HMO subsidiaries contract to provide medical care
services to a defined, enrolled population for a predetermined, prepaid monthly
fee for group, Medicaid, individual and Medicare HMO plans throughout their
respective service areas. All of the HMOs are state licensed and some are also
federally qualified.
The Company's wholly-owned subsidiary, Foundation Health Federal Services,
Inc. ("Federal Services"), administers large, multi-year managed care government
contracts. Federal Services subcontracts to affiliated and unrelated third
parties the administration and health care risk of parts of these contracts.
These programs include: (i) a CHAMPUS managed care contact in Washington and
Oregon to provide health care services to approximately 227,000 CHAMPUS-eligible
beneficiaries which commenced health care services in March 1995 (the
"Washington/Oregon Contract"), (ii) a similar contract in Texas, Louisiana,
Arkansas and Oklahoma to provide health care services to approximately 590,000
CHAMPUS-eligible beneficiaries which commenced delivery of health care services
in November 1995 (the "Region 6 Contract") and (iii) the multi-year TRICARE
managed care contract to provide health care services to approximately 720,000
CHAMPUS-eligible beneficiaries in California and Hawaii which commenced delivery
of health care services in April 1996 (the "California/Hawaii Contract")
Federal Services also administers contracts in Massachusetts, New Jersey,
Georgia and Maine to enroll Medicaid eligible individuals in managed care
programs in those states. Federal Services is not at risk for the provision of
any health care services under any of these contracts.
The Company's specialty services subsidiaries offer managed care products
related to workers' compensation insurance, administration and cost containment,
behavioral health, dental, vision, and pharmaceutical products and services. The
Company's largest specialty services subsidiary, California Compensation
Insurance Company ("CalComp"), acquired in August 1993, is primarily engaged in
writing workers' compensation insurance in California. CalComp enables the
Company to utilize its managed care capabilities and provider networks to reduce
the medical costs associated with workers' compensation claims and provides the
Company with the ability to market "24 hour" risk products covering employees
for medical care both on and off the job. In February 1995, the Company acquired
Business Insurance Company ("BICO"). BICO was acquired to geographically
diversify CalComp's underwriting risk as a result of reduced premium levels on
policies written in California and to take advantage of perceived opportunities
because of favorable national workers' compensation reform. BICO is licensed to
write workers' compensation policies in 49 states.
The Company owns and operates two hospitals, the East Los Angeles Doctors
Hospital, a 128-bed general hospital located in East Los Angeles, California and
the Memorial Hospital of Gardena, a 200-bed general hospital located in Gardena,
California (the "Hospitals"). The health care services provided by the Hospitals
are general medical and surgical services, subacute, pediatrics, intensive and
coronary care, physical therapy, respiratory care and emergency room services.
The Hospitals received approximately 79% of their revenues from Medicare and
Medicaid programs during the year ended June 30, 1996.
DISCONTINUED OPERATIONS
During fiscal 1996 changes were occurring in the physician practice
management industry which led the Company to adopt a plan in the third quarter
to completely discontinue the operations of this segment. In
connection with this
32
<PAGE>
changed environment and with its plan to discontinue this segment,
the following transactions were entered into with FPA Medical Management,
Inc. ("FPA") and certain of its affiliated entities, none of which are
affiliated with the Company.
In January 1996 the Company completed the sale, initiated in the second
quarter of fiscal 1996, of its affiliated California Independent Practice
Associations ("IPAs") to FPA for a purchase price consisting of cash and a
promissory note payable over 10 years. Notes receivable under a revolving
credit agreement with the IPAs in the amount of $10 million were repaid to the
Company and no gain or loss was recognized in connection with this transaction.
In June 1996, the Company completed the sale, initiated in the third
quarter of fiscal 1996 of its affiliated Florida and Arizona IPAs to FPA for
aggregate consideration of $20 million, consisting of $3 million in cash and a
promissory note in the amount of $17 million which is due and payable six months
after closing and bears a floating interest rate. A gain of $10.4 million was
recognized by the Company and is included in discontinued operations for fiscal
1996.
On June 28, 1996, the Company and the sole shareholder of the Medical
Practices entered into a Stock and Note Purchase Agreement whereby the
Company will sell all the outstanding stock of FHMS, its management services
organization, and the sole shareholder will sell all the outstanding stock of
the holding company for the Medical Practices to FPA. The Medical Practices
and FHMS operations are treated as discontinued operations in the Company's
Consolidated Financial Statements. The aggregate consideration consists of
$2 million cash, $75 million of FPA common stock, $22 million bridge note due
five months after closing and bearing a floating interest rate and a $12
million note to be consolidated with the assumption of the intercompany
indebtedness of FHMS, the holding company and the Medical Practices to the
Company by FPA (estimated to be $80 million as of June 30, 1996), which amount
will be adjusted for liabilities incurred, up to $12 million, between June
30, 1996 and the closing of the transaction, currently anticipated to be the
second quarter of fiscal year 1997. The consolidated note will bear interest
at a floating rate with amortization of principal on a 15 year schedule with
the remaining principal and accrued interest due 54 months after close. FPA
will also assume other liabilities owed by FHMS, the Holding Company and the
Medical Practices to third parties (estimated to be $41 million as of June
30, 1996). The promissory notes will be secured by the assets and stock of
FPA, the purchasing company, FHMS, the holding company, and the Medical
Practices. The promissory notes will be guaranteed by FPA. The Company's
affiliated health plans in Arizona, California and Florida will have agreed
to pay FPA an aggregate of $55 million during the period commencing August
1996 through December 1996 for continued and uninterrupted access as defined
in the Purchase Agreement to the professional providers of the IPAs and the
Medical Practices for the Company's affiliated health plan enrolles. This
transaction will be recorded in the financial statements in the quarter it
closes, presently anticipated to be the second quarter of fiscal 1997.
Operating losses since the measurement date are being deferred because of an
anticipated gain on the sale of the Company's physician practice management
subsidiary and affiliated Medical Practices.
As part of these transactions, the Company's affiliated health plans have
entered into 30-year provider agreements with the IPAs and Medical Practices
to ensure that the Company's enrollees have continued and uninterrupted
access to the providers of the Medical Practices and IPAs.
CONSUMMATED BUSINESS ACQUISITIONS - POOLING TRANSACTIONS
FISCAL YEAR 1995
On October 31, 1994, 6,862,051 shares of the Company's common stock were
issued in exchange for all of the outstanding common stock of CareFlorida Health
Systems, Inc. ("CareFlorida"). At the time of acquisition, CareFlorida provided
comprehensive health care services to approximately 143,000 members in Florida
through its HMO and PPO subsidiaries.
On November 1, 1994, 13,124,027 shares of the Company's common stock were
issued in exchange for all of the outstanding common stock of TDMC, including
its majority interest of 60.5% of the outstanding common stock of Intergroup
Healthcare Corporation ("Intergroup"). Additionally, 7,577,336 shares were
issued for the purchase of the remaining 39.5% minority interest of Intergroup.
All outstanding Intergroup options were exchanged for options to purchase
500,290 shares of the Company's common stock. TDMC employed approximately 190
physicians at the date of merger who provided health care services to patients
in Arizona through 15 primary care centers, five urgent care centers, two
behavioral health centers and one surgery center. At the time of merger,
Intergroup provided comprehensive health care services to approximately 379,000
HMO and life and accident insurance members and 104,000 PPO members primarily in
Arizona and Utah.
In connection with the mergers of CareFlorida, TDMC and Intergroup in
fiscal 1995, the Company recorded a charge for acquisition, restructuring and
merger costs of $124.8 million.
The acquisition and restructuring charge represented 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.
33
<PAGE>
The components of this charge included (in millions):
<TABLE>
<S> <C>
Professional fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $21.5
Cancellation of certain contractual obligations and other settlement costs . . . 27.1
Write-off of certain redundant hardware, software and other settlement costs . . 17.9
Elimination of duplicate facilities. . . . . . . . . . . . . . . . . . . . . . . 13.0
Transition and severance related payments to employees . . . . . . . . . . . . . 36.5
Other integration and restructuring. . . . . . . . . . . . . . . . . . . . . . . 8.8
-----
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $124.8
-----
-----
</TABLE>
These costs satisfy the definition of "exit costs" as set forth in Emerging
Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)," that are directly related to the mergers.
The Company has substantially completed its integration and restructuring of the
combined entities as of June 30, 1996.
In accordance with the pooling of interests method of accounting the
Company's consolidated financial statements and notes thereto have been restated
to include the accounts of TDMC (including its 60.5% interest in Intergroup) and
CareFlorida for all periods presented. Prior to the mergers, CareFlorida and
TDMC each reported on a calendar year basis. Accordingly, the consolidated
financial statements include CareFlorida's and TDMC's financial statements
restated to the Company's fiscal year basis. Separate and combined results of
the Company, CareFlorida and TDMC for the period prior to consummation of the
mergers are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30
1994
----
<S> <C>
Revenues:
Foundation Health Corporation - as previously reported. . . . . . . . . . . . . $1,717,821
TDMC- year ended December 31, 1993. . . . . . . . . . . . . . . . . . . . . . . 419,283
CareFlorida- year ended December 31, 1993 . . . . . . . . . . . . . . . . . . . 154,122
Adjustments (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71,711
---------
Combined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,362,937
---------
---------
Net income:
Foundation Health Corporation - as previously reported. . . . . . . . . . . . . $82,153
TDMC- year ended December 31, 1993. . . . . . . . . . . . . . . . . . . . . . . 4,841
CareFlorida- year ended December 31, 1993 . . . . . . . . . . . . . . . . . . . 6,664
Adjustments (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (17)
---------
Combined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $93,641
---------
---------
</TABLE>
(1) Primarily reflects adjustments to calendar year results to conform to the
Company's fiscal year reporting and certain reclassifications to conform to the
Company's presentation.
FISCAL YEAR 1996
In March 1996 the Company issued stock for Managed Health Network, Inc. and
its subsidiaries (collectively "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
interest 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, with the Company's consolidated financial statements.
34
<PAGE>
CONSUMMATED BUSINESS ACQUISITIONS (PURCHASE TRANSACTIONS) AND DISPOSITIONS
FISCAL YEAR 1994
In July 1993, the Company acquired all of the outstanding common stock of
Managed Alternative Care, a subacute care management company, for $6,000,000,
paid in cash, which resulted in goodwill of $5,500,000.
In August 1993, the Company acquired all of the outstanding common stock of
a holding company primarily engaged in writing workers' compensation insurance
in California through its wholly-owned subsidiary, CalComp, for $65,268,000,
paid in cash. In addition, all outstanding options were exchanged for options to
purchase 29,475 shares of the Company's common stock. The acquisition resulted
in goodwill of $5,001,000.
Effective January 1, 1994, the Company acquired substantially all of the
outstanding shares of common stock of Gem Holding Corporation ("Gem"), a holding
company primarily engaged in writing health, individual life, annuities, group
life, disability and dental insurance. At the date of acquisition, Gem provided
services to approximately 83,000 individuals in six western states. The purchase
price was $17,800,000 which was paid in cash. The acquisition resulted in
goodwill of approximately $4,500,000.
In April 1994, the Company acquired all of the outstanding common stock of
Premier Medical Network ("Premier"). Premier provides third party administrative
services to approximately 98,000 individuals through a PPO network in Utah. The
purchase price was $1,500,000, paid in cash. The acquisition resulted in
goodwill of $1,200,000.
FISCAL YEAR 1995
In July 1994, the Company acquired all of the outstanding common stock of
The Noetics Group and all of the assets of Reviewco for consideration consisting
of the issuance of 378,358 shares of the Company's common stock valued at $16
million, 118,236 shares of common stock valued at $5 million, which was placed
in escrow and cash of $16 million. The release of the escrow shares was subject
to the attainment of certain profitability targets by Reviewco. The escrow was
terminated as of July 31, 1996. The acquisition resulted in goodwill of
$27,773,000. The Noetics Group provides workers' compensation third party
administration services for self-funded employers. Reviewco operates a medical
bill review and cost-containment business for the workers' compensation
industry.
In November 1994, the Company acquired all of the outstanding common stock
of Southern Colorado Health Plan, Inc. ("SCHP"), and its parent corporation for
consideration consisting of 241,672 shares of the Company's common stock valued
at $8,900,000. The acquisition resulted in goodwill of $6,755,000. At the date
of acquisition, SCHP provided health care services to 7,100 members through its
HMO based in Pueblo, Colorado.
In November 1994, the Company acquired all of the outstanding common stock
of Community Medical Plan, Inc. ("CMP") and certain affiliated health care
centers for consideration of $32.9 million, consisting of $25 million in paid
cash and at closing the issuance of promissory notes of $7.9 million due
November 15, 1995. At the date of acquisition, CMP served approximately
25,000 Medicaid beneficiaries in Florida. The acquisition resulted in goodwill
of $32,752,000.
35
<PAGE>
In November 1994, the Company issued 7,577,336 shares of its common stock
for the purchase of 39.5% of the outstanding common stock of Intergroup (the
"Intergroup Minority Interest"). The acquisition of the Intergroup Minority
Interest, which was accounted for as a purchase, was valued at $249,109,000 and
resulted in goodwill of $207,371,000. The unaudited pro forma combined total
revenues, net income and earnings per share of the Company and the Intergroup
Minority Interest, assuming the Company had acquired the Intergroup Minority
Interest on July 1, 1993, are as follows (in thousands, except per share
amounts):
PRO FORMA
YEAR ENDED JUNE 30,
-------------------
1994 1995
---- ----
Total revenues. . . . . . . . . . . . . . . . . . $2,362.9 $2,459.9
-------- --------
-------- --------
Net income. . . . . . . . . . . . . . . . . . . . $96.9 $50.6
-------- --------
-------- --------
Earnings per share. . . . . . . . . . . . . . . . $1.74 $0.89
-------- --------
-------- --------
This unaudited pro forma information reflects the elimination of the
Intergroup Minority Interest and the amortization of the goodwill related to the
purchase of the Intergroup Minority Interest. The unaudited pro forma results of
operations are not necessarily indicative of the combined results that would
have occurred had the acquisition taken place on July 1, 1993, nor are they
necessarily indicative of results that may occur in the future.
In February 1995, CalComp acquired, BICO, a 50-state licensed property and
casualty company, for an aggregate purchase price of $13,201,000, consisting of
the fair market value of investments and intangible assets which was paid in
cash at closing. This company which had no insurance business in force at
closing enables CalComp to geographically expand its managed care workers'
compensation products. No goodwill was recorded as a result of this transaction.
FISCAL YEAR 1996
On June 28, 1996, the Company acquired the minority interest in
the Utah HMO operations for approximately $5.8 million. Also on June 28,
1996, the Company sold its financial interest in Premier Medical Network in
Utah for approximately $7.1 million.
In September 1995, the Company acquired a medical practice and related
facilities in Arizona for approximately $6.2 million.
In January 1996, the Company sold its affiliated California IPAs to FPA for
a purchase price consisting of cash and a promissory note payable over 10 years.
The notes receivable under the revolving credit agreements with the IPAs in the
amount of $10 million were repaid to the Company and terminated in connection
with the transaction.
In June 1996, the Company sold its affiliated Florida and Arizona IPAs to
FPA for aggregate consideration of $20 million, consisting of cash in the amount
of $3 million and a promissory note in the amount of $17 million which is due
and payable six months after closing and bears a floating interest rate.
The above acquisitions have been accounted for under the purchase method of
accounting and accordingly, the operations of these companies have been included
in the Company's consolidated financial statements from their respective dates
of acquisition.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries and its affiliated physician-owned Medical
Practices. The Company does not own the Medical Practices, but it does exercise
significant influence and control over certain aspects of their operations and,
accordingly, the Company believes that
36
<PAGE>
consolidation of the financial operations of the Medical Practices is necessary
to present fairly the financial position and results of operations of the
Company. All significant intercompany transactions have been eliminated in
consolidation.
USE OF ESTIMATES
In preparing the consolidated financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the consolidated financial statements and revenues and expenses during the
reporting period. Actual results could differ significantly from those
estimates.
REVENUE RECOGNITION
Commercial premium revenue includes HMO and PPO premiums from employer
groups and individuals and from Medicare recipients who have purchased
supplemental benefit coverage, which premiums are based on a predetermined
prepaid fee, Medicaid revenues based on multi-year contracts to provide care to
Medicaid recipients, and revenue under Medicare risk contracts to provide care
to enrolled Medicare recipients. Revenue is recognized in the month in which the
related enrollees are entitled to health care services. Premiums collected in
advance are recorded as unearned premium.
Revenue under government contracts is recognized in the month in which the
eligible beneficiaries are entitled to health care services. Certain government
contracts also contain cost and performance incentive provisions which adjust
the contract price based on actual performance, and revenue under certain
contracts is subject to price adjustments attributable to inflation and other
factors. The effects of these adjustments are recognized on a monthly basis.
Amounts receivable under government contracts are comprised primarily of
estimated amounts receivable under these cost and performance incentive
provisions, price adjustments, and change orders for services not originally
specified in the contracts.
Specialty services revenue is recognized in the month in which the
administrative services are performed or the period that coverage for service is
provided. Workers' compensation premium revenue is recognized ratably over the
period to which the premium relates. The insurance policies currently written by
the Company are for a period of one year or less. Billed premium in excess of
premiums earned represents the liability for unearned premium. Premiums earned
include an estimate for earned but unbilled premiums.
Patient service revenue is recorded on the accrual basis in the period in
which services are provided at established rates regardless of whether
collection in full is anticipated. Contractual and charitable allowances, the
results of other arrangements for providing services at less than established
rates and the provision for doubtful accounts are reported as deductions from
patient service revenue. Contractual allowances include differences between
established billing rates and amounts estimated by management as recoverable in
accordance with reimbursement rates in effect. Differences between final
settlements and amounts accrued in previous years are reported as adjustments to
the current year's provision for contractual allowance.
Unearned premiums related to commercial and specialty services lines of
business totaled $64,930,000 and $61,455,000 at June 30, 1995 and 1996 and are
included in other liabilities on the consolidated balance sheet.
RESERVES FOR CLAIMS, LOSSES AND LOSS ADJUSTMENT EXPENSES AND HEALTH CARE
SERVICES EXPENSES
Except as discussed below, reserves for claims, losses and loss adjustment
expenses and health care services expenses are based upon the accumulation of
cost estimates for unpaid claims and losses reported prior to the close of the
accounting period, together with a provision for the current estimate of the
probable cost of claims, losses and loss adjustment expenses that have occurred
but have not yet been reported. Such estimates are based on many variables
including individual cases for reported losses, estimates of unreported losses
using historical and statistical information and other factors. Workers'
compensation claims, losses and loss adjustment expenses, and specialty health
care services expenses are included in specialty services costs in the
statements of operations. The methods for making the estimates and for
establishing the resulting reserves are continually reviewed and updated, and
any adjustments resulting therefrom are reflected in current operations. Such
estimates are subject to the impact of changes in the regulatory environment and
37
<PAGE>
economic conditions. Given the inherent variability of such estimates, the
actual liability could differ significantly from the amounts provided. While the
ultimate amount of claims and losses and the related expenses paid are dependent
on future developments, management is of the opinion that the reserves for
claims, losses and loss adjustment expenses is adequate to cover such claims,
losses and expenses. These liabilities are reduced by estimated amounts
recoverable from third parties for subrogation.
The Company has capitation contracts with individual practice associations,
medical groups and hospitals ("Capitated Providers") to provide medical care
services to enrollees. The Capitated Providers are at risk for the cost of
medical care services provided to the Company's enrollees in the relevant
geographic areas; however, the Company is ultimately responsible for the
provision of services to its enrollees should the Capitated Providers be unable
to provide the contracted services. Certain Capitated Providers also provide
claims processing and other administrative services. The Capitated Providers are
either paid a fixed percentage of premiums collected in the geographic areas
they service or a fixed amount per enrollee for enrollees in their respective
service areas. Medical care expenses relating to these Capitated Providers are
included in commercial health care services expense and amounted to
$398,700,000, $467,735,000 and $660,644,000 for the years ended June 30, 1994,
1995 and 1996.
The HMOs also contract with hospitals, physicians and other providers of
health care, pursuant to discounted fee for service arrangements and hospital
per diems under which providers bill the HMOs for each individual service
provided to enrollees.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments with original maturities of
three months or less.
INVESTMENTS
Prior to July 1, 1994, the Company classified its securities as short-term
investments and fixed maturities. Securities with an original maturity of one
year or less at the date of acquisition were classified as short-term
investments. Such investments were carried at cost, which approximated market
value. Declines in market value which were determined by management to be other
than temporary were recorded as charges to the statement of operations.
Investments with fixed maturities primarily included long-term investment grade
bonds and were carried at amortized cost. It is the Company's policy to invest
in notes, bonds and money market securities, limited by certain restrictions.
The cost of investments sold is determined using the specific identification
method.
Effective July 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS No. 115"). The adoption of SFAS No. 115 did not have
a material effect on the Company's consolidated financial position or results of
operations.
In accordance with SFAS No. 115, the Company classifies investments held by
trustees or agencies pursuant to state regulatory requirements as held to
maturity based on the Company's ability and intent to hold these investments to
maturity. Such investments are presented at amortized cost. All other
investments are classified as available for sale and are reported at fair value
based on quoted market prices, with unrealized gains and losses excluded from
earnings and reported as a separate component of stockholders' equity, net of
income tax effects. For purposes of calculating realized gains and losses on the
sale of investments available for sale, the amortized cost of each investment
sold is used. The Company has no trading securities.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation is provided using
the straight-line method for all assets over their estimated useful lives as
follows:
Buildings and improvements. . . . . . . . . . . . . . . . . 5-40 years
Furniture and equipment . . . . . . . . . . . . . . . . . . 3-10 years
38
<PAGE>
Expenditures for maintenance and repairs are expensed as incurred. Major
improvements which increase the estimated useful life of an asset are
capitalized. Upon the sale or retirement of assets, recorded cost and related
accumulated depreciation are removed from the accounts, and any gain or loss on
disposal is reflected in operations.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consists primarily of goodwill and
other intangibles which arise as a result of various business acquisitions and
the acquisition of the Company through a leveraged buy-out on December 30, 1986,
at which time the assets and liabilities of the Company were recorded at their
appraised values. In addition, the Company's policy is to defer direct and
incremental pre-operating costs related to its HMO subsidiaries' geographic
expansion and the opening of health care centers. These costs are deferred prior
to the commencement of significant operations at which time the Company begins
amortizing such costs over a three-year period. Goodwill and other intangible
assets are amortized using the methods listed below over appropriate periods not
exceeding 40 years. Fully amortized intangible assets and related accumulated
amortization are removed from the accounts. The Company evaluates the carrying
value of its intangible assets at each balance sheet date.
Goodwill and other intangible assets are amortized as follows:
<TABLE>
<CAPTION>
LIFE METHOD
---- ------
<S> <C> <C>
Subscribers . . . . . . . . . . . . . . . . . . . 22 years Declining balance
Employer group contracts. . . . . . . . . . . . . 22 years Straight line
Goodwill. . . . . . . . . . . . . . . . . . . . . 22-40 years Straight line
Organization and preoperating costs . . . . . . . 3-8 years Straight line
Noncompetition and employment agreements. . . . . Term of related agreement Straight line
Debt issue costs. . . . . . . . . . . . . . . . . Term of related debt Straight line
</TABLE>
Goodwill and other intangible assets are reported, net of accumulated
amortization of $48,131,000 and $70,890,000 at June 30, 1995 and 1996.
INCOME TAXES
The Company accounts for income taxes using the liability method. Deferred
income tax assets and liabilities result from temporary differences between the
tax basis of assets and liabilities and their reported amounts in the
consolidated financial statements that will result in taxable or deductible
amounts in future years.
The Company adopted SFAS No. 109, "Accounting for Income Taxes" effective
July 1, 1993. The adoption of SFAS No. 109 did not have a significant effect on
the Company's results of operations for the periods presented. No valuation
allowance resulted from the adoption of SFAS No. 109.
DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs, including commissions, premium taxes and other
acquisition costs related to the production or renewal of workers' compensation
and indemnity business, are deferred. Such costs are amortized as the related
premiums are earned. The amortization of such deferred policy acquisition costs
related to property casualty insurance policies were as follows, $25,788,000,
$24,947,000 and $30,729,000, for the years ended June 30, 1994, 1995 and 1996.
If it is determined that future policy revenues on existing insurance contracts
are not adequate to cover related losses and expenses, deferred policy
acquisition costs are written down. However, to date, no write-downs have been
made. Earnings on invested funds between the time of premium receipts and
related claim payments are considered in determining whether a premium
deficiency exists. Deferred policy acquisition costs totaled $20,824,000 and
$27,804,000 at June 30, 1995 and 1996 and are included in other assets.
39
<PAGE>
DIVIDENDS TO POLICYHOLDERS
Dividends to workers' compensation policyholders are generally declared 18
to 24 months after expiration of the participating policies. A provision is
made for estimated dividends to be paid related to premium revenue recognized.
EARNINGS PER SHARE
Earnings per share is calculated by dividing net income by the weighted
average number of shares of common stock plus common stock equivalent shares
outstanding using the treasury stock method. Earnings per share has been
restated for all periods presented to reflect the mergers of CareFlorida and
TDMC accounted for as poolings of interests as discussed in Note 1.
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 does not expect that implementation of this Standard will have a
material impact on its results of operations.
In March 1995, the Financial Accounting Standards Board issued Statement
No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed of" ("SFAS No. 121"). The Statement requires that long-
lived assets and certain identifiable intangibles to be held and used by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. The
Statement also requires that long-lived assets and certain identifiable
intangibles to be disposed of be reported at the lower of carrying amounts or
fair value less cost to sell. This Statement will be effective for the Company
beginning in fiscal 1997. Adoption of SFAS No. 121 is not expected to have a
material effect on the Company's consolidated financial statements.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to current
year presentation.
40
<PAGE>
NOTE 3 - INVESTMENTS
As of June 30, 1995, the amortized cost, gross unrealized holding gains and
losses and fair value of the Company's investments were as follows (in
thousands):
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
------------------------------------------ --------------------------------------------
GROSS GROSS GROSS GROSS
UNREALIZED UNREALIZED UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
---- ----- ------ ----- ---- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and
agencies $108,951 $ 643 $(1,256) $108,338 $17,263 $224 $ (45) $17,442
Obligations of states and
other political subdivisions 385,827 580 (4,231) 382,176 27,703 79 (249) 27,533
Corporate debt securities 8,120 119 (267) 7,972 845 111 - 956
Equity securities 4,089 39 (170) 3,958 - - - -
Other debt securities 39,152 - - 39,152 3,934 - - 3,934
--------- ------- -------- -------- ------- ---- ------ -------
Total $546,139 $ 1,381 $(5,924) $541,596 $49,745 $414 $(294) $49,865
--------- ------- -------- -------- ------- ---- ------ -------
--------- ------- -------- -------- ------- ---- ------ -------
</TABLE>
As of June 30, 1996, the amortized cost, gross unrealized holding gains and
losses and fair value of the Company's investments were as follows (in
thousands):
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
------------------------------------------ --------------------------------------------
GROSS GROSS GROSS GROSS
UNREALIZED UNREALIZED UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
---- ----- ------ ----- ---- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and
agencies $ 89,341 $ 75 $ (2,193) $ 87,223 $ 12,431 $ 12 $ (77) $ 12,366
Obligations of states and
other political subdivisions 584,371 1,341 (7,872) 577,840 16,675 67 (85) 16,657
Corporate debt securities 6,334 94 (223) 6,205 - - - -
Equity securities 1,372 1 (111) 1,262 - - -
Other debt securities 10,504 - (11) 10,493 2,785 - - 2,785
--------- ------- -------- -------- ------- ---- ------ -------
Total $691,922 $1,511 $(10,410) $683,023 $31,891 $79 $(162) $31,808
--------- ------- --------- -------- ------- ---- ------ -------
--------- ------- --------- -------- ------- ---- ------ -------
</TABLE>
41
<PAGE>
At June 30, 1996, the contractual maturities of the Company's investments
were as follows (in thousands):
<TABLE>
<CAPTION>
AT AMORTIZED COST AT FAIR MARKET VALUE
----------------------------------------------- -----------------------------------------------
YEARS TO MATURITY YEARS TO MATURITY
----------------------------------------------- -----------------------------------------------
LESS THAN 1 TO 5 5 TO 10 OVER 10 LESS THAN 1 TO 5 5 TO 10 OVER 10
1 YEAR YEARS YEARS YEARS 1 YEAR YEARS YEARS YEARS
------ ----- ----- ----- ------ ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE:
U.S. government and
agencies $20,052 $ 50,904 $ 18,226 $ 159 $19,970 $ 49,878 $ 17,206 $ 169
Obligations of states and
other political
subdivisions 22,090 174,318 204,982 182,981 22,127 173,215 202,501 179,997
Corporate debt securities 561 2,855 2,021 897 559 2,754 1,986 906
Equity securities 21 - - 1,351 22 - - 1,240
Other debt securities 2,110 8,394 - - 2,098 8,395 - -
------- -------- -------- -------- ------- -------- -------- --------
Total $44,834 $236,471 $225,229 $185,388 $44,776 $234,242 $221,693 $182,312
------- -------- -------- -------- ------- -------- -------- --------
------- -------- -------- -------- ------- -------- -------- --------
HELD TO MATURITY:
U.S. government and
agencies $ 4,409 $ 7,555 $ 467 $ - $ 4,416 $ 7,503 $ 447 $ -
Obligations of states and
other political
subdivisions 390 7,644 5,351 3,290 390 7,600 5,392 3,275
Other debt securities 2,685 - 100 - 2,685 - 100 -
------- -------- -------- -------- ------- -------- -------- --------
Total held to maturity $ 7,484 $ 15,199 $ 5,918 $ 3,290 $ 7,491 $ 15,103 $ 5,939 $ 3,275
------- -------- -------- -------- ------- -------- -------- --------
------- -------- -------- -------- ------- -------- -------- --------
</TABLE>
Proceeds from sales and maturities of available for sale securities during
1995 were $770,673,000, resulting in gross realized gains and losses of $13,000
and $122,000, respectively.
Proceeds from the sales and maturities of available for sale securities
during 1996 were $459,852,000 resulting in gross realized gains and losses of
$2,695,000 and $196,000, respectively.
The Company's regulated subsidiaries are required to keep securities on
deposit in various states where they are licensed. At June 30, 1996,
$404,570,000 in securities are restricted to satisfy various state regulatory
and licensing requirements. Additionally, at June 30, 1996, $4,897,000 in
securities were pledged as collateral under reinsurance agreements.
Pursuant to the Financial Accounting Standard Board's implementation
guidance, the Company made a one-time transfer of approximately $9,009,000 of
securities from the hold to maturity classification to the available for sale
classification prior to December 31, 1995.
Investment income, including realized investment gains and losses, were as
follows (in thousands):
YEAR ENDED
----------
JUNE 30,
--------
1994 1995 1996
---- ---- ----
Short-term investments . . . . . . . . . . . $ 3,035 $ - $ -
Fixed maturities . . . . . . . . . . . . . . 26,832 - -
Available for sale . . . . . . . . . . . . . - 31,938 35,396
Held to maturity . . . . . . . . . . . . . . - 3,283 1,944
Other. . . . . . . . . . . . . . . . . . . . 6,096 7,763 12,169
Less-investment expenses . . . . . . . . . . (991) (534) (854)
-------- -------- --------
Net investment income. . . . . . . . . . . . $ 34,972 $ 42,450 $ 48,655
-------- -------- --------
-------- -------- --------
Net investment income generated by property casualty operations were as
follows, $14,072,000, $21,437,000, and $26,794,000 for the years ended June 30,
1994, 1995 and 1996.
42
<PAGE>
NOTE 4 - LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the reserves for losses and loss adjustment expenses related to
workers' compensation and indemnity insurance policies, for the years ended
June 30, 1995 and June 30, 1996 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1995 JUNE 30, 1996
------------- -------------
<S> <C> <C>
Beginning balance . . . . . . . . . . . . . . . . . . . . . . . . $ 395,846 $ 414,330
Less-ceded losses and loss adjustment expense reserves. . . . . . (103,318) (81,667)
---------- ----------
Net beginning balance . . . . . . . . . . . . . . . . . . . . . . 292,528 332,663
---------- ----------
---------- ----------
Incurred related to:
Current fiscal year . . . . . . . . . . . . . . . . . . . . . . 232,643 492,090
Prior fiscal years . . . . . . . . . . . . . . . . . . . . . . . (7,614) (19,897)
---------- ----------
Total incurred. . . . . . . . . . . . . . . . . . . . . . . . . . 225,029 472,193
---------- ----------
---------- ----------
Paid related to:
Current fiscal year. . . . . . . . . . . . . . . . . . . . . . . (41,092) (242,942)
Prior fiscal years . . . . . . . . . . . . . . . . . . . . . . . (143,802) (173,348)
---------- ----------
---------- ----------
Total paid. . . . . . . . . . . . . . . . . . . . . . . . . . . . (184,894) (416,290)
---------- ----------
Net ending balance. . . . . . . . . . . . . . . . . . . . . . . . 332,663 388,566
Plus-ceded losses and loss adjustment expense reserves. . . . . . 81,667 72,620
---------- ----------
Ending balance. . . . . . . . . . . . . . . . . . . . . . . . . . $ 414,330 $461,186
---------- ----------
---------- ----------
</TABLE>
During the fiscal years ended June 30, 1995 and 1996, the Company
experienced favorable loss and loss adjustment expense reserve development of
$7,614,000 and $19,897,000, respectively. This reduction of the estimated loss
and loss adjustment expense is primarily the result of favorable loss
development related to the 1993 and 1994 accident years, offset in part by
adverse loss development for the 1992 and prior accident years.
NOTE 5 - EXCESS LIABILITY INSURANCE AND REINSURANCE
Under reinsurance agreements, the Company reinsures certain workers'
compensation risks with other insurance companies. Reinsurance contracts do not
relieve the Company from its obligations to policyholders. Failure of reinsurers
to honor their obligations could result in losses to the Company. The Company
regularly evaluates the financial condition of its reinsurers. Based on this
evaluation, management believes the reinsurers are creditworthy and that any
potential losses on these agreements will not have a material impact on the
consolidated financial statements.
The Company's workers' compensation subsidiaries maintain specific excess
reinsurance on workers' compensation which provides coverage in excess of
$1,000,000 per occurrence for accident year 1996, in excess of $500,000 per
occurrence for accident years 1994 and 1995, $350,000 per occurrence for
accident years 1992 and 1993 and in excess of $250,000 per occurrence for
accident years 1989 through 1991. The agreements provide coverage up to a
maximum of $200 million per occurrence, including the Company's retention. In
addition, the Company also maintained a pro rata reinsurance agreement wherein
the reinsurer assumed a proportional amount of net premiums earned and related
losses. The quota share percentage ranged from 5% to 40% (5% at June 30, 1994)
during the year ended June 30, 1994. As of July 1, 1994 the quota share
agreement was terminated. The workers' compensation subsidiaries entered
into a 30% quota share treaty to cede a proportional amount of net premiums
earned and related loss and loss adjustment expenses incurred, effective July
1, 1996. The 30% ceding rate is applicable from July 1, 1996 to December 31,
1996. Effective January 1, 1997, the quota share reinsurance ceding rate is
reduced to 7.5%, and subsequently reduced again to 3.75% from July 1, 1997 to
December 31, 1997. Effective January 1, 1998, the Company may terminate the
agreement.
43
<PAGE>
The effect of reinsurance on workers' compensation premium written and
earned, and losses incurred for the eleven months from August 1, 1993 (date of
acquisition) to June 30, 1994 and the years ended June 30, 1995 and 1996 is
summarized as follows (in thousands):
PREMIUMS PREMIUMS LOSSES
WRITTEN EARNED INCURRED
------- ------ --------
Eleven months ended June 30, 1994
Direct. . . . . . . . . . . . . . . . . $307,913 $309,379 $199,854
Assumed . . . . . . . . . . . . . . . . 20 16 (1,356)
Ceded . . . . . . . . . . . . . . . . . (32,122) (35,448) (27,016)
--------- --------- ---------
Net . . . . . . . . . . . . . . . . . . $275,811 $273,947 $171,482
--------- --------- ---------
--------- --------- ---------
Year ended June 30, 1995
Direct. . . . . . . . . . . . . . . . . $370,408 $373,954 $215,674
Assumed . . . . . . . . . . . . . . . . 4,423 4,393 973
Ceded . . . . . . . . . . . . . . . . . (19,396) (20,296) 8,382
--------- --------- ---------
Net . . . . . . . . . . . . . . . . . . $355,435 $358,051 $225,029
--------- --------- ---------
--------- --------- ---------
Year ended June 30, 1996
Direct. . . . . . . . . . . . . . . . . $506,696 $503,408 316,585
Assumed . . . . . . . . . . . . . . . . 16,354 16,354 5,708
Ceded . . . . . . . . . . . . . . . . . (33,383) (35,316) (11,451)
--------- --------- ---------
Net . . . . . . . . . . . . . . . . . . $489,667 $484,446 $310,842
--------- --------- ---------
--------- --------- ---------
At June 30, 1995 and 1996, the Company has an aggregate recoverable for
workers' compensation losses, paid and unpaid, including incurred but not
reported, allocated loss adjustment expenses, and unearned premiums with a
carrying value of $86,272,000, and $64,293,000 respectively, with a single
reinsurer.
The Company's HMO subsidiaries purchase individual excess liability
insurance for hospital costs in excess of deductible amounts. Premiums for this
insurance are included in commercial health care services expense. Amounts
recoverable under such contracts are included as reductions of commercial health
care services expense.
NOTE 6 - PROPERTY AND EQUIPMENT
Property and equipment comprised the following (in thousands):
JUNE 30,
-----------------------
1995 1996
---- ----
Land $ 29,840 $ 27,354
Construction in progress 22,362 11,370
Buildings and improvements 106,450 132,600
Furniture and equipment 137,391 203,651
--------- ---------
296,043 374,975
Less - accumulated depreciation (85,508) (117,411)
--------- ---------
$ 210,535 $ 257,564
--------- ---------
--------- ---------
Depreciation expense on property and equipment was $19,958,000, $21,680,000
and $29,507,000 for the years ended June 30, 1994, 1995 and 1996.
44
<PAGE>
NOTE 7 - NOTES PAYABLE, CAPITAL LEASES AND OTHER FINANCING ARRANGEMENTS
Notes payable, capital leases and other financing arrangements comprised
the following (in thousands):
JUNE 30,
---------------------
1995 1996
---- ----
7.75% Senior Notes due June 1, 2003 $ 124,596 124,647
Capital lease obligations 3,767 1,981
Unsecured notes payable pursuant to business
acquisition, bearing interest at 4.167% due
November 15, 1995 (Note 1) 7,909 -
Unsecured revolving line of credit bearing
interest at 6.313% and 5.788% at June 30, 1995
and 1996 20,000 165,000
Other 1,211 4,978
--------- -------
157,483 296,606
Deferred compensation (Note 10) 10,000 12,530
--------- -------
$ 167,483 $ 309,136
--------- -------
--------- -------
In June 1993, the Company issued $125,000,000 of senior notes due June 1,
2003 ("Senior Notes"). The Senior Notes bear interest at 7.75% which is due
semi-annually on December 1 and June 1. The Notes are general unsecured
obligations of the Company, will rank PARI PASSU with all future unsecured and
unsubordinated indebtedness of the Company and are effectively subordinated to
creditors of the Company's subsidiaries. The indenture contains certain
covenants that, among other things, (i) restrict the ability of the Company and
its Restricted Subsidiaries (as defined) to (a) pay dividends and make other
distributions and certain investments, (b) grant liens on their assets, (c)
enter into or permit certain sale and lease-back transactions or (d) engage in
certain mergers, consolidations and sales of assets, and (ii) restrict the
ability of the Company's Restricted Subsidiaries to incur additional
indebtedness or issue shares of preferred stock.
The Company has a $300 million unsecured revolving credit agreement with
Citicorp USA, Inc., as Administrative Agent for the lenders thereto (the "Credit
Agreement") which expires December 5, 1999. Principal amounts outstanding under
the Credit Agreement bear interest, at the Company's option, at either
Citibank's base rate or the Eurodollar rate plus a margin depending upon the
Company's public debt rating or level of total debt to total capitalization. Any
interest payments are due quarterly and principal is due at maturity. The
agreement contains customary terms, events of default and covenants (including
financial covenants related to net worth, fixed charge coverage and total debt
to total capitalization) which, among other things, limit the incurring of
additional debt. The Credit Agreement also limits the ability of the Company to
make cash dividends and stock repurchases if the aggregate amount of such
dividends and repurchases exceeds 50% of the cumulative consolidated net income
of the Company beginning with the fiscal year ended June 30, 1994, plus the
after tax effect of up to $125 million of restructuring charges, to the extent
deducted from earnings, plus $25 million after June 30, 1995. As of June 30,
1996, the amount available for cash dividends and stock repurchases under the
Credit Agreement was approximately $241,740,000. Subsequent to June 30, 1996,
the Company borrowed an additional $120 million under the Credit Agreement.
The Company leases some of its data processing and telecommunications
equipment under capital leases that provide for minimum annual rentals and
purchase options. Equipment under capital leases was $15,002,000 and $15,819,000
at June 30, 1995 and 1996 and the related accumulated depreciation was
$9,593,000 and $11,555,000 at June 30, 1995 and 1996.
45
<PAGE>
Future minimum payments under notes payable, capital leases and other
financing arrangements are as follows (in thousands):
YEAR ENDING JUNE 30,
--------------------
1997 $ 22,539
1998 21,227
1999 15,072
2000 175,099
2001 10,022
Thereafter 153,529
---------
397,488
Less - Amount representing interest (100,882)
---------
$ 296,606
---------
---------
NOTE 8 - INCOME TAXES
The provision for income taxes comprised the following (in thousands):
YEAR ENDED JUNE 30,
-------------------
1994 1995 1996
---- ---- ----
Current:
Federal $ 59,761 $ 44,230 $ 36,624
State 10,725 8,275 5,617
-------- -------- --------
Total current 70,486 52,505 42,241
-------- -------- --------
-------- -------- --------
Deferred:
Federal (686) (14,813) 19,329
State 154 (7,792) 2,748
-------- -------- --------
Total deferred (532) (22,605) 22,077
-------- -------- --------
Total provision for income taxes $ 69,954 $ 29,900 $ 64,318
-------- -------- --------
-------- -------- --------
A reconciliation of the statutory federal income tax rate and the effective
tax rate as a percentage of pretax income is as follows:
YEAR ENDED JUNE 30,
-------------------
1994 1995 1996
---- ---- ----
Statutory rate 35% 35% 35%
State income and franchise taxes, net
of federal tax benefit 4 3
Amortization of goodwill 1 5 1
Nondeductible acquisition costs - 4 -
Tax exempt interest income (4) (9) (3)
Recognition of net operating loss
carryforwards - - (3)
Taxes on undistributed income from
subsidiaries 3 -
Other - (1) (3)
----- ---- ----
Effective tax rate 39% 34% 30%
----- ---- ----
----- ---- ----
46
<PAGE>
The tax effects of the significant temporary differences which comprise the
net deferred tax asset at June 30, 1995 and 1996 were as follows (in thousands):
JUNE 30,
--------------------
1995 1996
---- ----
Deferred state income taxes $ 2,018 $ 1,835
Accrued vacation 3,217 3,854
Deferred compensation 5,828 5,060
Accrued expenses 9,360 4,612
Insurance loss reserves 23,838 22,178
Policyholder dividends 5,536 3,327
Restructuring costs 32,755 -
Investment in subsidiary - 10,156
Net operating losses - 12,104
Policy acquisition costs (6,186) (7,732)
Depreciation and amortization (4,777) (8,709)
Bond premium/discount (1,759) (754)
Valuation allowance - (1,654)
Other (2,266) 1,210
-------- --------
Net deferred tax asset $ 67,564 $ 45,487
-------- --------
-------- --------
NOTE 9 -CAPITAL STOCK
PREFERRED STOCK
The Company is authorized to issue 1,000,000 shares of $1 par value
preferred stock. No preferred stock was outstanding as of June 30, 1995 or 1996.
STOCKHOLDER RIGHTS PLAN
The Company's Stockholder Rights Plan provides for distribution of Rights
(as defined in the Stockholder Rights Plan) to holders of outstanding shares of
common stock. Except as set forth below, each Right, when exercisable, entitles
the stockholder to purchase from the Company one one-thousandth share of a new
series of the Company's preferred stock at a price of $105 per share, subject to
adjustment.
The Rights are not currently exercisable, but would become exercisable if
certain events occurred related to a person or group ("Acquiring Person")
acquiring or attempting to acquire 15% or more of the outstanding shares of
common stock. In the event that the Rights become exercisable, each Right
(except for Rights beneficially owned by the Acquiring Person, which become null
and void) would entitle the holder to purchase, for the exercise price then in
effect, shares of the Company's common stock having a value of twice the
exercise price.
The Rights may be redeemed by the Board of Directors in whole, but not in
part, at a price of $.01 per Right. The Rights have no voting or dividend
privileges and are attached to, and do not trade separately from, the common
stock. A total of 80,000 shares of preferred stock are reserved for future
issuance under this Rights Agreement, which expire on October 10, 2001.
STOCK REPURCHASE PROGRAM
In April 1993, the Board of Directors of the Company approved the
establishment of a stock repurchase program which, as amended, authorizes
acquisition from time to time, of up to 5.7 million shares of its outstanding
common stock in the open market. As of June 30, 1994, 1995, and 1996 the
repurchase of 1,445,500 and 1,545,500 and 1,795,500 shares had been completed
pursuant to this program. The stock repurchase program was cancelled
effective September 30, 1996.
47
<PAGE>
DIVIDENDS PAID
During the year ended June 30, 1994, CareFlorida paid cash dividends of $2
million on its common stock. As discussed in Note 1, the Company's consolidated
financial statements have been restated to reflect the results of CareFlorida in
accordance with the pooling of interest method of accounting.
Other than the CareFlorida dividend described above, the Company has never
paid cash dividends on its common stock. The Company presently intends to retain
its earnings for the development of its business and does not anticipate paying
cash dividends on its common stock in the foreseeable future. In December 1994,
the Company established a $300 million unsecured revolving Credit Agreement with
Citicorp USA, Inc. as Administrative Agent (the "Credit Agreement") for the
lenders parties thereto. Among other restrictive covenants in the Credit
Agreement, the Company's ability to pay cash dividends is restricted. See Note
7 for a more detailed description of the Credit Agreement.
STOCK OPTIONS
Under the Company's Restated and Amended 1990 Stock Option Plan (the "1990
Plan"), options may be either incentive stock options or nonqualified stock
options which expire no later than 10 years from the date of grant. Under the
1990 Plan, the Company has reserved 5,525,000 shares of common stock for the
granting of options. During the years ended June 30, 1994, 1995, and 1996, the
Company granted nonqualified options to purchase 1,083,750, 786,750 and 598,750
shares of the Company's common stock at exercise prices ranging from as 85 to
100% of the fair market value of the stock at the date of grant. Currently,
options are granted at prices determined by the Compensation and Organizational
Committee of the Board of Directors of the Company (the "Compensation
Committee") but may not be less than 100% of the fair market value of the stock
on the date of grant. As of June 30, 1995 and 1996, the total number of options
outstanding under the 1990 Plan were 3,154,939 and 3,041,023.
The Company has reserved 238,000 shares of the Company's common stock from
the granting of options under the 1992 Nonstatutory Stock Option Plan (the "1992
Plan") established in connection with a business acquisition in May 1992. Under
the 1992 Plan, options are granted to employees of the Company or its
subsidiaries at the discretion of a committee of the subsidiary's Board of
Directors. Options are granted at an exercise price equal to the fair market
value of the stock at the date of grant, subject to a vesting schedule of up to
three years, and expire no later than 10 years from the date of grant. Under the
1992 Plan, nonqualified options to purchase 49,300 shares were granted during
the year ended June 30, 1993. As of June 30, 1995 and 1996, the number of
options outstanding under the 1992 Plan were 38,036 and 20,001.
The Company has reserved 1,600,000 shares of the Company's common stock
under the 1993 Nonstatutory Stock Option Plan (the "1993 Plan") established in
October 1993 (as amended in fiscal year 1996). Under the 1993 Plan, options are
granted at the discretion of the Company's Board of Directors to physician
employees of affiliated professional corporations. Options are granted at an
exercise price equal to the fair market value of the stock at the date of grant.
Under the 1993 Plan, nonqualified options to purchase 381,399 and 384,075 shares
were granted during the years ended June 30, 1995 and 1996. As of June 30, 1995
and 1996, the number of options outstanding under the 1993 Plan were 499,874 and
755,790.
During the year ended June 30, 1992, the Company granted nonqualified stock
options to purchase 172,500 shares of the Company's common stock at exercise
prices determined as 85% of the fair market value of the stock at the date of
grant pursuant to employment agreements entered into in connection with a
business acquisition. Options vested 10% per year beginning July 1, 1992, with
provisions for accelerated vesting in the event certain profitability targets of
the acquired company were exceeded. During the year ended June 30, 1994, the
employment agreements were terminated and all unvested options were canceled.
48
<PAGE>
A summary of the Company's nonqualified and incentive stock options
outstanding is as follows:
<TABLE>
<CAPTION>
SHARES WEIGHTED AVERAGE
------ EXERCISE PRICE
--------------
<S> <C> <C>
Outstanding at June 30, 1993. . . . . . . . . . . . . . 2,297,579 22.19
Options exchanged pursuant to acquisition (Note 1). . . 29,475 9.41
Granted . . . . . . . . . . . . . . . . . . . . . . . . 1,229,250 38.17
Exercised . . . . . . . . . . . . . . . . . . . . . . . (572,347) 14.66
Canceled. . . . . . . . . . . . . . . . . . . . . . . . (202,482) 24.10
---------
Outstanding at June 30, 1994. . . . . . . . . . . . . . 2,781,475 30.52
Options exchanged pursuant to acquisition (Note 1). . . 500,290 18.09
Granted . . . . . . . . . . . . . . . . . . . . . . . . 1,168,149 31.60
Exercised . . . . . . . . . . . . . . . . . . . . . . . (330,796) 18.05
Canceled. . . . . . . . . . . . . . . . . . . . . . . . (229,021) 31.98
---------
Outstanding at June 30, 1995. . . . . . . . . . . . . . 3,890,097 30.22
Options exchanged pursuant to MHN acquisition (Note 1). 88,962 12.78
Granted . . . . . . . . . . . . . . . . . . . . . . . . 982,825 39.16
Exercised . . . . . . . . . . . . . . . . . . . . . . . (807,987) 21.04
Canceled. . . . . . . . . . . . . . . . . . . . . . . . (267,470) 31.48
---------
Outstanding at June 30, 1996. . . . . . . . . . . . . . 3,886,427 33.94
---------
---------
</TABLE>
A summary of options exercisable and shares available for future grant
under all option arrangements is as follows:
JUNE 30,
--------
1995 1996
---- ----
Options exercisable . . . . . . . . . . . . . 1,609,941 1,756,794
Shares available for grant. . . . . . . . . . 1,665,609 1,931,173
The Company receives a tax deduction for the excess of the market value of
the Company's common stock over the exercise price of the option at the date
nonqualified options are exercised by employees of the Company. The related tax
benefit is credited to common stock. The Company makes no charges against
capital with respect to options granted.
NOTE 10 - EMPLOYEE BENEFIT PLANS
EMPLOYEE STOCK PURCHASE PLAN
The Company has reserved 750,000 shares of common stock under an employee
stock purchase plan which became effective October 1, 1990. Full-time employees
of the Company and substantially all of its subsidiaries are eligible to
participate in this Plan if they have been continuously employed by the Company
for not less than six months. Employees electing to participate authorize
payroll deductions of up to 10% of their base compensation to purchase shares of
common stock at 85% of the then fair market value of the stock on the date of
purchase. During the years ended June 30, 1994, 1995 and 1996, 30,413, 39,389
and 37,536 shares of common stock were purchased under this plan.
49
<PAGE>
DEFINED CONTRIBUTION PLANS
The Company sponsors several defined contribution retirement plans intended
to be qualified under Sections 401(a) and 401(k) of the Internal Revenue Code.
Participation in the plans is available to substantially all employees.
Generally, employees may contribute up to 10% of their annual compensation to
the plans on a pre-tax basis and up to 10% on an after-tax basis. Under the
plans, the Company makes matching contributions of up to 6% of each
participating employee's base salary. The Company's contributions to the plans
totaled $5,961,000, $4,173,000 and $3,847,000 for the years ended June 30, 1994,
1995, and 1996.
DEFERRED COMPENSATION PLAN
Under the Company's deferred compensation plan certain members of
management, highly compensated employees and non-employee Board members may
defer payment of up to 90% of their compensation. The Company makes matching
contributions subject to a vesting schedule, of up to 10% of an employee
participant's compensation if the participant's base salary is at least
$120,000 ($100,000 prior to January 1, 1996). The deferred compensation,
together with Company matching amounts and accumulated interest which is
accrued but unfunded, is distributable in cash by lump sum or in monthly,
quarterly or annual installments (not exceeding 20 years) upon the earlier of
the date of distribution elected by the participant or termination of
employment. At June 30, 1995 and 1996, the liability under this deferred
compensation plan amounted to $10,000,000 and $12,530,000. The Company's
expense under the plan totaled $1,664,000, $1,955,000 and $3,089,000 for the
years ended June 30, 1994, 1995 and 1996.
During the year ended June 30, 1995, the Company amended the plan by
increasing the interest rate paid to participants to 140% of Moody's corporate
bond rate and by allowing participants to receive 90% of vested funds before
scheduled distributions by irrevocably forfeiting the remaining 10%.
During 1993, TDMC established a deferred compensation plan which called for
payment of deferred compensation to TDMC physicians with five years of service
at termination of employment (the "TDMC Plan"); as part of the merger of TDMC
with the Company the TDMC Plan was frozen in November 1994 and the present value
of each participant's benefits was established. Under the terms of the TDMC
Plan, interest accrues at the Citibank base rate plus 1/4%. The deferred
compensation is distributable in annual installments (not to exceed 10) upon
termination of employment. At June 30, 1995 and 1996, the liability under this
deferred compensation plan amounted to $6,389,000 and $5,703,000 and is
included in the net liabilities of discontinued operations on the Company's
consolidated financial statements. The Company's expense under the plan totaled
$2,885,000, $765,000 and $910,000 for the years ended June 30, 1994, 1995 and
1996.
DEFINED BENEFIT RETIREMENT PLANS
One of the Company's subsidiaries offers a non-contributory defined benefit
retirement plan ("Retirement Plan") covering substantially all of its employees.
The Retirement Plan is designed to meet the provisions of the Employee
Retirement Income Security Act of 1974. The benefits are primarily based upon
years of service and compensation. The retirement plan was terminated effective
December 31, 1995.
During the fiscal year ended June 30, 1995, the Company adopted two
unfunded non-qualified defined benefit pension plans, a Supplemental Executive
Retirement Plan and a Directors' Retirement Plan (collectively, the "SERP"),
which cover key executives, as selected by the Board of Directors, and
nonemployee directors. Currently there are sixteen participants in the plans.
Benefits are based on years of service and compensation in the last five years
of employment (for key executives) or the highest three years within the last
10 years of service (for non-employee directors).
50
<PAGE>
The discount rate and rate of increase in future compensation levels used
in determining the actuarial present value of the projected benefit obligations
were 7.5% and 6%, respectively, in 1994 and 1995 for the Retirement Plan, and 8%
and 4%, in 1995 and 1996 for the SERP. The funded status and amounts recognized
in the Company's consolidated financial statements for the Retirement Plan is as
follows (in thousands):
<TABLE>
<CAPTION>
RETIREMENT PLAN
-------------------
YEAR ENDED JUNE 30,
-------------------
1994 1995
---- ----
<S> <C> <C>
Actuarial present value of:
Vested benefit obligation . . . . . . . . . . . . . . . . . $ (540) $ (651)
Nonvested benefit obligation. . . . . . . . . . . . . . . . (38) (46)
--------- --------
Accumulated benefit obligation. . . . . . . . . . . . . . . $ (578) $ (697)
--------- --------
--------- --------
Projected benefit obligation. . . . . . . . . . . . . . . . $(1,184) $(1,447)
Plan assets at fair value . . . . . . . . . . . . . . . . . 783 1,380
--------- --------
Projected benefit obligation in excess of plan assets . . . (401) (67)
Deferred losses . . . . . . . . . . . . . . . . . . . . . . 212 153
Unrecognized net transition obligation. . . . . . . . . . . 118 109
--------- --------
Pension asset (liability) . . . . . . . . . . . . . . . . . $ (71) $ 195
--------- --------
--------- --------
Net pension expense was comprised of:
Service cost. . . . . . . . . . . . . . . . . . . . . . . . $ 136 $ 157
Interest cost . . . . . . . . . . . . . . . . . . . . . . . 83 99
Net amortization and deferral . . . . . . . . . . . . . . . 18 20
Return on plan assets . . . . . . . . . . . . . . . . . . . (57) (77)
--------- --------
Net pension expense . . . . . . . . . . . . . . . . . . . . $ 180 $ 199
--------- --------
--------- --------
</TABLE>
51
<PAGE>
The funded status and amortization recognized in the Company's consolidated
financial statements for the SERP Plan is as follows (in thousands):
SERP PLAN
---------
YEAR ENDED JUNE 30,
------------------
1995 1996
---- ----
Actuarial present value of:
Vested benefit obligation $ (470) $(3,979)
Nonvested benefit obligation (315) (1,685)
-------- --------
Accumulated benefit obligation $ (785) $(5,664)
-------- --------
-------- --------
Projected benefit obligation $(1,130) $(9,898)
Plan assets at fair value - -
-------- --------
Projected benefit obligation in excess of plan assets (1,130) (9,898)
Deferred benefit obligation - 2,717
Unrecognized net transition obligation 296 3,646
Additional liability - (2,129)
-------- --------
SERP liability $ (834) $(5,664)
-------- --------
-------- --------
Net SERP expense was comprised of:
Service cost $ 788 $ 1,578
Interest cost 25 617
Net amortization and deferral 21 506
-------- --------
Net SERP expense $ 834 $ 2,701
-------- --------
-------- --------
During the year ended June 30, 1995, the Company adopted an unfunded
Executive Retiree Medical Plan, which covers key executives, as selected by the
Board of Directors, and their spouses and dependents. The plan provides medical,
dental, and vision benefits during retirement. At June 30, 1995 and 1996, the
projected benefit obligation was $343,000 and $459,000, the unrecognized net
transition obligation was $194,000 and $172,000, the unrecognized net loss was
$63,000 and $59,000, and the pension liability was $86,000 and $228,000. The
components of post-retirement benefit expense for the years ended June 30, 1995
and 1996 included service cost of $45,000 and $93,000, interest cost of $19,000
and $26,000, and net amortization and deferral of $22,000 and $ 23,000, for
total benefit expense of $86,000 and $ 142,000. The medical cost trend rate
assumed was 14%, trending down to 6.5% over a ten year period. The weighted
average discount rate used in determining the accumulated postretirement benefit
obligation at June 30, 1995 and 1996 was 7.5%.
The impact of increasing the assumed health care cost trend rates by 1
percentage point in each year would not have a significant effect on the
accumulated postretirement benefit obligation or the aggregate of the service
and interest cost components of net periodic postretirement benefit cost for the
year ended June 30, 1996.
The Company purchases company-owned life insurance policies to cover the
cost of benefits under the Supplemental Executive Retirement Plan, the
Directors' Retirement Plan, the Executive Retiree Medical Plan, and the deferred
compensation plan. The cash surrender value of these policies at June 30, 1995
and 1996, included in other assets, was $13,090,000 and $33,707,000.
NOTE 11- REGULATORY AND CONTRACTUAL CAPITAL REQUIREMENTS
The Company's HMO subsidiaries are required to maintain a minimum level of
tangible net equity or minimum capital and surplus. The required total tangible
net equity and minimum capital and surplus for all HMOs is approximately
$31,594,000 at June 30, 1996. Under certain government contracts, Federal
Services is required to maintain a current ratio of 1:1 and certain HMO
subsidiaries are required to maintain a current ratio of 1:1 under Medicaid
contracts. The Company's life, accident and health insurance subsidiaries are
required by the Departments of Insurance in the states in which they are
licensed to maintain minimum capital and surplus aggregating $34,861,000. The
Company's workers' compensation
52
<PAGE>
insurance subsidiaries are required by the Departments of Insurance in the
states in which they are licensed to maintain minimum capital and surplus of
$5,000,000. In certain of the states in which the workers' compensation
subsidiaries are licensed to operate, regulations allow the Insurance
Commissioner, at their discretion, to require additional surplus amounts based
on types of insurance written and amount of premiums inforce. As a result,
actual capital and surplus requirements are significantly above the minimum
requirement as previously stated. The Company and its subsidiaries are in
compliance with the applicable minimum regulatory and capital requirements
described above.
As a result of the above requirements and certain other regulatory
requirements, certain subsidiaries are subject to restrictions on their ability
to make dividend payments, loans or other transfers of cash to the Company. Such
restrictions, unless amended or waived, limit the use of any cash generated by
these subsidiaries to pay obligations of the Company. As of June 30, 1996,
restricted net assets of these subsidiaries totaled approximately $71,455,000.
NOTE 12- RESTATEMENT
Subsequent to the issuance of its financial statements for the year
ended June 30, 1996, the Company reconsidered, in light of recent industry
developments, its prior accounting treatment for its affiliated
physician-owned Medical Practices and determined that certain adjustments to
consolidate those Medical Practices were required to be made to the previously
reported amounts as of and for the years ended June 30, 1994, 1995 and 1996.
As discussed in Note 1, the operations of the affiliated physician-owned
Medical Practices along with the Company's physician practice managment
subsidiary, are being treated as discontinued operations as they represent a
segment that is in the process of being sold.
A summary of the effects of the restatement in the determination of loss from
discontinued operations for the years ended June 30, 1994, 1995, and 1996 is as
follows (dollars in thousands):
YEAR ENDED JUNE 30
----------------------------
1994 1995 1996
---- ---- ----
Revenues $ 109,450 $ 118,297 $ 153,762
Expenses 127,057 168,004 234,375
--------- --------- ---------
Net loss before income taxes (17,607) (49,707) (80,613)
Benefit for income taxes (5,224) (4,366) (48,357)
Deferral of losses from measurement date - - 17,496
(Loss) gain related to IPAs - (4,500) 10,800
--------- --------- ---------
Net loss from discontinued operations $ (12,383) $ (49,841) $ (3,960)
--------- --------- ---------
--------- --------- ---------
A summary of the effects of the restatement for the years ended June 30,
1994, 1995, and 1996 is as follows (dollars in thousands):
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
1994:
Total revenues $ 2,362,937 $ 2,360,699
Total expenses 2,197,064 2,183,389
Income from continuing operations 93,641 99,958
Loss from discontinued operations - (12,383)
Net income 93,641 87,575
Earnings per share - continuing operations 1.92 2.05
Earnings per share - discontinued operations - (0.25)
Earnings per share - net income 1.92 1.80
Total assets 1,498,508 1,432,025
Total liabilities 1,076,065 1,015,648
Total stockholders' equity $ 422,443 $ 416,377
1995:
Total revenues $ 2,459,924 $ 2,459,423
Total expenses 2,381,392 2,371,410
Income from continuing operations 49,449 55,851
Loss from discontinued operations - (49,841)
Net income 49,449 6,010
Earnings per share - continuing operations 0.90 1.02
Earnings per share - discontinued operations - (0.91)
Earnings per share - net income 0.90 0.11
Total assets 1,964,207 1,884,689
Total liabilities 1,207,308 1,177,295
Total stockholders' equity $ 756,899 $ 707,394
53
<PAGE>
1996:
Total revenues $ 3,415,817 $ 3,407,628
Total expenses 3,175,222 3,191,068
Income from continuing operations 166,440 152,242
Loss from discontinued operations - (3,960)
Net income 166,440 148,282
Earnings per share - continuing operations 2.86 2.61
Earnings per share - discontinued operations - (0.07)
Earnings per share - net income 2.86 2.54
Total assets 2,426,399 2,337,653
Total liabilities 1,491,810 1,470,727
Total stockholders' equity $ 934,589 $ 866,926
NOTE 13 - COMMITMENTS AND CONTINGENCIES
During the year ended June 30, 1995, the Company entered into a $60 million tax
retention operating lease with NationsBank of Texas, N.A., as Administrative
Agent for the Lenders who are parties thereto and First Security Bank of Utah,
N.A., as Owner Trustee (the "TROL" agreement) for the construction of health
care centers and corporate facilities.
Under the TROL agreement, rental payments commence upon completion of
construction, with a guarantee of 87% to the lessor of the residual value of
properties leased at the end of the lease term. After the initial five year
noncancelable lease term, the lease may be extended by agreement of the parties
or the Company must purchase or arrange for sale of the leased properties. The
Company has committed to a guaranteed residual value of $22.5 million at
June 30, 1996 under this agreement.
The future minimum rental payments required under operating leases for all of
the Company's office space and equipment and for properties under construction
that have initial or remaining noncancelable lease terms in excess of one year
are as follows (in thousands):
YEAR ENDING JUNE 30,
--------------------
1997. . . . . . . . . . . . . . . . . . . . . . . $ 27,367
1998. . . . . . . . . . . . . . . . . . . . . . . 21,265
1999. . . . . . . . . . . . . . . . . . . . . . . 16,581
2000. . . . . . . . . . . . . . . . . . . . . . . 11,547
2001. . . . . . . . . . . . . . . . . . . . . . . 5,441
Thereafter. . . . . . . . . . . . . . . . . . . . 1,340
--------
$ 83,541
--------
--------
Lease expense for office space and equipment was $18,429,000 $21,723,000
and $31,232,000 for the years ended June 30, 1994, 1995 and 1996.
The Company maintains general liability and managed care professional
liability and directors and officers insurance and other insurance coverage in
amounts the Company believes to be adequate. The Company requires contracting
health care providers to maintain malpractice insurance coverage in amounts
customary in the industry.
In the ordinary course of its business the Company is a party to claims and
legal actions by enrollees, providers and others. The Company also undergoes
governmental audits and investigations with regard to its government contracts
and with respect to operations of its HMO, insurance, and third party
administrator subsidiaries. After consulting with legal counsel, the Company is
of the opinion that any liability that may ultimately be incurred as a result of
these claims, legal actions, audits or investigations will not have a material
adverse effect on the consolidated financial position or results of operations
of the Company.
NOTE 14 - SUBSEQUENT EVENT
On October 1, 1996, the Company entered into an Agreement and Plan of
Merger with Health Systems International, Inc. ("HSI"). Under the definitive
agreement approved by both companies' boards of directors, the Company will
merge into a wholly-owned subsidiary of HSI with the Company surviving the
merger as a wholly-owned subsidiary of HSI. HSI will change its name to
Foundation Health Systems, Inc. Completion of the transaction, which will be
a tax-free combination and accounted
54
<PAGE>
for as a pooling-of-interests, is subject to stockholder and regulatory
approval as well as other customary conditions and is expected to be completed
in January 1997. The Company's stockholders will receive 1.3 shares of HSI
Class A common stock for each share of Company common stock owned (the
"exchange ratio"). Holders of Company options will receive substitute HSI
options based on the same exchange ratio.
55
<PAGE>
FOUNDATION HEALTH CORPORATION
SUPPLEMENTAL SCHEDULE
CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(RESTATED)
ASSETS
JUNE 30,
----------------------------
1995 1996
------------ ------------
Cash and cash equivalents $ 1,954 $ 5,210
Advances to subsidiaries 10,336 20,009
Property and equipment, net 8,510 11,600
Investments in subsidiaries 772,637 897,770
Organization and debt issuance cost, net 14,047 4,470
Other assets 167,311 302,954
------------ ------------
$974,795 $1,242,013
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable and capital leases $177,674 $ 353,160
Accounts payable and other liabilities 89,727 21,927
------------ ------------
267,401 375,087
------------ ------------
Stockholders' equity
Common stock 518,671 533,855
Retained Earnings 194,744 343,026
Unrealized holdings losses (2,974) (6,908)
Common stock held in treasury, at cost (3,047) (3,047)
------------ ------------
707,394 866,926
------------ ------------
$974,795 $1,242,013
------------ ------------
------------ ------------
56
<PAGE>
FOUNDATION HEALTH CORPORATION
SUPPLEMENTAL SCHEDULE
CONDENSED STATEMENT OF OPERATIONS
(DOLLARS IN THOUSANDS)
(RESTATED)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES:
Government contracts $ 978 $ 1,432 $ 1,554
Interest and other income 7,095 8,124 13,432
Administrative revenue 82,516 31,906 36,930
Equity in subsidiary income 58,806 45,113 125,592
------------ ------------ ------------
149,395 86,575 177,508
------------ ------------ ------------
EXPENSES:
Selling, general and administrative 31,852 19,438 21,969
Amortization and depreciation 303 754 1,235
Interest expense 10,265 11,795 16,998
Acquisition and restructuring costs 84,436 -
------------ ------------ ------------
42,420 116,423 40,202
------------ ------------ ------------
Income before income taxes 106,975 (29,848) 137,306
Provision for income taxes 19,400 (35,858) (10,976)
------------ ------------ ------------
Net income $ 87,575 $ 6,010 $ 148,282
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
57
<PAGE>
FOUNDATION HEALTH CORPORATION
SUPPLEMENTAL SCHEDULE
CONDENSED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(RESTATED)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 87,575 $ 6,010 $ 148,282
Adjustments to reconcile net income to cash
used for operating activities:
Amortization and depreciation 305 830 1,235
Equity in subsidiary income (58,920) (45,113) (125,592)
Change in assets and liabilities, net of effects
from acquisition of businesses:
Other assets (3,560) (44,736) (13,712)
Other liabilities 6,466 49,604 (55,985)
Deferred income taxes, net (2,457) (11,163) 24,812
Investment in and advances to subsidaries (50,301) 36,672 (9,673)
------------ ------------ ------------
Net cash used for operating activities (20,892) (7,896) (30,633)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (673) (6,399) (3,679)
Decrease in short-term investments 112,966 - -
Purchase of available for sale investments - (256,450) -
Sales and maturities of available for sale investments - 292,344 -
Purchases of held to maturity investments - (12,949) -
Maturities of held to maturity investments - 10,967 -
Notes receivables - - (15,019)
Notes receivables from affiliates (35,708) (43,352) (114,365)
Acquisition of businesses (73,242) (15,727) (1,813)
------------ ------------ ------------
Net cash from (used for) investing activities 3,343 (31,566) (134,876)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes payable and capital leases (282) (382) (9,057)
Proceeds from issuances of notes payable and capital leases 30,542 188,351
Proceeds from issuances of common stock - net 812 6,448 1,254
Proceeds from exercise of stock options 8,403 5,920 16,932
Tax benefits related to stock options 5,410 4,645 6,721
Cash dividend received 27,400 54,997 28,050
Stock repurchase and other adjustments related to mergers (27,363) (3,047) (17,557)
Investments in subsidiaries (52,751) (89,564) (45,929)
------------ ------------ ------------
Net cash from (used for) financing activities (38,371) 9,559 168,765
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (55,920) (29,903) 3,256
Cash and cash equivalents, beginning of year 87,777 31,857 1,954
------------ ------------ ------------
Cash and cash equivalents, end of year $ 31,857 $ 1,954 $ 5,210
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
58
<PAGE>
EXHIBIT 11.0
FOUNDATION HEALTH CORPORATION
EARNINGS PER SHARE CALCULATION
UTILIZING THE TREASURY STOCK METHOD
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(RESTATED)
<TABLE>
<CAPTION>
PRIMARY
-------
QUARTER ENDED JUNE 30, YEAR ENDED JUNE 30,
-------------------------- ---------------------------
1996 1995 1996 1995
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Proceeds upon exercise of options outstanding $ 82,612 $ 46,780
----------- -----------
----------- -----------
Average market price of common stock $ 38.53 $ 29.45
----------- -----------
----------- -----------
Weighted average common shares outstanding 58,776,537 57,115,655
Issued shares - exercise of options 2,593,214 1,863,165
Shares assumed to be repurchased with proceeds from exercise (2,144,027) (1,588,539)
----------- -----------
Weighted average shares outstanding (A) 59,225,724 57,390,281 58,292,971 54,780,162
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Income from continuing operations (B) $ 35,740 $ 38,358 $ 152,242 $ 55,851
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Income (loss) from discontinued operations (C) $ 6,300 $ (25,179) $ (3,960) $ (49,841)
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Net income (D) $ 42,040 $ 13,179 $ 148,282 $ 6,010
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Earnings (loss) per share:
Continuing operations ( B / A ) $ 0.60 $ 0.67 $ 2.61 $ 1.02
Discontinued operations ( C / A ) $ 0.11 $ (0.44) $ (0.07) $ (0.91)
----------- ----------- ----------- ------------
Net earnings ( D / A ) $ 0.71 $ 0.23 $ 2.54 $ 0.11
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
<CAPTION>
FULLY DILUTED
-------------
QUARTER ENDED JUNE 30, YEAR ENDED JUNE 30,
-------------------------- ---------------------------
1996 1995 1996 1995
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Proceeds upon exercise of options outstanding $ 82,612 $ 46,780
----------- -----------
----------- -----------
Greater of average or end of period market price of
common stock $ 38.53 $ 29.45
----------- -----------
----------- -----------
Weighted average common shares outstanding 58,833,659 57,204,332
Issued shares - exercise of options 2,593,792 1,863,908
Shares assumed to be repurchased with proceeds from exercise (2,144,027) (1,588,539)
----------- -----------
Weighted average shares outstanding (A) 59,283,424 57,479,701 58,360,278 54,863,527
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Income from continuing operations (B) $ 35,740 $ 38,358 $ 152,242 $ 55,851
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Income (loss) from discontinued operations (C) $ 6,300 $ (25,179) $ (3,960) $ (49,841)
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Net income (D) $ 42,040 $ 13,179 $ 148,282 $ 6,010
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
Earnings (loss) per share:
Continuing operations ( B / A ) $ 0.60 $ 0.67 $ 2.61 $ 1.02
Discontinued operations ( C / A ) $ 0.11 $ (0.44) $ (0.07) $ (0.91)
----------- ----------- ----------- ------------
Net earnings ( D / A ) $ 0.71 $ 0.23 $ 2.54 $ 0.11
----------- ----------- ----------- ------------
----------- ----------- ----------- ------------
</TABLE>
59
<PAGE>
EXHIBIT 13.1
Report of Ernst & Young, Independent Auditors
Stockholders and Board of Directors
Intergroup Healthcare Corporation
We have audited the consolidated statements of income, changes in stockholders'
equity, and cash flows of Intergroup Healthcare Corporation for the year ended
December 31, 1993. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of Intergroup Healthcare Corporation for the year ended December 31,
1993 in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Tucson, Arizona
February 16, 1994, except
Note 17 as to which the date is
March 18, 1994
60
<PAGE>
EXHIBIT 13.2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of Thomas-Davis Medical Centers, P.C.
Tucson, Arizona
We have audited the consolidated statements of operations, cash flows, and
changes in shareholders' equity of Thomas-Davis Medical Centers, P.C. and
Subsidiaries for the year ended December 31, 1993. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit. We did not
audit the financial statements of Intergroup Healthcare Corporation, a 62.6%
owned subsidiary, which statements reflect total revenues of $392,036,000 for
the year ended December 31, 1993. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for Intergroup Healthcare Corporation, is based
solely on the report of the other auditors.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the results of the operations and cash flow of Thomas-Davis
Medical Centers, P.C. and Subsidiaries for the year ended December 31, 1993, in
conformity with generally accepted accounting principles.
STEVENSON, JONES & HOLMASS, P.C.
Tucson, Arizona
April 27, 1994
61
<PAGE>
EXHIBIT 13.3
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of CareFlorida Health Systems, Inc.
We have audited the consolidated statements of income, changes in stockholders'
equity, and cash flows of CareFlorida Health Systems, Inc. And Subsidiaries for
the year ended December 31, 1993. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
CareFlorida Health Systems, Inc. And Subsidiaries for the year ended December
31, 1993 in conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Miami, Florida
February 28, 1994
62
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in: (1) Registration Statement
on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit
Sharing and 401(k) Plan, (2) Registration Statement on Form S-8 (No. 33-36850)
relating to the Foundation Health Corporation 1990 Stock Option Plan,
(3) Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation
Health Corporation Employee Stock Purchase Plan, (4) Registration Statement on
Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of
Foundation Health Corporation, (5) Registration Statement on Form S-8
(No. 33-48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation
Health Corporation and the Foundation Health Corporation Incentive Common Stock
Option Agreement, (6) Registration Statement on Form S-8 (No. 33-53468) relating
to the Century MediCorp 1983 Incentive Stock Option Plan and Century MediCorp
1985, 1988, 1989 and 1991 nonstatutory stock option plans, (7) Registration
Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock Plan of Business
Insurance Corporation, (8) Registration Statement on Form S-3 (No. 33-80512)
relating to the 1993 Nonstatutory Stock Option Plan of Foundation Health
Corporation, (9) Registration Statement on Form S-8 (No. 33-86568) relating to
the Intergroup Healthcare Corporation Stock Option and Incentive Plan and Stock
Option Agreement, and (10) Registration Statement on Form S-8 (No. 33-86566)
relating to the Foundation Health Corporation 1990 Stock Option Plan (as amended
and restated), of our report dated July 25, 1996 and November 18, 1996, as to
Notes 1, 2, 6, 7, 8, 9, 10, 12, 13 and 14 appearing in this Amended Annual
Report on Form 10-K/A of Foundation Health Corporation for the year ended
June 30, 1996.
DELOITTE & TOUCHE LLP
Sacramento, California
November 18, 1996
63
<PAGE>
EXHIBIT 23.2
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the: (1) Registration Statement
on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit
Sharing and 401(k) Plan, (2) Registration Statement on Form S-8 (No. 33-36850)
relating to the Foundation Health Corporation 1990 Stock Option Plan, (3)
Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation
Health Corporation Employee Stock Purchase Plan, (4) Registration Statement on
Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of
Foundation Health Corporation, (5) Registration Statement on Form S-8 (No.
33-48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation
Health Corporation and the Foundation Health Corporation Incentive Common Stock
Option Agreement, (6) Registration Statement on Form S-8 (No. 33-53468) relating
the Century MediCorp 1983 Incentive Stock Option Plan and Century MediCorp 1985,
1988, 1989 and 1991 nonstatutory stock option plans, (7) Registration Statement
on Form S-8 (No. 33-67062) relating to the 1989 Stock Plan of Business Insurance
Corporation, (8) Registration Statement on Form S-3 (No. 33-80512) relating to
the 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation, (9)
Registration Statement on Form S-8 (No. 33-86568) relating to the Intergroup
Healthcare Corporation Stock Option and Incentive Plan and Stock Option
Agreement, and (10) Registration Statement on Form S-8 (No. 33-86566) relating
to the Foundation Health Corporation 1990 Stock Option Plan (as amended and
restated), of our report dated February 16, 1994, except Note 17 as to which the
date is March 18, 1994, with respect to the consolidated financial statements of
Intergroup Healthcare Corporation for the year ended December 31, 1993,
appearing in this Amended Annual Report on Form 10-K/A of Foundation Health
Corporation for the year ended June 30, 1996.
ERNST & YOUNG LLP
Tucson, Arizona
November 18, 1996
64
<PAGE>
EXHIBIT 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the: (1) Registration Statement
on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit
Sharing and 401(k) Plan; (2) Registration Statement on Form S-8 (No. 33-36850)
relating to the Foundation Health Corporation 1990 Stock Option Plan; (3)
Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation
Health Corporation Employee Stock Purchase Plan; (4) Registration Statement on
Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of
Foundation Health Corporation; (5) Registration Statement on Form S-8 (No.
33-48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation
Health Corporation and the Foundation Health Corporation Incentive Common Stock
Option Agreements; (6) Registration Statement on Form S-8 (No. 33-53468)
relating to the Century Medicorp 1983 Incentive Stock Option Plan and Century
Medicorp 1985, 1988, 1989 and 1991 nonstatutory stock option plans; (7)
Registration Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock
Plan of Business Insurance Corporation; and (8) Registration Statement on Form
S-3 (No. 33-80512) relating to the 1993 Nonstatutory Stock Option Plan of
Foundation Health Corporation; (9) Registration Statement on Form S-8 (No.
33-86568) relating to the Intergroup Healthcare Corporation Stock Option and
Incentive Plan and Stock Option Agreement; (10) Registration Statement on Form
S-8 (No. 33-86566) relating to the Foundation Health Corporation 1990 Stock
Option Plan (as amended and restated), of our report dated April 27, 1994,
appearing in this Amended Annual Report on Form 10-K/A of Foundation Health
Corporation for the year ended June 30, 1996.
STEVENSON, JONES & HOLMASS, P.C.
Tucson, Arizona
November 18, 1996
65
<PAGE>
EXHIBIT 23.4
CONSENT OF INDEPENDENT ACCOUNTS
We consent to incorporation by reference in the (1) Registration Statement on
Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit
Sharing and 401(k) Plan, (2) Registration Statement on Form S-8 (No. 33-36850)
relating to the Foundation Health Corporation 1990 Stock Option Plan, (3)
Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation
Health Corporation Employee Stock Purchase Plan, (4) Registration Statement on
Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of
Foundation Health Corporation, (5) Registration Statement on Form S-8 (No.
33-48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation
Health Corporation and the Foundation Health Corporation Incentive Common Stock
Option Agreement, (6) Registration Statement on Form S-8 (No. 33-534468)
relating to the Century MediCorp. 1983 Incentive Stock Option Plan and Century
MediCorp 1985, 1988, 1989 and 1991 nonstatutory stock option plans, (7)
Registration Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock
Plan of Business Insurance Corporation, (8) Registration Statement on Form S-3
(No. 33-80512) relating to the 1993 Nonstatutory Stock Option Plan of Foundation
Health Corporation, (9) Registration Statement on Form S-8 (No. 33-86568)
relating to the Intergroup Healthcare Corporation Stock Option and Incentive
Plan and Stock Option Agreement, and (10) Registration Statement on Form S-8
(No. 33-86566) relating to the Foundation Health Corporation 1990 Stock Option
Plan (as amended and restated), of our report dated February 28, 1994, on our
audit of the consolidated statements of income, changes in stockholders' equity,
and cash flows of CareFlorida Health Systems, Inc. and Subsidiaries for the year
ended December 31, 1993 which report is included in the Amended Annual Report on
Form 10-K/A of Foundation Health Corporation.
COOPERS & LYBRAND L.L.P.
Miami, Florida
November 18, 1996
66
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM
10-K/A FILED BY FOUNDATION HEALTH CORPORATION FOR THE FISCAL YEAR ENDED JUNE 30,
1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 226,156
<SECURITIES> 714,914
<RECEIVABLES> 416,223
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 257,564<F1>
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<TOTAL-ASSETS> 2,337,653
<CURRENT-LIABILITIES> 0
<BONDS> 309,136
0
0
<COMMON> 533,855
<OTHER-SE> 333,071
<TOTAL-LIABILITY-AND-EQUITY> 2,337,653
<SALES> 3,339,753
<TOTAL-REVENUES> 3,407,628
<CGS> 0
<TOTAL-COSTS> 3,176,384
<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> 14,684
<INCOME-PRETAX> 216,560
<INCOME-TAX> 64,318
<INCOME-CONTINUING> 152,242
<DISCONTINUED> (3,960)
<EXTRAORDINARY> 0
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<NET-INCOME> 148,282
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