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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________________ TO _________________
COMMISSION FILE NUMBER: 1-12718
------------------------
FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4288333
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
21600 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of principal executive offices) (Zip Codes)
</TABLE>
(818) 676-6978
Registrant's telephone number, including area code
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
As of November 10, 1998, 117,143,066 shares of Class A Common Stock, $.001
par value per share, were outstanding (exclusive of 3,194,374 shares held as
treasury stock) and 5,047,642 shares of Class B Common Stock, $.001 par value
per share, were outstanding.
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<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I--FINANCIAL INFORMATION
Item 1--Financial Statements
Condensed Consolidated Balance Sheets, September 30, 1998 and December 31, 1997.............. 3
Condensed Consolidated Statements of Operations for the Third Quarter Ended September 30,
1998 and 1997.............................................................................. 4
Condensed Consolidated Statements of Operations for the Nine Months Ended
September 30, 1998 and 1997................................................................ 5
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1998 and 1997................................................................ 6
Notes to Condensed Consolidated Financial Statements......................................... 7
Item 2--Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................... 12
Item 3--Quantitative and Qualitative Disclosures About Market Risk............................. 24
PART II--OTHER INFORMATION
Item 1--Legal Proceedings...................................................................... 26
Item 2--Changes in Securities.................................................................. 27
Item 3--Defaults Upon Senior Securities........................................................ 29
Item 4--Submission of Matters to a Vote of Security Holders.................................... 29
Item 5--Other Information...................................................................... 29
Item 6--Exhibits and Reports on Form 8-K....................................................... 33
Signatures..................................................................................... 41
</TABLE>
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Cash and cash equivalents......................................................... $ 389,896 $ 559,360
Securities available for sale..................................................... 523,780 553,001
Premiums receivable, net.......................................................... 257,966 224,383
Amounts receivable under government contracts..................................... 275,378 272,060
Deferred taxes.................................................................... 248,399 213,695
Reinsurance and other receivables................................................. 153,168 130,875
Other assets...................................................................... 132,313 223,900
Net assets of discontinued operations............................................. 273,362 267,713
------------- ------------
Total current assets............................................................ 2,254,262 2,444,987
Securities held to maturity....................................................... 11,209 12,885
Property and equipment, net....................................................... 408,017 427,149
Goodwill and other intangible assets, net......................................... 1,017,089 1,044,727
Other assets...................................................................... 179,980 146,602
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Total Assets.................................................................... $ 3,870,557 $4,076,350
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Reserves for claims and other settlements......................................... $ 874,820 $ 967,815
Unearned premiums................................................................. 134,469 244,340
Notes payable and capital leases.................................................. 2,043 3,593
Amounts payable under government contracts........................................ 71,554 78,441
Accounts payable and other liabilities............................................ 395,635 470,483
------------- ------------
Total current liabilities....................................................... 1,478,521 1,764,672
Notes payable and capital leases.................................................. 1,431,360 1,308,979
Other liabilities................................................................. 112,755 106,725
------------- ------------
Total Liabilities............................................................... 3,022,636 3,180,376
------------- ------------
Stockholders' Equity:
Common stock and additional paid-in capital....................................... 634,892 628,735
Retained earnings................................................................. 308,969 370,394
Unrealized investment losses, net of taxes........................................ (109) (7,324)
Common stock held in treasury, at cost............................................ (95,831) (95,831)
------------- ------------
Total Stockholders' Equity...................................................... 847,921 895,974
------------- ------------
Total Liabilities and Stockholders' Equity...................................... $ 3,870,557 $4,076,350
------------- ------------
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</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THIRD QUARTER ENDED
SEPTEMBER 30
--------------------------
<S> <C> <C>
1998 1997
------------ ------------
REVENUES
Health plan premiums................................................................ $ 1,852,797 $ 1,446,122
Government contracts revenues....................................................... 242,584 228,863
Specialty services.................................................................. 98,132 89,013
Investment and other income......................................................... 20,441 29,381
------------ ------------
Total revenues...................................................................... 2,213,954 1,793,379
------------ ------------
EXPENSES
Health plan services................................................................ 1,661,460 1,221,798
Government contracts health care services........................................... 188,501 163,398
Specialty services.................................................................. 84,327 77,267
Selling, general and administrative................................................. 263,026 194,391
Amortization and depreciation....................................................... 32,599 23,992
Interest............................................................................ 23,626 15,452
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2,253,539 1,696,298
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Asset impairments and other charges related to FPA Medical Management............... 28,130 --
Restructuring charges............................................................... 21,183 --
Other charges....................................................................... 38,674 --
------------ ------------
87,987 --
------------ ------------
Total expenses.................................................................... 2,341,526 1,696,298
------------ ------------
Income (loss) from continuing operations before income taxes.......................... (127,572) 97,081
Income tax provision (benefit)........................................................ (38,953) 37,278
------------ ------------
Income (loss) from continuing operations.............................................. (88,619) 59,803
Income from discontinued operations................................................... -- 9,098
------------ ------------
NET INCOME (LOSS)..................................................................... $ (88,619) $ 68,901
------------ ------------
------------ ------------
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
Continuing operations............................................................... $ (0.73) $ 0.49
Discontinued operations............................................................. -- 0.08
------------ ------------
Total............................................................................... $ (0.73) $ 0.57
------------ ------------
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WEIGHTED AVERAGE COMMON AND COMMON STOCK EQUIVALENT SHARES OUTSTANDING:
Basic............................................................................... 122,133 121,281
Diluted............................................................................. 122,133 121,908
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
--------------------------
<S> <C> <C>
1998 1997
------------ ------------
REVENUES
Health plan premiums................................................................ $ 5,566,749 $ 4,304,421
Government contracts revenues....................................................... 705,573 698,517
Specialty services.................................................................. 283,942 244,549
Investment and other income......................................................... 70,035 89,333
------------ ------------
Total revenues...................................................................... 6,626,299 5,336,820
------------ ------------
EXPENSES
Health plan services................................................................ 4,864,056 3,606,501
Government contracts health care services........................................... 544,138 520,798
Specialty services.................................................................. 230,394 209,833
Selling, general and administrative................................................. 769,880 612,368
Amortization and depreciation....................................................... 94,945 73,480
Interest............................................................................ 67,680 47,575
------------ ------------
6,571,093 5,070,555
------------ ------------
Asset impairments and other charges related to FPA Medical Management............... 78,130 --
Restructuring charges............................................................... 21,183 149,400
Gem costs........................................................................... -- 57,500
Other charges....................................................................... 38,674 196,709
------------ ------------
137,987 403,609
------------ ------------
Total expenses...................................................................... 6,709,080 5,474,164
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Loss from continuing operations before income taxes................................... (82,781) (137,344)
Income tax benefit.................................................................... (21,356) (38,979)
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Loss from continuing operations....................................................... (61,425) (98,365)
Income from discontinued operations................................................... -- 25,619
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NET LOSS.............................................................................. $ (61,425) $ (72,746)
------------ ------------
------------ ------------
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
Continuing operations............................................................... $ (0.50) $ (0.79)
Discontinued operations............................................................. -- 0.21
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Total............................................................................... $ (0.50) $ (0.58)
------------ ------------
------------ ------------
WEIGHTED AVERAGE COMMON AND COMMON STOCK EQUIVALENT SHARES OUTSTANDING:
Basic............................................................................... 121,903 123,947
Diluted............................................................................. 121,903 123,947
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THIRD QUARTER NINE MONTHS ENDED
ENDED SEPTEMBER 30
SEPTEMBER 30, ------------------------
1998 1998 1997
------------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.............................................................. $ (88,619) $ (61,425) $ (72,746)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Amortization and depreciation....................................... 32,599 94,945 73,480
Changes in net assets of discontinued operations.................... (3,059) (6,634) (44,189)
Asset impairments and other charges related to FPA Medical
Management........................................................ 22,000 57,000 --
Other changes....................................................... 14,729 14,018 8,700
Change in assets and liabilities, net of effects from acquisition of
businesses:
Premiums receivable and unearned subscriber premiums................ 17,722 (143,454) (124,701)
Other assets........................................................ 12,480 (50,676) (175,013)
Amounts receivable/payable under government contracts............... 23,692 (10,205) 212
Reserves for claims and other settlements........................... 21,247 (92,995) (120,062)
Accounts payable and accrued liabilities............................ 59,286 (44,977) 120,254
------------- ----------- -----------
Net cash provided by (used in) operating activities..................... 112,077 (244,403) (334,065)
------------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of securities available for sale..................... 175,940 600,914 536,329
Purchases of securities available for sale............................ (133,599) (567,382) (298,726)
Maturity or redemption of securities held to maturity................. 2,229 5,841 2,380
Purchases of securities held to maturity.............................. (723) (3,517) (2,274)
Purchases of property and equipment................................... (28,317) (105,580) (75,681)
Acquisition of business, net of cash acquired......................... -- -- (16,114)
Other................................................................. 4,683 10,360 98,546
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Net cash provided by (used in) investing activities..................... 20,213 (59,364) 244,460
------------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock
purchases........................................................... 440 12,789 16,036
Proceeds from issuance of notes and other financing arrangements...... 10,000 125,560 579,582
Repayment of debt and other liabilities............................... (3,520) (4,046) (538,381)
Purchase of treasury stock............................................ -- -- (108,287)
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Net cash provided by (used in) financing activities..................... 6,920 134,303 (51,050)
------------- ----------- -----------
Net increase (decrease) in cash and cash equivalents.................... 139,210 (169,464) (140,655)
Cash and cash equivalents, beginning of period.......................... 250,686 559,360 487,938
------------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................ $ 389,896 $ 389,896 $ 347,283
------------- ----------- -----------
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</TABLE>
See Notes to Condensed Consolidated Financial Statements.
6
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following notes should be read in conjunction with the notes to the
consolidated financial statements and the management's discussion and analysis
of financial condition and results of operations as of December 31, 1997 and
1996 and for each of the three years in the period ended December 31, 1997
included in the Foundation Health Systems, Inc. (the "Company") Annual Report on
Form 10-K for the year ended December 31, 1997. Such consolidated financial
statements and the management's discussion and analysis give retroactive effect
to the FHS Combination which was accounted for as a pooling of interests and to
the proposed sale of the Company's workers' compensation operations which has
been accounted for as discontinued operations, all further described below.
NOTE 1 BASIS OF PRESENTATION
In the opinion of management, the accompanying condensed consolidated
financial statements include all adjustments necessary for a fair presentation
of the consolidated financial position of the Company and the consolidated
results of its operations and its cash flows for the interim periods presented.
All adjustments presented in these condensed consolidated financial statements
are of a normal recurring nature except as discussed in Notes 2 and 3 below.
Although the Company believes that the disclosures in these financial statements
are adequate to make the information presented not misleading, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to the rules and regulations of the Securities and
Exchange Commission applicable to quarterly reports on Form 10-Q. Results of
operations for the interim periods are not necessarily indicative of results to
be expected for the full year. Certain prior period amounts have been
reclassified to conform with the current period presentation.
The condensed consolidated financial statements give retroactive effect to
the April 1, 1997 merger transaction (the "FHS Combination") involving Health
Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC").
The FHS Combination was accounted for as a pooling of interests for accounting
and financial reporting purposes. The pooling of interests method of accounting
is intended to present, as a single interest, two or more common stockholder
interests which were previously independent and assumes that the combining
companies have been merged from inception. Consequently, the Company's condensed
consolidated financial statements have been prepared and/or restated as though
HSI and FHC always had been combined for all periods presented.
The condensed consolidated financial statements give retroactive effect to
reflect the Company's workers' compensation business as discontinued operations.
On May 5, 1998, the Company entered into a definitive agreement to sell such
workers' compensation insurance operations (see Note 4). The accompanying
financial statements also have been restated to reflect the effects of the
discontinued operations.
NOTE 2 ASSET IMPAIRMENT
On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its
affiliated medical groups, provided services to approximately 150,000 of the
Company's affiliated members in Arizona and California. FPA has indicated that
it will discontinue its medical group operations in these markets. As a result,
the Company will have to find new tenants for, or sell, the 14 healthcare
facilities it currently leases to FPA in these markets and make other
arrangements for provider services to the Company's affiliated members.
7
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2 ASSET IMPAIRMENT (CONTINUED)
Management's analysis of this situation indicates that the likely
replacement lease terms from these properties will be inadequate to enable the
Company to sell the facilities and recover their carrying value. Based on
management's best estimate of recovery for the real estate and the impairment of
notes receivable and other Company assets due to the FPA bankruptcy filing, the
Company recorded a charge of $50 million during the second quarter ended June
30, 1998. The Company recorded an additional $28.1 million charge during the
third quarter ended September 30, 1998 which was primarily related to additional
impairment in the value of real estate assets leased to FPA. Elements of the
second and third quarter charges include approximately $57 million for real
estate asset impairments, approximately $10 million for a note receivable
impairment and approximately $11.1 million for other items.
NOTE 3 MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS
Net restructuring costs of $149.4 million were recorded during the year
ended December 31, 1997 related to the FHS Combination and the restructuring of
the Company's Eastern Division health plans. As of September 30, 1998, $88.1
million of the net restructuring charge has resulted in cash outlays and $21.2
million is expected to require future outlays of cash. In addition, $70.4
million of merger costs, $118.6 million of other costs and $57.5 million of
premium deficiency costs of Gem Insurance Company were recorded during 1997. It
is expected that $10.6 million of these other charges will require future
outlays of cash.
During the third quarter ended September 30, 1998, excluding the $28.1
million related to the FPA bankruptcy (see Note 2), the Company recorded $146.9
million of restructuring and other charges. These charges were primarily related
to severance costs of $21.2 million related to staff reductions in selected
health plans and the corporate centralization and consolidation; other special
charges totaling $38.7 million related to the adjustment of amounts due from a
hospital system that filed bankruptcy totaling $18.6 million, premium deficiency
reserves for certain of the Company's non-core health plans totaling $12.0
million, $8.1 million related to other items; and other charges, mostly related
to contractual adjustments included primarily in health care costs totaling
$87.0 million. As of September 30, 1998, $23.4 million of the total $175 million
has resulted in cash outlays and $64.4 million is expected to require future
outlays of cash.
NOTE 4 DISCONTINUED OPERATIONS
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business and thereby adopted a plan to discontinue this
segment of its business through divestiture of its workers' compensation
insurance subsidiaries. As a result, the Company is reporting its workers'
compensation insurance segment as discontinued operations for each period
presented in the condensed consolidated financial statements. Consistent with
the foregoing, on May 5, 1998 the Company entered into a definitive agreement to
sell its workers' compensation insurance operations to Superior National
Insurance Group, Inc. The transaction is expected to close in the fourth quarter
of 1998 and is expected to yield the Company, following the settlement of
various contractual obligations, approximately $200 million in cash without
giving effect to expected positive tax considerations.
8
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4 DISCONTINUED OPERATIONS (CONTINUED)
The following sets forth the summarized balance sheets as of September 30,
1998 and December 31, 1997 and results of operations for the third quarter and
nine-month periods ended September 30, 1998 and 1997 for the workers'
compensation insurance companies to be sold (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
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<S> <C> <C>
Total assets........................................................................ $ 1,288,970 $1,260,335
Total liabilities................................................................... 1,030,992 1,000,815
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Net assets.......................................................................... 257,978 259,520
Amounts to reconcile to net assets from discontinued operations:
Elimination of net notes payable and other net receivables........................ 112,589 107,193
Loss on disposition............................................................... (97,205) (99,000)
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Net assets from discontinued operations............................................. $ 273,362 $ 267,713
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</TABLE>
<TABLE>
<CAPTION>
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
<S> <C> <C> <C> <C>
1998 1997 1998 1997
--------- ---------- ---------- ----------
Total revenues.................................................... $ 59,383 $ 138,320 $ 291,047 $ 406,541
Total expenses.................................................... 45,315 127,749 301,610 377,406
--------- ---------- ---------- ----------
Income (loss) before income taxes................................. 14,068 10,571 (10,563) 29,135
Provision (benefit) for income taxes.............................. 3,755 1,473 (8,768) 3,516
--------- ---------- ---------- ----------
Net income (loss)................................................. 10,313 9,098 (1,795) 25,619
Income (loss) after measurement date anticipated in loss on
disposition..................................................... 10,313 -- (1,795) --
--------- ---------- ---------- ----------
Net income from discontinued operations........................... $ -- $ 9,098 $ -- $ 25,619
--------- ---------- ---------- ----------
--------- ---------- ---------- ----------
</TABLE>
The loss on disposition of $99 million recorded at December 31, 1997
included the anticipated results of operations through the disposal date and
therefore the net income (loss) of $10.3 million and $(1.8) million for the
third quarter and nine-month periods ended September 30, 1998, respectively, are
not reflected on the Company's condensed consolidated statements of operations
for those respective periods.
NOTE 5 COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130 "Reporting
Comprehensive Income." This standard requires that an enterprise report, by
major components and as a single total, the change in its net assets during the
period from non-owner sources which is defined as net income plus direct
9
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FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5 COMPREHENSIVE INCOME (CONTINUED)
adjustments to stockholders' equity such as unrealized investment adjustments.
The Company's comprehensive income pursuant to such standard is as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
<S> <C> <C> <C> <C>
1998 1997 1998 1997
---------- ---------- ---------- ----------
Net income (loss)................................................. $ (88,619) $ 68,901 $ (61,425) $ (72,746)
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities not included in net
income........................................................ 6,039 4,064 7,215 (6,698)
---------- ---------- ---------- ----------
Comprehensive income (loss)....................................... $ (82,580) $ 72,965 $ (54,210) $ (79,444)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
NOTE 6 EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share excludes dilution and reflects income or
loss divided by the weighted average shares of common stock outstanding during
the periods presented. Diluted earnings (loss) per share is based upon the
weighted average shares of common stock and dilutive common stock equivalents
(all of which are comprised of stock options) outstanding during the periods
presented; no adjustment to income is required. Common stock equivalents arising
from dilutive stock options are computed using the treasury stock method.
A reconciliation of shares used to calculate basic and diluted earnings per
share is as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1998 1997 1998 1997
--------- --------- --------- ---------
Weighted average outstanding shares during the period................. 122,133 121,281 121,903 123,947
Additional common shares issuable under employee stock option plans
using the treasury stock method..................................... 9 627 149 501
Excluded antidilutive common shares................................... (9) (149) (501)
--------- --------- --------- ---------
Weighted average outstanding shares during the period assuming
exercise of stock options........................................... 122,133 121,908 121,903 123,947
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
NOTE 7 COMMITMENTS AND CONTINGENCIES
On November 5, 1998, the Company entered into a definitive agreement to sell
its health plan subsidiaries in Louisiana, Oklahoma and Texas. The transaction
is subject to various closing conditions, including the receipt of all necessary
regulatory approvals and certain financial contingencies, and is expected to
close in early 1999.
On November 6, 1998, the Company amended the terms related to its $1.5
million revolving credit facility. The amendment provides for less restrictive
financial covenants and revises the interest rate. The interest rate is at the
applicable LIBOR rate plus margin based on the Company's unsecured credit rating
at the time of the borrowing. As of November 10, 1998, the rate was LIBOR plus
1.25%.
10
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7 COMMITMENTS AND CONTINGENCIES (CONTINUED)
Complaints have been filed in federal and state courts seeking an
unspecified amount of damages on behalf of an alleged class of persons who
purchased shares of common stock, convertible subordinated debentures and
options to purchase common stock of FPA at various times between February 3,
1997 and May 15, 1998. The complaints allege that the Company and certain former
officers violated federal and state securities laws by misrepresenting and
failing to disclose certain information about a 1996 agreement between the
Company and FPA, about FPA's business and about the Company's 1997 sale of FPA
common stock held by the Company. Management believes these suits are without
merit and intends to vigorously defend the actions.
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Management believes that the final outcome of
these proceedings will not have a material adverse effect upon the Company's
results of operations or financial condition.
NOTE 8 RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("SFAS 131") was issued in
June 1997 and establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas and major customers. SFAS 131 only requires
additional disclosures and will have no effect on the financial position or
results of operations; however, it is likely that more segments will be reported
in the notes to the consolidated financial statements. SFAS 131 is effective for
fiscal years beginning after December 15, 1997, and the Company plans to adopt
it as of December 31, 1998.
Statement of Financial Accounting Standards No. 132, "Employers Disclosures
About Pensions and Other Postretirement Benefits" ("SFAS 132") was issued in
February 1998 and revises current pension and other benefit plan disclosures.
SFAS 132 only requires additional disclosures and will have no effect on the
financial position or results of operations. SFAS 132 is effective for fiscal
years beginning after December 15, 1997, and the Company plans to adopt it as of
December 31, 1998.
Statement of Position 97-3, "Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments" ("SOP 97-3") was issued by the American
Institute of Certified Public Accountants in December 1997 and provides guidance
for determining when an insurance company or other enterprises should recognize
a liability for guaranty-fund assessments and guidance for measuring the
liability. SOP 97-3 is effective for 1999 financial statements. The adoption of
SOP 97-3 is not expected to have a material effect on the financial position or
results of operations of the Company.
11
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Foundation Health Systems, Inc. (the "Company") is an integrated managed
care organization which administers the delivery of managed health care
services. Through its subsidiaries, the Company offers group, individual,
Medicaid and Medicare health maintenance organization ("HMO") and preferred
provider organization ("PPO") plans; government sponsored managed care plans;
and managed care products related to bill review, administration and
cost-containment, behavioral health, dental, vision and pharmaceutical products
and services.
CONSOLIDATED OPERATING RESULTS
The Company's net loss from continuing operations for the third quarter
ended September 30, 1998 was $(88.6) million, or $(.73) per diluted share,
compared to net income from continuing operations for the same period in 1997 of
$59.8 million, or $0.49 per diluted share.
During the third quarter ended September 30, 1998, the Company recorded
restructuring and other charges totaling $175 million on a pre-tax basis. The
total $175 million charge included $87.0 related primarily to premium deficiency
reserves for the Company's Medicare operations in the Northeast division,
payment disputes with provider groups, and costs associated with contract
terminations and exiting rural markets, $21.2 million of restructuring charges,
$28.1 million in real estate and asset impairments related to the FPA Medical
Management, Inc. ("FPA") bankruptcy, $18.6 million related to the bankruptcy of
a large hospital system, and the balance of $20.1 million which is primarily
premium deficiency reserves related to certain of the Company's non-core health
plan operations.
Excluding the third quarter charges described above and the results of
discontinued operations for the 1997 quarter, the basic and diluted earnings per
share for the third quarters ended September 30, 1998 and September 30, 1997
were $.24 and $.49, respectively.
The Company's net loss from continuing operations for the nine months ended
September 30, 1998 was $(61.4) million, or $(.50) per diluted share, compared to
a net loss from continuing operations for the same period in 1997 of ($98.4)
million, or $(.79) per diluted share. Excluding the third quarter charges
described above in 1998, and the merger, restructuring, and other costs of
$346.1 million, Gem costs of $57.5 million and the results of discontinued
operations in 1997, the basic and diluted earnings per share for nine months
ended September 30, 1998 and September 30, 1997 were $.71 and $1.31,
respectively.
REVENUES AND HEALTH CARE COSTS
The Company's revenues for the third quarter and nine months ended September
30, 1998 as compared to the same periods in 1997 grew by $420.6 million and
$1,289.5 million or 23.5% and 24.2%, respectively. Growth in revenues for the
third quarter and nine months ended September 30, 1998 was due primarily to the
acquisitions that occurred in the fourth quarter of 1997, including Physicians
Health Services, Inc. ("PHS"), FOHP, Inc. ("FOHP"), and PACC HMO, Inc. and PACC
Health Plans, Inc. (collectively, "PACC"). Excluding these acquisitions,
revenues grew by $42.1 million and $162.5 million for the third quarter and nine
months ended September 30, 1998, respectively. The growth from existing
businesses was due to increases in premium rates in virtually all markets and
significant increases in Medicaid enrollment in the California Division.
Specialty Services Division revenue increased for the third quarter and for
the nine months ended September 30, 1998 as compared to the same periods in 1997
by $9.1 million and $39.4 million or 10.2% and 16.1%, respectively, primarily
due to increased revenue from new contracts, drug manufacturer rebates, the
Company's behavioral health plans, and bill review, cost containment and
administrative services businesses, which were offset by certain contract
terminations.
12
<PAGE>
The increase in revenues for the third quarter of 1998 included increased
Government Contracts Division revenue resulting from CHAMPUS contract downward
price adjustments occurring in the third quarter of 1997.
Investment and other income for the third quarter and nine months ended
September 30, 1998 was $8.9 million and $19.3 million lower as compared to the
same periods in 1997 as a result of 1997 interest income and gain on redemption
of the notes receivable from FPA and the gain on the sale of FPA common stock
included in the second quarter of 1997. The third quarter and nine months ended
September 30, 1997 also included a one-time gain on sale of certain Medicaid
contracts and rental income from FPA.
The Health Plan medical care ratio ("MCR") (medical costs as a percentage of
health plan revenues) for the third quarter and nine months ended September 30,
1998 increased to 89.7% and 87.4%, respectively, from 84.5% and 83.8% for the
respective periods in 1997. Excluding the other charges included in operations
($57.1 million of the $87.0 million) during the third quarter of 1998, the MCR
would have been 86.4% and 86.3% for the third quarter and nine months ended
September 30, 1998, respectively. The increase in the MCR was primarily due to
higher pharmacy costs in all divisions and benefit cost increases which exceeded
premium rate increases.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses
increased by $68.6 million and $157.5 million or 35.3% and 25.7% for the third
quarter and nine months ended September 30, 1998 as compared to the same periods
in 1997. The increase in SG&A expenses is primarily due to additional SG&A
expenses associated with the acquisitions that occurred in 1997. The
administrative expense ratio (SG&A as a percentage of health plan and government
contracts revenue) increased to 12.6% and 12.3% for the third quarter and nine
months ended September 30, 1998 from 11.6% and 12.2%, respectively, for the
comparable periods in 1997. Excluding the other charges reflected in operations
($10.8 million of the $87.0 million) during the third quarter of 1998, the
administrative expense ratio would have been 12.0% and 12.1% for the third
quarter and nine months ended September 30, 1998, respectively. The change in
this ratio is the result of continued focus on cost control and continued
benefits of integration synergies from acquisitions, offset by increased
expenditures related to consolidation and integration of the Company's
administrative facilities.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense increased by $8.6 million and $21.5
million for the third quarter and nine months ended September 30, 1998 as
compared to the same periods in 1997. This was primarily due to higher levels of
intangibles and fixed assets as a result of the acquisition of companies that
occurred in the fourth quarter of 1997 and increased expenditures on fixed
assets primarily related to consolidation and integration of the Company's
administrative facilities.
ASSET IMPAIRMENTS RELATED TO FPA MEDICAL MANAGEMENT
On July 19, 1998, FPA filed for bankruptcy protection under Chapter 11 of
the federal Bankruptcy Code. FPA, through its affiliated medical groups,
provided services to approximately 240,000 of the Company's members in Arizona
and California. FPA indicated that it will discontinue its medical group
operations in these markets.
The Company recorded a $50.0 million charge in the second quarter ended June
30, 1998 related to the FPA bankruptcy. Asset impairment and other charges
related to the FPA bankruptcy totaled $28.1 million in the third quarter of
1998. These charges primarily related to real estate assets leased to FPA.
Elements of the second and third quarter 1998 charge include approximately $57
million for real estate asset impairments, approximately $10 million for a note
receivable from FPA and approximately $11.1 million for other items related to
FPA.
13
<PAGE>
INTEREST EXPENSE
Interest expense increased by $8.2 million and $20.1 million for the third
quarter and nine months ended September 30, 1998, respectively, as compared to
the same periods during the prior year. The increase in interest expense was due
to higher debt levels associated with the Company's revolving lines of credit.
The additional borrowings were incurred for general corporate purposes as well
as the purchase of PHS, FOHP and PACC in the fourth quarter of 1997.
INCOME TAX PROVISION
The effective tax benefit rate on income (loss) from continuing operations
for the third quarter and nine months ended September 30, 1998 of (30.5%) and
(25.8%) changed from the effective tax provision (benefit) rate of 38.4% and
(28.4%) for the same periods in 1997 because of the charges recorded in 1998 and
1997 from merger, restructuring, other costs and Gem costs, portions of which
were not deductible for tax purposes. The effective tax provision rate differs
from the statutory federal rate of 35% due to state income taxes and tax-exempt
income, offset by non-deductible goodwill amortization.
LINE OF BUSINESS REPORTING
The Company currently operates in the managed health care segment. The
managed health care segment's continuing operations are in three primary lines
of business: (i) health plan operations; (ii) government contracts; and (iii)
specialty services. Discontinued operations include the workers' compensation
insurance segment.
CONTINUING OPERATIONS
HEALTH PLANS
Revenues generated by the Company's Health Plan operations increased $406.7
million or 28.1% for the third quarter ended September 30, 1998 and $1,262.3
million or 29.3% for the nine months ended September 30, 1998 compared to the
same periods in 1997. The primary reason for the increase is the acquisitions
that occurred in the fourth quarter of 1997 including PHS, FOHP and PACC which
contributed approximately $378.5 million and $1,127.0 million, respectively, in
revenue during the third quarter and first nine months of 1998. In addition,
Medicaid enrollment growth in the California division and premium rate increases
in the aggregate for all divisions contributed to the overall increase in
revenues for the health plans.
The MCR for the Company's Health Plan operations increased to 89.7% and
87.4% for the third quarter and nine months ended September 30, 1998 as compared
to 84.5% and 83.8% in the same periods in 1997. These increases were primarily a
result of pharmacy cost increases in all divisions, benefit cost increases which
exceeded premium rate increases and the charges recorded in the third quarter of
1998. The third quarter of 1998 charges totaling $57.1 million represented 3.3%
and 1.1% of the increase for the third quarter and nine months ended September
30, 1998, respectively.
The Company's Commercial product lines are profitable and have been adding
membership in the aggregate over the prior year. Premium rate increases in the
Commercial line of products contributed to revenue increases for the third
quarter and nine months ended September 30, 1998 compared to the same periods in
1997 in all divisions of the Company, but were partially offset by enrollment
decreases in Commercial HMO markets in California and the health plans in the
western and central states. Commercial health care costs on a per member per
month basis have increased 13.9% and 9.6% in the third quarter and nine months
ended September 30, 1998, respectively, as compared to the same periods in 1997.
The Company's Medicare product lines in the California market are
profitable, but are experiencing lower margins than in the prior year. The
Medicare products in the Company's Northeast health plans have shown an
underwriting loss of approximately $23.5 million for the nine months ended
September 30,
14
<PAGE>
1998. Medicare premium rates and enrollment have increased in the Northeast
markets, but enrollment rates are expected to slow. Medicare health care costs
in the California and Northeast markets continue to increase faster than premium
rates.
Medicaid enrollment in the California division has increased significantly
resulting in a 35.2% and 56.0% increase in member months in the third quarter
and nine months ended September 30, 1998,respectively, compared to the same
periods in 1997. However, Medicaid premium rates have decreased in all markets.
Medicaid health care costs have remained steady or decreased on a per member per
month basis in all of the Company's markets except for several of its Western
health plans, which have experienced higher costs due to several high cost
claims.
GOVERNMENT CONTRACTS AND SPECIALTY SERVICES
Government Contracts Division revenue increased by $13.7 million or 6.0% for
the third quarter ended September 30, 1998 compared to the same period in 1997.
The increase in revenue was primarily due to decreased revenue in the third
quarter of 1997 resulting from retroactive price adjustments and the related
risk sharing provisions of CHAMPUS contracts. Government Contracts Division
revenue for the nine months ended September 30, 1998 increased $7.1 million or
1.0% compared to the same period in 1997 primarily due to the retroactive
pricing adjustment in the third quarter which reduced contract prices because of
lower than anticipated health care costs. The price adjustment feature of the
CHAMPUS contracts results in reduced revenues when health care costs decline
more than anticipated.
Revenues generated by the Company's Specialty Services Division for the
third quarter of 1998 increased by $9.1 million or 10.2% as compared to the
third quarter of 1997 and increased by $39.4 million or 16.1% for the nine
months ended September 30, 1998 compared to the same period in 1997. These
increases are primarily the result of higher drug manufacturer rebates, new
business as a result of the FHS Combination, and continued growth in the
Company's managed behavioral health network and bill review cost containment
businesses.
Government contracts and specialty services costs as a percentage of
government contracts and specialty services revenues increased to 80.1% in the
third quarter of 1998 from 75.7% in the third quarter of 1997. This ratio for
the nine months ended September 30, 1998 was 78.3% compared to 77.5% for the
nine months ended September 30, 1997. Prior to the third quarter of 1998 charge
of $14.6 million, this ratio was 75.8% in the third quarter of 1998 and 76.8%
for the nine months ended September 30, 1998. This decrease for the nine months
ended September 30, 1998 is primarily due to increased revenues from drug
rebates coupled with reduced administrative expenses as a percentage of revenue
in the bill review cost containment business, partially offset by the 1997
revenues resulting from Medicaid administrative contract revenue activity with
only administrative costs and no associated health care costs.
DISCONTINUED OPERATIONS
WORKERS' COMPENSATION INSURANCE BUSINESS
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business and thereby adopted a plan to discontinue this
segment of its business through divestiture of its workers' compensation
insurance subsidiaries. As a result, the Company is reporting its workers'
compensation insurance segment as discontinued operations. Consistent with the
foregoing, on May 5, 1998 the Company entered into a definitive agreement to
sell its workers' compensation insurance operations to Superior National
Insurance Group, Inc. The transaction is expected to close in the fourth quarter
of 1998 and is expected to yield the Company, following the settlement of
various contractual obligations, approximately $200 million in cash without
giving effect to expected positive tax considerations.
15
<PAGE>
REVENUE
Total workers' compensation revenue in the third quarter of 1998 of $59.4
million is $78.9 million or 57.1% less than the third quarter of 1997. Net
earned premium of $43.2 million in the third quarter of 1998 is $83.9 million or
67.5% less than the net earned premium of $127.1 million in the third quarter of
1997. The decrease in premium is due primarily to the implementation of a quota
share reinsurance treaty effective May 1, 1998. Under terms of this quota share
agreement, gross premium earned on all policies with estimated annual premium in
excess of $25,000 at policy inception along with 100% of the associated net
losses and allocated loss adjustment expenses are ceded to the reinsurer, with a
33.5% ceding commission returned to the Company. In the third quarter of 1998,
$98.5 million of earned premium was ceded under this quota share reinsurance
treaty.
For the nine months ended September 30, 1998, total revenue of $291.0
million was $115.5 million or 28.4% less than the same period in 1997. Net
earned premium for the nine months ended September 30, 1998 of $255.5 million is
$117.9 million or 31.6% less than the same period in 1997, primarily as a result
of the aforementioned quota share treaty. During the first nine months of 1998,
earned premium of $154.8 million was ceded under the 1998 quota share treaty.
COSTS
Workers' compensation costs of $36.9 million, including general and
administrative costs, decreased $84.9 million or 69.7% in the third quarter of
1998 compared to the same period in 1997. The decrease is primarily due to a
ceding commission of $33.0 million under the quota share treaty mentioned above.
For the nine months ended September 30, 1998, total workers' compensation
costs, including general and administrative costs, of $278.9 million are $81.0
million or 22.5% less than the same period in 1997. The decrease is primarily
due to a ceding commission on the quota share reinsurance treaty of $51.9
million.
NET INCOME (LOSS)
The loss on disposition of $99.0 million recorded at December 31, 1997
included the anticipated results of operations through the disposal date and
therefore, the net income (loss) of $10.3 million and ($1.8) million for the
third quarter and nine months ended September 30, 1998 is not reflected in the
Company's condensed consolidated statement of operations for these periods.
The following tables present financial information reflecting the Company's
continuing operations for its primary lines of business:
16
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(AMOUNTS IN THOUSANDS, EXCEPT PMPM AND PER SHARE DATA)
<TABLE>
<CAPTION>
THIRD QUARTER
ENDED
THIRD QUARTER ENDED SEPTEMBER SEPTEMBER 30,
30, 1998 1997
------------------------------ -------------
<S> <C> <C> <C>
CATEGORIZATION
AMOUNT OR OF TOTAL AMOUNT OR
PERCENT CHARGES PERCENT
------------- -------------- -------------
REVENUES
Health plan premiums........................................... $ 1,852,797 $ 4,500 $ 1,446,122
Government contracts revenues.................................. 242,584 228,863
Specialty services............................................. 98,132 89,013
Investment and other income.................................... 20,441 29,381
------------- -------------- -------------
Total revenues............................................... 2,213,954 4,500 1,793,379
------------- -------------- -------------
EXPENSES
Health plan services........................................... 1,661,460 (57,063) 1,221,798
Government contracts health care services...................... 188,501 (14,600) 163,398
Specialty services............................................. 84,327 77,267
Selling, general and administrative ("SG&A")................... 263,026 (10,850) 194,391
Amortization and depreciation.................................. 32,599 23,992
Interest....................................................... 23,626 15,452
------------- -------------- -------------
2,253,539 (82,513) 1,696,298
------------- -------------- -------------
Asset impairments and other charges related to FPA Medical
Management................................................... 28,130 (28,130) --
Restructuring charges.......................................... 21,183 (21,183) --
Other charges.................................................. 38,674 (38,674) --
------------- -------------- -------------
87,987 (87,987) --
------------- -------------- -------------
Total expenses................................................. 2,341,526 (170,500) 1,696,298
------------- -------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES..... (127,572) 175,000 97,081
Income tax provision (benefit)................................... (38,953) 57,645 37,278
------------- -------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS......................... $ (88,619) $ 117,355 $ 59,803
------------- -------------- -------------
------------- -------------- -------------
OPERATING RATIOS:
Health plan medical care ratio................................. 89.7% (3.3)% 84.5%
Government contracts and specialty services medical care
ratio........................................................ 80.1 (4.3) 75.7
SG&A as a percent of health plan and government contracts
revenues..................................................... 12.6 (0.6) 11.6
HEALTH PLAN PER MEMBER PER MONTH:
Health plan premiums........................................... $ 143.79 $ 0.35 $ 138.44
Health plan services........................................... $ 128.95 $ (4.43) $ 116.96
</TABLE>
17
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(AMOUNTS IN THOUSANDS, EXCEPT PMPM AND PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
NINE MONTHS ENDED SEPTEMBER SEPTEMBER 30,
30, 1998 1997
------------------------------ -------------
<S> <C> <C> <C>
CATEGORIZATION
AMOUNT OR OF TOTAL AMOUNT OR
PERCENT CHARGES PERCENT
------------- -------------- -------------
REVENUES
Health plan premiums........................................... $ 5,566,749 $ 4,500 $ 4,304,421
Government contracts revenues.................................. 705,573 698,517
Specialty services............................................. 283,942 244,549
Investment and other income.................................... 70,035 89,333
------------- -------------- -------------
Total revenues............................................... 6,626,299 4,500 5,336,820
------------- -------------- -------------
EXPENSES
Health plan services........................................... 4,864,056 (57,063) 3,606,501
Government contracts health care services...................... 544,138 (14,600) 520,798
Specialty services............................................. 230,394 209,833
Selling, general and administrative ("SG&A")................... 769,880 (10,850) 612,368
Amortization and depreciation.................................. 94,945 73,480
Interest....................................................... 67,680 47,575
------------- -------------- -------------
6,571,093 (82,513) 5,070,555
------------- -------------- -------------
Asset impairments and other charges related to FPA Medical
Management................................................... 78,130 (78,130) --
Restructuring charges.......................................... 21,183 (21,183) 149,400
Gem costs...................................................... -- -- 57,500
Other charges.................................................. 38,674 (38,674) 196,709
------------- -------------- -------------
137,987 (137,987) 403,609
------------- -------------- -------------
Total expenses................................................. 6,709,080 (220,500) 5,474,164
------------- -------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES..... (82,781) 225,000 (137,344)
Income tax provision (benefit)................................... (21,356) 77,320 (38,979)
------------- -------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS......................... $ (61,425) $ 147,680 $ (98,365)
------------- -------------- -------------
------------- -------------- -------------
OPERATING RATIOS:
Health plan medical care ratio................................. 87.4% (1.1)% 83.8%
Government contracts and specialty services medical care
ratio........................................................ 78.3 (1.5) 77.5
SG&A as a percent of health plan and government contracts
revenues..................................................... 12.3 (0.2) 12.2
HEALTH PLAN PER MEMBER PER MONTH:
Health plan premiums........................................... $ 142.09 $ 0.11 $ 139.02
Health plan services........................................... $ 124.15 $ (1.45) $ 116.48
</TABLE>
18
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS INFORMATION
CONTINUING OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
-------------------------- SEPTEMBER 30,
PERCENT 1997
INCREASE ---------------
ENROLLMENT (DECREASE) ENROLLMENT
------------- ----------- ---------------
<S> <C> <C> <C>
Health Plan
Commercial.............................................................. 3,377 20.1% 2,812
Medicare risk........................................................... 323 24.7 259
Medicaid................................................................ 554 41.0 393
----- ----- -----
4,254 22.8 3,464
Government
CHAMPUS PPO and indemnity............................................... 822 (14.6) 963
CHAMPUS HMO............................................................. 766 12.0 684
----- ----- -----
1,588 (3.6) 1,647
----- ----- -----
Combined.................................................................. 5,842 14.3% 5,111
----- ----- -----
----- ----- -----
</TABLE>
19
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state laws and regulations, and must have
adequate reserves for claims. Certain subsidiaries must maintain ratios of
current assets to current liabilities of 1:1 pursuant to certain government
contracts. The Company believes it is in compliance with these contractual and
regulatory requirements in all material respects.
The Company regularly evaluates cash requirements for current operations and
commitments, and for capital acquisitions and other strategic transactions. The
Company may elect to raise additional funds for these purposes, either through
additional debt or equity, the sale of investment securities or otherwise, as
appropriate.
Government health care receivables and payables are best estimates of
payments that are ultimately collectible or payable. Since these amounts are
subject to government audit and negotiation, amounts ultimately collected may
vary from current estimates. Additionally, the timely collection of such
receivables is also impacted by government audit and negotiation.
For the nine months ended September 30, 1998, cash used in operating
activities was $244.4 million compared to $334.1 million in the same nine month
period of 1997. This use of cash for operating activities in 1998 was due
primarily to the timing of receipt of payments under federal and state Medicare
and Medicaid contracts, a reduction of claims inventory, payments for merger,
restructuring and other costs, regulatory deposits required in the Northeast,
CHAMPUS contract bid price adjustment payments and physician risk sharing
payments. For the quarter ended September 30, 1998, cash provided by operating
activities was $112.1 million.
Net cash used by investing activities was $59.4 million during the first
nine months of 1998 as compared to $244.5 million of net cash provided by
investing activities during the same period in 1997. The change is due primarily
to higher net purchases of securities available for sale and higher capital
spending during the 1998 period as well as FPA's redemption of a note payable in
the June 1997 quarter carried as an other asset on the Company's balance sheet.
Net cash generated from financing activities was $134.3 million in the nine
months ended September 30, 1998 as compared to $51.1 million used for financing
activities during the same period in 1997. The net change in the first nine
months of 1998 compared to the same period in 1997 was due primarily to
additional borrowings under the revolving line of credit primarily for capital
contributions to acquired subsidiaries in the Northeast, payments to regulated
subsidiaries in the discontinued operations segment under corporate tax sharing
agreements and loan repayments to the Government Contracts subsidiary to cover
bid price adjustment payments and other cash needs of that subsidiary.
Additionally, no purchases of treasury stock or debt repayments were made in
1998 as had occurred in the 1997 period.
The Company has a $1.5 billion credit facility (the "Credit Facility") with
Bank of America as Administrative Agent for the Lenders thereto, which was
amended by Amendments dated April 6, July 31, and November 6, 1998 with the
Lenders (the "Amendments"). All previous revolving credit facilities were
terminated and rolled into the Credit Facility on July 8, 1997. At the election
of the Company, and subject to customary covenants, loans are initiated on a bid
or committed basis and carry interest at offshore or domestic rates, at the
applicable LIBOR Rate plus margin or the bank reference rate. Actual rates on
borrowings under the Credit Facility vary, based on competitive bids and the
Company's unsecured credit rating at the time of the borrowing. As of September
30, 1998, the Company was in compliance with the financial covenants of the
Credit Facility, as amended by the Amendments. The Credit Facility is available
for five years, until July 2002, but it may be extended under certain
circumstances for two additional years. Due to operating and investing
requirements, the outstanding balance under the Credit Facility has increased
from $1.265 billion at December 31, 1997, to $1.39 billion at September 30, 1998
($1.38 billion at
20
<PAGE>
June 30, 1998). As of November 10, 1998, the same amount was outstanding under
the Credit Facility, with interest at LIBOR plus 1.25%.
The Company's subsidiaries must comply with certain minimum capital
requirements under applicable state laws and regulations. The long-term portion
of principal and interest payments under the California Wellness Foundation
Notes issued by the Company in connection with the Health Net conversion is
subordinated to Health Net meeting tangible equity requirements under applicable
California statutes and regulations. As of September 30, 1998, the Company's
subsidiaries were in compliance with minimum capital requirements.
Legislation has been or may be enacted in certain states in which the
Company's subsidiaries operate imposing substantially increased minimum capital
and/or statutory deposit requirements for HMOs in such states. Such statutory
deposits may only be drawn upon under limited circumstances relating to the
protection of policyholders. The Company's HMO subsidiary operating in New
Jersey was required to increase its statutory deposits by approximately $51
million in 1998 pursuant to such legislation.
The Company believes that cash from operations, existing working capital,
lines of credit and funds from planned divestitures of business are adequate to
fund existing obligations, introduce new products and services, and continue to
develop health care-related businesses, assuming that the Company completes its
previously announced workers' compensation divestiture on schedule and
substantially achieves its financial performance objectives for the balance of
1998. Such cash adequacy also assumes that no substantial additional statutory
deposits are imposed upon the Company's operating subsidiaries prior to
successful completion of these assumptions. In the event these assumptions are
not achieved, the Company may be required to pursue alternate financing
arrangements in order to maintain adequate liquidity.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit margin is
low; hence, it is especially sensitive to inflation. Increases in medical
expenses or contracted medical rates without corresponding increases in premiums
could have a material adverse effect on the Company.
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, regulatory changes, utilization,
new technologies, hospital costs, major epidemics and numerous other external
influences may affect the Company's operating results. Accordingly, past
financial performance is not necessarily a reliable indicator of future
performance, and investors should not use historical records to anticipate
results or future period trends.
The Company's HMO and insurance subsidiaries are required to maintain
reserves to cover their estimated ultimate liability for expenses with respect
to reported and unreported claims incurred. These reserves are estimates of
future payments based on various assumptions. Establishment of appropriate
reserves is an inherently uncertain process, and there can be no certainty that
currently established reserves will prove adequate in light of subsequent actual
experience, which in the past has resulted and in the future could result in
loss reserves being too high or too low. The accuracy of these estimates may be
affected by external forces such as changes in the rate of inflation, the
regulatory environment, the judicial
21
<PAGE>
administration of claims, medical costs and other factors. Future loss
development or governmental regulators could require reserves for prior periods
to be increased, which would adversely impact earnings in future periods. In
light of present facts and current legal interpretations, management believes
that adequate provisions have been made for claims and loss reserves.
Reference is also made to the disclosures contained under the heading
"Cautionary Statements" included in the Company's various filings with the
Securities and Exchange Commission and the documents incorporated by reference
therein, which could cause the Company's actual results to differ from those
projected in forward looking statements of the Company made on behalf of the
Company. In addition, certain of these factors may have affected the Company's
past results and may affect future results.
YEAR 2000
The Company recognizes that the arrival of the Year 2000 requires computer
systems to be able to recognize the date change from 1999 to 2000 and, like
other companies, is assessing and modifying its computer applications and
business processes to provide for their continued functionality.
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, prepare invoices or
engage in normal business activities. In addition, the year 2000 problems of the
Company's providers and customers, including governmental entities, can affect
the Company's operations, which are highly dependent upon information technology
for processing claims, determining eligibility and exchanging information.
PROJECT STATUS. The Year 2000 effort for the Company has the highest
priority of technology projects. The project has dedicated resources with
multiple teams to address unique systems environments. Uniform project
management techniques have been adopted with overall oversight responsibility
residing with the Company's Chief Technology Officer, assisted by a special
project manager hired by the Company. Selected systems will be retired with the
business functions being converted to Year 2000 compliant systems. A number of
the Company's systems include packaged software from large vendors that the
Company is closely monitoring to ensure that these systems will be Year 2000
compliant. The Company believes that vendors will make timely updates available
to ensure that all remaining software is Year 2000 compliant. The remaining
systems' compliance with Year 2000 will be addressed by internal technical
staff. The Company has engaged IBM to assist in the program management of the
project. The Company has also retained legal consultants to assist in the review
of insurance and the Company's obligations and rights, and intends to retain a
technical consultant to help develop contingency plans.
The Company has divided its Year 2000 effort into five phases: (1)
Assessment and Strategy, (2) Detailed Analysis and Planning, (3) Remediation,
(4) Testing and Implementation and (5) Certification. The Company believes that
Phase 1 is almost complete. The Company's geographical and specialty service
divisions are conducting a detailed internal self-assessment as to their
compliance, needs, risks and contingency planning, which will then be reviewed
and prioritized at the corporate level. The Company believes that it has
completed approximately 80% of Phase 2, approximately 30% of Phase 3 and
approximately 15% of Phase 4 relating to its internal technology. The Company
has established the third quarter of 1999 to complete all phases and is
endeavoring to accelerate completion ahead of that time.
THIRD PARTIES. The Company has commenced an inventory of third party
relationships, identifying them and analyzing their strategic importance to the
Company and their Year 2000 readiness. The Company expects to complete its risk
assessment for third parties in the fourth quarter of 1998. There can be no
assurances that the systems of other companies on which the Company relies will
be compliant on a
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timely basis, or that the failure by a third party to be compliant would not
have a material adverse effect on the Company.
COSTS. The Company is evaluating on an ongoing basis the related costs to
resolve its potential Year 2000 problems. The Company currently estimates that
the total cost for the project will exceed $17 million, excluding the costs to
accelerate the replacement of hardware or software otherwise required to be
purchased by the Company, and the use of existing personnel to assist in the
project. In this quarter, the first quarter in which the Company separately
tracked the costs relating to the project, the Company has expended
approximately $5.3 million relating to, among other things, the cost to repair
or replace software and related hardware problems, cost of assessment, analysis
and planning and internal and external communications.
However, notwithstanding the foregoing, the costs of the project and the
timetable in which the Company plans to complete the Year 2000 compliance
requirements are based on estimates derived from utilizing numerous assumptions
of future events including the continued availability of certain resources,
third party modification plans and other factors. There can therefore be no
assurance that these estimates will be achieved and actual results and costs
could differ materially from these estimates.
Certain insurance coverages for defense costs associated with Year 2000
litigation have already been secured under the Company's Directors and Officers
Liability Insurance policy and will be re-evaluated upon renewal of that policy.
At this time it is unclear as to extent of existing insurance coverage, if any,
the Company may have to cover potential Year 2000 costs and liabilities under
its other insurance policies. The Company is currently analyzing the
availability of such coverage under other existing and future insurance policies
and products.
CONTINGENCY PLANNING. An important part of the Company's Year 2000 project
involves identifying worst case scenarios and seeking to develop contingency
plans. Each geographical and specialty services division of the Company is
ranking its critical business functions in one of four categories, from the most
important (a function which is vital to the line of business and which has a
significant impact on the Company's reputation and critical daily operations,
for which an alternative must be immediately available), to the least important
(a function which has a negligible effect on the Company's provision of services
and reputation and for which alternatives are readily available). In addition to
acting to address the most critical problems first in its remediation effort,
the Company will also seek to develop its contingency plans to prioritize the
most critical business functions. The Company has just begun its efforts in this
area.
RISKS. The Company is highly dependent upon its own information technology
systems and that of its providers and customers. The Company or third party's
failure to correct a material Year 2000 problem could result in a failure of or
interruption in the Company's business activities and operations. Such
interruptions and failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the readiness of third-party providers and customers, the Company
is not able at this time to determine whether the Year 2000 problems will have a
material adverse effect on the Company's results of operations, liquidity or
financial condition. The Company's Year 2000 project is expected to reduce
significantly the Company's level of uncertainty and the possibility of
significant or long-lasting interruptions of the Company's business operations;
however, the Company believes that it is impossible to predict all of the areas
in which material problems may arise.
Forward-looking statements contained in this Year 2000 section should be
read in connection with the Company's cautionary statements identifying
important risk factors that could cause the Company's actual results to differ
materially from those projected in these forward-looking statements, which
cautionary statements were previously filed with the Company's Annual Report on
form 10-K for the year ended December 31, 1997.
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ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CONTINUING OPERATIONS
The Company is exposed to interest rate and market risk primarily due to its
investing and borrowing activities. Market risk generally represents the risk of
loss that may result from the potential change in the value of a financial
instrument as a result of fluctuations in interest rates and in equity prices.
Interest rate risk is a consequence of maintaining fixed income investments. The
Company is exposed to interest rate risks arising from changes in the level or
volatility of interest rates, prepayment speeds and/or the shape and slope of
the yield curve. In addition, the Company is exposed to the risk of loss related
to changes in credit spreads. Credit spread risk arises from the potential that
changes in an issuer's credit rating or credit perception may affect the value
of financial instruments.
The Company has several bond portfolios to fund reserves. The Company
attempts to manage the interest rate risks related to its investment portfolios
by actively managing the asset/liability duration of its investment portfolios.
The overall goal of the investment portfolios is to support the ongoing
operations of the Company's business units. The Company's philosophy is to
actively manage assets to maximize total return over a multiple-year time
horizon, subject to appropriate levels of risk. Each business unit will have
additional requirements with respect to liquidity, current income and
contribution to surplus. The Company manages these risks by setting risk
tolerances, targeting asset-class allocations, diversifying among assets and
asset characteristics, and using performance measurement and reporting.
The Company uses a value-at-risk model to assess the market risk of its
investments. The estimation of potential losses that could arise from changes in
market conditions is typically accomplished through the use of statistical
models which seek to predict risk of loss based on historical price and
volatility patterns. The Company's measured value at risk for its investments
from continuing operations, using a 95 percent confidence level, was
approximately $3.3 million at September 30, 1998.
The Company's calculated value-at-risk exposure represents an estimate of
reasonably possible net losses that could be recognized on its investment
portfolios assuming hypothetical movements in future market rates and are not
necessarily indicative of actual results which may occur. It does not represent
the maximum possible loss nor any expected loss that may occur, since actual
future gains and losses will differ from those estimated, based upon actual
fluctuations in market rates, operating exposures, and the timing thereof, and
changes in the Company's investment portfolios during the year.
In addition, the Company has some interest rate market risk due to its
borrowings. Notes payable, capital leases and other financing arrangements
totaled $1.4 billion at September 30, 1998 and the related average interest rate
was 6.1% (which interest rate is subject to change pursuant to the terms of the
Credit Facility). See a description of the Credit Facility under "Liquidity and
Capital Resources." The table below presents the expected cash flows of market
risk sensitive instruments at September 30, 1998. These cash flows include both
expected principal and interest payments consistent with the terms of the
outstanding debt as of September 30, 1998 (dollars in thousands).
<TABLE>
<CAPTION>
1998 1999 2000 2001 2002 BEYOND TOTAL
------- ------- -------- ------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Long-term Borrowings
Fixed Rate................................................ $ 4,329 $ 4,329 $ 26,680 $ 2,540 $ 2,540 $10,161 $ 50,580
Floating Rate............................................. 83,051 83,817 83,817 83,817 1,431,909 -- 1,766,411
------- ------- -------- ------- ---------- ------- ----------
Total....................................................... $87,380 $88,146 $110,497 $86,357 $1,434,449 $10,161 $1,816,991
------- ------- -------- ------- ---------- ------- ----------
------- ------- -------- ------- ---------- ------- ----------
</TABLE>
24
<PAGE>
DISCONTINUED OPERATIONS
The Company has entered into a definitive agreement to sell its
risk-assuming workers' compensation insurance businesses which represent a
separate segment of business. Therefore the results of these businesses have
been reported as discontinued operations.
The Company's measured value-at-risk of its investments from discontinued
operations at a 95 percent confidence level, at September 30, 1998 was
approximately $3.1 million.
The discontinued operations businesses do not have any significant interest
rate risk due to debt.
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PART II. OTHER INFORMATION
INTRODUCTION
As referenced in Part I above, the current operations of Foundation Health
Systems, Inc. (the "Company") are a result of the April 1, 1997 merger
transaction (the "Merger" or the "FHS Combination") involving Health Systems
International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant
to the Merger, FH Acquisition Corp., a wholly owned subsidiary of HSI ("Merger
Sub"), merged with and into FHC and FHC survived as a wholly owned subsidiary of
HSI, which changed its name to "Foundation Health Systems, Inc." and thereby
became the Company. Pursuant to the Agreement and Plan of Merger (the "Merger
Agreement") that evidenced the Merger, FHC stockholders received 1.3 shares of
the Company's Class A Common Stock for every share of FHC common stock held.
In connection with the Merger, the Company amended its Certificate of
Incorporation to change the name of the Company as referenced above and to
increase the number of authorized shares of the Company's Common Stock to
380,000,000 shares consisting of 350,000,000 shares of Class A Common Stock and
30,000,000 shares of Class B Common Stock.
In connection with the Merger, the Company also, among other things, amended
the Company's By-Laws to effect certain changes to the governance provisions of
the Company following the Merger, including provisions related to the structure
of the Company's Board of Directors and the committees of the Company's Board of
Directors. Except in certain circumstances, during a transition period following
the consummation of the Merger and up to, but not including, the election of
directors at the Company's May 2000 Annual Meeting of Stockholders, the
Company's Board of Directors is to consist of 11 members to be designated as set
forth in the Company's Certificate of Incorporation and By-Laws. Pursuant to
such designations the Company's Board of Directors is currently comprised of the
following ten members (there currently exists one vacancy on the Board of
Directors which vacancy is in the process of being filled): J. Thomas Bouchard,
George Deukmejian, Thomas T. Farley, Patrick Foley, Earl B. Fowler, Roger F.
Greaves, Richard W. Hanselman, Malik M. Hasan, M.D., Richard J. Stegemeier and
Raymond S. Troubh. As set forth under the heading "Recent Developments" below,
Dr. Hasan has agreed that, in connection with his recent retirement, he will
resign from the Board of Directors sometime between September 30, 1998 and March
1, 1999.
ITEM 1. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
On November 7, 1996 the Company's predecessor, HSI, filed a lawsuit against
Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive
Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V.
MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414,
Superior Court of California, County of Los Angeles. The lawsuit arises out of
the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July
1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS,
representing over sixteen percent of the total outstanding equity of HDS, voted
its shares in favor of the acquisition of HDS by Medaphis. HSI received as the
result of the acquisition 976,771 shares of Medaphis Common Stock in exchange
for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company
succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has
been substituted for HSI as plaintiff in the suit.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core business, and had artificially
maintained its stock prices through a series of acquisitions and accounting
maneuvers which provided the illusion of growth while hiding the reality of its
weakening financial and business condition. The Company alleges that Medaphis,
Brown and other insiders deceived the Company by presenting materially false
financial statements and by failing to disclose that Medaphis
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<PAGE>
would shortly reveal a "write off" of up to $40 million in reorganization costs
and would lower its earnings estimate for the following year, thereby more than
halving the value of the Medaphis shares received by the Company. The Company
alleges that these false and misleading statements were contained in oral
communications with the Company, as well as in the registration statement and
the prospectus provided by Medaphis to all HDS shareholders in connection with
the HDS acquisition. Further, despite knowing of the Company's discussions to
form a strategic alliance of its own with HDS, Medaphis and the individual
defendants wrongfully interfered with that prospective business relationship by
proposing to acquire HDS using Medaphis stock whose market price was
artificially inflated by false and misleading statements. The Company alleges
that the defendants' actions constitute violations of both federal and state
securities laws, as well as fraud and other torts under state law. The Company
is seeking either rescission of the transaction or damages in excess of $38
million. The defendants have denied the allegations in the complaint, and the
Company is vigorously pursuing its claims against Medaphis.
Recently the Company moved to disqualify the law firm representing certain
of the individual defendants. The trial court granted the Company's motion, and
the law firm and its clients have appealed such decision. In addition, the trial
court granted a stay of the case in order to permit the law firm to appeal.
Argument on the appeal was held on November 10, 1998. Prior to the stay the case
was in the early stages of discovery, and no trial date has yet been set.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in
federal and state courts seeking an unspecified amount of damages on behalf of
an alleged class of persons who purchased shares of common stock, convertible
subordinated debentures and options to purchase common stock of FPA Medical
Management, Inc. ("FPA") at various times between February 3, 1997 and May 15,
1998. The FPA Complaints name as defendants FPA, certain of FPA's present and
former officers and directors, FPA's auditors, the Company and certain of the
Company's former officers. The FPA Complaints allege that the Company and such
former officers violated federal and state securities laws by misrepresenting
and failing to disclose certain information about a 1996 transaction between the
Company and FPA, about FPA's business and about the Company's 1997 sale of FPA
common stock held by the Company. The Company has filed a motion to dismiss all
claims asserted against it in the consolidated federal class actions but has not
formally responded to the other complaints.
Management believes these suits against the Company and its former officers
are without merit and intends to defend the actions vigorously.
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Based in part on advice from litigation counsel
to the Company and upon information presently available, management of the
Company is of the opinion that the final outcome of all such proceedings should
not have a material adverse effect upon the Company's results of operations or
financial condition.
ITEM 2. CHANGES IN SECURITIES
REVOLVING CREDIT FACILITY
On July 8, 1997 the Company entered into a Credit Agreement with the banks
identified therein (the "Banks") and Bank of America National Trust and Savings
Association ("Bank of America"), in its capacity as the Administrative Agent,
pursuant to which the Company obtained an unsecured five-year $1.5 billion
revolving credit facility maturing on July 7, 2002. The Credit Agreement
replaced (i) the Company's prior Amended and Restated Credit Agreement, dated as
of April 26, 1996, with Bank of America, as agent, providing for a $700 million
unsecured revolving credit facility and (ii) FHC's prior
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<PAGE>
(A) Revolving Credit Agreement, dated as of December 5, 1994, with Citicorp USA,
Inc., as agent, providing for a $300 million unsecured revolving credit facility
and (B) Revolving Credit Agreement, dated as of December 17, 1996, with
Citibank, N.A., as administrative agent, providing for a $200 million unsecured
revolving credit facility.
The Credit Agreement contains customary representations and warranties,
affirmative and negative covenants and events of default. Specifically, Section
7.11 of the Credit Agreement provides that the Company and its subsidiaries may,
so long as no event of default exists: (i) declare and distribute stock as a
dividend; (ii) purchase, redeem or acquire its stock, options and warrants with
the proceeds of concurrent public offerings; and (iii) at any time after the
consummation of the contemplated sale of the Company's workers' compensation
insurance business, declare and pay dividends or purchase, redeem or otherwise
acquire its capital stock, warrants, options or similar rights with cash subject
to certain specified limitations.
Under the Credit Agreement, as amended pursuant to the First Amendment and
Waiver to Credit Agreement dated as of April 6, 1998, the Second Amendment to
Credit Agreement dated as of July 31, 1998 and the Third Amendment to Credit
Agreement dated as of November 6, 1998 (collectively, the "Amendments") with the
Banks, the Company is: (i) obligated to maintain certain covenants keyed to the
Company's financial condition and performance (including a Total Leverage Ratio
and Fixed Charges Coverage Ratio); (ii) obligated to limit liens; (iii) subject
to customary covenants, including (A) disposition of assets only in the ordinary
course and generally at fair value and (B) restrictions on acquisitions,
mergers, consolidations, loans, leases, joint ventures, contingent obligations
and certain transactions with affiliates; (iv) permitted to sell the Company's
workers' compensation insurance business and other businesses and assets,
provided that 100% of the net proceeds with respect to the sale of the workers'
compensation insurance business and 50% of the net proceeds in excess of $10
million in any given calendar year with respect to the sale of all other
businesses and assets shall be applied towards repayment of the outstanding
Loans, and with the exception of the net proceeds of the workers' compensation
business sale, the amount of the required repayments will also permanently
reduce the Commitments under the Credit Agreement by such amounts until the
Commitments are reduced to an amount not greater than $750 million; and (v)
permitted to incur additional indebtedness in an aggregate amount not to exceed
$1,000,000,000 upon certain terms and conditions, including mandatory prepayment
of the outstanding Loans with a certain portion of the proceeds from the
issuance of such indebtedness, resulting in a permanent reduction of the
aggregate amount of Commitments under the Credit Agreement by the amount so
prepaid. The Amendments also provided for an increase in the interest and
facility fees under the Credit Agreement. A copy of the Third Amendment is
included as Exhibit 10.65 to this Quarterly Report on Form 10-Q.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend
distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights and the expiration of the Rights and in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then outstanding and no separate Rights Certificates will be distributed.
Subject to certain exceptions contained in the Rights Agreement dated as of June
1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights
Agent (the "Rights Agreement"), the Rights will separate from the Common Stock
in the event any person acquires 15% or more of the outstanding Class A Common
Stock, the Board of Directors of the Company declares a holder of 10% or more to
the outstanding Class A Common Stock
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<PAGE>
to be an "Adverse Person," or any person commences a tender offer for 15% of the
Class A Common Stock (each event causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock, at a price of $170.00
per one-thousandth share. However, in the event any person acquires 15% or more
of the outstanding Class A Common Stock, or the Board of Directors of the
Company declares a holder of 10% or more of the outstanding Class A Common Stock
to be an "Adverse Person," the Rights (subject to certain exceptions contained
in the Rights Agreement) will instead become exercisable for Class A Common
Stock having a market value at such time equal to $340.00. The Rights are
redeemable under certain circumstances at $.01 per Right and will expire, unless
earlier redeemed, on July 31, 2006.
A copy of the Rights Agreement has been filed with the Securities and
Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on
Form 8-A (File No. 001-12718). In connection with its execution of the Merger
Agreement for the FHS Combination, the Company entered into Amendment No. 1 (the
"Rights Amendment") to the Rights Agreement to exempt the Merger Agreement and
related transactions from triggering the Rights. In addition, the Rights
Amendment modifies certain terms of the Rights Agreement applicable to the
determination of certain "Adverse Persons," which modifications become effective
upon consummation of the transactions provided for under the Merger Agreement.
This summary description of the Rights does not purport to be complete and is
qualified in its entirety by reference to the Rights Agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the quarter ended September 30, 1998.
ITEM 5. OTHER INFORMATION
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company has previously filed with its Annual
Report on Form 10-K for the year ended December 31, 1997 certain cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others,
could cause the Company's actual financial or enrollment results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to the Company. The factors should be considered in
conjunction with any discussion of operations or results by the Company or its
representatives, including any forward-looking discussion, as well as comments
contained in press releases, presentations to securities analysts or investors,
or other communications by the Company.
In making these statements, the Company was not and is not undertaking to
address or update each factor in future filings or communications regarding the
Company's business or results, and is not undertaking to address how any of
these factors may have caused changes to discussions or information contained in
previous filings or communications. In addition, certain of these matters may
have affected the Company's past results and may affect future results.
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<PAGE>
RECENT DEVELOPMENTS
THE CALIFORNIA WELLNESS FOUNDATION
Pursuant to the Amended Foundation Shareholder Agreement, dated as of
January 28, 1992 (the "CWF Shareholder Agreement"), by and among the Company,
the CWF and certain stockholders (the "HNMH Stockholders") of HN Management
Holdings, Inc. (a predecessor to the Company) ("HNMH") named therein, the CWF is
subject to various volume and manner of sale restrictions specified in the CWF
Shareholder Agreement which limit the number of shares that the CWF may dispose
of prior to December 31, 1998. The CWF and the Company are also party to a
Registration Rights Agreement dated as of March 2, 1995 (the "CWF Registration
Rights Agreement") pursuant to which the CWF has the right to demand
registration for sale in underwritten public offerings of up to 8,026,298 shares
of Class B Common Stock.
Under the relevant provisions of California law, when a corporation converts
from nonprofit to for-profit corporate status, the equivalent of the fair market
value of the nonprofit corporation must be contributed to a successor charity
that has a charitable purpose consistent with the purposes of the nonprofit
entity. The CWF was formed to be the charitable recipient of the conversion
settlement when Health Net (a subsidiary of the Company) effected a conversion
from nonprofit to for-profit status, which occurred in February 1992 (the
"Conversion"). In connection with the Conversion, Health Net issued to the CWF
promissory notes in the original principal amount of $225 million (the "CWF
Notes") and shares of Class B Common Stock (which immediately prior to the
business combination involving HNMH and QualMed, Inc. were split to become
25,684,152 shares of Class B Common Stock then held by the CWF). While such
shares are held by the CWF, they are entitled to the same economic benefit as
Class A Common Stock, but are non-voting in nature. If the CWF sells or
transfers such shares to an unrelated third party, they automatically convert to
Class A Common Stock. As of September 30, 1998, approximately $18.3 million in
principal of the CWF Notes remained outstanding.
On February 25, 1998, the CWF notified the Company of its intention to sell
up to 8,026,000 shares of Class B Common Stock pursuant to the CWF Registration
Rights Agreement in an underwritten public offering. Pursuant to the terms of
the CWF Registration Rights Agreement, the Company upon receipt of a
notification under such agreement must prepare and file a registration statement
with respect to such shares with the Securities and Exchange Commission as
expeditiously as possible but in no event later than 90 days following receipt
of the notice, subject to certain exceptions. Pursuant to the terms of a letter
agreement dated June 1, 1998 between the CWF and the Company (the "Letter
Agreement"), the Company provided its consent under the CWF Registration Rights
Agreement to permit the CWF to sell certain shares of Class B Common Stock in
private sales transactions (subject to the terms and conditions set forth in
such Letter Agreement) in lieu of such underwritten public offering. Effective
June 18, 1998, the CWF sold 5,250,000 shares of Class B Common Stock to
unrelated third parties in accordance with the Letter Agreement, which shares of
Class B Common Stock sold by the CWF automatically converted on a one-for-one
basis into shares of Class A Common Stock. Pursuant to the terms of the Letter
Agreement, all of such 5,250,000 shares sold reduced the number of shares
subject to registration under the CWF Registration Rights Agreement on a
one-for-one basis. As a result of such sales, the CWF currently holds 5,047,642
shares of Class B Common Stock.
As of December 31, 1998, the various volume and manner of sale restrictions
contained in the CWF Shareholder Agreement referred to above expire pursuant to
the terms of such agreement.
SALE OF WORKERS' COMPENSATION BUSINESS
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business as a result of various adverse developments
arising in 1997 in the workers' compensation insurance business, primarily
related to the workers' compensation claims environment in California. As
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, such
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<PAGE>
adverse developments resulted in the need for the Company to strengthen its
workers' compensation reserves at the end of 1997. These developments also led
the Company to adopt a plan to discontinue this segment of its business, through
divestiture of its workers' compensation risk-assuming insurance subsidiaries.
In this connection, on May 5, 1998 the Company entered into a definitive
agreement (the "Workers' Compensation Sale Agreement") to sell its risk-assuming
workers' compensation insurance operations (the "Workers' Compensation
Operations") to Superior National Insurance Group, Inc. of Calabasas, California
("Superior National"). The transaction, subject to customary closing conditions
including regulatory approvals, is expected to close in the fourth quarter of
1998 and is expected to yield the Company, following the settlement of various
contractual obligations, approximately $200 million in cash without giving
effect to expected positive tax considerations.
As required under the terms of the Workers' Compensation Sale Agreement, the
Company has obtained a commitment from a third party reinsurance company to
purchase reinsurance that will cover up to $150 million of adverse loss
development in the Workers' Compensation Operations for losses incurred through
December 31, 1997. Such reinsurance coverage was increased by $25 million for
adverse loss development in exchange for additional purchase price consideration
pursuant to the terms of the Workers' Compensation Sales Agreement at Superior
National's request. A copy of the Workers' Compensation Sale Agreement was filed
as Exhibit 10.66 to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1998.
In addition to the sale of the Workers' Compensation Operations, the Company
and Superior National have agreed to a contract under which the Company's
administrative services businesses that currently provide certain services to
the Workers' Compensation Operations would continue to provide such services and
additional services to Superior National for a period of five years after
closing. The Company estimates that, based on past results and the expected
contribution from Superior National's operations, this five-year service
agreement will create additional total revenue in the range of $40 to $50
million for the Company's administrative service subsidiaries over such
five-year term.
OTHER POTENTIAL DIVESTITURES
On November 4, 1998, the Company entered into a definitive agreement to sell
its HMO operations in the states of Texas, Louisiana and Oklahoma to AmCareco,
Inc. As previously disclosed, the Company had been reviewing a possible exit
plan to exit its HMO operations in these states due to inadequate returns on
invested capital. As part of the sale transaction, which is expected to close in
early 1999, the Company will retain a minority equity position in the buyer, and
will enter into various services agreements with the buyer to provide various
transition services post-closing. The transaction is subject to regulatory
approval, certain financing contingencies and standard closing conditions.
The Company has decided to review the possibility of divesting its direct
ownership of two Southern California hospitals, a 128-bed hospital located in
Los Angeles, California, the East Los Angeles Doctors Hospital, and a 200-bed
hospital located in Gardena, California, the Memorial Hospital of Gardena.
Direct ownership of these two hospitals is not consistent with the Company's
business philosophy to manage health care through contracts with independent
providers of medical services. The Company is presently responding to inquiries
of parties which have expressed an interest in purchasing these hospitals.
As described in its Annual Report on Form 10-K for the year ended December
31, 1997, the Company continues to evaluate the profitability realized or likely
to be realized by its existing businesses and operations, and is reviewing from
a strategic standpoint which of such businesses or operations should be
divested.
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FPA MEDICAL MANAGEMENT, INC.
On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its
affiliated medical groups, provided services to approximately 240,000 of the
Company's affiliated members in Arizona and California. FPA has indicated that
it will discontinue its medical group operations in these markets.
As a result, the Company will have to find new tenants for, or sell, the 14
healthcare facilities it currently leases to FPA in these markets and make other
arrangements for provider services to the Company's affiliated members. The
Company believes that the likely replacement lease terms from these properties
will be inadequate to enable the Company to sell the facilities and recover
their carrying value.
Based on management's best estimate of recovery for the real estate and the
impairment of notes receivable and other Company assets due to the FPA
bankruptcy filing, the Company recorded a charge of $50 million during the
second quarter ended June 30, 1998. The Company recorded an additional $28.1
million charge during the third quarter ended September 30, 1998 which was
primarily related to additional impairment in the value of real estate assets
leased to FPA. Elements of the second and third quarter charges include
approximately $57 million for real estate asset impairments, approximately $10
million for a note receivable impairment and approximately $11.1 million for
other items.
In 1996, Foundation Health Corporation ("FHC"), a predecessor to the
Company, sold certain medical groups and IPAs to FPA for approximately $220
million in total consideration. As part of the transaction, FHC retained
ownership of the related medical clinics and leased them to FPA. FPA was
contractually committed to a deferred purchase of these clinics at a purchase
price equal to the Company's book value in the assets. It is the value of these
clinics that is being written down in connection with the above-referenced
charges. As part of the total consideration for the FPA transaction FHC received
approximately four million shares of FPA common stock and secured notes. The
Company sold all of these shares in the second quarter of 1997 for $79 million
and, during the same period, FPA redeemed all of such notes.
HEADQUARTERS DESIGNATION
On June 25, 1998, the Board of Directors of the Company formally designated
Los Angeles, California as the corporate headquarters of the Company, with the
physical offices of such corporate headquarters to be located in Woodland Hills,
California.
EXECUTIVE OFFICER CHANGES
On August 7, 1998, the Company announced that Malik M. Hasan, M.D. had
retired as Chief Executive Officer of the Company and that Dr. Hasan would
continue as non-executive Chairman of the Board of Directors of the Company
until sometime between September 30, 1998 and March 1, 1999, at which time Dr.
Hasan would resign as Chairman of the Board of Directors and as a director. In
connection with such retirement, the Company and Dr. Hasan entered into an Early
Retirement Agreement which provided for, among other matters, the termination of
Dr. Hasan's Employment Agreement with the Company and for certain payments and
releases.
Due to Dr. Hasan's retirement, Jay M. Gellert, formerly President and Chief
Operating Officer of the Company, became President and Chief Executive Officer
of the Company as of August 7, 1998. As a result, Mr. Gellert is directly
responsible for the Company's strategic direction with all senior line and staff
management reporting directly to him. The Company also announced that a new
Chairman of the Board of Directors will be named when Dr. Hasan leaves the post
next year.
Effective November 2, 1998, Karen Coughlin became President of FHS Northeast
Division. Ms. Coughlin was formerly with Humana where, most recently, she was in
charge of one of Humana's two main operating divisions.
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ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this Quarterly Report on Form
10-Q or are incorporated herein by reference:
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2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health
Systems International, Inc., FH Acquisition Corp. and Foundation Health
Corporation (filed as Exhibit 2.5 to the Company's Annual Report on Form
10-K for the year ended December 31, 1996, which is incorporated by
reference herein).
2.2 Agreement and Plan of Merger, dated May 8, 1997, by and among the Company,
PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as
Exhibit 2.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, which is incorporated by reference
herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997,
by and among the Company, PHS Acquisition Corp. and Physicians Health
Services, Inc. (filed as Exhibit 2.3 to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1997, which is
incorporated by reference herein).
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant
(filed as Exhibit 4.1 to the Company's Registration Statement on Form
S-8 (File No. 333-24621), which is incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2
to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997, which is incorporated by reference herein).
4.1 Form of Class A Common Stock Certificate (included as Exhibit 4.2 to the
Company's Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated by
reference herein).
4.2 Form of Class B Common Stock Certificate (included as Exhibit 4.3 to the
Company's Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated by
reference herein).
4.3 Form of Indenture of Foundation Health Corporation (FHC) (filed as an
exhibit to FHC's Registration Statement on Form S-3 (File No. 33-68684),
which is incorporated by reference herein).
4.4 Form of Senior Notes of FHC (filed as an exhibit to FHC's Registration
Statement on Form S-3 (File No. 33-68684), which is incorporated by
reference herein).
10.1 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc.,
HN Management Holdings, Inc. and Malik M. Hasan, M.D. (filed as Exhibit
10.18 to the Company's Registration Statements on Forms S-1 and S-4
(File nos. 33-72892 and 33-72892-01, respectively) which is incorporated
by reference herein).
10.2 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc.,
HN Management Holdings, Inc. and Dale T. Berkbigler, M.D. (filed as
Exhibit 10.20 to the Company's Registration Statements on Forms S-1 and
S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is
incorporated by reference herein).
10.3 Severance Payment Agreement, dated as of April 25, 1994, among the
Company, Health Net and James J. Wilk (filed as Exhibit 10.9 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1994, which is incorporated by reference herein).
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10.4 Severance Payment Agreement dated March 31, 1997 between the Company and
Health Net and James J. Wilk (filed as Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997,
which is incorporated by reference herein)
10.5 Severance Payment Agreement, dated as of April 25, 1994, among the
Company, QualMed, Inc. and B. Curtis Westen (filed as Exhibit 10.10 to
the Company's Annual Report on Form 10-K for the year ended December 31,
1994, which is incorporated by reference herein).
10.6 Letter Agreement dated April 23, 1997 between B. Curtis Westen and the
Company (filed as Exhibit 10.6 to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997, which is incorporated by
reference herein).
10.7 Amendment No. 1 to Employment Agreement dated as of April 25, 1994, by and
among the Company, QualMed, Inc. and Malik Hasan, M.D. (filed as Exhibit
10.16 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
10.8 Amended and Restated Employment Agreement, dated March 10, 1997, by and
between the Company and Malik M. Hasan, M.D. (Filed as Exhibit 10.3 to
the Company's Annual Report on Form 10-K for the year ended December 31,
1996, which is incorporated by reference herein).
10.9 Amendment No. 1 to Employment Agreement dated as of April 27, 1994, by and
among the Company, QualMed, Inc. and Dale T. Berkbigler, M.D. (filed as
Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1994, which is incorporated by reference herein).
10.10 Office Lease, dated as of January 1, 1992, by and between Warner
Properties III and Health Net (filed as Exhibit 10.23 to the Company's
Registration Statements on Forms S-1 and S-4 (File Nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference herein).
10.11 The Company's Second Amended and Restated 1991 Stock Option Plan (filed as
Exhibit 10.30 to Registration Statement on Form S-4 (File No. 33-86524)
which is incorporated by reference herein).
10.12 The Company's Second Amended and Restated Non-Employee Director Stock
Option Plan (filed as Exhibit 10.31 to Registration Statement on Form
S-4 (File No. 33-86524) which is incorporated by reference herein).
10.13 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.33 to the
Company's Registration Statements on Forms S-1 and S-4 (File nos.
33-72892 and 33-72892-01, respectively) which is incorporated by
reference herein).
10.14 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35
to Registration Statement on Form S-4 (File No. 33-86524) which is
incorporated by reference herein).
10.15 Deferred Compensation Agreement dated as of March 3, 1995, by and among
Malik M. Hasan, M.D., the Company and the Compensation and Stock Option
Committee of the Board of Directors of the Company (filed as Exhibit
10.31 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1994, which is incorporated by reference herein).
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10.16 Trust Agreement for Deferred Compensation Arrangement for Malik M. Hasan,
M.D., dated as of March 3, 1995, by and between the Company and Norwest
Bank Colorado N.A. (filed as Exhibit 10.32 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1994, which is
incorporated by reference herein).
10.17 Registration Rights Agreement dated as of March 2, 1995 between the
Company and The California Wellness Foundation (filed as Exhibit No.
28.2 to the Company's Current Report on Form 8-K dated March 2, 1995,
which is incorporated by reference herein).
10.18 The Company's 1995 Stock Appreciation Right Plan (filed as Exhibit 10.12
to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1995, which is incorporated by reference herein).
10.19 Amended and Restated Credit Agreement dated as of April 26, 1996 among the
Company, Bank of America National Trust and Savings Association, as
Agent, and financial institutions party thereto (filed as Exhibit 10.1
to the Company's Current Report on Form 8-K dated May 3, 1996, which is
incorporated by reference herein).
10.20 Amendment No. 1 to Credit Agreement dated as of May 10, 1996 among the
Company, Bank of America National Trust and Savings Association, as
Agent, and financial institutions party thereto (filed as Exhibit 10.32
to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1996, which is incorporated by reference herein).
10.21 Amendment No. 2 to Credit Agreement dated as of May 28, 1996 among the
Company, Bank of America National Trust and Savings Association, as
Agent, and financial institutions party thereto (filed as Exhibit 10.33
to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996, which is incorporated by reference herein).
10.22 Amendment No. 3 to Credit Agreement dated as of January 31, 1997 among the
Company, Bank of America National Trust and Savings Association, as
Agent, and financial institutions party thereto (filed as Exhibit 10.33
to the Company's Annual Report on Form 10-K for the year ended December
31, 1996, which is incorporated by reference herein).
10.23 Credit Agreement dated July 8, 1997 among the Company, the banks
identified therein and Bank of America National Trust and Savings
Association in its capacity as Administrative Agent (providing for an
unsecured $1.5 billion revolving credit facility) (filed as Exhibit
10.23 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1997, which is incorporated by reference herein).
10.24 Guarantee Agreement dated July 8, 1997 between the Company and First
Security Bank, National Association (filed as Exhibit 10.24 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1997, which is incorporated by reference herein).
10.25 Employment Letter Agreement dated May 28, 1996 between Michael D. Pugh and
QualMed, Inc. (filed as Exhibit 10.35 to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1996, which is incorporated
by reference herein).
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10.26 Employment Letter Agreement dated June 4, 1996 between Arthur M. Southam
and the Company and Health Net (filed as Exhibit 10.36 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which
is incorporated by reference herein) 10.27 Employment Letter Agreement
dated July 3, 1996 between Jay M. Gellert and the Company (filed as
Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996, which is incorporated by reference
herein).
10.27 Rights Agreement dated as of June 1, 1996 by and between the Company and
Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to
the Company's Registration Statement on Form 8-A (File No. 001-12718)
which is incorporated by reference herein).
10.28 First Amendment to the Rights Agreement dated as of October 1, 1996, by
and between the Company and Harris Trust and Savings Bank, as Rights
Agent (filed as Exhibit 10.40 to the Company's Annual Report on Form
10-K for the year ended December 31, 1996, which is incorporated by
reference herein).
10.29 Amended and Restated Employment Agreement, dated December 16, 1996, by and
among the Company, Foundation Health Corporation and Kirk A. Benson
(filed as Exhibit 10.2 to the Company's Registration Statement on Form
S-4 (File No. 333-19273), which is incorporated by reference herein).
10.30 Consulting Agreement, dated as of May 1, 1997, between the Company, FHC
and Allen J. Marabito, (filed as Exhibit 10.35 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which
is incorporated by reference herein).
10.31 1990 Stock Option Plan of Foundation Health Corporation (filed as Exhibit
4.5 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
10.32 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation
(filed as Exhibit 4.6 to the Company's Registration Statement on Form
S-8 (File No. 333-24621), which is incorporated by reference herein).
10.33 1989 Stock Plan of Business Insurance Corporation (as Amended and Restated
Effective September 22, 1992) (filed as Exhibit 4.7 to the Company's
Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
10.34 Managed Health Network, Inc. Incentive Stock Option Plan (filed as Exhibit
4.8 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
10.35 Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan
(filed as Exhibit 4.9 to the Company's Registration Statement on Form
S-8 (File No. 333-24621), which is incorporated by reference herein).
10.36 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation (as
amended and restated September 7, 1995) (filed as Exhibit 4.10 to the
Company's Registration Statement on Form S-8 (File No. 333-24621), which
is incorporated by reference herein).
10.37 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for
the year ended June 30, 1994 filed with the Commission on September 24,
1994, which is incorporated by reference herein).
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10.38 Foundation Health Systems, Inc. 1997 Stock Option Plan (filed as Exhibit
10.45 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1997, which is incorporated by reference herein).
10.39 Foundation Health Systems, Inc. Third Amended and Restated Non-Employee
Director Stock Option Plan (filed as Exhibit 10.46 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which
is incorporated by reference herein).
10.40 Foundation Health Systems, Inc. Employee Stock Purchase Plan (filed as
Exhibit 10.47 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997, which is incorporated by reference herein).
10.41 Foundation Health Systems, Inc. Performance-Based Annual Bonus Plan (filed
as Exhibit 10.48 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997, which is incorporated by reference herein).
10.42 Participation Agreement dated as of May 25, 1995 among Foundation Health
Medical Services, as Construction Agent and Lessee, FHC, as Guarantor,
First Security Bank of Utah, N.A., as Owner Trustee, Sumitomo Bank
Leasing and Finance, Inc., The Bank of Nova Scotia and NationsBank of
Texas, N.A., as Holders and NationsBank of Texas, N.A., as
Administrative Agent for the Lenders; and Guaranty Agreement dated as of
May 25, 1995 by FHC for the benefit of First Security Bank of Utah, N.A.
(filed as an exhibit to FHC's Form 10-K for the year ended June 30,
1995, filed with the Commission on September 27, 1995, which is
incorporated by reference herein).
10.43 FHC's Deferred Compensation Plan, as amended and restated (filed as an
exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with
the Commission on September 27, 1995, which is incorporated by reference
herein).
10.44 FHC's Supplemental Executive Retirement Plan, as amended and restated
(filed as an exhibit to FHC's Form 10-K for the year ended June 30,
1995, filed with the Commission on September 27, 1995, which is
incorporated by reference herein).
10.45 FHC's Executive Retiree Medical Plan, as amended and restated (filed as an
exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with
the Commission on September 27, 1995, which is incorporated by reference
herein).
10.46 Agreement and Plan Reorganization dated January 9, 1996 by and between FHC
and Managed Health Network, Inc. (filed as Annex 1 of Proxy
Statement/Prospectus contained in FHC's Registration Statement on Form
S-4 (File No. 333-00517), which is incorporated by reference herein).
10.47 Stock and Note Purchase Agreement by and between FHC, Jonathan H. Scheff,
M.D., FPA Medical Management, Inc., FPA Medical Management of
California, Inc. and FPA Independent Practice Association dated as of
June 28, 1996 (filed as Exhibit 10.109 to FHC's Annual Report on Form
10-K for the year ended June 30, 1996, which is incorporated by
reference herein).
10.48 $300 Million Revolving Credit Agreement (the "FHC Credit Agreement") dated
as of December 5, 1994, among FHC, as Borrower, Citicorp USA, Inc., as
Administrative Agent, Wells Fargo Bank, N.A. and NationsBank of Texas,
N.A., as Co-Agents and Citicorp Securities, Inc., as Arranger, and the
Other Banks and Financial Institutions Party thereto (filed as an
Exhibit to FHC's quarterly report on Form 10-Q for the quarter ended
December 31, 1994 filed with the Commission on February 14, 1994, which
is incorporated by reference herein).
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10.49 First Amendment Agreement (to the FHC Credit Agreement) dated as of August
9, 1995 among FHC, as Borrower, the Lenders parties to the FHC Credit
Agreement, Citicorp USA, Inc., as Administrative Agent, Wells Fargo
Bank, N.A. and NationsBank of Texas, N.A., as Co-Agents, and Citicorp
Securities, Inc., as Arranger (filed as Exhibit 10.52 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997,
which is incorporated by reference herein).
10.50 Second Amendment Agreement (to the FHC Credit Agreement), dated as of June
28, 1996 among FHC, the Lenders and Citicorp USA, Inc. (filed as Exhibit
10.53 to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1997, which is incorporated by reference herein).
10.51 Third Amendment Agreement and Waiver (to the FHC Credit Agreement) dated
December 13, 1996 among FHC, the Lenders and Citibank, N.A. (as
successor to Citicorp USA, Inc.), as Administrative Agent (filed as
Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, which is incorporated by reference
herein).
10.52 Fourth Amendment Agreement and Waiver (to the FHC Credit Agreement) dated
January 28, 1997 among FHC, the Lenders and Citibank, N.A. (as successor
to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.55
to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997, which is incorporated by reference herein).
10.53 Fifth Amendment Agreement (to the FHC Credit Agreement) dated April 1,
1997 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp
USA, Inc.), as Administrative Agent (filed as Exhibit 10.56 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1997, which is incorporated by reference herein).
10.54 $200 million Revolving Credit Agreement (the "FHC Revolving Credit
Agreement") dated as of December 17, 1996 among FHC, the Lenders and
Citibank, N.A., as Administrative Agent for the Lenders (filed as
Exhibit 10.57 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, which is incorporated by reference
herein).
10.55 First Amendment Agreement and Waiver (to the FHC Revolving Credit
Agreement) dated as of January 28, 1997 among FHC, the Lenders and
Citibank, N.A., as Administrative Agent for the Lenders (filed as
Exhibit 10.58 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, which is incorporated by reference
herein).
10.56 Second Amendment Agreement and Waiver (to the FHC Revolving Credit
Agreement) among FHC, the Lenders and Citibank, N.A., as Administrative
Agent for the Lenders (filed as Exhibit 10.59 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997, which is
incorporated by reference herein).
10.57 Lease Agreement between HAS-First Associates and FHC dated August 1, 1988
and form of amendment thereto (filed as an exhibit to FHC's Registration
Statement on Form S-1 (File No. 33-34963), which is incorporated by
reference herein).
10.58 Agreement and Plan of Reorganization dated as of June 27, 1994 by and
among FHC, CareFlorida Health Systems, Inc., and the other parties
signatory thereto (filed as an exhibit to FHC's Current Report on Form
8-K filed with the Commission on June 28, 1994, which is incorporated by
reference herein).
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10.59 Agreement and Plan of Merger dated as of July 28, 1994 between FHC and
Intergroup Healthcare Corporation (filed as an exhibit to FHC's Current
Report on Form 8-K filed with the Commission on August 9, 1994, which is
incorporated by reference herein).
10.60 Agreement and Plan of Merger dated as of July 28, 1994 between FHC and
Thomas-Davis Medical Centers, P.C. (filed as an exhibit to FHC's Current
Report on Form 8-K filed with the Commission on August 9, 1994, which is
incorporated by reference herein).
10.61 Amended Letter Agreement between the Company and Jay M. Gellert dated as
of August 22, 1997 (filed as Exhibit 10.69 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997, which is
incorporated by reference herein).
10.62 Form of Credit Facility Commitment Letter, dated March 27, 1998, between
the Company and the Majority Banks (as defined therein) (filed as
Exhibit 10.70 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, which is incorporated by reference herein).
10.63 First Amendment and Waiver to Credit Agreement, dated as of April 6, 1998,
among the Company, Bank of America National Trust and Savings
Association and the Banks (as defined therein) (filed as Exhibit 10.64
to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998, which is incorporated by reference herein).
10.64 Second Amendment to Credit Agreement, dated as of July 31, 1998, among the
Company, Bank of America National Trust and Savings Association and the
Banks (as defined therein)(filed as Exhibit 10.65 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, which
is incorporated by reference herein.
*10.65 Third Amendment to Credit Agreement, dated as of November 6, 1998, among
the Company, Bank of America National Trust and Savings Association and
the Banks (as defined therein), a copy of which is filed herewith.
10.66 Purchase Agreement by and between Foundation Health Corporation and
Superior National Insurance Group, Inc., dated as of May 5, 1998 (filed
as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998, which is incorporated by reference
herein).
10.67 Employment Letter Agreement between the Company and Dale Terrell dated
December 31, 1997 (filed as Exhibit 10.71 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1997, which is incorporated
by reference herein).
10.68 Employment Letter Agreement between the Company and Steven P. Erwin dated
March 11, 1998 (filed as Exhibit 10.72 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997, which is incorporated by
reference herein).
10.69 Employment Agreement, dated as of December 31, 1997, between the Company
and Maurice Costa (filed as Exhibit 10.73 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1997, which is incorporated
by reference herein).
10.70 Employment Agreement, dated as of December 31, 1997, between the Company
and Robert L. Natt (filed as Exhibit 10.74 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997, which is
incorporated by reference herein).
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10.71 Employment Letter Agreement, dated October 10, 1997, between the Company
and Alex Labak (filed as Exhibit 10.75 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997, which is incorporated by
reference herein).
10.72 Employment Letter, dated June 9, 1995, between Philip Katz, Ph.D. and
Health Net (filed as Exhibit 10.38 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1995, which is incorporated by
reference herein).
10.73 Employment Letter Agreement, dated June 25, 1998, between the Company and
B. Curtis Westen (filed as Exhibit 10.73 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998, which is
incorporated by reference herein).
10.74 Employment Letter Agreement, dated July 31, 1998, between the Company and
Michael White (filed as Exhibit 10.74 to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998, which is incorporated
by reference herein).
10.75 Letter Agreement, dated June 1, 1998, between the Company and The
California Wellness Foundation (filed as Exhibit 10.75 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, which
is incorporated by reference herein).
10.76 Form of Severance Payment Agreement entered into between the Company and
various of its executive officers on April 6, 1998 (filed as Exhibit
10.76 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998, which is incorporated by reference herein).
10.77 Early Retirement Agreement, dated as of August 6, 1998, between the
Company and Malik M. Hasan, M.D. (filed as Exhibit 10.77 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1998, which is incorporated by reference herein).
11.1 Statement relative to computation of per share earnings of the Company
(included in the notes to the Financial Statements contained in this
Quarterly Report on Form 10-Q).
21.1 Subsidiaries of the Company (filed as Exhibit 21.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, which
is incorporated by reference herein).
*27.1 Financial Data Schedule, a copy of which has been filed with the EDGAR
version of this filing.
</TABLE>
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* A copy of the Exhibit is filed herewith.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed by the Company during the
quarterly period ended September 30, 1998.
40
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
<TABLE>
<S> <C> <C>
FOUNDATION HEALTH SYSTEMS, INC.
(REGISTRANT)
Date: November 13, 1998 By: /s/ JAY M. GELLERT
-----------------------------------------
Jay M. Gellert
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: November 13, 1998 By: /s/ STEVEN P. ERWIN
-----------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
</TABLE>
41
<PAGE>
EXHIBIT 10.65
THIRD AMENDMENT TO
CREDIT AGREEMENT
THIS THIRD AMENDMENT TO CREDIT AGREEMENT is made and dated as of
November 6, 1998 (the "THIRD AMENDMENT") among FOUNDATION HEALTH SYSTEMS,
INC. (the "COMPANY"), the Banks party to the Credit Agreement referred to
below, and BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national
banking association, as Administrative Agent (the "AGENT"), and amends that
certain Credit Agreement dated as of July 8, 1997, as amended by that certain
First Amendment and Waiver to Credit Agreement (the "FIRST AMENDMENT") dated
as of April 6, 1998 and that certain Second Amendment to Credit Agreement
(the "SECOND AMENDMENT") dated as of July 31, 1998 (as further amended or
modified from time to time, the "CREDIT AGREEMENT").
RECITALS
WHEREAS, the Company has requested the Agent and the Banks to amend
certain provisions of the Credit Agreement, and the Agent and the Banks are
willing to do so, on the terms and conditions specified herein;
NOW, THEREFORE, for good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereby agree as follows:
1. TERMS. All terms used herein shall have the same meanings as in the
Credit Agreement unless otherwise defined herein.
2. AMENDMENT. The Credit Agreement is hereby amended as follows:
2.1 AMENDMENTS TO SECTION 1.01.
(a) The definition of the term "Applicable Level" in Section
1.01 of the Credit Agreement is hereby amended and restated in its entirety
to read as follows:
"APPLICABLE LEVEL" means one of the levels set forth below
determined by the Senior Unsecured Debt Rating as follows:
"LEVEL 1" means any period during which the Senior Unsecured Debt
Rating is better than or equal to at least one of the following ratings:
(i) BBB+ by S&P and/or (ii) Baa1 by Moody's.
"LEVEL 2" means any period (other than a Level 1 Period) during
which the Senior Unsecured Debt Rating is better than or equal to at
least one of the following ratings: (i) BBB by S&P and/or (ii) Baa2
by Moody's.
<PAGE>
"LEVEL 3" means any period (other than a Level 1 Period or Level
2 Period) during which the Senior Unsecured Debt Rating is better than
or equal to at least one of the following ratings: (i) BBB- by S&P
and/or (ii) Baa3 by Moody's.
"LEVEL 4" means any period (other than a Level 1 Period, Level 2
Period or Level 3 Period) during which the Senior Unsecured Debt Rating
is better than or equal to at least one of the following ratings:
(i) BB+ by S&P and/or (ii) Ba1 by Moody's.
"LEVEL 5" means any period (other than a Level 1 Period, Level 2
Period, Level 3 Period or Level 4 Period) during which the Senior
Unsecured Debt Rating is better than or equal to at least one of the
following ratings: (i) BB by S&P and/or (ii) Ba2 by Moody's.
"LEVEL 6" means any period other than a Level 1 Period, Level 2
Period, Level 3 Period, Level 4 Period or Level 5 Period.
For purposes of the foregoing, (a) if the Senior Unsecured Debt
Ratings fall within different Levels, the Applicable Level shall be based
upon the higher (numerically lower) of the available Levels unless such
Levels are more than one Level apart, in which case, the Applicable Level
shall be one Level higher than the lower Level; (b) if only one Senior
Unsecured Debt Rating exists, the Applicable Level shall be based upon the
Level in which such rating falls; and (c) if no Senior Unsecured Debt Rating
shall be available, the Applicable Level shall be Level 6.
(b) The definition of the term "Applicable Margin" in Section 1.01
of the Credit Agreement is hereby amended and restated in its entirety to
read as follows:
"APPLICABLE MARGIN" means, in the case of Facility Fees, Base Rate
Committed Loans or Offshore Rate Committed Loans, a rate per annum
determined by reference to the Applicable Level as follows:
<PAGE>
<TABLE>
<CAPTION>
Applicable Applicable Base Rate Applicable Offshore Facility
Level Margin Rate Margin Fee
------ -------------------- ------------------- ---
<S> <C> <C> <C>
Level 1 0.000% 0.625% 0.175%
Level 2 0.000% 0.800% 0.200%
Level 3 0.250% 1.000% 0.250%
Level 4 0.500% 1.125% 0.375%
Level 5 1.000% 1.500% 0.500%
Level 6 1.500% 2.000% 0.500%
</TABLE>
The Applicable Margin shall be effective on the earlier of the date on which
such rating change is publicly announced or on the date written confirmation
of a change in the Senior Unsecured Debt Rating is sent to the Company by S&P
or Moody's. Notwithstanding the foregoing, from November 6, 1998 until the
consummation of the Workers Compensation Disposition, the Applicable Level
shall not be higher (numerically lower) than Level 3.
(c) Clause (f) of the definition of the term "Indebtedness" in Section
1.01 of the Credit Agreement is hereby amended and restated in its entirety
to read as follows:
"(f) all obligations with respect to synthetic leases entered
into after November 6, 1998 (excluding renewals or extensions of synthetic
leases entered into prior to such date) and all obligations with respect
to Capital Leases;"
(d) The definition of the term "Net Worth" in Section 1.01 of the
Credit Agreement is hereby amended and restated in its entirety to read as
follows:
"NET WORTH" of the Company on any day of determination means an
amount equal to the sum of (a) the excess of Total Assets over Total
Liabilities PLUS (b) for the fiscal quarters ending September 30, 1998 and
thereafter, 25% of the Specified Charges recorded by the Company on
September 30, 1998 and December 31, 1998 (but in no event more than
$43,750,000).
(e) The definition of the term "Specified Charges" in Section 1.01 of
the Credit Agreement is hereby amended and restated in its entirety to read
as follows:
"SPECIFIED CHARGES" means those items, and only those items, set
forth on Part 1 of Schedule 1.01 hereof.
2.2 AMENDMENT TO SCHEDULE 1.01.
(a) Schedule 1.01 of the Credit Agreement is hereby amended and
restated to read in its entirety as set forth on Schedule 1.01 hereto.
2.3 AMENDMENTS TO SECTION 2.09.
(a) Section 2.09 of the Credit Agreement is hereby amended by adding
the following subsection (e) thereto:
<PAGE>
(e) Subject to Section 3.04, until the aggregate Commitments
shall have permanently been reduced to an amount not in excess of
$750,000,000, the Company shall ratably prepay Committed Loans by an amount
equal to 50% of net cash proceeds from all asset sales except for (i) the
Workers Compensation Disposition and (ii) asset sales generating aggregate
net proceeds up to $10,000,000 in any fiscal year. Such prepayment shall
be made on the next Interest Payment Date for Offshore Rate Committed Loans
(or, if there shall be no Offshore Rate Committed Loans outstanding, on the
next Interest Payment Date for Base Rate Committed Loans) occurring after
completion of such sales, taking into account all applicable Requirements
of Law. The Company shall give the Administrative Agent not less than one
Business Day's notice of such prepayment, and such notice of prepayment
shall specify the date and amount of such prepayment and the Type(s) of
Committed Loans to be prepaid. The Administrative Agent will promptly
notify each Bank of its receipt of any such notice, and of such Bank's
Pro Rata Share of such prepayment. If such notice is given by the Company,
the Company shall make such prepayment and the payment amount specified in
such notice shall be due and payable on the date specified therein,
together with, in the case of Offshore Rate Committed Loans only, accrued
interest to each such date on the amount prepaid and any amounts required
pursuant to Section 3.04. On the date such prepayment is required to be
made, the aggregate Commitments shall automatically and permanently be
reduced by the amount of the required prepayment.
2.4 AMENDMENTS TO SECTION 6.13.
(a) Section 6.13 of the Credit Agreement is hereby amended by deleting
the figure "$100,000,000" and replacing it with the figure "$25,000,000".
2.5 AMENDMENTS TO SECTION 7.01.
(a) Clause (h) of Section 7.01 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(h) Liens on assets of corporations which become Subsidiaries
after November 6, 1998; PROVIDED, HOWEVER, that such Liens existed at the
time the respective corporations became Subsidiaries and were not created
in anticipation thereof and PROVIDED, FURTHER, that all such Liens in the
aggregate at any time outstanding do not exceed $50,000,000 in the
aggregate;"
(b) Clause (i) of Section 7.01 of the Credit Agreement is hereby
amended by deleting the figure "$75,000,000" and replacing it with the figure
"$50,000,000".
2.6 AMENDMENTS TO SECTION 7.03.
(a) Clause (e) of Section 7.03 of the Credit Agreement is hereby
amended by deleting the figure "$50,000,000" and replacing it with the figure
"$20,000,000".
<PAGE>
2.7 AMENDMENTS TO SECTION 7.04.
(a) Clause (e) of Section 7.04 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(e) other investments in the Healthcare Business which comply with
clause (ii) of the definition of Permitted Acquisitions and are not listed
on part (b) of Schedule 5.16, but which, together with the amount of Joint
Ventures permitted pursuant to Section 7.09(b), do not in the aggregate
exceed (i) $50,000,000 for any period of four consecutive fiscal quarters
commencing after December 31, 1997 or (ii) if the Total Leverage Ratio has
been below 3.0 to 1.0 for four consecutive fiscal quarters, $100,000,000 for
the next four fiscal quarters, at the end of which four fiscal quarter
period such limitation shall again be redetermined for the next four fiscal
quarters; or"
(b) Clause (f) of Section 7.04 of the Credit Agreement is hereby amended
by deleting the figure "$50,000,000" and replacing it with the figure
"$20,000,000".
2.8 AMENDMENTS TO SECTION 7.05.
(a) Clause (e) of Section 7.05 of the Credit Agreement is hereby amended
by deleting the figure "$150,000,000" and replacing it with the figure
"$100,000,000".
2.9 AMENDMENTS TO SECTION 7.09.
(a) Clause (b) of Section 7.09 of the Credit Agreement is hereby amended
and restated in its entirety to read as follows:
"(b) other Joint Ventures in the Healthcare Business which
require aggregate expenditures by the Company or any of its Subsidiaries in
an amount which, together with amount of investments permitted pursuant to
Section 7.04(e), do not in the aggregate exceed (i) $50,000,000 for any
period of four consecutive fiscal quarters commencing after December 31,
1997 or (ii) if the Total Leverage Ratio has been below 3.0 to 1.0 for four
consecutive fiscal quarters, $100,000,000 for the next four fiscal quarters,
at the end of which four fiscal quarter period such limitation shall be
again redetermined for the next four fiscal quarters and"
(b) Clause (c) of Section 7.09 of the Credit Agreement is hereby amended
by deleting the figure "$50,000,000" and replacing it with the figure
"$20,000,000".
2.10 AMENDMENTS TO SECTION 7.11.
(a) Clause (d) of Section 7.11 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(d) from and after consummation of the Workers Compensation
Disposition, declare or pay cash dividends to its stockholders and purchase,
redeem or otherwise acquire shares of its capital stock or warrants, rights
or options to acquire any such shares for cash; PROVIDED, that the
cumulative amount of such dividends, purchases, redemptions and acquisitions
from and after consummation of the Workers
<PAGE>
Compensation Disposition shall not exceed $100,000,000 plus, after the Total
Leverage Ratio shall have been less than 3.0 to 1.0 for 4 consecutive fiscal
quarters, 25% of net income of the Company and its Subsidiaries arising
after the end of such four quarter period."
2.11 AMENDMENTS TO SECTION 7.12.
(a) Clause (a) of Section 7.12 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(a) the Total Leverage Ratio, as of any date set forth below,
to exceed the ratio set forth below opposite such date:
<TABLE>
<CAPTION>
Date Maximum Total Leverage Ratio
---------------------------------------------------------------
<S> <C>
September 30, 1998 4.00 to 1.00
December 31, 1998 4.00 to 1.00
March 31, 1999 3.50 to 1.00
June 30, 1999 3.50 to 1.00
September 30, 1999 3.25 to 1.00
December 31, 1999 3.25 to 1.00
Thereafter 3.00 to 1.00
</TABLE>
(b) Clause (b) of Section 7.12 of the Credit Agreement is hereby amended
and restated in its entirety to read as follows:
"(b) the Fixed Charges Coverage Ratio to be less than 1.75 to
1.00 at any time; or"
2.12 AMENDMENT TO SCHEDULE 7.04.
(a) Schedule 7.04 of the Credit Agreement is hereby amended and
restated in its entirety as set forth on Schedule 7.04 hereto.
3. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants to
the Agent and the Banks that, on and as of the date hereof, and after giving
effect to this Third Amendment:
3.1 AUTHORIZATION. The execution, delivery and performance by the
Company of this Third Amendment has been duly authorized by all necessary
corporate action, and this Third Amendment has been duly executed and delivered
by the Company.
3.2 BINDING OBLIGATION. This Third Amendment constitutes the legal,
valid and binding obligation of the Company, enforceable against it in
accordance with its terms, except as enforceability may be limited by
applicable bankruptcy, insolvency, or similar laws affecting the enforcement
of creditors' rights generally or by equitable principles relating to
enforceability.
3.3 NO LEGAL OBSTACLE TO AMENDMENT. The execution, delivery and
performance of this Third Amendment will not (a) contravene the Organization
Documents of the Company;
<PAGE>
(b) constitute a breach or default under any contractual restriction or
violate or contravene any law or governmental regulation or court decree or
order binding on or affecting the Company which individually or in the
aggregate does or could reasonably be expected to have a Material Adverse
Effect; or (c) result in, or require the creation or imposition of, any Lien
on any of the Company's properties. No approval or authorization of any
governmental authority is required to permit the execution, delivery or
performance by the Company of this Third Amendment, or the transactions
contemplated hereby.
3.4 INCORPORATION OF CERTAIN REPRESENTATIONS. After giving effect to
the terms of this Third Amendment, the representations and warranties of the
Company set forth in Article V of the Credit Agreement are true and correct
in all respects on and as of the date hereof as though made on and as of the
date hereof, except as to such representations made as of an earlier
specified date.
3.5 DEFAULT. No Default or Event of Default under the Credit
Agreement has occurred and is continuing.
4. CONDITIONS, EFFECTIVENESS. The effectiveness of this Third Amendment
shall be subject to the compliance by the Company with its agreements herein
contained, and to the delivery of the following to Agent in form and
substance satisfactory to Agent of the following on or before November 9,
1998:
4.1 AUTHORIZED SIGNATORIES. A certificate, signed by the Secretary or
an Assistant Secretary of the Company and dated the date of this Third
Amendment, as to the incumbency of the person or persons authorized to
execute and deliver this Third Amendment and any instrument or agreement
required hereunder on behalf of the Company.
4.2 FEES. Payment to the Administrative Agent, for the pro rata benefit
of each Bank executing this Third Amendment on or before 3:00 p.m., Pacific
time, on November 6, 1998, of an amendment fee in an amount equal to .25% of
the aggregate amount of the Commitments held by the Banks that have so
executed this Third Amendment; and payment of all other fees and expenses of
the Arrangers in connection with this Third Amendment (including, without
limitation, the fees and expenses of the counsel to the Arrangers).
4.3 OTHER EVIDENCE. Such other evidence with respect to the Company or
any other person as the Agent or any Bank may reasonably request to establish
the consummation of the transactions contemplated hereby, the taking of all
corporate action in connection with this Third Amendment and the Credit
Agreement and the compliance with the conditions set forth herein.
5. CONDITION SUBSEQUENT. On or before December 31, 1998, the Company shall
deliver to the Agent a certificate, signed by the Secretary or an Assistant
Secretary of the Company as to the resolutions of the Company's board of
directors authorizing or ratifying the transactions contemplated by the Third
Amendment, which certificate shall be in form and substance satisfactory to
the Agent. If the Company shall fail to deliver such a certificate by
December 31, 1998, then this Third Amendment shall cease to be effective as
of such date.
<PAGE>
6. MISCELLANEOUS.
6.1 EFFECTIVENESS OF THE CREDIT AGREEMENT AND THE NOTES. Except as
hereby expressly amended, the Credit Agreement and the Notes shall each
remain in full force and effect, and are hereby ratified and confirmed in all
respects on and as of the date hereof.
6.2 WAIVERS. This Third Amendment is limited solely to the matters
expressly set forth herein and is specific in time and in intent and does not
constitute, nor should it be construed as, a waiver or amendment of any other
term or condition, right, power or privilege under the Credit Agreement or
under any agreement, contract, indenture, document or instrument mentioned
therein; nor does it preclude or prejudice any rights of the Agent or the
Banks thereunder, or any exercise thereof or the exercise of any other right,
power or privilege, nor shall it require the Majority Banks to agree to an
amendment, waiver or consent for a similar transaction or on a future
occasion, nor shall any future waiver of any right, power, privilege or
default hereunder, or under any agreement, contract, indenture, document or
instrument mentioned in the Credit Agreement, constitute a waiver of any
other right, power, privilege or default of the same or of any other term or
provision.
6.3 COUNTERPARTS. This Third Amendment may be executed in any number of
counterparts, and all of such counterparts taken together shall be deemed to
constitute one and the same instrument. Section 2.5 of this Third Amendment
shall become effective when the Company, the Agent and all of the Banks shall
have signed a copy hereof and the same shall have been delivered to the
Agent. All other provisions of this Third Amendment shall become effective
when the Company, the Agent and the Majority Banks shall have signed a copy
hereof and the same shall have been delivered to the Agent.
6.4 GOVERNING LAW. THIS THIRD AMENDMENT SHALL BE GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA.
IN WITNESS WHEREOF, the parties hereto have caused this Third Amendment to be
duly executed and delivered as of the date first written above.
FOUNDATION HEALTH SYSTEMS, INC.
By: /s/ SIGNATURE
----------------------------------
BANK OF AMERICA NATIONAL TRUST AND SAVINGS
ASSOCIATION, as Administrative Agent
By: /s/ SIGNATURE
----------------------------------
[OTHER SIGNATURE BLOCKS HAVE BEEN OMITTED
FROM THIS COPY]
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 389,896
<SECURITIES> 523,780
<RECEIVABLES> 686,512<F1>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,254,262
<PP&E> 408,017<F2>
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,870,557
<CURRENT-LIABILITIES> 1,478,521
<BONDS> 1,431,360<F3>
0
0
<COMMON> 634,892<F4>
<OTHER-SE> 213,029
<TOTAL-LIABILITY-AND-EQUITY> 3,870,557
<SALES> 6,556,264
<TOTAL-REVENUES> 6,626,299
<CGS> 5,638,588
<TOTAL-COSTS> 6,408,468
<OTHER-EXPENSES> 232,932<F5>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 67,680
<INCOME-PRETAX> (82,781)
<INCOME-TAX> (21,356)
<INCOME-CONTINUING> (61,425)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (61,425)<F6>
<EPS-PRIMARY> (0.50)<F7>
<EPS-DILUTED> (0.50)<F7>
<FN>
<F1>NET OF ALLOWANCE FOR DOUBTFUL ACCOUNTS.
<F2>NET OF ACCUMULATED DEPRECIATION.
<F3>INCLUDES NOTES PAYABLE AND CAPTIAL LEASES.
<F4>INCLUDES ADDITIONAL PAID-IN CAPITAL.
<F5>INCLUDES $137,987 OF ASSET IMPAIRMENT, RESTRUCTURING, GEM, AND OTHER CHARGES.
<F6>INLUDES $88,989 OF ASSET IMPAIRMENT, RESTRUCTURING, GEM, AND OTHER CHARGES, NET
OF TAXES.
<F7>INCLUDES $0.73 LOSS PER SHARE, NET TAXES, RESULTING FROM ASSET IMPAIRMENT,
RESTRUCTURING, GEM, AND OTHER CHARGES.
</FN>
</TABLE>
