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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
/ / TRANSITION REPORT PURSUANT TO SECTION 13(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 1-12718
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FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4288333
(State or other jurisdiction of (I.R.S. Employer identification
incorporation or organization) No.)
21600 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of principal executive offices) (Zip Codes)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 676-6978
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Class A Common Stock, $.001 par value New York Stock Exchange, Inc.
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (x)
The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 16, 1998 was $3,061,505,816 (which represents 106,719,157
shares of Class A Common Stock held by such non-affiliates multiplied by
$28.6875, the closing price of such stock on the New York Stock Exchange on
March 16, 1998).
The number of shares outstanding of the registrant's Class A Common Stock as
of March 16, 1998 was 111,308,582 (excluding 3,194,374 shares held as treasury
stock), and 10,297,642 shares of the registrant's Class B Common Stock were
outstanding as of such date.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III of this Form 10-K incorporates information by reference from the
registrant's definitive proxy statement to be filed with the Securities and
Exchange Commission within 120 days after the close of the year ended December
31, 1997.
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FOUNDATION HEALTH SYSTEMS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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PAGE NO.
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PART I
Item 1. Business............................................................................ 1
Item 2. Properties.......................................................................... 17
Item 3. Legal Proceedings................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders Other Information............... 19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 30
Item 6. Selected Financial Data............................................................. 32
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................ 33
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......................... 44
Item 8. Financial Statements and Supplementary Data......................................... 46
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure........................................................................ 83
PART III
Item 10. Directors and Executive Officers of the Registrant.................................. 83
Item 11. Executive Compensation.............................................................. 83
Item 12. Security Ownership of Certain Beneficial Owners and Management...................... 83
Item 13. Certain Relationships and Related Transactions...................................... 83
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K.................. 83
</TABLE>
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PART I
ITEM 1. BUSINESS
Foundation Health Systems, Inc. (the "Company" or "FHS") is an integrated
managed care organization which administers the delivery of managed health care
services. The Company's health maintenance organizations ("HMOs"), insured
preferred provider organizations ("PPOs") and government contracts subsidiaries
provide health benefits to 6.2 million individuals in 21 states through group,
individual, Medicare risk, Medicaid and CHAMPUS programs. The Company's
subsidiaries also offer managed health care products related to behavioral
health, dental, vision and prescription drugs, and offer managed health care
product coordination for multi-region employers and administrative services for
medical groups and self-funded benefits programs. Over the past several years,
the Company has developed a diversified product line and has achieved geographic
expansion throughout the United States. The Company operates and conducts its
HMO and other businesses through its wholly and majority owned subsidiaries.
The current operations of the Company are the result of the April 1, 1997
merger transaction (the "FHS Combination") involving Health Systems
International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant
to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the
FHS Combination, FH Acquisition Corp., a wholly owned subsidiary of HSI, merged
with and into FHC and FHC survived as a wholly owned subsidiary of HSI, which
changed its name to "Foundation Health Systems, Inc." and thereby became the
Company. Under the Merger Agreement, FHC stockholders received 1.3 shares of the
Company's Class A Common Stock for every share of FHC common stock held. The
shares of the Company's Class A Common Stock issued to FHC's stockholders in the
FHS Combination constituted approximately 61% of the outstanding stock of the
Company after the FHS Combination and the shares held by the Company's
stockholders prior to the FHS Combination (i.e., the prior stockholders of HSI)
constituted approximately 39% of the outstanding stock of the Company after the
FHS Combination.
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, in this
Annual Report on Form 10-K, the Company's consolidated financial statements have
been prepared and/or restated as though HSI and FHC always had been combined on
a calendar year basis.
The Company currently operates in the managed health care industry segment,
and in 1997 the Company operated in five different Divisions within such
segment, including three regional Health Plan Divisions and two additional
Specialty Divisions. Such Divisions encompass the following three primary lines
of business in which the Company continues to operate: (i) health plan
operations (through the three regional Health Plan Divisions described below);
(ii) government contracts (through the Government Operations Division described
below); and (iii) specialty services (through the Specialty Services Division
described below). As set forth below, the Company has discontinued its
risk-based operations in the Workers' Compensation segment.
The Company is one of the largest managed health care companies in the
United States, with more than 4.3 million full-risk and administrative services
only ("ASO") members through its Health Plan Divisions. The Company provides a
comprehensive range of health care services through HMOs organized into three
Health Plan Divisions located in the following geographic regions: the
California Division (encompassing only the state of California), the Eastern
Division (Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and
West Virginia) and the Western Division (Arizona, Colorado, Idaho, Louisiana,
New Mexico, Oklahoma, Oregon, Texas, Utah and Washington). The Company also
operates PPO networks providing access to health care services to over 4 million
individuals in 37 states and owns six health and life insurance companies
licensed to sell insurance in 38 states and the District of Columbia.
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The Company's HMOs market traditional HMO products to employer groups and
Medicare and Medicaid products directly to employer groups and individuals.
Health care services that are provided to the Company's commercial and
individual members include primary and specialty physician care, hospital care,
laboratory and radiology services, prescription drugs, dental and vision care,
skilled nursing care, physical therapy and mental health. The Company's HMO
service networks include approximately 43,000 primary care physicians and 74,000
specialists.
In addition to the Company's HMO and PPO operations in its three regional
Health Plan Divisions, the Company conducted business in 1997 through the
following two Specialty Divisions.
The Company's Government Operations Division oversees the provision of
contractual services to federal government programs such as the Civilian Health
and Medical Program of the Uniformed Services ("CHAMPUS"). The Company receives
revenues for administrative and management services and, under most of its
contracts, also accepts financial responsibility for a portion of the health
care costs.
The Company's Specialty Services Division oversees the provision of
supplemental programs to enrollees in the Company's HMOs, as well as to members
whose basic medical coverage is provided by non-FHS companies, including vision
coverage, dental coverage, managed behavioral health programs, and a
prescription drug program. The Specialty Services Division consists both of
operations in which the Company assumes underwriting risk in return for premium
revenue, and operations in which the Company provides administrative services
only, including certain of the behavioral health and pharmacy benefits
management programs. Such Division also provides certain bill review and third
party administrative services as described elsewhere in this Annual Report.
Finally, the Company's Workers' Compensation segment consists of operations
in which the Company assumes workers' compensation claims risk in return for
premium revenue, and certain non-risk operations including providing access to
managed care networks, utilization review services and third party
administrative services. As noted below in the section of this Annual Report on
Form 10-K entitled "Discontinued Operations and Anticipated Divestitures," the
Company has recently determined to discontinue its risk-based workers'
compensation operations and to transfer its non-risk workers' compensation
services to its Speciality Services Division.
The Company utilizes sophisticated medical management systems to reduce
excess utilization of health care services. The Company continues to develop a
new generation medical management system which utilizes clinical protocols and
triage procedures to direct members to the most appropriate provider. The
Company believes that this new system, which it calls "Fourth Generation Medical
Management" (the "4-G System"), has the potential to represent a major advance
in applying sophisticated information systems to the practice of medicine. The
Smithsonian Institution has added the 4-G System to its Permanent Research
Collection of Information Technology Innovation at the National Museum of
American History, and the 4-G System was also a finalist for the 1997
Computerworld Smithsonian Award in Medicine.
The Company continues to evaluate the profitability realized or likely to be
realized by its existing businesses and operations, and the opportunities to
expand its businesses in profitable markets. In this connection, the Company is
reviewing from a strategic standpoint which of its businesses or operations
should be divested, and has targeted the Northeastern United States for
expansion due to the relatively low penetration of managed health care in the
region and such region's relatively higher average premiums as compared to the
Company's California and western regions. Consistent with this Northeast
expansion strategy, in 1997 the Company acquired Advantage Health, the trade
name for a group of managed health care companies headquartered in Pittsburgh,
with operations in West Virginia, Ohio and western Pennsylvania; Physicians
Health Services, Inc. ("PHS"), a group of managed health care companies
headquartered in Connecticut; and FOHP, Inc. ("FOHP"), a group of managed health
care companies located in Neptune, New Jersey. In 1997 the Company also acquired
PACC Health Plans, Inc. and PACC HMO, Inc. (collectively, "PACC"), a group of
managed care companies operating in Washington and Oregon.
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The Company was incorporated in 1990. Prior to the FHS Combination, the
Company was the successor to the business conducted by Health Net, now the
Company's HMO subsidiary in California, which became a subsidiary of the Company
in 1992, and HMO and PPO networks operated by QualMed, Inc. ("QualMed"), which
combined with the Company in 1994 to create HSI. FHC was incorporated in
Delaware in 1984. After the FHS Combination, the executive offices of the
Company remained at 21600 Oxnard Street, Woodland Hills, CA 91367. Except as the
context otherwise requires, the term the "Company" refers to FHS and its
subsidiaries.
HEALTH PLAN DIVISIONS
HMO AND PPO OPERATIONS. The Company's HMOs offer members a comprehensive
range of health care services, including ambulatory and outpatient physician
care, hospital care, pharmacy services, eye care, behavioral health and
ancillary diagnostic and therapeutic services. The Company offers a full
spectrum of managed health care products.
The integrated health care programs offered by the Company's HMOs include
products offered through both traditional Network Model HMOs (in which the HMOs
contract with individual physicians, physician groups and independent or
individual practice associations ("IPAs")) and IPA Model HMOs (in which the HMOs
contract with one or more IPAs that in turn subcontract with individual
physicians to provide HMO patient services) which offer quality care, cost
containment and comprehensive coverage; a matrix package which allows employees
to select their desired coverage from alternatives that have interchangeable
outpatient and inpatient co-payment levels; point-of-service programs which
offer a multi-tier design that provides both conventional HMO and indemnity-like
(in-network and out-of-network) tiers; a PPO-like tier which allows members to
self-refer to the network physician of their choice; and a managed indemnity
plan, which is provided for employees who reside outside of their HMO service
areas. The Company's PPO subsidiaries consist of networks of health care
providers which offer their services to health care third party payors, such as
insurers and self-funded employers.
The Company's strategy is to offer a wide range of managed health care
products and services to employers to assist them in containing health care
costs. The pricing of the products offered is designed to provide incentives to
both employers and employees to select and enroll in the products with greater
managed health care and cost containment elements. In general, the Company's HMO
subsidiaries provide comprehensive health care coverage for a fixed fee or
premium that does not vary with the extent or frequency of medical services
actually received by the member. PPO enrollees choose their medical care from
among the various contracting providers or choose a non-contracting provider and
are reimbursed on a traditional indemnity plan basis after reaching an annual
deductible. The Company assumes both underwriting and administrative expense
risk in return for the premium revenue it receives from its HMO and PPO
products. The HMOs and PPOs have contractual relationships with health care
providers for the delivery of health care to the Company's enrollees. While a
majority of the Company's members are covered by conventional HMO products, the
Company is continuing to expand its other product lines, thereby enabling it to
offer flexibility to an employer and to tailor its products to an employer's
particular needs.
As of December 31, 1997, the Company owned and operated HMOs and PPOs in
three regional Health Plan Divisions of the United States: The California
Division, the Western Division (Arizona, Colorado, Idaho, Louisiana, New Mexico,
Oklahoma, Oregon, Texas, Utah and Washington) and the Eastern Division
(Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and West
Virginia). The following table contains certain information relating to
commercial HMO and PPO members,
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Medicare members and employer groups under contract as of December 31, 1997 in
each region in which the Company operates (excluding point-of-service):
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CALIFORNIA WESTERN EASTERN
DIVISION DIVISION DIVISION
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Commercial HMO and PPO Members............................. 1,658,234 760,641 948,850
Medicare Members (risk only)............................... 153,485 72,559 85,937
Medicaid Members........................................... 294,591 53,982 94,470
</TABLE>
In addition, the following sets forth certain data regarding the Company's
employer groups in its commercial managed care operations of its Health Plan
Divisions:
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Number of Employer Groups........................................... 68,793
Largest Employer Group as % of enrollment........................... 4.9%
10 largest Employer Groups as % of enrollment....................... 15.6%
% of Members in Employer Groups with fewer
than 50 Eligible Members.......................................... 11.0%
</TABLE>
CALIFORNIA DIVISION. The California market is characterized by a
concentrated population. In early 1998, the Company merged the operations of two
of its California HMO subsidiaries, Health Net and Foundation Health, a
California Health Plan. The resulting HMO, Health Net, is believed by the
Company to be the second-largest HMO in the state of California in terms of
membership. The Company's commercial HMO membership in California as of December
31, 1997 was 1,658,234 which represented a decrease of 1% during 1997. The
Company's Medicare risk membership in California as of December 31, 1997 was
153,485 which represented an increase of 10% during 1997. The Company's Medicaid
membership in California as of December 31, 1997 was 294,591 members.
EASTERN DIVISION. The Eastern Division currently includes Company
operations in Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and
West Virginia. During 1997 the Company acquired Advantage Health, the trade name
for a group of managed health care companies headquartered in Pittsburgh, with
operations in Ohio, Pennsylvania and West Virginia; PHS, a group of managed
health care companies headquartered in Connecticut with operations in
Connecticut, New Jersey and New York; and FOHP, a group of managed health care
companies now headquartered in Neptune, New Jersey with operations in New
Jersey.
The Company believes its Pennsylvania HMO and PPO operations make it the
fourth largest HMO managed care provider in terms of membership in the
Commonwealth of Pennsylvania. The Company's commercial HMO membership in
Pennsylvania was 67,215 as of December 31, 1997 which represented an increase of
59% during 1997. The Company's Medicare risk membership in Pennsylvania was
15,070 as of December 31, 1997 which represented an increase of 10% during 1997.
The Company believes its Connecticut HMO and PPO operations make it the
largest HMO managed care provider in terms of membership in the state of
Connecticut. The Company's commercial HMO membership in Connecticut was 339,307
as of December 31, 1997 (including approximately 180,000 members from its
year-end acquisition of PHS. The Company's commercial HMO membership in
Connecticut at the end of 1996 was 129,047. The Company's Medicare risk
membership in Connecticut was 26,229 as of December 31, 1997 and the Company's
Medicaid membership in Connecticut was 47,175 as of December 31, 1997.
The Company believes its New Jersey HMO and PPO operations make it the
fourth-largest HMO managed care provider in terms of membership in the state of
New Jersey. The Company's commercial HMO membership in New Jersey was 299,021
(including approximately 68,000 PHS members) as of
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December 31, 1997. The Company's Medicare risk membership in New Jersey was
13,383 as of December 31, 1997 and the Company's Medicaid membership in New
Jersey was 21,442 as of December 31, 1997.
The Company believes its Florida HMO and PPO operations make it the
eighth-largest HMO managed care provider in terms of membership in the state of
Florida. The Company's commercial HMO membership in Florida was 93,714 as of
December 31, 1997 which represented an increase of 37% during 1997. The
Company's Medicare risk membership in Florida was 23,900 as of December 31, 1997
which represented a decrease of 6% during 1997. The Company's Medicaid
membership in Florida was 23,274 as of December 31, 1997, an 11% increase in
1997.
In New York, the Company's operations resulted from the acquisition of PHS.
The Company now has approximately 149,000 members in New York. The Company's HMO
and PPO operations in West Virginia and Ohio at this time are much smaller in
scope than its operations in the other states making up the Eastern Division.
WESTERN DIVISION. The Western Division currently includes Health Plan
operations in Arizona, Colorado, Idaho, Louisiana, New Mexico, Oklahoma, Oregon,
Texas, Utah and Washington. The Western Division also oversees the Company's six
health and life insurance companies licensed to sell insurance in 38 states and
the District of Columbia.
The Company's Washington HMO services Seattle and Spokane and also services
a limited number of residents who reside in the state of Idaho. The Company's
Oregon HMO services Portland and its vicinity. During 1997, the Company acquired
PACC, a Portland-based HMO with operations in Oregon and Washington. Portland,
Seattle and Spokane have experienced population growth rates greater than the
national average over the last several years. In addition, an increasing
percentage of the population in each of these areas has enrolled in HMOs in the
last several years. In Washington and Oregon, the Company believes that it ranks
sixth and fifth, respectively, with respect to total membership; the Company
believes that it ranks first in Washington and third in Oregon with respect to
the size of its primary care physician and specialist networks. The Company's
commercial HMO and PPO membership in Oregon was 163,406 (including 108,000 prior
PACC members) as of December 31, 1997. At year end 1996 the Company had 50,809
commercial members in Oregon. The Company's commercial HMO and PPO membership in
Washington was 94,937 as of December 31, 1997 which represented a decrease of 1%
during 1997. The Company's Medicare risk membership in Washington was 3,194 as
of December 31, 1997 which represented an increase of 14% during 1997. The
Company's Medicaid membership in Washington was 25,076 as of December 31, 1997
which represented an increase of 56% during 1997.
The Western Division also services the southwest region of the United
States, with operations in Arizona, Colorado, Louisiana, New Mexico, Oklahoma,
Texas and Utah. The Company's employer groups in the southwest consist
predominantly of companies with fewer than 50 employees, except for Arizona, in
which the Company's operations are dominated by large employer groups. During
1997, the Company merged its two Colorado HMOs, QualMed Plans for Health of
Colorado, Inc. and Foundation Health, A Colorado Health Plan, Inc. The Company
believes that the resulting HMO is the fourth largest HMO in Colorado as
measured by total membership. The Company's commercial HMO membership in
Colorado (including both the QualMed and Foundation plans) was 76,255 as of
December 31, 1997 which represented an increase of 5% during 1997. The Company's
Medicare membership in Colorado was 12,272 as of December 31, 1997 which
represented an increase of 6% during 1997. In New Mexico, the Company believes
that its ranks fourth, as measured by total membership and the size of its
provider network. The Company's commercial HMO membership in New Mexico was
34,130 as of December 31, 1997 which represented a decrease of 11% during 1997.
The Company's Medicare risk membership in New Mexico was 2,310 as of December
31, 1997 which represented an increase of 12% during 1997.
In Arizona, the Company believes that its commercial managed care operations
rank it first as measured by total membership and second as measured by the size
of its provider network. The Company's commercial HMO membership in Arizona was
304,653 as of December 31, 1997. The Company's
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Medicare risk membership in Arizona was 47,455 as of December 31, 1997 which
represented an increase of 10% during 1997.
Collectively, the Company's commercial HMO membership in Texas, Oklahoma,
Louisiana and Utah was 43,279 as of December 31, 1997. The Company's Medicaid
risk membership in these states was 24,714 as of December 31, 1997, a 26%
decrease in 1997. As noted below in the section of this Annual Report on Form
10-K entitled "Discontinued Operations and Anticipated Divestitures," the
Company is presently reviewing possible exit strategies for its HMO operations
in Texas, Oklahoma and Louisiana.
MEDICARE RISK. The Company expanded its Medicare risk business in 1997
through the addition of 49,419 Medicare risk enrollees and, as of December 31,
1997, the Company's Medicare risk plans had a combined membership of
approximately 309,333. The Company expects its Medicare risk business to
continue to increase in the future.
The Company offers its Medicare risk products directly to individuals and to
employer groups. To enroll in a Company Medicare risk plan covered persons must
be eligible for Medicare. Health care services normally covered by Medicare are
provided or arranged for by the Company, in conjunction with a broad range of
preventive health care services. The federal Health Care Financing
Administration ("HCFA") pays to the Company for each enrolled member a monthly
fee based, in part, upon the "Adjusted Average Per Capita Cost," as determined
by HCFA's analysis of fee-for-service costs related to beneficiary demographics.
Depending on plan design and other factors, the Company may charge a member a
premium or prepaid charge.
The Company's California Medicare risk product, Seniority Plus, was licensed
and certified to operate in 36 California counties as of December 31, 1997. The
Company's other HMOs are licensed and certified to offer Medicare risk plans in
8 counties in Colorado, 5 counties in New Mexico, 6 counties in Washington, 6
counties in Pennsylvania, 18 counties in Oregon, 8 counties in Connecticut, 6
counties in Arizona, 3 counties in Florida and 41 counties in New York and New
Jersey.
MEDICAID PRODUCTS. As of December 31, 1997, the Company had an aggregate of
approximately 443,043 Medicaid members, principally in California. To enroll in
these Medicaid products, an individual must be eligible for Medicaid benefits
under the appropriate state regulatory requirements. These HMOs offer, in
addition to standard Medicaid coverage, certain additional services including
dental and vision benefits. The applicable state agency pays the Company's HMOs
a monthly fee for each Medicaid member enrolled on a percentage of
fee-for-service costs. The Company has Medicaid members and operations in
California, Connecticut, Florida, New Jersey, New York, Oklahoma, Oregon, Texas
and Washington.
ADMINISTRATIVE SERVICES ONLY BUSINESS. The Company also provides third
party administrative services to large employer groups throughout its service
areas. Under these arrangements, the Company provides claims processing,
customer service, medical management and other administrative services without
assuming the risk for medical costs. The Company is generally compensated for
these services on a fixed per member per month basis.
INDEMNITY INSURANCE PRODUCTS. The Company offers indemnity products as part
of multiple option products in various markets. These products are offered by
the Company's six health and life insurance subsidiaries which are licensed to
sell insurance in 38 states and the District of Columbia. Through these
subsidiaries, the Company also offers HMO members certain auxiliary non-health
products such as group life, accidental death and disability and short-term
disability insurance, in conjunction with its managed care products.
Although the Western Division oversees the Company's health and life
insurance operations, such operations' products are provided throughout all of
the Company's service areas. The following table contains certain information
relating to such health and life insurance companies' insured PPO, point of
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service ("POS"), indemnity, group life and disability products as of December
31, 1997 in each of the three Health Plan Divisions in which the Company
operates:
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CALIFORNIA WESTERN EASTERN
DIVISION DIVISION DIVISION
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Insured PPO Members.......................................... 32,530 78,349 6,770
Point of Service Members..................................... 90,864 30,786 0
Indemnity Members............................................ 9,277 9,855 0
Group Life Members........................................... 80,876 70,594 811
Disability Product Members................................... 442 12,997 0
</TABLE>
SPECIALTY SERVICES DIVISION
The Company's Specialty Services Division offers behavioral health, dental,
vision, and pharmaceutical products and services as well as managed care
products related to bill review, administration and cost containment for
hospitals, health plans and other entities.
DENTAL AND VISION. Through DentiCare of California, Inc. ("DentiCare"), the
Company operates a dental HMO in California, Hawaii and Oklahoma and dental
administrative services in California and Colorado, serving approximately
633,000 enrollees as of December 31, 1997. This enrollment includes 206,000
enrollees who are beneficiaries under Medicaid dental programs, 142,000
enrollees who are also enrollees of affiliated Health Plan companies, 41,000
enrollees who are beneficiaries of Hawaii's Medicaid program and 23,000
enrollees who are beneficiaries under Medicaid contracts held by non-affiliated
third parties. DentiCare is also a participant in California's Healthy Families
Program, with initial beneficiary enrollment and service delivery commencing in
July 1998. Acquired by the Company in 1991, DentiCare has grown from total
revenues in 1992 of $24 million to $49 million for the year ended December 31,
1997.
Operating on administrative and information system platforms in common with
DentiCare is Foundation Health Vision Services, Inc., d.b.a. AVP Vision Services
("AVP"). AVP operates in four states and provides at-risk and administrative
services under various programs that result in the delivery of vision benefits
to over 675,000 enrollees. Total revenues from AVP operations for the year ended
December 31, 1997 exceeded $14 million. Since its acquisition by the Company in
1992, AVP has grown from 30,000 covered enrollees to 415,000 enrollees in
full-risk products and 262,000 enrollees covered under administrative services
contracts as of December 31, 1997.
Both DentiCare and AVP are licensed in California under the Knox-Keene
Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act") as
Specialized Health Care Service Plans, and compete with other HMOs, traditional
insurance companies, self-funded plans, PPOs and discounted fee-for-service
plans. The two companies share a common strategy to maximize the value and
quality of managed dental and vision care services while appropriately balancing
financial risk assumption among providers, enrollees and other entities to
achieve the effective and efficient use of available resources.
BEHAVIORAL HEALTH. The Company's subsidiaries organized under Managed
Health Network ("MHN") and Foundation Health PsychCare Services, Inc. ("FHPS"),
each licensed in California under the Knox-Keene Act as Specialized Health Care
Service Plans, offer managed behavioral health, employee assistance programs
("EAP") and substance abuse programs. MHN and FHPS, directly and through
Specialty Division affiliates, offer these programs on an insured and
self-funded basis to employers, governmental entities and other payors in
various states.
These products and services were provided to over 7.5 million individuals in
the year ended December 31, 1997, with approximately 2.96 million individuals
under risk-based programs, approximately 1.1 million individuals under
self-funded programs and approximately 3.47 million individuals under EAP
programs.
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The Company expects to effect the corporate merger of FHPS and MHN in 1998,
pending regulatory approvals.
MHN provides managed behavioral health programs to employers, governmental
agencies and public entitlement programs, such as CHAMPUS and Medicaid. Employer
group sizes range from Fortune 100 to mid-sized companies with 200 employees.
MHN's strategy is to continue its market share achievement in the Fortune 500,
health plan and CHAMPUS markets through a combination of direct and consultant/
broker sales. MHN intends to achieve additional market share by capitalizing on
competitor consolidation, remaining CHAMPUS procurement opportunities and the
growing state and county Medicaid behavioral carve-outs, funded on either a risk
or ASO basis.
PHARMACY BENEFIT MANAGEMENT. The Company has developed a significant,
free-standing capability to manage drug benefit quality and cost through its
pharmacy benefit management ("PBM") subsidiary, Integrated Pharmaceutical
Services, Inc. ("IPS"). Through its formulary programs, its national network of
contract pharmacies and its discount-rebate contracts with drug manufacturers,
IPS provides PBM services to over 13 million individuals enrolled in various
contracted health benefit and insurance programs. By linking utilization data
with formulary and rebate contracts with manufacturers, IPS strives to effect
the equivalent of significant bulk purchase discounts for its customers and
their enrollees. IPS has maintained pharmacy cost trends at 10% for the past two
calendar years for the Company's California health plan while pharmacy trends
for the state and the nation were significantly higher.
The management of IPS believes there currently exist significant growth
opportunities for PBMs that excel at flattening the drug cost trend for managed
care organizations and employer groups. The components of excellence are
knowledge-based programs such as turn key clinical intervention programs and
successfully leveraging pharmacy buying power. These are the strengths upon
which IPS is attempting to build.
BILL REVIEW SERVICES. The Company also provides third party administration
and bill review services with respect to workers's compensation claims primarily
to self-insured employers, and operates a medical review and cost-containment
business for the workers' compensation industry primarily within California.
These operations were previously part of the Company's Workers' Compensation
Division, the risk-based operations of which division the Company has recently
determined to discontinue.
GOVERNMENT OPERATIONS DIVISION
CHAMPUS. The Company's wholly-owned subsidiary, Foundation Health Federal
Services, Inc. ("Federal Services"), administers large, multi-year managed care
federal contracts for the United States Department of Defense (the "DoD").
Federal Services currently administers health care contracts for DoD's
TRICARE program covering 1.9 million eligible individuals under the Civilian
Health and Medical Program of the Uniformed Services ("CHAMPUS"). Through the
federal government's TRICARE program, Federal Services provides CHAMPUS families
with improved access to primary health care, lower out-of-pocket expenses and
fewer claims forms. Federal Services currently administers three TRICARE
contracts for five regions that cover the following states:
- Region 11: Washington, Oregon and part of Idaho
- Region 6: Texas, Arkansas, Oklahoma and part of Louisiana
- Regions 9, 10 & 12: California, Hawaii, Alaska and part of Arizona
During 1997, enrollment of CHAMPUS beneficiaries in the HMO option of the
TRICARE program for the Region 11 contract increased by 9% to 113,748 while the
total estimated number of eligible beneficiaries decreased by 2% to 237,488.
During 1997, enrollment of CHAMPUS beneficiaries in the HMO option of the
TRICARE program for the Region 6 contract increased by 28% to 266,899 while the
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total estimated number of eligible beneficiaries decreased by 1% to 626,267.
During 1997, enrollment of CHAMPUS beneficiaries in the HMO option of the
TRICARE program for the Regions 9, 10 and 12 contract increased by 45% to
332,103 while the total estimated number of eligible beneficiaries increased by
7% to 759,472 due to the addition of Alaska to the contract.
Under the TRICARE contracts, Federal Services shares health care cost risk
with the DoD for both gains and losses. Federal Services subcontracts to
affiliated and unrelated third parties for the administration and health care
risk of parts of these contracts. If all option periods are exercised by the DoD
and no extensions of the performance period are made, health care delivery ends
on February 29, 2000 for the Region 11 contract, on October 31, 2000 for the
Region 6 contract and on March 31, 2001 for the Regions 9, 10 and 12 contract.
Federal Services expects to compete for the rebid of all of these contracts.
Federal Services protested to the U.S. General Accounting Office (the "GAO")
concerning the awards of TRICARE contracts for Region 1 (northeast states) and
for Regions 2 and 5 (mid-Atlantic and mid-west states) to competitors of Federal
Services. The GAO sustained the protests and recommended that the DoD conduct
another round of competition for these contracts. The DoD filed petitions for
reconsideration of the protest decision by the GAO and the GAO is currently
considering those petitions. If the petitions are denied and the protest
decisions are upheld, Federal Services expects to compete again for these
contracts.
MEDICARE AND MEDICAID. As described earlier in this Annual Report on Form
10-K, the Company also contracts with federal and state governments to provide
managed Medicare and Medicaid health care programs. As of December 31, 1997, the
total number of Medicare risk enrollees in the Company's Medicare HMO operations
exceeded 309,000 members. As of December 31, 1997, the total number of Medicaid
risk enrollees in the Company's Medicaid HMO operations exceeded 443,000
members.
During 1997, Federal Services administered contracts with the states of
Massachusetts, New Jersey, Georgia, Maryland and Maine to enroll Medicaid
eligible individuals in managed care programs within such states. Federal
Services is not at risk for the provision of any health care services under
these contracts. The contract with the state of Maine expired on December 31,
1997. Federal Services entered into an agreement with MAXIMUS, Inc., effective
December 24, 1997, to sell the contracts for Massachusetts, New Jersey, Georgia
and Maryland. Federal Services is presently in discussions with these four
states to transfer these contracts to MAXIMUS, Inc.
WORKERS' COMPENSATION SEGMENT
The Company's Workers' Compensation segment applies the Company's managed
care concepts, such as use of specialized preferred provider networks and health
care utilization review, to the operations of its workers' compensation
subsidiaries. The Company's workers' compensation insurance companies consist of
the following entities: California Compensation Insurance Company, a specialty
workers' compensation carrier writing business primarily in California; Business
Insurance Company, a national workers' compensation specialty carrier;
Commercial Compensation Insurance Company, licensed to write multiple lines of
business in approximately 47 states; and Combined Benefits Insurance Company,
writing single source workers' compensation and group health insurance primarily
in California. As noted below in the section of this Annual Report on Form 10-K
entitled "Discontinued Operations and Anticipated Divestitures," the Company has
recently determined to discontinue its risk-based workers' compensation
operations.
PROVIDER RELATIONSHIPS AND RESPONSIBILITIES
PHYSICIAN RELATIONSHIPS. Upon enrollment in most of the Company's HMO
plans, each member selects a participating physician group ("PPG") or primary
care physician from the HMO's provider panel. The primary care physicians and
PPGs assume overall responsibility for the care of members. Medical care
provided directly by such physicians includes the treatment of illnesses not
requiring referral, as well as physical examinations, routine immunizations,
maternity and child care and other preventive health
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services. The primary care physicians and PPGs are responsible for making
referrals (approved by the HMO's or PPG's medical director) to specialists and
hospitals. Certain Company HMOs offer enrollees "open panels" under which
members may access any physician in the network without first consulting a
primary care physician.
The following table sets forth the number of primary care and specialist
physicians with whom the Company's HMOs (and certain of such HMOs' PPGs)
contracted as of December 31, 1997 in each of the three Health Plan Divisions of
the Company:
<TABLE>
<CAPTION>
CALIFORNIA WESTERN EASTERN
DIVISION DIVISION DIVISION
----------- ----------- -----------
<S> <C> <C> <C>
Primary Care Physicians....................................... 11,797 9,692 22,360
Specialist Physicians......................................... 23,613 26,795 23,783
----------- ----------- -----------
Totals........................................................ 35,410 36,487 46,143
</TABLE>
PPG and physician contracts are generally for a period of at least one year
and are automatically renewable unless terminated, with certain requirements for
maintenance of good professional standing and compliance with the Company's
quality, utilization and administrative procedures. In California and Arizona,
PPGs or primary care physicians generally receive a monthly "capitation" fee for
every member served. The capitation fee represents payment in full for all
medical and ancillary services specified in the provider agreements. The
non-physician component of all hospital services is covered by a combination of
capitation and/or per diem charges. In such capitated arrangements, in cases
where the capitated provider cannot provide the health care services needed,
such providers generally contract with specialists and other ancillary service
providers to furnish the requisite services pursuant to capitation agreements or
negotiated fee schedules with specialists. Many of the Company's HMOs outside
California and Arizona reimburse physicians according to a discounted
fee-for-service schedule, although several HMOs have commenced capitation
arrangements with certain providers and provider groups in their market areas.
HOSPITAL RELATIONSHIPS. The Company's HMOs arrange for hospital care
primarily through contracts with selected hospitals in their service areas. Such
hospital contracts generally provide for multi-year terms, with limited annual
reimbursement increases, and provide for payments on a variety of bases,
including capitation, per diem rates, case rates and discounted fee-for-service
schedules.
Covered inpatient hospital care for a member is comprehensive; it includes
the services of physicians, nurses and other hospital personnel, room and board,
intensive care, laboratory and x-ray services, diagnostic imaging and generally
all other services normally provided by acute-care hospitals. HMO or PPG nurses
and medical directors are actively involved in discharge planning and case
management, which often involves the coordination of community support services,
including visiting nurses, physical therapy, durable medical equipment and home
intravenous therapy.
The Company owns and operates a 128-bed hospital located in Los Angeles,
California, the East Los Angeles Doctors Hospital, and a 200-bed hospital
located in Gardena, California, the Memorial Hospital of Gardena. As noted below
in the section of this Annual Report on Form 10-K entitled "Discontinued
Operations and Anticipated Divestitures," the Company is reviewing the
feasibility of divesting direct ownership of these hospitals.
COST CONTAINMENT. In most HMO plan designs, the primary care physician or
PPG is responsible for authorizing all needed medical care except for emergency
medical services. By coordinating care through such physicians in cases where
reimbursement includes risk-sharing arrangements, the Company believes that
inappropriate use of medical resources is reduced and efficiencies are achieved.
To limit possible abuse in utilization of hospital services in non-emergency
situations, a certification process precedes the inpatient admission of each
member, followed by continuing review during the
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member's hospital stay. In addition to reviewing the appropriateness of hospital
admissions and continued hospital stay, the Company plays an active role in
evaluating alternative means of providing care to members and encourages the use
of outpatient care, when appropriate, to reduce the cost that would otherwise be
associated with an inpatient admission.
QUALITY ASSURANCE. Quality assurance is a continuing priority for the
Company. Most of the Company's HMOs have a quality assurance plan administered
by a committee comprised of medical directors and primary care and specialist
physicians. The committees' responsibilities include periodic review of medical
records, development and implementation of standards of care based on current
medical literature and community standards, and the collection of data relating
to results of treatment. All of the Company's HMOs also have a subscriber
grievance procedure and/or a member satisfaction program designed to respond
promptly to member grievances. Aspects of such member service programs take
place both within the PPGs and within the Company's HMOs. Set forth under the
heading "National Committee for Quality Assurance" below is information
regarding certain quality assurance accreditations received by the Company's
subsidiaries.
MANAGEMENT INFORMATION SYSTEMS
Effective information technology systems are critical to the Company's
operation. The Company's information technology systems include several computer
systems, each utilizing a combination of packaged and customized software and a
network of on-line terminals. The information technology systems gather and
store data on the Company's members and physician and hospital providers. The
systems contain all of the Company's necessary membership and claims-processing
capabilities as well as marketing and medical utilization programs. These
systems provide the Company with an integrated and efficient system of billing,
reporting, member services and claims processing and the ability to examine
member encounter information for the optimization of clinical outcomes.
In 1995, the Company embarked on a multi-year project to develop and install
a new information system designed to facilitate the seamless management of
patients throughout the entire health care continuum. This "Fourth Generation
Medical Management" project (the "4-G System") upon implementation would include
regional data repositories containing clinical and demographic data about each
of the Company's health plan members, which data serves as the basis for
enhanced clinical decision making. Physicians, hospitals and the Company's case
managers would have access to expert systems and an ever-expanding library of
clinical protocols which help in optimizing the diagnosis and treatment
decisions for each health plan member.
The Comprehensive Member Support Center ("Member Support Center"), located
in the Philadelphia area, is a sophisticated telecommunications center staffed
by experienced nurses that is the Company's initial application of the 4-G
System. Each Member Support Center nurse has access to member-specific health
information. In addition, expert clinical algorithms, developed by physicians at
leading hospitals and academic medical centers, guide nurse interactions with
members. As calls from members come into the center, the nurse can retrieve
detailed member and provider information and use the expert algorithms to guide
members to the most appropriate level of care for their condition. Outbound
activities of the call center includes clinical reminder calls to members and
consultive support for self-care protocols and educational materials. Whenever a
member accesses the center, his or her primary care physician receives a
follow-up report by fax, ensuring continuity of care.
When first introduced, the Member Support Center served only members in the
Philadelphia plan. Today, the Member Support Center serves more than three
million FHS members in 13 states. In 1998, it is anticipated that the members of
PHS and the Company's Arizona plan will be added to the center. The clinical
nurses at the center today are handling approximately 1,300 phone calls each day
from the Company's members. They interact with members 24 hours a day, seven
days a week, to help ensure that members have access to the right provider in
the right setting--no matter where they are in the United
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States. The Company is contemplating the creation of regional centers similar to
the Member Support Center which it believes will further strengthen the
connection between members and the Company.
The Company believes the Member Support Center is the most sophisticated
telecommunications system in the managed care industry today. The Company sees
it as a critical competitive advantage, especially in the Northeastern United
States where FHS offers "open access" health plans.
The Company also recognizes that the arrival of the Year 2000 poses a
challenge to the ability of computer systems to recognize the date change from
1999 to 2000 (the "Year 2000 Issue") and has begun to assess and modify its
computer applications and business processes to provide for their continued
functionality given the Year 2000 Issue. 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 (both external and
internal) 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 material miscalculations causing disruptions of operations, including, among
other things, the inability to process transactions, prepare invoices or engage
in normal business activities.
The costs of the Company's Year 2000 Issue projects and the timetable in
which the Company plans to complete the Year 2000 Issue compliance requirements
are set forth elsewhere in this Annual Report on Form 10-K and are based on
estimates derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors.
DISCONTINUED OPERATIONS AND ANTICIPATED DIVESTITURES
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 elsewhere in this Annual Report on Form 10-K, such adverse
developments caused the Company's workers' compensation reserves to be
inadequate which required the Company to strengthen such reserves at the end of
1997. These developments also led the Company to adopt a plan to completely
discontinue this segment of its business, through divestiture of its workers'
compensation risk-assuming insurance subsidiaries. The Company is presently
conducting the sale of these businesses.
The Company is presently reviewing a possible plan to exit its HMO
operations in the states of Texas, Louisiana and Oklahoma due to inadequate
returns on invested capital. The Company is presently reviewing an exit strategy
for such states' businesses (including potential sale transactions). In December
1997 the Company also entered into a sale agreement to divest its
non-operational HMO license in Alabama to an unaffiliated third party.
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.
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The Company is also analyzing the strategic fit of its Denticare managed
dental operations with the ongoing operations and operating strategy of the
Company and, in this connection, whether a sale of such operations could be
completed consistent with the Company's interests.
In addition, effective June 30, 1997, the Company divested its United
Kingdom operations.
As set forth elsewhere in this Annual Report on Form 10-K, 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.
ADDITIONAL INFORMATION CONCERNING THE COMPANY'S BUSINESS
MARKETING AND SALES. Marketing for group Health Plan business is a two-step
process in which the Company first markets to employer groups and then provides
information directly to employees once the employer has selected a Company HMO.
The Company typically uses its internal sales staff to serve the large employer
groups while independent brokers work with the Company's internal sales staff to
develop business with smaller employer groups. Once selected by an employer, the
Company solicits enrollees from the employee base directly. In 1997, the Company
marketed its programs and services primarily through its direct sales staff and
independent brokers, agents and consultants. During "open enrollment" periods
when employees are permitted to change health care programs, the Company uses
direct mail, work day and health fair presentations, telemarketing, and outdoor,
print, radio and television advertisements to attract new enrollees. The
Company's sales efforts are supported by its marketing division which includes
research and product development, corporate communications, public relations and
marketing services.
Premiums for each employer group are generally contracted for on a yearly
basis, payable monthly. Numerous factors are considered by the Company in fixing
its monthly premiums, including employer group needs and anticipated health-care
utilization rates as forecasted by the Company's management based on the
demographic composition of, and the Company's prior experience in, its service
areas. Premiums are also affected by applicable regulations that prohibit
experience rating of group accounts (i.e., setting the premium for the group
based on its past use of health care services) and by state regulations
governing the manner in which premiums are structured.
The Company believes that the importance of the ultimate health care
consumer (or member) in the health care product purchasing process is likely to
increase in the future. Accordingly, the Company intends to focus its marketing
strategies on the development of distinct brand identities and innovative
product service offerings that will appeal to potential Health Plan members.
COMPETITION. HMOs operate in a highly competitive environment in an
industry currently subject to significant changes from business consolidations,
new strategic alliances, legislative reform and market pressures brought about
by a better informed and better organized customer base. The Company's HMOs face
substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded
plans (including self-insured employers and union trust funds), Blue Cross/Blue
Shield plans and traditional indemnity insurance carriers, some of which have
substantially larger enrollments and greater financial resources than the
Company. The Company believes that the principal competitive features affecting
its ability to retain and increase membership include the range and prices of
benefit plans offered, provider network, quality of service, responsiveness to
user demands, financial stability, comprehensiveness of coverage, diversity of
product offerings and market presence and reputation. The relative importance of
each of these features and key competitors vary by market. The Company believes
that it competes effectively with respect to all of these factors.
Kaiser Foundation Health Plan ("Kaiser") is the largest HMO in California
and in the United States and the Company's principal competitor in the
California HMO industry. In addition to Kaiser, the Company's other HMO
competitors include PacifiCare of California (which recently purchased FHP
Health Plan), California Care (Blue Cross) and CIGNA Healthplans of California,
Inc. In addition, there
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<PAGE>
are a number of other types of competitors including self-directed plans,
traditional indemnity insurance plans and other managed care plans.
The Company competes in California for employers and members against other
HMOs, self-funded plans, traditional health insurers and a variety of PPOs. The
establishment of PPOs has been encouraged by legislation in California that
enables insurance companies to negotiate fees with health care providers and to
extend economic incentives to insureds to utilize such providers without
significant legal restrictions. However, the California Department of
Corporations (the "DOC"), which regulates all California HMOs, has interpreted
California law to prohibit California PPOs that lack an HMO license from
compensating providers on a capitated or other prepaid or periodic basis unless
those providers themselves have an HMO license. Thus, only HMOs may legally
enter into such financial arrangements with providers, while PPOs are limited to
fee-for-service arrangements.
The Company's Colorado HMO competes primarily against other HMOs including
Kaiser and PacifiCare of Colorado, as well as with a Blue Cross/Blue Shield HMO,
other commercial carriers and various hospital or physician-owned HMOs. The
Company's largest competitor in New Mexico is Presbyterian Health Plan. The
Company's New Mexico HMO also competes with Lovelace Health Plan (an HMO owned
by CIGNA Corporation) and Blue Cross/Blue Shield. The Company's largest
competitor in Arizona is Health Partners. The Company's Arizona HMO also
competes with CIGNA, PacifiCare, Aetna, and Blue Cross/Blue Shield. In Utah, the
Company competes with Intermountain Health Plan and PacifiCare, among other
companies.
The Company's Oregon HMO competes primarily against other HMOs including
Kaiser, PacifiCare of Oregon, The Good Health Plan, and a Blue Cross/Blue Shield
HMO, and with various PPOs. The Company's Washington HMO competes primarily with
Group Health Cooperative of Puget Sound, Kaiser, HealthPlus (Blue Cross), and
with commercial carriers, self-funded plans and other Blue Cross/Blue Shield
organizations.
The Company's HMOs in Connecticut compete for business with commercial
insurance carriers, Blue Cross and Blue Shield of Connecticut and more than ten
HMOs. The Company's main competitors in Pennsylvania, New York and New Jersey
are Aetna/U.S. Healthcare, Independence Blue Cross, Empire Blue Cross, Oxford
Health Plans, AmeriHealth and Keystone East. The Company's HMO operations in
Florida compete for business with Humana Medical Plan, United HealthCare, Health
Options, and Prudential HealthCare, among others.
GOVERNMENT REGULATION. The Company believes it is in compliance in all
material respects with all current state and federal regulatory requirements
applicable to the business to be conducted by its subsidiaries. Certain of these
requirements are discussed below.
FEDERAL HMO STATUTES. Under the Federal Health Maintenance Organization Act
of 1973 (the "HMO Act"), services to members must be provided substantially on a
fixed, prepaid basis without regard to the actual degree of utilization of
services. Although premiums established by an HMO may vary from account to
account through composite rate factors and special treatment of certain broad
classes of members, traditional experience rating of accounts (i.e.,
retrospective adjustments for a group account based on that group's past use of
health care services) is not permitted under the HMO Act; prospective rating
adjustments are, however, allowed. Several of the Company's HMOs are federally
qualified in certain parts of their respective service areas under the HMO Act
and are therefore subject to the requirements of such act to the extent
federally qualified products are offered and sold.
Additionally, there are a number of proposed federal laws currently before
Congress to further regulate managed health care. The Company cannot predict the
ultimate fate of any of these legislative proposals. The Company's Medicare risk
contracts are subject to regulation by HCFA. HCFA has the right to audit HMOs
operating under Medicare contracts to determine the quality of care being
rendered and the degree of compliance with HCFA's contracts and regulations.
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<PAGE>
CALIFORNIA HMO REGULATIONS. California HMOs such as Health Net and certain
of the Company's specialty plans are subject to state regulation, principally by
the DOC under the Knox-Keene Health Care Service Plan Act of 1975, as amended
(the "Knox-Keene Act"). Among the areas regulated by the Knox-Keene Act are: (i)
adequacy of administrative operations, (ii) the scope of benefits required to be
made available to members, (iii) manner in which premiums are structured, (iv)
procedures for review of quality assurance, (v) enrollment requirements, (vi)
composition of policy making bodies to assure that plan members have access to
representation, (vii) procedures for resolving grievances, (viii) the
interrelationship between HMOs and their health care providers, (ix) adequacy
and accessibility of the network of health care providers, (x) provider
contracts and (xi) initial and continuing financial viability. Any material
modifications to the organization or operations of Health Net are subject to
prior review and approval by the DOC. This approval process can be lengthy and
there is no certainty of approval. In addition, under the Knox-Keene Act, Health
Net and certain other Company subsidiaries must file periodic reports with, and
are subject to periodic review by, the DOC.
Currently, the California legislature is considering a number of significant
managed health care measures which could materially alter California's
regulatory environment. Among such measures are proposals to establish an
entirely new regulatory structure for managed care, in lieu of the DOC. Other
legislative proposals focus on medical care dispute resolution mechanisms,
medical malpractice liability, and plan enrollee notification about plan
provisions and coverage. The Company cannot predict the ultimate fate of any of
these legislative proposals in California.
OTHER HMO REGULATIONS. In each state in which the Company does business,
HMOs must file periodic reports with, and their operations are subject to
periodic examination by, state licensing authorities. In addition, each HMO must
meet numerous state licensing criteria and secure the approval of state
licensing authorities before implementing certain operational changes, including
the development of new product offerings and, in some states, the expansion of
service areas. To remain licensed, each HMO must continue to comply with state
laws and regulations and may from time to time be required to change services,
procedures or other aspects of its operations to comply with changes in
applicable laws and regulations. HMOs are required by state law to meet certain
minimum capital and deposit and/or reserve requirements in each state and may be
restricted from paying dividends to their parent corporations under certain
circumstances from time to time. Several states have increased minimum capital
requirements, which increases are typically phased in over a period of time.
Regulations in these and other states may be changed in the future to further
increase equity requirements. Such increases could require the Company to
contribute additional capital to its HMOs. Any adverse change in governmental
regulation or in the regulatory climate in any state could materially impact the
HMOs operating in that state. The HMO Act and state laws place various
restrictions on the ability of HMOs to price their products freely. The Company
must comply with certain provisions of certain state insurance and similar laws,
especially as it seeks ownership interests in new HMOs, PPOs and insurance
companies, or otherwise expands its geographic markets or diversifies its
product lines.
INSURANCE REGULATIONS. State departments of insurance (the "DOIs") regulate
insurance and third party administrator business conducted by certain
subsidiaries of the Company (the "Insurance Subsidiaries") pursuant to various
provisions of state insurance codes and regulations promulgated thereunder. The
Insurance Subsidiaries are subject to various capital reserve and other
financial requirements established by the DOIs. The Insurance Subsidiaries must
also file periodic reports regarding their activities regulated by the DOIs and
are subject to periodic reviews of those activities by the DOIs. The Company
must also obtain approval from or file with the DOIs for all of its group and
individual policies prior to issuing those policies. The Company does not
believe that the requirements imposed by the DOIs will have a material impact on
the ability of the Insurance Subsidiaries to conduct their business profitably.
NATIONAL COMMITTEE FOR QUALITY ASSURANCE ("NCQA"). NCQA, an independent,
non-profit organization that reviews and accredits HMOs, assesses an HMO's
quality improvement, utilization management,
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<PAGE>
credentialing process, commitment to members' rights and preventive health
services. HMOs that comply with NCQA's review requirements and quality standards
receive NCQA accreditation. After an NCQA review is completed, NCQA will issue
one of four designations. These are (i) accreditation for three years; (ii)
accreditation for one year; (iii) provisional accreditation for twelve to
eighteen months to correct certain problems with a follow-up review to determine
qualification for accreditation; and (iv) not accredited. Intergroup, the
Company's HMO in Arizona, has received NCQA accreditation for three years.
Health Net, PHS, Foundation Health, a Florida Health Plan, QualMed Pennsylvania,
QualMed Plans for Health of Colorado, and QualMed, a Washington Health Plan have
all received one year accreditation from NCQA. Certain of the Company's other
Health Plan subsidiaries are in the process of applying for NCQA accreditation.
SERVICE MARKS
The Company's service marks and/or trademarks include, among others: THE
ACUTE CARE ALTERNATIVE-Registered Trademark-, Alliance 2000-SM-, Alliance
1000-SM-, Asthmawise-SM-, AVP-SM-, AVP Vision Plans-SM-, BabyWell-SM-, BEING
WELL-Registered Trademark-, CARECAID-Registered Trademark-,
CMP-Registered Trademark-, COMBINED CARE-REGISTERED TRADEMARK-, COMBINED CARE
PLUS-SM-, COMMUNITY MEDICAL PLAN, INC. and design-Registered Trademark-, A CURE
FOR THE COMMON HMO-Registered Trademark-, Feetbeat Worksite Walking Program-SM-,
FIRM SOLUTIONS-Registered Trademark-, FLEX ADVANTAGE-Registered Trademark-, FLEX
NET-SM-, FOUNDATION HEALTH and design-Registered Trademark-, FOUNDATION HEALTH
GOLD-Registered Trademark-, Foundation Health Systems-SM-, GOOD HEALTH IS JUST
AROUND THE CORNER-Registered Trademark-, HANK-Registered Trademark-, HANK and
design-Registered Trademark-, HEALTH NET-Registered Trademark-, Health Net
ACCESS-SM-, Health Net Comp.24-SM-, Health Net ELECT-SM-, Health Net
INSIGHT-SM-, Health Net OPTIONS-SM-, Health Net SELECT-SM-, Health Net Seniority
Plus-SM-, Health Smart and design-SM-, Healthworks (stylized)-SM-, Heart &
Soul-SM-, IMET and design-Registered Trademark-, Indian
design-Registered Trademark-, INDIVIDUAL PREFERRRED PPO-Registered Trademark-,
InterCare-SM-, InterComp-SM-, InterFlex-SM-, Inter Mountain Employers Trust-SM-,
InterPlus-SM-, LIFE WITH DIGNITY AND HOPE-Registered Trademark-, MAKING QUALITY
HEALTH CARE AFFORDABLE-Registered Trademark-, M.D. Health Plan Personal Medical
Management-SM-, On the Road to Good Health-SM-, PHYSICIANS HEALTH
SERVICES-Registered Trademark-, Premier Medical Network-SM-, Premier Medical
Network It's Your Choice-SM-, QUALASSIST-Registered Trademark-,
QUALADMIT-Registered Trademark-, QUALCARE-Registered Trademark-, QUALCARE
PREFERRED-Registered Trademark-, QUAL-MED-Registered Trademark-, QUALMED-SM-,
QUALMED HEALTH & LIFE INSURANCE COMPANY-Registered Trademark-, QUALMED PLANS FOR
HEALTH-Registered Trademark-, Rapid Access-SM-, SENIOR
SECURITY-Registered Trademark-, SENIOR VALUE-Registered Trademark-, Someone at
Your Side-SM-, Sun/Mountain design-Registered Trademark-,The Final Piece of the
Healthcare Puzzle-SM-, VitalLine-SM-, VITALTEAM-Registered Trademark-, WELL
MANAGED CARE RIGHT FROM THE START-Registered Trademark-, WELL
REWARDS-Registered Trademark-, Well Woman-SM-, Wise Choice-SM-, WORKING WELL
TOGETHER-Registered Trademark- and Your Partner in Healthy Living-SM- and
certain designs related to the foregoing.
The Company utilizes these and other marks in connection with the marketing
and identification of products and services. The Company believes such marks are
valuable and material to its marketing efforts.
EMPLOYEES
The Company currently employs approximately 15,200 employees. Such employees
perform a variety of functions, including administrative services for employers,
providers, and members, negotiation of agreements with physician groups,
hospitals, pharmacies and other health care providers, handling claims for
payment of hospital and other services and providing data processing services.
The Company's employees are not unionized and the Company has not experienced
any work stoppage since its organization. The Company considers its relations
with its employees to be very good.
As set forth elsewhere in this Annual Report on Form 10-K, in connection
with the FHS Combination the Company adopted a significant restructuring plan
which provides for a workforce reduction, the consolidation of employee benefit
plans and the consolidation of certain office locations.
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ITEM 2. PROPERTIES
The Company owns its offices in Pueblo, Colorado and leases office space for
its principal executive offices in Woodland Hills and its offices in Rancho
Cordova, California.
The Pueblo facility, with approximately 72,000 square feet, is subject to a
mortgage in the aggregate principal amount of approximately $1 million. The
Company is also renovating three Pueblo properties which it obtained in 1996
with approximately 188,400 aggregate square feet and intends to receive public
funds for certain of such properties' renovation from the City and County of
Pueblo in return for certain employment commitments.
The Woodland Hills facility, with approximately 300,000 square feet, is
leased pursuant to a ten year base lease expiring in 2001 on an anchor
full-service gross basis with annual rent in 1997 of approximately $8.6 million.
The Company and its subsidiaries also lease an aggregate of approximately
550,000 square feet of office space in Rancho Cordova, California. The Company's
aggregate rent obligations under these leases were approximately $9.2 million in
1997. These leases expire at various dates through July 2002.
In addition to the Company's office space in Pueblo, Woodland Hills and
Rancho Cordova, the Company and its subsidiaries lease approximately 220 sites
in 27 states, comprising roughly 2.2 million square feet of space.
The Company owns in total approximately 1.7 million square feet of space.
The Company owns approximately 535,000 aggregate square feet of space for health
care centers in California and Arizona and approximately 249,000 square feet of
space for two hospitals in Southern California. The Company also owns
approximately a dozen office buildings, in Arizona, California, Colorado and
Connecticut, which collectively encompass about 840,000 square feet of space.
Management believes that its ownership and rental costs are consistent with
those available for similar space in the applicable local area. The Company's
properties are well maintained, considered adequate and are being utilized for
their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
RESTRICTED STOCK DISPUTE
Following the conversion of Health Net to a for-profit subsidiary of the
Company (the "Conversion"), a restricted stock plan (the "Restricted Stock
Plan") was adopted and restricted shares of the Company ("Restricted Shares")
were issued to certain management employees of Health Net. In February 1993, the
DOC informed Health Net that it believed the issuance of Restricted Shares of
the Company to persons who were stockholders of the Company as of the date of
the Conversion (the "Restricted Share Recipients") violated certain provisions
and terms imposed by the DOC in connection with the Conversion. In March 1993,
the DOC insisted that such restricted shares be rescinded and stated that the
DOC would take steps necessary to revoke the approval of the Conversion if the
issuance of the Restricted Shares was not rescinded (the "Conditional Revocation
Order"). In April 1993 the Restricted Share Recipients agreed to rescind all of
the Restricted Shares issued to them, under express protest to the DOC.
Subsequently, certain of the Restricted Share Recipients filed a formal protest
with the DOC requesting a hearing regarding the correctness of the decision.
On September 14, 1994, Health Net, the Company and certain of the Restricted
Share Recipients, on behalf of all the Restricted Share Recipients (the
"Petitioners"), filed a Petition for Writ of Administrative Mandamus in the
Superior Court of the County of Los Angeles (Case No. BS030426) (the "Writ
Proceeding"). The Writ Proceeding sought to overturn the Conditional Revocation
Order and to require the Commissioner of the DOC to follow procedures set forth
in the Administrative Procedures Act which would result in an administrative
hearing regarding the correctness of the Conditional Revocation Order
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or, in the alternative, to treat the Conditional Revocation Order as a final
agency action and to have the Court order the Commissioner of the DOC to rescind
the Conditional Revocation Order.
On May 25, 1995, the Petitioners filed an amended petition expanding the
original claims and adding a new cause of action for a declaratory judgment that
would revoke the rescission of the issuance of the Restricted Shares. The DOC
and the CWF filed new demurrers to the amended petition on July 3, 1995. At a
hearing on July 28, 1995, the Court sustained the demurrers without leave to
amend. On August 7, 1995, the Petitioners filed objections to the Court's
Statement of Decision. On August 15, 1995, the Court overruled the objections of
the Petitioners to the Court's Statement of Decision. On September 8, 1995, the
Court entered an Order of Dismissal, and the Amended Petition for Writ of
Mandate and Complaint for Declaratory Relief of the Petitioners was dismissed.
On September 19, 1995, the DOC served notice of the entry of the Order of
Dismissal. On October 18, 1995, the Petitioners filed a Notice of Appeal. The
opening brief was filed on March 15, 1996, and the Respondents' briefs were
filed on or around June 13, 1996. The reply briefs to the Respondents' briefs
were timely filed on August 19, 1996 and the Court set oral arguments on the
appeal for November 13, 1996.
On November 26, 1996, the California Court of Appeals entered an order
affirming the trial court decision. During the first week of January 1997, the
Petitioners filed a petition for review asking the California Supreme Court to
consider the matter. The DOC and the CWF filed oppositions to the petition for
review on January 21, 1997 and January 23, 1997, respectively. On March 12,
1997, the California Supreme Court issued a ruling denying the petition for
review. This case is now resolved.
MEDAPHIS CORPORATION
On November 7, 1996 the Company's predecessor HSI filed a lawsuit against
Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive
Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V.
MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414,
Superior Court of California, County of Los Angeles. The lawsuit arises out of
the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July
1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS,
representing over sixteen percent of the total outstanding equity of HDS, voted
its shares in favor of the acquisition of HDS by Medaphis. HSI received as the
result of the acquisition 976,771 shares of Medaphis Common Stock in exchange
for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company
succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has
been substituted for HSI as plaintiff in the suit.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core business, and had artificially
maintained its stock prices through a series of acquisitions and accounting
maneuvers which provided the illusion of growth while hiding the reality of its
weakening financial and business condition. The Company alleges that Medaphis,
Brown and other insiders deceived the Company by presenting materially false
financial statements and by failing to disclose that Medaphis would shortly
reveal a "write off" of up to $40 million in reorganization costs and would
lower its earnings 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.
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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 until June 4, 1998 in order to permit the law
firm to appeal. The Company intends to press for an expedited appeal. Prior to
the stay the case was in the early stages of discovery. No trial date has yet
been set.
MONACELLI VS. GEM INSURANCE COMPANY
On December 29, 1994, a lawsuit entitled MARIO AND CHRISTIAN MONACELLI V.
GEM INSURANCE COMPANY, ET AL (Case No. CV94-20715) was initiated in Maricopa
County (Arizona) Superior Court against Gem Insurance Company, a subsidiary of
the Company ("Gem"), for bad faith and misrepresentation. Plaintiffs
subsequently asserted claims in the same action against their insurance agent,
Mark Davis, for negligence and misrepresentation. The Plaintiffs' claims arose
from the rescission of their health insurance policy based on their alleged
failure to disclose an X-ray, taken one year before the Plaintiffs filled out
their insurance application, which revealed an undiagnosed mass on Mr.
Monacelli's lung. Plaintiffs incurred approximately $70,000 in medical expenses
in connection therewith. Prior to trial, the agent recanted certain portions of
his deposition testimony and admitted that the Plaintiffs had told him that Mr.
Monacelli had undergone certain tests which were not revealed on the
application. Based on this new information, Gem paid the Plaintiffs' medical
expenses with interest.
The case went to trial in April of 1997 against Gem and the agent. A jury
verdict was ultimately rendered awarding the Plaintiffs $1 million in
compensatory damages and assessing fault 97% to Gem and 3% to the agent, Mark
Davis. In addition, the jury awarded $15 million in punitive damages against
Gem. Thereafter, the plaintiffs filed a motion seeking to recover an additional
$4 million in attorneys' fees, and Gem filed post-trial motions for judgment
notwithstanding the verdict, for a new trial and for remittitur of the jury
verdict. Gem's motion for judgment notwithstanding the verdict was denied. The
court granted Gem's motion for remittitur and remitted the jury verdict to an
award of $1 million in compensatory damages and $2 million in punitive damages.
The court further ordered that if the plaintiffs did not accept the remittitur
order, Gem's motion for new trial would be granted. The plaintiffs accepted the
court's remittitur. Their motion for attorneys' fees is currently pending.
Notwithstanding the plaintiffs' acceptance of the court's remittitur, Gem plans
to appeal the verdict.
In addition, on July 15, 1997 Gem filed a complaint against Mr. Davis and
his spouse in Maricopa County (Arizona) Superior Court (Case No. CV97-13053)
asserting a claim for indemnity against Mr. Davis with respect to the Monacelli
case.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of the
Company, either through solicitation of proxies or otherwise, during the fourth
quarter of the year ended December 31, 1997.
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OTHER INFORMATION
REVOLVING CREDIT FACILITY
On July 8, 1997 the Company entered into a Credit Agreement with the banks
identified therein (the "Banks") and Bank of America National Trust and Savings
Association ("Bank of America"), in its capacity as the Administrative Agent,
pursuant to which the Company obtained an unsecured five-year $1.5 billion
revolving credit facility maturing on July 7, 2002. The Credit Agreement
replaced (i) the Company's prior Amended and Restated Credit Agreement, dated as
of April 26, 1996, with Bank of America, as agent, providing for a $700 million
unsecured revolving credit facility and (ii) FHC's prior (A) Revolving Credit
Agreement, dated as of December 5, 1994, with Citicorp USA, Inc., as agent,
providing for a $300 million unsecured revolving credit facility and (B)
Revolving Credit Agreement, dated as of December 17, 1996, with Citibank, N.A.,
as administrative agent, providing for a $200 million unsecured revolving credit
facility.
The Credit Agreement contains customary representations and warranties,
affirmative and negative covenants and events of default. Specifically, Section
7.11 of the Credit Agreement provides that the Company and its subsidiaries may,
so long as no event of default exists: (i) declare and distribute stock as a
dividend; (ii) purchase, redeem or acquire its stock, options and warrants with
the proceeds of concurrent public offerings; and (iii) declare and pay dividends
or purchase, redeem or otherwise acquire its capital stock, warrants, options or
similar rights with cash subject to certain specified limitations.
Under the Credit Agreement, as amended pursuant to a Letter Agreement dated
March 27, 1998 (the "Credit Facility Letter Agreement") with the Banks, the
Company is: (i) obligated to maintain certain covenants keyed to the Company's
financial condition and performance (including a Total Leverage Ratio and Fixed
Charge Ratio); (ii) obligations to limit liens; (iii) subject to customary
covenants, including (A) disposition of assets only in the ordinary course and
generally at fair value and (B) restrictions on acquisitions, mergers,
consolidations, loans, leases, joint ventures, contingent obligations and
certain transactions with affiliates; (iv) permitted to sell the Company's
workers' compensation insurance business, provided that the net proceeds shall
be applied towards repayment of the outstanding Loans under the Credit
Agreement; and (v) permitted to incur additional indebtedness in an aggregate
amount not to exceed $1,000,000,000 upon certain terms and conditions, including
mandatory prepayment of the outstanding Loans with a certain portion of the
proceeds from the issuance of such indebtedness, resulting in a permanent
reduction of the aggregate amount of commitments under the Credit Agreement by
the amount so prepaid. The Credit Facility Letter Agreement, a copy of which is
filed as Exhibit 10.70 to this Annual Report on Form 10-K, also provided for an
increase in the interest and facility fees under the Credit Agreement.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend
distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights and the expiration of the Rights and in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then outstanding and no separate Rights Certificates will be distributed.
Subject to certain exceptions contained in the Rights Agreement dated as of June
1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights
Agent (the "Rights Agreement"), the Rights will separate from the Common Stock
in the event any person acquires 15% or more of the outstanding Class A Common
Stock, the Board of Directors of the Company declares a holder of 10% or more to
the outstanding Class A Common Stock to be an "Adverse Person," or any person
commences a tender offer for 15% of the Class A Common Stock (each event causing
a "Distribution Date").
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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.
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.
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.
In addition, the CWF Shareholder Agreement, in conjunction with the Letter
Agreement executed by the Company and the Trustees of a Trust (holding shares on
behalf of the HNMH Stockholders) on March 9, 1995 and ratified by the Company's
Board of Directors on March 16, 1995 (the "Letter Agreement") requires the CWF
to offer its shares of Class B Common Stock to the Company prior to selling such
shares to any other person. In this respect, the CWF Shareholder Agreement
permits the CWF to offer and sell up to 80% of the CWF's interest in the Class B
Common Stock (or all but 5,136,830 of such shares) to the Company prior to
December 31, 1998. The CWF Shareholder Agreement, in conjunction with the Letter
Agreement, requires the CWF to provide the Company with notice on or before
January 31 of each year setting forth the number of shares, if any, being
offered to the Company. The Company then has 45 days following receipt of such
notice to notify the CWF of its intention to purchase such number of shares.
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On January 27, 1997, the CWF provided the Company with notice of its offer
to sell 3,852,653 shares of Class B Common Stock, provided that at the Company's
option the number of shares could be increased to not more than 5,000,000
shares. Pursuant to such offer and subsequent letter agreements (collectively,
the "1997 Notice Materials") the CWF agreed to extend until June 20, 1997 the
time by which the Company could notify the CWF of its intention to purchase or
redeem such number of shares of Class B Common Stock. Accordingly, after
appropriate notice was given and effective June 27, 1997, the Company redeemed
4,550,000 shares of Class B Common Stock from the CWF at a price of $24.469 per
share.
In addition, on June 18, 1997, the Company provided its consent under the
CWF Shareholder Agreement to permit the CWF to sell 3,000,000 shares of Class B
Common Stock to an unrelated third party. Pursuant to the 1997 Notice Materials,
the CWF also retained the right to sell the balance of the 5,000,000 shares not
redeemed by the Company (or up to 450,000 shares) to unrelated third parties.
Sales of such 450,000 shares to unrelated third parties were consummated
throughout August of 1997. On November 6, 1997, the Company also provided its
consent under the CWF Shareholder Agreement to permit the CWF to sell 1,000,000
shares of Class B Common Stock to an unrelated third party. Pursuant to the
Company's Certificate of Incorporation, such 3,000,000 shares, 450,000 shares
and 1,000,000 shares of Class B Common Stock automatically converted into shares
of Class A Common Stock in the hands of such third parties.
As a result of such transactions, the CWF now holds 10,297,642 shares of
Class B Common Stock and, as of December 31, 1997, approximately $18.8 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 additional 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. The Company is
responding to the CWF notification in accordance with the terms of the CWF
Registration Rights Agreement. Any shares of Class B Common Stock sold by CWF to
third parties will automatically convert on a one-for-one basis into shares of
Class A Common Stock.
REDEMPTION OF THE FHC PUBLIC DEBT
FHC, a subsidiary of the Company, consummated a cash tender offer on June
27, 1997 of all of its $125 million outstanding principal amount of 7 3/4%
Senior Notes due 2003 (the "FHC Notes").
The price paid for each tendered FHC Note was based on a fixed spread of 25
basis points over the reference yield of the 6 1/4% U.S. Treasury Notes due
February 15, 2003, plus accrued and unpaid interest to the applicable settlement
date. Accordingly, the reference yield was 6.365%, the reference yield plus the
fixed spread was 6.615% and the purchase price per $1,000 principal amount of
the FHC Notes was $1,054.77, plus accrued and unpaid interest.
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby filing 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 following factors should be considered
in
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conjunction with any discussion of operations or results by the Company or its
representatives, including any forward-looking discussion, as well as comments
contained in press releases, presentations to securities analysts or investors,
or other communications by the Company.
In making these statements, the Company is not undertaking to address or
update each factor in future filings or communications regarding the Company's
business or results, and is not undertaking to address how any of these factors
may have caused changes to discussions or information contained in previous
filings or communications. In addition, certain of these matters may have
affected the Company's past results and may affect future results.
HEALTH CARE COSTS. A large portion of the revenue received by the Company
is expended to pay the costs of health care services or supplies delivered to
its members. The total health care costs incurred by the Company are affected by
the number of individual services rendered and the cost of each service. Much of
the Company's premium revenue is set in advance of the actual delivery of
services and the related incurring of the cost, usually on a prospective annual
basis. While the Company attempts to base the premiums it charges at least in
part on its estimate of expected health care costs over the fixed premium
period, competition, regulations and other circumstances may limit the Company's
ability to fully base premiums on estimated costs. In addition, many factors may
and often do cause actual health care costs to exceed those costs estimated and
reflected in premiums. These factors may include increased utilization of
services, increased cost of individual services, catastrophes, epidemics,
seasonality, new mandated benefits or other regulatory changes and insured
population characteristics.
The managed care industry is labor intensive and its profit margin is low.
Hence, it is especially sensitive to inflation. Health care industry costs have
been rising annually at rates higher than the Consumer Price Index. Increases in
medical expenses without corresponding increases in premiums could have a
material adverse effect on the Company.
PHARMACEUTICAL COSTS. The costs of pharmaceutical products and services are
increasing faster than the costs of other medical products and services. Thus,
the Company's HMOs face ever higher pharmaceutical expenses. Though the
Specialty Services Division's managed pharmaceutical care operations endeavor to
keep pharmaceutical costs low for the Company's HMOs, there can be no assurances
that the Company will be able to do so in the face of rapidly rising prices.
Also, statutory and regulatory changes may significantly alter the Company's
ability to manage pharmaceutical costs through restricted formularies of
products available to the Company's health plan members.
MEDICAL MANAGEMENT. The Company's profitability is dependent, to a large
extent, upon its ability to accurately project and manage health care costs,
including without limitation, appropriate benefit design, utilization review and
case management programs, and its risk sharing arrangements with providers,
while providing members with quality health care. For example, high
out-of-network utilization of health care providers and services may have
significant adverse affects on the Company's ability to manage health care costs
and member utilization of health care. There can be no assurance that the
Company through its medical management programs will be able to continue to
manage medical costs sufficiently to restore and/ or maintain profitability in
all of its product lines.
MARKETING. The Company markets its products and services through both
employed sales people and independent sales agents. Although the Company has a
number of such sales employees and agents, if certain key sales employees or
agents or a large subset of such individuals were to leave the Company, its
ability to retain existing customers and members could be impaired. In addition,
certain of the Company's customers or potential customers consider rating,
accreditation or certification of the Company by various private or governmental
bodies or rating agencies necessary or important. Certain of the Company's
health plans or other business units may not have obtained or may not desire or
be able to obtain or maintain such accreditation or certification which could
adversely affect the Company's ability to obtain or retain business with such
customers.
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The managed health care industry has recently received a significant amount
of negative publicity. Such general publicity, or any negative publicity
regarding the Company in particular, could adversely affect the Company's
ability to sell its products or services or could create regulatory problems for
the Company. Furthermore, recently, the managed care industry has experienced
significant merger and acquisition activity. Speculation or uncertainty about
the Company's future could adversely affect the ability of the Company to market
its products.
COMPETITION. The Company competes with a number of other entities in the
geographic and product markets in which it operates, some of which other
entities may have certain characteristics or capabilities which give them an
advantage in competing with the Company. The Company believes there are few
barriers to entry in these markets, so that the addition of new competitors can
occur relatively easily. Certain of the Company's customers may decide to
perform for themselves functions or services formerly provided by the Company,
which could result in a decrease in the Company's revenues. Certain of the
Company's providers may decide to market products and services to Company
customers in competition with the Company. In addition, significant merger and
acquisition activity has occurred in the industry in which the Company operates
as well as in industries which act as suppliers to the Company such as the
hospital, physician, pharmaceutical and medical device industries. This activity
may create stronger competitors and/or result in higher health care costs.
Provider service organizations may be created by health care providers to offer
competing managed care products. To the extent that there is strong competition
or that competition intensifies in any market, the Company's ability to retain
or increase customers, its revenue growth, its pricing flexibility, its control
over medical cost trends and its marketing expenses may all be adversely
affected.
PROVIDER RELATIONS. One of the significant techniques the Company uses to
manage health care costs and utilization and monitor the quality of care being
delivered is contracting with physicians, hospitals and other providers. Because
of the large number of providers with which the Company's health plans contract,
the Company currently believes it has a limited exposure to provider relations
issues. In any particular market, however, providers could refuse to contract
with the Company, demand higher payments or take other actions which could
result in higher health care costs, less desirable products for customers and
members or difficulty in meeting regulatory or accreditation requirements.
In some markets, certain providers, particularly hospitals,
physician/hospital organizations or multi-specialty physician groups, may have
significant market positions or even monopolies. Many of these providers may
compete directly with the Company. If such providers refuse to contract with the
Company or utilize their market position to negotiate favorable contracts or
place the Company at a competitive disadvantage, the Company's ability to market
products or to be profitable in those areas could be adversely affected.
ADMINISTRATION AND MANAGEMENT. The level of administrative expense is a
partial determinant of the Company's profitability. While the Company attempts
to effectively manage such expenses, increases in staff-related and other
administrative expenses may occur from time to time due to business or product
start-ups or expansions, growth or changes in business, acquisition, regulatory
requirements or other reasons. Such expense increases are not clearly
predictable and increases in administrative expenses may adversely affect
results.
The Company currently believes it has a relatively experienced, capable
management staff. Loss of certain managers or a number of such managers could
adversely affect the Company's ability to administer and manage its business.
RESTRUCTURING COSTS. In connection with the FHS Combination, the Company
adopted a restructuring plan during the quarter ended June 30, 1997, the
principal elements of which include: a workforce reduction; the consolidation of
employee benefit plans; the consolidation of facilities in geographic locations
where office space is duplicated; the consolidation of overlapping provider
networks; and the consolidation of information systems at all locations to
standardized systems. The Company anticipates the
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<PAGE>
plan will be substantially completed by the end of 1998. During the quarter
ended December 31, 1997, the Company adopted an additional restructuring plan
and recorded a restructuring charge related to the integration of the Company's
Eastern Division health plans in connection with its acquisition of PHS and
FOHP. Although the Company believes it is "on track" to timely complete its
restructuring plans, there can be no assurances that unforeseen difficulties in
accomplishing any one or more of the elements of the plans will substantially
delay the completion of the plans and materially adversely affect the Company's
future profitability.
MANAGEMENT INFORMATION SYSTEMS. The Company's business is significantly
dependent on effective information systems. The information gathered and
processed by the Company's management information systems assists the Company
in, among other things, pricing its services, monitoring utilization and other
cost factors, processing provider claims, billing its customers on a timely
basis and identifying accounts for collection. The Company has many different
information systems for its various businesses. The Company is in the process of
attempting to reduce the number of systems and also to upgrade and expand its
information systems capabilities. Any difficulty associated with or failure to
successfully implement such updated management information systems, or any
inability to expand processing capability in the future in accordance with its
business needs, could result in a loss of existing customers and difficulty in
attracting new customers, customer and provider disputes, regulatory problems,
increases in administrative expenses or other adverse consequences. In addition,
the Company may, from time-to-time, obtain significant portions of its
systems-related or other services or facilities from independent third parties
which may make the Company's operations vulnerable to such third parties'
failure to perform adequately.
The Company also recognizes that the arrival of the Year 2000 poses a unique
worldwide challenge to the ability of virtually all computer systems to
recognize the date change from 1999 to 2000 (the "Year 2000 Issue") and has
begun to assess and modify its computer applications and business processes to
provide for their continued functionality given the Year 2000 Issue. 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 (both external and internal) 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 material miscalculations causing disruptions
of operations, including, among other things, the inability to process
transactions, prepare invoices or engage in normal business activities.
There can be no assurance that the systems of the Company or of other
companies on which the Company's systems rely will be timely converted and/or
modified, and such failure could have a material adverse effect on the Company
and its operations. The costs of the Company's Year 2000 Issue projects and the
timetable in which the Company plans to complete the Year 2000 Issue compliance
requirements set forth elsewhere in this Annual Report on Form 10-K are based on
estimates derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. There can be no assurance that these estimates will be achieved
and actual results could differ materially from these plans and estimates.
At this time it is also unclear as to the extent of existing insurance
coverage, if any, the Company may have to cover these potential Year 2000 Issue
liabilities.
MANAGEMENT OF GROWTH. The Company has made several large acquisitions in
recent years, and has an active ongoing acquisition program. Failure to
effectively integrate acquired operations could result in increased
administrative costs or customer confusion or dissatisfaction. The Company may
also not be able to manage this growth effectively, including not being able to
continue to develop processes and systems to support its growing operations.
There can be no assurance that the Company will be able to maintain its
historical growth rate.
POTENTIAL DIVESTITURES. 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 its
25
<PAGE>
businesses or operations should be divested. In this regard the Company (i) has
decided to divest its workers' compensation insurance business, (ii) is
considering divestiture of direct ownership of two southern California
hospitals, (iii) is currently reviewing plans to exit its HMO operations in the
states of Texas, Louisiana and Oklahoma and (iv) is analyzing the strategic fit
of its Denticare managed dental operations with the ongoing operations and
operating strategy of the Company. There can be no assurance that the Company
will complete any of these transactions. Further, entering into and evaluating
these transactions may entail certain risks and uncertainties in addition to
those which may result from any such change in the Company's business
operations, including but not limited to, extraordinary transaction costs,
unknown indemnification liabilities or unforeseen administrative needs, any of
which could result in reduced revenues, increased charges, post transaction
administrative costs or could otherwise have a material adverse effect on the
Company's business, financial condition or results of operations. See "Item 1.
Business--Discontinued Operations and Anticipated Divestitures."
GOVERNMENT PROGRAMS AND REGULATION. The Company's business is subject to
extensive federal and state laws and regulations, including, but not limited to,
financial requirements, licensing requirements, enrollment requirements and
periodic examinations by governmental agencies. The laws and rules governing the
Company's business and interpretations of those laws and rules are subject to
frequent change. For example, as described earlier in this Annual Report on Form
10-K, in the section entitled "California HMO Regulations," the California
legislature may in 1998 make significant changes in the laws regulating HMOs
operating in that state. Existing or future laws and rules could force the
Company to change how it does business and may restrict the Company's revenue
and/or enrollment growth and/or increase its health care and administrative
costs. In particular, the Company's HMO and insurance subsidiaries are subject
to regulations relating to cash reserves, minimum net worth, premium rates and
approval of policy language and benefits. Although such regulations have not
significantly impeded the growth of the Company's business to date, there can be
no assurance that the Company will be able to continue to obtain or maintain
required governmental approvals or licenses or that regulatory changes will not
have a material adverse effect on the Company's business. Delays in obtaining or
failure to obtain or maintain such approvals, or moratoria imposed by regulatory
authorities, could adversely affect the Company's revenue or the number of its
members, could increase costs, or could adversely affect the Company's ability
to bring new products to market as forecasted.
A significant portion of the Company's revenues relate to federal, state and
local government health care coverage programs, such as Medicare and Medicaid
programs. Such contracts carry certain risks such as higher comparative medical
costs, government regulatory and reporting requirements, the possibility of
reduced or insufficient government reimbursement in the future, and higher
marketing and advertising costs per member as the result of marketing to
individuals as opposed to groups. Such risk contracts also are generally subject
to frequent change including changes which may reduce the number of persons
enrolled or eligible, reduce the revenue received by the Company or increase the
Company's administrative or health care costs under such programs. In the event
government reimbursement were to decline from projected amounts, the Company's
failure to reduce the health care costs associated with such programs could have
a material adverse effect upon the Company's business. Changes to such
government programs in the future may also affect the Company's willingness to
participate in such programs.
The Company is also subject to various governmental audits and
investigations. Such activities could result in the loss of licensure or the
right to participate in certain programs, or the imposition of fines, penalties
and other sanctions. In addition, disclosure of any adverse investigation or
audit results or sanctions could negatively affect the Company's reputation in
various markets and make it more difficult for the Company to sell its products
and services.
The amount of government receivables represents the Company's best estimate
of government liability. The receivables are generally subject to government
audit and negotiation and the final amounts actually received may be greater or
less than the amounts recognized by the Company.
26
<PAGE>
LOSS RESERVES. The Company's loss reserves are estimates of future costs
based on various assumptions. The accuracy of these estimates may be affected by
external forces such as changes in the rate of inflation, the regulatory
environment, the judicious administration of claims, medical costs and other
factors. Included in the loss reserves are estimates for incurred but not
reported ("IBNR") claims which are established for unreported claims and adverse
loss developments relating to current and prior years. Estimates are continually
monitored and reviewed and, as settlements are made or estimates adjusted,
differences are reflected in current operations. Such estimates are subject to
the impact of changes in the regulatory environment and economic conditions.
Given the inherent variability of such estimates, the actual liability could
differ significantly from the amounts provided. Moreover, if the assumptions on
which the estimates are based prove to be incorrect and reserves are inadequate
to cover the Company's actual experience, the Company's profitability could be
adversely affected.
LITIGATION AND INSURANCE. The Company is subject to a variety of legal
actions to which any corporation may be subject, including employment and
employment discrimination-related suits, employee benefit claims, breach of
contract actions, tort claims, shareholder suits, including for securities
fraud, and intellectual property related litigation. In addition, because of the
nature of its business, the Company incurs and likely will continue to incur
potential liability for claims related to its business, such as failure to pay
for or provide health care, poor outcomes for care delivered or arranged,
provider disputes, including disputes over withheld compensation and claims
related to self-funded business. In some cases, substantial non-economic or
punitive damages may be sought. While the Company currently has insurance
coverage for some of these potential liabilities, others may not be covered by
insurance, the insurers may dispute coverage or the amount of insurance may not
be enough to cover the damages awarded. In addition, certain types of damages,
such as punitive damages, may not be covered by insurance and insurance coverage
for all or certain forms of liability may become unavailable or prohibitively
expensive in the future.
STOCK MARKET. Recently, the market prices of the securities of certain of
the publicly-held companies in the industry in which the Company operates have
shown volatility and sensitivity in response to many factors, including public
communications regarding managed care, legislative or regulatory actions, health
care cost trends, pricing trends, competition, earning or membership reports of
particular industry participants, and acquisition activity. There can be no
assurances regarding the level of stability of the Company's share price at any
time or the impact of these or any other factors on the share price.
RECENT DEVELOPMENTS
FOUNDATION HEALTH CORPORATION. Effective April 1, 1997, the Company was
formed pursuant to the FHS Combination involving HSI and FHC. Pursuant to the
FHS Combination, FHC merged into a newly created subsidiary of HSI and each
outstanding share of FHC capital stock was converted into 1.3 shares of HSI's
Class A Common Stock. As part of the FHS Combination HSI remained as the
ultimate parent company and changed its name to "Foundation Health Systems,
Inc." The FHS Combination was tax-free and accounted for as a pooling of
interests.
The Merger Agreement governing the FHS Combination also provided for, among
other things, amendment of the Company's By-Laws to effect certain changes to
the governance provisions of the Company following the FHS Combination,
including provisions related to the structure of the Company's Board of
Directors and the committees of the Company's Board of Directors.
ADVANTAGE HEALTH. On April 1, 1997 the Company completed the acquisition of
Advantage Health, the trade name for a group of managed health care companies
based in Pittsburgh, PA for $12.5 million in cash. Advantage Health has
approximately 35,000 full-risk members. In 1996 Advantage Health recorded
revenues of approximately $56 million, with about ninety percent (90%) from
health plan operations. The Company purchased Advantage Health from St. Francis
Health System, which has a short-term option to reacquire a twenty percent (20%)
interest in Advantage Health for $2.5 million. Advantage Health remains a party
to long-term provider agreements with the St. Francis Health System.
27
<PAGE>
PACC. On October 22, 1997 the Company completed its acquisition of PACC HMO
and PACC Health Plans, each an Oregon non-profit corporation (collectively,
"PACC") pursuant to an Agreement and Plan of Reorganization, dated as of March
20, 1997 and effective on April 9, 1997 (the "Reorganization Agreement"), among
the Company, QualMed Health Plan, Inc., an Oregon corporation and an indirect
wholly-owned subsidiary of the Company ("QMO"), and PACC.
As part of such transaction and as provided for in the Reorganization
Agreement, PACC organized Northwest Health Foundation (the "PACC Foundation") as
an Oregon nonprofit public benefit corporation which received the net
acquisition consideration proceeds. The PACC Foundation also assumed certain of
PACC's obligations under the Reorganization Agreement (including indemnification
obligations) at closing. Although the total purchase price for PACC was $68
million, under the Reorganization Agreement the Company received an
approximately $10.1 million credit for certain physician payment obligations of
PACC it assumed, and was permitted to transfer to the PACC Foundation an
aggregate of $14.3 million in investments previously owned by PACC. As a result,
the Company paid the PACC Foundation a net purchase price of approximately $43.7
million.
The transaction was structured as a merger of PACC into QMO, with QMO as the
surviving corporation which was renamed QualMed Plans for Health of Oregon, Inc.
The merger was immediately preceded by an acquisition and assumption by QualMed
Washington Health Plan, Inc. (a Washington corporation and indirect wholly-owned
subsidiary of the Company) of various contracts of PACC relating to PACC's
health care service contractor business in the state of Washington and the
acquisition and assumption by QualMed Health & Life Insurance Company (an
insurance company domesticated under the laws of the state of Colorado and an
indirect wholly-owned subsidiary of the Company) of various contracts of PACC
relating to PACC's health maintenance organization business in the state of
Washington.
Immediately prior to its acquisition by the Company, PACC (based in
Clackamas, Oregon) had health plan operations in Oregon and Washington, with
approximately 116,000 medical members (approximately 108,000 of which were
located in the Portland, Oregon area). Approximately 67,000 of such members were
in PACC HMO (a commercial health maintenance organization), with the balance in
PACC Health Plans (primarily a preferred provider organization).
FIRST OPTION HEALTH PLAN. On April 30, 1997, the Company purchased
convertible debentures (the "FOHP Debentures") of FOHP, Inc., a New Jersey
corporation ("FOHP"), in the aggregate principal amount of approximately $51.7
million. The FOHP Debentures were convertible into up to 71 percent of the
fully-diluted equity of FOHP at the Company's discretion, and the Company so
converted the FOHP Debentures effective December 1, 1997. Additionally,
effective December 8, 1997, the Company purchased additional convertible
debentures of FOHP in the aggregate principal amount of approximately $29
million. The Company immediately converted approximately $18.9 million of these
additional convertible debentures of FOHP into 92,804,003 shares of Common Stock
of FOHP. As a result, the Company now owns approximately 98% of the outstanding
shares of FOHP common stock. The remaining approximately $10 million of
convertible debentures of FOHP owned by the Company may be converted into
fully-diluted equity of FOHP at the Company's election. Upon the conversion of
all of the convertible debentures of FOHP into fully-diluted equity of FOHP, the
Company will own approximately 99.99% of the total outstanding equity of FOHP.
Effective December 31, 1997, the Company purchased nonconvertible debentures
in the amount of $24 million from FOHP. The debentures mature on December 31,
2002. The debentures were issued to the Company in consideration for additional
capital contributions made by the Company pursuant to the Amended and Restated
Securities Purchase Agreement, dated February 10, 1997, and as amended March 13,
1997, among the Company, FOHP, and First Option Health Plan of New Jersey, Inc.
("FOHP-NJ"), a wholly-owned subsidiary of FOHP (collectively, the "Definitive
Agreements"). Pursuant to the Definitive Agreements, at any time during the 1999
calendar year, the Company may acquire any
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<PAGE>
remaining shares of FOHP not owned by the Company pursuant to a tender offer,
merger, combination or other business combination transaction for consideration
(to be paid in cash or stock of the Company) equal to the value of such FOHP
stock based on appraiser determinations.
FOHP (headquartered in Neptune, New Jersey) is owned by physicians,
hospitals and other health care providers and is the sole shareholder of
FOHP-NJ, a New Jersey corporation. FOHP-NJ is a managed health care company
providing commercial products for businesses and individuals, along with
Medicare, Medicaid and workers' compensation programs. FOHP-NJ currently has
more than 250,000 members in New Jersey enrolled in its commercial, Medicare,
Medicaid and PPO programs.
The Company also provides a variety of management services to FOHP,
including provider contracting, utilization review and quality assurance and
employee relations, sales and marketing and strategic planning. The Company
receives monthly management fees from FOHP for such services in an amount equal
to two percent of FOHP's premium revenue. The Company, at its option, may also
provide information systems and claims processing services to FOHP.
Approximately $1,700,000 of the $51.7 million principal amount of the original
FOHP Debentures reflected fees paid to the Company by FOHP for such management
services provided by the Company prior to the closing of the sale of the FOHP
Debentures; such principal amount was immediately converted into FOHP common
stock.
PHYSICIANS HEALTH SERVICES, INC. On December 31, 1997, the Company
completed its acquisition of Physicians Health Services, Inc. ("PHS"), a
449,000-member health plan with operations in the New York metropolitan area,
including northern New Jersey, and throughout the state of Connecticut. The
Company paid approximately $265 million for the approximately nine million PHS
shares then outstanding and caused PHS to cash-out approximately $6 million in
PHS employee stock options as part of the acquisition. The Company funded the
acquisition with cash on hand and existing bank credit lines.
In addition, PHS is a joint venture partner with The Guardian Life Insurance
Company of America ("Guardian") to market the "Healthcare Solutions" health
insurance products in the New York City metropolitan area. The Guardian and the
Company have indicated that they intend to work cooperatively under the current
joint venture agreements and to build and expand Healthcare Solutions products
in the tri-state area.
COMMERCIAL COMPENSATION INSURANCE COMPANY. On May 14, 1997 Business
Insurance Group, Inc. ("BIG"), a subsidiary of the Company, acquired the
Christiania General Insurance Corporation of New York, now known as Commercial
Compensation Insurance Company ("CCIC"). CCIC was purchased by BIG to more
effectively compete in the workers' compensation and group accident and health
markets outside of California. CCIC is currently licensed in 46 states with 26
workers' compensation licenses and 26 group accident and health licenses.
GEM INSURANCE COMPANY. Gem Insurance Company ("Gem"), a subsidiary of the
Company, had previously reached definitive agreement prior to the end of the
second quarter of 1997 regarding a reinsurance transaction with The Centennial
Life Insurance Company ("Centennial"). Pursuant to this agreement, Centennial
was to reinsure, administer and manage Gem's accident and health, life and
annuity policies in exchange for a reinsurance premium. The transaction was not
ultimately consummated due to the unanticipated failure to satisfy certain
closing conditions including the failure to receive certain regulatory
approvals. Gem established a reserve in the amount of $57.5 million for the
estimated premium deficiency related to these policies.
Since October of 1997, Gem has implemented a restructuring plan to reduce
operating losses and its in force insurance risk. In 1997 the majority of Gem's
losses were related to business in Utah and Nevada, and Gem initiated a
withdrawal from the Nevada insurance markets on September 20, 1997, and began
restructuring Utah insurance products in the fourth quarter of 1997 (which
restructuring was completed on March 11, 1998). Commission rates were also
reduced to market-level rates in all states and general agents were terminated
in Nevada and Utah.
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Gem is currently reviewing its restructuring alternatives with the
Departments of Insurance in the other states in which it operates. These
alternatives include a potential restructuring of the business or withdrawal.
Gem is currently licensed in nine states with business in seven of such states.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the
Company's Class A Common Stock, par value $.001 per share (the "Class A Common
Stock") on The New York Stock Exchange, Inc. ("NYSE") since January 2, 1995.
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
Calendar Quarter - 1995
First Quarter................................................................ 33 7/8 24 7/8
Second Quarter............................................................... 34 1/8 25
Third Quarter................................................................ 30 3/8 27 7/8
Fourth Quarter............................................................... 34 1/4 29 1/4
Calendar Quarter - 1996
First Quarter................................................................ 37 1/8 30 3/8
Second Quarter............................................................... 37 1/8 26 7/8
Third Quarter................................................................ 28 7/8 19 3/8
Fourth Quarter............................................................... 29 1/8 22 5/8
Calendar Quarter - 1997
First Quarter................................................................ 30 3/4 23 1/8
Second Quarter............................................................... 33 24 1/4
Third Quarter................................................................ 33 15/16 29 11/16
Fourth Quarter............................................................... 33 3/8 22 1/16
Calendar Quarter - 1998
First Quarter (through March 16, 1998)....................................... 29 1/16 22 1/4
</TABLE>
On March 16, 1998, the last reported sales price per share of the Class A
Common Stock was $28 11/16 per share.
DIVIDENDS
No dividends have been paid by the Company during the preceding two fiscal
years. The Company has no present intention of paying any dividends on its
Common Stock.
The Company is a holding company and, therefore, its ability to pay
dividends depends on distributions received from its subsidiaries, which are
subject to regulatory net worth requirements and certain additional state
regulations which may restrict the declaration of dividends by HMOs, insurance
companies and licensed managed health care plans. The payment of any dividend is
at the discretion of the Company's Board of Directors and depends upon the
Company's earnings, financial position, capital requirements and such other
factors as the Company's Board of Directors deems relevant.
Under the Credit Agreement entered into on July 8, 1997 with Bank of America
as agent, the Company cannot declare or pay cash dividends to its stockholders
or purchase, redeem or otherwise acquire shares of its capital stock or
warrants, rights or options to acquire such shares for cash except to the extent
permitted under such Credit Agreement as described elsewhere in this Annual
Report on Form 10-K.
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<PAGE>
HOLDERS
As of March 24, 1998, there were approximately 2,000 holders of record and
an additional approximately 25,500 beneficial holders of Class A Common Stock.
The California Wellness Foundation (the "CWF") is the only holder of record of
the Company's Class B Common Stock, par value $.001 per share (the "Class B
Common Stock") which constitutes approximately 8.5% of the Company's aggregate
equity. Under the Restated Certificate, shares of the Company's Class B Common
Stock have the same economic benefits as shares of the Company's Class A Common
Stock, but are non-voting. Upon the sale or other transfer of shares of Class B
Common Stock by the CWF to an unrelated third party, such shares automatically
convert into Class A Common Stock.
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ITEM 6. SELECTED FINANCIAL DATA
FOUNDATION HEALTH SYSTEMS, INC.
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------------------------
1997 1996 1995 1994 1993
---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues
Health plan premiums................................ $5,829,444 $5,395,125 $4,557,214 $3,863,965 $3,196,112
Government contracts................................ 949,168 908,730 279,380 209,980 860,498
Specialty services.................................. 342,107 316,993 210,533 139,853 111,626
Investment and other income......................... 114,300 88,392 66,510 51,698 42,151
---------- --------- --------- --------- ---------
7,235,019 6,709,240 5,113,637 4,265,496 4,210,387
---------- --------- --------- --------- ---------
Expenses
Health plan services................................ 4,912,532 4,598,074 3,643,463 3,091,890 2,562,650
Government health care services..................... 711,757 706,076 174,040 147,629 688,800
Specialty services.................................. 290,319 289,744 182,380 121,299 101,391
Selling, general and administrative................. 851,826 859,996 657,275 536,209 531,558
Amortization and depreciation....................... 98,353 112,916 89,356 66,741 55,832
Interest............................................ 63,555 45,372 33,463 23,081 26,643
Merger, restructuring, and other costs.............. 338,425 44,108 20,164 125,379 29,725
Gem costs........................................... 57,500
---------- --------- --------- --------- ---------
7,324,267 6,656,286 4,800,141 4,112,228 3,996,599
---------- --------- --------- --------- ---------
Income (loss) from continuing operations before income
taxes and minority interest......................... (89,248) 52,954 313,496 153,268 213,788
Income tax provision (benefit)........................ (21,418) 14,124 124,345 70,169 98,399
Minority interest..................................... 7,275
---------- --------- --------- --------- ---------
Income (loss) from continuing operations.............. (67,830) 38,830 189,151 83,099 108,114
Discontinued operations:
Income (loss) from operations, net of tax........... (30,409) 25,084 3,028 18,434 6,218
Gain (loss) on disposition, net of tax.............. (88,845) 20,317
---------- --------- --------- --------- ---------
Net income (loss)..................................... $ (187,084) $ 84,231 $ 192,179 $ 101,533 $ 114,332
---------- --------- --------- --------- ---------
---------- --------- --------- --------- ---------
Basic earnings (loss) per share
Continuing operations............................. $ (0.55) $ 0.31 $ 1.54 $ 0.73 $ 0.96
Discontinued operations........................... (0.25) 0.20 0.02 0.16 0.06
Discontinued operations gain (loss) on
disposition..................................... (0.72) 0.16
---------- --------- --------- --------- ---------
Net............................................... $ (1.52) $ 0.67 $ 1.56 $ 0.89 $ 1.02
---------- --------- --------- --------- ---------
---------- --------- --------- --------- ---------
Diluted earnings (loss) per share
Continuing operations............................. $ (0.55) $ 0.31 $ 1.53 $ 0.72 $ 0.95
Discontinued operations........................... (0.25) 0.20 0.02 0.16 0.05
Discontinued operations gain (loss) on
disposition..................................... (0.72) 0.16
---------- --------- --------- --------- ---------
Net............................................... $ (1.52) $ 0.67 $ 1.55 $ 0.88 $ 1.00
---------- --------- --------- --------- ---------
---------- --------- --------- --------- ---------
Weighted average common and common stock equivalent
shares outstanding:
Basic............................................... 123,333 124,453 122,741 113,723 112,294
Diluted............................................. 123,821 124,966 123,674 115,658 113,879
Balance Sheet Data
Cash & cash equivalents and investments............. $1,125,246 $1,137,133 $ 885,974 $ 872,244 $ 840,185
Total assets........................................ 4,076,350 3,423,776 2,733,765 2,218,506 1,775,475
Notes payable and capital leases--noncurrent........ 1,308,979 791,618 547,522 301,356 360,687
Stockholders' equity................................ 895,974 1,183,411 1,068,255 877,466 522,622
</TABLE>
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ITEM 7. 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
REVENUES
The Company's revenues grew by $525.8 million or 7.8% for the year ended
December 31, 1997 as compared to the same period in 1996. Growth in revenues for
the year was due to slightly higher health plan premiums for the Company's
commercial membership and membership growth in Medicaid contracts in California,
commercial membership growth on the east coast, and the partial year impact of
acquisitions that occurred in the second and fourth quarters of 1997. Higher
investment and other income includes gains on sale of the Company's investments
in FPA Medical Management, Inc. ("FPA"), interest received on notes and rental
income on real estate from FPA that resulted from the sale of the Company's
physician practice management operations during 1996 to FPA, a gain on the
redemption of notes receivable by FPA held by the Company, and a gain on the
sale of certain Medicaid contracts. Revenues for the year ended December 31,
1996 increased by $1,595.6 million or 31.2% as compared to the same period in
1995. Revenue increases in 1996 were due to the full year impact of new
acquisitions in Connecticut and Pennsylvania and the partial year impact of the
Mental Health Network ("MHN') acquisition, commercial and Medicare risk
membership growth in California, new CHAMPUS government contracts and higher
cash and investment balances resulting in increased investment and other income.
The overall medical care ratio ("MCR") (medical costs as a percentage of
revenue) for the year ended December 31, 1997 was 83.1% compared to 84.5% for
the year ended December 31, 1996. The decline is due primarily to higher medical
costs and loss contracts that negatively impacted the MCR in 1996 as well as
favorable reserve development in 1997 in certain of the Company's health plans
as well as improved health care and subcontractor performance on certain
government contracts. The 1997 reduction in MCR was offset slightly by
escalating health care costs including higher pharmacy costs coupled with a
relatively flat premium environment, particularly in the California market and
throughout the Company's health plans. The overall MCR for the year ended
December 31, 1996 was 84.5% as compared to 79.3% during the same period in 1995.
The increase in the MCR was due to the aforementioned higher medical costs and
loss contracts that were charged in 1996 as well as due to continued pricing
pressures throughout the Company's health plans and an increase in pharmacy
costs.
SELLING, GENERAL, AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses
decreased by $8.2 million or 1.0% for the year ended December 31, 1997 as
compared to the same period in 1996, and increased by $202.7 million or 30.8%
for the year ended December 31, 1996 as compared to the same period in 1995. The
administrative expense ratio (SG&A as a percentage of health plan and government
contracts revenue) decreased to 12.6% for the year ended December 31, 1997 from
13.6% for the year ended December 31, 1996. The administrative expense ratio was
flat at 13.6% for the year ended December 31, 1996 as compared to the the year
ended December 31, 1995. Favorable expense reductions occurred for the year
ended December 31, 1997 as a percentage of revenues due to the Company's ongoing
efforts to aggressively control its SG&A expenses and synergy savings associated
with the integration of HSI and FHC after the FHS Combination. This was offset
partially by additional SG&A expenses associated with
33
<PAGE>
the new acquisitions during 1997. While SG&A expenses increased by $202.7
million during 1996 as a result of new acquisitions, additional administrative
expenses associated with CHAMPUS government contracts, and general growth in the
commercial business, SG&A as a percentage of total revenue was essentially flat
for the year ended 1996 as compared to 1995.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense declined by $14.6 million for the year
ended December 31, 1997 as compared to the same period in 1996 due to certain
intangible assets becoming fully amortized by the end of 1996, fixed assets
becoming fully depreciated in early 1997 in the California division and fixed
asset write-offs primarily associated with the Company's restructuring plans
discussed below. Amortization and depreciation expense increased by $23.6
million for the year ended December 31, 1996 as compared to the same period in
1995 primarily due to higher levels of fixed asset expenditures and goodwill
amortization as a result of acquisitions.
INTEREST EXPENSE
Interest expense increased by $18.2 million and $11.9 million during 1997
and 1996, respectively, as compared to the same periods during the prior year.
The increase in interest expense during both years was due to higher debt levels
associated with the Company's revolving lines of credit partially offset by
lower interest rates.
MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS
Restructuring costs of $149.4 million, $27.4 million and $12.2 million were
recorded for the years ended December 31, 1997, 1996 and 1995, respectively. The
1997 charge was primarily the result of a restructuring plan adopted in
connection with the FHS Combination, and included costs related to severance and
benefits, provider network consolidation, asset impairments and real estate
lease terminations. Of the $149.4 million, $61.7 million resulted in cash
payments as of December 31, 1997, with $45.2 million expected in future cash
payments. The 1996 restructuring costs included severance, asset impairments and
lease termination costs and required cash outlays of approximately $7.3 million.
The 1995 restructuring costs represented severance payments.
Merger costs totaling $70.4 million were recorded in 1997 and included
transaction, consulting, debt consolidation and other merger costs directly
related to the FHS Combination. Merger costs of $8.0 million related to the
terminated merger between HSI and Wellpoint Health Network were recorded in
1995.
Other costs totaling $118.6 million, including the write-off of various
receivables, litigation and loss contract accruals were recorded during 1997.
Additionally, during 1996, $16.7 million of other costs related to loss contract
accruals and consulting were recorded. The Company also established a premium
deficiency reserve of $57.5 million related to its Gem Insurance Company during
1997.
See Note 14, "Merger, Restructuring and Other Costs and Gem Costs", to the
consolidated financial statements for further information.
INCOME TAX PROVISION AND BENEFIT
The tax benefit on losses from continuing operations for the year ended
December 31, 1997 of 24.0% differs from the tax provision rate of 26.7% on
income from continuing operations for the year ended 1996 due primarily to
nondeductible merger transaction costs associated with the FHS Combination
during 1997 and a reduction in tax exempt interest income.
The reduced tax provision rate of 26.7% in 1996 relative to the 1995 rate of
39.7% was primarily a result of tax benefits associated with net operating loss
carryforwards of acquired subsidiaries, increased research and development
credits, elimination of a duplicate tax for undistributed income between an
34
<PAGE>
acquired subsidiary and its former parent, increased proportion of tax-exempt
income as a percentage of pre-tax income, and a settlement of an IRS
examination.
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 worker's compensation
insurance and physician practice management ("Medical Practices") segments.
CONTINUING OPERATIONS
HEALTH PLANS
Revenues generated by the Company's health plan operations increased $434.3
million or 8.1% for the year ended December 31, 1997 compared to the same period
in 1996 and $837.9 million or 18.4% for the period ended December 31, 1996
compared to the same period in 1995. The increase in revenues for the year ended
December 31, 1997 as compared to the same period in 1996 is primarily due to
enrollment increases in the Medicaid lines of business and enrollment and
premium increases in the Medicare lines of business in California, commercial
enrollment increases in Connecticut and Arizona, and the partial year impact of
the acquisitions of Advantage Health in Pennsylvania, FOHP, Inc. ("FOHP") in New
Jersey, and PACC HMO and PACC Health Plans (collectively, "PACC") in Oregon. The
increase in revenues for the year ended December 31, 1996 as compared to the
same period in 1995 is due to acquisitions in the Northeast, including M.D.
Health Plan operating in Connecticut and Greater Atlantic Health Plan of
Pennsylvania, and increased Medicare risk and Medicaid enrollment in California.
Health care costs increased by 6.8% for the year ended December 31, 1997 as
compared to the same period in 1996. In the California market, health care costs
increased as a result of higher pharmacy costs for both the commercial and
Medicare lines of business, percentage of premium provider contracting
arrangements, increased hospital utilization in the Medicare line of business,
and increased enrollment in the Medicaid line of business. While health care
costs increased during 1997, the health plans' MCR declined to 84.3% for the
year ended December 31, 1997 from 85.2% for the comparable period in 1996
primarily due to higher medical costs in 1996 and favorable loss reserve
development in certain health plan operations during 1997. The health plans' MCR
increased to 85.2% in 1996 as compared to 79.9% for the same period in 1995.
Continued downward pressure on pricing, coupled with increased pharmacy costs
and utilization contributed to the overall health plan MCR.
GOVERNMENT CONTRACTS
Government contracts revenue increased by $40.4 million or 4.4% for the year
ended December 31, 1997, compared to the same period in 1996 as a result of the
California/Hawaii CHAMPUS contract being active for only 9 months in 1996
compared to a full year in 1997. Revenues increased $629.4 million for the year
ended December 31, 1996 or 225% compared to the same period in 1995. The
increase was due to the California/Hawaii CHAMPUS contract which began in April
1996 as well as the full year impact of the Washington/Oregon and Region 6
CHAMPUS contracts (Texas, Arkansas, Oklahoma and Louisiana) which began health
care delivery on March 1, 1995 and November 1, 1995, respectively.
Government health care costs as a percentage of government contract revenue
decreased from 77.7% in 1996 to 75.0% in 1997 as a result of improved health
care and subcontractor performance on the California/Hawaii and
Washington/Oregon CHAMPUS contracts, and the favorable impact of change order
revenue and cost development in 1997. Cost percentages for the year 1996
compared to 1995 increased to 77.7% primarily due to the recognition of
implementation revenue in 1995 for the Washington/Oregon, Region 6 and
California/Hawaii CHAMPUS contracts, which did not have associated health care
costs.
35
<PAGE>
SPECIALTY SERVICES
The Company's specialty services subsidiaries offer behavioral health,
dental, vision, and pharmaceutical products and services as well as managed care
products related to bill review, administration and cost containment for
hospitals, health plans and other entities. Revenues generated by the Company's
specialty services operations for 1997 increased by $25.1 million or 7.9% as
compared to the same period in 1996 primarily due to the impact of a full year's
revenue from MHN which was acquired in March 1996. The increase in revenue was
offset somewhat by the sale of certain ancillary health care service operations
in 1996 and reduced revenue from various ASO operations. Revenues for 1996 as
compared to 1995 increased due to the acquisition of MHN in March 1996 as well
as growth in ASO, bill review and other services.
The Company expects continued pressure from employer groups to maintain
modest increases in premiums for behavioral health, dental and vision products.
Specialty services costs have decreased as a percentage of specialty services
revenue to 84.9% for 1997 as compared to 91.4% in 1996. The decrease is due to
the adverse reserve development recognized in the fourth quarter of 1996 which
resulted in a higher MCR during 1996 as well as the favorable benefit of the MHN
acquisition. Specialty services costs as a percentage of revenue increased to
91.4% in 1996 from 86.6% in 1995 due to the aforementioned adverse reserve
development recognized in 1996.
DISCONTINUED OPERATIONS
WORKERS' COMPENSATION INSURANCE 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 elsewhere in this Annual Report on Form 10-K, such adverse
developments caused the Company to strengthen its workers' compensation reserves
at the end of 1997. These developments also led the Company to adopt a plan to
completely discontinue this segment of its business, through divestiture of its
workers' compensation risk-assuming insurance subsidiaries. The Company is
presently conducting the sale of these businesses.
The Company's workers compensation insurance companies consist of the
following: California Compensation Insurance Company, a specialty workers'
compensation carrier writing business primarily in California; Business
Insurance Company, a national workers' compensation specialty carrier;
Commercial Compensation Insurance Company, and Combined Benefits Insurance
Company, writing single source workers' compensation and employee group health
insurance primarily in California.
The workers' compensation companies entered into a quota share reinsurance
agreement ("Quota Share Treaty") with General Reinsurance Corporation ("Gen Re")
effective July 1, 1996 and also entered into an aggregate excess of loss
reinsurance agreement ("Aggregate Treaty") with Gen Re effective January 1,
1997.
Under the Quota Share Treaty, the Company ceded 30% of its net premiums
earned, losses and allocated loss adjustment expenses incurred to Gen Re from
July 1, 1996 to December 31, 1996 and ceded 7.5% of its net retained business
from January 1, 1997 to June 30, 1997. The Quota Share Treaty contains a
provisional ceding commission, which adjusts based on actual reported loss
experience on the subject business. The Company stopped ceding under the quota
share treaty effective July 1, 1997.
The Aggregate Treaty was entered into at a premium cost of $32 million, in
exchange for $37.3 million of reinsurance coverage for the first six months of
1997. Effective July 1, 1997 a second six-month Aggregate Treaty was entered
into with Gen Re at a cost of $61.5 million, in exchange for $75 million of
reinsurance coverage. For the twelve months ended December 31, 1997, a total of
$93.5 million of
36
<PAGE>
premiums were ceded to Gen Re for aggregate excess of loss reinsurance
protection, and the Company ceded $112.3 million of ceded losses incurred for
the year.
Workers' compensation revenue of $560.9 million increased 8.1% in 1997 as
compared to 1996. The increase in revenue is due to an increase in gross premium
revenues, investment income and capital gains, offset by the cost of the
Aggregate Excess Treaty.
Net premiums earned increased by 6.3% in 1997 as compared to 1996 due
primarily to national expansion of workers' compensation in states outside
California, offset by reduced premium writings in California. Premiums earned on
policies issued in California continue to be negatively affected by price
competition since the start of competitive rating on January 1, 1995.
Revenue of $518.7 million in 1996 increased by $101.6 million or 24.4% as
compared to 1995. The increase in revenue was due primarily to an increase in
premium revenues.
Net investment income for 1997 increased $3.9 million or 11.3%. The
increased investment income is due to an increase in assets available for
investment, from higher operational cash flow and capital surplus contributions
of $120 million in mid-1996 to the insurance operations to support premium
writings.
Net investment income of $34.3 million in 1996 increased $9.9 million or
40.6% compared to 1995. The increase in investment income is due to an increase
in assets available for investment from operational cash flow and capital
contributions.
Realized capital gains of $7.2 million in 1997 were an increase of $6.6
million from 1996. This increase was due to reductions in long term interest
rates in the bond market, primarily for tax-exempt bonds, provided an
opportunity to sell securities and realize gains in the fourth quarter of 1997.
The primary ratios used to measure underwriting performance of the workers'
compensation companies are the loss and loss adjustment expense ratio, the
underwriting expense ratio, and the policyholder dividend ratio, which when
added together constitute the combined ratio. These ratios are calculated as a
percentage of net premiums earned.
The following sets forth the workers' compensation companies underwriting
experience as measured by its combined ratio and its components for the twelve
months ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Loss and Loss Adjustment Expense..................................... 86.6% 79.4% 62.8%
Underwriting Expense................................................. 32.1 23.6 23.5
Policyholder Dividends............................................... .2 (1.1) 1.4
--------- --------- ---------
COMBINED RATIO....................................................... 118.9% 101.9% 87.7%
--------- --------- ---------
--------- --------- ---------
</TABLE>
The loss and loss adjustment expense ratio increased to 86.6% in 1997 as
compared to 79.4% in 1996. The increase in 1997 is primarily due to an increase
in the estimates for accident year 1996 and prior loss and loss adjustment
expenses incurred, which estimates were increased by $75.2 million in 1997. The
cause of the increase in the accident year 1996 and prior estimates was due to
changes to the California permanent disability rating schedules in April 1997
which adversely affected average claim severity in California. The change to the
permanent disability rating schedules had a negative affect on the entire
California workers' compensation industry. In addition, a court ruling in late
1996 expanded the presumption of the treating physician related to workers'
compensation workplace injuries in determining the disability of the injured
worker. The impact of this court ruling also increased claim severity. The
increase to accident year 1996 and prior loss estimates represented 14.7% of net
premiums earned for 1997. The effect of the accounting of the Aggregate Treaty
reduced the loss and loss adjustment expense ratio by 5.2%, due to more ceded
losses incurred than ceded premiums earned.
37
<PAGE>
The underwriting expense ratio increased by 8.5% in 1997 as compared to
1996. The increase in the ratio is primarily due to the accounting for the
Aggregate Treaty, which does not have an underwriting expense provision as part
of the agreement. Also, under the Quota Share Treaty, the ceding of the
Company's net retained business was substantially less in 1997 than in 1996. As
such, ceded commission in 1996 under the Quota Share Treaty has a positive
effect on the underwriting expense ratio, and a lower beneficial impact on the
ratio in 1997. The pro-forma impact to the underwriting expense ratio without
accounting for the Aggregate and Quota Share Treaties would have been 24.9% in
1997 compared to 24.0% in 1996.
The loss and loss adjustment expense ratio increased 166 basis points in
1996 as compared to 1995. In 1995, this ratio was favorably impacted by a $26.5
million reduction to accident year 1994 and prior loss and loss adjustment
expense estimates. In 1996, the comparable amount of development for accident
years 1995 and prior was an increase to the losses and loss adjustment expense
incurred of $20.1 million.
The loss from discontinued operations for the segment was $30.4 million in
1997 as compared to income of $22.2 in 1996. The loss in 1997 was primarily due
to the strengthening of reserves in the amount of $75.2 million in the fourth
quarter of 1997. In addition, the Company recorded an estimate of the loss to be
incurred when the workers' compensation insurance operations are sold of
approximately $99.0 million, net of tax.
PHYSICIAN PRACTICE MANAGEMENT BUSINESS
On June 28, 1996 the Company executed a Stock and Note Purchase Agreement
with FPA for the purchase by FPA of the Company's Medical Practices. The
transaction was consummated in November 1996 and the Company recognized a net of
tax gain on sale of $20.3 million, net of $17.6 million of taxes, in 1996. In
1997, the Company recognized an additional $10.1 million gain on the sale, net
of $2.8 million of taxes, as a result of the final settlement of certain
contractual provisions. The income and loss on discontinued operations, net of
taxes, for the Medical Practices was $2.9 million during 1996 and $48.9 million
during 1995. The results in both years were primarily due to insufficient
patient volume being served by the Medical Practices. In 1996, the loss was
reduced by a gain of $10.8 million related to the sale of various independent
practice associations.
The following table presents financial information reflecting the Company's
continuing operations for its primary lines of business:
38
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
YEAR ENDED DECEMBER 31, 1997 DECEMBER 31, 1996
-------------------------------------- -------------------------
PERCENT PERCENT PERCENT
AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL
PERCENT REVENUE (DECREASE) PERCENT REVENUE
------------ ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues
Health plan premiums............................... $ 5,829,444 80.6% 8.1% $ 5,395,125 80.5%
Government contracts............................... 949,168 13.1 4.4 908,730 13.5
Specialty services................................. 342,107 4.7 7.9 316,993 4.7
Investment and other income........................ 114,300 1.6 29.3 88,392 1.3
------------ ----- ------------ -----
7,235,019 100.0 7.8 6,709,240 100.0
------------ ----- ------------ -----
Expenses
Health plan services............................... 4,912,532 67.9 6.8 4,598,074 68.5
Government health care services.................... 711,757 9.9 0.8 706,076 10.5
Specialty services................................. 290,319 4.0 0.2 289,744 4.3
Selling, general and administrative
("SG&A")......................................... 851,826 11.8 (1.0) 859,996 12.8
Amortization and depreciation...................... 98,353 1.4 (12.9) 112,916 1.7
Interest........................................... 63,555 0.9 40.1 45,372 0.7
Merger, restructuring and other costs.............. 338,425 4.7 -- 44,108 0.7
Gem costs.......................................... 57,500 0.8 -- --
------------ ----- ------------ -----
7,324,267 101.2 10.0 6,656,286 99.2
------------ ----- ------------ -----
Income (loss) from continuing operations before
income taxes....................................... (89,248) (1.2) (268.5) 52,954 0.8
Income tax provision (benefit)....................... (21,418) (0.3) (251.6) 14,124 0.2
------------ ----- ------------ -----
Income (loss) from continuing operations............. $ (67,830) (0.9)% (274.7 ) $ 38,830 0.6 %
------------ ----- ------------ -----
------------ ----- ------------ -----
Basic earnings (loss) per share...................... $ (0.55) $ 0.31
Diluted earnings (loss) per share.................... (0.55) 0.31
Weighted average common and common stock equivalent
shares outstanding:
Basic.............................................. 123,333 124,453
Diluted............................................ 123,821 124,966
Operating ratios:
Overall medical care ratio......................... 83.1% 84.5%
Health plan medical care ratio..................... 84.3 85.2
Government contracts medical care ratio............ 75.0 77.7
Specialty services medical care ratio.............. 84.9 91.4
SG&A as a percent of health plan and government
contracts revenues............................... 12.6 13.6
Effective tax rate (benefit)--continuing
operations....................................... (24.0) 26.7
</TABLE>
39
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
YEAR ENDED DECEMBER 31, 1996 1995
---------------------------------------- -------------------------
PERCENT PERCENT PERCENT
AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL
PERCENT REVENUE (DECREASE) PERCENT REVENUE
------------ ----------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues
Health plan premiums............................... $ 5,395,125 80.5% 18.4% $ 4,557,214 89.1%
Government contracts............................... 908,730 13.5 225.3 279,380 5.5
Specialty services................................. 316,993 4.7 50.6 210,533 4.1
Investment and other income........................ 88,392 1.3 32.9 66,510 1.3
------------ ----- ------------ -----
6,709,240 100.0 31.2 5,113,637 100.0
------------ ----- ------------ -----
Expenses
Health plan services............................... 4,598,074 68.5 26.2 3,643,463 71.2
Government health care services.................... 706,076 10.5 305.7 174,040 3.4
Specialty services................................. 289,744 4.3 58.9 182,380 3.6
Selling, general and administrative
("SG&A")......................................... 859,996 12.8 30.8 657,275 12.9
Amortization and depreciation...................... 112,916 1.7 26.4 89,356 1.7
Interest........................................... 45,372 0.7 35.6 33,463 0.7
Merger, restructuring and other costs.............. 44,108 0.7 -- 20,164 0.4
Gem costs.......................................... -- -- --
------------ ----- ------------ -----
6,656,286 99.2 38.7 4,800,141 93.9
------------ ----- ------------ -----
Income from continuing operations before income
taxes.............................................. 52,954 0.8 (83.1) 313,496 6.1
Income tax provision................................. 14,124 0.2 (88.6) 124,345 2.4
------------ ----- ------------ -----
Income from continuing operations.................... $ 38,830 0.6% (79.5) $ 189,151 3.7 %
------------ ----- ------------ -----
------------ ----- ------------ -----
Basic earnings per share............................. $ 0.31 $ 1.54
Diluted earnings per share........................... 0.31 1.53
Weighted average common and common stock equivalent
shares outstanding:
Basic.............................................. 124,453 122,741
Diluted............................................ 124,966 123,674
Operating ratios:
Overall medical care ratio......................... 84.5% 79.3%
Health plan medical care ratio..................... 85.2 79.9
Government contracts medical care ratio............ 77.7 62.3
Specialty services medical care ratio.............. 91.4 86.6
SG&A as a percent of health plans and government
contracts revenues............................... 13.6 13.6
Effective tax rate--continuing operations.......... 26.7 39.7
</TABLE>
40
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
LINE OF BUSINESS FINANCIAL INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
1997
-------------------------- DECEMBER 31,
PERCENT 1996
INCREASE ---------------
ENROLLMENT (DECREASE) ENROLLMENT
------------- ----------- ---------------
<S> <C> <C> <C>
Health Plan
Commercial............................................................... 3,522 27.0% 2,774
Medicare risk............................................................ 308 30.0 237
Medicaid................................................................. 442 40.3 315
----- ----- -----
4,272 28.4 3,326
----- ----- -----
Government
CHAMPUS PPO and indemnity................................................ 1,090 5.3 1,035
CHAMPUS HMO.............................................................. 801 47.5 543
----- ----- -----
1,891 19.8 1,578
----- ----- -----
ASO 48 (85.2) 324
----- ----- -----
Combined................................................................. 6,211 18.8 5,228
----- ----- -----
----- ----- -----
</TABLE>
LIQUDITY 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 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. 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 are best estimates of payments that are
ultimately collectible. Since these amounts are subject to government audit and
negotiation, amounts ultimately collected may vary from current estimates.
For the year ended December 31, 1997, cash used from operating activities
was $125.9 million compared to $6.7 million in the prior year. This was due
primarily to payments for merger, restructuring and other costs associated with
the FHS Combination, as well as Gem costs. This was partially offset by
fluctuations in operating assets and liabilities primarily caused by timing
differences in the payment of accounts payables and other liabilities, reserves
for claims and other settlements, and deferred taxes at each respective year
end. Net cash used by investing activities was $134.8 million during 1997 as
compared to $184.8 million during 1996. This decrease during 1997 was due to
higher net redemptions of investments available for sale, an early payment
related to the FPA note receivable, offset by the cost of the acquisitions of
FOHP, Physician Health Services, Inc. ("PHS"), PACC, Advantage Health and
Christiania General Insurance Corporation. Net cash generated from financing
activities was $332.1 million in 1997 as
41
<PAGE>
compared to $348.8 million during the same period in 1996. The increase in 1997
was due primarily to additional draws under the revolving line of credit of
$566.2 million that was used primarily to finance the new acquisitions, offset
by the repurchase of stock from the California Wellness Foundation of $111
million and the repayment of Senior Notes of $125 million.
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 pursuant to a Letter Agreement dated March 27, 1998 with the Lenders
(the "Credit Facility Letter Agreement"). All previous revolving credit
facilities were terminated and rolled into the Credit Facility on July 8, 1997.
At the election of the Company, and subject to customary covenants, loans are
initiated on a bid or committed basis and carry interest at offshore or domestic
rates, at the applicable LIBOR Rate plus margin or the bank reference rate.
Actual rates on borrowings under the Credit Facility vary, based on competitive
bids and the Company's unsecured credit rating at the time of the borrowing.
Under the Credit Facility Letter Agreement, the margins used in setting the
facility fee and borrowing rates under the Credit Facility were increased.
Accordingly, the Company will incur an increase in the "all in" margin of 0.05%
based on its debt rating as of December 31, 1997 under the terms of the Credit
Facility. Any decrease in such rating would result in an increase in such
margin. The Credit Facility is available for five years, until July 2002, but it
may be extended under certain circumstances for two additional years. (See,
OTHER INFORMATION--REVOLVING CREDIT FACILITY contained in this report for
further information concerning the Revolving Credit Facility)
On June 27, 1997 the Company consummated a cash tender offer to repurchase
all of its $125 million outstanding principal amount of 7 3/4% Senior Notes due
2003. The purchase price per $1,000 principal amount of notes was $1,054.77.
During the quarter ended June 30, 1997, the Company sold 4,076,087 shares of
common stock of FPA that it had received as consideration in its sale of the
Medical Practices. The proceeds from the sale of stock were approximately $79
million, or an average of $19.45 per share. In addition, as of June 30, 1997 FPA
prepaid approximately $98.7 million due on a promissory note received as
consideration in the Company's sale of its Medical Practices.
On June 27, 1997, the Company redeemed 4,550,000 shares of Class B Common
Stock from The California Wellness Foundation ("the CWF") at a price of $24.47
per share. The Company provided its consent to permit the CWF to sell 3,000,000
shares of Class B Common Stock to an unrelated third party in June of 1997 and
to sell 450,000 shares of Class B Common Stock to unrelated third parties
throughout August of 1997. On November 6, 1997, the Company also provided its
consent to permit the CWF to sell 1,000,000 shares of Class B Common Stock to an
unrelated third party. Pursuant to the Company's Certificate of Incorporation,
such 3,000,000 shares, 450,000 shares and 1,000,000 shares of Class B Common
Stock automatically converted into shares of Class A Common Stock in the hands
of such third parties.
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 CWF Notes issued to 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 December 31, 1997, the Company's subsidiaries were in
compliance with minimum capital requirements.
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.
42
<PAGE>
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, regulatory changes, utilization,
new technologies, hospital costs, major epidemics and numerous other external
influences may affect the Company's operating results. Accordingly, past
financial performance is not necessarily a reliable indicator of future
performance, and investors should not use historical records to anticipate
results or future period trends.
The Company's HMO and insurance subsidiaries are required to maintain
reserves to cover their estimated ultimate liability for expenses with respect
to reported and unreported claims incurred. These reserves are estimates of
future payments based on various assumptions. Establishment of appropriate
reserves is an inherently uncertain process, and there can be no certainty that
currently established reserves will prove adequate in light of subsequent actual
experience, which in the past has resulted and in the future could result in
loss reserves being too high or too low. The accuracy of these estimates may be
affected by external forces such as changes in the rate of inflation, the
regulatory environment, the judicial administration of claims, medical costs and
other factors. Future loss development or governmental regulators could require
reserves for prior periods to be increased, which would adversely impact
earnings in future periods. In light of present facts and current legal
interpretations, management believes that adequate provisions have been made for
claims and loss reserves.
Reference is also made to the disclosures contained under the heading
"Cautionary Statements" included elsewhere in this Annual Report or Form 10-K,
which could cause the Company's actual results to differ from those projected in
forward looking statements of the Company made on behalf of the Company. In
addition, certain of these factors may have affected the Company's past results
and may affect future results.
YEAR 2000
The Company recognizes that the arrival of the Year 2000 requires computer
systems to be able to recognize the date change from 1999 to 2000 and, like
other companies, is assessing and modifying its computer applications and
business processes to provide for their continued functionality.
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, prepare invoices or
engage in normal business activities.
The Year 2000 effort for the Company has the highest priority of technology
projects. The project has dedicated resources with multiple teams to address
unique systems environment. Uniform project management techniques are in place
with overall oversight responsibility residing with the Company's Chief
Technology Officer. Emphasis has been placed on business unit involvement and
the use of internal staff enhanced by external specialists. Selected systems
will be retired with the business functions being converted to Year 2000
compliant systems. A number of the Company's systems include packaged software
from large vendors that the Company is closely monitoring to ensure that these
systems are Year 2000 compliant. The Company believes that vendors will make
timely updates available to ensure that all
43
<PAGE>
remaining purchased software is Year 2000 compliant. The remaining systems'
compliance with Year 2000 will be addressed by internal technical staff.
The Company has initiated formal communications with others with whom it
does significant business to determine their Year 2000 issues. There can be no
assurances that the systems of other companies on which the Company's systems
rely will be timely converted, or that the failure to convert by another company
would not have a material adverse effect on the Company.
The Company does not anticipate that the related overall costs to resolve
these potential Year 2000 problems will be material to any single year. The
total current cost estimate for the Year 2000 project is between $13 and $17
million, of which approximately $2 million has been incurred to date. These
costs are expensed as incurred.
However, notwithstanding the foregoing, the costs of the project and the
timetable in which the Company plans to complete the Year 2000 compliance
requirements are based on estimates derived utilizing numerous assumptions of
future events including the continued availability of certain resources, third
party modification plans and other factors. There can therefore be no assurance
that these estimates will be achieved and actual results could differ materially
from these estimates.
At this time it is unclear as to the extent of existing insurance coverage,
if any, the Company may have to cover potential year 2000 liabilities. The
Company is currently analyzing the obtainment of such coverage.
ITEM 7A. 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% confidence level, was approximately $5.2
million at December 31, 1997.
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
44
<PAGE>
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.
The Company, however, believes that any loss incurred would be offset by the
effects of interest rate movements on the respective liabilities, since these
liabilities are affected by many of the same factors that affect asset
performance; that is, economic activity, inflation and interest rates, as well
as regional and industry factors.
In addition, the Company has some interest rate market risk due to its
borrowings. Notes payable, capital leases and other financing arrangements total
$1,309 million and the related average interest rate is 6.09% (which interest
rate is subject to change pursuant to the terms of the credit agreement). 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 December 31, 1997. These cash flows include both expected
principal and interest payments consistent with the terms of the outstanding
debt as of December 31, 1997.
<TABLE>
<CAPTION>
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 BEYOND TOTAL
--------- --------- ---------- --------- ------------ --------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Long-term Borrowings
Fixed Rate..................... $ 4,329 $ 4,329 $ 24,288 $ 2,540 $ 2,715 $ 10,859 $ 49,060
Floating Rate.................. 75,900 75,900 75,900 75,900 1,340,900 0 1,644,500
--------- --------- ---------- --------- ------------ --------- ------------
Total............................ $ 80,229 $ 80,229 $ 100,188 $ 78,440 $ 1,343,615 $ 10,859 $ 1,693,560
--------- --------- ---------- --------- ------------ --------- ------------
--------- --------- ---------- --------- ------------ --------- ------------
</TABLE>
DISCONTINUED OPERATIONS
The Company announced that it plans to sell its 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, a 95 percent confidence level at December 31, 1997, was
approximately $9.2 million, out of a total market value of investments of $625
million.
The discontinued operations businesses do not have any significant interest
rate risk due to debt.
45
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF THE AUDIT COMMITTEE
OF THE BOARD OF DIRECTORS
OF FOUNDATION HEALTH SYSTEM, INC.
The Board of Directors of the Company addresses its oversight responsibility for
the consolidated financial statements through its Audit Committee (the
"Committee"). The Committee currently consists of Gov. George Deukmejian, Thomas
T. Farley, Earl B. Fowler (Chairman) and Richard J. Stegemeier, each of whom is
an independent outside director.
In fulfilling its responsibilities in 1997, the Committee reviewed the overall
scope of the independent auditors' audit plan and reviewed the independent
auditors' non-audit services to the Company. The Committee also exercised
oversight responsibilities over various financial and regulatory matters.
The Committee's meetings are designed to facilitate open communication between
the independent auditors and Committee members. To ensure auditor independence,
the Committee meets privately with the independent auditors providing for full
and free access to the Committee.
Earl B. Fowler, Chairman
Audit Committee
March 30, 1998
46
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Foundation Health Systems, Inc.
Woodland Hills, California
We have audited the accompanying consolidated balance sheets of Foundation
Health Systems, Inc. and subsidiaries (the "Company") as of December 31, 1997
and 1996, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1997. Our audits also included the financial statement schedule of Condensed
Financial Information listed in the Index at Item 14(a)(2). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on our audits. The
consolidated financial statements and financial statement schedule give
retroactive effect to the merger of Health Systems International, Inc. and
Foundation Health Corporation, which has been accounted for as a pooling of
interests as discussed in Note 1 to the consolidated financial statements. As
described in Note 1 to the consolidated financial statements, the financial
statements of Foundation Health Corporation were restated to conform to the
calendar year end of Foundation Health Systems, Inc. as of December 31, 1997 and
1996 and for each of the three years in the period ended December 31, 1997.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Foundation Health Systems, Inc.
and subsidiaries at December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 27, 1998
47
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents.......................................................... $ 559,360 $ 487,938
Investments--available for sale.................................................... 553,001 634,978
Premium receivables, net of allowance for doubtful accounts of $22.9 million and
$18.2 million at December 31, 1997 and 1996...................................... 224,383 150,782
Amounts receivable under government contracts...................................... 272,060 221,787
Deferred taxes..................................................................... 213,695 96,486
Reinsurance and other receivables.................................................. 130,875 74,169
Other assets....................................................................... 188,606 161,904
Net assets of discontinued operations.............................................. 267,713 381,572
------------ ------------
Total current assets................................................................. 2,409,693 2,209,616
Investments--held to maturity...................................................... 12,885 14,217
Property and equipment, net........................................................ 427,149 304,748
Goodwill and other intangible assets, net.......................................... 1,044,727 704,951
Other assets....................................................................... 181,896 190,244
------------ ------------
Total Assets......................................................................... $ 4,076,350 $3,423,776
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Reserves for claims and other settlements.......................................... $ 967,815 $ 798,980
Unearned premiums.................................................................. 244,340 177,048
Notes payable and capital leases................................................... 3,593 85,476
Amounts payable under government contracts......................................... 78,441 44,323
Accounts payable and other liabilities............................................. 470,483 324,355
------------ ------------
Total current liabilities............................................................ 1,764,672 1,430,182
Notes payable and capital leases................................................... 1,308,979 791,618
Other liabilities.................................................................. 106,725 18,565
------------ ------------
Total liabilities.................................................................... 3,180,376 2,240,365
------------ ------------
Commitments and contingencies (Note 12)
Stockholders' equity
Preferred stock, $.001 par value, 10,000 shares authorized, none issued and
outstanding......................................................................
Class A common stock, $.001 par value, 350,000 shares authorized, 114,449 and
109,179 shares issued and outstanding at December 31, 1997 and 1996.............. 114 109
Class B non-voting convertible common stock, $.001 par value, 30,000 shares
authorized, 10,298 and 19,298 shares issued and outstanding at December 31, 1997
and 1996......................................................................... 10 19
Additional paid in capital......................................................... 628,611 721,482
Treasury Class A common stock, 3,194 shares and 3,324 shares at December 31, 1997
and 1996......................................................................... (95,831) (98,878)
Retained earnings.................................................................. 370,394 557,478
Unrealized investment gains (losses), net of taxes................................. (7,324) 3,201
------------ ------------
Total stockholders' equity........................................................... 895,974 1,183,411
------------ ------------
Total Liabilities and Stockholders' Equity........................................... $ 4,076,350 $3,423,776
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements
48
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Revenues
Health plan premiums.................................................. $ 5,829,444 $ 5,395,125 $ 4,557,214
Government contracts.................................................. 949,168 908,730 279,380
Specialty services.................................................... 342,107 316,993 210,533
Investment and other income........................................... 114,300 88,392 66,510
------------ ------------ ------------
7,235,019 6,709,240 5,113,637
------------ ------------ ------------
Expenses
Health plan services.................................................. 4,912,532 4,598,074 3,643,463
Government health care services....................................... 711,757 706,076 174,040
Specialty services.................................................... 290,319 289,744 182,380
Selling, general and administrative................................... 851,826 859,996 657,275
Amortization and depreciation......................................... 98,353 112,916 89,356
Interest.............................................................. 63,555 45,372 33,463
Merger, restructuring and other costs................................. 338,425 44,108 20,164
Gem costs............................................................. 57,500
------------ ------------ ------------
7,324,267 6,656,286 4,800,141
------------ ------------ ------------
Income (loss) from continuing operations before income taxes............ (89,248) 52,954 313,496
Income tax provision (benefit).......................................... (21,418) 14,124 124,345
------------ ------------ ------------
Income (loss) from continuing operations................................ (67,830) 38,830 189,151
Discontinued operations:
Income (loss) from operations, net of tax............................. (30,409) 25,084 3,028
Gain (loss) on disposition, net of tax................................ (88,845) 20,317
------------ ------------ ------------
Net income (loss)....................................................... $ (187,084) $ 84,231 $ 192,179
------------ ------------ ------------
------------ ------------ ------------
Basic earnings (loss) per share
Continuing operations................................................. $ (0.55) $ 0.31 $ 1.54
Discontinued operations............................................... (0.25) 0.20 0.02
Discontinued operations gain (loss) on disposition.................... (0.72) 0.16
------------ ------------ ------------
Net................................................................... $ (1.52) $ 0.67 $ 1.56
------------ ------------ ------------
------------ ------------ ------------
Diluted earnings (loss) per share
Continuing operations................................................. $ (0.55) $ 0.31 $ 1.53
Discontinued operations............................................... (0.25) 0.20 0.02
Discontinued operations gain (loss) on disposition.................... (0.72) 0.16
------------ ------------ ------------
Net................................................................... $ (1.52) $ 0.67 $ 1.55
------------ ------------ ------------
------------ ------------ ------------
Weighted average common and common stock equivalent shares outstanding:
Basic................................................................. 123,333 124,453 122,741
Diluted............................................................... 123,821 124,966 123,674
</TABLE>
See accompanying notes to consolidated financial statements
49
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
-----------------------------------
COMMON STOCK
CLASS A CLASS B ADDITIONAL HELD IN TREASURY
---------------------- -------------------------- PAID-IN ----------------------
SHARES AMOUNT SHARES AMOUNT CAPITAL SHARES AMOUNT
--------- ----------- ----------- ------------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995.............. 99,617 $ 100 25,684 $ 26 $ 614,696 (2,797) $ (54,670)
Issuance of common stock-net............ 41 1,203
Exercise of stock options including
related tax benefit................... 1,711 1 22,312
Employee stock purchase plan............ 99 2,039
Purchase of treasury stock.............. (1,296) (35,849)
Retirement of treasury stock............ (3,963) (4) (54,958) 3,963 87,472
Advance to repurchase Class A shares....
Unrealized gain on investments available
for sale..............................
Net income..............................
--------- ----- ----------- --- ----------- ----------- ---------
Balance at December 31, 1995............ 97,505 97 25,684 26 585,292 (130) (3,047)
Issuance of common stock-net............ 1,468 3 4,386
Exercise of stock options including
related tax benefit................... 1,216 1 29,546
Employee stock purchase plan............ 121 2,576
Employee profit sharing plan............ 166 4,558
Sale of common stock.................... 9,581 10 (6,386) (7) 95,828
Purchase of treasury stock.............. (4,072) (105,419)
Retirement of treasury stock............ (878) (2) (704) 878 9,588
Unrealized loss on investments available
for sale..............................
Net income..............................
--------- ----- ----------- --- ----------- ----------- ---------
Balance at December 31, 1996............ 109,179 109 19,298 19 721,482 (3,324) (98,878)
Redemption of common stock.............. (4,550) (4) (111,330)
Retirement of treasury stock............ (130) (3,047) 130 3,047
Exercise of stock options including
related tax benefit................... 842 19,310
Conversion of Class B to Class A........ 4,450 5 (4,450) (5)
Employee stock purchase plan............ 108 2,196
Unrealized loss on investments available
for sale..............................
Net loss................................
--------- ----- ----------- --- ----------- ----------- ---------
Balance at December 31, 1997............ 114,449 $ 114 10,298 $ 10 $ 628,611 (3,194) $ (95,831)
--------- ----- ----------- --- ----------- ----------- ---------
--------- ----- ----------- --- ----------- ----------- ---------
<CAPTION>
UNREALIZED
INVESTMENT
GAINS AND
(LOSSES),
RETAINED NET OF TAXES
EARNINGS AND OTHER TOTAL
--------- ------------ ----------
<S> <C> <C> <C>
Balance at January 1, 1995.............. $ 338,790 $ (21,476) $ 877,466
Issuance of common stock-net............ 1,203
Exercise of stock options including
related tax benefit................... 22,313
Employee stock purchase plan............ 2,039
Purchase of treasury stock.............. (35,849)
Retirement of treasury stock............ (32,510)
Advance to repurchase Class A shares.... (16,330) (16,330)
Unrealized gain on investments available
for sale.............................. 25,233 25,233
Net income.............................. 192,179 192,179
--------- ------------ ----------
Balance at December 31, 1995............ 498,459 (12,573) 1,068,254
Issuance of common stock-net............ 4,389
Exercise of stock options including
related tax benefit................... 29,547
Employee stock purchase plan............ 2,576
Employee profit sharing plan............ 4,558
Sale of common stock.................... 95,831
Purchase of treasury stock.............. (105,419)
Retirement of treasury stock............ (25,212) 16,330
Unrealized loss on investments available
for sale.............................. (556) (556)
Net income.............................. 84,231 84,231
--------- ------------ ----------
Balance at December 31, 1996............ 557,478 3,201 1,183,411
Redemption of common stock.............. (111,334)
Retirement of treasury stock............
Exercise of stock options including
related tax benefit................... 19,310
Conversion of Class B to Class A........
Employee stock purchase plan............ 2,196
Unrealized loss on investments available
for sale.............................. (10,525) (10,525)
Net loss................................ (187,084) (187,084)
--------- ------------ ----------
Balance at December 31, 1997............ $ 370,394 $ (7,324) $ 895,974
--------- ------------ ----------
--------- ------------ ----------
</TABLE>
See accompanying notes to consolidated financial statements
50
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).............................................................. $(187,084) $ 84,231 $ 192,179
Adjustments to reconcile net income (loss) to net cash provided (used) by
operating activities:
Amortization and depreciation................................................ 98,353 112,916 89,356
Loss on disposal of United Kingdom Operations................................ 12,676
Loss on early redemption of Senior Notes..................................... 9,586
Write-down of fixed assets................................................... 8,456 14,963
Amortization of bond discounts............................................... 628 1,124 609
Gain on sale of investments available for sale............................... (4,610) (2,173) (1,200)
Gain on note receivable early redemption..................................... (3,079)
Other changes in net assets of discontinued operations....................... (5,395) (78,589) (94,835)
(Gain) loss on disposition of discontinued operations........................ 88,845 (20,317) 3,028
(Income) loss from discontinued operations................................... 30,409 (25,084)
Change in assets and liabilities, net of effects from acquisition of
businesses:
Premium receivable and unearned subscriber premiums.......................... 3,105 35,941 76
Other assets................................................................. (112,302) (239,013) (94,521)
Amounts receivable/payable under government contracts........................ (16,155) (101,711) (42,840)
Reserves for claims and other settlements.................................... (55,450) 165,695 16,905
Accounts payable and accrued liabilities..................................... 6,145 45,351 (17,340)
--------- --------- ---------
Net cash provided (used) from operating activities............................... (125,872) (6,666) 51,417
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of investments available for sale............................. 597,691 441,550 810,526
Purchases of investments available for sale.................................... (406,818) (513,734) (883,534)
Maturity of investments held to maturity....................................... 3,591 7,613 24,008
Purchases of investments held to maturity...................................... (2,274) (7,835) (9,288)
Purchases of property and equipment............................................ (131,669) (95,751) (85,719)
Proceeds from note receivables................................................. 93,011 825
Investment in other companies.................................................. (21,949)
Other.......................................................................... 5,316 (17,562) (8,413)
Acquisition of businesses, net of cash acquired................................ (293,625) 108 (150,460)
--------- --------- ---------
Net cash used for investing activities........................................... (134,777) (184,786) (324,829)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock purchases........... 21,506 31,756 22,570
Proceeds from sale of stock.................................................... 95,828
Proceeds from issuance of notes payable and other financing arrangements....... 566,240 331,576 370,000
Repayment of debt and other non-current liabilities............................ (144,341) (4,939) (162,551)
Advances to repurchase shares of Class A common stock.......................... (16,330)
Stock repurchase............................................................... (111,334) (105,418) (35,849)
--------- --------- ---------
Net cash provided by financing activities........................................ 332,071 348,803 177,840
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents............................. 71,422 157,351 (95,572)
Cash and cash equivalents, beginning of year..................................... 487,938 330,587 426,159
--------- --------- ---------
Cash and cash equivalents, end of year........................................... $ 559,360 $ 487,938 $ 330,587
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL CASH FLOWS DISCLOSURE :
Cash paid during the year for:
Interest....................................................................... $ 56,056 $ 43,337 $ 32,501
Income taxes................................................................... (3,534) 65,698 65,259
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations...................................................... $ 3,993 $ 401
Notes and stocks received on sale of Medical Practices......................... 201,118
Transfer of investment as consideration for PACC acquisition................... 14,310
Conversion of FOHP convertible debentures to equity............................ 70,654
Transfer of investments from held to maturity to available for sale............ $ 2,913
Issuance of notes and assumption of liabilities as consideration in acquisition
of GHH....................................................................... 28,200
Profit sharing plan shares issued.............................................. 4,558
ACQUISITION OF BUSINESSES:
Fair value of assets acquired.................................................. $ 849,487 $ 23,650 $ 300,604
Liabilities assumed............................................................ 438,448 12,903 105,787
Issuance of common stock....................................................... 6,631
--------- --------- ---------
Cash paid for acquisitions..................................................... 411,039 4,116 194,817
Less cash acquired for acquisitions............................................ 117,414 4,224 44,357
--------- --------- ---------
Net cash paid in acquisitions.................................................. $ 293,625 $ (108) $ 150,460
--------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements
51
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--DESCRIPTION OF BUSINESS
The current operations of Foundation Health Systems, Inc. (the "Company" or
"FHS") are a result of the April 1, 1997 merger transaction (the "FHS
Combination") involving Health Systems International, Inc. ("HSI") and
Foundation Health Corporation ("FHC"). Pursuant to the FHS Combination, FH
Acquisition Corp., a wholly owned subsidiary of HSI ("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 FHS Combination, FHC stockholders received 1.3 shares of the
Company's Class A Common Stock for every share of FHC common stock held,
resulting in the issuance of approximately 76.7 million shares of the Company's
Class A Common Stock to FHC stockholders. The shares of the Company's Class A
Common Stock issued to FHC's stockholders in the FHS Combination constituted
approximately 61% of the outstanding stock of the Company after the FHS
Combination and the shares held by the Company's stockholders prior to the FHS
Combination (i.e. the prior stockholders of HSI) constituted approximately 39%
of the outstanding stock of the Company after the FHS Combination.
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
consolidated financial statements have been prepared and/or restated as though
HSI and FHC always had been combined. Although prior to the FHS Combination FHC
reported on a fiscal year ended June 30 basis, the consolidated financial
statements have been restated to reflect the Company's calendar year basis.
CONTINUING OPERATIONS
The Company is an integrated managed care organization which administers the
delivery of managed health care services. Continuing operations consist of three
separate lines of business: health plans, government contracts and specialty
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 administration and cost-containment,
behavioral health, dental, vision and pharmaceutical products and other
services.
The Company's health plans provide a wide range of managed health care
services throughout the United States with more than 4.3 million at-risk and
administrative services only members. The Company provides a comprehensive range
of health care services through HMOs organized into three operational divisions
located in the following geographic regions: the California Division which
includes Health Net, a California health maintenance organization, the Eastern
Division (Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and
West Virginia) and the Western Division (Arizona, Colorado, Idaho, Louisiana,
New Mexico, Oklahoma, Oregon, Texas, Utah and Washington). The Company's
commercial HMO subsidiaries contract to provide medical care services to a
defined, enrolled population for a predetermined, prepaid monthly fee for group,
Medicaid, individual and Medicare HMO plans throughout their respective service
areas. All of the HMOs are state licensed and some are also federally qualified.
The Company also operates PPO networks which provide access to health care
services and owns six health and life insurance companies licensed to sell
insurance throughout the United States.
52
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--DESCRIPTION OF BUSINESS (CONTINUED)
The Company's wholly-owned subsidiary, Foundation Health Federal Services,
Inc. ("Federal Services"), administers large, multi-year managed care government
contracts. Federal Services subcontracts to affiliated and unrelated third
parties the administration and health care risk of parts of these contracts.
Federal Services currently administers health care programs covering 1.9 million
eligible individuals under the Civilian Health and Medical Program of the
Uniformed Services ("CHAMPUS"). Through the Federal Government's TRICARE
program, Federal Services provides CHAMPUS families with improved access to
primary health care, lower out-of-pocket expenses and fewer claims forms.
Federal Services currently administers three TRICARE contracts in five regions
that cover the following states:
- Region 6: Texas, Arkansas, Oklahoma and Louisiana
- Regions 9, 10 & 12: California, Hawaii, Alaska and portions of Arizona
- Region 11: Washington, Oregon and portions of Idaho
The Company's specialty services subsidiaries offer behavioral health,
dental, vision, and pharmaceutical products and services as well as managed care
products related to bill review, administration and cost containment for
hospitals, health plans and other entities.
DISCONTINUED OPERATIONS
WORKERS' COMPENSATION INSURANCE SEGMENT--The Company revised its strategy of
maintaining a presence in the workers' compensation insurance business and
adopted a plan to discontinue this segment of its business through divestiture
of its workers' compensation insurance subsidiaries. The Company is currently in
negotiation for the sale of the business. As a result, the Company is reporting
its workers' compensation insurance segment as discontinued operations in the
consolidated financial statements (see Note 15).
The workers' compensation insurance companies consist of the following:
California Compensation Insurance Company, a specialty workers' compensation
carrier writing business primarily in California; Business Insurance Company, a
national workers' compensation specialty carrier; Commercial Compensation
Insurance Company (f/k/a Christiania General Insurance Corporation); and
Combined Benefits Insurance Company, writing single source workers' compensation
and employee health insurance primarily in California.
PHYSICIAN PRACTICE MANAGEMENT SEGMENT--On June 28, 1996 the Company executed
a Stock and Note Purchase Agreement with FPA Medical Management, Inc. ("FPA"), a
national health care management services organization, for the purchase by FPA
of the Company's physician practice management subsidiary and affiliated
physician-owned medical practices (collectively, the "Medical Practices"). The
transaction was consummated in November 1996. The consolidated financial
statements report this segment as discontinued operations (see Note 15).
RESTATEMENT FOR FHS COMBINATION
As previously stated, the Company's consolidated financial statements have
been prepared and/or restated as though HSI and FHC always had been combined.
The following summary reflects the adjustments required to change FHC from a
June 30 fiscal year end to the Company's calendar year end.
53
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--DESCRIPTION OF BUSINESS (CONTINUED)
The separate and combined results of the Company and FHC for the two years
and period prior to the consummation of the FHS Combination are as follows (in
thousands):
<TABLE>
<CAPTION>
QUARTER ENDED YEAR ENDED DECEMBER 31,
MARCH 31, -----------------------------
1997 1996 1995
------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
REVENUE
HSI total revenues and investment income as previously
reported............................................ $ 850,404 $ 3,242,858 $ 2,765,222
FHC June 30 fiscal year basis......................... 1,044,740 3,407,628 2,459,423
Net adjustments to reflect FHC on a calendar year
basis............................................... -- 560,028 299,762
Adjustments to reflect workers' compensation insurance
subsidiaries as discontinued operations............. (125,125) (501,274) (410,770)
------------- ------------- -------------
Combined.............................................. $ 1,770,019 $ 6,709,240 $ 5,113,637
------------- ------------- -------------
------------- ------------- -------------
NET INCOME
HSI as previously reported............................ $ 24,572 $ 73,592 $ 89,592
FHC June 30 fiscal year basis......................... 33,909 148,282 6,010
Net adjustments to reflect FHC on a calendar year
basis............................................... -- (137,643) 96,577
------------- ------------- -------------
Combined.............................................. $ 58,481 $ 84,231 $ 192,179
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned and majority-owned subsidiaries. All significant
intercompany transactions have been eliminated in consolidation except for
transactions between the Company's continuing operations subsidiaries and the
discontinued operations segments discussed in Note 15. The accompanying
consolidated financial statements have been restated for the FHS Combination
accounted for as a pooling of interests as discussed in Note 1.
REVENUE RECOGNITION
Commercial premium revenue includes HMO and PPO premiums from employer
groups and individuals and from Medicare recipients who have purchased
supplemental benefit coverage, which premiums are based on a predetermined
prepaid fee, Medicaid revenues based on multi-year contracts to provide care to
Medicaid recipients, and revenue under Medicare risk contracts to provide care
to enrolled Medicare recipients. Revenue is recognized in the month in which the
related enrollees are entitled to health care services. Premiums collected in
advance are recorded as unearned premiums.
Revenue under government contracts is recognized in the month in which the
eligible beneficiaries are entitled to health care services. Government
contracts also contain cost and performance incentive provisions which adjust
the contract price based on actual performance, and revenue under contracts is
subject to price adjustments attributable to inflation and other factors. The
effects of these adjustments are recognized on a monthly basis. Amounts
receivable under government contracts are comprised primarily of estimated
amounts receivable under these cost and performance incentive provisions, price
adjustments, and change orders for services not originally specified in the
contracts.
54
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Specialty services revenue is recognized in the month in which the
administrative services are performed or the period that coverage for services
is provided.
HEALTH CARE EXPENSES
The cost of health care services is recognized in the period in which it is
provided and includes an estimate of the cost of services which have been
incurred but not yet reported. Such costs include payments to primary care
physicians, specialists, hospitals, outpatient care facilities and the costs
associated with managing the extent of such care. The estimate for reserves for
claims and other settlements is based on actuarial projections of hospital and
other costs using historical studies of claims paid. Estimates are continually
monitored and reviewed and, as settlements are made or estimates adjusted,
differences are reflected in current operations. Such estimates are subject to
the impact of changes in the regulatory environment and economic conditions.
Given the inherent variability of such estimates, the actual liability could
differ significantly from the amounts provided. While the ultimate amount of
claims and losses paid are dependent on future developments, management is of
the opinion that the reserves for claims and other settlements are adequate to
cover such claims and losses. These liabilities are reduced by estimated amounts
recoverable from third parties for subrogation.
The Company generally contracts in California and Arizona with various
medical groups to provide professional care to certain of its members on a
capitation or fixed per member per month fee basis. Capitation contracts
generally include a provision for stop-loss and non-capitated services for which
the Company is liable. Professional capitated contracts also generally contain
provisions for shared risk, whereby the Company and the medical groups share in
the variance between actual hospital costs and predetermined goals.
Additionally, the Company contracts with certain hospitals to provide hospital
care to enrolled members on a capitation basis. The HMOs also contract with
hospitals, physicians and other providers of health care, pursuant to discounted
fee-for-service arrangements and hospital per diems under which providers bill
the HMOs for each individual service provided to enrollees.
CASH AND CASH EQUIVALENTS
Cash equivalents include all highly liquid investments with a maturity of
three months or less when purchased.
The Company and its consolidated subsidiaries are required to set aside
certain funds for restricted purposes pursuant to regulatory requirements. As of
December 31, 1997 and 1996, cash and cash equivalent balances of $37.9 million
and $5.5 million, respectively, are restricted and included in other noncurrent
assets.
INVESTMENTS
The Company classifies certain debt investments held by trustees or agencies
pursuant to state regulatory requirements as held to maturity based on the
Company's ability and intent to hold these investments to maturity. Such
investments are presented at amortized cost. All other investments are
classified as available for sale and are reported at fair value based on quoted
market prices, with unrealized gains and losses excluded from earnings and
reported as a separate component of stockholders' equity, net of income tax
effects. The cost of investments sold is determined in accordance with the
specific identification method and realized gains and losses are included in
investment income.
55
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Restricted investments totaled $14.6 million and $14.2 million at December
31, 1997 and 1996. In addition, $20.3 million in investments are restricted in
connection with the California Wellness Foundation (the "CWF") note payable at
December 31, 1997 and 1996 (see Note 6).
PROPERTY AND EQUIPMENT
Property and equipment are stated at historical cost less accumulated
depreciation. Depreciation is computed using the straight-line method over the
lesser of estimated useful lives of the various classes of assets or the lease
term. Lives of the assets range from 3 to 40 years.
Expenditures for maintenance and repairs are expensed as incurred. Major
improvements which increase the estimated useful life of an asset are
capitalized. Upon the sale or retirement of assets, recorded cost and related
accumulated depreciation are removed from the accounts, and any gain or loss on
disposal is reflected in operations.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consist primarily of goodwill and other
intangible assets which arise as a result of various business acquisitions.
Other intangible assets consist of the value of employer group contracts and
provider networks. Goodwill and other intangible assets are amortized using the
methods listed below over appropriate periods not exceeding 40 years. Fully
amortized goodwill and other intangible assets and related accumulated
amortization are removed from the accounts. The Company evaluates the carrying
value of its goodwill and other intangible assets periodically based on fair
values or undiscounted operating cash flows whenever significant events or
changes occur which might impair recovery of recorded costs, and it writes down
recorded costs of the assets to fair value when recorded costs, prior to
impairment, are higher.
Goodwill and other intangible assets consisted of the following at December
31, 1997 (in thousands):
<TABLE>
<CAPTION>
ACCUMULATED AMORTIZATION
COST AMORTIZATION NET BALANCE PERIOD
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Goodwill................................................ $ 1,026,992 $ 78,339 $ 948,653 27-40 years
Provider network........................................ 20,686 4,864 15,822 5-20 years
Employer group contracts................................ 120,089 62,380 57,709 11 years
Other................................................... 69,070 46,527 22,543 4-15 years
------------ ------------ ------------
Total................................................... $ 1,236,837 $ 192,110 $ 1,044,727
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
Goodwill and other intangible assets consisted of the following at December
31, 1996 (in thousands):
<TABLE>
<CAPTION>
ACCUMULATED AMORTIZATION
COST AMORTIZATION NET BALANCE PERIOD
---------- ------------ ----------- -------------
<S> <C> <C> <C> <C>
Goodwill................................................... $ 652,088 $ 62,316 $ 589,772 27-40 years
Provider network........................................... 25,035 3,761 21,274 5-20 years
Employer group contracts................................... 122,140 53,467 68,673 11 years
Other...................................................... 68,194 42,962 25,232 4-15 years
---------- ------------ -----------
Total...................................................... $ 867,457 $ 162,506 $ 704,951
---------- ------------ -----------
---------- ------------ -----------
</TABLE>
Amortization expense on goodwill and other intangible assets was $40.3
million, $45.2 million and $33.1 million for the years ended December 31, 1997,
1996 and 1995, respectively.
56
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of cash equivalents, investments and premium
receivables. All cash equivalents and investments are managed within established
guidelines which limit the amounts which may be invested with one issuer.
Concentrations of credit risk with respect to premium receivables are limited
due to the large number of payers comprising the Company's customer base. The
Company's ten largest employer groups accounted for 36.2% and 29.9% of
receivables and 16.3% and 16.8% of premium revenue as of December 31, 1997 and
1996, respectively, and for the years then ended.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", which
requires changes in current earnings per share ("EPS") reporting requirements.
The Company adopted SFAS No. 128 in the fourth quarter of 1997 and restated all
prior period EPS data presented in the accompanying financial statements. Basic
EPS excludes dilution and reflects income divided by the weighted average shares
of common stock outstanding during the periods presented. Diluted EPS is based
upon the weighted average shares of common stock and dilutive common stock
equivalents (stock options) outstanding during the periods presented; no
adjustment to income is required. Common stock equivalents arising from dilutive
stock options are computed using the treasury stock method.
Options to purchase an aggregate of 6.6 million, 4.1 million and 1.3 million
shares of common stock during 1997, 1996 and 1995, respectively, were not
included in the computation of diluted EPS because the options' exercise price
was greater than the average market price of the common stock. These options
expire through December 2007.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts of cash equivalents, investments available
for sale and notes payable approximate their carrying amounts in the financial
statements and have been determined by the Company using available market
information and appropriate valuation methodologies. The carrying amount of cash
equivalents approximate fair value due to the short maturity of those
instruments. The fair values of investments are estimated based on quoted market
prices and dealer quotes for similar investments. The fair value of notes
payable is estimated based on the quoted market prices for the same or similar
issues or on the current rates offered to the Company for debt with the same
remaining maturities. Considerable judgment is required to develop estimates of
fair value. Accordingly, the estimates are not necessarily indicative of the
amounts the Company could have realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
57
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The fair value estimates are based on pertinent information available to
management as of December 31, 1997 and 1996. Although management is not aware of
any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued for purposes of these
financial statements since that date, and therefore, current estimates of fair
value may differ significantly.
STOCK-BASED COMPENSATION
During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation". The Company has chosen to continue
accounting for stock-based compensation under the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees." Under the intrinsic value method, compensation cost for
stock options is measured at the date of grant as the excess, if any, of the
quoted market price of the Company's stock over the exercise price of the option
(see Note 7).
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
During 1997, the Financial Accounting Standards Board issued SFAS No. 130
"Reporting Comprehensive Income", which requires that an enterprise report, by
major components and as a single total, the change in its net assets during the
period from nonowner sources; SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information", which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas, and major customers;
and SFAS No. 132 "Employers Disclosures About Pensions and Other Postretirement
Benefits", which revises and standardizes pension and other benefit plan
disclosures. Adoption of these statements will not impact the Company's
consolidated financial position, results of operations or cash flows. These
statements are effective for fiscal years beginning after December 15, 1997.
NOTE 3--ACQUISITIONS
The following summarizes acquisitions and strategic investments by the
Company for the three years ended December 31, 1997:
1997
ADVANTAGE HEALTH--On April 1, 1997 the Company completed the acquisition of
Advantage Health, a group of managed health care companies based in Pittsburgh,
Pennsylvania, for $12.5 million in cash. The acquisition has been recorded using
purchase accounting and the excess of the purchase price over the fair value of
the assets acquired was recorded as goodwill. The goodwill, in the amount of
$19.7 million, is being amortized on a straight line basis over 35 years.
Advantage Health has approximately 35,000 full-risk members in Pennsylvania,
Ohio and West Virginia. The Company purchased Advantage Health from St. Francis
Health System, which has an option to re-acquire a 20 percent interest in
Advantage Health for $2.5 million. Advantage Health remains a party to long-term
provider agreements with the St. Francis Health System.
PACC--On October 22, 1997, effective October 1, 1997, the Company completed
the acquisitions of PACC HMO and PACC Health Plans (collectively, "PACC"), which
are managed health care companies based near Portland, Oregon, for a net
purchase price of approximately $43.7 million in cash. The acquisition has been
recorded using purchase accounting and the excess of the purchase price over the
fair value of the assets acquired was recorded as goodwill. The goodwill, in the
amount of $32.2 million, is
58
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--ACQUISITIONS (CONTINUED)
being amortized on a straight-line basis over 40 years. PACC is a 116,000 member
health plan with operations in Oregon and Washington.
FOHP--On April 30, 1997 the Company made a $51.7 million investment in FOHP,
Inc. ("FOHP"). FOHP was owned by physicians, hospitals and other health care
providers and was the sole shareholder of First Option Health Plan of New
Jersey, Inc. ("FOHP-NJ"), a managed health care company. The Company's initial
investment was in the form of FOHP debentures convertible into up to 71 percent
of FOHP's outstanding equity at the Company's discretion. As of December 1, 1997
the Company converted these initial FOHP debentures into 71 percent of FOHP's
equity. Additionally, effective December 8, 1997 FOHP issued an additional $29.0
million of convertible debentures to the Company which immediately converted
approximately $18.9 million of these debentures into an additional 27 percent of
FOHP's outstanding equity increasing FHS' equity holding in FOHP to
approximately 98 percent. Goodwill of $107.7 million was recorded as a result of
these transactions. On December 31, 1997 the Company purchased nonconvertible
debentures in the amount of $24 million from FOHP. FOHP currently has more than
250,000 members in New Jersey enrolled in its commercial, Medicare, Medicaid and
PPO programs.
PHYSICIANS HEALTH SERVICES--On December 31, 1997 the Company completed the
acquisition of Physicians Health Services, Inc. ("PHS"), a group of managed
health care companies based in Shelton Connecticut. The Company paid
approximately $265 million for the approximately nine million PHS shares then
outstanding and caused PHS to cash-out approximately $6 million in PHS employee
stock options as part of the acquisition. The acquisition has been recorded
using purchase accounting and the excess of the purchase price over the fair
value of the assets acquired was recorded as goodwill. The goodwill, in the
amount of $218.9 million, is being amortized on a straight-line basis over 40
years. PHS is a 449,000 member health plan with operations in the New York
metropolitan area, including northern New Jersey, and throughout the state of
Connecticut.
CHRISTIANIA GENERAL INSURANCE CORPORATION--On May 14, 1997 the Business
Insurance Group, Inc., a subsidiary of the Company, acquired the Christiania
General Insurance Corporation of New York ("CGIC") for $12.7 million in cash.
The acquisition has been recorded using purchase accounting and the excess of
the purchase price over the fair value of the assets acquired was recorded as
goodwill. The goodwill, in the amount of $5.2 million, is being amortized on a
straight-line basis over 20 years. As discussed in Note 1, the workers'
compensation segment is reported as discontinued operations and includes CGIC.
The following table reflects unaudited pro forma combined results of
operations of the Company and Advantage Health, PACC, FOHP, PHS, and CGIC on the
basis that the acquisitions had taken place at the beginning of each year ended
December 31 (in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Total revenues.................................... $8,373,830 $7,593,247
Loss from continuing operations................... (176,589) (1,890)
Net income (loss)................................. (295,746) 45,570
Basic and diluted earnings (loss) per share:
Continuing operations........................... (1.43) (.02)
Net............................................. (2.39) .37
</TABLE>
59
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--ACQUISITIONS (CONTINUED)
1996
MANAGED HEALTH NETWORK--In March 1996 the Company issued stock for Managed
Health Network, Inc. and its subsidiaries (collectively "MHN"), a privately held
company providing employee assistance and managed behavioral health programs to
more than 2.7 million covered lives through its subsidiaries, in a pooling of
interests transaction valued at approximately $45 million.
1995
MDEC--On March 15, 1995 the Company acquired all of the outstanding stock of
M.D. Enterprises of Connecticut, Inc. ("MDEC"), and its wholly-owned subsidiary,
M.D. Health Plan, an HMO operating in Connecticut, for $100.5 million. The
goodwill, in the amount of $89.1 million and employer group contracts in the
amount of $8.0 million, is being amortized on a straight-line basis over 35 and
11 years, respectively.
HDS--In 1995, the Company acquired shares of preferred stock of Health Data
Sciences Corporation ("HDS"), representing a minority equity interest in HDS,
for an aggregate purchase price of approximately $21.9 million. In July 1996,
HDS was acquired by Medaphis Corporation ("Medaphis") and the Company's
preferred stock in HDS was converted into 976,771 shares of Medaphis common
stock. Since the acquisition of HDS by Medaphis the value of Medaphis common
stock has substantially declined, and the Company has therefore reflected an
unrealized loss of $15.6 million related to its investment in Medaphis common
stock. In connection with the decline the Company filed a lawsuit against
Medaphis in 1996 claiming, among other things, that misleading financial
performance information was given to the Company prior to the acquisition. The
complaint seeks rescission of the transaction or damages in excess of $38.0
million. As of December 31, 1997, the litigation is ongoing.
GHH--On December 1, 1995, the Company acquired the outstanding stock of G.
H. Holdings ("GHH") and certain of its for-profit subsidiaries, including
Greater Atlantic Health Services (now known as QualMed Plans for Health), an HMO
operating in Pennsylvania and New Jersey, for $126.5 million in cash and notes
(the "GHH Transaction"). The acquisition has been accounted using purchase
accounting and the excess of the purchase price over the fair value of assets
acquired in the amount of $88.4 million was recorded as goodwill. Goodwill is
being amortized on a straight-line basis over 35 years. The Company subsequently
divested certain of GHH's subsidiaries.
BICO--In February 1995, California Compensation Insurance Company acquired
Business Insurance Company ("BICO"), a national workers' compensation specialty
carrier, for $13.2 million in cash. The acquisition has been recorded using
purchase accounting and no goodwill was recorded as a result of this
transaction.
60
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--INVESTMENTS
As of December 31, 1997, the amortized cost, gross unrealized holding gains
and losses and fair value of the Company's investments were as follows (in
thousands):
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
--------------------------------------------- ---------------------------------------------
GROSS GROSS GROSS GROSS
UNREALIZED UNREALIZED UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Asset backed
securities............. $ 122,313 $ 901 $ (1,537) $ 121,677
U.S. government and
agencies............... 88,468 808 (269) 89,007 $ 9,675 $ 69 $ (4) $ 9,740
Obligations of states and
other political
subdivisions........... 184,399 1,742 (144) 185,997
Corporate debt
securities............. 73,521 704 (122) 74,103
Securities held by
depository............. 20,912 20,912
Other securities......... 74,118 2,918 (15,731) 61,305 3,210 3,210
--------- --------- --------- --------- --------- --------- --------- ---------
$ 563,731 $ 7,073 $(17,803) $ 553,001 $ 12,885 $ 69 $ (4) $ 12,950
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>
As of December 31, 1996, the amortized cost, gross unrealized holding gains
and losses and fair value of the Company's investments were as follows (in
thousands):
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
--------------------------------------------- ---------------------------------------------
GROSS GROSS GROSS GROSS
UNREALIZED UNREALIZED UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Asset backed
securities............. $ 187,204 $ 498 $ (972) $ 186,730
U.S. government and
agencies............... 100,989 121 (911) 100,199 $ 11,806 $ 31 $ (25) $ 11,812
Obligations of states and
other political
subdivisions........... 100,825 339 (287) 100,877
Corporate debt
securities............. 94,732 473 (1,321) 93,884
Securities held by
depository............. 25,019 25,019
Other securities......... 123,785 16,218 (11,734) 128,269 2,411 2,411
--------- --------- --------- --------- --------- --- --- ---------
$ 632,554 $ 17,649 $(15,225) $ 634,978 $ 14,217 $ 31 $ (25) $ 14,223
--------- --------- --------- --------- --------- --- --- ---------
--------- --------- --------- --------- --------- --- --- ---------
</TABLE>
61
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--INVESTMENTS (CONTINUED)
At December 31, 1997, the contractual maturities of the Company's
investments were as follows (in thousands):
<TABLE>
<CAPTION>
ESTIMATED
COST FAIR VALUE
-------- ----------
<S> <C> <C>
AVAILABLE FOR SALE:
Due in one year or less......................... $173,550 $ 173,854
Due after one year through five years........... 137,126 138,462
Due after five years through ten years.......... 75,999 77,180
Due after ten years............................. 26,800 26,755
-------- ----------
413,475 416,251
Asset-backed securities......................... 122,313 121,677
Equity securities............................... 27,943 15,073
-------- ----------
Total available for sale.......................... $563,731 $ 553,001
-------- ----------
-------- ----------
HELD TO MATURITY
Due in one year or less......................... $ 6,951 $ 6,952
Due after one year through five years........... 5,934 5,999
-------- ----------
Total held to maturity............................ $ 12,885 $ 12,951
-------- ----------
-------- ----------
</TABLE>
Proceeds from sales and maturities of investments available for sale during
1997 were $605.3 million, resulting in realized gains and losses of $4.7 million
and $75 thousand, respectively.
Proceeds from the sales and maturities of investments available for sale
during 1996 were $441.6 million resulting in gross realized gains and losses of
$2.5 million and $300 thousand, respectively.
The Company's regulated subsidiaries are required to keep investments on
deposit in various states where they are licensed. At December 31, 1997, $34.9
million in securities are restricted to satisfy various state regulatory and
licensing requirements.
NOTE 5--PROPERTY AND EQUIPMENT
Property and equipment comprised the following at December 31 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Land.............................................. $ 28,302 $ 20,694
Construction in progress.......................... 19,472 12,066
Buildings and improvements........................ 159,571 114,353
Furniture, equipment and software................. 526,781 395,528
---------- ----------
734,126 542,641
Less--accumulated depreciation.................... 306,977 237,893
---------- ----------
$ 427,149 $ 304,748
---------- ----------
---------- ----------
</TABLE>
62
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--PROPERTY AND EQUIPMENT (CONTINUED)
Depreciation expense on property and equipment was $58.1 million, $67.7
million and $56.3 million for the years ended December 31, 1997, 1996 and 1995.
NOTE 6--NOTES PAYABLE, CAPITAL LEASES AND OTHER FINANCING ARRANGEMENTS
Notes payable, capital leases and other financing arrangements comprised the
following at December 31 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
Revolving credit facility, variable interest at
LIBOR plus .35% at December 31, 1997,
unsecured....................................... $1,265,000
Senior Notes due June 1, 2003, interest at 7.75%,
unsecured, repaid June 1997 (see note 14)....... $124,673
Revolving credit facility, variable interest at
5.95% at December 31, 1996, unsecured........... 319,000
Revolving credit facility, variable interest at
6.40% at December 31, 1996, unsecured........... 380,000
GHH note payable, due December 2000, interest at
7.95%, unsecured................................ 22,500 22,500
CWF note payable, due quarterly with a balloon
payment due 2006, variable interest of 2.5%
above 3 year Treasury Bill rate, 10.3% at
December 31, 1997 and 1996, secured by
substantially all of the assets of Health Net... 18,754 19,331
Capital leases and other notes payable............ 6,318 11,590
---------- --------
Total notes payable and capital leases............ 1,312,572 877,094
Less notes payable and capital leases-current
portion......................................... 3,593 85,476
---------- --------
Notes payable and capital leases-noncurrent
portion......................................... $1,308,979 $791,618
---------- --------
---------- --------
</TABLE>
REVOLVING CREDIT FACILITY
The Company's Credit Facility, as amended, provides for an unsecured
five-year $1.5 billion revolving credit facility which replaced (i) the
Company's prior $700 million unsecured revolving credit facility with Bank of
America, as agent, and (ii) FHC's prior $300 million unsecured revolving credit
facility with Citicorp USA, Inc., as agent, and $200 million unsecured revolving
credit facility with Citibank, N.A., as administrative agent. The facility is
available to the Company and its subsidiaries for general corporate purposes,
including permitted acquisitions.
Bank of America is the administrative agent and co-lead bank with Citibank
N.A. for the other participating banks named in the Credit Agreement. 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,
but subject to the applicable LIBOR Rate plus margin or a base rate (which is
the higher of .50% above the Federal Funds Rate or the Bank of America
"reference rate"). Actual rates on borrowings under the facility vary based on
competitive bidding and the Company's unsecured debt rating at the time of the
borrowing. The facility is available for five years, until July 2002, but may be
extended, under certain circumstances, for two additional years until July 2004.
63
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--NOTES PAYABLE, CAPITAL LEASES AND OTHER FINANCING ARRANGEMENTS
(CONTINUED)
The weighted average annual interest rate on the Company's notes payable and
capital leases was approximately 6.24%, 6.39% and 7.44% for the years ended
December 31, 1997, 1996 and 1995.
Scheduled principal repayments on notes payable, capital leases and other
financing arrangements for the next five years are as follows (in thousands):
<TABLE>
<S> <C>
1998............................................................ $ 3,593
1999............................................................ 2,199
2000............................................................ 24,368
2001............................................................ 1,088
2002............................................................ 1,265,958
Thereafter...................................................... 15,366
-----------
Total notes payable and capital leases........................ $ 1,312,572
-----------
-----------
</TABLE>
NOTE 7--STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS
The Company has various stock option plans which cover certain employees,
officers and non-employee directors, and employee stock purchase plans under
which nearly all full-time employees of the Company are eligible to participate.
These plans have been approved by the stockholders.
Under the 1989, 1990, 1991, 1992, 1993 and 1997 employee stock option plans
and the non-employee director stock option plan, the Company grants options at
prices at or above the market value of the stock on the date of grant. The
options carry a maximum term of 10 years and in general vest ratably over 3
years, 5 years or over the 3rd, 4th and 5th anniversaries of the date of grant.
The Company has reserved a total of 24.9 million shares of its Class A Common
Stock for issuance under the stock option plans. The Company anticipates all
future option grants will be made under the 1997 stock option plan.
Under the 1990, 1993 and 1997 employee stock purchase plans, the Company
provides employees with the opportunity to purchase stock through payroll
deductions. Eligible employees may purchase up to $25,000 in fair market value
annually of the Company's Class A Common Stock at 85% of the lower of the market
price on either the first or last day of each offering period, except under the
1990 plan which specifies a purchase price at 85% of the market price on the
date of purchase. The Company has reserved a total of 650 thousand shares of its
Class A Common Stock for issuance under the 1997 plan. The 1990 and 1993 plans
were terminated effective September 1997 and November 1997, respectively.
64
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS (CONTINUED)
Stock option activity and weighted average exercise prices for the years
ended December 31 is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------- ----------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ------- ------------- ------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January 1.......................... 7,051,940 $27.75 6,519,232 $24.44 7,355,064 $ 20.59
Granted........................................... 3,912,040 32.18 2,338,031 32.50 1,624,856 25.69
Exercised......................................... (830,021) 22.66 (1,237,312) 19.52 (1,998,009) 11.33
Canceled.......................................... (497,128) 28.61 (568,011) 27.32 (462,679) 24.18
---------- ------------- ------------
Outstanding at December 31........................ 9,636,831 $29.94 7,051,940 $27.75 6,519,232 $ 24.44
---------- ------------- ------------
---------- ------------- ------------
Exerciseable at December 31....................... 5,116,533 4,640,576 3,282,878
---------- ------------- ------------
---------- ------------- ------------
</TABLE>
Under the 1990, 1993 and 1997 employee stock purchase plans, the Company
sold 100 thousand, 117 thousand and 88 thousand shares of its stock to employees
in 1997, 1996 and 1995, respectively.
The following table summarizes the weighted average exercise price and
weighted average remaining contractual life for significant option groups
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
- --------------- --------- ---------------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
$ 3.21 - $27.75 2,531,599 5.98 years $21.72 2,054,136 $21.07
27.88 - 32.25 1,935,638 6.72 years 29.65 1,555,364 29.62
32.50 - 32.50 3,622,500 9.68 years 32.50 0.00
32.69 - 52.81 1,547,094 7.63 years 37.77 1,507,033 37.87
--------- ---------
$ 3.21 - $52.81 9,636,831 7.78 years $29.94 5,116,533 $28.62
--------- ---------
--------- ---------
</TABLE>
The weighted average fair value for options granted during 1997, 1996 and
1995 was $9.95, $10.46 and $12.86, respectively. The weighted-average fair value
for employee purchase rights during 1997, 1996 and 1995 was $5.68, $6.21 and
$6.70, respectively. The fair values were estimated using the Black-Sholes
option-pricing model. The following weighted average assumptions were used in
the fair value calculation for 1997, 1996 and 1995, respectively: (i) risk-free
interest rate of 5.71%, 6.23% and 7.70% for option grants and 5.66%, 5.79% and
7.13% for employee purchase rights; (ii) expected option lives of 3.7 years, 2.7
years and 3.1 years and expected employee purchase right lives of 2.1 months,
3.3 months, and 3.3 months; (iii) expected volatility for both options and
employee purchase rights of 30.0%, 37.6% and 37.2%; and (iv) no expected
dividend yield for either options or employee purchase rights.
The Company applies APB Opinion 25 and related Interpretations in accounting
for its plans. Accordingly, no compensation cost has been recognized for its
stock option or employee stock purchase plans. Had compensation cost for the
Company's plans been determined based on the fair value at the grant dates of
options and employee purchase rights consistent with the method of SFAS No. 123,
the
65
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS (CONTINUED)
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below for the years ended December 31 (in thousands,
except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
---------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss)................................. As reported $ (187,084) $ 84,231 $192,179
Pro forma (193,638) 69,226 187,591
Basic earnings (loss) per share................... As reported (1.52) 0.67 1.56
Pro forma (1.57) 0.56 1.53
Diluted earnings (loss) per share................. As reported (1.52) 0.67 1.55
Pro forma (1.56) 0.55 1.52
</TABLE>
As fair value criteria was not applied to option grants and employee
purchase rights prior to 1995, and additional awards in future years are
anticipated, the effects on net income and earnings per share in this pro forma
disclosure may not be indicative of future amounts.
NOTE 8--CAPITAL STOCK
The Company has two classes of Common Stock. The Company's Class B Common
Stock has the same economic benefits as the Company's Class A Common Stock but
is non-voting. Upon the sale or transfer of shares of Class B Common Stock by
the CWF to an unrelated third party, such shares automatically convert into
Class A Common Stock. The CWF is the only holder of record of the Company's
Class B Common Stock.
PUBLIC OFFERING
On May 15, 1996, the Company completed a public offering in which the
Company sold 3,194,374 shares of Class A Common Stock and the CWF sold 6,386,510
shares of Class A Common Stock (constituting 6,386,510 shares of Class B Common
Stock which automatically converted into shares of Class A Common Stock upon the
sale) for a per share purchase price to the public of $30.00 (the "Offering").
The net proceeds received by the Company from the sale of the 3,194,374 shares
of Class A Common Stock were approximately $92.4 million after deducting
underwriting discounts and commissions and estimated expenses of the Offering
payable by the Company. The Company used its net proceeds from the Offering to
repurchase 3,194,374 shares of Class A Common Stock held pursuant to the
Associate Trust Agreement from certain Class A Stockholders. The Company
repurchased these shares of Class A Common Stock from the Class A Stockholders
at $30.00 per share less transaction costs associated with the Offering,
amounting to $1.08 per share. All of these 3,194,374 shares of Class A Common
Stock repurchased are currently held in treasury. The Company did not receive
any of the proceeds from the sale of shares of Class A Common Stock in the
Offering by the CWF.
On June 27, 1997, the Company redeemed 4,550,000 shares of Class B Common
Stock from the CWF at a price of $24.47 per share. The Company provided its
consent to permit the CWF to sell 3,000,000 shares of Class B Common Stock to an
unrelated third party in June of 1997 and to sell 450,000 shares of Class B
Common Stock to unrelated third parties throughout August of 1997. On November
6, 1997, the Company also provided its consent to permit the CWF to sell
1,000,000 shares of Class B Common Stock to an unrelated third party. Pursuant
to the Company's Certificate of Incorporation, such 3,000,000 shares,
66
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--CAPITAL STOCK (CONTINUED)
450,000 shares and 1,000,000 shares of Class B Common Stock automatically
converted into shares of Class A Common Stock in the hands of such third
parties.
As a result of such transactions, the CWF now holds 10,297,642 shares of
Class B Common Stock at December 31, 1997.
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.
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 of the outstanding Class A Common
Stock to be an "Adverse Person," or any person commences a tender offer for 15%
of the Class A Common Stock (each event causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock, at a price of $170.00
per one-thousandth share. However, in the event any person acquires 15% or more
of the outstanding Class A Common Stock, or the Board of Directors of the
Company declares a holder of 10% or more of the outstanding Class A Common Stock
to be an "Adverse Person," the Rights (subject to certain exceptions contained
in the Rights Agreement) will instead become exercisable for Class A Common
Stock having a market value at such time equal to $340.00. The Rights are
redeemable under certain circumstances at $.01 per Right and will expire, unless
earlier redeemed, on July 31, 2006.
In connection with the FHS Combination, the Company entered into Amendment
No. 1 to the Rights Agreement to exempt the FHS Combination and related
transactions from triggering the Rights. In addition, the amendment modified
certain terms of the Rights Agreement applicable to the determination of certain
"Adverse Persons," which modifications became effective upon consummation of the
FHS Combination.
NOTE 9--EMPLOYEE BENEFIT PLANS
DEFINED CONTRIBUTION RETIREMENT PLANS
The Company and certain subsidiaries sponsor defined contribution retirement
plans intended to qualify under Sections 401(a) and 401(k) of the Internal
Revenue Code of 1986, as amended (the "Code"). Participation in the plans is
available to substantially all employees who meet certain eligibility
requirements and elect to participate. Employees may contribute up to the
maximum limits allowed by Section 401(k) of the Code, with Company contributions
based on matching or other formulas. The Company's expense under the plans
totaled $4.2 million, $5.1 million and $4.5 million for the years ended December
31, 1997, 1996 and 1995, respectively.
67
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--EMPLOYEE BENEFIT PLANS (CONTINUED)
DEFINED BENEFIT RETIREMENT PLANS
In 1995 the Company adopted two unfunded non-qualified defined benefit
pension plans, a Supplemental Executive Retirement Plan and a Directors'
Retirement Plan (collectively, the "FHC SERPs"). In 1996 the Company adopted two
additional unfunded non-qualified defined benefit pension plans, a Supplemental
Executive Retirement Plan and a Directors' Retirement Plan (collectively, the
"HSI SERPs"). These plans cover key executives, as selected by the Board of
Directors, and non-employee directors. Benefits under the plans are based on
years of service and level of compensation.
As part of the FHS Combination, the FHC SERPs were frozen in April 1997 at
which time each participant became 100% vested in their benefits under the plans
which are equal to 90% of the actuarial equivalent of the participant's
retirement benefit as of December 31, 1996. All benefits under the FHC SERPs
were paid out either in cash, or as a rollover to the deferred compensation
plan.
The following table sets forth the funded status of the FHC SERPs and HSI
SERPs and the amounts recognized in the Company's consolidated financial
statements at December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Actuarial present value of:
Vested benefit obligation.............................................. $ 4,702 $ 10,591
Nonvested benefit obligation........................................... 885 4,654
--------- ---------
Accumulated benefit obligation........................................... $ 5,587 $ 15,245
--------- ---------
--------- ---------
Projected benefit obligation............................................. $ 8,078 $ 21,912
Plan assets at fair value................................................ -- --
--------- ---------
Projected benefit obligation in excess of plan assets.................... 8,078 21,912
Unrecognized net (gain) loss............................................. 316 (7,294)
Unrecognized prior service cost.......................................... (4,248) (4,503)
Unrecognized net transition obligation................................... (3,506)
Additional liability..................................................... 1,441 8,636
--------- ---------
Pension liability........................................................ $ 5,587 $ 15,245
--------- ---------
--------- ---------
</TABLE>
Net pension costs included the following components for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Service cost.................................................... $ 1,331 $ 2,150 $ 1,183
Interest cost on projected benefit obligation................... 820 1,283 321
Net amortization and deferral................................... 533 1,000 264
Plan termination expense--FHC SERP.............................. 12,074
--------- --------- ---------
$ 14,758 $ 4,433 $ 1,768
--------- --------- ---------
--------- --------- ---------
</TABLE>
68
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--EMPLOYEE BENEFIT PLANS (CONTINUED)
The projected benefit obligation and net pension cost were determined using
discount rates of 7.50%, 7.88% and 8% for 1997, 1996 and 1995, respectively and
an assumed rate of compensation increase of 4%, 5% and 4% for 1997, 1996 and
1995, respectively.
DEFERRED COMPENSATION PLANS
Under the Company's deferred compensation plan certain members of
management, highly compensated employees and non-employee Board members may
defer payment of up to 90% of their compensation. As part of the FHS
Combination, the plan was frozen in May 1997 at which time each participant's
account was credited with three times the 1996 Company match (or a lesser amount
for certain prior participants) and each participant became 100% vested in all
such contributions. The current provisions with respect to the form and timing
of payments under the plan remain unchanged. At December 31, 1997 and 1996, the
liability under the plan amounted to $29.3 million and $19.9 million. The
Company's expense under the plan totaled $7.8 million, $3.7 million and $3.1
million for the years ended December 31, 1997, 1996, and 1995.
POST-RETIREMENT HEALTH AND LIFE PLANS
Certain subsidiaries of the Company sponsor post-retirement defined benefit
health care plans that provide post-retirement medical benefits to key
executives, employees and dependents who meet certain eligibility requirements.
Under these plans, the Company pays a percentage of the costs of medical, dental
and vision benefits during retirement. The plans include certain cost-sharing
features such as deductibles, coinsurance and maximum annual benefit amounts
which vary based principally on years of credited service. The accumulated
post-retirement benefit obligation under the plans was $6.3 million and $5.2
million at December 31, 1997 and 1996 respectively. The net periodic
post-retirement cost was $1.3 million, $828 thousand and $798 thousand for the
years ended December 31, 1997, 1996 and 1995 respectively.
The weighted-average annual assumed rate of increase in the per capita cost
of covered benefits (i.e. health care cost trend rate) is 7.25% for 1997, and is
assumed to decrease gradually to 4.5% for 2007 and remain at that level
thereafter. The impact of increasing the assumed health care cost trend rate by
1 percentage point would not have a significant effect on the accumulated
post-retirement benefit obligation or the aggregate of the service and interest
cost components of the net periodic post-retirement benefit cost for the year
ended December 31, 1997.
PERFORMANCE-BASED ANNUAL BONUS PLAN
In 1997, the Company had a Performance-Based Annual Bonus Plan that
qualified under Section 162(m) of the Code (the "Prior 162(m) Plan"). Under the
Prior 162(m) Plan, if the Company achieved $62.5 million in consolidated income
from operations before taxes, certain executives were potentially eligible to
receive cash bonuses from a pool of 2.5% of such consolidated operating income
based on the executives' salaries in relation to the pool. Amounts payable to
such executives from such pool were subject to downward adjustment by the
Company's Compensation and Stock Option Committee of the Board of Directors. The
$62.5 million performance goal for the Prior 162(m) Plan was not met for 1997.
The Company's Stockholders adopted a new Performance-Based Annual Bonus Plan
that qualifies under Section 162(m) of the Code which became effective on
January 1, 1998 and replaced the Prior 162(m) Plan.
69
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--EMPLOYEE BENEFIT PLANS (CONTINUED)
EMPLOYEE STOCK PURCHASE PLANS
The Company sponsors employee stock purchase plans available to
substantially all employees who meet certain eligibility requirements and elect
to participate (see Note 7).
NOTE 10--INCOME TAXES
Significant components of the provision (benefit) for income taxes are as
follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal.................................................. $ (12,894) $ 13,687 $ 80,115
State.................................................... 3,183 2,593 19,092
---------- --------- ----------
Total current.............................................. (9,711) 16,280 99,207
---------- --------- ----------
Deferred:
Federal.................................................. (57,150) 7,420 14,854
State.................................................... (5,478) 1,123 1,364
---------- --------- ----------
Total deferred............................................. (62,628) 8,543 16,218
---------- --------- ----------
Total provision (benefit) for income taxes................. $ (72,339) $ 24,823 $ 115,425
---------- --------- ----------
---------- --------- ----------
</TABLE>
Income tax expense (benefit) is included in the financial statements as
follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Continuing operations...................................... $ (21,418) $ 14,124 $ 124,345
Discontinued operations.................................... (50,921) 10,699 (8,920)
---------- --------- ----------
Total provision (benefit) for income taxes................. $ (72,339) $ 24,823 $ 115,425
---------- --------- ----------
---------- --------- ----------
</TABLE>
70
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--INCOME TAXES (CONTINUED)
A reconciliation of the statutory federal income tax rate and the effective
income tax rate on income from continuing operations is as follows for the years
ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Statutory federal income tax rate................................ (35)% 35% 35%
State and local taxes, net of federal income tax effect.......... (3) 3 6
Tax exempt interest income....................................... (2) (3) (1)
Goodwill amortization............................................ 6 6 1
Valuation allowance adjustment................................... (2) (5) 0
Merger transaction costs......................................... 8 0 0
Pooling transactions............................................. 0 (4) 0
IRS settlement................................................... 0 (4) 0
Other, net....................................................... 4 (1) (1)
-- -- --
Effective income tax rate...................................... (24)% 27% 40%
-- -- --
-- -- --
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
as of December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
(IN THOUSANDS)
<S> <C> <C>
CURRENT DEFERRED TAX ASSETS:
Accrued liabilities.................................................. $ 70,547 $ 50,995
Accrued compensation and benefits.................................... 28,150 22,582
Restructuring reserves............................................... 30,057 317
Net operating loss carryforwards..................................... 140,862 11,178
Other, net........................................................... 1,524 12,689
---------- ---------
Net deferred tax assets before valuation allowance................... 271,140 97,761
Valuation allowance.................................................. (57,445) (1,275)
---------- ---------
Total deferred tax assets............................................ $ 213,695 $ 96,486
---------- ---------
---------- ---------
NONCURRENT DEFERRED TAX LIABILITIES:
Depreciable and amortizable property................................. $ 66,608 $ 6,106
Other, net........................................................... 839 3,345
---------- ---------
Total deferred tax liabilities....................................... $ 67,447 $ 9,451
---------- ---------
---------- ---------
</TABLE>
As of December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $324 million from continuing operations, of which
$126 million may be subject to carryover limitations under Section 382 of the
Code. A valuation allowance has been provided to account for the potential
limitations associated with utilization of net operating loss carryforwards. The
net operating loss carryforwards expire between 2006 and 2012.
The valuation allowance increase of $56.2 million is due to the acquisition
of a subsidiary for which the future realizability of such subsidiary's deferred
tax assets, primarily related to net operating loss carryforwards, is uncertain.
71
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--REGULATORY REQUIREMENTS
All of the Company's health plans as well as its insurance subsidiaries are
required to periodically file financial statements with regulatory agencies in
accordance with statutory accounting and reporting practices. Under the
California Knox-Keene Health Care Service Plan Act of 1975, as amended,
California plans must comply with certain minimum capital or tangible net equity
requirements. The Company's non-California health plans, as well as its health
and life insurance companies, must comply with their respective state's minimum
regulatory net worth requirements generally under the regulation of the
respective state's department of insurance.
The regulatory net worth of the Company's health plans exceeded the minimum
aggregate requirement by approximately $243 million and $368 million at December
31, 1997 and 1996, respectively. Under certain government contracts. Federal
Services is required to maintain a current ratio of 1:1 and certain HMO
subsidiaries are required to maintain a current ratio of 1:1 under Medicaid
contracts.
As a result of the above requirements and certain other regulatory
requirements, certain subsidiaries are subject to restrictions on their ability
to make dividend payments, loans or other transfers of cash to the Company. Such
restrictions, unless amended or waived, limit the use of any cash generated by
these subsidiaries to pay obligations of the Company. As of December 31, 1997,
restricted assets of these subsidiaries totaled approximately $52.5 million.
NOTE 12--COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
The Company is involved in various legal proceedings, which are routine in
its business. In the opinion of management, based upon current facts and
circumstances known by the Company, the resolution of these matters should not
have a material adverse effect on the financial position or results of
operations of the Company.
OPERATING LEASES
The Company leases administrative and medical office space under various
operating leases. Certain medical office space is subleased to participating
medical groups doing business with the Company. Certain leases contain renewal
options and rent escalation clauses.
In 1995, the Company entered into a $60 million tax retention operating
lease with NationsBank of Texas, N.A., as Administrative Agent for the Lenders
who are parties thereto, and First Security Bank of Utah, N.A., as Owner
Trustee, (the "TROL Agreement") for the construction of health care centers and
corporate facilities. Under the TROL Agreement, rental payments commence upon
completion of construction, with a guarantee of 87% to the lessor of the
residual value of properties leased at the end of the lease term. After the
initial five year noncancelable lease term, the lease may be extended by
agreement of the parties or the Company must purchase or arrange for sale of the
leased properties. The Company has committed to a guaranteed residual value of
$30.8 million under this agreement.
72
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum lease commitments for noncancelable operating leases at
December 31, 1997 are as follows (in thousands):
<TABLE>
<S> <C>
1998...................................................... $ 46,477
1999...................................................... 42,083
2000...................................................... 38,614
2001...................................................... 35,552
2002...................................................... 13,535
Thereafter................................................ 7,695
---------
Total minimum lease commitments........................... $ 183,956
---------
---------
</TABLE>
Rent expense totaled $48.7 million, $46.8 million and $39.3 million in 1997,
1996 and 1995, respectively.
NOTE 13--RELATED PARTIES
Two current directors of the Company and one prior director are partners in
law firms which received legal fees totaling $1.1 million, $1.0 million, and
$1.9 million in 1997, 1996, and 1995, respectively. An officer of a contracted
hospital was also a member of the Company's Board of Directors until April 1,
1997. Medical costs paid to the provider totaled $67.1 million, $58.7 million,
and $55.3 million in 1997, 1996, and 1995, respectively. Such contracted
hospital is also an employer group of the Company. The Company received annual
premium revenues of $1.2 million in 1997, $3.4 million in 1996 and $3.0 million
in 1995. Certain stockholders and prior directors of the Company are officers of
consulting firms which received approximately $132 thousand in 1997, $1.3
million in 1996 and $140 thousand in 1995, pursuant to consulting agreements to
pay for certain consulting services provided to the Company.
In 1995, the Company advanced an aggregate sum of approximately $16.3
million to three of its former executive officers and directors in connection
with the future repurchase of shares of the Company's Class A Common Stock held
by such individuals. This repurchase agreement was entered into in connection
with certain severance agreements between the Company and each such individual
in connection with his or her termination of employment. Such advances were
non-interest bearing and were secured by a pledge of shares of Class A Common
Stock, which shares were ultimately repurchased by the Company in January 1996.
During the first quarter of 1996, the Company repurchased 303,879 shares of
its Class A Common Stock from certain current and former management employees of
the Company and HN Management Holdings, Inc., a predecessor to the Company. The
repurchased shares were held pursuant to the Amended and Restated Health Net
Associate Trust Agreement dated as of May 1, 1994 on behalf of certain founding
stockholders of the Company at the date of the conversion of Health Net to
for-profit status. The repurchased shares, having an aggregate value of $9.6
million, were immediately canceled and netted against Class A Common Stock,
additional paid-in-capital, and retained earnings.
Certain transactions between the Company's continuing operations
subsidiaries and the discontinued operations segments are not eliminated (see
Note 15).
73
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS
The following sets forth the principal components of merger, restructuring
and other costs for the ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C>
Severance and benefit related costs................................ $ 62.0 $ 5.4 $ 12.2
Provider network consolidation costs............................... 35.4
Asset impairment costs............................................. 44.3 17.4
Real estate lease termination costs................................ 7.7 4.6
--------- --------- ---------
Total restructuring costs........................................ 149.4 27.4 12.2
Merger related costs............................................... 70.4 8.0
Other costs........................................................ 118.6 16.7
--------- --------- ---------
Total merger, restructuring and other costs...................... $ 338.4 $ 44.1 $ 20.2
--------- --------- ---------
--------- --------- ---------
</TABLE>
1997 COSTS
RESTRUCTURING COSTS
In connection with the FHS Combination, the Company adopted a restructuring
plan effective June 30, 1997 (the "June 1997 Plan"), the principal elements of
which include: a workforce reduction of approximately 1,050 employees, the
consolidation of employee benefit plans, the consolidation of facilities in
geographic locations where office space is duplicated, the consolidation of
overlapping provider networks, and the consolidation of information systems at
all locations to standardized systems. The June 1997 Plan, which the Company
anticipates will be completed by the end of 1998, resulted in a restructuring
charge of $188.1 million for the quarter ended June 30, 1997.
Severance and benefit related costs include a terminations benefits plan and
contractually required change of control payments to senior executives. Also
included are the costs of settlements of benefit plans terminated as a result of
the restructuring plan to conform benefits for the merged companies. Provider
network consolidation costs include costs to consolidate overlapping provider
networks, primarily in California, and the costs of exiting existing provider
contracts as legally, regulatory or administratively required. Real estate lease
termination costs include facilities consolidation costs primarily in geographic
regions where there is overlapping office space usage. Asset impairment costs
are primarily a result of the Company's plan to be on common operating systems
and hardware platforms. These costs include impairment of hardware, software and
other systems related assets.
During the quarter ended December 31, 1997, the Company adopted a
restructuring plan (the "December 1997 Plan") and recorded a $6.0 million
restructuring charge related to the Company's Eastern Division health plans. The
plan relates to the integration of the Company's Eastern Division operations in
connection with its acquisition of PHS and FOHP in the quarter ended December
31, 1997.
The Company also recorded a credit of $44.7 million for previously recorded
restructuring charges during the fourth quarter. The credit consisted of $42.0
million for the June 1997 Plan and $2.7 million for the December 1996 Plan (see
"1996 Costs").
74
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS (CONTINUED)
The restructuring credits to the June 1997 Plan resulted from the following:
$22.2 million from the Company's determination to continue to operate certain
facilities originally identified for lease termination, $9.7 million from
reductions to initially anticipated involuntary severance costs, $8.1 million
from reductions to certain anticipated provider network consolidation and other
contract termination costs and $2.0 million in reductions to asset impairment
costs primarily related to the reclassification of workers' compensation
insurance subsidiaries related charges to discontinued operations.
Of the $149.4 million in net restructuring costs recorded during the year
ended December 31, 1997, $61.7 million represented cash payments and $15.8
million noncash activities as of December 31, 1997 and $45.2 million is expected
to require future outlays of cash and $26.7 million represents future noncash
activities.
MERGER COSTS
In connection with the June 1997 Plan, $70.4 million in merger costs were
recorded. The significant components of the charge include the following: $22.6
million of transaction costs, primarily consisting of investment banking, legal,
accounting, filing and printing fees; $22.7 million of merger consulting costs;
$5.9 million of former senior executive consulting costs; $2.4 million of
directors and officers liability coverage required by the merger agreement; $9.6
million in costs to consolidate debt facilities; and $7.2 million of other
merger related costs.
OTHER COSTS
During the quarters ended June 30, and December 31, 1997, $86.3 million and
$32.3 million, respectively, in other costs were recorded and included the
following components: $30.5 million for receivables related to provider
contracts that will not be renewed; $17.2 for government receivables related to
prior contracts and adjustments on current contracts being negotiated with the
Department of Defense; $15.1 million for litigation settlement estimates
primarily related to former FHC subsidiaries; $12.6 million for the loss on sale
of the United Kingdom operations; $16.1 million for loss contract accruals,
including $10.1 million related to the Company's health plans in Texas,
Louisiana and Oklahoma; $7.7 million related to contract termination costs; $8.2
million in other receivables; and $11.2 million of other costs.
These costs were shown as other costs on the Company's consolidated
statement of operations because of their unusual nature. If not for their
unusual nature, approximately $53.8 million of these costs would have been
recorded as health plan services, $35.0 million as selling, general and
administrative and $17.2 million as government health care services.
GEM COSTS
The Company established a premium deficiency of $57.5 million related to the
Company's Gem Insurance Company ("Gem") during the year ended December 31, 1997.
During the quarter ended June 30, 1997, the Company had reached a definitive
agreement regarding a reinsurance transaction with The Centennial Life Insurance
Company ("Centennial"). Pursuant to this agreement, Centennial was to reinsure
and manage Gem's accident and health, life and annuity policies in exchange for
a reinsurance premium. The cost of the reinsurance along with the write-down of
certain Gem assets that were not recoverable based on the terms of the agreement
totaled $57.5 million. The transaction was not ultimately consummated due to the
unanticipated failure to satisfy certain closing conditions, including the
failure to
75
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS (CONTINUED)
receive certain regulatory approvals. Gem established a reserve for the
estimated premium deficiency related to these policies. As of December 31, 1997,
$14.0 million remained in this reserve which is expected to be adequate to cover
future premium deficiencies.
1996 COSTS
During the quarter ended December 31, 1996, the Company recorded
restructuring costs of $27.4 million which included $5.4 million of executive
and other involuntary severance costs, $17.4 million of software, hardware and
other asset impairment costs, and $4.6 million of facilities consolidation costs
(the "December 1996 Plan"). As stated above under "1997 Costs," $2.7 million in
reductions to the December 1996 Plan were recorded during the quarter ended
December 31, 1997 as a result of the Company's determination to continue to
operate certain facilities originally identified for lease termination. Of the
$27.4 million in restructuring costs recorded during the year ended December 31,
1996, $7.3 million has been paid and $17.4 million represented noncash
write-offs as of December 31, 1997.
The Company also recorded $16.7 million of other costs in the quarter ended
December 31, 1996 including loss contract accruals related to governmental
employer groups in the Company's non-California markets, consulting and other
costs. If not for their unusual nature, approximately $8.5 million of these
costs would have been recorded as health plan services and $8.2 million as
selling, general and administrative expenses.
1995 COSTS
In connection with the Company's terminated merger agreement with Wellpoint
Health Networks, Inc. and Blue Cross of California announced December 28, 1995,
the Company incurred restructuring and merger-related costs of $20.2 million
during the year ended December 31, 1995. Such costs included $8.0 million of
legal, accounting and consulting fees, as well as severance related costs of
$12.2 million resulting from agreements with certain key executives in
contemplation of the proposed merger.
NOTE 15--DISCONTINUED OPERATIONS
Discontinued operations include the Company's workers' compensation
insurance and physician practice management segments. The loss on the sale of
discontinued operations, net of $18.2 million of taxes, of $88.8 million for the
year ended December 31, 1997 includes an estimated loss to be incurred when the
workers' compensation insurance segment is sold of approximately $99 million,
and an offsetting credit of $10.2 million related to the sale of the Company's
physician practice management segment.
WORKERS' COMPENSATION INSURANCE COMPANIES
The Company revised its strategy of maintaining a presence in the workers'
compensation insurance business. As a result of this decision, the Company
adopted a plan to completely discontinue this segment of its business through
divestiture of its workers' compensation insurance subsidiaries. The Company is
currently in negotiation for the sale of the business. As a result, the Company
is reporting its workers' compensation insurance segment as discontinued
operations for each year presented in the consolidated financial statements and
related footnotes.
76
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--DISCONTINUED OPERATIONS (CONTINUED)
The following sets forth the summarized balance sheet and results of
operations for the workers' compensation insurance companies to be sold as of
December 31, 1997 and 1996, and for each of the three years ended December 31
(in thousands):
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Assets:
Cash and investments................................................................ $ 723,350 $ 713,668
Premiums and reinsurance receivables................................................ 305,985 224,354
Other assets........................................................................ 231,000 142,288
------------ ------------
Total assets...................................................................... 1,260,335 1,080,310
------------ ------------
Liabilities:
Reserves for claims................................................................. 728,421 590,584
Note payable to Parent.............................................................. 122,621 129,157
Other liabilities................................................................... 149,773 83,123
------------ ------------
Total liabilities................................................................. 1,000,815 802,864
------------ ------------
Net assets............................................................................ 259,520 277,446
Amounts to reconcile to net assets from discontinued operations:
Elimination of net notes payable to Parent and other net receivables from Parent and
subsidiaries...................................................................... 107,193 104,126
Loss on disposition................................................................. (99,000)
------------ ------------
Net assets of discontinued operations................................................. $ 267,713 $ 381,572
------------ ------------
------------ ------------
</TABLE>
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Revenues
Premiums................................................................... $ 511,268 $ 480,830 $ 390,973
Investment and other income................................................ 49,675 37,844 26,147
---------- ---------- ----------
Total revenues........................................................... 560,943 518,674 417,120
---------- ---------- ----------
Expenses
Losses and loss adjustment................................................. 443,204 381,898 246,857
Other underwriting......................................................... 161,114 105,873 94,924
Interest................................................................... 9,107 4,330
Other...................................................................... 10,673 3,202 2,810
---------- ---------- ----------
Total expenses........................................................... 624,098 495,303 344,591
---------- ---------- ----------
Income (loss) before income taxes............................................ (63,155) 23,371 72,529
Income tax provision (benefit)............................................... (32,746) 1,197 20,591
---------- ---------- ----------
Income (loss) from discontinued operations................................... $ (30,409) $ 22,174 $ 51,938
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Cash and investments at December 31, 1997 consist primarily of the following
based on market values: U.S. government and agencies of 6%, obligations of
states and other political subdivisions of 80%, and cash and cash equivalents of
14%. The cost and market value of cash and investments at December 31, 1997 are
$716 million and $723 million, respectively, and $711 million and $714 million
at December 31,
77
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--DISCONTINUED OPERATIONS (CONTINUED)
1996. Investment income includes realized gains on sale of investments of $44
million, $31 million and $25 million for the year ended December 31, 1997, 1996
and 1995, respectively.
The workers' compensation insurance subsidiaries limit their exposure by
reinsuring certain levels of risk with other insurers. In the event that all or
any of the reinsuring companies might be unable to meet their obligations under
the reinsurance agreement, the workers' compensation insurance companies would
be liable for such obligations. The workers' compensation insurance companies
regularly evaluate the financial condition of their reinsurers. Based on this
evaluation, management believes the reinsurers are creditworthy and that any
potential losses on these agreements will not have a material impact on the
Company's consolidated financial statements. At December 31, 1997 and 1996,
reinsurance receivable balances on ceded reserves and paid losses totaled $221.2
million and $136.1 million, respectively.
The effect of reinsurance on workers' compensation insurance companies
premiums written, premiums earned and losses incurred for the three years ended
December 31, 1997 is summarized as follows:
<TABLE>
<CAPTION>
PREMIUMS PREMIUMS LOSSES
WRITTEN EARNED INCURRED
----------- ----------- -----------
<S> <C> <C> <C>
Year Ended December 31, 1997
Direct................................................................... $ 647,427 $ 652,706 $ 593,192
Assumed.................................................................. 13,006 11,202 8,496
Ceded.................................................................... (141,981) (152,640) (158,484)
----------- ----------- -----------
Net.................................................................. $ 518,452 $ 511,268 $ 443,204
----------- ----------- -----------
----------- ----------- -----------
Year Ended December 31, 1996
Direct................................................................... $ 619,462 $ 607,089 $ 461,312
Assumed.................................................................. 12,945 12,775 7,221
Ceded.................................................................... (150,228) (139,034) (86,635)
----------- ----------- -----------
Net.................................................................. $ 482,179 $ 480,830 $ 381,898
----------- ----------- -----------
----------- ----------- -----------
Year Ended December 31, 1995
Direct................................................................... $ 408,737 $ 402,633 $ 252,151
Assumed.................................................................. 11,041 11,041 3,585
Ceded.................................................................... (22,701) (22,701) (8,879)
----------- ----------- -----------
Net $ 397,077 $ 390,973 $ 246,857
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
78
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--DISCONTINUED OPERATIONS (CONTINUED)
Activity in the reserves for losses and loss adjustment expenses related to
the workers' compensation insurance companies, for the years ended December 31,
1997 and 1996 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Beginning balance....................................................................... $ 590,584 $ 443,370
Less-ceded losses and loss adjustment expense reserves.................................. (121,326) (76,309)
----------- -----------
Net beginning balance................................................................... 469,258 367,061
----------- -----------
Incurred related to:
Current calendar year................................................................. 367,825 361,533
Prior calendar years.................................................................. 75,379 20,365
----------- -----------
Total incurred...................................................................... 443,204 381,898
----------- -----------
Paid related to:
Current calendar year................................................................. (135,056) (106,540)
Prior calendar years.................................................................. (255,856) (173,161)
----------- -----------
Total paid.......................................................................... (390,912) (279,701)
----------- -----------
Net ending balance...................................................................... 521,550 469,258
Plus-ceded losses and loss adjustment expense reserves.................................. 206,871 121,326
----------- -----------
Ending balance.......................................................................... $ 728,421 $ 590,584
----------- -----------
----------- -----------
</TABLE>
The workers' compensation insurance companies results of operations include
certain transactions with the Company's continuing operations subsidiaries which
have not been eliminated from the Company's consolidated statement of
operations. Such transactions include the following amounts recorded by the
workers' compensation insurance companies for the years ended December 31, 1997,
1996 and 1995: interest expense related to the note payable to Parent of $8.3
million, $4.3 million and $0, respectively; and other underwriting expenses
related to services provided primarily by the Company's bill review services
subsidiary of $14.5 million, $10.1 million and $5.6 million, respectively.
PHYSICIAN PRACTICE MANAGEMENT COMPANIES
During 1995 and 1996, changes were occurring in the physician practice
management industry which led the Company to adopt a plan to completely
discontinue the operations of the Medical Practices. In connection with this
changed environment and with its plan to discontinue this segment, the following
transactions were entered into with FPA and certain of its affiliated entities,
none of which are affiliated with the Company.
On June 28, 1996, the Company and the sole shareholder of the Medical
Practices executed a Stock and Note Purchase Agreement whereby the Company sold
all the outstanding stock of its management services organization and the sole
shareholder sold all of the outstanding stock of the holding company for the
Medical Practices to FPA. The aggregate consideration consisted of $2 million
cash, $75 million of FPA common stock, $22 million bridge note receivable and
$104 million of Medical Practices' notes payable to the Company assumed by FPA.
At December 31, 1996, the $75 million of FPA common stock was included in
investments available for sale and the $126 million of notes receivable was
included in other current
79
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--DISCONTINUED OPERATIONS (CONTINUED)
assets. During the year ended December 31, 1997, the FPA common stock was sold
and the notes receivable were repaid by FPA.
The transaction was consummated in November 1996 and the Company recognized
a gain on sale of $20.3 million, net of $17.6 million of taxes, during the
quarter ended December 31, 1996. During the year ended December 31, 1997, the
Company recognized an additional $10.1 million gain on sale, net of $2.8 million
of taxes, based on the final settlement of certain contractual provisions
related to the disposition of the Medical Practices.
During January and June of 1996, the Company completed the sale of its
affiliated independent practice associations ("IPAs") in California, Florida and
Arizona to FPA for total consideration of $30 million in cash and notes. Gains
of $10.8 million were recognized by the Company during the year ended December
31, 1996 and are included in income from discontinued operations.
As part of these transactions, the Company's affiliated health plans entered
into 30-year provider agreements with the IPAs and Medical Practices to ensure
that the Company's enrollees have continued and uninterrupted access to the
providers of the IPAs and Medical Practices. At December 31, 1997 and 1996,
obligations under these agreements of $7.7 million and $33.8 million,
respectively, are included in other current liabilities.
The following sets forth the summarized results of operations for the
Medical Practices for the year ended December 31, 1995 and the eleven months
ended November 30, 1996, (in thousands):
<TABLE>
<CAPTION>
11 MONTHS YEAR ENDED
NOVEMBER 30, DECEMBER 31,
1996 1995
------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Revenues
Premiums from affiliates........................................................... $ 129,488 $ 100,015
Other.............................................................................. 23,963 31,745
------------ ------------
Total revenues................................................................... 153,451 131,760
------------ ------------
Expenses
Health care services............................................................... 208,336 184,485
Interest to Parent................................................................. 10,830 10,038
Other.............................................................................. 11,334 13,408
------------ ------------
Total expenses................................................................... 230,500 207,931
------------ ------------
Loss before income taxes............................................................. (77,049) (76,171)
Income tax benefit................................................................... (32,359) (29,511)
------------ ------------
Loss from Medical Practices.......................................................... (44,690) (46,660)
Deferral of losses subsequent to Measurement Date.................................... 36,800 --
Gain (loss) on sale of independent practice associations............................. 10,800 (2,250)
------------ ------------
Income (loss) from discontinued operations........................................... $ 2,910 $ (48,910)
------------ ------------
------------ ------------
</TABLE>
The Medical Practices' results of operations include certain transactions
with the Company's continuing operations subsidiaries which have not been
eliminated from the Company's consolidated statement of
80
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--DISCONTINUED OPERATIONS (CONTINUED)
operations. Such transactions include the following amounts recorded by the
Medical Practices' for the eleven months ended November 30, 1996 and the year
ended December 31, 1995: premiums received from certain of the Company's health
plans of $129.5 million and $100.0 million, respectively; and interest expense
related to a note payable to Parent of $10.8 and $10.0 million, respectively.
NOTE 16--QUARTERLY INFORMATION (UNAUDITED)
The following restated interim financial information presents the 1997 and
1996 results of operations on a quarterly basis (in thousands, except per share
data) (see Note 1):
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
1997:
Total revenues........................................... $ 1,770,019 $ 1,773,422 $1,793,379 $1,898,199
Income (loss) from continuing operations before income
taxes.................................................. 78,683 (313,108) 97,081 48,096
Income (loss) from continuing operations................. 47,624 (205,792) 59,803 30,535
Net income (loss)........................................ 58,481 (200,128) 68,901 (114,338)
BASIC EARNINGS (LOSS) PER SHARE
Continuing operations.................................. 0.38 (1.64) 0.49 0.25
Net.................................................... 0.47 (1.60) 0.57 (0.94)
DILUTED EARNINGS (LOSS) PER SHARE
Continuing operations.................................. 0.38 (1.64) 0.49 0.25
Net.................................................... 0.47 (1.60) 0.57 (0.94)
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
1996:
Total revenues........................................... $ 1,544,992 $ 1,712,207 $1,729,287 $1,722,754
Income (loss) from continuing operations before income
taxes.................................................. 82,701 67,456 70,321 (167,524)
Income (loss) from continuing operations................. 51,105 44,234 40,701 (97,210)
Net income (loss)........................................ 62,277 66,488 57,518 (102,052)
BASIC EARNINGS (LOSS) PER SHARE
Continuing operations.................................. 0.42 0.35 0.33 (0.78)
Net.................................................... 0.51 0.53 0.46 (0.82)
DILUTED EARNINGS (LOSS) PER SHARE
Continuing operations.................................. 0.41 0.35 0.33 (0.78)
Net.................................................... 0.50 0.53 0.46 (0.82)
</TABLE>
81
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1997. Such information is
incorporated herein by reference and made a part hereof.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1997. Such information is
incorporated herein by reference and made a part hereof.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1997. Such information is
incorporated herein by reference and made a part hereof.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1997. Such information is
incorporated herein by reference and made a part hereof.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS
1. FINANCIAL STATEMENTS
The following consolidated financial statements are included in this Annual
Report on Form 10-K:
Report of Deloitte & Touche LLP
Consolidated balance sheets at December 31, 1997 and 1996
Consolidated statements of operations for each of the three years in the
period ended December 31, 1997
Consolidated statements of stockholders' equity for each of the three
years in the period ended December 31, 1997
Consolidated statements of cash flows for each of the three years in the
period ended December 31, 1997.
Notes to consolidated financial statements
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2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules are filed as a part of this
Annual Report on Form 10-K:
Schedule I--Condensed Financial Information of The Company
Section 403.04B Schedule--Reconciliation of Beginning and Ending Loss and
Loss Adjustment Expense
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
3. EXHIBITS
The following exhibits are filed as part of this Annual Report on Form 10-K
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).
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*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).
*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).
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*10.15 Deferred Compensation Agreement dated as of March 3, 1995, by and among Malik
M. Hasan, M.D., the Company and the Compensation and Stock Option Committee
of the Board of Directors of the Company (filed as Exhibit 10.31 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1994,
which is incorporated by reference herein).
*10.16 Trust Agreement for Deferred Compensation Arrangement for Malik M. Hasan, M.D.,
dated as of March 3, 1995, by and between the Company and Norwest Bank
Colorado N.A. (filed as Exhibit 10.32 to the Company's Annual Report on Form
10-K for the year ended December 31, 1994, which is incorporated by reference
herein).
10.17 Registration Rights Agreement dated as of March 2, 1995 between the Company and
the 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).
*10.28 Employment Letter Agreement dated September 30, 1996 between Douglas C. Werner
and the Company (filed as Exhibit 10.38 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1996, which is incorporated by
reference herein).
*10.29 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).
*10.30 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).
*10.31 Amended and Restated Employment Agreement, dated December 16, 1996, by and
among the Company, Foundation Health Corporation and Daniel D. Crowley (filed
as Exhibit 10.1 to the Company's Registration Statement on Form S-4 (File No.
333-19273), which is incorporated by reference herein).
*10.32 Employment Agreement Termination Agreement, dated as of May 1, 1997, by and
between Daniel D. Crowley, the Company and FHC (filed as Exhibit 10.32 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997,
which is incorporated by reference herein).
*10.33 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).
*10.34 Amended and Restated Employment Agreement, dated December 16, 1996, by and
among the Company, Foundation Health Corporation and Jeffrey L. Elder (filed
as Exhibit 10.4 to the Company's Registration Statement on Form S-4 (File No.
333-19273), which is incorporated by reference herein).
*10.35 Amended and Restated Employment Agreement, dated December 16, 1996, by and
among the Company, Foundation Health Corporation and Allen J. Marabito (filed
as Exhibit 10.5 to the Company's Registration Statement on Form S-4 (File No.
333-19273), which is incorporated by reference herein).
*10.36 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).
*10.37 Foundation Health Corporation Employee Stock Purchase Plan (filed as Exhibit
4.3 to the Company's Registration Statement on Form S-8 (File No. 333-24621),
which is incorporated by reference herein).
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*10.38 Foundation Health Corporation Profit Sharing and 401(k) Plan (Amended and
Restated effective January 1, 1994) (filed as Exhibit 4.4 to the Company's
Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
*10.39 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).
*10.40 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).
*10.41 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).
*10.42 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).
*10.43 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).
*10.44 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).
*10.45 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for the
year ended June 30, 1994 filed with the Commission on September 24, 1994,
which is incorporated by reference herein).
*10.46 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).
*10.47 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).
*10.48 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).
*10.49 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).
10.50 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).
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*10.51 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).
*10.52 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).
*10.53 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).
10.54 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).
10.55 Stock and Note Purchase Agreement by and between FHC, Jonathan H., Schoff,
M.D., FPA Medical Management, Inc., FPA Medical Management of California,
Inc. and FPA Independent Practice Association dated as of June 28, 1996
(filed as Exhibit 10.109 to FHC's Annual Report on Form 10-K for the year
ended June 30, 1996, which is incorporated by reference herein).
10.56 $300 Million Revolving Credit Agreement (the "FHC Credit Agreement") dated as
of December 5, 1994, among FHC, as Borrower, Citicorp USA, Inc., as
Administrative Agent, Wells Fargo Bank, N.A. and NationsBank of Texas, N.A.,
as Co-Agents and Citicorp Securities, Inc., as Arranger, and the Other Banks
and Financial Institutions Party thereto (filed as an Exhibit to FHC's
quarterly report on Form 10-Q for the quarter ended December 31, 1994 filed
with the Commission on February 14, 1994, which is incorporated by reference
herein).
10.57 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).
10.58 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).
10.59 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).
10.60 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).
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10.61 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).
10.62 $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).
10.63 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).
10.64 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).
10.65 Lease Agreement between HAS-First Associates and FHC dated August 1, 1998 and
form of amendment thereto (filed as an exhibit to FHC's Registration
Statement on Form S-1 (File No. 33-34963), which is incorporated by reference
herein).
10.66 Agreement and Plan of Reorganization dated as of June 27, 1994 by and among
FHC, CareFlorida Health Systems, Inc., and the other parties signatory
thereto (filed as an exhibit to FHC's Current Report on Form 8-K filed with
the Commission on June 28, 1994, which is incorporated by reference herein).
10.67 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).
10.68 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).
*+10.69 Amended Letter Agreement between the Company and Jay M. Gellert dated as of
August 22, 1997, a copy of which is filed herewith.
+10.70 Form of Credit Facility Commitment Letter, dated March 27, 1998, between the
Company and the Majority Banks (as defined therein), a copy of which is filed
herewith.
*+10.71 Employment Letter Agreement between the Company and Dale Terrell dated December
31, 1997, a copy of which is filed herewith.
*+10.72 Employment Letter Agreement between the Company and Steven P. Erwin dated March
11, 1998, a copy of which is filed herewith.
*+10.73 Employment Agreement, dated as of December 31, 1997, between the Company and
Maurice Costa, or copy of which is filed herewith.
*+10.74 Employment Agreement, dated as of December 31, 1997, between the Company and
Robert L. Natt, a copy of which is filed herewith.
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*+10.75 Employment Letter Agreement, dated October 10, 1997, between the Company and
Alex Labak, a copy of which is filed herewith.
*10.76 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).
+11.1 Statement relative to computation of per share earnings of the Company
(included in the notes to the Financial Statements contained in this Annual
Report on Form 10-K).
+21.1 Subsidiaries of the Company, a copy which is filed herewith.
+23.1 Consent of Deloitte & Touche LLP, a copy of which is filed herewith.
+27.1 Financial Data Schedule for 1997, 1996 and 1995 Annual Data, a copy of which
has been filed with the EDGAR version of this filing.
+27.2 Financial Data Schedule for 1997 Quarterly Data, a copy of which has been filed
with the EDGAR version of this filing.
+27.3 Financial Data Schedule for 1996 Quarterly Data, a copy of which has been filed
with the EDGAR version of this filing.
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* Management contract or compensatory plan or arrangement required to be filed
(and/or incorporated by reference) as an exhibit to this Annual Report on
Form 10-K pursuant to Item 14(c) of Form 10-K.
+ A copy of the exhibit is being filed with this Annual Report on Form 10-K.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by the Company
during the quarterly period ended December 31, 1997:
1. A Current Report on Form 8-K dated October 23, 1997 announcing the
Company's completion of its acquisition of PACC HMO and PACC Health
Plan (together, "PACC") and the merger of PACC with the Company's
existing HMO in Oregon.
2. A Current Report on Form 8-K dated December 31, 1997 announcing (i)
the Company's acquisition of Physicians Health Services, Inc. ("PHS")
effective December 31, 1997 pursuant to an Agreement and Plan of
Merger dated as of May 8, 1997, by and between the Company, PHS
Acquisition Corp., a wholly-owned subsidiary of the Company, and PHS;
and (ii) that the Company had purchased additional subordinated
debentures of FOHP, Inc. ("FOHP"), and that the Company had recently
converted approximately $70 million in principal amount of
subordinated convertible debentures into approximately 98% of the
outstanding equity of FOHP.
No other Current Reports on Form 8-K were filed by the Company during
the quarterly period ended December 31, 1997.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this Report to be
signed on its behalf by the undersigned thereunto duly authorized, on March 30,
1998.
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FOUNDATION HEALTH SYSTEMS, INC.
By: /s/ MALIK M. HASAN, M.D.
-----------------------------------------
Malik M. Hasan, M.D.
CHAIRMAN OF THE BOARD OF DIRECTORS AND
CHIEF EXECUTIVE OFFICER (PRINCIPAL
EXECUTIVE OFFICER)
By: /s/ STEVEN P. ERWIN
-----------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING AND FINANCIAL
OFFICER)
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Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf of
the Company and in the capacities indicated on March 30, 1998.
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<CAPTION>
SIGNATURE TITLE
- ------------------------------ --------------------------
<S> <C> <C>
/s/ J. THOMAS BOUCHARD
- ------------------------------ Director
J. Thomas Bouchard
/s/ GOV. GEORGE DEUKMEJIAN
- ------------------------------ Director
Gov. George Deukmejian
/s/ THOMAS T. FARLEY
- ------------------------------ Director
Thomas T. Farley
/s/ PATRICK FOLEY
- ------------------------------ Director
Patrick Foley
/s/ ADMIRAL EARL B. FOWLER
- ------------------------------ Director
Admiral Earl B. Fowler
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<CAPTION>
SIGNATURE TITLE
- ------------------------------ --------------------------
<S> <C> <C>
/s/ ROGER F. GREAVES
- ------------------------------ Director
Roger F. Greaves
/s/ RICHARD W. HANSELMAN
- ------------------------------ Director
Richard W. Hanselman
/s/ MALIK M. HASAN, M.D. Director, Chairman of the
- ------------------------------ Board of Directors and
Malik M. Hasan, M.D. Chief Executive Officer
/s/ RICHARD J. STEGEMEIER
- ------------------------------ Director
Richard J. Stegemeier
/s/ RAYMOND S. TROUBH
- ------------------------------ Director
Raymond S. Troubh
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SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
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DECEMBER 31
--------------------------
1997 1996
------------ ------------
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ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 16,740 $ 9,460
Investments available for sale...................................................... 9,007 24,130
Other assets........................................................................ 46,902 23,197
Due from subsidiaries............................................................... 473,431
Net assets of discontinued operations............................................... 267,713 381,572
------------ ------------
Total current assets.................................................................. 813,793 438,359
Property and equipment, net........................................................... 22,895 3,515
Goodwill and other intangible assets, net............................................. 559,368 203,309
Investment in subsidiaries............................................................ 829,822 998,313
Other assets.......................................................................... 70,342 358
------------ ------------
Total assets...................................................................... $2,296,220 $1,643,854
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to subsidiaries................................................................. $ 73,283 $ 106,907
Other current liabilities........................................................... 35,907 9,984
------------ ------------
Total current liabilities......................................................... 109,190 116,891
Notes payable......................................................................... 1,287,500 342,373
Other liabilities..................................................................... 3,556 1,179
------------ ------------
Total liabilities................................................................. 1,400,246 460,443
------------ ------------
Stockholders' equity:
Common stock and additional paid-in capital......................................... 628,735 721,610
Common stock held in treasury, at cost.............................................. (95,831) (98,878)
Retained earnings................................................................... 370,394 557,478
Unrealized investment gains (losses), net of taxes.................................. (7,324) 3,201
------------ ------------
Total stockholders' equity........................................................ 895,974 1,183,411
------------ ------------
Total liabilities and stockholders' equity...................................... $2,296,220 $1,643,854
------------ ------------
------------ ------------
</TABLE>
See accompanying notes
93
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Investment and other income.................................................. $ 6,485 $ 5,171 $ 2,966
Expenses:
General and administrative................................................. 17,288 11,879 4,811
Amortization and depreciation.............................................. 8,526 7,217 1,899
Interest................................................................... 42,118 22,063 13,234
Merger, restructuring and other costs...................................... 42,189 2,500 20,164
----------- ---------- ----------
110,121 43,659 40,108
----------- ---------- ----------
Loss from continuing operations before income taxes and equity in net income
of subsidiaries............................................................ (103,636) (38,488) (37,142)
Income tax benefit........................................................... 39,533 11,861 14,596
Equity in net income of subsidiaries......................................... (3,727) 65,457 211,697
----------- ---------- ----------
Loss from continuing operations.............................................. (67,830) 38,830 189,151
Discontinued operations:
Income (loss) from operations, net of tax.................................. (30,409) 25,084 3,028
Gain (loss) on disposition, net of tax..................................... (88,845) 20,317
----------- ---------- ----------
Net income (loss)........................................................ $ (187,084) $ 84,231 $ 192,179
----------- ---------- ----------
----------- ---------- ----------
</TABLE>
See accompanying notes
94
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES................................... $ (521,154) $ 11,091 $ (112,815)
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales or maturity of investments available for sale...................... 11,400
Purchases of investments available for sale.............................. (309) (20,160) (15,574)
Purchases of property and equipment, net................................. (20,695) (3,273) (743)
Other assets............................................................. (130,755) (2,941)
Acquisition of businesses net of cash acquired........................... (293,625) (4,113) (139,462)
----------- ----------- -----------
Net cash used by investing activities...................................... (433,984) (30,487) (155,779)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock plan
purchases.............................................................. 21,506 17,485 4,524
Proceeds from sale of stock.............................................. 95,828
Proceeds from issuance of notes payable.................................. 946,000 9,000 310,000
Principal payments on notes payable...................................... (873)
Advances to repurchase common stock...................................... (16,330)
Redemption of common stock............................................... (111,334) (105,418) (24,418)
Cash dividends received from subsidiaries................................ 140,994
Capital contributions to subsidiaries.................................... (33,875) (700) (539)
----------- ----------- -----------
Net cash provided by financing activities.................................. 962,418 16,195 273,237
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents....................... 7,280 (3,201) 4,643
Cash and cash equivalents, beginning of period............................. 9,460 12,661 8,018
----------- ----------- -----------
Cash and cash equivalents, end of period................................... $ 16,740 $ 9,460 $ 12,661
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
95
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The Company's investment in subsidiaries is stated at cost plus equity in
undistributed earnings of subsidiaries. The Company's share of net income of its
unconsolidated subsidiaries is included in consolidated income using the equity
method. Parent company only financial statements should be read in conjunction
with the Company's consolidated financial statements.
Certain prior year amounts have been reclassified to conform with current
year presentation.
2. GUARANTEES
Health Net, the Company's California health plan, has $18.8 million of
long-term debt outstanding as of December 31, 1997 due to the California
Wellness Foundation. Such debt was incurred in connection with the conversion of
Health Net to for-profit status. In connection with the issuance of the original
debt totaling $225 million, the Company has guaranteed the performance of Health
Net under the debt agreements, including payment of all principal and interest.
96
<PAGE>
SECTION 403.04B SCHEDULE
FOUNDATION HEALTH SYSTEMS, INC.
RECONCILIATION OF BEGINNING AND ENDING LOSS AND LOSS ADJUSTMENT EXPENSE
RESERVES AND EXHIBIT OF REDUNDANCIES (DEFICIENCIES)--UNAUDITED
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for unpaid losses and loss
adjustment expenses.................... $ 53,170 $ 55,089 $ 76,296 $ 158,268 $ 206,993 $ 219,464 $ 268,191 $ 322,394
Paid (cumulative) as of:
One year later......................... 14,186 11,649 20,541 59,110 103,361 106,693 115,189 129,284
Two years later........................ 21,998 20,780 36,151 106,334 167,932 191,397 184,304 204,245
Three years later...................... 27,849 28,389 44,665 130,826 211,087 233,537 214,676 243,210
Four years later....................... 33,527 31,492 50,240 146,186 233,168 249,012 226,187
Five years later....................... 35,630 34,015 53,896 154,514 241,693 252,921
Six years later........................ 37,448 35,975 56,301 161,152 244,308
Seven years later...................... 39,121 37,374 58,577 164,606
Eight years later...................... 40,346 38,970 59,858
Nine years later....................... 41,854 39,780
Ten years later........................ 42,637
Liability re-estimated as of:
One year later......................... 53,321 51,147 75,988 160,141 218,747 251,012 262,032 295,856
Two years later........................ 51,382 51,991 65,376 162,040 242,231 257,134 256,135 270,293
Three years later...................... 54,349 43,651 61,098 172,981 242,533 262,582 250,238 296,016
Four years later....................... 47,241 41,513 66,135 172,269 245,877 268,031 254,791
Five years later....................... 46,116 44,701 66,174 173,581 249,220 270,478
Six years later........................ 47,011 45,364 66,569 174,892 257,332
Seven years later...................... 47,928 45,452 66,963 175,053
Eight years later...................... 47,883 45,541 67,786
Nine years later....................... 47,839 46,906
Ten years later........................ 49,371
Redundancy (deficiency).................. $ 3,799 $ 8,183 $ 8,510 ($ 16,785) ($ 50,339) ($ 51,014) $ 13,400 $ 26,378
Net reserve--end of period............... $ 322,394
Reinsurance recoverable on unpaid losses and loss adjustment expenses................................................. 90,366
---------
Gross reserve--end of period.......................................................................................... 412,760
Net re-estimated reserve--end of period............................................................................... 296,016
Re-estimated reinsurance recoverable.................................................................................. 91,848
---------
Gross re-estimated reserve--end of period............................................................................. 387,864
---------
Gross cumulative redundancy (deficiency).............................................................................. $ 24,896
---------
---------
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Liability for unpaid losses and loss
adjustment expenses.................... $ 367,061 $ 469,258 $ 521,550
Paid (cumulative) as of:
One year later......................... 173,161 255,856
Two years later........................ 288,885
Three years later......................
Four years later.......................
Five years later.......................
Six years later........................
Seven years later......................
Eight years later......................
Nine years later.......................
Ten years later........................
Liability re-estimated as of:
One year later......................... 387,426 544,637
Two years later........................ 410,082
Three years later......................
Four years later.......................
Five years later.......................
Six years later........................
Seven years later......................
Eight years later......................
Nine years later.......................
Ten years later........................
Redundancy (deficiency).................. ($ 43,021) ($ 75,379)
Net reserve--end of period............... $ 367,061 $ 469,258 $ 521,550
Reinsurance recoverable on unpaid losses 76,309 121,326 206,871
--------- --------- ---------
Gross reserve--end of period............. 443,370 590,584 728,421
---------
---------
Net re-estimated reserve--end of period.. 410,082 544,637
Re-estimated reinsurance recoverable..... 83,202 134,668
--------- ---------
Gross re-estimated reserve--end of period 493,284 679,305
--------- ---------
Gross cumulative redundancy (deficiency). ($ 49,914) ($ 88,721)
--------- ---------
--------- ---------
</TABLE>
Note: The loss and loss adjustment expense reserves relate to the Company's
discontinued workers' compensation insurance businesses.
97
<PAGE>
Exhibit 10.69
[LETTERHEAD]
August 22, 1997
Mr. Jay M. Gellert
440 Davis Street, Unit 913
San Francisco, CA 94111
Re: Offer of Employment
Dear Jay:
We are pleased to revise the terms of your employment with Foundation Health
Systems, Inc. ("FHS") and its subsidiaries, Health Net and QualMed, Inc.
(hereinafter collectively referred to as the "Company"), in the exempt
positions of President and Chief Operating Officer of FHS and Chairman of
Health Net and QualMed, Inc., to increase your annual base salary to $500,000.
In these capacities, you will report to Malik M. Hasan, M.D., the Chairman
of the Board of Directors and Chief Executive Officer of FHS. Your office
will be located in Woodland Hills, California.
As a senior executive of the Company, your annual base salary will be
reviewed each year by the FHS Compensation and Stock Option Committee (the
"Committee"). Please be aware that a review should not be construed as a
guarantee for salary increase.
You will also be eligible to participate in the FHS Management Bonus Plan.
Under this plan you can earn up to 90% of your base salary as a target bonus,
subject to the discretion of the Committee, if certain goals based upon Company
and your individual performance are achieved. The goals which will be used to
measure your performance will be established by the Committee.
As to any bonus award, you must be actively employed and on the Company
payroll at the time said bonus is to be paid which is on or before March 31
of each year. The Committee in its sole discretion will award amounts as it
deems appropriate consistent with the guidelines of the FHS Management Bonus
Plan. If you are deemed to be one of FHS' five highest paid executive
officers for any given year, you will participate in the FHS
Performance-Based Annual Bonus Plan as adopted by FHS shareholders in 1997 or
as hereafter amended, modified or superseded, in lieu of the Management Bonus
Plan. (The FHS Performance-Based Annual Bonus Plan is designed to address
the limitations imposed under federal tax law on the Company's ability to
deduct certain compensation paid to the five highest paid executive officers.)
<PAGE>
Mr. Jay M. Gellert
August 22, 1997
Page 2
In addition to the foregoing, and subject to (1) any applicable prerequisite
length of employment or other eligibility requirements and (2) your continued
employment with the Company, you will be eligible for consideration to receive
and/or participate in the fringe benefits set forth in the Company's applicable
Plan Documents, Associate Handbooks and/or Policy Statement, subject to the
Company's right to enhance, increase, reduce, eliminate or otherwise modify at
any time these or other fringe benefits (including the bonus plans referenced
above). Your Company benefits include:
- Associate 401(k) Savings Plan
- Group medical coverage for you and your eligible dependents at current
monthly rates applicable to the Company's employees
- Group dental coverage for you and your eligible dependents at current
monthly rates applicable to the Company's employees
- Group term life insurance (supplemental term life insurance and term
life insurance for your dependents is also available at your expense)
- Short-term and long-term disability benefits
- Paid Time Off in accordance with policy (with a minimum of 22 days per
year)
- Continued participation in FHS' stock option program for senior
executives. Notwithstanding any provisions to the contrary set forth
in your agreement with the Company dated June 3, 1996 related to a
grant to purchase 100,000 shares of FHS Class A Common Stock, in the
event you should leave the Company for any reason other than just
cause, you shall have the right to exercise your options on the shares
covered by the June 3, 1996 agreement for a one-year period from the
date you terminate employment (except in the event you breach the
non-compete agreement set forth herein as described below).
- Eligibility to participate in the Company's Supplemental Executive
Retirement Plan
- Reimbursement of reasonable, substantiated monthly business expenses
- Company paid holidays
- Education Assistance Program
<PAGE>
Mr. Jay M. Gellert
August 22, 1997
Page 3
- A car allowance of $1,000 per month plus a corporate charge card which
can be used for Company-related expenses
- A cellular phone for your vehicle
- A fax machine to be installed at your home
- Financial planning allowance for tax advice and financial counseling
subject to a maximum of $5,000 per year beginning with 1996
The Company will provide you with housing in Woodland Hills, California at
a reasonable monthly cost. Weekend trips to your residence in San Francisco
will be at the Company's expense. Any modification to the housing provided
you in Woodland Hills, California must be approved in advance by the
Committee. In addition, the Committee may review and modify such housing
arrangements in their sole discretion from time to time. You may, at your
option, decide to relocate to Southern California. Should you decide to
relocate, the Company will provide you with certain benefits to assist you
in relocating to Woodland Hills, including:
- Payment for all packing, shipping and unloading of all your reasonable
household items upon your move and up to 60 days storage
- Rental car in Woodland Hills for 10 days
- Up to two round-trip airline coach tickets for purposes of house
hunting
- One-way airline coach tickets as final transportation to Woodland
Hills for you and each member of your family
- Assistance with the sale of your current home to include payment of up
to 7% real estate commission, and assistance in the purchase of a new
home to include payment of up to two points
- Federal and state tax gross-ups on the above items, as allowed by law
Additionally, acceptance of this offer of employment will protect you in the
unlikely event a Change-of-Control transaction (as defined below) occurs
resulting in termination of your employment. If, during a two-year period
following a Change-of-Control transaction, you are terminated by the Company or
voluntarily resign for "good reason" (as defined below), you will receive
severance pay equal to three years of the total of your then current annual base
salary and
<PAGE>
Mr. Jay M. Gellert
August 22, 1997
Page 4
targeted bonus ("Change of Control Severance"). The total Change of Control
Severance payments made to you will not exceed the Internal Revenue Code Section
280G limitations which impose penalty taxes and deduction limitations on "excess
parachute payments." The Committee agrees to consider proposals with you in
good faith to restructure the Change of Control Severance in the event payments
are limited by Internal Revenue Code Section 280G. This restructuring could
involve reallocating some portion of the payments to a bona fide consulting
services agreement.
Change-of-Control is defined as any one of the following:
- A 51% change in beneficial ownership as a result of a single
transaction of all capital stock of FHS;
- A change in the majority of outside directors of FHS' Board of
Directors over two years, which is unapproved by a majority of FHS'
current directors;
- The sale of substantially all of FHS' assets to an unrelated third
party; or
- The liquidation or dissolution of FHS.
For purposes of your Change-of-Control severance benefit, "good reason" means
a material reduction in the scope of your position, duties or
responsibilities, or of your salary or status with the Company, or relocation
of your office outside of California, or your removal from your positions
referred to above as determined by the Committee existing as of the date of
the Change-of-Control, except in connection with the termination of your
employment for disability, normal retirement or cause, or by voluntary
resignation other than for good reason.
If you are terminated by the Company for a reason other than just cause or
during a two year period following a Change-of-Control transaction, you will
be entitled to receive severance pay equal to three years of your then
current annual base salary and one year of your targeted bonus. In addition,
the Company shall engage you as a consultant effective upon termination of
your employment, for a payment equal to two years of your then current
targeted bonus. All of your stock options which are vested on the date of
termination of your employment shall remain exercisable during the term of
your service as a consultant (not to exceed the expiration of the option, and
subject to the one-year minimum period of exercisability set forth above for
options covered by the June 3, 1996 agreement). Any severance and consulting
payments made to you pursuant to this document will be made on a monthly
basis in equal monthly amounts commencing as of the end of the month
immediately succeeding termination subject to verification that you have not
breached the non-compete agreement set forth below. In the event you breach
the non-compete agreement set forth below, your consulting agreement and your
stock options will terminate effective upon the date of breach.
<PAGE>
Mr. Jay M. Gellert
August 22, 1997
Page 5
The Committee retains the right to review and modify the severance pay and
consulting payments provided to you in the preceding paragraph in the event your
base salary or targeted bonus are increased. Any such modification will not
decrease the severance pay or consulting payments below the amounts which would
be payable if calculated as of the date of this agreement.
Should disagreements arise with respect to this offer of employment, you and the
Company agree to submit the matter to binding arbitration. The Company shall
also have the right to pursue an equitable remedy pursuant to the applicable
laws of Delaware with respect to the non-compete and confidentiality
restrictions set forth below. The prevailing party in either the arbitration
and/or the equitable remedy action shall recover all attorney's fees and costs
incurred.
This offer of employment shall remain confidential and, if accepted by you,
will obligate you to the following one-year non-compete agreement in the
event severance payments are made to you hereunder. Accordingly, if you
accept this offer you agree that you will not, for a period of one (1) year
after any termination of your employment with the Company, undertake any
employment or activity on behalf of a Competitor (as defined below) in the
geographical area in which you performed services for the Company or any of
its affiliates (the "Market Area"), which employment or activity could call
upon you to reveal, to make judgments on or otherwise use any confidential
business information or trade secrets of the business of the Company or any
of its affiliates to which you had access during your employment with the
Company; provided that this non-compete restriction shall only be applicable
in the event you receive either Change of Control Severance or severance pay
hereunder.
For these purposes, "Competitor" shall refer to Kaiser and its affiliates, and
any publicly-traded or mutual health maintenance organization, healthcare
management company, physician group, insurance company or similar entity that
provides managed health care or related services similar to those provided by
the Company or any of its affiliates within the Market Area. It is hereby
further agreed that if an arbitrator or any court of competent jurisdiction
shall determine that the restrictions imposed in this non-compete agreement are
unreasonable, invalid or unlawful (including, but not limited to, the definition
of Market Area or Competitor or the time period during which this restriction is
applicable), the parties hereto hereby agree to any restrictions that such
arbitrator or court would find to be reasonable under the circumstances. It is
further agreed that the Company shall have all equitable remedies available to
enforce this non-competition restriction and the confidentiality restriction set
forth in the following paragraph.
You acknowledge and agree that, during the period of your employment by the
Company, you will have access to and become acquainted with various confidential
information and practices, confidential customer information, and pricing
methodology. All documents, memoranda, reports, files, correspondence, lists
and other written, electronic and graphic records affecting or relating to the
Company's business that you may prepare, use, observe, possess or control shall
<PAGE>
Mr. Jay M. Gellert
August 22, 1997
Page 6
be and remain the Company's sole property, and you shall not disclose any of
these items, except as required in the course of your employment by the Company.
In the event of the termination of your employment, you shall deliver promptly
to the Company all written and/or graphic records containing such trade secrets
or confidential information.
Nothing set forth herein is intended to create any condition or term of
employment other than that of an "at-will" employee. In other words, by
accepting employment with the Company you confirm that your employment is
voluntary and that there is no obligation on your part or on the part of the
Company to continue that employment relationship for any period of time. While
the Company certainly hopes that there will be a long and mutually satisfactory
relationship between you and the Company, it is expressly understood and agreed
that your employment can be terminated by either you or the Company at any time,
for any reason and with or without prior notice of any kind. The only way in
which this "at will" employment relationship can be changed is by a written
agreement, approved by the Committee, and signed by you and the Company.
The foregoing describes the terms of this offer of employment. Any prior or
contemporaneous agreements or representations, whether oral or written, which
may have been made or discussed but which are not included herein, are of no
force or effect whatsoever or at all. The Committee has approved this offer of
employment. Please execute and return to me the enclosed extra copy of this
offer of employment.
Sincerely,
FOUNDATION HEALTH SYSTEMS, INC.
/s/ B. Curtis Westen, Esq.
- --------------------------------
B. Curtis Westen, Esq.
Senior Vice President, General
Counsel and Secretary
I hereby accept the terms of this offer of employment as outlined above.
/s/ Jay M. Gellert
- ---------------------------
Jay M. Gellert
<PAGE>
[LOGO]
BankAmerica
March 27, 1998 Bank of America NT&SA
555 South Flower Street, 11th Floor
Via Facsimile Los Angeles, CA 90071
- -------------
Gina Meador
Mr. Michael P. White Vice President-Agency Specialist
Vice President & Assistant Treasurer USCG-Agency Management
Foundation Health Systems, Inc. Los Angeles #20529
3400 Data Drive (213) 228-5245
Rancho Cordova, CA 95670 Fax (213) 228-2299
RE: Foundation Health Systems, Inc.
First Amendment and Waiver to the $1.5 Billion
Revolving Credit Agreement Dated as of July 8, 1997
Dear Mr. White:
Please refer to the attached copy of the letter dated March 21, 1998 (the
"Letter Agreement") regarding the Proposed First Amendment and Waiver (the
"First Amendment") to the $1.5 Billion Revolving Credit Agreement Dated as of
July 8, 1997, from Bank of America NT&SA and Citicorp USA, Inc. to your and
the Banks party to the Credit Agreement ("Credit Agreement").
The First Amendment requires approval by Majority Banks. This letter will
confirm that Bank of America NT&SA, as Agent, has received copies of the
Letter Agreement executed by Majority Banks. As you know, the Letter
Agreement evidences the commitments of the signatories thereto to the terms
set forth therein, subject only to completion of documentation.
As soon as we receive your comments on the draft of the First Amendment that
was previously forwarded to you, we will finalize that document and
distribute it to the Banks.
Sincerely,
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, AS AGENT
/s/ Gina Meador
Gina Meador
Vice President
Agency Specialist
attachment
cc: Greg Seibly (with attachment)
Brian Newhouse (w/o attachment)
<PAGE>
[FORM OF CREDIT FACILITY LETTER AGREEMENT]
March 21, 1998
VIA TELECOPY
- ------------
Mr. Michael P. White
Vice President & Assistant Treasurer
Foundation Health Systems, Inc.
3400 Data Drive
Rancho Cordova, California 95670
The Financial Institutions Party to the
Hereinafter-Described Credit Agreement
Re: Credit Agreement dated as of July 8, 1997 among Foundation Health
Systems, Inc., Bank of America National Trust and Savings
Association and Citicorp USA, as Agents, and the Other Financial
Institutions Party Thereto (the "Credit Agreement").
Ladies and Gentlemen:
Based upon our discussion over the past several weeks, Bank of America
National Trust and Savings Association ("Bank of America") and Citicorp USA
("Citicorp") are pleased to present you with the following proposed changes
to the Credit Agreement. The proposed changes will be evidenced by a First
Amendment and Waiver to the Credit Agreement ("First Amendment"). Capitalized
terms used in this letter shall have the meanings assigned to such terms in
the Credit Agreement.
The key provisions of the First Amendment are as follows:
The definition of Specified Charges shall be amended to include only those
items set forth on Part I of Exhibit A hereto.
Subject to the following sentence, the definitions of Adjusted EBITDA, Net
Cash Flow and Fixed Charges shall be revised to exclude all effects of the
Company's workers compensation business (the amount of such exclusions from
Net Cash Flow and Fixed Charges for the quarters ending on or before December
31, 1997 are set forth on Part 2 of Exhibit A hereto). If the aggregate
losses, reserves and charges (without duplication) for the Company's workers
compensation business after December 31, 1997 exceed the $25,000,000 reserve
permitted under
<PAGE>
Mr. Michael P. White
March 21, 1998
Page 2
the definition of Specified Charges, the amount of such excess shall be
included in the calculation of Adjusted EBITDA and Net Cash Flow.
For the purpose of calculating covenant compliance with Sections 7.12(a) and
7.12(b), from and after October 1, 1997, the definitions of Adjusted EBITDA,
Net Cash Flow and Fixed Charges (which shall incorporate the revised
definition of Specified Charges) shall be used.
Section 7.02 and 7.03 shall be revised to permit the sale of the Company's
discontinued workers compensation business. All net proceeds (less costs of
sale) from the sale of the Company's discontinued workers compensation
business shall be used to reduce outstanding debt under the Credit Agreement.
Section 7.05(c) shall be amended by deleting the phrase "the Closing Date"
and replacing it with "December 31, 1997."
Section 7.05(e) shall be amended by deleting the existing exclusions set
forth therein and by replacing them with an exclusion for additional
Indebtedness incurred by the Company after December 31, 1997 in an aggregate
amount not to exceed $1,000,000,000 so long as such Indebtedness (other than
Specified Indebtedness, as hereinafter defined) is not senior in right of
payment to the Obligations, contains no covenants, events of default or
other material provisions that are more restrictive than those contained in
the Credit Agreement, and has principal payment dates commencing after July
8, 2002. Except in the case of Specified Indebtedness, the first $250,000,000
of proceeds from the issuance of such additional Indebtedness and 50% of all
such proceeds in excess of $250,000,000 shall be used to repay outstandings
under the Credit Agreement and to permanently reduce the Commitments under
the Credit Agreement. For purposes hereof, the term "Specified Indebtedness"
shall mean up to $200,000,000 of Indebtedness of the Company (exclusive of
any Indebtedness for borrowed money or Commercial Paper Debt) incurred after
December 31, 1997.
Section 7.11 shall be amended to prohibit the prepayment or redemption prior
to stated maturity of any of the additional Indebtedness permitted by the
First Amendment (other than specified Indebtedness).
Section 7.12(a) shall be revised as follows:
<TABLE>
<CAPTION>
Period Ended Maximum Total Leverage Ratio
------------ ----------------------------
<S> <C>
12/31/1997 3.50 to 1.00
03/31/1998 4.00 to 1.00
06/30/1998 3.75 to 1.00
09/30/1998 3.50 to 1.00
12/31/1998 3.25 to 1.00
<PAGE>
Mr. Michael P. White
March 21, 1998
Page 3
Thereafter 3.00 to 1.00
</TABLE>
Section 7.12(b) shall be revised as follows:
<TABLE>
<CAPTION>
Period Ended Maximum Fixed Charge Coverage Ratio
------------ -----------------------------------
<S> <C>
12/31/1997 2.50 to 1.00
03/31/1998 2.25 to 1.00
06/30/1998 1.50 to 1.00
09/30/1998 1.50 to 1.00
12/31/1998 1.75 to 1.00
Thereafter 2.00 to 1.00
</TABLE>
Section 7.12(c) shall be revised to insert the phrase "(without giving effect
to any losses)" after the date "June 30, 1997" in the third line thereof.
Subject to the following sentence, a fee of 7.5 bps will be payable to all
Banks that have executed the First Amendment by 2:00 p.m., Pacific time, on
April 6, 1998, and an additional 7.5 bps will be payable to all Banks that
have delivered written commitments to execute the First Amendment by 4:00
p.m., Pacific time, on March 27, 1998. Both such fees will be paid on April
6, 1998 if and only if the First Amendment shall have been executed by the
Majority Banks on or before such date.
In the First Amendment, the pricing grid will be revised as follows (note
that the Total Leverage Ratio portion of the existing grid will be
eliminated):
<TABLE>
<CAPTION>
Senior
Applicable Unsecured Offshore
Level Debt Rating* Facility Fee Rate Margin Drawn Margin
- ----- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
1 A-/A3 10.0 bps 20.0 bps 30.0 bps
2 BBB+/Baa1 12.5 bps 22.5 bps 35.0 bps
3 BBB/Baa2 15.0 bps 25.0 bps 40.0 bps
4 BBB-/Baa3 17.5 bps 32.5 bps 50.0 bps
5 BB+/Ba1 20.0 bps 55.0 bps 75.0 bps
6 BB/Ba2 22.5 bps 77.5 bps 100.0 bps
7 BB-/Ba3 25.0 bps 125.0 bps 150.0 bps
8 Less than BB-/Ba3 30.0 bps 170.0 bps 200.0 bps
</TABLE>
<PAGE>
Mr. Michael P. White
March 21, 1998
Page 4
* The Company's Senior Unsecured Debt Rating shall be determined as
provided in the Credit Agreement. To the extent that the Company
does not maintain a Senior Unsecured Debt Rating, pricing shall be
set at Level 8.
If you agree with the foregoing, please sign and return to us the
enclosed copy of this letter no later than 4:00 p.m., Pacific time, on March
27, 1998.
By your execution hereof, this letter will constitute your binding
commitment with respect to the terms hereof. Your commitment will be subject
only to the completion documentation for the First Amendment.
Best regards,
[NAME OF BANK]
[SIGNATURE]
Agreed to and Accepted
this ___ day of March, 1998
FOUNDATION HEALTH SYSTEMS, INC.
By______________________________
Title:
Agreed to and Accepted
this ___ day of __________, 1998
________________________________
Name of Bank
By______________________________
Title:
<PAGE>
EXHIBIT A
(in 000's)
Part 1
- --------------------------------------------------------------------------------
SPECIFIED CHARGES
<TABLE>
<CAPTION>
Actual Actual Actual Actual 1/1/98
Quarter Quarter Quarter Quarter and
3/31/97 6/30/97 9/30/97 12/31/97 thereafter
------- ------- ------- -------- ----------
<S> <C> <C> <C> <C> <C>
Remove Workers Comp.
Insurance EBITDA $(16,581) $(10,926) $(14,054) $ 88,577 $ -
Reserve for Loss on Sale
of W/C $ - $ - $ - $120,000 $ -
Additional Losses, Reserves
and Charges in Connection
with W/C $ - $ - $ - $ - $25,000
Acquisition and
Restructuring Charges and
Recovery-Net $ - $ - $ - $ (7,684) $ -
Acquisition and
Restructuring Charge $ - $348,400 $ - $ - $ -
Medical Group Sale
Restructuring Charge
Recovery $ - $ - $ - $(13,000) $ -
-------- -------- -------- -------- -------
Specified Charges $(16,581) $337,474 $(14,054) $187,893 $25,000
-------- -------- -------- -------- -------
-------- -------- -------- -------- -------
</TABLE>
- --------------------------------------------------------------------------------
Part 2
- --------------------------------------------------------------------------------
ADJUSTMENT TO NET CASH FLOW AND FIXED CHARGES
RELATED TO WORKERS' COMPENSATION
<TABLE>
<CAPTION>
Actual Actual Actual Actual
Quarter Quarter Quarter Quarter
3/31/97 6/30/97 9/30/97 12/31/97
------- ------- ------- --------
<S> <C> <C> <C> <C>
Capital Expenditures $ 2,300 $ 3,500 $ 2,500 $ 1,845
Operating Lease Payments $(2,177) $(2,122) $(2,357) $(1,401)
------- ------- ------- -------
Adjustment to Net Cash
Flow (by Quarter) $ 123 $ 1,378 $ 143 $ 444
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
- --------------------------------------------------------------------------------
<PAGE>
Exhibit 10.71
[LETTERHEAD]
December 31, 1997
Mr. Dale Terrell
10580 Durham Place
Powell, Ohio 43065
Dear Mr. Terrell:
I would like to confirm the offer made to you for the Exempt position of Senior
Vice President and Chief Information Officer for Foundation Health Systems, Inc.
("FHS"). This offer is subject to the approval of the Compensation and Stock
Option Committee of the FHS Board of Directors.
You will be reporting directly to the President and Chief Operating officer for
Foundation Health Systems, Inc. (FHS). Your monthly base salary in this
position will be $22,917. Associates are paid on a bi-weekly basis with 26 pay
periods per year.
The Company will provide to you a one-time engagement bonus of $25,000 payable
within thirty days of your date of employment. The engagement bonus payment is
subject to normal payroll deductions.
You will also be eligible to participate, beginning in the 1998 calendar year,
in the FHS Executive Incentive Plan ("Plan") with a target opportunity of 50
percent of your base annualized salary, prorated from your date of hire. Any
Plan bonus payments are governed by the provisions of the Plan and are dependent
upon attainment of corporate, business entity and your individual goals.
As part of your long-term incentive program, you will be eligible to participate
in the Company's stock option program. The Company's management will recommend
to the Compensation and Stock Option Committee (hereafter "Committee") that you
receive 25,000 shares as part of your offer of employment. It will be within
the sole discretion of the Committee to determine whether the recommendation to
grant you a specific number of shares will be approved. At all times, all stock
option grants remain within the sole discretion of the Committee.
<PAGE>
PAGE TWO
You will participate in this FHS Choices benefit program. This cafeteria
style plan includes medical, vision, dental, life insurance, long-term and
short-term disability protection, an employee assistance program,
participation in our 401(k) Plan, and participation in our deferred
compensation plan. In our 401(k) Plan, consistent with IRS regulations, the
Company will match your contribution at $.50 for every dollar contributed up
to six percent (6%) of your compensation. You will also be eligible for an
automobile allowance consistent with policy and commensurate with that
received by Associates with similar levels of responsibility. The current
automobile allowance for your level of responsibility is $1,000 per month.
Although our current qualified and non-qualified retirement plans are
specific in regard to their consistency of application, we will explore
possible flexibility within the plans that might address the issues raised in
our conversation. Obviously, no action can be taken that threatens the
integrity of any plan.
The Company will provide relocation reimbursement according to Company policy
on IRS approvable expenses associated with your move. We have agreed to
reimburse to you reasonable temporary living expenses for up to six months if
necessary. The Human Resource department will coordinate arrangements for the
physical move of your household goods. Additionally, we will pay you
one-half month's salary to cover the cost of miscellaneous moving expenses
not specifically identified in our offer to you. This miscellaneous moving
expense payment will be made following your relocation.
As we discussed, if following six months of active marketing of your current
residence, you have not been successful in selling the property, FHS will
provide to you a "bridge loan" up to the verifiable equity that you have in
the property. At that time, a promissory note will be prepared for your
signature containing terms and conditions of the loan.
To assist you in the sale of your current home, and in the purchase of a home
in your new location, the Company will provide the following assistance:
SALE OF FORMER RESIDENCE
- ------------------------
- - Real estate transfer taxes.
- - Transfer stamp fees.
- - Abstract costs.
- - Legal fees.
- - Notary fees.
- - Escrow fees.
- - Lender or mortgage company service charges.
- - Loan prepayment penalties paid by the seller.
- - In the event that title insurance must be provided to the buyer as accepted
proof of the seller's good title, you will be reimbursed for the actual cost
of insurance.
<PAGE>
PAGE THREE
- - If your house is sold through a recognized real estate agency, reimbursement
will be made for the realtors' sales commission fee at the rate prevailing
at that location, not to exceed 7.0 percent. No reimbursement will be made
for commissions or expenses not actually incurred.
No reimbursement will be made for capital improvements or repairs considered
necessary to make the prior residence ready for sale.
PURCHASE OF NEW RESIDENCE
- -------------------------
- - Legal fees related to title opinions and recording fees.
- - Credit verification.
- - Loan application or origination fees that are customary in the destination
location (not to exceed one percent of loan amount).
- - Inspections required to obtain loan.
- - Abstracting fees if title insurance is not required.
- - Title insurance, if required by the lending institution and/or title service
company, paid in lieu of abstracting fees.
- - Loan discount charges (not to exceed 2 percent of loan amount).
- - One appraisal fee on the home conducted by a recognized appraisal agency.
At the end of the calendar year in which relocation expenses are incurred,
your income will be "grossed-up" to recognize the tax impact resulting from
eligible relocation expenses. However, the miscellaneous moving expense
payment is not subject to gross-up.
Should you voluntarily leave the Company within one year from your date of
hire for any reason you will be responsible for reimbursing the Company
within five business days of the date of your termination of employment, 50%
of the total relocation expenses paid on your behalf.
We have recently presented a severance program proposal to our Compensation
and Stock Option Committee of the Board of Directors. With the Committee's
approval, we will implement the program for selected senior management staff
members. If approved, you will participate in that program at a level
commensurate with peers holding levels of responsibility similar to that
required in the CIO position. We will communicate details of that plan when
available.
The employment relationship with the Company is at the mutual consent of each
employee and the Company. Nothing in this offer letter is intended to
guarantee your continued employment with the Company or employment for any
specific length of time. While the Company hopes that employment
relationships will be mutually beneficial and rewarding, both you and the
Company maintain the right to terminate the relationship at-will, at any
time, with or without cause. The at-will nature of your employment with the
Company cannot be modified or superseded except by a written agreement signed
by you and the President and Chief Operating Officer of FHS, that clearly and
expressly specifies the intent to modify the at-will relationship.
<PAGE>
PAGE FOUR
In accepting employment with the Company, you acknowledge that no Company
representative has made an oral or written promise or representation contrary
to this paragraph. Furthermore, you acknowledge that this paragraph presents
the only agreement between you and the Company concerning the duration of
your employment and the at-will nature of the employment relationship.
During your employment with the Company, you will have access to and become
acquainted with certain proprietary and confidential information and
practices ("Confidential Information"). Confidential Information includes
all information that is not generally known to the Company's competitors and
the public, and that has or could have commercial value to the Company's
business. It includes, but is not limited to, customer information, customer
lists, and pricing methodology.
In accepting employment with the Company, you acknowledge and agree that all
documents, memoranda, reports, files, correspondence, lists and other
written, electronic and graphic records affecting or relating to the
Company's business that you may prepare, use, observe, possess or control
(including, but not limited to, any materials containing Confidential
Information) shall be and remain the Company's sole property, and you agree
not to make use of or disclose to any third party any such material,
Confidential or otherwise, except for the benefit of the Company and in the
course of your employment with the Company. If your employment with the
Company is terminated (voluntarily or otherwise), you agree to deliver to the
Company within five business days of termination all written and/or graphic
records affecting or relating to the Company's business, including but not
limited to material containing Confidential Information.
You have agreed to certify that you have no other agreement, relationship, or
commitment to any other person or entity that conflicts with your obligations
to the Company under this offer letter. If you are unable to so certify, all
such agreement(s) must be identified here:
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
You also agree not to use or disclose any Confidential Information or trade
secrets of others, including all prior employers, in your work at the
Company. Should a situation arise in which you believe that your job duties
may lead to the use or disclosure of confidential information or trade
secrets of another, you agree to notify Dan Smithson in the Human Resources
Department or Curt Westen in the Corporate Legal Department of the situation
immediately. You represent and warrant that you returned all property and
confidential information belonging to all prior employers.
<PAGE>
PAGE FIVE
Finally, this letter sets forth all the terms of this offer of employment.
Together it supersedes any previous and contemporaneous oral and written
communications and representations. To confirm your acceptance of these
terms please sign, date and return a copy of this letter in the enclosed
self-addressed envelope. An additional copy of the offer letter is enclosed
for your file.
Dale, we are excited about the prospect of you joining our management team,
and are confident that it will offer the professional challenge and career
opportunity you are seeking. If you have any questions regarding the above
information or if I can assist you in any way, please call me at (916)
631-5061.
Sincerely,
/s/ Dan Smithson
- ----------------------
Dan Smithson
Senior Vice President
Corporate Human Resources
I hereby accept and agree to the terms of this offer of employment as outlined
above.
/s/ Dale P. Terrell January 5, 1998
- --------------------------- ---------------------
Signature Date
<PAGE>
Exhibit 10.72
[LOGO]
March 11, 1998
Mr. Steven P. Erwin
P.O. Box 29046
Portland, OR 97296-9046
Re: Offer of Employment
Dear Steve:
On behalf of Foundation Health Systems, Inc. ('FHS'), I would like to confirm
our offer to you for the exempt position of Executive Vice President and
Chief Financial Officer for FHS. In this position you will report directly
to the Chairman and Chief Executive Officer of FHS and will earn a monthly
salary of at least $29,166.67. Associates are paid on a biweekly basis with
26 pay periods per year. Performance of each of the Company's Associates is
generally reviewed on an annual basis, and any adjustment to salary is
ordinarily made upon the completion of such performance review. Any
adjustment to your compensation must be made by the Compensation and Stock
Option Committee of the FHS Board of Directors (the "Committee"). You will
be provided an automobile allowance of $1,000 per month, subject to normal
payroll deductions, and subject to any changes to the FHS automobile
allowance policy that may be made from time to time.
FHS will provide to you a one-time $125,000 loan (with interest accrued at
the Prime Rate) payable by you upon demand in the event of voluntary
termination of your employment or should the Company terminate you for cause.
Following the completion of one year of active employment the principal and
any accrued interest will be forgiven. Additionally, the loan will be
forgiven during the first year of service if you depart from the Company
involuntarily without cause, due to "Good Reason" following a change of
control, or due to death or disability.
In addition, you will be eligible to participate in the Company's Executive
Incentive Plan, as it may be modified from time to time by the Committee.
Under the plan, bonus payments are dependent upon Company and individual
performance measures. You will be eligible to participate in the plan
beginning in 1998, with a target bonus opportunity of 70 percent of your base
salary. The maximum bonus payable under provisions of the plan is 105
percent of base salary. Any bonus payout for 1998 will be prorated based on
your hire date and will be paid in 1999 following outside audit of the
Company's performance and determination of your success in accomplishing
individual performance objectives. To be eligible for any bonus payment, you
must be actively employed and on the Company
<PAGE>
PAGE TWO
OFFER LTR/STEVEN P. ERWIN
3/11/98
payroll at the time the bonus is paid. Bonus calculations are based on the
base salary in effect on December 31st of the respective Plan Year. It is
understood that the Committee and the Company will award bonus amounts, if
any, as it deems appropriate consistent with the guidelines of the Plan. You
acknowledge that in the event you are to be one of the top five highest paid
executive officers of the Company for a given year under applicable federal
securities laws, your bonus for that year, if any, will be subject to the
Company's Performance Based 162(m) Plan in lieu of the Executive Incentive
Plan.
The Company's management has recommended to the Committee that you be granted
a stock option award. The Committee has approved that recommendation. The
number of shares underlying the option will be 175,000 and the option will be
granted on the terms and subject to the conditions of the Company's current
form of stock option agreement. Under this 'mega-grant', shares will vest
one-third per year until fully vested after three full years of active
service. It is not anticipated that additional grants will be made during
your first three years of employment. The `strike price' for the shares will
reflect the stock price at the close of business on March 11, 1998. It is
understood that any recommendations made by the Company's management for any
subsequent years will be made consistent with your performance and relatively
comparable to the awards made at that time to the executive management tier
group of the Company. At all times, all stock option grants remain within
the sole and absolute discretion of the Committee.
In addition to the foregoing, subject to your continued employment with the
Company and plan provisions that currently allow benefits to become effective
the first of the month following thirty (30) days of employment (May 1,
1998), you will be eligible to receive and/or participate in Company-offered
benefits subject to plan criteria. You will receive under separate cover,
information about Company benefits program's including group medical, dental,
vision, life insurance, short-term and long-term disability insurance,
401(k), Company-recognized holidays, the employee stock purchase plan,
tuition reimbursement and participation in our deferred compensation program.
In our 401(k) plan, subject to IRS regulations, the Company will match your
contribution at $.50 for every dollar contributed up to six percent (6%) of
salary. In the deferred compensation plan you may defer up to 50 percent of
your base compensation and up to 100 percent of your incentive compensation.
The Company's Paid Time Off ("PTO") benefit will be provided to you for
illness, vacation and personal time off. You will accrue PTO at a rate of 23
days per year between your date of hire and 120 months of service, and 25
days per year thereafter. The Company will also reimburse you for one
athletic/health club membership. In case of a conflict between this summary
and the official plan documents, the official Plan documents will always
govern. In addition, the Company reserves the right to change, amend, or
terminate the benefits plans at any time, with or without notice.
<PAGE>
PAGE THREE
OFFER LTR/STEVEN P. ERWIN
3/11/98
You will also be eligible to participate in the FHS Supplemental Executive
Retirement Plan ("SERP"). Under provisions of the SERP you can vest and
accrue a retirement benefit of up to 50 percent of your base salary plus
incentive compensation. This benefit is integrated (offset) with other
retirement benefits provided by the Company and with 50 percent of social
security. The Company will provide you with six and one-half (6 1/2) years
of service credit entering the plan and will credit you with 1.5 years of
additional credit for each of your first three full years of active service.
However, should you voluntarily leave the company during the first five years
of employment or if you are terminated for cause during that same timeframe,
you will forfeit all accelerated vesting credit (i.e. any credit in excess of
one year of credit for each year of service).
Following acceptance of employment, please contact Jan Zlotowicz, Vice
President Human Resources, at (818) 676-8002 to schedule your orientation.
Enclosed are I-9 forms as well as the documentation required to complete the
I-9 forms. We are required to verify your eligibility to work in the United
States within three days of your start date. (A list of appropriate
documentation can be found on the reverse side of the I-9 form).
The Company will provide you with an option of benefits targeted to assist
you in relocating to the Los Angeles, California area. Attached you will
find a copy of the Relocation Guideline that we agree is subject to
modifications, to the Company's reasonable satisfaction, to meet the
following relocation requirements particular to your relocation
circumstances; your approval of the carrier used to move your household
effects, additional insurance coverage, special moving provisions to cover
specific items, up to six months of temporary living if necessary and two
Company funded trips home per month during the period of temporary living. A
"Relocation Benefits Modification Exhibit" is attached that further describes
these approved modifications and additions to the Relocation Guideline and is
hereby incorporated by reference.
To assist you in the sale of your current home, and in the purchase of a home
in your new location, the Company will provide the following assistance:
SALE OF FORMER RESIDENCE
- ------------------------
- - Real estate transfer, excise, and sales tax.
- - Transfer stamp fees.
- - Abstract costs.
- - Legal fees.
- - Notary fees.
- - Escrow fees.
- - Lender or mortgage company service charges.
- - Loan repayment penalties paid by the seller.
<PAGE>
PAGE FOUR
OFFER LTR/STEVEN P. ERWIN
3/11/98
- - In the event that title insurance must be provided to the buyer as accepted
proof of the seller's good title, you will be reimbursed for the actual cost
of insurance.
- - If your house is sold through a recognized real estate agency, reimbursement
for the Realtors' sales commission fee at the rate prevailing at that
location, not to exceed 7.0 percent. No reimbursement will be made for
commissions or expenses not actually incurred.
- - Environmental inspection and audit fees.
PURCHASE OF NEW RESIDENCE
- -------------------------
- - Real estate transfer, excise and sales tax.
- - Legal fees related to title opinions and recording fees.
- - Credit verification.
- - Loan application or origination fees that are customary in the destination
location (not to exceed one percent of loan amount).
- - Inspections required to obtain a loan.
- - Abstracting fees if title insurance is not required.
- - Title insurance, if required by the lending institution and/or title Service
Company, paid in lieu of abstracting fees.
- - Loan discount charges (not to exceed 2 percent of loan amount).
- - One appraisal fee on the home conducted by a recognized appraisal agency.
- - Environmental inspection and audit fees.
Additionally, the Company will provide a one-time miscellaneous moving
expense payment equal to one-half month base salary. This payment is
intended to cover relocation expenses not specifically identified in our
relocation policy.
Should you voluntarily leave the Company within one year from your date of
hire for any reason, you will be responsible for reimbursing the Company
within five business days of the date of your termination of your employment 50%
of the total relocation expenses paid on your behalf. For purposes of this
paragraph, termination by reason of death or disability will not be deemed to
be voluntary termination.
At the end of the calendar year in which relocation expenses are incurred,
your income will be "grossed-up" to recognize the federal, state and any
local tax impact that may result from the relocation assistance provided.
However, the miscellaneous moving expense payment is not subject to gross-up.
To assist you in tax preparation and financial planning activities, the Company
will provide up to $5,000 reimbursement for expenses related to that activity.
Additionally, the Company will provide a cellular phone for business use and
remote computer hardware and full systems capability.
<PAGE>
PAGE FIVE
OFFER LTR/STEVEN P. ERWIN
3/11/98
The Company will provide you with protection in the event of the termination
of your employment without "cause" (absent a change of control). Under the
terms of this agreement "cause" is defined as clear and willful failure to
perform your duties not resulting from complete or partial incapacity due
to physical or mental illness or impairment, that continues after reasonable
written notice and an opportunity to correct any such failure; gross
misconduct or fraud; or conviction of, or a plea of "guilty" or "no contest"
to a felony. In the event that your employment is terminated involuntarily
without cause, and you agree and sign the Company's standard Confidential and
General Release Agreement, you will be provided a severance package which
will include a severance payment totaling twenty-four (24) months of base
salary in effect at the date of your termination, but in no case less than
two times your highest annual base salary in effect during your employment
with FHS, together with all other severance benefits payable under the
"Separation Agreement and Release of Claims". Payment of base salary under
provisions of the severance package will be made on a salary continuation
basis until the sum of twenty-four (24) months of base salary is paid in
full. During this period of severance payment, should you elect to continue
your medical benefits, the Company will pay the premium to provide you and
your dependents medical and dental coverage under COBRA, or if not available
under COBRA, some other plan substantially similar to that which the Company
provided you as an active employee.
If within the first two years following a change of control, your employment
is involuntarily terminated by the Company without cause, as defined above,
or should you voluntarily terminate your employment for "Good Reason", within
thirty (30) days of your termination from the Company, you will be provided a
change of control severance payment equal to three times your highest annual
base salary earned at any time during your employment with FHS. The total
change of control severance payments made to you will not exceed the Internal
Revenue Code Section 280G limitations which impose penalty taxes and
deduction limitations on "excess parachute payments". For the purposes of
this agreement, "Good Reason" is defined as any one of the following: a
demotion, a reduction in title, a reduction in base compensation including
salary and bonus opportunity, a reduction in responsibility or authority, or
a requirement to relocate your primary place of employment more than 50
miles. During the three-year period from and after the date of your
termination of employment, the Company will also provide you and your covered
dependents medical and dental coverage by paying the COBRA premium, if
eligible under COBRA, or the premium to provide coverage substantially
similar to that which the Company provided you as an active employee.
Additionally, if within the first two years following a change of control,
your employment is involuntarily terminated by the Company without cause or you
voluntarily terminate your employment for "Good Reason", you will become
fully vested in the SERP in the same manner as if you had been employed for
15 years and reached age 62. Additionally, any and all shares of FHS stock
granted under the FHS Stock Option Program will become fully vested. In the
event that a future change of control program is provided to the executive
management tier group and
<PAGE>
PAGE SIX
OFFER LTR/STEVEN P. ERWIN
3/11/98
that program provides a benefit greater than that provided by this agreement,
you will receive the improved benefit. If an improved program is made
available, you will receive a revised document to reflect the changes.
You agree, through the signing of this letter, that your employment with the
company is at the mutual consent of each employee and the Company and is an
"at-will" employment relationship. Nothing in this letter is intended to
guarantee your continued employment with the Company or employment for any
specific length of time. While the Company hopes that your employment
relationship will be mutually beneficial and rewarding, both you and the
Company retain the right to terminate the employment relationship at will, at
any time, with or without cause. The at-will nature of your employment with
the Company cannot be modified or superseded except by a written agreement,
approved by the Committee of the Board of Directors and signed by you and the
Chief Executive Officer or President of FHS, that clearly and expressly
specifies the intent to modify the at-will relationship. In accepting
employment with the Company, you acknowledge that no Company representative
has made any oral or written promise or representation contrary to this
paragraph. Furthermore, you acknowledge that this paragraph represents the
only agreement between you and the Company concerning the duration of your
employment and the at-will nature of the employment relationship.
During your employment with the Company, you will have access to and become
acquainted with certain proprietary and confidential information and
practices ("Confidential Information"). Confidential Information includes
all information that is not generally known to the Company's competitors and
the public, and that has or could have commercial value to the Company's
business. It includes, but is not limited to, customer information, customer
lists, and pricing methodology.
In accepting employment with the Company, you acknowledge and agree that all
documents, memoranda, reports, files, correspondence, lists and other
written, electronic and graphic records affecting or relating to the
Company's business that you may prepare, use, observe, possess or control
(including, but not limited to, any materials containing Confidential
Information) shall be and remain the Company's sole property, and you agree
not to make use of or disclose to any third party any such material,
confidential or otherwise, except for the benefit of the Company and in the
course of your employment with the Company. If your employment is terminated
(voluntary or otherwise), you agree to deliver to the Company within five
business days of termination all written and/or graphic records affecting or
relating to the Company's business, including but not limited to material
containing Confidential Information.
<PAGE>
PAGE SEVEN
OFFER LTR/STEVEN P. ERWIN
3/11/98
You have agreed to certify that you have no other agreement, relationship, or
commitment to any other person or entity that conflicts with your obligations
to the Company under this offer letter. If you are unable to so certify, all
such agreement(s) must be identified here:
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
You agree not to use or disclose any Confidential Information or trade
secrets of others, including all prior employers, in your work at the
Company. Should a situation arise in which you believe that your job duties
may lead to the use or disclosure of confidential information or trade
secrets of another, you agree to notify Debra Taylor, or Dan Smithson in the
Human Resources Department of the situation immediately.
Finally, this letter sets forth all the terms of this offer of employment. It
supersedes all previous and contemporaneous oral and written communications and
representations. To confirm your acceptance of these terms, please sign, date
and return a copy of this letter, in the enclosed self addressed envelope. An
additional copy of the offer letter is enclosed for your files.
Steve, we look forward to you joining our senior management team as scheduled
effective March 11, 1998. Should you have any questions, prior to or during
your employment, please feel free to contact me at (916) 631-5061.
Sincerely,
/s/ Danny O. Smithson
- -----------------------------
Danny O. Smithson
Senior Vice President
Corporate Human Resources
<PAGE>
PAGE EIGHT
OFFER LTR/STEVEN P. ERWIN
3/11/98
I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS
OUTLINED ABOVE.
/s/ STEVEN P. ERWIN
- ---------------------------------
SIGNATURE
cc: Jay Gellert
Enclosures: Relocation Guideline
Relocation Benefits Modification Exhibit
General Release
I-9 Information
<PAGE>
EXHIBIT 10.73
EMPLOYMENT AGREEMENT
This Agreement dated as of December 31, 1997 is between Maurice A. Costa
(the "Executive") and Foundation Health Systems, Inc., a Delaware corporation
(the "Company").
WHEREAS, the Company desires to continue to employ the Executive as the
President of its businesses and operations related to workers' compensation (the
"Division"), and the Executive desires to continue to be employed as the
President of the Division for the term and upon the conditions hereinafter set
forth:
NOW, THEREFORE, in consideration of the agreements and covenants contained
herein, the Executive and the Company hereby agree as follows:
ARTICLE I
Employment
Section 1.01. POSITION; TERM; RESPONSIBILITIES. The Company shall
continue to employ the Executive as the President of the Division for a term
commencing on the date set forth above (the "Commencement Date") and ending on
December 31, 2000, subject to earlier termination pursuant to Article III hereof
(such term, the "Employment Period"). Subject to the direction of the Chairman
of the Board of Directors and Chief Executive Officer of the Company (the
"Company CEO"), and of the President and Chief Operating Officer of the Company
(the "Company President"), the Executive shall be responsible for the operation
and administration of the Division and the implementation of policies set by the
Company's Board of Directors, the Company CEO and the Company President as such
policies relate to the Division. The Executive also shall perform such other
executive and administrative duties (not inconsistent with the position of
President of the Division) as the Executive may reasonably be expected to be
capable of performing on behalf of the Company, as may from time to time be
authorized or directed by the Company CEO or the Company President.
Section 1.02. DUTIES. During the Employment Period, the Executive shall
perform faithfully the duties assigned to him hereunder to the best of his
abilities and shall devote his full and undivided business time and attention to
the transaction of the Company's business and shall not engage in any other
business activities that could reasonably be construed to interfere with such
duties, except with the approval of the Company CEO or the Company President.
<PAGE>
ARTICLE II
Compensation
Section 2.01. BASE SALARY. As compensation for the Executive's services
hereunder, the Company shall pay to the Executive a salary at the rate of
$350,000 per year (the "Base Salary") during the Employment Period, payable in
installments in accordance with the Company's normal compensation payment
schedule for the Company's senior executives.
Section 2.02. SPECIAL AND RETENTION BONUSES. The Company shall pay to the
Executive (i) a special bonus in the amount of $50,000 on the Commencement Date
and (ii) a retention bonus in the amount of $150,000 payable in two installments
of $75,000 each, with the first installment payable on the Commencement Date and
the second installment payable on the first anniversary thereof PROVIDED that
the Executive continues to be employed hereunder on such anniversary by the
Company or one of its affiliates. The Company's agreement to pay to the
Executive such special bonus and retention bonus is in consideration of the
Executive's forfeiture as of the Commencement Date of a portion of the option
granted to him pursuant to the Nonqualified Stock Option Agreement dated
September 4, 1997 under the Foundation Health Systems, Inc. 1997 Stock Option
Plan to purchase 175,000 shares of Class A Common Stock of the Company, par
value $.001 per share ("Common Stock"). The portion of such option forfeited by
the Executive shall be in respect of an aggregate of 60,000 shares of Class A
Common Stock, with the remaining outstanding option being an option to purchase
38,333 shares of Class A Common Stock on each of September 4, 1998 and September
4, 1999 and 38,334 shares of Class A Common Stock on September 4, 2000.
Section 2.03. INCENTIVE COMPENSATION. The Executive shall be eligible to
participate in the Foundation Health Systems, Inc. Executive Incentive Plan for
each fiscal year of the Company within the Employment Period. The Company
President shall recommend to the Compensation and Stock Option Committee of the
Board of Directors that the Executive be eligible to receive each such year an
incentive compensation award ("Incentive Award") on the same terms and
conditions, except as provided herein, as Incentive Awards are awarded to the
Company's Business Unit Executives (the "Unit Executive Incentive Award Group").
Section 2.04. OTHER COMPENSATION. (a) PAID-TIME OFF. The Executive
shall be entitled to 30 "paid-time off days" (as defined by the Company) for
each full calendar year in the Employment Period (and a pro-rata number of
paid-time off days for any partial year in the Employment Period).
(b) CERTAIN EXECUTIVE BENEFITS. During the Employment Period, the
Executive shall continue to participate in the Foundation Health Corporation
Supplemental Executive Retirement Plan ("FHC SERP"), with effective
participation for vesting purposes being August 3, 1993, and shall be eligible
for the Executive Retiree Medical Plan and the Split-Dollar Life Insurance
Program, in each case according to the terms thereof as in effect from
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time to time. The Executive's benefit under the FHC SERP shall become 100%
vested and nonforfeitable on the last day of the Employment Period if the
Executive's employment with the Company is terminated other than for "Cause" (as
defined in Section 3.01) or, as provided in Section 3.07, if there is a Change
of Control prior to December 31, 2000.
(c) OTHER BENEFITS. During the Employment Period, the Executive shall be
entitled to participate in all employee benefit plans, including group health,
life and disability plans, and to receive all other fringe benefits as are from
time to time generally made available to senior executives of the Company, and
nothing in this Agreement is intended to duplicate benefits under such plans or
such fringe benefits.
Section 2.05. EXPENSE REIMBURSEMENTS. The Company shall reimburse the
Executive for all proper expenses incurred by him in the performance of his
duties and responsibilities hereunder in accordance with the policies and
procedures of the Company.
ARTICLE III
Termination of Employment; Change of Control
Section 3.01. Termination for Cause. If the Executive's employment is
terminated by the Company for "Cause", then this Agreement shall terminate and
no payments shall be made to the Executive hereunder after such employment
termination, except that the Executive shall be entitled to receive any unpaid
Base Salary accrued in respect of services performed through the date of the
Executive's termination of employment and reimbursements for expenses as
described in Section 2.05 incurred through such date. Any payments or
distributions under any employee benefit plan described in Section 2.04(b) or
(c) shall be paid or distributed in accordance with such plan.
For purposes of this Agreement, "Cause" means any act of dishonesty or
insubordination, incompetence, habitual drunkenness, narcotic drug addition, or
other material misconduct of any kind, significant activities harmful to the
reputation of the Company, refusal to perform, or substantial disregard of, the
duties described in Article I, significant violation of any statutory or common
law duty of loyalty to the Company, the Executive's material breach of any
provision of this Agreement, moral turpitude, or the commission of a felony.
Section 3.02. DEATH. In the event of the death of the Executive during
the Employment Period, (i) any accrued and unpaid compensation under Sections
2.01, 2.02 and 2.03 and any unreimbursed expenses under Section 2.05 shall be
paid to such person or persons or the executors, administrators or other legal
representatives of such person or persons (and in such order of priority) as the
Executive may have designated in a written instrument filed with the Company's
Human Resources Officer (all such persons, executors, administrators and other
legal representatives being hereinafter, collectively, "Designated
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Successors") and (ii) any payments or distributions under any employee benefit
plan described in Section 2.04(b) or (c) shall be paid or distributed in
accordance with such plan.
Section 3.03. DISABILITY. In the event that the Executive becomes
unable to perform his duties hereunder by reason of disability, upon
submission of documentation evidencing the Executive's disability, the
Executive shall be entitled to receive any unpaid compensation pursuant to
Sections 2.01, 2.02, and 2.03 accrued through the date of such event and
reimbursement for expenses as described in Section 2.05 incurred through such
date, and the Executive shall be entitled to the benefits under the
disability plans of the Company then in effect. Any payments or distributions
under any employee benefit plan described in Section 2.04(b) or (c) shall be
paid or distributed in accordance with such plan.
Section 3.04. RESIGNATION. Notwithstanding the provisions of Section
1.01, the Executive shall be entitled during the Employment Period to terminate
his employment hereunder voluntarily upon written notice to the Company. In the
event that the Executive voluntarily terminates his employment pursuant to this
Section 3.04, the Employment Period shall terminate effective upon such
termination and the Executive shall be entitled to receive any unpaid
compensation pursuant to Section 2.01 accrued through the date of such
termination and reimbursement for expenses described in Section 2.05 incurred
through such date. Any payments or distributions under any employee benefit
plan described in Section 2.04(b) or (c) shall be paid or distributed in
accordance with such plan.
Section 3.05. OTHER TERMINATION. The Company may, pursuant to this
Section 3.05, terminate the Executive's employment hereunder for any reason
other than the reasons set forth in Section 3.01, 3.02, 3.03 or 3.04 upon
written notice to the Executive. In addition, the Executive may, pursuant to
this Section 3.05, terminate his employment hereunder upon written notice to the
Company if the Company unilaterally materially reduces the position of the
Executive described in Section 1.01. In the event that prior to a Change in
Control (as defined in Section 3.07(d)) the Company shall exercise its right to
terminate the Executive's employment pursuant to this Section 3.05 or in the
event that prior to such a Change in Control the Executive shall exercise his
right to terminate his employment pursuant to this Section 3.05, the Employment
Period shall terminate effective on the date set forth in written notice thereof
and the Executive shall be entitled to receive (a) Base Salary ratably through
December 31, 2000, (b) the second installment of the retention bonus described
in Section 2.02 if not yet then paid, (c) reimbursement of expenses incurred
through such date pursuant to Section 2.05, and (d) any payments or
distributions pursuant to the terms of the employee benefit plans then in
effect.
Section 3.06. NONCOMPETITION -- NONRISK INSURANCE OPERATIONS. If prior to
December 31, 2000 Executive's employment with the Company terminates for reasons
set forth in Section 3.01, 3.03, 3.04 or 3.05, then the Executive shall refrain
for a period of twelve months beginning on the date of such termination of
employment from:
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(i) engaging in any activities whether as employer, proprietor,
partner, stockholder (other than the holder of less than 2% of the stock of
a corporation the securities of which are traded on a national securities
exchange or in the over-the-counter market), director, officer, employee or
otherwise, in competition with (1) the non-risk insurance operations of the
Division and other businesses conducted at the date hereof by the Company
or any of its subsidiaries or affiliates over which the Executive shall
have exercised, directly or indirectly, any supervisory, management, fiscal
or operating control during the Employment Period (the "Managed
Businesses"), or (2) any business in which the Managed Businesses are
substantially engaged at any time during the Employment Period, other than
the business of the Division related to the risk insurance operations;
(ii) soliciting, in competition with the Managed Businesses, of any
person who is a customer of the nonrisk insurance businesses conducted by
the Managed Businesses at the date hereof or of any business in which the
Managed Businesses are substantially engaged at any time during the
Employment Period, other than the risk insurance operations of the
Division; and
(iii) inducing or attempting to persuade any employee of the Managed
Businesses to terminate his or her employment relationship in order to
enter into competitive employment.
The provisions contained in paragraphs (i) and (ii) of this Section shall
apply within all territories in which any of the Managed Businesses is
actively engaged in the conduct of business during the Employment Period,
including, without limitation, the territories in which customers are then
being solicited.
Section 3.07. CHANGE OF CONTROL. (a) TERMINATION OF EMPLOYMENT. If a
Change of Control (as defined in subsection (d) hereof) occurs prior to December
31, 2000 and if the Executive's employment with the Company terminates and the
Executive does not become an employee, on substantially the same terms and
conditions as the Employee was employed immediately prior to the Change of
Control, or the entity that either directly or indirectly owns or operates the
risk insurance operations of the Division after the Change of Control (the
"Buyer"), then (i) for the greater of (A) the EXCESS of 36 months (including
partial months) OVER the number of months (including partial months) during
which the Executive performed services hereunder and (B) 18 months (x) the
Company shall make all payments to the Executive described in Sections 2.01 and
2.02, and (y) the Employee shall be eligible for benefits under the Executive
Retiree Medical Plan, the Split-Dollar Life Insurance Program and the employee
benefit plans described in Section 2.04(a) and (c), PROVIDED that the terms of
such plans and program so provide on the date of the Executive's termination of
employment, and (ii) the Executive's benefit under the FHC SERP shall become
100% vested and nonforfeitable on the date of the Executive's termination of
employment. The Company shall
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reimburse the Executive for expenses (as described in Section 2.05) incurred
through the date on which such Change of Control occurs.
(b) NO TERMINATION OF EMPLOYMENT. If prior to December 31, 2000 a Change
of Control occurs and immediately thereafter either the Executive remains in
employment with the Company or the Executive becomes an employee of the Buyer,
on substantially the same terms and conditions as his employment with the
Company immediately before the Change of Control, then the Executive's benefit
under the FHC SERP shall become 100% vested and nonforfeitable on the date of
the Executive's termination of employment.
(c) NONCOMPETITION -- RISK INSURANCE OPERATIONS. If prior to December 31,
2000 a Change of Control occurs and the Executive's employment with the Company
terminates and the Executive does not become an employee of the Buyer in
connection with the Change of Control, on substantially the same terms and
conditions as the Employee was employed immediately prior to the Change of
Control, then the Company immediately after the Change of Control shall have the
right, but not the obligation, to pay upon the direction of the Buyer an amount
equal to $525,000 to the Executive in consideration of the Executive's agreement
(i) to release the Company, by executing a written release on a form provided by
the Company, from all then present and future claims against the Company, and
(ii) for a period of twelve months beginning on the date of a Change of Control
to provide services to the Buyer that are either similar to the type of services
the Executive performed for the Company prior to the Change of Control or that
require the Executive's business knowledge or expertise and to refrain from:
(i) engaging in any activities whether as employer, proprietor,
partner, stockholder (other than the holder of less than 2% of the stock of
a corporation the securities of which are traded on a national securities
exchange or in the over-the-counter market), director, officer, employee or
otherwise, in competition with the Buyer's business related to risk
insurance operations of the Division ("Buyer's Business");
(ii) soliciting, in competition with the Buyer's Business any person
who is a customer of the risk insurance operations of the Division at the
date hereof or on the date of the Change of Control; and
(iii) inducing or attempting to persuade any employee of the Managed
Businesses to terminate his or her employment relationship in order to
enter into competitive employment with the Buyer's Business.
The provisions contained in paragraphs (i) and (ii) of this Section shall apply
within all territories in which any of the Managed Businesses is actively
engaged in the conduct of
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business during the Employment Period, including, without limitation, the
territories in which customers are then being solicited.
(d) DEFINITION OF CHANGE OF CONTROL. A "Change of Control" shall mean (i)
the consummation of any consolidation or merger of the Company, as a result of
which the risk insurance operations of the Division is no longer owned by the
Company or an affiliate thereof, (ii) any sale, lease, exchange, or other
transfer (in one transaction or a series of related transactions) of all, or
substantially all, of the assets of the risk insurance operations of the
Division to a person unrelated to the Company, or (iii) the adoption of any plan
or proposal for the liquidation or dissolution of the risk insurance operations
of the Division.
ARTICLE IV
Confidential Information
The Executive shall not, at any time during the Employment Period or
thereafter, make use of any bidding information (or computer programs thereof)
of any of the Managed Companies, nor divulge any trade secrets or other
confidential information of any of the Managed Companies, except to the extent
that such information becomes a matter of public record, is published in a
newspaper, magazine or other periodical available to the general public or as
the Company CEO or the Company President may so authorize in writing. When the
Executive shall cease to be employed by the Company, the Executive shall
surrender to the Company all records and other documents obtained by him or
entrusted to him during the course of his employment hereunder (together with
all copies thereof) which pertain specifically to any of the businesses of the
Managed Companies; PROVIDED, HOWEVER, that the Executive may retain copies of
such documents as necessary for the Executive's personal records for federal and
state income tax purposes.
ARTICLE V
Miscellaneous
Section 5.01. REMEDIES. Without limiting the right of the Company to
pursue all other legal and equitable remedies available for violation by the
Executive of the provisions contained in Section 3.06, Section 3.07(c) and
Article IV, it is expressly agreed by the Executive and the Company that such
other remedies cannot fully compensate the Company for any such violation and
that the Company shall be entitled to injunctive relief to prevent any such
violation or any continuing violation thereof. Each party intends and agrees
that if in any action before any court or agency legally empowered to enforce
the provisions of Section 3.06, Section 3.07(c) or Article IV any term,
restriction, covenant or promise contained therein is found to be unreasonable
and accordingly unenforceable, then such term, restriction, covenant or promise
shall be deemed modified to the extent necessary to make it enforceable by such
court or agency. The provisions of Section 3.06, Section 3.07(c) and Article IV
shall survive the conclusion of the Executive's Employment by the Company.
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Section 5.02. TAX WITHHOLDING/RIGHTS OF OFFSET. The Company shall have
the right to deduct and withhold from all payments made pursuant to the terms of
this Agreement all federal, state and local taxes as may be required by law.
The Company also shall have the right to set off against the amount of any such
payment the amount of any debt, judgment, claim, expense or other obligation
owed at such time by the Executive to the Company or any of its affiliates.
Section 5.03. MODIFICATION AND WAIVER. This Agreement may not be modified
or amended except by an instrument in writing signed by the parties. No term or
condition of this Agreement will be deemed to have been waived except by written
instrument of the party charged with such waiver. Each such waiver shall
operate only as to the specific term or condition waived.
Section 5.04. SEVERABILITY. If for any reason any provision of this
Agreement is held invalid, such invalidity will not affect any other provision
hereof, which shall remain in full force and effect.
Section 5.05. EFFECT OF PRIOR AGREEMENTS. This Agreement contains the
entire understanding between the Company and the Executive relating to the
subject matter hereof and supersedes any prior agreement, communication or
understanding between the Company and the Executive relating to such subject
matter.
Section 5.06. NOTICES. Any notice or request required or permitted to be
given hereunder shall be sufficient if in writing and delivered personally or
sent by registered or certified mail, return receipt requested, as follows: if
to the Executive, to his address as set forth in the records of the Company, and
if to the Company, to its address hereinabove set forth, or to any other address
designated by either party by notice similarly given. Such notice shall be
deemed to have been given upon the personal delivery or such mailing thereof, as
the case may be.
Section 5.07. ASSIGNMENT AND SUCCESSION. The rights and obligations of
the Company under this Agreement shall inure to the benefit of and be binding
upon its successors and assigns, and the Executive's rights and obligations
hereunder shall inure to the benefit of and be binding upon his Designated
Successors.
Section 5.08. HEADINGS. The Article, Section paragraph and subparagraph
headings are for convenience of reference only and shall not define or limit the
provisions hereof.
Section 5.09. APPLICABLE LAW. This Agreement shall at all times be
governed by and construed, interpreted and enforced in accordance with the
internal laws, (as opposed to conflict of laws provisions) of the State of
California.
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IT WITNESS WHEREOF, the Company has caused this Agreement to be signed by
its duly authorized officer and the Executive has signed this Agreement as of
the day and year first above written.
FOUNDATION HEALTH SYSTEMS, INC.
By: /s/ Jay M. Gellert
---------------------------------
Jay M. Gellert
President and Chief Operating Officer
/s/ Maurice A. Costa
----------------------------------
Maurice A. Costa
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EXHIBIT 10.74
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT (this "Agreement") made and entered into as of the
31st day of December, 1997, by and between Foundation Health Systems, Inc., a
Delaware corporation ("Parent") and Robert L. Natt (the "Executive").
WHEREAS, Parent and PHS have entered into an Agreement and Plan of Merger
(the "Merger Agreement"), dated as of May 8, 1997, pursuant to which, among
other things, a wholly owned subsidiary of Parent will be merged with and into
Physicians Health Services, Inc. ("PHS") as of the "Effective Time," as defined
in the Merger Agreement (such transaction, the "Merger");
WHEREAS, the Executive is currently serving as President and Co-Chief
Executive Officer of PHS and the Board of Directors of Parent (the "Board")
desires to secure the continued employment of the Executive in accordance
herewith;
WHEREAS, PHS is party with the Executive to an employment agreement,
effective as of October 29, 1996, and a conditional employment agreement,
effective as of March 13, 1995 (such agreements, collectively, the "Prior
Agreements");
WHEREAS, Parent desires to employ the Executive, and the Executive desires
to be employed by Parent, on the terms and conditions herein set forth and in
lieu of the terms and conditions of the Prior Agreements; and
WHEREAS, the parties desire to enter into this Agreement effective as of
the Effective Time, setting forth the terms and conditions for the employment
relationship of the Executive with Parent and PHS;
NOW, THEREFORE, in consideration of the mutual premises and the respective
covenants and agreements of the parties herein contained, the parties hereto
agree as follows:
1. OPERATION OF AGREEMENT; EMPLOYMENT AND TERM
(a) This Agreement shall be effective and binding immediately upon
its execution by all parties hereto, but anything in this Agreement to the
contrary notwithstanding, this Agreement shall not be operative
<PAGE>
unless and until the Effective Time occurs. Upon the occurrence of the
Effective Time, without further action, this Agreement shall become immediately
operative.
(b) EMPLOYMENT. Parent agrees to employ the Executive, and the
Executive agrees to be employed by Parent, in accordance with the terms and
provisions of this Agreement.
(c) TERM. The term of this Agreement (the "Term") shall commence on
the date (the "Effective Date") on which the Effective Time occurs and shall
continue until December 31, 2000 (such period, the "Initial Term"); PROVIDED,
HOWEVER, that, commencing on January 1, 2001 and each successive January 1
thereafter, the Initial Term shall automatically be extended for one (1)
additional year unless, not later than July 1 of the preceding year, either
party shall have given notice (i) of nonrenewal of the Term or (ii) that such
party wishes to renegotiate the terms of this Agreement.
2. DUTIES AND POWERS OF EXECUTIVE.
(a) POSITION AND DUTIES. For the period during which the Executive
provides services to Parent under this Agreement (the "Employment Period"), the
Executive shall be responsible for and manage the tri-state (New York,
Connecticut and New Jersey) operations of Parent. The Executive in this
capacity agrees to use his best efforts during the Employment Period to protect,
encourage and promote the interests of Parent and to perform such other duties
consistent with his position that may be reasonably assigned to him by the
President or Chief Executive Officer of Parent and/or by the Board. During the
Employment Period, and excluding any periods of vacation and sick leave to which
the Executive is entitled, the Executive shall devote substantially all of his
attention and time during normal business hours to the business and affairs of
the Company and shall use his reasonable best efforts to carry out his duties
and responsibilities faithfully and efficiently. It shall not be considered a
violation of the foregoing for the Executive to serve on corporate, industry,
civic or charitable boards or committees, as long as such activities do not
materially interfere with the performance of his duties and responsibilities
with Parent in accordance with this Agreement.
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(b) LOCATION. The Executive's services shall be performed primarily
at One Far Mill Crossing, Shelton, Connecticut, 06484 (the "Principal Place of
Employment"), or in such other place as such offices are relocated. Throughout
the Employment Period, the Executive shall be provided with appropriate office
space and secretarial services commensurate with his title and position.
3. COMPENSATION. The Executive shall receive the following compensation
for his services hereunder to the Company:
(a) SALARY. During the Employment Period, the Executive's annual
base salary ("Base Salary") shall be $320,000, payable in accordance with
Parent's general payroll practices as in effect from time to time.
(a) CASH-BASED INCENTIVE COMPENSATION.
(i) GENERAL. During the Employment Period, the Executive shall
be eligible to participate in Parent's short-term and long-term incentive
compensation plans, including equity-based compensation plans, on a basis no
less favorable than that of other similarly situated executives of Parent. The
Executive hereby acknowledges that the Compensation and Stock Option Committee
of the Board (the "Committee") has sole discretion to determine the amount of
annual cash bonus or other incentives that may be earned by the Executive under
Parent's Annual Management Bonus Plan (as adopted by the Committee on June 6,
1997) or any other such plan in which the Executive may participate during the
Employment Period; however, Parent hereby agrees to recommend to the Committee
that the Executive's annual cash bonus for that annual period of the Term
commencing on January 1, 1998, will be targeted to 70% of his Base Salary if
performance goals are met, and that such percentage of Base Salary may be
increased if and to the extent that performance goals for such plan year are
exceeded. If he is deemed to be one of Parent's five highest-paid executive
officers for any given year during the Employment Period, the Executive shall
participate in Parent's Performance-Based Annual Bonus Plan as adopted by
Parent's stockholders in 1997 (or any successor plan thereto), in lieu of the
Annual Management Bonus Plan (or any successor plan thereto).
(ii) 1997 BONUS. Parent and the Executive hereby agree that the
Executive's bonus in respect
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of the period ending on December 31, 1997, shall be determined in accordance
with the terms of PHS's existing bonus plan, which amount shall be subject to
the attainment of the goals set forth in such plan and which amount must be
fully budgeted and accrued for in the financial statements of PHS presented to
Parent pursuant to the terms of the Merger Agreement.
(iii) SIGNING BONUS. As soon as practicable, but in no event
later than five (5) business days following the Effective Time, Parent shall pay
to the Executive a lump sum in cash equal to $46,500 (net of applicable
withholding tax).
(iv) RETENTION BONUS. Parent shall pay to the Executive an
aggregate amount in cash equal to $500,000 (such aggregate amount, the
"Retention Bonus"), as follows: $250,000 (less applicable withholding tax) no
later than five (5) days following the first anniversary of the Effective Time;
and $250,000 (less applicable withholding tax) no later than five (5) days
following the second anniversary of the Effective Time. The Retention Bonus
shall become payable to the Executive only if he is employed hereunder upon such
anniversary dates; PROVIDED, HOWEVER, that any portion of the Retention Bonus
not yet paid to the Executive shall become immediately due and payable upon the
Executive's Date of Termination (as defined herein) in the event that such
termination of employment occurs prior to the second anniversary of the
Effective Time and is (A) by Parent for other than "Cause" or (B) by the
Executive for "Good Reason" (as each such term is defined herein).
(c) EQUITY-BASED INCENTIVE COMPENSATION.
(i) The Executive hereby acknowledges and agrees that he will
not be eligible for participation in any equity-based compensation or incentive
plans of parent until after the third anniversary of the Effective Time, and
except as provided in this Section 3(c)(i), the Executive is not entitled to be
granted any equity-based awards during the three (3) year period commencing upon
the Effective Time and ending upon the third anniversary thereof. In lieu of
participation in Parent's equity-based compensation plans until the third
anniversary of the Effective Time, Parent shall grant to the Executive, as of
the Effective Time, a nonqualified option (the "Special Option") under Parent's
1997 Stock Option Plan (the "Parent Option Plan") to purchase an aggregate of
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150,000 shares of the common stock (the "Common Stock") of Parent on the terms
and conditions set forth in the Option Agreement attached hereto as Exhibit A at
an exercise price equal to the Fair Market Value (as defined in the Parent
Option Plan) of the Common Stock as of the Effective Time.
(ii) Beginning on the third anniversary of the Effective Time,
for the remainder of the Employment Period, the Executive will be eligible to
participate in Parent's equity-based compensation plans on terms, if any, to be
determined by the Committee.
(d) OTHER BENEFITS. During the Employment Period, the Executive
shall be eligible to participate in savings, retirement, supplemental
retirement, welfare (including without limitation medical, dental,
hospitalization and life insurance, and short-term and long-term disability) and
fringe benefit plans, practices, policies and programs of Parent on a basis no
less favorable to the Executive than in effect with respect to similarly
situated executives of Parent. Except as provided in the Merger Agreement, the
Executive shall also be entitled to carry-over all accrued benefits, such as
vacation and sick days, that he would have received from his former employment
but for the fact of the termination of the Prior Agreements. During the
Employment Period, Parent shall make available to the Executive, at its cost and
expense, (i) a leased automobile on terms substantially similar to that in
effect with respect to similarly situated executives of Parent, which terms
shall include reasonable insurance and maintenance costs and (ii) membership at
two (2) private clubs in New York City, which memberships shall be used by the
Executive for the purposes of business entertainment on behalf of Parent.
4. EXPENSES. Parent shall reimburse the Executive for all reasonable
expenses, including expenses for first-class air travel, other travel and
entertainment and parking fees in New York City, properly incurred by him in the
performance of his duties hereunder in accordance with policies established from
time to time by the Board. Parent shall also pay all reasonable legal expenses
of the Executive, up to a maximum of $15,000, that are incurred in connection
with negotiating this Agreement.
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5. TERMINATION OF EMPLOYMENT.
(a) DEATH. The Employment Period shall be terminated automatically
by Parent upon the Executive's death during such period, in which case the
Executive shall be entitled to the payment and benefits set forth in Section
6(d) of this Agreement.
(b) BY PARENT FOR CAUSE. Parent may terminate the Executive's
employment hereunder for Cause, in which case the Executive shall be entitled to
the payments and benefits set forth in Section 6(d) of this Agreement.
For purposes of this Agreement, "Cause" includes, without
limitation, acts of dishonesty, insubordination, incompetence or moral
turpitude, conviction of a felony which is materially and demonstrably
injurious to the Company, habitual drunkenness, narcotic drug addiction, or
other material misconduct of any kind. Poor performance of the Company shall
not, in and of itself, be considered "Cause." In the event that the
Executive receives a Notice of Termination for Cause in accordance with
Sections 5(f) and 10(b) hereof which indicates that the Executive has acted
(or failed to act) in a manner constituting insubordination, incompetence or
other material misconduct, the Executive shall have the opportunity, during a
fourteen (14) day period beginning on the date of receipt of such Notice, to
cure such act or failure to act. Further, actions taken at the direction of
the Board, or actions based on the recommendations of Parent's legal counsel
or qualified outside advisors shall be presumed to be taken in good faith and
for the best interest of the Company.
(c) BY THE EXECUTIVE FOR GOOD REASON. The Executive may terminate
his employment hereunder for Good Reason, unless Parent shall have previously
delivered to the Executive written notice that Cause exists (except that such
notice shall not be required in the case of a termination resulting from the
Executive's conviction of the type of felony set forth in Section 5(b) above),
in which case the Executive shall be entitled to the payments and benefits set
forth in Section 6(a) or 6(b) of this Agreement, as applicable. For purposes of
this Agreement, "Good Reason" shall mean (i) a reduction in the Executive's
reporting duties, such that he no longer reports directly to the President of
Parent; (ii) a material reduction by Parent in the Execu-
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tive's annual base salary as in effect on the date hereof (except for
across-the-board salary reductions similarly affecting all senior executives
of Parent); (iii) the relocation of the Executive's Principal Place of
Employment to a location more than 50 miles from the Executive's Principal
Place of Employment (except for required travel on Parent's or PHS's
business); or (iv) the failure by Parent to pay to the Executive any portion
of the Executive's compensation (except pursuant to an across-the-board
compensation deferral similarly affecting all senior executives of Parent)
within five (5) business days of the date such compensation is due. In order
for any termination for Good Reason to be effective, the Executive shall have
delivered to Parent written notice of the act or failure to act giving rise
to such termination for Good Reason within thirty (30) days following the
first occurrence of such event or condition, and Parent shall have been given
ten (10) business days from the receipt of such written notice to cure such
act or failure to act.
(d) BY PARENT OTHER THAN FOR CAUSE OR DEATH. Notwithstanding any
other provision of this Agreement, Parent may terminate the Executive's
employment other than for Cause or death, in which case the Executive shall be
entitled to the payments and benefits set forth under Section 6(a) or 6(b) of
this Agreement, as applicable.
(e) BY THE EXECUTIVE OTHER THAN FOR GOOD REASON. Notwithstanding any
other provision of this Agreement, the Executive may terminate his employment
other than for Good Reason, in which case the Executive shall be entitled to the
payments and benefits set forth under Section 6(d) of this Agreement.
(f) NOTICE OF TERMINATION. Any termination by Parent or by the
Executive shall be communicated by Notice of Termination to the other party
hereto given in accordance with Section 10(b) of this Agreement. For purposes
of this Agreement, a "Notice of Termination" means a written notice which (i)
indicates the specific termination provision in this Agreement relied upon, (ii)
to the extent applicable, sets forth in reasonable detail the facts and
circumstances claimed to provide a basis for termination of the Executive's
employment under the provision so indicated, and (iii) if the Date of
Termination (as defined in paragraph (g) of this Section 5) is other than the
date of receipt of such
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notice, specifies the termination date (which date shall be not more than thirty
(30) days after the giving of such notice).
The failure by the Executive or Parent to set forth in the Notice of
Termination any fact or circumstance which contributes to a showing of Good
Reason shall not waive any right of the Executive hereunder or preclude the
Executive from asserting such fact or circumstance in enforcing the Executive's
rights hereunder.
(g) DATE OF TERMINATION. "Date of Termination" means (i) if the
Executive's employment is terminated by the Executive for Good Reason, the
date of receipt of the Notice of Termination or any later date specified
therein, as the case may be, (ii) if the Executive's employment hereunder is
terminated by Parent other than on account of death, or by the Executive other
than for Good Reason, the date on which Notice of Termination is delivered and
(iii) if the Executive's employment is terminated by reason of death, the date
of death.
6. OBLIGATIONS OF PARENT UPON TERMINATION.
(a) TERMINATION DURING FIRST TWO YEARS OF TERM BY THE EXECUTIVE FOR
GOOD REASON OR BY PARENT OTHER THAN FOR CAUSE. If, during the first two (2)
years of the Term, the Executive shall terminate his employment for Good Reason
or Parent shall terminate the Executive's employment for any reason other than
Cause or death, the Executive shall be entitled to the following benefits:
(i) Parent shall pay to the Executive all vested benefits to
which the Executive is entitled under the terms of the employee benefit plans
in which the Executive is a participant as of the Date of Termination and a
lump sum amount in cash equal to the sum of (A) the Executive's Base Salary
through the Date of Termination to the extent not theretofore paid, (B) any
compensation previously deferred by the Executive (together with any accrued
interest or earnings thereon) and any accrued vacation pay and (C) any other
amounts due the Executive as of the Date of Termination, in each case to the
extent not theretofore paid (hereinafter referred to as the "Accrued
Obligation"). The amounts specified in this Section 6(a)(i) shall be paid
within thirty (30) days after the Date of Termination; and
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(ii) in lieu of any severance benefit otherwise payable to the
Executive,
(A) Parent shall pay to the Executive, within five (5) days
following the Date of Termination, a lump sum amount in cash equal to
the product of (x) the Executive's Base Salary as in effect as of the
Date of Termination and (y) (I) if such termination is by the
Executive under Section 5(c)(i) hereof, the number two (2) or (II) if
such termination is by the Executive under clause (ii), (iii) or (iv)
of paragraph 5(c) hereof (or by Parent other than for Cause or death),
the number 2.99; and
(B) for a period of one (1) year following the Date of
Termination, Parent shall continue to provide the Executive and his
dependents with medical (including hospital, surgical, and major
medical) insurance coverage as in effect as of the Date of
Termination; PROVIDED, HOWEVER, that Parent's obligation to provide
benefits under this Section 5(a)(ii)(B) shall be reduced to the extent
similar benefits are provided by a subsequent employer.
(b) TERMINATION DURING REMAINDER OF TERM BY THE EXECUTIVE FOR GOOD
REASON OR BY PARENT OTHER THAN FOR CAUSE OR DEATH. During the period commencing
on the second anniversary of the Effective Time and continuing until the end of
the Term (as such Term may be extended), if the Executive shall terminate his
employment for Good Reason or Parent shall terminate the Executive's employment
for any reason other than Cause or death, the Executive shall be entitled to the
following benefits:
(i) Parent shall pay to the Executive a lump sum amount in cash
equal to the Accrued Obligation; and
(ii) in lieu of any severance benefit otherwise payable to the
Executive,
(A) Parent shall pay the Executive a lump sum amount in
cash, within five (5) days following the Date of Termination, equal to
the product of (x) the Executive's Base salary as in
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effect as of the Date of Termination and (y) the number one and
one-half (1.5); and
(B) for a period of one (1) year following the Date of
Termination, Parent shall continue to provide the Executive and his
dependents with medical (including hospital, surgical, and major
medical) insurance coverage as in effect as of the Date of
Termination; PROVIDED, HOWEVER, that Parent's obligation to provide
benefits under this Section 5(b)(ii)(B) shall be reduced to the extent
similar benefits are provided by a subsequent employer.
(c) NON-RENEWAL OF TERM. In the event that either party gives
notice that it will not renew or extend the Term (as such Term may be extended),
Parent shall, within five (5) business days following the expiration of the
Term, pay the Executive a lump sum amount in cash equal to (i) the Accrued
Obligation and (ii) the product of (A) the Executive's Base Salary as in effect
as of the date of the expiration of the Term and (B) the number one and one-half
(1.5).
(d) TERMINATION FOR OTHER REASON. If the Executive's employment
shall be terminated by Parent for Cause or death, or by the Executive other than
for Good Reason, Parent shall have no further obligations to the Executive under
this Agreement other than the obligation to pay the Executive the Accrued
Obligation.
(e) GROSS-UP IN CONNECTION WITH THE MERGER. If any of the
payments or benefits received or to be received by the Executive in connection
with the Merger (whether pursuant to the terms of this Agreement or any other
plan, arrangement or agreement with PHS or Parent (such payments or benefits,
excluding the Gross-Up Payment (as defined below), being hereinafter referred to
as the "PHS Total Payments") will be subject to the excise tax (the "Excise
Tax") imposed pursuant to section 4999 of the Internal Revenue Code of 1986, as
amended (the "Code"), Parent shall pay to the Executive an additional amount, in
cash (the "Gross-Up Payment"), such that the net amount retained by the
Executive, after deduction of any Excise Tax on the PHS Total Payments and any
federal, state and local income and employment taxes and Excise Tax upon any
Gross-Up Payment, shall be equal to the Total Payments.
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For purposes of determining whether any of any PHS Total Payments will
be subject to the Excise Tax and the amount of such Excise Tax, (i) all of
the PHS Total Payments shall be treated as "parachute payments" (within the
meaning of section 280G(b)(2) of the Code unless, in the opinion of tax
counsel ("Tax Counsel") reasonably acceptable to the Executive, paid for by
Parent and selected by the accounting firm which is Parent's independent
auditor (the "Auditor"), such payments or benefits (in whole or in part) do
not constitute parachute payments, including by reason of section
280G(b)(4)(A) of the Code, (ii) all "excess parachute payments" within the
meaning of section 280G(b)(1) of the Code shall be treated as subject to the
Excise Tax unless, in the opinion of Tax Counsel, such excess parachute
payments (in whole or in part) represent reasonable compensation for services
actually rendered (within the meaning of section 280G(b)(4)(B) of the Code)
in excess of the "Base Amount," as defined in section 280G(b)(3) of the Code,
allocable to such reasonable compensation, or are otherwise not subject to
the Excise Tax, and (iii) the value of any noncash benefits or any deferred
payment or benefit shall be determined by the Auditor in accordance with the
principles of sections 280G(d)(3) and (4) of the Code. For purposes of
determining the amount of the Gross-Up Payment, the Executive shall be deemed
to pay federal income tax at the highest marginal rate of federal income
taxation in the calendar year in which the Gross-Up Payment is to be made and
state and local income taxes at the highest marginal rate of taxation in the
state and locality of the Executive's residence on the Date of Termination
(or if there is no Date of Termination, then the date on which the Gross-Up
Payment is calculated for purposes of this Section 6(e), net of the maximum
reduction in federal income taxes which could be obtained from deduction of
such state and local taxes.
In the event that the Excise Tax is finally determined to be less than the
amount taken into account hereunder in calculating the Gross-Up Payment, the
Executive shall repay to Parent, within five (5) business days following the
time that the amount of such reduction in the Excise Tax is finally determined,
the portion of the Gross-Up Payment attributable to such reduction (plus that
portion of the Gross-Up Payment attributable to the Excise Tax and federal,
state and local income and employment taxes imposed on the Gross-Up Payment
being repaid by the Executive), plus
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interest on the amount of such repayment at the rate provided in section
1274(b)(2)(B) of the Code. In the event that the Excise Tax is determined to
exceed the amount taken into account hereunder in calculating the Gross-Up
Payment (including by reason of any payment the existence or amount of which
cannot be determined at the time of the Gross-Up Payment), Parent shall make an
additional Gross-Up Payment in cash in respect of such excess (plus any
interest, penalties or additions payable by the Executive with respect to such
excess) within five (5) business days following the time that the amount of such
excess is finally determined. The Executive and Parent shall each reasonably
cooperate with the other in connection with any administrative or judicial
proceedings concerning the existence or amount of liability for Excise Tax with
respect to the PHS Total Payments.
7. FULL SETTLEMENT; NO MITIGATION. Except as provided in Sections
6(a)(ii)(B) and 6(b)(ii)(B) hereof, Parent's obligation to make the payments
provided for in this Agreement and otherwise to perform their obligations
hereunder shall not be subject to any set-off, counterclaim, recoupment, defense
or other claim, right or action which Parent may have against the Executive or
others. In no event shall the Executive be obligated to seek other employment or
take any other action by way of mitigation of the amounts (including amounts for
damages for breach) payable to the Executive under any of the provisions of this
Agreement.
8. CONFIDENTIAL INFORMATION; NON-COMPETITION.
(a) During the Employment Period and at all times thereafter, the
Executive shall not, without the prior written consent of the Board, disclose or
use for any purpose (except in the course of his employment under this Agreement
and in furtherance of the business of the Company) confidential information,
proprietary data and customer lists of Parent or PHS, except as required by
applicable law or legal process; provided, however, that "confidential
information, proprietary data and customer lists" shall not include any
information known generally to the public or ascertainable from public or
published information (other than as a result of unauthorized disclosure by the
Employee) or any information of a type not otherwise considered confidential by
persons engaged in the same business or a business similar to that conducted by
Parent. The Executive
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agrees to deliver to Parent at the termination of his employment all memoranda,
notes, plans, records, lists, reports and other documents (and copies thereof)
relating to the business of Parent and PHS which he may then possess or have
under his control.
(b) (i) During the Employment Period, the Executive shall not engage
in "Competition" with Parent. For purposes of this Agreement, Competition by
the Executive shall mean the Executive's engaging in, or otherwise directly or
indirectly being employed by or acting as a consultant or lender to, or being a
director, officer, employee, principal, agent, stockholder, member, owner or
partner of, or permitting his name to be used in connection with the activities
of any other business or organization anywhere in the United States which
competes, directly or indirectly, with the business of Parent as the same shall
be constituted at any time during or following the Term (and any extensions
thereof).
(ii) For the twelve (12) month period following the Employment
Period, the Executive shall not engage in Competition (as defined above and
modified herein for purposes of this subsection (b)(ii) only), with Parent in
(a) any locality or region of the United States, and (b) any substantive area,
for which the Executive had responsibility during the Employment Period;
PROVIDED, that it shall not be a violation of this sub-paragraph for the
Executive to become the registered or beneficial owner of up to two percent (2%)
of any class of the capital stock of a competing corporation registered under
the Securities Exchange Act of 1934, as amended, provided that the Executive
does not actively participate in the business of such corporation until such
time as this covenant expires.
(iii) For the twelve (12) month period following the termination
of this Agreement for any reason, the Executive agrees that he will not,
directly or indirectly, for his benefit or for the benefit of any other person,
firm or entity, do any of the following:
(A) solicit from any customer doing business with Parent as
of such termination, business of the same or of a similar nature to the
business of Parent with such customer;
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(B) solicit from any known potential customer of Parent
business of the same or of a similar nature to that which has been the
subject of a known written or oral bid, offer or proposal by Parent, or of
substantial preparation with a view to making such a bid, proposal or
offer, within six (6) months prior to such termination;
(C) solicit the employment or services of, or hire, any
person who was known to be employed by or was a known consultant to Parent
upon the termination of this Agreement, or within six (6) months prior
thereto; or
(D) otherwise knowingly interfere with the business or
accounts of Parent.
9. SUCCESSORS.
(a) ASSIGNMENT BY EXECUTIVE. This Agreement is personal to the
Executive and, without the prior written consent of Parent, shall not be
assignable by the Executive otherwise than by will or the laws of descent and
distribution. This Agreement shall inure to the benefit of and be enforceable
by the Executive's legal representatives.
(b) SUCCESSORS AND ASSIGNS. This Agreement shall inure to the
benefit of and be binding upon Parent, and their respective successors and
assigns.
(c) ASSUMPTION. Parent shall require any successor (whether direct
or indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets thereof to expressly assume and
agree to perform this Agreement in the same manner and to the same extent that
Parent, as the case may be, would be required to perform this Agreement if no
such succession had taken place. As used in this Agreement, Parent shall mean
Parent, as hereinbefore defined and any successor to its businesses and/or
assets as aforesaid that assumes and agrees to perform this Agreement by
operation of law, or otherwise.
10. MISCELLANEOUS.
(a) GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of
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New York, without reference to its principles of conflict of laws. The captions
of this Agreement are not part of the provisions hereof and shall have no force
or effect. This Agreement may not be amended, modified, repealed, waived,
extended or discharged except by an agreement in writing signed by the party
against whom enforcement of such amendment, modification, repeal, waiver,
extension or discharge is sought.
(b) NOTICES. All notices and other communications hereunder shall be
in writing and shall be given by hand delivery to the other party or by
registered or certified mail, return-receipt requested, postage prepaid,
addressed, in the case of Parent, to Parent's headquarters and, in the case of
the Executive, to the address on the signature page of this Agreement or, in
either case, to such other address as any party shall have subsequently
furnished to the other parties in writing. Notice and communications shall be
effective when actually received by the addressee.
(c) ARBITRATION. Any dispute or controversy arising under or in
connection with this Agreement shall be settled exclusively by arbitration.
The parties shall utilize the services of the American Arbitration
Association ("AAA"). Pursuant to its standard procedures, the AAA shall
appoint one neutral arbitrator from its panel of arbitrators, unless the
parties mutually agree that a panel of three (3) arbitrators be appointed,
which will make decisions by a majority vote. The arbitrator or arbitrators
shall have the power to award all appropriate relief as if the claims heard
in this proceeding had been brought in a state court of general jurisdiction
over the specific claim in question. The arbitration hearing shall be
conducted in New York, New York or another location agreed to by the parties
in accordance with the rules of the AAA then in effect. A Judgment may be
entered on the arbitrator's or arbitrators' award in any court having
jurisdiction.
(d) SEVERABILITY. The invalidity or unenforceability of any
provision of this Agreement shall not affect the validity or enforceability of
any other provision of this Agreement.
(e) TAXES. Parent may withhold from any amounts due and payable
under this Agreement such federal, state or local taxes as shall be required to
be withheld pursuant to any applicable law or regulation.
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(f) NO WAIVER. Any party's failure to insist upon strict compliance
with any provision hereof or the failure to assert any right such party may have
hereunder shall not be deemed to be a waiver of such provision or right or any
other provision or right of this Agreement.
(g) ENTIRE AGREEMENT; SURVIVAL. This Agreement entered into as of
the date hereof among Parent and the Executive and contains the entire agreement
of the Executive and Parent or their respective predecessors or subsidiaries
with respect to the subject matter of the Agreement, and all promises,
representations, understandings, arrangements and prior agreements, including
without limitation the Prior Agreements, are superseded by this Agreement. Any
provision hereof which by its terms applies in whole or part after a termination
of the Executive's employment hereunder shall survive such termination.
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IN WITNESS WHEREOF, the Executive has executed this Agreement and, pursuant
to due authorization from its Board, the Company has caused this Agreement to be
executed, as of the day and year first above written.
FOUNDATION HEALTH SYSTEMS, INC.
By: /s/ SIGNATURE
-----------------------------
Name:
Title:
ROBERT L. NATT
/s/ Robert L. Natt
-------------------------------
Address: 51 Tuckahoe Road
Easton, CT 06612
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EXHIBIT A
NONQUALIFIED STOCK OPTION AGREEMENT
UNDER THE FOUNDATION HEALTH SYSTEMS, INC.
1997 STOCK OPTION PLAN
Agreement made as of ______, 1998 (the "Grant Date"), between Foundation
Health Systems, Inc., a Delaware corporation (the "Company") and Robert L. Natt,
an employee of the Company or a Subsidiary of the Company (the "Optionee").
Pursuant to the Foundation Health Systems, Inc. 1997 Stock Option Plan (the
"Plan"), the Compensation and Stock Option Committee of the Board of Directors
of the Company (the "Committee") has determined that the Optionee is to be
granted, on the terms and conditions set forth herein, a nonqualified stock
option (the "Option") to purchase shares of Class A Common Stock of the Company,
par value $.001 per share (the "Common Stock"), and hereby grants such Option.
Capitalized terms used but not defined herein shall have the meanings set forth
in the Plan.
1. NUMBER OF SHARES AND OPTION PRICE. The Option is to purchase
150,000 shares of Common Stock (the "Option Shares") at a price of $[____] (the
"Option Price"), which is equal to the fair market value of the Option Shares as
of the Grant Date.
2. EXERCISE OF OPTION. Subject to the accelerated vesting
provisions contained in Sections 3(f) and (g) below, the Option shall become
exercisable in cumulative installments on the dates (the "Vesting Dates") one
year after the Grant Date to the extent of 33-1/3% of the Option Shares covered
by the Option, and on each subsequent anniversary of the Grant Date to the
extent of an additional 33-1/3% of the Option Shares covered by the Option,
until the Option has become exercisable as to all of the Option Shares. The
Option may be exercised only to purchase whole shares, and in no case may a
fraction of a share be purchased.
3. TERM OF OPTION AND TERMINATION OF EMPLOYMENT.
(a) GENERAL TERM. The term of the Option and this Option
Agreement shall commence on the date hereof. The right of the Optionee to
exercise the Option with respect to any Option Shares, to purchase any
such Option Shares and all other rights of the Optionee with respect to any
such Option Shares shall terminate on the tenth anniversary of the Grant
Date, unless the Option has been earlier terminated as provided either in
paragraphs (b) through (h) below or under the Plan.
(b) DEATH OF OPTIONEE. If the Optionee shall die prior to the
exercise of the Option, then:
(i) if the Optionee dies while employed by an Employer (as
defined in the Plan), then the Option (subject to clause (v) below)
may be exercised by the legatee(s) or personal representative of the
Optionee at any time within one year after the Optionee's death;
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(ii) if the Optionee's employment with the Employer was
terminated due to a Disability (as defined in the Plan) and the
optionee dies within one year after termination of employment, then
the Option (subject to clause (v) below) may be exercised by the
legatee(s) or personal representative of the Optionee any time
during the remainder of the period during which the Optionee would
have been able to exercise the Option pursuant to subsection (c)
below had the Optionee not died;
(iii) if the Optionee retires pursuant to any retirement
plan of the Employer or in the absence of any such plan, pursuant to
the Committee's discretionary determination that such termination of
employment shall be treated as retirement for purposes of the Plan and
this Option Agreement, and the Optionee dies during the period after
retirement when the Option was still exercisable by the Optionee, then
the Option (subject to clause (v) below) may be exercised by the
legatee(s) or personal representative of the Optionee at any time
during the remainder of the period during which the Optionee would
have been able to exercise the Option pursuant to subsection (d) below
had the Optionee not died;
(iv) if the Optionee dies within three months after
termination of employment by the Employer without Cause, as determined
pursuant to Subsection 3(f), and clauses (ii) and (iii) above are not
applicable, then the Option (subject to clause (v) below) may be
exercised by the legatee(s) or personal representative of the Optionee
at any time within one year after the Optionee's death; and
(v) the exercise of the Option after the termination of
employment of the Optionee for any reason (including, but not limited
to, termination by reason of death of the Optionee) is subject to the
original expiration date of the Option.
(c) DISABILITY. If the Optionee's employment with the Employer
shall terminate prior to the exercise of the Option as a result of a
Disability, then the Option (subject to clause (b)(v) above) may be
exercised by the Optionee (or his or her personal representative) at any
time within one year after the Optionee's termination of employment.
(d) RETIREMENT. If the Optionee's employment with the Employer
shall terminate prior to the exercise of the Option as a result of
retirement pursuant to any retirement plan of the Employer or in the
absence of any such plan, pursuant to the Committee's discretionary
determination that such termination of employment shall be treated as
retirement for purposes of the Plan and this Option Agreement, then the
Option (subject to clause (b)(v) above) may be exercised at any time within
one year after the Optionee's termination of employment.
(e) TERMINATION BY THE EMPLOYER FOR CAUSE. If the Optionee's
employment with the Employer shall be terminated by the Employer prior to
the exercise of the Option for Cause (as defined in the Plan) then the
Option shall immediately terminate.
(f) TERMINATION BY THE EMPLOYER WITHOUT CAUSE. If prior to the
exercise of the Option, the Optionee's employment with the Employer shall
be terminated by the Employer without Cause (as defined in the Plan), then
the Option shall become immediately exercisable in
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full and (subject to clause (b)(v) above) may be exercised at any time
within three months after the Optionee's termination of employment.
(g) TERMINATION BY THE OPTIONEE FOR GOOD REASON. If prior to
the exercise of the Option, the Optionee's employment with the Employer
shall be terminated by the Optionee for Good Reason pursuant to clause
(ii), (iii) or (iv) of Section 5(c) of the Optionee's employment agreement
with the Employer, dated as of December 31, 1997 (the "Employment
Agreement"), the Option shall become immediately exercisable in full and
(subject to clause (b)(v) above) may be exercised at any time within three
months after the Optionee's termination of employment. The accelerated
vesting provided for in the immediately preceding sentence shall be of no
force and effect and the Option shall be subject to the terms of paragraph
(h) below if the Optionee's employment with the Employer shall be
terminated by the Optionee for Good Reason pursuant to clause (i) of
Section 5(c) of the Employment Agreement.
(h) TERMINATION FOR OTHER REASON. If prior to the exercise of
the Option, the Optionee's employment with the Employer shall be terminated
for any reason other than as set forth in paragraphs (b) through (g) above,
then the Option (subject to clause (b)(v) above) held by the Optionee may
be exercised at any time within one month after the Optionee's termination
of employment.
(i) EMPLOYMENT/ASSOCIATION WITH COMPANY COMPETITOR. If within
six months after any termination of the Optionee's employment with an
Employer, the Optionee undertakes any employment or activity with a
Competitor (defined below) in the geographical area in which the Optionee
performed services for the Employer (the "Market Area"), where the loyal
and complete fulfilment of the duties of the competitive employment or
activity would call upon the Optionee to reveal, to make judgments on or
otherwise use any confidential business information or trade secrets of the
business of the Company or any Subsidiary to which the Optionee had access
during his employment with the Employer, then:
(A) the Option shall immediately terminate; and
(B) the Optionee shall promptly pay to the Company an
amount of cash equal to the Gain Realized (as defined
below) on any Option Shares acquired during the
Restricted Period (as defined below).
For the purposes of this clause (i), "Restricted Period" shall refer to the
period of time commencing ninety days prior to such termination of the
Optionee's employment and ending six months after such termination; "Gain
Realized" shall equal the difference between (i) the Option Price
applicable to the Option Shares and (ii) the greater of the Fair Market
Value (as defined in the Plan) of the Option Shares (x) on the date of
acquisition of such Option Shares or (y) on the date such competitive
activity with a Competitor was commenced by the Optionee; and "Competitor"
shall refer to any health maintenance organization, health care management
company, physician group, insurance company or similar entity that provides
managed health care or related services similar to those provided by the
Company or any Subsidiary. It is hereby further agreed that if any court
of competent jurisdiction shall determine that the restrictions imposed in
this clause (h) are unreasonable (including, but not limited to, the
definition of Market Area or Competitor or the time period during which
this provision is applicable), the parties hereto
3
<PAGE>
hereby agree to any restrictions that such court would find to be
reasonable under the circumstances.
4. NOTICES. Any notice required or permitted under the Plan shall
be deemed given when delivered personally, or when deposited in a United States
Post Office, postage prepaid, addressed, as appropriate, to the Optionee either
at the last known address set forth in the records of the Company or such other
address as the Optionee may designate in writing to the Company.
5. FAILURE TO ENFORCE NOT A WAIVER. The failure of the Company to
enforce at any time any provision of this Option Agreement or the Plan shall in
no way be construed to be a waiver of such provision or of any other provision
hereof.
6. INCORPORATION OF PLAN; ENTIRE AGREEMENT. The Plan is hereby
incorporated by reference and made a part hereof, and the Option and this Option
Agreement are subject to all terms and conditions of the Plan. This Option
Agreement and the Plan, taken together, constitutes the entire agreement between
the parties relating to or effecting the Option, and no promises, terms,
conditions or obligations other than those contained in this Option Agreement or
the Plan shall be valid or binding. Any prior agreements, statements or
promises, either oral or written, made by any party or agent of any party
relating to or effecting the Option that are not contained in the Option
Agreement or the Plan are of no force or effect.
7. RIGHTS OF A STOCKHOLDER. The Optionee shall have no rights as a
stockholder with respect to any Option Shares unless and until certificates for
shares of Common Stock are issued to the Optionee.
8. CHANGE OF CONTROL. Section 6.8 of the Plan provides for the
acceleration of exercisability of Options in the event of a Change in
Control, as such term is defined in the Plan. The Optionee hereby
acknowledges that the Committee retains the right to determine whether the
acceleration of exercisability provided for in said Section 6.8 shall have
occurred with respect to the Option (notwithstanding the provisions of such
Section 6.8) in those instances (unless otherwise determined by the Board) in
which (A) the holders of the Common Stock immediately prior to an Approved
Transaction or Control Purchase (as defined in the Plan) own more than 50% of
the voting common stock of the surviving corporation immediately after such
Approved Transaction or Control Purchase, (B) the holders of all classes of
common stock of the Company immediately prior to an Approved Transaction or
Control Purchase own more than 50% of the total equity of the surviving
corporation immediately after such Approved Transaction or Control Purchase,
(C) the Approved Transaction or Control Purchase does not result in a Board
Change and (D) the Approved Transaction or Control Purchase does not result
in a substantial change in the executive officers of the Company.
9. RIGHTS TO TERMINATE EMPLOYMENT. Nothing in the Plan or in
this Agreement shall confer upon the Optionee the right to continue in the
employment of an Employer or affect any right which an Employer may have to
terminate the employment of the Optionee. The Optionee specifically
acknowledges that the Employer intends to review Optionee's performance from
time to time, and that the Company and/or the Employer has the right to
terminate Optionee's employment at any time, including a time in close
proximity to a Vesting Date, for any reason, with or without cause.
4
<PAGE>
10. AMENDMENT. The Board may terminate or amend the Plan at any
time, provided, however, that the termination or any modification or amendment
to the Plan shall not, without the consent of the Optionee, affect the rights of
the Optionee under this Agreement.
11. COMPLIANCE WITH APPLICABLE LAW. The Option is subject to the
condition that if the listing, registration or qualification of the shares
subject to the Option upon any securities exchange or under any law, or the
consent or approval of any governmental body, or the taking of any other action,
is necessary or desirable as a condition of, or in connection with, the purchase
or delivery of shares hereunder, the Option may not be exercised, in whole or in
part, unless such listing, registration, qualification, consent or approval
shall have been effected or obtained, free of any conditions not acceptable to
the Company. The Company agrees to use reasonable efforts to effect or obtain
any such listing, registration, qualification, consent or approval.
12. DECISIONS OF BOARD OF DIRECTORS. The Board of Directors or the
Committee shall have the right to resolve all questions which may arise in
connection with the Option or its exercise. Any interpretation, determination
or other action made or taken by the Board of Directors or the Committee
regarding the Plan or this Agreement shall be final, binding and conclusive.
5
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Option
Agreement as of the date and year set forth above.
FOUNDATION HEALTH SYSTEMS, INC.
By:___________________________
Name: Jay M. Gellert
Title: President and Chief Operating Officer
THE UNDERSIGNED OPTIONEE HEREBY EXPRESSLY ACKNOWLEDGES
AND AGREES THAT (I) HE/SHE IS AN EMPLOYEE AT WILL AND
MAY BE TERMINATED BY THE EMPLOYER AT ANY TIME, WITH OR
WITHOUT CAUSE, (II) THE OPTION MAY NOT BE EXERCISED
WITH RESPECT TO ANY OPTION SHARES THAT ARE NOT OR DO
NOT BECOME VESTED IN ACCORDANCE WITH THE TERMS OF THIS
AGREEMENT ON THE DATE OF ANY SUCH TERMINATION AND (III)
THE OPTION MAY BE EXERCISED WITH RESPECT TO OPTION
SHARES THAT ARE OR MAY BECOME VESTED ON THE DATE OF ANY
SUCH TERMINATION ONLY TO THE EXTENT EXPRESSLY PROVIDED
IN THIS AGREEMENT.
IN ADDITION, THE UNDERSIGNED OPTIONEE HEREBY
ACKNOWLEDGES THAT THIS OPTION GRANT IS MEANT TO BE A
THREE-YEAR "MEGA-GRANT" AND THAT HE WILL THEREFORE NOT
BE CONSIDERED FOR ANY FUTURE OPTION, S.A.R. OR
RESTRICTED STOCK GRANTS UNTIL THREE YEARS AFTER THE
GRANT DATE.
The undersigned hereby accepts and agrees to all the
terms and provisions of the foregoing Option Agreement
and to all the terms and provisions of the Foundation
Health Systems, Inc. 1997 Stock Option Plan
incorporated by reference herein.
___________________Optionee
6
<PAGE>
[LETTERHEAD]
October 10, 1997
Mr. Alex Labak
233 Old Short Hills Road
Short Hills, New Jersey 07078
Dear Alex:
On behalf of Foundation Health Systems, Inc. I would like to confirm the
final terms of our offer of employment for the position of Senior Vice
President and Chief Marketing Officer. This document supersedes all
previously distributed offer letters and addendums.
You will earn a monthly base salary of $29,167. You will also be eligible to
participate in the Executive Incentive Program. Your incentive opportunity is
based upon attainment of corporate and individual goals. Your incentive
target will be 70 percent of your base annualized salary with a maximum
potential of 105 percent of your base annualized salary. For calendar year
1997 your incentive payment will be pro-rated from your hire date. However,
during your first eighteen months of employment, we will guarantee an
incentive payment of 35 percent of your base annualized salary.
In response to the impact of forfeiting the incentive payment earned at your
prior employer, we have committed that within thirty days of your start of
employment, the company will pay to you a $175,000 engagement bonus. This
engagement bonus is subject to normal payroll deductions. If you should
voluntarily leave the employment of Foundation Health Systems within two
years of your start date, for reason other than a substantial reduction in
authority or responsibility, you would be required to repay to the company
1/24 ($7,291) of the engagement bonus for each full month that your
department precedes your two year anniversary date with FHS. Following two
full years of employment there will be no continuing requirement to make
repayment to the company.
Additionally, we will pay to you $42,000 per year to replace aspects of the
expatriate benefit program provided to you by your former employer. This
payment will be grossed up by the company to cover the additional tax
liability that you will incur as a consequence of the payment. Included
within this payment are the costs related to an annual payment into the
Austrian pension program and an educational allowance.
<PAGE>
PAGE TWO
As part of our long-term incentive program, we have agreed that you will
participate in our stock option program. You will receive 175,000 options
granted at the stock price at the close of business on your date of
employment or $958,000 and $105,000 options granted at the stock price at the
close of business on your date of employment. The stock options and/or cash
payment will vest and/or be paid equally over a three year period with the
exception that any outstanding portion of the $958,000 payment will be made
in the case of involuntary termination for any reason other than cause.
You will be reimbursed up to $5,000 per year for expenses related to personal
tax/financial planning. We will also fund the normal and reasonable expenses
related to membership in a country club determined to be appropriate by you
and Jay Gellert.
Foundation Health Systems offers an excellent benefits plan to the employees
of our new company. This cafeteria style plan includes medical, vision,
dental, life insurance, long-term and short-term disability protection, an
employee assistant program, participation in our 401(k) Plan, and
participation in our deferred compensation plan. In our 401(k) Plan,
consistent with IRS regulations, the Company will match your contribution at
$.50 for every dollar contributed up to six percent (6%) of your
compensation. We have agreed that you will not be required to make an
employee contribution to the cost of these benefits. Specific details of each
benefit will be explained to you during orientation.
To cover the cost of your business related travel the company will provide a
$1,000 per month automobile allowance. Additionally, we have agreed that you
will annually accrue twenty-five days of personal time off under our PTO
program.
As a key member of our management team, the company will provide relocation
reimbursement according to company policy to cover the reasonable costs
associated with your move. Generally, this reimbursement covers the expenses
associated with the sale of a former residence, if any, and the expenses
related to the purchase of a new residence. In addition, Human Resources will
coordinate arrangements for the physical move of your household goods. Alex,
I am available to discuss this relocation assistance and will make myself
personally available to assist you whenever necessary.
Per corporate policy, should you voluntarily leave the Company prior to the
completion of one years service, you would be obligated to reimburse to the
Company fifty percent of the relocation assistance and engagement incentives
offered to you with the exception of the $175,000 engagement bonus, which is
covered under previously stated terms.
<PAGE>
PAGE THREE
Additionally, to assist you in meeting the additional tax liability that may
result from your relocation, Foundation Health Systems will "gross up" those
expenses not allowed by IRS regulations.
Foundation Health Systems will provide you with reasonable protection in the
event of the termination of your employment without cause or a substantial
reduction in authority or responsibility. In the event that your employment
is terminated involuntarily, and without cause, or if you should incur a
substantial reduction in authority or responsibility, you will be provided a
severance package of one year of base salary in effect at that time. In the
event of involuntary termination as a consequence of a change-of-control, or
if you should incur a substantial reduction in authority or responsibility as
a result of a change-of-control, you will be provided a severance package of
eighteen months at your monthly base salary in effect at that time.
Should you leave the company involuntarily and without cause, we have agreed
to cover the expense associated with relocating you and your family to a
geographic location of your choice. Included in this relocation expense
reimbursement is the cost to sell your place of residence and a guarantee of
95 percent of the original purchase price of the property. This assistance
will be offset by any reimbursement that might be provided by a new employer
to cover the same expenses.
We are jointly agreeing, through this letter, that your employment with
Foundation Health Systems is voluntary, on both of our parts, and on an
"employee-at-will" basis. While we both hope that our relationship will be a
continuing one, we also agree that your employment is not for a fixed term,
but is subject to termination by you or by Foundation Health Systems at any
time for reasons which either party believes sufficient in its discretion.
The foregoing constitutes all of our agreements and understandings regarding
your employment. There are no other oral or written agreements regarding your
employment and no one else is authorized to make other arrangements. Nothing
in this offer of employment, or in any oral or written policy of Foundation
Health Systems, may be construed to create an expressed or implied contract
or to impose further contractual obligations in connection with your
employment.
Please acknowledge your acceptance of the terms of this contingent employment
offer by signing and returning to myself or Jay Gellert, the duplicate
confirmation letter at your earliest convenience, but, in any event, prior to
your employment start date to be determined by yourself and Jay.
<PAGE>
PAGE FOUR
Alex, we are excited about you joining our management team and are confident
that we can offer the professional challenge and career opportunity you are
seeking. If you have any questions regarding the above information or if I
can assist you in any way, please call me at (916) 631-5316.
Sincerely,
/s/ Dan Smithson
Dan Smithson
Senior Vice President
Corporate Human Resources
Acknowledgement:
/s/ Alex Labak 10/15/97
__________________________________ ____________________________
Signature Date
<PAGE>
EXHIBIT 21.1 SUBSIDIARIES OF FOUNDATION HEALTH SYSTEMS, INC.
Foundation Health Systems, Inc. (DE)*
-QualMed, Inc. (DE)
-QualMed Plans for Health of Colorado, Inc. (CO)
-San Luis Valley Physicians Service Corp., Ltd. (CO Limited
Partnership) (1)
-QualMed Health & Life Insurance Company (CO)
-QualMed Washington Health Plan, Inc. (WA)
-QualMed Plans for Health, Inc. (NM)
-QualMed Oregon Health Plan, Inc. (OR)
-Preferred Health Network, Inc. (CA)
-Midwest Business Medical Association, Ltd. (IL)
-Health Net (CA)
-Health Net Life Insurance Company (CA)
-PCA of California Insurance Agency (CA)
-HSI Advantage Health Holdings, Inc. (DE)
-QualMed Plans for Health of Ohio and West Virginia, Inc. (OH)
-QualMed Plans for Health of Western Pennsylvania, Inc. (PA)
-Pennsylvania Health Care Plan, Inc. (PA)
-National Pharmacy Services, Inc. (DE)
-Integrated Pharmacy Systems, Inc. (PA)(2)
-HSI Eastern Holdings, Inc. (DE)
-Greater Atlantic Health Service, Inc. (DE)
-QualMed Plans for Health, Inc. (PA)
-Greater Atlantic Preferred Plus, Inc. (PA)
-Employ Better Care, Inc. (PA)
-Foundation Health Corporation (DE)
-Foundation Health Preferred Administrators (CA)
-Foundation Health National Life Insurance Company (TX)
-FH-Arizona Surgery Centers, Inc. (AZ)
-FH Surgery Limited, Inc. (CA)
-FH Surgery Centers, Inc. (CA)
-Foundation Health Facilities, Inc. (CA)
-FH Assurance Company (Cayman Islands)
-Foundation Health Warehouse Company (CA)
-Memorial Hospital of Gardena, Inc. (CA)
-East Los Angeles Doctors Hospital, Inc. (CA)
-Foundation Health Vision Services (CA)
-Denticare of California, Inc. (CA)
-Managed Alternative Care, Inc. (CA)
-American VitalCare, Inc. (CA)
-Foundation Health Federal Services, Inc. (DE)
-Catalina Professional Recruiters, Inc. (AZ)
-FHC International, Inc. (DE)
-Foundation Health International Management Services (CA)
-Foundation Health Pharmaceutical Services, Inc. (CA)
-Integrated Pharmaceutical Services (CA)
-Foundation Health, A Florida Health Plan, Inc. (FL)
-Foundation Health Medical Group, Florida, Inc. (FL)
-Foundation Health, A Louisiana Health Plan, Inc. (LA)
-Foundation Health, An Oklahoma Health Plan, Inc. (OK)
-Foundation Health, A Texas Health Plan, Inc. (TX)
-Preferred Health Providers, Inc. (FL)
<PAGE>
-Foundation Health Psychcare Services, Inc. (CA)
-Intercare, Inc. (AZ)
-Intergroup Health Plan, Inc. (AZ)
-Intergroup Prepaid Health Services of Arizona, Inc. (AZ)
-Interlease of Arizona, Inc. (AZ)
-Intergroup Healthcare Corporation of Utah (UT)
-Intergroup of Utah, Inc. (UT)
-Managed Health Network, Inc. (DE)
-Health Management Center West, Inc. (MA)
-Health Management Center, Inc. (MA)
-Health Management Center, Inc. of Wisconsin (WI)
-HMC PPO, Inc. (MA)
-Managed Health Network (CA)
-MHN Reinsurance Company of Arizona (AZ)
-MHN Services (CA)
-Business Insurance Group, Inc. (DE)
-Business Insurance Company (DE)
-California Compensation Insurance Company (CA)
-Combined Benefits Insurance Company (CA)
-Commercial Compensation Insurance Company (NY)
-Foundation Health Medical Resource Management (CA)
-Foundation Integrated Risk Management Solutions, Incorporated
(CA)
-Axis Integrated Resources, Inc. (DE)
-Gem Holding Corporation (UT)(3)
-Gem Insurance Company (UT)
-QualMed Plans for Health of Pennsylvania, Inc. (PA)(4)
-FOHP, Inc. (NJ)(5)
-First Option Health Plan of New Jersey, Inc. (NJ)
-First Option Health Plan of New York, Inc. (NY)
-First Option Health Plan of Pennsylvania, Inc. (PA)
-FOHP Agency, Inc. (NJ)
-Physicians Health Services, Inc. (DE)
-Physicians Health Services (Bermuda) Ltd. (Bermuda)
-Physicians Health Services of Connecticut, Inc. (CT)
-Physicians Health Services of New Jersey, Inc. (NJ)
-Physicians Health Services of New York, Inc. (NY)
-Physicians Health Services Insurance of New York, Inc. (NY)
-Physicians Health Insurance Services, Inc. (CT)
-PHS Insurance of Connecticut, Inc. (CT)
-PHS Real Estate, Inc. (DE)
-PHS Real Estate II, Inc. (DE)
-HN Reinsurance Limited (Cayman Islands)
-M.D. Health Plan, Inc. (CT)
*All subsidiaries wholly owned unless otherwise indicated.
(1) A limited partnership in which QualMed Plans for Health of Colorado, Inc.
is an 83.4% limited partner.
(2) National Pharmacy Services, Inc. owns approximately 90% of the outstanding
common stock.
(3) Foundation Health Corporation owns approximately 99.9% of the outstanding
common stock.
<PAGE>
(4) Foundation Health Systems, Inc. owns approximately 83.0% of the outstanding
common stock.
(5) Foundation Health Systems, Inc. owns approximately 97.9% of the outstanding
common stock.
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in (i) Registration Statement
No. 33-74780 on Form S-8, (ii) Registration Statement No. 333-24621 on Form
S-8, (iii) Registration Statement No. 33-90976 on Form S-8, and (iv)
Registration Statement No. 333-35193 on Form S-8, of our report dated March
27, 1998, appearing in this Annual Report on Form 10-K of Foundation Health
Systems, Inc. for the year ended December 31, 1997.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 27, 1998
<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>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1997 JAN-01-1996 JAN-01-1995
<PERIOD-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<CASH> 559,360 487,938 330,587
<SECURITIES> 553,001 634,978 541,231
<RECEIVABLES> 496,443<F1> 372,569<F1> 272,818<F1>
<ALLOWANCES> 0 0 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 2,409,693 2,209,616 1,602,659
<PP&E> 427,149<F2> 304,748<F2> 283,844<F2>
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 4,076,350 3,423,776 2,733,765
<CURRENT-LIABILITIES> 1,764,672 1,430,182 1,107,616
<BONDS> 1,308,979<F3> 791,618<F3> 547,522<F3>
0 0 0
0 0 0
<COMMON> 124<F4> 128<F4> 123<F4>
<OTHER-SE> 895,850 1,183,283 1,068,132
<TOTAL-LIABILITY-AND-EQUITY> 4,076,350 3,423,776 2,733,765
<SALES> 0 0 0
<TOTAL-REVENUES> 7,235,019 6,709,240 5,113,637
<CGS> 0 0 0
<TOTAL-COSTS> 5,914,608 5,593,894 3,999,883
<OTHER-EXPENSES> 1,346,104<F5> 1,017,020<F5> 766,795<F5>
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 63,555 45,372 33,463
<INCOME-PRETAX> (89,248) 52,954 313,496
<INCOME-TAX> (21,418) 14,124 124,345
<INCOME-CONTINUING> (67,830) 38,830 189,151
<DISCONTINUED> (119,254)<F6> 45,401<F6> 3,028<F6>
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (187,084) 84,231 192,179
<EPS-PRIMARY> (1.52) 0.67 1.56
<EPS-DILUTED> (1.52) 0.67 1.55
<FN>
<F1>Net of allowances for doubtful accounts.
<F2>Net of accumulated depreciation.
<F3>Includes borrowings under FHS revolving credit facility, miscellaneous
notes payable and capital leases.
<F4>Net of treasury stock.
<F5>Includes merger, restructuring and other costs and Gem costs.
<F6>Includes loss from dicontinued operations, net of tax and loss on
disposition net of tax.
</FN>
</TABLE>
<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>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> SEP-30-1997 JUN-30-1997 MAR-31-1997
<PERIOD-START> JUL-01-1997 APR-01-1997 JAN-01-1997
<PERIOD-END> SEP-30-1997 JUN-30-1997 MAR-31-1997
<CASH> 347,283 439,087 397,629
<SECURITIES> 386,295 417,993 648,037
<RECEIVABLES> 418,938 411,338 406,248
<ALLOWANCES> 0 0 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 2,042,919 2,126,448 2,159,097
<PP&E> 338,734 315,713 309,140
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 3,264,912 3,319,945 3,422,197
<CURRENT-LIABILITIES> 1,259,917 1,446,366 1,344,048
<BONDS> 917,130 904,988 839,688
0 0 0
0 0 0
<COMMON> 121 122 125
<OTHER-SE> 1,019,207 939,316 1,231,768
<TOTAL-LIABILITY-AND-EQUITY> 3,264,912 3,319,945 3,422,197
<SALES> 0 0 0
<TOTAL-REVENUES> 1,793,379 1,773,422 1,770,019
<CGS> 0 0 0
<TOTAL-COSTS> 1,462,463 1,437,490 1,437,179
<OTHER-EXPENSES> 218,383 631,855 239,219
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 15,452 17,185 14,938
<INCOME-PRETAX> 97,081 (313,108) 78,683
<INCOME-TAX> 37,278 (107,316) 31,059
<INCOME-CONTINUING> 59,803 (205,792) 47,624
<DISCONTINUED> 9,098 5,664 10,857
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 68,901 (200,128) 58,481
<EPS-PRIMARY> .57 (1.60) .47
<EPS-DILUTED> .57 (1.59) .47
</TABLE>
<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>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> SEP-30-1996 JUN-30-1996 MAR-31-1996
<PERIOD-START> JUL-01-1996 APR-01-1996 JAN-01-1996
<PERIOD-END> SEP-30-1996 JUN-30-1996 MAR-31-1996
<CASH> 245,708 252,768 247,124
<SECURITIES> 540,459 544,104 548,554
<RECEIVABLES> 368,222 339,608 303,311
<ALLOWANCES> 0 0 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 1,935,017 1,684,845 1,565,316
<PP&E> 304,992 298,106 293,811
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 3,085,560 2,843,433 2,720,902
<CURRENT-LIABILITIES> 1,035,000 1,014,408 941,952
<BONDS> 753,618 597,769 572,937
0 0 0
0 0 0
<COMMON> 125 125 124
<OTHER-SE> 1,274,674 1,213,323 1,139,498
<TOTAL-LIABILITY-AND-EQUITY> 3,085,560 2,843,433 2,720,902
<SALES> 0 0 0
<TOTAL-REVENUES> 1,729,287 1,712,207 1,544,992
<CGS> 0 0 0
<TOTAL-COSTS> 1,421,176 1,393,440 1,229,323
<OTHER-EXPENSES> 225,441 241,343 223,467
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 12,349 9,968 9,501
<INCOME-PRETAX> 70,321 67,456 82,701
<INCOME-TAX> 29,620 23,222 31,596
<INCOME-CONTINUING> 40,701 44,234 51,105
<DISCONTINUED> 16,817 22,254 11,172
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 57,518 66,488 62,277
<EPS-PRIMARY> 0.46 0.53 0.51
<EPS-DILUTED> 0.46 0.53 0.50
</TABLE>
