<PAGE>
- --------------------------------------------------------------------------------
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1999
OR
<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 1-12718
------------------------
FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4288333
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
21650 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of principal executive (Zip Code)
offices)
</TABLE>
(818) 676-6978
Registrant's telephone number, including area code
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
The number of shares outstanding of the registrant's Class A Common Stock as
of November 8, 1999 was 118,950,245 (excluding 3,194,374 shares held as treasury
stock) and 3,305,242 shares of Class B Common Stock were outstanding as of such
date.
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<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
PART I--FINANCIAL INFORMATION
Item 1--Financial Statements
Condensed Consolidated Balance Sheets as of September 30,
1999 and December 31, 1998.............................. 3
Condensed Consolidated Statements of Operations for the
Third Quarter Ended September 30, 1999 and 1998......... 4
Condensed Consolidated Statements of Operations for the
Nine Months Ended September 30, 1999 and 1998........... 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998........... 6
Notes to Condensed Consolidated Financial Statements...... 7
Item 2--Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 16
Item 3--Quantitative and Qualitative Disclosures About
Market Risk............................................... 27
PART II--OTHER INFORMATION
Item 1--Legal Proceedings................................... 29
Item 2--Changes in Securities............................... 30
Item 3--Defaults Upon Senior Securities..................... 31
Item 4--Submission of Matters to a Vote of Security
Holders................................................... 31
Item 5--Other Information................................... 31
Item 6--Exhibits and Reports on Form 8-K.................... 35
Signatures.................................................. 41
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
-------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 675,918 $ 763,865
Investments--available for sale........................... 525,567 525,082
Premiums receivable, net.................................. 187,114 230,157
Amounts receivable under government contracts............. 298,370 321,411
Deferred taxes............................................ 209,569 160,446
Reinsurance and other receivables......................... 135,529 147,827
Other assets.............................................. 106,048 91,096
---------- ----------
Total current assets.................................... 2,138,115 2,239,884
Property and equipment, net................................. 289,511 345,269
Goodwill and other intangible assets, net................... 922,513 977,910
Deferred taxes.............................................. -- 118,759
Other assets................................................ 158,032 181,447
---------- ----------
Total Assets............................................ $3,508,171 $3,863,269
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Reserves for claims and other settlements................. $1,067,765 $1,006,799
Unearned premiums......................................... 91,874 288,683
Notes payable and capital leases.......................... 2,531 1,760
Amounts payable under government contracts................ 52,293 69,792
Accounts payable and other liabilities.................... 297,943 458,397
---------- ----------
Total current liabilities............................... 1,512,406 1,825,431
Notes payable and capital leases............................ 1,084,349 1,254,278
Deferred taxes.............................................. 27,302 --
Other liabilities........................................... 28,540 39,518
---------- ----------
Total Liabilities....................................... 2,652,597 3,119,227
---------- ----------
Stockholders' Equity:
Common Stock and additional paid-in capital............... 643,161 641,945
Treasury Class A common stock, at cost.................... (95,831) (95,831)
Accumulated other comprehensive loss...................... (1,971) (7,308)
Retained earnings......................................... 310,215 205,236
---------- ----------
Total stockholders' equity.............................. 855,574 744,042
---------- ----------
Total Liabilities and Stockholders' Equity.............. $3,508,171 $3,863,269
========== ==========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THIRD QUARTER ENDED
SEPTEMBER 30,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
(UNAUDITED)
REVENUES
Health plan premiums...................................... $1,761,510 $1,769,291
Government contracts/Specialty services................... 372,778 348,732
Investment and other income............................... 27,010 20,441
Net loss on sale of businesses............................ (23) --
---------- ----------
Total revenues.......................................... 2,161,275 2,138,464
---------- ----------
EXPENSES
Health plan services...................................... 1,495,784 1,551,072
Government contracts/Specialty services................... 244,326 232,346
Selling, general and administrative....................... 314,008 354,706
Depreciation.............................................. 17,574 20,276
Amortization.............................................. 10,505 12,323
Interest.................................................. 20,737 23,626
Restructuring, asset impairments and other costs.......... -- 71,687
---------- ----------
Total expenses.......................................... 2,102,934 2,266,036
---------- ----------
Income (loss) before income taxes........................... 58,341 (127,572)
Income tax provision (benefit).............................. 23,252 (38,953)
---------- ----------
Net income (loss)........................................... $ 35,089 $ (88,619)
---------- ----------
Basic and diluted earnings (loss) per share................. $ 0.29 $ (0.73)
========== ==========
Weighted average shares outstanding:
Basic....................................................... 122,310 122,133
Diluted..................................................... 122,733 122,133
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
(UNAUDITED)
REVENUES
Health plan premiums...................................... $5,277,588 $5,331,922
Government contracts/Specialty services................... 1,105,882 1,017,595
Investment and other income............................... 67,643 70,035
Net gain on sale of businesses............................ 47,725 --
---------- ----------
Total revenues.......................................... 6,498,838 6,419,552
---------- ----------
EXPENSES
Health plan services...................................... 4,470,578 4,527,221
Government contracts/Specialty services................... 725,220 657,388
Selling, general and administrative....................... 950,597 1,033,412
Depreciation.............................................. 52,350 58,189
Amortization.............................................. 32,033 36,756
Interest.................................................. 63,332 67,680
Restructuring, asset impairments and other costs.......... 21,059 121,687
---------- ----------
Total expenses.......................................... 6,315,169 6,502,333
---------- ----------
Income (loss) before income taxes and cumulative effect of
change in accounting principle............................ 183,669 (82,781)
Income tax provision (benefit).............................. 73,273 (21,356)
---------- ----------
Income (loss) before cumulative effect of change in
accounting principle...................................... 110,396 (61,425)
Cumulative effect of change in accounting principle, net of
taxes..................................................... 5,417 --
Net income (loss)........................................... $ 104,979 $ (61,425)
---------- ----------
Basic and diluted earnings (loss) per share:
Income (loss) before cumulative effect of change in
accounting principle...................................... $ 0.91 $ (0.50)
Cumulative effect of change in accounting principle......... 0.05 --
---------- ----------
Net income (loss)........................................... $ 0.86 $ (0.50)
========== ==========
Weighted average shares outstanding:
Basic....................................................... 122,274 121,903
Diluted..................................................... 122,431 121,903
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1999 1998
--------- ---------
<S> <C> <C>
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 104,979 $ (61,425)
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Amortization and depreciation............................. 84,383 94,945
Net gain on sale of businesses and real estate............ (54,585) --
Cumulative effect of change in accounting principle....... 5,417 --
Asset impairments......................................... -- 47,000
Other changes............................................. 4,855 7,384
Changes in assets and liabilities, net of effect of
dispositions:
Premiums receivable..................................... 21,778 (33,583)
Unearned premiums....................................... (195,150) (109,871)
Other assets............................................ 84,051 (50,676)
Amounts receivable/payable under government contracts... 5,542 (10,205)
Reserves for claims and other settlements............... 72,229 (92,995)
Accounts payable and other liabilities.................. (169,204) (34,977)
--------- ---------
Net cash used in operating activities....................... (35,705) (244,403)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of investments............................. 504,713 606,755
Purchase of investments..................................... (519,092) (570,899)
Net purchases of property and equipment..................... (26,478) (105,580)
Net proceeds from the sale of businesses and buildings...... 126,568 --
Other....................................................... 29,989 10,360
--------- ---------
Net cash provided by (used in) investing activities......... 115,700 (59,364)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock
purchases................................................. 1,216 12,789
Proceeds from issuance of notes payable and other financing
arrangements.............................................. 141,275 125,560
Repayment of debt and other non-current liabilities......... (310,433) (4,046)
--------- ---------
Net cash provided by (used in) financing activities......... (167,942) 134,303
--------- ---------
Net decrease in cash and cash equivalents................... (87,947) (169,464)
Cash and cash equivalents, beginning of period.............. 763,865 559,360
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 675,918 $ 389,896
========= =========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
6
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following notes should be read in conjunction with the notes to the
consolidated financial statements and the Management's Discussion and Analysis
of Financial Condition and Results of Operations for each of the three years in
the period ended December 31, 1998 incorporated by reference in the Foundation
Health Systems, Inc. (the "Company") Annual Report on Form 10-K for the year
ended December 31, 1998 as well as the consolidated operating results presented
in the Management's Discussion and Analysis contained in this Quarterly Report
on Form 10-Q.
NOTE 1--BASIS OF PRESENTATION
In the opinion of management, the accompanying condensed consolidated
financial statements include all normal and recurring adjustments necessary for
a fair presentation of the consolidated financial position of the Company and
the consolidated results of its operations and its cash flows for the interim
periods presented. Although the Company believes that the disclosures in these
financial statements are adequate to make the information presented not
misleading, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission (the "Commission") applicable to
quarterly reports on Form 10-Q. Results of operations for the interim periods
are not indicative of results to be expected for the full year.
Certain prior period amounts have been reclassified to conform with the
current period presentation. In the second and third quarters ended June 30,
1999 and September 30, 1999, respectively, the Company reclassified and adjusted
certain intercompany revenues and expenses which did not impact net income or
earnings per share. In addition, in the first quarter ended March 31, 1999, the
Company reclassified medical management expenses from health plan medical
expense to selling, general and administrative expenses ("SG&A") and also
recorded SG&A expenses of its Specialty services businesses in SG&A, rather than
in Specialty services costs as had been the case in prior periods.
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS
The following sets forth the principal components of restructuring, asset
impairments and other costs for the three and nine months ended September 30
(amounts in millions):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Severance and benefit related costs......................... $ -- $21.2 $18.5 $ 21.2
Asset impairments and other charges related to FPA Medical
Management................................................ -- 28.1 -- 78.1
Real estate lease termination costs......................... -- 0.8
Other costs................................................. -- 22.4 1.8 22.4
----- ----- ----- ------
Total....................................................... $ -- $71.7 $21.1 $121.7
===== ===== ===== ======
</TABLE>
1999 CHARGES
The Company initiated a formal plan to dispose of certain Central Division
health plans included in the Company's Health Plan Services segment in
accordance with its anticipated divestitures program in the
7
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS (CONTINUED)
fourth quarter of 1998. In this connection, the Company announced its plan to
close the Colorado regional processing center, terminate employees and transfer
its operations to the Company's other administrative facilities. In addition,
the Company announced its plans to consolidate certain administrative functions
in its Northwest health plan operations. During the quarter ended March 31,
1999, the Company recorded pretax charges for restructuring and other charges of
$21.1 million (the "1999 Charges").
The following table summarizes the 1999 Charges by type (amounts in
millions):
<TABLE>
<CAPTION>
1999 ACTIVITY
------------------- BALANCE AT EXCEPTED
1999 CASH SEPTEMBER 30, FUTURE CASH
CHARGES PAYMENTS NON-CASH 1999 OUTLAYS
-------- -------- -------- -------------- -----------
<S> <C> <C> <C> <C> <C>
Severance and benefit related costs....... $18.5 $(5.8) $-- $12.7 $12.7
Other costs............................... 1.8 (0.8) -- 1.0 1.0
Real estate lease termination costs....... 0.8 (0.8) -- -- --
----- ----- --- ----- -----
Total..................................... $21.1 $(7.4) $-- $13.7 $13.7
===== ===== === ===== =====
</TABLE>
SEVERANCE AND BENEFIT RELATED COSTS--The 1999 Charges included
$18.5 million for severance and benefit related costs related to executives and
operations employees at the Colorado regional processing center and operations
employees at the Northwest health plans. The operations functions include
premium accounting, claims, medical management, customer service, sales and
other related departments. The 1999 Charges included the termination of a total
of 773 employees. As of September 30, 1999, 388 employees had been terminated
and $5.8 million had been paid. Termination of the remaining 385 employees is
expected to be completed during the first half of 2000. No adjustments to the
original estimates have been recorded as of September 30, 1999.
REAL ESTATE LEASE TERMINATION AND OTHER COSTS--The 1999 Charges included
$0.8 million to terminate real estate lease obligations and $1.8 million in
other costs to close the Colorado regional processing center.
1998 CHARGES
During 1998, the Company recorded charges primarily related to the
bankruptcy of FPA Medical Management, Inc. ("FPA"), the centralization and
consolidation of the Company's corporate finance and human resources functions,
and the impairment of certain long-lived assets held for disposal as a result of
the Company's anticipated divestiture program approved in the fourth quarter of
1998.
8
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS (CONTINUED)
The following two tables summarize the 1998 charges by quarter and by type
(amounts in millions):
<TABLE>
<CAPTION>
ACTIVITY THROUGH
DECEMBER 31, 1998 1999 ACTIVITY
--------------------- BALANCE AT --------------------- BALANCE AT EXPECTED
1998 CASH DECEMBER 31, CASH SEPTEMBER 30, FUTURE CASH
CHARGES PAYMENTS NON-CASH 1998 PAYMENTS NON-CASH 1999 OUTLAYS
-------- --------- --------- ------------- --------- --------- -------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Severance and benefit
related costs........... $ 21.2 $(13.2) $ (1.9) $ 6.1 $ (4.9) $ -- $ 1.2 $1.2
Asset impairment and other
charges related to
FPA..................... 84.1 (11.0) (63.5) 9.6 (5.6) (0.4) 3.6 0.6
Asset impairment and other
costs................... 112.4 -- (102.3) 10.1 (0.8) (3.1) 6.2 --
Other costs............... 22.4 (2.1) (9.6) 10.7 (1.4) (9.0) 0.3 0.3
------ ------ ------- ----- ------ ------ ----- ----
Total..................... $240.1 $(26.3) $(177.3) $36.5 $(12.7) $(12.5) $11.3 $2.1
====== ====== ======= ===== ====== ====== ===== ====
Second Quarter 1998
Charge.................. $ 50.0 $ (4.5) $ (41.1) $ 4.4 $ (4.4) $ -- $ -- $ --
Third Quarter 1998
Charge.................. 71.7 (17.1) (33.9) 20.7 (6.5) (9.1) 5.1 2.1
Fourth Quarter 1998
Charge.................. 118.4 (4.7) (102.3) 11.4 (1.8) (3.4) 6.2 --
------ ------ ------- ----- ------ ------ ----- ----
Total..................... $240.1 $(26.3) $(177.3) $36.5 $(12.7) $(12.5) $11.3 $2.1
====== ====== ======= ===== ====== ====== ===== ====
</TABLE>
SEVERANCE AND BENEFIT RELATED COSTS--During the third quarter ended
September 30, 1998, the Company recorded severance costs of $21.2 million
related to staff reductions in selected health plans and corporate
centralization and consolidation. This plan includes the termination of 683
employees in 7 geographic locations primarily relating to corporate finance and
human resources functions and California operations. As of September 30, 1999,
570 employees had been terminated and termination of the remaining
113 employees is expected to occur during the fourth quarter of 1999. No
adjustments to the original estimates have been recorded as of September 30,
1999.
FPA MEDICAL MANAGEMENT--On July 19, 1998, FPA Medical Management, Inc.
("FPA") filed for bankruptcy protection under Chapter 11 of the Federal
Bankruptcy Code. FPA, through its affiliated medical groups, provided services
to approximately 190,000 of the Company's affiliated members in Arizona and
California and also leased health care facilities from the Company. FPA has
discontinued its medical group operations in these markets and the Company has
made other arrangements for health care services to the Company's affiliated
members. The FPA bankruptcy and related events and circumstances caused
management to re-evaluate the decision to continue to operate the facilities and
management determined to sell the 14 properties, subject to bankruptcy court
approval. Management immediately commenced the sale process upon such
determination. The estimated fair value of the assets held for disposal was
determined based on the estimated sales prices less the related costs to sell
the assets. Management believed that the net proceeds from a sale of the
facilities would be inadequate to enable the Company to recover their carrying
value. Based on management's best estimate of the net realizable values, the
Company recorded charges of $50.0 million during the second quarter of 1998,
$28.1 million during the third quarter of 1998 and $6.0 million during the
fourth quarter of 1998. These charges were comprised of $63.0 million for real
estate asset impairments, $10.0 million impairment adjustment of a note received
as consideration in connection with the 1996 sale of the Company's physician
practice management business and $11.1 million for other items. These other
items included payments made to
9
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS (CONTINUED)
Arizona physician specialists totaling $3.4 million for certain obligations that
FPA had assumed but was unable to pay due to its bankruptcy, advances to FPA to
fund certain operating expenses totaling $3.0 million, and other various costs
totaling $4.7 million. The carrying value of the assets held for disposal
totaled $12.4 million at September 30, 1999. There has been no further
adjustment to the carrying value of the assets held for disposal during 1999. As
of September 30, 1999, 10 properties have been sold which has resulted in net
gains of $4.4 million during 1999 and $3.6 million in 1998 which are included in
investment and other income. The remaining properties are expected to be sold
during the fourth quarter of 1999. The suspension of real estate depreciation
has an annual impact of approximately $2.0 million.
ASSET IMPAIRMENT AND OTHER CHARGES--During the fourth quarter ended
December 31, 1998, the Company recorded impairment and other charges totaling
$112.4 million. During the fourth quarter of 1998, the Company initiated a
formal plan to dispose of certain Central Division health plans included in the
Company's Health Plan Services segment in accordance with its previously
disclosed anticipated divestitures program. The sale of most of these health
plans has occurred during the nine months ended September 30, 1999 with the
remaining health plans and real estate expected to be sold by the end of 1999.
The Company evaluated the carrying value of the assets for these health plans
and the related service center and holding company, and determined that the
carrying value of these assets exceeded the estimated fair value of these
assets. Estimated fair value was determined by the Company based on the then
current stages of sales negotiations, including letters of intent, definitive
agreements, and sales discussions, net of expected transaction costs. In the
case of the service center and holding company operations, buildings, furniture,
fixtures, equipment and software development projects were determined by
management to have no continuing value to the Company, due to abandoning plans
for development of this location and its systems and programs as a centralized
operations center. Accordingly, in the fourth quarter of 1998, the Company
adjusted the carrying value of these long-lived assets to their estimated fair
value, resulting in a non-cash asset impairment charge of approximately
$112.4 million. This asset impairment charge of $112.4 million consisted of
$40.3 million for write-downs of abandoned furniture, equipment and software
development projects, $20.9 million for write-down of buildings and
improvements, $30.0 million for write-down of goodwill and $21.2 million for
other impairments and other charges. The fair value was based on expected net
realizable value. Revenues and pre-tax income attributable to these plans
identified for disposition were $202.5 million and $76,000, respectively, for
the nine months ended September 30, 1999. The carrying value of these assets as
of September 30, 1999 was $45.8 million. No subsequent adjustments were made to
the carrying value of these assets in 1999. The annual impact of suspending
depreciation of these assets is approximately $13 million.
OTHER COSTS--During the third quarter ended September 30, 1998, the Company
recorded other costs totaling $22.4 million which included the adjustment of
amounts due from a third party hospital system that filed for bankruptcy which
were not related to the normal business of the Company totaling $18.6 million,
and $3.8 million related to other items such as fees for consulting services to
be provided by one of the Company's prior executives and costs related to
exiting certain rural Medicare markets.
In addition to the above, other charges totaling $103.3 million were
recorded in the third quarter ended September 30, 1998. These charges mostly
related to contractual adjustments, equitable adjustments relating to government
contracts, payment disputes with contracted provider groups and premium
deficiency reserves and were primarily included in health care costs within the
consolidated statement of operations.
10
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER COSTS (CONTINUED)
1997 CHARGES
The Company adopted a restructuring plan during the quarter ended June 30,
1997 related to the merger of Foundation Health Corporation and Health Systems
International, Inc. (the "FHS Combination"), which created the Company, and a
restructuring plan during the quarter ended December 31, 1997 related to the
integration of the Company's Eastern Division health plans (collectively the
"1997 Plans"). The principal elements of the 1997 Plans included a workforce
reduction of approximately 1,235 employees in 13 geographic locations, the
consolidation of employee benefit plans, the consolidation of facilities in
geographic locations where office space is duplicated, the consolidation of
overlapping provider networks as required in obtaining regulatory approval for
the FHS Combination, and the consolidation of information systems at all
locations to standardized systems. The 1997 Plans resulted in restructuring
costs totaling $149.5 million, net of modifications to the initial estimates of
$42.0 million which were also recorded during 1997. As of September 30, 1999,
the 1997 Plans are substantially complete with the remaining terminations of
employees and settlement of remaining obligations expected to be completed prior
to the end of 1999.
During 1997, the Company also recorded merger costs of $69.6 million related
to the FHS Combination, costs of $57.5 million related to premium deficiency
reserves at Gem Insurance Company, a Company subsidiary, and other costs of
$12.6 million related to the loss on sale of the Company's United Kingdom
operations.
The following two tables summarize the 1997 charges by quarter and by type
(amounts in millions):
<TABLE>
<CAPTION>
ACTIVITY THROUGH
DECEMBER 31, 1998
1997 NET ----------------- BALANCE AT
1997 MODIFICATIONS 1997 CASH DECEMBER 31,
CHARGES TO ESTIMATE CHARGES PAYMENTS NON-CASH 1998
-------- ------------- -------- --------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Severance and benefit related
costs........................... $ 71.1 $ (9.7) $ 61.4 $ (51.9) $ (6.6) $ 2.9
Provider network consolidation
costs........................... 44.3 (8.1) 36.2 (27.7) -- 8.5
Asset impairment costs............ 46.0 (2.0) 44.0 (5.4) (35.2) 3.4
Real estate lease termination
costs........................... 30.1 (22.2) 7.9 (5.0) -- 2.9
------ ------ ------ ------- ------ -----
Total restructuring costs......... 191.5 (42.0) 149.5 (90.0) (41.8) 17.7
Merger related costs.............. 73.2 (3.6) 69.6 (64.8) (4.8) --
Gem costs......................... 57.5 -- 57.5 (54.0) (3.5) --
Other costs....................... 12.6 -- 12.6 -- (12.6) --
------ ------ ------ ------- ------ -----
Total............................. $334.8 $(45.6) $289.2 $(208.8) $(62.7) $17.7
====== ====== ====== ======= ====== =====
Second Quarter 1997 Charge........ $328.8 $(45.6) $283.2 $(205.0) $(60.5) $17.7
Fourth Quarter 1997 Charge........ 6.0 -- 6.0 (3.8) (2.2) --
------ ------ ------ ------- ------ -----
Total............................. $334.8 $(45.6) $289.2 $(208.8) $(62.7) $17.7
====== ====== ====== ======= ====== =====
<CAPTION>
1999 ACTIVITY
------------- BALANCE AT EXPECTED
CASH SEPTEMBER 30, FUTURE CASH
PAYMENTS NON-CASH 1999 OUTLAYS
--------- --------- -------------- -----------
<S> <C> <C> <C> <C>
Severance and benefit related
costs........................... $(0.8) $ -- $2.1 $2.1
Provider network consolidation
costs........................... (5.5) -- 3.0 3.0
Asset impairment costs............ -- (1.1) 2.3 --
Real estate lease termination
costs........................... (2.3) -- 0.6 0.6
----- ----- ---- ----
Total restructuring costs......... (8.6) (1.1) 8.0 5.7
Merger related costs.............. -- -- -- --
Gem costs......................... -- -- -- --
Other costs....................... -- -- -- --
----- ----- ---- ----
Total............................. $(8.6) $(1.1) $8.0 $5.7
===== ===== ==== ====
Second Quarter 1997 Charge........ $(8.6) $(1.1) $8.0 $5.7
Fourth Quarter 1997 Charge........ -- -- -- --
----- ----- ---- ----
Total............................. $(8.6) $(1.1) $8.0 $5.7
===== ===== ==== ====
</TABLE>
11
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3--COMPREHENSIVE INCOME
The Company's comprehensive income for the third quarter and nine months
ended September 30 is as follows (amounts in thousands):
<TABLE>
<CAPTION>
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss)..................................... $35,089 $(88,619) $104,979 $(61,425)
Other comprehensive income, net of tax--
Net change in unrealized appreciation (depreciation)
on investments.................................... 8,439 6,039 5,337 7,215
------- -------- -------- --------
Comprehensive income (loss)........................... $43,528 $(82,580) $110,316 $(54,210)
======= ======== ======== ========
</TABLE>
NOTE 4--EARNINGS PER SHARE
Basic earnings per share excludes dilution and reflects income divided by
the weighted average shares of common stock outstanding during the periods
presented. Diluted earnings per share is based upon the weighted average shares
of common stock and dilutive common stock equivalents (all of which are
comprised of stock options) outstanding during the periods presented; no
adjustment to income is required. Common stock equivalents arising from dilutive
stock options are computed using the treasury stock method. There were 423,000
and 157,000 common stock equivalents for the third quarter and nine months ended
September 30, 1999, and no such common stock equivalents for the third quarter
and nine months ended September 30, 1998.
12
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5--SEGMENT INFORMATION
Presented below are segment data for the three and nine months ended
September 30, 1999 and 1998 (amounts in thousands):
<TABLE>
<CAPTION>
GOVERNMENT
CONTRACTS/
HEALTH PLAN SPECIALTY
SERVICES SERVICES OTHER TOTAL
----------- ---------- --------- ----------
<S> <C> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1999
Revenues from external sources............ $1,761,510 $ 372,778 $ 26,987 $2,161,275
Intersegment revenues..................... 94,013 -- 6,690 100,703
Income (loss) before income taxes......... 55,454 31,505 (28,618) 58,341
THREE MONTHS ENDED SEPTEMBER 30, 1998
Revenues from external sources............ $1,769,291 $ 348,732 $ 20,441 $2,138,464
Intersegment revenues..................... 85,540 -- 6,253 91,793
Income (loss) before income taxes......... (58,386) 25,744 (94,930) (127,572)
NINE MONTHS ENDED SEPTEMBER 30, 1999
Revenues from external sources............ $5,277,588 $1,105,882 $ 115,368 $6,498,838
Intersegment revenues..................... 267,943 -- 20,538 288,481
Income (loss) before income taxes and
cumulative effect of change in
accounting principle.................... 114,485 88,337 (19,153) 183,669
Segment Assets............................ 2,470,084 1,043,502 (5,415)(a) 3,508,171
NINE MONTHS ENDED SEPTEMBER 30, 1998
Revenues from external sources............ $5,331,922 $1,017,595 $ 70,035 $6,419,552
Intersegment revenues..................... 249,341 -- 23,831 273,172
Income (loss) before income taxes......... 13,627 89,438 (185,846) (82,781)
Segment Assets............................ 2,511,790 908,347 449,046 (a) 3,869,183
</TABLE>
- ------------------------
(a) Includes $2,426,309 and $2,687,233 of assets related to corporate and other
entities as of September 30, 1999 and 1998, respectively, and $2,431,724 and
$2,238,187 of intersegment eliminations as of September 30, 1999 and 1998,
respectively.
NOTE 6--CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1999, the Company adopted Statement of Position 98-5
"Reporting on the Costs of Start-Up Activities" and changed its method of
accounting for start-up and organization costs. The change involved expensing
these costs as incurred, rather than the Company's previous accounting principle
of capitalizing and subsequently amortizing such costs.
The change in accounting principle resulted in the write-off of the costs
capitalized as of January 1, 1999. The cumulative effect of the write-off was
$5.4 million (net of tax benefit of $3.7 million) and has been expensed and
reflected in the condensed consolidated statement of operations for the nine
months ended September 30, 1999.
13
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--DISPOSITION OF ASSETS
During the third quarter ended September 30, 1999, the Company completed the
sale of its HMO operations in New Mexico, its two California hospitals and one
of its bill review subsidiaries. For the sales of these businesses, the Company
received net cash proceeds of $37.8 million, and notes receivable of
$12.2 million. The sales of these businesses resulted in a net loss of $23,000,
before taxes.
On September 21, 1999, the Company executed a definitive agreement with
PacifiCare of Colorado, Inc. to transition all of its membership in Colorado by
March 31, 2000. The previously disclosed Letter of Intent with WellPoint Health
Networks Inc. has expired.
During the second quarter ended June 30, 1999, the Company completed the
sale of its HMO operations in the states of Texas, Louisiana and Oklahoma and
its preferred provider organization network subsidiary, Preferred Health
Network, Inc. As part of the transactions, the Company received certain cash
proceeds and convertible preferred stock. The Company recognized total losses on
the sales of $5.8 million, before taxes, in the second quarter ended
June 30, 1999.
On March 31, 1999, the Company completed the sale of certain of its pharmacy
benefits processing operations for net cash proceeds of $65.0 million and
recognized a gain of $53.6 million, before taxes.
On December 10, 1998, the Company completed the sale of the workers'
compensation segment which was accounted for as discontinued operations for the
three and nine months ended September 30, 1998. The loss on disposition of
$99 million recorded at December 31, 1997 included the anticipated results of
discontinued operations through the date of disposition; accordingly, net losses
of $4.2 million and $7.9 million related to the operations of the workers'
compensation segment are not reflected on the Company's condensed consolidated
statements of operations for the three and nine months ended September 30, 1998,
respectively.
NOTE 8--LEGAL PROCEEDINGS
Complaints have been filed in federal and state courts seeking an
unspecified amount of damages on behalf of an alleged class of persons who
purchased shares of common stock, convertible subordinated debentures and
options to purchase common stock of FPA Medical Management, Inc. ("FPA") at
various times between February 3, 1997 and May 15, 1998. The complaints allege
that the Company and certain former officers violated federal and state
securities laws by misrepresenting and failing to disclose certain information
about a 1996 agreement between the Company and FPA, about FPA's business and
about the Company's 1997 sale of FPA common stock held by the Company.
Subsequent to the Company's filing of a motion to dismiss all claims asserted
against it in the consolidated federal class actions, all claims against the
Company's former officers were voluntarily dismissed from the consolidated class
actions in both federal and state court. Thereafter, all proceedings in the
consolidated federal class actions were stayed and a motion to dismiss was
denied without prejudice to renewal after the expiration of the stay. The stay
has since expired and the Company intends to renew its motion to dismiss all
claims asserted against it. Management believes these suits are without merit
and intends to vigorously defend the actions.
The Company and certain of it subsidiaries are also parties to various other
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of business. Based in part on advice from litigation counsel to
the Company and upon information presently available, management of the
14
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--LEGAL PROCEEDINGS (CONTINUED)
Company is of the opinion that the final outcome of all such proceedings should
not have a material adverse effect on the financial position or results of
operations of the Company.
NOTE 9--SUBSEQUENT EVENTS
In October 1999, the Company entered into a definitive agreement to sell the
capital stock of its HMO subsidiary in the State of Washington. The Company also
entered into definitive agreements to transition its commercial membership in
Washington to various third party HMO and insurance companies. The Company
anticipates completing the sale and transition by the end of April 2000. In
addition, the Company completed the sale of its HMO operations in Utah during
October 1999.
15
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Foundation Health Systems, Inc. (together with its subsidiaries, the
"Company") is an integrated managed care organization which administers the
delivery of managed health care services. The Company's operations consist of
two operating segments: Health Plan Services and Government contracts/ 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 Health Plan Services segment consists of HMOs organized into four
operational divisions located in the following geographic regions: the
California Division, the Northeast Division, the Central Division and the
Arizona Division. During the nine months ended September 30, 1999, these health
plans were located in Arizona, California, Colorado, Connecticut, Florida,
Idaho, New Jersey, New York, Ohio, Oregon, Pennsylvania, Utah, Washington and
West Virginia. The Company sold its HMO operations in the states of Louisiana,
Oklahoma and Texas effective April 30, 1999 and in the state of New Mexico
effective September 30, 1999. The Company's health plans provide a wide range of
managed health care services throughout the United States with approximately
4.0 million at risk and administrative services only members. The Company's HMO
subsidiaries contract to provide medical care services to a defined, enrolled
population for a predetermined, prepaid monthly fee for group, individual
Medicare and Medicaid 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
five health and life insurance companies licensed to sell insurance throughout
most of the United States. The financial results include the results of the two
California hospitals through August 31, 1999, the date they were sold.
The Government contracts/Specialty services segment administers large,
multi-year managed health care government contracts. This segment subcontracts
to affiliated and unrelated third parties the administration and health care
risk of parts of these contracts and currently administers health care programs
covering approximately 1.5 million eligible individuals under the Civilian
Health and Medical Program of the Uniformed Services ("CHAMPUS") through the
TRICARE program. Currently, the Company provides these services under three
TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma,
Oregon, Texas, Washington and parts of Arizona, Idaho and Louisiana. This
segment also offers behavioral health, pharmacy management, dental and vision
services and sub-acute hospital unit management as well as managed care and
workers' compensation products related to bill review, administration and cost
containment for hospitals, health plans and other entities.
This discussion and analysis contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve risks and uncertainties which may cause
actual results to differ materially from those projected or implied in these
statements. The risks and uncertainties faced by the Company include, but are
not limited to, those set forth under "Additional Information Concerning the
Company's Business," "Cautionary Statements" and other sections within the
Company's filings with the Securities and Exchange Commission.
CONSOLIDATED OPERATING RESULTS
The Company's net income for the third quarter ended September 30, 1999 was
$35.1 million, or $0.29 per basic and diluted share, compared to a net loss for
the comparable period in 1998 of $88.6 million, or $0.73 per basic and diluted
share. The Company's net income for the nine months ended September 30, 1999 was
$105.0 million, or $0.86 per basic and diluted share, compared to a net loss for
the comparable period in 1998 of $61.4 million or $0.50 per basic and diluted
share. Excluding the cumulative effect of the change in accounting principle for
organization and start up costs recorded during the first quarter of 1999, net
income was $110.4 million or $0.91 per basic and diluted share for the nine
months ended September 30, 1999.
16
<PAGE>
The table below and the paragraphs that follow provide selected financial
information related to the Company's performance for the three and nine months
ended September 30, 1999 and 1998. Certain 1998 amounts have been reclassified
to conform with the current period presentation. In the second and third
quarters ended June 30, 1999 and September 30, 1999, respectively, the Company
reclassified and adjusted certain intercompany revenues and expenses which did
not impact net income or earnings per share. The reclassifications did result in
higher reported revenues in its Government contracts/Specialty services unit and
lower reported revenues and costs in its Health Plan Services unit compared with
amounts previously disclosed. FHS believes this more accurately reflects the
performance of its specialty companies as if they were independent entities. In
addition, in the first quarter ended March 31, 1999, the Company reclassified
medical management expenses from health plan medical expenses to selling,
general and administrative expenses ("SG&A") and also recorded SG&A expenses of
its Specialty services businesses in SG&A, rather than in Government
contracts/Specialty services costs as had been the case in prior periods.
<TABLE>
<CAPTION>
THIRD QUARTER ENDED NINE MONTHS ENDED
------------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(AMOUNTS IN THOUSANDS, EXCEPT PER MEMBER PER MONTH
AMOUNTS)
<S> <C> <C> <C> <C>
REVENUES:
Health plan premiums....................... $1,761,510 $1,769,291 $5,277,588 $5,331,922
Government contracts/Specialty services.... 372,778 348,732 1,105,882 1,017,595
Investment and other income................ 27,010 20,441 67,643 70,035
Net gain (loss) on sale of businesses
sold..................................... (23) -- 47,725 --
---------- ---------- ---------- ----------
Total revenues........................... 2,161,275 2,138,464 6,498,838 6,419,552
---------- ---------- ---------- ----------
EXPENSES:
Health plan services....................... 1,495,784 1,551,072 4,470,578 4,527,221
Government contracts/Specialty services.... 244,326 232,346 725,220 657,388
Selling, general and administrative........ 314,008 354,706 950,597 1,033,412
Depreciation............................... 17,574 20,276 52,350 58,189
Amortization............................... 10,505 12,323 32,033 36,756
Interest................................... 20,737 23,626 63,332 67,680
Asset impairment and other charges......... -- 71,687 21,059 121,687
---------- ---------- ---------- ----------
Total expenses........................... 2,102,934 2,266,036 6,315,169 6,502,333
---------- ---------- ---------- ----------
Income (loss) before income taxes and
cumulative effect of change in accounting
principle.................................. 58,341 (127,572) 183,669 (82,781)
Income tax provision (benefit)............... 23,252 (38,953) 73,273 (21,356)
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of
change in accounting principle............. 35,089 (88,619) 110,396 (61,425)
Cumulative effect of change in accounting
principle.................................. -- -- 5,417 --
---------- ---------- ---------- ----------
Net income (loss)............................ $ 35,089 (88,619) $ 104,979 $ (61,425)
========== ========== ========== ==========
Administrative (SG&A + Depreciation) Ratio... 15.54% 17.70% 15.71% 17.19%
Health plan MCR.............................. 84.91% 87.67% 84.71% 84.91%
Government contracts/Specialty services
MCR........................................ 65.54% 66.63% 65.58% 64.60%
Overall MCR.................................. 81.53% 84.20% 81.39% 81.65%
Health plan premiums per member per month.... $ 139.65 $ 128.61 $ 138.10 $ 127.35
Health plan services per member per month.... 118.58 111.88 116.99 108.13
</TABLE>
17
<PAGE>
ENROLLMENT INFORMATION
SEPTEMBER 30, 1999
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PERCENT
1999 1998 CHANGE
-------- -------- --------
<S> <C> <C> <C>
Health Plan Services:
Commercial..................................... 3,045 3,361 (9.4)%
Medicare Risk.................................. 267 323 (17.3)%
Medicaid....................................... 676 555 21.8 %
----- -----
3,988 4,239 (5.9)%
===== =====
Government Contracts:
CHAMPUS PPO and Indemnity...................... 661 783 (15.6)%
CHAMPUS HMO.................................... 840 685 22.6 %
----- -----
1,501 1,468 2.2 %
===== =====
</TABLE>
REVENUES AND HEALTH CARE COSTS
The Company's revenues increased by $22.8 million or 1.1% for the third
quarter ended September 30, 1999 and $79.3 million or 1.2% for the nine months
ended September 30, 1999 as compared to the comparable periods in 1998. Health
Plan revenues decreased $7.8 million and $54.3 million for the third quarter and
nine months ended September 30, 1999, respectively, as compared to the
comparable periods in 1998. This was due primarily to decreases in enrollment
partially offset by increases in premium rates. In addition, for the third
quarter and nine months ended September 30, 1999, the Company's Health plan
revenues include $23.4 million and $93.3 million, respectively, from its
subsidiaries that have been sold during the first nine months of 1999, as
compared to $42.2 million and $133.7 million for the same subsidiaries during
the third quarter and nine months ended September 30, 1998. See "Segment
Information--Health Plan Services" for further discussion.
Growth in Government contracts/Specialty services revenues totaled
$24.0 million and $88.3 million for the third quarter and nine months ended
September 30, 1999, respectively, as compared to the comparable periods in 1998.
This growth is primarily due to increases in government contracts membership and
growth in the managed behavioral health network. See "Segment
Information--Government Contracts/Specialty Services" for further discussion.
Included in total revenues for the nine months ended September 30, 1999 is a
$47.7 million net gain on the sale of certain businesses during the first
nine months of 1999.
The overall medical care ratio ("MCR") (medical costs as a percentage of
Health Plan premiums and Government contracts/Specialty services revenues) for
the third quarter and nine months ended September 30, 1999 was 81.53% and
81.39%, respectively, as compared to 84.20% and 81.65%, respectively, for the
comparable periods in 1998. Excluding the other charges as discussed in Note 2
to the accompanying condensed consolidated financial statements, the MCR would
have been 80.08% and 80.28% for the third quarter and nine months ended
September 31, 1998, respectively. There were no such adjustments in 1999. The
increase in the MCRs was primarily due to increased pharmacy costs in most of
the Company's health plans, partially offset by increases in premium rates. See
"Segment Information" for further discussion.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses
decreased by $40.7 million or 11.5% for the third quarter ended September 30,
1999 as compared to the comparable periods in 1998, and $82.8 million or 8.0%
for the nine months ended September 30, 1999 as compared to the comparable
18
<PAGE>
periods in 1998. Excluding the restructuring and other charges, the SG&A
expenses decreased by $25.5 million and $67.7 million for the third quarter and
nine months ended September 30, 1999. The divestiture of non-core plans
accounted for approximately $13.9 million and $25.6 million of the decrease for
the third quarter and nine months ended September 30, 1999, respectively. The
remaining decrease in SG&A expenses during 1999 is primarily attributable to the
Company's ongoing efforts to control its SG&A expenses.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense decreased by $4.5 million and
$10.6 million for the third quarter and nine months ended September 30, 1999,
respectively, as compared to the comparable periods in 1998. The decrease is due
to the $30.0 million write-down of goodwill and other long-lived assets to their
estimated fair value during the year ended December 31, 1998 and the write-off
of organization and pre-operating costs of $9.1 million during the
first quarter ended March 31, 1999.
INTEREST EXPENSE
Interest expense decreased by $2.9 million and $4.3 million for the third
quarter and nine months ended September 30, 1999, respectively, as compared to
the comparable periods in 1998. A decrease in interest expense from the
reduction in the revolving credit facility balance was partially offset by a
higher average borrowing rate of 6.7% in 1999 as compared to 6.1% in the
comparable period in 1998.
INCOME TAX PROVISION AND BENEFIT
The effective tax provision rate was 39.9% on income from operations for the
third quarter and nine months ended September 30, 1999, respectively, compared
to the effective tax benefit rate on continuing operations of 30.5% and 25.8%,
respectively, for the comparable periods in 1998. The difference from the
statutory tax rate is primarily due to California state taxes which only
benefited 50% of the prior year losses and permanent differences related to
tax-exempt investment income.
RESTRUCTURING AND OTHER COSTS
The Company initiated a formal plan to dispose of certain Central Division
health plans included in the Company's Health Plan Services segment in
accordance with its anticipated divestitures program in the fourth quarter of
1998. In this connection, the Company announced its plan to close the Colorado
regional processing center, terminate employees and transfer its operations to
the Company's other administrative facilities. In addition, the Company
announced it plans to consolidate certain administrative functions in its
Northwest health plan operations. During the quarter ended March 31, 1999, the
Company recorded pretax charges for restructuring and other charges of
$21.1 million.
SEVERANCE AND BENEFIT RELATED COSTS--The 1999 Charges included $18.5 million for
severance and benefit related costs related to executives and operations
employees at the Colorado regional processing center and operations employees at
the Northwest health plans. The operations functions include premium accounting,
claims, medical management, customer service, sales and other related
departments. The 1999 Charges included the termination of a total of 773
employees. As of September 30, 1999, 388 employees had been terminated and $5.8
million had been paid. Termination of the remaining 385 employees is expected to
be completed during the first half of 2000. No adjustments to the original
estimates recorded have been identified as of September 30, 1999.
REAL ESTATE LEASE TERMINATION AND OTHER COSTS--The 1999 Charges included $0.8
million to terminate real estate lease obligations and $1.8 million in other
costs to close the Colorado regional processing center.
19
<PAGE>
During 1998, the Company recorded charges primarily related to the
bankruptcy of FPA Medical Management, Inc. ("FPA"), the centralization and
consolidation of the Company's corporate finance and human resources functions,
and the impairment of certain long-lived assets held for disposal as a result of
the Company's anticipated divestiture program approved in the fourth quarter of
1998.
During the third quarter ended September 30, 1998, the Company recorded
severance costs of $21.2 million related to staff reductions in selected health
plans and corporate centralization and consolidation. This plan includes the
termination of 683 employees in 7 geographic locations primarily relating to
corporate finance and human resources functions and California operations. As of
September 30, 1999, 570 employees had been terminated and termination of the
remaining 113 employees is expected to occur during the fourth quarter of 1999.
On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection under Chapter 11 of the Federal Bankruptcy Code. FPA, through its
affiliated medical groups, provided services to approximately 190,000 of the
Company's affiliated members in Arizona and California and also leased health
care facilities from the Company. FPA has discontinued its medical group
operations in these markets and the Company has made other arrangements for
health care services to the Company's affiliated members. The FPA bankruptcy and
related events and circumstances caused management to re-evaluate the decision
to continue to operate the facilities and management determined to sell the
14 properties, subject to bankruptcy court approval. Management immediately
commenced the sale process upon such determination. The estimated fair value of
the assets held for disposal was determined based on the estimated sales prices
less the related costs to sell the assets. Management believed that the net
proceeds from a sale of the facilities would be inadequate to enable the Company
to recover their carrying value. Based on management's best estimate of the net
realizable values, the Company recorded charges of $50.0 million during the
second quarter of 1998, $28.1 million during the third quarter of 1998 and
$6.0 million during the fourth quarter of 1998. These charges were comprised of
$63.0 million for real estate asset impairments, $10.0 million impairment
adjustment of a note received as consideration in connection with the 1996 sale
of the Company's physician practice management business and $11.1 million for
other items. These other items included payments made to Arizona physician
specialists totaling $3.4 million for certain obligations that FPA had assumed
but was unable to pay due to its bankruptcy, advances to FPA to fund certain
operating expenses totaling $3.0 million, and other various costs totaling
$4.7 million. The carrying value of the assets held for disposal totaled
$12.4 million at September 30, 1999. As of September 30, 1999, ten properties
have been sold which has resulted in net gains of $4.4 million during 1999 and
$3.6 million in 1998. The remaining properties are expected to be sold during
the fourth quarter of 1999. The suspension of real estate depreciation has an
annual impact of approximately $2.0 million.
During the fourth quarter ended December 31, 1998, excluding $6.0 million
related to the FPA bankruptcy discussed above, the Company recorded impairment
and other charges totaling $112.4 million. During the fourth quarter of 1998,
the Company initiated a formal plan to dispose of certain Central Division
health plans included in the Company's Health Plan Services segment in
accordance with its previously disclosed anticipated divestitures program. The
sale of most of these health plans has occurred during the nine months ended
September 30, 1999 with the remaining health plans and real estate expected to
be sold by the end of 1999. The Company evaluated the carrying value of the
assets for these health plans and the related service center and holding
company, and determined that the carrying value of these assets exceeded the
estimated fair value of these assets. Accordingly, in the fourth quarter of
1998, the Company adjusted the carrying value of these long-lived assets to
their estimated fair value, resulting in a non-cash asset impairment charge of
approximately $112.4 million. This asset impairment charge of $112.4 million
consisted of $40.3 million for write-downs of abandoned furniture, equipment and
software development projects, $20.9 million for write-down of buildings and
improvements, $30.0 million for write-down of goodwill and $21.2 million for
other impairments and other charges. The fair value was based on expected net
realizable value. Revenues and pre-tax income attributable to these plans
identified
20
<PAGE>
for disposition were $202.5 million and $76,000, respectively, for the nine
months ended September 30, 1999. The carrying value of these assets as of
September 30, 1999 was $45.8 million. No subsequent adjustments were made to
these assets in 1999. The annual impact of suspending depreciation is
approximately $13 million.
During the third quarter ended September 30, 1998, the Company recorded
other costs totaling $22.4 million which included the adjustment of amounts due
from a third party hospital system that filed for bankruptcy which were not
related to the normal business of the Company totaling $18.6 million, and
$3.8 million related to other items such as fees for consulting services to be
provided by one of the Company's prior executives and costs related to exiting
certain rural Medicare markets.
In addition to the above, other charges totaling $103.3 million were
recorded in the third quarter ended September 30, 1998. These charges mostly
related to contractual adjustments, equitable adjustments relating to government
contracts, payment disputes with contracted provider groups and premium
deficiency reserves and were primarily included in health care costs within the
consolidated statement of operations.
SEGMENT INFORMATION
HEALTH PLAN SERVICES
Health Plan revenues decreased by $7.8 million or 0.4% for the third quarter
ended September 30, 1999 as compared to the comparable period in 1998, and by
$54.3 or 1.0% for the nine months ended September 30, 1999 as compared to the
comparable period in 1998. These decreases were primarily due to a 6% decrease
in period-end enrollment in the Company's health plans as of September 30, 1999.
Of the total 251,000 membership decline, 71,000 members were enrolled in plans
that have been sold. For the third quarter and nine months ended September 30,
1999, the Company's Health plan revenues include $23.4 million and
$93.3 million, respectively, from its subsidiaries that have been sold during
the first nine months of 1999, as compared to $42.2 million and $133.7 million
for the same subsidiaries during the third quarter and nine months ended
September 30, 1998. These decreases were partially offset by an average increase
in premium rates as a result of instituting more rigorous pricing discipline
which yielded a revenue per member per month ("PMPM") increase of 8.6% and 8.4%,
respectively, for the third quarter and nine months ended September 30, 1999.
Health Plan costs decreased by $55.3 million, or 3.6% for the third quarter
ended September 30, 1999 as compared to the comparable period in 1998, and by
$56.6 million or 1.0% for the nine months ended September 30, 1999 as compared
to the comparable period in 1998. The health plans MCR decreased to 84.91% for
the third quarter ended September 30, 1999 from 87.67% for the comparable period
in 1998 and decreased to 84.71% for the nine months ended September 30, 1999
from 84.91% for the comparable period in 1998. Excluding the restructuring and
other charges as discussed in Note 2 to the condensed consolidated financial
statements, the MCR would have been 83.55% and 83.54% for the third quarter and
nine months ended September 30, 1998, respectively. There were no such
adjustments in 1999. The increases in MCRs were primarily due to a 12% increase
in pharmacy costs in most of the Company's health plans, partially offset by an
8% increase in premium rates.
GOVERNMENT CONTRACTS/SPECIALTY SERVICES
Government contracts/Specialty services revenue increased by $24.0 million
or 6.9% during the third quarter ended September 30, 1999 as compared to the
same period in 1998, and by $88.3 million or 8.7% for the nine months ended
September 30, 1999 as compared to the same period in 1998. Favorable revenue
adjustments under government contracts, coupled with a 16% growth in the managed
behavioral health network, were partially offset by loss of revenues previously
generated by certain pharmacy benefit processing operations of $23 million which
were sold during the first quarter ended March 31, 1999.
21
<PAGE>
Government contracts/Specialty services MCR decreased to 65.54% in the third
quarter ended September 30, 1999 from 66.63% for the comparable 1998 period.
Government contracts/Specialty services MCR increased to 65.58% in the nine
months ended September 30, 1999 from 64.60% for the comparable 1998 period.
Excluding the restructuring and other charges, the MCR would have been 62.44%
and 63.17% for the third quarter and nine months ended September 30, 1998,
respectively. There were no such adjustments in 1999. These increases were
primarily due to retroactive adjustments recorded in 1998 which decreased mental
health care costs related to government contracts. There were no such
adjustments in 1999.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit margin is
low; hence, it is especially sensitive to inflation. Increases in medical
expenses or contracted medical rates without corresponding increases in premiums
could have a material adverse effect on the Company.
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, regulatory changes, utilization,
new technologies, hospital costs, major epidemics and numerous other external
influences may affect the Company's operating results. Accordingly, past
financial performance is not 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.
The Company's HMO subsidiaries contract with providers in California, and to
a lesser degree in other areas, primarily through capitation fee arrangements.
Under a capitation fee arrangement, the Company's subsidiary pays the provider a
fixed amount per member on a regular basis and the provider accepts the risk of
the frequency and cost of member utilization of services. The inability of
providers to properly manage costs under capitation arrangements can result in
financial instability of such providers. Any financial instability of capitated
providers could lead to claims for unpaid health care against the Company's HMO
subsidiaries, even though such subsidiaries have made their regular payments to
the capitated providers. Depending on state law, the Company's HMO subsidiaries
may be liable for such claims.
22
<PAGE>
YEAR 2000
The Company recognizes that the arrival of the year 2000 requires computer
systems to be able to recognize the date change from 1999 to 2000 and, like
other companies, is assessing and modifying its computer applications and
business processes to provide for their continued functionality.
The "Year 2000" issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, prepare invoices or
engage in normal business activities. In addition, the Year 2000 problems of the
Company's providers and customers, including governmental entities, can affect
the Company's operations, which are highly dependent upon information technology
for processing claims, determining eligibility and exchanging information.
PROJECT STATUS--The Year 2000 effort for the Company has the highest
priority of technology projects and has the full support of the Company's
management. The project has dedicated resources with multiple teams to address
its unique systems environment. Uniform project management techniques have been
adopted with overall oversight responsibility residing with the Company's Chief
Technology Officer, assisted by a special project manager hired by the Company.
An executive management committee is also actively and directly involved in an
oversight capacity in the Company's Year 2000 project and receives monthly
reports from the project manager. In addition, the project manager regularly
meets with the Company's audit committee to further discuss the Company's
Year 2000 issues.
The Company is addressing its Year 2000 issues in several ways. Selected
systems are being 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. Certain vendors have made, and the
Company expects that vendors will continue to make, timely updates available to
ensure that all remaining purchased software is Year 2000 compliant. The Company
has determined that there are no significant applications for which the Company
does not have adequate ability to work around in the event of failure. The
remaining systems' compliance with Year 2000 has been and continues to be
addressed by internal technical staff. The Company has engaged IBM Global
Services to assist in the program management of the project. In addition, the
Company has assessed its third party relationships with respect to
non-information technology assets and services, retained IBM's The Wilkerson
Group, and has developed contingency plans to provide continuity of material
relationships. Legal consultants have been retained to assist with insurance
review and assessment of the Company's obligations and rights.
The Company has divided its internal Year 2000 effort into five phases:
(1) Assessment and Strategy, (2) Detailed Analysis and Planning,
(3) Remediation, (4) Testing and Implementation, and (5) Certification. During
the third quarter of 1999, the Company substantially completed all phases of its
Year 2000 project. The Company has completed testing and implementation of all
of its "mission critical" operational systems (as defined under "contingency
planning" below) with certification scheduled to be complete by November 30,
1999. The Company is finalizing testing and implementation of a few remaining
minor systems and expects to complete such process and certify such systems by
November 30, 1999. The
23
<PAGE>
following table sets forth the estimated percentage completion of each of the
Company's Year 2000 phases with respect to its mission critical systems,
non-mission critical systems and Year 2000 project overall.
<TABLE>
<CAPTION>
PHASE 1 PHASE 2 PHASE 3 PHASE 4 PHASE 5
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Overall October 1999................................ 100% 100% 100% 99% 78%
Mission critical systems as of October 1999......... 100% 100% 100% 100% 87%
Non-mission critical systems as of October 1999..... 100% 100% 100% 94% 52%
Overall July 1999 (as reported in the Company's
Quarterly Report on Form 10-Q, second quarter,
1999)............................................. 100% 100% 100% 88% 54%
</TABLE>
THIRD PARTIES--The Company has completed its assessment of third party
relationships and has identified general purpose utility vendors, care delivery
organizations (such as providers), customer service vendors and certain other
entities as strategically important to the Company. During the third quarter,
the Company obtained assurances from certain delegated authorities and other
providers as to their Year 2000 readiness and the Company is endeavoring to
obtain such assurances from all delegated authorities and strategically
important providers. There can be no assurance that the systems of other
companies on which the Company relies will be compliant on a timely basis, that
any Year 2000 problems of such companies will be timely remedied or that the
failure by a third party to be compliant would not have a material adverse
effect on the Company.
COSTS--The Company is evaluating on an on-going basis the related costs to
resolve its potential Year 2000 problems. The Company estimates that the total
cost for the project will be approximately $34-36 million, excluding the costs
to accelerate the replacement of hardware or software otherwise required to be
purchased by the Company. Through the third quarter of 1999, the Company
expended approximately $30.8 million relating to, among other things, the cost
to repair or replace software and related hardware problems, the cost of
assessment, analysis and planning, and internal and external communications. The
remaining estimated costs of the Company's Year 2000 project relate to
certification efforts for certain remaining systems, on-going systems monitoring
and contingency preparations. The Company currently estimates that the
percentages of its total expenditures for Year 2000 issues will be approximately
as follows: 38% for internal costs, 29% for outside consultants and contractors
and 33% for software-related and hardware-related costs. The Company has
established a line-item in its overall operating budget specifically for
Year 2000 costs. The operating subsidiaries for each line of business of the
Company, however, are paying for the costs of assessment, planning, remediation,
testing and certification of Year 2000 issues for their respective operations.
Notwithstanding the foregoing, the costs of the project and the state of the
Company's Year 2000 readiness are based on estimates derived from utilizing
numerous assumptions of future events including the continued availability of
certain resources, third party modification plans and other factors. There can
be no assurances that these estimates are accurate and the Company's actual
costs and readiness could differ materially from these estimates.
Certain insurance coverages for defense costs associated with Year 2000
litigation have already been secured under the Company's Directors and Officers
Liability Insurance policy. 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 costs and liabilities under its other insurance policies. The Company
is engaged in ongoing efforts to analyze the availability of such coverage under
other existing and future insurance policies and products.
CONTINGENCY PLANNING--An important part of the Company's Year 2000 project
involves identifying worst case scenarios and seeking to develop contingency
plans. The Company has completed the assessment of its mission critical business
functions and has prioritized them in order to address the most critical issues
first in remediation efforts and to develop alternatives to these critical
processes as part of contingency planning. A mission critical business activity
or system is one that cannot be without an automated or functional system for a
period of 21 days without causing significant business impact to the
24
<PAGE>
particular line of business. Among other things, the Company's divisions have
assessed potential negative impacts on a valid member's ability to receive
services, the ability to generate revenue, the need for additional expenditures,
compliance with legal, regulatory or accreditation requirements, meeting
contractual obligations and reimbursing providers, vendors and agents. The
Company has documented and tested its contingency plans. Such contingency plans
include, among other things, the use of manual as well as on-line files of its
members to avoid disruption in the verification of membership and eligibility
for the provision of health care services to its members. The Company has also
undertaken certain scheduling adjustments to increase the availability of
Company personnel to address potential Year 2000 problems. There can be no
assurance, however, that the contingency plans of the Company, if implemented,
will adequately address Year 2000 problems that may arise or prevent such
problems from having a material adverse effect on the Company's operations.
RISKS--The Company is highly dependent upon its own information technology
systems and that of its providers and customers. Failure by the Company or a
third party to correct a material Year 2000 problem could result in a failure of
or an interruption in the Company's business activities and operations. Such
interruptions and failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the readiness of third party providers and customers, the Company
is not able to conclusively determine whether the Year 2000 problem will have a
material adverse effect on the Company's results of operations, liquidity or
financial condition. The Company's Year 2000 project is expected to reduce
significantly the Company's level of uncertainty and the possibility of
significant or long-lasting interruptions of the Company's business operations;
however, the Company believes that it is impossible to predict all of the areas
in which material problems may arise, including, among other areas, third party
relationships and the provision of utilities.
Forward-looking statements contained in this Year 2000 section should be
read in connection with the Company's cautionary statements identifying
important risk factors that could cause the Company's actual results to differ
materially from those projected in these forward-looking statements, which
cautionary statements are contained in the Company's Annual Report on Form 10-K
for the year ended December 31, 1998. The information contained herein is
intended to be a "Year 2000 Readiness Disclosure" as defined in the Year 2000
Information and Readiness Disclosure Act of 1998 enacted on October 19, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state laws and regulations, and must have
adequate reserves for claims. Certain subsidiaries must maintain ratios of
current assets to current liabilities 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 or payable. Since these amounts are subject to government
audit and negotiation, amounts ultimately collected may vary from current
estimates. Additionally, the timely collection of such receivables is also
impacted by government audit and negotiation.
For the nine months ended September 30, 1999, cash used by operating
activities was $35.7 million compared to $244.4 million in the comparable period
of 1998. This change was due primarily to increases
25
<PAGE>
in reserves for claims and other settlements, the collection of premiums
receivable and the decrease in other assets, which were offset by decreases in
unearned premiums, and in accounts payable and other liabilities. The timing
differences in Medicare and Medicaid payments also affected cash flow from
operations. Excluding these timing differences, cash flow from operations would
have been a positive $70.3 million and a negative $122.4 million for the nine
months ended September 30, 1999 and 1998, respectively. Net cash provided by
investing activities was $115.7 million during the nine months ended
September 30, 1999 as compared to cash used in investing activities of
$59.4 million during the comparable period in 1998. This increase was primarily
due to the proceeds from the sale of certain businesses and buildings of
$126.6 million. Net cash used in financing activities was $167.9 million during
the nine months ended September 30, 1999 as compared to cash provided by
financing activities of $134.3 million during the comparable period in 1998. The
change was primarily due to the repayment of funds drawn under the Company's
Credit Facility (as defined below).
The Company has a $1.5 billion credit facility (the "Credit Facility"), with
Bank of America as Administrative Agent for the Lenders thereto, which was
amended by a Letter Agreement dated as of March 27, 1998 and Amendments in
April, July, and November 1998 and in March 1999 with the Lenders (the
"Amendments"). All previous revolving credit facilities were terminated and
rolled into the Credit Facility on July 8, 1997. At the election of the Company,
and subject to customary covenants, loans are initiated on a bid or committed
basis and carry interest at offshore or domestic rates, at the applicable LIBOR
rate plus margin or the bank reference rate. Actual rates on borrowings under
the Credit Facility vary, based on competitive bids and the Company's unsecured
credit rating at the time of the borrowing. As of September 30, 1999, the
Company was in compliance with the financial covenants of the Credit Facility,
as amended by the Amendments. As of September 30, 1999, the maximum commitment
level under the Credit Agreement was approximately $1.4 billion, of which
approximately $320 million remained available. The Credit Facility expires in
July 2002, but it may be extended under certain circumstances for two additional
years.
In October 1999, the Company sold the outstanding capital stock of
Intergroup of Utah, Inc., the Company's HMO subsidiary in the state of Utah, to
Altius Health Plans Inc. Certain affiliates of the Company continue to provide
certain administrative and other services to such HMO operations for a
transitionary period pursuant to agreements entered into in connection with the
sale.
In addition, On September 21, 1999, the Company announced that it had
executed a definitive agreement with PacifiCare of Colorado, Inc.
("PacifiCare-CO") to transition all of its membership in Colorado to
PacifiCare-CO by March 31, 2000. The Company also announced that its previously
disclosed Letter of Intent with WellPoint Health Networks Inc. has expired.
Pursuant to the definitive agreement, PacifiCare-CO will offer replacement
coverage to substantially all of the Company's Colorado HMO membership and
PacifiCare Life Assurance Company ("PLAC") will issue replacement indemnity
coverage to substantially all of the Company's Colorado Point of Service ("POS")
membership. PacifiCare-CO will offer to enroll such HMO members at the earliest
date possible in comparable PacifiCare-CO benefit plans within PacifiCare-CO's
service area at PacifiCare's rates. The transition arrangement was subject to
various conditions and regulatory approval. Regulatory approval of the
transaction was received on November 2, 1999.
In October 1999, the Company announced that it had entered into a definitive
agreement to sell the capital stock of QualMed Washington Health Plan, Inc., the
Company's HMO subsidiary in the state of Washington ("QM-Washington"), to
American Family Care Inc. ("AFC"). Upon completion of the transaction, AFC will
assume control of the health-plan license and retain the Medicaid and Basic
Health Plan membership of QM-Washington. At the same time, the Company announced
that it had entered into definitive agreements with PacifiCare of
Washington, Inc. ("PacifiCare-WA") and Premera Blue Cross to transition its
commercial membership in Washington to such companies. As part of such
agreements, PacifiCare-WA will offer replacement coverage to QM-Washington's HMO
and POS groups in western Washington and Premera Blue Cross will offer
replacement coverage to substantially all of
26
<PAGE>
QM-Washington's HMO and POS group membership in eastern Washington. The sale
agreement and transition arrangements are subject to various conditions and
certain regulatory approvals. The Company anticipates completing the sale and
transition by the end of April 2000.
Effective as of September 20, 1999, the Company and Medaphis (which changed
its name to Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement
Agreement and Release pursuant to which the Company received net proceeds of
approximately $25 million consisting of cash from Per-Se and Per-Se's insurers
and proceeds from the sale of both the 976,771 shares of Medaphis (now Per-Se)
common stock then owned by the Company and additional shares of Per-Se common
stock issued to the Company as part of the settlement. In exchange, the Company
and Per-Se terminated the ongoing litigation and granted each other a general
release.
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 promissory notes issued to The
California Wellness Foundation in connection with the Health Net conversion to
for-profit status is subordinated to Health Net meeting tangible equity
requirements under applicable California statutes and regulations. During the
third quarter of 1999, the Company was not required to make any contributions to
its subsidiaries to meet risk-based capital requirements of the regulated
entities. The Company will, however, make contributions to its subsidiaries, as
necessary, to meet risk-based capital requirements under, state laws and
regulations during the last quarter of 1999. The Company contributed
$11.5 million to its subsidiaries to meet other capital requirements during the
first nine months ended September 30, 1999. As of September 30, 1999,the
Company's subsidiaries were in compliance with minimum capital requirements.
Legislation has been or may be enacted in certain states in which the
Company's subsidiaries operate imposing substantially increased minimum capital
and/or statutory deposit requirements for HMOs in such states. Such statutory
deposits may only be drawn upon under limited circumstances relating to the
protection of policyholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 ("VAR") model, which follows a
variance/covariance methodology, to assess the market risk for its investment
portfolio. VAR is a method of assessing investment risk that uses standard
statistical techniques to measure the worst expected loss in the portfolio over
an assumed portfolio disposition period under normal market conditions. The
determination is made at a given statistical confidence level.
27
<PAGE>
The Company assumed a portfolio disposition period of 30 days with a
confidence level of 95 percent for the 1998 computation of VAR. The computation
further assumes that the distribution of returns is normal. Based on such
methodology and assumptions, the computed VAR was approximately $3.9 million as
of September 30, 1999.
The Company's calculated value-at-risk exposure represents an estimate of
reasonably possible net losses that could be recognized on its investment
portfolios assuming hypothetical movements in future market rates and are not
necessarily indicative of actual results which may occur. It does not represent
the maximum possible loss nor any expected loss that may occur, since actual
future gains and losses will differ from those estimated, based upon actual
fluctuations in market rates, operating exposures, and the timing thereof, and
changes in the Company's investment portfolios during the year. 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
totaled $1,089 million at September 30, 1999 and the related average interest
rate was 6.7% (which interest rate is subject to change pursuant to the terms of
the Credit Facility). See a description of the Credit Facility under "Liquidity
and Capital Resources." The table below presents the expected cash flows of
market risk sensitive instruments at September 30, 1999. These cash flows
include both expected principal and interest payments consistent with the terms
of the outstanding debt as of September 30, 1999 (amounts in thousands).
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 BEYOND TOTAL
-------- -------- -------- ---------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Long-term Borrowings
Floating Rate........ $391,813 $73,968 $73,968 $1,104,034 $ -- $ -- $1,643,783
Fixed Rate........... 15,373 -- -- -- -- -- 15,373
-------- ------- ------- ---------- ------- ------- ----------
Total................ $407,186 $73,968 $73,968 $1,104,034 $ -- $ -- $1,659,156
======== ======= ======= ========== ======= ======= ==========
</TABLE>
28
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
On November 7, 1996 the Company's predecessor, HSI, filed a lawsuit against
Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive
Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V.
MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414,
Superior Court of California, County of Los Angeles (the "Medaphis Action"). The
lawsuit arose 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. The Company
alleged 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.
Effective as of September 20, 1999, the Company and Medaphis (which changed
its name to Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement
Agreement and Release pursuant to which the Company received net proceeds of
approximately $25 million consisting of cash from Per-Se and Per-Se's insurers
and proceeds from the sale of both the 976,771 shares of Medaphis (now Per-Se)
common stock then owned by the Company and additional shares of Per-Se common
stock issued to the Company as part of the settlement. In exchange, the Company
and Per-Se terminated the ongoing litigation and granted each other a general
release.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in
federal and state courts seeking an unspecified amount of damages on behalf of
an alleged class of persons who purchased shares of common stock, convertible
debentures and options to purchase common stock of FPA Medical Management, Inc.
("FPA") at various times between February 3, 1997 and May 15, 1998. The FPA
Complaints name as defendants FPA, certain of FPA's auditors, the Company and
certain of the Company's former officers. The FPA Complaints allege that the
Company and such former officers violated federal and state securities laws by
misrepresenting and failing to disclose certain information about a 1996
transaction between the Company and FPA, about FPA's business and about the
Company's 1997 sale of FPA common stock held by the Company. The Company has
filed a motion to dismiss all claims asserted against it in the consolidated
federal class actions but has not formally responded to the other complaints.
Subsequent to the Company's filing of a motion to dismiss all claims asserted
against it in the consolidated federal class action, all claims against the
Company's former officers were voluntarily dismissed from the consolidated class
actions in both federal and state court. Thereafter, all proceedings in the
consolidated federal class actions were stayed and the motion to dismiss was
denied without prejudice to renewal after the expiration of the stay. The stay
has since expired and the Company plans to renew its motion to dismiss all
claims asserted against it. Management believes these suits against the Company
and its former officers are without merit and intends to defend the actions
vigorously.
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Based in part on advice from litigation counsel
to the Company and upon information presently available, management of
29
<PAGE>
the Company is of the opinion that the final outcome of all such proceedings
should not have a material adverse effect upon the Company's results of
operations or financial condition.
ITEM 2. CHANGES IN SECURITIES
REVOLVING CREDIT FACILITY
The Company has an unsecured, five-year $1.5 billion revolving credit
facility pursuant to a Credit Agreement dated July 8, 1997 (the "Credit
Agreement") with the banks identified in the Credit Agreement (the "Banks") and
Bank of America National Trust and Savings Association ("Bank of America") as
Administrative Agent. All previous revolving credit facilities were terminated
and rolled into the Credit Agreement. 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
as of March 27, 1998, the First Amendment and Waiver to Credit Agreement dated
as of April 6, 1998, the Second Amendment to Credit Agreement dated as of
July 31, 1998, the Third Amendment to Credit Agreement dated as of November 6,
1998 and the Fourth Amendment to Credit Agreement dated as of March 26, 1999
(collectively, the "Amendments"), with the Banks, the Company is: (i) obligated
to maintain certain covenants keyed to the Company's financial condition and
performance (including a Total Leverage Ratio and Fixed Charge Ratio);
(ii) obligated to limit liens; (iii) subject to customary covenants, including
(A) disposition of assets only in the ordinary course and generally at fair
value and (B) restrictions on acquisitions, mergers, consolidations, loans,
leases, joint ventures, contingent obligations and certain transactions with
affiliates; (iv) permitted to sell the Company's workers' compensation insurance
business, provided that the net proceeds shall be applied towards repayment of
the outstanding loans under the Credit Agreement (which sale the Company
completed on December 10, 1998); and (v) permitted to incur additional
indebtedness in an aggregate amount not to exceed $1,000,000,000 upon certain
terms and conditions. The Credit Agreement also provides for mandatory
prepayment of the outstanding loans under the Credit Agreement with a certain
portion of the proceeds from the issuance of such indebtedness and from the
sales of assets, resulting in a permanent reduction of the aggregate amount of
commitments under the Credit Agreement by the amount so prepaid. As of
September 30, 1999, the maximum commitment level permitted under the Credit
Agreement was approximately $1.4 billion, of which approximately $320 million
remained available. The Amendments 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 of the outstanding Class A Common Stock
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to be an "Adverse Person," or any person commences a tender offer for 15% or
more 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 or commences
a tender offer for 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 merger transaction involving Foundation Health Corporation and
Health Systems International, Inc., the Company's predecessors, 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 became 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 entirely by reference to the
Rights Agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the quarter ended September 30, 1999.
ITEM 5. OTHER INFORMATION
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company has previously filed with its Annual
Report on Form 10-K for the year ended December 31, 1998 certain cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others,
could cause the Company's actual financial or enrollment results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to the Company. The factors should be considered in
conjunction with any discussion of operations or results by the Company or its
representatives, including any forward-looking discussion, as well as comments
contained in press releases, presentations to securities analysts or investors,
or other communications by the Company.
In making these statements, the Company was not and is not undertaking to
address or update each factor in future filings or communications regarding the
Company's business or results, and is not undertaking to address how any of
these factors may have caused changes to discussions or information contained in
previous filings or communications. In addition, certain of these matters may
have affected the Company's past results and may affect future results.
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RECENT DEVELOPMENTS
FOHP. In 1997, the Company purchased convertible debentures (the "FOHP
Debentures") of FOHP, Inc., a New Jersey corporation ("FOHP"), in the aggregate
principal amount of approximately $80.7 million and converted approximately
$70.6 million principal amount of the FOHP Debentures into shares of common
stock of FOHP. As a result, the Company owned approximately 98% of the
outstanding shares of FOHP common stock.
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.
Pursuant to an Agreement and Plan of Merger dated as of October 26, 1998,
Physicians Health Services of New Jersey, Inc., a New Jersey HMO wholly-owned by
the Company, merged with and into FOHP-NJ on January 1, 1999 and FOHP-NJ changed
its name to Physicians Health Services of New Jersey, Inc. ("PHS-NJ"). On
December 31, 1998, the Company converted $1,197,183 principal amount of its
remaining convertible debentures of FOHP into common stock of FOHP. As a result,
the Company owned approximately 99.6% of the outstanding equity of FOHP. The
minority shareholders of FOHP were physicians, hospitals and other health care
providers.
Pursuant to an Agreement and Plan of Merger dated as of November 16, 1998,
which was approved by the stockholders of FOHP at a special meeting held
July 29, 1999, a wholly-owned subsidiary of the Company merged into FOHP on
July 30, 1999 and FOHP became a wholly-owned subsidiary of the Company. In
connection with the merger, the former minority shareholders of FOHP are
entitled to either $0.25 per share (the value per FOHP share as of December 31,
1998 as determined by an outside appraiser) or payment rights which entitle the
holders to receive as much as $15.00 per payment right on or about July 1, 2001,
provided that, with respect to the payment rights (i) for provider shareholders,
other than hospitals, such shareholder must remain a provider of PHS-NJ until
July 1, 2001 and agree to remain a provider to PHS-NJ from July 1, 2001 until
December 31, 2001, and a specified number of hospital shareholders must not
leave the provider network prior to December 31, 2001 for such provider
shareholder to be eligible to receive such payment, (ii) for hospital
shareholders, such payment rights are subject to the same foregoing conditions
and additional conditions relating to reimbursement rates, enrollment of
hospital employees in PHS-NJ health plans, and payments of premiums to PHS-NJ
for such hospital shareholder to be eligible to receive such payment and
(iii) for provider shareholders, other than hospitals, such shareholder will be
entitled to receive additional consideration of $2.25 per payment right and a
pro rata portion of a bonus to be funded by monies forfeited by hospital
shareholders, provided that PHS-NJ achieves certain annual returns on common
equity and certain of the foregoing conditions are met.
MEDPARTNERS PROVIDER NETWORK, INC. On March 11, 1999, MedPartners Provider
Network, Inc. ("MPN"), a Knox-Keene licensed entity and a subsidiary of
MedPartners, Inc., a publicly-held physician practice and pharmacy benefit
management company (now known as Caremark Rx, Inc.), was placed into
conservatorship by the State of California under Section 1393(c) of the
California Health and Safety Code. The conservator immediately filed a petition
under Chapter 11 of the Bankruptcy Code on behalf of MPN.
MedPartners, Inc., MPN and the State of California executed an Amended and
Restated Operations and Settlement Agreement dated as of June 16, 1999 (the "O&S
Agreement"), containing the basic principles for an orderly transition of the
California operations of MedPartners, Inc., and the resolution of unpaid
provider claims. A bankruptcy court order approving the O&S Agreement was
obtained by MPN on July 19, 1999. Although court approval of the O&S Agreement
has been obtained, a number of conditions subsequent and third party consents
required by such agreement are yet to occur or be obtained before the
transactions reflected therein will become effective.
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At this time, no assurances can be given that a final settlement agreement
on the terms reflected in the O&S Agreement will become effective or be
implemented. In the event of a final implementation of a settlement on the terms
reflected in the O&S Agreement, the Company believes that the bankruptcy of MPN
will not have a material adverse effect on the Company's California operations.
If the settlement reflected in the O&S Agreement is not fully implemented, such
failure could have a material adverse effect on the Company's California
operations in the event the Company is ultimately held liable to pay unpaid
provider claims.
At the time MPN was placed into conservatorship, MPN and various provider
groups and clinics affiliated with MedPartners, Inc. provided health care
services to approximately 215,000 enrollees of the Company's Health Net HMO
subsidiary. As of August 1999, sales had been consummated on all of the
physician groups associated with MedPartners, Inc. Accordingly, all Health Net
enrollees have been moved to the successor physician groups or other providers.
INSURANCE SUBSIDIARIES. In July 1999, the Company completed the
restructuring of certain of its insurance subsidiaries by merging Foundation
Health National Life Insurance Company ("FHNL") with Foundation Health Systems
Life and Health Insurance Company ("FHS Life") under a holding company
subsidiary of the Company, FHS Life Holdings Company, Inc.
LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On April 30, 1999, the
Company completed the sale of its HMO operations in the states of Texas,
Louisiana and Oklahoma to AmCareco, Inc. As part of the transaction, the Company
received convertible preferred stock of the buyer and cash in excess of certain
statutory surplus and minimum working capital requirements of the plans sold.
The transaction is subject to certain post-closing adjustments and affiliates of
the Company continue to provide certain administrative, behavioral health and
other services to such HMO operations for a transitionary period pursuant to
agreements entered into in connection with the sale.
PHARMACY BENEFITS MANAGEMENT SERVICES. On March 31, 1999, the Company
completed the sale to Advance Paradigm of the capital stock of Foundation Health
Pharmaceutical Services, Inc., and certain pharmacy benefit processing services
of Integrated Pharmaceutical Services, Inc. for approximately $65 million in
cash. In addition, as part of the transaction, Advance Paradigm provides to the
Company at competitive rates claims processing, retail network management and
payment of claims pharmacy benefits services under a services agreement. Advance
Paradigm also provides pharmacy mail service to the Company's Health Plan
Divisions. For a period of five years, the Company may not compete with respect
to such services in any market in which Advance Paradigm conducts business,
subject to certain exceptions.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company
("Gem"), a subsidiary of the Company, has implemented a restructuring plan to
reduce operating losses and its in-force insurance risk. As a part of such
restructuring, Gem is in the process of withdrawing from certain insurance
markets. Upon completion of its current withdrawals, Gem will be operating in
only two states. As of September 30, 1999 the number of Gem's insureds was
approximately 1,000. Currently, Foundation Health Systems Life and Health
Insurance Company, a subsidiary of the Company, services Gem's insureds through
an administrative services agreement between the companies. The Company is
reviewing the possibility of winding up the operations of Gem or merging such
operations into another insurance subsidiary of the Company.
COLORADO OPERATIONS. On September 21, 1999, the Company announced that it
had executed a definitive agreement with PacifiCare of Colorado, Inc.
("PacifiCare-CO") to transition all of its membership in Colorado to
PacifiCare-CO by March 31, 2000. The Company also announced that its previously
disclosed Letter of Intent with WellPoint Health Networks Inc. has expired.
Pursuant to the definitive agreement, PacifiCare-CO will offer replacement
coverage to substantially all of the Company's Colorado HMO membership and
PacifiCare Life Assurance Company ("PLAC") will issue replacement indemnity
coverage to substantially all of the Company's Colorado POS membership.
PacifiCare-CO will offer to
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enroll such HMO members at the earliest date possible in comparable
PacifiCare-CO benefit plans within PacifiCare-CO's service area at
PacifiCare-CO's rates. The transition arrangement was subject to various
conditions and regulatory approval. Regulatory approval of the transaction was
received on November 2, 1999.
In August 1999, in connection with the Company's wind down of its business
in Colorado, the Company sold its regional claims processing facility and
accompanying real estate in Pueblo, Colorado, including certain equipment and
other assets located at the facility, to the Pueblo Economic Development Company
and The TPA, Inc. for total aggregate proceeds of approximately $5 million.
WASHINGTON OPERATIONS. In October 1999, the Company announced that it had
entered into a definitive agreement to sell the capital stock of QualMed
Washington Health Plan, Inc., the Company's HMO subsidiary in the state of
Washington ("QM-Washington"), to American Family Care Inc. ("AFC"). Upon
completion of the transaction, AFC will assume control of the health-plan
license and retain the Medicaid and Basic Health Plan membership of
QM-Washington. At the same time, the Company announced that it had entered into
definitive agreements with PacifiCare of Washington, Inc. ("PacifiCare-WA") and
Premera Blue Cross to transition its commercial membership in Washington to such
companies. As part of such agreements, PacifiCare-WA will offer replacement
coverage to QM-Washington's HMO and POS groups in western Washington and Premera
Blue Cross will offer replacement coverage to substantially all of
QM-Washington's HMO and POS group membership in eastern Washington. Replacement
coverage will consist of the new company's benefit plans in the new company's
service areas at the new company's rates. The sale agreement and transition
arrangements are subject to various conditions and certain regulatory approvals.
The Company anticipates completing the sale and transition by the end of
April 2000.
NEW MEXICO OPERATIONS. In September 1999, the Company sold the capital
stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the
state of New Mexico, to Health Care Horizons, Inc. Certain affiliates of the
Company continue to provide certain administrative and other services to such
HMO operations for a transitionary period pursuant to agreements entered into in
connection with the sale.
PREFERRED HEALTH NETWORK, INC. In May 1999, the Company sold the capital
stock of Preferred Health Network, Inc., its PPO network subsidiary ("PHN"), to
Beyond Benefits, Inc. PHN and the Company, or certain affiliates thereof,
entered into agreements at closing to provide each other with certain continued
access to each other's networks.
UTAH OPERATIONS. In October 1999, the Company sold the outstanding capital
stock of Intergroup of Utah, Inc., the Company's HMO subsidiary in the state of
Utah, to Altius Health Plans Inc. Certain affiliates of the Company continue to
provide certain administrative and other services to such HMO operations for a
transitionary period pursuant to agreements entered into in connection with
the sale.
SOUTHERN CALIFORNIA HOSPITALS. In August 1999, the Company sold East Los
Angeles Doctors Hospital and Memorial Hospital of Gardena, two Southern
California hospitals, to HealthPlus+ Corporation and certain affiliated
entities. Certain subsidiaries of the Company continue to maintain contractual
arrangements with the hospitals following the sale.
OTHER POTENTIAL DIVESTITURES
CERTAIN OTHER OPERATIONS. The Company continues to evaluate the
profitability realized or likely to be realized by its existing businesses and
operations, and is reviewing from a strategic standpoint which of such
businesses or operations should be divested.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this Quarterly Report on
Form 10-Q or are incorporated herein by reference:
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2.1 Agreement and Plan of Merger, dated October 1, 1996, by and
among Health Systems International, Inc., FH Acquisition
Corp. and Foundation Health Corporation (filed as
Exhibit 2.5 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996, which is incorporated by
reference herein).
2.2 Agreement and Plan of Merger, dated May 8, 1997, by and
among the Company, PHS Acquisition Corp. and Physicians
Health Services, Inc. (filed as Exhibit 2.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997, which is incorporated by reference herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated
October 20, 1997, by and among the Company, PHS Acquisition
Corp. and Physicians Health Services, Inc. (filed as
Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997, which is
incorporated by reference herein).
3.1 Fourth Amended and Restated Certificate of Incorporation of
the Registrant (filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (File No. 333-24621),
which is incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed
as Exhibit 3.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997, which is
incorporated by reference herein).
3.3 Certain Amendments to the Fifth Amended and Restated Bylaws
of the Registrant, (filed as Exhibit 3.3 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
June 30, 1999, 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 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).
4.4 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).
10.1 Letter Agreement dated June 1, 1998 between The California
Wellness Foundation and the Company (filed as Exhibit 10.75
to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998, which is incorporated by
reference herein).
10.2 Employment Letter Agreement between the Company and Karin D.
Mayhew dated January 22, 1999 (filed as Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, which is incorporated by reference
herein).
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10.3 Employment Letter Agreement between the Company and Ross D.
Henderson dated April 29, 1999 (filed as Exhibit 10.3 to
the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, which is incorporated by reference
herein).
10.4 Letter Agreement dated June 25, 1998 between B. Curtis
Westen and the Company (filed as Exhibit 10.73 to the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998, which is incorporated by reference
herein).
10.5 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).
10.6 Amended Letter Agreement between the Company and Jay M.
Gellert dated as of August 22, 1997 (filed as
Exhibit 10.69 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, which is incorporated
by reference herein).
10.7 Employment Letter Agreement between the Company and Dale
Terrell dated December 31, 1997 (filed as Exhibit 10.71 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, which is incorporated by reference
herein).
10.8 Employment Letter Agreement between the Company and Steven
P. Erwin dated March 11, 1998 (filed as Exhibit 10.72 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997, which is incorporated by reference
herein).
10.9 Employment Agreement between the Company and Maurice Costa
dated December 31, 1997 (filed as Exhibit 10.71 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997, which is incorporated by reference
herein).
10.10 Employment Letter Agreement between Foundation Health
Corporation and Gary S. Velasquez dated May 1, 1996 (filed
as Exhibit 10.13 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, which is
incorporated by reference herein).
10.11 Employment Agreement between Foundation Health Corporation
and Edward J. Munno dated November 8, 1993 (filed as
Exhibit 10.14 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, which is incorporated
by reference herein).
10.12 Amendment Number One to Employment Agreement between
Foundation Health Corporation and Edward J. Munno dated
May 1, 1996 (filed as Exhibit 10.15 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998,
which is incorporated by reference herein).
10.13 Employment Letter Agreement between the Company and Cora
Tellez dated November 16, 1998 (filed as Exhibit 10.16 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated by reference
herein).
10.14 Employment Letter Agreement between the Company and Karen
Coughlin dated March 12, 1998 (filed as Exhibit 10.17 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated by reference
herein).
10.15 Employment Letter Agreement between the Company and J.
Robert Bruce dated September 22, 1998 (filed as
Exhibit 10.18 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, which is incorporated
by reference herein).
10.16 Waiver and Release of Claims between the Company and Robert
Natt (filed as an exhibit to the Company's Form 10-K for the
year ended December 31, 1998, filed with the Commission on
March 31, 1999, which is incorporated by reference herein).
10.17 Form of Severance Payment Agreement dated December 4, 1998
by and between the Company and various of its executive
officers (filed as Exhibit 10.21 to the Company's Form 10-K
for the year ended December 31, 1998, which is incorporated
by reference herein).
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10.18 Early Retirement Agreement dated August 6, 1998 between the
Company and Malik M. Hasan, M.D. (filed as Exhibit 10.77 to
the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998, which is incorporated by reference
herein).
10.19 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).
10.20 Severance Payment Agreement between the Company and J.
Robert Bruce dated September 15, 1998 (filed as
Exhibit 10.23 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, which is incorporated
by reference herein).
10.21 Severance Payment Agreement between the Company and Maurice
Costa dated April 6, 1998 (filed as Exhibit 10.24 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated by reference
herein).
10.22 Waiver and Release of Claims between the Company and Dale T.
Berkbigler, M.D. dated as of June 30, 1999 (filed as Exhibit
10.22 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999, which is incorporated by
reference herein).
10.23 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).
10.24 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).
10.25 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).
10.26 The Company's Performance-Based Annual Bonus Plan (filed as
Exhibit 10.35 to Registration Statement on Form S-4 (File
No. 33-86524), which is incorporated by reference herein).
10.27 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).
10.28 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).
10.29 The Company's Deferred Compensation Plan Trust Agreement
dated as of September 1, 1998 between the Company and Union
Bank of California (filed as Exhibit 10.31 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1998, which is incorporated by reference herein).
10.30 The Company's 401(k) Associate Savings Plan (filed as
Exhibit 4.5 to the Company's Registration Statement on
Form S-8 filed on March 31, 1998, which is incorporated by
reference herein).
10.31 The Company's 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).
10.32 The Company's 1998 Stock Option Plan (filed as Exhibit 4.5
to the Company's Registration Statement on Form S-8 filed on
December 4, 1998, which is incorporated by reference
herein).
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10.33 The Company's 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).
10.34 The Company's 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).
10.35 The Company's 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).
10.36 The Company's Supplemental Executive Retirement Plan
effective as of January 1, 1996 (filed as Exhibit 10.65 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated by reference
herein).
10.37 The Company's Deferred Compensation Plan effective as of
May 1, 1998 (filed as Exhibit 10.66 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998,
which is incorporated by reference herein).
10.38 The Company's 1995 Stock Appreciation Rights 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).
10.39 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).
10.40 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).
10.41 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).
10.42 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).
10.43 Participation Agreement dated as of May 25, 1995 among
Foundation Health Medical Services, as Construction Agent
and Lessee, FHC, as Guarantor, First Security Bank of Utah,
N.A., as Owner Trustee, Sumitomo Bank Leasing and
Finance, Inc., The Bank of Nova Scotia and NationsBank of
Texas, N.A., as Holders and NationsBank of Texas, N.A., as
Administrative Agent for the Lenders; and Guaranty Agreement
dated as of May 25, 1995 by FHC for the benefit of First
Security Bank of Utah, N.A. (filed as an exhibit to FHC's
Form 10-K for the year ended June 30, 1995, filed with the
Commission on September 27, 1995, which is incorporated by
reference herein).
10.44 FHC's Deferred Compensation Plan, as amended and restated
(filed as Exhibit 10.99 to FHC's Annual Report on Form 10-K
for the year ended June 30, 1995, which is incorporated by
reference herein).
10.45 FHC's Supplemental Executive Retirement Plan, as amended and
restated (filed as Exhibit 10.100 to FHC's Annual Report on
Form 10-K for the year ended June 30, 1995, which is
incorporated by reference herein).
10.46 FHC's Executive Retiree Medical Plan, as amended and
restated (filed as Exhibit 10.101 to FHC's Annual Report on
Form 10-K for the year ended June 30, 1995, which is
incorporated by reference herein).
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.47 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).
10.48 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).
10.49 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).
10.50 First Amendment and Waiver to Credit Agreement dated
April 6, 1998 among the Company, Bank of America National
Trust and Savings Association and the Banks (as defined
therein) (filed as Exhibit 10.64 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1998,
which is incorporated by reference herein).
10.51 Second Amendment to Credit Agreement dated July 31, 1998
among the Company, Bank of America National Trust and
Savings Association and the Banks (as defined therein)
(filed as Exhibit 10.65 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998, which is
incorporated by reference herein).
10.52 Third Amendment to Credit Agreement, dated November 6, 1998,
among the Company, Bank of America National Trust and
Savings Association and the Banks (as defined therein)
(filed as Exhibit 10.65 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998, which is
incorporated by reference herein).
10.53 Fourth Amendment to Credit Agreement, dated as of March 26,
1999, among the Company, Bank of America National Trust and
Savings Association and the Banks, as defined therein (filed
as Exhibit 10.64 to the Company's Form 10-K for the year
ended December 31, 1998, which is incorporated by reference
herein).
10.55 Form of Credit Facility Commitment Letter dated March 27,
1998 between the Company and the Majority Banks (as defined
therein) (filed as Exhibit 10.70 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997,
which is incorporated by reference herein).
10.56 Registration Rights Agreement dated as of March 2, 1995
between the Company and the California Wellness Foundation
(filed as Exhibit No. 28.2 to the Company's Current Report
on Form 8-K dated March 2, 1995, which is incorporated by
reference herein).
10.57 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).
10.58 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).
10.59 Asset Purchase Agreement dated December 31, 1998 by and
between the Company and Access Health, Inc. (filed as
Exhibit 10.62 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, filed with the
Commission on March 31, 1999, which is incorporated by
reference herein).
</TABLE>
39
<PAGE>
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<CAPTION>
<S> <C>
10.60 Purchase Agreement dated February 26, 1999 by and among the
Company, Foundation Health Pharmaceutical Services, Inc.,
Integrated Pharmaceutical Services, Inc., and Advance
Paradigm, Inc. (filed as Exhibit 10.63 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1998, which is incorporated by reference herein).
10.61 Settlement Agreement and Release dated September 20, 1999 by
and between the Company and Per-Se Technologies, Inc.
(formerly Medaphis Corporation) (filed as Exhibit 99.1 to
the Company's Current Report on Form 8-K dated
September 20, 1999, 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 Condensed
Consolidated Financial Statements contained in this
Quarterly Report on Form 10-Q).
*27.1 Financial Data Schedule for the third quarter ended
September 30, 1999, a copy of which has been filed with the
EDGAR version of this filing.
</TABLE>
- ------------------------
* A copy of the Exhibit is filed herewith.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by the Company during
the quarterly period ended September 30, 1999:
(i) A report dated July 20, 1999 was filed on July 20, 1999 announcing
that the Company had reached a definitive agreement to sell East Los Angeles
Doctors Hospital and Memorial Hospital of Gardena to Health Plus+
Corporation.
(ii) A report dated September 20, 1999 was filed on September 23, 1999
announcing that the Company had entered into a Settlement Agreement and
Release with Per-Se Technologies, Inc. (formerly Medaphis Corporation) with
respect to certain outstanding claims against such company.
No other Current Reports on Form 8-K were filed by the Company during such
quarter.
40
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C> <C>
FOUNDATION HEALTH SYSTEMS, INC.
(REGISTRANT)
By: /s/ JAY M. GELLERT
-----------------------------------------
Jay M. Gellert
Date: November 15, 1999 PRESIDENT AND CHIEF EXECUTIVE OFFICER
By: /s/ STEVEN P. ERWIN
-----------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT AND
Date: November 15, 1999 CHIEF FINANCIAL OFFICER
</TABLE>
41
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 675,918
<SECURITIES> 525,567
<RECEIVABLES> 485,484<F1>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,138,115
<PP&E> 289,511<F2>
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,508,171
<CURRENT-LIABILITIES> 1,512,406
<BONDS> 1,084,349<F3>
0
0
<COMMON> 126
<OTHER-SE> 855,448<F4>
<TOTAL-LIABILITY-AND-EQUITY> 3,508,171
<SALES> 0
<TOTAL-REVENUES> 6,498,838
<CGS> 0
<TOTAL-COSTS> 5,195,798
<OTHER-EXPENSES> 1,056,039
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 63,332
<INCOME-PRETAX> 183,669
<INCOME-TAX> 73,273
<INCOME-CONTINUING> 110,396
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 5,417
<NET-INCOME> 104,979
<EPS-BASIC> .86
<EPS-DILUTED> .86
<FN>
<F1>NET OF ALLOWANCES FOR DOUBTFUL ACCOUNTS.
<F2>NET OF ACCUMULATED DEPRECIATION.
<F3>INCLUDES BORROWING UNDER REVOLVING CREDIT FACILITY, MISCELLANEOUS NOTES
PAYABLE AND CAPITAL LEASES.
<F4>NET TREASURY STOCK.
</FN>
</TABLE>
