<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 1-12718
------------------------
FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
DELAWARE 95-4288333
<S> <C>
(State or other jurisdiction (I.R.S. Employer
of Identification
incorporation or organization) No.)
21650 OXNARD STREET, WOODLAND 91367
HILLS, CA
(Address of principal (Zip Code)
executive 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 May 12, 1999 was 117,215,876 (excluding 3,194,374 shares held as treasury
stock), and 5,047,642 shares of the registrant's 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--March 31, 1999 and December 31,
1998.................................................................. 3
Condensed Consolidated Statements of Operations for the First Quarter
Ended March 31, 1999 and 1998......................................... 4
Condensed Consolidated Statements of Cash Flows for the First Quarter
Ended March 31, 1999 and 1998......................................... 5
Notes to Condensed Consolidated Financial Statements.................... 6
Item 2--Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 8
Item 3--Quantitative and Qualitative Disclosures About Market Risk........ 17
PART II--OTHER INFORMATION
Item 1--Legal Proceedings................................................. 19
Item 2--Changes in Securities............................................. 20
Item 3--Defaults Upon Senior Securities................................... 21
Item 4--Submission of Matters to a Vote of Security Holders............... 21
Item 5--Other Information................................................. 21
Item 6--Exhibits and Reports on Form 8-K.................................. 25
Signatures................................................................ 31
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
1998
MARCH 31, ------------
1999
------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents.......................................................... $ 615,574 $ 763,865
Investments--available for sale.................................................... 564,365 525,082
Premiums receivable, net........................................................... 222,257 230,157
Amounts receivable under government contracts...................................... 292,495 321,411
Deferred taxes..................................................................... 145,184 160,446
Reinsurance and other receivables.................................................. 153,941 147,827
Other assets....................................................................... 78,268 91,096
------------ ------------
Total current assets............................................................. 2,072,084 2,239,884
Property and equipment, net........................................................ 334,130 345,269
Goodwill and other intangible assets, net.......................................... 960,316 977,910
Other assets....................................................................... 344,892 366,478
------------ ------------
Total Assets..................................................................... $ 3,711,422 $3,929,541
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Reserves for claims and other settlements.......................................... $ 1,016,909 $ 961,399
Unearned premiums.................................................................. 100,091 288,683
Notes payable and capital leases................................................... 1,569 1,760
Amounts payable under government contracts......................................... 78,282 69,792
Accounts payable and other liabilities............................................. 441,836 503,797
------------ ------------
Total current liabilities........................................................ 1,638,687 1,825,431
Notes payable and capital leases................................................... 1,193,679 1,254,278
Other liabilities.................................................................. 94,060 105,790
------------ ------------
Total Liabilities................................................................ 2,926,426 3,185,499
------------ ------------
Stockholders' Equity:
Common Stock and additional paid-in capital........................................ 642,355 641,945
Treasury Class A common stock, at cost............................................. (95,831) (95,831)
Accumulated other comprehensive loss............................................... (8,685) (7,308)
Retained earnings.................................................................. 247,157 205,236
------------ ------------
Total stockholders' equity....................................................... 784,996 744,042
------------ ------------
Total Liabilities and Stockholders' Equity....................................... $ 3,711,422 $3,929,541
------------ ------------
------------ ------------
</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)
(UNAUDITED)
<TABLE>
<CAPTION>
FIRST QUARTER ENDED
MARCH 31,
--------------------------
1999 1998
------------ ------------
<S> <C> <C>
REVENUES
Health plan premiums................................................................ $ 1,855,423 $ 1,844,484
Government contracts/Specialty services............................................. 348,352 304,740
Investment and other income......................................................... 18,657 26,150
Gain on sale of pharmacy benefits management operations............................. 53,558 --
------------ ------------
Total revenues.................................................................... 2,275,990 2,175,374
------------ ------------
EXPENSES
Health plan services................................................................ 1,564,777 1,544,092
Government contracts/Specialty services............................................. 238,799 191,468
Selling, general and administrative................................................. 321,915 343,850
Depreciation........................................................................ 17,739 17,820
Amortization........................................................................ 10,984 13,021
Interest............................................................................ 21,938 21,861
Restructuring and other costs....................................................... 21,059 --
------------ ------------
Total expenses.................................................................... 2,197,211 2,132,112
------------ ------------
Income from operations before income taxes and cumulative effect of change in
accounting principle................................................................ 78,779 43,262
Income tax provision.................................................................. 31,441 17,024
------------ ------------
Income before cumulative effect of change in accounting principle..................... 47,338 26,238
Cumulative effect of change in accounting principle................................... 5,417 --
------------ ------------
Net income............................................................................ $ 41,921 $ 26,238
------------ ------------
------------ ------------
Basic and diluted earnings per share:
Income before cumulative effect of change in accounting principle..................... $ 0.39 $ 0.22
Cumulative effect of change in accounting principle................................... 0.05 --
------------ ------------
Net income............................................................................ $ 0.34 $ 0.22
------------ ------------
------------ ------------
Weighted average shares outstanding:
Basic................................................................................. 122,233 121,614
Diluted............................................................................... 122,233 121,907
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FIRST QUARTER ENDED
MARCH 31,
------------------------
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................................................. $ 41,921 $ 26,238
Adjustments to reconcile net income to net cash used in operating activities:
Amortization and depreciation......................................................... 28,723 30,841
Gain on sale of pharmacy benefits management operations............................... (53,558) --
Cumulative effect of change in accounting principle................................... 5,417 --
Changes in net assets of discontinued operations...................................... -- (30,324)
Other changes......................................................................... 648 939
Changes in assets and liabilities:
Premiums receivable................................................................. 7,900 (19,086)
Unearned premiums................................................................... (188,592) (111,640)
Other assets........................................................................ 38,705 29,957
Amounts receivable/payable under government contracts............................... 37,406 20,488
Reserves for claims and other settlements........................................... 55,510 (49,991)
Accounts payable and accrued liabilities............................................ (78,702) (85,520)
----------- -----------
Net cash used in operating activities................................................... (104,622) (188,098)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of investments......................................................... 98,232 120,109
Purchase of investments................................................................. (142,312) (166,712)
Purchases of property and equipment..................................................... (9,017) (26,450)
Sales of property and equipment......................................................... 2,381 --
Net proceeds from the sale of pharmacy benefits management operations................... 65,000 --
Other................................................................................... 2,427 --
----------- -----------
Net cash provided by (used in) investing activities..................................... 16,711 (73,053)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock purchases.................... 410 1,385
Proceeds from issuance of notes payable and other financing arrangements................ 20,000 45,000
Repayment of debt and other non-current liabilities..................................... (80,790) (654)
----------- -----------
Net cash provided by (used in) financing activities..................................... (60,380) 45,731
----------- -----------
Net decrease in cash and cash equivalents............................................... (148,291) (215,420)
Cash and cash equivalents, beginning of period.......................................... 763,865 559,360
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................................ $ 615,574 $ 343,940
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
<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.
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. The Company reclassified medical management
expenses from health plan services costs to selling, general and administrative
("SG&A") expenses. The Company also reclassified SG&A expenses of its Specialty
Services division from Government Contracts/Specialty Services costs to SG&A
expenses. In conjunction with its segment reporting, the Company is reporting
the revenues and expenses of its Government Contracts/Specialty Services segment
on a combined basis in the condensed consolidated statements of operations.
NOTE 2--RESTRUCTURING AND OTHER COSTS
During 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 anticipated divestitures program. In this
connection, the Company adopted a formal plan during the first quarter ended
March 31, 1999 to close the Colorado regional support center for these health
plans and transfer its operations to the Company's other administrative
facilities. The closure is expected to be completed by the end of 1999. The
Company recorded a pretax restructuring charge of $21.1 million including $18.5
million for severance and $2.6 million for other expenses associated with the
closing of the facility. As of March 31, 1999, no cash payments have been made
and $21.1 million is expected to require future outlays of cash.
During 1997 and 1998, the Company adopted restructuring plans, the principal
elements of which included a workforce reduction, the consolidation of employee
benefit plans, the consolidation of facilities in certain geographic locations,
the consolidation of overlapping provider networks and the consolidation of
information systems at all locations. Of the $146.8 million in restructuring
costs recorded as part of the 1997 plans, $93.2 million represented cash
payments and $42.4 million represented non-cash activities through March 31,
1999. Of the remaining amounts, $7.5 million is expected to require future
outlays of cash and $3.7 million represents future non-cash activities. Of the
$21.2 million in restructuring costs recorded as part of the 1998 plan, $15.5
million represented cash payments and $2.0 million represented non-cash
activities through March 31, 1999. Of the remaining amounts, $3.7 million is
expected to require future outlays of cash.
6
<PAGE>
NOTE 3--COMPREHENSIVE INCOME
The Company's comprehensive income for the first quarters ended March 31 is
as follows (amounts in thousands):
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Net Income.................................................................................. $ 41,921 $ 26,238
Other comprehensive income (loss), net of tax:
Change in unrealized appreciation (depreciation) on investments........................... (1,377) 3,805
--------- ---------
Comprehensive Income........................................................................ $ 40,544 $ 30,043
--------- ---------
--------- ---------
</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 no such
shares of common stock equivalents for the three months ended March 31, 1999 and
293,000 shares for the three months ended March 31, 1998.
NOTE 5--SEGMENT INFORMATION
Presented below are segment data for the first quarter ended March 31, 1999
and 1998 (amounts in thousands):
<TABLE>
<CAPTION>
GOVERNMENT
CONTRACTS/
HEALTH PLAN SPECIALTY CORPORATE/
SERVICES SERVICES OTHER TOTAL
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
MARCH 31, 1999
Revenues from external sources.............................. $ 1,855,423 $ 348,352 $ 72,215 $ 2,275,990
Intersegment revenues....................................... 1,681 40,485 7,946 50,112
Income before income taxes and cumulative effect of change
in accounting principle................................... 8,497 32,597 37,685 78,779
MARCH 31, 1998
Revenues from external sources.............................. $ 1,844,484 $ 304,740 $ 26,150 $ 2,175,374
Intersegment revenues....................................... 6,230 31,035 8,246 45,511
Income before income taxes.................................. 35,621 26,333 (18,692) 43,262
</TABLE>
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 three
months ended March 31, 1999.
7
<PAGE>
NOTE 7--DISPOSITION OF ASSETS
On March 31, 1999, the Company completed the sale of certain of its pharmacy
benefits management operations for net cash proceeds of $65.0 million and
recognized a net gain of $53.6 million.
On November 4, 1998, the Company entered into a definitive agreement for the
sale of its HMO operations in the states of Texas, Louisiana and Oklahoma to
AmCareco, Inc. The sale was consummated effective April 30, 1999. 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.
In December 1997, the Company adopted a formal plan to sell its workers'
compensation segment which was accounted for as discontinued operations for the
first quarter ended March 31, 1998. The loss on disposition of $99 million
recorded at December 31, 1997 included the anticipated results of discontinued
operations through the disposal date; accordingly, net losses of $4.2 million
related to the operations of the workers' compensation segment are not reflected
on the Company's condensed consolidated statement of operations for the quarter
ended March 31, 1998. On December 10, 1998, the Company completed the sale of
the workers' compensation segment.
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.
Management believes these suits are without merit and intends to vigorously
defend the actions.
The Company is involved in various other legal proceedings, which are
routine in its business. In the opinion of management, based upon current facts
and circumstances known by the Company, the resolution of these matters should
not have a material adverse effect on the financial position or results of
operations of the Company.
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 first quarter ended March 31, 1999, these health
plans were located in Arizona, California, Colorado, Connecticut, Florida,
Idaho, Louisiana, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon,
Pennsylvania, Texas, Utah, Washington and West Virginia. As discussed above, the
Company sold its HMO operations in the States of Louisiana, Oklahoma and Texas
effective April 30, 1999. The Company's health plans provide a wide range of
managed health care services throughout the United States with approximately 4.1
million at risk and administrative services only members. The Company's HMO
subsidiaries contract to provide medical care services to a defined,
8
<PAGE>
enrolled population for a predetermined, prepaid monthly fee for group,
Medicaid, individual and Medicare plans throughout their respective service
areas. All of the HMOs are state licensed and some are also federally qualified.
The Company also operates PPO networks which provide access to health care
services and owns six health and life insurance companies licensed to sell
insurance throughout most of the United States. The financial results include
the results of two hospitals owned by the Company operating in California.
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 Commission.
CONSOLIDATED RESULTS OF OPERATIONS
The Company's net income for the first quarter ended March 31, 1999 was
$41.9 million, or $0.34 per diluted share, compared to net income for the
comparable period in 1998 of $26.2 million, or $0.22 per diluted share.
Excluding the cumulative effect of the change in accounting principle for
organization and start up costs, net income was $47.3 million or $0.39 per
diluted share for the first quarter ended March 31, 1999.
9
<PAGE>
The table below and the paragraphs which follow provide selected financial
information related to the Company's performance in the first quarter ended
March 31, 1999 and 1998 (amounts in thousands except PMPM data):
<TABLE>
<CAPTION>
FIRST QUARTER ENDED
MARCH 31,
--------------------------
1999 1998
------------ ------------
<S> <C> <C>
Total revenues........................................................................ $ 2,275,990 $ 2,175,374
------------ ------------
Expenses:
Health plan services................................................................ 1,564,777 1,544,092
Government contracts/Specialty services............................................. 238,799 191,468
Selling, general and administrative................................................. 321,915 343,850
Depreciation........................................................................ 17,739 17,820
Amortization........................................................................ 10,984 13,021
Interest............................................................................ 21,938 21,861
Restructuring and other costs....................................................... 21,059 --
------------ ------------
Total expenses........................................................................ 2,197,211 2,132,112
------------ ------------
Overall MCR........................................................................... 81.8% 80.8%
Administrative (SG&A+depreciation) ratio.............................................. 15.4% 16.8%
HEALTH PLAN SERVICES SEGMENT:
Health plan premiums.................................................................. $ 1,855,423 $ 1,844,484
Health plan MCR....................................................................... 84.3% 83.7%
Health plan premiums per member per month............................................. $ 143.95 $ 136.33
Health plan services per member per month............................................. $ 121.40 $ 114.13
GOVERNMENT CONTRACTS/SPECIALTY SERVICES SEGMENT:
Government contracts/Specialty services revenues...................................... $ 348,352 $ 304,740
Government contracts/Specialty services MCR........................................... 68.6% 62.8%
</TABLE>
ENROLLMENT INFORMATION
FIRST QUARTER ENDED MARCH 31,
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PERCENT
1999 1998 CHANGE
--------- --------- ---------
<S> <C> <C> <C>
Health Plan Services:
Commercial........................................................................ 3,141 3,523 (10.8%)
Medicare Risk..................................................................... 283 310 (8.7%)
Medicaid.......................................................................... 642 488 31.6%
--------- ---------
4,066 4,321 (5.9%)
--------- ---------
--------- ---------
Government Contracts:
CHAMPUS PPO and Indemnity......................................................... 713 882 (19.2%)
CHAMPUS HMO....................................................................... 803 720 11.5%
--------- ---------
1,516 1,602 (5.4%)
--------- ---------
--------- ---------
</TABLE>
10
<PAGE>
REVENUES AND HEALTH CARE COSTS
The Company's revenues grew by $100.6 million or 4.6% for the first quarter
ended March 31, 1999 as compared to the comparable period in 1998. Growth in
Health Plan revenues of $10.9 million was due primarily to increases in premium
rates in virtually all markets partially offset by decreases in commercial
enrollment. Growth in Government contracts/Specialty services revenues totaled
$43.6 million due to growth in mental health services and certain revenue
adjustments under government contracts. See "Segment Information" for further
discussion of Health Plan and Government Contract/Specialty Services.
The overall medical care ratio ("MCR") (medical costs as a percentage of
Health Plan premiums and Government contracts/Specialty services revenues) for
the first quarter ended March 31, 1999 was 81.8% as compared to 80.8% for the
comparable period in 1998. The increase was primarily due to higher pharmacy
costs in all divisions, benefit cost increases which exceeded premium rate
increases, and increased utilization of pharmaceuticals and provider services
throughout the Company's health plans.
On March 31, 1999, the Company completed the sale of certain of its pharmacy
benefits management operations. As a result, the Company recorded $65 million in
net cash proceeds and a net gain of $53.6 million.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses
decreased by $21.9 million or 6.4% for the first quarter ended March 31, 1999 as
compared to the comparable period in 1998. The decrease in SG&A expenses during
1999 is primarily attributable to the Company's ongoing efforts to control its
SG&A expenses and savings associated with the integration of its 1997
acquisitions.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense decreased by $2.1 million for the
first quarter ended March 31, 1999 as compared to the comparable period in 1998.
The decrease is due to write-downs of goodwill and other long-lived assets to
their estimated fair value during the year ended December 31, 1998.
INTEREST EXPENSE
Interest expense was $21.9 million for the first quarters ended March 31,
1999 and 1998. Decreased interest expense from the reduction in the revolving
credit facility balance was offset by a higher borrowing rate in 1999 as
compared to the comparable period in 1998.
INCOME TAX PROVISION
The effective tax provision rate was 39.9% on income from operations for the
first quarter ended March 31, 1999 compared to the effective tax provision rate
on continuing operations of 39.4% for the comparable period in 1998.
RESTRUCTURING AND OTHER COSTS
During 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 anticipated divestitures program. In this
connection, the Company adopted a formal plan during the first quarter ended
March 31, 1999 to close the Colorado regional support center for these health
plans and transfer its operations to the Company's other administrative
facilities. The closure is expected to be completed by the end of 1999. The
Company recorded a pretax restructuring charge of $21.1 million including $18.5
million for severance and $2.6 million for other expenses associated with the
closing of the facility.
11
<PAGE>
SEGMENT INFORMATION
HEALTH PLAN SERVICES
Health Plan Services revenues increased by $10.9 million or 0.6% in the
first quarter ended March 31, 1999 as compared to the comparable period in 1998
primarily due to average premium rate increases of 8.0% in the commercial market
which were offset by a 5.9% decrease in enrollment. Health plan health care
costs increased by $20.7 million, or 1.3%, for the first quarter ended March 31,
1999 as compared to the comparable period in 1998. The health plans MCR
increased from 83.7% in the first quarter ended March 31, 1998 to 84.3% in the
comparable period in 1999 due to higher medical costs particularly in physician
and hospital fee for service costs, an increase in pharmacy costs and increased
utilization of pharmaceuticals and provider services.
The Company's commercial business is experiencing lower margins than in 1998
due to health care cost increases outpacing health plan revenue increases in
1999. Premium rate increases in the commercial line of products contributed to
revenue increases for the first quarter ended March 31, 1999 as compared to the
comparable period in 1998 in virtually all of the Company's health plans, but
were partially offset by enrollment decreases in commercial HMO markets.
Commercial health plan revenues and health care costs on a per member per month
basis have increased approximately 8% and 11%, respectively, during the first
quarter ended March 31, 1999 as compared to the comparable period in 1998.
The Company's Medicare business is experiencing higher margins than in 1998,
particularly in the Northeast division. Medicare premium rates have increased in
all markets averaging about 6% due to new premiums charged to members and a
favorable mix shift from exiting unfavorable markets. Medicare health care costs
on a per member per month basis have increased approximately 5% during the first
quarter ended March 31, 1999 as compared to the comparable period in 1998.
The Company's Medicaid business is experiencing lower margins than in 1998.
Medicaid revenues and health care costs on a per member per month basis have
increased approximately 1% and 8%, respectively, during the first quarter ended
March 31, 1999 as compared to the comparable period in 1998. Medicaid enrollment
in the California division has increased significantly resulting in a 42.9%
increase in member months during the first quarter ended March 31, 1999,
compared to the comparable period in 1998. Medicaid premium rates have increased
slightly in all markets except for the Northeast where they have decreased by
1.3%. Medicaid health care costs have increased on a per member per month basis
in all of the Company's markets.
GOVERNMENT CONTRACTS/SPECIALTY SERVICES
Government contracts/Specialty services revenue increased by $43.6 million
or 14.3% during the first quarter ended March 31, 1999 as compared to the
comparable period in 1998 primarily due to certain revenue adjustments under
government contracts and growth in the Company's managed behavioral health
network and bill review cost containment businesses.
The Government contracts/Specialty services MCR increased to 68.6% for the
first quarter ended March 31, 1999 compared to 62.8% for the comparable period
in 1998. This increase for the first quarter ended March 31, 1999 is primarily
due to increased pharmacy costs and increased utilization of provider services.
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.
12
<PAGE>
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, regulatory changes, utilization,
new technologies, hospital costs, major epidemics and numerous other external
influences may affect the Company's operating results. Accordingly, past
financial performance is not 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.
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.
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<PAGE>
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. The Company believes that vendors
will make timely updates available to ensure that all remaining purchased
software is Year 2000 compliant. The remaining systems' compliance with Year
2000 will 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, has retained IBM's The Wilkerson
Group, and is developing 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 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 first quarter
of 1999, the Company made substantial progress in its efforts to address Year
2000 issues. The Company has established the third quarter of 1999 to complete
all phases and is endeavoring to accelerate completion ahead of that time. The
following table sets forth the estimated percentage completion of each of the
Company's Year 2000 phases with respect to its Year 2000 project overall.
<TABLE>
<CAPTION>
PHASE 1 PHASE 2 PHASE 3 PHASE 4 PHASE 5
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Overall--May 1999................................................ 100% 100% 93% 55% 3%
Overall--February 1999 (as reported in the Company's Annual
Report on Form 10-K)........................................... 100% 83% 54% 11% 0%
</TABLE>
THIRD PARTIES--The Company's inventory of third party relationships 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. The assessment continues and is expected to be
completed within the second quarter of 1999. The Company is also in the process
of following up with the important third parties identified in the assessment to
help ensure that the relationships will not be materially interrupted or
affected by the Year 2000 problem. There can be no assurance that the systems of
other companies on which the Company relies will be compliant on a timely basis,
or that the failure by a third party to be compliant would not have a material
adverse effect on the Company.
COSTS--The Company is evaluating on an on-going basis the related costs to
resolve its potential Year 2000 problems. The Company has reduced its estimate
of the total cost for the project from approximately $42.7 million to $36-40
million, excluding the costs to accelerate the replacement of hardware or
software otherwise required to be purchased by the Company. The decrease is a
result principally of a reduction in the anticipated duration of the employment
of outside consultants and contractors and a shift of certain responsibilities
to internal labor. Through the first quarter of 1999, the Company expended
approximately $20.2 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 Company
currently estimates that the percentages of its total expenditures for Year 2000
issues will be approximately as follows: 35% for internal costs, 30% for outside
consultants and contractors and 35% for
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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 and testing of Year
2000 issues for their respective operations.
Notwithstanding the foregoing, the costs of the project and the timetable in
which the Company plans to complete the Year 2000 compliance requirements are
based on estimates derived from utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. There can be no assurances that these
estimates will be achieved and actual results and costs could differ materially
from these estimates.
Certain insurance coverages for defense costs associated with Year 2000
litigation have already been secured under the Company's Directors and Officers
Liability Insurance policy and will be re-evaluated upon renewal of that policy.
At this time, it is unclear as to 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 currently analyzing the
availability of such coverage under other existing and future insurance policies
and products.
CONTINGENCY PLANNING--An important part of the Company's Year 2000 project
involves identifying worst case scenarios and seeking to develop contingency
plans. The Company has completed the assessment of its mission critical business
functions and has sought to prioritize 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 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 is in the process of documenting and validating its contingency
plans and expects to complete such process by the end of the second quarter of
1999. The Company currently anticipates that its contingency plans will include
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.
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 at this time to determine whether the Year 2000 problems will have a
material adverse effect on the Company's results of operations, liquidity or
financial condition. The Company's Year 2000 project is expected to reduce
significantly the Company's level of uncertainty and the possibility of
significant or long-lasting interruptions of the Company's business operations;
however, the Company believes that it is impossible to predict all of the areas
in which material problems may arise.
The Company has been formally communicating with others with whom it does
significant business to determine their Year 2000 issues. The Company is
currently projecting to complete its assessment of third party risks by the end
of the second quarter of 1999. There can be no assurances that the systems of
other companies on which the Company's systems rely will be Year 2000 ready,
that any Year 2000 problems of such companies will be timely remedied, or that
the failure by another company to be Year 2000 ready would not have a material
adverse effect on the Company.
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
15
<PAGE>
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 first quarter ended March 31, 1999, cash used in operating
activities was $104.6 million compared to $188.1 million in the first quarter of
1998. This change was due primarily to increases in reserves for claims and
other settlements and collection of premiums receivable, which were offset by
decreases in unearned premiums, accounts payable and other liabilities. Net cash
provided by investing activities was $16.7 million during the first quarter of
1999 as compared to cash used in investing activities of $73.1 million during
1998. This increase was primarily due to the proceeds from the sale of pharmacy
benefits management operations. Net cash used in financing activities was $60.4
million during the first quarter of 1999 as compared to cash provided by
financing activities of $45.7 million during the comparable period in 1998. The
decrease in 1999 was due to the repayment of funds drawn under the Company's
Credit Facility (as defined below), which were partially offset by additional
drawings under the Credit Facility.
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 March 31, 1999, the Company
was in compliance with the financial covenants of the Credit Facility, as
amended by the Amendments. The Credit Facility expires in July 2002, but it may
be extended under certain circumstances for two additional years.
In February 1999, the Company entered into an agreement to sell certain of
its pharmacy benefits management operations to an unrelated third party. On
March 31, 1999, the Company completed the sale. The net proceeds of $65 million
from the sale was used in April 1999 to reduce corporate debt.
16
<PAGE>
The Company has initiated a formal plan to dispose of certain non-core
health plans included in the Company's Health Plan Services segment. It is
anticipated that the sales of these health plans will be completed during 1999.
In this regard, the Company adopted a formal plan to close the regional support
center connected to the health plans in the Central Division. The phase-down of
the support center is expected to be completed by the end of 1999. During the
first quarter ended March 31, 1999, the Company recorded restructuring and other
costs of $21.1 million associated with this facility closure.
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
first quarter of 1999, the Company contributed $21.7 million to its subsidiaries
to meet risk-based or other capital requirements of the regulated entities. As
of March 31, 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 model to assess the market risk of its
investments. The estimation of potential losses that could arise from changes in
market conditions is typically accomplished through the use of statistical
models which seek to predict risk of loss based on historical price and
volatility patterns. The Company's measured value at risk for its investments
from continuing operations, using a 95% confidence level, was approximately $4.0
million at March 31, 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.
17
<PAGE>
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 $1.195 million at March 31, 1999 and the related average interest rate
was 6.8% (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 March 31, 1999. These cash flows include both
expected principal and interest payments consistent with the terms of the
outstanding debt as of March 31, 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............... $ 217,090 $ 77,340 $ 77,340 $ 1,139,940 $ 2,540 $ 13,866 $ 1,528,116
---------- --------- --------- ------------ --------- --------- ------------
</TABLE>
18
<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 lawsuit arises out of
the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July
1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS,
representing over sixteen percent of the total outstanding equity of HDS, voted
its shares in favor of the acquisition of HDS by Medaphis. HSI received as the
result of the acquisition 976,771 shares of Medaphis Common Stock in exchange
for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company
succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has
been substituted for HSI as plaintiff in the suit.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core business, and had artificially
maintained its stock prices through a series of acquisitions and accounting
maneuvers which provided the illusion of growth while hiding the reality of its
weakening financial and business condition. The Company alleges that Medaphis,
Brown and other insiders deceived the Company by presenting materially false
financial statements and by failing to disclose that Medaphis would shortly
reveal a "write off" of up to $40 million in reorganization costs and would
lower its earnings estimate for the following year, thereby more than halving
the value of the Medaphis shares received by the Company. The Company alleges
that these false and misleading statements were contained in oral communications
with the Company, as well as in the registration statement and the prospectus
provided by Medaphis to all HDS shareholders in connection with the HDS
acquisition. Further, despite knowing of the Company's discussions to form a
strategic alliance of its own with HDS, Medaphis and the individual defendants
wrongfully interfered with that prospective business relationship by proposing
to acquire HDS using Medaphis stock whose market price was artificially inflated
by false and misleading statements. The Company alleges that the defendants'
actions constitute violations of both federal and state securities laws, as well
as fraud and other torts under state law. The Company is seeking either
rescission of the transaction or damages in excess of $38 million. The
defendants have denied the allegations in the complaint, and the Company is
vigorously pursuing its claims against Medaphis.
The Company moved to disqualify the law firm representing certain of the
individual defendants. The trial court granted the Company's motion, and the law
firm and its clients appealed such decision. In addition, the trial court
granted a stay of the case in order to permit the law firm to appeal. On
November 30, 1998, the Appellate Court affirmed the trial court's decision. New
counsel has been substituted in as counsel for certain of the individual
defendants. The court ordered stay has been lifted and, therefore, discovery is
now permitted to resume. The case is in the early stages of discovery.
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
into 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.
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<PAGE>
Management believes these suits against the Company and its former officers
are without merit and intends to defend the actions vigorously.
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Based in part on advice from litigation counsel
to the Company and upon information presently available, management of the
Company is of the opinion that the final outcome of all such proceedings should
not have a material adverse effect upon the Company's results of operations or
financial condition.
ITEM 2. CHANGES IN SECURITIES
REVOLVING CREDIT FACILITY
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 of the Company
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,
including mandatory prepayment of the outstanding loans under the Credit
Agreement with a certain portion of the proceeds from the issuance of such
indebtedness, resulting in a permanent reduction of the aggregate amount of
commitments under the Credit Agreement by the amount so prepaid. The Amendments
also provided for an increase in the interest and facility fees under the Credit
Agreement.
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
20
<PAGE>
in certain other circumstances. Rights will attach to all Common Stock
certificates representing shares then outstanding and no separate Rights
certificates will be distributed. Subject to certain exceptions contained in the
Rights Agreement dated as of June 1, 1996 by and between the Company and Harris
Trust and Savings Bank, as Rights Agent (the "Rights Agreement"), the Rights
will separate from the Common Stock in the event any person acquires 15% or more
of the outstanding Class A Common Stock, the Board of Directors of the Company
declares a holder of 10% or more to the outstanding Class A Common Stock to be
an "Adverse Person," or any person commences a tender offer for 15% 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 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 entirety by reference to the
Rights Agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the quarter ended March 31, 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-
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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.
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 (collectively, the "Definitive
Agreements"). Pursuant to the Definitive Agreements, at any time during the 1999
calendar year, the Company may acquire any remaining shares of FOHP not owned by
the Company pursuant to a tender offer, merger, combination or other business
combination transaction for consideration (to be paid in cash or stock of the
Company) equal to the value of such FOHP stock based on appraisal
determinations.
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 now owns approximately 99.6% of the outstanding equity of FOHP. The
minority shareholders of FOHP are physicians, hospitals and other health care
providers.
Pursuant to an Agreement and Plan of Merger dated as of November 16, 1998, a
wholly-owned subsidiary of the Company will merge with and into FOHP and FOHP
will become a wholly-owned subsidiary of the Company. The merger is anticipated
to occur in the second quarter of 1999. In connection with the merger, the
current minority shareholders of FOHP will be entitled to either the value of
their shares as of December 31, 1998 as determined by an appraiser or payment
rights which entitle the holders to receive not less than $15.00 per payment
right on or about July 1, 2001, provided that, with respect to the payment
rights (i) for a provider shareholder, such shareholder agrees to remain a
provider to PHS-NJ until December 31, 2001 and a specified number of hospital
providers in the provider network does not leave the network prior to December
31, 2001, (ii) for a hospital provider shareholder, such payment rights will be
subject to additional conditions to payment relating to reimbursement rates,
enrollment of hospital employees in PHS-NJ health plans, and payments of
premiums to PHS-NJ and (iii) for a non-provider shareholder, 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 provider
shareholders, provided that PHS-NJ achieves certain annual returns on common
equity.
QUALMED PLANS FOR HEALTH OF PENNSYLVANIA, INC. Effective December 31, 1998,
the Company purchased the minority interests in QualMed Plans for Health of
Pennsylvania, Inc. ("QualMed-PA"), a then majority-owned subsidiary of the
Company, for approximately $2 million. Previously, the Company owned
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approximately 83% of the common stock of QualMed-PA. In January 1999, the
Company transferred the assets of QualMed-PA, including the assets relating to
its preferred provider organization ("MaxNet(R)") and managed workers'
compensation ("CompTek(R)") business and operations, to Preferred Health
Network, Inc., another wholly-owned subsidiary of the Company.
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, 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. MPN and various provider groups and clinics affiliated with MedPartners,
Inc. provide health care services to approximately 215,000 enrollees of the
Company's Health Net HMO subsidiary.
The Company continues to monitor the situation closely and has been involved
in discussions with various parties to attempt to maintain continuity of care
and to minimize the impact that MPN's conservatorship and bankruptcy could have
on affected Health Net members. The Company understands from various public
statements made by MedPartners, Inc. that it intends to divest its California
clinic operations.
MedPartners, Inc., MPN and the State of California have executed a letter of
intent containing the basic principles for an orderly transition of the
California operations of MedPartners, Inc. and the resolution of provider
claims. Definitive documentation of this settlement is being drafted and
discussed. At this time, no assurances can be given that such a settlement
agreement will be entered into and implemented. In the event of the execution
and implementation of the settlement agreement, the Company believes that the
bankruptcy of MPN will not have a material adverse effect on the Company's
California operations. Failure to execute and implement such a settlement
agreement could have a material adverse effect on the Company's California
operations in the event the Company is ultimately held liable to pay the
provider claims and/or the Company is unable to quickly transition its members
covered by MPN to alternate providers. However, the Company is developing
various transitional strategies that it believes would reduce any such adverse
impact in the event such a settlement agreement is not executed and implemented.
INSURANCE SUBSIDIARIES. The Company is in the process of restructuring its
insurance subsidiaries to merge Foundation Health National Life Insurance
Company ("FHNL") and 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 will continue to provide certain administrative, behavioral health
and other services to such HMO operations for a transitionary period pursuant to
separate agreements.
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 $65.0 million in
cash. In addition, as part of the transaction, Advance Paradigm will provide to
the Company at competitive rates claims processing, retail network management
and payment of claims pharmacy benefits services under a services agreement.
Advance Paradigm will also provide 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.
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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. In 1997, Gem initiated
a withdrawal from the Nevada insurance markets, and began restructuring its
insurance products in Utah and then in certain other markets. Gem also reduced
commissions to market-level rates and terminated certain general agents. Gem
continued to implement such restructuring plan in 1998. As a result, the number
of Gem's insureds dropped from over 100,000 at the start of 1998 to
approximately 1,300 at April 30, 1999. Gem has filed notices of intention to
withdraw from Nebraska and the small group market in Colorado. 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. Upon completion of its current withdrawals, Gem will
be licensed in only five states.
COLORADO OPERATIONS. In March 1999, the Company entered into a letter of
intent to sell the capital stock of QualMed Plans for Health of Colorado, Inc.,
the Company's HMO subsidiary in the state of Colorado, to Wellpoint Health
Networks Inc. The Company anticipates closing the sale by the end of 1999.
Although the Company has entered into a letter of intent for the foregoing sale,
consummation of the sale is subject to executing a definitive agreement mutually
satisfactory to the parties and satisfaction of all conditions to be set forth
therein, including obtaining regulatory approvals. In addition, the Company has
decided to close its regional support center in Pueblo, Colorado and expects to
complete such closing by the end of 1999.
NEW MEXICO OPERATIONS. In March 1999, the Company also entered into a
definitive agreement to sell 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. Although the Company has entered into a definitive agreement for
the foregoing sale, consummation of the sale is subject to various conditions
and certain regulatory approvals. The Company anticipates closing the sale by
the end of 1999.
OTHER POTENTIAL DIVESTITURES
SOUTHERN CALIFORNIA HOSPITALS. The Company is reviewing the possibility of
divesting its ownership of two Southern California hospitals, a 128-bed hospital
located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a
200-bed hospital located in Gardena, California, the Memorial Hospital of
Gardena. The Company is presently responding to inquiries of parties which have
expressed an interest in the purchase of such businesses.
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.
DIRECTOR AND EXECUTIVE OFFICER CHANGES
In February 1999, the Board of Directors of the Company elected Jay M.
Gellert, the Company's President and Chief Executive Officer, to fill a vacancy
on the Board of Directors. Effective March 1, 1999, Malik M. Hasan, M.D.
resigned from the Company's Board of Directors. Accordingly, there currently
exists a vacancy on the Board of Directors. The Board of Directors is currently
in the process of recruiting an appropriate replacement director to fill the
vacancy pursuant to and in accordance with the Company's Fifth Amended and
Restated By-Laws. In May 1999, the Board of Directors elected Richard W.
Hanselman as Chairman of the Board of Directors.
In April 1999, Karin D. Mayhew became Senior Vice President Human Resources
of the Company. In May 1999, Ross D. Henderson, M.D. became Senior Vice
President and Chief Medical Officer of the Company. Dr. Henderson succeeded Dale
T. Berkbigler, M.D. in such position.
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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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<CAPTION>
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).
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2.2 Agreement and Plan of Merger, dated May 8, 1997, by and among the Company, PHS
Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which
is incorporated by reference herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and
among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed
as Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997, which is incorporated by reference herein).
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant (filed as
Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which
is incorporated by reference herein).
4.1 Form of Class A Common Stock Certificate (included as Exhibit 4.2 to the Company's
Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively), which is incorporated by reference herein).
4.2 Form of Class B Common Stock Certificate (included as Exhibit 4.3 to the Company's
Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively), which is incorporated by reference herein).
4.3 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, a copy of which is filed herewith.
*10.3 Employment Letter Agreement between the Company and Ross D. Henderson dated April
29, 1999, a copy of which is filed herewith.
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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 the Company 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,
1999 (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 Exhibit
10.20 to the Company's Form 10-K for the year ended December 31, 1998, which is
incorporated by reference herein).
10.17 Form of Severance Payment Agreement dated December 4, 1998 by and between the Com-
pany 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 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 Form 10-K for the year ended December
31, 1998, which is incorporated by reference herein).
10.22 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).
10.23 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).
10.24 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).
10.25 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).
10.26 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).
10.27 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).
10.28 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 Form 10-K for the year ended December 31, 1998, which is incorporated by
reference herein).
10.29 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).
10.30 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).
10.31 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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10.32 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).
10.33 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).
10.34 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).
10.35 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).
10.36 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).
10.37 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).
10.38 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for the year
ended June 30, 1994, which is incorporated by reference herein).
10.39 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).
10.40 FHC's Deferred Compensation Plan, as amended and restated (filed as an exhibit to
FHC's Form 10-K for the year ended June 30, 1995, which is incorporated by reference
herein).
10.41 FHC's Supplemental Executive Retirement Plan, as amended and restated (filed as an
exhibit to FHC's Form 10-K for the year ended June 30, 1995, which is incorporated
by reference herein).
10.42 FHC's Executive Retiree Medical Plan, as amended and restated (filed as an exhibit
to FHC's Form 10-K for the year ended June 30, 1995, which is incorporated by
reference herein).
10.43 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).
10.44 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).
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10.45 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).
10.46 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).
10.47 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).
10.48 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).
10.49 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).
10.50 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).
10.51 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).
10.52 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).
10.53 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).
10.54 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 Form 10-K for the year
ended December 31, 1998, which is incorporated by reference herein).
10.55 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 Form 10-K for the
year ended December 31, 1998, which is incorporated by reference herein).
10.56 The Company's Supplemental Executive Retirement Plan effective as of January 1, 1996
(filed as Exhibit 10.65 to the Company's Form 10-K for the year ended December 31,
1998, which is incorporated by reference herein).
10.57 The Company's Deferred Compensation Plan effective as of May 1, 1998 (filed as
Exhibit 10.66 to the Company's Form 10-K for the year ended December 31, 1998, which
is incorporated by reference herein).
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10.58 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).
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 first quarter ended March 31, 1999, a copy of which
has been filed with the EDGAR version of this filing.
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* A copy of the Exhibit is filed herewith.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed by the Company during the
quarterly period ended March 31, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
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FOUNDATION HEALTH SYSTEMS, INC.
(REGISTRANT)
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By: /s/ JAY M. GELLERT
------------------------------------------
Jay M. Gellert
Date: May 14, 1999 PRESIDENT AND CHIEF EXECUTIVE OFFICER
By: /s/ STEVEN P. ERWIN
------------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT AND
Date: May 14, 1999 CHIEF FINANCIAL OFFICER
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EXHIBIT 10.2
January 22, 1999
Karin Mayhew
23 Cornwall Lane
Guilford, Connecticut 06437
Re: Terms of Employment
Dear Karin:
On behalf of Foundation Health Systems, Inc. (hereinafter the "Company"), I
would like to confirm our offer to you for the exempt position of Senior Vice
President of Human Resources of the Company. The position will be located in
Woodland Hills, California and, as we discussed, your anticipated start date
will be April 1, 1999. In this position you will report directly to the
President and Chief Executive Officer of the Company, and will be considered
a "Tier 1" executive officer of the Company. You will earn a monthly salary
of $22,916.67. As is our current practice, you will be paid on a bi-weekly
basis with 26 pay periods per year. Performance of each of the Company's
Associates is generally reviewed on an annual basis, and any adjustment to
salary is ordinarily made upon the completion of such performance review. Any
adjustment to your compensation must be made with the approval of the
Compensation and Stock Option Committee of the Company's Board of Directors
(the "Committee"). You will be provided a $1,000 per month automobile
allowance subject to normal payroll deductions, and subject to any changes
that may be made from time to time to the overall automobile allowance
program.
As we discussed, given your delayed start date of April 1, 1999 and the fact
that prior to such date you will not be actively employed but will instead be
utilizing your accumulated accrued vacation from your prior employer, we would
expect you to spend approximately two weeks of your time on the Company's
business prior to your start date. The Company will reimburse your reasonable
business expenses (including any necessary travel) for your service prior to
April 1, 1999. During this time, it is anticipated that you would participate in
all meetings of the Company's 401(k) Plan Steering Committee (members of which
include Steve Erwin, Curt Westen, and other senior management members) and would
also assist in restructuring the Company's Human Resources function including
establishing a process to recruit a Corporate Director of Compensation and
Benefits.
<PAGE>
Offer Letter to Karin Mayhew
January 22, 1999
Page 2
Upon commencement of your employment, FHS will provide to you a one-time
$300,000 loan (with interest accrued at the Prime Rate and amortized
straight-line over a five-year period) payable by you in full upon demand
upon termination of your employment with the Company. One-fifth of the
principal and any accrued interest of such loan will be forgiven on each of
the first through fifth anniversaries of your date of hire subject to your
continued employment with the Company. Any accrued interest and principal of
such loan will be forgiven in the event you are terminated by the Company
without cause or within two years of a change of control. The Company agrees
that it will consider your reasonable requests, if any, to restructure the
timing, nature and/or characterization of such loan as may be suggested by
your tax/financial advisers; provided that such restructuring would not
disadvantage the Company and would not result in a modification of your
obligation to repay such amount in the instances set forth above.
In addition, you will be eligible to participate in the executive Incentive
Plan as it may be modified from time to time by the Committee. Under the
Plan, bonus payments are dependent upon Company and individual performance
measures. You will be eligible to participate in the Plan in 1999 with a
target bonus opportunity of 70 percent of your base salary and a minimum,
guaranteed bonus of $50,000 for such 1999 Plan year. The maximum bonus
payable to you under provisions of the Plan is 105 percent of base salary.
Any bonus payout for 1999 will be paid in 2000 following outside audit of the
Company's performance and determination of your success in accomplishing
individual performance objectives. To be eligible for any bonus payment, you
must be actively employed and on the Company payroll at the time the bonus is
paid. Bonus calculations are based on the base annual salary in effect on
December 31st of the respective Plan year (pro-rated for the portion of the
year a given participant was an employee of the Company). It is understood
that the Committee and the Company will award bonus amounts, if any, as it
deems appropriate consistent with the guidelines of the Plan. You acknowledge
that in the event you are one of the top five highest paid executive officers
of the Company for a given year under applicable federal securities laws,
your bonus for that year, if any, will be subject to the Company's
Performance-Based 162(m) Plan in lieu of the Executive Incentive Plan.
Incentive compensation payments are subject to normal payroll deductions.
As part of our long-term incentive program, you will be eligible to participate
in the Company's stock option program. Management will recommend to the
Committee that you be granted a stock option on the date you commence full-time
employment with the Company (which is anticipated to be April 1, 1999) (the
"Grant Date") to purchase an aggregate of 100,000 shares of the Company's Class
A Common Stock with an exercise price equal to the last sales price for such
common stock on the New York Stock Exchange as of the Grant Date. The option
will vest at the rate of 1/3rd of the shares covered thereby on each of the
first through third anniversaries of the Grant Date. A stock option agreement
formalizing this grant will be provided to you under separate cover following
your date of hire containing the standard terms and conditions
<PAGE>
Offer Letter to Karin Mayhew
January 22, 1999
Page 3
currently used by the Company. Any future recommendation for additional
options made by the Company's management will be made consistent with your
performance and generally comparable to peer managers of the Company at the
time option recommendations are presented to the Committee. It is further
agreed that this initial grant to you will be considered a three year
"mega-grant" and you will therefore not be eligible to receive additional
option grants for a period of three years except (i) to the extent other
executive officers in a similar situation become eligible and the Committee
reasonably determines that it is appropriate and equitable that such
eligibility should extend to you or (ii) in such other circumstances where
the Committee, in its sole discretion, determines to grant additional stock
options to you based upon your future performance. At all times, all stock
option grants remain within the sole discretion of the Committee.
You will also be provided with the Company's standard relocation benefits for
you to relocate from Connecticut to the Woodland Hills area. Such relocation
benefits are described in, and are subject to, the attached guidelines.
In addition to the foregoing, and subject to your continued employment with
the Company, you will be eligible to participate in Company-offered benefits
if you meet certain criteria. These benefits include group medical, dental,
vision, life insurance, short-term and long-term disability insurance, 401(k)
plan, Company-recognized holidays, tuition reimbursement and participation in
our deferred compensation program. In our 401(k) plan, the Company currently
matches your contribution at $.50 for every dollar contributed up to six
percent (6%) of your compensation (subject to certain limitations). The
Company's Paid Time Off ("PTO") benefit is provided to you for illness,
vacation and personal time off. Under the PTO program you accrue PTO at a
rate of 23 days per year between your date of hire and 120 months of service,
and 25 days per year thereafter. In case of a conflict between this summary
and the official documents, the official documents will always govern. In
addition, the Company reserves the right to change, amend or terminate the
benefits plans at any time, with or without notice.
You will also be eligible to participate in the Company's existing
Supplemental Executive Retirement Plan ("SERP") or a successor plan. Under
provisions of the SERP you can vest and accrue a retirement benefit of up to
50 percent of your base salary plus incentive compensation. This benefit is
integrated (offset) with other retirement benefits provided by the Company
and with 50 percent of your social security benefits. You will receive credit
for one additional year of service under the SERP plan upon completing five
years of service with the Company.
To assist you in tax preparation and financial planning activities, the
Company will also provide to you up to $5,000 in annual reimbursement for
expenses related to that activity.
The Company will provide you with protection in the event of termination of your
employment pursuant to, and subject to the terms and conditions of, the
Company's current standard
<PAGE>
Offer Letter to Karin Mayhew
January 22, 1999
Page 4
Severance Payment Agreement for Tier 1 Officers of the Company. A copy of
this form of Severance Payment Agreement which will be entered into upon your
date of hire is attached for your reference and information.
You agree, through the signing of this letter agreement, that your employment
with the Company is at the mutual consent of you and the Company and is an
"at-will" employment relationship. Nothing in this letter is intended to
guarantee your continued employment with the Company or employment for any
specific length of time. While the Company hopes that your employment
relationship will be mutually beneficial and rewarding, both you and the
Company retain the right to terminate the employment relationship at will, at
any time, with or without cause. The at-will nature of your employment with
the Company cannot be modified or superseded except by a written agreement,
signed by you and the President and Chief Executive Officer of the Company,
that clearly and expressly specifies the intent to modify the at-will
relationship. In accepting employment with the Company, you acknowledge that
no Company representative has made any oral or written promise or
representation contrary to this paragraph. Furthermore, you acknowledge that
this paragraph represents the only agreement between you and the Company
concerning the duration of your employment and the at-will nature of the
employment relationship.
During your employment with the Company, you will have access to and become
acquainted with certain proprietary and confidential information and
practices ("Confidential Information"). Among other things, Confidential
Information includes all information that is not generally known to the
Company's competitors and the public, and that has or could have commercial
value to the Company's business. It includes, but is not limited to, customer
information, customer lists and pricing methodology.
In accepting this new position with the Company, you acknowledge and agree
that all documents, memoranda, reports, files, correspondence, lists and
other written, electronic and graphic records affecting or relating to the
Company's business that you may prepare, use, observe, process or control
(including, but not limited to, any materials containing Confidential
Information) shall be and remain the Company's sole property, and you agree
not to make use of or disclose to any third party any such material,
confidential or otherwise, except for the benefit of the Company and in the
course of your employment with the Company. If your employment is terminated
(voluntarily or otherwise), you agree to deliver to the Company within five
business days of termination all written and/or graphic records affecting or
relating to the Company's business, including but not limited to material
containing Confidential Information.
You have agreed and certify that you have no other agreement, relationship or
commitment to any other person or entity that conflicts with your obligations
to the Company under this offer letter. If you are unable to so certify, all
such agreements, relationships and commitments must be identified here:
<PAGE>
Offer Letter to Karin Mayhew
January 22, 1999
Page 5
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
You agree not to use or disclose any confidential information or trade
secrets of others, including all prior employers, in your work at the
Company. Should a situation arise in which you believe that your job duties
may lead to the use or disclosure of confidential information or trade
secrets of another, you agree to notify the Company's Senior Vice President,
General Counsel and Secretary of the situation immediately.
All of the foregoing confidentiality restrictions and obligations are more
fully described in the form of Severance Payment Agreement attached hereto
and referenced above.
Finally, this letter sets forth all the terms of this offer of employment. It
supersedes all previous and contemporaneous oral and written communications
and representations. To confirm your acceptance of these terms, please sign,
date and return a copy of this letter to the Senior Vice President, General
Counsel and Secretary, Foundation Health Systems, Inc., 21600 Oxnard Street,
Woodland Hills, California 91367.
Karin, we are pleased to offer you this professional opportunity and are
excited about the contributions that you can make to the Company as part of
our management team. Should you have any questions, please feel free to
contact me at (818) 676-6703.
Sincerely,
/s/ Jay M. Gellert
Jay M. Gellert
President and Chief Executive Officer
I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED
ABOVE.
/s/ Karin D. Mayhew 1/31/99
- -------------------------------------- ----------------------------------
SIGNATURE DATE
<PAGE>
EXHIBIT 10.3
April 29, 1999
Ross D. Henderson, M.D.
50 E. Tangerine Road
Tucson, AZ 85737
Re: Terms of Employment
Dear Ross:
On behalf of Foundation Health Systems, Inc. (hereinafter the "Company") I would
like to confirm our offer to you for your promotion to the exempt position of
Senior Vice President and Chief Medical Officer for the Company. In this
position you will report directly to the President and Chief Executive Officer
of the Company. You will earn a monthly salary of $29,166.67. As is our current
practice, you will be paid on a bi-weekly basis with 26 pay periods per year.
Performance of each of the Company's Associates is generally reviewed on an
annual basis, and any adjustment to salary is ordinarily made upon the
completion of such performance review. You will also be provided a $1,000 per
month automobile allowance, subject to any changes that might be made from time
to time to the overall automobile allowance program.
In addition, during 1999 you will be eligible to participate in the Management
Incentive Plan which allows you an opportunity to earn up to 70 percent of your
base salary. The receipt of any incentive compensation is contingent upon
achieving Company and individual objectives. You must be actively employed and
on the Company payroll at the time incentive compensation is paid. Incentive
compensation calculations are based on the base salary in effect on December
31st of the Executive Incentive Plan year. Incentive compensation payments are
subject to normal payroll deductions.
As part of our long-term incentive program, you are eligible to participate in
the Company's stock option program. In this connection and as part of your
promotion, the Compensation and Stock Option Committee of the Company's Board of
Directors (hereinafter the "Committee") has granted to you, effective April 22,
1999 (the "Grant Date"), a stock option (the "Option") to purchase an aggregate
of 68,781 shares (the "Option Shares") of the Company's Class A Common Stock.
The Option will vest with respect to one-third of the Option Shares on each of
the first three anniversaries of the Grant Date until the Option becomes fully
exercisable, and the exercise price for the Option is equal to $13.0625 per
share, the closing sales price per share of the Company's Class A Common Stock
on the Grant Date. Any additional grants remain within the sole discretion of
the Committee.
In addition to the foregoing, and subject to your continued employment with the
Company, you will be eligible to continue participation in Company-offered
benefits if you meet certain criteria. These benefits include group medical,
dental, vision, life insurance, short-term and long-term disability insurance,
401(k) plan, Company-recognized holidays tuition reimbursement and
<PAGE>
Page 2
Offer ltr/Ross Henderson M.D.
April 29,1999
participation in our deferred compensation program. In our 401(k) plan, the
Company currently matches your contribution at $.50 for every dollar contributed
up to six percent (6%) of your compensation (subject to certain limitations).
The Company's Paid Time Off ("PTO") benefit is provided to you for illness,
vacation and personal time off. Under the PTO program you accrue PTO at a rate
of 25 days per year. In case of a conflict between this summary and the official
documents, the official documents will always govern. In addition, the Company
reserves the right to change, amend or terminate the benefits plans at any time,
with or without notice.
To assist you in tax preparation and financial planning activities, the Company
will provide up to $5,000.00 in annual reimbursement for expenses related to
this activity. Invoices for services received should be submitted to the Human
Resources Department for approval. The Company will also provide you with a
relocation benefit program targeted to assist you in relocating to Southern
California. Attached you will find a copy of the Relocation Benefits Guideline
applicable to you. If you have any questions regarding the relocation benefits
please contact me at your convenience at (818) 676-7835.
Upon your relocation and/or your purchase of a new residence in Southern
California, FHS will provide to you a one-time $150,000 loan (the "Loan"). The
outstanding principal amount of the Loan shall bear simple interest per annum at
a rate equal to the Prime Rate as reported in the Wall Street Journal on the
date the loan proceeds are provided to you. Such rate shall be adjusted on the
first day of each calendar year to the Prime Rate in effect on such day.
Provided that you are still employed by the Company at such time, the Loan
principal and any accrued interest will be forgiven, one-half on January 1, 2001
and the remaining one-half on January 1, 2002. Additionally, the full amount of
Loan principal and any accrued interest thereon will be forgiven in full prior
to January 1, 2002 if you are involuntarily terminated without "Cause", leave
the Company for "Good Reason" following a "Change of Control", or are unable to
work due to disability or upon your death.
Any unforgiven and unpaid principal of the Loan, plus any unforgiven and unpaid
accrued interest thereon shall be due and payable by you upon demand by the
Company in the event you voluntary terminate your employment with the Company
for any reason other than Good Reason following a Change of Control. For
purposes of this letter agreement, Good Reason, Cause and Change of Control are
defined in the Company's Standard Severance Payment Agreement for Tier 1
Officers of the Company described below. This loan will be subject to the
further standard terms and conditions contained in a Promissory Note to be
forwarded to you under separate cover.
Additionally, the Company will provide you with protection in the event of the
termination of your employment pursuant to, and subject to the terms and
conditions of, the Company's current standard Severance Payment Agreement for
Tier 1 Officers of the Company. A copy of this form of Severance Payment
Agreement which will be entered into is attached for your reference and
information.
<PAGE>
Page 3
Offer ltr/Ross Henderson M.D.
April 29,1999
You agree, through the signing of this letter, that your employment with the
Company is at the mutual consent of each of you and the Company and is an
"at-will" employment relationship. Nothing in this letter is intended to
guarantee your continued employment with the Company or employment for any
specific length of time. While the Company hopes that your employment
relationship will be mutually beneficial and rewarding, both you and the Company
retain the right to terminate the employment relationship at will, at any time,
with or without cause. The at-will nature of your employment with the Company
cannot be modified or superseded except by a written agreement, signed by you
and the President and Chief Executive Officer of the Company, that clearly and
expressly specifies the intent to modify the at-will relationship and upon
approval of the Committee. In accepting employment with the Company, you
acknowledge that no Company representative has made any oral or written promise
or representation contrary to this paragraph. Furthermore, you acknowledge that
this paragraph represents the only agreement between you and the Company
concerning the duration of your employment and the at-will nature of the
employment relationship.
You agree, without further compensation, to cooperate with and assist the
Company in the investigation of, preparation for or defense of any actual or
threatened third party claim, investigation or proceeding involving the Company
or its predecessors or affiliates and arising from or relating to, in whole or
in part, your employment with the Company or its predecessors or affiliates for
which the Company requests your assistance, which cooperation and assistance
shall include, but not be limited to, providing testimony and assisting in
information and document gathering efforts. Such obligation on your part will
continue to apply not only during you employment with the Company but after
post-termination of such employment. In this connection, it is agreed that the
Company will use its reasonable best efforts to assure that the request for such
cooperation will not unduly interfere with your other material business and
personal obligations and commitments. Furthermore, the Company will reimburse to
you all reasonable expenses directly related to your requested participation.
During your employment with the Company, you will have access to and become
acquainted with certain proprietary and confidential information and practices
("Confidential Information"). Confidential Information includes all information
that is not generally known to the Company's competitors and the public, and
that has or could have commercial value to the Company's business. It includes,
but is not limited to, customer information, customer lists, and pricing
methodology.
In accepting this new position with the Company, you acknowledge and agree that
all documents, memoranda, reports, files, correspondence, lists and other
written, electronic and graphic records affecting or relating to the Company's
business that you may prepare, use, observe, possess or control (including, but
not limited to, any materials containing Confidential Information) shall be and
remain the Company's sole property, and you agree not to make use of or disclose
to any third party any such material, confidential or otherwise, except for the
benefit of the Company and in the course of your employment with the Company. If
your employment is terminated (voluntary or otherwise), you agree to deliver to
the Company within five business days of termination all written and/or graphic
records affecting or relating to the Company's business, including but not
<PAGE>
Page 4
Offer ltr/Ross Henderson M.D.
April 29,1999
limited to material containing Confidential Information.
You have agreed and certify that you have no other agreement, relationship, or
commitment to any other person or entity that conflicts with your obligations to
the Company under this offer letter. If you are unable to so certify, all such
agreement(s) must be identified here:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
You agree not to use or disclose any confidential information or trade secrets
of others, including all prior employers, in your work at the Company. Should a
situation arise in which you believe that your job duties may lead to the use or
disclosure of confidential information or trade secrets of another, you agree to
notify the Corporate General Counsel and Secretary or myself in the Corporate
Human Resources Department of the situation immediately.
Finally, this letter sets forth all the terms of this offer of employment. It
supersedes all previous and contemporaneous oral and written communications and
representations. To confirm your acceptance of these terms, please sign, date
and return a copy of this letter to the Senior Vice President of Human
Resources. An additional copy of the offer letter is enclosed for your files.
Ross, we are pleased to present you this professional opportunity and are
excited about the contributions that you can make to the Company as part of our
Corporate management team. Should you have any questions please feel free to
contact me at (818) 676-7835.
Sincerely,
/s/ Karin Mayhew
Karin Mayhew
Senior Vice President
Corporate Human Resources
Attachment: Form of Severance Payment Agreement
Relocation Benefits Guideline
CC: Jay Gellert
I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED
ABOVE.
/s/ ROSS D. HENDERSON 4/30/99
--------------------- -------
SIGNATURE DATE
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THIS
SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS.
</LEGEND>
<CIK> 0000916085
<NAME> FOUNDATION HEALTH SYSTEMS, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 615,574
<SECURITIES> 564,365
<RECEIVABLES> 514,752<F1>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,072,084
<PP&E> 334,134<F2>
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,711,422
<CURRENT-LIABILITIES> 1,638,687
<BONDS> 1,193,679<F3>
0
0
<COMMON> 125
<OTHER-SE> 784,871<F4>
<TOTAL-LIABILITY-AND-EQUITY> 3,711,422
<SALES> 0
<TOTAL-REVENUES> 2,275,990
<CGS> 0
<TOTAL-COSTS> 1,803,576
<OTHER-EXPENSES> 371,697
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,938
<INCOME-PRETAX> 78,779
<INCOME-TAX> 31,441
<INCOME-CONTINUING> 47,338
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 5,417
<NET-INCOME> 41,921
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.34
<FN>
<F1>NET OF ALLOWANCES FOR DOUBTFUL ACCOUNTS.
<F2>NET OF ACCUMULATED DEPRECIATION.
<F3>INCLUDES BORROWINGS UNDER REVOLVING CREDIT FACILITY, MISCELLANEOUS NOTES
PAYABLE AND CAPITAL LEASES.
<F4>NET OF TREASURY STOCK.
</FN>
</TABLE>
