<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 1-12718
------------------------
FOUNDATION HEALTH SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
DELAWARE 95-4288333
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
21650 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 676-6978
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -----------------------------
<S> <C>
New York Stock
Class A Common Stock, $.001 par value Exchange, Inc.
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 17, 2000 was $965,797,495 (which represents 121,675,275
shares of Class A Common Stock held by such non-affiliates multiplied by
$7.9375, the closing sales price of such stock on the New York Stock Exchange on
March 17, 2000).
The number of shares outstanding of the registrant's Class A Common Stock as
of March 17, 2000 was 121,835,631 (excluding 3,194,374 shares held as treasury
stock), and 563,742 shares of the registrant's Class B Common Stock were
outstanding as of such date.
DOCUMENTS INCORPORATED BY REFERENCE
Part II of this Form 10-K incorporates by reference certain information from
the registrant's Annual Report to Stockholders for the year ended December 31,
1999 ("Annual Report to Stockholders"). Part III of this Form 10-K incorporates
by reference certain information from the registrant's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the close of the year ended December 31, 1999.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART I
ITEM 1. BUSINESS
Foundation Health Systems, Inc. (the "Company" or "FHS") is an integrated
managed care organization which administers the delivery of managed health care
services. The Company's health maintenance organizations ("HMOs"), insured
preferred provider organizations ("PPOs") and government contracts subsidiaries
provide health benefits to approximately 5.5 million individuals in 18 states
through group, individual, Medicare risk, Medicaid and TRICARE (formerly
Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS"))
programs. The Company's subsidiaries also offer managed health care products
related to behavioral health, dental, vision and prescription drugs, and offer
managed health care product coordination for multi-region employers and
administrative services for medical groups and self-funded benefits programs.
The Company operates and conducts its HMO and other businesses through its
subsidiaries.
The Company currently operates within two segments of the managed health
care industry: Health Plan Services and Government Contracts/Specialty Services.
During 1999, the Health Plan Services segment consisted of four regional
divisions: Arizona (Arizona and Utah), California (encompassing only the state
of California), Central (Colorado, Florida, Idaho, Louisiana, New Mexico,
Oklahoma, Oregon, Texas and Washington) and Northeast (Connecticut, New Jersey,
New York, Ohio, Pennsylvania and West Virginia). During 1999, the Company
divested its health plans or entered into arrangements to transition the
membership of its health plans in the states of Colorado, Idaho, Louisiana, New
Mexico, Oklahoma, Texas, Utah and Washington. See "Discontinued Operations and
Anticipated Divestitures." Effective January 1, 2000, as a result of such
divestitures, the Company consolidated and reorganized its Health Plan Services
segment into two regional divisions, the Eastern Division (Connecticut, Florida,
New Jersey, New York, Ohio, Pennsylvania and West Virginia) and the Western
Division (Arizona, California and Oregon). The Company is one of the largest
managed health care companies in the United States, with approximately 4 million
at-risk and administrative services only ("ASO") members in its Health Plan
Services segment. The Company also owns health and life insurance companies
licensed to sell insurance in 33 states and the District of Columbia.
The Company's HMOs market traditional HMO products to employer groups and
Medicare and Medicaid products to employer groups and directly to individuals.
Health care services that are provided to the Company's commercial and
individual members include primary and specialty physician care, hospital care,
laboratory and radiology services, prescription drugs, dental and vision care,
skilled nursing care, physical therapy and mental health. The Company's HMO
service networks include approximately 56,000 primary care physicians and 69,000
specialists.
The Company's Government Contracts/Specialty Services segment consists of
the Government Contracts Division and the Specialty Services Division. The
Company's Government Contracts Division oversees the provision of contractual
services to federal government programs such as TRICARE (formerly CHAMPUS). The
Company receives revenues for administrative and management services and, under
most of its contracts, also accepts financial responsibility for a portion of
the health care costs. The Company's Specialty Services Division oversees the
provision of supplemental programs to enrollees in the Company's HMOs, as well
as to members whose basic medical coverage is provided by non-FHS companies,
including vision coverage, dental coverage, managed behavioral health programs
and a prescription drug program. The Specialty Services Division consists of
both operations in which the Company assumes underwriting risk in return for
premium revenue, and operations in which the Company provides administrative
services only, including certain of the behavioral health and pharmacy benefits
management programs. Such Division also provides certain bill review and third
party administrative services as described elsewhere in this Annual Report.
The Company continues to evaluate the profitability realized or likely to be
realized by its existing businesses and operations, and the opportunities to
expand its businesses in profitable markets. In 1999,
1
<PAGE>
the Company substantially completed its divestiture program by selling a PPO
network subsidiary, a third-party administrator subsidiary, two Southern
California hospitals, its HMO operations in Louisiana, New Mexico, Oklahoma,
Texas and Utah, certain of its pharmacy benefits management assets, a regional
claims processing facility and accompanying real estate in Colorado, and certain
care centers and other real estate. The Company also entered into definitive
agreements to transition to third parties its health plan and indemnity plan
membership in the states of Colorado, Idaho and Washington. In addition, the
Company purchased the remaining minority interests of FOHP, Inc., a then
majority-owned subsidiary of the Company which owns a managed health care
company in New Jersey. See "Discontinued Operations and Anticipated
Divestitures" and "Other Information--Recent Developments."
The Company was incorporated in 1990. The current operations of the Company
are the result of the April 1, 1997 merger transaction (the "FHS Combination")
involving Health Systems International, Inc. ("HSI") and Foundation Health
Corporation ("FHC"). Pursuant to the Agreement and Plan of Merger (the "Merger
Agreement") that evidenced the FHS Combination, FH Acquisition Corp., a
wholly-owned subsidiary of HSI, merged with and into FHC and FHC survived as a
wholly-owned subsidiary of HSI, which changed its name to "Foundation Health
Systems, Inc." and thereby became the Company.
The FHS Combination was accounted for as a pooling of interests for
accounting and financial reporting purposes. The pooling of interests method of
accounting is intended to present, as a single interest, two or more common
stockholder interests which were previously independent and assumes that the
combining companies have been merged from inception. Consequently, the Company's
consolidated financial statements incorporated by reference into this Annual
Report on Form 10-K have been prepared and/or restated as though HSI and FHC
always had been combined on a calendar year basis.
Prior to the FHS Combination, the Company was the successor to the business
conducted by Health Net, now the Company's HMO subsidiary in California, which
became a subsidiary of the Company in 1992, and HMO and PPO networks operated by
QualMed, Inc. ("QualMed"), which combined with the Company in 1994 to create
HSI. FHC was incorporated in Delaware in 1984. The executive offices of the
Company are located at 21650 Oxnard Street, Woodland Hills, CA 91367. Except as
the context otherwise requires, the term "Company" refers to FHS and its
subsidiaries.
HEALTH PLAN DIVISIONS
HMO AND PPO OPERATIONS. The Company's HMOs offer members a comprehensive
range of health care services, including ambulatory and outpatient physician
care, hospital care, pharmacy services, eye care, behavioral health and
ancillary diagnostic and therapeutic services. The Company offers a full
spectrum of managed health care products.
The integrated health care programs offered by the Company's HMOs include
products offered through both traditional Network Model HMOs (in which the HMOs
contract with individual physicians, physician groups and independent or
individual practice associations ("IPAs")) and IPA Model HMOs (in which the HMOs
contract with one or more IPAs that in turn subcontract with individual
physicians to provide HMO patient services) which offer quality care, cost
containment and comprehensive coverage; a matrix package which allows employees
to select their desired coverage from alternatives that have interchangeable
outpatient and inpatient co-payment levels; point-of-service programs which
offer a multi-tier design that provides both conventional HMO and indemnity-like
(in-network and out-of-network) tiers; a PPO-like tier which allows members to
self-refer to the network physician of their choice; and a managed indemnity
plan which is provided for employees who reside outside of their HMO service
areas.
The Company's strategy is to offer a wide range of managed health care
products and services to employers to assist them in containing health care
costs. The pricing of the products offered is designed to provide incentives to
both employers and employees to select and enroll in the products with greater
managed health care and cost containment elements. In general, the Company's HMO
subsidiaries provide comprehensive health care coverage for a fixed fee or
premium that does not vary with the extent or
2
<PAGE>
frequency of medical services actually received by the member. PPO enrollees
choose their medical care from among the various contracting providers or choose
a non-contracting provider and are reimbursed on a traditional indemnity plan
basis after reaching an annual deductible. The Company assumes both underwriting
and administrative expense risk in return for the premium revenue it receives
from its HMO and PPO products. The Company's subsidiaries have contractual
relationships with health care providers for the delivery of health care to the
Company's enrollees. While a majority of the Company's members are covered by
conventional HMO products, the Company is continuing to expand its other product
lines, thereby enabling it to offer flexibility to an employer and to tailor its
products to an employer's particular needs.
The following table contains certain information relating to commercial HMO
and PPO members, Medicare members and employer groups under contract as of
December 31, 1999 in each region in which the Company operated in 1999
(excluding point-of-service):
<TABLE>
<CAPTION>
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
-------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Commercial HMO and PPO Members........ 290,949 1,428,692 337,654 813,017
Medicare Members (risk only).......... 56,942 124,396 32,570 51,798
Medicaid Members...................... -- 500,076 77,986 100,291
</TABLE>
In addition, the following sets forth certain data regarding the Company's
employer groups in the commercial managed care operations of its Health Plan
Divisions as of December 31, 1999:
<TABLE>
<S> <C>
Number of Employer Groups................................... 30,385
Largest Employer Group as % of enrollment................... 11.9%
10 largest Employer Groups as % of enrollment............... 15.7%
</TABLE>
ARIZONA DIVISION
In Arizona, the Company believes that its commercial managed care operations
rank it second largest both as measured by total membership and by size of
provider network. The Company's commercial HMO membership in Arizona was 283,478
as of December 31, 1999. The Company's Medicare risk membership in Arizona was
56,942 as of December 31, 1999, which represented an increase of 11% during
1999. During 1999, the Arizona Division also oversaw certain of the Company's
health and life insurance companies licensed to sell insurance in 33 states and
the District of Columbia. In October 1999, the Company sold its HMO operations
in Utah. See "Discontinued Operations and Anticipated Divestitures." Effective
January 1, 2000, the Arizona Division, the California Division and the Company's
HMO operations in Oregon were consolidated to form the Company's new Western
Division.
CALIFORNIA DIVISION
The California market is characterized by a concentrated population. Health
Net, the Company's California HMO, is believed by the Company to be the
third-largest HMO in the state of California in terms of membership and the
largest in terms of size of provider network. The Company's commercial HMO
membership in California as of December 31, 1999 was 1,387,049, which
represented a decrease of 10% during 1999. The Company's Medicare risk
membership in California as of December 31, 1999 was 124,396, which represented
a decrease of 3% during 1999. The decreases in commercial HMO and Medicare risk
membership are due, in part, to the Company's pricing discipline and its focus
on profitable accounts. The Company's Medicaid membership in California as of
December 31, 1999 was 500,076 members, an increase of approximately 14% during
1999. As referenced above, effective January 1, 2000, the Arizona Division, the
California Division and the Company's HMO operations in Oregon were consolidated
to form the Company's new Western Division.
3
<PAGE>
CENTRAL DIVISION
During 1999, the Central Division included Health Plan operations in
Colorado, Florida, Idaho, Louisiana, New Mexico, Oklahoma, Oregon, Texas and
Washington. During 1999, the Company sold its HMO operations in the states of
Louisiana, New Mexico, Oklahoma and Texas, and a portion of its HMO operations
in the state of Washington, and entered into definitive agreements to transition
its HMO and indemnity membership in the states of Colorado, Idaho and Washington
to third parties. See "Discontinued Operations and Anticipated Divestitures."
Subsequently, the Company consolidated and reorganized its Health Plan Divisions
into the Eastern Division, which consists of the Northeast Division and Florida,
and the Western Division, which consists of the Arizona Division, California
Division and Oregon.
The Company believes its Florida HMO and PPO operations make it the ninth
largest HMO managed care provider in terms of membership and second largest HMO
in terms of size of provider network in the state of Florida. The Company's
commercial HMO membership in Florida was 88,064 as of December 31, 1999, which
represented an increase of 5% during 1999. The Company's Medicare risk
membership in Florida was 29,053 as of December 31, 1999, which represented an
increase of 17% during 1999. The Company's Medicaid membership in Florida was
18,325 as of December 31, 1999, which represented a 35% decrease in 1999.
The Company believes that its Oregon HMO and PPO operations make it the
sixth largest HMO managed care provider in terms of membership and third largest
HMO in terms of size of provider network. The Company's commercial HMO and PPO
membership in Oregon was 100,437 as of December 31, 1999, which represented a
decrease of 24% during 1999. The decrease is due, in part, to the Company's
pricing discipline and its focus on profitable accounts.
NORTHEAST DIVISION
During 1999, the Northeast Division included Company operations in
Connecticut, New Jersey, New York, Ohio, Pennsylvania and West Virginia. As
referenced above, effective January 1, 2000, the Northeast Division and the
Company's operations in Florida were consolidated to form the Company's new
Eastern Division.
In Connecticut, New Jersey and New York, the Company and The Guardian Life
Insurance Company of America ("The Guardian") together offer both HMO and
indemnity products through a joint venture doing business as "Healthcare
Solutions." In general, the Company and The Guardian share equally in the
profits of the joint venture, subject to certain terms of the joint venture
arrangement related to expenses. The Guardian is a mutual insurer (owned by its
policy owners) which offers financial products and services, including
individual life and disability income insurance, employee benefits, pensions and
401(k) products. The Guardian is headquartered in New York and has more than
2,400 financial representatives in 119 general agencies.
The Company believes its Connecticut HMO and PPO operations make it the
largest HMO managed care provider in terms of membership and size of provider
network in the state of Connecticut. The Company's commercial HMO membership in
Connecticut was 338,072 as of December 31, 1999 (including 54,681 members under
The Guardian arrangement), a decrease of approximately 5% since the end of 1998.
The Company's Medicare risk membership in Connecticut was 27,150 as of
December 31, 1999, which represented a decrease of 39% during 1999, and the
Company's Medicaid membership in Connecticut was 74,593 as of December 31, 1999,
which represented an increase of 19% during 1999. The decreases in commercial
HMO and Medicare risk membership are due, in part, to the Company's pricing
discipline and its focus on profitable accounts.
The Company believes its New Jersey HMO and PPO operations make it the third
largest HMO managed care provider in terms of membership and the second largest
in terms of size of provider network in the state of New Jersey. The Company's
commercial HMO membership in New Jersey was 215,473 as of
4
<PAGE>
December 31, 1999 (including 83,054 members under The Guardian arrangement), a
decrease of 7% since the end of 1998. The Company's Medicare risk membership in
New Jersey was 1,897 as of December 31, 1999, which represented a decrease of
30% during 1999, and the Company's Medicaid membership in New Jersey was 25,698
as of December 31, 1999, which represented an increase of 16% during 1999. The
decreases in commercial HMO and Medicare risk membership are due, in part, to
the Company's pricing discipline and its focus on profitable accounts.
In New York, the Company had 227,119 members as of December 31, 1999, which
represented an increase of 21% during 1999. Such membership included 117,009
members under The Guardian arrangement. The Company believes its New York HMO
and PPO operations make it the fifth largest HMO managed care provider in terms
of membership and the second largest in terms of size of provider network in the
state of New York.
The Company's commercial HMO membership in eastern Pennsylvania was 41,738
as of December 31, 1999, which represented a decrease of 13% during 1999. The
Company's Medicare risk membership in eastern Pennsylvania was 13,366 as of
December 31, 1999, which represented a decrease of 5% during 1999. The decreases
in commercial HMO and Medicare risk membership are due, in part, to the
Company's pricing discipline and its focus on profitable accounts. Collectively,
the Company's commercial HMO membership in Ohio, western Pennsylvania and West
Virginia was approximately 16,500 as of December 31, 1999. The Company's
Medicare risk membership in Ohio, western Pennsylvania and West Virginia was
approximately 2,500 collectively as of December 31, 1999.
MEDICARE. The Company's Medicare+ Choice plans as of December 31, 1999 had
a combined membership of approximately 265,751 compared to 322,171 as of
December 31, 1998. The decrease in membership is due, in part, to exiting
certain markets in connection with the substantial completion of the Company's
divestiture program in 1999, the Company's pricing discipline and its focus on
profitable accounts.
The Company offers its Medicare+ Choice products directly to individuals and
to employer groups. To enroll in a Company Medicare+ Choice plan, covered
persons must be eligible for Medicare. Health care services normally covered by
Medicare are provided or arranged by the Company, in conjunction with a broad
range of preventive health care services. The federal Health Care Financing
Administration ("HCFA") pays the Company a monthly amount for each enrolled
member based, in part, upon the "Adjusted Average Per Capita Cost," as
determined by HCFA's analysis of fee-for-service costs related to beneficiary
demographics. Depending on plan design and other factors, the Company may charge
a monthly premium.
The Company's California Medicare+ Choice product, Seniority Plus, was
licensed and certified to operate in 22 California counties as of December 31,
1999. The Company's other HMOs are licensed and certified to offer Medicare+
Choice plans in 9 counties in Pennsylvania, 34 counties in Oregon, 7 counties in
Connecticut, 6 counties in Arizona, 3 counties in Florida, 20 counties in New
Jersey and 12 counties in New York.
MEDICAID PRODUCTS. As of December 31, 1999, the Company had an aggregate of
approximately 678,353 Medicaid members, principally in California. To enroll in
these Medicaid products, an individual must be eligible for Medicaid benefits
under the appropriate state regulatory requirements. The respective HMOs offer,
in addition to standard Medicaid coverage, certain additional services including
dental and vision benefits. The applicable state agency pays the Company's HMOs
a monthly fee for each Medicaid member enrolled on a percentage of
fee-for-service costs. In 1999, the Company had Medicaid members and operations
in California, Connecticut, Florida, New Jersey, New York and Washington.
ADMINISTRATIVE SERVICES ONLY BUSINESS. The Company also provides
third-party administrative services to large employer groups throughout its
service areas. Under these arrangements, the Company provides claims processing,
customer service, medical management and other administrative services without
5
<PAGE>
assuming the risk for medical costs. The Company is generally compensated for
these services on a fixed per member per month basis.
INDEMNITY INSURANCE PRODUCTS. The Company offers indemnity products as
"stand-alone" products and as part of multiple option products in various
markets. These products are offered by the Company's health and life insurance
subsidiaries which are licensed to sell insurance in 33 states and the District
of Columbia. Through these subsidiaries, the Company also offers HMO members
certain auxiliary non-health products such as group life and accidental death
and disability insurance.
The Company's health and life insurance products are provided throughout
most of the Company's service areas. The following table contains certain
information relating to such health and life insurance companies' insured PPO,
point of service ("POS"), indemnity and group life products as of December 31,
1999 in each of the four Health Plan Divisions in which the Company operated in
1999:
<TABLE>
<CAPTION>
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
-------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Insured PPO Members...................... 7,471 41,643 3,124 0
Point of Service Members................. 1,937 99,997 24,418 230,292(a)
Indemnity Members........................ 261 8,324 279 0
Group Life Members....................... 2,791 19,441 14,802 0
</TABLE>
- ------------------------
(a) Represents members under the Company's arrangement with The Guardian
described elsewhere in this Annual Report on Form 10-K.
GOVERNMENT CONTRACTS DIVISION
TRICARE. The Company's wholly-owned subsidiary, Foundation Health Federal
Services, Inc. ("Federal Services"), administers large, multi-year managed care
federal contracts with the United States Department of Defense ("DoD").
Federal Services currently administers health care contracts for DoD's
TRICARE program covering 1.5 million eligible individuals under TRICARE
(formerly CHAMPUS). Through the federal government's TRICARE program, Federal
Services provides TRICARE-eligible beneficiaries with improved access to care,
lower out-of-pocket expenses and fewer claims forms. Federal Services currently
administers three TRICARE contracts for five regions that cover the following
states:
- Region 11: Washington, Oregon and part of Idaho
- Region 6: Arkansas, Oklahoma, most of Texas, and part of Louisiana
- Regions 9, 10 and 12: California, Hawaii, Alaska and part of Arizona
During 1999, enrollment of TRICARE beneficiaries in the HMO option (called
"TRICARE Prime") of the TRICARE program for the Region 11 contract increased by
3% to 136,212 while the total estimated number of eligible beneficiaries, based
on DoD data, decreased by 1% to 247,717. During 1999, enrollment of TRICARE
beneficiaries in TRICARE Prime for the Region 6 contract increased by 13% to
364,099 while the total estimated number of eligible beneficiaries, based on DoD
data, decreased by 1% to 614,166. During 1999, enrollment of TRICARE
beneficiaries in TRICARE Prime for the Regions 9, 10 and 12 contract increased
by 6% to 351,513 while the total estimated number of eligible beneficiaries,
based on DoD data and excluding Alaska, decreased by 2% to 633,483. DoD
estimated numbers of eligible beneficiaries are subject to revision when actual
numbers become available.
Under the TRICARE contracts, Federal Services shares health care cost risk
with DoD for both gains and losses. Federal Services subcontracts to affiliated
and unrelated third parties for the administration and health care risk of parts
of these contracts. If all option periods are exercised by DoD and no further
extensions of the performance period are made, health care delivery ends on
October 31, 2000 for the
6
<PAGE>
Region 6 contract, on March 31, 2001 for the Regions 9, 10 and 12 contract, and
February 28, 2002 for the Region 11 contract. The DoD Authorization Act for
government fiscal year 1999 authorized DoD to extend the term of the current
TRICARE contracts for two years. Federal Services and DoD negotiated a
modification to the contract for Region 11 to add additional option periods
which, if exercised, will extend the period of health care delivery to
February 28, 2002. Federal Services and DoD are currently negotiating
modifications to the contracts for Region 6 and Regions 9, 10 and 12 to add
additional option periods which, if exercised, will extend the period of health
care delivery to October 31, 2002 for the Region 6 contract and March 31, 2003
for the Regions 9, 10 and 12 contract. Federal Services also expects to compete
for the rebid of those contracts.
Federal Services protested to the U.S. General Accounting Office (the "GAO")
concerning the award of the TRICARE contract for Regions 2 and 5 (mid-Atlantic
and mid-west states) to a competitor of Federal Services. The GAO sustained the
protest and recommended that DoD conduct another round of competition for that
contract. DoD filed a petition for reconsideration of the protest decision by
the GAO. The GAO denied DoD's petition for reconsideration of the Regions 2 and
5 decision and DoD re-opened the competition for that contract on July 27, 1999.
Federal Services expects to compete for the rebid of the contract for Regions 2
and 5. Proposals for the Regions 2 and 5 contract are currently due to be
submitted to DoD on April 14, 2000 and health care delivery is currently
scheduled to commence on September 1, 2001.
VETERANS AFFAIRS. During 1999, Federal Services administered nine contracts
with the U.S. Department of Veterans Affairs to manage Community Based
Outpatient Clinics ("CBOCs") in five states. Federal services also manages four
contracts with the U.S. Department of Veterans Affairs for claims re-pricing
services.
SPECIALTY SERVICES DIVISION
The Company's Specialty Services Division offers behavioral health, dental,
vision and pharmacy benefit management products and services as well as managed
care products related to bill review, administration and cost containment for
hospitals, health plans and other entities.
DENTAL AND VISION. Through DentiCare of California, Inc. ("DentiCare"), the
Company operates a dental HMO in California and Hawaii and performs dental
administrative services for an affiliate company in California and Colorado,
serving in the aggregate approximately 562,000 enrollees as of December 31,
1999. This enrollment includes 122,832 enrollees who are beneficiaries under
Medicaid dental programs, of which 34,431 enrollees are beneficiaries of
Hawaii's Medicaid program, and 88,401 enrollees who are also enrollees of
affiliated Health Plans. DentiCare is also a participant in California's Healthy
Families Program, for which initial beneficiary enrollment and service delivery
commenced in July 1998. Acquired by the Company in 1991, DentiCare has grown
from total revenues in 1992 of $24 million to $51 million for the year ended
December 31, 1999.
Operating on administrative and information system platforms in common with
DentiCare is Foundation Health Vision Services, Inc., d.b.a. AVP Vision Services
("AVP"). AVP operates in California and Arizona and provides at-risk and
administrative services under various programs that result in the delivery of
vision benefits to over 685,000 enrollees. Total revenues from AVP operations
for the year ended December 31, 1999 were $11 million. Since its acquisition by
the Company in 1992, AVP has grown from 30,000 covered enrollees to 423,000
enrollees in full-risk products and 262,000 enrollees covered under
administrative services contracts as of December 31, 1999.
Both DentiCare and AVP are licensed in California under the Knox-Keene
Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"), as
Specialized Health Care Service Plans, and compete with other HMOs, traditional
insurance companies, self-funded plans, PPOs and discounted fee-for-service
plans. The two companies share a common strategy to maximize the value and
quality of managed dental
7
<PAGE>
and vision care services while appropriately balancing financial risk assumption
among providers, enrollees and other entities to achieve the effective and
efficient use of available resources.
BEHAVIORAL HEALTH. The Company's behavioral health subsidiary, Managed
Health Network ("MHN"), is licensed in California under the Knox-Keene Act as a
Specialized Health Care Service Plan. MHN, directly and through Specialty
Services affiliates, offers behavioral health, substance abuse and employee
assistance programs ("EAPs") on an insured and self-funded basis to employers,
governmental entities and other payors in various states.
MHN provides managed behavioral health programs to employers, governmental
agencies and public entitlement programs, such as TRICARE and Medicaid. Employer
group sizes range from Fortune 100 to mid-sized companies with 200 employees.
MHN's strategy is to continue its market share achievement in the Fortune 500,
health plan and TRICARE markets through a combination of direct and consultant/
broker sales. MHN intends to achieve additional market share by capitalizing on
competitor consolidation, remaining TRICARE procurement opportunities and the
growing state and county Medicaid behavioral carve-outs, funded on either a risk
or administrative-services-only ("ASO") basis.
These products and services were provided to over 8.6 million individuals in
the year ended December 31, 1999, with approximately 3.6 million individuals
under risk-based programs, approximately 1.4 million individuals under
self-funded programs, and approximately 3.6 million individuals under EAP
programs.
WORKERS' COMPENSATION ADMINISTRATIVE SERVICES. The Company's subsidiaries
organized under Employer & Occupational Services Group, Inc. ("EOS"), formerly
WC Division, Inc., provide a full range of workers' compensation administrative
services to insurers, self-funded employers, third-party claims administrators
and public agencies. These services include injury reporting and provider
referral, automated bill review and PPO network access, field and telephonic
case management, direction of care and practice management, claim/benefit
administration, claim investigation and adjudication, litigation management and
employer personnel services. During 1999, EOS' Managed Care Services unit
provided services on more than $1.2 billion of billed charges for medical care
for covered beneficiaries of its customers. The unit processed over 2.6 million
bills from providers and hospitals located in 50 states and handled 90,000
intake calls resulting in the processing of over 47,000 injury reports and
40,000 medical care cases referred for case management services and/or
utilization review services. EOS' Claims Administration Services unit handled
more than 26,000 claims, with aggregate benefit payments by its payor customers
in excess of $237 million. Also, EOS' Employment Services unit, a temporary
staffing and direct placement service for managed care, workers' compensation
and information technology specialists, placed 3,200 temporary assignments and
had 127 personnel available for assignment in 14 states.
PHARMACY BENEFIT MANAGEMENT. Effective March 31, 1999, the Company sold
certain pharmacy benefit management assets to Advance Paradigm, Inc. ("Advance
Paradigm"). In addition, the Company and Advance Paradigm entered into a
services agreement, whereby Advance Paradigm provides to the Company's Health
Plan Divisions certain pharmacy benefit management services, primarily,
processing of claims with respect to pharmacy benefits, mail order service and
retail pharmacy network management. See "Discontinued Operations and Anticipated
Divestitures." The Company continues to manage drug manufacturer rebates,
clinical management of the pharmacy benefit and pharmacy reporting.
PROVIDER RELATIONSHIPS AND RESPONSIBILITIES
PHYSICIAN RELATIONSHIPS. Upon enrollment in most of the Company's HMO
plans, each member selects a participating physician group ("PPG") or primary
care physician from the HMO's provider panel. The primary care physicians and
PPGs assume overall responsibility for the care of members. Medical care
provided directly by such physicians includes the treatment of illnesses not
requiring referral, as well as physical examinations, routine immunizations,
maternity and child care, and other preventive health
8
<PAGE>
services. The primary care physicians and PPGs are responsible for making
referrals (approved by the HMO's or PPG's medical director) to specialists and
hospitals. Certain Company HMOs offer enrollees "open panels" under which
members may access any physician in the network without first consulting a
primary care physician.
The following table sets forth the number of primary care and specialist
physicians with whom the Company's HMOs (and certain of such HMOs' PPGs) were
contracted as of December 31, 1999 in each of the four Health Plan Divisions
operated by the Company in 1999:
<TABLE>
<CAPTION>
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
-------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Primary Care Physicians.................. 1,090 33,424 7,506 14,020
Specialist Physicians.................... 2,764 23,312 13,233 29,670
----- ------ ------ -------
Total.................................... 3,854 56,736 20,739 43,690
</TABLE>
PPG and physician contracts are generally for a period of at least one year
and are automatically renewable unless terminated, with certain requirements for
maintenance of good professional standing and compliance with the Company's
quality, utilization and administrative procedures. In California PPGs generally
receive a monthly "capitation" fee for every member served. The capitation fee
represents payment in full for all medical and ancillary services specified in
the provider agreements. The non-physician component of all hospital services is
covered by a combination of capitation and/or per diem charges. In such
capitated arrangements, in cases where the capitated provider cannot provide the
health care services needed, such providers generally contract with specialists
and other ancillary service providers to furnish the requisite services pursuant
to capitation agreements or negotiated fee schedules with specialists. Many of
the Company's HMOs outside California reimburse physicians according to a
discounted fee-for-service schedule, although several HMOs have commenced
capitation arrangements with certain providers and provider groups in their
market areas.
HOSPITAL RELATIONSHIPS. The Company's HMOs arrange for hospital care
primarily through contracts with selected hospitals in their service areas. Such
hospital contracts generally provide for multi-year terms and provide for
payments on a variety of bases, including capitation, per diem rates, case rates
and discounted fee-for-service schedules.
Covered inpatient hospital care for a member is comprehensive; it includes
the services of physicians, nurses and other hospital personnel, room and board,
intensive care, laboratory and x-ray services, diagnostic imaging and generally
all other services normally provided by acute-care hospitals. HMO or PPG nurses
and medical directors are actively involved in discharge planning and case
management, which often involves the coordination of community support services,
including visiting nurses, physical therapy, durable medical equipment and home
intravenous therapy.
In August 1999, the Company sold two hospitals which it owned and operated:
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. See "Discontinued Operations and Anticipated
Divestitures."
COST CONTAINMENT. In most HMO plan designs, the primary care physician or
PPG is responsible for authorizing all needed medical care except for emergency
medical services. By coordinating care through such physicians in cases where
reimbursement includes risk-sharing arrangements, the Company believes that
inappropriate use of medical resources is reduced and efficiencies are achieved.
To limit possible abuse in utilization of hospital services in non-emergency
situations, a certification process precedes the inpatient admission of each
member, followed by continuing review during the member's hospital stay. In
addition to reviewing the appropriateness of hospital admissions and continued
9
<PAGE>
hospital stay, the Company plays an active role in evaluating alternative means
of providing care to members and encourages the use of outpatient care, when
appropriate, to reduce the cost that would otherwise be associated with an
inpatient admission.
QUALITY ASSESSMENT. Quality assessment is a continuing priority for the
Company. Most of the Company's health plans have a quality assessment plan
administered by a committee comprised of medical directors and primary care and
specialist physicians. The committees' responsibilities include periodic review
of medical records, development and implementation of standards of care based on
current medical literature and community standards, and the collection of data
relating to results of treatment. All of the Company's health plans also have a
subscriber grievance procedure and/or a member satisfaction program designed to
respond promptly to member grievances. Aspects of such member service programs
take place both within the PPGs and within the Company's health plans. Set forth
under the heading "National Committee for Quality Assurance" below is
information regarding certain quality assessment accreditations received by the
Company's subsidiaries.
Health Benchmarks, Inc. ("HBI"), formerly the Company's Quality Initiatives
Division, was incorporated in 1999 as a wholly-owned subsidiary of the Company.
HBI is a health services information company which provides services to the
managed care sector, employers and the pharmaceutical industry. These services
include data management (data warehouse tools) and data analysis,
pharmacoeconomic analysis, Phase III and IV clinical trial support, and disease
management programs and services that support NCQA and Health Plan Employer Data
and Information Set ("HEDIS") initiatives. HBI assists decision-makers in
allocating health resources cost-effectively through evidence-based programs.
HBI also supports certain quality assessment activities of the Company's health
plans. In addition, HBI designs, implements and administers performance-based
contracting programs for hospitals and physicians on behalf of managed care
companies.
MANAGEMENT INFORMATION SYSTEMS
Effective information technology systems are critical to the Company's
operations. The Company's information technology systems include several
computer systems, each utilizing a combination of packaged and customized
software and a network of on-line terminals. The information technology systems
gather and store data on the Company's members and physician and hospital
providers. The systems contain all of the Company's necessary membership and
claims-processing capabilities as well as marketing and medical utilization
programs. These systems provide the Company with an integrated and efficient
system of billing, reporting, member services and claims processing, and the
ability to examine member encounter information for the optimization of clinical
outcomes.
The Company implemented a Year 2000 project to address the challenges posed
by the "Year 2000" issue. The Year 2000 issue is the result of computer programs
having been written in a language that used two digits rather than four to
define the applicable year. Any of the Company's computer programs (both
external and internal) that have date/time sensitive software and the outdated
software language may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in a system failure or material miscalculations
causing disruptions of operations, including, among other things, the inability
to process transactions, prepare invoices or engage in normal business
activities. As of March 15, 2000, the Company has not identified any significant
disruptions or operational problems resulting from Year 2000 issues. There can
be no assurance, however, that the Company will not still experience significant
Year 2000 problems, including as a result of third party Year 2000 problems.
The costs of the Company's Year 2000 project are set forth under the heading
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Company's 1999 Annual Report to Stockholders attached as an
exhibit to this Annual Report on Form 10-K.
10
<PAGE>
DISCONTINUED OPERATIONS AND ANTICIPATED DIVESTITURES
PHARMACY BENEFIT MANAGEMENT ASSETS. 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 management assets of
Integrated Pharmaceutical Services for approximately $65 million in cash. In
addition, the Company and Advance Paradigm entered into a services agreement,
whereby Advance Paradigm provides to the Company's Health Plan Divisions certain
pharmacy benefit management services, primarily, processing of claims with
respect to pharmacy benefits, mail order service and retail pharmacy network
management. 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.
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.
PREFERRED HEALTH NETWORK, INC. In May 1999, the Company sold the capital
stock of Preferred Health Network, Inc., a PPO network ("PHN"), to Beyond
Benefits, Inc. PHN and the Company, or certain affiliates thereof, entered into
agreements at closing to provide each other with certain continued access to
each other's networks.
SOUTHERN CALIFORNIA HOSPITALS. In August 1999, the Company sold East Los
Angeles Doctors Hospital and Memorial Hospital of Gardena, two Southern
California hospitals, to HealthPlus+ Corporation and certain affiliated
entities. Certain subsidiaries of the Company continue to maintain contractual
arrangements with the hospitals following the sale.
FHPA. In September 1999, the Company sold the capital stock of Foundation
Health Preferred Administrators, Inc., a third-party administrator subsidiary of
the Company, to Capitol Administrators, Inc.
NEW MEXICO OPERATIONS. In September 1999, the Company sold the capital
stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the
state of New Mexico, to Health Care Horizons, Inc.
UTAH OPERATIONS. In October 1999, the Company sold the outstanding capital
stock of Intergroup of Utah, Inc., the Company's HMO subsidiary in the state of
Utah, to Altius Health Plans Inc.
HN REINSURANCE LIMITED. In October 1999, the Company sold the outstanding
capital stock of HN Reinsurance Limited, a Cayman Island reinsurance subsidiary,
to AmCareco, Inc.
COLORADO OPERATIONS. In November 1999, the Company commenced the transition
of its membership in Colorado to PacifiCare of Colorado, Inc. ("PacifiCare-CO")
pursuant to a definitive agreement with PacifiCare-CO. The Company believes the
transition will be completed during the first half of 2000. Pursuant to the
definitive agreement, PacifiCare-CO is offering replacement coverage to
substantially all of the Company's Colorado HMO membership and PacifiCare Life
Assurance Company is issuing replacement indemnity coverage to substantially all
of the Company's Colorado POS membership. PacifiCare-CO is offering to enroll
such HMO members at the earliest date possible in comparable PacifiCare-CO
benefit plans within PacifiCare-CO's service area at PacifiCare's rates.
In August 1999, in connection with the Company's wind down of its business
in Colorado, the Company sold its regional claims processing facility and
accompanying real estate in Pueblo, Colorado, including certain equipment and
other assets located at the facility, to the Pueblo Economic Development Company
for total aggregate proceeds of approximately $5 million and certain other
consideration
11
<PAGE>
(including a complete release from the City of Pueblo of liabilities arising out
of certain agreements between the City and the Company).
WASHINGTON OPERATIONS. In December 1999, the Company sold the capital stock
of QualMed Washington Health Plan, Inc., the Company's HMO subsidiary in the
state of Washington ("QM-Washington"), to American Family Care Inc. ("AFC"). AFC
assumed control of the health-plan license and acquired the Medicaid and Basic
Health Plan membership of QM-Washington. The commercial HMO membership of
QM-Washington is being transitioned to PacifiCare of Washington, Inc.
("PacifiCare-WA"), Premera Blue Cross and Blue Cross of Idaho pursuant to
definitive agreements with such companies. As part of such agreements,
PacifiCare-WA will offer replacement coverage to QM-Washington's HMO and POS
groups in western Washington, Premera Blue Cross will offer replacement coverage
to substantially all of QM-Washington's HMO and POS group membership in eastern
Washington and Blue Cross of Idaho will offer replacement coverage for certain
members who reside in Idaho. Replacement coverage will consist of the new
company's benefit plans in the new company's service areas at the new company's
rates. The transition commenced in January 2000 and is anticipated to be
substantially completed during the first half of 2000.
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. Previously, the Company owned approximately 83% of the common stock of
QualMed-PA. In January 1999, the Company transferred certain assets of
QualMed-PA, including the assets relating to its preferred provider
organization, MaxNet-Registered Trademark-, to Preferred Health Network, Inc.,
then another wholly-owned subsidiary of the Company. As set forth above in this
"Discontinued Operations and Anticipated Divestitures," the Company subsequently
sold the capital stock of Preferred Health Network, Inc.
INSURANCE SUBSIDIARIES. In July 1999, the Company completed the
restructuring of certain of its insurance subsidiaries by merging Foundation
Health National Life Insurance Company ("FHNL") with Foundation Health Systems
Life and Health Insurance Company ("FHS Life") under a holding company
subsidiary of the Company, FHS Life Holdings Company, Inc.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company
("Gem"), a subsidiary of the Company, has implemented a restructuring plan to
reduce operating losses and its in-force insurance risk. As part of such
restructuring, Gem is withdrawing from certain insurance markets. Upon
completion of its current withdrawals, Gem will be operating in only two states.
As of December 31, 1999, the number of Gem's insureds was under 1,000.
Currently, Foundation Health Systems Life and Health Insurance Company, a
subsidiary of the Company, services Gem's insureds through an administrative
services agreement between the companies. The Company is reviewing the
possibility of winding up the operations of Gem or merging such operations into
another insurance subsidiary of the Company.
REAL ESTATE TRANSACTIONS. During 1999, the Company completed the sale of
nine health care centers for net proceeds of approximately $17.6 million. Such
care centers were part of fourteen care centers originally leased to, and
subsequently vacated by, FPA Medical Management, Inc. As of March 17, 2000, the
Company has sold twelve such care centers. As set forth above, in August 1999,
in connection with the Company's wind down of its business in Colorado, the
Company sold its regional claims processing facility and accompanying real
estate in Pueblo, Colorado, including certain equipment and other assets located
at the facility, to the Pueblo Economic Development Company for total aggregate
proceeds of approximately $5 million and certain other consideration. In
addition, in 1999, the Company sold a land parcel in Roseville, California and
certain other real estate located in Pueblo, Colorado for aggregate net proceeds
of approximately $913,000.
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.
12
<PAGE>
ADDITIONAL INFORMATION CONCERNING THE COMPANY'S BUSINESS
MARKETING AND SALES. Marketing for group Health Plan business is a two-step
process in which the Company first markets to employer groups and then provides
information directly to employees once the employer has selected a Company HMO.
The Company typically uses its internal sales staff to serve the large employer
groups while independent brokers work with the Company's internal sales staff to
develop business with smaller employer groups. Once selected by an employer, the
Company solicits enrollees from the employee base directly. In 1999, the Company
marketed its programs and services primarily through its direct sales staff and
independent brokers, agents and consultants. During "open enrollment" periods
when employees are permitted to change health care programs, the Company uses
direct mail, work day and health fair presentations, telemarketing, outdoor
print, radio and television advertisements to attract new enrollees. The
Company's sales efforts are supported by its marketing division which includes
research and product development, corporate communications, public relations and
marketing services.
Premiums for each employer group are generally contracted for on a yearly
basis, payable monthly. Numerous factors are considered by the Company in fixing
its monthly premiums, including employer group needs and anticipated health-care
utilization rates as forecasted by the Company's management based on the
demographic composition of, and the Company's prior experience in, its service
areas. Premiums are also affected by applicable regulations that prohibit
experience rating of group accounts (i.e., setting the premium for the group
based on its past use of health care services) and by state regulations
governing the manner in which premiums are structured.
The Company believes that the importance of the ultimate health care
consumer (or member) in the health care product purchasing process is likely to
increase in the future. Accordingly, the Company intends to focus its marketing
strategies on the development of distinct brand identities and innovative
product service offerings that will appeal to potential Health Plan members.
COMPETITION. HMOs operate in a highly competitive environment in an
industry currently subject to significant changes from business consolidations,
new strategic alliances, legislative reform and market pressures brought about
by a better informed and better organized customer base. The Company's HMOs face
substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded
plans (including self-insured employers and union trust funds), Blue Cross/Blue
Shield plans, and traditional indemnity insurance carriers, some of which have
substantially larger enrollments and greater financial resources than the
Company. The Company believes that the principal competitive features affecting
its ability to retain and increase membership include the range and prices of
benefit plans offered, provider network, quality of service, responsiveness to
user demands, financial stability, comprehensiveness of coverage, diversity of
product offerings, and market presence and reputation. The relative importance
of each of these features and key competitors vary by market. The Company
believes that it competes effectively with respect to all of these factors.
Kaiser Foundation Health Plan ("Kaiser") is the largest HMO in California
and is a competitor of the Company in the California HMO industry. In addition
to Kaiser, the Company's other HMO competitors include PacifiCare of California,
California Care (Blue Cross), Blue Shield, Aetna and CIGNA Healthplans of
California, Inc. There are also a number of other types of competitors including
self-directed plans, traditional indemnity insurance plans, and other managed
care plans. Despite the concentration of membership in the large health plans,
the environment in the state is also impacted by small, regional-based HMOs,
whose combined membership constitutes approximately 20-25% of the market. In
addition, the Company competes in California against a variety of PPOs.
The Company's largest competitor in Arizona is Health Partners. The
Company's Arizona HMO also competes with CIGNA, PacifiCare, Aetna and Blue
Cross/Blue Shield. The Company's Oregon HMO competes primarily against other
HMOs including Kaiser, PacifiCare of Oregon, Providence, Blue Cross Lifewise and
Blue Shield Regions, and with various PPOs.
13
<PAGE>
The Company's HMOs in Connecticut compete for business with commercial
insurance carriers, Blue Cross and Blue Shield of Connecticut, Aetna/U.S.
Healthcare and more than ten other HMOs. The Company's main competitors in
Pennsylvania, New York and New Jersey are Aetna/U.S. Healthcare, Independence
Blue Cross, Empire Blue Cross, Oxford Health Plans, AmeriHealth, United Health
Care, Horizon Blue Cross and Keystone Health Plan East. The Company's HMO
operations in Florida compete for business with Humana Medical Plan, United
Health Care, Health Options and Prudential HealthCare, among others.
In 1999, the Company sold its HMO operations in Louisiana, New Mexico,
Oklahoma, Texas and Utah, and a portion of its HMO operations in Washington, and
entered into definitive agreements to transition its HMO and indemnity
membership in Colorado, Idaho and Washington to third parties. See "Discontinued
Operations and Anticipated Divestitures."
GOVERNMENT REGULATION. The Company believes it is in compliance in all
material respects with all current state and federal regulatory requirements
applicable to the business being conducted by its subsidiaries. Certain of these
requirements are discussed below.
CALIFORNIA HMO REGULATIONS. California HMOs such as Health Net and certain
of the Company's specialty plans are subject to California state regulation,
principally by the DOC under the Knox-Keene Act. In 1999, California enacted a
law transferring jurisdiction of the Knox-Keene Act to a new agency, the
Department of Managed Care, which will become effective no later than July 1,
2000. Among the areas regulated by the Knox-Keene Act are: (i) adequacy of
administrative operations, (ii) the scope of benefits required to be made
available to members, (iii) manner in which premiums are structured,
(iv) procedures for review of quality assurance, (v) enrollment requirements,
(vi) composition of policy making bodies to assure that plan members have access
to representation, (vii) procedures for resolving grievances, (viii) the
interrelationship between HMOs and their health care providers, (ix) adequacy
and accessibility of the network of health care providers, (x) provider
contracts, and (xi) initial and continuing financial viability of the HMO and
its risk-bearing providers. Any material modifications to the organization or
operations of Health Net are subject to prior review and approval by the DOC.
This approval process can be lengthy and there is no certainty of approval.
Other significant changes require filing with the DOC, which may then comment
and require changes. In addition, under the Knox-Keene Act, Health Net and
certain other Company subsidiaries must file periodic reports with, and are
subject to periodic review and investigation by, the DOC. Non-compliance with
the Knox-Keene Act may result in an enforcement action, fines and penalties, and
in egregious cases, limitations on or revocation of the Knox-Keene license.
The DOC has also required the Company and its Knox-Keene licensed
subsidiaries to provide the DOC with a number of undertakings in connection with
the FHS Combination and the merger of the Company's two California full-service
HMOs in 1998. These undertakings obligate the affected companies to certain
requirements not applicable to licensees generally, or prohibit or require
regulatory approval preceding the institution of certain changes. While the
Company has been permitted to withdraw a number of these undertakings, others
remain in effect and constrain the Company's flexibility of operations. The
Company does not believe, however, that the remaining undertakings have a
material adverse effect on the Company and its licensees taken as a whole.
FEDERAL HMO REGULATION. Under the Federal Health Maintenance Organization
Act of 1973 (the "HMO Act"), services to members must be provided substantially
on a fixed, prepaid basis without regard to the actual degree of utilization of
services. Premiums established by an HMO may vary from account to account
through composite rate factors and special treatment of certain broad classes of
members, and through prospective (but not retrospective) rating adjustments.
Several of the Company's HMOs are federally qualified in certain parts of their
respective service areas under the HMO Act and are therefore subject to the
requirements of such act to the extent federally qualified products are offered
and sold.
14
<PAGE>
Additionally, there are a number of recently enacted federal laws that
further regulate managed health care. Such legislation includes the Balanced
Budget Act of 1997 and the Health Insurance Portability and Accountability Act
of 1996 ("HIPAA"). The primary effects of HIPAA are that it (i) limits
pre-existing condition exclusions applicable to individuals changing jobs or
moving to individual coverage, (ii) guarantees the availability of health
insurance for employees in the small group market and (iii) prevents the
exclusion of individuals from coverage under group plans based on health status.
The Company's Medicare risk contracts are subject to regulation by HCFA.
HCFA has the right to audit HMOs operating under Medicare contracts to determine
the quality of care being rendered and the degree of compliance with HCFA's
contracts and regulations. The Company's Medicaid business is also subject to
regulation by HCFA, as well as state agencies.
PENDING FEDERAL AND STATE LEGISLATION. There are a number of initiatives
and regulations currently pending at the federal and state level which could
increase regulation of the health care industry. Such legislation includes
"managed care reform," "patients bill of rights," regulations under HIPAA and
certain other initiatives which, if enacted, could have significant adverse
effects on the Company's operations. See "Item 4--Cautionary Statements--Federal
and State Legislation." The Company cannot predict the outcome of any of the
pending legislative or regulatory proposals, nor the extent to which the Company
may be affected by the enactment of any such legislation or regulation.
OTHER HMO REGULATIONS. In each state in which the Company does business,
HMOs must file periodic reports with, and their operations are subject to
periodic examination by, state licensing authorities. In addition, each HMO must
meet numerous state licensing criteria and secure the approval of state
licensing authorities before implementing certain operational changes, including
the development of new product offerings and, in some states, the expansion of
service areas. To remain licensed, each HMO must continue to comply with state
laws and regulations and may from time to time be required to change services,
procedures or other aspects of its operations to comply with changes in
applicable laws and regulations. HMOs are required by state law to meet certain
minimum capital and deposit and/or reserve requirements in each state and may be
restricted from paying dividends to their parent corporations under certain
circumstances from time to time. Several states have increased minimum capital
requirements, pursuant to proposals by the National Association of Insurance
Commissioners to institute risk-based capital requirements. Regulations in these
and other states may be changed in the future to further increase equity
requirements. Such increases could require the Company to contribute additional
capital to its HMOs. Any adverse change in governmental regulation or in the
regulatory climate in any state could materially impact the HMOs operating in
that state. The HMO Act and state laws place various restrictions on the ability
of HMOs to price their products freely. The Company must comply with certain
provisions of state insurance and similar laws, including regulations governing
the Company's ability to seek ownership interests in new HMOs, PPOs and
insurance companies, or otherwise expand its geographic markets or diversify its
product lines.
INSURANCE REGULATIONS. State departments of insurance (the "DOIs") regulate
insurance and third-party administrator business conducted by certain
subsidiaries of the Company (the "Insurance Subsidiaries") pursuant to various
provisions of state insurance codes and regulations promulgated thereunder. The
Insurance Subsidiaries are subject to various capital reserve and other
financial, operating and disclosure requirements established by the DOIs and
state laws. The Insurance Subsidiaries must also file periodic reports regarding
their activities regulated by the DOIs and are subject to periodic reviews of
those activities by the DOIs. The Company must also obtain approval from, or
file copies with, the DOIs for all of its group and individual policies prior to
issuing those policies. The Company does not believe that the requirements
imposed by the DOIs will have a material impact on the ability of the Insurance
Subsidiaries to conduct their business profitably.
15
<PAGE>
NATIONAL COMMITTEE FOR QUALITY ASSURANCE ("NCQA"). NCQA is an independent,
non-profit organization that reviews and accredits HMOs and assesses an HMO's
quality improvement, utilization management, credentialing process, commitment
to members' rights and preventive health services. HMOs that comply with NCQA's
review requirements and quality standards receive NCQA accreditation. After an
NCQA review is completed, NCQA will issue one of four designations. These are
(i) accreditation for three years; (ii) accreditation for one year;
(iii) provisional accreditation for twelve to eighteen months to correct certain
problems with a follow-up review to determine qualification for accreditation;
and (iv) not accredited. Foundation Health, A Florida Health Plan, Inc.; Health
Net, the Company's HMO in California; and Intergroup Prepaid Health Services of
Arizona, Inc., the Company's HMO in Arizona, have all received NCQA
accreditations for three years. QualMed Plans for Health, Inc. (Pennsylvania)
and QualMed Plans for Health of Western Pennsylvania, Inc. have each received
one year provisional accreditation from NCQA. QualMed Plans for Health of Ohio
and West Virginia, Inc. applied for NCQA accreditation in October 1998, but did
not receive it. Certain of the Company's other Health Plan subsidiaries are in
the process of applying for NCQA accreditation.
SERVICE MARKS
The Company's service marks and/or trademarks include, among others: THE
ACUTE CARE ALTERNATIVE-Registered Trademark-, Alliance 2000-SM- Alliance
1000-SM-, Asthmawise-SM-, AVP-SM-, AVP Vision Plans-SM-, BabyWell-SM-, BEING
WELL-Registered Trademark-, CARECAID-Registered Trademark-, CMP-Registered
Trademark-, COMBINED CARE-Registered Trademark-, COMBINED CARE PLUS-SM-,
COMMUNITY MEDICAL PLAN, INC. and design-Registered Trademark-, A CURE FOR THE
COMMON HMO-Registered Trademark-, Feetbeat Worksite Walking Program-SM-, FIRM
SOLUTIONS-Registered Trademark-, FLEX ADVANTAGE-Registered Trademark-, FLEX
NET-SM-, FOUNDATION HEALTH and design-Registered Trademark-, FOUNDATION HEALTH
GOLD-Registered Trademark-, Foundation Health Systems-SM-, HANK-Registered
Trademark-, HANK and design-Registered Trademark-, HEALTH NET-Registered
Trademark-, Health Net ACCESS-SM-, Health Net Comp.24-SM-, Health Net ELECT-SM-,
Health Net INSIGHT-SM-, Health Net OPTIONS-SM-, Health Net SELECT-SM-, Health
Net Seniority Plus-SM-, Health Smart and design-SM-, Healthworks (stylized)-SM-,
Heart & Soul-SM-, IMET and design-Registered Trademark-, Indian
design-Registered Trademark-, INDIVIDUAL PREFERRED PPO-Registered Trademark-,
InterCare-SM-, InterComp-SM-, InterFlex-SM-, Inter Mountain Employers Trust-SM-,
InterPlus-SM-, LIFE WITH DIGNITY AND HOPE-Registered Trademark-, MAKING QUALITY
HEALTH CARE AFFORDABLE-Registered Trademark-, M.D. Health Plan Personal Medical
Management-SM-, On the Road to Good Health-SM-, PHYSICIANS HEALTH
SERVICES-Registered Trademark-, QUALASSIST-Registered Trademark-,
QUALADMIT-Registered Trademark-, QUALCARE-Registered Trademark-, QUALCARE
PREFERRED-Registered Trademark-, QUAL-MED-Registered Trademark-, QUALMED-SM-,
QUALMED HEALTH & LIFE INSURANCE COMPANY-Registered Trademark-, QUALMED PLANS FOR
HEALTH-Registered Trademark-, Rapid Access-SM-, SENIOR SECURITY-Registered
Trademark-, SENIOR VALUE-Registered Trademark-, Someone at Your Side-SM-,
Sun/Mountain design-Registered Trademark-, The Final Piece of the Healthcare
Puzzle-SM-, VitalLine-SM-, VITALTEAM-Registered Trademark-, WELL MANAGED CARE
RIGHT FROM THE START-Registered Trademark-, WELL REWARDS-Registered Trademark-,
Well Woman-SM-, Wise Choice-SM-, WORKING WELL TOGETHER-Registered Trademark-,
and Your Partner in Healthy Living-SM-, and certain designs related to the
foregoing.
The Company utilizes these and other marks in connection with the marketing
and identification of products and services. The Company believes such marks are
valuable and material to its marketing efforts.
EMPLOYEES
The Company currently employs approximately 12,000 employees, excluding
temporary employees. Such employees perform a variety of functions, including
administrative services for employers, providers and members, negotiation of
agreements with physician groups, hospitals, pharmacies and other health care
providers, handling claims for payment of hospital and other services, and
providing data processing services. The Company's employees are not unionized
and the Company has not experienced any work stoppage since its organization.
The Company considers its relations with its employees to be very good.
In connection with the FHS Combination, the Company adopted a significant
restructuring plan which provides for a workforce reduction, the consolidation
of employee benefit plans and the consolidation of certain office locations,
which the Company has been effectuating. In addition, the Company's
16
<PAGE>
substantial completion of its divestiture program in 1999 resulted in additional
workforce reductions and operational consolidations.
ITEM 2. PROPERTIES
The Company leases office space for its principal executive offices in
Woodland Hills, California and its offices in Rancho Cordova, California.
The Woodland Hills facility, with approximately 410,000 square feet, is
leased pursuant to two leases, the earlier of which expires in December 2001
with respect to 300,000 square feet. The Company has a right to renew each of
such leases. The aggregate rent for the two leases for 1999 was approximately
$11.1 million. The Company's principal executive offices are located in the
Woodland Hills facility, as are much of the Company's California HMO operations.
The Company and its subsidiaries also lease an aggregate of approximately
390,000 square feet of office space in Rancho Cordova, California. The Company's
aggregate rent obligations under these leases were approximately $6.1 million in
1999. These leases expire at various dates through January 2003. The Rancho
Cordova facilities serve as a regional data processing center and house certain
Specialty Services and California HMO operations.
The Company also leases a total of approximately 250,000 square feet of
office space in Irvine, California and San Rafael, California for certain
Specialty Services operations. In addition to the Company's office space
referenced above, the Company and its subsidiaries lease approximately 140 sites
in 23 states, comprising roughly 1.85 million square feet of space.
In addition, the Company owns facilities comprising, in the aggregate,
nearly 1.1 million square feet of space. These facilities include headquarters
for the Company's health plan subsidiaries in Connecticut and Arizona, as well
as data processing facilities located in Rancho Cordova, California. The Company
is currently considering the sale of certain care centers in California and
Arizona.
In August 1999, in connection with the Company's wind down of its business
in Colorado, the Company sold its regional claims processing facility and
accompanying real estate in Pueblo, Colorado, including certain equipment and
other assets located at the facility. See "Discontinued Operations and
Anticipated Divestitures." Such facility consisted of approximately 72,500
square feet of office space. The Company is in the process of selling certain
remaining facilities in Pueblo, Colorado. Also in August 1999, the Company sold
two Southern California hospitals owned and operated by the Company, which
hospitals comprised approximately 250,000 square feet of space.
Management believes that its ownership and rental costs are consistent with
those available for similar space in the applicable local area. The Company's
properties are well maintained, considered adequate and are being utilized for
their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
In July 1996, the Company's predecessor, HSI, the owner of 1,234,544 shares
of Series F Preferred Stock of Health Data Sciences Corporation ("HDS"), voted
its HDS shares in favor of the acquisition of HDS by Medaphis Corporation
("Medaphis"). HSI received as the result of the acquisition 976,771 shares of
Medaphis common stock in exchange for its Series F Preferred Stock. In November
1996, HSI filed a lawsuit against Medaphis and its former Chairman and Chief
Executive Officer. The Company alleged that Medaphis and certain 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.
17
<PAGE>
In September 1999, the Company and Medaphis (which changed its name to
Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement Agreement and
Release pursuant to which the Company received net proceeds of approximately $25
million consisting of cash from Per-Se and Per-Se's insurers and proceeds from
the sale of both the 976,771 shares of Medaphis (now Per-Se) common stock then
owned by the Company and additional shares of Per-Se common stock issued to the
Company as part of the settlement. In exchange, the Company and Per-Se
terminated the ongoing litigation and granted each other a general release.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in
federal and state courts seeking an unspecified amount of damages on behalf of
an alleged class of persons who purchased shares of common stock, convertible
debentures and options to purchase common stock of FPA Medical Management, Inc.
("FPA") at various times between February 3, 1997 and May 15, 1998. The FPA
Complaints name as defendants FPA, certain of FPA's auditors, the Company and
certain of the Company's former officers. The FPA Complaints allege that the
Company and such former officers violated federal and state securities laws by
misrepresenting and failing to disclose certain information about a 1996
transaction between the Company and FPA, about FPA's business and about the
Company's 1997 sale of FPA common stock held by the Company. All claims against
the Company's former officers were voluntarily dismissed from the consolidated
class actions in both federal and state court. The Company has filed a motion to
dismiss all claims asserted against it in the consolidated federal class actions
but has not formally responded to the other complaints. Management believes
these suits against the Company and its former officers are without merit and
intends to defend the actions vigorously.
PAY V. FOUNDATION HEALTH SYSTEMS, INC.
On November 22, 1999, a complaint was filed in the United States District
Court for the Southern District of Mississippi in a lawsuit entitled PAY V.
FOUNDATION HEALTH SYSTEMS, INC. (2:99CV329). The two count complaint seeks
certification of a nationwide class action and alleges that cost containment
measures used by FHS-affiliated health maintenance organizations, preferred
provider organizations and point-of-service health plans violate provisions of
the federal Racketeer Influenced and Corrupt Organizations Act ("RICO") and the
federal Employee Retirement Income Security Act ("ERISA"). The action seeks
unspecified damages and injunctive relief. On January 24, 2000, FHS filed a
motion to stay consideration of class certification issues until the resolution
of a motion to transfer or dismiss the action for lack of jurisdiction and
venue. On January 25, 2000, the court stayed the case pending resolution of
matters in an action pending in the Southern District of Mississippi against
Humana, Inc. Management believes the suit is without merit and intends to
vigorously defend the action.
BAJA INC. V. LOS ANGELES MEDICAL MANAGEMENT CORP., EAST LOS ANGELES DOCTORS
HOSPITAL FOUNDATION, INC.
In September 1983, a lawsuit was filed in Los Angeles Superior Court by Baja
Inc. ("Baja") against East Los Angeles Doctors Hospital Foundation, Inc.
("Hospital") and Century Medicorp ("Century") arising out of a multi-phase
written contract for operation of a pharmacy at the Hospital during the period
September 1978 through September 1983. In October 1992, Foundation Health
Corporation, now a subsidiary of the Company, acquired the Hospital and Century,
and thereafter continued the vigorous defense of this action. In August 1993,
the Court awarded Baja $549,532 on a portion of its claim. In December 1994, the
Court concluded that Baja also could seek certain additional damages subject to
proof. On July 5, 1995, the Court awarded Baja an additional $1,015,173 (plus
interest) in lost profits damages. In October 1995, both of the parties
appealed. The Court of Appeal reversed portions of the judgment, directing the
trial court to conduct additional hearings on Baja's damages. In January 2000,
after further proceedings on the issue of Baja's lost profits, the Court awarded
Baja an additional $4,996,019,
18
<PAGE>
plus prejudgment interest. The Company is in the process of preparing
appropriate post trial motions in this case, and is also considering an appeal
of the Court's final judgment.
STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC.
Physicians Health Services, Inc. ("PHS"), a subsidiary of the Company, was
sued on Dec. 14, 1999 in the United States District Court in Connecticut by the
Attorney General of Connecticut, Richard Blumenthal, acting on behalf of a group
of state residents. The lawsuit is premised on ERISA, and alleges that PHS has
violated its duties under that Act by managing its prescription drug formulary
in a manner that serves its own financial interest rather than those of plan
beneficiaries. The suit seeks to have PHS revamp its formulary system, and to
provide patients with written denial notices and instructions on how to appeal.
PHS intends to defend the suit vigorously, and has filed a motion to dismiss
which asserts that the state residents the Attorney General purports to
represent all received a prescription drug appropriate for their conditions and
therefore suffered no injuries whatsoever, that his office lacks standing to
bring the suit and that the allegations fail to state a claim under ERISA. The
State must file an answer to the motion by March 15, 2000, and a decision is
expected this spring.
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various
other legal proceedings, many of which involve claims for coverage encountered
in the ordinary course of its business. Based in part on advice from litigation
counsel to the Company and upon information presently available, management of
the Company is of the opinion that the final outcome of all such proceedings
should not have a material adverse effect upon the Company's results of
operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of the
Company, either through solicitation of proxies or otherwise, during the fourth
quarter of the year ended December 31, 1999.
OTHER INFORMATION
REVOLVING CREDIT FACILITY
The Company has an unsecured, five-year $1.5 billion revolving credit
facility pursuant to a Credit Agreement dated July 8, 1997 (the "Credit
Agreement") with the banks identified in the Credit Agreement (the "Banks") and
Bank of America National Trust and Savings Association ("Bank of America") as
Administrative Agent. All previous revolving credit facilities were terminated
and rolled into the Credit Agreement. The Credit Agreement contains customary
representations and warranties, affirmative and negative covenants, and events
of default. Specifically, Section 7.11 of the Credit Agreement provides that the
Company and its subsidiaries may, so long as no event of default exists:
(i) declare and distribute stock as a dividend; (ii) purchase, redeem or acquire
its stock, options and warrants with the proceeds of concurrent public
offerings; and (iii) declare and pay dividends or purchase, redeem or otherwise
acquire its capital stock, warrants, options or similar rights with cash subject
to certain specified limitations.
Under the Credit Agreement, as amended pursuant to a Letter Agreement dated
as of March 27, 1998, the First Amendment and Waiver to Credit Agreement dated
as of April 6, 1998, the Second Amendment to Credit Agreement dated as of
July 31, 1998, the Third Amendment to Credit Agreement dated as of November 6,
1998 and the Fourth Amendment of 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
19
<PAGE>
transactions with affiliates; and (iv) permitted to incur additional
indebtedness in an aggregate amount not to exceed $1,000,000,000 upon certain
terms and conditions. The Credit Agreement also provides for mandatory
prepayment of the outstanding loans under the Credit Agreement with a certain
portion of the proceeds from the issuance of such indebtedness and from the
sales of assets, resulting in a permanent reduction of the aggregate amount of
commitments under the Credit Agreement by the amount so prepaid. As of
December 31, 1999, the maximum commitment level permitted under the Credit
Agreement was approximately $1.37 billion, of which approximately $330 million
remained available. The Amendments also provided for an increase in the interest
and facility fees under the Credit Agreement.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend
distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights and the expiration of the Rights, and in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then outstanding and no separate Rights certificates will be distributed.
Subject to certain exceptions contained in the Rights Agreement dated as of
June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as
Rights Agent (the "Rights Agreement"), the Rights will separate from the Common
Stock in the event any person acquires 15% or more of the outstanding Class A
Common Stock, the Board of Directors of the Company declares a holder of 10% or
more of the outstanding Class A Common Stock to be an "Adverse Person," or any
person commences a tender offer for 15% or more of the Class A Common Stock
(each event causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock at a price of $170.00 per
one-thousandth share. However, in the event any person acquires or commences a
tender offer for 15% or more of the outstanding Class A Common Stock, or the
Board of Directors of the Company declares a holder of 10% or more of the
outstanding Class A Common Stock to be an "Adverse Person," the Rights (subject
to certain exceptions contained in the Rights Agreement) will instead become
exercisable for Class A Common Stock having a market value at such time equal to
$340.00. The Rights are redeemable under certain circumstances at $.01 per Right
and will expire, unless earlier redeemed, on July 31, 2006.
A copy of the Rights Agreement has been filed with the Securities and
Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on
Form 8-A (File No. 001-12718). In connection with its execution of the Merger
Agreement for the merger transaction involving Foundation Health Corporation and
Health Systems International, Inc., the Company's predecessors, the Company
entered into Amendment No. 1 (the "Rights Amendment") to the Rights Agreement to
exempt the Merger Agreement and related transactions from triggering the Rights.
In addition, the Rights Amendment modifies certain terms of the Rights Agreement
applicable to the determination of certain "Adverse Persons," which
modifications became effective upon consummation of the transactions provided
for under the Merger Agreement. This summary description of the Rights does not
purport to be complete and is qualified in its entirely by reference to the
Rights Agreement.
20
<PAGE>
THE CALIFORNIA WELLNESS FOUNDATION
Pursuant to the Amended California Wellness Foundation Shareholder
Agreement, dated as of January 28, 1992 (the "CWF Shareholder Agreement"), by
and among the Company, The California Wellness Foundation (the "CWF"), and
certain stockholders (the "HNMH Stockholders") of HN Management Holdings, Inc.
(a predecessor to the Company) ("HNMH") named therein, the CWF was subject to
various volume and manner of sale restrictions specified in the CWF Shareholder
Agreement which limited the number of shares of Class B Common Stock that the
CWF could dispose of prior to December 31, 1998. The CWF and the Company are
also party to a Registration Rights Agreement dated as of March 2, 1995 (the
"CWF Registration Rights Agreement") pursuant to which the CWF has the right to
demand registration for sale in underwritten public offerings of up to 8,026,298
shares of Class B Common Stock.
Under the relevant provisions of California law, when a corporation converts
from nonprofit to for-profit corporate status, the equivalent of the fair market
value of the nonprofit corporation must be contributed to a successor charity
that has a charitable purpose consistent with the purposes of the nonprofit
entity. The CWF was formed to be the charitable recipient of the conversion
settlement when Health Net (a subsidiary of the Company) effected a conversion
from nonprofit to for-profit status, which occurred in February 1992 (the
"Conversion"). In connection with the Conversion, Health Net issued to the CWF
promissory notes in the original principal amount of $225 million (the "CWF
Notes") and shares of Class B Common Stock (which immediately prior to the
business combination involving HNMH and QualMed, Inc. were split to become
25,684,152 shares of Class B Common Stock then held by the CWF). While such
shares are held by the CWF, they are entitled to the same economic benefit as
Class A Common Stock, but are non-voting in nature. If the CWF sells or
transfers such shares to an unrelated third party, they automatically convert to
Class A Common Stock.
Pursuant to certain agreements with the CWF, the Company redeemed 4,550,000
shares of Class B Common Stock from the CWF on June 27, 1997. The CWF has also
sold shares of Class B Common Stock to unrelated third parties, which shares of
common stock automatically converted into shares of Class A Common Stock at the
time of such sales.
As a result of various sales of Class B Common Stock by CWF, CWF has
gradually reduced its holdings and, as of March 17, 2000, held 563,742 shares of
Class B Common Stock. On November 15, 1999, $13,482,745, representing the
remaining principal and interest under the CWF Notes, was paid off. As a result,
the CWF Notes are no longer outstanding.
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby filing cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others,
could cause the Company's actual financial or enrollment results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to the Company. The following factors should be considered
in conjunction with any discussion of operations or results by the Company or
its representatives, including any forward-looking discussion, as well as
comments contained in press releases, presentations to securities analysts or
investors, or other communications by the Company.
In making these statements, the Company is not undertaking to address or
update each factor in future filings or communications regarding the Company's
business or results, and is not undertaking to address how any of these factors
may have caused changes to discussions or information contained in previous
filings or communications. In addition, certain of these matters may have
affected the Company's past results and may affect future results.
21
<PAGE>
HEALTH CARE COSTS. A large portion of the revenue received by the Company
is expended to pay the costs of health care services or supplies delivered to
its members. The total health care costs incurred by the Company are affected by
the number of individual services rendered and the cost of each service. Much of
the Company's premium revenue is set in advance of the actual delivery of
services and the related incurring of the cost, usually on a prospective annual
basis. While the Company attempts to base the premiums it charges at least in
part on its estimate of expected health care costs over the fixed premium
period, competition, regulations and other circumstances may limit the Company's
ability to fully base premiums on estimated costs. In addition, many factors may
and often do cause actual health care costs to exceed those costs estimated and
reflected in premiums. These factors may include increased utilization of
services, increased cost of individual services, catastrophes, epidemics,
seasonality, new mandated benefits or other regulatory changes, and insured
population characteristics.
The managed health care industry is labor intensive and its profit margin is
low. Hence, it is especially sensitive to inflation. Health care industry costs
have been rising annually at rates higher than the Consumer Price Index.
Increases in medical expenses without corresponding increases in premiums could
have a material adverse effect on the Company.
PHARMACEUTICAL COSTS. The costs of pharmaceutical products and services are
increasing faster than the costs of other medical products and services. Thus,
the Company's HMOs face ever higher pharmaceutical expenses. The inability to
manage pharmaceutical costs could have an adverse effect on the Company's
financial condition.
MEDICAL MANAGEMENT. The Company's profitability is dependent, to a large
extent, upon its ability to accurately project and manage health care costs,
including without limitation, appropriate benefit design, utilization review and
case management programs, and to secure appropriate risk-sharing arrangements
with providers, while providing members with quality health care. For example,
high out-of-network utilization of health care providers and services may have
significant adverse affects on the Company's ability to manage health care costs
and member utilization of health care. There can be no assurance that the
Company through its medical management programs will be able to continue to
manage medical costs sufficiently to restore and/or maintain profitability in
all of its product lines.
FEDERAL AND STATE LEGISLATION. There are numerous legislative proposals
currently before Congress and the state legislatures which, if enacted, could
materially affect the managed health care industry and the regulatory
environment. Recent financial difficulties of certain health care service
providers and plans and/or continued publicity of the health care industry could
alter or increase legislative consideration of these or additional proposals.
These proposals include "managed care reform," "patients bill of rights" and
certain other initiatives which, if enacted, could have significant adverse
effects on the Company's operations. Such measures propose, among other things,
to:
- expand a health plan's exposure to tort and other liability, under federal
and/or state law, including for coverage determinations and provider
malpractice and care decisions;
- restrict a health plan's ability to limit coverage to medically necessary
care;
- require third party review of certain care decisions;
- expedite or modify grievance and appeals procedures;
- mandate certain benefits and services that could increase costs;
- limit a health plan's ability to use medical information for managed care
coordination, disease management and research;
- mandate additional administrative oversight and structure for handling
medical information;
- restrict a health plan's ability to select and/or terminate providers; and
- restrict or eliminate the use of prescription drug formularies.
In particular, the Department of Health and Human Services has proposed
certain regulations under the Health Insurance Portability and Accountability
Act of 1996. Currently, the primary effects of HIPAA are that it (i) limits
pre-existing condition exclusions applicable to individuals changing jobs or
moving to
22
<PAGE>
individual coverage, (ii) guarantees the availability of health insurance for
employees in the small group market and (iii) prevents the exclusion of
individuals from coverage under group plans based on health status. The proposed
regulations under HIPAA could significantly impact how individually identifiable
health information is stored and disclosed, as well as materially increase the
responsibilities, and potential liabilities, of parties who handle such
information. While such regulations have not yet been enacted and are subject to
change, there can be no assurance that such regulations or similar regulations
will not be enacted.
The Company cannot predict the outcome of any of these legislative or
regulatory proposals, nor the extent to which the Company may be affected by the
enactment of any such legislation or regulation. Legislation or regulation which
causes the Company to change its current manner of operation or increases its
exposure to liability could have a material adverse effect on the Company's
results of operations, financial condition and ability to compete.
COMPETITION. The Company competes with a number of other entities in the
geographic and product markets in which it operates, some of which other
entities may have certain characteristics, capabilities or resources which give
them an advantage in competing with the Company. These competitors include HMOs,
PPOs, self-funded employers, insurance companies, hospitals, health care
facilities and other health care providers. The Company believes there are few
barriers to entry in these markets, so that the addition of new competitors can
readily occur. Certain of the Company's customers may decide to perform for
themselves functions or services currently provided by the Company, which could
result in a decrease in the Company's revenues. Certain of the Company's
providers may decide to market products and services to Company customers in
competition with the Company. In addition, significant merger and acquisition
activity has occurred in the industry in which the Company operates as well as
in industries which act as suppliers to the Company such as the hospital,
physician, pharmaceutical and medical device industries. This activity may
create stronger competitors and/or result in higher health care costs. Provider
service organizations may be created by health care providers to offer competing
managed care products. To the extent that there is strong competition or that
competition intensifies in any market, the Company's ability to retain or
increase customers, its revenue growth, its pricing flexibility, its control
over medical cost trends and its marketing expenses may all be adversely
affected.
PROVIDER RELATIONS. One of the significant techniques the Company uses to
manage health care costs and utilization and to monitor the quality of care
being delivered is to contract with physicians, hospitals and other providers.
Because of the large number of providers with which the Company's health plans
contract, the Company currently believes it has a limited exposure to provider
relations issues. In any particular market, however, providers could refuse to
contract with the Company, demand higher payments or take other actions which
could result in higher health care costs, less desirable products for customers
and members, insufficient provider access for current members or to support
growth, or difficulty in meeting regulatory or accreditation requirements.
In some markets, certain providers, particularly hospitals,
physician/hospital organizations or multi-specialty physician groups, may have
significant market positions or even monopolies. Many of these providers may
compete directly with the Company. If such providers refuse to contract with the
Company or utilize their market position to negotiate favorable contracts or
place the Company at a competitive disadvantage, the Company's ability to market
products or to be profitable in those areas could be adversely affected.
The Company contracts with providers in California and to a lesser degree in
other areas, primarily through capitation fee arrangements. Under a capitation
fee arrangement, the Company 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. Providers who enter into such arrangements
generally contract with specialists and other secondary providers to provide
services not offered by the primary provider. The inability of providers to
properly manage costs under capitation arrangements can result in financial
instability of such providers and the termination of their relationship with the
Company. In addition,
23
<PAGE>
payment or other disputes between the primary provider and specialists with whom
it contracts can result in a disruption in the provision of services to the
Company's members or a reduction in the services available. A primary provider's
financial instability or failure to pay secondary providers for services
rendered could lead secondary providers to demand payment from the Company, even
though the Company has made its regular capitated payments to the primary
provider. Depending on state law, the Company could be liable for such claims.
In California, the liability of the Company's HMO subsidiaries for unpaid
provider claims has not been definitively settled. There can be no assurance
that the Company's subsidiaries will not be liable for unpaid provider claims.
There can also be no assurance that providers with whom the Company contracts
will properly manage the costs of services, maintain financial solvency or avoid
disputes with secondary providers, the failure of any of which could have an
adverse effect on the provision of services to members and the Company's
operations.
MARKETING. The Company markets its products and services through both
employed sales people and independent sales agents. Although the Company has a
number of such sales employees and agents, if certain key sales employees or
agents or a large subset of such individuals were to leave the Company, its
ability to retain existing customers and members could be impaired. In addition,
certain of the Company's customers or potential customers consider rating,
accreditation or certification of the Company by various private or governmental
bodies or rating agencies necessary or important. Certain of the Company's
health plans or other business units may not have obtained or may not desire or
be able to obtain or maintain such accreditation or certification which could
adversely affect the Company's ability to obtain or retain business with such
customers.
The managed health care industry has recently received a significant amount
of negative publicity. Such general publicity, or any negative publicity
regarding the Company in particular, could adversely affect the Company's
ability to sell its products or services, could require changes to the Company's
products or services, or could create regulatory problems for the Company. In
this connection, certain of the Company's subsidiaries have experienced
significant negative enrollment trends in certain lines of business.
Furthermore, the managed care industry recently has experienced significant
merger and acquisition activity. Speculation, uncertainty or negative publicity
about the Company or certain of its lines of business could adversely affect the
ability of the Company to market its products.
GOVERNMENT PROGRAMS AND REGULATION. The Company's business is subject to
extensive federal and state laws and regulations, including, but not limited to,
financial requirements, licensing requirements, enrollment requirements and
periodic examinations by governmental agencies. The laws and rules governing the
Company's business and interpretations of those laws and rules are subject to
frequent change. For example, as described earlier in this Annual Report on Form
10-K, in the section entitled "California HMO Regulations," the California
legislature has recently made significant changes to the laws regulating HMOs
operating in that state. Existing or future laws and rules could force the
Company to change how it does business and may restrict the Company's revenue
and/or enrollment growth, and/or increase its health care and administrative
costs, and/or increase the Company's exposure to liability with respect to
members, providers or others. In particular, the Company's HMO and insurance
subsidiaries are subject to regulations relating to cash reserves, minimum net
worth, premium rates, and approval of policy language and benefits. Although
such regulations have not significantly impeded the growth of the Company's
business to date, there can be no assurance that the Company will be able to
continue to obtain or maintain required governmental approvals or licenses or
that regulatory changes will not have a material adverse effect on the Company's
business. Delays in obtaining or failure to obtain or maintain such approvals,
or moratoria imposed by regulatory authorities, could adversely affect the
Company's revenue or the number of its members, increase costs or adversely
affect the Company's ability to bring new products to market as forecasted. In
addition, efforts to enact changes to Medicare could impact the structure of the
Medicare program, benefit designs and reimbursement. Changes to the current
operation of the Company's Medicare services could have a material adverse
affect on the Company's results of operations.
24
<PAGE>
A significant portion of the Company's revenues relate to federal, state and
local government health care coverage programs, such as Medicare and Medicaid
programs. Such contracts carry certain risks such as higher comparative medical
costs, government regulatory and reporting requirements, the possibility of
reduced or insufficient government reimbursement in the future, and higher
marketing and advertising costs per member as a result of marketing to
individuals as opposed to groups. Such risk contracts also are generally subject
to frequent change including changes which may reduce the number of persons
enrolled or eligible, reduce the revenue received by the Company or increase the
Company's administrative or health care costs under such programs. In the event
government reimbursement were to decline from projected amounts, the Company's
failure to reduce the health care costs associated with such programs could have
a material adverse effect upon the Company's business. Changes to such
government programs in the future may also affect the Company's willingness to
participate in such programs.
The Company is also subject to various governmental audits and
investigations. Such activities could result in the loss of licensure or the
right to participate in certain programs, or the imposition of fines, penalties
and other sanctions. In addition, disclosure of any adverse investigation or
audit results or sanctions could negatively affect the Company's reputation in
various markets and make it more difficult for the Company to sell its products
and services.
The amount of government receivables set forth in the Company's financial
statements represents the Company's best estimate of the government's liability.
As of December 31, 1999, the Company's government receivables were $290.3
million. The receivables are estimates and generally subject to government audit
and negotiation. In addition, inherent in government contracts are an
uncertainty of and vulnerability to government disagreements. The final amounts
actually received by the Company may be significantly greater or less than the
amounts recognized by the Company.
MANAGEMENT INFORMATION SYSTEMS. The Company's business is significantly
dependent on effective information systems. The information gathered and
processed by the Company's management information systems assists the Company
in, among other things, pricing its services, monitoring utilization and other
cost factors, processing provider claims, billing its customers on a timely
basis and identifying accounts for collection. The Company's customers and
providers also depend upon the Company's information systems for membership
verification, claims status and other information. The Company has many
different information systems for its various businesses and such systems
require continual maintenance, upgrading and enhancement to meet the Company's
operational needs. Moreover, the merger, acquisition and divestiture activity of
the Company requires frequent transitions to or from, and the integration of,
various information management systems. The Company is in the process of
attempting to reduce the number of its systems and also to upgrade and expand
its information systems capabilities. Any difficulty associated with the
transition to or from information systems, any inability or failure to properly
maintain management information systems, or any inability or failure to
successfully update or expand processing capability in the future in accordance
with the Company's business needs, could result in operational disruptions, loss
of existing customers and difficulty in attracting new customers, customer and
provider disputes, regulatory problems, increases in administrative expenses
and/or other adverse consequences. In addition, the Company may, from
time-to-time, obtain significant portions of its systems-related or other
services or facilities from independent third parties which may make the
Company's operations vulnerable to such third parties' failure to perform
adequately.
The Company undertook an extensive effort to assess and modify its computer
applications and business processes to provide for their continued functionality
in light of the "Year 2000" issue. The "Year 2000" issue is the result of
computer programs having been written in a language that used two digits rather
than four to define the applicable year. Any of the Company's computer programs
that have time sensitive software and the outdated software language 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.
25
<PAGE>
As of March 15, 2000, the Company has not identified any significant
disruptions or operational problems resulting from Year 2000 issues. In
addition, the Company is not aware of any significant problems experienced by
delegated authorities or strategically important third parties that would have a
material adverse impact on the Company's operations. There can be no assurance,
however, that the Company will not still experience significant disruptions or
operational problems related to Year 2000 issues, including as a result of Year
2000 problems experienced by third parties.
The costs of the Company's Year 2000 project are set forth under the heading
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Company's 1999 Annual Report to Stockholders attached as an
exhibit to this Annual Report on Form 10-K.
ADMINISTRATION AND MANAGEMENT. The level of administrative expense is a
partial determinant of the Company's profitability. While the Company attempts
to effectively manage such expenses, increases in staff-related and other
administrative expenses may occur from time to time due to business or product
start-ups or expansions, growth or changes in business, acquisitions, regulatory
requirements or other reasons. Such expense increases are not clearly
predictable and increases in administrative expenses may adversely affect
results.
The Company currently believes it has a relatively experienced, capable
management staff. Loss of certain managers or a number of such managers could
adversely affect the Company's ability to administer and manage its business.
MANAGEMENT OF GROWTH. The Company has made several large acquisitions in
recent years, and continues to explore acquisition opportunities. Failure to
effectively integrate acquired operations could result in increased
administrative costs or customer confusion or dissatisfaction. The Company may
also not be able to manage this growth effectively, including not being able to
continue to develop processes and systems to support growing operations. There
can be no assurance that the Company will be able to maintain its historic
growth rate or efficiently or effectively expand its operations.
POTENTIAL DIVESTITURES. In 1999, the Company substantially completed a
program to divest certain non-core assets. There can be no assurance that
indemnification obligations, unknown liabilities or unforeseen post-transaction
costs related to such transactions will not have an adverse effect on the
Company's business or financial condition. Furthermore, there can be no
assurance that, having divested such non-core operations, the Company will be
able to achieve greater profitability, or any profitability, strengthen its core
operations or compete more effectively in its existing markets. In addition, the
Company continues to evaluate the profitability realized or likely to be
realized by its existing businesses and operations, and is reviewing from a
strategic standpoint which of its businesses or operations should be divested.
Entering into, evaluating or consummating divestiture transactions may entail
certain risks and uncertainties in addition to those which may result from any
such change in the Company's business operations, including but not limited to
extraordinary transaction costs, unknown indemnification liabilities or
unforeseen administrative needs, any of which could result in reduced revenues,
increased charges, post-transaction administrative costs or could otherwise have
a material adverse effect on the Company's business, financial condition or
results of operations. See "Discontinued Operations and Anticipated
Divestitures."
LOSS RESERVES. The Company's loss reserves are estimates of future costs
based on various assumptions. The accuracy of these estimates may be affected by
external forces such as changes in the rate of inflation, the regulatory
environment, the judicious administration of claims, medical costs and other
factors. Included in the loss reserves are estimates for the costs of services
which have been incurred but not reported ("IBNR"). Estimates are continually
monitored and reviewed and, as settlements are made or estimates adjusted,
differences are reflected in current operations. Such estimates are subject to
the impact of changes in the regulatory environment and economic conditions.
Given the inherent variability of such estimates, the actual liability could
differ significantly from the amounts provided. Moreover, if the assumptions on
which the estimates are based prove to be incorrect and reserves are inadequate
to cover the Company's actual experience, the Company's financial condition
could be adversely affected.
26
<PAGE>
LITIGATION AND INSURANCE. The Company is subject to a variety of legal
actions to which any corporation may be subject, including employment and
employment discrimination-related suits, employee benefit claims, breach of
contract actions, tort claims, shareholder suits, including for securities
fraud, and intellectual property related litigation. In addition, because of the
nature of its business, the Company incurs and likely will continue to incur
potential liability for claims related to its business, such as failure to pay
for or provide health care, poor outcomes for care delivered or arranged,
provider disputes, including disputes over withheld compensation, and claims
related to self-funded business. In some cases, substantial non-economic or
punitive damages may be sought. While the Company currently has insurance
coverage for some of these potential liabilities, others may not be covered by
insurance (such as punitive damages), the insurers may dispute coverage or the
amount of insurance may not be enough to cover the damages awarded. In addition,
insurance coverage for all or certain forms of liability may become unavailable
or prohibitively expensive in the future.
STOCK MARKET. Recently, the market prices of the securities of certain of
the publicly-held companies in the industry in which the Company operates have
shown volatility and sensitivity in response to many factors, including public
communications regarding managed care, legislative or regulatory actions,
litigation or threatened litigation, health care cost trends, pricing trends,
competition, earning or membership reports of particular industry participants,
and acquisition activity. There can be no assurances regarding the level or
stability of the Company's share price at any time or the impact of these or any
other factors on the share price.
RECENT DEVELOPMENTS
PHARMACY BENEFITS MANAGEMENT ASSETS. 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 management assets of
Integrated Pharmaceutical Services for approximately $65 million in cash. In
addition, the Company and Advance Paradigm entered into a services agreement,
whereby Advance Paradigm provides to the Company's Health Plan Divisions certain
pharmacy benefit management services, primarily, processing of claims with
respect to pharmacy benefits, mail order service and retail pharmacy network
management. 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.
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.
PREFERRED HEALTH NETWORK, INC. In May 1999, the Company sold the capital
stock of Preferred Health Network, Inc., a PPO network ("PHN"), to Beyond
Benefits, Inc. PHN and the Company, or certain affiliates thereof, entered into
agreements at closing to provide each other with certain continued access to
each other's networks.
SOUTHERN CALIFORNIA HOSPITALS. In August 1999, the Company sold East Los
Angeles Doctor's Hospital and Memorial Hospital of Gardena, two Southern
California hospitals, to HealthPlus+ Corporation and certain affiliated
entities. Certain subsidiaries of the Company continue to maintain contractual
arrangements with the hospitals following the sale.
FHPA. In September 1999, the Company sold the capital stock of Foundation
Health Preferred Administrators, Inc., a third-party administrator subsidiary of
the Company, to Capitol Administrators, Inc.
27
<PAGE>
NEW MEXICO OPERATIONS. In September 1999, the Company sold the capital
stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the
state of New Mexico, to Health Care Horizons, Inc.
UTAH OPERATIONS. In October 1999, the Company sold the outstanding capital
stock of Intergroup of Utah, Inc., the Company's HMO subsidiary in the state of
Utah, to Altius Health Plans Inc.
HN REINSURANCE LIMITED. In October 1999, the Company sold the outstanding
capital stock of HN Reinsurance Limited, a Cayman Island reinsurance subsidiary,
to AmCareco, Inc.
COLORADO OPERATIONS. Effective November 16, 1999, the Company commenced the
transition of its membership in Colorado to PacifiCare of Colorado, Inc.
("PacifiCare-CO") pursuant to a definitive agreement with PacifiCare-CO. The
Company believes the transition will be completed during the first half of 2000.
Pursuant to the definitive agreement, PacifiCare-CO is offering replacement
coverage to substantially all of the Company's Colorado HMO membership and
PacifiCare Life Assurance Company is issuing replacement indemnity coverage to
substantially all of the Company's Colorado POS membership. PacifiCare-CO is
offering to enroll such HMO members at the earliest date possible in comparable
PacifiCare-CO benefit plans within PacifiCare-CO's service area at PacifiCare's
rates.
In August 1999, in connection with the Company's wind down of its business
in Colorado, the Company sold its regional claims processing facility and
accompanying real estate in Pueblo, Colorado, including certain equipment and
other assets located at the facility, to the Pueblo Economic Development Company
for total aggregate proceeds of approximately $5 million and certain other
consideration (including a complete release from the City of Pueblo of
liabilities arising out of certain agreements between the City and the Company).
WASHINGTON OPERATIONS. In December 1999, the Company sold the capital stock
of QualMed Washington Health Plan, Inc., the Company's HMO subsidiary in the
state of Washington ("QM-Washington"), to American Family Care Inc. ("AFC"). AFC
assumed control of the health-plan license and acquired the Medicaid and Basic
Health Plan membership of QM-Washington. The commercial HMO membership of
QM-Washington is being transitioned to PacifiCare of Washington, Inc.
("PacifiCare-WA"), Premera Blue Cross and Blue Cross of Idaho pursuant to
definitive agreements with such companies. As part of such agreements,
PacifiCare-WA will offer replacement coverage to QM-Washington's HMO and POS
groups in western Washington, Premera Blue Cross will offer replacement coverage
to substantially all of QM-Washington's HMO and POS group membership in eastern
Washington and Blue Cross of Idaho will offer replacement coverage for certain
members who reside in Idaho. Replacement coverage will consist of the new
company's benefit plans in the new company's service areas at the new company's
rates. The transition commenced on January 1, 2000 and is anticipated to be
substantially completed during the first half of 2000.
MEDAPHIS. In July 1996, the Company's predecessor, HSI, the owner of
1,234,544 shares of Series F Preferred Stock of Health Data Sciences Corporation
("HDS"), voted its HDS shares in favor of the acquisition of HDS by Medaphis
Corporation ("Medaphis"). HSI received as the result of the acquisition 976,771
shares of Medaphis common stock in exchange for its Series F Preferred Stock. In
November 1996, HSI filed a lawsuit against Medaphis and its former Chairman and
Chief Executive Officer. The Company alleged that Medaphis and certain 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.
In September 1999, the Company and Medaphis (which changed its name to
Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement Agreement and
Release pursuant to which the Company received net proceeds of approximately $25
million consisting of cash from Per-Se and Per-Se's insurers and proceeds from
the sale of both the 976,771 shares of Medaphis (now Per-Se) common stock then
owned by
28
<PAGE>
the Company and additional shares of Per-Se common stock issued to the Company
as part of the settlement. In exchange, the Company and Per-Se terminated the
ongoing litigation and granted each other a general release.
MEDPARTNERS PROVIDER NETWORK, INC. On March 11, 1999, MedPartners Provider
Network, Inc. ("MPN"), a Knox-Keene licensed entity and a subsidiary of
MedPartners, Inc., a publicly-held physician practice and pharmacy benefit
management company (now known as Caremark Rx, Inc.) was placed into
conservatorship by the State of California under Section 1393(c) of the
California Health and Safety Code. The conservator immediately filed a petition
under Chapter 11 of the Bankruptcy Code on behalf of MPN.
MedPartners, Inc., MPN and the State of California executed an Amended and
Restated Operations and Settlement Agreement dated as of June 16, 1999 (the "O&S
Agreement"), containing the basic principles for an orderly transition of the
California operations of MedPartners, Inc., and the resolution of unpaid
provider claims. A Bankruptcy Court Order approving the O&S Agreement was
obtained by MPN on July 19, 1999. Although court approval of the O&S Agreement
has been obtained, a number of conditions subsequent and third party consents
required by such agreement are yet to occur or be obtained before the
transactions reflected therein will become effective.
At this time, no assurances can be given that a final settlement agreement
on the terms reflected in the O&S Agreement will become effective or be
implemented. In the event of a final implementation of a settlement on the terms
reflected in the O&S Agreement, the Company believes that the bankruptcy of MPN
will not have a material adverse effect on the Company's California operations.
If the settlement reflected in the O&S Agreement is not fully implemented, such
failure could have a material adverse effect on the Company's California
operations in the event the Company is ultimately held liable to pay unpaid
provider claims.
At the time MPN was placed into conservatorship, MPN and various provider
groups and clinics affiliated with MedPartners, Inc. provided health care
services to approximately 215,000 enrollees of the Company's Health Net HMO
subsidiary. As of August 1999, sales had been consummated on all of the
physician groups associated with MedPartners, Inc. Accordingly, all Health Net
enrollees have been moved to the successor physician groups or other providers.
REAL ESTATE TRANSACTIONS. During 1999, the Company completed the sale of
nine health care centers for net proceeds of approximately $17.6 million. Such
care centers were part of fourteen care centers originally leased to, and
subsequently vacated by, FPA Medical Management, Inc. As of March 17, 2000, the
Company has sold twelve such care centers. As set forth above, in August 1999,
in connection with the Company's wind down of its business in Colorado, the
Company sold its regional claims processing facility and accompanying real
estate in Pueblo, Colorado, including certain equipment and other assets located
at the facility, to the Pueblo Economic Development Company for total aggregate
proceeds of approximately $5 million and certain other consideration. In
addition, in 1999, the Company sold a land parcel in Roseville, California and
certain other real estate located in Pueblo, Colorado for aggregate net proceeds
of approximately $913,000.
FOHP. In 1997, the Company purchased convertible and nonconvertible
debentures of FOHP, Inc., a New Jersey corporation ("FOHP"), in the aggregate
principal amounts of approximately $80.7 million and $24 million, respectively.
In 1997 and 1998, the Company converted certain of the convertible debentures
into shares of Common Stock of FOHP, resulting in the Company owning 99.6% of
the outstanding common stock of FOHP. The nonconvertible debentures mature on
December 31, 2002.
Effective January 1, 1999, Physicians Health Services of New Jersey, Inc., a
New Jersey HMO wholly-owned by the Company, merged with and into First Option
Health Plan of New Jersey ("FOHP-NJ"), a New Jersey HMO subsidiary of FOHP, and
FOHP-NJ changed its name to Physicians Health Services of New Jersey, Inc.
("PHS-NJ"). Effective July 30, 1999, upon approval by the stockholders of FOHP
at a special meeting, a wholly-owned subsidiary of the Company merged into FOHP
and FOHP became a
29
<PAGE>
wholly-owned subsidiary of the Company. In connection with the merger, the
former minority shareholders of FOHP are entitled to either $0.25 per share (the
value per FOHP share as of December 31, 1998 as determined by an outside
appraiser) or payment rights which entitle the holders to receive as much as
$15.00 per payment right on or about July 1, 2001, provided certain hospital and
other provider participation conditions are met. Additional consideration of
$2.25 per payment right will be paid to certain holders of the payment rights if
PHS-NJ achieves certain annual returns on common equity and the participation
conditions are met.
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. Previously, the Company owned approximately 83% of the common stock of
QualMed-PA. In January 1999, the Company transferred certain assets of
QualMed-PA, including the assets relating to its preferred provider
organization, MaxNet-Registered Trademark-, to Preferred Health Network, Inc.,
then another wholly-owned subsidiary of the Company. As set forth above in this
"Recent Developments," the Company subsequently sold the capital stock of
Preferred Health Network, Inc.
INSURANCE SUBSIDIARIES. In July 1999, the Company completed the
restructuring of certain of its insurance subsidiaries by merging Foundation
Health National Life Insurance Company ("FHNL") with Foundation Health Systems
Life and Health Insurance Company ("FHS Life") under a holding company
subsidiary of the Company, FHS Life Holdings Company, Inc.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company
("Gem"), a subsidiary of the Company, has implemented a restructuring plan to
reduce operating losses and its in-force insurance risk. As part of such
restructuring, Gem is withdrawing from certain insurance markets. Upon
completion of its current withdrawals, Gem will be operating in only two states.
As of December 31, 1999, the number of Gem's insureds was under 1,000.
Currently, Foundation Health Systems Life and Health Insurance Company, a
subsidiary of the Company, services Gem's insureds through an administrative
services agreement between the companies. The Company is reviewing the
possibility of winding up the operations of Gem or merging such operations into
another insurance subsidiary of the Company.
OTHER POTENTIAL DIVESTITURES
CERTAIN OTHER OPERATIONS. The Company continues to evaluate the
profitability realized or likely to be realized by its existing businesses and
operations, and is reviewing from a strategic standpoint which of such
businesses or operations should be divested.
NEW VENTURES GROUP
The Company believes that the Internet and related new technologies will
fundamentally change managed care organizations. Accordingly, the Company has
created a New Ventures Group to focus on the strategic direction of the Company
in light of the Internet and related technologies and to pursue opportunities
consistent with such direction. Currently, the Company is developing
collaborative approaches with business partners to transform their existing
assets and expertise into new e-business opportunities. The Company believes
that net-enabled connectivity among purchasers, consumers, managed care
organizations, providers and other trading partners is a prerequisite to
creating and capturing e-business opportunities. The Company is currently
developing business concepts to take advantage of those market opportunities
that provide value to consumers, purchasers of benefits and the providers of
medical and health care services.
30
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the
Company's Class A Common Stock, par value $.001 per share (the "Class A Common
Stock"), on The New York Stock Exchange, Inc. ("NYSE") since January 2, 1998.
<TABLE>
<CAPTION>
HIGH LOW
----------- -----------
<S> <C> <C>
Calendar Quarter--1998
First Quarter............................................. 29 1/16 22 1/4
Second Quarter............................................ 32 5/8 25 3/8
Third Quarter............................................. 26 7/8 9
Fourth Quarter............................................ 15 3/4 5 7/8
Calendar Quarter--1999
First Quarter............................................. 12 7/16 7 11/16
Second Quarter............................................ 20 1/16 10 13/16
Third Quarter............................................. 16 15/16 8 7/8
Fourth Quarter............................................ 10 1/2 6 1/4
Calendar Quarter--2000
First Quarter (through March 17, 2000).................... 11 11/16 7 7/8
</TABLE>
On March 17, 2000, the last reported sales price per share of the Class A
Common Stock was $7 15/16 per share.
DIVIDENDS
No dividends have been paid by the Company during the preceding two fiscal
years. The Company has no present intention of paying any dividends on its
Common Stock.
The Company is a holding company and, therefore, its ability to pay
dividends depends on distributions received from its subsidiaries, which are
subject to regulatory net worth requirements and certain additional state
regulations which may restrict the declaration of dividends by HMOs, insurance
companies and licensed managed health care plans. The payment of any dividend is
at the discretion of the Company's Board of Directors and depends upon the
Company's earnings, financial position, capital requirements and such other
factors as the Company's Board of Directors deems relevant.
Under the Credit Agreement entered into on July 8, 1997 with Bank of America
as agent, the Company cannot declare or pay cash dividends to its stockholders
or purchase, redeem or otherwise acquire shares of its capital stock or
warrants, rights or options to acquire such shares for cash except to the extent
permitted under such Credit Agreement as described elsewhere in this Annual
Report on Form 10-K.
HOLDERS
As of March 17, 2000, there were approximately 2,000 holders of record of
Class A Common Stock. The California Wellness Foundation (the "CWF") is the only
holder of record of the Company's Class B Common Stock, par value $.001 per
share (the "Class B Common Stock"), which constitutes less than 1% of the
Company's aggregate equity. Under the Company's Fourth Amended and Restated
Certificate of Incorporation, shares of the Company's Class B Common Stock have
the same economic benefits as shares of the Company's Class A Common Stock, but
are non-voting. Upon the sale or other transfer of shares of
31
<PAGE>
Class B Common Stock by the CWF to an unrelated third party, such shares
automatically convert into Class A Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on page 1, and is incorporated herein by reference and
made a part hereof.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on pages 15 through 23, and is incorporated herein by
reference and made a part hereof.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on page 24, and is incorporated herein by reference and
made a part hereof.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on pages 25 through 53, and is incorporated herein by
reference and made a part hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1999. Such information is
incorporated herein by reference and made a part hereof.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1999. Such information is
incorporated herein by reference and made a part hereof.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1999. Such information is
incorporated herein by reference and made a part hereof.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1999. Such information is
incorporated herein by reference and made a part hereof.
32
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS
1. FINANCIAL STATEMENTS
The following consolidated financial statements are incorporated by
reference into this Annual Report on Form 10-K from pages 25 to 53 of the
Company's Annual Report to Stockholders for the year ended December 31, 1999:
Report of Deloitte & Touche LLP
Consolidated balance sheets at December 31, 1999 and 1998
Consolidated statements of operations for each of the three years in the
period ended December 31, 1999
Consolidated statements of stockholders' equity for each of the three years
in the period ended December 31, 1999
Consolidated statements of cash flows for each of the three years in the
period ended December 31, 1999
Notes to consolidated financial statements
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule and accompanying report thereon
are filed as a part of this Annual Report on Form 10-K:
Report of Deloitte & Touche LLP
Schedule I--Condensed Financial Information of Registrant (Parent Company
Only)
All other schedules are omitted because they are not applicable, not
required or because the required information is included in the consolidated
financial statements or notes thereto which are incorporated by reference into
this Annual Report on Form 10-K from the Company's 1999 Annual Report to
Stockholders.
3. EXHIBITS
The following exhibits are filed as part of this Annual Report on Form 10-K
or are incorporated herein by reference:
<TABLE>
<C> <S>
2.1 Agreement and Plan of Merger, dated October 1, 1996, by and
among Health Systems International, Inc., FH Acquisition
Corp. and Foundation Health Corporation (filed as
Exhibit 2.5 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996, which is incorporated by
reference herein).
2.2 Agreement and Plan of Merger, dated May 8, 1997, by and
among the Company, PHS Acquisition Corp. and Physicians
Health Services, Inc. (filed as Exhibit 2.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997, which is incorporated by reference herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated
October 20, 1997, by and among the Company, PHS Acquisition
Corp. and Physicians Health Services, Inc. (filed as
Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997, which is
incorporated by reference herein).
</TABLE>
33
<PAGE>
<TABLE>
<C> <S>
3.1 Fourth Amended and Restated Certificate of Incorporation of
the Registrant (filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (File No. 333-24621),
which is incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed
as Exhibit 3.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997, which is
incorporated by reference herein).
3.3 Certain Amendments to the Fifth Amended and Restated Bylaws
of the Registrant (filed as Exhibit 3.3 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999, which is incorporated by reference
herein).
4.1 Form of Class A Common Stock Certificate (included as
Exhibit 4.2 to the Company's Registration Statements on
Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively), which is incorporated by reference herein).
4.2 Form of Class B Common Stock Certificate (included as
Exhibit 4.3 to the Company's Registration Statements on
Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively), which is incorporated by reference herein).
4.3 Rights Agreement dated as of June 1, 1996 by and between the
Company and Harris Trust and Savings Bank, as Rights Agent
(filed as Exhibit 99.1 to the Company's Registration
Statement on Form 8-A (File No. 001-12718), which is
incorporated by reference herein).
4.4 First Amendment to the Rights Agreement dated as of
October 1, 1996, by and between the Company and Harris Trust
and Savings Bank, as Rights Agent (filed as Exhibit 10.40 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, which is incorporated by reference
herein).
*10.1 Employment Letter Agreement between the Company and Karin D.
Mayhew dated January 22, 1999 (filed as Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, which is incorporated by reference
herein).
*10.2 Employment Letter Agreement between the Company and Ross D.
Henderson dated April 29, 1999 (filed as Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, which is incorporated by reference
herein).
*10.3 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).
*10.4 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).
*10.5 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).
*10.6 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).
*10.7 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).
*10.8 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).
</TABLE>
34
<PAGE>
<TABLE>
<C> <S>
*10.9 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 herein by
reference).
*10.10 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
herein by reference).
*10.11 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 herein by reference).
*10.12 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 herein by
reference).
*10.13 Employment Letter Agreement between the Company and Karen
Coughlin dated March 12, 1998 (filed as Exhibit 10.17 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated herein by
reference).
*10.14 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
herein by reference).
*10.15 Form of Severance Payment Agreement dated December 4, 1998
by and between the Company and various of its executive
officers (filed as Exhibit 10.21 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998,
which is incorporated herein by reference).
*10.16 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).
*10.17 Severance Payment Agreement between the Company and J.
Robert Bruce dated September 15, 1998 (filed as
Exhibit 10.23 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, which is incorporated
herein by reference).
*10.18 Severance Payment Agreement between the Company and Maurice
Costa dated April 6, 1998 (filed as Exhibit 10.24 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated herein by
reference).
*10.19 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 herein by
reference).
*10.20 Waiver and Release of Claims between the Company and Robert
Natt (filed as Exhibit 10.20 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1998, which is
incorporated herein by reference).
*10.21 Waiver and Release of Claims between the Company and Dale T.
Berkbigler, M.D. dated as of July 1, 1999 (filed as
Exhibit 10.22 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999, which is
incorporated herein by reference).
</TABLE>
35
<PAGE>
<TABLE>
<C> <S>
*10.22 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).
*10.23 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).
*10.24 The Company's Deferred Compensation Plan effective as of
May 1, 1998 (filed as Exhibit 10.66 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998,
which is incorporated herein by reference).
*10.25 The Company's Deferred Compensation Plan Trust Agreement
dated as of September 1, 1998 between the Company and Union
Bank of California (filed as Exhibit 10.31 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1998, which is incorporated herein by reference).
*10.26 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).
*10.27 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).
*10.28 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 herein by
reference).
*10.29 The Company's 1995 Stock Appreciation Right Plan (filed as
Exhibit 10.12 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1995, which is
incorporated by reference herein).
*10.30 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).
*10.31 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).
*10.32 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).
*10.33 The Company's Employee Stock Purchase Plan (filed as
Exhibit 10.47 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997, which is
incorporated by reference herein).
*10.34 The Company's Performance-Based Annual Bonus Plan (filed as
Exhibit 10.35 to Registration Statement on Form S-4 (File
No. 33-86524), which is incorporated by reference herein).
*10.35 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).
</TABLE>
36
<PAGE>
<TABLE>
<C> <S>
*10.36 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
herein by reference).
*10.37 The Company's Supplemental Executive Retirement Plan
effective as of January 1, 1996 (filed as Exhibit 10.65 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated herein by
reference).
*10.38 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).
*10.39 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).
*10.40 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).
*10.41 FHC Directors Retirement Plan (filed as an exhibit to FHC's
Annual Report on Form 10-K for the year ended June 30, 1994
filed with the Commission on September 24, 1994, which is
incorporated by reference herein).
*10.42 FHC's Deferred Compensation Plan, as amended and restated
(filed as Exhibit 10.99 to FHC's Annual Report on Form 10-K
for the year ended June 30, 1995, filed with the Commission
on September 27, 1995, which is incorporated by reference
herein).
*10.43 FHC's Supplemental Executive Retirement Plan, as amended and
restated (filed as Exhibit 10.100 to FHC's Annual Report on
Form 10-K for the year ended June 30, 1995, filed with the
Commission on September 27, 1995, which is incorporated by
reference herein).
*10.44 FHC's Executive Retiree Medical Plan, as amended and
restated (filed as Exhibit 10.101 to FHC's Annual Report on
Form 10-K for the year ended June 30, 1995, filed with the
Commission on September 27, 1995, which is incorporated by
reference herein).
10.45 Stock and Note Purchase Agreement by and between FHC,
Jonathan H., Scheff, M.D., FPA Medical Management, Inc., FPA
Medical Management of California, Inc. and FPA Independent
Practice Association dated as of June 28, 1996 (filed as
Exhibit 10.109 to FHC's Annual Report on Form 10-K for the
year ended June 30, 1996, which is incorporated by reference
herein).
10.46 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).
10.47 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).
</TABLE>
37
<PAGE>
<TABLE>
<C> <S>
10.48 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).
10.49 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).
10.50 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).
10.51 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).
10.52 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).
10.53 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).
10.54 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).
10.55 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).
10.56 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).
10.57 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).
10.58 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).
10.59 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).
</TABLE>
38
<PAGE>
<TABLE>
<C> <S>
10.60 Settlement Agreement and Release dated September 20, 1999 by
and between the Company and Per-Se Technologies, Inc.
(formerly Medaphis Corporation) (filed as Exhibit 99.1 to
the Company's Current Report on Form 8-K dated
September 20, 1999, which is incorporated by reference
herein).
11.1 Statement relative to computation of per share earnings of
the Company (included in Note 2 to the Financial
Statements, which is incorporated by reference from
pages 25 to 53 of the Annual Report to Stockholders for the
year ended December 31, 1999).
+13.1 Selected portions of the 1999 Annual Report to Stockholders,
a copy of which portions are filed herewith.
+21.1 Subsidiaries of the Company, a copy of which is filed
herewith.
+23.1 Consent of Deloitte & Touche LLP, a copy of which is filed
herewith.
+27.1 Financial Data Schedule for 1999, a copy of which has been
filed with the EDGAR version of this filing.
</TABLE>
- ------------------------
* Management contract or compensatory plan or arrangement required to be filed
(and/or incorporated by reference) as an exhibit to this Annual Report on
Form 10-K pursuant to Item 14(c) of Form 10-K.
+ A copy of the exhibit is being filed with this Annual Report on Form 10-K.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed by the Company during the
quarterly period ended December 31, 1999.
39
<PAGE>
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Board of Directors and Stockholders of
Foundation Health Systems, Inc.
Woodland Hills, California
We have audited the consolidated financial statements of Foundation Health
Systems, Inc. (the "Company") as of December 31, 1999 and 1998 and for each of
the three years in the period ended December 31, 1999, and have issued our
report thereon dated February 29, 2000, appearing in and incorporated by
reference in this Annual Report on Form 10-K of Foundation Health Systems, Inc.
for the year ended December 31, 1999. Our audits also included the financial
statement schedule of Foundation Health Systems, Inc., listed in Item 14(a)(2).
The financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Los Angeles, California
February 29, 2000
40
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 108,057 $ 74,767
Investments available for sale............................ 11,756 3,352
Other assets.............................................. 13,549 6,654
Due from subsidiaries..................................... 285,588 597,321
---------- ----------
Total current assets.................................... 418,950 682,094
Property and equipment, net................................. 21,437 7,854
Investment in subsidiaries.................................. 1,584,007 1,459,335
Notes receivable due from subsidiaries...................... 39,385 --
Other assets................................................ 59,189 65,881
---------- ----------
Total assets............................................ $2,122,968 $2,215,164
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to subsidiaries....................................... 11,684 72,915
Other current liabilities................................. 177,048 159,484
---------- ----------
Total current liabilities............................... 188,732 232,399
Notes payable............................................... 1,039,250 1,235,500
Other liabilities........................................... 3,787 3,223
---------- ----------
Total liabilities....................................... 1,231,769 1,471,122
---------- ----------
Stockholders' equity:
Common stock and additional paid-in capital............... 643,498 641,945
Common stock held in treasury, at cost.................... (95,831) (95,831)
Retained earnings......................................... 347,601 205,236
Accumulated other comprehensive loss...................... (4,069) (7,308)
---------- ----------
Total stockholders' equity.............................. 891,199 744,042
---------- ----------
Total liabilities and stockholders' equity............ $2,122,968 $2,215,164
========== ==========
</TABLE>
See accompanying note to condensed financial statements.
41
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- --------- ---------
<S> <C> <C> <C>
Revenues:
Investment and other income............................... $ 7,379 $ 5,766 $ 6,485
Net gain on sale of businesses and buildings.............. 58,332 5,600 --
-------- --------- ---------
Total revenues.............................................. 65,711 11,366 6,485
-------- --------- ---------
Expenses:
General and administrative................................ 40,961 27,480 17,288
Amortization and depreciation............................. 3,153 2,197 1,315
Interest.................................................. 90,386 91,717 42,118
Asset impairment, merger, restructuring and other costs... 3,746 39,602 42,189
-------- --------- ---------
Total expenses.............................................. 138,246 160,996 102,910
-------- --------- ---------
Loss from continuing operations before income taxes and
equity in net income of subsidiaries...................... (72,535) (149,630) (96,425)
Income tax benefit.......................................... 19,393 61,333 39,533
Equity in net income (loss) of subsidiaries................. 195,819 (76,861) (10,938)
-------- --------- ---------
Income (loss) from continuing operations.................... 142,677 (165,158) (67,830)
Discontinued operations:
Loss from operations, net of tax.......................... -- -- (30,409)
Loss from disposition, net of tax......................... -- -- (88,845)
-------- --------- ---------
Income (loss) before cumulative effect of a change in
accounting principle...................................... 142,677 (165,158) (187,084)
Cumulative effect of a change in accounting principle, net
of tax.................................................... (312) -- --
-------- --------- ---------
Net income (loss)........................................... $142,365 $(165,158) $(187,084)
======== ========= =========
</TABLE>
See accompanying note to condensed financial statements.
42
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES.................... $ 84,743 $ (39,871) $(521,154)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales or maturity of investments available for sale....... 22,576 8,777 11,400
Purchases of investments available for sale............... -- (6,264) (309)
Sales of property and equipment........................... 170 16,376 --
Purchases of property and equipment....................... (2,630) (3,532) (20,695)
Other assets.............................................. 7,765 4,771 (130,755)
Proceeds from the sale of businesses and properties....... 137,728 -- --
Sale of net assets of discontinued operations............. -- 257,100 --
Acquisition of businesses, net of cash acquired........... -- -- (293,625)
--------- --------- ---------
Net cash provided by (used in) investing activities......... 165,609 277,228 (433,984)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock
purchases............................................... 1,553 13,209 21,506
Proceeds from issuance of notes payable................... 220,000 155,000 946,000
Principal payments on notes payable....................... (416,250) (207,000) (873)
Stock repurchase.......................................... -- -- (111,334)
Cash dividends received from subsidiaries................. 75,040 2,900 140,994
Capital contributions to subsidiaries..................... (97,405) (143,439) (33,875)
--------- --------- ---------
Net cash provided by (used in) financing activities......... (217,062) (179,330) 962,418
--------- --------- ---------
Net increase in cash and cash equivalents................... 33,290 58,027 7,280
Cash and cash equivalents, beginning of period.............. 74,767 16,740 9,460
--------- --------- ---------
Cash and cash equivalents, end of period.................... $ 108,057 $ 74,767 $ 16,740
========= ========= =========
</TABLE>
See accompanying note to condensed financial statements.
43
<PAGE>
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
NOTE TO CONDENSED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
Foundation Health Systems, Inc.'s ("FHS") investment in subsidiaries is
stated at cost plus equity in undistributed earnings (losses) of subsidiaries.
FHS' share of net income (loss) of its unconsolidated subsidiaries is included
in consolidated income (loss) using the equity method. This condensed financial
information of registrant should be read in conjunction with the consolidated
financial statements of Foundation Health Systems, Inc. and subsidiaries.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this Report to be
signed on its behalf by the undersigned thereunto duly authorized, on the 20th
day of March, 2000.
<TABLE>
<S> <C> <C>
FOUNDATION HEALTH SYSTEMS, INC.
By: /s/ JAY M. GELLERT
-----------------------------------------
Jay M. Gellert
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
By: /s/ STEVEN P. ERWIN
-----------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING AND FINANCIAL
OFFICER)
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf of
the Company and in the capacities indicated on the 20th day of March, 2000.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ J. THOMAS BOUCHARD
------------------------------------------- Director March 20, 2000
J. Thomas Bouchard
/s/ GEORGE DEUKMEJIAN
------------------------------------------- Director March 20, 2000
Gov. George Deukmejian
/s/ THOMAS T. FARLEY
------------------------------------------- Director March 20, 2000
Thomas T. Farley
/s/ PATRICK FOLEY
------------------------------------------- Director March 20, 2000
Patrick Foley
/s/ EARL B. FOWLER
------------------------------------------- Director March 20, 2000
Admiral Earl B. Fowler
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ JAY M. GELLERT
------------------------------------------- Director March 20, 2000
Jay M. Gellert
/s/ ROGER F. GREAVES
------------------------------------------- Director March 20, 2000
Roger F. Greaves
/s/ RICHARD W. HANSELMAN
------------------------------------------- Director March 20, 2000
Richard W. Hanselman
/s/ RICHARD J. STEGEMEIER
------------------------------------------- Director March 20, 2000
Richard J. Stegemeier
/s/ RAYMOND S. TROUBH
------------------------------------------- Director March 20, 2000
Raymond S. Troubh
</TABLE>
46
<PAGE>
[The following portions of the Foundation Health Systems, Inc. 1999 Annual
Report to Stockholders are incorporated by reference into the Foundation
Health Systems, Inc. Annual Report on Form 10-K for the year ended December
31, 1999.]
[Certain statements contained in this report are "forward looking" statements
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such statements involve risks and uncertainties and actual
results may differ materially from those results expressed or implied by such
"forward looking" statements. For more information, please refer to the
"Cautionary Statements," "Additional Information Concerning the Company's
Business" and "Risk Factors" sections of the Company's various filings with
the Securities and Exchange Commission and the respective documents
incorporated by reference therein.]
<PAGE>
FINANCIAL HIGHLIGHTS
Foundation Health Systems, Inc.
Year ended December 31,
<TABLE>
<CAPTION>
(Amounts in thousands, except per share data) 1999 1998(3) 1997(3) 1996(3) 1995(3)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA(2):
REVENUES
Health plan services premiums $7,031,055 $7,124,161 $5,482,893 $5,395,125 $4,557,214
Government contracts/Specialty services 1,529,855 1,411,267 1,408,402 1,225,723 489,913
Investment and other income 86,977 93,441 114,300 88,392 66,510
Net gain on sale of businesses and
properties 58,332 5,600 - - -
---------- ---------- ---------- ---------- ----------
Total revenues 8,706,219 8,634,469 7,005,595 6,709,240 5,113,637
---------- ---------- ---------- ---------- ----------
EXPENSES
Health plan services 5,950,002 6,090,472 4,470,816 4,606,574 3,643,463
Government contracts/Specialty services 1,002,893 924,075 990,576 995,820 356,420
Selling, general and administrative 1,301,743 1,413,771 1,185,018 868,196 657,275
Depreciation and amortization 112,041 128,093 98,353 112,916 89,356
Interest 83,808 92,159 63,555 45,372 33,463
Asset impairment, merger, restructuring
and other costs 11,724 240,053 286,525 27,408 20,164
---------- ---------- ---------- ---------- ----------
Total expenses 8,462,211 8,888,623 7,094,843 6,656,286 4,800,141
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations
before income taxes 244,008 (254,154) (89,248) 52,954 313,496
Income tax provision (benefit) 96,226 (88,996) (21,418) 14,124 124,345
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations 147,782 (165,158) (67,830) 38,830 189,151
Discontinued operations(2):
Income (loss) from discontinued
operations, net of tax - - (30,409) 25,084 3,028
Gain (loss) on disposition, net of tax - - (88,845) 20,317 -
---------- ---------- ---------- ---------- ----------
Income (loss) before cumulative effect
of a change in accounting principle 147,782 (165,158) (187,084) 84,231 192,179
Cumulative effect of a change in
accounting principle, net of tax (5,417) - - - -
---------- ---------- ---------- ---------- ----------
Net income (loss) $ 142,365 $ (165,158) $ (187,084) $ 84,231 $ 192,179
---------- ---------- ---------- ---------- ----------
BASIC EARNINGS (LOSS) PER SHARE:
Continuing operations $ 1.21 $ (1.35) $ (0.55) $ 0.31 $ 1.54
Income (loss) from discontinued
operations, net of tax - - (0.25) 0.20 0.02
Gain (loss) on disposition of
discontinued operations, net of tax - - (0.72) 0.16 -
Cumulative effect of a change in
accounting principle (0.05) - - - -
---------- ---------- ---------- ---------- ----------
Net $ 1.16 $ (1.35) $ (1.52) $ 0.67 $ 1.56
---------- ---------- ---------- ---------- ----------
DILUTED EARNINGS (LOSS) PER SHARE:
Continuing operations $ 1.21 $ (1.35) $ (0.55) $ 0.31 $ 1.53
Income (loss) from discontinued
operations, net of tax - - (0.25) 0.20 0.02
Gain (loss) on disposition of
discontinued operations, net of tax - - (0.72) 0.16 -
Cumulative effect of a change in
accounting principle (0.05) - - - -
---------- ---------- ---------- ---------- ----------
Net $ 1.16 $ (1.35) $ (1.52) $ 0.67 $ 1.55
---------- ---------- ---------- ---------- ----------
Weighted average shares outstanding:
Basic 122,289 121,974 123,333 124,453 122,741
Diluted 122,343 121,974 123,333 124,966 123,674
BALANCE SHEET DATA:
Cash and cash equivalents and investments
available for sale $1,467,142 $1,288,947 $1,112,361 $1,122,916 $ 871,818
Total assets 3,696,481 3,863,269 4,076,350 3,423,776 2,733,765
Notes payable and capital leases -
noncurrent 1,039,352 1,254,278 1,308,979 791,618 547,522
Stockholders' equity 891,199 744,042 895,974 1,183,411 1,068,255
OPERATING CASH FLOW $ 297,128 $ 100,867 $(125,872) $ (6,666) $ 51,417
---------- ---------- ---------- ---------- ----------
</TABLE>
(1) No cash dividends were declared in each of the years presented.
(2) See Note 3 to the Consolidated Financial Statements for discussion of
acquisitions during 1997 and dispositions during 1999 impacting the
comparability of information. Additionally, the Company's workers'
compensation segment sold in 1998 and physician practice management segment
sold in 1996 have been accounted for as discontinued operations.
(3) Certain reclassifications have been made to 1998 and 1997 statements of
operations data to conform to the 1999 presentation. Comparable information
for 1996 and 1995 reclassifications are not available.
-1-
<PAGE>
1999 FINANCIAL REVIEW
<TABLE>
<S> <C>
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS .............................. 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS .............. 15
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ......................................... 24
REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS ............................................ 25
REPORT OF INDEPENDENT AUDITORS ..................................................................... 25
CONSOLIDATED BALANCE SHEETS ........................................................................ 26
CONSOLIDATED STATEMENTS OF OPERATIONS .............................................................. 27
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY .................................................... 28
CONSOLIDATED STATEMENTS OF CASH FLOWS .............................................................. 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ......................................................... 32
</TABLE>
-13-
<PAGE>
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the Company's
Class A Common Stock, par value $.001 per share (the "Class A Common Stock"), on
the New York Stock Exchange, Inc. ("NYSE") since January 2, 1998.
<TABLE>
High Low
---- ---
<S> <C> <C>
Calendar Quarter - 1998
First Quarter 29 1/16 22 1/4
Second Quarter 32 5/8 25 3/8
Third Quarter 26 7/8 9
Fourth Quarter 15 3/4 5 7/8
Calendar Quarter - 1999
First Quarter 12 7/16 7 11/16
Second Quarter 20 1/16 10 13/16
Third Quarter 16 15/16 8 7/8
Fourth Quarter 10 1/2 6 1/4
Calendar Quarter - 2000
First Quarter 11 11/16 7 7/8
(through March 17, 2000)
</TABLE>
On March 17, 2000, the last reported sales price per share of the Class A
Common Stock was $7 15/16 per share.
DIVIDENDS
No dividends have been paid by the Company during the preceding two fiscal
years.The Company has no present intention of paying any dividends on its
Common Stock.
The Company is a holding company and, therefore, its ability to pay
dividends depends on distributions received from its subsidiaries, which are
subject to regulatory net worth requirements and certain additional state
regulations which may restrict the declaration of dividends by HMOs, insurance
companies and licensed managed health care plans. The payment of any dividend is
at the discretion of the Company's Board of Directors and depends upon the
Company's earnings, financial position, capital requirements and such other
factors as the Company's Board of Directors deems relevant.
Under the Credit Agreement entered into on July 8, 1997 (as amended)
with Bank of America as agent, the Company cannot declare or pay cash
dividends to its stockholders or purchase, redeem or otherwise acquire shares
of its capital stock or warrants, rights or options to acquire such shares
for cash except to the extent permitted under such Credit Agreement as
described elsewhere in the Company's Annual Report on Form 10-K.
HOLDERS
As of March 17, 2000, there were approximately 2,000 holders of record of Class
A Common Stock. The California Wellness Foundation (the "CWF") is the only
holder of record of the Company's Class B Common Stock, par value $.001 per
share (the "Class B Common Stock"), which constitutes under 1% of the
Company's aggregate equity. Under the Company's Fourth Amended and Restated
Certificate of Incorporation, shares of the Company's Class B Common Stock have
the same economic benefits as shares of the Company's Class A Common Stock, but
are non-voting. Upon the sale or other transfer of shares of Class B Common
Stock by the CWF to an unrelated third party, such shares automatically convert
into Class A Common Stock.
-14-
<PAGE>
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, excluding corporate
functions, 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 Company currently operates within two segments of the managed health
care industry: Health Plan Services and Government Contracts/Specialty Services.
During 1999, the Health Plan Services segment consisted of four regional
divisions: Arizona (Arizona and Utah), California (encompassing only the State
of California), Central (Colorado, Florida, Idaho, Louisiana, New Mexico,
Oklahoma, Oregon, Texas and Washington) and Northeast (Connecticut, New
Jersey, New York, Ohio, Pennsylvania and West Virginia). During 1999, the
Company divested its health plans or entered into arrangements to transition the
membership of its health plans in the states of Colorado, Idaho, Louisiana, New
Mexico, Oklahoma, Texas, Utah and Washington. Effective January 1, 2000, as a
result of such divestitures, the Company consolidated and reorganized its Health
Plan Services segment into two regional divisions, the Eastern Division
(Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and West
Virginia) and the Western Division (Arizona, California and Oregon). The Company
is one of the largest managed health care companies in the United States, with
approximately 4 million at-risk and administrative services only ("ASO") members
in its Health Plan Services segment.The Company also owns health and life
insurance companies licensed to sell insurance in 33 states and the District of
Columbia.
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 TRICARE (formerly
known as the Civilian Health and Medical Program of the Uniformed Services
("CHAMPUS")). 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, dental, and vision services as well as managed care
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 detailed from time
to time in the Company's filings with the Securities and Exchange Commission
(the "Commission") 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" in Part I of Form 10-K and other sections within the Company's
filings with the Commission.
CONSOLIDATED OPERATING RESULTS
The Company's income from continuing operations for the year ended December 31,
1999 was $147.8 million, or $1.21 per diluted share, compared to a loss from
continuing operations for the same period in 1998 of $165.2 million, or $1.35
per diluted share. The Company's loss from continuing operations for the year
ended December 31, 1997 was $67.8 million, or $0.55 per diluted share.
During the years ended December 31, 1999, 1998 and 1997, the Company
recorded on a pre-tax basis asset impairment, restructuring, merger and other
charges totaling $11.7 million (the "1999 Charges"), $240.1 million (the
"1998 Charges") and $286.5 million (the "1997 Charges"), respectively. These
charges are further described in the "Asset Impairment, Merger, Restructuring
and Other Charges" section.
-15-
<PAGE>
The table below and the discussion that follows summarize the Company's
performance in the last three fiscal years. Certain 1998 and 1997 amounts have
been reclassified to conform to the 1999 presentation.
<TABLE>
<CAPTION>
Year ended December 31,
(Amounts in thousands) 1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Total revenues $8,706,219 $8,634,469 $7,005,595
---------- ---------- ----------
Expenses:
Health plan services expenses(1) 5,950,002 6,090,472 4,470,816
Government contracts and specialty services expenses(1) 1,002,893 924,075 990,576
Selling, general and administrative(1) 1,301,743 1,413,771 1,185,018
Amortization and depreciation 112,041 128,093 98,353
Interest 83,808 92,159 63,555
Asset impairment, restructuring, merger, and other charges(1) 11,724 240,053 286,525
---------- ---------- ----------
Total expenses 8,462,211 8,888,623 7,094,843
---------- ---------- ----------
Income (loss) from continuing operations before income taxes $ 244,008 $ (254,154) $ (89,248)
---------- ---------- ----------
Overall medical care ratio 81.22% 82.18% 79.25%
Administrative expense ratio 16.02% 17.49% 18.04%
HEALTH PLAN SERVICES SEGMENT:
Health plan premiums $7,031,055 $7,124,161 $5,482,893
Health plan medical care ratio 84.62% 85.49% 81.54%
Health plan premiums per member per month $ 138.76 $ 128.98 $ 129.76
Health plan services per member per month $ 117.42 $ 110.27 $ 105.81
GOVERNMENT CONTRACTS/SPECIALTY SERVICES SEGMENT:
Government contracts and specialty services revenues $1,529,855 $1,411,267 $1,408,402
Government contracts and specialty services expense medical care ratio 65.55% 65.48% 70.33%
---------- ---------- ----------
</TABLE>
(1) Charges of $11.7 million, $240.1 million and $286.5 million in 1999, 1998
and 1997, respectively, are included in asset impairment, restructuring,
merger and other charges. Other charges of $170.8 million and $109.4
million in 1998 and 1997, respectively, are included in Health Plan
Services, Government Contracts/Specialty Services and selling, general and
administrative expenses.
ENROLLMENT INFORMATION
The table below summarizes the Company's enrollment information for the last
three fiscal years.
<TABLE>
<CAPTION>
Year ended December 31, Percent Percent
(Amounts in thousands) 1999 1998 Change 1997 Change
----- ----- ------- ----- -------
<S> <C> <C> <C> <C> <C>
Health Plan Services:
Commercial 3,006 3,287 (8.6)% 3,522 (6.7)%
Medicare Risk 287 326 (12.0)% 308 5.8%
Medicaid 678 586 15.7% 442 32.6%
----- ----- ------- ----- -------
3,971 4,199 (5.4)% 4,272 (1.7)%
----- ----- ------- ----- -------
Government Contracts:
TRICARE PPO and Indemnity 644 784 (17.9)% 1,090 (28.1)%
TRICARE HMO 852 783 8.8% 801 (2.2)%
----- ----- ------- ----- -------
1,496 1,567 (4.5)% 1,891 (17.1)%
----- ----- ------- ----- -------
-16-
</TABLE>
<PAGE>
REVENUES AND HEALTH CARE COSTS
The Company's total revenues increased by $71.8 million or 1% for the year ended
December 31, 1999 as compared to 1998. The decrease in Health Plan Services
segment revenues of $93.1 million or 1% was offset by an increase in Government
Contracts/Specialty Services segment revenues of $118.6 million or 8%. The
decrease in Health Plan Services segment revenues for the year was due to
enrollment declines resulting from divestitures of non-core plans and planned
membership attrition from pricing actions. Enrollment in the Company's health
plans declined by approximately 5% or 228,000 members of which 71,000 members
were from divested health plans for the year ended December 31, 1999 as compared
to 1998. This membership decrease was offset by premium rate increases as
described below. The increase in Government Contracts/Specialty Services segment
revenues was due primarily to increases in TRICARE revenues of 11% and continued
growth in the Company's behavioral health network, including TRICARE affiliated
business, of 21%.
The Company's commercial product lines are profitable. Premium rate
increases of 8% in the commercial line of products contributed to revenue
increases for the year ended December 31, 1999 as compared to the prior year.
These premium rate increases were partially offset by a 9% enrollment decrease
from the divestitures of non-core plans and planned membership attrition from
pricing actions, resulting in an increase in commercial premium revenue.
The Company's Medicare product lines are profitable. Medicare premium rates
have increased 7%, but enrollment has declined by 12% due to the Company exiting
certain unprofitable counties, primarily in the Northeast health plans. The
Company's Medicaid product lines are profitable. Medicaid premium rates have
increased in all markets averaging about 5%. Medicaid enrollment has increased
in all divisions resulting in a 16% increase in membership.
Also contributing to the increase in total revenues was a $58.3 million
net gain on sale of businesses and properties. During 1999, the Company
completed nine divestitures transactions, essentially completing its
divestitures program of non-core businesses. See Note 3 - Acquisitions and
Dispositions to the consolidated financial statements.
The Company's total revenues increased by $1.6 billion or 23% for the year
ended December 31, 1998 as compared to 1997. Growth in the Health Plan Services
segment revenues of $1.6 billion or 30% for the year was due primarily to the
acquisitions that occurred in the fourth quarter of 1997, including Physicians
Health Services, Inc. ("PHS"), FOHP, Inc. ("FOHP") and PACC HMO, Inc. and PACC
Health Plans, Inc. (collectively "PACC"). These acquisitions collectively
accounted for approximately $1.4 billion of the increase. Excluding these
acquisitions, health plan revenues increased by approximately $199 million or 4%
for the year ended December 31, 1998. The growth from existing health plan
businesses was due to increases in premium rates averaging 4% on a per member
per month basis in virtually all markets which were partially offset by a 2%
decrease in average membership. See the Enrollment Information section of the
previous table for year-end membership information. Growth in the Government
Contracts/Specialty Services segment revenues totaled $2.9 million for the year
ended December 31, 1998, primarily due to continued growth in the Company's
managed behavioral health network.
The overall medical care ratio ("MCR") (medical costs as a percentage of
the sum of Health Plan Services and Government Contracts/Specialty Services
revenues) for the year ended December 31, 1999 was 81.22% as compared to 82.18%
for the year ended December 31, 1998. This resulted from the 8% premium rate
increase which exceeded a 7% increase in health care costs on a per member per
month basis for the Health Plan Services segment.
The overall MCR for the year ended December 31, 1998 was 82.18% as compared
to 79.25% for the year ended December 31, 1997. This resulted primarily from
increases in health care costs (4% on a per member per month basis). The
increase in health care costs was primarily due to higher pharmacy costs in all
divisions, which increased by 18%.
Health Plan Services costs decreased by $140.5 million or 2% for the year
ended December 31, 1999 as compared to 1998 primarily as a result of a 5%
decrease in enrollment. The Health Plan Services MCR decreased to 84.62% in 1999
from 85.49% in 1998 due to an increased focus on medical management.
Health Plan Services costs increased by $1.6 billion or 36% for the year
ended December 31, 1998 as compared to 1997 primarily as a result of enrollment
increases in the Northeast Division, Medicaid enrollment growth in the
California Division, and pharmacy cost increases in all divisions. The Health
Plans Services MCR increased to 85.49% in 1998 from 81.54% in 1997 due to higher
medical costs particularly in physician and hospital fee-for-service costs,
increases in pharmacy costs and increased utilization.
The Government Contracts/Specialty Services MCR increased slightly to
65.55% for 1999 as compared to 65.48% for 1998. This increase for 1999 was
primarily due to the movement of health care services from military treatment
facilities to civilian facilities which resulted in higher costs than originally
specified in the contract.
The Government Contracts/Specialty Services MCR decreased to 65.48% for
1998 compared to 70.33% for 1997. This decrease for 1998 is primarily due to
improved health care and subcontractor performance on the TRICARE contracts
which was partially offset by increased pharmacy costs and higher health care
claim costs on TRICARE contracts.
-17-
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company's selling, general and administrative ("SG&A") expenses decreased by
$112.0 million or 8% for the year ended December 31, 1999 as compared to 1998.
The administrative expense ratio (SG&A and depreciation as a percentage of
Health Plan, Government Contracts and Specialty Services revenues) decreased to
16.02% for the year ended December 31, 1999 from 17.49% for the year ended
December 31, 1998. This decrease is primarily attributable to the Company's
ongoing efforts to control its SG&A expenses and savings associated with the
consolidating certain health plans.
The SG&A expenses increased by $228.8 million or 19% for the year ended
December 31, 1998 as compared to 1997. The increase in SG&A expenses during 1998
is primarily due to the SG&A expenses associated with the businesses acquired
during 1997. The administrative expense ratio decreased to 17.49% for the year
ended December 31, 1998 from 18.04% for the year ended December 31, 1997. This
decrease 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 which were partially offset by increased expenditures related to
the consolidation and integration of the Company's administrative facilities.
AMORTIZATION AND DEPRECIATION
Amortization and depreciation expense decreased by $16.1 million to $112.0
million in 1999 from $128.1 million in 1998. This decrease was primarily due to
a $61.2 million write-down of fixed assets in the fourth quarter of 1998 and
impairment charges for goodwill in 1998 which amounted to $30.0 million. See
"Asset Impairment, Merger, Restructuring and Other Charges" below and Note 15 to
the consolidated financial statements.
Amortization and depreciation expense increased by $29.7 million to $128.1
million in 1998 from $98.4 million in 1997. This increase was due to increases
in intangible assets and fixed assets as a result of the acquisitions that
occurred primarily in the fourth quarter of 1997 and increased capital
expenditures primarily related to the consolidation and integration of the
Company's administrative facilities.
INTEREST EXPENSE
Interest expense decreased by $8.4 million to $83.8 million in 1999 from
$92.2 million in 1998. This decrease was due to a net decline in the
revolving credit borrowings as a result of cash proceeds from divestitures
and overall improved financial performance. Interest expense increased by
$28.6 million to $92.2 million in 1998 from $63.6 million in 1997. This
increase was due to increased borrowings associated with the Company's
revolving lines of credit partially offset by lower interest rates.
ASSET IMPAIRMENT, MERGER, RESTRUCTURING
AND OTHER CHARGES
This section should be read in conjunction with Notes 14 and 15, and the tables
contained therein, to the consolidated financial statements.
1999 CHARGES
The Company initiated during the fourth quarter of 1998 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 connection with this, the Company announced its plan to close the
Colorado regional processing center, terminate employees associated with the
support center and transfer these operations to the Company's other
administrative facilities. In addition, the Company announced its plans to
consolidate certain administrative functions in its Northwest health plan
operations. During the quarter ended March 31, 1999, the Company recorded
pretax charges for restructuring and other charges of $21.1 million which
included $18.5 million for severance and benefit costs related to executives
and employees at the Colorado regional processing center and at the Northwest
health plans, and $2.6 million for the termination of real estate obligations
and other costs to close the Colorado regional processing center. As of
December 31, 1999, $1.4 million of the initial reserve was reversed and $8.9
million is expected to require future outlays of cash in 2000. As the closing
of the Colorado regional processing center (which is expected to be
substantially completed in the first quarter of 2000) was related to the
disposition of certain Central Division health plans, management does not
expect the closure to have a significant impact on future results of
operations or cash flows. During the fourth quarter of 1999, the Company
recorded asset impairment costs totaling $6.2 million in connection with
pending dispositions of non-core businesses. These charges included a further
adjustment of $4.7 million to adjust the carrying value of the Company's
Pittsburgh health plans to fair value for which the Company previously
recorded an impairment charge in 1998. The Company also adjusted the carrying
value of its subacute operations by $1.5 million to fair value. The revenue
and pretax losses attributable to these operations were $66.2 million and
$1.4 million, respectively, for the year ended December 31, 1999. The
carrying value of these assets as of December 31, 1999 was $16.2 million.
In addition, during 1999, modifications to reduce remaining reserves for
the 1998 and 1997 restructuring plans, primarily related to asset impairment,
totaling $14.2 million were recorded.
-18-
<PAGE>
1998 CHARGES
On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy
protection under Chapter 11 of the Federal Bankruptcy Code. FPA, through its
affiliated medical groups, provided services to approximately 190,000 of the
Company's affiliated members in Arizona and California and also leased health
care facilities from the Company. FPA has discontinued its medical group
operations in these markets and the Company has made other arrangements for
health care services to the Company's affiliated members. The FPA bankruptcy and
related events and circumstances caused management to re-evaluate the decision
to continue to operate the facilities and management determined to sell the 14
properties, subject to bankruptcy court approval. Management immediately
commenced the sale process upon such determination. The estimated fair value of
the assets held for disposal was determined based on the estimated sales prices
less the related costs to sell the assets.
Management believed that the net proceeds from a sale of the facilities
would be inadequate to enable the Company to recover their carrying value.
Based on management's best estimate of the net realizable values, the Company
recorded charges totaling approximately $84.1 million. These charges were
comprised of $63.0 million for real estate asset impairments, $10.0 million
impairment adjustment of a note received as consideration in connection with
the 1996 sale of the Company's physician practice management business and
$11.1 million for other items. These other items included payments made to
Arizona physician specialists totaling $3.4 million for certain obligations
that FPA had assumed but was unable to pay due to its bankruptcy, advances to
FPA to fund certain operating expenses totaling $3.0 million, and other
various costs totaling $4.7 million. The carrying value of the assets held
for disposal totaled $11.3 million and $24.3 million at December 31, 1999 and
1998, respectively. There has been no further adjustment to the carrying
value of the assets held for disposal. As of December 31, 1999, 12 properties
have been sold. The remaining properties are expected to be sold during the
second half of 2000. The suspension of depreciation on these 12 properties
held for disposal has an annual impact of approximately $2.0 million.
During the third quarter ended September 30, 1998, the Company recorded
severance and benefit costs totaling $21.2 million related to staff reductions
in selected health plans and the centralization and consolidation of corporate
functions, and other costs for amounts due from a third-party hospital system
that filed for bankruptcy which were not related to the normal business of the
Company totaling $18.6 million, and other charges of $3.8 million related to
fees for consulting services from one of the Company's former executives and
costs related to exiting certain rural Medicare markets.
In addition to the above, other charges totaling $103.3 million were
recorded in the third quarter ended September 30, 1998. These charges mostly
related to contractual adjustments of $13 million, equitable adjustments
relating to government contracts of $17 million, payment disputes with
contracted provider groups of $24 million, premium deficiency reserves of $35
million, and other legal and relocation costs of $14.3 million and were
primarily included in health care costs within the consolidated statement of
operations.
As mentioned previously, during the fourth quarter of 1998, the Company
initiated a formal plan to dispose of certain Central Division health plans
included in the Company's Health Plan Services segment in accordance with its
previously disclosed anticipated divestitures program. The Company sold most of
these health plans during 1999. Pursuant to SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,"
the Company evaluated the carrying value of the assets for these health plans
and the related service center and holding company, and determined that the
carrying value of these assets exceeded the estimated fair value of these
assets. Estimated fair value was determined by the Company based on the then
current stages of sales negotiations, including letters of intent, definitive
agreements and sales discussions, net of expected transaction costs. In the case
of the service center and holding company operations, buildings, furniture,
fixtures, equipment and software development projects were determined by
management to have no continuing value to the Company, due to abandoning plans
for development of this location and its systems and programs as a centralized
operations center. Accordingly, in the fourth quarter of 1998, the Company
adjusted the carrying value of these long-lived assets to their estimated fair
value, resulting in a non-cash asset impairment charge of approximately $112.4
million. This asset impairment charge of $112.4 million consisted of $40.3
million for write-downs of abandoned furniture, equipment and software
development projects, $20.9 million for write-down of buildings and
improvements, $30.0 million for write-down of goodwill and $21.2 million for
other impairments and other charges. The fair value was
-19-
<PAGE>
based on expected net realizable value. Revenue and pre-tax income attributable
to these plans identified for disposition were $191.3 million and $9.8 million,
respectively, for the year ended December 31, 1999. The carrying value of these
assets as of December 31, 1999 and 1998 was $22.1 million and $42.8 million,
respectively. No subsequent adjustments were made to the carrying value of these
assets in 1999 or 1998. As discussed under "1999 Charges," further adjustments
to carrying value of $4.7 million were recorded in 1999. The annual impact of
suspending depreciation of these assets is $13.0 million.
In addition, the Company recorded additional costs of $48.9 million related
to anticipated bad debts totaling $17.4 million, premium deficiency reserves of
$22.1 million for certain health plans whose health care costs exceed
contractual premium revenues and additional claims reserves and other costs
totaling $9.4 million. These costs were recorded in the fourth quarter of 1998.
Management assesses the profitability of contracts when operating results or
forecasts indicate probable future losses. In preparing forecasts and budgets
for the 1999 operating year as well as performing specific year-end analysis on
claims reserves, it became probable that losses on certain groups of contracts
would not be covered by future premiums. Loss contracts were identified in
approximately 12 different operating units as a result of this process. Reserves
were recorded in the fourth quarter of 1998 primarily for the Company's Florida
health plan as the result of management's assessment of a large provider's
likely exposure to insolvency for which the Company carried risk-share
receivables. The provider had made payments on the receivables during the year.
Conditions worsened in the fourth quarter of 1998 creating a significant risk to
the collectibility of the receivables that previously did not exist. The Company
also recorded an additional $18.6 million of other charges primarily related to
litigation in the normal course of business for non-core operations which were
reflected as SG&A expenses on the consolidated statement of operations.
The total 1998 charges recorded by the Company during the second, third
and fourth quarters of 1998 were $410.9 million, of which $240.1 million was
recorded as asset impairment, merger, restructuring, and other charges on the
consolidated statement of operations. During 1999, modifications to the 1998
initial estimates of $12.6 million were recorded. These credits to the 1998
charges resulted from the following: $10.7 million from reductions to asset
impairment costs and $1.9 million from reductions to initially anticipated
involuntary severance costs and other adjustments. As of December 31, 1999,
the 1998 restructuring plans were essentially completed.
1997 CHARGES
The 1997 Charges recorded by the Company were $395.9 million, of which $286.5
million was recorded as asset impairment, merger, restructuring and other
charges on the consolidated statement of operations. These charges related to
the FHS Combination and the restructuring of the Company's Northeast Division
health plans. The principal elements of these charges included (i)
restructuring costs of $146.8 million, including $2.7 million of reductions
to initial estimates of the 1996 plan, for a workforce reduction, the
consolidation of employee benefit plans, the consolidation of facilities in
geographic locations where office space is duplicated, the consolidation of
overlapping provider networks, and the consolidation of information systems
to standardized systems; (ii) $69.6 million in merger-related costs primarily
for investment banking, legal, accounting and other costs; (iii) premium
deficiency reserves of $57.5 million related to the Company's Gem Insurance
Company ("Gem"); and (iv) other charges of $12.6 million related to the loss
on the sale of the United Kingdom operations. Additionally, $109.4 million
was related to receivable write-offs, loss contract accruals and other
termination costs, which were recorded as health care services and SG&A
expenses on the consolidated statement of operations. During 1999,
modifications to the 1997 initial estimates of $1.6 million were recorded. As
of December 31, 1999, the 1997 restructuring plans were essentially completed.
INCOME TAX PROVISION AND BENEFIT
The 1999 tax provision rate of 39.4% on income from continuing operations varied
from the 1998 tax benefit rate of 35.0% on losses from continuing operations
mainly due to non-deductible impairment charges incurred in 1998. The 1997 tax
benefit rate of 24.0% was lower than the 1998 tax benefit rate of 35.0%,
resulting primarily from non-deductible merger and restructuring charges
incurred in 1997.
DISCONTINUED OPERATIONS
WORKERS' COMPENSATION INSURANCE BUSINESS
In December 1997, the Company adopted a formal plan to sell its workers'
compensation segment. In December 1997, the Company estimated the loss on the
disposal of the workers' compensation segment would approximate $99.0 million
(net of an income tax benefit of $21.0 million) which included the anticipated
results of operations during the phase-out period from December 1997 through the
-20-
<PAGE>
date of disposal. On December 10, 1998, the Company completed the sale of the
workers' compensation segment. The assets sold consisted primarily of
investments, premiums and reinsurance receivables. The selling price was $257
million in cash.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit margin is
low; hence, it is especially sensitive to inflation. Increases in medical
expenses or contracted medical rates without corresponding increases in premiums
could have a material adverse effect on the Company.
Various federal and state legislative initiatives regarding the health care
industry have been proposed during recent legislative sessions, and health care
reform and similar issues continue to be in the forefront of social and
political discussion. If health care reform or similar legislation is enacted,
such legislation could impact the Company. Management cannot at this time
predict whether any such initiative will be enacted and, if enacted, the impact
on the financial condition or results of operations of the Company.
The Company's ability to expand its business is dependent, in part, on
competitive premium pricing and its ability to secure cost-effective contracts
with providers. Achieving these objectives is becoming increasingly difficult
due to the competitive environment. In addition, the Company's profitability is
dependent, in part, on its ability to maintain effective control over health
care costs while providing members with quality care. Factors such as health
care reform, integration of acquired companies, increased cost of individual
services, regulatory changes, utilization, new technologies, hospital costs,
major epidemics and numerous other external influences may affect the Company's
operating results. Accordingly, past financial performance is not necessarily a
reliable indicator of future performance, and investors should not use
historical records to anticipate results or future period trends.
The Company's HMO and insurance subsidiaries are required to maintain
reserves to cover their estimated ultimate liability for expenses with respect
to reported and unreported claims incurred. These reserves are estimates of
future payments based on various assumptions. Establishment of appropriate
reserves is an inherently uncertain process, and there can be no certainty that
currently established reserves will prove adequate in light of subsequent actual
experience, which in the past has resulted, and in the future could result, in
loss reserves being too high or too low. The accuracy of these estimates may be
affected by external forces such as changes in the rate of inflation, the
regulatory environment, the judicial administration of claims, medical costs and
other factors. Future loss development or governmental regulators could require
reserves for prior periods to be increased, which would adversely impact
earnings in future periods. In light of present facts and current legal
interpretations, management believes that adequate provisions have been made for
claims and loss reserves.
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. In California, the issue of whether HMOs can be liable for unpaid
provider claims has not been definitively settled. The Department of
Corporations ("DOC") has issued a written statement to the effect that HMOs are
not liable for such claims, but there is currently ongoing litigation
challenging that ruling.
YEAR 2000
The Company undertook an extensive effort to assess and modify its computer
applications and business processes to provide for their continued functionality
in light of the "Year 2000" issue.
The "Year 2000" issue is the result of computer programs having been
written in a language that used two digits rather than four to define the
applicable year. Any of the Company's computer programs that have time-sensitive
software and the outdated software language 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.
-21-
<PAGE>
PROJECT - The Company addressed its Year 2000 issues in several ways.
Selected systems were retired with the business functions being converted to
Year 2000 compliant systems. The Company closely monitored its systems that
utilized packaged software from large vendors to ensure that these systems were
Year 2000 compliant. The Company also took advantage of certain updates made
available by vendors to ensure Year 2000 compliance of certain software used by
the Company. The remaining systems' compliance was addressed by internal
technical staff. In addition, the Company completed an assessment of third-party
relationships and sought to obtain assurances from all delegated authorities and
strategically important providers as to their Year 2000 readiness.
As of March 15, 2000, the Company has not identified any significant
disruptions or operational problems resulting from Year 2000 issues. In
addition, the Company is not aware of any significant problems experienced by
delegated authorities or strategically important third parties that would have a
material adverse impact on the Company's operations. There can be no assurance,
however, that the Company will not still experience significant disruptions or
operational problems related to Year 2000 issues, including as a result of Year
2000 problems experienced by third parties.
COSTS - The total cost for the Company's Year 2000 project was
approximately $33.4 million, excluding the costs to accelerate the replacement
of hardware or software otherwise required to be purchased by the Company. The
percentages of the Company's total expenditures for Year 2000 issues were
approximately as follows: 38% for internal costs, 29% for outside consultants
and contractors, and 33% for software-related and hardware-related costs. The
operating subsidiaries for each line of business of the Company paid for the
costs of assessment, planning, remediation, testing and certification of Year
2000 issues for their respective operations.
CONTINGENCY PLANNING - An important part of the Company's Year 2000 project
involved identifying worst case scenarios and developing contingency plans. The
Company continues to keep the contingency plans in place in the event a
significant Year 2000 problem should occur. There can be no assurance, however,
that the contingency plans of the Company, if implemented, will adequately
address problems that may arise or prevent such problems from having a material
adverse effect on the Company's operations.
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.
Forward-looking statements contained in this Year 2000 section should be
read in connection with the Company's cautionary statements identifying
important risk factors that could cause the Company's actual results to differ
materially from those projected in these forward-looking statements, which
cautionary statements are contained in the Company's Annual Report on Form 10-K
for the year ended December 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Certain of the Company's subsidiaries must comply with minimum capital and
surplus requirements under applicable state laws and regulations, and must have
adequate reserves for claims. Certain subsidiaries must maintain ratios of
current assets to current liabilities of 1:1 pursuant to certain government
contracts. The Company believes it is in compliance with these contractual and
regulatory requirements in all material respects.
The Company believes that cash from operations, existing working capital
and lines of credit 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 significantly from
current estimates. Additionally, the timely collection of such receivables is
also impacted by government audit and negotiation and could extend for periods
beyond a year.
For the year ended December 31, 1999, cash provided by operating activities
was $297.1 million compared to cash provided by operating activities of $100.9
million in the prior year. This change was due primarily to the collection of
premiums receivable and timing of payments related to reserves for claims. Net
cash provided by investing activities was $163.4 million during 1999 as compared
to cash provided by investing activities of $147.0 million during 1998. This
increase during 1999 was primarily due to a decrease in the net purchases of
fixed assets offset by a decrease in net proceeds from the sale of businesses
and buildings. Net cash used in financing activities was $213.9 million in 1999
as compared to cash used in financing activities of $43.3 million during the
same period in 1998. The increase in
-22-
<PAGE>
1999 was due to the increased 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 Amendments in April, July, November 1998 and 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 December
31, 1999, the Company was in compliance with the financial covenants of the
Credit Facility, as amended by the Amendments. The Credit Facility is available
for five years, until July 2002, but it may be extended under certain
circumstances for two additional years. The outstanding balance under the Credit
Facility has decreased from $1.225 billion at December 31, 1998 to $1.039
billion at December 31, 1999. As of March 14, 2000, the amount outstanding under
the Credit Facility totaled $1.039 billion with interest at LIBOR plus 1.50%.
The remaining principal and interest of the promissory notes issued to
The California Wellness Foundation in connection with the Health Net
conversion to for-profit status was repaid early in 1999. As a result, these
notes are no longer outstanding.
On December 31, 1999, the Company sold the capital stock of QualMed
Washington Health Plan, Inc., the Company's HMO subsidiary in the state of
Washington ("QM-Washington"), to American Family Care ("AFC"). Upon completion
of the transaction, AFC assumed control of the health plan license and retained
the Medicaid and Basic Health Plan membership of QM-Washington. The Company also
entered into definitive agreements with PacifiCare of Washington, Inc.
("PacifiCare-WA") and Premera Blue Cross to transition its commercial membership
in Washington to such companies. As part of such agreements, PacifiCare-WA has
offered replacement coverage to QM-Washington's HMO and POS groups in western
Washington and Premera Blue Cross has offered replacement coverage to
substantially all of QM-Washington's HMO and POS group membership in eastern
Washington.
In addition, on September 21, 1999, the Company announced that it had
executed a definitive agreement with PacifiCare of Colorado, Inc.
("PacifiCare-CO") to transition all of its membership in Colorado to
PacifiCare-CO by March 31, 2000. The Company also announced that its previously
disclosed letter of intent with WellPoint Health Networks Inc. had expired.
Pursuant to the definitive agreement, PacifiCare-CO is offering replacement
coverage to substantially all of the Company's Colorado HMO membership and
PacifiCare Life Assurance Company ("PLAC") is issuing replacement indemnity
coverage to substantially all of the Company's Colorado Point of Service ("POS")
membership.
Effective as of September 20, 1999, the Company and Medaphis (which changed
its name to Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement
Agreement and Release pursuant to which the Company received net proceeds of
approximately $25 million consisting of cash from Per-Se and Per-Se's insurers
and proceeds from the sale of both the 976,771 shares of Medaphis (now Per-Se)
common stock then owned by the Company and additional shares of Per-Se common
stock issued to the Company as part of the settlement. In exchange, the Company
and Per-Se terminated the ongoing litigation and granted each other a general
release. The gain recognized in the consolidated statement of operations as of
December 31, 1999 was immaterial.
The Company's subsidiaries must comply with certain minimum capital
requirements under applicable state laws and regulations. During 1999, the
Company contributed $97.4 million to its subsidiaries to meet risk-based or
other capital requirements of the regulated entities. As of December 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, or allowing regulators to impose,
substantially increased minimum capital and/or statutory deposit requirements
for HMOs and insurance companies in such states. Such statutory deposits may
only be drawn upon under limited circumstances relating to the protection of
policyholders. For example, the Company's HMO subsidiary operating in New Jersey
was required to increase its statutory deposits by approximately $51 million in
1998 pursuant to such legislation.
-23-
<PAGE>
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 for the investment portfolios is to provide a source of
liquidity and 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 has additional requirements with respect to liquidity, current
income and contribution to surplus. The Company manages these risks by setting
risk tolerances, targeting asset-class allocations, diversifying among assets
and asset characteristics, and using performance measurement and reporting.
The Company uses a value-at-risk ("VAR") model, which follows a
variance/covariance methodology, to assess the market risk for its investment
portfolio. VAR is a method of assessing investment risk that uses standard
statistical techniques to measure the worst expected loss in the portfolio over
an assumed portfolio disposition period under normal market conditions. The
determination is made at a given statistical confidence level.
The Company assumed a portfolio disposition period of 30 days with a
confidence level of 95 percent for the 1999 computation of VAR. The computation
further assumes that the distribution of returns is normal. Based on such
methodology and assumptions, the computed VAR was approximately $2.7 million as
of December 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. 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 $1.041 billion at December 31, 1999 with a related average interest rate
of 6.78% (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 following presents the expected cash outflows of market risk
sensitive debt obligations at December 31, 1999. These cash outflows include
both expected principal and interest payments consistent with the terms of the
outstanding debt as of December 31, 1999.
<TABLE>
<CAPTION>
(Amounts in thousands) 2000 2001 2002 2003 2004 Beyond Total
-------- ------- ---------- ------- ------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Long-term floating rate
borrowings:
Principal $ - $ - $1,039,250 $ - $ - $ - $1,039,250
Interest 94,302 79,243 39,622 - - - 213,167
-------- ------- ---------- ------- ------- ------- ----------
Total Cash Outflow $ 94,302 $79,243 $1,078,872 $ - $ - $ - $1,252,417
-------- ------- ---------- ------- ------- ------- ----------
</TABLE>
-24-
<PAGE>
REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS OF FOUNDATION HEALTH
SYSTEMS INC.
The Board of Directors of the Company addresses its oversight responsibility for
the consolidated financial statements through its Audit Committee (the
"Committee"). The Committee currently consists of Gov. George Deukmejian, Thomas
T. Farley, Earl B. Fowler (Chairman) and Richard J. Stegemeier, each of whom is
an independent outside director.
In fulfilling its responsibilities in 1999, the Committee reviewed the overall
scope of the independent auditors' audit plan and reviewed the independent
auditors' non-audit services to the Company. The Committee also exercised
oversight responsibilities over various financial and regulatory matters.
The Committee's meetings are designed to facilitate open communication between
the independent auditors and Committee members. To ensure auditor independence,
the Committee meets privately with both the independent auditors and also with
the chief auditor of the Company's Internal Audit Department, thereby providing
for full and free access to the Committee.
/s/ Earl B. Fowler
Earl B. Fowler, Chairman
Audit Committee
February 29, 2000
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Foundation Health Systems, Inc.
Woodland Hills, California
We have audited the accompanying consolidated balance sheets of
Foundation Health Systems, Inc. and subsidiaries (the "Company") as of December
31, 1999 and 1998, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Foundation Health Systems,
Inc. and subsidiaries at December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Los Angeles, California
February 29, 2000
-25-
<PAGE>
CONSOLIDATED BALANCE SHEETS
FOUNDATION HEALTH SYSTEMS, INC.
<TABLE>
<CAPTION>
December 31,
(Amounts in thousands) 1999 1998
---------- ----------
<C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $1,010,539 $ 763,865
Investments - available for sale 456,603 525,082
Premium receivables, net of allowance for doubtful accounts
(1999 - $21,937; 1998 - $28,522) 149,992 230,157
Amounts receivable under government contracts 290,329 321,411
Deferred taxes 209,037 160,446
Reinsurance and other receivables 153,427 147,827
Other assets 77,866 91,096
---------- ----------
Total current assets 2,347,793 2,239,884
Property and equipment, net 280,729 345,269
Goodwill and other intangible assets, net 909,586 977,910
Deferred taxes - 118,759
Other assets 158,373 181,447
---------- ----------
Total assets $3,696,481 $3,863,269
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Reserves for claims and other settlements $1,138,801 $1,006,799
Unearned premiums 224,381 288,683
Notes payable and capital leases 1,256 1,760
Amounts payable under government contracts 43,843 69,792
Accounts payable and other liabilities 322,048 458,397
---------- ----------
Total current liabilities 1,730,329 1,825,431
Notes payable and capital leases 1,039,352 1,254,278
Deferred taxes 5,624 -
Other liabilities 29,977 39,518
---------- ----------
Total liabilities 2,805,282 3,119,227
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock ($0.001 par value, 10,000 shares
authorized, none issued and outstanding) - -
Class A common stock ($0.001 par value, 350,000 shares
authorized; issued 1999 - 123,429; 1998 - 120,362) 123 120
Class B non-voting convertible common stock
($0.001 par value, 30,000 shares authorized;
issued and outstanding 1999 - 2,138; 1998 - 5,048) 2 5
Additional paid-in capital 643,373 641,820
Treasury Class A common stock, at cost
(1999 - 3,194 shares; 1998 - 3,194 shares) (95,831) (95,831)
Retained earnings 347,601 205,236
Accumulated other comprehensive loss (4,069) (7,308)
---------- ----------
Total stockholders' equity 891,199 744,042
---------- ----------
Total liabilities and stockholders' equity $3,696,481 $3,863,269
---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
-26-
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
FOUNDATION HEALTH SYSTEMS, INC.
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
(Amounts in thousands, except per share data) 1999 1998 1997
-----------------------------------------
<S> <C> <C> <C>
REVENUES
Health plan services premiums $7,031,055 $7,124,161 $5,482,893
Government contracts/Specialty services 1,529,855 1,411,267 1,408,402
Investment and other income 86,977 93,441 114,300
Net gain on sale of businesses and properties 58,332 5,600 -
-----------------------------------------
Total revenues 8,706,219 8,634,469 7,005,595
-----------------------------------------
EXPENSES
Health plan services 5,950,002 6,090,472 4,470,816
Government contracts/Specialty services 1,002,893 924,075 990,576
Selling, general and administrative 1,301,743 1,413,771 1,185,018
Depreciation 70,010 78,951 58,100
Amortization 42,031 49,142 40,253
Interest 83,808 92,159 63,555
Asset impairment, merger, restructuring and other costs 11,724 240,053 286,525
-----------------------------------------
Total expenses 8,462,211 8,888,623 7,094,843
Income (loss) from continuing operations before income taxes 244,008 (254,154) (89,248)
Income tax provision (benefit) 96,226 (88,996) (21,418)
-----------------------------------------
Income (loss) from continuing operations 147,782 (165,158) (67,830)
Discontinued operations:
Loss from discontinued operations, net of tax - - (30,409)
Loss on disposition, net of tax - - (88,845)
-----------------------------------------
Income (loss) before cumulative effect of a change in accounting principle 147,782 (165,158) (187,084)
Cumulative effect of a change in accounting principle, net of tax (5,417) - -
-----------------------------------------
Net income (loss) $ 142,365 $ (165,158) $ (187,084)
-----------------------------------------
Basic and diluted earnings (loss) per share:
Continuing operations $ 1.21 $ (1.35) $ (0.55)
Loss from discontinued operations, net of tax - - (0.25)
Loss on disposition of discontinued operations, net of tax - - (0.72)
Cumulative effect of a change in accounting principle (0.05) - -
-----------------------------------------
Net $ 1.16 $ (1.35) $ (1.52)
-----------------------------------------
Weighted average shares outstanding:
Basic 122,289 121,974 123,333
Diluted 122,343 121,974 123,333
-----------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
-27-
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOUNDATION HEALTH SYSTEMS, INC.
<TABLE>
<CAPTION>
Common Stock Additional
Class A Class B Paid-in
(Amounts in thousands) Shares Amount Shares Amount Capital
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1997 109,179 $109 19,298 $19 $721,482
Comprehensive loss:
Net loss
Change in unrealized depreciation on
investments, net
-------------------------------------------------------------------------
Total comprehensive loss - - - - -
-------------------------------------------------------------------------
Redemption of common stock (4,550) (4) (111,330)
Retirement of treasury stock, net (130) (3,047)
Exercise of stock options including
related tax benefit 842 19,310
Conversion of Class B to Class A 4,450 5 (4,450) (5)
Employee stock purchase plan 108 2,196
-------------------------------------------------------------------------
Balance at December 31, 1997 114,449 114 10,298 10 628,611
Comprehensive income (loss):
Net loss
Change in unrealized depreciation on
investments, net
-------------------------------------------------------------------------
Total comprehensive income (loss) - - - - -
-------------------------------------------------------------------------
Exercise of stock options including
related tax benefit 497 1 9,584
Conversion of Class B to Class A 5,250 5 (5,250) (5)
Employee stock purchase plan 166 3,625
-------------------------------------------------------------------------
Balance at December 31, 1998 120,362 120 5,048 5 641,820
Comprehensive income:
Net income
Change in unrealized depreciation on
investments, net
-------------------------------------------------------------------------
Total comprehensive income - - - - -
-------------------------------------------------------------------------
Exercise of stock options including
related tax benefit 5
Conversion of Class B to Class A 2,910 3 (2,910) (3)
Employee stock purchase plan 152 1,553
-------------------------------------------------------------------------
Balance at December 31, 1999 123,429 $123 2,138 $2 $643,373
-------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
-28-
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
<TABLE>
<CAPTION>
Accumulated
Common Stock Other
Held in Treasury Retained Comprehensive
(Amounts in thousands) Shares Amount Earnings Income (Loss) Total
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1997 (3,324) $(98,878) $557,478 $3,201 $1,183,411
Comprehensive loss:
Net loss (187,084) (187,084)
Change in unrealized depreciation on
investments, net (10,525) (10,525)
----------------------------------------------------------------------
Total comprehensive loss - - (187,084) (10,525) (197,609)
----------------------------------------------------------------------
Redemption of common stock (111,334)
Retirement of treasury stock, net 130 3,047 -
Exercise of stock options including
related tax benefit 19,310
Conversion of Class B to Class A -
Employee stock purchase plan 2,196
----------------------------------------------------------------------
Balance at December 31, 1997 (3,194) (95,831) 370,394 (7,324) 895,974
Comprehensive income (loss):
Net loss (165,158) (165,158)
Change in unrealized depreciation on
investments, net 16 16
----------------------------------------------------------------------
Total comprehensive income (loss) - - (165,158) 16 (165,142)
----------------------------------------------------------------------
Exercise of stock options including
related tax benefit - 9,585
Conversion of Class B to Class A -
Employee stock purchase plan 3,625
----------------------------------------------------------------------
Balance at December 31, 1998 (3,194) (95,831) 205,236 (7,308) 744,042
Comprehensive income (loss):
Net income 142,365 142,365
Change in unrealized depreciation on
investments, net 3,239 3,239
----------------------------------------------------------------------
Total comprehensive income - - 142,365 3,239 145,604
----------------------------------------------------------------------
Exercise of stock options including
related tax benefit -
Conversion of Class B to Class A -
Employee stock purchase plan 1,553
----------------------------------------------------------------------
Balance at December 31, 1999 (3,194) $(95,831) $347,601 $(4,069) $891,199
----------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
-29-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOUNDATION HEALTH SYSTEMS, INC.
<TABLE>
<CAPTION>
Year ended December 31,
(Amounts in thousands) 1999 1998 1997
----------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 142,365 $ (165,158) $ (187,084)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Amortization and depreciation 112,041 128,093 98,353
Net (gain) loss on sale of businesses and properties (58,332) (5,600) 12,676
Cumulative effect of a change in accounting principle 5,417 - -
Impairment of assets 11,724 159,066 8,456
Other changes in net assets of discontinued operations - - (5,395)
Loss on disposition of discontinued operations - - 88,845
Loss from discontinued operations - - 30,409
Other changes 5,648 15,041 2,525
Changes in assets and liabilities, net of effects of acquisitions and
dispositions:
Premiums receivable and unearned subscriber premiums (8,973) 38,569 3,105
Other assets 63,902 (69,671) (112,302)
Amounts receivable/payable under government contracts 5,130 (58,000) (16,155)
Reserves for claims and other settlements 167,084 (6,416) (55,450)
Accounts payable and accrued liabilities (148,878) 64,943 6,145
----------------------------------------
Net cash provided by (used in) operating activities 297,128 100,867 (125,872)
----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale or maturity of investments 642,150 727,435 597,691
Purchase of investments (606,350) (697,472) (406,818)
Net purchases of property and equipment (36,592) (147,782) (131,669)
Proceeds from notes receivables - - 93,011
Sale of net assets of discontinued operations - 257,100 -
Proceeds from sale of businesses and properties 137,728 - -
Acquisitions of businesses, net of cash acquired - - (293,625)
Other 26,486 7,682 6,633
----------------------------------------
Net cash provided by (used in) investing activities 163,422 146,963 (134,777)
----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock purchases 1,553 13,209 21,506
Proceeds from issuance of notes payable and other financing arrangements 221,276 155,575 566,240
Repayment of debt and other noncurrent liabilities (436,705) (212,109) (144,341)
Stock repurchase - - (111,334)
----------------------------------------
Net cash provided by (used in) financing activities (213,876) (43,325) 332,071
----------------------------------------
Net increase in cash and cash equivalents 246,674 204,505 71,422
Cash and cash equivalents, beginning of year 763,865 559,360 487,938
----------------------------------------
Cash and cash equivalents, end of year $1,010,539 $ 763,865 $ 559,360
----------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
-30-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------
(Amounts in thousands ) 1999 1998 1997
----------------------------------------
<S> <C> <C> <C>
SUPPLEMENTAL CASH FLOWS DISCLOSURE:
Interest paid $ 85,212 $85,981 $ 56,056
Income taxes paid (refunded) 6,106 (87,799) (3,534)
----------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Capital lease obligations $ - $ 2,530 $ 3,993
Notes and stocks received on sale of businesses 22,909 - -
Transfer of investments as consideration for PACC acquisition - - 14,310
Conversion of FOHP convertible debentures to equity - 1,197 70,654
ACQUISITION OF BUSINESSES:
Fair value of assets acquired - - $849,487
Liabilities assumed - - 438,448
----------------------------------------
Cash paid for acquisitions - - 411,039
Less: cash acquired in acquisitions - - 117,414
----------------------------------------
Net cash paid for acquisitions $ - $ - $293,625
----------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
-31-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS
The current operations of Foundation Health Systems, Inc. (the "Company" or
"FHS") are a result of the April 1, 1997 merger transaction (the "FHS
Combination") involving Health Systems International, Inc. ("HSI") and
Foundation Health Corporation ("FHC"). Pursuant to the FHS Combination, FH
Acquisition Corp., a wholly-owned subsidiary of HSI ("Merger Sub"), merged with
and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed
its name to "Foundation Health Systems, Inc." and thereby became the Company.
Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that
evidenced the FHS Combination, FHC stockholders received 1.3 shares of the
Company's Class A Common Stock for every share of FHC common stock held,
resulting in the issuance of approximately 76.7 million shares of the Company's
Class A Common Stock to FHC stockholders. The shares of the Company's Class A
Common Stock issued to FHC's stockholders in the FHS Combination constituted
approximately 61% of the outstanding stock of the Company after the FHS
Combination and the shares held by the Company's stockholders prior to the FHS
Combination (i.e. the prior stockholders of HSI) constituted approximately 39%
of the outstanding stock of the Company after the FHS Combination.
The FHS Combination was accounted for as a pooling of interests for
accounting and financial reporting purposes. The pooling of interests method of
accounting is intended to present, as a single interest, two or more common
stockholder interests which were previously independent and assumes that the
combining companies have been merged from inception. Consequently, the Company's
consolidated financial statements have been prepared and/or restated as though
HSI and FHC always had been combined. Although prior to the FHS Combination FHC
reported on a fiscal year ended June 30 basis, the consolidated financial
statements have been restated to reflect the Company's calendar year basis.
The consolidated financial statements give retroactive effect to the FHS
Combination which was accounted for as a pooling of interests and to the sale of
the Company's workers' compensation business which was accounted for as
discontinued operations (see Note 3).
CONTINUING OPERATIONS
The Company is an integrated managed care organization which administers the
delivery of managed health care services. Continuing operations, excluding
corporate functions, consist of two 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 Company currently operates within two segments of the managed health
care industry: Health Plan Services and Government
Contracts/Specialty Services. During 1999, the Health Plan Services segment
consisted of four regional divisions: Arizona (Arizona and Utah), California
(encompassing only the State of California), Central (Colorado, Florida,
Idaho, Louisiana, New Mexico, Oklahoma, Oregon, Texas and Washington) and
Northeast (Connecticut, New Jersey, New York, Ohio, Pennsylvania and West
Virginia). During 1999, the Company divested its health plans or entered into
arrangements to transition the membership of its health plans in the states
of Colorado, Idaho, Louisiana, New Mexico, Oklahoma, Texas, Utah and
Washington. Effective January 1, 2000, as a result of such divestitures, the
Company consolidated and reorganized its Health Plan Services segment into
two regional divisions, the Eastern Division (Connecticut, Florida, New
Jersey, New York, Ohio, Pennsylvania and West Virginia) and the
Western Division (Arizona, California and Oregon). The Company is one of the
largest managed health care companies in the United States, with
approximately 4 million at-risk and administrative services only ("ASO")
members in its Health Plan Services segment. The Company also owns health and
life insurance companies licensed to sell insurance in 33 states and the
District of Columbia.
The Government Contracts/Specialty Services segment administers large,
multi-year managed 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 1.5 million eligible individuals under TRICARE (formerly known as the
Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS")).
Currently, there are three TRICARE contracts that cover Alaska, Arkansas,
California, Hawaii, Oklahoma, Oregon, Texas, and Washington, and parts of
Arizona, Idaho and Louisiana. This segment also offers behavioral health,
dental, vision, and pharmaceutical products and services as well as managed care
products related to bill review, administration and cost containment for
hospitals, health plans and other entities.
DISCONTINUED OPERATIONS
WORKERS' COMPENSATION INSURANCE SEGMENT - In December 1997, the Company revised
its strategy of maintaining a presence in the workers' compensation
risk-assuming insurance business and adopted a formal plan to discontinue and
sell this segment through divestiture of its workers' compensation insurance
subsidiaries. The Company completed its sale of this segment on December 10,
1998. The consolidated financial statements give retroactive effect to the
foregoing (see Note 3).
-32-
<PAGE>
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned and majority-owned subsidiaries. All significant intercompany
transactions have been eliminated in consolidation except for transactions
between the Company's continuing operations subsidiaries and the discontinued
operations segments discussed in Note 3. The accompanying consolidated financial
statements have been restated for the FHS Combination accounted for as a pooling
of interests and for the discontinued operations as discussed in Note 1.
RECLASSIFICATIONS
Certain amounts in the 1998 and 1997 consolidated financial statements and notes
have been reclassified to conform to the 1999 presentation.
REVENUE RECOGNITION
Health plan services premium revenues include HMO and PPO premiums from employer
groups and individuals and from Medicare recipients who have purchased
supplemental benefit coverage, which premiums are based on a predetermined
prepaid fee, Medicaid revenues based on multi-year contracts to provide care to
Medicaid recipients, and revenue under Medicare risk contracts to provide care
to enrolled Medicare recipients. Revenue is recognized in the month in which the
related enrollees are entitled to health care services. Premiums collected in
advance are recorded as unearned premiums.
Government contracts revenues are recognized in the month in which the
eligible beneficiaries are entitled to health care services. Government
contracts also contain cost and performance incentive provisions which adjust
the contract price based on actual performance, and revenue under contracts is
subject to price adjustments attributable to inflation and other factors. The
effects of these adjustments are recognized on a monthly basis, although the
final determination of these amounts could extend significantly beyond the
period during which the services were provided. Amounts receivable under
government contracts are comprised primarily of estimated amounts receivable
under these cost and performance incentive provisions, price adjustments, and
change orders for services not originally specified in the contracts.
Specialty services revenues are recognized in the month in which the
administrative services are performed or the period that coverage for services
is provided.
HEALTH CARE EXPENSES
The cost of health care services is recognized in the period in which services
are provided and includes an estimate of the cost of services which have been
incurred but not yet reported. Such costs include payments to primary care
physicians, specialists, hospitals, outpatient care facilities and the costs
associated with managing the extent of such care. The Company estimates the
amount of the provision for service costs incurred but not reported using
standard actuarial methodologies based upon historical data including the period
between the date services are rendered and the date claims are received and
paid, denied claim activity, expected medical cost inflation, seasonality
patterns and changes in membership. The estimates for service costs incurred but
not reported are made on an accrual basis and adjusted in future periods as
required. Any adjustments to the prior period estimates are included in the
current period. Such estimates are subject to the impact of changes in the
regulatory environment and economic conditions. Given the inherent variability
of such estimates, the actual liability could differ significantly from the
amounts provided. While the ultimate amount of claims and losses paid are
dependent on future developments, management is of the opinion that the recorded
reserves are adequate to cover such costs. These liabilities are reduced by
estimated amounts recoverable from third parties for subrogation.
The Company generally contracts with various medical groups to provide
professional care to certain of its members on a capitation, or fixed per member
per month fee basis. Capitation contracts generally include a provision for
stop-loss and non-capitated services for which the Company is liable.
Professional capitated contracts also generally contain provisions for shared
risk, whereby the Company and the medical groups share in the variance between
actual costs and predetermined goals. Additionally, the Company contracts with
certain hospitals to provide hospital care to enrolled members on a capitation
basis. The HMOs also contract with hospitals, physicians and other providers of
health care, pursuant to discounted fee-for-service arrangements, hospital per
diems, and case rates under which providers bill the HMOs for each individual
service provided to enrollees.
The Company assesses the profitability of contracts for providing health
care services when operating results or forecasts indicate probable future
losses. Contracts are grouped in a manner consistent with the method of
determining premium rates. Losses are determined by comparing anticipated
premiums to the total of health care related costs less reinsurance recoveries,
if any, and the cost of maintaining the contracts. Losses, if any, are
recognized in the period the loss is determined and are classified as Health
Plan Services.
During 1998, premium deficiency reserves were specifically determined in
accordance with this policy for the Louisiana, Oklahoma, and Texas plans, which
the Company sold in 1999. See Note 3 - Acquisitions and Dispositions. These
future losses were probable as a result of increasing health care costs, on a
per member per month basis, driven by a declining membership base.
-33-
<PAGE>
CASH AND CASH EQUIVALENTS
Cash equivalents include all highly liquid investments with a maturity of three
months or less when purchased.
The Company and its consolidated subsidiaries are required to set aside
certain funds for restricted purposes pursuant to regulatory requirements. As of
December 31, 1999 and 1998, cash and cash equivalent balances of $52.9 million
and $65.5 million, respectively, are restricted and included in other noncurrent
assets.
INVESTMENTS
Investments classified as available for sale are reported at fair value based on
quoted market prices, with unrealized gains and losses excluded from earnings
and reported as other comprehensive income, net of income tax effects. The cost
of investments sold is determined in accordance with the specific identification
method and realized gains and losses are included in investment income.
Certain debt investments are held by trustees or agencies pursuant to
state regulatory requirements. These investments totaled $31.8 million in
1999 and $61.8 million in 1998, and are included in other noncurrent assets
(see Note 11). Market values approximate carrying value at December 31, 1999
and 1998.
GOVERNMENT CONTRACTS
Amounts receivable or payable under government contracts are based on three
TRICARE contracts in five regions which include both amounts billed ($5.1
million and $75.0 million of net receivables at December 31, 1999 and 1998,
respectively) and estimates for amounts to be received under cost and
performance incentive provisions, price adjustments and change orders for
services not originally specified in the contracts. Such estimates are
determined based on information available as well as historical performance and
collection of which could extend for periods beyond a year. Differences, which
may be material, between the amounts estimated and final amounts collected are
recorded in the period when determined.
Additionally, the reserves for claims and other settlements includes
approximately $189.7 million and $162.4 million relating to health care services
provided under these contracts as of December 31, 1999 and 1998, respectively.
PROPERTY AND EQUIPMENT
Property and equipment are stated at historical cost less accumulated
depreciation. Depreciation is computed using the straight-line method over the
lesser of estimated useful lives of the various classes of assets or the lease
term. The useful life for buildings and improvements is estimated at 40 years,
and the useful lives for furniture, equipment and software range from three to
eight years (see Note 5).
Expenditures for maintenance and repairs are expensed as incurred. Major
improvements which increase the estimated useful life of an asset are
capitalized. Upon the sale or retirement of assets, the recorded cost and the
related accumulated depreciation are removed from the accounts, and any gain or
loss on disposal is reflected in operations.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets arise primarily as a result of various
business acquisitions and consist of identifiable intangible assets acquired and
the excess of the cost of the acquisitions over the tangible and intangible
assets acquired and liabilities assumed (goodwill). Identifiable intangible
assets consist of the value of employer group contracts, provider networks,
non-compete agreements and debt issuance costs. Goodwill and other intangible
assets are amortized using the straight-line method over the estimated lives of
the related assets listed below. In accordance with Accounting Principles Board
("APB") Opinion No. 17, the Company periodically evaluates these estimated lives
to determine if events and circumstances warrant revised periods of
amortization. The Company further evaluates the carrying value of its goodwill
and other intangible assets based on estimated fair value or undiscounted
operating cash flows whenever significant events or changes occur which might
impair recovery of recorded costs. Fully amortized goodwill and other intangible
assets and the related accumulated amortization are removed from the accounts.
Impairment is measured in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to be Disposed Of" and is based on whether the asset will
be held and used or held for disposal. An impairment loss on assets to be held
and used is measured as the amount by which the carrying amount exceeds the fair
value of the asset. Fair value of assets held for disposal would additionally be
reduced by costs to sell the asset. For the purposes of analyzing impairment,
assets, including goodwill, are grouped at the lowest level for which there are
identifiable independent cash flows, which is generally at the operating
subsidiary level. Estimates of fair value are determined using various
techniques depending on the event that indicated potential impairment (see Note
15). Impairment charges for goodwill in 1999 and 1998 amounted to $4.7 million
and $30.0 million, respectively (see Note 15).
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 consolidated statement of operations for the year ended
December 31, 1999.
-34-
<PAGE>
Goodwill and other intangible assets consisted of the following at December
31, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
Accumulated Amortization
Cost Amortization Net Balance Period
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Goodwill $ 981,600 $ 157,924 $ 823,676 9-40 years
Provider network 69,466 15,515 53,951 14-40 years
Employer group contracts 92,900 68,874 24,026 11-23 years
Other 27,002 19,069 7,933 5-7 years
- -----------------------------------------------------------------------------------------------------
Total $ 1,170,968 $ 261,382 $ 909,586
- -----------------------------------------------------------------------------------------------------
</TABLE>
Goodwill and other intangible assets consisted of the following at December
31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
Accumulated Amortization
Cost Amortization Net Balance Period
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Goodwill $ 1,031,122 $ 152,321 $ 878,801 9-40 years
Provider network 69,466 12,978 56,488 14-40 years
Employer group contracts 92,900 60,724 32,176 11-23 years
Other 27,114 16,669 10,445 5-7 years
- -----------------------------------------------------------------------------------------------------
Total $ 1,220,602 $ 242,692 $ 977,910
- -----------------------------------------------------------------------------------------------------
</TABLE>
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash equivalents, investments and premium
receivables. All cash equivalents and investments are managed within established
guidelines which limit the amounts which may be invested with one issuer.
Concentrations of credit risk with respect to premiums receivable are limited
due to the large number of payers comprising the Company's customer base. The
Company's 10 largest employer groups accounted for 32% and 17% of receivables
and 15% and 12% of premium revenue as of December 31, 1999 and 1998,
respectively, and for the years then ended.
EARNINGS PER SHARE
The Company adopted in 1997, SFAS No. 128, "Earnings Per Share." As required by
SFAS No. 128, basic EPS excludes dilution and reflects income divided by the
weighted average shares of common stock outstanding during the periods
presented. Diluted EPS is based upon the weighted average shares of common stock
and dilutive common stock equivalents (stock options) outstanding during the
periods presented; no adjustment to income was required. Common stock
equivalents arising from dilutive stock options are computed using the treasury
stock method; in 1999 this amounted to 54,000 shares. Such shares amounting to
207,000 and 488,000 were anti-dilutive in 1998 and 1997, respectively.
Options to purchase an aggregate of 11.4 million, 13.4 million, and 9.6
million shares of common stock during 1999, 1998, and 1997, respectively, were
not included in the computation of diluted EPS because the options' exercise
price was greater than the average market price of the common stock. These
options expire through December 2009.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles ("GAAP") requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Principal
areas requiring the use of estimates include the determination of allowances for
doubtful accounts, reserves for claims and other settlements, reserves for
professional and general liabilities, amounts receivable or payable under
government contracts, remaining reserves for restructuring and other charges,
and net realizable values for assets where impairment charges have been
recorded.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts of cash equivalents, investments available for
sale and notes payable approximate their carrying amounts in the financial
statements and have been determined by the Company using available market
information and appropriate valuation methodologies. The carrying amounts of
cash equivalents approximate fair value due to the short maturity of those
instruments. The fair values of investments are estimated based on quoted market
prices and dealer quotes for similar investments. The fair value of notes
payable is estimated based on the quoted market prices for the same or similar
issues or on the current rates offered to the Company for debt with the same
remaining maturities. Considerable judgment is required to develop estimates of
fair value. Accordingly, the estimates are not necessarily indicative of the
amounts the Company could have realized in a current market exchange. The use
-35-
<PAGE>
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
The fair value estimates are based on pertinent information available to
management as of December 31, 1999 and 1998. Although management is not aware of
any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued for purposes of these
financial statements since that date, and therefore, current estimates of fair
value may differ significantly.
STOCK-BASED COMPENSATION
The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). As permitted under SFAS 123, the Company
has elected to continue accounting for stock-based compensation under the
intrinsic value method prescribed in APB Opinion No. 25, "Accounting for Stock
Issued to Employees." Under the intrinsic value method, compensation cost for
stock options is measured at the date of grant as the excess, if any, of the
quoted market price of the Company's stock over the exercise price of the option
(see Note 7).
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130 "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting
and presenting comprehensive income and its components. Comprehensive income
includes all changes in stockholders' equity (except those arising from
transactions with stockholders) and includes net income and net unrealized
appreciation (depreciation), after tax, on investments available for sale.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"),
which is required to be adopted in fiscal years beginning after June 15, 2000.
Management does not anticipate that the adoption of SFAS 133 will have a
significant effect on the financial position of the Company or its results of
operations.
NOTE 3 - ACQUISITIONS AND DISPOSITIONS
The following summarizes acquisitions, strategic investments, and dispositions
by the Company during the three years ended December 31, 1999.
1999 TRANSACTIONS
In connection with its planned divestiture of non-core operations, the Company
completed the sale of certain of its non-affiliate pharmacy benefits management
operations for net cash proceeds of $65.0 million and recognized a net gain of
$60.6 million. In addition, the Company also completed the sale of its HMO
operations in Utah, Washington, New Mexico, Louisiana, Texas and Oklahoma, as
well as the sale of its two hospitals, a bill review subsidiary, a third-party
administrator subsidiary and a PPO network subsidiary. For these businesses, the
Company received an aggregate of $60.5 million in net cash proceeds, $12.2
million in notes receivable, $10.7 million in stocks and recognized a net loss
of $9.1 million, before taxes. See Note 15 for impairment charges recognized
during 1998 on certain of these dispositions.
In connection with the disposition of the HMO operation in Washington, the
Company sold the Medicaid and Basic Health Plan membership and retained under a
reinsurance and administrative agreement the commercial membership. At the same
time, the Company entered into definitive agreements with PacifiCare of
Washington, Inc. and Premera Blue Cross to transition the Company's commercial
membership in Washington. The Company anticipates substantially completing the
transition during the first half of 2000. The Company also entered into a
definitive agreement with PacifiCare of Colorado, Inc. to transition the
Company's HMO membership in Colorado. The dispositions do not have a material
effect on the consolidated financial statements.
1998 TRANSACTIONS
WORKERS' COMPENSATION - In December 1997, the Company adopted a formal plan to
sell its workers' compensation segment which was accounted for as discontinued
operations. On December 10, 1998, the Company completed the sale of the workers'
compensation segment. The net assets sold consisted primarily of investments,
premiums and reinsurance receivables, and reserves for claims. The selling price
was $257.1 million in cash.
Total revenues for the workers' compensation segment amounted to $560.9
million and $518.7 million in 1997 and 1996, respectively. Net income (loss)
amounted to a $30.4 million loss in 1997 and income of $22.2 million in 1996
after applicable income tax benefits of $32.7 million and expense of $1.2
million, respectively.
In December 1997, the Company estimated that the loss on the disposal of
the workers' compensation segment would approximate $99.0 million (net of income
tax benefit of $21.0 million) which included an anticipated loss
-36-
<PAGE>
from operations during the phase-out period from December 1997 through the date
of disposal. The pre-tax loss in 1998 was an additional $30.2 million. This was
offset by an increase in the rate of the tax benefit of the transaction.
Accordingly, the accompanying statement of operations for the year ended
December 31, 1998 does not reflect any additional net gain or loss from the
disposition.
CALL CENTER OPERATIONS - In December 1998, the Company sold the clinical
algorithms used in its call center operations for $36.3 million in cash, net of
transaction costs, and recorded a gain of $1.2 million. In addition, the Company
entered into a long-term services agreement with the buyer to provide such
services to its members for a period of 10 years.
1997 TRANSACTIONS
ADVANTAGE HEALTH - On April 1, 1997, the Company completed the acquisition of
Advantage Health, a group of managed health care companies based in Pittsburgh,
Pennsylvania, for $12.5 million in cash. The acquisition was recorded using
purchase accounting and the excess of the purchase price over the fair value of
the net liabilities assumed of $19.7 million was recorded as goodwill which was
being amortized on a straight-line basis over 40 years. In December 1998, the
Company adjusted the carrying value of the goodwill to its estimated fair value
(see Note 15). Advantage Health remains a party to long-term provider agreements
with the seller.
PACC - On October 22, 1997, the Company completed the acquisitions of PACC
HMO and PACC Health Plans (collectively, "PACC"), which are managed health care
companies based near Portland, Oregon, for a purchase price of approximately
$43.7 million in cash and $14.3 million in investments. The acquisition was
recorded using purchase accounting and the excess of the purchase price over the
fair value of the assets acquired was recorded as goodwill. The goodwill, in the
amount of $30.2 million, is being amortized on a straight-line basis over 40
years.
FOHP - On April 30, 1997, the Company made a $51.7 million investment in
FOHP, Inc. ("FOHP"). FOHP was owned by physicians, hospitals and other health
care providers and was the sole shareholder of First Option Health Plan of New
Jersey, Inc. ("FOHP-NJ"), a managed health care company. The Company's initial
investment was in the form of FOHP debentures convertible up to 71 percent of
FOHP's outstanding equity at the Company's discretion. As of December 1, 1997,
the Company converted these initial FOHP debentures into 71 percent of FOHP's
equity. Additionally, effective December 8, 1997, FOHP issued an additional
$29.0 million of convertible debentures to the Company which immediately
converted approximately $18.9 million of these debentures into an additional 27
percent of FOHP's outstanding equity increasing FHS' equity holding in FOHP to
approximately 98 percent. Goodwill of $98.9 million was recorded as a result of
these transactions and is being amortized on a straight-line basis over 40
years. On December 31, 1997, the Company purchased nonconvertible debentures in
the amount of $24 million from FOHP. On December 31, 1998, the Company converted
approximately $1.2 million of its remaining principal amount of convertible
debentures of FOHP into common stock of FOHP. Effective July 30, 1999, the
Company purchased the remaining .4% minority interests in FOHP.
PHYSICIANS HEALTH SERVICES - On December 31, 1997, the Company completed
the acquisition of Physicians Health Services, Inc. ("PHS"), a group of managed
health care companies based in Shelton, Connecticut. The Company paid
approximately $265 million for the approximately nine million PHS shares then
outstanding and caused PHS to cash-out approximately $6 million in PHS employee
stock options as part of the acquisition. The acquisition has been recorded
using purchase accounting and the excess of the purchase price over the fair
value of the assets acquired was recorded as goodwill. The goodwill, in the
amount of $218.9 million, is being amortized on a straight-line basis over 40
years.
CHRISTIANIA GENERAL INSURANCE CORPORATION - On May 14, 1997, the Business
Insurance Group, Inc., then a subsidiary of the Company, acquired the
Christiania General Insurance Corporation of New York ("CGIC") for $12.7 million
in cash. The acquisition has been recorded using purchase accounting and the
excess of the purchase price over the fair value of the assets acquired was
recorded as goodwill. The goodwill, in the amount of $5.2 million, was being
amortized on a straight-line basis over 20 years. As previously discussed, the
workers' compensation segment is reported as discontinued operations and
includes CGIC. The remaining goodwill was reflected in the calculation of the
net loss on the sale of this segment.
The following table reflects unaudited pro forma combined results of
operations of the Company and Advantage Health, PACC, FOHP, PHS, and CGIC on the
basis that the acquisitions had taken place at the beginning of the year ended
December 31, 1997 (in thousands, except per share data):
<TABLE>
<CAPTION>
1997
- -----------------------------------------------------------
<S> <C>
Total revenues $8,144,406
Loss from continuing operations (176,589)
Net loss (295,746)
Basic and diluted loss per share:
Continuing operations (1.43)
Net (2.39)
- -----------------------------------------------------------
</TABLE>
-37-
<PAGE>
NOTE 4 - INVESTMENTS
As of December 31, the amortized cost, gross unrealized holding gains and losses
and fair value of the Company's available-for-sale investments were as follows
(amounts in thousands):
<TABLE>
<CAPTION>
1999
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Carrying
Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Asset-backed securities $116,628 $ 5 $(1,600) $115,033
U.S. government and agencies 98,998 13 (1,645) 97,366
Obligations of states and other political subdivisions 138,830 10 (833) 138,007
Corporate debt securities 69,602 8 (1,209) 68,401
Other securities 37,808 8 (20) 37,796
- -------------------------------------------------------------------------------------------------------------------
$461,866 $ 44 $(5,307) $456,603
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
1998
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Carrying
Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Asset-backed securities $135,819 $2,120 $ (39) $137,900
U.S. government and agencies 59,527 1,385 (48) 60,864
Obligations of states and other political subdivisions 181,464 2,964 (17) 184,411
Corporate debt securities 57,468 1,539 (36) 58,971
Other securities 79,409 209 (23) 79,595
- -------------------------------------------------------------------------------------------------------------------
513,687 8,217 (163) 521,741
Equity securities 22,103 - (18,762) 3,341
- -------------------------------------------------------------------------------------------------------------------
$535,790 $8,217 $(18,925) $525,082
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1999, the contractual maturities of the Company's
available-for-sale investments were as follows (in thousands):
<TABLE>
<CAPTION>
Estimated
Cost Fair Value
- -----------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 101,865 $101,847
Due after one year
through five years 252,165 249,068
Due after five years
through ten years 56,323 54,846
Due after ten years 51,513 50,842
- -----------------------------------------------------------
Total available for sale $ 461,866 $456,603
- -----------------------------------------------------------
</TABLE>
Proceeds from sales and maturities of investments available for sale
during 1999 were $642.2 million, resulting in realized gains and losses of
$.7 million and $.1 million, respectively. Proceeds from sales and maturities
of investments available for sale during 1998 were $727.4 million, resulting
in realized gains and losses of $3.6 million and $0.3 million, respectively.
Proceeds from sales and maturities of investments available for sale during
1997 were $597.7 million, resulting in realized gains and losses of $4.7
million and $0.1 million, respectively.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment comprised the following at December 31 (amounts in
thousands):
<TABLE>
<CAPTION>
1999 1998
- ------------------------------------------------------------
<S> <C> <C>
Land $ 20,645 $ 25,195
Construction in progress 18,930 17,824
Buildings and improvements 111,936 157,056
Furniture, equipment and
software 473,042 533,897
- ------------------------------------------------------------
624,553 733,972
Less accumulated depreciation 343,824 388,703
- ------------------------------------------------------------
$280,729 $345,269
- ------------------------------------------------------------
</TABLE>
See Notes 14 and 15 for impairment charges and write-offs recognized during
1998.
-38-
<PAGE>
NOTE 6 - NOTES PAYABLE, CAPITAL LEASES AND OTHER FINANCING ARRANGEMENTS
Notes payable, capital leases and other financing arrangements comprised the
following at December 31 (amounts in thousands):
<TABLE>
<CAPTION>
1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Revolving credit facility, variable interest at LIBOR plus 1.50% at
December 31, 1999, unsecured $1,039,250 $1,225,000
Note payable, due December 2000, interest at 7.95%, unsecured - 10,500
Note payable to California Wellness Foundation, due quarterly with a balloon
payment due 2006, variable interest of 2.5% above 3 year Treasury Note
auction rate, 8.16% at December 31, 1998
secured by a cash collateral pledge - 17,646
Capital leases and other notes payable 1,358 2,892
- -------------------------------------------------------------------------------------------------------------------
Total notes payable and capital leases 1,040,608 1,256,038
Notes payable and capital leases-current portion 1,256 1,760
- -------------------------------------------------------------------------------------------------------------------
Notes payable and capital leases-noncurrent portion $1,039,352 $1,254,278
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
REVOLVING CREDIT FACILITY
The Company established in July 1997, a $1.5 billion credit facility (the
"Credit Facility") with Bank of America (as Administrative Agent for the Lenders
thereto, as amended in April, July, and November 1998 and March 1999 (the
"Amendments")). All previous revolving credit facilities were terminated and
rolled into the Credit Facility. 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. These rates were 7.19% and 6.19% at December 31, 1999 and
1998, respectively. Under the Amendments, the Company's public issuer rating
becomes the exclusive means of setting the facility fee and borrowing rates
under the Credit Facility. In addition, certain covenants including financial
covenants were amended. The Credit Facility is available for five years, until
July 2002, but it may be extended under certain circumstances for two additional
years. The weighted average annual interest rate on the Company's notes payable
and capital leases was approximately 6.78%, 6.30% and 6.24% for the years ended
December 31, 1999, 1998 and 1997. The maximum amount outstanding under the
Credit Facility during 1999 was $1.225 billion and maximum commitment level is
$1.369 billion at December 31, 1999.
As of December 31, 1999, the Company was in compliance with the financial
covenants of the Credit Facility, as amended in March 1999. The Company may be
restricted from paying dividends under certain circumstances from time to time
under this Credit Facility.
Scheduled principal repayments on notes payable, capital leases and other
financing arrangements for the next five years are as follows (in thousands):
<TABLE>
- ---------------------------------------------------------
<S> <C>
2000 $1,256
2001 19
2002 1,039,333
2003 -
2004 -
Thereafter -
- ---------------------------------------------------------
Total notes payable and capital leases $1,040,608
- ---------------------------------------------------------
</TABLE>
NOTE 7 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS
The Company has various stock option plans which cover certain employees,
officers and non-employee directors, and employee stock purchase plans under
which substantially all full-time employees of the Company are eligible to
participate. The stockholders have approved these plans except for the 1998
Stock Option Plan which was adopted by the Company's Board of Directors.
Under the 1989, 1990, 1991, 1992, 1993, 1997 and 1998 employee stock option
plans and the non-employee director stock option plans, the Company grants
options at prices at or above the fair market value of the stock on the date of
grant. The options carry a maximum term of up to 10 years and in general vest
ratably over three to five years. The Company has reserved a total of 23.2
million shares of its Class A Common Stock for issuance under the stock option
plans.
Under the 1997 Employee Stock Purchase plans, the Company provides
employees with the opportunity to purchase stock through payroll deductions.
Eligible employees may purchase on a monthly basis the Company's Class A Common
Stock at 85% of the lower of the market price on either the first or last day of
each month.
-39-
<PAGE>
Stock option activity and weighted average exercise prices for the years
ended December 31 are presented below:
<TABLE>
<CAPTION>
1999 1998 1997
----------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Options Price Options Price Options Price
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January 1 13,418,473 $20.87 9,636,831 $29.94 7,051,940 $27.75
Granted 785,549 12.62 8,021,018 14.05 3,912,040 32.18
Exercised (5,000) 14.50 (514,064) 18.64 (830,021) 22.66
Canceled (1,914,605) 19.93 (3,725,312) 30.28 (497,128) 28.61
- -------------------------------------------------------------------------------------------------------------------
Outstanding at December 31 12,284,417 $20.47 13,418,473 $20.87 9,636,831 $29.94
- -------------------------------------------------------------------------------------------------------------------
Exercisable at December 31 4,824,708 4,140,362 5,116,533
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes the weighted average exercise price and
weighted average remaining contractual life for significant option groups
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------------------------------------
Weighted Average Weighted Weighted
Range of Number of Remaining Average Number of Average
Exercise Prices Options Contractual Life Exercise Price Options Exercise Price
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$6.63 - $10.84 710,000 9.06 $10.14 69,666 $10.65
11.50 - 12.94 5,775,185 5.10 12.91 428,031 12.91
13.00 - 32.50 4,900,732 6.71 27.35 3,428,511 28.29
34.69 - 52.81 898,500 5.29 39.74 898,500 39.74
- -------------------------------------------------------------------------------------------------------------------
$6.63 - $52.81 12,284,417 5.98 $20.47 4,824,708 $28.80
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
The weighted average fair value for options granted during 1999, 1998 and
1997 was $6.10, $6.00 and $9.95, respectively. The fair values were estimated
using the Black-Sholes option-pricing model. The following weighted average
assumptions were used in the fair value calculation for 1999, 1998 and 1997,
respectively: (i) risk-free interest rate of 6.31%, 4.57% and 5.71%; (ii)
expected option lives of 3.9 years, 4.6 years and 3.7 years; (iii) expected
volatility for both options and employee purchase rights of 55.7%, 44.5% and
30.0%; and (iv) no expected dividend yield.
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its plans. Accordingly, no compensation cost has been recognized
for its stock option or employee stock purchase plans. Had compensation cost for
the Company's plans been determined based on the fair value at the grant dates
of options and employee purchase rights consistent with the method of SFAS No.
123, the Company's net income and earnings per share would have been reduced to
the pro forma amounts indicated below for the years ended December 31 (amounts
in thousands, except per share data):
<TABLE>
<CAPTION>
1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (loss) As reported $142,365 $(165,158) $(187,084)
Pro forma 132,043 (171,022) (193,638)
Basic earnings (loss) per share As reported 1.16 (1.35) (1.52)
Pro forma 1.08 (1.40) (1.57)
Diluted earnings (loss) per share As reported 1.16 (1.35) (1.52)
Pro forma 1.08 (1.40) (1.56)
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
-40-
<PAGE>
On December 4, 1998, options representing approximately 1.9 million shares
of stock granted during 1990 through 1997 at exercise prices ranging from $11.70
to $35.25 were exchanged for options representing approximately 1.4 million
shares of stock at an exercise price of $12.94, which was the fair market value
of the underlying shares on the grant date.
As fair value criteria was not applied to option grants and employee
purchase rights prior to 1995, and additional awards in future years are
anticipated, the effects on net income and earnings per share in this pro forma
disclosure may not be indicative of future amounts.
NOTE 8 - CAPITAL STOCK
The Company has two classes of Common Stock. The Company's Class B Common Stock
has the same economic benefits as the Company's Class A Common Stock but is
non-voting. Upon the sale or transfer of shares of Class B Common Stock by the
California Wellness Foundation (the "CWF") to an unrelated third party, such
shares automatically convert into Class A Common Stock. The CWF is the only
holder of record of the Company's Class B Common Stock.
PUBLIC OFFERING
On May 15, 1996, the Company completed a public offering in which the Company
sold 3,194,374 shares of Class A Common Stock and the CWF sold 6,386,510 shares
of Class A Common Stock (constituting 6,386,510 shares of Class B Common Stock
which automatically converted into shares of Class A Common Stock upon the sale)
for a per share purchase price to the public of $30.00 (the "Offering"). The
proceeds received by the Company from the sale of the 3,194,374 shares of Class
A Common Stock were approximately $92.4 million after deducting underwriting
discounts and commissions and estimated expenses of the Offering payable by the
Company. The Company used its net proceeds from the Offering to repurchase
3,194,374 shares of Class A Common Stock from certain Class A Stockholders. The
Company repurchased these shares of Class A Common Stock from the Class A
Stockholders at $30.00 per share less transaction costs associated with the
Offering, amounting to $1.08 per share. All of these 3,194,374 shares of Class A
Common Stock repurchased are currently held in treasury. The Company did not
receive any of the proceeds from the sale of shares of Class A Common Stock in
the Offering by the CWF.
On June 27, 1997, the Company redeemed 4,550,000 shares of Class B
Common Stock from the CWF at a price of $24.469 per share. The Company
provided its consent to permit the CWF to sell 3,000,000 shares of Class B
Common Stock to an unrelated third party in June of 1997 and the CWF had the
right to sell an additional 450,000 shares of Class B Common Stock to
unrelated third parties, which it did throughout August of 1997. On November
6, 1997, the Company also provided its consent to permit the CWF to sell
1,000,000 shares of Class B Common Stock to unrelated third parties. In
addition, on June 1, 1998, the Company gave its consent to permit the CWF to
sell (and on June 18, 1998, the CWF sold) 5,250,000 shares of Class B Common
Stock to unrelated third parties. In 1999, the CWF sold 2,909,600 shares of
Class B Common Stock to unrelated third parties. Pursuant to the Company's
Certificate of Incorporation, all of such shares of Class B Common Stock
automatically converted into shares of Class A Common Stock in the hands of
such third parties.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend
distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights, and the expiration of the Rights and in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then outstanding and no separate Rights Certificates will be distributed.
Subject to certain exceptions contained in the Rights Agreement, the Rights will
separate from the Common Stock in the event any person acquires 15% or more of
the outstanding Class A Common Stock, the Board of Directors of the Company
declares a holder of 10% or more of the outstanding Class A Common Stock to be
an "Adverse Person," or any person commences a tender offer for 15% of the Class
A Common Stock (each event causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock, at a price of $170.00
per one-thousandth share. However, in the event any person acquires 15% or more
of the outstanding Class A Common Stock, or the Board of Directors of the
Company declares a holder of 10% or more of the outstanding Class A Common Stock
to be an "Adverse Person," the Rights (subject to certain exceptions contained
in the Rights Agreement) will instead become exercisable for Class A Common
Stock having a market value at such time equal to $340.00. The Rights are
redeemable under certain circumstances at $.01 per Right and will expire, unless
earlier redeemed, on July 31, 2006.
-41-
<PAGE>
In connection with the FHS Combination, the Company entered into Amendment
No. 1 to the Rights Agreement to exempt the FHS Combination and related
transactions from triggering the Rights. In addition, the amendment modified
certain terms of the Rights Agreement applicable to the determination of certain
"Adverse Persons," which modifications became effective upon consummation of the
FHS Combination.
NOTE 9 - EMPLOYEE BENEFIT PLANS
DEFINED CONTRIBUTION RETIREMENT PLANS
The Company and certain subsidiaries sponsor defined contribution retirement
plans intended to qualify under Section 401(a) and 401(k) of the Internal
Revenue Code of 1986, as amended (the "Code"). Participation in the plans is
available to substantially all employees who meet certain eligibility
requirements and elect to participate. Employees may contribute up to the
maximum limits allowed by Sections 401(k) and 415 of the Code, with Company
contributions based on matching or other formulas. The Company's expense under
the plans totaled $7.8 million, $7.4 million and $4.2 million for the years
ended December 31, 1999, 1998 and 1997, respectively.
DEFERRED COMPENSATION PLANS
Effective May 1, 1998, the Company adopted a deferred compensation plan pursuant
to which certain management and highly compensated employees are eligible to
defer between 5% and 50% of their regular compensation and between 5% and 100%
of their bonuses, and non-employee Board members are eligible to defer up to
100% of their directors compensation. The compensation deferred under this plan
is credited with earnings or losses measured by the mirrored rate of return on
investments elected by plan participants. Each plan participant is fully vested
in all deferred compensation and earnings credited to his or her account. At
December 31, 1999, the employee deferrals were invested through a trust.
Prior to May 1997, certain members of management, highly compensated
employees and non-employee Board members were permitted to defer payment of up
to 90% of their compensation under a prior deferred compensation plan (the
"Prior Plan"). As part of the FHS Combination, the Prior Plan was frozen in May
1997 at which time each participant's account was credited with three times the
1996 Company match (or a lesser amount for certain participants) and each
participant became 100% vested in all such contributions. The current provisions
with respect to the form and timing of payments under the Prior Plan remain
unchanged. At December 31, 1999 and 1998, the liability under these plans
amounted to $20.9 million and $27.9 million, respectively. The Company's expense
under this plan totaled $5.6 million, $6.1 million and $7.8 million for the
years ended December 31, 1999, 1998 and 1997, respectively.
PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
RETIREMENT PLANS - In 1992, the Company adopted a non-qualified Supplemental
Executive Retirement Plan (the "Prior SERP"). Certain key executives were
eligible to participate in the Prior SERP. Under the provisions of the Prior
SERP, these executives could elect to credit amounts to the Prior SERP in lieu
of compensation. The annual amount so credited was equal to 50% of the premium
that would be required to fund a premium variable life insurance policy. The
Company then credited the executives SERP account with the remaining 50%
premium. The amounts contributed under this plan are credited with earnings or
losses measured by the mirrored rate of return on investments elected by plan
participants. Upon death, prior to retirement or termination, beneficiaries are
entitled to receive the entire death benefit under the policy plus an additional
78.5% of policy benefits. At retirement or termination, the executive is
entitled to the cash surrender value of the policy (up to the value of the
executive's account) plus an additional 78.5% of the value of the executive's
account. The retirement or termination benefit must be paid to the executive in
a lump sum. This Prior SERP was discontinued in December 1995.
In 1995, the Company adopted two unfunded non-qualified defined benefit
pension plans, a Supplemental Executive Retirement Plan and a Directors'
Retirement Plan (collectively, the "FHC SERPs"). The Company has two additional
unfunded non-qualified defined benefit pension plans, a Supplemental Executive
Retirement Plan (adopted in 1996) and a Directors' Retirement Plan
(collectively, the "HSI SERPs"). These plans cover key executives, as selected
by the Board of Directors, and non-employee directors. Benefits under the plans
are based on years of service and level of compensation.
As part of the FHS Combination, the FHC SERPs were frozen in April 1997 at
which time each participant became 100% vested in his or her benefits under the
plans which are equal to 90% of the actuarial equivalent of the participant's
retirement benefit as of December 31, 1996. All benefits under the FHC SERPs
were paid out either in cash, or as a rollover to the FHS deferred compensation
plan.
POSTRETIREMENT HEALTH AND LIFE PLANS - Certain subsidiaries of the Company
sponsor postretirement defined benefit health care plans that provide
postretirement medical benefits to directors, key executives, employees and
dependents who meet certain eligibility requirements. Under these plans, the
Company pays a percentage of the costs of medical, dental and vision benefits
during retirement. The plans include certain cost-sharing features such as
deductibles, co-insurance and maximum annual benefit amounts which vary based
principally on years of credited service.
-42-
<PAGE>
On December 31, 1998, the Company adopted SFAS No. 132 "Employers'
Disclosures about Pension and Other Postretirement Benefits" ("SFAS No. 132"),
which revises employers' disclosures about pension and other postretirement
benefit plans. SFAS No. 132 standardizes the disclosure requirements. The
Company has chosen to disclose the information required by SFAS No. 132 by
aggregating retirement plans into one category and postretirement plans into
another category.
The following table sets forth the plans' funded status and amounts
recognized in the Company's financial statements (amounts in thousands):
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
----------------------------------------------
1999 1998 1999 1998
========== =========== =========== ===========
<S> <C> <C> <C> <C>
Change in benefit obligation:
Benefit obligation, beginning of year $ 15,103 $ 8,078 $ 4,060 $ 5,527
Service cost 1,762 1,525 603 356
Interest cost 989 756 324 252
Plan amendments - 1,501 - (777)
Benefits paid (1,112) (262) (94) (209)
Actuarial loss (gain) (4,455) 3,505 613 (1,089)
---------- ----------- ----------- -----------
Projected benefit obligation, end of year $ 12,287 $ 15,103 $ 5,506 $ 4,060
---------- ----------- ----------- -----------
Change in fair value of plan assets:
Plan assets, beginning of year $ - $ - $ - $ -
Employer contribution 1,112 262 21 138
Benefits paid (1,112) (262) (21) (138)
---------- ----------- ----------- -----------
Plan assets, end of year $ - $ - $ - $ -
---------- ----------- ----------- -----------
Funded status of plans $(12,287) $(15,103) $ (5,506) $ (4,060)
Unrecognized prior service cost 4,969 5,442 (211) (217)
Unrecognized (gain) loss (3,338) 1,220 (1,645) (2,316)
---------- ----------- ----------- -----------
Net amount recognized $(10,656) $ (8,441) $ (7,362) $ (6,593)
---------- ----------- ----------- -----------
Amounts recognized in the consolidated balance sheet:
Accrued benefit liability $(10,656) $(10,161) $ (7,362) $ (6,593)
Intangible asset - 1,720 - -
---------- ----------- ----------- -----------
Net amount recognized $(10,656) $ (8,441) $ (7,362) $ (6,593)
---------- ----------- ----------- -----------
</TABLE>
The components of net periodic benefit costs for the years ended December
31, 1999, 1998 and 1997 are as follows (amounts in thousands):
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
--------------------------------------------------------------------------
1999 1998 1997 1999 1998 1997
========== ============= ============ ============= ============ =========
<S> <C> <C> <C> <C> <C> <C>
Service cost $1,762 $1,525 $1,122 $603 $356 $ -
Interest cost 989 756 418 324 252 86
Amortization of transition obligation - - - - - 10
Amortization of prior service cost 474 308 293 (6) (8) 37
Amortization of unrecognized
(gain) loss 103 72 (17) (58) (115) (6)
---------- ------------- ------------ ------------- ------------ --------
3,328 2,661 1,816 863 485 127
Cost of subsidiary plan
curtailment - 1,896 - - (13) 531
---------- ------------- ------------ ------------- ------------ ---------
Net periodic benefit cost $3,328 $4,557 $1,816 $863 $472 $ 658
---------- ------------- ------------ ------------- ------------ ---------
</TABLE>
-43-
<PAGE>
The weighted average annual discount rate assumed was 7.75% and 6.75% for
the years ended December 31, 1999 and 1998, respectively, for both pension plan
benefit plans and other postretirement benefit plans. Weighted average
compensation increases of between 2% to 6% for the years ended December 31, 1999
and 1998, respectively, were assumed for the pension benefit plans.
For measurement purposes, depending upon the type of coverage offered, a 6%
annual rate of increase in the per capita cost covered health care benefits was
assumed for 1999, and 6.25% was assumed for 1998. These rates were assumed to
decrease gradually to 4.5% in 2006 for 1999 and between 4.5% and 6.0% in 2005
for 1998.
The Company has multiple postretirement medical benefit plans. The Company
acquired PACC effective September 30, 1997, including its frozen postretirement
benefit plan. The PACC plan is non-contributory. The FHC plan is contributory by
certain participants. The account for the FHC plan anticipates future
cost-sharing changes to the plan consistent with the Company's expressed intent
to increase retiree contributions at the same rates as the Company's premium
increases. The Health Net plan is non-contributory for employees retired prior
to December 1, 1995 who have attained the age of 62; employees retiring after
December 1, 1995 who have attained age 62 contribute from 25% to 100% of the
cost of coverage depending upon years of service.
A one-percentage-point change in assumed health care cost trend rates would
have the following effects (amounts in thousands):
<TABLE>
<CAPTION>
1-percentage 1-percentage
point increase point decrease
================== ================
<S> <C> <C>
Effect on total of service
and interest cost, 1999 $ 249 $(182)
Effect on postretirement
benefit obligation,
12/31/99 1,171 (887)
------------------ ----------------
</TABLE>
The Company has no minimum pension liability adjustment to be included in
comprehensive income.
PERFORMANCE-BASED ANNUAL BONUS PLAN
In 1998, the Company adopted a Performance-Based Annual Bonus Plan that
qualified under Section 162(m) of the Code (the "162(m) Plan"). Under the 162(m)
Plan, if the Company achieved greater than $250 million in consolidated income
from operations before taxes (as determined under GAAP consistently applied,
excluding any non-recurring or extraordinary charges), certain executives were
potentially eligible to receive cash bonuses from a pool of $7.5 million based
on the executives' salaries in relation to the pool. Amounts payable to such
executives from such pool were subject to downward adjustment by the Company's
Compensation and Stock Option Committee of the Board of Directors. The $250
million performance goal for the 162(m) Plan was not met for 1999. This existing
162(m) Plan will terminate effective December 31, 1999 in the event stockholder
approval of a new Management Incentive Plan is received at the Company's 2000
Annual Stockholders Meeting.
NOTE 10 - INCOME TAXES
Significant components of the provision (benefit) for income taxes are as
follows for the years ended December 31 (amounts in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
========== =========== ==========
<S> <C> <C> <C>
Current:
Federal $ 29,080 $ 6,346 $(12,894)
State (6,448) 3,897 3,183
---------- ----------- ----------
Total current 22,632 10,243 (9,711)
---------- ----------- ----------
Deferred:
Federal 52,419 (121,800) (57,150)
State 21,175 (7,630) (5,478)
---------- ----------- ----------
Total deferred 73,594 (129,430) (62,628)
---------- ----------- ----------
Total provision
(benefit) for
income taxes $ 96,226 $(119,187) $(72,339)
---------- ----------- ----------
</TABLE>
Income tax expense (benefit) is included in the consolidated financial
statements as follows for the years ended December 31 (amounts in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
========== =========== ==========
<S> <C> <C> <C>
Continuing
operations $ 96,226 $ (88,996) $(21,418)
Discontinued
operations - (30,191) (50,921)
---------- ----------- ----------
Total provision
(benefit) for
income taxes $ 96,226 $(119,187) $(72,339)
---------- ----------- ----------
</TABLE>
A reconciliation of the statutory federal income tax rate and the effective
income tax rate on income from continuing operations is as follows for the years
ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
======== ======= =======
<S> <C> <C> <C>
Statutory federal income
tax rate 35% (35)% (35)%
State and local taxes, net of
federal income tax effect 4 (1) (3)
Tax exempt interest income (1) (1) (2)
Goodwill amortization 3 6 6
Valuation allowance adjustment - - (2)
Examination settlements (2) - -
Merger transaction costs - (3) 8
Other, net - (1) 4
-------- ------- -------
Effective income tax rate 39% (35)% (24)%
-------- ------- -------
</TABLE>
-44-
<PAGE>
Significant components of the Company's deferred tax assets and liabilities
as of December 31 are as follows (amounts in thousands):
<TABLE>
<CAPTION>
1999 1998
=========== ===========
<S> <C> <C>
DEFERRED TAX ASSETS:
Accrued liabilities $ 52,491 $ 91,993
Insurance loss reserves and
unearned premiums 6,144 3,616
Tax credit carryforwards 8,059 -
Accrued compensation and
benefits 33,838 31,097
Restructuring reserves 4,025 30,462
Net operating loss carryforwards 165,023 190,913
Other 16,363 5,667
----------- ------------
Deferred tax assets before
valuation allowance 285,943 353,748
Valuation allowance (47,092) (48,452)
----------- ------------
Net deferred tax assets $238,851 $305,296
----------- ------------
DEFERRED TAX LIABILITIES:
Depreciable and amortizable
property $ 35,388 $ 26,077
Other 50 14
----------- ------------
Deferred tax liabilities $ 35,438 $ 26,091
=========== ============
</TABLE>
In 1998 and 1997, income tax benefits attributable to employee stock option
transactions of $6.3 million and $4.5 million, respectively, were allocated to
stockholders' equity. No income tax benefits were allocated to stockholders'
equity during 1999.
As of December 31, 1999, the Company had federal and state net operating
loss carryforwards of approximately $439.9 million and $246.2 million,
respectively. The net operating loss carryforwards expire between 2001 and 2019.
Limitations on utilization may apply to approximately $111.2 million and $143.4
million of the federal and state net operating loss carryforwards, respectively.
Accordingly, valuation allowances have been provided to account for the
potential limitations on utilization of these tax benefits. The valuation
allowance decrease of $1.4 million in 1999 was due primarily to utilization of
state net operating loss carryforwards. Of the $47.1 million (tax effected)
remaining valuation allowance, $45.4 million, pertains primarily to an acquired
subsidiary's deferred tax assets. In the event that any portion of the deferred
tax assets related to this subsidiary is realized, the future tax benefits will
be allocated to reduce the associated goodwill.
NOTE 11 - REGULATORY REQUIREMENTS
All of the Company's health plans as well as its insurance subsidiaries are
required to periodically file financial statements with regulatory agencies in
accordance with statutory accounting and reporting practices. Under the
California Knox-Keene Health Care Service Plan Act of 1975, as amended,
California plans must comply with certain minimum capital or tangible net equity
requirements. The Company's non-California health plans, as well as its health
and life insurance companies, must comply with their respective state's minimum
regulatory capital requirements and in certain cases, maintain minimum
investment amounts for the restricted use of the regulators which as of December
31, 1999 totaled $84.7 million. Also, under certain government regulations,
certain subsidiaries are required to maintain a current ratio of 1:1 and to meet
other financial standards.
As a result of the above requirements and other regulatory requirements,
certain subsidiaries are subject to restrictions on their ability to make
dividend payments, loans or other transfers of cash to the Company. Such
restrictions, unless amended or waived, limit the use of any cash generated by
these subsidiaries to pay obligations of the Company. Management believes that
as of December 31, 1999, substantially all of the Company's health plans and
insurance subsidiaries met their respective regulatory requirements.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
In July 1996, the Company's predecessor, HSI, the owner of 1,234,544 shares
of Series F Preferred Stock of Health Data Sciences Corporation ("HDS"), voted
its HDS shares in favor of the acquisition of HDS by Medaphis Corporation
("Medaphis"). HSI received as the result of the acquisition 976,771 shares of
Medaphis common stock in exchange for its Series F Preferred Stock.
In November 1996, HSI filed a lawsuit against Medaphis and its former Chairman
and Chief Executive Officer. The Company alleged that Medaphis and certain
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.
In September 1999, the Company and Medaphis (which changed its name to
Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement Agreement and
Release pursuant to which the Company received net proceeds of approximately
$25 million consisting of cash from Per-Se and Per-Se's insurers and proceeds
from the sale of both the 976,771 shares of Medaphis (now Per-Se) common
stock then owned by the Company and additional shares of Per-Se common stock
issued to the Company as part of the settlement. In exchange, the Company and
Per-Se terminated the ongoing litigation and granted each other a general
release. The gain recognized in the consolidated statement of operations as
of December 31, 1999 was immaterial.
-45-
<PAGE>
Complaints have been filed in federal and state courts seeking an
unspecified amount of damages on behalf of an alleged class of persons who
purchased shares of common stock, convertible subordinated debentures and
options to purchase common stock of FPA at various times between February 3,
1997 and May 15, 1998. The complaints allege that the Company and certain former
officers violated federal and state securities laws by misrepresenting and
failing to disclose certain information about a 1996 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. Based in part on advice from litigation
counsel to the Company and upon information presently available, management
believes these suits are without merit and intends to vigorously defend the
actions.
In November 1999, a complaint was filed seeking certification of a
nationwide class action and alleging that cost containment measures used by
FHS-affiliated health maintenance organizations, preferred provider
organizations and point-of-service health plans violate provisions of the
federal Racketeer Influenced and Corrupt Organizations Act and the federal
Employee Retirement Income Security Act ("ERISA"). The action seeks
unspecified damages and injunctive relief. In January 2000, the court stayed
the case pending resolution of matters in an action pending against one of
the Company's competitors. Based in part on advice from litigation counsel to
the Company and upon information presently available, management believes
this suit is without merit and intends to vigorously defend the action.
In September 1983, a lawsuit was filed by Baja, Inc. ("Baja") against a
hospital that was subsequently acquired by the Company in October 1992. The
lawsuit arose out of a multi-phase written contract for operation of a pharmacy
at the hospital during the period September 1978 through September 1983. In
August 1993, Baja was awarded $549,532 on a portion of its claim. In July 1995,
Baja was awarded an additional $1,015,173 plus interest in lost profits damages.
In October 1995, both parties appealed the decision and portions of the judgment
were reversed. In January 2000, after further proceedings on the issue of Baja's
lost profits, Baja was awarded an additional $4,996,019 plus pre-judgment
interest. The Company is in the process of preparing appropriate post-trial
motions in this case, and is also considering an appeal of the final judgment.
Such costs have been accrued and recorded in the consolidated financial
statements.
In December 1999, one of the Company's subsidiaries was sued by the
Attorney General of Connecticut on behalf of a group of state residents. The
lawsuit is premised on ERISA, and alleges that the Company has violated its
duties under that act and seeks to have the Company revamp its formulary system,
and to provide patients with written denial notices and instructions on how to
appeal. The Company intends to defend the lawsuit vigorously, and has filed a
motion to dismiss which asserts that the state residents all received a
prescription drug appropriate for their conditions and therefore suffered no
injuries whatsoever, that the Attorney General's office lacks standing to bring
the suit, and that the allegations fail to state a claim under ERISA. A decision
is expected in the second quarter of 2000.
The Company is involved in various other legal proceedings, which are
routine in its business.
Based in part on advice from litigation counsel to the Company and upon
information presently available, the resolution of all of the above matters
should not have a material adverse effect on the financial position or results
of operations of the Company.
OPERATING LEASES
The Company leases administrative and medical office space under various
operating leases. Certain medical office space is subleased to participating
medical groups doing business with the Company. Certain leases contain renewal
options and rent escalation clauses.
In 1995, the Company entered into a $60 million tax retention operating
lease with NationsBank of Texas, N.A., as Administrative Agent for the Lenders
who are parties thereto, and First Security Bank of Utah, N.A., as Owner
Trustee, (the "TROL Agreement") for the construction of health care centers and
a corporate facility. Under the TROL Agreement, rental payments commenced upon
completion of construction, with a guarantee of 87% to the lessor of the
residual value of properties leased at the end of the lease term. After the
initial five year noncancelable lease term, the lease may be extended by
agreement of the parties or the Company must purchase or arrange for sale of the
leased properties. The Company has committed to a maximum guaranteed residual
value of $30.8 million under this agreement at December 31, 1999.
Future minimum lease commitments for noncancelable operating leases at
December 31, 1999 are as follows (amounts in thousands):
<TABLE>
<S> <C>
2000 $ 44,440
2001 37,969
2002 23,411
2003 13,349
2004 7,656
Thereafter 6,224
-----------
Total minimum lease commitments $133,049
-----------
</TABLE>
Rent expense totaled $49.0 million, $50.3 million and $48.7 million in
1999, 1998 and 1997, respectively.
-46-
<PAGE>
NOTE 13 - RELATED PARTIES
Two current directors of the Company and one prior director are partners in law
firms which received legal fees totaling $1.2 million, $1.0 million, and $1.1
million in 1999, 1998, and 1997, respectively. One current director is an
officer of IBM which the Company paid $9.0 million and $8.0 million for services
in 1999 and 1998, respectively, and one current director is also a director of a
temporary staffing company which the Company paid $11.0 million and $20.4
million in 1999 and 1998, respectively. An officer of a contracted hospital was
also a member of the Company's Board of Directors until April 1, 1997. Medical
costs paid to the hospital totaled $67.1 million in 1997. Such contracted
hospital is also an employer group of the Company from which the Company
receives premium revenues at standard rates.
A director of the Company was paid an aggregate of $95,000 in consulting
fees in 1999 and 2000 due to various services provided to the Company in
connection with the closing of its operations in Pueblo,Colorado (see Note 15).
In addition, two of this director's law firm partners purchased a building from
the Company in Pueblo,Colorado, for $405,000 in 1999.
During 1998, three executive officers of the Company, in connection with
their hire or relocation, received one-time loans from the Company
aggregating $775,000 which ranged from $125,000 to $400,000 each. The loans
accrue interest at the prime rate and each is payable upon demand by the
Company in the event of a voluntary termination of employment of the
respective officer or termination for cause. During 1999, three executive
officers of the Company, in connection with their hire or relocation,
received one-time loans from the Company aggregating $550,000 which ranged
from $100,000 to $300,000 each. The loans accrue interest at the prime rate
and each is payable upon demand by the Company in the event of a voluntary
termination of employment of the respective officer or termination for cause.
The principal and interest of the loans will be forgiven by the Company at
varying times between one and five years after the date of hire or relocation of
the respective officers. As of December 31, 1999 a portion of a loan to one
executive officer was forgiven for $83,000 and the aggregate outstanding
principal balance of the six loans was $1,242,000.
NOTE 14 - ASSET IMPAIRMENT, MERGER, RESTRUCTURING AND OTHER CHARGES
The following sets forth the principal components of asset impairment, merger,
restructuring and other costs for the years ended December 31 (amounts in
millions):
<TABLE>
<CAPTION>
1999 1998 1997
======== ======== =======
<S> <C> <C> <C>
Severance and benefit
related costs $17.2 $ 21.2 $ 61.4
Provider network
consolidation costs - - 36.2
Real estate lease
termination costs 0.8 - 7.9
Asset impairments and other
charges related to FPA
Medical Management - 84.1 -
Asset impairment and
other costs 6.2 112.4 44.0
Merger related costs - - 69.6
Gem costs - - 57.5
Other costs 1.7 22.4 12.6
-------- -------- -------
25.9 240.1 289.2
-------- -------- -------
Modifications to prior year
restructuring plans (14.2) - (2.7)
-------- -------- -------
Total $11.7 $ 240.1 $286.5
-------- -------- -------
</TABLE>
1999 CHARGES
The following tables summarize the 1999 charges by quarter and by type (amounts
in millions):
<TABLE>
<CAPTION>
1999 Activity
1999 Net ------------- Balance at Expected
1999 Modifications 1999 Cash December 31, Future Cash
Charges to Estimate Charges Payments Non-Cash 1999 Outlays
============ ============== =========== ============ ============= ============ ==========
<C> <C> <C> <C> <C> <C> <C> <C>
Severance and benefit
related costs $18.5 $(1.3) $17.2 $ (8.6) - $8.6 $ 8.6
Asset impairment costs 6.2 - 6.2 - $ (6.2) - -
Real estate lease
termination costs 0.8 - 0.8 (0.8) - - -
Other costs 1.8 (0.1) 1.7 (1.4) - 0.3 0.3
------------ -------------- ----------- ------------ ------------- ------------ ----------
Total $27.3 $(1.4) $25.9 $(10.8) $ (6.2) $8.9 $8.9
------------ -------------- ----------- ------------ ------------- ------------ ----------
First Quarter 1999
Charge $21.1 $(1.4) $19.7 $(10.8) - $8.9 $ 8.9
Fourth Quarter 1999
Charge 6.2 - 6.2 - (6.2) - -
------------ -------------- ----------- ------------ ------------- ------------ ----------
Total $27.3 $(1.4) $25.9 $(10.8) $ (6.2) $8.9 $ 8.9
------------ -------------- ----------- ------------ ------------- ------------ ----------
</TABLE>
-47-
<PAGE>
The Company initiated during the fourth quarter of 1998 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 announced in 1999 its plan to close the
Colorado regional processing center, terminate employees and transfer its
operations to the Company's other administrative facilities. In addition, the
Company also announced its plans to consolidate certain administrative functions
in its Northwest health plan operations. During the first and fourth quarters
ended March 31, 1999 and December 31, 1999, the Company recorded pretax charges
for restructuring and other charges of $21.1 million (the "1999 Charges") and
$6.2 million, respectively.
SEVERANCE AND BENEFIT RELATED COSTS - The 1999 Charges included $18.5
million for severance and benefit costs related to executives and operations
employees at the Colorado regional processing center and operations employees at
the Northwest health plans. The operations functions include premium accounting,
claims, medical management, customer service, sales and other related
departments. The 1999 Charges included the termination of a total of 773
employees. As of December 31, 1999, 457 employees had been terminated and $8.6
million had been paid. Termination of the remaining 316 employees is expected to
be completed during the first half of 2000. Modifications to the initial
estimate of $1.3 million were recorded during 1999.
ASSET IMPAIRMENT COSTS - During the fourth quarter ended December 31, 1999,
the Company recorded asset impairment costs totaling $6.2 million related to
impairment of certain long-lived assets held for disposal (see Note 15).
REAL ESTATE LEASE TERMINATION AND OTHER COSTS - The 1999 Charges included
$2.6 million related to termination of real estate obligations and other costs
to close the Colorado regional processing center.
1998 CHARGES
The following tables summarize the 1998 charges by quarter and by type (amounts
in millions):
<TABLE>
<CAPTION>
Activity during 1998 1999 Activity
-------------------- ------------- Expected
Balance at 1999 Balance at Future
1998 Cash Dec. 31, Cash Modifications Dec.31, Cash
Charges Payments Non-Cash 1998 Payments Non-Cash to Estimate 1999 Outlays
======== ========== ========== ========= ======== ======== ============= ========== =======
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Severance and benefit related
costs $ 21.2 $ (13.2) $ (1.9) $ 6.1 $ (5.0) $ - $ (1.0) $ 0.1 $ 0.1
Asset impairment and other
charges related to FPA 84.1 (11.0) (63.5) 9.6 (5.6) (3.4) (0.6) - -
Asset impairment and other 112.4 - (97.8) 14.6 (0.8) (3.1) (10.7) - -
Other costs 22.4 (2.1) (9.6) 10.7 (1.4) (9.0) (0.3) - -
-------- -------- --------- ------- -------- ------- -------- ------ ------
Total $ 240.1 $ (26.3) $ (172.8) $ 41.0 $ (12.8) $(15.5) $ (12.6) $ 0.1 $ 0.1
-------- -------- --------- ------- -------- ------- -------- ------ ------
Second Quarter 1998 Charge $ 50.0 $ (4.5) $ (41.1) $ 4.4 $ (4.4) $ - $ - $ - $ -
Third Quarter 1998 Charge 71.7 (17.1) (33.9) 20.7 (6.6) (12.1) (1.9) 0.1 0.1
Fourth Quarter 1998 Charge 118.4 (4.7) (97.8) 15.9 (1.8) (3.4) (10.7) - -
-------- -------- --------- ------- -------- ------- -------- ------ ------
Total $ 240.1 $ (26.3) $ (172.8) $ 41.0 $ (12.8) $(15.5) $ (12.6) $ 0.1 $ 0.1
-------- -------- --------- ------- -------- ------- -------- ------ ------
</TABLE>
SEVERANCE AND BENEFIT RELATED COSTS - During the third quarter ended
September 30, 1998, the Company recorded severance costs of $21.2 million
related to staff reductions in selected health plans and the corporate
centralization and consolidation. This plan includes the termination of 683
employees in seven geographic locations primarily relating to corporate finance
and human resources functions and California operations. As of December 31,
1999, termination of employees had been completed and $20.1 million had been
recorded as severance under this plan.
FPA MEDICAL MANAGEMENT - On July 19, 1998, FPA Medical Management, Inc.
("FPA") filed for bankruptcy protection under Chapter 11 of the Federal
Bankruptcy Code. FPA, through its affiliated medical groups, provided services
to approximately 190,000 of the Company's affiliated members in Arizona and
California and also leased health care facilities from the Company. FPA has
discontinued its medical group operations in these markets and the Company has
made other arrangements for health care services to the Company's affiliated
members. The FPA bankruptcy and related events and circumstances caused
management to re-evaluate the decision to continue to operate the facilities and
management determined to sell the 14 properties, subject to bankruptcy court
approval. Management immediately commenced the sale process upon such
determination. The estimated fair value of the assets held for disposal was
determined based on the estimated sales prices less the related costs to sell
the assets. Management believed that the net proceeds from a sale of the
facilities would be inadequate to enable the Company to recover their carrying
value. Based on management's best
-48-
<PAGE>
estimate of the net realizable values, the Company recorded charges totaling
approximately $84.1 million. These charges were comprised of $63.0 million for
real estate asset impairments, $10.0 million impairment adjustment of a note
received as consideration in connection with the 1996 sale of the Company's
physician practice management business and $11.1 million for other items. These
other items included payments made to Arizona physician specialists totaling
$3.4 million for certain obligations that FPA had assumed but was unable to pay
due to its bankruptcy, advances to FPA to fund certain operating expenses
totaling $3.0 million, and other various costs totaling $4.7 million. The
carrying value of the assets held for disposal totaled $11.3 million at December
31, 1999. There have been no further adjustments to the carrying value of these
assets held for disposal. As of December 31, 1999, 12 properties have been sold
which has resulted in net gains of $5.0 million during 1999 and $3.6 million in
1998 which are included in net gains on sale of businesses and buildings. The
remaining properties are expected to be sold during 2000. The suspension of real
estate depreciation has an annual impact of approximately $2.0 million. The
results of operations attributable to FPA real estate assets were immaterial
during 1998 and 1999.
ASSET IMPAIRMENT AND OTHER CHARGES - During the fourth quarter ended
December 31, 1998, the Company recorded impairment and other charges totaling
$118.4 million. Of this amount, $112.4 million related to impairment of certain
long-lived assets held for disposal (see Note 15) and $6 million related to the
FPA bankruptcy.
OTHER COSTS - The Company recorded other costs of $22.4 million which
included the adjustment of amounts due from a third-party hospital system that
filed for bankruptcy which were not related to the normal business of the
Company totaling $18.6 million, and $3.8 million related to other items such as
fees for consulting services from one of the Company's prior executives and
costs related to exiting certain rural Medicare markets.
During 1999, modifications of $12.6 million to the initial estimates were
recorded. These credits to the 1998 charges included: $10.7 million from
reductions to asset impairment costs and $1.9 million from reductions to
initially anticipated involuntary severance costs and other adjustments.
In addition, other charges totaling $103.3 million were recorded in the
third quarter ended September 30, 1998. These charges mostly related to
contractual adjustments, equitable adjustments relating to government contracts,
payment disputes with contracted provider groups and premium deficiency reserves
and were primarily included in health care costs within the consolidated
statement of operations. The Company also recorded in the fourth quarter ended
December 31, 1998, $67.5 million of other charges primarily related to
litigation in the normal course of business for non-core operations totaling
$18.6 million and other charges totaling $48.9 million primarily related to bad
debts, claims and premium deficiency reserves for certain health plans whose
health care costs exceeded the contractual premiums. These charges are included
as part of health plan services and SG&A expenses within the consolidated
statement of operations.
1997 CHARGES
The following tables summarize the 1997 charges by quarter and by type
(amounts in millions):
<TABLE>
<CAPTION>
Activity during
1997 and 1998
1997 Net -----------------
Modifications 1997 Cash
1997 Charge to Estimate Charges Payments Non-Cash
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Severance and benefit
related costs $ 71.1 $ (9.7) $ 61.4 $ (51.9) $ (6.6)
Provider network
consolidation costs 44.3 (8.1) 36.2 (27.7) -
Asset impairment
costs 46.0 (2.0) 44.0 (5.4) (35.2)
Real estate lease
termination costs 30.1 (22.2) 7.9 (5.0) -
- -----------------------------------------------------------------------------------
Total restructuring
costs 191.5 (42.0) 149.5 (90.0) (41.8)
Merger related costs 73.2 (3.6) 69.6 (64.8) (4.8)
Gem costs 57.5 - 57.5 (54.0) (3.5)
Other costs 12.6 - 12.6 - (12.6)
- -----------------------------------------------------------------------------------
Total $ 334.8 $ (45.6) $ 289.2 $ (208.8) $ (62.7)
- -----------------------------------------------------------------------------------
Second Quarter
1997 Charge $ 328.8 $ (45.6) $ 283.2 $ (205.0) $ (60.5)
Fourth Quarter
1997 Charge 6.0 - 6.0 (3.8) (2.2)
- -----------------------------------------------------------------------------------
Total $ 334.8 $ (45.6) $ 289.2 $ (208.8) $ (62.7)
- -----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
1999 Activity Expected
Balance at ----------------- 1999 Balance at Future
Dec. 31, Cash Modifications Dec.31, Cash
1998 Payments Non-Cash to Estimate 1999 Outlays
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Severance and benefit
related costs $ 2.9 $ (2.4) $ - $ (0.5) $ - $ -
Provider network
consolidation costs 8.5 (7.0) (0.7) (0.8) - -
Asset impairment
costs 3.4 - (3.3) (0.1) - -
Real estate lease
termination costs 2.9 (2.7) - (0.2) - -
- ---------------------------------------------------------------------------------------------
Total restructuring
costs 17.7 (12.1) (4.0) (1.6) - -
Merger related costs - - - - - -
Gem costs - - - - - -
Other costs - - - - - -
- ---------------------------------------------------------------------------------------------
Total $ 17.7 $ (12.1) $ (4.0) $ (1.6) $ - $ -
- ---------------------------------------------------------------------------------------------
Second Quarter
1997 Charge $ 17.7 $ (12.1) $ (4.0) $ (1.6) $ - $ -
Fourth Quarter
1997 Charge - - - - - -
- ---------------------------------------------------------------------------------------------
Total $ 17.7 $ (12.1) $ (4.0) $ (1.6) $ - $ -
- ---------------------------------------------------------------------------------------------
</TABLE>
-49-
<PAGE>
RESTRUCTURING COSTS - The Company adopted a restructuring plan during the
quarter ended June 30, 1997 related to the merger of Foundation Health
Corporation and Health Systems International, Inc. (the "FHS Combination"),
which created the Company (the "June 1997 Plan"). The principal elements of the
June 1997 Plan included a workforce reduction, the consolidation of employee
benefit plans, the consolidation of facilities in geographic locations where
office space was duplicated, the consolidation of overlapping provider networks
as required in obtaining regulatory approval for the FHS Combination, and the
consolidation of information systems at all locations to standardized systems.
The June 1997 Plan is substantially completed as of December 31, 1999.
During December 1997, the Company adopted a restructuring plan (the
"December 1997 Plan") and recorded a $6.0 million restructuring charge related
to the Company's Northeast Division health plans. The plan relates to the
integration of the Company's Eastern Division operations in connection with its
acquisition of PHS and FOHP in 1997.
SEVERANCE AND BENEFIT RELATED COSTS - Severance and benefit related costs
of $61.4 million included a termination benefits plan and contractually required
change of control payments to senior executives. The two restructuring plans
during 1997 included the termination of 1,235 employees in 13 geographic
locations, primarily related to duplicative claims processing functions and sale
forces. As of December 31, 1999, the termination of employees had been completed
and $54.3 million had been paid in severance and related benefits under these
plans. Also included are changes in benefit plan costs that were primarily
related to the loss incurred on curtailment and settlement of the Supplemental
Executive Retirement Plan of FHC and the expense for amounts credited to
participants' accounts in connection with the termination of future benefits
under the FHC deferred compensation plan (see Note 9). These benefit plan
actions were effected pursuant to the change of control of FHC in connection
with the FHS Combination.
PROVIDER NETWORK COSTS - Asset Provider network consolidation costs of
$36.2 million relate to the requirement to re-contract with many of the
Company's providers in conjunction with obtaining regulatory approval from the
State of California for the FHS Combination. The Company was required to resolve
disputed claims with certain providers for contract releases in order to comply
with the regulatory conditions of approval imposed on the Company; these costs
totaled $36.2 million. Real estate lease termination costs include facilities
consolidation costs primarily in geographic regions where there was overlapping
office space usage.
ASSET IMPAIRMENT CHARGES - Asset impairment costs totaling $44.0 million
are primarily a result of the Company's plan to be on common operating
systems and hardware platforms. These costs are primarily related to software
development projects that were abandoned totaling $24.6 million, hardware
totaling $4.8 million, various FHC provider receivables totaling $8.8 million
that the Company determined not to pursue as a result of certain regulatory
approval conditions related to the FHS Combination, and various other assets
totaling $5.8 million. These assets were written off since management
determined that they would not be used in operations. Of the total costs of
$44.0 million, approximately $31.4 million was related to the Health Plans
segment, $3.8 million was related to the Government Contracts/Specialty
Services segment and the remaining $8.8 million was related to Corporate
functions.
The restructuring credits to the June 1997 Plan of $42.0 million were
subsequently recorded in 1997 and resulted from the following: $22.2 million
from the Company's determination to continue to operate certain facilities
originally identified for lease termination; $9.7 million from reductions to
initially anticipated involuntary severance costs; $8.1 million from reductions
to certain anticipated provider network consolidation and other contract
termination costs; and $2.0 million in reductions to asset impairment costs
primarily related to the reclassification of workers' compensation insurance
subsidiaries related charges to discontinued operations. During 1999,
modifications to initial estimates of $1.6 million were recorded.
MERGER COSTS - In connection with the June 1997 Plan, $69.6 million in
merger costs were recorded. The significant components of the charge include the
following: $22.6 million of transaction costs, primarily consisting of
investment banking, legal, accounting, filing and printing fees; $22.7 million
of merger consulting costs; $5.9 million of former senior executive consulting
costs; $2.4 million of directors and officers liability coverage required by the
merger agreement; $9.6 million in costs related to the early retirement of FHC
public debt; and $6.4 million of other merger related costs.
GEM COSTS - The Company established a premium deficiency of $57.5 million
related to the Company's Gem Insurance Company ("Gem") during the year ended
December 31, 1997. During the quarter ended June 30, 1997, the Company had
reached a definitive agreement regarding a reinsurance transaction with The
Centennial Life Insurance Company ("Centennial"). Pursuant to this agreement,
Centennial was to reinsure and manage Gem's accident and health, life and
annuity policies in exchange for a reinsurance premium. The cost of the
reinsurance along with the write-down of certain Gem assets that were not
recoverable based on the terms of the agreement totaled $57.5 million. These
costs were recorded and disclosed as reinsurance costs. During the quarter ended
September 30, 1997, the transac-
-50-
<PAGE>
tion was not ultimately consummated due to the unanticipated failure to satisfy
certain closing conditions, including the failure to receive certain regulatory
approvals. As a result, Gem established a reserve for the estimated premium
deficiency related to these policies for the intervening period. These losses
were determined by projecting premiums, health care costs and expenses by state
separately for group and individual contracts (including state insurance
department mandated renewals). Actual premium and health care costs were used as
the basis of the projection. Expenses were projected using historically adjusted
costs as a percentage of premium or per member basis. This method is consistent
with the Company's manner of acquiring, servicing and measuring the
profitability of its insurance contracts.
OTHER COSTS - During the quarter ended June 30, 1997, the Company
recorded $12.6 million for the loss on sale of the United Kingdom operations.
In addition, during the two quarters ended June 30 and December 31, 1997,
$77.1 million and $32.3 million, respectively, in other costs were recorded.
The significant components of the charge included the following: $30.5
million for receivables related to provider contracts that will not be
renewed; $17.2 million for government receivables related to prior contracts
and adjustments on current contracts being negotiated with the Department of
Defense; $15.1 million for litigation settlement estimates primarily related
to former FHC subsidiaries; $16.1 million for loss contract accruals,
including $10.1 million related to the Company's health plans in Texas,
Louisiana and Oklahoma; $7.7 million related to contract termination costs;
$8.2 million in other receivables; and $14.6 million of other costs.
Approximately $53.8 million was recorded as health plan services, $38.4
million as SG&A and $17.2 million as government health care services in the
consolidated statement of operations. In addition, $2.7 million in credits
related to modifications of the Company's 1996 restructuring plan were
recorded in 1997.
NOTE 15 - IMPAIRMENT OF LONG-LIVED ASSETS
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 previously disclosed anticipated divestitures program.
Pursuant to SFAS No. 121, the Company evaluated the carrying values of the
assets for these health plans and the related service center and holding
company, and determined that the carrying value of these assets exceeded the
estimated fair values of these assets. Estimated fair value is determined by the
Company based on the current stages of sales negotiation, including letters of
intent, definitive agreements, and sales discussions, net of expected
transaction costs.
In the case of the service center and holding company operations,
buildings, furniture, fixtures, equipment and software development projects were
determined by management to have no continuing value to the Company, due to the
Company abandoning plans for the development of this location and its systems
and programs as a centralized operations center.
Accordingly, in the fourth quarter of 1998, the Company adjusted the
carrying value of these long-lived assets to their estimated fair value,
resulting in a non-cash asset impairment charge of approximately $112.4 million
(see Note 14). This asset impairment charge of $112.4 million consists of $40.3
million for write-downs of abandoned furniture, equipment and software
development projects; $20.9 million write-down of buildings and improvements;
$30.0 million for write-down of goodwill; and $21.2 million for other
impairments and other charges. The fair value is based on expected net
realizable value. Revenue and pretax income attributable to these Central
Division plans were $191.3 million and $9.8 million for the year ended December
31, 1999 and revenue and pretax loss were $346.8 million and $36.1 million for
the year ended December 31, 1998. The carrying value of these assets as of
December 31, 1999 and 1998 was $22.1 million and $42.8 million, respectively. No
subsequent adjustments were made to these assets in 1998. Further adjustments to
carrying value of $4.7 million were recorded in 1999. The annual impact of
suspending depreciation is approximately $13.0 million.
During the fourth quarter of 1999, the Company recorded asset impairment
costs totaling $6.2 million in connection with pending dispositions of
non-core businesses. These charges included a further adjustment of
$4.7 million to adjust the carrying value of the Company's Pittsburgh health
plans to fair value. The Company also adjusted the carrying value of its
subacute operations by $1.5 million to fair value. The revenue and pretax
losses attributable to these operations were $66.2 million and $1.4 million
for the year ended December 31, 1999. The carrying value of these assets as of
December 31, 1999 was $16.2 million.
-51-
<PAGE>
NOTE 16 - SEGMENT INFORMATION
As of December 31, 1998, the Company adopted SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
establishes annual and interim reporting standards for an enterprise's
reportable segments and related disclosures about its products, services,
geographic areas and major customers. Under SFAS 131, reportable segments are
to be defined on a basis consistent with reports used by management to assess
performance and allocate resources. The Company's reportable segments are
business units that offer different products to different classes of
customers. The Company has two reportable segments: Health Plan Services and
Government Contracts/Specialty Services. The Health Plan Services segment
provides a comprehensive range of health care services through HMO and PPO
networks. The Government Contracts/Specialty Services segment administers
large, multi-year managed care government contracts and also offers
behavioral, dental, vision, and pharmaceutical products and services.
The Company evaluates performance and allocates resources based on profit
or loss from operations before income taxes. The accounting policies of the
reportable segments are the same as those described in the summary of
significant accounting policies, except intersegment transactions are not
eliminated.
Presented below are segment data for the three years in the period ended
December 31 (amounts in thousands):
<TABLE>
<CAPTION>
Government
Contracts/
Specialty Corporate
1999 Health Plan Services and Other(1) Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external sources $7,031,055 $1,529,855 $ - $8,560,910
Intersegment revenues 7,921 346,845 - 354,766
Investment and other income 81,342 8,241 (2,606) 86,977
Interest expense 5,624 103 78,081 83,808
Depreciation and amortization 71,186 14,960 25,895 112,041
Asset impairment, merger, restructuring,
and other costs 13,045 (2,743) 1,422 11,724
Segment profit (loss) 179,786 132,326 (68,104) 244,008
Segment assets 2,598,582 1,168,961 (71,062) 3,696,481
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Government
Contracts/
Specialty Corporate
1998 Health Plan Services and Other(1) Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external sources $7,124,161 $1,411,267 $ - $8,535,428
Intersegment revenues 7,448 355,488 - 362,936
Investment and other income 69,760 18,110 5,571 93,441
Interest expense 11,937 805 79,417 92,159
Depreciation and amortization 87,579 15,104 25,410 128,093
Asset impairment, merger, restructuring,
and other costs 142,703 5,200 92,150 240,053
Segment profit (loss) (154,546) 113,833 (213,441) (254,154)
Segment assets 2,780,783 800,767 281,719 3,863,269
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Government
Contracts/
Specialty Corporate
1997 Health Plan Services and Other(1) Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external sources $5,482,893 $1,408,402 $ - $6,891,295
Intersegment revenues 28,487 346,551 - 375,038
Investment and other income 72,351 19,248 22,701 114,300
Interest expense 8,474 1,443 53,638 63,555
Depreciation and amortization 67,952 9,648 20,753 98,353
Asset impairment, merger, restructuring,
and other costs 127,365 23,199 135,961 286,525
Segment profit (loss) 110,027 186,959 (386,234) (89,248)
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
(i) Includes intersegment eliminations.
-52-
<PAGE>
NOTE 17 - QUARTERLY INFORMATION (UNAUDITED)
The following interim financial information presents the 1999 and 1998 results
of operations on a quarterly basis (in thousands, except per share data) (see
Note 1). Certain revenue amounts have been reclassified to conform to the fourth
quarter of 1999 presentation:
<TABLE>
<CAPTION>
March 31 June 30 September 30 December 31
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1999:
Total revenues $2,218,942 $2,125,661 $2,164,375 $2,197,241
Income from continuing operations
before income taxes 78,779 46,549 58,341 60,339
Income before cumulative effect of a change
in accounting principle, net of tax 47,338 27,969 35,089 37,386
Net income 41,921 27,969 35,089 37,386
BASIC AND DILUTED EARNINGS PER SHARE(i)
Income before cumulative effect of a change in
accounting principle, net of tax 0.39 0.23 0.29 0.31
Net income 0.34 0.23 0.29 0.31
- -------------------------------------------------------------------------------------------------------------------
<CAPTION>
March 31 June 30 September 30 December 31
- -------------------------------------------------------------------------------------------------------------------
1998:
<S> <C> <C> <C> <C>
Total revenues $2,113,708 $2,167,380 $2,138,464 $2,214,917
Income (loss) from continuing operations
before income taxes 43,262 1,529 (127,572) (171,373)
Net income (loss) 26,238 956 (88,619) (103,733)
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE(i)
Net income (loss) 0.22 0.01 (0.73) (0.85)
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
(i) The sum of the quarterly earnings (loss) per share amounts may not equal
the year-to-date earnings (loss) per share amounts due to rounding.
-53-
<PAGE>
SUBSIDIARIES OF FOUNDATION HEALTH SYSTEMS, INC.
Foundation Health Systems, Inc. (DE)*
-QualMed, Inc. (DE)
-QualMed Plans for Health of Colorado, Inc. (CO)
-San Luis Valley Physicians Service Corp., Ltd.
(CO Limited Partnership)(1)
-QualMed Oregon Health Plan, Inc. (OR)
-Health Net (CA) (2)
-Health Net Life Insurance Company (CA)
- HSI Advantage Health Holdings, Inc. (DE)
-QualMed Plans for Health of Ohio and West Virginia, Inc. (OH)
-QualMed Plans for Health of Western Pennsylvania, Inc. (PA)
-Pennsylvania Health Care Plan, Inc. (PA)
-National Pharmacy Services, Inc. (DE)
-Integrated Pharmacy Systems, Inc. (PA) (3)
- HSI Eastern Holdings, Inc. (PA)
-Greater Atlantic Health Service, Inc. (DE)
-QualMed Plans for Health, Inc. (PA)
-Greater Atlantic Preferred Plus, Inc. (PA)
-Employ Better Care, Inc. (PA)
-Foundation Health Corporation (DE)
-FH-Arizona Surgery Centers, Inc. (AZ)
-FH Surgery Limited, Inc. (CA)
-FH Surgery Centers, Inc. (CA)
-Foundation Health Facilities, Inc. (CA)
-FH Assurance Company (Cayman Islands)
-Foundation Health Warehouse Company (CA)
-Memorial Hospital of Gardena, Inc. (CA)
-East Los Angeles Doctors Hospital, Inc. (CA)
-Foundation Health Vision Services (CA)
-Denticare of California, Inc. (CA)
-Managed Alternative Care, Inc. (CA)
-American VitalCare, Inc. (CA)
-Foundation Health Federal Services, Inc. (DE)
-Catalina Professional Recruiters, Inc. (AZ)
-FHPS, Inc. (CA)
-Health Benchmarks, Inc. (DE)
-Integrated Pharmaceutical Services (CA)
-Foundation Health, A Florida Health Plan, Inc. (FL)
-Intercare, Inc. (AZ)
-Intergroup Health Plan, Inc. (AZ)
-Intergroup Prepaid Health Services of Arizona, Inc. (AZ)
-Interlease of Arizona, Inc. (AZ)
-Managed Health Network, Inc. (DE)
-Health Management Center, Inc. of Wisconsin (WI)
-FHS Life Holdings Company Inc. (DE)
-Foundation Health Systems Life & Health Insurance Company
(CO)
-1-
<PAGE>
-HMC PPO, Inc. (MA)
-Managed Health Network (CA)
-MHN Reinsurance Company of Arizona (AZ)
-MHN Services (CA)
--MHN Services IPA, Inc. (NY)
-Employer & Occupational Services Group, Inc. (CA)
-Foundation Health Medical Resource Management (CA)
-Foundation Integrated Risk Management Solutions,
Incorporated (CA)
-AXIS Integrated Resources, Inc. (DE)
-Gem Holding Corporation (UT) (4)
-Gem Insurance Company (UT)
-MedEmpower, Inc. (DE)
-MedUnite, Inc. (DE)
-QualMed Plans for Health of Pennsylvania, Inc. (PA)
-Physicians Health Services, Inc. (DE)
-FOHP, Inc. (NJ)
-Physicians Health Services of New Jersey, Inc. (NJ)
-First Option Health Plan of Pennsylvania, Inc. (PA)
-FOHP Agency, Inc. (NJ)
-Physicians Health Services (Bermuda) Ltd. (Bermuda)
-Physicians Health Services of Connecticut, Inc. (CT)
-Physicians Health Services of New York, Inc. (NY)
-Physicians Health Services Insurance of New York, Inc. (NY)
-Physicians Health Insurance Services, Inc. (CT)
-PHS Insurance of Connecticut, Inc. (CT)
-PHS Real Estate, Inc. (DE)
-PHS Real Estate II, Inc. (DE)
*All subsidiaries wholly owned unless otherwise indicated.
(1) A limited partnership in which QualMed Plans for Health of Colorado, Inc.
is an 83.4% limited partner.
(2) Foundation Health Systems, Inc. owns approximately 86% of the outstanding
common stock; Foundation Health Corporation owns approximately 14% of the
outstanding common stock.
(3) National Pharmacy Services, Inc. owns approximately 90% of the outstanding
common stock.
(4) Foundation Health Corporation owns approximately 99.99% of the outstanding
common stock.
-2-
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
To the Board of Directors and Stockholders of
Foundation Health Systems, Inc.
Woodland Hills, California
We consent to the incorporation by reference in Registration Statements on Forms
S-8 (i) filed on December 4, 1998 and on March 31, 1998, and (ii) No. 333-35193,
No. 333-24621, No. 33-74780 and No. 33-90976 of our report dated February 29,
2000, appearing in and incorporated by reference in this Annual Report on Form
10-K of Foundation Health Systems, Inc. (the "Company") for the year ended
December 31, 1999.
/s/ Deloitte & Touche LLP
- -------------------------
Los Angeles, California
February 29, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,010,539
<SECURITIES> 456,603
<RECEIVABLES> 440,321<F1>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,347,793
<PP&E> 280,729<F2>
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,696,481
<CURRENT-LIABILITIES> 1,730,329
<BONDS> 1,039,352<F3>
0
0
<COMMON> 125
<OTHER-SE> 891,074<F4>
<TOTAL-LIABILITY-AND-EQUITY> 3,696,481
<SALES> 0
<TOTAL-REVENUES> 8,706,219
<CGS> 0
<TOTAL-COSTS> 6,952,895
<OTHER-EXPENSES> 1,425,508
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 83,808
<INCOME-PRETAX> 244,008
<INCOME-TAX> 96,226
<INCOME-CONTINUING> 147,782
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 5,417
<NET-INCOME> 142,365
<EPS-BASIC> 1.16
<EPS-DILUTED> 1.16
<FN>
<F1>NET OF ALLOWANCES FOR DOUBTFUL ACCOUNTS
<F2>NET OF ACCUMULATED DEPRECIATION
<F3>INCLUDES BORROWING UNDER REVOLVING CREDIT FACILITY, MISCELLANEOUS NOTES
PAYABLE AND CAPITAL LEASES
<F4>NET TREASURY STOCK
</FN>
</TABLE>
