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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 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
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FOUNDATION HEALTH SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
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)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 676-6978
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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New York Stock
Class A Common Stock, $.001 par value Exchange, Inc.
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.
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PART I
ITEM 1. BUSINESS
Foundation Health Systems, Inc. (the "Company" or "FHS") is an integrated
managed care organization which administers the delivery of managed health care
services. The Company's health maintenance organizations ("HMOs"), insured
preferred provider organizations ("PPOs") and government contracts subsidiaries
provide health benefits to 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,
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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
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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):
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
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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
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:
Number of Employer Groups................................... 30,385
Largest Employer Group as % of enrollment................... 11.9%
10 largest Employer Groups as % of enrollment............... 15.7%
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.
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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
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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
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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:
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
-------- ---------- -------- ---------
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
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(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
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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
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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
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:
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
-------- ---------- -------- ---------
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
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
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
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
(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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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.
HIGH LOW
----------- -----------
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
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
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
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:
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).
33
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).
34
*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).
35
*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).
36
*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).
37
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).
38
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.
- ------------------------
* 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
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
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
1999 1998
------------- -------------
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
========== ==========
See accompanying note to condensed financial statements.
41
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- --------- ---------
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)
======== ========= =========
See accompanying note to condensed financial statements.
42
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
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
========= ========= =========
See accompanying note to condensed financial statements.
43
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
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.
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)
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.
SIGNATURE TITLE DATE
--------- ----- ----
/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
45
SIGNATURE TITLE DATE
--------- ----- ----
/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
46