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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: September 30, 2004

or

For the transition period from                  to                 

Commission File Number: 1-12718

HEALTH NET, INC.

(Exact name of registrant as specified in its charter)

(818) 676-6000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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.    x  Yes    ¨  No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    x  Yes    ¨  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

The number of shares outstanding of the registrant’s Common Stock as of November 3, 2004 was 111,031,260 (excluding 23,173,029 shares held as treasury stock).

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HEALTH NET, INC.

INDEX TO FORM 10-Q

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

HEALTH NET, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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HEALTH NET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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HEALTH NET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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HEALTH NET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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HEALTH NET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

Health Net, Inc. (referred to hereafter as the Company, Health Net, we, us or our) prepared the accompanying unaudited condensed consolidated financial statements following the rules and regulations of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules and regulations, certain notes or other financial information that are normally required by accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted if they substantially duplicate the disclosures contained in our annual audited financial statements. The accompanying unaudited condensed consolidated financial statements should be read together with our 2003 consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2003.

We are responsible for the accompanying unaudited condensed consolidated financial statements. These condensed consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results in accordance with GAAP. In accordance with GAAP, we make certain estimates and assumptions that affect the reported amounts. Actual results could differ from estimates.

Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be indicative of those for the full year.

2. SIGNIFICANT ACCOUNTING POLICIES

Comprehensive Income

Our comprehensive income (loss) is as follows (amounts in thousands):

Earnings Per Share

Basic earnings (loss) per share excludes dilution and reflects net income (loss) divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings (loss) per share is based upon the weighted average shares of common stock and dilutive common stock equivalents (stock options and restricted stock) outstanding during the periods presented. Common stock equivalents arising from dilutive stock options are computed using the treasury stock method. There were 957,000 and 1,149,000 shares of dilutive common stock equivalents for the three and nine months ended September 30, 2004, respectively, and 2,704,000 and 2,204,000 shares of dilutive common stock equivalents for the three and nine months ended September 30, 2003, respectively. Included in the dilutive common stock equivalents for the three and nine months ended September 30, 2004 are 122,000 and 110,000 shares of dilutive restricted common stock, respectively, and 66,000 and 46,000 shares of dilutive restricted common stock for the three and nine months ended September 30, 2003, respectively.

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Options to purchase an aggregate of 9,148,000 and 8,630,000 shares of common stock during the three and nine months ended September 30, 2004, respectively, and 96,000 and 1,396,000 shares of common stock during the three and nine months ended September 30, 2003, respectively, were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common stock for each respective period. These options expire through September 2014.

In April 2002, our Board of Directors authorized us to repurchase up to $250 million (net of exercise proceeds and tax benefits from the exercise of employee stock options) of our common stock. In August 2003, our Board of Directors authorized us to repurchase up to an additional $200 million (net of exercise proceeds and tax benefits from the exercise of employee stock options) of our common stock. As a result of the ratings downgrade issued by Moody’s Investor Service (Moody’s) in September 2004 with respect to our senior unsecured debt rating, we have announced that we have no present intention to continue repurchasing shares of common stock under our stock repurchase program through the end of 2004 (see Notes 7 and 9). As of September 13, 2004, we had repurchased an aggregate of 19,978,655 shares of our common stock under this repurchase program (see Note 7) and have not repurchased any further shares of common stock since that date.

Stock-Based Compensation

As permitted under Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), we have elected to continue accounting for stock-based compensation under the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB Opinion No. 25). Under the intrinsic value method, compensation cost for stock options is measured at the date of grant as the excess, if any, of the quoted market price of our common stock over the exercise price of the option. We apply APB Opinion No. 25 and related Interpretations in accounting for our option plans. Had compensation cost for our plans been determined based on the fair value at the grant dates of options and employee purchase rights consistent with the method of SFAS No. 123, our net income and earnings per share would have been reduced to the pro forma amounts indicated below (amounts in thousands, except per share data):

The weighted average fair value for options granted during the three and nine months ended September 30, 2004 was $6.48 and $6.84, respectively. The weighted average fair value for options granted during the three and nine months ended September 30, 2003 was $8.60 and $8.02, respectively. The fair values were estimated using the Black-Scholes option-pricing model.

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The weighted average assumptions used in the fair value calculation for the following periods were:

As fair value criteria were not applied to option grants and employee purchase rights prior to 1995, and additional awards in future years are anticipated, the effects on net income and earnings per share in this pro forma disclosure may not be indicative of future amounts.

Restricted Stock

During the nine months ended September 30, 2004 and 2003, we entered into restricted stock agreements with certain employees and awarded 66,000 and 190,000 shares, respectively, of nonvested common stock under those agreements. The shares issued pursuant to the agreements are subject to restrictions on transfers, voting rights and certain other conditions. Upon issuance of the restricted shares pursuant to the agreements, an unamortized compensation expense equivalent to the market value of the shares on the date of grant was charged to stockholders’ equity as unearned compensation. This unearned compensation will be amortized over the respective restricted periods. Compensation expense recorded for these restricted shares was $288,000 and $771,000 during the three months ended September 30, 2004 and 2003, respectively, and $1,304,000 and $1,594,000 during the nine months ended September 30, 2004 and 2003, respectively.

We become entitled to an income tax deduction in an amount equal to the taxable income reported by the holders of the restricted shares when the restrictions are released and the shares are issued. Restricted shares are forfeited if the employees terminate prior to the lapsing of restrictions. We record forfeitures of restricted stock, if any, as treasury share repurchases and any compensation cost previously recognized is reversed in the period of forfeiture.

Goodwill and Other Intangible Assets

Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets” which, among other things, eliminates amortization of goodwill and other intangibles with indefinite lives. Intangible assets, including goodwill, that are not subject to amortization will be tested for impairment annually or more frequently if events or changes in circumstances indicate that we might not recover the carrying value of these assets.

We identified the following six reporting units within our businesses: Health Plans, Government Contracts, Behavioral Health, Dental & Vision, Subacute and Employer Services Group. In accordance with the transition requirements of SFAS No. 142, we completed an evaluation of goodwill at each of our reporting units at January 1, 2002. We also re-assessed the useful lives of our other intangible assets and determined that they properly reflect the estimated useful lives of these assets. We perform our annual impairment test as of June 30 in each year. During the three months ended December 31, 2003, we sold our dental, vision and employer services group subsidiaries. During the three months ended March 31, 2004, we sold our subacute subsidiaries (see Note 6). As a result of our 2003 and 2004 divestitures, Health Plans is our only reporting unit with goodwill as of September 30, 2004. All goodwill balances related to the reporting units sold in 2003 and as of September 30, 2004 were recovered and written off as part of the sale transactions.

We performed our annual impairment test on our goodwill and other intangible assets as of June 30, 2004 at our Health Plans reporting unit and also re-evaluated the useful lives of our other intangible assets with the assistance of the same independent third-party professional services firm that assisted us in the impairment

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testing and measurement process in the prior year. No goodwill impairment was identified in our Health Plans reporting unit. We also determined that the estimated useful lives of our other intangible assets properly reflected the current estimated useful lives.

The changes in the carrying amount of goodwill by reporting unit are as follows (amounts in millions):

The intangible assets that continue to be subject to amortization using the straight-line method over their estimated lives are as follows (amounts in millions):

Estimated annual pretax amortization expense for other intangible assets for the current year and each of the next four years ending December 31 is as follows (amounts in millions):

Restricted Cash and Investments

We and our consolidated subsidiaries are required to set aside certain funds for restricted purposes pursuant to state regulatory requirements. We have discretion as to whether we invest such funds in cash and cash equivalents or other investments. As of September 30, 2004 and December 31, 2003, the restricted cash and cash

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equivalents balances totaled $58.0 million and $62.4 million, respectively, and are included in other noncurrent assets. Long-term debt investments held by trustees or agencies pursuant to state regulatory requirements totaled $0.6 million and $0.8 million as of September 30, 2004 and December 31, 2003, respectively, and are included in other noncurrent assets. Short-term investments held by trustees or agencies pursuant to state regulatory requirements were $89.5 million and $72.7 million as of September 30, 2004 and December 31, 2003, respectively, and are included in investments available for sale. In addition, in connection with the expiration of our old TRICARE contracts, we have set aside $88.0 million in cash as of September 30, 2004 as required under those TRICARE contracts to pay the run-out claims. These amounts are included in other noncurrent assets on the accompanying condensed consolidated balance sheets.

Interest Rate Swap Contracts

On February 20, 2004, we entered into four interest rate swap contracts (Swap Contracts) to hedge interest rate risk on our 8.375% senior notes due 2001, of which $400 million in aggregate principal amount is outstanding (Senior Notes). The Swap Contracts are reflected at fair value in our consolidated balance sheet and the related Senior Notes are reflected at an amount equal to the sum of their carrying value plus or minus an adjustment representing the change in fair value of the Senior Notes attributable to the interest risk being hedged. The changes in the fair value of the Swap Contracts offset the changes in the adjusted carrying value of our Senior Notes being hedged. The net effect on our operating results is that the interest expense on our Senior Notes is recorded based on variable interest rates. See Note 9 for additional information on our Swap Contracts.

Recently Issued Accounting Pronouncements

In March 2004, the Emerging Issues Task Force (EITF) reached consensus on the remaining issues for Issue No. 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” and as a result reached a final consensus on an other-than-temporary impairment model for debt and equity securities within the scope of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and equity securities that are not subject to the scope of SFAS No. 115 and not accounted for under the equity method of accounting (i.e., cost method investments). The EITF also reached a consensus that the three-step model used to determine other-than-temporary impairments must be applied prospectively to all current and future investments, in interim or annual reporting periods beginning after June 15, 2004. On September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF Issue 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, ‘The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments,’ delaying the effective date for the recognition and measurement guidance of EITF 03-1 on impairment loss that is other than temporary (i.e., steps two and three of the three-step impairment model), as contained in paragraphs 10-20, until certain implementation issues are addressed and a final FSP providing implementation guidance is issued. The final FSP providing implementation guidance is expected to be issued in early December 2004. The disclosure requirements of the consensus remain in effect. Quantitative and qualitative disclosure requirements for investments accounted for under SFAS No. 115 were effective for the first annual reporting period ending after December 15, 2003. We disclosed such quantitative and qualitative information in the notes to our consolidated financial statements as of December 31, 2003. All new disclosure requirements related to cost method investments are effective for the annual reporting periods ending after June 15, 2004. Comparative information for the periods prior to the period of initial application is not required.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS No. 150). SFAS No. 150 addresses the issuer’s accounting for certain freestanding financial instruments. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003 and pre-existing instruments as of the beginning of the first interim period that commences after June 15, 2003. As of September 30, 2004, the adoption of SFAS No. 150 had no impact on our consolidated financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities

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under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133). SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as stated as follows, and for hedging relationships designated after June 30, 2003. The guidance is applied prospectively. The provisions of SFAS No. 149 that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003 will continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist will be applied to existing contracts as well as new contracts entered into after June 30, 2003. As of September 30, 2004, the adoption of SFAS No. 149 has had no impact on our consolidated financial position or results of operations.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” and subsequently revised the interpretation in December 2003 (FIN 46R). FIN 46R requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from the other parties. The maximum exposure of any investment that may be determined to be a variable interest entity is limited to the amount invested. As revised, FIN 46R is now generally effective for financial statements for interim or annual periods ending after March 31, 2004. As of September 30, 2004, the adoption of FIN 46R has had no impact on our consolidated financial position or results of operations.

3. TRICARE CONTRACTS

In August 2003, we were awarded a new five-year contract for the TRICARE North Region that supports approximately 2.8 million Military Health System (MHS) eligible beneficiaries, including providing health care and administrative services for 1.7 million TRICARE eligibles and providing only administrative services for 1.1 million other MHS-eligible beneficiaries (active duty personnel and TRICARE/Medicare dual eligible beneficiaries). This contract covers Connecticut, Delaware, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Vermont, Virginia, West Virginia, Wisconsin and the District of Columbia. In addition, the contract covers a small portion of Tennessee, Missouri and Iowa. Health care delivery began on the new North Region contract on July 1, 2004 for the area that was previously TRICARE Regions 2 and 5 (now referred to as the Mid-Atlantic and Heartland sub-regions) and September 1, 2004 for the area that was previously TRICARE Region 1 (now referred to as the National Capital and Northeast sub-regions ).

The new TRICARE North Region contract is made up of two major revenue components, health care and administrative services. Health care services revenue includes health care costs, including paid claims and estimated incurred but not reported (IBNR) expenses, for care provided for which we are at risk and underwriting fees earned for providing the health care and assuming underwriting risk in the delivery of care. Administrative services revenue encompasses all other services provided to both the government customer and to beneficiaries, including services such as medical management, claims processing, enrollment, customer services and other services unique to the managed care support contracts with the government.

Health care costs and associated revenues are recognized as the costs are incurred and the revenue is earned. Revenue related to administrative services is recognized as it is earned. Amounts receivable and payable under the government contracts related to estimated health care IBNR expenses are reported separately on the accompanying condensed consolidated balance sheet as of September 30, 2004. These amounts are the same since all of the estimated health care IBNR expenses incurred are offset by the same amount of revenues earned.

4. SEGMENT INFORMATION

We operate within two reportable segments: Health Plan Services and Government Contracts. Our Health Plan Services reportable segment includes the operations of our health plans in the states of Arizona, California,

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Connecticut, New Jersey, New York and Oregon, the operations of our health and life insurance companies and our behavioral health and pharmaceutical services subsidiaries. Coverage for all members enrolled in our Pennsylvania health plan was discontinued on January 11, 2004.

Our Government Contracts reportable segment includes government-sponsored multi-year managed care plans through the TRICARE program and other government contracts.

We evaluate performance and allocate resources based on profit or loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003, except that intersegment transactions are not eliminated.

Our segment information is as follows (amounts in millions):

A reconciliation of the total reportable segments’ measures of profit to our consolidated income from continuing operations before income taxes is as follows (amounts in millions):

Income (loss) from other corporate entities, which are not part of our Health Plan Services and Government Contracts reportable segments, are excluded from our measurement of segment performance. Other corporate entities include our facilities, warehouse, reinsurance and surgery center subsidiaries and our employer services group division (which was sold in October 2003). Severance and related benefits related to an involuntary workforce reduction (see Note 5) and (loss) gain on sale of businesses are excluded from our measurement of segment performance since they are not part of our core operations and are not managed within either of our reportable segments.

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5. SEVERANCE AND RELATED BENEFIT COSTS

On May 4, 2004, we announced that, in order to enhance efficiency and reduce administrative costs, we would commence an involuntary workforce reduction of approximately 500 positions, which includes reductions resulting from an intensified performance review process, throughout many of our functional groups and divisions, most notably in the Northeast (the May 2004 Plan). During the three and nine months ended September 30, 2004, we recorded pretax severance and benefit related costs of $5.2 million and $22.6 million, respectively, in connection with the May 2004 Plan. As of September 30, 2004, 426 positions had been eliminated and $12.7 million of the severance and benefit related costs had been paid out. We currently anticipate that we will record additional severance and benefit related costs of $2.9 million during the three months ending December 31, 2004. We expect that an additional $12.7 million and $0.1 million will be paid out during the three months ending December 31, 2004 and March 31, 2005, respectively. We plan to use cash flows from operations to fund these payments. Elimination of the remaining identified 74 positions covered by the involuntary workforce reduction is anticipated to be substantially completed during the three months ending December 31, 2004.

Severance and benefit related costs expected to be incurred in connection with the May 2004 Plan as of September 30, 2004 are as follows (amounts in millions):

A reconciliation of our liability balances for severance and benefit related costs incurred in connection with the May 2004 Plan is as follows (amounts in millions):