-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UPPELs5zo8BC0nDP0iuA74aKMNGrulv8jQBCqaL+NhCm661EPV5+HKU025ffmgy2 YIjynm2+SCnpZO3vNXPDZw== 0000912057-96-019443.txt : 19960904 0000912057-96-019443.hdr.sgml : 19960904 ACCESSION NUMBER: 0000912057-96-019443 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 18 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960903 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FOUNDATION HEALTH CORPORATION CENTRAL INDEX KEY: 0000859493 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 680014772 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10540 FILM NUMBER: 96625169 BUSINESS ADDRESS: STREET 1: 3400 DATA DR CITY: RANCHO CORDOVA STATE: CA ZIP: 95670 BUSINESS PHONE: 9166315000 MAIL ADDRESS: STREET 1: 3400 DATA DRIVE CITY: RANCHO CORDOVA STATE: CA ZIP: 95670 10-K 1 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1996 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. COMMISSION FILE NO. 1-10540 FOUNDATION HEALTH CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 68-0014772 (State or other jurisdictionof (I.R.S. Employer incorporation or organization) Identification No.) 3400 DATA DRIVE, RANCHO CORDOVA, CA 95670 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (916) 631-5000 Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED Common Stock $.01 par value New York Stock 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. X Yes 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. /X/ ---- The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on August 29, 1996 as reported on the New York Stock Exchange Composite Tape was approximately $1,770,627,271. As of August 29, 1996, the Registrant had 58,960,724 shares of Common Stock outstanding and entitled to vote in the election of directors. DOCUMENTS INCORPORATED BY REFERENCE Parts of the following document are incorporated by reference to Part III of this Form 10-K Report: Proxy Statement for Registrant's 1996 Annual Meeting of Stockholders. PART I ITEM 1. BUSINESS. Foundation Health Corporation (the "Company") is an integrated managed care organization which administers the delivery of managed health care services. Through its subsidiaries, the Company offers group, Medicaid, individual and Medicare health maintenance organization ("HMO") and preferred provider organization ("PPO") plans; government sponsored managed care plans; and managed care products related to workers' compensation insurance, administration and cost-containment, behavioral health, dental, vision and pharmaceutical products and services. The Company has implemented managed care cost-containment programs, cost-effective medical delivery systems and medical information management to enable it to meet its business strategies. Over the past several years, the Company has developed a diversified product line, has established a full range of medical delivery systems and has achieved geographic expansion throughout the west, southwest and southeast areas of the United States and in the United Kingdom. The Company was incorporated in Delaware in 1984. The Company's executive offices are located at 3400 Data Drive, Rancho Cordova, California 95670, and its telephone number is (916) 631-5000. Unless the context otherwise requires, the term "Company" as used in this Report refers to Foundation Health Corporation, a Delaware corporation, and its subsidiaries. BUSINESS STRATEGY The Company's business strategy is to develop, market and support the delivery of quality, cost-effective managed care products that address the health care needs of the Company's commercial, specialty services and government customers. The Company's business plan has the following primary objectives: (i) Increase enrollment of covered medical risk lives (including Medicare, Medicaid and CHAMPUS lives); (ii) Achieve significant market share in commercial, government and specialty services managed care products in the markets the Company serves; (iii) Differentiate the Company's products by providing a system of quality, accessible health care services for the Company's members; and (iv) Create administrative processes that, when measured against standards of performance, reflect outstanding service and create satisfied and long-term provider and customer relationships. EXPANSION AND DIVESTITURE OF OPERATIONS The Company continually evaluates opportunities to expand its business and considers whether to divest or cease offering the products of certain of its businesses. These opportunities may include acquisitions or dispositions of a specialty services managed care product, insurance and HMO operations or affiliated provider relationships. The Company also devotes significant attention to internal development of new products and techniques for the containment of health care costs, the measurement of the outcomes and efficiencies of health care delivered and the management of health care delivery systems. On August 31, 1995, the Company and Thomas-Davis Medical Centers, P.C. ("TDMC") acquired Tucson Medical Associates, Ltd., an Arizona based physician group, to enhance the number of physician providers of TDMC to provide greater access for the Company's HMO members in Arizona. 2 On March 6, 1996, the Company acquired Managed Health Network, Inc. and its subsidiaries (collectively, "MHN"), which provide behavioral health managed care programs, both on an at-risk and administration only basis, including employee assistance programs. The Company is integrating the operations of MHN with those of Foundation Health PsychCare Services, Inc., its behavioral health subsidiary. The Company has revised its strategy of creating proprietary networks of independent practice associations ("IPAs"), which contract with physicians to provide medical services to the Company's members, and establishing affiliated medical groups which operated from Company owned and managed health care centers. This change in strategy was due to the emergence of large, competitive physician management companies with the necessary size and expertise to manage provider networks and the required reporting and information systems. In January 1996, FPA Medical Management, Inc. ("FPA"), a national health care management services organization, purchased three California IPAs affiliated with the Company. On June 28, 1996, the Company sold its Florida and Arizona IPAs to FPA. Also on June 28, 1996, the Company executed a Stock and Note Purchase Agreement with FPA for the purchase by FPA of the Company's physician practice management operations and affiliated medical groups in California ("Foundation Health Medical Group, Inc.") and Arizona ("Thomas-Davis Medical Centers, P.C."). This transaction is subject to customary closing conditions, including regulatory and FPA stockholder approval. As part of these transactions, the Company's affiliated health plans have entered into 20-year provider agreements with the IPAs and medical groups to ensure that the Company's enrollees have continued and uninterrupted access to the providers of the medical groups and IPAs. See Note 1 of Notes to Consolidated Financial Statements. On June 28, 1996, the Company acquired the minority interest in its Intergroup of Utah HMO operations and sold to the minority owner the Company's interest in Premier Medical Networks in Utah. COMMERCIAL MANAGED CARE MEDICAL HMO AND PPO. The Company owns medical HMO subsidiaries which operate in Arizona, California, Colorado, Florida, Louisiana, Oklahoma, Texas and Utah. The HMOs provide comprehensive health care coverage for a fixed fee or premium that does not vary with the extent or frequency of medical services actually received by the member. The Company's insurance subsidiaries have established PPOs products. PPOs are generally a network of health care providers which offer their services to health care purchasers, such as insurers and self-funded employers. 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 medical HMO and PPO products. The HMOs and PPOs have contractual arrangements with health care providers for the delivery of health care to the Company's enrollees. Cost-effective delivery of health care services by such providers is achieved through appropriate use of health care services, emphasizing preventive health care services and encouraging the reduction of unnecessary hospitalization and other services. The Company's California HMO was awarded four Medicaid contracts, and is subcontractor under two other contracts, in California to deliver managed care to up to 616,000 Medicaid beneficiaries. Implementation of these programs commenced in fiscal year 1996 with delivery of health care services currently anticipated to commence during fiscal year 1997. 3 The following chart describes the Company's commercial HMO and insured PPO membership by state and product: COMMERCIAL HMO AND INSURED PPO MEDICAL LIVES JUNE 30, 1996 (IN THOUSANDS) STATE GROUP AND MEDICARE INDIVIDUAL RISK MEDICAID TOTAL Arizona 313 40 7 360 California 577 21 199 797 Colorado 33 0 0 33 Florida 69 26 19 114 Louisiana 23 0 0 23 Oklahoma 2 0 25 27 Texas 24 0 0 24 Utah 87 0 10 97 Other 67 0 0 67 --- --- --- --- Total 1,195 87 260 1,542 ----- --- --- ----- ----- --- --- ----- PROVIDER ARRANGEMENTS. The Company's medical HMOs arrange for the delivery of health care services to their enrollees by contracting with physicians, either directly or through IPAs and medical groups, hospitals and other health care providers for a defined range of health services, including primary and specialty care and outpatient diagnostic services. Each enrollee's primary care physician plays a significant role in cost-control by practicing preventive medicine and managing the use of specialty physicians, hospitals and ancillary providers. The Company pays for health care services provided by IPAs and medical groups on a capitated basis or pursuant to discounted fee-for-service arrangements. Under capitation arrangements, the Company pays the IPA or medical group a fixed amount per member per month to cover the payment of all or most medical services regardless of utilization, which transfers the risk of certain health care costs to the provider organization. The Company also uses various risk sharing and incentive arrangements to manage further the cost of providing health care. The Company contracts for hospital services under a variety of arrangements including capitation, per diem, discounted fee-for-service and case rate arrangements. CONTROL OF HEALTH CARE COSTS. The profitability of the Company depends on its ability to effectively control health care costs. Advances in medical technologies, inflation, increasing hospital costs, the occurrence of major epidemics and numerous other external factors, including the aging of the population and other demographic characteristics affecting the delivery of health care, may affect the ability of HMOs, including the Company's HMOs, to predict and control health care costs. The Company manages health care costs by entering into payment arrangements with health care providers and by sharing the risk of certain health care costs with certain of the Company's contracting providers. The Company continues to seek capitation arrangements with its physician providers. In addition, several of the Company's hospital providers are paid pursuant to capitation arrangements. Under the Company's utilization review system, certain routine hospital admissions and lengths of stay require prior authorization and concurrent review. Post-discharge utilization review procedures are performed to evaluate the quality and utilization of care. Health professionals also monitor and become involved in case management of catastrophic cases in an effort to assist enrollees in obtaining medical care and treatment options that may be more appropriate and cost-effective than a long-term hospital stay. RISK MANAGEMENT. In addition to the Company's cost control systems, the use of medical underwriting criteria is an integral part of its risk management efforts. In addition, the Company mitigates part of the risk of catastrophic losses by 4 maintaining reinsurance coverage for annual hospital costs incurred in the treatment of an enrollee's illness. The Company believes that its reinsurance policies significantly limit, at a reasonable premium cost, the risk of catastrophic costs incurred by its enrollees. The Company also maintains general liability, property, fidelity, and managed care professional liability, errors and omissions and directors and officers insurance coverage in amounts the Company believes to be adequate. The Company requires contracting physicians, physician groups, dentists, hospitals and ancillary providers to maintain malpractice insurance coverage in amounts customary in the industry. QUALITY MANAGEMENT. The Company's HMOs have programs to evaluate the quality and appropriateness of care provided to its enrollees. The providers participate in quality management programs through peer review procedures conducted with the Company's medical directors. These procedures involve reviews of the tests, types of treatment and procedures performed for specific diagnoses as well as reviews of aggregate data. When considering whether to contract with a provider, the Company's HMOs conduct a credentialling evaluation of the applicant, including licensure, board certification, residency program completion, malpractice claims history and ability to accommodate enrollment demands. The Company's HMOs have customer service departments that work directly with enrollees to respond to their concerns and have grievance procedures to investigate and resolve enrollees' complaints. The Company's HMOs also conduct periodic surveys to assess enrollees' satisfaction with the health care delivery system, health care received and responsiveness to enrollees' needs. MANAGED CARE INDEMNITY PRODUCTS. Through the Company's indemnity insurance subsidiaries, the Company expands the managed care options for enrollees by making available PPO, point-of-service and other insured managed care products, including certain specialty services insured products. These companies also offer group term and dependent life, accidental death and dismemberment and long-term disability coverage. SPECIALTY SERVICES MANAGED CARE The Company is utilizing its experience in managing HMOs to apply managed care concepts to areas such as dental, vision, prescription drugs, behavioral health, workers' compensation insurance and administration and ancillary services. This assists employers and other payers in meeting cost-containment and integration of benefits goals both on an insured and self-funded basis. The Company believes that offering a continuum of integrated managed care products and selling them across broad product lines will result in new sources of revenue, will increase membership in existing employer groups and will enable the Company to sell its integrated products to new employer groups. The Company's specialty services managed care operations consist of the following groups: DENTAL. DentiCare of California, Inc. ("DentiCare"), the Company's dental HMO, offers prepaid commercial and Medicaid dental care services. DentiCare served approximately 473,000 enrollees as of June 30, 1996. VISION. Foundation Health Vision Services dba AVP Vision Plans ("AVP"), the Company's vision HMO, offers prepaid vision services in the major metropolitan areas of California. AVP served approximately 331,000 enrollees as of June 30, 1996. BEHAVIORAL HEALTH. Foundation Health PsychCare Services, Inc. and MHN provide managed care behavioral health, employee assistance and substance abuse programs on both an insured and self-funded basis to employers, governmental entities and other payers throughout the United States through a network of contracted providers. These companies provided services to approximately 6.6 million eligible beneficiaries as of June 30, 1996. WORKERS' COMPENSATION SERVICES. The Company applies its managed care concepts, such as use of specialized preferred provider networks and utilization review, to the operations of its workers' compensation subsidiaries, California Compensation Insurance Company ("CalComp"), Business Insurance Company ("BICO") and Combined Benefits Life Insurance Company ("CBLIC"), which had estimated aggregate annual premiums in force at June 30, 1996 of over $585 million. These subsidiaries expand the Company's workers' compensation products to include insured risk products, permit the Company to apply its managed care expertise to reduce the medical costs associated with workers' compensation claims and enable the Company to develop 5 and market "24 hour" risk or "Combined Care" products covering employees for medical care both on and off the job. The Company provides third party administration of workers' compensation claims primarily to self-insured employers, and operates a medical review and cost-containment business for the workers' compensation industry primarily within California. PHARMACEUTICAL MANAGED CARE SERVICES. Integrated Pharmaceutical Services ("IPS"), the Company's pharmaceutical subsidiary, provides pharmaceutical managed care services, including a national pharmacy network and formulary, pharmacy adjudication and claims processing services, to reduce enrollees and employer groups health care costs. IPS is also developing disease state management projects with pharmaceutical manufacturers to enable outcomes research and information to enhance the quality of care provided to the Company's enrollees. SELF-FUNDED PRODUCTS. The Company has developed self-funded products, including a provider network, for employers who desire the cost containment aspects of an HMO product but who want to self-insure the health care cost risk. The Company's third party administration subsidiaries provide administrative only arrangements, including utilization review, managed care and claims administration services to employer groups and to medical groups and IPAs that are paid on a capitated, at-risk basis. GOVERNMENT CONTRACTS The Company, through Foundation Health Federal Services, Inc. ("FHFS"), its government contracts subsidiary, administers large, multi-year managed care government programs. FHFS subcontracts to affiliated and unrelated third parties the administration and health care risk of parts of these contracts. These programs include: (i) a CHAMPUS managed care contract in Washington and Oregon (the "Washington/Oregon Contract") to provide health care services to approximately 227,000 CHAMPUS-eligible beneficiaries which commenced health care services in March, 1995, (ii) a similar contract in Texas, Louisiana, Arkansas and Oklahoma (the "Region 6 Contract") to provide health care services to approximately 590,000 CHAMPUS-eligible beneficiaries which commenced delivery of health care services in November 1995, and (iii) the multi-year TRICARE managed care contract to provide health care services to approximately 720,000 CHAMPUS-eligible beneficiaries in California and Hawaii (the "California/Hawaii Contract") which commenced delivery of health care services in April 1996. The Company intends to compete for other managed care contracts as they are announced by federal and state agencies. There can be no assurance that the Company will be successful in managing the implementation and delivery of services under several large, multi-year government managed care contracts or whether any such contracts will provide the Company with an adequate level of profitability. FHFS also administers contracts in Massachusetts, New Jersey, Georgia and Maine to enroll Medicaid eligible individuals in managed care programs in those states. FHFS is not at risk for the provision of any health care services under any of these contracts. PATIENT SERVICES The Company owns and operates 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. Both of these hospitals are accredited by the Joint Commission on the Accreditation of Healthcare Organizations. The Company's strategy in maintaining ownership of these hospitals depends on the continued cost-efficiency of the hospitals, integration of the hospitals into the Company's Southern California HMO networks, particularly with respect to the Medicaid population, and development of subacute or related units which offer less costly care than acute hospitalization and which contribute to the hospitals' revenues. Through its wholly owned subsidiaries, American VitalCare, Inc. and Managed Alternative Care, Inc., the Company is also engaged in the management of hospital subacute care units serving chronically ill patients. 6 INFORMATION TECHNOLOGY The Company's information technology systems include several computer systems, each utilizing customized software and a network of on-line terminals. The Company's operations use its computer-based information technology systems for various purposes including claims processing, general accounting and health services reporting. These systems also include enrollment and billing functions, including membership verification capabilities, and analysis of transactions relating to providers and enrollees, such as claims status, hospital admissions and lengths of stay, outpatient care, utilization and various reporting capabilities required for accreditation, including HEDIS and NCQA, outcomes data and cost analyses. The Company is heavily dependent on its information technology systems and is in the process of integrating the systems of its recently acquired operations. These systems will need to be further enhanced as the Company's business expands and it offers new products; there is no assurance the Company will not experience interruptions in service as a result of the enhancement and integration of its information technology systems. SALES AND MARKETING The Company's sales and marketing strategy for its managed care products is defined and coordinated by its corporate sales staff. Primary responsibility for the Company's products resides with a direct sales force at both the corporate and subsidiary levels. In addition, these products are sold through independent insurance agents and brokers. The Company is emphasizing cross-marketing of its products to current and prospective customers through its corporate and subsidiary sales and marketing staff. Medicaid and Medicare risk products are primarily marketed by the HMOs' sales employees. Sales and marketing efforts are also supported by advertising programs that employ television, radio, newspapers, billboard and direct mail. COMPETITION The managed health care industry evolved primarily as a result of health care buyers' concerns regarding rising health care costs. The industry's goal is to infuse greater cost effectiveness and accountability into the health care system through the development of managed care products, including HMOs, PPOs, and specialized services such as mental health or pharmacy benefit programs, while increasing the accessibility and quality of health care services. The managed health care industry is highly competitive, both nationally and in the Company's various service areas. As HMO and PPO penetration of the health care market and the effects of health care reforms increase nationwide, the Company expects that competition for new contracts with large employer and government groups, small employer groups and individuals will intensify. In addition, employers may choose to self-insure the health care risk while seeking benefit administration and utilization review services from third parties to assist them in controlling and reporting health care costs. In such an environment, the Company believes that having a broad line of health care programs and products available will be important in being selected by employers to manage the health care products or coverage offered to their employees. The Company's managed care products compete for group and individual membership with conventional health insurance plans, Blue Cross/Blue Shield plans, other HMOs, PPOs, third party administrators and health care companies, and employers or groups who elect to self-insure. The Company also faces competition from hospitals, health care facilities and other health care providers who have combined and formed their own networks to contract directly with employer groups and other prospective customers for the delivery of health care services, including in California and other states, the trends for provider groups to accept full risk for the provision of medical services. The Company's ability to increase the number of persons covered by its products or services or to increase its premiums and fees can be affected by the Company's level of competition in any particular area. The Company believes that the principal competitive factors affecting the Company's business include price, the level and quality of service provided or arranged for, provider network capabilities, the offering of innovative products and marketplace reputation. Further, the Company believes the current factors that generally help it in regard to competitors are the breadth of its product line, its geographic scope and diversity, its significant market position in certain geographic areas, the strength of its provider network and its expertise in managing large government managed care contracts. In a number of markets, the Company may be at a disadvantage with respect to competitors with larger market shares, broader networks, or more established market place name and reputation. 7 GOVERNMENT REGULATION Substantially all of the Company's businesses are regulated at both the federal and state level. Government regulation varies from jurisdiction to jurisdiction and from product to product. Changes in applicable laws and regulations are continually being considered and the interpretation of existing laws and rules may also change from time to time. Regulatory agencies generally have broad discretion in promulgating regulations and in interpreting and enforcing laws and rules. The Company is unable to predict what regulatory changes may occur or the impact on the Company of any particular change; however, the Company's operations and financial results could be negatively affected by regulatory revisions. See "Cautionary Statements-Health Care Reform." Certain minimum tangible net equity, capital and surplus and other financial viability requirements are imposed on the Company's HMOs and insurance subsidiaries by regulatory authorities in the states in which these subsidiaries operate. In addition, certain of the Company's government contracts require the contracting subsidiaries to maintain specified current ratio or equity levels or parent guarantees of certain aspects of the financial performance of the contracts. The Company's HMOs and insurance subsidiaries are required to file periodic statutory financial statements in each jurisdiction in which they are licensed and are generally subject to annual financial, medical or other audits. Additionally, such companies are periodically examined by the supervisory agencies of the jurisdictions in which they are licensed to do business. A number of jurisdictions have enacted small group insurance and rating reforms which generally limit the ability of insurers and HMOs to use risk selection as a method of controlling costs for small group business. These laws may generally limit or eliminate use of pre-existing conditions exclusions, experience rating and industry class rating and may limit the amount of rate increases from year to year. The Company is potentially subject to governmental investigations and audits and enforcement actions related to its businesses. These include possible government actions relating to the federal Employee Retirement Income Security Act ("ERISA"), which regulates insured and self-insured health coverage plans offered by employers and the Company's services to such plans and employers, provision of services pursuant to the Federal Employees Health Benefit Plan ("FEHBP"), federal and state fraud and abuse laws and laws relating to utilization management and the delivery of health care. The Company is currently involved in various government audits with respect to its government contracts, Medicare and Medicaid programs and the operations of its insurance and HMO subsidiaries. The Company believes that it is currently in compliance in all material respects with the various federal and state licensing regulations and contract requirements applicable to its operations. To maintain such compliance, it may be necessary for the Company to make changes from time to time in its services, products, capital structure or marketing methods. Non-compliance with government regulations or contract requirements could subject the Company to fines, penalties, cease and desist orders, investigations, audits, reimbursement of funds previously received, lower reimbursement levels and contract or program termination. There can be no assurance that the Company will be able to obtain or maintain any necessary governmental approvals to continue to implement its business strategy of product growth and geographic expansion. The Company is in the process of seeking accreditation by the National Committee on Quality Assurance ("NCQA") of its Florida HMO operations, which accreditation is a condition of doing business as an HMO in that state. Failure to obtain accreditation within specific time frames could result in suspension of enrollment levels or revocation of licensure, which could have a material adverse effect on the Company's future operating results. The Company's Arizona HMO received NCQA full accreditation in December 1995 and its California HMO received provisional NCQA accreditation effective for 15 months in July 1996. Other states and employer groups are increasingly requiring NCQA or other similar accreditation as a condition to purchasing health care benefits from managed care companies. HMOS. All of the states in which the Company's HMOs offer products have enacted statutes regulating the activities of those HMOs. As a result, the HMOs are subject to extensive regulation regarding the scope of benefits provided to HMO members and the terms of group benefit agreements, the HMOs' financial condition, including minimum 8 tangible net equity, quality assurance and utilization review procedures, enrollment requirements, manner of structuring member premiums, member grievance procedures, provider contracts, marketing and advertising. The Company's HMOs which have Medicare risk contracts are subject to regulation by the Health Care Financing Administration ("HCFA"), a branch of the United States Department of Health and Human Services. HCFA has the right to audit HMOs operating under Medicare risk contracts to determine each HMO's compliance with HCFA's contracts and regulations and the quality of care being rendered to the HMO's enrollees. The Company's Medicare contracts are renewed annually unless the Company or HCFA elects to terminate the contracts. HCFA also may unilaterally terminate the Company's Medicare contracts if the Company fails to continue to meet compliance and eligibility standards. While the federal government may implement changes in the Medicare risk-based program, the Company believes that HMOs will continue to be an important factor in the federal government's overall efforts to control medical costs. However, the loss of Medicare contracts or termination or modification of the HCFA risk-based Medicare program could have an adverse effect on the revenue, profitability and business prospects of the Company as the Company's Medicare business grows. The services reimbursed by Medicare and Medicaid are subject to various requirements and restrictions imposed by contract, law and regulation. The Company's HMOs which have Medicaid contracts are subject to both federal and state regulation regarding services to be provided to Medicaid enrollees, payment for those services and other aspects of the Medicaid program. Both Medicare and Medicaid have in force and/or have proposed regulations relating to fraud and abuse, physician incentive plans and provider referrals which may affect the Company's operations. INSURANCE SUBSIDIARIES. The Company's insurance subsidiaries are subject to regulation by the Department of Insurance (the "DOI") in each state in which the entity is licensed. Regulatory authorities exercise extensive supervisory power over insurance companies with regard to the licensing of insurance companies, including the nature of, and limitation on, an insurance company's investments, periodic examination of the operations of insurance companies, and the establishment of capital and surplus requirements for insurance companies. In addition, the offering of new products may require the approval of these regulatory agencies. INSURANCE HOLDING COMPANY REGULATIONS. Certain of the Company's HMOs and each of the Company's insurance subsidiaries are subject to regulation under state insurance holding company regulations. Such insurance holding company laws and regulations generally require registration with the state DOI and the filing of certain reports describing capital structure, ownership, financial condition, certain intercompany transactions and general business activities. Various notice and reporting requirements generally apply to transactions between companies within an insurance holding company system, depending on the size and nature of the transactions. Certain state insurance holding company laws and regulations require prior regulatory approval or, in certain circumstances, prior notice of, certain transactions between the regulated companies and their affiliates. HOSPITAL REGULATION. The operation of the Company's hospitals is also subject to federal, state and local government regulation. These facilities are subject to periodic inspection by state licensing agencies to determine that standards of medical care and the physical plant necessary for continued licensure are maintained. The hospitals are subject to environmental legislation by virtue of the real property owned by the hospitals and by their operations, including regulation of the disposal of medical waste. Under the federal reimbursement program for inpatients, Medicare pays a predetermined rate for each covered hospitalization. Each hospitalization is classified into one of several hundred diagnosis related groups, which classification determines the rate paid for the hospitalization. Outpatient services are reimbursed on the basis of reasonable cost and/or per procedure price. The East Los Angeles Doctors Hospital and Memorial Hospital of Gardena have Medicaid contracts which are subject to cancellation by the state or the hospital on 120 days' prior notice without cause. If either hospital's Medicare contract was terminated, the hospital would also be required to cease participation in Medicaid. For the fiscal year ended June 30, 1996, the hospitals received approximately 79% of their total revenues from the Medicare and Medicaid contracts. The termination of participation in these programs would threaten the hospitals' viability. 9 EMPLOYEES As of June 30, 1996, the Company and its subsidiaries employed approximately 10,500 individuals. None of the Company's employees is presently covered by a collective bargaining agreement, and the Company believes its employee relations are good. ITEM 2. PROPERTIES. As of June 30, 1996, the Company leased approximately 1.75 million aggregate square feet of space primarily for administrative offices, data processing facilities and claims processing in the states in which it is doing business. These leases expire at various dates through December 2003. The Company owns approximately 463,000 aggregate square feet of space for health care centers in California and Arizona and approximately 249,000 square feet of space for the two hospitals in Southern California. The Company also leases approximately 313,000 aggregate square feet of space for health care centers in Arizona, California and Florida, which leases expire at various dates through June 2001. ITEM 3. LEGAL PROCEEDINGS. The Company maintains general liability, managed care professional liability, directors and officers liability and other insurance coverage it believes is typical in the industry. In the ordinary course of its business, the Company is subject to claims and legal actions by enrollees, providers and others. There can be no assurance that claims in excess of the Company's insurance coverage will not arise or that all claims would be covered by such insurance. Two actions, as previously disclosed, filed in 1993 against the Company, its dental HMO subsidiary and certain present and former executive officers of the Company and such subsidiary, have been resolved with no material adverse effect on the Company's financial results. The Company is subject to federal and state legislation prohibiting activities and arrangements that provide economic inducements for the referral of business or other activities that may be deemed to constitute "fraud or abuse" under government programs. The Company, like many other government contractors, is subject to private lawsuits by persons (generally employees or former employees) who may assert the rights of the government by filing an action under seal if such person purports to have information that the contractor submitted a claim to the government that could be false. Upon filing, the government has the opportunity to intervene and assume control of the case. The Company has been informed of two such complaints; the government informed the Company that it has declined to intervene in one such filed complaint and in the other action, the government and the Company are resolving the matter, which resolution will not have a material adverse effect on the Company. With respect to the Securities and Exchange Commission ("SEC") investigation commencing in August 1992 regarding trading in the common stock of Century Medicorp, Inc. ("CMC") and the Company prior to the announcement of the merger of CMC with the Company, on April 29, 1996, the SEC staff advised the Company that it has closed, without recommending any action, its investigation concerning the CMC merger as it pertains to the Company. In August 1995, the Company was requested to provide information in connection with a SEC non-public inquiry into trading in the common stock of Intergroup Healthcare Corporation ("Intergroup") prior to the July 1995 announcement of the proposed merger of Intergroup and the Company. The SEC has not requested information about any director or officer of the Company and has advised the Company that its inquiry is not to be considered as an adverse reflection on any person or as an indication that any violation of law has occurred. After consulting with legal counsel, the Company believes that any liability that may ultimately be incurred as a result of the claims, legal actions, investigations or audits described above and in "Government Regulation" will not have a material adverse effect on the consolidated financial position or results of operations of the Company. 10 CAUTIONARY STATEMENTS The following discussion contains certain cautionary statements regarding the Company's business and results of operations which should be considered by investors and others. These statements discuss matters which may in part be discussed elsewhere in this Form 10-K and which may have been discussed in other documents prepared by the Company pursuant to federal or state securities laws. This discussion is intended to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. 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, any of the matters discussed below may have affected the Company's past results and may affect future results, so that the Company's actual results for the first fiscal quarter 1997 and beyond may differ materially from those expressed in prior communications. 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 enrollees. 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 that estimated and reflected in premiums. These factors may include increased utilization of services, increased cost of individual services, catastrophes, epidemics, seasonality, general inflation, new mandated benefits or other regulatory changes and insured population characteristics. WORKERS' COMPENSATION INSURANCE. The Company, primarily through CalComp in California and BICO in other states, writes managed care workers' compensation business. For the fiscal year ended June 30, 1996, approximately 83% of the Company's direct written workers' compensation premiums were in California. Since January 1995, policies in California have been issued under "open rating" rules instead of the "minimum rate" laws which had been in effect. The open rating environment brings uncertainties to premium revenues and operating profits due to increased price competition. Although the Company intends to continue to underwrite each account taking into consideration the insured's risk profile, prior loss experience, loss prevention plans and other underwriting considerations, there can be no assurance that the Company will be able to continue to operate profitably in the California workers' compensation industry or that future workers' compensation legislation will not be adopted in California or other states which may adversely affect the Company's results of operations. A key part of the Company's workers' compensation business strategy is continued geographic expansion. Future growth of the Company's operations depends, in part, on its ability to manage workers' compensation programs for customers in states outside of California. In order to operate effectively in a new state, the Company must obtain all necessary regulatory approvals, develop a broker and provider network, achieve acceptance of the Company in the local market, adapt its procedures to that state's workers' compensation system and regulation and establish internal controls that enable it to conduct operations in several locations. Although the Company believes its managed care approach to workers' compensation will be effective in states other than California, the Company has limited experience with its techniques in these other states and there can be no assurance that the Company can successfully use these techniques in other states. Future growth will also be dependent on the ability of the Company to maintain sufficient capital to support such growth. The Company's insurance subsidiaries are required to maintain reserves to cover their estimated ultimate liability for loss and loss adjustment expense with respect to reported and unreported claims incurred. These reserves do not represent an exact calculation of liabilities but rather are estimates involving judgment and actuarial projections. The 11 accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, medical costs and other factors. Because certain workers' compensation claims may not be reported for several years, estimating reserves for such claims can be more difficult and uncertain than estimating reserves in other lines of insurance in which the period between the occurrence of the claim and final determination of the Company's liability is shorter. Establishment of reserves is an inherently uncertain process and there can be no certainty that currently established reserves will prove to be adequate to cover actual ultimate expenses. Subsequent actual experience could result in loss reserves being too high or too low. Higher than expected claim costs could require reserves for prior periods to be increased, which would adversely impact the Company's earnings in future periods. HEALTH CARE REFORM. There have been numerous legislative and regulatory initiatives at both the federal and state levels to address, among other aspects of the nation's health care system, the continuing increases in health care costs and the lack of health care coverage for a significant segment of the population. The Health Insurance Portability and Accountability Act of 1996 (the "1996 Act"), which was recently adopted by Congress and signed by President Clinton, contains a number of provisions to reform the nation's health care system. These provisions include guaranteed insurance coverage and "portability" of health insurance when changing jobs; limited use of pre- existing conditions as the basis for exclusion from coverage; creation of medical savings accounts; mandatory or voluntary regional health alliances or purchasing cooperatives; increase in the tax deductibility of premiums for the self employed; and numerous fraud and abuse provisions containing significant criminal and civil law enhancements (some of which will apply not only to federal health programs, such as Medicare and Medicaid, but to private health plans as well). To varying degrees, many of the provisions of the 1996 Act and other pending bills contemplate the involvement of state governments in the regulation and implementation of federal health care reform legislation. Various states are considering forms of single-payer systems, restructuring of Medicaid programs, "any willing provider" legislation that could require managed care companies to contract with any medical provider who agrees to the terms of the company's standard provider contract and payment schedule and "patient care initiatives" which address consumer protection issues in the managed care environment. All or any of these potential forms of legislation could adversely affect the Company's business. The Company is unable to predict how existing federal or state laws and regulations may be changed or interpreted, what additional laws or regulations affecting its businesses may be enacted or proposed, when and which of the proposed laws will be adopted or what effect the new laws and regulations will have on its businesses. However, certain of the proposals, if adopted, could have a material adverse effect on the Company's business, while others, if adopted, could potentially benefit the Company's business. Although the effects of these activities cannot yet be determined, the Company remains committed to participate in the debate over health care reform and in the restructuring of the health care system. MERGERS, ACQUISITIONS AND EXPANSION. Mergers and acquisitions have played an important role in the implementation of the Company's business strategy and are expected to continue to be important to the Company's growth and development. The Company's product offerings and HMO, PPO and specialty services enrollment have been expanded through these acquisitions. As a result, the Company is subject to the uncertainties and risks associated with any business that has grown rapidly and has expanded into new product and geographic areas. These mergers and acquisitions have placed substantial demands on the Company's management and financial resources. The integration of the acquired companies' operations continues to be slower, more complex and more costly than originally anticipated, especially in systems and functional areas such as claims processing, data management and finance. There can be no assurance that the combined companies will realize the full cost savings or revenue enhancements the Company expects to realize in connection with the recent acquisitions or that such savings or enhancements will be realized at the points in time currently anticipated. Furthermore, there can be no assurance that any cost savings which are realized will not be offset by decreases in revenues or increases in other expenses. The Company will encounter similar uncertainties and risks with respect to any future acquisitions it may make. The Company has start-up HMO and specialty services operations in a number of states and the United Kingdom thereby exposing the Company to different methods of operations and management and the effect of varying state regulations. These operations have required and will continue to incur significant expenses related to creating the 12 infrastructure for operations, satisfying net equity or capital and surplus requirements, hiring and training personnel, obtaining necessary regulatory approvals and operating until sufficient revenues are achieved to offset the overhead costs. There can be no assurance that the Company will be successful in managing HMOs at multiple locations or in obtaining sufficient revenues to be profitable. The Company's United Kingdom operations are experiencing greater losses during the initial phase of operations and larger capital requirements than originally anticipated; there can be no assurance that the critical mass needed for these operations to become profitable within a reasonable time period will be realized. Failure of the United Kingdom operations would have an adverse effect on the Company's operating results. From time to time the Company engages in the evaluation of potential acquisitions. No assurance can be given as to the Company's ability to compete successfully at favorable prices for available acquisition candidates or to complete future acquisitions, or as to the financial effect on the Company of any acquisitions. Future acquisitions by the Company may involve significant cash expenditures and may result in increased indebtedness and interest and amortization expense or decreased operating income, which could have an adverse impact on the Company's future operating results or a dilutive effect on the Company's earnings per share. COMPETITION. In many of its geographic or product markets the Company competes with a number of other entities, some of which may have certain characteristics or capabilities which give them an advantage in competing with the Company. The Company believes there are few barriers to entry in some markets, so that the addition of new competitors can occur relatively easily. Certain of the Company's customers may decide to perform for themselves functions or services formerly provided by the Company, which would 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. 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. The media are not generally aware of the high degree of regulatory oversight of the managed care industry or the degree to which the industry's health care delivery networks have enhanced the ability to measure, monitor and improve the quality of health care services. As a result, the managed care industry has recently been the subject of significant amounts 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 or could create regulatory problems for the Company. PROVIDER RELATIONS. One of the significant techniques the Company uses to manage health care costs and utilization and monitor the quality of care being delivered is contracting with physicians, hospitals and other providers. Because of the geographic diversity of the Company's HMOs and the large number of providers with which most of those HMOs contract, the Company currently believes it has a limited exposure to potential disruption in relations with specific providers. 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 or difficulty 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. 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 contracts that 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 has recently divested its affiliated IPAs and has pending transactions to divest its affiliated medical groups in California and Arizona; although the Company has entered into long-term provider contracts with the purchaser of these IPAs and medical groups, a significant change in market conditions, benefits or provider costs or an 13 adverse change in the financial viability of the purchaser of the IPAs and medical groups, could adversely affect the cost of health care provided to the Company's enrollees under these arrangements. 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, expansions, growth or changes in business, acquisitions, regulatory requirements or other reasons. Such cost increases are not clearly predictable and may adversely affect the Company's financial results. INFORMATION SYSTEMS. The Company's business is significantly dependent on effective information systems. The Company has many different information systems for its various businesses. The Company is in the process of attempting to reduce the number of systems and also upgrade and expand its information systems capabilities. Failure to maintain an effective and efficient information system could result in loss of existing customers and difficulty in attracting new customers, customer and provider disputes, regulatory problems, increases in administrative expenses or other adverse consequences. In addition, the Company may, from time to time, obtain significant portions of its services or facilities from independent third parties which may make the Company's operations vulnerable to such third party's failure to perform adequately. The Company has made several large acquisitions in recent years. Failure to effectively integrate acquired operations could result in increased administrative costs and poor customer relations. GOVERNMENT PROGRAMS AND REGULATION. The Company's business is heavily regulated. The laws and rules governing the Company's business and interpretations of those laws and rules are subject to frequent change. 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. Regulatory approvals must be obtained and maintained to market many of the Company's products and services. Delays in obtaining or failure to obtain or maintain such approvals could adversely affect the Company's revenue or the number of its enrollees, or could increase costs. A significant portion of the Company's revenues relate to federal, state and local government health care coverage programs. These types of programs, such as the federal CHAMPUS and Medicare programs and the federal and state Medicaid program, 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. Such changes have in the past and may in the future adversely affect the Company's financial results and its willingness to continue participation in such programs. The Company is also subject to various governmental audits and investigations. Adverse findings 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. LITIGATION AND INSURANCE. The Company is subject to a variety of legal actions to which any corporation may be subject, including employment-related suits, employee benefit claims, breach of contract actions and tort claims. 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, the insurers may dispute coverage or the amount of insurance may not be enough to cover the damages awarded. In addition, certain types of damages, such as punitive damages, may not be covered by insurance and 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, health care cost trends, pricing trends, 14 competition, earnings or membership reports of particular industry participants, and acquisition activity. There can be no assurance regarding the level or stability of the Company's share price at any time or of the impact of these or any other factors on the share price. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company, who are elected by and serve at the discretion of the Board of Directors, subject to rights under employment agreements, are as follows: Daniel D. Crowley, age 48, has been a director and the President and Chief Executive Officer of the Company since May 1989. In May 1990, Mr. Crowley was appointed Chairman of the Board of Directors of the Company. Steven D. Tough, age 45, has been President and Chief Operating Officer -- Government Operations since October 1994. He has been employed by the Company and its subsidiaries in various capacities since 1978. Mr. Tough has been a director of the Company since 1988. Jeffrey L. Elder, age 48, was appointed Senior Vice President-Chief Financial Officer of the Company in July 1992. Mr. Elder joined the Company as Vice President-Financial Operations in July 1989 and was appointed Vice President-Chief Financial Officer in March 1990. Mr. Elder has been a director of the Company since 1991. Kirk A. Benson, age 46, was appointed President and Chief Operating Officer -- Commercial Operations in October, 1994 and has served as Senior Vice President-Corporate Development of the Company since July 1991. Mr. Benson has been employed by the Company in various capacities since March 1989. Allen J. Marabito, age 50, joined the Company as Senior Vice President-General Counsel and Secretary in July 1991. There are no family relationships among directors or executive officers of the Company. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. The Company's common stock is listed on the New York Stock Exchange, Inc. (the "NYSE") under the symbol "FH." The following table sets forth, for the periods indicated, the high and low sales prices of the common stock on the NYSE Composite Tape. PRICE RANGE OF -------------- COMMON STOCK -------------- HIGH LOW ------- ------- Fiscal Year 1995 First Quarter. . . . . . . . . . . . . . . . . . . . . $39 5/8 $31 1/4 Second Quarter . . . . . . . . . . . . . . . . . . . . 37 1/2 29 3/4 Third Quarter. . . . . . . . . . . . . . . . . . . . . 34 7/8 26 3/8 15 Fourth Quarter . . . . . . . . . . . . . . . . . . . . 32 3/4 26 7/8 Fiscal Year 1996 First Quarter. . . . . . . . . . . . . . . . . . . . . 39 1/8 26 5/8 Second Quarter . . . . . . . . . . . . . . . . . . . . 46 3/4 36 1/2 Third Quarter. . . . . . . . . . . . . . . . . . . . . 43 7/8 35 5/8 Fourth Quarter . . . . . . . . . . . . . . . . . . . . 41 35 Fiscal Year 1997 First Quarter (through August 29, 1996). . . . . . . . . . . . . . . . . 35 7/8 24 1/4 On August 29, 1996, the closing sale price of the common stock was $30 1/8 per share. As of August 29, 1996, there were approximately 706 holders of record of the common stock. The Company has never paid cash dividends on its common stock, except that CareFlorida Health Systems, Inc., which became a wholly-owned subsidiary of the Company in October 1994, paid cash dividends to its shareholders prior to the merger. The Company presently intends to retain its earnings for the development of its business and does not anticipate paying cash dividends on its common stock in the foreseeable future. The Company's loan agreements restrict payment of cash dividends on the Company's common stock. 16 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FOUNDATION HEALTH CORPORATION YEARS ENDED JUNE 30, ----------------------------------------------------------------------- 1992 1993 1994 1995 1996 ------------ ------------- -------------- ------------- ------------ (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) STATEMENT OF OPERATIONS DATA (1): Revenues: Commercial premiums $ 900,660 $ 1,102,392 $ 1,358,616 $ 1,664,509 $ 2,002,695 Government contracts 670,271 746,827 542,726 187,493 586,011 Specialty services 50,627 89,135 380,726 509,807 699,854 Patient service revenue, net 40,612 43,483 41,358 41,323 50,244 Investment and other income 21,449 24,874 39,511 56,792 77,013 ------------ ------------- -------------- ------------- ------------ 1,683,619 2,006,711 2,362,937 2,459,924 3,415,817 ------------ ------------- -------------- ------------- ------------ Expenses: Commercial health care services 711,735 862,602 1,067,027 1,290,367 1,607,073 Government contracts health care services 171,983 188,139 152,185 67,508 375,480 Government contracts subcontractor costs 419,817 432,903 252,743 66,551 40,572 Specialty services costs 47,950 79,366 355,208 438,124 616,109 Patient service costs 40,973 38,156 37,599 33,561 36,216 Selling, general and administrative 175,135 230,506 291,130 307,802 423,652 Amortization and depreciation 18,390 21,388 28,463 41,102 61,021 Interest Expense 6,035 4,239 12,709 11,555 15,099 Acquisition and restructuring costs (2) - 12,413 - 124,822 - ------------ ------------- -------------- ------------- ------------ 1,592,018 1,869,712 2,197,064 2,381,392 3,175,222 ------------ ------------- -------------- ------------- ------------ Income before income taxes and minority interest 91,601 136,999 165,873 78,532 240,595 Provision for income taxes 34,737 57,026 64,834 26,821 74,155 Minority interest 4,042 6,636 7,398 2,262 - ------------ ------------- -------------- ------------- ------------ Net income available to common shareholders $ 52,822 $ 73,337 $ 93,641 $ 49,449 $ 166,440 ------------ ------------- -------------- ------------- ------------ ------------ ------------- -------------- ------------- ------------ Earnings per share $ 1.32 $ 1.53 $ 1.92 $ 0.90 $ 2.86 ------------ ------------- -------------- ------------- ------------ ------------ ------------- -------------- ------------- ------------ Weighted average common and common stock equivalent shares outstanding 40,022,322 47,870,576 48,688,221 54,780,162 58,292,971 ------------ ------------- -------------- ------------- ------------ ------------ ------------- -------------- ------------- ------------ JUNE 30, ----------------------------------------------------------------------- 1992 1993 1994 1995 1996 ------------ ------------- -------------- ------------- ------------ BALANCE SHEET DATA (1) Cash and investments $ 291,919 $ 485,370 $ 765,572 $ 795,278 $ 939,752 Total assets 632,037 916,247 1,498,508 1,964,207 2,426,399 Notes payable and capital leases 51,688 142,048 170,108 180,054 318,668 Stockholders' equity 263,427 342,398 422,443 756,899 934,589
- ----------- (1) The Company's consolidated financial statements have been restated to reflect the results of acquisitions accounted for in accordance with the pooling of interests method of accounting. See Note 1 of Notes to the Consolidated Financial Statements. (2) In connection with certain acquisitions the Company recorded charges for acquisition and restructuring costs. See Note 1 of Notes to the Consolidated Financial Statements. 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. CONSOLIDATED OPERATING RESULTS The Company achieved record revenues and earnings for the fiscal year ended June 30, 1996. The growth in revenues was primarily driven by (i) commercial enrollment gains from the Company's individual, Medicaid, and Medicare risk products, (ii) continued growth in net earned workers' compensation premium due to growth in premiums written and (iii) revenues related to an entire year of health care delivery under the Washington/Oregon Contract and commencement of health care delivery under the Region 6 Contract during the second quarter. Additionally, in September 1995 implementation of the Califiornia/Hawaii Contract commenced and delivery of health care services began in the fourth quarter. These results were offset in part by losses from the Company's Gem Insurance Company ("Gem") PPO operations and HMO operations in Utah. Fiscal year 1995 revenues were primarily driven by commercial enrollment gains, especially from the Company's individual and Medicare risk products, additional Medicaid enrollment as a result of the acquisition of the Florida Medicaid HMO, growth in net earned workers' compensation premium due to sales and recapture of ceded premium and commencement of health care delivery under the Washington/Oregon Contract during the third quarter. This growth was offset by the January 31, 1994 expiration of the CHAMPUS Reform Initiative Contract for California and Hawaii (the "CRI Contract"). Fiscal year 1994 revenues included $431.3 million in revenues related to the CRI Contract. Revenues in fiscal year 1994 exceeded revenues in fiscal year 1993 primarily as a result of increased commercial enrollment and specialty services revenues, including revenues generated from CalComp which was acquired in August 1993. Investment and other income, included as a component of the Company's revenues, increased in fiscal 1996 over fiscal year 1995 primarily due to investment of excess surplus and reserves generated by operations and to the sale of IPAs in Florida and Arizona which resulted in gains recognized of approximately $10.4 million in the fourth quarter of fiscal year 1996. Increases in each of the other years is due primarily to the investment of excess surplus and reserves generated by operations, a significant part of investments are held by CalComp and its subsidiaries in tax-exempt securities. The Company's selling, general and administrative ("SG&A") expenses in fiscal year 1996 increased due primarily to the implementation costs of the Region 6 and California/Hawaii Contracts. The Company's SG&A expenses in fiscal year 1995 increased over 1994 primarily due to the implementation costs of the Washington/Oregon and Region 6 Contracts and start-up of the New Jersey Medicaid administrative services only contract. Fiscal year 1994 SG&A expenses were driven primarily by expenses incurred related to the establishment and operation of government claims processing as an internal function and inclusion of SG&A expenses related to Gem, which was acquired January 1, 1994. The ratio of SG&A expenses to total revenues (the "SG&A ratio") increased from 12.3% in fiscal year 1994 to 12.5% in fiscal year 1995 and then decreased to 12.4% in fiscal year 1996. The increase from 1994 to 1995 was due primarily to the expiration of the CRI Contract which resulted in the cessation of contract operating revenues effective January 31, 1994 while various administrative costs related to claims processing and other activities continued during the wind-down period. The decrease from 1995 to 1996 was due to completion of the wind-down period of the CRI Contract during 1995 offset in part by lower revenue from increased pricing pressure on commercial premiums. Amortization and depreciation expense increased each year primarily due to increased depreciation as a result of the Company's ownership and construction of health care centers and increased amortization of intangibles incurred in connection with the purchase of the Intergroup minority interest and other business acquisitions during fiscal years 1994, 1995 and 1996. Interest expense decreased in fiscal year 1995 from fiscal 1994 as a result of the prepayment of $11.4 million in bank debt by TDMC in November 1994. Interest expense increased in 1996 over 1995 due to increased borrowing under the Company's unsecured revolving line of credit. Fiscal year 1997 interest expense is expected to increase due to increased borrowings under the Company's credit agreement. See "Liquidity and Capital Resources". In connection with the mergers of CareFlorida, TDMC and Intergroup, the Company recorded a charge for integration, restructuring and pooling costs of $124.8 million in fiscal year 1995. The acquisition and restructuring charge 18 represented the costs of acquiring and consolidating the companies' management information systems and administrative functions and positioning the Company to take advantage of best practices in health care delivery systems and managed care techniques after the mergers. The components of this charge included (in millions):
Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $21.5 Cancellation of certain contractual obligations and other settlement costs. . . 27.1 Write-off of certain redundant hardware, software and other settlement costs. . 17.9 Elimination of duplicate facilities . . . . . . . . . . . . . . . . . . . . . . 13.0 Transition and severance related payments to employees. . . . . . . . . . . . . 36.5 Other integration and restructuring . . . . . . . . . . . . . . . . . . . . . . 8.8 ------ Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $124.8 ------ ------
These costs satisfy the definition of "exit costs" as set forth in Emerging Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" that are directly related to the mergers. During the third quarter of fiscal 1996, the Company re-evaluated the restructuring liabilities as originally formulated in fiscal 1995. The re-evaluation resulted in an estimate of $16.7 million less than the original reserve. This excess reserve was offset by an approximately equivalent amount of restructuring costs arising from the Company's decision to restructure its operations in the United Kingdom and acquisition and integration costs associated with the merger of Managed Health Network, Inc. in March 1996. The Company has substantially completed its integration and restructuring of the combined entities as of June 30, 1996. As a result of the factors described above, fiscal year 1996 income before income taxes and minority interest increased to $240.6 million. In fiscal year 1995, income before income taxes and the minority interest grew to $203.3 million (before acquisition and restructuring costs). After acquisition and restructuring costs, income before income taxes and minority interest was $78.5 million in fiscal year 1995. Fiscal year 1994 income before income taxes and minority interest increased to $165.9 million as compared to $149.4 million (before acquisition and restructuring costs) for fiscal year 1993. After acquisition and restructuring costs, income before income taxes and minority interest was $137.0 million in fiscal year 1993. The tax provision for fiscal year 1996 decreased to 30.8% as compared to a rate of 34.2% for fiscal year 1995 as a result of the effect of non-deductible acquisition costs in fiscal year 1995 (which caused a higher than normal rate) and the effect of net operating loss carryforwards which became available during fiscal year 1996 (which caused a lower than normal rate) related to Managed Health Network, Inc., which was acquired by the Company in March 1996. Additional net operating loss carryforwards became available in fiscal year 1996 that further decreased the effective tax rate. The tax provision rate for 1995 of 34.2% was lower than the 1994 rate of 39.1% because of the combined effect of the acquisition and restructuring charge of $124.8 million and the resulting increased proportion of tax-exempt interest income as a percentage of pre-tax income. The rate was further reduced by the acquisition of Intergroup, which is not subject to state franchise or income taxes, and the elimination of a duplicate tax for undistributed income from Intergroup to its former parent company. These rate reductions were mitigated by the effects of non-deductible acquisition expenses. The tax rate is anticipated to increase in fiscal year 1997 as the availability of net operating loss carryforwards is not expected to recur. Minority interest in fiscal years 1994 and 1995 represents the allocation of Intergroup's net income to the holders of the 39.5% portion of Intergroup common stock not held by TDMC (the "Intergroup Minority Interest"), for the periods prior to the Company's acquisition of the Intergroup Minority Interest. Through the combination of the factors described above, net income grew from $93.6 million or $1.92 per share in fiscal year 1994 to net income of $128.8 million or $2.35 per share in fiscal year 1995 (before the $124.8 million acquisition and restructuring costs net of related tax-effects). After such charge net of related tax effects, net income for fiscal year 1995 19 was $49.4 million or $.90 per share. Net income increased in fiscal year 1996 to $166.4 million or $2.86 per share over the $128.8 million (before acquisition and restructuring costs, net of related tax benefits) or $2.35 per share in fiscal year 1995. LINE OF BUSINESS REPORTING The Company operates in a single industry segment, managed health care. The following table presents financial information reflecting the Company's operations by the three primary lines of business: (i) commercial operations; (ii) government contracts; and (iii) specialty services. 20 LINE OF BUSINESS FINANCIAL INFORMATION
FOUNDATION HEALTH CORPORATION (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) YEARS ENDED JUNE 30, 1994 1995 1996 ------------------------------------ ------------------------------------- ------------------------------- PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL INCREASE PERCENT REVENUE (DECREASE) PERCENT REVENUE (DECREASE) PERCENT REVENUE (DECREASE) ------------- --------- --------- ------------ --------- ---------- --------- -------- ---------- Revenues: Commercial premiums $ 1,358,616 57.5% 23.2% $ 1,664,509 67.7% 22.5% $ 2,002,695 58.6% 20.3% Government contracts 542,726 23.0 (27.3) 187,493 7.6 (65.5) 586,011 17.2 212.6 Specialty services 380,726 16.1 327.1 509,807 20.7 33.9 699,854 20.5 37.3 Patient service revenue, net 41,358 1.8 (4.9) 41,323 1.7 (0.1) 50,244 1.5 21.6 Investment and other income 39,511 1.7 58.8 56,792 2.3 43.7 77,013 2.3 35.6 ----------- -------- ------------- --------- ------------ ------- 2,362,937 100.0 17.8 2,459,924 100.0 4.1 3,415,817 100.0 38.9 ----------- -------- ------------- --------- ------------ ------- Expenses: Commercial health care services 1,067,027 45.2 23.7 1,290,367 52.5 20.9 1,607,073 47.0 24.5 Government contracts health care service 152,185 6.4 (19.1) 67,508 2.7 (55.6) 375,480 11.0 456.2 Government contracts subcontractor costs 252,743 10.7 (41.6) 66,551 2.7 (73.7) 40,572 1.2 (39.0) Specialty services costs 355,208 15.0 347.6 438,124 17.8 23.3 616,109 18.0 40.6 Patient service costs 37,599 1.6 (1.5) 33,561 1.4 (10.7) 36,216 1.1 7.9 Selling, general and administrative (SG&A) 291,130 12.3 26.3 307,802 12.5 5.7 423,652 12.4 37.6 Amortization and depreciation 28,463 1.2 33.1 41,102 1.7 44.4 61,021 1.8 48.5 Interest Expense 12,709 0.5 199.8 11,555 0.5 (9.1) 15,099 0.4 30.7 Acquisition and restructuring costs - 0.0 N/A 124,822 5.1 N/A - 0.0 N/A ----------- -------- ------------- --------- ------------ ------- 2,197,064 93.0 17.5 2,381,392 96.8 8.4 3,175,222 93.0 33.3 ----------- -------- ------------- --------- ------------ ------- Income before income taxes 165,873 7.0 21.1 78,532 3.2 (52.7) 240,595 7.0 206.4 Provision for income taxes 64,834 2.7 13.7 26,821 1.1 (58.6) 74,155 2.2 176.5 Minority interest 7,398 0.3 11.5 2,262 0.1 (69.4) - 0.0 N/A ----------- -------- ------------- --------- ------------ ------- Net Income $ 93,641 4.0% 27.7 $ 49,449 2.0% (47.2) $ 166,440 4.9% 236.6 ----------- -------- ------------- --------- ------------ ------- ----------- -------- ------------- --------- ------------ ------- Earnings per share $ 1.92 25.5 $ 0.90 (53.1) $ 2.86 216.3 ----------- ------------- ------------ ----------- ------------- ------------ Weighted average common and common stock equivalent shares outstanding 48,688,221 1.8 54,780,162 12.5 58,292,971 6.4 ----------- ------------- ------------ ----------- ------------- ------------ Operating Ratios Commercial loss ratio 78.5% 77.5% 80.2% Government contracts ratio 74.6 71.5 71.0 Specialty services ratio 93.3 85.9 88.0 Patient service ratio 90.9 81.2 72.1 S G & A to total revenues 12.3 12.5 12.4 Effective tax rate 39.1 34.2 30.8 Enrollment Commercial : Group and individual 828 25.3 992 19.8 1,195 20.5 Medicare risk 46 64.3 72 56.5 87 20.8 Medicaid 111 33.7 112 0.9 260 132.1 ------------- --------- ------- ------ ------- ------- 985 27.6 1,176 19.4 1,542 31.1 ------------- --------- ------- ------ ------- ------- Government CHAMPUS PPO and Indemnity 86 (87.9) 251 191.9 1,072 327.1 CHAMPUS HMO 24 (90.7) 86 258.3 457 431.4 ------------- --------- ------- ------ ------- ------- 110 (88.7) 337 206.4 1,529 353.7 ------------- --------- ------- ------ ------- ------- Combined 1,095 (37.2%) 1,513 38.2% 3,071 103.0% ------------- --------- ------- ------ ------- ------- ------------- --------- ------- ------ ------- -------
21 COMMERCIAL OPERATIONS Revenues generated by the Company's commercial operations increased in fiscal year 1996 over fiscal year 1995 due in part to a 31% increase in enrollment from existing lines of business and geographic expansion offset by reductions in commercial premium revenue per member due to continued competitive pricing pressures. Revenues generated by commercial operations in fiscal year 1995 increased over fiscal year 1994 due in part to inclusion of revenues from the January 1994 purchase of Gem and the November 1994 purchases of the Colorado HMO and the Florida Medicaid HMO as well as increased enrollment in existing lines of business. Revenues in fiscal year 1994 increased over fiscal year 1993, reflecting increased enrollment growth and as well as the inclusion of revenue from Gem for the last six months of fiscal year 1994. The Company anticipates revenues to increase during fiscal year 1997 primarily as a result of commercial enrollment growth and revenues related to delivery of health care services pursuant to the Medicaid Mainstream program in California anticipated to commence in mid-fiscal year 1997; however, the rate of increase is not expected to be at the same level as in prior years since, to some extent, prior year increases have resulted from businesses acquired and the Company anticipates continued pressure on its ability to increase premium rates. The Company expects continued pressure from employer groups and government agencies to reduce premiums. Health care costs on a per member basis increased slightly for fiscal year 1996 as compared to fiscal year 1995. The commercial loss ratio increased from 77.5% for fiscal year 1995 to 80.2% for fiscal year 1996. The increase in the ratio was due to the continued competitive premium pressures, new enrollees in higher loss ratio products and increased health care costs. The commercial loss ratio decreased slightly to 77.5% in fiscal year 1995 from 78.5% in fiscal year 1994. This decrease was due to the emphasis on controlling health care costs. The 1994 loss ratio was impacted by competitive pressures in California offset by greater profitability of the Company's Florida and Arizona HMOs. The Company believes that commercial premiums will increase at lower rates than it has experienced historically, or will be lower than current rates which may adversely affect the commercial loss ratio. The Company continues to seek to mitigate the effects of premium pressures by continued health care cost containment efforts. In addition, as the Company's Medicare risk business increases, the loss ratio may increase, as historically this product has a higher loss ratio than the Company's other commercial products. GOVERNMENT CONTRACTS Government contracts revenue increased in the fiscal year 1996 over fiscal year 1995 primarily due to revenues generated by the Washington/Oregon, Region 6 and California/Hawaii Contracts. These increases were offset by the expiration of the Base Realignment and Closure ("BRAC") Contract. Government contracts revenue for fiscal year 1995 decreased from fiscal year 1994 primarily due to the expiration of the CRI Contract in January 1994. The CRI Contract contributed revenues of $431.3 million in fiscal year 1994. The Company commenced health care delivery under its managed care contract in Louisiana and Texas in May 1993 and under the Washington/Oregon Contract in March 1995. Government contracts revenue is impacted by semi-annual bid price adjustments, annual price increases or decreases, risk sharing provisions and various other price adjustments attributable to change orders for additional services, inflation and other factors. The government contracts ratio improved in fiscal years 1994 and 1995. The improvement in those fiscal years was due primarily to lower health care costs under the CRI Contract attributable to effective managed care techniques, shifting of claims processing from an outside vendor to an internal function and increased change order revenue. The government contracts ratio improved slightly during fiscal year 1996 compared to fiscal year 1995. This was due primarily to several of the contracts being in the implementation period. Comparability of the government contracts ratio between periods is dependent on the mix of the contracts that are in the implementation phase versus contracts that are in the health care delivery phase. Administrative expenses relating to both phases are recorded as part of SG&A costs. Once the delivery of health care services begins, however, the expenses related to health care services are recorded either as government contracts health care services or as government contracts subcontractor costs. The government contracts ratio is expected to increase during fiscal year 1997 as health care services will be delivered under all three CHAMPUS contracts during the fiscal year 1997 as compared to staggered implementation during the fiscal year 1996. Health care services commenced in March 1995 under the Washington/Oregon Contract, in November 1995 under the Region 6 Contract and in April 1996 under the California/Hawaii Contract. 22 SPECIALTY SERVICES Specialty services revenues increased substantially during each of the last three fiscal years. A significant part of the increases was due to revenues generated by CalComp, the Company's workers' compensation bill review and third party administration subsidiaries and the acquisition of BICO by CalComp in February 1995. The improvement in the specialty services ratio in fiscal year 1995 over that of fiscal year 1994 was primarily due to improvement in the workers' compensation operating ratios, through the successful implementation of managed care programs, which has lowered worker's compensation medical costs, and to the addition of the worker's compensation bill review company, which has a lower administrative component than most of the other specialty services companies. The increase in the specialty services ratio in fiscal year 1996 over that of fiscal year 1995 is primarily due to an increase in the combined ratio in the worker's compensation business as described below. Commencing in fiscal year 1994, several significant reforms to the California workers' compensation laws affected CalComp. The reforms address various aspects of the workers' compensation system, including limitations on certain types of claims, restrictions on vocational rehabilitation benefits, additional penalties for fraud and abuse, and reductions in state-mandated minimum premium rates which culminated in open rating in California effective January 1, 1995. Since the acquisition of CalComp, the Company has taken various actions to mitigate the effects of the reforms and the sharp premium declines as a result of the more competitive pricing environment under open rating. These actions include development and implementation of its managed care approach to workers' compensation, continued use of loss prevention and return to work programs, shifting of the risk profile of CalComp's business, increased use of the Company's PPO and blended case management systems (which have reduced the average severity per claim). In addition, to diversify its underwriting risk as a result of reduced premium levels on policies written in California and to take advantage of perceived opportunities because of favorable national workers' compensation reform, the Company started to write workers' compensation policies in states outside of California through BICO, a subsidiary of CalComp, licensed to write insurance in 49 states. Since being purchased in February 1995, BICO has increased its estimated annual premiums inforce to over $100 million, and recognized direct premiums earned of approximately $42 million during fiscal 1996. BICO utilizes the same managed workers' compensation approach as CalComp to manage its claim costs. The Company believes these strategies should contribute to the continued growth of this part of the specialty services operations and partially offset the impact from the changes in the California workers' compensation marketplace. Four ratios are traditionally used to measure underwriting performance of workers' compensation companies: the loss and loss adjustment expense ratio, the underwriting expense ratio and the policyholder dividend ratio, which when added together constitute the combined ratio. A combined ratio of greater than 100% reflects an underwriting loss, while a combined ratio of less than 100% indicates an underwriting profit. The following table sets forth CalComp's and its subsidiaries underwriting experience as measured by its combined ratio and its components (computed on a generally accepted accounting principles basis) for the fiscal years ended June 30, 1996, 1995 and the eleven months from August 1, 1993 (the date of acquisition) to June 30, 1994: 1996 1995 1994 ---- ---- ---- Loss and loss adjustment expense ratio. . . . 64.2% 62.8% 62.8% Underwriting expense ratio. . . . . . . . . . 24.5 22.7 24.0 Policyholder dividend ratio . . . . . . . . . 1.1 1.4 7.4 --- --- --- Combined ratio. . . . . . . . . . . . . . . . 89.8% 86.9% 94.2% ----- ----- ----- ----- ----- ----- While average premium rates decreased during fiscal 1996, CalComp's loss and loss adjustment expense ratio showed a slight increase of 1.4%. CalComp continues to emphasize writing accounts and classes of business with the potential for lower than average claim severity and higher claim frequency, which permits CalComp's loss control staff and managed workers' compensation programs to reduce the number of reported claims. As a percent of covered insured payroll, 23 the claims frequency rate decreased by 8% during fiscal year 1996 compared to 1995. In addition to frequency as a percent of payroll decreasing, the average cost of new reported claims was 7% lower than new claims reported during fiscal 1995. This reduction in costs is due to the effective use of managed care techniques, which reduces the medical components of loss costs, lower allocated loss adjustment expenses by utilizing more cost efficient hearing representatives, emphasizing returning the injured worker to some form of modified work, and closing claims more quickly. The reductions in claim incidence and cost, and reductions in estimates for prior accident year claims did not fully offset the impact of reductions in premium revenue due to competitive rating, thereby producing a loss and loss adjustment expense ratio that increased by 1.4% from fiscal 1995. The underwriting expense ratio increased by 1.8%, primarily due to the reduction in premium rates in fiscal year 1996 over fiscal year 1995. The increase in these costs was greater than the increase in net premiums earned. This ratio, as a percent of net premiums earned, was significantly impacted by the reduction to premium rates in California for policies written after January 1, 1995. Premiums earned in fiscal 1995 included premiums for policies issued prior to the start of competitive rating. Premiums earned in fiscal 1996 were derived primarily from policies written subsequent to the start of competitive rating in California. In addition, operating costs were impacted by the establishment of regional offices for BICO in strategic locations in western and southern states. The policyholder dividend ratio for the fiscal year 1996 was 1.1%. In fiscal year 1996, CalComp issued less than 6% of its California policies on a participating basis. This resulted in minimal policyholder dividends accrued. Currently, California policyholders receive the benefit of lower workers' compensation premiums at the inception of their respective policies, as compared to policyholder dividends which were paid after policy expiration. Though CalComp writes participating policies through BICO in states outside of California, the portion of earned premiums represented by this group is relatively small in fiscal year 1996. CalComp was able to maintain a consistent loss and loss adjustment expense ratio in fiscal year 1995 through the successful implementation of managed care programs, and the increased use of internal staff to support fair hearing representatives in the settlement of claims, despite the 16% decrease in the minimum rates in California effective October 1, 1994, and the abolishment of minimum rates and the commencement of open rating effective January 1, 1995. The decrease in the combined ratio from fiscal year 1994 to fiscal year 1995 was primarily due to the 6.0% decrease in the policyholder dividend ratio and the 1.3% reduction in the underwriting expense ratio. The underwriting expense ratio decrease is primarily due to the decrease in employee salaries and benefits to 9.7% of premiums in fiscal year 1995 from 11.0% in fiscal year 1994. CalComp was able to achieve this decrease during a period when net premiums earned increased by 20%; however, approximately one-half of such increase was the result of cancellation of CalComp's quota share reinsurance arrangement effective July 1, 1994. Workers' compensation reforms and increased price competition have also resulted in lower policyholder dividends incurred as policyholders now receive the benefit of lower workers' compensation costs in the form of reduced premiums at the inception of the policy versus policyholder dividends paid after the policy expires. 24 QUARTERLY RESULTS The following table presents unaudited consolidated operating results for the last twelve fiscal quarters. The Company believes that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the following quarterly results when read in conjunction with the Company's consolidated financial statements included elsewhere herein. Results of operations for any particular quarter are not necessarily indicative of results of operations for a full fiscal year.
1ST 2ND 3RD 4TH --- --- --- --- QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) FISCAL 1994 Total revenues . . . . . . . . . . . . . . . . . . . . . . . $621.3 $637.5 $578.9 $525.2 Income before income taxes and minority interest . . . . . . $39.9 $47.7 $40.0 $38.3 Net income . . . . . . . . . . . . . . . . . . . . . . . . . $22.3 $27.3 $22.4 $21.7 Earnings per share . . . . . . . . . . . . . . . . . . . . . $0.47 $0.56 $0.46 $0.44 FISCAL 1995 Total revenues . . . . . . . . . . . . . . . . . . . . . . . $594.4 $598.5 $615.6 $651.4 Income (loss) before income taxes and minority interest. . . $39.3 $(76.8) $57.8 $58.2 Net income (loss). . . . . . . . . . . . . . . . . . . . . . $23.7 $(49.3) $36.3 $38.8 Earnings (loss) per share. . . . . . . . . . . . . . . . . . $0.48 $(0.90) $0.63 $0.68 FISCAL 1996 Total revenues . . . . . . . . . . . . . . . . . . . . . . . $722.4 $768.0 $867.8 $1057.6 Income before income taxes . . . . . . . . . . . . . . . . . $59.7 $61.4 $60.8 $58.7 Net income . . . . . . . . . . . . . . . . . . . . . . . . . $39.4 $41.7 $41.8 $43.5 Earnings per share . . . . . . . . . . . . . . . . . . . . . $0.69 $0.71 $0.72 $0.74
LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities was $156.8 million for the year ended June 30, 1996 as compared to $201.8 million for the prior year. The change is principally due to timing of the receipt or payment of amounts under government contracts as revenues are received monthly in arrears under the current CHAMPUS contracts, while previously some contracts were prepaid. The Company's cash and investments increased from $795.3 million at June 30, 1995 to $939.8 million at June 30, 1996. The Company invests its cash in investment grade securities. During fiscal year 1997, the Company expects capital expenditures to approximate $85.8 million, primarily consisting of $78.2 million for the purchase of computer hardware and software systems; $4.1 million for the purchase of furniture and equipment; and $3.5 million for other requirements. Other assets increased over the amount at June 30, 1995, which is primarily due to increases in pharmacy rebates, trade receivables, notes receivable related to IPA sales and the cash surrender value of life insurance policies related to the non-qualified defined benefit pension plans. In January 1996, the Company sold its affiliated California IPAs to FPA for a purchase price consisting of cash and a promissory note payable over 10 years, see notes 1 and 11 to the Consolidated Financial Statements. The notes receivable under the revolving credit agreements with the IPAs in the amount of $10 million were repaid to the Company and terminated in connection with the transaction. In connection with construction of its health care centers and of its administrative facilities the Company has a $60 million tax-retention operating lease financing with Nations Bank of Texas, N.A., as Administrative Agent for the Lenders parties thereto and First Security Bank of Utah, N.A., as Owner Trustee (the "TROL" financing). As of June 30, 1996, approximately $26 million of the TROL financing had been used for construction of health care centers. The Company expects that up to $5 million of the TROL financing will be used during fiscal year 1997 for the construction of its administrative facilities. 25 On June 28, 1996, the Company and the sole shareholder of the Foundation Health Medical Group, Inc. and Thomas-Davis Medical Centers, P.C. (collectively referred to as the "Medical Groups") entered into a Stock and Note Purchase Agreement whereby the Company will sell all the outstanding stock of Foundation Health Medical Services ("FHMS"), its management services organization, and the shareholder will sell all the outstanding stock of the holding company for the Medical Groups to FPA. The aggregate consideration consists of $2 million cash, $75 million of FPA common stock, $22 million bridge note due five months after closing and bearing a floating interest rate and a $12 million note to be consolidated with the assumption of the intercompany indebtedness of FHMS, the holding company and the Medical Groups to FHC by FPA (estimated to be $80 million as of June 30, 1996, which amount will be adjusted for liabilities incurred, up to $12 million, between June 30, 1996 and the closing of the transaction, currently anticipated for October 1, 1996). The consolidated note will bear interest at a floating rate with amortization of principal on a 15 year schedule with the remaining principal and accrued interest due 84 months after close. FPA will also assume other liabilities owed by FHMS, the Holding Company and the Medical Groups to third parties (estimated to be $41 million as of June 30, 1996). The promissory notes will be secured by the assets and stock of the FPA, the purchasing company, FHMS, the holding company and the Medical Groups. The promissory notes will be guaranteed by FPA. The Company's affiliated health plans in Arizona, California and Florida will have agreed to pay to FPA an aggregate of $55 million during the period commencing August 1996 through December 1998 for continued and uninterrupted access as defined in the Purchase Agreement to the professional providers of the IPAs and the Medical Groups for the Company's affiliated health plan enrollees. In December 1994, the Company established a $300 million unsecured revolving credit agreement with Citicorp USA, Inc. as Administrative Agent (the "Credit Agreement") for the lenders parties thereto. As of August 15, 1996, the Company has drawn $230 million under the Credit Agreement. In June 1993, the Company issued $125 million of Senior Notes due June 1, 2003, which bear interest at 7.75% due semiannually (the "Senior Notes"). See Notes 7 and 13 to the Consolidated Financial Statements for a more detailed description of the TROL financing, the Credit Agreement and the Senior Notes. In April 1993, the Company established a stock repurchase program (as amended) to acquire from time to time up to 5.7 million shares of the Company's common stock in the open market at prices deemed appropriate by management and subject to market conditions and other relevant factors. As of June 30, 1996, the Company had repurchased 1,795,500 shares under the program, 250,000 of which were repurchased in fiscal year 1996. The Company's regulated subsidiaries are required to maintain minimum tangible net equity or capital and surplus. As of June 30, 1996, restricted net assets of the subsidiaries totaled approximately $71.5 million. Certain subsidiaries must also maintain current ratios of 1:1. During fiscal year 1996, the Company contributed or advanced approximately $115 million to various of its subsidiaries to allow them to support and expand premium and revenue growth and to meet rating and regulatory agency requirements. As the Company's businesses continue to grow, the Company expects to contribute additional cash to certain subsidiaries to support premium and revenue growth. Subsequent to June 30, 1996, the Company drew down $65 million on its Credit Agreement to support premium and revenue growth in its insurance subsidiaries. Certain of the Company's regulated subsidiaries are required to keep securities on deposit in various states where they are licensed. At June 30, 1996, approximately $405 million in securities were restricted to satisfy various state regulatory and licensing requirements. Certain of the Company's subsidiaries are required to maintain reserves to cover their estimated ultimate liability for claims, losses and loss adjustment expenses with respect to reported and unreported claims incurred. These reserves are estimates of future costs based on various assumptions. Establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience, which in the past has resulted and in the future could result in loss reserves being too high or too low. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicial administration of claims, medical costs and other factors. Future loss development or governmental regulators could require reserves for prior periods to be increased, which would adversely impact earnings in future periods. The Company currently believes its available cash resources will be sufficient to meet its current operating requirements and internal development and integration activities. However, external financing sources may be required to 26 sustain growth in certain of the Company's regulated subsidiaries during fiscal year 1997. There currently are no other material definitive commitments for future use of the Company's available cash resources; however management continually evaluates opportunities to expand its operations, which includes internal development of new products and programs and may include additional acquisitions. RECENTLY ISSUED ACCOUNTING STANDARDS In October 1995, the Financial Accounting Standards Board issued Statement No. 123, "Accounting for Stock-Based Compensation". The new standard defines a fair value method of accounting for stock options and other equity instruments, such as stock purchase plans. Under this method, compensation cost is measured on the fair value of the stock award when granted and is recognized as expense over the service period, which is usually the vesting period. This standard will be effective for the Company beginning in fiscal 1997, and requires measurement of awards made on or after December 15, 1995. The new standard permits companies to continue to account for equity transactions with employees under existing accounting rules, but requires disclosure in a note to the financial statements of the pro forma net income and earnings per share as if the Company had applied the new method of accounting. The Company intends to follow the disclosure requirements for its employee stock plans. The new standard will also require that all stock-based transactions with non-employees be measured in accordance with the fair value method and recorded as expense. The Company has not determined the effect, if any, of implementing this standard on its results of operations. In March 1995, the Financial Accounting Standards Board issued Statement No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of ("FAS No. 121"). The Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amounts or fair value less cost to sell. This Statement will be effective for the Company beginning in fiscal 1997. Adoption of FAS No. 121 is not expected to have a significant effect on the Company's consolidated financial Statements. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and related financial information required to be filed hereunder are set forth at the pages indicated at Item 14(a) of this Report. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ------------ The Company's 1996 Annual Report to Stockholders is not to be deemed filed as a part of this Report. PART III Certain information required by Part III is omitted from this Report in that the registrant will file a definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement") not later than 120 days after the end of the fiscal year covered by this Report, and certain information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information concerning the Company's directors required by this Item is incorporated by reference from the Company's Proxy Statement. 27 The information concerning the Company's executive officers required by this Item is incorporated by reference to the section in Part I hereof entitled "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION. The information required by this item is incorporated by reference from the Company's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated by reference from the Company's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference from the Company's Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are filed as a part of this Report: 1. FINANCIAL STATEMENTS. The following Consolidated Financial Statements of Foundation Health Corporation and its subsidiaries and the Independent Auditors' Report therein are filed as part of this Report: Independent Auditors' Report Consolidated Balance Sheets as of June 30, 1995 and 1996 Consolidated Statements of Operations for the years ended June 30, 1994, 1995 and 1996 Consolidated Statements of Stockholders' Equity for the years ended June 30, 1994, 1995 and 1996 Consolidated Statements of Cash Flows for the years ended June 30, 1994, 1995 and 1996 Notes to Consolidated Financial Statements The independent auditors' reports for predecessor companies for the year ended December 31, 1993 are included in Exhibits 13.1, 13.2 and 13.3 2. FINANCIAL STATEMENT SCHEDULE AND OTHER FINANCIAL INFORMATION. The following financial statement schedule and other financial information of Foundation Health Corporation and its subsidiaries are filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Foundation Health Corporation: SCHEDULE - -------- Article 5, Schedule I - Condensed Financial Information of Registrant OTHER FINANCIAL INFORMATION - --------------------------- Section 403.04.b - Reconciliation of Beginning and Ending Class Reserves and Exhibit of Deficiencies (Redundancies) Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto. 3. EXHIBITS. The Exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Report. 28 Executive Compensation Plans and Arrangements: A. 1990 Stock Option Plan of Foundation Health Corporation (as amended and restated effective August 15, 1996) - Exhibit 10.102; B. Foundation Health Corporation Profit Sharing and 401(k) Plan (as amended and restated effective January 1, 1994) - Exhibit 10.103; Form 10-K filed September 27, 1995; C. Executive Incentive Plan of Foundation Health Corporation - Exhibit 10.3; Form 10-K filed September 23, 1994; D. Employment Agreement between Foundation Health Corporation and Daniel D. Crowley dated April 30, 1994 - Exhibit 10.84; Registration Statement No. 33-80432; E. Employment Agreement between Foundation Health Corporation and Steven D. Tough dated April 22, 1994 - Exhibit 10.86; Registration Statement No. 33-80432; Amended May 1, 1996- Exhibit 10.108; F. Employment Agreement between Foundation Health Corporation and Allen J. Marabito dated April 22, 1994 - Exhibit 10.88; Registration Statement No. 33-80432; Amended May 1, 1996- Exhibit 10.107; G. Employment Agreement between Foundation Health Corporation and Jeffrey L. Elder dated April 22, 1994 - Exhibit 10.85; Registration Statement No. 33-80432; Amended May 1, 1996- Exhibit 10.106; H. Employment Agreement between Foundation Health Corporation and Kirk A. Benson dated April 22, 1994 - Exhibit 10.87; Registration Statement No. 33-80432; Amended May 1, 1996- Exhibit 10.105; I. Employee Stock Purchase Plan - Exhibit 10.53; Registration Statement No. 33-38867; J. Amended and Restated Foundation Health Corporation Deferred Compensation Plan - Exhibit 10.99; Form 10-K filed September 27, 1995; K. Foundation Health Corporation Supplemental Executive Retirement Plan, as amended and restated - Exhibit 10.100; Form 10-K filed September 27, 1995; L. Foundation Health Corporation Executive Retiree Medical Plan, as amended and restated - Exhibit 10.101; Form 10-K filed September 27, 1995; (b) Reports on Form 8-K. The following reports on Form 8-K were filed by the Company during the fiscal quarter ended June 30, 1996: May 2, 1996 (related to pooling of interests 30 day combined financial statements for Managed Health Network, Inc. acquisition) 29 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. FOUNDATION HEALTH CORPORATION By /s/ DANIEL D. CROWLEY --------------------- Daniel D. Crowley CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Dated: August 30, 1996 KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Daniel D. Crowley, Allen J. Marabito and Patricia A. Burgess, and each of them, his true and lawful attorneys in fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys in fact, or his substitute or substitutes, may do or cause of be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ DANIEL D. CROWLEY Director, President and Chief August 30, 1996 - --------------------- Executive Officer (Principal Daniel D. Crowley Executive Officer) and Chairman of the Board /s/ DAVID A. BOGGS Director August 30, 1996 - ------------------ David A. Boggs /s/ JEFFREY L. ELDER Director, Senior Vice August 30, 1996 - -------------------- President-Chief Financial Jeffrey L. Elder Officer (Principal Financial and Accounting Officer) /s/ PATRICK FOLEY Director August 30, 1996 - ----------------- Patrick Foley /s/ EARL B. FOWLER Director August 30, 1996 - ------------------ Earl B. Fowler /s/ RICHARD W. HANSELMAN Director August 30, 1996 - ------------------------ Richard W. Hanselman /s/ ROSS D. HENDERSON, M.D Director August 30, 1996 - -------------------------- Ross D. Henderson, M.D. /s/ FRANK A. OLSON Director August 30, 1996 - ------------------ Frank A. Olson /s/ RICHARD J. STEGEMEIER Director August 30, 1996 - ------------------------- Richard J. Stegemeier /s/ STEVEN D. TOUGH Director August 30, 1996 - ------------------- Steven D. Tough /s/ RAYMOND S. TROUBH Director August 30, 1996 - --------------------- Raymond S. Troubh 30 FOUNDATION HEALTH CORPORATION CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1995 AND 1996 31 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Foundation Health Corporation We have audited the accompanying consolidated balance sheets of Foundation Health Corporation and its subsidiaries (the "Company") as of June 30, 1995 and 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1996. Our audits also included the financial statement schedule of Condensed Financial Information listed in the index at Item 14(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. The consolidated financial statements give retroactive effect to the merger of CareFlorida Health Systems, Inc. and a wholly-owned subsidiary of Foundation Health Corporation on October 31, 1994, and to the merger of Foundation Health Corporation and Thomas-Davis Medical Centers, P.C. on November 1, 1994, both of which have been accounted for as a pooling of interests as described in Note 1 to the consolidated financial statements. We did not audit the statements of income, stockholders' equity and cash flows of Thomas-Davis Medical Centers, P.C., for the year ended December 31, 1993, which statements reflect total revenues of $419,283,000. We also did not audit the statements of income, stockholders' equity and cash flows of CareFlorida Health Systems, Inc. for the year ended December 31, 1993, which statements reflect total revenues of $154,122,000. Those financial statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Thomas-Davis Medical Centers, P.C. and CareFlorida Health Systems, Inc. for such period, is based solely on the reports of the other auditors. As described in Note 1 to the consolidated financial statements, subsequent to the issuance of the reports of the other auditors, the financial statements of Thomas-Davis Medical Centers, P.C. and CareFlorida Health Systems, Inc. were restated to conform to the fiscal year of Foundation Health Corporation for the year ended June 30, 1994. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Foundation Health Corporation and its subsidiaries as of June 30, 1995 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule referred to above, 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. We also audited the adjustments described in Note 1 that were applied to restate the 1993 financial statements of Thomas-Davis Medical Centers, P.C. and CareFlorida Health Systems, Inc. In our opinion, such adjustments are appropriate and have been properly applied. DELOITTE & TOUCHE LLP Sacramento, California July 25, 1996 32 FOUNDATION HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) ASSETS JUNE 30, ---------------------------- 1995 1996 ------------- ------------- Cash and cash equivalents $ 203,937 $ 224,838 Investments : Available for sale investments 541,596 683,023 Held to maturity investments 49,745 31,891 Amounts receivable under government contracts 81,089 182,062 Reinsurance receivable 98,255 94,662 Premium and patient receivables, net of allowance for doubtful accounts of $11,915 and $13,675 at June 30, 1995 and 1996 100,727 139,501 Property and equipment, net 230,278 277,206 Goodwill and other intangible assets, net 409,342 409,514 Deferred income taxes 65,673 42,526 Other assets 183,565 341,176 ------------- ------------- $ 1,964,207 $ 2,426,399 ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Reserves for claims, losses and loss adjustment expenses $ 700,281 $ 883,911 Notes payable, capital leases and other financing arrangements 180,054 318,668 Amounts payable under government contracts 47,584 52,948 Accrued dividends to policyholders 16,405 9,726 Other liabilities 262,984 226,557 ------------- ------------- 1,207,308 1,491,810 ------------- ------------- Stockholders' equity Common stock and additional paid-in capital, $.01 par value, 100,000,000 shares authorized, 57,142,606 and 58,825,753 shares issued and outstanding at June 30, 1995 and 1996 518,671 533,855 Retained Earnings 244,249 410,689 Unrealized investment gains and losses, net of taxes (2,974) (6,908) Common stock held in treasury, at cost (3,047) (3,047) ------------- ------------- 756,899 934,589 ------------- ------------- $ 1,964,207 $ 2,426,399 ------------- ------------- ------------- ------------- The accompanying notes are an integral part of these consolidated financial statements. 33 FOUNDATION HEALTH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) YEAR ENDED JUNE 30, --------------------------------------- 1994 1995 1996 ----------- ----------- ----------- REVENUES: Commercial premiums $ 1,358,616 $ 1,664,509 $ 2,002,695 Government contracts 542,726 187,493 586,011 Specialty services revenue 380,726 509,807 699,854 Patient service revenue, net 41,358 41,323 50,244 Investment and other income 39,511 56,792 77,013 ----------- ----------- ----------- 2,362,937 2,459,924 3,415,817 ----------- ----------- ----------- EXPENSES: Commercial health care services 1,067,027 1,290,367 1,607,073 Government contracts health care services 152,185 67,508 375,480 Government contracts subcontractor costs 252,743 66,551 40,572 Specialty services costs 355,208 438,124 616,109 Patient service costs 37,599 33,561 36,216 Selling, general and administrative 291,130 307,802 423,652 Amortization and depreciation 28,463 41,102 61,021 Interest expense 12,709 11,555 15,099 Acquisition and restructuring costs - 124,822 - ----------- ----------- ----------- 2,197,064 2,381,392 3,175,222 ----------- ----------- ----------- Income before income taxes and minority interest 165,873 78,532 240,595 Provision for income taxes 64,834 26,821 74,155 Minority interest 7,398 2,262 - ----------- ----------- ----------- Net income $ 93,641 $ 49,449 $ 166,440 ----------- ----------- ----------- ----------- ----------- ----------- Earnings per share $ 1.92 $ 0.90 $ 2.86 ----------- ----------- ----------- ----------- ----------- ----------- Weighted average common and common stock equivalent shares outstanding 48,688,221 54,780,162 58,292,971 ----------- ----------- ----------- ----------- ----------- ----------- The accompanying notes are an integral part of these consolidated financial statements. 34 FOUNDATION HEALTH CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK UNREALIZED COMMON STOCK HELD IN TREASURY INVESTMENT ------------------------- ---------------------- RETAINED GAINS AND LOSSES, SHARES AMOUNT SHARES AMOUNT EARNINGS NET OF TAXES TOTAL ---------- ---------- --------- --------- ---------- ------------ ---------- Balance at June 30, 1993 47,219,097 $ 248,911 3,381,713 $ (9,667) $ 103,154 $ - $ 342,398 Issuance of common stock - net 2,087,971 1,627 - - - - 1,627 Purchase of treasury stock (1,400,281) 1,400,281 (27,666) - - (27,666) Exercise of stock options 572,347 8,661 - - - - 8,661 Assumption of stock options - 367 - - - - 367 Tax benefits related to stock options exercised - 5,410 - - - - 5,410 Dividends paid by predecessor company - - - - (1,995) - (1,995) Net income - - - - 93,641 - 93,641 ---------- ---------- ---------- ---------- ---------- ---------- --------- Balance at June 30, 1994 48,479,134 264,976 4,781,994 (37,333) 194,800 - 422,443 Cumulative effect of adoption of SFAS No. 115, net of taxes - - - - - (9,019) (9,019) Issuance of common stock 8,432,676 280,465 - - - - 280,465 Purchase of treasury stock (100,000) - 100,000 (3,047) - - (3,047) Retirement of treasury stock - (37,333) (4,781,994) 37,333 - - Exercise of stock options 330,796 5,920 - - - - 5,920 Tax benefits related to stock options exercised - 4,643 - - - - 4,643 Net unrealized holding - gains - - - - - 6,045 6,045 Net income - - - - 49,449 - 49,449 ---------- ---------- ---------- --------- ---------- ---------- ---------- Balance at June 30, 1995 57,142,606 518,671 100,000 (3,047) 244,249 (2,974) 756,899 Issuance of common stock - net 875,160 (86) 250,000 (8,384) - - (8,470) Exercise of stock options 807,987 16,932 - - - - 16,932 Retirement of treasury stock - (8,384) (250,000) 8,384 - - - Tax benefits related to stock options exercised - 6,722 - - - - 6,722 Net unrealized holding loss - - - - - (3,934) (3,934) Net income - - - - 166,440 - 166,440 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 1996 58,825,753 $ 533,855 100,000 $ (3,047) $ 410,689 $ (6,908) $ 934,589 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements. 35 FOUNDATION HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED JUNE 30, ---------------------------------- 1994 1995 1996 -------- --------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES : Net income $ 93,641 $ 49,449 $ 166,440 Adjustments to reconcile net income to cash provided by operating activities Amortization and depreciation 28,389 40,981 61,021 Amortization of bond discounts 3,719 5,396 2,769 Noncash restructuring costs - 11,486 - Gain on sale of IPAs - - (10,427) Change in assets and liabilities, net of effects from acquisition of businesses: Premium and patient receivables, net 11,577 912 (35,539) Reinsurance receivable 7,117 25,583 3,712 Other assets (28,266) (40,164) (95,561) Amounts receivable/payable under government contracts (10,761) 51,730 (95,609) Reserves for claims, losses and loss adjustment expenses 18,071 59,645 180,071 Accrued dividends to policyholders 7,115 (13,621) (6,679) Other liabilities 22,636 27,631 (38,324) Deferred income taxes, net (9,219) (17,265) 24,932 ---------- ---------- ---------- Net cash from operating activities 144,019 201,763 156,806 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES : Purchases of available for sale investments - (765,510) (599,302) Sales and maturities of available for sale investments - 770,673 459,852 Purchases of held to maturity investments - (39,112) (8,970) Maturities of held to maturity investments - 80,034 17,553 Purchases of short-term investments (367,253) - - Sales and maturities of short-term investments 435,201 - - Purchases of fixed maturity investments (731,324) - - Sales and maturities of fixed maturity investments 641,404 - - Acquisition of property and equipment (46,363) (107,257) (79,419) Increase in goodwill and other intangible assets (1,171) (42,126) (11,624) Increase in other assets (10,543) (35,376) (49,647) Acquisition of businesses, net of cash acquired (62,545) (41,874) (1,813) ---------- ---------- ---------- Net cash used for investing activities (142,594) (180,548) (273,370) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES : Principal payments on notes payable and capital leases (8,218) (16,451) (17,287) Proceeds from issuance of notes payable and capital leases 300 20,000 147,401 Proceeds from issuance of common stock - net 1,627 6,448 1,254 Proceeds from exercise of stock options 8,661 5,920 16,932 Tax benefits related to stock options 5,410 4,643 6,722 Stock repurchase and other adjustments related to mergers (27,666) (3,047) (17,557) Dividends paid by predecessor company (1,995) - - ---------- ---------- ---------- Net cash from (used for) financing activities (21,881) 17,513 137,465 ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents (20,456) 38,728 20,901 Cash and cash equivalents, beginning of year 185,665 165,209 203,937 ---------- ---------- ---------- Cash and cash equivalents, end of year $ 165,209 $ 203,937 $ 224,838 ---------- ---------- ---------- ---------- ---------- ---------- SUPPLEMENTAL CASH FLOWS DISCLOSURE : Interest paid $ 14,004 $ 13,907 $ 15,104 Income taxes paid 64,426 47,792 10,662 Noncash investing and financing activities Capital lease obligations 2,378 - 824 Deferred compensation 5,383 5,429 2,867 Transfer of investments from held to maturity to available for sale - - 9,090 Acquisition of businesses : Assets acquired $ 532,331 $ 392,509 $ 26,090 Liabilities assumed (439,740) (49,506) (13,239) Issuance of notes payable held in escrow (4,359) (7,909) - Issuance of common stock - (274,017) (6,631) ---------- ---------- ---------- Cash paid 88,232 61,077 6,220 Less cash acquired (25,687) (19,203) (4,407) ---------- ---------- ---------- Net cash paid $ 62,545 $ 41,874 $ 1,813 ---------- ---------- ---------- ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements. 36 FOUNDATION HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - DESCRIPTION OF BUSINESS Foundation Health Corporation (the "Company") operates an integrated multi-state managed care organization. The Company's operations are focused on its commercial health maintenance organization ("HMO") and preferred provider organization ("PPO") operations, government-sponsored managed care programs, and specialty services operations. The Company's commercial HMO subsidiaries contract to provide medical care services to a defined, enrolled population for a predetermined, prepaid monthly fee for group, Medicaid, individual and Medicare HMO plans throughout their respective service areas. All of the HMOs are state licensed and some are also federally qualified. The Company's wholly-owned subsidiary, Foundation Health Federal Services, Inc. ("Federal Services"), administers large, multi-year managed care government contracts. Federal Services subcontracts to affiliated and unrelated third parties the administration and health care risk of parts of these contracts. These programs include: (i) a CHAMPUS managed care contact in Washington and Oregon to provide health care services to approximately 227,000 CHAMPUS-eligible beneficiaries which commenced health care services in March 1995 (the "Washington/Oregon Contract"), (ii) a similar contract in Texas, Louisiana, Arkansas and Oklahoma to provide health care services to approximately 590,000 CHAMPUS-eligible beneficiaries which commenced delivery of health care services in November 1995 (the "Region 6 Contract") and (iii) the multi-year TRICARE managed care contract to provide health care services to approximately 720,000 CHAMPUS-eligible beneficiaries in California and Hawaii which commenced delivery of health care services in April 1996 (the "California/Hawaii Contract") Federal Services also administers contracts in Massachusetts, New Jersey, Georgia and Maine to enroll Medicaid eligible individuals in managed care programs in those states. Federal Services is not at risk for the provision of any health care services under any of these contracts. The Company's specialty services subsidiaries offer managed care products related to workers' compensation insurance, administration and cost containment, behavioral health, dental, vision, and pharmaceutical products and services. The Company's largest specialty services subsidiary, California Compensation Insurance Company ("CalComp"), acquired in August 1993, is primarily engaged in writing workers' compensation insurance in California. CalComp enables the Company to utilize its managed care capabilities and provider networks to reduce the medical costs associated with workers' compensation claims and provides the Company with the ability to market "24 hour" risk products covering employees for medical care both on and off the job. In February 1995, the Company acquired Business Insurance Company ("BICO"). BICO was acquired to geographically diversify CalComp's underwriting risk as a result of reduced premium levels on policies written in California and to take advantage of perceived opportunities because of favorable national workers' compensation reform. BICO is licensed to write workers' compensation policies in 49 states. The Company operates and manages Company-owned and leased health care centers in California, Arizona and Florida which provide primary and multi-specialty care to enrolled members. Physicians employed by professional corporations which are owned by Company-affiliated physicians provide services to the Company's members at the health care centers. The Company provides facilities and support functions to the health care centers and is reimbursed in the form of a management fee by the affiliated professional corporations. On June 28, 1996, the Company and the sole shareholder of the holding Company of Thomas-Davis Medical Centers, P.C. and Foundation Health Medical Group, Inc. (collectively referred to as the "Medical Groups") entered into a Stock and Note Purchase Agreement with FPA Medical Management, Inc. ("FPA") whereby the Company will sell all the outstanding stock of Foundation Health Medical Services ("FHMS"), its management services organization, and the shareholder will sell all the outstanding stock of the holding company for the Medical Groups to FPA and certain of its affiliated entities. The aggregate consideration consists of $2 37 million cash, $75 million of FPA common stock, $22 million bridge note due five months after closing and bearing a floating interest rate and a $12 million note to be consolidated with the assumption of the intercompany indebtedness of FHMS, the holding company and the Medical Groups to FHC by FPA (estimated to be $80 million as of June 30, 1996, which amount will be adjusted, up to $12 million, for liabilities incurred between June 30, 1996 and the closing of the transaction, currently anticipated for October 1, 1996). The consolidated note will bear interest at a floating rate with amortization of principal on a 15 year schedule with the remaining principal and accrued interest due 84 months after close. FPA will also assume other liabilities owed by FHMS, the Holding Company and the Medical Groups to third parties (estimated to be $41 million as of June 30, 1996). The promissory notes will be secured by the assets and stock of FPA, the purchasing company, FHMS, the holding company and the Medical Groups. The promissory notes will be quaranteed by FPA. The Company's affiliated health plans in Arizona, California and Florida have agreed to pay to FPA an aggregate of $55 million during the period commencing August 1996 through December 1998 for continued and uninterrupted access as defined in the Purchase Agreement to the professional providers of the IPAs and the Medical Groups for the Company's affiliated health plan enrollees. This transaction will be recorded in the financial statements in the quarter it closes. The Company owns and operates two hospitals, the East Los Angeles Doctors Hospital, a 128-bed general hospital located in East Los Angeles, California and the Memorial Hospital of Gardena, a 200-bed general hospital located in Gardena, California (the "Hospitals"). The health care services provided by the Hospitals are general medical and surgical services, subacute, pediatrics, intensive and coronary care, physical therapy, respiratory care and emergency room services. The Hospitals received approximately 79% of their revenues from Medicare and Medicaid programs during the year ended June 30, 1996. CONSUMMATED BUSINESS ACQUISITIONS - POOLING TRANSACTIONS FISCAL YEAR 1995 On October 31, 1994, 6,862,051 shares of the Company's common stock were issued in exchange for all of the outstanding common stock of CareFlorida Health Systems, Inc. ("CareFlorida"). At the time of acquisition, CareFlorida provided comprehensive health care services to approximately 143,000 members in Florida through its HMO and PPO subsidiaries. On November 1, 1994, 13,124,027 shares of the Company's common stock were issued in exchange for all of the outstanding common stock of TDMC, including its majority interest of 60.5% of the outstanding common stock of Intergroup Healthcare Corporation ("Intergroup"). Additionally, 7,577,336 shares were issued for the purchase of the remaining 39.5% minority interest of Intergroup. All outstanding Intergroup options were exchanged for options to purchase 500,290 shares of the Company's common stock. TDMC employed approximately 190 physicians at the date of merger who provided health care services to patients in Arizona through 15 primary care centers, five urgent care centers, two behavioral health centers and one surgery center. At the time of merger, Intergroup provided comprehensive health care services to approximately 379,000 HMO and life and accident insurance members and 104,000 PPO members primarily in Arizona and Utah. In connection with the mergers of CareFlorida, TDMC and Intergroup in fiscal 1995, the Company recorded a charge for acquisition, restructuring and merger costs of $124.8 million. The acquisition and restructuring charge represented the costs of acquiring and consolidating the companies' management information systems and administrative functions and positioning the Company to take advantage of best practices in health care delivery systems and managed care techniques after the mergers. 38 The components of this charge included (in millions): Professional fees. . . . . . . . . . . . . . . . . . . $21.5 Cancellation of certain contractual obligations and other settlement costs . . . . . . . . . . . . . . . 27.1 Write-off of certain redundant hardware, software and other settlement costs . . . . . . . . . . . . . . . 17.9 Elimination of duplicate facilities. . . . . . . . . . 13.0 Transition and severance related payments to employees. . . . . . . . . . . . . . . . . . . . . . . 36.5 Other integration and restructuring. . . . . . . . . . 8.8 ------ Total. . . . . . . . . . . . . . . . . . . . . . . . . $124.8 ------ ------ These costs satisfy the definition of "exit costs" as set forth in Emerging Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)," that are directly related to the mergers. The Company has substantially completed its integration and restrurcturing of the combined entities as of June 30, 1996. In accordance with the pooling of interests method of accounting the Company's consolidated financial statements and notes thereto have been restated to include the accounts of TDMC (including its 60.5% interest in Intergroup) and CareFlorida for all periods presented. Prior to the mergers, CareFlorida and TDMC each reported on a calendar year basis. Accordingly, the consolidated financial statements include CareFlorida's and TDMC's financial statements restated to the Company's fiscal year basis. Separate and combined results of the Company, CareFlorida and TDMC for the period prior to consummation of the mergers are as follows (in thousands): YEAR ENDED JUNE 30 ------------------ 1994 ---- Revenues: Foundation Health Corporation - as previously reported . . . . . . . . . . . . . . . . . . . . . . $1,717,821 TDMC- year ended December 31, 1993 . . . . . . . . . . 419,283 CareFlorida- year ended December 31, 1993. . . . . . . 154,122 Adjustments (1). . . . . . . . . . . . . . . . . . . . 71,711 ---------- Combined . . . . . . . . . . . . . . . . . . . . . . . . . $2,362,937 ---------- ---------- Net income: Foundation Health Corporation - as previously reported . . . . . . . . . . . . . . . . . . . . . . $82,153 TDMC- year ended December 31, 1993 . . . . . . . . . . 4,841 CareFlorida- year ended December 31, 1993. . . . . . . 6,664 Adjustments (1). . . . . . . . . . . . . . . . . . . . (17) --------- Combined . . . . . . . . . . . . . . . . . . . . . . . . . $93,641 --------- --------- (1) Primarily reflects adjustments to calendar year results to conform to the Company's fiscal year reporting and certain reclassifications to conform to the Company's presentation. FISCAL YEAR 1996 In March 1996 the Company issued stock for Managed Health Network, Inc. and its subsidiaries (collectively "MHN"), a privately held company providing employee assistance and managed behavioral health programs to more than 2.7 million covered lives through its subsidiaries, in a stock-for-stock, pooling of interest transaction valued at approximately $45 million. The Company has determined that the impact on prior years' financial statements of restatement of the Company's financial statements as a result of the MHN merger would not be significant and therefore, has combined MHN's net assets as of March 6, 1996, the date of acquisition, with the Company's consolidated financial statements. 39 CONSUMMATED BUSINESS ACQUISITIONS (PURCHASE TRANSACTIONS) AND DISPOSITIONS FISCAL YEAR 1994 In July 1993, the Company acquired all of the outstanding common stock of Managed Alternative Care, a subacute care management company, for $6,000,000, paid in cash, which resulted in goodwill of $5,500,000. In August 1993, the Company acquired all of the outstanding common stock of a holding company primarily engaged in writing workers' compensation insurance in California through its wholly-owned subsidiary, CalComp, for $65,268,000, paid in cash. In addition, all outstanding options were exchanged for options to purchase 29,475 shares of the Company's common stock. The acquisition resulted in goodwill of $5,001,000. Effective January 1, 1994, the Company acquired substantially all of the outstanding shares of common stock of Gem Holding Corporation ("Gem"), a holding company primarily engaged in writing health, individual life, annuities, group life, disability and dental insurance. At the date of acquisition, Gem provided services to approximately 83,000 individuals in six western states. The purchase price was $17,800,000 which was paid in cash. The acquisition resulted in goodwill of approximately $4,500,000. In April 1994, the Company acquired all of the outstanding common stock of Premier Medical Network ("Premier"). Premier provides third party administrative services to approximately 98,000 individuals through a PPO network in Utah. The purchase price was $1,500,000, paid in cash. The acquisition resulted in goodwill of $1,200,000. FISCAL YEAR 1995 In July 1994, the Company acquired all of the outstanding common stock of The Noetics Group and all of the assets of Reviewco for consideration consisting of the issuance of 378,358 shares of the Company's common stock valued at $16 million, 118,236 shares of common stock valued at $5 million, which was placed in escrow and cash of $16 million. The release of the escrow shares was subject to the attainment of certain profitability targets by Reviewco. The escrow was terminated as of July 31, 1996. The acquisition resulted in goodwill of $27,773,000. The Noetics Group provides workers' compensation third party administration services for self-funded employers. Reviewco operates a medical bill review and cost-containment business for the workers' compensation industry. In November 1994, the Company acquired all of the outstanding common stock of Southern Colorado Health Plan, Inc. ("SCHP"), and its parent corporation for consideration consisting of 241,672 shares of the Company's common stock valued at $8,900,000. The acquisition resulted in goodwill of $6,755,000. At the date of acquisition, SCHP provided health care services to 7,100 members through its HMO based in Pueblo, Colorado. In November 1994, the Company acquired all of the outstanding common stock of Community Medical Plan, Inc. ("CMP") and certain affiliated health care centers for consideration of $32.9 million, consisting of $25 million in paid cash and at closing the issuance of promissory notes of $7.9 million due November 15, 1995. At the date of acquisition, CMP served approximately 25,000 Medicaid beneficiaries in Florida. The acquisition resulted in goodwill of $32,752,000. 40 In November 1994, the Company issued 7,577,336 shares of its common stock for the purchase of 39.5% of the outstanding common stock of Intergroup (the "Intergroup Minority Interest"). The acquisition of the Intergroup Minority Interest, which was accounted for as a purchase, was valued at $249,109,000 and resulted in goodwill of $207,371,000. The unaudited pro forma combined total revenues, net income and earnings per share of the Company and the Intergroup Minority Interest, assuming the Company had acquired the Intergroup Minority Interest on July 1, 1993, are as follows (in thousands, except per share amounts): PRO FORMA YEAR ENDED JUNE 30, ------------------- 1994 1995 ---- ---- Total revenues . . . . . . . . . . . . . . . . . . . $2,362.9 $2,459.9 -------- -------- -------- -------- Net income . . . . . . . . . . . . . . . . . . . . . $96.9 $50.6 -------- -------- -------- -------- Earnings per share . . . . . . . . . . . . . . . . . $1.74 $0.89 -------- -------- -------- -------- This unaudited pro forma information reflects the elimination of the Intergroup Minority Interest and the amortization of the goodwill related to the purchase of the Intergroup Minority Interest. The unaudited pro forma results of operations are not necessarily indicative of the combined results that would have occurred had the acquisition taken place on July 1, 1993, nor are they necessarily indicative of results that may occur in the future. In February 1995, CalComp acquired, BICO, a 50-state licensed property and casualty company, for an aggregate purchase price of $13,201,000, consisting of the fair market value of investments and intangible assets which was paid in cash at closing. This company which had no insurance business in force at closing enables CalComp to geographically expand its managed care workers' compensation products. No goodwill was recorded as a result of this transaction. FISCAL YEAR 1996 On June 28, 1996, the Company acquired the remaining minority interest in the Utah HMO operations for approximately $5.8 million and at the same time sold its financial interest in Premier Medical Network in Utah for approximately $7.1 million. In September 1995, the Company acquired a medical practice and related facilities in Arizona for approximately $6.2 million. In January 1996, the Company sold its affiliated California IPAs to FPA for a purchase price consisting of cash and a promissory note payable over 10 years. The notes receivable under the revolving credit agreements with the IPAs in the amount of $10 million were repaid to the Company and terminated in connection with the transaction. In June 1996, the Company sold its affiliated Florida and Arizona IPAs to FPA for aggregate consideration of $20 million, consisting of cash in the amount of $3 million and a promissory note in the amount of $17 million which is due and payable six months after closing and bears a floating interest rate. The above acquisitions have been accounted for under the purchase method of accounting and accordingly, the operations of these companies have been included in the Company's consolidated financial statements from their respective dates of acquisition. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION AND BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. 41 USE OF ESTIMATES In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. REVENUE RECOGNITION Commercial premium revenue includes HMO and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, which premiums are based on a predetermined prepaid fee, Medicaid revenues based on multi-year contracts to provide care to Medicaid recipients, and revenue under Medicare risk contracts to provide care to enrolled Medicare recipients. Revenue is recognized in the month in which the related enrollees are entitled to health care services. Premiums collected in advance are recorded as unearned premium. Revenue under government contracts is recognized in the month in which the eligible beneficiaries are entitled to health care services. Certain government contracts also contain cost and performance incentive provisions which adjust the contract price based on actual performance, and revenue under certain contracts is subject to price adjustments attributable to inflation and other factors. The effects of these adjustments are recognized on a monthly basis. Amounts receivable under government contracts are comprised primarily of estimated amounts receivable under these cost and performance incentive provisions, price adjustments, and change orders for services not originally specified in the contracts. Specialty services revenue is recognized in the month in which the administrative services are performed or the period that coverage for service is provided. Workers' compensation premium revenue is recognized ratably over the period to which the premium relates. The insurance policies currently written by the Company are for a period of one year or less. Billed premium in excess of premiums earned represents the liability for unearned premium. Premiums earned include an estimate for earned but unbilled premiums. Patient service revenue is recorded on the accrual basis in the period in which services are provided at established rates regardless of whether collection in full is anticipated. Contractual and charitable allowances, the results of other arrangements for providing services at less than established rates and the provision for doubtful accounts are reported as deductions from patient service revenue. Contractual allowances include differences between established billing rates and amounts estimated by management as recoverable in accordance with reimbursement rates in effect. Differences between final settlements and amounts accrued in previous years are reported as adjustments to the current year's provision for contractual allowance. Unearned premiums related to commercial and specialty services lines of business totaled $64,930,000 and $61,455,000 at June 30, 1995 and 1996 and are included in other liabilities on the consolidated balance sheet. RESERVES FOR CLAIMS, LOSSES AND LOSS ADJUSTMENT EXPENSES AND HEALTH CARE SERVICES EXPENSES Except as discussed below, reserves for claims, losses and loss adjustment expenses and health care services expenses are based upon the accumulation of cost estimates for unpaid claims and losses reported prior to the close of the accounting period, together with a provision for the current estimate of the probable cost of claims, losses and loss adjustment expenses that have occurred but have not yet been reported. Such estimates are based on many variables including individual cases for reported losses, estimates of unreported losses using historical and statistical information and other factors. Workers' compensation claims, losses and loss adjustment expenses, and specialty health care services expenses are included in specialty services costs in the statements of operations. The methods for making the estimates and for establishing the resulting reserves are continually reviewed and updated, and any adjustments resulting therefrom 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. While the ultimate amount of claims and losses and the related expenses paid are dependent on future developments, management is of the opinion that the reserves for claims, losses and loss adjustment expenses is adequate to 42 cover such claims, losses and expenses. These liabilities are reduced by estimated amounts recoverable from third parties for subrogation. The Company has capitation contracts with individual practice associations, medical groups and hospitals ("Capitated Providers") to provide medical care services to enrollees. The Capitated Providers are at risk for the cost of medical care services provided to the Company's enrollees in the relevant geographic areas; however, the Company is ultimately responsible for the provision of services to its enrollees should the Capitated Providers be unable to provide the contracted services. Certain Capitated Providers also provide claims processing and other administrative services. The Capitated Providers are either paid a fixed percentage of premiums collected in the geographic areas they service or a fixed amount per enrollee for enrollees in their respective service areas. Medical care expenses relating to these Capitated Providers are included in commercial health care services expense and amounted to $398,700,000, $467,735,000 and $660,644,000 for the years ended June 30, 1994, 1995 and 1996. The HMOs also contract with hospitals, physicians and other providers of health care, pursuant to discounted fee for service arrangements and hospital per diems under which providers bill the HMOs for each individual service provided to enrollees. CASH AND CASH EQUIVALENTS Cash and cash equivalents include investments with original maturities of three months or less. INVESTMENTS Prior to July 1, 1994, the Company classified its securities as short-term investments and fixed maturities. Securities with an original maturity of one year or less at the date of acquisition were classified as short-term investments. Such investments were carried at cost, which approximated market value. Declines in market value which were determined by management to be other than temporary were recorded as charges to the statement of operations. Investments with fixed maturities primarily included long-term investment grade bonds and were carried at amortized cost. It is the Company's policy to invest in notes, bonds and money market securities, limited by certain restrictions. The cost of investments sold is determined using the specific identification method. Effective July 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). The adoption of SFAS No. 115 did not have a material effect on the Company's consolidated financial position or results of operations. In accordance with SFAS No. 115, the Company classifies investments held by trustees or agencies pursuant to state regulatory requirements as held to maturity based on the Company's ability and intent to hold these investments to maturity. Such investments are presented at amortized cost. All other investments are classified as available for sale and are reported at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of income tax effects. For purposes of calculating realized gains and losses on the sale of investments available for sale, the amortized cost of each investment sold is used. The Company has no trading securities. PROPERTY AND EQUIPMENT Property and equipment is recorded at cost. Depreciation is provided using the straight-line method for all assets over their estimated useful lives as follows: Buildings and improvements . . . . . . . . . . . . . . 5-40 years Furniture and equipment. . . . . . . . . . . . . . . . 3-10 years 43 Expenditures for maintenance and repairs are expensed as incurred. Major improvements which increase the estimated useful life of an asset are capitalized. Upon the sale or retirement of assets, recorded cost and related accumulated depreciation are removed from the accounts, and any gain or loss on disposal is reflected in operations. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets consists primarily of goodwill and other intangibles which arise as a result of various business acquisitions and the acquisition of the Company through a leveraged buy-out on December 30, 1986, at which time the assets and liabilities of the Company were recorded at their appraised values. In addition, the Company's policy is to defer direct and incremental pre-operating costs related to its HMO subsidiaries' geographic expansion and the opening of health care centers. These costs are deferred prior to the commencement of significant operations at which time the Company begins amortizing such costs over a three-year period. Goodwill and other intangible assets are amortized using the methods listed below over appropriate periods not exceeding 40 years. Fully amortized intangible assets and related accumulated amortization are removed from the accounts. The Company evaluates the carrying value of it intangible assets at each balance sheet date. Goodwill and other intangible assets are amortized as follows:
LIFE METHOD ---- ------ Subscribers. . . . . . . . . . . . . . . . . 22 years Declining balance Employer group contracts . . . . . . . . . . 22 years Straight line Goodwill . . . . . . . . . . . . . . . . . . 22-40 years Straight line Organization and preoperating costs. . . . . 3-8 years Straight line Noncompetition and employment agreements . . Term of related agreement Straight line Debt issue costs . . . . . . . . . . . . . . Term of related debt Straight line
Goodwill and other intangible assets are reported, net of accumulated amortization of $49,138,000 and $73,752,000 at June 30, 1995 and 1996. INCOME TAXES The Company accounts for income taxes using the liability method. Deferred income tax assets and liabilities result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. The Company adopted SFAS No. 109, "Accounting for Income Taxes" effective July 1, 1993. The adoption of SFAS No. 109 did not have a significant effect on the Company's results of operations for the periods presented. No valuation allowance resulted from the adoption of SFAS No. 109. DEFERRED POLICY ACQUISITION COSTS Policy acquisition costs, including commissions, premium taxes and other acquisition costs related to the production or renewal of workers' compensation and indemnity business, are deferred. Such costs are amortized as the related premiums are earned. The amortization of such deferred policy acquisition costs related to property casualty insurance policies were as follows, $25,788,000, $24,947,000 and $30,729,000, for the years ended June 30, 1994, 1995 and 1996. If it is determined that future policy revenues on existing insurance contracts are not adequate to cover related losses and expenses, deferred policy acquisition costs are written down. However, to date, no write-downs have been made. Earnings on invested funds between the time of premium receipts and related claim payments are considered in determining whether a premium deficiency exists. Deferred policy acquisition costs totaled $20,824,000 and $27,804,000 at June 30, 1995 and 1996 and are included in other assets. 44 DIVIDENDS TO POLICYHOLDERS Dividends to workers' compensation policyholders are generally declared 18 to 24 months after expiration of the participating policies. A provision is made for estimated dividends to be paid related to premium revenue recognized. EARNINGS PER SHARE Earnings per share is calculated by dividing net income by the weighted average number of shares of common stock plus common stock equivalent shares outstanding using the treasury stock method. Earnings per share has been restated for all periods presented to reflect the mergers of CareFlorida and TDMC accounted for as poolings of interests as discussed in Note 1. RECENTLY ISSUED ACCOUNTING STANDARDS In October 1995, the Financial Accounting Standards Board issued Statement No. 123, "Accounting for Stock-Based Compensation". The new standard defines a fair value method of accounting for stock options and other equity instruments, such as stock purchase plans. Under this method, compensation cost is measured on the fair value of the stock award when granted and is recognized as expense over the service period, which is usually the vesting period. This standard will be effective for the Company beginning in fiscal 1997, and requires measurement of awards made on or after December 15, 1995. The new standard permits companies to continue to account for equity transactions with employees under existing accounting rules, but requires disclosure in a note to the financial statements of the pro forma net income and earnings per share as if the Company had applied the new method of accounting. The Company intends to follow the disclosure requirements for its employee stock plans. The new standard will also require that all stock-based transactions with non-employees be measured in accordance with the fair value method and recorded as expense. The Company has not determined the effect, if any, of implementing this standard on its results of operations. In March 1995, the Financial Accounting Standards Board issued Statement No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of ("SFAS No. 121"). The Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amounts or fair value less cost to sell. This Statement will be effective for the Company beginning in fiscal 1997. Adoption of SFAS No. 121 is not expected to have a significant effect on the Company's consolidated financial statements. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to current year presentation. 45 NOTE 3 - INVESTMENTS As of June 30, 1995, the amortized cost, gross unrealized holding gains and losses and fair value of the Company's investments were as follows (in thousands):
Available for Sale Held to Maturity ----------------------------------------------- ----------------------------------------- Gross Gross Gross Gross Unrealized Unrealized Unrealized Unrealized Amortized Holding Holding Fair Amortized Holding Holding Fair Cost Gains Losses Value Cost Gains Losses Value ---- ----- ------ ----- ---- ----- ------ ----- U.S. government and agencies $ 108,951 $ 643 $ (1,256) $ 108,338 $ 17,263 $ 224 $ (45) $ 17,442 Obligations of states and other political subdivisions 385,827 580 (4,231) 382,176 27,703 79 (249) 27,533 Corporate debt securities 8,120 119 (267) 7,972 845 111 - 956 Equity securities 4,089 39 (170) 3,958 - - - - Other debt securities 39,152 - - 39,152 3,934 - - 3,934 --------- ------- -------- --------- -------- ----- ------- -------- Total $ 546,139 $ 1,381 $ (5,924) $ 541,596 $ 49,745 $ 414 $(294) $ 49,865 --------- ------- -------- --------- -------- ----- ------ -------- --------- ------- -------- --------- -------- ----- ------ --------
As of June 30, 1996, the amortized cost, gross unrealized holding gains and losses and fair value of the Company's investments were as follows (in thousands):
Available for Sale Held to Maturity ------------------------------------------ --------------------------------------- Gross Gross Gross Gross Unrealized Unrealized Unrealized Unrealized Amortized Holding Holding Fair Amortized Holding Holding Fair Cost Gains Losses Value Cost Gains Losses Value ---- ----- ------ ----- ---- ----- ------ ----- U.S. government and agencies $ 89,341 $ 75 $ (2,193) $ 87,223 $12,431 $12 $ (77) $12,366 Obligations of states and other political subdivisions 584,371 1,341 (7,872) 577,840 16,675 67 (85) 16,657 Corporate debt securities 6,334 94 (223) 6,205 - - - - Equity securities 1,372 1 (111) 1,262 - - - Other debt securities 10,504 - (11) 10,493 2,785 - - 2,785 --------- ------- --------- --------- -------- ----- ------ -------- Total $691,922 $1,511 $(10,410) $683,023 $31,891 $79 $(162) $31,808 --------- ------- --------- --------- -------- ----- ------ -------- --------- ------- --------- --------- -------- ----- ------ --------
46 At June 30, 1996, the contractual maturities of the Company's investments were as follows (in thousands):
At Amortized Cost At Fair Market Value -------------------------------------------- -------------------------------------------- Years to Maturity Years to Maturity -------------------------------------------- -------------------------------------------- Less than 1 to 5 5 to 10 Over 10 Less than 1 to 5 5 to 10 Over 10 1 Year Years Years Years 1 Year Years Years Years ------ ----- ----- ----- ------ ----- ----- ----- AVAILABLE FOR SALE: U.S. government and agencies $ 20,052 $ 50,904 $ 18,226 $ 159 $ 19,970 $ 49,878 $ 17,206 $ 169 Obligations of states and other political subdivisions 22,090 174,318 204,982 182,981 22,127 173,215 202,501 179,997 Corporate debt securities 561 2,855 2,021 897 559 2,754 1,986 906 Equity securities 21 - - 1,351 22 - - 1,240 Other debt securities 2,110 8,394 - - 2,098 8,395 - - -------- --------- --------- --------- -------- --------- --------- --------- Total $ 44,834 $ 236,471 $ 225,229 $ 185,388 $ 44,776 $ 234,242 $ 221,693 $ 182,312 -------- --------- --------- --------- -------- --------- --------- --------- -------- --------- --------- --------- -------- --------- --------- --------- HELD TO MATURITY U.S. government and agencies $ 4,409 $ 7,555 $ 467 $ - $ 4,416 $ 7,503 $ 447 $ - Obligations of states and other political subdivisions 390 7,644 5,351 3,290 390 7,600 5,392 3,275 Other debt securities 2,685 - 100 - 2,685 - 100 - ------- -------- ------- ------- ------- -------- ------- ------- Total held to maturity $ 7,484 $ 15,199 $ 5,918 $ 3,290 $ 7,491 $ 15,103 $ 5,939 $ 3,275 ------- -------- ------- ------- ------- -------- ------- ------- ------- -------- ------- ------- ------- -------- ------- -------
Proceeds from sales and maturities of available for sale securities during 1995 were $770,673,000, resulting in gross realized gains and losses of $13,000 and $122,000, respectively. Proceeds from the sales and maturities of available for sale securities during 1996 were $459,852,000 resulting in gross realized gains and losses of $2,695,000 and $196,000, respectively. The Company's regulated subsidiaries are required to keep securities on deposit in various states where they are licensed. At June 30, 1996, $404,570,000 in securities are restricted to satisfy various state regulatory and licensing requirements. Additionally, at June 30, 1996, $4,897,000 in securities were pledged as collateral under reinsurance agreements. Pursuant to the Financial Accounting Standard Board's implementation guidance, the Company made a one-time transfer of approximately $9,009,000 of securities from the hold to maturity classification to the available for sale classification prior to December 31, 1995. Investment income, including realized investment gains and losses, were as follows (in thousands): YEAR ENDED ---------- JUNE 30, -------- 1994 1995 1996 ---- ---- ---- Short-term investments. . . . . . . . . $ 3,035 $ - $ - Fixed maturities. . . . . . . . . . . . 26,832 - - Available for sale. . . . . . . . . . . - 31,938 35,396 Held to maturity. . . . . . . . . . . . - 3,283 1,944 Other . . . . . . . . . . . . . . . . . 6,096 7,763 12,169 Less-investment expenses. . . . . . . . (991) (534) (854) --------- -------- --------- Net investment income . . . . . . . . . $ 34,972 $ 42,450 $ 48,655 --------- -------- --------- --------- -------- --------- Net investment income generated by property casualty operations were as follows, $14,072,000, 21,437,000, and $26,794,000 for the years ended June 30, 1994, 1995 and 1996. 47 NOTE 4 - LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the reserves for losses and loss adjustment expenses related to workers' compensation and indemnity insurance policies, for the year ended June 30, 1995 and June 30, 1996 is summarized as follows (in thousands):
JUNE 30, 1995 JUNE 30, 1996 ------------- ------------- Beginning balance. . . . . . . . . . . . . . . . . . . . . $ 395,846 $ 414,330 Less-ceded losses and loss adjustment expense reserves . . (103,318) (81,667) ---------- ---------- Net beginning balance. . . . . . . . . . . . . . . . . . . 292,528 332,663 ---------- ---------- Incurred related to: Current fiscal year . . . . . . . . . . . . . . . . . . 232,643 492,090 Prior fiscal years. . . . . . . . . . . . . . . . . . . (7,614) (19,897) ---------- ---------- Total incurred . . . . . . . . . . . . . . . . . . . . . . 225,029 472,193 ---------- ---------- Paid related to: Current fiscal year . . . . . . . . . . . . . . . . . . (41,092) (242,942) Prior fiscal years. . . . . . . . . . . . . . . . . . . (143,802) (173,348) ---------- ---------- Total paid . . . . . . . . . . . . . . . . . . . . . . . . (184,894) (416,290) ---------- ---------- Net ending balance . . . . . . . . . . . . . . . . . . . . 332,663 388,566 Plus-ceded losses and loss adjustment expense reserves . . 81,667 72,620 ---------- ---------- Ending balance . . . . . . . . . . . . . . . . . . . . . . $ 414,330 $461,186 ---------- ---------- ---------- ----------
During the fiscal years ended June 30, 1995 and 1996, the Company experienced favorable loss and loss adjustment expense reserve development of $7,614,000 and $19,897,000, respectively. This reduction of the estimated loss and loss adjustment expense is primarily the result of favorable loss development related to the 1993 and 1994 accident years, offset in part by adverse loss development for the 1992 and prior accident years. NOTE 5 - EXCESS LIABILITY INSURANCE AND REINSURANCE Under reinsurance agreements, the Company reinsures certain workers' compensation risks with other insurance companies. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company regularly evaluates the financial condition of its reinsurers. Based on this evaluation, management believes the reinsurers are creditworthy and that any potential losses on these agreements will not have a material impact on the consolidated financial statements. The Company's workers' compensation subsidiaries maintain specific excess reinsurance on workers' compensation which provides coverage in excess of $1,000,000 per occurrence for accident year 1996, in excess of $500,000 per occurrence for accident years 1994 and 1995, in excess of $350,000 per occurrence for accident years 1992 and 1993 and in excess of $250,000 per occurrence for accident years 1989 through 1991. The agreements provide coverage up to a maximum of $200 million per occurrence, including the Company's retention. In addition, the Company also maintained a pro rata reinsurance agreement wherein the reinsurer assumed a proportional amount of net premiums earned and related losses. The quota share percentage ranged from 5% to 40% (5% at June 30, 1994) during the year ended June 30, 1994. As of July 1, 1994 the quota share agreement was terminated. Effective July 1, 1996, the workers' compensation subsidiaries entered into a 30% quota share treaty to cede a proportional amount of net premiums earned and related loss and loss adjustment expenses incurred. The 30% ceding rate is applicable from July 1, 1996 to December 31, 1996. Effective January 1, 1997, the quota share reinsurance ceding rate is reduced to 7.5%, and subsequently reduced again to 3.75% from July 1, 1997 to December 31, 1997. Effective January 1, 1998, the Company may terminate the agreement. 48 The effect of reinsurance on workers' compensation premium written and earned, and losses incurred for the eleven months from August 1, 1993 (date of acquisition) to June 30, 1994 and the years ended June 30, 1995 and 1996 is summarized as follows (in thousands): PREMIUMS PREMIUMS LOSSES WRITTEN EARNED INCURRED -------- -------- -------- Eleven months ended June 30, 1994 Direct . . . . . . . . . . . . . . . . $307,913 $309,379 $199,854 Assumed. . . . . . . . . . . . . . . . 20 16 (1,356) Ceded. . . . . . . . . . . . . . . . . (32,122) (35,448) (27,016) -------- -------- -------- Net. . . . . . . . . . . . . . . . . . $275,811 $273,947 $171,482 -------- -------- -------- -------- -------- -------- Year ended June 30, 1995 Direct . . . . . . . . . . . . . . . . $370,408 $373,954 $215,674 Assumed. . . . . . . . . . . . . . . . 4,423 4,393 973 Ceded. . . . . . . . . . . . . . . . . (19,396) (20,296) 8,382 -------- -------- -------- Net. . . . . . . . . . . . . . . . . . $355,435 $358,051 $225,029 -------- -------- -------- -------- -------- -------- Year ended June 30, 1996 Direct . . . . . . . . . . . . . . . . $506,696 $503,408 316,585 Assumed. . . . . . . . . . . . . . . . 16,354 16,354 5,708 Ceded. . . . . . . . . . . . . . . . . (33,383) (35,316) (11,451) -------- -------- -------- Net. . . . . . . . . . . . . . . . . . $489,667 $484,446 $310,842 -------- -------- -------- -------- -------- -------- At June 30, 1995 and 1996, the Company has an aggregate recoverable for workers' compensation losses, paid and unpaid, including incurred but not reported, allocated loss adjustment expenses, and unearned premiums with a carrying value of $86,272,000, and $64,293,000 respectively, with a single reinsurer. The Company's HMO subsidiaries purchase individual excess liability insurance for hospital costs in excess of deductible amounts. Premiums for this insurance are included in commercial health care services expense. Amounts recoverable under such contracts are included as reductions of commercial health care services expense. NOTE 6 - PROPERTY AND EQUIPMENT Property and equipment comprised the following (in thousands): JUNE 30, ------------------------------ 1995 1996 ---- ---- Land $ 29,840 $ 27,354 Construction in progress 22,362 11,370 Buildings and improvements 106,450 132,600 Furniture and equipment 168,075 238,499 ------- ------- 326,727 409,823 Less - accumulated depreciation (96,449) (132,617) ------- ------- $ 230,278 $ 277,206 ------- ------- ------- ------- Depreciation expense on property and equipment was $20,450,000, $25,190,000 and $36,400,000 for the years ended June 30, 1994, 1995 and 1996. 49 NOTE 7 - NOTES PAYABLE, CAPITAL LEASES AND OTHER FINANCING ARRANGEMENTS Notes payable, capital leases and other financing arrangements comprised the following (in thousands):
JUNE 30, ------------------------------- 1995 1996 ---- ---- 7.75% Senior Notes due June 1, 2003 $ 124,596 $ 124,647 Capital lease obligations 6,854 2,078 Unsecured notes payable pursuant to business acquisition, bearing interest at 4.167% due November 15, 1995 (Note 1) 7,909 - Unsecured revolving line of credit bearing interest at 6.313% and 5.788% at June 30, 1995 and 1996 20,000 165,000 Other 5,167 8,548 ------- ------- 164,526 300,273 Deferred compensation (Note 10) 15,528 18,395 ------- ------- $ 180,054 $ 318,668 ------- ------- ------- -------
In June 1993, the Company issued $125,000,000 of senior notes due June 1, 2003 ("Senior Notes"). The Senior Notes bear interest at 7.75% which is due semi-annually on December 1 and June 1. The Notes are general unsecured obligations of the Company, will rank PARI PASSU with all future unsecured and unsubordinated indebtedness of the Company and are effectively subordinated to creditors of the Company's subsidiaries. The indenture contains certain covenants that, among other things, (i) restrict the ability of the Company and its Restricted Subsidiaries (as defined) to (a) pay dividends and make other distributions and certain investments, (b) grant liens on their assets, (c) enter into or permit certain sale and lease-back transactions or (d) engage in certain mergers, consolidations and sales of assets, and (ii) restrict the ability of the Company's Restricted Subsidiaries to incur additional indebtedness or issue shares of preferred stock. The Company has a $300 million unsecured revolving credit agreement with Citicorp USA, Inc., as Administrative Agent for the lenders thereto (the "Credit Agreement") which expires December 5, 1999. Principal amounts outstanding under the Credit Agreement bear interest, at the Company's option, at either Citibank's base rate or the Eurodollar rate plus a margin depending upon the Company's public debt rating or level of total debt to total capitalization. Any interest payments are due quarterly and principal is due at maturity. The agreement contains customary terms, events of default and covenants (including financial covenants related to net worth, fixed charge coverage and total debt to total capitalization) which, among other things, limit the incurring of additional debt. The Credit Agreement also limits the ability of the Company to make cash dividends and stock repurchases if the aggregate amount of such dividends and repurchases exceeds 50% of the cumulative consolidated net income of the Company beginning with the fiscal year ended June 30, 1994, plus the after tax effect of up to $125 million of restructuring charges, to the extent deducted from earnings, plus $25 million after June 30, 1995. As of June 30, 1996, the amount available for cash dividends and stock repurchases under the Credit Agreement was approximately $241,740,000. Subsequent to June 30, 1996, the Company drew an additional $65 million under the Credit Agreement. The Company leases some of its data processing and telecommunications equipment under capital leases that provide for minimum annual rentals and purchase options. Equipment under capital leases was $23,995,000 and $16,010,000 at June 30, 1995 and 1996 and the related accumulated depreciation was $13,475,000 and $11,730,000 at June 30, 1995 and 1996. 50 Future minimum payments under notes payable, capital leases and other financing arrangements are as follows (in thousands): YEAR ENDING JUNE 30, - -------------------- 1997 $ 24,044 1998 21,791 1999 15,623 2000 175,536 2001 10,379 Thereafter 155,133 ------- 402,506 Less - Amount representing interest (102,233) ------- $ 300,273 ------- ------- NOTE 8 - INCOME TAXES The provision for income taxes comprised the following (in thousands): YEAR ENDED JUNE 30, ------------------- 1994 1995 1996 ---- ---- ---- Current: Federal $ 55,352 $ 40,469 $ 44,569 State 9,586 7,491 6,439 ------- ------ ------ Total current 64,938 47,960 51,008 ------ ------ ------ Deferred: Federal (336) (13,464) 19,573 State 232 (7,675) 3,574 ------ ------ ------ Total deferred (104) (21,139) 23,147 ------ ------ ------ Total provision for income taxes $ 64,834 $ 26,821 $ 74,155 ------ ------ ------ ------ ------ ------ A reconciliation of the statutory federal income tax rate and the effective tax rate as a percentage of pretax income is as follows: YEAR ENDED JUNE 30, ------------------ 1994 1995 1996 ---- ---- ---- Statutory rate 35% 35% 35% State income and franchise taxes, net of federal tax benefit 4 3 Amortization of goodwill 1 5 1 Nondeductible acquisition costs - 4 - Tax exempt interest income (4) (9) (3) Recognition of net operating loss carryforwards - - (3) Taxes on undistributed income from subsidiaries 3 - Other - (1) (2) ---- ---- ---- Effective tax rate 39% 34% 31% ---- ---- ---- ---- ---- ---- 51 The tax effects of the significant temporary differences which comprise the net deferred tax asset at June 30, 1995 and 1996 were as follows (in thousands): JUNE 30, ------------------------ 1995 1996 ---- ---- Deferred state income taxes $ 1,771 $ 1,433 Accrued vacation 3,628 4,245 Deferred compensation 5,973 7,331 Accrued expenses 9,092 4,598 Insurance loss reserves 23,838 22,178 Policyholder dividends 5,536 3,327 Restructuring costs 32,755 - Investment in subsidiary - 10,156 Net operating losses - 12,104 Policy acquisition costs (6,186) (7,732) Depreciation and amortization (6,709) (12,784) Bond premium/discount (1,759) (754) Valuation allowance - (1,654) Other (2,266) 78 ------- ------- Net deferred tax asset $ 65,673 $ 42,526 ------- ------- ------- ------- NOTE 9 -CAPITAL STOCK PREFERRED STOCK The Company is authorized to issue 1,000,000 shares of $1 par value preferred stock. No preferred stock was outstanding as of June 30, 1995 or 1996. STOCKHOLDER RIGHTS PLAN The Company's Stockholder Rights Plan provides for distribution of Rights (as defined in the Stockholder Rights Plan) to holders of outstanding shares of common stock. Except as set forth below, each Right, when exercisable, entitles the stockholder to purchase from the Company one one-thousandth share of a new series of the Company's preferred stock at a price of $105 per share, subject to adjustment. The Rights are not currently exercisable, but would become exercisable if certain events occurred related to a person or group ("Acquiring Person") acquiring or attempting to acquire 15% or more of the outstanding shares of common stock. In the event that the Rights become exercisable, each Right (except for Rights beneficially owned by the Acquiring Person, which become null and void) would entitle the holder to purchase, for the exercise price then in effect, shares of the Company's common stock having a value of twice the exercise price. The Rights may be redeemed by the Board of Directors in whole, but not in part, at a price of $.01 per Right. The Rights have no voting or dividend privileges and are attached to, and do not trade separately from, the common stock. A total of 80,000 shares of preferred stock are reserved for future issuance under this Rights Agreement, which expire on October 10, 2001. STOCK REPURCHASE PROGRAM In April 1993, the Board of Directors of the Company approved the establishment of a stock repurchase program which, as amended, authorizes acquisition from time to time, of up to 5.7 million shares of its outstanding common stock in the open market. As of June 30, 1994, 1995, and 1996 the repurchase of 1,445,500 and 1,545,500 and 1,795,500 shares had been completed pursuant to this program. 52 DIVIDENDS PAID During the year ended June 30, 1994, CareFlorida paid cash dividends of $2 million on its common stock. As discussed in Note 1, the Company's consolidated financial statements have been restated to reflect the results of CareFlorida in accordance with the pooling of interest method of accounting. Other than the CareFlorida dividend described above, the Company has never paid cash dividends on its common stock. The Company presently intends to retain its earnings for the development of its business and does not anticipate paying cash dividends on its common stock in the foreseeable future. In December 1994, the Company established a $300 million unsecured revolving Credit Agreement with Citicorp USA, Inc. as Administrative Agent (the "Credit Agreement") for the lenders parties thereto. Among other restrictive covenants in the Credit Agreement, the Company's ability to pay cash dividends is restricted. See Note 7 for a more detailed description of the Credit Agreement. STOCK OPTIONS Under the Company's Restated and Amended 1990 Stock Option Plan (the "1990 Plan"), options may be either incentive stock options or nonqualified stock options which expire no later than 10 years from the date of grant. Under the 1990 Plan, the Company has reserved 5,525,000 shares of common stock for the granting of options. During the years ended June 30, 1994, 1995, and 1996, the Company granted nonqualified options to purchase 1,083,750, 786,750 and 598,750 shares of the Company's common stock at exercise prices ranging from as 85 to 100% of the fair market value of the stock at the date of grant. Currently, options are granted at prices determined by the Compensation and Organizational Committee of the Board of Directors of the Company (the "Compensation Committee") but may not be less than 100% of the fair market value of the stock on the date of grant. As of June 30, 1995 and 1996, the total number of options outstanding under the 1990 Plan were 3,154,939 and 3,041,023. The Company has reserved 238,000 shares of the Company's common stock from the granting of options under the 1992 Nonstatutory Stock Option Plan (the "1992 Plan") established in connection with a business acquisition in May 1992. Under the 1992 Plan, options are granted to employees of the Company or its subsidiaries at the discretion of a committee of the subsidiary's Board of Directors. Options are granted at an exercise price equal to the fair market value of the stock at the date of grant, subject to a vesting schedule of up to three years, and expire no later than 10 years from the date of grant. Under the 1992 Plan, nonqualified options to purchase 49,300 shares were granted during the year ended June 30, 1993. As of June 30, 1995 and 1996, the number of options outstanding under the 1992 Plan were 38,036 and 20,001. The Company has reserved 1,600,000 shares of the Company's common stock under the 1993 Nonstatutory Stock Option Plan (the "1993 Plan") established in October 1993 (as amended in fiscal year 1996). Under the 1993 Plan, options are granted at the discretion of the Company's Board of Directors to physician employees of affiliated professional corporations. Options are granted at an exercise price equal to the fair market value of the stock at the date of grant. Under the 1993 Plan, nonqualified options to purchase 381,399 and 384,075 shares were granted during the years ended June 30, 1995 and 1996. As of June 30, 1995 and 1996, the number of options outstanding under the 1993 Plan were 499,874 and 755,790. During the year ended June 30, 1992, the Company granted nonqualified stock options to purchase 172,500 shares of the Company's common stock at exercise prices determined as 85% of the fair market value of the stock at the date of grant pursuant to employment agreements entered into in connection with a business acquisition. Options vested 10% per year beginning July 1, 1992, with provisions for accelerated vesting in the event certain profitability targets of the acquired company were exceeded. During the year ended June 30, 1994, the employment agreements were terminated and all unvested options were canceled. 53 A summary of the Company's nonqualified and incentive stock options outstanding is as follows:
SHARES WEIGHTED AVERAGE ------ EXERCISE PRICE -------------- Outstanding at June 30, 1993 . . . . . . . . . . . . . . . 2,297,579 22.19 Options exchanged pursuant to acquisition (Note 1) . . . . 29,475 9.41 Granted. . . . . . . . . . . . . . . . . . . . . . . . . . 1,229,250 38.17 Exercised. . . . . . . . . . . . . . . . . . . . . . . . . (572,347) 14.66 Canceled . . . . . . . . . . . . . . . . . . . . . . . . . (202,482) 24.10 --------- Outstanding at June 30, 1994 . . . . . . . . . . . . . . . 2,781,475 30.52 Options exchanged pursuant to acquisition (Note 1) . . . . 500,290 18.09 Granted. . . . . . . . . . . . . . . . . . . . . . . . . . 1,168,149 31.60 Exercised. . . . . . . . . . . . . . . . . . . . . . . . . (330,796) 18.05 Canceled . . . . . . . . . . . . . . . . . . . . . . . . . (229,021) 31.98 --------- Outstanding at June 30, 1995 . . . . . . . . . . . . . . . 3,890,097 30.22 Options exchanged pursuant to MHN acquisition (Note 1) . . 88,962 12.78 Granted. . . . . . . . . . . . . . . . . . . . . . . . . . 982,825 39.16 Exercised. . . . . . . . . . . . . . . . . . . . . . . . . (807,987) 21.04 Canceled . . . . . . . . . . . . . . . . . . . . . . . . . (267,470) 31.48 --------- Outstanding at June 30, 1996 . . . . . . . . . . . . . . . 3,886,427 33.94 --------- ---------
A summary of options exercisable and shares available for future grant under all option arrangements is as follows: JUNE 30, ------- 1995 1996 ---- ---- Options exercisable. . . . . . . . . . . . . 1,609,941 1,756,794 Shares available for grant . . . . . . . . . 1,665,609 1,931,173 The Company receives a tax deduction for the excess of the market value of the Company's common stock over the exercise price of the option at the date nonqualified options are exercised by employees of the Company. The related tax benefit is credited to common stock. The Company makes no charges against capital with respect to options granted. NOTE 10 - EMPLOYEE BENEFIT PLANS EMPLOYEE STOCK PURCHASE PLAN The Company has reserved 750,000 shares of common stock under an employee stock purchase plan which became effective October 1, 1990. Full-time employees of the Company and substantially all of its subsidiaries are eligible to participate in this Plan if they have been continuously employed by the Company for not less than six months. Employees electing to participate authorize payroll deductions of up to 10% of their base compensation to purchase shares of common stock at 85% of the then fair market value of the stock on the date of purchase. During the years ended June 30, 1994, 1995 and 1996, 30,413, 39,389 and 37,536 shares of common stock were purchased under this plan. 54 DEFINED CONTRIBUTION PLANS The Company sponsors several defined contribution retirement plans intended to be qualified under Sections 401(a) and 401(k) of the Internal Revenue Code. Participation in the plans is available to substantially all employees. Generally, employees may contribute up to 10% of their annual compensation to the plans on a pre-tax basis and up to 10% on an after-tax basis. Under the plans, the Company makes matching contributions of up to 6% of each participating employee's base salary. The Company's contributions to the plans totaled $5,961,000, $4,173,000 and $3,847,000 for the years ended June 30, 1994, 1995, and 1996. DEFERRED COMPENSATION PLAN Under the Company's deferred compensation plan certain members of management, highly compensated employees and non-employee Board members may defer payment of up to 90% of their compensation. The Company makes matching contributions subject to a vesting schedule, of up to 10% of an employee participant's compensation if the participant's base salary is at least $120,000. The deferred compensation, together with Company matching amounts and accumulated interest which is accrued but unfunded, is distributable in cash by lump sum or in monthly, quarterly or annual installments (not exceeding 20 years) upon the earlier of the date of distribution elected by the participant termination of employment. At June 30, 1995 and 1996, the liability under this deferred compensation plan amounted to $9,139,000 and $12,692,000. The Company's expense under the plan totaled $1,664,000, $1,955,000 and $3,089,000 for the years ended June 30, 1994, 1995 and 1996. During the year ended June 30, 1995, the Company amended the plan by increasing the interest rate paid to participants to 140% of Moody's corporate bond rate and by allowing participants to receive 90% of vested funds before scheduled distributions by irrevocably forfeiting the remaining 10%. During 1993, TDMC established a deferred compensation plan which called for payment of deferred compensation to TDMC physicians with five years of service at termination of employment (the "TDMC Plan"); as part of the merger of TDMC with the Company the TDMC Plan was frozen in November 1994 and the present value of each participant's benefits was established. Under the terms of the TDMC Plan, interest accrues at the Citibank base rate plus 1/4%. The deferred compensation is distributable in annual installments (not to exceed 10) upon termination of employment. At June 30, 1995 and 1996, the liability under this deferred compensation plan amounted to $6,389,000 and $5,703,000. The Company's expense under the plan totaled $2,885,000, $765,000 and $910,000 for the years ended June 30, 1994, 1995 and 1996. DEFINED BENEFIT RETIREMENT PLANS One of the Company's subsidiaries offers a non-contributory defined benefit retirement plan ("Retirement Plan") covering substantially all of its employees. The Retirement Plan is designed to meet the provisions of the Employee Retirement Income Security Act of 1974. The benefits are primarily based upon years of service and compensation. The retirement plan was terminated effective December 31, 1995. During the fiscal year ended June 30, 1995, the Company adopted two unfunded non-qualified defined benefit pension plans, a Supplemental Executive Retirement Plan and a Directors' Retirement Plan (collectively, the "SERP"), which cover key executives, as selected by the Board of Directors, and nonemployee directors. Currently there are sixteen participants in the plans. Benefits are based on years of service and compensation in the last five years of employment (for key executives) or the highest three years within the last 10 years of service (for non-employee directors). 55 The discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations were 7.5% and 6%, respectively, in 1994 and 1995 for the Retirement Plan, and 8% and 4%, in 1995 and 1996 for the SERP. The funded status and amounts recognized in the Company's consolidated financial statements for the Retirement Plan is as follows (in thousands): RETIREMENT PLAN -------------------- YEAR ENDED JUNE 30, -------------------- 1994 1995 ---- ---- Actuarial present value of: Vested benefit obligation $ (540) $ (651) Nonvested benefit obligation (38) (46) -------- -------- Accumulated benefit obligation $ (578) $ (697) -------- -------- -------- -------- Projected benefit obligation $(1,184) $(1,447) Plan assets at fair value 783 1,380 -------- -------- Projected benefit obligation in excess of plan assets (401) (67) Deferred losses 212 153 Unrecognized net transition obligation 118 109 -------- -------- Pension asset (liability) $ (71) $ 195 -------- -------- -------- -------- Net pension expense was comprised of: Service cost $ 136 $ 157 Interest cost 83 99 Net amortization and deferral 18 20 Return on plan assets (57) (77) ----- ----- Net pension expense $ 180 $ 199 -------- -------- -------- -------- 56 The funded status and amortization recognized in the Company's consolidated financial statements for the SERP Plan is as follows (in thousands): SERP PLAN --------- YEAR ENDED JUNE 30, ------------------- 1995 1996 ---- ---- Actuarial present value of: Vested benefit obligation $ (470) $ (3,979) Nonvested benefit obligation (315) (1,685) ---------- ---------- Accumulated benefit obligation $ (785) $ (5,664) ---------- ---------- ---------- ---------- Projected benefit obligation $ (1,130) $ (9,898) Plan assets at fair value - - ---------- ---------- Projected benefit obligation in excess of plan assets (1,130) (9,898) Deferred benefit obligation - 2,717 Unrecognized net transition obligation 296 3,646 Additional liability - (2,129) ---------- ---------- SERP liability $ (834) $ (5,664) ---------- ---------- ---------- ---------- Net SERP expense was comprised of: Service cost $ 788 $ 1,578 Interest cost 25 617 Net amortization and deferral 21 506 ---------- ---------- Net SERP expense $ 834 $ 2,701 --------- --------- --------- --------- During the year ended June 30, 1995, the Company adopted an unfunded Executive Retiree Medical Plan, which covers key executives, as selected by the Board of Directors, and their spouses and dependents. The plan provides medical, dental, and vision benefits during retirement. At June 30, 1995 and 1996, the projected benefit obligation was $343,000 and $459,000, the unrecognized net transition obligation was $194,000 and $172,000, the unrecognized net loss was $63,000 and $59,000, and the pension liability was $86,000 and $228,000. The components of post-retirement benefit expense for the years ended June 30, 1995 and 1996 included service cost of $45,000 and $93,000, interest cost of $19,000 and $26,000, and net amortization and deferral of $22,000 and $ 23,000, for total benefit expense of $86,000 and $ 142,000. The medical cost trend rate assumed was 14%, trending down to 6.5% over a ten year period. The weighted average discount rate used in determining the accumulated postretirement benefit obligation at June 30, 1995 and 1996 was 7.5%. The impact of increasing the assumed health care cost trend rates by 1 percentage point in each year would not have a significant effect on the accumulated postretirement benefit obligation or the aggregate of the service and interest cost componenets of net periodic postretirement benefit cost for the year ended June 30, 1996. The Company purchases company-owned life insurance policies to cover the cost of benefits under the Supplemental Executive Retirement Plan, the Directors' Retirement Plan, the Executive Retiree Medical Plan, and the deferred compensation plan. The cash surrender value of these policies at June 30, 1995 and 1996, included in other assets, was $13,090,000 and $33,707,000. NOTE 11 - RELATED PARTY TRANSACTIONS In December 1992, April 1993 and August 1994, as part of the consolidation of health care delivery systems resulting from the acquisition of CMC, a senior officer of the Company acquired two independent practice associations ("IPAs") in California which contract with physicians to provide medical services to the Company's enrollees. During fiscal year 1995, an additional IPA was formed in Arizona by a senior officer of the Company. During the years ended June 30, 1994, 1995 and 1996, charges for medical services provided by these IPAs to the Company's enrollees totaled approximately 57 $20,562,000, $40,070,000 and $22,224,000. In April 1993, the Company entered into a revolving credit agreement with one of the IPAs, the terms of which restrict the ability of the IPA and its sole shareholder to pay dividends, to incur additional indebtedness, to transfer shares, or to otherwise merge, sell or dispose of assets. The credit agreement bears interest at the rate of prime plus 2% which is payable quarterly. Principal is due on demand, or if no demand, no later than April 30, 1997. At June 30, 1994 and 1995, $3,900,000 and $5,300,000 was outstanding under the credit agreement. During fiscal year 1996, the Company sold its affiliated California and Arizona IPAs to FPA. See Note 1 to the Consolidated Financial Statements. During 1994, the Company contracted to provide health care services to the Company's enrollees at Company-managed health care centers. During the years ended June 30, 1994, 1995 and 1996, charges for medical services provided by the affiliated Medical Groups to the Company's enrollees totaled approximately $1,700,000, $85,000,000 and $123,189,000. The Company provides facilities and support functions to the health care centers and is reimbursed in the form of a management fee by the affiliated Medical Groups. The management fee totaled $4,307,000, $55,271,000 and $104,324,000 for the years ended June 30, 1994, 1995 and 1996. The Company has revolving credit agreements with the affiliated Medical Groups the terms of which restrict the ability of the affiliated Medical Groups to pay dividends and bonuses, acquire assets, enter into liens, incur additional indebtedness or to otherwise merge, sell or dispose of assets. The credit agreements bear interest at 7.75% and prime plus 1%, respectively. Principal and interest is due January 22, 1997 subject to automatic one year extensions of the maturity date unless the Company provides written notice of intent to terminate the agreements. At June 30, 1995 and 1996, $35,425,000 and $59,870,000 was outstanding under these agreements. On June 28, 1996, the Company entered into the stock and note purchase agreement regarding the sale of the Foundation Health Medical Services and the affiliated Medical Groups in California and Arizona to FPA. See Note 1 to the Consolidated Financial Statements. Management evaluates the collectibility of these loans and, if necessary, reserves are recorded to reduce carrying amounts to amounts deemed to be recoverable. No reserves have been deemed necessary as of the dates of these financial statements. NOTE 12 - REGULATORY AND CONTRACTUAL CAPITAL REQUIREMENTS The Company's HMO subsidiaries are required to maintain a minimum level of tangible net equity or minimum capital and surplus. The required total tangible net equity and minimum capital and surplus for all HMOs is approximately $31,594,000 at June 30, 1996. Under certain government contracts, Federal Services is required to maintain a current ratio of 1:1 and certain HMO subsidiaries are required to maintain a current ratio of 1:1 under Medicaid contracts. The Company's life, accident and health insurance subsidiaries are required by the Departments of Insurance in the states in which they are licensed to maintain minimum capital and surplus aggregating $34,861,000. The Company's workers' compensation insurance subsidiaries are required by the Departments of Insurance in the states in which they are licensed to maintain minimum capital and surplus of $5,000,000. In certain of the states in which the workers' compensation subsidiaries are licensed to operate, regulations allow the Insurance Commissioner, at their discretion, to require additional surplus amounts based on types of insurance written and amount of premiums inforce. As a result, actual capital and surplus requirements are significantly above the minimum requirement as previously stated. The Company and its subsidiaries are in compliance with the applicable minimum regulatory and capital requirements described above. As a result of the above requirements and certain other regulatory requirements, certain subsidiaries are subject to restrictions on their ability to make dividend payments, loans or other transfers of cash to the Company. Such restrictions, unless amended or waived, limit the use of any cash generated by these subsidiaries to pay obligations of the Company. As of June 30, 1996, restricted net assets of these subsidiaries totaled approximately $71,455,000. 58 NOTE 13 - COMMITMENTS AND CONTINGENCIES During the year ended June 30, 1995, the Company entered into a $60 million tax retention operating lease with NationsBank of Texas, N.A., as Administrative Agent for the Lenders who are parties thereto and First Security Bank of Utah, N.A., as Owner Trustee (the "TROL" agreement) for the construction of health care centers and corporate facilities. Under the TROL agreement, rental payments commence upon completion of construction, with a guarantee of 87% to the lessor of the residual value of properties leased at the end of the lease term. After the initial five year noncancelable lease term, the lease may be extended by agreement of the parties or the Company must purchase or arrange for sale of the leased properties. The Company has committed to a guaranteed residual value of $22.5 million at June 30, 1996 under this agreement. The future minimum rental payments required under operating leases for all of the Company's office space and equipment and for properties under construction that have initial or remaining noncancelable lease terms in excess of one year are as follows (in thousands): YEAR ENDING JUNE 30, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . $ 31,246 1998 . . . . . . . . . . . . . . . . . . . . . . . . . 24,433 1999 . . . . . . . . . . . . . . . . . . . . . . . . . 18,271 2000 . . . . . . . . . . . . . . . . . . . . . . . . . 12,116 2001 . . . . . . . . . . . . . . . . . . . . . . . . . 5,590 Thereafter . . . . . . . . . . . . . . . . . . . . . . 1,340 --------- $ 92,996 --------- --------- Lease expense for office space and equipment was $21,429,000 $25,425,000 and $35,787,000 for the years ended June 30, 1994, 1995 and 1996. The Company maintains general liability and managed care professional liability and directors and officers insurance and other insurance coverage in amounts the Company believes to be adequate. The Company requires contracting health care providers to maintain malpractice insurance coverage in amounts customary in the industry. In the ordinary course of its business the Company is a party to claims and legal actions by enrollees, providers and others. The Company also undergoes governmental audits and investigations with regard to its government contracts and with respect to operations of its HMO, insurance, and third party administrator subsidiaries. After consulting with legal counsel, the Company is of the opinion that any liability that may ultimately be incurred as a result of these claims, legal actions, audits or investigations will not have a material adverse effect on the consolidated financial position or results of operations of the Company. 59 FOUNDATION HEALTH CORPORATION SUPPLEMENTAL SCHEDULE CONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS) ASSETS JUNE 30, ------------------------------ 1995 1996 -------------- -------------- Cash and cash equivalents $ 1,954 $ 5,210 Advances to subsidiaries 10,336 20,009 Property and equipment, net 8,510 11,600 Investments in subsidiaries 822,142 965,433 Organization and debt issuance costs, net 14,047 4,470 Other assets 167,311 302,954 -------------- -------------- $ 1,024,300 $ 1,309,676 -------------- -------------- -------------- -------------- LIABILITIES AND STOCKHOLDERS' EQUITY Notes payable and capital leases $ 177,674 $ 353,160 Accounts payable and other liabilities 89,727 21,927 -------------- -------------- 267,401 375,087 Stockholders' equity Common stock 518,671 533,855 Retained Earnings 244,249 410,689 Unrealized holding losses (2,974) (6,908) Common stock held in treasury, at cost (3,047) (3,047) -------------- -------------- 756,899 934,589 -------------- -------------- $ 1,024,300 $ 1,309,676 -------------- -------------- -------------- -------------- S-1 FOUNDATION HEALTH CORPORATION SUPPLEMENTAL SCHEDULE CONDENSED STATEMENT OF OPERATIONS (DOLLARS IN THOUSANDS) YEAR ENDED JUNE 30, ----------------------------------- 1994 1995 1996 ----------- ----------- ----------- REVENUES : Government contracts $ 978 $ 1,432 $ 1,554 Interest and other income 7,095 8,124 13,432 Administrative revenue 82,516 31,906 36,930 Equity in subsidiary income 64,872 88,552 143,750 ----------- ----------- ----------- 155,461 130,014 195,666 ----------- ----------- ----------- EXPENSES : Selling, general and administrative 31,852 19,438 21,969 Amortization and depreciation 303 754 1,235 Interest expense 10,265 11,795 16,998 Acquisition and restructuring costs - 84,436 - ----------- ----------- ----------- 42,420 116,423 40,202 ----------- ----------- ----------- Income before income taxes 113,041 13,591 155,464 Provision for income taxes 19,400 (35,858) (10,976) ----------- ----------- ----------- Net income $ 93,641 $ 49,449 $ 166,440 ----------- ----------- ----------- ----------- ----------- ----------- S-2 FOUNDATION HEALTH CORPORATION SUPPLEMENTAL SCHEDULE CONDENSED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED JUNE 30, ---------------------------------------- 1994 1995 1996 ---------- ---------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES : Net income $ 93,641 $ 49,449 $ 166,440 Adjustments to reconcile net income to cash used for operating activities: Amortization and depreciation 305 830 1,235 Equity in subsidiary income (64,986) (88,552) (143,750) Change in assets and liabilities, net of effects from acquisition of businesses: Other assets (3,560) (44,736) (13,712) Other liabilitie 6,466 49,604 (55,985) Deferred income taxes, net (2,457) (11,163) 24,812 Investment in and advances to subsidiaries (50,301) 36,672 (9,673) ---------- ---------- ----------- Net cash used for operating activities (20,892) (7,896) (30,633) ---------- ---------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES : Acquisition of property and equipment (673) (6,399) (3,679) Decrease in short-term investments 112,966 - - Purchase of available for sale investments - (256,450) - Sales and maturities of available for sale investments - 292,344 - Purchases of held to maturity investments - (12,949) - Maturities of held to maturity investments - 10,967 - Notes receivable - - (15,019) Notes receivable from affiliates (35,708) (43,352) (114,365) Acquisition of businesses (73,242) (15,727) (1,813) ---------- ---------- ----------- Net cash from (used for) investing activities 3,343 (31,566) (134,876) ---------- ---------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES : Principal payments on notes payable and capital leases (282) (382) (9,057) Proceeds from issuance of notes payable and capital leases - 30,542 188,351 Proceeds from issuance of common stock - net 812 6,448 1,254 Proceeds from exercise of stock options 8,403 5,920 16,932 Tax benefits related to stock options 5,410 4,645 6,721 Cash dividends received 27,400 54,997 28,050 Stock repurchase and other adjustments related to mergers (27,363) (3,047) (17,557) Investment in subsidiaries (52,751) (89,564) (45,929) ---------- ---------- ----------- Net cash from (used for) financing activities (38,371) 9,559 168,765 ---------- ---------- ----------- Net increase (decrease) in cash and cash equivalents (55,920) (29,903) 3,256 Cash and cash equivalents, beginning of year 87,777 31,857 1,954 ---------- ---------- ----------- Cash and cash equivalents, end of year $ 31,857 $ 1,954 $ 5,210 ---------- ---------- ----------- ---------- ---------- -----------
S-3 FOUNDATION HEALTH CORPORATION SECTION 403.04B RECONCILIATION OF BEGINNING AND ENDING LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES AND EXHIBIT OF REDUNDANCIES (DEFICIENCIES) - UNAUDITED (DOLLARS IN THOUSANDS)
----------------------------------------------------------------------------------- 1986 1987 1988 1989 1990 1991 -------- -------- -------- -------- ---------- --------- Liability for unpaid losses and loss adjustment expenses $ 43,944 $ 53,170 $ 55,089 $ 76,296 $ 158,268 $ 206,993 Paid (cumulative) as of: One year later 13,607 14,186 11,649 20,541 59,110 103,361 Two years later 23,110 21,998 20,780 36,151 106,334 167,932 Three years later 28,268 27,849 28,389 44,665 130,826 221,087 Four years later 32,229 33,527 31,492 50,240 146,186 233,168 Five years later 37,007 35,630 34,015 53,896 154,514 236,652 Six years later 38,526 37,448 35,975 56,301 157,082 Seven years later 40,088 39,121 37,374 57,264 Eight years later 41,441 40,346 37,966 Nine years later 42,559 40,892 Ten years later 43,080 Liability re-estimated as of: One year later 51,633 53,321 51,147 75,988 160,141 218,747 Two years later 50,702 52,382 51,991 65,376 162,040 242,231 Three years later 50,506 54,349 43,651 61,098 172,981 242,533 Four years later 55,059 47,241 41,513 66,135 172,269 245,877 Five years later 48,512 46,116 44,701 66,174 173,581 243,623 Six years later 47,898 47,011 45,364 66,569 172,014 Seven years later 48,650 47,928 45,452 65,369 Eight years later 49,625 47,883 44,523 Nine years later 49,733 47,001 Ten years later 48,817 Redundancy (deficiency) $ (4,873) $ 6,169 $ 10,566 $ 10,927 $ (13,746) $ (36,630) Net reserve - end of period Reinsurance recoverable on unpaid losses and loss adjustment expenses Gross reserve - end of period Net re-estimated reserve - end of period Re-estimated reinsurance recoverable Gross re-estimated reserve - end of period Gross cumulative redundancy SIX MONTHS ENDED ----------------------------------------------------- JUNE 30, 1992 1993 1994 1995 1996 -------- --------- --------- --------- ---------- Liability for unpaid losses and loss adjustment expenses $219,464 $ 268,191 $ 322,394 $ 367,061 $ 404,370 Paid (cumulative) as of: One year later 106,693 115,189 129,284 100,846 Two years later 191,397 184,304 159,408 Three years later 233,537 192,725 Four years later 231,822 Five years later Six years later Seven years later Eight years later Nine years later Ten years later Liability re-estimated as of: One year later 251,012 262,032 295,856 350,545 Two years later 257,134 256,135 282,306 Three years later 262,582 246,970 Four years later 260,020 Five years later Six years later Seven years later Eight years later Nine years later Ten years later Redundancy (deficiency) $ (40,556) $ 21,221 $ 40,088 $ 16,516 Net reserve - end of period $ 322,394 $ 367,061 $ 404,370 Reinsurance recoverable on unpaid losses and loss adjustment expenses 90,366 76,309 72,620 ---------- --------- ---------- Gross reserve - end of period 412,760 443,370 476,990 Net re-estimated reserve - end of period 282,306 350,545 Re-estimated reinsurance recoverable 85,120 69,147 ---------- ---------- Gross re-estimated reserve - end of period 367,426 419,692 ---------- ---------- Gross cumulative redundancy $ 45,334 $ 23,678 ---------- ---------- ---------- ----------
Note: The last period for each of the calendar years in the above table reflect changes in the six-month period January 1, 1996 to June 30, 1996. S-4 FOUNDATION HEALTH CORPORATION ANNUAL REPORT ON FORM 10-K YEAR ENDED JUNE 30, 1996 EXHIBIT - ------- NUMBER DESCRIPTION - ------ ----------- 3.1(1) Restated Certificate of Incorporation of Foundation Health Corporation. 3.2(3) Amended and Restated Bylaws of Foundation Health Corporation. 4.1(6) Specimen of Foundation Health Corporation Common Stock certificate with Rights Legend. 4.2(6) Form of Rights Certificate (incorporated by reference to Foundation Health Corporation's Form 8-A dated September 27, 1991). 4.3(9) Form of Indenture. 4.4(9) Form of Senior Notes. 4.5(18) 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation, as amended. 10.3(16) Executive Incentive Plan of Foundation Health Corporation. 10.20(2) Lease Agreement between HAS-First Associates and Foundation Health Corporation dated August 1, 1988 and form of amendment thereto. 10.38(2) Stock Purchase and Asset Sale Agreement dated November 1, 1989 between Foundation Health Corporation and Foundation Health Federal Services, Inc. and amendment thereto. 10.39(2) Form of Indemnification Agreement. 10.53(1) Employee Stock Purchase Plan. 10.61(3) United States Government DoD Contract No. MDA 903 (91-C-0155 between DoD and Foundation Health Federal Services, Inc. dated June 7, 1991.) 10.62(4) Asset Purchase Agreement dated July 3, 1991 between Foundation Health Preferred Administrators and Preferred Administrators, Inc. 10.63(4) Asset Purchase Agreement dated December 1, 1991 among Foundation Health Pharmaceutical Services, Inc., Apollo Billing Service, and as to certain parts thereof, Anthony Ponzo, Patricia Ponzo and Robert Rhoads. 10.64(3) Agreement and Plan of Reorganization among Foundation Health Corporation, FH Acquisition Corporation and National Health Care Systems, Inc. 10.65(4) Stock Purchase Agreement dated February 14, 1991 between the Company and Western Universal Corporation. 10.67(5) Stock Purchase Agreement between Foundation Health Corporation, American Travelers Corporation and American Travelers Life Insurance Company dated March 31, 1992. 10.68(5) Stock and Asset Purchase Agreement among Foundation Health Corporation, Thomas R. and Linda S. Leonard and Bayport Leasing Company dated as of May 18, 1992. 10.69(5) Stock Purchase Agreement among Foundation Health Corporation, Deborah S. Greenfield and James Thompson dated as of May 15, 1992. 10.70(6) Stock Purchase Agreement among Foundation Health Corporation and the holders of common stock of Allstate Optical Services, Inc. dated as of June 8, 1992. 10.71(12) Agreement and Plan of Reorganization among Foundation Health Corporation, FHC Acquisition Corporation, Occupational Health Services, Inc. and the OHS shareholders dated July 31, 1992. 10.72(6) Agreement and Plan of Reorganization dated as of July 14, 1992, by and among Foundation Health Corporation, Century Medicorp, Inc. and FH Acquisition Corporation. 10.73(7) Century MediCorp, Inc. 1983 Incentive Stock Option Plan. 10.74(7) Century MediCorp, Inc. 1988 Nonstatutory Stock Option Plan. 64 10.75(7) Century MediCorp, Inc. 1989 Nonstatutory Stock Option Plan. 10.76(7) Century MediCorp, Inc. 1991 Nonstatutory Stock Option Plan. 10.79(9) Agreement and Plan of Reorganization among Foundation Health Corporation, FHC Acquisition Corporation and Business Insurance Corporation dated April 10, 1993. 10.80(10) 1989 Stock Plan of Business Insurance Corporation. 10.81(11) 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation. 10.82(13) MDA 903(91-C-0155 Modification for Implementation of BRAC expansion sites in Louisiana and Texas.) 10.83(14) Employment Agreement between Foundation Health Corporation and Daniel D. Crowley dated April 30, 1994. 10.85(14) Employment Agreement between Foundation Health Corporation and Jeffrey L. Elder dated April 22, 1994. 10.86(14) Employment Agreement between Foundation Health Corporation and Steven D. Tough dated April 22, 1994. 10.87(14) Employment Agreement between Foundation Health Corporation and Kirk A. Benson dated April 22, 1994. 10.88(14) Employment Agreement between Foundation Health Corporation and Allen J. Marabito dated April 22, 1994. 10.89(14) Agreement and Plan of Reorganization dated as of May 24, 1994 among Foundation Health Corporation, FHC Acquisition Subsidiary, Southern Colorado Health Plan, Inc., the stockholders of Southern Colorado Health Plan, Inc. and Southern Colorado Health Management, Inc. 10.90(14) Agreement and Plan of Reorganization dated as of May 2, 1994 among Foundation Health Corporation, The Noetics Group, Reviewco and the other parties signatory thereto. 10.91(15) Agreement and Plan of Reorganization dated as of June 27, 1994 by and among Foundation Health Corporation, CareFlorida Health Systems, Inc. and the other parties signatory thereto. 10.92(16) Agreement and Plan of Merger dated as of July 28, 1994 between Foundation Health Corporation and Intergroup Healthcare Corporation. 10.93(16) Agreement and Plan of Merger dated as of July 28, 1994 between Foundation Health Corporation and Thomas-Davis Medical Centers, P.C. 10.96(13) Foundation Health Corporation Directors' Retirement Plan. 10.97(17) $300 Million Revolving Credit Agreement dated as of December 5, 1994 among Foundation Health Corporation, as Borrower, Citicorp USA, Inc., as Administrative Agent, Wells Fargo Bank, N.A. and NationsBank of Texas, N.A., as Co-Agents and Citicorp Securities, Inc., as Arranger, and the Other Banks and Financial Institutions Party thereto. 10.98(18) Participation Agreement dated as of May 25, 1995 among Foundation Health Medical Services, as Construction Agent and Lessee, Foundation Health Corporation, 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 Foundation Health Corporation for the benefit of First Security Bank of Utah, N.A. 10.99(18) Foundation Health Corporation Deferred Compensation Plan, as amended and restated. 10.100(18) Foundation Health Corporation Supplemental Executive Retirement Plan, as amended and restated. 10.101(18) Foundation Health Corporation Executive Retiree Medical Plan, as amended and restated. 10.102 Foundation Health Corporation 1990 Stock Option Plan, as amended and restated effective August 15, 1996. 10.103(18) Foundation Health Corporation Profit Sharing and 401(k) Plan (as amended and restated effective January 1, 1994). 10.104(19) Agreement and Plan of Reorganization dated January 9, 1996 by and between the Registrant and Managed Health Network, Inc. 65 10.105 Amendment Number One to the Employment Agreement effective May 1, 1996 between the Registrant and Kirk A. Benson 10.106 Amendment Number One to the Employment Agreement effective May 1, 1996 between the Registrant and Jeffrey L. Elder 10.107 Amendment Number One to the Employment Agreement effective May 1, 1996 between the Registrant and Allen J. Marabito 10.108 Amendment Number One to the Employment Agreement effective May 1, 1996 between the Registrant and Steven D. Tough 10.109 Stock and Note Purchase Agreement by and between the Registrant, Jonathan H. Scheff, M.D., and FPA Medical Management, Inc. FPA Medical Management of California, Inc. and FPA Independent Practice Association dated as of June 28, 1996. 11.0 Computation of Earnings per Share. 12.0 Computation of Ratios. 13.1 Report of Ernst & Young LLP. 13.2 Report of Stevenson, Jones & Holmaas, P.C. 13.3 Report of Coopers & Lybrand LLP 21.0 Subsidiaries of Foundation Health Corporation. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Ernst & Young LLP. 23.3 Consent of Stevenson, Jones & Holmaas, P.C. 23.4 Consent of Coopers & Lybrand LLP 24.1 Power of Attorney (included on page i). - ------------------ (1) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-1 (File No. 33-38867). (2) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-1 (File No. 33-34963). (3) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-4 (File No. 33-42690). (4) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-1 (File No. 33-45513). (5) Incorporated by reference to the Exhibits to Registrant's Form 10-Q for the quarter ended March 31, 1992 filed with the Commission on May 14, 1992. (6) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-4 (File No. 33-51648). (7) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-8 (File No. 33-53468). (8) Incorporated by reference to the Exhibits to Registrant's Form 8-K filed on October 30, 1992. (9) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-3 (File No. 33-61684). (10) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-8 (File No. 33-67062). (11) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-8 (File No. 33-48561). (12) Incorporated by reference to the Exhibits to Registrant's Registration Statement on Form S-4 (File No. 33-51992). (13) Incorporated by reference to the Exhibits to Registrant's Form 10-K for the year ended June 30, 1994 filed with the Commission on September 24, 1994. (14) Incorporated by reference to the Exhibits to Registrant's Registration Statement on 66 Form S-4 (File No. 33-80432). (15) Incorporated by reference to the Exhibits to Registrant's current report on Form 8-K filed with the Commission on June 28, 1994. (16) Incorporated by reference to the Exhibits to Registrant's current report on Form 8-K filed with the Commission on August 9, 1994. (17) Incorporated by reference to the Exhibits to Registrant's quarterly report on Form 10-Q for the quarter ended December 31, 1994 filed with the Commission on February 14, 1995. (18) Incorporated by reference to the Exhibits to Registrants Form 10-K for the year ended June 30, 1995 filed with the Commission on September 27, 1995 (19) Incorporated by reference to Annex 1 of the Proxy Statement/Prospectus contained in Registrant's Registration Statement on Form S-4 (File No. 333-00517) 67 EX-10.102 2 EXHIBIT 10.102 EXHIBIT 10.102 1990 STOCK OPTION PLAN OF ------------------------- FOUNDATION HEALTH CORPORATION ----------------------------- (AS AMENDED AND RESTATED EFFECTIVE AUGUST 15, 1996) --------------------------------------------------- SECTION I. ESTABLISHMENT AND PURPOSE. The Plan was established in 1990, and it was most recently amended and restated effective August 15, 1996. The Plan offers selected employees, consultants and advisors and the non-employee directors of the Company an opportunity to acquire a proprietary interest in the success of the Company, or to increase such interest, by exercising Options to purchase Shares of the Company's Common Stock. Options granted under the Plan may include Nonstatutory Options as well as ISOs intended to qualify under section 422 of the Code. The Plan also offers the non-employee directors of the Company an opportunity to receive their directors' fees in the form of Shares of the Company's Common Stock. SECTION II. DEFINITIONS A. "BOARD OF DIRECTORS" shall mean the Board of Directors of the Company, as constituted from time to time. B. "CHANGE IN CONTROL" means the occurrence of either of the following events: 1. A change in the composition of the Board of Directors, as a result of which fewer than one half of the incumbent directors are directors who either: a. Had been directors of the Company 24 months prior to such change; or b. Were elected, or nominated for election, to the Board of Directors with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; or 2. Any "person" (as such term is used in sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) by the acquisition or aggregation of securities is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20% or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); except that any change in the relative beneficial ownership of the Company's securities by any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. For purposes of this Subsection (B)(2), the term "person" shall not include an employee benefit plan maintained by the Company. C. "CODE" shall mean the Internal Revenue Code of 1986, as amended. D. "COMMITTEE" shall be the committee of the Board of Directors of the Company, as described in Section III(A). E. "COMPANY" shall mean Foundation Health Corporation, a Delaware corporation. F. "DIRECTOR" shall mean any individual who is not a common-law employee of the Company or of a Subsidiary and who is duly elected and serving the Company as a member of the Board of Directors. 1 G. "EMPLOYEE" shall mean 1. An individual who is a common-law employee of the Company or of a Subsidiary; and 2. An independent contractor who performs services for the Company or a Subsidiary as an advisor or consultant and who is not a Director. Service as an independent contractor shall be considered employment for all purposes of the Plan, except as provided in Section IV(A). H. "EXERCISE PRICE" shall mean the amount for which one Share may be purchased upon exercise of an Option, as specified in the applicable Stock Option Agreement. I. "FAIR MARKET VALUE" shall mean the market price of Stock, determined by the Committee as follows: 1. If the Stock was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; 2. If the Stock was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; 3. If the Stock was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; and 4. If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. In all cases, the determination of Fair Market Value by the Committee shall be conclusive and binding on all persons. J. "ISO" shall mean an employee incentive stock option described in section 422 of the Code. K. "NONSTATUTORY OPTION" shall mean a stock option not described in section 422 or 423(b) of the Code. L. "OPTION" shall mean an ISO or Nonstatutory Option granted under the Plan and entitling the holder to purchase Shares. M. "OPTIONEE" shall mean an individual who holds an Option. N. "PLAN" shall mean this 1990 Stock Option Plan of Foundation Health Corporation, as amended from time to time. O. "SERVICE" shall mean service as an Employee or Director including a Director of any Subsidiary of the Company. P. "SHARE" shall mean one share of Stock, as adjusted in accordance with Section IX (if applicable). Q. "STOCK" shall mean the Common Stock of the Company. R. "STOCK OPTION AGREEMENT" shall mean the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her Option. 2 S. "SUBSIDIARY" shall mean any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. T. "TOTAL AND PERMANENT DISABILITY" shall mean that the Optionee is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted, or can be expected to last, for a continuous period of not less than 12 months. 3 SECTION III. ADMINISTRATION. A. COMMITTEE MEMBERSHIP. The Plan shall be administered by a committee that will satisfy Rule 16b-3 of the Securities Exchange Act of 1934, as amended, with respect to grants to officers and directors (the "Committee"). The members of the Committee shall be appointed by the Board of Directors. If no Committee has been appointed, the entire Board of Directors shall constitute the Committee. B. COMMITTEE PROCEDURES. The Board of Directors shall designate one of the members of the Committee as chairperson. The Committee may hold meetings at such times and places as it shall determine. The acts of a majority of the Committee members present at meetings at which a quorum exists, or acts reduced to or approved in writing by all Committee members, shall be valid acts of the Committee. C. COMMITTEE RESPONSIBILITIES. Subject to the provisions of the Plan, the Committee shall have full authority and discretion to take the following actions: 1. To interpret the Plan and to apply its provisions; 2. To adopt, amend or rescind rules, procedures and forms relating to the Plan; 3. To authorize any person to execute, on behalf of the Company, any instrument required to carry out the purposes of the Plan; 4. Except with respect to Optionees who are Directors, to determine when Options are to be granted under the Plan; 5. Except with respect to Optionees who are Directors, to select the Optionees; 6. Except with respect to Optionees who are Directors, to determine the number of Shares to be made subject to each Option; 7. Except with respect to Optionees who are Directors, to prescribe the terms and conditions of each Option, to determine whether such Option is to be classified as an ISO or as a Nonstatutory Option, and to specify the provisions of the Stock Option Agreement relating to such Option; 8. To amend any outstanding Stock Option Agreement, subject to applicable legal restrictions and to the consent of the Optionee who entered into such agreement; 9. To prescribe the consideration for the grant of each Option under the Plan and to determine the sufficiency of such consideration; and 10. To take any other actions deemed necessary or advisable for the administration of the Plan. All decisions, interpretations and other actions of the Committee shall be final and binding on all Optionees and all persons deriving their rights from an Optionee. No member of the Committee shall be liable for any action that he or she has taken or has failed to take in good faith with respect to the Plan or any Option. SECTION IV. ELIGIBILITY. A. EMPLOYEES. Only Employees (including, without limitation, independent contractors who are not Directors) shall be eligible for designation as Optionees by the Committee. In addition, only Employees who are common-law employees of the Company or of a Subsidiary shall be eligible for the grant of ISOs. 4 1. TEN-PERCENT STOCKHOLDERS. An Employee who owns more than 10 percent of the total combined voting power of all classes of outstanding stock of the Company or any of its Subsidiaries shall not be eligible for designation as an Optionee for an ISO unless (i) the Exercise Price is at least 110 percent of the Fair Market Value of a Share on the date of grant and (ii) the ISO by its terms is not exercisable after the expiration of five years from the date of grant. 2. ATTRIBUTION RULES. For purposes of Subsection (A)(1) above, in determining stock ownership, an Employee shall be deemed to own the stock owned, directly or indirectly, by or for his or her brothers, sisters, spouse, ancestors and lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be deemed to be owned proportionately by or for its stockholders, partners or beneficiaries. Stock with respect to which such Employee holds an option shall not be counted. 3. OUTSTANDING STOCK. For purposes of Subsection (A)(1) above, "outstanding stock" shall include all stock actually issued and outstanding immediately after the grant. "Outstanding stock" shall not include treasury shares or shares authorized for issuance under outstanding options held by the Employee or by any other person. B. DIRECTORS. Directors of the Company shall be eligible for participation in the Plan as set forth in Sections VI(B) and VIII. SECTION V. STOCK SUBJECT TO PLAN. A. BASIC LIMITATION. Shares offered under the Plan shall be authorized but unissued Shares or treasury Shares. The aggregate number of Shares which may be issued under the Plan upon exercise of Options shall not exceed 5,525,000 Shares, subject to adjustment pursuant to Section IX. Commencing with July 1, 1994, the Committee shall not grant options to any one individual covering a number of shares in excess of 1,000,000 (the "Allocation limit"), subject to adjustment pursuant to Section IX. The number of Shares which are subject to Options outstanding at any time under the Plan shall not exceed the number of Shares which then remain available for issuance under the Plan. The Company, during the term of the Plan, shall at all times reserve and keep available sufficient Shares to satisfy the requirements of the Plan. B. ADDITIONAL SHARES. In the event that any outstanding Option for any reason expires or is canceled or otherwise terminated, the Shares allocable to the unexercised portion of such Option shall again be available for the purposes of the Plan. C. ADJUSTMENT OF ALLOCATION LIMIT. If, as a result of subsequent regulations or other interpretive guidance, the Committee determines that (i) the inclusion of the Allocation Limit is not required in order for option grants to qualify as performance-based compensation under the provisions of Section 162(m) of the Code, or (ii) option grants can qualify as performance-based compensation even if the Allocation Limit was made less restrictive, the Committee will be entitled to amend the Plan accordingly (including amendments to adjust or eliminate altogether the Allocation Limit). SECTION VI. TERMS AND CONDITIONS OF OPTIONS. A. EMPLOYEES. 1. STOCK OPTION AGREEMENT. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company, which Stock Option Agreement shall have been approved in advance by the Committee. Such Option shall be subject to all applicable terms and conditions of the Plan and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. 5 2. NUMBER OF SHARES. Each Stock Option Agreement shall specify the number of shares that are subject to the Option and shall provide for the adjustment of such number in accordance with Section IX. The Stock Option Agreement shall also specify whether the Option is an ISO or a Nonstatutory Option. 3. EXERCISE PRICE. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price shall not be less than 100 percent of the Fair Market Value of a Share on the date of grant, except as otherwise provided in Section IV (A)(1). Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee at its sole discretion. The Exercise Price shall be payable in a form described in Section VII. 4. EXERCISABILITY AND TERM. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The vesting of any Option shall be determined by the Committee at its sole discretion. A Stock Option Agreement may provide for accelerated exercisability in the event of the Optionee's death, Total and Permanent Disability or retirement or other events. The Stock Option Agreement shall also specify the term of the Option. The term shall not exceed 10 years from the date of grant, except as otherwise provided in Section IV(A)(1). Subject to the preceding sentence, the Committee at its sole discretion shall determine when an Option is to expire. 5. EFFECT OF CHANGE IN CONTROL. The Committee may determine, at the time of granting an Option or thereafter, that such Option shall become fully exercisable as to all Shares subject to such Option in the event that a Change in Control occurs with respect to the Company. If the Committee finds that there is a reasonable possibility that, within the succeeding six months, a Change in Control will occur with respect to the Company, then the Committee may determine that any or all outstanding Options shall become fully exercisable as to all Shares subject to such Options. B. DIRECTORS. 1. STOCK OPTION AGREEMENTS. A Nonstatutory Option to purchase Shares shall be granted to each Director then in office on April 22, 1993. In the case of a Director who is not a Director on April 22, 1993, the grant of an option to such Director under this Subsection (B)(1) shall occur on the date such Director takes office. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan and to stockholder approval of this provision. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. 2. NUMBER OF SHARES. Each Stock Option Agreement shall specify the number of Shares that are subject to the Option and shall provide for the adjustment of such number in accordance with Section IX. The number of Shares that are subject to each Option under Subsection (B)(1) shall be 25,000. 3. EXERCISE PRICE. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price shall be 100 percent of the Fair Market Value of a Share on the date of grant. The Exercise Price shall be payable in cash or Common Stock. 4. EXERCISABILITY AND TERM. Each Stock Option Agreement shall specify that the Option is to become exercisable in accordance with the following schedule: Anniversary of Percentage of DATE OF GRANT SHARES EXERCISABLE ----------------------------------------------------- First 20% Second 40% Third 60% Fourth 80% Fifth 100% 6 The Stock Option Agreement shall specify the term of the Option which shall be 10 years from the date of grant, unless earlier terminated as set forth herein. C. WITHHOLDING TAXES. As a condition to the exercise of an Option, the Optionee shall make such arrangements as the Committee may require for the satisfaction of any federal, state, local or foreign withholding tax obligations that may arise in connection with such exercise. The Optionee shall also make such arrangements as the Committee may require for the satisfaction of any federal, state, local or foreign withholding tax obligations that may arise in connection with the disposition of Shares acquired by exercising an Option. The Committee may permit the Optionee to satisfy all or part of his or her withholding or income tax obligations by having the Company withhold a portion of any Shares that otherwise would be issued to him or her or by surrendering a portion of any Shares that previously were issued to him or her. Such Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. Any payment of taxes by assigning Shares to the Company may be subject to restrictions, including any restrictions required by rules of the Securities and Exchange Commission. D. NONTRANSFERABILITY. No Option shall be transferable by the Optionee other than by will, by a beneficiary designation executed by the Optionee and delivered to the Company or by the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her or by his or her guardian or legal representative. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. E. TERMINATION OF SERVICE (EXCEPT BY DEATH). If an Optionee's Service terminates for any reason other than his or her death, then his or her Option(s) shall expire on the earliest of the following occasions: 1. The expiration date determined pursuant to Subsection (A)(4) or (B)(4) above; 2. The date 90 days after the termination of his or her Service for any reason other than Total and Permanent Disability; or 3. The date 12 months after the termination of his or her Service by reason of Total and Permanent Disability. The Optionee may exercise all or part of his or her Option(s) at any time before the expiration of such Option(s) under the preceding sentence, but only to the extent that such Option(s) had become exercisable before his or her Service terminated or became exercisable as a result of the termination. The balance of such Option(s) shall lapse when the Optionee's Service terminates unless otherwise specified in the applicable Stock Option Agreement. In the event that the Optionee dies after the termination of his or her Service but before the expiration of his or her Option(s), all or part of such Option(s) may be exercised (prior to expiration) by the executors or administrators of the Optionee's estate or by any person who has acquired such Option(s) directly from him or her by bequest, beneficiary designation or inheritance, but only to the extent that such Option(s) had become exercisable before his or her Service terminated or became exercisable as a result of the termination. F. LEAVES OF ABSENCE. For purposes of Subsection E above, Service shall be deemed to continue while the Optionee is on military leave, sick leave or other bona fide leave of absence (as determined by the Committee). The foregoing notwithstanding, in the case of an ISO granted to an Employee under the Plan, Service shall not be deemed to continue beyond the first 90 days of such leave, unless the Optionee's reemployment rights are guaranteed by statute or by contract. G. DEATH OF OPTIONEE. If an Optionee dies while he or she is in Service, then his or her Option(s) shall expire on the earlier of the following dates: 1. The expiration date determined pursuant to Subsection (A)(4) or (B)(4) above; or 7 2. The date 12 months after his or her death. All or part of the Optionee's Option(s) may be exercised at any time before the expiration of such Option(s) under the preceding sentence by the executors or administrators of his or her estate or by any person who has acquired such Option(s) directly from him or her by bequest, beneficiary designation or inheritance, but only to the extent that such Option(s) had become exercisable before his or her death or became exercisable as a result of his or her death. The balance of such Option(s) shall lapse when the Optionee dies. H. NO RIGHTS AS A STOCKHOLDER. An Optionee, or a transferee of an Optionee, shall have no rights as a stockholder with respect to any Shares covered by his or her Option until the date of the issuance of a stock certificate for such Shares. No adjustments shall be made, except as provided in Section IX. I. MODIFICATION, EXTENSION AND ASSUMPTION OF OPTIONS. Within the limitations of the Plan, the Committee may modify, extend or assume outstanding Options or may accept the cancellation of outstanding Options (whether granted by the Company or another issuer) in return for the grant of new Options for the same or a different number of Shares and at the same or a different price. The foregoing notwithstanding, no modification of an Option shall, without the consent of the Optionee, impair his or her rights or increase his or her obligations under such Option. J. RESTRICTIONS ON TRANSFER OF SHARES. Any Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Shares. SECTION VII. PAYMENT FOR SHARES. A. GENERAL RULE. The entire Exercise Price of Shares issued under the Plan shall be payable in lawful money of the United States of America at the time when such Shares are purchased, except as follows: 1. In the case of an option granted under the Plan to an Employee, the Committee (at its sole discretion) may specify in the Stock Option Agreement that payment of the exercise price may be made in one or more of the forms described in Subsections (B), (C), (D) and (E) below. 2. In the case of a Nonstatutory Option granted under the Plan to a Director, payment may be made in one or both of the forms described in Subsections (B) and (D) below. B. SURRENDER OF STOCK. To the extent that this Subsection (B) is applicable and to the extent that applicable law permits, payment may be made all or in part with Shares which have already been owned by the Optionee or his or her representative for more than six months and which are surrendered to the Company in good form for transfer. Such Shares shall be valued at their Fair Market Value on the date when the new Shares are purchased under the Plan. C. PROMISSORY NOTE. To the extent that this Subsection (C) is applicable, a portion of the Exercise Price of Shares issued under the Plan may be payable by a full-recourse promissory note; provided that (i) the par value of such Shares must be paid in lawful money of the United States of America at the time when such Shares are purchased, (ii) the Shares are security for payment of the principal amount of the promissory note and interest thereon and (iii) the interest rate payable under the terms of the promissory note shall not be less than the minimum rate (if any) required to avoid the imputation of additional interest under the Code. Subject to the foregoing, the Committee (at its sole discretion) shall specify the term, interest rate, amortization requirements (if any) and other provisions of such note. D. EXERCISE/SALE. To the extent that this Subsection (D) is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to a securities broker approved by the Company to sell Shares and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. 8 E. EXERCISE/PLEDGE. To the extent that this Subsection (E) is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to pledge Shares to a securities broker or lender approved by the Company, as security for a loan, and to deliver all or part of the loan proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. SECTION VIII. PAYMENT OF DIRECTOR'S FEES IN STOCK. A. ELECTION. A Director may elect to receive his or her director's fees from the Company in the form of Shares to be issued under the Plan. Such an election may be made with respect to: 1. All director's fees, including (without limitation) annual retainer fees, meeting fees and fees paid to committee chairpersons, but not including expense reimbursements and consulting fees; or 2. Annual retainer payments only. An election under this Section VIII shall be filed with the Company on the prescribed form. The election shall apply only to fees payable at least six months after such form has been received by the Company. The election may be amended or canceled by filing a new form with the Company, but the new form shall apply only to fees payable at least six months after it has been received by the Company. The number of Shares to be issued shall be determined by dividing the amount of the fee by the Fair Market Value of one Share on the date when such fee otherwise would be paid in cash. B. WITHHOLDING TAXES. The Director shall satisfy all of his or her federal, state or local withholding tax obligations (if any) by having the Company withhold a portion of the Shares that otherwise would be issued to him or her. Such Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of taxes by assigning Shares to the Company shall be subject to any restrictions required by rules of the Securities and Exchange Commission. SECTION IX. ADJUSTMENT OF SHARES. A. GENERAL. In the event of a subdivision of the outstanding Stock, a declaration of a dividend payable in Shares, a declaration of a dividend payable in a form other than Shares in an amount that has a material effect on the value of Shares, a combination or consolidation of the outstanding Stock (by reclassification or otherwise) into a lesser number of Shares, a recapitalization or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (i) the number of Shares available for future grants under Section V, (ii) the number of Shares covered by each outstanding Option or (iii) the Exercise Price under each outstanding Option. B. MERGER; CONSOLIDATION. In the event that the Company is a party to a merger or consolidation, outstanding Options shall be subject to the agreement of merger or consolidation. Such agreement shall provide (i) for the assumption of outstanding Options by the surviving corporation or its parent, (ii) for their continuation by the Company, if the Company is a surviving corporation, (iii) for payment of a cash settlement equal to the difference between the amount to be paid for one Share under such agreement and the Exercise Price or (iv) for the acceleration of their exercisability followed by the cancellation of Options not exercised, in all cases other than clause (iii) without the Optionees' consent. (The Optionees' consent shall be required for a cash settlement.) Any cancellation shall not occur earlier than 30 days after such acceleration is effective and Optionees have been notified of such acceleration. In the case of Options that have been outstanding for less than 12 months, a cancellation need not be preceded by an acceleration. C. RESERVATION OF RIGHTS. Except as provided in this Section IX, an Optionee shall have no rights by reason of (i) any subdivision or consolidation of shares of stock of any class, (ii) the payment of any dividend or (iii) any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Shares subject to an Option. The grant of an Option pursuant to 9 the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. SECTION X. SECURITIES LAWS. Shares shall not be issued under the Plan unless the issuance and delivery of such Shares complies with (or is exempt from) all applicable requirements of law, including (without limitation) the Securities Act of 1933, as amended, the rules and regulations promulgated thereunder, state securities laws and regulations, and the regulations of any stock exchange on which the Company's securities may then be listed. SECTION XI. NO RIGHTS TO SERVICE. No provision of the Plan, nor any Option granted under the Plan, shall be construed to give any person any right to become, to be treated as, or to remain an Employee or Director of the Company, as the case may be. The Company and its Subsidiaries reserve the right to terminate any person's Service at any time and for any reason. SECTION XII. DURATION AND AMENDMENTS. A. TERM OF THE PLAN. The Plan, as amended and restated, is effective as of August 15, 1996. The Plan shall terminate automatically on March 31, 2000 and may be terminated on any earlier date pursuant to Subsection (B) below. B. RIGHT TO AMEND OR TERMINATE THE PLAN. The Committee may amend, suspend or terminate the Plan at any time and for any reason; provided, however, that any amendment of the Plan which increases the number of Shares available for issuance under the Plan (except as provided in Section IX), or which materially changes the class of persons who are eligible for the grant of ISOs, shall be subject to the approval of the Company's stockholders. Stockholder approval shall not be required for any other amendment of the Plan, except to the extent required by applicable law, rule or regulation. C. EFFECT OF AMENDMENT OR TERMINATION. No Shares shall be issued under the Plan after the termination thereof, except upon exercise of an Option granted prior to such termination. The termination of the Plan, or any amendment thereof, shall not affect any Share previously issued or any Option previously granted under the Plan. SECTION XIII. EXECUTION. To record the amendment and restatement of the Plan by the Committee to be effective as of August 15, 1996, the Company has caused its authorized officer to execute the same. FOUNDATION HEALTH CORPORATION By: /s/ Daniel D. Crowley -------------------------------------- President and Chief Executive Officer 10 EX-10.105 3 EXHIBIT 10.105 EXHIBIT 10.105 AMENDMENT NUMBER ONE TO EMPLOYMENT AGREEMENT This Amendment Number One to the Employment Agreement entered into as of April 22, 1994, by and between Kirk A. Benson (the "Employee") and Foundation Health Corporation, a Delaware corporation (the "Company") (the "Employment Agreement") is effective as of May 1, 1996. WHEREAS, the Company desires to amend certain provisions of the Employment Agreement to extend the term and restate the compensation provisions thereof; and WHEREAS, the Employee is amenable to such amendments; NOW THEREFORE, for good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Subsection 1(a) of the Employment Agreement shall be amended by deleting such subsection in its entirety and replacing it with the following Subsection 1(a): "(a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company for a five year period commencing as of the date hereof and ending May 1, 2001, and thereafter automatically renewable from year to year unless sooner terminated pursuant to Subsection (b), (c), (d) or (e) below." 2. Subsection 3(a) shall be amended by stating the annual rate of compensation as not less than $350,000 per year. 3. REMAINING TERMS. The remaining terms of the Employment Agreement shall remain in full force and effect. IN WITNESS WHEREOF, each of the parties has executed this Amendment Number One, in the case of the Company, by its duly authorized officer, as of the day and year first above written. /s/ Kirk A. Benson --------------------------------------- Employee FOUNDATION HEALTH CORPORATION By: /s/ Daniel D. Crowley -------------------------------- Its: President and CEO ----------------------------------- EX-10.106 4 EXHIBIT 10.106 EXHIBIT 10.106 AMENDMENT NUMBER ONE TO EMPLOYMENT AGREEMENT This Amendment Number One to the Employment Agreement entered into as of April 22, 1994, by and between Jeffrey L. Elder (the "Employee") and Foundation Health Corporation, a Delaware corporation (the "Company") (the "Employment Agreement") is effective as of May 1, 1996. WHEREAS, the Company desires to amend certain provisions of the Employment Agreement to extend the term and restate the compensation provisions thereof; and WHEREAS, the Employee is amenable to such amendments; NOW THEREFORE, for good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Subsection 1(a) of the Employment Agreement shall be amended by deleting such subsection in its entirety and replacing it with the following Subsection 1(a): "(a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company for a five year period commencing as of the date hereof and ending May 1, 2001, and thereafter automatically renewable from year to year unless sooner terminated pursuant to Subsection (b), (c), (d) or (e) below." 2. Subsection 3(a) shall be amended by stating the annual rate of compensation as not less than $300,000 per year. 3. REMAINING TERMS. The remaining terms of the Employment Agreement shall remain in full force and effect. IN WITNESS WHEREOF, each of the parties has executed this Amendment Number One, in the case of the Company, by its duly authorized officer, as of the day and year first above written. /s/ Jeffrey L. Elder --------------------------------------- Employee FOUNDATION HEALTH CORPORATION By: /s/ Daniel D. Crowley -------------------------------- Its: President and CEO ----------------------------------- EX-10.107 5 EXHIBIT 10.107 EXHIBIT 10.107 AMENDMENT NUMBER ONE TO EMPLOYMENT AGREEMENT This Amendment Number One to the Employment Agreement entered into as of April 22, 1994, by and between Allen J. Marabito (the "Employee") and Foundation Health Corporation, a Delaware corporation (the "Company") (the "Employment Agreement") is effective as of May 1, 1996. WHEREAS, the Company desires to amend certain provisions of the Employment Agreement to extend the term and restate the compensation provisions thereof; and WHEREAS, the Employee is amenable to such amendments; NOW THEREFORE, for good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Subsection 1(a) of the Employment Agreement shall be amended by deleting such subsection in its entirety and replacing it with the following Subsection 1(a): "(a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company for a five year period commencing as of the date hereof and ending May 1, 2001, and thereafter automatically renewable from year to year unless sooner terminated pursuant to Subsection (b), (c), (d) or (e) below." 2. Subsection 3(a) shall be amended by stating the annual rate of compensation as not less than $250,000 per year. 3. REMAINING TERMS. The remaining terms of the Employment Agreement shall remain in full force and effect. IN WITNESS WHEREOF, each of the parties has executed this Amendment Number One, in the case of the Company, by its duly authorized officer, as of the day and year first above written. /s/ Allen J. Marabito --------------------------------------- Employee FOUNDATION HEALTH CORPORATION By: /s/ Daniel D. Crowley -------------------------------- Its: President and CEO ----------------------------------- EX-10.108 6 EXHIBIT 10.108 EXHIBIT 10.108 AMENDMENT NUMBER ONE TO EMPLOYMENT AGREEMENT This Amendment Number One to the Employment Agreement entered into as of April 22, 1994, by and between Steven D. Tough (the "Employee") and Foundation Health Corporation, a Delaware corporation (the "Company") (the "Employment Agreement") is effective as of May 1, 1996. WHEREAS, the Company desires to amend certain provisions of the Employment Agreement to extend the term and restate the compensation provisions thereof; and WHEREAS, the Employee is amenable to such amendments; NOW THEREFORE, for good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Subsection 1(a) of the Employment Agreement shall be amended by deleting such subsection in its entirety and replacing it with the following Subsection 1(a): "(a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company for a five year period commencing as of the date hereof and ending May 1, 2001, and thereafter automatically renewable from year to year unless sooner terminated pursuant to Subsection (b), (c), (d) or (e) below." 2. Subsection 3(a) shall be amended by stating the annual rate of compensation as not less than $300,000 per year. 3. REMAINING TERMS. The remaining terms of the Employment Agreement shall remain in full force and effect. IN WITNESS WHEREOF, each of the parties has executed this Amendment Number One, in the case of the Company, by its duly authorized officer, as of the day and year first above written. /s/ Steven D. Tough --------------------------------------- Employee FOUNDATION HEALTH CORPORATION By: /s/ Daniel D. Crowley -------------------------------- Its: President and CEO ----------------------------------- EX-10.109 7 EXHIBIT 10.109 EXHIBIT 10.109 STOCK AND NOTE PURCHASE AGREEMENT by and between FOUNDATION HEALTH CORPORATION, a Delaware corporation as "Seller" JONATHAN H. SCHEFF, M.D. as "Selling Shareholder" on the one hand, and FPA MEDICAL MANAGEMENT, INC., a Delaware corporation as "FPA" FPA MEDICAL MANAGEMENT OF CALIFORNIA, INC., a Delaware corporation as "Purchasing Subsidiary" and FPA INDEPENDENT PRACTICE ASSOCIATION, An Osteopathic Corporation as "Purchasing Shareholder" on the other hand Dated as of June 28, 1996 TABLE OF CONTENTS - -----------------
PAGE ---- ARTICLE 1 DEFINITIONS 2 1.1 Defined Terms 2 1.2 Other Defined Terms 4 ARTICLE 2 PURCHASE AND SALE OF FHMS SHARES AND NOTES 5 2.1 Description of FHMS Shares and Notes 5 2.2 Sale of FHMS Shares by Seller 6 2.3 FHMS Share Purchase Price 6 2.4 Sale of FHMS Indebtedness by Seller 6 2.5 FHMS Indebtedness Purchase Price 6 2.6 Transfer Taxes and Fees 7 ARTICLE 3 APPOINTMENT OF DESIGNEE - SALE AND PURCHASE OF HOLDING COMPANY SHARES AND NOTES 7 3.1 Appointment of Purchasing Shareholder as Designee 7 3.2 Description of Shares and Notes 7 3.3 Exercise of Option 7 3.4 Sale of Holding Company Indebtedness by Seller 7 3.5 Holding Company Indebtedness Purchase Price 7 ARTICLE 4 CLOSING 8 4.1 Closing 8 4.2 Conveyances at Closing 8 ARTICLE 5 REPRESENTATIONS AND WARRANTIES OF SELLER 9 5.1 Organization 9 5.2 Authorization 9 5.3 No Material Adverse Change 9 5.4 Leased Real Property 9 5.5 Contracts and Commitments 9 5.6 Permits and Governmental Filings 10 5.7 No Conflict or Violation 10 5.8 Financial Statements 11 5.9 Litigation 11 5.10 Compensation 11 5.11 Compliance with Laws 11 5.12 Employee Benefits Matters 11 5.13 Insurance 13 5.14 No Undisclosed Liabilities. 13 5.15 Capital Structure 13 5.16 Real Property 14 5.17 Taxes 14 5.18 Proprietary Rights 14 5.19 Subsidiaries 14 5.20 Accounts Receivable 14 5.21 Brokers 14 5.22 Certain Real Estate and Legal Matters 14
PAGE ---- ARTICLE 6 REPRESENTATIONS AND WARRANTIES OF FPA AND PURCHASING SUBSIDIARY 17 6.1 Organization of FPA and Purchasing Subsidiary 18 6.2 Authorization 18 6.3 No Conflict or Violation 18 6.4 Permits and Governmental Filings 18 6.5 Financial Statements 18 6.6 SEC Documents 19 6.7 No Material Adverse Change 19 6.8 Compliance with Laws 19 6.9 Litigation 19 6.10 No Undisclosed Liabilities 19 6.11 Capital Structure 19 ARTICLE 7 COVENANTS OF PARTIES HERETO 20 7.1 Further Assurances 20 7.2 No Solicitation 20 7.3 Inspections 20 7.4 Conduct of Business 20 7.5 Employee Matters 21 7.6 FPA's Covenant Not to Compete 22 7.7 Purchase of Indebtedness;Post-Closing Adjustment 24 7.8 Preparation of the Proxy Statement 24 7.9 Stockholders Meeting 24 7.10 Agreement to Vote Shares 24 7.11 Surgery Center Referrals 25 7.12 Disease State Management 25 7.13 Real Estate Matters 25 7.14 Software Licenses 26 7.15 Guaranty Payments 26 ARTICLE 8 CONDITIONS TO SELLER'S AND SELLING SHAREHOLDER'S OBLIGATIONS 26 8.1 Representations, Warranties and Covenants 26 8.2 No Proceedings, Litigation or Laws 26 8.3 Opinion of Counsel 26 8.4 Certificates and Corporate Documents 26 8.5 Registration Rights Agreement 26 8.6 Guaranties 26 8.7 Intentionally Deleted 27 8.8 Intentionally Deleted 27 8.9 Master Lease Assignment 27 8.10 Professional Group Provider Agreements 27 8.11 Purchase Price. 27 8.12 HSR Act 27 8.13 Governmental Approvals 27 8.14 Related Agreements 27 8.15 Consents 27 8.16 No Material Adverse Changes 27 8.17 Transition Agreement. 27 8.18 Releases. 27 8.19 Pledge Agreements. 28 8.20 Security Agreement. 28 8.21 Board Approval. 28 8.22 Tax Opinion. 28
PAGE ---- ARTICLE 9 CONDITIONS TO FPA'S OBLIGATIONS 28 9.1 Representations, Warranties and Covenants 28 9.2 No Proceedings, Litigation or Laws 28 9.3 Opinion of Counsel 28 9.4 Certificates and Corporate Documents 29 9.5 Other Documents 29 9.6 HSR Act 29 9.7 Governmental Approvals 29 9.8 Intentionally deleted 29 9.9 Master Lease Assignment 29 9.10 Professional Group Provider Agreements 29 9.11 Related Agreements 29 9.12 Consents 29 9.13 Material Adverse Changes 29 9.14 Pre-Closing Transactions 29 9.15 Transition Agreement 30 9.16 Registration Rights Agreement 30 9.17 Notice of Designee 30 9.18 Board Approval. 30 9.19 Stockholder Approval 30 9.20 Voting Agreement 31 9.21 Physicians 31 9.22 Real Estate Matters 31 ARTICLE 10 ACTIONS BY SELLER AND FPA AFTER THE CLOSING 31 10.1 Books and Records 31 10.2 Taxes 31 10.3 338(h)(10) Election 31 10.4 Future Contractual Alliances 32 10.5 Certain Obligations Regarding Employees 32 10.6 Foundation Name 32 10.7 Reimbursement For Certain Tax Matters 33 10.8 Covenant 34 10.9 Solicitation of Employees 34 ARTICLE 11 SURVIVAL AND INDEMNIFICATION 35 11.1 Survival 35 11.2 No Other Representations 35 11.3 Indemnification by Seller 35 11.4 Limitations on Indemnity 35 11.5 Indemnification by FPA 36 11.6 Notice and Defense of Third-Party Claims 36 11.7 Limitation 36 11.8 Exclusivity 36 11.9 Right of Set-off 36 ARTICLE 12 MISCELLANEOUS 37 12.1 Termination 37 12.2 Assignment and No Third Party Beneficiaries 38 12.3 Notices 38 12.4 Choice of Law 39 12.5 Entire Agreement; Amendments and Waivers 39
PAGE ---- 12.6 Counterparts 39 12.7 Expenses 39 12.8 Invalidity 39 12.9 Publicity 39 12.10 Schedules 40
This Stock and Note Purchase Agreement, dated as of June 28, 1996 (the "AGREEMENT") is made by and between FPA MEDICAL MANAGEMENT, INC., a Delaware corporation ("FPA"), FPA MEDICAL MANAGEMENT OF CALIFORNIA, INC., a Delaware corporation and a wholly-owned subsidiary of FPA ("PURCHASING SUBSIDIARY"), FPA INDEPENDENT PRACTICE ASSOCIATION, An Osteopathic Corporation ("PURCHASING SHAREHOLDER"), JONATHAN H. SCHEFF, M.D., an individual ("SELLING SHAREHOLDER") and FOUNDATION HEALTH CORPORATION, a Delaware corporation ("SELLER"). W I T N E S S E T H: WHEREAS, Seller owns all of the issued and outstanding shares of capital stock of Foundation Health Medical Services, a California corporation, doing business in Arizona as TDMC Medical Services Corporation ("FHMS"); WHEREAS, FHMS is engaged in the business of providing facilities management, non-physician healthcare professionals and other administrative and management services to Holding Company (as defined below) and its subsidiaries ("FHMS'S BUSINESS"); WHEREAS, FPA desires to buy from Seller and Seller desires to sell to FPA, all of the outstanding capital stock of FHMS, on the terms and conditions set forth in this Agreement; WHEREAS, Selling Shareholder owns all of the issued and outstanding shares of capital stock of FHMG/TDMC Medical Group, a California Professional Corporation ("HOLDING COMPANY"); WHEREAS, Holding Company is engaged in the business of holding the stock of Foundation Health Medical Group, Inc., a California Professional Corporation ("FHMG") and Thomas Davis Medical Centers, P.C., an Arizona Professional Corporation ("TDMC"), its professional corporation subsidiaries and providing medical services through such subsidiaries' respective Practitioners (as defined below) ("HOLDING COMPANY'S BUSINESS"); WHEREAS, Seller has the right, pursuant to that certain Share Ownership Agreement (the "SHARE OWNERSHIP AGREEMENT"), dated as of June 27, 1996, to name a designee (the "DESIGNEE") who will have the option (the "OPTION") to purchase all of the outstanding shares of capital stock of Holding Company; WHEREAS, Purchasing Shareholder desires to be named the Designee by Seller and Seller desires to name Purchasing Shareholder the Designee; WHEREAS, Purchasing Shareholder desires to buy from Selling Shareholder pursuant to the Option and Selling Shareholder desires to sell to Purchasing Shareholder pursuant to the Option, all of the outstanding capital stock of Holding Company, on the terms and conditions set forth in this Agreement and the Share Ownership Agreement; WHEREAS, Seller owns the FHMS Indebtedness and the Holding Company Indebtedness (both as defined below); WHEREAS, Purchasing Subsidiary desires to purchase the FHMS Indebtedness and the Holding Company Indebtedness; and NOW, THEREFORE, in consideration of the mutual covenants and promises contained herein and for other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, the parties hereto agree as follows: ARTICLE 1 DEFINITIONS 1.1 DEFINED TERMS. As used herein, the terms below shall have the following meanings. "AFFILIATE" shall have the meaning set forth in the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder. When used in relation to FPA or Purchasing Subsidiary, "Affiliate" shall include Purchasing Shareholder. "BUSINESSES" shall mean FHMS's Business and Holding Company's Business, collectively. "FPA FINANCIAL STATEMENTS" shall mean (i) the audited consolidated balance sheet of FPA dated as of December 31, 1995 and the related consolidated statement of operations, stockholders' equity and cash flow for the fiscal year then ended and (ii) the unaudited consolidated balance sheet of FPA dated as of March 31, 1996, and the related consolidated statement of operations, stockholders' equity and cash flow for the three-month period then ended. "CARE CENTERS" shall mean the health care centers and other facilities operated by Seller prior to the Closing which are listed on SCHEDULE 1.1(a). "CODE" shall mean the Internal Revenue Code of 1986, as amended, and the rules and regulations thereunder. "CONFIDENTIALITY AGREEMENT" shall mean the letter agreement regarding confidentiality dated June 4, 1996 between Seller and FPA. "CONTRACT" shall mean any agreement, contract, lease, note, purchase order, mortgage, indenture, security agreement, license, instrument or other contract or commitment, whether oral or written. "DISCLOSURE SCHEDULE" shall mean, collectively, the schedules attached hereto which set forth the exceptions to the representations and warranties contained in Articles 5 and 6 hereof and certain other information called for by this Agreement. The Disclosure Schedule shall be prepared so as to make clear the party hereto or the Affiliate of a party hereto to which the matters or items listed thereon relate. "ENCUMBRANCE" shall mean any claim, lien, pledge, option, charge, easement, security interest, deed of trust, mortgage, right-of-way, encroachment, building or use restriction, encumbrance or other right of third parties, whether voluntarily incurred or arising by operation of law, and includes any existing agreement to give any of the foregoing in the future, and any contingent sale or other title retention agreement or lease in the nature thereof. "EXPIRING CONTRACT" shall mean any Contract which will expire, by its terms, on or before the Closing Date. "FAMILY AND SENIOR CARE, INC." shall mean FPA's affiliate which has filed an application for licensure as a limited licensed health care service plan under the Knox-Keene Health Care Services Plan Act of 1975, as amended. "FHCA" shall mean those Affiliates of Seller which offer benefit programs to commercial groups, Governmental Authorities, individual members or other sponsors of health care benefit plans and which are a party to a Professional Group Provider Agreement. "FHMS FINANCIAL STATEMENTS" shall mean the unaudited balance sheet of FHMS dated as of March 31, 1996, attached as SCHEDULE 1.1(b) hereto. "FINANCIAL STATEMENTS" shall mean the Holding Company Financial Statements and the FHMS Financial Statements, collectively. 2 "FINANCIAL STATEMENT DATE" shall mean March 31, 1996. "GAAP" shall mean U.S. generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity or other practices and procedures as may be approved by a significant segment of the accounting profession, which are applicable to the circumstances as of the date of determination. "GOVERNMENTAL AUTHORITY" shall mean any court, governmental agency, administrative authority or body, arbitrator or arbitration panel of the United States or any state, county, city or other political subdivision thereof. "HOLDING COMPANY FINANCIAL STATEMENTS" shall mean the respective unaudited balance sheets of FHMG and TDMC dated as of March 31, 1996, attached as SCHEDULE 1.1(b) hereto. "HSR ACT" shall mean the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder. "INCLUDING" or to "INCLUDE" any item shall mean containing or to contain such item as part of a whole, without any implied exclusion of other items. "INTERGROUP OF ARIZONA" shall mean Intergroup Prepaid Health Services of Arizona, Inc., doing business as Intergroup of Arizona, an Arizona corporation. "KNOWLEDGE" of a Person shall mean the actual knowledge of the Person if such Person is an individual, or if such Person is a corporation, shall mean the actual knowledge of the member or members of senior management of such Person (in the case of Seller, Daniel D. Crowley, Kirk A. Benson, Michael P. White, and Jerry Newman and with respect to SECTION 5.22 only, Joe Erway and, in the case of FPA, Seth M. Flam, Steven Lash, James A. Lebovitz, and Sol Lizerbram) with primary responsibility for the matters referred to, in both cases after reasonable inquiry. "LAWS" shall mean all laws, statutes, ordinances, regulations, rules, codes, orders, consent decrees, settlement agreements, and governmental requirements (including any ruling or requirement having the effect of law) of any federal, state or local government and any other governmental department or agency, and any judgment, decision, decree, writ, injunction, award, ruling or order of any Governmental Authority with jurisdiction. "LEASED REAL PROPERTY" shall mean all real property leased or subleased by Seller, Holding Company or any of Holding Company's subsidiaries and used in the Businesses. "LIABILITY" means any liability, including any indebtedness, any guaranty of indebtedness or obligations of any other Person, and any liability for Taxes. "MANAGEMENT AGREEMENT" shall mean, collectively (i) that certain Sublease and Management Agreement between FHMS and FHMG, dated as of May 12, 1993, as amended and (ii) that certain Sublease and Management Agreement between FHMS and TDMC, dated as of November 1, 1994, as amended. "MATERIAL ADVERSE EFFECT" or "MATERIAL ADVERSE CHANGE" shall mean, with respect to either FHMS's Business, Holding Company's Business, FPA or Purchasing Subsidiary, respectively, any material adverse effect on or change in their respective condition (financial or other), business or results of operations, or on the ability of FPA, Purchasing Subsidiary, Purchasing Shareholder, Seller or Selling Shareholder to consummate the transactions contemplated hereby and by the Related Agreements. "ORDINARY COURSE" shall mean the ordinary course of business consistent with prior practice. 3 "PERMITS" shall mean all licenses, permits, franchises, approvals, authorizations, accreditations, provider numbers, consents or orders of, or filings with, any Governmental Authority, necessary for the conduct of, or relating to the operation of, either of the Businesses. "PERSON" shall mean an individual, a partnership, a corporation, a trust, a limited liability company or partnership, an unincorporated organization, a Governmental Authority or any other entity. "PROFESSIONAL GROUP PROVIDER AGREEMENTS" shall mean, collectively, the Professional Group Provider Agreement, in substantially the form of Exhibit B hereto, to be entered into by and between FHCA and FHMG at the Closing and the Professional Group Provider Agreement, in substantially the form of Exhibit C hereto, to be entered into by and between FHCA and TDMC at the Closing. "PRACTITIONER" shall mean any licensed physician and surgeon, dentist, clinical psychologist, podiatrist, optometrist or paraprofessional employed by Holding Company or any of its subsidiaries, who provides professional or paraprofessional services in connection with Holding Company's Business. "RELATED AGREEMENTS" shall mean all agreements set forth on SCHEDULE 8.14. "REPRESENTATIVE" shall mean any officer, director, principal, attorney, agent, employee or other representative. "TAX" shall mean any federal, state, local, foreign or other tax, levy, impost, fee, assessment or other government charge, including income, estimated income, business occupation, property, payroll, personal property, sales, transfer, use, employment, commercial rent, occupancy, franchise or withholding taxes, and any premium, including interest, penalties and additions in connection therewith. 1.2 OTHER DEFINED TERMS. The following terms shall have the meanings given in the Sections set forth below: Term Section - ---------------------------------------------------------- Accounts 7.5(c)(ii) Actions 5.9 Agent 3.1 Bridge Note 2.3(a)(iii) Cash Payment 2.3(a)(i) Closing 4.1 Closing Date 4.1 Closing Price 2.3(a)(ii) Designee Recitals Designee Consideration 3.1 Employee 5.10 Employee Benefit Plans 5.12(b) Environmental Laws 5.22 ERISA 5.12(a)(i) Exclusivity Period 7.2 FHMG Recitals FHMG Agreement 5.6(c) FHMS Recitals FHMS Indebtedness 2.1 FHMS Indebtedness Purchase Price 2.5 FHMS Share Purchase Price 2.3(a) FHMS Shares 2.1 4 FHMS's Business Recitals FPA Common 2.3(a)(ii) FPA SEC Documents 6.6 FPA's Savings Plans 7.5(c)(ii) Foundation Name 10.6 Frozen 401(k) Plan 7.5(d) Hazardous Materials 5.22 Holding Company Recitals Holding Company Indebtedness 3.2 Holding Company Indebtedness Purchase Price 3.5 Holding Company Shares 3.2 Holding Company's Business Recitals Indemnitee 11.4 Indemnified Person 11.6 Indemnifying Person 11.6 Insurance Policies 5.13 Leases 5.22 Losses 11.3 Master Lease Assignment 8.9 Material Contracts 5.5 Nasdaq NMS 2.3(a)(ii) Non-Compete Period 7.6(a) Note Consideration 2.3(a)(iv) Option Recitals Owner 5.22 Pledge Agreement 8.19 Proxy Statement 7.8 Registration Rights Agreement 8.5 Rent Roll 5.22 Retained Employees 7.5(a) SEC 6.6 Secured Obligations 8.19 Seller's 401(k) Plan 7.5(c)(i) Share Consideration 2.3(a)(ii) Share Ownership Agreement Recitals Stockholder's Meeting 7.9 Transition Agreement 8.17 Transition Period 10.6 TDMC Recitals ARTICLE 2 PURCHASE AND SALE OF FHMS SHARES AND NOTES 2.1 DESCRIPTION OF FHMS SHARES AND NOTES. The shares of FHMS to be sold pursuant hereto (the "FHMS SHARES") shall consist of all of the issued and outstanding capital stock of FHMS and are described in SCHEDULE 2.1. The promissory notes and other indebtedness of FHMS to be sold pursuant hereto shall consist of the line items "Inter-Company Payable," "Notes Payable, FHC" and "Claims Payable" (the "FHMS INDEBTEDNESS") in the amounts shown on FHMS's balance sheet as of the Closing Date. For reference purposes only, the aggregate amount of such items, when combined with the aggregate amount of the Holding Company Indebtedness is estimated to be Seventy Nine Million Five Hundred Thousand Dollars ($79,500,000) as of June 30, 1996. 5 2.2 SALE OF FHMS SHARES BY SELLER. On the basis of the representations and warranties of the parties and subject to the terms and conditions hereinafter set forth, at the Closing, Seller shall sell, assign, transfer and deliver the FHMS Shares to Purchasing Subsidiary and Purchasing Subsidiary shall purchase, make payment for and accept the FHMS Shares from Seller at the price and in the manner set forth in this Article 2. 2.3 FHMS SHARE PURCHASE PRICE. (a) COMPONENTS OF FHMS SHARE PURCHASE PRICE. Upon the terms and subject to the conditions set forth herein, FPA shall deliver to Seller at the Closing in exchange for the sale, transfer, assignment, conveyance and delivery of the FHMS Shares to Purchasing Subsidiary, the following (collectively, the "FHMS SHARE PURCHASE PRICE"): (i) by wire transfer of immediately available funds to an account designated by Seller, cash in the amount of Two Million U.S. Dollars ($2,000,000) (the "CASH PAYMENT"); (ii) a number of shares (the "SHARE CONSIDERATION") of FPA's Common Stock ("FPA COMMON") equal to (A) (x) Seventy Five Million U.S. Dollars ($75,000,000) minus (y) the amount of any cash paid in lieu of FPA Common by FPA to Seller and in the same manner as the Cash Payment divided by (B) the Closing Price. The Closing Price shall be the average of the per share closing prices of FPA Common during the ten (10) trading days ending on the second trading day prior to Closing as reported on the National Market System on Nasdaq (the "NASDAQ NMS"). In the event that the Closing Price is less than $13.60 (the "Walk- Away Price"), then FPA may in its sole discretion terminate this Agreement by giving notice of termination to Seller no later than one day prior to Closing, PROVIDED, HOWEVER, that notwithstanding any such notice, Seller may cause the Closing to occur if it gives notice to FPA no later than the day prior to Closing that it will accept a number of shares of FPA Common equal to (A) $75,000,000 divided by (B) the Walk-Away Price, as the Share Consideration. (iii) a Promissory Note (the "BRIDGE NOTE"), issued by FPA, in the principal amount of Twenty Two Million Dollars, ($22,000,000) containing the terms set forth in Exhibit D hereto and otherwise in form and substance reasonably satisfactory to the parties hereto; (iv) a Promissory Note (the "NOTE CONSIDERATION"), issued by Purchasing Subsidiary, in the principal amount of Twelve Million U.S. Dollars ($12,000,000) , which note will be consolidated, at the Closing, into the Consolidated Note. (b) No fractional shares of FPA Common shall be issued, but in lieu thereof Seller shall receive from Purchasing Subsidiary an amount of cash (rounded up to the nearest whole cent) equal to the product of (i) the fraction of a share of FPA Common to which Seller would otherwise have been entitled times (ii) Closing Price. 2.4 SALE OF FHMS INDEBTEDNESS BY SELLER. On the basis of the representations and warranties of the parties and subject to the terms and conditions hereinafter set forth, at the Closing, Seller shall sell, assign, transfer and deliver the FHMS Indebtedness to Purchasing Subsidiary, without recourse, and Purchasing Subsidiary shall purchase, make payment for and accept the FHMS Indebtedness from Seller at the price and in the manner set forth in this Article 2. Neither FPA nor Purchasing Subsidiary shall have any recourse against Seller as a result of any default by FHMS under the FHMS Indebtedness, including any default resulting from FHMS's failure to make any payment of principal or interest or any other payment under the FHMS Indebtedness when due. 2.5 FHMS INDEBTEDNESS PURCHASE PRICE. Upon the terms and subject to the conditions set forth herein, Purchasing Subsidiary shall deliver to Seller at the Closing in exchange for the sale, transfer, assignment, conveyance and delivery of the FHMS Indebtedness, without recourse, a promissory note (the "FHMS INDEBTEDNESS PURCHASE PRICE") in a principal amount equal to the amount of FHMS Indebtedness shown on FHMS's pro forma balance sheet as 6 of the Closing Date (subject to adjustment following the Closing Audit), which promissory note will be consolidated, at the Closing, into the Consolidated Note. 2.6 TRANSFER TAXES AND FEES. Seller shall be responsible for any applicable documentary, use, filing, sales, transfer and other taxes or fees due or payable as a result of the conveyance, assignment, transfer or delivery of the FHMS Shares by Seller. ARTICLE 3 APPOINTMENT OF DESIGNEE - SALE AND PURCHASE OF HOLDING COMPANY SHARES AND NOTES 3.1 APPOINTMENT OF PURCHASING SHAREHOLDER AS DESIGNEE. On the basis of the representations and warranties of the parties and subject to the terms and conditions hereinafter set forth and in consideration for the sum of $15,000 (the "DESIGNEE CONSIDERATION") payable to Seller by or on behalf of Purchasing Shareholder by wire transfer at the Closing, at the Closing, Seller shall appoint Purchasing Shareholder Designee under the Share Ownership Agreement and shall so notify Selling Shareholder and the agent (the "AGENT") under the Share Ownership Agreement. 3.2 DESCRIPTION OF SHARES AND NOTES. The shares of Holding Company to be sold pursuant to the Option (the "HOLDING COMPANY SHARES") shall consist of all of the issued and outstanding capital stock of Holding Company and are described in SCHEDULE 3.2. The promissory notes and other indebtedness of Holding Company and its subsidiaries to be sold pursuant hereto shall consist of the line items "Inter-Company Payable," "Notes Payable, FHC" and "Claims Payable" (the "HOLDING COMPANY INDEBTEDNESS") in the amounts shown on Holding Company's consolidated balance sheet as of the Closing Date. For reference purposes only, the aggregate amount of such items, when combined with the aggregate amount of the FHMS Indebtedness is estimated to be Seventy Nine Million Five Hundred Thousand Dollars ($79,500,000) as of June 30, 1996. 3.3 EXERCISE OF OPTION. On the basis of the representations and warranties of the parties and subject to the terms and conditions hereinafter set forth, at the Closing, Purchasing Shareholder shall exercise the Option and Selling Shareholder shall sell, assign, transfer and deliver the Holding Company Shares to Purchasing Shareholder and Purchasing Shareholder shall purchase, make payment for and accept the Holding Company Shares from Selling Shareholder at the price and in the manner set forth in the Share Ownership Agreement. 3.4 SALE OF HOLDING COMPANY INDEBTEDNESS BY SELLER. On the basis of the representations and warranties of the parties and subject to the terms and conditions hereinafter set forth, at the Closing, Seller shall sell, assign, transfer and deliver the Holding Company Indebtedness to Purchasing Subsidiary, without recourse, and Purchasing Subsidiary shall purchase, make payment for and accept the Holding Company Indebtedness from Seller at the price and in the manner set forth in this Article 3. Neither FPA nor Purchasing Subsidiary shall have any recourse against Seller as a result of any default by Holding Company or any of its subsidiaries under the Holding Company Indebtedness, including any default resulting from a failure to make any payment of principal or interest under the Holding Company Indebtedness when due. 3.5 HOLDING COMPANY INDEBTEDNESS PURCHASE PRICE. Upon the terms and subject to the conditions set forth herein, Purchasing Subsidiary shall deliver to Seller at the Closing in exchange for the sale, transfer, assignment, conveyance and delivery of the Holding Company Indebtedness, without recourse, a promissory note (the "HOLDING COMPANY INDEBTEDNESS PURCHASE PRICE") in a principal amount equal to the amount of the Holding Company Indebtedness shown on Holding Company's pro forma consolidated balance sheet as of the Closing Date (subject to adjustment following the Closing Audit), which promissory note will be consolidated, at the Closing, into the Consolidated Note. 7 ARTICLE 4 CLOSING 4.1 CLOSING. The Closing of the transactions contemplated herein (the "CLOSING") shall be held at 9:00 a.m. local time at the San Francisco office of Pillsbury Madison & Sutro on the third business day after the conditions to closing set forth in Articles 8 and 9 hereof are satisfied or waived (the "CLOSING DATE"), unless the parties hereto otherwise agree. 4.2 CONVEYANCES AT CLOSING. (a) CASH PAYMENT. At the Closing, FPA shall deliver the Cash Payment to Seller in accordance with SECTION 2.3(a)(i). (b) SHARE CONSIDERATION. At the Closing, FPA shall issue to Seller a stock certificate representing the Share Consideration, in accordance with SECTION 2.3(a)(ii) together with any cash payable in lieu of fractional shares pursuant to SECTION 2.3(b). (c) BRIDGE NOTE. At the Closing, FPA shall execute and deliver to Seller the Bridge Note. (d) CONSOLIDATED NOTE. At the Closing, Purchasing Subsidiary shall execute and deliver to Seller a promissory note (the "Consolidated Note") in aggregate principal amount equal to the sum of the FHMS Indebtedness Purchase Price, the Holding Company Indebtedness Purchase Price (both of which amounts are subject to adjustment following the Closing Audit) and the Note Consideration, containing the terms set forth in the term sheet attached as Exhibit E hereto and otherwise in form and substance reasonably satisfactory to the parties hereto. (e) OPTION EXERCISE. At the Closing, Purchasing Shareholder shall exercise the Option and deliver or cause to be delivered to the Agent under the Share Ownership Agreement, the price of such Option as set forth therein. (f) HOLDING COMPANY SHARE CERTIFICATE. At the Closing and upon the exercise of the Option, the Agent under the Share Ownership Agreement shall deliver to Purchasing Shareholder a stock certificate representing the Holding Company Shares, accompanied by an appropriate stock assignment, which stock certificate shall be immediately delivered to Seller, together with an appropriate stock assignment, by Purchasing Shareholder pursuant to the Pledge Agreement. The Holding Company Shares shall be delivered free and clear of all Encumbrances, other than (i) Encumbrances created by the registration requirements of the Securities Act of 1933, as amended and (ii) Encumbrances contemplated hereby or by the Related Agreements. (g) FHMS SHARE CERTIFICATE. At the Closing, Seller shall deliver to Purchasing Subsidiary, a stock certificate representing the FHMS Shares, accompanied by an appropriate stock assignment, which stock certificate shall be immediately redelivered to Seller, together with an appropriate stock assignment, by Purchasing Subsidiary pursuant to the Pledge Agreement. The FHMS Shares shall be delivered free and clear of all Encumbrances, other than (i) Encumbrances created by the registration requirements of the Securities Act of 1933, as amended and (ii) Encumbrances contemplated hereby or by the Related Agreements. (h) CERTIFICATES; OPINIONS; CLOSING CONDITIONS. FPA, Purchasing Shareholder, Seller and Selling Shareholder shall deliver the agreements, certificates, opinions of counsel and other items described in ARTICLES 8 and 9. 8 ARTICLE 5 REPRESENTATIONS AND WARRANTIES OF SELLER Seller hereby represents and warrants to FPA as follows: 5.1 ORGANIZATION. FHMS is a corporation and each of Holding Company and each of its subsidiaries is a professional corporation, duly organized, validly existing and in good standing under the laws of its respective state of incorporation and is duly qualified and in good standing as a foreign corporation in any state other than its state of incorporation where its business requires that it be so qualified, with all requisite power and authority to own, lease and operate its respective properties and to carry on its respective Business as now being conducted. 5.2 AUTHORIZATION. Each of Seller and Selling Shareholder has full power and authority to enter into and perform this Agreement, the Related Agreements and the other agreements and documents contemplated by this Agreement to which it is a party and to carry out the transactions contemplated by this Agreement and such other agreements. Each of this Agreement and the Share Ownership Agreement has been duly and validly executed and delivered by each of Seller and Selling Shareholder, and constitutes and upon the execution and delivery by each of Seller and Selling Shareholder of the Related Agreements to which it is a party such Related Agreements will constitute, the legally valid and binding obligation of each of them, enforceable in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws and equitable principles relating to or limiting creditors' rights generally and general principles of equity. 5.3 NO MATERIAL ADVERSE CHANGE. Except as listed on SCHEDULE 5.3, since the Financial Statement Date, there has not been any Material Adverse Change in either of the Businesses. 5.4 LEASED REAL PROPERTY. SCHEDULE 5.4 contains a complete and accurate list of all Leased Real Property. With respect to such Leased Real Property, each of FHMS, Holding Company and Holding Company's subsidiaries has in all material respects performed all the respective obligations required to be performed by it with respect to the Leased Real Property as lessee under the leases of such property. Notwithstanding the foregoing, this representation shall not be deemed to be untrue in any material respect as of the Closing Date solely because any Expiring Contract has expired in accordance with its terms or has been renegotiated by FHMS, Holding Company or any of Holding Company's subsidiaries in consultation with FPA or in accordance with SECTION 9.14 (PRE- CLOSING TRANSACTIONS). 5.5 CONTRACTS AND COMMITMENTS. (a) SCHEDULE 5.5 contains a true and complete list of each of the following Contracts (the "MATERIAL CONTRACTS") to which FHMS, Holding Company, or any of Holding Company's subsidiaries is a party: (i) all Contracts (excluding Employee Benefit Plans and Contracts which can be terminated at will without subjecting FHMS, Holding Company or any of Holding Company's Subsidiaries to cost or penalty) providing for a commitment for employment or consultation services for a specified or unspecified term to, or otherwise relating to employment or the termination of employment of, any Employee; (ii) all Contracts with any Person containing any provision or covenant prohibiting or materially limiting the ability of FHMS, Holding Company or any of Holding Company's subsidiaries to engage in any business activity or compete with any Person in connection with their respective Businesses or prohibiting or materially limiting the ability of any Person to compete with FHMS, Holding Company or any of Holding Company's subsidiaries in connection with either of the Businesses; (iii) all material partnership, joint venture, shareholders' or other similar Contracts with any Person in connection with either of the Businesses; 9 (iv) all Contracts relating to the future disposition or acquisition of any assets material to either of the Businesses, other than dispositions or acquisitions in the Ordinary Course of business; (v) all other Contracts (other than Employee Benefit Plans, the Real Property Leases and Insurance Policies) with respect to either of the Businesses that (A) involve the payment or potential payment, pursuant to the terms of any such Contract, by or to FHMS, Holding Company or any of Holding Company's subsidiaries of more than $100,000 annually and (B) cannot be terminated within sixty (60) days after giving notice of termination without resulting in any material cost or penalty to FHMS, Holding Company or any of Holding Company's subsidiaries. (b) There is no default or event that with notice or lapse of time, or both, would constitute a default by FHMS, Holding Company or any of Holding Company's subsidiaries under any of the Material Contracts to which it is a party. To Seller's knowledge, neither FHMS, Holding Company nor any of Holding Company's subsidiaries has received written notice of a default under any Material Contract by any other party thereto. Each of the Material Contracts is enforceable against FHMS, Holding Company or one of Holding Company's subsidiaries, as the case may be, in accordance with its terms, except as such enforceability may be limited by general principles of equity or by bankruptcy, insolvency or other similar laws relating to rights of creditors. Neither FHMS, Holding Company nor any of Holding Company's subsidiaries has received notice that any party to any of the Material Contracts intends to cancel or terminate any of the Material Contracts or to exercise or not exercise any options under any of the Material Contracts. Notwithstanding the foregoing, this representation shall not be deemed to be untrue in any material respect as of the Closing Date solely because any Expiring Contract has expired in accordance with its terms or has been renegotiated by FHMS, Holding Company or any of Holding Company's subsidiaries in consultation with FPA or in accordance with SECTION 9.14 (PRE-CLOSING TRANSACTIONS). 5.6 PERMITS AND GOVERNMENTAL FILINGS. (a) PERMITS. To Seller's knowledge, SCHEDULE 5.6(a) sets forth a complete and accurate list of all material Permits which constitute all material Permits required to conduct the Businesses as now being conducted. No notice or warning from any authority with respect to the suspension, revocation, or termination of any material Permit has been received by Seller, FHMS, Holding Company or Selling Shareholder. Seller has caused FHMS to deliver or Selling Shareholder has caused Holding Company to deliver to FPA true, correct and complete copies of all Permits requested by FPA. (b) FILINGS. Except as disclosed on SCHEDULE 5.6(b) hereto, no notice to, declaration, filing or registration with, or Permit from, any Governmental Authority is required to be made or obtained by FHMS, Holding Company or any of Holding Company's subsidiaries in connection with the execution, delivery or performance of this Agreement and the consummation of the transactions contemplated by this Agreement and the Related Agreements, except for any such notices, declarations, filings, registrations or Permits the failure of which to be obtained would not reasonably be expected to have a Material Adverse Effect on either of the Businesses. (c) CERTAIN APPROVALS. FHCA has been consulted regarding the current medical director of FHMG in accordance with Section 2.1(h) of the Professional Provider Agreement (the "FHMG AGREEMENT") currently in effect between FHCA and FHMG. FHCA acknowledges receipt of copies of the written agreements pursuant to which Provider Risk Services (as defined in the FHMG Agreement) are rendered in accordance with Section 2.8 of the FHMG Agreement. 5.7 NO CONFLICT OR VIOLATION. None of the execution, delivery and performance of this Agreement, the consummation of the transactions contemplated hereby, and the compliance by Seller and Selling Shareholder with any of the provisions hereof, will (i) violate or conflict with any provision of the Articles or Certificate of Incorporation or Bylaws of FHMS or Holding Company or any of Holding Company's subsidiaries, (ii) violate, conflict with, or result in a 10 breach of any provision of, or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or result in the termination of, or accelerate the performance required by, or result in a right of termination or acceleration under, or result in the creation of any Encumbrance upon any material asset of FHMS, Holding Company or any of Holding Company's subsidiaries under, any of the terms, conditions or provisions of any Contract to which FHMS, Holding Company or any of Holding Company's subsidiaries is a party except for violations, conflicts, breaches, defaults, terminations, accelerations, rights of termination or acceleration, or Encumbrances that would not reasonably be expected to have a Material Adverse Effect on either of the Businesses or (iii) to Seller's knowledge, violate any Laws the violation of which would reasonably be expected to have a Material Adverse Effect on either of the Businesses. 5.8 FINANCIAL STATEMENTS. The Financial Statements (i) are in accordance with the books and records of FHMS, Holding Company and Holding Company's subsidiaries, as appropriate, and (ii) fairly and accurately present the assets and liabilities of the Businesses indicated therein as of the dates thereof. 5.9 LITIGATION. Except as disclosed on SCHEDULE 5.9, as of the date hereof there are no suits, labor disputes or other litigation or proceedings ("ACTIONS") pending or, to Seller's knowledge, threatened in writing against FHMS or Holding Company or any of Holding Company's subsidiaries, with respect to their respective Businesses, other than Actions that would not reasonably be expected to have a Material Adverse Effect on either of the Businesses. 5.10 COMPENSATION. SCHEDULE 5.10 contains a true and complete list of all employees of FHMS, Holding Company or any of Holding Company's subsidiaries (each, an "EMPLOYEE") specifying their names, job designations, dates of hire and rates of compensation. 5.11 COMPLIANCE WITH LAWS. FHMS's Business is in compliance with all Laws relating to FHMS's Business, except where the failure to comply would not reasonably be expected to have a Material Adverse Effect on FHMS's Business and Holding Company's Business is in compliance with all Laws relating to Holding Company's Business, except where the failure to comply would not reasonably be expected to have a Material Adverse Effect on Holding Company's Business. 5.12 EMPLOYEE BENEFITS MATTERS. (a) Except as set forth on SCHEDULE 5.12, neither FHMS, Holding Company nor any of Holding Company's subsidiaries is a party to and none participates in or has any liability or contingent liability with respect to: (i) any "employment benefit plan" (as that term is defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA")); (ii) any retirement or deferred compensation plan, incentive compensation plan, stock plan, unemployment compensation plan, vacation pay, severance pay, bonus or benefit arrangement, insurance or hospitalization program or any other fringe benefit arrangement for any employee, director, consultant or agent, whether pursuant to contract, arrangement, custom, informal understanding or otherwise, which does not constitute an employee benefit plan; or (iii) any employment agreement not terminable upon thirty (30) days' or less written notice without further liability; PROVIDED, HOWEVER, that nothing in this paragraph (a) shall require that SCHEDULE 5.12 include any plans, arrangements or agreements unless either (i) the plan, arrangement or agreement has been extended to persons because they have performed or will perform services for FHMS, Holding Company or any of Holding Company's subsidiaries or (ii) FPA may have any liability or contingent liability with respect to such plan, arrangement or agreement as a result of the execution of this Agreement or the transactions contemplated by this Agreement. 11 (b) A true and correct copy of each of the plans, arrangements or agreements listed on SCHEDULE 5.12 (the "EMPLOYEE BENEFIT PLANS") and all contracts relating thereto or the funding thereof, each as in effect on the date hereof, have been or will be made available to FPA by FHMS or Holding Company, as appropriate on or before July 15, 1996. (c) Except as set forth on SCHEDULE 5.12, none of the Employee Benefit Plans is a multiemployer plan (as defined in Section 3(37) of ERISA). (d) Except as set forth on SCHEDULE 5.12, each Employee Benefit Plan complies, in form and in operation in all material respects, with all applicable requirements of any Laws, including, to the extent applicable, Sections 401(a) and 501(a) of the Code, and, to Seller's knowledge, no event has occurred which will or could cause any such Employee Benefit Plan to fail to comply in all material respects with such requirements. (e) Except as set forth on SCHEDULE 5.12, neither FHMS, Holding Company nor any of Holding Company's subsidiaries has any liability or contingent liability with respect to its respective Business to provide medical, dental, life, accidental death and dismemberment, or long-term disability benefits from its general assets (other than to pay insurance premiums) and, with respect to each Employee Benefit Plan, all required contributions including premium payments, have been paid. (f) Except as set forth on SCHEDULE 5.12, neither FHMS, Holding Company nor any of Holding Company's subsidiaries has any liability or contingent liability, under any Employee Benefit Plan or otherwise, for any post-retirement medical or life insurance benefits, other than statutory liability for providing group health plan continuation coverage under Part 6 of Title 1 of ERISA and Section 4980B of the Code. (g) Except as set forth on SCHEDULE 5.12, with respect to any Employee Benefit Plan with respect to which FPA is assuming liabilities pursuant to SECTION 7.5 or from which assets and liabilities will be transferred to an employee benefit plan of FPA (or its Affiliates): (i) in the case of any such Employee Benefit Plan which is an "employee pension benefit plan" (within the meaning of Section 3(2) of ERISA), there have been no amendments thereto which are not the subject of a favorable determination letter issued with respect thereto by the IRS and no event has occurred which will or could give rise to disqualification of any such plan under such Sections or to a Tax under Section 511 of the Code; (ii) there have been no "prohibited transactions" (as described in Section 406 of ERISA or Section 4975 of the Code) with respect to any such Employee Benefit Plan; (iii) there have been no acts or omissions by FHMS, Holding Company or their respective Affiliates with respect to such Employee Benefit Plan which have given rise to or may give rise to fines, penalties, Taxes or related charges under Section 502 of ERISA or Chapters 43, 47 or 68 of the Code; (iv) none of the payments contemplated under such Employee Benefit Plan would, in the aggregate, constitute excess parachute payments (as defined in Section 280G of the Code (without regard to subsection (b)(4) thereof)); (v) there are no Actions (other than routine claims for benefits) pending or to Seller's knowledge threatened in writing involving any such Employee Benefit Plan or the assets thereof and no facts exist which could give rise to any such Actions (other than routine claims for benefits); and (vi) with respect to any such Employee Benefit Plan which is subject to Title IV of ERISA: i. there has been no reportable event (as described in Section 4043 of ERISA); 12 ii. no steps have been taken to terminate any such plan; iii. there has been no withdrawal (within the meaning of Section 4063 of ERISA) of a "substantial employer" (as defined in Section 4001(a)(2) of ERISA); iv. no event or condition has occurred which might constitute grounds under Section 4042 of ERISA for the termination of or the appointment of a trustee to administer any such plan; and v. if each such plan were terminated immediately after the Closing, there would be no unfunded liabilities with respect to any such plan, its participants or beneficiaries or the Pension Benefit Guaranty Corporation. 5.13 INSURANCE. SCHEDULE 5.13 lists all policies of fire, liability, life and employee health, environmental, medical malpractice, workers' compensation and other forms of insurance currently held and maintained by FHMS, Holding Company, or any of Holding Company's subsidiaries (the "INSURANCE POLICIES"). Seller believes that such Insurance Policies are commercially reasonable in amount and coverage. All of the Insurance Policies are in full force and effect, all billed premiums with respect thereto covering all periods up to and including the Closing Date have been paid or will have been paid on or prior to the Closing Date and no written notice of cancellation or termination has been received with respect to any such Policy, except for failures to pay or cancelations or terminations which would not reasonably be expected to have a Material Adverse Effect on FHMS's or Holdings Company's Business. 5.14 NO UNDISCLOSED LIABILITIES. Except as disclosed on SCHEDULE 5.14, or elsewhere in the Disclosure Schedule, since the Financial Statement Date (i) FHMS has not incurred any Liability material to FHMS's Business (ii) neither Holding Company nor any subsidiary of Holding Company has incurred any Liability material to Holding Company's Business, in each case other than in the Ordinary Course. 5.15 CAPITAL STRUCTURE. (a) The issued and outstanding FHMS Shares are held directly by Seller in the amount set forth on SCHEDULE 2.1 hereto and represent all of the outstanding capital stock of FHMS. The issued and outstanding Holding Company Shares are held directly by Selling Shareholder in the amount set forth on SCHEDULE 3.2 hereto and represent all of the outstanding capital stock of Holding Company. (b) All of the outstanding Holding Company Shares and FHMS Shares (i) were issued in compliance with applicable federal and state securities laws, (ii) are duly authorized, validly issued, fully paid and nonassessable and not subject to preemptive rights created by statute, the Articles of Incorporation or Bylaws of the respective issuer of such shares or any agreement to which Seller, FHMS, Selling Shareholder or Holding Company is bound and (iii) are not subject to any options, warrants or other rights to purchase, agreements or other obligations to issue or other rights to convert any obligations into shares of capital stock or ownership interests in Holding Company or FHMS, respectively, except that all of the Holding Company Shares are subject to the Option and except as set forth on SCHEDULE 5.15. The Holding Company Shares are wholly owned by Selling Shareholder free and clear of all Encumbrances except for the Option and as set forth on SCHEDULE 5.15 and the FHMS Shares are wholly owned by Seller free and clear of all Encumbrances except as set forth on SCHEDULE 5.15. (c) Except as set forth on SCHEDULE 5.15, there are no voting trusts, registration rights, proxies, shareholder agreements or other agreements or understandings with respect to the Holding Company Shares or the FHMS Shares. 13 5.16 REAL PROPERTY. Neither Holding Company nor any of Holding Company's subsidiaries owns any real property in fee. As of the Closing Date, FHMS will not own any real property in fee. 5.17 TAXES. Each of FHMS and Holding Company has duly filed or caused to be filed with the appropriate Governmental Authority all tax returns and reports required to be filed (subject to permitted extensions or amendments applicable to such filings) with respect to their respective Businesses at or prior to the Closing Date for all periods up to and including the Closing Date and will timely file subsequent to the Closing Date such tax returns as shall be due thereafter for periods up to and including the Closing Date and Seller shall be entitled to all the benefits, including any net operating losses, and be responsible for all the obligations of, such tax returns (which returns are or will be accurate and complete), and shall have paid all Taxes shown to have become due pursuant to such tax returns and will continue to pay such Taxes for periods ending on or before the Closing Date. FPA and Purchasing Shareholder shall join and cause Holding Company and FHMS to join, Seller and Selling Shareholder, as the case may be, in filing or amending any such tax returns, if required, at no out-of-pocket expense to FPA and Purchasing Shareholder. Neither FHMS, Holding Company nor any of Holding Company's subsidiaries is a party to any pending action or proceeding, nor, to the knowledge of Seller, is any such action or proceeding threatened in writing by any Governmental Authority against FHMS, Holding Company or any of Holding Company's subsidiaries for the assessment or collection of Taxes. Since the Financial Statement Date, no liability for Taxes has been incurred by FHMS, Holding Company or any of Holding Company's subsidiaries other than in the Ordinary Course of business. There are no liens for Taxes except for liens for property taxes not yet delinquent. 5.18 PROPRIETARY RIGHTS. Each of Holding Company and Holding Company's Subsidiaries owns or licenses all trademarks, trade or fictitious names, copyrights and proprietary know-how necessary or material to their respective Businesses as currently conducted. 5.19 SUBSIDIARIES. Neither of FHMS nor Holding Company owns, directly or indirectly, any interest or investment (whether equity or debt) in any corporation, partnership, business, trust, or other entity except as set forth on SCHEDULE 5.19 hereto. 5.20 ACCOUNTS RECEIVABLE. All accounts receivable of FHMS, FHMG and TDMC shown on the Financial Statements and all accounts receivable arising after the Financial Statement Date, arose from transactions in the Ordinary Course and have been collected or to Seller's knowledge, are collectible in at least their aggregate recorded amounts, net of any applicable reserve. 5.21 BROKERS. Other than Bear, Stearns & Co., Inc. which has acted on behalf of Seller and its Affiliates in connection with the transactions contemplated hereby, and whose commissions, fees and expenses are the sole responsibility of Seller, no Person has acted on behalf of Seller in connection with the transactions contemplated hereby in such a way as to give rise to a valid claim against FPA or its Affiliates for brokerage commissions, or finders' or similar fees. 5.22 CERTAIN REAL ESTATE AND LEGAL MATTERS. All references to the "Care Centers" in this SECTION 5.22 shall mean the real estate constituting the Care Centers only and shall not refer to any business operations or services conducted on or from the Care Centers. SCHEDULE 1.1(a) attached hereto contains a complete list of all Care Centers and indicates which Care Centers are owned, are leased from a third party or are leased under the May 25, 1995 Tax Retention Operating Lease (the "TROL") between FHMS and First Security Bank of Utah, N.A., as trustee under the FH Trust 1995-1 (the "TROL Lessor"). (a) Seller has no knowledge, and Seller has received no notice to the contrary, of any plan, study or effort of governmental authorities which could reasonably and materially and adversely affect the use of any of the Care Centers or could reasonably result in any charge being levied against, or any lien assessed upon, any of the Care Centers (other than usual and customary real property taxes and assessments for amounts not yet delinquent). Seller has no knowledge of any existing, proposed or contemplated plan to widen, modify or realign any street or highway contiguous to any of the Care Centers. 14 (b) No notices of violation of laws or governmental regulations relating to any of the Care Centers have been received by Seller. To the best of Seller's knowledge, the improvements to the Care Centers were constructed in all material respects in accordance with all plans, specifications, drawings and permits applicable thereto and are permitted, conforming structures under applicable laws and ordinances in effect at the time of construction. (c) There is no pending proceeding in eminent domain or any action to quiet title, which reasonably could materially and adversely affect any of the Care Centers, nor does Seller know of the existence of any threatened proceedings or of the existence of any facts which might give rise to such action or proceeding. (d) Seller has received all occupancy permits or similar permits necessary to occupy the Care Centers as they are currently being used and operated by Seller. (e) Except for those pending sales and assignments of Care Centers and interests therein as set forth on attached SCHEDULE 5.22(e) (collectively, the "Pending Transfers"), Seller has not entered into any other contracts for the sale of the Care Centers nor do there exist any rights of first offer or first refusal or options to purchase any of the Care Centers. The execution of final documentation and/or closing of any or all of the Pending Transfers shall not affect the terms or conditions of this Agreement). (f) Seller has no knowledge, and Seller has received no written notice to the contrary, of any special assessments which will result from work, activities or improvements done to the Care Centers by Seller or by any tenants or other parties, except as disclosed in title documents delivered by Seller to Purchasing Subsidiary or otherwise examined by or available to Purchasing Subsidiary. (g) As of the above date, to the best of Seller's knowledge, the Care Centers are not in violation of any federal, state or local law, ordinance or regulation promulgated thereunder relating to industrial hygiene or to the environmental conditions on, under or about the Care Centers including, but not limited to, all improvements, facilities, structures and equipment thereon, and the soil and groundwater thereunder. During the time in which Seller's Affiliates owned the Care Centers (each, an "OWNER"), neither the Owner nor, to the best of Seller's knowledge, any third party has used, released, generated, manufactured, or produced on, under or about the Care Centers, or transported to or from the Care Centers, any flammable explosives, radioactive materials, hazardous wastes or substances, polychlorinated biphenyls or similar materials that are dangerous to the public health (collectively, "Hazardous Materials") in violation of statutes, ordinances or regulations that govern the use and/or disposal of Hazardous Materials (collectively, "Environmental Laws"). (h) Each of the Care Centers is connected to and served by water, sewage disposal, drainage, telephone, gas, electricity and other utility equipment facilities and services required by law, or, to the best of Seller's knowledge, are reasonably adequate for the present use and operation of the Care Centers and which are installed and connected pursuant to valid permits required at the time of construction of the Care Center or installation of the utility. (i) To the best of Seller's knowledge, there are no physical or mechanical defects or deficiencies in the condition of the Care Centers that would result in the revocation of any required building or occupancy permit. (j) The Owners have not received any notices from any insurance company of any defects or inadequacies in the Care Centers. 15 (k) To the best of Seller's knowledge, there are no storage or other tanks or containers, or wells or other improvements below the surface of the Care Centers in violation of any Environmental Laws or in violation of statutes, ordinances and/or regulation governing the installation, use, sealing or removal of such storage tanks. The Owners did not install any underground storage tanks under any of the Care Centers. (l) Except for the leases and subleases of the Care Centers currently in effect and disclosed or made available for inspection by Seller (the "Leases"), there are no oral or written leases, subleases, occupancies, or tenancies in effect pertaining to the Care Centers. (m) Copies of the Leases, title documents, environmental reports and similar real estate related documents which have been given to Purchasing Subsidiary by Seller are true and correct copies thereof in all material respects. (n) The Owners have received no written notice from any of the tenants of any of the Care Centers informing the Owners of any material defects in the structure or mechanical systems of any of the Care Centers that would adversely affect use and occupancy of the Care Centers. (o) With respect of each of the Leases, except as may be otherwise set forth in the Leases, in the rent roll for the respective Care Centers provided by Seller to Purchasing Subsidiary, in documentation or information provided to or available to Purchasing Subsidiary during the normal course of Purchasing Subsidiary's due diligence, the following information is true and correct: (a) each of the Leases is in full force and effect according to the terms set forth therein and has not been further modified, amended, extended or assigned by Seller, in writing or otherwise; (b) all obligations of each Owner, as landlord under the Leases, which have accrued prior to Closing will be performed in all material respects and, to Seller's best knowledge, no tenant has asserted or has any defense to, or any offsets, abatements, concessions, claims against, any rent payable by it after the date hereof, or any calculation of rent, or the performance of any other obligations under such tenant's respective Lease; (c) to the best of Seller's knowledge, no tenant is in default under or in arrears in the payment of any sum payable or in the performance of any obligation required of it under its Lease, including but not limited to all rent, taxes, assessments, repairs and maintenance charges, insurance premiums, utilities or other charges or expenses, and, to the best of Seller's knowledge, no tenant has prepaid any rent or other charges; (d) to Seller's best knowledge, no tenant is unable to perform any or all of its obligations under its Lease, whether for financial or legal reasons or otherwise; (e) to Seller's best knowledge, no guarantor or any assignor under any of the Leases has been released or discharged from any obligation under or in connection with any of the Leases; (f) Seller has not applied any security deposit from a tenant to rent or any other obligation due from any tenant without Purchasing Subsidiary's prior written consent; (g) all work required to be done by any Owner, as landlord under each such Lease, has been or by the Closing will be done or furnished unless otherwise agreed by the parties and no tenant is entitled to any additional work during the term of its Lease; (h) neither the Leases nor the rents nor any other amounts payable thereunder have been assigned, pledged or encumbered by Seller, except in connection with existing indebtedness disclosed by Seller to Purchasing Subsidiary; and (i) Seller has not received from any tenant written notice of any presently pending dispute regarding the calculation of payment of rent, the terms of any Lease or any alleged default by Seller, as lessor, under such Lease, or of any bankruptcy, receivership, custodianship, reorganization, insolvency, assignment for benefit of creditors or other proceeding of a similar nature respecting any tenant, any Lease or the Care Centers. (p) Seller is not now nor at Closing will be a "foreign person" as defined in Internal Revenue Code section 1445. (q) To the best of Seller's knowledge, the Leases, environmental reports, title documents, rent rolls and other documents delivered by Seller to Purchasing Subsidiary or otherwise made available to Purchasing Subsidiary by Seller do not contain any false information that could, if relied upon, materially affect Purchasing Subsidiary's decision to purchase the Care Centers. 16 (r) Except for the Pending Transfers and as otherwise disclosed to Purchasing Subsidiary, neither the respective Owner's interest in the Leases, nor any of the rentals due or to become due under the Leases, has been or will be assigned prior to the Closing. (s) No leasing or brokerage fees or commissions of any nature whatsoever is now due or shall become due or owing by any Owner to any third party after the Closing under the existing provisions of any of the Leases. (t) Subject to the Pending Transfers and clause (u), below, Seller agrees to cause the Owners to continue to cause the Care Centers to be managed and maintained, reasonable wear and tear excepted, in the ordinary and usual course of business prior to the Closing; provided, however, Seller and the Owners shall not, without the prior written consent of Purchasing Subsidiary, convey any interest in the Care Centers or subject the Care Centers to any additional liens, encumbrances, covenants, conditions, easements, or rights of way adversely affecting the Care Centers or enter into any contracts, other than contracts terminable upon no less than thirty days prior notice. (u) The Owners will not hereafter modify, cancel, extend or otherwise change any of the terms, covenants, or conditions of the Leases, enter into, renew or extend any Leases (other than (i) documentation regarding any of the Pending Transfers, and (ii) Leases or cancellation or modifications of Leases with any Affiliates of Seller or with any Affiliates of or providers to the Owners, which may be modified, amended or canceled in the sole and absolute discretion of the respective Owners at any time before the Closing) without the prior written consent of Purchasing Subsidiary, which shall not be unreasonably withheld. If Purchasing Subsidiary does not disapprove any written request of Seller under this subparagraph within ten (10) days of such request, Purchasing Subsidiary shall be deemed to have approved such request. (v) To the extent insured as to the date of this Agreement, the respective Owners shall, at their sole cost and expense, will keep in full force all existing insurance policies affecting the Care Centers or any portion thereof through the Closing. Purchasing Subsidiary acknowledges that the assignment or subletting, as applicable of the Leases (collectively, the "Assignments") may require the written consent of the landlords or sublandlords (collectively, the "Landlords"). Seller shall solicit the Landlords' consent to the Assignments as soon as possible after the Closing. Notwithstanding the foregoing, Purchasing Subsidiary acknowledges that the Closing may occur notwithstanding the inability or failure to obtain the required consent of each of the Landlords, and Purchasing Subsidiary shall (i) waive any claims, actions, demands, causes of action, liabilities, judgments, costs and expenses (collectively, "Claims") Purchasing Subsidiary may incur as a result of the inability to obtain consent to the Assignments, and (ii) indemnify, defend and hold Seller harmless from and against any and all Claims that Purchasing Subsidiary may incur as a result of proceeding with the Assignments without the consent of each of the Landlords. Seller shall have no liability for any breach of any of the foregoing representations or warranties if Purchasing Subsidiary or Purchasing Subsidiary's agents, attorneys, or other representatives was either aware or through the exercise of reasonable diligence would have been aware of the facts to the contrary. ARTICLE 6 REPRESENTATIONS AND WARRANTIES OF FPA AND PURCHASING SUBSIDIARY Each of FPA and Purchasing Subsidiary hereby jointly and severally represents and warrants to Seller and Selling Shareholder as follows: 17 6.1 ORGANIZATION OF FPA AND PURCHASING SUBSIDIARY. Each of FPA and Purchasing Subsidiary is a corporation and Purchasing Shareholder is a professional corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware and is duly qualified and in good standing as a foreign corporation in any state other than its state of incorporation where its business requires that it be so qualified, with all requisite power and authority to own, lease and operate its properties and to carry on its business as now being conducted, and is qualified to do business as a foreign corporation in the States of California and Arizona. 6.2 AUTHORIZATION. Each of FPA, Purchasing Subsidiary and Purchasing Shareholder has full power, authority and capacity to enter into and perform this Agreement, the Related Agreements and the other agreements and documents contemplated by this Agreement to which it is a party and to carry out the transactions contemplated by this Agreement and such other agreements. This Agreement has been duly and validly executed and delivered by each of FPA, Purchasing Subsidiary and Purchasing Shareholder and constitutes and upon the execution and delivery by each of FPA, Purchasing Subsidiary and Purchasing Shareholder of the Related Agreements to which it is a party such Related Agreements will constitute, the legally valid and binding obligation of each of them, enforceable in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws and equitable principles relating to or limiting creditors' rights generally and general principles of equity. 6.3 NO CONFLICT OR VIOLATION. None of the execution, delivery and performance of this Agreement, the consummation of the transactions contemplated hereby, and the compliance by FPA, Purchasing Subsidiary and Purchasing Shareholder with any of the provisions hereof, will (i) violate or conflict with any provision of the respective Certificates of Incorporation or Bylaws of FPA or Purchasing Subsidiary, (ii) except as set forth on SCHEDULE 6.3, violate, conflict with, or result in a breach of any provision of, or constitute a default (or any event which, with notice or lapse of time or both, would constitute a default) under, or result in a right of termination or acceleration under, any of the terms, conditions or provisions of any contract, indebtedness, note, bond, indenture, security or pledge agreement, commitment, license, lease, franchise, permit, agreement, or other instrument or obligation to which FPA, Purchasing Subsidiary or Purchasing Shareholder is a party except for violations, conflicts, breaches, defaults, terminations, accelerations, rights of termination or acceleration, or Encumbrances that would not reasonably be expected to have a Material Adverse Effect on FPA or Purchasing Subsidiary or (iii) to FPA's knowledge violate any Laws the violation of which could reasonably be expected to have a Material Adverse Effect on FPA or Purchasing Subsidiary. 6.4 PERMITS AND GOVERNMENTAL FILINGS. (a) PERMITS. To FPA's knowledge, SCHEDULE 6.4(a) sets forth a complete and accurate list of all material Permits which constitute all material Permits required to conduct the respective businesses of FPA and Purchasing Subsidiary as now being conducted. No notice or warning from any authority with respect to the suspension, revocation, or termination of any material Permit has been received by FPA. FPA has delivered to Seller true, correct and complete copies of all Permits requested by Seller. (b) FILINGS. Except as disclosed on SCHEDULE 6.4(b) hereto, no notice to, declaration, filing or registration with, or Permit from, any governmental or regulatory body or authority is required to be made or obtained by FPA, Purchasing Subsidiary or Purchasing Shareholder in connection with the execution, delivery or performance of this Agreement and the consummation of the transactions contemplated by this Agreement and the Related Agreements, except for any such notices, declarations, filings, registrations or Permits, the failure of which to be obtained would not reasonably be expected to have a Material Adverse Effect on FPA or Purchasing Subsidiary. 6.5 FINANCIAL STATEMENTS. The FPA Financial Statements, together with the notes thereto (i) are in accordance with the books and records of FPA, (ii) fairly and accurately present the assets, liabilities and financial position of FPA as of the dates thereof and the results of operations for the periods then ended and (iii) have been prepared in accordance with GAAP consistently applied throughout the periods presented. 18 6.6 SEC DOCUMENTS. FPA (i) has provided to Seller and Selling Shareholder, a true and complete copy of FPA's Annual Report on Form 10-K (without exhibits) for the years ended December 31, 1994 and December 31, 1995, and Quarterly Report on Form 10-Q for the three (3) months ended March 31, 1996, and its definitive 1996 proxy statement filed by FPA with the SEC and (ii) will provide to Seller and Selling Shareholder all documents filed by FPA with the SEC at or prior to the Closing Date (collectively, with the documents listed in clause (i), the "FPA SEC DOCUMENTS"). As of their respective filing dates, FPA has made all necessary filings with the Securities and Exchange Commission ("SEC") required to be filed by it since October 20, 1994, the FPA SEC Documents comply or will comply in all material respects with the requirements of the Exchange Act or the Securities Act, and none of the FPA SEC Documents contains or will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading, except to the extent material statements in any of the foregoing are modified or superseded in accordance with applicable rules and regulations of the SEC by a subsequently filed FPA SEC Document delivered to the Shareholders prior to the date of this Agreement. 6.7 NO MATERIAL ADVERSE CHANGE. Except as listed on SCHEDULE 6.7, or in a FPA SEC Document since March 31, 1996, there has not been any Material Adverse Change in FPA. 6.8 COMPLIANCE WITH LAWS. To FPA's knowledge, each of FPA, Purchasing Subsidiary and Purchasing Shareholder is in compliance with all Laws, except where the failure to comply would not reasonably be expected to have a Material Adverse Effect on FPA or Purchasing Subsidiary. 6.9 LITIGATION. Except as disclosed on SCHEDULE 6.9, as of the date hereof there are no Actions pending or threatened in writing against FPA, Purchasing Subsidiary or Purchasing Shareholder other than Actions that would not reasonably be expected to have a Material Adverse Effect on FPA or Purchasing Subsidiary. 6.10 NO UNDISCLOSED LIABILITIES. Except as disclosed on SCHEDULE 6.10, since March 31, 1996, FPA has not incurred any liability material to FPA other than in the Ordinary Course. Purchasing Subsidiary has no Liabilities other than pursuant to this Agreement and the Related Agreements and is not a party to any Contract other than this Agreement and the Related Agreements to which it is a party. 6.11 CAPITAL STRUCTURE. (a) The authorized capital stock of FPA consists of 98,000,000 shares of Common Stock $.001 par value, 2,000,000 shares of Preferred Stock $.002 par value, the number and classes of outstanding equity securities of FPA (including securities convertible or exercisable into or exchangeable for equity securities of FPA) are as listed on SCHEDULE 6.11. The authorized capital stock of Purchasing Subsidiary consists of 100 shares of common stock, $.01 par value. (b) All of the outstanding shares of capital stock of FPA and Purchasing Subsidiary (i) were issued in compliance with applicable federal and state securities laws and (ii) are duly authorized, validly issued, fully paid and nonassessable and not subject to preemptive rights created by statute, the Certificate of Incorporation or Bylaws of the respective issuer of such shares or any agreement to which FPA or Purchasing Subsidiary is a party or by which it is bound. (c) The shares of FPA Common will, when issued and delivered to the Seller in accordance with this Agreement, be duly authorized, validly issued, fully paid and nonassessable and not subject to preemptive rights created by statute, FPA's Certificate of Incorporation, Bylaws or any agreement to which FPA is a party or by which it is bound. 19 ARTICLE 7 COVENANTS OF PARTIES HERETO Seller, Selling Shareholder, FPA, Purchasing Subsidiary and Purchasing Shareholder each covenant with the other as follows: 7.1 FURTHER ASSURANCES. Upon the terms and subject to the conditions contained herein, each of Seller, Selling Shareholder, FPA, Purchasing Subsidiary and Purchasing Shareholder agrees, both before and after the Closing, (i) to use all reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement and the Related Agreements, (ii) to execute any documents, instruments or conveyances of any kind which may be reasonably necessary or advisable to carry out any of the transactions contemplated hereunder or thereunder, and (iii) to cooperate with each other in connection with the foregoing, including using all reasonable efforts (A) to obtain all permits or licenses required to be obtained under any applicable Laws, (B) to effect all necessary registrations and filings, including submissions of information requested by governmental authorities, (C) to fulfill all conditions to this Agreement and (D) to consult with each other regarding renegotiation of any Expiring Contract. Seller, Selling Shareholder, FPA, Purchasing Subsidiary and Purchasing Shareholder will commence all action required under clause (A) above (including making all filings required under the HSR Act) as soon as reasonably practicable. 7.2 NO SOLICITATION. From the date of this Agreement to the Closing Date or earlier termination of this Agreement (the "EXCLUSIVITY PERIOD"), neither Seller nor Selling Shareholder will directly or indirectly make, entertain, solicit or encourage inquiries or proposals, enter into or conduct discussions, or negotiate or enter into an agreement with any party other than FPA, Purchasing Subsidiary and Purchasing Shareholder for the divestiture of FHMS or Holding Company, respectively, whether by way of an asset or stock sale, partnership, joint venture, merger, consolidation or other transaction (provided that the foregoing shall not limit or restrict restructuring or other changes by FHMS or Holding Company or any of Holding Company's subsidiaries). 7.3 INSPECTIONS. FPA, on the one hand, and Seller and Selling Shareholder, on the other, agree that, prior to the Closing, (i) FPA and its Representatives will have full access to such business, books, records, management and operations of FHMS, Holding Company and Holding Company's subsidiaries as may be reasonably required by FPA to evaluate the transactions contemplated by this Agreement and the Related Agreements PROVIDED, HOWEVER, that nothing contained herein shall give FPA or Purchasing Shareholder a right of access to the consolidated tax returns of Seller; and (ii) Seller and its Representatives will have full access to such business, books, records, management and operations of FPA and its Affiliates as may be reasonably required by Seller to evaluate the quality of healthcare services provided or to be provided by FPA or its affiliated medical groups. FPA will exercise reasonable efforts to minimize interference with the Businesses and Seller will exercise reasonable efforts to minimize interference with FPA's business. Each of FPA and Seller further agrees to provide the other with reasonable notice before visiting the other's or its Affiliates' facilities or contacting the other's or its Affiliates' employees, practitioners or allied health professionals for the purpose of inspecting and conducting the due diligence contemplated by this SECTION 7.3. 7.4 CONDUCT OF BUSINESS. Except as set forth in SCHEDULE 7.4 or as specifically contemplated by this Agreement and the Related Agreements or requested by FPA in writing, from the date hereof until the Closing, Seller will cause FHMS to and Selling Shareholder will cause Holding Company to operate its respective Business in the Ordinary Course. In addition, from the date hereof through the Closing, (i) Seller will not permit FHMS and Selling Shareholder will not permit Holding Company or any of its Subsidiaries, except in the Ordinary Course, to sell, transfer or assign or acquire any asset material to its respective Business (materiality for this purpose being defined as $100,000) and (ii) Seller will not permit FHMS to and Selling Shareholder will not permit Holding Company or Holding Company's subsidiaries to, enter into any Contract other than in the Ordinary Course. In addition, Seller will not permit FHMS to and Selling Shareholder will not permit Holding Company or any of its subsidiaries to (i) issue, deliver or sell or authorize or propose the issuance, delivery or sale of, or purchase or propose the purchase of, any shares of its capital stock of any class or securities convertible into, or rights, warrants or options to acquire, any such shares or other 20 convertible securities or (ii) amend their respective Articles or Certificates of Incorporation or Bylaws, except as may be necessary or advisable in connection with the transactions contemplated hereby and by the Related Agreements. 7.5 EMPLOYEE MATTERS. (a) EMPLOYEE BENEFITS GENERALLY. The employees of FHMS, Holding Company and Holding Company's subsidiaries who are retained by FPA or a subsidiary or Affiliate of FPA (including Purchasing Subsidiary) shall be referred to herein as the "Retained Employees." FPA shall provide each Retained Employee (and, to the extent applicable, the Retained Employee's respective eligible dependents) benefits which are substantially similar to those provided under the employee benefit plans applicable to similarly situated employees of FPA or its Affiliates. Without limiting the foregoing, FPA shall provide health coverage to each Retained Employee (and dependents) under a group health plan of FPA, shall waive any pre-existing condition exclusion that otherwise would apply, shall provide each Retained Employee (and dependent) with credit under the group health plan for any deductibles and co-payments paid during the coverage year with respect to the Retained Employee's (and dependent's) coverage prior to the Closing Date and shall provide such group health plan coverage as of the Closing Date. For purposes of determining eligibility to participate, vesting and benefit eligibility in any employee benefit plan of FPA, its subsidiaries or Affiliates, FPA shall give each Retained Employee full credit for the service credited to the Retained Employees under the Employee Benefit Plans. The preceding sentence does not require FPA to give any Retained Employee credit under its employee pension benefit plans for prior pension benefit accrual service under any Employee Benefit Plan. (b) ASSUMPTION OF LIABILITIES. Except as specifically provided in this SECTION 7.5 or in SECTION 10.5(a), effective as of the Closing Date, FPA agrees that FHMS shall have all liability and responsibility of Seller with respect to employees or former employees of FHMS or with respect to employees or former employees of the Holding Company or the Holding Company's subsidiaries, provided, that such liabilities are shown in the pro forma consolidated balance sheet attached hereto as SCHEDULE 1.1(b) (as may be further described on SCHEDULE 7.5(b)). Seller and its subsidiaries and Affiliates shall not retain any, and shall not be deemed to have retained any, of such liabilities or responsibilities. (c) SELLER'S 401(K) PLAN. (i) Effective as of the Closing Date and as soon as practicable thereafter, FPA shall cause FHMS to make all required contributions to be made to the Foundation Health Corporation Profit Sharing and 401(k) Plan (as amended and restated effective January 1, 1994) ("SELLER'S 401(k) PLAN") for each participating FHMS Employee. (ii) Each FHMS Employee shall cease to participate in Seller's 401(k) Plan for periods after the Closing Date. As soon as practicable after the Closing Date, as more fully described below, Seller and FPA shall arrange for the transfer of Seller's 401(k) Plan accounts (the "ACCOUNTS") of the FHMS Employees who are participants in Seller's 401(k) Plan and who elect to make such transfer during the election period established by Seller. Such Accounts shall be valued as of the last business day before the transfer is effected from Seller's 401(k) Plan and shall be transferred to one or more defined contribution plans (within the meaning of Section 3(34) of ERISA) which is or are maintained by FPA, its subsidiaries or Affiliates for the benefit of eligible employees and which is or are qualified under Section 401(a) of the Code (collectively, "FPA's SAVINGS PLANS"). FPA, its subsidiaries and Affiliates agree to cooperate with Seller, its subsidiaries and Affiliates in directing the trustee of any trust in which the assets of Seller's 401(k) Plan are invested to transfer to a new trustee or trustees or other funding agent or agents appointed by FPA or its Affiliates for FPA's Savings Plan, the amount of assets in the Accounts of the affected FHMS Employees participating in Seller's 401(k) Plan. Such transfer of assets of Seller's 401(k) Plan described above shall be made in cash or marketable securities. Such transfer of assets shall occur as soon as practicable after the last to occur of the receipt by Seller of FPA's (its subsidiary's or Affiliate's) certification that (i) FPA, its subsidiaries or Affiliates has established FPA's 21 Savings Plans; (ii) FPA, its subsidiaries or Affiliates has received or requested a favorable determination letter for FPA's Savings Plans from the Internal Revenue Service, and (iii) FPA's Savings Plans provide that each participating FHMS Employee shall, immediately after the date of the transfer of assets in the Accounts as described above, have an accrued benefit under FPA's Savings Plans at least equal to the benefit accrued under Seller's 401(k) Plan immediately prior to such date. As of the transfer date, FPA shall become the plan sponsor with respect to the transferred Accounts of FHMS Employees and shall assume all obligations and Liabilities under all applicable Laws with respect to such Accounts. (d) FROZEN 401(k) PLAN. Effective as of the Closing Date or as soon as practicable thereafter, Seller shall transfer in whole to FPA all of the assets and liabilities under the Thomas-Davis Medical Centers, P.C. Profit Sharing and 401(k) Plan and its related trust (the "FROZEN 401(k) PLAN"). As of the transfer date, FPA shall become the plan sponsor of the Frozen 401(k) Plan and shall assume all obligations and liability under all applicable Laws with respect to the Frozen 401(k) Plan. (e) SMART CHOICES PLAN. Effective as of the Closing Date and for the duration of the current coverage period, FPA shall establish a dependent care reimbursement account and a health care flexible spending account for FHMS Employees that continues benefits on the same terms as apply to the FHMS Employees under the Seller-sponsored SMART Choices Plan. In connection therewith, effective as of the Closing Date or as soon as practicable thereafter, Seller shall transfer to FPA account balances of FHMS Employees under the dependent care reimbursement account and the health care reimbursement account features of the Seller-sponsored SMART Choices Plan. Effective as of the Closing Date, with respect to such transferred accounts, FPA shall assume all obligations and Liabilities under all Applicable Laws. (f) MATCHING CONTRIBUTIONS. Effective as of the Closing Date, FPA shall assume all obligations and Liabilities of Seller with respect to the October 31, 1994 letter agreement attached hereto as Exhibit A, regarding the provision of a 401(k) matching contribution of up to six percent (6%) of their compensation, with respect to certain employees of TDMC. (g) COOPERATION OF FPA AND SELLER. FPA and Seller shall take all actions which they deem necessary or desirable to implement the provisions of this SECTION 7.5. (h) THIRD PARTY BENEFICIARIES. It is understood and agreed between FPA and Seller that all provisions contained in this Agreement with respect to employee benefit plans or employee compensation or employment are included for the sole benefit of the parties hereto and do not and shall not create any right in any other person, including, but not limited to, any Employee, any participant in any benefit or compensation plan or any beneficiary thereof. (i) ACTION BY FPA'S AFFILIATES. Any action required by FPA pursuant to this SECTION 7.5 shall be deemed satisfied to the extent such action is taken by an Affiliate of FPA. 7.6 FPA'S COVENANT NOT TO COMPETE. (a) FPA'S PROHIBITED CONDUCT. Each of FPA and Purchasing Subsidiary acknowledges and agrees that pursuant to the transactions contemplated hereby and due to the ongoing relationship among Seller, FHCA, Family and Senior Care, Inc., FHMG, TDMC, Purchasing Subsidiary and FPA contemplated hereby, by the Professional Group Provider Agreements and the other Related Agreements, FPA and its Affiliates will be receiving confidential and proprietary information concerning Seller, FHCA and their Affiliates and that the use of such information by FPA or its subsidiaries or Affiliates (including Purchasing Subsidiary) could result in serious economic detriment to Seller, FHCA and/or their Affiliates. Therefore, subject to the provisions of this SECTION 7.6, neither FPA nor any of its Affiliates (including Purchasing Subsidiary) shall seek to modify its respective Knox- Keene Act limited license so as to operate as a comprehensive health care service plan, or hold, acquire, or make any commitment to hold or acquire a controlling interest in, a comprehensive health plan, which 22 offers insured, self-insured or prepaid health insurance products to individuals, to CHAMPUS, FEHBP, Medicare, Medicaid or other state or federal healthcare programs, to commercial groups or other sponsors of health care benefit plans in the Provider Service Area (as defined in addenda B, C and D to each Professional Group Provider Agreement) until the earlier of (i) the expiration of the Professional Group Provider Agreements by their own terms or (ii) the first anniversary of the date the Professional Group Provider Agreements terminate as a result of a breach of such agreements by FHCA (the "NON-COMPETE PERIOD"). Without limiting the foregoing, the parties hereto understand and agree that FPA or an Affiliate of FPA is seeking a restricted health care service plan license from the California Department of Corporations in order to continue its operations as in effect on the date hereof and as of the Closing Date. Upon attainment of such license, FPA shall only utilize such license for the conduct of its business as currently conducted and shall not, either directly or indirectly, compete with Seller, FHCA or any of their respective Affiliates in the Provider Service Area during the Non-Compete Period by marketing or soliciting potential HMO enrollees as a direct contractor to employer groups, individuals or governmental entities. A termination of the Professional Group Provider Agreements due to a material breach thereof by FPA or an Affiliate of FPA shall not relieve FPA or its Affiliates from their obligations under this SECTION 7.6. (b) SELLER'S PROHIBITED CONDUCT. Subject to the provisions of this SECTION 7.6, until the earlier of (i) the date which is three (3) years from the date hereof or (ii) the termination of a Professional Group Provider Agreement, Seller shall not (i) purchase any medical group if the FHCA linked lives to FHMG or TDMC which are provided services by the medical groups acquired during such period in a given Provider Service Area exceed five percent (5%) of the number of FHCA linked lives to FHMG or TDMC within such Provider Service Area or (ii) purchase any independent physicians association or medical group within a five mile radius of any Care Center purchased pursuant hereto. (c) REMEDIES. The parties hereto acknowledge and agree that the breach of the provisions of this SECTION 7.6 by FPA or any of its Affiliates (including Purchasing Subsidiary) would cause irreparable harm to Seller and FHCA and that the party injured by such breach would not have an adequate remedy at law or in damages. Therefore, FPA consents to the issuance of an injunction or the other enforcement of equitable remedies against it or its Affiliates (including Purchasing Subsidiary) at the suit of Seller, without bond or other security, to compel performance of all the terms of this SECTION 7.6, and waives the defense of the availability of relief in damages. (d) SEVERABILITY. To the extent any provision of this SECTION 7.6 shall be invalid or unenforceable, it shall be considered deleted herefrom and the remainder of such provision and of this SECTION 7.6 shall be unaffected and shall continue in full force and effect. In furtherance and not in limitation of the foregoing, should the duration or geographical extent of, or business activities covered by any provision of this SECTION 7.6 be in excess of that which is valid and enforceable under applicable Law, then such provision shall be construed to cover only that duration, extent or activities which may validly and enforceably be covered. The parties hereto acknowledge the uncertainty of the Law in this respect and expressly stipulate that this SECTION 7.6 shall be given construction that renders its provisions valid and enforceable to the maximum extent (not exceeding its express terms) possible under applicable law. (e) TERMINATION OF COVENANT. Notwithstanding anything else contained herein, if the covenant of Buyer under SECTION 7.6(a), or the covenant of Seller under SECTION 7.6(b) is found to be unenforceable or if either Buyer or Seller or any of their respective Affiliates breach any such covenant and such breach is not cured within thirty (30) days of receipt of notice thereof, then the non-breaching party and its Affiliates shall be released from their obligations under SECTION 7.6(a) OR (b), as the case may be, and such provision shall be deemed terminated and of no further force and effect. 23 7.7 PURCHASE OF INDEBTEDNESS; POST-CLOSING ADJUSTMENT . The parties hereto acknowledge and agree that (i) Purchasing Subsidiary shall purchase the FHMS Indebtedness and the Holding Company Indebtedness as set forth in ARTICLES 2 AND 3 and (ii) that the Holding Company Indebtedness Purchase Price, the FHMS Indebtedness Purchase Price and the Note Consideration shall be represented by the Consolidated Note and, together with certain obligations under the Professional Group Provider Agreements and certain third party indebtedness shall be guaranteed by FPA in accordance with SECTION 8.6. The parties hereto understand and agree that (i) the Holding Company Indebtedness Purchase Price and the FHMS Indebtedness Purchase Price will be based, initially, on the amount of Holding Company Indebtedness and FHMS Indebtedness shown on the Pro Forma Consolidated Balance Sheet of FHMS, Holding Company and its subsidiaries as of the Closing Date, (PROVIDED, that for the period between June 30, 1996 and Closing there will be no reduction in the Note for any utilization by the Seller of tax benefits from FHMS, TDMC and FHMG, it being acknowledged and agreed that the Tax Sharing Agreements between FHC and each of FHMS, TDMC and FHMG obligating FHC to compensate each of FHMS, TDMC and FHMG for such utilization shall be terminated as of July 1, 1996) and that the principal amount of the Consolidated Note shall reflect such amounts, (ii) Seller shall cause an audit (the "Closing Audit") of the consolidated balance sheet of FHMS, Holding Company and its subsidiaries as of the Closing Date to be conducted promptly after the Closing Date and shall furnish Purchasing Subsidiary with the audited consolidated balance sheet of FHMS, Holding Company and Holding Company's subsidiaries within sixty (60) days following the Closing Date and (iii) following such audit, the principal amount of the Consolidated Note shall be adjusted such that it equals the actual audited amounts of FHMS Indebtedness and Holding Company Indebtedness (subject to the proviso in clause (i)) plus the Note Consideration, adjusted for any difference between (x) the interest paid on the Consolidated Note between the Closing Date and the date of such adjustment and (y) that which would have been paid had the Consolidated Note been based on the audited consolidated balance sheet at the Closing Date. In furtherance of the foregoing, Purchasing Subsidiary agrees to issue a new Consolidated Note in the adjusted amount and upon receipt of such new Consolidated Note, Seller agrees to cancel the existing Consolidated Note. 7.8 PREPARATION OF THE PROXY STATEMENT. FPA shall determine whether to seek stockholder approval of this Agreement and the Related Agreements and the transactions contemplated hereby and thereby. If such stockholder approval is sought, to the extent required by applicable Law, FPA shall promptly prepare and file with the SEC a Proxy Statement relating to the transactions contemplated hereby (the "PROXY STATEMENT") and Seller shall promptly furnish all information regarding itself, FHMS, Holding Company and Holding Company's subsidiaries as is reasonably requested by FPA and necessary for the preparation of the Proxy Statement. FPA shall also take any action (other than qualifying to do business in any jurisdiction in which it is now not so qualified) required to be taken under any applicable state and federal securities laws in connection with the issuance of FPA Common pursuant hereto. In addition, if FPA is required to prepare a Proxy Statement pursuant hereto, FPA shall obtain the services of a proxy solicitor reasonably satisfactory to Seller. 7.9 STOCKHOLDERS MEETING. If FPA is required to prepare a Proxy Statement pursuant hereto, FPA shall call a meeting of its stockholders (the "STOCKHOLDERS MEETING") to be held as promptly as practicable for the purpose of voting upon the approval of this Agreement, the Related Agreements and the transactions contemplated hereby and thereby. FPA's Boards of Directors shall recommend to its stockholders approval of such matters. If the Board of Directors of FPA is required by applicable law to review or restate their recommendation, this SECTION 7.9 shall not prohibit accurate disclosure that is required in any FPA SEC Document (including the Proxy Statement) or otherwise under applicable law of the opinion of the Board of Directors of FPA as of the date of such SEC Document or such other required disclosure as to the transactions contemplated hereby. 7.10 AGREEMENT TO VOTE SHARES. In consideration for the execution of this Agreement by Seller and Selling Shareholder, each officer of FPA who is a holder of FPA Common shall, in an agreement reasonably satisfactory to Seller, agree to vote all shares of FPA Common held by such person entitled to vote at the FPA Stockholders Meeting (and at any adjournment thereof) in favor of the transactions contemplated hereby and by the Related Agreements. In addition, FPA shall use it best efforts to have each non-officer director and beneficial owner of (5%) or more of the outstanding FPA Common to sign an agreement agreeing so to do. 24 7.11 SURGERY CENTER REFERRALS. Seller and FPA agree to and agree to cause their appropriate Affiliates to use their reasonable best efforts to enter into an agreement, prior to the Closing Date, providing for referrals from FHMG, TDMC and Intergroup IPA, P.C. ("IG IPA") to the surgery centers listed in such agreement such that the referral pattern from FHMG, TDMC and IG IPA to such surgery centers following the Closing shall be substantially similar to that prior to the Closing. 7.12 DISEASE STATE MANAGEMENT. Seller agrees to cause Integrated Pharmacy Services ("IPS") to and FPA agrees to cause its appropriate Affiliates to use their reasonable best efforts to enter into an agreement, prior to the Closing Date, pursuant to which FPA and such Affiliates would promote IPS's Disease State Management ("DSM") programs to physicians and employees in the care centers of such Affiliates and pursuant to which FPA would and would cause such Affiliates to, make all FHCA pharmacy claims data available to IPS in a format such as to allow IPS to fully develop and implement the DSM programs. 7.13 REAL ESTATE MATTERS. As promptly as reasonably possible but in no event later than forty-five (45) days following the date hereof, Seller shall, at its sole cost and expense, deliver to FPA the following documents and materials (which shall be delivered as they become available to Seller): (a) One or more title insurance commitments with respect to the Owned Care Centers dated no earlier than the date of this Agreement, issued by such title insurance company as may be reasonably acceptable to FPA and accompanied by copies of all documents, instruments and other matters referred to therein as exceptions. (b) Copies of surveys of the Owned Care Centers prepared by or on behalf of Seller or its affiliates; (c) Copies of the most recent real property tax bills with respect to the Owned Care Centers for the preceding tax year; (d) Copies of all real property service, maintenance, management, and other similar real property management contracts with respect to the Owned Care Centers to which Seller or one of its Affiliates is a party and which is in Seller's possession or control; (e) Copies of all certificates of occupancy in Seller's possession or control for the Owned Care Centers; (f) Copies of all warranties and guaranties currently in effect and in Seller's possession or control for the Owned Care Centers or any portion thereof; (g) Copies of all soil, seismological, geological, and drainage reports in Seller's possession or control with respect to the Owned Care Centers; (h) Copies of any "as built" plans and specifications in Seller's possession or control for the Owned Care Centers; (i) Copies of all Leases for the Owned Care Centers, and a current rent roll showing the names of all tenants under the Leases with respect to the Owned Care Centers; (j) Copies of the most recent utility bills and insurance claims in Seller's possession or control with respect to the Owned Care Centers for the preceding six (6) month period; (k) Copies of any environmental audits or studies for the Owned Care Centers to the extent in Seller's possession or control; For purposes of this SECTION 7.13, "Owned Care Centers" shall include those Care Centers owned by FHMS or any Affiliate of FHMS and those Care Centers leased by FHMS under the TROL. 25 7.14 SOFTWARE LICENSES. At Closing, FPA agrees to or to cause one of its Affiliates to assume those certain license and maintenance agreements between Foundation Health, a California Health Plan and the licensors of certain software which is used in connection with the Businesses, which agreements are set forth on SCHEDULE 7.14 hereto. 7.15 GUARANTY PAYMENTS. In the event Seller advances any funds pursuant to its guaranty of certain bank indebtedness of FPA, then FPA agrees to immediately pay Seller the amount of any funds so advanced. ARTICLE 8 CONDITIONS TO SELLER'S AND SELLING SHAREHOLDER'S OBLIGATIONS The respective obligations of Seller and Selling Shareholder to consummate the transactions provided for by this Agreement and the Related Agreements are subject, in the discretion of Seller and Selling Shareholder, respectively, to the satisfaction, on or prior to the Closing Date, of each of the following conditions, any of which may be waived on its or his own behalf by Seller or Selling Shareholder: 8.1 REPRESENTATIONS, WARRANTIES AND COVENANTS. All representations and warranties of each of FPA, Purchasing Subsidiary and Purchasing Shareholder contained in this Agreement shall be true and correct in all material respects (without duplication of any materiality standard contained therein) at and as of the date of this Agreement and at and as of the Closing Date, and each of FPA, Purchasing Subsidiary and Purchasing Shareholder shall have performed in all material respects all covenants required by this Agreement to be performed by it prior to the Closing. 8.2 NO PROCEEDINGS, LITIGATION OR LAWS. No Action by any Governmental Authority or other Person shall have been instituted or threatened which questions the validity or legality of the transactions contemplated by this Agreement and the Related Agreements or which asserts the right of a Governmental Authority to approve any aspect of such transactions and which would reasonably be expected to damage Seller or Selling Shareholder materially if the transactions contemplated hereunder or thereunder are consummated. There shall not be any Laws that make the purchase of the Businesses as contemplated by this Agreement and the Related Agreements illegal or otherwise prohibited. 8.3 OPINION OF COUNSEL. FPA shall have delivered to Seller and Selling Shareholder an opinion of Latham & Watkins, special counsel to FPA, Purchasing Subsidiary and Purchasing Shareholder, dated as of the Closing Date, in form and substance reasonably satisfactory to Seller and its counsel. 8.4 CERTIFICATES AND CORPORATE DOCUMENTS. Each of FPA and Purchasing Subsidiary shall have furnished Seller and Selling Shareholder with such certificates of its officers and others (including Purchasing Shareholder) to evidence compliance with the conditions set forth in this ARTICLE 8 as may be reasonably requested by Seller and Selling Shareholder. Seller and Selling Shareholder shall have received from each of FPA and Purchasing Subsidiary, resolutions adopted by their respective boards of directors and any required shareholder resolutions, approving this Agreement and the Related Agreements to which it is a party and the transactions contemplated by this Agreement and such Related Agreements, certified by FPA's and Purchasing Subsidiary's respective corporate secretaries. 8.5 REGISTRATION RIGHTS AGREEMENT. FPA and Seller shall have entered into a Registration Rights Agreement (the "REGISTRATION RIGHTS AGREEMENT"), containing the terms set forth in the term sheet attached as Exhibit F hereto and otherwise in form and substance reasonably satisfactory to the parties hereto. 8.6 GUARANTIES. FPA shall have (i) executed and delivered to Seller a Guaranty, containing the terms set forth in the term sheet attached as Exhibit G hereto and otherwise in form and substance reasonably satisfactory to the parties hereto, guaranteeing the Consolidated Note and the performance by any Affiliate of FPA that is a party thereto, of its obligations under the Professional Group Provider Agreements and (ii) executed and delivered to each of the third party payees under such indebtedness, a guaranty of the indebtedness to non-Affiliates shown on the pro forma consolidated balance sheet of FHMS, Holding Company and Holding Company's subsidiaries attached as SCHEDULE 1.1(b) hereto in the amounts outstanding on the Closing Date. 26 8.7 INTENTIONALLY DELETED. 8.8 INTENTIONALLY DELETED. 8.9 MASTER LEASE ASSIGNMENT. FPA, Purchasing Subsidiary and the designated "Assignors" thereunder shall have entered into a Master Lease Assignment (the "MASTER LEASE ASSIGNMENT"), in substantially the form of Exhibit I hereto. 8.10 PROFESSIONAL GROUP PROVIDER AGREEMENTS. FHCA shall have entered into a Professional Group Provider Agreement with FHMG in substantially the form of Exhibit B hereto and with TDMC in substantially in the form of Exhibit C hereto. 8.11 PURCHASE PRICE. FPA and Purchasing Subsidiary shall have delivered the FHMS Share Purchase Price to Seller and Purchasing Subsidiary shall have delivered the FHMS Indebtedness Purchase Price and the Holding Company Indebtedness Purchase Price and the Designee Price to Seller. 8.12 HSR ACT. The applicable waiting period, including any extension thereof, under the HSR Act shall have expired or been terminated. 8.13 GOVERNMENTAL APPROVALS. Such Governmental Authorities as may be required, shall have received notice of, or applications or other filings with respect to, the transactions contemplated by this Agreement and the Related Agreements and, where required, shall have approved same. 8.14 RELATED AGREEMENTS. The various parties named therein shall have entered into the agreements set forth on SCHEDULE 8.14 hereto in accordance herewith, all of which shall be in full force and effect and none of which shall have been amended or breached. In addition, each such party other than FPA shall have delivered to Seller and Selling Shareholder, in the form of a certificate, the equivalent of the representation made by Seller and FPA with respect to such Agreements in SECTION 5.2 (AUTHORIZATION) and SECTION 6.2 (AUTHORIZATION), respectively. 8.15 CONSENTS. All Permits, waivers and consents required to consummate the transactions contemplated hereby, including the consents listed on SCHEDULES 5.6(b) AND 6.4(b) shall have been obtained. 8.16 NO MATERIAL ADVERSE CHANGES. No violations or alleged violations of Law by any of FPA or its Affiliates (including Purchasing Subsidiary), including those arising from patterns or practices engaged in by such Persons, other than matters which have been previously publicly disclosed, shall have (i) resulted in any Material Adverse Change since the Financial Statement Date in FPA's or Purchasing Subsidiary's business or (ii) materially and adversely affected the ability of FPA, Purchasing Subsidiary or Purchasing Shareholder to consummate the transactions contemplated hereby and by the Related Agreements. 8.17 TRANSITION AGREEMENT. FPA, Purchasing Subsidiary and Seller shall have entered into a Transition Agreement (the "TRANSITION AGREEMENT"), in form and substance reasonably satisfactory to the parties hereto. 8.18 RELEASES. Each of Seller, Selling Shareholder, Intergroup of Arizona and such other Affiliates of Seller as are named therein shall have received a General Release, containing the terms set forth in the term sheet attached as Exhibit J hereto and otherwise in form and substance reasonably satisfactory to the parties hereto, from FHMS, Holding Company and each of Holding Company's subsidiaries releasing Seller, Selling Shareholder, Intergroup of Arizona and such other Affiliates of Seller from all claims which FHMS, Holding Company or any of Holding Company's subsidiaries may have against them arising from events or occurrences prior to Closing, including any claims which TDMC may have under the terms of that certain hospital risk sharing arrangement with Intergroup of Arizona. 27 8.19 PLEDGE AGREEMENTS. (i) Each of FPA, Purchasing Subsidiary, and Purchasing Shareholder shall have executed and delivered to Seller a Pledge Agreement (a "PLEDGE AGREEMENT") containing the terms set forth in the term sheet attached as Exhibit K hereto and otherwise in form and substance reasonably satisfactory to the parties hereto, pledging the shares of Purchasing Subsidiary, FHMS and of Holding Company, respectively, (ii) Holding Company shall have executed and delivered a Pledge Agreement, pledging the shares of FHMG and TDMC and (iii) FPA and any Affiliate of FPA possessing such an option shall have executed a Pledge Agreement, pledging any options it has to purchase any of the shares pledged pursuant to clauses (i) and (ii) hereof, in each case to secure Consolidated Note, the Bridge Note and the performance by Buyer and its Affiliates of their respective obligations under the Professional Group Provider Agreements (collectively, the "SECURED OBLIGATIONS"). 8.20 SECURITY AGREEMENT. Each of Purchasing Subsidiary, FHMS, Holding Company, FHMG and TDMC shall have executed and delivered to Seller a Security Agreement, containing the terms set forth in Exhibit L hereto and otherwise in form and substance reasonably satisfactory to the parties hereto, pledging its respective assets to secure the Secured Obligations. 8.21 BOARD APPROVAL. The Board of Directors of Seller shall have approved this Agreement and the Related Agreements and the transactions contemplated hereby and thereby. 8.22 TAX OPINION. Seller shall have received an opinion from Pillsbury Madison & Sutro LLP regarding certain tax matters relating to the transactions contemplated hereby, in form and substance reasonably satisfactory to Seller. ARTICLE 9 CONDITIONS TO FPA'S OBLIGATIONS The respective obligations of FPA, Purchasing Subsidiary and Purchasing Shareholder to consummate the transactions provided for by this Agreement and the Related Agreements are subject, in the discretion of FPA, Purchasing Subsidiary and Purchasing Shareholder, respectively, to the satisfaction, on or prior to the Closing Date, of each of the following conditions, any of which may be waived on its own behalf by FPA, Purchasing Subsidiary or Purchasing Shareholder: 9.1 REPRESENTATIONS, WARRANTIES AND COVENANTS. All representations and warranties of Seller and Selling Shareholder contained in this Agreement shall be true and correct in all material respects (without duplication of any materially standard contained therein) at and as of the date of this Agreement and at and as of the Closing Date, and each of Seller and Selling Shareholder shall have performed in all material respects all covenants required by this Agreement to be performed by it prior to the Closing. 9.2 NO PROCEEDINGS, LITIGATION OR LAWS. No Action by any Governmental Authority or other Person shall have been instituted or threatened which questions the validity or legality of the transactions contemplated by this Agreement and the Related Agreements or which asserts the right of a Governmental Authority to approve any aspect of such transactions and which would reasonably be expected to have a Material Adverse Effect on FPA if the transactions contemplated by this Agreement and the Related Agreements are consummated. There shall not be any Laws that make the purchase of the Businesses as contemplated by this Agreement and the Related Agreements illegal or otherwise prohibited. 9.3 OPINION OF COUNSEL. Seller shall have delivered to FPA an opinion of Pillsbury Madison & Sutro LLP, special counsel to Seller, in form and substance reasonably satisfactory to FPA and its counsel. 28 9.4 CERTIFICATES AND CORPORATE DOCUMENTS. Seller shall furnish FPA and Purchasing Shareholder with such certificates of its officers and others and Selling Shareholder shall furnish FPA and Purchasing Shareholder with such certificates, to evidence compliance with the conditions set forth in this ARTICLE 9 as may be reasonably requested by FPA and Purchasing Shareholder. FPA and Purchasing Shareholder shall have received from Seller resolutions adopted by the board of directors of Seller and any required shareholder resolutions approving this Agreement, the Related Agreements to which it is a party and the transactions contemplated by this Agreement and such Related Agreements, certified by Seller's corporate secretary. 9.5 OTHER DOCUMENTS. Seller shall have executed and delivered an assignment of the FHMS Shares, the FHMS Indebtedness and the Holding Company Indebtedness to Purchasing Subsidiary as provided in this Agreement and Selling Shareholder shall have executed and delivered an assignment of the Holding Company Shares to Purchasing Shareholder pursuant to the Option as provided in this Agreement and the Share Ownership Agreement, which documents shall be in a form reasonably satisfactory to FPA's counsel. 9.6 HSR ACT. The applicable waiting period, including any extension thereof, under the HSR Act shall have expired or been terminated. 9.7 GOVERNMENTAL APPROVALS. Such Governmental Authorities as may be required, shall have received notice of, or applications or other filings with respect to, the transactions contemplated by this Agreement and the Related Agreements and, where required, shall have approved same. 9.8 INTENTIONALLY DELETED. 9.9 MASTER LEASE ASSIGNMENT. FPA, Purchasing Subsidiary and the designated "Assignors" thereunder shall have entered into the Master Lease Assignment. 9.10 PROFESSIONAL GROUP PROVIDER AGREEMENTS. FHCA shall have entered into a Professional Group Provider Agreement with FHMG in substantially the form of Exhibit B hereto and with TDMC in substantially the form of Exhibit C hereto. 9.11 RELATED AGREEMENTS. The various parties named therein shall have entered into the Agreements listed on SCHEDULE 8.14 (RELATED AGREEMENTS), all of which shall be in full force and effect and none of which shall have been amended or breached. In addition, each such party other than Seller, Selling Shareholder, FHMS, Holding Company or any of Holding Company's subsidiaries shall have delivered to FPA, in the form of a certificate, the equivalent of the representation made by Seller and FPA with respect to the Related Agreements in SECTION 5.2 (AUTHORIZATION) and SECTION 6.2 (AUTHORIZATION). 9.12 CONSENTS. All Permits, waivers and consents required to consummate the transactions contemplated hereby, including the consents listed on SCHEDULES 5.6(b) AND 6.4(b) shall have been obtained. 9.13 MATERIAL ADVERSE CHANGES. No violations or alleged violations of Law by FHMS, Holding Company or any of their respective Affiliates, including those arising from patterns or practices engaged in by such Person, other than matters which have been previously publicly disclosed, shall have (i) resulted in any Material Adverse Change since the Financial Statement Date in FHMS's Business or Holding Company's Business or (ii) materially and adversely affected the ability of Seller or Selling Shareholder to consummate the transactions contemplated hereby and by the Related Agreements. 9.14 PRE-CLOSING TRANSACTIONS. (a) TRANSFER OF REAL PROPERTY. Seller shall have caused FHMS to transfer all real property owned by it in fee (together with all indebtedness encumbering such real property) to an Affiliate of Seller. 29 (b) TRANSFER OF CPR STOCK. Seller shall have caused the stock of Catalina Professional Recruiters, Inc. to have been transferred from FHMS to Seller or an Affiliate of Seller. (c) TRANSFER OF OTHER ASSETS AND LIABILITIES. Seller shall have caused those other assets and liabilities which are shown to have been transferred by FHMS, Holding Company or Holding Company's subsidiaries in the adjustments resulting in the pro forma consolidated balance sheet attached hereto as SCHEDULE 1.1(b) to have been transferred by FHMS, Holding Company or one of Holding Company's subsidiaries, as the case may be. 9.15 TRANSITION AGREEMENT. FPA and Seller shall have entered into the Transition Agreement. 9.16 REGISTRATION RIGHTS AGREEMENT. FPA and Seller shall have entered into the Registration Rights Agreement. 9.17 NOTICE OF DESIGNEE. Seller shall have notified the Agent and Selling Shareholder of Purchasing Shareholder's appointment as Designee in accordance with the Share Ownership Agreement. 9.18 BOARD APPROVAL. The Board of Directors of FPA shall have approved this Agreement and the Related Agreements and the transactions contemplated hereby and thereby. 9.19 STOCKHOLDER APPROVAL. FPA shall have obtained any approval of its stockholders required by applicable Law to be obtained in connection with the execution and delivery of this Agreement and the Related Agreements to which FPA is a party or to consummate the transactions contemplated hereby or thereby. 30 9.20 VOTING AGREEMENT. Seller shall have executed and delivered to FPA a Voting Agreement, containing the terms set forth in the term sheet attached as Exhibit M hereto and otherwise in form and substance reasonably satisfactory to the parties hereto. 9.21 PHYSICIANS. The number of physicians employed by Holding Company and its subsidiaries as of the Closing Date shall not be less than seventy five percent (75%) of the number of physicians employed by Holding Company and its subsidiaries as of the date hereof. 9.22 REAL ESTATE MATTERS. Purchasing Subsidiary shall, in its good faith business judgment, have approved (i) the condition of title to each owned Care Center, as described in the title commitments and the surveys delivered to or obtained by Purchasing Subsidiary (provided Purchasing Subsidiary shall not disapprove any title exception that does not have a material adverse effect on the use or operation of such Care Center), (ii) environmental audits or studies of the such Care Centers, (iii) all of the characteristics and aspects of each Care Centers which may reasonably affect its ownership, operation, use, development, marketability and/or economic viability, and (iv) the Leases and service contracts with respect to the Care Centers. ARTICLE 10 ACTIONS BY SELLER AND FPA AFTER THE CLOSING 10.1 BOOKS AND RECORDS. FPA and Purchasing Subsidiary, on the one hand, and Seller, on the other, each agree to cooperate with and make available to the other, during normal business hours, all books and records of such party, information and employees (without substantial disruption of employment) retained and remaining in existence after the Closing which are necessary or useful in connection with any tax inquiry, audit, investigation or dispute, any litigation or investigation or any other matter requiring any such books and records, information or employees for any reasonable business purpose, PROVIDED, HOWEVER, that nothing contained herein shall give FPA or Purchasing Shareholder a right of access to the consolidated tax returns of Seller. The party requesting any such books and records, information or employees shall bear all of the out-of-pocket costs and expenses (including attorneys' fees, but excluding reimbursement for salaries and employee benefits) reasonably incurred in connection with providing such books and records, information or employees. Each of FPA, Purchasing Subsidiary and Seller will retain such books and records in accordance with its corporate records retention policy or as required by law, whichever requires retention for a longer period. All information received pursuant to this SECTION 10.1 shall be subject to the terms of the Confidentiality Agreement. 10.2 TAXES. Seller shall pay, or cause to be paid, when due all Taxes for which FHMS, Selling Shareholder, Holding Company or any of Holding Company's subsidiaries is or may be liable or that are or may become payable with respect to all periods ending on or prior to the Closing. FPA shall pay, or cause to be paid, when due all Taxes for which FPA, Purchasing Subsidiary, Purchasing Shareholder, FHMS, Holding Company or any of Holding Company's subsidiaries is or may be liable or that are or may become payable with respect to all periods ending subsequent to the Closing. 10.3 338(h)(10) ELECTION. As soon as practicable after the Closing, and in no event later than 30 days after the delivery by Seller of the closing date balance sheet, Seller, FPA, Purchasing Subsidiary and Purchasing Shareholder will jointly make an election under Section 338(h)(10) of the Code (and a comparable election under state law) with respect to the purchase of stock of Holding Company and FHMS. In connection therewith, Seller, Selling Shareholder, FPA, Purchasing Subsidiary and Purchasing Shareholder agree to cooperate with each other and use their reasonable best efforts to effect such 338(h)(10) election. Without limiting the generality of the foregoing, the parties hereto agree that (i) Seller, Selling Shareholder, FPA, Purchasing Subsidiary and Purchasing Shareholder shall prepare and file all documents and materials necessary or appropriate in connection with making the Section 338(h)(10) Election, (ii) Seller, FPA and Purchasing Subsidiary shall use their reasonable best efforts to determine the allocation of the "modified 31 aggregate deemed sale price" and "adjusted grossed up basis" among the assets of FHMS (in accordance with the Section 338 Treasury Regulations) and (iii) Seller, FPA and Purchasing Subsidiary shall use their reasonable best efforts to determine the allocation of the "modified aggregate deemed sale price" and "adjusted grossed-up basis" among the assets of Holding Company and its subsidiaries (in accordance with the Section 338 Treasury Regulations). 10.4 FUTURE CONTRACTUAL ALLIANCES. Seller and FPA intend to expand their contractual relationships and agree to negotiate in good faith the terms of a provider contract for the benefit of Seller and its Affiliates and FPA and FPA's professional provider groups relating to all service areas of FPA and any Seller Affiliate engaged in the business of offering a benefit program, which overlap, as those service areas may change from time to time. 10.5 CERTAIN OBLIGATIONS REGARDING EMPLOYEES. (a) RETAINED OBLIGATIONS. Seller agrees to continue to perform its obligations relating to the grant of options to TDMC and FHMG employees as set forth on SCHEDULE 10.5, subject in each case to any conditions or terms set forth in such arrangements. (b) EMPLOYEE INFORMATION. In order to facilitate the performance of such obligations by Seller, FPA, Purchasing Subsidiary and Purchasing Shareholder agree to and to cause Holding Company and its subsidiaries to provide to Seller (i) on a monthly basis, a list of employees of Holding Company, TDMC or FHMG who have been terminated during the prior month and the date of termination and (ii) at least ten (10) business days prior to November 1, 1996 and November 1, 1997, a list of TDMC Practitioners who are eligible to receive options to purchase the common stock of Seller as set forth on SCHEDULE 10.5 and such other information as is required to effectuate the grant of such options. (c) TAIL INSURANCE. Seller shall manage all claims alleging medical malpractice by any Practitioner that fall within the "tail coverage" purchased by Holding Company and its subsidiaries immediately prior to Closing. To facilitate the management of such claims, FPA, Purchasing Subsidiary and Purchasing Shareholder agree to and agree to cause Holding Company and its subsidiaries to notify Seller of any potential claims which may fall within such tail coverage within ten (10) days of the date on which FPA, Purchasing Subsidiary, Purchasing Shareholder or any of their Affiliates first becomes aware of the existence of such potential claim. If notice of a claim or potential claim is not given in accordance with the preceding sentence, then neither Seller nor any of its Affiliates, including the Affiliate providing the tail coverage, shall have any liability with respect to such claim or potential claim, but only if Seller or one of its Affiliates is actually prejudiced by such failure to give appropriate notice. 10.6 FOUNDATION NAME. Notwithstanding anything else contained in this Agreement, it is the express intent of the parties hereto and such parties hereby agree that neither FPA nor its Affiliates (including Purchasing Subsidiary) shall gain any right, title or interest in the names "Foundation," "Foundation Health," "Foundation Health Medical Group," "Foundation Health Medical Services," or any similar name or derivation thereof (the "FOUNDATION NAME") pursuant to this Agreement, the Related Agreements and the transactions contemplated hereby and thereby, it being expressly understood that Seller and its Affiliates, as the case may be, shall retain all right, title and interest in and to the Foundation Name and that each of FHMS, Holding Company and Holding Company's subsidiaries shall forfeit any interest it might be deemed to have in the Foundation Name upon the transfer of the FHMS Shares and the Holding Company Shares, respectively, as contemplated hereby. Notwithstanding the foregoing, for a period of six (6) months (the "TRANSITION PERIOD") following the date hereof, and for the sole purpose of facilitating the transition of FHMS, Holding Company and Holding Company's subsidiaries from subsidiaries of Seller and Selling Shareholder to subsidiaries of Purchasing Subsidiary and Purchasing Shareholder, Seller grants FPA a non-exclusive, non-transferable license to use the names Foundation Health Medical Group and Foundation Health Medical Services in California only. Upon the expiration of the Transition Period, FPA and Purchasing Subsidiary shall have caused FHMS to and Purchasing Shareholder shall have caused Holding Company to (i) appropriately dispose of all letterhead, signage and other items containing or using the Foundation Name and (ii) to have ceased using the Foundation Name in any manner whatsoever. 32 10.7 REIMBURSEMENT FOR CERTAIN TAX MATTERS. (a) REIMBURSEMENT. If each of FPA, Purchasing Subsidiary and Purchasing Shareholder complies with its obligations under SECTION 10.3 hereof, but a basis in the assets of Holding Company and its subsidiaries equal to the "adjusted grossed-up basis" of the assets of such companies as of the date of Closing, calculated in the manner provided for pursuant to the Treasury Regulations under Section 338 of the Code, is not obtained thereby (for reasons other than any action or inaction by FPA or any of its Affiliates), then Seller shall pay to FPA the amount of the foregone tax benefit, as defined below, resulting from the failure to obtain such an adjusted grossed-up basis for those calendar quarters with respect to which the applicable period of limitations shall not have expired (such expiration to be measured as of the date it is determined that the "adjusted grossed up basis" has not been obtained) (the "Tax Indemnity"). For purposes of this indemnity, the foregone tax benefit for any calendar quarter shall conclusively be presumed to equal the present value, determined as of the Closing Date, of the estimated future tax benefit for such calendar quarter determined by assuming a deduction attributable to depreciation or amortization for such period in excess of the amount which would otherwise be available in such period in the amount provided for on SCHEDULE 10.7 attached hereto, at a discount rate and a combined federal and state income tax rate such that the present value of the foregone tax benefit from all deductions set forth on SCHEDULE 10.7 is equal to Thirty Seven Million Dollars ($37,000,000) as of the Closing Date. The amount determined pursuant to the foregoing provisions of this SECTION 10.7(a) shall be increased by the amount of any applicable penalties that result from a failure to successfully make the 338(h)(10) election that triggers Seller's indemnification obligation under this SECTION 10.7(a) and by the amount that would have been payable as interest (had such amount constituted a debt incurred at the date of this Agreement) from the date of this Agreement to the date payment of such amount is made, for this purpose conclusively presuming that the applicable interest rate is LIBOR plus 45 basis points per annum. The indemnity provided for hereunder is the sole and exclusive remedy of FPA and its Affiliates in the event that a basis in the assets of Holding Company and its subsidiaries equal the "adjusted grossed-up basis" of the assets of such companies is not obtained. (b) PRE-ACQUISITION LOSSES. In the event, but only in the event, that Seller is or has been obligated to pay the Tax Indemnity, and notwithstanding anything else contained herein, if, as and when FPA, Purchasing Subsidiary, FHMS or Holding Company or any of Holding Company's subsidiaries realizes any tax benefits attributable to pre-acquisition losses of FHMS, Holding Company or its subsidiaries, FPA will pay to Seller fifty percent (50%) of the amount of such tax benefit. The amount of FPA's tax benefit shall equal the difference between the income taxes payable by FPA (or any Affiliate of FPA) without the utilization of such pre-acquisition losses, and the amount of such taxes actually paid by FPA (or any Affiliate of FPA). In the event the use of such pre-acquisition losses results in a refund of previously paid tax, the amount of the tax benefits shall include any interest payments made in connection with such refund. Within 30 days of the filing of FPA's (or its Affiliate's) tax return (or 30 days after receipt of any payment attributable to a claim for refund) claiming the benefit of any pre-acquisition losses, FPA will cause its auditors to deliver a certificate to Seller setting forth the calculation of FPA's (or its Affiliate's) tax benefit, and certifying that such calculation is correct in all material respects. The cost of such certification shall be borne by Seller. At Seller's option, any amounts payable from FPA or any Affiliate of FPA to Seller under this Section may be offset against any amounts payable from Seller to FPA under this Section. 33 (c) CONTEST AND CONTROL. (i) FHC and FPA shall promptly (but in any event within 30 days of receipt of notice) give written notice (the "NOTICE") to each other of any inquiry, discussions with a tax authority, proposed adjustment, assertion of a claim, or the commencement of any suit, action or proceeding against such party (the "CONTESTED PARTY," and the party receiving the Notice, the "NOTICED PARTY") that challenges or questions the availability of a Section 338(h)(10) election based upon facts and circumstances uniquely within the control of the Noticed Party or based upon actions taken by, or failed to be taken by, the Noticed Party (each, a "PROPOSED ADJUSTMENT"). The failure of a Contested Party to provide the Noticed Party with Notice within the above time frame shall relieve the Noticed Party from its obligation to indemnify if such failure results in the loss or material impairment of the Noticed Party's rights under this Section 10.7(c). (ii) The Contested Party shall give the Noticed Party all information, including records in its possession and witnesses within its control, with respect to any Proposed Adjustment, and in each case the underlying facts relating thereto. In all matters related to the defense of a Proposed Adjustment, the Contested Party shall act in a reasonable manner. The Noticed Party and its counsel shall have the right to participate with the Contested Party and its counsel in (i) all conferences, meetings or proceedings with any tax authority, the subject matter of which is or includes any Proposed Adjustment, and (ii) all appearances before any court or administrative agency, the subject matter of which includes any Proposed Adjustment. The Noticed Party shall have the right to monitor and review the Contested Party's defense of any Proposed Adjustment, including specifically the right to review and comment on any briefs or other filings made in courts or to taxing authorities which take substantive positions with respect to Proposed Adjustments, a reasonable period of time before such filings are made. The Noticed Party's right to participate referred to herein shall include, without limitation, the right to participate in the submission and determination of the contents of documentation, protests, memoranda of fact and law and briefs, the conduct of oral arguments or presentations, the selection of witnesses, and the negotiation of stipulations of fact, all as may be deemed appropriate by the Noticed Party in its sole discretion but solely with respect to any Proposed Adjustment. A settlement of a Proposed Adjustment shall be binding upon the Noticed Party (with the result that the indemnity obligation under Section 10.7 hereof shall be effective) only if the Noticed Party consents to such settlement or unreasonably withholds consent to such settlement. 10.8 COVENANT. For a period commencing on the Closing Date and thereafter for a period of three (3) years, each of Seller and FHCA shall use their best efforts to encourage commercial members of FHCA and its affiliated health plans who, as of the Closing Date, have primary care physicians who are employees of FHMG or TDMC, to continue to select primary care physicians who are employees of FHMG or TDMC; in the event certain of such commercial members become unassigned due to the fact that their primary care physician is no longer employed by FHMG or TDMC and such members do not select another FHCA contracting physician, Seller and FHCA will assign such non-assigned members to a physician who is employed by FHMG or TDMC, subject in all cases to adequate availability and accessibility and other regulatory requirements of the parties. 10.9 SOLICITATION OF EMPLOYEES. During the period from the date hereof until that date which is six (6) months after the Closing Date, neither Seller or its Affiliates on the one hand, nor FPA or its Affiliates, on the other shall initiate or maintain contact with any officer, director or employee of the other regarding the employment of such individual, except for public solicitation of employment by general advertisement, contacts regarding employment initiated by the individual involved and contacts with Employees regarding their continued employment after the Closing. 34 ARTICLE 11 SURVIVAL AND INDEMNIFICATION 11.1 SURVIVAL. Each of the representations, warranties and covenants of each of FPA, Purchasing Subsidiary and Seller contained in this Agreement shall be deemed renewed by such party at the Closing as if made at such time and shall survive the Closing and shall continue in full force and effect for one (1) year thereafter, other than the representations and warranties of Seller made in SECTION 5.17 (TAXES), which shall survive for the applicable statute of limitations. A material misrepresentation or breach of warranty that is either (A) disclosed in a written notice, delivered by the breaching party to the non- breaching party after the date of this Agreement and at or prior to the Closing or (B) otherwise actually known to the non-breaching party prior to the Closing, allows the non-breaching party to refuse to proceed with the Closing, but does not give rise to a cause of action for damages or other relief. By nevertheless proceeding with the Closing, the non-breaching party waives any remedies for any misrepresentation or breach of warranty of which it was aware prior to the Closing. 11.2 NO OTHER REPRESENTATIONS. Notwithstanding anything to the contrary contained in this Agreement, it is the explicit intent of each party hereto that Seller is making no representations or warranties whatsoever, express or implied, except those representations and warranties contained in ARTICLE 5 and neither FPA nor Purchasing Subsidiary is making any representations or warranties whatsoever, express or implied, except those representations and warranties contained in ARTICLE 6. In particular, but without limiting the foregoing, Seller makes no representation or warranty to FPA with respect to any financial projection or forecast relating to the Businesses and neither FPA nor Purchasing Subsidiary makes any representation or warranty to Seller with respect to any financial projection or forecast relating to FPA's business. With respect to any projection or forecast delivered by or on behalf of any party hereto to any other party hereto, the party receiving such information acknowledges that (i) there are uncertainties inherent in attempting to make such projections and forecasts, (ii) such party is familiar with such uncertainties, (iii) such party is taking full responsibility for making its own evaluation of the adequacy and accuracy of all such projections and forecasts furnished to it and (iv) such party shall have no claim against the party furnishing such information with respect thereto. 11.3 INDEMNIFICATION BY SELLER. Except as otherwise expressly provided in this ARTICLE 11, Seller shall defend, indemnify and hold harmless FPA and shall reimburse FPA for, from and against, each and every demand, claim, loss, liability, judgment, damage, cost and expense (including without limitation, reasonable attorneys' fees), ("LOSSES") imposed on or incurred by FPA, relating to, resulting from or arising out of (i) any inaccuracy in any representation or warranty made by Seller under this Agreement and such inaccuracy is not disclosed in the Disclosure Schedule or in the Financial Statements; (ii) any breach of a covenant of this Agreement required to be performed by Seller or Selling Shareholder; and (iii) any taxes of FHMS, Holding Company or any of Holding Company's subsidiaries, relating to any pre-Closing period. 11.4 LIMITATIONS ON INDEMNITY. Notwithstanding anything to the contrary contained in this Agreement, no amounts of indemnity shall be payable by Seller to FPA as a result of any claim in respect of a Loss arising under SECTION 11.3 or by FPA to Seller as a result of a Loss arising under SECTION 11.5: (a) unless, until and then only to the extent that the party requesting indemnification (the "INDEMNITEE") has suffered, incurred, sustained or become subject to Losses referred to in SECTION 11.3 (other than Losses arising from a breach of SECTION 5.17) or SECTION 11.5 (other than Losses arising from Taxes for post-Closing periods), as the case may be, which exceed $200,000 in the aggregate; (b) with respect to any claim for indemnification thereunder, unless the Indemnified Person has given the Indemnifying Person proper notice in accordance with SECTION 11.6, as applicable, with respect to such claim, setting forth in reasonable detail the specific facts and circumstances pertaining thereto, (A) as soon as practical following the time at which the Indemnified Person discovered or reasonably should have discovered such claim (except to the extent the Indemnifying Person is not prejudiced by any delay in the delivery of such notice) and (B) in any event prior to the expiration of one (1) year following the Closing Date; (c) with respect to any Loss, to the extent that the Indemnitee had a reasonable opportunity, but failed in good faith to mitigate the Loss, including but not limited to the failure to use commercially reasonable efforts to recover under a policy of insurance or under a contractual right of set-off or indemnity; 35 (d) with respect to any Loss suffered, incurred or sustained by the Indemnitee or to which it becomes subject, to the extent it arises from or was caused by actions taken or failed to be taken by the Indemnitee or any of its Affiliates after the Closing. Notwithstanding anything else contained herein, the maximum amount for which Seller or FPA may be liable under this ARTICLE 11, in the aggregate for all claims made and Losses suffered by the other, shall be equal to Twenty Million U.S. Dollars ($20,000,000), PROVIDED, HOWEVER, that Seller shall indemnify FPA for all Losses arising from a breach of SECTION 5.17 and, PROVIDED, FURTHER, that FPA shall indemnify Seller from all Losses arising from Taxes for any post-Closing period. 11.5 INDEMNIFICATION BY FPA. Except as otherwise expressly provided in this ARTICLE 11, FPA shall defend, indemnify and hold harmless Seller and shall reimburse Seller for, from and against all Losses imposed on or incurred by Seller, relating to, resulting from or arising out of (i) any inaccuracy in any representation or warranty made by FPA under this Agreement, which inaccuracy is not disclosed in the Disclosure Schedule or in the FPA Financial Statements (ii) any breach of a covenant of this Agreement required to be performed by FPA or Purchasing Shareholder; and (iii) any taxes of FHMS, Holding Company or any of Holding Company's subsidiaries, relating to any post-Closing period. 11.6 NOTICE AND DEFENSE OF THIRD-PARTY CLAIMS. If any action, claim or proceeding shall be brought or asserted under this SECTION 11.6 against an indemnified party or any successor thereto (the "INDEMNIFIED PERSON") in respect of which indemnity may be sought under this ARTICLE 11 from an indemnifying person or any successor thereto (the "INDEMNIFYING PERSON"), the Indemnified Person shall give prompt written notice of such action or claim to the Indemnifying Person who shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified Person and the payment of all expenses; the Indemnified Person shall have the right to employ separate counsel in any of the foregoing actions, claims or proceedings and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of the Indemnified Person unless both the Indemnified Person and the Indemnifying Person are named as parties and the Indemnified Person and the Indemnifying Person shall in good faith determine that the representation by the same counsel is inappropriate. In the event that the Indemnifying Person, within ten days after notice of any such action or claim, fails to assume the defense thereof, the Indemnified Person shall have the right to undertake the defense, compromise or settlement of such action, claim or proceeding for the account of the Indemnifying Person, subject to the right of the Indemnifying Person to assume, at its expense, the defense of such action, claim or proceeding with counsel reasonably satisfactory to the Indemnified Person at any time prior to the settlement, compromise or final determination thereof. Anything in this ARTICLE 11 to the contrary notwithstanding, the Indemnifying Person shall not, without the Indemnified Person's prior written consent, settle or compromise any action or claim or consent to the entry of any judgment with respect to any action, claim or proceeding for anything other than money damages paid by the Indemnifying Person. The Indemnifying Person may, without the Indemnified Person's prior written consent, settle or compromise any such action, claim or proceeding or consent to entry of any judgment with respect to any such action or claim that requires solely the payment of money damages by the Indemnifying Person and that includes as an unconditional term thereof the release by the claimant or the plaintiff of the Indemnified Person from all liability with respect to such action, claim or proceeding. 11.7 LIMITATION. An Indemnifying Person shall have no liability under this ARTICLE 11 unless notice of a claim for indemnity, or notice of facts as to which an indemnifiable Loss is expected to be incurred, shall have been given prior to ninety days after the expiration of the appropriate statute of limitations with respect thereto, as the same may be extended from time to time by the Indemnifying Person. 11.8 EXCLUSIVITY. Except as otherwise specifically provided herein, the provisions of this ARTICLE 11 shall be the exclusive basis for the assertion of claims by or imposition of liability on the parties hereto arising under or as a result of this Agreement. Section 11.4 shall not apply to any fraudulent misrepresentation. 11.9 RIGHT OF SET-OFF. The parties hereto agree that Seller may satisfy any obligation to pay any amount to FPA arising under this Article 11 or SECTION 10.7 by, at Seller's option, either (i) paying cash, (ii) foregoing interest 36 payments due under the Bridge Note and/or the Consolidated Note equal to the amount so payable by Seller or (iii) reducing the principal amount of the Bridge Note and/or the Consolidate Note by the amount so payable. In addition, if FPA is finally determined under this Agreement to be obligated to pay Seller any amount under this Article 11 or SECTION 10.7, Seller may withhold any amounts due from Seller or any of Seller's Affiliates to FPA or any of FPA's Affiliates under any provider agreement, (including the Professional Group Provider Agreements) which amount will be set-off against the amount so payable, PROVIDED, HOWEVER, that the amount withheld under any provider agreement in any month may not exceed five percent of the total amount due under such provider agreement for such month. ARTICLE 12 MISCELLANEOUS 12.1 TERMINATION. (a) TERMINATION. This Agreement may be terminated at any time prior to Closing: (i) By mutual written consent of FPA and Seller or Selling Shareholder; (ii) By FPA if there is a material breach of any representation or warranty set forth in Article 5 hereof or any covenant or agreement to be complied with or performed by Seller or Selling Shareholder pursuant to the terms of this Agreement which would render impossible the satisfaction of a condition set forth in Article 9 (and such condition is not waived in writing by FPA); (iii) By Seller or Selling Shareholder if there is a material breach of any representation or warranty set forth in Article 6 hereof or of any covenant or agreement to be complied with or performed by FPA, Purchasing Subsidiary or Purchasing Shareholder pursuant to the terms of this Agreement which would render impossible the satisfaction of a condition set forth in Article 8 (and such condition is not waived in writing by Seller); or (iv) By any party hereto if the Closing has not occurred by October 31, 1996. (b) IN THE EVENT OF TERMINATION. In the event of termination of this Agreement: (i) Each party hereto will redeliver all documents, work papers and other material of each other party hereto relating to the transactions contemplated by this Agreement and the Related Agreements, whether so obtained before or after the execution hereof, to the party furnishing the same; (ii) The provisions of the Confidentiality Agreement shall continue in full force and effect; and (iii) No party hereto shall have any liability or further obligation to any other party to this Agreement or the Related Agreements, except (x) as stated in subsections (i) , (ii), (iv), (v) and (vi) of this SECTION 12.1(b), and (y) for any willful breach of this Agreement occurring prior to the proper termination of this Agreement. (iv) If this Agreement is not consummated because either Seller or FPA breaches a material representation or warranty or fails to perform a material covenant contained herein, and the other party has not breached any material representation or warranty or failed to perform a material covenant, and the non-breaching party chooses to terminate this Agreement as a direct result of such breach or failure, the breaching party shall promptly pay the non-breaching party (x) up to $500,000 to reimburse the non-breaching party for its documented expenses (including the fees and expenses of counsel, accountants, 37 consultant and advisors) incurred in connection with the transactions contemplated by this Agreement (the "Expenses") and (y) a fee of $1,000,000 as liquidated damages. (v) If this Agreement is not consummated because Seller or FPA does not obtain necessary board or stockholder approval, then such party failing to obtain such approval shall pay the other party promptly up to $500,000 in Expenses. (vi) If this Agreement is not consummated for any reason, in addition to any payments described in this Section, the Seller shall pay FPA promptly $3,000,000, which may be paid in a reduction in principal of any existing indebtedness owed by FHC and its affiliates to FPA and its affiliates, including any affiliated medical groups. 12.2 ASSIGNMENT AND NO THIRD PARTY BENEFICIARIES. Neither this Agreement nor any of the rights or obligations hereunder may be assigned by any party without the prior written consent of the other parties. Subject to the foregoing, this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns, and no other person shall have any right, benefit or obligation under this Agreement as a third party beneficiary or otherwise. 12.3 NOTICES. All notices, requests, demands and other communications which are required or may be given under this Agreement shall be in writing and shall be deemed to have been duly given when received if personally delivered; when transmitted if transmitted by facsimile; the day after being sent, if sent for next day delivery by recognized overnight delivery service (E.G., FEDERAL EXPRESS); and upon receipt, if sent by certified or registered mail, return receipt requested. In each case notice shall be given as follows: If to Seller or Selling Shareholder, addressed to: Foundation Health Corporation 3400 Data Drive Rancho Cordova, California 95670 Facsimile Number: (916) 631-5335 Attention: Kirk A. Benson, President and Chief Operating Officer - - Commercial Operations With a copy to: Pillsbury Madison & Sutro LLP 235 Montgomery Street San Francisco, California 94104 Facsimile Number: (415) 983-1200 Attention: Linda C. Williams, Esq. If to FPA, Purchasing Subsidiary or Purchasing Shareholder, addressed to: FPA Medical Management,Inc. 2878 Camino Del Rio South, Suite 301 San Diego, California 92108-3846 Facsimile Number: (619) 299-0708 Attention: Dr. Seth M. Flam, Chief Executive Officer With copies to: 38 FPA Medical Management,Inc. 2878 Camino Del Rio South, Suite 301 San Diego, California 92108-3846 Facsimile Number: (619) 299-0708 Attention: James A. Lebovitz, Esq. Senior Vice President, General Counsel and Secretary and Latham & Watkins 701 B Street, Suite 2100 San Diego, California 92101-8197 Facsimile Number: (619) 696-7419 Attention: Andrew Singer, Esq. or to such other place and with such other copies as a party may designate as to itself by written notice to the others. 12.4 CHOICE OF LAW. This Agreement shall be governed by, construed and enforced in accordance with the laws of the State of Delaware as applied to contracts entered into solely between residents of, and to be performed entirely in, such state. 12.5 ENTIRE AGREEMENT; AMENDMENTS AND WAIVERS. This Agreement and the Related Agreements to which the parties hereto are parties, together with all exhibits and schedules to be attached hereto and thereto (including the Disclosure Schedule), constitute or will constitute the entire agreement among the parties pertaining to the subject matter hereof and supersede or will supersede all prior agreements, understandings, negotiations and discussions, whether oral or written, of the parties, other than the Confidentiality Agreement. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. No amendment, supplement, modification or waiver of this Agreement shall be binding unless executed in writing by the party to be bound thereby. No waiver of any of the provisions of this Agreement shall be deemed to or shall constitute a waiver of any other provision hereof (whether or not similar), nor shall such waiver constitute a continuing waiver unless otherwise expressly provided. 12.6 COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement may be executed by original or facsimile signature if the party executing this Agreement by facsimile signature delivers an original signature to the other parties hereto promptly thereafter. 12.7 EXPENSES. Except as otherwise specified in this Agreement, each party hereto shall pay its own legal, accounting, out-of-pocket and other expenses incident to this Agreement and to any action taken by such party in preparation for carrying this Agreement into effect. 12.8 INVALIDITY. In the event that any one or more of the provisions contained in this Agreement or in any Related Agreement, shall, for any reason, be held to be invalid, illegal or unenforceable in any respect, then to the maximum extent permitted by law, such invalidity, illegality or unenforceability shall not affect any other provision of this Agreement or any other such instrument. 12.9 PUBLICITY. Except as may be required by law, FPA shall not and shall not permit any of its Affiliates to and Seller and Selling Shareholder shall not and shall not permit any of their respective Affiliates to, issue any press release or make any public statement regarding the transactions contemplated hereby or by the Related Agreements, without prior written approval of the other. FPA and Seller will issue joint press releases or public announcements after the execution and delivery of this Agreement and after the Closing. Seller, Selling Shareholder, FPA and Purchasing Shareholder each agree to portray the others in a positive light to enrollees and patients of the parties, other providers and the investment and financial community. 39 12.10 SCHEDULES. The inclusion of any item in one schedule hereto comprising part of the Disclosure Schedule shall be deemed for purposes of this Agreement to be an inclusion of such item in all schedules comprising part of the Disclosure Schedule. 40 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and year first above written. SELLER FPA By: /s/ Daniel D. Crowley By: /s/ Seth Flam ------------------------- ------------------------- Name: Daniel D. Crowley Name: Seth Flam ------------------ ------------------ Title: President and CEO Title: President and CEO ------------------ ------------------ PURCHASING SHAREHOLDER PURCHASING SUBSIDIARY By: /s/ Seth Flam By: /s/ Seth Flam ------------------------- ------------------------- Name: Seth Flam Name: Seth Flam ------------------ ------------------------- Title: President and CEO Title: President and CEO ------------------ ------------------ SELLING SHAREHOLDER By: /s/ Jonathan H. Scheff, M.D. ------------------------------- Name: Jonathan H. Scheff, M.D. ------------------------ Title: President ------------------------ 41 DISCLOSURE SCHEDULE 1.1(a) Care Centers 1.1(b) Holding Company and FHMS Financial Statements/Pro Forma Consolidated Balance Sheet 2.1 FHMS Share Ownership 3.2 Holding Company Share Ownership 5.3 Material Adverse Changes 5.4 Leased Real Property 5.5 Material Contracts 5.6(a) Seller/Holding Company Permits 5.6(b) Seller/Holding Company Filings 5.9 Litigation 5.10 Compensation 5.12 Employee Benefit Matters 5.13 Insurance Policies 5.14 Liabilities 5.15 Certain Rights Relating to Shares 5.19 Subsidiaries 5.22(e) Pending Transfers 6.3 No Conflicts 6.4(a) FPA Permits 6.4(b) FPA Filings 6.7 Material Adverse Changes 6.9 Litigation 6.10 Liabilities 6.11 Capital Structure 7.4 Conduct of Business 7.5(b) Employee Liabilities 7.14 License and Maintenance Agreements 8.14 Related Agreements 10.5 Retained Employee Obligations 10.7 Depreciation Deduction -i- EXHIBITS Exhibit A Letter Agreement Regarding Matching Contributions Exhibit B Form of Professional Group Provider Agreement (CA) Exhibit C Form of Professional Group Provider Agreement (AZ) Exhibit D Term Sheet Regarding Bridge Note Exhibit E Term Sheet Regarding Consolidated Note Exhibit F Term Sheet Regarding Registration Rights Exhibit G Term Sheet Regarding Guaranty Exhibit H Reserved Exhibit I Form of Master Lease Assignment Exhibit J Term Sheet Regarding General Release Exhibit K Term Sheet Regarding Pledge Agreements Exhibit L Term Sheet Regarding Security Agreements Exhibit M Term Sheet Regarding Voting Agreement -ii- EX-11.0 8 EXHIBIT 11.0 EXHIBIT 11.0 EARNINGS PER SHARE CALCULATION UTILIZING THE TREASURY STOCK METHOD (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
QUARTER ENDED JUNE 30, YEAR ENDED JUNE 30, ------------------------------ --------------------------- 1996 1995 1996 1995 ------------- -------------- -------------- -------------- Proceeds upon exercise of options outstanding $ 82,612 $ 46,780 ------------- -------------- ------------- -------------- Average market price of common stock $ 38.53 $ 29.45 ------------- -------------- ------------- -------------- Weighted average common shares outstanding 58,776,537 57,115,655 Issued shares - exercise of options 2,593,214 1,863,165 Shares assumed to be repurchased with proceeds from exercise (2,144,027) (1,588,539) ------------- -------------- -------------- -------------- Weighted average shares outstanding (A) 59,225,724 57,390,281 58,292,971 54,780,162 ------------- -------------- -------------- -------------- ------------- -------------- -------------- -------------- Net income (B) $ 43,539 $ 38,774 $ 166,440 $ 49,449 ------------- -------------- -------------- -------------- ------------- -------------- -------------- -------------- Earnings per share ((B) divided by (A)) $ 0.74 $ 0.68 $ 2.86 $ 0.90 ------------- -------------- -------------- -------------- ------------- -------------- -------------- --------------
EX-12.0 9 EXHIBIT 12.0 EXHIBIT 12.0 FOUNDATION HEALTH CORPORATION RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN THOUSANDS)
YEAR ENDED JUNE 30, ------------------------------------------------------------------------ 1992 1993 1994 1995 1996 ------------ ------------- ------------- ------------ ------------- 1. EARNINGS : (a) Income before income taxes $ 91,601 $ 136,999 $ 165,873 $ 78,532 $ 240,595 (b) Interest expense, net 6,035 4,239 12,709 11,555 15,099 (c) 1/3 operating rental expense 3,960 4,825 7,081 8,475 11,929 ------------ ------------- ------------- ------------ ------------- Total $ 101,596 $ 146,063 $ 185,663 $ 98,562 $ 267,623 ------------ ------------- ------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------- 2. FIXED CHARGES : (a) Interest expense $ 6,035 $ 4,239 $ 13,446 $ 13,095 $ 15,814 (b) 1/3 operating rental expense 3,960 4,825 7,081 8,475 11,929 ------------ ------------- ------------- ------------ ------------- Total $ 9,995 $ 9,064 $ 20,527 $ 21,570 $ 27,743 ------------ ------------- ------------- ------------ ------------- ------------ ------------- ------------- ------------ ------------- Ratio ( 1 divided by 2 ) 10.2 16.1 9.0 4.6 9.6 ------------ ------------- ------------- ------------ ------------- ------------ ------------- ------------- ------------ -------------
EX-13.1 10 EXHIBIT 13.1 EXHIBIT 13.1 Report of Ernst & Young, Independent Auditors Stockholders and Board of Directors Intergroup Healthcare Corporation We have audited the consolidated statements of income, changes in stockholders' equity, and cash flows of Intergroup Healthcare Corporation for the year ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Intergroup Healthcare Corporation for the year ended December 31, 1993 in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Tucson, Arizona February 16, 1994, except Note 17 as to which the date is March 18, 1994 -70- EX-13.2 11 EXHIBIT 13.2 EXHIBIT 13.2 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Thomas-Davis Medical Centers, P.C. Tucson, Arizona We have audited the consolidated statements of operations, cash flows, and changes in shareholders' equity of Thomas-Davis Medical Centers, P.C. and Subsidiaries for the year ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Intergroup Healthcare Corporation, a 62.6% owned subsidiary, which statements reflect total revenues of $392,036,000 for the year ended December 31, 1993. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Intergroup Healthcare Corporation, is based solely on the report of the other auditors. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, based on our audit and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the results of the operations and cash flow of Thomas-Davis Medical Centers, P.C. and Subsidiaries for the year ended December 31, 1993, in conformity with generally accepted accounting principles. STEVENSON, JONES & HOLMASS, P.C. Tuscon, Arizona April 27, 1994 -71- EX-13.3 12 EXHIBIT 13.3 EXHIBIT 13.3 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of CareFlorida Health Systems, Inc. We have audited the consolidated statements of income, changes in stockholders' equity, and cash flows of CareFlorida Health Systems, Inc. And Subsidiaries for the year ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of CareFlorida Health Systems, Inc. And Subsidiaries for the year ended December 31, 1993 in conformity with generally accepted accounting principles. COOPERS & LYBRAND LLP Miami, Florida February 28, 1994 -72- EX-21.0 13 EXHIBIT 21.0 EXHIBIT 21.0
SIGNIFICANT SUBSIDIARIES CORPORATION STATE OF INCORPORATION ---------------------------------------------------------------------------------------------------------- AMERICAN VITALCARE, INC. California ASSOCIATED CLAIMS MANAGEMENT OF NEVADA, INC. Nevada BUSINESS INSURANCE COMPANY Delaware CALIFORNIA COMPENSATION INSURANCE California CAREFLORIDA HEALTH PLAN, INC. Florida CATALINA PROFESSIONAL RECRUITERS, INC. Arizona CENTURY MEDICAL CORP., DBA CENTURY MEDICAL MANAGEMENT California CLAIMS TECHNICAL SERVICES, INC. Delaware CMP-HEALTH ADMINISTRATORS, INC. Florida COMBINED BENEFITS LIFE INSURANCE COMPANY California DENTICARE OF CALIFORNIA, INC. California EAST LOS ANGELES DOCTORS HOSPITAL, INC. California FH-ARIZONA SURGERY CENTER, INC. California FH ASSURANCE COMPANY Cayman Islands FH SURGERY CENTERS, INC. California FH SURGERY LIMITED, INC. California FHC INTERNATIONAL, INC. Delaware FOUNDATION HEALTH (UNLIMITED) United Kingdom FOUNDATION HEALTH FACILITIES, INC. California FOUNDATION HEALTH FEDERAL SERVICES, INC. Delaware FOUNDATION HEALTH INTERNATIONAL MANAGEMENT SERVICES California FOUNDATION HEALTH MEDICAL GROUP, FLORIDA, INC. Florida FOUNDATION HEALTH MEDICAL RESOURCE MANAGEMENT, DBA REVIEWCO California FOUNDATION HEALTH MEDICAL SERVICES California FOUNDATION HEALTH NATIONAL LIFE INSURANCE COMPANY Texas FOUNDATION HEALTH PHARMACEUTICAL SERVICES, NC. DBA APOLLO ENTERPRISES California FOUNDATION HEALTH PREFERRED ADMINISTRATORS California FOUNDATION HEALTH PSYCHCARE LIMITED United Kingdom FOUNDATION HEALTH PSYCHCARE SERVICES, INC. California FOUNDATION HEALTH TRAVEL LTD. United Kingdom -73- FOUNDATION HEALTH VISION SERVICES, DBA AVP VISION PLAN California FOUNDATION HEALTH WAREHOUSE COMPANY California FOUNDATION HEALTH, A CALIFORNIA HEALTH PLAN California FOUNDATION HEALTH, A COLORADO HEALTH PLAN, INC. Colorado FOUNDATION HEALTH, A LOUISIANA HEALTH PLAN, INC. Louisiana FOUNDATION HEALTH, A SOUTH FLORIDA HEALTH PLAN, INC. Florida FOUNDATION HEALTH, A TEXAS HEALTH PLAN, INC. Texas FOUNDATION HEALTH, AN ALABAMA HEALTH PLAN, INC. Alabama FOUNDATION HEALTH, AN OKLAHOMA HEALTH PLAN, INC. Oklahoma FOUNDATION INTEGRATED RISK MANAGEMENT SOLUTIONS, INCORPORATED California GEM HOLDING CORPORATION Utah GEM INSURANCE COMPANY Utah HEALTH MANAGEMENT CENTER WEST, INC. Massachusetts HEALTH MANAGEMENT CENTER WISCONSIN, INC. Wisconsin HEALTH MANAGEMENT CENTER, INC. Massachusetts HMC PPO, INC. Massachusetts INTEGRATED PHARMACEUTICAL SERVICES California INTERCARE, INC. Arizona INTERGROUP HEALTH PLAN, INC., DBA AHCCCS SELECT Arizona INTERGROUP HEALTHCARE CORPORATION OF UTAH Utah INTERGROUP OF UTAH, INC. Utah INTERGROUP PREPAID HEALTH SERVICES OF ARIZONA, INC. Arizona INTERLEASE OF ARIZONA, INC. Arizona JANNA CORPORATION Delaware MANAGED ALTERNATIVE CARE, INC. California MANAGED HEALTH NETWORK California MANAGED HEALTH NETWORK, INC. Delaware MEDNET EUROPE United Kingdom MEDNET SERVICES LIMITED United Kingdom MEMORIAL HOSPITAL OF GARDENA, INC. California MHN REINSURANCE COMPANY OF ARIZONA Arizona MHN SERVICES California PREFERRED HEALTH PROVIDERS, INC. Florida
-74- EX-23.1 14 EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in: (1) Registration Statement on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit Sharing and 401(k) Plan, (2) Registration Statement on Form S-8 (No. 33-36850) relating to the Foundation Health Corporation 1990 Stock Option Plan, (3) Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation Health Corporation Employee Stock Purchase Plan, (4) Registration Statement on Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of Foundation Health Corporation, (5) Registration Statement on Form S-8 (No. 33-48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation and the Foundation Health Corporation Incentive Common Stock Option Agreement, (6) Registration Statement on Form S-8 (No. 33-53468) relating to the Century MediCorp 1983 Incentive Stock Option Plan and Century MediCorp 1985, 1988, 1989 and 1991 nonstatutory stock option plans, (7) Registration Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock Plan of Business Insurance Corporation, (8) Registration Statement on Form S-3 (No. 33-80512) relating to the 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation, (9) Registration Statement on Form S-8 (No. 33-86568) relating to the Intergroup Healthcare Corporation Stock Option and Incentive Plan and Stock Option Agreement, and (10) Registration Statement on Form S-8 (No. 33-86566) relating to the Foundation Health Corporation 1990 Stock Option Plan (as amended and restated), of our report dated July 25, 1996, appearing in this Annual Report on Form 10-K of Foundation Health Corporation for the year ended June 30, 1996. DELOITTE & TOUCHE LLP Sacramento, California August 27, 1996 -75- EX-23.2 15 EXHIBIT 23.2 EXHIBIT 23.2 Consent of Ernst & Young LLP, Independent Auditors We consent to the incorporation by reference in the: (1) Registration Statement on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit Sharing and 401(k) Plan, (2) Registration Statement on Form S-8 (No. 33-36850) relating to the Foundation Health Corporation 1990 Stock Option Plan, (3) Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation Health Corporation Employee Stock Purchase Plan, (4) Registration Statement on Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of Foundation Health Corporation, (5) Registration Statement on Form S-8 (No. 33 - -48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation and the Foundation Health Corporation Incentive Common Stock Option Agreement, (6) Registration Statement on Form S-8 (No. 33-53468) relating the Century MediCorp 1983 Incentive Stock Option Plan and Century MediCorp 1985, 1988, 1989 and 1991 nonstatutory stock option plans, (7) Registration Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock Plan of Business Insurance Corporation, (8) Registration Statement on Form S-3 (No. 33-80512) relating to the 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation, (9) Registration Statement on Form S-8 (No. 33-86568) relating to the Intergroup Healthcare Corporation Stock Option and Incentive Plan and Stock Option Agreement, and (10) Registration Statement on Form S-8 (No. 33-86566) relating to the Foundation Health Corporation 1990 Stock Option Plan (as amended and restated), of our report dated February 16, 1994, except Note 17 as to which the date is March 18, 1994, with respect to the consolidated financial statements of Intergroup Healthcare Corporation for the year ended December 31, 1993, appearing in this Annual Report on Form 10-K of Foundation Health Corporation for the year ended June 30, 1996. ERNST & YOUNG LLP Tucson, Arizona August 27, 1996 -76- EX-23.3 16 EXHIBIT 23.3 EXHIBIT 23.3 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the: (1) Registration Statement on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit Sharing and 401(k) Plan; (2) Registration Statement on Form S-8 (No. 33-36850) relating to the Foundation Health Corporation 1990 Stock Option Plan; (3) Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation Health Corporation Employee Stock Purchase Plan; (4) Registration Statement on Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of Foundation Health Corporation; (5) Registration Statement on Form S-8 (No. 33- 48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation and the Foundation Health Corporation Incentive Common Stock Option Agreements; (6) Registration Statement on Form S-8 (No. 33-53468) relating to the Century Medicorp 1983 Incentive Stock Option Plan and Century Medicorp 1985, 1988, 1989 and 1991 nonstatutory stock option plans; (7) Registration Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock Plan of Business Insurance Corporation; and (8) Registration Statement on Form S-3 (No. 33-80512) relating to the 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation; (9) Registration Statement on Form S-8 (No. 33-86568) relating to the Intergroup Healthcare Corporation Stock Option and Incentive Plan and Stock Option Agreement; (10) Registration Statement on Form S-8 (No. 33-86566) relating to the Foundation Health Corporation 1990 Stock Option Plan (as amended and restated), of our report dated April 27, 1994, appearing in this Annual Report on Form 10-K of Foundation Health Corporation for the year ended June 30, 1996. STEVENSON, JONES & HOLMASS, P.C. Tucson, Arizona August 27, 1996 -77- EX-23.4 17 EXHIBIT 23.4 EXHIBIT 23.4 CONSENT OF INDEPENDENT ACCOUNTS We consent to incorporation by reference in the (1) Registration Statement on Form S-8 (No. 33-36847) relating to the Foundation Health Corporation Profit Sharing and 401(k) Plan, (2) Registration Statement on Form S-8 (No. 33-36850) relating to the Foundation Health Corporation 1990 Stock Option Plan, (3) Registration Statement on Form S-8 (No. 33-36849) relating to the Foundation Health Corporation Employee Stock Purchase Plan, (4) Registration Statement on Form S-8 (No. 33-44783) relating to the Non-Qualified Stock Option Plan of Foundation Health Corporation, (5) Registration Statement on Form S-8 (No. 33 - -48561) relating to the 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation and the Foundation Health Corporation Incentive Common Stock Option Agreement, (6) Registration Statement on Form S-8 (No.33-534468) relating to the Century MediCorp. 1983 Incentive Stock Option Plan and Century MediCorp 1985, 1988, 1989 and 1991 nonstatutory stock option plans, (7) Registration Statement on Form S-8 (No. 33-67062) relating to the 1989 Stock Plan of Business Insurance Corporation, (8) Registration Statement on Form S-3 (No. 33-80512) relating to the 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation, (9) Registration Statement on Form S-8 (No. 33-86568) relating to the Intergroup Healthcare Corporation Stock Option and Incentive Plan and Stock Option Agreement, and (10) Registration Statement on Form S-8 (No.33-86566) relating to the Foundation Health Corporation 1990 Stock Option Plan (as amended and restated), of our report dated February 28, 1994, on our audit of the consolidated statements of income, changes in stockholders' equity, and cash flows of CareFlorida Health Systems, Inc. and Subsidiaries for the year ended December 31, 1993 which report is included in the Annual Report on Form 10-K of Foundation Health Corporation. COOPERS & LYBRAND LLP Miami, Florida August 27, 1996 -78- EX-27 18 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM 10-K FILED BY FOUNDATION HEALTH CORPORATION FOR THE FISCAL YEAR ENDED JUNE 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR JUN-30-1996 JUL-01-1995 JUN-30-1996 224,838 714,914 416,225 0 0 0 277,206 0 2,426,399 0 318,668 0 0 533,855 400,734 2,426,399 3,338,804 3,415,817 0 3,160,123 0 0 15,099 240,595 74,155 0 0 0 0 166,440 2.86 0 NET PPE
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