-----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, A3BM3O8rqljcyXKwCyVx6/zQGPAgqbgIroElhN5bfW3n2xnML8oWIKoqbMVBdcmz pMFyb/xG2iXRI17HjvKSIg== 0001047469-98-031385.txt : 19980817 0001047469-98-031385.hdr.sgml : 19980817 ACCESSION NUMBER: 0001047469-98-031385 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FOUNDATION HEALTH SYSTEMS INC CENTRAL INDEX KEY: 0000916085 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE CARRIERS, NEC [6399] IRS NUMBER: 954288333 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12718 FILM NUMBER: 98687874 BUSINESS ADDRESS: STREET 1: 21600 OXNARD ST CITY: WOODLAND HILLS STATE: CA ZIP: 91367 BUSINESS PHONE: 7195420500 MAIL ADDRESS: STREET 1: 225 N MAIN ST CITY: PUEBLO STATE: CO ZIP: 81003 FORMER COMPANY: FORMER CONFORMED NAME: HEALTH SYSTEMS INTERNATIONAL INC DATE OF NAME CHANGE: 19940207 FORMER COMPANY: FORMER CONFORMED NAME: HN MANAGEMENT HOLDINGS INC/DE/ DATE OF NAME CHANGE: 19931213 10-Q 1 FORM 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 1998 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ______________ COMMISSION FILE NUMBER: 1-12718 ------------------------ FOUNDATION HEALTH SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 95-4288333 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) No.) 21600 OXNARD STREET, WOODLAND HILLS, CA 91367 (Address of principal executive offices) (Zip Codes) (818) 676-6978 Registrant's telephone number, including area code ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of August 10, 1998, 117,083,153 shares of Class A Common Stock, $.001 par value per share, were outstanding (exclusive of 3,194,374 shares held as treasury stock) and 5,047,642 shares of Class B Common Stock, $.001 par value per share, were outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FOUNDATION HEALTH SYSTEMS, INC. INDEX TO FORM 10-Q
PAGE ----- PART I--FINANCIAL INFORMATION Item 1--Financial Statements Condensed Consolidated Balance Sheets, June 30, 1998 and December 31, 1997............................... 3 Condensed Consolidated Statements of Operations for the Second Quarter Ended June 30, 1998 and 1997...... 4 Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 1998 and 1997.......... 5 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1998 and 1997.......... 6 Notes to Condensed Consolidated Financial Statements..................................................... 7 Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 11 Item 3--Quantitative and Qualitative Disclosures About Market Risk......................................... 21 PART II--OTHER INFORMATION Item 1--Legal Proceedings.................................................................................. 23 Item 2--Changes in Securities.............................................................................. 25 Item 3--Defaults Upon Senior Securities.................................................................... 26 Item 4--Submission of Matters to a Vote of Security Holders................................................ 27 Item 5--Other Information.................................................................................. 27 Item 6--Exhibits and Reports on Form 8-K................................................................... 31 Signatures................................................................................................. 39
2 PART I--FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS)
JUNE 30, DECEMBER 31, 1998 1997 ------------ ------------- (UNAUDITED) ASSETS Cash and cash equivalents......................................... $ 250,686 $ 559,360 Securities available for sale..................................... 557,588 553,001 Premiums receivable, net.......................................... 241,127 224,383 Amounts receivable under government contracts..................... 315,636 272,060 Deferred taxes.................................................... 241,748 213,695 Reinsurance and other receivables................................. 131,177 130,875 Other assets...................................................... 214,333 223,900 Net assets of discontinued operations............................. 270,303 267,713 ------------ ------------- Total current assets............................................ 2,222,598 2,444,987 Securities held to maturity....................................... 13,447 12,885 Property and equipment, net....................................... 436,344 427,149 Goodwill and other intangible assets, net......................... 1,029,462 1,044,727 Other assets...................................................... 175,011 146,602 ------------ ------------- Total Assets.................................................... $ 3,876,862 $ 4,076,350 ------------ ------------- ------------ ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Reserves for claims and other settlements......................... $ 853,573 $ 967,815 Unearned premiums................................................. 99,908 244,340 Notes payable and capital leases.................................. 4,741 3,593 Amounts payable under government contracts........................ 88,120 78,441 Accounts payable and other liabilities............................ 361,362 470,483 ------------ ------------- Total current liabilities....................................... 1,407,704 1,764,672 Notes payable and capital leases.................................. 1,422,182 1,308,979 Other liabilities................................................. 118,144 106,725 ------------ ------------- Total Liabilities............................................... 2,948,030 3,180,376 ------------ ------------- Stockholders' Equity: Common stock and additional paid-in capital....................... 633,223 628,735 Retained earnings................................................. 397,588 370,394 Unrealized investment gains and (losses), net of taxes............ (6,148) (7,324 ) Common stock held in treasury, at cost............................ (95,831) (95,831 ) ------------ ------------- Total Stockholders' Equity...................................... 928,832 895,974 ------------ ------------- Total Liabilities and Stockholders' Equity...................... $ 3,876,862 $ 4,076,350 ------------ ------------- ------------ -------------
See Notes To Condensed Consolidated Financial Statements 3 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
SECOND QUARTER ENDED JUNE 30, ------------------------ 1998 1997 ----------- ----------- Revenues Health plan premiums............................................... $ 1,869,468 $ 1,438,554 Government contracts premiums...................................... 249,362 223,620 Specialty services................................................. 94,697 77,506 Investment and other income........................................ 23,444 33,742 ----------- ----------- Total revenues................................................. 2,236,971 1,773,422 ----------- ----------- Expenses Health plan services............................................... 1,618,093 1,203,695 Government contracts health care services.......................... 192,346 166,488 Specialty services................................................. 72,859 67,307 Selling, general and administrative................................ 248,446 203,442 Amortization and depreciation...................................... 31,505 24,804 Interest........................................................... 22,193 17,185 ----------- ----------- 2,185,442 1,682,921 ----------- ----------- Asset impairments related to FPA Medical Management................ 50,000 -- Merger, restructuring and other costs.............................. -- 346,109 Gem costs.......................................................... -- 57,500 ----------- ----------- 50,000 403,609 ----------- ----------- Total expenses................................................. 2,235,442 2,086,530 ----------- ----------- Income (loss) from continuing operations before income taxes......... 1,529 (313,108) Income tax provision (benefit)....................................... 573 (107,316) ----------- ----------- Income (loss) from continuing operations............................. 956 (205,792) Income from discontinued operations.................................. -- 5,664 ----------- ----------- Net income (loss).................................................... $ 956 $ (200,128) ----------- ----------- ----------- ----------- Basic earnings (loss) per share: Continuing operations.............................................. $ 0.01 $ (1.64) Discontinued operations............................................ -- 0.04 ----------- ----------- Net................................................................ $ 0.01 $ (1.60) ----------- ----------- ----------- ----------- Diluted earnings (loss) per share: Continuing operations.............................................. $ 0.01 $ (1.64) Discontinued operations............................................ -- 0.04 ----------- ----------- Net................................................................ $ 0.01 $ (1.60) ----------- ----------- ----------- ----------- Weighted average common and common stock equivalent shares outstanding: Basic.............................................................. 121,957 125,306 Diluted............................................................ 122,335 125,777
See Notes To Condensed Consolidated Financial Statements 4 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------ 1998 1997 ----------- ----------- Revenues Health plan premiums............................................... $ 3,713,952 $ 2,858,299 Government contracts premiums...................................... 462,989 469,654 Specialty services................................................. 185,810 155,536 Investment and other income........................................ 49,594 59,952 ----------- ----------- Total revenues................................................. 4,412,345 3,543,441 ----------- ----------- Expenses Health plan services............................................... 3,202,596 2,384,703 Government contracts health care services.......................... 355,637 357,400 Specialty services................................................. 146,067 132,566 Selling, general and administrative................................ 506,854 417,977 Amortization and depreciation...................................... 62,346 49,488 Interest........................................................... 44,054 32,123 ----------- ----------- 4,317,554 3,374,257 ----------- ----------- Asset impairments related to FPA Medical Management................ 50,000 -- Merger, restructuring and other costs.............................. -- 346,109 Gem costs.......................................................... -- 57,500 ----------- ----------- 50,000 403,609 ----------- ----------- Total expenses................................................. 4,367,554 3,777,866 ----------- ----------- Income (loss) from continuing operations before income taxes......... 44,791 (234,425) Income tax provision (benefit)....................................... 17,597 (76,257) ----------- ----------- Income (loss) from continuing operations............................. 27,194 (158,168) Income from discontinued operations.................................. -- 16,521 ----------- ----------- Net income (loss).................................................... $ 27,194 $ (141,647) ----------- ----------- ----------- ----------- Basic earnings (loss) per share: Continuing operations.............................................. $ 0.22 $ (1.26) Discontinued operations............................................ -- 0.13 ----------- ----------- Net................................................................ $ 0.22 $ (1.13) ----------- ----------- ----------- ----------- Diluted earnings (loss) per share: Continuing operations.............................................. $ 0.22 $ (1.26) Discontinued operations............................................ -- 0.13 ----------- ----------- Net................................................................ $ 0.22 $ (1.13) ----------- ----------- ----------- ----------- Weighted average common and common stock equivalent shares outstanding: Basic.............................................................. 121,786 125,302 Diluted............................................................ 122,117 125,735
See Notes To Condensed Consolidated Financial Statements 5 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, -------------------- 1998 1997 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)................................................... $ 27,194 $(141,647) Adjustments to reconcile net income (loss) to net cash used for operating activities: Amortization and depreciation..................................... 62,346 49,488 Changes in net assets of discontinued operations.................. (3,575) (31,649) Asset impairments related to FPA Medical Management............... 45,000 -- Other changes..................................................... (711) 10,610 Change in assets and liabilities Premiums receivable and unearned subscriber premiums.............. (161,176) (137,690) Other assets...................................................... (63,156) (141,058) Amounts receivable/payable under government contracts............. (33,897) (21,470) Reserves for claims and other settlements......................... (114,242) (57,645) Accounts payable and accrued liabilities.......................... (114,263) 147,814 --------- --------- Net cash used for operating activities................................ (356,480) (323,247) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Sale or maturity of securities available for sale................... 424,974 452,300 Purchases of securities available for sale.......................... (433,783) (251,119) Disposition of securities held to maturity.......................... 3,612 1,550 Purchases of securities held to maturity............................ (2,794) (2,274) Purchases of property and equipment................................. (77,263) (40,451) Investment in other companies....................................... -- (16,112) Other............................................................... 5,677 98,128 --------- --------- Net cash provided by (used for) investing activities.................. (79,577) 242,022 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options and employee stock purchases......................................................... 12,349 12,861 Proceeds from issuance of notes payable and other financing arrangements...................................................... 115,560 262,520 Repayment of debt and other non-current liabilities................. (526) (130,828) Purchase of treasury stock.......................................... -- (112,179) --------- --------- Net cash provided by financing activities............................. 127,383 32,374 --------- --------- Net decrease in cash and cash equivalents............................. (308,674) (48,851) Cash and cash equivalents, beginning of period........................ 559,360 487,938 --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD.............................. $ 250,686 $ 439,087 --------- --------- --------- ---------
See Notes To Condensed Consolidated Financial Statements 6 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1--MERGER The current operations of Foundation Health Systems, Inc. (the "Company") are a result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the FHS Combination, FH Acquisition Corp., a wholly owned subsidiary of HSI, merged with and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company. Pursuant to the Agreement and Plan of Merger that evidenced the FHS Combination, FHC stockholders received 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held, resulting in the issuance of approximately 76.7 million shares of the Company's Class A Common Stock to FHC stockholders. The FHS Combination was accounted for as a pooling of interests for accounting and financial reporting purposes. The pooling of interests method of accounting is intended to present, as a single interest, two or more common stockholder interests which were previously independent and assumes that the combining companies have been merged from inception. Consequently, the Company's condensed consolidated financial statements have been prepared and/or restated as though HSI and FHC always had been combined. NOTE 2--BASIS OF PRESENTATION In the opinion of management, the accompanying condensed consolidated financial statements include all adjustments necessary for a fair presentation of the consolidated financial position of the Company and the consolidated results of its operations and its cash flows for the interim periods presented. All adjustments presented in these condensed consolidated financial statements are of a normal recurring nature. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. For further information please refer to the consolidated financial statements and notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. Results of operations for the interim periods are not necessarily indicative of results to be expected for the full year. NOTE 3--ASSET IMPAIRMENT On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its affiliated medical groups, currently provides services to approximately 150,000 of the Company's affiliated members in Arizona and California. FPA has indicated that it will discontinue its medical group operations in these markets. As a result, the Company will have to find new tenants for, or sell, the 13 healthcare facilities it currently leases to FPA in these markets and make other arrangements for provider services to the Company's affiliated members. Management's analysis of this situation indicates that the likely replacement lease terms from these properties will be inadequate to enable the Company to sell the facilities and recover their carrying value. Based on management's best estimate of recovery for the real estate and the impairment of notes receivable and other Company assets due to the FPA bankruptcy filing, the Company has recorded a charge of $50 million in the second quarter of 1998. Elements of the charge include approximately 7 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) NOTE 3--ASSET IMPAIRMENT (CONTINUED) $35 million for real estate asset impairments, approximately $10 million for a note receivable impairment and $5 million for other items. NOTE 4--MERGER, RESTRUCTURING AND OTHER COSTS AND GEM COSTS Net restructuring costs of $149.4 million were recorded during the year ended December 31, 1997 related to the FHS Combination and the restructuring of the Company's Eastern Division health plans. As of June 30, 1998, $84.0 million of the net restructuring charge has resulted in cash outlays and $25.3 million is expected to require future outlays of cash. In addition, $70.4 million of merger costs, $118.6 million of other costs and $57.5 million of premium deficiency costs of Gem Insurance Company were recorded during 1997. It is expected that $10.6 million of these other charges will require future outlays of cash. NOTE 5--DISCONTINUED OPERATIONS The Company revised its strategy of maintaining a presence in the workers' compensation insurance business and thereby adopted a plan to discontinue this segment of its business through divestiture of its workers' compensation insurance subsidiaries. As a result, the Company is reporting its workers' compensation insurance segment as discontinued operations for each period presented in the condensed consolidated financial statements. Consistent with the foregoing, on May 5, 1998 the Company entered into a definitive agreement to sell its workers' compensation insurance operations to Superior National Insurance Group, Inc. The transaction is expected to yield the Company approximately $290 million in cash net of tax considerations and the cost of reinsurance. The following sets forth the summarized balance sheets as of June 30, 1998 and December 31, 1997 and results of operations for the second quarter and six-month periods ended June 30, 1998 and 1997 for the workers' compensation insurance companies to be sold (in thousands):
JUNE 30, DECEMBER 31, 1998 1997 ---------- ------------- Total assets........................................................ $1,224,246 $ 1,260,335 Total liabilities................................................... 977,820 1,000,815 ---------- ------------- Net assets.......................................................... 246,426 259,520 Amounts to reconcile to net assets from discontinued operations: Elimination of net notes payable to Parent and other net receivables from Parent and subsidiaries........................ 110,769 107,193 Loss on disposition............................................... (86,892) (99,000) ---------- ------------- Net assets from discontinued operations............................. $ 270,303 $ 267,713 ---------- ------------- ---------- -------------
8 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) NOTE 5--DISCONTINUED OPERATIONS (CONTINUED)
SECOND QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------- -------------------- 1998 1997 1998 1997 --------- --------- --------- --------- Total revenues....................................... $ 81,686 $ 135,996 $ 231,665 $ 268,221 Total expenses....................................... 96,742 130,708 256,297 249,657 --------- --------- --------- --------- Income (loss) before income taxes.................... (15,056) 5,288 (24,632) 18,564 Provision (benefit) for income taxes................. (7,129) (376) (12,524) 2,043 --------- --------- --------- --------- Net income (loss).................................... (7,927) 5,664 (12,108) 16,521 Loss after measurement date anticipated in loss on disposition........................................ 7,927 -- 12,108 -- --------- --------- --------- --------- Net income from discontinued operations.............. $ -- $ 5,664 $ -- $ 16,521 --------- --------- --------- --------- --------- --------- --------- ---------
The loss on disposition of $99 million recorded at December 31, 1997 included the anticipated results of operations through the disposal date and therefore the net loss of $7.9 million and $12.1 million for the second quarter and six-month periods ended June 30, 1998, respectively, are not reflected on the Company's condensed consolidated statements of operations for those respective periods. NOTE 6--COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive Income." This standard requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from non-owner sources which is defined as net income plus direct adjustments to stockholders' equity such as unrealized investment adjustments and pension liability adjustments. The Company's comprehensive income pursuant to such standard is as follows (in thousands):
SECOND QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------- -------------------- 1998 1997 1998 1997 --------- --------- --------- --------- Net income (loss).................................... $ 956 $(200,128) $ 27,194 $(141,647) Other comprehensive income, net of tax: Unrealized gains (losses) on securities not included in net income........................... (2,629) 4,975 1,176 (10,762) --------- --------- --------- --------- Comprehensive income (loss).......................... $ (1,673) $(195,153) $ 28,370 $(152,409) --------- --------- --------- --------- --------- --------- --------- ---------
NOTE 7--EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share excludes dilution and reflects income or loss divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings (loss) per share is based upon the weighted average shares of common stock and dilutive common stock equivalents (stock options) outstanding during the periods presented; no adjustment to income is required. Common stock equivalents arising from dilutive stock options are computed using the treasury stock method. 9 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) NOTE 8--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS During 1997, the Financial Accounting Standards Board issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information", which establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers; and SFAS No. 132 "Employers Disclosures About Pensions and Other Postretirement Benefits", which revises and standardizes pension and other benefit plan disclosures. Adoption of these statements will not impact the Company's consolidated financial position, results of operations or cash flows. These statements are effective for fiscal years beginning after December 15, 1997. Accordingly, the Company plans to adopt these statements during the fourth quarter of 1998. NOTE 9--PRIOR PERIOD RECLASSIFICATION Certain prior period amounts have been reclassified to conform with the current period presentation. 10 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Foundation Health Systems, Inc. (the "Company") is an integrated managed care organization which administers the delivery of managed health care services. Through its subsidiaries, the Company offers group, individual, Medicaid and Medicare health maintenance organization ("HMO") and preferred provider organization ("PPO") plans; government sponsored managed care plans; and managed care products related to bill review, administration and cost-containment, behavioral health, dental, vision and pharmaceutical products and services. CONSOLIDATED OPERATING RESULTS The Company's net income from continuing operations for the quarter ended June 30, 1998 was $1.0 million, or $.01 per diluted share, compared to a net loss from continuing operations for the quarter ended June 30, 1997 of $205.8 million, or $1.64 per diluted share. Excluding the asset impairments charge related to FPA Medical Management, Inc. ("FPA") of $50 million in the 1998 quarter, and the merger, restructuring, other costs and Gem costs of $403.6 million in the 1997 quarter, the diluted earnings per share for the quarters ended June 30, 1998 and June 30, 1997 was $.26 and $.43, respectively. The Company's net income from continuing operations for the six months ended June 30, 1998 was $27.2 million, or $.22 per diluted share, compared to a net loss from continuing operations for the six months ended June 30, 1997 of $158.2 million, or $1.26 per diluted share. Excluding the asset impairments charge of $50 million in 1998 and the merger, restructuring, other costs and Gem costs of $403.6 million in 1997, the diluted earnings per share for the six months ended June 30, 1998 and June 30, 1997 was $.47 and $.81, respectively. REVENUES AND HEALTH CARE COSTS The Company's revenues for the quarter and six months ended June 30, 1998 as compared to the same periods in 1997 grew by $463.5 million and $868.9 million or 26.1% and 24.5%, respectively. Growth in revenues for the quarter and six months was due primarily to the acquisitions that occurred in the fourth quarter of 1997, including Physicians Health Services, Inc. ("PHS"), FOHP, Inc. ("FOHP"), and PACC HMO, Inc. and PACC Health Plans, Inc. (collectively, "PACC"). Excluding these acquisitions, revenues grew by $106.6 million and $160.4 million for the quarter and six months, respectively. The growth from existing businesses was due to increases in premium rates in virtually all markets and significant increases in Medicaid enrollment in the California Division contributed to the increase in revenue. Specialty Services Division revenue increased for the quarter and six months ended June 30, 1998 as compared to the same periods in 1997 by $17.2 million and $30.3 million or 22.2% and 19.5%, respectively, primarily due to increased revenue from drug manufacturer rebates, the Company's behavioral health plans, and bill review, cost containment and administrative services businesses. The increase for the second quarter of 1998 included increased Government Contracts Division revenue resulting from CHAMPUS contract downward price adjustments occurring in the second quarter of 1997. Investment and other income for the quarter and six months ended June 30, 1998 was $10.3 million and $10.4 million lower as compared to the same periods in 1997 as a result of 1997 interest income and gain on redemption of the notes receivable from FPA Medical Management, Inc. ("FPA") and the gain on the sale of FPA common stock included in the second quarter of 1997. The Health Plan medical care ratio ("MCR") (medical costs as a percentage of health plan revenues) for the quarter and six months ended June 30, 1998 increased to 86.6% and 86.2%, respectively, from 83.7% and 83.4% for the respective periods in 1997. The increase in the MCR was primarily due to higher pharmacy costs in all divisions and benefit cost increases which exceeded premium rate increases. 11 SELLING, GENERAL AND ADMINISTRATIVE COSTS The Company's selling, general and administrative ("SG&A") expenses increased by $45.0 million and $88.9 million or 22.1% and 21.3% for the quarter and six months ended June 30, 1998 as compared to the same periods in 1997. The increase in SG&A expenses is primarily due to additional SG&A expenses associated with the acquisitions that occurred in 1997. The administrative expense ratio (SG&A as a percentage of health plan and government contracts revenue) decreased to 11.7% and 12.1% for the quarter and six months ended June 30, 1998 from 12.2% and 12.6%, respectively, for the comparable periods in 1997. This lower ratio is the result of continued focus on cost control and continued benefits of integration synergies from acquisitions. AMORTIZATION AND DEPRECIATION Amortization and depreciation expense increased by $6.7 million and $12.9 million for the quarter and six months ended June 30, 1998 as compared to the same periods in 1997. This was primarily due to higher levels of intangibles and fixed assets as a result of the acquisition of companies that occurred in the fourth quarter of 1997 and increased expenditures on fixed assets primarily related to consolidation and integration of the Company's administrative facilities. ASSET IMPAIRMENTS RELATED TO FPA MEDICAL MANAGEMENT On July 19, 1998, FPA filed for bankruptcy protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its affiliated medical groups, currently provides services to approximately 150,000 of the Company's members in Arizona and California. FPA has indicated that it will discontinue its medical group operations in these markets. The Company recorded a $50 million charge in the second quarter ended June 30, 1998 primarily related to real estate assets currently leased to FPA. Elements of the charge include approximately $35 million for real estate asset impairments, approximately $10 million for a note receivable from FPA and approximately $5 million for other items related to FPA. INTEREST EXPENSE Interest expense increased by $5.0 million and $11.9 million for the quarter and six months ended June 30, 1998, respectively, as compared to the same periods during the prior year. The increase in interest expense was due to higher debt levels associated with the Company's revolving lines of credit. The additional borrowings were incurred for general corporate purposes as well as the purchase of PHS, FOHP and PACC in the fourth quarter of 1997. INCOME TAX PROVISION The tax provision rate on income from continuing operations for the quarter and six months ended June 30, 1998 of 37.5% and 39.3% increased from the tax benefit rate of 34.3% and 32.5% for the quarter and six months ended June 30, 1997 because of the charges recorded in 1997 from merger, restructuring, other costs and Gem costs, portions of which were not deductible for tax purposes. The tax provision rate differs from the statutory federal rate of 35% due to state income taxes and tax-exempt income, offset by non-deductible goodwill amortization. LINE OF BUSINESS REPORTING The Company currently operates in the managed health care segment. The managed health care segment's continuing operations are in three primary lines of business: (i) health plan operations; (ii) government contracts; and (iii) specialty services. Discontinued operations include the workers' compensation insurance segment. 12 CONTINUING OPERATIONS HEALTH PLANS Revenues generated by the Company's Health Plan operations increased $430.9 million or 30.0% for the quarter ended June 30, 1998 and $855.7 million or 29.9% for the six months ended June 30, 1998 compared to the same periods in 1997. The primary reason for the increase is the acquisitions that occurred in the fourth quarter of 1997 including PHS, FOHP and PACC which contributed approximately $384.4 million and $692.6 million, respectively, in revenue during the second quarter and first six months of 1998. In addition, Medicaid enrollment growth in the California division and premium rate increases in the aggregate for all divisions contributed to the overall increase in revenues for the health plans. The MCR for the Company's Health Plan operations increased to 86.6% and 86.2% for the quarter and six months ended June 30, 1998 as compared to 83.7% and 83.4% in the same periods in 1997. These increases were primarily a result of pharmacy cost increases in all divisions and benefit cost increases which exceeded premium rate increases. The Company's Commercial product lines are profitable and have been adding membership in the aggregate for all divisions. Premium rate increases in the Commercial line of products contributed to revenue increases for the quarter and six months ended June 30, 1998 compared to the same periods in 1997 in all divisions of the Company, but were partially offset by enrollment decreases in Commercial HMO markets in California and the Western health plans. Commercial health care costs on a per member per month basis have increased 11.5% in the quarter and six months ended June 30, 1998 as compared to the same periods in 1997. The Company's Medicare product lines in the California market are profitable, but are experiencing lower margins than in the prior year. The Medicare products in the Company's Northeast health plans have shown an underwriting loss of approximately $11.5 million for the six months ended June 30, 1998. Medicare premium rates and enrollment have increased in the Northeast markets, but enrollment rates are expected to slow. Medicare health care costs in the California and Northeast markets continue to increase faster than premium rates. Medicaid enrollment in the California division has increased significantly resulting in a 71% increase in member months in the quarter and six months ended June 30, 1998 compared to the same periods in 1997. However, Medicaid premium rates have decreased in all markets. Medicaid health care costs have remained steady or decreased on a per member per month basis in all of the Company's markets except for several of its Western health plans, which have experienced higher costs due to several high cost claims. GOVERNMENT CONTRACTS Government Contracts Division revenue increased by $25.7 million or 11.5% for the quarter ended June 30, 1998 compared to the same period in 1997. The increase in revenue was primarily due to decreased revenue in the second quarter of 1997 resulting from retroactive price adjustments and the related risk sharing provisions of CHAMPUS contracts, while 1998 second quarter revenues were impacted by positive retroactive adjustments related to estimated final settlements on CHAMPUS contracts. Government Contracts Division revenue for the six months ended June 30, 1998 decreased $6.7 million compared to the same period in 1997 primarily due to activity in the first quarter of 1998 which reduced contract prices because of lower than anticipated health care costs. The price adjustment feature of the CHAMPUS contracts results in reduced revenues when health care costs decline more than anticipated. Government contracts health care costs as a percentage of government contracts revenue increased to 77.1% in the second quarter of 1998 from 74.5% in the second quarter of 1997. This increase was primarily a result of second quarter 1997 revenues including Medicaid administrative contract revenue activity with 13 no associated health care costs, only administrative costs. This ratio for the six months ended June 30, 1998 was 76.8% compared to 76.1% for the six months ended June 30, 1997. SPECIALTY SERVICES Revenues generated by the Company's Specialty Services Division for the second quarter of 1998 increased by $17.2 million or 22.2% as compared to the second quarter of 1997 and increased by $30.3 million or 19.5% for the six months ended June 30, 1998 compared to the same period in 1997. These increases are primarily the result of higher drug manufacturer rebates and higher pharmacy cost recovery contract revenue in the current year quarter as well as growth in service fees by the Company's bill review cost containment and administrative services businesses, and continued growth in its managed behavioral health network businesses. Specialty Services Division costs decreased as a percentage of specialty services revenue to 76.9% for the second quarter of 1998 as compared to 86.8% in the second quarter of 1997 and to 78.6% for the six months ended June 30, 1998 compared to 85.2% for the same six month period in 1997. The reduction in this percentage was primarily due to increased revenues from drug rebates and manufacturer cost recovery contract revenue coupled with reduced administrative expenses as a percentage of revenue in the bill review, cost containment and administrative services businesses, partially offset by slightly higher costs due to a change in product mix in the managed behavioral health network businesses. DISCONTINUED OPERATIONS WORKERS' COMPENSATION INSURANCE BUSINESS The Company revised its strategy of maintaining a presence in the workers' compensation insurance business and thereby adopted a plan to discontinue this segment of its business through divestiture of its workers' compensation insurance subsidiaries. As a result, the Company is reporting its workers' compensation insurance segment as discontinued operations. Consistent with the foregoing, on May 5, 1998 the Company entered into a definitive agreement to sell its workers' compensation insurance operations to Superior National Insurance Group, Inc. The transaction is expected to yield the Company approximately $290 million in cash net of tax considerations and the cost of reinsurance. REVENUE Total workers' compensation revenue in the second quarter of 1998 of $81.7 million is $54.3 million or 39.9% less than the second quarter of 1997. Net earned premium of $72.7 million in the second quarter of 1998 is $52.2 million or 41.8% less than the net earned premium of $124.9 million in the second quarter of 1997. The decrease in premium is due primarily to the implementation of a quota share reinsurance treaty effective May 1, 1998. Under terms of this quota share agreement, gross premium earned on all policies with estimated annual premium in excess of $25,000 at policy inception along with 100% of the associated net losses and allocated loss adjustment expenses are ceded to the reinsurer, with a 33.5% ceding commission returned to the Company. In the second quarter of 1998, $59.8 million of earned premium was ceded under this quota share reinsurance treaty. For the six months ended June 30, 1998, total revenue of $231.7 million was $36.5 million or 13.6% less than the same period in 1997. Net earned premium for the six months ended June 30, 1998 of $212.3 million is $34.0 million or 13.8% less than the same period in 1997, primarily as a result of the aforementioned quota share treaty. In the second quarter of 1998, earned premium of $59.8 million was ceded under the 1998 quota share treaty. 14 COSTS Workers' compensation costs of $96.7 million, including general and administrative costs, decreased $34.0 million or 26.0% in the second quarter of 1998 compared to the same period in 1997. The decrease is primarily due to a ceding commission of $26.6 million under the quota share treaty mentioned above. For the six months ended June 30, 1998, total workers' compensation costs, including general and administrative costs, of $256.3 million are $6.6 million or 2.6% more than the same period in 1997. The ceding commission on the quota share reinsurance treaty offset higher claims costs in 1998. NET INCOME (LOSS) The loss on disposition of $99.0 million recorded at December 31, 1997 included the anticipated results of operations through the disposal date and therefore, the net loss of $7.9 million and $12.1 million for the quarter and six months ended June 30, 1998 is not reflected on the Company's condensed consolidated statement of operations for these periods. THE FOLLOWING TABLES PRESENT FINANCIAL INFORMATION REFLECTING THE COMPANY'S CONTINUING OPERATIONS FOR ITS PRIMARY LINES OF BUSINESS: 15 FOUNDATION HEALTH SYSTEMS, INC. LINE OF BUSINESS FINANCIAL INFORMATION CONTINUING OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
SECOND QUARTER ENDED SECOND QUARTER ENDED JUNE 30, 1998 JUNE 30, 1997 ----------------------------------- ---------------------- PERCENT PERCENT PERCENT AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL PERCENT REVENUE (DECREASE) PERCENT REVENUE --------- ----------- ----------- --------- ----------- Revenues Health plan premiums........................... $1,869,468 83.6% 30.0% $1,438,554 81.1% Government contracts premiums.................. 249,362 11.1 11.5 223,620 12.6 Specialty services............................. 94,697 4.2 22.2 77,506 4.4 Investment and other income.................... 23,444 1.1 (30.5) 33,742 1.9 --------- ----- --------- ----- Total revenues............................. 2,236,971 100.0 26.1 1,773,422 100.0 --------- ----- --------- ----- Expenses Health plan services........................... 1,618,093 72.3 34.4 1,203,695 67.9 Government contracts health care services...... 192,346 8.6 15.5 166,488 9.4 Specialty services............................. 72,859 3.3 8.2 67,307 3.8 Selling, general and administrative ("SG&A")... 248,446 11.1 22.1 203,442 11.5 Amortization and depreciation.................. 31,505 1.4 27.0 24,804 1.4 Interest....................................... 22,193 1.0 29.1 17,185 1.0 --------- ----- --------- ----- 2,185,442 97.7 29.9 1,682,921 95.0 --------- ----- --------- ----- Asset impairments related to FPA Medical Management................................... 50,000 2.2 100.0 -- -- Merger, restructuring and other costs.......... -- -- (100.0) 346,109 19.5 Gem costs...................................... -- -- (100.0) 57,500 3.2 --------- ----- --------- ----- 50,000 2.2 (87.6) 403,609 22.7 --------- ----- --------- ----- Total expenses............................. 2,235,442 99.9 7.1% 2,086,530 117.7 --------- ----- --------- ----- Income (loss) from continuing operations before income taxes................................... 1,529 0.1 (313,108) (17.7) Income tax provision (benefit)................... 573 0.0 (107,316) (6.1) --------- ----- --------- ----- Income (loss) from continuing operations......... $ 956 0.1% $(205,792) (11.6)% --------- ----- --------- ----- --------- ----- --------- ----- Earnings (loss) per share from continuing operations: Basic........................................ $ 0.01 $ (1.64) Diluted...................................... $ 0.01 $ (1.64) Weighted average common and common stock equivalent shares outstanding: Basic........................................ 121,957 125,306 Diluted...................................... 122,335 125,777 Operating ratios: Health plan medical care ratio................. 86.6% 83.7% Government contracts medical care ratio........ 77.1 74.5 Specialty services medical care ratio.......... 76.9 86.8 SG&A as a percent of health plan and government contracts revenues........................... 11.7 12.2
16 FOUNDATION HEALTH SYSTEMS, INC. LINE OF BUSINESS FINANCIAL INFORMATION CONTINUING OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
SIX MONTHS ENDED SIX MONTHS ENDED JUNE JUNE 30, 1998 30, 1997 ----------------------------------- ---------------------- PERCENT PERCENT PERCENT AMOUNT OR OF TOTAL INCREASE AMOUNT OR OF TOTAL PERCENT REVENUE (DECREASE) PERCENT REVENUE --------- ----------- ----------- --------- ----------- Revenues Health plan premiums........................... $3,713,952 84.2% 29.9% $2,858,299 80.6% Government contracts premiums.................. 462,989 10.5 (1.4) 469,654 13.3 Specialty services............................. 185,810 4.2 19.5 155,536 4.4 Investment and other income.................... 49,594 1.1 (17.3) 59,952 1.7 --------- ----- --------- ----- Total revenues............................. 4,412,345 100.0 24.5 3,543,441 100.0 --------- ----- --------- ----- Expenses Health plan services........................... 3,202,596 72.6 34.3 2,384,703 67.3 Government contracts health care services...... 355,637 8.1 (0.5) 357,400 10.1 Specialty services............................. 146,067 3.3 10.2 132,566 3.7 Selling, general and administrative ("SG&A")... 506,854 11.5 21.3 417,977 11.8 Amortization and depreciation.................. 62,346 1.4 26.0 49,488 1.4 Interest....................................... 44,054 1.0 37.1 32,123 0.9 --------- ----- --------- ----- 4,317,554 97.9 28.0 3,374,257 95.2 --------- ----- --------- ----- Asset impairments related to FPA Medical Management................................... 50,000 1.1 100.0 -- -- Merger, restructuring and other costs.......... -- -- (100.0) 346,109 9.8 Gem costs...................................... -- -- (100.0) 57,500 1.6 --------- ----- --------- ----- 50,000 1.1 (87.6) 403,609 11.4 --------- ----- --------- ----- Total expenses............................. 4,367,554 99.0 15.6 3,777,866 106.6 --------- ----- --------- ----- Income (loss) from continuing operations before income taxes................................... 44,791 1.0 (234,425) (6.6) Income tax provision (benefit)................... 17,597 0.4 (76,257) (2.1) --------- ----- --------- ----- Income (loss) from continuing operations......... $ 27,194 0.6% $(158,168) (4.5)% --------- ----- --------- ----- --------- ----- --------- ----- Earnings (loss) per share from continuing operations: Basic........................................ $ 0.22 $ (1.26) Diluted...................................... $ 0.22 $ (1.26) Weighted average common and common stock equivalent shares outstanding: Basic........................................ 121,786 125,302 Diluted...................................... 122,117 125,735 Operating ratios: Health plan medical care ratio................. 86.2% 83.4% Government contracts medical care ratio........ 76.8 76.1 Specialty services medical care ratio.......... 78.6 85.2 SG&A as a percent of health plan and government contracts revenues........................... 12.1 12.6
17 FOUNDATION HEALTH SYSTEMS, INC. LINE OF BUSINESS INFORMATION CONTINUING OPERATIONS (IN THOUSANDS) (UNAUDITED)
JUNE 30, 1998 JUNE 30, 1997 ------------------------ ------------- PERCENT INCREASE ENROLLMENT (DECREASE) ENROLLMENT ----------- ----------- ------------- Health Plan Commercial............................................. 3,524 23.7% 2,849 Medicare risk.......................................... 319 26.6 252 Medicaid............................................... 550 55.8 353 ----- ----- 4,393 27.2 3,454 Government CHAMPUS PPO and indemnity.............................. 821 (12.8) 941 CHAMPUS HMO............................................ 742 19.7 620 ----- ----- 1,563 0.1 1,561 ----- ----- Combined............................................... 5,956 18.8% 5,015 ----- ----- ----- -----
18 LIQUIDITY AND CAPITAL RESOURCES Certain of the Company's subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. Certain subsidiaries must maintain ratios of current assets to current liabilities of 1:1 pursuant to certain government contracts. The Company believes it is in compliance with these contractual and regulatory requirements in all material respects. The Company regularly evaluates cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. The Company may elect to raise additional funds for these purposes, either through additional debt or equity, the sale of investment securities or otherwise, as appropriate. Government health care receivables and payables are best estimates of payments that are ultimately collectible or payable. Since these amounts are subject to government audit and negotiation, amounts ultimately collected may vary from current estimates. Additionally, the timely collection of such receivables is also impacted by government audit and negotiation. For the six months ended June 30, 1998, cash used for operating activities was $356.5 million compared to $323.2 million in the same six month period of 1997. This use of cash for operating activities in 1998 was due primarily to a level of operating performance which was below the prior year level, the timing of receipt of payments under federal and state Medicare and Medicaid contracts, a reduction of claims inventory, payments for merger, restructuring and other costs, regulatory deposits required in the Northeast, CHAMPUS contract bid price adjustment payments and physician risk sharing payments. Net cash used by investing activities was $79.6 million during the first six months of 1998 as compared to $242.0 million of net cash provided by investing activities during the same period in 1997. The change is due primarily to higher net purchases of securities available for sale and higher capital spending during the 1998 period as well as FPA's redemption of a note payable in the June, 1997 quarter carried as an other asset on the Company's balance sheet. Net cash generated from financing activities was $127.4 million in the six months ended June 30, 1998 as compared to $32.4 million during the same period in 1997. The net change in the first six months of 1998 compared to the same period in 1997 was due primarily to additional borrowings under the revolving line of credit primarily for capital contributions to acquired subsidiaries in the Northeast, payments to regulated subsidiaries in the discontinued operations segment under corporate tax sharing agreements and loan repayments to the Federal Services subsidiary to cover bid price adjustment payments and other cash needs of that subsidiary. Additionally, no purchases of treasury stock or debt repayments were made in 1998 as had occurred in the 1997 period. The Company has a $1.5 billion credit facility (the "Credit Facility") with Bank of America as Administrative Agent for the Lenders thereto, which was amended by Amendments dated April 6 and July 31, 1998 with the Lenders (the "Amendments"). All previous revolving credit facilities were terminated and rolled into the Credit Facility on July 8, 1997. At the election of the Company, and subject to customary covenants, loans are initiated on a bid or committed basis and carry interest at offshore or domestic rates, at the applicable LIBOR Rate plus margin or the bank reference rate. Actual rates on borrowings under the Credit Facility vary, based on competitive bids and the Company's unsecured credit rating at the time of the borrowing. Under the Amendments, the Company's public issuer rating becomes the exclusive means of setting the facility fee and borrowing rates under the Credit Facility. In addition, certain covenants including financial covenants were amended. The Credit Facility is available for five years, until July 2002, but it may be extended under certain circumstances for two additional years. Due to operating and investing requirements, the outstanding balance under the Credit Facility has increased from $1.265 billion at December 31, 1997, to $1.31 billion at March 31, 1998, to $1.38 billion at June 30, 1998. As of August 10, 1998 $1.39 billion was outstanding under the Credit Facility. 19 The Company's subsidiaries must comply with certain minimum capital requirements under applicable state laws and regulations. The long-term portion of principal and interest payments under the California Wellness Foundation Notes issued by the Company in connection with the Health Net conversion is subordinated to Health Net meeting tangible equity requirements under applicable California statutes and regulations. As of June 30, 1998, the Company's subsidiaries were in compliance with minimum capital requirements. Legislation has been or may be enacted in certain states in which the Company's subsidiaries operate imposing substantially increased minimum capital and/or statutory deposit requirements for HMOs in such states. Such statutory deposits may only be drawn upon under limited circumstances relating to the protection of policyholders. The Company's HMO subsidiary operating in New Jersey was required to increase its statutory deposits by approximately $29 million in 1998 pursuant to such legislation. The Company believes that cash from operations, existing working capital, lines of credit and funds from planned divestitures of business are adequate to fund existing obligations, introduce new products and services, and continue to develop health care-related businesses, assuming that the Company completes its previously announced workers' compensation divestiture on schedule and substantially achieves its financial performance objectives for the balance of 1998. Such cash adequacy also assumes that no substantial additional statutory deposits are imposed upon the Company's operating subsidiaries prior to successful completion of these assumptions. In the event these assumptions are not achieved, the Company may be required to pursue alternate financing arrangements in order to maintain adequate liquidity. IMPACT OF INFLATION AND OTHER ELEMENTS The managed health care industry is labor intensive and its profit margin is low; hence, it is especially sensitive to inflation. Increases in medical expenses or contracted medical rates without corresponding increases in premiums could have a material adverse effect on the Company. Various federal and state legislative initiatives regarding the health care industry have been proposed during recent legislative sessions, and health care reform and similar issues continue to be in the forefront of social and political discussion. If health care reform or similar legislation is enacted, such legislation could impact the Company. Management cannot at this time predict whether any such initiative will be enacted and, if enacted, the impact on the financial condition or results of operations of the Company. The Company's ability to expand its business is dependent, in part, on competitive premium pricing and its ability to secure cost-effective contracts with providers. Achieving these objectives is becoming increasingly difficult due to the competitive environment. In addition, the Company's profitability is dependent, in part, on its ability to maintain effective control over health care costs while providing members with quality care. Factors such as health care reform, integration of acquired companies, regulatory changes, utilization, new technologies, hospital costs, major epidemics and numerous other external influences may affect the Company's operating results. Accordingly, past financial performance is not necessarily a reliable indicator of future performance, and investors should not use historical records to anticipate results or future period trends. The Company's HMO and insurance subsidiaries are required to maintain reserves to cover their estimated ultimate liability for expenses with respect to reported and unreported claims incurred. These reserves are estimates of future payments based on various assumptions. Establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience, which in the past has resulted and in the future could result in loss reserves being too high or too low. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicial administration of claims, medical costs and other factors. Future loss development or governmental regulators could require reserves for prior periods to be increased, which would adversely impact earnings in future periods. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for claims and loss reserves. 20 Reference is also made to the disclosures contained under the heading "Cautionary Statements" included in the Company's various filings with the Securities and Exchange Commission and the documents incorporated by reference therein, which could cause the Company's actual results to differ from those projected in forward looking statements of the Company made on behalf of the Company. In addition, certain of these factors may have affected the Company's past results and may affect future results. YEAR 2000 The Company recognizes that the arrival of the Year 2000 requires computer systems to be able to recognize the date change from 1999 to 2000 and, like other companies, is assessing and modifying its computer applications and business processes to provide for their continued functionality. The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, prepare invoices or engage in normal business activities. The Year 2000 effort for the Company has the highest priority of technology projects. The project has dedicated resources with multiple teams to address unique systems environment. Uniform project management techniques are in place with overall oversight responsibility residing with the Company's Chief Technology Officer. Emphasis has been placed on business unit involvement and the use of internal staff enhanced by external specialists. Selected systems will be retired with the business functions being converted to Year 2000 compliant systems. A number of the Company's systems include packaged software from large vendors that the Company is closely monitoring to ensure that these systems are Year 2000 compliant. The Company believes that vendors will make timely updates available to ensure that all remaining purchased software is Year 2000 compliant. The remaining systems' compliance with Year 2000 will be addressed by internal technical staff. The Company has initiated formal communications with others with whom it does significant business to determine their Year 2000 issues. There can be no assurances that the systems of other companies on which the Company's systems rely will be timely converted, or that the failure to convert by another company would not have a material adverse effect on the Company. The Company is evaluating on an ongoing basis the related costs to resolve these potential Year 2000 problems. The total current cost estimate for the Year 2000 project is between $13 and $17 million. These costs will continue to be incurred during 1998 and 1999 and are expensed as incurred. However, notwithstanding the foregoing, the costs of the project and the timetable in which the Company plans to complete the Year 2000 compliance requirements are based on estimates derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. There can therefore be no assurance that these estimates will be achieved and actual results could differ materially from these estimates. At this time it is unclear as to the extent of existing insurance coverage, if any, the Company may have to cover potential year 2000 liabilities. The Company is currently analyzing the obtainment of such coverage. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CONTINUING OPERATIONS The Company is exposed to interest rate and market risk primarily due to its investing and borrowing activities. Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and in equity prices. Interest rate 21 risk is a consequence of maintaining fixed income investments. The Company is exposed to interest rate risks arising from changes in the level or volatility of interest rates, prepayment speeds and/or the shape and slope of the yield curve. In addition, the Company is exposed to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer's credit rating or credit perception may affect the value of financial instruments. The Company has several bond portfolios to fund reserves. The Company attempts to manage the interest rate risks related to its investment portfolios by actively managing the asset/liability duration of its investment portfolios. The overall goal of the investment portfolios is to support the ongoing operations of the Company's business units. The Company's philosophy is to actively manage assets to maximize total return over a multiple-year time horizon, subject to appropriate levels of risk. Each business unit will have additional requirements with respect to liquidity, current income and contribution to surplus. The Company manages these risks by setting risk tolerances, targeting asset-class allocations, diversifying among assets and asset characteristics, and using performance measurement and reporting. The Company uses a value-at-risk model to assess the market risk of its investments. The estimation of potential losses that could arise from changes in market conditions is typically accomplished through the use of statistical models which seek to predict risk of loss based on historical price and volatility patterns. The Company's measured value at risk for its investments from continuing operations, using a 95 percent confidence level, was approximately $4.0 million at June 30, 1998. The Company's calculated value-at-risk exposure represents an estimate of reasonably possible net losses that could be recognized on its investment portfolios assuming hypothetical movements in future market rates and are not necessarily indicative of actual results which may occur. It does not represent the maximum possible loss nor any expected loss that may occur, since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in the Company's investment portfolios during the year. In addition, the Company has some interest rate market risk due to its borrowings. Notes payable, capital leases and other financing arrangements totaled $1.4 billion at June 30, 1998 and the related average interest rate was 6.1% (which interest rate is subject to change pursuant to the terms of the Credit Facility). See a description of the Credit Facility under "Liquidity and Capital Resources." The table below presents the expected cash flows of market risk sensitive instruments at June 30, 1998. These cash flows include both expected principal and interest payments consistent with the terms of the outstanding debt as of June 30, 1998 (dollars in thousands).
1998 1999 2000 2001 2002 BEYOND TOTAL --------- --------- ---------- --------- ------------ --------- ------------ Long-term Borrowings Fixed Rate................ $ 3,695 $ 4,329 $ 26,830 $ 2,540 $ 2,541 $ 19,999 $ 59,934 Floating Rate............. 84,151 82,938 82,938 82,938 1,421,469 -- 1,754,434 --------- --------- ---------- --------- ------------ --------- ------------ Total....................... $ 87,846 $ 87,267 $ 109,768 $ 85,478 $ 1,424,010 $ 19,999 $ 1,814,368 --------- --------- ---------- --------- ------------ --------- ------------ --------- --------- ---------- --------- ------------ --------- ------------
DISCONTINUED OPERATIONS The Company has entered into a definitive agreement to sell its risk-assuming workers' compensation insurance businesses which represent a separate segment of business. Therefore the results of these businesses have been reported as discontinued operations. The Company's measured value-at-risk of its investments from discontinued operations at a 95 percent confidence level, at June 30, 1998 was approximately $5.5 million. The discontinued operations businesses do not have any significant interest rate risk due to debt. 22 PART II. OTHER INFORMATION INTRODUCTION As referenced in Part I above, the current operations of Foundation Health Systems, Inc. (the "Company") are a result of the April 1, 1997 merger transaction (the "Merger" or the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the Merger, FH Acquisition Corp., a wholly owned subsidiary of HSI ("Merger Sub"), merged with and into FHC and FHC survived as a wholly owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company. Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the Merger, FHC stockholders received 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held. In connection with the Merger, the Company amended its Certificate of Incorporation to change the name of the Company as referenced above and to increase the number of authorized shares of the Company's Common Stock to 380,000,000 shares consisting of 350,000,000 shares of Class A Common Stock and 30,000,000 shares of Class B Common Stock. In connection with the Merger, the Company also, among other things, amended the Company's By-Laws to effect certain changes to the governance provisions of the Company following the Merger, including provisions related to the structure of the Company's Board of Directors and the committees of the Company's Board of Directors. Except in certain circumstances, during a transition period following the consummation of the Merger and up to, but not including, the election of directors at the Company's May 2000 Annual Meeting of Stockholders, the Company's Board of Directors is to consist of 11 members to be designated as set forth in the Company's Certificate of Incorporation and By-Laws. Pursuant to such designations the Company's Board of Directors is currently comprised of the following ten members (there currently exists one vacancy on the Board of Directors which vacancy is in the process of being filled): J. Thomas Bouchard, George Deukmejian, Thomas T. Farley, Patrick Foley, Earl B. Fowler, Roger F. Greaves, Richard W. Hanselman, Malik M. Hasan, M.D., Richard J. Stegemeier and Raymond S. Troubh. As set forth under the heading "Recent Developments" below, Dr. Hasan has agreed that, in connection with his recent retirement, he will resign from the Board of Directors sometime between September 30, 1998 and March 1, 1999. ITEM 1. LEGAL PROCEEDINGS MEDAPHIS CORPORATION On November 7, 1996 the Company's predecessor, HSI, filed a lawsuit against Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V. MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414, Superior Court of California, County of Los Angeles. The lawsuit arises out of the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July 1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS, representing over sixteen percent of the total outstanding equity of HDS, voted its shares in favor of the acquisition of HDS by Medaphis. HSI received as the result of the acquisition 976,771 shares of Medaphis Common Stock in exchange for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has been substituted for HSI as plaintiff in the suit. In its complaint, the Company alleges that Medaphis was actually a poorly run company with sagging earnings in its core business, and had artificially maintained its stock prices through a series of acquisitions and accounting maneuvers which provided the illusion of growth while hiding the reality of its weakening financial and business condition. The Company alleges that Medaphis, Brown and other insiders deceived the Company by presenting materially false financial statements and by failing to disclose that Medaphis would shortly reveal a "write off" of up to $40 million in reorganization costs and would lower its earnings 23 estimate for the following year, thereby more than halving the value of the Medaphis shares received by the Company. The Company alleges that these false and misleading statements were contained in oral communications with the Company, as well as in the registration statement and the prospectus provided by Medaphis to all HDS shareholders in connection with the HDS acquisition. Further, despite knowing of the Company's discussions to form a strategic alliance of its own with HDS, Medaphis and the individual defendants wrongfully interfered with that prospective business relationship by proposing to acquire HDS using Medaphis stock whose market price was artificially inflated by false and misleading statements. The Company alleges that the defendants' actions constitute violations of both federal and state securities laws, as well as fraud and other torts under state law. The Company is seeking either rescission of the transaction or damages in excess of $38 million. The defendants have denied the allegations in the complaint, and the Company is vigorously pursuing its claims against Medaphis. Recently the Company moved to disqualify the law firm representing certain of the individual defendants. The trial court granted the Company's motion, and the law firm and its clients have appealed such decision. In addition, the trial court granted a stay of the case in order to permit the law firm to appeal. Although the briefing for such appeal has been completed, no date has been set for orally arguing the appeal. Prior to the stay the case was in the early stages of discovery, and no trial date has yet been set. MONACELLI VS. GEM INSURANCE COMPANY On December 29, 1994, a lawsuit entitled MARIO AND CHRISTIAN MONACELLI V. GEM INSURANCE COMPANY, ET AL (Case No. CV94-20715) was initiated in Maricopa County (Arizona) Superior Court against Gem Insurance Company, a subsidiary of the Company ("Gem"), for bad faith and misrepresentation. Plaintiffs subsequently asserted claims in the same action against their insurance agent, Mark Davis, for negligence and misrepresentation. The Plaintiffs' claims arose from the rescission of their health insurance policy based on their alleged failure to disclose an X-ray, taken one year before the Plaintiffs filled out their insurance application, which revealed an undiagnosed mass on Mr. Monacelli's lung. Plaintiffs incurred approximately $70,000 in medical expenses in connection therewith. Prior to trial, the agent recanted certain portions of his deposition testimony and admitted that the Plaintiffs had told him that Mr. Monacelli had undergone certain tests which were not revealed on the application. Based on this new information, Gem paid the Plaintiffs' medical expenses with interest. The case went to trial in April of 1997 against Gem and the agent. A jury verdict was ultimately rendered awarding the Plaintiffs $1 million in compensatory damages and assessing fault 97% to Gem and 3% to the agent, Mark Davis. In addition, the jury awarded $15 million in punitive damages against Gem. Thereafter, the plaintiffs filed a motion seeking to recover an additional $4 million in attorneys' fees, and Gem filed post-trial motions for judgment notwithstanding the verdict, for a new trial and for remittitur of the jury verdict. Gem's motion for judgment notwithstanding the verdict was denied. The court granted Gem's motion for remittitur and remitted the jury verdict to an award of $1 million in compensatory damages and $2 million in punitive damages. The court further ordered that if the plaintiffs did not accept the remittitur order, Gem's motion for new trial would be granted. The plaintiffs accepted the court's remittitur. The court also awarded plaintiffs approximately $233,000 in attorneys' fees and interest. Notwithstanding the plaintiffs' acceptance of the court's remittitur, Gem planned to appeal the verdict. However, Gem and the plaintiffs reached agreement to settle the case in May of 1998 for an undisclosed amount thus avoiding any further costs associated with an appeal or new trial. FPA MEDICAL MANAGEMENT, INC. Since May 1998, several complaints (the "FPA Complaints") have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA Medical Management, Inc. ("FPA") at various times between February 3, 1997 and May 15, 1998. The 24 FPA Complaints name as defendants FPA, certain of FPA's present and former officers and directors, FPA's auditors, the Company and certain of the Company's former officers. The FPA Complaints allege that the Company and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between the Company and FPA, about FPA's business and about the Company's 1997 sale of FPA common stock held by the Company. The Company has not formally responded to these complaints. Management believes these suits against the Company and its former officers are without merit and intends to defend the actions vigorously. MISCELLANEOUS PROCEEDINGS The Company and certain of its subsidiaries are also parties to various legal proceedings, many of which involve claims for coverage encountered in the ordinary course of its business. Based in part on advice from litigation counsel to the Company and upon information presently available, management of the Company is of the opinion that the final outcome of all such proceedings should not have a material adverse effect upon the Company's results of operations or financial condition. ITEM 2. CHANGES IN SECURITIES REVOLVING CREDIT FACILITY On July 8, 1997 the Company entered into a Credit Agreement with the banks identified therein (the "Banks") and Bank of America National Trust and Savings Association ("Bank of America"), in its capacity as the Administrative Agent, pursuant to which the Company obtained an unsecured five-year $1.5 billion revolving credit facility maturing on July 7, 2002. The Credit Agreement replaced (i) the Company's prior Amended and Restated Credit Agreement, dated as of April 26, 1996, with Bank of America, as agent, providing for a $700 million unsecured revolving credit facility and (ii) FHC's prior (A) Revolving Credit Agreement, dated as of December 5, 1994, with Citicorp USA, Inc., as agent, providing for a $300 million unsecured revolving credit facility and (B) Revolving Credit Agreement, dated as of December 17, 1996, with Citibank, N.A., as administrative agent, providing for a $200 million unsecured revolving credit facility. The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and events of default. Specifically, Section 7.11 of the Credit Agreement provides that the Company and its subsidiaries may, so long as no event of default exists: (i) declare and distribute stock as a dividend; (ii) purchase, redeem or acquire its stock, options and warrants with the proceeds of concurrent public offerings; and (iii) declare and pay dividends or purchase, redeem or otherwise acquire its capital stock, warrants, options or similar rights with cash subject to certain specified limitations. Under the Credit Agreement, as amended pursuant to the First Amendment and Waiver to Credit Agreement dated as of April 6, 1998 (the "First Amendment") and the Second Amendment to Credit Agreement dated as of July 31, 1998 (the "Second Amendment" and, together with the First Amendment, the "Amendments") with the Banks, the Company is: (i) obligated to maintain certain covenants keyed to the Company's financial condition and performance (including a Total Leverage Ratio and Fixed Charge Ratio); (ii) obligated to limit liens; (iii) subject to customary covenants, including (A) disposition of assets only in the ordinary course and generally at fair value and (B) restrictions on acquisitions, mergers, consolidations, loans, leases, joint ventures, contingent obligations and certain transactions with affiliates; (iv) permitted to sell the Company's workers' compensation insurance business, provided that the net proceeds shall be applied towards repayment of the outstanding Loans under the Credit Agreement; and (v) permitted to incur additional indebtedness in an aggregate amount not to exceed $1,000,000,000 upon certain terms and conditions, including mandatory prepayment of the outstanding Loans with a certain portion of the proceeds from the issuance of such indebtedness, resulting in a permanent reduction of the 25 aggregate amount of commitments under the Credit Agreement by the amount so prepaid. The Amendments also provided for an increase in the interest and facility fees under the Credit Agreement. A copy of the Second Amendment is included as Exhibit 10.65 to this Quarterly Report on Form 10-Q. SHAREHOLDER RIGHTS PLAN On May 20, 1996, the Board of Directors of the Company declared a dividend distribution of one right (a "Right") for each outstanding share of the Company's Class A Common Stock and Class B Common Stock (collectively, the "Common Stock"), to stockholders of record at the close of business on July 31, 1996 (the "Record Date"). The Board of Directors of the Company also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the Distribution Date (as defined below), the redemption of the Rights and the expiration of the Rights and in certain other circumstances. Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights Certificates will be distributed. Subject to certain exceptions contained in the Rights Agreement dated as of June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights Agent (the "Rights Agreement"), the Rights will separate from the Common Stock in the event any person acquires 15% or more of the outstanding Class A Common Stock, the Board of Directors of the Company declares a holder of 10% or more to the outstanding Class A Common Stock to be an "Adverse Person," or any person commences a tender offer for 15% of the Class A Common Stock (each event causing a "Distribution Date"). Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder, upon the occurrence of a Distribution Date, to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, at a price of $170.00 per one-thousandth share. However, in the event any person acquires 15% or more of the outstanding Class A Common Stock, or the Board of Directors of the Company declares a holder of 10% or more of the outstanding Class A Common Stock to be an "Adverse Person," the Rights (subject to certain exceptions contained in the Rights Agreement) will instead become exercisable for Class A Common Stock having a market value at such time equal to $340.00. The Rights are redeemable under certain circumstances at $.01 per Right and will expire, unless earlier redeemed, on July 31, 2006. A copy of the Rights Agreement has been filed with the Securities and Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 001-12718). In connection with its execution of the Merger Agreement for the FHS Combination, the Company entered into Amendment No. 1 (the "Rights Amendment") to the Rights Agreement to exempt the Merger Agreement and related transactions from triggering the Rights. In addition, the Rights Amendment modifies certain terms of the Rights Agreement applicable to the determination of certain "Adverse Persons," which modifications become effective upon consummation of the transactions provided for under the Merger Agreement. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. 26 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 7, 1998, the Company held its 1998 Annual Meeting of Stockholders (the "Annual Meeting"). At the Annual Meeting, the Company's stockholders voted upon a proposal to elect three directors for a term of three years. The following provides voting information for all matters voted upon at the Annual Meeting, and includes a separate tabulation with respect to each nominee for director:
DIRECTOR NOMINEE VOTES FOR VOTES AGAINST VOTES WITHHELD - ------------------------------------------------ ------------- ------------------- -------------- Roger F. Greaves................................ 107,743,070 0 1,322,632 Richard W. Hanselman............................ 107,702,860 0 1,362,842 Raymond S. Troubh............................... 107,745,813 0 1,319,889
Each of Messrs. Greaves, Hanselman and Troubh were elected as a Class II director for a three-year term at the Annual Meeting. Other directors whose term of office as directors continued after the Annual Meeting were: J. Thomas Bouchard, Gov. George Deukmejian, Thomas T. Farley, Patrick Foley, Adm. Earl B. Fowler, Malik M. Hasan, M.D. and Richard J. Stegemeier. In total, 111,308,582 shares of Class A Common Stock were eligible to vote at the Annual Meeting, 109,065,702 shares were voted at the Annual Meeting and 2,242,880 were unvoted at the Annual Meeting. No other matters were submitted to a vote of the Company's security holders during the quarter ended June 30, 1998. ITEM 5. OTHER INFORMATION CAUTIONARY STATEMENTS In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company has previously filed with its Annual Report on Form 10-K for the year ended December 31, 1997 certain cautionary statements identifying important risk factors that could cause the Company's actual results to differ materially from those projected in forward-looking statements of the Company made by or on behalf of the Company. The Company wishes to caution readers that these factors, among others, could cause the Company's actual financial or enrollment results to differ materially from those expressed in any projected, estimated or forward-looking statements relating to the Company. The factors should be considered in conjunction with any discussion of operations or results by the Company or its representatives, including any forward-looking discussion, as well as comments contained in press releases, presentations to securities analysts or investors, or other communications by the Company. In making these statements, the Company was not and is not undertaking to address or update each factor in future filings or communications regarding the Company's business or results, and is not undertaking to address how any of these factors may have caused changes to discussions or information contained in previous filings or communications. In addition, certain of these matters may have affected the Company's past results and may affect future results. RECENT DEVELOPMENTS THE CALIFORNIA WELLNESS FOUNDATION Pursuant to the Amended Foundation Shareholder Agreement, dated as of January 28, 1992 (the "CWF Shareholder Agreement"), by and among the Company, the CWF and certain stockholders (the "HNMH Stockholders") of HN Management Holdings, Inc. (a predecessor to the Company) ("HNMH") named therein, the CWF is subject to various volume and manner of sale restrictions specified in the CWF Shareholder Agreement which limit the number of shares that the CWF may dispose of prior to 27 December 31, 1998. The CWF and the Company are also party to a Registration Rights Agreement dated as of March 2, 1995 (the "CWF Registration Rights Agreement") pursuant to which the CWF has the right to demand registration for sale in underwritten public offerings of up to 8,026,298 shares of Class B Common Stock. Under the relevant provisions of California law, when a corporation converts from nonprofit to for-profit corporate status, the equivalent of the fair market value of the nonprofit corporation must be contributed to a successor charity that has a charitable purpose consistent with the purposes of the nonprofit entity. The CWF was formed to be the charitable recipient of the conversion settlement when Health Net (a subsidiary of the Company) effected a conversion from nonprofit to for-profit status, which occurred in February 1992 (the "Conversion"). In connection with the Conversion, Health Net issued to the CWF promissory notes in the original principal amount of $225 million (the "CWF Notes") and shares of Class B Common Stock (which immediately prior to the business combination involving HNMH and QualMed, Inc. were split to become 25,684,152 shares of Class B Common Stock then held by the CWF). While such shares are held by the CWF, they are entitled to the same economic benefit as Class A Common Stock, but are non-voting in nature. If the CWF sells or transfers such shares to an unrelated third party, they automatically convert to Class A Common Stock. As of June 30, 1998, approximately $18.4 million in principal of the CWF Notes remained outstanding. On February 25, 1998, the CWF notified the Company of its intention to sell up to 8,026,000 shares of Class B Common Stock pursuant to the CWF Registration Rights Agreement in an underwritten public offering. Pursuant to the terms of the CWF Registration Rights Agreement, the Company upon receipt of a notification under such agreement must prepare and file a registration statement with respect to such shares with the Securities and Exchange Commission as expeditiously as possible but in no event later than 90 days following receipt of the notice, subject to certain exceptions. Pursuant to the terms of a letter agreement dated June 1, 1998 between the CWF and the Company (the "Letter Agreement"), the Company provided its consent under the CWF Registration Rights Agreement to permit the CWF to sell certain shares of Class B Common Stock in private sales transactions (subject to the terms and conditions set forth in such Letter Agreement) in lieu of such underwritten public offering. Effective June 18, 1998, the CWF sold 5,250,000 shares of Class B Common Stock to unrelated third parties in accordance with the Letter Agreement, which shares of Class B Common Stock sold by the CWF automatically converted on a one-for-one basis into shares of Class A Common Stock. Pursuant to the terms of the Letter Agreement, all of such 5,250,000 shares sold reduced the number of shares subject to registration under the CWF Registration Rights Agreement on a one-for-one basis. As a result of such sales, the CWF currently holds 5,047,642 shares of Class B Common Stock. As of December 31, 1998, the various volume and manner of sale restrictions contained in the CWF Shareholder Agreement referred to above expire pursuant to the terms of such agreement. SALE OF WORKERS' COMPENSATION BUSINESSES The Company revised its strategy of maintaining a presence in the workers' compensation insurance business as a result of various adverse developments arising in 1997 in the workers' compensation insurance business, primarily related to the workers' compensation claims environment in California. As discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, such adverse developments resulted in the need for the Company to strengthen its workers' compensation reserves at the end of 1997. These developments also led the Company to adopt a plan to discontinue this segment of its business, through divestiture of its workers' compensation risk-assuming insurance subsidiaries. In this connection, on May 5, 1998 the Company entered into a definitive agreement (the "Workers' Compensation Sale Agreement") to sell its risk-assuming workers' compensation insurance operations (the 28 "Workers' Compensation Operations") to Superior National Insurance Group, Inc. of Calabasas, California ("Superior National"). The transaction, subject to customary closing conditions including regulatory approvals and a favorable vote from Superior National's shareholders, is expected to close in the fourth quarter of 1998 and is expected to yield the Company approximately $290 million in cash net of tax considerations and the cost of reinsurance. As required under the terms of the Workers' Compensation Sale Agreement, the Company has obtained a commitment from a third party reinsurance company to purchase reinsurance that will cover up to $150 million of adverse loss development in the Workers' Compensation Operations for losses incurred through December 31, 1997. Such reinsurance coverage was increased by $25 million for adverse loss development incurred in 1998 in exchange for additional purchase price consideration pursuant to the terms of the Workers' Compensation Sales Agreement at Superior National's request. A copy of the Workers' Compensation Sale Agreement was filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. In addition to the sale of the Workers' Compensation Operations, the Company and Superior National have agreed to a contract under which the Company's administrative services businesses that currently provide certain services to the Workers' Compensation Operations would continue to provide such services and additional services to Superior National for a period of five years after closing. The Company estimates that, based on past results and the expected contribution from Superior National's operations, this five-year service agreement will create additional total revenue in the range of $40 to $50 million for the Company's administrative service subsidiaries over such five-year term. OTHER POTENTIAL DIVESTITURES The Company is presently reviewing possible plans to either divest or wind-down its HMO operations in the states of Texas, Louisiana and Oklahoma due to inadequate returns on invested capital. The Company is presently reviewing exit strategies for such states' businesses (including potential sale transactions). The Company has decided to review the possibility of divesting its direct ownership of two Southern California hospitals, a 128-bed hospital located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a 200-bed hospital located in Gardena, California, the Memorial Hospital of Gardena. Direct ownership of these two hospitals is not consistent with the Company's business philosophy to manage health care through contracts with independent providers of medical services. The Company is presently responding to inquiries of parties which have expressed an interest in purchasing these hospitals. As described in its Annual Report on Form 10-K for the year ended December 31, 1997, the Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of such businesses or operations should be divested. FPA MEDICAL MANAGEMENT, INC. On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy protection under Chapter 11 of the federal Bankruptcy Code. FPA, through its affiliated medical groups, currently provides services to approximately 150,000 of the Company's members in Arizona and California. FPA has indicated that it will discontinue its medical group operations in these markets. The Company announced on August 5, 1998 that it would record a $50 million nonrecurring charge in its second quarter ended June 30, 1998, primarily related to real estate assets currently leased to FPA. Elements of the charge include approximately $35 million for real estate asset impairment, approximately $10 million for a note from a prior California IPA sale to FPA and approximately $5 million in other items related to FPA. 29 In 1996, Foundation Health Corporation ("FHC"), a predecessor to the Company, sold certain medical groups and IPAs to FPA for approximately $220 million in total consideration. As part of the transaction, FHC retained ownership of the related medical clinics and leased them to FPA. FPA was contractually committed to a deferred purchase of these clinics at a purchase price equal to the Company's book value in the assets. It is the value of these clinics that is being written down in connection with the above-referenced charge. As part of the total consideration for the FPA transaction FHC received approximately four million shares of FPA common stock and secured notes. The Company sold all of these shares in the second quarter of 1997 for $79 million and, during the same period, FPA redeemed all of such notes. HEADQUARTERS DESIGNATION On June 25, 1998, the Board of Directors of the Company formally designated Los Angeles, California as the corporate headquarters of the Company, with the physical offices of such corporate headquarters to be located in Woodland Hills, California. EXECUTIVE OFFICER CHANGES On August 7, 1998, the Company announced that Malik M. Hasan, M.D. had retired as Chief Executive Officer of the Company and that Dr. Hasan would continue as non-executive Chairman of the Board of Directors of the Company until sometime between September 30, 1998 and March 1, 1999, at which time Dr. Hasan would resign as Chairman of the Board of Directors and as a director. In connection with such retirement, the Company and Dr. Hasan entered into an Early Retirement Agreement which provided for, among other matters, the termination of Dr. Hasan's Employment Agreement with the Company and for certain payments and releases, a copy of which agreement has been filed as an exhibit to this Quarterly Report on Form 10-Q. Due to Dr. Hasan's retirement, Jay M. Gellert, formerly President and Chief Operating Officer of the Company, became President and Chief Executive Officer of the Company as of August 7, 1998. As a result, Mr. Gellert is directly responsible for the Company's strategic direction with all senior line and staff management reporting directly to him. The Company also announced that a new Chairman of the Board of Directors will be named when Dr. Hasan leaves the post next year. 30 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed as part of this Quarterly Report on Form 10-Q or are incorporated herein by reference:
2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International, Inc., FH Acquisition Corp. and Foundation Health Corporation (filed as Exhibit 2.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 2.2 Agreement and Plan of Merger, dated May 8, 1997, by and among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is incorporated by reference herein). 3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant (filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 4.1 Form of Class A Common Stock Certificate (included as Exhibit 4.2 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 4.2 Form of Class B Common Stock Certificate (included as Exhibit 4.3 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 4.3 Form of Indenture of Foundation Health Corporation (FHC) (filed as an exhibit to FHC's Registration Statement on Form S-3 (File No. 33-68684), which is incorporated by reference herein). 4.4 Form of Senior Notes of FHC (filed as an exhibit to FHC's Registration Statement on Form S-3 (File No. 33-68684), which is incorporated by reference herein). 10.1 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc., HN Management Holdings, Inc. and Malik M. Hasan, M.D. (filed as Exhibit 10.18 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.2 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc., HN Management Holdings, Inc. and Dale T. Berkbigler, M.D. (filed as Exhibit 10.20 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein).
31
10.3 Severance Payment Agreement, dated as of April 25, 1994, among the Company, Health Net and James J. Wilk (filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.4 Severance Payment Agreement dated March 31, 1997 between the Company and Health Net and James J. Wilk (filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein) 10.5 Severance Payment Agreement, dated as of April 25, 1994, among the Company, QualMed, Inc. and B. Curtis Westen (filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.6 Letter Agreement dated April 23, 1997 between B. Curtis Westen and the Company (filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.7 Amendment No. 1 to Employment Agreement dated as of April 25, 1994, by and among the Company, QualMed, Inc. and Malik Hasan, M.D. (filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.8 Amended and Restated Employment Agreement, dated March 10, 1997, by and between the Company and Malik M. Hasan, M.D. (Filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 10.9 Amendment No. 1 to Employment Agreement dated as of April 27, 1994, by and among the Company, QualMed, Inc. and Dale T. Berkbigler, M.D. (filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.10 Office Lease, dated as of January 1, 1992, by and between Warner Properties III and Health Net (filed as Exhibit 10.23 to the Company's Registration Statements on Forms S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.11 The Company's Second Amended and Restated 1991 Stock Option Plan (filed as Exhibit 10.30 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein). 10.12 The Company's Second Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.31 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein). 10.13 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.33 to the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01, respectively) which is incorporated by reference herein). 10.14 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein).
32
10.15 Deferred Compensation Agreement dated as of March 3, 1995, by and among Malik M. Hasan, M.D., the Company and the Compensation and Stock Option Committee of the Board of Directors of the Company (filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.16 Trust Agreement for Deferred Compensation Arrangement for Malik M. Hasan, M.D., dated as of March 3, 1995, by and between the Company and Norwest Bank Colorado N.A. (filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated by reference herein). 10.17 Registration Rights Agreement dated as of March 2, 1995 between the Company and The California Wellness Foundation (filed as Exhibit No. 28.2 to the Company's Current Report on Form 8-K dated March 2, 1995, which is incorporated by reference herein). 10.18 The Company's 1995 Stock Appreciation Right Plan (filed as Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, which is incorporated by reference herein). 10.19 Amended and Restated Credit Agreement dated as of April 26, 1996 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated May 3, 1996, which is incorporated by reference herein). 10.20 Amendment No. 1 to Credit Agreement dated as of May 10, 1996 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.32 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996, which is incorporated by reference herein). 10.21 Amendment No. 2 to Credit Agreement dated as of May 28, 1996 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.33 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference herein). 10.22 Amendment No. 3 to Credit Agreement dated as of January 31, 1997 among the Company, Bank of America National Trust and Savings Association, as Agent, and financial institutions party thereto (filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 10.23 Credit Agreement dated July 8, 1997 among the Company, the banks identified therein and Bank of America National Trust and Savings Association in its capacity as Administrative Agent (providing for an unsecured $1.5 billion revolving credit facility) (filed as Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.24 Guarantee Agreement dated July 8, 1997 between the Company and First Security Bank, National Association (filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is incorporated by reference herein).
33
10.25 Employment Letter Agreement dated May 28, 1996 between Michael D. Pugh and QualMed, Inc. (filed as Exhibit 10.35 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference herein). 10.26 Employment Letter Agreement dated June 4, 1996 between Arthur M. Southam and the Company and Health Net (filed as Exhibit 10.36 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, which is incorporated by reference herein) 10.27 Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and the Company (filed as Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, which is incorporated by reference herein). 10.28 Rights Agreement dated as of June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 001-12718) which is incorporated by reference herein). 10.29 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 10.30 Amended and Restated Employment Agreement, dated December 16, 1996, by and among the Company, Foundation Health Corporation and Kirk A. Benson (filed as Exhibit 10.2 to the Company's Registration Statement on Form S-4 (File No. 333-19273), which is incorporated by reference herein). 10.31 Consulting Agreement, dated as of May 1, 1997, between the Company, FHC and Allen J. Marabito, (filed as Exhibit 10.35 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.32 1990 Stock Option Plan of Foundation Health Corporation (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.33 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation (filed as Exhibit 4.6 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.34 1989 Stock Plan of Business Insurance Corporation (as Amended and Restated Effective September 22, 1992) (filed as Exhibit 4.7 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.35 Managed Health Network, Inc. Incentive Stock Option Plan (filed as Exhibit 4.8 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.36 Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan (filed as Exhibit 4.9 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein).
34
10.37 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation (as amended and restated September 7, 1995) (filed as Exhibit 4.10 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). 10.38 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1994 filed with the Commission on September 24, 1994, which is incorporated by reference herein). 10.39 Foundation Health Systems, Inc. 1997 Stock Option Plan (filed as Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.40 Foundation Health Systems, Inc. Third Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.41 Foundation Health Systems, Inc. Employee Stock Purchase Plan (filed as Exhibit 10.47 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.42 Foundation Health Systems, Inc. Performance-Based Annual Bonus Plan (filed as Exhibit 10.48 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). 10.43 Participation Agreement dated as of May 25, 1995 among Foundation Health Medical Services, as Construction Agent and Lessee, FHC, as Guarantor, First Security Bank of Utah, N.A., as Owner Trustee, Sumitomo Bank Leasing and Finance, Inc., The Bank of Nova Scotia and NationsBank of Texas, N.A., as Holders and NationsBank of Texas, N.A., as Administrative Agent for the Lenders; and Guaranty Agreement dated as of May 25, 1995 by FHC for the benefit of First Security Bank of Utah, N.A. (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.44 FHC's Deferred Compensation Plan, as amended and restated (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.45 FHC's Supplemental Executive Retirement Plan, as amended and restated (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.46 FHC's Executive Retiree Medical Plan, as amended and restated (filed as an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on September 27, 1995, which is incorporated by reference herein). 10.47 Agreement and Plan Reorganization dated January 9, 1996 by and between FHC and Managed Health Network, Inc. (filed as Annex 1 of Proxy Statement/Prospectus contained in FHC's Registration Statement on Form S-4 (File No. 333-00517), which is incorporated by reference herein). 10.48 Stock and Note Purchase Agreement by and between FHC, Jonathan H. Schoff, M.D., FPA Medical Management, Inc., FPA Medical Management of California, Inc. and FPA Independent Practice Association dated as of June 28, 1996 (filed as Exhibit 10.109 to FHC's Annual Report on Form 10-K for the year ended June 30, 1996, which is incorporated by reference herein).
35
10.49 $300 Million Revolving Credit Agreement (the "FHC Credit Agreement") dated as of December 5, 1994, among FHC, 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 (filed as an Exhibit to FHC's quarterly report on Form 10-Q for the quarter ended December 31, 1994 filed with the Commission on February 14, 1994, which is incorporated by reference herein). 10.50 First Amendment Agreement (to the FHC Credit Agreement) dated as of August 9, 1995 among FHC, as Borrower, the Lenders parties to the FHC Credit Agreement, 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 (filed as Exhibit 10.52 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.51 Second Amendment Agreement (to the FHC Credit Agreement), dated as of June 28, 1996 among FHC, the Lenders and Citicorp USA, Inc. (filed as Exhibit 10.53 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.52 Third Amendment Agreement and Waiver (to the FHC Credit Agreement) dated December 13, 1996 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.53 Fourth Amendment Agreement and Waiver (to the FHC Credit Agreement) dated January 28, 1997 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.55 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.54 Fifth Amendment Agreement (to the FHC Credit Agreement) dated April 1, 1997 among FHC, the Lenders and Citibank, N.A. (as successor to Citicorp USA, Inc.), as Administrative Agent (filed as Exhibit 10.56 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.55 $200 million Revolving Credit Agreement (the "FHC Revolving Credit Agreement") dated as of December 17, 1996 among FHC, the Lenders and Citibank, N.A., as Administrative Agent for the Lenders (filed as Exhibit 10.57 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.56 First Amendment Agreement and Waiver (to the FHC Revolving Credit Agreement) dated as of January 28, 1997 among FHC, the Lenders and Citibank, N.A., as Administrative Agent for the Lenders (filed as Exhibit 10.58 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 10.57 Second Amendment Agreement and Waiver (to the FHC Revolving Credit Agreement) among FHC, the Lenders and Citibank, N.A., as Administrative Agent for the Lenders (filed as Exhibit 10.59 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein).
36
10.58 Lease Agreement between HAS-First Associates and FHC dated August 1, 1998 and form of amendment thereto (filed as an exhibit to FHC's Registration Statement on Form S-1 (File No. 33-34963), which is incorporated by reference herein). 10.59 Agreement and Plan of Reorganization dated as of June 27, 1994 by and among FHC, CareFlorida Health Systems, Inc., and the other parties signatory thereto (filed as an exhibit to FHC's Current Report on Form 8-K filed with the Commission on June 28, 1994, which is incorporated by reference herein). 10.60 Agreement and Plan of Merger dated as of July 28, 1994 between FHC and Intergroup Healthcare Corporation (filed as an exhibit to FHC's Current Report on Form 8-K filed with the Commission on August 9, 1994, which is incorporated by reference herein). 10.61 Agreement and Plan of Merger dated as of July 28, 1994 between FHC and Thomas-Davis Medical Centers, P.C. (filed as an exhibit to FHC's Current Report on Form 8-K filed with the Commission on August 9, 1994, which is incorporated by reference herein). 10.62 Amended Letter Agreement between the Company and Jay M. Gellert dated as of August 22, 1997 (filed as Exhibit 10.69 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.63 Form of Credit Facility Commitment Letter, dated March 27, 1998, between the Company and the Majority Banks (as defined therein) (filed as Exhibit 10.70 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.64 First Amendment and Waiver to Credit Agreement, dated as of April 6, 1998, among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein), (filed as Exhibit 10.64 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, which is incorporated by reference herein). *10.65 Second Amendment to Credit Agreement, dated as of July 31, 1998, among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein), a copy of which is filed herewith. 10.66 Purchase Agreement by and between Foundation Health Corporation and Superior National Insurance Group, Inc., dated as of May 5, 1998, (filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, which is incorporated by reference herein). 10.67 Employment Letter Agreement between the Company and Dale Terrell dated December 31, 1997 (filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.68 Employment Letter Agreement between the Company and Steven P. Erwin dated March 11, 1998 (filed as Exhibit 10.72 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.69 Employment Agreement, dated as of December 31, 1997, between the Company and Maurice Costa (filed as Exhibit 10.73 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein).
37
10.70 Employment Agreement, dated as of December 31, 1997, between the Company and Robert L. Natt (filed as Exhibit 10.74 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.71 Employment Letter Agreement, dated October 10, 1997, between the Company and Alex Labak (filed as Exhibit 10.75 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). 10.72 Employment Letter, dated June 9, 1995, between Philip Katz, Ph.D. and Health Net (filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, which is incorporated by reference herein). *10.73 Employment Letter Agreement, dated June 25, 1998, between the Company and B. Curtis Westen, a copy of which is filed herewith. *10.74 Employment Letter Agreement, dated July 31, 1998, between the Company and Michael White, a copy of which is filed herewith. *10.75 Letter Agreement, dated June 1, 1998, between the Company and The California Wellness Foundation, a copy of which is filed herewith. *10.76 Form of Severance Payment Agreement entered into between the Company and various of its executive officers on April 6, 1998, a copy of which is filed herewith. *10.77 Early Retirement Agreement, dated as of August 6, 1998, between the Company and Malik M. Hasan, M.D., a copy of which is filed herewith. 11.1 Statement relative to computation of per share earnings of the Company (included in the notes to the Financial Statements contained in this Quarterly Report on Form 10-Q). *21.1 Subsidiaries of the Company, a copy of which is filed herewith. *27.1 Financial Data Schedule, a copy of which has been filed with the EDGAR version of this filing.
- ------------------------ * A copy of the Exhibit is filed herewith. (b) Reports on Form 8-K No Current Reports on Form 8-K were filed by the Company during the quarterly period ended June 30, 1998. 38 SIGNATURES Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FOUNDATION HEALTH SYSTEMS, INC. (REGISTRANT) Date: August 14, 1998 By: ----------------------------------------- Jay M. Gellert PRESIDENT AND CHIEF EXECUTIVE OFFICER Date: August 14, 1998 By: ----------------------------------------- Steven P. Erwin EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
39 EX-10.65 2 EXHIBIT 10.65 EXHIBIT 10.65 SECOND AMENDMENT TO CREDIT AGREEMENT THIS SECOND AMENDMENT TO CREDIT AGREEMENT is made and dated as of July 31, 1998 (the "Second Amendment") among FOUNDATION HEALTH SYSTEMS, INC. (the "Company"), the Banks party to the Credit Agreement referred to below, and BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as Administrative Agent (the "Agent"), and amends that certain Credit Agreement dated as of July 8, 1997, as amended by that certain First Amendment and Waiver to Credit Agreement (the "FIRST AMENDMENT") dated as of April 6, 1998 (as further amended or modified from time to time, the "CREDIT AGREEMENT"). RECITALS WHEREAS, the Company has requested the Agent and the Banks to amend certain provisions of the Credit Agreement, and the Agent and the Banks are willing to do so, on the terms and conditions specified herein: NOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereby agree as follows: 1. TERMS. All terms used herein shall have the same meanings as in the Credit Agreement unless otherwise defined herein. 2. AMENDMENT. The Credit Agreement is hereby amended as follows: 2.1 AMENDMENT TO SCHEDULE 1.01. (a) Schedule 1.01 of the Credit Agreement is hereby amended and restated to read in its entirety as set forth on Schedule 1.01 hereto. 2.2 AMENDMENTS TO SECTION 7.12. (a) Clause (a) of Section 7.12 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "(a) the Total Leverage Ratio, as of any date set forth below, to exceed the ratio set forth below opposite such date: -1- DATE MAXIMUM TOTAL LEVERAGE RATIO ---- ---------------------------- June 30, 1998 3.75 to 1.00 September 30, 1998 3.75 to 1.00 December 31, 1998 3.25 to 1.00 Thereafter 3.00 to 1.00;" 3. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants to the Agent and the Banks that, on and as of the date hereof, and after giving effect to this Second Amendment: 3.1 AUTHORIZATION. The execution, delivery and performance by the Company of this Second Amendment has been duly authorized by all necessary corporate action, and this Second Amendment has been duly executed and delivered by the Company. 3.2 BINDING OBLIGATION. This Second Amendment constitutes the legal, valid and binding obligation of the Company, enforceable against it in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, or similar laws affecting the enforcement of creditors' rights generally or by equitable principles relating to enforceability. 3.3 NO LEGAL OBSTACLE TO AMENDMENT. The execution, delivery and performance of this Second Amendment will not (a) contravene the Organization Documents of the Company; (b) constitute a breach or default under any contractual restriction or violate or contravene any law or governmental regulation or court decree or order binding on or affecting the Company which individually or in the aggregate does or could reasonably be expected to have a Material Adverse Effect; or (c) result in, or require the creation or imposition of, any Lien on any of the Company's properties. No approval or authorization of any governmental authority is required to permit the execution, delivery or performance by the Company of this Second Amendment, or the transactions contemplated hereby. 3.4 INCORPORATION OF CERTAIN REPRESENTATIONS. After giving effect to the terms of this Second Amendment, the representations and warranties of the Company set forth in Article V of the Credit Agreement are true and correct in all respects on and as of the date hereof as though made on and as of the date hereof, except as to such representations made as of an earlier specified date. 3.5 DEFAULT. No Default or Event of Default under the Credit Agreement has occurred and is continuing. 4. CONDITIONS, EFFECTIVENESS. The effectiveness of this Second Amendment shall be subject to the compliance by the Company with its agreements herein contained, and to the delivery of the following to Agent in form and substance satisfactory to Agent; -2- 4.1 AUTHORIZED SIGNATORIES. A certificate, signed by the Secretary or an Assistant Secretary of the Company and dated the date of this Second Amendment, as to the incumbency of the person or persons authorized to execute and deliver this Second Amendment and any instrument or agreement required hereunder on behalf of the Company. 4.2 AUTHORIZING RESOLUTIONS. A certificate, signed by the Secretary or an Assistant Secretary of the Company and dated the date of this Second Amendment, as to the resolutions of the Company's board of directors authorizing the transactions contemplated by the First Amendment. 4.3 OTHER EVIDENCE. Such other evidence with respect to the Company or any other person as the Agent or any Bank may reasonably request to establish the consummation of the transactions contemplated hereby, the taking of all corporate action in connection with this Second Amendment and the Credit Agreement and the compliance with the conditions set forth herein. 5. MISCELLANEOUS. 5.1 EFFECTIVENESS OF THE CREDIT AGREEMENT AND THE NOTES. Except as hereby expressly amended, the Credit Agreement and the Notes shall each remain in full force and effect, and are hereby ratified and confirmed in all respects on and as of the date hereof. 5.2 WAIVERS. This Second Amendment is limited solely to the matters expressly set forth herein and is specific in time and in intent and does not constitute, nor should it be construed as, a waiver or amendment of any other term or condition, right, power or privilege under the Credit Agreement or under any agreement, contract, indenture, document or instrument mentioned therein; nor does it preclude or prejudice any rights of the Agent or the Banks thereunder, or any exercise thereof or the exercise of any other right, power or privilege, nor shall it require the Majority Banks to agree to an amendment, waiver or consent for a similar transaction or on a future occasion, nor shall any future waiver of any right, power, privilege or default hereunder, or under any agreement, contract, indenture, document or instrument mentioned in the Credit Agreement, constitute a waiver of any other right, power, privilege or default of the same or of any other term or provision. 5.3 COUNTERPARTS. This Second Amendment may be executed in any number of counterparts, and all of such counterparts taken together shall be deemed to constitute one and the same instrument. This Second Amendment shall not become effective until the Company, the Agent and the Majority Banks shall have signed a copy hereof and the same shall have been delivered to the Agent. 5.4 GOVERNING LAW. This Second Amendment shall be governed by and construed in accordance with the laws of the State of California. -3- IN WITNESS WHEREOF, the parties hereto have caused this Second Amendment to be duly executed and delivered as of the date first written above. FOUNDATION HEALTH SYSTEMS, INC. By: /s/ SIGNATURE ----------------------------------- BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as Administrative Agent By: /s/ SIGNATURE ----------------------------------- BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as a Bank By: /s/ SIGNATURE ----------------------------------- [NOTE: OTHER SIGNATURE LINES HAVE BEEN OMITTED.] -4- EX-10.73 3 EXHIBIT 10.73 EXHIBIT 10.73 [LETTERHEAD] June 25, 1998 Mr. B. Curtis Westen 2022 W. Las Flores Pueblo West, CO 81007 Re: Offer of Relocation and Employment Dear Curt: On behalf of Foundation Health Systems, Inc. ("FHS"), I would like to confirm our offer to you for the relocation of your position of Senior Vice President, General Counsel and Secretary of FHS to our corporate offices in Woodland Hills, California. In this position you will devote your full professional attention to the duties and responsibilities assigned to you. You will physically relocate your office to Woodland Hills as soon as practicable following the sale of your Pueblo residence. In this position you will report directly to the Chairman and Chief Executive Officer of FHS and will earn a monthly salary of at least $29,166.67, effective upon your relocation. Associates are paid on a bi-weekly basis with 26 pay periods per year. Performance of each of the Company's Associates is generally reviewed on an annual basis, and any adjustment to salary is ordinarily made upon the completion of such performance review. Any adjustment to your compensation must be made with the approval of the Compensation and Stock Option Committee of the FHS Board of Directors (the "Committee"). You will be provided an automobile allowance of $1,000 per month, subject to normal payroll deductions, and subject to any changes to the FHS automobile allowance policy that may be made from time to time. Upon your relocation and/or your purchase of a new residence in the Woodland Hills, California area, FHS will provide to you a one-time $250,000 loan (with interest accrued at the Prime Rate) payable by you upon demand in the event of voluntary termination of your employment or should the Company terminate you for cause. The principal and any accrued interest will be forgiven, one-third on each of the first, second and third anniversaries of the date of this letter. Additionally, the loan plus accrued interest will be forgiven in total prior to the third anniversary if you depart from the Company involuntarily without cause, due to "Good Reason" following a change of control, or due to death or disability. Good Reason, Change of Control and Cause are defined within the Severance Payment Agreement entered into between yourself and FHS on April 6, 1998. The Company agrees that it will consider your reasonable requests, if any, to restructure the timing, nature, and/or characterization of such loan as may be suggested by your tax/financial advisers; provided that such restructuring would not disadvantage the Company and would not result in a modification of your obligation to repay such amount in the instance set forth above. In addition, you agree that the loan proceeds shall be used by you towards your home purchase or the cost of improvements on your new residence. PAGE 2 OFFER LTR/B. CURTIS WESTEN 6/25/98 You will be eligible to continue your participation in the Company's Executive Incentive Plan, as it may be modified from time to time by the Committee. Under the plan, bonus payments are dependent upon Company and individual performance measures. You will be eligible to participate in the plan in 1998 with a target bonus opportunity of 70 percent of your base salary. The maximum bonus payable under provisions of the plan is 105 percent of base salary. Any bonus payout for 1998 will be paid in 1999 following outside audit of the Company's performance and determination of your success in accomplishing individual performance objectives. To be eligible for any bonus payment, you must be actively employed and on the Company payroll at the time the bonus is paid. Bonus calculations are based on the base annual salary in effect on December 31st of the respective Plan Year. It is understood that the Committee and the Company will award bonus amounts, if any, as it deems appropriate consistent with the guidelines of the Plan. You acknowledge that in the event you are to be one of the top five highest paid executive officers of the Company for a given year under applicable federal securities laws, your bonus for that year, if any, will be subject to the Company's Performance Based 162(m) Plan in lieu of the Executive Incentive Plan. In addition to the foregoing, subject to your continued employment with the Company and plan provisions, you will be eligible to receive and/or participate in Company-offered benefits subject to plan criteria. You will receive under separate cover, information about Company benefits programs, including group medical, dental, vision, life insurance, short-term and long-term disability insurance, 401(k), Company-recognized holidays, the employee stock purchase plan, tuition reimbursement and participation in our deferred compensation program. In our 401(k) plan, subject to IRS regulations, the Company will match your contribution at $.50 for every dollar contributed up to six percent (6%) of salary. In the deferred compensation plan you may defer up to 50 percent of your base compensation and up to 100 percent of your incentive compensation. The Company's Paid Time Off ("PTO") benefit will be provided to you for illness, vacation and personal time off. The Company will also reimburse you the reasonable expense for one athletic/health club and one country or social club membership. In case of a conflict between this summary and the official plan documents, the official Plan documents will always govern. In addition, the Company reserves the right to change, amend, or terminate the benefits plans at any time, with or without notice, with no obligation to replace the benefit. You will also be eligible to continue to participate in the Company's Supplemental Executive Retirement Plan ("SERP") or a successor plan. Under provisions of the SERP you can vest and accrue a retirement benefit of up to 50 percent of your base salary plus incentive compensation. This benefit is integrated (offset) with other retirement benefits provided by the Company and with 50 percent of your social security benefits. To assist you in tax preparation and financial planning activities, the Company will provide up to $5,000 in annual reimbursement for expenses related to that activity. Additionally, the Company will provide a cellular phone, a car phone and a home fax machine for business use. You will also be provided at your request remote personal computer hardware with full systems capability. PAGE 3 OFFER LTR/B. CURTIS WESTEN 6/25/98 The Company will provide you with an option of benefits targeted to assist you in relocating to the Los Angeles, California area. It is anticipated that the relocation will be completed by December 31, 1998. Any decision to extend relocation benefits beyond that date will be at the sole discretion of the Company. Attached you will find a copy of the Relocation Guideline that we agree is subject to modifications, to the Company's reasonable satisfaction, to meet the following relocation requirements particular to your relocation circumstances: your approval of the carrier used to move your household effects, additional insurance coverage, special moving provisions to cover specific items including the reasonable expense to move your horse, up to six months of temporary living if necessary and up to two Company funded trips home per month during the period of temporary living. You may forego any such trips home and allow your spouse to travel to the new location instead. If the sale of your home in Colorado has not occurred within 90 days following placement on the real estate market, the Company will arrange for and purchase the home from you. The purchase price will be $184,000.00, which is the average of two appraisals from certified appraisers that you have provided to the Company. To assist you in the sale of your current home, and in the purchase of a home in your new location, the Company will provide the following assistance: SALE OF FORMER RESIDENCE - ------------------------ * Real estate transfer, excise, and sales tax. * Transfer stamp fees. * Abstract costs. * Legal fees. * Notary fees. * Escrow fees. * Lender or mortgage company service charges. * Loan repayment penalties paid by the seller. * In the event that title insurance must be provided to the buyer as accepted proof of the seller's good title, you will be reimbursed for the actual cost of insurance. * If your house is sold through a recognized real estate agency, reimbursement for the Realtors' sales commission fee at the rate prevailing at that location, not to exceed 7.0 percent. No reimbursement will be made for commissions or expenses not actually incurred. * Environmental inspection and audit fees. PURCHASE OF NEW RESIDENCE - ------------------------- * Real estate transfer, excise and sales tax. * Legal fees related to title opinions and recording fees. * Escrow fees related to the closing that are required to be paid by the buyer. * Credit verification. * Loan application or origination fees that are customary in the destination location (not to exceed one percent of loan amount). PAGE 4 OFFER LTR/B. CURTIS WESTEN 6/25/98 * Inspections required to obtain a loan. * Abstracting fees if title insurance is not required. * Title insurance, if required by the lending institution and/or title Service Company, paid in lieu of abstracting fees. * Loan discount charges (not to exceed 2 percent of loan amount). * One appraisal fee on the home conducted by a recognized appraisal agency. * Environmental inspection (including structural assessment) and audit fees. * Up to two househunting trips for your spouse to join you in searching for a new residence in the Los Angeles, California area. * In the event you purchase a new residence in the Woodland Hills, California area prior to the sale of your Pueblo, Colorado residence, in lieu of reimbursing you for the temporary living expense referenced above, the Company shall reimburse you for all duplicate mortgage interest, real estate taxes, utilities and other normal related expenses, on the residence with the smaller mortgage payment, until you sell your Pueblo residence. Additionally, the Company will provide a one-time miscellaneous moving expense payment equal to one-half month base salary payable within thirty (30) days of your relocation. This payment is intended to cover relocation expenses not specifically identified in our relocation policy. Should you voluntarily leave the Company within one year from the date of this letter for any reason, you will be responsible for reimbursing the Company within five business days of the date of termination of your employment 50% of the total relocation expenses paid on your behalf. For purposes of this paragraph, termination by reason of "good reason" following a change of control or death or disability will not be deemed to be voluntary termination. At the end of the calendar year in which relocation expenses are incurred, your income will be "grossed-up" to recognize the federal, state and any local tax impact that may result from the relocation assistance provided. However, the miscellaneous moving expense payment is not subject to gross-up. The Company has executed a Severance Payment Agreement with you as of April 6, 1998 which provides certain severance benefits under the terms and conditions set forth therein. Such Severance Payment Agreement, and any Stock Option Agreements between you and the Company which are currently in force, remain legal agreements between you and the Company and are not affected by this letter Agreement. You agree, through the signing of this letter, that your employment with the company is at the mutual consent of each employee and the Company and is an "at-will" employment relationship. Nothing in this letter is intended to guarantee your continued employment with the Company or employment for any specific length of time. While the Company hopes that your employment relationship will be mutually beneficial and rewarding, both you and the Company retain the right to terminate the employment relationship at will, at PAGE 5 OFFER LTR/B. CURTIS WESTEN 6/25/98 any time, with or without cause. The at-will nature of your employment with the Company cannot be modified or superseded except by a written agreement, approved by the Committee or the Board of Directors and signed by you and an appropriately authorized officer of the Company, that clearly and expressly specifies the intent to modify the at-will relationship. In accepting employment with the Company, you acknowledge that no Company representative has made any oral or written promise or representation contrary to this paragraph. Furthermore, you acknowledge that this paragraph represents the only agreement between you and the Company concerning the duration of your employment and the at-will nature of the employment relationship. During your employment with the Company, you will have access to and become acquainted with certain proprietary and confidential information and practices ("Confidential Information"). Confidential Information includes all information that is not generally known to the Company's competitors and the public, and that has or could have commercial value to the Company's business. It includes, but is not limited to, customer information, customer lists, and pricing methodology. In accepting employment with the Company, you acknowledge and agree that all documents, memoranda, reports, files, correspondence, lists and other written, electronic (including but not limited to audio and video recordings) and graphic records affecting or relating to the Company's business that you may prepare, use, observe, possess or control (including, but not limited to, any materials containing Confidential Information) shall be and remain the Company's sole property, and you agree not to make use of or disclose to any third party any such material, confidential or otherwise, except for the benefit of the Company and in the course of your employment with the Company. If your employment is terminated (voluntary or otherwise), you agree to deliver to the Company within five business days of termination all written, electronic and/or graphic records affecting or relating to the Company's business, including but not limited to material containing Confidential Information. Notwithstanding the foregoing, you may retain copies of documents prepared by you or on your behalf for legal precedent purposes, provided such documents do not contain any Confidential Information. You agree not to use or disclose any Confidential Information or trade secrets of others, including all prior employers, in your work at the Company. Should a situation arise in which you believe that your job duties may lead to the use or disclosure of confidential information or trade secrets of another, you agree to notify Jan Zlotowicz, or myself in the Human Resources Department of the situation immediately. Finally, this letter sets forth the terms of this offer of employment. It supersedes all previous and contemporaneous oral and written communications and representations. In signing this agreement each party further acknowledges that it has not relied on any representations, inducements, promises or agreements, oral or written, made by any party or anyone acting on behalf of any party that are not embodied herein. To confirm your acceptance of these terms, please sign, date and return a copy of this letter, in the enclosed self addressed envelope. An additional copy of the offer letter is enclosed for your files. PAGE 6 OFFER LTR/B. CURTIS WESTEN 6/25/98 Curt, we look forward to you joining our senior management team in Woodland Hills as soon as practicable. Should you have any questions, prior to or during your employment, please feel free to contact me at (916) 631-5061. Sincerely, /s/ Danny O. Smithson - ----------------------------- Danny O. Smithson Senior Vice President Corporate Human Resources I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED ABOVE. /s/ B. Curtis Westen as of June 25, 1998 - --------------------- ------------------------- SIGNATURE DATE cc: Jay Gellert Dr. Malik Hasan Enclosures: Relocation Guideline EX-10.74 4 EXHIBIT 10.74 EXHIBIT 10.74 [LETTERHEAD] July 30, 1998 Mr. Michael White 8446 Marina Vista Lane Fair Oaks, CA 95628 Re: Terms of Employment Dear Michael: On behalf of Foundation Health Systems, Inc. (hereinafter "Company"), I would like to confirm our offer to you for the exempt position of Senior Vice President and Treasurer. In this position you will report directly to the Executive Vice President and Chief Financial Officer of the Company. Effective May 16, 1998, you will earn a monthly salary of $16,666.67. As is our current practice, you will continue to be paid on a biweekly basis with 26 pay periods per year. Performance of each of the Company's Associates is generally reviewed on an annual basis, and any adjustment to salary is ordinarily made upon the completion of such performance review. You will receive a $1,000 per month automobile allowance, subject to any changes that might be made from time to time to the overall automobile allowance program. In addition, during 1998 you will continue to be eligible to participate in the Executive Incentive Plan which allows you an opportunity to earn up to 50 percent of your base salary. The receipt of any incentive compensation is contingent upon achieving corporate and individual objectives. You must be actively employed and on the Company payroll at the time incentive compensation is paid. Incentive compensation calculations are based on the base salary in effect on December 31st of the Executive Incentive Plan year. Incentive compensation payments are subject to normal payroll deductions. I am pleased to advise you that the Company's Compensation and Stock Option Committee (hereinafter "Committee") has granted to you an out-of-cycle stock option to purchase 10,000 shares of the Company's Class A Common Stock. The exercise price for the option is equal to the last sales price on May 7, 1998, which was $31.9375. A stock option agreement formalizing this grant will follow under separate cover. Any future recommendation for additional options made by the Company's management will be made consistent with your performance and generally comparable to peer managers of the Company at the time option recommendations are presented to the Committee. At all times, all stock option grants remain within the sole discretion of the Committee. In addition to the foregoing, and subject to your continued employment with the Company, you will be eligible to continue participation in Company-offered benefits if you meet certain criteria. These benefits include group medical, dental, vision, life insurance, short-term and long-term disability insurance, 401(k) plan, Company-recognized holidays, the employee stock purchase Page 2 Offer ltr/Michael White July 30, 1998 plan, tuition reimbursement and participation in our deferred compensation program. In our 401(k) plan, the Company currently matches your contribution at $.50 for every dollar contributed up to six percent (6%). The Company's Paid Time Off ("PTO") benefit is provided to you for illness, vacation and personal time off. Under the PTO program you accrue PTO at a rate of 23 days per year between your date of hire and 120 months of service, and 25 days per year thereafter. In case of a conflict between this summary and the official documents, the official documents will always govern. In addition, the Company reserves the right to change, amend, or terminate the benefits plans at any time, with or without notice. The Company will provide you with protection in the event of the termination of your employment without "cause" (absent a change of control). Under the terms of this agreement "cause" is defined as clear and willful failure to perform your duties not resulting from complete or partial incapacity due to physical or mental illness or impairment that continues after reasonable written notice and an opportunity to correct such failure; gross misconduct or fraud; or conviction of, or a plea of "guilty" or "no contest" to a felony. In the event that your employment is terminated involuntarily without cause, and you agree and sign the Company's standard Severance Agreement and Release of Claims document, you will be provided a severance package which will include a severance payment totaling twelve (12) months of base salary in effect at the date of your termination, together with all other severance benefits payable under the Company's "Separation Agreement and Release of Claims". Payment of base salary under provisions of the severance package will be made on a salary continuation basis until the sum of twelve (12) months of base salary is paid in full. During this period of severance payment, should you elect to continue your medical benefits, the Company will pay the premium to provide you and your dependents medical and dental coverage under COBRA, or if not available under COBRA, some other plan substantially similar to that which the Company provided you as an active employee. If within the first two years following a change of control, your employment is involuntarily terminated by the Company without cause, as defined above, or should you voluntarily terminate your employment for "Good Reason", then within thirty (30) days of your termination from the Company, you will be provided a change of control severance payment totaling eighteen (18) months of base salary in effect at the date of your termination. For the purposes of this agreement, Change of Control shall mean any of the following which occurs subsequent to the date of this offer: (a) Any person (as such term is defined under Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), corporation or other entity (other than the company or any employee benefit plan sponsored by the Company or any of its subsidiaries) is or becomes the beneficial owner (as such term is defined in Rule 13d-3 under the Exchange Act) of securities of the Company representing twenty percent (20%) or more of the combined voting power of the outstanding securities of the Company which ordinarily (and apart from rights accruing under special circumstances) have the right to vote in the election of directors (calculated as provided in paragraph (d) of such Rule 13d-3 in the Page 3 Offer ltr/Michael White July 30, 1998 case of rights to acquire the Company's securities) (the "Securities"); b) As a result of a tender offer, merger, sale of assets or other major transaction, the persons who are directors of the Company immediately prior to such transaction cease to constitute a majority of the Board of Directors of the Company (or any successor corporations) immediately after such transaction; c) The Company is merged or consolidated with any other person, firm, corporation or other entity and, as a result, the shareholders of the Company, as determined immediately before such transaction, own less than eighty percent (80%) of the outstanding Securities of the surviving or resulting entity immediately after such transaction; d) A tender offer or exchange offer is made and consummated for the ownership of twenty percent (20%) or more of the outstanding Securities of the Company; e) The Company transfers substantially all its assets to another person, firm, corporation or other entity that is not a wholly-owned subsidiary of the Company; or f) The Company enters into a management agreement with another person, firm, corporation or other entity that is not a wholly-owned subsidiary of the Company and such management agreement extends hiring and firing authority over Employee to an individual or organization other than the Company. For the purposes of this agreement, "Good Reason" is defined as any one of the following: a) A demotion or substantial reduction in the scope of Employee's position, duties, responsibilities or status with the Company or any new parent company of the Company, or any removal of Employee from or any failure to reelect Employee to any of the positions (or functional equivalent of such positions) held by Employee immediately prior to a change-of-control, except in connection with the termination of his/her employment for disability, normal retirement or Cause or by Employee voluntarily other than for Good Reason; b) A reduction by the Company in Employee's Base Salary or a material reduction in the benefits or perquisites available to Employee as in effect immediately prior to any such reduction; c) A relocation of Employee to a work location more than fifty (50) miles from Employee's work location immediately prior to such proposed relocation; provided that such proposed relocation results in a materially greater commute for Employee based on Employee's residence immediately prior to such relocation; or d) The failure of the Company to obtain an assumption agreement, encompassing this agreement, from any successor resulting from a change of control. During the eighteen (18) month period from and after the date of your termination of Page 4 Offer ltr/Michael White July 30, 1998 employment, the Company will also provide you and your covered dependents, medical and dental coverage by paying the COBRA premium, if eligible under COBRA, or the premium to provide coverage substantially similar to that which the Company provided you as an active employee. Additionally, if within the first two years following a change of control, your employment is involuntarily terminated by the Company without cause or you voluntarily terminate your employment for "Good Reason", any and all shares of FHS stock granted under the FHS and FHC Stock Option Programs will become fully vested. Additionally, should you be required to relocate from your current primary work location the Company will provide you relocation assistance as outlined in the attached amended Relocation Benefits program. This reimbursement will be grossed up to cover the associated tax liability that you would likely to incur. To provide further assistance at the time of relocation, you will be provided a relocation bonus totaling three months of base salary in effect at that time. You agree, through the signing of this letter, that your employment with the Company is at the mutual consent of each employee and the Company and is an "at-will" employment relationship. Nothing in this letter is intended to guarantee your continued employment with the Company or employment for any specific length of time. While the Company hopes that your employment relationship will be mutually beneficial and rewarding, both you and the Company retain the right to terminate the employment relationship at will, at any time, with or without cause. The at-will nature of your employment with the Company cannot be modified or superseded except by a written agreement, signed by you and the President and Chief Operating Officer of FHS, that clearly and expressly specifies the intent to modify the at-will relationship. In accepting employment with the Company, you acknowledge that no Company representative has made any oral or written promise or representation contrary to this paragraph. Furthermore, you acknowledge that this paragraph represents the only agreement between you and the Company concerning the duration of your employment and the at-will nature of the employment relationship. During your employment with the Company, you will have access to and become acquainted with certain proprietary and confidential information and practices ("Confidential Information"). Confidential Information includes all information that is not generally known to the Company's competitors and the public, and that has or could have commercial value to the Company's business. It includes, but is not limited to, customer information, customer lists, and pricing methodology. In accepting this new position with the Company, you acknowledge and agree that all documents, memoranda, reports, files, correspondence, lists and other written, electronic and graphic records affecting or relating to the Company's business that you may prepare, use, observe, possess or control (including, but not limited to, any materials containing Confidential Information) shall be and remain the Company's sole property, and you agree not to make use of or disclose to any third party any such material, confidential or otherwise, except for the benefit of the Company and in the course of your employment with the Company. If your employment is terminated (voluntary or otherwise), you agree to deliver to the Company within five business Page 5 Offer ltr/Michael White July 30, 1998 days of termination all written and/or graphic records affecting or relating to the Company's business, including but not limited to material containing Confidential Information. You have agreed and certify that you have no other agreement, relationship, or commitment to any other person or entity that conflicts with your obligations to the Company under this offer letter. If you are unable to so certify, all such agreement(s) must be identified here: - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- You agree not to use or disclose any confidential information or trade secrets of others, including all prior employers, in your work at the Company. Should a situation arise in which you believe that your job duties may lead to the use or disclosure of confidential information or trade secrets of another, you agree to notify the Executive Vice President and Chief Financial Officer or myself in the Human Resources Department of the situation immediately. Finally, this letter sets forth all the terms of this offer of employment. It supersedes all previous and contemporaneous oral and written communications and representations. To confirm your acceptance of these terms, please sign, date and return a copy of this letter to the Senior Vice President of Human Resources. An additional copy of the offer letter is enclosed for your files. Michael, we are pleased to offer you this promotion and are excited about the contributions that you can make to the Company as part of our management team. Should you have any questions please feel free to contact me at (916) 631-5061. Sincerely, /s/ Danny O. Smithson - --------------------------------- Danny O. Smithson Senior Vice President Corporate Human Resources Attachment: Relocation Benefit guideline cc: Steven P. Erwin Page 6 Offer ltr/Michael White July 30, 1998 I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED ABOVE. /s/ Michael P. White 7/31/98 - ----------------------------- -------------------------- SIGNATURE DATE EX-10.75 5 EXHIBIT 10.75 EXHIBIT 10.75 [LETTERHEAD] CORPORATE LEGAL DEPARTMENT June 1, 1998 Mr. Gary Yates The California Wellness Foundation 6320 Canoga Avenue Woodland Hills, CA 91367 Re: THE CALIFORNIA WELLNESS FOUNDATION ---------------------------------- Dear Gary: The purpose of this letter is to set forth the revised agreements between Foundation Health Systems, Inc. ("FHS") and The California Wellness Foundation ("CWF") relating to CWF's proposed disposal of shares of FHS Class B Common Stock (the "Class B Common Stock"). In this connection and as discussed, it is proposed that FHS provide its consent under the Amended Shareholder Agreement (the "Shareholder Agreement") to certain private sale transactions (the "Proposed Private Sales") arranged by Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and other investment banking firms mutually selected by FHS and CWF involving 8,026,298 shares of Class B Common Stock held by CWF between the date hereof through and including June 30, 1998. The purpose of this letter is to confirm the revised agreements and understandings relative to FHS' consent to the Proposed Private Sales under the Shareholder Agreement, which letter is meant to replace the letter agreement dated November 6, 1997 previously entered into between the parties. Such revised agreements and understandings are as follows: 1. The Proposed Private Sales would not exceed 8,026,298 shares of Class B Common Stock (the "Subject Shares") and would not result in a sale price (net of reasonable third party sales commissions) that is a discount to the "Market Price" (defined below) of more than 5%. For purposes hereof, "Market Price" means the closing sales prices of FHS Class A Common Stock on the New York Stock Exchange, Inc. ("NYSE") for the date on which the Sales Period (defined below) commences. Mr. Gary Yates June 1, 1998 Page 2 2. Any shares of Class B Common Stock sold in the Proposed Private Sales would reduce the shares otherwise subject to registration under the Registration Rights Agreement between FHS and CWF on a one for one basis. 3. Such Proposed Private Sales would comply with all laws and regulation (including, but not limited to, the federal securities laws) and Health Net's (and FHS') undertakings to the California Department of Corporations (the "DOC"). FHS and CWF representatives have been in contact with the DOC to discuss the filings and approvals that must be made with and/or received from the DOC and, in this connection, we understand that the DOC has indicated that it will not object to the sale of the Subject Shares by CWF. 4. CWF hereby agrees to use DLJ as an investment banking firm to arrange for the sale of at least a majority of the Subject Shares, provided that CWF receives confirmation to its reasonable satisfaction that DLJ will be able to consummate such Proposed Private Sales on terms and conditions comparable with other investment banking firms of at least equivalent stature. In the event CWF and DLJ are not able to agree on terms and conditions with respect to the Proposed Private Sales prior to June 15, 1998, FHS and CWF agree to negotiate in good faith for a period of up to five business days to select another investment banking firm of equivalent stature to sell the Subject Shares. In the event such good faith negotiations do not result in the selection of a mutually agreeable investment banking firm, CWF shall have the right to select such firm to sell the Subject Shares provided such firm is of a stature equivalent to DLJ. 5. All of the Proposed Private Sales will occur prior to the open of the NYSE on July 1, 1998 pursuant to a sales process to be determined between CWF and the investment banking firm selected to sell the Subject Shares, which sales process will attempt to maximize the value to be received in selling the Subject Shares and preserve the market price of FHS' common stock during and after such sales. 6. CWF agrees to provide FHS with such information regarding the Proposed Private Sales as FHS may from time to time reasonably request, including without limitation information with respect to the proposed sale prices of the Subject Shares and other economic terms, the procedures anticipated to be used by CWF and DLJ in connection with the Proposed Private Sales and the status and timing of the Proposed Private Sales. Mr. Gary Yates June 1, 1998 Page 3 7. The parties agree to keep confidential the Proposed Private Sales, the existence of this letter agreement, the terms and provisions of this letter agreement and all discussions, negotiations and other information relating to the foregoing (collectively, the "Confidential Information") and will not (except as may be necessary to implement the Proposed Private Sales or as required by applicable law, regulation or legal process, and only after compliance with the provisions of this paragraph), without the other party's prior written consent, disclose the Confidential Information in any manner whatsoever. In the event that either party or any of such party's representatives or agents is requested pursuant to, or required by, applicable law, regulation or legal process to disclose any of the Confidential Information, the party receiving such request or order will notify the other party promptly so that the other party may seek a protective order or other appropriate remedy or, in the other party's sole discretion, waive compliance with the terms of this letter agreement. In the event that no such protective order or other remedy is obtained, or that the other party waives compliance with the terms of this letter agreement, the requesting party will furnish only that portion of the Confidential Information which the requesting party is advised in writing by counsel it legally required and will exercise its best efforts to obtain reliable assurance that confidential treatment will be accorded the Confidential Information. 8. Reference is made to that certain Registration Rights Agreement dated as of March 1, 1995 (the "Registration Rights Agreement") between CWF and FHS. In partial consideration for FHS' consent to the Proposed Private Sales under the Shareholder Agreement, CWF agrees to waive any and all rights it may have against FHS pursuant to the Registration Rights Agreement with respect to the failure, if any, of FHS to file a registration statement in connection with the February 25, 1998 demand registration notice letter of CWF to FHS (the "February 25th Notice") upon consummation of the Proposed Private Sales or sales of the Subject Shares by August 1, 1998 pursuant to a registered public offering (whichever occurs sooner). Between the date hereof and July 1, 1998, CWF agrees that FHS may suspend all activities related to the preparation and filing of a registration statement pursuant to the February 25th Notice. If any of the Subject Shares remain unsold after July 1, 1998, FHS shall recommence the preparation and filing of a registration statement within ten (10) days after receipt of notice from CWF of its intention to sell at least 2,000,000 of the unsold Subject Shares under the Registration Rights Agreement. 9. FHS is hereby granted an option (the "Option") to redeem up to 2,271,344 shares of Class B Common Stock held by CWF after the Proposed Private Sales at the Redemption Price (as defined below) as follows: (i) the Option would become Mr. Gary Yates June 1, 1998 Page 4 exercisable at the earlier of (A) the first trading day after the date on which the Sales Period ends or (B) July 1, 1998 (such earlier date referred to as the "Option Commencement Date"); (ii) the Option would remain exercisable in whole or in part for a ninety (90) day period commencing on the Option Commencement Date; (iii) the "Redemption Price" per share would be equal to the higher of (A) the product of (I) .97 and (II) the Market Price on the date of the Option exercise and (B) the average per share net proceeds received by CWF (i.e., after all sales commission and costs) for all previously consummated Proposed Private Sales; (iv) consummation of the redemption would be subject to the condition that appropriate DOC approval is obtained to permit FHS to consummate such redemption (unless FHS determines that such DOC approval is not required); and (v) redemption by FHS would be consummated no later than three (3) business days after DOC approval is obtained. 10. FHS would use its best reasonable efforts to receive DOC approval to consummate the redemption as expeditiously as possible (unless FHS determines that such DOC approval is not required); provided that it is understood that since the DOC has indicated it will need to assess the actual Redemption Price and its impact on FHS prior to giving such approval, such approval may not be formerly requested until after the Option exercise date. Accordingly, it is agreed that FHS will have a period of up to forty-five (45) days from the Option exercise date to obtain such DOC approval; provided that in the event DOC approval is not obtained within such forty-five day (45) period (unless FHS determines that such DOC approval is not required), the Option shall be null and void notwithstanding the exercise thereof. 11. CWF has represented to FHS that CWF has taken the position with the Internal Revenue Service, and continues to believe, that FHS is not a "disqualified person" for purposes of Section 4946 of the Internal Revenue Code. FHS has no reason to disagree with CWF's position. Moreover, both parties acknowledge and agree that FHS' exercise of the Option is not meant to be a purchase of shares but rather is meant to be a redemption of such shares (which redemption is consistent with FHS' prior redemption of CWF shares). Both parties also realize that such redemption procedure would fall within an exception to the "self-dealing" rules set forth in Internal Revenue Code Section 4941(d)(2)(F) and Treasury Regulations Section 53.4941(d)-3(d)(1) in the event FHS would be considered a "disqualified person." In this light, the parties acknowledge the importance of the redemption characterization of the Option and agree to take all actions consistent with such characterization. Mr. Gary Yates June 1, 1998 Page 5 12. CWF acknowledges that it is not currently in the possession of any material, non-public information of FHS (whether received from FHS, its representatives or otherwise) and that it will comply with all applicable securities laws (including those prohibiting the use of material, non-public information) in effecting the Proposed Private Sales. In addition, CWF acknowledges that in effecting any such Proposed Private Sales it is acting at its own risk, and that FHS is not responsible or any fluctuation in the Market Price of the Common Stock. By executing this letter agreement in the space provided below, CWF hereby accepts and agrees to all of such conditions, agreements and understandings and commitments to the obligations set forth herein. Please do not hesitate to contact either Jay Gellert at (818) 676-6703 or me at (719) 585-8077 with any questions you may have. Very truly yours, FOUNDATION HEALTH SYSTEMS, INC. /s/ B. Curtis Westen ------------------------------------ B. CURTIS WESTEN, ESQ. Senior Vice President, General Counsel and Secretary ACCEPTED AND AGREED TO BY: THE CALIFORNIA WELLNESS FOUNDATION By: /s/ Gary L. Yates ------------------------------------ Name: Gary L. Yates Title: President and CEO cc: Malik M. Hasan, M.D. Jay M. Gellert Michael E. Jansen, Esq. Russel I. Kully, Esq. Gordon Bava, Esq. EX-10.76 6 EXHIBIT 10.76 Exhibit 10.76 FORM OF SEVERANCE PAYMENT AGREEMENT This Severance Payment Agreement (this "Agreement") is entered into as of April 6, 1998, between Foundation Health Systems, Inc., a Delaware corporation (the "Company"), on the one hand, and __________________ ("Employee"), on the other hand. WHEREAS, the Company currently employs Employee as its ___________________; and WHEREAS, the Company and the Employee desire to enter into this Agreement to provide for the continued employment of the Employee by the Company upon the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, the Company and Employee hereto agree as follows: 1. TERM OF AGREEMENT. The term of this Agreement (the "Covered Period") shall commence on the date hereof (the "Effective Date") and continue throughout Employee's term of employment with the Company. Any payments to be made pursuant to Section 3 hereof shall only be made if Employee is terminated by the Company without Cause or terminated by Employee with Good Reason as provided in said Section 3. 2. DUTIES OF EMPLOYEE. Employee shall serve as __________________ of the Company. During the term of employment, except as otherwise provided herein, Employee shall devote his/her entire business time, attention and effort to the business of the Company and shall use his/her reasonable best efforts to promote the interests of the Company. 3. TERMINATION OF EMPLOYMENT. 3.1 TERMINATION BY THE COMPANY WITHOUT CAUSE. The Company may terminate Employee's employment without Cause (as defined below) at any time. In the event that the Company does so terminate Employee's employment without Cause at any time within two (2) years after a Change of Control (as defined below) of the Company Employee shall nevertheless be entitled, as a severance allowance, to (i) continuation of all medical, health, disability, life and accident insurance maintained for Employee's benefit immediately prior to the date of Employee's termination (collectively, "Benefits") for a period of [two (2)/three (3)] years from the date of termination and (ii) a lump sum cash payment equal to [two (2)/three (3)] times the base salary ("Base Salary") of the Employee in effect immediately prior to the date of Employee's termination. In the event that the Company does so terminate Employee's employment without Cause at any time that is not within two (2) years after a Change of Control of the Company, Employee shall nevertheless be entitled, as a severance allowance, to (i) continuation of all Benefits for a period of [one (1) year][six (6) months] from the date of termination and (ii) a lump sum cash payment equal to [one (1)][one-half(1/2)] times the Base Salary of the Employee in effect immediately prior to the date of Employee's termination. 3.2 TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate Employee's employment for Cause at any time without notice. In the event of such termination, Employee shall not be eligible to receive any payments set forth in this Section 3. For purposes of this Agreement, Cause shall include, without limitation, (a) an act of dishonesty causing harm to the Company, (b) the knowing disclosure of confidential information relating to the Company's business, (c) habitual drunkenness or narcotic drug addiction, (d) conviction of a felony or a misdemeanor involving moral turpitude, (e) willful refusal to perform or gross neglect of the duties assigned to Employee, (f) the willful breach of any law that, directly or indirectly, affects the Company, (g) a material breach by the Employee following a Change of Control of those duties and responsibilities of the Employee that do not differ in any material respect from the duties and responsibilities of the Employee during the 90-day period immediately prior to such Change of Control (other than as a result of incapacity due to physical or mental illness) which is demonstrably willful and deliberate on the Employee's part, which is committed in bad faith or without reasonable belief that such breach is in the best interests of the Company and which is not remedied in a reasonable period of time after receipt of written notice from the Company specifying such breach, or (h) breach of the provisions of Section 9 of this Agreement. 3.3 VOLUNTARY TERMINATION BY EMPLOYEE WITHOUT GOOD REASON. Notwithstanding anything to the contrary in this Agreement, whether express or implied, Employee may at any time terminate his/her employment for any reason by giving the Company fourteen (14) days prior written notice of the effective date of termination. In the event that Employee's employment with the Company is voluntarily terminated by Employee without Good Reason (as defined below), Employee shall not be eligible to receive any payments set forth in this Section 3. 3.4 VOLUNTARY TERMINATION BY EMPLOYEE WITH GOOD REASON. Notwithstanding the preceding Section 3.3, in the event that Employee's employment with the Company is voluntarily terminated by Employee with Good Reason within two (2) years after a Change of Control of the Company, Employee shall nevertheless be entitled, as a severance allowance, to (i) continuation of his/her Benefits for a period of [two (2)][three (3)] years from the date of termination and (ii) a lump sum cash payment equal to [two (2)][three (3)] times Base Salary of the Employee in effect immediately prior to the date of Employee's termination; provided that, in the event the Company requests, in writing, prior to such voluntary termination that Employee continue in the employ of the Company for a period of time up to 90 days following such Change of Control, then Employee shall forfeit such severance allowance if he/she voluntarily leaves the employ of the Company prior to the expiration of such period of time. For purposes of this Agreement, Good Reason shall mean any of the following which occurs subsequent to the Effective Date: (i) a demotion or a substantial reduction in the scope of Employee's position, duties, responsibilities or status with the Company or any new parent company of the Company, or any removal of Employee from or any failure to reelect Employee to any of the positions (or functional equivalent of such positions) referred to in the introductory 2 paragraphs hereof, except in connection with the termination of his/her employment for Disability (as defined below), normal retirement or Cause or by Employee voluntarily other than for Good Reason; (ii) a reduction by the Company in Employee's Base Salary or a material reduction in the benefits or perquisites available to Employee as in effect immediately prior to any such reduction; (iii) a relocation of Employee to a work location more than fifty (50) miles from Employee's work location immediately prior to such proposed relocation; provided that such proposed relocation results in a materially greater commute for Employee based on Employee's residence immediately prior to such relocation; or (iv) the failure of the Company to obtain the assumption agreement from any successor as contemplated in Section 12.5 of this Agreement. For purposes of this Agreement, Change of Control shall mean any of the following which occurs subsequent to the Effective Date: (a) Any person (as such term is defined under Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), corporation or other entity (other than the Company or any employee benefit plan sponsored by the Company or any of its subsidiaries) is or becomes the beneficial owner (as such term is defined in Rule 13d-3 under the Exchange Act) of securities of the Company representing twenty percent (20%) or more of the combined voting power of the outstanding securities of the Company which ordinarily (and apart from rights accruing under special circumstances) have the right to vote in the election of directors (calculated as provided in paragraph (d) of such Rule 13d-3 in the case of rights to acquire the Company's securities) (the "Securities"); (b) As a result of a tender offer, merger, sale of assets or other major transaction, the persons who are directors of the Company immediately prior to such transaction cease to constitute a majority of the Board of Directors of the Company (or any successor corporations) immediately after such transaction; (c) The Company is merged or consolidated with any other person, firm, corporation or other entity and, as a result, the shareholders of the Company, as determined immediately before such transaction, own less than eighty percent (80%) of the outstanding Securities of the surviving or resulting entity immediately after such transaction; (d) A tender offer or exchange offer is made and consummated for the ownership of twenty percent (20%) or more of the outstanding Securities of the Company; 3 (e) The Company transfers substantially all its assets to another person, firm, corporation or other entity that is not a wholly-owned subsidiary of the Company; or (f) The Company enters into a management agreement with another person, firm, corporation or other entity that is not a wholly-owned subsidiary of the Company and such management agreement extends hiring and firing authority over Employee to an individual or organization other than the Company. 4. PAYMENTS UPON TERMINATION OF EMPLOYMENT. In the event that the Employee's employment is terminated for any reason, then the Company shall pay to the Employee (or his/her beneficiaries or estate) in addition to any payments that may be due under Section 3 above or Section 5 below, within 30 days following the date of termination, a cash amount equal to the sum of the Employee's annual Base Salary from the Company through the date of termination, any compensation previously deferred by the Employee (together with any interest and earnings thereon), any vacation pay accrued prior to the termination date, any reimbursable expenses incurred by the Employee prior to the termination date and any other compensatory plan, arrangement or program payment to which Employee may be entitled, in each case to the extent not theretofore paid. 5. TERMINATION OF EMPLOYEE DUE TO DEATH OR DISABILITY. In the event that Employee's employment is terminated at any time during the Covered Period due to death or Disability, Employee (or his beneficiaries or estate) shall nevertheless be entitled, as a severance allowance, to (i) continuation of all Benefits for a period of [one (1) year] [six (6) months] from the date of termination and (ii) a lump sum cash payment equal to [one (1)] [one-half (1/2)] times the Base Salary of the Employee in effect immediately prior to the date of Employee's termination. For purposes of this Agreement, a termination for "Disability" shall mean a termination of Employee's employment due to the Employee's absence from his duties with the Company on a full-time basis for at least 180 consecutive days as a result of the Employee's incapacity due to physical or mental illness. 6. WITHHOLDING TAXES. The Company shall withhold from all payments due to the Employee (or his/her beneficiaries or estate) hereunder all taxes which, by applicable federal, state, local or other law, the Company may reasonably determine should be withheld therefrom. 7. TAX CONSEQUENCES. The Company shall have no obligation to any person entitled to the benefits of this Agreement with respect to any tax obligation any such person may incur as a result of or attributed to this Agreement or arising from any payments made or to be made hereunder. Nothing contained herein shall be construed as a warranty or representation of any kind by the Company to Employee with respect to the tax consequences of him or her with respect to this Agreement. 8. LIMITATION ON PAYMENTS BY THE COMPANY. Solely for the purposes of the computation of payments to be made pursuant to this Agreement and notwithstanding any other provisions hereof, payments to the Employee under this Agreement (other than the payments required to be made pursuant to Section 4 hereof) shall be reduced (but not below zero) so that the present 4 value, as determined in accordance with Section 280G(d)(4) of the Internal Revenue Code of 1986, as amended (the "Code"), of such payments plus any other payments that must be taken into account for purposes of any computation relating to the Employee under Section 280G(b)(2)(a)(ii) of the Code, shall not, in the aggregate, exceed 2.99 times the Employee's "base amount," as such term is defined in Section 280G(b)(3) of the Code. Notwithstanding any other provision hereof, no reduction in payments under the limitation contained in the immediately preceding sentence shall be applied to payments hereunder which do not constitute "excess parachute payments" within the meaning of the Code. Any payments in excess of the limitation of this Section 8 or otherwise determined to be "excess parachute payments" made to the Employee hereunder shall be deemed to be overpayments which shall constitute an amount owing from the Employee to the Company with interest from the date of receipt by the Employee to the date of repayment (or offset) at the applicable federal rate under Section 1274(d) of then Code, compounded semi-annually, which shall be payable to the Company upon demand; PROVIDED, HOWEVER, that no repayment shall be required under this sentence if in the written opinion of tax counsel satisfactory to the Employee and delivered to the Employee and the Company such repayment does not allow such overpayment to be excluded for federal income and excise tax purposes from the Employee's income for the year of receipt or afford the Employee a compensating federal income tax deduction for the year of repayment. 9. CONFIDENTIALITY. Employee acknowledges and agrees that, during the period of his/her employment by the Company, he/she has and will continue to have access to and become acquainted with various trade secrets, including, but not limited to, various procedures, practices, information regarding the organization and operation of the Company, confidential customer information, marketing methods, compilations of information and records that are owned by the Company and that are regularly used in the operation of its business. The parties stipulate that such items of information are important, material and confidential trade secrets and affect the successful conduct of the Company's business and its goodwill, and that any breach of this Section 9 shall be a material breach of this Agreement. All documents, memoranda, reports, files, correspondence, lists and other written and graphic records affecting or relating to the Company's business that Employee may prepare, use, observe, possess or control shall be and remain the Company's sole property. Employee shall not disclose any of these trade secrets, directly or indirectly, or use them in any way, either during the term of this Agreement or at any time thereafter, except as required in the course of his employment by the Company or as otherwise authorized in writing by the Company. In the event of the termination of Employee's employment with the Company, Employee shall deliver promptly to the Company all written or graphic records containing such trade secrets or confidential information of the Company. 10. ENFORCEMENT. The parties hereto agree that the Company would be damaged irreparably in the event any provision of Section 9 of this Agreement were not performed in accordance with its terms or were otherwise breached and that money damages would be inadequate remedy for any such nonperformance or breach. Therefore, the Company or its successors or assigns shall be entitled, in addition to other rights and remedies existing in their favor, to an injunction or injunctions to prevent any breach or threatened breach of any of such provisions and to enforce such provisions specifically (without posting a bond or other security). 5 11. SURVIVAL. Sections 9 and 10 of this Agreement and any rights and remedies arising out of this Agreement shall survive and continue in full force and effect in accordance with the respective terms thereof, notwithstanding any termination of this Agreement or the Employee's employment. 12. MISCELLANEOUS. 12.1 ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties and supersedes any and all other agreements, whether oral or written, between the parties hereto with respect to the subject matter hereof except that existing written severance arrangements or policies applicable to Employee shall continue in full force and effect for the term thereof to the extent, but only to the extent, such written arrangements or policies afford Employee a greater severance payment benefit than that provided for herein. Each party to this Agreement acknowledges that no representations, inducements, promises or agreements, oral or written, have been made by any party or anyone acting on behalf of any party that are not embodied herein, and that no other agreement, statement or promise not contained in this Agreement shall be valid or binding. 12.2 RIGHT TO TERMINATE EMPLOYMENT. It is hereby agreed that the relationship between the Company and Employee is merely an "at-will" employment relationship and that nothing in this Agreement shall confer upon Employee the right to continue in the employment of the Company or affect any right which the Company has to terminate the employment of Employee. 12.3 AMENDMENTS. This Agreement may not be amended or terminated other than by a written instrument signed by the party against whom enforcement of such amendment or termination is sought. No amendments to this Agreement or interpretations hereof or any waivers or modifications of any of the provisions hereof may be made on behalf of the Company without the approval of the Board of Directors or the Compensation and Stock Option Committee of the Company. 12.4 WAIVER. No waiver of any default under this Agreement shall constitute or operate as waiver of any subsequent default, and no delay, failure or omission in exercising or enforcing any right, privilege or option hereunder shall constitute a waiver, abandonment or relinquishment thereof. No waiver of any provision hereof by either party hereto shall be deemed to have been made unless or until such waiver shall have been reduced to writing and signed by the party making such waiver. Failure by either party to enforce any of the terms, covenants or conditions of this Agreement for any length of time or from time to time shall not be deemed to waive or decrease the rights of such party to insist thereafter upon strict performance by the other party. 12.5 SUCCESSORS; BINDING AGREEMENT. (a) This Agreement shall not be terminated by any merger or consolidation of the Company whereby the Company is or is not the surviving or resulting corporation or as a result of any transfer of all or substantially all of the assets of the Company. In the event of any such 6 merger, consolidation or transfer of assets, the provisions of this Agreement shall be binding upon the surviving or resulting corporation or the person or entity to which such assets are transferred. (b) The Company agrees that concurrently with any merger, consolidation or transfer of assets referred to in paragraph (a) of this Section 12.5, it will cause any successor or transferee unconditionally to assume, by written instrument delivered to the Employee (or his beneficiary or estate), all of the obligations of the Company hereunder. Failure of the Company to obtain such assumption prior to the effectiveness of any such merger, consolidation or transfer of assets shall be a breach of this Agreement and shall entitle the Employee to compensation and other benefits from the Company in the same amount and on the same terms as the Employee would be entitled hereunder if the Employee's employment were terminated following a Change of Control other than by the Company for Cause. For purposes of implementing the foregoing, the date on which any such merger, consolidation or transfer becomes effective shall be deemed the date of termination. (c) This Agreement shall inure to the benefit of and be enforceable by the Employee's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Employee shall die while any amounts would be payable to the Employee hereunder had the Employee continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to such person or persons appointed in writing by the Employee to receive such amounts or, if no person is so appointed, to the Employee's estate. 12.6 NOTICES. (a) For purposes of this Agreement, all notices and other communications required or permitted hereunder shall be in writing and shall be deemed to have been duly given when delivered or five days after deposit in the United States mail, certified and return receipt requested, postage prepaid, addressed (i) if to the Employee, to the most recent address set forth in the Company's personnel files of the Employee, and if to the Company, to Foundation Health Systems, Inc., 21600 Oxnard Street, Woodland Hills, CA 91367, attention: General Counsel, or (ii) to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. (b) A written notice of the Employee's date of termination by the Company or the Employee, as the case may be, to the other, shall (i) indicate the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Employee's employment under the provision so indicated and (iii) specify the termination date (which date shall be not less than 15 days after the giving of such notice). The failure by the Employee or the Company to set forth in such notice any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Employee or the Company hereunder or preclude the Employee or the Company from asserting such fact or circumstance in enforcing the Employee's or the Company's rights hereunder. 7 12.7 FULL SETTLEMENT. (a) The Company's obligation to make any payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Employee or others. In no event shall the Employee be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Employee under any of the provisions of this Agreement, and such amounts shall not be reduced whether or not the Employee obtains other employment. (b) The Company's obligation to make any payment provided for in this Agreement shall be expressly subject to Employee entering into a full release of all claims against the Company substantially in the form of the Waiver and Release of Claims attached as EXHIBIT A hereto. Employee hereby expressly agrees to execute such a Waiver and Release of Claims upon his or her termination of employment. 12.8 EMPLOYMENT WITH SUBSIDIARIES. Employment with the Company for purposes of this Agreement shall include employment with any corporation or other entity in which the Company has a direct or indirect ownership interest of 50% or more of the total combined voting power of the then outstanding securities of such corporation or other entity entitled to vote generally in the election of directors. 12.9 GOVERNING LAW; VALIDITY. The interpretation, construction and performance of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of Delaware without regard to the principle of conflicts of laws. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which other provisions shall remain in full force and effect. 12.10 COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original and all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. FOUNDATION HEALTH SYSTEMS, INC. By:______________________________ Name: Title: _________________________________ Employee: [name] 8 EX-10.77 7 EXHIBIT 10.77 EXHIBIT 10.77 EARLY RETIREMENT AGREEMENT EARLY RETIREMENT AGREEMENT, dated as of August 6, 1998, by and between FOUNDATION HEALTH SYSTEMS, INC., a Delaware corporation, formerly known as Health Systems International, Inc. (the "Company"), and MALIK M. HASAN, M.D. ("Executive"). WHEREAS, Executive has expressed his intention to retire from employment with the Company and, in connection with his retirement, the Company and Executive have determined to settle all of their respective rights and obligations in respect of his Employment Agreement (as defined below) and other matters pertaining to Executive's services with the Company; NOW, THEREFORE, in consideration of their mutual promises, the Company and Executive agree as follows: 1. CONTINUING BOARD MEMBERSHIP. Effective as of the date hereof, the Executive hereby retires from active employment and hereby resigns (i) as Chief Executive Officer of the Company, (ii) from employment with the Company and each of its subsidiaries and affiliates and (iii) from each other officer or executive position held with the Company and each directorship or officer or executive position held with each of the Company's subsidiaries or affiliates. Executive shall remain as Chairman of the Board of Directors of the Company ("Chairman") until such date after September 30, 1998 and on or before March 1, 1999 that Executive shall determine, at which time Executive shall retire from the Board and resign as a member of the Board. Without limiting the foregoing, during his continued service as Chairman, Executive shall not engage in any Competitive Activity (as hereinafter defined). For his service as Chairman, Executive shall receive a fee of $165,000, payable as soon as practicable (but not more than five business days) after the date hereof, which shall be in lieu of the annual retainer fee and meeting fees provided to each of the Company's other non-employee directors. As Chairman, Executive shall not be entitled to participate in any benefit or incentive program or to receive any stock option or other equity award generally made available to non-employees directors. 2. CANCELLATION OF THE EMPLOYMENT AGREEMENT. Executive and the Company are parties to an Amended and Restated Employment Agreement, dated as of March 10, 1997 (the "Employment Agreement"). The term of the Employment Agreement (determined without regard to any possible extension thereof) would have expired January 1, 2001. The Employment Agreement is hereby canceled and the parties shall have no further obligations to each other thereunder (other than for the Company's obligations to pay compensation earned prior to the date hereof). In consideration of the cancellation of the Employment Agreement, the Company shall pay Executive a single lump sum payment of $2,000,000 on or as soon as practicable (but in not event more than five business days) after the date hereof. 3. 1998 BONUS. As soon as practicable, but in no event later than five business days after the date hereof, the Company shall pay Executive $793,000, which is an amount equal to the opportunity available to Executive for 1998 under Section 11 of the Employment Agreement, multiplied by a fraction, the numerator of which is the number of weeks in 1998 during which Executive served as Chief Executive Officer (31) and the denominator of which is 52. 4. BENEFITS. (a) EMPLOYEE BENEFIT PROGRAMS. Except as otherwise expressly provided herein, Executive's participation in, and coverage under any and all Company provided benefit plans, policies and arrangements, including, without limitation, those available only to Executive or generally available to its employees or executives, shall cease on the date hereof. Executive shall be paid for 50 accrued and unused vacation days as soon as practicable (but not later than five business days) after the date hereof. The Company shall provide Executive and his eligible dependents with medical coverage, on the same basis as though Executive had continued in the employ of the Company, from and after the date hereof and through the date Executive attains age 65. In addition, after Executive has attained age 65 or following Executive's death, the Company shall provide Executive's current spouse (but not her dependents) with continued medical coverage on the same terms and conditions (except as expressly limited hereby) as such coverage was made available to Executive until the date she attains age 65; PROVIDED THAT such spousal coverage shall extend dependent coverage to Executive's currently eligible dependent child, to the extent that and so long as he is still eligible for dependent coverage under the Company's generally applicable policies and practices as in effect from time to time. Where applicable, the coverage provided pursuant to the two immediately preceding sentences will be secondary to any other coverage Executive or his spouse may from time to time have from any other source. If at any time that medical coverage is required to be provided to Executive or his spouse hereunder, coverage is not available to a former employee of the Company or his or her spouse or dependents for any reason under the Company's generally applicable employee benefit plans, the Company shall provide coverage (as otherwise required hereunder) which is comparable to that provided at such time to senior officers of the Company. (b) EQUIPMENT. Executive shall be entitled to retain the business equipment currently made available for his use that is listed on Schedule 1 hereto. In addition, upon written notice to the Company delivered within 30 days of the date hereof, Executive shall have the right to purchase from the Company any of the furniture in any of his offices, and either of the automobiles (but not the limousines) currently made available for his use, in each case, at a purchase price equal to the depreciated cost at which each such item is carried on the Company's books. To the extent that any such purchase results in income to Executive under applicable income tax laws, such income shall be treated as subject to all generally applicable rules regarding wage withholding and reporting. (c) DEFERRED COMPENSATION AGREEMENT. The Company has established a grantor trust to which it has made contributions under and pursuant to the terms of the Deferred Compensation Agreement between the Company and Executive, dated as of March 3, 1996. The assets held in such trust shall be distributed to Executive in accordance with the provisions of such Deferred Compensation Agreement (including, without limitation, Section 6(a) thereof) in full and complete settlement of all of Executive's rights under such agreement, PROVIDED THAT Executive is hereby deemed to elect a distribution in kind under Section 2 thereof and that such distribution shall occur on January 2, 1999. 5. SUPPORTING EMPLOYEES. Until October 15, 1998, the Company shall continue to make available, at its expense, all employees currently comprising Executive's staff at each of its locations and at Executive's residences, and to pay all costs associated with such support staff. During such sixty day period, the Company shall also pay all reasonable expenses related to the business equipment provided in support of Executive on the same basis as it paid such expenses immediately prior to the date hereof. After the expiration of such sixty day period, the Company shall not be responsible for providing such personnel to Executive nor for the expenses associated with such support or any business equipment, except that the Company shall be responsible for any expenses related to terminating any such employee's employment (should it decide to do so) or for terminating any contract regarding such services to which it is a party. Notwithstanding the foregoing, the Company shall make available to Executive a secretary at its office in Pueblo, Colorado until the earlier of April 15, 1999 or the date, if any, on which Executive engages in Competitive Activity (as hereinafter defined). 6. EXPENSES. All expenses previously incurred by Executive prior to June 1, 1998 have been paid or reimbursed, or shall not be paid or reimbursed. Executive shall have no responsibility for or liability to the Company for expenses incurred on or before that date that have been paid or reimbursed by the Company. Any reasonable business expenses incurred on or after June 1, 1998 shall be paid or reimbursed in accordance with the Company's generally applicable policies, subject to appropriate documentation and review. Any such expenses shall be submitted directly to the Company's Chief Executive Officer within five business days of the date hereof, or with respect to expenses incurred in the performance of his duties as Chairman, as soon as practicable (but in no event later than 30 days) after the incurrence thereof. 7. STOCK OPTIONS. In recognition of his retirement from the Company and subject to the provisions of this section 7, all stock options currently held by Executive which are not currently exercisable shall be and become exercisable at the same time at, and to the same extent as, which they would have become exercisable by Executive had he continued in the Company's employ; PROVIDED THAT any such options that have not become exercisable in accordance with the foregoing shall be forfeited and expire automatically on any date on which Executive undertakes employment with or provides other paid services (including as a medical manager or director, consultant, partner, or independent contractor) to, or becomes an investor in, any health maintenance organization, health care management company, physician group, insurance company or similar entity that provides managed health care or related services similar to those provided by the Company or any subsidiary in any geographical area in which the Company or any such subsidiary is currently providing such services ("Competitive Activity") or engages in a material breach of either of the covenants contained in section 9 and section 10 hereof. (Notwithstanding the foregoing, Competitive Activity shall not include (x) any investment by Executive of less than 5% in the outstanding voting securities of any public company; (y) services performed by Executive as a physician and not as an administrator, medical manager, medical director or executive or (z) services for any business or entity that has as its principal activity the direct provision of medical services to patients and which has no more than 20 affiliated physicians.) Each currently exercisable option and each option that shall hereafter become exercisable in accordance with the preceding provisions of this section 7 shall be exercisable by Executive (or, in the event of his death, his beneficiary) until May 31, 2001. Any stock options that have not been exercised prior to May 31, 2001 shall lapse and be canceled automatically without any further action. 8. RETIREMENT BENEFITS. (a) CURRENT SERP. The Company shall, solely for purposes of the Company's current Supplemental Executive Retirement Plan ("SERP"), credit Executive with years of service for the period of his service with Pueblo Physicians, Inc., a predecessor of predecessors of the Company, which shall have the effect of providing Executive with 15 years of service for purposes of such SERP. In addition, the Supplemental Benefit payable to Executive under the SERP shall in all events be determined assuming that Executive had attained age 62 prior to the date on which his benefits commence thereunder. The Supplemental Benefit payable to Executive, taking into account the preceding provisions of this section 8, shall be calculated in accordance with the terms of the SERP, except that in no event shall the bonus referred to in section 3 hereof be taken into account in determining the amount of Executive's benefits under the SERP. The Company shall provide Executive with a calculation of the monthly benefit payable under the SERP, taking into account all applicable offsets thereto, within ten business days of the date hereof. Except as otherwise expressly provided above, payment of any benefit under the SERP shall be made in accordance with its terms, and Executive shall have all rights of a participant under the SERP, including all elections as to the form of benefit. Executive shall have 30 days after the execution hereof to make any and all elections with respect to the form of payment under the SERP. Payment of benefits under the SERP shall commence as soon as practicable (but not later than ten business days) after receipt of Executive's election as to the form of annuity payment. (b) PRIOR RETIREMENT ACCOUNT. Prior to the adoption of the SERP, the Company (or one of its predecessors) maintained another nonqualified retirement benefit plan, which is an offset to the Supplemental Benefit provided under the SERP. The amount currently credited to Executive's benefit under such account shall be paid in accordance with the terms of such benefit plan and shall be calculated and quantified by the Company and identified to Executive within ten business days hereof. The balance in such account shall be distributed, at the election of Executive, by a single lump sum cash payment of the value of such account or by a distribution of the life insurance policies on Executive's life which the Company holds to assist it in meeting its obligations to Executive, as soon as practicable, but in no event later than 30 days following the execution hereof, in full and complete satisfaction of the Executive's rights thereunder. If Executive shall not have delivered written notice of the form of distribution within 20 days of the date hereof, Executive shall have been deemed to have elected to receive a distribution in kind. In the event that Executive receives a distribution in kind, the Company shall have no duty or obligation to make any premium payments on or in respect of such policies after the date of such distribution. 9. NON-SOLICITATION. Until May 31, 2001, Executive will not solicit or otherwise induce any executive of the Company or its subsidiaries to leave the employ of the Company or such subsidiaries or to become associated, whether as an executive, officer, partner, director, consultant or otherwise, with any business organization. 10. NON-DISCLOSURE. Without the prior written consent of the Company, except to the extent required by an order of a court having competent juris- diction or under subpoena from an appropriate government agency or as may be necessary in the conduct of his duties as Chairman, Executive shall not disclose or use in any way for his personal benefit or for the benefit of any third party, any trade secrets, customer lists, provider lists, product development and related information, marketing plans and related information, sales plans and related information, management organization and related information, operating policies and manuals, business plans and related information, financial records and related information or other financial, commercial, business or technical information related to the Company or any of its subsidiaries to any third person unless such information has been previously disclosed to the public by the Company or has become public knowledge other than by a breach of this Agreement. 11. INTENTION OF THE PARTIES. If any provision of Sections 7, 9 or 10 is determined by a court of competent jurisdiction not to be enforceable in the manner set forth in this Agreement, the Company and Executive agree that it is the intention of the parties that such provisions should be enforceable to the maximum extent possible under applicable law and that such court shall reform such provision to make it enforceable in accordance with the intent of the parties. Executive agrees that, if Executive shall breach any of the covenants contained in Section 9 or 10, in addition to the remedy described in section 7 hereof, the Company shall be entitled to such injunctive relief as a court or arbitrator shall reasonably determine unless such breach is an inadvertent breach that does not result in any significant harm to the Company. 12. RELEASES. (a) EXECUTIVE RELEASE. In consideration of a payment of $1,750,000, to be made in a single lump sum, on the eighth business day following execution thereof (but if, and only if, the release referred to below has not been revoked in accordance with its terms), Executive shall execute the release in favor of the Company attached hereto as Exhibit A. Such release shall pertain to any and all claims that Executive may now have or may hereafter have against the Company or any of its predecessors, subsidiaries or affiliates arising out of or in connection with Executive's employment with, or service as an officer or a director of, the Company or any of its subsidiaries, other than any claim for the benefits to be provided to Executive under this Agreement or under any of the Company's applicable employee benefit plans (other than any severance plan or policy or any other benefit plan or program specifically referred to in this Agreement and for which payment is made in accordance with the terms hereof, which payment is stated to be in satisfaction of Executive's rights thereunder). If such release is revoked by Executive as permitted thereunder, this section 12 and the provisions of section 7 shall be rendered void and without effect, and (x) the Company shall have no obligation to make the payment provided for in this section 12, (y) all of Executive's unexercisable options shall be forfeited and (z) Executive's currently exercisable stock options shall only be exercisable for 90 days after the date hereof. Except as provided in the immediately preceding sentence and the provisions of section 12(b), all other provisions of this Agreement shall remain in full force and effect. (b) COMPANY'S RELEASE. In consideration of Executive's release, Executive's covenants hereunder and the other benefits conveyed to the Company hereby, the Company shall execute the release in favor of Executive attached hereto as Exhibit B. Such release shall pertain to any and all claims that the Company may now have or may hereafter have against Executive arising out of or in connection with Executive's employment with, or service as an officer or a director of, the Company and any of its subsidiaries other than any claim under this Agreement, any claim arising out of or related to any intentional misconduct or fraud perpetrated against the Company or any of its affiliates or customers or any claim relating to the reimbursement of premiums paid in respect of the split-dollar life insurance policy on Executive's life. Notwithstanding anything contained herein to the contrary, if Executive revokes the release described in section 12(a), the Company's release under this Section 12(b) shall be rendered void and without effect. 13. INDEMNITY. The Company shall indemnify Executive in accordance with the terms and conditions of the Indemnification Agreement by and between the Company and Executive dated as of August 10, 1996, which is incorporated herein and expressly made a part hereof. The Company shall also use its reasonable commercial best efforts to cause Executive to be treated as an additional named insured on any liability and errors and omissions policies that it has in effect from time to time and which extend coverage generally to the Company's senior officers or directors for a period extending until the earlier to occur of one year from the date of Executive's death and twenty-two (22) years from the date hereof. 14. WITHHOLDING. All cash payments to be made under this Agreement shall be made net of all applicable income and employment taxes required to be withheld from such payments. To the extent any compensation is payable to Executive in accordance with this Agreement other than as a payment in cash, Executive shall be required to pay the Company an amount equal to all applicable income and employment taxes required to be withheld with respect thereto. 15. MISCELLANEOUS. This Agreement may be amended only by a written instrument signed by the Company and Executive. Except with respect to any other agreement between the Company and Executive that is specifically referenced herein and intended to continue beyond the execution of this Agreement, this Agreement shall constitute the entire agreement between the Company and Executive with respect to the subject matter hereof. The obligations of the Company to Executive and the covenants of Executive in favor of the Company shall survive the termination of Executive's continued services as a member of the Board of Directors. This Agreement shall be governed by the laws of the State of Delaware, other than the provisions thereof relating to conflict of laws. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors, heirs (in the case of Executive) and assigns. This Agreement may be executed in counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. Any notices to be given and any payments to be made hereunder shall be delivered in hand or sent by registered mail, return receipt requested, to the respective party at (i) the Company's California headquarters, if notice shall be to the Company, or (ii) the address of Executive's permanent residence as listed on the Company's records from time to time or to such other address as either such party shall direct in accordance with the requirements of this Section 15. IN WITNESS WHEREOF, the parties have executed this Early Retirement Agreement effective as of the day first written above. FOUNDATION HEALTH SYSTEMS, INC. By: /s/ Jay M. Gellert ------------------------------------------ Title: President and Chief Operating Officer MALIK M. HASAN, M.D. /s/ Malik M. Hasan --------------------------------------------- EX-21.1 8 EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARIES OF FOUNDATION HEALTH SYSTEMS, INC. ------------ ----------------------------------------------- Foundation Health Systems, Inc. (DE)* -QualMed, Inc. (DE) -QualMed Plans for Health of Colorado, Inc. (CO) -San Luis Valley Physicians Service Corp., Ltd. (CO Limited Partnership)(1) -Foundation Health Systems Life & Health Insurance Company (CO) -QualMed Washington Health Plan, Inc. (WA) -QualMed Plans for Health, Inc. (NM) -QualMed Oregon Health Plan, Inc. (OR) -Preferred Health Network, Inc. (CA) -Health Net (CA) -Health Net Life Insurance Company (CA) -PCA of California Insurance Agency (CA) -HSI Advantage Health Holdings, Inc. (DE) -QualMed Plans for Health of Ohio and West Virginia, Inc. (OH) -QualMed Plans for Health of Western Pennsylvania, Inc. (PA) -Pennsylvania Health Care Plan, Inc. (PA) -National Pharmacy Services, Inc. (DE) -Integrated Pharmacy Systems, Inc. (PA)(2) -HSI Eastern Holdings, Inc. (PA) -Greater Atlantic Health Service, Inc. (DE) -QualMed Plans for Health, Inc. (PA) -Greater Atlantic Preferred Plus, Inc. (PA) -Employ Better Care, Inc. (PA) -Foundation Health Corporation (DE) -Foundation Health Preferred Administrators (CA) -Foundation Health National Life Insurance Company (TX) -FH-Arizona Surgery Centers, Inc. (AZ) -FH Surgery Limited, Inc. (CA) -FH Surgery Centers, Inc. (CA) -Foundation Health Facilities, Inc. (CA) -FH Assurance Company (Cayman Islands) -Foundation Health Warehouse Company (CA) -Memorial Hospital of Gardena, Inc. (CA) -East Los Angeles Doctors Hospital, Inc. (CA) -Foundation Health Vision Services (CA) -Denticare of California, Inc. (CA) -Managed Alternative Care, Inc. (CA) -American VitalCare, Inc. (CA) -Foundation Health Federal Services, Inc. (DE) -Catalina Professional Recruiters, Inc. (AZ) -Foundation Health Pharmaceutical Services, Inc. (CA) -Integrated Pharmaceutical Services (CA) -Foundation Health, A Florida Health Plan, Inc. (FL) -Foundation Health Medical Group, Florida, Inc. (FL) -Foundation Health, A Louisiana Health Plan, Inc. (LA) -Foundation Health, An Oklahoma Health Plan, Inc. (OK) -Foundation Health, A Texas Health Plan, Inc. (TX) -Preferred Health Providers, Inc. (FL) -Intercare, Inc. (AZ) -Intergroup Health Plan, Inc. (AZ) -Intergroup Prepaid Health Services of Arizona, Inc. (AZ) -Interlease of Arizona, Inc. (AZ) -Intergroup of Utah, Inc. (UT) -Managed Health Network, Inc. (DE) -Health Management Center, Inc. (MA) -Health Management Center, Inc. of Wisconsin (WI) -HMC PPO, Inc. (MA) -Managed Health Network (CA) -MHN Reinsurance Company of Arizona (AZ) -MHN Services (CA) -Business Insurance Group, Inc. (DE) -Business Insurance Company (DE) -California Compensation Insurance Company (CA) -Combined Benefits Insurance Company (CA) -Commercial Compensation Insurance Company (NY) -Foundation Health Medical Resource Management (CA) -Foundation Integrated Risk Management Solutions, Incorporated (CA) -AXIS Integrated Resources, Inc. (DE) -Gem Holding Corporation (UT)(3) -Gem Insurance Company (UT) -QualMed Plans for Health of Pennsylvania, Inc. (PA)(4) -FOHP, Inc. (NJ)(5) -First Option Health Plan of New Jersey, Inc. (NJ) -First Option Health Plan of Pennsylvania, Inc. (PA) -FOHP Agency, Inc. (NJ) -Physicians Health Services, Inc. (DE) -Physicians Health Services (Bermuda) Ltd. (Bermuda) -Physicians Health Services of Connecticut, Inc. (CT) -Physicians Health Services of New Jersey, Inc. (NJ) -Physicians Health Services of New York, Inc. (NY) -Physicians Health Services Insurance of New York, Inc. (NY) -Physicians Health Insurance Services, Inc. (CT) -PHS Insurance of Connecticut, Inc. (CT) -PHS Real Estate, Inc. (DE) -PHS Real Estate II, Inc. (DE) -HN Reinsurance Limited (Cayman Islands) -M.D. Health Plan, Inc. (CT) *All subsidiaries wholly owned unless otherwise indicated. (1) A limited partnership in which QualMed Plans for Health of Colorado, Inc. is an 83.4% limited partner. (2) National Pharmacy Services, Inc. owns approximately 90% of the outstanding common stock. (3) Foundation Health Corporation owns approximately 99.9% of the outstanding common stock. (4) Foundation Health Systems, Inc. owns approximately 83.0% of the outstanding common stock. (5) Foundation Health Systems, Inc. owns approximately 97.9% of the outstanding common stock. -2- EX-27.1 9 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED CONSOLIDATED BALANCE SHEET AND CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1998 APR-01-1998 JUN-30-1998 250,686 557,588 556,763 0 0 2,222,598 436,344 0 3,876,862 1,407,704 1,422,182 0 0 0 928,832 3,876,862 2,213,527 2,236,971 1,883,298 1,883,298 329,951 0 22,193 1,529 573 956 0 0 0 956 0.01 0.01 Net of allowances for doubtful accounts Net of accumulated depreciation Includes revolving credit facility, misc. notes and capital leases Includes $50,000 of asset impairment charges $0.26 before asset impairment charges
-----END PRIVACY-ENHANCED MESSAGE-----