-----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, TPhwgAK97CxGl7Ml4awiRli3Kte8h8e2APHm03pzgiloGx5r082g6j9OSUJBrMYK CfhchhExI+4ljwSdSFapMA== 0001047469-99-012982.txt : 19990402 0001047469-99-012982.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-012982 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 22 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K SEC ACT: SEC FILE NUMBER: 001-12718 FILM NUMBER: 99583023 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-K 1 FORM 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998 / / 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 No.) incorporation or organization) 21650 OXNARD STREET, WOODLAND HILLS, CA 91367 (Address of principal executive offices) (Zip Codes)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 676-6978 Securities registered pursuant to Section 12(b) of the Act: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED - --------------------------------------------- --------------------------------------------- Class A Common Stock, $.001 par value New York Stock Exchange, Inc.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (x) No ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) The aggregate market value of the voting stock held by non-affiliates of the registrant at March 29, 1999 was $1,325,343,786 (which represents 119,805,088 shares of Class A Common Stock held by such non-affiliates multiplied by $11.0625, the closing sales price of such stock on the New York Stock Exchange on March 29, 1999). The number of shares outstanding of the registrant's Class A Common Stock as of March 12, 1999 was 120,319,926 (excluding 3,194,374 shares held as treasury stock), and 5,047,642 shares of the registrant's Class B Common Stock were outstanding as of such date. DOCUMENTS INCORPORATED BY REFERENCE: Part II of this Form 10-K incorporates by reference certain information from the registrant's Annual Report to Stockholders for the year ended December 31, 1998 ("Annual Report to Stockholders"). Part III of this Form 10-K incorporates by reference certain information from the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 1998. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS Foundation Health Systems, Inc. (the "Company" or "FHS") is an integrated managed care organization which administers the delivery of managed health care services. The Company's health maintenance organizations ("HMOs"), insured preferred provider organizations ("PPOs"), and government contracts subsidiaries provide health benefits to 5.8 million individuals in 21 states through group, individual, Medicare risk, Medicaid, and Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS") programs. The Company's subsidiaries also offer managed health care products related to behavioral health, dental and vision services, and offer managed health care product coordination for multi-region employers and administrative services for medical groups and self-funded benefits programs. The Company operates and conducts its HMO and other businesses through its subsidiaries. The Company currently operates within two segments of the managed health care industry: Health Plan Services and Government Contracts/Specialty Services. For a portion of 1998, the Company also operated a risk-assuming workers' compensation insurance business, which represented a separate segment of business. Such risk-assuming workers' compensation business was sold in December 1998, and is reported as "Discontinued Operations and Anticipated Divestitures." During 1998, the Health Plan Services segment consisted of four regional divisions: Arizona (Arizona and Utah), California (encompassing only the state of California), Central (Colorado, Florida, Idaho, Louisiana, New Mexico, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Washington and West Virginia) and Northeast (Connecticut, New Jersey and New York). Effective January 1, 1999, the Company slightly reorganized such divisions and moved the Ohio, Pennsylvania and West Virginia operations from the Central Division to the Northeast Division. The Company is one of the largest managed health care companies in the United States, with approximately 4.2 million full-risk and administrative services only ("ASO") members in its Health Plan Services segment. The Company also operates PPO networks providing access to health care services to over 4 million individuals in 37 states and owns six health and life insurance companies licensed to sell insurance in 33 states and the District of Columbia. The Company's HMOs market traditional HMO products to employer groups and Medicare and Medicaid products to employer groups and directly to individuals. Health care services that are provided to the Company's commercial and individual members include primary and specialty physician care, hospital care, laboratory and radiology services, prescription drugs, dental and vision care, skilled nursing care, physical therapy and mental health. The Company's HMO service networks include approximately 43,000 primary care physicians and 108,000 specialists. The Company's Government Contracts/Specialty Services segment consists of the Government Contracts Division and the Specialty Services Division. The Company's Government Contracts Division oversees the provision of contractual services to federal government programs such as CHAMPUS. The Company receives revenues for administrative and management services and, under most of its contracts, also accepts financial responsibility for a portion of the health care costs. The Company's Specialty Services Division oversees the provision of supplemental programs to enrollees in the Company's HMOs, as well as to members whose basic medical coverage is provided by non-FHS companies, including vision coverage, dental coverage, managed behavioral health programs and a prescription drug program. The Specialty Services Division consists both of operations in which the Company assumes underwriting risk in return for premium revenue, and operations in which the Company provides administrative services only, including certain of the behavioral health and pharmacy benefits management programs. Such Division also provides certain bill review and third party administrative services as described elsewhere in this Annual Report. The Company has entered into a definitive agreement for the sale of certain of its pharmacy benefit processing services. See "Discontinued Operations and Anticipated Divestitures." 2 The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and the opportunities to expand its businesses in profitable markets. The Company is reviewing the strategic importance of each of its businesses and operations, focusing its resources on its core and strong-performing businesses, and divesting itself of certain non-core and lesser-performing operations. Accordingly, in 1998 the Company sold its risk-assuming workers' compensation operations and certain member support center operations located in Philadelphia, and entered into a definitive agreement to sell its HMO operations in Louisiana, Oklahoma and Texas. In February 1999, the Company also entered into a definitive agreement for the sale of certain of its pharmacy benefit processing services. In addition, in March of 1999, the Company entered into a definitive agreement to sell its New Mexico operations, and signed a letter of intent to sell its Colorado operations. The Company has also undertaken to purchase the remaining minority interests of FOHP, Inc., a majority-owned subsidiary of the Company which owns a managed health care company in New Jersey. See "Discontinued Operations and Anticipated Divestitures" and "Other Information--Recent Developments." The Company was incorporated in 1990. The current operations of the Company are the result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the FHS Combination, FH Acquisition Corp., a wholly-owned subsidiary of HSI, merged with and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company. Under the Merger Agreement, FHC stockholders received 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held. The shares of the Company's Class A Common Stock issued to FHC's stockholders in the FHS Combination constituted approximately 61% of the outstanding stock of the Company after the FHS Combination and the shares held by the Company's stockholders prior to the FHS Combination (i.e., the prior stockholders of HSI) constituted approximately 39% of the outstanding stock of the Company after the FHS Combination. The FHS Combination was accounted for as a pooling of interests for accounting and financial reporting purposes. The pooling of interests method of accounting is intended to present, as a single interest, two or more common stockholder interests which were previously independent and assumes that the combining companies have been merged from inception. Consequently, the Company's consolidated financial statements incorporated by reference into this Annual Report on Form 10-K have been prepared and/or restated as though HSI and FHC always had been combined on a calendar year basis. Prior to the FHS Combination, the Company was the successor to the business conducted by Health Net, now the Company's HMO subsidiary in California, which became a subsidiary of the Company in 1992, and HMO and PPO networks operated by QualMed, Inc. ("QualMed"), which combined with the Company in 1994 to create HSI. FHC was incorporated in Delaware in 1984. The executive offices of the Company are located at 21650 Oxnard Street, Woodland Hills, CA 91367. Except as the context otherwise requires, the term the "Company" refers to FHS and its subsidiaries. HEALTH PLAN DIVISIONS HMO AND PPO OPERATIONS. The Company's HMOs offer members a comprehensive range of health care services, including ambulatory and outpatient physician care, hospital care, pharmacy services, eye care, behavioral health and ancillary diagnostic and therapeutic services. The Company offers a full spectrum of managed health care products. The integrated health care programs offered by the Company's HMOs include products offered through both traditional Network Model HMOs (in which the HMOs contract with individual physicians, physician groups and independent or individual practice associations ("IPAs")) and IPA Model HMOs (in which the HMOs contract with one or more IPAs that in turn subcontract with individual physicians to provide HMO patient services) which offer quality care, cost containment and comprehensive coverage; a 3 matrix package which allows employees to select their desired coverage from alternatives that have interchangeable outpatient and inpatient co-payment levels; point-of-service programs which offer a multi-tier design that provides both conventional HMO and indemnity-like (in-network and out-of-network) tiers; a PPO-like tier which allows members to self-refer to the network physician of their choice; and a managed indemnity plan which is provided for employees who reside outside of their HMO service areas. The Company's PPO subsidiaries consist of networks of health care providers which offer their services to health care third-party payors, such as insurers and self-funded employers. The Company's strategy is to offer a wide range of managed health care products and services to employers to assist them in containing health care costs. The pricing of the products offered is designed to provide incentives to both employers and employees to select and enroll in the products with greater managed health care and cost containment elements. In general, the Company's HMO subsidiaries provide comprehensive health care coverage for a fixed fee or premium that does not vary with the extent or frequency of medical services actually received by the member. PPO enrollees choose their medical care from among the various contracting providers or choose a non-contracting provider and are reimbursed on a traditional indemnity plan basis after reaching an annual deductible. The Company assumes both underwriting and administrative expense risk in return for the premium revenue it receives from its HMO and PPO products. The HMOs and PPOs have contractual relationships with health care providers for the delivery of health care to the Company's enrollees. While a majority of the Company's members are covered by conventional HMO products, the Company is continuing to expand its other product lines, thereby enabling it to offer flexibility to an employer and to tailor its products to an employer's particular needs. The following table contains certain information relating to commercial HMO and PPO members, Medicare members and employer groups under contract as of December 31, 1998 in each region in which the Company operated (excluding point-of-service):
ARIZONA CALIFORNIA CENTRAL NORTHEAST DIVISION DIVISION DIVISION DIVISION --------- ---------- --------- ----------- Commercial HMO and PPO Members.................. 294,032 1,534,961 514,786 782,403 Medicare Members (risk only).................... 51,280 150,650 61,756 58,486 Medicaid Members................................ -- 438,942 61,671 84,820
In addition, the following sets forth certain data regarding the Company's employer groups in its commercial managed care operations of its Health Plan Divisions as of December 31, 1998: Number of Employer Groups........................................... 63,729 Largest Employer Group as % of enrollment........................... 4.8% 10 largest Employer Groups as % of enrollment....................... 17.6%
ARIZONA DIVISION In Arizona, the Company believes that its commercial managed care operations rank it second largest both as measured by total membership and by size of provider network. The Company's commercial HMO membership in Arizona was 286,540 as of December 31, 1998. The Company's Medicare risk membership in Arizona was 51,280 as of December 31, 1998 which represented an increase of 8% during 1998. The Company's commercial HMO membership in Utah was 7,492 as of December 31, 1998. The Arizona Division also oversees the Company's six health and life insurance companies licensed to sell insurance in 33 states and the District of Columbia. 4 CALIFORNIA DIVISION The California market is characterized by a concentrated population. In mid 1998, the Company merged the operations of two of its California HMO subsidiaries, Health Net and Foundation Health, a California Health Plan. The resulting HMO, Health Net, is believed by the Company to be the third-largest HMO in the state of California in terms of membership and the largest in terms of size of provider network. The Company's commercial HMO membership in California as of December 31, 1998 was 1,534,961, which represented a decrease of 7% during 1998. The Company's Medicare risk membership in California as of December 31, 1998 was 150,650, which represented a decrease of 1% during 1998. The Company's Medicaid membership in California as of December 31, 1998 was 438,942 members. CENTRAL DIVISION. During 1998, the Central Division included Health Plan operations in Colorado, Florida, Idaho, Louisiana, New Mexico, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Washington and West Virginia. As of January 1, 1999, the Health Plan operations in Ohio, Pennsylvania and West Virginia were moved to the Northeast Division. The Company believes that its Colorado HMO is the fifth largest HMO in the state of Colorado as measured by total membership and second largest as measured by size of provider network. The Company's commercial HMO membership in Colorado was 77,269 as of December 31, 1998, which represented an increase of 1% during 1998. The Company's Medicare membership in Colorado was 10,324 as of December 31, 1998, which represented a decrease of 15% during 1998. As noted below in the section of this Annual Report on Form 10-K entitled "Discontinued Operations and Anticipated Divestitures," the company has entered into a letter of intent to sell its Colorado HMO operations. The Company believes its Florida HMO and PPO operations make it the ninth largest HMO managed care provider in terms of membership and fifth largest HMO in terms of size of provider network in the state of Florida. The Company's commercial HMO membership in Florida was 84,508 as of December 31, 1998, which represented a decrease of 9% during 1998. The Company's Medicare risk membership in Florida was 24,891 as of December 31, 1998, which represented an increase of 4% during 1998. The Company's Medicaid membership in Florida was 28,318 as of December 31, 1998, a 21% increase in 1998. In New Mexico, the Company believes that its ranks sixth largest as measured by total membership and tenth largest as measured by size of provider network. The Company's commercial HMO membership in New Mexico was 29,924 as of December 31, 1998, which represented a decrease of 12% during 1998. The Company's Medicare risk membership in New Mexico was 3,595 as of December 31, 1998, which represented an increase of 55% during 1998. As noted below in the section of this Annual Report on Form 10-K entitled "Discontinued Operations and Anticipated Divestitures," the Company has entered into a definitive agreement to sell its New Mexico HMO operations. The Company's commercial HMO membership in eastern Pennsylvania was 47,990 as of December 31, 1998, which represented a decrease of 28% during 1998. The Company's Medicare risk membership in eastern Pennsylvania was 14,033 as of December 31, 1998, which represented a decrease of 7% during 1998. Collectively, the Company's commercial HMO membership in Ohio, western Pennsylvania and West Virginia was approximately 20,200 as of December 31, 1998. The Company's Medicare risk membership in Ohio, western Pennsylvania and West Virginia was approximately 2,600 collectively as of December 31, 1998. The Company's Washington HMO services Seattle and Spokane and also services a limited number of residents who reside in the state of Idaho. The Company's Oregon HMO services Portland and its vicinity. In addition, an increasing percentage of the population in each of these areas has enrolled in HMOs in the last several years. In Washington and Oregon, the Company believes that it ranks third and sixth, 5 respectively, with respect to total membership; the Company believes that it ranks first in Washington and third in Oregon with respect to the size of its primary care physician and specialist networks. The Company's commercial HMO and PPO membership in Oregon was 131,889 as of December 31, 1998. At year end 1997, the Company had 163,406 commercial members in Oregon. The Company's commercial HMO and PPO membership in Washington was 105,372 as of December 31, 1998, which represented an increase of 10% during 1998. The Company's Medicare risk membership in Washington was 2,641 as of December 31, 1998, which represented a decrease of 20% during 1998. The Company's Medicaid membership in Washington was 30,658 as of December 31, 1998, which represented an increase of 23% during 1998. Collectively, the Company's commercial HMO membership in Texas, Oklahoma, and Louisiana was 29,752 as of December 31, 1998. As noted below in the section of this Annual Report on Form 10-K entitled "Discontinued Operations and Anticipated Divestitures", the Company has entered into a definitive agreement to sell these three HMOs. NORTHEAST DIVISION. During 1998, the Northeast Division included Company operations in Connecticut, New Jersey and New York. As referenced above, effective January 1, 1999, the Company's operations in the states of Ohio, Pennsylvania and West Virginia were moved from the Central Division to the Northeast Division. In the Company's Northeast Division, the Company and The Guardian Life Insurance Company of America ("The Guardian") together offer both HMO and indemnity products through a joint venture doing business as "Healthcare Solutions." In general, the Company and The Guardian share equally in the profits of the joint venture, subject to certain terms of the joint venture arrangement related to expenses. The Guardian is a mutual insurer (owned by its policy owners) which offers financial products and services, including individual life and disability income insurance, employee benefits, pensions and 401(k) products. The Guardian is headquartered in New York and has more than 2,000 agents distributing its products nationwide. The Company believes its Connecticut HMO and PPO operations make it the largest HMO managed care provider in terms of membership and size of provider network in the state of Connecticut. The Company's commercial HMO membership in Connecticut was 356,113 as of December 31, 1998 (including 48,415 members under The Guardian arrangement), an increase of approximately 5% since the end of 1997. The Company's Medicare risk membership in Connecticut was 44,627 as of December 31, 1998, which represented an increase of 70% during 1998, and the Company's Medicaid membership in Connecticut was 62,649 as of December 31, 1998, which represented an increase of 33% during 1998. The Company believes its New Jersey HMO and PPO operations make it the third largest HMO managed care provider in terms of membership and the largest in terms of size of provider network in the state of New Jersey. The Company's commercial HMO membership in New Jersey was 231,281 as of December 31, 1998 (including 77,260 members under The Guardian arrangement). The Company's Medicare risk membership in New Jersey was 2,695 as of December 31, 1998 and the Company's Medicaid membership in New Jersey was 22,171 as of December 31, 1998. In New York, the Company had 187,285 members as of December 31, 1998, which represented an increase of 25% during 1998. Such membership includes 88,164 members under The Guardian arrangement. The Company believes its New York HMO and PPO operations make it the fifth largest HMO managed care provider in terms of membership and the second largest in terms of size of provider network in the state of New York. MEDICARE RISK. The Company expanded its Medicare risk business in 1998 and, as of December 31, 1998, the Company's Medicare risk plans had a combined membership of approximately 322,171 compared to 309,333 as of December 31, 1997. 6 The Company offers its Medicare risk products directly to individuals and to employer groups. To enroll in a Company Medicare risk plan, covered persons must be eligible for Medicare. Health care services normally covered by Medicare are provided or arranged for by the Company, in conjunction with a broad range of preventive health care services. The federal Health Care Financing Administration ("HCFA") pays to the Company for each enrolled member a monthly fee based, in part, upon the "Adjusted Average Per Capita Cost," as determined by HCFA's analysis of fee-for-service costs related to beneficiary demographics. Depending on plan design and other factors, the Company may charge a member a premium or prepaid charge. The Company's California Medicare risk product, Seniority Plus, was licensed and certified to operate in 25 California counties as of December 31, 1998. The Company's other HMOs are licensed and certified to offer Medicare risk plans in 25 counties in Colorado, 10 counties in New Mexico, 6 counties in Washington, 9 counties in Pennsylvania, 34 counties in Oregon, 8 counties in Connecticut, 6 counties in Arizona, 3 counties in Florida, 21 counties in New Jersey and 11 counties in New York. MEDICAID PRODUCTS. As of December 31, 1998, the Company had an aggregate of approximately 585,500 Medicaid members, principally in California. To enroll in these Medicaid products, an individual must be eligible for Medicaid benefits under the appropriate state regulatory requirements. The respective HMOs offer, in addition to standard Medicaid coverage, certain additional services including dental and vision benefits. The applicable state agency pays the Company's HMOs a monthly fee for each Medicaid member enrolled on a percentage of fee-for-service costs. The Company has Medicaid members and operations in California, Connecticut, Florida, New Jersey, New York and Washington. ADMINISTRATIVE SERVICES ONLY BUSINESS. The Company also provides third-party administrative services to large employer groups throughout its service areas. Under these arrangements, the Company provides claims processing, customer service, medical management and other administrative services without assuming the risk for medical costs. The Company is generally compensated for these services on a fixed per member per month basis. INDEMNITY INSURANCE PRODUCTS. The Company offers indemnity products as "stand-alone" products and as part of multiple option products in various markets. These products are offered by the Company's six health and life insurance subsidiaries which are licensed to sell insurance in 33 states and the District of Columbia. Through these subsidiaries, the Company also offers HMO members certain auxiliary non-health products such as group life and accidental death and disability insurance. Although the Arizona Division oversees the Company's health and life insurance operations, such operations' products are provided throughout most of the Company's service areas. The following table contains certain information relating to such health and life insurance companies' insured PPO, point of service ("POS"), indemnity and group life products as of December 31, 1998 in each of the four Health Plan Divisions in which the Company operates:
ARIZONA CALIFORNIA CENTRAL NORTHEAST DIVISION DIVISION DIVISION DIVISION ----------- ----------- ----------- ----------- Insured PPO Members................................ 0 28,955 32,721 18,888 Point of Service Members........................... 0 96,209 30,899 214,199(a) Indemnity Members.................................. 9,142 9,213 1,039 0 Group Life Members................................. 3,364 34,923 23,594 0
- ------------------------ (a) Represents members under the Company's arrangement with The Guardian described elsewhere in this Annual Report on Form 10-K. 7 GOVERNMENT CONTRACTS DIVISION CHAMPUS. The Company's wholly-owned subsidiary, Foundation Health Federal Services, Inc. ("Federal Services"), administers large, multi-year managed care federal contracts for the United States Department of Defense ("DoD"). Federal Services currently administers health care contracts for DoD's TRICARE program covering 1.6 million eligible individuals under CHAMPUS. Through the federal government's TRICARE program, Federal Services provides CHAMPUS families with improved access to primary health care, lower out-of-pocket expenses and fewer claims forms. Federal Services currently administers three TRICARE contracts for five regions that cover the following states: - Region 11: Washington, Oregon and part of Idaho - Region 6: Texas, Arkansas, Oklahoma and part of Louisiana - Regions 9, 10 and 12: California, Hawaii, Alaska and part of Arizona During 1998, enrollment of CHAMPUS beneficiaries in the HMO option of the TRICARE program for the Region 11 contract increased by 16% to 131,782 while the total estimated number of eligible beneficiaries, based on DoD data, increased by 5% to 248,928. During 1998, enrollment of CHAMPUS beneficiaries in the HMO option of the TRICARE program for the Region 6 contract increased by 22% to 325,586 while the total estimated number of eligible beneficiaries, based on DoD data, decreased by 1% to 619,688. During 1998, enrollment of CHAMPUS beneficiaries in the HMO option of the TRICARE program for the Regions 9, 10 and 12 contract increased by 9% to 362,958 while the total estimated number of eligible beneficiaries, based on DoD data and excluding Alaska, decreased by 15% to 647,334 due to base realignments and closures. Under the TRICARE contracts, Federal Services shares health care cost risk with DoD for both gains and losses. Federal Services subcontracts to affiliated and unrelated third parties for the administration and health care risk of parts of these contracts. If all option periods are exercised by DoD and no extensions of the performance period are made, health care delivery ends on February 29, 2000 for the Region 11 contract, on October 31, 2000 for the Region 6 contract, and on March 31, 2001 for the Regions 9, 10 and 12 contract. The DoD Authorization Act for government fiscal year 1999 authorized DoD to extend the term of the current TRICARE contracts for two years. Federal Services and DoD are currently negotiating modifications to the contracts for Region 11 and Region 6 to add additional option periods which, if exercised, could extend the period of health care delivery to February 28, 2002 for the Region 11 contract and October 31, 2002 for the Region 6 contract. Federal Services expects to negotiate a similar extension to the Regions 9, 10 and 12 contract. Federal Services also expects to compete for the rebid of those contracts. Federal Services protested to the U.S. General Accounting Office (the "GAO") concerning the awards of TRICARE contracts for Region 1 (northeast states) and for Regions 2 and 5 (mid-Atlantic and midwest states) to competitors of Federal Services. The GAO sustained the protests and recommended that DoD conduct another round of competition for these contracts. DoD filed petitions for reconsideration of the protest decision by the GAO. The GAO denied DoD's petition for reconsideration of the Regions 2 and 5 decision and DoD will re-open competition for that contract on approximately April 1, 1999. Federal Services expects to compete for the rebid of the contract for Regions 2 and 5. Prior to the GAO deciding DoD's petition for reconsideration of the Region 1 protest decision, Federal Services entered into a litigation settlement agreement with DoD and the Region 1 contractor whereby Federal Services agreed not to seek the re-opening of competition for the Region 1 contract in exchange for certain financial considerations from both the Region 1 contractor and DoD. MEDICARE AND MEDICAID. During 1998, Federal Services administered contracts with the states of Massachusetts, New Jersey, Georgia and Maryland to enroll Medicaid eligible individuals in managed care 8 programs within those states. Federal Services is not at risk for the provision of any health care services under those contracts. Federal Services entered into an agreement with MAXIMUS, Inc., effective December 24, 1997, to sell the contracts for Massachusetts, New Jersey, Georgia, and Maryland. The contract with the state of Maryland expired on June 30, 1998. The contracts with New Jersey and Georgia have been novated to MAXIMUS, Inc., and novation of the contract with Massachusetts is pending. SPECIALTY SERVICES DIVISION The Company's Specialty Services Division offers behavioral health, dental, vision and pharmacy benefit management products and services as well as managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities. DENTAL AND VISION. Through DentiCare of California, Inc. ("DentiCare"), the Company operates a dental HMO in California and Hawaii and performs dental administrative services for an affiliate company in California and Colorado, serving in the aggregate approximately 575,000 enrollees as of December 31, 1998. This enrollment includes 143,000 enrollees who are beneficiaries under Medicaid dental programs, of which 42,000 enrollees are beneficiaries of Hawaii's Medicaid program, and 184,000 enrollees who are also enrollees of affiliated Health Plan companies. DentiCare is also a participant in California's Healthy Families Program, with initial beneficiary enrollment and service delivery commencing in July 1998. Acquired by the Company in 1991, DentiCare has grown from total revenues in 1992 of $24 million to $46 million for the year ended December 31, 1998. Operating on administrative and information system platforms in common with DentiCare is Foundation Health Vision Services, Inc., d.b.a. AVP Vision Services ("AVP"). AVP operates in California and Arizona and provides at-risk and administrative services under various programs that result in the delivery of vision benefits to over 636,000 enrollees. Total revenues from AVP operations for the year ended December 31, 1998 exceeded $11 million. Since its acquisition by the Company in 1992, AVP has grown from 30,000 covered enrollees to 374,000 enrollees in full-risk products and 262,000 enrollees covered under administrative services contracts as of December 31, 1998. Both DentiCare and AVP are licensed in California under the Knox-Keene Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"), as Specialized Health Care Service Plans and compete with other HMOs, traditional insurance companies, self-funded plans, PPOs and discounted fee-for-service plans. The two companies share a common strategy to maximize the value and quality of managed dental and vision care services while appropriately balancing financial risk assumption among providers, enrollees and other entities to achieve the effective and efficient use of available resources. BEHAVIORAL HEALTH. Effective July 1, 1998, the Company's behavioral health subsidiaries, Managed Health Network and Foundation Health Psychcare Services, Inc. (collectively, "MHN"), each licensed in California under the Knox-Keene Act as Specialized Health Care Service Plans, received regulatory approval of their merger. MHN, directly and through Specialty Services affiliates, offers behavioral health, substance abuse and employee assistance programs ("EAPs") on an insured and self-funded basis to employers, governmental entities and other payors in various states. MHN provides managed behavioral health programs to employers, governmental agencies and public entitlement programs, such as CHAMPUS and Medicaid. Employer group sizes range from Fortune 100 to mid-sized companies with 200 employees. MHN's strategy is to continue its market share achievement in the Fortune 500, health plan and CHAMPUS markets through a combination of direct and consultant/ broker sales. MHN intends to achieve additional market share by capitalizing on competitor consolidation, remaining CHAMPUS procurement opportunities and the growing state and county Medicaid behavioral carve-outs, funded on either a risk or administrative-services-only ("ASO") basis. These products and services were provided to over 8.8 million individuals in the year ended December 31, 1998, with approximately 3.6 million individuals under risk-based programs, approximately 9 1.5 million individuals under self-funded programs, and approximately 3.9 million individuals under EAP programs. WORKERS' COMPENSATION ADMINISTRATIVE SERVICES. The Company's subsidiaries organized under WC Division, Inc. provide a full range of managed care administrative services to insurers, self-funded employers, third-party claims administrators and public agencies. These services include automated bill review, telephonic claims reporting, automated utilization management, field and telephonic case management, and PPO network access and administration. The Company also offers ASO claims services as well as vocational rehabilitation and temporary employee placement and recruitment services. Certain of these operations were previously part of the Company's workers' compensation business, the risk-based operations of which the Company sold on December 10, 1998. See "Discontinued Operations and Anticipated Divestitures." WC Division, Inc. is in the process of changing its name to Employer & Occupational Services Group, Inc. PHARMACY BENEFIT MANAGEMENT. On February 26, 1999, the Company entered into a definitive agreement to sell to Advance Paradigm, Inc. ("Advance Paradigm") certain pharmacy benefit processing services, which it expects to complete on March 31, 1999. The Company's pharmacy benefit management business consists of claims processing, retail pharmacy network management, drug manufacturer rebate management, mail service pharmacy and payment of claims with respect to pharmacy benefits. As part of the sale, the Company and Advance Paradigm entered into a services agreement, whereby Advance Paradigm will provide to the Company's Health Plan Divisions at competitive rates the pharmacy management services being sold. See "Discontinued Operations and Anticipated Divestitures." PROVIDER RELATIONSHIPS AND RESPONSIBILITIES PHYSICIAN RELATIONSHIPS. Upon enrollment in most of the Company's HMO plans, each member selects a participating physician group ("PPG") or primary care physician from the HMO's provider panel. The primary care physicians and PPGs assume overall responsibility for the care of members. Medical care provided directly by such physicians includes the treatment of illnesses not requiring referral, as well as physical examinations, routine immunizations, maternity and child care, and other preventive health services. The primary care physicians and PPGs are responsible for making referrals (approved by the HMO's or PPG's medical director) to specialists and hospitals. Certain Company HMOs offer enrollees "open panels" under which members may access any physician in the network without first consulting a primary care physician. The following table sets forth the number of primary care and specialist physicians with whom the Company's HMOs (and certain of such HMOs' PPGs) contracted as of December 31, 1998 in each of the four Health Plan Divisions of the Company:
ARIZONA CALIFORNIA CENTRAL NORTHEAST DIVISION DIVISION DIVISION DIVISION ----------- ----------- ----------- ----------- Primary Care Physicians............................ 1,054 8,758 20,772 12,453 Specialist Physicians.............................. 2,708 49,472 29,419 27,152 Total.............................................. 3,762 58,230 50,191 39,605
PPG and physician contracts are generally for a period of at least one year and are automatically renewable unless terminated, with certain requirements for maintenance of good professional standing and compliance with the Company's quality, utilization and administrative procedures. In California and Arizona, PPGs generally receive a monthly "capitation" fee for every member served. The capitation fee represents payment in full for all medical and ancillary services specified in the provider agreements. The non-physician component of all hospital services is covered by a combination of capitation and/or per diem charges. In such capitated arrangements, in cases where the capitated provider cannot provide the health care services needed, such providers generally contract with specialists and other ancillary service providers 10 to furnish the requisite services pursuant to capitation agreements or negotiated fee schedules with specialists. Many of the Company's HMOs outside California and Arizona reimburse physicians according to a discounted fee-for-service schedule, although several HMOs have commenced capitation arrangements with certain providers and provider groups in their market areas. HOSPITAL RELATIONSHIPS. The Company's HMOs arrange for hospital care primarily through contracts with selected hospitals in their service areas. Such hospital contracts generally provide for multi-year terms and provide for payments on a variety of bases, including capitation, per diem rates, case rates, and discounted fee-for-service schedules. Covered inpatient hospital care for a member is comprehensive; it includes the services of physicians, nurses and other hospital personnel, room and board, intensive care, laboratory and x-ray services, diagnostic imaging, and generally all other services normally provided by acute-care hospitals. HMO or PPG nurses and medical directors are actively involved in discharge planning and case management, which often involves the coordination of community support services, including visiting nurses, physical therapy, durable medical equipment and home intravenous therapy. The Company owns and operates a 128-bed hospital located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a 200-bed hospital located in Gardena, California, the Memorial Hospital of Gardena. As noted below in the section of this Annual Report on Form 10-K entitled "Discontinued Operations and Anticipated Divestitures," the Company is reviewing the possibility of divesting its ownership of these hospitals. COST CONTAINMENT. In most HMO plan designs, the primary care physician or PPG is responsible for authorizing all needed medical care except for emergency medical services. By coordinating care through such physicians in cases where reimbursement includes risk-sharing arrangements, the Company believes that inappropriate use of medical resources is reduced and efficiencies are achieved. To limit possible abuse in utilization of hospital services in non-emergency situations, a certification process precedes the inpatient admission of each member, followed by continuing review during the member's hospital stay. In addition to reviewing the appropriateness of hospital admissions and continued hospital stay, the Company plays an active role in evaluating alternative means of providing care to members and encourages the use of outpatient care, when appropriate, to reduce the cost that would otherwise be associated with an inpatient admission. QUALITY ASSESSMENT. Quality assessment is a continuing priority for the Company. Most of the Company's HMOs have a quality assessment plan administered by a committee comprised of medical directors and primary care and specialist physicians. The committees' responsibilities include periodic review of medical records, development and implementation of standards of care based on current medical literature and community standards, and the collection of data relating to results of treatment. All of the Company's HMOs also have a subscriber grievance procedure and/or a member satisfaction program designed to respond promptly to member grievances. Aspects of such member service programs take place both within the PPGs and within the Company's HMOs. Set forth under the heading "National Committee for Quality Assurance" below is information regarding certain quality assessment accreditations received by the Company's subsidiaries. The Company's quality initiatives department also implements various programs to attempt to enhance access to quality health care and services for the Company's members. The mission of such department is to improve the health status and quality of life of the Company's members through the development and implementation of various programs including disease management programs, health assessment and member satisfaction surveys, data collection and tracking for the Health Plan Employer Data and Information Set ("HEDIS") initiative, and assistance with performance-based contracting with provider groups. 11 In December 1998, the Company sold the clinical content of its member support center services located in Philadelphia for approximately $36.3 million in net proceeds. The member support center is a telecommunications center staffed by nurses who respond to member calls through the retrieval of detailed clinical and demographic data regarding plan members and provider information and the use of clinical algorithms to guide members to the most appropriate level of care for their condition. As part of the sale, the Company's members who had access to the support center prior to the sale will continue to have access to similar services provided by the purchaser of the center for a period of up to ten years. See "Discontinued Operations and Anticipated Divestitures" below. MANAGEMENT INFORMATION SYSTEMS Effective information technology systems are critical to the Company's operation. The Company's information technology systems include several computer systems, each utilizing a combination of packaged and customized software and a network of on-line terminals. The information technology systems gather and store data on the Company's members and physician and hospital providers. The systems contain all of the Company's necessary membership and claims-processing capabilities as well as marketing and medical utilization programs. These systems provide the Company with an integrated and efficient system of billing, reporting, member services and claims processing, and the ability to examine member encounter information for the optimization of clinical outcomes. The Company also recognizes that the arrival of the Year 2000 poses a challenge to the ability of computer systems to recognize the date change from 1999 to 2000 (the "Year 2000 Issue") and is in the process of modifying its computer applications and business processes to provide for their continued functionality given the Year 2000 Issue. 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 (both external and internal) that have date/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 material miscalculations causing disruptions of operations, including, among other things, the inability to process transactions, prepare invoices or engage in normal business activities. The costs of the Company's Year 2000 Issue projects and the timetable in which the Company plans to complete the Year 2000 Issue compliance requirements are set forth under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1998 Annual Report to Stockholders attached as an exhibit to this Annual Report on Form 10-K and 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 be no assurance that these estimates will be achieved and actual results could differ materially from these plans and estimates. DISCONTINUED OPERATIONS AND ANTICIPATED DIVESTITURES RISK-BASED WORKERS' COMPENSATION OPERATIONS. In 1997, the Company revised its strategy of maintaining a presence in the workers' compensation insurance business as a result of various factors, including adverse developments arising in the workers' compensation insurance business, primarily related to the workers' compensation claims environment in California. In 1997 the Company adopted a plan to completely discontinue this segment of its business, through divestiture of its workers' compensation risk-assuming insurance subsidiaries. On December 10, 1998, the Company consummated the sale of Business Insurance Group, Inc. ("BIG"), its risk-based workers' compensation subsidiary. As part of the transaction, the Company funded the purchase of third party reinsurance to cover up to $175 million in adverse loss development related to BIG and its subsidiaries. The Company received approximately $200 million in cash for the sale, net of its costs and expenses for the transaction. Certain of the Company's subsidiaries entered into agreements with the buyer to continue to provide certain administrative services related to such operations for a period of five years. 12 LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On November 4, 1998, the Company entered into a definitive agreement for the sale of its HMO operations in the states of Texas, Louisiana and Oklahoma to AmCareco, Inc. As part of the transaction, the Company will receive convertible preferred stock of the buyer. The Company is pursuing a divestiture of these HMOs due to, among other reasons, inadequate returns on invested capital. Although the Company has entered into a definitive agreement for the foregoing sale, consummation of the sale is subject to numerous conditions and certain regulatory approvals. ALABAMA HMO OPERATIONS. In December 1997, the Company entered into a definitive agreement to sell its non-operational HMO license in Alabama to an unaffiliated third party, which sale was consummated in January 1998. PHARMACY BENEFITS MANAGEMENT SERVICES. In February 1999, the Company entered into a definitive agreement to sell to Advance Paradigm the capital stock of Foundation Health Pharmaceutical Services, Inc., and certain pharmacy benefit processing services of Integrated Pharmaceutical Services, Inc., for approximately $70 million in cash. In addition, the Company and Advance Paradigm entered into a services agreement, whereby Advance Paradigm will provide to the Company's Health Plan Divisions at competitive rates claims processing, retail network management, and payment of claims pharmacy benefits services. Advance Paradigm will also provide pharmacy mail service to the Health Plan Divisions. For a period of five years, the Company may not compete with respect to such services in any market in which Advance Paradigm conducts business, subject to certain exceptions. It is anticipated that the sale will be consummated on March 31, 1999. MEMBER SUPPORT CENTER OPERATIONS. During 1998, the Company operated a regional member support center located in Philadelphia. The support center was a telecommunications center staffed by nurses who responded to member calls through the retrieval of detailed clinical and demographic data regarding plan members and provider information, and the use of clinical algorithms to guide members to the most appropriate level of care for their condition. In December 1998, the Company sold the clinical content used in its member support center operations to Access Health, Inc. ("Access Health") for approximately $36.3 million in cash net proceeds. In addition, the Company entered into a long-term services agreement with Access Health pursuant to which all members who had access to the support center at the time of sale will continue to have such access for a period of ten years, with available annual extensions by the Company. In addition, as part of the transaction the Company agreed not to compete in such services for a period commencing on the closing date and ending two years after members cease to have access to the support center. SOUTHERN CALIFORNIA HOSPITALS. The Company is reviewing the possibility of divesting its 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. The Company is presently responding to inquiries of parties which have expressed an interest in the purchase of such businesses. GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company ("Gem"), a subsidiary of the Company, has implemented a restructuring plan to reduce operating losses and its in-force insurance risk. In 1997, Gem initiated a withdrawal from the Nevada insurance markets, and began restructuring its insurance products in Utah and then in certain other markets. Gem also reduced commissions to market-level rates and terminated certain general agents. Gem continued to implement such restructuring plan in 1998. As a result, the number of Gem's insureds dropped from over 100,000 at the start of 1998 to approximately 2,500 at December 31, 1998. Gem has filed notices of intention to withdraw from Nebraska and the small group market in Colorado. Currently, Foundation Health Systems Life and Health Insurance Company, a subsidiary of the Company, services Gem's insureds through an administrative services agreement between the companies. The Company is reviewing the possibility of winding up the operations 13 of Gem or merging such operations into another insurance subsidiary of the Company. Upon completion of its current withdrawals, Gem will be licensed in only five states. COLORADO OPERATIONS. In March 1999, the Company entered into a letter of intent to sell the capital stock of QualMed Plans for Health of Colorado, Inc., the Company's HMO subsidiary in the state of Colorado, to Wellpoint Health Networks Inc. The Company anticipates closing the sale in the first half of 1999. Although the Company has entered into a letter of intent for the foregoing sale, consummation of the sale is subject to execution of a definitive agreement mutually satisfactory to the parties and satisfaction of all conditions to be set forth therein, including obtaining certain regulatory approvals. In addition, the Company has decided to close its regional service center in Pueblo, Colorado in the first half of 1999. NEW MEXICO OPERATIONS. In March 1999, the Company also entered into a definitive agreement to sell the capital stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the state of New Mexico, to Health Care Horizons, Inc. Although the Company has entered into a definitive agreement for the foregoing sale, consummation of the sale is subject to numerous conditions and certain regulatory approvals. CERTAIN OTHER OPERATIONS. The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of such businesses or operations should be divested. ADDITIONAL INFORMATION CONCERNING THE COMPANY'S BUSINESS MARKETING AND SALES. Marketing for group Health Plan business is a two-step process in which the Company first markets to employer groups and then provides information directly to employees once the employer has selected a Company HMO. The Company typically uses its internal sales staff to serve the large employer groups while independent brokers work with the Company's internal sales staff to develop business with smaller employer groups. Once selected by an employer, the Company solicits enrollees from the employee base directly. In 1998, the Company marketed its programs and services primarily through its direct sales staff and independent brokers, agents and consultants. During "open enrollment" periods when employees are permitted to change health care programs, the Company uses direct mail, work day and health fair presentations, telemarketing, outdoor print, radio and television advertisements to attract new enrollees. The Company's sales efforts are supported by its marketing division which includes research and product development, corporate communications, public relations and marketing services. Premiums for each employer group are generally contracted for on a yearly basis, payable monthly. Numerous factors are considered by the Company in fixing its monthly premiums, including employer group needs and anticipated health-care utilization rates as forecasted by the Company's management based on the demographic composition of, and the Company's prior experience in, its service areas. Premiums are also affected by applicable regulations that prohibit experience rating of group accounts (i.e., setting the premium for the group based on its past use of health care services) and by state regulations governing the manner in which premiums are structured. The Company believes that the importance of the ultimate health care consumer (or member) in the health care product purchasing process is likely to increase in the future. Accordingly, the Company intends to focus its marketing strategies on the development of distinct brand identities and innovative product service offerings that will appeal to potential Health Plan members. COMPETITION. HMOs operate in a highly competitive environment in an industry currently subject to significant changes from business consolidations, new strategic alliances, legislative reform, and market pressures brought about by a better informed and better organized customer base. The Company's HMOs face substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded plans (including self-insured employers and union trust funds), Blue Cross/Blue Shield plans, and traditional indemnity 14 insurance carriers, some of which have substantially larger enrollments and greater financial resources than the Company. The Company believes that the principal competitive features affecting its ability to retain and increase membership include the range and prices of benefit plans offered, provider network, quality of service, responsiveness to user demands, financial stability, comprehensiveness of coverage, diversity of product offerings, and market presence and reputation. The relative importance of each of these features and key competitors vary by market. The Company believes that it competes effectively with respect to all of these factors. Kaiser Foundation Health Plan ("Kaiser") is the largest HMO in California and in the United States and is a competitor of the Company in the California HMO industry. In addition to Kaiser, the Company's other HMO competitors include PacifiCare of California, California Care (Blue Cross), Blue Shield, Aetna and CIGNA Healthplans of California, Inc. In addition, there are a number of other types of competitors including self-directed plans, traditional indemnity insurance plans, and other managed care plans. The Company also competes in California against a variety of PPOs. The establishment of PPOs has been encouraged by legislation in California that enables insurance companies to negotiate fees with health care providers and to extend economic incentives to insureds to utilize such providers without significant legal restrictions. But the California Department of Corporations (the "DOC"), which regulates all California HMOs, has interpreted California law to prohibit California PPOs that lack an HMO license from compensating providers on a capitated or other prepaid or periodic basis unless those providers themselves have an HMO license. Thus, only HMOs may legally enter into such financial arrangements with providers, while PPOs are limited to fee-for-service arrangements. The Company's Colorado HMO competes primarily against other HMOs including Kaiser, United Healthcare, and PacifiCare of Colorado, as well as with a Blue Cross/Blue Shield HMO, other commercial carriers, and various hospital or physician-owned HMOs. The Company's largest competitor in New Mexico is Presbyterian Health Plan. The Company's New Mexico HMO also competes with Lovelace Health Plan (an HMO owned by CIGNA Corporation) and Blue Cross/Blue Shield. The Company's largest competitor in Arizona is Health Partners. The Company's Arizona HMO also competes with CIGNA, PacifiCare, Aetna, and Blue Cross/Blue Shield. In Utah, the Company competes with Intermountain Health Plan and PacifiCare, among other companies. The Company's Oregon HMO competes primarily against other HMOs including Kaiser, PacifiCare of Oregon, The Good Health Plan, Blue Cross Lifewise and Blue Shield Regions, and with various PPOs. The Company's Washington HMO competes primarily with Group Health Cooperative of Puget Sound, Kaiser, HealthPlus (Blue Cross), and with commercial carriers, self-funded plans, and other Blue Cross/ Blue Shield organizations. The Company's HMOs in Connecticut compete for business with commercial insurance carriers, Blue Cross and Blue Shield of Connecticut, Aetna/U.S. Healthcare, and more than ten other HMOs. The Company's main competitors in Pennsylvania, New York, and New Jersey are Aetna/U.S. Healthcare, Independence Blue Cross, Empire Blue Cross, Oxford Health Plans, AmeriHealth, and Keystone East. The Company's HMO operations in Florida compete for business with Humana Medical Plan, United HealthCare, Health Options, and Prudential HealthCare, among others. GOVERNMENT REGULATION. The Company believes it is in compliance in all material respects with all current state and federal regulatory requirements applicable to the business to be conducted by its subsidiaries. Certain of these requirements are discussed below. FEDERAL HMO STATUTES. Under the Federal Health Maintenance Organization Act of 1973 (the "HMO Act"), services to members must be provided substantially on a fixed, prepaid basis without regard to the actual degree of utilization of services. Although premiums established by an HMO may vary from account to account through composite rate factors and special treatment of certain broad classes of members, traditional experience rating of accounts (i.e., retrospective adjustments for a group account 15 based on that group's past use of health care services) is not permitted under the HMO Act; prospective rating adjustments are, however, allowed. Several of the Company's HMOs are federally qualified in certain parts of their respective service areas under the HMO Act and are therefore subject to the requirements of such act to the extent federally qualified products are offered and sold. Additionally, there are a number of proposed federal laws currently before Congress to further regulate managed health care. The Company cannot predict the ultimate fate of any of these legislative proposals. The Company's Medicare risk contracts are subject to regulation by HCFA. HCFA has the right to audit HMOs operating under Medicare contracts to determine the quality of care being rendered and the degree of compliance with HCFA's contracts and regulations. The Company's Medicaid business is also subject to regulation by HCFA, as well as state agencies. CALIFORNIA HMO REGULATIONS. California HMOs such as Health Net and certain of the Company's specialty plans are subject to state regulation, principally by the DOC under the Knox-Keene Act. Among the areas regulated by the Knox-Keene Act are: (i) adequacy of administrative operations, (ii) the scope of benefits required to be made available to members, (iii) manner in which premiums are structured, (iv) procedures for review of quality assurance, (v) enrollment requirements, (vi) composition of policy making bodies to assure that plan members have access to representation, (vii) procedures for resolving grievances, (viii) the interrelationship between HMOs and their health care providers, (ix) adequacy and accessibility of the network of health care providers, (x) provider contracts, and (xi) initial and continuing financial viability. Any material modifications to the organization or operations of Health Net are subject to prior review and approval by the DOC. This approval process can be lengthy and there is no certainty of approval. Other significant changes require filing with the DOC, which may then comment and require changes. In addition, under the Knox-Keene Act, Health Net and certain other Company subsidiaries must file periodic reports with, and are subject to periodic review by, the DOC. The DOC has also required the Company and its Knox-Keene licensed subsidiaries to provide the DOC with a number of undertakings in connection with the FHS Combination and the merger of the Company's two California, full-service HMOs. These undertakings obligate the affected companies to certain requirements not applicable to licensees generally, or prohibit or require regulatory approval preceding the institution of certain changes. While the Company has been permitted to withdraw a number of these undertakings, others remain in effect and constrain the Company's flexibility of operations. The Company does not believe, however, that the remaining undertakings have a material adverse effect on the Company and its licensees taken as a whole. Currently, the California legislature is considering a number of significant managed health care measures which could materially alter California's regulatory environment. Among such measures are proposals to establish an entirely new regulatory structure for managed care, in lieu of the DOC. Other legislative proposals focus on medical care dispute resolution mechanisms, medical malpractice liability, and mandated benefits, such as mental health coverage. The Company cannot predict the ultimate fate of any of these legislative proposals in California. OTHER HMO REGULATIONS. In each state in which the Company does business, HMOs must file periodic reports with, and their operations are subject to periodic examination by, state licensing authorities. In addition, each HMO must meet numerous state licensing criteria and secure the approval of state licensing authorities before implementing certain operational changes, including the development of new product offerings and, in some states, the expansion of service areas. To remain licensed, each HMO must continue to comply with state laws and regulations and may from time to time be required to change services, procedures or other aspects of its operations to comply with changes in applicable laws and regulations. HMOs are required by state law to meet certain minimum capital and deposit and/or reserve requirements in each state and may be restricted from paying dividends to their parent corporations under certain circumstances from time to time. Several states have increased minimum capital requirements, pursuant to proposals by the National Association of Insurance Commissioners to institute risk-based 16 capital requirements. Regulations in these and other states may be changed in the future to further increase equity requirements. Such increases could require the Company to contribute additional capital to its HMOs. Any adverse change in governmental regulation or in the regulatory climate in any state could materially impact the HMOs operating in that state. The HMO Act and state laws place various restrictions on the ability of HMOs to price their products freely. The Company must comply with certain provisions of certain state insurance and similar laws, especially as it seeks ownership interests in new HMOs, PPOs and insurance companies, or otherwise expands its geographic markets or diversifies its product lines. INSURANCE REGULATIONS. State departments of insurance (the "DOIs") regulate insurance and third-party administrator business conducted by certain subsidiaries of the Company (the "Insurance Subsidiaries") pursuant to various provisions of state insurance codes and regulations promulgated thereunder. The Insurance Subsidiaries are subject to various capital reserve and other financial requirements established by the DOIs. The Insurance Subsidiaries must also file periodic reports regarding their activities regulated by the DOIs and are subject to periodic reviews of those activities by the DOIs. The Company must also obtain approval from, or file copies with, the DOIs for all of its group and individual policies prior to issuing those policies. The Company does not believe that the requirements imposed by the DOIs will have a material impact on the ability of the Insurance Subsidiaries to conduct their business profitably. NATIONAL COMMITTEE FOR QUALITY ASSURANCE ("NCQA"). NCQA is an independent, non-profit organization that reviews and accredits HMOs and assesses an HMO's quality improvement, utilization management, credentialing process, commitment to members' rights, and preventive health services. HMOs that comply with NCQA's review requirements and quality standards receive NCQA accreditation. After an NCQA review is completed, NCQA will issue one of four designations. These are (i) accreditation for three years; (ii) accreditation for one year; (iii) provisional accreditation for twelve to eighteen months to correct certain problems with a follow-up review to determine qualification for accreditation; and (iv) not accredited. Foundation Health, A Florida Health Plan, Inc.; Health Net, the Company's HMO in California; Intergroup Prepaid Health Services of Arizona, Inc., the Company's HMO in Arizona; and QualMed Washington Health Plan, Inc. (Spokane region), have all received NCQA accreditations for three years. QualMed Plans for Health, Inc. (Pennsylvania), QualMed Plans for Health of Colorado, Inc. and QualMed Washington Health Plan, Inc. (Seattle region) have all received one year accreditation from NCQA. Certain of the Company's other Health Plan subsidiaries are in the process of applying for NCQA accreditation. SERVICE MARKS The Company's service marks and/or trademarks include, among others: THE ACUTE CARE ALTERNATIVE-Registered Trademark-, Alliance 2000(sm) Alliance 1000(sm), Asthmawise(sm), AVP(sm), AVP Vision Plans(sm), BabyWell(sm), BEING WELL-Registered Trademark-, CARECAID-Registered Trademark-, CMP-Registered Trademark-, COMBINED CARE-Registered Trademark-, COMBINED CARE PLUS(sm), COMMUNITY MEDICAL PLAN, INC. and design-Registered Trademark-, A CURE FOR THE COMMON HMO-Registered Trademark-, Feetbeat Worksite Walking Program(sm), FIRM SOLUTIONS-Registered Trademark-, FLEX ADVANTAGE-Registered Trademark-, FLEX NET(sm), FOUNDATION HEALTH and design-Registered Trademark-, FOUNDATION HEALTH GOLD-Registered Trademark-, Foundation Health Systems(sm), GOOD HEALTH IS JUST AROUND THE CORNER-Registered Trademark-, HANK-Registered Trademark-, HANK and design-Registered Trademark-, HEALTH NET-Registered Trademark-, Health Net ACCESS(sm), Health Net Comp.24(sm), Health Net ELECT(sm), Health Net INSIGHT(sm), Health Net OPTIONS(sm), Health Net SELECT(sm), Health Net Seniority Plus(sm), Health Smart and design(sm), Healthworks (stylized)(sm), Heart & Soul(sm), IMET and design-Registered Trademark-, Indian design-Registered Trademark-, INDIVIDUAL PREFERRED PPO-Registered Trademark-, InterCare(sm), InterComp(sm), InterFlex(sm), Inter Mountain Employers Trust(sm), InterPlus(sm), LIFE WITH DIGNITY AND HOPE-Registered Trademark-, MAKING QUALITY HEALTH CARE AFFORDABLE-Registered Trademark-, M.D. Health Plan Personal Medical Management(sm), On the Road to Good Health(sm), PHYSICIANS HEALTH SERVICES-Registered Trademark-, Premier Medical Network(sm), Premier Medical Network It's Your Choice(sm), QUALASSIST-Registered Trademark-, QUALADMIT-Registered Trademark-, QUALCARE-Registered Trademark-, QUALCARE PREFERRED-Registered Trademark-, QUAL-MED-Registered Trademark-, QUALMED(sm), QUALMED HEALTH & LIFE INSURANCE COMPANY-Registered Trademark-, QUALMED PLANS FOR HEALTH-Registered Trademark-, Rapid Access(sm), SENIOR SECURITY-Registered Trademark-, SENIOR VALUE-Registered Trademark-, Someone at Your Side(sm), Sun/Mountain design-Registered Trademark-,The Final Piece 17 of the Healthcare Puzzle(sm), VitalLine(sm), VITALTEAM-Registered Trademark-, WELL MANAGED CARE RIGHT FROM THE START-Registered Trademark-, WELL REWARDS-Registered Trademark-, Well Woman(sm), Wise Choice(sm), WORKING WELL TOGETHER-Registered Trademark-, and Your Partner in Healthy Living(sm), and certain designs related to the foregoing. The Company utilizes these and other marks in connection with the marketing and identification of products and services. The Company believes such marks are valuable and material to its marketing efforts. EMPLOYEES The Company currently employs approximately 14,000 employees, excluding temporary employees. Such employees perform a variety of functions, including administrative services for employers, providers, and members, negotiation of agreements with physician groups, hospitals, pharmacies, and other health care providers, handling claims for payment of hospital and other services, and providing data processing services. The Company's employees are not unionized and the Company has not experienced any work stoppage since its organization. The Company considers its relations with its employees to be very good. In connection with the FHS Combination, the Company adopted a significant restructuring plan which provides for a workforce reduction, the consolidation of employee benefit plans and the consolidation of certain office locations, which the Company has been effectuating. ITEM 2. PROPERTIES The Company owns certain of its offices in Pueblo, Colorado and leases office space for its principal executive offices in Woodland Hills and its offices in Rancho Cordova, California. The Woodland Hills facility, with approximately 410,000 square feet, is leased pursuant to two leases, the earliest of which expires in December 2001 with respect to 300,000 square feet. The aggregate rent for the two leases for 1998 totaled approximately $11.7 million. The Company's principal executive offices are located in the Woodland Hills facility, and such facility contains much of the Company's California HMO operations. The Company and its subsidiaries also lease an aggregate of approximately 515,000 square feet of office space in Rancho Cordova, California. The Company's aggregate rent obligations under these leases were approximately $7.2 million in 1998. These leases expire at various dates through July 2002. The Rancho Cordova facilities serve as a regional data processing center. The Pueblo facility consists of approximately 311,000 square feet of office space. The facility is subject to a mortgage in the aggregate principal amount of approximately $280,000 as of December 31, 1998. The Pueblo facility includes three properties which the Company renovated in 1998. The Company has received public funds for certain of such properties' renovation from the City and County of Pueblo in return for certain employment commitments. In addition, the Company leases approximately 34,000 square feet of office space in Pueblo pursuant to three leases, the earliest of which expires in August 1999, at an aggregate rent of approximately $330,000 per year. As set forth elsewhere in this Annual Report on Form 10-K the Company has decided to close its regional services center in Pueblo in the first half of 1999. In addition to the Company's office space in Pueblo, Woodland Hills and Rancho Cordova, the Company and its subsidiaries lease approximately 165 sites in 26 states, comprising roughly 1.7 million square feet of space. The Company owns in total approximately 1.6 million square feet of space. The Company owns approximately 375,000 aggregate square feet of space for health care centers in California and Arizona and approximately 250,000 square feet of space for two hospitals in Southern California. The Company also owns approximately one dozen office buildings located in Arizona, California, Colorado and Connecticut, which collectively encompass approximately 960,000 square feet of space. 18 Management believes that its ownership and rental costs are consistent with those available for similar space in the applicable local area. The Company's properties are well maintained, considered adequate and are being utilized for their intended purposes. The Company is currently considering the sale of certain care centers and unimproved real estate owned by the Company, and the sale and leaseback of certain of its occupied facilities in Arizona, California and Connecticut. ITEM 3. 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 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. 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 appealed such decision. In addition, the trial court granted a stay of the case in order to permit the law firm to appeal. On November 30, 1998, the Appellate Court affirmed the trial court's decision. New counsel has been substituted in as counsel for certain of the individual defendants. The court ordered stay has been lifted and, therefore, discovery is now permitted to resume. The case is in the early stages of discovery. 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 19 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. Gem planned to appeal the verdict, but the parties agreed to settle the matter in May 1998 and avoid the uncertainties and cost of an appeal. In addition, on July 15, 1997 Gem filed a complaint against Mr. Davis and his spouse in Maricopa County (Arizona) Superior Court (Case No. CV97-13053) asserting a claim for indemnity against Mr. Davis with respect to the Monacelli case. Gem agreed to settle its claims against Mr. and Mrs. Davis in December 1998. 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 into debentures and options to purchase common stock of FPA Medical Management, Inc. ("FPA") at various times between February 3, 1997 and May 15, 1998. The FPA Complaints name as defendants FPA, certain of FPA's auditors, the Company and certain of the Company's former officers. The FPA Complaints allege that the Company and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between the Company and FPA, about FPA's business and about the Company's 1997 sale of FPA common stock held by the Company. The Company has filed a motion to dismiss all claims asserted against it in the consolidated federal class actions but has not formally responded to the other complaints. Management believes these suits against the Company and its former officers are without merit and intends to defend the actions vigorously. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the security holders of the Company, either through solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 1998. 20 OTHER INFORMATION REVOLVING CREDIT FACILITY The Company has an unsecured, five-year $1.5 billion revolving credit facility pursuant to a Credit Agreement dated July 8, 1997 (the "Credit Agreement") with the banks identified in the Credit Agreement (the "Banks") and Bank of America National Trust and Savings Association ("Bank of America") as Administrative Agent. All previous revolving credit facilities were terminated and rolled into the Credit Agreement. The Credit Agreement contains customary representations and warranties, affirmative and negative covenants, and events of default. Specifically, Section 7.11 of the Credit Agreement provides that the Company and its subsidiaries may, so long as no event of default exists: (i) declare and distribute stock as a dividend; (ii) purchase, redeem, or acquire its stock, options, and warrants with the proceeds of concurrent public offerings; and (iii) declare and pay dividends or purchase, redeem, or otherwise acquire its capital stock, warrants, options, or similar rights with cash subject to certain specified limitations. Under the Credit Agreement, as amended pursuant to the First Amendment and Waiver to Credit Agreement dated as of April 6, 1998, the Second Amendment to Credit Agreement dated as of July 31, 1998, the Third Amendment to Credit Agreement dated as of November 6, 1998 and the Fourth Amendment to Credit Agreement dated March 26, 1999 (collectively, the "Amendments") with the Banks, the Company is: (i) obligated to maintain certain covenants keyed to the Company's financial condition and performance (including a Total Leverage Ratio and Fixed Charge Ratio); (ii) obligated to limit liens; (iii) subject to customary covenants, including (A) disposition of assets only in the ordinary course and generally at fair value and (B) restrictions on acquisitions, mergers, consolidations, loans, leases, joint ventures, contingent obligations, and certain 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 (which sale the Company completed on December 10, 1998); 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 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. 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% or more of the Class A Common Stock (each event causing a "Distribution Date"). Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder, upon the occurrence of a Distribution Date, to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, at a price of $170.00 per 21 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 per share. 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 became effective upon consummation of the transactions provided for under the Merger Agreement. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement. 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 California Wellness Foundation (the "CWF"), and certain stockholders (the "HNMH Stockholders") of HN Management Holdings, Inc. (a predecessor to the Company) ("HNMH") named therein, the CWF was subject to various volume and manner of sale restrictions specified in the CWF Shareholder Agreement which limited the number of shares of Class B Common Stock that the CWF could dispose of prior to December 31, 1998. The CWF and the Company are also party to a Registration Rights Agreement dated as of March 2, 1995 (the "CWF Registration Rights Agreement") pursuant to which the CWF has the right to demand registration for sale in underwritten public offerings of up to 8,026,298 shares of Class B Common Stock. Under the relevant provisions of California law, when a corporation converts from nonprofit to for-profit corporate status, the equivalent of the fair market value of the nonprofit corporation must be contributed to a successor charity that has a charitable purpose consistent with the purposes of the nonprofit entity. The CWF was formed to be the charitable recipient of the conversion settlement when Health Net (a subsidiary of the Company) effected a conversion from nonprofit to for-profit status, which occurred in February 1992 (the "Conversion"). In connection with the Conversion, Health Net issued to the CWF promissory notes in the original principal amount of $225 million (the "CWF Notes") and shares of Class B Common Stock (which immediately prior to the business combination involving HNMH and QualMed, Inc. were split to become 25,684,152 shares of Class B Common Stock then held by the CWF). While such shares are held by the CWF, they are entitled to the same economic benefit as Class A Common Stock, but are non-voting in nature. If the CWF sells or transfers such shares to an unrelated third party, they automatically convert to Class A Common Stock. Pursuant to certain agreements with the CWF, the Company redeemed 4,550,000 shares of Class B Common Stock from the CWF on June 27, 1997. The CWF has also sold shares of Class B Common Stock to unrelated third parties, which shares of common stock automatically converted into shares of Class A Common Stock at the time of such sales. 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 22 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 the 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 and CWF Notes in the principal amount of approximately $17,646,000. CAUTIONARY STATEMENTS In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company is hereby filing cautionary statements identifying important risk factors that could cause the Company's actual results to differ materially from those projected in forward-looking statements of the Company made by or on behalf of the Company. The Company wishes to caution readers that these factors, among others, could cause the Company's actual financial or enrollment results to differ materially from those expressed in any projected, estimated, or forward-looking statements relating to the Company. The following factors should be considered in conjunction with any discussion of operations or results by the Company or its representatives, including any forward-looking discussion, as well as comments contained in press releases, presentations to securities analysts or investors, or other communications by the Company. In making these statements, the Company is not undertaking to address or update each factor in future filings or communications regarding the Company's business or results, and is not undertaking to address how any of these factors may have caused changes to discussions or information contained in previous filings or communications. In addition, certain of these matters may have affected the Company's past results and may affect future results. HEALTH CARE COSTS. A large portion of the revenue received by the Company is expended to pay the costs of health care services or supplies delivered to its members. The total health care costs incurred by the Company are affected by the number of individual services rendered and the cost of each service. Much of the Company's premium revenue is set in advance of the actual delivery of services and the related incurring of the cost, usually on a prospective annual basis. While the Company attempts to base the premiums it charges at least in part on its estimate of expected health care costs over the fixed premium period, competition, regulations, and other circumstances may limit the Company's ability to fully base premiums on estimated costs. In addition, many factors may and often do cause actual health care costs to exceed those costs estimated and reflected in premiums. These factors may include increased utilization of services, increased cost of individual services, catastrophes, epidemics, seasonality, new mandated benefits or other regulatory changes, and insured population characteristics. The managed health care industry is labor intensive and its profit margin is low. Hence, it is especially sensitive to inflation. Health care industry costs have been rising annually at rates higher than the Consumer Price Index. Increases in medical expenses without corresponding increases in premiums could have a material adverse effect on the Company. PHARMACEUTICAL COSTS. The costs of pharmaceutical products and services are increasing faster than the costs of other medical products and services. Thus, the Company's HMOs face ever higher pharmaceutical expenses. The inability to manage pharmaceutical costs could have an adverse effect on the Company's financial condition. 23 MEDICAL MANAGEMENT. The Company's profitability is dependent, to a large extent, upon its ability to accurately project and manage health care costs, including without limitation, appropriate benefit design, utilization review and case management programs, and its risk sharing arrangements with providers, while providing members with quality health care. For example, high out-of-network utilization of health care providers and services may have significant adverse affects on the Company's ability to manage health care costs and member utilization of health care. There can be no assurance that the Company through its medical management programs will be able to continue to manage medical costs sufficiently to restore and/or maintain profitability in all of its product lines. MARKETING. The Company markets its products and services through both employed sales people and independent sales agents. Although the Company has a number of such sales employees and agents, if certain key sales employees or agents or a large subset of such individuals were to leave the Company, its ability to retain existing customers and members could be impaired. In addition, certain of the Company's customers or potential customers consider rating, accreditation, or certification of the Company by various private or governmental bodies or rating agencies necessary or important. Certain of the Company's health plans or other business units may not have obtained or may not desire or be able to obtain or maintain such accreditation or certification which could adversely affect the Company's ability to obtain or retain business with such customers. The managed health care industry has recently received a significant amount of negative publicity. Such general publicity, or any negative publicity regarding the Company in particular, could adversely affect the Company's ability to sell its products or services or could create regulatory problems for the Company. Furthermore, the managed care industry recently has experienced significant merger and acquisition activity. Speculation or uncertainty about the Company's future could adversely affect the ability of the Company to market its products. COMPETITION. The Company competes with a number of other entities in the geographic and product markets in which it operates, some of which other entities may have certain characteristics or capabilities which give them an advantage in competing with the Company. These competitors include HMOs, PPOs, self-funded employers, insurance companies, hospitals, health care facilities, and other health care providers. The Company believes there are few barriers to entry in these markets, so that the addition of new competitors can readily occur. Certain of the Company's customers may decide to perform for themselves functions or services currently provided by the Company, which could result in a decrease in the Company's revenues. Certain of the Company's providers may decide to market products and services to Company customers in competition with the Company. In addition, significant merger and acquisition activity has occurred in the industry in which the Company operates as well as in industries which act as suppliers to the Company such as the hospital, physician, pharmaceutical, and medical device industries. This activity may create stronger competitors and/or result in higher health care costs. Provider service organizations may be created by health care providers to offer competing managed care products. To the extent that there is strong competition or that competition intensifies in any market, the Company's ability to retain or increase customers, its revenue growth, its pricing flexibility, its control over medical cost trends, and its marketing expenses may all be adversely affected. PROVIDER RELATIONS. One of the significant techniques the Company uses to manage health care costs and utilization and to monitor the quality of care being delivered is to contract with physicians, hospitals, and other providers. Because of the large number of providers with which the Company's health plans contract, the Company currently believes it has a limited exposure to provider relations issues. In any particular market, however, providers could refuse to contract with the Company, demand higher payments or take other actions which could result in higher health care costs, less desirable products for customers and members, insufficient provider access for current members or to support growth, or difficulty in meeting regulatory or accreditation requirements. 24 In some markets, certain providers, particularly hospitals, physician/hospital organizations or multi-specialty physician groups, may have significant market positions or even monopolies. Many of these providers may compete directly with the Company. If such providers refuse to contract with the Company or utilize their market position to negotiate favorable contracts or place the Company at a competitive disadvantage, the Company's ability to market products, or to be profitable in those areas could be adversely affected. The Company contracts with providers in California and Arizona, and to a lesser degree in other areas, primarily through capitation fee arrangements. Under a capitation fee arrangement, the Company pays the provider a fixed amount per member on a regular basis and the provider accepts the risk of the frequency and cost of member utilization of services. Providers who enter into such arrangements generally contract with specialists and other secondary providers to provide services not offered by the primary provider. The inability of providers to properly manage costs under capitation arrangements can result in financial instability of such providers and the termination of their relationship with the Company. In addition, payment or other disputes between the primary provider and specialists with whom it contracts can result in a disruption in the provision of services to the Company's members or a reduction in the services available. A primary provider's financial instability or failure to pay secondary providers for services rendered could lead secondary providers to demand payment from the Company, even though the Company has made its regular capitated payments to the primary provider. There can be no assurance that providers with whom the Company contracts will properly manage the costs of services, maintain financial solvency or avoid disputes with secondary providers, the failure of any of which could have an adverse effect on the provision of services to members and the Company's operations. ADMINISTRATION AND MANAGEMENT. The level of administrative expense is a partial determinant of the Company's profitability. While the Company attempts to effectively manage such expenses, increases in staff-related and other administrative expenses may occur from time to time due to business or product start-ups or expansions, growth or changes in business, acquisition, regulatory requirements, or other reasons. Such expense increases are not clearly predictable and increases in administrative expenses may adversely affect results. The Company currently believes it has a relatively experienced, capable management staff. Loss of certain managers or a number of such managers could adversely affect the Company's ability to administer and manage its business. FEDERAL AND STATE LEGISLATION. There are numerous legislative proposals currently before Congress and the state legislatures which, if enacted, could materially affect the managed health care industry and the regulatory environment. Recent financial troubles of certain health care service providers could alter or increase legislative consideration of these or additional proposals. The Company cannot predict the outcome of any of these legislative proposals, nor the extent to which the Company may be affected by the enactment of any such legislation. Legislation which causes the Company to change its current manner of operation could have a material adverse effect on the Company's results of operations and ability to compete. RESTRUCTURING COSTS. During 1998, the Company initiated the consolidation and centralization of its corporate functions and continued its workforce reduction in selected health plans. In addition, the Company initiated a formal plan to dispose of certain Central Division health plans included in the Company's Health Plan Services segment during the fourth quarter of 1998. It is anticipated that the divestiture of these plans will be completed during the first half of 1999. The Company evaluated the carrying values of the assets of these health plans and determined that the carrying value exceeded estimated fair values. The Company had previously recorded charges in the second and third quarters of 1998 related to management's best estimate of recovery for the real estate and the impairment of notes receivable and other Company assets due to the bankruptcy filing of FPA in July 1998. 25 During the second and third quarters of 1998, the Company recorded $78.1 million related to FPA's bankruptcy and $146.9 million of restructuring and other charges. These charges were primarily related to severance costs of $21.2 million related to staff reduction in selected health plans and corporate centralization and consolidation; other special charges totaling $38.7 million related to the adjustment of amounts due from a hospital system that filed bankruptcy totaling $18.6 million, premium deficiency reserves for certain of the Company's non-core health plans totaling $12.0 million, and $8.1 million related to other items. Other charges totaling $87.0 million were mostly related to contractual adjustments and were primarily included in health care costs within the consolidated statement of operations. As of December 31, 1998, approximately $27.5 million is expected to require future outlays of cash. As a direct consequence of the Company's evaluation of the estimated fair value of its anticipated divestitures and other items, the Company recorded asset impairment and other charges amounting to $185.9 million in the fourth quarter of 1998. Of this amount, approximately $112.4 million related to the carrying value of health plans anticipated to be divested; approximately $54.9 million primarily related to bad debts, claims and premium deficiency reserves; and approximately $18.6 million primarily related to litigation in the normal course of business. Of the charges in the fourth quarter, approximately $6 million resulted in cash outlays. The Company anticipates future cash outlays from the charges of approximately $50.1 million. The cash generated from the divestitures, however, is expected to exceed the cash impact of all such charges in both 1998 and 1999 combined. Although the Company continually seeks to integrate new operations and restructure existing operations efficiently, unforeseen difficulties could delay or substantially impede any one or more of the Company's restructuring efforts causing a material adverse effect on the Company's future profitability. There can be no assurance that the anticipated divestitures which are essential to the restructuring will be consummated. MANAGEMENT INFORMATION SYSTEMS. The Company's business is significantly dependent on effective information systems. The information gathered and processed by the Company's management information systems assists the Company in, among other things, pricing its services, monitoring utilization and other cost factors, processing provider claims, billing its customers on a timely basis, and identifying accounts for collection. The Company's customers and providers also depend upon the Company's information systems for membership verification, claims status, and other information. The Company has many different information systems for its various businesses. Moreover, the merger, acquisition and divestiture activity of the Company requires frequent transitions to or from, and the integration of, various information management systems. The Company is in the process of attempting to reduce the number of systems and also to upgrade and expand its information systems capabilities. Any difficulty associated with or failure to successfully implement such updated management information systems, or any inability to expand processing capability in the future in accordance with its business needs, could result in a loss of existing customers and difficulty in attracting new customers, customer and provider disputes, regulatory problems, increases in administrative expenses, or other adverse consequences. In addition, the Company may, from time-to-time, obtain significant portions of its systems-related or other services or facilities from independent third parties which may make the Company's operations vulnerable to such third parties' failure to perform adequately. The Company also recognizes that the arrival of the Year 2000 poses a unique worldwide challenge to the ability of virtually all computer systems to recognize the date change from 1999 to 2000 and has substantially completed its assessment of the Year 2000 Issue and is in the process of implementing remedial measures. 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 (both external and internal) that have date/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 material miscalculations causing disruptions of operations, including, among other things, the inability to process transactions, prepare invoices, or engage in normal business activities. 26 There can be no assurance that the systems of the Company or of other companies on which the Company's systems rely will be timely converted and/or modified, and such failure could have a material adverse effect on the Company and its operations. The costs of the Company's Year 2000 Issue projects and the timetable in which the Company plans to complete the Year 2000 Issue compliance requirements set forth under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1998 Annual Report to Stockholders attached as an exhibit to this Annual Report on Form 10-K 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 be no assurance that these estimates will be achieved and actual results could differ materially from these plans and estimates. The Company is also assessing the extent to which, if at all, the Company's existing insurance policies cover these potential Year 2000 Issue liabilities. MANAGEMENT OF GROWTH. The Company has made several large acquisitions in recent years, and continues to explore acquisition opportunities. Failure to effectively integrate acquired operations could result in increased administrative costs or customer confusion or dissatisfaction. The Company may also not be able to manage this growth effectively, including not being able to continue to develop processes and systems to support its growing operations. There can be no assurance that the Company will be able to maintain its historical growth rate. POTENTIAL DIVESTITURES. The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of its businesses or operations should be divested. In this regard the Company (i) has entered into definitive agreements to sell its HMOs in the states of New Mexico, Texas, Louisiana and Oklahoma, (ii) has entered into a letter of intent to sell its HMO operations in the state of Colorado, (iii) is considering divestiture of its ownership of two southern California hospitals, (iv) has entered into a definitive agreement to sell certain pharmacy benefit processing services, which sale is anticipated to be consummated on March 31, 1999 and (v) is reviewing the possibility of divesting its ownership of certain non-core operations. There can be no assurance that the Company will complete any of these transactions. Further, entering into, evaluating or consummating these transactions may entail certain risks and uncertainties in addition to those which may result from any such change in the Company's business operations, including but not limited to extraordinary transaction costs, unknown indemnification liabilities or unforeseen administrative needs, any of which could result in reduced revenues, increased charges, post transaction administrative costs or could otherwise have a material adverse effect on the Company's business, financial condition or results of operations. See "Item 1. Business--Discontinued Operations and Anticipated Divestitures." GOVERNMENT PROGRAMS AND REGULATION. The Company's business is subject to extensive federal and state laws and regulations, including, but not limited to, financial requirements, licensing requirements, enrollment requirements, and periodic examinations by governmental agencies. The laws and rules governing the Company's business and interpretations of those laws and rules are subject to frequent change. For example, as described earlier in this Annual Report on Form 10-K, in the section entitled "California HMO Regulations," the California legislature may in 1999 make significant changes in the laws regulating HMOs operating in that state, particularly in light of the bankruptcy of FPA in July 1998 and the state installation of a conservator over MedPartners Provider Network, a California health plan, in March 1999. Existing or future laws and rules could force the Company to change how it does business and may restrict the Company's revenue and/or enrollment growth and/or increase its health care and administrative costs. In particular, the Company's HMO and insurance subsidiaries are subject to regulations relating to cash reserves, minimum net worth, premium rates, and approval of policy language and benefits. Although such regulations have not significantly impeded the growth of the Company's business to date, there can be no assurance that the Company will be able to continue to obtain or maintain required governmental approvals or licenses or that regulatory changes will not have a material adverse 27 effect on the Company's business. Delays in obtaining or failure to obtain or maintain such approvals, or moratoria imposed by regulatory authorities, could adversely affect the Company's revenue or the number of its members, could increase costs, or could adversely affect the Company's ability to bring new products to market as forecasted. In addition, efforts to enact changes to Medicare could impact the structure of the Medicare program, benefit designs and reimbursement. Changes to the current operation of the Company's Medicare services could have a material adverse affect on the Company's results of operations. A significant portion of the Company's revenues relate to federal, state, and local government health care coverage programs, such as Medicare and Medicaid programs. Such contracts carry certain risks such as higher comparative medical costs, government regulatory and reporting requirements, the possibility of reduced or insufficient government reimbursement in the future, and higher marketing and advertising costs per member as a result of marketing to individuals as opposed to groups. Such risk contracts also are generally subject to frequent change including changes which may reduce the number of persons enrolled or eligible, reduce the revenue received by the Company or increase the Company's administrative or health care costs under such programs. In the event government reimbursement were to decline from projected amounts, the Company's failure to reduce the health care costs associated with such programs could have a material adverse effect upon the Company's business. Changes to such government programs in the future may also affect the Company's willingness to participate in such programs. The Company is also subject to various governmental audits and investigations. Such activities could result in the loss of licensure or the right to participate in certain programs, or the imposition of fines, penalties and other sanctions. In addition, disclosure of any adverse investigation or audit results or sanctions could negatively affect the Company's reputation in various markets and make it more difficult for the Company to sell its products and services. The amount of government receivables represents the Company's best estimate of the government's liability. As of December 31, 1998, the Company's government receivables were $321.4 million. The receivables are generally subject to government audit and negotiation and the final amounts actually received may be greater or less than the amounts recognized by the Company. LOSS RESERVES. The Company's loss reserves are estimates of future costs based on various assumptions. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicious administration of claims, medical costs, and other factors. Included in the loss reserves are estimates for the costs of services which have been incurred but not reported ("IBNR"). Estimates are continually monitored and reviewed and, as settlements are made or estimates adjusted, differences are reflected in current operations. Such estimates are subject to the impact of changes in the regulatory environment and economic conditions. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts provided. Moreover, if the assumptions on which the estimates are based prove to be incorrect and reserves are inadequate to cover the Company's actual experience, the Company's profitability could be adversely affected. LITIGATION AND INSURANCE. The Company is subject to a variety of legal actions to which any corporation may be subject, including employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims, shareholder suits, including for securities fraud, and intellectual property related litigation. In addition, because of the nature of its business, the Company incurs and likely will continue to incur potential liability for claims related to its business, such as failure to pay for or provide health care, poor outcomes for care delivered or arranged, provider disputes, including disputes over withheld compensation, and claims related to self-funded business. In some cases, substantial non-economic or punitive damages may be sought. While the Company currently has insurance coverage for some of these potential liabilities, others may not be covered by insurance (such as punitive damages), the insurers may dispute coverage or the amount of insurance may not be enough to cover the damages awarded. In addition, insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future. 28 STOCK MARKET. Recently, the market prices of the securities of certain of the publicly-held companies in the industry in which the Company operates have shown volatility and sensitivity in response to many factors, including public communications regarding managed care, legislative or regulatory actions, health care cost trends, pricing trends, competition, earning or membership reports of particular industry participants, and acquisition activity. There can be no assurances regarding the level of stability of the Company's share price at any time or the impact of these or any other factors on the share price. RECENT DEVELOPMENTS FOHP. In 1997, the Company purchased convertible debentures (the "FOHP Debentures") of FOHP, Inc., a New Jersey corporation ("FOHP"), in the aggregate principal amount of approximately $80.7 million and converted approximately $70.6 million principal amount of the FOHP Debentures into shares of Common Stock of FOHP. As a result, the Company owned approximately 98% of the outstanding shares of FOHP common stock. Effective December 31, 1997, the Company purchased nonconvertible debentures in the amount of $24 million from FOHP. The debentures mature on December 31, 2002. The debentures were issued to the Company in consideration for additional capital contributions made by the Company pursuant to the Amended and Restated Securities Purchase Agreement, dated February 10, 1997, and as amended March 13, 1997, among the Company, FOHP, and First Option Health Plan of New Jersey, Inc. ("FOHP-NJ"), a wholly-owned subsidiary of FOHP (collectively, the "Definitive Agreements"). Pursuant to the Definitive Agreements, at any time during the 1999 calendar year, the Company may acquire any remaining shares of FOHP not owned by the Company pursuant to a tender offer, merger, combination or other business combination transaction for consideration (to be paid in cash or stock of the Company) equal to the value of such FOHP stock based on appraiser determinations. Pursuant to an Agreement and Plan of Merger dated as of October 26, 1998, Physicians Health Services of New Jersey, Inc., a New Jersey HMO wholly-owned by the Company, merged with and into FOHP-NJ on January 1, 1999 and FOHP-NJ changed its name to Physicians Health Services of New Jersey, Inc. ("PHS-NJ"). On December 31, 1998, the Company converted $1,197,183 principal amount of its remaining convertible debentures of FOHP into common stock of FOHP. As a result, the Company now owns approximately 99.6% of the outstanding equity of FOHP. The minority shareholders of FOHP are physicians, hospitals and other health care providers. Pursuant to an Agreement and Plan of Merger dated as of November 16, 1998, a wholly-owned subsidiary of the Company will merge into FOHP and FOHP will become a wholly-owned subsidiary of the Company. The merger is anticipated to occur in the second quarter of 1999. In connection with the merger, the current minority shareholders of FOHP will be entitled to either the value of their shares as of December 31, 1998 as determined by an appraiser or payment rights which entitle the holders to receive not less than $15.00 per payment right on or about July 1, 2001, provided that, with respect to the payment rights (i) for a provider shareholder, such shareholder agrees to remain a provider to PHS-NJ until December 31, 2001 and a specified number of hospital providers in the provider network does not leave the network prior to December 31, 2001, (ii) for a hospital provider shareholder, such payment rights will be subject to additional conditions to payment relating to reimbursement rates, enrollment of hospital employees in PHS-NJ health plans, and payments of premiums to PHS-NJ and (iii) for a non-provider shareholder, such shareholder will be entitled to receive additional consideration of $2.25 per payment right and a pro rata portion of a bonus to be funded by monies forfeited by provider shareholders, provided that PHS-NJ achieves certain annual returns on common equity. FOHP (headquartered in Neptune, New Jersey) is the sole shareholder of PHS-NJ, a New Jersey corporation. PHS-NJ is a managed health care company providing commercial products for businesses and individuals, along with Medicare, Medicaid and workers' compensation programs. PHS-NJ currently has more than 250,000 members in New Jersey enrolled in its commercial, Medicare, Medicaid and PPO programs. 29 QUALMED PLANS FOR HEALTH OF PENNSYLVANIA, INC. Effective December 31, 1998, the Company purchased the minority interests in QualMed Plans for Health of Pennsylvania, Inc. ("QualMed-PA"), a then majority-owned subsidiary of the Company, for approximately $2 million. Previously, the Company owned approximately 83% of the common stock of QualMed-PA. In January 1999, the Company transferred the assets of QualMed-PA, including the assets relating to its preferred provider organization ("MaxNet-Registered Trademark-") and managed workers' compensation ("CompTek-Registered Trademark-") business and operations, to Preferred Health Network, Inc., another wholly-owned subsidiary of the Company. MEDPARTNERS PROVIDER NETWORK, INC. On March 11, 1999, MedPartners Provider Network, Inc. ("MPN"), a Knox-Keene licensed entity and a subsidiary of MedPartners, Inc., a publicly-held physician practice and pharmacy benefit management company, was placed into conservatorship by the State of California under Section 1393(c) of the California Health and Safety Code. The conservator immediately filed a petition under Chapter 11 of the Bankruptcy Code on behalf of MPN. MPN and various provider groups and clinics affiliated with MedPartners, Inc. provide health care services to approximately 215,000 enrollees of the Company's Health Net HMO subsidiary. The Company continues to monitor the situation closely and has been involved in discussions with various parties to attempt to maintain continuity of care and to minimize the impact that MPN's conservatorship and bankruptcy could have on affected Health Net members. The Company understands from various public statements made by MedPartners, Inc. that it intends to divest its California clinic operations. Although at this time the Company is unable to fully assess the potential financial implications of the foregoing actions, management of the Company believes that such actions will not have a material adverse effect on either the financial or operating condition of the Company. CONSOLIDATION. In a continuing effort to streamline its operations, the Company effectuated numerous consolidation transactions among its subsidiaries in 1998. In January 1998, Midwest Business Medical Association, Ltd., a PPO subsidiary of the Company, merged into Preferred Health Network, Inc. In May 1998, Foundation Health Medical Group Florida, Inc., a holding company whose assets had been previously sold, merged into its immediate parent company Foundation Health, A Florida Health Plan, Inc. In July 1998, the Company merged two subsidiaries operating in managed behavioral health services: Foundation Health Psychcare Services, Inc. and Managed Health Network, Inc. Intergroup Healthcare Corporation of Utah, a holding company which owns the Company's Utah HMO, merged into its immediate parent company, Foundation Health Corporation, in July 1998. Also in July 1998, Foundation Health, A California Health Plan, Inc. merged into Health Net, thereby consolidating the Company's California HMO plans. In December 1998, the Company merged its Connecticut health plans, M.D. Health Plan, Inc. and Physicians Health Services of Connecticut, Inc. Also in December 1998, Preferred Health Providers, Inc., a PPO subsidiary of the Company, merged into Foundation Health, A Florida Health Plan. In 1998, the Company also completed the integration of its Colorado health plans, Foundation Health, A Colorado Health Plan, Inc. and QualMed Plans for Health of Colorado, Inc., which merged in August 1997. INSURANCE SUBSIDIARIES. The Company is in the process of restructuring its insurance subsidiaries to merge Foundation Health National Life Insurance Company ("FHNL") and Foundation Health Systems Life and Health Insurance Company ("FHS Life") under a newly-formed holding company subsidiary of the Company, FHS Life Holdings Company, Inc. RISK-BASED WORKERS' COMPENSATION OPERATIONS. In 1997, the Company revised its strategy of maintaining a presence in the workers' compensation insurance business as a result of various factors, including adverse developments arising in the workers' compensation insurance business, primarily related to the workers' compensation claims environment in California. In 1997 the Company adopted a plan to completely discontinue this segment of its business, through divestiture of its workers' compensation 30 risk-assuming insurance subsidiaries. On December 10, 1998, the Company consummated the sale of Business Insurance Group, Inc. ("BIG"), its risk-based workers' compensation subsidiary. As part of the transaction, the Company funded the purchase of third party reinsurance to cover up to $175 million in adverse loss development related to BIG and its subsidiaries. The Company received approximately $200 million in cash for the sale, net of its costs and expenses for the transaction. Certain of the Company's subsidiaries entered into agreements with the buyer to continue to provide certain administrative services related to such operations for a period of five years. LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On November 4, 1998, the Company entered into a definitive agreement for the sale of its HMO operations in the states of Texas, Louisiana and Oklahoma to AmCareco, Inc. As part of the transaction, the Company will receive convertible preferred stock of the buyer. The Company is pursuing a divestiture of these HMOs due to, among other reasons, inadequate returns on invested capital. Although the Company has entered into a definitive agreement for the foregoing sale, consummation of the sale is subject to numerous conditions and certain regulatory approvals. ALABAMA HMO OPERATIONS. In December 1997, the Company entered into a definitive agreement to sell its non-operational HMO license in Alabama to an unaffiliated third party, which sale was consummated in January 1998. PHARMACY BENEFITS MANAGEMENT SERVICES. In February 1999, the Company entered into a definitive agreement to sell to Advance Paradigm the capital stock of Foundation Health Pharmaceutical Services, Inc., and certain pharmacy benefit processing services of Integrated Pharmaceutical Services, Inc., for approximately $70 million in cash. In addition, the Company and Advance Paradigm entered into a services agreement, whereby Advance Paradigm will provide to the Company's Health Plan Divisions at competitive rates claims processing, retail network management and payment of claims pharmacy benefits services. Advance Paradigm will also provide pharmacy mail service to the Health Plan Divisions. For a period of five years, the Company may not compete with respect to such services in any market in which Advance Paradigm conducts business, subject to certain exceptions. It is anticipated that the sale will be consummated on March 31, 1999. MEMBER SUPPORT CENTER OPERATIONS. During 1998, the Company operated a regional member support center located in Philadelphia. The support center was a telecommunications center staffed by nurses who responded to member calls through the retrieval of detailed clinical and demographic data regarding plan members and provider information, and the use of clinical algorithms to guide members to the most appropriate level of care for their condition. In December 1998, the Company sold the clinical content used in its member support center operations to Access Health, Inc. ("Access Health") for approximately $36.3 million in cash net proceeds. In addition, the Company entered into a long-term services agreement with Access Health pursuant to which all members who had access to the support center at the time of sale will continue to have such access for a period of ten years, with available annual extensions by the Company. In addition, as part of the transaction the Company agreed not to compete in such services for a period commencing on the closing date and ending two years after members cease to have access to the support center. SOUTHERN CALIFORNIA HOSPITALS. The Company is reviewing the possibility of divesting its 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. The Company is presently responding to inquiries of parties which have expressed an interest in the purchase of such businesses. GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company ("Gem"), a subsidiary of the Company, has implemented a restructuring plan to reduce operating losses and its in-force insurance risk. In 1997, Gem initiated a withdrawal from the Nevada insurance markets, and began restructuring its 31 insurance products in Utah and then in certain other markets. Gem also reduced commissions to market-level rates and terminated certain general agents. Gem continued to implement such restructuring plan in 1998. As a result, the number of Gem's insureds dropped from over 100,000 at the start of 1998 to approximately 2,500 at December 31, 1998. Gem has filed notices of intention to withdraw from Nebraska and the small group market in Colorado. Currently, Foundation Health Systems Life and Health Insurance Company, a subsidiary of the Company, services Gem's insured through an administrative services agreement between the companies. The Company is reviewing the possibility of winding up the operations of Gem or merging such operations into another insurance subsidiary of the Company. Upon completion of its current withdrawals, Gem will be licensed in only five states. COLORADO OPERATIONS. In March 1999, the Company entered into a letter of intent to sell the capital stock of QualMed Plans for Health of Colorado, Inc., the Company's HMO subsidiary in the state of Colorado, to Wellpoint Health Networks Inc. The Company anticipates closing the sale in the first half of 1999. Although the Company has entered into a letter of intent for the foregoing sale, consummation of the sale is subject to executing a definitive agreement mutually satisfactory to the parties and satisfaction of all conditions to be set forth therein, including obtaining regulatory approvals. In addition, the Company has decided to close its regional service center in Pueblo, Colorado in the first half of 1999. NEW MEXICO OPERATIONS. In March 1999, the Company also entered into a definitive agreement to sell the capital stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the state of New Mexico, to Health Care Horizons, Inc. Although the Company has entered into a definitive agreement for the foregoing sale, consummation of the sale is subject to numerous conditions and certain regulatory approvals. CERTAIN OTHER OPERATIONS. The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of such businesses or operations should be divested. 32 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The following table sets forth the high and low sales prices of the Company's Class A Common Stock, par value $.001 per share (the "Class A Common Stock"), on The New York Stock Exchange, Inc. ("NYSE") since January 2, 1996.
HIGH LOW --------- --------- Calendar Quarter--1996 First Quarter.................................................................................. 37 1/8 30 3/8 Second Quarter................................................................................. 37 1/8 26 7/8 Third Quarter.................................................................................. 28 7/8 19 3/8 Fourth Quarter................................................................................. 29 1/8 22 5/8 Calendar Quarter--1997 First Quarter.................................................................................. 30 3/4 23 1/8 Second Quarter................................................................................. 33 24 1/4 Third Quarter.................................................................................. 33 15/16 29 11/16 Fourth Quarter................................................................................. 33 3/8 22 1/16 Calendar Quarter--1998 First Quarter.................................................................................. 29 1/16 22 1/4 Second Quarter................................................................................. 32 5/8 25 3/8 Third Quarter.................................................................................. 26 7/8 9 Fourth Quarter................................................................................. 15 3/4 5 7/8 Calendar Quarter--1999 First Quarter (through March 29, 1999)......................................................... 12 7/16 7 11/16
On March 29, 1999, the last reported sales price per share of the Class A Common Stock was $11.0625 per share. DIVIDENDS No dividends have been paid by the Company during the preceding two fiscal years. The Company has no present intention of paying any dividends on its Common Stock. The Company is a holding company and, therefore, its ability to pay dividends depends on distributions received from its subsidiaries, which are subject to regulatory net worth requirements and certain additional state regulations which may restrict the declaration of dividends by HMOs, insurance companies and licensed managed health care plans. The payment of any dividend is at the discretion of the Company's Board of Directors and depends upon the Company's earnings, financial position, capital requirements and such other factors as the Company's Board of Directors deems relevant. Under the Credit Agreement entered into on July 8, 1997 with Bank of America as agent, the Company cannot declare or pay cash dividends to its stockholders or purchase, redeem or otherwise acquire shares of its capital stock or warrants, rights or options to acquire such shares for cash except to the extent permitted under such Credit Agreement as described elsewhere in this Annual Report on Form 10-K. HOLDERS As of March 29, 1999, there were approximately 2,000 holders of record of Class A Common Stock. The California Wellness Foundation (the "CWF") is the only holder of record of the Company's Class B 33 Common Stock, par value $.001 per share (the "Class B Common Stock"), which constitutes approximately 4% of the Company's aggregate equity. Under the Company's Fourth Amended and Restated Certificate of Incorporation, shares of the Company's Class B Common Stock have the same economic benefits as shares of the Company's Class A Common Stock, but are non-voting. Upon the sale or other transfer of shares of Class B Common Stock by the CWF to an unrelated third party, such shares automatically convert into Class A Common Stock. ITEM 6. SELECTED FINANCIAL DATA The information required by this Item is set forth in the Company's Annual Report to Stockholders on page 1, and is incorporated herein by reference and made a part hereof. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item is set forth in the Company's Annual Report to Stockholders on pages 17 through 27, and is incorporated herein by reference and made a part hereof. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is set forth in the Company's Annual Report to Stockholders on pages 27 through 28, and is incorporated herein by reference and made a part hereof. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is set forth in the Company's Annual Report to Stockholders on pages 29 through 56, and is incorporated herein by reference and made a part hereof. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1998. Such information is incorporated herein by reference and made a part hereof. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1998. Such information is incorporated herein by reference and made a part hereof. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1998. Such information is incorporated herein by reference and made a part hereof. 34 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1998. Such information is incorporated herein by reference and made a part hereof. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS 1. FINANCIAL STATEMENTS The following consolidated financial statements are incorporated by reference into this Annual Report on Form 10-K from pages 29 to 56 of the Company's Annual Report to Stockholders for the year ended December 31, 1998: Report of Deloitte & Touche LLP Consolidated balance sheets at December 31, 1998 and 1997 Consolidated statements of operations for each of the three years in the period ended December 31, 1998 Consolidated statements of stockholders' equity for each of the three years in the period ended December 31, 1998 Consolidated statements of cash flows for each of the three years in the period ended December 31, 1998 Notes to consolidated financial statements 35 2. FINANCIAL STATEMENT SCHEDULES The following financial statement schedules are filed as a part of this Annual Report on Form 10-K: Schedule I--Condensed Financial Information of Registrant All other schedules are omitted because they are not applicable, not required or because the required information is included in the consolidated financial statements or notes thereto which are incorporated by reference into this Annual Report on Form 10-K from the Company's 1998 Annual Report to Stockholders. 3. EXHIBITS The following exhibits are filed as part of this Annual Report on Form 10-K or are incorporated herein by reference: 2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International, Inc., FH Acquisition Corp. and Foundation Health Corporation (filed as Exhibit 2.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein). 2.2 Agreement and Plan of Merger, dated May 8. 1997, by and among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which is incorporated by reference herein). 2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is incorporated by reference herein). 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 Rights Agreement dated as of June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 001-12718) which is incorporated by reference herein). 4.4 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, which is incorporated by reference herein).
36 10.1 Letter Agreement dated June 1, 1998 between The California Wellness Foundation and the Company (filed as Exhibit 10.75 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, which is incorporated by reference herein). *10.2 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). *10.3 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). *10.4 Letter Agreement dated June 25, 1998 between B. Curtis Westen and the Company (filed as Exhibit 10.73 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, which is incorporated by reference herein). *10.5 Letter Agreement dated July 31, 1998 between Michael P. White and the Company (filed as Exhibit 10.74 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 which is incorporated by reference herein). *10.6 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). *10.7 Early Retirement Agreement dated August 6, 1998 between the Company and Malik M. Hasan, M.D. (filed as Exhibit 10.77 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998). *10.8 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). *10.9 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). *10.10 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). *10.11 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). *10.12 Employment Agreement between the Company and Maurice Costa dated December 31, 1997 (filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is incorporated by reference herein). *+10.13 Employment Letter Agreement between the Company and Gary S. Velasquez dated May 1, 1996, a copy of which is filed herewith. *+10.14 Employment Agreement between Foundation Health Corporation and Edward J. Munno dated November 8, 1993, a copy of which is filed herewith.
37 *+10.15 Amendment Number One to Employment Agreement between Foundation Health Corporation and Edward J. Munno dated May 1, 1996, a copy of which is filed herewith. *+10.16 Employment Letter Agreement between the Company and Cora Tellez dated November 16, 1998, a copy of which is filed herewith. *+10.17 Employment Letter Agreement between the Company and Karen Coughlin dated March 12, 1998, a copy of which is filed herewith. *+10.18 Employment Letter Agreement between the Company and J. Robert Bruce dated September 22, 1998, a copy of which is filed herewith. *+10.19 Employment Letter Agreement between the Company and Robert Natt dated December 31, 1997 (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). *+10.20 Waiver and Release of Claims between the Company and Robert Natt, a copy of which is filed herewith. *+10.21 Form of Severance Payment Agreement dated December 4, 1998 by and between the Company and various of its executive officers, a copy of which is filed herewith. *10.22 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). *+10.23 Severance Payment Agreement between the Company and J. Robert Bruce dated September 15, 1998, a copy of which is filed herewith *+10.24 Severance Payment Agreement between the Company and Maurice Costa dated April 6, 1998, a copy of which is filed herewith. *10.25 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). *10.26 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). *10.27 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). *10.28 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35 to Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by reference herein). *10.29 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).
38 *10.30 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). *+10.31 The Company's Deferred Compensation Plan Trust Agreement dated as of September 1, 1998 between the Company and Union Bank of California. *10.32 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). *10.33 The Company's 401(k) Associate Savings Plan (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 filed on March 31, 1998). *10.34 The Company's 1997 Stock Option Plan (filed as Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). *10.35 The Company's 1998 Stock Option Plan (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 filed on December 4, 1998). *10.36 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.47 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). *10.37 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.48 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). *10.38 The Company's Third Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is incorporated by reference herein). *10.39 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). *10.40 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). *10.41 Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan (filed as Exhibit 4.9 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). *10.42 Foundation Health Corporation Employee Stock Purchase Plan (filed as Exhibit 4.3 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). *10.43 Foundation Health Corporation Profit Sharing and 401(k) Plan (Amended and Restated effective January 1, 1994) (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by reference herein). *10.44 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).
39 *10.45 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). *10.46 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). *10.47 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). 10.48 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). *10.49 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). *10.50 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). *10.51 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). 10.52 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). 10.53 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). 10.54 Guarantee Agreement dated July 8, 1997 between the Company and First Security Bank, National Association (filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, which is incorporated by reference herein). 10.55 First Amendment and Waiver to Credit Agreement dated April 6, 1998 among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein) (filed as Exhibit 10.64 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, which is incorporated by reference herein).
40 10.56 Second Amendment to Credit Agreement dated July 31, 1998 among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein) (filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, which is incorporated by reference herein). 10.57 Third Amendment to Credit Agreement, dated November 6, 1998, among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein) (filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, which is incorporated by reference herein). 10.58 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). 10.59 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). 10.60 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). 10.61 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). +10.62 Asset Purchase Agreement dated December 31, 1998 by and between the Company and Access Health, Inc., a copy of which is filed herewith. +10.63 Purchase Agreement dated February 26, 1999 by and among the Company, Foundation Health Pharmaceutical Services, Inc., Integrated Pharmaceutical Services, Inc., and Advance Paradigm, Inc., a copy of which is filed herewith. +10.64 Fourth Amendment to Credit Agreement, dated as of March 26, 1999, among the Company, Bank of America National Trust and Savings Association and the Banks (as defined therein), a copy of which is filed herewith. *+10.65 The Company's Supplemental Executive Retirement Plan effective as of January 1, 1996, a copy of which is filed herewith. *+10.66 The Company's Deferred Compensation Plan effective as of May 1, 1998, a copy of which is filed herewith. 11.1 Statement relative to computation per share earnings of the Company (included in the notes to the Financial Statements, which are incorporated by reference from pages to of the Annual Report to Stockholders for the year ended December 31, 1998). +13.1 1998 Annual Report to Stockholders, a copy of which is filed herewith. +21.1 Subsidiaries of the Company, a copy which is filed herewith. +23.1 Consent and Report on Schedule of Deloitte & Touche LLP, a copy of which is filed herewith. +27.1 Financial Data Schedule for 1998, a copy of which has been filed with the EDGAR version of this filing.
41 99.1 Report of Deloitte & Touche LLP on the consolidated balance sheets of Foundation Health Systems, Inc. as of December 31, 1998 and 1997, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998, which is incorporated by reference from page 29 of the Annual Report to Stockholders for the fiscal year ended December 31, 1998.
- ------------------------ * Management contract or compensatory plan or arrangement required to be filed (and/or incorporated by reference) as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K. + A copy of the exhibit is being filed with this Annual Report on Form 10-K. (b) Reports on Form 8-K The following Current Report on Form 8-K was filed by the Company during the quarterly period ended December 31, 1998: A Current Report on Form 8-K dated December 23, 1998 announcing the Company's completion of its sale of Business Insurance Group, Inc., a wholly-owned subsidiary of the Company. No other Current Reports on Form 8-K were filed by the Company during the quarterly period ended December 31, 1998. 42 SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT FOUNDATION HEALTH SYSTEMS, INC. CONDENSED BALANCE SHEETS (AMOUNTS IN THOUSANDS)
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ ASSETS Current assets: Cash and cash equivalents.......................................................... $ 74,767 $ 16,740 Investments available for sale..................................................... 3,352 9,007 Other assets....................................................................... 6,654 46,902 Due from subsidiaries.............................................................. 597,321 473,431 Net assets from discontinued operations............................................ -- 267,713 ------------ ------------ Total current assets................................................................. 682,094 813,793 Property and equipment, net.......................................................... 7,854 22,895 Investment in subsidiaries........................................................... 1,459,335 1,389,190 Other assets......................................................................... 65,881 70,342 ------------ ------------ Total assets..................................................................... $2,215,164 $2,296,220 ------------ ------------ ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Due to subsidiaries................................................................ 185,516 73,283 Other current liabilities.......................................................... 46,883 35,907 ------------ ------------ Total current liabilities........................................................ 232,399 109,190 Notes payable........................................................................ 1,235,500 1,287,500 Other liabilities.................................................................... 3,223 3,556 ------------ ------------ Total liabilities................................................................ 1,471,122 1,400,246 ------------ ------------ Stockholders' equity: Common stock and additional paid-in capital........................................ 641,945 628,735 Common stock held in treasury, at cost............................................. (95,831) (95,831) Retained earnings.................................................................. 205,236 370,394 Accumulated other comprehensive loss............................................... (7,308) (7,324) ------------ ------------ Total stockholders' equity....................................................... 744,042 895,974 ------------ ------------ Total liabilities and stockholders' equity..................................... $2,215,164 $2,296,220 ------------ ------------ ------------ ------------
See accompanying note to condensed financial statements. 43 SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) FOUNDATION HEALTH SYSTEMS, INC. CONDENSED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------ 1998 1997 1996 ----------- ----------- ---------- Investment and other income................................................. $ 11,366 $ 6,485 $ 5,171 Expenses: General and administrative................................................ 27,480 17,288 11,879 Amortization and depreciation............................................. 2,197 1,315 1,155 Interest.................................................................. 91,717 42,118 22,063 Asset impairment, merger, restructuring and other charges................. 39,602 42,189 2,500 ----------- ----------- ---------- 160,996 102,910 37,597 ----------- ----------- ---------- Loss from continuing operations before income taxes and equity in net income of subsidiaries........................................................... (149,630) (96,425) (32,426) Income tax benefit.......................................................... 61,333 39,533 11,861 Equity in net income (loss) of subsidiaries................................. (76,861) (10,938) 59,395 ----------- ----------- ---------- Income (loss) from continuing operations.................................... (165,158) (67,830) 38,830 Discontinued operations: Income (loss) from operations, net of tax................................. -- (30,409) 25,084 Gain (loss) on disposition, net of tax.................................... -- (88,845) 20,317 ----------- ----------- ---------- Net income (loss)....................................................... $ (165,158) $ (187,084) $ 84,231 ----------- ----------- ---------- ----------- ----------- ----------
See accompanying note to condensed financial statements. 44 SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) FOUNDATION HEALTH SYSTEMS, INC. CONDENSED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ----------------------------------- 1998 1997 1996 ---------- ----------- ---------- Net Cash Flows from Operating Activities..................................... $ (39,871) $ (521,154) $ 11,091 ---------- ----------- ---------- Cash Flows from Investing Activities: Sales or maturity of investments available for sale........................ 8,777 11,400 -- Purchases of investments available for sale................................ (6,264) (309) (20,160) Sales of property and equipment............................................ 16,376 -- -- Purchases of property and equipment........................................ (3,532) (20,695) (3,273) Other assets............................................................... 4,771 (130,755) (2,941) Sale of net assets of discontinued operations.............................. 257,100 -- -- Acquisition of businesses.................................................. -- (293,625) (4,113) ---------- ----------- ---------- Net cash provided by (used in) investing activities.......................... 277,228 (433,984) (30,487) ---------- ----------- ---------- Cash Flows from Financing Activities: Proceeds from exercise of stock options and employee stock purchases....... 13,209 21,506 17,483 Proceeds from sale of stock................................................ -- -- 95,831 Proceeds from issuance of notes payable.................................... 155,000 946,000 9,000 Principal payments on notes payable........................................ (207,000) (873) -- Redemption of common stock................................................. -- (111,334) (105,419) Cash dividends received from subsidiaries.................................. 2,900 140,994 -- Capital contributions to subsidiaries...................................... (143,439) (33,875) (700) ---------- ----------- ---------- Net cash provided by (used in) financing activities.......................... (179,330) 962,418 16,195 ---------- ----------- ---------- Net increase (decrease) in cash and cash equivalents......................... 58,027 7,280 (3,201) Cash and cash equivalents, beginning of period............................... 16,740 9,460 12,661 ---------- ----------- ---------- Cash and cash equivalents, end of period..................................... $ 74,767 $ 16,740 $ 9,460 ---------- ----------- ---------- ---------- ----------- ----------
See accompanying note to condensed financial statements. 45 SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) FOUNDATION HEALTH SYSTEMS, INC. NOTE TO CONDENSED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 NOTE 1--BASIS OF PRESENTATION Foundation Health Systems, Inc.'s ("FHS") investment in subsidiaries is stated at cost plus equity in undistributed earnings (losses) of subsidiaries. FHS' share of net income (loss) of its unconsolidated subsidiaries is included in consolidated income (loss) using the equity method. This condensed financial information of registrant should be read in conjunction with the consolidated financial statements of Foundation Health Systems, Inc. and subsidiaries. 46 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized, on the day of March, 1999. FOUNDATION HEALTH SYSTEMS, INC. By: /s/ JAY M. GELLERT ----------------------------------------- Jay M. Gellert PRESIDENT AND CHIEF EXECUTIVE OFFICER (PRINCIPAL EXECUTIVE OFFICER) By: /s/ STEVEN P. ERWIN ----------------------------------------- Steven P. Erwin EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (PRINCIPAL ACCOUNTING AND FINANCIAL OFFICER) Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Company and in the capacities indicated on the day of March, 1999.
SIGNATURE TITLE DATE - ------------------------------ --------------------------- ------------------- /s/ J. THOMAS BOUCHARD Director - ------------------------------ March 31, 1999 J. Thomas Bouchard /s/ GEORGE DEUKMEJIAN Director - ------------------------------ March 31, 1999 Gov. George Deukmejian /s/ THOMAS T. FARLEY Director - ------------------------------ March 31, 1999 Thomas T. Farley /s/ PATRICK FOLEY Director - ------------------------------ March 31, 1999 Patrick Foley /s/ EARL B. FOWLER Director - ------------------------------ March 31, 1999 Admiral Earl B. Fowler /s/ JAY M. GELLERT Director - ------------------------------ March 31, 1999 Jay M. Gellert /s/ ROGER F. GREAVES Director - ------------------------------ March 31, 1999 Roger F. Greaves /s/ RICHARD W. HANSELMAN Director - ------------------------------ March 31, 1999 Richard W. Hanselman
47
SIGNATURE TITLE DATE - ------------------------------ --------------------------- ------------------- /s/ RICHARD J. STEGEMEIER Director - ------------------------------ March 31, 1999 Richard J. Stegemeier /s/ RAYMOND S. TROUBH Director - ------------------------------ March 31, 1999 Raymond S. Troubh
48 EX-10.13 2 EXHIBIT 10.13 Ex. 10.13 EMPLOYMENT AGREEMENT THIS AGREEMENT is entered into as of May 1, 1996 by and between GARY VELASQUEZ (the "Employee") and FOUNDATION HEALTH CORPORATION, a Delaware corporation (the "Company"). 1. TERM OF EMPLOYMENT. (a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company, for a three-year period commencing as of the date hereof and ending May 1, 1999, unless sooner terminated pursuant to Subsection (b), (c), or (d) below. (b) EARLY TERMINATION. Subject to Sections 6 and 7, the Company may terminate the Employee's employment by giving the Employee 30 days' advance notice in writing. The Employee may terminate his employment by giving the Company 30 days' advance notice in writing. The Employee's employment shall terminate automatically in the event of his death. Any waiver of notice shall be valid only if it is made in writing and expressly refers to the applicable notice requirement of this Section 1. (c) CAUSE. The Company may terminate the Employee's employment for Cause at any time by giving the Employee notice in writing. For all purposes under this Agreement, "Cause" shall mean (i) a failure by the Employee to perform his duties, other than a failure resulting from the Employee's complete or partial incapacity due to physical or mental illness or impairment, (ii) misconduct or fraud or (iii) conviction of, or a plea of "guilty" or "no contest" to, a felony. (d) DISABILITY. The Company may terminate the Employee's active employment due to Disability by giving the Employee 30 days' advance notice in writing. For all purposes under this Agreement, "Disability" shall mean that the Employee, at the time notice is given, has not performed his duties under this Agreement for at least 90 working days in a period of not more than 365 consecutive days as the result of his incapacity due to physical or mental illness. (e) RIGHTS UPON TERMINATION. Upon the termination of the Employee's employment pursuant to this Section 1, the Employee shall only be entitled to legally mandated benefits accruing during the period preceding the effective date of the termination, except as expressly provided in Section 6 or 7, as applicable. The payments under this Agreement shall fully discharge all responsibilities of the Company to the Employee upon the termination of his employment. (f) TERMINATION OF AGREEMENT. This Agreement shall terminate when all obligations of the parties hereunder have been satisfied. -1- 2. EMPLOYEE'S DUTIES. During the term of his employment under this Agreement, the Employee shall serve the Corporation as President and Chief Operating Officer - Foundation Health, a California Health Plan and shall devote his full business efforts and time to the Company and its subsidiaries and shall not render services to any other person or entity without the prior written consent of the Company's President and Chief Executive Officer or his designee. The foregoing, however, shall not preclude the Employee from engaging in appropriate civic, charitable or religious activities or from devoting a reasonable amount of time to private investments that do not interfere or conflict with his responsibilities to the Company. 3. BASE COMPENSATION. During the term of his employment under this Agreement, the Company agrees to pay the Employee as compensation for his services a base salary at the annual rate of $275,000 or at such higher rate as the Company may determine from time to time. Such salary shall be payable in accordance with the Company's standard payroll procedures. (The annual compensation specified in this Section 3, together with any changes in such compensation that the Company may grant from time to time, is referred to in this Agreement as "Base Compensation.") 4. EMPLOYEE BENEFITS. (a) During the term of his employment under this Agreement, the Employee shall be eligible to participate in employee benefit plans and compensation programs maintained by the Company, subject in each case to the generally applicable terms and conditions of the plan or program in question and to the determinations of any person or committee administering such plan or program. (b) Employee shall be eligible to participate in the Company's Executive Bonus Plan (or such other management incentive program adopted by the Board to replace such Bonus Plan) which may entitle Employee to an annual bonus for the fiscal year ending June 30, 1996, and for each fiscal year thereafter during the term. The bonus shall continue at 50% of Employee's Base Compensation. During the first year of employment, the bonus, if any, shall be prorated from date of employment. -2- 5. BUSINESS EXPENSES. During the term of his employment under this Agreement, the Employee shall be authorized to incur necessary and reasonable travel, entertainment and other business expenses in connection with his duties hereunder. The Company shall reimburse the Employee for such expenses upon presentation of an itemized account and appropriate supporting documentation, all in accordance with the Company's generally applicable policies. 6. CHANGE IN CONTROL. (a) DEFINITION. For all purposes under this Agreement, "Change in Control" shall mean the occurrence of any of the following events after the date of this Agreement: (i) A change in the composition of the Company's Board of Directors (the "Board"), as a result of which fewer than two-thirds of the incumbent directors are directors who either (A) had been directors of the Company 24 months prior to such change or (B) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; or (ii) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) through the acquisition or aggregation of securities is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"), except that any change in the relative beneficial ownership of the Company's securities by any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. (b) GOOD REASON. For purposes of Section 6 under this Agreement, unless otherwise consented to by Employee, "Good Reason" shall mean that the Employee: (i) Has been demoted; (ii) Has incurred a substantial reduction in his authority or responsibility; or (iii) Has incurred a reduction in his Base Compensation; -3- except that a mere change in reporting relationship or title as a result of organizational restructuring shall not be considered "Good Reason". (c) SEVERANCE PAYMENT. If, during the term of this Agreement and within two years after the occurrence of a Change in Control, the Employee voluntarily resigns his employment for Good Reason or the Company terminates the Employee's employment for any reason other than Cause, then the Employee shall be entitled to receive a severance payment from the Company (the "Severance Payment"). The Severance Payment shall be made in a lump sum not more than five business days following the date of the employment termination and shall be in an amount determined under Subsection (d) below. The Severance Payment shall be in lieu of any further payments to the Employee under Section 3 and any further accrual of benefits under Section 4 with respect to periods subsequent to the date of the employment termination. (d) AMOUNT. The amount of the Severance Payment shall be equal to 1.5 times the Employee's annual rate of Base Compensation, as in effect on the date of the employment termination. (e) INCENTIVE PROGRAMS. If, during the term of this Agreement, a Change in Control occurs with respect to the Company, the Employee shall become fully vested in all awards heretofore or hereafter granted to him under all incentive compensation, deferred compensation, bonus, stock option, stock appreciation rights, restricted stock, phantom stock or similar plans maintained by the Company, any contrary provisions of such plans notwithstanding. (f) INSURANCE COVERAGE. During the 12-month period commencing upon a termination of employment described in Subsection (c) above, the Employee (and, where applicable, his dependents) shall be entitled to continue participation in the basic group insurance plans maintained by the Company, including life, disability and health insurance programs, as if he were still an employee of the Company. Where applicable, the Employee's salary for purposes of such plans shall be deemed to be equal to his Base Compensation. To the extent that the Company finds it impossible to cover the Employee under its group insurance policies during such 12-month period, the Company shall provide the Employee with the same level of coverage at the same cost under individual policies. (g) NO MITIGATION. The Employee shall not be required to mitigate the amount of any payment contemplated by this Section 6 (whether by seeking new employment or in any other manner). (h) POOLING-OF-INTEREST ACCOUNTING RULES. Any other provision of this Agreement shall be invalid to the extent that the implementation of such provision would preclude the application of pooling-of-interests accounting treatment to a transaction (including a Change in Control) for which such treatment is to be adopted by the Company and which has been approved by the Board of Directors of the Company. If the pooling-of-interests accounting rules require the invalidation of one or more provisions of this Agreement, the adverse impact on -4- the Employee shall be proportionate to the adverse impact on all similarly situated employees of the Company, as determined by the Board of Directors of the Company. All determinations regarding the pooling-of-interests accounting rules for purposes off this Subsection (h) shall be made by the independent auditors retained by the Company most recently prior to the Change of Control ("the Auditors"). 7. TERMINATION BY COMPANY WITHOUT CAUSE. (a) CONTINUATION PERIOD. If, during the term of this Agreement, the Company terminates the Employee's employment for any reason other than Cause or Disability and if Section 6 does not apply, then the Employee shall be entitled to receive all of the payments and benefit coverage described in this Section 7. Such payments and benefit coverage shall continue for the period commencing on the date when the employment termination is effective and ending on the earlier of (i) the day 12 months after such date or (ii) the date of the Employee's death (the "Continuation Period"). (b) BASE COMPENSATION. During the Continuation Period, the Company shall pay the Employee, in accordance with Section 3, his Base Compensation at the annual rate in effect on the date of the employment termination. (c) INSURANCE COVERAGE. During the Continuation Period, the Employee (and, where applicable, his dependents) shall be entitled to continue participation in all insurance or similar plans maintained by the Company, including (without limitation) life, disability, health and accident insurance programs, as if he were still an employee of the Company. Where applicable, the Employee's salary for purposes of such plans shall be deemed to be equal to his Base Compensation. To the extent that the Company finds it impossible to cover the Employee under its group insurance policies during the Continuation Period, the Company shall provide the Employee with the same level of coverage at the same cost under individual policies. (d) INCENTIVE PROGRAMS. The Continuation Period shall not be counted as employment with the Company for purposes of vesting under all executive compensation programs maintained by the Company, including (without limitation) incentive compensation, deferred compensation, bonus, stock option, stock appreciation rights, restricted stock, phantom stock or similar plans maintained by the Company (any contrary provisions of such plans notwithstanding), including any pension, thrift or profit-sharing plan intended to qualify under section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), nor shall the Company be required to grant any new awards to the Employee under such executive compensation programs during the Continuation Period. The Continuation Period shall not be counted as employment with the Company for purposes of determining the expiration date of any stock option granted by the Company and held by the Employee when his employment terminates. (e) MITIGATION AND NEW EMPLOYMENT. The Employee shall not be required to mitigate the amount of any cash payment contemplated by this Section 7, except that any such -5- payment shall be reduced by any earnings that the Employee may receive from any other source. All of the Employee's insurance coverage under Subsection (c) above shall be discontinued (subject to applicable law) when the Employee becomes eligible for any group insurance coverage in connection with new employment or self-employment, regardless of whether the new group insurance coverage is equivalent to the coverage described in Subsection (c) above. 8. LIMITATION ON PAYMENTS. (a) BASIC RULE. Any other provision of this Agreement notwithstanding, the Company shall not be required to make any payment or transfer any property to, or for the benefit of, the Employee (under this Agreement or otherwise) that would be nondeductible by the Company by reason of section 280G of the Code or that would subject the Employee to the excise tax described in section 4999 of the Code. All calculations required by this Section 10 shall be performed by the Auditors, based on information supplied by the Company and the Employee, and shall be binding on the Company and the Employee. All fees and expenses of the Auditors shall be paid by the Company. (b) REDUCTIONS. If the amount of the aggregate payments or property transfers to the Employee must be reduced under this Section 8, then the Employee shall direct in which order the payments or transfers are to be reduced, but no change in the timing of any payment or transfer shall be made without the Company's consent. As a result of uncertainty in the application of sections 280G and 4999 of the Code at the time of an initial determination by the Auditors hereunder, it is possible that a payment will have been made by the Company that should not have been made (an "Overpayment") or that an additional payment that will not have been made by the Company could have been made (an "Underpayment"). In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against the Company or the Employee that the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment shall be treated for all purposes as a loan to the Employee that he shall repay to the Company, together with interest at the applicable federal rate specified in section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Employee to the Company if and to the extent that such payment would not reduce the amount that is nondeductible under section 280G of the Code or is subject to an excise tax under section 4999 of the Code. In the event that the Auditors determine that an Underpayment has occurred, such Underpayment shall promptly be paid or transferred by the Company to, or for the benefit of, the Employee, together with interest at the applicable federal rate specified in section 7872(f)(2) of the Code. 9. SUCCESSORS. (a) COMPANY'S SUCCESSORS. The Company shall require any successor (whether direct or indirect and whether by purchase, lease, merger, consolidation, liquidation or otherwise) to all or substantially all of the Company's business and/or assets, by an agreement in substance and form satisfactory to the Employee, to assume this Agreement and to agree -6- expressly to perform this Agreement in the same manner and to the same extent as the Company would be required to perform it in the absence of a succession. The Company's failure to obtain such agreement prior to the effectiveness of a succession shall be a breach of this Agreement and shall entitle the Employee to all of the compensation and benefits to which he would have been entitled hereunder if the Company had involuntarily terminated his employment without Cause immediately after such succession becomes effective. For all purposes under this Agreement, the term "Company" shall include any successor to the Company's business and/or assets which executes and delivers the assumption agreement described in this Subsection (a) or which becomes bound by this Agreement by operation of law. (b) EMPLOYEE'S SUCCESSORS. This Agreement and all rights of the Employee hereunder 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. 10. NO DISCLOSURE OR SOLICITATION. (a) CONFIDENTIAL INFORMATION. During the term of this Agreement and at all times thereafter, the Employee shall not, without the prior written consent of the Board, disclose or use for any purpose (except in the course of his employment under this Agreement and in furtherance of the business of the Company) confidential information, proprietary data and customer lists of the Company, except as required by applicable law or legal process; provided, however, that "confidential information, proprietary data and customer lists" shall not include any information known generally to the public or ascertainable from public or published information (other than as a result of unauthorized disclosure by the Employee) or any information of a type not otherwise considered confidential by persons engaged in the same business or a business similar to that conducted by the Company. The Employee agrees to deliver to the Company at the termination of his employment, or at any other time the Company may request, all memoranda, notes, plans, records, lists, reports and other documents (and copies thereof) relating to the business of the Company which he may then possess or have under his control. (b) SOLICITATION OF EMPLOYEES. During the term of this Agreement and, in the event of a termination under Section 7, during the Continuation Period, the Employee shall not, directly or indirectly: (i) Contact any employee or consultant of the Company or any of its subsidiaries to solicit such employee or consultant (or any entity in which such employee or consultant has a significant equity interest) to become an employee, partner or independent contractor of the Employee or any other person; or (ii) Employ or engage any present or former employee or consultant of the Company or any of its subsidiaries (or any entity in which such employee or consultant has a significant equity interest) as an employee, partner or independent contractor of the Employee or any other person, except an employee or consultant who has performed no -7- work for the company or any of its subsidiaries for three consecutive calendar years prior to employment or engagement by Employee. 11. MISCELLANEOUS PROVISIONS. (a) NOTICE. Notices and all other communications contemplated by this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by U.S. registered mail, return receipt requested and postage prepaid. In the case of the Employee, mailed notices shall be addressed to him at the home address which he most recently communicated to the Company in writing. In the case of the Company, mailed notices shall be addressed to its corporate headquarters, and all notices shall be directed to the attention of its Secretary. (b) WAIVER. No provision of this Agreement shall be modified, waived or discharged unless the modification, waiver or discharge is agreed to in writing and signed by the Employee and by an authorized officer of the Company (other than the Employee). No waiver by either party of any breach of, or of compliance with, any condition or provision of this Agreement by the other party shall be considered a waiver of any other condition or provision or of the same condition or provision at another time. (c) WHOLE AGREEMENT. No agreements, representations or understandings (whether oral or written and whether express or implied) which are not expressly set forth in this Agreement have been made or entered into by either party with respect to the subject matter hereof. This Agreement supersedes, without limitation, any prior agreement entered into by the parties (or by any wholly owned subsidiary of the Company and the Employee) hereto. (d) WITHHOLDING TAXES. All payments made under this Agreement shall be subject to reduction to reflect taxes required to be withheld by law. (e) CHOICE OF LAW. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of California. (f) SEVERABILITY. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision hereof, which shall remain in full force and effect. (g) ARBITRATION. Except as otherwise provided in Section 8, any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the California Code of Civil Procedure, Section 1280 et seq., except where federal law requires otherwise, and judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. All fees and expenses of the arbitrator and such Association shall be paid as determined by the arbitrator. -8- (h) NO ASSIGNMENT. The rights of any person to payments or benefits under this Agreement shall not be made subject to option or assignment, either by voluntary or involuntary assignment or by operation of law, including (without limitation) bankruptcy, garnishment, attachment or other creditor's process, and any action in violation of this Subsection (h) shall be void. IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by its duly authorized officer, as of the day and year first above written. /s/ GARY A. VELASQUEZ --------------------------------------- Employee FOUNDATION HEALTH CORPORATION By /s/ DANIEL D. CROWLEY ------------------------------------- Title Chairman, President & CEO ---------------------------------- -9- EX-10.14 3 EXHIBIT 10.14 Ex. 10.14 EMPLOYMENT AGREEMENT THIS AGREEMENT is entered into as of November 8, 1993, by and between ED MUNNO (the "Employee") and FOUNDATION HEALTH CORPORATION, a Delaware corporation (the "Company"). 1. TERM OF EMPLOYMENT. (a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company, for a three-year period commencing as of the date hereof and ending November 8, 1996, and thereafter automatically renewable from year to year unless sooner terminated pursuant to Subsection (b), (c), (d) or (e) below. (b) EARLY TERMINATION. Subject to Sections 6 and 7, the Company may terminate the Employee's employment by giving the Employee 30 days' advance notice in writing. The Employee may terminate his employment by giving the Company 30 days' advance notice in writing. The Employee's employment shall terminate automatically in the event of his death. Any waiver of notice shall be valid only if it is made in writing and expressly refers to the applicable notice requirement of this Section 1. (c) CAUSE. The Company may terminate the Employee's employment for Cause at any time by giving the Employee notice in writing. For all purposes under this Agreement, "Cause" shall mean (i) a failure by the Employee to perform his duties, other than a failure resulting from the Employee's complete or partial incapacity due to physical or mental illness or impairment, (ii) misconduct or fraud or (iii) conviction of, or a plea of "guilty" or "no contest" to, a felony. (d) DISABILITY. The Company may terminate the Employee's active employment due to Disability by giving the Employee 30 days' advance notice in writing. For all purposes under this Agreement, "Disability" shall mean that the Employee, as the time notice is given, has not performed his duties under this Agreement for at least 90 working days in a period of not more than 365 consecutive days as the result of his incapacity due to physical or mental illness. (e) RETIREMENT. The Company may terminate the Employee's employment due to the Employee having attained the later of (i) the Company's normal retirement age or (ii) 65 years old (hereinafter referred to as "Retirement") by giving the Employee 30 days advance notice in writing. (f) RIGHTS UPON TERMINATION. Except as expressly provided in Sections 6 and 7, upon the termination of the Employee's employment pursuant to this Section 1, the Employee shall only be entitled to the compensation, benefits and reimbursements described in Sections 3, 4 and 5 for the period preceding the effective date of the termination. The payments under this Agreement shall fully discharge all responsibilities of the Company to the Employee upon the termination of his employment. (g) TERMINATION OF AGREEMENT. This Agreement shall terminate when all obligations of the parties hereunder have been satisfied. 2. EMPLOYEE'S DUTIES. During the term of his employment under this Agreement, the Employee shall devote his full business efforts and time to the Company and its subsidiaries and shall not render services to any other person or entity without the prior written consent of the Company's President and Chief Executive Officer. The foregoing, however, shall not preclude the Employee from engaging in appropriate civic, charitable or religious activities or from devoting a reasonable amount of time to private investments that do not interfere or conflict with his responsibilities to the Company. 3. BASE COMPENSATION. During the term of his employment under this Agreement, the Company agrees to pay the Employee as compensation for his services a base salary at the annual rate of $129,996 or at such higher rate as the Company may determine from time to time. Such salary shall be payable in accordance with the Company's standard payroll procedures. Once the Company has increased such salary, it thereafter shall not be reduced. (The annual compensation specified in this Section 3, together with any increases in such compensation that the Company may grant from time to time, is referred to in this Agreement as "Base Compensation.") -2- 4. EMPLOYEE BENEFITS. During the term of his employment under this Agreement, the Employee shall be eligible to participate in employee benefit plans and executive compensation programs maintained by the Company, subject in each case to the generally applicable terms and conditions of the plan or program in question and to the determination of any person or committee administering such plan or program. 5. BUSINESS EXPENSES. During the term of his employment under this Agreement, the Employee shall be authorized to incur necessary and reasonable travel, entertainment and other business expenses in connection with his duties hereunder. The Company shall reimburse the Employee for such expenses upon presentation of an itemized account and appropriate supporting documentation, all in accordance with the Company's generally applicable policies. 6. CHANCE IN CONTROL. (a) DEFINITION. For all purposes under this Agreement, "Change in Control" shall mean the occurrence of any of the following events after the date of this Agreement: (i) A change in the composition of the Company's Board of Directors (the "Board"), as a result of which fewer than two-thirds of the incumbent directors are directors who either (A) had been directors of the Company 24 months prior to such change or (B) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; or (ii) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) through the acquisition or aggregation of securities is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"), except that any change in the relative beneficial -3- ownership of the Company's securities by any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. (b) GOOD REASON. For purposes of Section 6 under this Agreement, unless otherwise consented to by Employee, "Good Reason" shall mean that the Employee: (i) Has been demoted; (ii) Has incurred a substantial reduction in his authority or responsibility; or (iii) Has incurred a reduction in his Base Compensation; except that a mere change in reporting relationship as a result of organizational restructuring shall not be considered "Good Reason". (c) SEVERANCE PAYMENT. If, during the term of this Agreement and within two years after the occurrence of a Change in Control, the Employee voluntarily resigns his employment for Good Reason or the Company terminates the Employee's employment for any reason other than Cause or Retirement, then the Employee shall be entitled to receive a severance payment from the Company (the "Severance Payment"). The Severance Payment shall be made in a lump sum not more than five business days following the date of the employment termination and shall be in an amount determined under Subsection (d) below. The Severance Payment shall be in lieu of any further payments to the Employee under Section 3 and any further accrual of benefits under Section 4 with respect to periods subsequent to the date of the employment termination. (d) AMOUNT. The amount of the Severance Payment shall be equal to 1.5 times the Employee's annual rate of Base Compensation, as in effect on the date of the employment termination. (e) INCENTIVE PROGRAMS. If, during the term of this Agreement, a Change in Control occurs with respect to the Company, the Employee shall become fully vested in all awards heretofore or hereafter granted to him under all incentive compensation, deferred compensation, bonus, stock -4- option, stock appreciation rights, restricted stock, phantom stock or similar plans maintained by the Company, any contrary provisions of such plans notwithstanding. (f) INSURANCE COVERAGE. During the 18-month period commencing upon a termination of employment described in Subsection (c) above, the Employee (and, where applicable, his dependents) shall be entitled to continue participation in the basic group insurance plans maintained by the Company, including life, disability and health insurance programs, as if he were still an employee of the Company. Where applicable, the Employee's salary for purposes of such plans shall be deemed to be equal to his Base Compensation. To the extent that the Company finds it impossible to cover the Employee under its group insurance policies during such 18-month period, the Company shall provide the Employee with the same level of coverage at the same cost under individual policies. (g) NO MITIGATION. The Employee shall not be required to mitigate the amount of any payment contemplated by this Section 6 (whether by seeking new employment or in any other manner), nor shall any such payment be reduced by any earnings that the Employee may receive from any other source. (h) POOLING-OF-INTEREST ACCOUNTING RULES. Any other provisions of this Agreement shall be invalid to the extent that the implementation of such provision would preclude the application of pooling-of-interests accounting treatment to a transaction (including a Change in Control) for which such treatment is to be adopted by the Company and which has been approved by the Board of Directors of the Company. If the pooling-of-interests accounting rules require the invalidation of one or more provisions of this Agreement, the adverse impact on the Employee shall be proportionate to the adverse impact on all similarly situated employees of the Company, as determined by the Board of Directors of the Company. All determinations regarding the pooling-of-interests accounting rules for purposes of this Subsection (h) shall be made by the independent auditors retained by the Company most recently prior to the Change of Control ("the Auditors"). 7. TERMINATION BY COMPANY WITHOUT CAUSE. (a) CONTINUATION PERIOD. If, during the term of this Agreement, the Company terminates the Employee's employment for any reason other than Cause, Retirement or Disability and if Section 6 does not apply, then the Employee shall be entitled to receive all of the payments -5- and benefit coverage described in this Section 7. Such payments and benefit coverage shall continue for the period commencing on the date when the employment termination is effective and ending on the earlier of (i) the day 12 months after such date of (ii) the date of the Employee's death (the "Continuation Period"). (b) BASE COMPENSATION. During the Continuation Period, the Company shall pay the Employee, in accordance with Section 3, his Base Compensation at the annual rate in effect on the date of the employment termination. (c) INSURANCE COVERAGE. During the Continuation Period, the Employee (and, where applicable, his dependents) shall be entitled to continue participation in all insurance or similar plans maintained by the Company, including (without limitation) life, disability, health and accident insurance programs, as if he were still an employee of the Company. Where applicable, the Employee's salary for purposes of such plans shall be deemed to be equal to his Base Compensation. To the extent that the Company finds it impossible to cover the Employee under its group insurance policies during the Continuation Period, the Company shall provide the Employee with the same level of coverage at the same cost under individual policies. (d) INCENTIVE PROGRAMS. The Continuation Period shall be counted as employment with the Company for purposes of vesting under all executive compensation programs maintained by the Company, including (without limitation) incentive compensation, deferred compensation, bonus, stock option, stock appreciation rights, restricted stock, phantom stock or similar plans maintained by the Company (any contrary provisions of such plans notwithstanding), but not including any pension, thrift or profit-sharing plan intended to qualify under section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"). The preceding sentence shall not be construed to require the Company to grant any new awards to the Employee under such executive compensation programs during the Continuation Period. The Continuation Period shall also be counted as employment with the Company for purposes of determining the expiration date of any stock option granted by the Company and held by the Employee when his employment terminates. (e) MITIGATION AND NEW EMPLOYMENT. The Employee shall not be required to mitigate the amount of any cash payment contemplated by this Section 7, nor shall any such payment be reduced by any earnings that the Employee may receive from any other source. All of the Employee's insurance coverage under Subsection (c) above shall be -6- discontinued (subject to applicable law) when the Employee becomes eligible for any group insurance coverage in connection with new employment or self-employment, regardless of whether the new group insurance coverage is equivalent to the coverage described in Subsection (c) above. 8. LIMITATION ON PAYMENTS. (a) BASIC RULE. Any other provision of this Agreement notwithstanding, the Company shall not be required to make any payment or transfer any property to, or for the benefit of, the Employee (under this Agreement or otherwise) that would be nondeductible by the Company by reason of section 280G of the Code or that would subject the Employee to the excise tax described in section 4999 of the Code. All calculations required by this Section 8 shall be performed by Auditors, based on information supplied by the Company and the Employee, and shall be binding on the Company and the Employee. All fees and expenses of the Auditors shall be paid by the Company. (b) REDUCTIONS. If the amount of the aggregate payments or property transfers to the Employee must be reduced under this Section 8, then the Employee shall direct in which order the payments or transfers are to be reduced, but no change in the timing of any payment or transfer shall be made without the Company's consent. As a result of uncertainty in the application of sections 280G and 4999 of the Code at the time of an initial determination by the Auditors hereunder, it is possible that a payment will have been made by the Company that should not have been made (an "Overpayment") or that an additional payment that will not have been made by the Company could have been made (an "Underpayment"). In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against the Company or the Employee that the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment shall be treated for all purposes as a loan to the Employee that he shall repay to the Company, together with interest at the applicable federal rate specified in section 7872(f) (2) of the Code; provided, however, that no amount shall be payable by the Employee of the Company if and to the extent that such payment would not reduce the amount that is nondeductible under section 280G of the Code or is subject to an excise tax under sections 4999 of the Code. In the event that the Auditors determine that an Underpayment has occurred, such Underpayment shall promptly be paid or transferred by the Company to, or for the benefit of, the Employee, together with interest at the applicable federal rate specified in section 7872(f) (2) of the Code. -7- 9. SUCCESSORS. (a) COMPANY'S SUCCESSORS. The Company shall require any successor (whether direct or indirect and whether by purchase, lease, merger, consolidation, liquidation or otherwise) to all substantially all of the Company's business and/or assets, by an agreement in substance and form satisfactory to the Employee, to assume this Agreement and to agree expressly to perform this Agreement in the same manner and to the same extent as the Company would be required to perform it in the absence of a succession. The Company's failure to obtain such agreement prior to the effectiveness of a succession shall be a breach of this Agreement and shall entitle the Employee to all of the compensation and benefits to which he would have been entitled hereunder if the Company had involuntarily terminated his employment without Cause immediately after such succession becomes effective. For all purposes under this Agreement, the term "Company" shall include any successor to the Company's business and/or assets which executes and delivers the assumption agreement described in this Subsection (a) or which becomes bound by this Agreement by operation of law. (b) EMPLOYEE'S SUCCESSORS. This Agreement and all rights of the Employee hereunder shall inure to the benefit of, and be enforceable by, the Employees' personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. 10. NO DISCLOSURE OR SOLICITATION. (a) CONFIDENTIAL INFORMATION. During the term of this Agreement and at all times thereafter, the Employee shall not, without the prior written consent of the Board, disclose or use for any purpose (except in the course of his employment under this Agreement and in furtherance of the business of the Company) confidential information, proprietary data and customer lists of the Company, except as required by applicable law or legal process; provided, however, that "confidential information, proprietary data and customer lists" shall not include any information known generally to the public or ascertainable from public or published information (other than as a result of unauthorized disclosure by the Employee) or any information of a type not otherwise considered confidential by persons engaged in the same business or a business similar to that conducted by the Company. The Employee agrees to deliver to the Company at the termination of his employment, or at any other time the Company may request, all memoranda, notes, plans, records, lists, reports and any other documents (and -8- copies thereof) relating to the business of the Company which he may then possess or have under his control. (b) SOLICITATION OF EMPLOYEES. During the term of this Agreement and, in the event of a termination under Section 7, during the Continuation Period, the Employee shall not, directly or indirectly: (i) Contact any employee or consultant of the Company or any of its subsidiaries to solicit such employee or consultant (or any entity in which such employee or consultant has a significant equity interest) to become an employee, partner or independent contractor of the Employee or any other person; or (ii) Employ or retain any present or former employee or consultant of the Company or any of its subsidiaries (or any entity in which such employee or consultant has a significant equity interest) as an employee, partner or independent contractor of the Employee or any other person. 11. MISCELLANEOUS PROVISIONS. (a) NOTICE. Notices and all other communications contemplated by this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or when mailed by U.S. registered mail, return receipt requested and postage prepaid. In the case of the Employee, mailed notices shall be addressed to him at the home address which he most recently communicated to the Company in writing. In the case of the Company, mailed notices shall be addressed to its corporate headquarters, and all notices shall be directed to the attention of its Secretary. (b) WAIVER. No provisions of this Agreement shall be modified, waived or discharged unless the modification, waiver or discharge is agreed to in writing and signed by the Employee and by an authorized officer of the Company (other than the Employee). No waiver by either party of any breach of, or of compliance with, any condition or provision of this Agreement by the other party shall be considered a waiver of any other condition or provision or of the same condition or provision at another time. (c) WHOLE AGREEMENT. No agreements, representations or understandings (whether oral or written and whether express or implied) which are not expressly set forth in this Agreement have been made or entered into by either party with respect to the subject matter hereof. This Agreement supersedes, without limitation, any prior -9- agreement entered into by the parties (or by any wholly owned subsidiary of the Company and the Employee) hereto. (d) WITHHOLDING TAXES. All payments made under this Agreement shall be subject to reduction to reflect taxes required to be withheld by law. (e) CHOICE OF LAW. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of California. (f) SEVERABILITY. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision hereof, which shall remain in full force and effect. (g) ARBITRATION. Except as otherwise provided in Section 8, any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the California Code of Civil Procedure, Section 1280 et seq., except where federal law requires otherwise, and judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. All fees and expenses of the arbitrator and such Association shall be paid as determined by the arbitrator. (h) NO ASSIGNMENT. The rights of any person to payments or benefits under this Agreement shall not be made subject to option or assignment, either by voluntary or involuntary assignment or by operation of law, including (without limitation) bankruptcy, garnishment, attachment or other creditor's process, and any action in violation of this Subsection (h) shall be void. IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by its -10- duly authorized officer, as of the day and year first above written. /s/ ED MUNNO ------------------------------------------- Employee FOUNDATION HEALTH CORPORATION By /s/ DANIEL D. CROWLEY ---------------------------------------- Title PRESIDENT ------------------------------------- -11- EX-10.15 4 EXHIBIT 10.15 Ex. 10.15 AMENDMENT NUMBER ONE TO EMPLOYMENT AGREEMENT This Amendment Number One to the Employment Agreement entered into as of November 8, 1993, by and between Ed Munno (the "Employee") and Foundation Health Corporation, a Delaware corporation (the "Company") (the "Employment Agreement") is effective as of May 1, 1996. WHEREAS, the Company desires to amend certain provisions of the Employment Agreement to, among other matters, clarify certain provisions thereof; and WHEREAS, the Employee is amendable to such amendments; NOW THEREFORE, for good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Subsection 1(a) of the Employment Agreement shall be amended by deleting such subsection it its entirety and replacing it with the following Subsection 1(a): "(a) BASIC RULE. The Company agrees to continue the Employee's employment, and the Employee agrees to remain in employment with the Company for a three-year period commencing as of the date hereof and ending May 1, 1999, unless sooner terminated pursuant to Subsection (b), (c) or (d)." 2. Subsection 1(e) shall be deleted in its entirety. 3. Subsection 1(f) shall be amended by renumbering it Subsection 1(e). 4. Subsection 1(g) shall be amended by renumbering it Subsection 1(f). 5. Section 3 shall be amended by stating the annual rate of compensation as $240,000. 6. Subsection 6(c) shall be amended by deleting the word "Retirement" in the first sentence thereof. 7. Subsection 7(a) shall be amended by deleting the word "Retirement" in the first sentence thereof. 8. REMAINING TERMS The remaining terms of the Employment Agreement shall remain in full force and effect. 1 IN WITNESS WHEREOF, each of the parties has executed this Amendment Number One, in the case of the Company, by its duly authorized officer, as of the day and year first above written. /s/ ED MUNNO ----------------------------------------- Employee FOUNDATION HEALTH CORPORATION By: /s/ DANIEL D. CROWLEY -------------------------------------- Its: CHAIRMAN, PRESIDENT & CEO ------------------------------------- 2 EX-10.16 5 EXHIBIT 10.16 Ex. 10.16 [LOGO] November 16, 1998 Cora Tellez 1932 Cortereal Avenue Oakland, CA 94611 Re: Terms of Employment Dear Cora: On behalf of Foundation Health Systems, Inc. (hereinafter the "Company"), I would like to confirm our offer to you for the exempt position of President and Chief Executive Officer of Health Net. The position will be located in Woodland Hills, California and your anticipated start date is November 16, 1998. In this position you will report directly to the President and Chief Executive Officer of the Company. You will earn a monthly salary of $29,166.67. As is our current practice, you will be 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 Company's Board of Directors ("the Committee"). You will be provided a $1,000 per month automobile allowance, subject to normal payroll deductions, and subject to any changes that may be made from time to time to the overall automobile allowance program. Upon your employment, FHS will provide to you a one-time $400,000 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-half on each of the first and second anniversaries of your date of hire. Additionally, the loan plus accrued interest will be forgiven in total prior to the second 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 below in this letter agreement. 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 instances set forth above. In addition, beginning January 1, 1999 you will be eligible to participate in the 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 1999 with a target bonus opportunity of 70 percent of your base salary. The maximum bonus payable to you under provisions of the Plan is 105 percent of base salary. Page 2 Offer ltr/Cora Tellez November 16, 1998 Any bonus payout for 1999 will be paid in 2000 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 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. Incentive compensation payments are subject to normal payroll deductions. As part of our long-term incentive program, you will be eligible to participate in the Company's stock option program. The Committee has approved a stock option grant to you on the date you commence employment with the Company (the "Grant Date") to purchase an aggregate of 200,000 shares of the Company's Class A Common Stock with an exercise price equal to the last sales price for such common stock on the New York Stock Exchange as of the Grant Date. The option will vest at the rate of 1/3 of the shares covered thereby on each of the first through third anniversaries of the Grant Date. At the end of three years, that portion of the option representing 25,000 of the underlying shares may be "put" back to the Company by you for $250,000 or retained by you, at your discretion. A stock option agreement formalizing this grant will be provided to you under separate cover following your date of hire containing the standard terms and conditions currently used by the Company. 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. It is further agreed that this initial grant to you will be considered a three-year "mega-grant" and you will therefore not be eligible to receive additional option grants for a period of three years except (i) to the extent other executive officers in a similar situation become so eligible and the Committee reasonably determines that it is equitable that such eligibility should extend to you or (ii) in such other circumstances where the Committee, in its sole discretion, determines to grant additional stock options to you based upon your future performance. At all times, all stock option grants remain within the sole discretion of the Committee. In lieu of relocation benefits, the Company will provide to you a furnished business apartment in Woodland Hills (subject to reasonable approval by the Company's President and Chief Executive Officer) and air travel as required between Oakland and Woodland Hills for the duration of your employment with the Company. In addition to the foregoing, and subject to your continued employment with the Company, you will be eligible to participate 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, tuition reimbursements and participation in our deferred compensation program. In our 401(k) plan, the Company currently matches your Page 3 Offer ltr/Cora Tellez November 16, 1998 contribution at $.50 for every dollar contributed up to six percent (6%) of your compensation (subject to certain limitations). 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. You will also be eligible to participate in the Company's existing 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. As discussed, as of your date of hire, you will receive two years of vesting credit under this SERP. 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 also provide to you up to $5,000 in annual reimbursement for expenses related to that activity. 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 (i) 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; (ii) gross misconduct or fraud; or (iii) conviction of, or a plea of "guilty" or "no contest" to, a felony except in the case such conviction or plea is the result of your good-faith efforts to act in a way that would reasonably be construed to be in the best interests of the Company and its stockholders and such action does not violate clauses (i) or (ii) above. In the event that your employment is terminated involuntarily without Cause, and you agree and sign the Company's standard Separation Agreement and Release of Claims document, you will be provided a severance package which will include a lump sum severance payment totaling twenty-four (24) 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". 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 for period of twenty-four months after termination of employment in the event the severance payment set forth in this paragraph becomes payable. 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 package which will include a lump-sum severance payment totaling thirty-six (36) months of base salary in effect at the date of your termination provided you sign the Company's standard Separation Agreement and Release of Claims. During the thirty-six (36) month period from and after the date of your termination of Page 4 Offer ltr/Cora Tellez November 16, 1998 employment, should you elect to continue your medical benefits, 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 provided you sign the Company's standard Separation Agreement and Release of Claims. 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 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 your position, duties, responsibilities or status with the Company or any new parent company of the Company, Page 5 Offer ltr/Cora Tellez November 16, 1998 or any removal of you from or any failure to reelect you to any of the positions (or functional equivalent of such positions) held by you immediately prior to a Change of Control, except in connection with the termination of your employment for disability, normal retirement or Cause or by you voluntary other than for Good Reason; b) A reduction by the Company in your annual base salary or a material reduction in the benefits or perquisites available to you as in effect immediately prior to any such reduction; c) A relocation of you to a work location more than fifty (50) miles from your work location immediately prior to such proposed relocation: provided that such proposed relocation results in a materially greater commute for you based on your 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. You agree, through the signing of this letter agreement, that your employment with the Company is at the mutual consent of you 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 Executive 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 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 Page 6 Offer ltr/Cora Tellez November 16, 1998 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 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 Company's Corporate 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, General Counsel and Secretary, Foundation Health Systems, Inc. 21600 Oxnard Street, Woodland Hills, CA 91367. Cora, we are pleased to offer you this professional opportunity 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 (818) 676-6703. Sincerely, /s/ JAY GELLERT - ------------------------------------- Jay M. Gellert President and Chief Executive Officer I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED ABOVE. /s/ CORA M. TELLEZ 12/1/98 - ---------------------------------------- -------------------------------- Signature Date EX-10.17 6 EXHIBIT 10.17 EX. 10.17 March 12, 1999 Karen Coughlin 100 E. Huron Street Apt. 3505 Chicago, Illinois 60611 Re: Terms of Employment Dear Karen: On behalf of Foundation Health Systems, Inc. (hereinafter the "Company"), I would like to confirm our offer to you for the exempt position of President and Chief Executive Officer for the Northeast Division. In this position you will report directly to the President and Chief Executive Officer of the Company. You will earn a monthly salary of $29,166.67 commencing as of November 2, 1998, although your formal "start date" for employment purposes will be as of October 23, 1998 (the date you commenced providing services to the Company). As is our current practice, you will be 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 Company's Board of Directors (the "Committee"). You will be provided a $1,000 per month automobile allowance, subject to normal payroll deductions, and subject to any changes that may be made from time to time to the overall automobile allowance program. Upon your employment, FHS will provide to you a one-time $100,000 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-half on each of the first and second anniversaries of your date of hire. Additionally, the loan plus accrued interest will be forgiven in total prior to the second 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 below in this letter agreement. 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 advisors, provided that such restructuring would Karen Coughlin March 12, 1999 Page 2 not disadvantage the Company and would not result in a modification of your obligation to repay such amount in the instances set forth above. In addition, beginning January 1, 1999 you will be eligible to participate 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 1999 with a target bonus opportunity of 70 percent of your base salary. The maximum bonus payable to you under provisions of the Plan is 105 percent of base salary. Any bonus payout for 1999 will be paid in 2000 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 annual base 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 one of the top five highest paid executive officers of the Company for any year subsequent to 1999 under applicable federal securities laws, your bonus for that year, if any, will be subject to the Company's Performance Based 162(m) Plan (the "162(m) Plan") in lieu of the Executive Incentive Plan. It is agreed that you shall not participate in the 162(m) Plan for the 1999 plan year notwithstanding the terms of such plan. Furthermore, the President and Chief Executive Officer of the Company will discuss with the Committee the performance targets contained in the Company's 162(m) Plan in the context of the Company's financial performance at an upcoming Committee meeting. Incentive compensation payments are subject to normal payroll deductions. As part of our long-term incentive program, you will be eligible to participate in the Company's stock option program. The Committee has approved a stock option grant to you effective as of October 23, 1998, the date you commenced employment with the Company (the "Grant Date"), to purchase an aggregate of 400,000 shares of the Company's Class A Common Stock with an exercise price equal to $10.84. The option will vest at the rate of 44,000 options, 88,000 options, 133,000 options, 88,000 options and 47,000 options on each of the first through fifth anniversaries of the Grant Date, respectively. As discussed, the Committee is willing to consider a performance-based acceleration with respect to the fourth and fifth year option vesting. A stock option agreement formalizing this grant will be provided to you under separate cover containing the standard terms and conditions currently used by the Company. Any future recommendation for additional options made by the Company's management will Karen Coughlin March 12, 1999 Page 3 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. It is further agreed that this initial grant to you will be considered a three-year "mega-grant" and you will therefore not be eligible to receive additional option grants for a period of three years. At all times, all stock option grants remain within the sole discretion of the Committee. In lieu of relocation benefits (other than the transport of household goods already arranged for by the Company), the Company will provide to you an apartment in New York City (subject to reasonable approval by the Company's President and Chief Executive Officer) and travel to and from Chicago for you or your significant other or one of your family members on a weekly basis for the duration of your employment with the Company. In addition to the foregoing, and subject to your continued employment with the Company, you will be eligible to participate 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, 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%) of your compensation (subject to certain limitations). 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. You will also be eligible to participate in the Company's existing 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 also provide you up to $5,000 in annual reimbursement for expenses related to that activity. Karen Coughlin March 12, 1999 Page 4 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 sign the Company's standard Separation Agreement and Release of Claims document, you will be provided a severance package which will include a lump-sum severance payment totaling twenty-four (24) 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". 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, for a period of twenty-four months after termination of employment in the event the severance payment set forth in this paragraph becomes payable. 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 package which will include a lump-sum severance payment totaling thirty-six (36) months of base salary in effect at the date of your termination provided you sign the Company's standard Separation Agreement and Release of Claims. During the thirty-six (36) month period from and after the date of your termination of employment, should you elect to continue your medical benefits, 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 provided you sign the Company's standard Separation Agreement and Release of Claims. 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")), Karen Coughlin March 12, 1999 Page 5 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; e) The Company transfers sustantially 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 your position, duties, responsibilities or status with the Company or any new parent company of the Company, or any removal of you from or any failure to Karen Coughlin March 12, 1999 Page 6 reelect you to any of the positions (or functional equivalent of such positions) held by you immediately prior to a Change of Control, except in connection with the termination of your employment for disability, normal retirement or Cause or by you voluntarily other than for Good Reason; b) A reduction by the Company in your annual base salary or a material reduction in the benefits or perquisites available to you as in effect immediately prior to any such reduction; c) A relocation of you to a work location more than fifty (50) miles from your work location immediately prior to such proposed relocation; provided that such proposed relocation results in a materially greater commute for you based on your residence immediately prior to such relocation; d) The consummation by the Company of any transaction resulting in Greg Wolf (currently with Humana) being in a supervisory or management position over you, or the hire or retention of Greg Wolf by the Company resulting in the foregoing, or the consummation by the Company of any transaction with Humana if following such transaction Greg Wolf remains with the combined entity; or e) The failure of the Company to obtain an assumption agreement, encompassing this agreement, from any successor resulting from a Change of Control. You agree, through the signing of this letter agreement, that your employment with the Company is at the mutual consent of you 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 Executive 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. Karen Coughlin March 12, 1999 Page 7 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 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: - ------------------------------------------------------------------ (None other than previously disclosed to the Company) - ------------------------------------------------------------------ - ------------------------------------------------------------------ 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 Company's Corporate Human Resources Department of the situation immediately. Karen Coughlin March 12, 1999 Page 8 Finally, this letter sets forth all the terms of this offer of employment. It supercedes 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, General Counsel and Secretary, Foundation Health Systems, Inc., 21650 Oxnard Street, Woodland Hills, CA 91367. Karen, we are pleased to offer you this professional opportunity 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 (818) 676-6703. Sincerely, /s/ Jay M. Gellert - ------------------------------------- Jay M. Gellert President and Chief Executive Officer I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED ABOVE. Karen A. Coughlin 3-19-99 - -------------------------------------- -------------------------------------- SIGNATURE DATE EX-10.18 7 EXHIBIT 10.18 Ex. 10-18 [LOGO] September 22, 1998 Mr. Robert Bruce Foundation Health Systems, Inc. 225 North Main Street Pueblo, Colorado 81003 Re: Terms of Employment Dear Bob: On behalf of Foundation Health Systems, Inc. (hereinafter the "Company"), I would like to confirm our offer to you for the exempt position of President of FHS Central Division. In this position you will report directly to the President and Chief Executive Officer of the Company. Effective June 1, 1998, you will earn a monthly salary of $26,250.00. As is our current practice, you will continue to be 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. You will continue to receive a $1,000 per month automobile allowance and an annual reimbursement of up to $5,000 for financial/tax planning, subject to any changes that might be made from time to time to the overall programs. As part of this offer, within thirty days of acceptance or no later than January 31, 1999, at your option, you will receive a $50,000 engagement bonus. This engagement bonus will be "grossed up" to compensate you for any related income tax obligations. In addition, during 1998 you will be eligible to participate in the Executive Incentive Plan as a Group 1 participant. The plan allows you an opportunity to earn an incentive bonus each year of 70 to 105 percent of your base salary if target EPS is achieved or exceeded, subject to terms of such plan. The receipt of any such incentive compensation is contingent upon achieving corporate and individual objectives that will be approved by the President and Chief Executive Officer of the Company. However, it is anticipated that your personal objectives will reflect Florida financial results, modified to take into account the FHNI, reforecast and a reforecast of the Western Division to be agreed upon by October 1, 1998 between yourself and the President and Chief Executive Officer. 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 prior fiscal year. Incentive compensation payments are subject to normal payroll deductions. The Compensation and Stock Option Committee of the Company's Board of Directors (hereinafter the "Committee") has agreed that you will be granted the following options to purchase shares of the Company's Class A Common Stock under the Company's 1997 Stock Option Plan (the "Plan") as of the dates set forth: 75,000 Shares (7-1-98) 25,000 Shares (1-1-99) 25,000 Shares (7-1-99) The exercise price for the options will be equal to the fair market value of a share of the Company's Class A Common Stock on the date of grant as set forth in the Plan. These grants will be evidenced by the Company's standard agreement which will be forwarded to you following the dates of the grants. 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 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%) of base salary (subject to certain limits). 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 services, and 25 days per year thereafter. However, you will not accrue less than your current rate of PTO accrual. 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 these or any other benefit plans of the Company at any time, with or without notice. You will also be eligible to continue to participate in the Company's existing 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 retirements benefits provided by the Company and with 50 percent of your social security benefits. Specific terms and conditions of the severance and change of control program applicable to you that have been approved by the Committee will be evidenced by a Severance Payment Agreement which will be prepared by our Legal Department and forwarded to you under separate cover. Should you be required to relocate from your current primary work location the Company will provide you relocation assistance as outlined in our Relocation Benefits program. This reimbursement of relocation expense will be grossed up to cover the associated income tax liability that you would likely incur. A copy of the Relocation Benefits program is attached. In addition to the relocation benefits provided under our Relocation Benefits program, the Company and you have agreed to the following: - - You will continue to maintain your primary residence and business office in Philadelphia for the immediate future. - - The Company will provide you with a leased corporate apartment and a business office in the Denver, Colorado area. - - You will travel to the Denver based office as often as business needs may require and during these visits will utilize the corporate apartment provided. - - If following discussion between yourself and the Company regarding a new primary assignment it is determined that relocation is required, you will immediately offer your home in Philadelphia for sale. In the event that the home does not sell within 90 days of its placement on the real estate market, the Company will arrange to purchase the home at a price determined by the average of two independent certified appraisals. - - You will be reimbursed by the Company for up to three (3) points (in total) to reduce the finance interest rate and pay for the loan origination fee for your new residence at your new location. - - If you purchase a residence in a new employment location and the closing precedes the sale of your house in Pennsylvania, the Company will provide a bridge loan necessary to cover the down payment on the new residence purchase and advance you the good faith estimate of approvable closing costs. Following the actual close of the real estate transaction, any necessary reconciliation on the closing costs will be completed. The bridge loan will be repaid to the Company immediately following the close on the sale of your Pennsylvania residence. - - Should you purchase a residence in a new employment location prior to selling your residence in Pennsylvania and consequently you have two mortgage payments, in lieu of continuing temporary living expense payments, the Company will reimburse you the interest portion of the lesser of the two mortgage payments. The dual mortgage payment reimbursement will continue until the Pennsylvania residence is sold. - - Following relocation to a new employment location and until your family is relocated, the Company will reimburse you for bi-weekly weekend travel for you or your spouse. Trips may be taken every other weekend and effort should be made by you to book the travel well in advance to reduce the expense. PAGE 4 You agree, through the signing of this letter, that your employment with the Company is at the mutual consent of each of the 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 Executive 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 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 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: - -------------------------------------------------------------------------- - -------------------------------------------------------------------------- - -------------------------------------------------------------------------- PAGE 5 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 President and Chief Operating Officer of the Company 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 including but not limited to your prior employment letter agreement. 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. Bob, we are pleased to offer you this opportunity and are excited about the contributions that you can make to the Company in this expanded responsibility. Should you have any questions please feel free to contact me at (916) 631-5061. Sincerely, /s/ Danny O. Smithsen Danny O. Smithsen Senior Vice President Corporate Human Resources Attachment: Relocation Benefit guideline CC: Jay Gellert I HEREBY ACCEPT AND AGREE TO THE TERMS OF THIS OFFER OF EMPLOYMENT AS OUTLINED ABOVE. - ---------------------------------------- ------------------------------- SIGNATURE DATE EX-10.19 8 EXHIBIT 10.19 Ex. 10.19 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT (this "Agreement") made and entered into as of the 31st day of December, 1997, by and between Foundation Health Systems, Inc., a Delaware corporation ("Parent") and Robert L. Natt (the "Executive"). WHEREAS, Parent and PHS have entered into an Agreement and Plan of Merger (the "Merger Agreement"), dated as of May 8, 1997, pursuant to which, among other things, a wholly owned subsidiary of Parent will be merged with and into Physicians Health Services, Inc. ("PHS") as of the "Effective Time," as defined in the Merger Agreement (such transaction, the "Merger"); WHEREAS, the Executive is currently serving as President and Co-Chief Executive Officer of PHS and the Board of Directors of Parent (the "Board") desires to secure the continued employment of the Executive in accordance herewith; WHEREAS, PHS is party with the Executive to an employment agreement, effective as of October 29, 1996, and a conditional employment agreement, effective as of March 13, 1995 (such agreements, collectively, the "Prior Agreements"); WHEREAS, Parent desires to employ the Executive, and the Executive desires to be employed by Parent, on the terms and conditions herein set forth and in lieu of the terms and conditions of the Prior Agreements; and WHEREAS, the parties desire to enter into this Agreement effective as of the Effective Time, setting forth the terms and conditions for the employment relationship of the Executive with Parent and PHS; NOW, THEREFORE, in consideration of the mutual premises and the respective covenants and agreements of the parties herein contained, the parties hereto agree as follows: 1. OPERATION OF AGREEMENT; EMPLOYMENT AND TERM. (a) This Agreement shall be effective and binding immediately upon its execution by all parties hereto, but anything in this Agreement to the contrary notwithstanding, this Agreement shall not be operative unless and until the Effective Time occurs. Upon the occurrence of the Effective Time, without further action, this Agreement shall become immediately operative. (b) EMPLOYMENT. Parent agrees to employ the Executive, and the Executive agrees to be employed by Parent, in accordance with the terms and provisions of this Agreement. (c) TERM. The term of this Agreement (the "Term") shall commence on the date (the "Effective Date") on which the Effective Time occurs and shall continue until December 31, 2000 (such period, the "Initial Term"); PROVIDED, HOWEVER, that, commencing on January 1, 2001 and each successive January 1 thereafter, the Initial Term shall automatically be extended for one (1) additional year unless, not later than July 1 of the preceding year, either party shall have given notice (i) of nonrenewal of the Term or (ii) that such party wishes to renegotiate the terms of this Agreement. 2. DUTIES AND POWERS OF EXECUTIVE. (a) POSITION AND DUTIES. For the period during which the Executive provides services to Parent under this Agreement (the "Employment Period"), the Executive shall be responsible for and manage the tri-state (New York, Connecticut and New Jersey) operations of Parent. The Executive in this capacity agrees to use his best efforts during the Employment Period to protect, encourage and promote the interests of Parent and to perform such other duties consistent with his position that may be reasonably assigned to him by the President or Chief Executive Officer of Parent and/or by the Board. During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive shall devote substantially all of his attention and time during normal business hours to the business and affairs of the Company and shall use his reasonable best efforts to carry out his duties and responsibilities faithfully and efficiently. It shall not be considered a violation of the foregoing for the Executive to serve on corporate, industry, civic or charitable boards or committees, as long as such activities do not materially interfere with the performance of his duties and responsibilities with Parent in accordance with this Agreement. 2 (b) LOCATION. The Executive's services shall be performed primarily at One Far Mill Crossing, Shelton, Connecticut, 06484 (the "Principal Place of Employment"), or in such other place as such offices are relocated. Throughout the Employment Period, the Executive shall be provided with appropriate office space and secretarial services commensurate with his title and position. 3. COMPENSATION. The Executive shall receive the following compensation for his services hereunder to the Company: (a) SALARY. During the Employment Period, the Executive's annual base salary ("Base Salary") shall be $320,000, payable in accordance with Parent's general payroll practices as in effect from time to time. (b) CASH-BASED INCENTIVE COMPENSATION. (i) GENERAL. During the Employment Period, the Executive shall be eligible to participate in Parent's short-term and long-term incentive compensation plans, including equity-based compensation plans, on a basis no less favorable than that of other similarly situated executives of Parent. The Executive hereby acknowledges that the Compensation and Stock Option Committee of the Board (the "Committee") has sole discretion to determine the amount of annual cash bonus or other incentives that may be earned by the Executive under Parent's Annual Management Bonus Plan (as adopted by the Committee on June 6, 1997) or any other such plan in which the Executive may participate during the Employment Period; however, Parent hereby agrees to recommend to the Committee that the Executive's annual cash bonus for that annual period of the Term commencing on January 1, 1998, will be targeted to 70% of his Base Salary if performance goals are met, and that such percentage of Base Salary may be increased if and to the extent that performance goals for such plan year are exceeded. If he is deemed to be one of Parent's five highest-paid executive officers for any given year during the Employment Period, the Executive shall participate in Parent's Performance-Based Annual Bonus Plan as adopted by Parent's stockholders in 1997 (or any successor plan thereto), in lieu of the Annual Management Bonus Plan (or any successor plan thereto). (ii) 1997 BONUS. Parent and the Executive hereby agree that the Executive's bonus in respect 3 of the period ending on December 31, 1997, shall be determined in accordance with the terms of PHS's existing bonus plan, which amount shall be subject to the attainment of the goals set forth in such plan and which amount must be fully budgeted and accrued for in the financial statements of PHS presented to Parent pursuant to the terms of the Merger Agreement. (iii) SIGNING BONUS. As soon as practicable, but in no event later than five (5) business days following the Effective Time, Parent shall pay to the Executive a lump sum in cash equal to $46,500 (net of applicable withholding tax). (iv) RETENTION BONUS. Parent shall pay to the Executive an aggregate amount in cash equal to $500,000 (such aggregate amount, the "Retention Bonus"), as follows: $250,000 (less applicable withholding tax) no later than five (5) days following the first anniversary of the Effective Time; and $250,000 (less applicable withholding tax) no later than five (5) days following the second anniversary of the Effective Time. The Retention Bonus shall become payable to the Executive only if he is employed hereunder upon such anniversary dates; PROVIDED, HOWEVER, that any portion of the Retention Bonus not yet paid to the Executive shall become immediately due and payable upon the Executive's Date of Termination (as defined herein) in the event that such termination of employment occurs prior to the second anniversary of the Effective Time and is (A) by Parent for other than "Cause" or (B) by the Executive for "Good Reason" (as each such term is defined herein). (c) EQUITY-BASED INCENTIVE COMPENSATION. (i) The Executive hereby acknowledges and agrees that he will not be eligible for participation in any equity-based compensation or incentive plans of Parent until after the third anniversary of the Effective Time, and except as provided in this Section 3(c)(i), the Executive is not entitled to be granted any equity-based awards during the three (3) year period commencing upon the Effective Time and ending upon the third anniversary thereof. In lieu of participation in Parent's equity-based compensation plans until the third anniversary of the Effective Time, Parent shall grant to the Executive, as of the Effective Time, a nonqualified option (the "Special Option") under Parent's 1997 Stock Option Plan (the "Parent Option Plan") to purchase an aggregate of 4 150,000 shares of the common stock (the "Common Stock") of Parent on the terms and conditions set forth in the Option Agreement attached hereto as Exhibit A at an exercise price equal to the Fair Market Value (as defined in the Parent Option Plan) of the Common Stock as of the Effective Time. (ii) Beginning on the third anniversary of the Effective Time, for the remainder of the Employment Period, the Executive will be eligible to participate in Parent's equity-based compensation plans on terms, if any, to be determined by the Committee. (d) OTHER BENEFITS. During the Employment Period, the Executive shall be eligible to participate in savings, retirement, supplemental retirement, welfare (including without limitation medical, dental, hospitalization and life insurance, and short-term and long-term disability) and fringe benefit plans, practices, policies and programs of Parent on a basis no less favorable to the Executive than in effect with respect to similarly situated executives of Parent. Except as provided in the Merger Agreement, the Executive shall also be entitled to carry-over all accrued benefits, such as vacation and sick days, that he would have received from his former employment but for the fact of the termination of the Prior Agreements. During the Employment Period, Parent shall make available to the Executive, at its cost and expense, (i) a leased automobile on terms substantially similar to that in effect with respect to similarly situated executives of Parent, which terms shall include reasonable insurance and maintenance costs and (ii) membership at two (2) private clubs in New York City, which memberships shall be used by the Executive for the purposes of business entertainment on behalf of Parent. 4. EXPENSES. Parent shall reimburse the Executive for all reasonable expenses, including expenses for first-class air travel, other travel and entertainment and parking fees in New York City, properly incurred by him in the performance of his duties hereunder in accordance with policies established from time to time by the Board. Parent shall also pay all reasonable legal expenses of the Executive, up to a maximum of $15,000, that are incurred in connection with negotiating this Agreement. 5 5. TERMINATION OF EMPLOYMENT. (a) DEATH. The Employment Period shall be terminated automatically by Parent upon the Executive's death during such period, in which case the Executive shall be entitled to the payments and benefits set forth in Section 6(d) of this Agreement. (b) BY PARENT FOR CAUSE. Parent may terminate the Executive's employment hereunder for Cause, in which case the Executive shall be entitled to the payments and benefits set forth in Section 6(d) of this Agreement. For purposes of this Agreement, "Cause" includes, without limitation, acts of dishonesty, insubordination, incompetence or moral turpitude, conviction of a felony which is materially and demonstrably injurious to the Company, habitual drunkenness, narcotic drug addiction, or other material misconduct of any kind. Poor performance of the Company shall not, in and of itself, be considered "Cause." In the event that the Executive receives a Notice of Termination for Cause in accordance with Sections 5(f) and 10(b) hereof which indicates that the Executive has acted (or failed to act) in a manner constituting insubordination, incompetence or other material misconduct, the Executive shall have the opportunity, during a fourteen (14) day period beginning on the date of receipt of such Notice, to cure such act or failure to act. Further, actions taken at the direction of the Board, or actions based on the recommendations of Parent's legal counsel or qualified outside advisors shall be presumed to be taken in good faith and for the best interest of the Company. (c) BY THE EXECUTIVE FOR GOOD REASON. The Executive may terminate his employment hereunder for Good Reason, unless Parent shall have previously delivered to the Executive written notice that Cause exists (except that such notice shall not be required in the case of a termination resulting from the Executive's conviction of the type of felony set forth in Section 5(b) above), in which case the Executive shall be entitled to the payments and benefits set forth in Section 6(a) or 6(b) of this Agreement, as applicable. For purposes of this Agreement, "Good Reason" shall mean (i) a reduction in the Executive's reporting duties, such that he no longer reports directly to the President of Parent; (ii) a material reduction by Parent in the Execu- 6 tive's annual base salary as in effect on the date hereof (except for across-the-board salary reductions similarly affecting all senior executives of Parent); (iii) the relocation of the Executive's Principal Place of Employment to a location more than 50 miles from the Executive's Principal Place of Employment (except for required travel on Parent's or PHS's business); or (iv) the failure of Parent to pay to the Executive any portion of the Executive's compensation (except pursuant to an across-the-board compensation deferral similarly affecting all senior executives of Parent) within five (5) business days of the date such compensation is due. In order for any termination for Good Reason to be effective, the Executive shall have delivered to Parent written notice of the act or failure to act giving rise to such termination for Good Reason with thirty (30) days following the first occurrence of such event or condition, and Parent shall have been given ten (10) business days from the receipt of such written notice to cure such act or failure to act. (d) BY PARENT OTHER THAN FOR CAUSE OR DEATH. Notwithstanding any other provision of this Agreement, Parent may terminate the Executive's employment other than for Cause or death, in which case the Executive shall be entitled to the payments and benefits set forth under Section 6(a) or (6)(b) of this Agreement, as applicable. (e) BY THE EXECUTIVE OTHER THAN FOR GOOD REASON. Notwithstanding any other provision of this Agreement, the Executive may terminate his employment other than for Good Reason, in which case the Executive shall be entitled to the payments and benefits set forth under Section 6(d) of the Agreement. (f) NOTICE OF TERMINATION. Any termination by Parent or by the Executive shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 10(b) of this Agreement. For purposes of this Agreement, a "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated, and (iii) if the Date of Termination (as defined in paragraph (g) of this Section 5) is other than the date of receipt of such 7 notice, specifies the termination date (which date shall be not more than thirty (30) days after the giving of such notice). The failure by the Executive or Parent to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason shall not waive any right of the Executive hereunder or preclude the Executive from asserting such fact or circumstance in enforcing the Executive's rights hereunder. (g) DATE OF TERMINATION. "Date of Termination" means (i) if the Executive's employment is terminated by the Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if the Executive's employment hereunder is terminated by Parent other than on account of death, or by the Executive other than for Good Reason, the date on which Notice of Termination is delivered and (iii) if the Executive's employment is terminated by reason of death, the date of death. 6. OBLIGATIONS OF PARENT UPON TERMINATION. (a) TERMINATION DURING FIRST TWO YEARS OF TERM BY THE EXECUTIVE FOR GOOD REASON OR BY PARENT OTHER THAN FOR CAUSE. If, during the first two (2) years of the Term, the Executive shall terminate his employment for Good Reason or Parent shall terminate the Executive's employment for any reason other than Cause or death, the Executive shall be entitled to the following benefits: (i) Parent shall pay to the Executive all vested benefits to which the Executive is entitled under the terms of the employee benefit plans in which the Executive is a participant as of the Date of Termination and a lump sum amount in cash equal to the sum of (A) the Executive's Base Salary through the Date of Termination to the extent not theretofore paid, (B) any compensation previously deferred by the Executive (together with any accrued interest or earnings thereon) and any accrued vacation pay and (C) any other amounts due the Executive as of the Date of Termination, in each case to the extent not theretofore paid (hereinafter referred to as the "Accrued Obligation"). The amounts specified in this Section 6(a)(i) shall be paid within thirty (30) days after the Date of Termination; and 8 (ii) in lieu of any severance benefit otherwise payable to the Executive, (A) Parent shall pay to the Executive, within five (5) days following the Date of Termination, a lump sum amount in cash equal to the product of (x) the Executive's Base Salary as in effect as of the Date of Termination and (y) (I) if such termination is by the Executive under Section 5(c)(i) hereof, the number two (2) or (II) if such termination is by the Executive under clause (ii), (iii) or (iv) of paragraph 5(c) hereof (or by Parent other than for Cause or death), the number 2.99; and (B) for a period of one (1) year following the Date of Termination, Parent shall continue to provide the Executive and his dependents with medical (including hospital, surgical, and major medical) insurance coverage as in effect as of the Date of Termination; PROVIDED, HOWEVER, that Parent's obligation to provide benefits under this Section 5(a)(ii)(B) shall be reduced to the extent similar benefits are provided by a subsequent employer. (b) TERMINATION DURING REMAINDER OF TERM BY THE EXECUTIVE FOR GOOD REASON OR BY PARENT OTHER THAN FOR CAUSE OR DEATH. During the period commencing on the second anniversary of the Effective Time and continuing until the end of the Term (as such Term may be extended), if the Executive shall terminate his employment for Good Reason or Parent shall terminate the Executive's employment for any reason other than Cause or death, the Executive shall be entitled to the following benefits: (i) Parent shall pay to the Executive a lump sum amount in cash equal to the Accrued Obligation; and (ii) in lieu of any severance benefit otherwise payable to the Executive. (A) Parent shall pay the Executive a lump sum amount in cash, within five (5) days following the Date of Termination, equal to the product of (x) the Executive's Base Salary as in 9 effect as of the Date of Termination and (y) the number one and one-half (1.5); and (B) for a period of one (1) year following the Date of Termination, Parent shall continue to provide the Executive and his dependents with medical (including hospital, surgical, and major medical) insurance coverage as in effect as of the Date of Termination; PROVIDED, HOWEVER, that Parent's obligation to provide benefits under this Section 5(b)(ii)(B) shall be reduced to the extent similar benefits are provided by a subsequent employer. (c) NON-RENEWAL OF TERM. In the event that either party gives notice that it will not renew or extend the Term (as such Term may be extended), Parent shall, within five (5) business days following the expiration of the Term, pay the Executive a lump sum amount in cash equal to (i) the Accrued Obligation and (ii) the product of (A) the Executive's Base Salary as in effect as of the date of the expiration of the Term and (B) the number one and one-half (1.5). (d) TERMINATION FOR OTHER REASON. If the Executive's employment shall be terminated by Parent for Cause or death, or by the Executive other than for Good Reason, Parent shall have no further obligations to the Executive under this Agreement other than the obligation to pay the Executive the Accrued Obligation. (e) GROSS-UP IN CONNECTION WITH THE MERGER. If any of the payments or benefits received or to be received by the Executive in connection with the Merger (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with PHS or Parent (such payments or benefits, excluding the Gross-Up Payment (as defined below), being hereinafter referred to as the "PHS Total Payments") will be subject to the excise tax (the "Excise Tax") imposed pursuant to section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), Parent shall pay to the Executive an additional amount, in cash (the "Gross-Up Payment"), such that the net amount retained by the Executive, after deduction of any Excise tax on the PHS Total Payments and any federal, state and local income and employment taxes and Excise Tax upon any Gross-Up Payment, shall be equal to the Total Payments. 10 For purposes of determining whether any of any PHS Total Payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) all of the PHS Total Payments shall be treated as "parachute payments" (within the meaning of section 280G(b)(2) of the Code unless, in the opinion of tax counsel ("Tax Counsel") reasonably acceptable to the Executive, paid for by Parent and selected by the accounting firm which is Parent's independent auditor (the "Auditor"), such payments or benefits (in whole or in part) do not constitute parachute payments, including by reason of section 280G(b)(4)(A) of the Code, (ii) all "excess parachute payments" within the meaning of section 280G(b)(1) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of Tax Counsel, such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered (within the meaning of section 280G(b)(4)(B) of the Code) in excess of the "Base Amount," as defined in section 280G(b)(3) of the Code, allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of sections 280G(d)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income tax at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the Date of Termination (or if there is no Date of Termination, then the date on which the Gross-Up Payment is calculated for purposes of this Section 6(e)), net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Executive shall repay to Parent, within five (5) business days following the time that the amount of such reduction in the Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive), plus 11 interest on the amount of such repayment at the rate provided in section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder in calculating the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), Parent shall make an additional Gross-Up Payment in cash in respect of such excess (plus any interest, penalties or additions payable by the Executive with respect to such excess) within five (5) business days following the time that the amount of such excess is finally determined. The Executive and Parent shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the PHS Total Payments. 7. FULL SETTLEMENT; NO MITIGATION. Except as provided in Sections 6(a)(ii)(B) and 6(b)(ii)(B) hereof, Parent's obligation to make the payments provided for in this Agreement and otherwise to perform their obligations hereunder shall not be subject to any set-off, counterclaim, recoupment, defense or other claim, right or action which Parent may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts (including amounts for damages for breach) payable to the Executive under any of the provisions of this Agreement. 8. CONFIDENTIAL INFORMATION; NON-COMPETITION. (a) During the Employment Period and at all times thereafter, the Executive shall not, without the prior written consent of the Board, disclose or use for any purpose (except in the course of his employment under this Agreement and in furtherance of the business of the Company) confidential information, proprietary data and customer lists of Parent of PHS, except as required by applicable law or legal process; provided, however, that "confidential information, proprietary data and customer lists" shall not include any information known generally to the public or ascertainable from public or published information (other than as a result of unauthorized disclosure by the Employee) or any information of a type not otherwise considered confidential by persons engaged in the same business or a business similar to that conducted by Parent. The Executive 12 agrees to deliver to Parent at the termination of his employment all memoranda, notes, plans, records, lists, reports and other documents (and copies thereof) relating to the business of Parent and PHS which he may then possess or have under his control. (b) (i) During the Employment Period, the Executive shall not engage in "Competition" with Parent. For purposes of this Agreement, Competition by the Executive shall mean the Executive's engaging in, or otherwise directly or indirectly being employed by or acting as a consultant or lender to, or being a director, officer, employee, principal, agent, stockholder, member, owner or partner of, or permitting his name to be used in connection with the activities of any other business or organization anywhere in the United States which competes, directly or indirectly, with the business of Parent as the same shall be constituted at any time during or following the Term (and any extensions thereof). (ii) For the twelve (12) month period following the Employment Period, the Executive shall not engage in Competition (as defined above and modified herein for purposes of this subsection (b)(ii) only), with Parent in (a) any locality or region of the United States, and (b) any substantive area, for which the Executive had responsibility during the Employment Period; PROVIDED, that it shall not be a violation of this sub-paragraph for the Executive to become the registered or beneficial owner of up to two percent (2%) of any class of the capital stock of a competing corporation registered under the Securities Exchange Act of 1934, as amended, provided that the Executive does not actively participate in the business of such corporation until such time as this covenant expires. (iii) For the twelve (12) month period following the termination of this Agreement for any reason, the Executive agrees that he will not, directly or indirectly, for his benefit or for the benefit of any other person, firm or entity, do any of the following: (A) solicit from any customer doing business with Parent as of such termination, business of the same or of a similar nature to the business of Parent with such customer; 13 (B) solicit from any known potential customer of Parent business of the same or of a similar nature to that which has been the subject of a known written or oral bid, offer or proposal by Parent, or of substantial preparation with a view to making such a bid, proposal or offer, within six (6) months prior to such termination; (C) solicit the employment or services of, or hire, any person who was known to be employed by or was a known consultant to Parent upon the termination of this Agreement, or within six (6) months prior thereto; or (D) otherwise knowingly interfere with the business or accounts of Parent. 9. SUCCESSORS. (a) ASSIGNMENT BY EXECUTIVE. This Agreement is personal to the Executive and, without the prior written consent of Parent, shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives. (b) SUCCESSORS AND ASSIGNS. This Agreement shall inure to the benefit of and be binding upon Parent, and their respective successors and assigns. (c) ASSUMPTION. Parent shall require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets thereof to expressly assume and agree to perform this Agreement in the same manner and to the same extent that Parent, as the case may be, would be required to perform this Agreement if no such succession had taken place. As used in this Agreement, Parent shall mean Parent, as hereinbefore defined and any successor to its businesses and/or assets as aforesaid that assumes and agrees to perform this Agreement by operation of law, or otherwise. 10. MISCELLANEOUS. (a) GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of 14 New York, without reference to its principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended, modified, repealed, waived, extended or discharged except by an agreement in writing signed by the party against whom enforcement of such amendment, modification, repeal, waiver, extension or discharge is sought. (b) NOTICES. All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return-receipt requested, postage prepaid, addressed, in the case of Parent, to Parent's headquarters and, in the case of the Executive, to the address on the signature page of this Agreement or, in either case, to such other address as any party shall have subsequently furnished to the other parties in writing. Notice and communications shall be effective when actually received by the addressee. (c) ARBITRATION. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration. The parties shall utilize the services of the American Arbitration Association ("AAA"). Pursuant to its standard procedures, the AAA shall appoint one neutral arbitrator from its panel of arbitrators, unless the parties mutually agree that a panel of three (3) arbitrators be appointed, which will make decisions by a majority vote. The arbitrator or arbitrators shall have the power to award all appropriate relief as if the claims heard in this proceeding had been brought in a state court of general jurisdiction over the specific claim in question. The arbitration hearing shall be conducted in New York, New York or another location agreed to by the parties in accordance with the rules of the AAA then in effect. A Judgment may be entered on the arbitrator's or arbitrators' award in any court having jurisdiction. (d) SEVERABILITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (e) TAXES. Parent may withhold from any amounts due and payable under this Agreement such federal, state or local taxes as shall be required to be withheld pursuant to any applicable law or regulation. 15 (f) NO WAIVER. Any party's failure to insist upon strict compliance with any provision hereof or the failure to assert any right such party may have hereunder shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. (g) ENTIRE AGREEMENT; SURVIVAL. This Agreement entered into as of the date hereof among Parent and the Executive and contains the entire agreement of the Executive and Parent or their respective predecessors or subsidiaries with respect to the subject matter of the Agreement, and all promises, representations, understandings, arrangements and prior agreements, including without limitation the Prior Agreements, are superseded by this Agreement. Any provision hereof which by its terms applies in whole or part after a termination of the Executive's employment hereunder shall survive such termination. 16 IN WITNESS WHEREOF, the Executive has executed this Agreement and, pursuant to due authorization from its Board, the Company has caused this Agreement to be executed, as of the day and year first above written. FOUNDATION HEALTH SYSTEMS, INC. By /s/ Jay M. Gellert ---------------------------- Name: Title: ROBERT L. NATT /s/ Robert L. Natt ------------------------------ Address: 51 TUCKAHOE ROAD EASTON, CT 06612 17 EX-10.20 9 EXHIBIT 10.20 Ex 10.20 ROBERT L. NATT WAIVER AND RELEASE OF CLAIMS This WAIVER and RELEASE OF CLAIMS (this "Release") is made and entered into by and between Foundation Health Systems, Inc. and its affiliates and subsidiaries (hereinafter referred to as the "Company") and Robert L. Natt (hereinafter referred to as the "Employee"). WHEREAS, the Company and Employee are parties to an Employment Agreement dated December 31, 1997 (the "Employment Agreement") and desire to terminate the Employment Agreement as of the Termination Date. WHEREAS, the Company and Employee are entering into this Release as a condition to Employee's receipt of severance pay and certain other payments and benefits described below upon his or her termination of employment with the Company. NOW, THEREFORE, the Company and Employees agree as follows: 1. Employee's employment with the Company shall terminate on December 31, 1998 (the "Termination Date"). Upon execution of this Agreement, Employee shall not represent to anyone that he is an employee of the Company and shall not say or do anything purporting to bind the Company. 2. The Company shall provide Employee with the following payments and benefits: A. Following the Termination Date upon Employee's acceptance of the terms set forth herein as evidenced by Employee's signature set forth below and the expiration of the seven (7) day revocation period set forth below, Employee shall be entitled to: (i) a lump sum payment equal to $956,800 less applicable deductions and withholdings, representing 2.99 times Employee's base salary of $320,000 per year (the "Base Salary"); (ii) a lump sum payment equal to $250,000 less applicable deductions and withholdings representing Employee's retention bonus; (iii) medical, health, disability, life and accident insurance coverage for Employee and his dependents (i.e. his wife, unmarried dependent children ages 19-24 who are dependent on Employee for at least 50% of their financial support or are full-time students), at the levels and in the amounts existing at the Termination Date ("the Benefits"), through the FHS choices plan or another plan or plans of the Company's choosing, until the first to occur of the following: (a) Employee reaches age 65, or (b) Employee secures similar coverage through another employer. (iv) use of the automobile leased by the Company for Employee through September 14, 2001, the end of the lease term. The Company will continue to pay maintenance, repair insurance and other costs for the leased automobile associated with the lease through the end of the lease term provided Employee submits to the Company receipts for such repairs and maintenance. Employee shall have the option to purchase said automobile at the end of the lease term in accordance with the terms of said lease, provided Employee pays any applicable sales tax, transfer fees or other fees associated with said option to purchase; (v) payment of an amount not to exceed $12,000 to defray Employee's legal and financial planning expenses which amount shall be paid by Company directly to Employee's attorneys, Cummings & Lockwood, upon presentation of documentation by Cummings & Lockwood evidencing that such expenses have been incurred by Employee; (vi) outplacement services commensurate with that provided to other employees of the Company at Employee's level of responsibility; (vii) Employee's office chair and computer. (viii) reimbursement of Employee's University Club initiation fee and 1998 dues upon receipt of documentation showing that Employee has paid these fees and dues. B. Employee acknowledges and agrees that he has received all compensation and all earned and unused vacation/paid-time-off owing to Employee as of the Termination Date. C. The Company agrees that any stock options that were granted to Employee during his employment, will be fully vested as of the Termination Date and shall be exercisable through December 31, 2000, notwithstanding anything to the contrary contained in the applicable stock option plan of the Company. Employee further acknowledges and agrees that he is not entitled to receive or be granted and will not receive or be granted any additional stock, units, options or shares. 3. In consideration of the Company providing Employee those payments and benefits set forth in Section 2A above, and as a condition to receiving such payments and benefits, Employee freely and voluntarily enters into this Release and by signing this Release Employee, on his own behalf and on behalf of his heirs, beneficiaries, successors, representatives, trustees, administrators and assigns, hereby waives and releases the Company, and each of its past, present and future officers, directors, shareholders, employees, consultants, accountants, attorneys, agents, managers, insurers, sureties, parent and sister corporations, divisions, subsidiary corporations and entities, partners, joint venturers, affiliates, beneficiaries, successors, representatives and assigns, from any and all claims, demands, damages, debts, liabilities, controversies, obligations, actions or causes of action of any nature whatsoever, whether based on tort, statute, contract, indemnity, rescission or any other theory or recovery, including by not limited to claims arising under federal, state or local laws prohibiting discrimination in employment, including the Fair Employment and Housing Act, Title VII of the Civil Rights Act of 1964, as amended, the Civil Rights Act of 1870, as amended, claims of disability discrimination under the Americans with Disabilities Act, claims under the Age Discrimination in Employment Act, as amended ("ADEA"), the Worker Adjustment and Retraining Notification Act ("WARN") or claims for wrongful termination, breach of contract, breach of public policy, termination in violation of public policy, physical or mental harm or distress or claims arising out of the Company's right to terminate its employees, whether for compensatory, punitive, equitable or other relief, whether known, unknown, suspected or unsuspected, including without limitation claims which may have arisen or may in the future arise in connection with any event which occurred on or before the date of Employee's execution of this Release. The provisions in this paragraph are not intended to prohibit Employee from filing a claim for unemployment insurance or worker's compensation insurance. 4. Employee shall not initiate or cause to be initiated against the Company any compliance review, suit, action, investigation or proceeding of any kind, or voluntarily participate in same, individually or as a representative, witness or member of a class, under contract, law or regulation, federal, state or local, pertaining to any matter related to his employment with the Company. 5. Except as otherwise provided herein, Employee agrees he shall return to the Company immediately on execution of this Agreement any building key(s), security pass or other access or identification cards and any Company property in his possession, including but not limited to any documents, credit cards, computer equipment, mobile phones or data files. Employee agrees to submit all expense accounts and to pay promptly the outstanding balance on each corporate credit card that the Company previously issued to Employee. 6. Employee shall not, without the Company's written consent by an authorized representative, at any time prior or subsequent to the execution of this Release, disclose, use, remove or copy any confidential information, trade secret or proprietary information or customer lists of the Company, including without limitation, any technical, actuarial, economic, financial, procurement, provider, customer, underwriting, -2- contractual, managerial, marketing or other information of any type that has economic value in the business in which the Company is engaged, provided however, that confidential information, trade secret or proprietary information and customer lists shall not include any previously published information, information generally in the public domain or information required to be disclosed by applicable law or legal process. 7. A. For purposes of the Agreement, "Competition" by the Employees shall mean the Employee's engaging in, or otherwise directly or indirectly being employed by or acting as a consultant or lender to, or being a director, officer, employee, principal, agent, stockholder, member, owner or partner of, or permitting his name to be used in connection with the activities of any other business or organization anywhere in the United States which competes, directly or indirectly, with the business of the Company as the same shall be constituted at any time following the Termination Date. B. For the twelve (12) month period following the Termination Date, the Employee shall not engage in Competition (as defined above and modified herein for purposes of this subsection 7B only), with the Company in (a) any locality or region of the United States, and (b) any substantive area, for which the Employee had responsibility while employed by the Company; PROVIDED, that it shall not be a violation of this sub-paragraph for the Employee to become the registered or beneficial owner of up to two percent (2%) of any class of the capital stock of a competing corporation registered under the Securities Exchange Act of 1934, as amended, provided that the Employee does not actively participate in the business of such corporation until such time as this covenant expires. C. For the twelve (12) month period following the Termination Date, Employee agrees that he will not, directly or indirectly, for his benefit or for the benefit of any other person, firm or entity, do any of the following: (i) solicit from any customer doing business with the Company as of the Termination Date, business of the same or of a similar nature to the business of the Company with such customer; (ii) solicit from any known potential customer of the Company business of the same or of a similar nature to that which has been the subject of a known written or oral bid, offer or proposal by the Company, or of substantial preparation with a view to making such a bid, proposal or offer, within six (6) months prior to the Termination Date; (iii) solicit the employment or services of, or hire, any person who was known to be employed by or was a known consultant to the Company as of the Termination Date, or within six (6) months prior thereto; or (iv) otherwise knowingly interfere with the business or accounts of the Company. 8. Any developments or discoveries by Employee during the course of his employment with the Company through the Termination Date resulting in patents, lists of customers, trade secrets, specialized know-how or other intellectual property useful in the then current business of the Company shall be for the sole benefit of the Company. 9. Employee agrees to cooperate with the Company in defending or investigating any claim against the Company arising in whole or in part out of the Company's business during Employee's employment with the Company for which the Company requests Employee's assistance. The Company will use its reasonable best efforts to assure that any request for such cooperation will not unduly interfere with Employee's other material business and personal obligations and commitments. 10. Nothing contained herein shall be construed as an admission of any wrongful act, including but not limited to violation of any contract, express or implied, or any federal, state or local employment laws or -3- regulations, and nothing contained herein shall be used for any purpose except in proceedings related to the enforcement of this Release. 11. If any part or term of this Release is held invalid or unenforceable, such invalidity or unenforceability shall not affect in any way the validity or enforceability of any other part or term of this Release. This Release supersedes all other understandings and agreements of the parties, whether written or oral, including but not limited to the Employment Agreement. 12. Employee acknowledges that he has had an opportunity to consult and be represented by counsel of Employee's choosing in the review of this Release, and that he has been advised by the Company to do so, that the Employee is fully aware of the contents of the Release and of its legal effect, that the preceding paragraphs recite the sole consideration for this Release, and that Employee enters into this Release freely, without coercion, and based on the Employee's own judgment and not in reliance upon any representation or promise made by the other party, other than those contained herein. There may be no modification of the terms of this Release except in writing signed by the parties hereto. 13. Employee agrees and acknowledges that this Release recites all payments and benefits Employee is entitled to receive and that no other payments or benefits will be asserted or requested by Employee. 14. The Release shall be construed and governed by the laws of the State of California. Employee expressly waives the provisions of California Civil Code Section 1542 (or any applicable provision under any applicable state law) regarding the waiver of unknown claims. California Civil Code Section 1542 provides as follows: "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR EXPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR." 15. 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 Release (other than the payments required to be made pursuant to Section 2B hereof) shall be reduced (but not below zero) so that the present 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 14 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 the 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. EMPLOYEE ACKNOWLEDGES BY SIGNING BELOW that (i) Employee has not relied upon any representations, written or oral, not set forth in this Release; (ii) at the time Employee was given this Release Employee was informed in writing by the Company that (a) Employee had at least 21 days in which to consider whether Employee would sign the Release and (b) Employee should consult with an attorney before signing the Release; and (iii) Employee had an opportunity to consult with an attorney and either had such consultations or has freely decided to sign this Release without consulting an attorney. -4- Employee further acknowledges that he may revoke acceptance of this Release by delivering a letter of revocation within seven (7) days after the date set forth below addressed to: FHS Corporate Legal Department, 21600 Oxnard Street, Woodland Hills, CA 01367. Finally, Employee acknowledges that he understands that this Release shall not become effective until the eighth (8th) day following his signing this Release and that if Employee does not revoke his acceptance of the terms of this Release within the seven (7) day period following the date on which Employee signs this Release, then this Release shall be binding and enforceable. IN WITNESS WHEREOF, the parties hereto have executed this Release as of the dates set forth below. Employee Foundation Health Systems, Inc. By: /s/ Robert L. Natt By: /s/ B. Curtis Westen ----------------------------- ----------------------------- Name: Robert L. Natt Name: Title: Dated: 2/4/99 Dated: 2/4/99 -------------------------- -------------------------- -5- EX-10.21 10 EXHIBIT 10.21 [NAME] TIER 1 FORM OF SEVERANCE PAYMENT AGREEMENT This Severance Payment Agreement (this "Agreement") is entered into as of December 4, 1998 between Foundation Health Systems, Inc., a Delaware corporation (the "Company"), on the one hand, and [NAME] ("Employee"), on the other hand. WHEREAS, Employee currently serves as [TITLE]; and WHEREAS, Employee is currently party to a Severance Payment Agreement, dated April 6, 1998 (the "Existing Severance Payment Agreement"), with the Company and to an Employment Letter Agreement, dated ____, 199__ (the "Existing Employment Letter Agreement") with [a subsidiary of] the Company; and WHEREAS, in consideration for past efforts of the Employee and to entice Employee to continue to provide such efforts, the Company proposes to make the payments set forth in this Agreement in the event Employee's employment with the Company is terminated on the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, the parties 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 [TITLE]. During the term of employment, except as otherwise provided herein, Employee shall devote his/her entire productive time, energies and abilities to the business of the Company and shall at all times loyally and conscientiously perform all the duties and obligations required of him/her expressly or implicitly by the terms of this Agreement. 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 three (3) years from the date of termination and (ii) a lump sum cash payment equal to three (3) times the base salary of the Employee in effect immediately prior to the date of Employee's termination ("Base Salary"). 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 maintained immediately prior to the date of Employee's termination for a period of two (2) years from the date of termination and (ii) a lump sum cash payment equal to two (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, (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 form the Company specifying such breach or (h) breach of the provisions of Section 8 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 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 three (3) years from the date of termination and (ii) a lump sum cash payment equal to three (3) times the 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 removal of Employee from or any 2 failure to reelect Employee to any of the positions (or functional equivalent of such positions) referred to in the introductory paragraphs hereof, 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; (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 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 10.5 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; (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 3 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 following (in each case to the extent not theretofore paid): the Employee's Base Salary from the Company until 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. 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 from the date of termination and (ii) a lump sum cash payment equal to one (1) 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. All payments required to be made by the Company hereunder to Employee or his estate or beneficiaries shall be subject to the withholding of such amounts relating to taxes as the Company may reasonably determine should be withheld pursuant to any applicable law or regulation. 7. TAX CONSEQUENCES. 7.1 Notwithstanding any other provisions of this Agreement, in the event that any payment or benefit received or to be received by Employee in connection with a Change of Control or the termination of the Employee's employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any person whose actions result in a Change of Control or any person affiliated with the Company or such person) (all such payments and benefits, including the severance payments and benefits provided for in Section 3 hereof (the "Severance Payments"), being hereinafter called "Total Payments") would be subject (in whole or part), to the excise tax (the "Excise Tax") imposed under section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), then, after taking into account any reduction in the Total Payments provided by reason of section 280G of the Code in such other plan, arrangement or agreement, the cash Severance Payments shall first be reduced, and the noncash severance benefits shall thereafter be reduced, to the extent necessary so that no portion of the Total Payments is subject to the Excise Tax but only if (a) the net amount of such Total Payments, as so reduced (and after subtracting the net amount of federal, state and local income taxes on such reduced Total Payments) is greater than or equal to (b) the net amount of such Total Payments without such reduction (but after subtracting the net amount of federal, state and local income taxes on such Total Payments and the amount of Excise Tax to which the Employee would be subject in respect of such unreduced 4 Total Payments); PROVIDED, HOWEVER, that the Employee may elect to have the noncash Severance Payments reduced (or eliminated) prior to any reduction of the cash Severance Payments. 7.2 For purposes of determining whether and the extent to which the Total Payments will be subject to the Excise Tax, (i) no portion of the Total Payments the receipt or enjoyment of which the Employee shall have waived at such time and in such manner as not to constitute a "payment" within the meaning of section 280G(b) of the Code shall be taken into account, (ii) no portion of the Total Payments shall be taken into account which, in the opinion of tax counsel ("Tax Counsel") reasonably acceptable to the Employee and selected by the accounting firm (the "Auditor") which was, immediately prior to the Change of Control, the Company's independent auditor, does not constitute a "parachute payment" within the meaning of section 280G(b)(2) of the Code (including by reason of section 280G(b)(4)(A) of the Code) and, in calculating the Excise Tax, no portion of such Total Payments shall be taken into account which, in the opinion of Tax Counsel, constitutes reasonable compensation for services actually rendered, within the meaning of section 280G(b)(4)(B) of the Code, in excess of the Base Amount allocable to such reasonable compensation, and (iii) the value of any non-cash benefit or any deferred payment or benefit included in the Total Payments shall be determined by the Auditor in accordance with the principles of sections 280G(d)(3) and (4) of the Code. 7.3 At the time that payments are made under this Agreement, the Company shall provide the Employee with a written statement setting forth the manner in which such payments were calculated and the basis for such calculations including, without limitation, any opinions or other advice the Company has received from Tax Counsel, the Auditor or other advisors or consultants (and any such opinions or advice which are in writing shall be attached to the statement). 8. 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 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. 9. NON-COMPETITION. 9.1 The Employee hereby agrees that, during (i) the six-month period following a termination of the Employee's employment with the Company that entitles the Employee to receive 5 severance benefits under a written agreement with or policy of the Company or (ii) the twelve-month period following a termination of the Employee's employment with the Company that does not entitle the Employee to receive such severance benefits (the period referred to in either clause (i) or (ii), the "Noncompetition Period"), the Employee shall not undertake any employment or activity (including, but not limited to, consulting services) with a Competitor (as defined below), in any geographic areas in which the Company or its Subsidiaries operate (the "Market Area") where the loyal and complete fulfillment of the duties of the competitive employment or activity would call upon the Employee to reveal, to make judgments on or otherwise use any confidential business information or trade secrets of the business of the Company or any Subsidiary to which the Employee had access during his employment with the Company. For purposes of this Section, "Competitor" shall refer to 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. 9.2 In addition, the Employee agrees that, during the Noncompetion Period applicable to the Employee following termination of employment with the Company, the Employee shall not, directly or indirectly, solicit, interfere with, hire, offer to hire or induce any person, who is or was an employee of the Company or any of its Subsidiaries at the time of such solicitation, interference, hiring, offering to hire or inducement, to discontinue his or her relationship with the Company or any of its Subsidiaries or to accept employment by, or enter into a business relationship with, the Employee or any other entity or person. 9.3 It is hereby further agreed that if any court of competent jurisdiction shall determine that the restrictions imposed in this Section 9 are unreasonable (including, but not limited to, the definition of Market Area or Competitor or the time period during which this provision is applicable), the parties hereto hereby agree to any restrictions that such court would find to be reasonable under the circumstances. 9.4 The Employee acknowledges that the services to be rendered by him/her to the Company are of a special and unique character, which gives this Agreement a peculiar value to the Company, the loss of which may not be reasonably or adequately compensated for by damages in an action at law, and that a material breach or threatened breach by him/her of any of the provisions contained in this Section 9 will cause the Company irreparable injury. Employee therefore agrees that the Company may be entitled, in addition to the remedies set forth above in this Section and any other right or remedy, to a temporary, preliminary and permanent injunction, without the necessity of proving the inadequacy of monetary damages or the posting of any bond or security, enjoining or restraining Employee from any such violation or threatened violations. 10. MISCELLANEOUS. 10.1 ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties and supercedes any and all other agreements, whether oral or written, between the parties hereto with respect to the subject matter hereof. In this connection, it is expressly agreed that (a) the Existing Severance Payment Agreement shall be superceded by this Agreement and have no futher force or effect and (b) all severance payment provisions and provisions dealing with the application of Section 280G (of the Code) limitations set forth in the Existing Employment Letter Agreement shall be superseded by this Agreement and have no further force or effect. However, it is agreed that 6 all other terms and conditions contained in the Existing Employment Letter Agreement not referenced in sub-clause (b) of this Section 10.1 (including, but not limited to, provisions dealing with relocation matters and the Company's SERP) shall continue in full force and effect through the term thereof. Each party to this Agreement acknowledges than 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. 10.2 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. 10.3 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 of the Company or the Compensation and Stock Option Committee of the Board of Directors of the Company. 10.4 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. 10.5 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 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 10.5, 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. 7 (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. 10.6 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., 21650 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. 10.7 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. It is acknowledged that such Waiver and Release of Claims contains various other obligations of Employee, including but not limited to certain obligations to cooperate with and assist the Company in the preparation for the defense of any actual or threatened third party claim, investigation or proceeding that pertains to matters under Employee's supervision or control 8 while he/she was an officer or employee of the Company or one of its subsidiaries and to forego certain competitive activity with the Company. 10.8 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. 10.9 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. 10.10 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. 10.11 SURVIVAL AND ENFORCEMENT. Sections 8 and 9 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. The parties agree that the Company would be damaged irreparably in the event any provision of Sections 8 or 9 of this Agreement were not performed in accordance with its terms or were otherwise breached and that money damages would be an 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). IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. FOUNDATION HEALTH SYSTEMS, INC. By: ---------------------------------- Name: Jay M. Gellert Title: President and Chief Executive Officer ------------------------------------- Employee: [ name ] 9 EXHIBIT A FORM OF WAIVER AND RELEASE OF CLAIMS This WAIVER AND RELEASE OF CLAIMS (this "Release") is made and entered into by and between Foundation Health Systems, Inc. and it affiliates and subsidiaries (hereinafter referred to as the "Company") and ______________ (hereinafter referred to as the "Employee"). WHEREAS, the Company and Employee are parties to a Severance Payment Agreement dated as of December 4, 1998 (the "Severance Payment Agreement"), and are entering into this Release pursuant to Section ____ of the Severance Payment Agreement as a condition to Employee's receipt of a severance payment thereunder (capitalized terms used but not defined herein shall have the meanings set forth in the Severance Payment Agreement). NOW, THEREFORE, the Company and Employee agree as follows: 1. Employee's employment with the Company will terminate on _________________. Upon termination of employment, Employee will not represent to anyone that he or she is an employee of the Company and will not say or do anything purporting to bind the Company. 2. Employee's termination of employment with the Company shall be considered a [describe type of termination] under Section ___ of the Severance Payment Agreement, and Employee is therefore eligible to receive a lump sum payment equal to ___ times Base Salary and Benefits for a period of _____ after termination. 3. In partial consideration of the Company providing Employee those benefits and payments set forth above and as required by and in the Severance Payment Agreement as a condition to receive such payments and benefits, Employee freely and voluntarily enters into this Release and by signing this Release Employee, on his/her own behalf and on behalf of his or her heirs, beneficiaries, successors, representatives, trustees, administrators and assigns, hereby waives and releases the Company, and each of its past, present and future officers, directors, shareholders, employees, consultants, accountants, attorneys, agents, managers, insurers, sureties, parent and sister corporations, divisions, subsidiary corporations and entities, partners, joint venturers, affiliates, beneficiaries, successors, representatives and assigns, from any and all claims, demands, damages, debts, liabilities, controversies, obligations, actions or causes of action of any nature whatsoever, whether based on tort, statute, contract, indemnity, rescission or any other theory or recovery, including but not limited to claims arising under federal, state or local laws prohibiting discrimination in employment, including Title VII of the Civil Rights Act of 1964, as amended, the Civil Rights Act of 1866, as amended, claims of disability discrimination under the Americans with Disabilities Act, the Age Discrimination in Employment Act, as amended ("ADEA"), the Worker Adjustment and Retraining Notification Act ("WARN"), the California Fair Employment and Housing Act, the California Labor Code and the California Constitution (all as amended) or claims growing out of any legal restrictions on the Company's right to terminate its employees and whether for compensatory, punitive, equitable or other relief, 10 whether known, unknown, suspected or unsuspected, against the Company, including without limitation claims which may have arisen or may in the future arise in connection with any event which occurred on or before the date of Employee's execution of this Relase. The provisions in this paragraph are not intended to prohibit Employee from filing a claim for unemployment insurance. 4. Employee expressly waives any right or claim of right to assert hereafter that any claim, demand, obligation and/or cause of action has, through ignorance, oversight or error, been omitted from the terms of this Release. Employee makes this waiver with full knowledge of his/her rights and with specific intent to release both his/her known and unknown claims, and therefore specifically waives the provisions of Section 1542 of the Civil Code of California or other similar provisions of any other applicable law, which reads as follows: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor." . Employee understands and acknowledges the significance and consequence of this Release and of such specific waiver of Section 1542, and expressly agrees that this Agreement shall be given full force and effect according to each and all of its express terms and provisions, including those relating to unknown and unsuspected claims, demands, obligations and causes of action herein above specified. 5. Employee shall not initiate or cause to be initiated against the Company any compliance review, suit, action, investigation or proceeding of any kind, or voluntarily participate in same, individually or as a representative, witness or member of a class, under contract, law or regulation, federal, state or local, pertaining to any matter related to his/her employment with the Company, unless Employee first cooperates in making his/her allegations known to the Company for the Company to take corrective action at a time and place designated by the Company. In addition, Employee shall, without further compensation, cooperate with and assist the Company in the investigation of, preparation for or defense of any actual or threatened third party claim, investigation or proceeding involving the Company or its predecessors or affiliates and arising from or relating to, in whole or in part, Employee's employment with the Company or its predecessors or affiliates for which the Company requests Employee's assistance, which cooperation and assistance shall include, but not be limited to, providing testimony and assisting in information and document gathering efforts. In this connection, it is agreed that the Company will use its reasonable best efforts to assure that any request for such cooperation will not unduly interfere with Employee's other material business and personal obligations and commitments. 6. Employee agrees he or she will return to the Company immediately upon termination any building key(s), security pass or other access or identification cards and any Company property that was in his or her possession, including but not limited to any documents, credit cards, computer equipment, mobile phones or data files. Employee agrees to clear all expense accounts and pay all amounts owed on any corporate credit card(s) which the Company previously issued to Employee. 11 7. Employee shall not, without the Company's written consent by an authorized representative, at any time prior or subsequent to the execution of this Release, disclose, use, remove or copy any confidential, trade secret or proprietary information he/she acquired during the course of his/her employment by the Company, including without limitation, any technical, actuarial, economic, financial, procurement, provider, customer, underwriting, contractual, managerial, marketing or other information of any type that has economic value in the business in which the Company is engaged, but not including any previously published information or other information generally in the public domain. 8. In addition to any other part or term of this Release or the Severance Payment Agreement, Employee agrees that he or she will not, (a) for a period of one (1) year from the date of this Agreement, irrespective of the reason for the termination, either directly or indirectly, on his or her own behalf or on behalf of any other person: 1) make known to any person, firm, corporation or other entity of any type, the names and addresses of any of the Company's customers, enrollees or providers or any other information pertaining to them; or 2) disrupt, solicit or influence or attempt to solicit, disrupt or influence any of the Company's customers, employees, providers, vendors, agents or independent contractors with whom the Employee became acquainted during the course of employment or service for the purpose of terminating such a person's or entity's relationship with the Company or causing such a person or entity to associate with a competitor of the Company, and (b) for the six month period following the Termination Date, undertake any employment or activity prohibited by Section 9 of the Severance Payment Agreement. The prohibitions of this paragraph are not intended to deny employment opportunities within the Employee's field of employment but are limited only to those prohibitions necessary to protect the Company from unfair competition. 9. Any developments or discoveries by Employee during the course of his or her employment with the Company through the date of execution of this Release resulting in patents, lists of customers, trade secrets, specialized know-how or other intellectual property useful in the then current business of the Company shall be for the sole benefit of the Company. 10. Nothing contained herein shall be construed as an admission of any wrongful act, including but not limited to violation of any contract, express or implied, or any federal, state or local employment laws or regulations, and nothing contained herein shall be used for any purpose except in proceedings related to the enforcement of this Release or the Severance Payment Agreement. 11. If any part or term of this Release is held invalid or unenforceable, such invalidity or unenforceability shall not affect in any way the validity or enforceability of any other part or term of this Release. 12. The Employee acknowledges that he/she has had an opportunity to consult and be represented by counsel of his/her own choosing in the review of this Release, and that he/she has been advised by the Company to do so, that the Employee is fully aware of this Release and of its legal effect, that the preceding paragraphs recite the sole consideration for this Release, and that Employee enters into this Release freely, without coercion, and based on the Employee's 12 own judgment and not in reliance upon any representation or promise made by the other party, other than those contained herein. There may be no modification of the terms of this Release except in writing signed by the parties hereto. 13. This Release shall be construed and governed by the laws of the State of Delaware. EMPLOYEE ACKNOWLEDGES BY SIGNING BELOW that (i) Employee has not relied upon any representations, written or oral, not set forth in this Release; (ii) at the time Employee was given this Release Employee was informed in writing by the Company that (a) Employee had at least [21 DAYS] [45 DAYS (IF IN CONNECTION WITH AN EXISTING INCENTIVE OR EMPLOYMENT TERMINATION PROGRAM OFFERED TO A GROUP OR CLASS OF EMPLOYEES)] in which to consider whether Employee would sign the Release and (b) Employee should consult with an attorney before signing the Release; and (iii) Employee had an opportunity to consult with an attorney and either had such consultations or has freely decided to sign this Release without consulting an attorney. [IF EMPLOYEE IS AGE 40 OR OLDER AND THE 45 DAY CONSIDERATION PERIOD APPLIES (I.E., THE EMPLOYMENT TERMINATION IS IN CONNECTION WITH THE TERMINATION OF A GROUP OR CLASS OF EMPLOYEES), THEN THE FOLLOWING ACKNOWLEDGMENT SHOULD BE INCLUDED:] [Employee also acknowledges that at the time Employee was given this Release Employee was given written notice of the eligibility criteria for the program and the time limits applicable to the program, the job titles and ages (or dates of birth) of all individuals eligible for the program and the ages of the individuals in the same job classification or organizational unit who are not eligible for the program]. Employee further acknowledges that he or she may revoke acceptance of this Release by delivering a letter of revocation within seven (7) days after the date set forth below addressed to: FHS Corporate Legal Department, 21650 Oxnard Street, Woodland Hills, California 91367. Finally, Employee acknowledges that he or she understands that this Release will not become effective until the eighth (8th) day following his or her signing this Release and that if Employee does not revoke his or her acceptance of the terms of this Release within the seven (7) day period following the date on which Employee signs this Release, this Release will be binding and enforceable. IN WITNESS WHEREOF, the parties hereto have executed this Release as of the dates set forth below. Employee Foundation Health Systems, Inc. By: [ EXHIBIT COPY ] By: [EXHIBIT COPY ] ------------------------- ------------------------- Name: Name: Title: Dated: [TO BE INSERTED] Dated: [TO BE INSERTED] ---------------------- ---------------------- 13 EX-10.23 11 EXHIBIT 10.23 Ex. 10.23 SEVERANCE PAYMENT AGREEMENT This Severance Payment Agreement (this "Agreement") is entered into as of September 15, 1998, between Foundation Health Systems, Inc., a Delaware corporation (the "Company"), on the one hand, and J. Robert Bruce ("Employee"), on the other hand. WHEREAS, the Company currently employs Employee as its President and Chief Operating Officer FHS Central Division; 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 President and Chief Operating Officer FHS Central Division. 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 three (3) years from the date of termination and (ii) a lump sum cash payment equal to 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 from the date of termination and (ii) a lump sum cash payment equal to one (1) 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 form 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 three (3) years from the date of termination and (ii) a lump sum cash payment equal to 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 from the date of termination and (ii) a lump sum cash payment equal to one (1) 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 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 4 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 the 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). 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 5 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 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 6 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: Jay M. Gellert ---------------------------------------------- Name: Jay M. Gellert Title: President and Chief Executive Officer J. Robert Bruce ------------------------------------------------- Employee: J. Robert Bruce 8 EX-10.24 12 EXHIBIT 10.24 Ex. 10.24 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 Maurice A. Costa ("Employee"), on the other hand. WHEREAS, the Company currently employs Employee as its President of FHS Workers' Compensation Division; 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 President of FHS Workers' Compensation Division 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 three (3) years from the date of termination and (ii) a lump sum cash payment equal to 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 from the date of termination and (ii) a lump sum cash payment equal to one (1) 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 form 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 three (3) years from the date of termination and (ii) a lump sum cash payment equal to 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 from the date of termination and (ii) a lump sum cash payment equal to one (1) 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 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 4 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 the 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). 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 5 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: /s/ B. Curtis Westen -------------------------------------------------- Name: B. Curtis Westen, Esq. Title: Senior Vice President, General Counsel and Secretary Maurice Costa ----------------------------------------------------- Employee: Maurice A. Costa 8 EX-10.31 13 EXHIBIT 10.31 TRUST UNDER THE FOUNDATION HEALTH SYSTEMS, INC. DEFERRED COMPENSATION PLAN This Trust Agreement (the "Trust Agreement") is made and dated this ___ day of September, 1998 by and between Foundation Health Systems, Inc., a Delaware corporation, (the "Employer") and Union Bank of California (the "Trustee"). PURPOSE (a) WHEREAS, the Employer [and its designated affiliates, each such affiliate being included in the definition of Employer where the context requires] has adopted the plan or plans attached as Exhibit A or which subsequently may be designated in writing by the Employer (the "Plans") pursuant to which the Employer expects to incur unfunded deferred compensation liabilities with respect to certain employees of the Employer. (b) WHEREAS, Employer wishes to establish a trust (hereinafter called "Trust") and to contribute to the Trust assets that shall be held therein, subject to the claims of Employer's creditors in the event of Employer's Insolvency, as herein defined, until the amounts payable pursuant to the Plans are paid to Plan participants in such manner and at such times as specified in the Plan(s); (c) WHEREAS, it is the intention of the parties that this Trust shall constitute an unfunded arrangement and shall not affect the status of the Plan(s) as an unfunded plan maintained for the purpose of providing deferred compensation for a select group of management or highly compensated employees for purposes of Title I of the Employee Retirement Income Security Act of 1974; (d) WHEREAS, it is the intention of Employer to make contributions to the Trust to provide itself with a source of funds to assist it in the meeting of its liabilities under the Plan(s); NOW, THEREFORE, the parties do hereby establish the Trust and agree that the Trust shall be comprised, held and disposed of as follows: ARTICLE I ESTABLISHMENT OF TRUST 1.1 ESTABLISHMENT OF TRUST. The Employer hereby deposits with Trustee in Trust, which shall become the principal of the Trust to be held, administered and disposed of by Trustee as provided in this Trust Agreement. REVOCABILITY 1.2 TRUST IS IRREVOCABLE. The Trust hereby established shall be irrevocable. 1.3 The Trust is intended to be a grantor trust, of which Employer is the grantor, within the meaning of Subpart E, Part I, Subchapter J, Chapter 1, Subtitle A of the Internal Revenue Code of 1986, as amended, and shall be construed accordingly. 1.4 All money and property of every kind held by Trustee under this Trust Agreement (the Trust Fund ), including the principal of the Trust, and any earnings thereon shall be held separate and apart from other funds of Employer and shall be used exclusively for the uses and purposes of Participants and Employer's general creditors as herein set forth. Plan participants and beneficiaries of deceased participants (hereinafter called "Participants") shall have no preferred claim on, or any beneficial ownership interest in, any assets of the Trust. Any rights created under the Plan(s) and this Trust Agreement shall be mere unsecured contractual rights of Participants against Employer. Any assets held by the Trust will be subject to the claims of Employer's general creditors under federal and state law in the event of Insolvency, as defined in Article XI herein. 1.5 PAYMENTS TO EMPLOYER Employer shall have no right or power to direct Trustee to return to Employer or to divert to others any of the Trust assets before all payment(s) of benefits have been made to Participants pursuant to the terms of the Plan(s). 1.6 SIGNING AUTHORITY; ADMINISTRATOR. The Employer shall certify in writing to the Trustee the names and specimen signatures of all those who are authorized to act as or on behalf of the Employer, and those names and specimen signatures shall be updated as necessary by a duly authorized official of the Employer. The Employer shall promptly notify the Trustee if any person so designated is no longer authorized to act on behalf of the Employer. Until the Trustee receives written notice that a person is no longer authorized to act on behalf of the Employer, the Trustee may continue to rely on the Employer's designation of such person. 2 1.7 ACCEPTANCE OF ASSETS; TRUST COMPOSITION. All contributions or transfers shall be received by the Trustee in cash or in any other property acceptable to the Trustee. The Trust shall consist of the contributions and transfers received by the Trustee, together with the income and earnings from them and any increments to them. The Trustee shall hold, manage and administer the Trust in accordance with this Trust Agreement without distinction between principal and income. CONTRIBUTIONS 1.8 Employer, in its sole discretion, may at any time, or from time to time, make additional deposits of cash or other property in trust with Trustee to augment the principal to be held, administered and disposed of by Trustee as provided in this Trust Agreement. Neither Trustee nor any Participant shall have any right to compel such additional deposits. 1.9 NO DUTY OF TRUSTEE TO ENFORCE COLLECTION. Notwithstanding anything herein to the contrary, Trustee shall have no authority or obligation to enforce the collection of any contribution or transfer to the Trust. 1.10 PLAN ADMINISTRATION. The Employer and not the Trustee shall be responsible for administering the Plans (including without limitation determining the rights of the Employer's employees to participate in a Plan, determining any Participant's right to benefits under such Plan), and issuing statements to Participants of their interest in the Trust and Plan. 1.11 CHANGE IN CONTROL. For purposes of this Trust Agreement, a "Change in Control" shall be deemed to have occurred if (i) any person (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than a trustee (such as Trustee) or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, becomes the beneficial owner (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 20% or more of the total voting power represented by the Company's then outstanding voting securities; (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof; or (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 80% of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or 3 consolidation, or the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of (in one transaction or series of transactions) all or substantially all of the Company's assets. For purposes of this subsection, voting securities means any securities which vote generally in the election of directors. The Trustee shall have no independent duty to determine that a Change in Control has occurred and shall not be required to take any action or refrain from taking any actions hereunder which are based on a Change in Control having occurred prior to the time it receives written notice from the Employer or a Participant that a Change in Control has occurred or will occur and has had a reasonable opportunity to determine whether a Change in Control, in fact, has occurred. At the Trustee's request, the Employer shall furnish such evidence as may be necessary to enable the Trustee to determine whether a Change in Control has occurred. In taking or refraining from any action under this Trust Agreement, the Trustee may rely on its determination, including an opinion of counsel (who may be counsel to the Employer or the Trustee), that a Change in Control has occurred. The Trustee's determination as to whether a Change in Control has occurred shall be binding and conclusive on all persons. 1.12 PARTICIPANT ACCOUNTS. The Employer shall maintain in an equitable manner a separate account for each Participant under a Plan ( Account ) in which it shall keep a record of the share of such Participant under such Plan in the Trust. The Employer may appoint a third-party administrator to maintain such Accounts. A Participant's Account under a Plan shall represent the portion of the Trust allocated to provide such Participant benefits under such Plan. If the Trustee is directed by the Employer to segregate the Trust into separate Accounts for each Participant, at the time it makes a contribution to the Trust, the Employer shall certify to the Trustee the amount of such contribution being made in respect of each Participant under each Plan. The Trustee may rely on information provided to the Trustee by the Employer and the Trustee's and Employer's determination of Account values shall be conclusive and binding on all interested parties. 1.13 TAX REPORTING. The Employer and not the Trustee shall be responsible for all income tax reporting and calculation and payment of any wage withholding or other tax requirements in connection with the Trust and any contributions thereto, and any income earned thereby, and payments or distributions therefrom, and Employer agrees to indemnify and defend Trustee against any liability for any such taxes, interest or penalties resulting from or relating to the Trust. 4 ARTICLE II INVESTMENTS 2.1 EMPLOYER IS INVESTMENT MANAGER. The Employer shall have the power over and responsibility for the management and investment of Trust assets. The Employer may appoint an Investment Manager to direct the investment of Trust assets, provided the Trustee is notified in writing prior to such appointment. The Trustee shall have no duty to make recommendations regarding Trust assets and shall retain assets until directed in writing by Employer or Investment Manager to dispose of them. 2.2 FUNDING POLICY AND INVESTMENT GUIDELINES. The Employer shall have the responsibility for establishing and carrying out a funding policy and method, consistent with the objectives of the Plans, taking into consideration the Plans' short-term and long-term financial needs. The Trustee's responsibility for investment and diversification of the assets in the portion of the Trust for which the Trustee has investment discretion shall be subject to, and is limited by, the investment guidelines issued to it by the Employer. It is understood that, unless otherwise agreed in writing, the Employer, rather than the Trustee, shall be responsible for the overall diversification of Trust assets. 2.3 DISPOSITION OF INCOME. During the term of this Trust, all income received by the Trust, net of expenses and taxes, shall be accumulated and reinvested. ARTICLE III TRUSTEE'S POWERS 3.1 GENERAL TRUSTEE'S POWERS. Trustee shall have, without exclusion, all powers conferred on Trustees by applicable law, unless expressly provided otherwise herein, provided, however, that if an insurance policy is held as an asset of the Trust, Trustee shall have no power to name a beneficiary of the policy other than the Trust, to assign the policy (as distinct from conversion of the policy to a different form) other than to a successor Trustee, or to loan to any person the proceeds of any borrowing against such policy. (a) To invest and reinvest the Trust or any part thereof in any one or more kind, type, class, item or parcel of property, real, personal or mixed, tangible or intangible; or in any one or more kind, type, class, item or issue of investment or security; or in any one or more kind, type class or item of obligation, secured or unsecured; or in any combination of them; 5 (b) To acquire, sell and exercise options to buy securities ("call" options) and to acquire, sell and exercise options to sell securities ("put" options); (c) To buy, sell, assign, transfer, acquire, loan, lease (for any purpose, including beyond the life of this Trust), exchange and in any other manner to acquire, manage, deal with and dispose of all or any part of the Trust property, for cash or credit; (d) To make deposits with any bank or savings and loan institution, including any such facility of the Trustee or an affiliate thereof, provided that the deposit bears a reasonable rate of interest; (e) To retain all or any portion of the Trust in cash temporarily awaiting investment or for the purpose of making distributions or other payments, without liability for interest thereon, notwithstanding trustee's receipt of float; (f) To borrow money for any purpose connected with the protection, preservation or improvement of the Trust from any source other than a party in interest of the Plans, with or without giving security; to pay interest; to issue promissory notes and to secure the repayment thereof by pledging all or any part of the Trust assets; (g) To take all of the following actions: to vote proxies of any stocks, bonds or other securities; to give general or special proxies or powers of attorney with or without power of substitution; to exercise any conversion privileges, subscription rights or other options, and to make any payments incidental thereto; to consent to or otherwise participate in corporate reorganizations or other changes affecting corporate securities and to delegate discretionary powers and to pay any assessments or charges in connection therewith; and generally to exercise any of the powers of an owner with respect to stocks, bonds, securities or other property held in the Trust; (h) To make, execute, acknowledge and deliver any and all documents of transfer and conveyance and any and all other instruments that may be necessary or appropriate to carry out the powers herein granted; (i) To raze or move existing buildings; to make ordinary or extraordinary repairs, alterations or additions in and to buildings; to construct buildings and other structures and to install fixtures and equipment therein; (j) To pay or cause to be paid from the Trust any and all real or personal property taxes, income taxes or other taxes or assessments of any or all kinds levied or assessed upon or with respect to the Trust or the Plans; (k) Subject to the limitations of 3.1, to hold term or ordinary life insurance contracts or to acquire annuity contracts on the lives of Participants 6 (but in the case of conflict between any such contract and a Plan, the terms of the Plan shall prevail); to pay from the Trust the premiums on such contracts; to distribute, surrender or otherwise dispose of such contracts; to pay the proceeds, if any, of such contracts to the proper persons in the event of the death of the insured Participant; to enter into, modify, renew and terminate annuity contracts of deposit administration, of immediate participation or other group or individual type with one or more insurance companies and to pay or deposit all or any part of the Trust thereunder; to provide in any such contract for the investment of all or any part of funds so deposited with the insurance company in securities under separate accounts; to exercise and claim all rights and benefits granted to the contract holder by any such contracts. All payments and exercise of all powers with respect to insurance contracts shall be solely on the direction of Employer; (l) To exercise all the further rights, powers, options and privileges granted, provided for, or vested in trustees generally under applicable federal or state laws, as amended from time to time, it being intended that, except as otherwise provided in this Trust, the powers conferred upon the Trustee herein shall not be construed as being in limitation of any authority conferred by law, but shall be construed as in addition thereto. (m) Notwithstanding any powers granted to Trustee pursuant to this Trust Agreement or to applicable law, Trustee shall not have any power that could give this Trust the objective of carrying on a business and dividing the gains therefrom, within the meaning of section 301.7701-2 of the Procedure and Administrative Regulations promulgated pursuant to the Internal Revenue Code. 3.2 ADDITIONAL POWERS. In addition to the other powers enumerated above, the Trustee is authorized and empowered: (a) To invest funds in any type of interest-bearing account including, without limitation, time certificates of deposit or interest-bearing accounts issued by FOUNDATION HEALTH SYSTEMS, INC. To use other services or facilities provided by the UnionBanCal Corporation (UNBC), its subsidiaries or affiliates including Foundation Health Systems, Inc. (Bank), to the extent allowed by applicable law and regulation. Such services may include but are not limited to (1) the placing of orders for the purchase, exchange, investment or reinvestment of securities through any brokerage service conducted by, and (2) the purchase of units of any registered investment company managed or advised by Bank, UNBC, or their subsidiaries or affiliates and/or for which Bank, UNBC or their subsidiaries or affiliates act as custodian or provide other services for a fee, including, without limitation, the HighMark Group of mutual funds or the Stepstone Funds. The parties hereby acknowledge that the Bank may receive fees for such services in addition to the fees payable under this Agreement. Fee schedules for additional services shall be delivered to the appropriate party in advance of the provision of such services. Independent fiduciary approval of compensation 7 being paid to the Bank will be sought in advance to the extent required under applicable law and regulation. If Foundation Health Systems, Inc. does not have investment discretion, the services referred to above, as well as any additional services, shall be utilized only upon the appropriate direction of an authorized party. (b) To cause all or any part of the Trust to be held in the name of the Trustee (which in such instance need not disclose its fiduciary capacity) or, as permitted by law, in the name of any nominee, including the nominee name of any depository, and to acquire for the Trust any investment in bearer form; but the books and records of the Trust shall at all times show that all such investments are a part of the Trust and the Trustee shall hold evidences of title to all such investments as are available; (c) To serve as custodian with respect to the Trust assets, to hold assets or to hold eligible assets at the Depository Trust Company or other depository; (d) To employ such agents and counsel as may be reasonably necessary in administration and protection of the Trust assets and to pay them reasonable compensation; to employ any broker-dealer covered in the self-dealing section, and pay to such broker-dealer its standard commissions; to settle, compromise or abandon all claims and demands in favor of or against the Trust; and to charge any premium on bonds purchased at par value to the principal of the Trust without amortization from the Trust, regardless of any law relating thereto; (e) To abandon, compromise, contest, arbitrate or settle claims or demands; to prosecute, compromise and defend lawsuits, but without obligation to do so, all at the risk and expense of the Trust; (f) To permit such inspections of documents at the principal office of the Trustee as are required by law, subpoena or demand by United States or state agency during normal business hours of the Trustee; (g) To comply with all requirements imposed by law; (h) To seek written instructions from the Employer on any matter and await written instructions without incurring any liability. If at any time the Employer should fail to give directions to the Trustee, the Trustee may act in the manner that in its discretion it deems advisable under the circumstances for carrying out the purposes of this Trust. Such actions shall be conclusive on the Employer and the Participants on any matter if written notice of the proposed action is given to Employer five (5) days prior to the action being taken, and the Trustee receives no response; 8 (i) To compensate such executive, consultant, actuarial, accounting, investment, appraisal, administrative, clerical, secretarial, custodial, depository and legal firms, personnel and other employees or assistants as are engaged by the Employer in connection with the administration of the Plans and to pay from the Trust the necessary expenses of such firms, personnel and assistants, to the extent not paid by the Employer; (j) To impose a reasonable charge to cover the cost of furnishing to Participants statements or documents; (k) To act upon proper written directions of the Employer or any Participant including directions given by photostatic teletransmission using facsimile signature. If oral instructions are given, to act upon those in Trustee's discretion prior to receipt of written instructions. Trustee's recording or lack of recording of any such oral instructions taken in Trustee's ordinary course of business shall constitute conclusive proof of Trustee's receipt or non-receipt of the oral instructions; (l) To pay from the Trust the expenses reasonably incurred in the administration of the Trust; (m) To maintain insurance for such purposes, in such amounts and with such companies as the Employer shall elect, including insurance to cover liability or losses occurring by reason of the acts or omissions of fiduciaries (but only if such insurance permits recourse by the insurer against the fiduciary in the case of a breach of a fiduciary obligation by such fiduciary); (n) As directed by the Employer, to cause the benefits provided under the Plans to be paid directly to the persons entitled thereto under the Plans, and in the amounts and at the times and in the manner specified by the Plans, and to charge such payments against the Trust and Accounts with respect to which such benefits are payable; (o) To exercise and perform any and all of the other powers and duties specified in this Trust Agreement or the Plans; and in addition to the powers listed herein, to do all other acts necessary or desirable for the proper administration of the Trust, as though the absolute owner thereof. 9 ARTICLE IV TRUSTEE AND EMPLOYER DUTIES 4.1 LEGAL DUTIES. The Trustee and Employer shall exercise any of the foregoing powers from time to time as required by law. 4.2 PAYMENTS TO PARTICIPANTS (a) Employer shall deliver to Trustee a schedule (the "Payment Schedule") that indicates the amounts payable in respect of each Participant, that provides a formula or other instructions acceptable to Trustee for determining the amount so payable, the form in which such amount is to be paid (as provided for or available under the Plan(s)), and the time of commencement for payment of such amounts. Except as otherwise provided herein, Trustee shall make payments to the Participants in accordance with such Payment Schedule. As directed by Employer, the Trustee shall make provision for the reporting and withholding of any federal, state or local taxes that may be required to be withheld with respect to the payment of benefits pursuant to the terms of the Plan(s) and shall pay amounts withheld to the appropriate taxing authorities or determine that such amounts have been reported, withheld and paid by Employer. (b) The entitlement of a Participant to benefits under the Plan(s) shall be determined by Employer or such party as it shall designate under the Plan(s), and any claim for such benefits shall be considered and reviewed under the procedures set out in the Plan(s). (c) Employer may make payment of benefits directly to Participants as they become due under the terms of the Plan(s). Employer shall notify Trustee of its decision to make payment of benefits directly prior to the time amounts are payable to Participants. In addition, if the principal of the Trust, and earnings thereon, are not sufficient to make payments of benefits in accordance with the terms of the Plan(s), Employer shall make the balance of each such payment as it falls due. Trustee shall notify Employer where principal and earnings are not sufficient. Trustee shall have no duty or obligation to enforce or compel Employer to make payments hereunder. Employer may direct Trustee to reimburse Employer for payments made directly by Employer to Participants. (1) In the event payments are made by Employer directly to Participants, Employer shall have sole responsibility for the reporting and withholding of any federal, state, or local taxes that may be required to be withheld with respect to the payment of benefits pursuant to the terms of the Plan(s) and shall pay amounts withheld to the appropriate taxing authority. 10 (2) Trustee shall have no duty or responsibility with respect to the above stated reporting, withholding or payment of taxes and shall have no responsibility to determine that Employer has provided for such reporting, withholding or payment of such taxes. (3) Employer shall indemnify and hold Trustee harmless from any and all losses, claims, penalties or damages which may occur as a result of Trustee following in good faith the written direction of the Employer to reimburse Employer for payments made hereunder to Participants and arising from Employer's tax reporting, withholding and payment obligations hereunder. (d) Upon the satisfaction of all liabilities of the Employer under all Plans to all Participants the Trustee shall distribute any remaining Trust Fund to the Employer. Except as provided in (c) above, at no time prior to the Employer's Insolvency, as defined in Article XI, or the satisfaction of all liabilities of the Employer under the Plans in respect of all Participants having Accounts hereunder shall any part of the Trust revert to the Employer. 4.3 ACCOUNTS AND RECORDS. The Trustee shall keep accurate and detailed records of all investments, receipts, disbursements and all other transactions required to be done, including such specific records as shall be agreed upon in writing between the Employer and the Trustee. All such accounts, books and records shall be open to inspection and audit at all reasonable times by the Employer and by the Participants. Within sixty (60) days after the close of each quarter and Plan year and within sixty (60) days after the resignation or removal of the Trustee as provided in Article VI hereof, the Trustee shall render to the Employer a written account showing in reasonable summary the investments, receipts, disbursements and other transactions engaged in by the Trustee during the preceding Plan Year or accounting period with respect to the Trust. Such account shall set forth the assets and liabilities of the Trust. The Employer shall have sixty (60) days after the Trustee's mailing of each such quarterly or final account within which to file with the Trustee written objections to such account. Upon the expiration of each such period, the Trustee shall be forever released and discharged from all liability and accountability to the Employer with respect to the propriety of its acts and transactions shown in such account except with respect to any such acts or transactions as to which the Employer files written objections within such sixty-day period with the Trustee. Notwithstanding anything herein to the contrary, the Trustee shall have no duty or responsibility to obtain valuations of any assets of the Trust Fund, the value of which is not readily determinable on an established market. Employer shall bear sole responsibility for determining said valuations and shall be responsible for providing said valuations to Trustee in a timely manner. Trustee may conclusively rely on such valuations provided by Employer and shall be indemnified and held harmless by Employer with respect to such reliance. 11 4.4 REPORTS. The Trustee shall file such descriptions and reports and shall furnish such information and make such other publications, disclosures, registrations and other filings as are required of the Trustee by law. The Trustee shall have no responsibility to file reports or descriptions, publish information or make disclosures, registrations or other filings unless directed by the Employer. 4.5 FOLLOW EMPLOYER DIRECTION. The Trustee shall have the power and duty to comply promptly with all proper directions of the Employer. 4.6 INFORMATION TO BE PROVIDED TO TRUSTEE. The Employer shall maintain and furnish the Trustee with all reports, documents and information as shall be required by the Trustee to perform its duties and discharge its responsibilities under this Trust Agreement, including without limitation a certified copy of each of the Plans and all amendments thereto. The Trustee shall be entitled to rely on the most recent reports, documents and information furnished to it by the Employer. The Employer shall be required to notify the Trustee as to the termination of employment of any Participant by death, retirement or otherwise. The Employer shall arrange for each Investment Manager if appointed pursuant to Section 2.1, and each insurance company issuing contracts held by the Trustee pursuant to Section 3.1(k), to furnish the Trustee with such valuations and reports as are necessary to enable the Trustee to fulfill its obligations under this Trust Agreement, and the Trustee shall be fully protected in relying upon such valuations and reports. 4.7 (a) PAYMENTS TO PARTICIPANTS. Following a Change in Control, the Trustee shall not be subject to the provisions of Section 4.2(a) (regarding payments to Participants directed by the Employer), but rather shall commence distributions from the separate Account of a Participant upon the receipt of written notification by the Employer or by the Participant that such Participant has become entitled to receive benefit payments under a Plan. Such notification shall include the amount of such payments, the form and method of payment, the basis for the Participant's claim and the Participant's name, address and social security number. The Trustee may take any reasonable steps it deems necessary to verify that the Participant is entitled to receive the benefits claimed under the Plans. All benefits payable from the trust to a Participant under a Plan shall be paid solely from the separate Account established with respect to such Participant, and only to the extent the amounts credited to the Participant's Account are sufficient therefor, and such Participant's Account shall be charged with the amount of such payments. The Trustee shall have no responsibility for and shall incur no liability with respect to any payment made pursuant to a direction received in accordance with this Section 4.7(b) or with respect to the 12 Trustee's good faith determination that a Participant is or is not entitled to the payments claimed hereunder. (b) RECORDKEEPING AFTER CHANGE IN CONTROL. Upon Change in Control, the Trustee shall maintain all records regarding the Trust and its investment and such other Participant records specified in this Trust Agreement, including the maintenance of the Separate Accounts of each Participant as provided in Section 1.12. All such records shall be made available promptly on the request of the Employer. The Trustee shall also prepare and distribute annual statements to the Participants. ARTICLE V RESTRICTIONS ON TRANSFER 5.1 PERSONS TO RECEIVE PAYMENT. (a) The Trustee shall, except as otherwise provided in section 4.2(d) and subsection (b) hereunder, pay all amounts payable hereunder only to the person or persons designated under the Plans or deposit such amounts to the Participant's checking or savings account as directed by the Employer and not to any other person or corporation, and only to the extent of assets held in the Trust, and shall follow written instructions by the Employer. The Employer's written instructions, to the Trustee to make distributions or not to make distributions, and the amount thereof, shall be conclusive on all Participants. (b) Should any controversy arise as to the person or persons to whom any distribution or payment is to be made by the Trustee, or as to any other matter arising in the administration of the Plans or Trust, the Trustee may retain the amount in controversy pending resolution of the controversy or the Trustee may file an action seeking declaratory relief and/or may interplead the Trust assets in issue, and name as necessary parties the Employer, the Participants and/or any or all persons making conflicting demands. (c) The Trustee shall not be liable for the payment of any interest or income, except for that earned as a Trust investment, on any amount withheld or interpleaded under subsection (b). (d) The expense of the Trustee for taking any action under subsection (b) shall be paid to the Trustee from the Trust. 5.2 ASSIGNMENT AND ALIENATION PROHIBITED. Benefits payable to Participants under this Trust Agreement may not be anticipated, assigned (either at law or in equity), 13 alienated, pledged, encumbered or subjected to attachment, garnishment, levy, execution or other legal or equitable process. Notwithstanding the foregoing, the Trust shall at all times remain subject to the claims of creditors of the Employer in the event the Employer becomes Insolvent as provided in Article XI. ARTICLE VI RESIGNATION, REMOVAL AND SUCCESSION 6.1 RESIGNATION OR REMOVAL OF TRUSTEE. Trustee may resign at any time by written notice to the Employer, which shall be effective thirty (30) days after receipt of such notice unless Employer and Trustee agree otherwise. Prior to a Change in Control, the Employer may remove Trustee upon thirty (30) days' written notice to the Trustee (which notice may be waived by the Trustee). Upon and after the occurrence of a Change in Control, the Trustee may be removed only (i) by the Employer with the written consent of a majority of Participants; or (ii) by the written notice of a majority of Participants. Trustee may conclusively rely on Employer's certification that a majority has consented to the removal of the Trustee. 6.2 DESIGNATION OF SUCCESSOR. Upon notice of the Trustee's resignation or removal, the Employer shall promptly designate a successor Trustee who will accept transfer of the assets of the Trust; provided that, upon and after the occurrence of a Change in Control, such appointment shall be effected only (i) by the Employer with the written consent of a majority of the Participants; or (ii) by the written notice of a majority of the Participants. If, prior to a Change in Control, no successor Trustee is designated within thirty (30) days of notice of Trustee's resignation or removal, then the President and Chief Financial Officer of Employer are hereby designated as the successor Co-Trustees. 6.3 UPON RESIGNATION or removal of Trustee and appointment of a successor Trustee, all assets shall subsequently be transferred to the successor Trustee. The transfer shall be completed as soon as administratively feasible after receipt of notice of resignation, removal or transfer and appointment of and acceptance by successor Trustee, unless Employer extends the time limit. 6.4 COURT APPOINTMENT OF SUCCESSOR. If Trustee resigns or is removed, a successor shall be appointed, in accordance with Section 6.2 hereof, by the effective date of resignation or removal under paragraph 6.1 of this section. If no such appointment has been made after a Change in Control, Trustee may apply to a court of competent jurisdiction for appointment of a successor or for instructions. All expenses of Trustee in connection with the proceeding shall be allowed as administrative expenses of the Trust. Until a successor Trustee is appointed, the Trustee shall be entitled to be compensated for its services according to its published fee schedule then in effect for acting as Trustee. 14 6.5 SUCCESSOR'S POWERS. A successor Trustee shall have the same powers and duties as those conferred upon the original Trustee hereunder. A resigning Trustee shall transfer the Trust assets and shall deliver the assets of the Trust to the successor Trustee as soon as practicable. The resigning Trustee is authorized, however, to reserve such amount as may be necessary for the payment of its fees and expenses incurred prior to its resignation, and the Trust assets shall remain liable to reimburse the resigning Trustee for all fees and costs, expenses or attorneys' fees or losses incurred, whether before or after resignation, due solely to Trustee's holding title to and administration of Trust assets. 6.6 SUCCESSOR'S DUTIES. A successor Trustee shall have no duty to audit or otherwise inquire into the acts and transactions of its predecessor. ARTICLE VII AMENDMENT 7.1 POWER TO AMEND. This Trust Agreement may be amended by a written instrument executed by Trustee and Employer. No such amendment shall conflict with the terms of the Plan(s) nor shall it make the Trust revocable after it has become irrevocable in accordance with Section 1.2. 7.2 LIMITATION ON AMENDMENTS FOLLOWING A CHANGE IN CONTROL. Following a Change in Control, no amendment signed by the Employer and the Trustee shall become effective without the written consent of a two-thirds majority of the Participants then participating in the Plan. Trustee may conclusively rely on Employer's certification that two-thirds majority has voted in favor of amendment. ARTICLE VIII LIABILITIES 8.1 DECLARATION OF INTENT. To the full extent permitted by law, it is the intent of this Article to relieve each fiduciary from all liability for any acts or omissions of any other fiduciary or any other person and to declare the absence of liabilities of all persons referred to in this Article to the extent not imposed by law or by provisions of this Trust Agreement. Each of the following Sections, in declaring such limitation, is set forth without limiting the generality of this Section but in each case shall be subject to the provisions, limitations and policies set forth in this Section. 15 8.2 LIABILITY OF THE TRUSTEE. (a) The Trustee shall have no powers, duties or responsibilities with regard to the administration of the Plans or to determine the rights or benefits of any person having or claiming an interest under the Plans or in the Trust or under this Trust Agreement or to examine or control any disposition of the Trust or part thereof which is directed by the Employer, as applicable. (b) The Trustee shall have no liability for the adequacy of contributions for the purposes of the Plans or for enforcement of the payment thereof. (c) The Trustee shall have no liability for the acts or omissions of the Employer or Fiduciaries. (d) The Trustee shall have no liability for following proper directions of Employer or Employer's designated Fiduciaries, or any Participant when such directions are made in accordance with this Trust Agreement and the Plans. (e) During such period or periods of time, if any, as Employer or Investment Manager (collectively, "Fiduciary") is directing the investment and management of Trust assets, the Trustee shall have no obligation to determine the existence of any conversion, redemption, exchange, subscription or other right relating to any securities purchased on the directions of such Fiduciary if notice of any such right was given prior to the purchase of such securities. If such notice is given after the purchase of such securities, the Trustee shall notify such Fiduciary. The Trustee shall have no obligation to exercise any such right unless it is instructed to exercise such right, in writing, by the Fiduciary within a reasonable time prior to the expiration of such right. (f) During such period or periods of time, if any, as a Fiduciary is directing the investment and management of Trust assets, if such Fiduciary directs the Trustee to purchase securities issued by any foreign government or agency thereof, or by any corporation domiciled outside of the United States, it shall be the responsibility of the Fiduciary to advise the Trustee in writing with respect to any laws or regulations of any foreign countries or any United States territories or possessions which shall apply, in any manner whatsoever, to such securities, including, but not limited to, receipt of dividends or interest by the Trustee for such securities. 16 8.3 INDEMNIFICATION. (a) The Employer hereby agrees to indemnify and hold harmless the Trustee, its officers, directors, employees or agents, from and against any and all liabilities, claims for breach of fiduciary duty or otherwise, demands, damages, costs and expenses, including reasonable attorney's fees, arising from (i) any act taken or omitted by the Trustee in good faith in accordance with or due to the absence of directions from the Employer, its agents, or any Plan Participant, (ii) any act taken or omitted by a Fiduciary other than the Trustee in breach of such Fiduciary responsibilities under the Plan or this Agreement, and (iii) any action taken by the Trustee pursuant to a notification of an order to purchase or sell securities issued by Employer or a Plan Participant directly to a broker or dealer. (b) If the Trustee is named as a defendant in any lawsuit or other proceeding involving the Plan or the Trust for any reason including, without limitation, an alleged breach by the Trustee of its responsibilities under this Agreement, the Employer hereby agrees to indemnify the Trustee against all liabilities, costs, and expenses, including reasonable attorneys' fees, incurred by the Trustee unless the final judgment entered in the lawsuit or proceeding holds the Trustee guilty of gross negligence, willful misconduct, or a breach of fiduciary responsibility. If the final judgment holds the Trustee guilty of gross negligence, willful misconduct or a breach of fiduciary responsibility, the Employer hereby agrees to indemnify the Trustee only against liability in excess of the Trustee's allocable share of such liability. (c) The Employer shall have the right, but not the obligation, to conduct the defense of the Trustee in any legal proceeding covered by this section. However, any legal counsel selected to defend the Trustee must be acceptable to the Trustee, and the Trustee may elect to choose counsel, including in-house counsel, other than that selected by the Employer. The Employer may satisfy all or any part of its obligations under this section through insurance arrangements acceptable to the Trustee. ARTICLE IX DURATION, TERMINATION AND REPAYMENTS TO EMPLOYER 9.1 REVOCATION AND TERMINATION. The Trust shall not terminate until the date on which Participants are no longer entitled to benefits pursuant to the terms of the Plan(s). Upon termination of the Trust any assets remaining in the Trust shall be returned to Employer. In the event the Trust is terminated following the distribution of all payments and benefits called for herein, from the date of such termination of the Trust and until the final distribution of the remaining Trust assets, if any, the Trustee shall continue to have all the powers provided under this Trust Agreement that are necessary or desirable for the orderly liquidation and distribution of the Trust. 17 9.2 DURATION. This Trust shall continue in full force and effect for the maximum period of time permitted by law and in any event until the expiration of twenty-one years after the death of the last surviving person who was living at the time of execution hereof who at any time becomes a Participant in a Plan, unless this Trust is sooner terminated in accordance with this Trust Agreement. 9.3 PAYMENTS TO THE EMPLOYER PRIOR TO TERMINATION. No part of the Trust shall revert to the Employer at any time prior to the earlier of the Employer's Insolvency, as defined in Article XI, or the satisfaction of all liabilities under the Plans, as described in Section 9.1. 9.4 REVOCATION BY ALL PARTICIPANTS. Unless the Trust is revocable, upon written approval of all Participants entitled to payment of benefits pursuant to the terms of the Plan(s), Employer may terminate this Trust prior to the time all benefit payments under the Plan(s) have been made. All assets in the Trust at termination shall be returned to Employer. Trustee may rely conclusively on Employer's directive that all Participants have consented to such revocation and termination. ARTICLE X MISCELLANEOUS 10.1 EMERGENCIES AND DELEGATION. (a) In case of an emergency, the Trustee may act in the absence of directions from any other person having the power and duty to direct the Trustee with respect to the matter involved and shall incur no liability in so acting. (b) By written notice to the Trustee, the Employer may authorize the Trustee to act on matters in the ordinary course of the business of the Trust or on specific matters upon the signature of its delegate. 10.2 EXPENSES AND TAXES. (a) The Employer, or at its option, the Trust, shall quarterly pay the Trustee its expenses in administering the Trust and reasonable compensation for its services as Trustee at a rate to be agreed upon by the parties to this Trust Agreement, based upon Trustee's published fee schedule. However, the Trustee reserves the right to alter this rate of compensation at any time by providing the Employer with notice of such change at least thirty (30) days prior to its effective date. Reasonable compensation shall include compensation for any extraordinary services or computations required, such as determination of valuation of assets when current market values are not published and interest on funds to cover overdrafts. The Trustee shall have a lien on the Trust for compensation and for any reasonable expenses including counsel, appraisal, or accounting 18 fees, and these shall be withdrawn from the Trust and may be reimbursed by the Employer. (b) Reasonable counsel fees, reasonable costs, expenses and charges of the Trustee incurred or made in the performance of its duties, expenses relating to investment of the Trust such as broker's commissions, stamp taxes, and similar items and all taxes of any and all kinds that may be levied or assessed under existing or future laws upon or in respect to the Trust or the income thereof, and the Trustee's charges for issuing distribution checks to Participants or their representatives shall be paid from, and shall constitute a charge upon the Trust. (c) The Employer shall pay any federal, state or local taxes on the Trust, or any part thereof, and/or the income therefrom. In the event any Participant is determined to be subject to federal income tax on any amount under this Trust Agreement prior to the time of payment hereunder, the entire amount determined to be so taxable shall, at the Employer's direction, be distributed by the Trustee to such Participant from the Trust. For the above purposes, a Participant shall be determined to be subject to federal income tax with respect to the Trust upon the earlier of: (a) a final determination by the United States Internal Revenue Service ("IRS") addressed to the Participant which is not appealed to the courts; (b) an opinion of legal counsel designated in writing by the Employer, addressed to the Employer and the Trustee, that, by reason of Treasury Regulations, amendments to the Code, published IRS rulings, court decisions or other substantial precedent, amounts hereunder subject the Participant to federal income tax prior to payment. The Employer shall undertake at its discretion and at its sole expense to defend any tax claims described herein which are asserted by the IRS against any Participant, including attorney fees and costs of appeal, and shall have the sole authority to determine whether or not to appeal any determination made by the IRS or by a lower court. The Employer also agrees to reimburse any Participant under this Section for any interest or penalties in respect of tax claims hereunder upon receipt of documentation thereof. 10.3 THIRD PARTIES. (a) No person dealing with the Trustee shall be required to follow the application of purchase money paid or money loaned to the Trustee nor inquire as to whether the Trustee has complied with the requirements hereof. (b) In any judicial or administrative proceedings, only the Employer and the Trustee shall be necessary parties and no Participant or other person having or claiming any interest in the Trust shall be entitled to any notice or service of process (except as required by law). Any judgment, decision or award entered in any such proceeding or action shall be conclusive upon all interested persons. 19 10.4 ADOPTION BY AFFILIATED EMPLOYER. Any affiliate of the Employer (an "Affiliated Employer") may adopt one or more of the Employer's Plans with the approval of the Employer, and the Affiliated Employer shall concurrently become a party to this Trust Agreement by giving written notice of its adoption of the Plans and this Trust Agreement to the Trustee. Upon such written notice, the Affiliated Employer shall become a signatory to this Trust Agreement. 10.5 BINDING EFFECT; SUCCESSOR EMPLOYER. This Trust Agreement shall be binding upon and inure to the benefit of any successor to the Employer or its business as the result of merger, consolidation, reorganization, transfer of assets or otherwise and any subsequent successor thereto. In the event of any such merger, consolidation, reorganization, transfer of assets or other similar transaction, the successor to the Employer or its business or any subsequent successor thereto shall promptly notify the Trustee in writing of its successorship and shall promptly supply information required by the Trustee. 10.6 RELATION TO PLANS. All words and phrases used herein shall have the same meaning as in the Plans, and this Trust Agreement and the Plans shall be read and construed together. Whenever in the Plans it is provided that the Trustee shall act as therein prescribed, the Trustee shall be and is hereby authorized and empowered to do so for all purposes as fully as though specifically so provided herein or so directed by the Employer. 10.7 MEDIATION AND ARBITRATION OF DISPUTES. If a dispute arises under this Trust Agreement between or among the Employer and Trustee or any Participant, except as provided in Sections 5.1(b) and 6.4, the parties agree first to try in good faith to settle the dispute by mediation under the Commercial Mediation Rules of the American Arbitration Association. Thereafter, any remaining unresolved controversy or claim arising out of or relating to this Agreement, or the performance or breach thereof, shall be decided by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association and Title 9 of California Code of Civil Procedure Sections 1280 et seq. The sole arbitrator shall be a retired or former Judge associated with the American Arbitration Association. Judgement upon any award rendered by the arbitrator shall be final and may be entered in any court having jurisdiction. Each party shall bear its own costs, attorney's fees and its share of arbitration fees. The Alternate Dispute Resolution Agreement in this Agreement does not constitute a waiver of the parties' rights to a judicial forum in instances where arbitration would be void under applicable law, and does not preclude Bank from exercising it's rights to interplead the funds of the Account at the cost of the Account. 20 10.8 PARTIAL INVALIDITY. Any provision of this Trust Agreement prohibited by law shall be ineffective to the extent of any such prohibition, without invalidating the remaining provisions hereof. In the event of any such holding, the Employer and Trustee and, if applicable, Participants, will immediately amend this Trust Agreement as necessary to remedy any such defect. 10.9 CONSTRUCTION. This Trust Agreement shall be governed by and construed in accordance with the laws of California. 10.10 NOTICES. Any notice, report, demand or waiver required or permitted hereunder shall be in writing, shall be deemed received upon the date of delivery if given personally or, if given by mail, upon the receipt thereof, and shall be given personally or by prepaid registered or certified mail, return receipt requested, addressed to Employer and Trustee as listed below in Article XII; if to a Participant, to the last mailing address provided to the Trustee with respect to such individual, provided, however, that if any party or his or its successor shall have designated a different address by written notice to the other parties, then to the last address so designated. ARTICLE XI DISTRIBUTIONS IN THE EVENT OF INSOLVENCY OF EMPLOYER 11.1 TRUSTEE AND EMPLOYER RESPONSIBILITY UPON NOTICE OF EMPLOYER'S INSOLVENCY: (a) Insolvency. Trustee shall cease payment of benefits to Participants if the Employer is Insolvent. Employer shall be considered "Insolvent" for purposes of this Trust Agreement if (i) Employer is unable to pay its debts as they become due, or (ii) Employer is subject to a pending proceeding as a debtor under the United States Bankruptcy Code. (b) At all times during the continuance of this Trust, as provided in Section 1.4 hereof, the principal and income of the Trust shall be subject to claims of general creditors of Employer under federal and state law as set forth below. (1) The Board of Directors and Chief Operating Officer of Employer shall have the duty to inform Trustee in writing of Employer's Insolvency. If a person claiming to be a creditor of Employer alleges in writing to Trustee that Employer has become Insolvent, Trustee shall determine whether Employer is Insolvent and, pending such determination, Trustee shall discontinue payment of benefits to Participants. If Trustee is unable to obtain information sufficient to ascertain Insolvency, Trustee may seek instructions of a court of law or submit the matter for arbitration before the American Arbitration Association or interplead the Trust Assets at the expense of the Trust. 21 (2) Unless Trustee has actual knowledge of Employer's Insolvency, or has received written notice from Employer or a person claiming to be a creditor alleging that Employer is Insolvent, Trustee shall have no duty to inquire whether Employer is Insolvent. Trustee may in all events rely on such evidence concerning Employer's solvency as may be furnished to Trustee and that provides Trustee with a reasonable basis for making a determination concerning Employer's solvency. (3) If at any time Trustee has determined that Employer is Insolvent, Trustee shall discontinue payments to Participants and shall hold the assets of the Trust for the benefit of Employer's general creditors. Nothing in this Trust Agreement shall in any way diminish any rights of Participants to pursue their rights as general creditors of Employer with respect to benefits due under the Plan(s) or otherwise. (4) Trustee shall resume the payment of benefits to Participants in accordance with Section 4.2 of this Trust Agreement only after Trustee has determined that Employer is not Insolvent (or is no longer Insolvent). (c) Determination of Insolvency. Upon receipt of the aforesaid written notice of the Employer's Insolvency from a person claiming to be a creditor of the Employer, the Trustee shall notify the Employer, and the Employer, within thirty (30) days of receipt of such notice, shall engage an arbitrator (the "Arbitrator") acceptable to Trustee, from the American Arbitration Association to determine the Employer's solvency or Insolvency. The Employer shall cooperate fully and assist the Arbitrator, as may be requested by the Arbitrator, in such determination and Employer or Trust shall pay all costs relating to such determination. The Arbitrator shall notify the Employer and Trustee separately by registered mail of its findings. If the Arbitrator determines that the Employer is solvent or if once found Insolvent the Employer is no longer Insolvent, the Trustee shall resume holding the Trust assets for the benefit of the Participants and may make any distributions called for under this Trust Agreement, including any amounts which should have been distributed during the period when the Trustee suspended distributions in response to a notice of the Employer's Insolvency, including earnings (or losses) on such suspended distributions. If the Arbitrator determines that the Employer is Insolvent or is unable to make a conclusive determination of the Employer's Insolvency, the Trustee shall continue to retain the assets of the Trust until the Employer's status of solvency or Insolvency is decided by a court of competent jurisdiction or it distributes all or a portion of the Trust assets to any duly appointed receiver, trustee in bankruptcy, custodian or to the Employer's general creditors, but only as such distribution is ordered by a court of competent jurisdiction. The Trustee shall have no liability for relying upon the determination of the Arbitrator as to the Employer's solvency or Insolvency. 22 (d) If a court of competent jurisdiction orders distribution of only part of the Trust assets and does not specify the manner in which Trust assets are to be liquidated, the Trustee shall liquidate Trust assets as follows: (i) If such liquidation is ordered prior to a Change in Control, as directed by the Employer; or (ii) If such liquidation is ordered after a Change in Control or upon Insolvency of Employer, as determined by the Trustee in its sole and absolute discretion. If the Employer fails to provide instructions under subparagraph (i) above, as to the manner of liquidation within five (5) business days prior to the date the Trustee is required to comply with the court's order, the Trustee shall liquidate and shall have the authority to order any Investment Manager to liquidate the Trust assets in such manner as the Trustee shall determine in its sole and absolute discretion. The Trustee shall not be liable for any damages resulting from the Trustee's exercise in good faith of its power to liquidate assets as provided in this paragraph. (e) Provided that there are sufficient assets, if Trustee discontinues the payment of benefits from the Trust pursuant to subsection (b)(3) hereof and subsequently resumes such payments, the first payment following such discontinuance shall include the aggregate amount of all payments due to Participants under the terms of the Plan(s) for the period of such discontinuance, less the aggregate amount of any payments made to Participants by Employer in lieu of the payments provided for hereunder during any such period of discontinuance of which Trustee has actual knowledge. 23 Nothing in this Trust Agreement shall in any manner diminish any right of a Participant to pursue his or her rights as a general creditor of the Employer with regard to payments under the Trust or otherwise. ARTICLE XII EFFECTIVE DATE The effective date of this Trust Agreement shall be September 1, 1998. Executed at Rancho Cordova, CA. Foundation Health Systems, Inc. UNION BANK OF CALIFORNIA, N.A. "Employer", Sponsor of the Trustee 475 Sansome St., 12th Floor Foundation Health Systems, Inc. - -------------------------------- Deferred Compensation Plan (Address) --------------------------------- (PLAN) San Francisco, CA 94111 - -------------------------------- 21600 Oxnard Street Woodland Hills, Ca 91367 -------------------------------- (Address) By: /s/ Tim Shortt By: /s/ Danny O. Smithson -------------------------- ------------------------ Tim Shortt Danny O. Smithson -------------------------- ------------------------ (typed or printed name) (typed or printed name) By: /s/ Thomas M. Thurston By: /s/ Jay Gellert -------------------------- ------------------------ Thomas M. Thurston Jay Gellert -------------------------- ------------------------ (typed or printed name) (typed or printed name) Approved by Counsel to Employer: - ------------------------------- Counsel 24 EX-10.62 14 EX-10.62 Ex. 10.62 ASSET PURCHASE AGREEMENT BY AND BETWEEN FOUNDATION HEALTH SYSTEMS, INC. AND ACCESS HEALTH, INC. ASSET PURCHASE AGREEMENT THIS ASSET PURCHASE AGREEMENT (the "AGREEMENT"), dated as of the 31st day of December, 1998, is entered into by and between Foundation Health Systems, Inc. ("SELLER"), a corporation incorporated under the laws of the State of California, and Access Health, Inc. ("BUYER"), a corporation incorporated under the laws of the State of Delaware. WHEREAS, Seller owns certain assets used in connection with the provision of call center services through a telephone triage system (the "BUSINESS"); and WHEREAS, Seller desires to sell the assets associated with the Business, as more fully described herein, and Buyer desires to purchase and assume all such assets. NOW, THEREFORE, in consideration of the premises and subject to the representations, warranties, covenants and conditions contained herein, the parties agree as follows: ARTICLE 1. SALE OF ASSETS SECTION 1.01 SALE OF ASSETS. (a) Seller agrees that, at the Closing, as defined in Section 1.06 herein, it shall sell, transfer, and deliver to Buyer, for the consideration hereinafter provided, the clinical content used by Seller in the Business, described in Schedule 1.01(a), including all clinical assessment guidelines, algorithms and protocols (the "TRIAGE CLINICAL CONTENT") and all Intellectual Property Rights therein owned by Seller (collectively, "the ASSETS"). "INTELLECTUAL PROPERTY RIGHTS" shall mean all worldwide patents and other patent rights, utility models, copyrights, trade secrets, know-how, trademarks, service marks, confidential information and other intellectual property and proprietary rights, including without limitation all applications and registrations with respect thereto. The Triage Clinical Content will be stored on a CD-ROM which will be delivered to Buyer at a mutually agreed upon time prior to the Closing for verification of completeness. (b) For avoidance of doubt, Buyer shall not assume or be liable for any liabilities of Seller in respect of: (i) any tax on any profit derived from the sale under this Agreement; and (ii) the preparation or filing of any tax returns and the payment of any taxes, license fees or other charges levied, assessed or imposed upon the business and Assets of the Seller prior to the Closing Date (as defined herein). SECTION 1.02 NON-ASSUMPTION OF LIABILITIES. Buyer shall not assume any liabilities of Seller or be responsible for any obligations of Seller in connection with the sale of Assets provided in Section 1.01 or otherwise arising prior to the Closing. SECTION 1.03 RIGHT TO EMPLOY CERTAIN OF SELLER'S EMPLOYEES. Buyer shall have the right, but not the obligation, to offer employment to those employees of Seller associated with the operation of the Business, that are set forth on SCHEDULE 1.03. SECTION 1.04 EXCLUDED ASSETS. For avoidance of doubt, Seller will retain all other assets related to the Business or Seller's Fourth Generation Medical Management System (the "4G SYSTEM"), including computer systems, network equipment, certain clinical intellectual property, software applications and related intellectual property (excluding all clinical assessment guidelines, algorithms and protocols comprising the Assets), licenses to use certain technology from other vendors (the "EXCLUDED LICENSES"), and the rights to sell the 4G System and related technology (collectively the "4G SYSTEM ASSETS"). Seller's current 4G System products and the Excluded Licenses are generally set forth on SCHEDULE 1.04 hereto. (a) Excluded Licenses shall include all software licenses and maintenance, support and related agreements with each of Health Data Sciences Corporation, Systems Purkinje, Bolder Heuristics and Medical Scientists. (b) Seller shall retain the right to continue to employ all of Seller's employees related to the development, delivery and support of the 4G System, including technology support professionals, clinical and technical developers and related management and administrative personnel, except for those employees set forth on SCHEDULE 1.03. (c) Subject to Article 7, Seller shall retain all commercial opportunities for the license or resale of all components of the 4G System other than the Assets, including, but not limited to, all CHAMPUS/Department of Defense opportunities. SECTION 1.05 PURCHASE PRICE. The purchase price (the "PURCHASE PRICE") for the Assets shall be thirty-eight million four hundred thousand dollars ($38,400,000), shall be payable by certified or cashiers check, wire transfer or other same day funds, and shall be payable at the Closing, as set forth in Section 1.06 below. 2 SECTION 1.06 CLOSING. The closing of the transactions contemplated by this Agreement shall take place at 4:00 p.m. PST on December 31st, 1998, at the offices of the Seller, or such other place, time or date mutually agreed between the parties in writing (such closing being called the "CLOSING" and such date being called the "CLOSING DATE." SECTION 1.07 POST-CLOSING OBLIGATIONS. From time to time, at either party's request, whether at or after the Closing and without further consideration, the other party, at its expense, will execute and deliver such further instruments of conveyance and transfer and take such other action as the requesting party reasonably may require to convey and transfer to Buyer any of the Assets to be sold and otherwise to effectuate the terms of this Agreement. ARTICLE 2. REPRESENTATIONS AND WARRANTIES OF SELLER As of the date hereof and the Closing Date, Seller represents and warrants to Buyer, that: SECTION 2.01 ORGANIZATION, QUALIFICATION AND CORPORATE POWER. Seller is, and on the Closing Date will be, duly incorporated, validly existing, and in good standing under the laws of the State of Delaware. Seller has the corporate power and authority to own and hold its properties and to carry on its business as now conducted. SECTION 2.02 NO BREACH. the execution, delivery and performance by Seller of this Agreement and related agreements contemplated herein do not and will not on the Closing Date (i) contravene or conflict with the Certificate of Incorporation or Bylaws of Seller; (ii) contravene, violate, or conflict with any law, regulation, judgment, order or decree applicable to Seller; or (iii) constitute a default under or give rise to any right to terminate any agreement, contract or other instrument binding upon Seller, or any material license, permit or other similar authorization held by Seller. SECTION 2.03 OWNERSHIP. (i) Seller has good and marketable title to the assets and owns all right, title and interest in and to the Assets, free and clear of any and all mortgages, pledges, security interests, liens, charges, claims, restrictions and other encumbrances; (ii) there are no outstanding agreements or assignments inconsistent with the provisions of this Agreement or which would impair the exercise by Buyer of its full ownership rights in the Assets; (iii) no licenses or rights are required to be obtained from Seller or any third party in order for Buyer to fully exploit the Assets; (iv) no third party has been granted, and Seller shall not grant, any right in the Assets; (v) no past or present employee or consultant of Seller has any interest in the Assets and Seller has no knowledge of facts that could reasonably be expected to give rise to such a claim; (vi) Seller owns all Intellectual Property Rights in the Triage Clinical Content and has not acquired any Intellectual Property Rights relating to the Triage Clinical Content from any third party; (vii) Seller has no knowledge that any third party is infringing upon any of the Intellectual Property Rights; (viii) the Triage Clinical Content does not infringe the Intellectual Property Rights of any third party; (ix) the Triage Clinical Content conforms to the description in Schedule 1.01(a); and (x) the CD-ROM containing the Triage Clinical Content which was 3 verified by Buyer has not been altered in any manner from the time of verification to the Closing and has been stored under appropriate conditions. SECTION 2.04 VALIDITY. Seller has the full legal power and authority to execute and deliver this Agreement and all other agreements and documents necessary to consummate the transactions contemplated hereunder and all corporate action of Seller necessary for such execution and delivery and the performance hereof and thereof will have been duly taken on or before the Closing. No stockholder action by Seller is required to transfer the Assets to Buyer or consummate the transactions contemplated by this Agreement. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of Seller. This Agreement and all agreements related to the contemplated transaction when duly executed and delivered by Seller and, when duly executed by the Buyer, will constitute the legal, valid, and binding obligation of Seller enforceable in accordance with their terms, subject as to enforcement of remedies to the discretion of courts in awarding equitable relief and to applicable bankruptcy, reorganization, insolvency, moratorium and similar laws affecting the rights of creditors generally. The execution and delivery by Seller of this Agreement, and the performance of its obligations hereunder, does not require any action of any party other than Seller pursuant to or conflict with, or result in any violation of, or default under, or breach of any material contract, agreement or other undertaking of Seller, pursuant to any order or decree to which Seller is a party, or to which the Assets are subject, and will not conflict with, or result in any violation of, or default under (with or without notice or lapse of time, or both), or give rise to a right of termination, cancellation or acceleration of any obligation or loss of any benefit or creation of any security interest under (any such event, a "CONFLICT"). No consent, waiver, approval, order or authorization of, or registration, declaration or filing with, any court, administrative agency or commission or other federal, state, county, local or foreign governmental authority, instrumentality, agency or commission ("GOVERNMENT ENTITY") or any third party (so as not to trigger any Conflict), is required by or with respect to the company in connection with the execution and delivery of this Agreement, the sale and transfer of the Assets or the consummation of the transactions contemplated hereby. SECTION 2.05 LITIGATION AND INVESTIGATIONS. Except in the case of a claim Buyer may have against Seller, there is no (i) action, suit, claim, proceeding, or investigation pending or, to its knowledge, threatened against or affecting the Assets, or any of the employees providing services relating to the Assets, by any private party or any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign; (ii) arbitration proceeding relating to the Assets pending under collective bargaining agreements or otherwise; or (iii) governmental or professional inquiry pending or, to the knowledge of Seller, threatened against or affecting the Assets. Seller is not in default with respect to any order, writ, injunction, or decree known to or served upon them of any court or of any federal, state, municipal, or other governmental department, commission, board, bureau, agency, or instrumentality, domestic or foreign. SECTION 2.06 TRADEMARKS, PATENTS AND OTHER RIGHTS. Set forth in 4 SCHEDULE 2.06 is a list of all patents, patent rights, patent applications, trademarks, trademark applications, service marks, service mark applications, trade names and copyrights, and all applications for such which are in the process of being prepared, owned by, or registered in the name of, Seller and relating to the Assets. SECTION 2.07 FEES AND COMMISSIONS. Seller has not agreed to pay or become liable to pay any broker's, finder's, or originator's fees or commissions by reason of services alleged to have been rendered for, or at the instance of, Seller in connection with this Agreement and the transactions contemplated hereby. SECTION 2.08 YEAR 2000 COMPLIANCE. Seller makes no representation or warranty with regard to information systems readiness for or that the Assets will not otherwise be affected by the commencement of the year 2000. SECTION 2.09 OTHER APPROVALS. SCHEDULE 2.09 sets forth a list of all consents, approvals, qualifications, orders or authorizations of, or filings with, any governmental authority, including any court or other governmental third party, required in connection with Seller's valid execution, delivery, or performance of this Agreement, or the consummation of any transaction contemplated by this Agreement, with the exception of any clearance required under the Hart-Scott-Rodino Antitrust Improvement Act of 1976 (the "HSR ACT"), which clearance has been obtained. ARTICLE 3. REPRESENTATIONS AND WARRANTIES OF BUYER As of the date hereof and the Closing Date, Buyer represents and warrants to Seller: SECTION 3.01 ORGANIZATION, QUALIFICATION AND CORPORATE POWER. Buyer is, and on the Closing Date will be, duly incorporated, validly existing, and in good standing under the laws of the State of Delaware. Buyer has the corporate power and authority to own and hold its respective properties and to carry on its respective business as now conducted. SECTION 3.02 NO BREACH. The execution, delivery and performance by Buyer of this Agreement and related agreements contemplated herein do not and will not on the Closing Date (i) contravene or conflict with the respective Articles of Incorporation or respective Bylaws of Buyer; (ii) contravene, violate, or conflict with any material law, regulation, judgment, order or decree applicable to Buyer; or (iii) constitute a default under or give rise to any right to terminate any material agreement, contract or other instrument binding upon Buyer, or any material license, permit or other similar authorization held by Buyer. SECTION 3.03 VALIDITY. Buyer has the full legal power and authority to execute and deliver this Agreement and all other agreements and documents necessary to consummate the transactions contemplated hereunder and all corporate action of Buyer necessary for such execution and delivery and the performance thereof will have been duly taken. This Agreement 5 and all agreements related to the contemplated transaction when duly executed and delivered by Buyer and, when duly executed by the other parties thereto, will constitute the legal, valid, and binding obligation of Buyer enforceable in accordance with their terms, subject as to enforcement of remedies to the discretion of courts in awarding equitable relief and to applicable bankruptcy, reorganization, insolvency, moratorium and similar laws affecting the rights of creditors generally. The execution and delivery by Buyer of this Agreement, and the performance of its obligations hereunder, does not require any action of any party other than Buyer pursuant to any material contract, agreement or other undertaking of Buyer, or pursuant to any order or decree to which Buyer is a party or to which its properties or assets are subject. SECTION 3.04 FEES AND COMMISSIONS. Buyer has not agreed to pay or become liable to pay any broker's, finder's, or originator's fees or commissions by reason of services alleged to have been rendered for, or at the instance of, Buyer in connection with this Agreement and the transactions contemplated hereby. SECTION 3.05 OTHER APPROVALS. SCHEDULE 3.05 sets forth a list of all consents, approvals, qualifications, orders or authorizations of, or filings with, any governmental authority, including any court or other governmental third party, required in connection with Buyer's valid execution, delivery, or performance of this Agreement, or the consummation of any transaction contemplated by this Agreement, with the exception of any clearance required under the HSR act, which clearance has been obtained. ARTICLE 4. JOINT COVENANTS OF THE PARTIES SECTION 4.01 CONFIDENTIALITY OF BUSINESS INFORMATION. Each party shall use Confidential Information and all notes, documents and materials prepared by or for it which reflect, interpret, evaluate, include or are derived from Confidential Information ("EVALUATION MATERIAL") solely to evaluate and consider the proposed transactions. Upon the Closing, all Confidential Material and Evaluation Material relating to the Assets shall be owned by Buyer. Neither party shall use the Disclosing Party's Confidential Information or Evaluation Material to compete with or adversely affect the business or operations of the other or its Affiliates or for any other purpose except as permitted herein. For the purposes of this paragraph "CONFIDENTIAL INFORMATION" means all information in whatever form furnished to a party or its representatives by or on behalf of the other party which is marked as confidential or which the Receiving Party should have reason to know is treated as confidential by the Disclosing Party; provided that it does not include information which (i) is already in the Receiving Party's possession, and not previously provided by the Disclosing Party, provided that such information is not known by the receiving party to be subject to another confidentiality agreement with or other obligation of secrecy to the Disclosing Party or any third party, or (ii) becomes generally available to the public other than as a result of a disclosure by the Receiving party or the Receiving party's representatives. Upon request by a party at any time, the other party shall promptly return the original and all copies of all non-oral Confidential Information of the Disclosing Party and either 6 deliver or destroy the original and all copies of all Evaluation Material. Any party shall, upon request, certify as to its compliance with the preceding sentence. Prior to disclosing any information to a Representative, the party disclosing to such Representative shall obtain from such Representative an agreement to keep such information confidential and make no disclosure thereof, except as otherwise consistent with the terms of this Section 6.01. In the event that any disclosure is required to be made, each party shall cooperate with the other in order to limit the disclosure to the extent permitted by law. This Section 6.01 shall survive the termination of this Agreement. Notwithstanding the foregoing, in the event that the Confidentiality Agreement between Buyer and Seller, dated as of June 17, 1998, which shall remain in effect after Closing, contains a more restrictive term with regard to use and disclosure of Confidential Information than this Section 6.01, such agreement shall control and supercede this Section 6.01 with respect to such Confidential Information, except with respect to the Buyer's ownership upon Closing of Confidential Information and Evaluation Material relating to the Assets. SECTION 4.02 USE OF NAME. Buyer shall not use any and all trade names, trademarks, logos and trade dress belonging to Seller or its Affiliates, including, without limitation, those containing the words "FHS", "Foundation Health Systems", "QualMed", "4th Generation Medical Management", or "HealthLine", on its literature, inventory, products, labels, packaging, supplies or other materials relating to the Business as soon as available supplies thereof are exhausted and in any event within ninety (90) days after the Closing Date. Buyer shall re-label (by sticker or other reasonable method) its products, literature and other materials and supplies with its own trade name. SECTION 4.03 ANNOUNCEMENTS. The initial press releases with respect to the execution of this Agreement shall be reasonably acceptable to Buyer and Seller. Thereafter, so long as this Agreement is in effect, neither Buyer nor Seller nor any of their respective Affiliates shall issue or cause the publication of any press release with respect to the transactions contemplated hereby or this Agreement without consulting with the other party, except as may be required by law or by any listing agreement with a national securities exchange or market. SECTION 4.04 RELEASE. In consideration for the sale of the Assets hereunder, Buyer, for itself and its affiliates, hereby fully releases and discharges Seller, its subsidiaries, divisions, successors, assigns, representatives, shareholders, officers, directors, agents, employees, representatives, and assigns (collectively for purposes of this section "SELLER") from any and all actions, causes of action, claims, obligations, costs, losses, liabilities, damages and demands of whatsoever character, whether or not known, suspected or claimed ("CLAIMS"), which Buyer has or hereafter may have against Seller, solely to the extent such Claims arise out of or in any way relate to the Assets and Seller's ownership and use thereof prior to the Closing. This release does not apply to any Claim based upon or asserted to be based upon an act, omission or occurrence to the extent occurring subsequent to Closing. It is further understood and agreed that all rights under Section 1542 of the Civil Code of California are hereby expressly waived by Buyer. Said section reads as follows: 7 A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor. Notwithstanding the provisions of Section 1542, and for the purpose of implementing a full and complete release and discharge of Seller pursuant to this Section 4.04 and under the terms hereof, Buyer expressly acknowledges that this Agreement is intended to include in its effect, without limitation, all Claims which Buyer does not know or suspect to exist in its favor at the time of execution hereof, and this release contemplates the extinguishment of any such claim or claims. This Section 4.04 shall be in, and remain in, effect as a full and complete release according to its terms, notwithstanding the discovery or existence of any additional or different facts. Notwithstanding anything herein to the contrary, nothing in this Section 4.04 shall prevent Buyer from enforcing its rights pursuant to this Agreement, that certain Master Services Agreement by and among Seller and Buyer, of even date herewith (the "SERVICES AGREEMENT"), and that certain License Agreement between Seller and Buyer, of even date herewith. ARTICLE 5. NON-COMPETITION COVENANT SECTION 5.01 NON-COMPETITION. Seller will not compete with Buyer during the term of the Services Agreement, and for two years following its termination. During the term of the Services Agreement and for two (2) years following its termination, Seller shall not, directly or indirectly, own, operate, manage or control, or participate in the ownership, operation, management or control of, or be connected with or have any interest in or license or sublicense any Intellectual Property Rights to any enterprise, person, firm, corporation or business that is engaged in the commercial delivery of telephonically - based triage services (including referral and health care assessment services delivered as part of telephonically based triage services) or that licenses clinical triage algorithms and guidelines for use by others in the provision of telephonically - based triage services, provided that this covenant shall not apply to the activities of Managed Health Network, Inc. as conducted on the date hereof and shall not prohibit the Seller from (i) providing provider referral services to Members (as defined in the Services Agreement), or (ii) undertaking utilization review relating to Members. Notwithstanding the foregoing, if there is a change of control of Seller such that more than fifty percent (50%) of the ownership interest with respect to Seller prior to such change of control event is held after such event by an unrelated person or entity (the "ACQUIROR"), and such Acquiror operates telephonically-based triage services, such Acquiror and Seller shall have the right, at its discretion, either to (i) extinguish the noncompetition covenant set forth herein by making a liquidated damages payment of Ten Million Dollars ($10,000,000) in immediately available funds to Buyer, or (ii) extinguish the noncompetition covenant set forth herein by extending the term of the Services Agreement until the date two (2) years from the later of the previously-existing date of termination thereunder or the date of consummation of such change of control of Seller and maintaining services pursuant thereto during the extension period for at least as many Members (as defined in the Services Agreement) as were receiving services 8 pursuant thereto immediately prior to the earlier of Seller's execution of an agreement in connection with such change of control or public announcement that either an offer had been made to consummate, or Seller was in discussions to consummate, a change in control. SECTION 5.02 SEVERABILITY. If any particular prohibition or restriction contained in Section 5.01 is judged by a court of competent jurisdiction to be unenforceable, but would be judged enforceable by a court of competent jurisdiction if that particular prohibition or restriction was deleted or reduced, then the prohibitions or restrictions contained in Section 5.01 shall apply with that particular prohibition or restriction deleted or reduced by the minimum amount necessary. SECTION 5.03 ACKNOWLEDGEMENTS. Seller acknowledges that: (a) The prohibitions and restrictions contained in Section 5.01 are reasonable and necessary; and (b) Seller has received valuable consideration for agreeing to the covenants in Section 5.01. SECTION 5.04 DAMAGES. Seller and Buyer acknowledge that it will be difficult to compute the amount of damage or loss to Buyer if Seller violates any of its agreements under Section 5.01, that Buyer will be without an adequate legal remedy if Seller violates the provisions of this Section 5.01 and that any such violation may cause substantial irreparable injury and damage to Buyer not fully compensable by monetary damages. Therefore, Seller and Buyer agree that in the event of any violation by Seller of this Section 5.01, Buyer shall be entitled (i) to recover from Seller monetary damages, (ii) to obtain specific performance, injunctive or other equitable relief, of either a preliminary or permanent type, and (iii) to seek any and all other available rights or remedies at law or in equity which may be exercised concurrently with the rights granted hereunder. SECTION 5.05 TERMINATION OF COVENANT. At any time that Seller elects to terminate the Services Agreement, as provided therein, Seller shall have the right to terminate the provisions of this Article 5 upon payment to Buyer of the amount of Ten Million Dollars ($10,000,000) in immediately available funds, in addition to any payment due under the Services Agreement. 9 ARTICLE 6. INDEMNIFICATIONS SECTION 6.01 SELLER'S INDEMNIFICATION. Seller agrees to indemnify and hold Buyer harmless from and against any and all liabilities, losses, damages, costs, and expenses (including reasonable attorneys' fees) incurred or maintained by Buyer because of any inaccuracy in, or breach or violation of, the representations, warranties, and covenants made by Seller in this Agreement. Seller agrees to indemnify and hold Buyer harmless from any and all claims and liabilities arising out of the activities of Seller relating to the Assets prior to the Closing Date. SECTION 1.02 BUYER'S INDEMNIFICATION. Buyer agrees to indemnify and hold Seller harmless from and against any and all liabilities, losses, damages, costs, and expenses (including reasonable attorneys' fees) incurred or sustained by Seller because of any inaccuracy in, or breach or violation of, the representations, warranties, and covenants made by it in this Agreement. SECTION 6.03 LIMITATION ON AND EXPIRATION OF INDEMNIFICATION. Notwithstanding anything in this Article 6 to the contrary, Seller's rights to indemnification from Buyer, and Buyer's rights to indemnification from Seller shall be limited as follows: (a) All rights of the parties hereto to indemnification hereunder for breaches of representations and warranties (other than those set forth in Section 2.03 hereof) shall expire one (1) year after the closing date; PROVIDED, HOWEVER, if, prior to such expiration, a state of facts shall have become known which threatens to give rise to a liability against which any party hereto would be entitled to indemnification hereunder and the indemnified party shall have given notice of such facts to the indemnifying party, then the rights of the indemnified party to indemnification with respect to such liability shall continue until such liability shall have been finally determined and disposed of; PROVIDED, FURTHER, that Seller shall continue to indemnify and hold harmless Buyer for any breach of the representations and warranties under Section 2.03 herein for the term of the services agreement. (b) No party shall be shall be entitled to indemnification pursuant to Section 6.01 or 6.02 unless and until the aggregate amount of damages to which the foregoing indemnity relates, sustained by such party with respect to any individual claim, exceeds $100,000. SECTION 6.04 NOTICE AND CONTROL OF LITIGATION. If any claim or liability is asserted in writing against a party entitled to indemnification under this Article 6 (the "INDEMNIFIED PARTY") which would give rise to a claim under this Article 6, the Indemnified Party shall notify the person providing the indemnity ("INDEMNIFYING PARTY") in writing of the same within thirty (30) days of receipt of such written assertion of a claim or liability. The Indemnifying Party shall have the right to defend a claim and control the defense, settlement and 10 prosecution of any litigation. If the Indemnifying Party, within ten (10) days after notice of such claim, fails to defend such claim, the Indemnified Party will (upon further notice to the Indemnifying Party) have the right to undertake the defense, compromise or settlement of such claim on behalf of and for the account and risk of the Indemnifying Party, subject to the right of the Indemnifying Party to assume the defense of such claim at any time prior to settlement, compromise or final determination thereof. Anything in this Section 6.04 notwithstanding, (i) if there is a reasonable probability that a claim may adversely affect the Indemnified Party other than as a result of money damages or other money payments, the Indemnified Party shall have the right, at its own cost and expense, to defend, compromise and settle such claim, and (ii) the Indemnifying Party shall not, without the written consent of the Indemnified Party settle or compromise any claim or consent to the entry of any judgment which does not include as an unconditional term thereof the giving by the claimant to the Indemnified Party a release from all liability in respect to such claim. All parties agree to cooperate fully as necessary in the defense of such matters. Should the Indemnified Party fail to notify the Indemnifying Party in the time required above, this indemnity shall terminate and be of no further force and effect with respect to the subject matter of the required notice in the event that the Indemnified Party's failure to notify in the time required above adversely affects the Indemnifying Party's ability to defend such matter. SECTION 6.05 ADJUSTMENT FOR INSURANCE AND TAXES. The amount which an Indemnifying Party is required to pay to, for or on behalf of the other party (hereinafter referred to as an "INDEMNITEE") pursuant to this Article 6 shall be adjusted (including, without limitation, retroactively) (i) by any insurance proceeds actually recovered by or on behalf of such Indemnitee in reduction of the related indemnifiable loss (the "INDEMNIFIABLE LOSS") and (ii) to take account of any tax benefit realized as a result of any Indemnifiable Loss. Amounts required to be paid, as so reduced, are hereinafter sometimes called an "INDEMNITY PAYMENT". If an Indemnitee has received or has had paid on its behalf an Indemnity Payment for an Indemnifiable Loss and subsequently receives insurance proceeds for such Indemnifiable Loss, or realizes any tax benefit as a result of such Indemnifiable Loss, then the Indemnitee shall (x) promptly notify the Indemnifying Party of the amount and nature of such proceeds and benefits and (y) pay to the Indemnifying Party the amount of such insurance proceeds or tax benefit or, if lesser, the amount of the Indemnity Payment. SECTION 6.06 MITIGATION OF LOSS. Each Indemnitee is obligated to use all reasonable efforts to mitigate to the fullest extent practicable the amount of any Indemnifiable Loss for which it is entitled to seek indemnification hereunder, and the Indemnifying Party shall not be required to make any payment to an Indemnitee in respect of such Indemnifiable Loss to the extent such Indemnitee failed to comply with the foregoing obligation. SECTION 6.07 SUBROGATION. Upon making any Indemnity Payment, the Indemnifying Party will, to the extent of such payment, be subrogated to all rights of the Indemnitee against any third party in respect of the Indemnifiable Loss to which the payment relates; PROVIDED, HOWEVER, that until the Indemnitee recovers full payment of its Indemnifiable Loss, any and all claims of the Indemnifying Party against any such third party on account of 11 such payment are hereby made expressly subordinated and subjected in right of payment of the Indemnitee's rights against such third party. Without limiting the generality of any other provision hereof, each such Indemnitee and Indemnifying Party will duly execute, upon request, all instruments reasonably necessary to evidence and perfect the above-described subrogation and subordination rights. SECTION 6.08 EXCLUSIVE REMEDY. Following the Closing, and with the exception of the provisions of Articles 4 and 5, the indemnities provided for in this Article 6 shall be the sole and exclusive remedies of the parties and their respective officers, directors, employees, Affiliates, agents, representatives, successors and assigns for any breach of or inaccuracy in any representation or warranty or any breach, nonfulfillment or default in the performance of any of the covenants or agreements contained in this Agreement (but not any such covenants or agreements to the extent they are, by their terms, to be performed after the Closing Date). The parties shall not be entitled to a recission of this Agreement or to any further indemnification rights or claims of any nature whatsoever in respect thereof (whether by contract, common law, statute, law, regulation or otherwise, including, without limitation, under the Racketeer Influence and Corrupt Organizations Act of 1970, as amended), all of which the parties hereby waive, PROVIDED, HOWEVER, nothing herein is intended to waive any claims for fraud. ARTICLE 7. MISCELLANEOUS SECTION 7.01 DEFINITIONS. For the purposes of this Agreement: (a) The term "KNOWLEDGE" shall be defined as actual knowledge and knowledge of such other facts as to show bad faith; (b) The term "AFFILIATE" (or "AFFILIATES") shall mean an entity that is controlled by, controls, or is under common control with a party (directly or indirectly). SECTION 7.02 AMENDMENTS. This Agreement may not be amended or modified without the written consent of the parties hereto. SECTION 7.03 WAIVER. Failure to insist upon strict compliance with any of the terms, covenants, or conditions of this Agreement at any one time shall not be deemed a waiver of such term, covenant, or condition at any other time nor shall any waiver or relinquishment of any right or power herein at any time be deemed a waiver or relinquishment of the same or any other right or power at any other time. 12 SECTION 7.04 NOTICES. All notices, payments, or other communications required or permitted hereunder shall be in writing and shall be deemed to have been duly given if sent by registered or certified mail, postage prepaid, and return receipt requested to the parties, addressed as follows (or at such other addresses as designated by the parties from time to time): IF TO SELLER: Foundation Health Systems, Inc. 21600 Oxnard Street Woodland Hills, California 91367 Attn: President and Chief Executive, Government Operations and Specialty Services IF TO BUYER: Access Health, Inc. 335 Interlocken Parkway Broomfield, Colorado 80021 Attn: General Manager SECTION 1.05 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. SECTION 7.06 ENFORCEABILITY AND SEVERABILITY. In the event any provision of this Agreement or portion thereof is found to be wholly or partially invalid, illegal, or unenforceable in any proceeding, then such provision shall be deemed to be modified or restricted to the extent and in the manner necessary to render the same valid and enforceable, or shall be deemed excised from this Agreement, as the case may require, and this Agreement shall be construed and enforced to the maximum extent permitted by law as if such provision had been originally incorporated herein as so modified or restricted or as if such provision had not been originally incorporated herein, as the case may be. SECTION 7.07 GOVERNING LAWS AND CONSENT TO JURISDICTION. The laws of the State of California (irrespective of its choice of law principles) shall govern all issues concerning the validity of this Agreement, the construction of its terms and the interpretation and enforcement of the rights and duties of the parties. Each party irrevocably submits to the exclusive jurisdiction of the courts of the State of California and the Federal courts of the United States of America located in the State of California (and the California state and Federal courts having jurisdiction over appeals therefrom) in respect of the transactions contemplated by this Agreement, the other agreements and documents referred to herein and the transactions contemplated by this Agreement and such other documents and agreements. 13 SECTION 7.08 SECTION TITLES. The titles of the sections have been inserted as a matter of convenience and reference only and shall not control or affect the meaning or construction of this Agreement. SECTION 7.09 ASSIGNMENT. This Agreement shall not be assignable or delegated by any party without the prior written consent of the other except that Buyer may assign this Agreement to its parent company without prior written consent. SECTION 7.10 EXPENSES. Each party hereto will pay its own expenses in connection with the transactions contemplated hereby, whether or not such transactions shall be consummated. SECTION 7.11 SURVIVAL OF AGREEMENTS. All representations and warranties made in Sections 2 or 3 herein shall be effective as of the Closing Date and shall survive the execution and delivery of this Agreement until one (1) year from the date of Closing, except for Seller's representation and warrranty under Section 2.03, which shall survive until the termination of the Services Agreement. All statements contained in any certificate or other instrument delivered by Buyer or Seller, hereunder or in connection herewith shall be deemed to constitute representations and warranties made by that entity. Such representations and warranties shall survive until the time specified herein in full force and effect notwithstanding any investigation by the party relying upon them. SECTION 7.12 BROKERAGE. Each party hereto will indemnify and hold the others harmless against and in respect of any claim for brokerage or other commissions relative to this Agreement or to the transactions contemplated hereby, based in any way on agreements, arrangements, or understandings made or claimed to have been made by such party with any third party. SECTION 7.13 PARTIES IN INTEREST. All representations, covenants, and agreements contained in this Agreement by or on behalf of any of the parties hereto shall bind and inure to the benefit of the respective successors and assigns of the parties hereto whether so expressed or not. Seller acknowledges that Buyer's corporate parent is in the process of being acquired by McKesson Corporation. SECTION 7.14 REMEDIES. All remedies for breach of this Agreement shall be cumulative. SECTION 7.15 THIRD PARTIES. Except as specifically provided herein, this Agreement does not and is not intended to create any rights in any person or entity which is not a party to this Agreement. SECTION 7.16 SPECIFIC PERFORMANCE. Each party acknowledges and agrees that in the event of any breach of this Agreement, each non-breaching party would be irreparably and immediately harmed and could not be made whole by monetary damages. It is accordingly 14 agreed that the parties will (a) waive, in any action for specific performance, the defense of adequacy of a remedy at law and (b) be entitled, in addition to any other remedy to which they may be entitled, at law or in equity, to compel specific performance of this Agreement in any action instituted in accordance with Section 7.04. SECTION 7.17 ENTIRE AGREEMENT. This Agreement, including the Schedules and Exhibits hereto, constitutes the sole and entire agreement and understanding of the parties with respect to the subject matter hereof. All Schedules and Exhibits hereto are incorporated herein by reference. 15 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement to be effective as of the day and year first written above. ACCESS HEALTH, INC. FOUNDATION HEALTH SYSTEMS, INC. By: /s/ Joseph P. Tallman By: /s/ Gary S. Velasquez -------------------------- ----------------------------------------- Joseph P. Tallman Gary S. Velasquez -------------------------- ----------------------------------------- Print Name Print Name President President/CEO Government & Specialty -------------------------- ----------------------------------------- Title Services Division -------------------------- ----------------------------------------- Title 16 EX-10.63 15 EXHIBIT 10.63 Ex. 10.63 PURCHASE AGREEMENT among FOUNDATION HEALTH SYSTEMS, INC., FOUNDATION HEALTH CORPORATION, FOUNDATION HEALTH PHARMACEUTICAL SERVICES, INC., INTEGRATED PHARMACEUTICAL SERVICES, INC. and ADVANCE PARADIGM, INC. Dated: February 26, 1999 PURCHASE AGREEMENT This PURCHASE AGREEMENT (this "AGREEMENT") is made as of the 26th day of February 1999, by and among Advance Paradigm, Inc., a Delaware corporation ("BUYER"), Foundation Health Systems, Inc., a Delaware corporation (the "COMPANY"), Foundation Health Corporation ("FHC"), a California corporation, Foundation Health Pharmaceutical Services, Inc., a California corporation ("FHPS"), and Integrated Pharmaceutical Services, Inc., a California corporation ("IPS", and together with FHC and FHPS, the "SUBSIDIARIES"). The Company is the ultimate parent of the Subsidiaries. RECITALS: WHEREAS, the Company owns (directly or indirectly) all of the outstanding capital stock of the Subsidiaries; and WHEREAS, Buyer desires to purchase from the Company all of the outstanding capital stock of FHPS, and the Company desires to sell to Buyer all of the outstanding capital stock of FHPS, in accordance with the terms and conditions of this Agreement; and WHEREAS, Buyer desires to purchase from IPS certain assets of IPS, and IPS desires to sell to Buyer certain assets of IPS, in accordance with the terms and conditions of this Agreement. AGREEMENT: NOW, THEREFORE, in consideration of the premises and the mutual promises herein made, and in consideration of the representations, warranties, and covenants herein contained, Buyer, the Company and the Subsidiaries (collectively, the "PARTIES") agree as follows: ARTICLE 1 DEFINITIONS "ADVERSE CONSEQUENCES" means all actions, suits, proceedings, hearings, investigations, charges, complaints, claims, demands, injunctions, judgments, orders, decrees, rulings, damages, dues, penalties, fines, costs, amounts paid in settlement, Liabilities, obligations, Taxes, liens, losses, expenses, and fees, including, but not limited to, court costs and reasonable attorneys' fees and expenses. "AFFILIATE" has the meaning set forth in Rule 12b-2 of the regulations promulgated under the Securities Exchange Act. "AFFILIATED BUSINESS" means the pharmacy benefit requirements of the Company and its Affiliates, and employer groups, administrative services organizations and other third party clients of the Company and its Affiliates. "BUYER" has the meaning set forth in the preface to this Agreement. "BUYER PERMITS" shall have the meaning set forth in SECTION 3.6. "CHANGE OF CONTROL" of a company shall occur when: (i) a third party acquires fifty percent (50%) or more of the outstanding voting stock of such company; (ii) the company sells all or substantially all of its assets to a third party; or (iii) the company merges into or consolidates with another party such that (a) the company is not the surviving company, (b) if the surviving company, a majority of the Board of Directors of the company comprising the board immediately prior to such transaction does not also constitute a majority following such transaction, or (c) if the surviving company, a majority of the outstanding shares of the company's stock is not held by holders who held a majority of the shares of stock of the company immediately prior to such transaction. "CLAIM NOTICE" has the meaning set forth in SECTION 8.5. "CLOSING" has the meaning set forth in SECTION 2.5. "CLOSING DATE" has the meaning set forth in SECTION 2.5. "CODE" means the Internal Revenue Code of 1986, as amended, and the rules and regulations promulgated thereunder. "COMPANY" has the meaning set forth in the preface to this Agreement. "CONTRACT" means any agreement, contract, lease, note, mortgage, indenture, loan agreement, franchise agreement, covenant, employment agreement, license, instrument, purchase and sales order, commitment, undertaking or obligation. "CURRENT BALANCE SHEET" has the meaning set forth in SECTION 4.9. "CURRENT FINANCIAL STATEMENTS" has the meaning set forth in SECTION 4.8. "DEFAULT IN PHARMACY PAYMENT" has the meaning set forth in SECTION 5.12(d). "EMPLOYEE BENEFIT PLAN" means any (a) nonqualified deferred compensation or retirement plan or arrangement which is an Employee Pension Benefit Plan, (b) qualified defined contribution retirement plan or arrangement which is an Employee Pension Benefit Plan, (c) qualified defined benefit retirement plan or arrangement which is an Employee Pension Benefit Plan (including any Multiemployer Plan), or (d) Employee Welfare Benefit Plan or material fringe benefit plan or program. "EMPLOYEE PENSION BENEFIT PLAN" has the meaning set forth in ERISA Section 3(2). "EMPLOYEE WELFARE BENEFIT PLAN" has the meaning set forth in ERISA Section 3(1). "ENVIRONMENTAL, HEALTH, AND SAFETY REQUIREMENTS" shall mean all federal, state, and local statutes, regulations, ordinances and other provisions having the force or effect of law, all judicial and administrative orders and determinations, all contractual obligations and all common law concerning public health and safety, worker health and safety, and pollution or protection of the environment, including without limitation all those relating to the presence, use, production, generation, handling, transportation, treatment, storage, disposal, distribution, labeling, testing, processing, discharge, release, threatened release, control, or cleanup of any hazardous materials, substances or wastes, chemical substances or mixtures, pesticides, pollutants, contaminants, toxic chemicals, petroleum products or byproducts, asbestos, polychlorinated biphenyls, noise or radiation, each as amended and as now in effect. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. "FINANCIAL STATEMENTS" has the meaning set forth in SECTION 4.8. "FHPS PERMITS" shall have the meaning set forth in SECTION 4.19. "FHS SUCCESSOR" means any third party that acquires the Company or the Affiliated Business in a Change of Control transaction. "GAAP" means United States generally accepted accounting principles as in effect from time to time. "GOVERNMENTAL AUTHORITY" means any nation or government, any state, regional, local or other political subdivision thereof, and any entity or official exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "HART-SCOTT-RODINO ACT" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder. "INDEMNIFIED PARTY" has the meaning set forth in SECTION 8.4. "INDEMNIFYING PARTY" has the meaning set forth in SECTION 8.4. "INTELLECTUAL PROPERTY" has the meaning set forth in SECTION 4.21. "LIABILITY" means any liability (whether known or unknown, whether asserted or unasserted, whether absolute or contingent, whether accrued or unaccrued, whether liquidated or unliquidated, and whether due or to become due), including any liability for Taxes. "LIENS" means liens, claims, charges, options, pledges, security interests or other encumbrances. "MATERIAL ADVERSE CHANGE (OR EFFECT)" means a change (or effect) in the condition (financial or otherwise), properties, assets (including intangible assets), liabilities (including contingent liabilities), rights, obligations, operations, or business, which change (or effect), individually or in the aggregate, is materially adverse to the operations or business of FHPS, the Purchased Assets or Buyer, each taken as a whole. "MATERIAL CONTRACT" means each Contract to which the respective Person is a party, or by which it or its properties or assets are bound, and which is material to any of its businesses, assets, properties or prospects. "MULTIEMPLOYER PLAN" has the meaning set forth in ERISA Section 3(37). "NON-AFFILIATED BUSINESS" means the pharmacy benefit services offered to third party health plan customers by the Company, FHPS, IPS or their Affiliates prior to the Closing. "PARTIES" has the meaning set forth in the preface to this Agreement. "PBGC" means the Pension Benefit Guaranty Corporation. "PERSON" means an individual, a partnership, a corporation, an association, a joint stock company, a trust, a joint venture, an unincorporated organization, or a governmental entity (or any department, agency, or political subdivision thereof). "PRIOR FINANCIAL STATEMENTS" has the meaning set forth in SECTION 4.8. "PURCHASED ASSETS" means all of the assets of IPS identified on EXHIBIT A hereto. "PURCHASE PRICE" has the meaning set forth in SECTION 2.2. "PURCHASED MATERIAL CONTRACTS" has the meaning set forth in SECTION 4.22. "Section 338 ELECTION" has the meaning set forth in SECTION 5.5. "SECTION 338 FORMS" has the meaning set forth in SECTION 5.5. "SECURITIES ACT" means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. "SERVICE AGREEMENT" has the meaning set forth in SECTION 5.11. "SHARES" means all of the outstanding shares of the Common Stock, no par value, of FHPS. "STRADDLE PERIOD" means any taxable period which includes but does not end on the Closing Date. "TAX" means any federal, state, local, or foreign income, gross receipts, license, payroll, employment, excise, severance, stamp, occupation, premium, windfall profits, environmental (including taxes under Code Section 59A), customs duties, capital stock, franchise, profits, withholding, social security (or similar), unemployment, disability, real property, personal property, sales, use, transfer, registration, value added, alternative or add-on minimum, estimated, or other tax of any kind whatsoever, including any interest, penalty, or addition thereto, whether disputed or not. "THIRD PARTY CLAIM" has the meaning set forth in SECTION 8.4. ARTICLE 2 PURCHASE AND SALE 2.1 BASIC TRANSACTION. (a) On and subject to the terms and conditions of this Agreement, Buyer agrees to purchase from FHC, and FHC agrees to sell to Buyer, all of the Shares and IPS agrees to sell to Buyer and Buyer agrees to purchase all of the Purchased Assets, for the consideration specified in SECTION 2.2. (b) Prior to the Closing, the Company shall, and shall cause each of the Subsidiaries to, take any and all action necessary to contribute the Purchased Assets from IPS to FHPS as mutually agreed upon by the parties, so that the agreed upon Purchase Assets shall be assets of FHPS at the Closing. (c) Prior to the Closing, all of the outstanding shares of stock of IPS held by FHPS shall have been transferred to FHS or an Affiliate of FHS. 2.2 PURCHASE PRICE. Buyer agrees to pay to the Company, at the Closing, Seventy Million Dollars ($70,000,000.00) (the "PURCHASE PRICE") by wire transfer of federal or other immediately available funds to an account designated by Buyer. The allocation of the purchase price among the Purchased Assets and the Shares shall be as set forth in SCHEDULE 2.2. 2.3 ASSUMPTION OF LIABILITIES. On or subject to the terms and conditions of this Agreement, at the Closing, Buyer shall assume and agree to pay, perform and discharge all of the liabilities and obligations of FHPS identified on EXHIBIT B hereto, and the liabilities of the Company and IPS set forth in SCHEDULE 2.3 hereto related to the Purchased Assets purchased at the Closing. No other obligations of the Company or IPS shall be assumed by Buyer. 2.4 WARRANT FOR SHARES. Upon execution of this Agreement, Buyer shall issue to FHS a warrant to purchase 200,000 shares of the common stock of Buyer, subject to and in form and substance as set forth in the warrant agreement attached hereto as EXHIBIT E. 2.5 THE CLOSING. The closing of the transactions contemplated by this Agreement (the "CLOSING") shall take place at the offices of Epstein Becker & Green, P.C., 2 Embarcadero, San Francisco, California, commencing at 9:00 a.m., local time, on the later of March 31, 1999 or the second business day following the satisfaction or waiver of all conditions to the obligations of the Parties to consummate the transactions contemplated hereby (other than conditions with respect to actions the respective Parties will take at the Closing itself) or such other date as Buyer and the Company may mutually determine (the "CLOSING DATE"). 2.6 DELIVERIES AT THE CLOSING. At the Closing, (a) the Company shall deliver to Buyer the various certificates, instruments, and documents referred to in ARTICLE 6, (b) Buyer shall deliver to the Company the various certificates, instruments, and documents referred to in ARTICLE 7, (c) the Company shall deliver to Buyer the various certificates and transfer documents set forth on EXHIBIT C hereto, and (d) Buyer shall deliver to the Company the consideration specified in SECTION 2.2. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF BUYER Buyer makes the following representations and warranties to the Company: 3.1 CORPORATE STATUS. Buyer is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has the requisite power and authority to own or lease its properties and to carry on its business as presently conducted. There is no pending or threatened proceeding for the dissolution, liquidation, insolvency or rehabilitation of Buyer. 3.2 CORPORATE POWER AND AUTHORITY. Buyer has the corporate power and authority to execute and deliver this Agreement and the Service Agreement, to perform its obligations hereunder and under the Service Agreement and to consummate the transactions contemplated hereby and by the Service Agreement. Buyer has taken all corporate action necessary to authorize its execution and delivery of this Agreement, the performance of its obligations hereunder and the consummation of the transactions contemplated hereby. 3.3 ENFORCEABILITY. This Agreement has been duly executed and delivered by Buyer and constitutes its legal, valid and binding obligation enforceable against Buyer in accordance with its terms, except as the same may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and general equitable principles regardless of whether such enforceability is considered in a proceeding at law or in equity. 3.4 NO VIOLATION. The execution and delivery of this Agreement and the Service Agreement by Buyer, the performance by Buyer of its obligations hereunder and under the Service Agreement and the consummation by Buyer of the transactions contemplated by this Agreement and the Service Agreement will not (a) contravene any provision of the Certificate of Incorporation or Bylaws of Buyer, (b) violate or conflict with any law, statute, ordinance, rule, regulation, decree, writ, injunction, judgment, ruling or order of any Governmental Authority or of any arbitration award which is either applicable to, binding upon, or enforceable against Buyer, the occurrence of any of which would have a Material Adverse Effect on Buyer, (c) conflict with, result in any breach of, or constitute a default (or an event which would, with the passage of time or the giving of notice or both, constitute a default) under, or give rise to a right to terminate, amend, modify, abandon or accelerate, any Material Contract which is applicable to, binding upon or enforceable against Buyer, the occurrence of which would have a Material Adverse Effect on Buyer, (d) result in or require the creation or imposition of any Lien upon or with respect to any of the property or assets of Buyer, (e) give to any individual or entity a right or claim against the Buyer, which would have a Material Adverse Effect on Buyer or (f) require the consent, approval, authorization or permit of, or filing with or notification to, any Governmental Authority, any court or tribunal or any other Person, except (i) pursuant to the Hart-Scott-Rodino Act, the Exchange Act and the Securities Act and applicable inclusion requirements of Nasdaq, (ii) filings required under the securities or blue sky laws of the various states, (iii) any filings required to be made by the Subsidiaries, or (iv) any governmental permits or licenses required to operate the businesses of the Subsidiaries. 3.5 NO COMMISSIONS. Other than Morgan Stanley, no broker, finder, investment banker or other Person is or will be, in connection with the transactions contemplated by this Agreement, entitled to any brokerage, finder's or other fee or compensation based on any arrangement or agreement made by or on behalf of Buyer and for which Buyer or the Company will have any obligation or liability. 3.6 COMPLIANCE WITH LAW. Buyer has substantially complied with and is substantially complying with all applicable laws, rules, regulations and ordinances, and has the lawful authority and has obtained and now holds all material state, federal, special or local governmental authorizations, licenses, certificates (including Certificates of Need) and permits (collectively "BUYER PERMITS") needed or required to conduct its businesses, as such businesses are presently being conducted, the absence of which would have a Material Adverse Effect on Buyer, and has made all material filings required by applicable law and regulations. 3.7 OTHER APPROVALS. SCHEDULE 3.7 sets forth a list of all consents, approvals, qualifications, orders or authorizations of, or filings with, any governmental authority, including any court or other governmental third party, required in connection with Buyer's valid execution, delivery or performance of this Agreement and the Service Agreement, or the consummation of any transaction contemplated by this Agreement and the Service Agreement. 3.8 INVESTIGATION BY BUYER. In entering into this Agreement: (a) Buyer acknowledges that, except for the specific representations and warranties of the Company and the Subsidiaries contained in ARTICLE 4 hereof, none of the Company, the Subsidiaries, any Affiliate of the Company, or any of their respective directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives, makes or shall be deemed to have made any representation or warranty, either express or implied, as to the accuracy or completeness of any financial projections, forecasts or budgets provided or otherwise made available to Buyer or any of its directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives (including, without limitation, in any management presentations, supplemental information or other materials or information with respect to any of the above). With respect to any such projection or forecast delivered by or on behalf of the Company or the Subsidiaries to Buyer, Buyer acknowledges that: (i) there are uncertainties inherent in attempting to make such projections and forecasts; (ii) it is familiar with such uncertainties; (iii) it is taking full responsibility for making its own evaluation of the adequacy and accuracy of all such projections and forecasts so furnished to it; (iv) it is not acting in reliance on any such projection or forecast so furnished to it; and (v) it shall have no claim against any such person with respect to any such projection or forecast; and (b) Buyer agrees, to the fullest extent permitted by law, that the Company and the Subsidiaries and their respective directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives shall not have any liability or responsibility whatsoever to Buyer or any of its directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives on any basis (including, without limitation, in contract or tort, under Federal or state securities laws or otherwise) based upon any financial projections provided or otherwise made available, or statements made regarding such projections, (or omissions to so provide, make available or state), to Buyer or any of its directors, officers, employees, Affiliates, controlling persons, agents, advisors or representatives. 3.9 ACQUISITION FOR INVESTMENT. Buyer is acquiring the Shares solely for its own account and not with a view to any distribution or other disposition of such Shares, and the Shares will not be transferred except in a transaction registered or exempt from registration under the Securities Act. 3.10 ABILITY TO PERFORM UNDER SERVICES AGREEMENT. Buyer represents and warrants that it has or will have, the financial, personnel, and systems capabilities to perform its obligations under the Service Agreement, in accordance with the transition schedule set forth therein. ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE SUBSIDIARIES The Company and the Subsidiaries, jointly and severally, make the following representations and warranties to Buyer: 4.1 CORPORATE STATUS. Each of the Company and the Subsidiaries is a corporation, duly organized and validly existing and, except where the failure would not have a Material Adverse Effect on FHPS or the Purchased Assets, has the requisite power and authority to own or lease its properties and to carry on its business as presently conducted, except where any such failure would not have a Material Adverse Effect on FHPS or the Purchased Assets. Each of the Company and the Subsidiaries is duly qualified to do business as a foreign corporation in each of the jurisdictions where the nature of its properties and the conduct of its business require such qualification, except for such jurisdictions where the failure to be so qualified would not have a Material Adverse Effect on the Company or a Subsidiary. Each of the Company and the Subsidiaries is in good standing in each of the jurisdictions in which it is so qualified. There is no pending or threatened proceeding for the dissolution, liquidation, insolvency or rehabilitation of the Company or a Subsidiary. 4.2 POWER AND AUTHORITY. Each of the Company and the Subsidiaries has the corporate power and authority to execute and deliver this Agreement and the Service Agreement, to perform its obligations hereunder and under the Service Agreement, and to consummate the transactions contemplated hereby and by the Service Agreement. Each of the Company and the Subsidiaries has taken all corporate action necessary to authorize the execution and delivery of this Agreement and the Service Agreement, the performance of its obligations hereunder and under the Service Agreement, and the consummation of the transactions contemplated hereby and by the Service Agreement. 4.3 ENFORCEABILITY. Each of this Agreement and the Service Agreement has been duly executed and delivered by the Company and each of the Subsidiaries (hereinafter sometimes referred to individually as a "COMPANY PARTY" and collectively as the "COMPANY PARTIES") and constitutes the legal, valid and binding obligation of each of them, enforceable against each of them in accordance with its terms, except as the same may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and general equitable principles regardless of whether such enforceability is considered in a proceeding at law or in equity. 4.4 CAPITALIZATION. Schedule 4.4 sets forth, as of the date hereof, with respect to FHPS, (a) the number of authorized shares of each class of its capital stock, (b) the number of issued and outstanding shares of each class of its capital stock and (c) the number of shares of each class of its capital stock which are held in treasury. FHC owns 100% of the capital stock of FHPS. All of the issued and outstanding shares of capital stock of FHPS (a) have been duly authorized and validly issued and are fully paid and non-assessable, (b) were issued in compliance with all applicable state and federal securities laws and (c) were not issued in violation of any preemptive rights or rights of first refusal. Except as set forth on SCHEDULE 4.4, no preemptive rights, rights of first refusal or similar rights exist with respect to the shares of capital stock of FHPS, and no such rights arise or become exercisable by virtue of or in connection with the transactions contemplated hereby. Except as set forth on SCHEDULE 4.4, there are no outstanding or authorized rights, options, warrants, convertible securities, subscription rights, conversion rights, exchange rights or other agreements or commitments of any kind that could require FHPS to issue or sell any shares of its capital stock (or securities convertible into or exchangeable for shares of its capital stock). Except as set forth on SCHEDULE 4.4, there are no outstanding stock appreciation, phantom stock, profit participation or other similar rights with respect to FHPS. There are no proxies, voting rights or other agreements or understandings with respect to the voting or transfer of the capital stock of FHPS. The shares of capital stock of FHPS are free and clear of all Liens. FHPS is not obligated to redeem or otherwise acquire any of its outstanding shares of capital stock. 4.5 NO LIENS ON ASSETS. The Purchased Assets are free and clear of all Liens. 4.6 NO VIOLATION, CONSENTS. The execution and delivery of this Agreement and the Service Agreement by the Company Parties, the performance by each of the Company Parties of their obligations hereunder and under the Service Agreement and the consummation by them of the transactions contemplated by this Agreement and the Service Agreement will not (a) contravene any provision of the certificates of incorporation, bylaws or other organizational or governing document of the Company or a Subsidiary, (b) violate or conflict with any law, statute, ordinance, rule, regulation, decree, writ, injunction, judgment, ruling or order of any Governmental Authority or of any arbitration award which is either applicable to, binding upon or enforceable against the Company or a Subsidiary, the occurrence of any of which would have a Material Adverse Effect on FHPS or the Purchased Assets, (c) conflict with, result in any breach of, or constitute a default (or an event which would, with the passage of time or the giving of notice or both, constitute a default) under, or give rise to a right of payment under or the right to terminate, amend, modify, abandon or accelerate, any Material Contract which is applicable to, binding upon or enforceable against FHPS, the occurrence of any of which would have a Material Adverse Effect on FHPS or the Purchased Assets, subject to SECTION 5.12 below, (d) result in or require the creation or imposition of any Lien upon or with respect to any of the properties or assets of FHPS or the Purchased Assets, (e) except as set forth on SCHEDULE 4.6, give to any individual or entity a right or claim against FHPS which would have a Material Adverse Effect on FHPS or the Purchased Assets or (f) except as set forth on SCHEDULE 4.6, require the consent, approval, authorization or permit of, or filing with or notification to, any Governmental Authority, any court or tribunal or any other Person, except (i) pursuant to the Hart-Scott-Rodino Act and applicable reporting requirements of the Exchange Act, the Securities Act or the New York Stock Exchange, Inc., (ii) filings required under the securities or blue sky laws of the various states, or (iii) except where the failure to obtain such consent or approval would not have a Material Adverse Effect on FHPS or the Purchased Assets, or the ability of the Company to consummate the transactions set forth in this Agreement. 4.7 RECORDS OF FHPS. The copies of the certificates of incorporation and bylaws of FHPS and the agreements of FHPS and IPS which were provided to Buyer are true, accurate, and complete and reflect all amendments made through the date of this Agreement. The minute books and other records of corporate actions for FHPS made available to Buyer for review were correct and complete as of the date of such review, no further entries have been made through the date of this Agreement, such minute books and records contain the true signatures of the persons purporting to have signed them, and such minute books and records contain an accurate record of all corporate actions of the stockholders and directors (and any committees thereof) of FHPS taken by written consent or at a meeting since formation. All corporate actions taken by FHPS have been duly authorized or ratified. All accounts, books, ledgers and official and other records of FHPS have been fully, properly and accurately kept and are complete, and there are no material inaccuracies or discrepancies contained therein. The stock ledgers of FHPS, as previously made available to Buyer, contain accurate and complete records of all issuances, transfers and cancellations of shares of the capital stock of FHPS. To the Company Parties' knowledge, the books and all corporate (including minute books and stock record books) and financial records of FHPS are substantially complete and correct in all material respects and have been maintained in accordance with applicable sound business practices, laws and other requirements. 4.8 FINANCIAL STATEMENTS. The Company has delivered to Buyer the unaudited financial statements of FHPS, consisting of balance sheets at December 31, 1995, 1996 and 1997 and the related statements of operations for the respective periods then ended (collectively, the "FINANCIAL STATEMENTS"). The 1995, 1996 and 1997 financial statements of FHPS are referred to herein as its "PRIOR FINANCIAL STATEMENTS." The financial statements for the twelve (12) months ended December 31, 1998 are referred to herein as the "CURRENT FINANCIAL STATEMENTS." The Financial Statements (i) were prepared from the books and records of FHPS, (ii) were prepared in accordance with GAAP applied on a consistent basis (except as may be expressly indicated therein or in any notes thereto, or except for the absence of notes, statement of cash flows, and statement of shareholders equity which may otherwise be required under GAAP) and (iii) present fairly the financial position of FHPS as at the dates thereof and the results of its operations for the periods then ended (subject to normal year-end adjustments which would not in the aggregate have a Material Adverse Effect on the FHPS and any other adjustments expressly described therein or in the notes thereto). The balance sheets included in the Current Financial Statements do not reflect any writeup or revaluation increasing the book value of any assets, except as specifically disclosed in the notes thereto or as otherwise disclosed in writing to Buyer. All financial projections, forecasts, or budgets that the Company and the Subsidiaries have made available to Buyer have been or will be prepared in good faith based upon assumptions that the Company and the Subsidiaries believe to be reasonable. 4.9 CHANGES SINCE THE CURRENT BALANCE SHEET DATE. Except as set forth on SCHEDULE 4.9, since the date of the balance sheet dated as of December 31, 1998 included in the Current Financial Statements (the "CURRENT BALANCE SHEET"), FHPS has not (a) issued, sold, pledged, disposed of, encumbered, or authorized the issuance, sale, pledge, disposition, grant or encumbrance of any shares of its capital stock, or any options, warrants, convertible securities or other rights of any kind to acquire any shares of such capital stock or any other ownership interest of FHPS, (b) declared, set aside, made, or paid any dividend or other distribution payable in cash, stock, property or otherwise of or with respect to its capital stock or other securities, or reclassified, combined, split, subdivided or redeemed, purchased or otherwise acquired, directly or indirectly, any of its capital stock or other securities; (c) except for raises in the ordinary course and consistent with past practice, paid any bonus to or increased the rate of compensation of any of its officers or salaried employees or amended any other terms of employment of such persons; (d) sold, leased or transferred any of its properties or assets or acquired any properties or assets other than in the ordinary course of business consistent with past practice; (e) made or obligated itself to make capital expenditures other than in the ordinary course of business consistent with past practice; (f) made any payment in respect of its liabilities other than in the ordinary course of business consistent with past practice; (g) incurred any obligations or liabilities (including, without limitation, any indebtedness for borrowed money, issuance of any debt securities, or the assumption, guarantee, or endorsement of the obligations of any person) or entered into any transaction or series of transactions involving in excess of $15,000 individually or $50,000 in the aggregate out of the ordinary course of business, except for this Agreement and the transactions contemplated hereby; (h) suffered any theft, damage, destruction or casualty loss, whether or not covered by insurance, in excess of $15,000 individually or $50,000 in the aggregate; (i) suffered any extraordinary losses (whether or not covered by insurance); (j) waived, canceled, compromised or released any rights having a value in excess of $15,000 individually or $50,000 in the aggregate other than in the ordinary course of business consistent with past practice; (k) made or adopted any material change in its accounting practice or policies; (l) made any material adjustment to its books and records other than in respect of the conduct of its business activities in the ordinary course consistent with past practice; (m) entered into any material transaction with any other Company Party or any Affiliate of any of the Company Parties, except in the ordinary course of business; (n) entered into any employment agreement not terminable at will; (o) terminated, amended or modified any agreement involving an amount in excess of $15,000 individually or $50,000 in the aggregate other than in the ordinary course of business consistent with past practice; (p) imposed any material security interest or other Lien on any of its assets other than in the ordinary course of business consistent with past practice; (q) delayed paying any account payable beyond forty-five (45) days following the date on which it is due and payable except to the extent being contested in good faith; (r) made or pledged any charitable contributions in excess of $1,000 individually or $5,000 in the aggregate; (s) acquired (including, without limitation, for cash or shares of stock, by merger, consolidation, or acquisition of stock or assets) any interest in any corporation, partnership or other business organization or division thereof or any assets, or made any investment in another Person either by purchase of stock or securities, contributions or property transfer of capital other than as permitted or provided in this Agreement; (t) increased or decreased prices charged to customers, except in the ordinary course of business consistent with past practice, materially increased or decreased the average monthly inventory, other than in the ordinary course of business consistent with past practice, ordered any inventory which would be inconsistent with the prior practices of such Company, or taken any actions which might reasonably result in any material increase in the loss of customers; (u) entered into any other transaction or been subject to any event which has or may reasonably be expected to have a Material Adverse Effect on FHPS; or (v) agreed to do or authorized any of the foregoing. 4.10 LIABILITIES OF FHPS. Except as set forth on Schedule 4.10(a), FHPS has no liabilities or obligations, whether accrued, absolute, contingent or otherwise, except (a) to the extent reflected on the Current Balance Sheet and not heretofore paid or discharged; (b) liabilities incurred in the ordinary course of business consistent with past practice since the date of the Current Balance Sheet (none of which relates to breach of contract, breach of warranty, tort, infringement or violation of law, or which arose out of any action, suit, claim, governmental investigation or arbitration proceeding) and which, in the aggregate would not have a Material Adverse Effect on FHPS; (c) liabilities incurred prior to the date of the Current Balance Sheet which, in accordance with GAAP consistently applied, were not required to be recorded thereon and which, in the aggregate, would not have a Material Adverse Effect on FHPS; or (d) inter-company liabilities that on a consolidated basis are not reflected on the Current Balance Sheet. SCHEDULE 4.10(b) lists all indebtedness in excess of $10,000 owed by FHPS to a bank or any other Person, including without limitation, indebtedness for borrowed money (including principal and accrued but unpaid interest) and capitalized equipment leases of FHPS. SCHEDULE 4.10(c) lists each deposit account maintained by or for the benefit of FHPS with any bank, broker or other depository institution, and the names of all persons authorized to withdraw funds from each such account. 4.11 LITIGATION. Except as set forth on SCHEDULE 4.11, there is no action, suit or other legal or administrative proceeding or governmental investigation pending, or, to the Company Parties' knowledge, threatened against or anticipated or contemplated to be initiated by, FHPS, or FHPS' properties or assets, or the Purchased Assets, or which question the validity or enforceability of this Agreement or the transactions contemplated hereby, and, to the Company Parties' knowledge, there is no reasonable basis for any of the foregoing. The Company shall retain all actions, suits and other legal and administrative proceedings and governmental investigations set forth on SCHEDULE 4.11. There are no outstanding orders, decrees or stipulations issued by any Governmental Authority in any proceeding to which FHPS is or was a party which have not been substantially complied with or which continue to impose any material obligations on FHPS. 4.12 ENVIRONMENTAL MATTERS. Except as set forth on SCHEDULE 4.12: (a) During the period commencing from the date in 1991 on which FHPS became a wholly owned subsidiary of the Company to the date of this Agreement, the business of FHPS has been and is operated in compliance with all Federal, state and local environmental protection, health and safety or similar laws, statutes, ordinances, restrictions, licenses, rules, regulations, permit conditions and legal requirements, including without limitation the Federal Clean Water Act ("CWA") 42 U.S.C. Section 7401 ET SEQ., Safe Drinking Water Act, ("SDWA") 42 U.S.C. Section 300f ET SEQ., Resource Conservation & Recovery Act ("RCRA") 42 U.S.C. Section 6901 ET SEQ., Clean Air Act ("CAA") 42 U.S.C. Section 7401 ET SEQ., Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") 42 U.S.C. Section 9601 ET SEQ., Emergency Planning and Community Right to Know Act ("EPCRA") 42 U.S.C. Section 11001 ET SEQ., Toxic Substances Control Act ("TSCA") 15 U.S.C. Section 2601 ET SEQ., and the Occupational Safety and Health Act ("OSHA") 29 U.S.C. Section 655 ET SEQ., each as amended and currently in effect (collectively, "ENVIRONMENTAL LAWS"), except where the failure to be so in compliance would not result in a Material Adverse Effect on FHPS. (b) During the period commencing from the date in 1991 on which FHPS became a wholly owned subsidiary of the Company to the date of this Agreement, FHPS has not received any written notice from any Governmental Authority or other third party or, to the knowledge of the Company Parties, any other communication alleging or concerning any violation by FHPS, or responsibility for or liability of FHPS under any Environmental Law, which, if decided unfavorably to FHPS would have a Material Adverse Effect on FHPS or the Purchased Assets. There are no pending, or to the knowledge of the Company Parties, threatened, claims, suits, actions, proceedings or investigations with respect to the businesses or operations of FHPS alleging or concerning any violation of or responsibility for or liability under any Environmental Law, nor does any Company Party have any knowledge of any fact or condition that could give rise to such a claim, suit, action, proceeding or investigation which, if decided unfavorably to FHPS would have a Material Adverse Effect on FHPS or the Purchased Assets. 4.13 REAL ESTATE. FHPS does not currently own any real property. SCHEDULE 4.13 sets forth a list of all leases, licenses or similar use or occupancy agreements to which FHPS is a party, which are for the use or occupancy of real estate owned by a third party ("LEASES") (true and complete copies of which have previously been furnished to Buyer), in each case, setting forth: (i) the lessor and lessee thereof and the commencement date, term and renewal rights under each of the Leases; and (ii) the street address or legal description of each property covered thereby (the "LEASED PREMISES"). The Leases are in full force and effect and have not been amended except as disclosed in SCHEDULE 4.13, and there have been no notices of default by either party to the Leases. With respect to each such Leased Premises: (i) FHPS' interests in the Leased Premises are free and clear of any Liens, covenants and easements or title defects created or suffered to be created by FHPS, except for Liens for taxes which are not yet due or are otherwise being contested; and (ii) none of the Company Parties has received notice of (A) any condemnation proceeding with respect to any portion of the Leased Premises or any access thereto and, to the knowledge of the Company Parties, no such proceeding is contemplated by any Governmental Authority; or (B) any special assessment which may affect any of the Leased Premises and, to the knowledge of the Company Parties, no such special assessment is contemplated by any Governmental Authority, any of which would have a Material Adverse Effect on FHPS. 4.14 COMPLIANCE WITH LAWS. Except as set forth on SCHEDULE 4.14, FHPS is in substantial compliance with all laws, regulations and orders applicable to it, its business, operations, properties and assets, except where the failure to comply would not have a Material Adverse Effect on FHPS or the Purchased Assets. During the period commencing from when FHPS became a wholly owned subsidiary of the Company in 1991 to the date of this Agreement, FHPS has not been cited, fined or otherwise notified of any asserted past or present failure to comply with any laws, regulations or orders, where there remains any remedial action to be undertaken by FHPS as a result thereof, and no proceeding with respect to any such violation is pending or to the Company Parties' knowledge threatened. Except as set forth on SCHEDULE 4.14, FHPS is not subject to any decree or injunction to which it is a party which restricts the continued operation of its business or the expansion thereof to other geographical areas, customers and suppliers or lines of business, which decree or injunction has a Material Adverse Effect on FHPS. 4.15 LABOR AND EMPLOYMENT MATTERS. FHPS is not a party to or bound by any collective bargaining agreement or any other agreement with a labor union. There is not now any actual or threatened labor dispute, strike or work stoppage which affects or which may affect the business of FHPS or which may interfere with its continued operations. Except as set forth on SCHEDULE 4.15, none of the Company Parties is aware that any executive or key employee or group of employees of FHPS or IPS has any plans to terminate his, her or their employment with FHPS or IPS as a result of the transactions contemplated hereby or otherwise. 4.16 EMPLOYEE BENEFIT PLANS. (a) EMPLOYEE BENEFIT PLANS. SCHEDULE 4.16(a) contains a list setting forth each employee benefit plan or arrangement of FHPS, including but not limited to employee pension benefit plans, as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), Multiemployer Plans, if any, as defined in Section 3(37) of ERISA, employee welfare benefit plans, as defined in Section 3(1) of ERISA, deferred compensation plans, stock option plans, bonus plans, stock purchase plans, hospitalization, disability and other insurance plans, severance or termination pay plans and policies, whether or not described in Section 3(3) of ERISA, in which employees, their spouses or dependents, of the Company participate ("EMPLOYEE BENEFIT PLANS") (true and accurate copies of which, together with the most recent annual reports on Form 5500 and summary plan descriptions with respect thereto, were furnished to Buyer). (b) COMPLIANCE WITH LAW. With respect to each Employee Benefit Plan to the best knowledge of the Company Parties: (i) each has been administered in all respects in compliance with its terms and with all applicable laws, including, but not limited to, ERISA and the Code; (ii) no actions, suits, claims or disputes, other than routine benefit claims, are pending, or threatened; (iii) no audits, inquiries, reviews, proceedings, claims, or demands are pending with any governmental or regulatory agency; (iv) there are no facts which could give rise to any material liability in the event of any such investigation, claim, action, suit, audit, review, or other proceeding; (v) except as set forth on SCHEDULE 4.16(b), all reports, returns and similar documents required to be filed with any Governmental Authority or distributed to any plan participant have been duly or timely filed or distributed; and (vi) no "prohibited transaction" has occurred under Section 406 of ERISA or Section 4975 of the Code, except where the failure of any of the matters in subparagraphs (i)-(vi) would not have a Material Adverse Effect on FHPS. (c) TITLE IV PLANS. FHPS does not contribute to a Multiemployer Plan as described in Section 4001(a)(3) of ERISA or a defined benefit plan. (d) WELFARE PLANS. (i) Except as otherwise provided by applicable state or federal law, FHPS is not obligated under any employee welfare benefit plan as described in Section 3(1) of ERISA ("WELFARE PLAN") to provide medical or death benefits with respect to any employee or former employee of FHPS or its predecessors after termination of employment; (ii) no violations of the notice and continuation coverage requirements of Section 4980B of the Code or Sections 601 through 608 of ERISA have occurred with respect to any Welfare Plan that is a group health plan within the meaning of Section 5000(b)(1) of the Code which would have a Material Adverse Effect on FHPS; and (iii) there are no reserves, assets, surplus or prepaid premiums under any Welfare Plan which is an Employee Benefit Plan. (e) PBGC LIABILITY. FHPS (i) has never terminated or withdrawn from an employee benefit plan under circumstances resulting (or expected to result) in liability to the Pension Benefit Guaranty Corporation ("PBGC") (other than routine claims for benefits); (ii) has no assets subject to (or expected to be subject to) a lien for unpaid contributions to any employee benefit plan; (iii) has not failed to pay premiums to the PBGC when due (iv) is not subject to (or expected to be subject) an excise tax under Code Section 4971; (v) has not engaged in any transaction which would give rise to liability under Section 4069 or Section 4212(c) of ERISA; or (vi) has not violated Code Section 4980B or Section 601 through 608 of ERISA, any of which matters described in clauses (i)-(vi) would have a Material Adverse Effect on FHPS. (f) OTHER LIABILITIES. Except as set forth on SCHEDULE 4.16(f), (i) FHPS is not obligated to pay separation, severance, termination or similar benefits or to vest any person, in whole or in part, solely as a result of any transaction contemplated by this Agreement or solely as a result of a "change of control" (as such term is defined in Section 280G of the Code); and (ii) none of the Employee Benefit Plans has any unfunded liabilities which are not reflected on the Current Balance Sheet or the books and records of FHPS. 4.17 INSURANCE. FHPS and the Purchased Assets are covered by policies of insurance for its properties, assets and businesses (the "INSURANCE POLICIES"), which policies are in full force and effect, and which coverage amounts are adequate for the business conducted by FHPS and the Purchased Assets, and all premiums due thereon have been paid. Prior to the Closing Date, each of the Insurance Policies will be in full force and effect. FHPS has complied with the provisions of such Insurance Policies, except where the failure to comply would not have a Material Adverse Effect on FHPS. There is no pending claim under any of the Insurance Policies for an amount in excess of $10,000 individually or $50,000 in the aggregate that relates to loss or damage to the properties, assets or business of FHPS. 4.18 RECEIVABLES. All of the Receivables of FHPS, net of any allowance for doubtful accounts reflected in the Current Balance Sheet, are valid and legally binding, represent bona fide transactions and arose in the ordinary course of business of FHPS. To the best of the Company Parties' knowledge, all of the Receivables of FHPS reflected in each Current Balance Sheet are collectible in accordance with the terms of such receivables, without set off or counterclaims, subject to the allowance for doubtful accounts, if any, set forth on such Current Balance Sheet. For purposes of this Agreement, the term "RECEIVABLES" means all receivables of FHPS, including without limitation, trade account receivables arising from the provision of services, sale of inventory, notes receivable, and insurance proceeds receivable, whether or not billed. 4.19 LICENSES AND PERMITS. There are no licenses and governmental or official approvals, permits or authorizations required for the conduct of FHPS' business and operations, the absence of which would have a Material Adverse Effect on FHPS (collectively, the "FHPS PERMITS"). All FHPS Permits are valid and in full force and effect, FHPS is in compliance with the respective requirements thereof, no proceeding is pending or, to the Company Parties' knowledge, threatened to revoke or amend any of them, and none of the FHPS Permits is or will be impaired or affected, which impairment or affect would have a Material Adverse Effect on FHPS, by the execution and delivery of this Agreement or the consummation of the transactions contemplated hereby, except for such of the preceding which, individually or in the aggregate, would not have a Material Adverse Effect on FHPS or on the ability of the parties to consummate the transactions contemplated herein. 4.20 ADEQUACY OF THE ASSETS; RELATIONSHIPS WITH CUSTOMERS AND SUPPLIERS; AFFILIATED TRANSACTIONS. Except as set forth on SCHEDULE 4.20, the Purchased Assets, including Purchased Assets held by IPS, and assets and properties currently owned and operated by FHPS constitute, in the aggregate, all of the assets and properties used in the conduct of the business of FHPS and IPS, with respect to the Purchased Assets, in the manner in which and to the extent to which such business is currently being conducted. Neither FHPS, nor, with respect to the Purchase Assets, IPS, has received any notice from any current supplier of items essential to the conduct of its business that such supplier intends to terminate or materially alter a business relationship with FHPS or, with respect to the Purchased Assets, IPS, for any reason, involving an amount in excess of $50,000, and to the Company Parties' knowledge, no such supplier intends to terminate or materially alter any such business relationship with FHPS, or IPS. Neither FHPS nor IPS has received any notice from any customer that such customer intends to discontinue purchases of products or services from FHPS, or, in connection with the Purchased Assets, IPS, and to the Company Parties' knowledge no such customer intends to discontinue or cancel purchases or orders, involving in each case amounts in excess of $50,000. No Company Party has any direct or indirect interest in any customer, supplier or competitor of FHPS or in any Person from whom FHPS leases real or personal property, except to the extent that any such customer, supplier or competitor is also an Affiliate of the Company, or except for any passive investment interest held by any of the Company Parties. 4.21 INTELLECTUAL PROPERTY. Except as set forth in SCHEDULE 4.21, FHPS has full legal right, title and interest in and to all trademarks, service marks, trade names, copyrights, know-how, patents, trade secrets, licenses (including licenses for the use of computer software programs), and other intellectual property used in the conduct of its business (the "INTELLECTUAL PROPERTY"), the absence of which would have a Material Adverse Effect on FHPS or the Purchased Assets. SCHEDULE 4.21 sets forth a true and correct list of all Intellectual Property of FHPS. To the Company Parties' knowledge, FHPS owns or possesses adequate rights to use all Intellectual Property reasonably necessary to the conduct of the business of FHPS as presently conducted, and the unrestricted conduct and the unrestricted use and exploitation of the Intellectual Property does not infringe or misappropriate any rights held or asserted by any Person, except where the failure to possess such rights or the infringement would not have a Material Adverse Effect on FHPS or the Purchased Assets. To the Company Parties' knowledge, no Person is infringing on the Intellectual Property, and no payments are required for the continued use of the Intellectual Property, except for software licenses entered into in the ordinary course of business. None of the Intellectual Property has ever been declared invalid or unenforceable, or is the subject of any pending or, to the Company Parties' knowledge, threatened action for opposition, cancellation, declaration, infringement, or invalidity, unenforceability or misappropriation or like claim, action or proceeding, which declaration or unenforceability, or which pending or threatened action would have a Material Adverse Effect on FHPS if decided adversely to FHPS. 4.22 MATERIAL CONTRACTS. SCHEDULE 4.22 sets forth a list of each Material Contract of each Subsidiary, including all material contracts with customers for the provision of products or services by each Subsidiary, other than any Material Contract relating to any excluded assets or liabilities (the "PURCHASED MATERIAL CONTRACTS"). The copy of each Material Contract furnished to Buyer is a true and complete copy of the document it purports to represent and reflects all amendments thereto made through the date of this Agreement. Neither Subsidiary has violated any of the terms or conditions of any Purchased Material Contract which would permit termination or material modification of any Purchased Material Contract. All of the material covenants to be performed by each Subsidiary and, to the knowledge of the Company Parties, any other party thereto, have been fully performed in all material respects, and neither Subsidiary has received notice for breach or indemnification or notice of default or termination under any Purchased Material Contract by or against FHPS or IPS or to the knowledge of the Company Parties, any other party thereto. To the knowledge of the Company Parties, no event has occurred which constitutes, or after notice or the passage of time, or both, would constitute, a default by either Subsidiary under any Purchased Material Contract, and to the knowledge of the Company Parties no such event has occurred which constitutes or would constitute a material default by any other party. Neither Subsidiary is subject to any liability or payment resulting from re-negotiation of amounts paid under any Purchased Material Contract. As used in this Section 4.22, Purchased Material Contracts shall mean formal or informal, written or oral (a) loan agreements, indentures, mortgages, pledges, hypothecations, deeds of trust, conditional sale or title retention agreements, security agreements, equipment financing obligations or guaranties, or other sources of contingent liability in respect of any indebtedness or obligations to any other Person, or letters of intent or commitment letters with respect to same, which exceed $10,000 individually or $50,000 in the aggregate; (b) contracts obligating FHPS or IPS to provide products or services for a period of one year or more; (c) leases of real property extending for a period of one year or more; (d) leases of personal property which individually provide for total payments in excess of $10,000, or in the aggregate $25,000 and which are not cancelable without penalty on notice of sixty (60) days or less; (e) agreements providing for an independent contractor's services, or letters of intent with respect to same, where the payment due thereunder exceeds $10,000; (f) employment agreements, management service agreements, consulting agreements, having a value in the form of revenue or expense in excess of $10,000; (g) any contract relating to pending capital expenditures by FHPS in excess of $10,000; (h) contracts obligating FHPS to purchase supplies, equipment, media and related services of any kind, in an amount exceeding $10,000 and not cancelable without penalty on notice of thirty (30) days or less; (i) any non-competition agreements restricting FHPS in any manner; and (j) confidentiality agreements, non-competition agreements, employee handbooks, policy statements and any other agreements relating to any employee of FHPS, which is not terminable as of the Closing. 4.23 ACCURACY OF INFORMATION FURNISHED. Subject to Buyer's representation and warranty under SECTION 3.10, no representation, statement or information contained in this Agreement (including, without limitation, the various Schedules attached hereto) or any agreement executed in connection herewith or in any certificate delivered pursuant hereto or thereto contains any untrue statement of a material fact or omits any material fact necessary to make the information contained therein not misleading. The Company Parties have provided Buyer with true, accurate and complete copies of all documents listed or described in the various Schedules attached hereto. 4.24 NO COMMISSIONS. Other than S G Cowen Securities Corporation, neither the Company nor any Subsidiary has incurred any obligation for any finder's or broker's or agent's fees or commissions or similar compensation in connection with the transactions contemplated hereby. 4.25 ABSENCE OF SENSITIVE PAYMENTS. FHPS has not made or maintained (a) any contributions, payments or gifts of its funds or property to any governmental official, employee or agent where either the payment or the purpose of such contribution, payment or gift was or is illegal under the laws of the United States or any state thereof, or any other jurisdiction (foreign or domestic); or (b) any contribution, or reimbursement of any political gift or contribution made by any other Person, to candidates for public office, whether federal, state, local or foreign, where such contributions by FHPS were or would be a violation of applicable law. 4.26 TAX MATTERS. Within the times (including extensions) and in the manner prescribed by law, FHPS (or the Company, on behalf of FHPS) has filed all federal, state, local and foreign returns for Taxes ("RETURNS") required to be filed in any jurisdiction (including, without limitation, informational returns) and such Returns are complete, true and correct in all material respects. All Returns complied in all material respects with the tax laws, rules and regulations, as presently interpreted, applicable to such Returns. FHPS (or the Company on behalf of FHPS) has not waived or extended any statute of limitations relating to the assessment of any Taxes. No audit or examination of any of the Returns of FHPS is currently in progress or, to the Company Parties' knowledge, threatened or has occurred in the past. All Taxes required to be paid pursuant to such Returns have been paid on or before their respective due dates, including any extensions thereof. ARTICLE 5 ADDITIONAL AGREEMENTS 5.1 FURTHER ASSURANCES. Each party shall execute and deliver such additional instruments and other documents and shall take such further actions as may be necessary or appropriate to effectuate, carry out and comply with all of the terms of this Agreement and the transactions contemplated hereby. 5.2 COMPLIANCE WITH COVENANTS. The Company shall, and shall cause the Subsidiaries to, comply with all of the covenants of the Company Parties under this Agreement. 5.3 COOPERATION. Each of the parties agrees to cooperate with the other in the preparation and filing of all forms, notifications, reports and information, if any, required or reasonably deemed advisable pursuant to any law, rule or regulation in connection with the transactions contemplated by this Agreement and to use its respective reasonable best efforts to agree jointly on a method to overcome any objections by any Governmental Authority to any such transactions. In addition, the Company agrees to cooperate with Buyer, with third party costs paid by Buyer, in connection with any audit of historical financial information that may be required under the rules and regulations of the Securities and Exchange Commission. 5.4 APPLICATIONS AND OTHER ACTIONS. Each of the parties hereto shall use its reasonable best efforts to take, or cause to be taken, all appropriate actions, and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated herein, including, without limitation, using its reasonable best efforts to obtain all licenses, permits, consents, approvals, authorizations, qualifications and orders of any Governmental Authority and parties to Material Contracts with the Company and the Subsidiaries as are necessary for the consummation of the transactions contemplated hereby. Each of the parties shall make on a prompt and timely basis all governmental or regulatory notifications and filings required to be made by it for the consummation of the transactions contemplated hereby. 5.5 PURCHASE PRICE ALLOCATION AND SECTION 338 ELECTIONS. If requested by Buyer, Buyer, the Company and the Subsidiaries shall join in an election to have the provisions of Section 338(h)(10) of the Code and similar provisions of state law ("SECTION 338 ELECTION") apply to the acquisition of FHPS. Buyer shall be responsible for, and control, the preparation and filing of such election. Each of the Company and the Subsidiaries shall allocate the Purchase Price in accordance with SECTION 2.2 and shall report, act and file in all respects and for all purposes consistent with such SCHEDULE 2.2, unless to do so would cause undue hardship on the Company. Each of the Company and the Subsidiaries shall execute and deliver to Buyer such documents or forms (including Section 338 Forms, as defined below) as Buyer shall request or as are required by applicable law for an effective 338(h)(10) Election. "SECTION 338 FORMS" shall mean all returns, documents, statements, and other forms that are required to be submitted to any federal, state, county or other local taxing authority in connection with a 338(h)(10) Election, including, without limitation, any "statement of Section 338 election" and IRS Form 8023 (together with any schedules or attachments thereto) that are required pursuant to Treasury Regulations. 5.6 ACCESS TO INFORMATION. From the date hereof to the Closing Date, the Company shall, and shall cause each of the Subsidiaries and their respective directors, officers, employees, auditors, counsel and agents to, afford Buyer and Buyer's officers, employees, auditors, counsel and agents reasonable access, during regular business hours and upon reasonable advance notice, to its properties, offices and other facilities, to its officers and employees and to all books and records, and shall furnish such persons with all financial, operating and other data and information as may be requested. No information provided to or obtained by Buyer shall affect any representation or warranty in this Agreement. 5.7 NOTIFICATION OF CERTAIN MATTERS. From the date hereof to the Closing Date, each of the parties to this Agreement shall give prompt notice to the other parties of the occurrence or non-occurrence of any event which would likely cause any representation or warranty made by such party herein to be untrue or inaccurate or any covenant, condition or agreement contained herein not to be complied with or satisfied (provided, however, that, any such disclosure shall not in any way be deemed to amend, modify or in any way affect the representations, warranties and covenants made by any party in or pursuant to this Agreement). 5.8 CONFIDENTIALITY; PUBLICITY. Except as may be required by law or as otherwise permitted or expressly contemplated herein, no party hereto or their respective Affiliates, employees, agents and representatives shall disclose to any third party this Agreement, the subject matter or terms hereof or any confidential information or other proprietary knowledge concerning the business or affairs of the other party which it may have acquired from such party in the course of pursuing the transactions contemplated by this Agreement, including all notes, documents and materials prepared by or for the respective party which reflect, interpret, evaluate, include or are derived from such confidential information or proprietary knowledge of the other party, without the prior consent of the other party hereto; provided, that any information that is otherwise publicly available, without breach of this provision, or has been obtained from a third party, or has been requested pursuant to the order of a court of competent jurisdiction or governmental agency having the authority to obtain such information, or pursuant to the rules of any applicable stock exchange to which any of the parties is subject shall not be deemed confidential information; provided, however, that the party from whom disclosure is sought, regarding information concerning the other party shall promptly notify such party and allow such party to obtain any order blocking or otherwise controlling the disclosure of such information. Any press releases or any other public announcements concerning this Agreement or the transactions contemplated hereby shall be approved by both Buyer and the Company; PROVIDED, HOWEVER, that if any party reasonably believes that it has a legal obligation to make a press release and the consent of the other party cannot be obtained, then the release may be made without such approval. Prior to such time, the parties shall not make any public disclosure regarding the Agreement or the transactions contemplated hereby. 5.9 NO OTHER DISCUSSIONS. The Company Parties and their Affiliates shall not directly or indirectly, through any officer, director, employee, affiliate or agent or otherwise, take any action to solicit, initiate, seek, entertain, encourage, support or respond to any inquiry, proposal or offer from, furnish any information to, or participate in any negotiations with, any third party regarding any acquisition of FHPS or the Purchased Assets, any merger or consolidation with or involving FHPS or the Purchased Assets, or any acquisition of any material portion of the Shares of FHPS or Purchased Assets, including the grant of any license to any Intellectual Property of FHPS other than licenses in the ordinary course of business related to the sale of FHPS' products. The Company agrees that any such negotiations (other than negotiations with Buyer) in progress as of the date hereof will be suspended and that the Company will not accept or enter into any agreement, arrangement or understanding regarding any such third party acquisition transaction prior to the termination hereof. In the event a Company Party or any of their respective officers, directors, employees, affiliates or agents receives any proposal for, any third party acquisition transaction involving FHPS or the Purchased Assets, or any request for nonpublic information in connection with any such proposal, the Company will immediately notify Buyer, describing in detail the identity of the Person making such proposal and the terms and conditions of such proposal. Nothing contained in this Section shall be construed as limiting the ability of the Company as to any matter described in this section, with regard to any other assets of the Company other than the Purchased Assets and the Shares. 5.10 FHPS TAX MATTERS. (a) COMPANY RETURNS. The Company and/or FHPS shall duly prepare, or cause to be prepared, and the Company shall file, or cause to be filed, on a timely basis all Returns of FHPS for any period ending on or before the Closing Date. The Company shall file amended Tax Returns with respect to periods ending on or before the Closing Date only as agreed by Buyer and the Company. (b) BUYER RETURNS. Buyer shall duly prepare, or cause to be prepared, and file, or cause to be filed, on a timely basis all Returns of FHPS for any tax period which ends after the Closing Date, including but not limited to any Straddle Periods. Any such Returns with respect to the Straddle Periods shall, insofar as they relate to FHPS, be on a basis consistent with previous Returns filed in respect of FHPS, unless Buyer and the Company conclude that there is no reasonable basis for such position. (c) TAX COOPERATION. The Company and Buyer shall provide the other party with such forms, information and records and make such of its officers, directors, employees and agents available as may be reasonably requested by such other party in connection with the preparation of any Return or any audit or other proceeding, including any ruling request, that relates to FHPS. (d) COMPANY INDEMNIFICATION. The Company shall be liable for and shall indemnify and hold Buyer harmless against all Taxes of FHPS or attributable to the Purchased Assets payable for any taxable year or taxable period ending on or before the Closing Date. To appropriately apportion any income taxes relating to any taxable year, beginning before and ending after the Closing Date, the parties shall apportion such income taxes to the taxable period ending on or before the Closing Date by a closing of the books consistent with their past practice for reporting items, except that (i) exemptions, allowances or deductions that are calculated on a time basis, such as the deduction for depreciation shall be apportioned on a time basis, and (ii) all Taxes relating to actions outside the ordinary course of business, occurring after the Closing, on the Closing Date shall be apportioned to the period ending after the Closing Date. To appropriately apportion any non-income taxes relating to any taxable year beginning before and ending after the Closing Date, the parties shall apportion such non-income taxes to the taxable period ending on or before the Closing Date, as follows: (x) ad valorem taxes (including without limitations real and personal property taxes), shall be accrued on a daily basis over the period for which such taxes are levied, or, if it cannot be determined over the period such taxes are being levied, over the fiscal period of the relevant taxing authority in each case irrespective of the lien or assessment date of such taxes, (y) all taxes relating to actions outside the ordinary course of business occurring after the Closing on the Closing Date shall be apportioned to the period ending after the Closing Date, and (z) franchise and other privilege taxes not measured by income shall be accrued on a daily basis over the period to the which the privilege relates. (e) BUYER AND FHPS INDEMNIFICATION. Buyer and FHPS shall be liable for, and shall indemnify and hold the Company and any of its Affiliates harmless against any and all Taxes imposed on FHPS relating or apportioned to any taxable year or portion thereof ending after the Closing Date, including without limitation all Taxes relating to actions outside the ordinary course of business occurring after the Closing, on the Closing Date. (f) REFUNDS OR CREDITS. Buyer and FHPS shall promptly pay to the Company any refunds or credits (including interest paid to Buyer thereon) relating to Taxes for which the Company may be liable under SECTION 5.10 hereof. For purposes of this SECTION 5.10(f), the terms "refund" and "credit" shall include a reduction in Taxes and the use of an overpayment of Taxes as an audit or other tax offset. Receipt of a refund shall occur upon the filing of a Tax Return or an adjustment therein, using such reduction, overpayment or offset, or upon the receipt of cash. Upon the reasonable request and cost of the Company, Buyer shall prepare and file or cause to be prepared and filed, all claims for refunds relating to such Taxes; provided, however, that Buyer shall not be required to file such claims for refund to the extent such claim for refund would have a Material Adverse Effect on Buyer or FHPS in the future, or to the extent such claims for refund relate to a carryback of an item. Buyer shall be entitled to all other refunds and credits of Taxes; provided, however, Buyer will not allow the amendment of any Tax Return relating to any Taxes for a period (or portion thereof) ending on or prior to the Closing Date or the carryback of an item to a period ending on or prior to Closing without the Company's consent. (g) CONSENT. Whenever any taxing authority asserts a claim, makes an assessment or otherwise disputes the amount of taxes for which the Company is or may be liable under this Agreement, Buyer shall, if informed of such assertion, promptly inform the Company within fifteen business days, and the Company shall have the right to control the resulting proceedings and to determine whether and when to settle any such claim, assessment or dispute to the extent such proceedings or determinations affect the amount of taxes for which the Company may be liable under this Agreement. Whenever any taxing authority asserts a claim, makes an assessment, or otherwise disputes the amount of taxes for which the Buyer is liable under this Agreement, the Buyer shall have the right to control any resulting proceedings and to determine whether and when to settle any such claim, assessment or dispute, except to the extent such proceeding affect the amount of taxes for which the Company may be liable under this Agreement. (h) SURVIVAL. The obligations of the parties set forth in this SECTION 5.10 shall be unconditional and absolute and shall remain in effect until thirty days after the expiration of the applicable statute of limitations. 5.11 SERVICE AGREEMENT. Buyer, the Company and IPS shall enter into a service agreement (the "SERVICE AGREEMENT") in the form of EXHIBIT D hereto under which Buyer or any of its subsidiaries or Affiliates shall be the provider of certain mail order, network claims processing and other pharmacy benefit management services set forth in the Service Agreement. 5.12 TRANSITION OF SERVICES. (a) IMPLEMENTATION SCHEDULE. On or before the Closing, the parties will complete a schedule and attach it to this Agreement as SCHEDULE 5.12, which schedule will include the name, address, contact person and number of lives eligible for pharmacy benefits for each plan covered by the Affiliated Business and the Non-affiliated Business and the targeted date that such business will be transitioned to Buyer's pharmacy claims processing system (the "IMPLEMENTATION SCHEDULE"). The parties shall use their respective reasonable best efforts to ensure that all of such business is transitioned to and implemented by Buyer. (b) TRANSITION OF THE COMPANY AFFILIATED BUSINESS. Upon Closing, Buyer shall provide claims processing services, retail pharmacy network management services, rebate contracting and formulary management services, mail service pharmacy and other pharmacy benefit management services for the Company Affiliated Business in accordance with the terms and provisions set forth in the Service Agreement, including subject to the transition schedule set forth therein. (c) TRANSITION OF THE NON-AFFILIATED BUSINESS. (i) The Company agrees that, following the Closing and until such time as the claims processing services are implemented by Buyer for each plan, the Company shall continue to perform the same scope of claims processing services that it provided for each such plan prior to the Closing. The Company shall use its reasonable best efforts to ensure that during this transition period such services are performed in such a manner that is consistent with the ordinary course of business immediately prior to Closing in order to preserve and keep intact the business relationships with such plans. (ii) The Company and IPS agree that following the Closing and until such time as the FHS Affiliated Business has been transitioned to the jointly negotiated drug manufacturer agreements (as contemplated by the Service Agreement), upon the request of Buyer, the Company and IPS shall cause the Non-affiliated Business to be eligible for rebates under any or all of the existing IPS rebate agreements should Buyer determine in its sole discretion that it desires to continue to use such agreements for the Non-affiliated Business. The Company and IPS agree that such rebates will be serviced in accordance with Buyer's instructions. IPS agrees that all rebates collected by IPS based on the utilization of the Non-affiliated Business prior to Closing shall be paid by IPS following Closing pursuant to the terms and conditions of the respective agreements for the Non-affiliated Business, and that Advance Paradigm's obligation to pay such rebates on such business shall begin with the rebates collected for the quarter ending June 30, 1999. (iii) Upon Closing, subject to the respective agreements between Buyer and each plan covered by the Non-affiliated Business, mail pharmacy services shall be provided for the Non-Affiliated Business as determined by Buyer in its sole discretion. (d) PHARMACY NETWORK AGREEMENTS. Pursuant to the transactions contemplated by this Agreement, IPS will assign to FHPS prior to Closing or directly to Buyer as of the Closing, and Buyer will acquire, all of the retail pharmacy network contracts held by IPS, including, but not limited to those set forth on SCHEDULE 4.22, and Buyer will assume all of the rights and obligations thereunder upon Closing, or as soon thereafter as is practical; provided, however, that the parties may agree to substitute new agreements between Buyer and any such pharmacies in lieu of assignment of any such agreements. In addition, the parties will use their reasonable best efforts to obtain assignments of all other retail pharmacy network agreements, subject to any limitations imposed under applicable law or regulation affecting any of the Company's Affiliates. Subject to the respective agreements between Buyer and each plan covered by the Non-affiliated Business, the pharmacy eligible participants covered by such plans will continue to receive their prescription services from such retail pharmacies. The parties will use their reasonable best efforts to obtain a release of IPS and/or FHS from any liability arising from any such pharmacy network agreements from and after the Closing. In the event Buyer has failed or is otherwise unable to pay any such pharmacies in accordance with such agreements (a "DEFAULT IN PHARMACY PAYMENT"), upon written notice to Buyer and confirmation from Buyer's chief financial officer that such amounts have not been paid to the pharmacies or to the pharmacies' Affiliates or designees, FHS, or an FHS Affiliated Plan may make payment in order to remedy any such Default in Pharmacy Payment, and FHS shall have the right to offset any amounts that would have been due to Buyer for such claims under the Service Agreement for such claims. 5.13 CONDUCT OF COMPANY PENDING TRANSITION. From and after the date hereof and prior to the complete transition of the Affiliated Business and the Non-affiliated Business, unless Buyer shall otherwise agree in writing, and except as otherwise expressly contemplated by this Agreement, each of the Company and the Subsidiaries consents and agrees that the businesses of FHPS and the business relating to the Purchased Assets shall be conducted only in, and each of the Company and the Subsidiaries shall not take any action affecting FHPS or the Purchased Assets except in, the ordinary course of business and consistent with past practices, and each of the Company and the Subsidiaries shall use its best efforts to maintain and preserve the business organization, assets, employees and advantageous business relationships of FHPS and the Purchased Assets. 5.14 RESTRICTIVE COVENANTS. (a) In order to assure that Buyer will realize the benefits of the transactions contemplated hereby, subject to the Company's right to terminate the Service Agreement after five (5) years, during the term of the Service Agreement, but in any event not less than the five-year period following the Closing Date, the Company and its Affiliates shall not engage in pharmacy claims processing, retail pharmacy network management, mail service pharmacy, rebate management or (subject to Section 3 of the Service Agreement) the negotiation and performance of drug manufacturer agreements. Notwithstanding the foregoing, (i) if the parties' obligations regarding formulary management and drug manufacturer agreements are terminated in accordance with Section 11(c)(i) of the Service Agreement, then, so long as the Company complies with Section 11(c)(i) of the Service Agreement, the Company may thereafter provide such services for the FHS Affiliated Members; and (ii) if the Company releases Buyer from its obligations to perform the retail pharmacy network management services in accordance with Section 11(c)(ii) of the Service Agreement, then, so long as the Company is in compliance with Section 11(c)(ii) of the Service Agreement, the Company may thereafter provide such services for the FHS Affiliated Members; both (i) and (ii) including participation (which may include minority ownership interests representing not more than twenty percent (20%) of the equity or voting control) in cooperative groups or alliances, provided the Company shall not market such services to third parties. This section shall not be deemed to be a limitation on providing clinical services (including pharmacy formulary and rebate management services in accordance with Section 3 of the Service Agreement) to the FHS Affiliated Members and the Company's contracting medical groups, or the disease management services offered by the Company, or otherwise limit the Company or any Affiliate from undertaking activities relating to the processing and payment of medical claims generally as a payor of such claims. (b) SECTION 5.14(a) shall not be deemed to be a limitation on providing clinical services (including pharmacy formulary and rebate management services in accordance with Section 3 of the Services Agreement) to the Affiliated Business and the Company's contracting medical groups, or the disease management services offered by the Company, or otherwise limit the Company or any Affiliate from undertaking activities relating to the processing and payment of medical claims generally as a payor of such claims. (c) Nothing contained in this SECTION 5.14 shall limit any FHS Successor from owning and operating any business (or line of business), for the benefit of the enrollees of the FHS Successor or other third parties with whom the FHS Successor contracts, which would otherwise be construed as violating the provisions of this SECTION 5.14; provided that the FHS Successor shall be bound to this SECTION 5.14 with respect to the business of the Company and the Affiliated Business, including business that would have been attributable to the Company but for the Change of Control of the Company; and provided further that except as expressly otherwise stated herein, all terms, conditions and obligations of this Agreement shall become the obligations of any FHS Successor. The Buyer and the FHS Successor shall use their respective best efforts to agree on the allocation of enrollees between FHS and the FHS Successor that are subject to this provision. To the extent that the Company acquires any managed care company that has an ownership in or otherwise provides services that would conflict with this provision, this provision shall not apply to the enrollees of such managed care organization as of the effective date of such acquisition; provided that the provisions of this SECTION 5.14 shall continue to apply to any and all current and additional Affiliated Business. In addition, prior to consummating any acquisition of a managed care company that has an ownership interest on or otherwise provide services that would conflict with this SECTION 5.14, the Company shall notify Buyer of such acquisition, and Buyer shall engage in good faith negotiations regarding cooperative efforts with such entity, including Buyer's opportunity to acquire such business. (d) Notwithstanding anything contained herein to the contrary, in the event of a breach or threatened breach of the covenants contained in SECTION 5.14(a) hereof, Buyer may, in addition to any other available remedies, be entitled to an injunction enjoining the Company and its Affiliates or any person or persons acting for or with the Company in any capacity whatsoever from violating any of the terms herein, in accordance with applicable law regarding the award of an equitable remedy. 5.15 RETENTION OF LITIGATION BY THE COMPANY. The Parties agree that the Company shall retain all actions, suits and other legal and administrative proceedings and governmental investigations pending or threatened against FHPS, or FHPS' properties or assets, or the Purchased Assets. The Parties agree that the Buyer has not agreed to assume, and shall not be required to assume, any such pending or threatened action, suit or other legal or administrative proceeding or governmental investigation, and the Company agrees that it will take all actions and do all things necessary to ensure that Buyer is not liable for any of the foregoing. 5.16 FHPS FUNDS. The Company shall cause FHPS to have not less than Five Million Dollars ($5,000,000.00) in cash immediately prior to and at the Closing. ARTICLE 6 CONDITIONS TO THE OBLIGATIONS OF THE BUYER The obligations of Buyer to effect the transactions contemplated hereby shall be subject to the fulfillment at or prior to the Closing Date of the following conditions, any or all of which may be waived in whole or in part by Buyer: 6.1 ACCURACY OF REPRESENTATIONS AND WARRANTIES AND COMPLIANCE WITH OBLIGATIONS. The representations and warranties of the Company Parties contained in this Agreement shall be true and correct in all material respects at and as of the Closing Date with the same force and effect as though made at and as of that time except (a) for changes specifically permitted by this Agreement and (b) that those representations and warranties which address matters only as of a particular date shall remain true and correct as of such date. Each of the Company Parties shall have performed or complied with in all material respects all of their obligations required by this Agreement to be performed or complied with at or prior to the Closing Date. Each of the Company Parties shall have delivered to Buyer a certificate, dated as of the Closing, duly signed by the Chief Executive Officer and principal accounting officer, certifying that such representations and warranties are true and correct in all material respects and that all such obligations have been performed and complied with in all material respects. 6.2 NO MATERIAL ADVERSE CHANGE OR DESTRUCTION OF PROPERTY. Between September 30, 1998 and the Closing Date, (a) there shall have been no Material Adverse Change to FHPS or the Purchased Assets, (b) there shall have been no adverse federal, state or local legislative or regulatory change affecting in any material respect the services, products, business or prospects of FHPS or the Purchased Assets, and (c) none of the Purchased Assets or the assets of FHPS shall have been damaged by fire, flood, casualty, act of God or the public enemy or other cause (regardless of insurance coverage for such damage), which damages may have a Material Adverse Effect on the Purchased Assets or FHPS, or have become the subject of a condemnation proceeding, and the Company Parties shall have delivered to Buyer a certificate, dated as of the Closing Date, to that effect. 6.3 CORPORATE CERTIFICATES. The Company shall have delivered to Buyer (i) copies of the organizational documents of FHPS as in effect immediately prior to the Closing Date, (ii) copies of resolutions adopted by the Board of Directors and stockholders of the Company and the Subsidiaries authorizing the transactions contemplated by this Agreement, and (iii) a certificate of good standing of each of the Company and the Subsidiaries issued by the Secretary of State of its respective state of incorporation and each other state in which each is qualified to do business as of a recent date, certified in each case as of the Closing Date by the Secretary of the respective Company Party as being true, correct and complete. 6.4 OPINION OF COUNSEL. Buyer shall have received an opinion dated as of the Closing Date from counsel for the Company Parties in form and substance reasonably acceptable to Buyer. 6.5 CERTIFICATES AND TRANSACTION DOCUMENTS. Buyer shall have received from the Company all of the certificates and transfer documents set forth on EXHIBIT C. 6.6 CONSENTS AND APPROVALS. The Company Parties shall have received and furnished to Buyer all consents to the transaction contemplated hereby and waivers of rights to terminate or modify any material rights or obligations of the Company Parties from any Person from whom such consent or waiver is required under any Material Contract on or prior to the Closing and effective through and including the Closing Date, or who as a result of the transactions contemplated hereby, would have such rights to terminate or modify such Contracts or instruments, either by the terms thereof or as a matter of law. The requirements of the Hart-Scott-Rodino Act, if applicable, shall have been satisfied. 6.7 NO ADVERSE LITIGATION. There shall not be pending or threatened any action or proceeding by or before any court or other governmental body which shall seek to restrain, prohibit, invalidate or collect damages arising out of the transactions contemplated hereby, and which, in the reasonable judgment of Buyer, makes it inadvisable to proceed with the transactions contemplated hereby. 6.8 LIABILITIES. Prior to the Closing, the Company shall have obtained full satisfactions or releases of all obligations and liabilities due to or on behalf of any Affiliate of a Subsidiary. 6.9 LIENS. The shares of capital stock of each Subsidiary held by the Company shall be free and clear of any Liens. The Purchased Assets shall be free and clear of any Liens. 6.10 SERVICE AGREEMENT. The Service Agreement shall be executed and become effective immediately following the Closing. 6.11 IMPLEMENTATION SCHEDULE. Buyer and the Company shall have agreed upon the Implementation Schedule set forth on SCHEDULE 5.12. 6.12 FINANCIAL STATEMENTS. The Company shall have delivered, or shall have caused to be delivered, to Buyer the Prior Financial Statements and the Current Financial Statements. The Company shall have agreed to deliver the balance sheet of FHPS at March 31, 1999 within thirty (30) days of the Closing. ARTICLE 7 CONDITIONS TO THE OBLIGATIONS OF THE COMPANY PARTIES The obligations of the Company Parties to effect the transactions contemplated hereby shall be subject to the fulfillment at or prior to the Closing Date of the following conditions, any or all of which may be waived in whole or in part by the Company Parties: 7.1 ACCURACY OF REPRESENTATIONS AND WARRANTIES AND COMPLIANCE WITH OBLIGATIONS. The representations and warranties of Buyer contained in this Agreement shall be true and correct in all material respects at and as of the Closing Date with the same force and effect as though made at and as of that time except (a) for changes specifically permitted by or disclosed pursuant to this Agreement and (b) that those representations and warranties which address matters only as of a particular date shall remain true and correct as of such date. Buyer shall have performed and complied with in all material respects all of its obligations required by this Agreement to be performed or complied with at or prior to the Closing Date. Buyer shall have delivered to the Company a certificate, dated as of the Closing Date, and signed by an executive officer, certifying that such representations and warranties are true and correct in all material respects and that all such obligations have been performed and complied with in all material respects. 7.2 NO ADVERSE LITIGATION OR LEGISLATION. There shall not be pending or threatened any action or proceeding by or before any court or other governmental body which shall seek to restrain, prohibit, invalidate or collect damages arising out of the transactions contemplated hereby, and which, in the reasonable judgment of the Company Parties, makes it inadvisable to proceed with the transactions contemplated hereby. 7.3 NO MATERIAL ADVERSE CHANGE. Between September 30, 1998 and the Closing Date, there shall have been no Material Adverse Change to Buyer. 7.4 OPINION OF BUYER COUNSEL. The Company shall have received an opinion dated as of the Closing Date from counsel to Buyer in form and substance reasonably acceptable to the Company. 7.5 HART - SCOTT - RODINO ACT. The requirements of the Hart-Scott-Rodino Act, if applicable, shall have been satisfied. ARTICLE 8 REMEDIES FOR BREACHES OF THIS AGREEMENT 8.1 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All of the representations and warranties of the Parties contained in this Agreement shall survive the Closing (except if the Party suffering Adverse Consequences knew or had reason to know of any misrepresentation or breach of warranty or covenant at the time of Closing) and continue in full force and effect thereafter until the earlier of: (i) the completion of the Buyer's consolidated audit for the fiscal year ending March 31, 2000, or (ii) ninety (90) days following the end of the fiscal year ending March 31, 2000. 8.2 INDEMNIFICATION PROVISIONS FOR BENEFIT OF BUYER. In the event any Company Party breaches (or in the event any third party alleges facts that, if true, would mean any Company Party has breached) any representations, warranties, and covenants of the Company Parties contained herein, then the Company agrees to indemnify Buyer from and against any Adverse Consequences Buyer may suffer through and after the date of the claim for indemnification (including any Adverse Consequences suffered after the end of any applicable survival period) resulting from, arising out of, relating to, in the nature of, or caused by the breach (or the alleged breach), subject to the limitations set forth below. 8.3 INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE COMPANY. In the event Buyer breaches (or in the event any third party alleges facts that, if true, would mean Buyer has breached) any representations, warranties, and covenants of Buyer contained herein, then Buyer agrees to indemnify the Company from and against any Adverse Consequences the Company may suffer through and after the date of the claim for indemnification (including any Adverse Consequences suffered after the end of any applicable survival period) resulting from, arising out of, relating to, in the nature of or caused by the breach (or the alleged breach), subject to the limitations set forth below. 8.4 PROCEDURE FOR MATTERS INVOLVING THIRD PARTIES. (a) If any third party shall notify any Party (the "INDEMNIFIED PARTY") with respect to any matter (a "THIRD PARTY CLAIM") which may give rise to a claim for indemnification against any other Party (the "INDEMNIFYING PARTY") under this ARTICLE 8, then the Indemnified Party shall promptly issue a Claim Notice to the Indemnifying Party with respect thereto. (b) Any Indemnifying Party will have the right to defend the Indemnified Party against the Third Party Claim with counsel of its choice reasonably satisfactory to the Indemnified Party so long as (i) the Indemnifying Party notifies the Indemnified Party in writing within fifteen (15) days following the receipt of the Claim Notice that the Indemnifying Party will indemnify the Indemnified Party from and against the entirety of any Adverse Consequences the Indemnified Party may suffer resulting from, arising out of, relating to, in the nature of, or caused by the Third Party Claim, (ii) upon request of the Indemnified Party, the Indemnifying Party provides the Indemnified Party with evidence reasonably acceptable to the Indemnified Party that the Indemnifying Party will have the financial resources to defend against the Third Party Claim and fulfill its indemnification obligations hereunder, and (iii) the Indemnifying Party conducts the defense of the Third Party Claim actively and diligently. (c) The Indemnified Party: (i) may retain separate co-counsel at its sole cost and expense and participate in the defense of the Third Party Claim and (ii) will not consent to the entry of any judgment or enter into any settlement with respect to the Third Party Claim without the prior written consent of the Indemnifying Party (not to be withheld unreasonably); and the Indemnifying Party will not consent to the entry of any judgment or enter into any settlement with respect to the Third Party Claim without the prior written consent of the Indemnified Party (not to be withheld unreasonably). (d) In the event any of the conditions in SECTION 8.4(b) is or becomes unsatisfied, (i) the Indemnified Party may defend against the Third Party Claim in any manner it reasonably may deem appropriate, (ii) the Indemnifying Parties will reimburse the Indemnified Party promptly and periodically for the costs of defending against the Third Party Claim (including reasonable attorneys' fees and expenses), and (iii) the Indemnifying Parties will remain responsible for any Adverse Consequences the Indemnified Party may suffer resulting from, arising out of, relating to, in the nature of, or caused by the Third Party Claim to the fullest extent provided in this ARTICLE 8. 8.5 NOTICE OF CLAIM. A Party suffering Adverse Consequences that gives or could give rise to a claim for indemnification under this ARTICLE 8 shall promptly notify each other Party thereof in writing (a "CLAIM NOTICE") in accordance with SECTION 10.1. The Claim Notice shall contain a brief description of the nature of the Adverse Consequences suffered and, if practicable, an aggregate dollar value estimate of the Adverse Consequence suffered. No delay in the issuance of a Claim Notice shall relieve any Party from any obligation under this ARTICLE 8, unless and solely to the extent such Party is thereby prejudiced. 8.6 LIMITATION ON AND EXPIRATION OF INDEMNIFICATION. Notwithstanding anything in this ARTICLE 8 to the contrary, the Company's rights to indemnification from Buyer, and Buyer's rights to indemnification from the Company, shall be limited as follows: (a) all rights of the parties hereto to indemnification hereunder for breaches of representations and warranties shall expire following the completion of the Buyer's consolidated audit for the fiscal year ending March 31, 2000; provided, however, if, prior to such expiration, a state of facts shall have become known which threatens to give rise to a liability against which any party hereto would be entitled to indemnification hereunder and the indemnified party shall have given notice of such facts to the indemnifying party, then the rights of the indemnified party to indemnification with respect to such liability shall continue until such liability shall have been finally determined and disposed of; and provided, further, that any obligation for indemnification by the Company arising out of Taxes shall continue for the period of the applicable statute of limitations for such Taxes. (b) No party shall be entitled to indemnification pursuant to SECTION 8.1 or 8.2 unless and until the aggregate amount of damages resulting from any and all indemnification sustained by such party exceeds $500,000. Further, the aggregate amount to which an Indemnified Party shall be entitled to recover for all obligations of indemnification under this Section 8 shall not exceed the amount of $20 million. (c) whenever the word "material" or phrase "Material Adverse Effect" is used in this Agreement, it shall be construed as referring to damages with respect to any individual claim which exceeds $75,000. 8.7 ADJUSTMENT FOR INSURANCE. The amount which an Indemnifying Party is required to pay to, for or on behalf of the Indemnified Party pursuant to this Article 8 shall be adjusted (including, without limitation, retroactively) by any insurance proceeds actually recovered by or on behalf of such Indemnified Party in reduction of the related indemnifiable loss (the "INDEMNIFIABLE LOSS"). Amounts required to be paid, as so reduced, are hereinafter sometimes called an "INDEMNITY PAYMENT". If an Indemnified Party has received or has had paid on its behalf an Indemnity Payment for an Indemnifiable Loss and subsequently receives insurance proceeds for such Indemnifiable Loss, then the Indemnified Party shall (x) promptly notify the Indemnifying Party of the amount and nature of such proceeds, and (y) pay to the Indemnifying Party the amount of such insurance proceeds or, if lesser, the amount of the Indemnity Payment. 8.8 MITIGATION OF LOSS. Each Indemnified Party is obligated to use all reasonable efforts to mitigate to the fullest extent practicable the amount of any Indemnifiable Loss for which it is entitled to seek indemnification hereunder, and the Indemnifying Party shall not be required to make any payment to an Indemnitee in respect of such Indemnifiable Loss to the extent such Indemnified Party failed to comply with the foregoing obligation. 8.9 SUBROGATION. Upon making any Indemnity Payment, the Indemnifying Party will, to the extent of such payment, be subrogated to all rights of the Indemnified Party against any third party in respect of the Indemnifiable Loss to which the payment relates; PROVIDED, HOWEVER, that until the Indemnified Party recovers full payment of its Indemnifiable Loss, any and all claims of the Indemnifying Party against any such third party on account of such payment are hereby made expressly subordinated and subjected in right of payment of the Indemnified Party's rights against such third party. Without limiting the generality of any other provision hereof, each such Indemnified Party and Indemnifying Party will duly execute, upon request, all instruments reasonably necessary to evidence and perfect the above-described subrogation and subordination rights. 8.10 OTHER INDEMNIFICATION PROVISIONS. The foregoing indemnification provisions are in addition to, and not in derogation of, any statutory, equitable, or common law remedy (including without limitation any such remedy arising under Environmental, Health, and Safety Requirements) any Party may have with respect to the transactions contemplated by this Agreement; provided, however, that the limitations contained in SECTION 8.6 shall apply to such remedies, except with respect to any equitable remedy, or any rights of any of the parties arising under the Service Agreement. ARTICLE 9 TERMINATION, AMENDMENT AND WAIVER 9.1 TERMINATION. This Agreement may be terminated at any time prior to the Closing Date: (a) by mutual written consent of all of the parties hereto at any time prior to the Closing; or (b) by Buyer upon delivery of written notice to the Company in accordance with SECTION 10.1 of this Agreement in the event of a material breach by a Company Party of any provision of this Agreement; or (c) by the Company upon delivery of written notice to Buyer in accordance with SECTION 10.1 of this Agreement in the event of a material breach by Buyer of any provision of this Agreement; or (d) by Buyer or the Company upon delivery of written notice to the other in accordance with SECTION 10.1 of this Agreement, if the Closing shall not have occurred by March 31, 1999, unless the failure of the Closing to occur is the result of a breach by the terminating party that caused the Closing to be delayed. 9.2 EFFECT OF TERMINATION. Except for the provisions of ARTICLE 8 and SECTION 10.3 hereof, which shall survive any termination of this Agreement, in the event of termination of this Agreement pursuant to SECTION 9.1, this Agreement shall forthwith become void and of no further force and effect, and the parties shall be released from any and all obligations hereunder; provided, however, that nothing herein shall relieve any party from liability for the willful breach of any of its representations, warranties, covenants or agreements set forth in this Agreement. ARTICLE 10 GENERAL PROVISIONS 10.1 NOTICES. All notices, requests, demands, claims, and other communications hereunder shall be in writing and shall be deemed given if delivered by certified or registered mail (first class postage pre-paid), guaranteed overnight delivery or facsimile transmission, if such transmission is confirmed by delivery by certified or registered mail (first class postage pre-paid) or guaranteed overnight delivery, to the following addresses and telecopy numbers (or to such other addresses or telecopy numbers which such party shall designate by like notice to the other party): (a) if to Buyer to: Advance Paradigm, Inc. 545 E. John Carpenter Freeway, Suite 1570 Irving, Texas 75062 Attn: David D. Halbert Chief Executive Officer, President and Chairman Telecopy: (972) 830-6196 with a copy to: Akin, Gump, Strauss, Hauer & Feld, L.L.P. 1700 Pacific Avenue, Suite 4100 Dallas, Texas 75201 Attn: J. Kenneth Menges, Jr., P.C. Telecopy: (214) 969-4343 (b) if to the Company Parties to: Foundation Health Systems, Inc. 21650 Oxnard Street Woodland Hills, California 91367 Attention: Gary Velasquez President - Specialty Services Telecopy: 1-818-676-6616 with a copy to: Foundation Health Systems, Inc. 21650 Oxnard Street Woodland Hills, California 91367 Attention: B. Curtis Westen, Esquire Senior Vice President, General Counsel and Secretary Telecopy: 1-818-676-7503 and Epstein Becker & Green, P.C. 1227 25th Street, N.W. Washington, D.C. 20037 Attention: Robert D. Reif, Esquire Telecopy: 202-296-2882 10.2 ENTIRE AGREEMENT. This Agreement (including the Exhibits and Schedules attached hereto, and other documents delivered at the Closing pursuant hereto), contains the entire understanding of the parties in respect of its subject matter and supersedes all prior agreements and understanding (oral or written) between or among the parties with respect to such subject matter. The Exhibits and Schedules constitute a part of this Agreement as though set forth in full herein. 10.3 EXPENSES; SALES TAX. Except as otherwise provided herein, each party shall bear its own transaction fees. The Company shall bear, be responsible for and pay any state sales tax arising as a result of sale of the Shares. 10.4 AMENDMENT; WAIVER. This Agreement may not be modified, amended, supplemented, canceled, or discharged, except by written instrument executed by all parties. No failure to exercise and no delay in exercising, any right, power or privilege under this Agreement shall operate as a waiver, nor shall any single or partial exercise of any right, power or privilege hereunder preclude the exercise of such or any other right, power or privilege. No waiver of any breach of any provision shall be deemed to be a waiver of any preceding or succeeding breach of the same or any other provision, nor shall any waiver be implied from any course of dealing between the parties. No extension of time for performance of any obligations or other acts hereunder or under any other agreement shall be deemed to be an extension of the time for performance of any other obligations or any other acts. 10.5 BINDING EFFECT; ASSIGNMENT. The rights and obligations of this Agreement shall bind and inure to the benefit of the parties and their respective successors and permitted assigns. Nothing expressed or implied herein shall be construed to give any other Person any legal or equitable rights hereunder. Except as expressly provided herein, the rights and obligations of this Agreement may not be assigned by the Company Parties without the prior written consent of Buyer. Buyer may assign all or any portion of its rights hereunder to one or more of its wholly owned subsidiaries. 10.6 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be an original but all of which together shall constitute one and the same instrument. 10.7 INTERPRETATION. When a reference is made in this Agreement to an article, section, paragraph, clause, schedule or exhibit, such reference shall be deemed to be to this Agreement unless otherwise indicated. The headings contained herein and on the schedules are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement or the schedules. Whenever the words "include," "includes" or "including" are used in this Agreement, they shall be deemed to be followed by the words "without limitation." Time shall be of the essence in this Agreement. 10.8 GOVERNING LAW; INTERPRETATION. This Agreement shall be construed in accordance with and governed for all purposes by the laws of the State of Delaware without giving effect to the principles of conflicts of laws. 10.9 JURISDICTION; SERVICE OF PROCESS. Any action or proceeding seeking to enforce any provision of, or based on any right arising out of, this Agreement may be brought against any of the parties in the United States District Court for the District of Delaware and each of the parties consents to the jurisdiction of such court (and of the appropriate appellate courts) in any such action or proceeding and waives any objection to venue laid therein. Process in any action or proceeding referred to in the preceding sentence may be served on any party anywhere in the world. To the extent not prohibited by applicable law, each of the parties hereby waives any right to trial by jury in any action or proceeding based on or arising out of this Agreement. 10.10 ARM'S LENGTH NEGOTIATIONS. Each party hereto expressly represents and warrants to all other parties hereto that (a) before executing this Agreement, said party has fully informed himself or itself of the terms, contents, conditions, and effects of this Agreement; (b) said party has relied solely and completely upon his or its own judgment in executing this Agreement; (c) said party has had the opportunity to seek and has obtained the advice of counsel before executing this Agreement; (d) said party has acted voluntarily and of his or its own free will in executing this Agreement; (e) said party is not acting under duress, whether economic or physical, in executing this Agreement; and (f) this Agreement is the result of arm's length negotiations conducted by and among the parties and their respective counsel. [SIGNATURE PAGE FOLLOWS] IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as of the date first above written. ADVANCE PARADIGM, INC. By: /s/ David D. Halbert ---------------------------------------- Name: David D. Halbert -------------------------------------- Title: Chairman, CEO ------------------------------------- FOUNDATION HEALTH SYSTEMS, INC. By: /s/ Gary S. Velasquez ---------------------------------------- Name: Gary S. Velasquez -------------------------------------- Title: President Specialty Services ------------------------------------- FOUNDATION HEALTH PHARMACEUTICAL SYSTEMS, INC. By: /s/ Gary S. Velasquez ---------------------------------------- Name: Gary S. Velasquez -------------------------------------- Title: CEO ------------------------------------- INTEGRATED PHARMACEUTICAL SYSTEMS, INC. By: /s/ Gary S. Velasquez ---------------------------------------- Name: Gary S. Velasquez -------------------------------------- Title: CEO ------------------------------------- FOUNDATION HEALTH CORPORATION By: /s/ Gary S. Velasquez ---------------------------------------- Name: Gary S. Velasquez -------------------------------------- Title: ------------------------------------- EX-10.64 16 EXHIBIT 10.64 FOURTH AMENDMENT TO CREDIT AGREEMENT THIS FOURTH AMENDMENT TO CREDIT AGREEMENT is made and dated as of March 26, 1999 (the "FOURTH 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, that certain Second Amendment to Credit Agreement (the "SECOND AMENDMENT") dated as of July 31, 1998 and that certain Third Amendment (the "THIRD AMENDMENT") dated as of November 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 AMENDMENTS TO SECTION 1.01. (a) The definition of the term "Adjusted EBITDA" in Section 1.01 of the Credit Agreement is hereby amended by inserting ", any Specified Credits (calculated on a pre-tax basis)" after the words "any Specified Charges" in the fourth line thereof. (b) The definition of the term "Net Cash Flow" in Section 1.01 of the Credit Agreement is hereby amended by inserting ", any Specified Credits (calculated on a net of tax basis)" prior to the words "extraordinary gains" in the third line thereof. (c) The definition of the term "Net Worth" in Section 1.01 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: 1 "NET WORTH" of the Company on any day of determination means an amount equal to the excess of Total Assets over Total Liabilities. (d) There shall be added to Section 1.01 of the Credit Agreement, in appropriate alphabetical sequence, a new definition of the term "Specified Credits" reading in its entirety as follows: "SPECIFIED CREDITS" means the gains (net of costs and expenses of sale) realized from the sale of those assets set forth on Part 3 of Schedule 1.01 hereof. 2.2 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. 2.3 AMENDMENTS TO SECTION 2.09. (a) The first sentence of Clause (e) of Section 2.09 of the Credit Agreement is hereby amended and restated to read in its entirety as follows: "Subject to Section 3.04, until the aggregate Commitments shall have permanently been reduced to an amount not in excess of $750,000,000, the Company shall ratably prepay Committed Loans by an amount equal to (A) 100% of the net cash proceeds from the sale of its assets described on Schedule 2.09 (without giving effect to clause (ii) below) and (B) 50% of net cash proceeds from all other asset sales except for (i) the Workers Compensation Disposition and (ii) asset sales generating aggregate net proceeds up to $10,000,000 in any fiscal year." (b) Section 2.09 of the Credit Agreement is hereby amended by adding the following subsection (f) thereto: "(f) Subject to Section 3.04, until the aggregate Commitments shall have permanently been reduced to an amount not in excess of $750,000,000, at any time that the Company's Senior Unsecured Debt Rating shall not be at or above BBB - by S&P or at or above Baa3 by Moody's, the Company shall ratably prepay Committed Loans by an amount equal to 100% of the net proceeds from any issuance by the Company of equity securities after December 31, 1998 (other than any equity securities issued in connection with an Acquisition). Such prepayment shall be made on the next Interest Payment Date for Offshore Rate Committed Loans (or, if there shall be no Offshore Rate Committed Loans outstanding, on the next Interest Payment Date for Base Rate Committed Loans) occurring after completion of such issuance. The Company shall give the Administrative Agent not less than one Business Day's notice of such prepayment, and such notice of prepayment shall specify the date and amount of such prepayment and the Type(s) of Committed Loans to be prepaid. The Administrative Agent will promptly 2 notify each Bank of its receipt of any such notice, and of such Bank's Pro Rata Share of such prepayment. If such notice is given by the Company, the Company shall make such prepayment and the payment amount specified in such notice shall be due and payable on the date specified therein, together with, in the case of Offshore Rate Committed Loans only, accrued interest to each such date on the amount prepaid and any amounts required pursuant to Section 3.04. On the date such prepayment is required to be made, the aggregate Commitments shall automatically and permanently be reduced by the amount of the required prepayment." 2.4 ADDITION OF SCHEDULE 2.09. (a) There shall be added to the Credit Agreement a new Schedule 2.09 reading in its entirety as set forth on Schedule 2.09 hereto. 2.5 AMENDMENTS TO SECTION 7.12. (a) Clause (c) of Section 7.12 of the Credit Agreement is hereby amended and restated in its entirety to read as follows: "(c) its Net Worth to be less than the sum of (w) 85% of Net Worth as of December 31, 1998 PLUS (x) 50% of the net income of the Company and its Subsidiaries (without giving effect to losses) for each fiscal quarter ending on or after March 31, 1999 ." 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 Fourth Amendment: 3.1 AUTHORIZATION. The execution, delivery and performance by the Company of this Fourth Amendment has been duly authorized by all necessary corporate action, and this Fourth Amendment has been duly executed and delivered by the Company. 3.2 BINDING OBLIGATION. This Fourth 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 Fourth 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 3 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 Fourth Amendment, or the transactions contemplated hereby. 3.4 INCORPORATION OF CERTAIN REPRESENTATIONS. After giving effect to the terms of this Fourth 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 Fourth 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 of the following on or before March 31, 1999: 4.1 AUTHORIZED SIGNATORIES. A certificate, signed by the Secretary or an Assistant Secretary of the Company and dated the date of this Fourth Amendment, as to the incumbency of the person or persons authorized to execute and deliver this Fourth Amendment and any instrument or agreement required hereunder on behalf of the Company. 4.2 FEES. Payment to the Administrative Agent, for the pro rata benefit of each Bank that executed and returned the approval letter dated March 16, 1999 from the Agent to the Banks (the "Approval Letter") on or before 3:00 p.m., Pacific time, on March 26, 1999 and that thereafter executed this Fourth Amendment prior to March 31, 1999, of an amendment fee in an amount equal to .25% of the aggregate amount of the Commitments held by the Banks that have so executed the Approval Letter and this Fourth Amendment; and payment of all other fees and expenses of the Arrangers in connection with this Fourth Amendment (including, without limitation, the reasonable fees and expenses of the counsel to the Arrangers). 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 Fourth Amendment and the Credit Agreement and the compliance with the conditions set forth herein. 5. CONDITION SUBSEQUENT. On or before May 30, 1999, the Company shall deliver to the Agent a certificate, signed by the Secretary or an Assistant Secretary of the Company as to the resolutions of the Company's board of directors authorizing or ratifying the transactions contemplated by the Fourth Amendment, which certificate shall be in form and substance 4 satisfactory to the Agent. If the Company shall fail to deliver such a certificate by May 30, 1999, then this Fourth Amendment shall cease to be effective as of such date. 6. MISCELLANEOUS. 6.1 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. 6.2 WAIVERS. This Fourth 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. 6.3 COUNTERPARTS. This Fourth 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 Fourth Amendment shall become effective when the Company, the Agent and the Majority Banks shall have signed a copy hereof and the same shall have been delivered to the Agent. 6.4 GOVERNING LAW. This Fourth Amendment shall be governed by and construed in accordance with the laws of the State of California. 5 IN WITNESS WHEREOF, the parties hereto have caused this Fourth 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 -------------------------------------- [Balance of signatures not included with this copy] 6 EX-10.65 17 EXHIBIT 10.65 Exhibit 10.65 FOUNDATION HEALTH SYSTEMS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN Effective as of January 1, 1996 (As amended as of April 1, 1997 to reflect the change in name of Health Systems International, Inc. to Foundation Health Systems, Inc.) FOUNDATION HEALTH SYSTEMS, INC. TABLE OF CONTENTS
PAGE NO. ARTICLE I - INTRODUCTION 1.01 Purpose. . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.02 Effective Date and Term. . . . . . . . . . . . . . . . . . 1 1.03 Participation. . . . . . . . . . . . . . . . . . . . . . . 1 1.04 Applicability of ERISA . . . . . . . . . . . . . . . . . . 1 ARTICLE II - DEFINITIONS 2.01 Affiliated Company . . . . . . . . . . . . . . . . . . . . 1 2.02 Average Monthly Compensation . . . . . . . . . . . . . . . 2 2.03 Benefit Accrual Percentage . . . . . . . . . . . . . . . . 2 2.04 Board; Board of Directors. . . . . . . . . . . . . . . . . 2 2.05 Change in Control. . . . . . . . . . . . . . . . . . . . . 2 2.06 Code . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.07 Committee. . . . . . . . . . . . . . . . . . . . . . . . . 3 2.08 Common Stock . . . . . . . . . . . . . . . . . . . . . . . 3 2.09 Compensation . . . . . . . . . . . . . . . . . . . . . . . 4 2.10 Covered Employer . . . . . . . . . . . . . . . . . . . . . 4 2.11 Defined Benefit Plan . . . . . . . . . . . . . . . . . . . 4 2.12 Effective Date . . . . . . . . . . . . . . . . . . . . . . 4 2.13 ERISA. . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.14 Exchange Act . . . . . . . . . . . . . . . . . . . . . . . 4 2.15 100% Joint and Survivor Annuity. . . . . . . . . . . . . . 4 2.16 50% Joint and Survivor Annuity . . . . . . . . . . . . . . 5 2.17 401(k) Plan. . . . . . . . . . . . . . . . . . . . . . . . 5 2.18 Full-Time Employment . . . . . . . . . . . . . . . . . . . 5 2.19 Merger . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.20 Nonqualified Defined Benefit Plan. . . . . . . . . . . . . 5 2.21 Nonqualified Defined Contribution Plan . . . . . . . . . . 5 2.22 Normal Benefit Date. . . . . . . . . . . . . . . . . . . . 6 2.23 Normal Benefit Form. . . . . . . . . . . . . . . . . . . . 6 2.24 Normal Retirement. . . . . . . . . . . . . . . . . . . . . 6 2.25 Participant. . . . . . . . . . . . . . . . . . . . . . . . 6 2.26 Payment Commencement Date. . . . . . . . . . . . . . . . . 6 2.27 Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.28 Retirement; Retirement Date. . . . . . . . . . . . . . . . 6 2.29 Service Years. . . . . . . . . . . . . . . . . . . . . . . 7 2.30 Single Life Annuity. . . . . . . . . . . . . . . . . . . . 7 2.31 Specified Rate . . . . . . . . . . . . . . . . . . . . . . 7 2.32 Sponsor. . . . . . . . . . . . . . . . . . . . . . . . . . 8 i PAGE NO. 2.33 Spouse . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.34 Termination; Termination Date. . . . . . . . . . . . . . . 8 2.35 Termination for Cause. . . . . . . . . . . . . . . . . . . 8 ARTICLE III - ADMINISTRATION OF THE PLAN 3.01 Administration . . . . . . . . . . . . . . . . . . . . . . 9 3.02 Committee Authority; Rules and Regulations . . . . . . . . 9 3.03 Appointment of Agents. . . . . . . . . . . . . . . . . . . 9 3.04 Leave of Absence . . . . . . . . . . . . . . . . . . . . . 9 3.05 Actuarial Assumptions. . . . . . . . . . . . . . . . . . . 9 ARTICLE IV - BENEFITS 4.01 Eligibility and Vesting. . . . . . . . . . . . . . . . . . 10 4.02 Form of Supplemental Benefit . . . . . . . . . . . . . . . 10 4.03 Payment of Supplemental Benefit. . . . . . . . . . . . . . 11 4.04 Monthly Annuity Amount . . . . . . . . . . . . . . . . . . 11 4.05 Target Monthly Benefit . . . . . . . . . . . . . . . . . . 11 4.06 Monthly Offset Amount. . . . . . . . . . . . . . . . . . . 12 4.07 Special Rules for Early Retirement . . . . . . . . . . . . 17 4.08 Termination of Plan Participation. . . . . . . . . . . . . 17 4.09 Disability . . . . . . . . . . . . . . . . . . . . . . . . 18 4.10 Change in Control. . . . . . . . . . . . . . . . . . . . . 18 4.11 Termination for Cause. . . . . . . . . . . . . . . . . . . 18 ARTICLE V - DEATH OF A PARTICIPANT 5.01 Termination by Reason of Death . . . . . . . . . . . . . . 18 5.02 Form and Payment of Death Benefit. . . . . . . . . . . . . 19 5.03 Monthly Death Benefit Amount . . . . . . . . . . . . . . . 19 ARTICLE VI - MISCELLANEOUS PROVISIONS 6.01 Payments During Incapacity . . . . . . . . . . . . . . . . 20 6.02 Prohibition Against Assignment . . . . . . . . . . . . . . 20 6.03 Binding Effect . . . . . . . . . . . . . . . . . . . . . . 20 6.04 No Transfer of Interest. . . . . . . . . . . . . . . . . . 20 6.05 Amendment or Termination of the Plan . . . . . . . . . . . 21 6.06 No Right to Employment . . . . . . . . . . . . . . . . . . 21 6.07 Notices. . . . . . . . . . . . . . . . . . . . . . . . . . 22 6.08 Governing Law. . . . . . . . . . . . . . . . . . . . . . . 22 6.09 Titles and Headings; Gender of Terms . . . . . . . . . . . 22 6.10 Severability . . . . . . . . . . . . . . . . . . . . . . . 22 6.11 Tax Effect of Plan . . . . . . . . . . . . . . . . . . . . 23
ii FOUNDATION HEALTH SYSTEMS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN ARTICLE I INTRODUCTION 1.01 PURPOSE. This Foundation Health Systems, Inc. Supplemental Executive Retirement Plan is hereby established by the Board of Directors of the Sponsor to enable the Sponsor and the Affiliated Companies to attract, retain and motivate selected executives of the Sponsor and such Affiliated Companies by providing to such executives certain additional retirement income as more fully set forth herein. 1.02 EFFECTIVE DATE AND TERM. This Plan is adopted effective as of January 1, 1996, and shall continue in effect until terminated by the Board of Directors. 1.03 PARTICIPATION. Participation in this Plan is open only to those executives of the Sponsor or any Affiliated Company who are selected for participation in the Plan by the President of the Sponsor and approved by the Committee. The participation in this Plan by any such executive, and the payment of any benefits under this Plan to any such executive, shall be governed by the terms of this Plan and by the election form submitted by such executive pursuant to this Plan. 1.04 APPLICABILITY OF ERISA. This Plan is intended to be an unfunded plan maintained primarily for the purpose of providing deferred compensation to a select group of management or highly compensated employees within the meaning of ERISA. ARTICLE II DEFINITIONS 2.01 AFFILIATED COMPANY. "Affiliated Company" means any corporation other than the Sponsor in an unbroken chain of corporations beginning with the Sponsor if, at the time of reference, each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. 1 2.02 AVERAGE MONTHLY COMPENSATION. "Average Monthly Compensation" means, with respect to any Participant and as of any date of reference (the "Determination Date"), the quotient obtained by dividing (a) the aggregate amount of Compensation earned by such Participant during the consecutive 60-month period ending on such Determination Date by (b) a factor of 60, provided that any bonuses included in Compensation shall be deemed to have been earned pro-rata each month during the applicable period in which such bonuses were earned. Notwithstanding the preceding sentence, in the case of a Participant who, as of any applicable Determination Date, has not been employed by one or more Covered Employers during the consecutive 60-month period ending on such Determination Date, such Participant's Average Monthly Compensation as of such Determination Date shall be the quotient obtained by dividing (i) the total amount of Compensation earned by such Participant prior to, and including, such Determination Date by (ii) a factor equal to the number of months prior to, and including, such Determination Date during which such Participant was employed by a Covered Employer. 2.03 BENEFIT ACCRUAL PERCENTAGE. "Benefit Accrual Percentage" means, with respect to any Participant and as of any date of reference, the percentage obtained by multiplying (a) 50% by (b) a fraction (not to exceed 1) having a numerator equal to such Participant's Service Years (determined as of such reference date) and having a denominator equal to the greater of fifteen years or the total number of Service Years such Participant would have if such Participant continued in the employ of the Sponsor or an Affiliated Company uninterrupted through his Normal Benefit Date. 2.04 BOARD; BOARD OF DIRECTORS. "Board" and "Board of Directors" each mean the board of directors of the Sponsor. 2.05 CHANGE IN CONTROL. "Change in Control" means the occurrence of any of the following events: (i) an action of the Board (or, if approval of the Board is not required as a matter of law, the stockholders of the Sponsor) approving (a) any consolidation or merger of the Sponsor in which the Sponsor is not the continuing or surviving corporation or pursuant to which shares of Common Stock would be converted into cash, securities or other property, other than a Merger, (b) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Sponsor or (c) the adoption of any plan or proposal for the liquidation or dissolution of the Sponsor; 2 (ii) the purchase by any person (as such term is defined in Sections 13(d)(3) and 14(d)(2) of the Exchange Act), corporation or other entity (other than the Sponsor or any employee benefit plan sponsored by the Sponsor or an Affiliated Company) of any Common Stock of the Sponsor (or securities convertible into the Sponsor's Common Stock) for cash, securities or any other consideration pursuant to a tender offer or exchange offer, without the prior consent of the Board and, after such purchase, such person shall be the "beneficial owner" (as such term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Sponsor representing 20 percent or more of the combined voting power of the then outstanding securities of the Sponsor ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors (calculated as provided in Section (d) of such Rule 13d-3 in the case of rights to acquire the Sponsor's securities); (iii) a change in the composition of the Board during any period of two consecutive years, such that individuals who at the beginning of such period constitute the entire Board shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Sponsor's stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period; or (iv) the occurrence of such other transactions involving a significant issuance of voting stock or change in the composition of the Board that the Board determines to be a Change in Control for purposes of this Plan; provided that, notwithstanding the foregoing, none of the events relating to or resulting from the merger transaction involving the Sponsor and Foundation Health Corporation, consummated on April 1, 1997, shall constitute a Change in Control for purposes of this Plan. 2.06 CODE. "Code" means the Internal Revenue Code of 1986, as amended. 2.07 COMMITTEE. "Committee" means the Compensation and Stock Option Committee of the Board. 2.08 COMMON STOCK. "Common Stock" means the Class A Common Stock, $.001 par value per share, of the Sponsor. 3 2.09 COMPENSATION. "Compensation" means, with respect to any Participant, the base salary paid to such Participant by any Covered Employer, including any amounts not currently includible in such Participant's gross income by reason of any amount deferred for the period pursuant to any nonqualified deferred compensation arrangement between the Participant and any Covered Employer or pursuant to Code Section 402(e)(3) or Code Section 125. Except as provided in the following sentence, Compensation shall also include any annual bonus earned by any Participant and accrued by the applicable Covered Employer for the benefit of such Participant. Notwithstanding the foregoing, the Committee shall have the sole and absolute discretion to determine, at the time of any award under a bonus plan, or the payment of any bonus, that such bonus does not constitute Compensation for purposes of this Plan. 2.10 COVERED EMPLOYER. "Covered Employer" means and includes both (a) the Sponsor and (b) any Affiliated Company. 2.11 DEFINED BENEFIT PLAN. "Defined Benefit Plan" means the Health Net Defined Benefit Pension Plan, which was terminated effective as of December 31, 1994, and any other existing, frozen or previously terminated qualified defined benefit plan currently or previously maintained by the Sponsor, an Affiliated Company or any other entity acquired by the Sponsor or an Affiliated Company prior to or following the Effective Date hereof. 2.12 EFFECTIVE DATE. "Effective Date" means January 1, 1996. 2.13 ERISA. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 2.14 EXCHANGE ACT. "Exchange Act" means the Securities Exchange Act of 1934, as amended. 2.15 100% JOINT AND SURVIVOR ANNUITY. "100% Joint and Survivor Annuity" means an annuity which (a) provides a specified level monthly benefit during the life of the Participant and (b) following the death of the Participant provides a level monthly benefit to, and during the remaining life of, such Participant's surviving spouse (if any) equal to 100% of the monthly benefit provided to such Participant. 2.16 50% JOINT AND SURVIVOR ANNUITY. "50% Joint and Survivor Annuity" means an annuity which (a) provides a specified level monthly benefit during the life of the Participant and (b) following the 4 death of the Participant provides a level monthly benefit to, and during the remaining life of, such Participant's surviving spouse (if any) equal to 50% of the monthly benefit provided to such Participant. 2.17 401(k) PLAN. "401(k) Plan" means the Sponsor's 401(k) Associate Savings Plan, as such Plan is in effect as of the Effective Date and as it may be amended from time to time thereafter and any other existing, frozen or previously terminated 401(k) and/or profit sharing plan or any other qualified defined contribution plan currently or previously maintained by the Sponsor, an Affiliated Company or any other entity acquired by the Sponsor or an Affiliated Company prior to or following the Effective Date. 2.18 FULL-TIME EMPLOYMENT. "Full-Time Employment" means, with respect to any Participant, any employment or independent contractor relationship with any organization or person, whether or not the Sponsor or an Affiliated Company, pursuant to which such Participant performs services on a regular and continuous basis, provided, however, that any such relationship shall not constitute Full-Time Employment unless the Participant devotes at least an average of 35 hours per week to the performance of services pursuant to such relationship. For purposes of determining as of any given date whether the Participant meets the 35 hour requirement set forth in the preceding sentence, no more than the three-month period immediately preceding such given date shall be taken into account. 2.19 MERGER. "Merger" means any merger of the Sponsor in which the holders of Common Stock immediately prior to the merger have the same proportionate ownership of common stock of the surviving or resulting parent corporation immediately after the merger. 2.20 NONQUALIFIED DEFINED BENEFIT PLAN. "Nonqualified Defined Benefit Plan" means any existing, frozen or terminated nonqualified deferred compensation plan or supplemental executive retirement plan providing for a defined benefit currently or previously maintained by the Sponsor, an Affiliated Company or any other entity acquired by the Sponsor or an Affiliated Company prior to or following the Effective Date. 2.21 NONQUALIFIED DEFINED CONTRIBUTION PLAN. "Nonqualified Defined Contribution Plan" means any existing, frozen or terminated nonqualified deferred compensation plan or supplemental executive retirement plan which provides for contributions by the Participant and/or the Sponsor or an Affiliated Company currently or previously maintained by the Sponsor, an Affiliated Company or any other entity acquired by the Sponsor or an Affiliated Company prior to or following the Effective Date. 5 Nonqualified Defined Contribution Plan includes, but is not limited to, the Health Net Executive Deferral Plan and the Health Net Supplemental Credit Plan. 2.22 NORMAL BENEFIT DATE. "Normal Benefit Date" means, with respect to any Participant, the ninetieth (90th) day immediately following the day upon which such Participant attains (or is expected to attain) age 62. 2.23 NORMAL BENEFIT FORM. "Normal Benefit Form" means a Single Life Annuity. 2.24 NORMAL RETIREMENT. "Normal Retirement" means, with respect to any Participant, any Retirement of such participant having a Retirement Date which falls on or after the date such Participant attains age 62. 2.25 PARTICIPANT. "Participant" means any executive of the Sponsor or any Affiliated Company who is selected and approved for participation in this Plan as provided in Section 1.03 hereof. 2.26 PAYMENT COMMENCEMENT DATE. "Payment Commencement Date" means, with respect to any Participant, the ninetieth (90th) day after the earlier of (a) such Participant's Normal Benefit Date and (b) the later of (i) such Participant's Retirement Date and (ii) the date such Participant attains age 55. 2.27 PLAN. "Plan" means this Foundation Health Systems, Inc. Supplemental Executive Retirement Plan adopted as of the Effective Date and as it may be amended from time to time. 2.28 RETIREMENT; RETIREMENT DATE. "Retirement" occurs with respect to any Participant only if and when such Participant permanently ceases all Full-Time Employment for whatever reason (whether voluntary or involuntary and including death or Disability). The temporary cessation of a Participant's Full-Time Employment shall not constitute Retirement. The cessation of a Participant's Full-Time Employment shall be deemed to be temporary if, following such cessation, such Participant commences (or intends to commence) actively seeking Full-Time Employment; provided, however, that if such Participant subsequently abandons his search (or intended search) for Full-Time Employment prior to obtaining such Full-Time Employment, such Participant shall be deemed to incur Retirement at the time of such abandonment. The determination as to whether (and when) a Participant incurs Retirement shall be made solely by the Committee based on such evidence as the Committee, in its discretion, deems appropriate. 6 Such evidence may, but is not required to include, a representation of Retirement presented to the Committee by the Participant. If, following a determination by the Committee that a Participant has incurred Retirement, such participant recommences Full-Time Employment, such Participant shall nevertheless be deemed for all purposes of this Plan to have incurred Retirement in accordance with the Committee's original determination. A Participant's "Retirement Date" shall be the first day, as determined by the Committee, on which such Participant meets the requirements of Retirement as set forth in this Section 2.28. 2.29 SERVICE YEARS. "Service Years" means with respect to any Participant, the quotient obtained by dividing (a) the whole number of complete months (disregarding any incomplete month) elapsing during the period commencing on the date such Participant initially commenced employment with any Covered Employer and ending on such Participant's final Termination Date by (b) a factor of 12. In the case of any Participant who (a) commenced employment with a Covered Employer, (b) terminated such employment and (c) prior to the Effective Date re-commenced employment with any Covered Employer, such Participant shall be credited with Service Years for those periods prior to the Effective Date during which he was actually employed by any Covered Employer notwithstanding the fact that such pre-Effective Date employment with such Covered Employer was not continuous. Except as otherwise provided in Section 3.04 hereof (concerning leaves of absence), it is intended that a Participant shall cease earning Service Years upon his incurring any Termination after the Effective Date, regardless of whether such Participant is thereafter employed by the Sponsor any Affiliated Company. Notwithstanding the foregoing, in the case of a Participant whose Termination is due to a Disability, such Participant shall continue to be credited with Service Years as provided in Section 4.09. 2.30 SINGLE LIFE ANNUITY. "Single Life Annuity" means an annuity which provides a specified level monthly benefit until the death of the beneficiary. 2.31 SPECIFIED RATE. "Specified Rate" means an interest rate equal to 8% per annum, or such other annual interest rate as the Committee may from time to time designate as the Specified Rate, with any such designation to be given effect only on a prospective basis. 2.32 SPONSOR. "Sponsor" means Foundation Health Systems, Inc., a Delaware corporation. 7 2.33 SPOUSE. "Spouse" means, with respect to any Participant, only that person to whom such Participant is married as of such Participant's Termination Date, provided, however, that a person who has been married to a Participant for less than one year as of such Participant's Termination Date shall not be deemed to be the "Spouse" of such Participant. 2.34 TERMINATION; TERMINATION DATE. "Termination" means the voluntary or involuntary termination of a Participant's employment with the Sponsor and all Affiliated Companies for any reason (including death or Disability ). The determination as to whether a Participant's Termination constitutes Retirement shall be made by the Committee in accordance with the provisions of Section 2.28 hereof. "Termination Date" means, with respect to any Participant, the effective date of such Participant's Termination. 2.35 TERMINATION FOR CAUSE. "Termination for Cause" means, with respect to any Participant, a Termination incurred by such Participant as a result of any one or more of the following causes: (a) The Participant's substantial neglect of his duties and responsibilities as an employee of the Covered Employer; (b) The Participant's theft or other misappropriation of, or any malfeasance with respect to, any property of the Covered Employer; (c) A conviction of the Participant for any criminal offense, whether or not involving property of the Covered Employer, but only if the Committee reasonably believes such conviction may adversely affect either (i) the reputation of the Covered Employer or (ii) the Participant's ability to effectively perform his duties and responsibilities as an employee of the Covered Employer; (d) The Participant's use of illegal drugs or alcohol to an extent that such use interferes with his ability to perform, in an acceptable manner, his duties and responsibilities as an employee of the Covered Employer; (e) The Participant's solicitation of business on behalf of, or diversion of business to, any competitor of the Covered Employer with whom the Participant expects to become employed or otherwise associated following such Participant's Termination. 8 ARTICLE III ADMINISTRATION OF THE PLAN 3.01 ADMINISTRATION. This Plan shall be administered by the Committee. 3.02 COMMITTEE AUTHORITY; RULES AND REGULATIONS. The Committee shall have discretionary authority to (a) make, amend, interpret and enforce all appropriate rules and regulations for the administration of this Plan and (b) decide or resolve, in its discretion, any and all questions, including interpretations of this Plan, as may arise in connection with this Plan. Any decision or action of the Committee in respect of any question arising out of or in connection with the administration, interpretation and application of this Plan and the rules and regulations promulgated hereunder shall be final, conclusive and binding upon all persons having any interest in this Plan. 3.03 APPOINTMENT OF AGENTS. In the administration of this Plan, the Committee may from time to time employ agents (which may include officers and/or employees of the Sponsor) and delegate to them such administrative duties as the Committee deems appropriate. 3.04 LEAVE OF ABSENCE. In the event a Participant takes a leave of absence from active employment with the Sponsor or any Affiliated Company, the Committee shall determine, in its discretion, (a) whether such leave of absence shall be deemed to constitute a Termination for purposes of this Plan and (b) if such leave of absence is not deemed to constitute a Termination under this Plan, whether such Participant shall continue to earn Service Years during such leave of absence notwithstanding the provisions of Section 2.29 hereof. The Committee shall establish such standards and procedures as may be necessary so that, with respect to any determinations made by the Committee pursuant to either clause (a) or clause (b) of the preceding sentence, Participants in substantially similar circumstances shall be treated substantially alike. 3.05 ACTUARIAL ASSUMPTIONS. In any case in which it is necessary to make actuarial adjustments in order to carry out the provisions of this Plan (including, without limitation, the provisions requiring the determination of an actuarially equivalent benefit under Sections 4.02 and 4.06 hereof), the following rules shall apply: 9 (a) The interest/discount rate assumed in making such actuarial adjustments shall be a fixed rate equal to the Specified Rate then in effect at the time such actuarial adjustments are calculated; and (b) The mortality table used in making such actuarial adjustments shall be the 1983 Unisex Group Annuity Mortality Table (GAM83) or such other table approved by the Committee from time to time. ARTICLE IV BENEFITS 4.01 ELIGIBILITY AND VESTING. Except as otherwise provided in Section 4.11 and Article V hereof, upon incurring a Termination, a Participant shall receive a supplemental benefit under this Plan (a "Supplemental Benefit"), which Supplemental Benefit shall be paid to the extent vested, in such form and amounts, and at such times, as provided under this Plan. Notwithstanding the foregoing, and except as otherwise provided in Sections 4.09 and 4.10 hereof, a Participant who incurs a Termination shall be entitled to receive a Supplemental Benefit under this Plan only to the extent such Participant is vested in such Benefit. A Supplemental Benefit shall vest and become nonforfeitable up to a maximum of 100% as follows:
SERVICE YEARS VESTED PERCENTAGE ------------- ----------------- Less than 5 years 0% 5 years but less than 6 years 10% 6 years but less than 7 years 20% 7 years but less than 8 years 40% 8 years but less than 9 years 60% 9 years but less than 10 years 80% 10 or more years 100%
A Supplemental Benefit shall also be 100% vested upon the death of a Participant. 4.02 FORM OF SUPPLEMENTAL BENEFIT. Any Participant who is entitled to a Supplemental Benefit pursuant to Section 4.01 hereof shall receive such Supplemental Benefit in the form of an annuity, which annuity shall provide a series of level monthly payments for a period determined in accordance with the rules set forth herein below. With respect to any Participant, the amount of the level monthly payment 10 provided by such annuity (the "Monthly Annuity Amount") shall be determined in accordance with Section 4.04 hereof, subject to such modifications as may be applicable under this Section 4.02: (a) Except as provided in subsection (b) below, a Participant shall receive his Supplemental Benefit in the Normal Benefit Form. (b) A Participant who is entitled to receive a Supplemental Benefit may, with the consent of the Committee, elect in writing, on such form designated by the Committee and received by the Committee at least 15 months prior to the Payment Commencement Date (or, to the extent permitted by the Committee in its sole discretion, at such later time following any change in the Specified Rate or mortality table pursuant to Section 3.05), to receive his Supplemental Benefit in the form of either a 100% Joint and Survivor Annuity or a 50% Joint and Survivor Annuity. Notwithstanding such election, such Participant shall be entitled to receive his Supplemental Benefit in the form of a Joint and Survivor Annuity only if such Participant has a spouse as of such Participant's Payment Commencement Date and also has been married continuously for at least one year preceding such Participant's Payment Commencement Date. The amount of the Supplemental Benefit so designated by the Participant shall be the actuarial equivalent of the amount otherwise payable to the Participant in the Normal Benefit Form. If such election is not made or is invalid or void, the Participant's Supplemental Benefit shall be paid in the Normal Benefit Form. 4.03 PAYMENT OF SUPPLEMENTAL BENEFIT. Notwithstanding any other provisions of this Plan, payment of a Participant's Supplemental Benefit (or any portion thereof) shall commence on such Participant's Payment Commencement Date. 4.04 MONTHLY ANNUITY AMOUNT. Except to the extent modified pursuant to Sections 4.01 or 4.02 hereof, a Participant's "Monthly Annuity Amount" shall be the amount of such Participant's Target Monthly Benefit (as defined in Section 4.05 hereof) reduced, but not below zero, by such Participant's Monthly Offset Amount (as defined in Section 4.06 hereof). 4.05 TARGET MONTHLY BENEFIT. A Participant's "Target Monthly Benefit" shall be determined as of his Termination Date and shall be the amount calculated by multiplying (a) the Participant's Average Monthly Compensation determined as of his Termination Date by (b) his Benefit Accrual Percentage 11 determined as of his Termination Date (or later date in the case of Disability) by (c) his vesting percentage as of his Termination Date (or later date in the case of Disability) under Section 4.01. 4.06 MONTHLY OFFSET AMOUNT. A Participant's "Monthly Offset Amount" shall be the amount equal to the sum of such Participant's Social Security Offset Amount, plus such Participant's Qualified Plan Offset Amount, plus such Participant's Nonqualified Plan Offset Amount, plus such Participant's Employment Agreement Offset Amount (all as defined herein below). (a) A Participant's "Social Security Offset Amount" shall be determined in accordance with the following rules: (i) In the case of any Participant whose Termination constitutes Normal Retirement, such Participant's Social Security Offset Amount shall be 50% of the amount of the monthly Primary Social Security Benefit (as calculated by the Committee under paragraph (iii) below) to which such Participant is entitled following such Termination. (ii) In the case of any Participant whose Termination does not constitute Normal Retirement, such Participant's Social Security Offset Amount shall be 50% of the amount of the monthly Primary Social Security Benefit (as calculated by the Committee under paragraph (iii) below) to which such Participant would be entitled commencing on his Normal Benefit Date paid to such Participant in the Normal Benefit Form if, with respect to the period (if any) between such Participant's Termination Date and his Normal Benefit Date, (A) such Participant is assumed to have no earnings subsequent to his or her Termination and (B) the Social Security wage base and other provisions of the Social Security law relevant to the determination of benefits thereunder (including any applicable regulations and/or other pronouncements, such as wage base and other provisions) in effect as of such Participant's Termination Date had remained unchanged. (iii) Each Participant shall submit to the Board, for use in calculating such Participant's Primary Social Security Benefit and the corresponding Social Security Offset Amount under paragraphs (i) or (ii) above, as applicable, either (A) a written earnings history obtained from the Social Security Administration or (B) written evidence satisfactory to the Committee showing that such Participant has never earned wages subject to the jurisdiction of the U.S. Social Security Administration (e.g., a foreign Participant with no U.S. wages). In the event a 12 Participant fails to comply with the requirements of the preceding sentence within 90 days following such Participant's Payment Commencement Date, the Participant's Primary Social Security Benefit (for purposes of calculating his Social Security Offset Amount under paragraphs (i) or (ii) above, as applicable) shall be determined by the Committee using an estimated wage history, applying a salary scale projected backwards from the Participant's Payment Commencement Date to the age of 18, and based on (I) for the two years prior to the Participant's Payment Commencement Date, an increase of six percent (6%) per annum, and (II) for the period prior to such two year period, the actual change in average wages from year to year as determined by the Social Security Administration. Such estimated wage history shall be deemed correct for all purposes of this Plan. (b) A Participant's "Qualified Plan Offset Amount" shall be the sum of the Defined Benefit Plan Offset Amount and the 401(k) Plan Offset Amount determined with respect to such Participant under the following provisions, as applicable: (i) With respect to any Participant who was a Participant in any Defined Benefit Plan, such Participant's "Defined Benefit Plan Offset Amount" shall be the employer-provided portion (i.e., the portion attributable to employer contributions) of the amount of the monthly annuity payment to which such Participant would be entitled under any Defined Benefit Plan if all previous distributions representing the interests of the Participant thereunder and all other amounts the Participant would be entitled to under such Plan were paid in the Normal Benefit Form commencing on his Normal Benefit Date. The "Defined Benefit Plan Offset Amount" shall be zero with respect to any Participant who was not a participant in any Defined Benefit Plan. (ii) With respect to any Participant, such Participant's "401(k) Plan Offset Amount" shall be the amount of the monthly annuity payment to which such Participant would be entitled if the balance (determined as of such Participant's Payment Commencement Date) in such Participant's 401(k) Offset Account (as defined herein below) were paid to such Participant in the Normal Benefit Form commencing on his Normal Benefit Date. For purposes of this paragraph (ii), a Participant's "401(k) Offset Account" shall be a hypothetical account established and maintained with respect to such Participant as follows: A Participant's 401(k) Offset Account shall be established as of December 31, 1995, and such 401(k) 13 Offset Account shall have an initial balance equal to the actual balance (if any) as of December 31, 1995, in the account maintained under the 401(k) Plan for employer contributions made with respect to such Participant (excluding any employer contributions not currently includible in gross income by reason of Code Section 402(e)(3)). Thereafter, (A) commencing with the 1996 calendar year and ending with the calendar year in which such Participant incurs a Termination (the "Termination Year"), the balance in such Participant's 401(k) Offset Account shall be increased as of the end of each such calendar year (or, in the case of the Termination Year, as of such Participant's Termination Date) by the amount of such Participant's Hypothetical Employer Contribution (as defined in paragraph (iii) below) for such calendar year and the actual employer profit sharing contribution made for such calendar year with respect to such Participant under the terms of the 401(k) Plan; and (B) commencing January 1, 1996, and ending on such Participant's Payment Commencement Date, such Participant's 401(k) Offset Account shall also be increased as if the balance in such account (as increased from time to time by the Hypothetical Employer Contributions Described in Clause (A) above) were earning interest, compounded annually, from January 1, 1996 until such Participant's Payment Commencement Date at the Specified Rate applicable from time to time. (iii) As used in paragraph (ii) above, "Hypothetical Employer Contribution" means, with respect to any Participant, (A) for any calendar year prior to such Participant's Termination Year the maximum employer matching contribution that would have been made for such calendar year with respect to such Participant under the terms of the 401(k) Plan (disregarding the limits imposed by reason of Code Section 401(m)) assuming such Participant's before-tax deferral to the 401(k) Plan for such calendar year is equal to his Hypothetical Participant Deferral (as defined in paragraph (iv) below) with respect to such calendar year; and (B) for such Participant's Termination Year, an amount equal to the product obtained by multiplying (I) the Hypothetical Employer Contribution determined with respect to such Participant for the immediately preceding calendar year by (II) a fraction having a numerator equal to the number of days in such Termination Year prior to and including such Participant's Termination Date and having a denominator equal to 365. 14 (iv) For purposes of paragraph (iii) above, the "Hypothetical Participant Deferral" applicable to any Participant for any calendar year shall be the amount determined under the following provisions, whichever is applicable: (A) If, with respect to any calendar year, the 401(k) Plan administrative committee does not take any action, either during or after the close of such year, to reduce the level of Participant deferrals permitted to be made by any 401(k) Plan Participant for such year, then the Hypothetical Participant Deferral with respect to any Participant for such calendar year shall be the lesser of (I) the maximum amount such Participant would be permitted to contribute to the 401(k) Plan for such year under Code Section 402(g) or (II) the maximum amount the Participant would be permitted to contribute under the terms of the 401(k) Plan. (B) If, with respect to any calendar year, the 401(k) Plan administrative committee takes action during and/or after such year to reduce the level of Participant deferrals permitted to be made by any 401(k) Plan Participant for such year, then the Hypothetical Participant Deferral with respect to any Participant for such year shall be the lesser of (I) the maximum amount such Participant would be permitted to contribute to the 401(k) Plan for such year under Code Section 402(g) or (II) the product determined by multiplying such Participant's compensation for such year (as determined under the 401(k) Plan for anti-discrimination testing purposes) by the maximum "actual deferral percentage" for any highly compensated employee for such year (as determined under Code Section 401(k)(3)(B) after giving effect to any corrections made following the close of such year) applicable to "highly-compensated employees" (as defined in Code Section 414(q)). (c) A Participant's "Nonqualified Plan Offset Amount" shall be the sum of the Nonqualified Defined Benefit Plan Offset Amount and the Nonqualified Defined Contribution Plan Offset Amount determined with respect to such Participant under the following provisions as applicable: (i) With respect to any Participant who was a Participant in any Nonqualified Defined Benefit Plan (as defined in Section 2.20), such Participant's "Nonqualified Defined Benefit Plan Offset Amount" shall be the employer-provided portion (i.e., the 15 portion attributable to employer contributions including, but not limited to, any additional payment provided by the employer under such plan to enable the Participant to satisfy his or her tax liability) of the amount of the monthly annuity payment to which such Participant would be entitled under the Nonqualified Defined Benefit Plan if his benefits thereunder were paid in the Normal Benefit Form commencing on his Normal Benefit Date. The "Nonqualified Defined Benefit Plan Offset Amount" shall be zero with respect to any Participant who was not a participant in any Nonqualified Defined Benefit Plan. (ii) With respect to any Participant who was a Participant in any Nonqualified Defined Contribution Plan (as defined in Section 2.21), such Participant's "Nonqualified Defined Contribution Plan Offset Amount" shall be the amount of the monthly annuity payment to which such Participant would be entitled if the balance (determined as of such Participant's Payment Commencement Date) in such Participant's Nonqualified Defined Contribution Plan Offset Account (as defined herein below) were paid to such Participant in the Normal Benefit Form commencing on his Normal Benefit Date. For purposes of this paragraph (ii), a Participant's "Nonqualified Defined Contribution Plan Offset Account" shall be a hypothetical account established and maintained with respect to such Participant as follows: A Participant's Nonqualified Defined Contribution Plan Offset Account shall be established as of December 31, 1995 and shall have an initial balance equal to the actual balance (if any) as of December 31, 1995 in the account maintained under all Nonqualified Defined Contribution Plans for employer (I.E., nonelective) contributions made with respect to such Participant (including, but not limited to, any additional payment provided by the employer under such plan to enable the Participant to satisfy his tax liability). Thereafter (A) commencing with the 1996 calendar year and ending with the calendar year in which such Participant incurs a Termination (the "Termination Year"), the balance in such Participant's Nonqualified Defined Contribution Plan Offset Account shall be increased as of the end of each such calendar year (or, in the case of the Termination Year, as of such Participant's Termination Date) by the actual employer contributions made for such calendar year with respect to such Participant under the terms of the applicable Nonqualified Defined Contribution Plan; and (B) commencing January 1, 1996, and ending on such Participant's Payment Commencement Date, such Participant's 16 Nonqualified Defined Contribution Plan Offset Account shall also be increased as if the balance in such account (as increased from time to time by clause (A) above) were earning interest, compounded annually, from January 1, 1996 until such Participant's Payment Commencement Date at the Specified Rate applicable from time to time. (d) A Participant's "Employment Agreement Offset Amount" shall mean the employer-provided portion (I.E., the portion attributable to employer contributions) of the monthly annuity payment to which such Participant would be entitled from retirement benefits including, but not limited to, life insurance arrangements and any other amounts paid after Termination and not otherwise described in paragraphs (a) through (c) above pursuant to the Participant's individual employment agreement with the Sponsor or an Affiliated Company if the benefits thereunder were paid in the Normal Benefit Form commencing on his Normal Benefit Date. The Committee shall, in its sole and absolute discretion, determine whether any amounts payable under an employment agreement are intended to constitute retirement benefits and an offset under the Plan. The "Employment Agreement Offset Amount" shall be zero with respect to any Participant who, pursuant to his individual employment agreement, is not entitled to post-employment retirement benefits in addition to those specified in paragraphs (a) through (c) above. 4.07 SPECIAL RULES FOR EARLY RETIREMENT. In the case of any Participant whose Supplemental Benefit commences prior to his Normal Benefit Date, such Participant's Monthly Annuity Amount shall be determined as provided in Section 4.04 hereof, and then shall be reduced to reflect the commencement of benefits on a date earlier than the Normal Benefit Date by 0.5% for each full month by which such commencement date precedes the first day of the month next following the attainment of age 62. 4.08 TERMINATION OF PLAN PARTICIPATION. In the event that the Committee determines that a Participant's employment performance is no longer at a level which merits continued participation in the Plan, the Committee may terminate such Participant's participation in the Plan (without necessarily terminating such Participant's employment) as of the date specified by the Committee (the "Participation Severance Date"). Accordingly, notwithstanding any other provision of this Plan, the Supplemental Benefit payable to any Participant whose Plan participation is terminated pursuant to this Section 4.08 shall be calculated by taking into account, in determining the amount of such Participant's Target Monthly Benefit and whether such Participant has met the vesting requirement of Section 4.01 hereof, only the 17 Service Years and Compensation earned by such Participant as of his Participation Severance Date. Such Supplemental Benefit shall be paid to the Participant pursuant to the provisions of Section 4.03 herein. 4.09 DISABILITY. In the event that a Participant incurs a Termination as a result of such Participant's becoming Disabled, the Supplemental Benefit payable to such Participant under this Plan shall be determined with regard to the vesting requirement of Section 4.01 hereof assuming Service Years continue to accrue until the earliest of (a) age 62, (b) return to Full-Time Employment or (c) the death of the Participant. For purposes of this Plan, a Participant shall be deemed to be "Disabled" if and when, as a result of injury or sickness, such Participant is permanently impaired to such an extent that he cannot perform, and is not reasonably expected ever to be able to perform, each of the material duties of his position of employment with the Sponsor or any Affiliated Company. For the purpose of determining whether a Participant is Disabled, the Committee may require the Participant to submit to an examination by a competent physician or medical clinic selected by the Committee. 4.10 CHANGE IN CONTROL. Notwithstanding any other provision of this Plan, upon a Change in Control, all Participants in the Plan shall be fully vested in their Supplemental Benefits. All Participants shall be entitled to the Supplemental Benefit, reflecting actual Service Years, they would otherwise receive pursuant to this Article IV hereof. Upon and following a Change in Control, no Participant shall be removed from the Plan, nor shall his benefit be terminated, modified, reduced or eliminated without his express written consent. 4.11 TERMINATION FOR CAUSE. Notwithstanding any other provision of this Plan except Section 4.10, a Participant who incurs a Termination for Cause prior to a Change in Control shall not be entitled to a Supplemental Benefit, regardless of Service Years, under this Plan. ARTICLE V DEATH OF A PARTICIPANT 5.01 TERMINATION BY REASON OF DEATH. In the event that a Participant incurs a Termination by reason of his death, (a) such Participant shall not be entitled to receive a Supplemental Benefit under this Plan and (b) if such Participant has a Spouse at the time of his death, such Participant's Spouse (the "Surviving Spouse") shall be entitled to receive a special benefit (a "Death Benefit") at the times and in the 18 amounts set forth in this Article V. No Death Benefit shall be paid in respect of any Participant who does not have a Spouse at the time of his death. 5.02 FORM AND PAYMENT OF DEATH BENEFIT. A Surviving Spouse who is entitled to receive a Death Benefit pursuant to Section 5.01 hereof shall receive such Death Benefit in the form of a Single Life Annuity which provides a level monthly payment equal to the Monthly Death Benefit Amount specified in Section 5.03 hereof. Except as otherwise provided herein below, payment of a Surviving Spouse's Death Benefit shall commence on the ninetieth (90th) day (the "Death Benefit Commencement Date") after the Participant's death. 5.03 MONTHLY DEATH BENEFIT AMOUNT. The "Monthly Death Benefit Amount" applicable to any Surviving Spouse shall be an amount equal to the Monthly Annuity Amount of the Supplemental Benefit that would have been payable to the deceased Participant under Article IV hereof if such Participant had incurred a Retirement on the day prior to his death, provided, however, that the determination of such Monthly Annuity Amount shall take into account the following assumptions and special rules: (a) Such Monthly Annuity Amount shall be determined assuming the Participant would have received his Supplemental Benefit in the Normal Benefit Form, modified, if applicable, by the provisions of Section 4.07 hereof. (b) Such Monthly Annuity Amount shall be determined as if the Participant was 100% vested in the Supplemental Benefit. (c) The Payment Commencement Date used in determining such Monthly Annuity Amount shall be deemed to be the Surviving Spouse's Death Benefit Commencement Date (disregarding any provision in Article IV to the contrary), and if the deceased Participant's death occurred prior to his Normal Benefit Date, the provisions of Section 4.07 hereof shall be applied in determining the deceased Participant's Monthly Annuity Amount after first determining the amount of the Defined Benefit Plan Offset Amount pursuant to subsection (b) above. 19 ARTICLE VI MISCELLANEOUS PROVISIONS 6.01 PAYMENTS DURING INCAPACITY. In the event a Participant (or Surviving Spouse) is under mental or physical incapacity at the time of any payment to be made to such Participant (or Surviving Spouse) pursuant to this Plan, any such payment may be made to the conservator or other legally appointed personal representative having authority over and responsibility for the person or estate of such Participant (or Surviving Spouse), as the case may be, and for purposes of such payment references in this Plan to the Participant (or Surviving Spouse) shall mean and refer to such conservator or other personal representative, whichever is applicable. In the absence of any lawfully appointed conservator or other personal representative of the person or estate of the Participant (or Surviving Spouse) any such payment may be made to any person or institution that has apparent responsibility for the person and/or estate of the Participant (or Surviving Spouse) as determined by the Committee. Any payment made in accordance with the provisions of Section 6.01 to a person or institution other than the Participant (or Surviving Spouse) shall be deemed for all purposes of this Plan as the equivalent of a payment to such Participant (or Surviving Spouse), and the Sponsor shall have no further obligation or responsibility with respect to such payment. 6.02 PROHIBITION AGAINST ASSIGNMENT. Except as otherwise expressly provided in Section 6.01 hereof, the rights, interests and benefits of a Participant under this Plan (a) may not be sold, assigned, transferred, pledged, hypothecated, gifted, bequeathed or otherwise disposed of to any other party by such Participant or any Surviving Spouse, executor, administrator, heir, distributee or other person claiming under such Participant and (b) shall not be subject to execution, attachment or similar process. Any attempted sale, assignment, transfer, pledge, hypothecation, gift, bequest or other disposition of such rights, interests or benefits contrary to the foregoing provisions of this Section 6.02 shall be null and void and without effect. 6.03 BINDING EFFECT. The provisions of this Plan shall be binding upon the Sponsor, the Participants, all Affiliated Companies employing any Participants, and any successor-in-interest to the Sponsor. 20 6.04 NO TRANSFER OF INTEREST. Benefits under this Plan shall be payable solely from the general assets of the Sponsor (and, with respect to any Participant who is an employee of an Affiliated Company, also from the general assets of such Affiliated Company), and no person shall be entitled to look to any other source for payment of such benefits. The Sponsor (and, if applicable, any Affiliated Company) shall have and possess all title to, and beneficial interest in, any and all funds or reserves maintained or held by the Sponsor (or such Affiliated Company) on account of any obligation to pay benefits as required under this Plan, whether or not earmarked as a fund or reserve for such purpose; any such funds, other property or reserves shall be subject to the claims of the creditors of the Sponsor (or such Affiliated Company), and the provisions of this Plan are not intended to create, and shall not be interpreted as vesting, in any Participant, Surviving Spouse or other person, any right to or beneficial interest in any such funds, other property or reserves. Nothing in this Section 6.04 shall be construed or interpreted as prohibiting or restricting the establishment of a grantor trust within the meaning of Code Section 671 which is unfunded for purposes of Sections 201(2), 301(a)(3) and 401(a)(l) of ERISA, from which benefits under this Plan may be payable. 6.05 AMENDMENT OR TERMINATION OF THE PLAN. The Board of Directors may amend this Plan from time to time in any respect that it deems appropriate or desirable, and the Board may terminate this Plan at any time; provided, however, that any such amendment or termination may not, without the written consent of a Participant, eliminate or reduce the Supplemental Benefit that has accrued with respect to such Participant as of the effective date of such amendment or termination. For purposes of this Section 6.05, the Supplemental Benefit that has accrued with respect to any Participant as of the date of any amendment of termination of the Plan shall be deemed to be the Supplemental Benefit to which such Participant would be entitled pursuant to Article IV hereof if such Participant incurred Retirement immediately prior to such Plan amendment or Plan termination. 6.06 NO RIGHT TO EMPLOYMENT. This Plan is voluntary on the part of the Sponsor and its Affiliated Companies, and the Plan shall not be deemed to constitute an employment contract between any Participant and the Sponsor or any Affiliated Company, nor shall the adoption or existence of the Plan or any provision contained in the Plan be deemed to be a required condition of the employment of any Participant. Nothing contained in this Plan shall be deemed to give any Participant the right to continued employment with the Sponsor or any Affiliated Company, and the Sponsor and its Affiliated Companies may terminate any Participant at any time, in which case the Participant's rights arising under this Plan shall be only those expressly provided under the terms of this Plan. 21 6.07 NOTICES. All notices, requests or other communications (hereinafter collectively referred to as "Notices") required or permitted to be given hereunder or which are given with respect to this Plan shall be in writing and may be personally delivered, or may be deposited in the United States mail, postage prepaid and addressed as follows: To the Sponsor, any Affiliated Foundation Health Systems, Inc. Company or the Committee at: Attention: Senior Vice President, General Counsel and Secretary 21600 Oxnard Street Woodland Hills, California 91367 To a Participant at: The Participant's residential mailing address as reflected in the Sponsor's or Affiliated Company's employment records. A Notice which is delivered personally shall be deemed given as of the date of personal delivery, and a Notice mailed as provided herein shall be deemed given on the second business day following the date so mailed. Any Participant may change his address for purposes of Notices hereunder pursuant to a Notice to the Committee, given as provided herein, advising the Committee of such change. The Sponsor, any Affiliated Company and/or the Committee may at any time change its address for purposes of Notices hereunder. 6.08 GOVERNING LAW. This Plan shall be governed by, interpreted under and construed and enforced in accordance with the internal laws, and not the laws pertaining to conflicts or choice of laws, of the State of Delaware applicable to agreements made and to be performed wholly within the State of Delaware, except to the extent governed by the laws of the United States. 6.09 TITLES AND HEADINGS; GENDER OF TERMS. Article and Section headings herein are for reference purposes only and shall not be deemed to be part of the substance of this Plan or in any way to enlarge or limit the meaning or interpretation of any provision in this Plan. Use in this Plan of the masculine, feminine or neuter gender shall be deemed to include each of the omitted genders wherever the context so requires. 22 6.10 SEVERABILITY. In the event that any provision of this Plan is found to be invalid or otherwise unenforceable by a court or other tribunal of competent jurisdiction, such invalidity or unenforceability shall not be construed as rendering any other provision contained herein invalid or unenforceable, and all such other provisions shall be given full force and effect to the same extent as though the invalid and unenforceable provision was not contained herein. 6.11 TAX EFFECT OF PLAN. Neither the Sponsor nor any Affiliated Company warrants any tax benefit nor any financial benefit under this Plan. Without limiting the foregoing, the Sponsor and each Affiliated Company and their directors, officers, employees and agents shall be held harmless by the Participant from, and shall not be subject to any liability on account of, any Federal or State tax consequences or any consequences under ERISA of any determination as to the amount of Plan benefits to be paid, the method by which Plan benefits are paid, the persons to whom Plan benefits are paid, or the commencement or termination of the payment of Plan benefits. 23 FOUNDATION HEALTH SYSTEMS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN ELECTION OF FORM OF SUPPLEMENTAL BENEFIT The Executive hereby designates the Form of Supplemental Benefit under the Foundation Health Systems, Inc. Supplemental Executive Retirement Plan from the choices below as the desired form of payment of the Supplemental Benefit thereunder: [ ] Single Life Annuity [ ] 100% Joint and Survivor Annuity (only if Executive is married) [ ] 50% Joint and Survivor Annuity (only if Executive is married) If no election is made or the election is invalid or void, the Supplemental Benefit shall be paid in the form of a Single Life Annuity. IN WITNESS WHEREOF, the Executive has executed this election form as of the date set forth below. Dated: _______________________________ EX-10.66 18 EXHIBIT 10.66 Exhibit 10.66 FOUNDATION HEALTH SYSTEMS, INC. DEFERRED COMPENSATION PLAN I. INTRODUCTION The purposes of the Foundation Health Systems, Inc. Deferred Compensation Plan (the "Plan") are (i) to permit certain key employees of Foundation Health Systems, Inc., a Delaware corporation (the "Company"), and certain of its subsidiaries to defer receipt of the compensation payable to such employees and (ii) to permit directors of the Company to defer the receipt of certain meeting fees and other cash remuneration payable by the Company, until such times as set forth herein. II. DEFINITIONS For purposes of the Plan, the following capitalized terms shall have the meanings set forth in this Article. 2.1 "Account" shall mean all of the accounts kept on the books and records of the Company established on behalf of a Participant in the Plan to which amounts deferred by such Participant and earnings and losses thereon (as described in Section 3.3(b)) are credited. 2.2 "Beneficiary" shall mean the beneficiary or beneficiaries (including any contingent beneficiary) designated pursuant to Section 4.5. 2.3 "Board" shall mean the Board of Directors of the Company. 2.4 "Code" shall mean the Internal Revenue Code of 1986, as amended. 2.5 "Committee" shall mean the Compensation and Stock Option Committee of the Board. 2.6 "Common Stock" shall mean the Class A Common Stock, $.001 par value, of the Company. 2.7 "Company" shall mean Foundation Health Systems, Inc., a Delaware corporation, or any successor thereto. 2.8 "Compensation" shall mean, with respect to an Eligible Employee, the total earnings paid by an Employer to such Eligible Employee and properly reportable on Form W-2 for a Deferral Year (including bonuses and overtime), and all amounts not includible -1- in such Eligible Employee's gross income for federal income tax purposes solely on account of his or her election to have compensation reduced pursuant to the Plan, a qualified cash or deferred arrangement described in Section 401(k) of the Code or a cafeteria plan as defined in Section 125 of the Code, but excluding any reimbursements or other allowances for automobile, relocation, travel or education expenses (even if includible in the Eligible Employee's gross income for federal income tax purposes). "Compensation" shall mean, with respect to a Director, the fees and other cash remuneration payable to such Director during a Deferral Year. 2.9 "Deferral Year" shall mean the twelve-month period beginning each January 1, except that the first Deferral Year shall be the eight month period beginning on May 1, 1998. 2.10 "Director" shall mean a member of the Board. 2.11 "Disability" shall mean, with respect to an Eligible Employee, a disability within the meaning of the long-term disability plan maintained by the Employer of such Eligible Employee, on account of which such Eligible Employee is eligible for and receiving long-term disability benefits and, with respect to a Director, a disability within the meaning of the long-term disability plan maintained by the Company for its employees. 2.12 "Eligible Employee" shall mean an employee of an Employer whose annual base salary for a Deferral Year is scheduled to be at least $100,000 as of the first day of such Deferral Year (or such other amount determined by the Committee from time to time). An employee whose base salary is increased to $100,000 during a Deferral Year shall be an Eligible Employee as of the first day of the following Deferral Year. 2.13 "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. 2.14 "Effective Date" shall mean May 1, 1998. 2.15 "Employer" shall mean the Company or a Subsidiary, other than a Subsidiary that the Committee excludes from participation in the Plan. 2.16 "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. 2.17 "Investment Fund" shall mean an "open-end," "closed-end" or other collective investment fund selected by the Company from time to time as a measure for allocating deemed investment gains and losses to Participants' Accounts. 2.18 "Merger" shall mean any merger of the Company in which the holders of the Class A common stock, $.001 par value, of the Company immediately prior to the merger have the same proportionate ownership of common stock of the surviving or resulting parent corporation immediately after the merger. 2.19 "Participant" shall mean an Eligible Employee or Director who has elected to defer Compensation pursuant to the terms of the Plan. 2.20 "Regular Compensation" shall mean an Eligible Employee's Compensation for a Deferral Year, excluding any bonuses payable to such Eligible Employee during, or with respect to, such Deferral Year. 2.21 "Subsidiary" shall mean any corporation other than the Company in an unbroken chain of corporations beginning with the Company if, at the time of reference, each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. III. PARTICIPATION AND DEFERRALS 3.1 PARTICIPATION. (a) IN GENERAL. Each Eligible Employee and Director may participate in the Plan in a Deferral Year by specifying on an election form filed with the Company prior to the beginning of such Deferral Year the percentage(s) of the Compensation otherwise payable to him or her by an Employer during the Deferral Year to be deducted from such Compensation and deferred for payment at a later date pursuant to the Plan. The Company shall establish rules prescribing the time and manner in which election forms shall be filed with the Company. (b) INITIAL PARTICIPATION. An individual may participate in the Plan during the Deferral Year in which he or she becomes an Eligible Employee or Director by filing an election form with the Company within 30 days of becoming an Eligible Employee or a Director, as the case may be. 3.2 DEFERRAL ELECTIONS. An Eligible Employee may elect on the election form in the time and manner designated by the Company to defer the receipt of (i) between 5% and 50% of the Eligible Employee's Regular Compensation for a Deferral Year (or such greater percentage specified for such Eligible Employee on Exhibit A hereto, or determined from time to time by the Committee), (ii) between 5% and 100% of any bonus payable to such Eligible Employee during, or with respect to, the Deferral Year or (iii) both Regular Compensation and bonuses as described and subject to the limitations set forth in clauses (i) and (ii). A Director may elect on the election form designated by the Company to defer the receipt of any or all of the Compensation payable to such Director during the Deferral Year. Except as provided in Section 3.1, an election form must be filed prior to the Deferral Year for which the election is to be effective in accordance with rules prescribed by the Company. A Participant may not revoke or change an election to defer Compensation for a Deferral Year after the beginning of such year. In order to participate in the Plan for any subsequent Deferral Year, an Eligible Employee or Director must file a new election form with the Company prior to the Deferral Year for which the election is to be effective. In no event shall an election under the Plan apply to Compensation earned prior to the date on which the election to participate in the Plan for a Deferral Year is received by the Company. 3.3 DEFERRED COMPENSATION ACCOUNT. (a) CREDITING DEFERRED COMPENSATION. Any Compensation deferred by a Participant shall be credited to the Participant's Account as of the date on which, absent such election, such Compensation would have been payable to the Participant. (b) EARNINGS. Each Participant's Account shall be credited with deemed earnings, or reduced by deemed losses, equal to the earnings or losses that would have been realized or paid if assets in an amount equal to the balance of such Account were actually invested among the Investment Funds selected by the Participant in accordance with paragraphs (c) and (d) of this Section. Although the Company or an Employer might actually invest assets of the Company or such Employer according to the Participant's election, it is not required to do so nor to even set aside any assets to provide for payments hereunder. The Company may promulgate separate accounting and administrative rules to facilitate the deemed investment in an Investment Fund. (c) DEEMED INVESTMENT ELECTION. Upon the commencement of participation in the Plan, each Participant shall specify on his or her election form the whole percentage of the Participant's Account balance to be deemed invested in any one or more of the Investment Funds. (d) CHANGE OF DEEMED INVESTMENT ELECTION. A Participant may elect to change his or her deemed investment election as frequently as may be designated by the Company, and in any event at least quarterly. Any such change shall specify the whole percentages (or amounts if so permitted by the Company) to be deemed invested in one or more of the then available Investment Funds. A Participant may change his or her election (i) with respect to the balance of his or her Account as of the effective date of the Participant's new investment election, (ii) with respect to future amounts credited to the Participant's Account under Section 3.3(a) and (b) or (iii) both. A Participant's change of a deemed investment election must be made in accordance with the written rules and conditions provided by the Company to the Participants. (e) NOTICES. Each Participant shall receive written notice of his or her Account balance as soon as practicable following the last day of each calendar quarter. IV. PAYMENTS OF DEFERRED COMPENSATION 4.1 TIMING. (a) INITIAL ELECTION. Except as otherwise provided herein, the balance of a Participant's Account shall be paid or shall commence to be paid within 90 days after the last day of the calendar year (the "payment date") elected by the Participant on a form filed with the Company upon the commencement of his or her participation in the Plan. The payment date elected by the Participant may be (i) the last day of the year in which the Participant's employment with an Employer or service as a Director terminates (the "termination year") or (ii) the last day of any calendar year elected by the Participant, whether earlier or later than his or her termination year, provided that such payment date is no earlier than three years after the date the Participant files his or her payment election form. If a Participant continues to participate in the Plan following a payment date, then any of the Participant's Compensation deferrals occurring after the payment date shall be credited to a separate Account. The Participant must have on file with the Company an election form described in Section 3.2 which specifies a deferral amount, payment date, and deemed investment election for all amounts credited to such separate Account. (b) SUBSEQUENT ELECTION. A Participant may elect to change a previously elected payment date to a later date by filing a new election form with the Company at least one year prior to such previously elected payment date. The new payment date must be at least three years later than the previously elected payment date. (c) PRE-RETIREMENT TERMINATION OF EMPLOYMENT. Notwithstanding any payment date elected by a Participant, if the employment of such Participant with an Employer terminates for any reason prior to the date such Participant attains age 55, then the balance of such Participant's Account shall be paid to such Participant within 90 days after the last day of the year in which such termination of employment occurs. (d) DEATH. Notwithstanding any payment date elected by a Participant, if the employment of such Participant with an Employer or the service of such Participant as a Director terminates by reason of death, then the balance of such Participant's Account shall be paid to the Beneficiary of such Participant within 90 days after the last day of the year in which the Participant's death occurs. (e) DELAYED PAYMENT DATE. Notwithstanding any payment date elected by a Participant, the Committee may, in its sole discretion, defer the payment of all or any portion of a Participant's Account to the extent the Committee determines that the payment of such amount at the time elected by the Participant would cause the Participant's Employer to be unable to deduct any portion of the Participant's Compensation as a result of the limitations prescribed by Section 162(m) of the Code. 4.2 MANNER OF PAYMENT. Each Participant shall receive payment of the amount credited to the Participant's Account either in a single lump sum or in annual installments at least equal to $1,000 over a period of not less than two and not more than ten years, as elected by the Participant upon his or her commencement of participation in the Plan. Notwithstanding the foregoing, a Participant's Account shall be paid to such Participant or his or her Beneficiary in the form of a single lump sum if (i) the amount credited to such Account as of the payment date is less than $50,000, (ii) the Participant has not attained age 55 as of his or her payment date or (iii) the Participant's employment with an Employer or service as a Director terminates by reason of death. 4.3 EMERGENCY PAYMENTS. In the event of an Unforeseeable Financial Emergency, as hereinafter defined, the Participant may file a written request with the Company to receive all or any portion of the balance of such Participant's Account in an immediate lump sum payment. A Participant's written request for such a payment shall describe the circumstances which the Participant believes justify the payment and an estimate of the amount necessary to eliminate the Unforeseeable Financial Emergency. An "Unforeseeable Financial Emergency" shall mean unforeseeable severe financial hardship resulting from (i) the Participant's Disability, (ii) a sudden and unexpected illness or accident of the Participant or a dependent of the Participant, (iii) loss of the Participant's property due to casualty or (iv) such other extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant, all as determined in the sole discretion of the Company. Unforeseeable Financial Emergency payments shall be made only to the extent necessary to satisfy the emergency need and shall not be made to the extent the need is or may be relieved through reimbursement or compensation, by insurance or otherwise, by cessation of deferrals under the Plan or by liquidation of the Participant's assets (to the extent such liquidation itself would not cause severe financial hardship). Any Unforeseeable Financial Emergency payment from a Participant's Account shall be deemed to cancel any deferral election of the Participant then in effect and, unless otherwise determined by the Company, the Participant shall be suspended from making further deferral elections under the Plan during the remainder of the Deferral Year in which such payment is made and the Deferral Year immediately thereafter. 4.4 DISTRIBUTIONS TO MINOR AND INCOMPETENT PERSONS. If a payment is to be made to a minor or to an individual who, in the opinion of the Company, is unable to manage his or her financial affairs by reason of illness or mental incompetency, such distribution may be made to or for the benefit of any such individual in such of the following ways as the Company shall direct: (a) directly to any such minor individual if, in the opinion of the Company, he or she is able to manage his or her financial affairs, (b) to the legal representative of any such individual, (c) to a custodian under a Uniform Gifts to Minors Act for any such minor individual, or (d) to some near relative of any such individual to be used for the latter's benefit. Neither the Company nor any Employer shall be required to see to the application by any third party of any payment made to or for the benefit of a Participant or Beneficiary pursuant to this Section. 4.5 BENEFICIARIES. A Participant shall have the right to designate a Beneficiary, and amend or revoke such designation at any time, in writing. Such designation, amendment or revocation shall be effective upon receipt of the Participant's written designation by the Company. If a Participant is married at the time a beneficiary designation is submitted to the Company, the designation of a Beneficiary other than the Participant's spouse shall not be effective unless the Participant's spouse consents to such designation in writing, or it is established to the satisfaction of the Company that such consent could not be obtained because the Participant's spouse cannot be located or such other circumstances as may be considered by the Company. Subject to the preceding sentence, a Participant may from time to time, without the consent of any Beneficiary, change or cancel any such designation. Such designation and each change therein shall be made in the form prescribed by the Company and shall be filed with the Company. If no Beneficiary survives the Participant, the Company shall direct that payment of any balance to the Participant's Account be made in the following order of priority: (a) to the beneficiaries designated in the Participant's last will, if specific reference is made therein to the payment of such Account; or if none, (b) to the Participant's spouse; or if none, (c) to the Participant's descendants, per stirpes; or if none, (d) to the Participant's estate. V. ADMINISTRATION 5.1 COMMITTEE ADMINISTRATION. The Plan shall be administered by the Committee, which shall have full power and authority to interpret, construe and administer the Plan in accordance with the provisions herein set forth, except to the extent the Plan specifically provides that the Company shall carry out certain administrative duties. The Committee's interpretation and construction hereof, and actions hereunder, or the amount or recipient of the payments to be made herefrom, shall be binding and conclusive on all persons for all purposes. In this connection, the Committee and the Company may delegate to any Employer, committee, individual (whether or not an employee of an Employer) or entity any of their respective powers or duties hereunder. 5.2 INDEMNIFICATION. No officer or employee of the Company or any Employer shall be liable to any person for any action taken or omitted in connection with the interpretation and administration of the Plan unless attributable to his or her own willful misconduct or lack of good faith, and the Company shall indemnify and hold harmless such officers and employees from and against all claims, losses, damages, causes of action and expenses, including reasonable attorney fees and court costs, incurred in connection with such interpretation and administration of the Plan. The expenses of administering the Plan shall be paid by the Employers and shall not be charged against any Participant's Account. 5.3 CLAIMS PROCEDURE. In accordance with the regulations of the U.S. Secretary of Labor, the Company shall (i) provide adequate notice in writing to any Participant or Beneficiary whose claim for benefits under the Plan has been denied, setting forth the specific reasons for such denial and written in a manner calculated to be understood by such Participant or Beneficiary and (ii) afford a reasonable opportunity to any Participant or Beneficiary whose claim for benefits has been denied for a full and fair review by the Committee of the decision denying the claim. VI. MISCELLANEOUS 6.1 UNFUNDED STATUS AND APPLICATION OF ERISA. The Plan is intended to be an unfunded plan maintained primarily for the purpose of providing deferred compensation to a select group of management or highly compensated employees within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA and Department of Labor Regulation Section 2520.104-23. In order to meet the deferred obligations hereunder, the Company and the Employers may, but shall not be required to, establish a grantor trust and transfer thereto an amount necessary to provide payments equal to the aggregate balances of the Participants' Accounts. In the event that the Company or an Employer transfers any amounts to a grantor trust to provide payments hereunder, such amounts, and all income attributable to such amounts, shall be subject to the claims of the Company's or the Employer's general creditors. The Company's and each Employer's obligations hereunder shall constitute general, unsecured obligations, payable solely out of its general assets, and no Participant or Beneficiary shall have any right to any specific assets. The Plan constitutes a mere promise by the Company and each Employer to make benefit payments in the future. 6.2 LIMITATION ON RIGHTS. Neither the establishment of the Plan nor the payment of any Account hereunder shall be construed as giving or granting any person any legal or equitable rights against the Company, any Employer, the Board, the Committee, or any of their officers, trustees, associates, or agents, other than such as are specifically conferred by the express terms of the Plan. 6.3 SATISFACTION OF CLAIMS. The payment to a Participant, Beneficiary or other person of an Account balance hereunder pursuant to the terms of the Plan shall be in full satisfaction of all claims with respect to such Account that such person may have against the Company or any Employer. Prior to a Change in Control, the Committee may require any Participant, Beneficiary or other person, as a condition to payment, to execute a waiver and release in such form as shall be designated by the Committee. 6.4 NONASSIGNABILITY. No compensation deferred under the Plan or any amount credited to an Account shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment or garnishment, and any attempt to transfer or encumber the same shall be void, other than pursuant to a qualified domestic relations order as defined in Title I of ERISA. 6.5 AMENDMENT OF THE PLAN. The Committee may, in its sole discretion and without the consent of any Participant or Beneficiary, amend the Plan at any time and in any manner by duly adopted resolutions, including, without limitation, the acceleration of the payment of any Accounts hereunder; PROVIDED, HOWEVER, that no amendment shall reduce the amount credited to the Account of any Participant immediately prior to such amendment. 6.6 WITHDRAWAL BY AN EMPLOYER; TERMINATION OF THE PLAN. Each Employer may, in its sole discretion without the consent of any Participant or Beneficiary, terminate its participation in the Plan at any time by giving written notice thereof to the Committee and each Participant employed by such Employer. Notwithstanding any Participant's deferral election submitted to the Company pursuant to Sections 3.1 or 3.2, the amount credited to each Account shall be paid to the person entitled thereto at such time and in such manner as the Committee shall determine, but not later than payments would have been made had such Employer's participation in the Plan not been terminated. The Company may, in its sole discretion, terminate the Plan without the consent of, or notification to, any person. Upon the termination of the Plan, all Account balances shall be paid to Participants and Beneficiaries. 6.7 CHANGE IN CONTROL. If, following a Change in Control, as hereinafter defined, a Participant determines in good faith that the Company or an Employer has failed to comply with any of its obligations under the Plan or, if the Company or any other person takes any action to declare the Plan void or unenforceable or institutes any litigation or other legal action designed to deny or diminish or to recover from any Participant the benefits intended to be provided hereunder, then the Company irrevocably authorizes such Participant to retain counsel of his or her choice at the expense of the Company to represent such Participant in connection with the initiation or defense of any litigation or other legal action, whether by or against the Company or an Employer, or any director, officer, stockholder or other person affiliated with the Company or such Employer, or any successor thereto in any jurisdiction. For purposes of this Section, a "Change in Control" shall mean: (i) APPROVED TRANSACTION. An action of the Board (or, if approval of the Board is not required as a matter of law, the stockholders of the Company) approving (a) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of Common Stock would be converted into cash, securities or other property, other than a Merger, or (b) any sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company, or (c) the adoption of any plan or proposal for the liquidation or dissolution of the Company; (ii) CONTROL PURCHASE. The purchase by any person (as such term is defined in Sections 13(d)(3) and 14(d)(2) of the Exchange Act), corporation or other entity (other than the Company or any employee benefit plan sponsored by an Employer) of any Common Stock of the Company (or securities convertible into the Company's Common Stock) for cash, securities or any other consideration pursuant to a tender offer or exchange offer, without the prior consent of the Board and, after such purchase, such person shall be the "beneficial owner" (as such term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the then outstanding securities of the Company ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors (calculated as provided in Section (d) of such Rule 13d-3 in the case of rights to acquire the Company's securities); (iii) BOARD CHANGE. A change in the composition of the Board during any period of two consecutive years, such that individuals who at the beginning of such period constitute the entire Board shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Company's stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period; or (iv) OTHER TRANSACTIONS. The occurrence of such other transactions involving a significant issuance of voting stock or change in Board composition that the Board determines to be a Change in Control for purposes of the Plan. 6.8 NO CONTRACTUAL RIGHTS TO SERVE. Nothing in the Plan shall be interpreted as conferring any right on any employee to remain employed by an Employer for any stated period of time or otherwise change the employee's employment relationship with his or her Employer from an employment at will relationship or any right on any Director to continue as a Director. 6.9 SEVERABILITY. If a provision of the Plan shall be held illegal or invalid, the illegality or invalidity shall not affect the remaining parts of the Plan and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included in the Plan. 6.10 TAX WITHHOLDING, ETC. Any payment required under the Plan shall be subject to all requirements of the law with regard to income and employment withholding taxes, filings, and making of reports, and each Employer and Participant shall use its or his or her best efforts to satisfy promptly all such requirements, as applicable. 6.11 APPLICABLE LAW. The Plan and all rights hereunder and all determinations made and actions taken pursuant thereto, to the extent not otherwise governed by the Code or the laws of the United States, shall be governed by the laws of the State of Delaware and construed in accordance therewith without giving effect to the principles of conflicts of laws. EX-13.1 19 EXHIBIT 13.1
FINANCIAL HIGHLIGHTS Foundation Health Systems, Inc. Year Ended December 31, (Amounts in thousands, except per share data) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------ STATEMENT OF OPERATIONS DATA: REVENUES Health plan premiums $7,440,981 $5,829,444 $5,395,125 $4,557,214 $3,863,965 Government contracts 989,409 949,168 908,730 279,380 209,980 Specialty services 366,645 342,107 316,993 210,533 139,853 Investment and other income 99,041 114,300 88,392 66,510 51,698 - ------------------------------------------------------------------------------------------------------------------------ Total revenues 8,896,076 7,235,019 6,709,240 5,113,637 4,265,496 - ------------------------------------------------------------------------------------------------------------------------ EXPENSES Health plan services 6,547,747 4,912,532 4,598,074 3,643,463 3,091,890 Government contracts health care services 757,047 711,757 706,076 174,040 147,629 Specialty services 307,675 290,319 289,744 182,380 121,299 Selling, general and administrative 1,042,556 851,826 859,996 657,275 536,209 Amortization and depreciation 128,093 98,353 112,916 89,356 66,741 Interest 92,159 63,555 45,372 33,463 23,081 Asset impairment, merger, restructuring and other charges 274,953 395,925 44,108 20,164 125,379 - ------------------------------------------------------------------------------------------------------------------------ Total expenses 9,150,230 7,324,267 6,656,286 4,800,141 4,112,228 - ------------------------------------------------------------------------------------------------------------------------ Income (loss) from continuing operations before income tax (254,154) (89,248) 52,954 313,496 153,268 Income tax provision (benefit) (88,996) (21,418) 14,124 124,345 70,169 Income (loss) from continuing operations (165,158) (67,830) 38,830 189,151 83,099 Discontinued operations: Income (loss) from operations, net of tax - (30,409) 25,084 3,028 18,434 Gain (loss) on disposition, net of tax - (88,845) 20,317 - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (165,158) $ (187,084) $ 84,231 $ 192,179 $ 101,533 - ------------------------------------------------------------------------------------------------------------------------ BASIC EARNINGS (LOSS) PER SHARE: Continuing operations $ (1.35) $ (0.55) $ 0.31 $ 1.54 $ 0.73 Income (loss) from discontinued operations, net of tax (0.25) 0.20 0.02 0.16 Gain (loss) on disposition of discontinued operations, net of tax (0.72) 0.16 - ------------------------------------------------------------------------------------------------------------------------ Net $ (1.35) $ (1.52) $ 0.67 $ 1.56 $ 0.89 - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ DILUTED EARNINGS (LOSS) PER SHARE: Continuing operations $ (1.35) $ (0.55) $ 0.31 $ 1.53 $ 0.72 Income (loss) from discontinued operations, net of tax (0.25) 0.20 0.02 0.16 Gain (loss) on disposition of discontinued operations, net of tax (0.72) 0.16 - ------------------------------------------------------------------------------------------------------------------------ Net $ (1.35) $ (1.52) $ 0.67 $ 1.55 $ 0.88 - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------ Operating cash flow $ 100,867 $ (125,872) $ (6,666) $ 51,417 -(ii) Weighted average shares outstanding: Basic 121,974 123,333 124,453 122,741 113,723 Diluted 121,974 123,333 124,966 123,674 115,658 BALANCE SHEET DATA: Cash & cash equivalents and investments available for sale $1,288,947 $1,112,361 $1,122,916 $ 871,818 $ 840,332 Total assets 3,929,541 4,076,350 3,423,776 2,733,765 2,218,506 Notes payable and capital leases-noncurrent 1,254,278 1,308,979 791,618 547,522 301,356 Stockholders' equity(i) 744,042 895,974 1,183,411 1,068,255 877,466 - ------------------------------------------------------------------------------------------------------------------------
(i) No cash dividends were declared in each of the years presented. (ii) Information not available. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Foundation Health Systems, Inc. (together with its subsidiaries, the "Company") is an integrated managed care organization which administers the delivery of managed health care services. The Company's operations consist of two operating segments: Health Plan Services and Government Contracts/Specialty Services. Through its subsidiaries, the Company offers group, individual, Medicaid and Medicare health maintenance organization ("HMO") and preferred provider organization ("PPO") plans; government sponsored managed care plans; and managed care products related to administration and cost containment, behavioral health, dental, vision and pharmaceutical products and other services. The Health Plan Services segment consists of HMOs organized into four operational divisions located in the following geographic regions: the California Division, the Northeast Division, the Central Division and the Arizona Division. These health plans are located in Arizona, California, Colorado, Connecticut, Florida, Idaho, Louisiana, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Utah, Washington and West Virginia. The Company's health plans provide a wide range of managed health care services throughout the United States with approximately 4.2 million at risk and administrative services only members. The Company's HMO subsidiaries contract to provide medical care services to a defined, enrolled population for a predetermined, prepaid monthly fee for group, Medicaid, individual and Medicare plans throughout their respective service areas. All of the HMOs are state licensed and some are also federally qualified. The Company also operates PPO networks which provide access to health care services and owns six health and life insurance companies licensed to sell insurance throughout the United States. The Government Contracts/Specialty Services segment administers large, multi-year managed health care government contracts. This segment subcontracts to affiliated and unrelated third parties the administration and health care risk of parts of these contracts and currently administers health care programs covering approximately 1.6 million eligible individuals under the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS") through the TRICARE program. Currently, the Company provides these services under three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Texas, Washington and parts of Arizona, Idaho and Louisiana. This segment also offers behavioral health, dental, and vision services as well as managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities. This discussion and analysis contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties [detailed from time to time in the Company's filings with the Securities and Exchange Commission (the "Commission")] which may cause actual results to differ materially from those projected or implied in these statements. The risks and uncertainties faced by the Company include, but are not limited to, those set forth under "Additional Information Concerning the Company's Business," "Cautionary Statements" and other sections within the Company's filings with the Commission. CONSOLIDATED OPERATING RESULTS The Company's net loss from continuing operations for the year ended December 31, 1998 was $165.2 million, or $1.35 per diluted share, compared to a net loss from continuing operations for the same period in 1997 of $67.8 million, or $.55 per diluted share. During the year ended December 31, 1998, the Company recorded asset impairment, restructuring and other charges totaling $410.9 million on a pre-tax basis (the "1998 Charges"), or $2.13 per diluted share, net of taxes. The Company recorded $395.9 million and $44.1 million related to asset impairment, merger, restructuring and other charges during 1997 and 1996, respectively. These charges are further described in "Asset Impairment, Merger, Restructuring and Other Charges" below. Excluding these charges and the results of discontinued operations, the basic and diluted earnings per share for the years ended December 31, 1998, 1997 and 1996 were $.78, $1.89 and $.57, respectively. The table below and the discussion that follows summarize the Company's performance in the last three fiscal years.
Year Ended December 31, --------------------------------------------- (Amounts in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------- Total revenues $8,896,076 $7,235,019 $6,709,240 - -------------------------------------------------------------------------------------------------------------- Expenses: Health plan services expenses(i) 6,547,747 4,912,532 4,598,074 Government contracts and specialty services expenses 1,064,722 1,002,076 995,820 Selling, general and administrative 1,042,556 851,826 859,996 Amortization and depreciation 128,093 98,353 112,916 Interest 92,159 63,555 45,372 Asset impairment, restructuring, merger, and other charges(i) 274,953 395,925 44,108 - -------------------------------------------------------------------------------------------------------------- Total expenses 9,150,230 7,324,267 6,656,286 - -------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before income taxes $ (254,154) $ (89,248) $ 52,954 - -------------------------------------------------------------------------------------------------------------- Overall medical care ratio 86.5% 83.1% 84.5% Administrative expense ratio 12.4% 12.6% 13.6% HEALTH PLAN SERVICES SEGMENT: Health plan premiums $7,440,981 $5,829,444 $5,395,125 Health plan medical care ratio 88.0% 84.3% 85.2% Health plan premiums per member per month $ 143.43 $ 137.96 $ 135.17 Health plan services per member per month $ 126.24 $ 116.26 $ 115.20 GOVERNMENT CONTRACTS/SPECIALTY SERVICES SEGMENT: Government contracts and specialty services revenues $1,356,054 $1,291,275 $1,225,723 Government contracts and specialty services expenses medical care ratio 78.5% 77.6% 81.2% - ----------------------------------------------------------------------------------------------------------------
(i) 1998 Charges of $275.0 million are included in asset impairment, restructuring, merger and other charges and $135.9 million are included primarily in health plan services expenses. ENROLLMENT INFORMATION
Year Ended December 31, Percent Percent (Amounts in thousands) 1998 1997 Change 1996 Change - ------------------------------------------------------------------------------------------------------------- Health Plan Services: Commercial 3,287 3,522 (6.7)% 2,774 27.0% Medicare Risk 326 308 5.8% 237 30.0% Medicaid 586 442 32.6% 315 40.3% - ------------------------------------------------------------------------------------------------------------- 4,199 4,272 (1.7)% 3,326 28.4% - ------------------------------------------------------------------------------------------------------------- Government Contracts: CHAMPUS PPO and Indemnity 784 1,090 (28.1)% 1,035 5.3% CHAMPUS HMO 783 801 (2.2)% 543 47.5% - ------------------------------------------------------------------------------------------------------------- 1,567 1,891 (17.1)% 1,578 19.8% - -------------------------------------------------------------------------------------------------------------
REVENUES AND HEALTH CARE COSTS The Company's revenues grew by $1.7 billion or 23% for the year ended December 31, 1998 as compared to 1997. Growth in health plan revenues of $1.6 billion for the year was due primarily to the acquisitions that occurred in the fourth quarter of 1997, including Physicians Health Services, Inc. ("PHS"), FOHP, Inc. ("FOHP") and PACC HMO, Inc. and PACC Health Plans, Inc. (collectively "PACC"). Excluding these acquisitions, revenues grew by $1 billion for the year ended December 31, 1998. The growth from existing health plan businesses was due to increases in premium rates in virtually all markets and significant increases in Medicaid enrollment in California. Growth in government contracts revenues totaled $40.3 million and growth in specialty services revenues totaled $24.5 million. See "Segment Reporting" for discussion of Government Contracts/Specialty Services. The Company's revenues grew by $525.8 million or 7.8% for the year ended December 31, 1997 as compared to 1996. Growth in revenues for the year was due to slightly higher health plan premiums for the Company's commercial membership and membership growth in Medicaid contracts in California, commercial membership growth in the Northeast, and the partial year impact of acquisitions that occurred in the second and fourth quarters of 1997. Investment and other income was $99.0 million, $114.3 million and $88.4 million in 1998, 1997 and 1996, respectively. The increase in 1997 was primarily related to non-recurring gains from the sale of certain holdings and Medicaid contracts. The overall medical care ratio ("MCR") (medical costs as a percentage of revenue) for the year ended December 31, 1998 was 86.5% as compared to 83.1% for the year ended December 31, 1997. The increase was primarily due to higher pharmacy costs in all divisions, benefit cost increases which exceeded premium rate increases, increased utilization and continued pricing pressures throughout the Company's health plans. Excluding the 1998 Charges, the MCR was 85.0%. The overall MCR for the year ended December 31, 1997 was 83.1% compared to 84.5% for the year ended December 31, 1996. The decline is due primarily to higher medical costs and loss contracts that negatively impacted the MCR in 1996 as well as favorable reserve development in 1997 in certain of the Company's health plans as well as improved health care and subcontractor performance on certain government contracts. The 1997 reduction in MCR was offset slightly by escalating health care costs including higher pharmacy costs coupled with a relatively flat premium environment, particularly in the California market and throughout the Company's health plans. SELLING, GENERAL AND ADMINISTRATIVE COSTS The Company's selling, general and administrative ("SG&A") expenses increased by $190.7 million or 22.4% for the year ended December 31, 1998 as compared to 1997. The increase in SG&A expenses during 1998 is primarily due to the SG&A expenses associated with the businesses acquired during 1997. The administrative expense ratio (SG&A as a percentage of health plan and government contracts revenue) decreased to 12.4% for the year ended December 31, 1998 from 12.6% for the year ended December 31, 1997. This decrease is primarily attributable to the Company's ongoing efforts to aggressively control its SG&A expenses and synergy savings associated with the integration of its 1997 acquisitions which were partially offset by increased expenditures related to consolidation and integration of the Company's administrative facilities. Excluding the 1998 Charges, the administrative expense ratio was 12.2%. The Company's SG&A expenses decreased by $8.2 million or 1.0% for the year ended December 31, 1997 as compared to 1996. The administrative expense ratio decreased to 12.6% for the year ended December 31, 1997 as compared to 13.6% for the year ended December 31, 1996. This decrease reflects the Company's ongoing efforts to aggressively control its SG&A expenses and synergy savings associated with the integration of Health Systems International, Inc. and Foundation Health Corporation after the merger transaction (the "FHS Combination") involving such entities. This decrease was offset partially by additional SG&A expenses associated with the new acquisitions during 1997. AMORTIZATION AND DEPRECIATION Amortization and depreciation expense increased by $29.7 million in 1998 due to increases in intangible assets and fixed assets as a result of the acquisitions that occurred in the fourth quarter of 1997 and increased expenditures primarily related to the consolidation and integration of the Company's administrative facilities. Amortization and depreciation expense declined by $14.6 million for the year ended December 31, 1997 as compared to 1996 due to certain intangible assets becoming fully amortized by the end of 1996, fixed assets becoming fully depreciated in early 1997 and fixed asset write-offs primarily associated with the Company's restructuring plans discussed below. INTEREST EXPENSE Interest expense increased by $28.6 million due to increased borrowings under the revolving credit facility coupled with a higher borrowing rate in 1998 as compared to 1997. Interest expense increased by $18.2 million in 1997 as compared to 1996 due to higher debt levels associated with the Company's revolving lines of credit partially offset by lower interest rates. ASSET IMPAIRMENT, MERGER, RESTRUCTURING AND OTHER CHARGES On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. FPA, through its affiliated medical groups, provided services to approximately 190,000 of the Company's affiliated members in Arizona and California. FPA has discontinued its medical group operations in these markets. As a result, the Company is seeking new tenants for, or will sell, the 13 healthcare facilities it leased to FPA in these markets and has made other arrangements for provider services to the Company's affiliated members. To date, the Company has sold three of these healthcare facilities. Management's analysis of this situation indicated 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 recorded a charge of $50.0 million during the second quarter ended June 30, 1998. The Company recorded an additional $28.1 million during the third quarter ended September 30, 1998 which was primarily related to additional impairment of the value of real estate assets leased to FPA and an additional $6.0 million during the fourth quarter ended December 31, 1998 which was related to the FPA bankruptcy. Elements of the second, third and fourth quarter charges included approximately $63.0 million for real estate asset impairments, approximately $10.0 million for a note receivable impairment and $11.1 million for other items related to FPA. During the third quarter ended September 30, 1998, excluding the charges totaling $28.1 million related to the FPA bankruptcy, the Company recorded $146.9 million of restructuring and other charges. These charges included (i) $87.0 million related primarily to premium deficiency reserves for the Company's Medicare operations in the Northeast division, payment disputes with various provider groups, and costs associated with contract terminations and exiting rural markets which were recorded as health care costs; (ii) $21.2 million related to severance and benefits related to staff reductions in selected health plans and the centralization and consolidation of Corporate functions; (iii) $18.6 million related to the bankruptcy of a large hospital system; and (iv) $20.1 million of other costs primarily related to premium deficiency reserves established for certain of the Company's non-core health plan operations. As of December 31, 1998, $40.9 million of the total $175.0 million of the third quarter charges described above has resulted in cash outlays and $27.5 million is expected to require future outlays of cash. During the fourth quarter ended December 31, 1998, the Company initiated a formal plan to dispose of certain Central Division health plans included in the Company's Health Plan Services segment. It is anticipated that the divestiture of these plans will be completed during the first half of 1999. The Company evaluated the carrying values of the assets of these health plans and determined that the carrying value exceeded estimated fair value by $112.4 million. As a result, the Company recorded an impairment charge which is attributable to the following assets: Goodwill totaling $30.0 million, furniture and equipment totaling $40.3 million, building improvements totaling $20.9 million and other impairments totaling $21.2 million. In addition, the Company recorded $48.9 million primarily as health care costs. These costs were primarily related to anticipated bad debts totaling $17.4 million, premium deficiency reserves of $22.1 million for certain health plans whose health care costs exceed contractual premium revenues and additional claims reserves and other costs totaling $9.4 million. The Company also recorded an additional $18.6 million of other charges. As of December 31, 1998, $6.0 million of the total $185.9 million of the fourth quarter charges resulted in cash outlays and $50.1 million is expected to require future outlays of cash. As set forth above, the total 1998 Charges recorded by the Company were $410.9 million. Restructuring, merger and other charges of $395.9 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. The principal elements of these charges included (i) restructuring costs of $146.8 million for a workforce reduction, the consolidation of employee benefit plans, the consolidation of facilities in geographic locations where office space is duplicated, the consolidation of overlapping provider networks, and the consolidation of information systems to standardized systems; (ii) $69.6 million in merger related costs primarily for investment banking, legal, accounting and other costs; (iii) premium deficiency reserves of $57.5 million related to the Company's Gem Insurance Company ("Gem") and (iv) other charges of $122.0 million primarily related to other costs for certain of the Company's non-core operations. As of December 31, 1998, $86.9 million of the net 1997 restructuring charge has resulted in cash outlays and $13.8 million is expected to require future outlays of cash. During 1996, the Company recorded $44.1 million of restructuring and other charges. These charges were primarily comprised of restructuring costs of $27.4 million and $16.7 million of other costs including loss contract accruals related to governmental employer groups in the Company's non-California markets, consulting and other costs. INCOME TAX PROVISION AND BENEFIT The effective tax benefit rate of 35.0% on losses from continuing operations for the year ended December 31, 1998 increased compared to the effective tax benefit rate on continuing operations of 24.0% for the year ended 1997. The increased tax benefit rate was due primarily to nondeductible merger and restructuring costs during 1997. The 1996 effective tax provision rate on income of 26.7% differs from the statutory tax rate primarily due to various items including tax exempt interest income and a settlement of an Internal Revenue Service examination. SEGMENT REPORTING HEALTH PLAN SERVICES Health plan revenues increased by $1.6 billion or 27.6% primarily due to enrollment increases in the commercial, Medicare and Medicaid lines of business in the Northeast Division that was acquired in the fourth quarter of 1997. These acquisitions contributed approximately $977.8 million in revenues during the year ended December 31, 1998. In addition, Medicaid enrollment growth in the California division and premium rate increases for all divisions contributed to the overall increase in revenues for the health plans. Revenues generated by the Company's health plan operations increased $434.3 million or 8.1% for the period ended December 31, 1997 compared to the same period in 1996. The increase in revenues for the year ended December 31, 1997 as compared to the same period in 1996 is primarily due to enrollment increases in the Medicaid lines of business and enrollment and premium increases in the Medicare lines of business in California, commercial enrollment increases in Connecticut and Arizona, and the partial year impact of the acquisitions of Advantage Health in Pennsylvania, FOHP in New Jersey, and PACC in Oregon. Health plan health care costs increased by 33.3% for the year ended December 31, 1998 as compared to 1997 primarily as a result of enrollment increases in the Northeast Division, Medicaid enrollment growth in the California Division, pharmacy cost increases in all divisions and additional health care costs from the 1998 Charges totaling $104.3 million. The health plans MCR increased from 84.3% in 1997 to 88.0% in 1998 due to higher medical costs particularly in physician and hospital fee for service costs, increase in pharmacy costs and increased utilization. Excluding the 1998 Charges, the health plans MCR was 86.6%. Health plan health care costs increased by 6.8% for the year ended December 31, 1997 as compared to 1996. In the California market, health care costs increased as a result of higher pharmacy costs for both the commercial and Medicare lines of business, increased provider contracting arrangements, increased hospital utilization in the Medicare line of business, and increased enrollment in the Medicaid line of business. While health care costs increased during 1997, the health plans MCR declined to 84.3% for the year ended December 31, 1997 from 85.2% for the comparable period in 1996 primarily due to higher medical costs in 1996 and favorable loss reserve development in certain health plan operations during 1997. The Company's commercial product lines are profitable. Premium rate increases in the commercial line of products contributed to revenue increases for the year ended December 31, 1998 as compared to the same period in the prior year in all divisions of the Company, but were partially offset by enrollment decreases in commercial HMO markets in California and the health plans in the western and central states. Commercial health care costs on a per member per month basis have increased 8.1% during the year ended December 31, 1998 as compared to the year ended December 31, 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 $32.9 million for the year ended December 31, 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 53.9% increase in member months during the year ended December 31, 1998, compared to 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/SPECIALTY SERVICES Government contracts revenue increased by $40.2 million or 4.2% during the year ended December 31, 1998 as compared to 1997 primarily due to the full year effect of the retroactive pricing adjustment in the third quarter of 1997 which reduced 1997 contract prices, as well as from growth in 1998 due to actuarial adjustments in risk share revenue and favorable equitable adjustments resulting from governmental audits. Government contracts revenue increased by $40.4 million or 4.4% for the year ended December 31, 1997, compared to 1996 as a result of the California/Hawaii CHAMPUS contract being active for only 9 months in 1996 compared to a full year in 1997. Specialty services revenues increased by $24.5 million or 7.2% during the year ended December 31, 1998 as compared to 1997. These increases are primarily the result of higher drug manufacturer rebates, new business as a result of the FHS Combination, and continued growth in the Company's managed behavioral health network and bill review cost containment businesses. Specialty services revenues increased by $25.1 million or 7.9% for the year ended December 31, 1997 as compared to the same period in 1996 primarily due to the impact of a full year's revenue from Managed Health Network, Inc. which was acquired in March 1996. The increase in revenue was offset somewhat by the sale of certain ancillary health care service operations in 1996 and reduced revenue from various ASO operations. The Company expects continued market pressure to maintain modest increases in premiums for behavioral health, dental and vision products. The government contracts/specialty services MCR increased to 78.5% for 1998 compared to 77.6% for 1997. Excluding the 1998 Charges, this ratio was 77.4%. This increase for 1998 is primarily due to (i) the effect of the 1998 Charges (ii) increased pharmacy costs and higher health care claim costs on CHAMPUS contracts and (iii) the elimination of the Medicaid contract administration business which was sold in 1997 which contributed to revenues with no offsetting health care costs. The government contracts/specialty services MCR decreased to 77.6% for 1997 compared to 81.2% in 1996. This decrease for 1997 is primarily due to improved health care and subcontractor performance on the CHAMPUS contracts and due to adverse reserve development recognized in the fourth quarter of 1996 which resulted in a higher than usual MCR during 1996. DISCONTINUED OPERATIONS WORKERS' COMPENSATION INSURANCE BUSINESS In December 1997, the Company adopted a formal plan to sell its workers' compensation segment. In December 1997, the Company estimated the loss on the disposal of the workers' compensation segment would approximate $99.0 million (net of an income tax benefit of $21.0 million) which included the anticipated results of operations during the phase-out period from December 1997 through the date of disposal. On December 10, 1998, the Company completed the sale of the workers' compensation segment. The assets sold consisted primarily of investments, premiums and reinsurance receivables. The selling price was $257 million in cash. PHYSICIAN PRACTICE MANAGEMENT BUSINESS On June 28, 1996 the Company executed a Stock and Note Purchase Agreement with FPA for the purchase by FPA of the Company's medical practices (the "Medical Practices"). The transaction was consummated in November 1996 and the Company recognized a net of tax gain on sale of $20.3 million, net of $17.6 million of taxes, in 1996. In 1997, the Company recognized an additional $10.1 million gain on the sale, net of $2.8 million of taxes, as a result of the final settlement of certain contractual provisions. The income and loss on discontinued operations, net of taxes, for the Medical Practices was $2.9 million during 1996. The results were primarily due to insufficient patient volume being served by the Medical Practices. The 1996 loss was reduced by a gain of $10.8 million related to the sale of various independent practice associations. 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. 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. In addition, the Year 2000 problems of the Company's providers and customers, including governmental entities, can affect the Company's operations, which are highly dependent upon information technology for processing claims, determining eligibility and exchanging information. PROJECT STATUS-The Year 2000 effort for the Company has the highest priority of technology projects and has the full support of the Company's management. The project has dedicated resources with multiple teams to address its unique systems environment. Uniform project management techniques have been adopted with overall oversight responsibility residing with the Company's Chief Technology Officer, assisted by a special project manager hired by the Company. An executive management committee is also actively and directly involved in an oversight capacity in the Company's Year 2000 project and receives monthly reports from the project manager. In addition, the project manager regularly meets with the Company's audit committee to further discuss the Company's Year 2000 issues. The Company is addressing its Year 2000 issues in several ways. Selected systems are being 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 engaged IBM Global Services to assist in the program management of the project. In addition, the Company is in the process of assessing its third party relationships with respect to non-information technology assets and services. The Company has also retained legal consultants to assist in the review of insurance and the Company's obligations and rights, and IBM's The Wilkerson Group, technical consultants specializing in health care, to help develop contingency plans. The Company has divided its Year 2000 effort into five phases: (1) Assessment and Strategy, (2) Detailed Analysis and Planning, (3) Remediation, (4) Testing and Implementation, and (5) Certification. The Company's geographical and specialty service divisions are conducting a detailed self-assessment as to their compliance, needs, risks, and contingency planning, which will then be reviewed and prioritized at the corporate level. During the fourth quarter of 1998, the Company continued moving forward in its efforts to address Year 2000 issues, though its overall progress was less significant due to organizational changes and restructuring. The Year 2000 project is experiencing increased progress at the start of 1999. The Company has established the third quarter of 1999 to complete all phases and is endeavoring to accelerate completion ahead of that time. The following table sets forth the estimated percentage completion of each of the Company's Year 2000 phases as of February 1999 with respect to its core applications and information technology infrastructure, and its Year 2000 project overall.
Phase 1 Phase 2 Phase 3 Phase 4 Phase 5 ------------------------------------------------------------------------- Core applications and IT infrastructure 100% 94% 56% 15% 0% Overall 100% 83% 54% 11% 0% -------------------------------------------------------------------------
THIRD PARTIES-The Company has commenced an inventory of third party relationships, identifying them and analyzing their strategic importance to the Company and their Year 2000 readiness. The strategically important third party relationships identified by the Company are general purpose utility vendors, care delivery organizations (such as providers), and customer service vendors. The Company now anticipates completing its risk assessment for third parties in the second quarter of 1999. There can be no assurance that the systems of other companies on which the Company relies will be compliant on a timely basis, or that the failure by a third party to be compliant would not have a material adverse effect on the Company. COSTS-The Company is evaluating on an on-going basis the related costs to resolve its potential Year 2000 problems. The Company currently estimates that the total cost for the project will be approximately $42.7 million, excluding the costs to accelerate the replacement of hardware or software otherwise required to be purchased by the Company. Through 1998, the Company expended approximately $13.6 million relating to, among other things, the cost to repair or replace software and related hardware problems, cost of assessment, analysis and planning and internal and external communications. The Company estimates that the percentages of its total expenditures for Year 2000 issues will be approximately as follows: 35% for internal costs, 37% for outside consultants and contractors, 6.5% for software-related costs, and 21.5% for hardware-related costs. The Company has established a line-item in its overall operating budget specifically for Year 2000 costs. The operating subsidiaries for each line of business of the Company, however, are paying for the costs of assessment, planning, remediation and testing of Year 2000 issues for their respective operations. 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 from utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. There can be no assurances that these estimates will be achieved and actual results and costs could differ materially from these estimates. Certain insurance coverages for defense costs associated with Year 2000 litigation have already been secured under the Company's Directors and Officers Liability Insurance policy and will be re-evaluated upon renewal of that policy. 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 costs and liabilities under its other insurance policies. The Company is currently analyzing the availability of such coverage under other existing and future insurance policies and products. CONTINGENCY PLANNING. An important part of the Company's Year 2000 project involves identifying worst case scenarios and seeking to develop contingency plans. Each geographical and specialty services division of the Company is prioritizing its mission critical business functions in order to address the most critical issues first in remediation efforts and to develop alternatives to these critical processes as part of contingency planning. A mission critical business activity or system is one that cannot be without an automated or functional system for a period of 21 days without causing significant business impact to the particular line of business. Among other things, the Company's divisions are assessing potential negative impacts on a valid member's ability to receive services, the ability to generate revenue, the need for additional expenditures, compliance with legal, regulatory or accreditation requirements, meeting contractual obligations and reimbursing providers, vendors and agents. The Company is currently projecting to complete the assessment of its most critical business functions by the end of the first quarter of 1999 and the documentation and validation of its contingency plans by the end of the second quarter of 1999. The Company currently anticipates that its contingency plans will include the use of manual as well as on-line files of its members to avoid disruption in the verification of membership and eligibility for the provision of health care services to its members. RISKS-The Company is highly dependent upon its own information technology systems and that of its providers and customers. Failure by the Company or a third party to correct a material Year 2000 problem could result in a failure of or an interruption in the Company's business activities and operations. Such interruptions and failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the readiness of third party providers and customers, the Company is not able at this time to determine whether the Year 2000 problems will have a material adverse effect on the Company's results of operations, liquidity or financial condition. The Company's Year 2000 project is expected to reduce significantly the Company's level of uncertainty and the possibility of significant or long-lasting interruptions of the Company's business operations; however, the Company believes that it is impossible to predict all of the areas in which material problems may arise. The Company has initiated formal communications with others with whom it does significant business to determine their Year 2000 issues. The Company is currently projecting to complete its assessment of third party risks by the end of the second quarter of 1999. 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. Forward-looking statements contained in this Year 2000 section should be read in connection with the Company's cautionary statements identifying important risk factors that could cause the Company's actual results to differ materially from those projected in these forward-looking statements, which cautionary statements are contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. LIQUIDITY AND CAPITAL RESOURCES Certain of the Company's subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. Certain subsidiaries must maintain ratios of current assets to current liabilities of 1:1 pursuant to certain government contracts. The Company believes it is in compliance with these contractual and regulatory requirements in all material respects. The Company believes that cash from operations, existing working capital, 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. The Company regularly evaluates cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. The Company may elect to raise additional funds for these purposes, either through additional debt or equity, the sale of investment securities or otherwise, as appropriate. Government health care receivables are best estimates of payments that are ultimately collectible or payable. Since these amounts are subject to government audit and negotiation, amounts ultimately collected may vary from current estimates. Additionally, the timely collection of such receivables is also impacted by government audit and negotiation. For the year ended December 31, 1998, cash provided by operating activities was $100.9 million compared to cash used in operating activities of $125.9 million in the prior year. This change was due primarily to the timing of payments of accounts payable and other liabilities, including payments for merger, restructuring and other costs associated with the 1998 Charges. Net cash provided by investing activities was $147.0 million during 1998 as compared to cash used in investing activities of $134.8 million during 1997. This increase during 1998 was primarily due to cash received from the sale of the workers' compensation segment. Net cash used in financing activities was $43.3 million in 1998 as compared to cash provided by financing activities of $332.1 million during the same period in 1997. The decrease in 1998 was due to the repayment of funds drawn under the Company's Credit Facility (as defined below), which were partially offset by additional drawings under the Credit Facility. The Company has a $1.5 billion credit facility (the "Credit Facility"), with Bank of America as Administrative Agent for the Lenders thereto, which was amended by Amendments in April, July, November 1998 and March 1999 with the Lenders (the "Amendments"). All previous revolving credit facilities were terminated and rolled into the Credit Facility on July 8, 1997. At the election of the Company, and subject to customary covenants, loans are initiated on a bid or committed basis and carry interest at offshore or domestic rates, at the applicable LIBOR rate plus margin or the bank reference rate. Actual rates on borrowings under the Credit Facility vary, based on competitive bids and the Company's unsecured credit rating at the time of the borrowing. As of December 31, 1998, the Company was in compliance with the financial covenants of the Credit Facility, as amended by the Amendments. The Credit Facility is available for five years, until July 2002, but it may be extended under certain circumstances for two additional years. The outstanding balance under the Credit Facility has decreased from $1.265 billion at December 31, 1997 to $1.225 billion at December 31, 1998. As of March 18, 1999, the amount outstanding under the Credit Facility totaled $1.175 billion with interest at LIBOR plus 1.50%. In February 1999, the Company entered into an agreement to sell its pharmacy benefits management business to an unrelated third party for $70 million in cash. The Company intends to use the net proceeds from the sale to reduce corporate debt. The Company has initiated a formal plan to dispose of certain non-core health plans included in the Company's Health Plan Services segment. It is anticipated that the sales of these health plans will be completed during the first half of 1999. 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 promissory notes issued to the California Wellness Foundation in connection with the Health Net conversion to for-profit status is subordinated to Health Net meeting tangible equity requirements under applicable California statutes and regulations. During 1998, the Company contributed $132.1 million to its subsidiaries to meet risk-based or other capital requirements of the regulated entities. As of December 31, 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 $51 million in 1998 pursuant to such legislation. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to interest rate and market risk primarily due to its investing and borrowing activities. Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and in equity prices. Interest rate risk is a consequence of maintaining fixed income investments. The Company is exposed to interest rate risks arising from changes in the level or volatility of interest rates, prepayment speeds and/or the shape and slope of the yield curve. In addition, the Company is exposed to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer's credit rating or credit perception may affect the value of financial instruments. The Company has several bond portfolios to fund reserves. The Company attempts to manage the interest rate risks related to its investment portfolios by actively managing the asset/liability duration of its investment portfolios. The overall goal 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% confidence level, was approximately $3.4 million at December 31, 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. The Company, however, believes that any loss incurred would be offset by the effects of interest rate movements on the respective liabilities, since these liabilities are affected by many of the same factors that affect asset performance; that is, economic activity, inflation and interest rates, as well as regional and industry factors. In addition, the Company has some interest rate market risk due to its borrowings. Notes payable, capital leases and other financing arrangements total $1,256 million and the related average interest rate is 6.30% (which interest rate is subject to change pursuant to the terms of the credit agreement). 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 December 31, 1998. These cash flows include both expected principal and interest payments consistent with the terms of the outstanding debt as of December 31, 1998.
(Dollars in thousands) Year 1 Year 2 Year 3 Year 4 Year 5 Beyond Total - ------------------------------------------------------------------------------------------------------------ Long-term Borrowings Fixed Rate $ 4,005 $13,049 $ 2,148 $ 2,167 $2,186 $16,196 $ 39,751 Floating Rate 75,830 75,830 75,830 1,262,915 -- -- 1,490,405 - ------------------------------------------------------------------------------------------------------------- Total $79,835 $88,879 $77,978 $1,265,082 $2,186 $16,196 $1,530,156 - -------------------------------------------------------------------------------------------------------------
REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS OF FOUNDATION HEALTH SYSTEMS, INC. The Board of Directors of the Company addresses its oversight responsibility for the consolidated financial statements through its Audit Committee (the "Committee"). The Committee currently consists of Gov. George Deukmejian, Thomas T. Farley, Earl B. Fowler (Chairman) and Richard J. Stegemeier, each of whom is an independent outside director. In fulfilling its responsibilities in 1998, the Committee reviewed the overall scope of the independent auditors' audit plan and reviewed the independent auditors' non-audit services to the Company. The Committee also exercised oversight responsibilities over various financial and regulatory matters. The Committee's meetings are designed to facilitate open communication between the independent auditors and Committee members. To ensure auditor independence, the Committee meets privately with the independent auditors providing for full and free access to the Committee. /s/ Earl B. Fowler Earl B. Fowler, Chairman Audit Committee March 31, 1999 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Foundation Health Systems, Inc. Woodland Hills, California We have audited the accompanying consolidated balance sheets of Foundation Health Systems, Inc. and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Foundation Health Systems, Inc. and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP Los Angeles, California March 31, 1999 CONSOLIDATED BALANCE SHEETS Foundation Health Systems, Inc.
(Amounts in thousands) December 31, 1998 1997 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- ASSETS: Current Assets: Cash and cash equivalents $ 763,865 $ 559,360 Investments - available for sale 525,082 553,001 Premium receivables, net of allowance for doubtful accounts (1998 - $28,522; 1997 - $22,900) 230,157 224,383 Amounts receivable under government contracts 321,411 272,060 Deferred taxes 160,446 213,695 Reinsurance and other receivables 147,827 130,875 Other assets 91,096 188,606 Net assets of discontinued operations -- 267,713 - ---------------------------------------------------------------------------------------------------------------------- Total current assets 2,239,884 2,409,693 Property and equipment, net 345,269 427,149 Goodwill and other intangible assets, net 977,910 1,044,727 Other assets 366,478 194,781 - ---------------------------------------------------------------------------------------------------------------------- Total assets $3,929,541 $4,076,350 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Reserves for claims and other settlements $ 961,399 $ 967,815 Unearned premiums 288,683 244,340 Notes payable and capital leases 1,760 3,593 Amounts payable under government contracts 69,792 78,441 Accounts payable and other liabilities 503,797 470,483 - ---------------------------------------------------------------------------------------------------------------------- Total current liabilities 1,825,431 1,764,672 Notes payable and capital leases 1,254,278 1,308,979 Other liabilities 105,790 106,725 - ---------------------------------------------------------------------------------------------------------------------- Total liabilities 3,185,499 3,180,376 - ---------------------------------------------------------------------------------------------------------------------- Commitments and contingencies (Note 12) Stockholders' equity Preferred stock ($0.001 par value, 10,000 shares authorized, none issued and outstanding) -- -- Class A common stock ($0.001 par value, 350,000 shares authorized; issued 1998 - 120,362; 1997 - 114,449) 120 114 Class B non-voting convertible common stock ($0.001 par value, 30,000 shares authorized; issued and outstanding 1998 - 5,048; 1997 - 10,298) 5 10 Additional paid-in capital 641,820 628,611 Treasury Class A common stock, at cost (1998 - 3,194 shares; 1997 - 3,194 shares) (95,831) (95,831) Accumulated other comprehensive loss (7,308) (7,324) Retained earnings 205,236 370,394 - ---------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 744,042 895,974 - ---------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $3,929,541 $4,076,350 - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF OPERATIONS Foundation Health Systems, Inc.
(Amounts in thousands, except per share data) Years Ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- REVENUES Health plan premiums $7,440,981 $5,829,444 $5,395,125 Government contracts 989,409 949,168 908,730 Specialty services 366,645 342,107 316,993 Investment and other income 99,041 114,300 88,392 - ---------------------------------------------------------------------------------------------------------------------- Total revenues 8,896,076 7,235,019 6,709,240 - ---------------------------------------------------------------------------------------------------------------------- EXPENSES Health plan services 6,547,747 4,912,532 4,598,074 Government contracts health care services 757,047 711,757 706,076 Specialty services 307,675 290,319 289,744 Selling, general and administrative 1,042,556 851,826 859,996 Amortization and depreciation 128,093 98,353 112,916 Interest 92,159 63,555 45,372 Asset impairment, merger, restructuring and other charges 274,953 395,925 44,108 - ---------------------------------------------------------------------------------------------------------------------- Total expenses 9,150,230 7,324,267 6,656,286 - ---------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before income taxes (254,154) (89,248) 52,954 Income tax provision (benefit) (88,996) (21,418) 14,124 - ---------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations (165,158) (67,830) 38,830 Discontinued operations: Income (loss) from operations, net of tax -- (30,409) 25,084 Gain (loss) on disposition, net of tax -- (88,845) 20,317 - ---------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (165,158) $ (187,084) $ 84,231 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- Basic and diluted earnings (loss) per share: Continuing operations $ (1.35) $ (0.55) $ 0.31 Income (loss) from discontinued operations, net of tax -- (0.25) 0.20 Gain (loss) on disposition of discontinued operations, net of tax -- (0.72) 0.16 - ---------------------------------------------------------------------------------------------------------------------- Net $ (1.35) $ (1.52) $ 0.67 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding: Basic 121,974 123,333 124,453 Diluted 121,974 123,333 124,966 - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS Foundation Health Systems, Inc.
(Amounts in thousands) Years Ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(165,158) $(187,084) $ 84,231 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Amortization and depreciation 128,093 98,353 112,916 Loss on disposal of United Kingdom operations -- 12,676 -- Loss on early redemption of Senior Notes -- 9,586 -- Impairment of assets 193,966 8,456 14,963 Other changes in net assets of discontinued operations -- (5,395) (78,589) (Gain) loss on disposition of discontinued operations -- 88,845 (20,317) (Income) loss from discontinued operations -- 30,409 (25,084) Other changes 15,041 (7,061) (1,049) Changes in assets and liabilities, net of effects of acquisitions: Premium receivable and unearned subscriber premiums 38,569 3,105 35,941 Other assets (75,271) (112,302) (239,013) Amounts receivable/payable under government contracts (58,000) (16,155) (101,711) Reserves for claims and other settlements (6,416) (55,450) 165,695 Accounts payable and accrued liabilities 30,043 6,145 45,351 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 100,867 (125,872) (6,666) - ---------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Sale or maturity of investments 718,446 597,691 441,550 Purchase of investments (692,305) (406,818) (513,734) Purchases of property and equipment (147,782) (131,669) (95,751) Proceeds from notes receivables -- 93,011 825 Other 11,504 6,633 (17,784) Sale of net assets of discontinued operations 257,100 -- -- Acquisition of businesses, net of cash acquired -- (293,625) 108 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 146,963 (134,777) (184,786) - ---------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options and employee stock purchases 13,209 21,506 31,756 Proceeds from sale of stock -- -- 95,828 Proceeds from issuance of notes payable and other financing arrangements 155,575 566,240 331,576 Repayment of debt and other non-current liabilities (212,109) (144,341) (4,939) Stock repurchase -- (111,334) (105,418) - ---------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (43,325) 332,071 348,803 - ---------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 204,505 71,422 157,351 Cash and cash equivalents, beginning of year 559,360 487,938 330,587 - ---------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 763,865 $ 559,360 $ 487,938 - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Foundation Health Systems, Inc.
(Amounts in thousands) Years Ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL CASH FLOWS DISCLOSURE: Interest paid $ 85,981 $ 56,056 $ 43,337 Income taxes paid (refunded) (87,799) (3,534) 65,698 - ---------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Capital lease obligations $ 2,530 $ 3,993 $ 401 Notes and stocks received on sale of Medical Practices -- -- 201,118 Transfer of investment as consideration for PACC acquisition -- 14,310 -- Conversion of FOHP convertible debentures to equity 1,197 70,654 -- Profit sharing plan shares issued -- -- 4,558 ACQUISITION OF BUSINESSES: Fair value of assets acquired -- $849,487 $ 23,650 Liabilities assumed -- 438,448 12,903 Issuance of common stock -- -- 6,631 - ---------------------------------------------------------------------------------------------------------------------- Cash paid for acquisitions -- 411,039 4,116 Less cash acquired in acquisitions -- 117,414 4,224 - ---------------------------------------------------------------------------------------------------------------------- Net cash paid for acquisitions -- $293,625 $ (108) - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOUNDATION HEALTH SYSTEMS, INC.
Common Stock - ------------------------------------------------------------------------------------------------------- Additional Class A Class B Paid-in (Amounts in thousands) Shares Amount Shares Amount Capital - ---------------------------------------------------------------------------------------------------------------------- Balance at January 1, 1996 97,505 $ 97 25,684 $ 26 $585,292 Comprehensive income: Net income Change in unrealized depreciation on investments, net - ---------------------------------------------------------------------------------------------------------------------- Total comprehensive income - ---------------------------------------------------------------------------------------------------------------------- Issuance of common stock 1,468 3 4,386 Retirement of treasury stock, net (878) (2) (704) Exercise of stock options including related tax benefit 1,216 1 29,546 Employee stock purchase plan 121 2,576 Employee profit sharing plan 166 4,558 Sale of common stock 9,581 10 (6,386) (7) 95,828 Purchase of treasury stock - ---------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1996 109,179 109 19,298 19 721,482 Comprehensive income: Net income Change in unrealized depreciation on investments, net - ---------------------------------------------------------------------------------------------------------------------- Total comprehensive income - ---------------------------------------------------------------------------------------------------------------------- Redemption of common stock (4,550) (4) (111,330) Retirement of treasury stock, net (130) (3,047) Exercise of stock options including related tax benefit 842 19,310 Conversion of Class B to Class A 4,450 5 (4,450) (5) Employee stock purchase plan 108 2,196 - ---------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1997 114,449 114 10,298 10 628,611 Comprehensive income: Net income Change in unrealized depreciation on investments, net - ---------------------------------------------------------------------------------------------------------------------- Total comprehensive income - ---------------------------------------------------------------------------------------------------------------------- Exercise of stock options including related tax benefit 497 1 9,584 Conversion of Class B to Class A 5,250 5 (5,250) (5) Employee stock purchase plan 166 3,625 - ---------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 120,362 $120 5,048 $ 5 $ 641,820 - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOUNDATION HEALTH SYSTEMS, INC.
Common Stock Accumulated Held in Treasury Other ----------------------- Retained Comprehensive (Amounts in thousands) Shares Amount Earnings Income (Loss) Total - ------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 1996 (130) $ (3,047) $ 482,129 $ 3,757 $1,068,254 Comprehensive income: Net income 84,231 84,231 Change in unrealized depreciation on investments, net (556) (556) - ------------------------------------------------------------------------------------------------------------------------ Total comprehensive income 84,231 (556) 83,675 - ------------------------------------------------------------------------------------------------------------------------ Issuance of common stock 4,389 Retirement of treasury stock, net 878 9,588 (8,882) -- Exercise of stock options including related tax benefit 29,547 Employee stock purchase plan 2,576 Employee profit sharing plan 4,558 Sale of common stock 95,831 Purchase of treasury stock (4,072) (105,419) (105,419) - ------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1996 (3,324) (98,878) 557,478 3,201 1,183,411 Comprehensive income: Net income (187,084) (187,084) Change in unrealized depreciation on investments, net (10,525) (10,525) - ------------------------------------------------------------------------------------------------------------------------ Total comprehensive income (187,084) (10,525) (197,609) - ------------------------------------------------------------------------------------------------------------------------ Redemption of common stock (111,334) Retirement of treasury stock, net 130 3,047 -- Exercise of stock options including related tax benefit 19,310 Conversion of Class B to Class A -- Employee stock purchase plan 2,196 - ------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1997 (3,194) (95,831) 370,394 (7,324) 895,974 Comprehensive income: Net income (165,158) (165,158) Change in unrealized depreciation on investments, net 16 16 - ------------------------------------------------------------------------------------------------------------------------ Total comprehensive income (165,158) 16 (165,142) - ------------------------------------------------------------------------------------------------------------------------ Exercise of stock options including related tax benefit 9,585 Conversion of Class B to Class A -- Employee stock purchase plan 3,625 - ------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1998 (3,194) $ (95,831) $ 205,236 $ (7,308) $ 744,042 - ------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 NOTE 1 - DESCRIPTION OF BUSINESS The current operations of Foundation Health Systems, Inc. (the "Company" or "FHS") are a result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the FHS Combination, FH Acquisition Corp., a wholly owned subsidiary of HSI ("Merger Sub"), merged with and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company. Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the FHS Combination, FHC stockholders received 1.3 shares of the Company's Class A Common Stock for every share of FHC common stock held, resulting in the issuance of approximately 76.7 million shares of the Company's Class A Common Stock to FHC stockholders. The shares of the Company's Class A Common Stock issued to FHC's stockholders in the FHS Combination constituted approximately 61% of the outstanding stock of the Company after the FHS Combination and the shares held by the Company's stockholders prior to the FHS Combination (i.e., the prior stockholders of HSI) constituted approximately 39% of the outstanding stock of the Company after the FHS Combination. The FHS Combination was accounted for as a pooling of interests for accounting and financial reporting purposes. The pooling of interests method of accounting is intended to present, as a single interest, two or more common stockholder interests which were previously independent and assumes that the combining companies have been merged from inception. Consequently, the Company's consolidated financial statements have been prepared and/or restated as though HSI and FHC always had been combined. Although prior to the FHS Combination FHC reported on a fiscal year ended June 30 basis, the consolidated financial statements have been restated to reflect the Company's calendar year basis. The consolidated financial statements give retroactive effect to the FHS combination which was accounted for as a pooling of interests and to the sale of the Company's workers' compensation business which was accounted for as discontinued operations (see Note 3). CONTINUING OPERATIONS The Company is an integrated managed care organization which administers the delivery of managed health care services. Continuing operations consist of two segments: Health Plan Services and Government Contracts/Specialty Services. Through its subsidiaries, the Company offers group, individual, Medicaid and Medicare health maintenance organization ("HMO") and preferred provider organization ("PPO") plans; government sponsored managed care plans; and managed care products related to administration and cost containment, behavioral health, dental, vision and pharmaceutical products and other services. The Health Plan Services segment consists of HMOs organized into four operational divisions located in the following geographic regions: the California Division, the Northeast Division, the Central Division, and the Arizona Division. These health plans are located in Arizona, California, Colorado, Connecticut, Florida, Idaho, Louisiana, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Utah, Washington, and West Virginia. The Company's health plans provide a wide range of managed health care services throughout the United States with approximately 4.2 million at-risk and administrative services only members. The Company's commercial HMO subsidiaries contract to provide medical care services to a defined, enrolled population for a predetermined, prepaid monthly fee for group, Medicaid, individual and Medicare HMO plans throughout their respective service areas. All of the HMOs are state licensed and some are also federally qualified. The Company also operates PPO networks which provide access to health care services and owns six health and life insurance companies licensed to sell insurance throughout the United States. The Government Contracts/Specialty Services segment administers large, multi-year managed care government contracts. This segment subcontracts to affiliated and unrelated third parties the administration and health care risk of parts of these contracts and currently administers health care programs covering 1.6 million eligible individuals under the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS") through the TRICARE program. Currently, there are three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Texas, and Washington, and parts of Arizona, Idaho and Louisiana. This segment also offers behavioral health, dental, vision, and pharmaceutical products and services as well as managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities. DISCONTINUED OPERATIONS The consolidated financial statements give retroactive effect to the following (see Note 3): WORKERS' COMPENSATION INSURANCE SEGMENT - In December 1997, the Company revised its strategy of maintaining a presence in the workers' compensation insurance business and adopted a formal plan to discontinue and sell this segment through divestiture of its workers' compensation insurance subsidiaries. The Company completed its sale of this segment on December 10, 1998. PHYSICIAN PRACTICE MANAGEMENT SEGMENT - On June 28, 1996 the Company executed a Stock and Note Purchase Agreement with FPA Medical Management, Inc. ("FPA"), a national health care management services organization, for the purchase by FPA of the Company's physician practice management subsidiary and affiliated physician-owned medical practices (collectively, the "Medical Practices"). The transaction was consummated in November 1996. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION AND BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation except for transactions between the Company's continuing operations subsidiaries and the discontinued operations segments discussed in Note 3. The accompanying consolidated financial statements have been restated for the FHS Combination accounted for as a pooling of interests and for the discontinued operations as discussed in Note 1. RECLASSIFICATIONS Certain amounts in the 1997 and 1996 consolidated financial statements and notes have been reclassified to conform to the 1998 presentation. REVENUE RECOGNITION Health plan services premium revenues include HMO and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, which premiums are based on a predetermined prepaid fee, Medicaid revenues based on multi-year contracts to provide care to Medicaid recipients, and revenue under Medicare risk contracts to provide care to enrolled Medicare recipients. Revenue is recognized in the month in which the related enrollees are entitled to health care services. Premiums collected in advance are recorded as unearned premiums. Government contracts revenues are recognized in the month in which the eligible beneficiaries are entitled to health care services. Government contracts also contain cost and performance incentive provisions which adjust the contract price based on actual performance, and revenue under contracts is subject to price adjustments attributable to inflation and other factors. The effects of these adjustments are recognized on a monthly basis, although the final determination of these amounts could extend significantly beyond the period during which the services were provided. Amounts receivable under government contracts are comprised primarily of estimated amounts receivable under these cost and performance incentive provisions, price adjustments, and change orders for services not originally specified in the contracts. Specialty services revenues are recognized in the month in which the administrative services are performed or the period that coverage for services is provided. HEALTH CARE EXPENSES The cost of health care services is recognized in the period in which services are provided and includes an estimate of the cost of services which have been incurred but not yet reported. Such costs include payments to primary care physicians, specialists, hospitals, outpatient care facilities and the costs associated with managing the extent of such care. The estimate for reserves for claims and other settlements is based on actuarial projections of health care costs using historical studies of claims paid. Estimates are continually monitored and reviewed and, as settlements are made or estimates adjusted, differences are reflected in current operations. Such estimates are subject to the impact of changes in the regulatory environment and economic conditions. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts provided. While the ultimate amount of claims and losses paid are dependent on future developments, management is of the opinion that the reserves for claims and other settlements are adequate to cover such claims and losses. These liabilities are reduced by estimated amounts recoverable from third parties for subrogation. The Company generally contracts with various medical groups to provide professional care to certain of its members on a capitation, or fixed per member per month fee basis. Capitation contracts generally include a provision for stop-loss and non-capitated services for which the Company is liable. Professional capitated contracts also generally contain provisions for shared risk, whereby the Company and the medical groups share in the variance between actual costs and predetermined goals. Additionally, the Company contracts with certain hospitals to provide hospital care to enrolled members on a capitation basis. The HMOs also contract with hospitals, physicians and other providers of health care, pursuant to discounted fee-for-service arrangements, hospital per diems, and case rates under which providers bill the HMOs for each individual service provided to enrollees. CASH AND CASH EQUIVALENTS Cash equivalents include all liquid investments with a maturity of three months or less when purchased. The Company and its consolidated subsidiaries are required to set aside certain funds for restricted purposes pursuant to regulatory requirements. As of December 31, 1998 and 1997, cash and cash equivalent balances of $65.5 million and $37.9 million, respectively, are restricted and included in other noncurrent assets. INVESTMENTS Investments classified as available for sale are reported at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, net of income tax effects. The cost of investments sold is determined in accordance with the specific identification method and realized gains and losses are included in investment income. Certain debt investments are held by trustees or agencies pursuant to state regulatory requirements. Such investments which are classified as held to maturity are carried at an amortized cost of $61.8 million in 1998 and $14.6 million in 1997 and are included in other noncurrent assets (see Note 11). Market values approximate carrying value at December 31, 1998 and 1997. REVENUES RELATED TO GOVERNMENT CONTRACTS Amounts receivable or payable under government contracts are based on three TRICARE contracts in five regions which include both amounts billed (net receivables of $75.0 million and $108.8 million at December 31, 1998 and 1997, respectively) and estimates for amounts to be received under cost and performance incentive provisions, price adjustments and change orders for services not originally specified in the contracts. Such estimates are determined based on information available as well as historical performance. Differences, which may be material, between the amounts estimated and final amounts collected are recorded in the period when determined. Additionally, the reserves for claims and other settlements include approximately $162.4 million and $204.8 million relating to health care services provided under these contracts as of December 31, 1998 and 1997, respectively. PROPERTY AND EQUIPMENT Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method over the lesser of estimated useful lives of the various classes of assets or the lease term. The useful life for buildings and improvements is estimated at 40 years, and the useful lives for furniture, equipment and software range from three to eight years (see Note 5). Expenditures for maintenance and repairs are expensed as incurred. Major improvements which increase the estimated useful life of an asset are capitalized. Upon the sale or retirement of assets, the recorded cost and the related accumulated depreciation are removed from the accounts, and any gain or loss on disposal is reflected in operations. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets arise primarily as a result of various business acquisitions and consist of identifiable intangible assets acquired and the excess of the cost of the acquisitions over the tangible and intangible assets acquired (goodwill). Other intangible assets consist of the value of employer group contracts and provider networks. Goodwill and other intangible assets are amortized using the straight-line method over the estimated lives of the related assets listed below. Fully amortized goodwill and other intangible assets and the related accumulated amortization are removed from the accounts. The Company evaluates the carrying value of its goodwill and other intangible assets periodically based on estimated fair value or undiscounted operating cash flows whenever significant events or changes occur which might impair recovery of recorded costs. In such circumstances, recorded costs of the assets are written down to estimated fair value when recorded costs, prior to impairment, are higher. Impairment charges for goodwill in 1998 amounted to $30.0 million (see Note 15). Goodwill and other intangible assets consisted of the following at December 31, 1998 (dollars in thousands):
Accumulated Amortization Cost Amortization Net Balance Period - --------------------------------------------------------------------------------------------------- Goodwill $1,029,301 $136,088 $ 893,213 27-40 years Provider network 23,987 9,716 14,271 5-20 years Employer group contracts 138,323 90,828 47,495 11-22 years Other 50,540 27,609 22,931 4-15 years - -------------------------------------------------------------------------------- Total $1,242,151 $264,241 $ 977,910 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Goodwill and other intangible assets consisted of the following at December 31, 1997 (dollars in thousands):
Accumulated Amortization Cost Amortization Net Balance Period - --------------------------------------------------------------------------------------------------- Goodwill $1,026,992 $ 78,339 $ 948,653 27-40 years Provider network 20,686 4,864 15,822 5-20 years Employer group contracts 138,323 80,660 57,663 11-22 years Other 50,836 28,247 22,589 4-15 years - -------------------------------------------------------------------------------- Total $1,236,837 $192,110 $1,044,727 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Amortization expense on goodwill and other intangible assets, excluding the 1998 asset impairment charge of $30.0 million, was $42.3 million, $40.3 million and $45.2 million for the years ended December 31, 1998, 1997 and 1996, respectively. CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, investments and premiums receivable. All cash equivalents and investments are managed within established guidelines which limit the amounts which may be invested with one issuer. Concentrations of credit risk with respect to premium receivables are limited due to the large number of payers comprising the Company's customer base. The Company's ten largest employer groups accounted for 17% and 36% of receivables and 12% and 16% of premium revenue as of December 31, 1998 and 1997, respectively, and for the years then ended. EARNINGS PER SHARE The Company adopted in 1997, Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." As required by SFAS No. 128, basic EPS excludes dilution and reflects income divided by the weighted average shares of common stock outstanding during the periods presented. Diluted EPS is based upon the weighted average shares of common stock and dilutive common stock equivalents (stock options) outstanding during the periods presented; no adjustment to income was required. Common stock equivalents arising from dilutive stock options are computed using the treasury stock method, and in 1996 amounted to 513,000 shares. Such shares amounting to 207,000 and 488,000 were anti-dilutive in 1998 and 1997, respectively. Options to purchase an aggregate of 13.4 million, 9.6 million and 4.1 million shares of common stock during 1998, 1997 and 1996, respectively, were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common stock. These options expire through December 2007. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal areas requiring the use of estimates include the determination of allowances for doubtful accounts, reserves for claims and other settlements, reserves for professional and general liabilities, amounts receivable or payable under government contracts, remaining reserves for restructuring and other charges, and net realizable values for assets where impairment charges have been recorded. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value amounts of cash equivalents, investments available for sale and notes payable approximate their carrying amounts in the financial statements and have been determined by the Company using available market information and appropriate valuation methodologies. The carrying amounts of cash equivalents approximate fair value due to the short maturity of those instruments. The fair values of investments are estimated based on quoted market prices and dealer quotes for similar investments. The fair value of notes payable is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt with the same remaining maturities. Considerable judgment is required to develop estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amounts the Company could have realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates are based on pertinent information available to management as of December 31, 1998 and 1997. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly. STOCK-BASED COMPENSATION The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). As permitted under SFAS 123, the Company has elected to continue accounting for stock-based compensation under the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value method, compensation cost for stock options is measured at the date of grant as the excess, if any, of the quoted market price of the Company's stock over the exercise price of the option (see Note 7). COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and presenting comprehensive income and its components. Comprehensive income includes all changes in stockholders' equity (except those arising from transactions with stockholders) and includes net income and net unrealized appreciation (depreciation), after tax, on investments available for sale. The adoption of SFAS 130 had no impact on total stockholders' equity. Accumulated other comprehensive income at December 31, 1998, 1997 and 1996 consisted entirely of unrealized gains (losses), net of income taxes. The changes in unrealized gains (losses) during each of the three years ended December 31, 1998 include reclassification adjustments for gains (losses) realized in net income relating to unrealized gains (losses) previously recognized. Such reclassification adjustments net of income tax, are not material to the financial statements. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), which is required to be adopted in years beginning after June 15, 1999. Management does not anticipate that the adoption of SFAS 133 will have a significant effect on the financial position of the Company or its results of operations. The American Institute of Certified Public Accountants issued Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3") in December 1997, Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1") in March 1998 and Statement of Position 98-5 "Reporting on the Costs of Start-Up Activities" ("SOP 98-5") in April 1998, all of which are effective for the Company's 1999 financial statements. SOP 97-3 provides guidance for determining when an insurance company or other enterprises should recognize a liability for guaranty-fund assessments and guidance for measuring the liability. SOP 98-1 requires certain computer software and related costs for internal use to be capitalized and amortized. SOP 98-5 requires costs of start-up activities and organization costs to be expensed as incurred. The adoption of SOP 97-3 and SOP 98-1 is not expected to have a significant effect on the financial position of the Company or its results of operations. The initial application of SOP 98-5 in the first quarter of 1999 will result in a charge of approximately $10 million before income taxes representing the write-off of existing start-up and organization costs which will be reported as a cumulative effect of a change in accounting principle. NOTE 3 - ACQUISITIONS AND DISPOSITIONS The following summarizes acquisitions, strategic investments, and dispositions by the Company during the three years ended December 31, 1998. 1998 TRANSACTIONS WORKERS' COMPENSATION - In December 1997, the Company adopted a formal plan to sell its workers' compensation segment which was accounted for as discontinued operations. On December 10, 1998, the Company completed the sale of the workers' compensation segment. The net assets sold consisted primarily of investments, premiums and reinsurance receivables, and reserves for claims. The selling price was $257.1 million in cash. Total revenues for the workers' compensation segment amounted to $560.9 million and $518.7 million in 1997 and 1996, respectively. Net income (loss) amounted to a $30.4 million loss in 1997 and income of $22.2 million in 1996 after applicable income tax benefits of $32.7 million and expense of $1.2 million, respectively. In December 1997, the Company estimated that the loss on the disposal of the workers' compensation segment would approximate $99.0 million (net of income tax benefit of $21.0 million) which included an anticipated loss from operations during the phase-out period from December 1997 through the date of disposal. The pre-tax loss in 1998 was an additional $30.2 million. This was offset by an increase in the rate of the tax benefit of the transaction to 35%. Accordingly, the accompanying statement of operations for the year ended December 31, 1998 does not reflect any additional net gain or loss from the disposition. LOUISIANA, OKLAHOMA, AND TEXAS - In November 1998, the Company entered into a definitive agreement to sell its health plan subsidiaries in Louisiana, Oklahoma and Texas. The transaction is subject to various closing conditions, including the receipt of all necessary regulatory approvals and certain financial contingencies, and is expected to close in the first half of 1999. Impairment charges recorded in 1998 include a write down of the carrying value of these plans to their expected net realizable value. CALL CENTER OPERATIONS - In December 1998, the Company sold the clinical algorithms used in its call center operations for $36.3 million in cash, net of transaction costs, and recorded a gain of $1.2 million. In addition, the Company entered into a long-term services agreement with the buyer to provide such services to its members for a period of ten years. 1997 TRANSACTIONS ADVANTAGE HEALTH - On April 1, 1997, the Company completed the acquisition of Advantage Health, a group of managed health care companies based in Pittsburgh, Pennsylvania, for $12.5 million in cash. The acquisition was recorded using purchase accounting and the excess of the purchase price over the fair value of the net liabilities assumed of $19.7 million was recorded as goodwill. In December 1998, the Company adjusted the carrying value of the goodwill to its estimated fair value (see Note 15). Advantage Health remains a party to long-term provider agreements with the seller. PACC - On October 22, 1997, effective October 1, 1997, the Company completed the acquisitions of PACC HMO and PACC Health Plans (collectively, "PACC"), which are managed health care companies based near Portland, Oregon, for a purchase price of approximately $43.7 million in cash. The acquisition was recorded using purchase accounting and the excess of the purchase price over the fair value of the assets acquired was recorded as goodwill. The goodwill, in the amount of $32.2 million, is being amortized on a straight-line basis over 40 years. FOHP - On April 30, 1997, the Company made a $51.7 million investment in FOHP, Inc. ("FOHP"). FOHP was owned by physicians, hospitals and other health care providers and was the sole shareholder of First Option Health Plan of New Jersey, Inc. ("FOHP-NJ"), a managed health care company. The Company's initial investment was in the form of FOHP debentures convertible into up to 71 percent of FOHP's outstanding equity at the Company's discretion. As of December 1, 1997, the Company converted these initial FOHP debentures into 71 percent of FOHP's equity. Additionally, effective December 8, 1997, FOHP issued an additional $29.0 million of convertible debentures to the Company which immediately converted approximately $18.9 million of these debentures into an additional 27 percent of FOHP's outstanding equity increasing FHS' equity holding in FOHP to approximately 98 percent. Goodwill of $107.7 million was recorded as a result of these transactions and is being amortized on a straight-line basis over 40 years. On December 31, 1997, the Company purchased nonconvertible debentures in the amount of $24 million from FOHP. On December 31, 1998, the Company converted approximately $1.2 million of its remaining principal amount of convertible debentures of FOHP into common stock of FOHP. As a result, the Company now owns approximately 99.6% of the outstanding equity of FOHP. The Company is currently in the process of consummating the purchase of the remaining minority interest in FOHP. PHYSICIANS HEALTH SERVICES - On December 31, 1997, the Company completed the acquisition of Physicians Health Services, Inc. ("PHS"), a group of managed health care companies based in Shelton, Connecticut. The Company paid approximately $265 million for the approximately nine million PHS shares then outstanding and caused PHS to cash-out approximately $6 million in PHS employee stock options as part of the acquisition. The acquisition has been recorded using purchase accounting and the excess of the purchase price over the fair value of the assets acquired was recorded as goodwill. The goodwill, in the amount of $218.9 million, is being amortized on a straightline basis over 40 years. CHRISTIANIA GENERAL INSURANCE CORPORATION - On May 14, 1997, the Business Insurance Group, Inc., a subsidiary of the Company, acquired the Christiania General Insurance Corporation of New York ("CGIC") for $12.7 million in cash. The acquisition has been recorded using purchase accounting and the excess of the purchase price over the fair value of the assets acquired was recorded as goodwill. The goodwill, in the amount of $5.2 million, was being amortized on a straightline basis over 20 years. As previously discussed, the workers' compensation segment is reported as discontinued operations and includes CGIC. The remaining goodwill was reflected in the calculation of the net loss on the sale of this segment. The following table reflects unaudited pro forma combined results of operations of the Company and Advantage Health, PACC, FOHP, PHS, and CGIC on the basis that the acquisitions had taken place at the beginning of each year ended December 31 (in thousands, except per share data):
1997 1996 - ----------------------------------------------------------------------------------- Total revenues $ 8,373,830 $ 7,593,247 Loss from continuing operations (176,589) (1,890) Net income (loss) (295,746) 45,570 Basic and diluted earnings (loss) per share: Continuing operations (1.43) (0.02) Net (2.39) 0.37 - -----------------------------------------------------------------------------------
1996 TRANSACTIONS MANAGED HEALTH NETWORK - In March 1996, the Company issued stock for Managed Health Network, Inc. and its subsidiaries (collectively "MHN"), a privately held company providing employee assistance and managed behavioral health programs in a pooling of interests transaction valued at approximately $45 million. PHYSICIAN PRACTICE MANAGEMENT COMPANIES - On June 28, 1996, the Company and the sole shareholder of the Medical Practices executed a Stock and Note Purchase Agreement whereby the Company sold all the outstanding stock of its management services organization and the sole shareholder sold all of the outstanding stock of the holding company for the Medical Practices to FPA. The aggregate consideration consisted of $2 million cash, $75 million of FPA common stock, a $22 million bridge note receivable and $104 million of Medical Practices' notes payable to the Company which were assumed by FPA. During the year ended December 31, 1997, the FPA common stock was sold and the notes receivable were repaid by FPA. The transaction was consummated in November 1996 and the Company recognized a gain on sale of $20.3 million, net of $17.6 million of taxes, during the quarter ended December 31, 1996. During the year ended December 31, 1997, the Company recognized an additional $10.1 million gain on sale, net of $2.8 million of taxes, based on the final settlement of certain contractual provisions related to the disposition of the Medical Practices. During January and June of 1996, the Company completed the sale of its affiliated independent practice associations ("IPAs") in California, Florida and Arizona to FPA for total consideration of $30 million in cash and notes. Gains of $10.8 million were recognized by the Company during the year ended December 31, 1996 and are included in income from discontinued operations. This segment was accounted for as discontinued operations in 1996. Total revenues (unaudited) for the eleven-month period ended November 30, 1996 were $153.5 million (before intercompany eliminations of $129.5 million) with corresponding net losses from operations of $44.7 million after a tax benefit of $32.4 million. After considering the losses previously accrued, the net income from discontinued operations was $2.9 million. NOTE 4 - INVESTMENTS As of December 31, the amortized cost, gross unrealized holding gains and losses and fair value of the Company's available-for-sale investments were as follows (in thousands):
1998 - ------------------------------------------------------------------------------------------------------------------------ Gross Gross Unrealized Unrealized Amortized Holding Holding Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------------ Asset-backed securities $135,819 $2,120 $ (39) $137,900 U.S. government and agencies 59,527 1,385 (48) 60,864 Obligations of states and other political subdivisions 181,464 2,964 (17) 184,411 Corporate debt securities 57,468 1,539 (36) 58,971 Equity securities 27,103 -- (18,762) 8,341 Other securities 74,409 209 (23) 74,595 - ------------------------------------------------------------------------------------------------------------------------ $535,790 $8,217 $(18,925) $525,082 - ------------------------------------------------------------------------------------------------------------------------
1997 - ------------------------------------------------------------------------------------------------------------------------ Gross Gross Unrealized Unrealized Amortized Holding Holding Fair Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------------ Asset-backed securities $122,313 $ 901 $ (1,537) $121,677 U.S. government and agencies 88,468 808 (269) 89,007 Obligations of states and other political subdivisions 184,399 1,742 (144) 185,997 Corporate debt securities 73,521 704 (122) 74,103 Equity securities 27,943 -- (12,871) 15,072 Other securities 67,087 58 -- 67,145 - ------------------------------------------------------------------------------------------------------------------------ $563,731 $4,213 $(14,943) $553,001 - ------------------------------------------------------------------------------------------------------------------------
At December 31, 1998, the contractual maturities of the Company's available-for-sale investments were as follows (in thousands):
Estimated Cost Fair Value - ---------------------------------------------------------------------- Due in one year or less $104,855 $105,144 Due after one year through five years 170,234 173,512 Due after five years through ten years 61,541 63,490 Due after ten years 36,238 36,695 - ---------------------------------------------------------------------- 372,868 378,841 Asset-backed securities 135,819 137,900 Equity securities 27,103 8,341 - ---------------------------------------------------------------------- Total available for sale $535,790 $525,082 - ----------------------------------------------------------------------
Proceeds from sales and maturities of investments available for sale during 1998 were $718.4 million, resulting in realized gains and losses of $3.6 million and $0.3 million, respectively. Proceeds from sales and maturities of investments available for sale during 1997 were $597.7 million, resulting in realized gains and losses of $4.7 million and $0.1 million, respectively. Proceeds from sales and maturities of investments available for sale during 1996 were $441.6 million, resulting in realized gains and losses of $2.5 million and $0.3 million, respectively. NOTE 5 - PROPERTY AND EQUIPMENT Property and equipment comprised the following at December 31 (amounts in thousands):
1998 1997 - --------------------------------------------------------- Land $ 25,195 $ 28,302 Construction in progress 17,824 19,472 Buildings and improvements 157,056 159,571 Furniture, equipment and software 533,897 526,781 - --------------------------------------------------------- 733,972 734,126 Less accumulated depreciation 388,703 306,977 - --------------------------------------------------------- $345,269 $427,149 - ---------------------------------------------------------
Depreciation expense on property and equipment was $85.8 million, $58.1 million and $67.7 million for the years ended December 31, 1998, 1997 and 1996. Impairment charges in 1998 amounted to $61.2 million (see Note 15). NOTE 6 - NOTES PAYABLE, CAPITAL LEASES AND OTHER FINANCING ARRANGEMENTS Notes payable, capital leases and other financing arrangements comprised the following at December 31 (amounts in thousands):
1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Revolving credit facility, variable interest at LIBOR plus 1.50% at December 31, 1998, unsecured $1,225,000 $1,265,000 Note payable, due December 2000, interest at 7.95%, unsecured 10,500 22,500 Note payable to the California Wellness Foundation, due quarterly with a balloon payment due 2006, variable interest of 2.5% above 3 year Treasury Note auction rate, 8.16% and 10.27% at December 31, 1998 and 1997, respectively, secured by a cash collateral pledge 17,646 18,754 Capital leases and other notes payable 2,892 6,318 - ------------------------------------------------------------------------------------------------------------------------ Total notes payable and capital leases 1,256,038 1,312,572 Less notes payable and capital leases - current portion 1,760 3,593 - ------------------------------------------------------------------------------------------------------------------------ Notes payable and capital leases - noncurrent portion $1,254,278 $1,308,979 - ------------------------------------------------------------------------------------------------------------------------
REVOLVING CREDIT FACILITY The Company established in July 1997, a $1.5 billion credit facility (the "Credit Facility") with Bank of America [as Administrative Agent for the Lenders thereto, as amended in April, July and November 1998 and March 1999 (the "Amendments")]. All previous revolving credit facilities were terminated and rolled into the Credit Facility. At the election of the Company, and subject to customary covenants, loans are initiated on a bid or committed basis and carry interest at offshore or domestic rates, at the applicable LIBOR Rate plus margin or the bank reference rate. Actual rates on borrowings under the Credit Facility vary, based on competitive bids and the Company's unsecured credit rating at the time of the borrowing (6.19% and 5.98% at December 31, 1998 and 1997, respectively). Under the Amendments, the Company's public issuer rating becomes the exclusive means of setting the facility fee and borrowing rates under the Credit Facility. In addition, certain covenants including financial covenants were amended. The Credit Facility is available for five years, until July 2002, but it may be extended under certain circumstances for two additional years. The weighted average annual interest rate on the Company's notes payable and capital leases was approximately 6.30%, 6.24% and 6.39% for the years ended December 31, 1998, 1997 and 1996. The maximum amount outstanding under the Credit Facility during 1998 was $1.39 billion. As of December 31, 1998, the Company was in compliance with the financial covenants of the Credit Facility, as amended in March 1999. Scheduled principal repayments on notes payable, capital leases and other financing arrangements for the next five years are as follows (in thousands): 1999 $ 1,760 2000 11,282 2001 865 2002 1,225,958 2003 1,060 Thereafter 15,113 - --------------------------------------------------------- Total notes payable and capital leases $1,256,038 - ---------------------------------------------------------
NOTE 7 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS The Company has various Stock Option plans which cover certain employees, officers and non-employee directors, and employee stock purchase plans under which substantially all full-time employees of the Company are eligible to participate. The stockholders have approved all of these plans except for the 1998 Stock Option Plan which was adopted by the Company's Board of Directors. Under the 1989, 1990, 1991, 1992, 1993, 1997 and 1998 employee stock option plans and the non-employee director stock option plan, the Company grants options at prices at or above the fair market value of the stock on the date of grant. The options carry a maximum term of up to 10 years and in general vest ratably over three to five years. The Company has reserved a total of 23.2 million shares of its Class A Common Stock for issuance under the stock option plans. Under the 1997 Employee Stock Purchase plans, the Company provides employees with the opportunity to purchase stock through payroll deductions. Eligible employees may purchase on a monthly basis the Company's Class A Common Stock at 85% of the lower of the market price on either the first or last day of each month. Stock option activity and weighted average exercise prices for the years ended December 31 is presented below:
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Number of Exercise Number of Exercise Number of Exercise Options Price Options Price Options Price - --------------------------------------------------------------------------------------------------------------------------- Outstanding at January 1 9,636,831 $29.94 7,051,940 $27.75 6,519,232 $24.44 Granted 8,021,018 14.05 3,912,040 32.18 2,338,031 32.50 Exercised (514,064) 18.64 (830,021) 22.66 (1,237,312) 19.52 Canceled (3,725,312) 30.28 (497,128) 28.61 (568,011) 27.32 - --------------------------------------------------------------------------------------------------------------------------- Outstanding at December 31 13,418,473 $20.87 9,636,831 $29.94 7,051,940 $27.75 - --------------------------------------------------------------------------------------------------------------------------- Exercisable at December 31 4,140,362 5,116,533 4,640,576 - ---------------------------------------------------------------------------------------------------------------------------
The following table summarizes the weighted average exercise price and weighted average remaining contractual life for significant option groups outstanding at December 31, 1998:
Options Outstanding Options Exercisable - ------------------------------------------------------------------------------------------------------------------------ Weighted Average Weighted Weighted Range of Number of Remaining Average Number of Average Exercise Prices Options Contractual Life Exercise Price Options Exercise Price - ------------------------------------------------------------------------------------------------------------------------ $9.88 - $12.25 507,338 9.69 years $11.88 10,338 $11.66 12.57 - 12.94 6,570,228 6.07 years 12.94 11,576 12.61 13.50 - 32.50 5,387,657 7.35 years 28.11 3,165,198 27.29 32.79 - 52.81 953,250 6.33 years 39.45 953,250 39.45 - ------------------------------------------------------------------------------------------------------------------------ $9.88 - $52.81 13,418,473 6.74 years $20.87 4,140,362 $30.01 - ------------------------------------------------------------------------------------------------------------------------
The weighted average fair value for options granted during 1998, 1997 and 1996 was $6.00, $9.95 and $10.46, respectively. The fair values were estimated using the Black-Scholes option-pricing model. The following weighted average assumptions were used in the fair value calculation for 1998, 1997 and 1996, respectively: (i) risk-free interest rate of 4.57%, 5.71% and 6.23%; (ii) expected option lives of 1.9 years, 3.7 years and 2.7 years; (iii) expected volatility of 44.5%, 30.0% and 37.6%; and (iv) no expected dividend yield. The Company applies APB Opinion 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option or employee stock purchase plans. Had compensation cost for the Company's plans been determined based on the fair value at the grant dates of options and employee purchase rights consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below for the years ended December 31 (amounts in thousands, except per share data):
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Net income (loss) As reported $(165,158) $(187,084) $84,231 Pro forma (171,022) (193,638) 69,226 Basic earnings (loss) per share As reported (1.35) (1.52) 0.67 Pro forma (1.40) (1.57) 0.56 Diluted earnings (loss) per share As reported (1.35) (1.52) 0.67 Pro forma (1.40) (1.56) 0.55 - ---------------------------------------------------------------------------------------------------------------
On December 4, 1998, options representing approximately 1.9 million shares of stock granted during 1990 through 1997 at exercise prices ranging from $11.70 to $35.25 were exchanged for options representing approximately 1.4 million shares of stock at an exercise price of $12.94, which was the fair market value of the underlying shares at the grant date. As fair value criteria was not applied to option grants and employee purchase rights prior to 1995, and additional awards in future years are anticipated, the effects on net income and earnings per share in this pro forma disclosure may not be indicative of future amounts. NOTE 8 - CAPITAL STOCK The Company has two classes of Common Stock. The Company's Class B Common Stock has the same economic benefits as the Company's Class A Common Stock but is non-voting. Upon the sale or transfer of shares of Class B Common Stock by the California Wellness Foundation (the "CWF") to an unrelated third party, such shares automatically convert into Class A Common Stock. The CWF is the only holder of record of the Company's Class B Common Stock. PUBLIC OFFERING On May 15, 1996, the Company completed a public offering in which the Company sold 3,194,374 shares of Class A Common Stock and the CWF sold 6,386,510 shares of Class A Common Stock (constituting 6,386,510 shares of Class B Common Stock which automatically converted into shares of Class A Common Stock upon the sale) for a per share purchase price to the public of $30.00 (the "Offering"). The net proceeds received by the Company from the sale of the 3,194,374 shares of Class A Common Stock were approximately $92.4 million after deducting underwriting discounts and commissions and estimated expenses of the Offering payable by the Company. The Company used its net proceeds from the Offering to repurchase 3,194,374 shares of Class A Common Stock from certain Class A Stockholders. The Company repurchased these shares of Class A Common Stock from the Class A Stockholders at $30.00 per share less transaction costs associated with the Offering, amounting to $1.08 per share. All of these 3,194,374 shares of Class A Common Stock repurchased are currently held in treasury. The Company did not receive any of the proceeds from the sale of shares of Class A Common Stock in the Offering by the CWF. On June 27, 1997, the Company redeemed 4,550,000 shares of Class B Common Stock from the CWF at a price of $24.47 per share. The Company provided its consent to permit the CWF to sell 3,000,000 shares of Class B Common Stock to an unrelated third party in June of 1997 and to sell 450,000 shares of Class B Common Stock to unrelated third parties throughout August of 1997. On November 6, 1997, the Company also provided its consent to permit the CWF to sell 1,000,000 shares of Class B Common Stock to an unrelated third party. In addition, effective June 18, 1998, the Company gave its consent to permit the CWF to sell (and the CWF sold) 5,250,000 shares of Class B Common Stock to an unrelated third party. Pursuant to the Company's Certificate of Incorporation, all of such shares of Class B Common Stock automatically converted into shares of Class A Common Stock in the hands of such third parties. SHAREHOLDER RIGHTS PLAN On May 20, 1996, the Board of Directors of the Company declared a dividend distribution of one right (a "Right") for each outstanding share of the Company's Class A Common Stock and Class B Common Stock (collectively, the "Common Stock"), to stockholders of record at the close of business on July 31, 1996 (the "Record Date"). The Board of Directors of the Company also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the Distribution Date (as defined below), the redemption of the Rights, and the expiration of the Rights and in certain other circumstances Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights Certificates will be distributed. The Rights will separate from the Common Stock in the event any person acquires 15% or more of the outstanding Class A Common Stock, the Board of Directors of the Company declares a holder of 10% or more of the outstanding Class A Common Stock to be an "Adverse Person," or any person commences a tender offer for 15% of the Class A Common Stock (each event causing a "Distribution Date"). Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder, upon the occurrence of a Distribution Date, to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, at a price of $170.00 per one-thousandth share. However, in the event any person acquires 15% or more of the outstanding Class A Common Stock, or the Board of Directors of the Company declares a holder of 10% or more of the outstanding Class A Common Stock to be an "Adverse Person," the Rights (subject to certain exceptions contained in the Rights Agreement) will instead become exercisable for Class A Common Stock having a market value at such time equal to $340.00. The Rights are redeemable under certain circumstances at $.01 per Right and will expire, unless earlier redeemed, on July 31, 2006. In connection with the FHS Combination, the Company entered into Amendment No. 1 to the Rights Agreement to exempt the FHS Combination and related transactions from triggering the Rights. In addition, the amendment modified certain terms of the Rights Agreement applicable to the determination of certain "Adverse Persons," which modifications became effective upon consummation of the FHS Combination. NOTE 9 - EMPLOYEE BENEFIT PLANS DEFINED CONTRIBUTION RETIREMENT PLANS The Company and certain subsidiaries sponsor defined contribution retirement plans intended to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended (the "Code"). Participation in the plans is available to substantially all employees who meet certain eligibility requirements and elect to participate. Employees may contribute up to the maximum limits allowed by Sections 401(k) and 415 of the Code, with Company contributions based on matching or other formulas. The Company's expense under the plans totaled $7.4 million, $4.2 million and $5.1 million for the years ended December 31, 1998, 1997 and 1996, respectively. DEFERRED COMPENSATION PLANS Effective May 1, 1998, the Company adopted a deferred compensation plan pursuant to which certain management and highly compensated employees are eligible to defer between 5% and 50% of their regular compensation and between 5% and 100% of their bonuses, and non-employee Board members are eligible to defer up to 100% of their directors compensation. The compensation deferred under such plan is credited with earnings or losses measured by the rate of return on investments elected by plan participants. Each plan participant is fully vested in all deferred compensation and earnings credited to his or her account. Prior to May 1997, certain members of management, highly compensated employees and non-employee Board members were permitted to defer payment of up to 90% of their compensation under a prior deferred compensation plan (the "Prior Plan"). As part of the FHS Combination, the Prior Plan was frozen in May 1997 at which time each participant's account was credited with three times the 1996 Company match (or a lesser amount for certain prior participants) and each participant became 100% vested in all such contributions. The current provisions with respect to the form and timing of payments under the Prior Plan remain unchanged. At December 31, 1998 and 1997, the liability under these Plans amounted to $27.9 million and $29.3 million, respectively. The Company's expense under these Plans totaled $6.1 million, $7.8 million and $3.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS RETIREMENT PLANS - In 1995, the Company adopted two unfunded non-qualified defined benefit pension plans, a Supplemental Executive Retirement Plan and a Directors' Retirement Plan (collectively, the "FHC SERPs"). In 1996, the Company adopted two additional unfunded non-qualified defined benefit pension plans, a Supplemental Executive Retirement Plan and a Directors' Retirement Plan (collectively, the "HSI SERPs"). These plans cover key executives, as selected by the Board of Directors, and non-employee directors. Benefits under the plans are based on years of service and level of compensation. As part of the FHS Combination, the FHC SERPs were frozen in April 1997 at which time each participant became 100% vested in his or her benefits under the plans which are equal to 90% of the actuarial equivalent of the participant's retirement benefit as of December 31, 1996. All benefits under the FHC SERPs were paid out either in cash, or as a rollover to the deferred compensation plan. POSTRETIREMENT HEALTH AND LIFE PLANS - Certain subsidiaries of the Company sponsor postretirement defined benefit health care plans that provide postretirement medical benefits to directors, key executives, employees and dependents who meet certain eligibility requirements. Under these plans, the Company pays a percentage of the costs of medical, dental and vision benefits during retirement. The plans include certain cost-sharing features such as deductibles, coinsurance and maximum annual benefit amounts which vary based principally on years of credited service. On December 31, 1998, the Company adopted SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("FAS 132"), which revises employers' disclosures about pension and other postretirement benefit plans. FAS 132 standardizes the disclosure requirements. The Company has chosen to disclose the information required by FAS 132 by aggregating retirement plans into one category and postretirement plans into another category. The following table sets forth the plans' funded status and amounts recognized in the Company's financial statements:
Pension Benefits Other Benefits ------------------------- ------------------------- (in thousands) 1998 1997 1998 1997 - ---------------------------------------------------------------------------------------- ------------------------- Change in benefit obligation: Benefit obligation, beginning of year $ 7,018 $ 5,540 $1,084 $ 1,142 Service cost 1,463 1,122 -- -- Interest cost 674 417 73 86 Plan amendments 1,501 -- 23 -- Benefits paid (188) -- (138) (43) Actuarial loss (gain) 3,479 (61) (46) (101) - ---------------------------------------------------------------------------------------- ------------------------- Projected benefit obligation, end of year $ 13,947 $ 7,018 $ 996 $ 1,084 - ---------------------------------------------------------------------------------------- ------------------------- Change in fair value of plan assets: Plan assets, beginning of year $ -- -- $-- $-- Actual return on plan assets -- -- -- -- Employer contribution 188 -- 138 43 Benefits paid (188) -- (138) (43) - ---------------------------------------------------------------------------------------- ------------------------- Plan assets, end of year -- -- -- -- - ---------------------------------------------------------------------------------------- ------------------------- Funded status of plans $(13,947) $(7,018) $ (996) $(1,084) Unrecognized transition obligation -- -- -- -- Unrecognized prior service cost 5,417 4,209 539 552 Unrecognized (gain)/loss 834 (713) (432) (421) - ---------------------------------------------------------------------------------------- ------------------------- Net amount recognized $ (7,696) $(3,522) $ (889) $ (953) - ---------------------------------------------------------------------------------------- ------------------------- Prepaid benefit cost: Accrued benefit liability $ (9,391) $(4,572) $ (889) $ (953) Intangible asset 1,695 1,050 -- -- - ---------------------------------------------------------------------------------------- ------------------------- Net amount recognized $ (7,696) $(3,522) $ (889) $ (953) - ---------------------------------------------------------------------------------------- -------------------------
The components of net periodic benefit costs for the years ended December 31, 1998, 1997 and 1996 are as follows:
Pension Benefits Other Benefits -------------------------------------- ------------------------------------- (in thousands) 1998 1997 1996 1998 1997 1996 - -------------------------------------------------------------------------- ------------------------------------- Service cost $1,463 $1,122 $1,066 $-- $-- $ 94 Interest cost 674 418 348 74 86 48 Amortization of unrecognized transition obligation -- -- -- -- 10 14 Amortization of unrecognized prior service cost 293 293 293 37 37 22 Amortization of unrecognized (gain)/loss 37 (17) -- (24) (6) 3 - -------------------------------------------------------------------------- ------------------------------------- 2,467 1,816 1,707 87 127 181 Cost of subsidiary plan curtailment 1,896 -- -- (13) 531 -- - -------------------------------------------------------------------------- ------------------------------------- Net periodic benefit cost $4,363 $1,816 $1,707 $74 $658 $181 - -------------------------------------------------------------------------- -------------------------------------
The projected benefit obligation, accumulated benefit obligation and plan assets for the pension plan were $13,947,000, $9,391,000, and $0 at December 31, 1998, respectively, and $7,018,000, $4,572,000, and $0 at December 31, 1997, respectively. The weighted average annual discount rate assumed was 6.75% and 7.25% for the years ended December 31, 1998 and 1997, respectively, for both pension benefit plans and other postretirement benefit plans. Weighted average compensation increases of 6% for the years ended December 31, 1998 and 1997 were assumed for the pension benefit plans. For measurement purposes, a 6.25% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1998, and 6.5% was assumed for 1997. These rates were assumed to decrease gradually to 4.5% in 2006 for 1998 and 2005 for 1997 and remain at that level thereafter. The Company has multiple postretirement benefit plans. The Company acquired PACC effective September 30, 1997, including its frozen post-retirement benefit plan. The PACC plan is non-contributory. The FHC plan is contributory by certain participants. The account for the FHC plan anticipates future cost-sharing changes to the plan consistent with the Company's expressed intent to increase retiree contributions at the same rate as the Company's premium increases. A one-percentage-point change in assumed health care cost trend rates would have the following effects (amounts in thousands):
1-percentage 1-percentage point increase point decrease - -------------------------------------------------------------------- Effect on total of service and interest cost, 1998 11 (9) Effect on postretirement benefit obligation, 12/31/98 102 (84) - --------------------------------------------------------------------
The Company has no minimum pension liability adjustment to be included in comprehensive income. PERFORMANCE BASED ANNUAL BONUS PLAN In 1998, the Company adopted a Performance-Based Annual Bonus Plan that qualified under Section 162(m) of the Code (the "162(m) Plan"). Under the 162(m) Plan, if the Company achieved greater than $250 million in consolidated income from operations before taxes (as determined under GAAP consistently applied, excluding any nonrecurring or extraordinary charges), certain executives were potentially eligible to receive cash bonuses from a pool of $7.5 million based on the executives' salaries in relation to the pool. Amounts payable to such executives from such pool were subject to downward adjustment by the Company's Compensation and Stock Option Committee of the Board of Directors. The $250 million performance goal for the 162(m) Plan was not met for 1998. NOTE 10 - INCOME TAXES Significant components of the provision (benefit) for income taxes are as follows for the years ended December 31:
(in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------- Current: Federal $ 6,346 $(12,894) $13,687 State 3,897 3,183 2,593 - ----------------------------------------------------------------------------------- Total current 10,243 (9,711) 16,280 - ----------------------------------------------------------------------------------- Deferred: Federal (121,800) (57,150) 7,420 State (7,630) (5,478) 1,123 - ----------------------------------------------------------------------------------- Total deferred (129,430) (62,628) 8,543 - ----------------------------------------------------------------------------------- Total provision (benefit) for income taxes $(119,187) $(72,339) $24,823 - -----------------------------------------------------------------------------------
Income tax expense (benefit) is included in the consolidated financial statements as follows for the years ended December 31:
(in thousands) 1998 1997 1996 - -------------------------------------------------------------------- Continuing operations $ (88,996) $(21,418) $14,124 Discontinued operations (30,191) (50,921) 10,699 - -------------------------------------------------------------------- Total provision (benefit) for income taxes $(119,187) $(72,339) $24,823 - --------------------------------------------------------------------
A reconciliation of the statutory federal income tax rate and the effective income tax rate on income from continuing operations is as follows for the years ended December 31:
1998 1997 1996 - -------------------------------------------------------------- Statutory federal income tax rate (35)% (35)% 35% State and local taxes, net of federal income tax effect (1) (3) 3 Tax exempt interest income (1) (2) (3) Goodwill amortization 6 6 6 Valuation allowance adjustment -- (2) (5) Merger transaction costs (3) 8 -- Pooling transactions -- -- (4) IRS settlement -- -- (4) Other, net (1) 4 (1) - -------------------------------------------------------------- Effective income tax rate (35)% (24)% 27% - --------------------------------------------------------------
Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows:
(in thousands) 1998 1997 - ----------------------------------------------------------------------------- DEFERRED TAX ASSETS: Accrued liabilities $ 91,993 $ 70,547 Accrued compensation and benefits 31,097 28,150 Restructuring reserves 30,462 30,057 Net operating loss carryforwards 190,913 140,862 Other, net 9,283 1,524 - ----------------------------------------------------------------------------- Deferred tax assets before valuation allowance 353,748 271,140 Valuation allowance (48,452) (57,445) - ----------------------------------------------------------------------------- Net deferred tax assets $305,296 $213,695 - ----------------------------------------------------------------------------- DEFERRED TAX LIABILITIES: Depreciable and amortizable property $ 26,077 $ 66,608 Other, net 14 839 - ----------------------------------------------------------------------------- Deferred tax liabilities $ 26,091 $ 67,447 - -----------------------------------------------------------------------------
As of December 31, 1998, the Company had federal net operating loss carryforwards of approximately $469.0 million of which $111.0 million may be subject to carryover limitations under Section 382 of the Internal Revenue Code. A valuation allowance has been provided to account for the potential limitations associated with utilization of net operating loss carryforwards. The net operating loss carryforwards expire between 2006 and 2018. Noncurrent deferred tax assets of $144.9 million at December 31, 1998 are included, net of noncurrent deferred tax liabilities of $26.1 million, in other noncurrent assets. Noncurrent deferred tax liabilities at December 31, 1997 of $67.4 million are included in other noncurrent liabilities. The valuation allowance increase of $56.2 million in 1997 (decreased by $9.0 million in 1998) was due to the acquisition of a subsidiary for which the future realizability of such subsidiary's deferred tax assets, primarily related to net operating loss carryforwards, is uncertain. In the event that the deferred tax assets related to this subsidiary are realized, the future tax benefits will be allocated to reduce the associated goodwill. NOTE 11 - REGULATORY REQUIREMENTS All of the Company's health plans as well as its insurance subsidiaries are required to periodically file financial statements with regulatory agencies in accordance with statutory accounting and reporting practices. Under the California Knox Keene Health Care Service Plan Act of 1975, as amended, California plans must comply with certain minimum capital or tangible net equity requirements. The Company's non-California health plans, as well as its health and life insurance companies, must comply with their respective state's minimum regulatory net worth requirements generally under the regulation of the respective state's department of insurance and in certain cases, maintain minimum investment amounts for the restricted use of the regulators which as of December 31, 1998 totaled $127.3 million. Also, under certain government contracts, certain subsidiaries are required to maintain a current ratio of 1:1. As a result of the above requirements and certain other regulatory requirements, certain subsidiaries are subject to restrictions on their ability to make dividend payments, loans or other transfers of cash to the Company. Such restrictions, unless amended or waived, limit the use of any cash generated by these subsidiaries to pay obligations of the Company. Management believes that as of December 31, 1998, substantially all of the Company's health plans and insurance subsidiaries met their respective regulatory requirements. NOTE 12 - COMMITMENTS AND CONTINGENCIES LEGAL PROCEEDINGS Complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA at various times between February 3, 1997 and May 15, 1998. The complaints allege that the Company and certain former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 agreement between the Company and FPA, about FPA's business and about the Company's 1997 sale of FPA common stock held by the Company. Management believes these suits are without merit and intends to vigorously defend the actions. The Company is involved in various other legal proceedings, which are routine in its business. In the opinion of management, based upon current facts and circumstances known by the Company, the resolution of these matters should not have a material adverse effect on the financial position or results of operations of the Company. OPERATING LEASES The Company leases administrative and medical office space under various operating leases. Certain medical office space is subleased to participating medical groups doing business with the Company. Certain leases contain renewal options and rent escalation clauses. In 1995, the Company entered into a $60 million tax retention operating lease with NationsBank of Texas, N.A., as Administrative Agent for the Lenders who are parties thereto, and First Security Bank of Utah, N.A., as Owner Trustee, (the "TROL Agreement") for the construction of health care centers and corporate facilities. Under the TROL Agreement, rental payments commence upon completion of construction, with a guarantee of 87% to the lessor of the residual value of properties leased at the end of the lease term. After the initial five year noncancelable lease term, the lease may be extended by agreement of the parties or the Company must purchase or arrange for sale of the leased properties. The Company has committed to a guaranteed residual value of $35.3 million under this agreement at December 31, 1998. Future minimum lease commitments for noncancelable operating leases at December 31, 1998 are as follows (amounts in thousands): 1999 $ 47,933 2000 41,084 2001 36,161 2002 22,453 2003 12,203 Thereafter 9,582 - ------------------------------------------ Total minimum lease commitments $169,416 - ------------------------------------------
Rent expense totaled $50.3 million, $48.7 million and $46.8 million in 1998, 1997 and 1996, respectively. NOTE 13 - RELATED PARTIES Two current directors of the Company and one prior director are partners in law firms which received legal fees totaling $1.0 million, $1.1 million, and $1.0 million in 1998, 1997, and 1996, respectively. One current director is an officer of IBM which the Company paid $8.0 million for services in 1998, and one current director is also a director of a temporary staffing company which the Company paid $20.4 million for services in 1998. An officer of a contracted hospital was also a member of the Company's Board of Directors until April 1, 1997. Medical costs paid to the provider totaled $67.1 million and $58.7 million in 1997 and 1996, respectively. Such contracted hospital is also an employer group of the Company from which the Company receives premium revenues at standard rates. NOTE 14 - ASSET IMPAIRMENT, MERGER, RESTRUCTURING AND OTHER CHARGES The following sets forth the principal components of merger, restructuring and other costs for the year ended December 31:
(amounts in millions) 1998 1997 1996 - ----------------------------------------------------------- Severance and benefit related costs $ 21.2 $ 61.4 $ 5.4 Provider network consolidation costs -- 36.2 -- Asset impairment costs -- 44.0 17.4 Real estate lease termination costs -- 5.2 4.6 - ----------------------------------------------------------- Total restructuring costs 21.2 146.8 27.4 Asset impairments and other charges related to FPA Medical Management 84.1 -- -- Asset impairment charges and other 112.4 -- -- Merger related costs -- 69.6 -- Gem costs -- 57.5 -- Other costs 57.3 122.0 16.7 - ----------------------------------------------------------- Total $275.0 $395.9 $44.1 - -----------------------------------------------------------
1998 CHARGES On July 19, 1998, FPA Medical Management, Inc. ("FPA") filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. FPA, through its affiliated medical groups, provided services to approximately 190,000 of the Company's affiliated members in Arizona and California. FPA has discontinued its medical group operations in these markets. As a result, the Company is seeking new tenants for, or will sell, the 13 healthcare facilities it leased to FPA in these markets and has made other arrangements for provider services to the Company's affiliated members. Based on these events and circumstances, management believes that the likely replacement lease terms from these properties or the net proceeds from a sale of the facilities will be inadequate to enable the Company to 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 recorded charges totaling approximately $84.1 million which was comprised of $63.0 million for real estate asset impairments, $10.0 million for a note receivable impairment and $11.1 million for other items. During the third quarter ended September 30, 1998, excluding $28.1 million related to the FPA bankruptcy as discussed above, the Company recorded $146.9 million of restructuring and other charges. These charges were primarily related to severance costs of $21.2 million related to staff reduction in selected health plans and the corporate centralization and consolidation; other special charges totaling $38.7 million which included the adjustment of amounts due from a hospital system that filed bankruptcy totaling $18.6 million, premium deficiency reserves for certain of the Company's non-core health plans totaling $12.0 million and $8.1 million related to other items. Other charges not included in the table above totaling $87.0 million were mostly related to contractual adjustments and were primarily included in health care costs within the consolidated statement of operations. As of December 31, 1998, $40.9 million of the total $175 million has resulted in cash outlays and $27.5 million is expected to require future outlays of cash. During the fourth quarter ended December 31, 1998, the Company recorded impairment and other charges totaling $185.9 million. Of this amount, $112.4 million related to impairment of certain long-lived assets to be disposed of (see Note 15). The Company recorded $18.6 million of other charges primarily related to litigation in the normal course of business. The Company also recorded other charges not included in the table above totaling $54.9 million primarily related to bad debts, claims and premium deficiency reserves for certain health plans whose health care costs exceeded the contractual premiums. These charges are included as part of health plan services and selling, general and administrative expenses within the consolidated statement of operations. 1997 CHARGES RESTRUCTURING COSTS - In connection with the FHS Combination, the Company adopted a restructuring plan effective June 30, 1997 (the "June 1997 Plan"), the principal elements of which include: a workforce reduction of approximately 1,050 employees, the consolidation of employee benefit plans, the consolidation of facilities in geographic locations where office space is duplicated, the consolidation of overlapping provider networks, and the consolidation of information systems at all locations to standardized systems. The June 1997 Plan, which is substantially completed as of December 31, 1998, resulted in a restructuring charge of $185.5 million for the quarter ended June 30, 1997. Severance and benefit related costs include a termination benefits plan and contractually required change of control payments to senior executives. Also included are the costs of settlements of benefit plans terminated as a result of the restructuring plan to conform benefits for the merged companies. Provider network consolidation costs include costs to consolidate overlapping provider networks, primarily in California, and the costs of exiting existing provider contracts as legally, regulatory or administratively required. Real estate lease termination costs include facilities consolidation costs primarily in geographic regions where there is overlapping office space usage. Asset impairment costs are primarily a result of the Company's plan to be on common operating systems and hardware platforms. These costs include impairment of hardware, software and other systems related assets. During December 1997, the Company adopted a restructuring plan (the "December 1997 Plan") and recorded a $6.0 million restructuring charge related to the Company's Eastern Division health plans before a $2.7 million reduction for the December 1996 Plan (see "1996 Charges"). The plan relates to the integration of the Company's Eastern Division operations in connection with its acquisition of PHS and FOHP in 1997. The Company also recorded a credit of $44.7 million for previously recorded restructuring charges during the fourth quarter of 1997. The credit consists of $42.0 million for the June 1997 Plan and $2.7 million for the December 1996 Plan (see "1996 Charges"). The restructuring credits to the June 1997 Plan resulted from the following: $22.2 million from the Company's determination to continue to operate certain facilities originally identified for lease termination, $9.7 million from reductions to initially anticipated involuntary severance costs, $8.1 million from reductions to certain anticipated provider network consolidation and other contract termination costs and $2.0 million in reductions to asset impairment costs primarily related to the reclassification of workers' compensation insurance subsidiaries related charges to discontinued operations. Of the $146.8 million in net restructuring costs recorded as part of the 1997 plans, $86.9 million represented cash payments and $42.2 million noncash activities through December 31, 1998. As of December 31, 1998, $13.8 million is expected to require future outlays of cash and $3.9 million represents future noncash activities. MERGER COSTS - In connection with the June 1997 Plan, $69.6 million in merger costs were recorded. The significant components of the charge include the following: $22.6 million of transaction costs, primarily consisting of investment banking, legal, accounting, filing and printing fees; $22.7 million of merger consulting costs; $5.9 million of former senior executive consulting costs; $2.4 million of directors and officers liability coverage required by the merger agreement; $9.6 million in costs to consolidate debt facilities; and $6.4 million of other merger related costs. OTHER COSTS - During the quarters ended June 30, and December 31, 1997, $89.7 million and $32.3 million, respectively, in other costs were recorded. The significant components of the charge included the following: $30.5 million for receivables related to provider contracts that will not be renewed; $17.2 for government receivables related to prior contracts and adjustments on current contracts being negotiated with the Department of Defense; $15.1 million for litigation settlement estimates primarily related to former FHC subsidiaries; $12.6 million for the loss on sale of the United Kingdom operations; $16.1 million for loss contract accruals, including $10.1 million related to the Company's health plans in Texas, Louisiana and Oklahoma; $7.7 million related to contract termination costs; $8.2 million in other receivables; and $14.6 million of other costs. These costs are shown as other costs on the Company's consolidated statement of operations because of their nature. If not for their nature, approximately $53.8 million would have been recorded as health plan services, $38.4 million as selling, general and administrative and $17.2 million as government health care services. GEM COSTS - The Company established a premium deficiency of $57.5 million related to the Company's Gem Insurance Company ("Gem") during the year ended December 31, 1997. During the quarter ended June 30, 1997, the Company had reached a definitive agreement regarding a reinsurance transaction with The Centennial Life Insurance Company ("Centennial"). Pursuant to this agreement, Centennial was to reinsure and manage Gem's accident and health, life and annuity policies in exchange for a reinsurance premium. The cost of the reinsurance along with the write-down of certain Gem assets that were not recoverable based on the terms of the agreement totaled $57.5 million. The transaction was not ultimately consummated due to the unanticipated failure to satisfy certain closing conditions, including the failure to receive certain regulatory approvals. Gem established a reserve for the estimated premium deficiency related to these policies for the intervening period. As of December 31, 1998, this charge was substantially completed. 1996 CHARGES During 1996, the Company recorded restructuring costs of $27.4 million which included $5.4 million of executive and other involuntary severance costs, $17.4 million of software, hardware and other asset impairment costs, and $4.6 million of facilities consolidation costs (the "December 1996 Plan"). As stated above under "1997 Costs," $2.7 million in reductions to the December 1996 Plan were recorded during 1997 as a result of the Company's decision to continue to operate certain facilities originally identified for lease termination. The Company also recorded $16.7 million of other costs in 1996 including loss contract accruals related to governmental employer groups in the Company's non-California markets, consulting and other costs. If not for their unusual nature, approximately $8.5 million of these costs would have been recorded as health plan services and $8.2 million as selling, general and administrative expenses. No further costs are expected. NOTE 15 - IMPAIRMENT OF LONG-LIVED ASSETS During 1998, the Company initiated a formal plan to dispose of certain Central Division health plans included in the Company's Health Plan Services segment in accordance with previously disclosed anticipated divestitures program. It is anticipated that the sales of these health plans will be completed during the first half of 1999. Pursuant to SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," the Company evaluated the carrying values of the assets for these health plans and determined that they exceeded their estimated fair values. Accordingly, in the fourth quarter of 1998, the Company adjusted the carrying value of these long-lived assets to their estimated fair value, resulting in a noncash asset impairment charge of approximately $112.4 million (see Note 14). This asset impairment charge of $112.4 million consists of $40.3 million for write-down of furniture, equipment and software, $20.9 million write-down of buildings and improvements, $30.0 million for write-down of goodwill and $21.2 million for other impairments and other charges. The fair value is based on expected net realizable value. NOTE 16 - SEGMENT INFORMATION As of December 31, 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes annual and interim reporting standards for an enterprise's reportable segments and related disclosures about its products, services, geographic areas and major customers. Under SFAS 131, reportable segments are to be defined on a basis consistent with reports used by management to assess performance and allocate resources. The Company's reportable segments are business units that offer different products to different classes of customers. The Company has two reportable segments: Health Plan Services and Government Contracts/Specialty Services. The Health Plan Services segment provides a comprehensive range of health care services through HMO and PPO networks. The Government Contracts/Specialty Services segment administers large, multi-year managed care government contracts and also offers behavioral, dental, vision, and pharmaceutical products and services. The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies, except intersegment transactions are not eliminated. Presented below are segment data for the three years in the period ended December 31, 1998 (amounts in thousands):
Government Contracts/ Health Plan Specialty 1998 Services Services Other Total - ---------------------------------------------------------------------------------------------------------- Revenues from external sources $7,440,981 $1,356,054 $ -- $8,797,035 Intersegment revenues 16,388 234,380 -- 250,768 Investment and other income 69,760 18,110 16,011 103,881 Interest expense 11,937 805 1,927 14,669 Depreciation and amortization 87,579 15,104 2,074 104,757 Asset impairment costs(i) 147,596 5,200 15,162 167,958 Restructuring, merger and other charges(i) 7,107 -- 19,871 26,978 Segment profit (loss)(i) (154,613) 113,832 (33,161) (73,942) Segment assets 2,799,484 1,099,368 142,143 4,040,995 - --------------------------------------------------------------------------------------------------------------
(i) Asset impairment, restructuring, merger and other charges exclude $135.9 million of other charges which were primarily included in health plan services expenses.
Government Contracts/ Health Plan Specialty 1997 Services Services Other Total - ----------------------------------------------------------------------------------------------------------- Revenues from external sources $5,829,444 $1,291,275 $ -- $7,120,719 Intersegment revenues 28,487 304,678 -- 333,165 Investment and other income 72,351 19,248 13,906 105,505 Interest expense 8,474 1,443 2,243 12,160 Depreciation and amortization 67,952 9,648 2,019 79,619 Restructuring, merger and other charges 181,165 40,399 315 221,879 Segment profit (loss) 14,864 58,332 655 73,851 Segment assets 3,457,663 527,859 87,052 4,072,574 - -----------------------------------------------------------------------------------------------------------
Government Contracts/ Health Plan Specialty 1996 Services Services Other Total - ----------------------------------------------------------------------------------------------------------- Revenues from external sources $5,395,125 $1,225,723 $ -- $6,620,848 Intersegment revenues 20,108 297,378 -- 317,486 Investment and other income 63,211 8,808 11,180 83,199 Interest expense 5,460 1,071 672 7,203 Depreciation and amortization 88,369 9,505 348 98,222 Restructuring, merger and other charges 19,708 4,500 -- 24,208 Segment profit (loss) 45,777 18,052 -- 63,829 - ------------------------------------------------------------------------------------------------------------
The following are reconciliations of reportable segment revenues, profit or loss, segment assets, and other significant items for the three years in the period ended December 31, 1998 (amounts in thousands):
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Revenues: Total external revenues $ 8,797,035 $ 7,120,719 $6,620,848 Total intersegment revenues 250,768 333,165 317,486 Eliminations (250,768) (333,165) (317,486) - --------------------------------------------------------------------------------------------------------------------------- Consolidated $ 8,797,035 $ 7,120,719 $6,620,848 - --------------------------------------------------------------------------------------------------------------------------- Profit or Loss: Total for reportable segments $ (73,942) $ 73,851 $ 63,829 Other (180,212) (163,099) (10,875) - --------------------------------------------------------------------------------------------------------------------------- Total income before taxes $ (254,154) $ (89,248) $ 52,954 - --------------------------------------------------------------------------------------------------------------------------- Assets: Total for reportable segments $ 4,040,995 $ 4,072,574 Other 2,125,045 1,461,276 Eliminations (2,236,499) (1,457,500) - ------------------------------------------------------------------------------------------------------ Consolidated $ 3,929,541 $ 4,076,350 - ------------------------------------------------------------------------------------------------------ Investment and other income: Total for reportable segments $ 103,881 $ 105,505 $ 83,199 Other 28,698 38,815 19,904 Eliminations (33,538) (30,020) (14,711) - --------------------------------------------------------------------------------------------------------------------------- Consolidated $ 99,041 $ 114,300 $ 88,392 - --------------------------------------------------------------------------------------------------------------------------- Interest expense: Total for reportable segments $ 14,669 $ 12,160 $ 7,203 Other 95,396 62,998 45,407 Eliminations (17,906) (11,603) (7,238) - --------------------------------------------------------------------------------------------------------------------------- Consolidated $ 92,159 $ 63,555 $ 45,372 - --------------------------------------------------------------------------------------------------------------------------- Depreciation and amortization: Total for reportable segments $ 104,757 $ 79,619 $ 98,222 Other 23,336 18,734 14,694 - --------------------------------------------------------------------------------------------------------------------------- Consolidated $ 128,093 $ 98,353 $ 112,916 - --------------------------------------------------------------------------------------------------------------------------- Asset impairment: Total for reportable segments $ 167,958 $ -- $ -- Other 31,538 44,300 17,400 - --------------------------------------------------------------------------------------------------------------------------- Consolidated $ 199,496 $ 44,300 $ 17,400 - --------------------------------------------------------------------------------------------------------------------------- Merger, restructuring and other charges: Total for reportable segments $ 26,978 $ 221,879 $ 24,208 Other 48,479 129,746 2,500 - --------------------------------------------------------------------------------------------------------------------------- Consolidated $ 75,457 $ 351,625 $ 26,708 - ---------------------------------------------------------------------------------------------------------------------------
The reconciling amounts to adjust total reportable segment amounts to consolidated amounts represent amounts from non-reportable operating segments comprised primarily of corporate units. NOTE 17 - QUARTERLY INFORMATION (UNAUDITED) The following restated interim financial information presents the 1998 and 1997 results of operations on a quarterly basis (in thousands, except per share data) (see Note 1):
March 31 June 30 September 30 December 31 - --------------------------------------------------------------------------------------------------------------------------- 1998: Total revenues $2,175,374 $2,236,971 $2,213,954 $2,269,777 Income (loss) from continuing operations before income taxes 43,262 1,529 (127,572) (171,373) Income (loss) from continuing operations 26,238 956 (88,619) (103,733) Net income (loss) 26,238 956 (88,619) (103,733) BASIC AND DILUTED EARNINGS (LOSS) PER SHARE Continuing operations 0.22 0.01 (0.73) (0.85) Net 0.22 0.01 (0.73) (0.85) - --------------------------------------------------------------------------------------------------------------------------- March 31 June 30 September 30 December 31 - --------------------------------------------------------------------------------------------------------------------------- 1997: Total revenues $1,770,019 $1,773,422 $1,793,379 $1,898,199 Income (loss) from continuing operations before income taxes 78,683 (313,108) 97,081 48,096 Income (loss) from continuing operations 47,624 (205,792) 59,803 30,535 Net income (loss) 58,481 (200,128) 68,901 (114,338) BASIC AND DILUTED EARNINGS (LOSS) PER SHARE(I) Continuing operations 0.38 (1.64) 0.49 0.25 Net 0.47 (1.60) 0.57 (0.94) - ---------------------------------------------------------------------------------------------------------------------------
(i) The sum of quarterly earnings (loss) per share amounts may not equal the year-to-date earnings (loss) per share amounts due to transactions affecting the weighted average number of shares outstanding in each quarter. NOTE 18 - SUBSEQUENT EVENTS In February 1999, the Company entered into a definitive agreement to sell all of the outstanding shares of its pharmacy benefit management subsidiary, Foundation Health Pharmaceutical Services, Inc., for $70 million in cash. Completion of the transaction is subject to certain closing conditions, and is expected to close in the first half of 1999. In March 1999, the Company signed a letter of intent to sell its Colorado health plan subsidiary. The completion of the transaction will be subject to reaching a definitive agreement and various conditions, including the receipt of all necessary regulatory approvals and other customary closing conditions. In March 1999, the Company also entered into a definitive agreement to sell all of the outstanding shares of its New Mexico health plan subsidiary. Completion of the transaction is subject to various conditions and certain regulatory approvals. EX-21.1 20 EXHIBIT 21.1 Ex. 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) (2) -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) (3) -HSI Eastern Holdings, Inc. (PA) -Greater Atlantic Health Service, Inc. (DE) -QualMed Plans for Health, Inc. (PA) -Greater Atlantic Preferred Plus, Inc. (PA) -Employ Better Care, Inc. (PA) -Foundation Health Corporation (DE) -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, A Louisiana Health Plan, Inc. (LA) -Foundation Health, An Oklahoma Health Plan, Inc. (OK) -Foundation Health, A Texas Health Plan, Inc. (TX) -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) --MHN Services IPA, Inc. (NY) -WC Division, Inc. (CA) -Foundation Health Medical Resource Management (CA) -Foundation Integrated Risk Management Solutions, Incorporated (CA) -AXIS Integrated Resources, Inc. (DE) -Gem Holding Corporation (UT) (4) -Gem Insurance Company (UT) -QualMed Plans for Health of Pennsylvania, Inc. (PA) -FOHP, Inc. (NJ) (5) -Physicians Health Services 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 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) *All subsidiaries wholly owned unless otherwise indicated. (1) A limited partnership in which QualMed Plans for Health of Colorado, Inc. is an 83.4% limited partner. (2) Foundation Health Systems, Inc. owns approximately 86% of the outstanding common stock; Foundation Health Corporation owns approximately 14% of the outstanding common stock. (3) National Pharmacy Services, Inc. owns approximately 90% of the outstanding common stock. (4) Foundation Health Corporation owns approximately 99.99% of the outstanding common stock. (5) Foundation Health Systems, Inc. owns approximately 99.6% of the outstanding common stock. EX-23.1 21 EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE To the Board of Directors and Stockholders of Foundation Health Systems, Inc. Woodland Hills, California We consent to the incorporation by reference in Registration Statements on Forms S-8 (i) filed on December 4, 1998 and on March 31, 1998, and (ii) No. 333-35193, No. 333-24621, No. 33-74780 and No. 33-90976 of our report dated March 31, 1999, appearing in and incorporated by reference in this Annual Report on Form 10-K of Foundation Health Systems, Inc. (the "Company") for the year ended December 31, 1998. Our audits of the financial statements referred to in our aforementioned report also included the financial statement schedule of Foundation Health Systems, Inc., listed in Item 14(a). The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE Los Angeles, California March 31, 1999 EX-27.1 22 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR YEAR YEAR DEC-31-1998 DEC-31-1997 DEC-31-1996 JAN-01-1998 JAN-01-1997 JAN-01-1996 DEC-31-1998 DEC-31-1997 DEC-31-1996 763,865 559,360 487,938 525,082 553,601 634,978 580,090 519,343 390,769 28,522 22,900 18,200 0 0 0 2,239,884 2,409,693 2,209,616 733,972 734,126 542,641 388,703 306,977 237,893 3,929,541 4,076,350 3,423,776 1,825,431 1,764,672 1,430,182 1,254,278 1,308,979 791,618 0 0 0 0 0 0 125 124 128 743,917 895,850 1,183,283 3,929,541 4,076,350 3,423,776 0 0 0 8,896,076 7,235,019 6,709,240 0 0 0 7,612,469 5,914,608 5,593,894 1,445,602 1,346,104 1,017,020 0 0 0 92,159 63,555 45,372 (254,154) (89,248) 52,954 (88,996) (21,418) 14,124 (165,158) (67,830) 38,830 0 (119,254) 45,401 0 0 0 0 0 0 (165,158) (187,084) 84,231 (1.35) (1.52) 0.67 (1.35) (1.52) 0.67 Includes borrowings under revolving credit facility, miscellaneous notes payable and capital leases. Net of treasury stock. Includes asset impairment, merger, restructuring and other charges. Includes income (loss) from discontinued operations, net of tax and gain (loss) on disposition of discontinued operations, net of tax.
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