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UNITED STATES
       SECURITIES AND EXCHANGE COMMISSION
                                         Washington, D.C. 20549


...
HEALTH NET, INC.
                                                        INDEX TO FORM 10-Q

                             ...
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
                                                         HEALTH ...
HEALTH NET, INC.
                        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                 ...
HEALTH NET, INC.
                        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                 ...
HEALTH NET, INC.
                        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 ...
HEALTH NET, INC.
                   NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 ...
HEALTH NET, INC.
         NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                               ...
HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                ...
HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                ...
HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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HEALTH NET, INC.
       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                 ...
HEALTH NET, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                ...
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
  RESULTS OF OPERATIONS
     Health Net, Inc. (for...
June 30, 2001. As of June 30, 2001, we had 163,000 members in the discontinued Florida plan. The
effect of the suspension ...
CONSOLIDATED OPERATING RESULTS
     Our net loss for the second quarter ended June 30, 2001 was $14.2 million, or $0.12 pe...
Enrollment Information
    The table below summarizes our enrollment information at June 30, 2001 and 2000.

             ...
Health Plan Services Premiums
    Health Plan Services premiums increased $308.9 million or 17.2% for the second quarter e...
• Increased benefit payments from our behavioral health care subsidiary due to parity provisions
      requiring behaviora...
increasingly difficult due to the competitive environment. In addition, our profitability depends, in part,
on our ability...
amount of $400 million) issued in April 2001 for Senior Notes (aggregate principal amount of
$400 million) registered unde...
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  1. 1. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: June 30, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 1-12718 HEALTH NET, 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 Code) (818) 676-6000 Registrant’s telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: The number of shares outstanding of the registrant’s Class A Common Stock as of August 9, 2001 was 123,278,436 (excluding 3,194,374 shares held as treasury stock) and no shares of Class B Common Stock were outstanding as of such date.
  2. 2. HEALTH NET, INC. INDEX TO FORM 10-Q Page Part I—FINANCIAL INFORMATION Item 1—Financial Statements Condensed Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000 . . . . . . . 3 Condensed Consolidated Statements of Operations for the Second Quarter Ended June 30, 2001 and 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 2001 and 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Item 3—Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . 28 Part II—OTHER INFORMATION Item 1—Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Item 2—Changes in Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Item 3—Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Item 4—Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Item 5—Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Item 6—Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 2
  3. 3. PART I—FINANCIAL INFORMATION Item 1. Financial Statements HEALTH NET, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Amounts in thousands) (Unaudited) June 30, December 31, 2001 2000 ASSETS Current Assets: Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,245,437 $1,046,735 Investments—available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 424,753 486,902 Premiums receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194,314 174,654 Amounts receivable under government contracts . . . . . . . . . . . . . . . . . . . 99,640 334,187 Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,419 141,752 Reinsurance and other receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143,199 141,140 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,731 74,184 Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,300,493 2,399,554 Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295,612 296,009 Goodwill and other intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . 829,047 863,419 Other noncurrent assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123,904 111,134 Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,549,056 $3,670,116 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Reserves for claims and other settlements . . . . . . . . . . . . . . . . . . . . . . . . $1,261,647 $1,242,389 Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208,408 238,571 Notes payable and capital leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 49 Amounts payable under government contracts . . . . . . . . . . . . . . . . . . . . . 2,287 972 Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 314,032 329,100 Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,786,374 1,811,081 Revolving credit facilities and capital leases . . . . . . . . . . . . . . . . . . . . . . . . . 230,000 766,450 Senior notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398,607 — Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,655 8,635 Other noncurrent liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,524 22,819 Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,449,160 2,608,985 Commitments and contingencies Stockholders’ Equity: Common stock and additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . 656,316 649,292 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539,434 511,224 Treasury Class A common stock, at cost . . . . . . . . . . . . . . . . . . . . . . . . . . (95,831) (95,831) Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . (23) (3,554) Total Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,099,896 1,061,131 Total Liabilities and Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . $3,549,056 $3,670,116 See accompanying notes to condensed consolidated financial statements. 3
  4. 4. HEALTH NET, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) (Unaudited) Second Quarter Ended June 30, 2001 2000 REVENUES Health plan services premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,104,501 $1,795,591 Government contracts/Specialty services . . . . . . . . . . . . . . . . . . . . . . . . . . 417,699 408,554 Investment and other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,503 25,455 Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,546,703 2,229,600 EXPENSES Health plan services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,816,199 1,530,497 Government contracts/Specialty services . . . . . . . . . . . . . . . . . . . . . . . . . . 302,300 272,694 Selling, general and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 332,724 314,885 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,088 17,072 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,460 9,723 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,408 21,933 Loss on assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76,072 — Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,569,251 2,166,804 (Loss) income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (22,548) 62,796 Income tax (benefit) provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,343) 24,101 Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (14,205) $ 38,695 Basic and diluted (loss) earnings per share: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.12) $ 0.32 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.12) $ 0.32 Weighted average shares outstanding: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123,029 122,441 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123,029 122,712 See accompanying notes to condensed consolidated financial statements. 4
  5. 5. HEALTH NET, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) (Unaudited) Six Months Ended June 30, 2001 2000 REVENUES Health plan services premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,179,200 $3,583,567 Government contracts/Specialty services . . . . . . . . . . . . . . . . . . . . . . . . . . 805,789 797,534 Investment and other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,838 47,834 Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,034,827 4,428,935 EXPENSES Health plan services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,583,593 3,053,015 Government contracts/Specialty services . . . . . . . . . . . . . . . . . . . . . . . . . . 575,335 527,357 Selling, general and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672,302 633,982 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,060 33,952 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,839 19,304 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,846 43,267 Loss on assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76,072 — Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,990,047 4,310,877 Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,780 118,058 Income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,570 45,308 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,210 $ 72,750 Basic and diluted earnings per share: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.23 $ 0.59 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.23 $ 0.59 Weighted average shares outstanding: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,938 122,414 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125,103 122,530 See accompanying notes to condensed consolidated financial statements. 5
  6. 6. HEALTH NET, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) (Unaudited) Six Months Ended June 30, 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........ $ 28,210 $ 72,750 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization and depreciation . . . . . . . . . . . . . . . . . . . . . . . . . ........ 51,899 53,256 Loss on assets held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . ........ 76,072 — Other changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........ 1,528 6,240 Changes in assets and liabilities: Premiums receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19,660) 5,406 Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (30,163) (36,120) Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,886) 43,004 Amounts receivable/payable under government contracts . . . . . . . . . . . . 235,862 (97,802) Reserves for claims and other settlements . . . . . . . . . . . . . . . . . . . . . . . 2,964 (55,335) Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . (23,928) (56,646) Net cash provided by (used in) operating activities . . . . . . . . . . . . . . . . . . . . 316,898 (65,247) CASH FLOWS FROM INVESTING ACTIVITIES Sales or maturities of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 442,844 138,699 Purchases of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (374,336) (120,112) Net purchases of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . (36,948) (13,457) Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (13,702) (15,432) Net cash provided by (used in) investing activities . . . . . . . . . . . . . . . . . . . . . 17,858 (10,302) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from exercise of stock options and employee stock purchases . . . . . 5,360 545 Proceeds from issuance of notes and other financing arrangements . . . . . . . . 495,102 60,029 Repayment of debt and other noncurrent liabilities . . . . . . . . . . . . . . . . . . . . (636,516) (106,927) Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (136,054) (46,353) Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . 198,702 (121,902) Cash and cash equivalents, beginning of period . . . . . . . . . . . . . . . . . . . . . . 1,046,735 1,010,539 Cash and cash equivalents, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,245,437 $ 888,637 See accompanying notes to condensed consolidated financial statements. 6
  7. 7. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION Health Net, Inc. (formerly named Foundation Health Systems, Inc., together with its subsidiaries may be referred to hereafter as the Company, we, us or our) prepared the condensed consolidated financial statements following the rules and regulations of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules and regulations, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (GAAP) can be condensed or omitted if they substantially duplicate the disclosures contained in the annual audited financial statements. We are responsible for the unaudited financial statements included in this document. The financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results in accordance with GAAP. In accordance with GAAP, we make certain estimates and assumptions that affect the reported amounts. Actual results could differ from estimates. As these are condensed financial statements, one should also read our 2000 consolidated financial statements and notes included in our Form 10-K filed in March 2001. Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. 2. COMPREHENSIVE INCOME Our comprehensive income for the second quarter and six months ended June 30 is as follows (amounts in thousands): Second Quarter Six Months Ended June 30, Ended June 30, 2001 2000 2001 2000 Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(14,205) $38,695 $28,210 $72,750 Other comprehensive (loss) income, net of tax: Net change in unrealized (depreciation) appreciation on investments available for sale . . . . . . . . . . . . . . . . . . . . . . . (212) 609 3,531 227 Comprehensive (loss) income . . . . . . . . . . . . . . . . . . . . . . . . $(14,417) $39,304 $31,741 $72,977 3. EARNINGS PER SHARE Basic earnings per share excludes dilution and reflects net income or loss divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings per share is based upon the weighted average shares of common stock and dilutive common stock equivalents (all of which are comprised of stock options) outstanding during the periods presented. Common stock equivalents arising from dilutive stock options are computed using the treasury stock method. There were 2,165,000 shares of dilutive common stock equivalents for the six months ended June 30, 2001, and 271,000 and 116,000 shares of dilutive common stock equivalents for the second quarter and six months ended June 30, 2000, respectively. For the second quarter ended June 30, 2001, 1,886,000 shares of common stock equivalents were excluded from the computation of diluted loss per share due to their antidilutive effect. 7
  8. 8. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 3. EARNINGS PER SHARE (Continued) Options to purchase an aggregate of 7,291,000 shares of common stock during the six months ended June 30, 2001, and an aggregate of 10,208,000 and 10,301,000 shares of common stock during the second quarter and six months ended June 30, 2000, respectively, were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common stock. 4. SEGMENT INFORMATION Our segment information for the second quarter and six months ended June 30, 2001 and 2000 is as follows (amounts in thousands): Government Contracts/ Health Plan Speciality Corporate Services Services and Other Total Second Quarter Ended June 30, 2001 Revenues from external sources . . . . . . . . . . . . . . . . $2,104,501 $417,699 — $2,522,200 Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 31,897 — 31,897 Income (loss) before income taxes . . . . . . . . . . . . . . 63,645 11,847 $ (98,040) (22,548) Second Quarter Ended June 30, 2000 Revenues from external sources . . . . . . . . . . . . . . . . $1,795,591 $408,554 — $2,204,145 Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 16,948 — 16,948 Income (loss) before income taxes . . . . . . . . . . . . . . 73,281 28,482 $ (38,967) 62,796 Six Months Ended June 30, 2001 Revenues from external sources . . . . . . . . . . . . . . . . $4,179,200 $805,789 — $4,984,989 Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 46,781 — 46,781 Income (loss) before income taxes . . . . . . . . . . . . . . 151,266 21,980 $(128,466) 44,780 Six Months Ended June 30, 2000 Revenues from external sources . . . . . . . . . . . . . . . . $3,583,567 $797,534 — $4,381,101 Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 33,594 — 33,594 Income (loss) before income taxes . . . . . . . . . . . . . . 140,854 49,180 $ (71,976) 118,058 5. DIVESTITURES AND OTHER INVESTMENTS In January 2001, we entered into a definitive agreement, and subsequently amended the agreement, to sell our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, LLC. Effective August 1, 2001, we completed the sale. In connection with the sale, we received approximately $49 million which consists of $23 million in cash and approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We estimated and recorded a $76.1 million pre-tax loss on the sales of our Florida health plan and the related corporate facility building during the second quarter ended June 30, 2001. 8
  9. 9. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 5. DIVESTITURES AND OTHER INVESTMENTS (Continued) Pursuant to SFAS No. 121, we evaluated the carrying values of the assets for Florida health plan and adjusted the carrying value of certain long-lived assets to their estimated fair value. Included in the $76.1 million pre-tax loss on net assets of Florida health plan and the related corporate facility building were $40.8 million in non-cash asset impairment charges consisting of $18.5 million for goodwill impairment on Florida health plan, $4.4 million write-down to its fair value of the corporate facility building owned by one of our subsidiaries and used by Florida health plan, $15.3 million reserve for other contractual receivables and $2.6 million write-off of an unrealizable deferred tax asset related to Florida health plan. The carrying value of the net assets of Florida health plan, before the goodwill impairment of $18.5 million, was $41.5 million as of June 30, 2001. The net assets were primarily comprised of cash and cash equivalents and reserves for claims and other settlements. These net assets are included as part of our Health Plan Services segment as of June 30, 2001. In addition, obligations under the terms of the amended definitive agreement to provide up to $28 million of reinsurance to guarantee against claims costs in excess of certain medical care ratio levels of the Florida health plan for the 18-month period subsequent to the close of the sale were recorded as a liability as of June 30, 2001. Other accrued costs resulting from the sale of the Florida health plan totaled $7.3 million. Our Florida health plan, excluding the $76.1 million loss on net assets held for sale, had premium revenues of $147.9 million and a net loss of $13.2 million for the second quarter ended June 30, 2001, and premium revenues of $303.9 million and a net loss of $15.2 million for the six months ended June 30, 2001. The effect of the suspension of the depreciation on the corporate facility building was immaterial for the six months ended June 30, 2001. Throughout 2000 and the six months ended June 30, 2001, we have provided funding in the aggregate amount of approximately $6.3 million to MedUnite, Inc., an independent company, funded and organized by seven major managed health care companies. MedUnite, Inc. is designed to provide on-line internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment. The funded amounts are included in other noncurrent assets. In August 2001, we provided additional funding in the amount of approximately $3.7 million to MedUnite, Inc. 6. LEGAL PROCEEDINGS SUPERIOR NATIONAL INSURANCE GROUP, INC. We and our former wholly-owned subsidiary, Foundation Health Corporation (FHC), which merged into the Company in January 2001, were named in an adversary proceeding, Superior National Insurance Group, Inc. v. Foundation Health Corporation, Foundation Health Systems, Inc. and Milliman & Robertson, Inc. (M&R), filed on April 28, 2000, in the United States Bankruptcy Court for the Central District of California, case number SV00-14099GM. The lawsuit relates to the 1998 sale of Business Insurance Group, Inc. (BIG), a holding company of workers’ compensation companies operating primarily in California, by FHC to Superior National Insurance Group, Inc. (Superior). 9
  10. 10. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 6. LEGAL PROCEEDINGS (Continued) On March 3, 2000, the California Department of Insurance seized BIG and Superior’s other California insurance subsidiaries. On April 26, 2000, Superior filed for bankruptcy. Two days later, Superior filed its lawsuit against us, FHC and M&R. Superior alleges in the lawsuit that: • the BIG transaction was a fraudulent transfer under federal and California bankruptcy laws in that Superior did not receive reasonably equivalent value for the $285 million in consideration paid for BIG; • we, FHC and M&R defrauded Superior by making misstatements as to the adequacy of BIG’s reserves; • Superior is entitled to rescind its purchase of BIG; • Superior is entitled to indemnification for losses it allegedly incurred in connection with the BIG transaction; • FHC breached the Stock Purchase Agreement; and • we and FHC were guilty of California securities laws violations in connection with the sale of BIG. Superior seeks $300 million in compensatory damages, unspecified punitive damages and the costs of the action, including attorneys’ fees. On August 1, 2000, a motion filed by us and FHC to remove the lawsuit from the jurisdiction of the Bankruptcy Court to the United States District Court for the Central District of California was granted. The lawsuit is now pending in the District Court under case number SACV00-0658 GLT. The parties are currently engaged in discovery. We intend to defend ourselves vigorously in this litigation. FPA MEDICAL MANAGEMENT, INC. Since May 1998, several complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA Medical Management, Inc. (FPA) at various times between February 3, 1997 and May 15, 1998. The complaints name as defendants FPA, certain of FPA’s auditors, us and certain of our former officers. The complaints allege that we and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between us and FPA, about FPA’s business and about our 1997 sale of FPA common stock held by us. All claims against our former officers were voluntarily dismissed from the consolidated class actions in both federal and state court. We have filed a motion to dismiss all claims asserted against us in the consolidated federal class actions but have not formally responded to the other complaints. We intend to vigorously defend the actions. 10
  11. 11. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 6. LEGAL PROCEEDINGS (Continued) ROMERO (FORMERLY PAY) V. FOUNDATION HEALTH SYSTEMS, INC. On November 22, 1999, a complaint was filed in the United States District Court for the Southern District of Mississippi in a lawsuit entitled Pay v. Foundation Health Systems, Inc. (2:99CV329). The complaint seeks certification of a nationwide class action and alleges that cost containment measures used by our health maintenance organizations, preferred provider organizations and point-of-service health plans violate provisions of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) and the federal Employee Retirement Income Security Act (ERISA). The action seeks unspecified damages and injunctive relief. The case was stayed on January 25, 2000, pending the resolution of various procedural issues involving similar actions filed against Humana Inc. On June 23, 2000, the plaintiffs filed amended complaints in a Humana action that had been consolidated pursuant to the multi-district litigation statute in the Southern District of Florida to add claims against other managed care organizations, including us. On October 23, 2000, the court allowed the plaintiffs to further amend the complaint against us to add two new named plaintiffs and withdraw the originally named plaintiff, Kerrie Pay, from the action. Consequently, this case will now be entitled Romero v. Foundation Health Systems, Inc. On October 23, 2000, the Judicial Panel on Multi-District Litigation ruled that the action originally filed against us in the Southern District of Mississippi should be consolidated, for purposes of pre-trial proceedings only, with other cases pending against managed care organizations in the United States District Court for the Southern District of Florida in Miami. We filed a motion to dismiss the case and on June 12, 2001, the court entered an order dismissing all claims brought against Health Net with leave for the plaintiffs to re-file an amended complaint. On this same date, the court stayed discovery until after the court rules upon motions to dismiss the amended complaints and any motions to compel arbitration. On June 29, 2001, the plaintiffs filed a third amended class action complaint which re-alleges causes of action under RICO, ERISA, common law civil conspiracy and common law unjust enrichment. The third amended class action complaint seeks unspecified compensatory and treble damages and equitable relief. On July 24, 2001, the court heard oral argument on class certification issues. We intend to vigorously defend the action. SHANE V. FOUNDATION HEALTH SYSTEMS, INC. On August 17, 2000, a complaint was filed in the United States District Court for the Southern District of Florida in a lawsuit entitled Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (00-1334-MD). The complaint seeks certification of a nationwide class action on behalf of physicians and alleges that the defendant managed care companies’ methods of reimbursing physicians violate provisions of RICO, ERISA, certain federal regulations and various state laws. The action seeks unspecified damages and injunctive relief. On September 22, 2000, we filed a motion to dismiss, or in the alternative to compel arbitration. On December 11, 2000, the court granted in part and denied in part our motion to compel arbitration. Under the court’s December arbitration order, plaintiff Dennis Breen, the single named plaintiff to allege a direct contractual relationship with us, was compelled to arbitrate his direct claims against us. We have filed an appeal in the United States Court of Appeals for the 11th Circuit seeking to overturn the portion of the district court’s December ruling that did not order certain claims to arbitration. On 11
  12. 12. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 6. LEGAL PROCEEDINGS (Continued) April 26, 2001, the court modified its December arbitration order and is now retaining jurisdiction over certain direct claims of plaintiff Breen relating to a single contract. On March 2, 2001, the District Court for the Southern District of Florida issued an order granting the dismissal of certain claims with prejudice and the dismissal of certain other claims without prejudice, and denying the dismissal of certain claims. On March 26, 2001, a consolidated amended complaint was filed in this action against managed care companies, including us. This consolidated complaint adds new plaintiffs, including Leonard Klay and the California Medical Association (who, as set forth below, had previously filed claims against the Company), and has, in addition to revising the pleadings of the original claims, added a claim under the California Business and Professions Code. On May 1, 2001, we filed a motion to compel arbitration of the claims of all individual plaintiffs that allege to have treated persons insured by us. On that same date, we filed a motion to dismiss the action. Preliminary discovery and briefing regarding the plaintiffs’ motion for class certification has taken place. On May 7, 2001, the court heard oral argument on class certification issues. On May 9, 2001, the court entered a scheduling order permitting further discovery. On May 14, 2001, Health Net joined in a motion for stay of proceedings in Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (00-1334-MD) in the United States District Court for the Southern District of Florida pending appeal in the 11th Circuit Court of Appeals. On June 17, 2001, the district court stayed discovery until after the district court rules upon motions to dismiss and motions to compel arbitration. This order staying discovery also applies to other actions transferred to the district court by the Judicial Panel on Multidistrict Litigation, namely California Medical Association v. Blue Cross of California, Inc. et al. and Klay v. Prudential Ins. Co. of America, et al. On June 25, 2001, the 11th Circuit Court of Appeals entered an order staying all proceedings in the district court pending resolution of the appeals relating to the district court’s ruling on motions to compel arbitration. We intend to vigorously defend the action. STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC. Physicians Health Services, Inc. (PHS), a subsidiary of ours, was sued on December 14, 1999 in the United States District Court in Connecticut by the Attorney General of Connecticut, Richard Blumenthal, acting on behalf of a group of state residents. The lawsuit was premised on ERISA, and alleged that PHS violated its duties under ERISA by managing its prescription drug formulary in a manner that served its own financial interest rather than those of plan beneficiaries. The suit sought to have PHS revamp its formulary system, and to provide patients with written denial notices and instructions on how to appeal. PHS filed a motion to dismiss which asserted that the state residents the Attorney General purported to represent all received a prescription drug appropriate for their conditions and therefore suffered no injuries whatsoever, that his office lacked standing to bring the suit and that the allegations failed to state a claim under ERISA. On July 12, 2000, the court granted PHS’ motion and dismissed the action. The State of Connecticut has appealed the dismissal and argument on the appeal was held before the United States Court of Appeals for the Second Circuit on May 1, 2001. We intend to vigorously defend the action. Meanwhile, on September 7, 2000, the Attorney General of Connecticut, Richard Blumenthal, filed another lawsuit against Physicians Health Services of Connecticut, Inc. (PHS-CT). This new suit also names Foundation Health Systems, Inc., Anthem Blue Cross and Blue Shield of CT, Anthem Health Plans, Inc., CIGNA Healthcare of CT, Inc., Oxford Health Plans of CT, Inc. as defendants, and asserts 12
  13. 13. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 6. LEGAL PROCEEDINGS (Continued) claims against PHS-CT and us that are similar, if not identical, to those asserted in the previous lawsuit that was dismissed on July 12, 2000. On November 30, 2000, the clerk of the Judicial Panel on Multi- District Litigation entered an order conditionally transferring this case to the United States District Court for the Southern District of Florida to be consolidated for pretrial proceedings only with the other cases against managed care organizations pending in that court. The clerk of the Judicial Panel on Multi-District Litigation stayed the conditional transfer order on December 15, 2000 pending briefing and argument concerning whether transfer is appropriate. On April 17, 2001, the Judicial Panel on Multi-district Litigation transferred this action to the Southern District of Florida for coordinated or consolidated pretrial proceedings. We intend to vigorously defend the action. ALBERT V. PHYSICIANS HEALTH SERVICES OF CONNECTICUT, INC. On September 7, 2000, a complaint was filed in the United States District Court for the District of Connecticut in a lawsuit entitled Albert v. CIGNA Healthcare of Connecticut, Inc., et al. (including Physicians Health Services of Connecticut, Inc. and Foundation Health Systems, Inc.) (300CV1717-CJS). The complaint seeks certification of a nationwide class action and alleges that the defendant managed care companies’ various practices violate provisions of ERISA. The action seeks unspecified damages and injunctive relief. On November 30, 2000, the clerk of the Judicial Panel on Multi-District Litigation entered an order conditionally transferring this case to the United States District Court for the Southern District of Florida to be consolidated for pre-trial proceedings only with the other cases against managed care organizations pending in that court. The clerk of the Judicial Panel on Multi-District Litigation stayed the conditional transfer order on December 18, 2000 pending briefing and argument concerning whether transfer is appropriate. On March 20, 2001, the Judicial Panel on Multi-district Litigation transferred this action to the Southern District of Florida for coordinated or consolidated pretrial proceedings. We intend to vigorously defend the action. CALIFORNIA MEDICAL ASSOCIATION V. BLUE CROSS OF CALIFORNIA, INC., PACIFICARE HEALTH SYSTEMS, INC., PACIFICARE OPERATIONS, INC. AND FOUNDATION HEALTH SYSTEMS, INC. In May 2000, the California Medical Association filed a lawsuit, purportedly on behalf of its member physicians, in the United States District Court for the Northern District of California against several managed care organizations, including the Company, entitled California Medical Association v. Blue Cross of California, Inc., PacifiCare Health Systems, Inc., PacifiCare Operations, Inc. and Foundation Health Systems, Inc. The plaintiff alleges that the manner in which the defendants contract and interact with its member physicians violates provisions of RICO. The action seeks declaratory and injunctive relief, as well as costs and attorneys’ fees. We filed a motion to dismiss the action on various grounds. In August 2000, plaintiffs in other actions pending against different managed care organizations petitioned the Judicial Panel on Multi-District Litigation to consolidate the California action with the other actions in the U.S. District Court for the Northern District of Alabama. In light of the pending petition, the California court stayed the action and the hearing on the Company’s motion to dismiss the complaint for ninety days pending a determination of the petition to consolidate. On October 23, 2000, the Judicial Panel on Multi-District Litigation ruled that this case should be 13
  14. 14. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 6. LEGAL PROCEEDINGS (Continued) consolidated, for purposes of pre-trial proceedings only, with other cases pending against managed care organizations in the United States District Court for the Southern District of Florida in Miami. On February 22, 2000, the California Medical Association filed an amended complaint in the Southern District of Florida adding claims under certain federal regulations and the California Business and Professions Code. As set forth above, on March 26, 2001, the California Medical Association was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action. As further noted above, on June 17, 2001, the district court entered an order which applies to this case and stays discovery until after the court rules upon motions to dismiss and motions to compel arbitration. We intend to vigorously defend the action. CONNECTICUT STATE MEDICAL SOCIETY V. PHYSICIANS HEALTH SERVICES OF CONNECTICUT, INC. On February 14, 2001, the Connecticut State Medical Society filed a complaint in Connecticut State Court against Physicians Health Services of Connecticut, Inc. alleging violations of the Connecticut Unfair Trade Practices Act. The complaint alleges that PHS-CT engaged in conduct that was designed to delay, deny, impede and reduce lawful reimbursement to physicians who rendered medically necessary health care services to PHS-CT health plan members. The complaint, which is similar to others filed against us and other managed care companies, seeks declaratory and injunctive relief. On March 13, 2001, the Company removed this action to federal court. On March 28, 2001, the plaintiffs moved to remand the action to state court. On April 19, 2001, we filed with the Judicial Panel on Multi-district Litigation our motion to transfer this case to the Southern District of Florida for consolidated pretrial proceedings with the managed care litigation already pending there. On April 25, 2001, we filed our opposition to the plaintiffs’ motion for remand. On April 27, 2001, the court consolidated this action and Lynch v. Physicians Health Services of Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the complaint, but intends to vigorously defend the action. KEVIN LYNCH, M.D. AND KAREN LAUGEL, M.D. V. PHYSICIANS HEALTH SERVICES OF CONNECTICUT, INC. On February 14, 2001, a purported class action lawsuit was filed in Connecticut State Court against Physicians Health Services of Connecticut, Inc. by Kevin Lynch, M.D. and Karen Laugel, M.D. on behalf of physicians members of the Connecticut State Medical Society who provide health care services to PHS-CT health plan members pursuant to provider service contracts. The complaint alleges that PHS-CT engaged in improper, unfair and deceptive practices by denying, impeding and/or delaying lawful reimbursement to physicians. The complaint, similar to the complaint referred to above filed against PHS-CT on the same day by the Connecticut State Medical Society, seeks declaratory and injunctive relief, and damages. On March 13, 2001, we removed this action to federal court. On March 28, 2001, the plaintiffs moved to remand the action to state court. On April 19, 2001, we filed with the Judicial Panel on Multi-district Litigation our motion to transfer this case to the Southern District of Florida for consolidated pretrial proceedings with the managed care litigation already pending there. On April 25, 2001, we filed our opposition to the plaintiffs’ motion for remand. On 14
  15. 15. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 6. LEGAL PROCEEDINGS (Continued) April 27, 2001, the court consolidated this action and CSMS v. Physicians Health Services of Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the complaint, but intends to vigorously defend the action. LEONARD KLAY, M.D. V. PRUDENTIAL INS CO OF AMERICA, UNITED HEALTHCARE, AETNA, INC., AETNA US HEALTHCARE, CIGNA CORP., CONNECTICUT GENERAL CORP., FOUNDATION HEALTH SYSTEMS, INC., PACIFICARE HEALTH SYSTEMS AND WELLPOINT HEALTH NETWORKS, INC. On February 22, 2001, a purported class action complaint was filed in the United States District Court for the Southern District of Florida against several managed care companies, including us, on behalf of individual physicians in California who provided health care services to members of the defendants’ health plans. The complaint alleges violations of RICO, ERISA, certain federal regulations, the California Business and Professions Code and certain state common law doctrines, and seeks declaratory and injunctive relief, and damages. As set forth above, on March 26, 2001, Leonard Klay was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action. As further noted above, on June 17, 2001, the district court entered an order which applies to this case and stays discovery until after the court rules upon motions to dismiss and motions to compel arbitration. We intend to vigorously defend the actions. KAREN L., ET AL. V. PHYSICIANS HEALTH SERVICES, INC. This action was instituted on November 17, 1999 on behalf of a putative state-wide class against PHS, a subsidiary of ours, in the United States District Court for the District of Connecticut seeking injunctive relief for alleged violations of the Federal Medicaid statute, 42 U.S.C. §1396a(a)(3), the Due Process Clause of the Fourteenth Amendment to the United States Constitution, the Connecticut Unfair Trade Practices Act, Conn. Gen. Stat. §42-110a et seq., and the Connecticut Unfair Insurance Practices Act, Conn. Gen. Stat. §38a-815 et seq. The plaintiffs in this action allege that PHS failed to adequately notify class members of adverse actions regarding coverage of claims made by enrollees of PHS’ Medicaid managed care plans and that PHS failed to adequately ensure that those Medicaid enrollees can apply for and be furnished with prescription drug benefits without delay. On July 6, 2001, the district court granted plaintiff’s motion for class certification certifying a class consisting of all past, present and future Medicaid recipients who were, are or will be enrolled in any managed care plan offered by PHS to Medicaid recipients, under contract with the Commissioner of the State of Connecticut, Department of Social Services. We intend to vigorously defend this action. MISCELLANEOUS PROCEEDINGS We and certain of our subsidiaries are also parties to various other legal proceedings, many of which involve claims for coverage encountered in the ordinary course of our business. Based in part on advice from our litigation counsel and upon information presently available, management is of the opinion that the final outcome of all such proceedings should not have a material adverse effect upon our results of operations or financial condition. 15
  16. 16. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board (FASB) issued the following Statements of Financial Accounting Standards (SFAS) that are effective in 2000 or 2001: • In July 2001, the Financial Accounting Standards Board (‘‘FASB’’) issued two new pronouncements: Statement of Financial Accounting Standards (‘‘SFAS’’) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141 is effective as follows: a) use of the pooling-of-interest method is prohibited for business combinations initiated after June 30, 2001; and b) the provisions of SFAS 141 also apply to all business combinations accounted for by the purchase method that are completed after June 30, 2001 (that is, the date of the acquisition is July 2001 or later). There are also transition provisions that apply to business combinations completed before July 1, 2001, that were accounted for by the purchase method. SFAS 142 is effective for fiscal years beginning after December 15, 2001 for all goodwill and other intangible assets recognized in an entity’s statement of financial position at that date, regardless of when those assets were initially recognized. We are currently evaluating the provisions of SFAS 141 and SFAS 142. • In September 2000, the FASB issued SFAS No. 140, ‘‘Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125)’’ (SFAS No. 140). SFAS No. 140 provides accounting standards that are based on consistent application of financial-components approach that focuses on control. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. SFAS No. 140 is effective for recognition and reclassification of collateral and for related disclosures for fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 has had no material effect on our consolidated financial position or results of operations. • In March 2000, the FASB issued Interpretation No. 44, ‘‘Accounting for Certain Transactions Involving Stock Compensation’’ (Interpretation No. 44). Interpretation No. 44 provides guidance on certain implementation issues related to Accounting Principles Board Opinion 25, ‘‘Accounting for Stock Issued to Employees.’’ Interpretation No. 44 was effective July 1, 2000 and did not have an impact on our consolidated financial position or results of operations. • In December 1999, the Securities and Exchange Commission issued, then subsequently amended, Staff Accounting Bulletin No. 101 ‘‘Revenue Recognition in Financial Statements’’ (SAB 101). SAB 101, as amended, provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. We adopted SAB 101 effective October 1, 2000. The adoption of SAB 101 did not have a material effect on our consolidated financial position or results of operations. • In June 1998, the FASB issued, then subsequently amended, SFAS No. 133 ‘‘Accounting for Derivative Instruments and Hedging Activities’’ (SFAS No. 133). SFAS No. 133, as amended by SFAS No. 138 ‘‘Accounting for Certain Derivative Instruments and Certain Hedging Activities,’’ is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards requiring that all derivatives be recorded in the balance sheet as either an asset or liability measured at fair value and that changes in fair value be recognized currently in earnings, unless specific hedge accounting criteria are met. We adopted 16
  17. 17. HEALTH NET, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) 7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued) SFAS No. 133, as amended, effective January 1, 2001. The adoption of SFAS No. 133 had no effect on our consolidated financial position or results of operations. 8. SENIOR NOTES AND CREDIT FACILITIES On April 12, 2001, we completed our offering of $400 million aggregate principal amount of 8.375 percent Senior Notes due in April 2011 at a discount of $1.4 million. The net proceeds of $395.1 million from the Senior Notes were used to repay outstanding borrowings under our then-existing revolving credit facility. We have agreed to exchange the Senior Notes (aggregate principal amount of $400 million) issued in April 2001 for Senior Notes (aggregate principal amount of $400 million) registered under the Securities Act of 1933, as amended, pursuant to an Exchange and Registration Rights Agreement, a copy of which was filed as Exhibit 4.6 to the Company’s Form 10-Q for the quarter ended March 31, 2001. On June 28, 2001, we entered into credit agreements for two new revolving syndicated credit facilities with Bank of America, N.A. as administrative agent, that replaced our previous credit facility. The new facilities, providing for an aggregate of $700 million in borrowings, consist of a $175 million 364-day revolving credit facility and a $525 million five-year revolving credit and competitive advance facility. As of June 30, 2001, the net carrying value of the Senior Notes and the credit facilities were $398.6 million and $230 million, respectively. The $230 million outstanding under the credit facilities is under the five-year facility. 9. SUBSEQUENT EVENT Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, LLC as discussed in Note 5. 17
  18. 18. ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Health Net, Inc. (formerly named Foundation Health Systems, Inc., together with its subsidiaries may be referred to herein as the Company, we, us or our) is an integrated managed care organization which administers the delivery of managed health care services. Through our subsidiaries, we offer group, individual, Medicaid and Medicare health maintenance organization (HMO), point of service (POS) 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. We currently operate within two segments: Health Plan Services and Government Contracts/ Specialty Services. Effective January 1, 2000, as a result of certain previously disclosed divestitures, we consolidated and reorganized our Health Plan Services segment into two regional divisions: • Northeast Division (consisting of Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and West Virginia), and • Western Division (consisting of Arizona, California and Oregon) In 2000, we decided to exit the Ohio, West Virginia and Western Pennsylvania markets and provided notice of our intention to withdraw from these service areas to the appropriate regulators. As of February 2001, we no longer had any members in these markets. As of June 30, 2001, we still have 3,000 commercial members in Washington to be transitioned out as part of the Washington health plan sale in 1999. In January 2001, we entered into a definitive agreement, and subsequently amended the agreement, to sell our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, LLC. Effective August 1, 2001, we completed the sale. In connection with the sale, we received approximately $49 million which consists of $23 million in cash and approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We estimated and recorded a $76.1 million pre-tax loss on the sales of our Florida health plan and the related corporate facility building during the second quarter ended June 30, 2001. Pursuant to SFAS No. 121, we evaluated the carrying values of the assets for Florida health plan and adjusted the carrying value of certain long-lived assets to their estimated fair value. Included in the $76.1 million pre-tax loss on net assets of Florida health plan and the related corporate facility building were $40.8 million in non-cash asset impairment charges consisting of $18.5 million for goodwill impairment on Florida health plan, $4.4 million write-down to its fair value of the corporate facility building owned by one of our subsidiaries and used by Florida health plan, $15.3 million reserve for other contractual receivables and $2.6 million write-off of an unrealizable deferred tax asset related to Florida health plan. The carrying value of the net assets of Florida health plan, before the goodwill impairment of $18.5 million, was $41.5 million as of June 30, 2001. The net assets were primarily comprised of cash and cash equivalents and reserves for claims and other settlements. These net assets are included as part of our Health Plan Services segment as of June 30, 2001. In addition, obligations under the terms of the amended definitive agreement to provide up to $28 million of reinsurance to guarantee against claims costs in excess of certain medical care ratio levels of the Florida health plan for the 18-month period subsequent to the close of the sale were recorded as a liability as of June 30, 2001. Other accrued costs resulting from the sale of the Florida health plan totaled $7.3 million. Our Florida health plan, excluding the $76.1 million loss on net assets held for sale, had premium revenues of $147.9 million and a net loss of $13.2 million for the second quarter ended June 30, 2001, and premium revenues of $303.9 million and a net loss of $15.2 million for the six months ended 18
  19. 19. June 30, 2001. As of June 30, 2001, we had 163,000 members in the discontinued Florida plan. The effect of the suspension of the depreciation on the corporate facility building was immaterial for the six months ended June 30, 2001. Throughout 2000 and the six months ended June 30, 2001, we have provided funding in the aggregate amount of approximately $6.3 million to MedUnite, Inc., an independent company, funded and organized by seven major managed health care companies. MedUnite, Inc. is designed to provide on-line internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment. The funded amounts are included in other noncurrent assets. In August 2001, we provided additional funding in the amount of approximately $3.7 million to MedUnite, Inc. We are one of the largest managed health care companies in the United States, with approximately 4.2 million at-risk and administrative services only (ASO) members in our Health Plan Services segment. We also own health and life insurance companies licensed to sell PPO, POS and indemnity products, as well as certain auxiliary non-health products such as life and accidental death and disability insurance in 35 states and the District of Columbia. Our Government Contracts/Specialty Services segment administers large multi-year managed health care government contracts. Certain components of these contracts, including administrative and assumption of health care risk, are subcontracted to affiliated and unrelated third parties. We administer health care programs covering approximately 1.5 million eligible individuals under TRICARE. We have three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Washington and parts of Arizona, Idaho, Louisiana and Texas. The Department of Defense extended all three contracts in 2000 for periods up to two years. Through this segment, we also offer behavioral health, dental and vision services as well as employee and occupational services comprising managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities. This discussion and analysis and other portions of this Form 10-Q contain ‘‘forward-looking statements’’ within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, that involve risks and uncertainties. All statements other than statements of historical information provided or incorporated by reference herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words ‘‘believes,’’ ‘‘anticipates,’’ ‘‘plans,’’ ‘‘expects’’ and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, the matters described in the ‘‘Cautionary Statements’’ section and other portions of our Annual Report on Form 10-K for the fiscal year ended December 31, 2000 and the risks discussed in our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which reflect management’s analysis, judgment, belief or expectation only as of the date hereof. Except as required by law, we undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report. 19
  20. 20. CONSOLIDATED OPERATING RESULTS Our net loss for the second quarter ended June 30, 2001 was $14.2 million, or $0.12 per basic share and diluted share, compared to net income for the same period in 2000 of $38.7 million or $0.32 per basic and diluted share. Our net income for the six months ended June 30, 2001 was $28.2 million, or $0.23 per basic share and diluted share, compared to net income for the same period in 2000 of $72.8 million or $0.59 per basic share and diluted share. Included in our results for the second quarter and six months ended June 30, 2001, is a $76.1 million loss on assets held for sale in connection with the divestiture of our Florida operations. The table below and the discussions that follows summarize our financial performance for the second quarter and six months ended June 30, 2001 and 2000, respectively. Certain 2000 amounts have been reclassified to conform to the 2001 presentation. These reclassifications did not affect net income or earnings per share. Second Quarter Ended Six Months Ended June 30, June 30, 2001 2000 2001 2000 (Amounts in thousands, except per member per month data) Revenues: Health plan services premiums . . . . . . . . . . . . . . $2,104,501 $1,795,591 $4,179,200 $3,583,567 Government contracts/Specialty services . . . . . . . 417,699 408,554 805,789 797,534 Investment and other income . . . . . . . . . . . . . . . 24,503 25,455 49,838 47,834 Total revenues . . . . . . . . . . . . . . . . . . . . . . . . 2,546,703 2,229,600 5,034,827 4,428,935 Expenses: Health plan services . . . . . . . . . . . . . . . . . . . . . 1,816,199 1,530,497 3,583,593 3,053,015 Government contracts/Specialty services . . . . . . . 302,300 272,694 575,335 527,357 Selling, general and administrative . . . . . . . . . . . 332,724 314,885 672,302 633,982 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,088 17,072 33,060 33,952 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,460 9,723 18,839 19,304 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,408 21,933 30,846 43,267 Loss on assets held for sale . . . . . . . . . . . . . . . . 76,072 — 76,072 — Total expenses . . . . . . . . . . . . . . . . . . . . . . . . 2,569,251 2,166,804 4,990,047 4,310,877 (Loss) income before income taxes . . . . . . . . . . . . (22,548) 62,796 44,780 118,058 Income tax (benefit) provision . . . . . . . . . . . . . . . . (8,343) 24,101 16,570 45,308 Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . $ (14,205) $ 38,695 $ 28,210 $ 72,750 Health plan services medical care ratio (MCR) . . . . 86.3% 85.2% 85.7% 85.2% Government contracts/Specialty services MCR . . . . 72.4% 66.7% 71.4% 66.1% Administrative (SG&A + Depreciation) ratio . . . . . 13.8% 15.1% 14.1% 15.2% Health plan premiums per member per month . . . . $ 167.38 $ 155.15 $ 167.93 $ 153.75 Health plan services per member per month . . . . . $ 147.25 $ 135.23 $ 146.83 $ 133.91 20
  21. 21. Enrollment Information The table below summarizes our enrollment information at June 30, 2001 and 2000. June 30, Percent 2001 2000 Change (Enrollees in Thousands) Health Plan Services: Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,002 2,786 7.8 % Medicare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 222 1.0 % Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 735 592 24.2 % Continuing plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,961 3,600 10.0 % Discontinued plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166 167 (0.6)% Total Health Plan Services . . . . . . . . . . . . . . . . . . . . . . . . . 4,127 3,767 9.6 % Government Contracts: TRICARE PPO and Indemnity . . . . . . . . . . . . . . . . . . . . 558 564 (1.1)% TRICARE HMO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 906 891 1.7 % Total Government Contracts . . . . . . . . . . . . . . . . . . . . . . . . 1,464 1,455 0.6 % ASO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 84 (4.8)% The following discussion on enrollment changes relates to our continuing plans only and excludes our discontinued plans. Discontinued plans include Colorado, Florida and Washington. As of June 30, 2001, we had membership in Florida and Washington. We no longer had any membership in Colorado as of June 30, 2001. Membership in these plans is expected to decline due to completion of divestitures or as the operations in these plans continue to wind down. Commercial membership increased 7.8% to 3.0 million members at June 30, 2001 compared to 2.8 million members at June 30, 2000 primarily due to the following: • 13.6% increase in California primarily in small group, individual sales of POS products and small business and individual/family plan PPO products, • 9.1% increase in New York primarily in small group POS and HMO products, and • 6.8% increase in New Jersey primarily in small group POS and HMO products. Medicare membership remained at a constant level across all markets at June 30, 2001 compared to June 30, 2000. Medicaid membership increased 24.2% to 735,000 members at June 30, 2001 compared to 592,000 members at June 30, 2000 primarily due to increased sales of children’s health programs in California, particularly the Healthy Families program. Government contracts covered approximately 1.5 million eligible individuals under the TRICARE program at June 30, 2001 and 2000. Dependents of active-duty military personnel and retirees and their dependents are automatically eligible to receive benefits under the TRICARE program. Any changes in the enrollment reflect the timing of when the individuals become eligible. 21
  22. 22. Health Plan Services Premiums Health Plan Services premiums increased $308.9 million or 17.2% for the second quarter ended June 30, 2001 and $595.6 million or 16.6% for the six months ended June 30, 2001 as compared to the same periods in 2000 primarily due to the following: • 9.2% increase in per member per month (PMPM) premiums due to rate increases for the six months ended June 30, 2001, and • 9.6% increase in net membership as compared to June 30, 2000. Government Contracts/Specialty Services Revenues Government Contracts/Specialty Services revenues increased $9.1 million or 2.2% for the second quarter ended June 30, 2001 and $8.3 million or 1.0% for the six months ended June 30, 2001, as compared to the same periods in 2000 primarily due to the following: • Increase in revenues from TRICARE contracts from higher health care costs resulting in higher risk share revenues from the government and increased change orders, offset by • Decrease in revenues from the mental health portion of the TRICARE contracts shifting from fee-for-service to ASO. Investment and Other Income Investment and other income decreased $1.0 million or 3.7% for the second quarter ended June 30, 2001, for short-term investments, partially offset by higher investable assets, as compared to the same period in 2000. The $1.0 million decrease in investment and other income reflects the decrease in the average yield during the second quarter ended June 30, 2001, as compared to the same period in 2000. Investment and other income increased $2.0 million or 4.2% for the six months ended June 30, 2001, as compared to the same period in 2000. The $2.0 million increase in investment and other income was due to higher investable assets partially offset by a decrease in the average yield rate during the six months ended June 30, 2001, as compared to the same period in 2000. This decrease in the average yield is consistent with the continued decline in short-term interest rates during the second quarter ended June 30, 2001. Health Plan Services Medical Care Ratio (MCR) Health Plan Services costs rose 8.9% on PMPM basis for the second quarter ended June 30, 2001 and 9.6% on PMPM basis for the six months ended June 30, 2001 as compared to the same periods in 2000. This increase in the second quarter ended June 30, 2001 as compared to the same period in 2000 includes a 9% increase in pharmacy costs, an 8% increase in hospital costs and a 4.5% increase in physician costs on a PMPM basis. The MCR for the second quarter ended June 30, 2001 increased to 86.3% and to 85.7% for the six months ended June 30, 2001 from 85.2% as compared to the same periods in 2000, respectively. Government Contracts/Specialty Services MCR Government Contracts/Specialty Services MCR increased to 72.4% and 71.4% in the second quarter and six months ended June 30, 2001, respectively, as compared to 66.7% and 66.1% for the same periods in 2000, respectively. The increases are primarily due to the following: • Decrease in revenues from the mental health portion of the TRICARE contracts shifting from fee-for-service to ASO, and 22
  23. 23. • Increased benefit payments from our behavioral health care subsidiary due to parity provisions requiring behavioral health service providers to offer the same level of services to all current health plan members as well as increased benefit levels on new businesses. Selling, General and Administrative (SG&A) Expenses The administrative expense ratio (SG&A and depreciation as a percentage of Health Plan premiums and Government Contracts/Specialty Services revenues) decreased to 13.8% and 14.1% for the second quarter and six months ended June 30, 2001, respectively, from 15.1% and 15.2% for the same periods in 2000, respectively. This decrease is primarily attributable to our ongoing efforts to control our SG&A expenses. We continue to focus efforts on ways to adopt technology to our business processes to improve efficiencies. Amortization and Depreciation Amortization and depreciation expense for the second quarter and six months ended June 30, 2001 decreased by $1.2 million or 4.7% and $1.4 million or 2.5%, respectively, as compared to the same periods in 2000. The decrease is primarily due to various leasehold improvements, personal computer equipment and software being completely depreciated prior to or during the second quarter ended June 30, 2001. Interest Expense Interest expense decreased by $5.5 million or 25.2% for the second quarter ended June 30, 2001 and by $12.4 million or 28.7% for the six months ended June 30, 2001, as compared to the same periods in 2000. This decrease reflects the $364.4 million decline in long-term debt to $628.6 million from $993.0 million as of June 30, 2000. During the first quarter ended March 31, 2001, we used the net proceeds of $284.0 million, after certain payments to vendors, from our global settlement of the outstanding TRICARE receivables to paydown our long-term debt. Income Tax Provision The effective income tax rate was 37.0% for the second quarter and six months ended June 30, 2001, as compared with 38.4% for the same periods in 2000, respectively. The rate declined primarily due to tax minimization strategies. The effective tax rate of 37.0% for the second quarter and six months ended June 30, 2001, respectively, differed from the statutory federal tax rate of 35.0% due primarily to state income taxes, goodwill amortization, and tax-exempt investment income. IMPACT OF INFLATION AND OTHER ELEMENTS The managed health care industry is labor intensive and its profit margin is low, so 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 us. Federal and state legislators continue to propose various legislative initiatives regarding the health care industry, including federal ‘‘patients’ bill of rights’’ legislation. See ‘‘Item 5—Recent Developments—Legislation.’’ If federal or state legislatures enact further health care reform or similar legislation, the legislation could affect us. Management cannot at this time predict the specifics of any of these initiatives, whether federal or state legislatures will enact any of these initiatives or, if enacted, how any of these initiatives will financially impact us. Our ability to expand our business depends, in part, on competitive premium pricing and our ability to secure cost-effective contracts with providers. Achieving these objectives is becoming 23
  24. 24. increasingly difficult due to the competitive environment. In addition, our profitability depends, in part, on our ability to maintain effective control over health care costs while providing members with quality care. Factors such as health care reform, regulatory changes, increased cost of medical services, utilization, new technologies and drugs, hospital costs, major epidemics and numerous other external influences may affect our operating results. Accordingly, past financial performance is not necessarily a reliable indicator of future performance. Investors should not use historical records to anticipate results or future period trends. Our 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 and are based on various assumptions. External forces such as changes in the rate of inflation, the regulatory environment, medical costs and other factors may affect reserves. Establishment of appropriate reserves is an inherently uncertain process. There can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Reserve estimates in the past have been, and in the future may be, too high or too low. 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. Our California HMO subsidiary contracts with providers in California primarily through capitation fee arrangements. Our HMO subsidiaries in other areas contract with providers, to a lesser degree, through capitation fee arrangements. Under a capitation fee arrangement, our subsidiary 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. The inability of providers to properly manage costs under capitation arrangements can result in financial instability of such providers. Any financial instability of capitated providers could lead to claims for unpaid health care against our HMO subsidiaries, even though such subsidiaries have made their regular payments to the capitated providers. Depending on state law, our HMO subsidiaries may or may not be liable for such claims. In California, the issue of whether HMOs are liable for unpaid provider claims has not been definitively settled. The California agency that until July 1, 1999 acted as regulator of HMOs had issued a written statement to the effect that HMOs are not liable for such claims. However, there is currently ongoing litigation on the subject among providers and HMOs, including our California HMO subsidiary. LIQUIDITY AND CAPITAL RESOURCES Certain of our subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. Certain of our subsidiaries must maintain ratios of current assets to current liabilities pursuant to certain government contracts. We believe we are in compliance with these contractual and regulatory requirements in all material respects. We believe that cash from operations, existing working capital and lines of credit are adequate to fund existing obligations, introduce new products and services, and continue to develop health care-related businesses. We regularly evaluate cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. We may elect to raise additional funds for these purposes through additional debt or equity, the sale of investment securities or otherwise. On April 12, 2001, we completed our offering of $400 million aggregate principal amount of 8.375 percent (or all-in cost rate of 8.54%) Senior Notes due in April 2011. The net proceeds of $395.1 million from the Senior Notes were used to repay outstanding borrowings under our then-existing revolving credit facility. We have agreed to exchange the Senior Notes (aggregate principal 24
  25. 25. amount of $400 million) issued in April 2001 for Senior Notes (aggregate principal amount of $400 million) registered under the Securities Act of 1933, as amended, pursuant to an Exchange and Registration Rights Agreement, a copy of which was filed as Exhibit 4.6 to the Company’s Form 10-Q for the quarter ended March 31, 2001. On June 28, 2001, we completed the refinancing of our credit facility maturing in July 2002. The previous credit facility was refinanced with two new credit facilities, a 364-day $175.0 million revolving credit facility and a five-year $525.0 million revolving credit and competitive advance facility. Government health care receivables are best estimates of payments that are ultimately collectible or payable. Since these amounts are subject to government audit, negotiation and appropriations, amounts ultimately collected may vary significantly from current estimates. Additionally, the timely collection of these receivables is also impacted by government audit and negotiation and could extend for periods beyond a year. In December 2000, our subsidiary, Health Net Federal Services, Inc., and the Department of Defense agreed to a settlement of approximately $389 million for outstanding receivables related to our three TRICARE contracts and for the completed contract for the Civilian Health and Medical Program of the Uniformed Services Reform Initiative. Approximately $60 million of the settlement amount was received in December 2000. The majority of the remaining settlement that was received on January 5, 2001 was used to reduce the amounts receivable under government contracts. The receivable items settled by this payment include change orders, bid price adjustments, equitable adjustments and claims. These receivables developed as a result of TRICARE health care costs rising faster than the forecasted health care cost trends used in the original contract bids, data revisions on formal contract adjustments, and routine contract changes for benefits. Net proceeds of $284 million, after paying vendors, providers and amounts owed back to the government, were applied to the continuing operating needs of the three TRICARE contracts and to reducing the outstanding balance of the notes payable. Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, LLC. In connection with the sale, we received approximately $49 million which consists of $23 million in cash and approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We recorded a $76.1 million pre-tax loss on the sales of our Florida health plan and the related corporate facility building for the second quarter ended June 30, 2001. Operating Cash Flows Net cash provided by operating activities was $316.9 million for the six months ended June 30, 2001 compared to net cash used in operating activities of $65.2 million for the same period in 2000. This change was primarily due to the net proceeds of $284 million, after certain payments to vendors, from our global settlement of the outstanding TRICARE receivables. In July and August 2001, we paid approximately $21.0 million to certain former minority shareholders of a current subsidiary in connection with a merger involving that subsidiary in 1999. We are obligated to pay up to an additional $12.7 million to former minority shareholders in connection with the merger, approximately $6 million of which is contingent on our New Jersey health plan meeting certain financial performance criteria. These amounts totaling $33.7 million were recorded as a current liability as of December 31, 2000. See ‘‘Item 5—Recent Developments—FOHP’’ for a more complete description. 25

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