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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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-19147
Coventry Health Care, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-2073000
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 581-0600
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Common stock purchase rights
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 registrant's voting Common Stock held
by non-affiliates of the registrant as of February 28, 1999 (computed by
reference to the closing sales price of such stock on The Nasdaq Stock Market
on such date) was $630,790,576.
As of February 28, 1999, there were 58,847,894 shares of the
registrant's voting Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the registrant's Proxy Statement for its 1999 Annual Meeting of
Shareholders to be filed subsequent to the filing of this Form 10-K Report are
incorporated by reference in items 10 through 13 of Part III hereof.
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COVENTRY HEALTH CARE, INC.
FORM 10-K
TABLE OF CONTENTS
PART I Page
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Item 1: Business 1
Item 2: Properties 10
Item 3: Legal Proceedings 10
Item 4: Submission of Matters to a Vote of Security Holders 10
PART II
Item 5: Market for Registrant's Common Equity and Related Stockholder Matters 11
Item 6: Selected Consolidated Financial Data 12
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 7A: Quantitative and Qualitative Disclosures About Market Risk 28
Item 8: Financial Statements and Supplementary Data 29
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 54
PART III
Item 10: Directors and Executive Officers of the Registrant 55
Item 11: Executive Compensation 55
Item 12: Security Ownership of Certain Beneficial Owners and Management 55
Item 13: Certain Relationships and Related Transactions 55
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 56
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PART I
The statements contained in this Form 10-K that are not historical are
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, which are subject to risks and
uncertainties. These forward-looking statements may be affected by a number of
factors, including the "Risk Factors" contained in Management's Discussion and
Analysis of Financial Condition and Results of Operations in this Form 10-K, and
actual operations and results may differ materially from those expressed in this
Form 10-K. Among the factors that may materially affect the Company's business
are potential increases in medical costs, difficulties in increasing premiums
due to competitive pressures, price restrictions under Medicaid and Medicare,
imposition of regulatory restrictions, issues relating to marketing of products
or accreditation or certification of the products by private or governmental
bodies, difficulties in obtaining or maintaining favorable contracts with health
care providers, credit risks on global capitation arrangements, financing costs
and contingencies and litigation risk.
Item 1: Business
General
Coventry Health Care, Inc. (together with its subsidiaries, the
"Company"), successor in interest to Coventry Corporation, is a managed
health care company that provides comprehensive health benefits and services to
a broad cross section of employer and government-funded groups in the Midwest,
Mid-Atlantic and Southeastern United States. Health care services are provided
to employer groups and government funded groups through a variety of full-risk
health care plans including health maintenance organization ("HMO"), point of
service ("POS") and preferred provider organization ("PPO") products. The
Company also administers self-insured plans for large employer groups.
The Company was formed in connection with the acquisition of certain
health plans from Principal Health Care, Inc. ("PHC") in April 1998. As part of
these related transactions, the shareholders of Coventry Corporation received
approximately 60% of the Company's outstanding common stock and PHC received
approximately 40% of the Company's outstanding common stock, on a fully diluted
basis. At that time, the Company also entered into a management services
agreement and certain marketing and other agreements with Principal Mutual Life
Insurance Company, now known as Principal Life Insurance Company ("Principal
Life"), the ultimate parent of PHC, at that time.
As of December 31, 1998, the Company had 1,167,041 members for whom
it assumes underwriting risk ("risk members") and 218,273 members of
self-insured employers for whom it provides management services but does not
assume underwriting risk. The following tables show the total number of members
as of December 31, 1998 and 1997 and the percentage change in membership between
these dates, where applicable. The December 31, 1998 membership figures reflect
the acquisition of the PHC health plans and the disposition of Principal Health
Care of Florida, Inc. and Principal Health Care of Illinois, Inc., all of which
occurred in 1998.
December 31,
----------------------- Percentage
1998 1997 Change
- ------------------------------------------------------------------------------------------------
St. Louis 320,179 260,884 22.73%
Pennsylvania 427,177 448,103 (4.67%)
Iowa 79,306 - N/A
Richmond 55,259 56,836 (2.77%)
Delaware/Baltimore 54,329 - N/A
Kansas City 51,993 - N/A
Louisiana 39,730 - N/A
Wichita 35,342 - N/A
Nebraska 34,598 - N/A
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Indiana 27,280 - N/A
Carolinas 21,575 - N/A
Georgia 20,273 - N/A
-------------------------------------------
Total risk membership 1,167,041 765,823 72.71%
Total non-risk membership 218,273 148,910 50.30%
-------------------------------------------
Total membership 1,385,314 914,733 69.06%
===========================================
Commercial 1,000,699 622,942 85.05%
Governmental programs 166,342 142,881 18.91%
-------------------------------------------
Total risk membership 1,167,041 765,823 72.71%
Total non-risk membership 218,273 148,910 50.30%
-------------------------------------------
Total membership 1,385,314 914,733 69.06%
===========================================
PRODUCTS
Commercial
Health Maintenance Organizations
The Company's HMO products provide comprehensive healthcare benefits to
members, including ambulatory and inpatient physician services, hospitalization,
pharmacy, dental, optical, mental health, and ancillary diagnostic and
therapeutic services. In general, a fixed monthly enrollment fee covers all HMO
services although some benefit plans require copayments or deductibles in
addition to the basic enrollment fee. A primary care physician assumes overall
responsibility for the care of a member, including preventive and routine
medical care and referrals to specialists and consulting physicians. While an
HMO member's choice of providers is limited to those within the health plan's
HMO network, the HMO member is typically entitled to coverage of a broader
range of health care services than is covered by typical reimbursement or
indemnity policies.
Preferred Provider Organizations and Point of Service
The Company, through its health plans, offers flexible provider products,
including PPO and POS products which permit members to participate in managed
care but allow them to choose, at the time services are required, to use
providers not participating in the managed care network. If a non-participating
provider is utilized, deductibles and copayments are generally higher and
increase the out-of-pocket costs to the member. PPO/POS premiums are typically
lower than HMO premiums due to the increased out-of-pocket costs borne by the
members.
Governmental Programs
Medicare
In late 1995, the Company introduced a Medicare product, for which the
Company assumes risk, under the name "Advantra" in the St. Louis market. In
1996, the Company began marketing this product in its western Pennsylvania and
central Pennsylvania markets. The Company also marketed a Medicare risk product
in the Chicago, Illinois and Jacksonville, Florida markets. Effective December
31, 1998, the Company exited the Medicare program in several counties,
representing approximately 18,000 members, approximately 10,000 of whom were in
the Illinois and Florida health plans that were sold effective November
30, 1998 and December 31, 1998, respectively. The remaining counties were exited
because the reimbursement rates were not adequate and/or the Company was not
successful in its efforts to increase reimbursement rates.
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Under a Medicare risk contract, the Company receives a county-specific
fixed premium per member per month from the U.S. Health Care Financing
Administration ("HCFA"), which reflects certain county-specific demographics of
the Medicare population of each region. However, the product also carries the
risk of higher utilization and related medical costs than commercial products
and the possibility of regulatory or legislative changes that may reduce
premiums or increase mandated benefits in the future. The Company is also
subject to increased government regulation and reporting requirements related
to the product. The Company continues to evaluate the feasibility of expansion
into additional markets with its Medicare product.
The Company also offers Medicare cost and supplement products. Under a
Medicare cost contract, the Company is reimbursed by HCFA only for the cost of
services rendered to the plan members, including a portion of administrative
expenses. HCFA periodically audits the cost of services and, as a result, the
Company is at risk for less than full reimbursement. Medicare supplement members
enroll individually and pay a monthly premium for comprehensive health services
not covered under Medicare. A majority of the Company's former Medicare cost and
supplement members converted to the Company's Advantra product during 1996.
Medicaid
The Company offers health care coverage to Medicaid recipients in the
St. Louis and central Missouri, Richmond, Virginia, Delaware, and Iowa markets.
Medicaid recipients in the St. Louis, central Missouri and Delaware markets are
generally required to choose a managed care provider. In Richmond, Virginia, and
Iowa, enrollment in a Medicaid HMO is voluntary. Under a Medicaid risk contract,
the participating state pays a monthly premium per member based on the age, sex,
and eligibility category of the recipients enrolled in the Company's plans.
The Company determined, at the end of 1996, that its Florida operations
were not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, the Company discontinued operations in the Florida
Medicaid HMO market on June 30, 1997. The Company also exited the western and
central Pennsylvania Medicaid Markets for similar reasons effective December 31,
1997 and March 31, 1998, respectively.
Like the Medicare risk product, the Medicaid product makes the Company's
financial results more susceptible to government regulation and legislative
changes in premium levels and benefit structure. Under current regulations,
HMOs offering Medicaid products on a mandatory enrollment basis must, within
certain time frames, broaden their membership to include at least 25%
commercial HMO members. The Company's Medicaid operations are concentrated in
the St. Louis and Delaware markets. The Company believes that its existing
commercial membership satisfies all regulatory commercial membership
requirements . See "Government Regulation."
Management Services
The Company's health plans offer management services to large
employers who self-insure their employee health benefits. Under
related contracts, employers who fund their own health plans receive the
benefit of provider pricing arrangements from the health plan, and the health
plan also provides a variety of administrative services such as claims
processing, utilization review and quality assurance for the employers. The
health plan receives an administrative fee for these services but does not
assume the healthcare cost underwriting risk. Certain of the Company's
management services contracts include performance and utilization management
standards which affect the fees received for these services. The Company also
offers a PPO product to other third-party payors under which the Company
provides rental of and access to the Company's PPO network, claims repricing
and utilization review. The Company does not accept underwriting risk for this
product. Non-risk membership in the tables above do not reflect
membership attributable to this product. The Company also provides management
services to employer group beneficiaries that have elected HMO coverage under
products marketed jointly with Principal Life.
Delivery Systems
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The Company's health plans maintain provider networks that furnish health
care services through contractual arrangements with physicians, hospitals and
other health care providers, rather than providing reimbursement to the member
for the charges of such providers. Because the health plans receive the same
amount of revenue from their members irrespective of the cost of healthcare
services provided, they must manage both the utilization of services and the
unit cost of the services.
The Company's health plans' networks historically have utilized a variety
of physician care delivery systems that differed primarily in the
characterization of the relationship between the Company and the participating
physicians. Prior to 1997, the Company utilized staff models in the western and
central Pennsylvania and St. Louis markets to deliver primary care and certain
specialist services through physicians who were employed exclusively by the
health plan. The exclusive full-time employment of physicians in a staff model
generally enabled the health plan to predict costs more effectively, maintain
quality and respond quickly to consumer issues. However, staff model operations
also involved substantial investment in facilities and personnel that could not
be immediately adjusted to take into account changes in the membership or third
party payor pricing trends. In addition to providing health care to plan
members, these staff models also accepted non-member patients on a
fee-for-service basis in an effort to help cover the costs associated with the
medical offices.
The Company determined in late 1996 to seek to dispose of the staff model
operations in Pittsburgh, Pennsylvania and St. Louis, Missouri. Effective March
31, 1997, the Company completed its sale of a majority of the medical offices
in Pittsburgh, Pennsylvania associated with Allegheny Health, Education and
Research Foundation ("AHERF"), a major provider organization in the Pittsburgh
market, for approximately $20 million. Upon the sale, the Company entered into
a long-term global capitation agreement with AHERF that increased the Company's
globally capitated membership in western Pennsylvania to approximately 250,000
members, or 91%, of the Company's commercial, Medicaid and Medicare membership
in western Pennsylvania. Under the arrangement, AHERF received a fixed
percentage of premium to cover all the medical costs provided to the globally
capitated members.
In July 1998, AHERF filed for bankruptcy protection under Chapter 11. As
a result, the Company, which is ultimately responsible for the medical costs of
the capitated members, recorded a charge of $55.0 million to establish a reserve
for the medical costs incurred by members covered by the AHERF agreement at the
time of the bankruptcy filing and other potential bankruptcy charges. Under
applicable bankruptcy laws, AHERF could reject and refuse to perform under the
global capitation agreement. Generally, under Chapter 11 a debtor company such
as AHERF may affirm or reject its contractual obligations prior to confirmation
of a plan of reorganization, and if a contract is rejected, the contractual
damages become an unsecured claim in the Chapter 11 proceeding. Although AHERF
has not formally rejected the risk-sharing agreement as of the date of this
filing, the parties are negotiating a resolution of the arrangement and,
currently, neither AHERF nor the Company is operating under the existing
agreement. The Company has filed a lawsuit against certain hospital subsidiaries
of AHERF that were not included in the bankruptcy filing. The lawsuit is seeking
a court order declaring that the Company is not liable for the payment of $21.5
million of medical services provided by the hospitals to the Company's members
prior to the date of AHERF's bankruptcy filing and compelling the hospitals to
fulfill their contractual obligations to continue to provide health care
services to the membership in western Pennsylvania. The lawsuit also includes a
claim for damages to recover the losses incurred by the Company as a consequence
of AHERF's default of its obligations under the risk-sharing agreement. In
response to the lawsuit, the hospitals have filed a counterclaim alleging that
HAPA, notwithstanding AHERF's assumption of the payment obligation, is liable to
the hospitals for the payment of medical services provided prior to AHERF's
bankruptcy. The Company intends to vigorously defend against the counterclaim.
The Company believes that the reserve established is adequate to provide for the
claims incurred with respect to the AHERF arrangement and the related AHERF
bankruptcy uncertainties. For the year ended December 31, 1998, $33.8 million
has been paid for medical claims related to this reserve.
Effective May 1, 1997, the Company completed its sale of the medical
offices associated with Group Health Plan, Inc., its health plan in St. Louis,
Missouri, to BJC Health System ("BJC"), a major provider organization in the
St. Louis market, for approximately $26.9 million. Upon the sale, the Company
entered into a long-term global capitation agreement with BJC, since amended,
that covered approximately 33.3% of the risk membership in St. Louis at
December 31, 1998. Under the agreement, BJC
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receives a fixed percentage of premium to cover all of the medical treatment
received by the globally capitated members. Global capitation agreements limit
the Company's exposure to the risk of increasing medical costs, but expose the
Company to risk as to the adequacy of the financial and medical care resources
of the provider organization. To the extent that the respective provider
organization faces financial difficulties or otherwise is unable to perform its
obligations under the global capitation agreements, the Company, which is
responsible for the coverage of its members pursuant to its customer
agreements, will be required to perform such obligations, and may have to incur
costs in doing so in excess of the amounts it would otherwise have to pay under
the global capitation agreements.
Effective September 30, 1997, the Company completed the sale of its
remaining five medical offices associated with HAPA to ProMedCo Management
Company. The agreement covered 21 physicians who serve approximately 12,000
members. The approximately $2.0 million of proceeds from the sale approximated
the carrying value of the medical offices.
All of the Company's health plans currently offer an open panel delivery
system. In an open panel structure, individual physicians or physician groups
contract with the health plans to provide services to members but also maintain
independent practices in which they provide services to individuals who are not
members of the Company's health plans.
Health Care Provider Compensation
Under most open panel contracts, each primary care physician is paid a
monthly fixed capitation fee for each enrollee selecting the physician and may
receive additional compensation from risk-sharing arrangements with the health
plan to the extent that pre-established utilization and quality goals are
achieved. Contracting specialist physicians are compensated under both
discounted fee-for-service arrangements and capitation arrangements. The
majority of the Company's contracts with hospitals provide for inpatient per
diem or per case hospital rates, while outpatient services are typically
contracted on a discounted fee-for-service basis. The Company pays many of its
hospital and ancillary providers on a fixed fee schedule or a monthly fixed
capitation fee. In the central Pennsylvania and St. Louis markets, the Company
maintains risk sharing arrangements with integrated networks of physicians and
providers. The Company has credit and operating risk associated with these
arrangements. One of the risk sharing agreements in the St. Louis market is
currently in arbitration over amounts in dispute. Additionally, the Company has
significant membership covered by global capitation agreements in St. Louis, as
discussed above.
Quality Assurance
The Company has established systems to monitor the availability,
appropriateness and effectiveness of the patient care it provides. Monitoring
the number of physicians and support personnel needed for the number of
enrollees served assists in maintaining the availability of care at appropriate
levels. Utilization data collected and disseminated in the context of
controlling costs are also a valuable indicator of over or under utilization of
necessary services and helps the Company's health plans provide optimal care to
their members.
The Company's health plans also have internal quality assurance review
committees made up of physicians and other staff members whose responsibilities
include periodic review of medical records, development and implementation of
standards of care based on current medical literature and the collection of data
relating to results of treatment. Studies are regularly conducted to discover
possible adverse medical outcomes for both quality and risk management purposes.
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Appointment availability, member waiting times and environments are
monitored. A membership services department is responsible for monitoring and
maintaining member satisfaction, and the Company's health plans periodically
conduct membership surveys of both existing and former members concerning
services furnished and suggestions for improvement.
Utilization Management and Review
A managed care company's profitability is dependent on maintaining
effective controls over utilization of health care services consistent with the
provision of high quality care. Each of the Company's health plans either
employs physicians or contracts with physicians as Medical Directors who oversee
the delivery of medical services. The Medical Director supervises medical
managers (physicians and nurses) who review and approve the primary care
physicians' referrals to specialists and hospitals. Medical managers also
continually review the status of hospitalized patients and compare their medical
progress with established clinical criteria. In addition, nurses make hospital
rounds to review patients' medical progress and perform quality assurance and
utilization functions.
Medical managers also monitor the utilization of diagnostic services and
encourage use of outpatient surgery and testing where appropriate. Data showing
each physician's utilization profile for diagnostic tests, specialty referrals
and hospitalization are collected by each health plan and provided to the health
plan's physicians. These results are monitored by medical managers in an attempt
to ensure the use of cost-effective, medically appropriate services.
Marketing
The Company's commercial health plans are marketed primarily to employer
groups as alternatives to conventional fee-for-service health care and indemnity
health insurance programs. Employers generally pay all or part of their
employees' health care premiums, and many continue to offer their employees a
conventional insurance plan even if one or more of the Company's products are
offered.
Commercial marketing is generally a two-step process in which
presentations are made first to employers and then directly to employees. Once
selected by an employer, the Company solicits members from the employee base
directly. During periodic "open enrollments," in which employees are permitted
to change health care programs, the Company uses direct mail, worksite
presentations, and radio and television advertisements to contact prospective
members. The Company also markets through independent insurance brokers, agents,
and employee benefits consultants. Virtually all of the Company's employer group
contracts are renewable annually, and enrollment is continuously affected by
employee turnover within employer groups.
The Company's Medicaid products are marketed directly to individuals
while its Medicare products are marketed to both individuals and employer group
retirees. Individual marketing to Medicare beneficiaries is conducted through
use of a direct sales force and advertising efforts that include television,
radio, newspaper, billboards, and direct mail. The Company also markets Medicare
products through independent insurance brokers and agents. The Company's
Medicaid and Medicare contracts are renewable annually, and Medicare and
Medicaid enrollees may disenroll monthly.
Each of the Company's health plans employs a full-time marketing staff.
The marketing staff uses advertising and promotional material prepared by
advertising firms as well as market research programs.
No single employer group accounted for 10% or more of the Company's
consolidated revenues in 1998. For the year ended December 31, 1998, HealthCare
USA of Missouri, LLC ("HCUSA"),a subsidiary, received approximately $110.4
million or 100% of its revenues from the State of Missouri for Medicaid
members. Also, the Company's health plan in Wichita received approximately
$25.0 million, or 66.0%, of its revenues from one employer group.
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Competition
The Company's health plans operate in highly competitive environments and
compete with other HMOs, PPOs, indemnity insurance carriers and, most recently,
physician-hospital organizations. While competitive pressures in 1997 had an
adverse affect on premiums from the Company's commercial products, the
environment has generally improved in 1998, allowing the Company to implement
rate increases of 6%-8%. That trend is expected to continue in 1999. In some
cases, employer groups have moved from the traditional commercial HMO plans
toward the lower premium flexible provider products.
The Company believes that the principal factors influencing an employer
group's decision to choose among health care options are the price of the
benefit plans offered, locations of the health care providers, reputation for
quality care, financial stability, comprehensiveness of coverage, and diversity
of product offerings.
The Company also competes with other managed care organizations and
indemnity insurance carriers in seeking to obtain and retain favorable contracts
with hospitals and other providers of services to the Company's health plans.
Government Regulation
The Company's HMOs are required to file periodic reports with, and are
subject to periodic review by, state and federal licensing authorities that
regulate them. The HMOs are required by state law to meet certain minimum
capital and deposit and/or reserve requirements and may be restricted from
paying dividends under certain circumstances. They are also required to provide
their members with certain mandated benefits. The HMOs are required to have
quality assurance and education programs for their professionals and enrollees.
Certain states' laws further require that representatives of the HMOs' members
have a voice in policy making.
In 1996, HCFA promulgated regulations ("Physician Incentive Plan
Regulations") enforcing Sections 4204(a) and 4731 of the Omnibus Budget
Reconciliation Act of 1990 ("OBRA 90"), which prohibit HMOs with Medicare,
Medicaid or CHAMPUS contracts from including any direct or indirect payment to
physicians or groups as an inducement to reduce or limit medically necessary
services to Medicare beneficiaries and Medicaid recipients. Under the Physician
Incentive Plan Regulations, HMOs must, among other things, disclose to HCFA
information regarding physician compensation in such detail as to allow HCFA to
determine compliance with the regulations, and assure that stop-loss insurance
is in place, if the physician or physician group has been placed in "substantial
financial risk" for referral services provided to Medicare beneficiaries and
Medicaid recipients. These regulations became effective in 1996 and have a range
of compliance dates which began in January 1997.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
was signed into law on August 21, 1996. HIPAA amended Title I of the Employee
Retirement Income Security Act of 1974 ("ERISA"), the Code, and the Public
Health Service Act. HIPAA applies to both "group health plans" and "health
insurance issuers" and generally became effective for plan years beginning after
June 30, 1997. A "health insurance issuer" is defined under HIPAA to include
both insurance companies and HMOs subject to state laws that regulate insurance.
HIPAA limits the use of exclusions for preexisting conditions; prohibits
discrimination against both employees and dependents based on health status;
requires health insurance issuers to guarantee renewability and availability of
health coverage to certain employers and individuals; and requires group health
plans and health insurance issuers to issue certificates of creditable coverage.
With respect to health insurance issuers, states have the primary responsibility
for enforcement of HIPAA. (In some states, the U.S. Department of Health and
Human Services ("HHS") will be enforcing HIPAA's requirements.) The Company is
considered a health insurance issuer and is subject to HIPAA's requirements.
On April 1, 1997, the Departments of Labor, HHS and the Treasury issued
interim regulations that interpret many of the provisions of HIPAA. The states
are in the process of enacting implementing laws and regulations in this area.
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The Newborns' and Mothers' Health Protection Act ("NMHPA") of 1996 was
signed into law on September 26, 1996. This law applies to group health plans
and health insurance issuers and became effective for plan years beginning on or
after January 1, 1998. NMHPA prohibits group health plans and health insurance
issuers from restricting benefits for a mother's or newborn child's hospital
stay in connection with childbirth to less than 48 hours for a vaginal delivery
or less than 96 hours for a cesarean section. Authorization or precertification
requirements cannot be imposed for these mandatory minimum hospital stays. The
Company is considered a health insurance issuer and subject to NMHPA's
requirements. Federal regulations implementing NMHPA have not yet been
promulgated.
The Mental Health Parity Act of 1996 ("MHPA") was signed into law on
September 26, 1996. This law applies to group health plans and health insurance
issuers and became effective for plan years beginning on or after January 1,
1998. MHPA prohibits group health plans and health insurance issuers providing
mental health benefits from imposing lower aggregate annual or lifetime
dollar-limits on mental health benefits than any such limits for medical and
surgical benefits. MHPA's requirements do not apply to small employers who have
between 2 and 50 employees or to any group health plan whose costs increase one
percent or more due to the application of these requirements. The Company is
considered a health insurance issuer and subject to NMHPA's requirements.
Federal regulations implementing MHPA have not yet been promulgated.
The Women's Health and Cancer Rights Act of 1998 ("WHCRA") was signed
into law on October 21, 1998. This law applies to group health plans and health
insurance issuers and became effective for plan years after October 21, 1998.
WHCRA requires group health plans and health insurance issuers providing
coverage for mastectomies to provide benefits for reconstructive surgery.
Specifically, the law mandates that if an enrollee elects reconstructive
surgery after a mastectomy, a group health plan or health insurance issuer must
provide benefits for reconstruction of the affected breast, surgery and
reconstruction of the other breast to produce a symmetrical appearance,
prosthesis and treatment of physical complications at all stages of the
mastectomy, including lymphedemas. This coverage may be subject to the same
annual deductions and coinsurance provisions as established for other plan
benefits.
All of the Company's HMOs that contract with HCFA to provide services to
Medicare beneficiaries pursuant to a Medicare risk contract are subject to
federal laws and regulations. These HMOs may also be subject to state laws
governing Medicare contracting. HCFA has the right to audit any health plan
operating under a Medicare risk contract to determine the plan's compliance with
federal law. The Company's HMOs with Medicare risk contracts must also comply
with the requirements established by peer review organizations ("PROs"), which
are organizations under contract with HCFA to monitor the quality of health care
received by Medicare beneficiaries and under contract with certain states to
monitor the quality of health care received by Medicaid recipients. In addition,
cost reimbursement reports are required with respect to Medicare cost contracts
and are subject to audit and revision.
On August 5, 1997, the President signed into law the Balanced Budget Act
of 1997 ("BBA"). This law made revisions to the Medicare program, including:
permitting provider-sponsored organizations to offer services to Medicare
beneficiaries; requiring managed care plans serving Medicare beneficiaries to
make medically necessary care available 24 hours a day, to provide coverage a
"prudent lay person" would deem necessary and to provide grievance and appeal
procedures; and prohibiting such plans from restricting providers' advice
concerning medical care. The BBA also revised the method of calculation of the
payments made to the Company's plan by Medicare and is expected to reduce the
annual increase in such payments from the amounts that would have been paid
under former calculation methods.
All of the Company's HMOs that contract with states to provide services
to Medicaid recipients are subject to state and federal laws and regulations.
HCFA and the appropriate state regulatory agency have the right to audit any
health plan operating under a Medicaid managed care contract to determine the
plan's compliance with state and federal law. In some instances, states engage
PROs to perform quality assurance and utilization review oversight of Medicaid
managed care plans. The Company's HMOs are required to abide by these PRO
requirements.
The Social Security Act imposes criminal and civil penalties for paying
or receiving remuneration (which is deemed to include a kickback, bribe or
rebate) in connection with any federal health care program including, but not
limited to, the Medicare, Medicaid and CHAMPUS programs. The law and the related
regulations have been interpreted to prohibit the payment, solicitation,
offering or receipt of any form of remuneration in return for the referral of
federal health care program patients or any item or service that is reimbursed,
in whole or in part, by any federal health care program. Similar anti-kickback
provisions have been adopted by many states which apply regardless of the source
of reimbursement. In 1966, as part of HIPAA, Congress adopted a statutory
exception for certain risk sharing arrangements which has not yet been
interpreted by the Office of the Inspector General as no regulation, either
proposed or final, has yet been published. Nevertheless, the Department of
Health and Human Services ("DHHS") has adopted safe harbor regulations
specifying certain relationships and activities that are deemed not to violate
the federal anti-kickback statute. Specifically, DHHS has adopted safe harbor
regulations
8
11
addressing: (i) HMOs' waivers of Medicare and Medicaid beneficiaries' obligation
to pay cost-sharing amounts or to provide other incentives in order to attract
Medicare and Medicaid enrollees; and (ii) certain discounts offered to prepaid
health plans by contracting providers. The Company believes that the incentives
offered by its HMOs to Medicare and Medicaid beneficiaries and the discounts its
plans receive from contracting health care providers should satisfy the
requirements of the safe harbor regulations. However, failure to satisfy each
criterion of the applicable safe harbor does not mean that the arrangement
constitutes a violation of the law; rather the safe harbor regulations provide
that the arrangement must be analyzed on the basis of its specific facts and
circumstances. The Company believes that its arrangements do not violate the
federal or similar state anti-kickback laws.
The Company contracts with the United States Office of Personnel
Management ("OPM") to provide managed health care services under the Federal
Employees Health Benefits Program ("FEHBP"). These contracts with OPM and
applicable government regulations establish premium rating requirements for the
FEHBP. OPM conducts periodic audits of its contractors to, among other things,
verify that the premiums established under the OPM contracts are established in
compliance with the community rating and other requirements under FEHBP. Such
audits could result in material adjustments.
Numerous health care proposals have been introduced in the U.S. Congress
and in state legislatures. These include provisions which place limitations on
premium levels, increase minimum capital and reserves and other financial
viability requirements, prohibit or limit capitated arrangements or provider
financial incentives, mandate benefits (including mandatory length of stay with
surgery or emergency room coverage), limit the ability to manage care, require
external review of health plan decisions and require contracting with all
willing providers. If enacted, certain of these proposals could have an adverse
effect on the Company. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Legislation and Regulation" in
Part II of this Report.
Risk Management
The HMOs maintain general liability and professional liability (medical
malpractice, managed care liability, and medical excess "stop loss") insurance
coverage in amounts the Company believes to be adequate. Contracting physicians
are also required to maintain professional liability coverage. No assurance can
be given as to the future availability or costs of such insurance or that the
liability will not exceed the limit of the insurance coverage.
Employees
At December 31, 1998, The Company employed approximately 3,050 persons,
none of whom are covered by a collective bargaining agreement.
9
12
Trademarks
The Company has the right to use the name "HealthAmerica" in Illinois,
Missouri, Pennsylvania and West Virginia. The Company has federal and/or state
registered service marks for "HealthAssurance," "GHP Access," "Healthcare USA,"
"Doc Bear," "CarePlus," "Coventry " and "Advantra." The Company has entered
into a licensing agreement with Principal Life pursuant to which it can use the
names "Principal Health Care", "The Principal," "The Principal Financial Group,"
"Principal Health Care 65," and "PrinChoice," for a limited period of time in
geographic locations where PHC operated HMOs.
Item 2: Properties
As of December 31, 1998, the Company leased approximately 171,359
square feet of space for its corporate office in Bethesda, Maryland, the
majority of which is subleased. The Company also leased approximately 722,167
aggregate square feet for office space, subsidiary operations, and customer
service centers in the various markets where the Company's health plans operate.
The Company's leases expire at various dates from 1999 through 2006. The Company
also owns a building in Richmond, Virginia with approximately 45,000 square
feet, which is used for administrative services related to its health plan in
that market. The Company believes that its facilities are adequate for its
operations.
Item 3: Legal Proceedings
In the normal course of business, the Company has been named as
defendant in various legal actions seeking payments for claims denied by the
Company, medical malpractice, and other monetary damages. The claims are in
various stages of proceedings and some may ultimately be brought to trial.
Incidents occurring through December 31, 1998 may result in the assertion of
additional claims. With respect to medical malpractice, the Company carries
professional malpractice and general liability insurance for each of its
operations on a claims-made basis with varying deductibles for which the Company
maintains reserves. In the opinion of management, the outcome of any of these
actions will not have a material adverse effect on the financial position or
results of operations of the Company.
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year 1998.
10
13
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder
Matters
Price Range of Common Stock
The Company's common stock is traded on the Nasdaq Stock Market's
National Market under the symbol "CVTY." The following tables set forth the
quarterly range of high and low closing sales prices of the common stock on
Nasdaq during the calendar period indicated:
1998 1997
------------------------------------------------------------------------------------------------
High Low High Low
------------------------------------------------------------------------------------------------
First Quarter $19 1/4 $12 3/8 $12 1/2 $6 7/8
Second Quarter 19 1/8 12 3/4 16 11 1/8
Third Quarter 16 3 7/8 19 7/8 14 1/2
Fourth Quarter 10 1/4 4 5/8 18 3/8 13 5/8
------------------------------------------------------------------------------------------------
On March 24, 1999, the Company had approximately 460 shareholders of
record, not including beneficial owners of shares held in nominee name.
Dividends
The Company has not paid any cash dividends on its common stock and
expects for the foreseeable future to retain all of its earnings to finance the
development of its business. The Company's ability to pay dividends is also
restricted by insurance regulations applicable to its subsidiaries. Subject to
the terms of such insurance regulations, any future decision as to the payment
of dividends will be at the discretion of the Company's Board of Directors and
will depend on the Company's earnings, financial position, capital requirements
and other relevant factors. See Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
11
14
Item 6: Selected Consolidated Financial Data
(in thousands, except per share data)
Operations Statement Data (1) December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------------------------------------------------------------
Operating revenues $2,110,383 $ 1,228,351 $ 1,057,129 $ 852,390 $ 776,643
Operating earnings (loss) (36,195) 5,739 (91,346) (1,275) 55,023
Net earnings (loss) (11,741) 11,903 (61,287) 18 29,288
Net earnings (loss) per share - basic (2) (0.22) 0.36 (1.87) - 0.96
Net earnings (loss) per share - diluted (2) (0.22) 0.35 (1.87) - 0.93
Weighted average common shares outstanding - basic (2)(4) 52,477 33,210 32,818 31,526 30,511
Weighted average common shares outstanding - diluted (2)(4) 52,477 33,912 32,818 32,150 31,550
Balance Sheet Data (1) December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------------------------------------------------------------
Cash and investments $614,582 $ 240,091 $ 168,423 $ 147,777 $ 133,975
Total assets 1,090,593 487,182 448,945 385,675 343,771
Long-term obligations and notes
payable (including current maturities) 88,367 109,268 102,985 77,868 73,643
Stockholders' equity and
partners' capital (3) 436,539 117,818 100,427 153,851 134,124
(1) Amounts presented for 1998 reflect the acquisition of the PHC health
plans as of December 31, 1998 and include the results of operations of
the acquired PHC health plans beginning April 1, 1998, the date of
acquisition. See Management's Discussion and Analysis of Financial
Condition and Results of Operations.
(2) Reflects the two-for-one split of the Company's common stock which
occurred in August, 1994.
(3) Predecessor company of a wholly owned subsidiary of the Company was an
S Corporation.
(4) Restated to comply with SFAS 128, "Earnings per share."
12
15
Supplementary Financial Information
The following is a summary of unaudited quarterly results of operations
(in thousands, except per share data) for the years ended December 31, 1998 and
1997.
Quarter Ended
---------------------------------------------------------------------------------
March 31, 1998 June 30, 1998 September 30, December 31,
(1)(2) 1998 1998(3)
---------------------------------------------------------------------------------
Operating revenues $ 330,209 $ 583,804 $ 593,278 $ 603,092
Operating earnings (loss) 7,178 (51,238) 2,179 5,686
Net earnings (loss) 4,707 (27,756) 5,068 6,240
Net earnings (loss) per share - basic 0.14 (0.47) 0.09 0.11
Net earnings (loss) per share - diluted 0.13 (0.47) 0.09 0.11
Quarter Ended
--------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1997 (4) 1997 (5) 1997 (6) 1997
--------------------------------------------------------------------------------
Operating revenues $ 299,345 $ 301,081 $ 306,694 $ 321,231
Operating earnings (loss) (8,021) 1,997 5,976 5,787
Net earnings (loss) (851) 6,590 2,658 3,506
Net earnings (loss) per share - basic (0.03) 0.20 0.08 0.11
Net earnings (loss) per share - diluted (0.03) 0.19 0.08 0.10
(1) Effective April 1, 1998, the Company completed its acquisition of
certain assets of PHC from Principal Life. The acquisition was accounted
for using the purchase method of accounting and, accordingly, the
operations of PHC have been included in the Company's consolidated
financial statements since the date of acquisition. As a result of the
merger, an estimated reserve of $7.8 million was established for the costs
related to the relocation of the corporate office from Nashville,
Tennessee to Bethesda, Maryland and other merger related expenses.
(2) The second quarter 1998 operating results were affected by the
establishment of a reserve for the costs incurred by members covered by
the AHERF agreement and other potential charges as a result of the
bankruptcy filing by AHERF. The establishment of the reserves resulted
in a charge to earnings of $55.0 million.
(3) The merger costs were less than the reserve established in the second
quarter of 1998, resulting in a credit to earnings of $1.3 million.
(4) Effective March 31, 1997, the Company completed the sale of the
majority of its medical offices in Pittsburgh, Pennsylvania associated
with HAPA to a major health care provider organization. The sale price
was $20.0 million and the transaction resulted in a pretax gain of
approximately $6.0 million.
(5) Effective May 1, 1997, the Company completed the sale of the medical
offices associated with Group Health Plan, Inc., its health plan in St.
Louis, Missouri, to a major health care provider organization. The sale
price was $26.9 million and the transaction resulted in a pretax gain
of approximately $9.6 million.
(6) In August 1997, the Company entered into an agreement to sell the
medical offices associated with HAPA's health plan operations
in Harrisburg, Pennsylvania. The sale price was $2.0 million and the
transaction resulted in a pretax loss of $0.2 million. Also in the
third quarter, the Company sold its two remaining medical offices located
in Pittsburgh, Pennsylvania for $0.3 million in cash and recorded a pretax
loss of $0.4 million.
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16
Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the
accompanying audited consolidated financial statements and notes.
Results of Operations
The following table (in thousands, except percentages and membership
data) is provided to facilitate a more meaningful discussion regarding the
results of the Company's operations for the three years ended December 31, 1998.
1998 1997 1996
---------------------------------------------------------------------------------------------
Amount Percent of Percent Amount Percent of Percent Amount Percent of
Operating Increase Operating Increase Operating
Revenues (Decrease) Revenues (Decrease) Revenues
---------------------------------------------------------------------------------------------
Operating revenues:
Managed care premiums $ 2,033,372 96.4% 68.3% $ 1,208,149 98.4 % 16.6 % $ 1,035,778 98.0 %
Management services 77,011 3.6% 281.2% 20,202 1.6 % (5.4)% 21,351 2.0 %
- ---------------------------------------------------------------------------------------------------------------------------------
Total operating revenues 2,110,383 100.0% 71.8% 1,228,351 100.0 % 16.2 % 1,057,129 100.0 %
- ---------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Health benefits (1) 1,767,374 83.7% 70.0% 1,039,860 84.7 % 11.7 % 940,532 89.0 %
Selling, general and administrative 291,919 13.8% 71.7% 170,017 13.8 % 3.0 % 165,081 15.6 %
Depreciation and amortization 25,793 1.2% 102.5% 12,735 1.0 % (70.3)% 42,862 4.1 %
AHERF charge 55,000 2.6% - - - - - -
Merger costs 6,492 0.3% - - - - - -
- ---------------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss) (36,195) (1.7%) (730.7%) 5,739 0.5 % 106.3 % (91,346) (8.6)%
Other income, net 27,251 1.3% 9.5% 24,880 2.0 % 86.0 % 13,379 1.3 %
Interest expense (8,566) (0.4%) (16.6%) (10,275) (0.8)% 64.2 % (6,257) (0.6)%
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes
and minority interest (17,510) (0.8%) (186.1%) 20,344 1.7 % 124.2 % (84,224) (8.0)%
- ---------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (11,741) $ 11,903 $ (61,287)
=================================================================================================================================
Membership at December 31:
Commercial 1,000,699 622,942 599,218
Governmental Programs 166,342 142,881 141,889
Non-risk 218,273 148,910 152,969
- ---------------------------------------------------------------------------------------------------------------------------------
1,385,314 914,733 894,076
=================================================================================================================================
(1) The medical loss ratio (health benefits as a percentage of managed care
premiums) was 86.9%, 86.1% and 90.8% in 1998, 1997 and 1996,
respectively.
General
Effective April 1, 1998, the Company completed its acquisition of
certain assets of PHC from Principal Life for a total purchase price of
$330.2 million including transaction costs of approximately $5.7 million.
The acquisition was accounted for using the purchase method of accounting, and
accordingly, the operating results of the PHC plans have been included in the
Company's consolidated financial statements since the date of acquisition.
Coincident with the closing of the transaction, the Company entered
into a Marketing Services Agreement and a Management Services Agreement with
Principal Life. Both agreements extend through December 31, 1999. Pursuant to
these agreements, the Company recognized approximately $23.0 million for the
year ended December 31, 1998, and expects to receive payments of approximately
$26.4 million in 1999.
As a result of the transaction, the Company assumed an agreement with
Principal Life, whereby Principal Life pays a fee for access to the Company's
PPO network based on a fixed rate per each employee entitled to access the PPO
network and a percentage of savings realized by Principal Life. Under this
agreement, the Company recognized approximately $12.0 million for the year
ended December 31, 1998. The maximum amount that can be paid under the
percentage of savings component of the agreement is $8.0 million for 1999.
Effective November 30, 1998, the Company sold its subsidiary, Principal
Health Care of Illinois, Inc. for $4.3 million in cash. This plan had
approximately 56,000 risk members and approximately 2,400 non-risk members as of
November 30, 1998 and reported $71.1 million in revenues since April 1, 1998,
the date of acquisition.
Effective December 31, 1998, the Company sold its subsidiary,
Principal Health Care of Florida, Inc. for $95.0 million in cash. The Florida
Health plan had approximately 156,000 risk members and approximately 5,500
non-risk members at December 31, 1998 and reported $172.5 million in revenues
since April 1, 1998, the date of acquisition.
The proceeds from both sales were used to retire the Credit Facility,
to assist in improving the capital position of the Company's regulated
subsidiaries, and for other general corporate purposes.
In March 1997, the Company entered into a global capitation agreement
with Allegheny Health, Education and Research Foundation ("AHERF") covering
approximately 250,000 members in the western Pennsylvania market. Under the
Agreement AHERF received 78% to 82% of the premium to cover all of the medical
expenses of the capitated members. In July 1998, AHERF filed for bankruptcy
protection under Chapter 11. As a result, the Company, which is ultimately
responsible for the medical costs of the capitated members, recorded a charge of
$55.0 million to establish a reserve for the medical costs incurred by members
covered by the AHERF agreement at the time of the bankruptcy filing and other
potential bankruptcy charges. Under applicable bankruptcy laws, AHERF could
reject and refuse to perform under the global capitation agreement. Generally,
under Chapter 11, a debtor company such as AHERF may affirm or reject its
contractual obligations prior to confirmation of a plan of reorganization, and
if a contract is rejected, the contractual damages become an unsecured claim in
the Chapter 11 proceeding. Although AHERF has not formally rejected the risk-
sharing agreement as of the date of this filing, the parties are negotiating a
resolution of the arrangement and, currently, neither AHERF nor the Company is
operating under the existing agreement. The Company has filed a lawsuit against
certain hospital subsidiaries of AHERF that were not included in the bankruptcy
filing. The lawsuit is seeking a court order declaring that the Company is not
liable for the payment of $21.5 million of medical services provided By the
hospitals to the Company's members prior to the date of AHERF's bankruptcy
filing and compelling the hospitals to fulfill their contractual obligations to
continue to provide health care services to the membership in western
Pennsylvania. The lawsuit also includes a claim for damages to recover the
losses incurred by the Company as a consequence of AHERF's default of its
obligations under the risk-sharing agreement. In response to the lawsuit, the
hospitals have filed a counterclaim alleging that HAPA, notwithstanding AHERF's
assumption of the payment obligation, is liable to the hospitals for the payment
of medical services provided prior to AHERF's bankruptcy. The Company intends to
vigorously defend against the counterclaim. The Company believes that the
reserve established is adequate to provide for the claims incurred with respect
to the AHERF arrangement and other related AHERF bankruptcy uncertainties. For
the year ended December 31, 1998, $33.8 million has been paid for medical claims
related to this reserve.
During the three years ended December 31, 1998, the Company experienced
substantial growth in operating revenues due primarily to membership growth,
much of which was attributable to the acquisition of the PHC plans effective
April 1, 1998. Additional membership growth was achieved through marketing
efforts, acquisitions, geographic expansion and increased product offerings.
14
17
The Company's managed care premium revenues during the three years
ended December 31, 1998 were comprised primarily of premiums from its commercial
HMO products and flexible provider products, including PPO and POS products for
which the Company assumes full underwriting risk. Premiums for such PPO/POS
products are typically lower than HMO premiums due to medical underwriting
and higher deductibles and copayments that are required from the PPO/POS
members. Prior to the sale of the Company's medical offices discussed below,
additional revenue was received from other medical services provided on a fee-
for-service basis in those medical offices.
Premium rates for commercial HMO products are reviewed by various state
agencies based on rate filings. While the Company has not had such filings
modified, no assurance can be given that approvals for rate submissions will
continue. Premium rates for the Medicaid and Medicare risk products are
established by governmental regulatory agencies and may be reduced by regulatory
action.
The Company's management services revenues result from operations in
which the Company's health plans provide administrative and other services to
self-insured employers and to employer group beneficiaries that have elected HMO
coverage under products jointly marketed with Principal Life. The Company
receives an administrative fee for these services, but does not assume
underwriting risk. In addition, the Company also offers a PPO product to other
third party payors, under which it provides rental of and access to the
Company's PPO network, claims repricing and utilization review, and does not
assume underwriting risk.
The Company's operating expenses are primarily medical costs including
medical claims under contracted relationships with a wide variety of providers,
capitation payments and, prior to their sale in 1997, expenses relating to the
operation of the Company's health centers. Medical claims expense also includes
an estimate of claims incurred but not reported ("IBNR"). The Company believes
that the estimates for IBNR liabilities relating to its businesses are adequate
in order to satisfy its ultimate claims liability with respect thereto. In
determining the Company's medical claims reserves, the Company employs plan by
plan standard actuarial reserving methods (specific to the plan's membership,
product characteristics, geographic territories and provider network) that
consider utilization frequency and unit costs of inpatient, outpatient,
pharmacy, and other medical costs as well as claim payment backlogs and the
changing timing of provider reimbursement practices. Calculated reserves are
reviewed by underwriting, finance and accounting, and other appropriate plan and
corporate personnel and judgments are then made as to the necessity for reserves
in addition to the above calculated amounts. Changes in assumptions for medical
costs caused by changes in actual experience, changes in the delivery system,
changes in pricing due to ancillary capitation and fluctuations in the claims
backlog could cause these estimates to change in the near term. The Company
periodically monitors and reviews IBNR, and as actual settlements are made or
reserves adjusted, differences are reflected in current operations.
Comparison of 1998 to 1997
Managed care premiums increased in 1998 $825.2 million, or 68.3%,
compared to 1997. The PHC plans accounted for approximately $697.7 million, or
84.6%, of the increase. Exclusive of the PHC plans, the Medicare risk membership
increased by 25,285 members, or 66.0%. Medicare risk membership has a
significantly higher per member per month premium (approximately three times)
when compared to commercial risk membership and represented an increase in
premiums, exclusive of the PHC plans, of $117.9 million from $161.1 million in
1997 to $279.0 million in 1998. The increase in Medicare risk membership was
offset by a 20,047 decrease in Medicaid risk membership primarily resulting from
the Company's decision to exit the Medicaid market in Pennsylvania in the first
quarter of 1998. In addition, revenues per member per month, exclusive of the
PHC plans, increased by 3.3% for HMO members, 8.3% for PPO/POS members and 5.5%
for Medicaid members in 1998 over 1997. Excluding Medicaid membership, risk
membership grew by 25,885, or 3.9%. The Company continues to implement rate
increases that averaged approximately 7% in the fourth quarter of 1998 and
expects similar rate increases to be implemented in 1999.
15
18
The Company has exited the Medicare program in several counties
representing approximately 18,000 members as of December 31, 1998. Approximately
10,000 of those members were in the Illinois and Florida health plans that were
sold effective November 30, 1998 and December 31, 1998, respectively. The
remaining markets are being exited because the reimbursement rates are not
adequate and/or the Company was not successful in negotiating adequate
reimbursement rates.
Management services revenue increased $56.8 million for the year ended
December 31, 1998, or 281.2%, from the prior year. Management services and
marketing services agreements that were entered into coincident with the
acquisition of the PHC plans accounted for approximately $23.0 million, or
40.5%, of the increase. Approximately $30.5 million, or 53.7%, of the increase
is primarily attributable to the PHC Administrative Services Only ("ASO")
operations and PPO access fees. Exclusive of the PHC plans and the related
agreements with Principal Life, management services revenue increased
approximately $3.3 million, or 5.8%, attributable to transition services
related to global capitation agreements and rate increases to ASO customers.
Membership
Commercial Risk Governmental Risk
-----------------------------------------------------------------------
HMO PPO/POS Medicare Medicaid Non-Risk Total
-----------------------------------------------------------------------------------------------------------------------
1998
----
Pennsylvania 207,067 194,539 25,571 - 103,288 530,465
St. Louis (1) 138,031 62,615 38,028 81,505 23,029 343,208
Richmond 51,980 264 - 3,015 14,812 70,071
Nebraska 34,598 - - - 720 35,318
Kansas City 51,993 - - - 5,526 57,519
Wichita 35,342 - - - 399 35,741
Louisiana 39,730 - - - 161 39,891
Delaware 37,500 - - 16,829 58,062 112,391
Iowa 77,912 - - 1,394 10,778 90,084
Indiana 27,280 - - - 750 28,030
Georgia 20,273 - - - 748 21,021
Carolina 21,575 - - - - 21,575
-----------------------------------------------------------------------------------------------------------------------
Total 743,281 257,418 63,599 102,743 218,273 1,385,314
=======================================================================================================================
1997
----
Pennsylvania 238,122 174,157 12,141 23,683 111,087 559,190
St. Louis 103,456 52,932 26,173 78,323 21,281 282,165
Richmond 54,095 180 - 2,561 16,542 73,378
-----------------------------------------------------------------------------------------------------------------------
Total 395,673 227,269 38,314 104,567 148,910 914,733
=======================================================================================================================
(1) St. Louis includes PHC of St. Louis membership in 1998.
Health benefits expense increased $727.5 million for the year ended
December 31, 1998, or 70.0%, compared to 1997. The PHC plans accounted for
approximately $612.5 million, or 84.2%, of the increase. The
16
19
Company's medical loss ratio increased slightly to 86.9% from 86.1% in the
previous year, primarily as a result of increases in Medicare membership.
The Company continues to focus intensely on ways to control its medical
costs, including implementation of best practices to reduce inpatient days and
improvement of the overall quality and level of care. The Company is also
continuously monitoring and renegotiating with its provider networks to improve
reimbursement rates and improve access to the network for its members.
As previously discussed, in July 1998, AHERF, the global capitation
provider organization in western Pennsylvania, filed for bankruptcy protection
under Chapter 11. As a result, the extent to which AHERF will perform
its obligations under the global capitation agreement is uncertain. In addition
to the charge to provide for the estimated claims that were incurred but not
reported ("IBNR")on behalf of the globally capitated members at the date of the
bankruptcy filing, the medical loss ratio for the globally capitated members was
negatively impacted compared to the percentage of premium paid to AHERF under
the global capitation agreement. In addition, the Company increased
administrative staff for patient utilization and medical management in western
Pennsylvania.
Medical claim liability accruals are periodically monitored and
reviewed with differences for actual settlements from reserves reflected in
current operations. In addition to the procedures for determining reserves as
discussed above, the Company reviews the actual payout of claims relating to
prior period accruals, which may take up to six months to fully develop. Medical
costs are affected by a variety of factors, including the severity and frequency
of claims, that are difficult to predict and may not be entirely within the
Company's control. The Company continually refines its reserving practices to
incorporate new cost events and trends.
Selling, general and administrative ("SGA") expense for the year ended
December 31, 1998 increased $121.9 million, or 71.7%, compared to 1997. The PHC
plans accounted for approximately $92.8 million, or 76.1%, of the increase. The
remainder of the increase in SGA is primarily attributable to the increased
costs relating to administrative processes, particularly in claims processing,
associated with the growth of the Medicare product in certain markets. SGA
expense as a percent of revenue remained at 13.8% for the year ended 1998. In an
effort to control costs and improve customer service, the Company is in the
process of migrating certain of its operating activities (e.g., customer
service, claims processing, billing and enrollment) to regional service centers.
It is anticipated that the service centers will be fully operational in the
fourth quarter of 1999.
Depreciation and amortization for the year ended December 31, 1998
increased $13.1 million, or 102.5%, compared to 1997. Depreciation expense from
the PHC plans accounted for approximately $2.3 million, or 17.6%, of the
increase. The remainder of the increase is attributable to the amortization of
intangibles and goodwill recorded in connection with the acquisition of the PHC
plans.
Loss from operations was $36.2 million for the year ended December 31,
1998. Excluding the $61.5 million of charges associated with the AHERF
bankruptcy and the relocation of the corporate headquarters and other merger
related costs, operating earnings were $25.3 million for the year ended December
31, 1998 compared to $5.7 million for the corresponding period in 1997. The
increase in the operating earnings, exclusive of the $61.5 million of charges in
1998, is attributable to various factors as previously described.
Other income, net of interest expense, increased $4.1 million for the
year ended December 31, 1998, or 27.9%, from the corresponding period in the
prior year. Other income, net of interest expense, related to the PHC plans
accounted for approximately $10.1 million, or 246.3%, of the increase.
Exclusive of the PHC plans, other income, net of interest expense, decreased by
$6.0 million. This reduction was primarily attributable to a $15.0 million
pre-tax gain related to the sale of medical offices that was recognized in the
prior year, offset by increased investment income resulting from the increase
in invested assets subsequent to the acquisition of the PHC plans.
The Company's net loss was $11.7 million for the year ended December
31, 1998. Net loss per common and common equivalent share was $0.22 for the year
ended December 31, 1998 compared to earnings per common
17
20
and common equivalent share of $0.35 for the corresponding period in 1997.
Excluding the $61.5 million of charges associated with the AHERF bankruptcy and
the relocation of the corporate headquarters and other merger related costs,
the Company reported earnings per common and common equivalent share of $0.50
in 1998. The weighted average number of common shares outstanding were
approximately 52,477,000 and 33,912,000 for the years ended December 31, 1998
and 1997, respectively. The increase in the weighted average number of shares
outstanding in 1998 was primarily attributable to the shares issued in April
1998 related to the acquisition of the PHC plans. Effective in the fourth
quarter of 1997, the Company adopted SFAS 128, "Earnings Per Share."
Accordingly, prior periods have been restated.
Comparison of 1997 to 1996
Managed care premiums increased $172.4 million, or 16.6% to $1,208
million for 1997 compared to 1996. The revenue increase for the year was
enhanced by the growth in Medicare risk membership of 18,024 (which has a
significantly higher per member per month premium when compared to the
commercial and Medicaid products and represented an increase in premiums of
$98.2 million from $62.9 million in 1996 to $161.1 million in 1997) and
increases in premium rates as members renew. Premium yields on HMO, PPO/POS and
Medicaid members increased by 3.0%, 3.1% and 4.5% in 1997 compared to 1996,
respectively. The revenue increase is also a result of risk membership growth of
20,657, or 2.3%, from the prior year. The relatively small growth in risk
membership reflects the closing of the Florida Medicaid plan effective June 30,
1997, which had 21,747 members. Excluding the impact of exiting Florida, risk
membership grew by 52,758, or 7.4%.
Membership
Commercial Risk Governmental Risk
-------------------------------------------------------------
HMO PPO/POS Medicare Medicaid Non-Risk Total
-------------------------------------------------------------------------------------------------------------------
1997
----
Pennsylvania 238,122 174,157 12,141 23,683 111,087 559,190
St. Louis 103,456 52,932 26,173 78,323 21,281 282,165
Richmond 54,095 180 - 2,561 16,542 73,378
Jacksonville - - - - - -
-------------------------------------------------------------------------------------------------------------------
Total 395,673 227,269 38,314 104,567 148,910 914,733
===================================================================================================================
1996
----
Pennsylvania 267,733 136,756 5,359 14,134 117,465 541,447
St. Louis 97,689 39,579 14,931 76,829 24,574 253,602
Richmond 57,047 104 - 2,904 10,930 70,985
Jacksonville 310 - - 27,732 - 28,042
-------------------------------------------------------------------------------------------------------------------
Total 422,779 176,439 20,290 121,599 152,969 894,076
===================================================================================================================
Health benefits expense increased $109.1 million, or 11.7%, in 1997,
compared to 1996, as a result of the increase in risk enrollment and increases
in medical costs. The Company's medical loss ratio decreased to 86.1% from 89.9%
in the previous year. Medical loss ratios in western Pennsylvania and St. Louis
decreased due to the global capitation agreements signed in 1997. Approximately
$232.9 million and $70.8 million (22.4% and 6.8% of
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health benefit expense for the 1997 period) represented amounts paid or accrued
with respect to global capitation agreements with AHERF and BJC, respectively.
See "Risk Factors -- Risks of Agreements with Providers" for a discussion of
the credit and operational risk associated with global capitation agreements
with single provider organizations. Medical loss ratios increased in the
central Pennsylvania region due to increases in inpatient alternatives (such as
outpatient surgery), referrals to specialists, pharmacy and increased health
benefit expense associated with the Medicaid membership. Significant medical
cost increases in the Medicare risk product in St. Louis, Missouri were a
result of increased Medicare risk membership and utilization of inpatient
services.
The Company determined, at the end of 1996, that its Florida operations
were not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, the Company discontinued operations in the Florida HMO
market on June 30, 1997. The Company established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market and
the reserve is believed to be sufficient to cover the anticipated costs. During
the third quarter of 1997, the Company began to exit its Medicaid operations in
Pennsylvania. The Company fully exited the western and central Pennsylvania
Medicaid markets effective December 31, 1997 and March 31, 1998, respectively.
Medical claim liability accruals are periodically monitored and
reviewed with differences for actual settlements reflected in current
operations. In addition to the Company's procedures for determining reserves as
discussed above, the Company reviews the actual payout of claims relating to
prior period accruals, which may take up to six months to fully develop. Medical
costs are affected by a variety of factors, including the severity and frequency
of claims, that are difficult to predict and may not be entirely within the
Company's control. The Company continually refines its reserving practices to
incorporate new cost events and trends.
Selling, general and administrative ("SGA") expense increased $4.9
million, or 3.0%, from the prior year, but as a percent of revenue decreased
from 15.6% in 1996 to 13.8% in 1997. SGA in 1996 included termination costs of
$8.1 million and charge-off of capitalized new market development costs of $4.3
million. The increase in SGA in 1997 is primarily attributable to the increase
in full risk membership, additional personnel costs relating to the
re-engineering of administrative processes in claims processing, information
systems and customer services and costs associated with the growth of the
Company's Medicare risk product.
Depreciation and amortization decreased $30.1 million, or 70.3%, from
1996. This decrease is primarily the result of the medical office sales in
1997, write-off of $20.1 million of goodwill related to the acquisition of
PARTNERS Health Plan of Pennsylvania, Inc. due to application of SFAS 121 and
APB 17 in 1996 and charge-offs of $4.3 million of property and equipment due to
application of the impairment criteria of SFAS 121 in 1996.
Income from operations was $5.8 million, a $97.1 million improvement
over the prior year. Excluding the 1996 termination costs, contract loss
provisions, capitalized costs, goodwill and other charge-offs, operating income
in 1997 was a $56.3 million improvement over the loss for 1996. This $56.3
million improvement in operating income for 1997 is primarily attributable to
strong membership and revenue increases, a lower medical loss ratio, a lower SGA
expense ratio and lower depreciation and amortization resulting from the medical
office sales.
Other income increased $11.5 million. Effective March 31, 1997, the
Company sold substantially all of its western Pennsylvania medical offices to
AHERF. The sales price was $20 million and the transaction resulted in a pretax
gain of approximately $6.0 million. Also, effective May 1, 1997, the Company
completed the sale of its St. Louis, Missouri medical offices to BJC. The sales
price was $26.9 million and the transaction resulted in a pretax gain of
approximately $9.6 million. During the third quarter, the Company completed the
sale of the remaining medical offices in Pennsylvania. The sales price for the
third quarter transactions was $2.4 million and resulted in a pretax loss of
$0.6 million. Other income for 1996 included a $4.9 million gain on the sale of
Champion Dental Services, Inc., a subsidiary of Group Health Plan, Inc.
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Investment income increased $2.4 million primarily due to higher cash
and investments when compared to the prior year. Interest expense increased $4.0
million due primarily to a higher interest rate on the Company's term loan.
The Company's net income was $11.9 million, or $73.2 million more than
the prior year. Net income per common and common equivalent share was $0.35 per
share in 1997 compared to a $1.87 loss per share in 1996. The weighted average
number of common shares outstanding were approximately 33,912,000 and 32,818,000
for the year ended December 31, 1997 and 1996, respectively. Effective in the
fourth quarter, the Company adopted SFAS 128, "Earnings Per Share." Accordingly,
prior periods have been restated.
Liquidity and Capital Resources
The Company's total cash and investments, excluding deposits of $12.8
million restricted under state regulations, increased $367.7 million to $601.8
million at December 31, 1998 from $234.1 million at December 31, 1997. The
increase is primarily attributable to the acquisition of the PHC plans that
increased cash and investments by $250.3 million as of April 1, 1998, the date
of acquisition, as well as the net proceeds from the sale of the Florida and
Illinois health plans that were effective December 31, 1998 and November 30,
1998, respectively. The Company's investment guidelines emphasize investment
grade fixed income instruments in order to provide short-term liquidity and
minimize the risk to principal. The Company believes that since its long-term
investments are available for sale, the amount of such investments should be
added to current assets when assessing the Company's working capital and
liquidity; on such basis, current assets plus long-term investments available
for sale less short-term liabilities increased to $187.3 million at December 31,
1998 from $76.4 million at December 31, 1997.
The Company's HMOs and insurance company subsidiary are required by
state regulatory agencies to maintain minimum surplus balances, thereby limiting
the dividends the Company may receive from its HMOs and insurance company
subsidiary. After giving effect to these statutory reserve requirements, the
Company's regulated subsidiaries had surplus in excess of statutory requirements
of approximately $93.4 million and $52.9 million at December 31, 1998 and
December 31, 1997, respectively. The Company will be required to provide
additional capital to its regulated subsidiaries to provide for additional
medical claim liabilities related to the AHERF bankruptcy. Excluding funds held
by entities subject to regulation, the Company had cash and investments of
approximately $96.8 million and $28.6 million at December 31, 1998 and December
31, 1997, respectively, which are available to pay intercompany balances to
regulated subsidiaries and for general corporate purposes. The Company also has
entered into agreements with certain of its regulated subsidiaries to provide
additional capital if necessary to prevent the subsidiary's insolvency.
On December 29, 1997, the Company entered into a credit agreement with
a group of banks (the "Credit Facility"), which replaced a prior credit
agreement. Using a portion of the proceeds received from the sale of its Florida
health plan, the Company retired the Credit Facility and the $42.2 million
balance then outstanding effective December 31, 1998. On December 31, 1998, the
effective interest rate on the indebtedness retired was 7.0625%.
During the quarter ending June 30, 1997, the Company entered into a
securities purchase agreement ("Warburg Agreement") with Warburg, Pincus
Ventures, L.P. ("Warburg") and Franklin Capital Associates III, L.P.
("Franklin") for the purchase of $40 million of Coventry's 8.3% Convertible
Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with
warrants to purchase 2.35 million shares of the Company's common stock for
$42.35 million. The Coventry Notes are convertible into 4.0 million shares of
the Company's common stock and are exchangeable at the Company's or Warburg's
option for shares of convertible preferred stock. Interest is payable in
additional Coventry Notes and, as a result, the accrued interest at December
31, 1998 has been added to the outstanding indebtedness, resulting in $45.5
million of Coventry Notes outstanding at such date.
Projected capital investments in 1999 of approximately $16.9 million
consist primarily of computer hardware, software and related equipment costs
associated with the development and implementation of improved operational and
communications systems.
The Company believes that cash flows generated from operations, cash on
hand and investments, and excess funds in certain of its regulated subsidiaries
will be sufficient to fund continuing operations through December 31, 1999.
Legislation and Regulation
Numerous proposals have been introduced in the United States Congress
and various state legislatures relating to health care reform. Some proposals,
if enacted, could among other things, restrict the Company's ability
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to raise prices and to contract independently with employers and providers.
Certain reform proposals favor the growth of managed health care, while others
would adversely affect managed care. Although the provisions of any legislation
adopted at the state or federal level cannot be accurately predicted at this
time, management of the Company believes that the ultimate outcome of currently
proposed legislation would not have a material adverse effect on the Company and
its results of operations in the short-term. See Item 1: Business, Government
Regulation.
Litigation and Insurance
The Company may be subject to certain types of litigation, including
medical malpractice claims, claim disputes pertaining to contracts and other
arrangements with providers, employer groups and their employees and individual
members, and disputes relating to HMO denials of coverage for certain types of
medical procedures or treatments. In addition, the Company has contingent
litigation risk in connection with certain discontinued operations. Such
litigation may result in losses to the Company. The Company maintains insurance
coverage in amounts it believes to be adequate, including professional liability
(medical malpractice) and general liability insurance. Contracting physicians
are required to maintain professional liability insurance. In addition, the
Company carries "stop-loss" reinsurance to reimburse it for costs resulting from
catastrophic injuries or illnesses to its members. Nonetheless, no assurance can
be given as to the future availability or cost of such insurance and reinsurance
or that litigation losses will not exceed the limits of the insurance coverage
and reserve. In the opinion of management and based on the facts currently
known, the outcome of these actions should not have a material adverse effect on
the financial position or results of operations of the Company.
New Accounting Standards
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is
effective for both interim and annual reporting periods ending after December
15, 1997. The Company adopted the new standard in its reporting for the quarter
and the year ended December 31, 1997, including required restatement of prior
periods. The adoption of this standard did not have a material impact on
earnings per share.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive
Income," which is effective for fiscal years beginning after December 15, 1997
and requires restatement of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of certain items,
including unrealized gains and losses on certain securities, be reflected in the
financial statements. The Company adopted SFAS 130 effective January 1, 1998.
The adoption of this standard did not have a material effect on the Company's
consolidated financial statements.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This standard requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS No. 131 also requires that
all public business enterprises report information about the revenues derived
from the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. Effective December 31, 1998, the Company adopted
SFAS 131.
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities." This Statement requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether they qualify for hedge accounting. This standard is effective for
fiscal years beginning after June 15, 1999. The Company does not believe that
adoption of this standard will have a material effect on its future results of
operations.
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In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides authoritative guidance for the capitalization of certain costs related
to computer software developed or obtained for internal applications, such as
external direct costs of materials and services, payroll costs for employees and
certain interest costs. Costs incurred during the preliminary project stage, as
well as training and data conversion costs, are to be expensed as incurred.
SOP 98-1 is effective for fiscal years beginning after December 15, 1998. The
Company has not yet quantified the impact of adopting SOP 98-1 on the results of
its operations.
Inflation
Health care cost inflation has exceeded the general inflation rate and
the Company has implemented cost control measures and risk sharing arrangements
which seek to reduce the effect of health care cost inflation. During 1998, the
Company implemented increases in premiums rates designed to offset at least a
portion of inflationary cost increases while maintaining competitive rates
within its markets.
Quarterly Results of Operations
The quarterly consolidated results of operations of the Company are
summarized in Item 6: Selected Consolidated Financial Data, Supplementary
Financial Information.
1999 Outlook
The Company's membership in January 1999 was approximately 1,397,000
members, an increase of 52.5% over January 1998. The increase was primarily
attributable to the acquisition of the PHC plans. Of the January 1999
membership, approximately 1,156,000 were risk members and approximately 241,000
were non-risk members.
The Company operates in highly competitive markets, but generally
believes that the pricing environment is improving in its existing markets, thus
creating the opportunity for reasonable price increases. However, there is no
assurance that the Company will be able to increase premiums at rates equal to
or in excess of increases in its health care costs.
For 1999, the Company continues to pursue ways to improve its
underwriting processes and oversight in both risk and management services
products with the objective of increasing premium yields and profitable growth
in its markets. The Company's migration of certain of its operating
activities (e.g., customer service, claims processing, billing and enrollment)
to regional service centers is expected to be completed by the fourth quarter of
1999. The Company expects that the regional service centers will allow it to
provide improved levels of service in a more cost effective manner. The
integration of the PHC health plans has allowed the Company to strengthen its
balance sheet and gain entry into additional markets. Management believes that
existing markets have potential for growth for the Company's commercial and
governmental products. Management believes that the foregoing should result in
progressive improvements in 1999, although realization is dependent upon a
variety of factors, some of which may be outside the control of the Company.
Impact of Year 2000
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The Company's business is significantly dependent on information
systems. The Company has implemented a Year 2000 readiness program designed to
prevent material information system disruption associated with the Millenium
date change. The program includes an inventory and review of all core
application systems, networks, desktop systems, infrastructure and critical
information supply chains. The Company's Year 2000 readiness program can be
broken down into five categories: 1) IS hardware, software and networks, 2)
office equipment which relies on microchips or telecommunications, 3) buildings
and facilities, 4) business partners and customers, and 5) business risk and
contingency planning. It is anticipated that the program will be substantially
completed by the end of the second quarter of 1999. The total estimated cost of
the program is approximately $13.1 million, of which $9.0 million has been
incurred through December 31, 1998. The cost of Year 2000 modifications is
based on management's best estimates. Actual costs, however, may differ from
those currently anticipated. All Year 2000 initiatives are monitored by a
steering committee made up of management personnel representing the Company's
legal, compliance, finance, actuarial, medical and IS departments. The steering
committee reports the status of the Company's Year 2000 readiness program to
senior management who report to the board of directors.
While the Company currently believes that its planning efforts and
anticipated modifications to existing systems and purchases of new systems will
be adequate to address its Year 2000 concerns, there can be no assurance that
the systems of other companies on which the Company's systems and operations
rely will be converted on a timely basis and will not have a material adverse
effect on the Company.
The specific phases of the Year 2000 readiness program are as follows:
IS Hardware, Software and Networks
The Company has historically purchased its core software applications
rather than build them. The Company is currently operating on two different
platforms for its core managed health care software applications. The former
Coventry Corporation health plans use the IDX managed care system. The current
release of that system is vendor certified to be Year 2000 compliant and the
Company has converted its applications to that current release. Final testing
of the conversion is in process. All integration testing and operating system
upgrades are scheduled for completion by May 30, 1999. The former PHC health
plans are using a different third party product, which has been customized and
is no longer supported by the vendor. That system utilizes Julian dates for all
internal processes and is Year 2000 compliant. As part of the Company's
readiness program, the entire application has been reviewed and necessary
changes identified. Those programming modifications have been completed, tested
and are in production. The computer operating systems are tested and two are in
production. It is anticipated that the remaining systems will be in production
by April 15, 1999.
The Company has requested all vendors of currently installed software
to disclose their products' current Year 2000 readiness and their plan for
achieving Year 2000 readiness. All internally developed systems were
inventoried and plans were made to either upgrade, modify or replace them as
necessary to make them Year 2000 compliant. All vendor software code except as
noted is certified to be Year 2000 ready. All network and server hardware and
software systems have been tested and repaired and are now Year 2000 compliant
with the exception of PC upgrades which will be completed by September 30,
1999.
Other major purchased applications that are non-compliant are being
replaced by upgraded software from vendors or replaced by new purchased
systems. Those applications include replacements for the Company's general
ledger and financial reporting applications, a data warehouse for financial and
medical information decision support, and a proposal and rating system to
support the underwriting and marketing processes. The general ledger,
underwriting and data warehouse systems are complete and in production. Non
critical financial and human resource systems are scheduled to be completed by
July 31, 1999.
Office Equipment
The Company has requested its significant office equipment vendors to
submit Year 2000 readiness statements about their products. The Company expects
that it will receive substantially all of such statements by June 1999 and is
determining the extent to which nonconforming office equipment should be
upgraded or replaced. Second notices to non-conforming or non-responding vendors
have been issued.
Buildings and Facilities
All landlords and building management companies have been sent surveys
with respect to each key operating and security system in Company locations.
The Company currently anticipates that this process will be complete by June
1999. Surveys received have been evaluated to assess potential risks. Second
requests have been sent to landlords and management companies that have not yet
responded.
Business Partners and Customers
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The Company is in the process of communicating with its key business
associates, such as financial institutions, third party vendors, provider and
hospital networks, contractors and service providers to ensure that those
parties have appropriate plans to remediate Year 2000 issues where their
systems interface with the Company's systems or otherwise impact its
operations. The Company is assessing the extent to which its operations are
vulnerable should those organizations fail to remediate properly their computer
systems. The Company anticipates that these communications will be completed by
June 1999; however, the Company has little or no control over the efforts of
those key business associates and other suppliers to become Year 2000
compliant. Certain of the services provided by those parties, particularly
telecommunications providers, financial institutions and major hospitals and
medical care providers, could have a material adverse effect on the Company's
financial condition and results of operations if these services or operations
are not Year 2000 compliant.
Risk Assessment and Contingency Planning
The Company is reviewing its existing contingency plans for necessary
modifications to address specific Year 2000 issues, and expects to continue this
process through September 30, 1999. As part of its contingency planning the
Company is analyzing the most reasonable likely worst case scenario that could
result from Year 2000-related failures. The Company's best estimate of that
scenario, based on current information would involve a combination of major
operational disruptions by its principal depository financial institutions,
utility and telecommunication suppliers and its largest hospital and provider
networks in its Pennsylvania and Missouri markets. The Company's Year 2000
readiness program and contingency planning efforts are designed to prevent
and/or mitigate the effects of such possible failures.
Risk Factors
Risks of Governmental Programs and Regulations
The Company's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws and rules could force the Company to
change how it does business and may restrict the Company's revenue and/or
enrollment growth and/ or increase its health care and administrative costs.
Regulatory approvals must be obtained and maintained to market many of the
products and services of the Company. Delays in obtaining or failure to obtain
or maintain such approvals could adversely affect the Company's revenue or the
number of covered lives, or could increase costs.
The Company is subject to risks associated with offering Medicaid and
Medicare risk products, including pricing and other regulatory restrictions,
potentially higher medical loss ratios and risks associated with entering new
markets. The Company currently intends to continue to expand these products, and
its exposure to such risks will increase. The Company's HMO subsidiaries that
provide managed health care services under the Federal Employees Health Benefits
Program are subject to audit, in the normal course of business, by the OPM, and
such audits could result in material adjustments. As discussed in "Government
Regulation," the Company's financial results are also susceptible to future
state and federal regulatory measures, including health care reform. Recently,
the Clinton Administration and various leaders of the U.S. Congress have
proposed legislation which could result in increased costs to managed care
providers.
Limitations on Ability to Increase Revenues
Increases in the Company's revenues will be generally dependent upon
its ability to increase premiums and membership as well as the mix of the
products sold. The Company's membership, excluding the membership acquired from
PHC, recently has shown only moderate increases. Although premium rates for
managed care plans generally have increased recently, competitive pressures,
regulatory restrictions and consumer preference for lower-priced health care
options may cause decreases or severely limit increases in the future. The
premiums from governmental programs, such as Medicare or Medicaid, are generally
not based on an individual company's anticipated costs and cannot be adjusted by
the Company. Recent legislation has limited Medicare premium increases
substantially compared to prior years. Certain of the Company's customers
represent a significant
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percentage of the membership of one or more of its respective health plans, and
the loss of one or more of such customers could cause a material adverse effect
on the revenues of the Company in the future.
Limits on Ability to Project Actual Health Care Costs
A substantial portion of the revenue received by the Company is
expected to pay the costs of health care services or supplies delivered to
persons covered by its health plan and insurance products. 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 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 estimated, including increased cost of individual
services, catastrophes, epidemics, seasonality, general inflation, new mandated
benefits or other regulatory changes and insured population characteristics.
Accordingly, there may be discrepancies between reserves for
incurred-but-not-reported liabilities and the actual amount of such liabilities.
Historically, increases in health care prices and utilization have caused health
care costs to rise faster than general inflation. While these increases have
moderated recently, there can be no assurance that health care prices or
utilization will not again increase at a more rapid pace.
Risks of Agreements with Providers
Prior to 1997, the Company's St. Louis and Pennsylvania health plans
offered members access to Company-owned and Company-staffed medical centers, as
well as to networks of contracting providers. During 1997, the Company's medical
centers were sold to provider systems which have contracted to provide care to
the Company's members continuing to use such centers. The Company expects that
substantially all its members will be serviced by providers contracting with
the Company to provide the requisite medical care. The ability of the Company to
contract successfully with a sufficiently large number of providers in a given
geographic market will impact the relative attractiveness of its managed care
products in those markets. The terms of such provider contracts also have a
material impact on the Company's medical costs and its ability to control such
costs. In certain markets currently served by the Company, certain provider
systems have significant market positions, and may compete with the Company. If
such provider systems refuse to contract with the Company, place the Company at
a competitive disadvantage or use their market position to negotiate contracts
unfavorable to the Company, the Company's product offerings or profitability in
such market areas could be adversely affected.
Among the medical cost control techniques the Company has utilized are
capitation agreements with providers pursuant to which providers are paid a
fixed dollar amount per member per month under the agreement, with the provider
obligated to provide all of a particular type of medical service required by the
members, and global capitation agreements, pursuant to which a single integrated
hospital-physician provider system provides substantially all hospital and
medical services to a large number of members for a fixed percentage of the
premium charged by the Company with respect to those members. While these
systems may shift to the contracting provider system the risk that medical costs
will exceed the amounts anticipated, the Company is exposed to the risk that the
provider systems will be financially unable or unwilling to fulfill their
payment or medical care obligations under the capitation agreements, and to the
risk that members may prefer other providers in the market.
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Recent Operating Losses
The Company's operating loss in 1998 was primarily attributable to
charges related to the establishment of reserves related to the AHERF bankruptcy
and the relocation of the corporate headquarters and other merger related costs.
The Company's management believes that its operating results will continue to
improve in 1999 and 2000, as to which, however, there can be no assurance.
Information Systems and Administrative Expense Risks
The level of administrative expense is a significant factor in the
Company's operating results. 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, acquisitions, regulatory requirements or other
reasons. Such expense increases are not clearly predictable and increases in
administrative expenses may adversely affect results.
Financing Risk
The Company's recent financial losses may make it more difficult to
obtain financing on satisfactory terms in the future. In addition, operating
losses by a subsidiary may require the Company to make investments in, or to
refinance loans to, such subsidiary in order to maintain required capital
levels. Many of the state regulatory authorities in states in which the Company
conducts business are expected to increase capital requirements for managed care
companies in the next two years.
The National Association of Insurance Commissioners has proposed that
states adopt risk-based capital standards that, if implemented, would require
new minimum capitalization limits for health care coverage provided by HMOs and
other risk-bearing health care entities. To date, no state where the Company
has HMO operations has adopted those standards. The Company does not expect
this legislation to have a material impact on its consolidated financial
position in the near future. The Company believes that cash flows from
operations will be sufficient to fund any additional regulatory risk-based
capital.
Risk of Competition
The Company operates in a highly competitive industry. In many of its
geographic and product markets, the Company competes with a number of entities,
some of which may have certain characteristics or capabilities that give them a
competitive advantage. The Company believes that there are few barriers to entry
in these markets, so that the addition of new competitors can occur relatively
easily. Certain of the Company's existing customers may decide to perform for
themselves functions or services formerly provided by the Company resulting in a
decrease in the Company's revenues. In addition, significant merger and
acquisition activity has occurred in the managed care industry as well as in
other segments of the health care industry, both nationally and in various local
markets. This activity may create stronger competitors and/or result in higher
health care costs. To the extent that there is strong competition or that
competition intensifies in any market, the Company's ability to retain or
increase customers, its revenue growth, its pricing flexibility, its control
over medical costs trends and its marketing expenses may all be adversely
affected.
Marketing Risk
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's ability to retain
existing customers and members could be impaired. In addition, certain of the
customers or potential customers of the Company 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 care industry has recently received significant amounts of negative
publicity. Such general publicity, or any negative publicity regarding the
Company in particular, could adversely affect the Company's ability to sell its
products or services or could create regulatory problems for the Company.
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Litigation and Insurance Risk
The health care industry in general is susceptible to litigation and
insurance risks, including medical malpractice liability, disputes relating to
the denial of coverage and the adequacy of "stop-loss" reinsurance for costs
resulting from catastrophic injuries or illnesses. The Company has contingent
litigation risk with certain discontinued operations. Such litigation may result
in losses to the Company which could have a material adverse effect on the
operations, financial performance, cash flows or prospects of the Company.
Stock Market Risk
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, earnings or membership reports of
particular industry participants, and acquisition activity. There can be no
assurance regarding the level or stability of the Company's share price at any
time or of the impact of these or any other factors on the share price.
Management of Indemnity Health Insurance Policies
Upon the closing of the acquisition of the PHC health plans, Principal
Life and the Company entered into a management services agreement ("Management
Services Agreement"), a renewal rights agreement ("Renewal Rights Agreement"),
and a co-insurance agreement ("Coinsurance Agreement") whereby the Company
manages certain of Principal Life's indemnity health insurance policies
("Indemnity Health Insurance Policies") in the markets where the Company does
business on December 31, 1999, and would offer to renew such policies in force
at that time. The Company has no recent experience in the management or
operation of a substantial indemnity health insurance business, and there can
be no assurance that existing customers will renew their existing Indemnity
Health Insurance Policies with Principal Life while the Management Services
Agreement is effective, or that such customers will agree to renew such
policies with a Company subsidiary formed for such purpose (CHLIC) at the
expiration of the Management Services Agreement and there can be no assurance
that benefits from the Management Service Agreement will be realized. The
Management Services Agreement expires on December 31, 1999. There can be no
assurance that revenues received under that agreement can be replaced from
other sources. In addition, to the extent policy holders elect to renew the
Indemnity Health Insurance Policies with Principal Life after December 31,
1999, CHLIC will be required to reinsure such policies which will require that
CHLIC increase its capital by an amount estimated to be between $50 million to
$100 million. There can be no assurance that the Company will be able to
restructure its operations to make existing capital available, generate
sufficient funds from operations to increase CHLIC's capital to required levels
prior to December 31, 1999 or will be able to raise such capital from external
sources. The Company is currently in negotiation with Principal Life to
terminate the Renewal Rights and Coinsurance Agreement.
Risk of Substantial Beneficial ownership of the Company by Principal
Life and Affiliates
As a result of the Company's acquisition of the PHC health plans,
Principal Life and its affiliates (collectively, "Principal Life") owns
approximately 40% of the Company's common stock, on a fully diluted basis.
Although it has agreed to a limitation on acquiring additional shares of the
Company's common stock and from taking certain other actions, "Principal Life"
will be permitted under certain circumstances to acquire additional shares in
order to maintain ownership of up to 40% of the common stock, and has the right
to elect at least one member of the Company's Board of Directors for each 6%
ownership of the Company's common stock, until April 2003 or certain other
actions are taken by the Company. After April 2003, or after a third party
acquires more voting securities than those held by Principal Life, there will
be no restrictions on the acquisition of the Company's common stock by
Principal Life. Prior to September 1999, as long as Principal Life maintains
ownership of 40% of the Company's Common Stock, it is highly unlikely that any
matter involving a shareholder
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vote, including the issuance of more than 20% of the Company's common stock, or
an acquisition of the Company by merger, consolidation, share exchange or other
transaction could be effectuated if Principal Life were opposed thereto.
Thereafter, from September 1999 and until April 2003, Principal Life has
agreed to vote its shares in favor of an acquisition required to be approved by
shareholders that the Board has recommended and has been approved by a majority
of the Company's shareholders, other than Principal Life. After April 2003,
there will be no restrictions on the acquisition of additional shares of the
Company's common stock by Principal Life, and as a result, Principal Life, in
addition to having an effective veto over transactions involving a shareholder
vote (assuming it were to continue to beneficially own 40% of the Company's
common stock), could acquire over 50% of the Company's common stock and
exercise actual control of the Company without a vote of the remaining
Company's shareholders.
Item 7A: Quanitative and Qualitative Disclosures of Market Risk
The Company's only material risk in investments in financial
instruments is in its debt securities portfolio. The Company invests primarily
in marketable state and municipal, U.S. Government and agencies, corporate,
and mortgage-backed debt securities. The Company does not invest in financial
instruments of a hedging or derivative nature.
The Company has established policies and procedures to manage its
exposure to changes in the fair value of its investments. These policies
include an emphasis on credit quality, management of portfolio duration,
maintaining or increasing investment income through high coupon rates and
actively managing profile and security mix depending upon market conditions.
The Company has classified all of its investments as available-for-sale. The
fair value of the Company's investments in debt securities at December 31,
1998 was $205.8 million. Debt securities at December 31, 1998 mature according
to their contractual terms, as follows (actual maturities may differ because of
call or prepayment rights):
1998 Amortized Fair
Cost Value
---------------------------------
Maturities:
Within 1 year $ 46,451 $ 46,915
1 to 5 years 57,362 57,949
6 to 10 years 29,382 29,423
Over 10 years 70,441 71,472
Other securities without stated maturity
---------------------------------
Total short-term and long-term securities $ 203,636 $ 205,759
=================================
The Company believes its investment portfolio is diversified and
expects no material loss to result from the failure to perform by the issuer of
the debt securities it holds. The mortgage-backed securities are insured by
GNMA and FNMA.
The Company's projections of hypothetical net losses in fair value of
the Company's market rate sensitive instruments, should potential changes in
market rates occur, are presented below. While the Company believes
that the potential market rate change is reasonably possible, actual results
may differ.
Based on the Company's debt securities portfolio and interest rates at
December 31, 1998, a 100 basis point increase in interest rates would result in
a decrease of $6.3 million, or 3.1%, in the fair value of the portfolio.
Changes in interest rates may affect the fair value of the debt securities
portfolio and may result in unrealized gains or losses. Gains or losses would
be realized upon the sale of the investments.
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Item 8: Financial Statements and Supplementary Data
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors
of Coventry Health Care, Inc.:
We have audited the accompanying consolidated balance sheets of
Coventry Health Care, Inc. (successor in interest to Coventry Corporation) and
subsidiaries 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 audits 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 consolidated 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, the financial statements referred to above present
fairly, in all material respects, the financial position of Coventry Health
Care, Inc. and subsidiaries as of 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.
ARTHUR ANDERSEN LLP
Baltimore, Maryland
February 16, 1999
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Consolidated Balance Sheets
(in thousands, except share data)
December 31,
- -------------------------------------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 408,823 $ 153,979
Short-term investments 43,689 3,870
Accounts receivable, net of allowance for doubtful
accounts of $12,023 and $7,378, respectively 46,204 40,005
Other receivables 19,754 16,663
Deferred income taxes 65,521 35,771
Prepaid expenses and other current assets 7,054 4,687
- -------------------------------------------------------------------------------------------------------------
Total current assets 591,045 254,975
Long-term investments 162,070 82,242
Property and equipment, net 35,820 21,937
Goodwill and intangible assets, net 295,966 108,637
Other assets 5,692 19,391
- -------------------------------------------------------------------------------------------------------------
Total assets $ 1,090,593 $ 487,182
=============================================================================================================
Liabilities and Stockholders' Equity
Medical claims liabilities $ 355,806 $ 118,022
Accounts payable and other accrued liabilities 163,469 102,981
Deferred revenue 46,412 39,093
Current portion of long-term debt and notes payable 166 765
- -------------------------------------------------------------------------------------------------------------
Total current liabilities 565,853 260,861
Convertible exchangeable subordinated notes 45,538 42,042
Long-term debt and notes payable 820 43,677
Other long-term liabilities 41,843 22,784
Stockholders' equity:
Common stock, $.01 par value; 200,000,000 shares authorized;
59,274,370 shares issued and 58,834,810 outstanding in 1998; and
33,712,665 shares issued and 33,273,105 outstanding in 1997 593 337
Additional paid-in capital 476,430 146,426
Accumulated other comprehensive earnings 794 592
Accumulated deficit (36,278) (24,537)
Treasury stock, at cost, 439,560 shares (5,000) (5,000)
- -------------------------------------------------------------------------------------------------------------
Total stockholders' equity 436,539 117,818
- -------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 1,090,593 $ 487,182
=============================================================================================================
See notes to consolidated financial statements.
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Consolidated Statements of Operations
(in thousands, except per share data)
Year Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
Operating revenues:
Managed care premiums $ 2,033,372 $ 1,208,149 $ 1,035,778
Management services 77,011 20,202 21,351
- ----------------------------------------------------------------------------------------------------------------------------------
Total operating revenues 2,110,383 1,228,351 1,057,129
- ----------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Health benefits 1,767,374 1,039,860 940,532
Selling, general and administrative 291,919 170,017 165,081
Depreciation and amortization 25,793 12,735 42,862
AHERF charge 55,000 - -
Merger costs 6,492 - -
- ----------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 2,146,578 1,222,612 1,148,475
- ----------------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss) (36,195) 5,739 (91,346)
Other income, net 27,251 24,880 13,379
Interest expense (8,566) (10,275) (6,257)
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes and minority interest (17,510) 20,344 (84,224)
Provision for (benefit from) income taxes (5,769) 8,422 (22,860)
Minority interest in earnings (loss) of
consolidated subsidiary, net of income tax - 19 (77)
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (11,741) $ 11,903 $ (61,287)
==================================================================================================================================
Net earnings (loss) per share
Basic $ (0.22) $ 0.36 $ (1.87)
==================================================================================================================================
Diluted $ (0.22) $ 0.35 $ (1.87)
==================================================================================================================================
See notes to consolidated financial statements.
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Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1998, 1997 and 1996 (in thousands)
Retained
Additional Accumulated Other Earnings Treasury Total
Common Paid-In Comprehensive (Accumulated Stock Stockholders'
Stock Capital Earnings Deficit) at Cost Equity
----------------------------------------------------------------------------------------
Balance, December 31, 1995 $ 323 $ 128,119 $ 562 $ 24,847 $ - $ 153,851
Comprehensive earnings (loss)
Net loss (61,287) (61,287)
Unrealized gain (loss) on securities,
net of reclassifications (167) (167)
------------
Comprehensive earnings (loss) (61,454)
Issuance of common stock, including
exercise of options and warrants 7 5,739 5,746
Tax benefit of stock options exercised 2,284 2,284
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 330 136,142 395 (36,440) - 100,427
Comprehensive earnings (loss)
Net earnings 11,903 11,903
Unrealized gain (loss) on securities,
net of reclassifications 197 197
------------
Comprehensive earnings (loss) 12,100
Issuance of common stock, including
exercise of options and warrants 7 7,722 (5,000) 2,729
Issuance of warrants 2,353 2,353
Tax benefit of stock options exercised 209 209
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 337 146,426 592 (24,537) (5,000) 117,818
Comprehensive earnings (loss)
Net loss (11,741) (11,741)
Unrealized gain (loss) on securities,
net of reclassifications 202 202
------------
Comprehensive earnings (loss) (11,539)
Issuance of common stock, including
exercise of options and warrants 256 304,888 305,144
Issuance of warrants 25,000 25,000
Tax benefit of stock options exercised 116 116
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 593 $ 476,430 $ 794 $(36,278) $(5,000) $ 436,539
- ----------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
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Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
- ----------------------------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net earnings (loss) $(11,741) $11,903 $(61,287)
Adjustments to reconcile net earnings (loss) to
cash provided by operating activities:
Depreciation and amortization 25,793 12,735 42,862
Deferred income tax benefit (19,439) (11,701) (15,989)
Gain on sales of medical offices & property disposals (399) (13,338) -
Increase in receivable due to sale of subsidiary - - (5,500)
Non-cash interest on convertible debt 3,496 2,042 -
Other 3,608 (383) 84
Changes in assets and liabilities,
net of effects of the purchase of subsidiaries:
Accounts receivable 11,425 (2,432) (5,285)
Other receivables 16,049 715 (6,749)
Prepaid expenses and other current assets (422) 2,013 (907)
Other assets 2,373 2,874 (5,652)
Medical claims liabilities 61,247 (28,060) 49,350
Accounts payable and other accrued liabilities (23,603) 26,000 41,838
Deferred revenue 577 24,205 549
Other long-term liabilities (685) (4,312) 1,251
- ----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 68,279 22,261 34,565
- ----------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures, net (3,236) (7,218) (12,688)
Sales of investments 122,871 37,329 75,511
Purchases of investments & other (138,076) (34,137) (80,049)
Payments for purchases of subsidiaries, net of cash acquired - - (27,256)
Proceeds from sales of subsidiaries & medical offices 99,277 53,977 -
Cash acquired from acquisition of PHC 148,600 - -
- ----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 229,436 49,951 (44,482)
- ----------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of convertible exchangeable notes - 40,000 40,164
Payments on long-term debt (44,286) (48,961) (14,474)
Net proceeds from issuance of stock 1,415 2,729 5,746
Proceeds from issuance of stock warrants - 2,353 -
- ----------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (42,871) (3,879) 31,436
- ----------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 254,844 68,333 21,519
Cash and cash equivalents at beginning of period 153,979 85,646 64,127
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $408,823 $153,979 $85,646
==========================================================================================================
- ----------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid for interest $ 3,386 $ 7,572 $ 5,862
Income taxes paid (refunded), net $ 9,487 $(4,456) $ 1,309
- ----------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
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Notes to Consolidated Financial Statements
As of December 31, 1998, 1997 and 1996
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Coventry Health Care, Inc. (together with its subsidiaries, the
"Company") is a managed health care company that provides comprehensive health
benefits and services to a broad cross section of employer and
government-funded groups in the Midwest, Mid-Atlantic and Southeastern United
States. Health care services are provided through a variety of full-risk
health care plans, including health maintenance organization ("HMO"), point of
service ("POS") and preferred provider organization ("PPO") products.
Additionally, the Company administers self-insured health plans of certain
large employers.
The Company began operations in 1987 with the acquisition of the
American Service Companies ("ASC") entities, including the Coventry Health and
Life Insurance Company ("CHLIC"). In 1988, the Company acquired HealthAmerica
Pennsylvania, Inc. ("HAPA"), a Pennsylvania HMO. In 1990, the Company acquired
Group Health Plan, Inc. ("GHP"), a St. Louis, Missouri HMO. Southern Health
Services, Inc. ("SHS"), a Richmond, Virginia, HMO, was acquired by the Company
in 1994. In 1995, the Company acquired HealthCare USA, Inc. ("HCUSA"), a
Jacksonville, Florida-based Medicaid managed care company. On April 1, 1998,
the Company acquired certain assets of Principal Health Care, Inc. ("PHC") from
Principal Mutual Life Insurance Company, now known as Principal Life Insurance
Company ("Principal Life"). See Note B to consolidated financial statements.
Principles of Consolidation - The consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant
intercompany transactions have been eliminated. Interests of other investors
in the Company's majority owned (or otherwise effectively-controlled)
subsidiaries are accounted for as minority interests and are included in other
long-term liabilities for financial reporting purposes.
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure 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.
Cash and Cash Equivalents - Cash and cash equivalents consist
principally of overnight repurchase agreements, money market funds, commercial
paper and certificates of deposit. The Company considers all highly liquid
securities purchased with an original maturity of three months or less to be
cash equivalents. The carrying amounts of cash and cash equivalents reported in
the accompanying consolidated balance sheets approximate fair value.
Investments - The Company accounts for investments in accordance with
Statement of Financial Accounting Standards No. 115 ("SFAS" 115), "Accounting
for Certain Investments in Debt and Equity Securities". The Company considers
all of its investments as available-for-sale, and accordingly, records
unrealized gains and losses, net of deferred income taxes, as a separate
component of stockholders' equity. Realized gains and losses on the sale of
these investments are determined on a specific identification basis.
Investments with original maturities in excess of three months and
less than one year are classified as short-term investments and generally
consist of time deposits, U.S. Treasury Notes, and obligations of various
states and municipalities. Long-term investments have original maturities in
excess of one year and primarily consist of debt securities.
Other Receivables - Other receivables include interest receivable,
reinsurance claims receivable, receivables from providers and suppliers and any
other receivables that do not relate to premiums.
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37
Property and Equipment - Property and equipment are recorded at cost.
Depreciation is computed using the straight-line method over the estimated
lives of the related assets or, if shorter, over the terms of the respective
leases.
Long-lived Assets - The Company has adopted Statement of Financial
Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." In accordance
with SFAS 121, the Company evaluates long-lived assets to be held for events or
changes in circumstances that would indicate that the carrying value may not be
recoverable. In making that determination, the Company considers a number of
factors, including undiscounted future cash flows, prior to interest expense.
The Company measures an impairment loss by comparing the fair value of the
assets to its carrying value. Fair values are determined by using market prices
for similar assets, if available, or discounted future estimated cash flows,
prior to interest expense. Assets held for sale are recorded at the lower of
the carrying amount or fair value, less any cost of disposition.
Goodwill and Intangible Assets - Goodwill and intangible assets consist of costs
in excess of the fair value of the net assets of subsidiaries or operations
acquired. Goodwill is amortized using the straight-line method over periods
ranging from 15 to 35 years. The remaining unamortized goodwill and intangible
asset balances at December 31, 1998 are as follows (in thousands):
Accumulated
Description Useful Life Amount Amortization Net Book Value
- -------------------------------- ------------ ----------------- --------------- ----------------
Marketing Service Agreement 1.75 years $ 1,500 $ 643 $ 857
Customer Lists 5 years 11,700 6,222 5,478
HMO Licenses 15-20 years 10,700 655 10,045
Management Services
Agreement 1.75 years 4,688 2,009 2,679
Renewal Rights Agreement 35 years 20,312 435 19,877
Goodwill 15-35 years 307,750 50,720 257,030
- -------------------------------- ------------ ----------------- --------------- ----------------
Total $356,650 $60,684 $295,966
- -------------------------------- ------------ ----------------- --------------- ----------------
Amortization expense for the years ended December 31, 1998, 1997 and 1996 was
approximately $13.6 million, $3.8 million and $27.2 million, respectively. In
accordance with SFAS 121 and Accounting Principles Board ("APB") Opinion No.17,
the Company periodically evaluates the realizability of goodwill and intangible
assets and the reasonableness of the related lives in light of factors such as
industry changes, individual market competitive conditions, and operating
income. The 1996 amount includes a write-off of $20.1 million of goodwill that
was determined to be impaired in accordance with SFAS 121.
Other Assets - Other assets consist of loan acquisition costs, assets
related to the supplemental executive retirement plan (See Note N to
consolidated financial statements), restricted assets, deferred charges and
certain costs incurred to develop new service areas and new products prior to
the initiation of revenues. Loan acquisition costs are amortized over the term
of the related debt while the other assets are amortized over their expected
periods of benefit, where applicable. The preoperational new service area and
new product costs were amortized over their expected period of benefit up to
eight years. Effective April 1, 1997, the Company adopted a one-year period for
amortization of new service area and new product costs. $2.7 million of expense
was included in selling, general and administrative expense due to this change.
These costs were fully amortized at December 31, 1997. Accumulated amortization
of other assets was approximately $3.4 million and $9.1 million at December 31,
1998 and 1997, respectively.
Medical Claims Liabilities - Medical claims liabilities consist of
actual claims reported but not paid and estimates of health care services
incurred but not reported. The estimated claims incurred but not reported are
based on historical data, current enrollment, health service utilization
statistics, and other related information. Although considerable variability is
inherent in such estimates, management believes that the liability is adequate.
The Company also establishes reserves, if required, for the probability that
anticipated future health care costs and
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38
maintenance costs under the group of existing contracts will exceed anticipated
future premiums and reinsurance recoveries on those contracts. The estimated
future costs include fixed and variable, direct and allocable, indirect costs.
These accruals are continually monitored and reviewed, and as settlements are
made or accruals adjusted, differences are reflected in current operations.
Changes in assumptions for medical costs caused by changes in actual experience
could cause these estimates to change in the near term.
Revenue Recognition - Managed care premiums are recorded as revenue in
the month in which members are entitled to service. Premiums collected in
advance are recorded as deferred revenue. Employer contracts are typically on
an annual basis, subject to cancellation by the employer group or the Company
upon thirty days written notice. Management services revenues are recognized in
the period in which the related services are performed. Premiums for services
to federal employee groups are subject to audit and review by the Office of
Personnel Management ("OPM") on a periodic basis. Such audits are usually a
number of years in arrears. The Company provides reserves, on an estimated
basis annually, based on the appropriate guidelines. Any differences between
actual results and estimates are recorded in the year the audits are finalized.
Such adjustments have not been material to the financial statements of the
Company.
Reinsurance - Premiums paid to reinsurers are reported as health
benefits expense and the related reinsurance recoveries are reported as
deductions from health benefits expense.
Income Taxes - The Company files a consolidated tax return for the
Company and its wholly owned consolidated subsidiaries. The Company accounts
for income taxes in accordance with Statement of Financial Accounting Standards
No. 109 ("SFAS 109"). The deferred tax assets and/or liabilities are determined
by multiplying the differences between the financial reporting and tax
reporting bases for assets and liabilities by the enacted tax rates expected to
be in effect when such differences are recovered or settled. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. See Note G for disclosures related to income
taxes.
Minority Interest - For 1997 and 1996, the minority interest
represents a joint venture interest of 51% in Pennsylvania HealthMate, Inc.
("HealthMate").
Stock-based Compensation - The Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation." As permitted by SFAS 123,
the Company has elected to continue to account for stock-based compensation to
employees under APB Opinion No. 25, and complies with the disclosure
requirements for SFAS 123. See Note J for disclosures related to stock-based
compensation.
Earnings per Share - In the fourth quarter of 1997, the Company
adopted Statement of Financial Accounting Standards No. 128 ("SFAS 128"),
"Earnings per Share." SFAS 128 establishes new standards for computing and
presenting earnings per share ("EPS"), replacing primary EPS with "basic EPS."
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. The adoption of SFAS 128 did not have a material effect on the
Company's earnings per share. All prior periods have been restated to comply
with SFAS 128. See Note Q for calculation of EPS.
Comprehensive Earnings - Effective January 1, 1998, the Company adopted
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income." SFAS 130 requires that changes in the amounts of certain
items, including unrealized gains and losses on certain securities, be shown in
the financial statements. The adoption of this standard did not have a material
effect on the Company's consolidated financial statements.
Segment reporting - Effective December 31, 1998, the Company adopted
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures
about Segments of an Enterprise and Related Information." This standard
requires that a public business enterprise report financial and descriptive
information about its reportable operating segments. Operating segments are
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker in
deciding how
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39
to allocate resources and in assessing performance. SFAS 131 also requires that
all public business enterprises report information about the revenues derived
from the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. The Company has two reportable segments:
Commercial products and Government products. The products are provided to a
cross section of employer groups through the Company's health plans in the
Midwest, Mid-Atlantic, and Southeastern United States. Commercial products
include HMO, PPO, and POS products. HMO products provide comprehensive health
care benefits to enrollees through a primary care physician. PPO and POS
products permit members to participate in managed care but allow them the
flexibility to utilize out of network providers in exchange for an increase in
out-of-pocket costs to the member. Governmental products include Medicare Risk,
Medicare Cost, and Medicaid. The Company provides comprehensive health benefits
to members participating in government programs and receives premium payments
from federal and state governments. The Company evaluates the performance of
its operating segments and allocates resources based on gross margin. Assets
are not allocated to specific products and, accordingly, cannot be reported by
segment. See Note S for disclosures on segment reporting.
Other New Pronouncements- In June 1998, the FASB issued Statement of
Financial Accounting Standards No.133 ("SFAS 133" ), "Accounting for Derivative
Instruments and Hedging Activities." This Statement requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. This Statement is effective for
fiscal years beginning after June 15, 1999. The Company does not believe that
adoption of this standard will have a material effect on its future results of
operations.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides authoritative guidance for the capitalization of certain costs related
to computer software developed or obtained for internal applications, such as
external direct costs of materials and services, payroll costs for employees and
certain interest costs. Costs incurred during the preliminary project stage, as
well as training and data conversion costs, are to be expensed as incurred. SOP
98-1 is effective for fiscal years beginning after December 15, 1998. The
Company does not believe that adoption of this standard will have a material
effect on its future results of operations.
Reclassifications - Certain 1996 and 1997 amounts have been
reclassified to conform to the 1998 presentation.
B. ACQUISITIONS AND DISPOSITIONS
Effective April 1, 1998, the Company completed its acquisition of
certain assets of PHC from Principal Life for a total purchase price of
approximately $330.2 million including transaction costs of approximately $5.7
million. The acquisition was accounted for using the purchase method of
accounting, and accordingly the operating results of PHC have been included in
the Company's consolidated financial statements since the date of acquisition.
The purchase price consisted of 25,043,704 shares of the Company's common stock
at an assigned value of $11.96 per share. In addition, a warrant valued at
$25.0 million ("the Warrant") was issued that gives Principal Life the right to
acquire additional shares of stock in the event that their ownership percentage
is diluted below 40%. The warrant is included as a component of additional
paid-in capital in the accompanying consolidated financial statements. Through
April 2003, Principal Life is restricted from buying additional shares of the
Company's common stock to increase its ownership percentage above 40%.
Coincident with the closing of the transaction, the Company entered
into a Marketing Services Agreement and a Management Services Agreement with
Principal Life. Both agreements extend through December 31, 1999. The Company
recognized revenue of approximately $23.0 million for the year ended December
31, 1998 related to these agreements, and expects to receive payments of
approximately $26.4 million in 1999.
The Company also entered into a Renewal Rights Agreement and a
Coinsurance Agreement with Principal Life, whereby the Company manages certain
of Principal Life's indemnity health insurance policies in the markets where the
Company does business and, on December 31, 1999, would offer to renew such
policies in force at that time.
As a result of the transaction, the Company assumed an agreement with
Principal Life, whereby Principal Life pays a fee for access to the Company's
PPO network based on a rate per contract and a percentage of savings realized by
Principal Life. The Company recognized revenue of approximately $12.0 million
for the year ended December 31, 1998 related to this agreement. The maximum
amount that can be paid under the percentage of savings component of the
agreement is $8.0 million for 1999.
On December 31, 1998, the Company sold its subsidiary, Principal
Health Care of Florida, Inc., for $95.0 million in cash. The Florida health
plan accounted for approximately 156,000 risk members and approximately 5,500
non-risk members as of December 31, 1998 and reported approximately $172.5
million in revenues since April 1, 1998, the date of acquisition.
Effective November 30, 1998, the Company sold its subsidiary,
Principal Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois
health plan accounted for approximately 56,000 risk members and approximately
2,400 non-risk members as of November 30, 1998 and reported approximately $71.1
million in revenues since the date of acquisition.
The proceeds from both sales were used to retire the Credit Facility,
to assist in improving the capital position of the Company's regulated entities,
and for other general corporate purposes. Given the short time period between
the respective acquisition and sale dates and the lack of events or other
evidence which would indicate differing values, no gain or loss was recognized
on the sales of the Florida and Illinois health plans, as the sales prices were
considered by management to be equivalent to the fair values allocable to these
plans at the date of their acquisition from PHC in April 1998.
In connection with the acquisition of certain PHC health plans, and
the sales of the Florida and Illinois plans, the Company recorded reserves in
purchase accounting of approximately $33.0 million for the estimated transition
costs of the PHC plans. These reserves are primarily comprised of severance
costs related to involuntary terminations of former PHC employees, relocation
costs of former PHC personnel, lease termination costs and contract termination
costs. For the year ended December 31, 1998, the Company has expended
approximately $18.2 million related to these reserves. The Company expects to
make payments on the remaining reserves through July 2002.
The purchase price for certain of the PHC plans, net of the impact of
the sales of the Florida and Illinois health plans, was allocated to the
assets, including the identifiable intangible assets, and liabilities based on
estimated fair values. The excess of purchase price, over the net identified
tangible and intangible assets acquired of approximately $134.4 million, was
allocated to goodwill. The amounts allocated to the identifiable intangible
assets and goodwill and their related useful lives are as follows:
Description Amount Useful Life
- -------------------------------------------------------------------
Marketing Services Agreement $ 1,500,000 1.75 years
Customer Lists 7,233,000 5 years
HMO Licenses 10,000,000 20 years
Management Services Agreement 4,687,500 1.75 years
Renewal Rights and Coinsurance
Agreements 20,312,500 35 years
Goodwill 156,795,028 35 years
-------------
Total $ 200,528,028
=============
The following unaudited pro-forma condensed consolidated results of
operations assumes the PHC acquisition and the sales of the Florida and
Illinois health plans occurred on January 1, 1998 and 1997 and excludes the
one-time charge to merger costs of $6.5 million, see Note D:
(in thousands, except per share data)
Year ended December 31,
1998 1997
---------------- --------------------
(unaudited) (unaudited)
Operating revenues $2,021,580 $1,875,411
Net loss (32,165) (22,694)
Earnings per share, basic (0.55) (0.39)
37
40
In August 1997, the Company entered into agreements to sell certain
medical offices associated with HealthAmerica, its health plan in Harrisburg,
Pennsylvania. The sales price was $2.1 million and the transaction resulted in
a pretax loss of $0.2 million. Additionally, in the third quarter of 1997, the
Company sold its two remaining medical offices in Pittsburgh, Pennsylvania for
$0.3 million in cash and recorded a pretax loss of $0.4 million. All gains or
losses resulting from medical office sales are reflected in other income, net in
the accompanying Consolidated Statement of Operations.
Effective May 1, 1997, the Company completed its sale of the medical
offices associated with GHP, its health plan in St. Louis, Missouri, to a major
health care provider organization. The sales price was $26.9 million and the
transaction resulted in a pretax gain of approximately $9.6 million. Coincident
with the sale,
38
41
the Company entered into a long-term global capitation agreement with the
purchaser covering approximately 83,000 members, pursuant to which the provider
organization receives a fixed percentage of premiums to cover all of the
medical treatment the globally capitated members receive.
Effective March 31, 1997, the Company completed its sale of the
medical offices associated with HealthAmerica Pennsylvania, Inc., its health
plan in Pittsburgh, Pennsylvania, to a major health care provider organization.
The sales price was $20.0 million and the transaction resulted in a pretax gain
of approximately $6.0 million. Coincident with the sale, the Company entered
into a long-term global capitation agreement with the purchaser which increased
the globally capitated membership in western Pennsylvania to approximately
250,000 members. Under the agreement, the provider organization will receive a
fixed percentage of premiums to cover all of the medical treatment the globally
capitated members will receive.
Effective March 22, 1996, the Company purchased 81% of the common
stock of PARTNERS Health Plan of Pennsylvania, Inc. and acquired the remaining
19% of the common stock through the merger of a subsidiary of the Company with
and into PARTNERS, whose name was changed to Coventry Health Plan of
Pennsylvania, Inc.("CHP"). CHP is the holding company for Coventry Health Plan
of Western Pennsylvania, Inc., which, at the time of acquisition, was known as
Aetna Health Plan of Western Pennsylvania, Inc. and served approximately 16,000
HMO members in the Pittsburgh area. Consideration for the transaction was
approximately $35 million in cash, of which approximately $32.1 million was
recorded as goodwill. The acquisition was accounted for under the purchase
method of accounting and, accordingly, the net assets were included in the
consolidated financial statements from the effective date of acquisition. During
1996, the Company determined that the intangible assets acquired were impaired
and $20.1 million of the goodwill was written off through amortization expense.
The Company believes the remaining intangible is realizable on a discounted cash
flow basis.
C. AHERF CHARGE
In March 1997, the Company entered into a global capitation agreement
with Allegheny Health, Education and Research Foundation ("AHERF") covering
approximately 250,000 members in the western Pennsylvania market. Under the
agreement, AHERF was paid 78% to 82% of the premium to cover all of the medical
expenses of the capitated members. In July 1998, AHERF filed for bankruptcy
protection under Chapter 11. As a result, the Company, which is ultimately
responsible for the medical costs of the capitated members, recorded a charge
of $55.0 million to establish a reserve for the medical costs incurred by
members covered by the AHERF agreement at the time of the bankruptcy filing and
other potential bankruptcy charges. Under applicable bankruptcy laws, AHERF
could reject and refuse to perform under the global caitation agreement.
Generally, under Chapter 11 a debtor company such as AHERF may affirm or reject
its contractual obligations prior to confirmation of a plan of reorganization,
and if a contract is rejected, the contractual damages become an unsecured claim
in the Chapter 11 proceeding. Although AHERF has not formally rejected the
risk-sharing agreement as of the date of this filing, the parties are
negotiating a resolution of the arrangement and, currently, neither AHERF nor
the Company is operating under the existing agreement. The Company has filed a
lawsuit against certain hospital subsidiaries of AHERF that were not included in
the bankruptcy filing. The lawsuit is seeking a court order declaring that the
Company is not liable for the payment of $21.5 million of medical services
provided by the hospitals to the Company's members prior to the date of AHERF's
bankruptcy filing and compelling the hospitals to fulfill their contractual
obligations to continue to provide health care services to the membership in
western Pennsylvania. The lawsuit also includes a claim for damages to recover
the losses incurred by the Company as a consequence of AHERF's default of its
obligations under the risk-sharing agreement. In response to the lawsuit, the
hospitals have filed a counterclaim alleging that HAPA, notwithstanding AHERF's
assumption of the payment obligation, is liable to the hospitals for the payment
of medical services provided prior to AHERF's bankruptcy. The Company intends to
vigorously defend against the counterclaim. The Company believes that the
reserve established is adequate to provide for claims incurred related to the
AHERF arrangement and other related AHERF bankruptcy uncertainties.
39
42
For the year ended December 31, 1998, $33.8 million has been paid for medical
claims related to this reserve.
D. MERGER COSTS
In connection with the acquisition of PHC, the Company relocated its
Corporate Headquarters from Nashville, Tennessee to Bethesda, Maryland. As a
result, the Company established a one-time reserve of approximately $6.5 million
for the incurred and anticipated costs related to the relocation of the
corporate office and other direct merger related costs. The reserve is
primarily comprised of severance costs related to involuntary terminations,
relocation costs for management personnel, and lease costs, net of sublease
income, related to the unused space remaining at the old headquarters location.
For the year ended December 31, 1998, the Company has paid approximately $4.4
million related to the reserve. The Company expects to make payments through
December 2002 related to these charges.
E. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following (in thousands):
December 31,
- -----------------------------------------------------------------------
1998 1997
- -----------------------------------------------------------------------
Land $ 481 $ 481
Buildings and leasehold improvements 11,922 9,583
Equipment 54,353 40,795
- -----------------------------------------------------------------------
66,756 50,859
Less accumulated depreciation (30,936) (28,922)
- -----------------------------------------------------------------------
Property and equipment, net $35,820 $21,937
=======================================================================
Depreciation expense for the years ended December 31, 1998, 1997, and
1996 was approximately $12.2 million, $8.9 million, and $15.7 million,
respectively.
F. INVESTMENTS IN DEBT AND EQUITY SECURITIES
The Company considers all of its investments as available-for-sale
securities and, accordingly, records unrealized gains and losses, as other
comprehensive earnings, in the stockholders' equity section of its consolidated
balance sheets. As of December 31, 1998 and 1997, stockholders' equity was
increased by approximately $0.3 million and $0.6 million, respectively, net
40
43
of a deferred tax cost of approximately $0.1 million and $0.4 million,
respectively, to reflect the net unrealized investment gain on securities.
The amortized cost, gross unrealized gain or loss and estimated fair
value of short-term and long-term investments by security type were as follows
at December 31, 1998 and 1997 (in thousands):
Amortized Unrealized Unrealized Fair
1998 Cost Gain Loss Value
---------------------------------------------------------------------------
State and municipal bonds $ 55,355 $ 548 $(290) $ 55,613
Asset-backed securities 10,728 71 (174) 10,625
Mortgage-backed securities 46,304 1,276 (141) 47,439
US Treasury & agencies securities 51,246 661 (316) 51,591
Other debt securities 40,003 529 (41) 40,491
---------------------------------------------------------------------------
$203,636 $3,085 $(962) $205,759
===========================================================================
Amortized Unrealized Unrealized Fair
1997 Cost Gain Loss Value
---------------------------------------------------------------------------
State and municipal bonds $50,438 $769 $ - $51,207
Asset-backed securities 9,935 74 - 10,009
Mortgage-backed securities 11,621 37 - 11,658
US Treasury securities 10,854 81 - 10,935
Other debt securities 2,278 25 - 2,303
---------------------------------------------------------------------------
$85,126 $986 $ - $86,112
===========================================================================
41
44
The amortized cost and estimated fair value of short-term and
long-term investments by contractual maturity were as follows at December 31,
1998 and December 31, 1997 (in thousands):
1998 Amortized Fair
Cost Value
-------------------------
Maturities:
Within 1 year $ 46,451 $ 46,915
1 to 5 years 57,362 57,949
6 to 10 years 29,382 29,423
Over 10 years 70,441 71,472
-------------------------
Total short-term and long-term securities $203,636 $205,759
=========================
1997 Amortized Fair
Cost Value
-------------------------
Maturities:
Within 1 year $10,040 $10,009
1 to 5 years 29,073 29,396
6 to 10 years 12,707 12,879
Over 10 years 33,306 33,828
-------------------------
Total short-term and long-term securities $85,126 $86,112
=========================
Proceeds from the sale of investments were approximately $122.9
million and $37.3 million for the years ended December 31, 1998 and 1997,
respectively. Gross investment gains of approximately $860,000 and no gross
investment losses were realized on these sales for the year ended December 31,
1998 compared to gross investment gains of approximately $275,000 and gross
investment losses of $194,000 for the year ended December 31, 1997.
G. INCOME TAXES
The provision (benefit) for income taxes consists of the following
(in thousands):
Year Ended December 31,
- -----------------------------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------------------------
Current provision (benefit):
Federal $ 12,907 $16,439 $(6,181)
State 763 3,684 (690)
Deferred provision (benefit):
Federal (14,695) (9,943) (15,565)
State (4,744) (1,758) (424)
- -----------------------------------------------------------------------------------------
$(5,769) $8,422 $(22,860)
=========================================================================================
42
45
The expected tax provision based on the statutory rate of 35% differs
from the Company's effective tax rate as a result of the following:
Year Ended December 31,
1998 1997 1996
- ------------------------------------------------------------------------------------------
Statutory federal tax rate (35.00%) 35.00% (35.00%)
- ------------------------------------------------------------------------------------------
Effect of:
State income taxes, net of federal benefit (4.04%) 6.15% (1.40%)
Amortization of goodwill 18.60% 5.98% 10.26%
Tax exempt interest income (13.77%) (5.54%) (1.25%)
Other 1.27% (0.19%) 0.25%
- ------------------------------------------------------------------------------------------
Income tax provision (benefit) (32.94%) 41.40% (27.14%)
==========================================================================================
The effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31, 1998 and 1997 are presented below (in thousands):
December 31,
1998 1997
- -------------------------------------------------------------------
Deferred tax assets:
Deferred revenue $ 2,804 $ 3,123
Medical liabilities 5,799 4,590
Accounts receivable 7,921 5,128
Deferred compensation 4,211 3,776
Accrued professional fees 1,689 622
Provision for long-term contracts 1,675 778
Accrued acquisition 3,123 604
Property and equipment - 1,811
Other assets 7,911 4,966
Contingent liabilities 31,173 19,445
Net operating loss carryforward 3,769 1,433
- -------------------------------------------------------------------
Gross deferred tax assets 70,075 46,276
Less valuation allowance (3,252) (916)
- -------------------------------------------------------------------
Deferred tax asset 66,823 45,360
- -------------------------------------------------------------------
Deferred tax liability:
Property and equipment (982) -
Intangibles (12,562) -
Other - (383)
- -------------------------------------------------------------------
Gross deferred tax liabilities (13,544) (383)
- -------------------------------------------------------------------
Net deferred tax asset $ 53,279 $ 44,977
===================================================================
The valuation allowance for deferred tax assets as of December 31, 1998 is $3.3
million due to the Company's belief that the realization of a large portion of
the deferred tax asset resulting from federal and state net operating loss
carryforwards is doubtful. The valuation allowance provided at December 31,
1998 will be allocated to reduce goodwill and other intangible assets if the
realization of the net operating loss carryforwards becomes more likely than
not.
43
46
H. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES
The Company has issued to Warburg, Pincus Ventures, L.P.
("Warburg") and Franklin Capital Associates III L.P. ("Franklin" and
collectively with Warburg the "Investors") $40 million of the Convertible
Exchangeable Subordinated Notes of the Company (the "Coventry Convertible
Notes"), together with warrants to purchase 2.35 million shares of the Company's
common stock, for $42.4 million. The Coventry Convertible Notes are exchangeable
at the Company's or Warburg's option for shares of Series A Convertible
Preferred Stock ("Preferred Stock"). The authorization of 6,000,000 shares of
Preferred Stock has been approved by the Company's shareholders.
The Coventry Convertible Notes accrue interest at 8.3% payable in
interest notes semiannually in arrears for the first two years and at 5.0%
payable in cash or in interest notes semiannually in arrears, thereafter. The
interest notes accrue interest from the point of issuance under the same terms
and conditions as the Coventry Convertible Notes. The Coventry Convertible
Notes are required to be repaid in an amount equal to 33%, 50% and 100%,
respectively, of the aggregate principal amount outstanding as of the fifth,
sixth and seventh anniversaries of the respective Coventry Convertible Note's
issuance date. The Coventry Convertible Notes may be prepaid at the option of
the Company after the third anniversary date of issuance if the market price of
the Company's common stock exceeds certain targets.
The Coventry Convertible Notes and interest notes are exchangeable for
Preferred Stock at a $10 per share conversion rate. The Preferred Stock
accrues dividends at 8.3% until May 29, 1999. Dividends are payable in
additional shares of Preferred Stock. The Preferred Stock may be called and is
required to be repaid with the same repayment terms as the Coventry Convertible
Notes. The Preferred Stock is convertible into common stock on a share for
share basis.
The Coventry Convertible Notes and interest notes are convertible into
common stock at a $10 per share conversion rate.
I LONG-TERM DEBT AND NOTES PAYABLE
Long-term debt and notes payable consists of the following (in thousands):
December 31,
1998 1997
-----------------------------------
Borrowings under the Credit Facility $ - $42,824
Notes payable to U.S. DHHS 781 1,173
Other notes payable 205 445
-----------------------------------
986 44,442
Less current portion (166) (765)
-----------------------------------
Total long-term debt and notes payable $ 820 $43,677
===================================
On December 29, 1997, the Company entered into a credit agreement with
a group of banks (the "Credit Facility"). The Credit Facility refinanced the
previous agreement and totaled $42.8 million. The effective rate on the
indebtedness under the Credit Facility was 7.0625% at December 31, 1998. The
Credit Facility was paid in full on December 31, 1998.
44
47
Notes payable to the U. S. Department of Health and Human Services
("U.S. DHHS") represent obligations which were assumed in the acquisition of
HAPA. Under the terms of the notes, principal is payable in various annual
installments through June 30, 2000 with interest payable semi-annually at rates
ranging from 7.75% to 9.125%. The notes are secured by certain assets of the
Company.
The fair value of the Company's long-term borrowings is based on
quoted market rates. The carrying amount of the Company's borrowings
approximates fair value.
Maturities of long-term debt during each of the ensuing two years
ending December 31 are as follows (in thousands):
Year Amount
- ------------------------ --------------
1999 $166
2000 820
--------------
$986
==============
Interest expense for the year ended December 31, 1998 was $8.6
million, which includes $3.2 million related to the Credit Facility and $3.5
million related to the Coventry Convertible Notes.
J. STOCK OPTIONS, WARRANTS AND EMPLOYEE STOCK PURCHASE PLAN
As of December 31, 1998, the Company had one stock incentive plan, the
Amended and Restated 1998 Stock Incentive Plan (the "1998 Plan"), with an
aggregate of 7 million shares of common stock authorized for issuance
thereunder to key employees, consultants and directors in the form of stock
options, restricted stock and other stock-based awards. At April 1, 1998, the
1998 Plan assumed the obligations of six stock option plans of Coventry
Corporation with total outstanding options representing 3,322,714 shares, and
one stock option plan of Principal Health Care, Inc. with total outstanding
options representing 750,000 shares, as a result of the acquisition of the PHC
plans. Under the 1998 Plan, the terms and conditions of grants are established
on an individual basis with the exercise price of the options being equal to
not less than 100% of the market value of the underlying stock at the date of
grant. Options generally become exercisable after one year in 20% to 25%
increments per year and expire ten years from the date of grant. The 1998
Plan is authorized to grant either incentive stock options or nonqualified
stock options at the discretion of the Compensation and Benefits Committee of
the Board of Directors.
As of September 10, 1998, employees of the Company were offered an
opportunity to exchange their existing options (issued at a higher exercise
price) for a reduced number of new options (issued at a lower exercise price)
equivalent to the same value as their existing options, based upon a
Black-Scholes equal valuation model. Employees could choose to decline the
offer of new options and keep their existing options. As a result, the
Company cancelled approximately 4,370,100 shares, and reissued repriced options
equal to approximately 3,714,182 shares. The options canceled were at exercise
prices ranging from a high of $22.750 to a low of $6.3750. The options were
reissued in accordance with an exchange formula (using the Black-Scholes equal
valuation model) that issued one-half of the new options at an exercise price
of the then current market value ($5.00) and the remaining one-half at 150% of
the then current market value ($7.50). The resulting value of the repriced
options was the same as the exchanged options.
The assumed plans are the Coventry Corporation 1997 Stock Incentive
Plan, the Coventry Corporation 1993 Stock Option Plan (as amended), the
Southern Health Management Corporation 1993 Stock Option Plan, the Coventry
Corporation 1993 Outside Directors Stock Option Plan (as amended), the Coventry
Corporation Third Amended and Restated 1989 Stock Option Plan, the Coventry
Corporation Amended and Restated 1987 Statutory-Nonstatutory Stock Option Plan,
and the Principal Health Care, Inc. 1997 Non-Qualified Stock Option Plan.
45
48
At various dates in 1996, the Company canceled, repriced, and reissued
approximately 1.3 million shares under option. The options canceled were at
prices ranging from a high of $25.00 to a low of $15.63. The shares were
reissued at market on the date of reissue and the prices ranged from a high of
$18.13 to a low of $12.75.
During 1997, the Company adopted the 1997 Stock Incentive Plan (the
"1997 Plan"). Under the 1997 Plan, the Company may grant options and other
rights with respect to the Company's common stock to officers, other key
employees, consultants and outside directors of the Company. A total of
1,600,000 shares of common stock was reserved for this issuance.
With the merger of SHS in December 1994, the Company assumed SHS's
incentive stock option plan. The Company issued options for 146,030 shares of
common stock in exchange for 42,500 options to acquire shares of SHS common
stock granted under SHS's incentive stock option plan. These options were
exercisable upon the completion of the merger with SHS and expire in 2003.
The Company follows APB No. 25, under which no compensation cost has
been recognized in connection with stock option grants. Had compensation cost
for these plans been determined consistent with Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation," the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:
1998 1997 1996
---- ---- ----
Net income (loss): As Reported $(11,741) $11,903 $(61,287)
Pro Forma (14,224) 8,790 (63,949)
EPS, basic As Reported $ (0.22) $ 0.36 $ (1.87)
EPS, diluted As Reported $ (0.22) $ 0.35 $ (1.87)
EPS, basic
& diluted Pro Forma (0.27) 0.26 (1.95)
Because the SFAS 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Transactions with respect to the plans for the three years ended
December 31, 1998 were as follows (shares in thousands):
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- ----------------------------------------------------------------------------------------------------------------
Outstanding at beginning of
year 3,261 $13 2,858 $13 2,381 $14
Granted 7,627 8 1,584 $15 2,898 $13
Exercised (110) 12 (166) $12 (621) $ 6
46
49
Canceled (5,337) 13 (1,015) $14 (1,800) $17
- ----------------------------------------------------------------------------------------------------------------
Outstanding at end of year 5,441 $8 3,261 $13 2,858 $13
- ----------------------------------------------------------------------------------------------------------------
Exercisable at end of year 837 $11 819 $13 708 $15
- ----------------------------------------------------------------------------------------------------------------
The following table summarizes information about stock options
outstanding at December 31, 1998 (shares in thousands):
Options Outstanding Options Exercisable
- ---------------------------------------------------------------------------------------------------------------------------
Number Weighted Average Weighted Number Weighted
Range of Exercise Outstanding at Remaining Average Exercisable at Average
Prices 12/31/98 Contractual Life Exercise Prices 12/31/98 Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
$4 - $5 1,697 8.8 $ 5 154 $ 5
$5 - $7 880 9.4 7 43 7
$7 - $8 1,518 8.5 8 149 8
$8 - $15 1,066 8.3 13 303 12
$15 - $25 280 7.6 17 188 18
-------------------------------------------------------------- ----------------------------------
$4 - $25 5,441 8.6 $8 837 $11
============================================================== ==================================
The fair value of the stock options included in the pro forma amounts
shown above was estimated as of the grant date using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
1998 1997 1996
- ------------------------------------------- ---------------- -----------------
Dividend yield 0% 0% 0%
Expected volatility 73% 64% 56%
Risk-free interest rate 5% 6% 6%
Expected life 4 years 5 years 5 years
- ------------------------------------------- ---------------- -----------------
The weighted-average grant date fair values for options granted in
1998, 1997 and 1996 were $4.53, $8.77, and $6.61, respectively.
At December 31, 1998, the Company had outstanding warrants granting
holders the right to purchase 6,075,373 shares of common stock. In July 1995,
100,000 warrants were issued at a price of $14.125 and expire in July 2000. In
December 1993, warrants were issued granting holders the right to purchase
800,000 shares at an exercise price of $21.00. Of the 800,000 shares, 550,300
were exercised before the expiration of the warrants in December 1995, and the
remaining 249,700 shares expired. During the first half of 1996, warrants for
170,000 shares were exercised at a price of $6.75 per share.
On July 7, 1997, the Company finalized the sale of $40 million of
Coventry Convertible Exchangeable Subordinated Notes, together with warrants to
purchase 2.35 million shares at $10.625 per share of common
47
50
stock. The purchase price for the warrants was $1.00 per share, valued by
Coventry and the purchaser. The warrants expire seven years from the purchase
date.
On April 1, 1998, the Company issued a warrant to PHC (the "Principal
Warrant") to purchase that number of shares of common stock equal to 66-2/3% of
the total number of shares of common stock actually issued upon the exercise or
conversion of the Company's employee stock options issued and outstanding at
March 31, 1998, on the same terms and conditions as set forth in the respective
options and warrants. Options and warrants that terminated or expired and are
not exercised, are also canceled in the Principal Warrant. At March 31, 1998,
the Company had options and warrants outstanding for 5,800,480 shares of common
stock, representing the right to purchase 3,866,986 shares under the Principal
Warrant. At December 31, 1998, the Principal Warrant represented the right to
purchase 3,462,368 shares, taking into account cancellations.
On May 18, 1998, the Company issued warrants to four individual
consultants to purchase 40,000 shares of common stock at an exercise price of
$13.625 per share, expiring in 2003. On October 22, 1998, the Company issued
warrants to certain providers to purchase 10,000 shares of common stock at an
exercise price of $7.625 per share, expiring in 2003. On December 21, 1998,
the Company issued a warrant to an individual in connection with the
acquisition of a health plan to purchase 85,239 shares of common stock at an
exercise price of $8.32 per share, expiring in 2003.
The Company implemented an Employee Stock Purchase Plan in 1994, which
allows substantially all employees who meet length of service requirements to
set aside a portion of their salary for the purchase of the Company's common
stock. At the end of each plan year, the Company will issue the stock to
participating employees at an issue price equal to 85% of the lower of the
stock price at the end of the plan year or the average stock price, as defined.
The Company has reserved 1.0 million shares of stock for this plan and has
issued 15,016, 7,074, and 19,465 shares in 1998, 1997, and 1996, respectively.
K. REINSURANCE
The Company has reinsurance agreements, through its subsidiary CHLIC,
with American Continental Insurance Company and Continental Assurance Company
for portions of the risk it has underwritten through its products. These
reinsurance agreements do not release the Company of its primary obligations to
its membership. Reinsurance premiums for the years ended December 31, 1998,
1997 and 1996, were approximately $1.0 million, $0.7 million and $1.8 million
respectively. Reinsurance recoveries for the same periods were approximately
$0.6 million, $0.4 million and $1.5 million. The Company remains liable to
its membership if the reinsurers are unable to meet their contractual
obligations under the reinsurance agreements. All reinsurance agreements are
subject to certain limits on hospital costs per patient-day. To minimize its
exposure to significant losses from reinsurer insolvencies, the Company
evaluates the financial condition of its reinsurers on an annual basis.
American Continental Insurance Company and Continental Assurance Company are
both currently A rated by the A.M. Best Company.
Medicaid risk exposures in Missouri are reinsured through the State of
Missouri mandated program with retention of $50,000 per member per year and 20%
coinsurance. Reinsurance recoveries for the years ended December 31, 1998 and
1997 were approximately $4.0 million and $1.2 million, respectively.
There were no reinsurance recoveries for the year ended December 31, 1996.
L. COMMITMENTS
The Company operates primarily in leased facilities with original
lease terms of up to ten years with options for renewal. The Company also
leases computer equipment with lease terms of approximately three years.
Leases that expire generally are expected to be renewed or replaced by other
leases.
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51
The minimum rental commitments payable and minimum sublease rentals to
be received by the Company during each of the next five years ending December
31 and thereafter for noncancellable operating leases are as follows (in
thousands):
Rental Sublease
Year Commitments Income
- --------------------- ----------------- ---------------
1999 $ 14,826 $ 3,632
2000 12,375 3,446
2001 11,336 3,327
2002 9,636 3,205
2003 7,389 2,926
Thereafter 6,718 2,885
----------------- ---------------
$62,280 $19,421
================= ===============
Total rent expense was approximately $14.6 million, $8.3 million and
$11.7 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
M. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
investments in marketable securities and accounts receivable. The Company
invests its excess cash in interest bearing deposits with major banks,
commercial paper and money market funds. Investments in marketable securities
are managed within guidelines established by the Board of Directors which
emphasize investment-grade fixed income securities and limit the amount that
may be invested in any one issuer. The fair value of the Company's financial
instruments is substantially equivalent to their carrying value and, although
there is some credit risk associated with these instruments, the Company
believes this risk to be minimal.
As discussed in Notes B and C to consolidated financial statements, the
Company entered into long-term global capitation arrangements with two
integrated provider organizations. To the extent that the Company becomes a
party to global capitation agreements with a single provider organization
serving substantial membership, the Company becomes exposed to credit risk with
respect to such organizations. The Company may utilize the following to manage
such risk: 1) contract with providers with significant net worth and cash
reserves; 2) require letters of credit or cash to be reserved for claims
payment and 3) monitor the providers' financial condition in regard to the
Company membership.
Concentration of credit risk with respect to accounts receivable is
limited due to the large number of customers comprising the Company's customer
base and their breakdown among geographical locations. See Note A for
additional information with respect to accounting policies for accounts
receivable.
The Company believes the allowance for doubtful collections adequately
provides for estimated losses as of December 31, 1998. The Company has a risk
of incurring loss if such allowances are not adequate.
As discussed in Note K to consolidated financial statements, the
Company has reinsurance agreements with a major insurance company. The Company
monitors the insurance companies' financial ratings to determine compliance with
standards set by state law. The Company has a credit risk associated with
these reinsurance agreements to the extent the reinsurer is unable to pay valid
reinsurance claims of the Company.
N. BENEFIT PLANS
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On July 1, 1994, Coventry Corporation adopted an employee defined
contribution retirement plan qualifying under IRC Section 401(k), the Coventry
Corporation Retirement Savings Plan (the "Plan"), which covers substantially all
employees of Coventry Corporation and its subsidiaries who meet certain
requirements as to age and length of service and who elect to participate in the
Plan. Similar retirement savings plans offered by (1) both HAPA and GHP and (2)
both CHMC and HCUSA were merged into the Plan effective July 1, 1994 and January
1, 1996, respectively. Effective March 31, 1998, the Company was formed as the
parent company of an affiliated group of companies that includes Coventry
Corporation. The Company, with the approval of Coventry Corporation, adopted and
became sponsor of the Plan effective April 1, 1998. On April 1, 1998, the
Coventry Health Care, Inc. Retirement Savings Plan (the "New Plan") was adopted
and any prior PHC and certain affiliated participant account balances included
in the assets of the former PHC qualified retirement plan were rolled over into
the New Plan at the election of the former PHC employees. Effective October 1,
1998, the Plan was merged with the New Plan. All employees that were
participants under the Plan became participants in the New Plan. On October 1,
1998, the assets of the Plan were merged and transferred to: (1) Principal Life
Insurance Company, as funding agent of the assets held under the terms of the
Flexible Investment Annuity Contract with Coventry Health Care, Inc., (2)
Delaware Charter Guarantee and Trust Company, as custodial trustee of the mutual
funds and (3) Bankers Trust Company, as custodial trustee of the New Plan's
participant loans and the Coventry Health Care, Inc. Common Stock.
Prior to 1998, under the Plan, employees were able to defer up to 15%
of their compensation, limited by the maximum compensation deferral amount
permitted by applicable law. The Company made matching contributions equal to
100% of the employee's contribution on the first 3% of the employee's
compensation deferral and equal to 50% of the employee's contribution on the
second 3% of the employee's compensation deferral. Prior to 1998, employees
vested in the Company's matching contributions in 20% increments annually over a
period of 5 years, based on length of service with the Company and/or its
subsidiaries. Effective January 1, 1998, under the Plan and the New Plan,
employees may defer up to 15% of their compensation, limited by the maximum
compensation deferral amount permitted by applicable law. The Company makes
matching contributions of the Company's common stock equal to 100% of the
employee's contribution on the first 3% of the employee's compensation deferral
and equal to 50% of the employee's contribution on the second 3% of the
employee's compensation deferral. Employees will vest in the Company's matching
contributions in 50% increments annually over a period of 2 years, based on
length of service with the Company and/or its subsidiaries. All costs of the
Plan and the New Plan are funded by the Company as they are incurred.
On July 1, 1994, Coventry Corporation adopted a supplemental executive
retirement plan (the "SERP"), which covers employees of Coventry Corporation and
its subsidiaries who (1) meet certain requirements as to age and management
responsibilities and/or salary, (2) are designated as being eligible to
participate in the SERP by the Compensation and Benefits Committee of the Board
of Directors of the Company, and (3) elect to participate in the SERP and the
New Plan. A similar supplemental executive retirement plan offered by HAPA was
merged into the SERP effective July 1, 1994. Effective April 1, 1998, the SERP
plan name changed to the Coventry Health Care, Inc. Supplemental Executive
Retirement Plan. Under the SERP, employees may defer up to 15% of their base
salary, and up to 100% of any bonus awarded, over and beyond the compensation
deferral limits of the Plan. The Company makes matching contributions equal to
100% of the employee's contribution on the first 3% of the employee's
compensation deferral and 50% of the employee's contribution on the second 3% of
the employee's compensation deferral. Prior to January 1, 1998, employees vested
in the Company's matching contributions in 20% increments annually over a period
of 5 years, based on length of service with the Company and/or its subsidiaries.
Effective January 1, 1998, employees vest in the Company's matching
contributions ratably over two years, based on length of service. All costs of
the SERP are funded by the Company as they are incurred.
The cost, principally employer matching contributions, of the benefit
plans charged to operations for 1998, 1997 and 1996 was approximately $4.0
million, $1.8 million and $2.4 million, respectively.
O. STATUTORY INFORMATION
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53
The Company's HMO subsidiaries are required by the respective domicile
states to maintain minimum statutory capital and surplus in the aggregate of
approximately $35.0 million at December 31, 1998. Combined statutory capital
and surplus of the Company's HMOs was approximately $128.4 million. The states
in which the Company's HMOs operate require the HMOs to maintain deposits with
the Department of Insurance. These deposits totaled $12.8 million at December
31, 1998.
CHLIC's authorized control level Risk-Based Capital is approximately
$12.7 million. Total adjusted statutory capital and surplus of CHLIC as of
December 31, 1998 was approximately $33.2 million. Statutory deposits for CHLIC
as of December 31, 1998 totaled approximately $3.4 million.
P. OTHER INCOME
Other income for the years ended December 31, 1998, 1997, and 1996
includes investment income of approximately $25.5, $10.8 million, and $8.4
million, respectively. As described in Note B, other income includes $15.0
million in 1997 from the sale of medical offices. Additionally, in 1996, other
income includes a non-recurring gain of approximately $4.9 million as a result
of the sale of Champion Dental Service, Inc., a subsidiary GHP, for $5.5
million in cash.
Q. EARNINGS PER SHARE
Basic earnings per share ("EPS") is based on the weighted average number of
common shares outstanding during the year. Diluted EPS assumes the conversion
of convertible notes and the exercise of all options and warrants using the
treasury stock method. Net earnings is increased for interest expense on the
convertible notes. In all cases, however, losses are not diluted.
The following table summarizes the earnings and the average number of
common shares used in the calculation of basic and diluted EPS (in thousands,
except for per share amounts):
1998
-----------------------------------------------
Earnings
(Loss) Shares Per Share
(Numerator) (Denominator) Amount
-----------------------------------------------
Net Earnings (Loss) $(11,741)
---------------
Basic EPS $(11,741) 52,477 $(0.22)
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Effect of Dilutive Securities
Options and warrants
Convertible notes
-----------------------------------------------
Diluted EPS $(11,741) 52,477 $(0.22)
===============================================
1997
-----------------------------------------------
Earnings
(Loss) Shares Per Share
(Numerator) (Denominator) Amount
-----------------------------------------------
Net Earnings (Loss) $11,903
---------------
Basic EPS $11,903 33,210 $0.36
Effect of Dilutive Securities
Options and warrants 702
Convertible Notes
-----------------------------------------------
Diluted EPS $11,903 33,912 $0.35
===============================================
1996
-----------------------------------------------
Earnings
(Loss) Shares Per Share
(Numerator) (Denominator) Amount
-----------------------------------------------
Net Earnings (Loss) $(61,287)
---------------
Basic EPS $(61,287) 32,818 $(1.87)
Effect of Dilutive Securities
Options and warrants
-----------------------------------------------
Diluted EPS $(61,287) 32,818 $(1.87)
===============================================
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R. LEGAL PROCEEDINGS
In the normal course of business, the Company has been named as
defendant in various legal actions seeking payments for claims denied by the
Company, medical malpractice, and other monetary damages. The claims are in
various stages of proceedings and some may ultimately be brought to trial.
Incidents occurring through December 31, 1998 may result in the assertion of
additional claims. With respect to medical malpractice, the Company carries
professional malpractice and general liability insurance for each of its
operations on a claims made basis with varying deductibles for which the
Company maintains reserves. In the opinion of management, the outcome of these
actions will not have a material adverse effect on the financial position or
results of operations of the Company.
The Company's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws could have significant impact on the
Company's operations.
S. SEGMENT INFORMATION
For the Year Ended December 31, 1998
(in $000s)
Government
Commercial Programs Total
---------------------------------------------------
Revenues $1,561,640 471,732 2,033,372
Gross Margin 165,299 45,699 210,998
For the Year Ended December 31, 1997
(in $000s)
Government
Commercial Programs Total
--------------------------------------------------
Revenues $886,237 321,912 1,208,149
Gross Margin 132,340 35,949 168,289
For the Year Ended December 31, 1996
(in $000s)
Government
Commercial Programs Total
--------------------------------------------------
Revenues $839,850 195,928 1,035,778
Gross Margin 65,538 29,708 95,246
Following are reconciliations of reportable segment information to
financial statement amounts:
For the Years Ended December 31,
1998 1997 1996
--------------------------------------------
Revenues
Reportable Segments $2,033,372 $1,208,149 $1,035,778
Other 77,011 20,202 21,351
--------------------------------------------
Total revenues $2,110,383 $1,228,351 $1,057,129
============================================
Earnings (Loss) Before
Income Taxes:
Gross margin from
reportable segments $ 210,998 $168,289 $95,246
Other revenues 77,011 20,202 21,351
Selling, general and
administrative (291,919) (170,017) (165,081)
Depreciation and
amortization (25,793) (12,735) (42,862)
Merger costs (6,492) - -
Other income, net 27,251 24,880 13,379
Interest expense (8,566) (10,275) (6,257)
----------------------------------------------
Total earnings
(loss) before
income taxes $(17,510) $20,344 $(84,224)
==============================================
T. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of unaudited quarterly results of
operations (in thousands, except per share data) for the years ended December
31, 1998 and 1997.
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Quarter Ended
June 30, 1998 September 30, December 31,
March 31, 1998 (1)(2) 1998 1998(3)
---------------------------------------------------------------------
Operating revenues $ 330,209 $ 583,804 $ 593,278 $ 603,092
Operating earnings (loss) 7,178 (51,238) 2,179 5,686
Net earnings (loss) 4,707 (27,756) 5,068 6,240
Net earnings (loss) per share-basic 0.14 (0.47) 0.09 0.11
Net earnings (loss) per share-diluted 0.13 (0.47) 0.09 0.11
Quarter Ended
March 31, June 30, September 30, December 31,
1997 (4) 1997 (5) 1997 (6) 1997
-------------------------------------------------------------------------
Operating revenues $299,345 $301,081 $306,694 $321,231
Operating earnings (loss) (8,021) 1,997 5,976 5,787
Net earnings (loss) (851) 6,590 2,658 3,506
Net earnings (loss) per share-basic (0.03) 0.20 0.08 0.11
Net earnings (loss) per share-diluted (0.03) 0.19 0.08 0.10
(1) Effective April 1, 1998, the Company completed its acquisition of
certain assets of PHC from Principal Life. The acquisition was
accounted for using the purchase method of accounting and, accordingly,
the operations of PHC have been included in the Company's consolidated
financial statements since the date of acquisition. As a result of the
merger, an estimated reserve of $7.8 million was established for the costs
related to the relocation of the corporate office from Nashville,
Tennessee to Bethesda, Maryland and other merger related expenses.
(2) The second quarter 1998 operating results were affected by the
establishment of a reserve for the costs incurred by members covered by
the AHERF agreement and other potential charges as a result of the
bankruptcy filing by AHERF. The establishment of the reserves resulted
in a charge to earnings of $55.0 million.
(3) The merger costs were less than the reserve established in the second
quarter of 1998, resulting in a credit to earnings of $1.3 million.
(4) Effective March 31, 1997, the Company completed the sale of the
majority of its medical offices in Pittsburgh, Pennsylvania associated
with HAPA to a major health care provider organization. The sale price was
$20.0 million and the transaction resulted in a pretax gain of
approximately $6.0 million.
(5) Effective May 1, 1997, the Company completed the sale of the medical
offices associated with Group Health Plan, Inc., its health plan in St.
Louis, Missouri, to a major health care provider organization. The sale
price was $26.9 million and the transaction resulted in a pretax gain
of approximately $9.6 million.
(6) In August 1997, the Company entered into an agreement to sell the
medical offices associated with HAPA's health plan operations
in Harrisburg, Pennsylvania. The sale price was $2.0 million and the
transaction resulted in a pretax loss of $0.2 million. Also in the
third quarter, the Company sold its two remaining medical offices located
in Pittsburgh, Pennsylvania for $0.3 million in cash and recorded a pretax
loss of $0.4 million.
Item 9: Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
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PART III
Item 10: Directors and Executive Officers of the Registrant.
The information set forth under the captions "Directors and Executive
Officers" and "Election of Directors" in the Company's Proxy Statement for its
1999 Annual Meeting of Shareholders, which the Company intends to file within
120 days after its fiscal year-end, is incorporated herein by reference.
Item 11: Executive Compensation.
The information set forth under the caption "Executive Compensation"
in the Company's Proxy Statement for its 1999 Annual Meeting of Shareholders,
which the Company intends to file within 120 days after its fiscal year-end, is
incorporated herein by reference.
Item 12: Securities Ownership of Certain Beneficial Owners and Management.
The information set forth under the captions "Executive Compensation,"
"Voting Stock Outstanding and Shareholders," and "Voting Stock Ownership of
Principal Shareholders and Management" in the Company's Proxy Statement for its
1999 Annual Meeting of Shareholders, which the Company intends to file within
120 days after its fiscal year-end, is incorporated by reference herein.
Item 13: Certain Relationships and Related Transactions.
The information set forth under the caption "Certain Transactions" in
the Company's Proxy Statement for its 1999 Annual Meeting of Shareholders,
which the Company intends to file within 120 days after its fiscal year-end, is
incorporated by reference herein.
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PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. FINANCIAL STATEMENTS
Form 10-K
Pages
-----
Report of Independent Public Accountants 29
Consolidated Balance Sheets, December 31, 1998 and 1997 30
Consolidated Statements of Operations for the Years Ended December
31, 1998, 1997 and 1996 31
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 32
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 33
Notes to Consolidated Financial Statements, December 31, 1998, 1997,
and 1996 34 - 54
2. Financial statement schedules
Report of Independent Public Accountants S-1
Schedule II - Valuation and Qualifying Accounts S-2
3. Exhibits required to be filed by Item 601 of Regulation S-K.
Exhibit
No. Description of Exhibit
2.1 Capital Contribution and Merger Agreement dated as of
November 3, 1997 ("Combination Agreement") by and
among Coventry Corporation, Coventry Health Care,
Inc., Principal Mutual Life Insurance Company,
Principal Holding Company and Principal Health Care,
Inc. (Incorporated by reference to Exhibit 2.1 to Form
S-4, Registration Statement No. 333-45821, of Coventry
Health Care, Inc.).
2.2 Agreement and Plan of Merger by and among Coventry
Corporation, Coventry Health Care, Inc. and Coventry
Merger Corporation (Incorporated by reference to
Exhibit 2.2 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
3.1 Certificate of Incorporation of Coventry Health Care,
Inc. (Incorporated by reference to Exhibit 3.1 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
3.2 Bylaws of Coventry Health Care, Inc. (Incorporated by
reference to Exhibit 3.2 to Form S-4, Registration
Statement No. 333-45821 of Coventry Health Care,
Inc.).
4.1 Specimen Common Stock Certificate (Incorporated by
reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K dated April 8, 1998).
4.2 Rights Agreement dated March 30, 1998 between Coventry
Health Care, Inc.
56
59
and ChaseMellon Shareholder Services, L.L.C. as Rights
Agent (Incorporated by reference to Exhibit 4.2 to the
Company's Current Report on Form 8-K dated April 8,
1998).
4.3 Amendment No. 1 to Rights Agreement, dated as of
December 18, 1998 by and between Coventry Health Care,
Inc. and ChaseMellon Shareholder Services, LLC
(Incorporated by reference to Exhibit 2 to the
Company's Current Report on Form 8-K dated December
21, 1998).
4.4 Amended and Restated Securities Purchase Agreement
dated as of April 2, 1997, by and among Coventry
Corporation, Warburg, Pincus Ventures, L.P. and
Franklin Capital Associates III, L.P., together with
Exhibit A (Form of Convertible Note), Exhibit B (Form
of Warrant) and Exhibit C (Form of Certificate of
Designation of Series A Preferred Stock) (Incorporated
by reference to Exhibit 10 to Coventry Corporation's
Form 8-K dated May 7, 1997).
4.5 Amendment No. 1 to Amended and Restated Securities
Purchase Agreement dated August 1, 1998 between
Coventry Health Care, Inc. (successor by merger to
Coventry Corporation) and Warburg, Pincus Ventures,
L.P. (Incorporated by reference to Exhibit 4.13 to the
Company's Quarterly Report on Form 10-Q for the period
ended September 30, 1998).
4.6 Amended Form of Convertible Note (Incorporated by
reference to Exhibit 4.5 of Coventry Corporation's
Form 10-K for the year ended December 31, 1997).
4.7 Consent to the Combination Agreement of Warburg,
Pincus Ventures, L.P. dated December 18, 1998
(Incorporated by reference to Exhibit 4.7 to the
Company's Form 8-K dated April 8, 1998).
4.8 Common Stock Purchase Warrant dated as of April 1,
1998 issued to Principal Health Care, Inc. pursuant to
the Combination Agreement (Incorporated by reference
to Exhibit 4.5 to the Company's Form 8-K dated April
8, 1998).
4.9 Amendment No. 1 to Common Stock Purchase Warrant
effective as of October 29, 1998, issued to Principal
Health Care, Inc.
4.10 Form of Common Stock Purchase Warrant, as amended, of
Coventry Corporation (assumed by the Company as of
April 1, 1998) (Incorporated by reference to Exhibit
4.6 to the Company's Form 8-K dated April 8, 1998).
4.11 Shareholders' Agreement, dated as of April 1, 1998, by
and among Coventry Health Care, Inc., Principal Mutual
Life Insurance Company and Principal Health Care, Inc.
(Incorporated by reference to Exhibit 4.8 to the
Company's Form 8-K dated April 8, 1998).
10.1 Form of Coinsurance Agreement executed as of April 1,
1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.2 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.2 Form of Renewal Rights Agreement executed as of April
1, 1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.3 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
57
60
10.3 Form of Transition Agreement executed as of April 1,
1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.4 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.4 Form of Management Services Agreement executed as of
April 1, 1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.5 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.5 Form of Tax Benefit Restitution Agreement executed as
of April 1, 1998, pursuant to the Combination
Agreement (Incorporated by reference to Exhibit 10.7
to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.6 Form of License Agreement executed as of April 1,
1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.8 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.7 Form of Marketing Service Agreement executed as of
April 1, 1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.9 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.8 Principal Health Care of Florida, Inc. Stock Purchase
Agreement dated as of October 14, 1998, by and among
Coventry Health Care, Inc., as Seller, Blue Cross and
Blue Shield of Florida, Inc., Principal Health Care of
Florida, Inc. and Health Options, Inc., as Buyer
(Incorporated by reference to Exhibit 10.45 to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.9 Stock Purchase Agreement dated October 2, 1998,
between Coventry Health Care, Inc., as Seller, and
First American Group of Companies, Inc., as Buyer
(Incorporated by reference to Exhibit 10.46 to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.10 Employment Agreement effective as of January 1, 1999,
executed by Allen F. Wise and the Company.
10.11 Employment Agreement dated December 30, 1996 executed
by Dale B. Wolf and Coventry Corporation (assumed by
the Company as of April 1, 1998) (Incorporated by
reference to Exhibit 10 (v) to Coventry Corporation's
Form 10-K for the fiscal year ended December 31, 1996,
filed March 31, 1997).
10.12 Employment Agreement dated March 13, 1998 between
Thomas McDonough and Coventry Corporation (assumed by
the Company as of April 1, 1998) (Incorporated by
reference to Exhibit 10.33 to the Company's Form 10-Q,
Quarterly Report, for the quarter ended June 30,
1998).
10.13 Employment Letter dated May 22, 1998 between James E.
McGarry and Coventry Health Care, Inc. (Incorporated
by reference to Exhibit 10.34 to the Company's Form
10-Q, Quarterly Report, for the quarter ended June 30,
1998).
10.14 Form of Company's Employment Agreement executed by the
following
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61
executives upon terms substantially similar, except
as to compensation, dates of employment, position,
and as otherwise noted: Janet M. Stallmeyer, Sharon
I. Taylor, Francis S. Soistman, Jr., Robert J.
Mrizek, Harvey Pollack, C. David Roberts, Ronald M.
Chaffin, Bernard J. Mansheim, M. D., Thomas Davis
(included executive's right to terminate and receive
severance if he is required to relocate other than to
Atlanta, Georgia or Bethesda, Maryland), J. Stewart
Lavelle (includes executive's right to terminate and
receive severance if there is a material reduction in
position or compensation without consent, a change of
control or a requirement to relocate), and Harvey C.
DeMovick, Jr. (includes executive's right to
terminate and receive severance if there is a
significant change in his position or reporting
relationship as a result of a change in control)
(Incorporated by re reference to Exhibit 10.32 to the
Company's Form 10-Q, Quarterly Report, for the
quarter ended June 30, 1998).
10.15 Form of Coventry Corporation's Agreement (for Key
Senior Executives) dated September 12, 1995 (executed
by Richard H. Jones) (assumed by the Company as of
April 1, 1998) (Incorporated by reference to Exhibit
(xxviii) to Coventry Corporation's Form 10-Q,
Quarterly Report, for the quarter ended September 30,
1995).
10.16 Form of Company's Agreement (for Key Executives)
dated September 12, 1995 (executed by James R.
Hailey, Jan H. Hodges, and Shirley R. Smith)
(Incorporated by reference to Exhibit (xxix) to
Coventry Corporation's Form 10-Q, Quarterly Report,
for the quarter ended September 30, 1995)
10.17 Employment Agreement dated November 11, 1996 executed
by Richard H. Jones (Incorporated by reference to
Exhibit 10 (xxiv) to Coventry Corporations's Annual
Report on Form 10-K for the fiscal year ended December
31, 1996).
10.18 Agreement and Release dated May 29, 1998 between
Robert A. Mayer, Coventry Corporation and
HealthAmerica Pennsylvania, Inc. (Incorporated by
reference to Exhibit 10.35 to the Company's Form 10-Q,
Quarterly Report, for the quarter ended June 30,
1998).
10.19 Agreement and Release dated June 30, 1998 between
Kenneth J. Linde and Coventry Health Care, Inc.
(Incorporated by reference to Exhibit 10.36 to the
Company's Form 10-Q, Quarterly Report, for the quarter
ended June 30, 1998).
10.20 Second Amended and Restated 1987
Statutory-Nonstatutory Stock Option Plan (Incorporated
by reference to Exhibit 10.8.1 attached to Annual
Report on Coventry Corporation's Form 10-K for fiscal
year ended December 31, 1993).
10.21 Third Amended and Restated 1989 Stock Option Plan
(Incorporated by reference to Exhibit 10.8.2 attached
to Coventry Corporation's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993).
10.22 1993 Outside Directors Stock Option Plan (as amended)
(Incorporated by reference to Exhibit 10.8.3 attached
to Coventry Corporation's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.23 1993 Stock Option Plan (as amended) (Incorporated by
reference to Exhibit 10.8.4 attached to the Coventry
Corporation's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.24 Coventry Corporation 1997 Stock Incentive Plan, as
amended. (Incorporated by reference to Exhibit 10.29
to Coventry Corporation's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997).
59
62
10.25 Coventry Health Care, Inc. Amended and Restated 1998
Stock Incentive Plan (March 4, 1999).
10.26 Coventry Health Care 1999 Management Incentive Plan.
10.27 Form of Coventry Health Care, Inc. Retirement
Savings Plan, effective April 1, 1998.
10.28 Coventry Corporation Supplemental Executive Retirement
("SERP") Plan effective July 1, 1994 (Incorporated by
reference to Exhibit 4.2 to Coventry Corporation's
Form S-8, Registration Statement No. 33-81358).
10.29 First Amendment to SERP dated December 31, 1996
(Incorporated by reference to Exhibit 10.19 to
Coventry Corporation's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997).
10.30 Second Amendment to SERP dated July 15, 1997
(Incorporated by reference to Exhibit 10.20 to
Coventry Corporation's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997).
10.31 Third Amendment to SERP dated April 30, 1998
(Incoporated by reference to Exhibit 10.32.1 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.32 Southern Health Management Corporation 1993 Stock
Option Plan (Incorporated by reference to Exhibit
10.8.5 to Coventry Corporation's Annual Report on Form
10-K for the year ended December 31, 1995).
10.33 Employment Agreement dated October 14, 1996 executed
by Joe Carroll (Incorporated by reference to Exhibit
10 (xxii) to Coventry Corporation's Form 10-K for the
fiscal year ended December 31, 1996 filed March 31,
1997).
10.34 Employment Agreement dated January 15, 1997 executed
by Shirley R. Smith (Incorporated by reference to
Exhibit 10 (xxiv) to Coventry Corporation's Form 10-K
for the fiscal year ended December 31, 1996 filed
March 31, 1997).
10.35 Employment Agreement dated January 1, 1997 executed
by Jan H. Hodges (Incorporated by reference to
Exhibit 10 (xxvii) to Coventry Corporation's Form 10-K
for the fiscal year ended December 31, 1996 filed
March 31, 1997).
10.36 Risk Sharing Agreement dated as of March 31, 1997 by
and among Health America Pennsylvania Inc., Coventry
Corporation and Allegheny Health, Education and
Research Foundation. (Incorporated by reference to
Exhibit 10.1 to Coventry Corporation's Form 8-K/A
dated March 12, 1998)*
10.37 First Amendment to Risk Sharing Agreement, dated June
11, 1997, by and between Coventry Corporation and
Allegheny Health, Education & Research Foundation.
(Incorporated by reference to Exhibit 10.2 to Coventry
Corporation's Form 8-K/A dated March 12, 1998)*
10.38 Second Amendment to Risk Sharing Agreement, dated June
30, 1997, by and between Coventry Corporation and
Allegheny Health, Education & Research Foundation.
(Incorporated by reference to Exhibit 10.3 to Coventry
Corporation's Form 8-K/A dated March 12, 1998)*
60
63
10.39 Third Amendment to Risk Sharing Agreement, dated
August 25, 1997, by and between Coventry Corporation
and Allegheny Health, Education & Research Foundation
(Incorporated by reference to Coventry Corporation's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1997).*
10.40 Global Capitation Agreement, dated March 12, 1997, by
and among Group Health Plan, Inc., HealthCare USA of
Missouri, LLC and BJC Health Systems. (Incorporated by
reference to Exhibit 10.5 to Coventry Corporation's
Form 8-K/A dated March 12, 1998).*
10.41 Second Amendment to the Global Capitation Agreement by
and between Group Health Plan, Inc., HealthCare USA of
Missouri, LLC, and BJC Health System ("Amendment")
dated February 26, 1999.**
11.1 Computation of Net Earnings Per Common and Common
Equivalent Share
20. Joint Proxy Statement/Prospectus, dated March 12,
1998, of Coventry Health Care, Inc. (Incorporated by
reference to the Joint Proxy Statement/Prospectus
included in Coventry Health Care, Inc.'s Registration
Statement on Form S-4, as amended, No. 333-45821).
21.1 Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP (See Exhibit 23
attached to this Report)
27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K
Registrant filed on December 21, 1998, an amendment to its current
report on Form 8-K filed on April 23, 1998 relating to an
amendment to its Rights Agreement.
- --------
* Portions of this exhibit have been omitted and have been accorded
confidential treatment pursuant to Rule 24b-2 under the Securities Exchange
Act of 1934, as amended.
** Portions of this exhibit have been omitted and confidential treatment has
been requested pursuant to Rule 24b-2 under the Securities Exchange Act of 1934,
as amended.
61
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
COVENTRY HEALTH CARE, INC.
By: /s/ Allen F. Wise President, Chief Executive Officer and
---------------------------------- Director
Allen F. Wise
Executive Vice President, Chief Financial
By: /s/ Dale B. Wolf Officer, Treasurer and Principal Accounting
---------------------------------- Officer
Dale B. Wolf
Dated: March 29, 1999
Pursuant to the requirements of the Securities and Exchange Act of
1934, this Report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Title (Principal Function) Date
--------- -------------------------- ----
/s/ John H. Austin, M.D., M.P.H. Chairman of the Board and March 29, 1999
- ------------------------------------------------- Director
John H. Austin, M.D., M.P.H.
/s/ Allen F. Wise President, Chief Executive March 29, 1999
- ------------------------------------------------- Officer and Director
Allen F. Wise
Executive Vice President, Chief
Financial Officer,
/s/ Dale B. Wolf Treasurer March 29, 1999
- -------------------------------------------------
Dale B. Wolf
/s/ Lawrence N. Kugelman Director March 29, 1999
- -------------------------------------------------
Lawrence N. Kugelman
/s/ Laurence DeFrance Director March 29, 1999
- -------------------------------------------------
Laurence DeFrance
/s/ Emerson D. Farley, Jr., M.D. Director March 29, 1999
- -------------------------------------------------
Emerson D. Farley, Jr., M.D.
/s/ Richard H. Jones Director March 29, 1999
- -------------------------------------------------
Richard H. Jones
62
65
Director March 29, 1999
- -------------------------------------------------
Gary J. Cain
/s/ Patrick T. Hackett Director March 29, 1999
- -------------------------------------------------
Patrick T. Hackett
/s/ Elizabeth E. Tallett Director March 29, 1999
- -------------------------------------------------
Elizabeth E. Tallett
/s/ Thomas L. Blair Director March 29, 1999
- -------------------------------------------------
Thomas L. Blair
/s/ Thomas J. Graf Director March 29, 1999
- -------------------------------------------------
Thomas J. Graf
/s/ David J. Drury Director March 29, 1999
- -------------------------------------------------
David J. Drury
/s/ Rodman W. Moorhead, III Director March 29, 1999
- -------------------------------------------------
Rodman W. Moorhead, III
63
66
ARTHUR ANDERSEN LLP
Baltimore, Maryland
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Coventry Health Care, Inc:
We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Coventry Health Care, Inc. (successor in
interest to Coventry Corporation) and subsidiaries included in this Form 10-K
and have issued our report thereon dated February 16, 1999. Our audits were
made for the purpose of forming an opinion on the basic consolidated financial
statements taken as a whole. The schedule listed under Item 14(a)(2) is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part
of the basic consolidated financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth herein in
relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Baltimore, Maryland
February 16, 1999
S-1
67
SCHEDULE II
COVENTRY HEALTH CARE INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions Charged to Balance at
Balance at Costs and Expenses Deductions (Charge End of
Beginning of Period (1) (2) Offs) (1) (2) Period
------------------------------------------------------------------------------
Year ended December 31, 1998:
Allowance for doubtful accounts $7,378 $15,935 $(11,290) $12,023
Year ended December 31, 1997:
Allowance for doubtful accounts $8,000 $2,748 $(3,370) $7,378
Year ended December 31, 1996:
Allowance for doubtful accounts $2,700 $8,000 $(2,700) $8,000
(1) Additions to the allowance for doubtful accounts are included in
selling, general and administrative expense. All deductions or charge
offs are charged against the allowance for doubtful accounts.
(2) Additions to the allowance for retroactive terminations are included
in revenue.
S-2
68
INDEX TO EXHIBITS
Reg. S-K
Item 601
Exhibit
No. Description of Exhibit
2.1 Capital Contribution and Merger Agreement dated as of
November 3, 1997 ("Combination Agreement") by and
among Coventry Corporation, Coventry Health Care,
Inc., Principal Mutual Life Insurance Company,
Principal Holding Company and Principal Health Care,
Inc. (Incorporated by reference to Exhibit 2.1 to Form
S-4, Registration Statement No. 333-45821, of Coventry
Health Care, Inc.).
2.2 Agreement and Plan of Merger by and among Coventry
Corporation, Coventry Health Care, Inc. and Coventry
Merger Corporation (Incorporated by reference to
Exhibit 2.2 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
3.1 Certificate of Incorporation of Coventry Health Care,
Inc. (Incorporated by reference to Exhibit 3.1 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
3.2 Bylaws of Coventry Health Care, Inc. (Incorporated by
reference to Exhibit 3.2 to Form S-4, Registration
Statement No. 333-45821 of Coventry Health Care,
Inc.).
4.1 Specimen Common Stock Certificate (Incorporated by
reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K dated April 8, 1998).
4.2 Rights Agreement dated March 30, 1998 between Coventry
Health Care, Inc.
69
and ChaseMellon Shareholder Services, L.L.C. as Rights
Agent (Incorporated by reference to Exhibit 4.2 to the
Company's Current Report on Form 8-K dated April 8,
1998).
4.3 Amendment No. 1 to Rights Agreement, dated as of
December 18, 1998 by and between Coventry Health Care,
Inc. and ChaseMellon Shareholder Services, LLC
(Incorporated by reference to Exhibit 2 to the
Company's Current Report on Form 8-K dated December
21, 1998).
4.4 Amended and Restated Securities Purchase Agreement
dated as of April 2, 1997, by and among Coventry
Corporation, Warburg, Pincus Ventures, L.P. and
Franklin Capital Associates III, L.P., together with
Exhibit A (Form of Convertible Note), Exhibit B (Form
of Warrant) and Exhibit C (Form of Certificate of
Designation of Series A Preferred Stock) (Incorporated
by reference to Exhibit 10 to Coventry Corporation's
Form 8-K dated May 7, 1997).
4.5 Amendment No. 1 to Amended and Restated Securities
Purchase Agreement dated August 1, 1998 between
Coventry Health Care, Inc. (successor by merger to
Coventry Corporation) and Warburg, Pincus Ventures,
L.P. (Incorporated by reference to Exhibit 4.13 to the
Company's Quarterly Report on Form 10-Q for the period
ended September 30, 1998).
4.6 Amended Form of Convertible Note (Incorporated by
reference to Exhibit 4.5 of Coventry Corporation's
Form 10-K for the year ended December 31, 1997).
4.7 Consent to the Combination Agreement of Warburg,
Pincus Ventures, L.P. dated December 18, 1998
(Incorporated by reference to Exhibit 4.7 to the
Company's Form 8-K dated April 8, 1998).
4.8 Common Stock Purchase Warrant dated as of April 1,
1998 issued to Principal Health Care, Inc. pursuant to
the Combination Agreement (Incorporated by reference
to Exhibit 4.5 to the Company's Form 8-K dated April
8, 1998).
4.9 Amendment No. 1 to Common Stock Purchase Warrant
effective as of October 29, 1998, issued to Principal
Health Care, Inc.
4.10 Form of Common Stock Purchase Warrant, as amended, of
Coventry Corporation (assumed by the Company as of
April 1, 1998) (Incorporated by reference to Exhibit
4.6 to the Company's Form 8-K dated April 8, 1998).
4.11 Shareholders' Agreement, dated as of April 1, 1998, by
and among Coventry Health Care, Inc., Principal Mutual
Life Insurance Company and Principal Health Care, Inc.
(Incorporated by reference to Exhibit 4.8 to the
Company's Form 8-K dated April 8, 1998).
10.1 Form of Coinsurance Agreement executed as of April 1,
1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.2 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.2 Form of Renewal Rights Agreement executed as of April
1, 1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.3 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
70
10.3 Form of Transition Agreement executed as of April 1,
1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.4 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.4 Form of Management Services Agreement executed as of
April 1, 1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.5 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.5 Form of Tax Benefit Restitution Agreement executed as
of April 1, 1998, pursuant to the Combination
Agreement (Incorporated by reference to Exhibit 10.7
to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.6 Form of License Agreement executed as of April 1,
1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.8 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.7 Form of Marketing Service Agreement executed as of
April 1, 1998, pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 10.9 to Form
S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.8 Principal Health Care of Florida, Inc. Stock Purchase
Agreement dated as of October 14, 1998, by and among
Coventry Health Care, Inc., as Seller, Blue Cross and
Blue Shield of Florida, Inc., Principal Health Care of
Florida, Inc. and Health Options, Inc., as Buyer
(Incorporated by reference to Exhibit 10.45 to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.9 Stock Purchase Agreement dated October 2, 1998,
between Coventry Health Care, Inc., as Seller, and
First American Group of Companies, Inc., as Buyer
(Incorporated by reference to Exhibit 10.46 to the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.10 Employment Agreement effective as of January 1, 1999,
executed by Allen F. Wise and the Company.
10.11 Employment Agreement dated December 30, 1996 executed
by Dale B. Wolf and Coventry Corporation (assumed by
the Company as of April 1, 1998) (Incorporated by
reference to Exhibit 10 (v) to Coventry Corporation's
Form 10-K for the fiscal year ended December 31, 1996,
filed March 31, 1997).
10.12 Employment Agreement dated March 13, 1998 between
Thomas McDonough and Coventry Corporation (assumed by
the Company as of April 1, 1998) (Incorporated by
reference to Exhibit 10.33 to the Company's Form 10-Q,
Quarterly Report, for the quarter ended June 30,
1998).
10.13 Employment Letter dated May 22, 1998 between James E.
McGarry and Coventry Health Care, Inc. (Incorporated
by reference to Exhibit 10.34 to the Company's Form
10-Q, Quarterly Report, for the quarter ended June 30,
1998).
10.14 Form of Company's Employment Agreement executed by the
following
71
executives upon terms substantially similar, except
as to compensation, dates of employment, position,
and as otherwise noted: Janet M. Stallmeyer, Sharon
I. Taylor, Francis S. Soistman, Jr., Robert J.
Mrizek, Harvey Pollack, C. David Roberts, Ronald M.
Chaffin, Bernard J. Mansheim, M. D., Thomas Davis
(included executive's right to terminate and receive
severance if he is required to relocate other than to
Atlanta, Georgia or Bethesda, Maryland), J. Stewart
Lavelle (includes executive's right to terminate and
receive severance if there is a material reduction in
position or compensation without consent, a change of
control or a requirement to relocate), and Harvey C.
DeMovick, Jr. (includes executive's right to
terminate and receive severance if there is a
significant change in his position or reporting
relationship as a result of a change in control)
(Incorporated by re reference to Exhibit 10.32 to the
Company's Form 10-Q, Quarterly Report, for the
quarter ended June 30, 1998).
10.15 Form of Coventry Corporation's Agreement (for Key
Senior Executives) dated September 12, 1995 (executed
by Richard H. Jones) (assumed by the Company as of
April 1, 1998) (Incorporated by reference to Exhibit
(xxviii) to Coventry Corporation's Form 10-Q,
Quarterly Report, for the quarter ended September 30,
1995).
10.16 Form of Company's Agreement (for Key Executives)
dated September 12, 1995 (executed by James R.,
Hailey, Jan H. Hodges, and Shirley R. Smith)
(Incorporated by references to Exhibit (xxix) to
Coventry Corporation's Form 10-Q, Quarterly Report,
for the quarter ended September 30, 1995)
10.17 Employment Agreement dated November 11, 1996 executed
by Richard H. Jones (Incorporated by reference to
Exhibit 10 (xxiv) to Coventry Corporations's Annual
Report on Form 10-K for the fiscal year ended December
31, 1996).
10.18 Agreement and Release dated May 29, 1998 between
Robert A. Mayer, Coventry Corporation and
HealthAmerica Pennsylvania, Inc. (Incorporated by
reference to Exhibit 10.35 to the Company's Form 10-Q,
Quarterly Report, for the quarter ended June 30,
1998).
10.19 Agreement and Release dated June 30, 1998 between
Kenneth J. Linde and Coventry Health Care, Inc.
(Incorporated by reference to Exhibit 10.36 to the
Company's Form 10-Q, Quarterly Report, for the quarter
ended June 30, 1998).
10.20 Second Amended and Restated 1987
Statutory-Nonstatutory Stock Option Plan (Incorporated
by reference to Exhibit 10.8.1 attached to Annual
Report on Coventry Corporation's Form 10-K for fiscal
year ended December 31, 1993).
10.21 Third Amended and Restated 1989 Stock Option Plan
(Incorporated by reference to Exhibit 10.8.2 attached
to Coventry Corporation's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993).
10.22 1993 Outside Directors Stock Option Plan (as amended)
(Incorporated by reference to Exhibit 10.8.3 attached
to Coventry Corporation's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.23 1993 Stock Option Plan (as amended) (Incorporated by
reference to Exhibit 10.8.4 attached to the Coventry
Corporation's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.24 Coventry Corporation 1997 Stock Incentive Plan, as
amended. (Incorporated by reference to Exhibit 10.29
to Coventry Corporation's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997).
10.25 Coventry Health Care, Inc. Amended and Restated 1998
Stock Incentive Plan (March 4, 1999).
10.26 Coventry Health Care 1999 Management Incentive Plan.
10.27 Form of Coventry Health Care, Inc. Retirement Savings
Plan, effective April 1, 1998.
10.28 Coventry Corporation Supplemental Executive Retirement
("SERP") Plan effective July 1, 1994 (Incorporated by
reference to Exhibit 4.2 to Coventry Corporation's
Form S-8, Registration Statement No. 33-81358).
10.29 First Amendment to SERP dated December 31, 1996
(Incorporated by reference to Exhibit 10.19 to
Coventry Corporation's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997).
10.30 Second Amendment to SERP dated July 15, 1997
(Incorporated by reference to Exhibit 10.20 to
Coventry Corporation's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997).
10.31 Third Amendment to SERP dated April 30, 1998
(Incoporated by reference to Exhibit 10.32.1 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.32 Southern Health Management Corporation 1993 Stock
Option Plan (Incorporated by reference to Exhibit
10.8.5 to Coventry Corporation's Annual Report on Form
10-K for the year ended December 31, 1995).
10.33 Employment Agreement dated October 14, 1996 executed
by Joe Carroll (Incorporated by reference to Exhibit
10 (xxii) to Coventry Corporation's Form 10-K for the
fiscal year ended December 31, 1996 filed March 31,
1997).
10.34 Employment Agreement dated January 15, 1997 executed
by Shirley R. Smith (Incorporated by reference to
Exhibit 10 (xxiv) to Coventry Corporation's Form 10-K
for the fiscal year ended December 31, 1996 filed
March 31, 1997).
10.35 Employment Agreement dated January 1, 1997 executed
by Jan H. Hodges (Incorporated by reference to
Exhibit 10 (xxvii) to Coventry Corporation's Form 10-K
for the fiscal year ended December 31, 1996 filed
March 31, 1997).
10.36 Risk Sharing Agreement dated as of March 31, 1997 by
and among Health America Pennsylvania Inc., Coventry
Corporation and Allegheny Health, Education and
Research Foundation. (Incorporated by reference to
Exhibit 10.1 to Coventry Corporation's Form 8-K/A
dated March 12, 1998)*
10.37 First Amendment to Risk Sharing Agreement, dated June
11, 1997, by and between Coventry Corporation and
Allegheny Health, Education & Research Foundation.
(Incorporated by reference to Exhibit 10.2 to Coventry
Corporation's Form 8-K/A dated March 12, 1998)*
10.38 Second Amendment to Risk Sharing Agreement, dated June
30, 1997, by and between Coventry Corporation and
Allegheny Health, Education & Research Foundation.
(Incorporated by reference to Exhibit 10.3 to Coventry
Corporation's Form 8-K/A dated March 12, 1998)*
10.39 Third Amendment to Risk Sharing Agreement, dated
August 25, 1997, by and between Coventry Corporation
and Allegheny Health, Education & Research Foundation
(Incorporated by reference to Coventry Corporation's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1997).*
10.40 Global Capitation Agreement, dated March 12, 1997, by
and among Group Health Plan, Inc., HealthCare USA of
Missouri, LLC and BJC Health Systems. (Incorporated by
reference to Exhibit 10.5 to Coventry Corporation's
Form 8-K/A dated March 12, 1998).*
10.41 Second Amendment to the Global Capitation Agreement by
and between Group Health Plan, Inc., HealthCare USA of
Missouri, LLC, and BJC Health System ("Amendment")
dated February 26, 1999.**
11.1 Computation of Net Earnings Per Common and Common
Equivalent Share
20. Joint Proxy Statement/Prospectus, dated March 12,
1998, of Coventry Health Care, Inc. (Incorporated by
reference to the Joint Proxy Statement/Prospectus
included in Coventry Health Care, Inc.'s Registration
Statement on Form S-4, as amended, No. 333-45821).
21.1 Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP (See Exhibit 23
attached to this Report)
27 Financial Data Schedule (for SEC use only)
* Portions of this exhibit have been omitted and have been accorded
confidential treatment pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
** Portions of this exhibit have been omitted and are subject to a
request for confidential treatment pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934, as amended.