-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QyrGs55QPDo0CgPNQ5gp8sXmdQHGfyyfCRwPG063d5e1NPSFvWkyiJ+WVeLyyIZc LFdO30LWv3uK9gBF8BP/JA== 0000950133-99-001873.txt : 19990518 0000950133-99-001873.hdr.sgml : 19990518 ACCESSION NUMBER: 0000950133-99-001873 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COVENTRY HEALTH CARE INC CENTRAL INDEX KEY: 0001054833 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-OFFICES & CLINICS OF DOCTORS OF MEDICINE [8011] IRS NUMBER: 522073000 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-29676 FILM NUMBER: 99626522 BUSINESS ADDRESS: STREET 1: 6705 ROCKLEDGE DR STE 100 CITY: BETHESDA STATE: MD ZIP: 20817 BUSINESS PHONE: 3015810600 MAIL ADDRESS: STREET 1: 6705 ROCKLEDGE DR SUITE 100 STREET 2: STE 250 CITY: BETHESDA STATE: MD ZIP: 20817 10-Q 1 FORM 10-Q FOR COVENTRY HEALTH CARE, INC. 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 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 No.) 6705 ROCKLEDGE DRIVE, SUITE 900 BETHESDA, MD 20817 (Address of principal executive office) (Zip Code) (301) 581-0600 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class Outstanding at April 30, 1999 - ----- ----------------------------- Common Stock $.01 Par Value 58,861,191
2 COVENTRY HEALTH CARE, INC. FORM 10-Q TABLE OF CONTENTS
Page ---- PART I. FINANCIAL INFORMATION Item 1: Financial Statements Condensed Consolidated Balance Sheets at March 31, 1999 and December 31, 1998 1 Condensed Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998 2 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998 3 Notes to Condensed Consolidated Financial Statements 4 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3: Quantitative and Qualitative Disclosures about Market Risk 18 PART II. OTHER INFORMATION Item 1: Legal Proceedings 19 Items 2, 3, 4, and 5 19 Item 6: Exhibits and Reports on Form 8-K 19 Signatures 21
3 PART I. FINANCIAL INFORMATION ITEM 1: Financial Statements COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
March 31, December 31, ASSETS 1999 1998 -------------- ---------------- (unaudited) Cash and cash equivalents $ 383,435 $ 408,823 Short-term investments 25,572 43,689 Accounts receivable, net 50,850 46,204 Other receivables 18,445 19,754 Deferred income taxes and other current assets 70,195 72,575 -------------- ---------------- Total current assets 548,497 591,045 Long-term investments 155,118 162,070 Property and equipment, net 39,148 35,820 Goodwill and intangible assets, net 292,244 295,966 Other assets 5,677 5,692 -------------- ---------------- Total assets $ 1,040,684 $ 1,090,593 ============== ================ LIABILITIES AND STOCKHOLDERS' EQUITY Medical claim liabilities $ 309,102 $ 338,142 Other medical liabilities 58,540 62,732 Accounts payable and other accrued liabilities 118,210 118,401 Deferred revenue 21,281 46,412 Current portion of long-term debt and notes payable - 166 -------------- ---------------- Total current liabilities 507,133 565,853 Convertible exchangeable subordinated notes 46,465 45,538 Long-term debt 781 820 Other long-term liabilities 42,047 41,843 Stockholders' equity: Common Stock, $.01 par value; 200,000,000 shares authorized; 59,296,001 shares issued and 58,856,441 outstanding in 1999; and 59,287,454 shares issued and 58,847,894 outstanding in 1998 593 593 Additional paid-in capital 476,711 476,430 Accumulated other comprehensive (loss) income (61) 794 Accumulated deficit (27,985) (36,278) Treasury stock, at cost, 439,560 shares (5,000) (5,000) -------------- ---------------- Total stockholders' equity 444,258 436,539 -------------- ---------------- Total liabilities and stockholders' equity $ 1,040,684 $ 1,090,593 ============== ================
See notes to condensed consolidated financial statements. 1 4 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (unaudited)
Three months ended March 31, ----------------------------- 1999 1998 ------------- ------------- Operating revenues: Managed care premiums $ 507,678 $ 324,753 Management services 20,170 5,456 ------------- ------------- Total operating revenues 527,848 330,209 ------------- ------------- Operating expenses: Health benefits 433,641 275,314 Selling, general and administrative 78,530 44,967 Depreciation and amortization 6,994 2,750 ------------- ------------- Total operating expenses 519,165 323,031 ------------- ------------- Operating income 8,683 7,178 Other income, net 7,015 2,633 Interest expense (1,007) (1,833) ------------- ------------- Income before income taxes 14,691 7,978 Provision for income taxes 6,398 3,271 ------------- ------------- Net income $ 8,293 $ 4,707 ============= ============= Net income per share Basic $ 0.14 $ 0.14 ============= ============= Diluted $ 0.14 $ 0.13 ============= =============
See notes to condensed consolidated financial statements. 2 5 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Three months ended March 31, ------------------------------ 1999 1998 ------------- ------------ Net cash used in operating activities $ (46,854) $ (5,189) ------------- ------------ Cash flows from investing activities: Capital expenditures, net (2,921) (1,872) Sale of investments 50,641 6,017 Purchase of investments (26,252) (11,030) ----------- ------------ Net cash provided by (used in) investing activities 21,468 (6,885) ----------- ------------ Cash flows from financing acitivities: Payments of long-term debt and notes payable (48) (390) Net proceeds from issuance of stock 46 1,282 ----------- ------------ Net cash (used in) provided by financing activities (2) 892 ----------- ------------ Net decrease in cash and cash equivalents (25,388) (11,182) Cash and cash equivalents at beginning of the period 408,823 153,979 ----------- ------------ Cash and cash equivalents at end of the period $ 383,435 $ 142,797 =========== ============ Supplemental disclosures of cash flow information Cash paid during the period was as follows: Interest $ 18 $ 894 ============= ============ Income taxes $ 6,000 $ 8,648 ============= ============
See notes to condensed consolidated financial statements. 3 6 COVENTRY HEALTH CARE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. BASIS OF PRESENTATION The condensed consolidated financial statements of Coventry Health Care, Inc. and subsidiaries (the "Company") contained in this report are unaudited but reflect all adjustments, consisting of normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission (the "SEC"). The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's most recent Annual Report on Form 10-K, filed with the SEC on March 30, 1999. 2. SIGNIFICANT ACCOUNTING POLICIES Derivative Instruments - In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 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 the derivatives would be accounted for depending on the use of the derivatives and whether they qualify for hedge accounting. SFAS 133 is effective for fiscal years beginning after June 15, 1999. The Company does not believe that adoption of SFAS 133 will have a material effect on its future results of operations. Computer Software - Effective January 1, 1999, the Company adopted Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use" issued by the American Institute of Certified Public Accountants ("AICPA"). 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 adoption of SOP 98-1 did not have a material effect on the Company's consolidated financial statements. Reclassifications - Certain 1998 amounts have been reclassified to conform to the 1999 presentation. 3. ACQUISITIONS AND DISPOSITIONS Effective April 1, 1998, the Company completed its acquisition of certain health plans of Principal Health Care, Inc. ("PHC") from Principal Mutual Life Insurance Company ("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 4 7 at $25.0 million ("the Warrant") was issued that grants Principal Life the right to acquire additional shares of the Company's common stock in the event that its ownership percentage of such common stock is diluted below 40%. The Warrant is included as a component of additional paid-in capital in the accompanying condensed 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. Pursuant to these agreements the Company recognized revenue of approximately $6.2 million for the three months ended March 31, 1999 and expects to receive payments of approximately $26.4 million during the year ended December 31,1999 inclusive of the $6.2 million. 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. The Company currently is negotiating with Principal Life to terminate the Renewal Rights and Coinsurance agreements. 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 preferred provider organization network based on a fixed rate per employee entitled to access the PPO network and a percentage of savings realized by Principal Life. Under this agreement, the Company recognized revenue of approximately $2.0 million for the three months ended March 31, 1999. 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. 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. The proceeds from both sales were used to retire the Company's credit facility, to assist in improving the capital position of the Company's regulated subsidiaries, 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 sale 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 established reserves 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. Through March 31, 1999, the Company has expended approximately $20.2 million related to these reserves. The Company expects to make payments on the remaining reserves through July 2002. 5 8 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 $200.5 million excess of purchase price over the net identified tangible assets acquired was allocated to identifiable intangible assets and goodwill. The amounts allocated 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 ============
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. Through March 31, 1999, the Company has expended approximately $5.1 million related to the reserve. The Company expects to make payments through December 2002 related to these charges. 4. COMPREHENSIVE INCOME Comprehensive income for the three months ended March 31, 1999 and 1998 is as follows (in thousands):
1999 1998 ------------- ------------- Net income $ 8,293 $ 4,707 Other comprehensive income, net of tax: Net unrealized losses on securities, net of reclassification adjustment (855) (16) ------------- ------------- Comprehensive income $ 7,438 $ 4,691 ============= =============
5. EARNINGS PER SHARE Basic earnings per share ("EPS") is based on the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion of dilutive convertible notes and the exercise of dilutive options and warrants using the treasury stock method. Net income is increased for interest expense on the convertible notes. 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): 6 9
Quarter ended March 31, 1999 ------------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount ------------------------------------------------- Net Income $ 8,293 ------------------ Basic EPS $ 8,293 58,851 $ 0.14 Effect of Dilutive Securities Options and warrants 712 Convertible notes 4,521 Interest on convertible notes 516 ------------------------------------------------- Diluted EPS $ 8,809 64,084 $ 0.14 =================================================
Quarter ended March 31, 1998 ------------------------------------------------- Income Shares Per Share (Numerator) (Denominator) Amount ------------------------------------------------- Net Income $ 4,707 ------------------ Basic EPS $ 4,707 33,348 $ 0.14 Effect of Dilutive Securities Options and warrants 1,127 Convertible notes 4,166 Interest on convertible notes 476 ------------------------------------------------- Diluted EPS $ 5,183 38,641 $ 0.13 =================================================
6. SEGMENT REPORTING Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information", 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 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 and individuals 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. 7 10
For the Three Months Ended March 31, 1999 (in thousands) ------------------------------------------------------------------------------------- Commercial Government Programs Total ------------------------------------------------------------------------------------- Revenues $384,992 $ 122,686 $ 507,678 Gross Margin 61,453 12,584 74,037
For the Three Months Ended March 31, 1998 (in thousands) ------------------------------------------------------------------------------------- Commercial Government Programs Total ------------------------------------------------------------------------------------- Revenues $234,056 $ 90,697 $ 324,753 Gross Margin 38,103 11,336 49,439
Following are reconciliations of reportable segment information to financial statement amounts (in thousands):
For the Three Months Ended March 31, ------------------------------------ 1999 1998 ------------------------------------ Revenues Reportable Segments $507,678 $324,753 Other 20,170 5,456 -------- -------- Total revenues $527,848 $330,209 ======== ======== Earnings (Loss) Before Income Taxes: Gross margin from reportable segments $74,037 $49,439 Other revenues 20,170 5,456 Selling, general and administrative (78,530) (44,967) Depreciation and amortization (6,994) (2,750) Other income, net 7,015 2,633 Interest expense (1,007) (1,833) ------- ------- Total earnings before income taxes $14,691 $7,978 ======= ======
7. LEGAL PROCEEDINGS 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 related premiums to cover all of the 8 11 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 under the AHERF agreement at the time of the bankruptcy filing and other potential bankruptcy charges. 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 partners 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 in the Court of Common Pleas of Allegheny County, Pennsylvania, against certain affiliated hospitals 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 HealthAmerica Pennsylvania, Inc., 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 the reserve established is adequate to provide for the claims incurred related to the AHERF arrangement and other related AHERF bankruptcy uncertainties. Through March 31, 1999, approximately $34.7 million has been expended for medical claims from this reserve. Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the Company, entered into an agreement effective January 1, 1998 with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to provide health care services to GHP's members in the southern and western areas of St. Louis County, Missouri, which agreement contained certain risk sharing provisions. Disputes have arisen under the agreement, cross-claims have been made and the matter has been submitted to arbitration before the American Arbitration Association. GHP is demanding payment from Unity of $7.6 million and specific performance under the agreement. Unity is demanding payment from GHP of $14.5 million, specific performance of certain provisions of the agreement and suspension of its payment obligations. The Company believes that GHP has fulfilled all of its obligations under the agreement, that the amount demanded by GHP is properly due to GHP, and that GHP does not owe Unity the amounts claimed by Unity. The Company intends to vigorously pursue this matter. 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 March 31, 1999 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. 9 12 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Quarters ended March 31, 1999 and 1998 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. As of March 31, 1999, the Company had 1,148,830 members for whom it assumes underwriting risk ("risk members") and 246,527 members of self-insured employers for whom it provides management services but does not assume underwriting risk ("non-risk members"). The following tables show the total number of members as of March 31, 1999 and 1998 and the percentage change in membership between those dates, where applicable. The March 31, 1999 membership figures reflect the acquisition of various health plans from Principal Health Care, Inc.("PHC") and the disposition of the Principal Health Care of Florida, Inc. and Principal Health Care of Illinois, Inc. health plans all of which occurred in 1998.
MARCH 31, PERCENT 1999 1998 CHANGE ---- ---- ------ St. Louis(1) 325,044 266,671 21.9% Pennsylvania 401,706 441,329 (9.0%) Iowa 78,609 - N/A Richmond 47,733 58,209 (18.0%) Delaware/Baltimore 60,275 - N/A Kansas City 57,527 - N/A Louisiana 38,079 - N/A Wichita 39,980 - N/A Nebraska 27,175 - N/A Indiana 27,782 - N/A Carolinas 21,279 - N/A Georgia 23,641 - N/A --------- ------- Total risk membership 1,148,830 766,209 49.9% Total non-risk membership (2) 246,527 141,911 73.7% --------- ------- Total membership 1,395,357 908,120 53.7% ========= =======
MARCH 31, PERCENT 1999 1998 CHANGE ---- ---- ------ Commercial 977,601 617,017 58.4% Governmental Programs 171,229 149,192 14.8% --------- ------- Total risk membership 1,148,830 766,209 49.9% Non-risk membership (2) 246,527 141,911 73.7% --------- ------- Total membership 1,395,357 908,120 53.7% ========= =======
10 13 (1) Includes PHC of St. Louis membership in 1999. (2) 1999 non-risk membership includes 80,706 members attributable to the PHC Plans. The Company's operating expenses are primarily medical costs, including medical claims under contractual relationships with a wide variety of providers, and capitation payments. Medical claims expense also includes an estimate of claims incurred but not reported ("IBNR"). The Company currently 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 liabilities, the Company employs plan by plan standard actuarial reserve 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 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 its IBNR reserves, and as actual settlements are made or accruals adjusted, differences are reflected in current operations. RESULTS OF OPERATIONS Effective April 1, 1998, the Company completed its acquisition of certain health plans of PHC from Principal Mutual Life Insurance Company ("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 grants Principal Life the right to acquire additional shares of the Company's common stock in the event that its ownership percentage of such common stock 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. Pursuant to the agreements, the Company recognized revenue of approximately $6.2 million for the three months ended March 31, 1999, and expects to receive payments of approximately $26.4 million during the year ended December 31, 1999 inclusive of the $6.2 million. 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. The Company currently is negotiating with Principal Life to terminate the Renewal Rights and Coinsurance agreements. 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 preferred provider organization ("PPO") network based on a fixed rate per 11 14 employee entitled to access the PPO network and a percentage of savings realized by Principal Life. Under this agreement, the Company recognized revenue of approximately $2.0 million for the three months ended March 31, 1999. 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. 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. The proceeds from both sales were used to retire the Company's credit facility, to assist in improving the capital position of the Company's regulated subsidiaries, 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 sale 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 established reserves 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. Through March 31, 1999, the Company has expended approximately $20.2 million related to these reserves. The Company expects to make payments on the remaining reserves through July 2002. 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. Through March 31, 1999, the Company has expended approximately $5.1 million related to the reserve. The Company expects to make payments through December 2002 related to these charges. 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 related premiums 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 under the AHERF agreement at the time of the bankruptcy filing and other potential bankruptcy charges. 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. 12 15 Although AHERF has not formally rejected the risk-sharing agreement as of the date of this filing, the partners 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 in the Court of Common Pleas of Allegheny County, Pennsylvania, against certain affiliated hospitals 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 HealthAmerica Pennsylvania, Inc., 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 the reserve established is adequate to provide for the claims incurred related to the AHERF arrangement and other related AHERF bankruptcy uncertainties. Through March 31, 1999, approximately $34.7 million has been expended for medical claims related to this reserve. Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the Company, entered into an agreement effective January 1, 1998 with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to provide health care services to GHP's members in the southern and western areas of St. Louis County, Missouri, which agreement contained certain risk sharing provisions. Disputes have arisen under the agreement, cross-claims have been made and the matter has been submitted to arbitration before the American Arbitration Association. GHP is demanding payment from Unity of $7.6 million and specific performance under the agreement. Unity is demanding payment from GHP of $14.5 million, specific performance of certain provisions of the agreement and suspension of its payment obligations. The Company believes that GHP has fulfilled all of its obligations under the agreement, that the amount demanded by GHP is properly due to GHP, and that GHP does not owe Unity the amounts claimed by Unity. The Company intends to vigorously pursue this matter. QUARTERS ENDED MARCH 31, 1999 AND 1998 Managed care premiums increased by $182.9 million, or 56.3%, from the 1998 first quarter. The increase in managed care premiums was primarily attributable to the 382,621, or 49.9%, increase in risk membership to 1,148,830 at March 31, 1999. In addition to the increase in risk membership, premium yields increased by $6.71, or 4.8%, on a per member per month ("PMPM") basis to $147.50 PMPM, attributable to rate premium increases coupled with changes in the overall revenue mix due to the merger. The PHC operations accounted for 388,540, or 101.5%, of the increase in risk membership. Exclusive of the PHC operations, risk membership decreased by 5,919 members, or 0.8%, as a result of decreases in Medicaid and commercial membership of 11,953 and 6,651, respectively, offset by an increase in Medicare risk membership of 12,680, primarily in the St. Louis market. The decrease in Medicaid membership was attributable to the Company's exit from the Pennsylvania Medicaid market subsequent to the first quarter of 1998. The decrease in commercial membership occurred primarily in the western Pennsylvania market and was attributable to the disruption caused by the AHERF bankruptcy filing and the conversion of a large group from a commercial risk product to a self-funded product. Membership also decreased in other markets due to the Company's efforts to adhere to strict pricing discipline. The Company will continue to be diligent in obtaining adequate premium increases and expects its commercial premium rates to increase 6% to 8% during the remainder of 1999. The Company 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 Florida and Illinois health plans that were sold effective December and November 1998, respectively. The remaining markets were exited because the reimbursement rates were not adequate and/or the Company was not successful in renegotiating adequate reimbursement rates. Management services revenue increased $14.7 million, or 269.7%, from the 1998 first quarter. Approximately $7.9 million, or 53.7%, of the increase was primarily attributable to the PHC Administrative Services Only ("ASO") operations, and PPO access fees. Management services and marketing services agreements that were entered into coincident with the acquisition of the PHC health plans accounted for approximately $6.2 million, or 42.2%, of the increase. Exclusive of the PHC plans and the related agreements with Principal 13 16 Life, the management services revenue increased approximately $.6 million, or 4.1%. Health benefits expense increased $158.3 million, or 57.5%, from the prior year first quarter. The PHC operations accounted for approximately $136.8 million, or 86.4%, of the increase. Exclusive of the PHC operations, health benefits expense increased by approximately $21.5 million, or 7.8%. The Company's medical loss ratio increased slightly to 85.4% from 84.8% in the prior year first quarter due the AHERF bankruptcy filing and the increase in Medicare membership. The Company continues to focus 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 IBNR claims 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 increased $33.6 million, or 74.6%, from the prior year first quarter. SGA expense, as a percent of revenue, increased to 14.9% for the quarter ended March 31, 1999, from 13.6% in the prior year first quarter. The increase in SGA expense is primarily attributable to additional costs associated with the PHC health plans. In an effort to control costs and improve customer service, the Company is in the process of transferring certain of its operating activities (e.g., customer service, claims processing, billing and enrollment) to regional service centers, which are anticipated to be fully operational in the fourth quarter of 1999. Depreciation and amortization increased $4.2 million, or 154.3%, from the prior year first quarter. Depreciation related to the PHC operations accounted for approximately $0.4 million, or 9.5%, of the increase and amortization related to the intangibles and goodwill recorded as part of the PHC acquisition accounted for approximately $2.9 million, or 69.0%, of the increase. Other income, net increased by $4.4 million, or 166.4%, from the prior year first quarter 14 17 primarily due to increased investment income resulting from the increase in invested assets subsequent to the acquisition of PHC. Earnings from operations increased $1.5 million, or 21.0%, from the prior year first quarter attributable to the various factors as described above. The Company's net income was $8.3 million compared to $4.7 million for the first quarter of 1998. Net income per common and common equivalent share was $0.14 per share for the 1999 first quarter compared to net income per common and common equivalent share of $0.13 in the prior year first quarter. The weighted average common and common equivalent shares outstanding were approximately 64,083,708 and 38,641,000 for the quarters ended March 31, 1999 and 1998, respectively, the increase primarily attributable to the issuance of common stock in April 1998 related to the acquisition of the PHC health plans. LIQUIDITY AND CAPITAL RESOURCES The Company's total cash and investments, excluding deposits of $24.8 million restricted under state regulations, decreased $62.5 million to $539.3 million at March 31, 1999 from $601.8 million at December 31, 1998 primarily attributable to $46.9 million of cash used in operations for the quarter. A significant portion of the cash used in operations (approximately $32.1 million) was paid for medical claims associated with Principal Health Care of Florida, Inc. and Principal Health Care of Illinois, Inc., the two health plans that were sold effective December 31, 1998 and November 30, 1998, respectively. The reduction in cash and investments can also be attributable to the reduction of deferred revenue resulting from changes in the timing of premium payments from the U.S. Health Care Financing Administration for Medicare membership and the Company's efforts to reduce medical claims inventory in the first quarter of 1999. The Company's investment guidelines emphasize investment grade fixed income instruments to provide short-term liquidity and minimize the risk to principal. The Company believes that as 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 $196.5 million at March 31, 1999 from $187.3 million at December 31, 1998. The Company's health maintenance organizations 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 $111.2 million and $93.4 million at March 31, 1999 and December 31, 1998, respectively. Excluding funds held by entities subject to regulation, the Company had cash and investments of approximately $84.4 million and $96.8 million at March 31, 1999 and December 31, 1998, 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. 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 the Company'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 15 18 option for shares of convertible preferred stock. These notes are likely to be converted during 1999. Interest is payable in additional Coventry Notes and, as a result, the accrued interest at March 31, 1999 has been added to the outstanding indebtedness, resulting in $46.5 million of Coventry Notes outstanding at such date. Projected capital investments in 1999 of approximately $15.0 million consist primarily of computer hardware, software and related equipment costs associated with the development and implementation of improved operational and communications systems. Approximately $2.9 million has been expended for the three months ended March 31, 1999. 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 March 31, 2000. IMPACT OF YEAR 2000 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 Millennium 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 $11.4 million has been incurred through March 31, 1999. Other critical IS development proposals were not materially impacted by the Year 2000 initiatives. 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 in a live production environment. All integration testing and operating system upgrades are scheduled for completion by June 30, 1999, a 30 day delay from prior estimates. 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 16 19 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 are in production. All internally developed systems were inventoried and plans were made to upgrade, modify or replace them as necessary to make them Year 2000 compliant by June of 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 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 ready 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. Second surveys received have been evaluated to assess potential risks and no material risks have been found at this time. Business Partners and Customers 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. 17 20 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 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 by evaluating technology risks and where prudent, implementing contingency plans to deal with these risks. LEGISLATION AND REGULATION Numerous proposals have been introduced in the United States Congress and various state legislatures relating to managed health care reform. Some proposals, if enacted, could among other things, limit the Company's ability to control medical costs, expose the Company to liability to members for coverage denials or delays, require certain coverages and impose other requirements on managed care companies. Although the provisions of any legislation that may be 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 its operations. As a result of the introduction of Medicare and Medicaid risk products in 1995, the Company is subject to regulatory and legislative changes in those two government programs. On August 5, 1997, the President signed into law the Balanced Budget Act of 1997. This law made revisions to the Medicare and Medicaid programs, including permitting provider-sponsored organizations to offer services to Medicare beneficiaries, and requiring managed care plans serving Medicare beneficiaries to make medically necessary care available 24 hours a day, to provide coverage of emergency services that 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 Company does not believe this law will have a material adverse effect on its operations. RISK FACTORS The Company's business is subject to numerous risks and uncertainties which may affect the Company's results of operations in the future and may cause such future results of operations to differ materially and adversely from projections included in or underlying any forward-looking statements made by or on behalf of the Company. FORWARD LOOKING STATEMENTS The statements contained in this Form 10-Q 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 contained in Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998, and actual operations and results may differ materially from those expressed in this Form 10-Q. 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 3: Quantitative 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 March 31, 1999 was $180.7 million. Debt securities at March 31, 1999 mature according to their contractual terms, as follows (actual maturities may differ because of call or prepayment rights):
Fair Amortized Cost Value ------------------------------------------ (in thousands) Maturities: Within 1 year $ 30,973 $ 31,546 1 to 5 years 50,056 50,841 6 to 10 years 31,069 30,540 Over 10 years 66,805 67,763 Other securities without stated maturity - - ------------------------------------------ Total short-term and long-term securities $ 178,903 $ 180,690 ==========================================
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 March 31, 1999, a 100 basis point increase in interest rates would result in a decrease of $6.0 million, or 3.3%, 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. 18 21 PART II. OTHER INFORMATION ITEM 1: Legal Proceedings 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 related premiums 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 under the AHERF agreement at the time of the bankruptcy filing and other potential bankruptcy charges. 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 partners 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 in the Court of Common Pleas of Allegheny County, Pennsylvania, against certain affiliated hospitals 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 HealthAmerica Pennsylvania, Inc., 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 the reserve established is adequate to provide for the claims incurred related to the AHERF arrangement and other related AHERF bankruptcy uncertainties. Through March 31, 1999, approximately $34.7 million was paid for medical claims from this reserve. Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the Company, entered into an agreement effective January 1, 1998 with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to provide health care services to GHP's members in the southern and western areas of St. Louis County, Missouri, which agreement contained certain risk sharing provisions. Disputes have arisen under the agreement, cross-claims have been made and the matter has been submitted to arbitration before the American Arbitration Association. GHP is demanding payment from Unity of $7.6 million and specific performance under the agreement. Unity is demanding payment from GHP of $14.5 million, specific performance of certain provisions of the agreement and suspension of its payment obligations. The Company believes that GHP has fulfilled all of its obligations under the agreement, that the amount demanded by GHP is properly due to GHP, and that GHP does not owe Unity the amounts claimed by Unity. The Company intends to vigorously pursue this matter. 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 March 31, 1999 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. ITEMS 2, 3, 4 and 5: Not Applicable ITEM 6: Exhibits and Reports on Form 8-K (a) Exhibits required to be filed by Item 601 of Regulation S-K: 19 22
Exhibit No. Description of Exhibit ------------------------------------------------------------------------------------------ 11 Computation of Net Earnings Per Common and Common Equivalent Share 21 Subsidiaries of the Registrant 27 Financial data schedule (for SEC use only)
(b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended March 31, 1999. 20 23 SIGNATURES Pursuant to the requirements 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. ------------------------------------ (Registrant) Date: May 17, 1999 By: /s/ ALLEN F. WISE ------------------------------- Allen F. Wise President, Chief Executive Officer and Director Date: May 17, 1999 By: /s/ DALE B. WOLF ------------------------------- Dale B. Wolf Executive Vice President , Chief Financial Officer, Treasurer And Principal Accounting Officer
21 EX-11 2 COMPUTATION OF NET EARNINGS PER SHARE 1 EXHIBIT 11 Coventry Health Care, Inc. Computation of Net Earnings Per Share
Quarter ended March 31, 1999 ------------------------------------------------------------------------ Income Shares Per Share (Numerator) (Denominator) Amount ------------------------------------------------------------------------ Net Income $ 8,293 ------------------------- Basic EPS $ 8,293 58,851 $ 0.14 Effect of Dilutive Securities Options and warrants 712 Convertible notes 4,521 Interest on convertible notes 516 ------------------------------------------------------------------------ Diluted EPS $ 8,809 64,084 $ 0.14 ========================================================================
Quarter ended March 31, 1998 ------------------------------------------------------------------------ Income Shares Per Share (Numerator) (Denominator) Amount ------------------------------------------------------------------------ Net Income $ 4,707 ------------------------- Basic EPS $ 4,707 33,348 $ 0.14 Effect of Dilutive Securities Options and warrants 1,127 Convertible notes 4,166 Interest on convertible notes 476 ------------------------------------------------------------------------ Diluted EPS $ 5,183 38,641 $ 0.13 ========================================================================
EX-21 3 COVENTRY HEALTH CARE, INC. SUBSIDIARIES 1 EXHIBIT NO. 21 COVENTRY HEALTH CARE, INC. SUBSIDIARIES April 31, 1999
NAME OF SUBSIDIARY STATE OF INCORPORATION ------------------ ---------------------- 1. Coventry Corporation Tennessee 2. Coventry Health and Life Insurance Company Texas 3. Coventry Health and Life Insurance Company Delaware 4. Coventry Healthcare Management Corporation Delaware d/b/a HealthAssurance 5. Coventry HealthCare Management Corporation Virginia (i) Southern Health Services, Inc. Virginia (ii) Southern Health Benefit Services, Inc. Virginia 6. Coventry HealthCare Development Corporation Delaware (i) Coventry Health Plan of West Virginia West Virginia 7. Group Health Plan, Inc. Missouri (i) Specialty Services of Missouri, Inc. Missouri 8. HealthAmerica Pennsylvania, Inc.(1) Pennsylvania 9. HealthCare USA, Inc. Florida (i) HealthCare USA Midwest, Inc. Delaware (a) HealthCare USA of Missouri, LLC Missouri 10. HealthPass, Inc. Pennsylvania 11. Pennsylvania HealthCare USA, Inc. Pennsylvania 12. Principal Health Care of Iowa, Inc. Iowa 13. Principal Health Care Management Corporation Iowa 14. Principal Health Care of the Carolinas, Inc. North Carolina 15. Principal Health Care of Delaware, Inc. Delaware 16. Principal Health Care of Georgia, Inc. Georgia 17. Principal Health Care of Indiana, Inc. Delaware
2 18. Principal Health Care of Louisiana, Inc. Louisiana 19. Principal Health Care of Kansas City, Inc. Kansas 20. Principal Health Care of Nebraska, Inc. Nebraska 21. Principal Health Care of Pennsylvania, Inc. Pennsylvania 22. Principal Health Care of St. Louis, Inc. Delaware 23. Principal Health Care of South Carolina, Inc. South Carolina 24. Principal Health Care of Tennessee, Inc. Tennessee 25. United HealthCare Services of Iowa, Inc. Iowa
- -------- (1) The Medical Center HPJV, Inc., a Pennsylvania corporation and wholly owned subsidiary of HealthAmerica Pennsylvania, Inc. ("HealthAmerica"), and its subsidiary, Riverside Health Plan, Inc., a Pennsylvania corporation, were merged into HealthAmerica effective April 5, 1999. EX-27 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF COVENTRY HEALTH CARE, INC. FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 383,435 180,690 69,790 18,940 0 548,497 89,930 50,782 1,040,684 507,133 47,246 0 0 593 443,665 1,040,684 0 527,848 0 519,165 (7,015) 2,483 1,007 14,691 6,398 8,293 0 0 0 8,293 0.14 0.14
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