-----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, Md4iykA2oPngE8dHxIUQ2XMjo0BLNxyP90/RB5Ls5Q5yHWSERFYRm1uw+uqT0WNA 8bafBU9zlhPz204MNVEd2w== 0000950144-97-004880.txt : 19970501 0000950144-97-004880.hdr.sgml : 19970501 ACCESSION NUMBER: 0000950144-97-004880 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970430 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: COVENTRY CORP CENTRAL INDEX KEY: 0000867440 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-OFFICES & CLINICS OF DOCTORS OF MEDICINE [8011] IRS NUMBER: 621297579 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-19147 FILM NUMBER: 97591620 BUSINESS ADDRESS: STREET 1: 53 CENTURY BLVD STE 250 CITY: NASHVILLE STATE: TN ZIP: 37214 BUSINESS PHONE: 6153912449 MAIL ADDRESS: STREET 1: 53 CENTURY BLVD STREET 2: STE 250 CITY: NASHVILLE STATE: TN ZIP: 37214 FORMER COMPANY: FORMER CONFORMED NAME: CONVENTRY CORP DATE OF NAME CHANGE: 19600201 10-K/A 1 COVENTRY CORPORATION FORM 10-K/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K/A [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996] For the Fiscal Year Ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-19147 Coventry Corporation (Exact name of registrant as specified in its charter) Tennessee 62-1297579 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 53 Century Boulevard, Suite 250 Nashville, Tennessee 37214 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (615) 391-2440 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 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 March 14, 1997 (computed by reference to the closing price of such stock on The Nasdaq Stock Market) was $375,543,737. As of March 14, 1997, there were 33,014,834 shares of the registrant's voting Common Stock outstanding. 2 COVENTRY CORPORATION FORM 10-K/A TABLE OF CONTENTS
PART I Page ---- Item 1: Business 1 Item 2: Description of Property 9 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 8: Financial Statements and Supplementary Data 24 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 45 PART III Item 10: Directors and Executive Officers of the Registrant 46 Item 11: Executive Compensation 49 Item 12: Security Ownership of Certain Beneficial Owners and Management 55 Item 13: Certain Relationships and Related Transactions 56 PART IV Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 57
3 PART I ITEM 1: Business (a) General Development of the Business Coventry Corporation ("the Company") is a managed health care company that provides comprehensive health benefits and services to 894,076 members in Pennsylvania, Ohio, West Virginia, Missouri, Illinois, Virginia and Florida at December 31, 1996. 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 and preferred provider organization products. Additionally, the Company administers self-insured health plans of certain large employers. The Company's enrollment increased to 901,891 in January 1997. The Company's regional operations are based in Pittsburgh (western Pennsylvania, eastern Ohio and West Virginia), and Harrisburg (central Pennsylvania), (collectively, the "Pennsylvania Health Plans"), St. Louis, Missouri ("the St. Louis Health Plan"), Richmond, Virginia (the "Richmond Health Plan") and Jacksonville, Florida. The Company was incorporated in 1986 in Delaware. Its principal executive offices are located at 53 Century Boulevard, Suite 250, Nashville, Tennessee 37214, and its telephone number is (615) 391-2440. Unless the context indicates otherwise, references herein to "Coventry" and "the Company" include Coventry Corporation and its subsidiaries. (b) Financial Information about Industry Segments The Company operates only in the managed care industry, and accordingly, industry segment data is not applicable. (c) Narrative Description of Business Products Commercial Health Maintenance Organizations The Company's health maintenance organization ("HMO") products provide comprehensive health care benefits to enrollees, including ambulatory and inpatient physician services, hospitalization, pharmacy, dental, optical, mental health, ancillary diagnostic and therapeutic services. In general, a fixed monthly enrollment fee covers all HMO services, although some benefit plans require co-payments or deductibles in addition to the basic enrollee premium. A primary care physician assumes overall responsibility for the care of an enrollee, including preventive and routine medical care and referrals to specialists and consulting physicians. While an HMO enrollee's choice of providers is limited to those within the health plan's HMO network, the HMO enrollee is typically entitled to coverage of a broader range of healthcare services than are covered by typical reimbursement or indemnity policies. At December 31, 1996, the Company had approximately 416,000 commercial HMO members. The Pennsylvania Health Plans have licensed HMO service areas in Pittsburgh and eight surrounding counties in western Pennsylvania, 21 counties in central Pennsylvania, including the cities of Harrisburg, York, Lancaster, State College, Lebanon and Scranton and five counties in eastern Ohio. Through Coventry Health Plan of West Virginia, the Company serves Wheeling and 14 counties in West Virginia. The St. Louis Health Plan's service area includes St. Louis and 23 adjacent counties in Missouri and 23 counties in central and southern Illinois. The Richmond Health Plan services Richmond, Roanoke and 38 counties in central and southwestern Virginia. All of the commercial HMOs are federally qualified. 1 4 Preferred Provider Organizations and Point of Service The Company, through its regional health plans, also offers fully-insured flexible provider products, including preferred provider organization ("PPO") and point of service ("POS") products, which permit enrollees 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. Deductibles and co-payments generally increase the out-of-pocket costs to the enrollee if a non-participating provider is utilized. Fully insured PPO/POS premiums are typically lower than HMO premiums due to these increased out-of-pocket costs borne by enrollees. The Company's PPO and POS products are underwritten by Coventry Health and Life Insurance Company ("CHLIC") a Texas insurance company. PPO/POS products are currently offered by the western Pennsylvania, central Pennsylvania, St. Louis, and Richmond health plans. At December 31, 1996, approximately 176,000 Coventry members were enrolled in a flexible provider product. Medicare In late 1995, the Company introduced a Medicare risk product under the name "Advantra" (R) in the St. Louis market. In 1996 the Company began marketing this product in its western Pennsylvania and central Pennsylvania markets. Under a Medicare risk contract, the Company receives a fixed premium per member, which reflects certain demographics of the Medicare population of each region. At December 31, 1996, there were approximately 1.3 million Medicare eligibles in the Company's current service areas. The Company believes that the Medicare risk product represents substantial opportunity for enrollment growth. 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 which 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 also offers Medicare cost and supplement products. Under a Medicare cost contract, the Company is reimbursed by the U.S. Health Care Finance Administration ("HCFA") only for the cost of services rendered to the plan members, including services provided at the health plan's medical offices and 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. At December 31, 1996 the Company had approximately 28,000 Medicare members, including both risk and cost based members. Medicaid The Company offers health care coverage to Medicaid recipients in the north Florida, St. Louis and central Missouri, Richmond, Virginia, Pittsburgh and central Pennsylvania markets. The Company's Medicaid products in each region are generally similar to, and based upon, the products offered by its HealthCare USA, Inc. ("HCUSA") subsidiary in Jacksonville, Florida, and HCUSA generally administers the Company's Medicaid products in each of the other regions. Medicaid recipients in north Florida, St. Louis and central Missouri markets are generally required to choose a managed care provider. In Pittsburgh, central Pennsylvania and Richmond, Virginia, enrollment in a Medicaid HMO is voluntary. Under a Medicaid risk contract, the participating state pays a monthly premium based on the age and sex of the recipients enrolled in the Company's plans. 2 5 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 Florida HMO has not achieved this required percentage of commercial membership in Florida, but has received a waiver of this requirement through June, 1998. Premium rates paid to the Company's Medicaid operations in Florida were significantly reduced in 1995, and future funding levels cannot be predicted with certainty. As a result of premium rate reductions and the commercial membership requirements, the Company has determined that its Florida Medicaid operations are unlikely to be sufficiently profitable on a long-term basis to justify a continued presence in the Florida market and, as a result, the Company is considering various options concerning this business, with the long-term goal of exiting the Florida Medicaid market. Accordingly, the Company has established a reserve of $1.2 million at December 31, 1996 to reflect the anticipated costs of exiting this market. The Company believes that its existing commercial membership in its St. Louis Health Plan will satisfy the regulatory commercial membership requirements in Missouri. At December 31, 1996, approximately 122,000 Coventry members were enrolled in a Medicaid risk product, including approximately 28,000 in Florida, 77,000 in Missouri and 17,000 in other regions. See "Government Regulations." Administrative Services Only The Company's health plans offer an administrative services only ("ASO") product to large employers who self-insure their employee health benefits. Under the ASO 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 health care cost underwriting risk. Certain of the Company's ASO contracts include performance and utilization management standards which affect the fees received for these services. Approximately 153,000 of the Company's members were ASO members at December 31, 1996. Delivery Systems The health plans maintain provider networks which furnish health care services through direct employment of or contractual arrangements with physicians, hospitals and other health care providers, rather than providing reimbursement to the enrollee for the charges of such providers. Because the health plans receive the same amount of revenue from their enrollees irrespective of the cost of health care services provided, they must manage both the utilization of services and the unit cost of the services. The Company's health plans' networks utilize a variety of physician care delivery systems which differ primarily in the characterization of the relationship between the Company and the participating physicians. The Company utilizes staff models in western and central Pennsylvania and St. Louis, Missouri to deliver primary care and certain specialist services through physicians who are employed exclusively by the health plan. The exclusive full-time employment of physicians in a staff model generally enables the health plan to predict costs more effectively, maintain quality and respond quickly to consumer issues. However, staff model operations also involves substantial investment in certain costs, such as facilities and personnel, that cannot be immediately adjusted to take into account changes in the membership or third party provider pricing trends. During 1996, the Company initiated efforts to reduce overhead in its staff models by reducing staff employment and capitating certain specialist and ancillary functions. In addition to providing health care to plan members, these staff models also accept non-member patients on a fee-for-service basis, in an effort to help cover the costs associated with the medical offices. The Company employed approximately 200 physicians at December 31, 1996 in its staff model operations. The Company's staff model operations, in recent years, have suffered from over-capacity, and the Company has not been able to increase the number of members or other patients utilizing such operations sufficiently to make such operations profitable. As a result, the Company determined in late 1996 to seek to dispose of the staff model operations in Pittsburgh, Pennsylvania and St. Louis, Missouri. In March 1997, the Company entered into agreements to sell its medical offices associated with its health plan in St. Louis, Missouri to BJC Health Systems ("BJC"), a major provider organization in the St. Louis market, and to sell its medical offices associated with its health plan in Pittsburgh, Pennsylvania to Allegheny Health, Education and Research Foundation ("AHERF"), a major provider organization in the Pittsburgh market. The agreements are subject to the satisfaction of various conditions, including regulatory approval. After these sales, the Company's medical operations will be limited to employing 22 physicians in eight offices in the central Pennsylvania area. 3 6 Coincident with the sale of the St. Louis and Pittsburgh medical offices, the Company will enter into long-term global capitation arrangements with BJC and AHERF, pursuant to which these provider organizations will receive a fixed percentage of premiums to cover all the medical treatment the Company's globally capitated members receive from the health care systems. These arrangements are a continuation of the Company's efforts to enter into capitation agreements with major providers whereby the providers will provide all medical treatment for the Company's members in return for a fixed percentage of premium. While these agreements limit the Company's exposure to the risk of increasing medical costs, they expose the Company to risk as to the adequacy of the financial and medical care resources of the provider organization. All of the Company's health plans also 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 enrollees but also maintain independent practices in which they provide services to individuals who are not Coventry health plan enrollees. The Company contracts with approximately 18,000 physicians through the open panel model. Additionally, the Company is aware that entering into global capitation contracts with certain providers may cause disruption in its existing provider network. Health Care Provider Compensation The primary care physicians employed within the staff model operations are compensated under salary and bonus arrangements. 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. During 1996, the Company converted many of its hospital and ancillary contracts from discounted fee-for-service to fixed fee schedules or capitation arrangements. 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 enrollees. 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. Appointment availability, member waiting times and environments are monitored. A membership services department is responsible for ensuring enrollee satisfaction, and the Company's health plans periodically conduct membership surveys of both existing and former enrollees concerning services furnished and suggestions for improvement. The National Committee for Quality Assurance ("NCQA") is an independent, nonprofit institution that evaluates and accredits the quality assurance programs of managed care organizations and is recognized as the national authority on quality. Both the Pennsylvania plans have earned full accreditation. The Richmond and St. Louis plans received provisional accreditation in 1995 and 1996, respectively. In 1996, HCUSA met or exceeded all state standards in a Florida Medicaid Contract compliance review conducted by the Florida Agency for Healthcare Administration of 21 Medicaid HMOs. The Plan scored 100%, the highest rating received, on the quality of care standards specified in its 1996 Medicaid contract and a 98% overall rating. See "Medicaid" and "Government Regulation." 4 7 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 employs physicians as Medical Directors who oversee the delivery of medical services with respect to staff model and open panel operations. 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 enrollees 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 new enrollees. The Company also markets through independent insurance brokers and agents. 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, primarily in the Pittsburgh market, 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 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, totaling approximately 200 for the entire company. Each 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 1996. As of December 31, 1996, the employer groups which accounted for the ten highest amounts of managed care premiums for the western and central Pennsylvania, St. Louis and Richmond health plans represented approximately 26%, 28%, 28% and 62%, respectively, of each health plan's premiums. HCUSA received approximately $32.0 million or 27% of its revenue from the State of Florida and approximately $85.7 million or 73% from the State of Missouri. 5 8 Competition As of December 31, 1996, the Company estimates that its share of the commercial HMO market was approximately 50% in western Pennsylvania, 30% in central Pennsylvania, 26% in St. Louis, and 24% in Richmond. 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. During 1996 the Company continued to experience competitive pressures in its commercial products, most notably in the Pennsylvania and Missouri markets, which adversely affected the premiums that the Company has historically received from new and existing members, the membership growth opportunities, and the mix of products sold. 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, their 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. While the Company believes that the relatively large membership in its health plans places them in a favorable position in negotiating contracts, some of its competitors represent an equal or greater number of potential patients for such contracting providers and therefore may be in an equal or more favorable position to negotiate provider contracts. Government Regulation The Company's commercial HMOs are qualified under the federal Health Maintenance Organization Act of 1973, which was enacted to promote the development of HMOs. Only HMOs that continue to meet federal criteria for sound fiscal operation may retain their qualified status. In order to maintain such qualification, HMOs are required to set enrollment fees, or premiums, pursuant to a "community rating system", which permits rating by class and group specific rating on a prospective basis. The system can place an HMO at a disadvantage when competing with conventional insurers for the business of large employers; at the same time, it does not permit an established customer to demand rate reductions based upon its group's favorable medical experience. 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 enrollees with certain basic services based substantially on a fixed, prepaid fee basis. Even under community rating, however, an HMO may vary the type of non-fixed benefits offered. The HMOs are required to have quality assurance and education programs for their professionals and enrollees. State laws further require that representatives of the HMOs' enrollees have a voice in policy making. In 1996, HCFA promulgated regulations ("physician incentive regulations") enforcing Sections 4204(a) and 4731 of the Omnibus Budget Reconciliation Act of 1990 ("OBRA 90"). OBRA 90 and the physician incentive regulations prohibit HMOs with Medicare risk contracts from knowingly making incentive payments to physicians as an inducement to reduce or limit medically necessary services to Medicare beneficiaries. Under the physician incentive regulations, HMOs must, among other things, disclose to HCFA their physician compensation plan in such detail as to allow HCFA to determine compliance with the regulations, and provide assurance that stop-loss insurance is in place, if the HMO places a physician or physician group at "substantial financial risk" for services provided to Medicare beneficiaries. These regulations took effect beginning January 1997. On August 20, 1996, President Clinton signed into law the "Health Insurance Portability and Accountability Act of 1996," which took effect beginning January 1997. This legislation requires guaranteed issuance and renewability of certain health coverage for individuals and small groups, limits preexisting condition exclusions and provides for a demonstration project for medical savings accounts. In addition, more recent federal legislation, which will become effective beginning January 1998, requires health plans to provide parity for mental health benefits and at least 48 hours inpatient coverage for mothers and their newborns. 6 9 All of the Company's Medicare and Medicaid plans are subject to HCFA and state regulations. HCFA and the appropriate state agencies have the right to audit any health plan operating under a Medicare or Medicaid contract to determine the plan's compliance with HCFA and state regulations and quality of care being rendered to the plan's members. Because the Company has Medicare and Medicaid products, it also must comply with requirements established by peer review organizations ("PRO"s), which are organizations under contract with HCFA to monitor the quality of health care received by Medicare and Medicaid beneficiaries. PRO requirements relate to quality assurance and utilization review procedures. In addition, cost reimbursement reports are required with respect to Medicare cost contracts and are subject to audit and revision. The anti-kickback provisions of the Medicare and Medicaid laws prohibit the payment or receipt of any remuneration in return for the referral of a patient, the charges for which are subject to reimbursement by Medicare or Medicaid. The Department of Health and Human Services has adopted safe harbor regulations whereby, (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) discounts offered to prepaid health plans by contracting providers are not deemed to be violations of the anti-kickback provisions. 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 satisfy the requirements of the safe harbor regulations and do not in any event violate the anti-kickback provisions. The Company is subject to both federal and state regulations regarding services to be provided to Medicaid enrollees, payment for those services and other aspects of the Medicaid program. 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. During 1996, managed care premiums were reduced by $1.7 million for the settlement of OPM claims for 1995 and reserves for 1996 were established. 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 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 - Health Care Reform" in Part II of this Report. Risk Management The HMOs maintain general liability and professional liability (medical malpractice and managed care liability) insurance coverage in amounts the Company believes to be adequate. Contracting physicians are also required to maintain professional liability coverage. In addition to liability coverage, the Company carries "stop-loss" insurance to reimburse its HMOs for costs resulting from catastrophic illnesses. This insurance generally covers costs in excess of $500,000 up to $1 million for any enrollee in any one year for the St. Louis, Pennsylvania and Richmond Health Plans for commercial HMO members, costs in excess of $150,000 up to $1 million for any Medicare enrollee in any one year and costs in excess of $50,000 up to $1 million for any Medicaid enrollee in any year. Some coinsurance contributions by the Company are required. CHLIC maintains stop-loss insurance for the flexible provider products that generally covers costs in excess of $150,000 for any enrollee in any one year up to $1 million per enrollee per year. No assurance can be given as to the future availability or costs of such insurance or that risks will not exceed the limit of the insurance coverage. 7 10 Employees At December 31, 1996, the Company employed approximately 3,200 persons. None of the employees are covered by a collective bargaining agreement. 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." 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. Among the factors that may adversely affect the Company's business are difficulties in increasing premiums to cover increasing health care costs because of competitive pressures, regulatory restrictions and consumer preference for lower-priced health care options. The Company may also experience difficulties in obtaining and maintaining favorable contracts with health care providers and in predicting and controlling future health care costs. Accordingly, there may be potential discrepancies between reserves for incurred but not reported liabilities and the actual amount of such liabilities. To the extent that the Company becomes a party to global capitation agreements with a single provider organization, the Company becomes exposed to credit risk with respect to such organization. The nature of acquisitions gives rise to the possibility of incurred but not reported medical costs and contingent liabilities that may be undervalued at the time of acquisition. The Company may be required to write off the cost of certain assets if the expected results of an acquisition are not achieved. In selling assets, expected values may not be realized. The Company's recent financial losses may make it more difficult to obtain financing on as favorable terms in the future. In addition, operating losses at a subsidiary may require the Company to make investments in, or to refinance Company obligations to, such subsidiary in order to maintain required capital levels. The Company is also 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. As discussed in "Government Regulation", the Company's financial results are also susceptible to future state and federal regulatory measures, including health care reform. In addition, 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 to the Company's members. The Company has contingent litigation risk with certain discontinued operations. Such litigation may result in losses to the Company. This Annual Report on Form 10-K and other filings and statements made on behalf of the Company include forward-looking information which is based on current expectations at the time the filing or statement is made and is subject to a number of risks and uncertainties. Forward-looking statements, which are made in reliance on the safe harbor provided by the Private Securities Litigation Reform Act of 1995, may be affected by a number of factors, including the risk factors identified herein. 8 11 Item 2: Description of Property The Company leases in aggregate approximately 350,310 square feet of office space primarily for administrative offices in western Pennsylvania, central Pennsylvania, St. Louis, Missouri, Jacksonville, Florida and its corporate office in Nashville, Tennessee. In addition, the Company has 33 medical centers, of which 28 are leased for terms of one to fifteen years and summarized as follows:
Number of Leased Medical Approximate Leased Square Location Center Sites Footage - --------------------------- ------------------------ ------------------------- Western Pennsylvania 11 179,181 Central Pennsylvania 8 43,230 St. Louis 9 108,884 Richmond - - Jacksonville - - ------------------------ ------------------------- Total 28 331,295 ======================== =========================
The Company owns three medical centers in western Pennsylvania, two in St. Louis and an administrative building in Richmond. Combined, these properties have approximately 175,454 square feet. The medical office sites in western Pennsylvania and St. Louis, Missouri are included in the agreements to sell certain medical offices. See "Delivery Systems." In 1997, the Company plans to enter into a new lease agreement for the administrative offices located in Harrisburg, Pennsylvania. Renovations of other administrative offices will be completed as necessary. 9 12 Item 3: Legal Proceedings In the normal course of business, the Company has been named as defendant in various other 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, 1996 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 1996. 10 13 PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters Price Range of Common Stock Coventry Corporation common stock is traded in the Nasdaq Stock Market's National Market under the symbol "CVTY." The following tables show the quarterly range of high and low closing sales prices of the common stock on Nasdaq during the calendar period indicated:
1996 1995 - -------------------------------------------------------------------------------------------------- High Low High Low - -------------------------------------------------------------------------------------------------- First Quarter $20 7/8 $15 11/16 $30 $23 3/4 Second Quarter $20 15/16 $15 1/4 $29 1/2 $13 1/2 Third Quarter $15 5/8 $11 15/16 $21 1/4 $14 1/4 Fourth Quarter $11 1/2 $9 $22 1/8 $17 5/8
1997 - ------------------------------------------------------------- High Low - ------------------------------------------------------------- Through March 14, 1997 $11 3/8 $6 7/8
As of March 24, 1997, the Company had approximately 12,000 shareholders, including persons or entities holding common stock in nominee name, and 583 shareholders of record. 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 and by the terms of its credit facility. Subject to the terms of such insurance regulations and the Company's credit facility, 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" and Note G of the Notes to Consolidated Financial Statements. 11 14 Item 6: Selected Consolidated Financial Data (in thousands, except per share data) Operations Statement Data (1)
Year Ended December 31, - --------------------------------------------------------------------------------------------------------------------------------- 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------------- Operating revenues $1,057,129 $ 852,390 $ 776,643 $ 641,573 $ 475,454 - --------------------------------------------------------------------------------------------------------------------------------- Operating earnings (loss) $ (91,346) $ (1,275) $ 55,023 $ 43,177 $ 27,913 - --------------------------------------------------------------------------------------------------------------------------------- Earnings (loss) from continuing operations (2) $ (61,287) $ 18 $ 29,288 $ 22,005 $ 14,171 Loss on disposal of discontinued operations - - - - (3,846) Extraordinary items - - - - 4,005 - --------------------------------------------------------------------------------------------------------------------------------- Net earnings (loss) $ (61,287) $ 18 $ 29,288 $ 22,005 $ 14,330 - --------------------------------------------------------------------------------------------------------------------------------- Earnings (loss) per share (3): Continuing operations $ (1.86) $ 0.00 $ 0.93 $ 0.74 $ 0.51 Discontinued operations - - - - (0.14) Extraordinary items - - - - 0.15 - --------------------------------------------------------------------------------------------------------------------------------- Net earnings (loss) per share $ (1.86) $ 0.00 $ 0.93 $ 0.74 $ 0.52 - --------------------------------------------------------------------------------------------------------------------------------- Weighted average common and common equivalent shares outstanding (3) 33,011 32,164 31,425 29,585 27,547 - ---------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Data (1) December 31, - --------------------------------------------------------------------------------------------------------------------------------- 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------------- Cash and investments (4) $ 173,396 $ 147,777 $ 133,975 $ 116,014 $ 65,488 Total assets $ 448,945 $ 385,675 $ 343,771 $ 266,971 $ 207,836 Notes payable and long-term debt (including current maturities) $ 93,759 $ 67,907 $ 69,531 $ 44,185 $ 52,541 Stockholders' equity and partners' capital (5) $ 100,427 $ 153,851 $ 134,124 $ 96,906 $ 69,679
(1) All periods presented have been restated for the merger with HCUSA in 1995, Southern Health Management Corporation ("SHMC") in 1994 and for discontinued operations. (2) Interest expense on all outstanding debt for all periods has been attributed to continuing operations. (3) Reflects the two-for-one split of the Company's common stock which occurred in August, 1994. (4) Certain reclassifications have been made to the 1994 and 1995 financial statements to conform to the 1996 presentation. (5) Predecessor company of SHMC was an S Corporation. 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, 1996 and 1995.
Quarter Ended March 31, June 30, September 30, December 31, 1996(1) 1996(2) 1996 1996(3) -------------------------------------------------------------- Operating revenues $ 236,937 $ 257,737 $ 272,903 $ 289,552 Operating earnings (loss) $ (2,772) $ (14,346) $ 143 $ (74,371) Net earnings (loss) $ (968) $ (8,528) $ 348 $ (52,139) Net earnings (loss) per common and common equivalent share $ (0.03) $ (0.26) $ 0.01 $ (1.58) --------------------------------------------------------------- Weighted average common and common equivalent shares outstanding 32,854 33,041 33,021 33,024 ---------------------------------------------------------------
Quarter Ended March 31, June 30, September 30, December 31, 1995 1995(4) 1995(5) 1995(6) -------------------------------------------------------------- Operating revenues $ 209,652 $ 208,868 $ 211,137 $ 222,733 Operating earnings (loss) $ 16,253 $ 4,764 $ 1,118 $ (23,410) Net earnings (loss) $ 9,870 $ 2,177 $ 1,494 $ (13,523) Net earnings (loss) per common and common equivalent share $ 0.30 $ 0.07 $ 0.05 $ (0.42) -------------------------------------------------------------- Weighted average common and common equivalent shares outstanding 32,402 32,157 31,952 32,416 --------------------------------------------------------------
(1) The first quarter operating results were affected by termination and related costs to streamline the Company's administrative process and reduce staffing in health centers, primarily in the Pennsylvania and St. Louis plans for total adjustments of $5.2 million. (2) The second quarter operating results were affected by the establishment of reserves relating to multi-year contracts with certain employer groups, primarily in the St. Louis market. The Company expects to utilize these reserves over the remaining lives of the contracts and then either discontinue the contracts or significantly change the terms and conditions of the contracts with these parties. The establishment of these reserves resulted in total adjustments of $8.2 million. (3) The fourth quarter operating results were affected by the increase of reserves related to accounts receivable ($3.6 million), long-term contracts ($1.6 million), medical claims ($25.6 million), termination costs ($2.1 million), other reserves ($6.0 million), write-offs of goodwill ($21.0 million) and certain capitalized expenses ($6.7 million). (4) The second quarter operating results of 1995 were affected by merger costs for the purchase of HCUSA, severance and related costs associated with staff restructuring in Pittsburgh and St. Louis, additions to accruals for professional liability litigation and the settlement of certain Office of Personnel Management negotiations for total adjustments of approximately $7.0 million. (5) The third quarter operating results of 1995 were affected by an increase in medical claims liabilities for the western Pennsylvania market and start up expenses associated with Medicaid and Medicare product development and geographic expansion initiatives for total adjustments of approximately $6.5 million. (6) The fourth quarter operating results of 1995 were affected by the elimination of several of its new market development areas, personnel reductions in its operations and increases in legal, medical and contingency reserves for total adjustments of $21.8 million. 13 16 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations Coventry Corporation, headquartered in Nashville, Tennessee, 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 Pennsylvania, Ohio, West Virginia, Missouri, Illinois, Virginia and Florida. Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking information which is based upon current expectations and involves a number of risks and uncertainties. The forward- looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, may be affected by a number of factors, including the risk factors set forth in the Company's Annual Report on Form 10-K, and consequently, actual operations and results may differ materially from those expressed in these forward-looking statements. 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, imposition of regulatory restrictions, difficulties in obtaining or maintaining favorable contracts with healthcare providers, financing costs and contingencies and litigation risk. During the three year period ended December 31, 1996, the Company experienced substantial growth in operating revenues due primarily to membership growth. The Company achieved this membership growth through marketing efforts, acquisitions, geographic expansion and increased product offerings, including the introduction of Medicare and Medicaid risk products in 1995. The acquisition of HealthCare USA in 1995 allowed the Company to enter the Medicaid product market. Through HealthCare USA, the Company obtained a presence in the Florida Medicaid market and entered the St. Louis and central Missouri Medicaid markets during 1995, and continued to grow enrollment throughout 1996. At December 31, 1996, approximately 120,000 Coventry members were enrolled in a Medicaid risk product. The Company began marketing its Medicare risk product in the St. Louis, Missouri market in late 1995, and began marketing that product in the western and central Pennsylvania markets in 1996. At December 31, 1996, the Company had approximately 27,000 Medicare members, including both risk and cost based members. The Company's managed care premium revenues during the three year period ended December 31, 1996 were comprised primarily of commercial premiums from its HMO products and flexible provider products, including PPO and POS products for which the Company assumes full underwriting risk. Fully insured PPO/POS premiums are typically lower than HMO premiums due to the medical underwriting and the deductibles and copayments required from the PPO/POS members. Additional revenue is earned for other medical services provided on a fee-for-service basis in Company-operated 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. No assurance can be given that premium rates will not decrease in the future. 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. The Company receives an administrative fee for these services, but does not assume underwriting risk. A portion of these revenues, however, are dependent upon the Company meeting specific performance criteria. 14 17 The Company's operating expenses are primarily medical costs including medical claims under contracted relationships with a wide variety of providers, capitation payments and 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. The estimated IBNR is based on historical data, current enrollment, health service utilization statistics and other related information, determined on an actuarial basis. Changes in assumptions for medical costs caused by changes in actual experience could cause these estimates to change in the near term. The Company periodically monitors and reviews IBNR, and as settlements are made or accruals adjusted, differences are reflected in current operations. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards Number 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and Statement of Financial Accounting Standards Number 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." The adoption of provisions of SFAS 121 and SFAS 123 had no material effect on the financial position or results of operations of the Company. The following discussion should be read in conjunction with the accompanying 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, 1996.
1996 1995 1994 ------------------------------- -------------------------------- ------------------- Percent Percent Percent of Percent of Percent of Operating Increase Operating Increase Operating Amount Revenues (Decrease) Amount Revenues (Decrease) Amount Revenues - ---------------------------------------------------------------------------------------------------------------------------------- Operating revenues: Managed care premiums $1,035,778 98.00 % 22.7% $844,032 99.0 % 9.6 % $769,935 99.1 % Management services 21,351 2.00 % 155.5% 8,358 1.0 % 24.6 % 6,708 0.9 % - ---------------------------------------------------------------------------------------------------------------------------------- Total operating revenues 1,057,129 100.00 % 24.0% 852,390 100.0 % 9.8 % 776,643 100.0 % - ---------------------------------------------------------------------------------------------------------------------------------- Operating expenses: Health benefits (1) 930,739 88.00 % 30.5% 713,226 83.6 % 16.1 % 614,144 79.1 % Selling, general and administrative 165,081 15.60 % 33.6% 123,523 14.5 % 30.5 % 94,684 12.2 % Depreciation and amortization 42,862 4.10 % 192.3% 14,666 1.7 % 55.4 % 9,437 1.2 % Other charges 9,793 0.90 % -- Merger costs 2,250 0.3 % (32.9)% 3,355 0.4 % - ---------------------------------------------------------------------------------------------------------------------------------- Operating earnings (loss) (91,346) (8.60)% NM (1,275) (0.1)% (102.3)% 55,023 7.1 % Other income, net 13,379 1.20 % 73.6% 7,705 0.9 % 54.0 % 5,003 0.6 % Interest expense (6,257) (0.60)% 28.2% (4,881) (0.6)% 78.7 % (2,731) (0.4)% - ---------------------------------------------------------------------------------------------------------------------------------- Earnings (loss) before income taxes and minority interest (84,224) (8.00)% NM 1,549 0.2 % (97.3)% 57,295 7.4 % - ---------------------------------------------------------------------------------------------------------------------------------- Net earnings (loss) $ (61,287) $ 18 $ 29,288 ================================================================================================================================== Membership at December 31: Commercial 592,001 510,815 468,743 Medicare (2) 27,507 18,890 19,068 Medicaid 121,599 73,550 26,143 Management services 152,969 92,232 67,003 - ---------------------------------------------------------------------------------------------------------------------------------- 894,076 695,487 580,957 ==================================================================================================================================
(1) The medical loss ratio (health benefits as a percentage of managed care premiums) was 89.9%, 84.5% and 79.8% in 1996, 1995 and 1994, respectively. (2) Includes both full risk and cost-based members. 15 18 Comparison of 1996 to 1995 Managed care premiums increased $191.7 million, or 22.7%, to $1,036 million for the year ended 1996 compared to 1995. The increase was primarily attributable to the 137,852 member, or 22.9%, increase in risk membership from the prior year. Of this enrollment growth, 48,049 members, or 35%, were related to the Medicaid product and 81,186 members or 59%, were commercial members. The effect on revenues of the increased membership was partially offset by changes in commercial membership mix, with an increased percentage of that membership composed of the lower premium PPO and POS products compared to the HMO products, and a 4.3% decline in average HMO premium yield. Membership as of December 31, 1996 and 1995 was as follows:
Commercial Medicare HMO PPO/POS Cost Risk Medicaid Non-Risk Total 1996 ------------------------------------------------------------------------------------- Western PA 149,530 92,052 1,957 4,994 2,298 45,565 296,396 Central PA 115,780 44,704 466 365 11,836 71,900 245,051 St. Louis 92,895 39,579 4,794 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 415,562 176,439 7,217 20,290 121,599 152,969 894,076 ===================================================================================== 1995 Western PA 144,498 71,896 4,782 30,977 252,153 Central PA 102,772 17,154 443 38,391 158,760 St. Louis 87,973 28,726 13,234 431 47,388 11,895 189,647 Richmond 55,267 2,529 10,969 68,765 Jacksonville 26,162 26,162 ------------------------------------------------------------------------------------- Total 390,510 120,305 18,459 431 73,550 92,232 695,487 =====================================================================================
The Company experienced competitive pressures in its commercial products, which negatively affected the average premium the Company received and the mix of commercial products sold during 1996. The Company anticipates continued enrollment gains in 1997, although at a slower rate than seen in 1996. Enrollment gains are expected to be lower than gains realized in prior years as the Company focuses on profitability of current products and lines of business, including efforts to increase the average premium yield. No assurances can be given that increased yields are attainable. The Company anticipates losing certain customers due to more stringent underwriting practices. Gains in Medicaid and Medicare enrollments increased the Company's exposure to government regulation of premium levels and other requirements. The impact of legislative or regulatory changes in the Medicaid and Medicare programs could adversely affect enrollment, premiums and profitability of these products. Management services revenues increased approximately $13.0 million, or 155.5% from the prior year. The increase is attributable to the approximately 60,737 member increase in this product. Health benefits expense increased $217.5 million, or 30.5%, in 1996 compared to 1995 as a result of the increase in full-risk enrollment and increases in medical costs. As a result of the declining premium yields discussed above and increases in medical costs, including the effects of a decline in the proportion of risk membership utilizing staff medical facilities in Pittsburgh, Pennsylvania and St. Louis, Missouri, the medical loss ratios increased in all of the Company's markets as follows:
1996 1995 ----- ----- Western Pennsylvania 88.9% 87.3% Central Pennsylvania 89.2% 80.0% St. Louis 89.7% 86.2% Richmond 87.6% 82.5% Jacksonville 86.7% 80.0% Total 89.9% 84.5%
16 19 Health benefits expense increased on a per member per month basis from 1995 in all markets. The increases in medical costs are attributable to increases in the costs of inpatient services related to its Medicaid operations, inpatient alternatives (such as outpatient surgery) and pharmacy. Additionally, membership in the Company's western Pennsylvania medical office operations, which declined during 1995 primarily as a result of the loss of two significant accounts did not recover in 1996, continuing the excess capacity problem for the medical office operations. In March 1997, the Company entered into agreements to sell the Company's medical offices in western Pennsylvania and St. Louis, Missouri to major provider organizations in these markets. The agreements are subject to the satisfaction of various conditions, including regulatory approval. Coincident with the sale of the medical offices, the Company will enter into long-term global capitation arrangements with the purchasers of the medical offices, pursuant to which the provider organizations will receive a fixed percentage of premium to cover all of the costs of medical treatment the Company's globally capitated members receive from the health care systems. The Company anticipates these arrangements will reduce its medical costs as a percentage of premiums in western Pennsylvania and St. Louis, Missouri. The Company has determined that its Florida Medicaid operations are unlikely to be sufficiently profitable on a long-term basis to justify a continued presence in the Florida market and, as a result, the Company is considering exiting the Florida Medicaid market. Accordingly, the Company has established a reserve of $1.2 million at December 31, 1996 to reflect the anticipated costs of exiting this market. In the fourth quarter of 1996, the Company increased medical reserves by $25.6 million, attributable to the Company's quarterly process for adjusting for settlements of prior quarters. Medical claim liability accruals are periodically monitored and reviewed with differences reflected in current operations. 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. Selling, general, and administrative expense ("SGA") increased $41.6 million, or 33.6%, from 1995. As a percentage of total operating revenues, SGA increased from 14.5% in 1995 to 15.6% in 1996 due to increases in costs, declines in commercial premiums and the items discussed below. The Company decided to cease start-up development activities in certain markets in 1996. As a result of narrowing the focus of new market development, certain capitalized costs totaling $4.3 million were charged to SGA in 1996. During 1996, the Company also recorded approximately $8.1 million of charges related to personnel terminations and related severance. These charges resulted from administrative and medical office staff reductions due to excess capacity and the outsourcing of certain ancillary services capabilities. Additionally, provisions for uncollectible accounts and other charges related to SGA of approximately $9.0 million were recorded in 1996. Depreciation and amortization increased $28.2 million, or 192.3%, from 1995. This increase was due primarily to the write-off of goodwill related to the recently acquired PARTNERS Health Plan of Pennsylvania, Inc. of $20.1 million, write-downs of fixed assets of approximately $4.3 million and incremental depreciation expense recognized on additions to property and equipment. Other charges consisting of provisions for multi-year contracts of $9.8 million were recorded in 1996 to recognize anticipated losses on certain multi-employer group contracts, primarily in the St. Louis market. The Company expects to utilize these reserves over the remaining lives of the contracts and then either discontinue these contracts or significantly change the terms and conditions of the contracts with these parties. The contracts expire at varying dates through 1999 and cover approximately 30,000 members. Operating earnings for the year 1996 decreased $90.1 million from 1995 operating earnings. The decrease is primarily attributable to the decline in commercial yield, the increases in medical claims expense, the increase in IBNR reserves, the asset write-downs and other charges noted above. Other income, net increased $5.7 million, or 73.6%, from 1995. This increase was primarily due to a $4.9 million gain on the sale of Champion Dental Services, Inc. recorded in the fourth quarter of 1996. 17 20 Interest expense increased $1.4 million in 1996 over the prior year primarily due to a higher average outstanding debt balance for the year and an increased interest rate on long-term debt. The majority of the approximately $35 million purchase price of PARTNERS Health Plan of Pennsylvania, Inc. was funded through borrowings on the Company's long-term credit agreement. Provision for income taxes reflects a consolidated effective income tax benefit rate of 27.1% for 1996 compared to a provision of 98.7% for 1995. The increase in nondeductible goodwill amortization is the primary cause of the low effective income tax benefit rate in 1996. Loss for the year 1996 was $61.3 million. Loss per common and common equivalent share was $1.86 in 1996 compared to $0.00 in the prior year. The weighted average common and common equivalent shares outstanding increased to 33.0 million in 1996 compared to 32.2 million in 1995. Comparison of 1995 to 1994 Managed care premiums increased $74.1 million, or 9.6%, to $844.0 million for the year ended 1995 compared to 1994. The increase was primarily attributable to the 89,301 members, or 17.4%, increase in risk membership from the prior year. Of this enrollment growth, 47,047 members, or 53%, related to the Medicaid product. The effect of the increased membership on revenues was partially offset by changes in membership mix, with membership shifting from HMO products to the PPO and POS products which have lower per member premiums. During 1995, the Company introduced its Medicare risk product and expanded the Medicaid product. The Company had limited experience with the Medicaid and Medicare products, and as a result, with their underwriting, pricing, and utilization patterns. Gains in Medicaid and Medicare enrollments increased the Company's exposure to government regulation of premium levels and other requirements. Premium rates paid to the Company's Medicaid operations in Florida declined in the third quarter of 1995. Furthermore, in 1995 the Company experienced competitive pressures in its commercial products, which negatively affected the average premium that the Company has historically received from new and existing members, the membership growth opportunities and the mix of products sold. The average commercial premium received by the Company declined in 1995 by 1.6%. Management services revenues increased $1.7 million, or 24.6% from the prior year. The increase is attributable to the approximately 25,200 members, or 37.7%, increase in this product line. Approximately 10,600 of these new non-risk members resulted from the acquisition of a Virginia third party administrator in May 1995. Health benefits expense increased $99.1 million, or 16.1%, in 1995 compared to 1994 as a result of the increase in full-risk enrollment and increases in medical costs. The medical loss ratios increased in all of the Company's markets as follows:
1995 1994 ----- ----- Western Pennsylvania 87.3% 77.7% Central Pennsylvania 80.0% 78.4% St. Louis 86.2% 85.3% Richmond 82.5% 80.6% Jacksonville 80.0% 70.1% Total 84.5% 79.8%
18 21 In the western Pennsylvania market, health benefits expense increased 15.5% on a per member per month basis from 1994. The increase in medical costs in the western Pennsylvania market was attributable to higher utilization of inpatient alternatives and consultant services, and in general, each of the markets experienced increases in the costs of inpatient services, inpatient alternatives and consultant services relative to premium increases. Additionally, membership in the western Pennsylvania's medical office operations declined during 1995 primarily as a result of the loss of two significant accounts. Because the operating costs of the medical offices were not reduced, the loss of membership created excess capacity. The premium rate reduction in the third quarter of 1995 in HealthCare USA's Jacksonville Medicaid operations also contributed to the increase in the medical loss ratio. In the fourth quarter, the Company increased medical reserves, primarily for the western Pennsylvania market, in the course of the Company's quarterly process for adjusting for settlements of prior quarters. The total increase to medical reserves was approximately $13 million. Selling, general, and administrative expense increased $28.8 million, or 30.5%, from 1994. As a percentage of total operating revenues, SGA increased from 12.2% in 1994 to 14.5% in 1995. During 1995, the Company recorded approximately $3.0 million of charges related to personnel terminations and related severance. In the fourth quarter of 1995, the Company decided to narrow the focus of start-up development activities in 1996, while concentrating development and growth efforts in existing and contiguous markets and, as a result, certain capitalized costs were written off at year-end. Additionally, reserves for litigation and other contingencies were established. These year-end charges, totaling $7.3 million, were charged to SGA in 1995. The increase in SGA represents primarily product introduction costs, including additional personnel and systems support for government products introduced in 1995. These costs also include other selling, general and administrative costs associated with the geographic expansion of the western Pennsylvania market to West Virginia and eastern Ohio and additional administrative services capabilities. Depreciation and amortization increased $5.2 million, or 55.4%, from 1994. This increase was due primarily to the amortization of the goodwill resulting from the purchase of the remaining 20% Penn Group Corporation minority interest and increased depreciation expense corresponding to additions in net property and equipment from 1994. Merger costs of $2.3 million include all costs associated with the HealthCare USA merger which was accounted for as a pooling of interests. The 1994 costs were associated with the acquisition of Southern Health Management Corporation in Richmond, Virginia. Operating earnings for the year 1995 decreased $56.3 million from 1994 operating earnings. The decrease is primarily attributable to the increase in medical claims expense, SGA, and depreciation and amortization described above. Other income, net, consists primarily of investment income and increased $2.7 million, or 54%, from 1994. This increase was primarily due to the increase in cash and investments during the year. Interest expense increased $2.2 million in 1995 over the prior year due to a higher average outstanding debt balance for the year. Effective October 31, 1994, the Company purchased the remaining 20% minority interest in Penn Group Corporation for $50 million. The majority of the purchase price was funded through borrowings on the credit facility. 19 22 Provision for income taxes reflects a consolidated effective income tax rate of 98.7% for 1995 compared to 42.6% for 1994. The increase was primarily due to merger costs of $2.3 million, which are not deductible for tax purposes. The ratio of these costs to pretax earnings was significantly higher in 1995 than in 1994. Minority interest in earnings of consolidated subsidiary, net of income taxes decreased $3.6 million in 1995 compared to 1994. The 1994 income reflects ten months of the 20% minority interest in the Company's Pennsylvania HMO which was held by a third party until its purchase in the fourth quarter of 1994. The 1995 minority interest amount reflects a minority shareholder's 30% interest in Healthcare USA, LLC, the St. Louis-based Medicaid HMO. Net earnings decreased $29.3 million, or 99.9%, for the year 1995 compared to 1994. Earnings per common and common equivalent share was $0.00 compared to $0.93 in the prior year. The weighted average common and common equivalent shares outstanding increased to 32.2 million in 1995 compared to 31.4 million in 1994. Discontinued Operations Effective January 1, 1995, the Company entered into an agreement with United Insurance Companies, Inc. ("United"), whereby United assumption reinsured a closed book of business comprised of traditional indemnity insurance policies that were offered by the Company's insurance subsidiary prior to 1993. United has managed these discontinued operations since December 1992. Under the terms of the agreement, United assumed substantially all of the closed book of business claims, unearned premium reserves, and all other statutory liabilities, except for certain litigation reserves that are retained by the Company. 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 the Company 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 will not have a material adverse effect on the financial position or results of the operations of the Company. New Accounting Standards The Financial Accounting Standards Board has approved statements of financial accounting standards effective for fiscal period ending after December 15, 1997, which establishes standards for computing and presenting earnings per share and also establishes standards with respect to disclosure of information about an entity's capital structure. The Company is required to adopt the provisions in the fourth quarter of 1997 and does not expect the adoption thereof to have a material effect on the Company's financial position or results of operations. 20 23 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 1995 and 1996, the Company experienced downward pressure in premium rates, and as a result has implemented further cost control measures to reduce both medical and administrative expenses. An inability to successfully reduce expenses as a percentage of premium adversely impacted the Company's results of operations in 1996. Income Taxes In its income tax returns, the Company is amortizing approximately $21 million of its intangible assets over periods ranging from three to eight years. In the consolidated financial statements in the caption "Goodwill and Intangible Assets" is an aggregate of $116.4 million of goodwill at December 31, 1996 which, for financial reporting purposes, is being amortized over periods not exceeding 40 years. The different book and tax treatment arises because the Company believes the methodologies and assumptions utilized in the tax basis appraisal of these amounts are not appropriate for financial reporting purposes. The Omnibus Reconciliation Act of 1993 ("OBRA") enacted legislation, effective January 1, 1993, whereby all intangibles, including goodwill, acquired in certain transactions can be amortized for income tax purposes over 15 years. Although the provisions of the OBRA cannot be applied to the $21 million of tax intangibles, the Company believes that the legislation is indicative of the government's desire to minimize the costs of intangibles controversies. The Company believes it will eventually sustain a tax deduction for a substantial portion of the $21 million, but such a deduction is likely to be determined on the basis of a compromise with the government. Pending a final determination of its tax position, the Company's income tax provision has been adjusted to reflect no tax benefit in its financial statements for the deduction of these amounts. Quarterly Results of Operations The quarterly consolidated results of operations of the Company are summarized in Note T to Consolidated Financial Statements. Liquidity and Capital Resources The Company's total cash and investments, excluding restricted investments, increased $25.6 million to $173.4 million as of December 31, 1996 compared to $147.8 million at December 31, 1995. This increase is primarily attributable to $37.3 million of cash provided by operating activities and $42.7 million of cash from other activities including bank borrowings and net proceeds from the issuance of common stock. The cash provided was offset by $54.4 million used for capital expenditures, debt repayment and acquisitions. The Company invests cash not needed to fund current liabilities primarily in liquid portfolios of fixed income securities issued by the federal government and various states and municipalities. Current assets plus these investments exceeded current liabilities in 1996 by $19.7 million, compared to $49.1 million in 1995. The Company's HMOs and insurance subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the Company may receive from its HMOs and insurance subsidiaries. After giving effect to these statutory reserve requirements, the Company's regulated subsidiaries had funds in excess of statutory requirements of approximately $41.6 million and $43.0 million at December 31, 1996 and 1995, respectively. Excluding funds subject to regulation, the Company had cash and investments of approximately $16.5 million and $40.0 million in 1996 and 1995, respectively, which are available to pay intercompany balances to regulated companies and for general corporate purposes. 21 24 In March 1997, the Company entered into a letter of intent to sell $40 million of Convertible Exchangeable Subordinated Notes (the "Convertible Notes"), together with warrants to purchase 2.35 million shares of its common stock to Warburg, Pincus Ventures, L.P. ("Warburg") for $42.35 million subject to the negotiation of definitive documentation, the approval of state insurance regulators in certain states and the approval of the lending banks under the Company's credit facility. Proceeds from the sale are expected to be used to repay outstanding indebtedness and provide working capital. The Convertible Notes are expected to be convertible into 4 million shares of the Company's common stock and will be exchangeable at the Company's option for shares of convertible preferred stock, the authorization of which will require the approval of the Company's shareholders at the 1997 shareholders' meeting. Prior to June 30, 1996, the Company's long-term credit agreement (the "Credit Facility") with a group of banks provided for borrowings up to $125 million. The Credit Facility called for scheduled semi-annual commitment reductions of $20.83 million beginning February 18, 1997 with final reduction of $20.85 million on August 18, 1999. As a result of losses in the second quarter of 1996, the Company was not in compliance with certain financial covenants in the Credit Facility as of June 30, 1996. Effective September 30, 1996 the Company reached an agreement ("Amended Credit Facility") with the bank group amending the Credit Facility. Prior to the amendment, the Company voluntarily reduced the availability under the Credit Facility to $100 million, of which $90 million was outstanding at December 31, 1996. The Amended Credit Facility, which revised certain financial ratios the Company was required to maintain, increased the interest rate on the indebtedness by 0.8% and revised the required reductions in availability. At December 31, 1996, the effective interest rate on the indebtedness under the Amended Credit Facility was 7.56%. As a result of continuing losses in the fourth quarter of 1996, the Company was not in compliance with certain revised financial covenants in the Amended Credit Facility and therefore was in default under the terms of the Amended Credit Facility as of December 31, 1996. As a result, no further borrowings under the Amended Credit Facility were available. Subsequent to December 31, 1996, the Company entered into an amended and restated agreement ("Restated Credit Facility") with the bank group effective March 28, 1997 that, along with other changes, converts the amount outstanding under the Restated Credit Facility to a term loan, revises certain financial ratios the Company is required to maintain, effectively increases the interest rate of the indebtedness by 2.7% (to the greater of prime plus 2% or the federal funds rate plus 2.5%) and revises the amortization period of the loan. The Restated Credit Facility requires payments of $10 million on June 30, 1997, $7 million on September 30, 1997, $18 million on December 31, 1997 and $55 million on April 1, 1998. The Restated Credit Facility eliminated the defaults that existed under the Amended Credit Facility at December 31, 1996. The amendment also requires the Company to apply 50% of the net cash proceeds from the proposed Warburg, Pincus Ventures, L.P. transaction to the loan balance, with the payment being applied to reduce 1997 and 1998 amortization payments. The Restated Credit Facility also requires the Company to prepay loans upon receipt of an anticipated $9.5 million tax refund resulting from the carryback of operating losses to prior years, with the prepayment being applied to reduce the December 1997 amortization payment. The Restated Credit Facility requires the Company to apply 50% of the net cash proceeds of sales of the Company's capital stock to reduce the scheduled amortization in the inverse order of maturity, prohibits the sale of any substantial subsidiary and restricts the Company's ability to declare and pay cash dividends on its common stock. Prior to the closing of the proposed Warburg transaction, a material adverse change in the Company's financial condition or results of operations will constitute an event of default under the Restated Credit Facility. The Restated Credit Facility contains covenants relating to investments in non-admitted assets, operating margin, net worth levels and the creation or assumption of debt or liens on the assets of the Company. The Restated Credit Facility is collateralized by substantially all of the assets of the Company. On March 31, 1997, the effective interest rate on the indebtedness under the Restated Credit Facility was 10.5%. 22 25 As of December 31, 1996, approximately 96% of the Company's long-term debt was subject to fluctuations in interest rates. During 1996, the Company's capital expenditures were $12.7 million and included the costs of constructing a new health center in St. Louis, Missouri and expanding and renovating other medical centers and administrative offices. Other capital expenditures included the cost of acquiring and implementing new operational software systems designed to enhance the Company's medical management and information reporting capabilities. Projected capital investments in 1997 of approximately $13 million consist primarily of computer hardware, software and related equipment costs associated with the development and implementation of improved operational and communications systems and office equipment. The Company believes that cash flows generated from operations, cash on hand and investments, excess funds in certain of its regulated subsidiaries, cash flows from the sale of certain medical offices and financing alternatives will be sufficient to fund continuing operations and debt service obligations. If the proposed Convertible Notes transaction is not consummated, the Company will likely seek alternate financing in order to meet scheduled debt service obligations. The Company's investment guidelines emphasize investment grade fixed income instruments in order to provide short-term liquidity and minimize the risk to principal. Health Care Reform 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 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 run. 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. 1997 Outlook The Company's enrollment in January 1997 increased to approximately 902,000 members, an increase of 15.5% over January 1996. Of the January 1997 enrollment, approximately 763,000 are members under the full-risk products and approximately 139,000 members represent lives under management services plans. The Company operates in highly competitive markets, but believes that the pricing environment is improving in its existing markets, thus creating the opportunity for reasonable price increases in the Company's market areas. 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 1997, the Company has strengthened its underwriting processes and oversight in both risk and non-risk products with the objective of increasing premium yields and profitable growth. The Company will continue to pursue global capitation arrangements as part of its delivery system with the objectives of involving providers in medical cost management and stabilizing operating margins. The completion of the medical office sales in St. Louis, Missouri and Pittsburgh, Pennsylvania will improve liquidity and eliminate the financial losses associated with excess capacity in the Company's delivery system. Administrative processes in claims, information systems and customer services are being re-engineered with emphasis on low costs and high quality. The Company will focus on its existing markets for growth in commercial, Medicare risk and Medicaid membership by leveraging the value of its franchises and the volume of its membership base. The Company believes that these objectives should result in progressive improvements in operations during 1997, although realization of the benefit of these strategies is dependent upon a variety of factors, some of which may be outside the control of the Company. 23 26 Item 8: Financial Statements and Supplementary Data Report of Independent Public Accountants To the Board of Directors and Stockholders of Coventry Corporation: We have audited the accompanying consolidated balance sheets of Coventry Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated 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 consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Coventry Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Nashville, Tennessee February 21, 1997 (except for Notes G and S, as to which the date is March 31, 1997) 24 27 Consolidated Balance Sheets (in thousands, except share data)
December 31, - ------------------------------------------------------------------------------------------------------------ 1996 1995 - ------------------------------------------------------------------------------------------------------------ Assets Cash and cash equivalents $ 90,619 $ 67,435 Short-term investments 7,388 18,408 Accounts receivable, net of allowance for doubtful 37,921 32,118 accounts of $8,000 and $2,700, respectively Other receivables 22,661 10,909 Assets held for sale 23,856 - Deferred income taxes 20,449 8,415 Prepaid expenses and other current assets 5,397 6,151 - ----------------------------------------------------------------------------------------------------------- Total current assets 208,291 143,436 Long-term investments 75,389 61,934 Property and equipment, net 24,979 51,253 Goodwill and intangible assets, net 118,346 111,879 Other assets 21,940 17,173 - ----------------------------------------------------------------------------------------------------------- Total assets $ 448,945 $ 385,675 =========================================================================================================== Liabilities and Stockholders' Equity Medical claims liabilities $ 146,082 $ 92,160 Accounts payable 11,919 9,164 Accrued payroll and benefits 13,008 11,066 Other accrued liabilities 59,636 27,686 Deferred revenue 14,888 13,880 Current portion of long-term debt 36,468 2,307 - ----------------------------------------------------------------------------------------------------------- Total current liabilities 282,001 156,263 Long-term debt 57,291 65,600 Other long-term liabilities 9,226 7,994 Minority interest - 1,967 Stockholders' equity: Common Stock, $.01 par value; 50,000,000 shares authorized; issued and outstanding, 33,001,296 and 32,276,575 shares, respectively 330 323 Additional paid-in capital 136,142 128,119 Net unrealized investment gain 395 562 Retained earnings (accumulated deficit) (36,440) 24,847 - ----------------------------------------------------------------------------------------------------------- Total stockholders' equity 100,427 153,851 - ----------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 448,945 $ 385,675 ===========================================================================================================
See notes to consolidated financial statements. 25 28 Consolidated Statements of Operations (in thousands, except per share data)
Year Ended December 31, - ----------------------------------------------------------------------------------------------------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------------- Operating revenues: Managed care premiums $ 1,035,778 $ 844,032 $ 769,935 Management services 21,351 8,358 6,708 - ----------------------------------------------------------------------------------------------------------------------------- Total operating revenues 1,057,129 852,390 776,643 - ----------------------------------------------------------------------------------------------------------------------------- Operating expenses: Health benefits 930,739 713,226 614,144 Selling, general and administrative 165,081 123,523 94,684 Depreciation and amortization 42,862 14,666 9,437 Other charges 9,793 - - Merger costs - 2,250 3,355 - ----------------------------------------------------------------------------------------------------------------------------- Total operating expenses 1,148,475 853,665 721,620 - ----------------------------------------------------------------------------------------------------------------------------- Operating earnings (loss) (91,346) (1,275) 55,023 Other income, net 13,379 7,705 5,003 Interest expense (6,257) (4,881) (2,731) - ----------------------------------------------------------------------------------------------------------------------------- Earnings (loss) before income taxes and minority interest (84,224) 1,549 57,295 Provision for (benefit from) income taxes (22,860) 1,530 24,426 Minority interest in earnings (loss) of consolidated subsidiary, net of income tax (77) 1 3,581 - ----------------------------------------------------------------------------------------------------------------------------- Net earnings (loss) $ (61,287) $ 18 $ 29,288 ============================================================================================================================= Net earnings (loss) per common and common equivalent share $ (1.86) $ 0.00 $ 0.93 ============================================================================================================================= Weighted average common and common equivalent shares outstanding 33,011 32,164 31,425 - -----------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 26 29 Consolidated Statements of Stockholders' Equity Years Ended December 31, 1996, 1995 and 1994 (in thousands)
Retained Additional Net Unrealized Earnings Total Common Paid-In Investment (Accumulated Stockholders' Stock Capital Gain (Loss) Deficit) Equity --------------------------------------------------------------------------------- Balance, January 1, 1994 $ 293 $101,072 $ - $ (4,459) $ 96,906 Issuance of common stock, including exercise of options 19 7,062 7,081 Tax benefit of stock options exercised 1,653 1,653 Unrealized investment loss, net of income tax (804) (804) Net earnings 29,288 29,288 - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994 312 109,787 (804) 24,829 134,124 Issuance of common stock, including exercise of options and warrants 11 16,906 16,917 Tax benefit of stock options exercised 1,426 1,426 Unrealized investment gain, net of income tax 1,366 1,366 Net earnings 18 18 - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 323 128,119 562 24,847 153,851 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 Unrealized investment loss, net of income tax (167) (167) Net loss (61,287) (61,287) - -------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 $ 330 $136,142 $ 395 $(36,440) $ 100,427 ==========================================================================================================================
See notes to consolidated financial statements. 27 30 Consolidated Statements of Cash Flows (in thousands)
Year ended December 31, - -------------------------------------------------------------------------------------------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities of continuing operations: Net earnings (loss) $ (61,287) $ 18 $ 29,288 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 42,862 14,666 9,437 Benefit from deferred income taxes (15,989) (2,029) (657) Increase in receivable due to sale of subsidiary (5,500) - - Minority interest (19) 1 3,581 Other 103 (26) 386 Changes in assets and liabilities of continuing operations, net of effects of the purchase of subsidiaries: Accounts receivable (5,285) (7,099) (2,091) Other receivables (6,749) (4,913) (1,969) Prepaid expenses and other current assets 758 (582) 2,959 Other assets (5,652) (6,458) (1,563) Medical claims liabilities 49,350 21,736 4,849 Accounts payable 2,742 4,374 1,331 Other accrued liabilities 32,781 9,205 9,112 Income taxes payable 6,315 (15,173) 686 Deferred revenue 549 (3,756) (36) Other long-term liabilities 1,251 3,882 1,084 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities of continuing operations 36,230 13,846 56,397 Net cash used in operating activities of discontinued operations - - (542) - -------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 36,230 13,846 55,855 - -------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities of continuing operations: Capital expenditures, net (12,688) (16,319) (22,466) Sales of investments 75,511 53,224 41,109 Purchases of investments & other (80,049) (64,193) (55,841) Payments for purchases of subsidiaries, net of cash acquired (27,256) (2,524) (54,279) - -------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities of continuing operations (44,482) (29,812) (91,477) Net cash provided by investing activities of discontinued operations - - 8,809 - -------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (44,482) (29,812) (82,668) - -------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Borrowings of long-term debt 40,164 13,116 50,731 Payments on long-term debt (14,474) (14,740) (24,266) Net proceeds from issuance of stock 5,746 16,917 5,831 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 31,436 15,293 32,296 - -------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 23,184 (673) 5,483 Cash and cash equivalents at beginning of period 67,435 68,108 62,625 - -------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 90,619 $ 67,435 $ 68,108 ==================================================================================================================== ====================================================================================================================
See notes to consolidated financial statements. 28 31 Notes to Consolidated Financial Statements Years Ended December 31, 1996, 1995 and 1994 A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Coventry Corporation ("the Company") is a managed health care company that provides comprehensive health benefits and services to employer groups and government-funded groups in Pennsylvania, Ohio, West Virginia, Missouri, Illinois, Virginia and Florida. The Company began operations in 1987 with the acquisition of the American Service Companies ("ASC") entities. 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 ("HCUSA"), a Jacksonville, Florida-based Medicaid managed care company. Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated. 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 Equivalents - Cash equivalents consist principally of overnight repurchase agreements, money market funds 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 - Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). 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 the basis of specific cost. The adoption of SFAS 115 did not have a material effect on the consolidated financial statements. 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 consist primarily of state and municipal debt securities and obligations of the federal government and its agencies. 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 - Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards Number 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." Following the criteria set forth in SFAS 121, long-lived assets to be held are reviewed by the Company for events or changes in circumstances which would indicate that the carrying value may not be 29 32 recoverable. In making this determination, the Company considers a number of factors, including estimated future cash flows prior to interest and non-cash expenses associated with the long-lived asset. Assets held for sale are recorded at the lower of the carrying amount or fair value, less any costs associated with disposition. Goodwill and Intangible Assets - Goodwill and intangible assets consist primarily of costs in excess of the fair value of the net assets of subsidiaries or operations acquired which are amortized on a straight-line basis over periods not exceeding 40 years. Accumulated amortization of goodwill and intangible assets was approximately $40.3 million and $9.4 million at December 31, 1996 and 1995, respectively. In accordance with SFAS 121, 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 trends (see Note B to Consolidated Financial Statements). Other Assets - Other assets consist of loan acquisition costs, assets related to the supplemental executive retirement plan (Note M of the Notes to Consolidated Financial Statements), investment in a limited partnership, 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 are amortized over the expected benefit periods. Accumulated amortization of other assets was approximately $3.6 million and $4.6 million at December 31, 1996 and 1995, 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. 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. 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 Coventry 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. Minority Interest - For 1996, the minority interest represents a joint venture interest of 51% in Pennsylvania HealthMate, Inc. ("HealthMate"). In 1995, the minority interest represents a minority shareholder's 30% interest in HealthCare USA, Missouri LLC, a St. Louis-based Medicaid HMO. The Company purchased the remaining 30% effective January 1, 1996. In 1994, the minority interest represents a minority shareholder's 20% interest 30 33 in Penn Group Corporation (Penn Group), which owns 100% of HAPA. On October 31, 1994, the Company purchased the Penn Group minority interest. Earnings Per Share - Earnings per share is computed based on the weighted average shares of common stock and common stock equivalents outstanding during the period. Common stock equivalents arising from dilutive stock options and warrants are computed using the treasury stock method. Fully diluted earnings per share are not presented as the calculation is either antidilutive or does not materially affect earnings per share. SFAS no. 128, "Earnings per Share" has been issued effective for fiscal years ending after December 15, 1997. SFAS no. 128 establishes a new standard for computing and presenting earnings per share. The Company is required to adopt the provisions of SFAS No. 128 in the fourth quarter of 1997 and does not expect adoption thereof to have a material effect on the Company's financial position or results of operations. Reclassifications - Certain 1994 and 1995 amounts have been reclassified to conform to the 1996 presentation. B. MERGERS AND ACQUISITIONS Effective July 28, 1995, the Company acquired HCUSA, a Jacksonville, Florida-based managed care company. Under the terms of the agreement, 2,849,691 shares of the Company's common stock, valued at approximately $45 million, were exchanged for all of HCUSA's capital stock in a nontaxable transaction accounted for as a pooling of interests. HCUSA operates a 26,000 member HMO in Jacksonville and northeastern Florida, and through a subsidiary provides managed care services to Missouri Medicaid recipients. At December 31, 1996, HCUSA's Missouri subsidiary had approximately 77,000 enrollees. The Company's financial statements have been restated to include the results of HCUSA for all periods presented. Effective December 1, 1994, the Company acquired Southern Health Management Corporation ("SHMC"), the parent company of SHS, a physician owned HMO with approximately 45,000 members located in Richmond and central Virginia. Under the terms of the agreement, common stock of the Company valued at approximately $75 million was given as consideration in a nontaxable transaction accounted for as a pooling of interests. Each of SHMC's 833,757 outstanding shares of common stock was converted into 3.436 shares of the Company's common stock resulting in 2,864,789 shares being issued. Additionally, 42,500 outstanding options to acquire SHMC's common stock were converted to options to acquire 146,030 shares of the Company's common stock. Accounting policies of the two companies were the same; therefore, no conforming adjustments were needed. No intercompany transactions existed between the companies for the periods presented, and certain reclassifications were made to SHMC's and HCUSA's financial statements to agree with Coventry's presentation. In connection with the merger of SHMC, the Company recorded $3.4 million in the third and fourth quarters of 1994 for transaction costs. In connection with the merger of HCUSA, the Company recorded $2.3 million of merger costs in the second quarter of 1995. These costs include expenses for investments bankers, SEC filing and shareholder reporting fees and professional fees. Effective March 22, 1996, the Company purchased 81% of the common stock of PARTNERS Health Plan of Pennsylvania, Inc. ("PARTNERS") from a subsidiary of Aetna Life & Casualty Company, now known as Aetna Services, Inc. ("Aetna") and acquired the remaining 19% of the common stock of PARTNERS through the merger of a subsidiary of the Company with and into PARTNERS. PARTNERS is the holding company for Coventry Health Plans of Western Pennsylvania, Inc. ("CHP"), which at the time of acquisition 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 has been accounted for under the purchase method of accounting and, 31 34 accordingly, the net assets have been included in the consolidated financial statements from the effective date of acquisition. In conjunction with the acquisition, the Company received a non-compete agreement from Aetna and expected to enter into a favorable joint marketing agreement with Aetna and to have the opportunity to acquire other Aetna membership at a favorable price. These opportunities have not come to fruition and are not expected to, given Aetna's acquisition of another competitor in the western Pennsylvania market. As a result of these events, the Company filed suit against Aetna and the competitor alleging breach of the acquisition agreement, seeking enforcement of the non- compete agreement and requesting other forms of relief. Based on the current and future expected operating results, the Company has reduced the carrying value of the goodwill to $10.0 million at December 31, 1996. Effective April 1, 1996 the Company entered into a Joint Venture Agreement with Hamilton Health Center, Inc. to create HealthMate, Inc., a company providing health care services to Medicaid recipients in central Pennsylvania. As part of the agreement the Company made an initial investment of $300,000 for ownership of 49% of HealthMate's common stock and is obligated under certain circumstances to make additional contributions totaling $550,000 over the next two and a half years. As of April 1, 1996 HealthMate had approximately 6,500 members. The Company has accounted for this transaction under the purchase method of accounting and, accordingly, the net assets have been included in the consolidated financial statements from the effective date of acquisition. Because the purchase price and the operations of the PARTNERS and HealthMate acquisitions for the periods presented are not material to the consolidated financial statements of the Company, pro forma financial information has not been included herein. Effective January 1, 1996, the Company purchased the 30% minority interest in HealthCare USA, Missouri LLC, a St. Louis-based Medicaid HMO. The purchase price was equal to the carrying value of the 30% ownership and as a result, no goodwill was recorded. The Company purchased two physician group practices in Pennsylvania in January 1995, and a third party administrator in Richmond, Virginia in May 1995. The combined adjusted purchase price for these three acquisitions was approximately $2.5 million, of which approximately $1.2 million was recorded as goodwill. The purchase price included approximately $600,000 related to noncompete agreements which have been recorded as intangible assets in the consolidated balance sheet and which will be amortized between four and ten years. In 1994, the Company purchased four physician group practices for which the combined adjusted purchase price was $3.7 million. Approximately $2.0 million of the combined purchase price related to noncompete agreements which have been recorded as intangible assets and which will be amortized over five to ten years. Approximately $1.2 million of the combined purchase price related to goodwill which will amortize over 25 years. These acquisitions have been accounted for under the purchase method of accounting and, accordingly, the net assets have been included in the consolidated financial statements from the effective dates of acquisition. The transactions and operations of the acquired entities are not significant in the consolidated financial statements of the Company. Effective October 31, 1994, the Company purchased the then remaining 20% minority interest in Penn Group Corporation, the parent company of HealthAmerica Pennsylvania, Inc., the Company's Pennsylvania HMO operations. The purchase price was approximately $50 million in cash, of which approximately $38.6 million was recorded as goodwill. 32 35 C. OTHER CHARGES At the end of the second quarter of 1996, the Company established reserves totaling $8.2 million for anticipated losses on multi-year contracts with certain employer groups, primarily in the St. Louis market. The Company expects to utilize these reserves over the remaining lives of the contracts and then either discontinue these products or significantly change the terms and conditions of the contracts with these parties. The contracts expire at varying dates through 1999 and cover approximately 30,000 members. In the fourth quarter of 1996, the Company re-evaluated its position in relation to the contracts and recorded additional reserves of $1.6 million. D. PROPERTY AND EQUIPMENT Property and equipment is comprised of the following (in thousands):
December 31, - -------------------------------------------------------------------------- 1996 1995 - -------------------------------------------------------------------------- Land $ 481 $ 3,116 Buildings and leasehold improvements 8,427 25,507 Equipment 39,162 49,016 - -------------------------------------------------------------------------- 48,070 77,639 Less accumulated depreciation (23,091) (26,386) - -------------------------------------------------------------------------- $ 24,979 $ 51,253 ==========================================================================
In February 1997, the Company announced the signing of agreements in principle for the sale of its medical offices in St. Louis, Missouri and Pittsburgh, Pennsylvania and definitive agreements for the sales of such offices were signed in March 1997, subject to the satisfaction of various conditions, including regulatory approval. Accordingly, property and equipment with a carrying value of approximately $23.9 million has been classified as a current asset on the 1996 balance sheet. The Company expects the net proceeds from the sale will exceed the carrying value. In accordance with SFAS 121 (Note A of the Notes to Consolidated Financial Statements), the Company determined that the carrying amounts of certain of its property and equipment may not be recoverable as of December 31, 1996. As a result, approximately $4.3 million of property and equipment charge-offs were recorded in the fourth quarter of 1996. 33 36 E. INVESTMENTS IN DEBT AND EQUITY SECURITIES The Company considers all of its investments as available for sale securities, as defined within the Statement, and accordingly, records unrealized gains and losses in the stockholders' equity section of its balance sheet. As of December 31, 1996 and 1995, stockholders' equity was increased by approximately $0.4 million and $0.6 million, respectively, net of a deferred tax cost of $0.1 million and $0.3 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, 1996 and 1995 (in thousands):
Amortized Unrealized Unrealized Fair 1996 Cost Gain Loss Value ---------------------------------------------------------- State and municipal bonds $50,926 $492 $ - $51,418 Asset-backed securities 9,407 - (31) 9,376 Mortgage-backed securities 13,740 - (85) 13,655 US Treasury securities 7,897 31 - 7,928 Other debt securities 329 - - 329 Equity securities 25 46 - 71 ---------------------------------------------------------- $82,324 $569 $ (116) $82,777 ==========================================================
Amortized Unrealized Unrealized Fair 1995 Cost Gain Loss Value ---------------------------------------------------------- State and municipal bonds $59,892 $788 $- $60,680 Asset-backed securities 7,654 - - 7,654 Mortgage-backed securities 526 - - 526 US Treasury securities 9,517 74 - 9,591 Other debt securities 1,815 - - 1,815 Equity securities 12 64 - 76 ---------------------------------------------------------- $79,416 $926 $- $80,342 ==========================================================
34 37 The amortized cost and estimated fair value of short-term and long-term investments by contractual maturity were as follows at December 31, 1996 and December 31, 1995 (in thousands):
Amortized Fair Cost Value 1996 ---------------------- Maturities: Within 1 year $ 7,366 $ 7,388 1 to 5 years 26,140 26,229 6 to 10 years 7,383 7,494 Over 10 years 41,410 41,595 Other securities without stated maturity 25 71 ---------------------- Total short-term and long-term securities $82,324 $82,777 ======================
Amortized Fair Cost Value 1995 -------------------- Maturities: Within 1 year $18,406 $18,408 1 to 5 years 24,477 24,762 6 to 10 years 6,344 6,424 Over 10 years 30,177 30,672 Other securities without stated maturity 12 76 --------------------- Total short-term and long-term securities $79,416 $80,342 =====================
Proceeds from the sale of investments were approximately $76 million and $53 million for the twelve months ending December 31, 1996 and 1995, respectively. Gross investments gains of approximately $45,000 and gross investments losses of $14,000 were realized on these sales for the twelve months ended December 31, 1996 compared to $26,000 of gross investments gains for the year ended December 31, 1995. Realized gains and losses from securities sales are determined on the specific identification of the securities. F. INCOME TAXES The provision (benefit) for income taxes attributable to earnings consisted of the following (in thousands):
Year Ended December 31, -------------------------------------------------------------------------------------------------------------- 1996 1995 1994 -------------------------------------------------------------------------------------------------------------- Current provision (benefit): Federal $ (6,181) $ 3,125 $ 21,285 State (690) 434 3,798 Deferred provision (benefit): Federal (15,565) (1,819) (558) State (424) (210) (99) - --------------------------------------------------------------------------------------------------------------- $ (22,860) $ 1,530 $ 24,426 ===============================================================================================================
35 38 The expected tax provision (benefit) 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, - ----------------------------------------------------------------------------------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- Statutory federal tax rate (35.00)% 35.00 % 35.00 % Effect of: State income taxes, net of federal benefit (1.40)% 9.40 % 5.71 % Amortization of goodwill 10.26 % 69.07 % 1.40 % Tax exempt interest income (1.25)% (75.37)% (1.10)% Change in valuation reserve - - (1.42)% Merger costs - 49.71 % 2.02 % Other 0.25 % 10.92 % 1.02 % - ----------------------------------------------------------------------------------------------------------- Income tax provision (benefit) (27.14)% 98.73 % 42.63 % ===========================================================================================================
The effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below (in thousands):
December 31, 1996 1995 - --------------------------------------------------------------------------------------------------------------- Deferred tax assets: Medical liabilities $ 7,816 $ 984 Accounts receivable 2,897 904 Provision for long-term contracts 3,183 - Other accruals and deferred revenue 10,943 6,234 Net operating loss carryforward 2,534 640 - --------------------------------------------------------------------------------------------------------------- Gross deferred tax assets 27,373 8,762 Less valuation allowance (911) (640) - --------------------------------------------------------------------------------------------------------------- Deferred tax asset 26,462 8,122 - --------------------------------------------------------------------------------------------------------------- Deferred tax liability: Property and equipment (609) (1,031) Capitalized development costs (1,806) - Unrealized gain on securities available for sale (128) (363) Other (332) (1,063) - --------------------------------------------------------------------------------------------------------------- Gross deferred tax liabilities (2,875) (2,457) - --------------------------------------------------------------------------------------------------------------- Net deferred tax asset $ 23,587 $ 5,665 ===============================================================================================================
The valuation allowance for deferred tax assets as of December 31, 1996 was $0.9 million due to the Company's belief that the realization of the deferred tax asset resulting from federal and state net operating loss carryforwards associated with certain acquisitions is doubtful. The valuation allowance provided at December 31, 1996 will be allocated to reduce goodwill and other intangible assets if the realization of the acquired net operating loss carryforwards becomes more likely than not. 36 39 G. NOTES PAYABLE AND LONG-TERM DEBT Long-term debt consists of the following (in thousands):
December 31, 1996 1995 Borrowings under the Credit Facility $90,000 $62,000 Note payable to U.S. DHHS 1,762 2,303 Other notes payable 1,997 3,604 ---------------------- 93,759 67,907 Less current portion of long-term debt (36,468) (2,307) ---------------------- Total long-term debt $57,291 $65,600 ======================
Prior to June 30, 1996, the Company's long-term credit agreement (the "Credit Facility") with a group of banks provided a reducing revolving line of credit of $125 million, collateralized by substantially all of the Company's assets. The Credit Facility originally called for scheduled semi-annual commitment reductions totaling $20.8 million beginning February 18, 1997 and terminating availability on August 18, 1999. As of June 30, 1996, the Company was not in compliance with certain financial covenants in the Credit Facility. Effective September 30, 1996, the Company reached an agreement ("Amended Credit Facility") with the bank group amending the Credit Facility. Prior to the amendment, the Company voluntarily reduced the availability under the Credit Facility to $100 million. The Amended Credit Facility, along with other changes, revised certain financial ratios that the Company was required to maintain, increased the interest rate on the indebtedness by 0.8% and revised the required reductions in availability. At December 31, 1996, the effective interest rate on indebtedness under the Amended Credit Facility was 7.56%. As of December 31, 1996, the Company was not in compliance with certain revised financial covenants in the Amended Credit Facility. Subsequent to December 31, 1996, the Company entered into an amended and restated agreement ("Restated Credit Facility") with the bank group effective March 28, 1997, that along with other changes, converts the amount outstanding under the Restated Credit Facility to a term loan, revises certain financial ratios the Company is required to maintain, effectively increases the interest rate on the indebtedness by 2.7% and revises the amortization period of the loan. The Restated Credit Facility requires payments of $10 million on June 30, 1997, $7 million on September 30, 1997, $18 million on December 31, 1997 and $55 million on April 1, 1998. The Restated Credit Facility eliminated the defaults that existed under the Amended Credit Facility at December 31, 1996. Obligations under the Restated Credit Facility will bear interest at a rate equal to the higher of the prime rate plus 2.0% or the federal funds rate plus 2.5%. The Restated Credit Facility requires the Company to apply 50% of the net cash proceeds of sales of the Company's equity securities to reduce the scheduled amortizations, prohibits the sale of any substantial subsidiary and restricts the Company's ability to declare and pay cash dividends on its common stock. The Restated Credit Facility contains covenants relating to net worth, investments in non-admitted assets, operating margins and the creation or assumption of debt or liens on the assets of the Company. Prior to the closing of the proposed Warburg transactions described in Note S, a material adverse change in the Company's financial condition or results of operations will constitute an event of default under the Restated Credit Facility. The Restated Credit Facility is collaterlized by substantially all of the assets of the Company. On March 31, 1997 the effective interest rate on the indebtedness under the Restated Credit Facility was 10.5%. Notes payable to the U. S. Department of Health and Human Services ("U.S. DHHS") represents 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. Other notes payable relate primarily to the acquisition of two physician group practices in 1995 and four in 1994 (see Note D of the Notes to Consolidated Financial Statements). Under the terms of these acquisitions, a portion of the total purchase price is deferred for terms ranging between two and four years. These deferred payments do not accrue interest. 37 40 Maturities of long-term debt during each of the ensuing five years ending December 31 and thereafter are as follows (in thousands): 1997 $ 36,468 1998 56,210 1999 687 2000 376 2001 18 Thereafter - -------- $ 93,759 ========
H. STOCK DIVIDEND On August 3, 1994, the Company's Board of Directors approved a two-for-one stock split in the form of a stock dividend with one additional share of common stock issued for every share held by shareholders of record as of July 20, 1994. All share and per share amounts for 1994 have been adjusted to reflect the stock split. I. STOCK OPTIONS, WARRANTS AND EMPLOYEE STOCK PURCHASE PLAN As of December 31, 1996, the Company had five stock option plans for issuance of common stock to key employees, including physicians and directors. Under these plans, the exercise provisions and prices of the options are established on an individual basis with the exercise price of the options generally being equal to 100% of the market value of the underlying stock at the date of grant. Options generally become exercisable after one year in 20-25% increments per year and expire ten years from the date of grant. The plans provide for incentive or nonqualified stock options to be issued at the discretion of the Board of Directors. With the merger of SHMC in December 1994, the Company assumed SHMC'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 SHMC common stock granted under SHMC's incentive stock option plan. These options were exercisable upon the completion of the merger with SHMC and expire in 2003. With the merger of HCUSA in July 1995, the Company exchanged 2,849,691 shares of the Company's common stock for all of HCUSA's common stock, preferred stock and stock options. Transactions with respect to the plans for the three years ended December 31, 1996 were as follows and have been restated to reflect the two-for-one stock split in the form of a stock dividend in August 1994:
Number of Option Price Shares Per Share - ----------------------------------------------------------------------------------------------------------------- Outstanding at January 1, 1994 1,732,430 $ 1.275 - $21.250 Granted 588,850 $16.875 - $25.000 Exercised (284,820) $ 1.275 - $13.563 Canceled (93,000) $ 4.750 - $21.250 - ----------------------------------------------------------------------------------------------------------------- Outstanding at December 31, 1994 1,943,460 $ 3.780 - $25.000 Granted 716,750 $15.875 - $24.500 Exercised (246,668) $ 3.780 - $21.250 Canceled (169,000) $ 5.000 - $24.250 - ----------------------------------------------------------------------------------------------------------------- Outstanding at December 31, 1995 2,244,542 $ 3.780 - $25.000 Granted 2,891,589 $ 9.625 - $20.625 Exercised (450,224) $ 3.780 - $18.125 Canceled (1,823,489) $ 5.000 - $25.000 - ----------------------------------------------------------------------------------------------------------------- Outstanding at December 31, 1996 2,862,418 $ 3.780 - $25.000 =================================================================================================================
38 41 Options vested and exercisable at December 31, 1996, 1995 and 1994 were 740,017, 888,573 and 664,266, respectively. At December 31, 1996, the Company had outstanding warrants granting holders the right to purchase 100,000 shares of common stock. The 100,000 warrants were issued in July 1995 at a price of $14.125 and expire July 2000. Warrants were issued in December 1993 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 in December 1995. The remaining 249,700 warrants expired in December 1995. During the first half of 1996, 170,000 warrants were exercised at a price of $6.75. At various dates in 1996, the Company repriced, canceled 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. As of December 31, 1996, the Company had reserved an aggregate of approximately 3.3 million common shares for options and warrants, approximately 0.4 million of which are available for future grants. 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 Company 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 13,267 and 19,465 shares in 1995 and 1996, respectively, under this plan. In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards Number 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." SFAS 123 establishes new financial accounting and reporting standards for stock-based compensation plans. The Company has adopted only the disclosure requirements of SFAS 123. As a result, no compensation cost has been recorded for the Company's stock option plans. In addition, based on the number of options outstanding and the historical and extrapolated future trends of factors affecting valuation of those options, management has determined that any compensation cost attributable to options granted is immaterial. J. REINSURANCE The Company has reinsurance agreements, through its subsidiary CHLIC, with a major insurance company for portions of the risk it has underwritten through its products. In 1996, commercial HMO risk was reinsured to $500,000 per member per year in excess of a maximum loss retention of $500,000 per member per year and 20% coinsurance, subject to certain limits on hospital costs per patient-day. PPO risk was reinsured to $850,000 per member per year in excess of maximum loss retention of $150,000 per member per year and 20% coinsurance. Medicaid in Florida and Pennsylvania was reinsured to $950,000 per member per year in excess of a maximum loss retention of $50,000 per member per year and 20% coinsurance. Medicaid risk in Missouri was reinsured through the state of Missouri mandated program with retention of $50,000 per member per year and 20% coinsurance. Medicare risk was reinsured $850,000 per member per year in excess of a maximum loss retention of $150,000 per member per year and 20% coinsurance. 39 42 Reinsurance premiums for the years ended December 31, 1996, 1995 and 1994, were approximately $1.8 million, $2.8 million and $3.3 million, respectively. Reinsurance recoveries for the same periods were approximately $1.5 million, $0.9 million and $1.3 million. K. COMMITMENTS The Company operates primarily in leased facilities with original lease terms ranging from two to fifteen years. 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. The minimum rental commitments payable by the Company during each of the next five years ended December 31 and thereafter for noncancellable operating leases are as follows (in thousands):
Year Amount ----- ------ 1997 $ 9,690 1998 7,859 1999 5,841 2000 4,368 2001 3,484 -------- Thereafter 12,750 -------- $ 43,992 ========
Total rent expense was approximately $11.7 million, $10.5 million and $10.6 million for the years ended December 31, 1996, 1995, and 1994, respectively. As a result of premium rate reductions in Florida in 1995 and the commercial membership requirements, the Company has determined that its Florida Medicaid operations are unlikely to be sufficiently profitable on a long-term basis to justify a continued presence in the Florida market and, as a result, the Company is considering various options concerning this business, with the long-term goal of exiting the Florida Medicaid market if premium rates are not increased. Accordingly, the Company has established a reserve of $1.2 million at December 31, 1996 to reflect the anticipated costs of exiting this market. L. 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 premiums 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 Note S to Consolidated Financial Statements, the Company will enter 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. As of December 31, 1996, the western Pennsylvania, central Pennsylvania, St. Louis, Richmond and HCUSA subsidiaries comprised 37%, 16%, 17%, 2% and 28% of accounts receivable, respectively. The Company's largest employer group, the U.S. Office of Personnel Management, accounted for approximately 5% of the Company's managed care 40 43 premiums in 1996 and approximately 14% of the accounts receivable at December 31, 1996. The Company believes the allowance for doubtful collections adequately provides for estimated losses as of December 31, 1996. The Company has a risk of incurring loss if such allowances are not adequate. M. BENEFIT PLANS On July 1, 1994, the Company adopted an employee retirement plan qualifying under IRC Section 401(k), the Coventry Corporation Retirement Savings Plan (the "Plan"), which covers substantially all employees of the Company and its subsidiaries who meet certain requirements as to age and length of service and who elect to participate in the Plan. Similar retirements 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. Under the 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 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 deferred. Employees vest 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. All costs of the Plan are funded by the Company as they are incurred. On July 1, 1994, the Company adopted a supplemental executive retirement plan (the "SERP"), which covers employees of the Company 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 Plan. A similar supplemental executive retirements plan offered by HAPA was merged into the SERP effective July 1, 1994. 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 deferred and 50% of the employee's contribution on the second 3% of the employee's compensation deferred. Employees vest 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. 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 the years 1996, 1995 and 1994 was approximately $2.4 million, $3.1 million and $3.5 million, respectively. 41 44 N. STATUTORY INFORMATION The Company's HMO subsidiaries are required by the respective domicile states to maintain minimum statutory capital and surplus in the aggregate of approximately $14.0 million at December 31, 1996. Combined statutory capital and surplus of the Company's HMO was approximately $27.9 million. The states in which the Company's HMOs operate require the HMOs to maintain deposits with the Department of Insurance. At December 31, 1996, these deposits totaled $2.8 million and are included as other long-term assets in the financial statements. CHLIC is required to maintain minimum statutory capital and surplus of approximately $3.0 million. Statutory capital and surplus of CHLIC as of December 31, 1996 was approximately $30.7 million. Statutory deposits for CHLIC as of December 31, 1996 totaled approximately $3.7 million. O. OTHER INCOME Other income for the years ended December 31, 1996, 1995, and 1994 includes investment income of approximately $8.4 million, $7.4 million, and $5.0 million, respectively. Additionally, in the fourth quarter of 1996, other income includes a non-recurring gain of approximately $4.9 million as a result of the sale of Champion Dental Service, Inc. P. SUPPLEMENTAL DISCLOSURES OF CASH FLOW Cash paid during the periods for interest and income taxes is as follows (in thousands):
Year ended December 31, - --------------------------------------------------------------------------- 1996 1995 1994 - --------------------------------------------------------------------------- Interest $ 5,862 $ 4,517 $ 2,491 Income taxes $ 1,309 $16,410 $19,240
Q. DISCONTINUED OPERATIONS On March 30, 1992, the Company's Board of Directors approved a plan pursuant to which the Company discontinued certain operations of ASC. ASC provided individually underwritten health care benefits coverage to self-employed individuals or small employers through CHLIC. The Company retains CHLIC insurance licenses in 43 states and CHLIC continues to underwrite the indemnity portion of certain flexible provider products offered by the Company's HMOs. Effective December 1, 1992, the Company entered into an agreement with United Insurance Companies, Inc. ("United"), whereby United assumed management responsibility for the discontinued operations; accordingly, the small-group policies remaining in force comprised a closed book of business. Effective January 1, 1995, United assumption reinsured the ASC closed book of business. Under the terms of the agreement, United assumed substantially all of the closed book of business claims, unearned premium reserves, and all other statutory liabilities, except for certain litigation reserves that are retained by the Company. 42 45 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, 1996 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. S. SUBSEQUENT EVENTS In March 1997, the Company entered into agreements to sell the medical offices associated with Group Health Plan, its health plan in St. Louis, Missouri and HealthAmerica, its health plan in Pittsburgh, Pennsylvania, to major healthcare provider organizations in these markets. The purchase price is $27 million in cash for the St. Louis medical offices and $20 million in cash for the Pittsburgh offices. The initial agreements cover medical offices serving 92,000 members at Group Health Plan and 80,000 members at HealthAmerica. The agreements are subject to the satisfaction of various conditions, including regulatory approval. Coincident with the sale of the medical offices, the Company will enter into long-term global capitation arrangements with the purchasers of the medical offices, pursuant to which the provider organizations will receive a fixed percentage of premiums to cover all the medical treatment the Company's globally capitated members receive from the health care systems. The transactions are expected to occur in the first half of 1997 and therefore, the assets of the respective medical offices have been classified as current assets as of December 31, 1996. The anticipated proceeds from the transactions are expected to exceed the current carrying value of the medical offices. On March 17, 1997, the Company announced that it entered into a letter of intent with Warburg, Pincus Ventures, L.P. ("Warburg") for Warburg's purchase of $40 million of Convertible Exchangeable Subordinated Notes of the Company, together with warrants to purchase 2.35 million shares of the Company's common stock. The notes are expected to be convertible into 4 million shares of the Company's common stock. The investment by Warburg is subject to the negotiation of definitive terms, the approval of state insurance regulators in certain states, and the approval of the lending banks under the Credit Facility. The notes will be exchangeable at the Company's option for shares of convertible preferred stock, the authorization of which will require the approval of the Company's shareholders at the 1997 shareholders' meeting. If the proposed Convertible Notes transaction is not consummated, the Company will likely seek alternative financing in order to meet scheduled debt service obligations. 43 46 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, 1996 and 1995.
Quarter Ended March 31, June 30, September 30, December 31, 1996(1) 1996(2) 1996 1996(3) ------------------------------------------------------------------ Operating revenues $ 236,937 $ 257,737 $ 272,903 $ 289,552 Operating earnings (loss) $ (2,772) $ (14,346) $ 143 $ (74,371) Net earnings (loss) $ (968) $ (8,528) $ 348 $ (52,139) Net earnings (loss) per common and common equivalent share $ (0.03) $ (0.26) $ 0.01 $ (1.58) ------------------------------------------------------------------ Weighted average common and common equivalent shares outstanding 32,854 33,041 33,021 33,024 ------------------------------------------------------------------
Quarter Ended March 31, June 30, September 30, December 31, 1995 1995(4) 1995(5) 1995(6) ----------------------------------------------------------------- Operating revenues $ 209,652 $ 208,868 $ 211,137 $ 222,733 Operating earnings (loss) $ 16,253 $ 4,764 $ 1,118 $ (23,410) Net earnings (loss) $ 9,870 $ 2,177 $ 1,494 $ (13,523) Net earnings (loss) per common and common equivalent share $ 0.30 $ 0.07 $ 0.05 $ (0.42) ----------------------------------------------------------------- Weighted average common and common equivalent shares outstanding 32,402 32,157 31,952 32,416 =================================================================
(1) The first quarter operating results were affected by termination and related costs to streamline the Company's administrative process and reduce staffing in health centers, primarily in the Pennsylvania and St. Louis plans for total adjustments of $5.2 million. (2) The second quarter operating results were affected by the establishment of reserves relating to multi-year contracts with certain employer groups, primarily in the St. Louis market. The Company expects to utilize these reserves over the remaining lives of the contracts and then either discontinue the contracts or significantly change the terms and conditions of the contracts with these parties. The establishment of these reserves resulted in total adjustments of $8.2 million. (3) The fourth quarter operating results were affected by the increase of reserves related to accounts receivable ($3.6 million), long-term contracts ($1.6 million), medical claims ($25.6 million), termination costs ($2.1 million), other reserves ($6.0 million), write-offs of goodwill ($21.0 million) and certain capitalized expenses ($6.7 million). (4) The second quarter operating results of 1995 were affected by merger costs for the purchase of HCUSA, severance and related costs associated with staff restructuring in Pittsburgh and St. Louis, additions to accruals for professional liability litigation and the settlement of certain Office of Personnel Management negotiations for total adjustments of approximately $7.0 million. (5) The third quarter operating results of 1995 were affected by an increase in medical claims liabilities for the western Pennsylvania market and start up expenses associated with Medicaid and Medicare product development and geographic expansion initiatives for total adjustments of approximately $6.5 million. (6) The fourth quarter operating results of 1995 were affected by the elimination of several of its new market development areas, personnel reductions in the operations and increases in legal, medical and contingency reserves for total adjustments of $21.8 million. 44 47 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 45 48 PART III Item 10: Directors and Executive Officers of the Registrant The Company's directors and executive officers are as follows:
NAME AGE POSITION - ---- --- -------- John H. Austin, M.D........... 52 Director(1)(2) Philip N. Bredesen............ 53 Director Laurence DeFrance............. 52 Director(1)(2) Emerson D. Farley, Jr., M.D... 58 Director Richard H. Jones.............. 41 Director, Senior Vice President, Finance and Development Lawrence N. Kugelman.......... 54 Director Allen F. Wise................. 54 Director, Chief Executive Officer and President Joseph N. Carroll............. 58 Vice President of Operations Raul Coronado, M.D., M.S...... 58 Vice President and Medical Director Christopher T. Fey............ 45 Vice President James L. Gore................. 59 Vice President James R. Hailey............... 40 Vice President, Specialty Markets Jan H. Hodges................. 37 Vice President, Finance Nancy I. Lorenz............... 49 Vice President, Government Programs George R. Mark................ 36 Vice President Robert A. Mayer............... 54 Senior Vice President Frederick G. Merkel........... 43 Regional Vice President Thomas J. Murray.............. 51 Vice President Shirley R. Smith.............. 52 Vice President, Corporate General Counsel and Secretary Dale B. Wolf.................. 43 Senior Vice President, Chief Financial Officer and Treasurer
- --------------- (1) Member of Compensation and Benefits Committee (2) Member of Audit and Finance Committee Dr. Austin has been a director of the Company since January 1988 and was elected Chairman of the Board of Directors in December 1995. From October 1994 to March 1997, he served as President of the Professional Services Division of Unihealth, one of the nation's largest voluntary non-profit healthcare networks. From July 1992 to October 1994 he was a self-employed healthcare consultant. He was employed as Executive Vice President and Medical Director for Health Plan of America, a health maintenance organization ("HMO"), from 1987 until June 1992. Mr. Bredesen accepted a position as a director of the Company in April 1997. He was formerly a director of the Company from its founding in November 1986 to January 1993. He is currently the Mayor of the Metropolitan Government of Nashville and Davidson County, Tennessee, having been elected to that position in August 1991 and re-elected in August 1995. Mr. DeFrance has been a director of the Company since August 1990. He is currently self-employed. He was a member of the Board of Directors of DeVlieg-Bullard, Inc., a manufacturer of precision engineered machine tools, from April 1986 to December 1994. He was DeVlieg-Bullard's President from April 1986 to March 1992 and its Chief Executive Officer from December 1989 to March 1992. Dr. Farley has been a director of the Company since December 1994. Dr. Farley founded Medical Specialists, Inc., a multi-specialty internal medicine group located in Richmond, Virginia, in 1972, and has been a practicing member of that group since its inception. Since 1989 he has been the Medical Consultant for Signet Bank in Richmond, Virginia. From 1984 to 1994, he was the Chairman of the Board of Directors of Southern Health Management Corporation (now known as Coventry HealthCare Management Corporation). Mr. Jones has been a director of the Company since December 1995. A certified public accountant, Mr. Jones was named President and Chief Executive Officer of Group Health Plan, Inc. on October 7, 1996. He is 46 49 also Senior Vice President, Finance and Development of the Company and was Treasurer of the Company from June 1993 until December 1996. From November 1990 to June 1993, he was Vice President, Chief Financial Officer and Treasurer of the Company. Mr. Kugelman has been a director of the Company since August 1992. He was interim Chief Executive Officer and President of the Company from December 1995 until October 6, 1996. From March 1995 until December 1995 he was a self-employed healthcare consultant. He was Executive Vice President of American Medical International, an organization that owns and operates acute care hospitals nationwide, from January 1993 to March 1995. From July 1992 to December 1992, he was Executive Director of the Sisters of St. Joseph Healthcare Foundation, which was created in connection with HealthPlan of America's conversion from not-for-profit to for-profit status. He was President and Chief Executive Officer of Health Plan of America from September 1986 to July 1992. Mr. Wise was elected a director of the Company in October 1996. He was named President and Chief Executive Officer of the Company on October 7, 1996. He was Executive Vice President of MetraHealth Company, Inc. from October 1994 until it was acquired by United HealthCare Corp. in October 1995 and was Executive Vice President of United HealthCare Corp. from October 1995 until October 1996. From January 1994 to October 1994 he was President and Chief Executive Officer of Wise Health System, a healthcare investment company. From 1991 to 1994, Mr. Wise was President and Chief Executive Officer of Keystone Health Plan, a managed healthcare company, and was also Chief Operating Officer of Independence Blue Cross, a healthcare insurance company located in Philadelphia, Pennsylvania. Dr. Coronado was elected Vice President and Medical Director of the Company on April 16, 1997 and has served as Vice President and Chief Medical Officer of the Company's subsidiary HealthCare USA-Missouri, LLC since July 1996. From 1995 to June 1996, Dr. Coronado was the Chief Medical Officer for Harmony Health Plan, a West Orange, New Jersey HMO and from 1994 to 1995 he was the Chief Medical Officer of The Prudential Insurance Company/Prucare, an insurance company located in Suffren, New York. From 1993 to 1994, Dr. Coronado was the Medical Director for Fidelis Care, a Medicaid managed healthcare plan located in Brooklyn, New York. From 1988 to 1993, Dr. Coronado was the Associate Medical Director for US HealthCare, Inc., an HMO company located in Blue Belle, Pennsylvania, and also maintained a private family medical practice in Summit and Morristown, New Jersey. Mr. Carroll was elected Vice President of Operations of the Company on October 14, 1996. From April 1996 to October 1996, he was a self-employed healthcare consultant. From March 1992 to April 1996, Mr. Carroll was the Senior Vice President and Chief Information Officer of Independence Blue Cross, a healthcare insurance company located in Philadelphia, Pennsylvania. Mr. Fey has been a Vice President of the Company since September 1995. Since 1992 he has been Chief Executive Officer of HealthCare USA, Inc. From 1992 to November 1995 and from March 20, 1996 to the present he has been President of HealthCare USA, Inc. From 1990 to 1992, Mr. Fey was President of Healthcare Communication Services, Inc., a healthcare consulting and publishing company located in Gainesville, Florida. Mr. Gore has been a Vice President of the Company since December 1994. Since 1990 he has been President and Chief Executive Officer of Coventry HealthCare Management Company and its two subsidiaries, Southern Health Benefit Services, Inc., a third party claims administrator for claims processing, and Southern Health Services, Inc., a 57,000 member open panel HMO located in Richmond, Virginia. Mr. Hailey has been the Vice President, Specialty Markets, of the Company since March 1994. Prior to joining the Company, Mr. Hailey was employed by SmithKline Beecham Pharmaceuticals ("SmithKline"), an international pharmaceutical company. From March 1982 to March 1994, Mr. Hailey's experience at SmithKline included managed care sales, marketing, sales management and hospital sales. For more than three years, he practiced clinical pharmacy in a teaching hospital. Mr. Hailey holds a Doctor of Pharmacy license. Ms. Hodges has been the Vice President, Finance of the Company since November 1994. Ms. Hodges was Director of Taxation and Treasury of the Company from February 1991 to November 1994. Ms. Hodges is a certified public accountant. Ms. Lorenz has been the Vice President, Government Programs of the Company since March 1995. From January 1994 to March 1995, Ms. Lorenz served as Director of Government Programs for Sanus Corporate Health Systems (now known as NYLCare), a managed healthcare company, in Fort Lee, New Jersey, and was responsible for the nationwide expansion of Medicare and Medicaid risk contracts. From 1991 to 1993 she served as Medicare Program Coordinator for the Health Care Financing Administration in New York. Mr. Mark was named Vice President of the Company and Vice President and Chief Financial Officer of HealthAmerica Pennsylvania, Inc. on December 16, 1996. From October 1993 to December 1996, Mr. Mark was a partner with Coopers & Lybrand L.L.P., an international professional services firm. From September 1991 to October 1993, he was a senior manager with the same firm. Mr. Mark is a certified public accountant. 47 50 Mr. Mayer was named Senior Vice President of the Company and Chief Operating Officer of HealthAmerica Pennsylvania, Inc. on February 10, 1997. From November 1994 to February 1997, he was President and Chief Executive Officer of Independence Financial Services Corp., an insurance holding company located in Stamford, Connecticut. From February 1989 to November 1994, Mr. Mayer was Senior Vice President, Chief Financial Officer, Treasurer and a Director of Sierra Health Services, Inc., a managed care company located in Las Vegas, Nevada which provides a wide range of services. Mr. Merkel has been a Regional Vice President of the Company since April 1994. Since October 1995 he has been Chief Executive Officer of HealthAmerica Pennsylvania, Inc. He was President and Chief Executive Officer of HealthAmerica of Central Pennsylvania, a division of HealthAmerica Pennsylvania, Inc., from February 1991 to October 1995. Mr. Murray has been a Vice President of the Company since December 1995. He is also Senior Vice President and Chief Marketing Officer of HealthAmerica Pennsylvania, Inc. He previously served as President, from November 1995 to March 1997, and as Senior Vice President, Marketing from October 1988 to November 1995, of HealthAmerica Pennsylvania, Inc.'s Pittsburgh operation. Ms. Smith has been a Vice President, Corporate General Counsel and Secretary of the Company since March 1994. From August 1993 to March 1994, she was Acting General Counsel and Secretary of the Company. From April 1989 to August 1993, she was Assistant General Counsel of the Company. Mr. Wolf was elected Senior Vice President, Chief Financial Officer and Treasurer of the Company on December 9, 1996. From August 1995 to December 1996, he was Executive Vice President of SpectraScan Health Services, Inc., a Connecticut women's healthcare services company. From January 1995 to August 1995, Mr. Wolf was Senior Vice President, Business Development for MetraHealth Companies, Inc., a Connecticut managed healthcare company. Prior to that, from August 1988 to December 1994, Mr. Wolf was Vice President, Specialty Operations Officer for the Managed Care and Employee Benefits Operations of The Travelers, a Hartford, Connecticut insurance company. Mr. Wolf is a Fellow of the Society of Actuaries. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Based solely upon a review of Forms 3, 4 and 5 and amendments thereto furnished to the Company during fiscal year 1996 pursuant to Rule 16a-3(e) of the Exchange Act and upon written representations from reporting persons that Form 5 was not required to report late filings, all reporting persons filed on a timely basis, except the following: Christopher T. Fey filed one late report relating to three transactions. --------------------- 48 51 Item 11: Executive Compensation The following table sets forth annual, long-term and other compensation awarded to, earned by or paid to the Chief Executive Officer and the persons who, in fiscal 1996, were the other four most highly compensated executive officers of the Company (the "Named Executive Officers") for the three fiscal years ended December 31, 1994, 1995 and 1996: SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION AWARDS --------------- ANNUAL COMPENSATION SECURITIES ------------------- UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS/SARS(#) COMPENSATION - --------------------------- ---- -------- -------- --------------- ------------ Allen F. Wise (1)...................... 1996 $137,395 $ -- 400,000 $ -- President & Chief Executive Officer 1995 -- -- -- -- 1994 -- -- -- -- Lawrence N. Kugelman(2)................ 1996 247,262 -- 25,000(3) 6,500(5) Director, Former President & Chief 1995 24,167 -- 2,000(4) 27,000(6) Executive Officer 1994 -- -- 2,000(4) 26,000(6) Frederick G. Merkel.................... 1996 245,607 -- 100,000(3) 1,182(5) Regional Vice President 1995 219,371 -- 25,000 2,910(5) 1994 151,940 67,500 60,000 1,000(5) Richard H. Jones....................... 1996 229,588 -- 100,000(3) 6,750(5) Senior Vice President, Finance & 1995 205,000 -- 25,000 6,000(5) Development 1994 180,290 64,000 -- 6,000(5) Thomas J. Murray....................... 1996 229,343 -- 20,000(3) 11,177(5) Vice President 1995 198,799 12,637 25,000 9,123(5) 1994 134,675 65,900 -- 4,587(5) Christopher T. Fey..................... 1996 220,966 -- 25,000(3) -- Vice President 1995 222,819 -- 140,000 -- 1994 143,162 -- -- --
- --------------- (1) Allen F. Wise was appointed President and Chief Executive Officer effective October 7, 1996. (2) Lawrence N. Kugelman served as interim President and Chief Executive Officer from December 14, 1995 through October 6, 1996. (3) Does not include options granted in exchange for outstanding options. See Report on Repricing of Options, p. 11 of this Proxy Statement. (4) Options granted under the 1993 Directors Plan. (5) Consists of employee contributions to the Company's Retirement Savings Plan and related nonqualified Supplemental Executive Retirement Plan. (6) Consists of Outside Director fees. 49 52 The following table provides information on option grants to the Named Executive Officers during fiscal 1996. No stock appreciation rights ("SARs") were granted during fiscal 1996. OPTION/SAR GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS(1) ------------------------------------------------- PERCENT OF TOTAL NUMBER OF OPTIONS/ POTENTIAL REALIZABLE VALUE AT SECURITIES SARS ASSUMED ANNUAL RATES OF UNDERLYING GRANTED TO EXERCISE STOCK PRICE APPRECIATION OPTIONS/ EMPLOYEES OR BASE FOR OPTION TERM SARS IN FISCAL PRICE EXPIRATION ------------------------------ NAME GRANTED(#) YEAR ($/SHARE) DATE 5% 10% - ---- ----------- ---------- --------- ---------- ------------- ------------- Allen F. Wise................. 400,000 35.4% $11.00 10/07/06 $2,772,000 $6,996,000 Lawrence N. Kugelman.......... 25,000 2.2 12.75 03/01/06 200,813 506,813 Frederick G. Merkel........... 100,000 8.8 12.75 09/06/06 803,250 2,027,250 Richard H. Jones.............. 100,000 8.8 12.75 09/06/06 803,250 2,027,250 Thomas J. Murray.............. 20,000 1.8 12.75 03/01/06 160,650 405,450 Christopher T. Fey............ 25,000 2.2 12.75 03/01/06 200,813 506,813
- --------------- (1) Generally, all options vest in equal increments annually over a four year period; Mr. Wise's options vest in equal increments annually over three years. Upon a sale or transfer of all or substantially all of the capital stock or assets of the Company, or a merger or consolidation with an unaffiliated entity, all options will fully vest immediately. The following table provides information as to options exercised or held during fiscal 1996 by the Named Executive Officers: AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
NUMBER OF SECURITIES VALUE OF UNDERLYING UNEXERCISED UNEXERCISED IN-THE-MONEY OPTIONS/SARS AT OPTIONS/SARS AT FISCAL YEAR-END FISCAL YEAR-END (#) ($) SHARES ---------------- ---------------- ACQUIRED ON VALUE EXERCISABLE(E)/ EXERCISABLE(E)/ NAME EXERCISE (#) REALIZED ($) UNEXERCISABLE(U) UNEXERCISABLE(U) - ---- ------------ ------------ ---------------- ---------------- Allen F. Wise................... -- $ -- --E $ --E 400,000U --U Lawrence N. Kugelman............ -- -- 29,000E --E --U --U Frederick G. Merkel............. -- -- 80,168E 8,046E 152,500U --U Richard H. Jones................ -- -- 121,036E 4,321E 127,500U --U Thomas J. Murray................ -- -- 48,584E --E 41,750U --U Christopher T. Fey.............. -- -- 50,000E --E 115,000U --U
50 53 COMPENSATION AND BENEFITS COMMITTEE Laurence DeFrance (Chair) John H. Austin, M.D. DIRECTORS' COMPENSATION All directors are reimbursed by the Company for out-of-pocket expenses incurred in connection with attendance at meetings. Members of the Board of Directors who are not officers or employees of the Company, its subsidiaries or affiliates ("Outside Directors") each receive an annual retainer of $16,000 paid in quarterly installments of $4,000 each. Outside Directors also receive $1,000 for each meeting of the Board of Directors or any committee thereof attended, and $500 for each telephonic meeting. Pursuant to the 1993 Outside Directors Stock Option Plan, as amended (the "1993 Directors Plan"), each director who is not an employee of or consultant to the Company or one of its subsidiaries receives a grant of stock options for 2,000 shares, or 6,000 shares in the case of the Chairman of the Board of Directors, of the Company's Common Stock on January 1 of each year. Because Dr. Farley serves as a consultant to Coventry HealthCare Management Corporation, a subsidiary of the Company, he is eligible to receive options under the Company's stock option plans for employees and consultants but is not eligible to receive options under the 1993 Directors Plan. Mr. Kugelman did not receive the stock option grant on January 1, 1996, because he was employed by the Company as Interim President and Chief Executive Officer on that date. EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS Allen F. Wise. Mr. Wise entered into an Employment Agreement effective October 7, 1996 for an initial term of one year (the "Initial Term"), which will continue on a year-to-year basis as long as a new employment contract is not executed or the agreement has not been otherwise terminated. Under the terms of the agreement, Mr. Wise receives a base salary of $450,000 per year. In addition, upon execution of the agreement, Mr. Wise received non-qualified stock options to purchase 400,000 shares of the Company's Common Stock at an exercise price of $11.00 per share, the fair market value per share of the Common Stock as of October 7, 1996. These options will vest over a period of three years, subject to acceleration in the event that substantially all of the assets or capital stock of the Company are sold or transferred or the Company is merged or consolidated with an unaffiliated entity. Mr. Wise is also eligible to receive an annual incentive bonus of up to 100% of his base salary, determined 50% on achievement of performance factors by the Company and the remainder to be granted in the sole discretion of the Compensation and Benefits Committee of the Board of Directors. If Mr. Wise's employment is terminated by the Company for any reason other than cause, or he terminates his employment with the Company as a result of a significant change in the nature or the scope of his position and authority following a Change in Control (as defined below), the Company will continue to pay his base salary at that time plus that portion of his annual incentive bonus which is based on the Company's performance, if those criteria are met, for a period of twelve months, plus any time period remaining in the Initial Term. In consideration of these benefits, Mr. Wise agreed not to compete with the Company during the term of his employment and for one year thereafter. Christopher T. Fey. Mr. Fey entered into an Employment Agreement with HealthCare USA, Inc., effective February 17, 1994, which was amended by an Amendment dated February 3, 1995, and executed by Mr. Fey, HealthCare USA, Inc. and the Company. Under the terms of this agreement, Mr. Fey receives a base salary (currently $220,096 per year) and is also eligible to participate in the Company's bonus programs available to officers. If Mr. Fey's employment is terminated by the Company for any reason other than cause, the Company will continue to pay his base salary at the time for a period of one year following termination of employment. In consideration of these benefits, Mr. Fey agreed not to compete with the Company during the term of his employment and for one year thereafter. Richard H. Jones. Mr. Jones entered into an Employment Agreement with the Company effective November 11, 1996 for an initial term of two years, which will continue on a year-to-year basis as long as a new employment contract is not executed or the agreement has not been otherwise terminated. Under the terms of this agreement, Mr. Jones receives a base salary of $265,000 per year and was granted non-qualified options to purchase 100,000 shares of the Company's Common Stock at an exercise price of $12.75 per share, the fair market value per share of the Common Stock as of September 6, 1996. These options will vest over a period of four years, subject to acceleration in the event that substantially all of the assets or capital stock of the Company are sold or transferred or the Company is merged or consolidated with an unaffiliated entity. Of the options granted to Mr. Jones under his Employment Agreement, options to purchase 25,000 shares were exchanged for existing nonvested options to purchase the same number of shares at a higher price. Mr. Jones is eligible to participate in any annual incentive bonus programs available to officers of the Company and to receive other incentive compensation as determined annually by the Compensation and Benefits Committee of the Board of Directors. Additionally, Mr. Jones will be eligible to receive a retention bonus in the amount of $400,000 to be paid in full on January 31, 1999, if he is and has been continuously employed with the Company or a subsidiary of the Company until that time. In the event Mr. Jones terminates his employment for Good Reason (as defined below), or in the event the Company terminates his employment for any reason other than cause, Mr. Jones will continue to receive his yearly base salary for a period of 24 months following termination and will be allowed to exercise any vested options. In the event Mr. Jones' employment is terminated at any time within three years following the occurrence of a Change in Control (as defined below), the terms of this agreement, except with respect to the exercise and acceleration of options to purchase Common Stock, will become null and void, and the 51 54 terms and conditions of that certain Change in Control Agreement executed by Mr. Jones and the Company as of September 12, 1995 will control. In consideration of these benefits, Mr. Jones agreed not to compete with the Company during the term of his employment and for two years thereafter. Under the terms and conditions of that Change in Control Agreement, in exchange for an agreement not to compete with the Company for a period of one year following the termination of his employment with the Company, Mr. Jones will receive an amount equal to 299.99% of his base salary plus 299.99% of his annual bonus if at any time within three years after a Change in Control (as defined below) his employment is terminated by the Company for any reason other than cause, or if he terminates his employment with the Company for Good Reason (as defined below). Under this agreement, benefits are payable as follows: (i) one-third of the total amount due will be paid in substantially equal semi-monthly installments over the twelve months immediately following termination of employment; and (ii) the remaining two-thirds will be paid in a lump sum within five business days after the expiration of such twelve month period. Frederick G. Merkel. Mr. Merkel entered into an Employment Agreement with the Company effective September 1, 1996, for an initial term of two years, which will continue on a year-to-year basis as long as a new employment contract is not executed or the agreement has not been otherwise terminated. Under the terms of this Agreement, Mr. Merkel receives a base salary of $265,000 per year, and was granted options to purchase 100,000 shares of the Company's Common Stock at an exercise price of $12.75 per share, the fair market value per share of the Common Stock as of September 6, 1996. These options will vest over a period of four years, subject to acceleration in the event that substantially all of the assets or capital stock of the Company are sold or transferred or the Company is merged or consolidated with an unaffiliated entity. Of the options granted to Mr. Merkel under his Employment Agreement, options to purchase 25,000 shares were exchanged for existing nonvested options to purchase the same number of shares at a higher price. Mr. Merkel is eligible to participate in any annual incentive bonus programs available to officers of the Company and to receive other incentive compensation as determined annually by the Compensation and Benefits Committee of the Board of Directors. Additionally, Mr. Merkel will be eligible to receive a retention bonus in the amount of $400,000 to be paid in full on January 31, 1999, if he is and has been continuously employed with the Company or a subsidiary of the Company until that time. In the event Mr. Merkel terminates his employment for Good Reason (as defined below), or in the event the Company terminates his employment for any reason other than cause, Mr. Merkel will continue to receive his yearly base salary for a period of 24 months following termination and will be allowed to exercise any vested options. In the event Mr. Merkel's employment is terminated at any time within three years following the occurrence of a Change in Control (as defined below), the terms of this agreement, except with respect to the exercise and acceleration of options to purchase Common Stock, will become null and void, and the terms and conditions of that certain Change in Control Agreement executed by Mr. Merkel and the Company as of September 12, 1995 will control. In consideration of these benefits, Mr. Merkel agreed not to compete with the Company during the term of his employment and for two years thereafter. Under the terms and conditions of that Change in Control Agreement, in exchange for an agreement not to compete with the Company for a period of one year following the termination of his employment with the Company, Mr. Merkel will receive an amount equal to 299.99% of his base salary plus 299.99% of his annual bonus if at any time within three years after a Change in Control (as defined below) his employment is terminated by the Company for any reason other than cause, or he terminates his employment with the Company for Good Reason (as defined below). Under this agreement, benefits are payable as follows: (i) one-third of the total amount due will be paid in substantially equal semi-monthly installments over the twelve months immediately following termination of employment; and (ii) the remaining two-thirds will be paid in a lump sum within five business days after the expiration of such twelve month period. Thomas J. Murray. Mr. Murray entered into an Employment Agreement with the Company effective July 28, 1995, for an initial term of one year, which will continue on a year-to-year basis as long as a new employment contract is not executed or the agreement has not been otherwise terminated. Under the terms of this agreement, Mr. Murray receives a base salary (currently $227,513 per year) and is also eligible to participate in any annual incentive bonus programs available to officers of the Company and to receive other incentive compensation as determined annually by the Compensation and Benefits Committee of the Board of Directors of the Company. During the term of the Agreement, if Mr. Murray's employment is terminated for any reason other 52 55 than cause, or Mr. Murray terminates his employment for Good Reason (as defined below), Mr. Murray will continue to receive his yearly base salary for a period of 12 months following termination. If at any time within two years following the occurrence of a Change in Control Mr. Murray's employment with the Company is terminated for any reason other than cause, or he terminates his employment for Good Reason, Mr. Murray will receive 150% of his base salary and 150% of his bonus at the time of termination. In consideration of these benefits, Mr. Murray agreed not to compete with Company during the term of his employment and for a period of one year thereafter or 18 months thereafter in the case of termination following a Change in Control. Definitions. For purposes of the agreements described above, a "Change in Control" is defined to include any of the following events: (i) the acquisition of at least a majority of the outstanding shares of the Company's Common Stock by any person or entity; (ii) the merger or consolidation of the Company into or with another entity if, as a result, the persons who owned a majority of the Common Stock prior to the transaction do not own a majority after the transaction; (iii) the sale of substantially all of the assets of the Company; or (iv) any change in the composition of the Board of Directors such that persons who at the beginning of any period of up to two years constituted at least a majority of the Board of Directors cease to constitute at least a majority of the Board of Directors at the end of such period. For purposes of the agreements described above, "Good Reason" is generally defined to include a significant change in the nature or scope of the executive's position and authority or a reduction in base salary. In the Change in Control Agreements and Mr. Murray's Employment Agreement, "Good Reason" also includes certain substantial reductions in incentive compensation or a change in the location in which the executive is required to perform services. Acceleration of Other Options on a Change in Control. The Compensation and Benefits Committee has determined that certain key executive officers who are granted stock options under the Company's stock option plans will become fully vested in all options granted to them if, during their employment, substantially all of the capital stock or assets of the Company are sold or transferred, or if the Company is merged into or consolidated with another unaffiliated entity. 53 56 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During the year ended December 31, 1996, the members of the Compensation and Benefits Committee were Laurence DeFrance (Chair), Emerson D. Farley, Jr., M.D. and John H. Austin, M.D. Neither Mr. DeFrance nor Dr. Austin is an officer or employee or former officer or employee of the Company or any of its subsidiaries; and neither Mr. DeFrance nor Dr. Austin has any relationship requiring disclosure by the Company under applicable rules and regulations promulgated by the Securities and Exchange Commission. As described below, Dr. Farley serves as a consultant to a subsidiary of the Company. Dr. Farley resigned from the Compensation and Benefits Committee on December 18, 1996. After the 1996 annual meeting of shareholders, Dr. Farley did not participate in decisions of the Compensation and Benefits Committee concerning executive compensation that would otherwise qualify for the performance-based compensation exemption from the $1,000,000 limit on the tax deductibility of certain executive compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). The Company and Dr. Farley entered into a Consulting Agreement dated January 1, 1995, under which Dr. Farley provides consulting services to Coventry HealthCare Management Corporation, the Company's subsidiary headquartered in Richmond, Virginia, in exchange for a fee of $72,000 per annum. Dr. Farley served as Chairman of Southern Health Management Corporation, the predecessor of Coventry HealthCare Management Corporation, prior to its acquisition by the Company on December 1, 1994. The Consulting Agreement is for a period of one year renewable annually but may be terminated by either party by giving the other party 60 days prior written notice of such termination. In addition, unvested non-qualified options held by Dr. Farley to purchase 5,000 shares of Common Stock at an exercise price of $24.50 per share and vested non-qualified options held by Dr. Farley to purchase 7,000 shares of Common Stock at an exercise price of $24.50 per share were exchanged on September 6, 1996 and November 6, 1996 for new options to purchase the equivalent number of shares at the fair market value as of September 6, 1996 of $12.75 per share. The fair market value of the Company's Common Stock as of November 6, 1996 was $9.625 per share. 54 57 Item 12: Security Ownership of Certain Beneficial Owners and Management The following table sets forth certain information, as of March 31, 1997, regarding the beneficial ownership of the Company's Common Stock by (i) each person or group who is known by the Company to be the beneficial owner of more than five percent of the Common Stock, (ii) all directors and nominees for director of the Company, (iii) each executive officer named in the Executive Compensation Table and (iv) all directors and executive officers of the Company as a group. The number of shares beneficially owned by each director or executive officer is determined under rules promulgated by the Securities and Exchange Commission, and the information is not necessarily indicative of beneficial ownership for any other purpose. The Company believes that each of the beneficial owners of the Common Stock listed below, based on information furnished by such owner, has sole voting and investment power (or shares such powers with his or her spouse or in the case of an entity, with its affiliates) with respect to such shares, subject to the information contained in the notes to the table.
AMOUNT AND NATURE OF PERCENT BENEFICIAL OF VOTING NAME AND ADDRESS OF BENEFICIAL OWNER OWNERSHIP STOCK(1) - ------------------------------------ ---------- --------- Massachusetts Financial Services Company(2)................. 3,282,065 9.9% 500 Boylston Street Boston, MA 02116 The Crabbe Huson Group, Inc.(3)............................. 2,539,500 7.7% 121 S.W. Morrison, Suite 1400 Portland, OR 97204 Neuberger & Berman, LLC(4).................................. 2,509,200 7.6% 605 Third Avenue New York, NY 10158-3698 Philip N. Bredesen.......................................... 1,769,276 5.4% Office of the Mayor 107 Metropolitan Courthouse Nashville, TN 37201 John H. Austin, M.D......................................... 29,834(5) * Laurence DeFrance........................................... 13,334(5) * Emerson D. Farley, Jr., M.D................................. 77,510(5) * Christopher T. Fey.......................................... 510,640(5) 1.6% Richard H. Jones............................................ 121,036(5) * Lawrence N. Kugelman........................................ 64,000(5) * Frederick G. Merkel......................................... 80,688(5) * Thomas J. Murray............................................ 48,584(5) * Allen F. Wise............................................... 2,125 * Executive Officers and Directors as a Group (19 persons).... 1,046,229(5) 8.6%
- --------------- * Less than one percent. (1) For purposes of this table, a person or group of persons is deemed to beneficially own shares issuable upon the exercise of warrants or options that are currently exercisable or that will become exercisable within 60 days from the date set forth above. (2) According to its most recent Schedule 13G, Massachusetts Financial Services Company is a Delaware corporation. (3) According to its most recent Schedule 13G, the Crabbe Huson Group, Inc. is an Oregon corporation. (4) According to its most recent Schedule 13G, Neuberger & Berman, LLC is a New York limited liability company. (5) Includes the following shares issuable upon exercise of stock options which are currently exercisable or which will become exercisable within 60 days of the date set forth above: John H. Austin, M.D., 15,334 shares subject to options; Laurence DeFrance, 11,334 shares subject to options; Emerson D. Farley, Jr., M.D., 17,000 shares subject to options; Christopher T. Fey, 50,000 shares subject to options; Richard H. Jones, 121,036 shares subject to options; Lawrence N. Kugelman, 29,000 shares subject to options; Frederick G. Merkel, 80,168 shares subject to options; Thomas J. Murray, 48,584 shares subject to options; and all executive officers and directors as a group (19 persons), 443,168 shares subject to options. 55 58 Item 13: Certain Relationships and Related Transactions The Company and Dr. Emerson D. Farley, Jr. entered into a Consulting Agreement dated January 1, 1995, under which Dr. Farley provides consulting services to Coventry Healthcare Management Corporation, the Company's subsidiary headquartered in Richmond, Virginia, in exchange for a fee of $72,000 per annum. The Consulting Agreement is for a period of one year renewable annually but may be terminated by either party by giving the other party 60 days prior written notice of such termination. In addition, unvested non-qualified options held by Dr. Farley to purchase 5,000 shares of Common Stock at an exercise price of $24.50 per share and vested non-qualified options held by Dr. Farley to purchase 7,000 shares of Common Stock at an exercise price of $24.50 per share were exchanged on September 6, 1996 and November 6, 1996 for new options to purchase the equivalent number of shares at the fair market value as of September 6, 1996 of $12.75 per share. The fair market value of the Company's Common Stock as of November 6, 1996 was $9.625 per share. Christopher T. Fey and his wife, Tamara T. Fey, entered into a revolving line of credit promissory note (the "Note") on April 15, 1994, in the original principal amount of $250,000, in favor of HealthCare USA, Inc., headquartered in Jacksonville, Florida. The Company acquired HealthCare USA, Inc. on July 28, 1995. The maturity date of the Note is the earlier of December 31, 1997 or the date that Mr. Fey ceases to be employed by HealthCare USA, Inc. 56 59 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Consolidated Balance Sheets, December 31, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . 25 Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Notes to Consolidated Financial Statements, December 31, 1996, 1995, and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 to 44 2. Financial statement schedule 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. Exhibits required to be filed by Item 601 of Regulation S-K, whether filed herewith or incorporated herein by reference, are listed on the Index to Exhibits of this filing. (b) 1. Reports on Form 8-K Form 8-K relating to February 24, 1997 press release was filed on February 26, 1997.
57 60 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 CORPORATION By: /s/ Allen F. Wise President, Chief Executive Officer and ------------------------- Director Allen F. Wise Dated: April 30, 1997 58 61 ARTHUR ANDERSEN LLP Nashville, Tennessee REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Coventry Corporation: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Coventry Corporation and subsidiaries for the three years ended December 31, 1996 included in the Form 10-K and have issued our report thereon dated February 21, 1997 (except for Notes G and S, as to which the date is March 31, 1997). 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)(ii) 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 Nashville, Tennessee February 21, 1997 S-1 62 SCHEDULE II COVENTRY CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (in thousands)
Balance at Additions Beginning of Charged to Costs Deductions Balance at Period and Expenses (1) (Charge Offs) (1) End of Period ------------ ----------------- ----------------- ------------- Year ended December 31, 1996: Allowance for doubtful accounts $ 2,700 $ 8,000 $(2,700) $ 8,000 ======= ======= ======= ======= Year ended December 31, 1995: Allowance for doubtful accounts $ 2,200 $ 3,100 $(2,600) $ 2,700 ======= ======= ======= ======= Year ended December 31, 1994: Allowance for doubtful accounts $ 1,240 $ 4,100 $(3,140) $ 2,200 ======= ======= ======= =======
(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. S-2 63 INDEX TO EXHIBITS Reg. S-K Item 601 Exhibit No. Description of Exhibit (2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession: (i) Agreement and Plan of Merger dated February 3, 1995 among the Company, Coventry Acquisition Corporation and HealthCare USA, Inc. (Incorporated by reference to Exhibit 2.1 to Form S-4 on Form S-3, Registration Statement Nos. 33-90268 and 33-95084) (ii) Stock Purchase and Sale Agreement dated as of October 31, 1994 between the Company and Presbyterian University Hospital. (Incorporated by reference to Exhibit 2.1 to Form 8-K dated October 31, 1994 and filed with the SEC on November 2, 1994) (iii) Stock Purchase and Merger Agreement by and among AHP Holdings, Inc., PARTNERS Health Plan of Pennsylvania, Inc., the Company and Coventry Acquisition Corporation dated as of December 18, 1995 (Incorporated by reference to Exhibit 2.2 to Annual Report on Form 10-K for the year ended December 31, 1995) and Amendment No. 1 thereto dated March 20, 1996 (Incorporated by reference to Exhibit 2(ii) to the PARTNERS Health Plan of Pennsylvania, Inc. Current Report on Form 8-K dated March 20, 1996). (3) Articles of Incorporation and Bylaws: (i) Fifth Restated Certificate of Incorporation of Coventry Corporation (Incorporated by reference to Exhibit 3.1 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1994) (ii) Bylaws of Coventry Corporation (Incorporated by reference to Exhibit 3.2 to Form S-1, Registration Statement No. 33-36616), Amendment No. 1 (Incorporated by reference to Exhibit 3.2.1 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1994), and Amendment No. 2 (See Exhibit 3.2.2 attached to the Annual Report on Form 10-K for the year ended December 31, 1995). (4) Instruments Defining the Rights of Security Holders, Including Indentures: (i) Specimen Common Stock Certificate (See Exhibit 4.1 attached to the Annual Report on Form 10-K for the year ended December 31, 1995 and the Company's Certificate of Incorporation referenced at (3)(i) above) (ii) See Second Amended and Restated Credit Agreement referenced at 10(i) below and the amendments thereto referenced at 10(i), 10(xx) and 10(xxi) below. (iii) Shareholder Rights Agreement dated February 7, 1996 between the Company and Chemical Mellon Shareholder Services, L.L.C. (Incorporated by reference to Exhibit 4 to Form 8-K, Current Report, dated February 7, 1996) 64 (10) Material Contracts (i) Second Amended and Restated Credit Agreement dated as of November 20, 1992 among the Company, Morgan Guaranty Trust Company of New York, Fleet National Bank, Third National Bank in Nashville, NationsBank of Tennessee, N.A., Citicorp USA, Inc., Mellon Bank, N.A., First American National Bank, and Morgan Guaranty Trust Company of New York as Agent ($125,000,000 Credit Facility) (See Exhibit 10.6 attached to the Annual Report on Form 10-K for the year ended December 31, 1995) and related documents (Incorporated by reference to Exhibit 10.6 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1994), Amendment No. 1 (See Exhibit 10.6.1 attached to the Annual Report on Form 10-K for the year ended December 31, 1995) and Amendment No. 2 (See Exhibit 10.6.2 attached to the Annual Report on Form 10-K for the year ended December 31, 1995) (ii) Amended and Restated Employment Agreement dated December 1, 1994, between Southern Health Management Corporation, the Company and James L. Gore (Incorporated by reference to Exhibit 10.7.7 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1994)* (iii) Employment Agreement dated February 17, 1994 between HealthCare USA, Inc. and Christopher T. Fey, as amended by Amendment to Employment Agreement dated February 3, 1995 between HealthCare USA, Inc., the Company and Mr. Fey (effective as to the Company on July 28, 1995) (Incorporated by reference to Exhibit (xxv) to Form 10-Q, Quarterly Report, for the quarter ended September 30, 1995)* (iv) Employment Agreement dated September 16, 1996 executed by Allen F. Wise** (v) Employment Agreement dated December 30, 1996 executed by Dale B. Wolf** (vi) Form of Company's Agreement (for Key Senior Executives) dated September 12, 1995 (executed by Richard H. Jones and Frederick G. Merkel) (Incorporated by reference to Exhibit (xxviii) to Form 10-Q, Quarterly Report, for the quarter ended September 30, 1995)* (vii) Form of Company's Agreement (for Key Executives) dated September 12, 1995 (executed by James R. Hailey, Jan H. Hodges, Nancy I. Lorenz and Shirley R. Smith) (Incorporated by reference to Exhibit (xxix) to Form 10-Q, Quarterly Report, for the quarter ended September 30, 1995)* (viii) Employment Agreement dated as of July 28, 1995, between Thomas Murray, HealthAmerica Pennsylvania, Inc. and the Company (See Exhibit 10.7.1 attached to the Annual Report on Form 10-K for the year ended December 31, 1995)* (ix) Second Amended and Restated 1987 Statutory-Nonstatutory Stock Option Plan (Incorporated by reference to Exhibit 10.8.1 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1993)* 65 (x) Third Amended and Restated 1989 Stock Option Plan (Incorporated by reference to Exhibit 10.8.2 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1993)* (xi) 1993 Outside Directors Stock Option Plan (as amended)(See Exhibit 10.8.3 attached to the Annual Report on Form 10-K for the year ended December 31, 1995)* (xii) 1993 Stock Option Plan (as amended)(See Exhibit 10.8.4 attached to the Annual Report on Form 10-K for the year ended December 31, 1995)* (xiii) Coventry Corporation Supplemental Executive Retirement Plan effective July 1, 1994 (Incorporated by reference to Exhibit 4.2 to Form S-8, Registration Statement No. 33-81358)* (xiv) Coventry Share Plan (stock purchase plan) effective September 1, 1994 (Incorporated by reference to Exhibit 4.1 to Form S-8, Registration Statement No. 33-82562)* (xv) Southern Health Management Corporation 1993 Stock Option Plan (See Exhibit 10.8.5 attached to the Annual Report on Form 10-K for the year ended December 31, 1995)* (xvi) Coinsurance Agreement effective January 1, 1995, between American Service Life Insurance Company (now known as Coventry Health and Life Insurance Company) and Mid-West National Life Insurance Company of Tennessee (See Exhibit 10.9.1 attached to the Annual Report on Form 10-K for the year ended December 31, 1995) (xvii) Assumption Reinsurance Agreement between American Service Life Insurance Company (now known as Coventry Health and Life Insurance Company) and Mid-West National Life Insurance Company of Tennessee (See Exhibit 10.9.2 attached to the Annual Report on Form 10-K for the year ended December 31, 1995) (xviii) Subordinated Promissory Surplus Note dated May 12, 1995 in the amount of $2,797,445 from HealthCare USA of Missouri, L.L.C. to the Company (See Exhibit 10.9.3 attached to the Annual Report on Form 10-K for the year ended December 31, 1995) (xix) License Agreement dated as of December 31, 1992 between Maxicare Health Plans, Inc. and the Company (Incorporated by reference to Exhibit 10.18.1 attached to Annual Report in Form 10-K for fiscal year ended December 31, 1993) and Amendment No. 1 to License Agreement between Maxicare Health Plans, Inc. and the Company (Incorporated by reference to Exhibit 10.18.2 attached to Annual Report on Form 10-K for fiscal year ended December 31, 1993) (xx) Amendment No. 3 to the Second Amended and Restated Credit Agreement, dated as of September 30, 1996, among the Company, the Banks listed on the signature pages thereof and Morgan Guaranty Trust Company of New York as Agent (See Exhibit 10.6.3 attached to the Annual Report on Form 10-K for the year ended December 31, 1996).** (xxi) Amendment No. 4 to the Second Amended and Restated Credit Agreement, dated as of January 10, 1997, among the Company, the Banks listed on the signature pages thereof and Morgan Guaranty Trust Company of New York as Agent (See Exhibit 10.6.4) attached to the Annual Report on Form 10-K for the year ended December 31, 1996.** (xxii) Employment Agreement dated October 14, 1996 executed by Joe Carroll** (xxiii) Employment Agreement dated January 1, 1997 executed by Jan H. Hodges** (xxiv) Employment Agreement dated November 11, 1996 executed by Richard H. Jones** (xxv) Employment Agreement dated January 15, 1997 executed by Nancy I. Lorenz** (xxvi) Employment Agreement dated January 27, 1997 executed by George R. Mark** (xxvii) Employment Agreement dated January 24, 1997 executed by Robert A. Mayer** (xxviii) Employment Agreement dated February 10, 1996 executed by Frederick G. Merkel** (xxix) Employment Agreement dated January 15, 1997 executed by Shirley R. Smith** (xxx) Retention Bonus Agreement dated December 31, 1996, executed by James L. Gore** (11) Statement re Computation of Per Share Earnings (i) Computation of Net Earnings Per Common and Common Equivalent Share (See Exhibit 11 attached to this Report). (21) Subsidiaries of the Registrant (i) Subsidiaries of the Registrant (See Exhibit 21 attached to this Report) (23) Consents of Experts and Counsel (i) Consent of Arthur Andersen LLP (See Exhibit 23 attached to this Report) All other exhibits for which provision is made in Item 601 of Regulation S-K promulgated by the Securities and Exchange Commission are either not required by the instructions to Item 601 or are inapplicable and, therefore, have been omitted. * Management contract or compensatory plan. ** Previously filed as part of Annual Report on Form 10-K for fiscal year ended December 31, 1996. (27) Financial Data Schedule EX-11 2 COMPUTATION OF PER SHARE EARNINGS 1 Exhibit 11 Coventry Corporation Computation of Net Earnings Per Common and Common Equivalent Share (1)
Years ended December 31 ------------------------------------------------ (amounts in thousands except per share data) 1996 1995 1994 - ------------------------------------------------------------------------------- ------------- -------------- ------------- Net Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(61,287) $ 18 $29,288 ============= ============== ============= Weighted average number of common shares: Shares outstanding at beginning of period (2) . . . . . . . . . . . . . . 32,277 31,194 30,306 Effect of exercise of stock options, warrants and employee plans . . . . 538 332 205 Weighted average number of common and common equivalent shares: Additional equivalent shares issuable from assumed exercise of stock options 196 638 914 ------------- -------------- ------------ Weighted average number of common and common equivalent shares outstanding - primary basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,011 32,164 31,425 Incremental (decremental) equivalent shares from application of the fully diluted computation . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 (14) 125 ------------- -------------- ------------- Weighted average number of common and common equivalent shares outstanding - fully diluted basis . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,019 32,150 31,550 ============= ============== ============= Net earnings per common and common equivalent share: Primary and fully diluted . . . . . . . . . . . . . . . . . . . . . . . . $ (1.86) $ 0.00 $ 0.93 ============= ============== =============
(1) After giving effect to 2 for 1 stock split in the form of a stock dividend on August 3, 1994. (2) Restated for the purchases of HealthCare USA in 1995 and Southern Health Management Corporation in 1994 accounted for as poolings of interests. EX-21 3 SUBSIDIARES OF REGISTRANT 1 Exhibit 21 COVENTRY CORPORATION SUBSIDIARIES A. Coventry Health and Life Insurance Company - Texas insurance corporation B. CHC Financial, Inc. - Tennessee B.1. Coventry Health Plan of Pennsylvania, Inc. - Pennsylvania B.1.a. Coventry Health Plans of Western Pennsylvania - Pennsylvania B.2. Coventry HealthCare Physician Management, Inc. - Delaware B.3. Coventry HealthCare Properties, Inc. - Delaware C. Coventry HealthCare Development Corporation - Delaware C.1. Coventry Health Plan of Tennessee, Inc. - Tennessee C.2. Coventry Health Plan of Texas, Inc. - Texas C.3. Coventry Health Plan of West Virginia, Inc. - West Virginia C.4. Coventry Health Plan of Mississippi, Inc. - Mississippi D. Penn Group Corporation - Delaware D.1. Healthpass, Inc. - Pennsylvania D.2. HealthAmerica Pennsylvania, Inc. - Pennsylvania D.2.a. Penn Group Medical Associates, Inc. (NOTE: to be sold) - Pennsylvania D.2.b. The Medical Center HPJV, Inc. - Pennsylvania D.2.b.i. Riverside Health Plan, Inc. - Pennsylvania E. Group Health Plan, Inc. - Missouri F. Coventry HealthCare Management Corporation - Virginia F.1. Southern Health Services, Inc. - Virginia F.2. Southern Health Benefit Services, Inc. - Virginia G. HealthCare USA, Inc. - Florida G.1. Pennsylvania HealthCare USA, Inc. - Pennsylvania G.2. HealthCare USA - Alabama, Inc. - Alabama G.3. HealthCare USA Midwest, Inc. - Delaware G.3.a. HealthCare USA of Missouri, LLC - Missouri LLC G.4. HealthCare USA - Ohio, Inc. - Ohio H. Coventry Healthcare Management Corporation - Delaware EX-23 4 CONSENT OF ARTHUR ANDERSEN 1 Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the inclusion of our reports dated February 21, 1997, included in the Annual Report on Form 10-K/A for the year ended December 31, 1996 and, in the Company's previous filings as listed: Form S-1 Registration Statement No. 33-56642 Form S-3 Registration Statement No. 33-72348 Form S-8 Registration Statement No. 33-71806 Form S-8 Registration Statement No. 33-57014 Form S-8 Registration Statement No. 33-81356 Form S-8 Registration Statement No. 33-81358 Form S-8 Registration Statement No. 33-82562 Form S-8 Registration Statement No. 33-87114 Form S-4 Registration Statement No. 33-90268 Form S-3 Registration Statement No. 33-95084 Form S-8 Registration Statement No. 33-97246 ARTHUR ANDERSEN LLP Nashville, Tennessee March 31, 1997 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 90,619 82,777 45,921 8,000 2,091 208,291 48,070 23,091 448,945 282,001 50,926 0 0 330 100,427 448,945 0 1,070,508 0 1,148,475 0 8,000 6,257 (84,224) (22,860) (61,287) 0 0 0 (61,287) (1.86) (1.86) OPERATING REVENUE AND OTHER INCOME INCLUDES LOSS OF CONSOLIDATED SUBSIDIARY (MINORITY INTEREST)
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