<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 10, 1998
REGISTRATION NO. 333-45821
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
------------------------
COVENTRY HEALTH CARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS ARTICLES OF INCORPORATION)
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DELAWARE 8011 52-207300
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
6705 ROCKLEDGE DRIVE, SUITE 100, BETHESDA, MARYLAND 20817
(301) 581-0600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
DALE B. WOLF
501 CORPORATE DRIVE, SUITE 400
FRANKLIN, TENNESSEE 37067
(615) 771-4141
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
COPIES TO:
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BOB F. THOMPSON THOMAS M. FARAH
BASS, BERRY & SIMS PLC EPSTEIN, BECKER & GREEN, P.C.
2700 FIRST AMERICAN CENTER 1227 25TH STREET, N.W., SUITE 700
NASHVILLE, TENNESSEE 37238 WASHINGTON, D.C. 20037
(615) 742-6200 (202) 861-0900
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: As soon as practicable after the effective date of this Registration
Statement.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
------------------------
THE REGISTRANT WILL AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.
================================================================================
<PAGE> 2
PRELIMINARY COPY
COVENTRY CORPORATION
501 CORPORATE DRIVE, SUITE 400
FRANKLIN, TENNESSEE 37067
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON MARCH 31, 1998
To the Shareholders of Coventry Corporation:
The Board of Directors of Coventry Corporation ("Coventry") has unanimously
approved and recommended to shareholders a Capital Contribution and Merger
Agreement dated as of November 3, 1997 ("Combination Agreement") by and among,
inter alia, Coventry, Coventry Health Care, Inc. ("Newco"), Principal Health
Care, Inc. ("PHC") and Principal Mutual Life Insurance Company ("Mutual") and a
related Agreement and Plan of Merger ("Merger Plan") by and among Coventry,
Newco and Coventry Merger Corporation ("Merger Sub"). A Special Meeting of
Shareholders (the "Special Meeting") of Coventry Corporation ("Coventry") will
be held on March 31, 1998 at 9:30 a.m., local time, at SunTrust Bank Building,
Fourth Floor Conference Room, 201 4th Avenue North, Nashville, Tennessee for the
following purposes:
1. To approve the Combination Agreement and the related Merger Plan.
2. To adjourn the Special Meeting, if necessary, to permit further
solicitation of proxies in the event that there are not sufficient votes at
the time of the Special Meeting to approve the Combination Agreement and
the related Merger Plan.
3. To transact such other business as may properly come before the
Special Meeting or any adjournment thereof.
The close of business on February 2, 1998 is the record date for the
determination of shareholders entitled to notice of and to vote at the Special
Meeting. Only shareholders of record at such time will be entitled to notice of
and to vote at the Special Meeting.
The Combination Agreement and related Merger Plan provide that at the
effective time (the "Effective Time"), Merger Sub will merge with and into
Coventry, with Coventry being the surviving corporation, and each outstanding
share of Coventry's common stock ("Coventry Common Stock") shall be converted
into one share of Newco's common stock ("Newco Common Stock") and one right
(each a "Newco Right") to be issued under that certain rights agreement between
Newco and ChaseMellon Shareholder Services, LLC. In addition, each outstanding
convertible exchangeable subordinated promissory note (collectively the
"Coventry Convertible Notes") issued by Coventry shall be converted into a
convertible exchangeable subordinated promissory note (collectively the "Newco
Convertible Notes") containing substantially the same terms and conditions as
the Coventry Convertible Notes. Because each outstanding share of Coventry
Common Stock will be exchanged for one share of Newco Common Stock and one Newco
Right, no fractional shares will be issued by Newco in the Merger.
Simultaneously at the Effective Time, PHC, an indirect wholly-owned
subsidiary of Mutual, will effect a capital contribution to Newco of certain
assets, including the issued and outstanding capital stock of certain of PHC's
wholly-owned subsidiaries (including its health maintenance organization ("HMO")
subsidiaries in sixteen states); Newco will assume the liabilities of PHC,
including all liabilities of PHC relating to the PHC Assets, except certain
liabilities, and Newco will issue to PHC that number of shares of Newco Common
Stock and Newco Rights as shall equal 66 2/3% of the shares of Newco Common
Stock issued to Coventry's shareholders in the Merger plus 66 2/3% of the shares
of Newco Common Stock issuable upon conversion of the Newco Convertible Notes
(or in the event the Coventry Convertible Notes are converted into shares of
Coventry Preferred Stock prior to the Effective Time, the shares of Newco Common
Stock issuable upon conversion of the Newco Preferred Stock). Based on the
33,304,462 shares of Coventry Common Stock outstanding on February 2, 1998 and
the 4,166,000 shares issuable upon conversion of $41,660,000 principal amount of
Coventry Convertible Notes outstanding on that date, Newco will issue
approximately 33,304,462 shares of Newco Common Stock to Coventry's shareholders
and 24,980,308 shares of Newco Common Stock to PHC.
<PAGE> 3
After the Effective Time, Coventry and PHC's HMO subsidiaries will be
subsidiaries of Newco. PHC will continue as an indirect wholly-owned subsidiary
of Mutual after the Effective Time, and in addition to the Newco Common Stock,
will continue to own approximately 21.6% of the assets shown on the September
30, 1997 balance sheet of PHC included herein.
The terms and conditions of the Combination Agreement are more fully
described in the Proxy Statement/Prospectus accompanying this Notice of Special
Meeting. The Combination Agreement and the Merger Plan are attached as Annex I
and II, respectively, to the Proxy Statement/Prospectus. As of February 18,
1997, the aggregate value of the shares of Newco Common Stock issuable in the
Combination Agreement was approximately $984 million, which value is based upon
the average high and low prices of Coventry Common Stock reported by The NASDAQ
Stock Market. The aggregate value of such shares at the Effective Time will
depend upon the value of the Coventry Common Stock at such time.
The holders of Coventry Common Stock will not be entitled to dissenters'
rights or appraisal in connection with the vote to approve the transactions
contemplated by the Combination Agreement.
A form of proxy and a Proxy Statement/Prospectus containing more detailed
information with respect to the matters to be considered at the Special Meeting
accompany this notice. A copy of the Combination Agreement is attached as Annex
I to the Proxy Statement/Prospectus and a copy of the Merger Plan is Annex II to
the Combination Agreement.
By Order of the Board of Directors,
SHIRLEY R. SMITH
Secretary
Franklin, Tennessee
March 12, 1998
IN ORDER TO ASSURE YOUR REPRESENTATION AT THE SPECIAL MEETING, PLEASE COMPLETE,
SIGN, DATE AND MAIL PROMPTLY THE ENCLOSED PROXY, WHICH IS BEING SOLICITED BY THE
BOARD OF DIRECTORS, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING. AN ADDRESSED
RETURN ENVELOPE WHICH REQUIRES NO POSTAGE IF MAILED IN THE UNITED STATES IS
ENCLOSED FOR THAT PURPOSE. THE PROXY MAY BE REVOKED AT ANY TIME PRIOR TO THE
VOTE AT THE SPECIAL MEETING BY FOLLOWING THE PROCEDURES SET FORTH IN THE PROXY
STATEMENT/PROSPECTUS.
<PAGE> 4
PROXY STATEMENT
OF
COVENTRY CORPORATION
SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD MARCH 31, 1998
PROSPECTUS
OF
COVENTRY HEALTH CARE, INC.
33,238,434 SHARES OF
COMMON STOCK
This Prospectus relates to shares of common stock of Coventry Health Care,
Inc., a Delaware corporation ("Newco"), issuable to the shareholders of Coventry
Corporation, a Tennessee corporation ("Coventry"), upon consummation of the
Merger (as defined below). This Prospectus also serves as the Proxy Statement of
Coventry for its special meeting of shareholders (the "Special Meeting") to be
held on March 31, 1998. See "The Special Meeting."
This Proxy Statement/Prospectus presents the terms of a proposed combination
(the "Business Combination") of the managed care businesses of Coventry and PHC
in Newco, a newly-formed Delaware corporation, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997 (the
"Combination Agreement"), by and among Coventry, Newco, Coventry Health Care,
Inc., a Maryland corporation, Principal Mutual Life Insurance Company, an Iowa
mutual insurance company and the indirect parent of PHC ("Mutual"), Principal
Holding Company, an Iowa corporation and wholly owned subsidiary of Mutual
("Holding"), and PHC, a wholly owned subsidiary of Holding. Newco was formed for
the purpose of entering into the transactions described herein and is currently
owned by Coventry and PHC.
Pursuant to the Combination Agreement, at or prior to the effective time of
the transactions contemplated thereby (the "Effective Time"):
Coventry, Newco and Coventry Merger Corporation, a Tennessee corporation
and wholly owned subsidiary of Newco ("Merger Sub"), shall enter into an
Agreement and Plan of Merger (the "Merger Plan"), substantially in the form
of Exhibit 1.2(a) to the Combination Agreement, and, pursuant to the Merger
Plan, shall effect a merger (the "Merger") of Merger Sub with and into
Coventry whereby (i) each issued and outstanding share of Coventry's common
stock, par value $0.01 per share ("Coventry Common Stock"), outstanding at
the Effective Time shall be converted into one share of Newco's common
stock, par value $0.01 per share (the "Newco Common Stock"), and one right
(collectively, the "Newco Rights") to be issued pursuant to a rights
agreement between Newco and ChaseMellon Shareholder Services, LLC (the
"Newco Rights Agreement"); (ii) each right (collectively, the "Coventry
Rights") issued under that certain Rights Agreement, dated February 7, 1996
and amended as of May 7, 1997, by and between Coventry and ChaseMellon
Shareholder Services, LLC (the "Coventry Rights Agreement"), shall be
canceled, retired, and cease to exist; (iii) each of the outstanding
convertible exchangeable subordinated promissory notes (the "Coventry
Convertible Notes") issued by Coventry under that certain Amended and
Restated Securities Purchase Agreement, dated May 7, 1997, will be converted
into convertible notes of Newco (the "Newco Convertible Notes") containing
substantially the same terms and conditions as the Coventry Convertible
Notes; and (iv) each issued and outstanding share, if any, of Coventry's
Series A Convertible Preferred Stock, par value $0.01 per share (the
"Coventry Preferred Stock") will be converted into the right to receive one
share of Newco's Series A Convertible Preferred Stock, par value $0.01 per
share (the "Newco Preferred Stock") containing substantially the same terms
and conditions as the Coventry Preferred Stock.
At the Effective Time, PHC will effect a capital contribution (the
"Capital Contribution") to Newco of certain assets, including the issued and
outstanding stock of certain of PHC's wholly-owned subsidiaries (including
its health maintenance organization subsidiaries in sixteen states,
including Alabama, Delaware, Florida, Georgia, Illinois, Indiana, Iowa,
Kansas, Louisiana, Maryland, Missouri, Nebraska, New Jersey, North Carolina,
Pennsylvania and South Carolina), all real or personal property owned or
leased by PHC, all accounts receivable, cash, securities,
------------------------------------------------------
This Proxy Statement/Prospectus and the form of proxy are first being mailed
to shareholders of Coventry on or about March 12, 1998.
<PAGE> 5
contract rights, prepaid liabilities, and all other assets except for
specified excluded assets (the PHC assets being transferred, collectively,
the "PHC Assets"); Newco will assume all of the liabilities of PHC,
including all liabilities of PHC relating to the PHC Assets and the stock
options issued under PHC's 1997 Non-Qualified Stock Option Plan (the "PHC
Options") but excluding liabilities under PHC's other employee benefit
plans, tax liabilities with respect to the pre-closing operations of PHC and
its subsidiaries, liabilities relating to certain assets of PHC not
transferred to Newco and certain other specified excluded liabilities (the
PHC liabilities being assumed, the "PHC Liabilities") (the PHC Assets,
together with the PHC Liabilities, hereinafter being referred to as the "PHC
Business") and Newco will issue to PHC that number of shares of Newco Common
Stock and Newco Rights as shall equal 66 2/3% of the shares of Newco Common
Stock issued to the shareholders of Coventry in the Merger plus 66 2/3% of
the shares of Newco Common Stock issuable upon conversion of the Newco
Convertible Notes (or in the event Coventry Convertible Notes are converted
into Coventry Preferred Stock at or prior to the Effective Time, the shares
of Newco Common Stock issuable upon conversion of the Newco Preferred Stock)
(such shares of Newco Common Stock and Newco Rights issuable to PHC at the
Effective Time hereinafter, collectively, being referred to as the "PHC
Consideration"). The PHC Consideration will constitute 40% of (i) the issued
shares of Newco Common Stock immediately after the Effective Time and (ii)
the shares of Newco Common Stock issuable upon conversion of the Coventry
Convertible Notes or the Coventry Preferred Stock outstanding immediately
after the Effective Time, and a similar percentage of the Newco Rights.
Pursuant to a Shareholders' Agreement among Newco, PHC, and Mutual (the
"Shareholders' Agreement") to be effective at the Effective Time, Mutual,
together with its affiliates, will be entitled to designate six of the
fifteen members of Newco's Board of Directors.
The accompanying proxy is solicited by and on behalf of the Board of
Directors of Coventry. The expense of the solicitation of proxies, including the
cost of preparing, assembling and mailing, will be borne by Coventry. Proxies
will be solicited by the use of the mails and may also be solicited by personal
interview, or by telephone, telecopy or telegram by directors, officers and
regular employees of Coventry. No directors, officers or regular employees of
Coventry will receive additional compensation for soliciting proxies. Coventry
has retained Georgeson & Company, Inc. ("Georgeson") to assist in the
solicitation of proxies for which Coventry will pay a fee to Georgeson not to
exceed $25,000 plus reimbursement of reasonable expenses in connection
therewith.
Coventry will (i) request banking institutions, brokerage firms, custodians,
trustees, nominees and fiduciaries to forward solicitation material to the
beneficial owners of Coventry Common Stock held of record by such persons, (ii)
furnish the number of copies thereof necessary to supply such material to all
such beneficial holders and (iii) reimburse the reasonable forwarding expenses
incurred by such record holders.
SEE "RISK FACTORS" ON PAGE 20 FOR MATTERS THAT SHOULD BE CONSIDERED BY THE
SHAREHOLDERS OF COVENTRY BEFORE VOTING ON THE COMBINATION AGREEMENT.
THE SECURITIES TO BE ISSUED IN THE MERGER AND CAPITAL CONTRIBUTION HAVE NOT BEEN
APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR BY ANY
STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
THE DATE OF THIS PROXY STATEMENT/PROSPECTUS
IS MARCH 12, 1998.
<PAGE> 6
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by Coventry Corporation pursuant to the
Exchange Act (Commission File No. 0-19147) are hereby incorporated by reference
in this Proxy Statement/Prospectus:
1. Coventry's amended Annual Report on Form 10-K/A for the fiscal year
ended December 31, 1996, filed with the Commission on April 30, 1997 and
July 25, 1997.
2. Coventry's Proxy Statement Dated July 29, 1997 for its Annual
Meeting of Shareholders held on August 20, 1997, as supplemented on August
5, 1997.
3. Coventry's Quarterly Report on Form 10-Q for the fiscal quarter
ended September 30, 1997, filed with the Commission on November 14, 1997;
4. Coventry's Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 1997, filed with the Commission on August 14, 1997.
5. Coventry's amended Quarterly Report on Form 10-Q/A for the fiscal
quarter ended March 31, 1997, filed with the Commission on July 3, 1997.
6. Coventry's Current Reports on Form 8-K filed with the Commission on
February 6, 1998, January 9, 1998, November 7, 1997, July 9, 1997, May 14,
1997, April 14, 1997 and February 26, 1997.
All reports and other documents filed with the Commission by Coventry
pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the
date of this Proxy Statement/Prospectus and prior to the Special Meeting shall
be deemed to be incorporated by reference herein and to be a part hereof from
the respective dates of filing of such reports and other documents. Any
statement contained herein or in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for all purposes to the extent that a statement contained herein or in any other
subsequently filed document that is also incorporated or deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Proxy Statement/Prospectus.
THIS PROXY STATEMENT/PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE WITH
RESPECT TO COVENTRY THAT ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. COPIES
OF THESE DOCUMENTS (NOT INCLUDING EXHIBITS TO SUCH DOCUMENTS UNLESS SUCH
EXHIBITS ARE SPECIFICALLY INCORPORATED BY REFERENCE IN SUCH DOCUMENTS OR HEREIN)
ARE AVAILABLE WITHOUT CHARGE TO ANY PERSON TO WHOM THIS PROXY
STATEMENT/PROSPECTUS IS DELIVERED UPON WRITTEN OR ORAL REQUEST TO THE FOLLOWING:
COVENTRY CORPORATION
501 CORPORATE DRIVE, SUITE 400
FRANKLIN, TENNESSEE 37067
ATTENTION: DALE B. WOLF,
SENIOR VICE PRESIDENT, CHIEF
FINANCIAL OFFICER AND TREASURER
IN ORDER TO ENSURE TIMELY DELIVERY, ANY REQUEST FOR DOCUMENTS SHOULD BE
MADE BY MARCH 24, 1998.
<PAGE> 7
TABLE OF CONTENTS
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SUMMARY OF PROXY STATEMENT/PROSPECTUS....................... 1
Summary Historical Financial Data of Coventry............. 11
Summary Financial Data of PHC............................. 12
Pro Forma Selected Financial Data (Unaudited)............. 13
Comparative Per Share Data................................ 18
RISK FACTORS................................................ 20
Limits on Ability to Project Actual Health Care Costs..... 20
Limitations on Ability to Increase Revenue................ 20
Risks of Governmental Programs and Regulations............ 20
Risks of Agreements with Providers........................ 21
Administration and Management............................. 21
Integration of the Businesses............................. 22
Financing................................................. 22
Administered Health Insurance Policies.................... 22
Competition............................................... 23
Ownership by Mutual and PHC............................... 23
Marketing................................................. 23
Litigation and Insurance Risk............................. 24
Stock Market.............................................. 24
THE SPECIAL MEETING......................................... 25
Genera1................................................... 25
Record Date............................................... 25
Vote Required............................................. 25
Voting and Revocation of Proxies.......................... 25
Solicitation of Proxies................................... 26
TERMS OF THE BUSINESS COMBINATION........................... 27
Merger.................................................... 27
Capital Contribution...................................... 27
Administered Health Insurance Policies.................... 27
Background of the Business Combination.................... 28
Recommendation of Coventry's Board of Directors........... 30
Opinion of Financial Advisor to Coventry.................. 31
Effective Time of the Business Combination................ 34
Exchange of Certificates.................................. 35
Representations and Warranties............................ 35
Conditions to the Combination Agreement................... 36
Regulatory Approvals...................................... 38
Business Pending the Business Combination................. 38
Waiver and Amendment...................................... 40
Tangible Net Value Adjustment............................. 40
Taxes..................................................... 41
Termination............................................... 42
No Solicitation of Transactions........................... 43
Termination Fee; Third Party Bids......................... 44
Shareholders' Agreement................................... 44
Administered Health Insurance Policies.................... 48
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i
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Newco Warrant............................................. 49
Ancillary Agreements...................................... 49
Interests of Certain Persons in the Business
Combination............................................ 50
Accounting Treatment...................................... 50
Certain Federal Income Tax Consequences................... 51
No Appraisal Rights....................................... 52
Expenses.................................................. 52
The Nasdaq Stock Market Listing........................... 53
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA OF
COVENTRY CORPORATION...................................... 54
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF COVENTRY CORPORATION......... 55
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA OF
PRINCIPAL HEALTH CARE, INC................................ 67
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF PRINCIPAL HEALTH CARE,
INC....................................................... 68
INFORMATION CONCERNING COVENTRY CORPORATION................. 77
BUSINESS.................................................. 77
Overview.................................................. 77
Products.................................................. 77
Delivery Systems.......................................... 79
Health Care Provider Compensation......................... 80
Quality Assurance......................................... 80
Utilization Management and Review......................... 81
Marketing................................................. 81
Competition............................................... 82
Government Regulation..................................... 82
Risk Management........................................... 84
Employees................................................. 85
Trademarks................................................ 85
Description of Property................................... 85
Legal Proceedings......................................... 85
INFORMATION CONCERNING PRINCIPAL HEALTH CARE, INC........... 86
BUSINESS.................................................. 86
Overview.................................................. 86
Products.................................................. 86
Delivery Systems.......................................... 88
Quality Management........................................ 88
Utilization Management and Review......................... 89
Marketing................................................. 89
Competition............................................... 90
Government Regulation..................................... 91
Risk Management........................................... 93
Employees................................................. 93
Trademarks................................................ 93
Description of Property................................... 93
Legal Proceedings......................................... 93
</TABLE>
ii
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INFORMATION CONCERNING COVENTRY HEALTH CARE, INC............ 94
BUSINESS.................................................. 94
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 94
MANAGEMENT.................................................. 97
Directors................................................. 97
Executive Officers........................................ 99
Newco Executive Compensation.............................. 100
Coventry Employment Contracts and Termination of
Employment and Change-in-Control Arrangements.......... 101
Certain Relationships and Related Transactions............ 102
PHC Employment Contracts and Termination of Employment and
Change-in-Control Arrangements......................... 102
DESCRIPTION OF NEWCO RIGHTS AGREEMENT....................... 103
NEWCO OPTION PLANS.......................................... 105
DESCRIPTION OF CAPITAL STOCK................................ 113
Newco Common Stock........................................ 113
Description of the Newco Preferred Stock.................. 113
Description of the Undesignated Preferred Stock........... 116
CERTAIN DIFFERENCES IN RIGHTS OF NEWCO AND COVENTRY
SHAREHOLDERS.............................................. 117
LEGAL MATTERS............................................... 123
EXPERTS..................................................... 123
AVAILABLE INFORMATION....................................... 123
INDEX TO FINANCIAL STATEMENTS............................... F-1
ANNEXES
ANNEX I Capital Contribution and Merger Agreement effective as of
November 3, 1997 (amending and restating the Capital
Contribution and Share Exchange Agreement dated November
3, 1997)
ANNEX II Form of Agreement and Plan of Merger
ANNEX III Form of Warrant
ANNEX IV Form of Shareholders' Agreement by and among Coventry Health
Care, Inc., Principal Mutual Life Insurance Company, and
Principal Health Care, Inc.
ANNEX V Opinion of Credit Suisse First Boston Corporation
</TABLE>
NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED IN THIS PROXY STATEMENT/PROSPECTUS AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATION SHOULD NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROXY STATEMENT/PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL, OR A SOLICITATION OF AN OFFER TO PURCHASE, THE SECURITIES OFFERED HEREBY,
NOR DOES IT CONSTITUTE THE SOLICITATION OF A PROXY IN ANY JURISDICTION IN WHICH,
OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION OF
AN OFFER OR PROXY SOLICITATION. NEITHER THE DELIVERY OF THIS PROXY
STATEMENT/PROSPECTUS NOR ANY DISTRIBUTION OF THE SECURITIES OFFERED HEREBY
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF PHC OR COVENTRY SINCE THE DATE HEREOF.
iii
<PAGE> 10
SUMMARY OF PROXY STATEMENT/PROSPECTUS
The following summary is qualified in its entirety by reference to the more
detailed information included in this Proxy Statement/Prospectus, and the
appendices hereto, including, but not limited to, the Combination Agreement as
set forth as Appendix A hereto and the Merger Plan, substantially in the form of
Exhibit 1 to the Combination Agreement. The information contained in this Proxy
Statement/Prospectus with respect to PHC and its affiliates has been supplied by
PHC, and the information with respect to Newco and Coventry's affiliates has
been supplied by Coventry. Capitalized terms which are used but not defined in
this summary are defined elsewhere in this Proxy Statement/Prospectus.
The following summary contains forward-looking information which is based
upon current expectations and involves a number of risks and uncertainties. The
forward-looking statements may be affected by a number of factors, including the
risk factors set forth herein under "Risk Factors", and consequently, actual
operations and results may differ materially from those expressed in these
forward-looking statements. Among the factors that may materially affect
Coventry's, PHC's and Newco's business are potential increases in medical costs,
difficulties in increasing premiums due to competitive pressures, price
restrictions under Medicaid or Medicare, imposition of regulatory restrictions,
issues relating to marketing of products, accreditation or certification by
private or governmental bodies, difficulties in obtaining or maintaining
favorable contracts with health care providers, credit risks on certain global
capitation arrangements, financing costs and contingencies and litigation risk.
There are also several factors relating to the Business Combination that may
materially affect Newco's business operations after the Effective Time,
including the risks associated with the integration of Coventry's and PHC's
business operations and the lack of recent experience by Coventry or PHC in the
management or operation of a substantial indemnity health insurance business. In
addition, there are certain risks to Coventry's shareholders associated with the
ownership by Mutual and its affiliates of approximately 40% of the Newco Common
Stock. See "RISK FACTORS."
THE COMPANIES
Coventry Corporation
Coventry is a managed health care company that at September 30, 1997
provided comprehensive health benefits and services to 897,758 members in
Pennsylvania, Ohio, West Virginia, Missouri, Illinois and Virginia. Health care
services are provided to employer groups and government funded groups through a
variety of full-risk health care plans, including health maintenance
organizations ("HMOs") and preferred provider organization ("PPO") products.
Coventry's 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. Coventry, through its regional health plans, also
offers fully-insured flexible provider products, including PPO products 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. In addition, Coventry
markets a Medicare risk product under the name "Advantra(R)" in the St. Louis,
western and central Pennsylvania, West Virginia, Ohio, and Illinois markets and
offers health care coverage to Medicaid recipients in the St. Louis and central
Missouri markets. Coventry's health plans offer an administrative services only
product to employers who self-insure their employee's health benefits.
Coventry's health plans maintain provider networks which furnish health
care services through contractual arrangements with physicians, hospitals and
other health care providers, rather than providing reimbursement to the enrollee
for the charges of such products. 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 unit
costs of the services. In the aggregate, Coventry contracts with approximately
18,000 physicians and 270 hospitals for its HMO, PPO and POS programs.
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<PAGE> 11
Principal Health Care, Inc.
PHC was incorporated as an Iowa corporation on January 7, 1987 and is a
wholly owned subsidiary of Holding, which is a wholly owned subsidiary of
Mutual. PHC is a managed health care company that at September 30, 1997 provided
comprehensive health benefits and services to 670,695 members in sixteen states,
including Alabama, Delaware, Florida, Georgia, Illinois, Indiana, Iowa, Kansas,
Louisiana, Maryland, Missouri, Nebraska, New Jersey, North Carolina,
Pennsylvania and South Carolina. PHC's Texas and Mid-Atlantic health plans,
which had a membership of approximately 52,000 at September 30, 1997, will not
be included in the PHC Assets to be transferred to Newco by PHC.
PHC provides health care services to employer groups and government funded
groups through a variety of health care benefit plans and risk arrangements,
which include traditional and open access HMO products and POS products on both
a full risk and administrative services only basis, and full risk programs under
contract with federal and state governments for Medicare and Medicaid
beneficiaries. PHC's HMO benefit plans provide comprehensive health care
benefits to enrollees, including ambulatory and inpatient physician services,
hospitalization, mental health, ancillary diagnostic and therapeutic, and in
most cases pharmacy services. PHC also administers a PPO network that it rents
to other payors.
PHC's health plans maintain provider networks which generally furnish
health care services through contractual arrangements with physicians, hospitals
and other health care providers. Because the health plans receive the same
amount of revenue from their enrollees irrespective of the cost of health care
services provided, PHC must manage both the utilization and the unit cost of
those services. All of PHC's health plans offer an Individual Practice
Association ("IPA") model delivery system, in which individual providers,
provider groups and provider networks contract with the health plans to provide
health care services to plan enrollees. In the aggregate, PHC contracts with
approximately 39,000 physicians and 440 hospitals for its HMO programs and with
approximately 51,200 physicians and 600 hospitals for its PPO programs.
Coventry Health Care, Inc.
On December 17, 1997, Coventry Corporation and PHC organized Newco solely
for the purpose of effecting the transactions contemplated by the Combination
Agreement. Prior to the Effective Time, Newco will own no assets other than the
stock of Merger Sub, and will conduct no business operations. Newco will
organize Merger Sub as a Tennessee corporation solely for the purpose of
effecting the Merger. Prior to the Effective Time, Merger Sub will own no assets
and will conduct no business operations.
SPECIAL MEETING OF SHAREHOLDERS
A Special Meeting of the Shareholders of Coventry to consider and vote on
the Combination Agreement, which provides for the Merger and the Capital
Contribution, will be held on March 31, 1998 at 9:30 a.m., local time, at
SunTrust Bank Building, Fourth Floor Conference Room, 201 4th Avenue North,
Nashville, Tennessee. Only the holders of record of Coventry Common Stock at the
close of business on February 2, 1998 will be entitled to notice of and to vote
at the Special Meeting. On that date there were outstanding 33,238,434 shares of
Coventry Common Stock, with each share being entitled to one vote.
PURPOSE OF THE SPECIAL MEETING
The purpose of the Special Meeting is for the Coventry shareholders to
consider and vote upon the Combination Agreement which provides for (i) the
Merger Plan, pursuant to which each issued share of Coventry Common Stock shall
be converted into one share of Newco Common Stock and one Newco Right and
Coventry shall become a wholly-owned subsidiary of Newco and (ii) the Capital
Contribution, pursuant to which PHC shall transfer to Newco the PHC Business and
Newco shall issue to PHC the PHC Consideration, which will constitute 40% of the
sum of (i) the issued and outstanding shares of Newco Common Stock immediately
after the Effective Time and (ii) and the shares of Newco Common Stock issuable
upon conversion of the Coventry Convertible Notes or the Coventry Preferred
Stock and a similar percentage of the Newco Rights. Pursuant to a Shareholders'
Agreement among Newco, PHC and Mutual,
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<PAGE> 12
Mutual, together with its affiliates, will be entitled to designate six of the
fifteen members of Newco's Board of Directors. See "Combination
Agreement -- Description of Merger."
VOTE REQUIRED
Approval and adoption of the Combination Agreement, which includes the
approval and adoption of the Merger Plan, requires the affirmative vote by the
holders of a majority of the votes entitled to be cast by the holders of record
of the Coventry Common Stock at the Special Meeting, in person or by proxy. As
of February 2, 1998, the directors, executive officers and their affiliates of
Coventry and PHC collectively beneficially owned 2,692,300 shares of the
Coventry Common Stock (exclusive of shares which would be received upon the
exercise of options and warrants and the conversion of convertible securities),
representing approximately 8.0% of the voting power of the Coventry Common
Stock. See "The Special Meeting -- Votes Required."
EFFECTS OF THE MERGER AND CAPITAL CONTRIBUTION
Pursuant to the Merger Plan, at the Effective Time: (i) Merger Sub will
merge with and into Coventry; (ii) each issued share of Coventry Common Stock
shall be converted into the right to receive one share of Newco Common Stock and
one Newco Right; (iii) each outstanding Coventry Convertible Note issued under
the Amended and Restated Securities Purchase Agreement, dated May 7, 1997 (the
"Warburg Agreement"), by and among Coventry, Warburg, Pincus Ventures L.P.
("Warburg") and Franklin Capital Associates III L.P. ("Franklin"), as amended,
shall be converted into a Newco Convertible Note; (iv) each issued and
outstanding share, if any, of Coventry Preferred Stock shall be converted into
the right to receive one share of Newco Preferred Stock; (v) each option then
outstanding under Coventry's stock option plans listed in Schedule 1.2 of the
Combination Agreement (the "Coventry Options") and each warrant listed in
Schedule 1.2 of the Combination Agreement (the "Coventry Warrants") to purchase
shares of Coventry Common Stock shall be assumed by Newco and shall be
exercisable upon the same terms and conditions as under the applicable Coventry
Options or Coventry Warrants except that each such Coventry Option and Coventry
Warrant shall be exercisable for shares of Newco Common Stock; and (vi) each
right issued under the Coventry Rights Agreement, shall be canceled, retired and
cease to exist. The exchange ratio is subject to adjustment upon any stock
split, reverse stock split, stock dividend, recapitalization or other similar
transaction involving the number of issued and outstanding shares of Coventry
Common Stock. Pursuant to the Merger, Coventry's shareholders will collectively
receive approximately 33,238,434 shares of Newco Common Stock, representing,
together with the shares of Newco Common Stock issuable upon the conversion of
the Coventry Convertible Notes or the Coventry Preferred Stock, 60% of the sum
of (i) the shares of Newco Common Stock issued and outstanding immediately after
the Effective Time and (ii) the shares of Newco Common Stock issuable upon
conversion of the Newco Convertible Notes or the Newco Preferred Stock.
Pursuant to the Capital Contribution, PHC will transfer at the Effective
Time to Newco the PHC Assets, including the issued and outstanding stock of
certain of its wholly-owned subsidiaries (including its HMO subsidiaries in
sixteen states including Alabama, Delaware, Florida, Georgia, Illinois, Indiana,
Iowa, Kansas, Louisiana, Maryland, Missouri, Nebraska, New Jersey, North
Carolina, Pennsylvania and South Carolina), all real or personal property owned
or leased by PHC, all accounts receivable, cash, securities, contract rights,
prepaid liabilities, and all other assets except for specified excluded assets.
The book value of the PHC Assets including property and excluding $43.1 million
of recorded goodwill at September 30, 1997 was approximately $288.6 million.
Newco will assume the PHC Liabilities, including debt of $2.3 million. The PHC
Liabilities include all liabilities of PHC relating to the PHC Assets and the
PHC Options but do not include liabilities under PHC's other employee benefit
plans, tax liabilities with respect to the pre-closing operations of PHC and its
subsidiaries, liabilities relating to certain assets of PHC not transferred to
Newco and certain other specified excluded liabilities. In consideration of the
transfer of such assets, Newco will issue to PHC the PHC Consideration, which
will constitute 40% of the sum of (i) the issued and outstanding shares of Newco
Common Stock immediately after the Effective Time and (ii) the shares of Newco
Common Stock issuable upon conversion of the Newco Convertible Notes or the
Newco Preferred Stock, and a similar percentage of
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<PAGE> 13
the Newco Rights issued and outstanding immediately after the Effective Time.
Based on the 33,304,462 shares of Coventry Common Stock outstanding on February
2, 1998 and the 4,166,000 shares issuable upon conversion of $41,660,000
principal amount of Convertible Notes outstanding on that date, Newco will issue
approximately 33,304,462 shares of Newco Common Stock to Coventry's shareholders
and 24,980,308 shares of Newco Common Stock to PHC. After the Effective Time,
Coventry and PHC's HMO subsidiaries will be subsidiaries of Newco. PHC will
continue as an indirect wholly-owned subsidiary of Mutual after the Effective
Time, and in addition to the Newco Common Stock, will own approximately 21.6% of
the assets shown on the September 30, 1997 balance sheet of PHC included herein.
Pursuant to the Shareholders' Agreement, Mutual, together with its affiliates,
will be entitled to designate six of the fifteen members of Newco's Board of
Directors.
RISK FACTORS
In addition to the risks relating to the traditional business operations of
Coventry and PHC, the transactions contemplated by the Combination Agreement are
subject to a number of risks and uncertainties, including, the risks associated
with the integration of the business operations of Coventry and the PHC
Business, the lack of recent experience by Coventry and PHC in administering or
operating a substantial indemnity health insurance business, and, with respect
to Coventry's shareholders, the ownership by Mutual and its affiliates of
approximately 40% of the Newco Common Stock. The business operations of Coventry
and PHC, and, after the Effective Time, of Newco, may be materially adversely
affected by a number of factors, including, without limitation, (i) competition,
regulations and other circumstances that may limit their ability to charge
premium revenues in excess of costs incurred; (ii) changes in the laws and
regulations governing their industry or the interpretations of existing laws and
regulations; (iii) pricing, regulatory restrictions, potentially higher medical
loss ratios, and other risks associated with Medicaid and Medicare products;
(iv) increased risks of audits by governmental agencies and private payors which
may lead to contested charges, reduced premiums or increased administrative
expenses; (v) recent operating losses by both Coventry and PHC; (vi) an
inability to increase future premiums to existing members or increase the number
of members in order to spread unanticipated costs over a larger membership pool;
(vii) the potential loss of certain significant customers; (viii) financing
costs and contingencies; and (ix) litigation and insurance risks, including
medical malpractice liability, inadequacy of "stop loss" reinsurance, and
disputes relating to denial of coverage. There can be no assurance that Coventry
and PHC will not encounter difficulties in the integration of their respective
business operations, including problems relating to the integration of the
companies' management information, accounting, accrual and control systems,
executive management and culture, or that the expected benefits from such
integration will be realized. Neither Coventry nor PHC has recent experience in
the management or operation of a substantial indemnity health insurance business
and, as a result, there can be no assurance that Newco will be successful in the
management of the Administered Health Insurance Policies (as defined below). As
a result of the Business Combination, Mutual and its affiliates will own
approximately 40% of Newco's voting securities (assuming conversion of Newco's
Convertible Notes) and, although restricted by certain provisions of the
Shareholders' Agreement, will be in a position to exercise influence over
matters requiring shareholder vote, will designate six of the fifteen members of
Newco's Board of Directors, and, after the restrictions contained in the
Shareholders' Agreement shall expire, could acquire over 50% of the Newco Common
Stock and exercise actual control of Newco without a vote of the remaining
shareholders.
OPINION OF THE FINANCIAL ADVISOR TO COVENTRY
Credit Suisse First Boston Corporation ("CSFB") has delivered its written
opinion to the Board of Directors of Coventry to the effect that, as of the date
of such opinion and subject to certain matters discussed therein, the
consideration to be paid by Newco in the Business Combination is fair to
Coventry from a financial point of view (the "CSFB Opinion"). For information on
the assumptions made, matters considered and limits of reviews by CSFB, see
"Terms of the Business Combination -- Opinion of Financial Advisor to Coventry".
A copy of the CFSB Opinion is attached as Annex V to this Proxy
Statement/Prospectus and is incorporated herein by reference. Shareholders of
Coventry are urged to read carefully the opinion in its entirety.
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<PAGE> 14
RECOMMENDATION OF THE BOARD OF DIRECTORS
The Board of Directors of Coventry believes the Combination Agreement is in
the best interest of Coventry and its shareholders and recommends that
shareholders approve the Combination Agreement and the related Merger Plan. The
Board's unanimous approval and recommendation to shareholders is based upon its
consideration of a number of factors, primarily the growth potential of PHC's
business and the combined enterprise; the increased financial and operating
leverage afforded to the combined enterprise by geographic diversification and
substantial expansion of membership over that available to Coventry on a
stand-alone basis; the opportunities for integration efficiencies; and its view
that the financial terms of the Business Combination, including the
consideration paid to PHC and Mutual and the value of the PHC Assets and other
consideration received in exchange, were fair to Coventry and its shareholders.
The Board also considered certain negative elements to the proposed combination,
including the risk that integration of the two companies may be difficult and
may not be accomplished as anticipated; the risk that the financial results of
the PHC operations acquired will not improve as anticipated; and, given the
large percentage interest of Newco to be owned beneficially by Mutual, the
potential for Mutual's interest to conflict with those of Coventry's public
shareholders and to prevent certain transactions which might be in the best
interest of those shareholders. However, the Board of Directors concluded that
the advantages and opportunities of the proposed combination significantly
outweighed the risks. The Board of Directors considered that the transaction
would not constitute a change of control of Coventry since Coventry's
shareholders would beneficially own approximately 60% of Newco immediately after
the Effective Time, Coventry's Board members would constitute nine of the 15
directors of Newco and the terms of the Shareholders' Agreement include
limitations on Mutual's board representation, ability to acquire additional
Newco shares above the 40% level and vote in the event of certain third party
acquisition proposals. The Board of Directors does not believe that its
recommendation in favor of the Combination Agreement is subject to any conflicts
of interest.
EXCHANGE OF COVENTRY STOCK CERTIFICATES
The Merger and Capital Contribution will become effective as of the
Effective Time specified in the Articles of Merger. Coventry currently
anticipates that, if approved by the shareholders of Coventry, the Effective
Time will be on or about March 31, 1998. See "Terms of the Business
Combination -- Effective Time."
As soon as practicable after the Effective Time, instructions on how to
exchange certificates representing shares of Coventry Common Stock for
certificates representing shares of Newco Common Stock will be sent to each
shareholder of record of Coventry. COVENTRY SHAREHOLDERS ARE REQUESTED NOT TO
SEND IN STOCK CERTIFICATES UNTIL THEY HAVE RECEIVED WRITTEN INSTRUCTIONS TO DO
SO. See "Terms of the Business Combination -- Exchange of Certificates."
THE BUSINESS COMBINATION
Combination Agreement
Pursuant to the Combination Agreement, Coventry will effect the Merger and
PHC will effect the Capital Contribution.
Pursuant to the Merger Plan, at the Effective Time: (i) Merger Sub will
merge with and into Coventry; (ii) each issued share of Coventry Common Stock
shall be converted into the right to receive one share of Newco Common Stock and
one Newco Right; (iii) each Coventry Convertible Note shall be converted into
the right to receive a Newco Convertible Note; (iv) each issued and outstanding
share, if any, of Coventry Preferred Stock shall be converted into the right to
receive one share of Newco Preferred Stock; (v) each Coventry Option and each
Coventry Warrant to purchase shares of Coventry Common Stock shall be assumed by
Newco and shall be exercisable upon the same terms and conditions as under the
applicable Coventry Option or Coventry Warrants except that each such Coventry
Option and Coventry Warrant shall be exercisable for shares of Newco Common
Stock; and (vi) each right issued under the Coventry Rights Agreement shall be
retired and canceled and shall no longer exist. The exchange ratio is subject to
adjustment upon any stock split, reverse stock split, stock dividend,
recapitalization or other similar transaction involving
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<PAGE> 15
the number of issued and outstanding shares of Coventry Common Stock. Pursuant
to the Merger, Coventry's shareholders will collectively receive approximately
33,238,434 shares of Newco Common Stock, constituting approximately 60% of the
shares of Newco Common Stock issued and outstanding immediately after the
Effective Time, together with the shares of Newco Common Stock issuable upon the
conversion of the Newco Convertible Notes or the Newco Preferred Stock.
Pursuant to the Capital Contribution, PHC will transfer at the Effective
Time to Newco the PHC Business and Newco will assume the PHC Liabilities and
issue to PHC the PHC Consideration, which will constitute 40% of the sum of (i)
the issued and outstanding shares of Newco Common Stock immediately after the
Effective Time and (ii) the shares of Newco Common Stock issuable upon
conversion of the Newco Convertible Notes or the Newco Preferred Stock, and a
similar percentage of the Newco Rights.
At the Effective Time, Newco, Mutual and PHC will enter into the
Shareholders' Agreement which includes (i) a standstill agreement, pursuant to
which Mutual and its affiliates will agree for the five-year period following
the Effective Time (A) not to acquire more than 40% of the total of issued and
outstanding shares of Newco Common Stock other than pursuant to the Combination
Agreement and the instruments and agreements thereunder and (B) not to take
certain other actions; (ii) certain restrictions on direct or indirect transfers
of Newco Common Stock by Mutual and/or its affiliates; (iii) registration rights
pursuant to which Mutual and/or its affiliates may demand that Newco register
certain shares of Newco Common Stock under a registration statement filed with
the Commission and may participate as a selling party in other registered
offerings of the Newco Common Stock; and (iv) Mutual, together with its
affiliates, will have the right to designate six of the fifteen members of the
Newco Board of Directors.
Administered Health Insurance Policies
At or prior to the Effective Time, Newco will enter into an agreement with
Mutual (the "Management Services Agreement") to manage, for 3.3% of the premium
revenue attributable therefrom, that portion of those indemnity health insurance
policies issued by Mutual which provide coverage in the Newco markets
("Administered Health Insurance Policies"), which markets will include those
geographic areas in which Coventry, PHC and their respective subsidiaries
conduct business operations. The earned premium for the Administered Health
Insurance Policies was approximately $432 million for the nine months ended
September 30, 1997. The Management Services Agreement will terminate on December
31, 1999 at which time Newco's indirectly wholly-owned subsidiary, Coventry
Health and Life Insurance Company ("CHLIC"), will have the obligation, pursuant
to a renewal rights agreement (the "Renewal Rights Agreement"), to offer to
renew the insurance policies constituting the Administered Health Insurance
Policies and, to the extent that customers choose to renew such policies with
Mutual rather than CHLIC, will reinsure such policies pursuant to a coinsurance
agreement (the "Coinsurance Agreement") with Mutual.
Newco Warrant
Newco will issue to Mutual at the Effective Time a warrant (the "Newco
Warrant") that gives Mutual the right to purchase from Newco that number of
shares of Newco Common Stock as shall equal 66 2/3% of the total number of
shares of Newco Common Stock as shall actually be issued by Newco upon the
exercise or conversion of the Coventry Options, Coventry Warrants and PHC
Options assumed by Newco upon the same terms and conditions as set forth in the
Coventry Options, Coventry Warrants and PHC Options. As of December 5, 1997,
Coventry had outstanding 3,302,587 Coventry Options with an average exercise
price of $13.47 and 2,477,766 Coventry Warrants with an average exercise price
of $10.79. As of December 31, 1997, PHC had outstanding 750,000 PHC Options with
an exercise price per option equal to $14.50. Mutual's right to purchase shares
of Newco Common Stock under the Newco Warrant will vest, from time to time, with
respect to the number of shares of Newco Common Stock as shall be issued upon
exercise of the Coventry Options, Coventry Warrants or PHC Options, upon receipt
of notice from Newco of the exercise and issuance of such shares and shall
terminate upon the expiration of the Newco Warrant on the later of (x) the 90th
day following receipt of notice of exercise of the underlying Coventry Option,
Conventry Warrant or PHC Option or (y) the expiration of the exercise period of
such underlying option or warrant. Based on the exercise periods of the
underlying Coventry Options, Coventry Warrants or PHC Options, the Newco Warrant
will terminate
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<PAGE> 16
with respect to 6% through 2003, and 44%, 3%, 20%, 26%, and 1% of the shares
covered thereby in the years 2004 through 2008, respectively. Coventry estimates
that the fair market value of the Newco Warrant as of November 4, 1997 was
approximately $25.0 million.
Relative Voting Power Before and After the Effective Time
The following table sets forth the relative voting power in Coventry and in
Newco, before and after exercise of the Newco Warrant and all stock options and
warrants held by each as of March 9, 1997, of, respectively, (i) Mutual, (ii)
Warburg, (iii) all directors and executive officers of Coventry, as a group, and
(iv) all other shareholders of Coventry.
<TABLE>
<CAPTION>
AFTER THE EFFECTIVE TIME
---------------------------------------
AFTER EXERCISE
PRIOR TO EXERCISE OF OF NEWCO
NEWCO WARRANT WARRANT AND
AND OPTIONS AND OPTIONS AND
PRIOR TO THE WARRANTS HELD WARRANTS HELD AT
EFFECTIVE TIME AT MARCH 9, 1997 MARCH 9, 1997
-------------- -------------------- ----------------
<S> <C> <C> <C>
Mutual............................................. 0 40.0% 40.0%(3)
Warburg(1)......................................... 11.9% 7.1% 9.4%
All Coventry directors and executive officers as a
group(2)......................................... 6.1% 3.5% 6.1%
All other Coventry shareholders.................... 82.0% 49.4% 44.5%
</TABLE>
(1) Assumes the conversion by Warburg of $37,490,000 principal amount of
Convertible Notes into 3,749,000 shares of Coventry (and after the Effective
Time Newco) Preferred Stock, which has one vote per share.
(2) Excluding shares beneficially owned by Warburg.
(3) Mutual's percentage ownership does not change as a result of the exercise of
the Newco Warrant because the number of shares of Newco Common Stock
issuable upon exercise of the Newco Warrant equals 66 2/3% of the options
and warrants of Coventry and PHC outstanding at the Effective Time and the
Newco Warrant is exercisable after the Effective Time only to the extent
that such options and warrants (including those held by directors and
executive officers) shall have been exercised.
Newco Headquarters and Directors and Officers
Newco's headquarters will be located at 6705 Rockledge Drive, Suite 100,
Bethesda, Maryland 20817. The Board of Directors of Newco on the Effective Time
will consist of the Board of Directors of Coventry immediately prior to the
Merger and six directors designated by Mutual. Allen F. Wise, the President and
Chief Executive Officer of Coventry, will serve as President and Chief Executive
Officer of Newco after the Effective Time. Kenneth J. Linde, President and Chief
Executive Officer of PHC, will serve as Executive Vice President and Chief
Operating Officer of Newco after the Effective Time. Dale B. Wolf, Senior Vice
President, Chief Financial Officer and Treasurer of Coventry, will serve as
Chief Financial Officer and Treasurer of Newco after the Effective Time.
Conditions
The obligations of Coventry, Mutual and PHC to consummate the transactions
contemplated by the Combination Agreement are subject to certain conditions,
including, but not limited to: (i) the Combination Agreement shall have been
approved and adopted by the affirmative vote of the holders of a majority of the
shares of the Coventry Common Stock entitled to be cast at the Special Meeting;
(ii) all material authorizations, consents and approvals of third parties shall
have been obtained; (iii) this Proxy Statement/Prospectus shall have been
declared effective under the Securities Act and shall not be subject to any stop
order; (iv) no action or proceeding shall have been instituted before a court or
other governmental body by any governmental agency or public authority to
restrain or prohibit the transactions contemplated by the Combination Agreement
or to obtain an amount of damages or other material relief in connection
therewith and no governmental agency shall have given notice to the effect that
the consummation of the transactions contemplated by the Combination Agreement
will constitute a violation of any law or that it intends to commence
proceedings to restrain the consummation thereof; (v) Coventry and PHC shall
have each
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<PAGE> 17
received an opinion of counsel as to certain tax matters; and (vi) certain other
conditions customary in transactions of this nature, including the receipt of
other necessary regulatory approvals and the performance by the parties of their
respective obligations under the Combination Agreement shall have been waived or
satisfied. See "Combination Agreement -- Conditions to the Combination." In the
event that a condition to closing is waived by Coventry, its Board of Directors
will consider at that time whether to resolicit shareholders. The Board will
take into account the materiality of the condition waived and whether it would
be considered important to shareholders in determining whether to approve or
disapprove the Combination Agreement in determining whether resolicitation is
appropriate.
The Board of Directors of Coventry will not waive the conditions that the
Coventry shareholders approve the Merger and Capital Contribution or that
Coventry receive an opinion of Bass, Berry & Sims PLC that the Merger is a
tax-free reorganization. With respect to the other conditions set forth in the
Combination Agreement, the Board of Directors will determine whether or not the
condition is material to the shareholders of Coventry and, if the Board
determines the condition is material to shareholders, will not waive the
condition without the resolicitation of shareholder approval.
Regulatory Approvals
The Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the
"HSR Act"), provides that certain business combination agreements (including the
Combination Agreement) may not be consummated until certain information has been
furnished to the Department of Justice (the "DOJ") and the Federal Trade
Commission (the "FTC") and certain waiting period requirements have been
satisfied. On December 23, 1997, Coventry and PHC made their respective filings
with the DOJ and the FTC with respect to the proposed Business Combination and
on January 20, 1998 received notice from the FTC of early termination of the HSR
waiting period.
In order to consummate the transactions contemplated by the Combination
Agreement, Coventry, PHC and Mutual will be required to obtain the approval of
insurance regulatory officials in several states, including Alabama, Delaware,
Florida, Georgia, Illinois, Indiana, Iowa, Louisiana, Missouri, Nebraska, New
Jersey, North Carolina, Pennsylvania, Texas, Virginia, and West Virginia.
Generally, such regulatory officials must approve acquisitions unless the terms
are deemed unreasonable by said regulatory officials, the transaction is not in
the best interest of the policyholder or the public, or the transaction would
substantially lessen competition. As of March 10, 1998, approvals were received
from Alabama, Illinois, Nebraska and Virginia.
Ancillary Agreements
At the Effective Time, Newco and Mutual will enter into certain other
agreements, including a Marketing Services Agreement (the "Marketing Services
Agreement"), pursuant to which Newco will provide certain marketing and other
support services in the geographic markets in which Newco shall conduct business
(the "Newco Markets"), a related License Agreement (the "License Agreement") and
a Transition Agreement (the "Transition Agreement"), pursuant to which Mutual
will perform certain administrative functions for, and furnish other services
to, Newco as are currently performed by Mutual on behalf of PHC with respect to
the PHC Business and Mutual will terminate, as of the Effective Time, any
agreements between Mutual and PHC and/or PHC's subsidiaries. In addition, Newco
will assume certain PPO Access Agreements (the "PPO Agreements"), which are
currently in force between Mutual and PHC and/or PHC's subsidiaries, pursuant to
which Mutual will have the option to access Newco's PPOs in certain of the Newco
Markets. The Marketing Services Agreement, License Agreement, Transition
Agreement and PPO Agreements are herein collectively referred to as the
"Ancillary Agreements."
Waiver, Amendment and Termination
The Combination Agreement provides that any party, by action taken by its
Board of Directors, may, to the extent legally allowed, (i) extend the time for
the performance of any of the obligations or other acts of the other parties
thereto, (ii) waive any inaccuracies in the representations and warranties made
to such party, and (iii) waive compliance with any of the agreements or
conditions contained therein.
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<PAGE> 18
The Combination Agreement may be amended, by action taken by the Boards of
Directors of Coventry and Mutual, at any time before or after approval by the
shareholders of Coventry, by a written agreement of the parties to the
Combination Agreement, provided that after any approval by the shareholders of
Coventry, no amendment may be made which by law or other applicable requirement
requires the further approval by the shareholders of Coventry without obtaining
such further approval.
The Combination Agreement may be terminated and the Merger and Capital
Contribution may be abandoned at any time prior to the Effective Time, before or
after the approval of the Combination Agreement by the shareholders of PHC and
Coventry, by the mutual consent of Coventry, Mutual and PHC. The Combination
Agreement may be terminated and the Merger and Capital Contribution may be
abandoned by action of the Board of Directors of either Coventry, Mutual or PHC
if (a) the Merger and Capital Contribution shall not have been consummated by
June 30, 1998, or (b) the approval of Coventry's shareholders shall not have
been obtained at a meeting duly convened therefor or at any adjournment thereof,
or (c) a United States federal or state court of competent jurisdiction or
United States federal or state governmental, regulatory or administrative agency
or commission shall have issued an order, decree or ruling or taken any other
action permanently restraining, enjoining or otherwise prohibiting the
transactions contemplated by the Combination Agreement and such order, decree,
ruling or other action shall have become final and non-appealable. The
Combination Agreement may be terminated by Coventry or Newco as one party, or
Mutual, Holding or PHC as the other party in the event of a breach by the other
party of any representation or warranty contained in the Combination Agreement
or in any document delivered in connection therewith or there has been a
material breach of any of the covenants or agreements set forth in the
Combination Agreement on the part of the other party, which breach is not
curable or, if curable, is not cured within 30 days after written notice of such
breach is delivered to the offending party. The Combination Agreement shall
terminate without further action by the parties if, prior to the Effective Time,
the Board of Directors of Coventry shall have exercised its fiduciary obligation
to approve an unsolicited acquisition proposal from a third party meeting
certain conditions set forth in the Combination Agreement, or to withdraw its
recommendation to Coventry's shareholders in support of transactions
contemplated by the Combination Agreement as a result of such unsolicited
acquisition proposal.
Termination Fee; Third Party Bids
In the event the Combination Agreement is terminated by Coventry's Board of
Directors as a result of the withdrawal of its recommendation to Coventry's
shareholders in support of the transactions contemplated by the Combination
Agreement due to, or the approval by Coventry's Board of Directors of, an
unsolicited acquisition proposal that meets certain conditions as described
above, then the potential acquiror shall promptly pay (or, if the potential
acquiror fails to pay, Coventry shall promptly pay) to Mutual $20,000,000, which
amount shall be due regardless of whether or not the transaction contemplated by
such unsolicited acquisition proposal shall be consummated. No termination fee
is payable in the event that the Combination Agreement is otherwise terminated.
Interest of Certain Persons in the Combination Agreement
Coventry will become a direct, wholly owned subsidiary of Newco upon
consummation of the Merger. The Board of Directors of Newco at the Effective
Time will consist of 15 members, nine of whom currently serve as members of
Coventry's Board of Directors and six of whom will be designees of Mutual. The
executive officers of Newco at the Effective Time, will consist of substantially
all of the current executive officers of Coventry and certain executive officers
of PHC. The directors and executive officers of Newco that are currently
officers of Coventry hold Coventry Options to purchase 1,048,536 shares of
Coventry Common Stock. The directors and executive officers of Newco that are
currently executive officers of PHC hold the PHC Options to purchase 750,000
shares of PHC's common stock. Upon the consummation of the Merger and Capital
Contribution, Newco will assume the Coventry Options and the PHC Options under
the same terms and conditions as set forth therein and in Newco's 1998 Incentive
Stock Option Plan (the "Newco Plan") and each such option will be exercisable
for that number of shares of Newco Common Stock as shall equal the number of
shares of Coventry Common Stock or PHC's common stock currently issuable upon
9
<PAGE> 19
exercise of the option. The Combination Agreement will not result in the
acceleration of the outstanding Coventry Options or PHC Options and will not
constitute a change of control under Coventry's employment agreement and change
of control agreements. See "Combination Agreement -- Interests of Certain
Persons in the Combination Agreement."
Accounting Treatment
The Merger and the Capital Contribution will be accounted for as a common
control transfer from Coventry to Newco at historical cost and the purchase of
the PHC Business by Newco. The historical book basis of the assets, liabilities
and shareholders' equity of Coventry will become the carrying value of the
assets, liabilities and shareholders' equity of Newco, and the PHC Assets and
PHC Liabilities comprising the PHC Business will be recorded on the books of
Newco at their fair value. Any cost in excess of the net asset fair value of the
PHC Business will be amortized using the straight-line method over a period to
be determined by Newco based upon its estimate of the useful life of the net
assets acquired. The unaudited pro forma selected financial data contained in
this Proxy Statement/Prospectus has been prepared using the purchase method of
accounting to account for the Business Combination.
The Nasdaq Stock Market Listing
The Coventry Common Stock is listed on The Nasdaq Stock Market. Newco shall
obtain, prior to the Effective Time, approval for the listing of the shares of
Newco Common Stock to be issued in the Merger and pursuant to the Capital
Contribution on The Nasdaq Stock Market.
NO APPRAISAL RIGHTS
Under Section 48-23-102(c) of the Tennessee Business Corporation Act, as
amended, the holders of Coventry Common Stock will not be entitled to
dissenters' rights or appraisal in connection with the Merger or Capital
Contribution. "See Terms of the Business Combination -- No Appraisal Rights."
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
It is anticipated that no gain or loss for federal income tax purposes will
be recognized by the shareholders of Coventry with respect to their exchange of
Coventry Common Stock for Newco Common Stock pursuant to the Merger. It is a
condition to consummation of the Merger that Coventry will receive an opinion
from its legal counsel, Bass, Berry & Sims PLC, to the effect that, among other
things, no gain or loss will be recognized by the Coventry shareholders with
respect to the shares of Newco Common Stock received in the Merger. For a more
complete description of the federal income tax consequences of the Merger, see
"Combination Agreement -- Certain Federal Income Tax Consequences."
BECAUSE OF THE COMPLEXITIES OF THE TAX LAWS, IT IS RECOMMENDED THAT EACH
SHAREHOLDER CONSULT HIS OWN TAX ADVISOR CONCERNING THE APPLICABLE FEDERAL, STATE
AND LOCAL INCOME TAX CONSEQUENCES OF THE BUSINESS COMBINATION.
10
<PAGE> 20
SUMMARY HISTORICAL FINANCIAL DATA
The following summary financial data and other operating information for
the five years ended December 31, 1996 are derived from the audited consolidated
financial statements of Coventry and PHC. The financial data for the nine-month
periods ended September 30, 1997 and 1996 are derived from unaudited financial
statements. The unaudited financial statements include all adjustments,
consisting of normal recurring accruals, which Coventry and PHC consider
necessary for a fair presentation of the financial position and the results of
operations for those periods.
Operating results for the nine-month period ended September 30, 1997 are
not necessarily indicative of the results that may be expected for the entire
year ending December 31, 1997. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included herein.
SUMMARY CONSOLIDATED FINANCIAL DATA OF COVENTRY
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED(1)
------------------------------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT DATA(3)
Operating revenues.............. $475,454 $641,573 $776,643 $852,390 $1,057,129
Operating earnings (loss)....... 27,913 43,177 55,023 (1,275) (91,346)
Earnings (loss) from continuing
operations.................... 14,171 22,005 29,288 18 (61,287)
Loss on disposal of discontinued
operations.................... (3,846)
Extraordinary items............. 4,005
-------- -------- -------- -------- ----------
Net earnings (loss)............. $ 14,330 $ 22,005 $ 29,288 $ 18 $ (61,287)
======== ======== ======== ======== ==========
Earnings (loss) per share(2):
Continued operations.......... $ 0.51 $ 0.74 $ 0.93 $ 0.00 $ (1.86)
Discontinued operations....... (0.14)
Extraordinary items........... 0.15
-------- -------- -------- -------- ----------
Net earnings (loss) per
share....................... $ 0.52 $ 0.74 $ 0.93 $ 0.00 $ (1.86)
======== ======== ======== ======== ==========
Weighted average common and
common equivalent shares
outstanding(2)................ 27,547 29,585 31,425 32,164 33,011
BALANCE SHEET DATA(3)
Cash and investments(4)......... $ 65,488 $116,014 $133,975 $144,469 $ 168,423
Total assets.................... $207,836 $266,971 $343,771 $385,675 $ 448,945
Long-term obligations and notes
payable (including current
maturities)................... $ 59,856 $ 53,017 $ 73,643 $ 77,868 $ 102,985
Stockholders' equity and
partners' capital(5).......... $ 69,679 $ 96,906 $134,124 $153,851 $ 100,427
<CAPTION>
NINE MONTHS ENDED(1)
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
1996 1997
------------- -------------
<S> <C> <C>
OPERATIONS STATEMENT DATA(3)
Operating revenues.............. $767,577 $907,120
Operating earnings (loss)....... (16,647) (48)
Earnings (loss) from continuing
operations.................... (9,148) 8,397
Loss on disposal of discontinued
operations....................
Extraordinary items.............
-------- --------
Net earnings (loss)............. $ (9,148) $ 8,397
======== ========
Earnings (loss) per share(2):
Continued operations.......... $ (0.28) $ 0.25
Discontinued operations.......
Extraordinary items...........
-------- --------
Net earnings (loss) per
share....................... $ (0.28) $ 0.25
======== ========
Weighted average common and
common equivalent shares
outstanding(2)................ 32,839 33,505
BALANCE SHEET DATA(3)
Cash and investments(4)......... $148,131 $217,590
Total assets.................... $445,803 $437,121
Long-term obligations and notes
payable (including current
maturities)................... $108,061 $ 98,086
Stockholders' equity and
partners' capital(5).......... $151,924 $113,230
</TABLE>
- ---------------
(1) The medical loss ratio (health benefits as a percentage of managed care
premiums) was 82.4%, 81.8%, 79.8%, 84.5% and 89.9% in 1992, 1993, 1994,
1995, and 1996, respectively. The medical loss ratio was 86.5% and 86.6% for
the nine months ending September 30, 1996 and September 30, 1997,
respectively.
(2) Reflects the two-for-one split of Coventry's common stock which occurred in
August 1994.
(3) All periods presented have been restated for the merger with HCUSA in 1995,
Southern Health Management Corporation ("SHMC") in 1994 and for discontinued
operations.
(4) Certain reclassifications have been made to the financial statements to
conform to the 1997 presentation.
(5) The predecessor company of SHMC was an S Corporation.
11
<PAGE> 21
SUMMARY CONSOLIDATED FINANCIAL DATA OF PHC
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
------------------------------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA(1)
Operating revenues:
Managed care premiums......... $284,909 $335,327 $422,963 $574,360 $806,351
Management services........... 10,837 17,265 61,276 75,408 67,711
Other......................... 1,875 2,119 1,970 1,569 1,524
Total operating revenues.... 297,621 354,711 486,208 651,336 875,586
Operating expenses:
Health benefits............... 249,854 275,372 347,646 519,975 740,972
Selling, general and
administrative.............. 37,010 51,970 110,776 166,126 196,358
Depreciation and
amortization................ 4,437 5,387 8,807 11,649 15,745
Loss on impairment of
goodwill....................
Operating earnings (loss)....... 6,320 21,982 18,979 (46,414) (77,490)
Other income, net(2)............ 322 874 558 1,727 2,732
Interest income................. 4,603 3,927 6,150 11,465 14,162
Earnings (loss) before income
taxes(2)...................... 11,245 26,783 25,688 (33,222) (60,596)
Cumulative effective as of
January 1, 1993 of change in
method of accounting for
income taxes.................. 514
Net Earnings (loss)(2).......... 5,912 15,938 18,448 (22,693) (40,408)
BALANCE SHEET DATA(1)
Cash and investments(3)......... $ 83,010 $125,905 $177,799 $201,464 $253,273
Total assets(3)................. 128,304 208,908 334,444 383,409 462,768
Long term obligations........... 414 1,269 1,322 3,105 3,920
Stockholders' equity(3)......... 69,737 234,301 211,605 234,301 254,477
<CAPTION>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
1996 1997
------------- -------------
<S> <C> <C>
INCOME STATEMENT DATA(1)
Operating revenues:
Managed care premiums......... $605,250 $ 645,936
Management services........... 50,330 41,842
Other......................... 713 851
Total operating revenues.... 656,294 688,628
Operating expenses:
Health benefits............... 562,370 552,126
Selling, general and
administrative.............. 139,947 160,258
Depreciation and
amortization................ 11,502 12,121
Loss on impairment of
goodwill.................... 6,000
Operating earnings (loss)....... (57,526) (41,876)
Other income, net(2)............ 1,530 8,638
Interest income................. 10,622 10,699
Earnings (loss) before income
taxes(2)...................... (45,374) (22,540)
Cumulative effective as of
January 1, 1993 of change in
method of accounting for
income taxes..................
Net Earnings (loss)(2).......... (31,223) (14,969)
BALANCE SHEET DATA(1)
Cash and investments(3)......... $240,267 $ 246,518
Total assets(3)................. 472,552 435,941
Long term obligations........... 4,895 4,263
Stockholders' equity(3)......... 262,362 227,497
</TABLE>
- ---------------
(1) Includes operations of plans acquired commencing on the date of closing of
the respective transaction. 1993 -- Healthplus HMO, Inc. in Indiana; United
HealthCare, Inc. in Iowa; 1994 -- SouthCare Medical Alliance in Georgia;
Coastal Bend Health Plan, Inc. in Texas; CIGNA HealthCare of
Kansas/Missouri, Inc.; 1996 -- Admar Group, Inc.; Metra HealthCare Plan of
St. Louis, Inc.
(2) Includes $2.5 million for equity in earnings of UP & UP, Inc. in 1996.
(3) Increases in equity in excess of earnings each year primarily represent
capital contributions from Mutual.
12
<PAGE> 22
PRO FORMA SELECTED FINANCIAL DATA
(UNAUDITED)
The unaudited pro forma statements of operating data for the year ended
December 31, 1996, and for the nine months ended September 30, 1997 have been
prepared based on the historical operating statements of Coventry and PHC, as
adjusted for PHC to reflect the elimination of certain businesses of PHC that
are expected to be sold prior to the Business Combination (Principal Health Care
of the Mid-Atlantic, Inc., and Principal Health Care of Texas, Inc.) or are to
be retained by Mutual (the equity investment in United Payors and United
Providers, Inc., 50% of the equity investment in American Psych Systems, Inc.
and 50% of the common stock warrants for Accordant Health Systems, Inc. and
Advanced ParadigM, Inc.), and thereafter adjusted to give pro forma effect to
reflect the acquisition of the PHC Business and related transactions, and the
issuance of the additional shares and warrant, as if the Business Combination
and related transactions had occurred and the additional shares and warrant had
been issued on January 1 of each respective year. The unaudited pro forma
balance sheet data as of September 30, 1997 has been prepared based on the
historical balance sheets of Coventry and PHC, as adjusted to reflect the
purchase of the PHC Business by Coventry. The allocation of the purchase price
to the acquired assets (the PHC Business, the Management Services Agreement, the
Renewal Rights Agreement or the Coinsurance Agreement and the Marketing Services
Agreement) is tentative and subject to the final determination of relative fair
market value of the assets. Management believes the final purchase price
allocation will not vary materially from the tentative allocation. The
transaction with Mutual and its subsidiaries will be accounted for as a purchase
of assets by Newco. The simultaneous conversion of Coventry Common Stock into
Newco Common Stock pursuant to the Merger will be accounted for as a common
control transfer at the historical cost basis of Coventry. The pro forma
statements of operating data may not be indicative of the future results of
operations and what the actual results of operations would have been had the
Business Combination and related transactions described above been effective
January 1 of each respective year. The pro forma selected financial data should
be read in connection with the historical financial statements and notes thereto
of Coventry and PHC included herein.
13
<PAGE> 23
PRO FORMA BALANCE SHEET DATA
SEPTEMBER 30, 1997
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PHC ADJUSTED PRO FORMA CONSOLIDATED
COVENTRY PHC ADJUSTMENTS PHC ADJUSTMENTS PRO FORMA
---------- ---------- ----------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents............. $141,236 $113,017 $ (12,523)(a) $ 86,914 $(10,000)(e) $218,150
12,756(b) --
(26,336)(c)
Short-term investments................ 4,951 53,629 (6,803)(a) 46,826 51,777
Accounts receivable, net.............. 34,976 23,993 (3,352)(a) 22,854 57,830
2,213(b) --
Other receivables..................... 15,021 30,185 (701)(a) 28,914 43,935
199(b) --
(769)(c) --
Deferred income taxes and other
current assets...................... 12,834 19,708 (3,934)(a) 16,674 29,508
1,523(b)
(623)(c) --
-------- -------- --------- -------- -------- --------
Total current assets.......... 209,018 240,532 (38,350) 202,182 (10,000) 401,200
--
Long-term investments................. 71,403 79,872 (23,031)(a) 57,059 128,462
551(b) --
(333)(c)
Property and equipment, net........... 22,856 24,098 (2,285)(a) 22,460 45,316
647(b)
Goodwill and intangible assets, net... 112,281 87,096 (40,159)(a) 46,937 159,960(e) 344,178
25,000(d)
Other assets.......................... 21,563 4,344 (1,312)(a) 3,032 24,595
-------- -------- --------- -------- -------- --------
Total assets.................. $437,121 $435,942 $(104,272) $331,670 $174,960 $943,751
======== ======== ========= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claim liabilities............. $116,743 $116,768 $ (14,556)(a) $108,878 $ $225,621
11,791(b) --
(5,125)(c) --
Accounts payable and other accrued
liabilities......................... 94,132 69,845 (5,743)(a) 58,905 -- 153,037
6,098(b) --
(11,295)(c)
Deferred revenue...................... 14,930 5,801 (483)(a) 5,318 -- 20,248
--
Current portion of long-term debt and
notes payable....................... 49,172 238 (15)(a) 223 -- 49,395
-------- -------- --------- -------- -------- --------
Total current liabilities..... 274,977 192,652 (19,328) 173,324 -- 448,301
Convertible exchangeable subordinated
notes............................... 41,180 -- -- -- 41,180
Long-term debt........................ 1,286 1,324 (43)(a) 1,281 -- 2,567
Other long-term liabilities........... 6,448 14,469 (7,254)(a) 7,127 -- 13,575
(88)(c)
Stockholders' equity:
Common Stock, $.01 par value;
50,000,000 shares authorized;
33,589,464 issued (including 439,560
shares owned by a subsidiary),
33,149,904 shares outstanding in
1997 and 33,001,296 shares issued
and outstanding in 1996............. 336 25 (25)(c) 251(e) 587
Additional paid-in capital............ 145,498 270,473 (87,874)(a) 149,938 149,709(e) 470,145
(32,661)(c) 25,000(d)
Net unrealized investment gain........ 439 828 (55)(a) -- -- 439
(773)(c)
Accumulated deficit................... (28,043) (43,829) 21,923(a) (28,043)
21,906(c)
Treasury stock, at cost, 439,560
shares.............................. (5,000) -- -- -- (5,000)
-------- -------- --------- -------- -------- --------
Total stockholders' equity.... 113,230 227,497 (77,559) 149,938 174,960 438,128
-------- -------- --------- -------- -------- --------
Total liabilities and
stockholders' equity........ $437,121 $435,942 $(104,272) $331,670 $174,960 $943,751
======== ======== ========= ======== ======== ========
</TABLE>
14
<PAGE> 24
PRO FORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PHC ADJUSTED PRO FORMA CONSOLIDATED
COVENTRY PHC ADJUSTMENTS PHC ADJUSTMENTS PRO FORMA
---------- ---------- ----------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums..... $1,035,778 $806,351 $(102,735)(a) $781,380 $ $1,817,158
77,764(b)
Management services....... 21,351 69,235 (31,513)(a) 37,722 59,073
---------- -------- --------- -------- -------- ----------
Total operating
revenues......... 1,057,129 875,586 (56,484) 819,102 1,876,231
Operating expenses:
Health benefits........... 930,739 740,972 (86,727)(a) 727,153 1,657,892
72,908(b)
Selling, general and
administrative.......... 165,081 196,358 (51,855)(a) 153,320 318,401
8,817(b)
Depreciation and
amortization............ 42,862 15,745 (6,436)(a) 9,309 3,259(d) 60,508
5,078(e)
Other charges............. 9,793 9,793
---------- -------- --------- -------- -------- ----------
Total operating
expenses......... 1,148,475 953,075 (63,293) 889,782 8,337 2,046,594
---------- -------- --------- -------- -------- ----------
Operating earnings (loss)... (91,346) (77,489) 6,809 (70,680) (8,337) (170,363)
Other income, net........... 13,379 16,894 (4,167)(a) 14,271 27,650
1,544(b)
Interest expense............ (6,257) (6,257)
---------- -------- --------- -------- -------- ----------
Earnings (loss) before
income taxes and minority
interest.................. (84,224) (60,595) 4,186 (56,409) (8,337) (148,970)
Provision for (benefit from)
income taxes.............. (22,860) (20,187) 1,632(a)(b) (18,555) (1,417)(g) (42,832)
Minority interest in
earnings (loss) of
consolidated subsidiary,
net of income tax......... (77) (77)
---------- -------- --------- -------- -------- ----------
Net earnings (loss)......... $ (61,287) $(40,408) $ 2,554 $(37,854) $ (6,920) $ (106,061)
========== ======== ========= ======== ======== ==========
Net earnings (loss) per
common and common
equivalent share.......... $ (1.86) $ (1.83)
========== ======== ========= ======== ======== ==========
Weighted average common and
common equivalent shares
outstanding............... 33,011 25,070(e) 58,081
========== ======== ========= ======== ======== ==========
</TABLE>
15
<PAGE> 25
PRO FORMA STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PHC ADJUSTED PRO FORMA CONSOLIDATED
COVENTRY PHC ADJUSTMENTS PHC ADJUSTMENTS PRO FORMA
---------- ---------- ----------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums......... $892,357 $645,936 $(75,001)(a) $642,492 $ $1,534,849
71,557(b)
Management services........... 14,763 42,692 (18,698)(a) 23,994 38,757
-------- -------- -------- -------- -------- ----------
Total operating
revenues............. 907,120 688,628 (22,142) 666,486 1,573,606
Operating expenses:
Health benefits............... 772,363 552,126 (62,119)(a) 557,412 1,329,775
67,405(b)
Selling, general and
administrative.............. 124,892 160,258 (34,783)(a) 133,295 258,187
7,820(b)
Depreciation and
amortization................ 9,913 18,121 (10,869)(a) 7,573 2,444(d) 23,941
321(b) 4,011(e)
-------- -------- -------- -------- -------- ----------
Total operating
expenses............. 907,168 730,505 (32,225) 698,280 6,455 1,611,903
-------- -------- -------- -------- -------- ----------
Operating earnings (loss)....... (48) (41,877) 10,083 (31,794) (6,455) (38,297)
Other income, net............... 22,353 19,337 (4,972)(a) 15,846 38,199
1,481(b)
Interest expense................ (8,278) (8,278)
-------- -------- -------- -------- -------- ----------
Earnings (loss) before income
taxes and minority interest... 14,027 (22,540) 6,592 (15,948) (6,455) (8,376)
Provision for (benefit from)
income taxes.................. 5,611 (7,571) 2,531(a)(b) (5,040) (1,097)(g) (526)
Minority interest in (income)
loss of consolidated
subsidiary, net of income
tax........................... 19 19
-------- -------- -------- -------- -------- ----------
Net earnings (loss)............. $ 8,397 $(14,969) $ 4,061 $(10,908) $ (5,358) $ (7,869)
======== ======== ======== ======== ======== ==========
Net earnings (loss) per common
and common equivalent share... $ 0.25 $ (0.13)
======== ======== ======== ======== ======== ==========
Weighted average common and
common equivalent shares
outstanding................... 33,505 25,070(e) 58,575
======== ======== ======== ======== ======== ==========
</TABLE>
16
<PAGE> 26
COVENTRY HEALTH CARE, INC.
NOTES TO PRO FORMA SELECTED FINANCIAL DATA
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(a) Reflects the elimination of certain assets of PHC that are expected to be
sold prior to the Business Combination (Principal Health Care of the
Mid-Atlantic, Inc. and Principal Health Care of Texas, Inc.) or are to be
retained by Mutual (the equity investment in United Payors and United
Providers, Inc., 50% of the equity investment in American Psych Systems,
Inc., the Admar Group, Inc. and 50% of the common stock warrants for
Accordant Health Systems, Inc. and Advanced ParadigM, Inc.) excluded from
the proposed transaction, using an effective tax rate of 39%. In July 1997,
PHC transferred its ownership interest of America's Health Plan ("AHP") to
Holdings as a dividend and return of capital. AHP's operating results are
included in the pro forma statement of operations until the effective date
of the transfer. AHP's operating results are not material to the pro forma
statement of operations.
(b) Reflects an estimate of the results of operations and the balance sheet of
FHP of Illinois, Inc. ("FHP") using an effective tax rate of 39%. FHP was
acquired by PHC effective October 1, 1997, and as a result, is not included
in the historical financial statements of PHC.
(c) Reflects transaction related adjustments such as the retention of certain
liabilities by PHC and the adjustment to arrive at the target tangible net
worth amount of $103 million.
(d) Reflects the issuance of the Newco Warrant valued at approximately $25.0
million. This value was determined through the application of standard
option pricing methodology to the schedule of warrant terms, and reflecting
the volatility of the underlying equity security and Coventry's historical
lapse experience for employee options. The value was allocated between the
Management Services Agreement and the Renewal Rights Agreement and the
Coinsurance Agreement to be assumed by Newco at the end of the Management
Services Agreement. The allocations were $4.7 million and $20.3 million for
the Management Services Agreement and the Renewal Rights Agreement or the
Coinsurance Agreement, respectively. The useful lives were established at
1.75 years for the Management Services Agreement and 35 years for the
Renewal Rights Agreement or the Coinsurance Agreement.
(e) Reflects the issuance of approximately 25.1 million shares of Newco Common
Stock valued at market on November 3, 1997 for Coventry Common Stock
($14.50) and transaction costs to purchase certain assets and liabilities
of PHC. Due to the restricted nature of the shares to be issued, the
Company has applied a discount of 17.5% to the trading market value of the
shares. Of the goodwill and other intangible assets recorded, $1.5 million
was allocated to the Marketing Services Agreement, $5.0 million was
allocated to the customer lists and $10.0 million was allocated to the HMO
licenses with the remainder of the purchase price allocated to the goodwill
of the PHC Business. The amortization periods of 1.75 years, 5 years, 20
years and 35 years were assigned to the Marketing Services Agreement,
customer lists, licenses and the goodwill, respectively. The increase in
depreciation and amortization represents the incremental amounts over the
amounts contained in the historical financial statements of PHC. The
allocations above are tentative. Final allocations will not differ
materially from the above allocations.
(f) Reflects an estimated effective tax benefit on the adjusting entries of 17%
for the periods ending September 30, 1997 and December 31, 1996.
(g) Co-incident with the closing of the transactions, the Company will enter
into a Marketing Services Agreement and a Management Services Agreement
with Mutual. Both agreements are initially scheduled to terminate on
December 31, 1999. The Company expects to receive payments under the
agreements of approximately $24.7 million and $26.4 million in 1998 and
1999, respectively. These amounts have not been included in the Pro Forma
Selected Financial Data presented herein. Had the effect of these contracts
been included in the Pro Forma Selected Financial Data for the periods
presented, net income (loss) would have been $6.8 million and $(84.8)
million in 1997 and 1996, respectively. Pro Forma earnings (loss) per share
would have been $0.12 and $(1.46) in 1997 and 1996, respectively.
17
<PAGE> 27
COMPARATIVE PER SHARE DATA
The following table presents historical per share data of Coventry and PHC
and equivalent pro forma per share data of Newco after giving effect to the
Business Combination using the purchase method of accounting, assuming the
Business Combination had been effective during all periods presented. The pro
forma data does not purport to be indicative of the results of future operations
or the results that would have occurred had the Business Combination been
consummated at the beginning of the periods presented. The information set forth
below should be read in conjunction with the financial statements and notes
thereto of Coventry, the financial statements and notes thereto of PHC and the
unaudited pro forma selected financial data, which are included elsewhere in
this Proxy Statement/Prospectus. Neither Coventry nor PHC paid any cash
dividends on its common stock during the periods presented.
<TABLE>
<CAPTION>
PHC
NEWCO COVENTRY ----------------------------
------------ ---------- EQUIVALENT
CONSOLIDATED PRO
PRO FORMA HISTORICAL HISTORICAL(1) FORMA(2)
------------ ---------- ------------- ------------
<S> <C> <C> <C> <C>
Book value per share of common stock outstanding:
At September 30, 1997.......................... $7.52 $ 3.42 $32,298.20 $37,750.40
Fully diluted income (loss) per share:
Year ended December 31, 1996................... (1.83) (1.86) (7,276.00) (9,186.60)
Nine Months ended September 30, 1997........... (0.13) 0.25 (1,875.60) (652.60)
</TABLE>
- ---------------
(1) Historical PHC amounts were adjusted for the amounts that relate to assets
to be retained by Mutual.
(2) The equivalent pro-forma per share data for PHC is computed by multiplying
Newco's consolidated pro-forma per share information by 5,020, the exchange
ratio.
MARKET PRICE AND DIVIDEND INFORMATION
There is no established trading market for the Newco Common Stock or the
common stock of PHC. Coventry Common Stock is traded on The Nasdaq Stock Market
under the symbol "CVTY." The following table sets forth, for the periods
indicated, the high and low closing sale prices for Coventry Common Stock.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1995
First Quarter............................................... 30 23 3/4
Second Quarter.............................................. 29 1/2 13 1/2
Third Quarter............................................... 21 1/4 14 1/4
Fourth Quarter.............................................. 22 1/8 17 5/8
1996
First Quarter............................................... 20 7/8 15 11/16
Second Quarter.............................................. 20 15/16 15 1/4
Third Quarter............................................... 15 5/8 11 15/16
Fourth Quarter.............................................. 11 1/2 9
1997
First Quarter............................................... 13 1/4 6 5/8
Second Quarter.............................................. 16 7/8 10 3/8
Third Quarter............................................... 20 1/8 14 3/8
Fourth Quarter.............................................. 19 1/8 13 5/8
1998
First Quarter (through March 9, 1998)....................... 17 5/8 12 15/16
</TABLE>
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<PAGE> 28
On November 3, 1997, the last trading day prior to announcement of the
execution of the Combination Agreement, the closing sales price per share of
Coventry Common Stock as reported on The Nasdaq Stock Market was $14.50. On
March , 1998, the closing sale price per share was $ . As of February 2,
1998, there were approximately 474 holders of record of Coventry Common Stock.
Coventry has never declared or paid a cash dividend on its Common Stock. It
is the present policy of the Board of Directors of Coventry to retain all
earnings to support operations and to finance expansion; therefore, Coventry
does not anticipate that Newco will declare or pay cash dividends on the Newco
Common Stock in the foreseeable future. The declaration and payment of dividends
in the future will be determined based on a number of factors, including Newco's
earnings, financial condition and requirements, restrictions in financing
agreements and other factors deemed relevant by the Board of Directors of Newco.
Coventry anticipates that the payment of dividends by Newco will be prohibited
under the terms of the credit facility with its lending banks.
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<PAGE> 29
RISK FACTORS
This Proxy Statement/Prospectus and other filings and statements made on
behalf of Newco 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 may be affected by
a number of factors, including the risk factors identified herein.
RISKS OF GOVERNMENTAL PROGRAMS AND REGULATIONS
Coventry's and PHC's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws and rules could force Newco to
change how it does business and may restrict Newco's revenue and/or enrollment
growth and/ or increase its health care and administrative costs. Regulatory
approvals must be obtained and maintained to market many of the products and
services of Coventry and PHC. Delays in obtaining or failure to obtain or
maintain such approvals could adversely affect Newco's revenue or the number of
covered lives, or could increase costs.
Each of Coventry and PHC is, and Newco will be, 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. Newco currently intends to continue to
expand these products, and its exposure to such risks will increase. Coventry's
and PHC's HMO subsidiaries which provide managed health care services under the
Federal Employees Health Benefits Program are subject to audit, in the normal
course of business, by the United States Office of Personnel Management ("OPM"),
and such audits could result in material adjustments. As discussed in
"Government Regulation," Coventry's and PHC's financial results are also
susceptible to future state and federal regulatory measures, including health
care reform. Recently, the Clinton Administration and various leaders of the
U.S. Congress have proposed legislation which could result in increased costs to
managed care providers.
LIMITATIONS ON ABILITY TO INCREASE REVENUES
Increases in Newco's revenues will be generally dependent upon its ability
to increase premiums and number of members, as well as the mix of the products
sold. Coventry's health care plan membership recently has shown only moderate
increases; while membership in PHC's plans has increased at a more vigorous rate
prior to 1997, much of the increased membership was not profitable, and recent
PHC premium rate increases may result in fewer members in the future. Although
premium rates for managed care plans generally have increased recently,
competitive pressures, regulatory restrictions and consumer preference for
lower-priced health care options may cause decreases or severely limit increases
in the future. The premiums from governmental programs such as Medicare or
Medicaid are generally not based on an individual company's anticipated costs
and cannot be adjusted by the company. Certain of the customers of Coventry and
of PHC represent a significant percentage of the membership of one or more of
their respective health plans, and the loss of one or more of such customers
could cause a material adverse effect on the revenues of Newco in the future.
LIMITS ON ABILITY TO PROJECT ACTUAL HEALTH CARE COSTS
A substantial portion of the revenue received by Coventry and PHC, and
expected to be received by Newco, is expected to pay the costs of health care
services or supplies delivered to persons covered by its health plan and
insurance products. The total health care costs incurred by Coventry and PHC,
and to be incurred by Newco, are affected by the number of individual services
rendered and the cost of each service. Much of the premium revenue is set in
advance of the actual delivery of services and the related incurring of the
cost, usually on a prospective annual basis. While Coventry and PHC attempt to
base the premiums they charge at least in part on their estimate of expected
health care costs over the fixed premium period, competition, regulations and
other circumstances may limit their and Newco's ability to fully base premiums
on estimated costs. In addition, many factors may and often do cause actual
health care costs to exceed those estimated, including increased cost of
individual services, catastrophes, epidemics, seasonality, general
20
<PAGE> 30
inflation, new mandated benefits or other regulatory changes and insured
population characteristics. Accordingly, there may be discrepancies between
reserves for incurred-but-not-reported liabilities and the actual amount of such
liabilities. Historically, increases in health care prices and utilization have
caused health care costs to rise faster than general inflation. While these
increases have moderated recently, there can be no assurance that health care
prices or utilization will not again increase at a more rapid pace.
RISKS OF AGREEMENTS WITH PROVIDERS
Prior to 1997, Coventry's St. Louis and Pennsylvania health plans offered
members access to Company-owned and -staffed medical centers, as well as to
networks of contracting providers. During 1997, the Company's medical centers
were sold to provider systems which have contracted to provide care to the
Company's members continuing to use such centers. Newco expects that
substantially all its membership will be served by providers contracting with
Newco to provide the requisite medical care. The ability of Newco to contract
successfully with a sufficiently large number of providers in a given geographic
market will impact the relative attractiveness of its managed care products in
those markets. The terms of such provider contracts also have a material impact
on Newco's medical costs and its ability to control such costs. In certain
markets, currently served by Coventry and PHC, certain provider systems have
significant market positions, and may compete with Coventry or PHC and, in the
future, Newco. If such provider systems refuse to contract with Newco, place
Newco at a competitive disadvantage or use their market position to negotiate
contracts unfavorable to Newco, Newco's product offerings or profitability in
such market areas could be adversely affected.
Among the medical cost control techniques Coventry has utilized, and Newco
will continue to utilize, are capitation agreements with providers pursuant to
which providers are paid a fixed dollar amount per member under the agreement,
with the provider obligated to provide all of a particular type of medical
service required by the members, and global capitation agreements, pursuant to
which a single integrated hospital-physician provider system provides
substantially all hospital and medical services to large number of members for a
fixed percentage of the premium charged by Coventry. While these systems may
shift to the contracting provider system the risk that medical costs will exceed
the amounts anticipated, Coventry and Newco will be exposed to the risk that the
provider systems will be financially unable or unwilling to fulfill their
payment or medical care obligations under the capitation agreements, and to the
risk that members may prefer other providers in the market.
RECENT OPERATING LOSSES
Coventry experienced significant operating losses in 1996 and in the first
quarter of 1997 and has only recently returned to profitability. PHC incurred
operating losses in 1995, 1996 and the first nine months of 1997. While
management of Coventry believes that the operating results of the PHC Business
will improve in 1998 and 1999 and that efficiencies in combined operations after
the Effective Time will improve the profitability of the combined companies, no
assurance can be given that such efficiencies or profitability will be achieved.
INFORMATION SYSTEMS AND ADMINISTRATIVE EXPENSE RISKS
The level of administrative expense is a significant factor in the
operating results of Coventry, PHC and, in the future, Newco. While Coventry and
PHC attempt to effectively manage such expenses, increases in staff-related and
other administrative expenses may occur from time to time due to business or
product start-ups or expansions, growth or changes in business, acquisitions,
regulatory requirements or other reasons. Such expense increases are not clearly
predictable, and increases in administrative expenses may adversely affect
results. As a result of the Business Combination, the parties will seek to
reduce the level of their combined administrative expense through integration
efficiencies, including some personnel reductions. However, the substantially
greater scope of Newco's operations over those of Coventry and PHC,
respectively, may lead to increases in administrative expenses, particularly in
the short term.
21
<PAGE> 31
Coventry's and PHC's businesses are significantly dependent on effective
information systems. Coventry and PHC have different information systems for
their various businesses. Newco will attempt to reduce the number of systems and
also upgrade and expand its information systems capabilities. Failure to
maintain an effective and efficient information system could result in loss of
existing customers and difficulty in attracting new customers, customer and
provider disputes, regulatory problems, increases in administrative expenses or
other adverse consequences. In addition, Newco, may, from time to time, obtain
significant portions of its systems-related or other services or facilities from
independent third parties which may make Newco,'s operations vulnerable to such
third party's failure to perform adequately. Although both Coventry and PHC have
undertaken programs designed to prevent material information system disruption
at January 1, 2000, such programs have not been completed and are subject to the
failure of third party vendors to comply with planned software revisions.
RISK OF INTEGRATION OF THE BUSINESSES
The Business Combination involves the integration of two companies that
have previously been operated independently. Among the factors considered by the
Coventry Board of Directors in connection with its approval of the Combination
Agreement were the opportunities of integration efficiencies that should result
from such integration. No assurance can be given that difficulties will not be
encountered in such integration, including, without limitation, difficulties
relating to the integration of the companies' management information,
accounting, accrual and control systems, executive management and culture, or
that the benefits expected from such operation and integration will be realized.
Because of the demands placed on the management information systems of the
combined companies, the integrated operations of Coventry and PHC are especially
susceptible to risks associated with a malfunction in these systems, including
an impairment of the systems' operations caused by the year 2000 problem. Any
delays or unexpected costs incurred in connection with such operation and
integration could have a material adverse effect on Newco's business, results of
operations or financial condition.
FINANCING RISK
Coventry's and PHC's recent financial losses may make it more difficult to
obtain financing on as favorable terms in the future. In addition, operating
losses by a subsidiary may require Coventry, PHC or Newco to make investments
in, or to refinance loans to, such subsidiary in order to maintain required
capital levels. Many of the state regulatory authorities in states in which
Coventry and PHC conduct business are expected to increase capital requirements
for managed care companies in the next two years. Coventry currently has a
credit facility with a group of banks, under which Coventry has $42.8 million of
outstanding indebtedness. The credit facility currently requires repayment in
full on April 1, 1999. Consummation of the transactions contemplated by the
Combination Agreement will require approval from Conventry's lending banks,
which Coventry anticipates will be received.
ADMINISTERED HEALTH INSURANCE POLICIES RISK
The Management Services Agreement and Renewal Rights Agreement contemplate
that Newco will manage the Administered Health Insurance Policies in the Newco
Markets and offer to renew such policies as are in force on December 31, 1999.
Although Coventry believes that more than 50% of the Administered Health
Insurance Policies utilize preferred provider networks or other elements of
managed care similar to Newco's business, a significant amount of the policies
will be indemnity policies under which the insurer is liable for all claims
(subject to certain deductible amounts or copayment percentages) regardless of
whether the provider has an agreement with the insurer. Neither Coventry nor PHC
has any recent experience in the management or operation of a substantial
indemnity health insurance business, and there can be no assurance that existing
customers will renew their existing indemnity health insurance policies with
Mutual while the Management Services Agreement is effective, or that such
customers will agree to renew such policies with CHLIC at the expiration of the
Management Services Agreement, and there can be no assurance that the benefits
expected from the Management Service Agreement, Renewal Rights Agreement and
Reinsurance Agreement will be realized. In addition, while Newco, to the extent
policy holders elect to renew the
22
<PAGE> 32
Administered Health Insurance Policies with Mutual after December 31, 1999,
CHLIC will be required to reinsure such policies which will require that CHLIC
increase its capital by an amount estimated to be between $50 million to $100
million. There can be no assurance that Newco will be able to restructure its
operations to free up existing capital, generate sufficient funds from
operations to increase CHLIC's capital to required levels prior to December 31,
1999 or will be able to raise such capital from external sources.
RISK OF COMPETITION
Coventry and PHC operate, and Newco will operate, in a highly competitive
industry. In many of its geographic or product markets, Newco will compete with
a number of other entities, some of which may have certain characteristics or
capabilities that give them an advantage in competing with Newco. In many of
Newco's markets, Newco will initially have a small share of the total market for
the managed health insurance business and will be exposed to additional risks
relating to competition with larger or more established competitors. Coventry
believes that there are few barriers to entry in these markets, so that the
addition of new competitors can occur relatively easily. Certain of Coventry's
and PHC's existing customers may decide to perform for themselves functions or
services formerly provided by Coventry or PHC, resulting in a decrease of
Newco's projected revenue. In addition, significant merger and acquisition
activity has occurred in the managed care industry as well as in other segments
of the health care industry, both nationally and in various local markets. This
activity may create stronger competitors and/or result in higher health care
costs. To the extent that there is strong competition or that competition
intensifies in any market, Newco's ability to retain or increase customers, its
revenue growth, its pricing flexibility, its control over medical costs trends
and its marketing expenses may all be adversely affected.
RISK OF SUBSTANTIAL BENEFICIAL OWNERSHIP OF NEWCO BY MUTUAL AND PHC
As a result of the Merger and the Capital Contribution, PHC will own
approximately 40% of the Newco Common Stock and, although it has agreed to a
limitation on acquiring additional shares of the Newco Common Stock and from
taking certain other actions, Mutual and its affiliates will be permitted under
certain circumstances to acquire additional shares of Newco Common Stock in
order to maintain a collective ownership of up to 40% of the Newco Common Stock,
and to elect six of the fifteen members of Newco's Board of Directors, until the
earlier of the fifth anniversary of the Effective Time or certain other actions
are taken by Newco. After the fifth anniversary of the Effective Time or after a
third party acquires more voting securities than those held by Mutual, there
will be no restrictions on the acquisition of Newco Common Stock by Mutual and
its affiliates. During the period from the Effective Time until eighteen months
thereafter, so long as Mutual maintains ownership of 40% of the Newco Common
Stock, it is highly unlikely that any matter involving a shareholder vote,
including the issuance of more than 20% of the Newco Common Stock, or an
acquisition of Newco by merger, consolidation, share exchange or other
transaction could be effectuated if Mutual were opposed thereto. During the
period beginning eighteen months after the Effective Time and ending on the
fifth anniversary of the Effective Time, Mutual has agreed to vote its shares in
favor of an acquisition required to be approved by shareholders that the Board
has recommended and has been approved by a majority of Newco's shareholders
(other than Mutual and its affiliates). During the period after the termination
of the "standstill restrictions" contained in the Shareholders' Agreement, and
in any event after the fifth anniversary of the Effective Time, there will be no
restrictions on the acquisition of additional shares of Newco Common Stock by
Mutual and its affiliates, and as a result, Mutual, in addition to having an
effective veto over transactions involving a shareholder vote (assuming it were
to continue to beneficially own 40% of Newco's securities), could acquire over
50% of the outstanding Newco Common Stock and exercise actual control of Newco
without a vote of the remaining Newco shareholders.
MARKETING RISK
Coventry and PHC market their products and services through both employed
sales people and independent sales agents. Although each of Coventry and PHC has
a number of such sales employees and agents, if certain key sales employees or
agents or a large subset of such individuals were to leave, Newco's ability to
retain existing customers and members could be impaired. In addition, certain of
the customers or
23
<PAGE> 33
potential customers of Coventry and PHC consider rating, accreditation or
certification of Coventry and PHC by various private or governmental bodies or
rating agencies necessary or important. Certain of Newco's health plans or other
business units may not have obtained or may not desire or be able to obtain or
maintain such accreditation or certification which could adversely affect
Newco's ability to obtain or retain business with such customers. The managed
care industry has recently received significant amounts of negative publicity.
Such general publicity, or any negative publicity regarding Coventry and PHC in
particular, could adversely affect Newco's ability to sell its product or
services or could create regulatory problems for Newco.
LITIGATION AND INSURANCE RISK
The health care industry in general is susceptible to litigation and
insurance risks, including medical malpractice liability, disputes relating to
the denial of coverage and the adequacy of "stop-loss" reinsurance for costs
resulting from catastrophic injuries or illnesses to Coventry's or PHC's
members. Coventry and PHC have contingent litigation risk with certain
discontinued operations. Such litigation may result in losses to Coventry, PHC
and Newco which could have a material adverse effect on the operations,
financial performance or prospects of Newco.
STOCK MARKET RISK
Recently, the market prices of the securities of certain of the
publicly-held companies in the industry in which Coventry and PHC operate have
shown volatility and sensitivity in response to many factors, including public
communications regarding managed care, legislative or regulatory actions, health
care cost trends, pricing trends, competition, earnings or membership reports of
particular industry participants, and acquisition activity. There can be no
assurance regarding the level or stability of Newco's share price at any time or
of the impact of these or any other factors on the share price.
24
<PAGE> 34
THE SPECIAL MEETING
GENERAL
This Proxy Statement/Prospectus is being furnished to the shareholders of
Coventry in connection with the solicitation of proxies on behalf of the Board
of Directors of Coventry for use at the Special Meeting to be held on March 31,
1998, at 9:30 a.m., local time, at SunTrust Bank Building, Fourth Floor
Conference Room, 201 4th Avenue North, Nashville, Tennessee, or any adjournments
thereof. The purpose of the Special Meeting is to consider and vote upon a
proposal to approve the Combination Agreement and to transact such other
business as may properly come before the Special Meeting.
Each copy of this Proxy Statement/Prospectus mailed to holders of Coventry
Common Stock is accompanied by a form of proxy for use at the Special Meeting.
This Proxy Statement/Prospectus is also furnished to Coventry shareholders as a
prospectus in connection with the issuance to them of shares of Newco Common
Stock upon consummation of the Merger. As of the record date for the Special
Meeting, there were 33,238,434 shares of Coventry Common Stock outstanding, each
of which is entitled to one vote on the Combination Agreement and each other
matter properly submitted at the Special Meeting.
RECORD DATE
The Board of Directors of Coventry has fixed the close of business on
February 2, 1998 as the record date for the determination of the holders of
Coventry Common Stock entitled to receive notice of and to vote at the Special
Meeting.
VOTE REQUIRED
Approval and adoption of the Combination Agreement, which includes approval
and adoption of the Merger Plan, requires the affirmative vote by the holders of
a majority of the votes entitled to be cast by the holders of record of the
Coventry Common Stock at the Special Meeting, in person or by proxy. Abstentions
and broker non-votes will be considered present, and since a majority vote of
all outstanding shares is required to approve the Combination Agreement, will
have the same effect in the vote as a vote against the Combination Agreement. In
the event there is not present at the Special Meeting a majority of shares
outstanding voting either for or against the proposal to approve of the
Combination Agreement and related Merger Plan, management of Coventry
anticipates that it will move to adjourn the meeting for an appropriate period
to continue to solicit additional proxies. Any motion to adjourn the Special
Meeting will require the affirmative vote by the holders of a majority of the
shares present at the meeting. As of February 2, 1998 the directors, executive
officers and their affiliates of Coventry and PHC collectively held or shared
power to vote with respect to 2,692,300 shares of the Coventry Common Stock,
representing approximately 8.0% of the Coventry Common Stock outstanding.
VOTING AND REVOCATION OF PROXIES
Shares of Coventry Common Stock represented by a proxy properly signed and
received at or prior to the Special Meeting, unless subsequently revoked, will
be voted in accordance with the instructions thereon. If a proxy is signed and
returned without indicating any voting instructions, shares of Coventry Common
Stock represented by the proxy will be voted FOR the proposal to approve the
Combination Agreement, which includes approval of the related Merger Plan, and
FOR a motion by management of Coventry, if any, to adjourn the Special Meeting
to continue to solicit proxies therefor. An adjournment or postponement for the
purpose of soliciting additional proxies will not have any effect on proxies
submitted with respect to matters not voted on, unless such proxies are revoked.
Any proxy given pursuant to this solicitation may be revoked by the person
giving it at any time before the proxy is voted by the filing of an instrument
revoking it or of a duly executed proxy bearing a later date with the Secretary
of Coventry prior to or at the Special Meeting. Written revocation need not be
in any particular, specified form. Attendance at the Special Meeting will not in
and of itself constitute a revocation of a proxy.
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<PAGE> 35
The Board of Directors of Coventry is not aware of any business to be acted
upon at the Special Meeting of Shareholders other than as described herein. If,
however, other matters are properly brought before the Special Meeting, or any
adjournments thereof, the persons appointed as proxies will be permitted to vote
or act thereon at their sole discretion.
SOLICITATION OF PROXIES
Proxies will be solicited by mail. Georgeson & Company, Inc. has been
retained by Coventry, at a fee not to exceed $25,000 plus reimbursement of
expenses, to assist in soliciting proxies. In addition, directors, officers and
employees of Coventry, who will not be specifically compensated for such
services, may solicit proxies from the shareholders of Coventry personally or by
telephone or telegram or other forms of communications. Nominees, fiduciaries
and other custodians will be requested to forward soliciting materials to
beneficial owners and will be reimbursed for their reasonable expenses incurred
in doing so.
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<PAGE> 36
TERMS OF THE BUSINESS COMBINATION
THE DESCRIPTION OF THE BUSINESS COMBINATION CONTAINED IN THIS PROXY
STATEMENT/PROSPECTUS SUMMARIZES AND DISCLOSES THE MATERIAL PROVISIONS OF THE
COMBINATION AGREEMENT AND THE ANCILLARY AGREEMENTS THERETO (THE "ANCILLARY
AGREEMENTS"); IT IS NOT COMPLETE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO THE COMBINATION AGREEMENT, THE FULL TEXT OF WHICH IS ATTACHED AS ANNEX I
HERETO AND INCORPORATED HEREIN BY REFERENCE IN ITS ENTIRETY. ALL COVENTRY
STOCKHOLDERS ARE URGED TO READ THE COMBINATION AGREEMENT AND THE ANCILLARY
AGREEMENTS IN THEIR ENTIRETY.
Pursuant to the Combination Agreement, at the Effective Time, Coventry will
effect the Merger and PHC will effect the Capital Contribution.
MERGER
Pursuant to the Merger Plan: (i) Merger Sub will merge with and into
Coventry; (ii) each issued share of Coventry Common Stock shall be converted
into the right to receive one share of Newco Common Stock and one Newco Right;
(iii) each outstanding Coventry Convertible Note shall be converted into the
right to receive a Newco Convertible Note; (iv) each issued and outstanding
share, if any, of Coventry Preferred Stock shall be converted into the right to
receive one share of Newco Preferred Stock; (v) each Coventry Option and each
Coventry Warrant shall be assumed by Newco and shall be exercisable upon the
same terms and conditions as under the applicable Coventry Options or Coventry
Warrants except that each such Coventry Option and Coventry Warrant shall be
exercisable for shares of Newco Common Stock; and (vi) each right issued under
the Coventry Rights Agreement shall be canceled, retired and cease to exist. The
exchange ratio is subject to adjustment upon any stock split, reverse stock
split, stock dividend, recapitalization or other similar transaction involving
the number of issued and outstanding shares of Coventry Common Stock. Pursuant
to the Merger, Coventry's shareholders will collectively receive approximately
33,238,434 shares of Newco Common Stock, representing, together with the shares
of Newco Common Stock issuable upon conversion of the Newco Convertible Notes or
the Newco Preferred Stock, 60% of the sum of (i) the shares of Newco Common
Stock issued and outstanding immediately after the Effective Time and (ii) the
shares of Newco Common Stock issuable upon conversion of the Newco Convertible
Notes or the Newco Preferred Stock.
CAPITAL CONTRIBUTION
Pursuant to the Capital Contribution, PHC will transfer at the Effective
Time to Newco the PHC Assets, including the issued and outstanding stock of
certain of its wholly-owned subsidiaries (including its HMO subsidiaries in
approximately sixteen states including Delaware, Florida, Iowa, Illinois,
Kansas, Missouri, Nebraska, Indiana, Louisiana, North Carolina, South Carolina
and Georgia), all real or personal property owned or leased by PHC, all accounts
receivable, cash, securities, contract rights, prepaid liabilities, and all
other assets except for specified excluded assets. The book value of the PHC
Assets including property and excluding $43.1 million of recorded goodwill at
September 30, 1997 was approximately $288.6 million. Newco will assume the PHC
Liabilities, including debt of $2.3 million. The PHC Liabilities include all
liabilities of PHC relating to the PHC Assets and the PHC Options but do not
include liabilities under PHC's other employee benefit plans, tax liabilities
with respect to the pre-closing operations of PHC and its subsidiaries,
liabilities relating to certain assets of PHC not transferred to Newco and
certain other specified excluded liabilities. In consideration of the transfer
of such assets, Newco will issue to PHC the PHC Consideration, which will
constitute 40% of the sum of (i) the issued and outstanding shares of Newco
Common Stock immediately after the Effective Time and (ii) the shares of Newco
Common Stock issuable upon conversion of the Newco Convertible Notes or the
Newco Preferred Stock and a similar percentage of the Newco Rights. Pursuant to
the Shareholders' Agreement, Mutual, together with its affiliates, will be
entitled to designate six of the fifteen members of Newco's Board of Directors.
ADMINISTERED HEALTH INSURANCE POLICIES
At or prior to the Effective Time, Newco will enter into the Management
Services Agreement to manage, for 3.3% of premium revenue attributable
therefrom, the Administered Health Insurance Policies. The earned premium for
the Administered Health Insurance Policies was approximately $432 million for
the nine months ended September 30, 1997. The Management Services Agreement will
terminate on December 31, 1999 at
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which time Newco's indirectly wholly-owned subsidiary, CHLIC will have the
obligation, pursuant to a Renewal Rights Agreement, to offer to renew the
Administered Health Insurance Policies and, to the extent that customers choose
to renew such policies with Mutual rather than CHLIC after December 31, 1999,
will reinsure such policies pursuant to a Coinsurance Agreement with Mutual.
In addition, Newco will issue to Mutual at the Effective Time the Newco
Warrant that gives Mutual the right to purchase from Newco that number of shares
of Newco Common Stock as shall equal 66 2/3% of the total number of shares of
Newco Common Stock as shall actually be issued by Newco upon the exercise or
conversion of the Coventry Options, Coventry Warrants and PHC Options issued and
outstanding at the Effective Time upon the same terms and conditions as set
forth in the Coventry Options, Coventry Warrants and PHC Options.
BACKGROUND OF THE BUSINESS COMBINATION
On June 11, 1997, Coventry senior management was approached by an officer
of PHC and a representative of Goldman, Sachs & Co. ("Goldman Sachs") concerning
whether Coventry was interested in consideration of certain potential
transactions, including a potential merger with PHC; Coventry's senior
management responded affirmatively. On July 31, 1997, Coventry's senior
management met with PHC's senior management to determine mutual compatibility
and the respective strategic goals which were desired, including possible
transaction terms which might accomplish such goals. Coventry's senior
management held numerous discussions approximately three weeks later with
representatives of Mutual. On September 9, 1997, Coventry, PHC and Mutual
entered into a confidentiality agreement (the "Confidentiality Agreement").
Subsequently, the parties exchanged financial and operational information
including historical financial statements and internal forecasts. Over the
course of the next month, the parties discussed the elements of a possible
transaction, the relative beneficial ownership of PHC's and of Coventry's
existing shareholders in the common company stock of the continued entity, the
restrictions that would be applicable to Mutual and/or PHC as a substantial
shareholder in a publicly-held company, headquarters location of the combined
entity and the management positions in the combined entity to be held by each
party's senior management.
During the week of October 7 to October 14, Coventry's management and
counsel met with PHC and Mutual management and counsel to discuss generally the
proposed transaction structure, the nature of the assets to be owned by Newco
following the Effective Time, the approximate percentage interest in Newco to be
held by PHC and by Coventry's shareholders following the Effective Time and
various other business issues associated with the proposed transaction. The
parties also commenced mutual due diligence investigations. In connection with
the transaction structure, the parties determined that in order to assure that
PHC and Mutual would not recognize taxable gain in the transaction, a new parent
company must acquire the PHC Assets and issue its shares to Coventry's
shareholders in exchange for outstanding shares of Coventry. In these
discussions, Coventry's management and representatives stated that Coventry was
unwilling to engage in a transaction involving a change of control of Coventry,
and that Coventry's directors should be a majority of the directors and its
shareholders own a majority of the shares of the new parent company.
On October 14, 1997, Coventry agreed to retain Goldman Sachs as a financial
advisor in connection with the possible transaction with PHC. Prior to such
engagement, Coventry was advised by Mutual that Goldman Sachs had acted and
would continue to act as a financial advisor to Mutual with respect to various
matters in addition to the transactions contemplated by the Combination
Agreement. Each of Coventry, Mutual, and PHC consented to Goldman Sachs
concurrently acting as a financial advisor to the other parties to the
transaction with the understanding that Goldman Sachs would not render a
fairness opinion to any party. As set forth below, Coventry subsequently
retained CSFB to advise its Board as to the fairness to Coventry from a
financial point of view of the consideration to be paid by Newco in the Business
Combination. Goldman Sachs did not act as the representative of any party in the
negotiations leading to the Combination Agreement. Representatives of Goldman
Sachs did, however, arrange and coordinate with the parties certain of the
discussions leading to the Combination Agreement and discussed with the parties
to such agreement alternative structures for the transaction, including the
possibility (which was rejected because of certain adverse tax effects to
Mutual) that PHC would merge with Coventry and prior thereto dividend certain
assets to Mutual. In addition, Goldman Sachs from time to time assisted the
parties to the Combination Agreement
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in their analyses of the financial ramifications of such a transaction. Goldman
Sachs was not asked to and did not render a fairness opinion to any of the
parties to the transaction.
On October 15, 1997, Coventry's Board of Directors held a special meeting
at which management reviewed with the Board the discussions which had been held
to date with PHC, the proposed transaction structure, the PHC Assets and the
percentage interest in Newco exchanged therefor, and certain other business
issues which remained open between the parties, including the terms of the
Shareholders' Agreement. Management also discussed Coventry's most recent
financial results, including a return to profitability in the most recent
quarter, its current challenges, its strategic position in the managed care
industry and various problems which would be associated with the acquisition by
Coventry of certain other potential acquisition targets. Based on its review of
these matters, the Board authorized management to retain an investment banking
firm to review the fairness to Coventry from a financial point of view of the
proposed consideration to be paid to PHC, to continue to conduct a due diligence
investigation of PHC and its subsidiaries and their operations, and to continue
negotiation of the terms of a definitive transaction agreement.
During the period from October 16 to November 2, the parties concluded
mutual due diligence investigations, and management of Coventry, PHC and Mutual
and their respective counsel negotiated the terms of the Agreements. On October
13, 1997, Coventry retained CSFB as a financial advisor to provide an opinion to
the Board of Directors with respect to the fairness from a financial point of
view to Coventry of the consideration to be paid by Newco in the transaction. In
considering investment banking firms to provide a fairness opinion concerning
the proposal transaction, management considered those firms that it believed
were familiar with Coventry's operations and experienced in providing financial
advice concerning similar transactions in the managed care industry. Coventry
also solicited proposals from one other investment banking firm which it
considered similarly qualified with CSFB but selected CSFB on the basis of the
foregoing factors and the financial terms agreed to with CSFB.
On November 3, 1997, the Board of Directors of Coventry met to consider the
definitive agreements. At that meeting, management and Coventry's counsel
reviewed the terms of the agreements, and counsel discussed the nature of the
fiduciary duty of the Board of Directors under Tennessee law applicable to its
consideration of the proposed transaction. CSFB reviewed financial information
concerning the PHC Assets and Coventry and the proposed transaction, and gave
their oral opinion that as of such date and based upon and subject to certain
matters discussed with the Board, the consideration to be paid by Newco for the
Business Combination was fair from a financial point of view to Coventry.
Following discussion of and questions by the Coventry Board to Coventry's senior
management and its financial and legal advisors, the members of Coventry's Board
voted unanimously to approve the Capital Contribution and Share Exchange
Agreement, Ancillary Agreements and related matters.
Because of the impending adoption of regulations by the Internal Revenue
Service permitting the tax-free exchange of warrants in certain merger
transactions and the beneficial tax consequences that might be realized by
holders of outstanding Coventry Warrants, tax counsel to Coventry advised that
the share exchange by the holders of Coventry Common Stock contemplated under
the Capital Contribution and Share Exchange Agreement should be replaced by a
reverse triangular merger of a subsidiary of Newco with and into Coventry, with
Coventry surviving the merger and shares of Coventry Common Stock being
converted into shares of Newco Common Stock. Coventry proposed such change to
the other parties to the Capital Contribution and Share Exchange Agreement and
to Warburg, the holder of 90% of the outstanding Coventry Warrants. Messrs.
Rodman W. Moorehead and Patrick T. Hackett, Coventry directors, are Senior
Managing Director and Managing Director, respectively, of E.M. Warburg, Pincus &
Co., LLC ("E.M. Warburg"), an affiliate of Warburg. See "Security Ownership of
Certain Beneficial Owners and Management." Coventry's Board of Directors
concluded that such change in transaction structure did not alter the
consequences to Coventry's shareholders of the transaction, financial or
otherwise, in any material respect. By resolutions adopted by unanimous written
consent dated December 18, 1997, the Coventry Board approved the Combination
Agreement, amending and restating the Capital Contribution and Share Exchange
Agreement, in order to change the structure of the transaction from a share
exchange to a merger and to make certain other immaterial changes thereto and to
the Ancillary Agreements. The Combination Agreement is effective as of November
3, 1997.
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RECOMMENDATION OF COVENTRY'S BOARD OF DIRECTORS
The Board of Directors of Coventry believes that the terms of the
Combination Agreement are fair to, and that the Business Combination is in the
best interests of, Coventry and its shareholders. Accordingly, the Board of
Directors of Coventry has unanimously approved the Business Combination pursuant
to the terms of the Combination Agreement and unanimously recommends approval by
the stockholders of Coventry. In its deliberations with respect to the Business
Combination, the Board of Directors consulted with management of Coventry and
the financial and legal advisors to Coventry. The composite mix of information
available to the Board of Directors with respect to the Business Combination
included information regarding the matters enumerated below. While this
information was considered by the Board of Directors, the Board of Directors did
not evaluate and make determinations with respect to each such factor. Rather,
the Board of Directors made its judgment that the Business Combination was fair
and in the best interest of Coventry and its shareholders based upon the total
mix of information available to it, and the judgments of individual directors
may have been influenced to a greater or lesser degree by different factors
discussed below.
(i) As a factor in favor of the Business Combination, the Board of
Directors noted while Coventry's Missouri and Pennsylvania HMO plans have
significant market shares in their respective markets, the lack of
geographic diversification exposed Coventry to adverse legal or regulatory
developments in those two states and to the risk that aggressive pricing
tactics by its principal competition in those markets, which had
significantly larger financial resources, could adversely affect market
share and profitability;
(ii) correspondingly, the Board also considered as favorable the fact
that the proposed Business Combination would represent a significant
geographic diversification and expansion into fourteen states, would
provide increased financial and operating leverage through aggregate scale
in a consolidating industry and substantial opportunities for growth of the
PHC Business' membership and market share, including expansion through
customers of the Administered Health Insurance Policies shifting their
coverage to the managed care business, as well as opportunity for potential
future collaboration with Mutual in product development and marketing;
(iv) the Board considered information concerning the financial
position, results of operation, businesses, competitive position and
prospects of the PHC Business, including the losses experienced in the
recent years by PHC and the reduced losses in PHC's most recent nine-month
period. The Board considered the possibility that such losses would
continue after the acquisition and the risk that the operations of the
combined entities may not be successfully integrated as significant risks
and concerns; however, the Board concluded the opportunities for operating
synergies in the Business Combination (particularly in overlapping or
adjacent geographic areas) and the renegotiation of PHC's relationship with
Mutual should result in enhanced revenue and reduced expenses sufficient to
assure improved PHC operating results. Additionally, the Board believed
that Coventry's senior management, based on its recent experience in
improving Coventry's operations, had the requisite managerial skills to
assist in the accomplishment of PHC's turnaround;
(v) The Board considered the business and management philosophies of
PHC and of Mutual to be compatible with those of Coventry, including an
emphasis on quality customer service delivered through cross-functional
teams, the importance of the highest level of integrity in business
dealings, and a firm commitment to the future of managed care;
(vi) The Board considered as a favorable factor the financial terms of
the Business Combination, including but not limited to the share for share
conversion of the outstanding shares of Coventry Common Stock to shares of
Newco Common Stock in the Merger, the number of shares of Newco Common
Stock to be issued to PHC in the Capital Contribution, and the percentage
of Newco Common Stock on a fully diluted basis represented thereby, the
Newco Warrant to be issued to Mutual in connection with the Administered
Health Insurance Policies, and the Tangible Net Value Adjustment provision
of the Combination Agreement;
(vii) The Board considered that the relatively large ownership portion
to be beneficially owned by Mutual and its ability to maintain that
position through the operation of its subscription rights and
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through exercise of the Newco Warrant as a disadvantage, particularly since
such portion would make approval of transactions favored by a majority of
shares owned by the public shareholders of Newco (which would initially be
the existing shareholders of Coventry) very difficult to obtain if not
favored by Mutual. However, the Board also considered that these concerns
were appropriately addressed by the Shareholders' Agreement with Mutual,
including the limitation on the number of Mutual's representatives on the
Board of Directors to six of fifteen directors, the absence of any
supermajority voting requirements for Board action, the five-year
standstill limitation on additional purchases by Mutual of shares of Newco
Common Stock and on certain other actions, Mutual's right to maintain its
percentage of ownership in the event additional shares of Newco Common
Stock were issued to third parties in certain circumstances, the mechanisms
established in the event a third party makes a bona fide tender or exchange
offer or acquisition proposal for Newco, including granting Mutual the
right to make a matching or better offer and providing that, for the period
beginning on the date eighteen months after the Effective Time and ending
on the expiration of the standstill provisions, Mutual will not vote its
shares to block certain acquisition transactions of or by Newco which are
recommended by the Board and approved by a majority of the other Newco
shareholders;
(viii) The Board considered as favorable the condition to the
Combination Agreement that a legal opinion be obtained that the Merger will
be a tax-free reorganization and the conversion and exchange of shares of
Coventry Common Stock for shares of Newco Common Stock will not be taxable
to Coventry's shareholders; and
(ix) the opinion of CSFB that, as of the date of such opinion, and
subject to certain matters discussed with the Board, the consideration to
be paid by Newco in the Business Combination was fair to Coventry from a
financial point of view.
OPINION OF FINANCIAL ADVISOR TO COVENTRY
CSFB was engaged to render a fairness opinion to Coventry in connection
with the Business Combination. CSFB is an internationally recognized investment
banking firm and is regularly engaged in the valuation of businesses and
securities in connection with mergers and acquisitions, leveraged buyouts,
negotiated underwritings, competitive biddings, secondary distributions of
listed and unlisted securities, private placements and valuations for estate,
corporate and other purposes.
In connection with CSFB's engagement, Coventry requested that CSFB evaluate
the fairness to Coventry, from a financial point of view, of the consideration
to be paid by Newco in the Business Combination. CSFB was instructed by Coventry
to assume that the transaction did not constitute a change of control of
Coventry. At a meeting of Coventry's Board of Directors held on November 3,
1997, CSFB orally advised the Board that, as of such date and based upon and
subject to certain matters discussed with the Board, the consideration to be
paid by Newco in the Business Combination was fair to Coventry from a financial
point of view. CSFB subsequently confirmed its opinion in writing (the "CSFB
Opinion"), a copy of which is attached.
In arriving at its opinion, CSFB, among other things (i) reviewed certain
publicly available business and financial information relating to Coventry, the
PHC Business and Mutual's Administered Health Insurance Policies, as well as the
Merger and Capital Contribution Agreement, the Coinsurance Agreement, the
Management Services Agreement, the Marketing Services Agreement and the other
exhibits to the Merger and Capital Contribution Agreement, (ii) reviewed certain
other information, including financial forecasts, provided to CSFB by Mutual for
the Administered Health Insurance Policies and by Coventry and PHC, (iii) met
with the managements of Coventry, PHC and Mutual to discuss their respective
businesses and prospects, (iv) considered certain financial and stock market
data of Coventry and compared that data with similar data for other publicly
held companies in businesses similar to that of Coventry, and (v) considered the
financial terms of certain other business combinations and other transactions
that had recently been effected.
In connection with the CSFB Opinion, CSFB did not assume responsibility for
independent verification of any of the information provided to or otherwise
reviewed by CSFB and relied upon such information being
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complete and accurate in all material respects. With respect to the financial
forecasts, CSFB assumed that they were reasonably prepared on bases reflecting
the best currently available estimates and judgments of the managements of
Coventry, PHC and Mutual as to the future financial performance of Coventry, the
PHC Business and the Administered Health Insurance Policies, respectively. In
addition, CSFB did not make an independent evaluation or appraisal of the assets
or liabilities (contingent or otherwise) of Coventry, the PHC Business or the
Administered Health Insurance Policies, nor was CSFB furnished with any such
evaluations or appraisals. The CSFB Opinion is necessarily based on information
available to it and financial economic, market and other conditions as they
existed and could be evaluated on the date of the CSFB Opinion. The CSFB Opinion
was rendered during a period of unusual volatility in the financial markets and
is necessarily subject to the absence of further material developments in the
financial, economic and market conditions from those prevailing on the date
thereof.
CSFB expressed no opinion as to the value of the Newco Common Stock when
issued to the Coventry shareholders pursuant to the Merger or the prices at
which the Newco Common Stock would trade subsequent to the Business Combination.
Although CSFB evaluated the fairness from a financial point of view to Coventry
of the consideration to be paid by Newco in the Business Combination, CSFB was
not requested to, and did not, recommend the specific consideration payable in
the Business Combination, which consideration was determined through
arm's-length negotiations between Coventry, PHC and Mutual. No other limitations
were imposed on CSFB with respect to the investigations made or procedures
followed by CSFB in rendering its opinions.
A copy of the CSFB Opinion, which sets forth the assumptions made, matters
considered and limitations on the review undertaken by CSFB, is attached as
Annex V to this Proxy Statement/Prospectus and is incorporated herein by
reference. CSFB has consented to the use of the CSFB Opinion in this Proxy
Statement/Prospectus, a copy of which has been filed as an exhibit to the
Registration Statement on Form S-4 (the "Registration Statement") of which this
Proxy Statement/Prospectus forms a part. Shareholders of Coventry are urged to
read the CSFB Opinion carefully in its entirety. The CSFB Opinion relates only
to the fairness from a financial point of view to Coventry of the consideration
to be paid by Newco in the Business Combination, does not address any other
aspects of the Business Combination or any related transaction and does not
constitute a recommendation to any shareholder as to how such shareholder should
vote with respect to the proposed Business Combination. The summary of the CSFB
Opinion set forth in this Proxy Statement/ Prospectus is qualified in its
entirety by reference to the full text of the CSFB Opinion.
Summary of Analyses
The following is a summary of the material financial analyses performed by
CSFB in connection with its presentation to the Coventry Board on November 3,
1997 and delivery of the CSFB Opinion, and does not purport to be a complete
description of the analyses conducted by CSFB in arriving at its opinion.
Discounted Cash Flow Analysis. CSFB performed a discounted cash flow
analysis of the projected unlevered free cash flows (net operating profit after
taxes, plus depreciation and amortization expense, less capital expenditures,
and less increases in working investment) of the PHC Business for the period
1997 through 2002, based upon (i) projections for the period 1997 to 2000
provided to CSFB by the management of PHC and projections for the period 2001 to
2002 extrapolated by CSFB (the "Company Case") and (ii) alternative projections
for the period 1997 to 2002 reflecting more conservative estimates (the "Base
Case"). The Company Case projections included (i) projected revenues of $812.8
million in 1997, $1,082.4 million in 1998, $1,353.6 million in 1999, $1,585.6
million in 2000, $1,849.2 million in 2001 and $2,184.9 million in 2002, (ii)
projected earnings before interest, taxes, depreciation and amortization
("EBITDA") of ($14.7) million in 1997, ($0.5) million in 1998, $36.8 million in
1999, $66.1 million in 2000, $89.6 million in 2001 and $114.7 million 2002;
(iii) projected earnings before interest and taxes ("EBIT") of ($24.3) million
in 1997, ($13.3) million in 1998, $23.6 million in 1999, $52.4 million in 2000,
$73.6 million in 2001 and $95.8 million in 2002; and (iv) projected net income
of ($14.6) million in 1997, ($8.0) million in 1998, $14.1 million in 1999, $31.4
million in 2000, $44.2 million in 2001 and $57.5 million in 2002. The Base Case
projections included (i) projected revenues of $812.8 million in 1997, $1,064.3
million in 1998, $1,306.8 million in 1999, $1,527.8 million in 2000, 1,783.4
million in 2001 and $2,110.0 million in 2002; (ii) projected
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EBITDA of ($14.7) million in 1997, $0.0 million in 1998, $27.2 million in 1999,
$49.9 million in 2000, $68.1 million in 2001 and $84.3 million in 2002; (iii)
projected EBIT of ($24.4) million in 1997, ($12.8) million in 1998, $14.0
million in 1999, $36.2 million in 2000, $52.1 million in 2001 and $65.4 million
in 2002; and (iv) projected net income of ($14.7) million in 1997, ($7.7)
million in 1998, $8.4 million in 1999, $21.7 million in 2000, $31.3 million in
2001 and $39.2 million in 2002.
Based on these various projections, CSFB developed an enterprise value
range for the PHC Business utilizing discount rates of 11.5% to 14.5%, terminal
value multiples of EBITDA of 7.0x to 10.0x and terminal value multiples of Net
Income of 14.0x to 20.0x. CSFB utilized the Company Case and Base Case scenarios
for the PHC Business merely as points of reference for the Coventry Board and in
no way intended to suggest parameters or forecasts as to minimum or maximum
enterprise valuation ranges for the PHC Business. Utilizing discount rates of
12.5% to 13.5% and EBITDA multiples of 8.0x and 9.0x applied to estimated 2002
EBITDA, this analysis resulted in an enterprise value range for the PHC Business
of $417 million to $481 million in the Company Case and $320 million to $367
million in the Base Case. Utilizing discount rates of 12.5% to 13.5% and Net
Income multiples of 16.0x and 18.0x applied to estimated 2002 Net Income, this
analysis resulted in an enterprise value range for the PHC Business of $418
million to $481 million in the Company Case and $307 million to $351 million in
the Base Case. When taken together with the estimated value of the Administered
Health Insurance Policies ($50-$60 million), the discounted cash flow analysis
resulted in an overall enterprise value range of approximately $470 million to
$540 million in the Company Case and of approximately $365 million to $420
million in the Base Case.
Comparable Companies Analysis. CSFB performed a comparable companies
analysis in which it compared certain publicly available financial data,
projections of future financial performance and market statistics (based upon
closing stock prices as of October 31, 1997) of ten publicly traded single
market and regionally focused health maintenance organizations and health care
indemnity insurers. The "comparable companies" included: Coventry, John Alden,
Maxicare Health Plans, Mid Atlantic Medical Services, Oxford Health Plans,
RightChoice, Sierra Health Services, Trigon, United Wisconsin, and Wellpoint
(collectively, the "Comparable Companies"). CSFB calculated the equity market
value (market value of fully diluted common shares less proceeds from the
exercise of options, warrant and other common stock equivalents) and the
adjusted market value (equity market value plus total debt, total preferred
stock and minority interest, less excess cash and marketable securities) of the
Comparable Companies. CSFB also derived multiples of common stock prices per
share relative to estimated 1997 EPS and 1998 EPS earnings per share ("EPS") for
the Comparable Companies. This analysis indicated that (i) the common stock
prices to estimated 1997 EPS multiples ranged from 14.4x to 100.6x, with a
median of 18.0x and a mean of 32.8x and (ii) the common stock prices to
estimated 1998 EPS multiples ranged from 11.3x to 24.9x, with a median of 14.0x
and a mean of 15.6x. CSFB also considered the estimated five-year EPS compounded
annual growth rate for the Comparable Companies, which ranged from 14.3% to
35.0%, with a median of 15.0% and a mean of 18.3%. CSFB then calculated the
estimated 1997 price/earnings ratio to five-year EPS compounded annual growth
rate for the Comparable Companies, which ranged from 95.9% to 293.2% for 1997,
with a median of 118.1% and a mean of 160.8%, and the estimated 1998
price/earnings ratio to five-year EPS compounded annual growth rate for the
Comparable Companies, which ranged from 56.7% to 118.4%, with a median of 90.1%
and a mean of 87.9%. Based on management's belief that the PHC Business is not
expected to have any earnings in 1997 and 1998, CSFB did not take this
methodology into account in determining an enterprise value range for the PHC
Business.
Comparable Acquisitions Analysis. Using publicly available information,
CSFB reviewed six recent, publicly announced acquisitions of health maintenance
organizations of comparable size or geographic scope to PHC which occurred since
August 1996 involving companies in the managed care industry: the acquisition by
Humana Inc. of ChoiceCare Corporation, the acquisition by Humana Inc. of
Physician Corporation of America, the acquisition by Foundation Health Systems,
Inc. of Physicians Health Services, Inc., the acquisition by CIGNA Corporation
of Healthsource, Inc., the business combination of Foundation Health Corporation
and Health Systems International, Inc., and the acquisition by PacifiCare Health
Systems, Inc. of FHP International Corporation (collectively, the "Comparable
Acquisitions"). For each of the Comparable Acquisitions, CSFB compared (i) the
adjusted market value to revenue, EBITDA and EBIT of the acquired
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company and the adjusted market value per member and adjusted member and (ii)
the equity market value to latest twelve month ("LTM") net income of the
acquired company. CSFB's analysis indicated that (a) adjusted market value as a
multiple of (i) revenues ranged from 0.3x to 0.9x, with a mean of 0.6x and a
median of 0.5x, (ii) EBITDA ranged from 5.3x to 34.1x, with a mean of 19.6x and
a median of 19.5x, and (iii) EBIT ranged from 6.6x to 49.7x, with a mean of
23.4x and a median of 13.9x, and (b) adjusted market value per member ranged
from $269 to $1,262, with a mean of $703 and a median of $657, and adjusted
market value per adjusted member ranged from $385 to $1,201, with a mean of $773
and a median of $691. This analysis also indicated that equity market value to
LTM net income ranged from 12.4x to 61.7x, with a mean of 35.6x and a median of
32.5x. The comparable acquisitions analysis resulted in an enterprise value
range for the PHC Business of $400 million to $500 million.
Reference Range. On the basis of the valuation methodologies employed in
the analyses described above, CSFB developed an enterprise value range for the
PHC Business of $400 million to $500 million.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. Selecting
portions of the analyses or of the summary set forth above, without considering
the analyses as a whole, could create an incomplete view of the process
underlying the CSFB Opinion. In performing the foregoing analyses in order to
determine the reference range set forth above, CSFB did not form a conclusion as
to whether any individual analysis, considered singly, supported or failed to
support an opinion as to fairness from a financial point of view. Rather, in
reaching its conclusion, CSFB considered the results of the analyses in light of
each other and ultimately reached its opinion as to fairness based on the
results of all such analyses taken as a whole. Furthermore, in arriving at its
fairness opinion, CSFB did not attribute any particular weight to any analysis
or factor considered by it. No company or transaction used in the above analyses
as a comparison is identical to Coventry, the PHC Business, or the Business
Combination. The analyses were prepared solely for purposes of CSFB providing
its opinion to the Coventry Board as to the fairness from a financial point of
view to Coventry of the consideration to be paid by Newco in the Business
Combination, and do not purport to be appraisals or necessarily reflect the
prices at which businesses or securities actually may be sold. Analyses based
upon forecasts of future results are not necessarily indicative of actual future
results, which may be significantly more or less favorable than suggested by
such analyses. Such analyses are based upon numerous factors or events beyond
the control of Coventry, PHC, Mutual, their respective advisors or any other
person and are inherently uncertain. Actual future results may be materially
different from those forecast.
Fee and Other Information
Pursuant to the terms of CSFB's engagement, Coventry has agreed to pay CSFB
a financial advisory fee of $450,000 for its services in connection with
evaluating the Business Combination and rendering an opinion as to the fairness
of the consideration. Coventry also has agreed to reimburse CSFB for its
out-of-pocket expenses, including the reasonable fees and expenses of its
counsel, and to indemnify CSFB and certain related persons against certain
liabilities, including liabilities under the federal securities laws.
In the ordinary course of business, CSFB and its affiliates may actively
trade the debt and equity securities of Coventry and the debt securities of
Mutual for their own account and for the accounts of customers and, accordingly,
may at any time hold a long or short position in such securities.
EFFECTIVE TIME OF THE BUSINESS COMBINATION
The Merger will become effective upon the filing of an Articles of Merger
by Merger Sub and Coventry under the Tennessee Business Corporation Act, or at
such later time as may be specified in the Articles of Merger. The Merger Plan
requires that this filing be made, subject to satisfaction or waiver of the
separate conditions to the obligations of each party to consummate the Business
Combination as set forth in the Combination Agreement, no later than three
business days after satisfaction or waiver of such conditions or at such other
time as may be agreed by the parties to the Combination Agreement. It is
anticipated that such filing will be made as soon as reasonably possible after
the Special Meeting and after all regulatory approvals have been obtained, and
that the Effective Time will occur upon such filing. There can be, however, no
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assurance as to whether or when the Business Combination will occur. See
"-- Conditions to the Business Combination" and "--Regulatory Approvals".
EXCHANGE OF CERTIFICATES
From and after the Effective Time, each holder of a certificate evidencing
ownership of shares of Coventry Common Stock will be entitled to receive in
exchange therefor, upon surrender thereof to the Exchange Agent (as defined in
the Combination Agreement), a certificate or certificates representing the
number of shares of Newco Common Stock into which such shares of Coventry Common
Stock have been converted, and any dividends or other distributions to which
such holder is entitled as a result of the Business Combination as provided in
the Combination Agreement.
At the Effective Time, holders of shares of Coventry Common Stock
immediately prior to the Effective Time will cease to be, and will have no
rights as, stockholders of Coventry, other than the right to receive the shares
of Newco Common Stock into which such shares have been converted and any
dividends or other distributions to which they may be entitled under the
Combination Agreement. Holders of Coventry Common Stock will be treated as
stockholders of record of Newco for purposes of voting at any annual or special
meeting of stockholders of Newco after the Effective Time, both before and after
such time as they exchange their certificates of Coventry Common Stock for
certificates of Newco Common Stock as provided in the Combination Agreement.
Neither Newco nor Coventry will be liable to any holder of shares of
Coventry Common Stock for any shares of Newco Common Stock (or dividends or
other distributions with respect thereto) delivered to a public official
pursuant to any applicable abandoned property, escheat or similar law.
REPRESENTATIONS AND WARRANTIES
The Combination Agreement contains various customary representations and
warranties of the parties thereto.
The representations and warranties of Coventry, with respect to Coventry
and its several subsidiaries, including Newco ("Coventry Subsidiaries"), include
representations and warranties as to: (i) the corporate organization and good
standing of Coventry and the Coventry Subsidiaries, (ii) the capitalization of
Coventry and the Coventry Subsidiaries, (iii) the power and authority of
Coventry and the Coventry Subsidiaries to execute, deliver and perform the
Combination Agreement, (iv) the consents and approvals required to be obtained
by Coventry and the Coventry Subsidiaries prior to the Effective Time, (v)
Coventry's and the Coventry Subsidiaries' compliance with the law, (vi)
litigation and investigations relating to Coventry and the Coventry
Subsidiaries, (vii) absence of defaults, conflicts, etc., (viii) change in
ownership, (ix) certain reports, schedules, registration statements and proxy
statements filed by Coventry with the Securities and Exchange Commission (the
"Commission") since January 1, 1995, (x) the absence of certain developments,
(xi) the validity of Coventry's and the Coventry Subsidiaries' material
contracts, (xii) the absence of undisclosed liabilities, (xiii) employees of
Coventry and the Coventry Subsidiaries, (xiv) tax matters, (xv) employee benefit
plans, (xvi) patents, licenses, etc., (xvii) title to tangible assets, (xviii)
real property owned or leased by Coventry and the Coventry Subsidiaries, (xix)
insurance, (xx) transactions with related parties, (xxi) interest in
competitors, (xxii) registration rights, (xxiii) brokerage, (xxiv) absence of
illegal or unauthorized payments, (xxv) takeover statute and rights plan, and
(xxvi) that the Combination Agreement, Ancillary Agreements and schedules and
exhibits thereto do not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements contained therein, in
light of the circumstances in which they were made, not misleading.
The representations and warranties of PHC, with respect to PHC and its
several subsidiaries (the "PHC Subsidiaries"), include representations and
warranties as to: (i) the corporate organization and good standing of PHC and
the PHC Subsidiaries, (ii) good and marketable title to the PHC Assets, (iii)
the power and authority of PHC and the PHC Subsidiaries to execute, deliver and
perform the Combination Agreement, (iv) the consents and approvals required to
be obtained by PHC and the PHC Subsidiaries prior to the Effective Time, (v)
PHC's and the PHC Subsidiaries' compliance with the law, (vi) litigation and
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investigations relating to PHC and the PHC Subsidiaries, (vii) absence of
defaults, conflicts, etc., (viii) change in ownership, (ix) the fact that PHC
has furnished Coventry with true and complete copies of audited and unaudited
financial statements and certain reports for the period beginning January 1,
1992 to September 30, 1997, (x) the absence of certain developments, (xi) the
validity of PHC's and the PHC Subsidiaries' material contracts, (xii) the
absence of undisclosed liabilities, (xiii) employees of PHC and the PHC
Subsidiaries, (xiv) tax matters, (xv) employee benefit plans, (xvi) patents,
licenses, etc., (xvii) title to tangible assets, (xviii) real property leased by
PHC and the PHC Subsidiaries, (xix) insurance, (xx) transactions with related
parties, (xxi) interest in competitors, (xxii) brokerage, (xxiii) absence of
illegal or unauthorized payments and (xxiv) that the Combination Agreement,
Ancillary Agreements and schedules and exhibits thereto do not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements contained therein, in light of the circumstances in which
they were made, not misleading.
The representations and warranties of Mutual, with respect only to the
Administered Health Insurance Policies, include representations and warranties
as to: (i) the corporate organization and good standing of Mutual, (ii) the
validity of the Mutual Indemnity Agreements (as defined in the Combination
Agreement), (iii) the power and authority of Mutual to execute, deliver and
perform the Combination Agreement, (iv) the consents and approvals required to
be obtained by Mutual prior to the Effective Time, (v) Mutual's compliance with
the law, (vi) litigation and investigations relating to the Administered Health
Insurance Policies, (vii) absence of defaults, conflicts, etc., (viii)
information with respect to the premiums owing under the Mutual Indemnity
Agreements, (ix) ownership of Coventry Common Stock by Mutual and its
subsidiaries, (x) the absence of undisclosed liabilities and (xi) brokerage.
CONDITIONS TO THE COMBINATION AGREEMENT
The conditions set forth below constitute all material conditions to the
obligation of the parties to the Combination Agreement to consummate the
transactions contemplated by the Combination Agreement.
Conditions to Each Party's Obligations
The obligation of each of the parties to the Combination Agreement to
consummate the transactions contemplated thereby is subject to, among others,
the following conditions: (i) the Combination Agreement and the transactions
contemplated thereby shall have been approved and adopted by the shareholders of
Coventry; (ii) the Commission shall have declared the Registration Statement
effective and such effectiveness shall not be the subject of any stop order or
proceedings seeking a stop order; (iii) the shares of Newco Common Stock to be
issued to the stockholders of Coventry shall have been approved for listing on
The Nasdaq Stock Market; (iv) the waiting period applicable to the consummation
of the Business Combination under the HSR Act shall have expired or been
terminated; (v) the applicable approvals and any applicable waiting periods
under any laws, rules or regulations governing insurance and insurance
companies, HMOs, PPOs, health care services plans, third party administrators or
other managed health care organizations shall have been received, waived or
terminated; (vi) all other consents, authorizations, orders and approvals of (or
filings or registrations with) any governmental commission, board or other
regulatory body required in connection with the execution, delivery and
performance of the Combination Agreement shall have been obtained without the
imposition of any condition or made, except for filings in connection with the
Business Combination and any other documents required to be filed after the
Effective Time and except where the conditions imposed, individually or in the
aggregate, would not result in, individually or in the aggregate, a material
adverse effect on the business, operations, properties, prospects or condition
(financial or otherwise) of Newco following the Effective Time; (vii) no action
or proceeding shall have been instituted before a court or other governmental
body by any governmental agency or public authority to restrain or prohibit the
transactions contemplated by the Combination Agreement or to obtain an amount of
damages or other material relief in connection with the execution of the
Combination Agreement or the related agreements or the consummation of the
Business Combination; and no governmental agency shall have given notice to any
party to the Combination Agreement to the effect that consummation of the
transactions contemplated by the Combination Agreement would constitute a
violation of any law or that it intends to commence proceedings to
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restrain consummation of the Business Combination; (viii) each of the parties to
the Ancillary Agreements shall have executed and delivered a counterpart
signature page to each such Ancillary Agreement to the other party or parties
thereto and shall perform all such acts required to be performed thereby at or
prior to the Effective Time.
Conditions to the Obligations of PHC and Mutual
The obligation of PHC to effect the Capital Contribution and of PHC and
Mutual to enter into the Ancillary Agreements is subject to the following
conditions: (i) Coventry and Newco shall have performed their respective
agreements, and shall not have breached any representations, warranties, and
covenants contained in the Combination Agreement; (ii) Coventry shall have
obtained the consent of Warburg (the "Warburg Consent") and a consent from each
of the persons from whom the failure to obtain a consent would cause a material
adverse effect; (iii) Coventry shall have all approvals necessary to the
ownership of their property and to the operation of their respective businesses,
which if violated or not obtained would not have a material adverse effect; (iv)
from the date of the Combination Agreement through the Effective Time, there
shall not have occurred any Coventry Material Adverse Effect (as defined in the
Combination Agreement); (v) Coventry shall have received an opinion of Bass,
Berry & Sims PLC to the effect that the Merger will be treated as a
reorganization described in Section 368(a)(2)(E) of the Code and that Coventry
and the Coventry shareholders exchanging Coventry Common Stock will recognize no
gain or loss for federal income tax purposes as a result of the consummation of
the Merger; (vi) Coventry shall have consummated the refinancing of its current
credit facility with such lenders and upon such terms and conditions as shall be
reasonably satisfactory to PHC, Holding and Mutual; (vii) Coventry shall not
have received any notification, written or oral, from The Nasdaq Stock Market or
the Commission to the effect that Coventry is in violation of any The Nasdaq
Stock Market listing requirement; (viii) Coventry shall have caused CHLIC to
have entered into the Coinsurance Agreement.
Conditions to the Obligations of Coventry and Newco
The obligation of Coventry and Newco to effect the Merger and Newco to
effect the Capital Contribution and to enter into the Ancillary Agreements is
subject to the following conditions: (i) Mutual and PHC shall each have
performed its agreements, and shall not have breached any representations,
warranties, and covenants contained in the Combination Agreement; (ii) Coventry
shall receive comfort letters, in form and substance satisfactory to it, with
respect to the procedures undertaken by them through a date which is not earlier
than five business days prior to the dates specified in (A) and (B) below
relating to the financial statements of PHC and the PHC Subsidiaries contained
in the Registration Statement and the other matters customarily included in
comfort letters relating to transactions similar to the Business Combination,
(A) dated immediately prior to the date of mailing of the Proxy
Statement/Prospectus, and (B) dated immediately prior to the Effective Time, a
bring down of the letter provided in subsection (A); (iii) from the date of the
Combination Agreement through the Effective Time, there shall not have occurred
any Principal Material Adverse Effect (as defined in the Combination Agreement)
or Mutual Material Adverse Effect (as defined in the Combination Agreement);
(iv) PHC and each of the PHC Subsidiaries have all PHC Approvals (as defined in
the Combination Agreement) necessary to the ownership of their property and to
the operation of their respective businesses, which if violated or not obtained
would not have a material adverse effect; (v) PHC and Mutual shall have obtained
consent from each person from whom the failure to obtain a consent to the
transactions contemplated by the Combination Agreement would have a material
adverse effect; (vi) PHC shall have received an opinion of LeBouef, Lamb, Greene
& MacRae, L.L.P., in form and substance satisfactory to PHC to the effect that,
except with respect to the Newco Warrant, the Capital Contribution will be
treated as a non-taxable transfer described in Section 351 of the Internal
Revenue Code of 1986, as amended (the "Code") and that, except with respect to
the Newco Warrant, Newco, PHC and PHC Subsidiaries will recognize no gain or
loss for federal income tax purposes as a result of the consummation of the
Capital Contribution; and (vii) Mutual and each PHC Subsidiary which is a party
to a PPO network access agreement with Mutual shall amend such PPO network
access agreements, to be effective prior to the Closing, to provide for payment
by Mutual a reasonable percentage of savings-based fees consistent with those
charged by competitive networks. Such amendments shall be subject to Coventry's
prior
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consent, which shall not be unreasonably withheld. In the event that a condition
to closing is waived by Coventry, its Board of Directors will consider at that
time whether to resolicit shareholders. The Board will take into account the
materiality of the condition waived and whether it would be considered important
to shareholders in determining whether to approve or disapprove the Combination
Agreement in determining whether resolicitation is appropriate.
The Board of Directors of Coventry will not waive conditions to the
Combination Agreement that the Coventry shareholders approve the Merger and
Capital Contribution or the opinion by tax counsel that the Merger is not a
tax-free reorganization. With respect to the other conditions set forth in the
Combination Agreement, the Board of Directors will determine whether or not the
condition is material to the shareholders of Coventry and, if the Board
determines the condition is material to shareholders, will not waive the
condition without the resolicitation of shareholder approval.
REGULATORY APPROVALS
As conditions precedent to the consummation of the Business Combination,
the Combination Agreement requires, among other things: (i) that the HSR Act
waiting period has expired or been terminated and (ii) that all other
governmental approvals required for the consummation of the Business Combination
have been obtained, except where the failure to obtain such approvals would not
have a material adverse effect on the business of Newco.
HSR Act
The HSR Act prohibits consummation of the Business Combination until
certain information has been furnished to the Antitrust Division of the DOJ and
the FTC and certain waiting period requirements have been satisfied. On December
23, 1997, PHC and Coventry made their respective filings with the DOJ and the
FTC with respect to the Combination Agreement and on January 20, 1998 received
notice from the FTC of early termination of the HSR waiting period. On January
20, 1998, PHC and Coventry were advised that FTC had granted early termination
of the waiting period.
In order to consummate the transactions contemplated by Combination
Agreement, Coventry, PHC and Mutual will be required to obtain the approval of
insurance regulatory officials in several states, including Alabama, Delaware,
Florida, Georgia, Illinois, Indiana, Iowa, Louisiana, Missouri, Nebraska, New
Jersey, North Carolina, Pennsylvania, Texas, Virginia, and West Virginia.
Generally, such regulatory officials must approve the acquisitions unless the
terms are deemed thereby to be unreasonable by said regulatory officials, the
transaction is not in the best interest of the policyholder or the public, or
the transaction would substantially lessen competition. As of March 10, 1998,
approvals were received from Alabama, Illinois, Nebraska, and Virginia.
BUSINESS PENDING THE BUSINESS COMBINATION
The Combination Agreement provides that, during the period from the date of
execution of the Combination Agreement until the Effective Time, except as
provided in the Combination Agreement, Coventry, PHC, Newco and Mutual (with
respect to the Administered Health Insurance Policies) will conduct their
respective businesses in the usual, regular and ordinary course in substantially
the same manner as previously conducted and will use their reasonable efforts to
preserve intact their present business organization, to keep available the
services of their key employees and to preserve their relationships with
customers, suppliers and others having business dealings with them.
In addition, the Combination Agreement provides that unless the other party
has consented in writing, each of Newco, Coventry and PHC shall, and shall cause
each of its respective subsidiaries to: (i) conduct its operations according to
its usual, regular and ordinary course in substantially the same manner as
conducted prior to the execution of the Combination Agreement; (ii) use its
reasonable efforts to preserve intact its business organizations and goodwill,
keep available the services of its respective officers and employees and
maintain satisfactory relationships with those persons having business
relationships with them; (iii) confer on a regular basis with one or more
representatives of the other parties to the Combination Agreement to report
operational matters of materiality and any proposals to engage in material
transactions; (iv) not amend its
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respective articles of incorporation and bylaws; (v) notify promptly the other
parties to the Combination Agreement of any material change in the condition
(financial or otherwise), business, properties, assets, liabilities or
prospects, any material litigation or material governmental complaints,
investigations or hearings (or communications indicating that the same may be
contemplated), or the breach in any material respect of any representation or
warranty contained in the Combination Agreement; (vi) deliver promptly to the
other parties to the Combination Agreement true and correct copies of (A) with
respect to Coventry, any report, statement or schedule filed with the
Commission; (B) with respect to PHC, audited financial statements prepared for
the period ending December 31, 1997 and delivered to Coventry on or before March
15, 1998; (vii) not (A) except pursuant to the exercise of options, warrants,
conversion rights and other contractual rights existing on the date of the
Combination Agreement and disclosed pursuant to the Combination Agreement, issue
any shares of its capital stock, effect any stock split or otherwise change its
capitalization as it existed on the date of the Combination Agreement, (B)
grant, confer or award any option, warrant, conversion right or other right not
existing on the date of the Combination Agreement to acquire any shares of its
capital stock, other than options granted to new employees hired after the date
of the Combination Agreement under the Coventry Stock Option Plans (as defined
in the Combination Agreement), (C) except as contemplated by the provisions of
the Combination Agreement increase any compensation to employees or enter into
or amend any employment agreement with any of its present or future officers or
directors, except for normal increases consistent with past practice, the
payment of cash bonuses to officers pursuant to and consistent with existing
plans or programs or officers that shall be hired after the date of the
Combination Agreement in the usual, regular and ordinary course of business and
changes to existing Coventry employment agreements approved by its Board of
Directors as consideration for the waiver by employee parties thereto of the
acceleration of the vesting thereof resulting from consummation of the
transactions contemplated by the Combination Agreement, or (D) adopt any new
employee benefit plan (including any stock option, stock benefit or stock
purchase plan) or amend any existing employee benefit plan in any material
respect, except for changes which do not increase the benefits to participants
in such plans and except as contemplated in the Combination Agreement; (viii)
not (A) declare, any shares of its capital stock (except, in the case of
Coventry, any dividends owing on the Series A Preferred Stock and, in the case
of PHC, cash dividends) or (B) except in connection with the use of shares of
capital stock to pay the exercise price or tax withholding in connection with
stock-based employee benefit plans, directly or indirectly redeem, purchase or
otherwise acquire any shares of its capital stock or capital stock of any of its
Subsidiaries, or make any commitment for any such action; (ix) not acquire,
except as expressly contemplated by the Combination Agreement or as disclosed by
PHC or Coventry, direct or indirect control over any corporation, association,
firm or organization, other than in connection with mergers, acquisitions, or
other transactions approved in writing in advance by the other, or involving
consideration valued in the aggregate not in excess of $10,000,000 for all such
transactions; (x) execute, with respect to PHC, a Restructuring Plan, in the
form as developed by PHC with the reasonable approval of Coventry; (xi) not
enter into or amend any material agreement (including, without limitation, any
agreement with its senior lenders); (xii) not (A) sell, lease or otherwise
dispose of any of its assets (except for the excluded assets) which are
material, individually or in the aggregate, except in the ordinary course of
business or (B) sell any capital stock of any of the PHC Subsidiaries; (xiii)
not take any actions that would, or would be reasonably likely to, adversely
affect the status of (A) the Merger as a non-taxable exchange described in
Section 368(a)(2)(E) of the Code and (B) the Capital Contribution as a non-
taxable exchange described in Section 351 of the Code; (xiv) inform the other
parties to the Combination Agreement regarding (A) the progress of any material
claim, action, suit, litigation, proceeding, arbitration, investigation, audit,
or controversy relating to taxes or (B) any change of its methods of reporting
income or deductions for Federal income tax purposes from those employed in the
preparation of its Federal income tax return for the taxable year ending
December 31, 1996, except as may be required by law; and (xv) not (A) make or
rescind any material express or deemed election relating to taxes of the PHC
Subsidiaries or (B) make a request for a Tax Ruling from the Internal Revenue
Service or enter into a closing agreement, settlements or compromise with
respect to any material tax matter or respect of the PHC Subsidiaries.
The Combination Agreement provides further that, prior to the Effective
Time, unless Coventry has consented in writing thereto (which consent shall not
be unreasonably withheld), Mutual shall (with respect only to the Administered
Health Insurance Policies): (i) conduct its operations according to their usual,
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regular and ordinary course in substantially the same manner as conducted prior
to the execution of the Combination Agreement; (ii) use its reasonable efforts
to preserve intact its business organizations and goodwill, keep available the
services of its respective officers and employees and maintain satisfactory
relationships with those persons having business relationships with them; and
(iii) promptly notify the other parties hereto of any material change in the
condition (financial or otherwise), business, properties, assets, liabilities or
prospects, any material litigation or material governmental complaints,
investigations or hearings (or communications indicating that the same may be
contemplated), or the breach in any material respect of any representation or
warranty contained in the Combination Agreement.
WAIVER AND AMENDMENT
The Combination Agreement provides that, at any time prior to the Effective
Time, all parties to the Combination Agreement may (i) extend the time for the
performance of any of the obligations or other acts of the other party contained
in the Combination Agreement; (ii) waive any inaccuracies in the representations
and warranties of the other party contained in the Combination Agreement or in
any document delivered pursuant to the Combination Agreement; and (iii) subject
to the limitations regarding amendment of the Combination Agreement described in
the following sentence, and except for certain mutual conditions to closing,
waive compliance with the agreements or conditions under the Combination
Agreement. In addition, the Combination Agreement may be amended at any time
upon the written agreement of PHC and Coventry without the approval of
stockholders of either company, except that after the Special Meeting no
amendment may be made which by law requires a further approval by the
stockholders of PHC and Coventry without obtaining such further approvals.
TANGIBLE NET VALUE ADJUSTMENT
As used in the Combination Agreement, the term "Tangible Net Value" shall
mean the difference as of immediately prior to the Effective Time between (x)
the aggregate book value of the tangible PHC Assets calculated in accordance
with Generally Accepted Accounting Principles ("GAAP"), consistent with the
accounting principles applied in PHC's financial statements as adjusted in
accordance with the immediately succeeding paragraph and (y) the aggregate book
value of the PHC Liabilities calculated in accordance with GAAP, consistent with
the accounting principles applied in PHC's financial statements as adjusted in
accordance with the immediately succeeding paragraph.
Section 6.19(c) of the Combination Agreement provides that as soon as
practicable, but in no event later than 90 days following the Effective Time,
PHC shall prepare and deliver to Coventry a balance sheet of PHC as of the close
of business on the last business day prior to the Effective Time (the "Closing
Balance Sheet") that sets forth the Tangible Net Value. The Closing Balance
Sheet shall be prepared in accordance with GAAP applied on a consistent basis
with prior periods and shall be delivered together with an audit opinion thereon
of Ernst & Young, LLP or such other independent certified public accounting firm
of recognized national standing as Coventry may designate (the "Accountants")
stating that the Closing Balance Sheet has been prepared in accordance with GAAP
applied on a consistent basis with prior periods. PHC shall retain the
Accountants for purposes of delivering such opinion and PHC shall pay all fees
and expenses thereof.
Coventry may, however, dispute any amounts reflected on the Closing Balance
Sheet, or in the Tangible Net Value calculation, but only on the basis that such
amounts were not arrived at in accordance with GAAP applied on a consistent
basis with prior periods; provided that Coventry shall notify PHC in writing of
each disputed amount and specify the amount thereof in dispute within 30 days of
receipt by Coventry of the Closing Balance Sheet. Coventry may retain
accountants for purposes of performing such review and in such event shall pay
all fees and expenses thereof.
In the event of such a dispute, PHC and/or its accountants, and Coventry
and/or its accountants, shall attempt in good faith to reconcile their
differences and any solution by them as to any disputed amounts shall be final,
binding and conclusive on the parties. If the parties are unable to reach a
resolution to such effect within 20 days of Coventry's written notice of dispute
to PHC, PHC shall cause the Accountants to submit the accounts remaining in
dispute for resolution to another nationally recognized firm of independent
accountants
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reasonably acceptable to both Coventry and PHC. Those accountants shall, within
30 days after such submission, determine and report to the parties upon such
remaining disputed amounts, and such reports shall be final, binding and
conclusive on the parties hereto. The fees and disbursements of this independent
accounting firm shall be allocated equally between Coventry and PHC.
If the Tangible Net Value is less than $103,000,000 (the "Target Value"),
then PHC and/or Mutual shall deliver to Newco cash by wire transfer of
immediately available funds in an amount equal to the difference between the
Tangible Net Value and the Target Value promptly after the 30th day immediately
following receipt of the Closing Balance Sheet or, if later, promptly after the
determination of the Tangible Net Value. If the Tangible Net Value is greater
than the Target Value, then Newco shall deliver to PHC cash by wire transfer of
immediately available funds in an amount equal to the difference between the
Tangible Net Value and the Target Value.
TAXES
Except as contemplated by the Combination Agreement, on or prior to the
Effective Time, PHC and Mutual shall terminate any tax-sharing agreements or
similar arrangements with respect to or involving the PHC Subsidiaries after
settling all obligations under the Combination Agreement. The PHC Subsidiaries
shall not be bound or have any liability under the Combination Agreement for
amounts due in respect of pre-acquisition date tax periods, except as provided
in Section 6.20(b) to the Combination Agreement.
The PHC Subsidiaries will be required to join in the filing of a
consolidated federal income tax return with Mutual for the period from January
1, 1998, to the Effective Time. Mutual shall be responsible for paying the
actual Federal Income Tax due for the PHC Subsidiaries for the period in 1998
ending on the Effective Time. In the determination of Tangible Net Value
pursuant to Section 6.19(a) of the Combination Agreement, the Closing Balance
Sheet shall not reflect any liability for the portion of such federal income Tax
of the Mutual consolidated group for 1997 attributable to PHC or the PHC
Subsidiaries.
For any state or local income, franchise or other tax return of a PHC
Subsidiary that involves a period beginning before and ending after the
Effective Time (a "Straddle Period"), regardless of who pays the tax to the
governmental authority, PHC shall be responsible for the portion of the Tax
attributable to the Pre-Acquisition Date Tax Period (except for premium taxes)
and Coventry shall be responsible for the portion of the Tax attributable to the
Post-Acquisition Date Tax Period. The allocation of total Tax paid in connection
with any such Tax Return between the Pre-Acquisition Date Tax Period and the
Post-Acquisition Date Tax Period shall be in proportion to the number of days in
each such period. For premium taxes, the allocation of total Tax paid between
the Pre-Acquisition Date Tax Period and the Post-Acquisition Date Tax Period
shall be based on the gross premiums (or other measure of such Tax) received
during the Pre-Acquisition Date Tax Period and the Post-Acquisition Date Tax
Period, respectively, with such premiums being pro-rated on a daily basis for
the month within which the Effective Time falls. If Coventry or the PHC
Subsidiary should pay more Tax after the Effective Time with regard to a Tax
Return for a Straddle Period than required by the foregoing allocation, then PHC
shall reimburse Coventry or the PHC Subsidiary for the excess amount paid by
Coventry or the PHC Subsidiary after the Effective Time. If PHC or the PHC
Subsidiary should pay more Tax before the Effective Time with regard to a Return
for a Straddle Period than required by the foregoing allocation, then Coventry
shall reimburse PHC for the excess amount paid by PHC or the PHC Subsidiary
before the Effective Time.
Mutual shall have the right to pursue and shall be entitled to retain, or
receive from Newco or any of its Subsidiaries (including the PHC Subsidiaries)
prompt payment of, any overpayment, refund or credit of Taxes (as defined in the
Combination Agreement) for any and all Pre-Acquisition Date Tax Periods (as
defined in the Combination Agreement). If Newco or any of its Subsidiaries
(including the PHC Subsidiaries) receives a Tax refund to which Mutual is
entitled pursuant to the Combination Agreement, Newco or the Subsidiary, as the
case may be, shall pay or cause the recipient to pay the amount of such refund
(including any interest received thereon) to such other party within 10 days
after receipt thereof. Within 90 days after the end of each taxable year
following the Effective Time, Newco shall have its tax officer tender to Mutual
a statement showing the aggregate amount of all Tax refunds received to which
Mutual is entitled.
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Upon request, Newco shall promptly provide (and cause any of its
Subsidiaries, including the PHC Subsidiaries, to provide) Mutual with such
cooperation and assistance, documents and other information, without charge, as
it may reasonably request in connection with the pursuit of any overpayment,
refund or credit described in Section 6.20(d) of the Combination Agreement.
In addition, Newco and Mutual shall enter into that certain Tax Benefit
Restitution Agreement at the Effective Time, pursuant to which Newco will
reimburse Mutual for certain Tax Benefits (as defined in Section 2(b) of the Tax
Benefit Agreement) after the Effective Time from the utilization of a PHC
Subsidiary Loss Carryover (as defined in the Tax Benefit Agreement) in
accordance with the terms and conditions as set forth in the Tax Benefit
Agreement.
TERMINATION
Termination by Mutual Consent
The Combination Agreement may be terminated and the Merger and Capital
Contribution may be abandoned at any time prior to the Effective Time, before or
after the approval of the Combination Agreement by the shareholders of PHC and
Coventry, by the mutual consent of Coventry, Mutual and PHC.
Termination by Either Coventry or PHC
The Combination Agreement may be terminated and the Merger and Capital
Contribution may be abandoned by action of the Board of Directors of any of
Coventry, Mutual or PHC if (a) the Merger and Capital Contribution shall not
have been consummated by June 30, 1998, (b) the approval of Coventry's
shareholders shall not have been obtained at a meeting duly convened therefor or
at any adjournment thereof, or (c) a United States federal or state court of
competent jurisdiction or United States federal or state governmental,
regulatory or administrative agency or commission shall have issued an order,
decree or ruling or taken any other action permanently restraining, enjoining or
otherwise prohibiting the transactions contemplated by the Combination Agreement
and such order, decree, ruling or other action shall have become final and
non-appealable; provided, that the party seeking to terminate the Combination
Agreement pursuant to this clause (c) shall have used all commercially
reasonable efforts to remove such injunction, order or decree.
Termination by PHC
The Combination Agreement may be terminated and the Capital Contribution
may be abandoned at any time prior to the Effective Time, before or after the
adoption and approval by the shareholders of Coventry by action of the Board of
Directors of PHC or Mutual, if (a) there has been a breach by Coventry or Newco
of any representation or warranty contained in the Combination Agreement or in
any document delivered in connection therewith (without giving effect to any
limitation as to materiality set forth therein or applicable thereto) either
when such representation or warranty was made or at and as of the Effective
Time, as if made at and as of such time (except to the extent expressly made as
of any earlier date, in which case as of such date), except where the failure of
such representations and warranties to be so true and correct (without giving
effect to any limitation as to materiality set forth therein or applicable
thereto) does not have, and is not likely to have, individually or in the
aggregate, a Coventry Material Adverse Effect or a Newco Material Adverse Effect
or (b) there has been a material breach of any of the covenants or agreements
set forth in the Combination Agreement on the part of Coventry, which breach is
not curable or, if curable, is not cured within 30 days after written notice of
such breach, specifying in reasonable detail the nature of the breach, is given
by PHC or Mutual to Coventry.
Termination by Coventry
The Combination Agreement may be terminated and the Merger may be abandoned
at any time prior to the Effective Time, before or after the approval by the
shareholders of Coventry by action of the Board of Directors of Coventry, if (a)
there has been a breach by PHC or Mutual of any representation or warranty
contained in the Combination Agreement or in any document delivered in
connection therewith (without
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giving effect to any limitation as to materiality set forth therein or
applicable thereto) either when such representation or warranty was made or at
and as of the Effective Time, as if made at and as of such time (except to the
extent expressly made as of any earlier date, in which case as of such date),
except where the failure of such representations and warranties to be so true
and correct (without giving effect to any limitation as to materiality set forth
therein or applicable thereto) does not have, and is not likely to have,
individually or in the aggregate, a PHC Material Adverse Effect, a Mutual
Material Adverse Effect or a Newco Material Adverse Effect or (b) there has been
a material breach of any of the covenants or agreements set forth in the
Combination Agreement on the part of PHC or Mutual, which breach is not curable
or, if curable, is not cured within 30 days after written notice of such breach,
specifying in reasonable detail the nature of the breach, is given by Coventry
to PHC.
Automatic Termination
The Combination Agreement shall terminate without further action by the
parties if, prior to the Effective Time, the Board of Directors of Coventry
shall have exercised its rights to approve an unsolicited Acquisition Proposal,
as defined in "-- No Solicitation of Transactions," below, or to withdraw its
recommendation to Coventry's shareholders in support of transactions
contemplated by the Combination Agreement as a result of an unsolicited
Acquisition Proposal.
NO SOLICITATION OF TRANSACTIONS
Prior to the Effective Time, Mutual, Holding, PHC and Coventry each agree
(a) that none of them nor any of their Subsidiaries shall, and each of them
shall direct and use its best efforts to cause its respective officers,
directors, employees, agents and representatives (including, without limitation,
any investment banker, attorney or accountant retained by it or any of its
Subsidiaries) not to, initiate, solicit or encourage, directly or indirectly,
any inquiries or the making or implementation of any proposal or offer
(including, without limitation, any proposal or offer to its shareholders) with
respect to a merger, acquisition, consolidation or similar transaction directly
or indirectly involving, or any purchase or acquisition, directly or indirectly,
of all or any significant portion of the assets or any equity securities of, PHC
or any of the PHC Subsidiaries or Coventry or any of the Coventry Subsidiaries
(any such proposal or offer being hereinafter referred to as an "Acquisition
Proposal") or engage in any negotiations concerning, or provide any confidential
information or data to, or have any discussions with, any person relating to an
Acquisition Proposal, or otherwise facilitate any effort or attempt to make or
implement an Acquisition Proposal; (b) that they and each of them will
immediately cease and cause to be terminated any existing activities,
discussions or negotiations with any parties conducted prior to the execution of
the Combination Agreement with respect to any of the foregoing and each will
take the necessary steps to inform the individuals or entities referred to above
of the obligations undertaken in this Section 6.1 of the Combination Agreement;
and (c) that they and each of them will notify the other parties to the
Combination Agreement immediately if any such inquiries or proposals are
received by, any such information is requested from, or any such negotiations or
discussions are sought to be initiated or continued with it. Notwithstanding the
foregoing, any reorganization of Mutual shall not violate the provisions of the
Combination Agreement if such reorganization shall not result in any transfer of
the PHC Assets or Mutual Indemnity Agreements to any Person who is not an
Affiliate of Mutual and any such transferee agrees to be bound by the provisions
of the Combination Agreement.
Notwithstanding anything to the contrary contained in the Combination
Agreement, Coventry and its Board of Directors (i) may participate in
discussions or negotiations (including, as a part thereof, making any
counterproposal) with or furnish information to any third party making an
unsolicited written Acquisition Proposal that the Board determines is a bona
fide offer (a "Potential Acquiror") if Coventry's Board of Directors is advised
by a nationally recognized investment banking firm designated by Coventry and
reasonably acceptable to Mutual that such Potential Acquiror has the financial
wherewithal to consummate such an Acquisition Proposal (or that it is confident
that such Potential Acquiror will be capable of consummating such Acquisition
Proposal) provided that (a) the Board determines in good faith, after receiving
advice from such financial advisor, that such third party has submitted to
Coventry an Acquisition Proposal which is a superior proposal to the
transactions contemplated under the Combination Agreement (a
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"Superior Proposal"), and (b) the Board determines in good faith, based upon
advice of its outside legal counsel, that participation in such discussions or
negotiations or furnishing such information is necessary to fulfill the Board's
fiduciary duties under applicable law. The Board shall be entitled to withdraw
its recommendation in favor of the transactions contemplated by the Combination
Agreement, and to approve and recommend acceptance by shareholders of an
unsolicited written Acquisition Proposal that is a Superior Proposal if the
Board determines in good faith that such actions are in the best interests of
its shareholders, and, based upon advice of its outside counsel the Board
determines in good faith that such approval is necessary to fulfill the Board's
fiduciary duty under applicable law, and provision is made by Potential Acquiror
to pay the fee provided in Section 8.5(b) of the Combination Agreement at the
time therein specified. Coventry agrees that any non-public information
furnished to a Potential Acquiror will be pursuant to a confidentiality
agreement substantially similar to the confidentiality provisions of the
confidentiality agreement entered into between Coventry, Mutual and PHC. In the
event that Coventry shall determine to provide any information as described
above, or shall receive any such unsolicited Acquisition Proposal, it shall
promptly inform Mutual in writing as to the fact that information is to be
provided and shall furnish to Mutual the identity of the recipient of such
information and/or the Potential Acquiror and the terms of such Acquisition
Proposal, except to the extent that the Board determines in good faith, based
upon advice of its outside legal counsel, that any such action described in this
sentence would violate such Board's fiduciary duties under, or otherwise
violate, applicable law. Coventry will keep Mutual reasonably informed of the
status (including amendments or proposed amendments) of any such Acquisition
Proposal except to the extent that the Board determines in good faith, based
upon advice of its outside legal counsel, that any such action would violate
such Board's fiduciary duties under, or otherwise violate, applicable law.
TERMINATION FEE; THIRD PARTY BIDS
In the event the Combination Agreement is terminated by Coventry's Board of
Directors as a result of the withdrawal of its recommendation to Coventry's
shareholders in support of the transactions contemplated by the Combination
Agreement due to, or the approval by Coventry's Board of Directors of, an
unsolicited Acquisition Proposal that meets certain conditions, then the
Potential Acquiror shall promptly pay (or if the Potential Acquiror fails to pay
Coventry shall promptly pay) to Mutual $20,000,000, which amount shall be due
regardless of whether or not the transaction contemplated by such unsolicited
Acquisition Proposal shall be consummated. No termination fee is payable in the
event the Combination Agreement is terminated for other reasons.
SHAREHOLDERS' AGREEMENT
At or before the Effective Time, Newco, Mutual and PHC will enter into the
Shareholders' Agreement that includes the following provisions:
Restrictions on Transfer
The Shareholders' Agreement provides that each of Mutual and PHC will not,
directly or indirectly: (i) sell or otherwise transfer the shares of Newco
Common Stock, acquired thereby under the Combination Agreement or otherwise
except pursuant to an effective registration under the Securities Act or in a
transaction which, in the opinion of counsel reasonably satisfactory to Newco,
qualifies as an exempt transaction under the Securities Act and the rules and
regulations promulgated thereunder; and (ii) on or before the fifth anniversary
of the Shareholders' Agreement, sell or otherwise transfer, or permit any of its
subsidiaries, directly or indirectly, to sell or to transfer, the shares of
Newco Common Stock acquired thereby under the Combination Agreement or
otherwise, to any person other than an entity that is an Affiliate (as defined
under Rule 13d-3 of the Securities Exchange Act of 1934, as amended) of Mutual
and/or PHC (such affiliate, now or in the future, a "Mutual Affiliate") which
agrees to be bound by the terms of the Shareholder Agreement, unless such sale
or transfer (A) is a registered offering made in accordance with the
registration rights provisions of the Shareholders' Agreement, (B) is made
pursuant to and in compliance with Rule 144 under the Securities Act, or (C)
shall have been approved by the written consent of Newco's Board of Directors.
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Standstill Agreement
Under the Shareholders' Agreement, Mutual covenants and agrees that, on or
before the fifth anniversary of the date of the Shareholders' Agreement, it will
not, and will cause Mutual Affiliates to not, without the prior written consent
of a majority of the members of Newco's Board of Directors, do any of the
following except pursuant to the subscription rights granted under Section 2 of
the Shareholders' Agreement: (a) acquire, offer or agree to acquire any shares
of Newco Common Stock (or options or warrants to acquire, or securities
convertible into or exchangeable for, shares of Common Stock) if, as a result of
such acquisition, Mutual (together with any Mutual Affiliates) would
Beneficially Own (as defined in the Shareholders' Agreement) more than a number
of shares of Newco Common Stock in excess of a number equal to forty percent
(40%) of the outstanding shares of Newco Common Stock plus forty percent (40%)
of the shares of Newco Common Stock issuable upon conversion of the Newco
Convertible Notes plus forty percent (40%) of the number of shares of Newco
Common Stock issuable upon conversation of the Newco Preferred Stock; provided,
however, that, for purposes of computing such amount, the 37,900 shares of Newco
Common Stock Beneficially Owned by Invista Capital Management, Inc. ("Invista")
on November 3, 1997 shall be excluded from such calculation for as long as such
shares are regarded as Beneficially Owned by Invista (and no longer) and
provided that no executive officer or director of Mutual or PHC or any employee
of Mutual, PHC, or any of their affiliates other than officers, directors or
employees of Invista charged with the responsibility therefor shall participate
in the voting of such shares and provided further that for so long as the Newco
Convertible Notes are outstanding, Mutual and the Mutual Affiliates, in the
aggregate, will not vote or act on written consent in any matter coming before
shareholders at any shareholder meeting or shareholder action in excess of forty
percent (40%) of the shares of Newco Common Stock outstanding plus forty percent
(40%) of the shares of Newco Preferred Stock outstanding; (b) directly or
indirectly commence or participate in a solicitation of proxies either to oppose
the election of any Person (as defined in the Shareholders' Agreement) to the
Board of Directors or to seek the removal of any Person from the Board of
Directors, which Person has been nominated by the Nominating Committee of the
Board of Directors; (c) vote its shares of Newco Common Stock for the election
of any Person to the Board of Directors other than the Persons nominated by the
Nominating Committee of the Board of Directors; or (d) directly or indirectly
make or solicit or assist any third party to make a tender or exchange offer to
purchase any shares of Newco Common Stock or make any public announcement
concerning, or submit any written proposal to the Board of Directors of Newco
for a merger, acquisition of substantially all of the assets or similar
transaction involving Newco.
Subscription Rights
Pursuant to the Shareholders' Agreement, if at any time after the date of
the Shareholders' Agreement, Newco proposes to issue equity securities of any
kind (the term "equity securities" shall include for these purposes any
warrants, options or other rights to acquire equity securities and debt
securities convertible into equity securities but shall not include the issuance
of securities (i) upon conversion of the Newco Preferred Stock or Newco
Convertible Notes, (ii) pursuant to which Newco or any of its subsidiaries
acquires another corporation or other entity by merger, consolidation, exchange
offer, Merger, purchase of substantially all of the assets or stock, or other
form of reorganization, (iii) pursuant to any employee or director stock option
or incentive plans, stock bonus plan, employee stock purchase plan, employee
savings plan, supplemental executive retirement plan, management equity program,
or similar employee or director stock plan, (iv) to providers and/or customers
of Newco in an amount not to exceed 2% of the shares of Newco Common Stock
outstanding from and after the date of the Shareholders' Agreement, (vi)
pursuant to the Newco Rights Agreement, or (viii) under the Newco Warrant, then,
as to PHC, Newco shall: (a) give written notice setting forth in reasonable
detail (i) the designation and all of the terms and provisions of the securities
proposed to be issued (the "Proposed Securities"), including, where applicable,
the voting powers, preferences and relative participating, optional or other
special rights, and the qualification, limitations or restrictions thereof and
interest rate and maturity; (ii) the price and other terms of the proposed sale
of such securities; (iii) the amount of such securities proposed to be issued;
and (iv) such other information as the holders of the Securities (as defined in
the Shareholders' Agreement) may reasonably request in order to evaluate the
proposed issuance; (b) offer to issue to PHC (and/or to any other Mutual
Affiliate which shall own shares of Common Stock) upon the terms described in
subparagraph (a) above a portion of the Proposed Securities
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(the "Subscription Securities") equal to a percentage determined by dividing (x)
the number of shares of Common Stock owned by PHC and/or any Mutual Affiliate
immediately preceding the issuance of the Proposed Securities, by (y) the total
number of shares of Newco Common Stock outstanding immediately preceding the
issuance of the Proposed Securities (provided that in no event shall such
percentage exceed 40%). PHC and/or Mutual Affiliate must notify Newco of its
intent to exercise its purchase rights under the Shareholders' Agreement within
ten (10) days after receipt of such notice from Newco and purchase the
Subscription Securities upon the closing of the issuance of the Proposed
Securities. Upon the expiration of the offering period described above, Newco
will be free to sell such Subscription Securities that PHC and/or any Mutual
Affiliate has not elected to purchase during the ninety (90) days following such
expiration on terms and conditions no more favorable to the purchasers thereof
than those offered to PHC and/or any Mutual Affiliate. Any Subscription
Securities offered or sold by Newco after such ninety (90) day period must be
reoffered to PHC and/or any Mutual Affiliate pursuant to the subscription rights
granted under the Shareholders' Agreement.
Right to Match Offer
During such period as the standstill (the "Standstill") pursuant to Section
4 of the Shareholders' Agreement shall be effective, in the event a third party
makes a bona fide tender or exchange offer (a "Bona Fide Offer") to purchase a
majority of the issued and outstanding shares of Common Stock or to effect a
merger in which the acquisition of substantially all of the assets or similar
transaction involving Newco, then Mutual shall be permitted to make a competing
offer (the "Mutual Offer") to the Board of Directors of Newco. Upon the receipt
of any Bona Fide Offer, the Board of Directors shall establish a special
committee (the "Special Committee"), consisting of members of the Board of
Directors that are neither members of Newco's management nor members of the
Board of Directors designated by Mutual pursuant to the terms of Section 7 of
the Shareholders' Agreement. The Special Committee shall determine whether it is
advisable and in the best interest of Newco to solicit additional offers from
any other party or parties, shall retain any legal or financial advisory
services deemed necessary or advisable to assist it in its analysis of the Bona
Fide Offer, the Mutual Offer and any other offers solicited from third parties
by Newco, and shall establish any procedures deemed necessary or advisable to
regulate the process pursuant to which Newco entertains and analyzes the
competing offers. The Special Committee shall analyze each such offer and shall
make a recommendation to the entire Board of Directors with respect to whether
any such offer is one that Newco should recommend to its shareholders. If the
Special Committee shall determine that the value of the Bona Fide Offer or any
other offer solicited from a third party is greater than the value of the Mutual
Offer, then Mutual shall have the opportunity to amend the Mutual Offer to match
or exceed the value of the higher offer and each of the other parties that has
submitted an offer to Newco shall have the right to submit a revised offer to
Newco. If the Special Committee shall determine that, after Newco shall have
received the final offer from each such party, the value of the Mutual Offer is
equal to or greater than any other offer received by Newco and that the Mutual
Offer is advisable and in the best interest of Newco's shareholders, then Mutual
shall be permitted to take any action deemed necessary or convenient to acquire
that number of shares of Newco Common Stock as specified in the Mutual Offer for
the terms (including price) set forth in the Mutual Offer.
Voting By Mutual
During such period as the Standstill shall be effective, in the event that
(i) a third party makes a Bona Fide Offer to purchase all of the issued and
outstanding shares of Newco Common Stock or to effect a merger or similar
transaction, and the Special Committee shall determine in accordance with the
procedures set forth in Section 6 of the Shareholders' Agreement that the
acceptance of the Bona Fide Offer is in the best interests of Newco's
shareholders or (ii) a Special Committee determines that it is in the best
interests of Newco's shareholders for Newco to issue shares of Newco Common
Stock in connection with a company acquisition and, in connection with such
acquisition, a vote of the holder's of Newco's Common Stock is required by law
or by applicable requirements of The Nasdaq Stock Market or any other securities
exchange on which shares of the Newco Common Stock are traded, then, in either
event, Mutual agrees to refrain from voting and to cause each Mutual Affiliate
to refrain from voting all of their shares of Newco Common Stock at any meeting
of Newco's shareholders held for the purpose of considering such proposal (or,
if an approval of shareholders
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is required by reference to all shares outstanding, to vote its shares of Newco
Common Stock and to cause each Mutual Affiliate to vote its shares of Newco
Common Stock in favor of such proposal) provided that each of the following
conditions set forth below are satisfied at such time: (a) the date of the
shareholders meeting shall be on or after the date that is eighteen (18) months
following the Effective Date (as defined in the Shareholders' Agreement) and
during the period as Section 4 shall be effective; (b) the Board shall have
received the written opinion of a nationally recognized investment banking firm
selected by Newco and reasonably acceptable to Mutual that the proposed
transaction is fair to Newco and its shareholders from a financial standpoint;
and (c) Newco's shareholders (other than Mutual and the Mutual Affiliates) shall
have voted in favor of the proposed transaction by majority vote.
Mutual Nominees to Board
For so long as Mutual Beneficially Owns at least 10% (the "Minimum
Percentage") of the then issued and outstanding shares of Newco Common Stock and
shall not have breached in any material respect, without cure, any provision of
the Shareholders' Agreement, Newco will (i) nominate and use its best efforts to
cause its shareholders to elect and to retain as directors on the Board of
Directors at least one nominee designated by Mutual for each 6% of the issued
and outstanding Newco Common Stock then held by Mutual (such nominees are
collectively hereinafter referred to as the "Mutual Directors") and (ii) use its
best efforts to cause its Board of Directors to limit the number of members of
the Compensation Committee, Audit Committee and Finance Committee of the Board
of Directors to three directors and to cause one Mutual Director (as defined in
the Shareholders' Agreement) to be appointed as a member of each such committee.
Any vacancy created by the death, disability, retirement or removal of any
Mutual Director on the Board of Directors or on any such committee of the Board
of Directors shall be filled by the Board of Directors in accordance with
written instructions of Mutual. In the event the number of members of the Board
of Directors is increased to more than 15 directors, for so long as Mutual owns
the Minimum Percentage, Mutual shall be entitled to the whole number of Mutual
Directors obtained by multiplying (a) the number of directors on the Board of
Directors (including Mutual Directors) by (b) a fraction, (x) the numerator of
which is equal to the number of shares of Newco Common Stock then beneficially
owned (within the meaning of Rule 13d-3 under the Exchange Act) by Mutual and
(y) the denominator of which is equal to the total number of shares of Newco
Common Stock then issued and outstanding. In the event any calculation of the
number of Directors (as defined in the Shareholders' Agreement) that Mutual is
entitled to designate shall not produce a whole number of Mutual Directors, then
the number of Mutual Directors shall be rounded to the nearest whole number
(with percentages greater than or equal to 50% being rounded up to the next
whole number and percentages less than 50% being rounded down to the next whole
number).
Registration Rights
Pursuant to Section 9 of the Shareholders' Agreement, Mutual and PHC shall
have the right to demand on four occasions that Newco effect a registration by
preparing and filing a registration statement in compliance with the Securities
Act (and any post-effective amendments filed or required to be filed); provided,
however, that (a) the registrable securities pursuant to such request shall have
an anticipated aggregate public offering price (before any underwriting
discounts and commissions) of not less than $20,000,000; and (b) if in the good
faith judgment of the Board based upon the written opinion of a nationally
recognized investment banking firm selected by Newco and reasonably acceptable
to Mutual and/or PHC, such registration would have a material adverse effect on
the market price of the shares of Newco Common Stock and such securities
represent more than twenty percent (20%) of the then outstanding shares of Newco
Common Stock, Newco shall have the right to limit the number of registrable
securities to be registered pursuant to such request; provided, however, that
Newco shall use reasonable commercial efforts to register not less than fifty
percent (50%) of the number of the securities requested to be registered or to
facilitate a private sale of such number of such securities to institutional
investors in a manner that would ameliorate the anticipated material adverse
effect of any such sale on the market price of the shares of Newco Common Stock.
Not withstanding the foregoing, if, at the time of such request, all shares then
requested to be sold could be sold pursuant to Rule 144(k) under the Securities
Act, then the Newco shall not be obligated to pay registration expenses of more
than $75,000 in connection with such registration. In addition to the right to
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demand registration of shares of Newco Common Stock, Mutual and PHC shall have
the right to participate in any other registered public offering of Newco Common
Stock as a selling stockholder.
Effect on Newco Rights Agreement
At or prior to the Effective Time, Newco shall have adopted the Newco
Rights Agreement, substantially in the form attached as Exhibit 8 to the
Combination Agreement, pursuant to which PHC, Mutual and/or any Mutual Affiliate
shall be exempt from the definition of an "Acquiring Person" (as defined under
the Newco Rights Agreement) for so long as none of PHC, Mutual and/or any Mutual
Affiliate has breached in any material respect, any provision of Sections 1(a)
or 4 of the Shareholders' Agreement while such sections remain effective, and
after such Sections shall no longer be effective, until such time as Mutual and
the Mutual Affiliates shall collectively Beneficially Own less than fifteen
percent (15%) of the Newco Common Stock.
ADMINISTERED HEALTH INSURANCE POLICIES
At or prior to the Effective Time, Newco will enter into the Management
Services Agreement to manage the Administered Health Insurance Policies. The
Management Services Agreement will terminate on December 31, 1999 at which time
Newco's indirectly wholly-owned subsidiary, CHLIC, will have the obligation,
pursuant to a Renewal Rights Agreement, to offer to renew the insurance policies
constituting the Administered Health Insurance Policies then in force, and to
reinsure, pursuant to a Coinsurance Agreement, all such policies whose holders
elect to renew with Mutual instead of CHLIC.
Management Services Agreement
Pursuant to the Management Services Agreement, Mutual will appoint Newco at
the Effective Time to provide the management services specified in Schedule 2.01
thereto (the "Management Services") during the period commencing at the
Effective Time and ending on December 31, 1999 with respect to the Administered
Health Insurance Policies. The Management Services to be provided under the
agreement include, without limitation, financial consulting, state and federal
government relations, customer relations, sales support, sales management,
product development, systems consultation, claim product oversight, customer
satisfaction feedback, underwriting oversight and competitiveness evaluation. In
addition, in order to support the orderly administration and transition of
Administered Health Insurance Policies, Newco may provide additional services
outside the scope of services described in the Management Services Agreement
which are in lieu of similar services which would have been provided by Mutual.
Mutual and Newco will mutually agree in advance on the scope of these additional
services and the compensation or reimbursement to be provided for such services.
As compensation for the Management Services to be rendered by Newco, Mutual
shall pay to Newco a monthly management fee equal to three and three-tenths
percent (3.3%) of Net Premiums (as defined under the Management Services
Agreement) earned by Mutual during such month in accordance with GAAP on or
before the 30th day of each month with respect to Net Premiums received during
the previous month. Mutual estimates that the Net Premiums will be approximately
$550 million for fiscal year 1997. The monthly management fee was determined by
Coventry, on behalf of Newco, and Mutual through arms length negotiations.
Renewal Rights Agreement
Pursuant to the terms of the Renewal Rights Agreement, (i) Mutual will
provide to CHLIC on the first Business Day after January 1, 2000, and from time
to time thereafter, a true and complete list of the insured parties, and a
summary of the coverages provided, under the Administered Health Insurance
Policies; (ii) in connection with the non-renewal of such policies by Mutual, to
the extent permitted by applicable law and contractual obligations, Mutual shall
send to each insured party written notice encouraging such insured party to
renew such policy with CHLIC; and (iii) CHLIC shall, in connection with the
first expiration of each Administered Health Insurance Policy on or after
January 1, 2000, (or, with respect to such policies renewed by Mutual subsequent
to January 1, 2000, in connection with the next such expiration), offer to renew
and make a good faith effort to renew each such policy.
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Coinsurance Agreement
On and after January 1, 2000, to the extent that customers choose to renew
the Administered Health Insurance Policies with Mutual instead of CHLIC, CHLIC
will reinsure the Administered Health Insurance Policies in accordance with the
terms of the Coinsurance Agreement. Pursuant to the Coinsurance Agreement,
Mutual agrees to reinsure with CHLIC, and CHLIC agrees to indemnify Mutual for,
(a) all Ultimate Net Loss (as defined under the Coinsurance Agreement) incurred
by Mutual under the reinsured policies (the "Policies") and (b) unearned
premiums returned to policyholders upon the cancellation of Policies on or after
such date (the "Reinsured Risks"). Coventry expects that Newco will, during the
twelve month period immediately following the effectiveness of the Coinsurance
Agreement, renew the Policies pursuant to the terms of the Rights Renewal
Agreement as described below.
NEWCO WARRANT
Newco will issue to Mutual at the Effective Time the Newco Warrant that
gives Mutual the right to purchase from Newco that number of shares of Newco
Common Stock equal to 66 2/3% of the total number of shares of Newco Common
Stock as shall actually be issued by Newco upon the exercise or conversion of
the Coventry Options, Coventry Warrants and PHC Options, issued and outstanding
at the Effective Time upon the same terms and conditions as set forth in the
Coventry Options, Coventry Warrants and PHC Options, respectively. As of March
10, 1998, Coventry had outstanding 3,355,045 Coventry Options with an average
exercise price of $13.47 and 2,477,766 Coventry Warrants with an average
exercise price of $10.79. As of December 31, 1997, PHC had outstanding 750,000
PHC Options with an exercise price per share of $14.50. Mutual's right to
purchase shares of Newco Common Stock under the Newco Warrant will vest, from
time to time, with respect to the number of shares of Newco Common Stock as
shall be issued upon exercise of the Coventry Options, Coventry Warrants or PHC
Options upon receipt of notice from Newco of the exercise and issuance of such
shares and shall terminate upon the expiration of the Newco Warrant on the later
of (x) the 90th day following receipt of notice of exercise of the underlying
Coventry Option, Coventry Warrant or PHC Option or (y) the expiration of the
exercise periods of such underlying option or warrant. Based on the exercise
periods of the underlying Coventry Options, Coventry Warrants or PHC Options,
the Newco Warrant will terminate with respect to 6% through 2003, and 44%, 3%,
20%, 26%, and 1% of the shares covered thereby in the years 2004 through 2008,
respectively.
ANCILLARY AGREEMENTS
At the Effective Time, Mutual and Newco shall enter into the Marketing
Services Agreement, the License Agreement, the Transition Agreement and the PPO
Agreements. Pursuant to the Marketing Services Agreement, Mutual shall engage
Newco to provide certain marketing and support services in the Newco Markets for
certain of Mutual's businesses other than the Administered Health Insurance
Policies. Mutual will compensate Newco in the amount of $4 million per calendar
quarter in 1998 and $2.5 million per calendar quarter in 1999 for the services
to be rendered under the Marketing Services Agreement. In order to permit Newco
to perform its services under the Marketing Services Agreement, Mutual and Newco
will enter into the License Agreement pursuant to which Mutual shall grant Newco
and its subsidiaries a royalty free license to use Mutual's name and marks in
the United States subject to certain restrictions and required approvals.
Pursuant to the Transition Agreement, Mutual shall provide certain
administrative functions and services to Newco necessary for the operation of
the PHC Business. In addition, at or prior to the Effective Time, Mutual, PHC
and/or PHC's subsidiaries shall terminate any agreements, arrangements or
commitments between them as such relate to the PHC Business. At the Effective
Time, Newco shall assume the PPO Agreements currently in force between Mutual,
PHC and/or PHC's subsidiaries, pursuant to which Mutual shall have the option to
access Newco's PPOs for certain of Mutual's clients in the Newco Markets. The
existing PPO Agreements between Mutual and PHC and its subsidiary will be
amended prior to the Effective Time to increase the fee payable by Mutual
thereunder to a fee equal to $2.50 per program member per month plus a
percentage of savings expected to equal $4 million per calendar quarter in 1998
and $2 million per calendar quarter in 1999. The fees under the Marketing
Services Agreement were determined by arms length
49
<PAGE> 59
negotiation between Coventry, on behalf of Newco, and Mutual, and the amended
fees under the PPO Agreements were determined by Coventry, on behalf of Newco,
PHC and Mutual.
INTERESTS OF CERTAIN PERSONS IN THE BUSINESS COMBINATION
In considering the recommendations of the Board of Directors of Coventry
with respect to the Combination Agreement and the transactions contemplated
thereby, stockholders of Coventry should be aware that certain members of the
management of Coventry and the Board of Directors of Coventry have certain
interests in the Business Combination that are in addition to the interests of
the stockholders generally. Coventry will become a direct, wholly owned
subsidiary of Newco upon consummation of the Merger. The Board of Directors of
Newco immediately prior to the Effective Time will consist of fifteen members,
nine of whom currently serve as members of Coventry's Board of Directors and six
of whom will be designees of Mutual. The executive officers of Newco immediately
prior to the Effective Time, will consist of substantially all of the current
executive officers of Coventry and certain executive officers of PHC. The
directors and executive officers of Newco immediately prior to the Effective
Time will serve as the initial directors and executive officers of Newco after
the Effective Time. The directors and executive officers of Newco that are
currently officers of Coventry hold Coventry Options to purchase 1,098,536
shares of Coventry Common Stock. The directors and executive officers of Newco
that are currently executive officers of PHC hold PHC Management Options to
purchase 750,000 shares of PHC Common Stock. Upon the consummation of the Merger
and Capital Contribution, Newco will assume the Coventry Options and the PHC
Management Options under the same terms and conditions set forth therein and in
the Newco Plan and each such option will be exercisable for that number of
shares of Newco Common Stock as shall equal the number of shares of Coventry
Common Stock or PHC Common Stock currently issuable upon exercise of the option.
ACCOUNTING TREATMENT
The Merger and the Capital Contribution will be accounted for as a common
control transfer from Coventry to Newco at historical cost and the purchase of
the PHC Business by Newco. The historical book basis of the assets, liabilities
and shareholders equity of Coventry will become the carrying value of the
assets, liabilities and shareholders equity of Newco, and the PHC Assets and PHC
Liabilities comprising the PHC Business will be recorded on the books of Newco
at their fair value. Any cost in excess of the net asset fair value of the PHC
Business, will be amortized using the straight-line method over a period to be
determined by Newco based upon its estimate of the useful life of the net assets
acquired. The unaudited pro forma selected financial data contained in this
Proxy Statement/Prospectus has been prepared using the purchase method of
accounting to account for the Business Combination.
50
<PAGE> 60
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following paragraphs set forth the material federal income tax
consequences of the Merger to Coventry and to the shareholders of Coventry and
is based upon the Code, the applicable Treasury Department regulations
thereunder (the "Regulations"), judicial authority and current administrative
rulings and practice, all as in effect as of the date hereof. Future
legislation, regulations, administrative rulings or court decisions could
significantly change such authorities either prospectively or retroactively. The
following paragraphs do not address the consequences of the Merger under state,
local or foreign law nor does it address all aspects of federal income taxation
that may be important to a stockholder in light of such stockholder's particular
circumstances or to stockholders subject to special rules including, without
limitation, foreign institutions, insurance companies, tax-exempt entities,
dealers in securities or persons who acquired Coventry stock pursuant to the
exercise of an employee option (or otherwise as compensation) or any other
derivative security. In addition, these paragraphs apply only to a holder (a)
who is a U.S. citizen or resident, a U.S. corporation, partnership, or other
entity created or organized under the laws of the United States, or an estate or
trust other than a "foreign estate" or "foreign trust" as defined in Section
7701(a)(31) of the Code and (b) who holds his respective shares of Coventry
stock as capital assets within the meaning of Section 1221 of the Code.
No ruling from the Internal Revenue Service (the "IRS") concerning the
federal income tax consequences of the Merger will be requested. It is a
condition to the Combination Agreement that Coventry receive an opinion from
Bass, Berry & Sims PLC that the Merger qualifies for federal income tax purposes
as a reorganization under Section 368(a)(2)(E) of the Code and, accordingly,
that the Merger will have the tax consequences set forth below. The opinion will
be based upon (i) certain assumptions set forth therein and (ii) representations
by the managements of Coventry and PHC dated as of the date of the consummation
of the Merger. The opinion referred to above neither binds nor precludes the IRS
from adopting a contrary position and no assurance can be given that contrary
positions will not be successfully asserted by the IRS or adopted by a court if
the issues are litigated.
THE FOLLOWING SETS FORTH THE MATERIAL FEDERAL INCOME TAX CONSEQUENCES OF
THE MERGER, WITHOUT REFERENCE TO THE PARTICULAR FACTS AND CIRCUMSTANCES OF ANY
PARTICULAR SHAREHOLDER. IN ADDITION, ANY NON-INCOME TAX OR ANY FOREIGN, STATE OR
LOCAL TAX CONSEQUENCES OF THE MERGER ARE NOT ADDRESSED HEREIN. THE TAX
CONSEQUENCES OF ANY TRANSACTION OTHER THAN THE MERGER ARE ALSO NOT DISCUSSED
HEREIN. EACH STOCKHOLDER IS STRONGLY URGED TO CONSULT WITH SUCH STOCKHOLDER'S
TAX ADVISOR TO DETERMINE THE PARTICULAR UNITED STATES FEDERAL, STATE, LOCAL OR
FOREIGN INCOME OR OTHER TAX CONSEQUENCES OF THE MERGER TO SUCH STOCKHOLDER.
Tax Consequences of the Merger
Tax Consequences to Coventry Shareholders. Coventry shareholders will not
recognize income, gain or loss upon the receipt of Newco Common Stock in
exchange for their shares of Coventry Common Stock pursuant to the Merger. The
tax basis of the shares of Newco Common Stock received by Coventry shareholders
will be the same as the tax basis of the shares of Coventry Common Stock
exchanged therefor. The holding period of the shares of Newco Common Stock
received by Coventry shareholders will include the holding period of the shares
of Coventry Common Stock surrendered therefor. The IRS has taken the position
that the receipt of rights to purchase stock at substantially less than market
value exercisable only upon certain unsolicited offers to acquire control of the
issuer, which are similar to the Newco Rights, is not a taxable exchange or
dividend where at the time of the transaction, the rights are not then
exercisable and are inseparable from the underlying common stock. Accordingly,
the receipt of the Newco Rights by Coventry shareholders will not be taxable.
Holders of Coventry Warrants who receive warrants to purchase Newco Common
Stock in exchange for their Coventry Warrants in the Merger will not recognize
gain under regulations of the Treasury Department going into effect with respect
to transactions occurring after March 8, 1998. Such an exchange in a
51
<PAGE> 61
reorganization will be treated as an exchange of securities having a principal
amount of zero and, hence, will not be a taxable exchange.
Certain holders of Coventry Options received their Coventry Options in
connection with the performance of services, as an employee, officer, director
or in some other capacity. Holders of these Coventry Options who receive options
to purchase Newco Common Stock in the Merger will not recognize income, gain or
loss on the receipt of Newco Options.
Tax Consequences to Coventry. No income, gain or loss will be recognized
by Coventry pursuant to the Merger.
Information Reporting. In general, each Coventry shareholder will be
required to retain records and file with such holder's U.S. federal income tax
return a statement setting forth the cost or other basis of stock or securities
transferred in the Merger and a statement in full of the amount and fair market
value of stock, securities, other property or money received in the Merger.
Tax Consequences of an Investment in Newco Common Stock
Cash Dividends. Any cash dividends that are paid in respect of the Newco
Common Stock, to the extent paid out of Newco's current or accumulated earnings
and profits, will be taxable as ordinary income. Corporate shareholders of Newco
generally will qualify for the intercorporate dividends received deduction with
respect to such dividends, subject to a minimum holding period and other
applicable requirements. To the extent that Newco does not have sufficient
current or accumulated earnings and profits, all or a portion of any
distribution made with respect to Newco Common Stock in any particular year will
not qualify as dividends for United States federal income tax purposes and, as a
result, will not be eligible for the dividends-received deduction. A
distribution in respect of the Newco Common Stock that does not constitute a
dividend for United States federal income tax purposes will represent a
non-taxable distribution to the extent of the shareholder's basis in Newco
Common Stock (correspondingly reducing such shareholder's basis in such shares
of stock) and, to the extent such distribution exceeds the shareholder's basis
in such stock, as capital gain. Under certain circumstances, a corporate
shareholder that receives "extraordinary dividends," as defined in Section
1059(c) of the Code, is required to reduce its tax basis in the stock on which
such dividends are paid by the non-taxed portion of such dividends.
Backup Withholding. Certain noncorporate shareholders may be subject to
backup withholding at a rate of 31% on dividends received on Newco Common Stock
if (i) the shareholder fails to furnish or certify his correct taxpayer
identification number to the payor in the manner required, (ii) Newco is
notified by the IRS that the shareholder has failed to report payments of
interest and dividends properly or that the taxpayer identification number
furnished to Newco is incorrect, or (iii) under certain circumstances, the
shareholder fails to certify that he has not been notified by the IRS that he is
subject to backup withholding for failure to report interest and dividend
payments. Any amounts withheld under the backup withholding rules from a payment
to a shareholder will be allowed as a credit against such shareholder's United
States federal income tax liability and may entitle the shareholder to a refund,
provided that the required information is furnished to the IRS.
NO APPRAISAL RIGHTS
Under Section 48-23-102(c) of the Tennessee Business Corporation Act,
holders of Coventry Common Stock will not be entitled to dissenters' rights or
appraisal in connection with the Merger and Capital Contribution.
EXPENSES
The Combination Agreement provides that, except as described under
"-- Termination Fee; Third Party Bids", all costs and expenses incurred in
connection with the Combination Agreement and the transactions
52
<PAGE> 62
contemplated thereby shall be paid by the party incurring such expense, except
that expenses of printing and mailing this Proxy Statement/Prospectus shall be
shared equally by PHC and Coventry.
THE NASDAQ STOCK MARKET LISTING
A listing application will be filed with The Nasdaq Stock Market to list
the shares of Newco Common Stock to be issued to Coventry stockholders and to
PHC in connection with the Business Combination under Coventry's existing
symbol, CVTY. Although no assurance can be given that the shares of Newco Common
Stock so issued will be accepted for listing, Newco anticipates that these
shares will qualify for listing on The Nasdaq Stock Market upon official notice
of issuance thereof. It is a condition to the Business Combination that such
shares of Newco Common Stock be approved for listing on The Nasdaq Stock Market
upon official notice of issuance at the Effective Time.
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<PAGE> 63
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
OF COVENTRY CORPORATION
The selected consolidated financial data (in thousands, except for
membership data) of Coventry for each of the five years ended December 31, 1996,
are derived from the audited financial statements of Coventry. The selected
consolidated financial and operating data of Coventry for the nine months ended
September 30, 1997 and 1996 is derived from unaudited financial statements
which, in the opinion of management, include all adjustments consisting of
normal recurring accruals adjustments, necessary for a fair presentation of the
financial condition and the results of operations. Operating results for the
nine months ended September 30, 1997 are not indicative of results of the full
year. The following data should be read in conjunction with "Management's
Discussion and Analysis of the Financial Condition and Results of Operations"
and the consolidated financial statements, including the notes thereto, included
in this Proxy Statement/ Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED(1)
------------------------------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT DATA(3)
Operating revenues............. $475,454 $641,573 $776,643 $852,390 $1,057,129
Operating earnings (loss)...... 27,913 43,177 55,023 (1,275) (91,346)
Earnings (loss) from continuing
operations................... 14,171 22,005 29,288 18 (61,287)
Loss on disposal of
discontinued operations.... (3,846)
Extraordinary items.......... 4,005
-------- -------- -------- -------- ----------
Net earnings (loss)............ $ 14,330 $ 22,005 $ 29,288 $ 18 $ (61,287)
======== ======== ======== ======== ==========
Earnings (loss) per share(2):
Continued operations......... $ 0.51 $ 0.74 $ 0.93 $ 0.00 $ (1.86)
Discontinued operations...... (0.14)
Extraordinary items.......... 0.15
-------- -------- -------- -------- ----------
Net earnings (loss) per
share...................... $ 0.52 $ 0.74 $ 0.93 $ 0.00 $ (1.86)
======== ======== ======== ======== ==========
Weighted average common and
common equivalent shares
outstanding(2)............... 27,547 29,585 31,425 32,164 33,011
BALANCE SHEET DATA(3)
Cash and investments(4)........ $ 65,488 $116,014 $133,975 $144,469 $ 168,423
Total assets................... $207,836 $266,971 $343,771 $385,675 $ 448,945
Long-term obligations and notes
payable (including current
maturities).................. $ 59,856 $ 53,017 $ 73,643 $ 77,868 $ 102,985
Stockholders' equity and
partners' capital(5)......... $ 69,679 $ 96,906 $134,124 $153,851 $ 100,427
OPERATING STATEMENT DATA(3)
Membership at December 31:
Commercial................... 344,858 423,023 468,743 510,815 592,001
Medicare(6).................. 16,594 17,907 19,068 18,890 27,507
Medicaid(7).................. -- 6,930 26,143 73,550 121,599
Management Services.......... 2,861 61,458 67,003 92,232 152,969
-------- -------- -------- -------- ----------
Total.......................... 364,313 509,318 580,957 695,487 894,076
======== ======== ======== ======== ==========
<CAPTION>
NINE MONTHS ENDED(1)
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
1996 1997
------------- -------------
<S> <C> <C>
OPERATIONS STATEMENT DATA(3)
Operating revenues............. $767,577 $907,120
Operating earnings (loss)...... (16,647) (48)
Earnings (loss) from continuing
operations................... (9,148) 8,397
Loss on disposal of
discontinued operations....
Extraordinary items..........
-------- --------
Net earnings (loss)............ $ (9,148) $ 8,397
======== ========
Earnings (loss) per share(2):
Continued operations......... $ (0.28) $ 0.25
Discontinued operations......
Extraordinary items..........
-------- --------
Net earnings (loss) per
share...................... $ (0.28) $ 0.25
======== ========
Weighted average common and
common equivalent shares
outstanding(2)............... 32,839 33,505
BALANCE SHEET DATA(3)
Cash and investments(4)........ $148,131 $217,590
Total assets................... $445,803 $437,121
Long-term obligations and notes
payable (including current
maturities).................. $108,061 $ 98,086
Stockholders' equity and
partners' capital(5)......... $151,924 $113,230
OPERATING STATEMENT DATA(3)
Membership at December 31:
Commercial................... 592,110 612,645
Medicare(6).................. 23,696 38,285
Medicaid(7).................. 110,624 102,271
Management Services.......... 150,994 144,557
-------- --------
Total.......................... 877,424 897,758
======== ========
</TABLE>
- ---------------
(1) The medical loss ratio (health benefits as a percentage of managed care
premiums) was 82.4%, 81.8%, 79.8%, 84.5% and 89.9% in 1992, 1993, 1994,
1995, and 1996, respectively. The medical loss ratio was 86.5% and 86.6% for
the nine months ending September 30, 1996 and September 30, 1997,
respectively.
(2) Reflects the two-for-one split of Coventry's common stock which occurred in
August 1994.
(3) All periods presented have been restated for the merger with HCUSA in 1995,
Southern Health Management Corporation ("SHMC") in 1994 and for discontinued
operations.
(4) Certain reclassifications have been made to the financial statements to
conform to the 1997 presentation.
(5) The predecessor company of SHMC was an S Corporation.
(6) Included both full risk and cost-based members.
(7) Effective June 30, 1997, Coventry discontinued its Medicaid operations in
Jacksonville, Florida.
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<PAGE> 64
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OF COVENTRY CORPORATION
YEAR ENDED DECEMBER 31, 1996 AND
QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
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 may be affected by a number of factors, including the
risk factors set forth herein under "Risk Factors," and consequently, actual
operations and results may differ materially from those expressed in these
forward-looking statements.
RESULTS OF OPERATIONS
The following table is provided to facilitate a more meaningful discussion
regarding the results of Coventry's operations for the three years ended
December 31, 1996 and the nine months ended September 30 of 1997 and 1996.
<TABLE>
<CAPTION>
1994 1995 1996
--------------------- ---------------------------------- ------------------------------------
PERCENT OF PERCENT OF PERCENT PERCENT OF PERCENT
OPERATING OPERATING INCREASE OPERATING INCREASE
AMOUNT REVENUES AMOUNT REVENUES (DECREASE) AMOUNT REVENUES (DECREASE)
-------- ---------- -------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums... $769,935 99.1% $844,032 99.0% 9.6% $1,035,778 98.0% 22.7%
Management services..... 6,708 0.9% 8,358 1.0% 24.6% 21,351 2.0% 155.5%
-------- ----- -------- ------ ---------- -----
Total operating
revenues.............. 776,643 100.0% 852,390 100.0% 9.8% 1,057,129 100.0% 24.0%
-------- ----- -------- ------ ---------- -----
Operating expenses:
Health benefits (1)..... 614,144 79.1% 713,226 83.6% 16.1% 930,739 88.0% 30.5%
Selling, general and
administrative........ 94,684 12.2% 123,523 14.5% 30.5% 165,081 15.6% 33.6%
Depreciation and
amortization.......... 9,437 1.2% 14,666 1.7% 55.4% 42,862 4.1% 192.3%
Other charges........... 9,793 0.9% NM
Merger costs............ 3,355 0.4% 2,250 0.3% (32.9)%
-------- ----- -------- ------ ---------- -----
Operating (loss)......... 55,023 7.1% (1,275) (0.1)% (102.3)% (91,346) (8.6)% NM
Other income, net........ 5,003 0.6% 7,705 0.9% 54.0% 13,379 1.2% 73.6%
Interest expense......... (2,731) (0.4)% (4,881) (0.6)% 78.7% (6,257) (0.6)% 28.2%
-------- ----- -------- ------ ---------- -----
Earnings (loss) before
income taxes and
minority interest....... 57,295 7.3% 1,549 0.2% (97.3)% (84,224) (8.0)% NM
Net earnings (loss)...... $ 29,288 3.8% $ 18 0.0% (99.9)% $ (61,287) (5.8)% NM
======== ======== ==========
Membership at December 31:
Commercial.............. 468,743 510,815 592,001
Medicare (2)............ 19,068 18,890 27,507
Medicaid................ 26,143 73,550 121,599
Management services..... 67,003 92,232 152,969
-------- -------- ----------
580,957 695,487 894,076
======== ======== ==========
<CAPTION>
30-SEPT-96 30-SEPT-97
--------------------- ----------------------------------
PERCENT OF PERCENT OF PERCENT
OPERATING OPERATING INCREASE
AMOUNT REVENUES AMOUNT REVENUES (DECREASE)
-------- ---------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums... $757,277 98.7% $892,357 98.4% 17.8%
Management services..... 10,300 1.3% 14,763 1.6% 43.3%
-------- ----- -------- -----
Total operating
revenues.............. 767,577 100.0% 907,120 100.0% 18.2%
-------- ----- -------- -----
Operating expenses:
Health benefits (1)..... 655,322 85.4% 772,363 85.1% 17.9%
Selling, general and
administrative........ 108,876 14.2% 124,892 13.8% 14.7%
Depreciation and
amortization.......... 11,783 1.5% 9,913 1.1% (15.9)%
Other charges........... 8,243 1.1%
Merger costs............
-------- ----- -------- -----
Operating (loss)......... (16,647) (2.2)% (48) NM 99.7%
Other income, net........ 6,546 0.9% 22,353 2.5% 241.5%
Interest expense......... (5,345) (0.7)% (8,278) (0.9)% 54.9%
-------- ----- -------- -----
Earnings (loss) before
income taxes and
minority interest....... (15,446) (2.0)% 14,027 1.5% 190.8%
Net earnings (loss)...... $ (9,148) (1.2)% $ 8,397 0.9% 191.8%
======== ========
Membership at December 31
Commercial.............. 592,110 612,645
Medicare (2)............ 23,696 38,285
Medicaid................ 110,624 102,271
Management services..... 150,994 144,557
-------- --------
877,424 897,758
======== ========
</TABLE>
- ---------------
(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.
The medical loss ratio was 86.5% and 86.6% for the nine months ending
September 30, 1996 and September 30, 1997, respectively.
(2) Includes both full risk and cost-based members.
55
<PAGE> 65
GENERAL
During the three year period ended December 31, 1996, Coventry experienced
substantial growth in operating revenues due primarily to membership growth.
Coventry 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.
Coventry'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 Coventry 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
was 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 Coventry 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.
Coventry's management services revenues result from operations in which
Coventry's health plans provide administrative and other services to
self-insured employers. Coventry receives an administrative fee for these
services, but does not assume underwriting risk. A portion of these revenues,
however, are dependent upon Coventry meeting specific performance criteria.
Coventry'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 Coventry's health
centers. Medical claims expense also includes an estimate of claims incurred but
not reported ("IBNR"). Coventry believes that the estimates for IBNR liabilities
relating to its businesses are adequate in order to satisfy its ultimate claims
liability with respect thereto. In determining Coventry's medical claims
reserves, Coventry employs plan by plan standard actuarial reserve methods
(specific to the plan's membership, product characteristics, geographic
territories and provider network) which consider utilization frequency and unit
costs of inpatient, outpatient, pharmacy, and other medical costs as well as
claim payment backlogs and the changing timing of provider reimbursement
practices. Calculated reserves are reviewed by underwriting, finance and
accounting, and other appropriate plan and corporate personnel and judgments are
then made as to the necessity for reserves in addition to the above calculated
amounts. Changes in assumptions for medical costs caused by changes in actual
experience, changes in the delivery system, changes in pricing due to ancillary
capitation and fluctuations in the claims backlog could cause these estimates to
change in the near term. Coventry periodically monitors and reviews IBNR, and as
actual settlements are made or accruals adjusted, differences are reflected in
current operations.
The following discussion should be read in conjunction with the
accompanying consolidated financial statements and notes.
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Managed care premiums increased $135.1 million, or 17.8%, from the prior
year nine months. This increase is a result of risk membership growth of 26,771,
or 3.7%, from the prior period. The relatively small growth in risk membership
reflects the closing of the Florida Medicaid plan effective June 30, 1997, which
had 21,747 members. The revenue increase in the first nine months was enhanced
by the growth in Medicare risk membership (which has a significantly higher per
member per month premium when compared to the commercial products) and increases
in premium rates as members renew.
Management services revenue increased $4.5 million or 43.3% from the prior
year. This increase is primarily attributable to the increase in the average per
member per month administration fee and revenues from transition services
provided to the global capitation provider in St. Louis, Missouri.
56
<PAGE> 66
Health benefits expense increased $117.0 million, or 17.9%, in 1997,
compared to 1996, as a result of the increase in risk enrollment and increases
in medical costs. Coventry's medical loss ratio increased to 86.6% from 86.5% in
the corresponding nine months. Medical loss ratios increased in the central
Pennsylvania region due to increases in inpatient alternatives (such as
outpatient surgery), referrals to specialists, pharmacy and increased health
benefit expense associated with the Medicaid membership. Significant medical
cost increases in the Medicare risk product in St. Louis, Missouri were a result
of increased Medicare risk membership and high utilization of inpatient
services. Approximately $153 million and $50 million (19.8% and 6.9% of health
benefit expense for the 1997 period) represented amounts paid or accrued with
respect to global capitation agreements with respectively, Alleghany Health,
Education and Research Foundation ("AHERF") and BJC Health System ("BJC"). See
"Risk Factors -- Risks of Agreements with Providers" for a discussion of the
credit and operational risk associated with global capitation agreements with
single provider organizations.
Coventry determined, at the end of 1996, that its Florida operations were
not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, Coventry discontinued operations in the Florida HMO
market on June 30, 1997. Coventry established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market and
the reserve is believed to be sufficient to cover the anticipated costs. During
the third quarter of 1997, Coventry began to exit its Medicaid operations in
Pennsylvania. On September 30, 1997 the Medicaid membership was 4,236 and 18,043
in western Pennsylvania and central Pennsylvania, respectively.
Selling, general and administrative ("SGA") expense increased $16.0
million, or 14.7%, from the prior year corresponding nine months. SGA in the
first half of 1996 included termination costs of $6.0 million related to
personnel reductions associated with streamlining Coventry's administrative
processes and reducing staffing in its medical offices. The increase in SGA is
primarily attributable to the increase in full risk membership, additional
personnel costs relating to the re-engineering of administrative processes in
claims processing, information systems and customer services and costs
associated with the growth of Coventry's Medicare risk product.
At the end of the second quarter of 1996, Coventry established reserves
totaling $8.2 million for anticipated losses on multi-year contracts with
certain employer groups, primarily in the St. Louis market. Coventry 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. Coventry continually evaluates the
underlying costs expected to be incurred in servicing the contracts.
Depreciation and amortization decreased $1.9 million, or 15.9%, from 1996.
This decrease is primarily the result of the medical office sales in 1997.
Losses from operations were $48 thousand, a $16.6 million improvement over
the prior year nine months. Excluding the 1996 termination costs and contract
loss provisions, the operating loss would have been a $2.4 million improvement
over the loss for the nine months ended September 30, 1996. This $2.4 million
decrease in the operating loss for the nine months ended September 30, 1997 is
primarily attributable to lower depreciation and amortization resulting from the
medical office sales.
Other income increased $15.8 million. As discussed in note 4 to the
condensed unaudited consolidated financial statements. Effective March 31, 1997,
Coventry sold substantially all of its western Pennsylvania medical offices to
AHERF. The sales price was $20 million and the transaction resulted in a pretax
gain of approximately $6.0 million. Also, effective May 1, 1997, Coventry
completed the sale of its St. Louis, Missouri medical offices to BJC. The sales
price was $26.9 million and the transaction resulted in a pretax gain of
approximately $9.6 million. During the third quarter, Coventry completed the
sale of the remaining medical offices in Pennsylvania. The sales price for the
third quarter transactions was $2.4 million and resulted in a pretax loss of
$0.6 million.
Investment income increased $.9 million primarily due to higher cash and
investments when compared to the prior year. Interest expense increased $2.9
million due primarily to a higher interest rate on Coventry's term loan.
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<PAGE> 67
Coventry's net income was $8.4 million, or $17.5 million more than the
prior year nine months. Net income per common and common equivalent share was
$0.25 per share in the first nine months of 1997 compared to a $0.28 loss per
share in the first nine months of 1996. The weighted average common and common
equivalent shares outstanding were approximately 33,305,000 and 32,839,000 for
the nine months ended September 30, 1997 and 1996, respectively.
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. The decline in average HMO
premium yield of $5.57 on a per member per month basis equated to a reduction in
premiums of approximately $26.5 million in 1996 when compared to 1995.
Membership as of December 31, 1995 and 1996 was as follows:
<TABLE>
<CAPTION>
COMMERCIAL MEDICARE
------------------ ----------------
HMO PPO/POS COST RISK MEDICAID NON-RISK TOTAL
------- ------- ------ ------ -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
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(1)...... 26,162 26,162
------- ------- ------ ------ ------- ------- -------
Total........... 390,510 120,305 18,459 431 73,550 92,232 695,487
======= ======= ====== ====== ======= ======= =======
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(1)...... 310 27,732 28,042
------- ------- ------ ------ ------- ------- -------
Total........... 415,562 176,439 7,217 20,290 121,599 152,969 894,076
======= ======= ====== ====== ======= ======= =======
</TABLE>
- ---------------
(1) Effective June 30, 1997, Coventry discontinued its Medicaid operations in
Jacksonville, Florida.
Coventry experienced competitive pressures in its commercial products,
which negatively affected the average premium Coventry received and the mix of
commercial products sold during 1996. As Coventry entered 1997, management
anticipated continued enrollment gains in 1997, although at a slower rate than
seen in 1996. Enrollment gains were expected to be lower than gains realized in
prior years as Coventry focused on profitability of current products and lines
of business, including efforts to increase the average premium yield. Coventry
believed that it would lose certain of its existing commercial membership due to
more stringent underwriting practices and higher revenue requirements, but that
the potential loss in 1997 would be less than 5%.
Gains in Medicaid and Medicare enrollments increased Coventry'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.
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<PAGE> 68
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 Coventry's markets as follows:
<TABLE>
<CAPTION>
1996 1995
----- -----
<S> <C> <C>
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%
</TABLE>
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 Coventry's Medicaid operations,
inpatient alternatives (such as outpatient surgery) and pharmacy. Additionally,
membership in Coventry'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, Coventry entered into agreements to sell Coventry's medical
offices in western Pennsylvania and St. Louis, Missouri to major provider
organizations in these respective markets for $27 million in cash for the St.
Louis medical offices and $20 million in cash for the Pittsburgh offices. The
agreements were subject to the satisfaction of various conditions, including
regulatory approval. Coincident with the sale of the medical offices, Coventry
entered 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
Coventry's globally capitated members receive from the health care systems.
Coventry anticipates these arrangements in western Pennsylvania and St. Louis,
Missouri will reduce its medical costs as a percentage of premiums, enable
Coventry to reduce administrative staff in patient utilization and medical
management and effectively shift the risk of medical costs fluctuations to the
provider networks. To the extent that Coventry becomes a party to global
capitation agreements with a single provider organization serving substantial
membership, Coventry becomes exposed to credit and operational risk with respect
to such organizations.
Coventry determined that its Florida Medicaid operations were not
sufficiently profitable to justify a continued presence in the Florida market
and, as a result, Coventry decided to exit the Florida Medicaid market.
Accordingly, Coventry established a reserve of $1.2 million at December 31, 1996
to reflect the anticipated costs of exiting this market.
Medical claim liability accruals are periodically monitored and reviewed
with differences for actual settlements reflected in current operations. In
addition to Coventry's procedures for determining reserves as discussed above,
Coventry reviews the actual payout of claims relating to prior period accruals,
which may take up to six months to fully develop. Medical costs are affected by
a variety of factors, including the severity and frequency of claims, that are
difficult to predict and may not be entirely within Coventry's control. Coventry
continually refines its reserving practices to incorporate new cost events and
trends.
During 1996, Coventry experienced certain fluctuations in claims backlogs
and changes in its underlying utilization and cost trends. At the end of each
quarter in 1996, Coventry estimated the effects of these events in its reserving
methodologies and provided additional estimated expenses.
During the fourth quarter of 1996, Coventry confirmed through claims
payment activity that Coventry's costs had increased during 1996 at levels
slightly higher than estimated during the earlier quarters. These additional
costs were caused by both continued adverse utilization and cost severity
trends. As a result, Coventry recorded additional provisions ($25.6 million) in
the fourth quarter of 1996 to reflect additional expenses on prior quarter
claims ($4.3 million), to reflect additional expenses for current quarter claims
($3.0
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<PAGE> 69
million) and to provide reserves in excess of the actuarial determined midpoint
amounts. Coventry decided to provide the additional reserves due to possible
unanticipated reserve needs, the growth of Coventry's business and the possible
effects of changing provider contracting and reimbursement methodologies.
Coventry expects to maintain additional claim reserves as a part of its ongoing
reserve determinations.
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. Coventry 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, Coventry 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,
due to an increase of 32% in premium receivables during 1996 and an increase in
the past due amounts due to delinquent collections, provisions for uncollectible
accounts were increased by approximately $5.3 million during the year. The
additional expenses were incurred during each quarter of the year as the past
due amounts increased.
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. In accordance with SFAS 121, Coventry determined that the carrying
amounts of certain of its property and equipment (primarily data processing
equipment that will not be utilized in the future as a result of a change in
management information systems structure determined by Coventry in the fourth
quarter) was not 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.
Effective March 22, 1996, Coventry purchased the common stock of PARTNERS
Health Plan of Pennsylvania, Inc. ("PARTNERS") from Aetna Life & Casualty
Company ("Aetna"). At the time of acquisition PARTNERS 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 price included, among other typical
business assets and goodwill, consideration for non-compete agreements, the
expectation of entering into a favorable joint marketing agreement and the
opportunity to acquire additional Aetna membership at a favorable price. During
the fourth quarter of 1996, Coventry determined that none of the opportunities
were being realized, cash flows were short of expectations (losses in 1996
versus projected positive cash flows) and that Aetna had purchased U.S.
Healthcare, which has operations in Coventry's service areas. In addition,
Coventry filed suit against Aetna and U.S. Healthcare alleging breach of the
acquisition agreement, seeking enforcement of the non-compete agreement and
requesting other forms of relief. Based on fair value estimates of the
intangibles on both the sales recovery and discounted cash flow basis, the
intangibles were written down to an amount that supported the estimated fair
value ($10.0 million) of the assets. The litigation against Aetna and U.S.
Healthcare was settled recently without admission of liability by either party
and by each party releasing the other from all non-competition agreements. As of
the settlement date, the remaining intangible asset is realizable on a
discounted cash flow basis.
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. Coventry is
utilizing these reserves over the remaining lives of the contracts and then will
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.
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<PAGE> 70
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 Coventry'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, Coventry introduced its Medicare risk product and expanded the
Medicaid product. Coventry 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 Coventry's
exposure to government regulation of premium levels and other requirements.
Premium rates paid to Coventry's Medicaid operations in Florida declined in the
third quarter of 1995.
Furthermore, in 1995 Coventry experienced competitive pressures in its
commercial products, which negatively affected the average premium that Coventry
has historically received from new and existing members, the membership growth
opportunities and the mix of products sold. The average commercial premium
received by Coventry 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 Coventry's markets as
follows:
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
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%
</TABLE>
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.
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<PAGE> 71
Medical claim liability accruals are periodically monitored and reviewed
with differences for actual settlements reflected in current operations. In
addition to Coventry's procedures for determining reserves as discussed above,
Coventry reviews the actual payout of claims relating to prior period accruals,
which may take up to six months to fully develop. Medical costs are affected by
a variety of factors, including the severity and frequency of claims, that are
difficult to predict and may not be entirely within Coventry's control. Coventry
continually refines its reserving practices to incorporate new cost events and
trends.
At the end of the second quarter of 1995, Coventry identified adverse
trends that were occurring in western Pennsylvania in both the utilization and
cost areas. Coventry was also experiencing service delays in several of its
major plans, which created fluctuations in its claim backlogs. Coventry,
recognizing these factors as a part of its process, increased the medical claims
reserves from $66 million at December 1994 to $76 million at June 1995. During
the fourth quarter of 1995, Coventry confirmed through claims payment activity
that Coventry's costs had increased during 1995 at levels slightly higher than
estimated during the earlier quarters. These additional costs were caused by
both continued adverse utilization and costs severity trends. As a result,
Coventry recorded additional provisions ($13.0 million) in the fourth quarter of
1995 to reflect additional expenses on prior quarter claims ($2.5 million), to
reflect additional expenses for current quarter claims ($4.0 million) and to
provide reserves in excess of the actuarial determined midpoint amounts.
Coventry decided to provide the additional reserves due to possible
unanticipated reserve needs, the growth of Coventry's business and the possible
effects of changing provider contracting and reimbursement methodologies.
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, Coventry recorded
approximately $3.0 million of charges related to personnel terminations and
related severance. In the fourth quarter of 1995, Coventry 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, previously capitalized costs incurred prior to and during 1995 of $5.1
million were expensed at year-end. Additionally, a reserve for ongoing
litigation and other contingencies of $2.2 million was established.
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, Coventry 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.
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<PAGE> 72
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 Coventry'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.
LIQUIDITY AND CAPITAL RESOURCES
Coventry's total cash and investments, excluding deposits of $8.4 million
restricted under state regulations, increased $49.2 million to $217.6 million at
September 30, 1997 from $168.4 million at December 31, 1996. Cash and cash
equivalents increased $55.6 million to $141.2 million at September 30, 1997.
Cash provided by operations of $1.1 million in the nine month period was
primarily the result of depreciation and amortization and income tax refunds
offset by a reduction in medical claims payable resulting from Coventry's new
global capitation arrangements where Coventry no longer has medical claims risk
for certain members. Cash flows provided by investing activities in the nine
month period of $53.5 million were primarily the result of the sales of medical
offices and a subsidiary. Cash flows provided by financing activities were the
result of the sale of the Coventry Convertible Notes and Coventry Warrants,
reduced by long-term debt repayments.
Cash from operating activities improved by approximately $29 million in
1996 compared to 1995. The decline in net income of approximately $61 million
was offset by increased depreciation and amortization of approximately $28
million, an increase in medical claim liabilities of approximately $27 million,
an increase in other accrued liabilities of approximately $24 million and cash
flows from other working capital items of approximately $11 million.
Cash from operating activities declined by approximately $50 million in
1995 when compared to 1994. The decline in net income of approximately $29
million was increased by the reduction in current income taxes payable of
approximately $15 million and an increase in other assets of approximately $9
million.
Coventry's HMOs and insurance subsidiaries are required by state regulatory
agencies to maintain minimum surplus balances, thereby limiting the dividends
Coventry may receive from its HMOs and insurance subsidiaries. After giving
effect to these statutory reserve requirements, Coventry's regulated
subsidiaries had surplus in excess of statutory requirements of approximately
$45.9 million and $41.6 million at September 30, 1997 and December 31, 1996,
respectively. Excluding funds subject to regulation, Coventry had cash and
investments of approximately $34.2 million and $16.5 million at September 30,
1997 and December 31, 1996, respectively, which are available to pay
intercompany balances to regulated companies and for general corporate purposes.
As a result of losses in the fourth quarter of 1996, Coventry was not in
compliance with certain revised financial covenants in its Amended Credit
Facility. Coventry entered into the Restated Credit Facility that, along with
other changes, converted the amount outstanding under the Restated Credit
Facility to a term loan, revised certain financial ratios Coventry is required
to maintain, effectively increased 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
revised the amortization period of the loan. The Restated Credit Facility
required 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.
Coventry was in compliance with the covenants contained in the Restated Credit
Facility as of September 30, 1997.
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<PAGE> 73
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 Coventry. The Restated Credit
Facility is collateralized by substantially all of the assets of Coventry.
On September 30, 1997, the effective interest rate on the indebtedness
under the Restated Credit Facility was 10.5%.
The Restated Credit Facility required Coventry apply 50% of the net cash
proceeds from the sale of the Coventry Convertible Notes and warrants to the
loan balance, with the payment being applied to reduce 1997 and 1998
amortization payments. The Restated Credit Facility also required Coventry to
prepay loans upon receipt of $7.5 million of tax refunds 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 Coventry to apply 50% of the net cash proceeds of sales of Coventry's
capital stock to reduce the scheduled amortization in the inverse order of
maturity, prohibits the sale of any substantial subsidiary and restricts
Coventry's ability to declare and pay cash dividends on its common stock.
On April 2, 1997, Coventry announced that it entered into the Warburg
Agreement for the purchase by Warburg and Franklin of $40 million of the
Coventry Convertible Notes, together with warrants to purchase 2.35 million
shares of Coventry's common stock for $42.35 million. The Coventry Convertible
Notes are convertible into 4 million shares of Coventry Common Stock. On May 9,
1997, Warburg and Franklin purchased $26.8 million of the Coventry Convertible
Notes and 1.6 million warrants for an aggregate purchase price of $28.4 million.
Approximately $20 million of the proceeds was utilized to prepay a portion of
the outstanding indebtedness under the Restated Credit Facility. Following
approval from certain state insurance regulators, the remaining investment by
Warburg of approximately $13.9 million was completed on June 30, 1997 and the
total proceeds were used to retire $14 million of indebtedness under the
Restated Credit Facility. The $14 million payment was comprised of $7.0 million
of mandatory prepayments from the Warburg proceeds, $1.4 million for the
required June 30 payment, $0.5 million of the anticipated tax refund and $5.1
million of optional prepayment. During the third quarter of 1997, Coventry made
payments of $7.8 million on the Restated Credit Facility. The payments included
$7.0 million of the income tax refund and $0.8 million from the exercise of
stock options.
The Coventry Convertible Notes will be exchangeable at Coventry's option
for shares of convertible preferred stock. Interest is payable semi-annually and
accrues at 8.3%. Interest is payable in additional Coventry Convertible Notes
and as a result, the accrued interest at September 30, 1997 has been added to
the outstanding indebtedness.
As a result of the 1997 payments, at September 30, 1997, the payments
required on December 31, 1997 and April 1, 1998 under the Restated Credit
Facility were reduced to $5.2 million and $43.1 million, respectively.
Projected capital investments in 1997 of approximately $10 million consist
primarily of computer hardware, software and related equipment costs associated
with the development and implementation of improved operational and
communications systems.
Coventry believes that cash flows generated from operations, cash on hand
and investments, excess funds in certain of its regulated subsidiaries and other
financing alternatives will be sufficient to fund continuing operations and debt
service obligations through March 31, 1998. Coventry believes that completion of
the Warburg transaction, strengthening its underwriting processes, entering into
global capitation arrangements, completing the medical office sales and
re-engineering its administrative processes will have a favorable effect on
liquidity in 1997 and future periods. As of December 31, 1997 Coventry entered
into an amendment to the Restated Credit Facility to extend the term of the
credit agreement to April 1, 1999. The amendment lowered interest rates and
modified certain covenants on terms more favorable to Coventry. Coventry's
investment guidelines emphasize investment grade fixed income instruments in
order to provide short-term liquidity and minimize the risk to principal.
64
<PAGE> 74
LEGISLATION AND REGULATION
Numerous proposals have been introduced in the United States Congress and
various state legislatures relating to health care reform. Some proposals, if
enacted, could among other things, restrict Coventry'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 Coventry believes that the ultimate outcome of currently proposed legislation
would not have a material adverse effect on Coventry and its results of
operations in the short run.
As a result of the introduction of Medicare and Medicaid risk products in
1995, Coventry is subject to regulatory and legislative changes in those two
government programs. On August 5, 1997, the President signed into law the
Balanced Budget Act of 1997. This law made revisions to the Medicare program,
including permitting provider-sponsored organizations to offer services to
Medicare beneficiaries, and requiring managed care plans serving Medicare
beneficiaries to make medically necessary care available 24 hours a day, to
provide coverage a "prudent lay person" would deem necessary and to provide
grievance and appeal procedures, and prohibiting such plans from restricting
providers' advice concerning medical care. Coventry does not believe this
legislation will have a material adverse effect on its operations.
DISCONTINUED OPERATIONS
Effective January 1, 1995, Coventry 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 Coventry'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 Coventry.
LITIGATION AND INSURANCE
Coventry 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, Coventry has contingent
litigation risk in connection with certain discontinued operations. Such
litigation may result in losses to Coventry. Coventry maintains insurance
coverage in amounts Coventry believes to be adequate including professional
liability (medical malpractice) and general liability insurance. Contracting
physicians are required to maintain professional liability insurance. In
addition, Coventry 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
Coventry.
NEW ACCOUNTING STANDARDS
Effective January 1, 1996, Coventry 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
Coventry.
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. Coventry is required to adopt the
provisions in the fourth quarter of 1997 and does
65
<PAGE> 75
not expect the adoption thereof to have a material effect on Coventry's
financial position or results of operations.
INFLATION
Health care cost inflation has exceeded the general inflation rate and
Coventry has implemented cost control measures and risk sharing arrangements
which seek to reduce the effect of health care cost inflation. During 1995 and
1996, Coventry 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 Coventry's results of operations in
1996.
INCOME TAXES
In its income tax returns, Coventry 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 Coventry
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, Coventry believes that the legislation is indicative of the
government's desire to minimize the costs of intangibles controversies. Coventry
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, Coventry's income tax
provision has been adjusted to reflect no tax benefit in its financial
statements for the deduction of these amounts.
66
<PAGE> 76
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
OF PRINCIPAL HEALTH CARE, INC.
The following selected financial data and other operating information (in
thousands, except membership data) for the five years ended December 31, 1996
are derived from the audited consolidated financial statements of PHC. The
financial data for the nine-month periods ended September 30, 1997 and 1996 are
derived from unaudited financial statements. The unaudited financial statements
include all adjustments, consisting of normal recurring accruals, which PHC
considers necessary for a fair presentation of the financial position and the
results of operations for those periods.
Certain businesses of PHC that are expected to be sold prior to the
Business Combination (Principal Health Care of the Mid-Atlantic, Inc. and
Principal Health Care of Texas, Inc.) or are to be retained by Mutual (the
equity investment in United Payors and United Providers, Inc., 50% of the equity
investment in American Psych Systems, Inc. and 50% of the common stock warrants
for Accordant Health Systems, Inc. and Advanced Paradigm, Inc.) will not be
included in the Business Combination. The PHC transferred business represents
77.8% of assets, 86.4% of revenues, and 85.3% of the operating expenses of PHC.
The following financial data and other operating information has not been
adjusted to remove the net assets and results of operations of the businesses to
be retained by Mutual. The historical operating results of PHC may not
necessarily be indicative of the future operating performance of the businesses
to be transferred as part of the Merger.
Operating results for the nine-month periods ended September 30, 1997 are
not necessarily indicative of the results that may be expected for the entire
year ending December 31, 1997. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included herein.
<TABLE>
<CAPTION>
YEAR ENDED
------------------------------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1992 1993 1994 1995 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA(1)
Operating revenues:
Managed care premiums....... $284,909 $335,327 $422,963 $574,360 $806,351
Management services......... 10,837 17,265 61,276 75,408 67,711
Other....................... 1,875 2,119 1,970 1,569 1,524
Total operating
revenues................ 297,621 354,711 486,208 651,336 875,586
Operating expenses:
Health benefits............. 249,854 275,372 347,646 519,975 740,972
Selling, general and
administrative............ 37,010 51,970 110,776 166,126 196,358
Depreciation and
amortization.............. 4,437 5,387 8,807 11,649 15,745
Loss on impairment of
goodwill..................
Operating earnings (loss)..... 6,320 21,982 18,979 (46,414) (77,490)
Other income, net(2).......... 322 874 558 1,727 2,732
Interest income............... 4,603 3,927 6,150 11,465 14,162
Earnings (loss) before income
taxes(2).................... 11,245 26,783 25,688 (33,222) (60,596)
Cumulative effective as of
January 1, 1993 of change in
method of accounting for
income taxes................ 514
Net Earnings (loss)(2)...... 5,912 15,938 18,448 (22,693) (40,408)
BALANCE SHEET DATA
Cash and investments(3)....... $ 83,010 $125,905 $177,799 $201,464 $253,273
Total assets(3)............... 128,304 208,908 334,444 383,409 462,768
Long term obligations......... 414 1,269 1,322 3,105 3,920
Stockholders' equity(3)....... 69,737 234,301 211,605 234,301 254,477
OPERATING STATEMENT DATA
Membership at end of period:
Commercial.................. 157,388 249,856 331,086 463,783 582,965
Medicare.................... 1,360 1,158 2,023
Medicaid.................... 12,323
Management services......... 56,043 107,445 134,911 135,959 117,869
-------- -------- -------- -------- --------
Total......................... 213,431 357,301 467,357 600,900 715,180
======== ======== ======== ======== ========
<CAPTION>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
1996 1997
------------- -------------
<S> <C> <C>
INCOME STATEMENT DATA(1)
Operating revenues:
Managed care premiums....... $605,250 $645,936
Management services......... 50,330 41,842
Other....................... 713 851
Total operating
revenues................ 656,294 688,628
Operating expenses:
Health benefits............. 562,370 552,126
Selling, general and
administrative............ 139,947 160,258
Depreciation and
amortization.............. 11,502 12,121
Loss on impairment of
goodwill.................. 6,000
Operating earnings (loss)..... (57,526) (41,876)
Other income, net(2).......... 1,530 8,638
Interest income............... 10,622 10,699
Earnings (loss) before income
taxes(2).................... (45,374) (22,540)
Cumulative effective as of
January 1, 1993 of change in
method of accounting for
income taxes................
Net Earnings (loss)(2)...... (31,223) (14,969)
BALANCE SHEET DATA
Cash and investments(3)....... $240,267 $246,518
Total assets(3)............... 472,552 435,941
Long term obligations......... 4,895 4,263
Stockholders' equity(3)....... 262,362 227,497
OPERATING STATEMENT DATA
Membership at end of period:
Commercial.................. 580,238 555,969
Medicare.................... 1,222 3,680
Medicaid.................... 13,307 13,317
Management services......... 120,323 97,729
-------- --------
Total......................... 715,090 670,695
======== ========
</TABLE>
- ---------------
(1) Includes operations of plans acquired commencing on the date of closing of
the respective transaction. 1993 -- Healthplus HMO, Inc. in Indiana; United
HealthCare, Inc. in Iowa; 1994 -- SouthCare Medical Alliance in Georgia;
Coastal Bend Health Plan, Inc. in Texas; CIGNA HealthCare of
Kansas/Missouri, Inc.; 1996 -- Admar Group, Inc.; Metra HealthCare Plan of
St. Louis, Inc.
(2) Includes $2.5 million equity in earnings of UP & UP in 1996.
(3) Increases in equity in excess of earnings each year primarily represent
capital contributions from Mutual.
67
<PAGE> 77
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF PRINCIPAL HEALTH CARE, INC.
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward looking information that is based on management's
current knowledge of factors affecting PHC's business and PHC's actual results
may differ materially if these assumptions prove invalid. Significant risk
factors, while not all inclusive, are: the possibility of increased price
competition in PHC's marketplace; the possibility of state or federal budget
related mandates that reduce premiums for Medicaid or Medicare recipients; and
the potential for increased medical expenses. Factors that may contribute to
increased medical expenses include: increased utilization by PHC's membership;
inflation of costs in the provider community; federal or state mandates that
increase benefits, higher costs for newly developed and/or the enhanced
pharmaceuticals; the possibility that PHC is not able to expand its service
territory as planned due to regulatory delays and/or inability to contract with
appropriate providers; or the possibility that PHC is not able to increase its
market share at the anticipated premium rates.
The following table (in thousands, except percentages and membership data)
is provided to facilitate a more meaningful discussion regarding the results of
PHC's operations for the three years ended December 31, 1996 and the nine months
ended September 30, 1997 and 1996.
<TABLE>
<CAPTION>
1994 1995 1996
--------------------- ---------------------------------- ----------------------------------
PERCENT OF PERCENT OF PERCENT PERCENT OF PERCENT
OPERATING OPERATING INCREASE OPERATING INCREASE
AMOUNT REVENUES AMOUNT REVENUES (DECREASE) AMOUNT REVENUES (DECREASE)
-------- ---------- -------- ---------- ---------- -------- ---------- ----------
$'S IN (000)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums... $422,963 87.0% $574,360 88.2% 35.8% $806,351 92.1% 40.4%
Management services..... 61,276 12.6 75,408 11.6 23.1 67,711 7.7 (10.2)
Other................... 1,969 0.4 1,568 0.2 (20.4) 1,524 0.2 (2.8)
Total operating
revenues............ 486,208 100.0 651,336 100.0 34.0 875,586 100.0 34.4
-------- ----- -------- ----- -------- -----
Operating expense:
Health benefits(1)...... 347,646 71.5 519,975 79.8 49.6 740,972 84.6 42.5
Selling, general and
administrative........ 110,776 22.8 166,126 25.5 50.0 196,358 22.4 18.2
Depreciation and
amortization.......... 8,807 1.8 11,649 1.8 32.3 15,746 1.8 35.2
Loss on impairment of
goodwill..............
-------- ----- -------- ----- -------- -----
Operating earnings
(loss).................. 18,979 3.9 (46,414) (7.1) (344.6) (77,490) (8.8) 67.0
Other income, net........ 558 0.1 1,727 0.3 209.5 160 0.0 (90.7)
Gain on investment....... 2,572 .3
Gain on sale of sub......
Interest income.......... 6,151 1.3 11,465 1.8 86.4 14,162 1.6 23.5
-------- ----- -------- ----- -------- -----
Earnings (loss) before
income taxes............ 25,688 5.3 (33,222) (5.1) (229.3) (60,596) (6.9) (82.4)
Net earnings (loss)...... 18,448 3.8 (22,693) (3.5) (223.0) (40,408) (4.6) (78.1)
-------- ----- -------- ----- -------- -----
Membership at end of
period:
Commercial.............. 331,086 463,783 582,965
Medicare................ 1,360 1,158 2,023
Medicaid................ 12,323
Management services..... 134,911 135,959 117,869
-------- -------- --------
467,357 600,900 715,180
======== ======== ========
<CAPTION>
30-SEPT-96 30-SEPT-97
--------------------- ----------------------------------
PERCENT OF PERCENT OF PERCENT
OPERATING OPERATING INCREASE
AMOUNT REVENUES AMOUNT REVENUES (DECREASE)
-------- ---------- -------- ---------- ----------
$'S IN (000)
<S> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums... $605,250 92.2% $645,936 93.8% 6.7%
Management services..... 50,330 7.7 41,841 6.1 (16.9)
Other................... 714 0.1 851 0.1 19.2
Total operating
revenues............ 656,294 100.0 688,628 100.0 4.9
-------- ----- -------- -----
Operating expense:
Health benefits(1)...... 562,370 85.7 552,126 80.2 (1.8)
Selling, general and
administrative........ 139,948 21.3 160,258 23.3 14.5
Depreciation and
amortization.......... 11,502 1.8 12,120 1.8 5.4
Loss on impairment of
goodwill.............. 6,000 0.9
-------- ----- -------- -----
Operating earnings
(loss).................. (57,526) (8.8) (41,876) (6.5) 27.2
Other income, net........ 254 0.0 48 0.0 81.1
Gain on investment....... 1,276 1.6 3,892 0.6 (62.5)
Gain on sale of sub...... 4,698 0.7
Interest income.......... 10,622 .2 10,699 1.6 0.7
-------- ----- -------- -----
Earnings (loss) before
income taxes............ (45,374) (6.9) (22,540) (3.5) 50.0
Net earnings (loss)...... (31,223) (4.8) (14,969) (2.3) 52.1
-------- ----- -------- -----
Membership at end of
period:
Commercial.............. 580,238 555,969
Medicare................ 1,222 3,680
Medicaid................ 13,307 13,317
Management services..... 120,323 97,729
-------- --------
715,090 670,695
======== ========
</TABLE>
- ---------------
(1) The medical loss ratio (health benefits as a percentage of care premiums)
was 82.2%, 90.5% and 91.9% in 1994, 1995 and 1996, respectively for the nine
months ending September 1996 and 1997, the medical loss ratio was 92.9% and
85.5%, respectively.
68
<PAGE> 78
GENERAL
During the three years ended December 31, 1996, PHC experienced substantial
growth in membership and operating revenues in both existing markets and markets
where acquisitions and start-ups occurred. PHC had commenced a strategic effort
to increase its market share through competitive pricing and acquisitions. PHC
also began to expand by acquiring and starting other managed care companies that
either supported PHC markets or markets heavily penetrated by Mutual. In
addition, PHC developed and marketed Medicaid and Medicare benefit plans in
selected markets.
PHC acquired several HMOs during this period. Coastal Bend Health Plan,
Inc., serving the greater Corpus Christi Texas market was acquired in October,
1994. PHC acquired the Wichita, Kansas operations from CIGNA HealthCare of
Kansas/Missouri, Inc. in December, 1994. PHC purchased the MetraHealth Care Plan
of St. Louis, Inc. in March, 1996. During 1996 these acquisitions generated
approximately $100 million in revenues.
PPOs were also purchased during this period. These purchases included the
acquisition of SouthCare Medical Alliance of Atlanta, Georgia in April, 1994. In
December, 1995, Holding transferred its ownership of America's Health Plan, Inc.
("AHP") to PHC. The Admar Group, Inc. ("Admar"), was purchased in March of 1996;
both Admar and AHP develop and market proprietary health care provider networks.
These acquisitions, combined with efforts to expand existing products, resulted
in the growth of related network rental fees from $8.7 million in 1994, to
nearly $34.7 million in 1996. The ownership of AHP was transferred to Holding
effective July 1997 and the ownership of Admar Group was transferred to Holding
effective October 1997.
The marketing of PHC's Medicaid product began in the State of Delaware in
January 1996. PHC began marketing a Medicare product in the Jacksonville,
Florida area in July 1996. PHC continues to evaluate the feasibility of offering
Medicare and Medicaid products in other markets.
The strategy to increase membership was successful. Over the three year
period, total membership grew by 357,879 members, or 100.2%, to 715,180 members
at December 31, 1996. While the HMO plans were aggressively growing, PHC began
to make significant investments in its Management Information Systems. This
resulted in, among other things, the replacement of the mainframe computer to
enhance the capacity and speed of processing for the managed care applications,
the deployment of local and wide area networks, enhanced communication systems,
such as automated call routers and integrated voice response systems, and state
of the art decision support systems. The impact of this and other strategic
administrative initiatives resulted in additional costs that were not supported
immediately by membership growth but were necessary for PHC to support health
plan operations, and to meet the ever increasing demand for the volume and
sophistication of information.
Other initiatives included the development and expansion of PHC's
behavioral health company, Principal Behavioral Health Care ("PBHC"). This
company administered the mental health benefits on behalf of PHC health plans
under capitated arrangements. Once PBHC was established in those markets, it
began to offer their services to all payors and expanded their products.
As PHC realized additional losses resulting from both its competitive
pricing and increased administrative loads, the strategy shifted away from
aggressive growth and to controlled profitable growth. The impact of the
increased premium rates, as well as the benefits resulting from the investments
in the Management Information Systems has been realized and is reflected in the
results from operations for the nine months ended September 30, 1997. These
investments provided a basis to grow the HMOs, build upon the existing PPO
membership and expand into new markets and products.
All of these actions have positioned PHC to provide quality claims
processing and customer service to providers and employer groups. Resources were
used to enhance the market presence of each HMO as operations were moved to the
local market to be closer to the customer. This has allowed each health plan the
ability to react with more flexibility to meet its individual customer and
provider needs. PHC will continue these and other efforts to ensure that each
health plan has the information to understand their operations, the staff to
design and implement processes that provide a competitive edge, and the access
to the expertise of the corporate office to assist in interpreting their
information and identifying possible enhancements to their processes.
69
<PAGE> 79
PHC's operating expenses are primarily medical costs including medical
claims under contracted relationships with a wide variety of providers. Medical
claims expense also includes an estimate of IBNR liabilities. PHC believes that
the estimates for IBNR liabilities relating to its businesses are adequate in
order to satisfy its ultimate claim liability with respect thereto. In
determining PHC's medical claim reserves, PHC employs plan by plan standard
actuarial reserve methods (specific to the plan's membership, product
characteristics, geographic territories and provider network) which consider
utilization frequency and unit costs of inpatient, outpatient, pharmacy and
other medical costs as well as claim payment backlogs. Calculated reserves are
reviewed by finance and accounting and other appropriate plan and corporate
personnel and judgments are then made as to the necessity for additional
reserves in excess of those calculated. Changes in assumptions for medical costs
caused by the changes in actual experience, changes in the delivery system,
changes in pricing due to ancillary capitation and fluctuations in the claims
backlog could cause these estimates to change in the near term. PHC routinely
monitors and reviews the IBNR estimate, and as actual settlements are made or
accruals adjusted, differences are reflected in current operations. PHC
continually refines its reserving practices to incorporate new events and
trends.
The following discussion should be read in conjunction with the
accompanying consolidated financial statements and notes.
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
The following tables show the total number of enrollees as of September 30,
1997 and the percentage change in PHC's enrollment.
<TABLE>
<CAPTION>
SEPTEMBER 30
------------------ PERCENT
1996 1997 CHANGE
------- ------- -------
<S> <C> <C> <C>
Carolinas............................................... 7,415 19,677 165%
Delaware................................................ 98,715 99,069 0%
Florida................................................. 170,056 135,149 (21%)
Georgia................................................. 7,582 12,978 71%
Illinois(1)............................................. 26,821 18,075 (33%)
Indiana................................................. 42,095 32,448 (23%)
Iowa.................................................... 94,793 92,947 (2%)
Kansas City............................................. 94,583 90,368 (4%)
Louisiana............................................... 38,998 35,063 (10%)
Mid-Atlantic(2)......................................... 32,352 21,907 (32%)
Nebraska................................................ 36,232 30,533 (16%)
St. Louis............................................... 29,932 42,929 43%
Texas(3)................................................ 35,516 39,552 11%
------- -------
Total Managed Care...................................... 715,090 670,695 (6%)
======= =======
</TABLE>
- ---------------
(1) PHC acquired FHP of Illinois, Inc. effective October 1, 1997. The
acquisition added approximately 54,000 fully insured HMO members to the
Illinois market at that time.
(2) Approximately 12,000 fully insured members as of September 30, 1997 will not
be included in the assets to be contributed to Newco at the Effective Time.
(3) The entire Texas health plan is excluded from the assets to be contributed
to Newco at the Effective Time.
<TABLE>
<CAPTION>
SEPTEMBER 30
------------------ PERCENT
1996 1997 CHANGE
------- ------- -------
<S> <C> <C> <C>
Commercial HMO.......................................... 385,395 366,247 (5%)
Commercial POS.......................................... 194,843 189,722 (3%)
Medicare................................................ 1,222 3,680 201%
Medicaid................................................ 13,307 13,317 0%
Non-Risk................................................ 120,323 97,729 (19%)
------- -------
Total Managed Care...................................... 715,090 670,695 (6%)
======= =======
</TABLE>
70
<PAGE> 80
Managed care premiums increased $40.7 million, or 6.7%, to $645.9 million
for the nine months ended September 1997 compared to the corresponding period in
the prior year primarily as a result of increased premium rates. Fully insured
membership decreased by 21,801 members, or 3.7%, over the prior year. The
enrollment decrease was primarily attributable to the Florida markets where
significant rating actions were taken to compensate for the higher than expected
cost of providing services to small groups pursuant to small group reform. The
membership decreases were experienced in both the POS and HMO products. The
growth in the St. Louis market is the result of the acquisition of the
MetraHealth Care Plan of St. Louis, Inc. Carolinas, a start-up market, has
experienced significant growth over the past year. While total membership
decreased, the premium yield per member per month increased approximately 7.86%.
Overall, the increase of $9.29 on a per member per month basis equated to an
increase in premiums of approximately $46.5 million.
The consolidated net loss decreased by $16.3 million or 52.1% from the
$31.2 million loss reported for the nine months ended September 30, 1996. The
reduction in the net loss is primarily attributable to the improvement of the
medical loss ratio resulting from reductions in medical costs and increased
premium rates over the corresponding period for the prior year.
PPO, contract, ASO and other non-risk revenues decreased by $8.5 million or
16.9% from the nine months ended September 30, 1996. That decrease was driven
primarily by a reduction of contract revenues from AHP. In the second quarter of
1996, AHP modified its program requirements. Certain existing clients were
unwilling to abide by the new program requirements. Those clients were referred
to UP&UP, a company with alternative program requirements. As a result, contract
revenues decreased by $3.5 million.
Medical benefits decreased by $10.2 million or 1.8% over the nine months
ending September 30, 1996. That decrease was primarily a result of declining
membership as well as improvements in our provider contracts. In addition,
reserves that were set up for premium deficiency at December 31, 1996 were
reduced by $3.4 million as those contracts expired during 1997. PHC's medical
loss ratio decreased from 92.9% to 85.5% for the nine months ending September
30, 1997.
Other income increased by $7.1 million or 464.6% from the nine months
ending September 30, 1996. That increase was primarily attributable to the gain
on the sale of PBHC recorded in the third quarter of 1997 and nine months of
equity in earnings of UP&UP versus only 3 months in 1996.
SGA increased by $20.3 million or 14.5%. That increase was driven primarily
by an increase in salaries, wages, and fringe benefits, an increase in
consulting expenses, and an increase in rent expense. The increase in salaries
and fringes can be attributed to growth and acquisitions and increased rent
resulting from the relocation of the Corporate Headquarters. The increase in
consulting expenses was heavily driven by the investment in management
information systems.
On February 13, 1998, PHC entered into an amended letter of intent
outlining the significant terms of a proposed sale of Principal Health Care of
Texas, Inc. If the transaction is completed in accordance with the letter of
intent, PHC will realize a net loss of approximately $6 million. This
anticipated loss has been deemed to be evidence of an impairment of recorded
goodwill for Principal Health Care of Texas, Inc. The impairment, net of related
deferred taxes, has been reflected in the financial statements for September 30,
1997. In light of recent operating losses of many of its operating subsidiaries,
PHC evaluated the possibility of impairment of recorded goodwill at September
30, 1997 by means of an analysis of estimated undiscounted future cash flows.
That analysis indicated that, other than the goodwill recorded by Principal
Health Care of Texas, there was no indication of a current impairment loss.
COMPARISON OF 1996 TO 1995
Managed care premiums increased $232.0 million, or 40.4%, to $806.4 million
for the year ended 1996 compared to 1995. The increase was primarily
attributable to the 132,370 member, or 28.5% increase in fully insured
membership over the prior year. The increase in members resulted in a 2.2%
increase in premium yield. The increase of $1.84 on a per member per month basis
equated to an increase in premiums of approximately $9.3 million. The enrollment
growth was spread across all markets and between commercial HMO and POS
products. The most significant increases were experienced in the St. Louis,
Delaware, Florida, and Kansas City markets. The acquisition of the MetraHealth
Care Plan of St. Louis increased the fully insured membership in that market by
31,160 members. The participation in the Delaware Medicaid Program
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increased the fully insured membership in that market by 12,114 members. PHC
also began marketing the PHC 65 Medicare program in the Jacksonville market in
1996.
Membership as of December 31, 1996 and 1995 was as follows:
<TABLE>
<CAPTION>
COMMERCIAL
-----------------
HMO POS MEDICARE MEDICAID NON-RISK TOTAL
------- ------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
1996 ENTITY
Carolina................................. 549 9,006 9,555
Delaware................................. 23,925 7,491 12,114 54,338 97,868
Florida.................................. 90,908 64,038 992 14,113 170,051
Georgia.................................. 1,905 6,071 785 8,761
Illinois................................. 6,555 12,269 7,943 26,767
Indiana.................................. 22,931 10,369 10,212 43,512
Iowa..................................... 70,825 9,756 1,031 209 12,234 94,055
Kansas City.............................. 55,815 21,936 14,319 92,070
Louisiana................................ 16,909 21,984 88 38,981
Mid-Atlantic............................. 8,638 20,801 551 29,990
Nebraska................................. 26,036 7,103 2,885 36,024
St. Louis................................ 29,613 1,547 4 31,164
Texas.................................... 35,985 397 36,382
------- ------- ----- ------ ------- -------
Total............................... 390,594 192,371 2,023 12,323 117,869 715,180
======= ======= ===== ====== ======= =======
</TABLE>
<TABLE>
<CAPTION>
COMMERCIAL
-----------------
HMO POS MEDICARE MEDICAID NON-RISK TOTAL
------- ------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
1995 ENTITY
Carolina................................. 137 1,252 1,389
Delaware................................. 25,744 5,070 51,472 82,286
Florida.................................. 82,626 53,190 12,411 148,227
Georgia.................................. 235 89 555 879
Illinois................................. 4,460 5,213 10,298 19,971
Indiana.................................. 18,498 5,869 10,056 34,423
Iowa..................................... 66,644 8,080 1,158 13,653 89,535
Kansas City.............................. 41,704 12,911 25,724 80,339
Louisiana................................ 20,265 21,018 109 41,392
Mid-Atlantic............................. 9,730 20,988 485 31,203
Nebraska................................. 22,500 5,723 4,012 32,235
Texas.................................... 31,837 7,184 39,021
------- ------- ----- ------ ------- -------
Total............................... 324,380 139,403 1,158 135,959 600,900
======= ======= ===== ====== ======= =======
</TABLE>
As a result of losses experienced from competitive pricing actions in 1995
as well as increased administrative costs caused by the membership growth, PHC
began increasing premium rates as it changed from a strategy of aggressive
growth to one of more controlled profitable growth. The rate increases realized
during 1996 resulted in the increased premium yields that continued in 1997. PHC
experienced a decrease in enrollment in 1997 over 1996 levels as a result of the
increased premium rates. The loss of enrollment was less than 10%.
PHC's participation in Medicaid and Medicare programs increased its
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.
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PPO, contract, ASO and other non-risk fees decreased approximately $7.7
million or 10.2% over the prior year. The decrease was primarily attributable to
a reduction of contract revenues from AHP. The decrease was primarily
attributable to a reduction in contract revenues from AHP. In the second quarter
of 1996, AHP modified its program requirements. Certain existing clients were
unwilling to abide by the new program requirements. Those clients were referred
to UP&UP, a company with alternative program requirements. As a result, contract
revenues decreased by $3.5 million.
Medical services and hospitalization expenses increased $221.0 million, or
42.5%, to $741.0 million for the year ended 1996 compared to 1995 as a result of
the increase in at-risk enrollment and increases in medical costs. While premium
yields were increasing in 1996, the timing of renewals resulted in increasing
medical loss ratios for several markets. Overall, the HMO operations experienced
an increase in the medical loss ratio of 1.4%. A summary of the medical loss
ratios in all markets is as follows:
Medical services and hospitalization costs increased on a per member per
month basis over 1995 levels by $4.01, or 3.9%, to $107.45 from $103.44. During
1996, PHC began to aggressively negotiate its contractual provider arrangements
in an effort to reduce net medical costs. The recent membership growth enhanced
PHC's negotiating position with its providers. The effects of the recontracting
efforts were not fully realized until the latter part of 1996 and the nine
months ended September 30, 1997.
In addition to the liability arising from services rendered to members but
unpaid at year end, PHC also establishes reserves, if required, for the
probability that anticipated future health care and maintenance costs under the
group of existing contracts will exceed anticipated future premiums and
stop-loss recoveries on those contracts. PHC increased these reserves by $0.9
million related to such contracts in 1996 compared to $6.4 million in 1995.
SGA increased $30.2 million, or 18.2%, to $196.4 million from $166.1
million reported for the prior year 1995. The increase in total SG&A can be
attributed to increased personnel, distribution systems, and information systems
costs. Salaries and related costs increased by $26.4 million, or 37.0% over the
prior year. The increase in salary costs was a result of growth and
acquisitions. Broker commissions and distribution costs increased by $13.0
million, or 106%, over the prior year. This increase can be attributed to the
growth in the small group sector, which has a high commission structure on a per
contract basis. As a percentage of total operating revenues, SG&A decreased from
25.5% in 1995 to 22.4% in 1996. Overall, SG&A continued to be impacted by
investments in Management Information Systems.
Depreciation and amortization increased $4.1 million, or 35.2%, from 1995.
This increase can be attributed to the acquisition of the MetraHealth Care Plan
of St. Louis, Inc. and the Admar Group that resulted in an increase in goodwill
and other intangibles of $47.6 million from 1995.
Operating losses increased $31.1 million, or 67.0%, from 1995 operating
losses. The increase is attributable to the combination of the significant
growth in fully insured membership, medical costs increasing at a faster rate
than premiums, and the increased SG&A costs to support the additional growth and
investments in Management Information Systems.
Investment income increased $2.7 million, or 23.5% from the prior year. The
increase is primarily attributable to the increase in invested assets resulting
from the growth in membership and related increases in reserves.
Income tax provision (benefit) increased $9.7 million, or 91.7% from the
prior year 1995. The benefit reflects a consolidated effective income tax
benefit rate of 33.4% compared to 31.7% for 1995.
Net loss for the year increased $17.7 million, or 78.1%, compared to the
prior year 1995.
COMPARISON OF 1995 TO 1994
In 1995, PHC began an effort to grow its membership base in existing
markets and expansion into new key markets. This strategy was developed in
conjunction with PHC's strategic goals for an increased presence in certain
markets. POS products, which include out of network benefits, were attractively
priced in an effort to reach new members who had not previously considered
managed care. As a result of this strategy, the
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premium yield on a per member per month basis declined 9.3% to $112.71 for the
year ended December 31, 1995.
Managed care premiums increased $151.4 million, or 35.8%, to $574.4 million
for the year ended 1995 compared to 1994. The increase was driven primarily by
the 132,495 members, or 39.9%, increase in fully insured membership from the
prior year. Most of this growth was in commercial lines of business. PHC
experienced a 88,507 member, or 174%, increase in the POS products over the 1994
levels. The commercial HMO products experienced a 44,190 member, or 15.8%,
increase over the prior year 1994. Very little change occurred in the Non-Risk
or Medicare membership base.
The markets that experienced the most significant growth as a result of
this strategy were the Florida, Mid-Atlantic, and Illinois markets. The Florida
markets experienced a 59.2% increase in revenues to $135.6 million, with the
most dramatic growth occurring in the South Florida and Tampa regions.
Mid-Atlantic revenues grew 228.8%, or $23.8 million, over 1994 levels. Much of
this growth was related to a State of Maryland program to provide coverage for
small groups. The Illinois market experienced a $5.9 million, or 125.8% increase
as the commercial HMO business grew from 2,179 members at December 31, 1994 to
9,673 members at December 31, 1995.
The 1995 increase in revenues was also impacted by acquisitions and other
transactions that occurred in 1994. These transactions did not fully impact the
1994 results; therefore, revenue increases are influenced by the comparison of a
full year's worth of activity in 1995 compared to a partial year's activity in
1994. The Texas operations reflected three months or $7.5 million in revenues in
1994, as the acquisition of this entity was not finalized until October. In
December of 1994, a transaction with the CIGNA Corporation to exchange the PHC
of Ohio operations for CIGNA's Wichita operations was completed. This
transaction gave PHC of Kansas City one month of revenues in 1994, compared to
twelve months of revenues in 1995. Kansas City's revenues increased $29.7
million in 1995, offset by a corresponding decrease of $27.4 million in the Ohio
operations.
PPO, Contract, ASO and Other Non-Risk fees rose $14.1 million over prior
year 1994 due primarily to the acquisition of AHP. This company was transferred
to PHC from Holding in December of 1995. Aside from this transaction, PPO
network rental income in existing markets increased 26.7% between 1994 and 1995.
This was the result of the purchase in April of 1994 of the SouthCare Medical
Alliance in Georgia. The effect of this transaction was not fully recognized
until 1995.
As a consequence of PHC's competitive pricing strategy, additional
liabilities were incurred. PHC's practice is to establish reserves, if required,
for the probability that anticipated future health care and maintenance costs
under the group of existing contracts will exceed anticipated future premiums
and stop-loss insurance recoveries on those contracts. As a result, PHC
recognized $6.4 million in additional reserves for the year 1995 related to such
contracts, compared to approximately $1.1 million in additional reserves that
were incurred in 1994.
Overall, delivery system costs associated with the HMO operations in 1995
increased $172.3 million or 49.6% in total over the 1994 costs. This translates
into a 1.2% increase on a per member per month basis. The combination of the
reduction in premium revenues and the slight increase in medical costs have the
following results on medical loss ratios by entity:
SGA increased $55.3 million or 50% over the 1994 levels. This was the
result of a corresponding increase in membership, the purchase and
implementation of a new mainframe computer system, the acquisition of AHP, and
the complete impact of the operational costs of the PBHC. Salary and related
expenses increased $27.7 million. Rental expense for office space and equipment
rose $4.1 million. Consulting expenses were up $8.7 million driven mostly by the
system conversion along with an additional $4.3 million related to the loss on
the disposal of the old mainframe computer. Broker commissions and incentive
compensation increased $7.9 million as more small groups were sold in South
Florida and Mid-Atlantic resulting from state small group reform initiatives.
The commission schedules for these groups are proportionately higher than for
larger groups.
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Depreciation and amortization expenses in 1995 for the HMO operations
increased $2.8 million or 32.3% over 1994. This increase is directly related to
the purchase of the Texas operations and the assumed intangible asset associated
with the CIGNA transaction acquisition. Because these transactions occurred late
in 1994, October and December respectively, the corresponding amortization costs
were not realized for a full twelve months until 1995. In addition, office
equipment purchased to support the new employees contributed to the increased
depreciation costs.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow from operations was negatively impacted in 1994 and 1995 because
of an increase in receivables related to ASO products. Cash flow in 1996 was
improved because of an effort to collect amounts due from ASO groups on a more
timely basis. Such efforts fell behind again in 1997. We have devoted resources
to improve these processes on a more permanent basis to minimize future
disruptions to cash flows from operations. Cash flows were also diminished in
1997 as a result of accelerated medical payments resulting from new global
capitation and disease management agreements. Those arrangements, entered into
to control medical costs, required that PHC pay providers in advance for
services rather than paying for them as claims are reported and adjudicated. The
decrease in membership from the prior year has also negatively impacted cash
from operations as the payment of the liability for claims incurred for those
members is no longer offset by current premium receipts.
PHC's investing activities have included investments in HMO and other
managed health care companies. Significant acquisitions were made in 1994 and
1996. Those acquisitions were funded by capital contributions from Mutual. In
addition, $44.2 million was contributed by Mutual in 1995 to fund start up HMOs
in the Carolina, Tampa, Orlando, and South Florida markets. An additional $8.6
million was contributed by Mutual during the nine months ended September 30,
1997 to fund the acquisition of FHP of Illinois, Inc. The acquisition is more
fully described in Note 13 (unaudited) to the financial statements. An
additional $35.0 million was contributed in October 1997 for the remainder of
the purchase price and working capital requirements related to that acquisition.
Purchases of property and equipment were significant in 1995 as PHC made
significant investments in technology to improve its Management Information
Systems and additional investments were made in fixed assets resulting from
growth and acquisitions.
PHC currently has access to a revolving line of credit with Mutual of $25.0
million that is used to provide short-term capital resources for routine cash
flow fluctuations. At September 30, 1997, approximately $12.0 million was
outstanding under the line of credit. That amount is included in Due from Mutual
in the accompanying unaudited financial statements as of September 30, 1997.
Certain PHC subsidiaries that are subject to regulation by state insurance
departments must notify state regulators before the payment of any dividends to
PHC and, in certain circumstances, must receive positive affirmation prior to
such payment. PHC's regulated subsidiaries had surplus in excess of statutory
requirements of $64.8 million and $46.6 million as of September 30, 1997 and
December 31, 1996, respectively.
As a result of the change in PHC's strategy from aggressive growth to more
controlled profitable growth, PHC believes that the cash flow generated from
operations along with its current liquidity and borrowing capabilities are
adequate for both current and expanded operations.
PHC will make certain capital expenditures over the near term to continue
to enhance its Management Information Systems and to make necessary improvements
to existing and new administrative offices as a result of growth and
acquisitions.
LITIGATION AND INSURANCE
PHC 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. PHC maintains insurance coverage in amounts
PHC believes to be adequate including professional liability (medical
malpractice) and general liability insurance. Contracting physicians are
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<PAGE> 85
required to maintain professional liability insurance. In addition, PHC 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 and cash flows of PHC.
INCOME TAXES
PHC is included in the consolidated federal and state tax returns filed by
Mutual. The historical difference between pretax earnings for financial
reporting purposes and taxable income for income tax purposes relate primarily
to non-deductible goodwill and temporary differences such as deductions for bad
debt allowance.
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INFORMATION CONCERNING COVENTRY CORPORATION
BUSINESS
OVERVIEW
Coventry is a managed healthcare company that provides comprehensive health
benefits and services to 897,758 members in Pennsylvania, Ohio, West Virginia,
Missouri, Illinois, and Virginia at September 30, 1997, of which 753,201 were
full-risk members and 144,557 were self-insured members. Healthcare services are
provided to employer groups and government funded groups through a variety of
full-risk healthcare plans, including HMOs and PPO products. Additionally,
Coventry administers self-insured health plans of certain large employers.
Coventry was incorporated in 1986 in Delaware and changed its jurisdiction
of incorporation to Tennessee in April 1997. Its principal executive offices are
located at 501 Corporate Drive, Suite 400, Franklin, Tennessee 37238, and its
telephone number is (615) 771-4141. Unless the context indicates otherwise,
references herein to "Coventry" include Coventry Corporation and its
subsidiaries.
The following tables show the total number of enrollees as of September 30,
1997 in the geographic markets in which Coventry conducts operations and the
products which Coventry offers:
<TABLE>
<CAPTION>
GEOGRAPHIC MARKET SEPT. 30, 1997 PRODUCT SEPT. 30, 1997
----------------- -------------- ------- --------------
<S> <C> <C> <C>
Western Pennsylvania 294,401 Commercial HMO 392,272
Central Pennsylvania 259,022 Commercial PPO/POS 224,070
St. Louis 275,315 Medicare Risk 34,388
Richmond 72,020 Medicaid(1) 102,271
Jacksonville(1) -- Non-Risk 144,557
Total: 897,758 Total: 897,758
</TABLE>
- ---------------
(1) Effective June 30, 1997, Coventry discontinued its Medicaid operations in
Jacksonville, Florida.
PRODUCTS
Commercial Health Maintenance Organizations
Coventry's HMO products provide comprehensive healthcare 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.
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, Coventry serves Wheeling and 14 counties
in West Virginia. The St. Louis Health Plan service area includes St. Louis and
23 adjacent counties in Missouri and 23 counties in central and southern
Illinois. The Richmond Health Plans services Richmond, Roanoke and 38 counties
in central and southwestern Virginia.
Preferred Provider Organizations and Point of Service
Coventry, through its regional health plans, also offers fully-insured
flexible provider products, including PPO and 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
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copayments 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. Coventry's PPO and POS products are underwritten by CHLIC.
PPO/POS products are currently offered by the western Pennsylvania, central
Pennsylvania, St. Louis, and Richmond health plans.
Medicare
In late 1995, Coventry introduced a Medicare risk product under the name
"Advantra"(R) in the St. Louis market. In 1996 Coventry began marketing this
product in its western Pennsylvania and central Pennsylvania markets.
Under a Medicare risk contract, Coventry receives a fixed premium per
member, which reflects certain demographics of the Medicare population of each
region. At December 31, 1996, there were approximately 1.4 million Medicare
eligibles in Coventry's current service areas. Coventry 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. Coventry is also subject to increased government regulation and
reporting requirements related to the product.
Coventry also offers Medicare cost and supplement products. Under a
Medicare cost contract, Coventry 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, Coventry 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
Coventry's former Medicare cost and supplement members converted to Coventry's
Advantra product during 1996.
Medicaid
Coventry offers healthcare coverage to Medicaid recipients in the St. Louis
and central Missouri, Richmond, Virginia, Pittsburgh and central Pennsylvania
markets. Medicaid recipients in 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 Coventry's plans.
Coventry determined, at the end of 1996, that its Florida operations were
not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, Coventry discontinued operations in the Florida
Medicaid HMO market on June 30, 1997. Coventry established a reserve of $1.2
million at December 31, 1996 to reflect the anticipated costs of exiting this
market and the reserve is believed to be sufficient to cover the anticipated
costs. During the third quarter of 1997, Coventry determined that it will exit
its Medicaid operations in Pennsylvania. On September 30, 1997, the Medicaid
membership was 4,236 and 18,043 in western Pennsylvania and central
Pennsylvania, respectively.
Like the Medicare risk product, the Medicaid product makes Coventry'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. Coventry believes that its existing commercial membership in its St.
Louis Health Plans will satisfy the regulatory commercial membership
requirements in Missouri. See "Government Regulation."
Administrative Services Only
Coventry'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
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<PAGE> 88
plans receive the benefit of provider pricing arrangements from the health plan,
and the health plan also provides a variety of administrative services such as
claims processing, utilization review and quality assurance for the employers.
The health plan receives an administrative fee for these services but does not
assume the healthcare cost underwriting risk. Certain of Coventry's ASO
contracts include performance and utilization management standards which affect
the fees received for these services.
DELIVERY SYSTEMS
The health plans maintain provider networks which furnish healthcare
services through contractual arrangements with physicians, hospitals and other
healthcare 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 healthcare services
provided, they must manage both the utilization of services and the unit cost of
the services.
Coventry's health plans' networks historically have utilized a variety of
physician care delivery systems which differed primarily in the characterization
of the relationship between Coventry and the participating physicians. Prior to
1997, Coventry utilized 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 enabled the health
plan to predict costs more effectively, maintain quality and respond quickly to
consumer issues. However, staff model operations also involved substantial
investment in certain costs, such as facilities and personnel, that could not be
immediately adjusted to take into account changes in the membership or third
party provider pricing trends. In addition to providing healthcare to plan
members, these staff models also accepted non-member patients on a
fee-for-service basis, in an effort to help cover the costs associated with the
medical offices.
Coventry's staff model operations, in recent years, suffered from
over-capacity, and Coventry was not able to increase the number of members or
other patients utilizing such operations sufficiently to make such operations
profitable. As a result, Coventry determined in late 1996 to seek to dispose of
the staff model operations in Pittsburgh, Pennsylvania and St. Louis, Missouri.
Effective March 31, 1997, Coventry completed its sale of the medical offices
associated with HealthAmerica Pennsylvania, Inc., its health plan in Pittsburgh,
Pennsylvania, to AHERF, a major provider organization in the Pittsburgh market.
The sales price was $20 million and the transaction resulted in a pretax gain of
approximately $6.0 million. Coincident with the sale, Coventry entered into a
long-term global capitation agreement with the purchaser which increased the
globally capitated membership in western Pennsylvania to approximately 226,000
members, or 91% of the commercial, Medicaid and Medicare risk membership in
western Pennsylvania. Under the agreement, the organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive. Effective September 30, 1997, Coventry completed
its sale of its remaining five medical offices associated with HealthAmerica
Pennsylvania, Inc. to ProMedCo Management Company. The agreement covered 21
physicians who serve approximately 12,000 members. The approximately $2.0
million proceeds from the sale approximate the carrying value of the medical
offices. Effective May 1, 1997, Coventry completed its sale of the medical
offices associated with Group Health Plans, its health plan in St. Louis,
Missouri, to BJC, a major provider organization in the St. Louis market. The
sales price was $26.9 million and the transaction resulted in a pretax gain of
approximately $9.6 million. Coincident with the sale, Coventry entered into a
long-term capitation agreement with the purchaser covering approximately 83,000
members, or 45% of the commercial, Medicaid and Medicare risk membership in St.
Louis. Under the agreement, the provider organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive. These arrangements are a continuation of
Coventry's efforts to enter into capitation agreements with major providers
whereby the providers will provide all medical treatment for Coventry's members
in return for a fixed percentage of premium. While these agreements limit
Coventry's exposure to the risk of increasing medical costs, they expose
Coventry to risk as to the adequacy of the financial and medical care resources
of the provider organization. To the extent that the respective provider should
face financial difficulties or otherwise be unable to perform its obligations
under the global capitation agreements, Coventry, which is responsible for the
coverage of its members pursuant to its customer
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<PAGE> 89
agreements, will be required to perform such obligations, and may have to incur
costs in doing so in excess of the amounts it would otherwise have to pay under
the global capitation agreements.
In July 1997, regulatory approval was received to add approximately 11,000
Ohio members to the western Pennsylvania global capitalization contract. In
August, Coventry received regulatory approval to add approximately 13,000 West
Virginia members to the western Pennsylvania global capitalization contract.
These arrangements in western Pennsylvania and St. Louis, Missouri effectively
reduce Coventry's medical cost as a percentage of premiums, enable Coventry to
reduce administrative staff in patient utilization and medical management and
shift the risk of medical cost fluctuations to the provider networks. As of
September 30, 1997, the global capitation agreements covered 99% and 48% of the
risk membership in western Pennsylvania and St. Louis, Missouri, respectively.
However, since the global capitation arrangements are with single provider
organizations, Coventry is exposed to credit and operating risks with respect to
the financial strength of such organizations. Additionally, there is also a risk
that entering into global capitation contracts with certain providers will cause
disruption in Coventry's existing provider network. However, due to the large
number of providers included in the original network, the Company believes that
the risk that an individual provider would not fulfill their obligations is
minimal and manageable. In addition, HMO members can go outside of the provider
network for treatment at no additional cost to Coventry.
All of Coventry'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. Coventry contracts with approximately 18,000 physicians
through the open panel model.
HEALTH CARE PROVIDER COMPENSATION
Under most open panel contracts, each primary care physician is paid a
monthly fixed capitation fee for each enrollee selecting the physician and may
receive additional compensation from risk-sharing arrangements with the health
plan to the extent that pre-established utilization and quality goals are
achieved. Contracting specialist physicians are compensated under both
discounted fee-for-service arrangements and capitation arrangements. The
majority of Coventry'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, Coventry converted many of
its hospital and ancillary contracts from discounted fee-for-service to fixed
fee schedules or capitation arrangements. During 1997, Coventry entered into
global capitation arrangements in western Pennsylvania and St. Louis, Missouri,
pursuant to which the provider organizations will receive a fixed percentage of
premium to cover all of the costs of medical treatment Coventry's globally
capitated members receive from the health care systems. As of September 30, 1997
the global capitations arrangements covered 99% and 48% of the risk membership
in western Pennsylvania and St. Louis, Missouri, respectively. However, since
the global capitations arrangements are with single provider organizations and
cover substantial membership, Coventry is exposed to substantial credit and
operating risk with respect to such organizations.
QUALITY ASSURANCE
Coventry 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 Coventry's health plans provide optimal care to
their enrollees.
Coventry's health plans also have internal quality assurance review
committees made up of physicians and other staff members whose responsibilities
include periodic review of medical records, development and implementation of
standards of care based on current medical literature and the collection of data
relating to results of treatment. Studies are regularly conducted to discover
possible adverse medical outcomes for both quality and risk management purposes.
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Appointment availability, member waiting times and environments are
monitored. A membership services department is responsible for ensuring enrollee
satisfaction, and Coventry'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.
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 Coventry's health plans employs
physicians as Medical Directors who oversee the delivery of medical services.
The Medical Director supervises medical managers (physicians and nurses) who
review and approve the primary care physicians' referrals to specialists and
hospitals. Medical managers also continually review the status of hospitalized
patients and compare their medical progress with established clinical criteria.
In addition, nurses make hospital rounds to review patients' medical progress
and perform quality assurance and utilization functions.
Medical managers also monitor the utilization of diagnostic services and
encourage use of outpatient surgery and testing where appropriate. Data showing
each physician's utilization profile for diagnostic tests, specialty referrals
and hospitalization are collected by each health plan and provided to the health
plan's physicians. These results are monitored by medical managers in an attempt
to ensure the use of cost-effective, medically appropriate services.
MARKETING
Coventry'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 Coventry'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, Coventry solicits enrollees from the employee base directly. During
periodic "open enrollments," in which employees are permitted to change health
care programs, Coventry uses direct mail, worksite presentations, and radio and
television advertisements to contact new enrollees. Coventry also markets
through independent insurance brokers and agents. Virtually all of Coventry's
employer group contracts are renewable annually, and enrollment is continuously
affected by employee turnover within employer groups.
Coventry'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.
Coventry also markets through independent insurance brokers and agents.
Coventry's Medicaid and Medicare contracts are renewable annually, and Medicare
and Medicaid enrollees may disenroll monthly.
Each of Coventry'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 Coventry's
consolidated revenues in 1996. As of September 30, 1997, 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 23%, 24%, 20% and 56%, respectively, of each health
plan's premiums. As of September 30, 1997, HCUSA received approximately $74.7
million or 82% of its revenues from the State of Missouri.
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Subsequent to the closing of operations in Jacksonville, Florida, HCUSA will
receive 100% of its revenues from the State of Missouri.
COMPETITION
As of December 31, 1997, Coventry estimated that it ranked number one in
the commercial HMO markets of Western and Central Pennsylvania, and holds number
two positions in the commercial HMO market in St. Louis, Missouri and Richmond,
Virginia markets.
Coventry'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 Coventry continued to experience
competitive pressures in its commercial products, most notably in the
Pennsylvania and Missouri markets, which adversely affected the premiums that
Coventry 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.
Coventry 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.
Coventry 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 Coventry's health plans. While
Coventry 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
Coventry'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.
Coventry'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. Certain states' 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, Medicaid or CHAMPUS contracts from including any direct or
indirect payment to physicians or groups as an inducement to reduce or limit
medically necessary services to Medicare beneficiaries and Medicaid recipients.
Under the physician incentive 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
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place, if the HMO places a physician or physician group at "substantial
financial risk" for services provided to Medicare beneficiaries and Medicaid
recipients. These regulations took effect in 1996 and have a range of compliance
dates beginning January 1997.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
was signed into law on August 21, 1996. HIPAA amended Title I of the Employee
Retirement Income Security Act of 1974 ("ERISA"), the Code, and the Public
Health Service Act. HIPAA applies to both "group health plans" and "health
insurance issuers" and generally becomes effective for plan years beginning
after June 30, 1997. A "health insurance issuer" is defined under HIPAA to
include both insurance companies and HMOs subject to State laws that regulate
insurance. HIPAA limits the use of exclusions for preexisting conditions;
prohibits discrimination against both employees and dependents based on health
status; requires health insurance issuers to guarantee renewability and
availability of health coverage to certain employers and individuals; and
requires group health plans and health insurance issuers to issue certificates
of creditable coverage. With respect to health insurance issuers, states have
the primary responsibility for enforcement of HIPAA. (In some states, HHS will
be enforcing HIPAA's requirements.) Coventry would be considered a health
insurance issuer and subject to HIPAA's requirements.
On April 1, 1997, the Departments of Labor, Health and Human Services and
the Treasury issued interim regulations that interpret many of the provisions of
HIPAA. The states are in the process of enacting implementing laws and
regulations in this area.
The Newborns' and Mothers' Health Protection Act ("NMHPA") of 1996 was
signed into law on September 26, 1996. This law applies to group health plans
and health insurance issuers and becomes effective for plan years beginning on
or after January 1, 1998. NMHPA prohibits group health plans and health
insurance issuers from restricting benefits for a mother's or newborn child's
hospital stay in connection with childbirth to less than 48 hours for a vaginal
delivery or less than 96 hours for a caesarean section. Authorization or
precertification requirements cannot be imposed for these mandatory minimum
hospital stays. Coventry would be considered a health insurance issuer and
subject to NMHPA's requirements. Federal regulations implementing NMHPA have not
yet been promulgated.
The Mental Health Parity Act of 1996 ("MHPA") was signed into law on
September 26, 1996. This law applies to group health plans and health insurance
issuers and becomes effective for plan years beginning on or after January 1,
1998. MHPA prohibits group health plans and health insurance issuers providing
mental health benefits from imposing lower aggregate annual or lifetime
dollar-limits on mental health benefits than any such limits for medical and
surgical benefits. MHPA's requirements do not apply to small employers who have
between 2 and 50 employees or to any group health plan whose costs increase one
percent or more due to the application of these requirements. Coventry would be
considered a health insurance issuer and subject to NMHPA's requirements.
Federal regulations implementing MHPA have not yet been promulgated.
All of Coventry's HMOs that contract with HCFA to provide services to
Medicare beneficiaries pursuant to a Medicare risk contract are subject to
federal laws and regulations. These HMOs may also be subject to state laws
governing Medicare contracting. HCFA has the right to audit any health plan
operating under a Medicare risk contract to determine the plan's compliance with
federal law. Coventry HMOs with Medicare risk contracts must also comply with
the requirements established by peer review organizations ("PROs"), which are
organizations under contract with HCFA to monitor the quality of health care
received by Medicare beneficiaries and under contract with certain states to
monitor the quality of health care received by Medicaid recipients.
All of Coventry's HMOs that contract with states to provide services to
Medicaid recipients are subject to state and federal laws and regulations. HCFA
and the appropriate state regulatory agency have the right to audit any health
plan operating under a Medicaid managed care contract to determine the plan's
compliance with state and federal law. In some instances, states engage PROs to
perform quality assurance and utilization review oversight of Medicaid managed
care plans. Coventry HMOs would be required to abide by these PROs requirements.
In addition, cost reimbursement reports are required with respect to Medicare
cost contracts and are subject to audit and revision.
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The Social Security Act imposes criminal and civil penalties for paying or
receiving remuneration (which is deemed to include a kickback, bribe or rebate)
in connection with any federal health care program including, but not limited
to, the Medicare, Medicaid and CHAMPUS programs. The law and the related
regulations have been interpreted to prohibit the payment, solicitation,
offering or receipt of any form of remuneration in return for the referral of
federal health care program patients or any item or service that is reimbursed,
in whole or in part, by any federal health care program. Similar anti-kickback
provisions have been adopted by many states which apply regardless of the source
of reimbursement. The Department of Health and Human Services ("DHHS") has
adopted safe harbor regulations specifying certain relationships and activities
that are deemed not to violate the federal anti-kickback statute. Specifically,
DHHS has adopted safe harbor regulations 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)
certain discounts offered to prepaid health plans by contracting providers are
deemed not to be violations of the anti-kickback provisions. Coventry believes
that the incentives offered by its HMOs to Medicare and Medicaid beneficiaries
and the discounts its plans receive from contracting health care providers
should satisfy the requirements of the safe harbor regulations. However, failure
to satisfy each criterion of applicable safe harbor does not mean that the
arrangement constitutes a violation of the law; rather the safe harbor
regulations state that the arrangement must be analyzed on the basis of its
specific facts and circumstances. Accordingly, Coventry believes that its
arrangements do not violate the federal anti-kickback laws or similar state
anti-kickback laws.
Coventry 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.
Coventry contracts with the 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 an OPM audit 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 Coventry. 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 Coventry
believes to be adequate. Contracting physicians are also required to maintain
professional liability coverage. In addition to liability coverage, Coventry
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 Coventry 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.
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EMPLOYEES
At September 30, 1997, Coventry employed approximately 2,100 persons. None
of the employees are covered by a collective bargaining agreement.
TRADEMARKS
Coventry has the right to use the name "HealthAmerica" in Illinois,
Missouri, Pennsylvania and West Virginia. Coventry has federal and/or state
registered service marks for "HealthAssurance," "GHP Access," "Healthcare USA,"
"Doc Bear," "CarePlus," "Coventry" and "Advantra."
DESCRIPTION OF PROPERTY
Coventry leases in aggregate approximately 266,131 square feet of office
space primarily for administrative offices in western Pennsylvania, central
Pennsylvania, St. Louis, Missouri, and its corporate office in Nashville,
Tennessee. Coventry owns an administrative building in Richmond, Virginia, which
has approximately 45,000 square feet. The Company believes that its facilities
are appropriate for its operations.
LEGAL PROCEEDINGS
In the normal course of business, Coventry has been named as defendant in
various other legal actions seeking payments for claims denied by Coventry,
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, Coventry carries professional
malpractice and general liability insurance for each of its operations on a
claims-made basis with varying deductibles for which Coventry 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 Coventry.
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INFORMATION CONCERNING PRINCIPAL HEALTH CARE, INC.
BUSINESS
OVERVIEW
PHC was incorporated as an Iowa corporation on January 7, 1987, and is a
wholly owned subsidiary of Holding, which is a wholly owned subsidiary of
Mutual. PHC's principal executive offices are located at 6705 Rockledge Drive,
Suite 100, Bethesda, Maryland 20817 and its telephone number is (301) 581-0600.
Under the terms of the Combination Agreement, businesses representing 77.8% of
PHC's assets, 86.4% of PHC's revenues and 85.3% of PHC's operating expenses as
estimated based on PHC's September 30, 1997 financial statements will be
transferred to Newco in exchange for 40% of the common stock of Newco. The
assets and liabilities to be so transferred are referred to hereinafter as the
PHC Transferred Group.
PHC is a managed health care company that provides comprehensive health
benefits and services to its members. Health care services are provided to
employer groups and government funded groups through a variety of health care
benefit plans and risk arrangements. These include traditional and open access
HMO products and POS products on both a full-risk and administrative services
only basis, and full risk programs under contract with federal and state
governments for Medicare and Medicaid beneficiaries. PHC also administers a PPO
network that it rents to other payors. Certain assets of PHC that are expected
to be sold prior to the Business Combination (Principal Health Care of the
Mid-Atlantic, Inc. and Principal Health Care of Texas, Inc.) or are to be
retained by Mutual (the equity investment in United Payors and United Providers,
Inc., 50% of the equity investment in American Psych Systems, Inc. and 50% of
the common stock warrants for Accordant Health Systems, Inc. and Advanced
Paradigm, Inc.) will not be included in the Business Combination. Membership in
the plans not transferred accounted for approximately 52,000 members at
September 30, 1997.
PRODUCTS
Commercial Health Maintenance Organizations
PHC's HMO benefit plans provide comprehensive health care benefits to
enrollees, including ambulatory and inpatient physician services,
hospitalization, mental health, ancillary diagnostic and therapeutic, and in
most cases pharmacy services. At September 30, 1997, PHC had a total of
approximately 556,000 members in these commercial benefit plans. In general, a
fixed monthly enrollment fee covers all HMO benefits, although all benefit plans
require copayments or deductibles in addition to the basic member premium. In
most plans, a primary care physician assumes overall responsibility for the care
of an enrollee, including preventive and routine medical care and referrals to
specialists and other services. POS benefit plans, representing about 190,000 of
the total commercial members, allow members to access benefits outside the
network without primary physician involvement. Open access benefit plans,
representing about 30,000 of the total commercial members, allow access to the
network at any point for covered benefits, without prior authorization from a
primary care physician. The POS and open access benefit plans generally have
higher copayments and deductibles to the extent that either primary care
physician access is not required or the member chooses to use providers of care
outside of the HMO's network. However, in all benefit plans, the enrollee is
typically entitled to coverage of a broader range of health care services than
are covered by typical reimbursement or indemnity policies.
PHC Transferred Group includes health plans in the following metropolitan
areas and their surrounding counties:
<TABLE>
<CAPTION>
CITY STATE
---- -----
<S> <C>
Mobile, Alabama
Dover, Delaware
Wilmington, Delaware
Jacksonville, Florida
Miami, Florida
Orlando, Florida
Pensacola, Florida
Tampa, Florida
Atlanta, Georgia
Evansville, Indiana
Ft. Wayne, Indiana
Indianapolis, Indiana
</TABLE>
<TABLE>
<CAPTION>
CITY STATE
---- -----
<S> <C>
DesMoines, Iowa
Wichita, Kansas
Baton Rouge, Louisiana
New Orleans, Louisiana
Baltimore, Maryland
Kansas City, Missouri
St. Louis, Missouri
Lincoln, Nebraska
Omaha, Nebraska
Charlotte, North Carolina
Raleigh/Durham North Carolina
</TABLE>
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Preferred Provider Organizations
PHC also offers a PPO product to other payors. Services provided under this
product include the rental of and access to PHC's PPO network, claims repricing,
and utilization review. PHC does not accept underwriting risk for this product.
Rather, it rents access to its provider network to other insurance carriers,
allowing them access to negotiated fee schedules. Approximately $3.8 million, or
54.8% of PHC's revenue from its PPO product for the nine months ended September
30, 1997 is from Mutual. PHC's largest concentration of PPO revenue is in the
Georgia markets with approximately 328,000 covered individuals.
Medicare
In August, 1996, PHC introduced a Medicare risk product in Jacksonville,
Florida. At September 30, 1997, there were 2,740 members in the program. PHC
believes that the Medicare risk product represents a substantial growth
opportunity. PHC has developed a set of financial and other criteria by which to
evaluate the feasibility of developing and marketing its Medicare product in
other markets.
Under a Medicare risk contract, PHC receives a fixed premium per member per
month from the HCFA (See "Government Regulation"), which reflects certain
demographics of the Medicare population of each region. The product also carries
the risk of higher utilization and related medical costs than commercial
products, and the possibility of regulatory or legislative changes that may
reduce premiums or increase mandated benefits in the future. PHC is also subject
to increased government regulation and reporting requirements related to the
product.
Medicaid
PHC offers health care coverage to Medicaid recipients in Delaware and
Iowa. At September 30, 1997, 13,317 PHC members were enrolled in a Medicaid risk
product, comprised of 12,616 in Delaware, and 701 in Iowa. Medicaid recipients
in Delaware are generally required to choose a managed care provider. In Iowa,
enrollment in a Medicaid HMO is voluntary. Under a Medicaid risk contract, the
participating state pays a monthly premium based on such demographic factors as
the category of aid, locality, age and gender of the recipients enrolled in
PHC's plans. PHC provides traditional HMO benefit plans to Medicaid
beneficiaries through a separately contracted provider network.
Like the Medicare risk product, the Medicaid product makes PHC'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 (i.e., Medicaid eligibles most
enroll in one of the managed care products offered) must, within certain time
frames, ensure that their membership includes at least 25% commercial HMO
members. The Delaware and Iowa plans meet this criterion.
Administrative Services Only
PHC's health plans offer an ASO product to large employers who self-insure
their employee health benefits. Approximately 66,000 of PHC's members were ASO
members at September 30, 1997 with approximately 57,000, or 86.0% of those
members in the Delaware health plan. Under the ASO contracts, employers who fund
their own health benefits receive the advantage 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 management 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 PHC's ASO contracts include performance and utilization
management standards which affect the fees received for these services. PHC also
provides services to employer group beneficiaries that have elected HMO coverage
under products marketed jointly with Mutual. Approximately 31,000 members were
covered under those products at September 30, 1997.
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DELIVERY SYSTEMS
PHC's health plans maintain provider networks which generally furnish
health care services through contractual arrangements with physicians, hospitals
and other health care 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 and the unit cost of
those services.
All of PHC's health plans offer an open panel delivery system. In an open
panel structure, individual physicians or physician groups contract with the
health plans to provide services to members but also maintain independent
practices in which they provide services to individuals who are not Principal
Health Care members.
The networks maintained by PHC's health plans utilize a variety of
physician care delivery systems that differ primarily in the characterization of
the relationship between PHC and the participating physicians. Some arrangements
transfer certain of the risks for the cost of medical services to the provider.
This can apply to individual providers as well as to groups of providers. Under
open panel contracts, each primary care physician is paid a monthly fixed
capitation fee for each member 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. Some
primary care physicians are compensated on a discounted fee for service basis.
Contracting specialist physicians are compensated under both discounted fee-
for-service arrangements and capitation arrangements.
The majority of PHC's contracts with hospitals provide for inpatient per
diem or per case hospital rates, while outpatient services are typically
contracted on a fixed fee or discounted fee-for-service basis. Per diem
contracts shift the financial risk for intensity of services to the hospital
provider. Per case arrangements shift the risk for both intensity and length of
hospital stay to the hospital provider. Many per diem contracts contain "stop
loss" outlier provisions whereby discounted payments replace per diems when
charges for a specific hospital stay reach a catastrophic amount. In some of the
global capitation arrangements referred to above, the risk for hospital care is
also shifted to the capitated provider.
In some markets, PHC contracts with physician or physician/hospital based
organizations to accept risk for a wide variety of services (e.g., "global" or
"multi-specialty" capitation arrangements). PHC also maintains contracts with
several provider entities that contract to accept risk and medical management of
care for certain rare and chronic diseases after diagnosis of the member. While
all of these agreements limit PHC's exposure to the risk of increasing medical
costs, they expose PHC to risk as to the adequacy of the financial and medical
care resources of the provider organization. Additionally, PHC is aware that
entering into global capitation contracts with a limited number of providers may
cause disruption in an existing provider network.
In the aggregate, PHC contracts with about 39,000 physicians and 440
hospitals for its HMO programs, and with about 51,200 physicians and 600
hospitals for its PPO programs.
QUALITY MANAGEMENT
PHC has established systems to monitor the availability, appropriateness
and effectiveness of the patient care it provides. Goals of PHC's Quality
Management Program include: continuous improvement in the delivery of health
care and services to members, working with providers of care to help them in
their responsibility to provide clinical care to members that meets the highest
standards of quality consistent with accepted medical practices, improving
member satisfaction with the quality of care and services provided, and
compliance with local, state, and national regulatory requirements and all
applicable accreditation standards.
PHC's health plans also have internal Quality Management 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, and to
serve as the basis for action plans related to improving the availability,
appropriateness, and effectiveness of care rendered to PHC's members. The
activities of each plan's quality
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and risk management programs are monitored by local plan management, by the
local physician-based Quality Management Committee, and by a national Quality
Management Oversight Committee.
Appointment availability, member waiting times and provider environments
are monitored at all plans. A membership services department is responsible for
ensuring member satisfaction, and PHC's health plans periodically conduct
membership surveys of both existing and former members concerning services
furnished and suggestions for improvement.
The 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. PHC's Illinois, Delaware, Iowa,
Jacksonville, Kansas City, Louisiana, Nebraska, and Wichita health plans have
received either provisional or one-year NCQA accreditation. All other plans are
either in the process of applying or are preparing to do so.
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. To that end, PHC has established a Utilization
Management Program. Among the goals of that program are to promote the effective
and efficient utilization of facilities and services through an ongoing
monitoring program, and to develop, implement, and maintain utilization
management systems that maximize effective and efficient use of resources. Among
the methods used in daily management of utilization are pre-authorization of
referrals and specific services, including non-emergency inpatient stays and
surgical procedures, and daily review of the status of hospitalized patients to
compare their medical progress with established clinical criteria. In addition,
PHC employs seven full-time physicians, supplemented by part-time contracted
physicians, as medical directors to oversee utilization and quality management.
On an ongoing basis, PHC is making increasing use of case management and
disease management programs provided both internally and through contracted
specialty and disease management organizations. These programs work with
providers to encourage adherence to plans for the most effective management of a
patient through either an individual case or a long-term disease, using
education and prevention, and specifically targeted timely ongoing treatment and
interventions. PHC also disseminates appropriate data on utilization, including
individual physician utilization profiles, to the providers of care, along with
normative data to facilitate valid comparisons with peers and with accepted
standards of care. Results of the program are monitored by plan executive and
medical management and a Utilization Management Committee at the local level,
and by a national Utilization Management Oversight Committee.
MARKETING
PHC's commercial HMO benefit plans are marketed primarily to employer
groups as alternatives to conventional fee-for-service health care and indemnity
health insurance programs. Distribution is accomplished through two main
channels: marketing by company employees, and marketing through two related
independent marketing organizations. Both channels use brokers and employee
benefits consultants extensively. In 1997 year to date, approximately 84.0% of
new enrollee contracts have come from the PHC employee channel. A portion of
PHC's business, mainly in the POS products (see Commercial Health Maintenance
Organization) is on an exclusive carrier basis. 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 PHC's products
are offered.
Commercial marketing is generally a two-step process in which presentations
are made first to employers and/or brokers and other employer representatives,
and then directly to employees. Once selected by an employer, PHC solicits
enrollees from the employee base directly. During periodic "open enrollments,"
in which employees are permitted to change health care programs, PHC uses direct
mail, work site presentations where permission is granted by the employer, and
radio and television advertisements to reach new enrollees.
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The vast majority of PHC's employer group contracts are renewable annually.
Material exceptions are a fully insured contract with a group encompassing
approximately 64% of the enrollees in the Wichita plan -- coupled with a
matching three-year provider risk commitment -- both expiring in the year 2000;
combined St. Louis and Kansas City markets contract involving 15,000 enrollees
and expiring in December 1997, which will not be renewed; a 14,000-member public
employee contract in the New Orleans market, expiring in September 1998 and up
for potential 3-year renewal; a contract with a purchasing coalition in St.
Louis with approximately 7,900 members with participation ending in December
1999; and the State of Delaware administrative services only agreement, covering
about 46,000 enrollees and expiring in July, 1998, also up for potential 3-year
renewal for PHC and other incumbent carriers. In all the above cases, enrollment
is continuously affected by employee turnover within employer groups and, except
as noted above, although PHC is confident of its continuing competitive
viability, there can be no assurance of the renewal of any such contract upon
its expiration.
PHC's Medicaid products are marketed to individuals, while its Medicare
products are marketed to both individuals and employer group retirees.
Individual marketing to Medicare beneficiaries is conducted through use of a
direct sales force and advertising efforts that include television, radio,
newspaper, billboards, and direct mail. PHC's Medicaid and Medicare contracts
are renewable annually, and Medicare and Medicaid enrollees may disenroll
monthly.
Each of PHC's health plans employs a full-time marketing staff, totaling
approximately 184 for the entire company at September 30, 1997. Each marketing
staff uses advertising and promotional material prepared by advertising firms as
well as market research programs.
No single employer group accounts for more than 4% of PHC's consolidated
full-risk commercial premium revenue. The top ten employer groups account for
approximately 16% of PHC's consolidated average billed premium. In certain
markets, there is exposure to a predominant influence of one or more large
groups. The percentages of commercial billed premium revenue for the top ten
full-risk employer groups in each market, for the period January through June
1997, are as follows: Charlotte -- 17%; Delaware -- 40%; Georgia -- 30%;
Illinois -- 20%; Indiana -- 38%; Iowa -- 48% Jacksonville -- 37%; Kansas
City -- 53%; Louisiana -- 71%; Nebraska -- 67%; Orlando -- 28%;
Pensacola -- 48%; Raleigh/Durham -- 43%; South Florida -- 13%; St. Louis -- 56%;
Tampa -- 29%; and Wichita -- 86%.
The exposures related to a single employer group or groups with a
proportion in excess of 10% of total billed premium are: Iowa -- 22%; Kansas
City -- 13%; New Orleans -- 43%; Nebraska -- 16%, 13%, and 12%;
Pensacola -- 11%; St. Louis - 21%, 16%, and 11%; Tampa -- 10%; and
Wichita -- 62%. While there can be no assurance that any of these contracts will
not be canceled, or that enrollment in any of them will not decrease, PHC
believes it is in a good competitive position to retain business in a large
enough proportion of them such that any enrollment losses are not expected to be
material on a consolidated basis.
COMPETITION
PHC's health plans operate in highly competitive environments and compete
with other HMOs, PPOs, indemnity insurance carriers and, most recently,
physician-hospital organizations. The environment in which PHC operates
continues to be one of accelerating industry consolidation at the national and
regional insurer levels, thus often creating larger competitors with more
financial and contracting leverage. New provider-based organizations are also
forming in many of PHC's markets, creating aggressive competition that can
depress pricing at least in the short term. During 1997 PHC has continued to
experience competitive pressures in its commercial products, although it has
been able to increase its per member per month gross commercial premium revenue
by 9.1% between December 31, 1996 and September 30, 1997. This compares with an
increase of 2.2% for the full year 1996. Unit revenue increases have been offset
by membership decreases in some markets. To the extent that premium increases by
PHC place its prices at a level considered too high in any given market, the
risk of such membership decreases continues.
In some cases, employer groups have moved from the traditional commercial
HMO benefit plans toward products that provide more flexibility. PHC has
addressed this need through its POS products, most notably its "Maximum Choice"
plan. Under "Maximum Choice," a health plan member may choose, at any point, to
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receive services in-network with primary care authorization, in-network without
primary care authorization, or out-of-network. Each choice carries with it
different copayment and deductible levels. This benefit plan design also allows
PHC to deliver more benefits in network, thus taking advantage of discounts and
other provider contractual relationships.
PHC 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. While PHC believes it has strength in all these areas,
experience has shown that pricing is the predominant influence in most market
segments, including the small group market, in which PHC has enrolled a
significant number of employer groups. This market characteristic places PHC at
risk for predatory pricing competition.
PHC also faces considerable competition in the Medicare market, both in its
current operation and in some of those for which it is considering application
to the HCFA. Such competition takes the form more of resources devoted to
aggressive marketing than to either pricing or product differentiation. Other
prospective markets are less penetrated, thus, creating a positive potential
outlook.
PHC 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 PHC's health plans. Due to the
relatively small size of most of its plans, PHC can be placed at a competitive
disadvantage, because some of its competitors represent a greater number of
potential patients for such contracting providers and, therefore, may be in a
position to negotiate more favorable provider contracts.
GOVERNMENT REGULATION
PHC's HMOs are required to file periodic reports with, and are subject to
periodic review and audit 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. The HMOs are required to have quality assurance and education
programs for their professionals and enrollees. Certain states' laws further
require that representatives of the HMOs' enrollees have a means for
participation in policy making.
In 1996, HCFA promulgated regulations ("physician incentive regulations")
enforcing Sections 4204(a) and 4731 of OBRA 90. OBRA 90 and the physician
incentive regulations prohibit HMOs with Medicare, Medicaid or CHAMPUS contracts
from including any direct or indirect payment to physicians or groups as an
inducement to reduce or limit medically necessary services to Medicare
beneficiaries and Medicaid recipients. Under the physician incentive
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 and Medicaid recipients. These
regulations took effect in 1996 and have a range of compliance dates beginning
January 1997.
The HIPAA was signed into law on August 21, 1996. HIPAA amended Title I of
ERISA, the Code, and the Public Health Service Act. HIPAA applies to both "group
health plans" and "health insurance issuers" and generally becomes effective for
plan years beginning after June 30, 1997. A "health insurance issuer" is defined
under HIPAA to include both insurance companies and HMOs subject to State laws
that regulate insurance. HIPAA limits the use of exclusions for preexisting
conditions; prohibits discrimination against both employees and dependents based
on health status; requires health insurance issuers to guarantee renewability
and availability of health coverage to certain employers and individuals; and
requires group health plans and health insurance issuers to issue certificates
of creditable coverage. With respect to health insurance issuers, states have
the primary responsibility for enforcement of HIPAA. (In some states, HHS will
be enforcing HIPAA's requirements.) PHC would be considered a health insurance
issuer and subject to HIPAA's requirements.
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On April 1, 1997, the Departments of Labor, Health and Human Services and
the Treasury issued interim regulations that interpret many of the provisions of
HIPAA. The states are in the process of enacting implementing laws and
regulations in this area.
The NMHPA of 1996 was signed into law on September 26, 1996. This law
applies to group health plans and health insurance issuers and becomes effective
for plan years beginning on or after January 1, 1998. NMHPA prohibits group
health plans and health insurance issuers from restricting benefits for a
mother's or newborn child's hospital stay in connection with childbirth to less
than 48 hours for a vaginal delivery or less than 96 hours for a caesarean
section. Authorization or precertification requirements cannot be imposed for
these mandatory minimum hospital stays. PHC would be considered a health
insurance issuer and subject to NMHPA's requirements. Federal regulations
implementing NMHPA have not yet been promulgated.
The MHPA was signed into law on September 26, 1996. This law applies to
group health plans and health insurance issuers and becomes effective for plan
years beginning on or after January 1, 1998. MHPA prohibits group health plans
and health insurance issuers providing mental health benefits from imposing
lower aggregate annual or lifetime dollar-limits on mental health benefits than
any such limits for medical and surgical benefits. MHPA's requirements do not
apply to small employers who have between 2 and 50 employees or to any group
health plan whose costs increase one percent or more due to the application of
these requirements. PHC would be considered a health insurance issuer and
subject to NMHPA's requirements. Federal regulations implementing MHPA have not
been promulgated.
All of PHC's HMOs that contract with HCFA to provide services to Medicare
beneficiaries pursuant to a Medicare risk contract are subject to federal laws
and regulations. These HMOs may also be subject to state laws governing Medicare
contracting. HCFA has the right to audit any health plan operating under a
Medicare risk contract to determine the plan's compliance with federal law. PHC
HMOs with Medicare risk contracts must also comply with the requirements
established by PROs, which are organizations under contract with HCFA to monitor
the quality of health care received by Medicare beneficiaries and under contract
with certain states to monitor the quality of health care received by Medicaid
recipients.
All of PHC's HMOs that contract with states to provide services to Medicaid
recipients are subject to state and federal laws and regulations. HCFA and the
appropriate state regulatory agency have the right to audit any health plan
operating under a Medicaid managed care contract to determine the plan's
compliance with state and federal law. In some instances, states engage PROs to
perform quality assurance and utilization review oversight of Medicaid managed
care plans. PHC HMOs would be required to abide by these PROs requirements. In
addition, cost reimbursement reports are required with respect to Medicare cost
contracts and are subject to audit and revision.
The Social Security Act imposes criminal and civil penalties for paying or
receiving remuneration (which is deemed to include a kickback, bribe or rebate)
in connection with any federal health care program including, but not limited
to, the Medicare, Medicaid and CHAMPUS programs. The law and the related
regulations have been broadly interpreted to prohibit the payment, solicitation,
offering or receipt of any form of remuneration in return for the referral of
federal health care program patients or any item or service that is reimbursed,
in whole or in part, by any federal health care program. Similar anti-kickback
provisions have been adopted by many states which apply regardless of the source
of reimbursement. The Department of Health and Human Services ("DHHS") has
adopted safe harbor regulations specifying certain relationships and activities
that are deemed not to violate the federal anti-kickback statute. Specifically,
DHHS has adopted safe harbor regulations 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)
certain discounts offered to prepaid health plans by contracting providers are
deemed not to be violations of the anti-kickback provisions. PHC believes that
the incentives offered by its HMOs to Medicare and Medicaid beneficiaries and
the discounts its plans receive from contracting health care providers should
satisfy the requirements of the safe harbor regulations. However, failure to
satisfy each criterion of applicable safe harbor does not mean that the
arrangement constitutes a violation of the law; rather the safe harbor
regulations state that the arrangement must be analyzed on the basis of its
specific facts and
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circumstances. Accordingly, PHC believes that its arrangements do not violate
the federal anti-kickback laws or similar state anti-kickback laws.
PHC 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.
PHC contracts with the OPM to provide managed health care services under
the 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.
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 PHC.
RISK MANAGEMENT
The HMOs maintain general liability and professional liability (medical
malpractice and managed care liability) insurance coverage in amounts PHC
believes to be adequate. Contracting physicians are also required to maintain
professional liability coverage. In addition to liability coverage, PHC carries
"stop-loss" insurance to reimburse its HMOs for costs resulting from
catastrophic illnesses. This coverage generally applies to 90% of inpatient
hospital costs for a given patient in a calendar year above certain deductible
amounts which vary by health plan. In 1997, these amounts range from $60,000 to
$80,000. The coverage is currently underwritten through an agreement with
Mutual. 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.
EMPLOYEES
At September 30, 1997, PHC employed approximately 1,800 persons. None of
the employees is covered by a collective bargaining agreement.
TRADEMARKS
PHC has the right to use the name "Principal Health Care." PHC owns no
trademarks.
DESCRIPTION OF PROPERTY
PHC leases in aggregate approximately 591,000 square feet of office space
primarily for administrative offices in North Carolina, Delaware, Florida,
Georgia, Illinois, Indiana, Iowa, Kansas, Missouri, Louisiana, Nebraska, and its
Corporate office in Bethesda, Maryland. PHC believes its facilities are
appropriate for its operations.
LEGAL PROCEEDINGS
In the normal course of business, PHC has been named as defendant in
various legal actions seeking payments for claims denied by PHC, 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 September 30, 1997 may result in the assertion of additional claims.
With respect to medical malpractice, PHC carries processional malpractice and
general liability insurance for its operation on a claims made basis with
varying deductibles. 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 and cash flows of PHC.
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INFORMATION CONCERNING COVENTRY HEALTH CARE, INC.
BUSINESS
Newco, which was organized by Coventry and PHC on December 17, 1997 as a
Delaware corporation, was formed solely for the purpose of effecting the
transactions contemplated under the Combination Agreement. Prior to the
Effective Time, Newco shall organize Merger Sub as a Tennessee corporation for
the sole purpose of effecting the Merger. Prior to the Effective Time, neither
Newco nor Merger Sub will own any assets or conduct any business operations.
Newco is currently owned by Coventry and PHC and has issued 600 shares of
Newco Common Stock to Coventry and 400 shares of Newco Common Stock to PHC in
consideration of an initial capital contribution by each such party of $1.00 per
share. These shares of Newco Common Stock held by Coventry and PHC will be
canceled at the Effective Time. The current directors of Newco are Dale B. Wolf,
Senior Vice President, Chief Financial Officer and Treasurer of Coventry, and
Kenneth J. Linde, President and Chief Executive Officer of PHC. Mr. Wolf
currently serves as the President and Chief Executive Officer of Newco. Shirley
R. Smith, Vice President, Corporate General Counsel and Secretary of Coventry,
currently serves as Vice President and Secretary of Newco.
After the Effective Time, Coventry will be a wholly-owned subsidiary of
Newco and those subsidiaries of PHC that PHC shall transfer to Newco pursuant to
the Capital Contribution will be wholly-owned subsidiaries of Newco. After the
Effective Time, Newco will conduct business operations as a managed healthcare
company that provides comprehensive health benefits and services in the markets
in which Coventry and PHC currently operate. See the information set forth
herein under "Certain Information Concerning Coventry -- Business" and "Certain
Information Concerning PHC -- Business."
Newco's principal office is located at 6705 Rockledge Drive, Suite 100,
Bethesda, Maryland 20817.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of February 13,
1998, regarding the beneficial ownership of Coventry's Common Stock by (i) each
person or group who is known by Coventry to be the beneficial owner of more than
five percent of the Common Stock, (ii) all directors and nominees for director
of Coventry, (iii) each executive officer named in the Executive Compensation
Table and (iv) all directors and executive officers of Coventry as a group.
Information on beneficial owners other than officers or directors is based on
the most recent information filed by such beneficial owners with the Securities
and Exchange Commission. 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. Coventry believes that
each of the beneficial owners of the Common Stock listed below who is an
executive officer or director of Coventry, based on information furnished by
such owner, has sole voting and investment power (or shares such power 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.
<TABLE>
<CAPTION>
PERCENT OF
NUMBER OF COMMON STOCK
SHARES OF BENEFICIALLY OWNED
COMMON STOCK ---------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED PRE-MERGER POST-MERGER
- ------------------------------------ ------------------ ---------- -----------
<S> <C> <C> <C>
Warburg Pincus Ventures, L.P.(2).................. 6,517,047(3) 16.6% 9.9%
466 Lexington Avenue
New York, NY 10017
The Crabbe Huson Group, Inc.(4)................... 3,124,800 9.3% 5.4%
121 S.W. Morrison, Suite 1400
Portland, OR 97204
</TABLE>
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<TABLE>
<CAPTION>
PERCENT OF
NUMBER OF COMMON STOCK
SHARES OF BENEFICIALLY OWNED
COMMON STOCK ---------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED PRE-MERGER POST-MERGER
- ------------------------------------ ------------------ ---------- -----------
<S> <C> <C> <C>
Montgomery Asset Management, LLC(5)............... 2,617,000 7.9% 4.5%
101 California Street
San Francisco, CA 94111
Philip N. Bredesen(6)............................. 1,769,271 5.3% 3.0%
Office of the Mayor
107 Metropolitan Courthouse
Nashville, TN 37201
John H. Austin, M.D............................... 48,834(7) * *
Laurence DeFrance................................. 15,334(7) * *
Emerson D. Farley, Jr., M.D....................... 76,510(7) * *
Patrick T. Hackett(2)(3)(8)....................... 6,527,047 16.6% 9.9%
Richard H. Jones.................................. 164,995(7) * *
Lawrence N. Kugelman.............................. 66,000(7) * *
Rodman W. Moorehead, III(2)(3)(9)................. 6,522,047 16.6% 9.9%
Allen F. Wise..................................... 207,134(7) * *
Executive Officers and Directors as a Group (21
persons)........................................ 2,669,047(7) 8.0% 4.6%
</TABLE>
- ---------------
* Less than one percent
(1) For the 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 the joint Schedule 13D (the "Joint 13D") filed by Warburg, E.M.
Warburg, Joel Ackerman, Jonathan S. Leff, Patrick T. Hackett and Warburg,
Pincus & Co. ("WP"), E.M. Warburg is a New York limited liability company
that manages Warburg, a Delaware limited partnership, and WP is a New York
general partnership that is the sole general partner of Warburg Ventures.
According to the Joint 13D, Lionel I. Pincus is the managing partner of WP
and the managing member of E.M. Warburg and may be deemed to control both WP
and E.M. Warburg. The Joint 13D indicates that Joel Ackerman, Jonathan S.
Leff and Patrick T. Hackett, (the "Trustees"), have been appointed as voting
trustees under a Voting Trust Agreement, dated April 15, 1997, relating to
all shares of Coventry Preferred Stock or Coventry Common Stock that Warburg
may acquire. Mr. Leff is an employee of E.M. Warburg, and Messrs. Ackerman,
Hackett and Rodman W. Moorehead, III are general partners of WP and Managing
Directors and members of E.M. Warburg and Messrs. Hackett and Moorehead are
directors of Coventry. The address of each of the voting trustees is 466
Lexington Avenue, New York, N.Y. 10017. Under the terms of the Voting Trust
Agreement, the Trustees, acting by majority vote, have exclusive authority
to vote the shares held pursuant to the Voting Trust Agreement for the ten
year term of the Voting Trust Agreement. The Voting Trust Agreement will
terminate earlier if Warburg shall be deemed to beneficially own less than
ten percent of the Common Stock and shall give notice of termination to the
Trustees. Under the terms of the warrants held by Warburg, the warrant shall
not be exercisable as to any shares, the ownership of which by Warburg would
require approval under various state laws, unless and until such regulatory
approval has been obtained. Based upon approximately 58,284,770 shares of
Newco Common Stock expected to be outstanding immediately after the
Effective Time, warrants to purchase approximately 113,186 shares of Newco
Common Stock would not be exercisable pursuant to the foregoing provision
until Warburg received state regulatory approval from insurance regulatory
authorities in various states.
(3) Shares shown as beneficially owned by Warburg consists of 655,000 shares of
Common Stock, 3,749,400 shares of Coventry Common Stock that may be acquired
on conversion of $37,494,000 in aggregate
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principal amount of the Coventry Convertible Notes held by Warburg (or on
conversion of Coventry Preferred Stock if authorized and issued in exchange
for the Coventry Convertible Notes) and warrants to purchase 2,117,647
shares of Coventry Common Stock held by Warburg Ventures.
(4) According to its most recent Schedule 13G, The Crabbe Huson Group, Inc. is
an Oregon corporation.
(5) According to its most recent Schedule 13G, Montgomery Asset Management, LLC
is a Delaware limited liability company.
(6) Mr. Bredesen's shares are owned jointly by his wife, Andrea Conte.
(7) 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., 21,334 shares subject to
options; Laurence DeFrance, 13,334 shares subject to options; Emerson D.
Farley, Jr., M.D., 9,500 shares subject to options; Richard H. Jones,
161,036 shares subject to options; Lawrence N. Kugelman, 31,000 shares
subject to options; Allen F. Wise, 133,333 shares subject to options; and
all executive officers and directors as a group (21 persons), 631,747 shares
subject to options.
(8) Mr. Hackett disclaims beneficial ownership of the Common Stock that may be
acquired by Warburg on conversion of the Convertible Exchangeable Senior
Subordinated Notes, the Series A Preferred Stock (if authorized and issued
in exchange for the notes) or on the exercise of warrants. See Notes 2 and 3
above.
(9) Mr. Moorhead disclaims beneficial ownership of the Common Stock that may be
acquired by Warburg on conversion of the Convertible Exchangeable Senior
Subordinated Notes, the Series A Preferred Stock (if authorized and issued
in exchange for the notes) or on the exercise of warrants. See Notes 2 and 3
above.
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MANAGEMENT
DIRECTORS
Coventry's Board of Directors currently consists of nine persons, all of
whom are expected to be directors of Newco. Pursuant to the terms of the Warburg
Agreement, for so long as the Coventry Convertible Notes remain outstanding, the
holders of the Coventry Convertible Notes are entitled to designate two
directors. The holders of Coventry Preferred Stock, into which the Coventry
Convertible Notes are convertible, have the exclusive right, voting separately
as a class, to elect two directors for so long as at least 1,000,000 shares of
Coventry Preferred Stock remain outstanding. The holders of the Coventry
Convertible Notes have designated Messrs. Hackett and Moorehead. The Newco
Convertible Notes and Newco Preferred Stock contain substantially the same
rights with respect to designation or election of directors. In addition, the
Shareholders' Agreement provides that Mutual shall be entitled to designate six
directors. Mutual has designated Ms. Tallett and Messrs. Blair, Cain, Drury,
Graf and Linde.
The following are the full names and ages of each director of Newco.
<TABLE>
<CAPTION>
NAME AGE
- ---- ---
<S> <C>
John H. Austin, M.D......................................... 53
Thomas L. Blair............................................. 53
Philip N. Bredesen.......................................... 54
Gary M. Cain................................................ 54
Laurence DeFrance........................................... 53
David J. Drury.............................................. 53
Emerson D. Farley, Jr., M.D................................. 59
Thomas J. Graf.............................................. 49
Patrick T. Hackett.......................................... 36
Richard H. Jones............................................ 42
Lawrence N. Kugelman........................................ 55
Kenneth J. Linde............................................ 51
Rodman W. Moorhead, III..................................... 54
Elizabeth E. Tallett........................................ 48
Allen F. Wise............................................... 55
</TABLE>
Dr. Austin has been a director of Coventry since January 1988 and was
elected Chairman of the Board of Directors in December 1995. Dr. Austin has been
employed with Arcadian Management Services since June 1997. From March 1997
until June 1997, Dr. Austin was self-employed as a health care consultant. 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 health
care networks. From July 1992 to October 1994 he was a self-employed health care
consultant. He was employed as Executive Vice President and Medical Director for
Health Plan of America, a HMO from 1987 until June 1992. He is currently a
director of Quadramed Corporation.
Thomas L. Blair founded UP&UP in January 1995 and currently serves as the
its Chief Executive Officer and Chairman of the Board. He was the founder of AHP
in 1989 and served as its President and Chief Executive Officer from 1989 to
1992 and served as a member of AHP's Board after its acquisition by Mutual
through July 1993. From June 1993 until January 1995, Mr. Blair served as chief
executive officer and sole shareholder of IM&I, Inc. From 1977 until 1988, Mr.
Blair was a Principal of Jurgovan & Blair, Inc. ("JBI"), which developed and
managed HMOs and installed proprietary managed care systems in over sixty HMOs
and other managed care entities. JBI was acquired in 1986 by a major
publicly-traded insurer.
Mr. Bredesen accepted a position as a director of Coventry in April 1997.
He was formerly a director of Coventry 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.
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Mr. Cain has been employed by Mutual since 1966, where he currently serves
as Vice President. He is also an Executive Committee member of International
Claim Association.
Mr. DeFrance has been a director of Coventry since August 1990. Since March
1992 he has been self-employed as a business consultant and private investor. 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.
Mr. Drury has been employed by Mutual since 1966, where he currently serves
as Chairman and Chief Executive Officer. He is also a board member for Drake
University, Health Insurance Association of America ("HIAA"), American Council
for Capital Formation, Des Moines Development Corporation, and a member of Iowa
State University Business Advisory Council, Iowa Natural Heritage Advisory
Committee, ACLI Tax Steering Committee, and Actuaries Club of Des Moines.
Dr. Farley has been a director of Coventry since December 1994. Since 1972,
Dr. Farley has been engaged in the private practice of medicine in Richmond,
Virginia. 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. Graf has been employed by Mutual since 1972, where he currently serves
as Senior Vice President. He is a Fellow of the Society of Actuaries ("FSA") and
a Member of the American Academy of Actuaries ("MAAA"). Mr. Graf is also a
member and past President of Actuaries Club of Des Moines, a member of Greater
Des Moines Chamber of Commerce and past President of Cystic Fibrosis Foundation,
Iowa chapter, and Combined Health Appeal of Iowa.
Mr. Hackett has been a Managing Director of E.M. Warburg, which manages
Warburg Pincus Ventures since 1994. He served as an Associate at E.M. Warburg
from 1990 to 1991 and as Vice President from 1991 to 1993. Mr. Hackett is a
member of the Board of Directors of Transition Systems, Inc., a provider of
software and related services to the health care industry, and several privately
held companies.
Mr. Jones has been a director of Coventry since December 1995. A certified
public accountant, Mr. Jones was named President and Chief Executive Officer of
Group Health Plan, Inc., a wholly-owned subsidiary of Coventry, on October 7,
1996. He is also a Senior Vice President of Coventry and was Treasurer of
Coventry from June 1993 until December 1996. From November 1990 to June 1993, he
was Vice President, Chief Financial Officer and Treasurer of Coventry.
Mr. Kugelman has been a director of Coventry since August 1992. He was
interim Chief Executive Officer and President of Coventry from December 1995
until October 6, 1996. From March 1995 until December 1995 he was a
self-employed health care 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 Health
care 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. Linde has been President and CEO of PHC from its founding in January
1987. He serves on the Board of Directors of all of the PHC HMO plans. From
January 1985 to January 1987, Mr. Linde was Vice President, Eastern Division of
The Travelers Managed Care Systems, Inc. From October 1980 to February 1985, Mr.
Linde was Director, Division of Qualification, U.S. Department of Health and
Human Services.
Mr. Moorhead has been employed since 1973 by E.M. Warburg, a specialized
financial services firm in New York, where he currently serves as Senior
Managing Director. He is a director of NeXstar Pharmaceuticals, Inc.,
Transkaryotic Therapies, Inc., Xomed Surgical Products, Inc. and several private
companies. He is a Trustee of The Taft School and a member of the Overseer's
Committee on University Resources, Harvard College.
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Ms. Tallett is President and Chief Executive Officer of Dioscor, Inc.,
Serex, Inc. and most recently Gryphon Pharmaceuticals, Inc. Form 1973 to 1982
she served in a number of positions with the U.K. subsidiary of Warner-Lambert.
She was named to head the strategic planning functions for Warner-Lambert in New
Jersey in 1984 and became director of marketing operations for its Parke-Davis
pharmaceutical division. She joined Centocor, Inc. in 1987 and served as
President of its pharmaceutical products business from 1989 to 1992. She was
named as President and Chief Executive Officer of Transcell Technologies, Inc.
in 1992 and assumed her present positions with Disoscor, Inc. and Serex, Inc. in
1996, and with Gryphon Pharmaceuticals, Inc. in 1997. Ms. Tallett also serves as
Director for Serex, Inc., Varian Associates, Inc., and Prosperity New Jersey,
Inc. She is Director and Treasurer of Biotechnology Council of New Jersey and a
member of the New Jersey Commission on Prosperity.
Mr. Wise was elected a director of Coventry in October 1996. He was named
President and Chief Executive Officer of Coventry on October 7, 1996. Mr. Wise
was Executive Vice President of Metra Health, a managed health care Exchange
Agent, from October 1994 until it was acquired by United Health care Corp., a
managed health care Exchange Agent, in October 1995. He retained the same title
with United Health care Corp. until October 1996. From January 1994 to October
1994 he was President and Chief Executive Officer of Wise Health System, a
health care investment Exchange Agent. From 1991 to 1994, Mr. Wise was President
and Chief Executive Officer of Keystone Health Plan, a managed health care
Exchange Agent, and was also Chief Operating Officer of Independence Blue Cross,
a health care insurance Exchange Agent located in Philadelphia, Pennsylvania.
EXECUTIVE OFFICERS
The following are the persons who have been designated as executive
officers of Newco as of the date of this Proxy Statement/Prospectus. Additional
persons may be designated as executive officers of Newco prior to consummation
of the Business Combination.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Allen F. Wise........................ 55 President and Chief Executive Officer
Kenneth J. Linde..................... 51 Executive Vice President and Chief Operating Officer
Dale B. Wolf......................... 43 Chief Financial Officer
Sharon I. Taylor..................... 45 Senior Vice President of Operations
</TABLE>
Ms. Taylor has been Vice President -- Operations of Principal Health Care,
Inc. and all of its subsidiaries since May 1994, and was named Senior Vice
President -- Operations in June 1997. From January 1987 to May 1994, she served
as Vice President -- Finance and Administration for Principal Health Care, Inc.
and its subsidiaries. From July 1985 to January 1987, she was Regional
Controller of The Travelers Health Network, prior to which Ms. Taylor was
Director of Finance and Administration of Companion Health Care, a subsidiary of
Blue Cross/Blue Shield of South Carolina.
Mr. Wolf was elected Senior Vice President, Chief Financial Officer and
Treasurer of Coventry on December 9, 1996. From August 1995 to December 1996, he
was Executive Vice President of SpectraScan Health Services, Inc., a Connecticut
women's health care services company. From January 1995 to August 1995, Mr. Wolf
was Senior Vice President, Business Development for MetraHealth Companies, Inc.,
a Connecticut managed health care 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.
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NEWCO EXECUTIVE COMPENSATION
The following tables set forth annual, long-term and the other compensation
awarded to, earned by or paid to certain executive officers of Coventry (the
"Named Coventry Executive Officer") who have been named as executive officers of
Newco for the three fiscal years ended December 31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION ----------------------------
--------------------------------- SECURITIES
OTHER RESTRICTED UNDERLYING
ANNUAL STOCK OPTIONS/SARS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS (#) COMPENSATION
- --------------------------- ---- -------- -------- ------------ ---------- --------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Allen F. Wise(1).......... 1997 $464,400 $562,500(2) $ 74,745(3) $850,000 150,000 $22,448(4)
President & Chief 1996 137,395 -- -- 400,000 240
Executive Officer 1995 -- -- -- -- --
Dale B. Wolf(1)........... 1997 288,302 250,000(5) 146,614 -- 100,000 13,484(6)
Senior Vice President,
Chief Financial Officer
and Treasurer 1996 -- -- -- 100,000 --
1995 -- -- --
</TABLE>
- ---------------
(1) Allen F. Wise was appointed President and Chief Executive Officer of
Coventry effective October 7, 1996. Dale B. Wolf was appointed Senior Vice
President, Chief Financial Officer and Treasurer effective December 9, 1996.
(2) Includes 10,676 shares of unrestricted stock at fair market value as of the
date of grant.
(3) Relocation expenses reimbursement (taxable and nontaxable, and including
gross-up of taxable portion).
(4) Group life insurance premium ($1,743.75) employer matching contribution to
Coventry; 401(k) Plan ($4,177) and employer matching contribution to
Coventry's Supplemental Executive Retirement Plan ($16,527.71).
(5) Includes 5,890 shares of unrestricted stock at fair market value as of date
of grant.
(6) Group life insurance premium ($510), employer matching contribution to
Coventry's 401(K) Plan ($4,434) and employer match in Coventry's
Supplemental Executive Retirement Plan ($8,539).
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table provides information on option grants to the Named
Coventry Executive Officers during fiscal 1997. No stock appreciation rights
("SARs") were granted during fiscal 1997.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS (1)
------------------------------------------------
PERCENT OF
TOTAL
NUMBER OF OPTIONS/ POTENTIAL REALIZABLE VALUE AT
SECURITIES SARS ASSUMED ANNUAL RATES OF
UNDERLYING GRANTED TO EXERCISE STOCK PRICE APPRECIATION FOR
OPTIONS/ EMPLOYEES OR BASE OPTION TERM
SARS IN FISCAL PRICE EXPIRATION ------------------------------
NAME GRANTED(#) YEAR ($/SHARE) DATE 5% 10%
- ---- ---------- ---------- --------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Allen F. Wise................... 150,000 9.9% $ 17.00 7/17/07 $1,603,681 $4,064,043
50,000 3.3% 17.00 7/17/00 133,981 281,350
Dale B. Wolf.................... 50,000 3.3% 11.625 3/27/07 365,545 926,363
50,000 3.3% 15.9375 7/15/07 501,150 1,270,014
</TABLE>
- ---------------
(1) Generally, all options vest in equal increments annually over a four year
period; Mr. Wise's options vest in equal increments annually over three
years.
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<PAGE> 110
The following table provides information as to options exercised or held
during fiscal 1997 by the Named Coventry Executive Officers:
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
NUMBER OF SECURITIES IN-THE-MONEY
UNDERLYING UNEXERCISED OPTIONS/SARS AT
OPTIONS/SARS AT FISCAL YEAR-END
FISCAL YEAR-END(#) ($)
SHARES VALUE ---------------------- -----------------
ACQUIRED ON REALIZED EXERCISABLE (E)/ EXERCISABLE (E)/
NAME EXERCISE(#) ($) UNEXERCISABLE (U) UNEXERCISABLE (U)
- ---- ----------- --------- ---------------------- -----------------
<S> <C> <C> <C> <C>
Allen F. Wise......................... -- $ -- 133,333 E $ 566,665E
466,667 U NA
Dale B. Wolf.......................... -- $ -- 25,000 E $ 121,875E
175,000 U $ 181,250U
</TABLE>
CONVENTRY EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND
CHANGE-IN-CONTROL ARRANGEMENTS
Allen F. Wise. Mr. Wise entered into an Employment Agreement with Coventry
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 Coventry's Common Stock at an exercise
price of $11.00 per share, the fair market value per share of the Coventry
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 Coventry are sold or transferred or Coventry 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 Coventry 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 Coventry for any
reason other than cause, or he terminates his employment with Coventry 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), Coventry will
continue to pay his base salary at that time plus that portion of his annual
incentive bonus which is based on Coventry'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 Coventry during the term of his employment and for one year thereafter.
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 Coventry's Common Stock by
any person or entity; (ii) the merger or consolidation of Coventry 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 Coventry; 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. The consummation of the Combination
Agreement will not constitute a "Change in Control."
For purposes of the agreement 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. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
Coventry 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, Coventry'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
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<PAGE> 111
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 Coventry's Common Stock as of November 6, 1996 was $9.625
per share.
Rodman W. Moorhead, III and Patrick T. Hackett are Senior Managing Director
and Managing Director, respectively, of E.M. Warburg, which manages Warburg
Ventures.
PHC EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
With respect to certain executive officers of PHC (the "PHC Named Executive
Officers") who have been named as executive officers of Newco, the following is
a description of the employment contracts and other arrangements to which Newco
has agreed.
Kenneth J. Linde. Mr. Linde will enter into an Employment Agreement with
Newco effective as of the Effective Time 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. Linde receives a base salary
of $450,000 per year. In addition, Newco agrees to assume certain PHC Options,
which will entitle Mr. Linde to purchase 400,000 shares of Newco Common Stock at
an exercise price of $14.50 per share. 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 Newco are sold or transferred or Newco is merged or
consolidated with an unaffiliated entity. Mr. Linde 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 Newco and the remainder to be granted in
the sole discretion of the Compensation and Benefits Committee of the Board of
Directors. If Mr. Linde's employment is terminated by Newco for any reason other
than Good Cause, or he terminates his employment with Newco 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), Newco will continue to pay his
base salary at that time plus that portion of his annual incentive bonus which
is based on Newco's performance, if those criteria are met, for a period of
twelve months, plus any time period remaining in the Initial Term. In addition,
if (x) Mr. Linde is terminated without Good Cause at any time before the second
anniversary of the Effective Time or (y) the position of President and Chief
Executive Officer of Newco is vacant and Mr. Linde shall not be offered such
position and, as a result, Mr. Linde tenders his resignation within thirty days
thereafter, Mr. Linde shall be entitled to receive a payment (the "Global
Severance Payment") in the amount of $2,500,000 in lieu of any other severance
payments to which he might be entitled, and shall be entitled to receive such
stock options to purchase Newco Common Stock that are vested at the termination
of this employment. In consideration of these benefits, Mr. Linde agreed not to
compete with Newco during the term of his employment and for one year
thereafter.
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 Newco's Common Stock by any
person or entity; (ii) the merger or consolidation of Newco 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 Newco; 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.
DESCRIPTION OF NEWCO RIGHTS AGREEMENT
At the Effective Time, each Coventry Right issued under that certain Rights
Agreement by and between Coventry and ChaseMellon Shareholder Services, L.L.C.
shall be converted into one Newco Right to be
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<PAGE> 112
issued pursuant to the Newco Rights Agreement. Each Newco Right entitles the
registered holder to purchase from Newco one-tenth of one share of Newco Common
Stock at a price of $80.00 per one-tenth of one share (the "Purchase Price"),
upon the terms and subject to the conditions set forth in the Newco Rights
Agreement.
Until the earlier of the close of business (i) ten business days after a
public announcement that a person or group of affiliated or associated persons
(excluding Newco, any subsidiary of Newco, any employee benefit plan maintained
by Newco or any of its subsidiaries, or any entity holding shares of Newco
Common Stock for or pursuant to any such plan) have acquired beneficial
ownership of 15% or more of the shares of Newco Common Stock (thereby becoming
an "Acquiring Person") or (ii) ten business days after the commencement of, or
the first public announcement of an intention to make, a tender offer or
exchange offer the consummation of which would result in a person or group
(excluding Newco, any subsidiary of Newco, any employee benefit plan maintained
by Newco or any of its subsidiaries, or any entity holding shares of Newco
Common Stock for or pursuant to any such plan) becoming an Acquiring Person (the
earlier of such dates being called the "Exercisability Date"), the Newco Rights
will be evidenced, with respect to any certificate for shares of Newco Common
Stock outstanding as of the Record Date (as defined in the Newco Rights
Agreement), by such certificate together with a copy of a Summary of Rights (as
defined in the Newco Rights Agreement) and, with respect to any certificate for
shares of Newco Common Stock issued after the Record Date and before the
Exercisability Date (or earlier redemption or expiration of the Newco Rights),
by such certificate, which will bear a notation incorporating the Newco Rights
Agreement by reference.
Warburg will not be deemed to be an "Acquiring Person" unless Warburg
acquires an interest in shares representing 30% or more of the outstanding
shares of Newco Common Stock or Warburg directly or indirectly without the prior
approval of Newco's Board of Directors (i) commences or participates in a
solicitation of proxies in opposition to any proposal to shareholders by
management or in favor of any shareholder proposal opposed or not adopted by
management directly or indirectly, or (ii) solicits or assists any third party
to make a tender or exchange offer to purchase any shares of Newco Common Stock
or to propose a merger, Merger, acquisition of assets or similar transaction
involving Newco. The exception for Warburg will not apply to any transferee of
Warburg's interest in Newco.
Furthermore, Mutual, and any affiliate or associate of Mutual, will not be
deemed an "Acquiring Person" so long as none of them have breached any provision
of Section 1(b) or 4 of the Shareholders' Agreement, and, after the
Shareholders' Agreement shall no longer be effective, until such time as Mutual
shall beneficially own less than 15% of Newco Common Stock.
Until the Exercisability Date (or earlier redemption, exchange or
expiration of the Newco Rights), (i) the Newco Rights will be transferred with
and only with the shares of Newco Common Stock and (ii) the surrender for
transfer of any certificate for shares of Newco Common Stock represented by such
certificate will also constitute the transfer of the Newco Rights associated
with the shares of Newco Common Stock represented by such certificate. As soon
as practicable following the Exercisability Date, separate certificates
evidencing the Newco Rights ("Newco Rights Certificates") will be mailed to
holders of record of the shares of Newco Common Stock as of the close of
business on the Exercisability Date, and such separate Newco Right Certificates
alone will evidence the Newco Rights.
The Newco Rights are not exercisable until the Exercisability Date. The
Rights will expire on February 7, 2006 (the "Final Expiration Date"), unless the
Final Expiration Date is extended or unless the Rights are earlier redeemed or
exchanged by Newco, in each case as described below.
The purchase price payable, and the number of shares of Newco Common Stock
or other securities or property issuable, upon exercise of the Newco Rights are
subject to adjustment from time to time to prevent dilution (i) in the event of
a stock dividend on, or a subdivision, combination or reclassification of, the
shares of Newco Common Stock, (ii) upon the issuance to holders of the shares of
Newco Common Stock of certain rights, options or warrants to subscribe for or
purchase shares of Newco Common Stock at a price, or securities convertible into
shares of Newco Common Stock with a conversion price, less than the then current
market price of the shares of Newco Common Stock, or (iii) upon the distribution
to holders of the shares of Newco Common Stock of evidences of indebtedness or
assets (excluding regular quarterly cash dividends or
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<PAGE> 113
dividends payable in shares of Newco Common Stock) or of subscription rights or
warrants (other than those referred to above). The number of outstanding Newco
Rights and the number of shares of Newco Common Stock issuable upon exercise of
each Newco Right are also subject to adjustment in the event of a stock split of
the shares of Newco Common Stock or a stock dividend on the shares of Newco
Common Stock payable in shares of Newco Common Stock or subdivisions,
consolidations or combinations of the shares of Newco Common Stock occurring, in
any such case, prior to the Exercisability Date.
In the event, following the first date of public announcement by Newco or
an Acquiring Person that an Acquiring Person has become such (the "Stock
Acquisition Date"), Newco is, in effect, acquired in a merger or other business
combination transaction or more than 50% of its consolidated assets or earning
power is sold, proper provision will be made so that each holder of a Newco
Right, other than Newco Rights that were or are beneficially owned by the
Acquiring Person, will thereafter have the right to receive, upon the exercise
thereof at the then current Purchase Price (as defined in the Newco Rights
Agreement), that number of shares of Newco Common Stock of the Acquiring Person
equal to the result obtained by dividing (x) the then current Purchase Price
multiplied by the number tenths of a share of Newco Common Stock for which a
Newco Right is then exercisable by (y) 50% of the market price per share of
Newco Common Stock of the Acquiring Person at the time of such transaction. In
the event any person becomes an Acquiring Person, proper provision will be made
so that each holder of a Newco Right, other than Newco Rights that were or are
beneficially owned by the Acquiring Person which Newco Rights will thereafter be
null and void and the holder thereof shall have no rights with respect to such
Newco Rights, whether under the Newco Rights Agreement or otherwise, will
thereafter have the right to receive, upon the exercise thereof at the then
current purchase price, a number of shares of Newco Common Stock equal to the
result obtained by dividing the then current purchase price by 50% of the market
price per share of Newco Common Stock at the date such person became an
Acquiring Person. Under certain circumstances, other securities, property, cash
or combinations thereof, including a combination with shares of Newco Common
Stock, that are equal in value to the number of shares of Newco Common Stock for
which the Newco Right is exercisable may be issued in lieu of shares of Newco
Common Stock for which the Newco Right is exercisable.
Under certain circumstances, after a person becomes an Acquiring Person,
the Board of Directors of Newco may exchange the Newco Rights (other than Newco
Rights owned by the Acquiring Person), in whole or in part, at an exchange ratio
of one share of Newco Common Stock per Newco Right (subject to adjustment). With
certain exceptions, no adjustment in the purchase price will be required until
cumulative adjustments require an adjustment of at least 1% in such purchase
price. No fractional shares of Newco Common Stock will be issued, and in lieu
thereof, an adjustment in cash will be made based on the market price of the
shares of Newco Common Stock on the last trading day prior to the date of
exercise.
At any time prior to the close of business on the tenth business day after
the Stock Acquisition Date, Newco may redeem the Newco Rights in whole, but not
in part, at a price of $.001 per Newco Right (the "Redemption Price"), which may
be paid in cash, with shares of Newco Common Stock or other consideration deemed
appropriate by the Board of Directors of Newco. Immediately upon the action of
the Board of Directors of Newco to redeem the Newco Rights, Newco shall announce
the redemption, the right to exercise the Newco Rights will terminate, and the
only right of the holders of Newco Rights will be to receive the Redemption
Price.
Until a Newco Right is exercised, the holder thereof, as such, will have no
rights as a shareholder of Newco, including, without limitation, the right to
vote or to receive dividends.
The terms of the Newco Rights may be amended by the Board of Directors of
Newco without the consent of the holders of the Newco Rights at any time to cure
any ambiguity or to correct or supplement any defective or inconsistent
provisions and may, prior to the Exercisability Date, be amended to change or
supplement any other provision in any manner that Newco may deem necessary or
desirable. After the Exercisability Date, the terms of the Newco Rights may be
amended (other than to cure ambiguities or to correct or supplement defective or
inconsistent provisions) only so long as the amendment does not adversely affect
the interests of the holders of the Newco Rights (not including an Acquiring
Person, in whose hands the Newco Rights are void).
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The Newco Rights have certain anti-takeover effects. The Newco Rights will
cause substantial dilution to a person or group that attempts to acquire Newco
without conditioning the offer on a substantial number of Newco Rights being
acquired. The Newco Rights should not interfere with any merger or other
business combination approved by the Board of Directors of Newco since the Board
of Directors may, at its option, at any time prior to the close of business on
the tenth business day after the Stock Acquisition Date, redeem all but not less
than all the then outstanding Newco Rights at the Redemption Price.
A copy of the Newco Rights Agreement has been filed as an exhibit to this
Registration Statement. This summary description of the Newco Rights does not
purport to be complete and is qualified in its entirety by reference to the
Newco Rights Agreement, which is hereby incorporated herein by reference.
NEWCO OPTION PLAN
Under the Newco Plan, Newco may grant options and other rights with respect
to the Newco Common Stock to officers, other key employees, consultants and
Outside Directors (as defined in the Newco Plan) of Newco. A total of 7,000,000
shares of Newco Common Stock (equal to approximately 12.0% of the shares of
Newco Common Stock to be issued and outstanding immediately after the Effective
Time) are reserved for issuance under the Newco Plan.
As a condition of the Combination Agreement, Newco will assume Coventry's
obligations under each of the Coventry Plans (as defined below), and will assume
PHC's obligations under the PHC Plan (as defined below). At the Effective Time,
Coventry will issue to each holder of an option to purchase shares of Coventry
Common Stock under the Coventry Plans, and to each holder of an option to
purchase shares of PHC Common Stock under the PHC Plan, an option under the
Newco Plan to purchase shares of Newco Common Stock pursuant to the same terms
and subject to the same conditions as set forth in such holder's existing option
under the Coventry Plan or PHC Plan. At and after the Effective Time,
approximately 4.0 million shares of Newco Common Stock will be issuable upon
exercise of the options under the Newco Plan to be granted to the holders of
options under the Coventry Plans and the PHC Plans and approximately 3.0 million
shares of Newco Common Stock (equal to approximately 5.1% of the Newco Common
Stock to be outstanding at the Effective Time) will be reserved for issuance
under the Newco Plan.
DESCRIPTION OF THE NEWCO PLAN
The following is a description of the Newco Plan, the terms of which are
substantially the same as the terms of Newco's 1998 Stock Incentive Plan. Under
the Newco Plan, the Company may grant options and other rights with respect to
the Company's Common Stock to officers, other key employees, consultants and
Outside Directors of the Company.
In order for compensation under options and SARs granted to the CEO and
certain other executive officers to be exempt from the $1,000,000 limitation on
the deductibility of executive compensation under Section 162(m) of the Code,
the Plan must specify, and shareholders must approve, a limitation on the number
of shares that may be granted to any such executive officer in any year. Under
the Newco Plan, no officer of Newco or other person whose compensation may be
subject to the limitations on deductibility under Section 162(m) of the Code
will be eligible to receive awards under the Newco Plan relating to more than
400,000 shares of Newco Common Stock in any fiscal year (the "Section 162(m)
Maximum"). See "Section 162(m) Provisions" below.
In the event of any merger, reorganization, consolidation,
recapitalization, extraordinary cash dividend, stock dividend, stock split or
other change in Newco's corporate structure affecting the Newco Common Stock, an
appropriate substitution or adjustment will be made in the maximum number of
shares that may be awarded under the Newco Plan, in the number and option price
of options and other awards then outstanding under the Newco Plan and in the
Section 162(m) Maximum. An adjusted option price shall also be used to determine
the amount payable upon exercise of any SAR associated with an option. The Newco
Plan will be administered by a committee (the "Plan Committee") consisting of
not less than two Outside Directors
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appointed to serve by the Board of Directors. The initial Plan Committee will be
the Compensation and Benefits Committee of the Board of Directors.
Awards under the Newco Plan may be made to officers, other key employees
and Outside Directors of and consultants to Newco or any of its subsidiaries or
affiliates. The approximate number of employees who would potentially be
eligible for awards under the Newco Plan is 130 based on the actual number of
officers and Outside Directors and an estimated number of key employees and
consultants eligible for awards, but actual awards will be made only at the
discretion of the Plan Committee.
The Plan Committee shall have the authority to grant (i) stock options;
(ii) SARs; (iii) restricted stock; and/or (iv) other stock-based awards;
provided, however, that the power to grant and establish the terms and
conditions of awards to Outside Directors under the Newco Plan will be reserved
to the Board of Directors. All decisions made by the Plan Committee pursuant to
the Newco Plan shall be made in the Plan Committee's sole discretion and shall
be final and binding on all persons, including Newco and participants in the
Newco Plan.
Stock Options
ISOs and non-qualified stock options may be granted for such number of
shares as the Plan Committee may determine and may be granted alone, in addition
to or in tandem with other awards granted under the Newco Plan, but subject to
the per person limitation on awards; provided, however, that ISOs may be granted
only to employees of Newco, its subsidiaries or affiliates.
A stock option will be exercisable, in whole or in part, at such times and
subject to such terms and conditions as the Plan Committee may determine and
over a term to be determined by the Plan Committee, which term will be no more
than ten years after the date of grant, or no more than five years in the case
of an ISO awarded to certain 10% shareholders. The option price for any ISO
shall not be less than 100%, or 110% in the case of certain 10% shareholders, of
the fair market value of the Newco Common Stock as of the date of grant, and for
any non-qualified stock option will not be less than 100% of the fair market
value of the Newco Common Stock as of the date of grant. Payment of the option
price may be by check, note or such other instrument as the Plan Committee may
accept or, in the case of a non-qualified stock option, in shares of Newco
Common Stock or shares of restricted stock or shares subject to such option or
another award under the Newco Plan having a fair market value equal to the
option price.
Upon termination of an optionholder's employment for cause or upon
voluntary termination of employment by the optionee, such employee's stock
options will thereupon terminate. If an optionholder's employment is
involuntarily terminated without cause, stock options will be exercisable for
three months following termination or until the end of the option period,
whichever is shorter. On the disability of an employee, stock options will be
exercisable within the lesser of the remainder of the option period or, in the
case of a non-qualified stock option, three years, and in the case of an ISO,
one year from the date of disability. Upon the retirement of an employee, stock
options will be exercisable within the lesser of the remainder of the option
period or, in the case of a non-qualified stock option, three years, and in the
case of an ISO, three months from the date of retirement. Upon the death of an
employee, stock options will be exercisable by the deceased employee's legal
representative or legatee within the lesser of the remainder of the option
period or one year from the date of death. Only options which are exercisable on
the date of termination, death, disability or retirement may be subsequently
exercised or, except for an ISO, on such accelerated basis as determined by the
Plan Committee at or after grant.
SARs
SARs may be granted in conjunction with all or part of any stock option
granted under the Newco Plan. Once an SAR has been exercised, the related
portion of the stock option, if any, underlying the SAR will terminate. Upon
exercise of an SAR the optionee will receive cash and/or shares of Newco Common
Stock equal in value to the excess of the fair market value of one share of
Newco Common Stock over the option price per share in the related option
multiplied by the number of shares in respect of which the SAR shall have been
exercised. The method of payment shall be determined by the Plan Committee. SARs
shall be
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exercisable only at such time and to the extent that the options to which they
relate are exercisable, subject to any terms and conditions as determined by the
Plan Committee, and shall be transferrable only to the extent the underlying
option is transferrable.
Restricted Stock
Restricted stock may be granted alone, in addition to or in tandem with
other awards granted under the Newco Plan and/or cash awards made outside of the
Newco Plan, but must be accepted within 60 days after the award date. The
aggregate number of shares of Newco Common Stock that may be granted as shares
of restricted stock is limited to 3% of the then outstanding shares of Newco
Common Stock. The Plan Committee may condition the grant of restricted stock
upon the attainment of specified performance goals or such other factors as the
Plan Committee may determine. Upon termination of the employee's employment for
any reason during the restriction period, all shares subject to restriction will
vest, or be forfeited, in accordance with the terms and conditions established
by the Plan Committee at or after grant. During the restriction period, the
employee will have the right to vote the shares and to receive any cash
dividends, unless otherwise restricted by the Plan Committee. At the time of
award, the Plan Committee may permit or require that any cash dividends be
deferred and reinvested in additional shares of restricted stock. Stock
dividends will be treated as additional shares of restricted stock and will be
subject to the same terms and conditions as the initial grant.
Other Stock-Based Awards
The Plan Committee may also grant other types of awards that are valued by
reference to earnings per share or subsidiary performance. These awards may be
granted alone, in addition to or in tandem with stock options, SARs or
restricted stock granted under the Newco Plan or cash awards made outside of the
Newco Plan; provided, however, that none shall be granted in tandem with ISOs if
to do so would disqualify such ISOs under Section 422 of the Code. Such awards
will be made upon terms and conditions as the Plan Committee may in its
discretion provide. The Plan Committee may also provide for the grant of Newco
Common Stock upon completion of a specified performance period.
FEDERAL INCOME TAX ASPECTS OF THE NEWCO PLAN
The following is a brief summary of the federal income tax aspects of
awards made under the Newco Plan based upon the federal income tax laws in
effect on the date hereof. This summary is not intended to be exhaustive and
does not describe state or local tax consequences.
Incentive Stock Options
No taxable income is realized by the participant upon the grant or exercise
of an ISO. If Newco Common Stock is issued to a participant pursuant to the
exercise of an ISO, and if no disqualifying disposition of the shares is made by
the participant within two years of the date of grant or within one year after
the transfer of the shares to the participant, then: (i) upon the sale of the
shares, any amount realized in excess of the option price will be taxed to the
participant as long-term capital gain, and any loss sustained will be a capital
loss; and (ii) no deduction will be allowed to Newco for federal income tax
purposes. The exercise of an ISO will give rise to an item of tax preference
that may result in an alternative minimum tax liability for the participant
unless the participant makes a disqualifying disposition of the shares received
upon exercise.
If Newco Common Stock acquired upon the exercise of an ISO is disposed of
prior to the expiration of the holding periods described above, then generally:
(i) the participant will realize ordinary income in the year of disposition in
an amount equal to the excess, if any, of the fair market value of the shares at
exercise (or, if less, the amount realized on the disposition of the shares)
over the option price paid for such shares, and (ii) Newco will be entitled to
deduct any such recognized amount. Any further gain or loss realized by the
participant will be taxed as short-term or long-term capital gain or loss, as
the case may be, and will not result in any deduction by Newco.
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Subject to certain exceptions for disability or death, if an ISO is
exercised more than three months following the termination of the participant's
employment, the option will generally be taxed as a non-qualified stock option.
Non-Qualified Stock Options
Except as noted below, with respect to non-qualified stock options: (i) no
income is realized by the participant at the time the option is granted; (ii)
generally upon exercise of the option, the participant realizes ordinary income
in an amount equal to the difference between the option price paid for the
shares and the fair market value of the shares on the date of exercise, and
Newco will be entitled to a tax deduction in the same amount; and (iii) at
disposition, any appreciation (or depreciation) after the date of exercise is
treated either as short-term or long-term capital gain or loss, depending upon
the length of time that the participant has held the shares. See "Restricted
Stock" below for tax rules applicable where the spread value of an option is
settled in an award of restricted stock.
SARs
No income will be realized by a participant in connection with the grant of
an SAR. When the SAR is exercised, the participant will generally be required to
include as taxable ordinary income in the year of exercise an amount equal to
the amount of cash and the fair market value of any shares received. Newco will
be entitled to a deduction at the time and in the amount included in the
participant's income by reason of the exercise. If the participant receives
Newco Common Stock upon exercise of an SAR, the post-exercise appreciation or
depreciation will be treated in the same manner discussed above under
"Non-Qualified Stock Options."
Restricted Stock
A participant receiving restricted stock generally will recognize ordinary
income in the amount of the fair market value of the restricted stock at the
time the stock is no longer subject to forfeiture, less the consideration paid
for the stock. However, a participant may elect, under Section 83(b) of the
Code, within 30 days of the grant of the stock, to recognize taxable ordinary
income on the date of grant equal to the excess of the fair market value of the
shares of restricted stock (determined without regard to the restrictions) over
the purchase price of the restricted stock. Thereafter, if the shares are
forfeited, the participant will be entitled to a deduction, refund or loss, for
tax purposes only, in an amount equal to the purchase price of the forfeited
shares regardless of whether he made a Section 83(b) election. With respect to
the sale of shares after the forfeiture period has expired, the holding period
to determine whether the participant has long-term or short-term capital gain or
loss generally begins when the restriction period expires, and the tax basis for
such shares will generally be based on the fair market value of such shares on
such date. However, if the participant makes an election under Section 83(b),
the holding period will commence on the date of grant, the tax basis will be
equal to the fair market value of shares on such date (determined without regard
to restrictions), and Newco generally will be entitled to a deduction equal to
the amount that is taxable as ordinary income to the participant in the year
that such income is taxable.
Dividends and Dividend Equivalents
Dividends paid on restricted stock generally will be treated as
compensation that is taxable as ordinary income to the participant and will be
deductible by Newco. If, however, the participant makes a Section 83(b)
election, the dividends will be taxable as ordinary income to the participant
but will not be deductible by Newco.
Other Stock-Based Awards
The federal income tax treatment of other stock-based awards will depend on
the nature of any such award and the restrictions applicable to such award. Such
an award may, depending on the conditions
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applicable to the award, be taxable as an option, an award of restricted stock
or in a manner not described herein.
Section 162(m) Provisions
Section 162(m) of the Code imposes a limitation on the deductibility of
certain compensation paid to the chief executive officer and certain other
executive officers of publicly traded companies. Compensation paid to these
officers in excess of $1,000,000 cannot be claimed as a tax deduction by such
companies unless such compensation qualifies for an exemption as
performance-based compensation under Section 162(m) of the Code. It is
anticipated that compensation in respect of stock options and SARs granted under
the Newco Plan will qualify for an exemption as performance-based compensation
under Section 162(m) of the Code, if the exercise price per share for such
options and SARs is at least equal to the fair market value per share of Newco
Common Stock on the date of grant. Other awards (if any) granted under the Newco
Plan are not expected to qualify for an exemption as performance-based
compensation.
OTHER PROVISIONS OF THE NEWCO PLAN
Options and other rights that may be granted under the Newco Plan will vest
and become immediately exercisable (to the extent not theretofore vested and
exercisable), and the restrictions and forfeiture provisions applicable to
restricted stock and other stock-based awards will lapse if:
(i) any person or entity, including a "group" as defined in Section
13(d)(3) of the Exchange Act, other than Newco or a wholly-owned subsidiary
thereof or any employee benefit plan of Newco or any of its subsidiaries,
becomes the beneficial owner of Newco's securities having 35% or more of
the combined voting power of the then outstanding securities of Newco that
may be cast for the election of directors of Newco (other than as a result
of an issuance of securities initiated by Newco in the ordinary course of
business and other than transactions which are approved by a majority of
Newco's Board of Directors and in which Newco's shareholders (other than
Mutual and/or its subsidiaries and affiliates) immediately prior to the
consummation of the transactions own more than 50% of the voting securities
of the surviving corporation immediately after the transaction); or
(ii) as a result of, or in connection with, a cash tender or exchange
offer, merger or other business combination, sale of assets or contested
election, or any combination of the foregoing transactions, less than a
majority of the combined voting power of the then outstanding securities of
Newco, or any successor entity entitled to vote generally in the election
of directors of Newco or any such successor, are held in the aggregate by
holders of Newco's securities entitled to vote generally in the election of
directors of Newco immediately prior to such transaction;
(iii) during any period of two consecutive years, individuals who at
the beginning of such period constitute the Board of Directors cease for
any reason to constitute the majority thereof, unless the election or
nomination for election by Newco's shareholders of such individuals first
elected during such period was approved by a vote of at least two-thirds of
the directors then still in office who were directors at the beginning of
such period; or
(iv) the Plan Committee determines that a potential change in control
has occurred as a result of either (a) shareholder approval of an agreement
that would result in one of the events described above or (b) the
acquisition of beneficial ownership, directly or indirectly, by any person,
entity or group (other than Newco, any of its subsidiaries or any employee
benefit plans of Newco) of securities of Newco representing 5% or more of
the combined voting power of Newco's outstanding securities.
In addition to any other restrictions on transfer that may be applicable
under the terms of the Newco Plan or the applicable award agreement, no stock
option, SAR, restricted stock award or other stock-based award or other right
issued under the Newco Plan is transferrable by the participant without the
prior written consent of the Plan Committee, or in the case of an Outside
Director, the Board of Directors, other than (a) transfers by a participant to a
member of his or her Immediate Family or a trust for the benefit of the
participant or a
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member of his or her Immediate Family (except in the case of ISOs) or (b)
transfers by will or by the laws of descent and distribution (the designation of
a beneficiary will not constitute a transfer).
Following the occurrence of any event that would result in the acceleration
of vesting and exercisability as described above, the holders of stock options
and other rights will, unless otherwise determined by the Committee, receive
cash equal to the difference between the highest price paid per share of Newco
Common Stock in any transaction reported on the Nasdaq National Market, or paid
or offered in a bona fide transaction, during the 60 days immediately prior to
the change in control or potential change in control event and the exercise
price of the option or other right.
The Newco Plan may be amended, altered or discontinued by the Board of
Directors to the fullest extent permitted by the Exchange Act and the rules and
regulations promulgated thereunder, provided, however, that without the approval
of Newco's shareholders, no amendment, alteration or discontinuation may be made
which would (i) except as a result of a stock split, stock dividend,
extraordinary cash dividend, merger, recapitalization or similar transaction
affecting the Newco Common Stock, increase the maximum number of shares that may
be issued under the Newco Plan or increase the Section 162(m) Maximum, (ii)
change the provisions governing ISOs except as required or permitted under the
provisions governing ISOs in the Code, or (iii) make any change for which
applicable law or regulatory authority (including the regulatory authority of
the Nasdaq National Market or any other market or exchange on which the Newco
Common Stock is traded) would require shareholder approval or for which
shareholder approval would be required to secure full deductibility of
compensation received under the Newco Plan under Section 162(m) of the Code. No
amendment, alteration or discontinuation shall be made which would impair the
rights of an optionee without his consent.
The Newco Plan will expire on the tenth anniversary of the Effective Time,
but awards granted prior to such tenth anniversary may be extended beyond that
date.
DESCRIPTION OF COVENTRY PLANS
Pursuant to a resolution duly adopted by the Board of Directors of Newco
and pursuant to a shareholder vote by Coventry and PHC, as the only shareholders
of Newco, Newco will assume at the Effective Time each of Coventry's benefit
plans, as described below, in substantially the same form as then in effect.
As of December 31, 1996, Coventry 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 of Coventry.
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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:
<TABLE>
<CAPTION>
NUMBER OF OPTION PRICE
SHARES PER SHARE
---------- -----------------
<S> <C> <C>
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
========== =================
</TABLE>
Options vested and exercisable at December 31, 1996, 1995 and 1994 were
740,017, 888,573 and 664,266, respectively. As of December 31, 1996, Coventry
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.
Coventry 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 Coventry Common Stock. At the end
of each plan year, Coventry 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. Coventry 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.
On April 5, 1997, the Board of Directors of Coventry adopted the 1997 Stock
Incentive Plan (the "1997 Plan") and on August 20, 1997, the 1997 Plan was
approved by the shareholders of Coventry. Under the 1997 Plan, Coventry may
grant options and other rights with respect to the Coventry Common Stock to
officers, other key employees, consultants and Outside Directors of Coventry. A
total of 1,600,000 shares of Coventry Common Stock (equal to approximately 4.9%
of the issued and outstanding shares of Coventry Common Stock) are reserved for
issuance under the 1997 Plan.
As of December 31, 1997, Coventry had issued options to purchase a total of
498,250 shares of Coventry Common Stock under the 1997 Plan at an average option
price per share equal to $16.21. None of the options granted under the 1997 Plan
are currently vested and exercisable.
DESCRIPTION OF PHC PLAN
The PHC Plan contains substantially the same terms and conditions as
Coventry's 1997 Plan. Under the PHC Plan, PHC may grant options and other rights
with respect to PHC Common Stock to officers, other key employees, consultants
and outside directors of PHC. A total of 1,000,000 shares of PHC Common Stock
are reserved for issuance under the PHC Plan.
As of December 31, 1997, PHC had issued options to purchase a total of
750,000 shares of PHC Common Stock at an option price per share equal to $14.50,
which options will be assumed by Newco. None of the options granted under the
PHC Plan are currently vested and exercisable.
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of Newco consists of 200,000,000 shares of
Newco Common Stock, par value $0.01 per share, 6,000,000 shares of Newco
Preferred Stock, par value $0.01 per share, and 1,000,000 shares of undesignated
("blank check") preferred stock, par value $0.01 per share ("Undesignated
Preferred Stock"). The following description of Newco's capital stock does not
purport to be complete and is qualified in its entirety by reference to the
Delaware law and Newco's Certificate of Incorporation.
NEWCO COMMON STOCK
The shares of Newco Common Stock to be issued pursuant to the Merger will
be fully paid and nonassessable. Each holder of Newco Common Stock is entitled
to one vote per share in the election of directors and on all other matters
submitted to a vote of shareholders. Subject to the rights and preferences of
the Newco Preferred Stock and such shares, if any, of the 1,000,000 shares of
Undesignated Preferred Stock as may be issued in the future, each share of Newco
Common Stock will have an equal and ratable right to receive dividends as may be
declared by the Board of Directors out of funds legally available therefor and
to share equally and ratably in all assets available for distribution to
shareholders upon dissolution or liquidation. No holder of Newco Common Stock
has any preemptive rights to subscribe for any securities of Newco.
DESCRIPTION OF THE NEWCO PREFERRED STOCK
Dividend Preference
From the date of issuance until May 28, 1999 (the "Dividend Payment Date"),
the holders of Newco Preferred Stock will be entitled to receive, if when and as
declared, out of the net profits of Newco, dividends at the rate of $0.83 per
share per annum, payable solely in additional shares of Newco Preferred Stock,
valued at $10.00 per share, before any dividends are set apart for or paid upon
the Newco Common Stock or any other stock ranking on liquidation junior to the
Newco Preferred Stock in any year.
Dividends on the Newco Preferred Stock through the Dividend Payment Date
will be cumulative. Dividends shall be payable semi-annually on each November 28
and May 28, beginning May 28, 1998 through and including the Dividend Payment
Date. Under Delaware law, share dividends are not considered distributions and
may be made without reference to required levels of capital. The payment of
additional shares of Newco Preferred Stock to Warburg as a dividend will not
violate insurance laws or the terms of the Restated Credit Facility. At all
times after the Dividend Payment Date and when the Board of Directors of Newco
declares any cash dividend on the shares of Newco Common Stock, the Board of
Directors will be required to declare a cash dividend on each share of Newco
Preferred Stock equal to the dividend payable on each share of Newco Common
Stock multiplied by the number of shares of Newco Common Stock into which such
share of Newco Preferred Stock is convertible on the record date for such
dividend. Such dividend will be payable at the same time and otherwise on the
same terms as any dividend paid on the Newco Common Stock. Newco does not
currently pay cash dividends on its Newco Common Stock, and Newco does not
anticipate that any cash dividends will be declared or paid on the Newco Common
Stock or the Newco Preferred Stock in the foreseeable future. Any future
declaration of dividends will be subject to the discretion of the Board of
Directors.
Liquidation Preference
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of Newco, the holders of shares of Newco Preferred Stock then
outstanding will be entitled to be paid out of the assets of Newco available for
distribution to its shareholders, after and subject to the payment in full of
all amounts required to be distributed to the holders of any other preferred
stock of Newco ranking on liquidation prior and in preference to the Newco
Preferred Stock upon such liquidation, dissolution or winding up, but before any
payment may be made to the holders of stock subordinate to the Newco Preferred
Stock, an amount equal to $10.00 per share (subject to adjustment in the event
of any dividend, stock split, stock distribution or combination with respect to
such shares), plus any accrued but unpaid dividends as of the date of such
liquidation, dissolution or winding-up. A merger or consolidation of Newco into
or with another corporation, a
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merger or consolidation of any other corporation into or with Newco, or a sale,
conveyance, mortgage, pledge or lease of all or substantially all the assets of
Newco will be deemed to be a liquidation, dissolution or winding up of Newco for
the purposes of the Newco Preferred Stock, unless waived by the holders of a
majority of the then outstanding shares of Newco Preferred Stock or unless, as
of the date immediately preceding such merger or consolidation, the market price
is such that the outstanding shares of Newco Preferred Stock would be otherwise
redeemable under the terms of the Newco Preferred Stock.
Redemption
The shares of Newco Preferred Stock may not be redeemed prior to the third
anniversary of the Second Closing (as defined in the Warburg Agreement).
Thereafter, the Newco Preferred Stock will be subject to redemption, at the
option of Newco, if the market price of the Newco Common Stock on each of 20
consecutive days on which there was a price for such shares is at least $17.00
per share (appropriately adjusted for any stock split, stock dividend or similar
event) at a price in cash equal to the Redemption Price (as defined below) then
in effect.
Newco is required to redeem, to the extent permissible under Delaware law,
the shares of Newco Preferred Stock at a price of $10.00 per share (subject to
adjustments in the event of any stock dividend, stock split, stock distribution
or combination with respect to such shares), plus an amount equal to any
dividends accrued but unpaid thereon (the "Redemption Price") on May 15 in each
of 2002, 2003 and 2004 (each, a "Redemption Date") one-third of the shares of
Newco Preferred Stock issued and outstanding on the first Redemption Date or
such lesser number of shares as may then be outstanding.
Voting; Consent Rights; Election of Directors
Each issued and outstanding share of Newco Preferred Stock will be entitled
to the number of votes equal to the number of shares of Newco Common Stock into
which each such share of Newco Preferred Stock is convertible, at each meeting
of shareholders of Newco with respect to any and all matter presented to the
shareholders of Newco for their action or consideration other than the election
of directors, as described below. The holders of the Newco Preferred Stock will
vote together with the Newco Common Stock on all matters except the election of
directors, certain matters as to which the consent of the holders of a majority
of the shares of Newco Preferred Stock is required as described below, and
otherwise as required by law.
Newco may not, without first obtaining the affirmative vote or written
consent of the holders of a majority of the Newco Preferred Stock: (i) amend,
alter or repeal any provision of Newco's Certificate of Incorporation or amend,
alter or repeal any provision of Newco's Bylaws that would adversely affect the
rights of the holders of Newco Preferred Stock, including without limitation any
increase in the number of shares of Newco Preferred Stock; (ii) issue any shares
of Newco Preferred Stock other than upon the exchange of the Newco Convertible
Notes or payment of required dividends; or (iii) amend, alter or repeal the
preferences, special rights or other powers of the Newco Preferred Stock so as
to affect adversely the Newco Preferred Stock. For this purpose, the
authorization or issuance of any series of preferred stock with a preference or
priority over, or being on a parity with the Newco Preferred Stock as to the
right to receive dividends or amounts distributable upon liquidation,
dissolution or winding up of Newco will be deemed to affect adversely the Newco
Preferred Stock.
For so long as at least 1,000,000 shares of Newco Preferred Stock remain
outstanding (subject to adjustment in the event of any stock dividend, stock
split, stock distribution or combination with respect to such shares), the
holders of Newco Preferred Stock will have the exclusive right, voting
separately as a class, to elect two directors (the "Series A Directors"). In the
event the Board of Directors is increased to more than nine directors, for so
long as any shares of Newco Preferred Stock remain outstanding, the holders of
record of a majority of the outstanding shares of Newco Preferred Stock will be
entitled to select the number of Series A Directors obtained by multiplying the
number of directors on the Board of Directors (including the Series A directors)
by a fraction, the numerator of which is equal to the number of shares of Newco
Preferred Stock then outstanding and the denominator of which is equal to the
total number of shares of capital stock of Newco then outstanding measured in
each case on an as converted to Newco Common Stock basis.
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Each Series A Director will be (i) a partner, officer or employee of
Warburg or (ii) a person who is not a member of the board of directors or an
employee or consultant of any company which owns, manages or provides services
to HMOs or PPOs in any of the geographic markets in which Newco, its
subsidiaries, or the HMOs and PPOs managed by Newco or its subsidiaries operate
HMOs or PPOs as of the date such person agrees to be designated to the Board of
Directors of Newco. Each Series A Director so elected shall be in a separate
class from the other Series A Directors, and each shall serve for the term of
that class. In addition to the other requirements set forth in the Certificate
of Incorporation, a vacancy in the position of a Series A Director shall require
the affirmative vote of the holders of a majority of the Newco Preferred Stock
in order to be filled and the removal of a Series A Director shall require the
affirmative vote, at a special meeting of holders of Newco Preferred Stock
called for such purpose, or the written consent, of the holders of record of a
majority of the outstanding shares of Newco Preferred Stock.
Optional Conversion
Each share of Newco Preferred Stock may be converted at any time, at the
option of the holder thereof, into that number of fully-paid and nonassessable
shares of Newco Common Stock equal to a fraction, (x) the numerator of which is
equal to $10.00 and (y) the denominator of which is equal to the conversion
price then in effect (the "Conversion Price"); plus an additional number of
shares of Newco Common Stock equal to the amount of accrued but unpaid dividends
(whether or not currently payable) through the date of such conversion divided
by the Conversion Price then in effect. The Conversion Price will be initially
equal to $10.00 per share and will be subject to adjustment from time to time as
described below under the caption "Anti-dilution Provisions." Upon any
redemption of any Newco Preferred Stock or any liquidation of Newco, the right
of conversion will terminate at the close of business on the full business day
next preceding the date fixed for such redemption or for the payment of any
amounts distributable on liquidation to the holders of Newco Preferred Stock.
Because of the mandatory issuance of additional shares of Newco Preferred Stock
as dividends prior to the Dividend Payment Date, the Investors would own from
and after that date 4,707,634 shares Newco Preferred Stock which would be
convertible into a like number of shares of Newco Common Stock (assuring no
anti-dilution adjustment).
Mandatory Conversion
At any time, upon the affirmative vote of the holders of a majority of the
shares of Newco Preferred Stock then issued and outstanding, the Newco Preferred
Stock will be automatically converted into shares of Newco Common Stock at the
then effective Conversion Price.
Anti-dilution Provisions
The Warburg Agreement and the Certificate of Designation contain provisions
designed to prevent dilution of the conversion rights granted to the holders of
the Newco Convertible Notes or shares of Newco Preferred Stock, respectively,
which provisions provide for an adjustment to the Conversion Price in the event
of certain dilutive issuances. Subject to certain exceptions, the Conversion
Price and the number of shares issuable upon conversion of such Newco
Convertible Notes or such Newco Preferred Stock, as applicable, will be adjusted
in the event of an issuance or sale, or a transaction that is defined by the
provisions of the Warburg Agreement or the Certificate of Designation to be an
issuance or sale, of shares of Newco Common Stock by Newco at a price per share
less than the average market price for the ten-day trading period immediately
preceding such issuance (the "Market Price"). In such event, the Conversion
Price will be adjusted to equal the amount determined by the product of the
Conversion Price in effect immediately prior to such issuance by a fraction, (x)
the numerator of which will be equal to the sum of the number of shares of Newco
Common Stock deemed outstanding immediately prior to such issuance and the
number of shares that would have been issued in such transaction had the
purchase price per share been equal to the Market Price and (y) the denominator
of which shall be the total number of shares deemed outstanding after such
issuance.
For purposes of determining the adjustment to the Conversion Price,
"issuance or sale" of Newco Common Stock will include any issuance (including
any issuance in lieu of payment of a dividend) of any rights to subscribe for or
to purchase, or any options for the purchase of, Newco Common Stock or any stock
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or other securities convertible into or exchangeable for Newco Common Stock
(such rights or options hereinafter being called, "Options" and such convertible
or exchangeable securities hereinafter called, "Convertible Securities" in which
the aggregate consideration received by Newco as consideration for (a) the
issuance or grant of such Options or Convertible Securities, (b) the exercise of
such Option and (c) the conversion of such Convertible Security will be less
than the product of (x) the number of shares of Newco Common Stock issuable upon
the exercise of such Option or conversion of such Convertible Security and (y)
the Market Price. The anti-dilution provisions of the Warburg Agreement and the
Certificate of Designation will not apply to certain issuances of securities by
Newco, including (i) stock options to employees, consultants or directors of
Newco adopted by the Board of Directors, (ii) pursuant to options, warrants and
convertible securities in existence on the Closing Date (as defined in the
Warburg Agreement), (iii) upon exercise of the Warrants (as defined in the
Warburg Agreement), (iv) upon conversion of the Newco Preferred Stock or the
sale of additional shares of Newco Preferred Stock, and (v) in connection with
an underwritten public offering of securities for cash pursuant to a
registration statement filed under the Securities Act.
In addition, the anti-dilution provisions of the Warburg Agreement and the
Certificate of Designation provide that (a) the Conversion Price will be
adjusted to reflect any subdivisions or consolidations of the Newco Common
Stock; (b) upon any declaration of cash dividend, stock dividend, offering of
securities pro rata to holders of Newco Common Stock or any capital
reorganization or recapitalization, including any subdivision or combination of
the outstanding shares of Newco Common Stock, consolidation or merger of Newco
with, or sale of all or substantially all of Newco's assets to, another
corporation; or a voluntary or involuntary dissolution, liquidation or winding
up of Newco, Newco shall give the holders of the Newco Preferred Stock and Newco
Convertible Notes at least 20 days advance written notice; and (c) in the event
Newco grants, issues or sells any Options, Convertible Securities or rights to
purchase property ("Purchase Rights") to the holders of any class of Newco
Common Stock in a transaction that does not result in an adjustment to the
Conversion Price then in effect, Newco will provide the holder of the Newco
Preferred Stock or Newco Convertible Notes the right to acquire a pro rata
portion of the Purchase Rights.
Pursuant to the Warburg Consent to be executed and delivered by Warburg to
Coventry at or prior to the Effective Time, the above anti-dilution provisions
have been waived with respect to the Business Combination.
DESCRIPTION OF THE UNDESIGNATED PREFERRED STOCK
Newco is authorized to issue 1,000,000 shares of Undesignated Preferred
Stock. The terms "undesignated preferred stock" or "blank check preferred stock"
refer to preferred stock for which the designations, preferences, conversion
rights or other rights, including voting rights, qualifications, limitations or
restrictions thereof, are determined by board of directors of a company. The
authorization of Undesignated Preferred Stock gives the Board of Directors the
ability to authorize the creation and issuance of shares of preferred stock in
one or more series with such rights as may be determined in the Board's sole
discretion without further authorization by shareholders.
It is not possible to determine the actual effect of the designation of a
series of preferred stock on rights of the shareholders of Newco until the Board
of Directors determines the rights of the holders of the series of the preferred
stock. However, such effects might include (i) restrictions on the payment of
dividends to holders of the Newco Common Stock, (ii) dilution of the equity
interests and voting power if the series of preferred stock is convertible into
Newco Common Stock; and (iii) restrictions upon any distribution of assets to
the holders of the Newco Common Stock upon liquidation or dissolution and until
the satisfaction of any liquidation preference granted to the holders of
preferred stock.
The purpose of Undesignated Preferred Stock is to enhance Newco's ability
to take advantage of financing alternatives, including financing of acquisitions
by Newco, and shares of Undesignated Preferred Stock will only be issued in
financing transactions or as consideration for an acquisition by Newco. Newco
will not issue, without prior shareholder approval, any series of preferred
stock to any individual or group for any defensive or anti-takeover purpose. The
issuance of a series of preferred stock in a financing transaction or as
consideration for an acquisition by Newco, however, could have the effect of
discouraging or making an
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acquisition of Newco more costly in certain circumstances and provisions
requested by an investor could give the investor the ability to influence a
contest for control of Newco. The Board of Directors is not aware of any present
effort to accumulate shares of Newco Common Stock or take any other action for
the purpose of gaining control of Newco. An issuance of preferred stock could
also have the effect of diluting the earnings per share and book value per share
of the Newco Common Stock held by the shareholders.
In designating the preferences, limitations, and relative rights of any
series of preferred stock, the Board of Directors will, if this proposal is
approved by the shareholders of Newco, have the authority to provide that the
shares of any such series may: (i) have special, confidential, or limited voting
rights or no voting rights; provided, however, that the shares, if not
convertible into Newco Common Stock, will not have more than one vote per share,
except as otherwise required by law, and if convertible into Newco Common Stock
will not have more votes per share than they would have if they were so
converted, except as otherwise required by law; (ii) be redeemable or
convertible: (a) at the option of Newco, by the shareholder or another person on
the occurrence of a designated event; (b) for cash, indebtedness, securities, or
other property; or (c) in a designated amount or in an amount determined in
accordance with a designated formula or by reference to extrinsic data or
events; (iii) entitle the holders to distributions calculated in any manner,
including dividends that may be cumulative, noncumulative, or partially
cumulative; and (iv) have a preference over any other classes or series of
shares with respect to distributions, including dividends and distributions upon
the dissolution of Newco, all as Board of Directors may deem advisable and as
are not inconsistent with Delaware law or Newco's Certificate of Incorporation.
The exact terms of any series of preferred stock will be negotiated with
investors purchasing such stock and will vary depending on the particular needs
and concerns of such investors and Newco.
CERTAIN DIFFERENCES IN RIGHTS OF NEWCO AND COVENTRY SHAREHOLDERS
Coventry is a Tennessee corporation subject to the provisions of the
Tennessee Business Corporation Act (the "TBCA"). Newco is a Delaware corporation
subject to the provisions of the Delaware General Corporation Law (the "DGCL").
Stockholders of Coventry, whose rights are governed by Coventry's Restated
Charter and Bylaws and by the TBCA, will, upon consummation of the Merger,
become stockholders of Newco whose rights will then be governed by the
Certificate of Incorporation and Bylaws of Newco and by the DGCL. The following
is a summary of the material differences in the rights of stockholders of Newco
and Coventry and is qualified in its entirety by reference to the governing law
and the Certificate of Incorporation or Charter and Bylaws of each of Newco and
Coventry. Certain topics discussed below are also subject to federal law and the
regulations promulgated thereunder.
REQUIRED VOTE FOR AUTHORIZATION OF CERTAIN ACTIONS
The DGCL provides that the recommendation of a corporation's board of
directors and the approval of a majority of the outstanding shares of a
corporation's common stock entitled to vote thereon is required (i) to effect a
merger or consolidation in certain cases, (ii) to amend the certificate of
incorporation in most instances, and (iii) to sell, lease or exchange all or
substantially all of a corporation's assets. With respect to a merger, no vote
of the corporation's stockholders would be required if the corporation were the
surviving corporation and (i) the related agreement of merger did not amend the
corporation's certificate of incorporation, (ii) each share of common stock
outstanding immediately before the merger was an identical outstanding or
treasury share of common stock after the merger and (iii) the number of shares
of common stock to be issued in the merger (or to be issuable upon conversion of
any convertible instruments to be issued in the merger) did not exceed 20% of
the shares of the common stock outstanding immediately before the merger.
The TBCA provides that the approval of a corporation's board of directors
and of a majority of the outstanding shares of common stock entitled to vote
thereon would generally be required to approve a merger, share exchange, or to
sell, lease, exchange or otherwise dispose of substantially all of a
corporation's assets. In accordance with the TBCA, submission by a corporation's
board of directors of any such action may be conditioned on any basis, including
without limitation, conditions regarding a super-majority voting require-
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ment or that no more than a certain number of shares indicate that they will
seek dissenters' rights, if such rights are otherwise available.
With respect to a merger or share exchange, the TBCA provides that no vote
of the stockholders of a corporation would be required if the corporation were
the surviving corporation and (i) the charter would remain unchanged after the
transaction, subject to certain exceptions; (ii) each stockholder of the
corporation immediately before the transaction would hold an identical number of
shares, with identical rights and preferences, after the transaction; (iii) the
number of voting shares outstanding immediately after the transaction plus the
number of voting shares issuable as a result of the transaction (either by
conversion of securities issued pursuant to the transaction or the exercise of
rights and warrants issued pursuant to the transaction), will not exceed by more
than 20% the number of voting shares of the surviving corporation outstanding
immediately before the transaction; and (iv) the number of participating shares
outstanding immediately after the transaction, plus the number of participating
shares issuable as a result of the transaction (either by conversion of
securities issued pursuant to the transaction or the exercise of rights and
warrants issued pursuant to the transaction), will not exceed by more than 20%
the total number of participating shares outstanding immediately before the
transaction.
With respect to a sale, lease, exchange or other disposition of
substantially all the assets of a corporation, no vote of the stockholders of
the corporation would be required if such transfer were conducted in the regular
course of business or if such transfer were made to a wholly-owned subsidiary of
the corporation.
NUMBER OF DIRECTORS; FILLING OF VACANCIES ON THE BOARD
The number of members of Newco's Board of Directors shall initially be one
director and, immediately prior to the consummation of the Business Combination
shall increase to 15 directors, or such other number as shall be determined by
the Board of Directors of Newco. Upon the increase in the number of directors to
15 directors, each of the directors elected to the vacancies which result from
the increase in the number of directors shall be elected by the shareholders of
Newco and shall serve until the expiration of the term of the class of directors
to which such director shall be elected and until his or her successor is
elected and qualified. Thereafter, any vacancies on Newco's Board of Directors
shall be filled by the affirmative vote of a majority of the remaining directors
entitled to vote although less than a quorum of the Board of Directors. In
addition, the DGCL provides that if, at the time of filling any vacancy or newly
created directorship, the directors then in office constitute less than a
majority of the whole Board of Directors (as constituted immediately prior to
such increase), the Court of Chancery may, upon the application of any
stockholder or stockholders holding at least ten percent (10%) of the total
number of outstanding shares having the right to vote for such directors,
summarily order an election to be held to fill any such vacancies or newly
created directorships, or to replace the directors chosen by the directors then
in office. A director elected to fill a vacancy by the directors of Newco shall
serve until the next annual meeting of the shareholders and until his or her
successor shall be elected and qualifies.
The number of members of Coventry's Board of Directors may be increased or
decreased from time to time by Coventry's Board; provided, however, that the
number shall be not less than three or more than eleven. Any vacancies on
Coventry's Board shall be filled by the affirmative vote of a majority of the
remaining directors entitled to vote although less than a quorum of the Board of
Directors. A director elected to fill a vacancy on Coventry's Board shall be
elected for the unexpired term of his predecessor in office.
OFFICERS OF THE CORPORATION
The general and active control of the business and affairs of Newco belongs
to the President and Chief Executive Officer. The Executive Vice President and
Chief Operating Officer of Newco shall perform the duties of the Chief Operating
Officer of the corporation and such other duties as the Board of Directors shall
prescribe and, in the absence or disability of the Chief Executive Officer,
shall perform the duties and have the authority and exercise the power of the
Chief Executive Officer.
The general and active control of the business and affairs of Coventry
belongs to the President and Chief Executive Officer.
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INSPECTION OF BOOKS AND RECORDS
Under the DGCL, any stockholder of record, either in person or by attorney
or other agent, upon written demand under oath stating the purpose thereof, has
the right to inspect certain of a corporation's records during the corporation's
usual business hours. This right is limited, however, to inspection for "a
proper purpose," which is defined as "a purpose reasonably related to such
person's interest as a stockholder."
Under the TBCA, a corporation's stockholders are entitled to inspect and
copy, during regular business hours at the corporation's principal office, the
minutes of stockholder meetings, the charter, the bylaws, annual reports, and
certain other records of the corporation, provided the stockholder gives the
corporation written notice of his or her demand at least five business days
before the date on which he or she wishes to inspect and copy the records. In
addition, a stockholder who makes a demand in good faith, for a proper purpose,
and describes with reasonable particularity his or her purpose and the records
he or she desires to inspect, and if the records are directly connected with
this purpose, may also, upon five days' written notice, inspect and copy: (i)
accounting records of the corporation; (ii) the records of stockholders and
excerpts from minutes of any meeting of the corporation's board of directors;
(iii) records of any action of a committee of the corporation's board of
directors while acting in place of the board of directors on behalf of the
corporation; (iv) minutes of any meeting of the stockholders; and (v) records of
action taken by the stockholders or board of directors without a meeting.
ACTIONS BY WRITTEN CONSENT OF STOCKHOLDERS
The DGCL allows stockholders to act by written consent in lieu of a
stockholders meeting by the affirmative vote of not less than the minimum number
of votes that would be necessary to authorize or take the action at a
stockholders meeting called for the purpose.
The TBCA provides that any action that may be taken at a stockholders
meeting may be taken without a meeting only if a unanimous written consent
setting forth the matter is signed by each stockholder entitled to vote on the
matter. A unanimous written consent, however, is unattainable by a public
company in most circumstances.
DIVIDENDS AND OTHER DISTRIBUTIONS
Under the DGCL, dividends may be paid out of the surplus (as defined in the
DGCL) of the corporation or, if there is no surplus, out of net profits for the
year in which the dividend is declared and/or the preceding fiscal year
(provided that if paid out of net profits, the amount of capital of the
corporation is not less than the aggregate amount of the capital represented by
outstanding stock of all classes having a preference upon the distribution of
assets). The DGCL also prohibits the purchase or redemption of stock when the
capital of the corporation is impaired or if such redemption would impair the
capital of the corporation; however, shares entitled to a preference upon any
distribution of assets may be purchased or redeemed out of capital if they are
to be retired.
The TBCA provides that the a corporation generally may make dividends or
other distributions to its stockholders unless after the distribution either (i)
the corporation would not be able to pay its debts as they become due in the
usual course of business or (ii) the corporation's assets would be less than the
sum of its liabilities plus the amount that would be needed to satisfy the
preferential dissolution rights of its preferred stock.
VOLUNTARY DISSOLUTION
The DGCL permits the dissolution of a corporation if (i) the board of
directors, by resolution adopted by a majority of the whole board, deems such
dissolution advisable and (ii) a majority of the outstanding stock of the
corporation votes for the proposed dissolution at a stockholders meeting called
for the purpose of acting upon such resolution. The DGCL also permits
dissolution without action by the board of directors if all stockholders
entitled to vote thereon shall consent thereto in writing.
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The TBCA provides that a corporation may be dissolved if the corporation's
board of directors proposes dissolution and a majority of the outstanding shares
of the corporation's common stock entitled to vote thereon approves. In
accordance with the TBCA, the corporation's board of directors may condition its
submission of a proposal for dissolution on any basis, including a greater
stockholder vote requirement.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Both the DGCL and the TBCA provide in certain situations for mandatory and
permissive indemnification of directors and officers in substantially the same
manner. Both the DGCL and the TBCA provide that statutory indemnification is not
to be deemed exclusive of any other rights to which a director or officer
seeking indemnification may be entitled; provided, however, that the TBCA states
that no indemnification may be made if a final adjudication adverse to the
director or officer establishes his or her liability (i) for any breach of
loyalty to the corporation or its stockholders; (ii) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law; or (iii) for unlawful distributions.
The DGCL permits a corporation to include in its certificate of
incorporation a provision eliminating or limiting the personal liability of a
director to the corporation or its stockholders for monetary damages for breach
of the fiduciary duty as a director, provided that such provision shall not
eliminate or limit the liability of a director (i) for any breach of the
director's duty of loyalty to the corporation or its stockholders, (ii) for acts
or omissions in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) for violating Section 174 of the DGCL, or (iv) for any
transaction from which the director derived an improper personal benefit. Newco
has adopted such a provision which eliminates director liability to Newco and
its stockholders for damages for breach of fiduciary duty to the fullest extent
permitted by the DGCL. The TBCA does not contain a similar provision.
DISSENTERS' AND APPRAISAL RIGHTS
The DGCL provides that stockholders of a Delaware corporation do not have
appraisal rights when a Delaware corporation listed on a national securities
exchange, or with more than 2,000 stockholders of record, merges or consolidates
with another corporation, and consideration satisfying certain requirements is
paid to the Delaware corporation's stockholders (generally, stock of the
surviving corporation or stock of another public corporation). The TBCA contains
a similar provision, except that stockholders of a Tennessee corporation do not
have appraisal rights if the corporation is listed on a national securities
exchange, regardless of the consideration paid in the merger or consolidation.
The Newco Common Stock will be listed on The Nasdaq National Market prior to the
Effective Time. Consequently, appraisal rights are not available to stockholders
of Newco assuming the consideration satisfies the requirements under the DGCL.
The TBCA generally provides dissenters' rights for mergers and share
exchanges that would require stockholder approval, sales of substantially all
the assets (other than sales that are in the usual and regular course of
business and certain liquidations and court-ordered sales), and certain
amendments to the charter that materially and adversely affect rights in respect
of a dissenter's shares. Dissenters' rights are not available as to any shares
which are listed on an exchange registered under Section 6 of the Exchange Act
or are "national market system" securities as defined in rules promulgated
pursuant to the Exchange Act. The Coventry Common Stock is listed on The Nasdaq
National Market. Consequently, dissenters' rights are not available to
stockholders of Coventry.
BUSINESS COMBINATION STATUTE
The DGCL prohibits a publicly held Delaware corporation like Newco from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless (i) prior to such date either the
business combination or the transaction which resulted in the stockholder
becoming an interested stockholder is approved by the board of directors of the
corporation, (ii) upon consummation of the transaction which resulted in the
stockholder becoming an interested stockholder, the interested stockholder owns
at least 85% of the outstanding voting stock (excluding certain shares), or
(iii) on or after such date as the business
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combination is approved by the board and by the affirmative vote of at least
66 2/3% of the outstanding voting stock which is not owned by the interested
stockholder. A "business combination" as defined in the DGCL includes a merger,
asset sale and other transactions resulting in a financial benefit to the
stockholder. An "interested stockholder" as defined in the DGCL is a person who,
together with affiliates and associates, owns (or within three years, did own)
15% or more of the corporation's voting stock. For the purpose of the DGCL,
Newco's Board of Directors has preapproved the Business Combination with Mutual
and PHC, or any affiliate of either Mutual or PHC, with respect to the
transactions contemplated in the Combination Agreement.
The Tennessee Business Combination Act (the "Tennessee Business Combination
Act") provides that a party owning 10% or more of stock in a "resident domestic
corporation" (such party is called an "interested stockholder") cannot engage in
a business combination with the resident domestic corporation unless the
combination (i) takes place at least five years after the interested stockholder
first acquired 10% or more of the resident domestic corporation, and (ii) either
(A) is approved by at least 2/3 of the noninterested voting shares of the
resident domestic corporation or (B) satisfies certain fairness conditions
specified in the Tennessee Business Combination Act.
These provisions apply unless one of two events occurs. A business
combination with an entity can proceed without delay when approved by the target
corporation's board of directors before that entity becomes an interested
stockholder, or the resident corporation may enact a charter amendment or bylaw
to remove itself entirely from the Tennessee Business Combination Act. This
charter amendment or bylaw must be approved by a majority of the stockholders
who have held shares for more than one year prior to the vote. It may not take
effect for at least two years after the vote. Coventry has not adopted a
provision in its Charter or Bylaws removing it from coverage under the Tennessee
Business Combination Act.
The Tennessee Business Combination Act further provides an exemption from
liability for officers and directors of resident domestic corporations who do
not approve proposed business combinations or charter amendments and bylaws
removing their corporations from the Tennessee Business Combination Act's
coverage as long as the officers and directors act in "good faith belief" that
the proposed business combination would adversely affect their corporation's
employees, customers, suppliers, or the communities in which their corporation
operates and such factors are permitted to be considered by the board of
directors under the charter.
The United States Court of Appeals for the Sixth Circuit has held that the
Tennessee Business Combination Act is unconstitutional to the extent that it
applies to target corporations organized under the laws of states other than
Tennessee.
CONTROL SHARE ACQUISITION ACT
The Tennessee Control Share Acquisition Act ("TCSAA") strips a purchaser's
shares of voting rights any time an acquisition of shares in a covered Tennessee
corporation brings the purchaser's voting power to one-fifth, one-third or a
majority of all voting power. The purchaser's voting rights can be established
only by a majority vote of the other stockholders. The purchaser may demand a
special meeting of stockholders to conduct such a vote. The purchaser can demand
such a meeting before acquiring a control share only if it holds at least 10% of
outstanding shares and announces a good faith intention to make the control
share acquisition. A target corporation may or may not redeem the purchaser's
shares if the shares are not granted voting rights. The TCSAA applies only to a
corporation that has adopted a provision in its charter or bylaws expressly
declaring that the TCSAA will apply. Coventry has not adopted any provision in
its Charter or Bylaws electing protection under the TCSAA.
The United States Court of Appeals for the Sixth Circuit has held that the
TCSAA is unconstitutional as it applies to target corporations organized under
the laws of states other than Tennessee.
The DGCL contains no similar provisions with respect to control share
acquisitions.
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INVESTOR PROTECTION ACT
Tennessee's Investor Protection Act ("TIPA") applies to tender offers
directed at corporations (called "offeree companies") that have "substantial
assets" in Tennessee and that are either incorporated in or have a principal
office in Tennessee. The TIPA requires an offeror making a tender offer for an
offeree company to file with the Commissioner of Commerce and Insurance (the
"Commissioner") a registration statement. When the offeror intends to gain
control of the offeree company, the registration statement must indicate any
plans the offeror has for the offeree. The Commissioner may require additional
information material to the takeover offer and may call for hearings. The TIPA
does not apply to an offer that the offeree company's board of directors
recommends to stockholders.
In addition to requiring the offeror to file a registration statement with
the Commissioner, the TIPA requires the offeror and the offeree company to
deliver to the Commissioner all solicitation materials used in connection with
the tender offer. The TIPA prohibits "fraudulent, deceptive, or manipulative
acts or practices" by either side, and gives the Commissioner standing to apply
for equitable relief to the Chancery Court of Davidson County, Tennessee, or to
any other chancery court having jurisdiction whenever it appears to the
Commissioner that the offeror, the offeree company, or any of its respective
affiliates has engaged in or is about to engage in a violation of the TIPA. Upon
proper showing, the Chancery Court may grant injunctive relief. The TIPA further
provides civil and criminal penalties for violations.
The United States Court of Appeals for the Sixth Circuit has held that the
TIPA is unconstitutional to the extent that it applies to target corporations
organized under the laws of states other than Tennessee.
The DGCL contains no similar provisions with respect to investor
protection.
AUTHORIZED CORPORATION PROTECTION ACT
The Tennessee Authorized Corporation Protection Act ("TACPA") is the
vehicle through which the Tennessee statutes attempt to permit the Tennessee
Business Combination Act and the TCSAA to govern foreign corporations. The TACPA
provides that an authorized corporation can adopt a bylaw or a charter provision
electing to be subject to the operative provisions of the Tennessee Business
Combination Act and the TCSAA, which then become applicable "to the same extent
as such provisions apply to a resident domestic corporation." Authorized
corporations are those that are required to obtain a Certificate of Authority
from the Tennessee Secretary of State and that satisfy any two of certain tests
including having their principal place of business located in Tennessee; having
a significant subsidiary located in Tennessee; having a majority of such
corporation's fixed assets located in Tennessee; having more than 10% of the
beneficial owners of the voting stock or more than 10% of such corporation's
shares of voting stock beneficially owned by residents of Tennessee employing
more than 250 individuals in Tennessee or having an annual payroll paid to
residents of Tennessee that is in excess of $5,000,000; producing goods and/or
services in Tennessee that result in annual gross receipts in excess of
$10,000,000; or having physical assets and/or deposits located within Tennessee
that exceed $10,000,000 in value.
The United States Court of Appeals for the Sixth Circuit, however, has held
the TACPA is unconstitutional to the extent that it applies to target
corporations organized under the laws of states other than Tennessee.
The DGCL contains no similar provisions with respect to authorized
corporation protection.
GREENMAIL ACT
The Tennessee Greenmail Act ("TGA") applies to any corporation chartered
under the laws of Tennessee which has a class of voting stock registered or
traded on a national securities exchange or registered with the Commission
pursuant to Section 12(g) of the Exchange Act. The TGA provides that it is
unlawful for any corporation or subsidiary to purchase, either directly or
indirectly, any of its shares at a price above the market value, as defined in
the TGA, from any person who holds more than 3% of the class of the securities
purchased if such person has held such shares for less than two years, unless
either the purchase is first
121
<PAGE> 131
approved by the affirmative vote of a majority of the outstanding shares of each
class of voting stock issued or the corporation makes an offer of at least equal
value per share to all holders of shares of such class.
The DGCL contains no similar provision with respect to Greenmail.
LEGAL MATTERS
The validity of the shares of Newco Common Stock offered hereby will be
passed upon by Bass, Berry & Sims PLC, Nashville, Tennessee.
Bass, Berry & Sims PLC will render the opinion referred to under the
caption "Certain Federal Income Tax Consequences."
EXPERTS
The consolidated financial statements of Coventry included herein including
the consolidated balance sheets of Coventry and its 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 have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their report with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
The consolidated financial statements of PHC and its subsidiaries as of
December 31, 1996 and 1995, and for each of the three years in the period ended
December 31, 1996 have been audited by Ernst & Young, LLP, independent auditors,
as set forth in their report thereon and included herein. Such consolidated
financial statements are included herein in reliance upon such report given upon
the authority of such firm as experts in accounting and auditing.
AVAILABLE INFORMATION
Coventry is, and, as a result of the Business Combination, Newco will
become, subject to the informational requirements of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), and, in accordance therewith, files or
will file reports, proxy statements and other information with the Commission.
Such reports, proxy statements and other information can be inspected at, and
copies thereof may be obtained at prescribed rates from, the public reference
facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W.,
Washington, DC 20549, and from the Commission's Regional Offices at 7 World
Trade Center, Suite 1300, New York, New York 10048 and Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661-2511. The Commission
maintains a web site at http://www.sec.gov that contains such reports, proxy
statements and other information. The Coventry Common Stock is listed on The
Nasdaq Stock Market.
Newco has filed with the Commission a Registration Statement on Form S-4
under the Securities Act with respect to the securities of Newco to be issued in
connection with the Merger. As permitted by the rules and regulations of the
Commission, this Proxy Statement/Prospectus does not contain all of the
information set forth in the Registration Statement or the exhibits thereto. For
further information, reference is hereby made to such Registration Statement and
exhibits. Statements contained herein concerning provisions of documents are
necessarily summaries of the documents and each statement is qualified in its
entirety by reference to the copy of the applicable document filed with the
Commission.
122
<PAGE> 132
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
COVENTRY CORPORATION
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheet as of December 31, 1995 and
1996...................................................... F-3
Consolidated Statements of Operations for each of the three
years ended December 31, 1994, December 31, 1995 and
December 31, 1996......................................... F-4
Consolidated Statements of Stockholders' Equity for each of
the three years ended December 31, 1994, December 31, 1995
and December 31, 1996..................................... F-5
Consolidated Statements of Cash Flows of the three years
ended December 31, 1994, December 31, 1995 and December
31, 1996.................................................. F-6
Notes to Consolidated Financial Statements.................. F-7
Unaudited Condensed Consolidated Balance Sheets as of
December 31, 1996 and September 30, 1997.................. F-23
Unaudited Condensed Consolidated Statement of Operations for
each of the nine months ended September 30, 1996 and
1997...................................................... F-24
Unaudited Condensed Consolidated Statement of Cash Flows for
the nine months ended September 30, 1996 and 1997......... F-25
Notes to Condensed Unaudited Consolidated Financial
Statements................................................ F-26
PRINCIPAL HEALTH CARE, INC.
The historical consolidated financial statements of PHC have
been included herein. Because certain businesses of PHC
will not be transferred as part of The Merger and Capital
Contribution, the historical financial statements of PHC
should not be viewed as indicative of future operating
performance
Report of Independent Auditors.............................. F-29
Consolidated Balance Sheets as of December 31, 1995 and 1996
and the Unaudited Consolidated Balance Sheet as of
September 30, 1997........................................ F-30
Consolidated Statements of Income for each of the three
years ended December 31, 1994, December 31, 1995 and
December 31, 1996 and the Unaudited Consolidated
Statements of Income for each of the nine months ended
September 30, 1996 and 1997............................... F-32
Consolidated Statements of Stockholder's Equity for each of
the three years ended December 31, 1994, December 31, 1995
and December 31, 1996 and the Unaudited Consolidated
Statement of Stockholder's Equity for the nine months
ended September 30, 1997.................................. F-33
Consolidated Statements of Cash Flows for the three years
ended December 31, 1994, December 31, 1995 and December
31, 1996 and the Unaudited Consolidated Statements of Cash
Flows for the nine months ended September 30, 1996 and
1997...................................................... F-34
Notes to Consolidated Financial Statements.................. F-35
</TABLE>
F-1
<PAGE> 133
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)
F-2
<PAGE> 134
COVENTRY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 85,646 $ 64,127
Short-term investments...................................... 7,388 18,408
Accounts receivable, net of allowance for doubtful accounts
of $8,000 and $2,700, respectively........................ 37,921 32,118
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................... 10,370 9,459
-------- --------
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
======== ========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 135
COVENTRY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- -------- --------
<S> <C> <C> <C>
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
========== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 136
COVENTRY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
NET RETAINED
UNREALIZED EARNINGS TOTAL
COMMON ADDITIONAL INVESTMENT (ACCUMULATED STOCKHOLDERS'
STOCK PAID-IN CAPITAL GAIN (LOSS) DEFICIT) EQUITY
------ --------------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
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
===== ======== ====== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 137
COVENTRY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
-------- --------- --------
<S> <C> <C> <C>
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.............. (907) (3,890) 2,959
Other assets........................................... (5,652) (11,332) (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................................................ 34,565 5,664 56,397
Net cash used in operating activities of discontinued
operations................................................ -- -- (542)
-------- --------- --------
Net cash provided by operating activities................... 34,565 5,664 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) (59,319) (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) (24,938) (91,477)
Net cash provided by investing activities of discontinued
operations............................................. -- -- 8,809
-------- --------- --------
Net cash used in investing activities....................... (44,482) (24,938) (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........ 21,519 (3,981) 5,483
Cash and cash equivalents at beginning of period............ 64,127 68,108 62,625
-------- --------- --------
Cash and cash equivalents at end of period.................. $ 85,646 $ 64,127 $ 68,108
======== ========= ========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 138
COVENTRY CORPORATION
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.
OTHER RECEIVABLES -- Other receivables include interest receivable,
receivables from providers and suppliers and any other receivables that do not
relate to premiums.
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 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-
F-7
<PAGE> 139
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
lived asset. In the event such assets are judged to be impaired, the fair value
of the impaired asset is recorded based on future discounted cash flows and
sales recovery analysis. See Note B for further discussion. 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 ($116.4 million) and non-compete agreements ($1.9
million). Goodwill is amortized over periods ranging from 15 to 40 years and
non-compete agreements are amortized over the respective lives of the
agreements. 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 and APB 17, the Company periodically
evaluates the realizability of goodwill and intangible assets and the
reasonableness of the related lives in light of factors such as industry
changes, individual market competitive conditions, and operating income 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 expected benefit period up
to eight years. Effective April 1, 1997, the Company adopted a one-year period
for amortization of new service area and new product costs. 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 in Penn Group
Corporation (Penn Group), which owns 100% of HAPA. On October 31, 1994, the
Company purchased the Penn Group minority interest.
F-8
<PAGE> 140
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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,
accordingly, the net assets have been included in the consolidated financial
statements from the effective date of acquisition. The acquisition price
included, among other typical business assets and goodwill, consideration for
non-compete agreements, the expectation of entering into a favorable joint
marketing agreement and the
F-9
<PAGE> 141
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
opportunity to acquire additional Aetna membership at a favorable price. During
the fourth quarter of 1996, the Company determined that none of the
opportunities were being realized, cash flows were short of expectations (losses
in 1996 versus projected positive cash flows) and that Aetna had purchased U.S.
Healthcare, which has operations in the Company's service areas. In addition,
the Company filed suit against Aetna and U.S. Healthcare alleging breach of the
acquisition agreement, seeking enforcement of the non-compete agreement and
requesting other forms of relief. As a result, based on fair value estimates of
the intangibles on both the sales recovery and discounted cash flow basis, the
intangibles were written down to an amount that supported the estimated fair
value ($10.0 million) of the assets.
Effective April 1, 1996 the Company entered into a Joint Venture Agreement
with Hamilton Health Center, Inc. ("Hamilton") 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. Hamilton's rights are limited to the ability to
market the Company's product. HealthMate's only source of Medicaid membership is
through a government contract held by a wholly-owned subsidiary of the Company,
and as a result of the Company's contractual control rights, 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.
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
F-10
<PAGE> 142
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 cost structure in relation
to the contracts and recorded additional reserves of $1.6 million, primarily as
a result of increases in medical costs for inpatient alternatives such as
outpatient surgery and prescription drugs. The Company continually evaluates the
underlying costs expected to be incurred in servicing the contracts.
D. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
-------- --------
<S> <C> <C>
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
======== ========
</TABLE>
During the fourth quarter of 1996, the Company authorized an extensive
review of its medical office operations and commenced discussions with several
parties related to the probable disposition of such operations. 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, the Company determined that the carrying
amounts of certain of its property and equipment (primarily data processing
equipment that will not be utilized in the future as a result of a change in
management information systems structure determined by the Company in the fourth
quarter) was not 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.
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
F-11
<PAGE> 143
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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):
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
1996
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
======= ==== ===== =======
</TABLE>
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
1995
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
======= ==== ===== =======
</TABLE>
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):
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- -------
<S> <C> <C>
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
======= =======
</TABLE>
F-12
<PAGE> 144
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- -------
<S> <C> <C>
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
======= =======
</TABLE>
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):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
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
======== ======= =======
</TABLE>
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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
------- ------- ------
<S> <C> <C> <C>
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%
======= ======= ======
</TABLE>
F-13
<PAGE> 145
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
------- -------
<S> <C> <C>
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
======= =======
</TABLE>
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.
G. NOTES PAYABLE AND LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
------- -------
<S> <C> <C>
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
======= =======
</TABLE>
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
F-14
<PAGE> 146
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 transaction described in Note S, any event or condition
which has or could reasonably be expected to have a material adverse effect on
the Company's business, financial condition or results of operations will
constitute an event of default under the Restated Credit Facility. As of March
31, 1997, no such event or condition has occurred. 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%.
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.
Maturities of long-term debt during each of the ensuing five years ending
December 31 and thereafter are as follows (in thousands):
<TABLE>
<S> <C>
1997............................................... $36,468
1998............................................... 56,210
1999............................................... 687
2000............................................... 376
2001............................................... 18
Thereafter.................................... --
-------
$93,759
=======
</TABLE>
F-15
<PAGE> 147
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
The Company follows APB No. 25, under which no compensation cost has been
recognized in connection with stock option grants. Had compensation cost been
determined consistent with FASB Statement No. 123, effective January 1, 1995,
the Company's net income and earnings per share would have been reduced to the
following pro forma amounts:
<TABLE>
<CAPTION>
1996 1995
-------- ------
<S> <C> <C>
Net Income:
As Reported........................................... $(61,287) $ 18
Pro Forma............................................. (64,081) (835)
Primary and Fully Diluted EPS:
As Reported........................................... $ (1.86) $ --
Pro Forma............................................. (1.95) (0.03)
</TABLE>
Because the Statement No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Transactions with respect to the plans for the three years ended December
31, 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:
<TABLE>
<CAPTION>
1996 1995 1994
--------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE
---------- EXERCISE PRICE --------- EXERCISE PRICE --------- EXERCISE PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year............... 2,244,542 $14.08 1,943,460 $14.60 1,732,430 $ 9.76
Granted................. 2,891,589 13.39 716,750 16.30 588,850 19.59
Exercised............... (450,224) 6.43 (246,668) 14.96 (284,820) 7.72
Canceled................ (1,823,489) 17.44 (169,000) 19.34 (93,000) 14.13
---------- ------ --------- ------ --------- ------
Outstanding at end of
year.................. 2,862,418 12.97 2,244,542 14.08 1,943,460 12.35
---------- ------ --------- ------ --------- ------
Exercisable at end of
year.................. 707,609 $15.28 1,052,873 $10.53 664,266 $ 7.41
---------- ------ --------- ------ --------- ------
</TABLE>
F-16
<PAGE> 148
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/96 LIFE PRICES AT 12/31/96 PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 3.78 -$ 9.88................. 138,392 6.8 $ 7.53 74,226 $ 5.70
$10.00 - $11.00................ 698,000 9.8 $10.77 2,400 $11.00
$11.32 -$12.50................. 304,826 7.9 $11.79 103,572 $11.33
$12.75 - $12.75................ 1,155,414 8.3 $12.75 68,125 $12.75
$15.63 -$18.13................. 472,661 8.3 $17.11 366,411 $17.20
$18.75 - $25.00................ 93,125 7.4 $21.77 92,875 $21.78
--------- --- ------ ------- ------
$ 3.78 -$25.00................. 2,862,418 8.5 $12.93 707,609 $15.28
========= === ====== ======= ======
</TABLE>
The fair value of the stock options included in the pro forma amounts shown
above was estimated as of the grant date using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Dividend yield........................................... 0% 0%
Expected volatility...................................... 56% 74%
Risk-free interest rate.................................. 6% 6%
Expected life............................................ 5 years 3 years
</TABLE>
The weighted-average grant date fair values for options granted in 1996 and
1995 were $6.23 and $6.80, 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.
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. These reinsurance agreements do not release the Company of its
primary obligations to its membership. In 1996, commercial HMO risk was
F-17
<PAGE> 149
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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):
<TABLE>
<CAPTION>
YEAR AMOUNT
---- -------
<S> <C>
1997............................................... $ 9,690
1998............................................... 7,859
1999............................................... 5,841
2000............................................... 4,368
2001............................................... 3,484
Thereafter.................................... 12,750
-------
$43,992
=======
</TABLE>
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.
During the first quarter of 1996, termination and related costs of $5.2
million resulted from an initiative undertaken to streamline the Company's
administrative processes and reduce staffing in the Company's health centers,
primarily in the Pennsylvania and St. Louis plans. The costs relate to the
reduction of approximately 500 positions, 374 of which were health center
positions. Of the health center positions eliminated, 227 result from the
outsourcing of certain ancillary services to capitated vendors. At the end of
the second quarter, additional termination and related costs of $0.8 million
were recorded related to the curtailment of Medicaid operations in certain
markets. In the fourth quarter of 1996, $0.9 million of additional expenses were
recorded pertaining to the Pennsylvania, St. Louis and Medicaid staff
reductions.
Also, in the fourth quarter of 1996, 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 not sufficiently profitable
to justify a continued presence in the Florida market and, as a result, the
Company has decided to exit 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. As of December 31, 1996,
approximately $6.0 million of these $8.1 million of accruals had been paid.
F-18
<PAGE> 150
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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.
F-19
<PAGE> 151
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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. for $5.5 million cash. The transaction was
effective December 31, 1996 and the proceeds were recorded in other receivables
at December 31, 1996. The cash proceeds were collected in January 1997.
P. SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Cash paid during the periods for interest and income taxes is as follows
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
------ ------- -------
<S> <C> <C> <C>
Interest............................................... $5,862 $ 4,517 $ 2,491
Income taxes........................................... $1,309 $16,410 $19,240
</TABLE>
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.
F-20
<PAGE> 152
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
Coventry Convertible Notes transaction is not consummated, the Company will
likely seek alternative financing in order to meet scheduled debt service
obligations.
F-21
<PAGE> 153
COVENTRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1996(1) 1996(2) 1996 1996(3)
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
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
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995(4) 1995(5) 1995(6)
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
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
</TABLE>
- ---------------
(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), write-offs of goodwill ($21.0 million), certain capitalized
expenses ($6.7 million) and other premium and sales taxes, advertising,
legal and other expenses ($6.0 million).
(4) The second quarter operating results of 1995 were affected by merger costs
for the purchase of HCUSA ($2.3 million), severance and related costs
associated with staff restructuring in Pittsburgh and St. Louis ($2.0
million), additions to accruals for professional liability litigation ($1.2
million) and the settlement of certain Office of Personnel Management
negotiations ($1.5 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($5.1 million),
personnel reductions in the operations ($1.3 million), increases in legal
reserves ($1.5 million), medical and contingency reserves ($13.9 million)
for total adjustments of $21.8 million.
F-22
<PAGE> 154
COVENTRY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $141,236 $ 85,646
Short-term investments...................................... 4,951 7,388
Accounts receivable, net.................................... 34,976 37,921
Other receivables........................................... 15,021 22,661
Assets held for sale........................................ -- 23,856
Deferred income taxes and other current assets.............. 12,834 30,819
-------- --------
Total current assets................................... 209,018 208,291
Long-term investments....................................... 71,403 75,389
Property and equipment, net................................. 22,856 24,979
Goodwill and intangible assets, net......................... 112,281 118,346
Other assets................................................ 21,563 21,940
-------- --------
Total assets........................................... $437,121 $448,945
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claims liabilities.................................. $116,743 $146,082
Accounts payable and other accrued liabilities.............. 94,132 84,563
Deferred revenue............................................ 14,930 14,888
Current portion of long-term debt and notes payable......... 49,172 36,468
-------- --------
Total current liabilities.............................. 274,977 282,001
Convertible exchangeable subordinated notes................. 41,180 --
Long-term debt.............................................. 1,286 57,291
Other long-term liabilities................................. 6,448 9,226
Stockholders' equity:
Common Stock. $.01 par value; 50,000,000 shares
authorized, 33,589,464 issued (including 439,560 shares
owned by a subsidiary), 33,149,904 shares outstanding
in 1997; and 33,001,296 shares issued and outstanding
in 1996................................................ 336 330
Additional paid-in capital................................ 145,498 136,142
Net unrealized investment gain............................ 439 395
Accumulated deficit....................................... (28,043) (36,440)
Treasury stock, at cost, 439,560 shares................... (5,000) --
-------- --------
Total stockholders' equity................................ 113,230 100,427
-------- --------
Total liabilities and stockholders' equity................ $437,121 $448,945
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
F-23
<PAGE> 155
COVENTRY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Operating revenues
Managed care premiums..................................... $892,357 $757,277
Management services....................................... 14,763 10,300
-------- --------
Total operating revenues.................................. 907,120 767,577
Operating expenses:
Health Benefits........................................... 772,363 655,322
Selling, general and administrative....................... 124,892 108,876
Depreciation and amortization............................. 9,913 11,783
Other Charges............................................. 8,243
-------- --------
Total operating expenses.................................. 907,168 784,224
-------- --------
Operating earnings (loss)................................... (48) (16,647)
Other income, net........................................... 22,353 6,546
Interest expense............................................ (8,278) (5,345)
-------- --------
Earnings (loss) before income taxes and minority interest... 14,027 (15,446)
Provision for (benefit from) income taxes................... 5,611 (6,178)
Minority interest in (income) loss of consolidated
subsidiary, net of income tax............................. 19 (120)
-------- --------
Net earnings (loss)......................................... $ 8,397 $ (9,148)
======== ========
Net earnings (loss) per common and common equivalent
share..................................................... $ 0.25 $ (0.28)
======== ========
Weighted average common and common equivalent shares
outstanding............................................... 33,505 32,839
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
F-24
<PAGE> 156
COVENTRY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Net cash provided by operating activities................... $ 1,107 $ 8,982
Cash flows from investing activities:
Capital expenditures, net................................. (4,902) (11,736)
Sale of investments....................................... 27,885 50,046
Purchase of investments................................... (21,367) (35,770)
Proceeds from sale of subsidiary and medical offices...... 51,862
Payments for purchase of subsidiaries, net of cash
acquired............................................... (28,132)
-------- --------
Net cash provided by (used in) investing activities......... 53,478 (25,592)
-------- --------
Cash flows from financing activities:
Issuance of long-term debt and notes payable.............. 40,000 40,714
Payments of long-term debt and notes payable.............. (43,217) (13,700)
Net proceeds from issuance of stock and warrants.......... 4,222 5,589
-------- --------
Net cash provided by financing activities................... 1,005 32,603
-------- --------
Net increase in cash and cash equivalents................... 55,590 15,993
Cash and cash equivalents at beginning of the period........ 85,646 67,435
-------- --------
Cash and cash equivalents at end of the period.............. $141,236 $ 83,428
======== ========
Supplemental disclosure of cash flow information
Cash paid (received) during the period was as follows:
Interest.................................................. $ 6,119 $ 3,986
======== ========
Income taxes.............................................. $ (6,508) $ 1,322
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
F-25
<PAGE> 157
COVENTRY CORPORATION
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION. The condensed consolidated financial statements
of Coventry Corporation and subsidiaries (the "Company") contained in this
report are unaudited but reflect all adjustments, consisting of normal recurring
adjustments which, in the opinion of management, are necessary for fair
statement of the results of the interim periods reflected. Certain information
and footnote disclosures normally included in the consolidated financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to applicable rules and regulations of the Securities
and Exchange Commission (the "SEC"). Certain reclassifications have been made to
1996 amounts to conform to the 1997 presentation. The results of operations for
the interim periods reported herein are not necessarily indicative of results to
be expected for the full year. It is suggested that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements, notes thereto and management's discussion and analysis included in
the Company's most recent Annual Report on Form 10-K/A, filed with the SEC in
July 1997.
2. ACQUISITIONS. Effective March 22, 1996, the Company purchased 81% of
the common stock of PARTNERS Health Plan of Pennsylvania, Inc. and acquired the
remaining 19% of the common stock through the merger of a subsidiary of the
Company with and into PARTNERS, whose name was changed to Coventry Health Plan
of Pennsylvania, Inc.("CHP"). CHP is the holding company for Coventry Health
Plan of Western Pennsylvania, Inc., which, at the time of acquisition, was known
as Aetna Health Plan of Western Pennsylvania, Inc. and served approximately
16,000 HMO members in the Pittsburgh area. Consideration for the transaction was
approximately $35 million in cash, of which approximately $32.1 million was
recorded as goodwill. The acquisition has 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 date of acquisition. The
acquisition price included, among other typical business assets and goodwill,
consideration for non-compete agreements, the expectation of entering into a
favorable joint marketing agreement and the opportunity to acquire additional
Aetna membership at a favorable price. During the fourth quarter of 1996, the
Company determined that none of the opportunities were being realized, cash
flows were short of expectations (losses in 1996 versus projected positive cash
flows) and that Aetna had purchased U.S. Healthcare, which has operations in the
Company's service areas. In addition, the Company filed suit against Aetna and
U.S. Healthcare alleging breach of the acquisition agreement, seeking
enforcement of the non-compete agreement and requesting other forms of relief.
Based on the fair value estimates of the intangibles, on both a sales recovery
and discounted cash flow basis, the intangibles were written down to $10.0
million at December 31, 1996. The litigation against Aetna and U.S. Healthcare
was settled recently without admission of liability by either party. As of the
settlement date, the remaining intangible is realizable on a discounted cash
flow basis.
3. 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. The
Company continually evaluates the underlying costs expected to be incurred in
servicing the contracts.
4. SALE OF MEDICAL OFFICES. Effective March 31, 1997, the Company
completed its sale of the medical offices associated with HealthAmerica
Pennsylvania, Inc., its health plan in Pittsburgh, Pennsylvania, to a major
health care provider organization. The sales price was $20 million and the
transaction resulted in a pretax gain of approximately $6.0 million. Coincident
with the sale, the Company entered into a long-term global capitation agreement
with the purchaser which increased the globally capitated membership in western
Pennsylvania to approximately 226,000 members. Under the agreement, the provider
organization will receive a fixed percentage of premium to cover all of the
medical treatment the globally capitated members will receive.
F-26
<PAGE> 158
COVENTRY CORPORATION
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective May 1, 1997, the Company completed its sale of the medical
offices associated with Group Health Plan, its health plan in St. Louis,
Missouri, to a major health care provider organization. The sales price was
$26.9 million and the transaction resulted in a pretax gain of approximately
$9.6 million. Coincident with the sale, the Company entered into a long-term
global capitation agreement with the purchaser covering approximately 83,000
members, pursuant to which the provider organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive.
In August 1997, the Company entered into agreements to sell certain medical
offices associated with HealthAmerica, its health plan in Harrisburg,
Pennsylvania. The sales price was $2.1 million and the transaction resulted in a
pretax loss of $0.2 million. Additionally in the third quarter, the Company sold
its two remaining medical offices in Pittsburgh, Pennsylvania for $0.3 million
in cash and recorded a pretax loss of $0.4 million. All gains or losses
resulting from medical office sales are reflected in other income, net.
To the extent that Coventry becomes a party to global capitation agreements
with single provider organizations serving substantial membership, Coventry
becomes exposed to credit risk with respect to such organizations. Coventry may
utilize the following to manage such risk 1) contract with providers with
significant net worth and cash reserves 2) require letters of credit or cash to
be reserved for claims payment and 3) monitor the providers' financial condition
in regard to the Coventry membership.
5. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES. On April 2, 1997, the
Company announced that it entered into a securities purchase agreement with
Warburg, Pincus Ventures, L.P. ("Warburg")and Franklin Capital Associates III
L.P. ("Franklin" and collectively with Warburg the "Investors") for the
Investors' purchase of $40 million of the Convertible Exchangeable Subordinated
Notes of the Company (the "Coventry Convertible Notes"), together with warrants
to purchase 2.35 million shares of the Company's common stock, for $42.35
million. The Coventry Convertible Notes are convertible into four million shares
of the Company's common stock. On May 9, 1997, the Investors purchased $26.8
million of the Coventry Convertible Notes and 1.6 million warrants for an
aggregate purchase price of $28.4 million. Following approval from certain state
insurance regulators, the remaining investment by Warburg of approximately $13.9
million was completed on June 30, 1997. The Coventry Convertible Notes will be
exchangeable at the Company's option for shares of convertible preferred stock,
the authorization of which was approved by the Company's shareholders at the
1997 shareholders' meeting.
6. EARNINGS (LOSS) PER SHARE. Earnings (loss) per share is computed based
upon the weighted average shares of common stock and common stock equivalents
during the period. Common stock equivalents arising from dilutive stock options
and warrants are computed using the treasury stock method. In May and June of
1997, the Company issued Coventry Convertible Notes which are not considered
common stock equivalents. The fully diluted earnings per share calculation
assumes conversion of the Coventry Convertible Notes and adjusts earnings for
the interest that would not be paid in that event. Fully diluted earnings per
share are not presented, as the calculation does not materially affect earnings
per share for either period ending September 30, 1997.
7. RECENT ACCOUNTING PRONOUNCEMENTS. The Financial Accounting Standards
Board ("FASB") has issued Statement of Financial Accounting Standards ("SFAS")
No. 128 "Earnings Per Share" which is effective for both interim and annual
reporting periods ending after December 15, 1997. The Company will adopt the new
standard in its reporting for the quarter and the year ended December 31, 1997.
Management does not believe that adoption of this standard will have a material
impact on earnings per share.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive Income,"
which is effective for fiscal years beginning after December 15, 1997 and
requires restatement of earlier financial statements for comparative purposes.
SFAS No. 130 requires that changes in the amounts of certain items, including
gains and losses on certain securities, be shown in the financial statements.
Management has not yet determined the effect, if any, of SFAS No. 130 on the
consolidated financial statements.
F-27
<PAGE> 159
COVENTRY CORPORATION
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The FASB has also issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This standard requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS No. 131 also requires that
all public business enterprises report information about the revenues derived
from the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. This Statement is effective for financial
statements for periods beginning after December 15, 1997. Management has not yet
determined the effect, if any, of SFAS No. 131 on the consolidated financial
statements.
8. SUBSEQUENT EVENT. On November 3, 1997, a definitive Combination
Agreement (the "Merger Agreement") was entered into by and among Coventry
Corporation, a Tennessee corporation, Coventry Health Care, Inc., a newly-formed
Maryland corporation and wholly-owned subsidiary of Coventry Corporation
("Coventry Health Care"), Principal Mutual Life Insurance Company, an Iowa
mutual insurance company ("Principal Mutual"), Principal Holding Company, an
Iowa corporation and wholly-owned subsidiary of Principal Mutual ("Holding"),
and Principal Health Care, Inc., an Iowa corporation and wholly-owned subsidiary
of Holding ("PHC").
Pursuant to the Merger Agreement, the Company's shareholders will effect a
one for one nontaxable merger (the "Merger") with Coventry Health Care and PHC
will effect a capital contribution (the "Capital Contribution") to Coventry
Health Care of all of PHC's assets except for specified excluded assets and
PHC's liabilities except for specified excluded liabilities. Under the Exchange,
Coventry Health Care will issue to the Company's shareholders approximately 33
million shares of its common stock, representing approximately 60% of Coventry
Health Care's outstanding equity. Under the Capital Contribution, Coventry
Health Care will issue to PHC approximately 26 million shares of its common
stock, equal to approximately 40% of Coventry Health Care's outstanding equity.
The transaction will be treated as a purchase of PHC by Coventry Health Care,
Inc., the successor to the Company. PHC is a managed care company with
approximately $850 million in annualized 1997 revenues and 674,000 HMO members
in 18 markets throughout the Midwest and Southeastern United States.
In addition, Coventry Health Care will enter into an agreement to manage
that portion of Principal Mutual's health insurance indemnity book of business
in the Coventry Health Care markets. The management fee will be 3.3% of premium
and will expire December 31, 1999, at which time Coventry Health Care has agreed
that it will either reinsure or renew the business on the books of its
subsidiary, Coventry Health and Life Insurance Company. The indemnity premiums
for this book of business are estimated to be approximately $550 million for
1997. Coventry Health Care will also enter into a number of other agreements to
provide marketing and other services through December 1999 to Principal Mutual,
for which Coventry Health Care will be compensated. Mutual will receive a
warrant that gives Principal Mutual the right to purchase from Coventry Health
Care that number of shares of Coventry Health Care's Common Stock as shall equal
66 2/3% of the total number of shares of Coventry Health Care's common stock as
shall actually be issued by Coventry Health Care upon the exercise or conversion
of certain outstanding Coventry options, Coventry warrants and PHC options.
The transaction is subject to various conditions, including the approval of
various state regulatory agencies and approval of the Company's shareholders and
banks. The transaction is currently expected to be completed by the end of the
first quarter of 1998. When the transaction is completed, Principal Mutual will
have the right to nominate six directors on Coventry Health Care, Inc.'s
15-person Board of Directors. Principal Mutual will enter into a shareholders'
agreement containing standstill provisions and limitations on Principal Mutual's
voting rights in certain circumstances.
F-28
<PAGE> 160
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Principal Health Care, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Principal
Health Care, Inc. and Subsidiaries as of December 31, 1995, and 1996, and the
related consolidated statements of income, stockholder's equity, and cash flows
for the years ended December 31, 1994, 1995, and 1996. These financial
statements are the responsibility of PHC's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Principal
Health Care, Inc. and Subsidiaries at December 31, 1995 and 1996, and the
consolidated results of their operations and their cash flows for the years
ended December 31, 1994, 1995, and 1996 in conformity with generally accepted
accounting principles.
ERNST & YOUNG, LLP
February 26, 1997
Washington, DC
F-29
<PAGE> 161
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
---------------------------- -------------
1995 1996 1997
------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents...................... $116,380,532 $129,109,818 $113,017,433
Short-term investments......................... 42,257,501 46,902,532 53,628,721
Premiums receivable, less allowance for
doubtful accounts of $7,460,712 in 1995 and
$10,235,091 in 1996......................... 22,646,726 26,184,159 23,992,794
Interest and other receivables................. 14,502,927 15,113,757 17,449,520
ASO Receivable................................. 16,887,917 5,202,890 12,735,278
Prepaid expenses and other assets.............. 2,462,894 2,747,364 7,895,739
Due from Mutual................................ 18,876,069 13,187,083 658,947
Deferred tax asset............................. 8,093,710 11,359,402 11,153,480
------------ ------------ ------------
Total current assets............................. 242,108,276 249,807,005 240,531,912
Investments...................................... 42,825,620 60,588,463 58,641,479
Equity investment in associated companies........ 16,672,000 21,230,421
Property and equipment:
Furniture and equipment........................ 9,266,576 12,969,092 13,217,968
Data processing equipment...................... 23,081,896 29,916,905 26,777,398
Leasehold improvements......................... 824,361 1,105,386 4,950,288
------------ ------------ ------------
33,172,833 43,991,383 44,945,654
Less accumulated depreciation.................... 9,498,133 19,586,859 20,847,842
------------ ------------ ------------
23,674,700 24,404,524 24,097,812
Deferred tax asset, less current portion......... 1,135,663 743,508 4,343,861
Intangible assets:
Goodwill......................................... 79,562,975 124,214,754 102,680,170
Other intangible assets.......................... 9,936,447 12,989,373 12,989,373
------------ ------------ ------------
89,499,422 137,204,127 115,669,543
Less accumulated amortization.................... 15,834,496 26,651,892 28,573,710
------------ ------------ ------------
73,664,926 110,552,235 87,095,833
------------ ------------ ------------
Total assets..................................... $383,409,185 $462,767,735 $435,941,318
============ ============ ============
</TABLE>
See accompanying notes.
F-30
<PAGE> 162
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
---------------------------- -------------
1995 1996 1997
------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Estimated claims payable (reported and
unreported)................................. $ 90,300,860 $131,156,534 $116,767,965
Premium deficiency reserve..................... 8,133,000 8,469,000 5,113,500
Accounts payable and accrued expenses.......... 42,123,184 54,838,288 68,834,667
Deferred tax liability......................... 69,072 24,532 490,134
Current portion of notes payable and capital
leases...................................... 1,390,069 1,398,223 237,731
Current portion of other long-term
liabilities................................. 225,000 225,000 1,206,675
------------ ------------ ------------
Total current liabilities........................ 142,241,185 196,111,577 192,650,672
Profit sharing payable........................... 727,976 1,016,871 1,030,850
Payable to OPM................................... 1,280,192 1,280,192
Notes payable and capital leases, less current
portion........................................ 2,087,755 1,448,592 1,324,121
Deferred tax liability, less current portion..... 3,761,862 8,259,397 11,530,290
Other long-term liabilities, less current
portion........................................ 288,918 174,200 628,099
Stockholder's equity:
Common stock, par value $5 a share -- 5,000
shares authorized, issued and outstanding... 25,000 25,000 25,000
Additional paid-in capital..................... 220,435,300 281,913,621 270,472,954
Retained earnings (deficit).................... 12,651,679 (27,756,591) (43,828,636)
Unrealized gains on available-for-sale
securities, net of tax...................... 1,189,510 294,876 827,776
------------ ------------ ------------
Total stockholder's equity....................... 234,301,489 254,476,906 227,497,094
------------ ------------ ------------
Total liabilities and stockholder's equity....... $383,409,185 $462,767,735 $435,941,318
============ ============ ============
</TABLE>
See accompanying notes.
F-31
<PAGE> 163
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE-MONTH PERIOD ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------ ---------------------------
1994 1995 1996 1996 1997
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums.... $422,963,082 $574,359,628 $806,350,787 $605,249,552 $645,935,775
PPO, contract, ASO &
other non-risk fees... 61,275,639 75,408,235 67,710,723 50,330,493 41,841,557
Other.................... 1,969,621 1,568,511 1,524,371 713,497 850,725
------------ ------------ ------------ ------------ ------------
Total operating revenues... 486,208,342 651,336,374 875,585,881 656,293,542 688,628,057
Operating Expenses
Health benefits.......... 347,645,988 519,975,132 740,972,490 562,369,965 552,126,323
Selling, general &
administrative........ 110,776,469 166,126,151 196,357,591 139,947,395 160,257,589
Depreciation &
amortization.......... 8,806,940 11,649,066 15,745,326 11,502,142 12,120,613
Loss on impairment of
goodwill.............. 6,000,000
------------ ------------ ------------ ------------ ------------
Total operating expenses... 467,229,397 697,750,349 953,075,407 713,819,502 730,504,525
------------ ------------ ------------ ------------ ------------
Operating earnings
(loss)................... 18,978,945 (46,413,975) (77,489,526) (57,525,960) (41,876,468)
Investment income.......... 6,150,456 11,464,836 14,161,963 10,621,892 10,699,097
Gain on investment & equity
in net income of
associated companies..... 2,572,000 1,276,000 3,892,436
Gain on sale of
subsidiary............... 4,697,555
Other income, net.......... 558,191 1,726,939 159,881 254,031 47,672
------------ ------------ ------------ ------------ ------------
Earnings (loss) before
income tax (expense)
benefit.................. 25,687,592 (33,222,200) (60,595,682) (45,374,037) (22,539,708)
(Provision for) benefit
from income tax.......... (7,239,552) 10,528,964 20,187,412 14,150,645 7,570,611
------------ ------------ ------------ ------------ ------------
Net earnings (loss)........ $ 18,448,040 $(22,693,236) $(40,408,270) $(31,223,392) $(14,969,097)
============ ============ ============ ============ ============
</TABLE>
See accompanying notes.
F-32
<PAGE> 164
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
ADDITIONAL UNREALIZED RETAINED
COMMON PAID-IN NET GAIN EARNINGS
STOCK CAPITAL ON SECURITIES (DEFICIT) TOTAL
------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1993..... $25,000 $133,235,300 $ 16,896,875 $150,157,175
Cash capital contribution from
Holding........................ 43,000,000 43,000,000
Net earnings..................... 18,448,040 18,448,040
------- ------------ ---------- ------------ ------------
Balance at December 31, 1994..... 25,000 176,235,300 35,344,915 211,605,215
Cash capital contribution from
Holding........................ 44,200,000 44,200,000
Net loss......................... (22,693,236) (22,693,236)
Net change in unrealized gains on
available-for-sale securities,
net of income taxes of
$640,505....................... $1,189,510 1,189,510
------- ------------ ---------- ------------ ------------
Balance at December 31, 1995..... 25,000 220,435,300 1,189,510 12,651,679 234,301,489
Cash capital contribution from
Holding........................ 50,370,321 50,378,321
Non-cash capital contribution
from Holding................... 11,100,000 11,100,000
Net loss......................... (40,408,270) (40,408,270)
Net change in unrealized gains on
available-for-sale securities,
net of income taxes of
$481,724....................... (894,634) (894,634)
------- ------------ ---------- ------------ ------------
Balance at December 31, 1996..... 25,000 281,913,621 294,876 (27,756,591) 254,476,906
Cash capital contribution from
Holding........................ 8,559,333 8,559,333
Transfer of AHP to Holding....... (20,000,000) (1,102,948) (21,102,948)
Net loss......................... (14,969,097) (14,969,097)
Net change in unrealized gains on
available-for-sale securities,
net of income taxes of
$286,946....................... 532,900 532,900
------- ------------ ---------- ------------ ------------
Balance at September 30, 1997
(Unaudited).................... $25,000 $270,472,954 $ 827,776 $(43,828,636) $227,497,094
======= ============ ========== ============ ============
</TABLE>
See accompanying notes.
F-33
<PAGE> 165
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE-MONTH PERIOD ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------ ---------------------------
1994 1995 1996 1996 1997
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net earnings (loss)....................... $ 18,448,040 $(22,693,236) $(40,408,270) $(31,223,392) $(14,969,097)
Adjustments to reconcile net earnings
(loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization........... 8,806,940 11,649,066 15,745,326 11,502,141 12,120,613
Loss on disposal of fixed assets........ 121,942 4,267,680 195,987 7,564 2,208,903
Net amortization of investment discount
(premium)............................. 240,446 268,390 (444,314) (392,355) (389,087)
Gain on investment and equity in income
of associated companies............... (2,572,000) (1,276,000) (3,892,436)
Gain on sale of subsidiary.............. (4,697,555)
Loss on impairment of goodwill.......... 6,000,000
Deferred taxes.......................... 764,216 (6,375,346) (323,433) (800,649) 650,740
Premium deficiency reserve.............. 2,143,893 5,633,607 336,000 (540,000) (3,355,500)
Deferred rent expense................... 2,166,837
Changes in operating assets and
liabilities:
Premiums receivable, net.............. (4,499,284) (5,687,670) (3,610,433) (6,073,351) 2,191,365
Interest and other receivables........ (8,695,403) (14,295,368) 13,361,937 6,535,447 (15,011,962)
Prepaid expenses and other assets..... (277,980) (503,610) (14,676) (606,682) (2,364,111)
Due from/to Mutual.................... (16,952,848) 4,354,669 5,688,986 (2,653,561) (233,202)
Estimated claims payable.............. 12,918,722 19,303,820 35,630,671 28,078,316 (14,388,569)
Accounts payable, accrued expenses,
and other liabilities............... 11,654,629 (1,964,813) 11,168,728 14,942,166 10,072,462
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in) operating
activities.............................. 24,673,313 (6,042,811) 34,754,509 17,499,644 (23,890,599)
Investing activities
Purchases of property and equipment....... (6,743,435) (18,336,381) (7,509,201) (6,045,435) (7,846,299)
Purchases of investments (available-
for-sale)............................... (61,086,972) (63,924,048) (53,697,446) (19,488,839)
Purchases of investments
(held-to-maturity)...................... (19,379,631)
Proceeds from sale and maturity of
investments (available-for-sale)........ 50,261,005 29,924,106 15,918,567
Proceeds from maturity of investments
(held-to-maturity)...................... 6,391,685 7,579,875
Proceeds from sale of subsidiary.......... 7,000,000
Acquisitions, net of cash acquired........ (17,524,362) (45,367,259) (45,367,259)
Deferred organization and network
development costs....................... (226,950) (7,620) (1,968,550) (1,381,443)
------------ ------------ ------------ ------------ ------------
Net cash used in investing activities..... (37,482,693) (71,851,098) (68,508,053) (76,567,477) (4,416,571)
Financing activities
Proceeds from capital contributions....... 43,000,000 44,200,000 50,378,321 50,378,321 8,559,333
Return of capital and dividend of AHP to
Holding................................. (8,725,864)
Proceeds from draw on line of credit...... 12,000,000
Principal payments on capital lease
obligations............................. (172,107) (151,447) (183,263) (560,006) (102,261)
Issuance of notes payable................. 3,345,037 599,703 358,049
Principal payments on notes payable....... (546,899) (904,808) (1,669,860) (899,342) (965,976)
Additions to long-term liabilities........ 387,060 4,211,464 1,797,250
Payment of other long-term liabilities.... (3,029,131) (1,458,653) (347,697)
------------ ------------ ------------ ------------ ------------
Net cash provided by financing
activities.............................. 42,280,994 46,488,782 46,482,830 52,029,833 12,214,785
------------ ------------ ------------ ------------ ------------
Increase (decrease) in cash and cash
equivalents............................. 29,471,614 (31,405,127) 12,729,286 (7,038,000) (16,092,385)
Cash and cash equivalents at beginning of
period.................................. 118,314,045 147,785,659 116,380,532 116,380,532 129,109,818
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents at end of
period.................................. $147,785,659 $116,380,532 $129,109,818 $109,342,532 $113,017,433
============ ============ ============ ============ ============
</TABLE>
See accompanying notes.
F-34
<PAGE> 166
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
1. ORGANIZATION
Principal Health Care, Inc. was incorporated in Iowa on January 7, 1987.
Principal Health Care, Inc. and its subsidiaries (collectively referred to
herein as "PHC") are wholly owned subsidiaries of Principal Holding Company,
Inc. ("Holding"), which is wholly owned by Principal Mutual Life Insurance
Company ("Mutual").
PHC was formed to manage and insure the health care benefits of subscribers
under employee benefit plans in the private and public sectors nationwide. PHC's
primary operations are currently located in Florida, Iowa, Louisiana, and Texas.
Services are typically provided under one-year contracts with employers under
which PHC will insure the health benefits of the employees that select HMO
coverage. The HMO members also receive services under the standard contract that
includes utilization management, network management and claims services. In
addition, PHC operates PPOs and proprietary health care provider networks and
offers Administrative Services Only Contracts ("ASO") with employee benefit
plans to provide a full range of health care options without assuming insurance
risk, as well as combined HMO and indemnity products such as Triple Option Plans
in conjunction with Mutual.
2. ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of Principal
Health Care, Inc. and its subsidiaries, all of which are wholly owned.
Significant intercompany accounts and transactions have been eliminated.
Estimation Process
The preparation of financial statements requires management to make
estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions could change
in the future as more information becomes known, which could impact the amounts
reported and disclosed herein.
Cash Equivalents
PHC considers all highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents. The carrying amounts reported in
the accompanying balance sheets for these financial instruments approximate
their fair values.
Investments
On November 15, 1995, the FASB staff issued a Special Report, A Guide to
Implementation of Statement 115 on Accounting for Certain Investments on Debt
and Equity Securities. In accordance with provisions in that Special Report, PHC
chose to reclassify certain of its securities from held-to-maturity to
available-for-sale effective December 31, 1995. At the date of transfer,
December 31, 1995, the amortized cost of those securities was $53,665,330 and
the unrealized gains, net of tax, on those securities was $1,189,510, which is
included in stockholder's equity.
Investments are classified as available-for-sale and are stated at fair
value, with the unrealized gains and losses, net of tax, reported as a separate
component of stockholder's equity. These investments also include restricted
statutory deposits. The cost of securities sold is based on the specific
identification method. Realized gains or losses are recorded in investment
income.
At December 31, 1996 PHC owns 38.1% of the outstanding common stock of
United Payors & United Providers, Inc. ("UP & UP") and accounts for this
investment under the equity method of accounting (see Note 3).
F-35
<PAGE> 167
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets, which
vary from three to seven years.
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 recoverable. In making that determination, the Company
considers a number of factors, including undiscounted future estimated cash
flows, prior to interest expense. The Company measures an impairment loss by
comparing the fair value of the asset to its carrying value. Fair values are
measured by using market prices for similar assets, if available, or discounted
future estimated cash flows, prior to interest expense and the income tax
provision. Assets held for sale are recorded at the lower of the carrying amount
of fair value, less any costs associated with disposition.
Intangible Assets
Goodwill has been accumulated in the purchase of PHC subsidiaries. The
recorded amount represents the excess of the purchase price of those
subsidiaries over the net fair value of the assets and liabilities acquired that
can be identified and valued. Goodwill is amortized over its estimated useful
life. The remaining unamortized goodwill balances at December 31, 1996 are as
follows:
<TABLE>
<CAPTION>
ESTIMATED ACCUMULATED
USEFUL LIFE GOODWILL AMORTIZATION NET BOOK VALUE
- ------------ ------------ ------------ --------------
<S> <C> <C> <C>
less than 10 $ 1,941,745 $ 1,941,745 $ 0
10 42,410,849 13,173,251 29,237,598
15 22,848,303 1,269,348 21,578,955
40 57,013,857 4,030,501 52,983,356
------------ ----------- ------------
Total $124,214,754 $20,414,845 $103,799,909
</TABLE>
In March 1996, PHC acquired Admar Group, Inc. ("Admar"). Admar is in the
business of developing and marketing proprietary health care provider networks.
Admar capitalizes the direct cost associated with the development of new PPO
networks in specifically identified market areas that are not already served by
Admar. The costs are amortized on a straight line basis over 3 years beginning
in the month when Admar first bills a customer for the use of the network.
Deferred development costs of Admar included in other intangible assets at
December 31, 1996 were $6,292,987. The related accumulated amortization was
$2,955,088.
Other intangible assets consist of organization costs, the allocated value
of acquired employer groups and provider contracts, and operating licenses and
origination costs. These costs are generally being amortized over a period of
five years.
In accordance with SFAS 121 and APB 17, the Company periodically evaluates
the recoverability of goodwill and intangible assets and the reasonableness of
the related lives in the same manner as that used to evaluate the impairment of
long lived assets.
Estimated Claims Payable and Loss Adjustment Expense
PHC provides for the liability arising from services rendered to members
but unpaid at year-end, including the future costs of settling those claims,
based upon the experience of PHC and cost-per-member trends. Although
considerable variability is inherent in such estimates, management believes that
the liability
F-36
<PAGE> 168
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
is adequate. PHC also establishes reserves, if required, for the probability
that anticipated future health care and maintenance costs under the group of
existing contracts will exceed anticipated future premiums and stop-loss
insurance recoveries on those contracts. The estimated future costs include
fixed and variable, direct and allocable, indirect costs. Contracts are grouped
in a manner consistent with PHC's method for establishing premium rates. Any
required revisions to these estimates are reflected in the operations of the
period in which such revisions are determined.
Income Recognition
Premium revenue is recognized in the month that members are entitled to
health care services. Contract revenue is recognized based on contracted
percentage rates of the amount of cost savings realized by payor clients which
access PHC's health care provider network. In addition, PPO revenue is earned
through monthly administrative fees based on a per employee rate multiplied by
the current number of participants in the plan.
PHC has contractual arrangements with the Office of Personnel Management
("OPM") to provide health services to federal employees on an experience or
community-rated basis. Such contracts are generally terminable by either party
with sixty days notice.
Under the experience-rated contracts, PHC is permitted to draw funds from a
line of credit to the extent that administrative and claims expenses have been
paid. PHC's policy is to account for this arrangement as an ASO contract, as the
OPM is effectively self-insured for these federal employees, and report only
administrative fees earned in the financial statements.
Under the community-rated contracts, revenue is recognized based upon a
predetermined monthly premium based on anticipated community rates. Anticipated
contractual rate adjustments, made to reflect actual community rates, are
recorded by PHC in the annual contract year to which they relate.
In addition, under ASO and other non-risk contracts, PHC provides
administrative and claims processing services to certain groups without
retaining any risk of claim loss. Accordingly, PHC reflects only the contracted
fee for services in its financial statements.
Income Taxes
PHC is taxed at corporate rates based on existing tax laws and included in
the consolidated federal and state returns filed by its Parent. The income tax
provision includes federal and state income taxes both currently payable and
deferred because of differences between financial reporting and tax bases of
assets and liabilities. Deferred income tax assets or liabilities are measured
based on enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
Reclassification
Certain amounts for 1994 and 1995 have been reclassified to conform with
the 1996 presentation.
F-37
<PAGE> 169
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITION OF SUBSIDIARIES
The following table summarizes PHC's acquisition of wholly owned
subsidiaries over the last three years. Each acquisition listed was accounted
for as a purchase. The results of operations of the respective subsidiary are
included in the consolidated financial statements of PHC commencing upon the
closing of the transaction. Intangible assets acquired in the transactions are
being amortized over periods of ten to forty years.
<TABLE>
<CAPTION>
NET CASH INTANGIBLE
PAID ASSETS
DATE DESCRIPTION OF BUSINESS ACQUIRED (RECEIVED) TOTAL COST ACQUIRED
---- --------------------------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
April - 94 South Care Medical Alliance a
234,000 covered lives PPO
operating in Georgia............. $ 3,643,000 $ 7,365,000 $ 4,400,000
October - 94 Coastal Bend Health Plan, Inc., a
30,000 member HMO operating in
Texas............................ $22,104,000 $39,838,000 $27,600,000
December - 94 CIGNA HealthCare of
Kansas/Missouri, Inc. a 13,400
member HMO operating in Kansas
and Missouri..................... $(8,223,000) $15,600,000 $ 6,700,000
March - 96 Admar Group, Inc., a national
proprietary healthcare provider
network.......................... $21,590,000 $25,320,000 $20,100,000
March - 96 MetraHealth Care Plan of St.
Louis, Inc., a 31,000 member HMO
operating in Missouri............ $23,778,000 $28,648,000 $21,636,000
</TABLE>
The purchase price of CIGNA includes the historical book value of the
non-monetary assets of PHC's wholly owned subsidiary, Principal Health Care of
Ohio, Inc. ("Ohio"), exchanged in the transaction. The operating results of Ohio
are included in the consolidated financial statements of PHC through the date of
the closing of the transaction.
The acquisition of MetraHealth Care Plan of St. Louis, Inc. is subject to
an escrow agreement whereby $9,200,000 is being held in escrow to reimburse PHC
for any unfavorable changes, if any, in the total number of enrollees through
the settlement date. The amount due to PHC was determined to be $4.9 million in
March 1997. Final resolution of the settlement and other financial transition
issues was accomplished in December 1997. Because of the uncertainty surrounding
the collection of the settlement, the goodwill related to the acquisition was
not adjusted for the settlement until the cash was received.
Proforma consolidated revenues and net income of PHC, assuming the above
described acquisitions each occurred at the beginning of the year preceding the
year of acquisition are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Total revenue.................. $548,758,710 $737,717,204 $903,264,925
============ ============ ============
Net income (loss).............. $18,992,678 $(18,463,660) $(39,537,562)
============ ============ ============
</TABLE>
On June 10, 1996, PHC received one share of UP&UP preferred stock in the
form of a capital contribution from Mutual. On July 2, 1996 UP&UP issued 2.76
million shares of common stock in an initial public offering ("IPO").
Immediately preceding the IPO, PHC converted its preferred stock into 4,400,000
shares or 50% of UP&UP's then outstanding common stock. At the completion of the
transaction, PHC owned approximately 38.1% of the common stock of UP&UP, with a
carrying value of approximately $14,080,000 and a fair value based on the listed
stock price of approximately $48,400,000.
The amount contributed was reported at Mutual's historical book value,
adjusted to reflect their proportionate share of the IPO proceeds in excess of
the proportionate net book value of the shares sold in the IPO.
F-38
<PAGE> 170
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The purchase contracts related to three PHC subsidiaries included
agreements to share a portion of the net profits of those acquired companies
with the previous owners for a period of years. Amounts to be paid under these
contracts are expensed as earned. The subsidiaries with such agreements are as
follows:
<TABLE>
<CAPTION>
REMAINING LIFE OF
PERCENTAGE OF NET THE AGREEMENT AT DATE
PROFIT TO BE SHARED DECEMBER 31, 1996 PAYABLE
------------------- ----------------- --------
<S> <C> <C> <C>
PHC of Florida, Inc. ........................ 15% of profit 4 years yearly
related to members
selecting certain
primary care
physicians
PHC of Texas, Inc. .......................... 10% 3 years yearly
PHC of Georgia, Inc. ........................ 10% 8 years 12/31/99
and
12/31/04
</TABLE>
PHC of Delaware, Inc. has a similar agreement related to the extension of a
noncompete agreement with the previous owners of the plan. The agreement
requires PHC of Delaware, Inc. to share 10% of their cumulative net profits to
be paid on October 1, 1998. Amounts accrued under this agreement are charged to
earnings in the period in which the profits are generated.
4. INVESTMENTS
The following is a summary of investments classified as held-to-maturity:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- ------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1994
- -----------------------------
Certificates of deposit...... $ 3,684,173 $ 3,684,173
Money market account......... 563,357 $ 11,980 575,337
Corporate bonds.............. 514,060 $ (30,671) 483,389
U. S. government 25,251,985 79,841 (89,206) 25,242,620
securities.................
----------- ---------- --------- ------------
$30,013,575 $ 91,821 $(119,877) $ 29,985,519
=========== ========== ========= ============
</TABLE>
The following is a summary of investments classified as available-for-sale:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1995
- ----------------------------
1995 Certificates of $ 4,532,196 $ 4,532,196
deposit...................
Money market account........ 635,358 $ 757 $ (52) 636,063
Corporate bonds............. 8,809,245 337,129 9,146,374
U. S. government 69,276,307 1,505,793 (13,612) 70,768,488
securities................
------------ ---------- --------- ------------
$ 83,253,106 $1,843,679 $ (13,664) $ 85,083,121
============ ========== ========= ============
DECEMBER 31, 1996
- ----------------------------
1996 Certificates of $ 5,632,196 $ 5,632,196
deposit...................
Money market account........ 839,604 839,604
Corporate bonds............. 16,288,540 $ 237,438 $ (56,414) 16,469,564
U. S. government 84,276,998 508,053 (235,420) 84,549,631
securities................
------------ ---------- --------- ------------
$107,037,338 $ 745,491 $(291,834) $107,490,995
============ ========== ========= ============
</TABLE>
F-39
<PAGE> 171
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fair values of these investments have been determined by PHC from
independent quotations.
The amortized cost and fair values of the available-for-sale investments at
December 31, 1996, by expected maturity, are as follows:
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
------------ ------------
<S> <C> <C>
Due in less than one year..................... $ 46,890,302 $ 46,902,832
Due in one through five years................. 15,230,233 15,313,456
Due after five years through ten years........ 5,444,611 5,542,568
Due after ten years........................... 39,472,192 39,732,139
------------ ------------
$107,037,338 $107,490,995
============ ============
</TABLE>
The gross realized gains and losses on securities sold during the year
ended December 31, 1996 totaled approximately $960,000 and $77,000,
respectively. There were no sales of securities during the year ended December
31, 1994 and 1995. At December 31, 1996, PHC's investment in UP & UP had a fair
value of approximately $60,500,000, which was based on the listed market price
of its common stock.
5. REINSURANCE
PHC carries reinsurance coverage with Mutual and another insurance carrier
for instances when medical service costs for an individual member exceed various
contracted amounts in a one-year period. Reinsurance premiums for 1994, 1995,
and 1996 were approximately $8,071,000, $11,812,000, and $18,565,000,
respectively. Reinsurance recoveries for 1994, 1995, and 1996 were approximately
$8,971,000, $14,324,000, and $16,167,000, respectively, and are included as an
offset to hospitalization expense. PHC is contingently liable for reinsured
losses to the extent that the reinsurance companies cannot meet their
obligations under the reinsurance contracts. To minimize its exposure to
significant losses from reinsurer insolvencies, the Company evaluates the
financial condition of its reinsurers on an annual basis. Mutual, the primary
reinsurer, is currently rated an A+ by the A.M. Best Company, and maintains an
AA+ claims paying ability rating by Standard & Poor's. Accordingly, the
reinsurance coverage with Mutual was not considered to be a significant credit
risk to PHC.
6. OPERATING LEASES
PHC leases office facilities and equipment under operating leases which
include certain abatement and escalation clauses. PHC subleases a small portion
of its office space and receives monthly rental payments. Future minimum lease
payments under these leases are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
-----------
<S> <C>
1997.......................................... $ 9,464,069
1998.......................................... 10,007,663
1999.......................................... 7,615,179
2000.......................................... 5,574,022
2001.......................................... 4,663,051
Thereafter.................................... 22,159,180
-----------
Total minimum lease payments.................. $59,483,164
===========
</TABLE>
Total rent expense was approximately $4,200,000, $6,478,000, and
$11,103,000 for 1994, 1995, and 1996, respectively.
F-40
<PAGE> 172
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. NOTES PAYABLE AND CAPITAL LEASES
PHC has multiple promissory notes payable of $2,470,072 at December 31,
1996, bearing interest at 8.3%, with principal and interest payments due monthly
through 1999. PHC also leases certain equipment under capital leases. The
carrying values of these notes approximate their fair values. Aggregate
principal maturities on notes payable and payments on capital leases are as
follows:
<TABLE>
<S> <C>
1997........................................... $1,421,223
1998........................................... 1,314,471
1999........................................... 148,203
2000........................................... 3,966
----------
2,887,863
Less lease payments representing interest...... (41,048)
Less current portion........................... (1,398,223)
----------
Total.......................................... $1,448,592
==========
</TABLE>
PHC recognized and paid approximately $91,000, $61,000, and $31,000 of
interest expense on capital leases in 1994, 1995, and 1996, respectively.
Amortization of the assets related to capital leases is included in depreciation
and amortization expense.
8. RELATED PARTY TRANSACTIONS
Certain administrative functions related to human resources, legal, tax,
financial management, actuarial, and information systems support are provided to
PHC by Mutual. Certain local marketing, provider network development and
management and other consulting services related to managed care and other
health products are provided by PHC to Mutual. All direct costs and an
allocation of indirect costs of performing these functions are charged from the
organization providing the services to the organization receiving the services.
Management believes that the allocations are reasonable. The net cost to PHC
resulting from these arrangements amounted to $1,344,988, $1,062,051, $912,856
in 1994, 1995, and 1996, respectively.
PHC periodically invests available cash in a demand deposit pooled
investment fund maintained by Mutual. PHC held approximately $6,071,000 and
$1,950,000 in this fund at December 31, 1995 and 1996. PHC earned approximately
$512,000, $2,597,000, and $220,000 on amounts invested in this fund during 1994,
1995, and 1996, respectively.
PHC and Mutual entered into an agreement whereby both agreed to provide
medical benefits to employees and dependents of employer groups electing the
Triple Option Plan, a Mutual product. Mutual reimburses PHC for claims and
capitation expenses and pays an administrative fee to PHC for Triple Option
members who have selected one of PHC's HMO options. Administrative fees earned
of approximately $11,618,000, $10,717,000, and $11,791,000 are included in
non-risk fee revenue in 1994, 1995, and 1996, respectively.
In addition, Mutual pays PHC a fee for use of its provider network. These
fees paid by Mutual of approximately $17,647,000, $15,778,000, and $19,908,000
are included in non-risk fee revenue in 1994, 1995, and 1996, respectively.
Cross-selling of PHC's HMO product and Mutual's indemnity product has
resulted in net expense of approximately $109,000, $890,000, and $160,000 in
1994, 1995, and 1996, respectively, which is included in selling, general and
administrative expense.
In 1995, PHC and Mutual entered into an agreement whereby employee
assistance program services are provided to certain Mutual members. Mutual pays
an administrative fee to PHC for these members.
F-41
<PAGE> 173
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Administrative fees earned of approximately $1,731,000 and $4,504,000 are
included in non-risk fee revenue in 1995 and 1996, respectively.
9. INCOME TAXES
PHC is taxed at corporate rates based on existing tax laws. PHC's taxable
income or loss is included in the consolidated federal income tax return filed
by Mutual and the consolidated State income tax returns filed by Mutual.
Mutual has adopted the policy of allocating current income tax expense and
benefits to members of the consolidated group based upon the subsidiaries' pro
rata contribution of taxable income or taxable losses. As of December 31, 1995
and 1996 current federal taxes receivable of approximately $1,244,000 and
$3,850,000 are included in the balance due from Mutual, respectively. Taxes
refunded from Mutual during 1995 and 1996 were approximately $9,129,000 and
$17,028,000, respectively. Taxes paid to Mutual during 1994 were approximately
$11,732,000.
The provision for (benefit from) income taxes for the year ended December
31 consist of the following:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ------------ ------------
<S> <C> <C> <C>
CURRENT TAXES:
Federal........................................ $4,478,853 $ (6,578,049) $(20,247,671)
State.......................................... 1,996,483 2,385,973 432,285
Other.......................................... 38,458 (48,593)
---------- ------------ ------------
6,475,336 (4,153,618) (19,863,979)
DEFERRED TAXES:
Federal........................................ 733,647 (6,120,332) (310,496)
State.......................................... 30,569 (255,014) (12,937)
---------- ------------ ------------
764,216 (6,375,346) (323,433)
---------- ------------ ------------
PROVISION FOR (BENEFIT FROM) INCOME TAXES........ $7,239,552 $(10,528,964) $(20,187,412)
========== ============ ============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at December 31 are
as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
DEFERRED TAX ASSETS:
Allowance for doubtful accounts......................... $ 2,909,678 $ 3,991,685
Premium deficiency reserve.............................. 3,171,870 3,302,910
Discount on loss reserves............................... 1,169,849 1,699,136
Deferred premiums....................................... 256,808 422,506
Other................................................... 1,721,168 2,686,673
----------- -----------
Deferred tax assets....................................... 9,229,373 12,102,910
DEFERRED TAX LIABILITIES:
Difference in book to tax basis of equity in associated
company.............................................. (4,552,080)
Difference in book to tax basis of intangible assets.... (1,655,187) (1,560,000)
Difference in book to tax basis of property and
equipment............................................ (733,988) (1,087,791)
Other................................................... (1,441,759) (1,084,058)
----------- -----------
Deferred tax liabilities.................................. (3,830,934) (8,283,929)
----------- -----------
NET DEFERRED TAX ASSET.................................... $ 5,398,439 $ 3,818,981
=========== ===========
</TABLE>
F-42
<PAGE> 174
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The reconciliation of income tax from continuing operations computed at the
U.S. federal statutory tax rate for the year ended December 31 is as follows:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Tax at U.S. federal statutory rate.......................... 35% (35%) (35%)
State income taxes, net of federal tax benefit.............. 7 5 1
Non-deductibility of goodwill............................... 5 6 5
Loss on disposal of assets.................................. (6)
Other....................................................... (8) (2) (4)
-- --- ---
Effective tax rate.......................................... 39% (32%) (33%)
== === ===
</TABLE>
10. STATUTORY REQUIREMENTS
PHC is subject to various insurance regulations that require it to maintain
minimum amounts on deposit, minimum statutory net worth, and restricts the
payment of dividends without prior state approval in which PHC does business.
PHC has approximately $9,132,000 and $13,090,000 of investments held on deposit
with states and maintains minimum amounts of statutory net worth in each of
these states at December 31, 1995 and 1996, respectively.
11. EMPLOYEE BENEFIT PLANS
PHC has a defined qualified benefit pension plan covering substantially all
of its employees. The benefits are based on years of service and the employee's
compensation during the last five years of employment. PHC's funding policy is
to contribute annually the maximum amount that can be deducted for federal
income tax purposes. The actuarial cost method used in this plan is the entry
age normal-frozen initial liability method. Contributions are intended to
provide not only for benefits attributed to service to date but also for those
expected to be earned in the future.
The following table sets forth the qualified plan's funded status and
amounts recognized in PHC's consolidated balance sheet at December 31:
<TABLE>
<CAPTION>
1995 1996
----------- ------------
<S> <C> <C>
Actuarial present value of accumulated benefit obligation
including vested benefits of $1,909,997 and $2,952,706
as of December 31, 1995 and 1996, respectively......... $(3,253,202) $ (5,131,690)
=========== ============
Projected benefit obligation for service rendered to
date................................................... $(7,358,004) $(11,617,364)
Plan assets at fair value, primarily listed stocks and
U.S. bonds............................................. 4,734,100 6,996,879
----------- ------------
Projected benefit obligation in excess of plan assets.... (2,623,904) (4,620,485)
Unrecognized net gain from past experience different from
that assumed and effects of changes in assumptions..... (1,705,067) (2,093,111)
Prior service cost not yet recognized in net periodic
cost................................................... 1,224,272 1,560,976
Adjustment for contribution made from measurement date of
fiscal year-end........................................ 477,572
Unrecognized net asset amortized over 21.33 years, net of
amortization........................................... (59,595) (55,436)
----------- ------------
Accrued pension cost included in accounts payable and
accrued expenses....................................... $(2,686,722) $ (5,208,056)
=========== ============
</TABLE>
F-43
<PAGE> 175
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net periodic pension cost for the year ended December 31 included the
following components:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Service cost-benefits earned during the
period....................................... $2,559,979 $2,287,034 $3,329,473
Interest cost on projected benefit
obligation................................... 304,547 357,168 560,323
Actual return on plan assets................... 28,213 (563,455) (860,085)
Net amortization and deferral.................. (23,458) 373,583 446,767
---------- ---------- ----------
Net periodic pension cost...................... $2,869,281 $2,454,330 $3,476,478
========== ========== ==========
</TABLE>
The weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation was 6.0% at December 31, 1994 and 7.25% at December
31, 1995 and 1996. The expected long-term rate of return on plan assets was 8.0%
in 1994, 1995, and 1996.
Beginning in 1995, PHC has a non-qualified defined benefit pension plan
covering highly compensated employees. The benefits are based on years of
service and the employee's compensation during the last five years of
employment. The actuarial cost method used in the plan is the entry age normal
method. Contributions are intended to provide not only for benefits attributed
to service date, but also for those expected to be earned in the future.
The following table sets forth the non-qualified plan's funded status and
amounts recognized in PHC's consolidated balance sheet at December 31:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Actuarial present value of accumulated benefit obligation,
including vested benefits of $460,062 and $149,734 as of
December 31, 1995 and 1996, respectively................ $ (525,883) $ (270,461)
=========== ===========
Projected benefit obligation for service rendered to
date.................................................... $(1,926,172) $(1,568,608)
Plan assets at fair value................................. 4,273
----------- -----------
Projected benefit obligation in excess of plan assets..... (1,926,172) (1,564,335)
Unrecognized net gain from past experience different from
that assumed and effects of changes in assumptions...... (432,609)
Prior service cost not yet recognized in net periodic
cost.................................................... (334,317)
Unrecognized net asset amortized over 21.33 years, net of
amortization............................................ 1,456,793 1,352,736
----------- -----------
Accrued pension cost included in accounts payable and
accrued expenses........................................ $ (469,379) $ (978,525)
=========== ===========
</TABLE>
Net periodic pension cost for the year ended December 31 included the
following components:
<TABLE>
<CAPTION>
1995 1996
-------- --------
<S> <C> <C>
Service cost-benefits earned during the period.............. $252,160 $270,442
Interest cost on projected benefit obligation............... 113,162 139,647
Actual return on Plan assets................................ 1,007
Net amortization and deferral............................... 104,057 103,050
-------- --------
Net periodic pension cost................................... $469,379 $514,146
======== ========
</TABLE>
The weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation was 7.25% at December 31, 1995
F-44
<PAGE> 176
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and 1996. The expected long-term rate of return on plan assets was 8.0% and
6.05% in 1995 and 1996, respectively.
PHC's employees are also eligible for coverage in the savings plans of
Mutual, consisting of a 401(k) savings plan. Under the 401(k) defined
contribution plan, subject to certain limitations, employees may contribute up
to 15% of their salary to the plan which PHC matches at a rate of 50% up to the
first 4% of the employees contribution to a maximum of 2% of their total salary.
Employees become eligible for coverage in the plans upon achievement of certain
age and length of service requirements. PHC contributed approximately $297,000,
$419,000 and $668,000 to this plan in 1994, 1995 and 1996, respectively.
PHC's employees are also eligible for coverage in the defined benefit
post-retirement medical and life benefit plan of Mutual. A portion of the costs
associated with PHC's participation in the plan was allocated from Mutual and
recorded during 1995 and 1996.
12. CONTINGENCIES
PHC is involved in various legal actions arising in the normal course of
business. After review, including consultation with legal counsel, management
believes any ultimate liability that could arise from these actions would not
materially affect PHC's consolidated financial position or results of operations
and cash flows.
13. INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
Basis of presentation
The accompanying unaudited consolidated balance sheet for September 30,
1997, unaudited consolidated statement of stockholder's equity for the nine
months ended September 30, 1997 and the unaudited consolidated statements of
income and cash flows for the nine months ended September 30, 1996 and 1997 have
been prepared in accordance with generally accepted accounting principles for
interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the nine-month period
ended September 30, 1997 is not necessarily indicative of the results that may
be expected for the year ended December 31, 1997.
Information on Unconsolidated Investees
Information on unconsolidated investees income from equity earnings in
associated companies includes $1.25 million and $3.9 million of equity earnings
in UP & UP for the nine months ended September 30, 1996 and 1997, respectively.
UP & UP reported operating revenues of $3.0 million and $42.6 million and net
income of $7.6 million and $10.8 million for the nine months ended September 30,
1996 and 1997, respectively.
Sale of Principal Health Care of the Mid-Atlantic
In July 1997, PHC entered into a stock purchase agreement with Inova
Medical Foundation to sell all of the common stock of Principal Health Care of
the Mid-Atlantic, Inc. ("PHCMA"), for approximately $8,300,000 in cash.
Immediately prior to the completion of the transaction, PHC will retain through
the assignment of contracts with all employer groups located outside the
services area (all cities and counties in the State of Virginia where PHC was
licensed to do business, the District of Columbia, and the counties of Prince
George's, Montgomery, Calvert, Charles, and St. Mary's in the State of
Maryland), all receivables accrued through the closing date, certain fixed
assets and all cash held by PHCMA in excess of amounts necessary to meet
statutory minimum net worth requirements.
F-45
<PAGE> 177
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The final purchase price will be contingent upon the adequacy of the
liability for claims incurred but not reported and any unfavorable changes in
the total number of enrollees in employer groups from acquisition to settlement.
An escrow agreement was entered into that provides for approximately
$528,000 to be held in an interest bearing escrow account to be settled one year
after the close of the franchise.
The transaction was closed on December 31, 1997 and resulted in a gain of
approximately $2.5 million.
Sale of Principal Behavioral Health Care
In September 1997, PHC entered into a stock purchase agreement with
American Psych Systems Inc. ("APS"), to sell all of the common stock of
Principal Behavioral Health Care, Inc. ("PBHC"), for $7,000,000 in cash and
2,705,182 shares of APS common stock. PHC retained all accounts receivable and
substantially all liabilities of PBHC relating to transactions prior to the date
of escrow.
Concurrent with the acquisition, PHC's HMO subsidiaries entered into an
agreement with APS whereby APS will continue to provide behavioral health
services to those subsidiaries for a period of ten years at substantially the
same terms and conditions to those in existence prior to the acquisition. After
five years, the agreement is cancelable without cause by PHC with 90 days notice
and subject to a partial return of the original purchase price.
Acquisition of FHP of Illinois
In October 1997, PHC entered into a stock purchase agreement with
PacifiCare Health Plan Administrators, Inc. to acquire all of the outstanding
shares of capital stock of FHP of Illinois, Inc., for a preliminary purchase
price of approximately $38,500,000 in cash. The transaction will be accounted
for as a purchase. Because the transaction was structured so the acquired
company had a net worth of $0, the entire purchase price is expected to be
allocated as goodwill. The final purchase price is contingent on an audit of the
net assets acquired and changes in the total member of enrollees from
acquisition to settlement. The final purchase price is expected to be settled in
the first quarter of 1998.
Transfers to Mutual
In July 1997, PHC transferred to the Parent its ownership of America's
Health Plan, Inc. The transaction was accounted for as a dividend and return of
capital.
In October 1997, PHC transferred to the Parent its ownership in the Admar
Group, Inc. The transaction will be accounted for as a dividend and return of
capital.
Intent to sell Principal Health Care of Texas
On February 13, 1998, PHC entered into an amended letter of intent
outlining the significant terms of a proposed sale of Principal Health Care of
Texas, Inc. If the transaction is completed in accordance with the letter of
intent, PHC will realize a net loss of approximately $6 million. This
anticipated loss has been deemed to be evidence of an impairment of recorded
goodwill for Principal Health Care of Texas, Inc. The impairment, net of related
deferred taxes, has been reflected in the financial statements for September 30,
1997.
Merger
On November 3, 1997, a definitive Combination Agreement was entered into by
and among Mutual, Holding, PHC, Coventry, Newco, and Coventry Health Care, Inc.,
a newly formed Maryland Corporation.
F-46
<PAGE> 178
PRINCIPAL HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pursuant to the Combination Agreement, Coventry's shareholders will effect
a one for one tax free merger ("Merger") with Newco and PHC will effect a
capital contribution (the "Capital Contribution") to Newco of all of the PHC
Assets except for specified excluded assets and all of the PHC Liabilities
except for specified excluded liabilities. Under the Merger, Newco will issue
Coventry's shareholders approximately 53 million shares of Newco Common Stock,
representing approximately 60% of Newco's outstanding equity. Under the Capital
Contribution, Newco will issue to PHC approximately 26 million shares of Newco
Common Stock representing approximately 40% of Newco's outstanding equity. Based
on the stock price as of the close of business, Monday, November 3, 1997, the
value of the transaction is approximately $375 million. The transaction will be
treated as a purchase of PHC by Newco, the successor to Coventry. Coventry is a
managed care company with approximately $1.2 billion in annualized 1997 revenues
and 897,758 members in 6 markets in Pennsylvania, Ohio, West Virginia, Missouri,
Illinois, and Virginia.
F-47
<PAGE> 179
ANNEXES TO THE PROXY STATEMENT/PROSPECTUS
<TABLE>
<S> <C>
ANNEXES
ANNEX I Capital Contribution and Merger Agreement effective as of
November 3, 1997 (amending and restating the Capital
Contribution and Share Exchange Agreement dated November
3, 1997)
ANNEX II Form of Agreement and Plan of Merger
ANNEX III Form of Warrant
ANNEX IV Form of Shareholders' Agreement by and among Coventry Health
Care, Inc., Principal Mutual Life Insurance Company, and
Principal Health Care, Inc.
ANNEX V Opinion of Credit Suisse First Boston Corporation
</TABLE>
<PAGE> 180
CAPITAL CONTRIBUTION
AND
MERGER AGREEMENT
BY AND AMONG
COVENTRY CORPORATION,
A TENNESSEE CORPORATION,
COVENTRY HEALTH CARE, INC.,
A NEWLY-FORMED DELAWARE CORPORATION,
COVENTRY HEALTH CARE, INC.,
A MARYLAND CORPORATION AND WHOLLY OWNED SUBSIDIARY OF
COVENTRY CORPORATION,
PRINCIPAL HEALTH CARE, INC.,
AN IOWA CORPORATION AND WHOLLY OWNED SUBSIDIARY OF
PRINCIPAL HOLDING COMPANY,
PRINCIPAL HOLDING COMPANY,
AN IOWA CORPORATION AND WHOLLY OWNED SUBSIDIARY OF
PRINCIPAL MUTUAL INSURANCE COMPANY,
AND
PRINCIPAL MUTUAL LIFE INSURANCE COMPANY,
AN IOWA MUTUAL INSURANCE COMPANY
DATED AS OF DECEMBER 19, 1997
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TABLE OF CONTENTS
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1 THE MERGER AND CAPITAL CONTRIBUTION................................ 2
1.1 Organization of Merger Sub.................................. 2
1.2 The Merger.................................................. 2
1.3 Surrender and Payment....................................... 3
1.4 Adjustment of Merger Ratio.................................. 4
1.5 Effect of Merger............................................ 5
1.6 Principal Capital Contribution.............................. 5
1.7 Indemnity Reinsurance Contract.............................. 6
1.8 Tax Effect.................................................. 6
2 CLOSING AND EFFECTIVE TIME......................................... 7
2.1 The Closing................................................. 7
2.2 Effective Time.............................................. 7
3 REPRESENTATIONS AND WARRANTIES OF COVENTRY......................... 8
3.1 Corporate Organization...................................... 8
3.2 Capitalization.............................................. 8
3.3 Corporate Proceedings, etc. ................................ 9
3.4 Consents and Approvals...................................... 9
3.5 Compliance with Law......................................... 10
3.6 Litigation and Investigations............................... 12
3.7 Absence of Defaults, Conflicts, etc. ....................... 12
3.8 Change in Ownership......................................... 13
3.9 Reports and Financial Statements; SEC Documents............. 13
3.10 Absence of Certain Developments............................. 14
3.11 Material Contracts.......................................... 15
3.12 Absence of Undisclosed Liabilities.......................... 15
3.13 Employees................................................... 15
3.14 Tax Matters................................................. 15
3.15 Employee Benefit Plans...................................... 17
3.16 Patents, Licenses, etc. .................................... 19
3.17 Title to Tangible Assets.................................... 19
3.18 Real Property............................................... 20
3.19 Insurance................................................... 21
3.20 Transactions with Related Parties........................... 21
3.21 Interest in Competitors..................................... 21
3.22 Registration Rights......................................... 22
3.23 Brokerage................................................... 22
3.24 Illegal or Unauthorized Payments and Political
Contributions............................................... 22
3.25 Takeover Statute; Rights Plan............................... 22
3.26 Material Facts.............................................. 22
3.27 Coventry Material Adverse Effect............................ 22
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4 REPRESENTATIONS AND WARRANTIES OF PRINCIPAL........................ 23
4.1 Corporate Organization...................................... 23
4.2 Title to Assets............................................. 23
4.3 Corporate Proceedings, etc. ................................ 23
4.4 Consents and Approvals...................................... 24
4.5 Compliance with Law......................................... 24
4.6 Litigation and Investigations............................... 26
4.7 Absence of Defaults, Conflicts, etc. ....................... 27
4.8 Change in Ownership......................................... 27
4.9 Reports and Financial Statements............................ 27
4.10 Absence of Certain Developments............................. 28
4.11 Material Contracts.......................................... 29
4.12 Absence of Undisclosed Liabilities.......................... 29
4.13 Employees................................................... 29
4.14 Tax Matters................................................. 29
4.15 Employee Benefit Plans...................................... 31
4.16 Patents, Licenses, etc. .................................... 33
4.17 Title to Tangible Assets.................................... 33
4.18 Real Property............................................... 33
4.19 Insurance................................................... 34
4.20 Transactions with Related Parties........................... 34
4.21 Interest in Competitors..................................... 35
4.22 Brokerage................................................... 35
4.23 Illegal or Unauthorized Payments; Political Contributions... 35
4.24 Material Facts.............................................. 35
4.25 Principal Material Adverse Effect........................... 35
5 REPRESENTATIONS AND WARRANTIES OF MUTUAL........................... 36
5.1 Corporate Organization...................................... 36
5.2 Validity of Mutual Indemnity Agreements..................... 36
5.3 Corporate Proceedings, etc. ................................ 36
5.4 Consents and Approvals...................................... 37
5.5 Compliance with Law......................................... 37
5.6 Litigation.................................................. 37
5.7 Absence of Defaults, Conflicts, etc. ....................... 38
5.8 Premium Information......................................... 38
5.9 Ownership of Coventry Common Shares......................... 38
5.10 Absence of Undisclosed Liabilities.......................... 38
5.11 Brokerage................................................... 38
5.12 Mutual Material Adverse Effect.............................. 38
</TABLE>
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6 COVENANTS.......................................................... 39
6.1 Acquisition Proposals....................................... 39
6.2 Best Efforts................................................ 40
6.3 Conduct of Businesses....................................... 40
6.4 Conduct of Businesses....................................... 41
6.5 Registration Statement...................................... 41
6.6 Financial Statements........................................ 42
6.7 Listing Application......................................... 42
6.8 Meeting of Coventry's Shareholders.......................... 42
6.9 Filings; Other Action....................................... 43
6.10 Investigation and Confidentiality........................... 43
6.11 Publicity................................................... 44
6.12 Further Action.............................................. 44
6.13 Expenses.................................................... 44
6.14 Governance.................................................. 44
6.15 Employment Agreement........................................ 44
6.16 Corporate Headquarters...................................... 44
6.17 Certain Benefits............................................ 44
6.18 Ancillary Agreements........................................ 45
6.19 Tangible Net Value.......................................... 46
6.20 Taxes....................................................... 46
6.21 Merger Sub.................................................. 48
6.22 Qualification............................................... 48
6.23 Agreement and Plan of Merger................................ 48
7 CONDITIONS......................................................... 49
7.1 Conditions to Each Party's Obligations...................... 49
7.2 Conditions to Obligation of Principal and Mutual............ 49
7.3 Conditions to Obligation of Coventry and Newco.............. 50
8 TERMINATION........................................................ 52
8.1 Termination by Mutual Consent............................... 52
8.2 Termination by Either Coventry or Principal................. 52
8.3 Termination by Principal.................................... 52
8.4 Termination by Coventry..................................... 52
8.5 Automatic Termination....................................... 52
8.6 Effect of Termination and Abandonment....................... 53
8.7 Extension; Waiver........................................... 53
9 GENERAL PROVISIONS................................................. 54
9.1 Nonsurvival of Representations, Warranties and Agreements... 54
9.2 Indemnification............................................. 54
9.3 Notices..................................................... 54
9.4 Assignment, Binding Effect; Benefit......................... 55
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9.5 Entire Agreement............................................ 55
9.6 Amendment................................................... 55
9.7 Governing Law............................................... 55
9.8 Headings.................................................... 55
9.9 Interpretation.............................................. 55
9.10 Waivers..................................................... 55
9.11 Incorporation of Exhibits................................... 55
9.12 Severability................................................ 55
9.13 Enforcement of Agreement.................................... 55
9.14 Terms Defined............................................... 56
9.15 Counterparts................................................ 60
9.16 Disclosure Letters.......................................... 60
</TABLE>
LIST OF SCHEDULES
[OMITTED]
LIST OF EXHIBITS
[OMITTED]
iv
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CAPITAL CONTRIBUTION AND MERGER AGREEMENT
This CAPITAL CONTRIBUTION AND MERGER AGREEMENT (effective as of November 3,
1997, and amending and restating the Capital Contribution and Share Exchange
Agreement dated November 3, 1997) (this "Agreement"), is executed by and among
COVENTRY CORPORATION, a Tennessee corporation ("Coventry"), COVENTRY HEALTH
CARE, INC., a newly-formed Delaware corporation ("Newco"), COVENTRY HEALTH CARE,
INC., a Maryland corporation and wholly-owned subsidiary of Coventry ("Maryland
Newco"), PRINCIPAL MUTUAL LIFE INSURANCE COMPANY, an Iowa mutual insurance
company ("Mutual"), PRINCIPAL HOLDING COMPANY, an Iowa corporation and wholly
owned subsidiary of Mutual ("Holding"), and PRINCIPAL HEALTH CARE, INC., an Iowa
corporation and wholly owned subsidiary of Holding ("Principal"). The parties
agree that this Agreement amends and restates the Capital Contribution and Share
Exchange Agreement dated November 3, 1997, and Maryland Newco is a party to this
Agreement for such purpose only.
RECITALS
WHEREAS, the Boards of Directors of Coventry and Mutual each have
determined that a strategic combination between Coventry and Principal is in the
best interests of their respective companies, shareholders and/or policyholders
(as appropriate) and presents an opportunity for their respective companies to
achieve long-term strategic and financial benefits, and accordingly have agreed
to combine their managed care businesses and to enter into this Agreement; and
WHEREAS, for United States federal income tax purposes, it is intended that
the transfer of the Principal Assets (as defined below) by Principal to Newco
qualify as a transfer subject to Section 351(a) of the Internal Revenue Code of
1986, as amended, and the rules and regulations promulgated thereunder (the
"Code") and that the merger of Coventry Merger Corporation, a corporation to be
formed by Newco under Tennessee law as a wholly-owned subsidiary of Newco
("Merger Sub"), with and into Coventry, as provided in the Plan (as defined
below), qualify as a transfer subject to Section 351(a) of the Code and a
reorganization subject to Section 368(a)(2)(E) of the Code; and
WHEREAS, the parties intend that this Agreement amend and restate the
Capital Contribution and Share Exchange Agreement that certain of the parties
entered into on November 3, 1997;
NOW, THEREFORE, in consideration of the foregoing, and of the
representations, warranties, covenants and agreements contained herein, the
parties hereto agree as follows:
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<PAGE> 186
THE MERGER AND CAPITAL CONTRIBUTION
1.1 ORGANIZATION OF MERGER SUB. Promptly after the date hereof, Newco shall
organize Merger Sub.
1.2 THE MERGER.
(a) At or prior to the Effective Time, Coventry and Merger Sub shall
execute that certain Agreement and Plan of Merger, substantially in the
form attached as Exhibit 1.2(a) hereto (the "Plan").
(b) Upon the terms and subject to the conditions of this Agreement and
the Plan, at the Effective Time, Merger Sub shall merge with and into
Coventry and the separate existence of Merger Sub shall cease. Coventry
shall be the surviving corporation in the merger (the "Merger") and its
separate corporate existence, with all its purposes, objects, rights,
privileges, powers and franchises, shall continue unaffected and unimpaired
by the Merger.
(c) Pursuant to the Plan, at the Effective Time:
(i) each share of Newco's Common Stock, par value $0.01 per share
(the "Newco Common Stock"), issued and outstanding immediately prior to
the Effective Time shall, by virtue of the Merger and without any action
on the part of the holder thereof, be canceled and retired and cease to
exist;
(ii) each share of Coventry's Common Stock, par value $0.01 per
share ("Coventry Common Stock"), issued immediately prior to the
Effective Time shall, by virtue of the Merger and without any action on
the part of the holder thereof, be converted into the right to receive
(A) one share of Newco Common Stock and (B) one right (collectively, the
"Newco Rights") issuable under that certain Rights Agreement, dated as
of the Closing Date between Newco and ChaseMellon Shareholder Services,
LLC (the "Newco Rights Agreement"); and each holder of a certificate (a
"Common Certificate") representing shares of Coventry Common Stock shall
thereafter cease to have any rights with respect to such shares, except
the right to receive the shares of Newco Common Stock and the Newco
Rights upon the surrender of such Common Certificate;
(iii) all of the rights (collectively, the "Coventry Rights")
issued under that certain Rights Agreement, dated February 7, 1996,
between Coventry and ChaseMellon Shareholder Services, LLC, as amended
by that First Amendment to Rights Agreement, dated May 7, 1997 (as
amended, the "Coventry Rights Plan"), issued immediately prior to the
Effective Time shall be canceled and retired and cease to exist;
(iv) each share of Coventry's Series A Convertible Preferred Stock,
par value $0.01 per share ("Coventry Preferred Stock"), issued and
outstanding immediately prior to the Effective Time shall, by virtue of
the Merger and without any action on the part of the holder thereof, be
converted into the right to receive one share of Newco's Series A
Convertible Preferred Stock, par value $0.01 per share ("Newco Preferred
Stock"); all shares of Coventry Preferred Stock shall be canceled and
retired and shall cease to exist; and each holder of a certificate (a
"Preferred Certificate") (the Common Certificates and Preferred
Certificates, hereinafter collectively being referred to as the
"Certificates") representing any shares of Coventry Preferred Stock
shall thereafter cease to have any rights with respect to such shares,
except the right to receive the Newco Preferred Stock upon the surrender
of such Preferred Certificate;
(v) each Convertible Exchangeable Subordinated Note (the
"Convertible Notes") issued under that certain Amended and Restated
Securities Purchase Agreement, dated May 7, 1997 (the "Warburg
Agreement"), by and among Coventry, Warburg, Pincus Ventures L.P.
("Warburg") and Franklin Capital Associates III L.P. ("Franklin") and
then outstanding shall, by virtue of the Merger and without any action
on the part of the holder thereof, be converted into the right to
receive a Convertible Exchangeable Subordinated Note in accordance with
the terms of the Warburg Consent, a copy of which is attached as Exhibit
1 hereto;
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<PAGE> 187
(vi) each of the options (individually, a "Coventry Option" and
collectively, the "Coventry Options") then outstanding under Coventry's
stock option plans listed on Schedule 1.2 hereto (collectively, the
"Coventry Stock Option Plans") shall be converted, without any action on
the part of the holder thereof, into the right to purchase that number
of shares of Newco equal to the number of shares of Coventry Common
Stock issuable upon exercise as set forth in such Coventry Option; such
Coventry Options shall, by virtue of the Merger and without any further
action on the part of Coventry or the holder of any such Coventry
Option, be assumed by Newco; each of the warrants listed on Schedule 1.2
hereto (individually, a "Coventry Warrant" and collectively, the
"Coventry Warrants") shall be converted, without any action on the part
of the holder thereof, into the right to purchase that number of shares
of Newco equal to the number of shares of Coventry Common Stock issuable
upon exercise as set forth in such Coventry Warrant; such Coventry
Warrants shall, by virtue of the Merger and without any further action
on the part of Coventry or the holder of any such Coventry Warrant, be
assumed by Newco; each Coventry Option or Coventry Warrant assumed by
Newco shall be exercisable upon the same terms and conditions as under
the applicable Coventry Stock Option Plan and the applicable Coventry
Option issued thereunder or under the Coventry Warrant except that (i)
each such Coventry Option shall be exercisable for that whole number of
shares of Newco Common Stock into which the number of shares of Coventry
Common Stock subject to such Coventry Option or Coventry Warrant
immediately prior to the Effective Time would be converted under this
Section 1.2, and (ii) the option or warrant price per share of Newco
Common Stock shall be an amount equal to the option or warrant price per
share of Coventry Common Stock subject to such Coventry Option or
Coventry Warrant in effect immediately prior to the Effective Time; and
Newco shall reserve for issuance the number of shares of Newco Common
Stock that will become issuable upon the exercise of such Coventry
Options and Coventry Warrants, shall file as soon as possible after the
Effective Time, and maintain the effectiveness during the period the
Coventry Options are outstanding, Registration Statements on Forms S-8
under the Securities Act of 1933, as amended (the "Securities Act"),
with respect to the shares of Newco Common Stock issuable upon exercise
of the Coventry Options, upon demand pursuant to the terms of the
Warburg Agreement, will register the shares of Newco Common Stock
issuable upon exercise or conversion of the securities issued under the
Warburg Agreement, and shall take appropriate action to list all such
shares with The Nasdaq Stock Market ("Nasdaq") and to provide
appropriate notice of issuance to Nasdaq; and
(vii) all of the shares of common stock, par value $0.01 per share,
of Merger Sub issued and outstanding and held by Newco immediately prior
to the Effective Time shall, by virtue of the Merger and without any
action on the part of Newco, be converted into the right to receive a
total of 1,000 shares of Coventry Common Stock, which shares shall
represent all of the issued and outstanding shares of capital stock of
Coventry immediately after the Effective Time.
1.3 SURRENDER AND PAYMENT
(a) As of the Effective Time, pursuant to the Plan, Newco shall
deposit, or shall cause to be deposited, with an exchange agent selected by
Coventry, which shall be Coventry's Transfer Agent or such other party
reasonably satisfactory to Coventry (the "Exchange Agent"), for the benefit
of the holders of shares of Coventry Common Stock and Coventry Preferred
Stock, for exchange in accordance with this Article 1, certificates
representing the shares of Newco Common Stock and Newco Preferred Stock
(such cash and certificates for shares of Newco Common Stock and Newco
Preferred Stock, together with any dividends or distributions with respect
thereto, being hereinafter referred to as the "Exchange Fund") to be issued
pursuant to Section 1.2 hereof and paid pursuant to this Section 1.3 in
exchange for outstanding shares of Coventry Common Stock and Coventry
Preferred Stock.
(b) Promptly after the Effective Time, pursuant to the Plan, Coventry
shall cause the Exchange Agent to mail to each holder of record of a
Certificate or Certificates (i) a letter of transmittal which shall specify
that delivery shall be effected, and risk of loss and title to the
Certificates shall pass, only upon delivery of the Certificates to the
Exchange Agent and shall be in such form and have such other
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<PAGE> 188
provisions as Newco may reasonably specify and (ii) instructions for use in
effecting the surrender of the Certificates in exchange for certificates
representing shares of Newco Common Stock and/or Newco Preferred Stock.
Upon surrender of a Certificate for cancellation to the Exchange Agent
together with such letter of transmittal, duly executed and completed in
accordance with the instructions thereto, the holder of such Certificate
shall be entitled to promptly receive in exchange therefor (x) a
certificate representing that number of whole shares of Newco Common Stock
or Newco Preferred Stock, as appropriate, and (y) a check representing the
amount of unpaid dividends and distributions, if any, which such holder has
the right to receive in respect of the Certificate surrendered pursuant to
the provisions of this Section 1.3, after giving effect to any required
withholding tax, and the Certificate so surrendered shall forthwith be
canceled. No interest will be paid or accrued on the unpaid dividends and
distributions, if any, payable to holders of Certificates. In the event of
a transfer of ownership of Coventry Common Stock or Coventry Preferred
Stock which is not registered in the transfer records of Coventry, a
certificate representing the proper number of shares of Newco Common Stock
or Newco Preferred Stock, as appropriate, may be issued to such a
transferee if the Certificate representing such Coventry Common Stock or
Coventry Preferred Stock is presented to the Exchange Agent, accompanied by
all documents required to evidence and effect such transfer and to evidence
that any applicable stock transfer taxes have been paid.
(c) At or after the Effective Time, pursuant to the Plan, there shall
be no transfers on the stock transfer books of Coventry of the shares of
Coventry Common Stock which were outstanding immediately prior to the
Effective Time. If, after the Effective Time, Certificates are presented to
Newco, they shall be canceled and exchanged for certificates evidencing
ownership of shares of Newco Common Stock and/or Newco Preferred Stock
deliverable in respect thereof pursuant to this Agreement in accordance
with the procedures set forth in this Section 1.3.
(d) Pursuant to the Plan, any portion of the Exchange Fund (including
the proceeds of any investments thereof and any shares of Newco Common
Stock and Newco Preferred Stock) that remains unclaimed by the former
shareholders of Coventry one year after the Effective Time shall be
delivered to Newco. Any former shareholders of Coventry who have not
theretofore complied with this Section 1.3 shall thereafter look only to
Newco for payment of their shares of Newco Common Stock and/or Newco
Preferred Stock, unpaid dividends and distributions on the Newco Common
Stock and/or Newco Preferred Stock deliverable in respect of each share of
Coventry Common Stock or Coventry Preferred Stock, as appropriate, such
shareholder holds as determined pursuant to this Agreement, in each case,
without any interest thereon.
(e) Pursuant to the Plan, none of Coventry, Principal, Newco, the
Exchange Agent or any other person shall be liable to any former holder of
shares of Coventry Common Stock or Coventry Preferred Stock for any amount
properly delivered to a public official pursuant to applicable abandoned
property, escheat or similar laws.
(f) Pursuant to the Plan, in the event any Certificate shall have been
lost, stolen or destroyed, upon the making of an affidavit of that fact by
the person claiming such Certificate to be lost, stolen or destroyed and,
if required by Newco, the posting by such person of a bond in such
reasonable amount as Newco may direct as indemnity against any claim that
may be made against it with respect to such Certificate, the Exchange Agent
will issue in exchange for such lost, stolen or destroyed Certificate the
shares of Newco Common Stock and/or Newco Preferred Stock and unpaid
dividends and distributions on shares of Newco Common Stock and/or Newco
Preferred Stock deliverable in respect thereof pursuant to this Agreement.
1.4 ADJUSTMENT OF MERGER RATIO. Pursuant to the Plan, in the event that,
subsequent to the date of this Agreement but prior to the Effective Time,
Coventry changes the number of shares of Coventry Common Stock issued and
outstanding as a result of a stock split, reverse stock split, stock dividend,
recapitalization or other similar transaction, the merger ratio (the "Merger
Ratio") of one share of Coventry Common Stock for one share of Newco Common
Stock and one Newco Right and one share of Coventry Preferred Stock for one
share of Newco Preferred Stock shall be appropriately adjusted.
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1.5 EFFECT OF MERGER. Pursuant to the Plan, the Merger shall have the effect
specified in Section 48-21-108 of the Tennessee Business Corporation Act (the
"TBCA").
1.6 PRINCIPAL CAPITAL CONTRIBUTION.
(a) Subject to the terms and conditions of this Agreement, at the Effective
Time, Principal agrees to grant, contribute, convey, assign, transfer and
deliver to Newco (the "Capital Contribution") all right, title and interest in
all of its assets, except for those assets listed in Schedule 1.6(a)(i) hereto
(the "Excluded Assets") pursuant to an Assignment and Assumption Agreement
substantially in the form attached as Exhibit 2 hereto (the "Assignment and
Assumption Agreement") (the assets of Principal so transferred to Newco being
collectively referred to as the "Principal Assets"), in consideration of (i) the
issuance and delivery by Newco to Principal of such number of shares of Newco
Common Stock as shall equal the sum of (A) 66 2/3% of the shares of Newco Common
Stock issued to shareholders of Coventry in the Merger (other than shares issued
to Coventry Health and Life Insurance Company, a Texas mutual insurance company
("Coventry Health")) plus (B) 66 2/3% of the shares of Newco Common Stock
issuable upon the conversion of the Convertible Notes outstanding at the
Effective Time plus (C) 66 2/3% of the shares of Newco Common Stock issuable
upon conversion of the Newco Preferred Stock issued and outstanding at the
Effective Date and (ii) Newco Rights with respect to the shares of Newco Common
Stock issuable to Principal pursuant to (i) above. The Principal Assets shall
include all of the issued and outstanding capital stock of the wholly owned
subsidiaries of Principal listed on Schedule 1.6(a)(ii) under the caption
"Principal Subsidiaries" (collectively, the "Principal Subsidiaries"), all real
and personal property owned or leased by Principal, all accounts receivable,
cash, securities, contract rights, prepaid liabilities and all other assets of
Principal, other than the Excluded Assets.
(b) The Principal Assets shall be contributed and transferred to Newco
subject to, and Newco agrees to assume, all liabilities, liens, charges,
encumbrances and obligations of Principal, fixed, contingent or unmatured,
disclosed or undisclosed (the "Assumed Liabilities"), except for the excluded
liabilities, "Excluded Liabilities", pursuant to the Assignment and Assumption
Agreement, which Excluded Liabilities shall include (i) all tax liabilities of
the Principal Subsidiaries for Pre-Acquisition Date Tax Periods and of any other
member of the affiliated group of corporations (as defined in Section 1504(a) of
the Code) including Principal or any Principal Subsidiary on or prior to the
Closing Date, (ii) any of the Plans (including Pension Plans) as defined in
Section 4.15(a) of this Agreement sponsored by Mutual or Principal, and any
past, current or future liabilities or obligations with respect to any such
Plans or with respect to any Pension Plan subject to Title IV of ERISA in which
either Mutual, Principal, any Principal Subsidiary, or any ERISA Affiliate as
defined in Section 4.15(h) of this Agreement has ever sponsored, participated
in, contributed to or withdrawn from, (iii) all liabilities, liens, charges,
encumbrances and obligations of Principal, fixed, contingent or unmatured,
disclosed or undisclosed relating to the Excluded Assets, (iv) except for the
PHC Plan defined and described below, all liabilities and obligations of
Principal associated with the employment agreements with Kenneth J. Linde,
Sharon I. Taylor, Francis Soistman, Jr., Charles David Roberts, Robert J.
Mrizek, Harvey Pollack and Ron Chaffin, and (v) Excluded Liabilities set forth
on Section 1.6(a)(i) of the Principal Disclosure Letter. Principal, Holding and
Mutual, jointly and severally, shall indemnify Newco and hold it harmless from
any loss, liability, claim, damage or expense (including reasonable legal fees
and expenses) suffered or incurred by Newco to the extent arising from any
Excluded Liability.
Attached hereto as Exhibit 1.6 is a true and correct copy of the 1997
Non-Qualified Stock Option Plan (the "PHC Plan") pursuant to which PHC is
authorized to grant options to acquire up to 1,000,000 shares of common stock
par value $0.001 per share (the "PHC Common Stock"). Among the Assumed
Liabilities, each of the options (individually, a "PHC Option" and collectively,
the "PHC Options") issued and outstanding at the Effective Time under the PHC
Plan shall be converted, without any action on the part of the holder thereof,
into the right to purchase that number of shares of Newco Common Stock equal to
the number of shares of PHC Common Stock issuable upon the exercise of such PHC
Option and such PHC Options shall, by virtue of the Capital Contribution and
without further action on the part of Coventry or the holder of any such PHC
Option, be assumed by Newco. Each PHC Option assumed by Newco shall be
exercisable upon the same terms and conditions as under the PHC Option Plan and
the applicable PHC
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<PAGE> 190
Option issued thereunder except that (i) each such PHC Option shall be
exercisable for that whole number of shares of Newco Common Stock as shall equal
the number of PHC Common Stock issuable upon its exercise immediately prior to
the Effective Time and (ii) the option price per share of Newco Common Stock
shall be an amount equal to the option price per share of PHC Common Stock
subject to the PHC Option immediately prior to the Effective Time. Newco shall
reserve for issuance the number of shares of Newco Common Stock that will become
issuable upon exercise of such PHC Option, shall file as soon as possible after
the Effective Time, and maintain the effectiveness during the period the PHC
Options are outstanding, Registration Statements on Forms S-8 under the
Securities Act with respect to the shares of Newco Common Stock issuable upon
exercise of the PHC Options, and shall take appropriate action to list all such
shares with Nasdaq and to provide appropriate notice of issuance to Nasdaq.
Prior to the Effective Time, PHC shall provide to Newco and Coventry a list of
each person to whom a PHC Option has been granted and a copy of all of the
option agreements entered into pursuant to the PHC Plan. PHC covenants and
agrees not to amend the PHC Plan without the prior written consent of Newco and
Coventry and not to issue options to purchase a number of shares of PHC Common
Stock in excess of a total of 750,000 shares.
1.7 INDEMNITY REINSURANCE CONTRACT. In consideration of the execution and
delivery by Mutual of a Coinsurance Agreement, substantially in the form
attached as Exhibit 3 hereto (the "Coinsurance Agreement "), pursuant to which
Mutual will cede and Coventry Health will assume through indemnity reinsurance
effective January 1, 2000, all indemnity agreements listed in Exhibits 4(a) and
4(b) hereto (as amended from time to time), (collectively, the "Mutual Indemnity
Agreements") Newco agrees to issue to Mutual on the Effective Date a warrant
(the "Newco Warrant "), substantially in the form of Exhibit 5 hereto, pursuant
to which Mutual shall have the right to purchase a number of shares of Newco
Common Stock, equal to 66 2/3% of the total number of shares of Common Stock
issuable upon exercise or conversion of the options and warrants assumed by
Newco pursuant to Sections 1.2(c)(vi) and 1.6 hereto (collectively, the "Option
Securities") that shall be issued and outstanding at the Closing, and Exhibits
4(a) and 4(b) will not include any of the other assets owned or leased by
Mutual, which excluded assets include, without limitation, Mutual's indemnity
agreements in force in counties in which the Principal Subsidiaries and the
Coventry Subsidiaries do not currently conduct business or plan to conduct
business, the national account indemnity ASO business wherever located, and
indemnity agreements relating to non-medical insurance products (i.e. life,
disability, dental and vision) wherever located. The indemnity business
conducted by Mutual pursuant to the Mutual Indemnity Agreements, renewals
thereof and the issuance of new indemnity agreements generally in the same
geographic areas shall hereinafter be referred to as the "Mutual Indemnity
Business". Within 30 days following the end of each calendar month following the
Closing Date and thereafter until December 31, 1999, Mutual shall deliver to
Newco amended and restated Exhibits 4(a) and 4(b) , which shall include all
Mutual Indemnity Agreements in force as of the end of the preceding month,
including the renewal dates thereof. On the Closing Date, Mutual shall deliver
to Coventry a true and complete list of Mutual Indemnity Agreements in effect as
of the end of the second month preceding the Closing.
1.8 TAX EFFECT. It is the intent of the parties that the Capital Contribution
qualify as a transfer subject to Section 351(a) of the Code and that the Merger
qualify as a transfer subject to Section 351(a) of the Code and a reorganization
subject to Section 368(a)(2)(E) of the Code.
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CLOSING AND EFFECTIVE TIME
2.1 THE CLOSING. Subject to the terms and conditions of this Agreement, the
closing (the "Closing") of the Merger and the Capital Contribution shall take
place (a) at the offices of Bass, Berry & Sims PLC, First American Center,
Nashville, Tennessee, at 9:00 a.m., local time, on the third business day
immediately following the day on which the last to be fulfilled or waived of the
conditions set forth in Articles 6 and 7 hereof shall be fulfilled or waived in
accordance herewith or (b) at such other time, date or place as the parties
hereto may agree. The date on which the Closing occurs is hereinafter referred
to as the "Closing Date."
2.2 EFFECTIVE TIME. If all the conditions to the Merger and the Capital
Contribution set forth in Article 7 hereof shall have been fulfilled or waived
in accordance herewith and this Agreement shall not have been terminated as
provided in Article 8 hereof, the parties hereto shall cause an Articles of
Merger, meeting the requirements of Section 48-21-107 of the TBCA and
substantially in the form attached as Exhibit 1.2(a) hereto, and the Plan to be
properly executed and filed on the Closing Date. The Merger shall become
effective at the time of filing of the Articles of Merger with the Secretary of
State of the State of Tennessee in accordance with the TBCA or at such later
time which the parties hereto shall have agreed upon and designated in such
filing as the effective time of the Merger (the "Effective Time").
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REPRESENTATIONS AND WARRANTIES OF COVENTRY
Coventry represents and warrants to Principal, Mutual and Holding that
except as expressly set forth in the correspondingly numbered section on the
disclosure letter delivered on even date herewith to Principal, Mutual and
Holding (the "Coventry Disclosure Letter") to the extent specifically disclosed
with respect to the representation to which such exception applies:
3.1 CORPORATE ORGANIZATION.
(a) Each of Coventry and the Coventry Subsidiaries (a complete list of
which is set forth in Section 3.1(a) of the Coventry Disclosure Letter) is
a corporation duly organized, validly existing and in good standing under
the laws of its jurisdiction of incorporation.
(b) Section 3.1(b) of the Coventry Disclosure Letter contains true and
complete copies of the Charter and Bylaws of each of Coventry and Newco, as
amended through the date hereof (collectively, the "Coventry Organizational
Documents"). Coventry has provided Principal with true and correct copies
of the charter and bylaws of the other Coventry Subsidiaries (the "Coventry
Subsidiary Organizational Documents").
(c) Each of Coventry and the Coventry Subsidiaries has all requisite
power and authority and has all necessary approvals, licenses, permits and
authorization to own or lease its properties and to carry on its business
as now conducted. Newco is a newly-formed corporation established for the
purpose of the transactions contemplated by this Agreement and neither owns
any assets nor conducts any business. Each of Coventry and the Coventry
Subsidiaries has all requisite power and authority to execute and deliver
this Agreement and, subject to the approval of the shareholders of
Coventry, to perform its obligations hereunder.
(d) Each of Coventry and the Coventry Subsidiaries has filed all
necessary documents to qualify to do business as a foreign corporation in,
and is in good standing under the laws of, each jurisdiction in which the
conduct of its business or the nature of the property owned requires such
qualification, except where the failure to so qualify would result in a
Coventry Material Adverse Effect. Each of Coventry and the Coventry
Subsidiaries is duly registered, qualified and authorized to transact
business and is in good standing in each jurisdiction in which the conduct
of its business or the nature of its properties requires such registration,
qualification or authorization, except where the failure to be so
registered, qualified or authorized would not result in a Coventry Material
Adverse Effect.
(e) Except as set forth in Section 3.1(e)(i) of the Coventry
Disclosure Letter, all of the issued and outstanding capital stock of each
of Coventry and the Coventry Subsidiaries has been duly authorized and
validly issued, is fully paid and non-assessable, and, with regard to the
Coventry Subsidiaries, is owned of record and beneficially, directly or
indirectly, by Coventry free and clear of any mortgage, pledge, lien,
charge, security interest, claim or other legal or equitable encumbrance,
limitation or restriction. Except as set forth in Section 3.1(e)(ii) of the
Coventry Disclosure Letter, there are no outstanding options, warrants,
agreements, conversion rights, preemptive rights or other rights to
subscribe for, purchase or otherwise acquire any issued or unissued shares
of capital stock of Coventry or any Coventry Subsidiary. Except as set
forth in Section 3.1(e)(iii) of the Coventry Disclosure Letter, no Coventry
Subsidiary has any Subsidiary nor any equity interests or equity
investments in any partnership, trust or other entity or organization.
3.2 CAPITALIZATION.
(a) The authorized capital stock of Coventry consists of 100,000,000
shares of Coventry Common Stock and 6,000,000 shares of Coventry Preferred
Stock and 1,000,000 shares of undesignated ("blank check") preferred stock,
par value $0.01 per share. The issued and outstanding shares of capital
stock of Coventry consists of approximately 33,161,802 shares of Coventry
Common Stock. Section 3.2(a) of the Coventry Disclosure Letter sets forth
and describes all instances wherein Coventry Common Stock is held as
treasury stock. Coventry has no other shares of treasury stock. Except as
set forth in
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Section 3.2(a) of the Coventry Disclosure Letter, there are no bonds,
debentures, notes or other evidences of indebtedness issued or outstanding
having the right to vote on any matters on which Coventry's shareholders
may vote.
(b) The authorized capital stock of Newco consists of 200,000,000
shares of Newco Common Stock and 6,000,000 shares of Newco Preferred Stock
and 1,000,000 shares of undesignated ("blank check") preferred stock, par
value $0.01 per share. The issued and outstanding shares of capital stock
of Newco consists of 1,000 shares of Newco Common Stock which are held by
Coventry. Newco has no shares of treasury stock. There are no bonds,
debentures, notes or other evidences of indebtedness having the right to
vote on any matters on which Newco's shareholders may vote issued or
outstanding.
(c) All the outstanding shares of capital stock of each of Coventry
and the Coventry Subsidiaries were issued in accordance with any applicable
registration or qualification requirements of the Securities Act and any
relevant state securities laws or pursuant to valid exemptions therefrom.
(d) Except as set forth in Section 3.2(d) of the Coventry Disclosure
Letter, on the Closing Date there will be no shares of Coventry Common
Stock or any other equity security of Coventry issuable upon conversion,
exchange or exercise of any option, warrant or other security of Coventry
or any Coventry Subsidiary, and Coventry will not be obligated,
contractually or otherwise, to purchase, redeem or otherwise acquire any of
its outstanding shares. Except as set forth in Section 3.2(d) of the
Coventry Disclosure Letter, no shareholder of Coventry is entitled to any
preemptive or similar rights to subscribe for shares of capital stock of
Coventry.
3.3 CORPORATE PROCEEDINGS, ETC. Each of Coventry and the Coventry Subsidiaries
has the requisite corporate power to execute and deliver, to perform its
obligations under, and to consummate the transactions contemplated by, this
Agreement and each Ancillary Agreement to which it is a party. The execution,
delivery and performance of this Agreement and each Ancillary Agreement by
Coventry and Newco, and the consummation by Coventry and Newco of the
transactions contemplated hereby and thereby, have been duly authorized by all
necessary corporate action and no other corporate proceedings on the part of
Coventry and Newco are necessary to authorize this Agreement or any Ancillary
Agreement (other than with respect to the adoption of this Agreement by the
holders of Coventry Common Stock in accordance with the TBCA and the Coventry
Organizational Documents). This Agreement has been duly executed and delivered
by Coventry and Newco and, assuming the due authorization, execution and
delivery by the other parties hereto and the approval of the shareholders of
Coventry, constitutes the legal, valid and binding obligation of Coventry and
Newco, enforceable against Coventry and Newco in accordance with its respective
terms, except that such enforcement may be subject to bankruptcy, insolvency,
reorganization, moratorium or similar laws now or hereafter in effect relating
to creditors' rights and general principles of equity. As of the Closing Date,
each Ancillary Agreement will have been duly executed and delivered by Coventry,
Newco and Coventry Health, and subject to the due execution and delivery of such
agreements by the other parties thereto (other than Coventry, Newco and Coventry
Health), each Ancillary Agreement executed by Coventry, Newco and Coventry
Health will constitute the legal, valid and binding obligation of Coventry,
Newco and Coventry Health, enforceable against Coventry in accordance with its
respective terms, except that such enforcement may be subject to bankruptcy,
insolvency, reorganization, moratorium or similar laws now or hereafter in
effect relating to creditors' rights and general principles of equity.
3.4 CONSENTS AND APPROVALS. Except as set forth in Section 3.4 of the Coventry
Disclosure Letter, the execution and delivery by each of Coventry and Coventry
Subsidiaries of this Agreement and each of the Ancillary Agreements to which
Coventry or the Coventry Subsidiaries is a party, the performance by each of
Coventry and the Coventry Subsidiaries of its obligations hereunder and
thereunder and the consummation by Coventry and the Coventry Subsidiaries of the
transactions contemplated hereby and thereby do not require Coventry or any of
the Coventry Subsidiaries to obtain any consent, approval, clearance or action
of, or make any filing, submission or registration with, or give any notice to,
any Person or any federal, state, local or foreign government, any court,
administrative, regulatory or other governmental agency, commission or authority
or any non-government self-regulatory agency, commission or authority (a
"Governmental Entity").
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3.5 COMPLIANCE WITH LAW.
(a) Except for violations which would not result in a Coventry
Material Adverse Effect, Coventry and each of the Coventry Subsidiaries are
in compliance with, and are not in violation or default under, all federal,
state and local laws, ordinances, government rules and regulations
applicable to their business operations, properties, or assets, including
without limitation laws or regulations relating to: the environment;
occupational health and safety; insurance companies; health maintenance
organizations ("HMOs"); preferred provider organizations ("PPOs");
point-of-service health plans; third party administrators; the provision or
arrangement for the provision of health services; employee benefits; ERISA
plans; wages; work place safety; equal employment opportunity and race; and
religious, sex and age discrimination. Except as set forth in Section
3.5(a) of the Coventry Disclosure Letter, none of Coventry and the Coventry
Subsidiaries has received any notice of, and to the best of their
respective knowledge, there exists no threat or claim by any Governmental
Entity of, any violation or default by Coventry or any Coventry Subsidiary
with respect to any of the foregoing. No material expenditures, to
Coventry's knowledge, are or will be required in order to cause the current
operations or properties of Coventry or any of the Coventry Subsidiaries to
comply with any applicable laws, ordinances, governmental rules or
regulations at Closing.
(b) Coventry and each of the Coventry Subsidiaries have all licenses,
permits, franchises or other governmental authorizations ("Coventry
Approvals") necessary to the ownership of their property and to the
operation of their respective businesses, except where the failure to have
such Coventry Approvals would not result in a Coventry Material Adverse
Effect. None of Coventry and the Coventry Subsidiaries has finally been
denied any application for any such Coventry Approvals necessary for their
property or for the operation of their business. There is no action
pending, or to the best knowledge of Coventry or any of the Coventry
Subsidiaries, threatened or recommended by appropriate state or federal
agencies having jurisdiction thereof, to either revoke, withdraw, or
suspend any such Coventry Approvals, or which would result in a Coventry
Material Adverse Effect, or to terminate the participation of Coventry or
any of the Coventry Subsidiaries in Medicare, Medicaid, or other government
program, or any decision not to renew any such Approvals.
(c) Coventry and the Coventry Subsidiaries have complied with all
laws, rules, conditions of participation, and regulations governing all
Medicare, Medicaid, and any other arrangements with any Governmental Entity
(and/or an intermediary) and have filed all returns, cost reports and other
filings in any manner prescribed thereby except where the failure to so
comply, together with all other such failures, would not result in a
Coventry Material Adverse Effect. All returns, cost reports and other
filings made by Coventry and the Coventry Subsidiaries since January 1,
1992 to Medicare, Medicaid or any other Governmental Entity (and/or an
intermediary) or third party payor are true and complete except where the
failure to be so true and complete, together with all other such failures,
would not result in a Coventry Material Adverse Effect. Since January 1,
1992, no deficiency in any such returns, costs reports and other filings,
including deficiencies for late filings, has been asserted or to the best
of Coventry's knowledge, after reasonable investigation, threatened by any
federal, state or local agency or instrumentality or other entities
relating to Medicare or Medicaid or other government payor or third party
payor claims and to the best of Coventry's knowledge, after reasonable
investigation, there is no basis for any successful claims or requests for
recoupment from any such agency, instrumentality, entity or third party
payor except for any claims or requests which, together with all other such
claims or requests, would not result in a Coventry Material Adverse Effect.
None of Coventry and the Coventry Subsidiaries has been subject to any
written finding of fraudulent procedures or practices arising out of the
provision of health care insurance, managed care, claims administration, or
health care services or benefits relating to Medicare, Medicaid, or any
other Governmental Entity with which Coventry or any of the Coventry
Subsidiaries has a contract to provide insurance, managed care, claims
administration, or health care services or benefits and, none of Coventry
and the Coventry Subsidiaries is currently subject to any pending or
threatened audit relating to such fraudulent procedures or practices.
(d) In each state in which Coventry or any of the Coventry
Subsidiaries operates HMOs, PPOs, point of service plans, insurance plans
or other health care plans, each of Coventry and the Coventry
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Subsidiaries has filed copies of its (i) standard employer and other
individual and group subscriber agreements, (ii) contracts with physicians,
hospitals and other health care entities, and (iii) contracts for
management and administrative services (collectively, "Coventry
Agreements") with the applicable state authorities to the extent required
by law, including, but not limited to contracts required to be filed with
the state Departments of Insurance, Departments of Health or the agencies
responsible for each state's Medicaid program. Coventry and each of the
Coventry Subsidiaries are not providing services under any Agreements that
have not been filed and approved by the state regulatory authorities except
where the failure to so file would not result in a Coventry Material
Adverse Effect.
(e) Coventry and each of the Coventry Subsidiaries is and has operated
in compliance with all contractual, statutory, regulatory, and other
requirements (collectively "Coventry Government Contracts") applicable to
entities furnishing coverage to employees of federal, state and local
governments and subdivisions and to beneficiaries under programs sponsored
or administered by any such governments or subdivisions thereof, except
where non-compliance would not result in a Coventry Material Adverse
Effect. Except as set forth in Section 3.5(e) of the Coventry Disclosure
Letter, none of Coventry or any of the Coventry Subsidiaries is required to
pay any claim, penalty, fine, return of premium, repayment of costs
charged, or renegotiation of charges or fees as a result of any audit,
adjustment, charge, retroactive restatements of costs or charges, or other
liability with respect to any Coventry Government Contract, except where
such claim, penalty, fine, return of premium, repayment or renegotiation
would not result in a Coventry Material Adverse Effect.
(f) Coventry and each of the Coventry Subsidiaries has filed all
reports, filings and notices required to be filed with all applicable
Departments of Insurance, Departments of Health and HMO regulatory bodies
since January 1, 1992 except where the failure to so file would not result
in a Coventry Material Adverse Effect (as such documents have since the
time of their filing been amended, the "Coventry DOI Reports"). As of their
respective dates, the Coventry DOI Reports complied in all material
respects with the requirements of the laws, rules and regulations
applicable to such DOI Reports.
(g) None of Coventry and any of the Coventry Subsidiaries, nor the
officers, directors, employees or agents of Coventry or any of the Coventry
Subsidiaries, and to Coventry's knowledge none of the persons who provide
professional services under agreements with Coventry or any of the Coventry
Subsidiaries (as agents of such entities) has engaged in any activities
which are prohibited under Medicare or Medicaid statutes, under sec.sec.
1320a-7, 1320a-7a, 1320a-7b, or 1395nn of Title 42 of the United States
Code, the federal CHAMPUS statute, or the regulations promulgated pursuant
to such statutes or regulations or related state or local statutes or, to
Coventry's knowledge, which are prohibited by any private accrediting
organization from which Coventry or any of the Coventry Subsidiaries holds
or seeks accreditation, including but not limited to:
(i) knowingly and willfully making or causing to be made a false
statement or representation of a material fact in any application for
any benefit or payment;
(ii) knowingly and willfully making or causing to be made any false
statement or representation of a material fact for use in determining
rights to any benefit or payment;
(iii) presenting or causing to be presented a claim for
reimbursement for services that is for a material fact for use in
determining rights to any benefit or payment;
(iv) failure to disclose knowledge of the occurrence of any event
affecting the initial or continued right to any benefit or payment on
its own behalf or on behalf of another, with intent to fraudulently
secure such benefit or payment;
(v) knowingly and willfully offering, paying, soliciting or
receiving any remuneration (including any kickback, bribe, or rebate),
directly or indirectly, overtly or covertly, in cash or in kind (i) in
return for referring an individual to a person for the furnishing or
arranging for the furnishing of any item or service for which payment
may be made in whole or in part by CHAMPUS, Medicare, Medicaid, or other
state health care program, or (ii) in return for purchasing, leasing, or
ordering or arranging for or recommending purchasing, leasing, or
ordering any good, facility, service, or item for
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which payment may be made in whole or in part by CHAMPUS, Medicare,
Medicaid or other state health care program; or
(vi) knowingly and willfully making or causing to be made or
inducing or seeking to induce the making of any false statement or
representation (or omit to state a fact required to be stated therein or
necessary to make the statement contained therein not misleading) of a
material fact with respect to: (i) a facility in order that the facility
may qualify for CHAMPUS, Medicare, Medicaid or other state health care
program certification, or (ii) information required to be provided under
sec. 1124A of the Social Security Act (42 U.S.C. sec. 1320a-3).
(h) REPORTS OF EXAMINATIONS. Coventry has delivered to Principal
copies of all reports of examinations by a Governmental Entity issued
subsequent to December 31, 1995 (including draft reports not yet finalized)
conducted on each Coventry Subsidiary (collectively, the "Coventry Reports
of Examinations").
3.6 LITIGATION AND INVESTIGATIONS. Except as disclosed on Section 3.6(a) of the
Coventry Disclosure Letter, there is no: (i) action, suit, claim, proceeding, or
investigation pending or, to Coventry's knowledge, threatened against or
affecting Coventry or the Coventry Subsidiaries, or any of its employees, by any
private party or any federal, state, municipal, or other governmental
department, commission, board, bureau, agency or instrumentality, domestic or
foreign; or, to Coventry's knowledge, pending, threatened against, or affecting
persons or entities who perform professional services under agreement with
Coventry or the Coventry Subsidiaries before any professional self-governance,
oversight, or regulatory body; (ii) arbitration proceeding relating to Coventry
or the Coventry Subsidiaries pending under collective bargaining agreements or
otherwise; or (iii) governmental or professional inquiry pending or threatened
against or directly or indirectly affecting Coventry or the Coventry
Subsidiaries (including without limitation any inquiry as to the qualification
of Coventry or the Coventry Subsidiaries to hold or receive any license or
permit), and there is no basis for any of the foregoing as to Coventry or the
Coventry Subsidiaries, its officers or directors or, to Coventry's knowledge, as
to entities or persons who perform professional services for Coventry or the
Coventry Subsidiaries. Coventry has not received any opinion, memorandum, or
legal advice from legal counsel to the effect that it is exposed, from a legal
standpoint, to any liability which may be material to the business of Coventry
or the Coventry Subsidiaries as now conducted. Coventry and the Coventry
Subsidiaries are not in default with respect to any order, writ, injunction, or
decree known to or served upon it of any court or of any federal, state,
municipal, or other governmental department, commission, board, bureau, agency,
or instrumentality, domestic or foreign. Except as disclosed on Section 3.6(b)
of the Coventry Disclosure Letter, there is no action or suit by Coventry and
the Coventry Subsidiaries pending or threatened against others. Upon Coventry's
receipt of written approval for the transactions contemplated herein from the
applicable state and federal regulatory bodies, Coventry will have complied in
all material respects with all laws, rules, regulations, and orders applicable
to its businesses, operations, properties, assets, products, and services, and
that of the Coventry Subsidiaries, and Coventry and the Coventry Subsidiaries
has all necessary permits, licenses, and other authorizations required to
conduct its businesses as conducted, the absence of which would not result in a
Coventry Material Adverse Effect, including but not limited to, a state license
as a health maintenance organization. There is no existing law, rule,
regulation, or order, or proposed law, rule, regulation, or order, whether
federal, state, local, or professional, which would prohibit or restrict the
Coventry and the Coventry Subsidiaries from, or otherwise materially adversely
affect each of Coventry and the Coventry Subsidiaries in, conducting its
business in any jurisdiction in which it is now conducting business or in which
it proposes to conduct business.
3.7 ABSENCE OF DEFAULTS, CONFLICTS, ETC. The execution and delivery of this
Agreement does not and the execution and delivery of the Ancillary Agreements
will not, and the fulfillment of the terms hereof and thereof by Coventry and
the Coventry Subsidiaries will not, result in a breach of any of the terms,
conditions or provisions of, or constitute a default under, or result in the
modification of, or permit the acceleration of rights under or termination of,
any indenture, mortgage, deed of trust, credit agreement, note or other evidence
of indebtedness, non-competition agreement, profit-sharing arrangements, or
other material agreement, contract, commitment, understanding, arrangement or
restriction of Coventry or any of the Coventry Subsidiaries and any other party
or parties (collectively the "Coventry Key Agreements and Instruments,"),
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the Coventry Organizational Documents, the Coventry Subsidiary Organizational
Documents, or any law, ordinance, code, standard, judgment, rule or regulation
of any court or federal, state or foreign regulatory board or body or
administrative agency having jurisdiction over Coventry or any of the Coventry
Subsidiaries or over their respective properties, assets, or businesses. None of
Coventry and any of the Coventry Subsidiaries is in default under or in
violation of (and no event has occurred and no condition exists which, upon
notice or the passage of time (or both), would constitute a default under: (i)
the Coventry Organizational Documents or the Coventry Subsidiary Organizational
Documents, (ii) any Coventry Key Agreement and Instrument, or (iii) any order,
writ, injunction or decree of any court or any Federal, state, municipal or
other domestic or foreign governmental department, commission, board, bureau,
agency or instrumentality except, in the case of clause (ii), for defaults or
violations which would not result in a Coventry Material Adverse Effect.
3.8 CHANGE IN OWNERSHIP. Except as set forth in Section 3.8 of the Coventry
Disclosure Letter, the consummation of the transactions contemplated by this
Agreement will not result in (i) a Coventry Material Adverse Effect; (ii) any
material adverse change in the business operations of any of the Coventry
Subsidiaries; (iii) the loss of the benefits of any material relationship with
any subscriber group, employee, union trust, or governmental program, payor or
customer, physician, hospital, health care provider, claims administrator, or
supplier to Coventry or any of the Coventry Subsidiaries; (iv) the acceleration
of the vesting of any outstanding option, warrant, call, commitment, agreement,
conversion right, preemptive right or other right to subscribe for, purchase or
otherwise acquire any of the shares of the capital stock of Coventry or any of
the Coventry Subsidiaries, or debt securities of Coventry or any of the Coventry
Subsidiaries (collectively "Coventry Commitments," and each individually a
"Coventry Commitment "); (v) any obligation of Coventry to grant, extend or
enter into any Commitment; (vi) any right in favor of any Person to terminate or
cancel or otherwise affect any Coventry Key Agreement or Instrument; or (vii)
the existence of a triggering event under any employment, severance or
termination agreement or other compensation arrangement or any plan, or Coventry
Plan currently in effect, which (either alone or upon the occurrence of any
additional or subsequent event) could reasonably be expected to result in any
payment, acceleration, vesting or increase in benefits to any current or former
officer, employee, director, or independent contractor of Coventry or any
Coventry Subsidiary and which would constitute an "excess parachute payment" (as
such term is defined in Section 280G(b)(1) of the Code).
3.9 REPORTS AND FINANCIAL STATEMENTS; SEC DOCUMENTS.
(a) As of their respective dates, (or, if amended or superseded by a
filing prior to the date of this Agreement, then on the date of such
filing) Coventry SEC Reports were duly filed and complied in all material
respects with the requirements of the Securities Act or the Exchange Act,
as the case may be, and the rules and regulations of the SEC thereunder
applicable to such Coventry SEC Reports. As of their respective dates,
Coventry SEC Reports did not contain any untrue statement of a material
fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances
under which they were made, not misleading. The audited consolidated
financial statements and unaudited interim financial statements of Coventry
included in Coventry SEC Reports comply as to form in all material respects
with applicable accounting requirements of the Securities Act and with the
published rules and regulations of the SEC with respect thereto. The
financial statements included in Coventry SEC Reports (i) have been
prepared in accordance with generally accepted accounting principles
("GAAP") applied on a consistent basis (except as may be indicated therein
or in the notes thereto), (ii) present fairly, in all material respects,
the financial position of Coventry and the Coventry Subsidiaries as at the
dates thereof and the results of their operations and cash flow for the
periods then ended subject, in the case of the unaudited interim financial
statements, to normal year-end audit adjustments and any other adjustments
described therein and the fact that certain information and notes have been
condensed or omitted in accordance with the Exchange Act and the rules
promulgated thereunder, and (iii) are in all material respects, in
accordance with the books of account and records of Coventry and the
Coventry Subsidiaries except as indicated therein.
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(b) REPORTS BASED ON STATUTORY ACCOUNTING. Coventry has delivered to
Principal: Copies of Annual Statements filed by Coventry Subsidiaries as at
December 31 for each of the years 1992 through 1996 and audit reports
thereon prepared by independent certified public accountants, copies of
interim financial statements filed by Coventry Subsidiaries with regulatory
authorities for the periods ending March 31, 1997 and June 30, 1997, and a
draft of such financial report for the period ending as at September 30,
1997 (collectively, the "Coventry Interim Financial Statements"). Such
reports (collectively, the "Coventry Regulatory Statements") (i) have been
prepared in accordance with statutory accounting practices applied on a
consistent basis (except as may be indicated therein or in the notes
thereto), (ii) present fairly, in all material respects, the financial
positions of the Coventry Subsidiaries as at the dates thereof, and the
results of their operations and cash flows for the periods then ended,
subject, in the case of the unaudited interim Coventry Regulatory
Statements, to normal year-end audit adjustments and other adjustments
described therein, and (iii) are in all material respects in accordance
with the books of account and records of the Coventry Subsidiaries except
as indicated therein.
(c) DERIVATIVES, ETC. None of Coventry and any of the Coventry
Subsidiaries owns any interest in, or has any liability (including any
contingent liability) with respect to, any options, puts, calls, swaps,
exchange contracts or other derivatives or any other similar material off
balance sheet financing arrangements or liabilities.
(d) IBNR CALCULATIONS. All information furnished by Coventry to
Principal and Mutual regarding the historical calculation of the reserves
of Coventry or the Coventry Subsidiaries for incurred but not reported
("IBNR") claims was true and correct in all material respects and the
methodology for calculating IBNR claims has been consistent with sound
actuarial principles using accounting and reserve criteria consistently
applied by Coventry and the Coventry Subsidiaries in calculating IBNR
claims since December 31, 1994.
(e) SEC-RELATED CORRESPONDENCE. Coventry has delivered to Principal,
Holding and Mutual true and complete copies of all correspondence between
the SEC and Coventry or its legal counsel, accountants or other advisors
since January 1, 1997. Coventry is not aware of any material issues raised
by the SEC with respect to any of the SEC Reports, other than those
disclosed to Principal, Holding and Mutual pursuant to the immediately
preceding sentence.
3.10 ABSENCE OF CERTAIN DEVELOPMENTS. Except as set forth in Section 3.10 to the
Coventry Disclosure Letter and except as disclosed in the SEC Reports, since
December 31, 1996, there has been no (i) change or event which would result in a
Coventry Material Adverse Effect; (ii) declaration, setting aside or payment of
any dividend or other distribution with respect to the capital stock of
Coventry; (iii) issuance of capital stock (other than pursuant to the exercise
of options, warrants, or convertible securities outstanding at such date) or
options, warrants or rights to acquire capital stock; (iv) material loss,
destruction or damage to any property of Coventry or any Coventry Subsidiary,
whether or not insured; (v) acceleration or prepayment of any indebtedness for
borrowed money; (vi) labor dispute or disagreement involving Coventry or any
Coventry Subsidiary or any material change in their personnel or the terms and
conditions of employment; (vii) waiver of any valuable right in favor of
Coventry or any Coventry Subsidiary; (viii) loan or extension of credit to any
officer or employee of Coventry or any Coventry Subsidiary other than advances
for travel-related expenses and similar advances to officers and employees of
Coventry in the ordinary course of business and except for guarantees by
Coventry of the indebtedness, obligations or liabilities of any Coventry
Subsidiary; (ix) acquisition or disposition of any material assets (or any
contract or arrangement therefor), or any other material transaction by Coventry
or any Coventry Subsidiary otherwise than for fair value in the ordinary course
of business; (x) any incurrence, assumption or guarantee by Coventry or any
Coventry Subsidiary of any indebtedness, obligation or liability, other than in
the ordinary course of business; (xi) any sale, assignment, transfer or
disposition of, or any incurrence, creation or assumption of any Lien on, any
material asset of Coventry or any Coventry Subsidiary other than in the ordinary
course of business; (xii) any making of any loan, advance or capital
contributions to or investment in any Person other than loans, advances or
capital contributions to or investments in wholly owned Subsidiaries made in the
ordinary course of business; (xiii) (a) any increase in the rate or terms of
compensation (including bonuses) payable or to become payable by Coventry or any
Coventry Subsidiary to its directors or officers, except increases occurring in
the ordinary
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course of business in accordance with its customary practices, (b) any material
increase in the rate or terms of any Coventry Plans, payment or arrangement made
by Coventry to, for or with any such directors or officers, except increases
occurring in the ordinary course of business, (c) any employment, consulting,
deferred compensation, severance, retirement or other similar agreement entered
into with any director, officer, employee, agent of Coventry or any Coventry
Subsidiary (or any amendment to any such existing agreement), (d) any grant of
any severance or termination pay to any director, officer, employee, or agent of
Coventry or any Coventry Subsidiary; (xiv) any expenditure or commitment for
additions to property, plant or equipment of Coventry or any Coventry Subsidiary
that exceeds $500,000 individually; or (xv) any contract to do any of the
foregoing.
3.11 MATERIAL CONTRACTS. Section 3.11 of the Coventry Disclosure Letter sets
forth a true and complete list of each Key Agreement and Instrument. Each Key
Agreement and Instrument and any other material contract of Coventry or a
Coventry Subsidiary that is currently in effect, is valid, binding and
enforceable against Coventry or such Coventry Subsidiary and, to Coventry's best
knowledge, the other parties thereto, in accordance with its terms, and in full
force and effect on the date hereof.
3.12 ABSENCE OF UNDISCLOSED LIABILITIES. None of Coventry and any of the
Coventry Subsidiaries has any debt, obligation or liability (whether accrued,
absolute, contingent, liquidated or otherwise, whether due or to become due,
whether or not known to Coventry) except (i) liabilities disclosed in the Form
10-Q filed by Coventry for the quarter ending June 30, 1996, (ii) any such
liability incurred after June 30, 1996 in the ordinary course of business, (iii)
obligations under agreements set forth in Section 3.12 of the Coventry
Disclosure Letter, and (iv) obligations under agreements entered into, in the
usual and ordinary course of business, and none of the above (individually or in
the aggregate) would result in a Coventry Material Adverse Effect.
3.13 EMPLOYEES.
(a) Coventry and the Coventry Subsidiaries are in compliance in all
respects with all applicable laws regarding employment, wages, hours, equal
opportunity, collective bargaining and payment of social security and other
taxes except to the extent that noncompliance would not result in a
Coventry Material Adverse Effect. Since January 1, 1996, no complaint has
been filed or was pending with respect to any unfair labor practice or
discriminatory employment practice against Coventry or any Coventry
Subsidiary has been filed, nor, to the best of Coventry's knowledge, was
such a complaint threatened to be filed with or by the National Labor
Relations Board, the Equal Employment Opportunity Commission or any other
administrative agency, federal or state, that regulates labor or employment
practices. There is no grievance filed or, to the best of Coventry's
knowledge, threatened to be filed, against Coventry or any Coventry
Subsidiary by any employee pursuant to any collective bargaining or other
employment agreement to which Coventry or any Coventry Subsidiary is a
party or is bound. Coventry and the Coventry Subsidiaries have received no
complaints from any federal, state or local agency or regulatory body
alleging violations of occupational safety and health standards, except to
the extent that noncompliance would not result in a Coventry Material
Adverse Effect.
(b) Except as set forth in Section 3.13(b) of the Coventry Disclosure
Letter, the employment of each Person employed by Coventry or any of the
Coventry Subsidiaries is terminable at will without any penalty or
severance obligation of any kind on the part of the employer. All sums due
for employee compensation and benefits and all vacation time owing to any
employees of Coventry or any of the Coventry Subsidiaries have been duly
and adequately accrued on the accounting records of Coventry and the
Coventry Subsidiaries.
3.14 TAX MATTERS.
(a) All Tax Returns required under applicable law to be filed with or
provided to any person by Coventry or any Coventry Subsidiary have been
(and, as to Tax Returns not filed as of the date hereof, will be) timely
filed or provided in the manner prescribed by law and such Tax Returns were
(and, as to Tax Returns not filed as of the date hereof, will be), true,
complete and correct;
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(b) Coventry and each Coventry Subsidiary have within the time and in
the manner prescribed by law paid (and until the Effective Time will pay
within the time and in the manner prescribed by law) all Taxes due and
payable except for those contested in good faith and for which adequate
reserves have been taken;
(c) Coventry and each Coventry Subsidiary have established (and until
the Effective Time will maintain) on their books and records (i) reserves
adequate to pay all Taxes accrued but not yet due and payable and all
deficiencies asserted, proposed or threatened against Coventry or any
Coventry Subsidiary and (ii) reserves for deferred Taxes, in each case, in
accordance with GAAP;
(d) There are no Tax liens upon the assets of Coventry or any Coventry
Subsidiary except liens for Taxes not yet due;
(e) Coventry and each Coventry Subsidiary have complied (and until the
Effective Time will comply) with all applicable laws relating to
information reporting and to the withholding of Taxes (including, but not
limited to, information reporting and withholding of Taxes pursuant to
Sections 1441, 1442, 3402, 3405, 3406, 6047, 6049, 6051 and 6052 of the
Code or similar provisions under any foreign laws) and have, within the
time and in the manner prescribed by law, paid all amounts required to be
so withheld and paid over under all applicable laws;
(f) Neither Coventry nor any Coventry Subsidiary has requested any
extension of time within which to file any Tax Return, which Tax Return has
not since been filed;
(g) Except as set forth in Section 3.14(g) of the Coventry Disclosure
Letter, neither Coventry nor any Coventry Subsidiary has executed any
outstanding waivers or comparable consents regarding the application of the
statute of limitations with respect to any Taxes or Tax Returns. The
statute of limitations for the assessment of all Taxes has expired for all
applicable Tax Returns of Coventry and each Coventry Subsidiary or those
Tax Returns have been examined by the appropriate taxing authorities for
all periods through December 31, 1991, and no deficiencies, assessments or
written proposals for the assessment of any Taxes have been proposed,
asserted or assessed against Coventry or any Coventry Subsidiary that has
not been resolved and paid in full;
(h) Except as set forth in Section 3.14(h) of the Coventry Disclosure
Letter, no audits or other administrative proceedings or court proceedings
are presently pending with regard to any Taxes or Tax Returns of Coventry
or any Coventry Subsidiary. Neither Coventry nor any Coventry Subsidiary
has any knowledge of any threatened action, audit or administrative or
court proceeding with respect to any such Taxes or Tax Returns. Further, to
the best of the knowledge of Coventry and each Coventry Subsidiary, no
state of facts exists or has existed which would constitute grounds for the
assessment of any liability for Taxes with respect to the periods which
have not been audited by the Internal Revenue Service (the "IRS") or other
taxing authority;
(i) No power of attorney currently in force has been granted by
Coventry or any Coventry Subsidiary with respect to any matter relating to
Taxes;
(j) Neither Coventry nor any Coventry Subsidiary has received a Tax
Ruling or entered into a Closing Agreement with any taxing authority that
would result in a continuing Coventry Material Adverse Effect after the
Effective Time;
(k) Coventry and each Coventry Subsidiary have made available (or, in
the case of income Tax Returns not yet filed will make available) to Mutual
complete and accurate copies of (i) all income Tax Returns, and any
amendments thereto, filed by or on behalf of Coventry and each Coventry
Subsidiary for all taxable years since December 31, 1994 and (ii) all audit
reports received from any taxing authority relating to any Tax Return filed
by or on behalf of Coventry or any Coventry Subsidiary;
(l) Neither Coventry nor any Coventry Subsidiary is a party to any Tax
allocation or sharing agreement with any person (other than Coventry or a
Coventry Subsidiary). In addition, neither Coventry nor any Coventry
Subsidiary has any liability for Taxes of any Person other than Coventry or
a
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Coventry Subsidiary under Treasury Regulation Section 1.1502-6 (or any
similar provision of state, local or foreign law), as a transferee or
successor, by contract or otherwise;
(m) Except as set forth in Section 3.14(m) of the Coventry Disclosure
Letter, neither Coventry nor any Coventry Subsidiary is a party to any
contract or arrangement that, separately or in the aggregate, could, by
reason of the transactions contemplated by this Agreement, give rise to the
payment of any "excess parachute payment" within the meaning of Section
280G of the Code;
(n) No election under Section 338 of the Code (or any predecessor
provisions) has been made by or with respect to Coventry or any Coventry
Subsidiary or any of their respective assets or properties;
(o) No property of Coventry or any Coventry Subsidiary is property
that (i) Coventry or any Coventry Subsidiary or any party to this
transaction is or will be required to treat as being owned by another
Person pursuant to the provisions of Section 168(f)(8) of the Code (as in
effect prior to its amendment by the Tax Reform Act of 1986) or (ii) is
subject to the "alternative depreciation system" described in Section 168
of the Code;
(p) Neither Coventry nor any Coventry Subsidiary is required to
include in income any adjustment pursuant to Section 481(a) of the Code by
reason of a voluntary change in accounting method initiated by Coventry or
any Coventry Subsidiary and neither Coventry nor any Coventry Subsidiary
has proposed any such adjustment or change in accounting method;
(q) All transactions that could give rise to an understatement of
federal income Tax (within the meaning of Section 6661 of the Code for Tax
Returns filed on or before December 31, 1989, and within the meaning of
Section 6662 of the Code for Tax Returns filed after December 31, 1989)
have been adequately disclosed (or, with respect to Tax Returns not yet
filed will be adequately disclosed) on the Tax Returns of Coventry and the
Coventry Subsidiaries in accordance with Section 6661(b)(2)(B) of the Code
for Tax Returns filed on or prior to December 31, 1989, and in accordance
with Section 6662(d)(2)(B) of the Code for Tax Returns filed after December
31, 1989;
(r) As of December 31, 1996, Coventry and the Coventry Subsidiaries
had net operating loss carryovers available to offset future income as
disclosed on Section 3.14(r) of the Coventry Disclosure Letter. Section
3.14(r) of the Coventry Disclosure Letter discloses the amount of and year
of expiration of each net operating loss carryover;
(s) As of December 31, 1996, Coventry and the Coventry Subsidiaries
had Tax credit carryovers available to offset future Tax liability as
disclosed on Schedule 3.14(s) of the Coventry Disclosure Letter. Section
3.14(s) of the Coventry Disclosure Letter discloses the amount of and year
of expiration of each Tax credit carryover;
(t) Coventry is not and has not been a United States real property
holding company (as defined in Section 897(c)(2) of the Code) during the
applicable period specified in Section 897(c)(1)(ii) of the Code;
(u) Neither Coventry nor any Coventry Subsidiary has filed (or will
file prior to the Effective Time) a consent pursuant to Section 341(f) of
the Code or has agreed to have Section 341(f)(2) of the Code apply to any
disposition of a "subsection (f) asset" (as that term is defined in Section
341(f)(4) of the Code) owned by Coventry or any Coventry Subsidiary; and
(v) Neither Coventry nor any Coventry Subsidiary has taken any action
or has any knowledge of any fact or circumstance that would, or would be
reasonably likely to, adversely affect the status of (i) the Merger as a
nontaxable transfer discussed in Section 351(a) of the code and a
reorganization as described in Section 368(a)(2)(E) of the Code and (ii)
the Capital Contribution as a non-taxable exchange described in Section 351
of the Code.
3.15 EMPLOYEE BENEFIT PLANS.
(a) Section 3.15 of the Coventry Disclosure Letter lists each bonus,
deferred compensation, pension, stock option, stock appreciation right,
profitsharing or retirement plan, arrangement or practice,
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each medical, vacation, retiree medical, disability, life insurance,
severance pay plan, and each other agreement or fringe benefit plan,
arrangement or practice, to which Coventry or any Coventry Subsidiary
contributes or is a party or under which it may have a liability, whether
legally binding or not, which affects one or more of the employees or
former employees of Coventry or any Coventry Subsidiary, including all
"employee benefit plans" as defined by Section 3(3) of ERISA (collectively,
the "Coventry Plans"). All Coventry Plans which are subject to Title IV of
ERISA or the minimum funding standards of Section 412 of the Code shall be
referred to as the "Coventry Pension Plans."
(b) For each Coventry Plan which is an "employee benefit plan" under
Section 3(3) of ERISA, Coventry has delivered to Mutual correct and
complete copies of the plan documents and summary plan descriptions, the
most recent determination letter received from the Internal Revenue
Service, the most recent Form 5500 Annual Report, and all related trust
agreements, insurance contracts and funding agreements which implement each
such Coventry Plan.
(c) Neither Coventry nor any Coventry Subsidiary has any commitment,
whether formal or informal and whether legally binding or not, (i) to
create any additional such Coventry Plan; (ii) to modify or change any such
Coventry Plan; or (iii) to maintain for any period of time any such
Coventry Plan, except as accurately and completely described in Section
3.15 of the Coventry Disclosure Letter. Section 3.15 of the Coventry
Disclosure Letter contains an accurate and complete description of the
funding policies (and commitments, if any) of Coventry and the Coventry
Subsidiaries with respect to each such existing Coventry Plan.
(d) Except as disclosed in Section 3.15 of the Coventry Disclosure
Letter, (i) Coventry and the Coventry Subsidiaries have no unfunded past
service liability in respect of any of the Coventry Plans; (ii) the
actuarially computed value of vested benefits under any Coventry Pension
Plan (determined in accordance with methods and assumptions utilized by the
Pension Benefit Guaranty Corporation ("PBGC ") applicable to a plan
terminating on the date of determination) does not exceed the fair market
value of the fund assets relating to such Coventry Pension Plan; (iii)
neither Coventry nor any Coventry Subsidiary nor any Coventry Plan nor any
trustee, administrator, fiduciary or sponsor of any Coventry Plan has
engaged in any prohibited transactions as defined in Section 406 of ERISA
or Section 4975 of the Code for which there is no statutory exemption in
Section 408 of ERISA or Section 4975 of the Code; (iv) all filings, reports
and descriptions as to such Coventry Plans (including Form 5500 Annual
Reports, Summary Plan Descriptions, PBGC-1's and Summary Annual Reports)
required to have been made or distributed to participants, the Internal
Revenue Service, the United States Department of Labor and other
governmental agencies have been made in a timely manner or will be made on
or prior to the Closing Date; (v) there is no material litigation, disputed
claim, governmental proceeding or investigation pending or threatened with
respect to any of such Coventry Plans, the related trusts, or any
fiduciary, trustee, administrator or sponsor of such Coventry Plans; (vi)
such Coventry Plans have been established, maintained and administered in
all material respects in accordance with their governing documents and
applicable provisions of ERISA and the Code and Treasury Regulations
promulgated thereunder; (vii) there has been no "Reportable Event" as
defined in Section 4043 of ERISA with respect to any Coventry Pension Plan
that has not been waived by the Pension Benefit Guaranty Corporation; and
(viii) each Coventry Pension Plan and each Coventry Plan which is intended
to be a qualified plan under Section 401(a) of the Code has received,
within the last three years, a favorable determination letter from the
Internal Revenue Service.
(e) Coventry and the Coventry Subsidiaries have complied in all
material respects with all applicable federal, state and local laws, rules
and regulations relating to employees' employment and/or employment
relationships, including, without limitation, wage related laws,
anti-discrimination laws, employee safety laws and COBRA (defined herein to
mean the requirements of Section 4980B of the Code, Proposed Treasury
Regulation Section 1.162-26 and Part 6 of Subtitle B of Title I of ERISA).
(f) Except as disclosed in Section 3.15 of the Coventry Disclosure
Letter, the consummation of the transactions contemplated by this Agreement
will not (i) result in the payment or series of payments by Coventry or any
Coventry Subsidiary to any employee or other person of an "excess parachute
payment"
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within the meaning of Section 280G of the Code, (ii) entitle any employee
or former employee of Coventry or any Coventry Subsidiary to severance pay,
unemployment compensation or any other payment, and (iii) accelerate the
time of payment or vesting of any stock option, stock appreciation right,
deferred compensation or other employee benefits under any Coventry Plan
(including vacation and sick pay).
(g) Except as disclosed in Section 3.15 of the Coventry Disclosure
Letter, none of the Coventry Plans which are "welfare benefit plans,"
within the meaning of Section 3(1) of ERISA, provide for continuing
benefits or coverage after termination or retirement from employment,
except for COBRA rights under a "group health plan" as defined in Section
4980B(g) of the Code and Section 607 of ERISA.
(h) Neither Coventry nor any Coventry Subsidiary nor any entity
required to be aggregated with either Coventry or any Coventry Subsidiary
under Sections 414(b), (c), (m) or (o) of the Code (an "Coventry ERISA
Affiliate") has ever sponsored, participated in, contributed to or
withdrawn from a multi-employer plan as defined in Section 4001(a)(3) of
Title IV of ERISA, and neither Coventry nor any Coventry Subsidiary nor any
Coventry ERISA Affiliate has ever incurred any liability as a result of any
partial or complete withdrawal by any employer from such a multi-employer
plan as described under Sections 4201, 4203, or 4205 of ERISA.
(i) Except as disclosed in Section 3.15 of the Coventry Disclosure
Letter no Coventry Pension Plan has been completely or partially
terminated, or has any proceeding been instituted by the PBGC to terminate
any such Coventry Pension Plan; neither Coventry nor any Coventry
Subsidiary nor any Coventry ERISA Affiliate has incurred or presently owes
any liability to the PBGC or otherwise under Title IV of ERISA (including
PBGC premiums past due or excise taxes under Section 4971 of the Code), or
in connection with an "accumulated funding deficiency" within the meaning
of Section 302 of ERISA and Section 412 of the Code, whether or not waived.
3.16 PATENTS, LICENSES, ETC. Coventry or one of the Coventry Subsidiaries owns,
free and clear of all encumbrances, restrictions, liens, security interests and
charges, and have good and marketable title to, or hold adequate licenses or
otherwise possess all such rights as are necessary to use all patents (and
applications therefor), patent disclosures, trademarks, service marks, trade
names, copyrights (and applications therefor), inventions, discoveries,
processes, know-how, scientific, technical, engineering and marketing data,
formulae and techniques used or proposed to be used, in or necessary for the
conduct of its business as now conducted or as proposed to be conducted
(collectively, "Coventry Intellectual Property"). The Coventry Intellectual
Property is listed in Section 3.16 of the Coventry Disclosure Letter. None of
Coventry and any of the Coventry Subsidiaries has received notice nor otherwise
has reason to know of any conflict or alleged conflict with the rights of others
pertaining to the Coventry Intellectual Property described in this Section 3.16
where the effect of such conflict could result in a Coventry Material Adverse
Effect. To Coventry's best knowledge, Coventry's business, and the business of
any Coventry Subsidiary, as presently conducted and as proposed to be conducted,
does not infringe upon or violate any patent rights or trade secrets of others
and neither Coventry nor any Coventry Subsidiary has received notice of any such
claim infringement or violation. To Coventry's best knowledge, Coventry and the
Coventry Subsidiaries have the right to use all trade secrets, processes,
customer lists and other rights incident to their respective businesses as now
conducted or as proposed to be conducted. To Coventry's best knowledge, no
employee of Coventry or any of the Coventry Subsidiaries has violated any
employment agreement or proprietary information agreement which he had with a
previous employer or any patent policy of such employer, or is a party (in each
case, as a defendant) to or threatened by any litigation claiming that it is
infringing on any patents, trademarks, trade secrets, service names, trade
names, copyrights, licenses and the like.
3.17 TITLE TO TANGIBLE ASSETS. Except as set forth in Section 3.17 of the
Coventry Disclosure Letter, Coventry and the Coventry Subsidiaries have good
and, subject to regulatory approval, marketable title to the real and personal
property they own and all rights of possession and use under all leases
regarding real and personal property they lease, in each case subject to no
mortgage, pledge, lien, lease, encumbrance or charge, other than or resulting
from taxes which have not yet become due or delinquent and minor liens and
encumbrances
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which do not in any case materially detract from the value of the property
subject thereto, and do not materially impair the operations of Coventry and the
Coventry Subsidiaries. With respect to each parcel of real property owned by
Coventry or a Coventry Subsidiary, Coventry or the Coventry Subsidiary owns a
valid policy of title insurance with regard to that property.
3.18 REAL PROPERTY.
(a) The real property which Coventry or a Coventry Subsidiary owns or
leases, or has owned and disposed of at any time prior to the date hereof,
is set forth in Section 3.18(a) of the Coventry Disclosure Letter
(collectively, the "Coventry Properties").
(b) No storage tanks, including without limitation underground storage
tanks, are located on, in or under the Coventry Properties. There are no
Hazardous Substances (as hereinafter defined) on, in or under the Coventry
Properties, and none of Coventry, any Coventry Subsidiary and any third
party has engaged in or allowed the generation, production, use, handling,
manufacture, treatment, storage, disposal, arranging for disposal or
release of any Hazardous Substances on, in or under the Coventry Property,
except for the use, handling or storage in accordance with applicable
federal, state and local environmental laws of quantities thereof similar
to those quantities usually kept on similar premises by others in the same
business or profession as Coventry. There is no past or present action,
activity, event, condition or circumstance that could be expected to give
rise to any liability by Coventry under any Applicable Environmental Law,
any other statute relating to the environment, or any common law liability
relating to the environment, including without limitation liability related
to the presence of any Hazardous Substances on, in or under any real
property or improvements now or heretofore owned, leased, used or
controlled by Coventry, and also including liability related to the use,
handling, storage, generation, production, manufacture, treatment, release,
disposal or arranging for disposal of any Hazardous Substances by or on
behalf of Coventry, and liability arising by operation of contract or law.
Except as set forth in Section 3.18(b) of the Coventry Disclosure Letter,
no permits, registrations, licenses, authorizations, approvals or filings
are required under any Applicable Environmental Law with respect to the
operation of Coventry's business, including any such items as would be
required for the use, handling, storage, generation, production,
manufacture, treatment, release, disposal or arranging for disposal of any
Hazardous Substance or other materials. With respect to items listed in
Section 3.18(b) of the Coventry Disclosure Letter, if any, such items are
current and Coventry is in compliance with all terms and conditions
therein. "Hazardous Substances" means (i) any substance, contaminant
material, element, compound, mixture, solution, waste, chemical or
pollutant that is now or hereafter listed, defined, characterized or
regulated as hazardous, toxic, dangerous, medical, infectious, or word(s)
of similar import under or pursuant to any statute, law, ordinance, rule or
regulation of any federal, state, regional, county or local governmental
authority having jurisdiction over the Coventry Property or its use or
operation under any Applicable Environmental Law, (ii) petroleum, petroleum
derivatives or by-products, and other hydrocarbons, (iii) polychlorinated
byphenyls (PCBs), asbestos, radon and urea formaldehyde, and (iv)
radioactive substances, materials or waste. "Applicable Environmental Law"
means (i) the Comprehensive Environmental Response, Compensation and
Liability Act; (ii) the Resource Conservation and Recovery Act; (iii) the
Federal Water Pollution Control Act; (iv) the Clean Air Act; (v) the
Hazardous Material Transportation Act; (vi) the Toxic Substances Control
Act; (vii) the Emergency Planning and Community Right-to-Know Act of 1986;
(viii) any amendments to the foregoing Acts as adopted from time to time;
(ix) any rule, regulation, order, injunction, judgment, declaration or
decree implementing or interpreting any of the foregoing Acts, as amended;
and (x) any other federal, state, regional, county or local statute, law,
ordinance, rule, regulation, order or decree, regulating, relating to,
interpreting or imposing liability or standards of conduct concerning
hazardous, toxic, dangerous, medical, infectious, or word(s) of similar
import substance, contaminant, material, waste, chemical or pollutant, or
otherwise relating to the protection of the environment.
(c) Coventry has delivered to Principal correct and complete copies of
the leases and subleases (as amended to date) listed in Section 3.18(c) of
the Coventry Disclosure Letter. With respect to each such lease and
sublease:
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(i) the lease or sublease is legal, valid, binding, enforceable,
and in full force and effect;
(ii) the lease or sublease will continue to be legal, valid,
binding, enforceable, and in full force and effect on identical terms
following the consummation of the transactions contemplated hereby;
(iii) to Coventry's knowledge, no party to the lease or sublease is
in breach or default, and no event has occurred which, with notice or
lapse of time, would constitute a breach or default or permit
termination, modification, or acceleration thereunder;
(iv) no party to the lease or sublease has repudiated any provision
thereof;
(v) there are no disputes, oral agreements, or forbearance programs
in effect as to the lease or sublease;
(vi) with respect to each sublease, the representations and
warranties set forth in subsections (i) through (v) above are true and
correct with respect to the underlying lease;
(vii) none of Coventry and the Coventry Subsidiaries has assigned,
transferred, conveyed, mortgaged, deeded in trust, or encumbered any
interest in the leasehold or subleasehold;
(viii) all facilities leased or subleased thereunder have received
all approvals of governmental authorities (including licenses and
permits) required in connection with the operation thereof and have been
operated and maintained in accordance with applicable laws, rules, and
regulations;
(ix) all facilities leased or subleased thereunder are supplied
with utilities and other services necessary for the operation of said
facilities; and
(x) the owner of the facility leased or subleased has good and
marketable title to the parcel of real property, free and clear of any
security interest, easement, covenant, or other restriction, except for
installments of special easements not yet delinquent and recorded
easements, covenants, and other restrictions which do not impair the
current use, occupancy, or value, or the marketability of title, of the
property subject thereto.
3.19 INSURANCE. Coventry and the Coventry Subsidiaries and their respective real
and personal properties and assets are insured in such amounts, against such
losses and with such insurers as are prudent when considered in light of the
nature of the properties and businesses of Coventry and the Coventry
Subsidiaries and customary in light of Coventry's exposure. No notice of any
termination or threatened termination of any of such policies has been received
and such policies are in full force and effect.
3.20 TRANSACTIONS WITH RELATED PARTIES. Other than transactions entered into on
an arm's length basis, none of Coventry and any Coventry Subsidiary is a party
to any agreement with any of Coventry's employees, directors, officers or
shareholders or any Affiliate or family member of any of the foregoing under
which it: (i) leases any real or personal property (either to or from such
Person), (ii) licenses technology (either to or from such Person), (iii) is
obligated to purchase any tangible or intangible asset from or sell such asset
to such Person, (iv) purchases products or services from such Person or (v) has
borrowed money from or lent money to such Person. None of Coventry and any
Coventry Subsidiary employs as an employee or engages as a consultant any family
member of any of Coventry's directors or officers. Except as set forth in
Section 3.20 of the Coventry Disclosure Letter, to the best knowledge of
Coventry, there exist no agreements among shareholders of Coventry to act in
concert with respect to their voting or holding of Coventry Common Stock.
3.21 INTEREST IN COMPETITORS. Except as set forth in Section 3.21 of the
Coventry Disclosure Letter, none of Coventry, the Coventry Subsidiaries, and any
of their officers and, to the best of their knowledge, directors, has any
interest, either by way of contract or by way of investment (other than as
holder of not more than 2% of the outstanding capital stock of a publicly traded
Person) or otherwise, directly or indirectly, in any Person other than Coventry
that (i) provides any services or designs, produces or sells any product or
product lines or engages in any activity similar to or competitive with any
activity currently proposed to be conducted by Coventry or any of the Coventry
Subsidiaries or (ii) has any direct or indirect interest in any asset or
property, real or personal, tangible or intangible, of Coventry or any Coventry
Subsidiary.
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3.22 REGISTRATION RIGHTS. Except as set forth in Section 3.22 of the Coventry
Disclosure Letter, Coventry will not, as of the Closing Date, be under any
obligation, contractual or otherwise, to register any of its securities under
the Securities Act.
3.23 BROKERAGE. Except as set forth in Section 3.23 of the Coventry Disclosure
Letter, there are no claims for brokerage commissions or finder's fees or
similar compensation in connection with the transactions contemplated by this
Agreement based on any arrangement made by or on behalf of Coventry.
3.24 ILLEGAL OR UNAUTHORIZED PAYMENTS AND POLITICAL CONTRIBUTIONS. None of
Coventry, the Coventry Subsidiaries, and, to the best of their knowledge (after
reasonable inquiry of their executive officers and directors), any of the
current officers and directors of Coventry or any of the Coventry Subsidiaries
has, directly or indirectly, made or authorized any payment, contribution or
gift of money, property, or services (a) as a kickback or bribe to any Person or
(b) to any political organization, or the holder of or any aspirant to any
elective or appointive public office, except for personal political and
political action committee contributions not involving the use of funds of
Coventry or any of the Coventry Subsidiaries and except for contributions made
in accordance with applicable state law.
3.25 TAKEOVER STATUTE; RIGHTS PLAN. Neither PHC nor Mutual, nor any affiliates
of PHC or Mutual, is, as a result of its execution and delivery of this
Agreement, the performance of its obligations hereunder or the acquisition of
any Securities, an "interested shareholder" prohibited from entering into a
business combination with Newco or any Newco subsidiary pursuant to Section 203
of the General Corporate Law of the State of Delaware, nor will any such party
be, at the Effective Time, an "Acquiring Person" within the meaning of the Newco
Rights Agreement. A "Triggering Event " (as defined in the Newco Rights
Agreement) shall not be deemed to have occurred and the Rights (as defined in
the Newco Rights Agreement) shall not separate from the Common Stock as a result
of any of the transactions contemplated hereby. No other federal, state or local
statute or other authority enacted with regard to corporate takeovers is
applicable to the transactions contemplated hereby.
3.26 MATERIAL FACTS. This Agreement, the Coventry Disclosure Letter, the
Ancillary Agreements and the other agreements, documents, certificates or
written statements furnished or to be furnished to Principal, Holding or Mutual
through the Closing Date by or on behalf of Coventry in connection with the
transactions contemplated hereby do not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
contained therein or herein, in light of the circumstances in which they were
made, not misleading. There is no fact which is known to Coventry and which has
not been disclosed herein or otherwise in writing by Coventry to Principal,
Holding and Mutual which would result in a Coventry Material Adverse Effect.
3.27 COVENTRY MATERIAL ADVERSE EFFECT. As used in this Agreement, the term
"Coventry Material Adverse Effect " shall mean any material adverse effect on
the business, operations, properties, prospects, condition or results (financial
or otherwise) of Coventry and the Coventry Subsidiaries taken as a whole.
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REPRESENTATIONS AND WARRANTIES OF PRINCIPAL
Principal represents and warrants to Coventry and Newco that except as
expressly set forth in the correspondingly numbered section on the disclosure
letter delivered on even date herewith to Coventry (the "Principal Disclosure
Letter ") to the extent specifically disclosed with respect to the
representation to which such exception applies:
4.1 CORPORATE ORGANIZATION.
(a) Each of Principal and the Principal Subsidiaries (a complete list
of which is set forth in Section 4.1(a) of the Principal Disclosure Letter)
is a corporation duly organized, validly existing and in good standing
under the laws of its jurisdiction of incorporation.
(b) Section 4.1(b) of the Principal Disclosure Letter contains true
and complete copies of Articles of Incorporation and Bylaws of each of
Principal and the Principal Subsidiaries, as amended through the date
hereof (collectively, the "Principal Organizational Documents").
(c) Each of Principal and the Principal Subsidiaries has all requisite
power and authority and has all necessary approvals, licenses, permits and
authorization to own or lease its properties and to carry on its business
as now conducted. Each of Principal and the Principal Subsidiaries has all
requisite power and authority to execute and deliver this Agreement and to
perform its obligations hereunder.
(d) Each of Principal and the Principal Subsidiaries has filed all
necessary documents to qualify to do business as a foreign corporation in,
and is in good standing under the laws of, each jurisdiction in which the
conduct of its business or the nature of the property owned requires such
qualification, except where the failure to so qualify would result in a
Principal Material Adverse Effect. Each of Principal and the Principal
Subsidiaries is duly registered, qualified and authorized to transact
business and is in good standing in each jurisdiction in which the conduct
of its business or the nature of its properties requires such registration,
qualification or authorization, except where the failure to be so
registered, qualified or authorized would not have a Principal Material
Adverse Effect.
(e) All of the issued and outstanding shares of capital stock of
Principal are owned by Holding. Except as set forth in Section 4.1(e) of
the Principal Disclosure Letter, all of the issued and outstanding capital
stock of each of the Principal Subsidiaries has been duly authorized and
validly issued, is fully paid and non-assessable, and is owned of record
and beneficially, directly or indirectly, by Principal.
4.2 TITLE TO ASSETS. Principal has good and, subject to regulatory requirements
applicable thereto, marketable title to all of the material Principal Assets
and, except as imposed pursuant to regulatory requirements applicable thereto,
such Principal Assets are not subject to any mortgage, pledge, lien, security
interest, lease, conditional sales agreement, option, right of first refusal or
to any other encumbrance, restriction or charge, including taxes, except for
taxes not yet due or delinquent and minor liens and encumbrances which do not in
any case materially detract from the value of the property subject thereto, and
do not materially impair the operations of Principal and the Principal
Subsidiaries. With respect to each parcel of real property owned by Principal or
a Principal Subsidiary, Principal or the Principal Subsidiary owns a valid
policy of title insurance with regard to that property.
4.3 CORPORATE PROCEEDINGS, ETC. The execution, delivery and performance of this
Agreement and each of the Ancillary Agreements by Principal and the consummation
of the transactions contemplated hereby and thereby have been duly and validly
authorized by all requisite corporate action, and no other corporate proceedings
on the part of Principal are necessary to authorize the execution, delivery and
performance of this Agreement and each of the Ancillary Agreements and each of
the transactions and agreements contemplated hereby and thereby. This Agreement
has been duly executed and delivered by Principal and constitutes the valid and
binding obligation of Principal enforceable in accordance with its terms, except
as such enforcement may be limited by applicable bankruptcy, insolvency,
reorganization, moratorium or other laws of general application affecting
enforcement of creditors' rights or by general principles of equity. As of the
Closing Date, each Ancillary Agreement will have been duly executed and
delivered to Coventry by Principal and subject to the due execution and delivery
of such agreements by the other parties thereto, each Ancillary Agreement
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executed by Principal will constitute the valid and binding obligation of
Principal enforceable in accordance with its terms, except as such enforcement
may be limited by applicable bankruptcy, insolvency, reorganization, moratorium
or other laws of general application affecting enforcement of creditors' rights
or by general principles of equity.
4.4 CONSENTS AND APPROVALS. Except as set forth in Section 4.4 to the Principal
Disclosure Letter, the execution and delivery by Principal of this Agreement and
any Ancillary Agreement to which it is a party, the performance by Principal of
its obligations hereunder or thereunder and the consummation by Principal of the
transactions contemplated hereby and thereby do not require Principal or any of
the Principal Subsidiaries to obtain any consent, approval, clearance or action
of, or make any filing, submission or registration with, or give any notice to,
any Person or Governmental Entity.
4.5 COMPLIANCE WITH LAW.
(a) Except for violations which would not result in a Principal
Material Adverse Effect, Principal and each of the Principal Subsidiaries
are in compliance in all material respects with, and are not in violation
or default in any material respect under, all federal, state and local
laws, ordinances, government rules and regulations applicable to their
business operations, properties, or assets, including without limitation
laws or regulations relating to: the environment; occupational health and
safety; insurance companies; HMOs; PPOs; point-of-service health plans;
third party administrators; the provision or arrangement for the provision
of health services; employer benefits; ERISA plans; wages; work place
safety; equal employment opportunity and race; and religious, sex and age
discrimination. Except as set forth in Section 4.5(a) of the Principal
Disclosure Letter, none of Principal and any of the Principal Subsidiaries
has received any notice of, and to the best of their respective knowledge,
there exists no threat or claim by any Governmental Entity of, any
violation or default by Principal or any of the Principal Subsidiaries with
respect to any of the foregoing. No material expenditures, to the knowledge
of Principal, are or will be required in order to cause the current
operations or properties of Principal or any of the Principal Subsidiaries
to comply with any applicable laws, ordinances, governmental rules or
regulations at Closing.
(b) Principal and each of the Principal Subsidiaries have all
licenses, permits, franchises or other governmental authorizations
("Principal Approvals") necessary to the ownership of their property and to
the operation of their respective businesses, except where the failure to
have such Principal Approvals would not result in a Principal Material
Adverse Effect. None of Principal and any Principal Subsidiary has finally
been denied any application for any such Principal Approvals necessary for
their property or for the operation of their business. There is no action
pending, or to the best knowledge of Principal, threatened or recommended
by appropriate state or federal agencies having jurisdiction thereof, to
either revoke, withdraw, or suspend any such Principal Approvals, or which
would result in a Principal Material Adverse Effect, or to terminate the
participation of Principal or any of the Principal Subsidiaries in
Medicare, Medicaid, or other government program, or any decision not to
renew any such Principal Approvals.
(c) Principal and the Principal Subsidiaries have complied in all
material respects with all laws, rules, conditions of participation, and
regulations governing all Medicare, Medicaid, and any other arrangements
with any Governmental Entity (and/or an intermediary) and have filed all
returns, cost reports and other filings in any manner prescribed thereby
except where the failure to so comply, together with all other such
failures, would not result in a Principal Material Adverse Effect. All
returns, cost reports and other filings made by Principal and the Principal
Subsidiaries since January 1, 1992 to Medicare, Medicaid or any other
Governmental Entity (and/or an intermediary) or third party payor are true
and complete except where the failure to be so true and complete, together
with all other such failures, would not result in a Principal Material
Adverse Effect. Since January 1, 1992, no deficiency in any such returns,
costs reports and other filings, including deficiencies for late filings,
has been asserted or to the best of Principal's knowledge, after reasonable
investigation, threatened by any federal, state or local agency or
instrumentality or other entities relating to Medicare or Medicaid or other
government payor or third party payor claims and to the best of Principal's
knowledge, after reasonable investigation,
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there is no basis for any successful claims or requests for recoupment from
any such agency, instrumentality, entity or third party payor except for
any claims or requests which, together with all other such claims or
requests, would not result in a Principal Material Adverse Effect. None of
Principal and any of the Principal Subsidiaries has been subject to any
written finding of fraudulent procedures or practices arising out of the
provision of health care insurance, managed care, claims administration, or
health care services or benefits relating to Medicare, Medicaid, or any
other Governmental Entity with which Principal or any of the Principal
Subsidiaries has a contract to provide insurance, managed care, claims
administration, or health care services or benefits, and none of Principal
and any of the Principal Subsidiaries is currently subject to any pending
or threatened audit relating to such fraudulent procedures or practices.
(d) In each state in which Principal or any of the Principal
Subsidiaries operates HMOs, PPOs, point of service plans, insurance plans
or other health care plans, Principal and each of the Principal
Subsidiaries has filed copies of its (i) standard employer and other
individual and group subscriber agreements, (ii) contracts with physicians,
hospitals and other health care entities, and (iii) contracts for
management and administrative services (collectively, "Principal
Agreements") with the applicable state authorities to the extent required
by law, including, but not limited to contracts required to be filed with
the state Departments of Insurance, Departments of Health or the agencies
responsible for each state's Medicaid program. Principal and each of the
Principal Subsidiaries are not providing services under any Principal
Agreements that have not been filed and approved by the state regulatory
authorities except where the failure to so file would not result in a
Principal Material Adverse Effect.
(e) Principal and each of the Principal Subsidiaries is operating and
has operated in material compliance with all contractual, statutory,
regulatory, and other requirements applicable to entities furnishing
coverage to employees of federal, state and local governments and
subdivisions and to beneficiaries under programs sponsored or administered
by any such governments or subdivisions thereof (collectively "Principal
Government Contracts"). Except as set forth in Section 4.5(e) of the
Principal Disclosure Letter, none of Principal and any of the Principal
Subsidiaries is required to pay any claim, penalty, fine, return of
premium, repayment of costs charged, or renegotiation of charges or fees as
a result of any audit, adjustment, charge, retroactive restatements of
costs or charges, or other liability with respect to any Government
Contract, except where such claim, penalty, fine, return of premium,
repayment or renegotiation would not result in a Principal Material Adverse
Effect.
(f) Principal and each of the Principal Subsidiaries has filed all
reports, filings and notices required to be filed with all applicable
Departments of Insurance, Departments of Health and HMO regulatory bodies
since January 1, 1992 except where the failure to so file would not result
in a Principal Material Adverse Effect (as such documents have since the
time of their filing been amended, the "Principal DOI Reports"). As of
their respective dates, the Principal DOI Reports complied in all material
respects with the requirements of the laws, rules and regulations
applicable to such Principal DOI Reports.
(g) None of Principal and any of the Principal Subsidiaries, nor the
officers, directors, employees or agents of Principal or any of the
Principal Subsidiaries, and to Principal's knowledge none of the persons
who provide professional services under agreements with Principal or any of
the Principal Subsidiaries (as agents of such entities) has engaged in any
activities which are prohibited under Medicare or Medicaid statutes, under
sec.sec. 1320a-7, 1320a-7a, 1320a-7b, or 1395nn of Title 42 of the United
States Code, the federal CHAMPUS statute, or the regulations promulgated
pursuant to such statutes or regulations or related state or local statutes
or, to Principal's knowledge, which are prohibited by any private
accrediting organization from which Principal or any of the Principal
Subsidiaries holds or seeks accreditation, including but not limited to:
(i) knowingly and willfully making or causing to be made a false
statement or representation of a material fact in any application for
any benefit or payment;
(ii) knowingly and willfully making or causing to be made any false
statement or representation of a material fact for use in determining
rights to any benefit or payment;
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(iii) presenting or causing to be presented a claim for
reimbursement for services that is for a material fact for use in
determining rights to any benefit or payment;
(iv) failure to disclose knowledge of the occurrence of any event
affecting the initial or continued right to any benefit or payment on
its own behalf or on behalf of another, with intent to fraudulently
secure such benefit or payment;
(v) knowingly and willfully offering, paying, soliciting or
receiving any remuneration (including any kickback, bribe, or rebate),
directly or indirectly, overtly or covertly, in cash or in kind (i) in
return for referring an individual to a person for the furnishing or
arranging for the furnishing of any item or service for which payment
may be made in whole or in part by CHAMPUS, Medicare, Medicaid, or other
state health care program, or (ii) in return for purchasing, leasing, or
ordering or arranging for or recommending purchasing, leasing, or
ordering any good, facility, service, or item for which payment may be
made in whole or in part by CHAMPUS, Medicare, Medicaid or other state
health care program; or
(vi) knowingly and willfully making or causing to be made or
inducing or seeking to induce the making of any false statement or
representation (or omit to state a fact required to be stated therein or
necessary to make the statement contained therein not misleading) of a
material fact with respect to: (i) a facility in order that the facility
may qualify for CHAMPUS, Medicare, Medicaid or other state health care
program certification, or (ii) information required to be provided under
sec. 1124A of the Social Security Act (42 U.S.C. sec. 1320a-3).
(h) Reports of Examinations. Principal has delivered to Coventry
copies of all reports of examinations by a Governmental Entity issued
subsequent to December 31, 1995 (including draft reports not yet
finalized) conducted on each Principal Subsidiary (collectively, the
"Principal Reports of Examinations").
4.6 LITIGATION AND INVESTIGATIONS. Except as disclosed on Section 4.6 of the
Principal Disclosure Letter, there is no: (i) action, suit, claim, proceeding,
or investigation pending or, to Principal's knowledge, threatened against or
affecting Principal or the Principal Subsidiaries, or any of its employees, by
any private party or any federal, state, municipal, or other governmental
department, commission, board, bureau, agency or instrumentality, domestic or
foreign; or, to Principal's knowledge, pending, threatened against, or affecting
persons or entities who perform professional services under agreement with the
Principal or the Principal Subsidiaries before any professional self-governance,
oversight, or regulatory body; (ii) arbitration proceeding relating to Principal
or the Principal Subsidiaries pending under collective bargaining agreements or
otherwise; or (iii) governmental or professional inquiry pending or threatened
against or directly or indirectly affecting Principal or the Principal
Subsidiaries (including without limitation any inquiry as to the qualification
of Principal or the Principal Subsidiaries to hold or receive any license or
permit), and there is no basis for any of the foregoing as to Principal or the
Principal Subsidiaries, its officers or directors or, to Principal's knowledge,
as to entities or persons who perform professional services for the Principal or
the Principal Subsidiaries. Except as disclosed on Section 4.6 of the Principal
Disclosure Letter, Principal has not received any opinion, memorandum, or legal
advice from legal counsel to the effect that it is exposed, from a legal
standpoint, to any liability which may be material to the business of Principal
or the Principal Subsidiaries as now conducted. Principal and the Principal
Subsidiaries are not in default with respect to any order, writ, injunction, or
decree known to or served upon it of any court or of any federal, state,
municipal, or other governmental department, commission, board, bureau, agency,
or instrumentality, domestic or foreign. There is no action or suit by Principal
and the Principal Subsidiaries pending or threatened against others. Upon
Principal's receipt of written approval for the transactions contemplated herein
from the applicable state and federal regulatory bodies, Principal will have
complied in all material respects with all laws, rules, regulations, and orders
applicable to its businesses, operations, properties, assets, products, and
services, and that of the Principal Subsidiaries, and Principal and the
Principal Subsidiaries has all necessary permits, licenses, and other
authorizations required to conduct its businesses as conducted, the absence of
which would not result in a Principal Material Adverse Effect, including but not
limited to, a state license as a health maintenance organization. There is no
existing law, rule, regulation, or order, or proposed law, rule, regulation, or
order,
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whether federal, state, local, or professional, which would prohibit or restrict
the Principal and the Principal Subsidiaries from, or otherwise materially
adversely affect each of Principal and the Principal Subsidiaries in, conducting
its business in any jurisdiction in which it is now conducting business or in
which it proposes to conduct business.
4.7 ABSENCE OF DEFAULTS, CONFLICTS, ETC. The execution and delivery of this
Agreement does not, the execution and delivery of the Ancillary Agreements will
not, and the fulfillment of the terms hereof and thereof by Principal will not,
result in a breach of any of the terms, conditions or provisions of, or
constitute a default under, or result in the modification of, or permit the
acceleration of rights under or termination of, any indenture, mortgage, deed of
trust, credit agreement, note or other evidence of indebtedness, profit sharing
arrangement or other material agreement, contract, commitment, understanding,
arrangement or restriction of Principal or any of the Principal Subsidiaries
(collectively the "Principal Key Agreements and Instruments"), or the Principal
Organizational Documents, or any law, ordinance, code, standard, judgment, rule
or regulation of any court or federal, state or foreign regulatory board or body
or administrative agency having jurisdiction over Principal or any of the
Principal Subsidiaries or over their respective properties, assets or
businesses. None of Principal and the Principal Subsidiaries is in default under
or in violation of (and no event has occurred and no condition exists which,
upon notice or the passage of time (or both), would constitute a default under)
(i) the Principal Organization Documents, (ii) any Principal Key Agreement and
Instrument, or (iii) any order, writ, injunction or decree of any court or any
Federal, state, municipal or other domestic or foreign governmental department,
commission, board, bureau, agency or instrumentality except, in the case of
clause (ii), for defaults or violations which would not result a Principal
Material Adverse Effect.
4.8 CHANGE IN OWNERSHIP. The consummation of the transactions contemplated by
this Agreement will not result in (i) a Principal Material Adverse Effect, (ii)
the loss of the benefits of any material relationship with any subscriber group,
employee, union trust, or governmental program, payor or customer, physician,
hospital, health care provider, claims administrator, or supplier to Principal
or any of the Principal Subsidiaries, (iii) the acceleration of the vesting of
any outstanding option, warrant, call, commitment, agreement, conversion right,
preemptive right or other right to subscribe for, purchase or otherwise acquire
any of the shares of the capital stock of Principal or any of the Principal
Subsidiaries, or debt securities of Principal or any of the Principal
Subsidiaries (collectively "Principal Commitments," and each individually a
"Principal Commitment"), (iv) any obligation of Principal to grant, extend or
enter into any Commitment, or (v) any right in favor of any Person to terminate
or cancel any Principal Key Agreement or Instrument.
4.9 REPORTS AND FINANCIAL STATEMENTS.
(a) FINANCIAL STATEMENTS. Principal has delivered to Coventry: (i)
audited consolidated balance sheets of Principal and the Principal
Subsidiaries as of December 31 in each of the years 1992 through 1996
(including the notes thereto), and the related consolidated statements of
income, changes in shareholders' equity, and cash flows for each of the
fiscal years then ended, together with the report thereon of Ernst & Young
LLP, independent certified public accountants; (ii) an unaudited
consolidating balance sheet of Principal and the Principal Subsidiaries as
of September 30, 1997 and the related unaudited consolidating statement of
income for the nine months period then ended. Such financial statements
(collectively, the "Principal Financial Statements") and notes thereto (x)
have been prepared in accordance with GAAP applied on a consistent basis
(except as may be indicated therein or in the notes thereto), (y) present
fairly, in all material respect, the financial position of Principal and
the Principal Subsidiaries as of the dates thereof and the results of their
operations for the periods then ended, provided that the unaudited
financial statements of the Company do not include the footnotes required
by GAAP and are subject to year-end adjustments consistent with past
practice and do not include all retroactive adjustments relating to
incurred but not reported claims and enrollment related adjustments, and
(z) are in all material respect, in accordance with the books of account
and records of Principal and the Principal Subsidiaries except as indicated
therein.
(b) REPORTS BASED ON STATUTORY ACCOUNTING. Principal has delivered to
Coventry: Copies of Annual Statements filed by Principal Subsidiaries as at
December 31 for each of the years 1992 through 1996 and audit reports
thereon prepared by independent certified public accountants, copies of
interim financial
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statements filed by Principal Subsidiaries with regulatory authorities for
the periods ending March 31, 1997 and June 30, 1997, and a draft of such
financial report for the period ending as at September 30, 1997
(collectively, the "Principal Interim Financial Statements"). Such reports
(collectively, the "Principal Regulatory Statements") (i) have been
prepared in accordance with statutory accounting practices applied on a
consistent basis (except as may be indicated therein or in the notes
thereto), (ii) present fairly, in all material respects, the financial
positions of the Principal Subsidiaries as at the dates thereof, and the
results of their operations and cash flows for the periods then ended,
subject, in the case of the unaudited interim Principal Regulatory
Statements, to normal year-end audit adjustments and other adjustments
described therein, and (iii) are in all material respects in accordance
with the books of account and records of the Principal Subsidiaries except
as indicated therein.
(c) DERIVATIVES, ETC. None of Principal or any of the Principal
Subsidiaries owns any interest in, or has any liability (including any
contingent liability) with respect to, any options, puts, calls, swaps,
exchange contracts or other derivatives or any other similar material off
balance sheet financing arrangements or liabilities.
(d) IBNR CALCULATIONS. Information furnished by Principal to Coventry
regarding the historical calculation of the reserves of the Principal
Subsidiaries for IBNR claims was true and correct in all material respects
and the methodology for calculating IBNR claims has been consistent with
sound actuarial principles using accounting and reserve criteria
consistently applied by the Principal Subsidiaries in calculating IBNR
claims since [December 31, 1994].
4.10 ABSENCE OF CERTAIN DEVELOPMENTS. Except as set forth in Section 4.10 of the
Principal Disclosure Letter, since December 31, 1996, there has been no (i)
change or event which would result in a Principal Material Adverse Effect, (ii)
declaration, setting aside or payment of any dividend or other distribution with
respect to the capital stock of Principal, (iii) issuance of capital stock
(other than pursuant to the exercise of options, warrants, or convertible
securities outstanding at such date) or options, warrants or rights to acquire
capital stock, (iv) material loss, destruction or damage to any property of
Principal or any Principal Subsidiary, whether or not insured, (v) acceleration
or prepayment of any indebtedness for borrowed money, (vi) labor trouble
involving Principal or any Principal Subsidiary or any material change in their
personnel or the terms and conditions of employment, (vii) waiver of any
valuable right in favor of Principal or any Principal Subsidiary, (viii) loan or
extension of credit by Principal or any Principal Subsidiary to any officer or
employee of Principal or any Principal Subsidiary other than advances for
travelrelated expenses and similar advances to officers and employees of
Principal in the ordinary course of business or (ix) acquisition or disposition
of any material assets, other than Excluded Assets, (or any contract or
arrangement therefor), or any other material transaction by Principal or any
Principal Subsidiary otherwise than for fair value in the ordinary course of
business; (x) any incurrence, assumption or guarantee by Principal or any
Principal Subsidiary of any indebtedness, obligation or liability, other than in
the ordinary course of business; (xi) any sale, assignment, transfer or
disposition of, or any incurrence, creation or assumption of any Lien on, any
material asset of Principal or any Principal Subsidiary other than in the
ordinary course of business and except for guarantees by Principal of the
indebtedness, obligations or liabilities of any Principal Subsidiary; (xii) any
making of any loan, advance or capital contributions to or investment in any
Person other than loans, advances or capital contributions to or investments in
wholly owned Subsidiaries made in the ordinary course of business; (xiii) (a)
any increase in the rate or terms of compensation (including bonuses) payable or
to become payable by Principal or any Principal Subsidiary to its directors or
officers, except increases occurring in the ordinary course of business in
accordance with its customary practices, (b) any material increase in the rate
or terms of any Principal Plans, payment or arrangement made by Principal to,
for or with any such directors or officers, except increases occurring in the
ordinary course of business, (c) any employment, consulting, deferred
compensation, severance, retirement or other similar agreement entered into with
any director, officer, employee, agent of Principal or any Principal Subsidiary
(or any amendment to any such existing agreement), (d) any grant of any
severance or termination pay to any director, officer, employee, or agent of
Principal or any Principal Subsidiary; (xiv) any expenditure or commitment for
additions to property, plant or equipment of Principal or any Principal
Subsidiary that exceeds $500,000 individually; or (xv) any contract to do any of
the foregoing.
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4.11 MATERIAL CONTRACTS. Section 4.11 of the Principal Disclosure Letter sets
forth a true and complete list of each Principal Key Agreement and Instruments.
Each Principal Key Agreement and Instrument and any other material contract of
Principal and the Principal Subsidiaries that is currently in effect, is valid,
binding and enforceable against Principal or such Principal Subsidiary and, to
Principal's best knowledge, the other parties thereto, in accordance with its
terms, and in full force and effect on the date hereof.
4.12 ABSENCE OF UNDISCLOSED LIABILITIES. None of Principal and any of the
Principal Subsidiaries has any debt, obligation or liability (whether accrued,
absolute, contingent, liquidated or otherwise, whether due or to become due,
whether or not known to any such party) except for obligations under agreements
set forth in the Financial Statements, Section 4.12 to the Principal Disclosure
Letter and obligations under agreements entered into in the usual and ordinary
course of business, none of which (individually or in the aggregate) could have
a Principal Material Adverse Effect.
4.13 EMPLOYEES.
(a) Principal and the Principal Subsidiaries are in compliance in all
material respects with all laws regarding employment, wages, hours, equal
opportunity, collective bargaining and payment of social security and other
taxes except to the extent that noncompliance would result in a Principal
Material Adverse Effect. Except as set forth in Section 4.13a of the
Principal Disclosure Letter, since January 1, 1996, no complaint has been
filed or is pending with respect to any unfair labor practice or
discriminatory employment practice against Principal or any Principal
Subsidiary has been filed or, to the best of Principal's knowledge,
threatened to be filed with or by the National Labor Relations Board, the
Equal Employment Opportunity Commission or any other administrative agency,
federal or state, that regulates labor or employment practices, nor is any
grievance filed or, to the best of Principal's knowledge, threatened to be
filed, against Principal or any Principal Subsidiary by any employee
pursuant to any collective bargaining or other employment agreement to
which Principal or any Principal Subsidiary is a party or is bound.
Principal and the Principal Subsidiaries are in compliance with all
applicable federal, state and local laws and regulations regarding
occupational safety and health standards except to the extent that
noncompliance will not result in a Principal Material Adverse Effect, and
have received no complaints from any federal, state or local agency or
regulatory body alleging violations of any such laws and regulations.
(b) Except as set forth in Section 4.13(b) of the Principal Disclosure
Letter, the employment of all Persons employed by Principal or any of the
Principal Subsidiaries is terminable at will without any penalty or
severance obligation of any kind on the part of the employer. All sums due
for employee compensation and benefits and all vacation time owing to any
employees of Principal or any of the Principal Subsidiaries have been duly
and adequately accrued on the accounting records of Principal and the
Principal Subsidiaries.
4.14 TAX MATTERS.
(a) All Tax Returns required under applicable law to be filed with or
provided to any person by any Principal Subsidiary have been (and, as to
Tax Returns not filed as of the date hereof, will be) timely filed or
provided in the manner prescribed by law and such Tax Returns were (and, as
to Tax Returns not filed as of the date hereof, will be), true, complete
and correct;
(b) Each Principal Subsidiary has within the time and in the manner
prescribed by law paid (and until the Effective Time will pay within the
time and in the manner prescribed by law) all Taxes due and payable except
for those contested in good faith and for which adequate reserves have been
taken;
(c) Each Principal Subsidiary has established (and until the Effective
Time will maintain) on their books and records (i) reserves adequate to pay
all Taxes accrued but not yet due and payable and all deficiencies
asserted, proposed or threatened against such Principal Subsidiary and (ii)
reserves for deferred Taxes, in each case, in accordance with GAAP;
(d) There are no Tax liens upon the Principal Assets or the assets of
any Principal Subsidiary except liens for Taxes not yet due;
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(e) Each Principal Subsidiary has complied (and until the Effective
Time will comply) with all applicable laws relating to information
reporting and to the withholding of Taxes (including, but not limited to,
information reporting and withholding of Taxes pursuant to Sections 1441,
1442, 3402, 3405, 3406, 6047, 6049, 6051 and 6052 of the Code or similar
provisions under any foreign laws) and have, within the time and in the
manner prescribed by law, paid all amounts required to be so withheld and
paid over under all applicable laws;
(f) No Principal Subsidiary has requested any extension of time within
which to file any Tax Return, which Tax Return has not since been filed;
(g) Except as set forth in Section 4.14(g) of the Principal Disclosure
Letter, (i) no Principal Subsidiary has executed any outstanding waivers or
comparable consents regarding the application of the statute of limitations
with respect to any Taxes or Tax Returns, (ii) the statute of limitations
for the assessment of all Taxes has expired for all applicable Tax Returns
of each Principal Subsidiary or those Tax Returns have been examined by the
appropriate taxing authorities for all periods through December 31, 1992,
and no deficiencies, assessments or written proposals for the assessment of
any Taxes have been proposed, asserted or assessed against any Principal
Subsidiary that has not been resolved and paid in full;
(h) Except as set forth in Section 4.14(h) of the Principal Disclosure
Letter, (i) no audits or other administrative proceedings or court
proceedings are presently pending with regard to any Taxes or Tax Returns
of any Principal Subsidiary, and (ii) no Principal Subsidiary has any
knowledge of any threatened action, audit or administrative or court
proceeding with respect to any such Taxes or Tax Returns. Further, to the
best of the knowledge of each Principal Subsidiary, no state of facts
exists or has existed which would constitute grounds for the assessment of
any liability for Taxes with respect to the periods which have not been
audited by the IRS or other taxing authority;
(i) Except as set forth in Section 4.14(i) of the Principal Disclosure
Letter, no power of attorney currently in force has been granted by any
Principal Subsidiary with respect to any matter relating to Taxes;
(j) No Principal Subsidiary has received a Tax Ruling or entered into
a Closing Agreement with any taxing authority that would result in a
continuing Principal Material Adverse Effect after the Effective Time;
(k) Each Principal Subsidiary has made available (or, in the case of
income Tax Returns not yet filed will make available) to Coventry complete
and accurate copies of (i) all income Tax Returns, and any amendments
thereto, filed by or on behalf of each Principal Subsidiary for all taxable
years since December 31, 1994, and (ii) all audit reports received from any
taxing authority relating to any Tax Return filed by or on behalf of any
Principal Subsidiary;
(l) No Principal Subsidiary is a party to any Tax allocation or
sharing agreement with any Person (other than Mutual or any Mutual
Subsidiary). In addition, no Principal Subsidiary has any liability for
Taxes of any Person other than such Principal Subsidiary under Treasury
Regulation Section 1.1502-6 (or any similar provision of state, local or
foreign law), as a transferee or successor, by contract or otherwise;
(m) No Principal Subsidiary is a party to any contract or arrangement
that, separately or in the aggregate, could, by reason of the transactions
contemplated by this Agreement, give rise to the payment of any "excess
parachute payment" within the meaning of Section 280G of the Code;
(n) No election under Section 338 of the Code (or any predecessor
provisions) has been made by or with respect to any Principal Subsidiary or
any of their respective assets or properties;
(o) No Principal Asset or property of any Principal Subsidiary is
property that (i) any Principal Subsidiary or any party to this transaction
is or will be required to treat as being owned by another Person pursuant
to the provisions of Section 168(f)(8) of the Code (as in effect prior to
its amendment by the
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Tax Reform Act of 1986) or (ii) is subject to the "alternative depreciation
system" described in Section 168 of the Code;
(p) No Principal Subsidiary is required to include in income any
adjustment pursuant to Section 481(a) of the Code by reason of a voluntary
change in accounting method initiated by any Principal Subsidiary and no
Principal Subsidiary has proposed any such adjustment or change in
accounting method;
(q) All transactions that could give rise to an understatement of
federal income Tax (within the meaning of Section 6661 of the Code for Tax
Returns filed on or before December 31, 1989, and within the meaning of
Section 6662 of the Code for Tax Returns filed after December 31, 1989)
have been adequately disclosed (or, with respect to Tax Returns not yet
audited will be adequately disclosed) on the Tax Returns of each Principal
Subsidiary in accordance with Section 6661(b)(2)(B) of the Code for Tax
Returns filed on or prior to December 31, 1989, and in accordance with
Section 6662(d)(2)(B) of the Code for Tax Returns filed after December 31,
1989;
(r) As of December 31, 1996, the Principal Subsidiaries had no net
operating loss carryovers available to offset future tax liability;
(s) As of December 31, 1996, the Principal Subsidiaries had no Tax
credit carryovers available to offset future Tax liability;
(t) Neither Principal nor any Principal Subsidiary has filed (or will
file prior to the Effective Time) a consent pursuant to Section 341(f) of
the Code or has agreed to have Section 341(f)(2) of the Code apply to any
disposition of a "subsection (f) asset" (as that term is defined in Section
341(f)(4) of the Code) that is a Principal Asset or is owned by any
Principal Subsidiary;
(u) Neither Mutual, Holding Principal nor any Principal Subsidiary has
taken any action or has any knowledge of any fact or circumstance that
would, or would be reasonably likely to, adversely affect the status of (i)
the Merger as a non-taxable transfer as described in Section 351(a) of the
Code or a reorganization as described in Section 368(a)(2)(E) of the Code
and (ii) the Capital Contribution as a non-taxable exchange described in
Section 351(a) of the Code; and
(v) Mutual is not and has not been a United States real property
holding company (as defined in Section 897(c)(2) of the Code) during the
applicable period specified in Section 897(c)(1)(ii) of the Code.
4.15 EMPLOYEE BENEFIT PLANS.
(a) Section 4.15 of the Principal Disclosure Letter lists each bonus,
deferred compensation, pension, stock option, stock appreciation right,
profit-sharing or retirement plan, arrangement or practice, each medical,
vacation, retiree medical, disability, life insurance, severance pay plan,
and each other agreement or fringe benefit plan, arrangement or practice,
to which Principal or any Principal Subsidiary contributes or is a party or
under which it may have a liability, whether legally binding or not, which
affects one or more of the employees or former employees of Principal or
any Principal Subsidiary, including all "employee benefit plans" as defined
by Section 3(3) of ERISA (collectively, the "Principal Plans"). All
Principal Plans which are subject to Title IV of ERISA or the minimum
funding standards of Section 412 of the Code shall be referred to as the
"Principal Pension Plans."
(b) For each Principal Plan which is an "employee benefit plan" under
Section 3(3) of ERISA, Mutual has delivered to Coventry correct and
complete copies of the plan documents and summary plan descriptions, the
most recent determination letter received from the Internal Revenue
Service, the most recent Form 5500 Annual Report, and all related trust
agreements, insurance contracts and funding agreements which implement each
such Principal Plan.
(c) Neither Mutual, Principal, nor any Principal Subsidiary has any
commitment, whether formal or informal and whether legally binding or not,
(i) to create any additional such Principal Plan; (ii) to modify or change
any such Principal Plan; or (iii) to maintain for any period of time any
such Principal
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Plan, except as accurately and completely described in Section 4.15 of the
Principal Disclosure Letter. Section 4.15 of the Principal Disclosure
Letter contains an accurate and complete description of the funding
policies (and commitments, if any) of Mutual, Principal, and the Principal
Subsidiaries with respect to each such existing Principal Plan.
(d) Except as disclosed in Section 4.15 of the Principal Disclosure
Letter, (i) Principal and the Principal Subsidiaries have no unfunded past
service liability in respect of any of the Principal Plans; (ii) the
actuarially computed value of vested benefits under any Principal Pension
Plan (determined in accordance with methods and assumptions utilized by the
PBGC applicable to a plan terminating on the date of determination) does
not exceed the fair market value of the fund assets relating to such
Principal Pension Plan; (iii) neither Mutual, Principal, nor any Principal
Subsidiary nor any Principal Plan nor any trustee, administrator, fiduciary
or sponsor of any Principal Plan has engaged in any prohibited transactions
as defined in Section 406 of ERISA or Section 4975 of the Code for which
there is no statutory exemption in Section 408 of ERISA or Section 4975 of
the Code; (iv) all filings, reports and descriptions as to such Principal
Plans (including Form 5500 Annual Reports, Summary Plan Descriptions,
PBGC-1's and Summary Annual Reports) required to have been made or
distributed to participants, the Internal Revenue Service, the United
States Department of Labor and other governmental agencies have been made
in a timely manner or will be made on or prior to the Closing Date; (v)
there is no material litigation, disputed claim, governmental proceeding or
investigation pending or threatened with respect to any of such Principal
Plans, the related trusts, or any fiduciary, trustee, administrator or
sponsor of such Principal Plans; (vi) such Principal Plans have been
established, maintained and administered in all material respects in
accordance with their governing documents and applicable provisions of
ERISA and the Code and Treasury Regulations promulgated thereunder; (vii)
there has been no "Reportable Event" as defined in Section 4043 of ERISA
with respect to any Principal Pension Plan that has not been waived by the
Pension Benefit Guaranty Corporation; and (viii) each Principal Pension
Plan and each Principal Plan which is intended to be a qualified plan under
Section 401(a) of the Code has received, within the last three years, a
favorable determination letter from the Internal Revenue Service.
(e) Mutual, Principal, and the Principal Subsidiaries have complied in
all material respects with all applicable federal, state and local laws,
rules and regulations relating to employees' employment and/or employment
relationships, including, without limitation, wage related laws,
anti-discrimination laws, employee safety laws and COBRA (defined herein to
mean the requirements of Section 4980B of the Code, Proposed Treasury
Regulation Section 1.162-26 and Part 6 of Subtitle B of Title I of ERISA).
(f) Except as disclosed in Section 4.15 of the Principal Disclosure
Letter, the consummation of the transactions contemplated by this Agreement
will not (i) result in the payment or series of payments by Principal or
any Principal Subsidiary to any employee or other person of an "excess
parachute payment" within the meaning of Section 280G of the Code, (ii)
entitle any employee or former employee of Principal or any Principal
Subsidiary to severance pay, unemployment compensation or any other
payment, and (iii) accelerate the time of payment or vesting of any stock
option, stock appreciation right, deferred compensation or other employee
benefits under any Principal Plan (including vacation and sick pay).
(g) Except as disclosed in Section 4.15 of the Principal Disclosure
Letter, none of the Principal Plans which are "welfare benefit plans,"
within the meaning of Section 3(1) of ERISA, provide for continuing
benefits or coverage after termination or retirement from employment,
except for COBRA rights under a "group health plan" as defined in Section
4980B(g) of the Code and Section 607 of ERISA.
(h) Neither Mutual, Principal, nor any Principal Subsidiary nor any
entity required to be aggregated with either Mutual, Principal, or any
Principal Subsidiary under Sections 414(b), (c), (m) or (o) of the Code (a
"Principal ERISA Affiliate") has ever sponsored, participated in,
contributed to or withdrawn from a multi-employer plan as defined in
Section 4001(a)(3) of Title IV of ERISA, and neither Mutual, Principal, nor
any Principal Subsidiary nor any Principal ERISA Affiliate has ever
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incurred any liability as a result of any partial or complete withdrawal by
any employer from such a multi-employer plan as described under Sections
4201, 4203, or 4205 of ERISA.
(i) Except as disclosed in Section 4.15 of the Principal Disclosure
Letter, no Principal Pension Plan has been completely or partially
terminated, or has any proceeding been instituted by the PBGC to terminate
any such Principal Pension Plan; neither Mutual, Principal, nor any
Principal Subsidiary nor any Principal ERISA Affiliate has incurred or
presently owes any liability to the PBGC or otherwise under Title IV of
ERISA (including PBGC premiums past due or excise taxes under Section 4971
of the Code), or in connection with an "accumulated funding deficiency"
within the meaning of Section 302 of ERISA and Section 412 of the Code,
whether or not waived.
4.16 PATENTS, LICENSES, ETC. Principal or one of the Principal Subsidiaries
either owns, free and clear of all encumbrances, restrictions, liens, security
interests and charges, and has good and marketable title to, or holds adequate
licenses or otherwise possesses all such rights as are necessary to use all
patents (and applications therefor), patent disclosures, trademarks, service
marks, trade names, copyrights (and applications therefor), inventions,
discoveries, processes, know-how, scientific, technical, engineering and
marketing data, formulae and techniques used or proposed to be used, in or
necessary for the conduct of its business as now conducted or as proposed to be
conducted (collectively, "Principal Intellectual Property"). The Principal
Intellectual Property is listed in Section 4.16 of the Principal Disclosure
Letter. None of Principal nor any of the Principal Subsidiaries has received
notice nor otherwise has reason to know of any conflict or alleged conflict with
the rights of others pertaining to the Intellectual Property described in this
Section 4.16 where the effect of such conflict could result in a Principal
Material Adverse Effect. To Principal's best knowledge, Principal's business and
the business of any Principal Subsidiary, as presently conducted and as proposed
to be conducted, does not infringe upon or violate any patent rights or trade
secrets of others and neither Principal nor any Principal Subsidiary has
received notice of any such claim infringement or violation. To Principal's best
knowledge, Principal and the Principal Subsidiaries have the right to use all
trade secrets, processes, customer lists and other rights incident to their
respective businesses as now conducted or as proposed to be conducted. To
Principal's best knowledge, no employee of Principal or any of the Principal
Subsidiaries has violated any employment agreement or proprietary information
agreement which he had with a previous employer or any patent policy of such
employer. To Principal's best knowledge, none of Principal and any of the
Principal Subsidiaries, or any of their respective employees, is a party (in
each case, as a defendant) to or threatened by any litigation claiming that it
is infringing on any patents, trademarks, trade secrets, service names, trade
names, copyrights, licenses and the like.
4.17 TITLE TO TANGIBLE ASSETS. Except as set forth in Section 4.17 of the
Principal Disclosure Letter, Principal and the Principal Subsidiaries have good
and, subject to regulatory approval, marketable title to the real and personal
property they own and all rights of possession and use under all leases
regarding real and personal property they lease, in each case subject to no
mortgage, pledge, lien, lease, encumbrance or charge, other than or resulting
from taxes which have not yet become due or delinquent and minor liens and
encumbrances which do not in any case materially detract from the value of the
property subject thereto, and do not materially impair the operations of
Principal and the Principal Subsidiaries.
4.18 REAL PROPERTY.
(a) Principal and/or each Principal Subsidiary owns no real property
and leases the real property used with respect to the Principal
Subsidiaries described on Section 4.18(a) of the Principal Disclosure
Letter (collectively, the "Principal Properties").
(b) None of Principal or Principal Subsidiary has engaged in or
allowed the generation, production, use, handling, manufacture, treatment,
storage, disposal, arranging for disposal or release of any Hazardous
Substances on, in or under the Principal Properties, except for the use,
handling or storage in accordance with applicable federal, state and local
environmental laws of quantities thereof similar to those quantities
usually kept on similar premises by others in the same business or
profession as Principal. To the best knowledge of Principal, there is no
past or present action, activity, event, condition or circumstance that
could be expected to give rise to any liability by Principal under any
Applicable Environmental Law, any other statute relating to the
environment, or any common law liability relating to
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the environment, including without limitation liability related to the
presence of any Hazardous Substances on, in or under any real property or
improvements now or heretofore owned, leased, used or controlled by
Principal, and also including liability related to the use, handling,
storage, generation, production, manufacture, treatment, release, disposal
or arranging for disposal of any Hazardous Substances by or on behalf of
Principal, and liability arising by operation of contract or law. Except as
set forth in Section 4.18(b) of the Principal Disclosure Letter, no
permits, registrations, licenses, authorizations, approvals or filings are
required under any Applicable Environmental Law with respect to the
operation of Principal's business, including any such items as would be
required for the use, handling, storage, generation, production,
manufacture, treatment, release, disposal or arranging for disposal of any
Hazardous Substance or other materials. With respect to items listed in
Section 4.18(b) of the Principal Disclosure Letter, if any, such items are
current and Principal is in compliance with all terms and conditions
therein.
(c) Principal has delivered to Coventry correct and complete copies of
the leases and subleases (as amended to date) listed in Section 4.18(a) of
the Principal Disclosure Letter. With respect to each such lease and
sublease:
(i) the lease or sublease is legal, valid, binding, enforceable,
and in full force and effect;
(ii) the lease or sublease will continue to be legal, valid,
binding, enforceable, and in full force and effect on identical terms
following the consummation of the transactions contemplated hereby;
(iii) to Principal's knowledge, no party to the lease or sublease
is in breach or default, and no event has occurred which, with notice or
lapse of time, would constitute a breach or default or permit
termination, modification, or acceleration thereunder;
(iv) no party to the lease or sublease has repudiated any provision
thereof;
(v) there are no disputes, oral agreements, or forbearance programs
in effect as to the lease or sublease;
(vi) with respect to each sublease, the representations and
warranties set forth in subsections (i) through (v) above are true and
correct with respect to the underlying lease;
(vii) none of Principal and the Principal Subsidiaries has
assigned, transferred, conveyed, mortgaged, deeded in trust, or
encumbered any interest in the leasehold or subleasehold;
(viii) all facilities leased or subleased thereunder have received
all approvals of governmental authorities (including licenses and
permits) required in connection with the operation thereof and have been
operated and maintained in accordance with applicable laws, rules, and
regulations;
(ix) all facilities leased or subleased thereunder are supplied
with utilities and other services necessary for the operation of said
facilities; and
(x) the owner of the facility leased or subleased has good and
marketable title to the parcel of real property, free and clear of any
security interest, easement, covenant, or other restriction, except for
installments of special easements not yet delinquent and recorded
easements, covenants, and other restrictions which do not impair the
current use, occupancy, or value, or the marketability of title, of the
property subject thereto.
4.19 INSURANCE. The Principal Subsidiaries and their respective properties are
insured in such amounts, against such losses and with such insurers as are
prudent when considered in light of the nature of the properties and businesses
of the Principal Subsidiaries and customary in light of such companies'
respective exposure. No notice of any termination or threatened termination of
any of such policies has been received and such policies are in full force and
effect.
4.20 TRANSACTIONS WITH RELATED PARTIES. Other than transactions entered into on
an arm's length basis, none of Principal and any Principal Subsidiary is a party
to any agreement with any of their employees, directors, officers or
shareholders or any affiliate or family member of any of the foregoing under
which it: (i) leases any
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real or personal property (either to or from such Person), (ii) licenses
technology (either to or from such Person), (iii) is obligated to purchase any
tangible or intangible asset from or sell such asset to such Person, (iv)
purchases products or services from such Person or (v) has borrowed money from
or lent money to such Person. None of Principal and any Principal Subsidiary
employs as an employee or engages as a consultant any family member of any of
the directors or officers of Principal or any Principal Subsidiary.
4.21 INTEREST IN COMPETITORS. None of Principal and any Principal Subsidiary,
nor any of their respective officers or, to the best of their knowledge,
directors, has any interest, either by way of contract or by way of investment
(other than as holder of not more than 2% of the outstanding capital stock of a
publicly traded Person) or otherwise, directly or indirectly, in any Person
other than Mutual or any of its affiliates that (i) provides any services or
designs, produces or sells any product or product lines or engages in any
activity similar to or competitive with any activity currently proposed to be
conducted by Principal or any of the Principal Subsidiaries (ii) has any direct
or indirect interest in any asset or property, real or personal, tangible or
intangible, of Principal or any Principal Subsidiary.
4.22 BROKERAGE. Except as set forth on Section 4.22 of the Principal Disclosure
Letter, there are no claims for brokerage commissions or finder's fees or
similar compensation in connection with the transactions contemplated by this
Agreement based on any arrangement made by or on behalf of Principal.
4.23 ILLEGAL OR UNAUTHORIZED PAYMENTS; POLITICAL CONTRIBUTIONS. None of
Principal and any of the Principal Subsidiaries nor, to the best of Principal's
knowledge (after reasonable inquiry of its executive officers and directors),
any of the current officers and directors of Mutual, Principal or any of the
Principal Subsidiaries has, directly or indirectly, made or authorized any
payment, contribution or gift of money, property, or services, (a) as a kickback
or bribe to any Person or (b) to any political organization, or the holder of or
any aspirant to any elective or appointive public office except for personal
political or political action committee contributions not involving the use of
funds of Principal or any of the Principal Subsidiaries and except for
contributions made in accordance with applicable state law.
4.24 MATERIAL FACTS. This Agreement, the items furnished pursuant to the
Principal Disclosure Letter, Ancillary Agreements and the other agreements,
documents, certificates or written statements furnished or to be furnished to
Coventry through the Closing Date by or on behalf of Principal and the Principal
Subsidiaries in connection with the transactions contemplated hereby taken as a
whole, do not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements contained therein or herein, in
light of the circumstances in which they were made, not misleading. There is no
fact which is known to Principal and which has not been disclosed herein or
otherwise in writing by Principal to Coventry which would result in a Principal
Material Adverse Effect.
4.25 PRINCIPAL MATERIAL ADVERSE EFFECT. As used in this Agreement, the term
"Principal Material Adverse Effect" shall mean any material adverse effect on
the business, operations, properties, prospects, condition or results (financial
or otherwise) of Principal and the Principal Subsidiaries taken as a whole.
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REPRESENTATIONS AND WARRANTIES OF MUTUAL
Mutual represents and warrants to Coventry and Newco that except as
expressly set forth in the correspondingly numbered section on the disclosure
letter delivered with on even date herewith to Coventry (the "Mutual Disclosure
Letter") to the extent specifically disclosed with respect to the representation
to which such exception applies:
5.1 CORPORATE ORGANIZATION.
(a) Mutual is a mutual insurance company duly organized, validly
existing and in good standing under the laws of the State of Iowa.
(b) Holding is a corporation duly organized, validly existing and in
good standing under the laws of the State of Iowa.
(c) All of the issued and outstanding shares of capital stock of
Principal are owned by Holding free and clear of any lien, security
interest, hypothecation, pledge, encumbrance or other restriction. All of
the issued and outstanding shares of capital stock of Holding are owned by
Mutual free and clear of any lien, security interest, hypothecation,
pledge, encumbrance or other restriction. There are no shares of capital
stock or any other equity security of Principal or Holding issuable upon
conversion, exchange or exercise of any security of Principal or any
Principal Subsidiary and no rights, options, calls or warrants outstanding
or other agreements to acquire shares of capital stock or other equity
securities of Principal or Holding.
(d) Mutual has all requisite power and authority and has all necessary
approvals, licenses, permits and authorization to carry on the Mutual
Indemnity Business as now conducted. Each of Holding and Mutual has all
requisite power and authority to execute and deliver this Agreement and to
perform its obligations hereunder.
(e) Mutual has filed all necessary documents to qualify to operate the
Mutual Indemnity Business as a foreign corporation in, and is in good
standing under the laws of each jurisdiction in which the conduct of the
Mutual Indemnity Business or the nature of the property owned requires such
qualification, except where the failure to so qualify would not result in a
Mutual Material Adverse Effect.
5.2 VALIDITY OF MUTUAL INDEMNITY AGREEMENTS. Exhibit 4(a) and 4(b) hereto set
forth true and complete lists of the Mutual Indemnity Agreements as of September
30, 1997. Each Mutual Indemnity Agreement is valid and in full force and effect
on such date.
5.3 CORPORATE PROCEEDINGS, ETC. Each of Mutual and Holding has the requisite
corporate power to execute and deliver, to perform its obligations under, and to
consummate the transactions contemplated by, this Agreement and each Ancillary
Agreement to which it is a party. The execution and delivery of this Agreement
and each Ancillary Agreement by each of Mutual and Holding, and the consummation
by them of the transactions contemplated hereby and thereby, have been duly
authorized by all necessary corporate action and no other corporate proceedings
on the part of Mutual and Holding that are necessary to authorize this Agreement
or any Ancillary Agreement. This Agreement has been duly executed and delivered
by each of Mutual and Holding and, assuming the due authorization, execution and
delivery by the other parties hereto, constitutes the legal, valid and binding
obligation of Mutual and Holding, enforceable against each of Mutual and Holding
in accordance with its respective terms, except that such enforcement may be
subject to bankruptcy, insolvency, reorganization, moratorium or similar laws
now or hereafter in effect relating to creditors' rights and general principles
of equity. As of the Closing Date, each Ancillary Agreement will have been duly
executed and delivered to Mutual by Coventry, and, subject to the due execution
and delivery of such agreements by the other parties thereto, each Ancillary
Agreement executed by Mutual constitutes the legal, valid and binding obligation
of Mutual and Holding, enforceable against each of Mutual and Holding in
accordance with its respective terms, except that such enforcement may be
subject to bankruptcy, insolvency, reorganization, moratorium or similar laws
now or hereafter in effect relating to creditors' rights and general principles
of equity.
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5.4 CONSENTS AND APPROVALS.
(a) Except as set forth in Section 5.4(a) of the Mutual Disclosure
Letter, the execution and delivery by each of Mutual and Holding of this
Agreement and any Ancillary Agreement to which it is a party, the
performance by Mutual and Holding of its respective obligations hereunder
or thereunder and the consummation by Mutual and Holding of the
transactions contemplated hereby and thereby do not require Mutual or
Holding to obtain any consent, approval, clearance or action of, or make
any filing, submission or registration with, or give any notice to, any
Person or Governmental Entity.
(b) Mutual hereby represents that, as the sole shareholder of Holding,
it has approved the transactions contemplated by this Agreement and each of
the Ancillary Agreements to which Holding is a party and that Holding, as
the sole shareholder of Principal, has approved the transactions
contemplated by this Agreement and each of the Ancillary Agreements to
which Principal is a party.
5.5 COMPLIANCE WITH LAW.
(a) Mutual is in compliance in all material respects with, and is not
in violation or default in any material respect under, all federal, state
and local laws, ordinances, government rules and regulations applicable to
the Mutual Indemnity Business. Mutual has no knowledge of any actual or
claimed violation or default with respect to any of the foregoing. No
material expenditures, to the knowledge of Mutual, are or will be required
in order to cause the Mutual Indemnity Business to comply with any
applicable laws, ordinances, governmental rules or regulations at Closing.
(b) Mutual has all licenses, permits, franchises or other governmental
authorizations ("Mutual Approvals") necessary to the operation of the
Mutual Indemnity Business, which if violated or not obtained would not
result in a Mutual Material Adverse Effect. Mutual has not been finally
denied any application for any such Mutual Approvals necessary for
performance under the Mutual Indemnity Business. There is no action
pending, or to the best knowledge of Mutual, threatened or recommended by
appropriate state or federal agencies having jurisdiction thereof, to
either revoke, withdraw, or suspend any such Mutual Approvals, or which
would result in a Mutual Material Adverse Effect.
(c) Mutual is operating and has operated in material compliance with
all contractual, statutory, regulatory, and other requirements applicable
to entities furnishing coverage to employees of federal, state and local
governments and subdivisions and to beneficiaries under programs sponsored
or administered by any such governments or subdivisions thereof
(collectively "Mutual Government Contracts") with respect to each of the
Mutual Indemnity Agreements that is a Mutual Government Contract. Except as
set forth in Section 5.5(c) of the Mutual Disclosure Letter, Mutual is not
subject to any claim, penalty, fine, return of premium, repayment of costs
charged, or renegotiation of charges or fees as a result of any audit,
adjustment, charge, retroactive restatements of costs or charges, or other
liability with respect to any Mutual Government Contract, except where such
claim, penalty, fine, return of premium, repayment or renegotiation would
not result in a Mutual Material Adverse Effect.
(d) Mutual has filed all reports, filings and notices required to be
filed with respect to the Mutual Indemnity Business with all applicable
Departments of Insurance since January 1, 1992 except where the failure to
so file would not result in a Mutual Material Adverse Effect (as such
documents have since the time of their filing been amended, the "Mutual DOI
Reports"). As of their respective dates, the Mutual DOI Reports complied in
all material respects with the requirements of the laws, rules and
regulations applicable to such Mutual DOI Reports, except where the failure
to do so would result in a Mutual Material Adverse Effect.
5.6 LITIGATION. Except as disclosed in Section 5.6 of the Mutual Disclosure
Letter, there is no legal action, suit, arbitration or other legal,
administrative or other governmental investigation, inquiry or proceeding
(whether federal, state, local or foreign) pending or, to the best of Mutual's
knowledge, threatened against or affecting the Mutual Indemnity Business, except
for actions, suits, arbitrations, investigation, inquiries or proceedings that
would not result in a Mutual Material Adverse Effect. Except as set forth in
Section 5.6 of the Mutual Disclosure Letter, there are no formally initiated
grievances or litigation pending against Mutual relating to the Mutual Indemnity
Business involving claims from accounts, clients, covered persons, or
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enrollees relating to coverage of health claims or any claim for punitive,
exemplary or other extra-contractual damage except for grievances, litigation or
claims which would not result in a Mutual Material Adverse Effect. Mutual is not
subject to any order, writ, judgment, injunction, decree, determination or award
of any court or of any governmental agency or instrumentality (whether federal,
state, local or foreign) which would result in a Mutual Material Adverse Effect.
5.7 ABSENCE OF DEFAULTS, CONFLICTS, ETC. The execution and delivery of this
Agreement and the Coinsurance Agreement will not, and the fulfillment of the
terms hereof and thereof by Mutual will not, result in a breach of any of the
terms, conditions or provisions of, or constitute a default under, or result in
the modification of, or permit the acceleration of rights under or termination
of, any of the Mutual Indemnity Agreements, or any law, ordinance, code,
standard, judgment, rule or regulation of any court or federal, state or foreign
regulatory board or body or administrative agency having jurisdiction over
Mutual or over the Mutual Indemnity Business. Mutual is not in default under or
in violation of (and no event has occurred and no condition exists which, upon
notice or the passage of time (or both), would constitute a default under) (i)
the Mutual Indemnity Agreements, or (ii) any order, writ, injunction or decree
of any court or any federal, state, municipal or other domestic or foreign
governmental department, commission, board, bureau, agency or instrumentality,
except, in the case of this clause (ii), for defaults or violations which would
not result in a Mutual Material Adverse Effect.
5.8 PREMIUM INFORMATION. The earned premium of Mutual with respect to the
portion of the Mutual Indemnity Business identified on Exhibit 4(a) during the
period beginning on January 1, 1997 and ending on September 30, 1997 was
approximately $432 million.
5.9 OWNERSHIP OF COVENTRY COMMON SHARES. Other than the 37,900 shares of
Coventry Common Stock owned by Invista Capital Management, Inc., an indirect
wholly-owned subsidiary of Mutual, neither Mutual nor any affiliate thereof owns
any shares of Coventry Common Stock or any securities exercisable for or
convertible into shares of Coventry Common Stock.
5.10 ABSENCE OF UNDISCLOSED LIABILITIES. The Mutual Indemnity Business is not
subject to any obligation or liability (whether accrued, absolute, contingent,
liquidated or otherwise, whether due or to become due, whether or not known to
any such party) except for obligations set forth in the Mutual Disclosure
Letter, none of which (individually or in the aggregate) could result in a
Mutual Material Adverse Effect.
5.11 BROKERAGE. Except as set forth on Section 5.11 of the Mutual Disclosure
Letter, there are no claims for brokerage commissions or finder's fees or
similar compensation in connection with the transactions contemplated by this
Agreement based on any arrangement made by or on behalf of Mutual or Holding.
5.12 MUTUAL MATERIAL ADVERSE EFFECT. As used in this Agreement, the term "Mutual
Material Adverse Effect " shall mean any material adverse effect on the Mutual
Indemnity Business taken as a whole.
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COVENANTS
6.1 ACQUISITION PROPOSALS. Prior to the Effective Time, Mutual, Holding,
Principal and Coventry each agree (a) that none of them nor any of their
Subsidiaries shall, and each of them shall direct and use its best efforts to
cause its respective officers, directors, employees, agents and representatives
(including, without limitation, any investment banker, attorney or accountant
retained by it or any of its Subsidiaries) not to, initiate, solicit or
encourage, directly or indirectly, any inquiries or the making or implementation
of any proposal or offer (including, without limitation, any proposal or offer
to its shareholders) with respect to a merger, share exchange, acquisition,
consolidation or similar transaction directly or indirectly involving, or any
purchase or acquisition, directly or indirectly, of all or any significant
portion of the assets or any equity securities of, Principal or any of the
Principal Subsidiaries or Coventry or any of the Coventry Subsidiaries (any such
proposal or offer being hereinafter referred to as an "Acquisition Proposal ")
or engage in any negotiations concerning, or provide any confidential
information or data to, or have any discussions with, any person relating to an
Acquisition Proposal, or otherwise facilitate any effort or attempt to make or
implement an Acquisition Proposal; (b) that they and each of them will
immediately cease and cause to be terminated any existing activities,
discussions or negotiations with any parties conducted heretofore with respect
to any of the foregoing and each will take the necessary steps to inform the
individuals or entities referred to above of the obligations undertaken in this
Section 6.1; and (c) that they and each of them will notify the other parties
hereto immediately if any such inquiries or proposals are received by, any such
information is requested from, or any such negotiations or discussions are
sought to be initiated or continued with it. Notwithstanding the foregoing, any
reorganization of Mutual shall not violate the provisions of this Section 6.1 if
such reorganization shall not result in any transfer of the Principal Assets or
Mutual Indemnity Agreements to any Person who is not an Affiliate of Mutual and
any such transferee agrees to be bound by the provisions of this Agreement.
Notwithstanding anything to the contrary contained in this Section 6.1 or
in any other provision of this Agreement, Coventry and its Board of Directors
(i) may participate in discussions or negotiations (including, as a part
thereof, making any counterproposal) with or furnish information to any third
party making an unsolicited written Acquisition Proposal that the Board
determines is a bona fide offer (a "Potential Acquiror") if Coventry's Board of
Director's is advised by a nationally recognized investment banking firm
designated by Coventry and reasonably acceptable to Mutual that such Potential
Acquiror has the financial wherewithal to consummate such an Acquisition
Proposal (or that it is confident that such Potential Acquiror will be capable
of consummating such Acquisition Proposal) provided that (a) the Board
determines in good faith, after receiving advice from such financial advisor,
that such third party has submitted to Coventry an Acquisition Proposal which is
a superior proposal to the transactions contemplated under this Agreement (a
"Superior Proposal "), and (b) the Board determines in good faith, based upon
advice of its outside legal counsel, that participation in such discussions or
negotiations or furnishing such information is necessary to fulfill the Board's
fiduciary duties under applicable law. The Board shall be entitled to withdraw
its recommendation in favor of the transactions contemplated by this Agreement,
and to approve and recommend acceptance by shareholders of an unsolicited
written Acquisition Proposal that is a Superior Proposal if the Board determines
in good faith that such actions are in the best interests of its shareholders,
and, based upon advice of its outside counsel the Board determines in good faith
that such approval is necessary to fulfill the Board's fiduciary duty under
applicable law, and provision is made by Potential Acquiror to pay the fee
provided in Section 8.6(b) at the time therein specified. Coventry agrees that
any non-public information furnished to a Potential Acquiror will be pursuant to
a confidentiality agreement substantially similar to the confidentiality
provisions of the confidentiality agreement entered into between Coventry,
Mutual and Principal. In the event that Coventry shall determine to provide any
information as described above, or shall receive any such unsolicited
Acquisition Proposal, it shall promptly inform Mutual in writing as to the fact
that information is to be provided and shall furnish to Mutual the identity of
the recipient of such information and/or the Potential Acquiror and the terms of
such Acquisition Proposal, except to the extent that the Board determines in
good faith, based upon advice of its outside legal counsel, that any such action
described in this sentence would violate such Board's fiduciary duties under, or
otherwise violate, applicable law. Coventry will keep Mutual reasonably informed
of the status (including amendments or proposed amendments) of any such
Acquisition Proposal except to the extent that the Board determines in good
faith, based upon advice of its
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outside legal counsel, that any such action would violate such Board's fiduciary
duties under, or otherwise violate, applicable law.
6.2 BEST EFFORTS. Subject to the terms and conditions of this Agreement, each
party will use its reasonable best efforts to take, or to cause to be taken, all
actions and to do, or cause to be done, all things necessary, proper or
advisable under applicable laws and regulations to consummate the Merger and the
Capital Contribution and the other transactions contemplated by this Agreement
and each of the Ancillary Agreements.
6.3 CONDUCT OF BUSINESSES. Prior to the Effective Time, except as set forth in
the Principal Disclosure Letter or the Coventry Disclosure Letter or as
contemplated by any other provision of this Agreement, unless the other party
has consented in writing thereto, which consent shall not be unreasonably
withheld, each of Newco, Coventry and Principal shall, and shall cause each of
its respective Subsidiaries to:
(a) conduct its operations according to their usual, regular and
ordinary course in substantially the same manner as heretofore conducted;
(b) use its reasonable efforts to preserve intact its business
organizations and goodwill, keep available the services of its respective
officers and employees and maintain satisfactory relationships with those
persons having business relationships with them;
(c) confer on a regular basis with one or more representatives of the
other parties hereto to report operational matters of materiality and any
proposals to engage in material transactions;
(d) not amend its respective Organizational Documents;
(e) notify promptly the other parties hereto of any material change in
the condition (financial or otherwise), business, properties, assets,
liabilities or prospects, any material litigation or material governmental
complaints, investigations or hearings (or communications indicating that
the same may be contemplated), or the breach in any material respect of any
representation or warranty contained herein;
(f) deliver promptly to the other parties hereto true and correct
copies of (i) with respect to Coventry, any report, statement or schedule
filed with the Commission; (ii) with respect to Principal, (A) audited
financial statements, together with a report thereon of Ernst & Young LLP,
independent certified public accountant, prepared for the period ending
December 31, 1997 and delivered to Coventry on or before March 15, 1998;
(g) not (i) except pursuant to the exercise of options, warrants,
conversion rights and other contractual rights existing on the date hereof
and disclosed pursuant to this Agreement, issue any shares of its capital
stock, effect any stock split or otherwise change its capitalization as it
existed on the date hereof, (ii) grant, confer or award any option,
warrant, conversion right or other right not existing on the date hereof to
acquire any shares of its capital stock, other than options granted to new
employees hired after the date hereof under the Coventry Stock Option
Plans, (iii) except as contemplated by the provisions hereof increase any
compensation to employees or enter into or amend any employment agreement
with any of its present or future officers or directors, except for normal
increases consistent with past practice, the payment of cash bonuses to
officers pursuant to and consistent with existing plans or programs or
officers that shall be hired after the date hereof in the usual, regular
and ordinary course of business and changes to existing Coventry employment
agreements approved by its Board of Directors as consideration for the
waiver by employee parties thereto of the acceleration of the vesting
thereof resulting from consummation of the transactions contemplated by
this Agreement, or (iv) adopt any new employee benefit plan (including any
stock option, stock benefit or stock purchase plan) or amend any existing
employee benefit plan in any material respect, except for changes which do
not increase the benefits to participants in such plans and except as
contemplated herein;
(h) not (i) declare, set aside or pay any dividend or make any other
distribution or payment with respect to any shares of its capital stock
(except, in the case of Coventry, any dividends owing on the Coventry
Preferred Stock and, in the case of Principal, cash dividends) or (ii)
except in connection with the use of shares of capital stock to pay the
exercise price or tax withholding in connection with stock-
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based employee benefit plans, directly or indirectly redeem, purchase or
otherwise acquire any shares of its capital stock or capital stock of any
of its Subsidiaries, or make any commitment for any such action;
(i) not acquire, except as expressly contemplated by this Agreement or
as disclosed in the Principal Disclosure Letter or Coventry Disclosure
Letter, direct or indirect control over any corporation, association, firm
or organization, other than in connection with mergers, acquisitions, or
other transactions approved in writing in advance by the other, or
involving consideration valued in the aggregate not in excess of (i) with
respect to Coventry, $10,000,000 for all such transactions and (ii) with
respect to Principal, $10,000,000 for all such transactions;
(j) execute, with respect to Principal, a Restructuring Plan, in the
form as developed by Principal with the reasonable approval of Coventry;
(k) not enter into or amend any material agreement (including, without
limitation, any agreement with its senior lenders);
(l) not (i) sell, lease or otherwise dispose of any of its assets
(except for Excluded Assets) which are material, individually or in the
aggregate, except in the ordinary course of business or (ii) sell any
capital stock of any of its Subsidiaries;
(m) not take any actions that would, or would be reasonably likely to,
adversely affect the status of (i) the Merger as a non-taxable transfer
described in Section 351(a) of the Code and a reorganization as described
in Section 368(a)(2)(E) of the Code and (ii) the Capital Contribution as a
non-taxable exchange described in Section 351 of the Code;
(n) inform the other parties hereto regarding (i) the progress of any
material claim, action, suit, litigation, proceeding, arbitration,
investigation, audit, or controversy relating to Taxes or (ii) any change
of its methods of reporting income or deductions for federal income Tax
purposes from those employed in the preparation of its federal income Tax
Return for the taxable year ending December 31, 1996, except as may be
required by law; and
(o) not (i) make or rescind any material express or deemed election
relating to Taxes of Coventry, the Coventry Subsidiaries or the Principal
Subsidiaries or (ii) make a request for a Tax Ruling or enter into a
Closing Agreement, settlements or compromise with respect to any material
Tax matter or respect of the Principal Subsidiaries.
6.4 CONDUCT OF BUSINESSES. Prior to the Effective Time, except as set forth in
the Mutual Disclosure Letter or as contemplated by any other provision of this
Agreement, unless Coventry has consented in writing thereto (which consent shall
not be unreasonably withheld), Mutual shall (with respect to the Mutual
Indemnity Business):
(a) conduct its operations according to their usual, regular and
ordinary course in substantially the same manner as heretofore conducted;
(b) use its reasonable efforts to preserve intact its business
organizations and goodwill, keep available the services of its respective
officers and employees and maintain satisfactory relationships with those
persons having business relationships with them; and
(c) promptly notify the other parties hereto of any material change in
the condition (financial or otherwise), business, properties, assets,
liabilities or prospects, any material litigation or material governmental
complaints, investigations or hearings (or communications indicating that
the same may be contemplated), or the breach in any material respect of any
representation or warranty contained herein.
6.5 REGISTRATION STATEMENT. Mutual, Principal and Coventry shall cooperate and
promptly prepare and Coventry shall cause Newco to file with the Commission as
soon as practicable a Registration statement on Form S-4 (the "Form S-4 ") under
the Securities Act, with respect to Newco Common Stock issuable in the Merger, a
portion of which Registration Statement shall also serve as the proxy statement
with respect to the meeting of the shareholders of Coventry in connection with
the Merger (the "Proxy Statement/Prospectus"). The respective parties will cause
the Proxy Statement/Prospectus and the Form S-4 to comply as to form in
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all material respects with the applicable provisions of the Securities Act and
the Exchange Act, and the rules and regulations thereunder. Coventry shall use
its best efforts, and Principal will cooperate with Coventry, to have the Form
S-4 declared effective by the Commission as promptly as practicable. Coventry
shall use its best efforts to obtain, prior to the effective date of the Form
S-4, all necessary state securities law or "Blue Sky" permits or approvals
required to carry out the transactions contemplated by this Agreement and will
pay all expenses incident thereto. Coventry will use its best efforts to cause
the Proxy Statement/Prospectus to be mailed to Coventry's stockholders as
promptly as practicable after the Form S-4 is declared effective under the
Securities Act. Coventry agrees that the Proxy Statement/Prospectus and each
amendment or supplement thereto at the time of mailing thereof and at the time
of the meeting(s) of shareholders of Coventry, or, in the case of the Form S-4
and each amendment or supplement thereto, at the time it is filed or becomes
effective, will not include an untrue statement of a material fact or omit to
state a material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading; provided, however, that the foregoing shall not apply to the
extent that any such untrue statement of a material fact or omission to state a
material fact was made by Coventry in reliance upon and in conformity with
written information concerning Principal furnished to Coventry by Principal
specifically for use in the Proxy Statement/Prospectus. Principal agrees that
the information provided by it for inclusion in the Proxy Statement/Prospectus
and each amendment or supplement thereto, at the time of mailing thereof and at
the time of the meeting(s) of shareholders of Coventry, or, in the case of
information provided by Principal for inclusion in the Form S-4 or any amendment
or supplement thereto, at the time it is filed or becomes effective, will not
include an untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances under which they were made, not misleading. No
amendment or supplement to the Proxy Statement/Prospectus will be made by
Coventry or Principal without the approval of the other party. Coventry will
advise Principal, promptly after it receives notice thereof, of the time when
the Form S-4 has become effective or any supplement or amendment has been filed,
the issuance of any stop order, the suspension of the qualification of Coventry
Common Stock issuable in connection with the Merger and the Capital Contribution
for offering or sale in any jurisdiction, or any request by the Commission for
amendment of the Proxy Statement/Prospectus or the Form S-4 or comments thereon
and responses thereto or requests by the Commission for additional information.
6.6 FINANCIAL STATEMENTS.
(a) As soon as practicable after the date hereof but in no event later
than November 30, 1997, Mutual and Principal shall cause Ernst & Young LLP
to prepare and deliver to Coventry financial statements prepared in
conformity with the requirements of, and for the periods indicated in, Rule
3-05 of Regulation S-X under the Securities Act for Form S-4 with respect
to the Principal Assets together with an auditor's report and consent in
the form required by Regulation S-X, for use by Coventry in the preparation
of the Form S-4 and Proxy Statement/Prospectus; and
(b) Mutual and Principal shall cause Ernst & Young, LLP to prepare and
deliver on a timely basis, any other financial statements as may be
required.
6.7 LISTING APPLICATION. Newco shall promptly prepare and submit to the NASDAQ a
listing application for qualification of the shares of Newco Common Stock
issuable pursuant to the Merger, and shall use its best efforts to obtain, prior
to the Effective Time, approval for the listing of such Newco Common Stock,
subject to official notice of issuance.
6.8 MEETING OF COVENTRY'S SHAREHOLDERS. Coventry will take all action necessary
in accordance with applicable law and its Charter and Bylaws to convene a
meeting of its shareholders as promptly as practicable to consider and vote upon
the approval of this Agreement and the transactions contemplated hereby. The
Board of Directors of Coventry shall recommend such approval and Coventry shall
take all lawful action to solicit such approval; including, without limitation,
timely mailing the Proxy Statement/Prospectus (as defined in Section 6.5
hereof); provided, however, that such recommendation or solicitation is subject
to any action taken by, or upon authority of, the Board of Directors of Coventry
in accordance with the provisions of Section 6.1 hereof. It shall be a condition
to the mailing of the Proxy Statement/Prospectus that (i) Coventry
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shall have received (A) an opinion of Credit Suisse First Boston Corporation
("First Boston"), dated the date of the Proxy Statement/Prospectus, to the
effect that, as of the date thereof, the consideration to be paid by Newco
pursuant to the Merger is fair to Coventry's shareholders from a financial point
of view (the "Coventry Fairness Opinion") and (B) a "comfort" letter from Ernst
& Young LLP, independent public accountants for Principal, dated the date of the
Proxy Statement/Prospectus, with respect to the financial statements of
Principal and any others as may be required to be included in the Proxy
Statement/Prospectus, substantially in the form described in Section 7.2(b) (the
"Principal Comfort Letter").
6.9 FILINGS; OTHER ACTION. Subject to the terms and conditions herein provided,
each of Principal and Coventry shall: (a) promptly make its own, and use its
reasonable best efforts in cooperating with the other party with respect to such
other party's, filings and any other required submissions under the Securities
Act, the Exchange Act and the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended (the "HSR Act "), with respect to the Merger and the Capital
Contribution; and (b) use all reasonable efforts to cooperate with one another
in (i) determining which filings are required to be made prior to the Effective
Time with, and which consents, approvals, permits or authorizations are required
to be obtained prior to the Effective Time from, governmental or regulatory
authorities of the United States, the several states and foreign jurisdictions
in connection with the execution and delivery of this Agreement and the
consummation of the transactions contemplated hereby, including, without
limitation, any approvals or filings required under laws, rules or regulations
governing insurance and insurance companies, HMOs, PPOs, health care services
plans, third party administrators or other managed health care organizations and
all Forms A required in connection with the transaction contemplated under this
Agreement, and (ii) timely making all such filings and timely seeking all such
consents, approvals, permits or authorizations.
6.10 INVESTIGATION AND CONFIDENTIALITY.
(a) Prior to the Effective Time, Mutual, Holding and Principal each
will keep Coventry advised of all material developments relevant to the
Mutual Indemnity Business and the Principal Assets and to consummation of
the transactions contemplated by this Agreement and make or cause to be
made such investigation, if any, of the business and properties of Coventry
and the Coventry Subsidiaries and of their respective financial and legal
condition as Mutual or Principal reasonably deems necessary or advisable to
familiarize itself and its advisers with such business, properties, and
other matters, provided that such investigation shall be reasonably related
to the transactions contemplated hereby and shall not interfere
unnecessarily with normal operations. Principal agrees to furnish Coventry
and Coventry's advisers with such financial and operating data and other
information with respect to its businesses, properties, and employees as
Coventry shall from time to time reasonably request. No investigation by
Coventry shall affect the representations and warranties of Mutual, Holding
and Principal made hereunder. Coventry shall, and shall cause its advisers
and agents to, maintain the confidentiality of all confidential information
furnished to it by Mutual, Holding and Principal concerning their
respective business, operations, and financial condition and shall not use
such information for any purpose except in furtherance of the transactions
contemplated by this Agreement. If this Agreement is terminated prior to
the Effective Time, Coventry shall promptly return all documents and copies
thereof, and all work papers containing confidential information received
from Mutual, Holding and Principal.
(b) Prior to the Effective Time, Coventry will keep Mutual and
Principal advised of all material developments relevant to its business and
to consummation of the transactions contemplated by this Agreement and make
or cause to be made such investigation, if any, of the Mutual Indemnity
Business, Principal Assets and business and properties of Principal and the
Principal Subsidiaries and of their respective financial and legal
condition as Coventry reasonably deems necessary or advisable to
familiarize itself and its advisers with such business, properties, and
other matters, provided that such investigation shall be reasonably related
to the transactions contemplated hereby and shall not interfere
unnecessarily with normal operations. Coventry agrees to furnish Mutual's
and Principal's advisers with such financial and operating data and other
information with respect to its businesses, properties, and employees as
either Mutual or Principal shall from time to time reasonably request. No
investigation by either Mutual or Principal shall affect the
representations and warranties of Coventry. Mutual and Principal shall, and
shall cause its advisers and agents to, maintain the confidentiality of all
confidential
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information furnished to it by Coventry concerning its business,
operations, and financial condition and shall not use such information for
any purpose except in furtherance of the transactions contemplated by this
Agreement. If this Agreement is terminated prior to the Effective Time,
Mutual and Principal shall promptly return all documents and copies
thereof, and all work papers containing confidential information received
from Coventry.
6.11 PUBLICITY. All press releases relating to this Agreement issued by Newco,
Mutual, Principal and Coventry shall, subject to their respective legal
obligations (including requirements of the NASDAQ NMS and other similar
regulatory bodies), agree upon the text of any press release, before issuing any
such press release or otherwise making public or similar statements with respect
to the transactions contemplated hereby and in making any filings with any
federal or state governmental or regulatory agency or with any national
securities exchange with respect thereto; provided, however, that at all times
Newco shall comply with the provisions of the License Agreement. Mutual,
Principal and Coventry shall mutually agree upon guidelines and adhere to such
guidelines before making statements to their respective employees.
6.12 FURTHER ACTION. Each party hereto shall, subject to the fulfillment at or
before the Effective Time of each of the conditions of performance set forth
herein or the waiver thereof, perform such further acts and execute such
documents as may be reasonably required to effect the transactions contemplated
by this Agreement.
6.13 EXPENSES. Whether or not the Merger or Capital Contribution are
consummated, all costs and expenses incurred in connection with this Agreement
and the transactions contemplated hereby shall be paid by the party incurring
such expenses except as expressly provided herein and except that the expenses
incurred in connection with printing and mailing the Form S-4 and the Proxy
Statement/Prospectus shall be shared equally by Principal and Coventry.
6.14 GOVERNANCE.
(a) Coventry shall take all action necessary to cause the directors
comprising the full Board of Directors of Newco at the Effective Time to
consist of 15 directors and shall take all such action necessary to cause
Newco's Board of Directors to consist of the nine members of the Board of
Directors of Coventry and six Persons (the "Principal Directors") as shall
be designated by Principal at or before the Closing Date.
(b) Newco's Board of Directors shall take all action necessary to
cause each of the Audit Committee, Finance Committee and Compensation
Committee of the Board of Directors to consist of three members, one of
which shall be nominated by the Principal Directors.
(c) Newco's Board of Directors shall take all action necessary to
elect the following individuals as officers of Coventry at the Effective
Time: (i) Allen F. Wise shall be President and Chief Executive Officer; and
(ii) Kenneth J. Linde shall be Executive Vice President and Chief Operating
Officer.
6.15 EMPLOYMENT AGREEMENT. Prior to the Effective Time, Newco shall:
(a) assume Coventry's Employment Agreement with Allen F. Wise, except
that he shall serve as President and Chief Executive Officer;
(b) tender to Kenneth J. Linde an Employment Agreement in the form of
Exhibit 6 hereto for execution, such employment agreement to be effective
at the Effective Time.
6.16 CORPORATE HEADQUARTERS. Newco's headquarters shall be in Bethesda, Maryland
located at 6705 Rockledge Drive, Suite 100, Bethesda, Maryland 20817.
6.17 CERTAIN BENEFITS.
(a) As of the Closing Date, the Principal Subsidiaries shall cease to
be adopting employers of all Principal Plans (including Principal Pension
Plans) as defined in Section 4.15(a) of this Agreement sponsored by Mutual
or Principal, and Mutual and Principal shall take, or cause to be taken,
all such action as may be necessary to effect such cessation of
participation. Such Plans shall include all Principal Plans (including
Principal Pension Plans) listed in Section 4.15 of the Principal Disclosure
Letter and
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any Principal Plans (including Principal Pension Plans) not listed on such
schedule sponsored by Mutual or Principal, including without limitation,
the following Plans: (i) the Principal Health Care, Inc. Pension Plan (the
"Defined Benefit Plan"); (ii) the Principal Health Care, Inc. Select
Savings Plan (the "401(k) Plan"); (iii) the Principal Health Care, Inc.
Supplemental Executive Retirement Plan (the "Defined Benefit Plan SERP ");
(iv) the Principal Health Care, Inc. Select Savings Excess Plan (the
"401(k) Plan SERP "); and (v) the Principal Welfare Benefit Plan for
Employees (the "Welfare Plan").
(b) Notwithstanding any other provision in this Agreement, none of
Coventry, Newco and any of the Principal Subsidiaries shall assume any of
the Principal Plans (including Principal Pension Plans) sponsored by Mutual
or Principal, including without limitation, the Defined Benefit Plan, the
401(k) Plan, the Defined Benefit Plan SERP, the 401(k) Plan SERP, and the
Welfare Plan, or any past, current or future liabilities or obligations
with respect to any such Principal Plans or with respect to any Principal
Pension Plan subject to Title IV of ERISA in which either Mutual,
Principal, any Principal Subsidiary, or any Principal ERISA Affiliate as
defined in Section 4.15(h) of this Agreement has ever sponsored,
participated in, contributed to or withdrawn from, and neither Mutual nor
Principal shall be relieved of any such liabilities or obligations.
6.18 ANCILLARY AGREEMENTS. At or before the Closing, each of the parties hereto
covenants and agrees that it will enter and/or cause its subsidiaries or
affiliates to enter into all of the following agreements to which it is a party
(collectively, together with the employment agreements referenced in Section
6.15 hereto, the Coinsurance Agreement referenced in Section 1.7 hereto, the
Assignment and Assumption Agreement referenced in Section 1.6 hereto, the Plan
referenced in Section 1.2(a) hereto and the Articles of Merger referenced in
Section 2.2 hereto the "Ancillary Agreements"):
(a) Newco's Rights Agreement, substantially in the form attached as
Exhibit 7 hereto (the "Rights Amendment ");
(b) Renewal Rights Agreement between Coventry Health and Mutual,
substantially in the form attached as Exhibit 8 hereto (the "Renewal Rights
Agreement ");
(c) Transition Agreement between Newco and Mutual, substantially in
the form attached as Exhibit 9 hereto (the "Transition Agreement ");
(d) Management Services Agreement between Newco and Mutual,
substantially in the form attached as Exhibit 10 hereto (the "Service
Agreement ");
(e) Shareholders' Agreement between Newco, Principal and Mutual,
substantially in the form attached as Exhibit 11 hereto (the "Shareholders'
Agreement ");
(f) Tax Benefit Restitution Agreement between Newco and Mutual,
substantially in the form attached as Exhibit 12 hereto (the "Tax Benefit
Agreement ");
(g) License Agreement between Newco and Mutual, substantially in the
form attached as Exhibit 13 hereto (the "License Agreement");
(h) Marketing Service Agreement between Mutual and Newco,
substantially in the form attached as Exhibit 14 hereto ("Marketing
Agreement");
(i) Newco's 1998 Incentive Stock Option Plan, substantially in the
form attached as Exhibit 15 hereto, which authorizes Newco to issue up to a
total of 7,000,000 shares of Newco Common Stock in accordance with the
terms set forth therein;
(j) Amendment to the Principal Mutual Life Insurance Company
Administrative Agreement with Principal Health Care, Inc., substantially in
the form attached as Exhibit 16 hereto; and
(k) Amendment to The Administrative Agreement between Principal Health
Care of Georgia, Inc./SouthCare and Principal Mutual Life Insurance
Company, substantially in the form attached as Exhibit 17 hereto.
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6.19 TANGIBLE NET VALUE.
(a) As used herein, the term "Tangible Net Value" shall mean the
difference as of immediately prior to the Effective Time between (x) the
aggregate book value of the tangible Principal Assets calculated in
accordance with GAAP, consistent with the accounting principles applied in
Principal's financial statements and (y) the aggregate book value of the
Assumed Liabilities calculated in accordance with GAAP, consistent with the
accounting principles applied in Principal's financial statements.
(b) As soon as practicable, but in no event later than 90 days
following the Effective Time, PHC shall prepare and deliver to Coventry a
balance sheet of PHC as of the close of business on the last business day
prior to the Effective Time (the "Closing Balance Sheet") that sets forth
the Tangible Net Value. The Closing Balance Sheet shall be prepared in
accordance with GAAP applied on a consistent basis with prior periods and
shall be delivered together with an audit opinion thereon of Ernst & Young,
LLP or such other independent certified public accounting firm of
recognized national standing as PHC may designate (the "Accountants")
stating that the Closing Balance Sheet has been prepared in accordance with
GAAP applied on a consistent basis with prior periods. PHC shall retain the
Accountants for purposes of delivering such opinion and PHC shall pay all
fees and expenses thereof.
Coventry may, however, dispute any amounts reflected on the Closing Balance
Sheet or in the Tangible Net Value calculation, but only on the basis that such
amounts were not arrived at in accordance with GAAP applied on a consistent
basis with prior periods; provided that Coventry shall notify PHC in writing of
each disputed amount and specify the amount thereof in dispute within 30 days of
receipt by Coventry of the Closing Balance Sheet. Coventry may retain
accountants for purposes of performing such review and in such event shall pay
all fees and expenses thereof.
In the event of such a dispute, PHC and/or its accountants, and Coventry
and/or its accountants, shall attempt in good faith to reconcile their
differences and any solution by them as to any disputed amounts shall be final,
binding and conclusive on the parties. If the parties are unable to reach a
resolution to such effect within 20 days of Coventry's written notice of dispute
to PHC, PHC shall cause the Accountants to submit the accounts remaining in
dispute for resolution to another nationally recognized firm of independent
accountants reasonably acceptable to both Coventry and PHC. Those accountants
shall, within 30 days after such submission, determine and report to the parties
upon such remaining disputed amounts, and such reports shall be final, binding
and conclusive on the parties hereto. The fees and disbursements of this
independent accounting firm shall be allocated equally between Coventry and PHC.
(c) If the Tangible Net Value shall be less than $103,000,000 (the
"Target Value"), then Principal and/or Mutual shall deliver to Newco cash
by wire transfer of immediately available funds in an amount equal to the
difference between the Tangible Net Value and the Target Value promptly
after the 30th day immediately following receipt of the Closing Balance
Sheet or, if later, promptly after the determination of the Tangible Net
Value in accordance with the provisions of Section 6.19(b) hereof. If the
Tangible Net Value shall be greater than the Target Value, then Newco shall
deliver to Principal cash by wire transfer of immediately available funds
in an amount equal to the difference between the Tangible Net Value and the
Target Value.
6.20 TAXES.
(a) Except as contemplated by this Agreement, on or prior to the
Closing Date, Principal and Mutual shall terminate any tax-sharing
agreements or similar arrangements with respect to or involving the
Principal Subsidiaries after settling all obligations thereunder. The
Principal Subsidiaries shall not thereafter be bound thereby or have any
liability thereunder for amounts due in respect of Pre-Acquisition Date Tax
Periods, except as provided in Section 6.20(b).
(b) Coventry and Principal acknowledge that the Principal Subsidiaries
will be required to join in the filing of a consolidated federal income tax
return with Mutual for the period from January 1, 1997, to the Effective
Time. Mutual shall be responsible for paying the actual federal income Tax
due for the Principal Subsidiaries for the period in 1997 ending on the
Effective Time. In the determination of
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Tangible Net Value pursuant to Section 6.19(a), the Closing Balance Sheet
shall not reflect any liability for the portion of such federal income Tax
of the Mutual consolidated group for 1997 attributable to Principal or the
Principal Subsidiaries.
(c) For any state or local income, franchise or other Tax Return of a
Principal Subsidiary that involves a period beginning before and ending
after the Effective Time (a "Straddle Period "), regardless of who pays the
Tax to the governmental authority, Principal shall be responsible for the
portion of the Tax attributable to the Pre-Acquisition Date Tax Period
(except for premium taxes) and Coventry shall be responsible for the
portion of the Tax attributable to the Post-Acquisition Date Tax Period.
The allocation of total Tax paid in connection with any such Tax Return
between the Pre-Acquisition Date Tax Period and the Post-Acquisition Date
Tax Period shall be in proportion to the number of days in each such
period. For premium taxes, the allocation of total Tax paid between the
Pre-Acquisition Date Tax Period and the Post-Acquisition Date Tax Period
shall be based on the gross premiums (or other measure of such Tax)
received during the Pre-Acquisition Date Tax Period and the
Post-Acquisition Date Tax Period, respectively, with such premiums being
pro-rated on a daily basis for the month within which the Effective Time
falls. If Coventry or the Principal Subsidiary should pay more Tax after
the Effective Time with regard to a Tax Return for a Straddle Period than
required by the foregoing allocation, then Principal shall reimburse
Coventry or the Principal Subsidiary for the excess amount paid by Coventry
or the Principal Subsidiary after the Effective Time. If Principal or the
Principal Subsidiary should pay more Tax before the Effective Time with
regard to a Return for a Straddle Period than required by the foregoing
allocation, then Coventry shall reimburse Principal for the excess amount
paid by Principal or the Principal Subsidiary before the Effective Time.
(d) Mutual shall have the right to pursue and shall be entitled to
retain, or receive from Newco or any of its Subsidiaries (including the
Principal Subsidiaries) prompt payment of, any overpayment, refund or
credit of Taxes for any and all Pre-Acquisition Date Tax Periods. If Newco
or any of its Subsidiaries (including the Principal Subsidiaries) receives
a Tax refund to which Mutual is entitled pursuant to this Agreement, Newco
or the Subsidiary, as the case may be, shall pay or cause the recipient to
pay the amount of such refund (including any interest received thereon) to
such other party within 10 days after receipt thereof. Within 90 days after
the end of each taxable year following the Closing Date, Newco shall have
its tax officer tender to Mutual a statement showing the aggregate amount
of all Tax refunds received to which Mutual is entitled.
(e) Upon request, Newco shall promptly provide (and cause any of its
Subsidiaries, including the Principal Subsidiaries, to provide) Mutual with
such cooperation and assistance, documents and other information, without
charge, as it may reasonably request in connection with the pursuit of any
overpayment, refund or credit described in Section 6.20(d).
(f) Newco (and any of the Principal Subsidiaries) shall promptly
notify Mutual in writing within ten (10) days from the receipt of notice of
any pending or threatened Tax audits or assessments of Newco or any of the
Principal Subsidiaries for any Pre-Closing Taxable Year. Principal shall
have the sole right to represent the interests of Newco and/or any of the
Principal Subsidiaries, to settle all issues, and to employ counsel of its
choice at its expense, in any audit or other examination or administrative
or court proceeding relating to federal or state or local Income Taxes for
any Pre-Closing Taxable Year, provided that, with respect to issues
affecting the Newco Group in a Taxable Year beginning after the Closing
Date, Principal shall keep Newco reasonably informed on an on-going basis.
Principal shall be entitled to settle any issue relating to Taxes in
connection with the contests described in the preceding sentence.
All audits or administrative or court proceedings relating to any Straddle
Period shall be controlled jointly by Principal and Newco, each to employ
counsel of its choice at its expense, provided, however, that settlement (at the
administrative level or during the course of judicial proceedings) may only be
entered into with the consents of both Principal and Newco. In the event of an
issue arising pursuant to any contest referred to in this Section 6.20(f), if
Principal or Newco proposes to settle on terms acceptable to a state or local
Taxing Authority, but the other party, Newco or Principal, as the case may be,
disagrees with the proposed settlement, then the party proposing to settle may
pay the other party its share of the amount of
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Taxes attributable to the settlement proposed and, in that event, the other
party shall have sole responsibility for the settlement of such issue.
(g) For purposes of this Agreement,
(i) The term "Post-Acquisition Date Tax Period " means, with
respect to any period which includes but does not end on the Effective
Time, the portion of such period which begins on the Effective Time.
(ii) The term "Pre-Acquisition Date Tax Period " means any of the
following periods: (A) any period which begins before and ends on or
before the Effective Time; and (B) for any period which includes but
does not end on the Effective Time, the portion of such period which
ends on the Effective Time.
(iii) "Pre-Closing Taxable Year," as used in this Agreement, means
any Tax period which ends on or before the Effective Time.
(iv) "Closing Agreement," as used in this Agreement, shall mean a
written and legally binding agreement with a taxing authority relating
to Taxes.
(v) "Taxes," as used in this Agreement, shall mean any federal,
state, county, local or foreign taxes, charges, fees, levies, or other
assessments, including all net income, gross income, premium, sales and
use, ad valorem, transfer, gains, profits, windfall profits, excise,
franchise, real and personal property, gross receipts, capital stock,
production, business and occupation, employment, disability, payroll,
license, estimated, stamp, custom duties, severance or withholding
taxes, other taxes or similar charges of any kind whatsoever imposed by
any Governmental Entity, whether imposed directly on a Person or
resulting under Treasury Regulation Section 1.1502-6 (or any similar
provision of state, local or foreign law), as a transferee or successor,
by Contract or otherwise and includes any interest and penalties (civil
or criminal) on or additions to any such taxes or in respect of a
failure to comply with any requirement relating to any Tax Return and
any expenses incurred in connection with the determination, settlement
or litigation of any tax liability.
(vi) "Tax Ruling," as used in this Agreement, shall mean a written
ruling of a taxing authority relating to Taxes.
(vii) "Tax Return," as used in this Agreement, shall mean a report,
return or other information required under any applicable law to be
filed or provided to any Person with respect to Taxes including, where
permitted or required, combined or consolidated returns for any group of
entities that includes Coventry or any Coventry Subsidiary.
6.21 MERGER SUB. Promptly after the date hereof, Newco shall organize Merger Sub
as a Tennessee corporation and wholly-owned subsidiary of Newco.
6.22 QUALIFICATION. Promptly after the organization by Newco of Merger Sub,
Newco shall cause Merger Sub to be qualified as a foreign corporation authorized
to do business in the State of Maryland.
6.23 AGREEMENT AND PLAN OF MERGER. At or prior to the Effective Time, Coventry
shall, and Newco shall require Merger Sub to, properly execute the Plan and an
Articles of Merger of Coventry and Merger Sub, meeting the requirements of
Section 48-21-107 of the TBCA, and to file such Plan and Articles of Merger with
the Secretary of State of the State of Tennessee on the Closing Date.
[REMAINDER OF PAGE INTENTIONALLY BLANK]
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CONDITIONS
7.1 CONDITIONS TO EACH PARTY'S OBLIGATIONS. The respective obligation of the
parties hereto to effect the transactions contemplated by this Agreement shall
be subject to the fulfillment, or written waiver signed by each of the parties
hereto, at or prior to the Closing Date of the following conditions:
(a) This Agreement and the transactions contemplated hereby shall have
been approved and adopted by the affirmative vote of the shareholders of
Coventry in accordance with applicable law and the Coventry Organizational
Documents.
(b) The Commission shall have declared the Form S-4 effective and such
effectiveness shall not be the subject of any stop order or proceedings
seeking a stop order.
(c) The shares of Newco Common Stock to be issued to the holders of
Coventry Common Stock shall have been approved for listing on the NASDAQ
NMS.
(d) The waiting period applicable to the consummation of the Merger
and Capital Contribution under the HSR Act shall have expired or been
terminated.
(e) The applicable approvals and any applicable waiting periods under
any laws, rules or regulations governing insurance and insurance companies,
HMOs, PPOs, health care services plans, third party administrators or other
managed health care organizations shall have been received, waived or
terminated.
(f) All other consents, authorizations, orders and approvals of (or
filings or registrations with) any governmental commission, board or other
regulatory body required in connection with the execution, delivery and
performance of this Agreement shall have been obtained without the
imposition of any condition or made, except for filings in connection with
the Merger and Capital Contribution and any other documents required to be
filed after the Effective Time and except where the conditions imposed,
individually or in the aggregate, would not result in, individually or in
the aggregate, in a Coventry Material Adverse Effect, a Principal Material
Adverse Effect, a Mutual Material Adverse Effect or a material adverse
effect on the business, operations, properties, prospects or condition
(financial or otherwise) of Newco (a "Newco Material Adverse Effect ")
following the Effective Time.
(g) No action or proceeding shall have been instituted before a court
or other governmental body by any governmental agency or public authority
to restrain or prohibit the transactions contemplated by this Agreement or
to obtain an amount of damages or other material relief in connection with
the execution of the Agreement or the related agreements or the
consummation of the Merger and the Capital Contribution; and no
governmental agency shall have given notice to any party hereto to the
effect that consummation of the transactions contemplated by this Agreement
would constitute a violation of any law or that it intends to commence
proceedings to restrain consummation of the Merger and the Capital
Contribution.
(h) Each of the parties to the Ancillary Agreements shall have
executed and delivered a counterpart signature page to each such Ancillary
Agreement to the other party or parties thereto and shall perform all such
acts required to be performed thereby at or prior to the Closing.
7.2 CONDITIONS TO OBLIGATION OF PRINCIPAL AND MUTUAL. The obligation of
Principal to effect the Capital Contribution and of Principal and Mutual to
enter into the Ancillary Agreements shall be subject to the fulfillment, or
written waiver signed by a duly authorized officer of Principal, Holding and
Mutual, at or prior to the Closing Date of the following conditions:
(a) Coventry and Newco shall have performed their respective
agreements and covenants contained in this Agreement required to be
performed on or prior to the Closing Date and the representations and
warranties of Coventry and Newco contained in this Agreement and in any
document delivered in connection herewith shall be true and correct both
when made and at and as of the Closing Date, as if made at and as of such
time (except to the extent expressly made as of an earlier date, in which
case as of such date), except where the non-performance of any agreement or
covenant or the failure of such
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representations and warranties to be so true and correct (without giving
effect to any limitation as to materiality set forth therein or applicable
thereto) does not have, and is not likely to have, individually or in the
aggregate, a Coventry Material Adverse Effect or a Newco Material Adverse
Effect; and Principal shall have received a certificate of the Chief
Executive Officer of Coventry, dated the Closing Date, certifying to such
effect.
(b) Coventry shall have obtained the Warburg Consent and a consent
from each of the Persons from whom the failure to obtain a consent would
cause a Coventry Material Adverse Effect.
(c) Coventry and each of the Coventry Subsidiaries shall have all
Coventry Approvals necessary to the ownership of their property and to the
operation of their respective businesses, which if violated or not obtained
would not have a Coventry Material Adverse Effect.
(d) From the date of this Agreement through the Effective Time, there
shall not have occurred any Coventry Material Adverse Effect.
(e) Principal shall have received an opinion of LeBouef, Lamb, Greene
& MacRae, L.L.P., in form and substance satisfactory to Principal, dated as
of the Effective Time, which opinion may be based upon appropriate
representations of Principal, Newco and Coventry which are in form and
substance reasonably satisfactory to such counsel, to the effect that,
except with respect to the Newco Warrant, the Capital Contribution will be
treated as a non-taxable exchange described in Section 351 of the Code and
that, except with respect to the Newco Warrant, Newco, Principal and the
Principal Subsidiaries will recognize no gain or loss for Federal income
Tax purposes as a result of the consummation of the Capital Contribution.
(f) Principal shall have received a copy of the opinion referred to in
Section 7.3(g) of this Agreement, which opinion shall be in form and
substance reasonably satisfactory to Principal.
(g) Coventry shall have consummated the refinancing of its current
credit facility with such lenders and upon such terms and conditions as
shall be reasonably satisfactory to Principal, Holding and Mutual.
(h) Coventry shall not have received any notification, written or
oral, from NASDAQ or the SEC to the effect that Coventry is in violation of
any NASDAQ listing requirement.
(i) Coventry shall have caused Coventry Health to have entered into
the Coinsurance Agreement.
(j) Coventry and Newco shall have caused Coventry Merger Corporation
to have, and Coventry shall have, executed and filed the Agreement and Plan
of Merger. Coventry and Newco shall have executed and filed the Articles of
Merger.
7.3 CONDITIONS TO OBLIGATION OF COVENTRY AND NEWCO. The obligations of Coventry
and Newco to effect the Merger and of Newco to enter into the Ancillary
Agreements shall be subject to the fulfillment, or the written waiver signed by
a duly authorized officer of Coventry, at or prior to the Closing Date of the
following conditions:
(a) Mutual shall have performed its agreements and covenants
contained in this Agreement required to be performed on or prior to the
Closing Date and the representations and warranties of Mutual contained in
this Agreement and in any document delivered in connection herewith shall
be true and correct both when made and at and as of the Closing Date, as if
made at and as of such time (except to the extent expressly made as of an
earlier date, in which case as of such date), except where the non-
performance of such agreements or covenants or the failure of such
representations and warranties to be so true and correct (without giving
effect to any limitation as to materiality set forth therein or applicable
thereto) does not have, and is not likely to have, individually or in the
aggregate, a Mutual Material Adverse Effect; and Coventry shall have
received a certificate of a duly authorized officer of Mutual, dated the
Closing Date, certifying to such effect.
(b) Principal shall have performed its agreements and covenants
contained in this Agreement required to be performed on or prior to the
Closing Date and the representations and warranties of Principal contained
in this Agreement and in any document delivered in connection herewith
shall be true
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and correct both when made and at and as of the Closing Date, as if made at
and as of such time (except to the extent expressly made as of an earlier
date, in which case as of such date), except where the non-performance of
such agreements or covenants or the failure of such representations and
warranties to be so true and correct (without giving effect to any
limitation as to materiality set forth herein or applicable thereto) does
not have, and is not likely to have, individually or in the aggregate, a
Principal Material Adverse Effect, and Coventry shall have received a
certificate of the Chief Executive Officer of Principal, dated the Closing
Date, certifying to such effect.
(c) Coventry shall have received from Ernst & Young, LLP "comfort"
letters, in form and substance satisfactory to it, with respect to the
procedures undertaken by them through a date which is not earlier than five
business days prior to the dates specified in (i) and (ii) below relating
to the financial statements of Principal and the Principal Subsidiaries
contained in the Form S-4 and the other matters customarily included in
comfort letters relating to transactions similar to the Merger and Capital
Contribution, (i) dated immediately prior to the date of mailing of the
Proxy Statement/Prospectus, and (ii) dated immediately prior to the
Effective Time, a bring down of the letter provided in subsection (i).
(d) From the date of this Agreement through the Effective Time, there
shall not have occurred any Principal Material Adverse Effect or Mutual
Material Adverse Effect.
(e) Principal and each of the Principal Subsidiaries have all
Principal Approvals necessary to the ownership of their property and to the
operation of their respective businesses, which if violated or not obtained
would not have a Principal Material Adverse Effect.
(f) Principal and Mutual shall have obtained consent from each Person
from whom the failure to obtain a consent to the transactions contemplated
by this Agreement would have a Principal Material Adverse Effect.
(g) Coventry shall have received an opinion of Bass, Berry & Sims,
P.C., in form and substance satisfactory to Coventry, dated as of the
Effective Time, which opinion may be based upon appropriate representations
of Newco and Coventry which are in form and substance reasonably
satisfactory to such counsel, to the effect that the Merger will be treated
as a reorganization described in Section 368(a)(2)(E) of the Code and that
Newco, Coventry and the Coventry shareholders exchanging Coventry Common
Stock will recognize no gain or loss for Federal income Tax purposes as a
result of the consummation of the Merger.
(h) Coventry shall have received a copy of the opinion referred to in
Section 7.2(e) of this Agreement, which opinion shall be in form and
substance reasonably satisfactory to Coventry.
(i) Mutual and each Principal Subsidiary which is a party to a PPO
network access agreement with Mutual shall amend such PPO network access
agreements, to be effective prior to the Closing Date, to provide for
payment by Mutual of reasonable percentage of savings-based fees and
consistent with those charged by competitive networks. Such amendments
shall be subject to Coventry's prior consent, which shall not be
unreasonably withheld.
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TERMINATION
8.1 TERMINATION BY MUTUAL CONSENT. This Agreement may be terminated and the
Merger and Capital Contribution may be abandoned at any time prior to the
Effective Time, before or after the approval of this Agreement by the
shareholders of Principal and Coventry, by the mutual consent of Coventry,
Mutual and Principal.
8.2 TERMINATION BY EITHER COVENTRY OR PRINCIPAL. This Agreement may be
terminated and the Merger and Capital Contribution may be abandoned by action of
the Board of Directors of either Coventry, Mutual or Principal if (a) the Merger
and Capital Contribution shall not have been consummated by June 30, 1998, or
(b) the approval of Coventry's shareholders required by Section 7.1(a) hereof
shall not have been obtained at a meeting duly convened therefor or at any
adjournment thereof, or (c) a United States federal or state court of competent
jurisdiction or United States federal or state governmental, regulatory or
administrative agency or commission shall have issued an order, decree or ruling
or taken any other action permanently restraining, enjoining or otherwise
prohibiting the transactions contemplated by this Agreement and such order,
decree, ruling or other action shall have become final and non-appealable;
provided, that the party seeking to terminate this Agreement pursuant to this
clause (c) shall have used all commercially reasonable efforts to remove such
injunction, order or decree.
8.3 TERMINATION BY PRINCIPAL. This Agreement may be terminated and the Capital
Contribution may be abandoned at any time prior to the Effective Time, before or
after the adoption and approval by the shareholders of Coventry referred to in
Section 6.1(a), by action of the Board of Directors of Principal or Mutual, if
(a) there has been a breach by Coventry or Newco of any representation or
warranty contained in this Agreement or in any document delivered in connection
herewith (without giving effect to any limitation as to materiality set forth
therein or applicable thereto) either when such representation or warranty was
made or at and as of the Closing Date, as if made at and as of such time (except
to the extent expressly made as of any earlier date, in which case as of such
date), except where the failure of such representations and warranties to be so
true and correct (without giving effect to any limitation as to materiality set
forth therein or applicable thereto) does not have, and is not likely to have,
individually or in the aggregate, a Coventry Material Adverse Effect or a Newco
Material Adverse Effect or (b) there has been a material breach of any of the
covenants or agreements set forth in this Agreement on the part of Coventry,
which breach is not curable or, if curable, is not cured within 30 days after
written notice of such breach, specifying in reasonable detail the nature of the
breach, is given by Principal or Mutual to Coventry.
8.4 TERMINATION BY COVENTRY. This Agreement may be terminated and the Merger may
be abandoned at any time prior to the Effective Time, before or after the
approval by the shareholders of Coventry referred to in Section 6.1(a) hereof,
by action of the Board of Directors of Coventry, if (a) there has been a breach
by Principal or Mutual of any representation or warranty contained in this
Agreement or in any document delivered in connection herewith (without giving
effect to any limitation as to materiality set forth therein or applicable
thereto) either when such representation or warranty was made or at and as of
the Closing Date, as if made at and as of such time (except to the extent
expressly made as of any earlier date, in which case as of such date), except
where the failure of such representations and warranties to be so true and
correct (without giving effect to any limitation as to materiality set forth
therein or applicable thereto) does not have, and is not likely to have,
individually or in the aggregate, a Principal Material Adverse Effect, a Mutual
Material Adverse Effect or a Newco Material Adverse Effect or (b) there has been
a material breach of any of the covenants or agreements set forth in this
Agreement on the part of Principal or Mutual, which breach is not curable or, if
curable, is not cured within 30 days after written notice of such breach,
specifying in reasonable detail the nature of the breach, is given by Coventry
to Principal.
8.5 AUTOMATIC TERMINATION. This Agreement shall terminate without further action
by the parties if, prior to the Effective Time, the Board of Directors of
Coventry shall have exercised its rights under Section 6.1 to approve an
unsolicited Acquisition Proposal or to withdraw its recommendation to Coventry's
shareholders in support of transactions contemplated by this Agreement as a
result of an unsolicited Acquisition Proposal.
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8.6 EFFECT OF TERMINATION AND ABANDONMENT.
(a) Upon termination of this Agreement pursuant to this Article 8, all
obligations of the parties hereto shall terminate, except the obligations
of the parties pursuant to this Section 8.6 and except for the provisions
of Sections 6.10, 6.11, and 6.13. Moreover, in the event of termination of
this Agreement by either party pursuant to Section 8.3(a) or (b) hereof or
Section 8.4(a) or (b) hereof as a result of a willful breach of any
representation, warranty or covenant by the other party, nothing herein
shall prejudice the ability of the non-breaching party from seeking damages
from any other party for any breach of this Agreement, including without
limitation, attorneys' fees and the right to pursue any remedy at law or in
equity.
(b) In the event this Agreement is terminated pursuant to Section 8.5
hereof by Coventry's Board of Directors as a result of the withdrawal of
its recommendation to Coventry's shareholders in support of the
transactions contemplated by this Agreement due to, or the approval by
Coventry's Board of Directors of, an unsolicited Acquisition Proposal, then
the Potential Acquiror shall promptly pay (or if the Potential Acquiror
fails to pay Coventry shall promptly pay) to Mutual $20,000,000, which
amount shall be due if regardless of whether or not the transaction
contemplated by such unsolicited Acquisition Proposal shall be consummated.
8.7 EXTENSION; WAIVER. At any time prior to the Effective Time, any party
hereto, by action authorized by its Board of Directors, may, to the extent
legally allowed, (a) extend the time for the performance of any of the
obligations or other acts of the other parties hereto, (b) waive any
inaccuracies in the representations and warranties made to such party contained
herein or in any document delivered pursuant hereto and (c) waive compliance
with any of the agreements or conditions for the benefit of such party contained
herein. Any agreement on the part of a party hereto to any such extension or
waiver shall be valid only if set forth in an instrument in writing signed on
behalf of such party.
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GENERAL PROVISIONS
9.1 NONSURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS. All
representations, warranties and agreements in this Agreement or in any
instrument delivered pursuant to this Agreement shall be deemed to the extent
expressly provided herein to be conditions to the Merger and Capital
Contribution and shall not survive the Merger and Capital Contribution;
provided, however, that the agreements contained
in Sections 1.3, 1.8, 6.10, 6.11, 6.12, 6.13, 6.14, 6.15, 6.16, 6.17, 6.19,
6.20, 8.5, 8.6, and this Article 9 and the agreements delivered pursuant to this
Agreement shall survive the Merger and Capital Contribution.
9.2 INDEMNIFICATION. From and after the Effective Time, Newco agrees to
indemnify and hold harmless Mutual and Principal and each of their directors,
officers, employees, agents, representatives and affiliates from the Assumed
Liabilities and any and all losses, costs, claims, demands, expenses, fines and
penalties (including, without limitation, attorneys fees), arising out of or
caused by the Assumed Liabilities (whether or not arising prior to or following
the Effective Time.) From and after the Effective Time, Mutual and Principal
agree to indemnify and hold harmless Newco and each of its directors, officers,
employees, agents, representatives and affiliates from the Excluded Liabilities
and any and all losses, costs, claims, demands, expenses, fines and penalties
(including, without limitation, attorneys fees), arising out of or caused by the
Excluded Liabilities (whether or not arising prior to or following the Effective
Time.)
9.3 NOTICES. Any notice required to be given hereunder shall be sufficient if in
writing, and sent by facsimile and by courier service (with proof of service),
hand delivery or certified or registered mail (return receipt requested and
first-class postage prepaid), addressed as follows:
<TABLE>
<S> <C>
If to Mutual or Holding: If to Coventry or Newco:
Mark Movic Dale Wolf
Principal Mutual Life Insurance Company Coventry Health Care, Inc.
711 High Street 53 Century Boulevard
Des Moines, Iowa 50392 Nashville, Tennessee 37214
Telecopy Number: (515) 247-0130 Telecopy Number:
with a copy to: with a copy to:
Thomas M. Farah, Esq. Bob F. Thompson, Esq.
Epstein, Becker & Green, P.C. Bass, Berry & Sims PLC
1227 25th Street, N.W., Suite 700 2700 First American Center
Washington, D.C. 20037 Nashville, Tennessee 37238
Telecopy Number: (202) 296-2882 Telecopy Number: (615) 742-6298
and
Karen E. Shaff, Esq.
Principal Mutual Life Insurance Company
711 High Street
Des Moines, Iowa 50392
Telecopy Number: (515) 248-3011
If to Principal:
Kenneth J. Linde
Principal Health Care, Inc.
6705 Rockledge Drive
Suite 100
Bethesda, Maryland 20817
Telecopy Number:
with a copy to:
Thomas M. Farah, Esq.
Epstein, Becker & Green, P.C.
1227 25th Street, N.W., Suite 700
Washington, D.C. 20037
Telecopy Number: (202) 296-2882
</TABLE>
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<TABLE>
<S> <C>
and
Robert J. Mrizek, Esq.
Principal Health Care, Inc.
6705 Rockledge Drive
Suite 100
Bethesda, MD 20817
Telecopy Number: (301) 493-0743
</TABLE>
or to such other address as any party shall specify by written notice so given,
and such notice shall be deemed to have been delivered as of the date so
telecommunicated, personally delivered or mailed.
9.4 ASSIGNMENT, BINDING EFFECT; BENEFIT. Neither this Agreement nor any of the
rights, interests or obligations hereunder shall be assigned by any of the
parties hereto (whether by operation of law or otherwise) without the prior
written consent of the other parties. Subject to the preceding sentence, this
Agreement shall be binding upon and shall inure to the benefit of the parties
hereto and their respective successors and assigns.
9.5 ENTIRE AGREEMENT. This Agreement, the Exhibits, the Principal Disclosure
Letter, the Coventry Disclosure Letter and any documents delivered by the
parties in connection herewith constitute the entire agreement among the parties
with respect to the subject matter hereof and supersede all prior agreements and
understandings among the parties with respect thereto. No addition to or
modification of any provision of this Agreement shall be binding upon any party
hereto unless made in writing and signed by all parties hereto.
9.6 AMENDMENT. This Agreement may be amended by the parties hereto, by action
authorized by their respective Boards of Directors, at any time before or after
approval of matters presented in connection with the Merger by the shareholders
of Principal and Coventry, but after any such shareholder approval, no amendment
shall be made which by law requires the further approval of shareholders without
obtaining such further approval. This Agreement may not be amended except by an
instrument in writing signed on behalf of each of the parties hereto.
9.7 GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of Delaware without regard to its rules of
conflict of laws.
9.8 HEADINGS. Headings of the Articles and Sections of this Agreement are for
the convenience of the parties only, and shall be given no substantive or
interpretive effect whatsoever.
9.9 INTERPRETATION. In this Agreement, unless the context otherwise requires,
words describing the singular number shall include the plural and vice versa,
and words denoting any gender shall include all genders and words denoting
natural persons shall include corporations and partnerships and vice versa.
9.10 WAIVERS. Except as provided in this Agreement, no action taken pursuant to
this Agreement, including, without limitation, any investigation by or on behalf
of any party, shall be deemed to constitute a waiver by the party taking such
action of compliance with any representations, warranties, covenants or
agreements contained in this Agreement. The waiver by any party hereto of a
breach of any provision hereunder shall not operate or be construed as a waiver
of any prior or subsequent breach of the same or any other provision hereunder.
9.11 INCORPORATION OF EXHIBITS. The Principal Disclosure Letter, the Coventry
Disclosure Letter and the Exhibits attached hereto and referred to herein are
hereby incorporated herein and made a part hereof for all purposes as if fully
set forth herein.
9.12 SEVERABILITY. Any term or provision of this Agreement which is invalid or
unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective
to the extent of such invalidity or unenforceability without rendering invalid
or unenforceable the remaining terms and provisions of this Agreement or
affecting the validity or enforceability of any of the terms or provisions of
this Agreement in any other jurisdiction. If any provision of this Agreement is
so broad as to be unenforceable, the provision shall be interpreted to be only
so broad as is enforceable.
9.13 ENFORCEMENT OF AGREEMENT. The parties hereto agree that irreparable damage
would occur in the event that any of the provisions of this Agreement was not
performed in accordance with its specific terms or was
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<PAGE> 240
otherwise breached. It is accordingly agreed that the parties shall be entitled
to an injunction or injunctions to prevent breaches of this Agreement and to
enforce specifically the terms and provisions hereof, this being in addition to
any other remedy to which they are entitled at law or in equity.
9.14 TERMS DEFINED. As used in this Agreement, the following terms have the
respective meanings set forth below or set forth in the Section hereof following
such term:
"401(k) Plan" shall have the meaning set forth in Section 6.17 (a).
"401(k) Plan SERP" shall have the meaning set forth in Section 6.17
(a).
"Acquiring Person" shall have the meaning set forth in Section 3.25.
"Acquisition Proposal" shall have the meaning set forth in Section
6.1.
"Agreement" shall have the meaning set forth in the Preamble.
"Ancillary Agreements" shall have the meaning set forth in Section
6.18.
"Applicable Environmental Law" shall have the meaning set forth in
Section 3.18(b).
"Assignment and Assumption Agreement" shall have the meaning set forth
in Section 1.6(a).
"Assumed Liabilities" shall have the meaning set forth in Section
1.6(b).
"Capital Contribution" shall have the meaning set forth in Section
1.6(a).
"Certificates" shall have the meaning set forth in Section 1.2(c)(iv).
"Closing" shall have the meaning set forth in Section 2.1.
"Closing Agreement" shall have the meaning set forth in Section
6.20(g)(iii).
"Closing Balance Sheet" shall have the meaning set forth in Section
6.19(b).
"Closing Date" shall have the meaning set forth in Section 2.1.
"Code" shall have the meaning set forth in the section entitled
RECITALS.
"Coinsurance Agreement" shall have the meaning set forth in Section
1.7.
"Common Certificate" shall have the meaning set forth in Section
1.2(c)(ii).
"Convertible Notes" shall have the meaning set forth in Section
1.2(c)(v).
"Coventry" shall have the meaning set forth in the Preamble.
"Coventry Agreements" shall have the meaning set forth in Section
3.5(d).
"Coventry Approvals" shall have the meaning set forth in Section
3.5(b).
"Coventry Commitment" shall have the meaning set forth in Section 3.8.
"Coventry Common Stock" shall have the meaning set forth in Section
1.2(c)(ii).
"Coventry DOI Reports" shall have the meaning set forth in Section
3.5(f).
"Coventry Disclosure Letter" shall have the meaning set forth in the
section entitled
REPRESENTATIONS AND WARRANTIES OF COVENTRY.
"Coventry ERISA Affiliate" shall have the meaning set forth in Section
3.15(h).
"Coventry Fairness Opinion" shall have the meaning set forth in
Section 6.8.
"Coventry Government Contracts" shall have the meaning set forth in
Section 3.5(e).
"Coventry Health" shall have the meaning set forth in Section 1.6(a).
"Coventry Intellectual Property" shall have the meaning set forth in
Section 3.16.
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<PAGE> 241
"Coventry Interim Financial Statements" shall have the meaning set
forth in Section 3.9(b).
"Coventry Key Agreements and Instruments" shall have the meaning set
forth in Section 3.7.
"Coventry Material Adverse Effect" shall have the meaning set forth in
Section 3.27.
"Coventry Option" shall have the meaning set forth in Section
1.2(c)(vi).
"Coventry Organizational Documents" shall have the meaning set forth
in Section 3.1(b).
"Coventry Pension Plans" shall have the meaning set forth in Section
3.15(a).
"Coventry Plans" shall have the meaning set forth in Section 3.15(a).
"Coventry Preferred Stock" shall have the meaning set forth in Section
1.2(c)(iv).
"Coventry Properties" shall have the meaning set forth in Section
3.18(a).
"Coventry Regulatory Statements" shall have the meaning set forth in
Section 3.9(b).
"Coventry Reports of Examinations" shall have the meaning set forth in
Section 3.5(h).
"Coventry Rights" shall have the meaning set forth in Section
1.2(c)(iii).
"Coventry Rights Plan" shall have the meaning set forth in Section
1.2(c)(iii).
"Coventry SEC Reports" shall mean, collectively, (i) Annual Reports on
Form 10-K for the fiscal years ended December 31, 1995, December 31, 1996
and December 31, 1997, as filed with the Commission, (ii) Quarterly Reports
on Form 10-Q for the quarters ended March 31, 1997 and June 30, 1997, as
filed with the Commission, (iii) proxy statements related to all meetings
of its shareholders (whether annual or special) held since January 1, 1996,
and (iv) all other reports filed with or registration statements declared
effective by the Commission since January 1, 1996, except registration
statements on Form S-8 relating to employee benefit plans, which are all
the documents (other than preliminary material) that Coventry was required
to file with the Commission since that date.
"Coventry Stock Option Plans" shall have the meaning set forth in
Section 1.2(c)(vi).
"Coventry Subsidiary" shall have the meaning set forth in Section
3.1(a).
"Coventry Subsidiary Organizational Documents" shall have the meaning
set forth in Section 3.1(b).
"Coventry Warrant" shall have the meaning set forth in Section
1.2(c)(vi).
"Defined Benefit Plan" shall have the meaning set forth in Section
6.17(a).
"Defined Benefit Plan SERP" shall have the meaning set forth in
Section 6.17(a).
"Effective Time" shall have the meaning set forth in Section 2.2.
"Exchange Agent" shall have the meaning set forth in Section 1.3(a).
"Exchange Fund" shall have the meaning set forth in Section 1.3(a).
"Excluded Assets" shall have the meaning set forth in Section 1.6(a).
"Excluded Liabilities" shall have the meaning set forth in Section
1.6(b).
"First Boston" shall have the meaning set forth in Section 6.8.
"Form S-4" shall have the meaning set forth in Section 6.5.
"Franklin" shall have the meaning set forth in Section 1.2(c)(v).
"GAAP" shall have the meaning set forth in Section 3.9(a).
"Governmental Entity" shall have the meaning set forth in Section 3.4.
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"HMOs" shall have the meaning set forth in Section 3.5(a).
"Hazardous Substances" shall have the meaning set forth in Section
3.18(b).
"Holding" shall have the meaning set forth in Preamble.
"HSR Act" shall have the meaning set forth in Section 6.9.
"IBNR" shall have the meaning set forth in Section 3.9(d).
"IRS" shall mean the Internal Revenue Service.
"License Agreement" shall have the meaning set forth in Section
6.18(g).
"Marketing Agreement" shall have the meaning set forth in Section
6.18(h).
"Maryland Newco" shall have the meaning set forth in the Preamble.
"Merger" shall have the meaning set forth in Section 1.2(b).
"Merger Ratio" shall have the meaning set forth in Section 1.4.
"Merger Sub" shall have the meaning set forth in the RECITALS.
"Mutual" shall have the meaning set forth in the Preamble.
"Mutual Approvals" shall have the meaning set forth in Section 5.5(b).
"Mutual Disclosure Letter" shall have the meaning set forth in Section
entitled REPRESENTATIONS AND WARRANTIES OF MUTUAL.
"Mutual DOI Reports" shall have the meaning set forth in Section
5.5(d).
"Mutual Government Contracts" shall have the meaning set forth in
Section 5.5(c).
"Mutual Indemnity Agreements" shall have the meaning set forth in
Section 1.7.
"Mutual Indemnity Business" shall have the meaning set forth in
Section 1.7.
"Mutual Material Adverse Effect" shall have the meaning set forth in
Section 5.12.
"NASDAQ" shall mean National Association of Securities Dealers
Automated Quotation System.
"Nasdaq" shall have the meaning set forth in Section 1.2(c)(vi).
"Newco" shall have the meaning set forth in the Preamble.
"Newco Common Stock" shall have the meaning set forth in Section
1.2(c)(i).
"Newco Material Adverse Effect" shall have the meaning set forth in
Section 7.1(f).
"Newco Preferred Stock" shall have the meaning set forth in Section
1.2(c)(iv).
"Newco Rights" shall have the meaning set forth in Section 1.2(c)(ii).
"Newco Rights Agreement" shall have the meaning set forth in Section
1.2(c)(ii).
"Newco Warrant" shall have the meaning set forth in Section 1.7.
"Option Securities" shall have the meaning set forth in Section 1.7.
"PBGC" shall have the meaning set forth in Section 3.15(d).
"PPOs" shall have the meaning set forth in Section 3.5(a).
"Person" shall mean individual, corporation, partnership, limited
liability company, joint venture, association, trust, unincorporated
organization or other entity.
"Plan" shall have the meaning set forth in Section 1.2(a).
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"Post-Acquisition Date Tax Period" shall have the meaning set forth in
Section 6.20(g)(i).
"Potential Acquiror" shall have the meaning set forth in Section 6.1.
"Pre-Acquisition Date Tax Period" shall have the meaning set forth in
Section 6.20(g)(ii).
"Preferred Certificate" shall have the meaning set forth in Section
1.2(c)(iv).
"Principal" shall have the meaning set forth in the Preamble.
"Principal Agreements" shall have the meaning set forth in Section
4.5(d).
"Principal Approvals" shall have the meaning set forth in Section
4.5(b).
"Principal Assets" shall have the meaning set forth in Section 1.6(a).
"Principal Comfort Letter" shall have the meaning set forth in Section
6.8.
"Principal Commitment" shall have the meaning set forth in Section
4.8.
"Principal Directors" shall have the meaning set forth in Section
6.14(a).
"Principal Disclosure Letter" shall have the meaning set forth in the
section entitled REPRESENTATIONS AND WARRANTIES OF PRINCIPAL.
"Principal DOI Reports" shall have the meaning set forth in Section
4.5(f).
"Principal ERISA Affiliate" shall have the meaning set forth in
Section 4.15(h).
"Principal Financial Statement" shall have the meaning set forth in
Section 4.9(a).
"Principal Government Contracts" shall have the meaning set forth in
Section 4.5(e).
"Principal Intellectual Property" shall have the meaning set forth in
Section 4.16.
"Principal Interim Financial Statements" shall have the meaning set
forth in Section 4.9(b).
"Principal Key Agreements and Instruments" shall have the meaning set
forth in Section 4.7.
"Principal Material Adverse Effect" shall have the meaning set forth
in Section 4.25.
"Principal Organizational Documents" shall have the meaning set forth
in Section 4.1(b).
"Principal Pension Plan" shall have the meaning set forth in Section
4.15(a).
"Principal Plans" shall have the meaning set forth in Section 4.15(a).
"Principal Properties" shall have the meaning set forth in Section
4.18(a).
"Principal Regulatory Statements" shall have the meaning set forth in
Section 4.9(b).
"Principal Reports of Examinations" shall have the meaning set forth
in Section 4.5(h).
"Principal Subsidiaries" shall have the meaning set forth in Section
1.6(a).
"Proxy Statement/Prospectus" shall have the meaning set forth in
Section 6.5.
"Renewal Rights Agreement" shall have the meaning set forth in Section
6.18(b).
"Rights Amendment" shall have the meaning set forth in Section
6.18(a).
"SEC" shall mean the U.S. Securities and Exchange Commission.
"Securities Act" shall have the meaning set forth in Section
1.2(c)(vi).
"Service Agreement" shall have the meaning set forth in Section
6.18(d).
"Shareholders' Agreement" shall have the meaning set forth in Section
6.18(e).
"Straddle Period" shall have the meaning set forth in Section 6.20(c).
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"Subsidiaries," when used with respect to any party means any
corporation, partnership, joint venture or other legal entity or
organization, whether incorporated or unincorporated, of which such party
directly or indirectly owns or controls at least a majority of the
securities or other interests having by their terms ordinary voting power
to elect a majority of the board of directors or others performing similar
functions with respect to such corporation or other organization.
"Superior Proposal" shall have the meaning set forth in 6.1.
"Tangible Net Value" shall have the meaning set forth in 6.19(a).
"Target Value" shall have the meaning set forth in 6.19(c).
"Tax Return" shall have the meaning set forth in Section 6.20(g)(vi).
"Tax Ruling" shall have the meaning set forth in Section 6.20(g)(v).
"Tax Benefit Agreement" shall have the meaning set forth in Section
6.18(f).
"Taxes" shall have the meaning set forth in Section 6.20(g)(iv).
"TBCA" shall have the meaning set forth in Section 1.5.
"Transition Agreement" shall have the meaning set forth in Section
6.18(c).
"Triggering Event" shall have the meaning set forth in Section 3.25.
"Warburg" shall have the meaning set forth in Section 1.2(c)(v).
"Warburg Agreement" shall have the meaning set forth in Section
1.2(c)(v).
"Welfare Plan" shall have the meaning set forth in Section 6.17(a).
9.15 COUNTERPARTS. This Agreement may be executed by the parties hereto in
separate counterparts, each of which when so executed and delivered shall be an
original, but all such counterparts shall together constitute one and the same
instrument. Each counterpart may consist of a number of copies hereof each
signed by less than all, but together signed by all of the parties hereto.
9.16 DISCLOSURE LETTERS. Each party has received, by separate delivery, and
accepted disclosure letters from the other parties regarding the representations
and warranties contained in this Agreement.
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IN WITNESS WHEREOF, the parties have executed this Agreement and caused the
same to be duly delivered on their behalf on December , 1997.
<TABLE>
<S> <C>
ATTEST: COVENTRY CORPORATION
By: /s/ SHIRLEY R. SMITH By: /s/ ALLEN F. WISE
------------------------------------------------- --------------------------------------------
Name: Shirley R. Smith Name: Allen F. Wise
Title: Secretary Title: President and Chief Executive Officer
ATTEST: COVENTRY HEALTH CARE, INC.
(a Delaware corporation)
By: /s/ SHIRLEY R. SMITH
------------------------------------------------- By: /s/ DALE B. WOLF
Name: Shirley R. Smith --------------------------------------------
Title: Secretary Name: Dale B. Wolf
Title: President
ATTEST: COVENTRY HEALTH CARE, INC.
(a Maryland corporation)
By: /s/ SHIRLEY R. SMITH
------------------------------------------------- By: /s/ DALE B. WOLF
Name: Shirley R. Smith --------------------------------------------
Title: Secretary Name: Dale B. Wolf
Title: President
PRINCIPAL HEALTH CARE, INC.
By: /s/ KENNETH J. LINDE
--------------------------------------------
Name: Kenneth J. Linde
Title: President and Chief Executive Officer
PRINCIPAL HOLDING COMPANY
By: /s/ DAVID J. DRURY
--------------------------------------------
Name: David J. Drury
Title: Chairman and Chief Executive Officer
PRINCIPAL MUTUAL LIFE INSURANCE COMPANY
By: /s/ DAVID J. DRURY
--------------------------------------------
Name: David J. Drury
Title: Chairman and Chief Executive Officer
</TABLE>
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AGREEMENT AND PLAN OF MERGER
THIS AGREEMENT AND PLAN OF MERGER (this "Plan"), is executed as of the
day of , 1998, by and among Coventry Corporation, a Tennessee
corporation ("Coventry"), Coventry Health Care, Inc., a Delaware corporation
("Newco") and Coventry Merger Corporation, a Tennessee corporation wholly owned
by Newco ("Merger Sub").
WHEREAS, the Board of Directors of each of Coventry, Newco and Merger Sub
have determined that the merger (the "Merger") of Merger Sub with and into
Coventry is in the best interest of its respective corporation;
WHEREAS, the parties hereto desire that Merger Sub be merged with and into
Coventry and all of the issued and outstanding shares of the capital stock of
Coventry be automatically converted into shares of capital stock of Newco;
WHEREAS, upon the effectiveness of the Merger, all of the issued and
outstanding shares of Newco will be canceled; all of the issued and outstanding
shares of Merger Sub that are currently held by Newco will be converted into
1,000 shares of Coventry; and Coventry will be a wholly-owned subsidiary of
Newco; and
WHEREAS, for federal income tax purposes, it is intended that the Merger
provided for herein shall qualify as a transfer within the meaning of Section
351(a) of the Internal Revenue Code of 1986, as amended (the "Code") and a
reorganization within the meaning of Section 368(a)(2)(E) of the Code;
NOW, THEREFORE, in consideration of the foregoing, and of the
representations, warranties, covenants and agreements contained herein, the
parties hereto hereby agree as follows:
ARTICLE 1
THE PLAN OF MERGER
1.1 THE MERGER.
(a) Upon the terms and subject to the conditions of this Plan and that
certain Capital Contribution and Merger Agreement (effective as of November
3, 1997, and amending and restating the Capital Contribution and Share
Exchange Agreement dated November 3, 1997) executed on December , 1997
(the "Merger Agreement"), by and among Coventry, Newco, Coventry Health
Care, Inc. (a Maryland corporation), Principal Health Care, Inc.
("Principal,") an Iowa corporation, Principal Holding Company, an Iowa
corporation, and Principal Mutual Life Insurance Company, an Iowa mutual
insurance company, Merger Sub shall merge at the Effective Time (as defined
below in Section 2.2) with and into Coventry and the separate existence of
Merger Sub shall cease. Coventry shall be the surviving corporation (the
"Surviving Corporation") in the Merger and its separate corporate
existence, with all its purposes, objects, rights, privileges, powers and
franchises, shall continue unaffected and unimpaired by the Merger.
(b) At the Effective Time:
(i) each share of Newco's Common Stock, par value $0.01 per share
(the "Newco Common Stock"), issued and outstanding immediately prior to
the Effective Time shall, by virtue of the Merger and without any action
on the part of the holder thereof, be canceled and retired and cease to
exist;
(ii) each share of Coventry's Common Stock, par value $0.01 per
share ("Coventry Common Stock"), issued immediately prior to the
Effective Time shall, by virtue of the Merger and without any action on
the part of the holder thereof, be converted into the right to receive
(A) one share of Newco Common Stock and (B) one right (collectively, the
"Newco Rights") issuable under that certain Rights Agreement, dated as
of the Closing Date between Newco and ChaseMellon Shareholder Services,
LLC (the "Newco Rights Agreement"); and each holder of a certificate (a
"Common Certificate") representing shares of Coventry Common Stock shall
thereafter cease to
<PAGE> 247
have any rights with respect to such shares, except the right to receive
the shares of Newco Common Stock and the Newco Rights upon the surrender
of such Common Certificate;
(iii) all of the rights (collectively, the "Coventry Rights")
issued under that certain Rights Agreement, dated February 7, 1996,
between Coventry and ChaseMellon Shareholder Services, LLC, as amended
by that First Amendment to Rights Agreement, dated May 7, 1997 (as
amended, the "Coventry Rights Plan"), issued immediately prior to the
Effective Time shall be canceled and retired and cease to exist;
(iv) each share of Coventry's Series A Convertible Preferred Stock,
par value $0.01 per share ("Coventry Preferred Stock"), issued and
outstanding immediately prior to the Effective Time shall, by virtue of
the Merger and without any action on the part of the holder thereof, be
converted into the right to receive one share of Newco's Series A
Convertible Preferred Stock, par value $0.01 per share ("Newco Preferred
Stock"); all shares of Coventry Preferred Stock shall be canceled and
retired and shall cease to exist; and each holder of a certificate (a
"Preferred Certificate") (the Common Certificates and Preferred
Certificates, hereinafter collectively being referred to as the
"Certificates") representing any shares of Coventry Preferred Stock
shall thereafter cease to have any rights with respect to such shares,
except the right to receive the Newco Preferred Stock upon the surrender
of such Preferred Certificate;
(v) each Convertible Exchangeable Subordinated Note (the
"Convertible Notes") issued under that certain Amended and Restated
Securities Purchase Agreement, dated May 7, 1997 (the "Warburg
Agreement "), by and among Coventry, Warburg, Pincus Ventures L.P.
("Warburg") and Franklin Capital Associates III L.P. ("Franklin"), as
amended by that certain Warburg Consent, dated as of December , 1997
(the "Warburg Consent "), and then outstanding shall, by virtue of the
Merger and without any action on the part of the holder thereof, be
converted into the right to receive a Convertible Exchangeable
Subordinated Note in accordance with the terms of the Warburg Consent;
(vi) each of the options (individually, a "Coventry Option" and
collectively, the "Coventry Options") then outstanding under Coventry's
stock option plans listed on Schedule 1.2 hereto (collectively, the
"Coventry Stock Option Plans") shall be converted, without any action on
the part of the holder thereof, into the right to purchase that number
of shares of Newco equal to the number of shares of Coventry Common
Stock issuable upon exercise as set forth in such Coventry Option; such
Coventry Options shall, by virtue of the Merger and without any further
action on the part of Coventry or the holder of any such Coventry
Option, be assumed by Newco; each of the warrants listed on Schedule 1.2
hereto (individually, a "Coventry Warrant " and collectively, the
"Coventry Warrants") shall be converted, without any action on the part
of the holder thereof, into the right to purchase that number of shares
of Newco equal to the number of shares of Coventry Common Stock issuable
upon exercise as set forth in such Coventry Warrant; such Coventry
Warrants shall, by virtue of the Merger and without any further action
on the part of Coventry or the holder of any such Coventry Warrant, be
assumed by Newco; each Coventry Option or Coventry Warrant assumed by
Newco shall be exercisable upon the same terms and conditions as under
the applicable Coventry Stock Option Plan and the applicable Coventry
Option issued thereunder or under the Coventry Warrant except that (i)
each such Coventry Option shall be exercisable for that whole number of
shares of Newco Common Stock into which the number of shares of Coventry
Common Stock subject to such Coventry Option or Coventry Warrant
immediately prior to the Effective Time would be converted under this
Section 1.2, and (ii) the option or warrant price per share of Newco
Common Stock shall be an amount equal to the option or warrant price per
share of Coventry Common Stock subject to such Coventry Option or
Coventry Warrant in effect immediately prior to the Effective Time; and
Newco shall reserve for issuance the number of shares of Newco Common
Stock that will become issuable upon the exercise of such Coventry
Options and Coventry Warrants, shall file as soon as possible after the
Effective Time, and maintain the effectiveness during the period the
Coventry Options are outstanding, Registration Statements on Forms S-8
under the Securities Act of 1933, as amended (the "Securities Act "),
with respect to the shares of Newco
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Common Stock issuable upon exercise of the Coventry Options, upon demand
pursuant to the terms of the Warburg Agreement, will register the shares
of Newco Common Stock issuable upon exercise or conversion of the
securities issued under the Warburg Agreement, and shall take
appropriate action to list all such shares with The Nasdaq Stock Market
("Nasdaq") and to provide appropriate notice of issuance to Nasdaq; and
(vii) all of the shares of common stock, par value $0.01 per share,
of Merger Sub issued and outstanding and held by Newco immediately prior
to the Effective Time shall, by virtue of the Merger and without any
action on the part of Newco, be converted into the right to receive a
total of 1,000 shares of Coventry Common Stock, which shares shall
represent all of the issued and outstanding shares of capital stock of
Coventry immediately after the Effective Time.
1.3 SURRENDER AND PAYMENT.
(a) As of the Effective Time, Newco shall deposit, or shall cause to
be deposited, with an exchange agent selected by Coventry, which shall be
Coventry's Transfer Agent or such other party reasonably satisfactory to
Coventry (the "Exchange Agent "), for the benefit of the holders of shares
of Coventry Common Stock and Coventry Preferred Stock, for exchange in
accordance with this Article 1, certificates representing the shares of
Newco Common Stock and Newco Preferred Stock (such cash and certificates
for shares of Newco Common Stock and Newco Preferred Stock, together with
any dividends or distributions with respect thereto, being hereinafter
referred to as the "Exchange Fund ") to be issued pursuant to Section 1.2
hereof and paid pursuant to this Section 1.3 in exchange for outstanding
shares of Coventry Common Stock and Coventry Preferred Stock.
(b) Promptly after the Effective Time, Coventry shall cause the
Exchange Agent to mail to each holder of record of a Certificate or
Certificates (i) a letter of transmittal which shall specify that delivery
shall be effected, and risk of loss and title to the Certificates shall
pass, only upon delivery of the Certificates to the Exchange Agent and
shall be in such form and have such other provisions as Newco may
reasonably specify and (ii) instructions for use in effecting the surrender
of the Certificates in exchange for certificates representing shares of
Newco Common Stock and/or Newco Preferred Stock. Upon surrender of a
Certificate for cancellation to the Exchange Agent together with such
letter of transmittal, duly executed and completed in accordance with the
instructions thereto, the holder of such Certificate shall be entitled to
promptly receive in exchange therefor (x) a certificate representing that
number of whole shares of Newco Common Stock or Newco Preferred Stock, as
appropriate, and (y) a check representing the amount of unpaid dividends
and distributions, if any, which such holder has the right to receive in
respect of the Certificate surrendered pursuant to the provisions of this
Section 1.3, after giving effect to any required withholding tax, and the
Certificate so surrendered shall forthwith be canceled. No interest will be
paid or accrued on the unpaid dividends and distributions, if any, payable
to holders of Certificates. In the event of a transfer of ownership of
Coventry Common Stock or Coventry Preferred Stock which is not registered
in the transfer records of Coventry, a certificate representing the proper
number of shares of Newco Common Stock or Newco Preferred Stock, as
appropriate, may be issued to such a transferee if the Certificate
representing such Coventry Common Stock or Coventry Preferred Stock is
presented to the Exchange Agent, accompanied by all documents required to
evidence and effect such transfer and to evidence that any applicable stock
transfer taxes have been paid.
(c) At or after the Effective Time, there shall be no transfers on the
stock transfer books of Coventry of the shares of Coventry Common Stock
which were outstanding immediately prior to the Effective Time. If, after
the Effective Time, Certificates are presented to Newco, they shall be
canceled and exchanged for certificates evidencing ownership of shares of
Newco Common Stock and/or Newco Preferred Stock deliverable in respect
thereof pursuant to this Plan in accordance with the procedures set forth
in this Section 1.3.
(d) Any portion of the Exchange Fund (including the proceeds of any
investments thereof and any shares of Newco Common Stock and Newco
Preferred Stock) that remains unclaimed by the former shareholders of
Coventry one year after the Effective Time shall be delivered to Newco. Any
former
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<PAGE> 249
shareholders of Coventry who have not theretofore complied with this
Section 1.3 shall thereafter look only to Newco for payment of their shares
of Newco Common Stock and/or Newco Preferred Stock, unpaid dividends and
distributions on the Newco Common Stock and/or Newco Preferred Stock
deliverable in respect of each share of Coventry Common Stock or Coventry
Preferred Stock, as appropriate, such shareholder holds as determined
pursuant to this Plan, in each case, without any interest thereon.
(e) None of Coventry, Principal, Newco, the Exchange Agent or any
other person shall be liable to any former holder of shares of Coventry
Common Stock or Coventry Preferred Stock for any amount properly delivered
to a public official pursuant to applicable abandoned property, escheat or
similar laws.
(f) In the event any Certificate shall have been lost, stolen or
destroyed, upon the making of an affidavit of that fact by the person
claiming such Certificate to be lost, stolen or destroyed and, if required
by Newco, the posting by such person of a bond in such reasonable amount as
Newco may direct as indemnity against any claim that may be made against it
with respect to such Certificate, the Exchange Agent will issue in exchange
for such lost, stolen or destroyed Certificate the shares of Newco Common
Stock and/or Newco Preferred Stock and unpaid dividends and distributions
on shares of Newco Common Stock and/or Newco Preferred Stock deliverable in
respect thereof pursuant to this Plan.
1.4 ADJUSTMENT OF MERGER RATIO. In the event that, subsequent to the date of
this Plan but prior to the Effective Time, Coventry changes the number of shares
of Coventry Common Stock issued and outstanding as a result of a stock split,
reverse stock split, stock dividend, recapitalization or other similar
transaction, the merger ratio (the "Merger Ratio") of one share of Coventry
Common Stock for one share of Newco Common Stock and one Newco Right and one
share of Coventry Preferred Stock for one share of Newco Preferred Stock shall
be appropriately adjusted.
1.5 EFFECT OF MERGER. The Merger shall have the effect specified in Section
48-21-108 of the Tennessee Business Corporation Act (the "TBCA").
1.6 TAX EFFECT. It is the intent of the parties that the Merger qualify as a
transfer subject to Section 351(a) of the Code and a reorganization subject to
Section 368(a)(2)(E) of the Code.
ARTICLE 2
CLOSING AND EFFECTIVE TIME
2.1 THE CLOSING. Subject to the terms and conditions of this Plan, the closing
(the "Closing") of the Merger shall take place at the offices of Bass, Berry &
Sims PLC, First American Center, Nashville, Tennessee, at the time and on the
date of the closing of the Merger Agreement. The date on which the Closing
occurs is hereinafter referred to as the "Closing Date."
2.2 EFFECTIVE TIME. If all the conditions to this Plan and the Merger Agreement
shall have been fulfilled or waived in accordance therewith and this Plan shall
not have been terminated as provided in Article 4 hereof, the parties hereto
shall cause a Articles of Merger, meeting the requirements of Section 48-21-107
of the TBCA, to be properly executed and filed on the Closing Date. The Merger
shall become effective at the time of filing of the Articles of Merger with the
Secretary of State of the State of Tennessee in accordance with Section
48-21-108(e) the TBCA (the "Effective Time").
ARTICLE 3
THE SURVIVING CORPORATION
3.1 CHARTER. The Charter of Coventry in effect immediately prior to the
Effective Time shall be the Charter of the Surviving Corporation, until duly
amended in accordance with applicable law.
3.2 BYLAWS. The Bylaws of Coventry in effect immediately prior to the Effective
Time shall be the Bylaws of the Surviving Corporation, until duly amended in
accordance with applicable law.
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<PAGE> 250
3.3 DIRECTORS. The directors of Coventry immediately prior to the Effective Time
shall be the directors of the Surviving Corporation as of the Effective Time.
3.4 OFFICERS. The officers of Coventry immediately prior to the Effective Time
shall be the officers of the Surviving Corporation as of the Effective Time.
ARTICLE 4
APPROVAL OF MERGER; TERMINATION
4.1 APPROVAL OF MERGER.
(a) The Merger has been approved by the Board of Directors and
shareholders of each of Newco and Merger Sub.
(b) Subject to the fulfillment or waiver of the conditions set forth
in the Merger Agreement, Coventry's Board of Directors has approved the
Merger and has recommended the Merger to Coventry's shareholders for
approval by the shareholders of record on , 1998 at a special
meeting of shareholders to be held on March , 1998 (the "Special
Meeting"). The Board of Directors of Coventry shall, upon the declaration
by the Securities Exchange Commission of the effectiveness of a Prospectus
and Proxy Statement on Form S-4 under the Securities Act of 1933, as
amended, deliver written notice to the Coventry shareholders of the Special
Meeting in accordance with the provisions of Section 48-17-105 of the TBCA
and the Bylaws of Coventry as then in effect.
4.2 PLAN TERMINATION. This Plan shall terminate in the event of termination of
the Merger Agreement.
4.3 EFFECT OF TERMINATION. If this Plan shall be terminated as provided in
Section 4.2 hereof, all obligations of the parties hereunder shall terminate
without liability of any party to any other party.
ARTICLE 5
MISCELLANEOUS
5.1 HEADINGS. The headings in this Plan are intended solely for convenience of
reference and shall be given no effect in the construction or interpretation of
this Plan.
5.2 GOVERNING LAW. All questions with respect to this Plan and the rights and
liabilities of the parties shall be governed by the laws of the State of
Tennessee, regardless of the choice of law provisions in effect in Tennessee or
any other jurisdiction.
5.3 SUCCESSORS AND ASSIGNS. This Plan shall inure to the benefit of and be
binding on the successors and permitted assigns of each of the parties;
provided, however, that this Plan may not be assigned by any party without the
prior written consent of the other.
5.4 MODIFICATIONS. This Plan may not be amended, modified, waived, discharged,
or terminated except by an instrument in writing signed by each party hereto.
5.5 SEVERABILITY. The invalidity, illegality, or unenforceability of any
particular provision of this Plan shall not affect the other provisions hereof,
and this Plan shall be construed in all respects as if such invalid, illegal, or
unenforceable provision were omitted. Furthermore, in lieu of such invalid,
illegal, or unenforceable provision, there shall be added automatically as a
part of this Plan a provision as similar in terms to such illegal, invalid, or
unenforceable provision as may be possible and as may be valid, legal, and
enforceable.
5.6 COUNTERPARTS. This Plan may be executed simultaneously in one or more
counterparts, each of which will be deemed an original, but all of which
together will constitute one and the same instrument.
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IN WITNESS WHEREOF, the parties have duly executed this Plan as of the date
first above written.
COVENTRY CORPORATION
By:
Name:
Title:
COVENTRY HEALTH CARE, INC.
By:
Name:
Title:
COVENTRY MERGER CORPORATION
By:
Name:
Title:
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<PAGE> 252
ARTICLES OF MERGER
OF
COVENTRY CORPORATION
(A TENNESSEE CORPORATION)
AND
COVENTRY MERGER CORPORATION
(A TENNESSEE CORPORATION)
Pursuant to the provisions of Section 48-21-104 of the Tennessee Business
Corporation Act, these Articles of Merger provide that:
1. Coventry Merger Corporation, a Tennessee corporation ("Merger Sub"),
shall be merged with and into Coventry Corporation, a Tennessee corporation
("Coventry"), which shall be the surviving corporation.
2. In accordance with the provisions of Section 48-21-104 of the Tennessee
Business Corporation Act (the "TBCA"), the Agreement and Plan of Merger, dated
as of [ ], 1997, a copy of which is attached hereto as Attachment A
(the "Plan"), pursuant to which Merger Sub shall be merged with and into
Coventry, was adopted by: (a) the sole shareholder of Merger Sub by unanimous
written consent dated [ ], 1997 in accordance with Section 48-17-104 of
the TBCA and (b) the affirmative vote of the holders of a majority of the shares
of Coventry's capital stock entitled to vote at a special meeting called for the
purpose of approving the Plan held on March , 1998 in accordance with Section
48-17-105 of the TBCA.
3. The Merger shall be effective when these Articles of Merger are filed by
the Secretary of State of the State of Tennessee.
IN WITNESS WHEREOF, these Articles of Merger have been executed on behalf
of Coventry Corporation and Coventry Merger Corporation by their authorized
officers as of March , 1998.
COVENTRY CORPORATION
By:
Name:
Title:
COVENTRY MERGER CORPORATION
By:
Name:
Title:
<PAGE> 253
THIS WARRANT AND THE SECURITIES ISSUABLE UPON ITS EXERCISE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT "),
OR ANY STATE SECURITIES LAW, AND MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE
DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION UNDER THE SECURITIES
ACT OR IN A TRANSACTION WHICH, IN THE OPINION OF COUNSEL REASONABLY SATISFACTORY
TO COVENTRY HEALTH CARE, INC., IS EXEMPT FROM SUCH REGISTRATION.
COVENTRY HEALTH CARE, INC.
COMMON STOCK PURCHASE WARRANT
Attached hereto as Exhibit 1 is a list (the "Option List") of issued and
outstanding options (each, an "Option"), and warrants (each, a "Warrant," and
together with the Options the "Option Securities") that give the respective
holders thereof the right to acquire shares of Common Stock, par value $0.01 per
share (the "Common Stock"), of COVENTRY HEALTH CARE, INC., a Delaware
corporation (the "Company"). The Option List sets forth the name of each holder
of an Option Security, the date on which such Option Security may be exercised,
the date on which such Option Security expires, and the exercise price per share
of Common Stock issuable upon the exercise of such Option Security. Reference is
made herein to that certain Capital Contribution and Merger Agreement (effective
as of November 3, 1997, and amending and restating the Capital Contribution and
Share Exchange Agreement dated November 3, 1997), executed on December , 1997
(the "Merger Agreement"), by and among the Company, Coventry Health Care, Inc.
(a Maryland corporation), Coventry Corporation, a Tennessee corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company
("Principal Mutual "), Principal Holding Company, an Iowa corporation, and
Principal Health Care, Inc., an Iowa corporation ("Principal "). Capitalized
terms not herein defined shall have the meanings ascribed thereto in the Merger
Agreement.
The Company hereby certifies that, for value received, Principal or its
successor or assigns (the "Holder"), is entitled, subject to the terms set forth
below, to purchase from the Company, at any time and from time to time during
the period beginning on the date hereof and ending on the latest date of
expiration set forth on the Option List (the "Exercise Period ") for each Option
Security set forth on the Option List (and only during the period from the date
each such Option Security is exercised and ending on the later of the
termination date of the Option Security without regard to the actual date of
exercise by the holder of the Option Security, or the thirtieth day after Holder
receives notice from the Company of the exercise of the Option Security) a
corresponding number of shares of Common Stock equal to 66 2/3% of the number
of shares of Common Stock purchasable under such Option Security, at the
exercise price set forth on the Option List for such Option Security, provided
that in the event any Option Security shall not have been exercised and shall be
cancelled, then the right to purchase hereunder shall be correspondingly reduced
by 66 2/3% of the number of shares of Common Stock covered by such cancelled
option. This Warrant is herein called the "Principal Warrant."
1. EXERCISE OF WARRANT.
1.1 DELIVERY OF EXERCISE NOTICE. During the Exercise Period, on or before
the fifth business day immediately following the last calendar day of March,
June, September and December during each year of the Exercise Period, and at
least twenty (20) days before any meeting of the Company's shareholders or any
other action involving a vote of the Company's Common Stock, the chief financial
officer of the Company shall deliver to the Holder a written notice (each, a
"Warrant Notice") that sets forth (i) the number of shares of Common Stock that
the Holder shall thereafter be entitled to purchase, which number shall be equal
to the product of (x) 66 2/3% and (y) the number of shares of Common Stock that
were issued by the Company upon the exercise of any Option Securities since the
last Warrant Notice through the record date for the shareholder meeting or
voting event requiring the immediate Warrant Notice or, in all other cases,
through the period ending thirty (30) days before such Warrant Notice; (ii) the
price per share (the "Notice Price") received by the Company upon such exercise
of each of such Option Securities; and (iii) a description of any Option
Securities that have expired or have been canceled during the same period.
<PAGE> 254
1.2 EXERCISE. The purchase rights evidenced by this Warrant shall be
exercised by the Holder delivering to the Company a written notice substantially
in the form attached as Exhibit 2 hereto (the "Exercise Notice"), duly executed
by such Holder, accompanied by payment (the "Exercise Payment") of an amount
equal to the Notice Price multiplied by the number of shares being purchased
pursuant to such exercise, payable as follows: (a) by payment to the Company in
cash, by check, or by wire transfer of the Exercise Payment, or (b) by surrender
to the Company for cancellation of securities of the Company having a Market
Price (as hereinafter defined) on the date of exercise equal to the Exercise
Payment.
For purposes hereof, the term "Market Price" shall mean (a) if the Common
Stock is traded on a national securities exchange, the last reported sale price
of a share of Common Stock, regular way on such date or, in case no such sale
takes place on such date, the average of the closing bid and asked prices
thereof regular way on such date, in either case as officially reported on the
principal national securities exchange on which the Common Stock is then listed
or admitted for trading, or, (b) if the Common Stock is not then listed or
admitted for trading on any national securities exchange but is designated as a
national market system security by the National Association of Securities
Dealers, Inc. ("NASD"), the last reported trading price of the Common Stock on
such date, or (c) if not listed or admitted to trading on any national
securities exchange or designated as a national market system security, the
average of the reported bid and asked price of the Common Stock on such date in
the over-the-counter market as furnished by the National Quotation Bureau, Inc.,
or, if such firm is not then engaged in the business of reporting such prices,
as furnished by any member of the NASD selected by the Company or, (d) if the
shares of Common Stock are not so publicly traded, the fair market value
thereof, as determined in good faith by the Board of Directors of the Company.
2. DELIVERY OF STOCK CERTIFICATES ON EXERCISE. As soon as practicable after
any exercise of this Principal Warrant and receipt of the Exercise Payment, and
in any event within ten business days thereafter, the Company, at its expense,
will cause to be issued in the name of and delivered to the Holder a certificate
or certificates for the number of fully paid and non-assessable shares of Common
Stock or property to which such holder shall be entitled upon such exercise,
plus, in lieu of any fractional share to which such holder would otherwise be
entitled, cash in an amount determined in accordance with Section 3.5 hereof.
The Company agrees that the shares so purchased shall be deemed to be issued to
the holder hereof as the record owner of such shares as of the close of business
on the date the Exercise Notice shall have been delivered and payment made for
such shares as aforesaid.
3. OTHER ADJUSTMENTS. The number of shares of Common Stock issuable upon
exercise of this Principal Warrant shall be subject to adjustment from time to
time in accordance with this Section 3.
3.1 CANCELLATION OR EXPIRATION OF OPTION CONVERTIBLE SECURITIES. If any
Option Security shall expire or shall be canceled without being exercised, in
whole or in part, and any obligation of the Company to issue shares of Common
Stock thereunder shall terminate, then the right of the Holder to acquire any
shares of Common Stock relating to such canceled Option Security shall
immediately terminate and no longer be in effect.
3.2 PRINCIPAL WARRANT ADJUSTMENT. In the event the Exercise Price and/or
the number of shares underlying any Option Security shall be adjusted as a
result of the anti-dilution rights pertaining to such Option Security, then this
Principal Warrant shall likewise be adjusted with respect to such Option
Security.
3.3 REORGANIZATION, RECLASSIFICATION, CONSOLIDATION, MERGER OR SALE OF
ASSETS. If any capital reorganization or reclassification of the capital stock
of the Company, or consolidation or merger of the Company with another
corporation, or the sale of all or substantially all of its assets to another
corporation shall be effected in such a way that holders of Common Stock shall
be entitled to receive stock, securities, cash or other property with respect to
or in exchange for Common Stock, then, as a condition of such reorganization,
reclassification, consolidation, merger or sale, lawful and adequate provision
shall be made whereby the holder of this Principal Warrant shall have the right
to acquire and receive upon exercise of this Principal Warrant such shares of
stock, securities, cash or other property issuable or payable (as part of the
reorganization, reclassification, consolidation, merger or sale) with respect to
or in exchange for such number of outstanding shares of the Company's Common
Stock (the "Reorganization Consideration") as shall equal the product of (x)
forty
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<PAGE> 255
percent (40%) and (y) any Reorganization Consideration payable to the holders of
the Option Securities in connection with their ownership of such Option
Securities.
3.4 ADJUSTMENT BY BOARD OF DIRECTORS. If any event occurs as to which, in
the opinion of the Board of Directors of the Company, the provisions of this
Section 3 are not strictly applicable or if strictly applicable would not fairly
protect the rights of the holder of this Principal Warrant in accordance with
the essential intent and principles of such provisions, then the Board of
Directors shall make an adjustment in the application of such provisions, in
accordance with such essential intent and principles, so as to protect such
rights as aforesaid.
3.5 FRACTIONAL SHARES. The Company shall not issue fractions of shares of
Common Stock upon exercise of this Principal Warrant or scrip in lieu thereof.
If any fraction of a share of Common Stock would, except for the provisions of
this Section 3.5, be issuable upon exercise of this Principal Warrant, the
Company shall in lieu thereof pay to the person entitled thereto an amount in
cash equal to the Market Price, calculated to the nearest one-hundredth (1/100)
of a share.
3.6 OFFICER'S STATEMENT AS TO ADJUSTMENTS. Whenever the number of shares
issuable upon exercise of this Principal Warrant shall be adjusted as provided
in this Section 3, the Company shall deliver to the Holder, a statement, signed
by the Chief Financial Officer of the Company, showing in reasonable detail an
amended and restated Exhibit 1 to this Principal Warrant that will be effective
after such adjustment.
4. RESERVATION OF STOCK. The Company shall at all times reserve and keep
available out of its authorized but unissued stock, solely for the issuance and
delivery upon the exercise of this Principal Warrant, such number of its duly
authorized shares of Common Stock as from time to time shall be issuable upon
the exercise of this Principal Warrant.
5. REPLACEMENT OF WARRANT. Upon receipt of evidence reasonably satisfactory
to the Company of the loss, theft, destruction or mutilation of this Principal
Warrant and (in the case of loss, theft or destruction) upon delivery of an
indemnity agreement (with surety if reasonably required) in an amount reasonably
satisfactory to it, or (in the case of mutilation) upon surrender and
cancellation thereof, the Company will issue, in lieu thereof, a new warrant of
like tenor.
6. REMEDIES. The Company stipulates that the remedies at law of the Holder in
the event of any default by the Company in the performance of or compliance with
any of the terms of this Principal Warrant are not and will not be adequate, and
that the same may be specifically enforced.
7. NEGOTIABILITY, ETC. This Principal Warrant and any shares of Common Stock
issuable under this Principal Warrant may not be sold, pledged, hypothecated or
otherwise transferred except in accordance with the provisions of that certain
Shareholders' Agreement, of even date herewith, by and among the Company,
Principal and Principal Mutual.
8. NOTICES. All notices, consents, waivers, and other communications under
this Principal Warrant must be in writing and will be deemed to have been duly
given when (a) delivered by hand (with written confirmation of receipt), (b)
sent by telecopier (with written confirmation of receipt) provided that a copy
is mailed by registered mail, return receipt requested, or (c) when received by
the addressee, if sent by a nationally recognized overnight courier service
(receipt requested), in each case to the appropriate address and telecopier
number set forth below (or such other address and telecopier number as the
Company or the Principal may designate by notice to the other party):
(i) if to the Company:
Dale Wolf
Coventry Health Care, Inc.
53 Century Boulevard
Nashville, Tennessee 37214
Telecopy Number:
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<PAGE> 256
with a copy to:
Bob F. Thompson, Esq.
Bass, Berry & Sims PLC
2700 First American Center
Nashville, Tennessee 37238
Telecopy Number: (615) 742-6298
(ii) if to the Principal:
Kenneth J. Linde
Principal Health Care, Inc.
6705 Rockledge Drive
Suite 100
Bethesda, Maryland 20817
Telecopy Number:
with a copy to:
Thomas M. Farah, Esq.
Epstein, Becker & Green, P.C.
1227 25th Street, N.W., Suite 700
Washington, D.C. 20037
Telecopy Number: (202) 296-2882
and
Robert J. Mrizek, Esq.
Principal Health Care, Inc.
6705 Rockledge Drive
Suite 100
Bethesda, MD 20817
Telecopy Number: (301) 493-0743
and
Mark Movic
Principal Mutual Life Insurance Company
711 High Street
Des Moines, Iowa 50392
Telecopy Number: (515) 247-0130
and
Karen E. Shaff, Esq.
Principal Mutual Life Insurance Company
711 High Street
Des Moines, Iowa 50392
Telecopy Number: (515) 248-3011
9. HEADINGS, ETC. The headings in this Principal Warrant are for purposes of
reference only, and shall not limit or otherwise affect the meaning hereof.
10. CHANGE, WAIVER, ETC. Neither this Principal Warrant nor any term hereof may
be changed, waived, discharged or terminated orally but only by an instrument in
writing signed by the party against which enforcement of the change, waiver,
discharge or termination is sought.
11. GOVERNING LAW. THIS PRINCIPAL WARRANT SHALL BE CONSTRUED AND ENFORCED IN
ACCORDANCE WITH THE LAWS OF THE STATE OF DELAWARE, WITHOUT REGARD TO CONFLICT OF
LAWS PRINCIPLES IN EFFECT THEREIN.
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<PAGE> 257
IN WITNESS WHEREOF, COVENTRY HEALTH CARE, INC. has caused its duly
authorized officer to execute this Principal Warrant in its name and on its
behalf on the [ ] day of [ ], 1998.
<TABLE>
<S> <C>
Attest: COVENTRY HEALTH CARE, INC.
By: By:
Name: Name:
Title: Title:
</TABLE>
Dated: ________, 1998
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EXHIBIT 1
LIST OF OPTION SECURITIES
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EXHIBIT 2
FORM OF EXERCISE NOTICE
[TO BE SIGNED ONLY UPON EXERCISE OF WARRANT]
To Coventry Health Care, Inc.:
The undersigned, the holder of that certain Principal Warrant, dated
[ ], 1998 (the "Warrant"), issued by you, hereby acknowledges receipt
of a Warrant Notice on ________ from you; hereby irrevocably elects to exercise
the purchase right represented by such Principal Warrant for, and to purchase
thereunder, ________ shares of Common Stock, par value $0.01 per share, of
Coventry Health Care, Inc., herewith makes payment of $________ therefor; and
requests that the stock certificate for such shares be issued in the name of,
and be delivered, to the person listed below at the address listed under such
person's name:
Name:_______________________________________________________________________
Address:____________________________________________________________________
Dated: ________________________
(Signature must conform in all respects to name of holder as specified on the
face of the Warrant)
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SHAREHOLDERS' AGREEMENT
THIS SHAREHOLDERS' AGREEMENT (this "Agreement "), dated as of [ ],
is by and among Coventry Health Care, Inc., a Delaware corporation (the
"Company"), Principal Mutual Life Insurance Company, an Iowa mutual insurance
company ("Mutual "), and Principal Health Care, Inc., an Iowa corporation
("Principal "). Reference is made herein to that certain Capital Contribution
and Merger Agreement (effective as of November 3, 1997, and amending and
restating the Capital Contribution and Share Exchange Agreement dated as of
November 3, 1997) executed on December , 1997 (the "Merger
Agreement ") by and among the Company, Coventry Corporation, a Tennessee
corporation, Coventry Health Care, Inc., a Maryland corporation, Mutual,
Principal Holding Company, an Iowa corporation, and Principal. Capitalized terms
not herein defined shall have the meanings ascribed thereto in the Merger
Agreement.
WHEREAS, Section 6.18(e) of the Merger Agreement provides that the Company,
Principal and Mutual execute and deliver this Agreement as a condition precedent
to the effectiveness of the Merger Agreement;
WHEREAS, the parties hereto desire to effect the transactions contemplated
by the Merger Agreement and to enter into this Agreement in order to set forth
certain agreements and understandings with respect to the obligations, rights
and privileges of Principal as a shareholder of the Company;
NOW THEREFORE, in consideration of promises and mutual covenants and
agreements set forth herein and in the Merger Agreement, intending to be legally
bound hereby, the parties hereto agree as follows:
SECTION 1. RESTRICTION ON RESALE; LEGEND.
(a) RESALE OF SECURITIES. Principal and Mutual each hereby covenant
that:
(i) it will not, directly or indirectly, sell or otherwise transfer
the shares of the Company's common stock, par value $0.01 per share (the
"Common Stock"), acquired thereby under the Merger Agreement or
otherwise except pursuant to an effective registration under the
Securities Act of 1933, (the "Securities Act ") or in a transaction
which, in the opinion of counsel reasonably satisfactory to the Company,
qualifies as an exempt transaction under the Securities Act and the
rules and regulations promulgated thereunder; and
(ii) on or before the fifth anniversary hereof, it will not,
directly or indirectly, sell or otherwise transfer, or permit any of its
subsidiaries, directly or indirectly, to sell or to transfer, the shares
of Common Stock acquired thereby under the Merger Agreement or
otherwise, to any person other than an entity that is an Affiliate (as
defined under Rule 13d-3 of the Securities and Exchange Act of 1934, as
amended) of Mutual and/or Principal (such Affiliate, now or in the
future, a "Mutual Affiliate") which agrees to be bound by the terms of
this Agreement, unless such sale or transfer (A) is made in accordance
with the provisions of Section 9 hereof, (B) is made pursuant to and in
compliance with Rule 144 under the Securities Act, or (C) shall have
been approved by the written consent of the Company's Board of
Directors.
(b) STOCK LEGEND. The stock certificates evidencing ownership of the
shares of Common Stock acquired by Principal under the Merger Agreement
will bear substantially the following legends:
THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER
THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY
STATE SECURITIES LAW, AND MAY NOT BE SOLD, TRANSFERRED OR
OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE
REGISTRATION UNDER THE ACT OR IN A TRANSACTION WHICH, IN THE
OPINION OF COUNSEL REASONABLY ACCEPTABLE TO THE COMPANY, IS
EXEMPT FROM SUCH REGISTRATION.
THE SECURITIES EVIDENCED HEREBY ARE SUBJECT TO RESTRICTIONS ON
TRANSFER CONTAINED IN THAT CERTAIN SHAREHOLDERS'
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AGREEMENT, DATED [ ], BETWEEN PRINCIPAL MUTUAL LIFE
INSURANCE COMPANY, PRINCIPAL HEALTH CARE, INC. AND THE
COMPANY, A COPY OF WHICH AGREEMENT IS ON FILE AT THE OFFICE OF
THE SECRETARY OF THE COMPANY. ANY ATTEMPTED TRANSFER OF THE
SECURITIES IN VIOLATION OF THE PROVISIONS OF THE SHAREHOLDERS'
AGREEMENT SHALL BE VOID AB INITIO AND SHALL NOT BE RECOGNIZED
BY THE COMPANY.
The legend in the first paragraph above shall be removed by the Company
from and after the expiration of the holding period for restricted securities
under the Act, if the Company shall receive an opinion of counsel, from counsel
reasonably acceptable to the Company, that such legend is not required under the
Securities Act or any state securities laws. In addition, whenever any shares
cease to be subject to this Agreement and are not otherwise restricted
securities, the shareholder thereof shall be entitled to receive from the
Company, without expense, upon surrender to the Company of the certificate
representing such shares, a new certificate representing such shares, of like
tenor but without a legend of the character set forth above.
SECTION 2. SUBSCRIPTION RIGHT. If at any time after the date hereof, the Company
proposes to issue equity securities of any kind (the term "equity securities"
shall include for these purposes any warrants, options or other rights to
acquire equity securities and debt securities convertible into equity securities
but shall not include the issuance of securities (i) upon conversion of the
Preferred Stock ("Preferred Stock") or Convertible Promissory Notes
("Convertible Notes") issued under the Warburg Agreement, as amended by the
Warburg Consent, (ii) pursuant to which the Company or any of its subsidiaries
acquires another corporation or other entity by merger, consolidation, exchange
offer, share exchange, purchase of substantially all of the assets or stock, or
other form of reorganization, (iii) pursuant to any employee or director stock
option or incentive plans, stock bonus plan, employee stock purchase plan,
employee savings plan, supplemental executive retirement plan, management equity
program, or similar employee or director stock plan (iv) to providers and/or
customers of the Company in an amount not to exceed 2% of the shares of Common
Stock outstanding from and after the date hereof, (vi) pursuant to that certain
Rights Agreement dated as of the Closing Date between the Company and
ChaseMellon Shareholder Services, LLC ("Rights Agreement"), or (viii) under the
Warrant Agreement between the Company and Principal dated of even date herewith)
then, as to Principal, the Company shall:
(a) give written notice setting forth in reasonable detail (i) the
designation and all of the terms and provisions of the securities proposed
to be issued (the "Proposed Securities"), including, where applicable, the
voting powers, preferences and relative participating, optional or other
special rights, and the qualification, limitations or restrictions thereof
and interest rate and maturity; (ii) the price and other terms of the
proposed sale of such securities; (iii) the amount of such securities
proposed to be issued; and (iv) such other information as the holders of
the Securities may reasonably request in order to evaluate the proposed
issuance;
(b) offer to issue to Principal (and/or to any other Mutual Affiliate
which shall own shares of Common Stock) upon the terms described in
subparagraph (a) above an amount of Equity Securities identical to the
Proposed Securities (the "Subscription Securities") equal to (i) the number
of Proposed Securities to be issued times (ii) such percentage as will
allow Principal and the Mutual Affiliates to own, following the issuance of
the Proposed Securities, a percentage of such Equity Securities equal to a
percentage determined by dividing (x) the number of shares of Common Stock
owned by Principal and/or any Mutual Affiliate immediately preceding the
issuance of the Proposed Securities, by (y) the total number of shares of
Common Stock outstanding immediately preceding the issuance of the Proposed
Securities (provided that in no event shall such percentage determined by
dividing (x) by (y) exceed 40%).
(c) Principal and/or Mutual Affiliate must notify the Company of its
intent to exercise its purchase rights hereunder within ten (10) days after
receipt of such notice from the Company and purchase the Subscription
Securities upon the closing of the issuance of the Proposed Securities.
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(d) Upon the expiration of the offering period described above, the
Company will be free to sell such Subscription Securities that Principal
and/or any Mutual Affiliate has not elected to purchase during the ninety
(90) days following such expiration on terms and conditions no more
favorable to the purchasers thereof than those offered to Principal and/or
any Mutual Affiliate. Any Subscription Securities offered or sold by the
Company after such ninety (90) day period must be reoffered to Principal
and/or any Mutual Affiliate pursuant to this Section 2.
(e) The election by Principal and/or any Mutual Affiliate not to
exercise its subscription rights under this Section 2 in any one instance
shall not affect its right (other than in respect of a reduction in its
percentage holdings) as to any subsequent proposed issuance. Any sale of
such securities by the Company without first giving Principal and/or any
Mutual Affiliate the rights described in this Section 2 shall be void and
of no force and effect.
SECTION 3. EFFECT OF RIGHTS AGREEMENT. At or prior to the Closing, the Company
shall have adopted the Rights Agreement, substantially in the form attached as
Exhibit 8 to the Merger Agreement, pursuant to which Principal, Mutual and/or
any Mutual Affiliate shall be exempt from the definition of an "Acquiring
Person" (as defined under the Rights Agreement) for so long as none of
Principal, Mutual and/or any Mutual Affiliate has breached in any material
respect, any provision of Sections 1(a) or, 4 of this Agreement while such
sections remain effective, and after such sections shall no longer be effective,
until such time as Mutual and the Mutual Affiliates shall collectively
Beneficially Own less than fifteen percent (15%) of the Common Stock.
SECTION 4. STANDSTILL. Mutual hereby covenants and agrees that, on or before the
fifth anniversary of the date hereof, it will not, and will cause Mutual
Affiliates to not, without the prior written consent of a majority of the
members of the Company's Board of Directors, do any of the following except
pursuant to Section 2 hereof:
(a) acquire, offer or agree to acquire any shares of Common Stock (or
options or warrants to acquire, or securities convertible into or
exchangeable for, shares of Common Stock) if, as a result of such
acquisition, Mutual (together with any Mutual Affiliates) would
Beneficially Own more than a number of shares of Common Stock in excess of
a number equal to forty percent (40%) of the outstanding shares of Common
Stock plus forty percent (40%) of the shares of Common Stock issuable upon
conversion of the Convertible Notes plus forty percent (40%) of the number
of shares of Common Stock issuable upon conversation of the Preferred
Stock; provided, however, that, for purposes of computing such amount, the
37,900 shares of Common Stock Beneficially Owned by Invista Capital
Management, Inc. ("Invista") on December , 1997 shall be excluded from
such calculation for as long as such shares are regarded as Beneficially
Owned by Invista (and no longer) and provided that no executive officer or
director of Mutual or Principal or any employee of Mutual, Principal, or
any of their affiliates other than officers, directors or employees of
Invista charged with the responsibility thereof shall participate in the
voting of such shares and provided further that for so long as the
Convertible Notes are outstanding, Mutual and the Mutual Affiliates, in the
aggregate, will not vote or act on written consent in any matter coming
before shareholders at any shareholder meeting or shareholder action in
excess of forty percent (40%) of the shares of Common Stock outstanding
plus forty percent (40%) of the shares of Preferred Stock outstanding;
(b) directly or indirectly commence or participate in a solicitation
of proxies either to oppose the election of any Person to the Board of
Directors or to seek the removal of any Person from the Board of Directors,
which Person has been nominated by the Nominating Committee of the Board of
Directors;
(c) vote its shares of Common Stock for the election of any Person to
the Board of Directors other than the Persons nominated by the Nominating
Committee of the Board of Directors; or
(d) directly or indirectly make or solicit or assist any third party
to make a tender or exchange offer to purchase any shares of Common Stock
or make any public announcement concerning, or submit any written proposal
to the Board of Directors of the Company for a merger, share exchange,
acquisition of substantially all of the assets or similar transaction
involving the Company.
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SECTION 5. SUSPENSION OF COVENANTS. The provisions of Section 1(a)(ii) and 4
hereof shall thereafter cease to apply in the event of any of the following:
(a) the Company issues voting securities in an acquisition by the
Company of another corporation or entity by merger, consolidation, exchange
offer, purchase of substantially all of the assets or stock, or other form
of business combination ("Company Acquisition") to any Person as a result
of which such Person, together with its affiliates, shall own a number of
shares of voting securities that shall equal or exceed the number of such
shares owned by Mutual and the Mutual Affiliates in the aggregate;
(b) the number of shares of Common Stock then owned by Mutual and the
Mutual Affiliates, in the aggregate, shall be less than 10% of the then
issued and outstanding shares of Common Stock; or
(c) the number of shares of Common Stock then owed by any Person
(other than Warburg, or a Person who acquired a number of shares of Common
Stock in a Company Acquisition which did not equal or exceed the number of
shares owned by Mutual and the Mutual Affiliates in the aggregate, so long
as the Company does not permit such person to acquire additional shares of
Common Stock) and the Affiliates of such Person, in the aggregate, shall be
greater than 15% of the insured and outstanding shares of Common Stock
SECTION 6. RIGHT TO MATCH OFFER. During such period as Section 4 shall be
effective, in the event a third party makes a bona fide tender or exchange offer
(a "Bona Fide Offer") to purchase a majority of the issued and outstanding
shares of Common Stock or to effect a merger or share exchange in which the
acquisition of substantially all of the assets or similar transaction involving
the Company, then not withstanding the provisions of section 4, Mutual shall be
permitted to make a competing offer (the "Mutual Offer") to the Board of
Directors of the Company. Upon the receipt of any Bona Fide Offer, the Board of
Directors shall establish a special committee (the "Special Committee"),
consisting of members of the Board of Directors that are neither members of the
Company's management nor members of the Board of Directors designated by Mutual
pursuant to the terms of Section 7 hereof. The Special Committee shall determine
whether it is advisable and in the best interest of the Company to solicit
additional offers from any other party or parties, shall retain any legal or
financial advisory services deemed necessary or advisable to assist it in its
analysis of the Bona Fide Offer, the Mutual Offer and any other offers solicited
from third parties by the Company, and shall establish any procedures deemed
necessary or advisable to regulate the process pursuant to which the Company
entertains and analyzes the competing offers. The Special Committee shall
analyze each such offer and shall make a recommendation to the entire Board of
Directors with respect to whether any such offer is one that the Company should
recommend to its shareholders. If the Special Committee shall determine that the
value of the Bona Fide Offer or any other offer solicited from a third party is
greater than the value of the Mutual Offer, then Mutual shall have the
opportunity to amend the Mutual Offer to match or exceed the value of the higher
offer and each of the other parties that has submitted an offer to the Company
shall have the right to submit a revised offer to the Company. If the Special
Committee shall determine that, after the Company shall have received the final
offer from each such party, the value of the Mutual Offer is equal to or greater
than any other offer received by the Company and that the Mutual Offer is
advisable and in the best interest of the Company's shareholders, then,
notwithstanding the provisions of Section 4(a) hereof to the contrary, Mutual
shall be permitted to take any action deemed necessary or convenient to acquire
that number of shares of Common Stock as specified in the Mutual Offer for the
terms (including price) set forth in the Mutual Offer.
SECTION 7. VOTING BY MUTUAL. During such period as Section 4 shall be effective,
in the event that (i) a third party makes a Bona Fide Offer to purchase all of
the issued and outstanding shares of Common Stock or to effect a merger, share
exchange or similar transaction as contemplated in Section 6 hereof and the
Special Committee shall determine in accordance with the procedures set forth in
Section 6 that the acceptance of the Bona Fide Offer is in the best interests of
the Company's shareholders or (ii) a Special Committee organized pursuant to the
procedures set forth in Section 6 determines that it is in the best interests of
the Company's shareholders for the Company to issue shares of Common Stock in
connection with a Company acquisition and, in connection with such acquisition
the Company a vote of the holder's of the Company's Common Stock is required by
law or by applicable requirements of the National Association of Securities
Dealers, Inc.'s
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National Market System or any other securities exchange on which shares of the
Common Stock are traded, then, in either event, Mutual agrees to refrain from
voting and to cause each Mutual Affiliate to refrain from voting all of their
shares of Common Stock at any meeting of the Company's shareholders held for the
purpose of considering such proposal (or, if an approval of shareholders is
required by reference to all shares outstanding, to vote its shares of Common
Stock and to cause each Mutual Affiliate to vote its shares of Common Stock in
favor of such proposal) provided that each of the following conditions set forth
below are satisfied at such time:
(a) the date of the shareholders meeting shall be on or after the date
that is eighteen (18) months following the Effective Date and during the
period as Section 4 shall be effective;
(b) the Board shall have received the written opinion of a nationally
recognized investment banking firm selected by the Company and reasonably
acceptable to Mutual that the proposed transaction is fair to the Company
and its shareholders from a financial standpoint; and
(c) the Company's shareholders (other than Mutual and the Mutual
Affiliates) shall have voted in favor of the proposed transaction by
majority vote;
SECTION 8. MUTUAL NOMINEES TO BOARD. For so long as Mutual Beneficially Owns at
least 10% (the "Minimum Percentage") of the then issued and outstanding shares
of Common Stock and shall not have breached in any material respect, without
cure, any provision of this Agreement, the Company will (i) nominate and use its
best efforts to cause its shareholders to elect and to retain as directors on
the Board of Directors at least one nominee designated by Mutual for each 6% of
the issued and outstanding Common Stock then held by Mutual (such nominees are
collectively hereinafter referred to as the "Mutual Directors") and (ii) use its
best efforts to cause its Board of Directors to limit the number of members of
the Compensation Committee, Audit Committee and Finance Committee of the Board
of Directors to three directors and to cause one Mutual Director to be appointed
as a member of each such committee. Any vacancy created by the death,
disability, retirement or removal of any Mutual Director on the Board of
Directors or on any such committee of the Board of Directors shall be filled by
the Board of Directors in accordance with written instructions of Mutual. In the
event the number of members of the Board of Directors is increased to more than
15 directors, for so long as Mutual owns the Minimum Percentage, Mutual shall be
entitled to the whole number of Mutual Directors obtained by multiplying (a) the
number of directors on the Board of Directors (including Mutual Directors) by
(b) a fraction, (x) the numerator of which is equal to the number of shares of
Common Stock then beneficially owned (within the meaning of Rule 13d-3 under the
Exchange Act) by Mutual and (y) the denominator of which is equal to the total
number of shares of Common Stock then issued and outstanding. In the event any
calculation of the number of Directors that Mutual is entitled to designate
under this Section 7 shall not produce a whole number of Mutual Directors, then
the number of Mutual Directors shall be rounded to the nearest whole number
(with percentages greater than or equal to 50% being rounded up to the next
whole number and percentages less than 50% being rounded down to the next whole
number.) In the event that any of Mutual's nominees shall fail to be elected to
the Board of Directors, the provisions of Sections 1(a)(ii) and 4 hereof shall
terminate and be of no further force or effect. In the event that after the
expiration of Section 4, Mutual or any of the affiliates shall take any of the
actions specified in Section 4(b) or 4(c), then the Company's obligations
hereunder will cease.
SECTION 9. REGISTRATION RIGHTS.
9.1 DEFINITIONS. As used in this Section 9:
(a) the terms "register," "registered " and "registration" refer to a
registration effected by preparing and filing a registration statement in
compliance with the Securities Act (and any post-effective amendments filed
or required to be filed) and the declaration or ordering of effectiveness
of such registration statement;
(b) the term "Registrable Securities" means (i) shares of Common Stock
acquired by Principal under the Merger Agreement or pursuant to the
exercise of the Warrant issued under the Merger Agreement, (ii) any capital
stock of the Company issued as a dividend or other distribution with
respect
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to, or in exchange for or in replacement of, the shares of Common Stock, if
any, referred to in clause (i) hereof and any additional shares of Common
Stock acquired by Principal or a Mutual Affiliate from the Company pursuant
to the provisions of Section 2 hereof;
(c) the term "Holder" shall mean any holder of Registrable Securities;
(d) the term "Initiating Holder" shall mean any Holder or Holders who
in the aggregate are Holders of more than fifty percent (50.0%) of the then
outstanding Registrable Securities;
(e) "Registration Expenses" shall mean all expenses incurred by the
Company in compliance with Sections 9.2 and 9.3 hereof, including, without
limitation, all registration, filing fees and NASD fees, printing expenses,
fees and disbursements of counsel for the Company and of its independent
public accountants, fees and disbursements of one counsel for all the
Holders, blue sky fees and expenses and the expense of any special audits
or "cold comfort" letters incident to or required by any such registration
(but excluding the compensation of regular employees of the Company, which
shall be paid in any event by the Company) and any fees and disbursements
of underwriters customarily paid by issuers or sellers of securities, but
excluding Selling Expenses; and
(f) "Selling Expenses" shall mean all underwriting discounts and
selling commissions applicable to the sale of Registrable Securities and
all fees and disbursements of counsel for each of the Holders other than
fees and expenses of one counsel for all the Holders.
9.2 REQUESTED REGISTRATION.
(a) REQUEST FOR REGISTRATION. If the Company shall receive from an
Initiating Holder a written request that the Company effect any
registration with respect to all or a part of the Registrable Securities
and specifying the intended method of disposition thereon, the Company
will:
(i) give written notice of the proposed registration, qualification
or compliance to all other Holders of Registrable Securities promptly,
and in any event within 10 business days; and
(ii) as soon as practicable, use its diligent best efforts to
effect such registration as may be so requested (in accordance with the
intended method thereof as aforesaid) and as would permit or facilitate
the sale and distribution of all or such portion of such Registrable
Securities as are specified in such request, together with all or such
portion of the Registrable Securities of any Holder or Holders joining
in such request as are specified in a written request received by the
Company within ten (10) business days after written notice from the
Company is given under Section 9.2(a)(i) above; provided that the
Company shall not be obligated to effect, or take any action to effect,
any such registration pursuant to this Section 9.2:
(A) In any particular jurisdiction in which the Company would be
required to execute a general consent to service of process in
effecting such registration, qualification or compliance, unless the
Company is already subject to service in such jurisdiction and except
as may be required by the Securities Act or applicable rules or
regulations thereunder;
(B) After the Company has effected four (4) such registrations
pursuant to this Section 9.2 and such registrations have been
declared or ordered effective and the sales of such Registrable
Securities shall have closed; provided that any Holder may
participate in any such registration to the extent provided in
Section 9.2 if the registration as the result of a request of another
Initiating Holder;
(C) If the Registrable Securities requested by all Holders to be
registered pursuant to such request have an anticipated aggregate
public offering price (before any underwriting discounts and
commissions) of less than $20,000,000; or
(D) If in the good faith judgment of the Board based upon the
written opinion of a nationally recognized investment banking firm
selected by the Company and reasonably acceptable to the Holders,
such registration would have a material adverse effect on the market
price of the shares of Common Stock, the Company shall have the right
to limit the number of
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Registrable Securities requested by all Holders to be registered
pursuant to such request; provided, however, that the Company shall
use reasonable commercial efforts to register not less than fifty
percent (50%) of the number of Registrable Securities requested to be
registered or to facilitate a private sale of such number of
Registrable Securities to institutional investors in a manner that
would ameliorate the anticipated material adverse effect of any such
sale on the market price of the shares of Common Stock; provided,
further, that in the event the total number of shares that the
Selling Holders (as hereinafter defined) shall request to be
registered by the Company equals a number that is equal to or less
than twenty percent (20%) of the then outstanding shares of Common
Stock, then the provisions of this Subsection (i)(E) shall not apply;
The registration statement filed pursuant to the request of the Initiating
Holders may, subject to the provisions of Section 9.2(b) below, include other
securities of the Company which are held by Persons who, by virtue of agreements
with the Company, are entitled to include their securities in any such
registration.
(b) UNDERWRITING. If the Initiating Holders intend to distribute the
Registrable Securities covered by their request by means of an
underwriting, they shall so advise the Company as a part of their request
made pursuant to Section 9.2. If holders of securities of the Company other
than Registrable Securities who are entitled, by contract with the Company
or otherwise, to have securities included in such a registration (the
"Other Stockholders") request such inclusion, the Holders shall offer to
include the securities of such Other Stockholders in the underwriting and
may condition such offer on their acceptance of the further applicable
provisions of this Section 9. The Holders whose shares are to be included
in such registration and the Company shall (together with all Other
Stockholders proposing to distribute their securities through such
underwriting) enter into an underwriting agreement in customary form with
the representative of the underwriter or underwriters selected for such
underwriting by the Initiating Holders and reasonably acceptable to the
Company. Notwithstanding any other provision of this Section 9.2, if the
representative advises the Holders in writing that marketing factors
require a limitation on the number of shares to be underwritten, the
securities of the Company held by Other Stockholders shall be excluded from
such registration to the extent so required by such limitation. If, after
the exclusion of such shares, further reductions are still required, the
number of shares included in the registration by each Holder shall be
reduced on a pro rata basis (based on the number of shares held by such
Holder), by such minimum number of shares as is necessary to comply with
such request. No Registrable Securities or any other securities excluded
from the underwriting by reason of the underwriter's marketing limitation
shall be included in such registration. If any of the Holders or any Other
Stockholder who has requested inclusion in such registration as provided
above disapproves of the terms of the underwriting, such person may elect
to withdraw therefrom by written notice to the Company, the underwriter and
the Initiating Holders. The securities so withdrawn shall also be withdrawn
from registration. If the underwriter has not limited the number of
Registrable Securities and securities of the Company held by Other
Shareholders to be underwritten, the Company may include its securities for
its own account in such registration if the representative so agrees and if
the number of Registrable Securities and securities of the Company held by
Other Shareholders which would otherwise have been included in such
registration and underwriting will not thereby be limited.
9.3 COMPANY REGISTRATION.
(a) INCLUSION IN REGISTRATION. If the Company shall determine to
register any of its equity securities either for its own account or for the
account of a security holder or holders exercising their respective demand
registration rights, other than a registration relating solely to employee
benefit plans, or a registration relating solely to a SEC Rule 145
transaction, or a registration on any registration form which does not
permit secondary sales or does not include substantially the same
information as would be required to be included in a registration statement
covering the sale of Registrable Securities, the Company will:
(i) promptly, and in event within 10 business days, give to each of
the Holders a written notice thereof, its intended method of
disposition, such Holder's rights under this Section 9.3 and a list of
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the jurisdictions in which the Company intends to attempt to qualify
such securities under the applicable blue sky or other state securities
laws; and
(ii) include in such registration (and any related qualification
under blue sky laws or other compliance), and in any underwriting
involved therein, all the Registrable Securities specified in a written
request or requests, made by the Holders within fifteen (15) days after
receipt of the written notice from the Company described in clause (i)
above, except as set forth in Section 9.3(b) below. Such written request
may specify all or a part of the Holders' Registrable Securities. No
registration effected under this Section 9.3 shall relieve the Company
of its obligations to effect any registration upon request under Section
9.2.
(b) UNDERWRITING. If the registration of which the Company gives
notice is for a registered public offering involving an underwriting, the
Company shall so advise each of the Holders as a part of the written notice
given pursuant to Section 9.3(a)(i). In such event, the right of each of
the Holders to registration pursuant to this Section 9.3 shall be
conditioned upon such Holders' participation in such underwriting and the
inclusion of such Holders' Registrable Securities in the underwriting to
the extent provided herein; provided, however, that Mutual shall not be
required to participate in such underwriting if Mutual notifies the Company
that it is seeking registration of its shares solely to enable it to
distribute such shares to its shareholders or holders of mutual interests
issued thereby. The Holders whose shares are to be included in such
registration (other than Mutual if it elects not to participate in such
underwriting) shall (together with the Company and the Other Stockholders
distributing their securities through such underwriting) enter into an
underwriting agreement in customary form with the representative of the
underwriter or underwriters selected for underwriting by the Company.
Notwithstanding any other provision of this Section 9.3, if the
representative determines that marketing factors require a limitation on
the number of shares to be underwritten, the representative may (subject to
the allocation priority set forth below) limit the number of Registrable
Securities to be included in the registration and underwriting to not less
than fifteen percent (15.0%) of the securities included therein (based on
aggregate market values). The Company shall so advise all holders of
securities requesting registration, and the number of shares of securities
that are entitled to be included in the registration and underwriting shall
be allocated in the following manner: The securities of the Company held by
Other Stockholders of the Company (other than Registrable Securities and
other than securities held by holders who by contractual right demanded
such registration ("Demanding Holders")) shall be excluded from such
registration and underwriting to the extent required by such limitation,
and, if a limitation on the number of shares is still required, the number
of shares that may be included in the registration and underwriting by each
of the Holders and Demanding Holders shall be reduced, on a pro rata basis
(based on the number of shares held by such Holder), by such minimum number
of shares as is necessary to comply with such limitation. If any of the
Holders or any Other Stockholder disapproves of the terms of any such
underwriting, such person may elect to withdraw therefrom by written notice
to the Company and the underwriter. Any Registrable Securities or other
securities excluded or withdrawn from such underwriting shall be withdrawn
from such registration.
9.4 EXPENSES OF REGISTRATION. All Registration Expenses incurred in
connection with any registration, qualification or compliance pursuant to this
Section 9 shall be borne by the Company, and all Selling Expenses shall be borne
by the persons selling shares so registered pro rata on the basis of the number
of their shares so registered. Notwithstanding the foregoing, if the Holders
request registration pursuant to Section 9.2 and, at the time of such request,
all shares then requested to be sold could be sold pursuant to Rule 144(k) under
the Act, then the Company shall not be obligated to pay Registration Expenses of
more than $75,000 in connection with such registration.
9.5 REGISTRATION PROCEDURES. In the case of each registration effected by
the Company pursuant to this Section 9, the Company will keep the Holders, as
applicable, advised in writing as to the initiation of each registration and as
to the completion thereof. At its expense, the Company will:
(a) prepare and file with the SEC such appropriate form of
registration statement as shall be selected by the Company, and, in the
case of a registration pursuant to Section as shall be reasonably
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acceptable to Holders owning a majority (by number of Registrable
Securities) of the Registrable Securities so to be registered, to effect
such registration and thereafter use its best efforts to cause such
registration statement to become effective; provided, however, that in the
case of a registration requested pursuant to Section 9.2, if the Company
shall furnish to the Initiating Holders a certificate signed by the
Chairman of the Board stating that, in the good faith judgment of the
Board, the timing of the disclosure of any information that would be
required to be disclosed in such registration statement would be a serious
detriment to the Company and its shareholders if such disclosure were made
on or before the date the filing of such registration statement would be
required, then the Company shall have one additional period of not more
than 60 days within which to file such registration statement;
(b) (i) prepare and file with the SEC such amendments to such
registration statement and the prospectus used in connection therewith as
may be necessary to keep such registration statement effective for a period
of either (1) not less than 270 days or, if such registration statement
relates to an underwritten offering, such longer period as in the opinion
of counsel for the underwriters a prospectus is required by law to be
delivered in connection with sales of Registrable Securities by an
underwriter or dealer or (2) such shorter period which will terminate when
all of the Registrable Securities covered by such registration statement
have been disposed of in accordance with the intended method of disposition
by the Holders selling Registrable securities covered by such registration
statement (a "Selling Holder") (or other sellers of securities
thereunder)(but in any event not before the expiration of any longer period
required under the Securities Act), and (ii) comply with the provisions of
the Securities Act with respect to the disposition of all Registrable
Securities covered by such registration statement until such time as all of
such securities have been disposed of in accordance with the intended
method of disposition by the Selling Holders (or other sellers of
securities thereunder);
(c) furnish to each Selling Holder such number of conformed copies of
such registration statement and of each such amendment and supplement
thereto (in each case including all exhibits), such number of copies of the
prospectus contained in such registration statement (including each
preliminary prospectus and any summary prospectus) and any other prospectus
filed under the Securities Act, and such other documents in order to
facilitate the disposition of the Registrable Securities owned by such
Selling Holder as such Selling Holder may reasonably request;
(d) use its best efforts to register or qualify such Registrable
Securities and other securities covered by such registration statement
under such other securities or blue sky laws of such jurisdictions as each
Selling Shareholder and each other seller of securities thereunder shall
reasonably request, to keep such registration or qualification in effect
for so long as such registration statement remains in effect, and take any
other action which may be reasonably necessary or advisable to enable such
Selling Holder to consummate the disposition in such jurisdictions of the
Registrable Securities owned by such Selling Holder;
(e) use its best efforts to cause all Registrable Securities and other
securities covered by such registration statement to be registered with or
approved by, and make any other necessary registrations or filings with,
all other governmental authorities as may be necessary by virtue of the
business and operations of the Company to enable the Selling Holder and any
other sellers of securities thereunder to consummate the disposition of
such Shares;
(f) furnish to each Selling Holder a signed counterpart, addressed to
such Selling Holder (and the underwriters, if any) of an opinion of the
Company's counsel and a "cold comfort" letter from the Company's
independent public accountants, each in such form and covering such matters
as are customarily covered in opinions of issuer's counsel and in
accountants' letters delivered to the underwriters in under-written public
offerings of securities and, in the case of the accountants' letter, such
other financial matters, and, in the case of the legal opinion, such other
legal matters, as such Selling Holder may reasonably request;
(g) notify each Selling Holder selling Registrable Securities under
such registration statement, at any time when a prospectus relating thereto
is required to be delivered under the Securities Act, upon discovery that,
or upon the happening of any event as a result of which, the prospectus
included in such
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registration statement, as then in effect, includes an untrue statement of
a material fact or omits to state any material fact required to be stated
therein or necessary to make the statements therein not misleading in the
light of the circumstances under which they were made, and at the request
of any such Selling Holder promptly prepare and furnish to such Selling
Holder a reasonable number of copies of a supplement to or an amendment of
such prospectus as may be necessary so that, as thereafter delivered to the
purchasers of such securities, such prospectus shall not include an untrue
statement of a material fact or omit to state a material fact required to
be stated therein or necessary to make the statements therein not
misleading in the light of the circumstances under which they were made;
(h) otherwise use its best efforts to comply with all applicable rules
and regulations of the SEC;
(i) provide and cause to be maintained a transfer agent and registrar
for all Registrable Securities covered by such registration statement from
and after a date not later than the effective date of such registration
statement; and
(j) use its best efforts to list all Registrable Securities covered by
such registration statement on each securities exchange on which similar
securities issued by the Company are then listed or on the National
Association of Securities Dealers Automated Quotation System or an
internationally recognized stock exchange.
9.6 INDEMNIFICATION.
(a) The Company will indemnify each of the Holders, as applicable,
each of its officers, directors and partners, and each person controlling
each of the Holders, with respect to each registration which has been
effected pursuant to this Section 9, and each underwriter, if any, and each
person who controls any underwriter, against all claims, losses, damages
and liabilities (or actions in respect thereof) arising out of or based on
any untrue statement (or alleged untrue statement) of a material fact
contained in any prospectus, offering circular or other document (including
any related registration statement, notification or the like) incident to
any such registration, qualification or compliance, or based on any
omission (or alleged omission) to state therein a material fact required to
be stated therein or necessary to make the statements therein not
misleading, or any violation by the Company of the Securities Act or any
rule or regulation thereunder applicable to the Company and relating to
action or inaction required of the Company in connection with any such
registration, qualification or compliance, and will reimburse each of the
Holders, each of its officers, directors and partners, and each person
controlling each of the Holders, each such underwriter and each person who
controls any such underwriter, for any legal and any other expenses
reasonably incurred in connection with investigating and defending any such
claim, loss, damage, liability or action, provided that the Company will
not be liable in any such case to the extent that any such claim, loss,
damage, liability or expense arises out of or is based on any untrue
statement or omission based upon written information furnished to the
Company by the Holders or underwriter and stated to be specifically for use
therein.
(b) Each of the Holders will, if Registrable Securities held by it are
included in the securities as to which such registration, qualification or
compliance is being effected, indemnify the Company, each of its directors
and officers and each underwriter, if any, of the Company's securities
covered by such a registration statement, each person who controls the
Company or such underwriter, each Other Stockholder and each of their
officers, directors, and partners, and each person controlling such Other
Stockholder against all claims, losses, damages and liabilities (or actions
in respect thereof) arising out of or based on any untrue statement (or
alleged untrue statement) of a material fact contained in any such
registration statement, prospectus, offering circular or other document
made by such Holder, or any omission (or alleged omission) to state therein
a material fact required to be stated therein or necessary to make the
statements by such Holder therein not misleading, and will reimburse the
Company and such Other Stockholders, directors, officers, partners,
persons, underwriters or control persons for any legal or any other
expenses reasonably incurred in connection with investigating or defending
any such claim, loss, damage, liability or action, in each case to the
extent, but only to the extent, that such untrue statement (or alleged
untrue statement) or omission (or alleged omission) is made in such
registration statement, prospectus, offering circular or other document in
reliance upon and in conformity with written
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information furnished to the Company by such Holder for use therein;
provided, however, that the obligations of each of the Holders hereunder
shall be limited to an amount equal to the net proceeds to such Holder of
securities sold as contemplated herein.
(c) Each party entitled to indemnification under this Section 9.6 (the
"Indemnified Party") shall give notice to the party required to provide
indemnification (the "Indemnifying Party") promptly after such Indemnified
Party has actual knowledge of any claim as to which indemnity may be
sought, and shall permit the Indemnifying Party to assume the defense of
any such claim or any litigation resulting therefrom; provided that counsel
for the Indemnifying Party, who shall conduct the defense of such claim or
any litigation resulting therefrom, shall be approved by the Indemnified
Party (whose approval shall not unreasonably be withheld) and the
Indemnified Party may participate in such defense at such party's expense
(unless the Indemnified Party shall have reasonably concluded that there
may be a conflict of interest between the Indemnifying Party and the
Indemnified Party in such action, in which case the fees and expenses of
counsel shall be at the expense of the Indemnifying Party), and provided,
further, that the failure of any Indemnified Party to give notice as
provided herein shall not relieve the Indemnifying Party of its obligations
under this Section 9 unless the Indemnifying Party is materially prejudiced
thereby. No Indemnifying Party, in the defense of any such claim or
litigation shall, except with the consent of each Indemnified Party,
consent to entry of any judgment or enter into any settlement which does
not include as an unconditional term thereof the giving by the claimant or
plaintiff to such Indemnified Party of a release from all liability in
respect to such claim or litigation. Each Indemnified Party shall furnish
such information regarding itself or the claim in question as an
Indemnifying Party may reasonably request in writing and as shall be
reasonably required in connection with the defense of such claim and
litigation resulting therefrom.
(d) If the indemnification provided for in this Section 9.6 is held by
a court of competent jurisdiction to be unavailable to an Indemnified Party
with respect to any loss, liability, claim, damage or expense referred to
herein, then the Indemnifying Party, in lieu of indemnifying such
Indemnified Party hereunder, shall contribute to the amount paid or payable
by such Indemnified Party as a result of such loss, liability, claim,
damage or expense in such proportion as is appropriate to reflect the
relative fault of the Indemnifying Party on the one hand and of the
Indemnified Party on the other in connection with the statements or
omissions which resulted in such loss, liability, claim, damage or expense,
as well as any other relevant equitable considerations. The relative fault
of the Indemnifying Party and of the Indemnified Party shall be determined
by reference to, among other things, whether the untrue (or alleged untrue)
statement of a material fact or the omission (or alleged omission) to state
a material fact relates to information supplied by the Indemnifying Party
or by the Indemnified Party and the parties' relative intent, knowledge,
access to information and opportunity to correct or prevent such statement
or omission.
(e) Notwithstanding the foregoing, to the extent that the provisions
on indemnification and contribution contained in the underwriting agreement
entered into in connection with any underwritten public offering
contemplated by this Agreement are in conflict with the foregoing
provisions, the provisions in such underwriting agreement shall be
controlling.
(f) The foregoing indemnity agreement of the Company and the Holders
is subject to the condition that, insofar as they relate to any loss,
claim, liability or damage made in a preliminary prospectus but eliminated
or remedied in the amended prospectus on file with the Commission at the
time the registration statement in question becomes effective or the
amended prospectus filed with the Commission pursuant to Commission Rule
424(b) (the "Final Prospectus"), such indemnity agreement shall not inure
to the benefit of any underwriter if a copy of the Final Prospectus was
furnished to the underwriter and was not furnished to the person asserting
the loss, liability, claim or damage at or prior to the time such action is
required by the Securities Act.
9.7 INFORMATION BY THE HOLDERS. Each of the Holders holding securities
included in any registration shall furnish to the Company such information
regarding such Holder and the distribution proposed by such Holder
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as the Company may reasonably request in writing and as shall be reasonably
required in connection with any registration, qualification or compliance
referred to in this Section 9.
9.8 RULE 144 REPORTING. With a view to making available the benefits of
certain rules and regulations of the Commission which may permit the sale of
restricted securities to the public without registration, the Company agrees to:
(a) make and keep public information available as those terms are
understood and defined in Rule 144;
(b) use its best efforts to file with the SEC in a timely manner all
reports and other documents required of the Company under the Securities
Act and the Merger Act at any time after it has become subject to such
reporting requirements; and
(c) so long as the Holder owns any Registrable Securities, furnish to
the Holder upon request, a written statement by the Company as to its
compliance with the reporting requirements of Rule 144 (at any time from
and after ninety (90) days following the effective date of the first
registration statement filed by the Company for an offering of its
securities to the general public), and of the Securities Act and the Merger
Act (at any time after it has become subject to such reporting
requirements), a copy of the most recent annual or quarterly report of the
Company, and such other reports and documents so filed as the Holder may
reasonably request in availing itself of any rule or regulation of the
Commission allowing the Holder to sell any such securities without
registration.
9.9 "MARKET STAND-OFF " AGREEMENT.
(a) Each of the Holders agrees, if requested by the Company and an
underwriter of Common Stock (or other securities) of the Company, not to
sell or otherwise transfer or dispose of any Common Stock (or other
securities) of the Company held by such Holder during the 90-day period
following the effective date of a registration statement of the Company
filed under the Securities Act, provided that all executive officers and
directors of the Company enter into similar agreements. If requested by the
underwriters, the Holders shall execute a separate agreement to the
foregoing effect. The Company may impose stop-transfer instructions with
respect to the shares (or securities) subject to the foregoing restriction
until the end of said 90-day period. The provisions of this Section 9.8
shall be binding upon any transferee who acquires Registrable Securities,
whether or not such transferee is entitled to the registration rights
provided hereunder.
(b) The Company agrees, if requested by the Holders and the
underwriter selected thereby pursuant to Section 9.2(b), not to sell or
otherwise transfer or dispose of any Common Stock (or other securities) of
the Company pursuant to a public offering (other than an offering under
Form S-8) during the 90-day period following the effective date of a
registration statement of the Company filed under the Securities Act in
accordance with the provisions of Section 9.2 hereof, provided that all
Holders enter a "stand off" agreement under Section 9.9(a) hereof.
9.10 PREPARATION; REASONABLE INVESTIGATION. In connection with the
preparation and filing of each registration statement under the Securities Act
pursuant to this Agreement, the Company will give the Holders owning Shares to
be registered under such registration statement, their underwriters, if any, and
their respective counsel and accountants (the "Inspectors"), the opportunity to
participate in the preparation of such registration statement, each prospectus
included therein or filed with the SEC, and each amendment or supplement
thereto, and will give each of them such access to its books and records and
such opportunities to discuss the business of the Company with its officers and
the independent public accountants who have certified its financial statements
as shall be necessary, in the opinion of such Holders' and such underwriters'
respective counsel, to conduct a reasonable investigation within the meaning of
the Securities Act. Records which the Company determines in good faith to be
confidential and which it notifies the Inspectors in writing are confidential
shall be treated as confidential by each Inspector in accordance with such
procedures as such Inspector applies generally to information of this kind
unless (a) disclosure of such records is necessary to avoid or correct a
misstatement or omission in the registration statement or any prospectus used in
connection
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therewith, (b) the information contained in such records has become generally
available to the public, (c) disclosure is required in any report, statement or
testimony required to be submitted to any governments authority having or
claiming to have jurisdiction over such Inspector), or (d) disclosure is
required in response to any summons or subpoena or in connection with any
litigation.
9.11 ADJUSTMENT AFFECTING SHARES. The Company will not effect or permit to
occur any combination or subdivision of the Registrable Securities which would
adversely affect the ability of the Holders to include the Registrable
Securities in any registration of its securities contemplated by this Article 9
or the marketability of the Registrable Securities under any such registration.
9.12 TERMINATION. The registration rights set forth in this Section 9
shall not be available to any Holder if, in the opinion of counsel to the
Company, all of the Registrable Securities then owned by such Holder could be
sold in any 90-day period pursuant to Rule 144 under the Securities Act (without
giving effect to the provisions of Rule 144(k) in the case of a Holder owing
more than three percent (3.0%) of the Common Stock then outstanding).
9.13 ASSIGNMENT. The registration rights set forth in this Section 9 shall
be assignable, in whole or in part, to any transferee of Common Stock in a
private placement or other unregistered sale (who shall be bound by all
obligations of this Section 9).
SECTION 10. MISCELLANEOUS.
10.1 NOTICES. Any notice required to be given hereunder shall be
sufficient if in writing, and sent by facsimile and by courier service (with
proof of service), hand delivery or certified or registered mail (return receipt
requested and first-class postage prepaid), addressed: (x) if to the Company, at
the Company's principal business address at [ ] or (y) if to Mutual, at
the address of Mutual listed in the stock records of the Company, or (z) to such
other address as any party shall specify by written notice so given, and such
notice shall be deemed to have been delivered as of the date so
telecommunicated, personally delivered or if mailed, the date of receipt.
10.2 ASSIGNMENT, BINDING EFFECT; BENEFIT. Unless expressly provided in
this Agreement, neither this Agreement nor any of the rights, interests or
obligations hereunder shall be assigned by any of the parties hereto (whether by
operation of law or otherwise) without the prior written consent of the other
parties. Subject to the preceding sentence, this Agreement shall be binding upon
and shall inure to the benefit of the parties hereto and their respective
successors and assigns.
10.3 ENTIRE AGREEMENT. This Agreement constitutes the entire agreement
among the parties with respect to the subject matter hereof and supersedes all
prior agreements and understandings among the parties with respect thereto. No
addition to or modification of any provision of this Agreement shall be binding
upon any party hereto unless made in writing and signed by all parties hereto.
10.4 AMENDMENT. This Agreement may not be amended except by an instrument
in writing signed on behalf of each of the parties hereto.
10.5 GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of Delaware, without regard to its rules
of conflict of laws.
10.6 HEADINGS. Headings of the sections of this Agreement are for the
convenience of the parties only, and shall be given no substantive or
interpretive effect whatsoever.
10.7 INTERPRETATION. In this Agreement, unless the context otherwise
requires, words describing the singular number shall include the plural and vice
versa, and words denoting any gender shall include all genders and words
denoting natural persons shall include corporations and partnerships and vice
versa.
10.8 WAIVERS. Except as provided in this Agreement, no action taken
pursuant to this Agreement, including, without limitation, any investigation by
or on behalf of any party, shall be deemed to constitute a waiver by the party
taking such action of compliance with any representations, warranties, covenants
or agreements contained in this Agreement. The waiver by any party hereto of a
breach of any provision
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hereunder shall not operate or be construed as a waiver of any prior or
subsequent breach of the same or any other provision hereunder.
10.9 SEVERABILITY. Any term or provision of this Agreement which is
invalid or unenforceable in any jurisdiction shall, as to that jurisdiction, be
ineffective to the extent of such invalidity or unenforceability without
rendering invalid or unenforceable the remaining terms and provisions of this
Agreement or affecting the validity or enforceability of any of the terms or
provisions of this Agreement in any other jurisdiction. If any provision of this
Agreement is so broad as to be unenforceable, the provision shall be interpreted
to be only so broad as is enforceable.
10.10 ENFORCEMENT OF AGREEMENT. The parties hereto agree that irreparable
damage would occur in the event that any of the provisions of this Agreement was
not performed in accordance with its specific terms or was otherwise breached.
It is accordingly agreed that the parties shall be entitled to an injunction or
injunctions to prevent breaches of this Agreement and to enforce specifically
the terms and provisions hereof, this being in addition to any other remedy to
which they are entitled at law or in equity.
10.11 COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original and all of which
together shall be considered one and the same agreement.
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IN WITNESS WHEREOF, the parties have executed this Agreement and caused the
same to be duly delivered on their behalf on the day and year first written
above.
<TABLE>
<S> <C>
Attest: COVENTRY HEALTH CARE, INC.
By: Name:__________________________________ By: Name:_______________________________________
Title: Secretary Title: President and Chief Executive Officer
PRINCIPAL MUTUAL LIFE INSURANCE COMPANY
By: Name:_______________________________________
Title:
PRINCIPAL HEALTH CARE, INC.
By: Name:_______________________________________
Title:
</TABLE>
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[CREDIT SUISSE FIRST BOSTON CORPORATION LETTERHEAD]
FORM OF OPINION
March [ ], 1998
Board of Directors
Coventry Corporation
53 Century Boulevard
Nashville, TN 37214
Dear Sirs:
You have asked us to advise you with respect to the fairness to Coventry
Corporation ("Coventry") from a financial point of view of the consideration to
be paid by Coventry Health Care, Inc., a Delaware corporation ("Newco"),
pursuant to the terms of the Capital Contribution and Merger Agreement,
effective as of November 3, 1997 (the "Business Combination Agreement"), among
Coventry, Newco, Principal Health Care, Inc. ("Principal"), Coventry Health
Care, Inc., a Maryland corporation, Principal Holding Company ("Holding"), and
Principal Mutual Life Insurance Company ("Mutual"). The Business Combination
Agreement provides for the merger (the "Merger") of Coventry Merger Corporation,
a wholly owned subsidiary of Newco ("Merger Sub"), with and into Coventry,
whereby each issued and outstanding share of common stock of Coventry shall be
converted into the right to receive one share of common stock of Newco including
the associated common stock purchase rights (the "Newco Common Stock"). As a
result of the Merger, Newco shall own all of the issued and outstanding shares
of capital stock of Coventry, and the shareholders of Coventry (the "Coventry
Shareholders") shall own that number of shares of Newco Common Stock equal to
the number of shares of capital stock of Coventry which they formerly owned. At
the Effective Time (as defined in the Business Combination Agreement), Principal
will contribute (the "Capital Contribution") to Newco all right, title and
interest in substantially all of its assets, including all of the issued and
outstanding capital stock of the Principal Subsidiaries (as defined in the
Business Combination Agreement), all real and personal property owned or leased
by Principal, all accounts receivable, tax refunds, cash, securities, contract
rights, prepaid liabilities and all other assets of Principal, except for the
Excluded Assets (as defined in the Business Combination Agreement), in
consideration for the issuance and delivery by Newco to Principal of that number
of shares of Newco Common Stock which equals (A) 66 2/3% of the Newco Common
Stock issued to the Coventry Shareholders in the Merger plus (B) 66 2/3% of the
Newco Common Stock issuable upon conversion of Newco's Convertible Subordinated
Promissory Notes and Newco's Series A Convertible Preferred Stock outstanding at
the Effective Time. In addition, at the Effective Time, Newco will issue to
Mutual a warrant giving Principal the right to purchase a number of shares of
Newco Common Stock equal to 66 2/3 of the total number of shares of Newco Common
Stock issuable upon exercise or conversion of the options and warrants assumed
by Newco that are issued and outstanding at the closing of the Business
Combination Agreement, in consideration for the execution and delivery by Mutual
of a Co-Insurance Agreement pursuant to which Coventry Health and Life Insurance
Company will assume through indemnity reinsurance Mutual's indemnity health
insurance policies in markets where Coventry and Principal have a presence (the
"In-Market Indemnity Business"). The Business Combination Agreement also
provides for (x) a cash payment by Newco to Principal of the amount, if any, by
which Principal's Tangible Net Value (as defined in the Business Combination
Agreement) exceeds $103,000,000, or by Principal and/or Mutual to Newco of the
amount, if any, by which $103,000,000 exceeds Principal's Tangible Net Value and
(y) certain actions to be taken by Principal and Mutual which will result in
additional payments to Newco (the payments pursuant to clauses (x) and (y) being
referred to herein as the "Additional Payments"). Pursuant to the Business
Combination Agreement, at the Effective Time outstanding Convertible
Subordinated Promissory Notes and outstanding Series A Convertible Preferred
Stock of Coventry shall be converted into the right to receive Convertible
Subordinated Promissory Notes and Series A Convertible Preferred Stock,
respectively, of Newco and the Coventry Options and Coventry Warrants (each as
defined in the Business Combination Agreement) shall be assumed by Newco and
shall become exercisable for Newco Common Stock.
In connection with the transfer of the In-Market Indemnity Business, Mutual and
Newco will enter into (i) a Management Services Agreement (the "Management
Services Agreement") pursuant to which Newco will
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Board of Directors
March [ ], 1998
Page 2
provide to Mutual certain management services and receive a monthly management
fee of 3.3% of the net premiums earned by Mutual during such month with respect
to the In-Market Indemnity Business, and (ii) a Marketing Services Agreement
(the "Marketing Services Agreement") pursuant to which Newco will provide to
Mutual certain marketing services through December 1999. The Merger, the Capital
Contribution, the transfer of the In-Market Indemnity Business, the Additional
Payments and the payments by Mutual to Newco pursuant to the Management Services
Agreement and the Marketing Services Agreement are referred to herein
collectively as the "Business Combination."
In addition, Newco, Principal and Mutual will enter into a Shareholders'
Agreement (the "Shareholders' Agreement") containing, among other things, a five
year standstill agreement, various governance provisions and registration and
subscription rights in favor of Mutual.
In arriving at our opinion, we have reviewed certain publicly available business
and financial information relating to Coventry, Principal and Mutual's In-Market
Indemnity Business, as well as the Business Combination Agreement, the
Co-Insurance Agreement, the Management Services Agreement, the Marketing
Services Agreement, and the other exhibits to the Business Combination
Agreement. We have also reviewed certain other information, including financial
forecasts, provided to us by Mutual for the In-Market Indemnity Business and by
Coventry and Principal, and have met with each company's management to discuss
their respective businesses and prospects.
We have also considered certain financial and stock market data of Coventry, and
we have compared that data with similar data for other publicly held companies
in businesses similar to those of Coventry, and we have considered the financial
terms of certain other business combinations and other transactions which have
recently been effected. We also considered such other information, financial
studies, analyses and investigations and financial, economic and market criteria
which we deemed relevant. The opinion expressed herein is being rendered during
a period of unusual volatility in the financial markets, and it is necessarily
subject to the absence of further material developments in the financial,
economic and market conditions from those prevailing on the date hereof.
In connection with our review, we have not assumed any responsibility for
independent verification of any of the foregoing information and have relied on
its being complete and accurate in all material respects. With respect to the
financial forecasts, we have assumed that they have been reasonably prepared on
bases reflecting the best currently available estimates and judgments of the
respective managements of Coventry, Principal and Mutual as to the future
financial performance of Coventry, Principal and the In-Market Indemnity
Business, respectively. In addition, we have not made an independent evaluation
or appraisal of the assets or liabilities (contingent or otherwise) of Coventry,
Principal or the In-Market Indemnity Business, nor have we been furnished with
any such evaluations or appraisals. You have instructed us to assume that the
Business Combination will not constitute a change of control of Coventry. Our
opinion is necessarily based upon financial, economic, market and other
conditions as they exist and can be evaluated on the date hereof. We are not
expressing any opinion as to what the value of the Newco Common Stock actually
will be when issued to Coventry's shareholders pursuant to the Merger or the
prices at which such Newco Common Stock will trade subsequent to the Business
Combination.
Credit Suisse First Boston Corporation has been retained to render this fairness
opinion to the Board of Directors of Coventry in connection with the Business
Combination, and we will receive a fee for our services.
2
<PAGE> 277
Board of Directors
March [ ], 1998
Page 3
In the ordinary course of our business, Credit Suisse First Boston Corporation
and its affiliates may actively trade the debt and equity securities of Coventry
and the debt securities of Mutual for their own account and for the accounts of
customers and, accordingly, may at any time hold a long or short position in
such securities.
It is understood that this letter is not to be quoted or referred to, in whole
or in part, in any registration statement, prospectus or proxy statement, or in
any other document used in connection with the offering or sale of securities,
nor shall this letter be used for any other purposes, without Credit Suisse
First Boston Corporation's prior written consent, however, we consent to the
inclusion of this opinion letter in its entirety in the Registration Statement
on Form S-4, the proxy statement and the prospectus with respect to the Business
Combination.
Based upon and subject to the foregoing, it is our opinion that, as of the date
hereof, the consideration to be paid by Newco in the Business Combination is
fair to Coventry from a financial point of view.
Very truly yours,
CREDIT SUISSE FIRST BOSTON
CORPORATION
3
<PAGE> 278
PRELIMINARY COPY
CONFIDENTIAL -- FOR USE OF THE COMMISSION ONLY
PROXY DRAFT
COVENTRY CORPORATION
PROXY SOLICITED BY THE BOARD OF DIRECTORS
FOR THE SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON MARCH 31, 1998
The undersigned hereby appoints Dale B. Wolf and Shirley R. Smith, and each
of them, as proxies, with full power of substitution, to vote all shares of the
undersigned as shown below on this proxy at the Special Meeting of Shareholders
of Coventry Corporation to be held at 9:30 a.m., Central Daylight Saving Time,
on March 31, 1998, in the Fourth Floor Conference Room, SunTrust Bank Building,
201 4th Avenue North, Nashville, Tennessee 37219 and any adjournments thereof.
Your shares will be voted in accordance with your instructions. If no choice
is specified, shares will be voted FOR the approval of the Combination Agreement
(as hereinafter defined) and the related Merger Plan (as hereinafter defined)
and FOR adjournment of the Special Meeting, if necessary, to permit further
solicitation of proxies if there are not sufficient votes to approve the
Combination Agreement and related Merger Plan.
<TABLE>
<S> <C>
/X/ Please mark
vote in oval in
the following
manner using dark
ink only
</TABLE>
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ITEMS 1 AND 2
<TABLE>
<S> <C> <C> <C>
1. To approve that certain Capital Contribution and FOR AGAINST ABSTAIN
Merger Agreement effective as of November 3, 1997 / / / / / /
(amending and restating the Capital Contribution
and Share Exchange Agreement dated November 3,
1997) (the "Combination Agreement") and the
related Agreement and Plan of Merger (the "Merger
Plan").
2. To adjourn The Special Meeting, if necessary, to FOR AGAINST ABSTAIN
permit further solicitation of proxies in the / / / / / /
event that there are not sufficient votes at the
time of the Special Meeting to approve the
Combination Agreement and the related Merger
Plan.
</TABLE>
PLEASE SIGN HERE AND RETURN
PROMPTLY
-------------------------------
Signature
-------------------------------
Signature (if held jointly)
Date:____________________, 1998
Please sign exactly as your
name appears at left. If
registered in the names of two
or more persons, each should
sign. Executors,
administrators, trustees,
guardians, attorneys, and
corporate officers should print
their full names and titles.
<PAGE> 279
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
(a) The Delaware General Corporation Law ("DGCL") provides that a
corporation may indemnify any person made party to an action by reason of such
person's status as a director, officer, employee or agent of the corporation
against expenses, judgments, fines and settlements provided such person acted
(i) in good faith, (ii) in a manner reasonably believed to be in or not opposed
to the best interests of the Corporation and (iii) with respect to a criminal
action, had no reasonable cause to believe such person's conduct was unlawful.
The termination of an action by a judgment, order, settlement, conviction or
plea of nolo contendere shall not create a presumption that a person did not
meet the standard of conduct set forth above. In actions brought by or in the
right of the corporation, however, the DGCL provides that no indemnification may
be made if the person was adjudged to be liable to the corporation unless and
only to the extent that the Court of Chancery or the court in which such action
was brought shall determine upon application that, despite the adjudication of
liability but in view of all circumstances of the case, such person is fairly
and reasonably entitled to indemnity for such expenses which the court shall
deem proper. To the extent that a person is successful, on the merits or
otherwise, in the defense of any proceeding instigated because of his or her
status as a director, officer, employee or agent of a corporation, the DGCL
mandates that the corporation indemnify such person against reasonable expenses
incurred in the proceeding. A corporation may advance litigation expenses,
including attorneys' fees, to a person who is a party to a proceeding upon such
person undertaking to repay such amount if it shall ultimately be determined
that such person is not entitled to indemnification. The indemnification and
advancement of expenses under the DGCL are not deemed exclusive of any other
rights to which a person may be entitled under any bylaw, agreement, vote of
shareholders or disinterested directors or otherwise.
(b) Article VI of the Registrant's Certificate of Incorporation provides as
follows:
(i) To the fullest extent permitted by the DGCL, as amended from time to
time, a person who is or was a director, officer, employee or agent of the
Corporation shall not be liable to the Corporation or its stockholders for
monetary damages for breach of fiduciary duty as a director, officer, employee
or agent and shall be indemnified against any liability or expense incurred by
reason of the fact that such person is or was a director, officer, employee or
agent of the Corporation, if such person acted in good faith and in, or not
opposed to, the best interests of the Corporation, and, with respect to any
criminal action, had no reasonable cause to believe his conduct was unlawful.
II-1
<PAGE> 280
ITEM 21. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
2.1 Capital Contribution and Merger Agreement (included as Annex
I)
2.2 Agreement and Plan of Merger (included as Annex II)
+ 3.1 Newco Articles of Incorporation
+ 3.2 Newco Bylaws
+ 4.1 Form of Newco Rights Agreement
5.1 Opinion of Bass, Berry & Sims PLC as to the validity of the
shares being offered
8.1 Opinion of Bass, Berry & Sims PLC as to certain federal
income tax matters
10.1 Form of Newco Warrant (included as Annex III)
+10.2 Form of Coinsurance Agreement
+10.3 Form of Renewal Rights Agreement
+10.4 Form of Transition Agreement
+10.5 Form of Management Services Agreement
10.6 Form of Shareholders' Agreement (included as Annex IV)
+10.7 Form of Tax Benefit Restitution Agreement
+10.8 Form of License Agreement
+10.9 Form of Marketing Service Agreement
+10.10 Form of 1998 Incentive Stock Option Plan of Coventry Health
Care, Inc.
+10.11 Amendment to Administrative Agreement (PHC)
+10.12 Amendment to Administrative Agreement (PHC-Georgia)
10.13 Employment Agreement dated September 16, 1996 executed by
Allen F. Wise**
10.14 Form of Kenneth J. Linde Employment Agreement
10.15 Employment Agreement dated December 30, 1996 executed by
Dale B. Wolf**
10.16 Credit Agreement among Coventry Corporation, the Banks
listed therein and Morgan Guaranty Trust Company of New
York, as Agent (Incorporation by reference to Exhibit 10
attached to Coventry's Current Report on Form 8-K dated
January 9, 1997)
10.17 Form of Coventry's Agreement (for Key Senior Executives)
dated September 12, 1995 (executed by Richard H. Jones)
(Incorporated by reference to Exhibit (xxviii) to Form 10-Q,
Quarterly Report, for the quarter ended September 30, 1995)*
10.18 Form of Coventry's Agreement (for Key Executives) dated
September 12, 1995 (executed by James R. Hailey, Jan H.
Hodges and Shirley R. Smith) (Incorporated by reference to
Exhibit (xxix) to Form 10-Q, Quarterly Report, for the
quarter ended September 30, 1995)*
10.19 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)*
10.20 Employment Agreement dated January 1, 1997 executed by Jan
H. Hodges**
10.21 Employment Agreement dated January 24, 1997 executed by
Robert A. Mayer**
10.22 Employment Agreement dated January 15, 1997 executed by
Shirley R. Smith**
10.23 Risk Sharing Agreement dated as of March 31, 1997 by and
among HealthAmerica Pennsylvania, Inc., Coventry Corporation
and Allegheny Health, Education and Research Foundation***
10.24 First Amendment to Risk Sharing Agreement, dated June 11,
1997, by and between Coventry Corporation and Allegheny
Health, Education & Research Foundation***
10.25 Second Amendment to Risk Sharing Agreement, dated June 30,
1997, by and between Coventry Corporation and Alleghency
Health, Education & Research Foundation***
10.26 Third Amendment to Risk Sharing Agreement, dated July ,
1997, by and between Coventry Corporation and Allegheny
Health, Education & Research Foundation***
</TABLE>
II-2
<PAGE> 281
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
10.27 Global Capitation Agreement, dated March 12, 1997, by and
among Group Health Plan, Inc., HealthCare USA of Missouri,
LLC and BJC Health System***
10.28 Amended and Restated Securities Purchase Agreement, dated as
of April 2, 1997, by and among Coventry Corporation,
Warburg, Pincus Ventures, L.P. and Franklin Capital
Associates III, L.P., together with Exhibit A, Exhibit B,
Exhibit C, Schedule I, Schedule 2.1, Schedule 7.14, and
Schedule 12.14 thereto (Incorporated by reference to
Coventry's Current Report on Form 8-K dated May 7, 1997)
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Ernst & Young, LLP
23.3 Consent of Persons Named as Directors
23.4 Consent of CSFB (included in Opinion of CSFB, Annex V)
99. Opinion of CSFB (included as Annex V)
</TABLE>
- ---------------
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.
+ Previously filed on February 6, 1998.
* Management contract or compensatory plan.
** Previously filed as part of Coventry's Annual Report on Form 10-K for fiscal
year ended December 31, 1996.
*** Filed as exhibits 10.1 through 10.5, respectively, to Coventry's Current
Report on Form 8-K Dated February 6, 1998. Portions of these Exhibits are
subject to a request for confidential treatment, and to the extent such
request is granted, will be subject to confidential treatment.
<TABLE>
<CAPTION>
FINANCIAL STATEMENT SCHEDULES PAGE
- ----------------------------- ----
<S> <C>
Report of Independent Public Accountants of Coventry........ S-1
Schedule II -- Valuation and Qualifying Accounts............ S-2
Report of Independent Public Accountants of PHC............. S-3
Schedule II -- Valuation and Qualifying Accounts............ S-4
</TABLE>
ITEM 22. UNDERTAKINGS.
(a)(1) The undersigned Registrant hereby undertakes as follows: that prior
to any public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this Registration Statement, by any person or
party which is deemed to be an underwriter within the meaning of Rule 145(c),
the issuer undertakes that such reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other items of the applicable form.
(2) The Registrant undertakes that every prospectus (i) that is filed
pursuant to paragraph (b)(1) immediately preceding, or (ii) that purports to
meet the requirements of Section 10(a)(3) of the Act and is used in connection
with an offering of securities subject to Rule 145, will be filed as part of an
amendment to the Registration Statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act of 1933, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described under Item 14 above, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore,
II-3
<PAGE> 282
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
(c) The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Item 4, 10(b) or 11 of this form, within one business day of receipt of such
request, and to send the incorporated documents by first class mail or other
equally prompt means. This includes information contained in documents filed
subsequent to the effective date of this registration statement through the date
of responding to the request.
(d) The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the Registration Statement when it became effective.
II-4
<PAGE> 283
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in Nashville, Tennessee on
March , 1998.
COVENTRY HEALTH CARE, INC.
By: /s/ DALE B. WOLF
------------------------------------
Dale B. Wolf, President
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ DALE B. WOLF President and Director, Chief March , 1998
- ----------------------------------------------------- Executive Officer, Chief
Dale B. Wolf Financial Officer and Chief
Accounting Officer
/s/ KENNETH J. LINDE* Director March , 1998
- -----------------------------------------------------
Kenneth J. Linde
</TABLE>
- ---------------
* By Dale B. Wolf as Attorney-in-Fact
II-5
<PAGE> 284
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
<PAGE> 285
SCHEDULE II
COVENTRY CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS
BEGINNING OF CHARGED TO COSTS DEDUCTIONS BALANCE AT
PERIOD AND EXPENSES(1) (CHARGE OFFS)(1) END OF PERIOD
------------ ---------------- ---------------- -------------
<S> <C> <C> <C> <C>
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
====== ====== ======= ======
</TABLE>
- ---------------
(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
<PAGE> 286
REPORT OF INDEPENDENT AUDITORS
We have audited the financial statements of PHC as of December 31, 1996 and
1995, and for each of the three years in the period ended December 31, 1996, and
have issued our report thereon dated February 26, 1997 (included elsewhere in
this registration statement). Our audits also included Schedule II of PHC. This
financial statement schedule is the responsibility of PHC's management. Our
responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule of PHC referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
Ernst & Young LLP
February 26, 1997
Washington, DC
S-3
<PAGE> 287
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
PRINCIPAL HEALTH CARE, INC.
SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- --------------------- ------------------- ------------------------------------ ---------- -------------------
ADDITIONS
------------------------------------
BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT
DESCRIPTION BEGINNING OF PERIOD AND EXPENSED OTHER ACCOUNTS(1) DEDUCTIONS BEGINNING OF PERIOD
- ----------- ------------------- ---------------- ----------------- ---------- -------------------
<S> <C> <C> <C> <C> <C>
Year Ended December
31, 1996:
Allowance for
Doubtful
Accounts......... $7,460,712 $ 68,657 $10,235,091 $7,529,369 $10,235,091
Year Ended December
31, 1995:
Allowance for
Doubtful
Accounts......... $1,935,776 $154,607 $ 7,460,712 $2,090,383 $ 7,460,712
Year Ended December
31, 1994:
Allowance for
Doubtful
Accounts......... $1,191,708 $119,887 $ 1,935,776 $1,311,595 $ 1,935,776
</TABLE>
Notes:
(1) Amounts represent provision for estimated retroactive membership adjustments
to be made subsequent to the period in which the revenue was originally
reported. Amounts are reflected as a reduction of premium revenues in the
consolidated statements of income.
S-4
<PAGE> 288
EXHIBIT INDEX
The following is a list of exhibits to the Registration Statement:
<TABLE>
<CAPTION>
<C> <S>
2.1 Capital Contribution and Merger Agreement (included as Annex
I)
2.2 Agreement and Plan of Merger (included as Annex II)
+ 3.1 Newco Articles of Incorporation
+ 3.2 Newco Bylaws
+ 4.1 Form of Newco Rights Agreement
5.1 Opinion of Bass, Berry & Sims PLC as to the validity of the
shares being offered
8.1 Opinion of Bass, Berry & Sims PLC as to certain federal
income tax matters
10.1 Form of Newco Warrant (included as Annex III)
+10.2 Form of Coinsurance Agreement
+10.3 Form of Renewal Rights Agreement
+10.4 Form of Transition Agreement
+10.5 Form of Management Services Agreement
10.6 Form of Shareholders' Agreement (included as Annex IV)
+10.7 Form of Tax Benefit Restitution Agreement
+10.8 Form of License Agreement
+10.9 Form of Marketing Service Agreement
+10.10 Form of 1998 Incentive Stock Option Plan of Coventry Health
Care, Inc.
+10.11 Amendment to Administrative Agreement (PHC)
+10.12 Amendment to Administrative Agreement (PHC-Georgia)
10.13 Employment Agreement dated September 16, 1996 executed by
Allen F. Wise**
+10.14 Form of Kenneth J. Linde Employment Agreement
10.15 Employment Agreement dated December 30, 1996 executed by
Dale B. Wolf**
10.16 Credit Agreement among Coventry Corporation, the Banks
listed therein and Morgan Guaranty Trust Company of New
York, as Agent (Incorporation by reference to Exhibit 10
attached to Coventry's Current Report on Form 8-K dated
January 9, 1997)
10.17 Form of Coventry's Agreement (for Key Senior Executives)
dated September 12, 1995 (executed by Richard H. Jones)
(Incorporated by reference to Exhibit (xxviii) to Form 10-Q,
Quarterly Report, for the quarter ended September 30, 1995)*
10.18 Form of Coventry's Agreement (for Key Executives) dated
September 12, 1995 (executed by James R. Hailey, Jan H.
Hodges and Shirley R. Smith) (Incorporated by reference to
Exhibit (xxix) to Form 10-Q, Quarterly Report, for the
quarter ended September 30, 1995)*
10.19 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)*
10.20 Employment Agreement dated January 1, 1997 executed by Jan
H. Hodges**
10.21 Employment Agreement dated January 24, 1997 executed by
Robert A. Mayer**
10.22 Employment Agreement dated January 15, 1997 executed by
Shirley R. Smith**
10.23 Risk Sharing Agreement dated as of March 31, 1997 by and
among HealthAmerica Pennsylvania, Inc., Coventry Corporation
and Allegheny Health, Education and Research Foundation***
10.24 First Amendment to Risk Sharing Agreement, dated June 11,
1997, by and between Coventry Corporation and Allegheny
Health, Education & Research Foundation***
10.25 Second Amendment to Risk Sharing Agreement, dated June 30,
1997, by and between Coventry Corporation and Alleghency
Health, Education & Research Foundation***
10.26 Third Amendment to Risk Sharing Agreement, dated July ,
1997, by and between Coventry Corporation and Allegheny
Health, Education & Research Foundation***
</TABLE>
<PAGE> 289
<TABLE>
<C> <S>
10.27 Global Capitation Agreement, dated March 12, 1997, by and among Group Health Plan, Inc., HealthCare USA
of Missouri, LLC and BJC Health System***
10.28 Amended and Restated Securities Purchase Agreement, dated as of April 2, 1997, by and among Coventry
Corporation, Warburg, Pincus Ventures, L.P. and Franklin Capital Associates III, L.P., together with
Exhibit A, Exhibit B, Exhibit C, Schedule I, Schedule 2.1, Schedule 7.14, and Schedule 12.14 thereto
(Incorporated by reference to Coventry's Current Report on Form 8-K dated May 7, 1997)
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Ernst & Young, LLP
23.3 Consent of Persons Named as Directors
23.4 Consent of CSFB (included in the Opinion of CSFB, Annex V)
99. Opinion of CSFB (included as Annex V)
</TABLE>
- ---------------
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.
+ Previously filed on February 6, 1998.
* Management contract or compensatory plan.
** Previously filed as part of Coventry's Annual Report on Form 10-K for fiscal
year ended December 31, 1996.
*** Filed as exhibits 10.1 through 10.5, respectively, to Coventry's Current
Report on Form 8-K Dated February 6, 1998. Portions of these Exhibits are
subject to a request for confidential treatment, and to the extent such
request is granted, will be subject to confidential treatment.
<PAGE> 1
Exhibit 5.1
B A S S, B E R R Y & S I M S P L C
A PROFESSIONAL LIMITED LIABILITY COMPANY
ATTORNEYS AT LAW
2700 FIRST AMERICAN CENTER 1700 RIVERVIEW TOWER
NASHVILLE, TENNESSEE 37238-2700 POST OFFICE BOX 1509
TELEPHONE (615) 742-6200 KNOXVILLE, TENNESSEE 37901-1509
TELECOPIER (615) 742-6293 TELEPHONE (423) 521-6200
TELECOPIER (423) 521-6234
March 10, 1998
Coventry Health Care, Inc.
501 Corporate Drive, Suite 400
Franklin, TN 37204
Re: REGISTRATION STATEMENT ON FORM S-4
Dear Ladies and Gentlemen:
We have acted as your counsel in connection with the preparation of a
Registration Statement on Form S-4 (the "Registration Statement") to be filed by
you with the Securities and Exchange Commission on March 10, 1998, covering
the shares of common stock, no par value (the "Common Stock"), of Coventry
Health Care, Inc., a Delaware corporation (the "Company"), to be issued by the
Company pursuant to and in accordance with the Capital Contribution and Merger
Agreement dated as of November 3, 1997 (the "Combination Agreement") by and
among the Company, Coventry Corporation, Principal Health Care, Inc., Principal
Holding Company and Coventry Health Care, Inc., a Maryland corporation.
In connection with this opinion, we have examined and relied upon such
records, documents and other instruments as in our judgment are necessary or
appropriate in order to express the opinions hereinafter set forth and have
assumed the genuineness of all signatures, the authenticity of all documents
submitted to us as originals, and the conformity to original documents of all
documents submitted to us as certified or photostatic copies.
Based upon the foregoing and such other matters as we have deemed
relevant, we are of the opinion that the shares of Common Stock to be issued by
the Company, when issued and delivered in the manner and on the terms set forth
in the Combination Agreement and as described in the Registration Statement
(after the Registration Statement is declared effective), will be validly
issued, fully paid and nonassessable.
We hereby consent to the reference to our law firm in the Registration
Statement under the caption "Legal Matters" and to the use of this opinion as an
exhibit to the Registration Statement.
Sincerely,
/s/ Bass, Berry & Sims PLC
<PAGE> 1
Exhibit 8.1
B A S S, B E R R Y & S I M S P L C
A PROFESSIONAL LIMITED LIABILITY COMPANY
ATTORNEYS AT LAW
2700 FIRST AMERICAN CENTER 1700 RIVERVIEW TOWER
NASHVILLE, TENNESSEE 37238-2700 POST OFFICE BOX 1509
TELEPHONE (615) 742-6200 KNOXVILLE, TENNESSEE 37901-1509
TELECOPIER (615) 742-6293 TELEPHONE (423) 521-6200
TELECOPIER (423) 521-6234
March 10, 1998
Board of Directors
Coventry Corporation
53 Century Boulevard, Suite 250
Nashville, Tennessee 37214
Gentlemen:
You have requested our opinion regarding certain federal income tax
consequences of a merger and capital contribution to be effected through (i) a
merger (the "Merger") of Coventry Merger Corporation, a Tennessee corporation
("Subsidiary"), a wholly owned subsidiary of Coventry Health Care, Inc., a
Delaware corporation ("Newco"), into Coventry Corporation, a Tennessee
corporation ("Coventry"), with Coventry being the surviving corporation, and
(ii) a capital contribution (the "Capital Contribution") of certain assets by
Principal Health Care, Inc., an Iowa corporation ("PHC") to Newco, pursuant to
the terms of the Amended and Restated Capital Contribution and Merger Agreement
dated as of December 8, 1997 (the "Merger Agreement"), by and among Coventry and
PHC, and as described in the Registration Statement on Form S-4 as filed with
the Securities and Exchange Commission on March 10, 1998 (the "Registration
Statement").
Our opinion is based upon (i) the Merger Agreement, (ii) the facts set
forth in the Registration Statement, (iii) the assumption that representations
with respect to the Merger made by management of Coventry and PHC and by certain
shareholders of Coventry are true and correct today and will be true and correct
as of the effective time of the Merger, and (iv) current provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the regulations
thereunder, administrative rulings of the Internal Revenue Service and court
decisions. Based thereupon, and conditioned upon our understanding that the
transactions contemplated by the Merger Agreement will be carried out strictly
in accordance with the terms of the Merger Agreement it is our opinion that:
(1) Coventry's shareholders' ownership of Newco's common stock will be
included in the determination of whether the Merger and Capital
Contribution qualifies as a tax free transfer described in Section 351
of the Code.
(2) Provided that the Merger qualifies as a statutory merger under
applicable law, the Merger will constitute a reorganization within the
meaning of Section 368(a)(2)(E) of the Code.
(3) Coventry, Newco and Subsidiary will each be a "party to a
reorganization" within the meaning of Section 368(b) of the Code.
<PAGE> 2
Board of Directors
Page 2
March 10, 1998
(4) No gain or loss will be recognized to Coventry upon receipt of the
assets of Subsidiary in exchange for Newco Stock. IRC ss. 1032(a).
(5) No gain or loss will be recognized to Newco upon the receipt of
Coventry stock in exchange for stock of Newco. IRC ss. 354(a)(1).
(6) No gain or loss will be recognized to the shareholders of Coventry
upon the exchange of Coventry common stock solely for Newco common
stock. IRC ss. 354(a)(1).
(7) The basis of the Newco common stock received by the shareholders of
Coventry will be the same as the basis of the Coventry stock exchanged
therefor. IRC ss. 358(a)(1).
(8) The holding period of Newco common stock received by the shareholders
of Coventry will include the period during which the Coventry stock
surrendered in exchange therefor was held, provided the shareholders
of Coventry on the date of the Merger. IRC ss. 1223(1).
The opinion expressed herein is expressly premised and conditioned upon the
consummation of the Merger and Capital Contribution pursuant to the terms and
conditions of the Merger Agreement. Our opinions are also based upon the tax law
as in effect on the date hereof. You should note that future legislative
changes, administrative pronouncements and judicial decision could materially
alter the conclusions reached herein.
No opinion is expressed about the tax treatment of the Merger and Capital
Contribution under other provisions of the Code and regulations or about the tax
treatment of any conditions existing at the time of effects from, the Merger and
Capital Contribution that are not specifically covered by the above opinions.
This opinion letter is limited to the federal income tax issues specifically
addressed herein and we render no opinions regarding other issues that we have
not specifically addressed. Without limiting the generality of the immediately
preceding sentence, we specifically note that we render no opinion with respect
to state or local income tax ramifications of the Merger and Capital
Contribution.
We hereby consent to the use of our name in the Registration Statement and
to the filing of this letter as an exhibit to the Registration Statement. In
giving such consent, we do not thereby admit that we are in the category of
persons whose consent is required under section 7 of the Securities Act of 1933,
as amended, or the rules and regulations of the Securities and Exchange
Commission promulgated thereunder.
<PAGE> 3
Board of Directors
Page 3
March 10, 1998
We have rendered the foregoing opinion for the sole benefit and use of
Coventry, its Board of Directors and the Coventry shareholders and the views
herein may not be relied upon or furnished to any other person without our prior
written consent.
Sincerely,
/s/ Bass, Berry & Sims PLC
----------------------------------
Bass, Berry & Sims PLC
<PAGE> 1
Exhibit 10.14
EXECUTIVE VICE PRESIDENT AND CHIEF OPERATING OFFICER
EMPLOYMENT AGREEMENT
This Employment Agreement is entered into as of the ____ day of
_________, 199___, by and between Kenneth J. Linde ("Executive") and Coventry
Health Care, Inc. ("Employer"), a Delaware corporation with its principal place
of business at 6705 Rockledge Dr., Bethesda, Maryland 20817.
W I T N E S S E T H:
WHEREAS, Executive desires to enter into an employment relationship
with Employer and Employer desires to employ Executive; and
WHEREAS, Executive and Employer desire to set forth in a written
agreement the terms and conditions of such employment.
NOW, THEREFORE, in consideration of the premises hereof and of the
mutual promises and agreements contained herein, the parties hereto, intending
to be legally bound, hereby agree as follows:
1. EMPLOYMENT. On the Date of Employment (as defined in Section 3
below), Executive shall be engaged by Employer as its Executive Vice President
and Chief Operating Officer. Executive hereby agrees to such employment on and
after the Date of Employment under the terms and conditions hereinafter set
forth.
2. DUTIES. As Executive Vice President and Chief Operating Officer,
Executive shall report to the President and Chief Executive Officer and shall be
responsible for the overall direction, administration and leadership of
Employer, including, but not limited to, the establishment and implementation of
policies and directives, formulation of long range plans, goals and objectives,
effective management of employees, oversight of plan operations, and such other
powers and duties normally associated with such position or as may be delegated
or assigned to Executive by Employer's President and Chief Executive Officer or
Board of Directors. During the term of this Agreement, Executive shall also
serve without additional compensation in such other offices of the Employer or
its subsidiaries or affiliates to which he may be elected or appointed by the
Board of Directors of Employer or its subsidiaries or affiliates, respectively.
3. DATE OF EMPLOYMENT. Executive's employment shall commence on the
date of closing of the Merger and the Capital Contribution as those terms are
defined in that certain Capital Contribution and Merger Agreement, as amended,
effective as of November 3, 1997, by and among Employer, Coventry Corporation,
Coventry Health Care, Inc., (a Maryland corporation), Principal Health,
Principal Holding Company and Principal Mutual Life Insurance Company, (the
"Date of Employment").
4. INITIAL TERM. Subject to the terms and conditions set forth herein,
Executive shall be employed hereunder for an initial term of one year beginning
on the Date of Employment. If at the end of the initial term a new employment
contract is not executed, the term of this Agreement shall continue on a
year-to-year basis in the absence of notice of either party.
5. BASE COMPENSATION. For all duties rendered by Executive, Employer
shall pay Executive a base salary ("Base Salary") of Four Hundred Fifty Thousand
Dollars ($450,000), annually, to be reviewed on an annual basis based upon the
performance of Executive. The Base Salary shall be paid to Executive in equal
semi-monthly payments in accordance with Employer's
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<PAGE> 2
normal payroll policies.
6. ADDITIONAL COMPENSATION. During the period of this Agreement and as
a result of employment under this Agreement, Executive shall receive or be
eligible for the following additional compensation:
EMPLOYER STOCK OPTIONS: Employer shall assume that certain
Non-Qualified Stock Option Agreement (the "Stock Option Agreement") between
Executive and Principal Health Care, Inc., an Iowa corporation ("Principal
Health"), as of the Closing of the Merger and the Capital Contribution as those
terms are defined in that certain Capital Contribution and Merger Agreement, as
amended, entered into as of December ___, 1997, by and among Employer, Coventry
Corporation, Coventry Health Care, Inc., (a Maryland corporation), Principal
Health, Principal Holding Company and Principal Mutual Life Insurance Company,
which grants to Executive a nonqualified stock option to purchase 400,000 shares
of Common Stock of Principal Health Care, Inc., at an exercise price of $14.50
per share, vesting at a rate of one-third of the shares per year over a
three-year vesting period commencing March 31, 1999, or in the event of a change
in control (as defined in Principal Health's 1997 Non-Qualified Stock Option
Plan).
BONUS COMPENSATION: Executive shall be eligible for an annual bonus
("Bonus") potential of 100% of Base Compensation, which shall be determined as
follows: (i) up to 50% shall be based upon achievement of budget and other
operational performance factors, and (ii) all or any part of the remaining 50%
shall be granted in the sole discretion of the Compensation and Benefits
Committee (the "Committee") of the Board of Directors of Employer. Executive's
bonus and performance factors shall be determined on an annual basis by the
Committee, with Executive's initial Bonus amount and terms to be determined
within the first 60 days of employment based upon mutually agreeable criteria.
DISCRETIONARY EXPENSE ALLOWANCE: Executive shall be entitled to a
discretionary expense allowance of $1,200.00 per month.
OTHER BENEFITS: Executive will be eligible for participation in any
employee benefit programs available to officers of Employer from time to time as
provided in Section 15 below.
7. EXPENSES. Executive shall be reimbursed for ordinary and necessary
business expenses incurred by Executive on behalf of Employer and its
subsidiaries or affiliates upon presentation of vouchers in accordance with the
usual and customary procedure of Employer in relation to such expense items,
except that Employer may elect, at its option, to pay such expense items
directly rather than reimburse Executive therefor.
8. EXTENT OF SERVICE. Executive shall devote substantially all of his
working time, attention and energies to the business of the Employer and shall
not, during the term of this Agreement, take, directly or indirectly, an active
role in any other business activity without the prior written consent of the
Employer; but except as provided in Section 14(b), this Section shall not
prevent Executive from serving as a director of other entities not affiliated
with Employer, from making real estate or other investments of a passive nature
or from participating in the activities of a nonprofit charitable organization
where such participation does not require a substantial amount of time and does
not adversely affect Executive's ability to perform his duties under this
Agreement.
9. TERMINATION OF EMPLOYMENT. Employer may terminate this Agreement
with or without cause at any time during the term of this Agreement. If the
employment of Executive with Employer is terminated (i) by Employer for any
reason other than Good Cause (as defined in
2
<PAGE> 3
Section 25 below) or other than under the terms of Section 11 below, or (ii) by
Executive for Good Reason (as defined in Section 25 below), unless the terms of
Section 11 below apply, the following provisions will apply:
(a) Employer shall during the Severance Period (as
defined in Section 25 below), continue to pay
Executive an amount equal to:
(i) Executive's Base Salary at the time of
termination of employment; and
(ii) That portion of Executive's Bonus based on
achievement of budget and other operational
performance factors, if the criteria is met.
Such amount will be paid during the Severance Period
in monthly or other installments, similar to those
being received by Executive at the date of
termination of employment, and will commence as soon
as practicable following the date of termination of
employment.
(b) During the Severance Period Executive and his spouse
and family will continue to be covered by all Welfare
Plans (as defined in Section 25 below), maintained by
Employer in which he or his spouse or family were
participating immediately prior to the date of his
termination as if he continued to be an employee of
Employer; provided that, if participation in any one
or more of such Welfare Plans is not possible under
the terms thereof, Employer will provide
substantially identical benefits to the extent
possible. If, however, Executive obtains employment
with another employer during the Severance Period,
such coverage shall be provided until the earlier of:
(i) the end of the Severance Period or (ii) the date
on which the Executive and his spouse and family can
be covered under the plans of a new employer without
being excluded from full coverage because of any
actual pre-existing condition.
(c) Executive shall not be entitled to payments during
the Severance Period attributable to compensation for
vacation periods he would have earned had his
employment continued during the Severance Period or
to unused vacation periods accrued as of the date of
termination of employment.
(d) During the Severance Period Executive shall not be
entitled to reimbursement for fringe benefits such as
car allowance, dues and expenses related to club
memberships, and expenses for professional services.
Compensation under Section 9(a) and (b) hereof is contingent upon
Executive's compliance with Section 14 hereof.
10. TERMINATION BY EXECUTIVE. Executive may terminate his employment
hereunder at any time upon sixty (60) days prior written notice. Upon such
termination by Executive for other than Good Reason or pursuant to Section 11,
below, the Employer shall pay the Executive only his Base Salary due through the
date on which his employment is terminated at the rate in effect at the time of
notice of termination. The Employer shall then have no further obligation to
Executive under this Agreement; provided, however, Employer shall have the
option of paying Executive in accordance with the provisions of Section 9,
above, if Employer desires to continue to enforce
3
<PAGE> 4
Executive's continuing obligations under Sections 14(b), (c) and (d) below.
11. OTHER TERMINATION. If Executive voluntarily terminates his
employment hereunder or is involuntarily terminated for other than Good Cause at
any time within two years of the date of this Agreement, Employer shall pay
Executive Two Million Five Hundred Thousand Dollars ($2,500,000), to be payable
either in a lump sum or in installments, as Employer and Executive mutually
determine (the "Global Severance Payment"). If the position of President and
Chief Executive Officer of Employer is vacated at any time within the two-year
period, Executive shall be considered for the position upon submission of a
written request to the Board of Directors of Employer. If after due
consideration by the Board of Directors, Executive is not offered the position
and, as a result, Executive tenders his resignation within thirty (30) days
thereafter, Executive shall be entitled to receive the Global Severance Payment.
If Executive terminates his employment or is involuntarily terminated for other
than Good Cause under this Section 11, the payment Executive receives under this
Section 11 shall be paid in lieu of any other payments or benefits Executive
would have otherwise been entitled to receive hereunder; provided, however, the
terms and provisions of Section 14 hereof shall continue to be applicable during
the Severance Period. Executive shall, however, be entitled to receive such
stock options of Employer's Common Stock that are vested at the date of
termination of Executive.
12. SETOFF.
(a) With respect to Section 9, payments or benefits
payable to or with respect to Executive or his spouse
pursuant to this Agreement shall be reduced by the
amount of any claim of Employer against Executive or
his spouse or any debt or obligation of Executive or
his spouse owing to Employer.
(b) With respect to Section 9, payments or benefits
payable to or with respect to Executive pursuant to
this Agreement shall be reduced by any amount
Executive may earn or receive from employment with
another employer or from any other source, except as
expressly provided in Section 9(b).
13. DEATH. If Executive dies during the Severance Period:
(a) All amounts payable hereunder to Executive shall,
during the remainder of the Severance Period, be paid
to his surviving spouse. On the death of the survivor
of Executive and his spouse, no further benefits will
be paid under the Agreement.
(b) The spouse and family of Executive shall, during the
remainder of the Severance Period, be covered under
all Welfare Plans made available by Employer to
Executive or his spouse immediately prior to the date
of his death to the extent possible.
Any benefits payable under this Section 13 are in addition to any other
benefit due to Executive or his spouse or beneficiaries from Employer,
including, but not limited to, payments under any Incentive Plans.
14. RESTRICTIVE COVENANTS.
(a) Confidential Information. Executive agrees not to
disclose, either during the time he is employed by
the Employer or following termination of his
employment hereunder, to any person (other than a
person to whom
4
<PAGE> 5
disclosure is necessary in connection with the
performance of his duties as an employee of Employer
or to any person specifically authorized by the Board
of Directors of Employer) any material confidential
information concerning the Employer or any of its
Affiliates, including, but not limited to, strategic
plans, customer lists, contract terms, financial
costs, pricing terms, sales data or business
opportunities whether for existing, new or developing
businesses.
(b) Non-Competition. During the term of employment
provided hereunder and during the Severance Period,
if longer, Executive will not directly or indirectly
own, manage, operate, control or participate in the
ownership, management, operation or control of, or be
connected as an officer, employee, partner, director
or otherwise with, or any have financial interest in,
or aid or assist anyone else in the conduct of, any
business which is in competition with any business
conducted by the Employer or any Affiliate of
Employer in any state in which the Employer or any
Affiliate of Employer is conducting business on the
date of termination or expiration of this Agreement,
provided that ownership of 5% or less of the voting
stock of any public corporation shall not constitute
a violation hereof.
(c) Non-Solicitation. During the term of employment
provided for hereunder and during the Severance
Period, Executive will not (i) directly or indirectly
solicit business which could reasonably be expected
to conflict with the interest of Employer or any
Affiliate of Employer from any entity, organization
or person which has contracted with the Employer or
any Affiliate of Employer, which has been doing
business with the Employer or any Affiliate of
Employer, from which the Employer or any Affiliate of
Employer was soliciting business at the time of the
termination of employment or from which Executive
knew or had reason to know that Employer or any
Affiliate of Employer was going to solicit business
at the time of termination of employment, or (ii)
employ, solicit for employment, or advise or
recommend to any other persons that they employ or
solicit for employment, any employee of the Employer
or any Affiliate of Employer.
(d) Consultation. Executive shall, at the Employer's
written request, during the Severance Period,
cooperate with the Employer in concluding any matters
in which Executive was involved during the term of
his employment and will make himself available for
consultation with the Employer on other matters
otherwise of interest to the Employer. The Employer
agrees that such requests shall be reasonable in
number and will consider Executive's time required
for other employment and/or employment search.
(e) Enforcement. Executive and the Employer acknowledge
and agree that any of the covenants contained in this
Section 14 may be specifically enforced through
injunctive relief but such right to injunctive relief
shall not preclude the Employer from other remedies
which may be available to it.
(f) Continuing Obligation. Notwithstanding any
provision to the contrary or otherwise contained in
this Agreement, the agreement and covenants contained
in this Section 14 shall not terminate upon
Executive's termination of his employment with the
Employer or upon the termination of this Agreement
under any other provision of this Agreement;
provided, however,
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<PAGE> 6
in the event of Executive's voluntary termination
(except for Good Reason or pursuant to the terms of
Section 11, hereof), the obligations under Sections
14(b), (c) and (d) shall terminate upon Executive's
termination of employment unless Employer elects to
pay Executive the termination benefits set forth in
Section 9, above.
15. VACATION. During each year of this Agreement, Executive shall be
entitled to four (4) weeks paid vacation.
16. HEALTH AND WELFARE BENEFITS; PROFIT-SHARING PLANS. In addition to
the benefits specifically provided for herein, Executive and his family shall be
entitled to participate in all health and welfare benefit plans maintained by
the Employer for executive or managerial employees generally according to the
terms of such plans. Executive shall be entitled to participate in any
profit-sharing, retirement or similar plans established by Employer in which
executive or managerial employees of Employer participate, including any such
plan intended to comply with Section 401(k) of the Internal Revenue Code of
1986, as amended, and any such plan providing supplemental executive retirement
benefits.
17. EXECUTIVE ASSIGNMENT. No interest of Executive or his spouse or any
other beneficiary under this Agreement, or any right to receive any payment or
distribution hereunder, shall be subject in any manner to sale, transfer,
assignment, pledge, attachment, garnishment, or other alienation or encumbrance
of any kind, nor may such interest or right to receive a payment or distribution
be taken, voluntarily or involuntarily, for the satisfaction of the obligations
or debts of, or other claims against, Executive or his spouse or other
beneficiary, including claims for alimony, support, separate maintenance, and
claims in bankruptcy proceedings.
18. BENEFITS UNFUNDED. All rights of Executive and his spouse or other
beneficiary under this Agreement shall at all times be entirely unfunded and no
provision shall at any time be made with respect to segregating any assets of
Employer for payment of any amounts due hereunder. Neither Executive nor his
spouse or other beneficiary shall have any interest in or rights against any
specific assets of Employer, and Executive and his spouse or other beneficiary
shall have only the rights of a general unsecured creditor of Employer.
19. NOTICES. Any notice required or permitted to be given under this
Agreement shall be sufficient if in writing and sent by registered or certified
mail to his residence in the case of Executive, or to its principal office in
the case of the Employer and the date of receipt shall be deemed the date which
such notice has been provided.
20. WAIVER OF BREACH. The waiver by either party of any provision of
this Agreement shall not operate or be construed as a waiver of any subsequent
breach by the other party.
21. ASSIGNMENT. The rights and obligations of the Employer under this
Agreement shall inure to the benefit of and shall be binding upon the successors
and assigns of the Employer. The Executive acknowledges that the services to be
rendered by him are unique and personal, and Executive may not assign any of his
rights or delegate any of his duties or obligations under this Agreement.
22. ENTIRE AGREEMENT. This instrument contains the entire agreement of
the parties and, with the exception of the terms and conditions set forth in
Exhibit B to that certain Employment Agreement between Executive and Principal
Health Care, Inc. dated as of October 1, 1997, supersedes all other prior
agreements, employment contracts and understandings, both written and oral,
express or implied with respect to the subject matter of this Agreement and may
not be changed orally but only by an agreement in writing signed by the party
against whom enforcement of any waiver, change, modification, extension or
discharge is sought.
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<PAGE> 7
23. APPLICABLE LAW. This Agreement shall be governed by the laws of the
State of Maryland, without giving effect to the principles of conflicts of law
thereof.
24. HEADINGS. The sections, subjects and headings of this Agreement
are inserted for convenience only and shall not affect in any way the meaning or
interpretation of this Agreement.
25. DEFINITIONS. For purposes of this Agreement:
(a) "Affiliate" shall have the meaning set forth in Rule
144(a)(1) promulgated under the Securities Act of
1933, as amended.
(b) "Good Cause" shall be deemed to exist if, and only if:
(i) Executive is indicted or convicted of a felony;
(ii) Executive is involved in the commission of theft
or embezzlement of Employer's property or
similar acts involving moral turpitude; or
(iii) Executive willfully fails to substantially
perform his material duties under this Agreement
(excluding nonperformance resulting from
Executive's disability), which willful failure is
not cured within (30) days after written notice
from the President of the Company specifying the
act of willful nonperformance or within such
longer period (but no longer than ninety (90)
days in any event) as is reasonably required to
cure such willful nonperformance.
Without limiting the generality of the foregoing, if Executive
acted in good faith and in a manner he reasonably believed to
be in, and not opposed to, the best interest of Employer and
had no reasonable cause to believe his conduct was unlawful in
connection with any action taken by Executive in connection
with his duties, it shall not constitute Good Cause.
Notwithstanding anything herein to the contrary, in the event
Employer shall terminate the employment of Executive for Good
Cause hereunder, Employer shall give at least 30 days prior
written notice to Executive specifying in detail the reason or
reasons for Executive's termination.
(c) "Good Reason" shall exist if there is a significant
change in the nature or the scope of Executive's
position and authority as a result of a change in
control of Employer, which shall include the
following occurrences:
(i) the acquisition of at least a majority of
the outstanding shares of Common Stock (or
securities convertible into Common Stock) of
Employer by any person, entity or group (as
used in Section 13(d)(3)
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<PAGE> 8
and Rule 13d-5(b)(1) under the Exchange
Act);
(ii) the merger or consolidation of Employer with
or into another corporation or other entity,
or any share exchange or similar transaction
involving Employer and another corporation
or other entity, if as a result of such
merger, consolidation, share exchange or
other transaction, the persons who owned at
least a majority of the Common Stock of
Employer prior to the consummation of such
transaction do not own at least a majority
of the Common Stock of the surviving entity
after the consummation of such transaction;
(iii) the sale of all, or substantially all, of
the assets of Employer; or
(iv) any change in the composition of the Board
of Directors of Employer, 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 of Employer, or
persons whose nomination was approved by
such majority, cease to constitute at least
a majority of the Board of Directors of
Employer at the end of such period.
(d) "Severance Period" shall mean the period beginning on
the date the Executive's employment with Employer
terminates without Good Cause under circumstances
described in Section 9 plus 12 months thereafter.
(e) "Welfare Plans" shall mean any health and dental
plan, disability plan, survivor income plan and life
insurance plan or arrangement currently or hereafter
made available by Employer in which Executive is
eligible to participate.
26. COUNTERPARTS. This Agreement may be executed in counterparts, each
of which shall be deemed an original.
27. SEVERABILITY. In the event any provision of this Agreement is held
illegal or invalid, the remaining provisions of this Agreement shall not be
affected thereby. In the event that Section 14(b) is determined by a court of
competent jurisdiction to be invalid due to overbreadth, such Section 14(b)
shall be constructed as narrowly as necessary to be enforceable.
IN WITNESS WHEREOF, the parties have executed this Agreement on the day
and year first written above.
-------------------------------------
Kenneth J. Linde
COVENTRY HEALTH CARE, INC.
By:
-------------------------------------
Allen F. Wise
President and Chief Executive Officer
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<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion of our
reports dated February 21, 1997 (except for Notes G and S, as to which the date
is March 31, 1997) in this Form S-4 of Coventry HealthCare, Inc.
/s/ ARTHUR ANDERSEN LLP
Nashville, Tennessee
March 9, 1998
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our reports dated February 26, 1997, with respect to the financial
statements of Principal Health Care, Inc. and the related financial schedule
included in the Registration Statement (Form S-4) and related Prospectus of
Coventry Health Care, Inc. dated March 10, 1998.
/s/ Ernst & Young LLP
Washington, DC
March 10, 1998
<PAGE> 1
EXHIBIT 23.3
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ JOHN H. AUSTIN
----------------------------
John H. Austin, M.D.
<PAGE> 2
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ THOMAS L. BLAIR
----------------------------
Thomas L. Blair
<PAGE> 3
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ PHILIP N. BREDESEN
----------------------------
Philip N. Bredesen
<PAGE> 4
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ GARY M. CAIN
----------------------------
Gary M. Cain
<PAGE> 5
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ LAWRENCE DEFRANCE
----------------------------
Lawrence DeFrance
<PAGE> 6
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 23rd day of February, 1998.
/s/ DAVID J. DRURY
----------------------------
David J. Drury
<PAGE> 7
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ EMERSON D. FARLEY
----------------------------
Emerson D. Farley, Jr., M.D.
<PAGE> 8
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 23rd day of February, 1998.
/s/ THOMAS J. GRAF
----------------------------
Thomas J. Graf
<PAGE> 9
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ PATRICK T. HACKETT
----------------------------
Patrick T. Hackett
<PAGE> 10
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ RICHARD H. JONES
----------------------------
Richard H. Jones
<PAGE> 11
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ LAWRENCE N. KUGELMAN
----------------------------
Lawrence N. Kugelman
<PAGE> 12
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ RODMAN W. MOORHEAD, III
----------------------------
Rodman W. Moorhead, III
<PAGE> 13
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 23rd day of February, 1998.
/s/ ELIZABETH E. TALLETT
----------------------------
Elizabeth E. Tallett
<PAGE> 14
CONSENT TO SERVE AS DIRECTOR
OF
COVENTRY HEALTH CARE, INC.
In accordance with Rule 438 of the Securities Act of 1933, as amended, I,
the undersigned, do hereby (i) consent to serve as a Director on the Board of
Directors of Coventry Health Care, Inc., a Delaware corporation ("Newco"), after
the effective time of the combination of the managed care businesses of Coventry
Corporation, a Tennessee corporation ("Coventry"), and Principal Health Care,
Inc., an Iowa corporation ("PHC"), in Newco, pursuant to the terms of the
Capital Contribution and Merger Agreement effective as of November 3, 1997, by
and among Coventry, Newco, Coventry Health Care, Inc., a Maryland corporation,
Principal Mutual Life Insurance Company, an Iowa mutual insurance company and
the indirect parent of PHC ("Mutual"), Principal Holding Company, an Iowa
corporation and wholly owned subsidiary of Mutual ("Holding"), and PHC, a wholly
owned subsidiary of Holding, and (ii) consent to be named as a person about to
become a Director of Newco in that certain Form S-4 Registration Statement, No.
333-45821, filed with the Securities and Exchange Commission on behalf of
Newco.
EXECUTED this 24th day of February, 1998.
/s/ ALLEN F. WISE
----------------------------
Allen F. Wise
