<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file number 0-19147
COVENTRY HEALTH CARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-2073000
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6705 ROCKLEDGE DRIVE, SUITE 900 BETHESDA, MD 20817
(Address of principal executive office) (Zip Code)
(301) 581-0600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Class Outstanding at April 30, 1999
- ----- -----------------------------
<S> <C>
Common Stock $.01 Par Value 58,861,191
</TABLE>
<PAGE> 2
COVENTRY HEALTH CARE, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Balance Sheets
at March 31, 1999 and December 31, 1998 1
Condensed Consolidated Statements of Operations
for the three months ended March 31, 1999
and 1998 2
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1999 and 1998 3
Notes to Condensed Consolidated Financial Statements 4
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3: Quantitative and Qualitative Disclosures
about Market Risk 18
PART II. OTHER INFORMATION
Item 1: Legal Proceedings 19
Items 2, 3, 4, and 5 19
Item 6: Exhibits and Reports on Form 8-K 19
Signatures 21
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1: Financial Statements
COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 1999 1998
-------------- ----------------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 383,435 $ 408,823
Short-term investments 25,572 43,689
Accounts receivable, net 50,850 46,204
Other receivables 18,445 19,754
Deferred income taxes and
other current assets 70,195 72,575
-------------- ----------------
Total current assets 548,497 591,045
Long-term investments 155,118 162,070
Property and equipment, net 39,148 35,820
Goodwill and intangible assets, net 292,244 295,966
Other assets 5,677 5,692
-------------- ----------------
Total assets $ 1,040,684 $ 1,090,593
============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claim liabilities $ 309,102 $ 338,142
Other medical liabilities 58,540 62,732
Accounts payable and other accrued liabilities 118,210 118,401
Deferred revenue 21,281 46,412
Current portion of long-term debt and notes payable - 166
-------------- ----------------
Total current liabilities 507,133 565,853
Convertible exchangeable subordinated notes 46,465 45,538
Long-term debt 781 820
Other long-term liabilities 42,047 41,843
Stockholders' equity:
Common Stock, $.01 par value; 200,000,000 shares
authorized; 59,296,001 shares issued and 58,856,441
outstanding in 1999; and 59,287,454 shares issued
and 58,847,894 outstanding in 1998 593 593
Additional paid-in capital 476,711 476,430
Accumulated other comprehensive (loss) income (61) 794
Accumulated deficit (27,985) (36,278)
Treasury stock, at cost, 439,560 shares (5,000) (5,000)
-------------- ----------------
Total stockholders' equity 444,258 436,539
-------------- ----------------
Total liabilities and stockholders' equity $ 1,040,684 $ 1,090,593
============== ================
</TABLE>
See notes to condensed consolidated financial statements.
1
<PAGE> 4
COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
March 31,
-----------------------------
1999 1998
------------- -------------
<S> <C> <C>
Operating revenues:
Managed care premiums $ 507,678 $ 324,753
Management services 20,170 5,456
------------- -------------
Total operating revenues 527,848 330,209
------------- -------------
Operating expenses:
Health benefits 433,641 275,314
Selling, general and administrative 78,530 44,967
Depreciation and amortization 6,994 2,750
------------- -------------
Total operating expenses 519,165 323,031
------------- -------------
Operating income 8,683 7,178
Other income, net 7,015 2,633
Interest expense (1,007) (1,833)
------------- -------------
Income before income taxes 14,691 7,978
Provision for income taxes 6,398 3,271
------------- -------------
Net income $ 8,293 $ 4,707
============= =============
Net income per share
Basic $ 0.14 $ 0.14
============= =============
Diluted $ 0.14 $ 0.13
============= =============
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE> 5
COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------------------
1999 1998
------------- ------------
<S> <C> <C>
Net cash used in operating activities $ (46,854) $ (5,189)
------------- ------------
Cash flows from investing activities:
Capital expenditures, net (2,921) (1,872)
Sale of investments 50,641 6,017
Purchase of investments (26,252) (11,030)
----------- ------------
Net cash provided by (used in) investing activities 21,468 (6,885)
----------- ------------
Cash flows from financing acitivities:
Payments of long-term debt and notes payable (48) (390)
Net proceeds from issuance of stock 46 1,282
----------- ------------
Net cash (used in) provided by financing activities (2) 892
----------- ------------
Net decrease in cash and cash equivalents (25,388) (11,182)
Cash and cash equivalents at beginning of
the period 408,823 153,979
----------- ------------
Cash and cash equivalents at end of the period $ 383,435 $ 142,797
=========== ============
Supplemental disclosures of cash flow information
Cash paid during the period was as follows:
Interest $ 18 $ 894
============= ============
Income taxes $ 6,000 $ 8,648
============= ============
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 6
COVENTRY HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of Coventry Health Care,
Inc. and subsidiaries (the "Company") contained in this report are unaudited but
reflect all adjustments, consisting of normal recurring adjustments which, in
the opinion of management, are necessary for the fair presentation of the
results of the interim periods reflected. Certain information and footnote
disclosures normally included in the consolidated financial statements prepared
in accordance with generally accepted accounting principles have been omitted
pursuant to applicable rules and regulations of the Securities and Exchange
Commission (the "SEC"). The results of operations for the interim periods
reported herein are not necessarily indicative of results to be expected for the
full year. It is suggested that these condensed consolidated financial
statements be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's most recent Annual Report on Form 10-K,
filed with the SEC on March 30, 1999.
2. SIGNIFICANT ACCOUNTING POLICIES
Derivative Instruments - In June 1998, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS
133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of the derivatives would be accounted for depending on the use of the
derivatives and whether they qualify for hedge accounting. SFAS 133 is effective
for fiscal years beginning after June 15, 1999. The Company does not believe
that adoption of SFAS 133 will have a material effect on its future results of
operations.
Computer Software - Effective January 1, 1999, the Company adopted
Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use" issued by the American
Institute of Certified Public Accountants ("AICPA"). SOP 98-1 provides
authoritative guidance for the capitalization of certain costs related to
computer software developed or obtained for internal applications, such as
external direct costs of materials and services, payroll costs for employees and
certain interest costs. Costs incurred during the preliminary project stage, as
well as training and data conversion costs, are to be expensed as incurred. SOP
98-1 is effective for fiscal years beginning after December 15, 1998. The
adoption of SOP 98-1 did not have a material effect on the Company's
consolidated financial statements.
Reclassifications - Certain 1998 amounts have been reclassified to
conform to the 1999 presentation.
3. ACQUISITIONS AND DISPOSITIONS
Effective April 1, 1998, the Company completed its acquisition of certain
health plans of Principal Health Care, Inc. ("PHC") from Principal Mutual Life
Insurance Company ("Principal Life") for a total purchase price of approximately
$330.2 million including transaction costs of approximately $5.7 million. The
acquisition was accounted for using the purchase method of accounting, and
accordingly the operating results of PHC have been included in the Company's
consolidated financial statements since the date of acquisition. The purchase
price consisted of 25,043,704 shares of the Company's common stock at an
assigned value of $11.96 per share. In addition, a warrant valued
4
<PAGE> 7
at $25.0 million ("the Warrant") was issued that grants Principal Life the right
to acquire additional shares of the Company's common stock in the event that its
ownership percentage of such common stock is diluted below 40%. The Warrant is
included as a component of additional paid-in capital in the accompanying
condensed consolidated financial statements. Through April 2003, Principal Life
is restricted from buying additional shares of the Company's common stock to
increase its ownership percentage above 40%.
Coincident with the closing of the transaction, the Company entered into
a Marketing Services Agreement and a Management Services Agreement with
Principal Life. Both agreements extend through December 31, 1999. Pursuant to
these agreements the Company recognized revenue of approximately $6.2 million
for the three months ended March 31, 1999 and expects to receive payments of
approximately $26.4 million during the year ended December 31,1999 inclusive of
the $6.2 million.
The Company also entered into a Renewal Rights Agreement and a
Coinsurance Agreement with Principal Life, whereby the Company manages certain
of Principal Life's indemnity health insurance policies in the markets where the
Company does business and, on December 31, 1999, would offer to renew such
policies in force at that time. The Company currently is negotiating with
Principal Life to terminate the Renewal Rights and Coinsurance agreements.
As a result of the transaction, the Company assumed an agreement with
Principal Life, whereby Principal Life pays a fee for access to the Company's
preferred provider organization network based on a fixed rate per employee
entitled to access the PPO network and a percentage of savings realized by
Principal Life. Under this agreement, the Company recognized revenue of
approximately $2.0 million for the three months ended March 31, 1999. The
maximum amount that can be paid under the percentage of savings component of
the agreement is $8.0 million for 1999.
On December 31, 1998, the Company sold its subsidiary, Principal Health
Care of Florida, Inc., for $95.0 million in cash. The Florida health plan
accounted for approximately 156,000 risk members and approximately 5,500
non-risk members as of December 31, 1998.
Effective November 30, 1998, the Company sold its subsidiary, Principal
Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois health
plan accounted for approximately 56,000 risk members and approximately 2,400
non-risk members as of November 30, 1998.
The proceeds from both sales were used to retire the Company's credit
facility, to assist in improving the capital position of the Company's regulated
subsidiaries, and for other general corporate purposes. Given the short time
period between the respective acquisition and sale dates and the lack of events
or other evidence which would indicate differing values, no gain or loss was
recognized on the sales of the Florida and Illinois health plans, as the sale
prices were considered by management to be equivalent to the fair values
allocable to these plans at the date of their acquisition from PHC in April
1998.
In connection with the acquisition of certain PHC health plans and the
sales of the Florida and Illinois plans, the Company established reserves of
approximately $33.0 million for the estimated transition costs of the PHC plans.
These reserves are primarily comprised of severance costs related to involuntary
terminations of former PHC employees, relocation costs of former PHC personnel,
lease termination costs and contract termination costs. Through March 31, 1999,
the Company has expended approximately $20.2 million related to these reserves.
The Company expects to make payments on the remaining reserves through July
2002.
5
<PAGE> 8
The purchase price for certain of the PHC plans, net of the impact of the
sales of the Florida and Illinois health plans, was allocated to the assets,
including the identifiable intangible assets, and liabilities based on estimated
fair values. The $200.5 million excess of purchase price over the net
identified tangible assets acquired was allocated to identifiable intangible
assets and goodwill. The amounts allocated and their related useful lives are as
follows:
<TABLE>
<CAPTION>
Description Amount Useful Life
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Marketing Services Agreement $1,500,000 1.75 years
Customer Lists 7,233,000 5 years
HMO Licenses 10,000,000 20 years
Management Services Agreement 4,687,500 1.75 years
Renewal Rights and Coinsurance
Agreements 20,312,500 35 years
Goodwill 156,795,028 35 years
------------
Total $200,528,028
============
</TABLE>
In connection with the acquisition of PHC, the Company relocated its
corporate headquarters from Nashville, Tennessee to Bethesda, Maryland. As a
result, the Company established a one-time reserve of approximately $6.5 million
for the incurred and anticipated costs related to the relocation of the
corporate office and other direct merger related costs. The reserve is primarily
comprised of severance costs related to involuntary terminations, relocation
costs for management personnel, and lease costs, net of sublease income, related
to the unused space remaining at the old headquarters location. Through March
31, 1999, the Company has expended approximately $5.1 million related to the
reserve. The Company expects to make payments through December 2002 related to
these charges.
4. COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 1999 and 1998
is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Net income $ 8,293 $ 4,707
Other comprehensive income, net of tax:
Net unrealized losses on securities,
net of reclassification adjustment (855) (16)
------------- -------------
Comprehensive income $ 7,438 $ 4,691
============= =============
</TABLE>
5. EARNINGS PER SHARE
Basic earnings per share ("EPS") is based on the weighted average number
of common shares outstanding during the period. Diluted EPS assumes the
conversion of dilutive convertible notes and the exercise of dilutive options
and warrants using the treasury stock method. Net income is increased for
interest expense on the convertible notes.
The following table summarizes the earnings and the average number of
common shares used in the calculation of basic and diluted EPS (in thousands,
except for per share amounts):
6
<PAGE> 9
<TABLE>
<CAPTION>
Quarter ended March 31, 1999
-------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------------------------------------
<S> <C> <C> <C>
Net Income $ 8,293
------------------
Basic EPS $ 8,293 58,851 $ 0.14
Effect of Dilutive Securities
Options and warrants 712
Convertible notes 4,521
Interest on convertible notes 516
-------------------------------------------------
Diluted EPS $ 8,809 64,084 $ 0.14
=================================================
</TABLE>
<TABLE>
<CAPTION>
Quarter ended March 31, 1998
-------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------------------------------------
<S> <C> <C> <C>
Net Income $ 4,707
------------------
Basic EPS $ 4,707 33,348 $ 0.14
Effect of Dilutive Securities
Options and warrants 1,127
Convertible notes 4,166
Interest on convertible notes 476
-------------------------------------------------
Diluted EPS $ 5,183 38,641 $ 0.13
=================================================
</TABLE>
6. SEGMENT REPORTING
Statement of Financial Accounting Standards No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related Information", requires
that a public business enterprise report financial and descriptive information
about its reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS 131 also requires that all
public business enterprises report information about the revenues derived from
the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. The Company has two reportable segments:
commercial products and government products. The products are provided to a
cross section of employer groups and individuals through the Company's health
plans in the Midwest, Mid-Atlantic, and Southeastern United States. Commercial
products include HMO, PPO, and POS products. HMO products provide comprehensive
health care benefits to enrollees through a primary care physician. PPO and POS
products permit members to participate in managed care but allow them the
flexibility to utilize out of network providers in exchange for an increase in
out-of-pocket costs to the member. Governmental products include Medicare Risk,
Medicare Cost, and Medicaid. The Company provides comprehensive health benefits
to members participating in government programs and receives premium payments
from federal and state governments. The Company evaluates the performance of its
operating segments and allocates resources based on gross margin. Assets are not
allocated to specific products and, accordingly, cannot be reported by segment.
7
<PAGE> 10
<TABLE>
<CAPTION>
For the Three Months Ended March 31, 1999
(in thousands)
-------------------------------------------------------------------------------------
Commercial Government Programs Total
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $384,992 $ 122,686 $ 507,678
Gross Margin 61,453 12,584 74,037
</TABLE>
<TABLE>
<CAPTION>
For the Three Months Ended March 31, 1998
(in thousands)
-------------------------------------------------------------------------------------
Commercial Government Programs Total
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $234,056 $ 90,697 $ 324,753
Gross Margin 38,103 11,336 49,439
</TABLE>
Following are reconciliations of reportable segment information to financial
statement amounts (in thousands):
<TABLE>
<CAPTION>
For the Three Months Ended
March 31,
------------------------------------
1999 1998
------------------------------------
<S> <C> <C>
Revenues
Reportable Segments $507,678 $324,753
Other 20,170 5,456
-------- --------
Total revenues $527,848 $330,209
======== ========
Earnings (Loss) Before
Income Taxes:
Gross margin from
reportable segments $74,037 $49,439
Other revenues 20,170 5,456
Selling, general and
administrative (78,530) (44,967)
Depreciation and
amortization (6,994) (2,750)
Other income, net 7,015 2,633
Interest expense (1,007) (1,833)
------- -------
Total earnings
before income taxes $14,691 $7,978
======= ======
</TABLE>
7. LEGAL PROCEEDINGS
In March 1997, the Company entered into a global capitation agreement
with Allegheny Health, Education and Research Foundation ("AHERF") covering
approximately 250,000 members in the western Pennsylvania market. Under the
agreement AHERF received 78% to 82% of the related premiums to cover all of the
8
<PAGE> 11
medical expenses of the capitated members. In July 1998, AHERF filed for
bankruptcy protection under Chapter 11. As a result, the Company, which is
ultimately responsible for the medical costs of the capitated members, recorded
a charge of $55.0 million to establish a reserve for the medical costs incurred
by members under the AHERF agreement at the time of the bankruptcy filing and
other potential bankruptcy charges. Generally, under Chapter 11 a debtor company
such as AHERF may affirm or reject its contractual obligations prior to
confirmation of a plan of reorganization, and if a contract is rejected, the
contractual damages become an unsecured claim in the Chapter 11 proceeding.
Although AHERF has not formally rejected the risk-sharing agreement as of the
date of this filing, the partners are negotiating a resolution of the
arrangement and, currently, neither AHERF nor the Company is operating under the
existing agreement. The Company has filed a lawsuit in the Court of Common
Pleas of Allegheny County, Pennsylvania, against certain affiliated
hospitals of AHERF that were not included in the bankruptcy filing. The lawsuit
is seeking a court order declaring that the Company is not liable for the
payment of $21.5 million of medical services provided by the hospitals to the
Company's members prior to the date of AHERF's bankruptcy filing and compelling
the hospitals to fulfill their contractual obligations to continue to provide
health care services to the membership in western Pennsylvania. The lawsuit also
includes a claim for damages to recover the losses incurred by the Company as a
consequence of AHERF's default of its obligations under the risk-sharing
agreement. In response to the lawsuit, the hospitals have filed a counterclaim
alleging that HealthAmerica Pennsylvania, Inc., notwithstanding AHERF's
assumption of the payment obligation, is liable to the hospitals for the payment
of medical services provided prior to AHERF's bankruptcy. The Company intends to
vigorously defend against the counterclaim. The Company believes the reserve
established is adequate to provide for the claims incurred related to the AHERF
arrangement and other related AHERF bankruptcy uncertainties. Through March 31,
1999, approximately $34.7 million has been expended for medical claims from this
reserve.
Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the
Company, entered into an agreement effective January 1, 1998 with Unity Health
Network, L.L.C. ("Unity") for Unity's provider network to provide health care
services to GHP's members in the southern and western areas of St. Louis County,
Missouri, which agreement contained certain risk sharing provisions. Disputes
have arisen under the agreement, cross-claims have been made and the matter has
been submitted to arbitration before the American Arbitration Association. GHP
is demanding payment from Unity of $7.6 million and specific performance under
the agreement. Unity is demanding payment from GHP of $14.5 million, specific
performance of certain provisions of the agreement and suspension of its payment
obligations. The Company believes that GHP has fulfilled all of its obligations
under the agreement, that the amount demanded by GHP is properly due to GHP, and
that GHP does not owe Unity the amounts claimed by Unity. The Company intends to
vigorously pursue this matter.
In the normal course of business, the Company has been named as defendant
in various legal actions seeking payments for claims denied by the Company,
medical malpractice, and other monetary damages. The claims are in various
stages of proceedings and some may ultimately be brought to trial. Incidents
occurring through March 31, 1999 may result in the assertion of additional
claims. With respect to medical malpractice, the Company carries professional
malpractice and general liability insurance for each of its operations on a
claims made basis with varying deductibles for which the Company maintains
reserves. In the opinion of management, the outcome of these actions will not
have a material adverse effect on the financial position or results of
operations of the Company.
The Company's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws could have significant impact on the
Company's operations.
9
<PAGE> 12
ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Quarters ended March 31, 1999 and 1998
GENERAL
Coventry Health Care, Inc.(together with its subsidiaries, the
"Company"), successor in interest to Coventry Corporation, is a managed health
care company that provides comprehensive health benefits and services to a broad
cross section of employer and government-funded groups in the Midwest,
Mid-Atlantic and Southeastern United States.
As of March 31, 1999, the Company had 1,148,830 members for whom it
assumes underwriting risk ("risk members") and 246,527 members of self-insured
employers for whom it provides management services but does not assume
underwriting risk ("non-risk members"). The following tables show the total
number of members as of March 31, 1999 and 1998 and the percentage change in
membership between those dates, where applicable. The March 31, 1999 membership
figures reflect the acquisition of various health plans from Principal Health
Care, Inc.("PHC") and the disposition of the Principal Health Care of Florida,
Inc. and Principal Health Care of Illinois, Inc. health plans all of which
occurred in 1998.
<TABLE>
<CAPTION>
MARCH 31, PERCENT
1999 1998 CHANGE
---- ---- ------
<S> <C> <C> <C>
St. Louis(1) 325,044 266,671 21.9%
Pennsylvania 401,706 441,329 (9.0%)
Iowa 78,609 - N/A
Richmond 47,733 58,209 (18.0%)
Delaware/Baltimore 60,275 - N/A
Kansas City 57,527 - N/A
Louisiana 38,079 - N/A
Wichita 39,980 - N/A
Nebraska 27,175 - N/A
Indiana 27,782 - N/A
Carolinas 21,279 - N/A
Georgia 23,641 - N/A
--------- -------
Total risk membership 1,148,830 766,209 49.9%
Total non-risk membership (2) 246,527 141,911 73.7%
--------- -------
Total membership 1,395,357 908,120 53.7%
========= =======
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, PERCENT
1999 1998 CHANGE
---- ---- ------
<S> <C> <C> <C>
Commercial 977,601 617,017 58.4%
Governmental Programs 171,229 149,192 14.8%
--------- -------
Total risk membership 1,148,830 766,209 49.9%
Non-risk membership (2) 246,527 141,911 73.7%
--------- -------
Total membership 1,395,357 908,120 53.7%
========= =======
</TABLE>
10
<PAGE> 13
(1) Includes PHC of St. Louis membership in 1999.
(2) 1999 non-risk membership includes 80,706 members attributable to the PHC
Plans.
The Company's operating expenses are primarily medical costs, including
medical claims under contractual relationships with a wide variety of providers,
and capitation payments. Medical claims expense also includes an estimate of
claims incurred but not reported ("IBNR"). The Company currently believes that
the estimates for IBNR liabilities relating to its businesses are adequate in
order to satisfy its ultimate claims liability with respect thereto. In
determining the Company's medical claims liabilities, the Company employs plan
by plan standard actuarial reserve methods (specific to the plan's membership,
product characteristics, geographic territories and provider network) that
consider utilization frequency and unit costs of inpatient, outpatient, pharmacy
and other medical costs, as well as claim payment backlogs and the changing
timing of provider reimbursement practices. Calculated reserves are reviewed by
underwriting, finance and accounting, and other appropriate plan and corporate
personnel and judgments are then made as to the necessity for reserves in
addition to the calculated amounts. Changes in assumptions for medical costs
caused by changes in actual experience, changes in the delivery system, changes
in pricing due to ancillary capitation and fluctuations in the claims backlog
could cause these estimates to change in the near term. The Company periodically
monitors and reviews its IBNR reserves, and as actual settlements are made or
accruals adjusted, differences are reflected in current operations.
RESULTS OF OPERATIONS
Effective April 1, 1998, the Company completed its acquisition of certain
health plans of PHC from Principal Mutual Life Insurance Company ("Principal
Life") for a total purchase price of approximately $330.2 million including
transaction costs of approximately $5.7 million. The acquisition was accounted
for using the purchase method of accounting, and accordingly the operating
results of PHC have been included in the Company's consolidated financial
statements since the date of acquisition. The purchase price consisted of
25,043,704 shares of the Company's common stock at an assigned value of $11.96
per share. In addition, a warrant valued at $25.0 million ("the Warrant") was
issued that grants Principal Life the right to acquire additional shares of the
Company's common stock in the event that its ownership percentage of such
common stock is diluted below 40%. The Warrant is included as a component of
additional paid-in capital in the accompanying consolidated financial
statements. Through April 2003, Principal Life is restricted from buying
additional shares of the Company's common stock to increase its ownership
percentage above 40%.
Coincident with the closing of the transaction, the Company entered into
a Marketing Services Agreement and a Management Services Agreement with
Principal Life. Both agreements extend through December 31, 1999. Pursuant to
the agreements, the Company recognized revenue of approximately $6.2 million for
the three months ended March 31, 1999, and expects to receive payments of
approximately $26.4 million during the year ended December 31, 1999 inclusive of
the $6.2 million.
The Company also entered into a Renewal Rights Agreement and a
Coinsurance Agreement with Principal Life, whereby the Company manages certain
of Principal Life's indemnity health insurance policies in the markets where the
Company does business and, on December 31, 1999, would offer to renew such
policies in force at that time. The Company currently is negotiating with
Principal Life to terminate the Renewal Rights and Coinsurance agreements.
As a result of the transaction, the Company assumed an agreement with
Principal Life, whereby Principal Life pays a fee for access to the Company's
preferred provider organization ("PPO") network based on a fixed rate per
11
<PAGE> 14
employee entitled to access the PPO network and a percentage of savings realized
by Principal Life. Under this agreement, the Company recognized revenue of
approximately $2.0 million for the three months ended March 31, 1999. The
maximum amount that can be paid under the percentage of savings component of the
agreement is $8.0 million for 1999.
On December 31, 1998, the Company sold its subsidiary, Principal Health
Care of Florida, Inc., for $95.0 million in cash. The Florida health plan
accounted for approximately 156,000 risk members and approximately 5,500
non-risk members as of December 31, 1998.
Effective November 30, 1998, the Company sold its subsidiary, Principal
Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois health
plan accounted for approximately 56,000 risk members and approximately 2,400
non-risk members as of November 30, 1998.
The proceeds from both sales were used to retire the Company's credit
facility, to assist in improving the capital position of the Company's
regulated subsidiaries, and for other general corporate purposes. Given the
short time period between the respective acquisition and sale dates and the
lack of events or other evidence which would indicate differing values, no gain
or loss was recognized on the sales of the Florida and Illinois health plans,
as the sale prices were considered by management to be equivalent to the fair
values allocable to these plans at the date of their acquisition from PHC in
April 1998.
In connection with the acquisition of certain PHC health plans and the
sales of the Florida and Illinois plans, the Company established reserves of
approximately $33.0 million for the estimated transition costs of the PHC
plans. These reserves are primarily comprised of severance costs related to
involuntary terminations of former PHC employees, relocation costs of former
PHC personnel, lease termination costs and contract termination costs. Through
March 31, 1999, the Company has expended approximately $20.2 million related to
these reserves. The Company expects to make payments on the remaining reserves
through July 2002.
In connection with the acquisition of PHC, the Company relocated its
corporate headquarters from Nashville, Tennessee to Bethesda, Maryland. As a
result, the Company established a one-time reserve of approximately $6.5 million
for the incurred and anticipated costs related to the relocation of the
corporate office and other direct merger related costs. The reserve is primarily
comprised of severance costs related to involuntary terminations, relocation
costs for management personnel, and lease costs, net of sublease income, related
to the unused space remaining at the old headquarters location. Through March
31, 1999, the Company has expended approximately $5.1 million related to the
reserve. The Company expects to make payments through December 2002 related to
these charges.
In March 1997, the Company entered into a global capitation agreement
with Allegheny Health, Education and Research Foundation ("AHERF") covering
approximately 250,000 members in the western Pennsylvania market. Under the
agreement AHERF received 78% to 82% of the related premiums to cover all of the
medical expenses of the capitated members. In July 1998, AHERF filed for
bankruptcy protection under Chapter 11. As a result, the Company, which is
ultimately responsible for the medical costs of the capitated members, recorded
a charge of $55.0 million to establish a reserve for the medical costs incurred
by members under the AHERF agreement at the time of the bankruptcy filing and
other potential bankruptcy charges. Generally, under Chapter 11 a debtor company
such as AHERF may affirm or reject its contractual obligations prior to
confirmation of a plan of reorganization, and if a contract is rejected, the
contractual damages become an unsecured claim in the Chapter 11 proceeding.
12
<PAGE> 15
Although AHERF has not formally rejected the risk-sharing agreement as of the
date of this filing, the partners are negotiating a resolution of the
arrangement and, currently, neither AHERF nor the Company is operating under the
existing agreement. The Company has filed a lawsuit in the Court of Common Pleas
of Allegheny County, Pennsylvania, against certain affiliated hospitals of AHERF
that were not included in the bankruptcy filing. The lawsuit
is seeking a court order declaring that the Company is not liable for the
payment of $21.5 million of medical services provided by the hospitals to the
Company's members prior to the date of AHERF's bankruptcy filing and compelling
the hospitals to fulfill their contractual obligations to continue to provide
health care services to the membership in western Pennsylvania. The lawsuit also
includes a claim for damages to recover the losses incurred by the Company as a
consequence of AHERF's default of its obligations under the risk-sharing
agreement. In response to the lawsuit, the hospitals have filed a counterclaim
alleging that HealthAmerica Pennsylvania, Inc., notwithstanding AHERF's
assumption of the payment obligation, is liable to the hospitals for the payment
of medical services provided prior to AHERF's bankruptcy. The Company intends to
vigorously defend against the counterclaim. The Company believes the reserve
established is adequate to provide for the claims incurred related to the AHERF
arrangement and other related AHERF bankruptcy uncertainties. Through March 31,
1999, approximately $34.7 million has been expended for medical claims related
to this reserve.
Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the Company,
entered into an agreement effective January 1, 1998 with Unity Health Network,
L.L.C. ("Unity") for Unity's provider network to provide health care services to
GHP's members in the southern and western areas of St. Louis County, Missouri,
which agreement contained certain risk sharing provisions. Disputes have arisen
under the agreement, cross-claims have been made and the matter has been
submitted to arbitration before the American Arbitration Association. GHP is
demanding payment from Unity of $7.6 million and specific performance under the
agreement. Unity is demanding payment from GHP of $14.5 million, specific
performance of certain provisions of the agreement and suspension of its payment
obligations. The Company believes that GHP has fulfilled all of its obligations
under the agreement, that the amount demanded by GHP is properly due to GHP, and
that GHP does not owe Unity the amounts claimed by Unity. The Company intends to
vigorously pursue this matter.
QUARTERS ENDED MARCH 31, 1999 AND 1998
Managed care premiums increased by $182.9 million, or 56.3%, from the
1998 first quarter. The increase in managed care premiums was primarily
attributable to the 382,621, or 49.9%, increase in risk membership to 1,148,830
at March 31, 1999. In addition to the increase in risk membership, premium
yields increased by $6.71, or 4.8%, on a per member per month ("PMPM") basis to
$147.50 PMPM, attributable to rate premium increases coupled with changes in
the overall revenue mix due to the merger. The PHC operations accounted for
388,540, or 101.5%, of the increase in risk membership. Exclusive of the PHC
operations, risk membership decreased by 5,919 members, or 0.8%, as a result of
decreases in Medicaid and commercial membership of 11,953 and 6,651,
respectively, offset by an increase in Medicare risk membership of 12,680,
primarily in the St. Louis market. The decrease in Medicaid membership was
attributable to the Company's exit from the Pennsylvania Medicaid market
subsequent to the first quarter of 1998. The decrease in commercial membership
occurred primarily in the western Pennsylvania market and was attributable to
the disruption caused by the AHERF bankruptcy filing and the conversion of a
large group from a commercial risk product to a self-funded product. Membership
also decreased in other markets due to the Company's efforts to adhere to
strict pricing discipline. The Company will continue to be diligent in
obtaining adequate premium increases and expects its commercial premium rates
to increase 6% to 8% during the remainder of 1999.
The Company exited the Medicare program in several counties representing
approximately 18,000 members as of December 31, 1998. Approximately 10,000 of
those members were in the Florida and Illinois health plans that were sold
effective December and November 1998, respectively. The remaining markets were
exited because the reimbursement rates were not adequate and/or the Company was
not successful in renegotiating adequate reimbursement rates.
Management services revenue increased $14.7 million, or 269.7%, from the
1998 first quarter. Approximately $7.9 million, or 53.7%, of the increase was
primarily attributable to the PHC Administrative Services Only ("ASO")
operations, and PPO access fees. Management services and marketing services
agreements that were entered into coincident with the acquisition of the PHC
health plans accounted for approximately $6.2 million, or 42.2%, of the
increase. Exclusive of the PHC plans and the related agreements with Principal
13
<PAGE> 16
Life, the management services revenue increased approximately $.6 million, or
4.1%.
Health benefits expense increased $158.3 million, or 57.5%, from the
prior year first quarter. The PHC operations accounted for approximately $136.8
million, or 86.4%, of the increase. Exclusive of the PHC operations, health
benefits expense increased by approximately $21.5 million, or 7.8%. The
Company's medical loss ratio increased slightly to 85.4% from 84.8% in the prior
year first quarter due the AHERF bankruptcy filing and the increase in Medicare
membership.
The Company continues to focus on ways to control its medical costs,
including implementation of best practices to reduce inpatient days and
improvement of the overall quality and level of care. The Company is also
continuously monitoring and renegotiating with its provider networks to improve
reimbursement rates and improve access to the network for its members.
As previously discussed, in July 1998, AHERF (the global capitation
provider organization in western Pennsylvania) filed for bankruptcy protection
under Chapter 11. As a result, the extent to which AHERF will perform its
obligations under the global capitation agreement is uncertain. In addition to
the charge to provide for the estimated IBNR claims on behalf of the globally
capitated members at the date of the bankruptcy filing, the medical loss ratio
for the globally capitated members was negatively impacted compared to the
percentage of premium paid to AHERF under the global capitation agreement. In
addition, the Company increased administrative staff for patient utilization and
medical management in western Pennsylvania.
Medical claim liability accruals are periodically monitored and reviewed
with differences for actual settlements from reserves reflected in current
operations. In addition to the procedures for determining reserves as discussed
above, the Company reviews the actual payout of claims relating to prior period
accruals, which may take up to six months to fully develop. Medical costs are
affected by a variety of factors, including the severity and frequency of
claims, that are difficult to predict and may not be entirely within the
Company's control. The Company continually refines its reserving practices to
incorporate new cost events and trends.
Selling, general and administrative ("SGA") expense increased $33.6
million, or 74.6%, from the prior year first quarter. SGA expense, as a percent
of revenue, increased to 14.9% for the quarter ended March 31, 1999, from 13.6%
in the prior year first quarter. The increase in SGA expense is primarily
attributable to additional costs associated with the PHC health plans. In an
effort to control costs and improve customer service, the Company is in the
process of transferring certain of its operating activities (e.g., customer
service, claims processing, billing and enrollment) to regional service
centers, which are anticipated to be fully operational in the fourth quarter of
1999.
Depreciation and amortization increased $4.2 million, or 154.3%, from the
prior year first quarter. Depreciation related to the PHC operations accounted
for approximately $0.4 million, or 9.5%, of the increase and amortization
related to the intangibles and goodwill recorded as part of the PHC acquisition
accounted for approximately $2.9 million, or 69.0%, of the increase.
Other income, net increased by $4.4 million, or 166.4%, from the prior
year first quarter
14
<PAGE> 17
primarily due to increased investment income resulting from the increase in
invested assets subsequent to the acquisition of PHC.
Earnings from operations increased $1.5 million, or 21.0%, from the prior
year first quarter attributable to the various factors as described above.
The Company's net income was $8.3 million compared to $4.7 million for
the first quarter of 1998. Net income per common and common equivalent share was
$0.14 per share for the 1999 first quarter compared to net income per common and
common equivalent share of $0.13 in the prior year first quarter. The weighted
average common and common equivalent shares outstanding were approximately
64,083,708 and 38,641,000 for the quarters ended March 31, 1999 and 1998,
respectively, the increase primarily attributable to the issuance of common
stock in April 1998 related to the acquisition of the PHC health plans.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total cash and investments, excluding deposits of $24.8
million restricted under state regulations, decreased $62.5 million to $539.3
million at March 31, 1999 from $601.8 million at December 31, 1998 primarily
attributable to $46.9 million of cash used in operations for the quarter. A
significant portion of the cash used in operations (approximately $32.1 million)
was paid for medical claims associated with Principal Health Care of Florida,
Inc. and Principal Health Care of Illinois, Inc., the two health plans that were
sold effective December 31, 1998 and November 30, 1998, respectively. The
reduction in cash and investments can also be attributable to the reduction of
deferred revenue resulting from changes in the timing of premium payments from
the U.S. Health Care Financing Administration for Medicare membership and the
Company's efforts to reduce medical claims inventory in the first quarter of
1999.
The Company's investment guidelines emphasize investment grade fixed
income instruments to provide short-term liquidity and minimize the risk to
principal. The Company believes that as its long-term investments are available
for sale, the amount of such investments should be added to current assets when
assessing the Company's working capital and liquidity; on such basis, current
assets plus long-term investments available for sale, less short-term
liabilities, increased to $196.5 million at March 31, 1999 from $187.3 million
at December 31, 1998.
The Company's health maintenance organizations and insurance company
subsidiary are required by state regulatory agencies to maintain minimum surplus
balances, thereby limiting the dividends the Company may receive from its HMOs
and insurance company subsidiary. After giving effect to these statutory reserve
requirements, the Company's regulated subsidiaries had surplus in excess of
statutory requirements of approximately $111.2 million and $93.4 million at
March 31, 1999 and December 31, 1998, respectively. Excluding funds held by
entities subject to regulation, the Company had cash and investments of
approximately $84.4 million and $96.8 million at March 31, 1999 and December 31,
1998, respectively, which are available to pay intercompany balances to
regulated subsidiaries and for general corporate purposes. The Company also has
entered into agreements with certain of its regulated subsidiaries to provide
additional capital if necessary to prevent the subsidiary's insolvency.
During the quarter ending June 30, 1997, the Company entered into a
securities purchase agreement ("Warburg Agreement") with Warburg, Pincus
Ventures, L.P. ("Warburg") and Franklin Capital Associates III, L.P.
("Franklin") for the purchase of $40 million of the Company's 8.3% Convertible
Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with
warrants to purchase 2.35 million shares of the Company's common stock for
$42.35 million. The Coventry Notes are convertible into 4.0 million shares of
the Company's common stock and are exchangeable at the Company's or Warburg's
15
<PAGE> 18
option for shares of convertible preferred stock. These notes are likely to be
converted during 1999. Interest is payable in additional Coventry Notes and, as
a result, the accrued interest at March 31, 1999 has been added to the
outstanding indebtedness, resulting in $46.5 million of Coventry Notes
outstanding at such date.
Projected capital investments in 1999 of approximately $15.0 million
consist primarily of computer hardware, software and related equipment costs
associated with the development and implementation of improved operational and
communications systems. Approximately $2.9 million has been expended for the
three months ended March 31, 1999.
The Company believes that cash flows generated from operations, cash on
hand and investments, and excess funds in certain of its regulated subsidiaries
will be sufficient to fund continuing operations through March 31, 2000.
IMPACT OF YEAR 2000
The Company's business is significantly dependent on information systems.
The Company has implemented a Year 2000 readiness program designed to prevent
material information system disruption associated with the Millennium date
change. The program includes an inventory and review of all core application
systems, networks, desktop systems, infrastructure and critical information
supply chains. The Company's Year 2000 readiness program can be broken down into
five categories: 1) IS hardware, software and networks, 2) office equipment
which relies on microchips or telecommunications, 3) buildings and facilities,
4) business partners and customers, and 5) business risk and contingency
planning. It is anticipated that the program will be substantially completed by
the end of the second quarter of 1999. The total estimated cost of the program
is approximately $13.1 million, of which $11.4 million has been incurred through
March 31, 1999. Other critical IS development proposals were not materially
impacted by the Year 2000 initiatives. The cost of Year 2000 modifications is
based on management's best estimates. Actual costs, however, may differ from
those currently anticipated. All Year 2000 initiatives are monitored by a
steering committee made up of management personnel representing the Company's
legal, compliance, finance, actuarial, medical and IS departments. The steering
committee reports the status of the Company's Year 2000 readiness program to
senior management who report to the board of directors.
While the Company currently believes that its planning efforts and
anticipated modifications to existing systems and purchases of new systems will
be adequate to address its Year 2000 concerns, there can be no assurance that
the systems of other companies on which the Company's systems and operations
rely will be converted on a timely basis and will not have a material adverse
effect on the Company.
The specific phases of the Year 2000 readiness program are as follows:
IS Hardware, Software and Networks
The Company has historically purchased its core software applications
rather than build them. The Company is currently operating on two different
platforms for its core managed health care software applications. The former
Coventry Corporation health plans use the IDX managed care system. The current
release of that system is vendor certified to be Year 2000 compliant and the
Company has converted its applications to that current release in a live
production environment. All integration testing and operating system
upgrades are scheduled for completion by June 30, 1999, a 30 day delay from
prior estimates. The former PHC health plans are using a different third party
product, which has been customized and is no longer supported by the vendor.
That system utilizes Julian dates for all internal processes and is Year 2000
compliant. As part of the Company's
16
<PAGE> 19
readiness program, the entire application has been reviewed and necessary
changes identified. Those programming modifications have been completed, tested
and are in production. The computer operating systems are tested and are in
production.
All internally developed systems were inventoried and plans were made to
upgrade, modify or replace them as necessary to make them Year 2000
compliant by June of 1999. The Company has requested all vendors of currently
installed software to disclose their products' current Year 2000 readiness and
their plan for achieving Year 2000 readiness. All vendor software code except
as noted is certified to be Year 2000 ready. All network and server hardware
and software systems have been tested and repaired and are now Year 2000 ready
with the exception of PC upgrades which will be completed by September 30,
1999.
Other major purchased applications that are non-compliant are being
replaced by upgraded software from vendors or replaced by new purchased systems.
Those applications include replacements for the Company's general ledger and
financial reporting applications, a data warehouse for financial and medical
information decision support, and a proposal and rating system to support the
underwriting and marketing processes. The general ledger, underwriting and data
warehouse systems are complete and in production. Non-critical financial and
human resource systems are scheduled to be completed by July 31, 1999.
Office Equipment
The Company has requested its significant office equipment vendors to
submit Year 2000 readiness statements about their products. The Company expects
that it will receive substantially all of such statements by June 1999 and is
determining the extent to which nonconforming office equipment should be
upgraded or replaced. Second notices to non-conforming or non-responding vendors
have been issued.
Buildings and Facilities
All landlords and building management companies have been sent surveys
with respect to each key operating and security system in Company locations. The
Company currently anticipates that this process will be complete by June 1999.
Second surveys received have been evaluated to assess potential risks and no
material risks have been found at this time.
Business Partners and Customers
The Company is in the process of communicating with its key business
associates, such as financial institutions, third party vendors, provider and
hospital networks, contractors and service providers to ensure that those
parties have appropriate plans to remediate Year 2000 issues where their systems
interface with the Company's systems or otherwise impact its operations. The
Company is assessing the extent to which its operations are vulnerable should
those organizations fail to remediate properly their computer systems. The
Company anticipates that these communications will be completed by June 1999;
however, the Company has little or no control over the efforts of those key
business associates and other suppliers to become Year 2000 compliant. Certain
of the services provided by those parties, particularly telecommunications
providers, financial institutions and major hospitals and medical care
providers, could have a material adverse effect on the Company's financial
condition and results of operations if these services or operations are not Year
2000 compliant.
17
<PAGE> 20
Risk Assessment and Contingency Planning
The Company is reviewing its existing contingency plans for necessary
modifications to address specific Year 2000 issues, and expects to continue this
process through September 30, 1999. As part of its contingency planning the
Company is analyzing the most likely worst case scenario that could result from
Year 2000-related failures. The Company's best estimate of that scenario, based
on current information, would involve a combination of major operational
disruptions by its principal depository financial institutions, utility and
telecommunication suppliers and its largest hospital and provider networks in
its Pennsylvania and Missouri markets. The Company's Year 2000 readiness program
and contingency planning efforts are designed to prevent and/or mitigate the
effects of such possible failures by evaluating technology risks and where
prudent, implementing contingency plans to deal with these risks.
LEGISLATION AND REGULATION
Numerous proposals have been introduced in the United States Congress and
various state legislatures relating to managed health care reform. Some
proposals, if enacted, could among other things, limit the Company's ability to
control medical costs, expose the Company to liability to members for coverage
denials or delays, require certain coverages and impose other requirements on
managed care companies. Although the provisions of any legislation that may be
adopted at the state or federal level cannot be accurately predicted at this
time, management of the Company believes that the ultimate outcome of currently
proposed legislation would not have a material adverse effect on its operations.
As a result of the introduction of Medicare and Medicaid risk products in
1995, the Company is subject to regulatory and legislative changes in those two
government programs. On August 5, 1997, the President signed into law the
Balanced Budget Act of 1997. This law made revisions to the Medicare and
Medicaid programs, including permitting provider-sponsored organizations to
offer services to Medicare beneficiaries, and requiring managed care plans
serving Medicare beneficiaries to make medically necessary care available 24
hours a day, to provide coverage of emergency services that a "prudent lay
person" would deem necessary and to provide grievance and appeal procedures, and
prohibiting such plans from restricting providers' advice concerning medical
care. The Company does not believe this law will have a material adverse effect
on its operations.
RISK FACTORS
The Company's business is subject to numerous risks and uncertainties
which may affect the Company's results of operations in the future and may cause
such future results of operations to differ materially and adversely from
projections included in or underlying any forward-looking statements made by or
on behalf of the Company.
FORWARD LOOKING STATEMENTS
The statements contained in this Form 10-Q that are not historical are
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, which are subject to risks
and uncertainties. These forward-looking statements may be affected by a number
of factors, including the "Risk Factors" contained in Management's Discussion
and Analysis of Financial Condition and Results of Operations contained in Item
7 of the Company's Annual Report on Form 10-K for the year ended December 31,
1998, and actual operations and results may differ materially from those
expressed in this Form 10-Q. Among the factors that may materially affect the
Company's business are potential increases in medical costs, difficulties in
increasing premiums due to competitive pressures, price restrictions under
Medicaid and Medicare, imposition of regulatory restrictions, issues relating
to marketing of products or accreditation or certification of the products by
private or governmental bodies, difficulties in obtaining or maintaining
favorable contracts with health care providers, credit risks on global
capitation arrangements, financing costs and contingencies and litigation risk.
Item 3: Quantitative and Qualitative Disclosures of Market Risk
The Company's only material risk in investments in financial
instruments is in its debt securities portfolio. The Company invests primarily
in marketable state and municipal, U.S. Government and agencies, corporate, and
mortgage-backed debt securities. The Company does not invest in financial
instruments of a hedging or derivative nature.
The Company has established policies and procedures to manage its
exposure to changes in the fair value of its investments. These policies
include an emphasis on credit quality, management of portfolio duration,
maintaining or increasing investment income through high coupon rates and
actively managing profile and security mix depending upon market conditions.
The Company has classified all of its investments as available-for-sale. The
fair value of the Company's investments in debt securities at March 31, 1999
was $180.7 million. Debt securities at March 31, 1999 mature according to their
contractual terms, as follows (actual maturities may differ because of call or
prepayment rights):
<TABLE>
<CAPTION>
Fair
Amortized Cost Value
------------------------------------------
(in thousands)
Maturities:
<S> <C> <C>
Within 1 year $ 30,973 $ 31,546
1 to 5 years 50,056 50,841
6 to 10 years 31,069 30,540
Over 10 years 66,805 67,763
Other securities without stated maturity - -
------------------------------------------
Total short-term and long-term securities $ 178,903 $ 180,690
==========================================
</TABLE>
The Company believes its investment portfolio is diversified and
expects no material loss to result from the failure to perform by the issuer of
the debt securities it holds. The mortgage-backed securities are insured by
GNMA and FNMA.
The Company's projections of hypothetical net losses in fair value of
the Company's market rate sensitive instruments, should potential changes in
market rates occur, are presented below. While the Company believes that the
potential market rate change is reasonably possible, actual results may differ.
Based on the Company's debt securities portfolio and interest rates at
March 31, 1999, a 100 basis point increase in interest rates would result in a
decrease of $6.0 million, or 3.3%, in the fair value of the portfolio. Changes
in interest rates may affect the fair value of the debt securities portfolio
and may result in unrealized gains or losses. Gains or losses would be realized
upon the sale of the investments.
18
<PAGE> 21
PART II. OTHER INFORMATION
ITEM 1: Legal Proceedings
In March 1997, the Company entered into a global capitation agreement
with Allegheny Health, Education and Research Foundation ("AHERF") covering
approximately 250,000 members in the western Pennsylvania market. Under the
agreement AHERF received 78% to 82% of the related premiums to cover all of the
medical expenses of the capitated members. In July 1998, AHERF filed for
bankruptcy protection under Chapter 11. As a result, the Company, which is
ultimately responsible for the medical costs of the capitated members, recorded
a charge of $55.0 million to establish a reserve for the medical costs incurred
by members under the AHERF agreement at the time of the bankruptcy filing and
other potential bankruptcy charges. Generally, under Chapter 11 a debtor company
such as AHERF may affirm or reject its contractual obligations prior to
confirmation of a plan of reorganization, and if a contract is rejected, the
contractual damages become an unsecured claim in the Chapter 11 proceeding.
Although AHERF has not formally rejected the risk-sharing agreement as of the
date of this filing, the partners are negotiating a resolution of the
arrangement and, currently, neither AHERF nor the Company is operating under the
existing agreement. The Company has filed a lawsuit in the Court of Common
Pleas of Allegheny County, Pennsylvania, against certain affiliated
hospitals of AHERF that were not included in the bankruptcy filing. The lawsuit
is seeking a court order declaring that the Company is not liable for the
payment of $21.5 million of medical services provided by the hospitals to the
Company's members prior to the date of AHERF's bankruptcy filing and compelling
the hospitals to fulfill their contractual obligations to continue to provide
health care services to the membership in western Pennsylvania. The lawsuit also
includes a claim for damages to recover the losses incurred by the Company as a
consequence of AHERF's default of its obligations under the risk-sharing
agreement. In response to the lawsuit, the hospitals have filed a counterclaim
alleging that HealthAmerica Pennsylvania, Inc., notwithstanding AHERF's
assumption of the payment obligation, is liable to the hospitals for the payment
of medical services provided prior to AHERF's bankruptcy. The Company intends to
vigorously defend against the counterclaim. The Company believes the reserve
established is adequate to provide for the claims incurred related to the AHERF
arrangement and other related AHERF bankruptcy uncertainties. Through March 31,
1999, approximately $34.7 million was paid for medical claims from this
reserve.
Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the
Company, entered into an agreement effective January 1, 1998 with Unity Health
Network, L.L.C. ("Unity") for Unity's provider network to provide health care
services to GHP's members in the southern and western areas of St. Louis County,
Missouri, which agreement contained certain risk sharing provisions. Disputes
have arisen under the agreement, cross-claims have been made and the matter has
been submitted to arbitration before the American Arbitration Association. GHP
is demanding payment from Unity of $7.6 million and specific performance under
the agreement. Unity is demanding payment from GHP of $14.5 million, specific
performance of certain provisions of the agreement and suspension of its payment
obligations. The Company believes that GHP has fulfilled all of its obligations
under the agreement, that the amount demanded by GHP is properly due to GHP, and
that GHP does not owe Unity the amounts claimed by Unity. The Company intends to
vigorously pursue this matter.
In the normal course of business, the Company has been named as defendant
in various legal actions seeking payments for claims denied by the Company,
medical malpractice, and other monetary damages. The claims are in various
stages of proceedings and some may ultimately be brought to trial. Incidents
occurring through March 31, 1999 may result in the assertion of additional
claims. With respect to medical malpractice, the Company carries professional
malpractice and general liability insurance for each of its operations on a
claims made basis with varying deductibles for which the Company maintains
reserves. In the opinion of management, the outcome of these actions will not
have a material adverse effect on the financial position or results of
operations of the Company.
The Company's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws could have significant impact on the
Company's operations.
ITEMS 2, 3, 4 and 5: Not Applicable
ITEM 6: Exhibits and Reports on Form 8-K
(a) Exhibits required to be filed by Item 601 of Regulation S-K:
19
<PAGE> 22
<TABLE>
<CAPTION>
Exhibit
No. Description of Exhibit
------------------------------------------------------------------------------------------
<S> <C>
11 Computation of Net Earnings Per Common and Common
Equivalent Share
21 Subsidiaries of the Registrant
27 Financial data schedule (for SEC use only)
</TABLE>
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended March 31,
1999.
20
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C>
COVENTRY HEALTH CARE, INC.
------------------------------------
(Registrant)
Date: May 17, 1999 By: /s/ ALLEN F. WISE
-------------------------------
Allen F. Wise
President, Chief Executive
Officer and Director
Date: May 17, 1999 By: /s/ DALE B. WOLF
-------------------------------
Dale B. Wolf
Executive Vice President ,
Chief Financial Officer, Treasurer
And Principal Accounting Officer
</TABLE>
21
<PAGE> 1
EXHIBIT 11
Coventry Health Care, Inc.
Computation of Net Earnings Per Share
<TABLE>
<CAPTION>
Quarter ended March 31, 1999
------------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income $ 8,293
-------------------------
Basic EPS $ 8,293 58,851 $ 0.14
Effect of Dilutive Securities
Options and warrants 712
Convertible notes 4,521
Interest on convertible notes 516
------------------------------------------------------------------------
Diluted EPS $ 8,809 64,084 $ 0.14
========================================================================
</TABLE>
<TABLE>
<CAPTION>
Quarter ended March 31, 1998
------------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income $ 4,707
-------------------------
Basic EPS $ 4,707 33,348 $ 0.14
Effect of Dilutive Securities
Options and warrants 1,127
Convertible notes 4,166
Interest on convertible notes 476
------------------------------------------------------------------------
Diluted EPS $ 5,183 38,641 $ 0.13
========================================================================
</TABLE>
<PAGE> 1
EXHIBIT NO. 21
COVENTRY HEALTH CARE, INC.
SUBSIDIARIES
April 31, 1999
<TABLE>
<CAPTION>
NAME OF SUBSIDIARY STATE OF INCORPORATION
------------------ ----------------------
<S> <C>
1. Coventry Corporation Tennessee
2. Coventry Health and Life Insurance Company Texas
3. Coventry Health and Life Insurance Company Delaware
4. Coventry Healthcare Management Corporation Delaware
d/b/a HealthAssurance
5. Coventry HealthCare Management Corporation Virginia
(i) Southern Health Services, Inc. Virginia
(ii) Southern Health Benefit Services, Inc. Virginia
6. Coventry HealthCare Development Corporation Delaware
(i) Coventry Health Plan of West Virginia West Virginia
7. Group Health Plan, Inc. Missouri
(i) Specialty Services of Missouri, Inc. Missouri
8. HealthAmerica Pennsylvania, Inc.(1) Pennsylvania
9. HealthCare USA, Inc. Florida
(i) HealthCare USA Midwest, Inc. Delaware
(a) HealthCare USA of Missouri, LLC Missouri
10. HealthPass, Inc. Pennsylvania
11. Pennsylvania HealthCare USA, Inc. Pennsylvania
12. Principal Health Care of Iowa, Inc. Iowa
13. Principal Health Care Management Corporation Iowa
14. Principal Health Care of the Carolinas, Inc. North Carolina
15. Principal Health Care of Delaware, Inc. Delaware
16. Principal Health Care of Georgia, Inc. Georgia
17. Principal Health Care of Indiana, Inc. Delaware
</TABLE>
<PAGE> 2
<TABLE>
<S> <C>
18. Principal Health Care of Louisiana, Inc. Louisiana
19. Principal Health Care of Kansas City, Inc. Kansas
20. Principal Health Care of Nebraska, Inc. Nebraska
21. Principal Health Care of Pennsylvania, Inc. Pennsylvania
22. Principal Health Care of St. Louis, Inc. Delaware
23. Principal Health Care of South Carolina, Inc. South Carolina
24. Principal Health Care of Tennessee, Inc. Tennessee
25. United HealthCare Services of Iowa, Inc. Iowa
</TABLE>
- --------
(1) The Medical Center HPJV, Inc., a Pennsylvania corporation and wholly owned
subsidiary of HealthAmerica Pennsylvania, Inc. ("HealthAmerica"), and its
subsidiary, Riverside Health Plan, Inc., a Pennsylvania corporation, were merged
into HealthAmerica effective April 5, 1999.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF COVENTRY HEALTH CARE, INC. FOR THE THREE MONTHS ENDED
MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 383,435
<SECURITIES> 180,690
<RECEIVABLES> 69,790
<ALLOWANCES> 18,940
<INVENTORY> 0
<CURRENT-ASSETS> 548,497
<PP&E> 89,930
<DEPRECIATION> 50,782
<TOTAL-ASSETS> 1,040,684
<CURRENT-LIABILITIES> 507,133
<BONDS> 47,246
0
0
<COMMON> 593
<OTHER-SE> 443,665
<TOTAL-LIABILITY-AND-EQUITY> 1,040,684
<SALES> 0
<TOTAL-REVENUES> 527,848
<CGS> 0
<TOTAL-COSTS> 519,165
<OTHER-EXPENSES> (7,015)
<LOSS-PROVISION> 2,483
<INTEREST-EXPENSE> 1,007
<INCOME-PRETAX> 14,691
<INCOME-TAX> 6,398
<INCOME-CONTINUING> 8,293
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,293
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
</TABLE>
