<PAGE> 1
UNITED STATES
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 June 30, 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)
<TABLE>
<S> <C>
DELAWARE 52-2073000
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
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 July 31, 1999
- ----- ----------------------------
<S> <C>
Common Stock $.01 Par Value 59,078,766
</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 June 30, 1999 and December 31, 1998 1
Condensed Consolidated Statements of Operations
for the quarter and six months ended June 30, 1999
and 1998 2
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 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 14
Item 3: Quantitative and Qualitative Disclosures
about Market Risk 27
PART II. OTHER INFORMATION
Item 1: Legal Proceedings 28
Items 2, 3, 4, and 5 29
Item 6: Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
<PAGE> 3
COVENTRY HEALTH CARE, INC.AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------------- --------------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 243,613 $ 405,323
Short-term investments 57,006 46,714
Accounts receivable, net 49,706 43,466
Other receivables 36,658 23,126
Deferred income taxes 65,521 65,583
Other current assets 5,990 6,993
------------------- --------------------
Total current assets 458,494 591,205
Long-term investments 226,691 162,546
Property and equipment, net 38,109 35,780
Goodwill and intangible assets, net 268,927 295,966
Other assets 5,507 5,731
------------------- --------------------
Total assets $ 997,728 $ 1,091,228
=================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claim liabilities $ 279,869 $ 330,743
Other medical liabilities 58,393 73,079
Accounts payable and other accrued liabilities 99,568 115,717
Deferred revenue 19,037 46,414
------------------- --------------------
Total current liabilities 456,867 565,953
Convertible exchangeable subordinated notes 42,358 45,538
Long-term debt - 781
Other long-term liabilities 41,969 42,418
Stockholders' equity:
Preferred stock, $.01 par value; 6,000,000 shares
authorized; Series A, convertible, 473,705
shares issued and outstanding in 1999 5 -
Common stock, $.01 par value; 200,000,000 shares
authorized; 59,435,998 shares issued and 58,996,438
outstanding in 1999; and 59,287,454 shares issued
and 58,847,894 outstanding in 1998 594 593
Additional paid-in capital 483,049 476,429
Accumulated other comprehensive (loss) income (3,286) 794
Accumulated deficit (18,828) (36,278)
Treasury stock, at cost, 439,560 shares (5,000) (5,000)
------------------- --------------------
Total stockholders' equity 456,534 436,538
------------------- --------------------
Total liabilities and stockholders' equity $ 997,728 $ 1,091,228
=================== ====================
</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>
Quarter ended Six months ended
June 30, June 30,
-------------------------------- -----------------------------------
1999 1998 1999 1998
--------------- --------------- ------------------ ---------------
<S> <C> <C> <C> <C>
Operating revenues:
Managed care premiums $ 511,597 $ 561,145 $ 1,019,273 $ 885,898
Management services 20,234 22,659 40,405 28,115
--------------- --------------- ------------------ ---------------
Total operating revenues 531,831 583,804 1,059,678 914,013
Operating expenses:
Health benefits 439,490 480,985 873,130 756,299
Selling, general and administrative 75,641 83,390 154,172 128,357
Depreciation and amortization 7,074 7,887 14,045 10,637
AHERF charge - 55,000 - 55,000
Merger costs - 7,780 - 7,780
--------------- --------------- ------------------ ---------------
Total operating expenses 522,205 635,042 1,041,347 958,073
Operating earnings (loss) 9,626 (51,238) 18,331 (44,060)
Other income, net of interest expense 6,788 6,504 12,773 7,304
--------------- --------------- ------------------ ---------------
Earnings (loss) before income taxes 16,414 (44,734) 31,104 (36,756)
Provision for (benefit from) income
taxes 7,257 (16,978) 13,654 (13,707)
--------------- --------------- ------------------ ---------------
Net earnings (loss) $ 9,157 $ (27,756) $ 17,450 $ (23,049)
=============== =============== ================== ===============
Net earnings (loss) per share
Basic $ 0.16 $ (0.47) $ 0.30 $ (0.50)
=============== =============== ================== ===============
Diluted $ 0.15 $ - $ 0.29 $ -
=============== =============== ================== ===============
</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>
Six months ended
June 30,
---------------------------------------
1999 1998
------------------ ------------------
<S> <C> <C>
Net cash used in operating activities $ (91,104) $ (14,558)
------------------ ------------------
Cash flows from investing activities:
Capital expenditures, net (5,736) (4,610)
Net proceeds from sale of intangibles 12,841 -
Sale of investments 115,462 37,453
Purchase of investments (193,801) (40,629)
Cash acquired with purchase of PHC - 148,600
------------------ ------------------
Net cash (used in) provided by investing activities (71,234) 140,814
------------------ ------------------
Cash flows from financing activities:
Issuance of long-term debt and notes payable - 122
Payments of long-term debt and notes payable (829) (2,554)
Net proceeds from issuance of stock and warrants 1,457 1,414
------------------ ------------------
Net cash provided by (used in) financing activities 628 (1,018)
------------------ ------------------
Net (decrease) increase in cash and cash equivalents (161,710) 125,238
Cash and cash equivalents at beginning of
the period 405,323 153,979
------------------ ------------------
Cash and cash equivalents at end of the period $ 243,613 $ 279,217
================== ==================
Supplemental disclosures of cash flow information Cash paid during the period
was as follows:
Interest $ 25 $ 1,692
================== ==================
Income taxes $ 15,300 $ 14,993
================== ==================
</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 for the year ended December 31, 1998, 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,
2000. The Company does not believe that adoption of SFAS 133 (as amended by
SFAS 137) 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, now known as Principal 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
4
<PAGE> 7
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 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 $6.3
million for the three months ended June 30, 1999, and $12.5 million for the
six months ended June 30, 1999, and expects to receive payments of approximately
$26.4 million during the year ended December 31, 1999, inclusive of the $12.5
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. Effective June 1, 1999, the Company amended
these agreements with Principal Life and waived its rights to reinsure and renew
Principal Life's health insurance indemnity business located in the Company's
service area. The Company received $19.8 million in cash in exchange for
waiving these rights. At the date of the transaction, the Renewal Rights and
Coinsurance agreements had a net book value of $19.7 million resulting in an
after tax gain of $0.1 million.
As a result of the acquisition, 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
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 June 30, 1999
and $4.0 million for the six months ended June 30,1999. The maximum amount that
can be paid under the percentage of savings component of the agreement is $8.0
million for 1999.
Effective November 30, 1998, the Company sold its subsidiary,
Principal Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois
health plan accounted for approximately 56,000 risk members and approximately
2,400 non-risk members as of November 30, 1998.
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.
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.
5
<PAGE> 8
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
June 30, 1999, the Company has expended approximately $25.4 million related to
these reserves and expects to make payments on the remaining reserves
through July 2002.
The purchase price for 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 allocated amounts 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>
4. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES
During the quarter ending June 30, 1997, Coventry entered into a
securities purchase agreement ("Warburg Agreement") with Warburg, Pincus
Ventures, L.P. ("Warburg") and Franklin Capital Associates III, L.P.
("Franklin") for the purchase of $40 million of Coventry's 8.3% Convertible
Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with
warrants to purchase 2.35 million shares of Coventry's common stock for $42.35
million. The original amount of the Coventry Notes, $36.0 million held by
Warburg and $4.0 million held by Franklin, are convertible into 3.6 million
shares and 0.4 million shares of Coventry's common stock, respectively, and are
exchangeable at Coventry's or Warburg's option for shares of convertible
preferred stock. During the second quarter of 1999, Coventry converted all
Coventry Notes held by Franklin totaling $4.7 million, including interest, into
473,705 shares of Series A convertible preferred stock. The remaining Coventry
Notes are likely to be converted during the third quarter of 1999. In
accordance with the Warburg Agreement, effective May 28, 1999, the Coventry
Notes no longer bear interest.
6
<PAGE> 9
5. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows (in thousands):
<TABLE>
<CAPTION>
Quarter ended
6/30/99 6/30/98
--------------------- ------------------
<S> <C> <C>
Net income (loss) $ 9,157 $ (27,756)
Other comprehensive income (loss), net of tax:
Net unrealized (losses) gains on securities,
net of reclassification adjustment (3,225) 1,306
--------------------- ------------------
Comprehensive income (loss) $ 5,932 $ (26,450)
===================== ==================
</TABLE>
<TABLE>
<CAPTION>
Six months ended
6/30/99 6/30/98
-------------------- ------------------
<S> <C> <C>
Net income (loss) $ 17,450 $ (23,049)
Other comprehensive income (loss), net of tax:
Net unrealized (losses) gains on securities,
net of reclassification adjustment (4,080) 1,290
-------------------- ------------------
Comprehensive income (loss) $ 13,370 $ (21,759)
==================== ==================
</TABLE>
6. EARNINGS (LOSS) 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):
<TABLE>
<CAPTION>
Quarter ended June 30, 1999
------------------------------------------------------------
Income (Numerator) Shares (Denominator) Per Share Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net Income $9,157
----------------
Basic EPS $9,157 58,952 $0.16
Effect of Dilutive Securities
Options and warrants 762
Convertible preferred stocks 78
Convertible notes 4,510
Interest on convertible notes 332
------------------------------------------------------------
Diluted EPS $9,489 64,302 $0.15
============================================================
</TABLE>
7
<PAGE> 10
<TABLE>
<CAPTION>
Quarter ended June 30, 1998
------------------------------------------------------------
Loss (Numerator) Shares (Denominator) Per Share
Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net loss $(27,756)
----------------
Basic EPS $(27,756) 58,592 $(0.47)
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30, 1999
------------------------------------------------------------
Income Shares (Denominator) Per Share Amount
(Numerator)
------------------------------------------------------------
<S> <C> <C> <C>
Net Income $17,450
----------------
Basic EPS $17,450 58,902 $0.30
Effect of Dilutive Securities
Options and warrants 737
Convertible preferred stocks 39
Convertible notes 4,515
Interest on convertible notes 848
------------------------------------------------------------
Diluted EPS $18,298 64,193 $0.29
============================================================
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30, 1998
------------------------------------------------------------
Loss (Numerator) Shares (Denominator) Per Share Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net loss $(23,049)
----------------
Basic EPS $(23,049) 45,970 $(0.50)
</TABLE>
7. 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 members 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 increased
out-of-pocket costs. Government products include Medicare Risk, Medicare Cost,
and Medicaid. The Company provides comprehensive health benefits to members
participating in government programs and receives premium
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<PAGE> 11
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.
<TABLE>
<CAPTION>
For the Quarter Ended June 30, 1999
(in thousands)
------------------------------------------------------------
Government
Commercial Programs Total
------------------------------------------------------------
<S> <C> <C> <C>
Revenues $380,538 $131,059 $511,597
Gross Margin 58,084 14,023 72,107
</TABLE>
<TABLE>
<CAPTION>
For the Quarter Ended June 30, 1998
(in thousands)
------------------------------------------------------------
Government
Commercial Programs Total
------------------------------------------------------------
<S> <C> <C> <C>
Revenues $440,856 $120,289 $561,145
Gross Margin 12,856 12,304 25,160
</TABLE>
<TABLE>
<CAPTION>
For the six months ended June 30, 1999
(in thousands)
------------------------------------------------------------
Government
Commercial Programs Total
------------------------------------------------------------
<S> <C> <C> <C>
Revenues $765,528 $253,745 $1,019,273
Gross Margin 119,536 26,607 146,143
</TABLE>
<TABLE>
<CAPTION>
For the six months ended June 30, 1998
(in thousands)
------------------------------------------------------------
Government
Commercial Programs Total
------------------------------------------------------------
<S> <C> <C> <C>
Revenues $674,912 $210,986 $885,898
Gross Margin 50,959 23,640 74,599
</TABLE>
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<PAGE> 12
Following are reconciliations of reportable segment information to
financial statement amounts (in thousands):
<TABLE>
<CAPTION>
For the Quarter Ended
June 30,
------------------------------------------
1999 1998
------------------------------------------
<S> <C> <C>
Revenues
Reportable Segments $511,597 $561,145
Other 20,234 22,659
--------------- ---------------
Total revenues 531,831 583,804
-------------- ---------------
Earnings (Loss) Before
Income Taxes:
Gross margin from
reportable segments 72,107 25,160
Other revenues 20,234 22,659
Selling, general and
administrative (75,641) (83,390)
Depreciation and
amortization (7,074) (7,887)
Merger costs - (7,780)
Other income 7,480 8,491
Interest expense (692) (1,987)
---------------- ---------------
Total earnings (loss)
before income taxes $16,414 $(44,734)
================ ===============
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
For the Six Months Ended
June 30,
------------------------------------------
1999 1998
------------------------------------------
<S> <C> <C>
Revenues
Reportable Segments $1,019,273 $885,898
Other 40,405 28,115
--------------- ---------------
Total revenues 1,059,678 914,013
--------------- ---------------
Earnings (Loss) Before
Income Taxes:
Gross margin from
reportable segments 146,143 74,599
Other revenues 40,405 28,115
Selling, general and
administrative (154,172) (128,357)
Depreciation and
amortization (14,045) (10,637)
Merger costs - (7,780)
Other income 14,472 11,124
Interest expense (1,699) (3,820)
--------------- ----------------
Total earnings (loss)
before income taxes $31,104 $(36,756)
=============== ===============
</TABLE>
8. AHERF CHARGE
The Company and certain affiliated non-debtor hospitals of Allegheny
Health, Education and Research Foundation (AHERF) have been involved in
litigation to determine who had the financial responsibility for the medical
services provided to the Company's members as a consequence of the bankruptcy
filed by AHERF which precluded it from discharging its responsibilities for
the payment of those medical services under a global capitation agreement
between the Company and AHERF covering approximately 250,000 members in the
western Pennsylvania market. AHERF filed for bankruptcy protection on July 22,
1998, and shortly thereafter the Company filed a lawsuit against certain
non-debtor affiliated hospitals of AHERF seeking a declaratory judgment that
the Company was not obligated to pay in excess of $21.5 million to those
hospitals for medical services provided by them to the Company's members. The
lawsuit also included additional claims for monetary damages. In response to
the lawsuit, the hospitals filed a counterclaim alleging that the Company's
subsidiary, HealthAmerica Pennsylvania, Inc. was liable to the hospitals for
the payment of those medical services. 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 global capitation agreement at the time of the
bankruptcy filing. Although AHERF has not formally rejected the capitation
agreement as of the date of this filing, the parties are no longer operation
under the terms of that agreement. On June 22, 1999, the Company reached a
settlement with the affiliated non-debtor hospitals whereby the hospitals
agreed that the Company would not be liable for the payment of the medical
services rendered by those hospitals to the Company's members prior to July 21,
1998, the date of AHERF's bankruptcy filing. The hospitals agreed to dismiss
with prejudice their counterclaims against the Company and the Company agreed
to dismiss its lawsuit. The conditions to execute this settlement are expected
to be finalized over the next ninety days.
11
<PAGE> 14
9. MERGER COSTS
In connection with the acquisition of PHC, the Company relocated its
corporate headquarters from Nashville, Tennessee to Bethesda, Maryland. As a
result, the Company established a one-time reserve in the prior year of
approximately $7.8 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. The anticipated merger costs were less than the original
reserve established, resulting in a credit to earnings of $1.3 million in the
fourth quarter of 1998. As of June 30, 1999, the Company has expended
approximately $5.7 million related to the reserve. The Company expects to make
payments through December 2002 related to these charges.
10. LEGAL PROCEEDINGS
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 parties are proceeding with discovery and a date
for arbitration has been set. The Company intends to vigorously pursue this
matter.
The Company and AHERF have been involved in legal disputes concerning
payments due under a global capitation agreement between the parties covering
approximately 250,000 members in the western Pennsylvania market. See Footnote 8
for disclosures on AHERF litigation.
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 June 30, 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.
12
<PAGE> 15
11. SUBSEQUENT EVENTS
On July 26, 1999, the Company announced that its subsidiary, Principal
Health Care of the Carolinas, Inc., had signed a definitive agreement to acquire
Kaiser Foundation Health Plan of North Carolina's commercial membership in
Charlotte, North Carolina. Kaiser's Charlotte operation currently has
approximately 31,000 HMO and POS members and generates approximately $53.0
million in annual revenue. The transaction is expected to close in the fourth
quarter of 1999, subject to regulatory and other customary approvals. The
Company believes the acquisition will improve the North Carolina health plan's
financial position and allow it to capitalize on the growth potential in the
Charlotte market.
On August 4, 1999, the Company also announced that it had signed a
definitive agreement with Camcare, an integrated delivery system, to acquire
its managed care subsidiary, Carelink Health Plans("Carelink"). Carelink,
based in Charleston, West Virginia, has approximately 45,000 commercial HMO and
POS members, 12,000 Medicaid members and 1,500 enrollees from self-insured
employers; with annual premium revenue of approximately $93.0 million.
Carelink's service area is generally contiguous with the West Virginia counties
currently served by the Company's health plans in West Virginia and Virginia.
The acquisition is expected to close in the third or fourth quarter of 1999,
subject to regulatory and other customary approvals. The transaction will be
accounted for as a purchase in which the Company will pay approximately $8.0
million in cash (subject to final membership verification) in exchange for all
of Carelink's stock. Carelink will become a wholly-owned subsidiary of
Coventry, and will continue to use the Carelink name in its service area. As
part of the definitive agreement, Carelink will enter into a 5-year contract
with Camcare for health care services and a 3-year exclusive contract to
continue providing health benefit coverage to Camcare's employees and their
dependents.
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<PAGE> 16
ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Quarter and six months ended June 30, 1999 and 1998
GENERAL
Coventry Health Care, Inc. ("Coventry"), 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 June 30, 1999, Coventry had 1,151,328 members for whom it
assumes underwriting risk ("risk members") and 243,240 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 in continuing operations as of June 30, 1999 and 1998 and the
percentage change in membership between those dates, where applicable.
<TABLE>
<CAPTION>
JUNE 30, PERCENT
1999 1998 CHANGE
---- ---- ------
<S> <C> <C> <C>
Pennsylvania 395,486 416,564 (5.1%)
St. Louis 331,371 309,226 7.2%
Iowa 77,908 80,431 (3.1%)
Kansas City 60,006 43,819 36.9%
Delaware/Baltimore 58,784 53,442 10.0%
Richmond 52,284 58,573 (10.7%)
Wichita 40,508 32,621 24.2%
Louisiana 37,486 39,435 (4.9%)
Nebraska 27,794 33,110 (16.1%)
Georgia 25,206 16,602 51.8%
Indiana 24,621 27,684 (11.1%)
Carolina 19,874 21,317 (6.8%)
--------- ---------
Total risk membership by market 1,151,328 1,132,824 1.6%
Total non-risk membership 243,240 220,125 10.5%
--------- ---------
Total membership by market in
Continuing operations 1,394,568 1,352,949 3.1%
========= =========
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, PERCENT
1999 1998 CHANGE
---- ---- ------
<S> <C> <C> <C>
Commercial 966,886 977,693 (1.1%)
Medicare risk 63,439 54,724 15.9%
Medicare cost 728 2,471 (70.5%)
Medicaid 120,275 97,936 22.8%
--------- ---------
Total risk membership by product 1,151,328 1,132,824 1.6%
Non-risk membership 243,240 220,125 10.5%
--------- ---------
Total membership by product in
Continuing operations 1,394,568 1,352,949 3.1%
========= =========
</TABLE>
Coventry'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"). Coventry currently
believes that the estimates for IBNR liabilities are adequate to satisfy its
ultimate claims liability after all medical claims have been reported. In
determining the Company's IBNR liabilities, Coventry employs plan by plan
standard actuarial reserve methods (specific to the plan's membership, product
characteristics, geographic territories and provider network) that consider
14
<PAGE> 17
utilization frequency and unit costs of inpatient, outpatient, pharmacy and
other medical costs, as well as claim payment backlogs and the timing of
provider reimbursements. Reserve estimates 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 estimated
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 its IBNR
reserves, and as actual settlements are made or accruals adjusted, reflects
these differences in current operations.
RESULTS OF OPERATIONS
Effective April 1, 1998, Coventry completed its acquisition of certain
health plans of Principal Health Care, Inc. ("PHC") from Principal Mutual Life
Insurance Company, now known as Principal 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 Coventry's consolidated financial
statements since the date of acquisition. The purchase price consisted of
25,043,704 shares of Coventry'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
Coventry'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 Coventry's common stock to increase its ownership
percentage above 40%.
Coincident with the closing of the transaction, Coventry entered into
a Renewal Rights Agreement and a Coinsurance Agreement with Principal Life,
whereby it manages certain of Principal Life's indemnity health insurance
policies in the markets where Coventry does business and, on December 31, 1999,
would offer to renew such policies in force at that time. Effective June 1,
1999, Coventry amended these agreements with Principal Life and waived its
rights to reinsure and renew Principal Life's health insurance indemnity
business located in Coventry's service area. Coventry received $19.8 million
in cash in exchange for waiving these rights. At the date of the transaction,
the Renewal Rights and Coinsurance agreements had a net book value of $19.7
million resulting in an after tax gain of $0.1 million.
Coventry also 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, Coventry recognized
revenue of approximately $6.3 million for the three months ended June 30, 1999,
and $12.5 million for the six months ended June 30, 1999, and expects to
receive payments of approximately $26.4 million during the year ended December
31, 1999, inclusive of the $12.5 million.
As a result of the acquisition, Coventry assumed an agreement with
Principal Life, whereby Principal Life pays a fee for access to Coventry's
preferred provider organization ("PPO") 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, Coventry recognized revenue
of approximately $2.0 million for the three months ended June 30, 1999 and $4.0
million for the six months ended June 30, 1999. The maximum amount that can be
paid under the percentage of savings component of the agreement is $8.0 million
for 1999.
15
<PAGE> 18
On December 31, 1999, the Marketing Services Agreement, Management
Services Agreement, and PPO access agreement with Principal Life will expire
and Coventry will no longer receive revenue associated with these fees. In
anticipation of the loss of these fees, Coventry is planning to reduce selling,
general and administrative ("SG&A") costs through cost savings from service
center consolidation, headcount reductions and across-the-board reductions in
administrative expenses. Coventry expects the SG&A reductions to be completely
implemented by the third quarter of this year. In addition to SGA reductions,
Coventry plans on implementing rating improvements in two specific large
groups, improving margins in the central Pennsylvania Medicare market,
improving margins in the St. Louis Medicaid market, and increasing operating
revenues through the recently announced acquisitions in Charlotte and West
Virginia.
Effective November 30, 1998, Coventry 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.
On December 31, 1998, Coventry 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.
The proceeds from both sales were used to retire Coventry's credit
facility, to assist in improving the capital position of its 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, Coventry 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
June 30, 1999, Coventry has expended approximately $25.4 million related to
these reserves and 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 in the prior year of
approximately $7.8 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. The anticipated merger costs were less than the original
reserve established, resulting in a credit to earnings of $1.3 million in the
fourth quarter of 1998. As of June 30, 1999, the Company has expended
approximately $5.7 million related to the reserve. The Company expects to make
payments through December 2002 related to these charges.
On July 26, 1999, Coventry announced that its subsidiary, Principal
Health Care of the Carolinas, Inc., had signed a definitive agreement to
acquire Kaiser Foundation Health Plan of North Carolina's commercial
16
<PAGE> 19
membership in Charlotte, North Carolina. Kaiser's Charlotte operation
currently has approximately 31,000 HMO and Point-of-Service ("POS") members and
generates approximately $53.0 million in annual revenue. The transaction is
expected to close in the fourth quarter of 1999, subject to regulatory and
other customary approvals. Coventry believes the acquisition will improve the
North Carolina health plan's financial position and allow it to capitalize on
the growth potential in the Charlotte market.
On August 4, 1999, Coventry also announced that it had signed a
definitive agreement with Camcare, an integrated delivery system, to acquire
its managed care subsidiary, Carelink Health Plans("Carelink"). Carelink,
based in Charleston, West Virginia, has approximately 45,000 commercial HMO and
POS members, 12,000 Medicaid members and 1,500 enrollees from self-insured
employers with annual premium revenue of approximately $93.0 million.
Carelink's service area is contiguous with the West Virginia counties currently
served by Coventry's health plans in West Virginia and Virginia. The
acquisition is expected to close in the third or fourth quarter of 1999,
subject to regulatory and other customary approvals. The transaction will be
accounted for as a purchase in which the company will pay approximately $8.0
million in cash (subject to final membership verification) in exchange for all
of Carelink's stock. Carelink will become a wholly-owned subsidiary of
Coventry, and will continue to use the Carelink name in its service area. As
part of the definitive agreement, Carelink will enter into a 5-year contract
with Camcare for health care services and a 3-year exclusive contract to
continue providing health benefit coverage to Camcare's employees and their
dependents.
On July 13, 1999, Coventry announced a new program designed to provide
total health and lifestyle management to the Medicare population. The 5,000
member pilot, launched in the Pittsburgh area, will combine a system of
improved delivery of care with specialized life and medical interventions for
seniors with varying care needs. As of December 31, 1998, Coventry 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 Coventry was not successful in
renegotiating adequate reimbursement rates.
Coventry and certain affiliated non-debtor hospitals of Allegheny Health,
Education and Research Foundation (AHERF) have been involved in litigation to
determine who had the financial reponsibility for the medical services provided
to Coventry's members as a consequence of the bankruptcy filed by AHERF which
precluded it from discharging its responsibilities for the payment of those
medical services under a global capitation agreement between Coventry and AHERF
covering approximately 250,000 members in the western Pennsylvania market.
AHERF filed for bankruptcy protection on July 22, 1998, and shortly thereafter
Coventry filed a lawsuit against certain non-debtor affiliated hospitals of
AHERF seeking a declaratory judgment that Coventry was not obligated to pay in
excess of $21.5 million to those hospitals for medical services provided by
them to Coventry's members. The lawsuit also included additional claims for
monetary damages. In response to the lawsuit, the hospitals filed a
counterclaim alleging that Coventry's subsidiary, HealthAmerica Pennsylvania,
Inc. was liable to the hospitals for the payment of those medical services. As
a result, Coventry, 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 global
capitation agreement at the time of the bankruptcy filing. Although AHERF has
not formally rejected the capitation agreement as of the date of this filing,
the parties are no longer operating under the terms of that agreement. On June
22, 1999, Coventry reached a settlement with the affiliated non-debtor
hospitals whereby the hospitals agreed that Coventry would not be liable for the
payment of the medical services rendered by those hospitals to Coventry's
members prior to July 21, 1998, the date of AHERF's bankruptcy filing. The
hospitals agreed to dismiss with prejudice their counterclaims against Coventry
and Coventry agreed to dismiss its lawsuit. The conditions to execute this
settlement are expected to be finalized over the next ninety days.
17
<PAGE> 20
Group Health Plan, Inc. ("GHP"), a health plan subsidiary of Coventry,
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. Coventry 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 parties are
proceeding with discovery and a date for arbitration has been set. Coventry
intends to vigorously pursue this matter.
QUARTERS ENDED JUNE 30, 1999 AND 1998
Managed care premiums decreased by $49.5 million, or 8.8%, from the
prior year second quarter. This decrease was primarily attributable to the
reduction of membership resulting from the sales of the Florida and Illinois
health plans in the fourth quarter of 1998. Exclusive of the Florida and
Illinois operations, managed care premiums increased by $31.0 million, or 6.5%,
primarily due to the increase in Medicare risk and Medicaid membership of
31,054, or 20.3%. In addition to the increase in Medicare risk and Medicaid
membership, combined premium yields increased by $8.17 or 5.8%, on a per member
per month ("PMPM") basis to $149.53 PMPM, attributable to rate increases
coupled with changes in the overall product mix due to the merger. The Medicare
risk and Medicaid programs continue to grow in existing markets through
recently expanded programs. The increase in Medicare risk and Medicaid
membership was offset by a decrease in commercial membership of 10,807, or
1.1%. The decrease in commercial membership occurred primarily in the
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 Coventry's efforts to adhere to a strict pricing discipline. Coventry
will continue to be diligent in obtaining adequate premium increases and
expects its commercial premium rates to increase 8% to 10% during the remainder
of 1999.
Management services revenue decreased $2.4 million, or 10.7%, from the
prior year second quarter primarily due to the decrease in PPO revenue related
to the agreement with Principal Life.
Health benefits expense decreased $41.5 million, or 8.6%, from the
prior year second quarter. Excluding the Florida and Illinois operations in the
18
<PAGE> 21
prior year, health benefits expense increased $31.1 million, or 7.6%.
Coventry's medical loss ratio increased slightly to 85.9% from 85.7% in the
prior year second quarter.
As previously discussed, in July 1998, AHERF (the global capitation
provider organization for Coventry 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 such members was negatively impacted
compared to the percentage of premium paid to AHERF under the global capitation
agreement. In addition, Coventry increased administrative staff for patient
utilization and medical management in western Pennsylvania.
Coventry 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 providers for its members.
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, 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 the company's control. Coventry continually refines its reserving
practices to incorporate new cost events and trends.
SGA expense decreased $7.7 million, or 9.3%, from the prior year second
quarter. On a same store basis, SGA increased $5.6 million, or 8.0%, primarily
due to the company's consolidation of eighteen service centers to three
regional service centers. SGA expense, as a percent of revenue, decreased to
14.2% for the quarter ended June 30, 1999, from 14.3% in the prior year second
quarter. In an effort to control costs and improve customer service, Coventry
is in the process of transferring certain of its operating activities (e.g.,
customer service, claims processing, billing and enrollment) to regional
service centers. All activities are expected to be fully transferred by the
end of the fourth quarter of 1999.
Depreciation and amortization decreased $0.8 million, or 10.3%, from
the prior year second quarter. This decrease was primarily attributable to the
reduction of intangible assets resulting from the sales of the Florida and
Illinois health plans and the sale of the Renewal Rights and Coinsurance
Agreements described above.
Other income, net of interest expense, increased by $0.3 million, or
4.4%, from the prior year second quarter. On a same store basis, other income,
net of interest expense, increased $1.4 million, or 25.4%, primarily due to the
reduction of interest expense from the reduction of debt.
Earnings from operations increased $60.9 million from the prior year
second quarter. Excluding the $62.8 million of charges associated with the
AHERF bankruptcy and merger costs in the prior year, operating earnings
decreased $1.9 million, or 16.6%, attributable to the various factors as
described above.
Coventry's net income was $9.2 million compared to a net loss of $27.8
million for the second quarter of 1998. Net income per share was $0.15 for the
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<PAGE> 22
1999 second quarter compared to net loss per share of $0.47 in the prior year
second quarter. Excluding the AHERF charge and merger costs, Coventry would
have reported earnings per share of $0.17 in the prior year second quarter.
Excluding the AHERF charge and merger costs, the weighted average common shares
outstanding were approximately 64,301,823 and 64,764,526, on a diluted basis,
for the quarters ended June 30, 1999 and 1998, respectively.
20
<PAGE> 23
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
Managed care premiums increased $133.4 million for the six months
ended June 30, 1999, or 15.1%, from the corresponding period in 1998. This
increase was primarily attributable to the additional revenue associated with
the acquisition of the PHC plans in April 1998. The increase was also due to
the increase in Medicare risk and Medicaid membership of 31,054, or 20.3% in
continuing markets. In addition to the increase in risk membership, combined
premium yields increased by $7.69, or 5.5%, on a per member per month ("PMPM")
basis, to $148.55 PMPM, attributable to rate increases coupled with changes in
the overall product mix due to the merger. The Medicare risk and Medicaid
programs continue to grow in existing markets through recently expanded
programs. The increase in Medicare risk and Medicaid membership was offset by
a decrease in Commercial membership of 10,807, or 1.1%. 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 Coventry's efforts
to adhere to strict pricing discipline. Coventry will continue to be diligent
in obtaining adequate premium increases and expects its commercial premium
rates to increase 8% to 10% during the remainder of 1999.
Management services revenue increased $12.3 million for the six months
ended June 30, 1999, or 43.7%, from the corresponding period in 1998. The
increase of management services revenue is primarily related to the additional
revenue associated with the PHC Administrative Services Only ("ASO")
operations. Management services and marketing services agreements that were
entered into coincident with the acquisition of the PHC health plans accounted
for approximately $4.9 million, or 39.8%, of the increase. Exclusive of the
related agreements with Principal Life, management services revenue increased
approximately $7.4 million, or 60.2%.
Health benefits expense increased $116.8 million for the six months
ended June 30, 1999, or 15.4%, from the corresponding period in 1998 due to the
additional expenses associated with the acquisition of the PHC plans in April
1998. Coventry's medical loss ratio increased slightly to 85.7% from 85.4% in
the prior year six months due the residual impact of the AHERF bankruptcy
filing and the increase in Medicare and Medicaid membership.
SGA expense increased $25.8 million, or 20.1%, from the corresponding
period in 1998. SGA expense, as a percent of revenue, increased to 14.5% for the
six months ended June 30, 1999, from 14.0% in the corresponding period in the
prior year. The increase in SGA expense was primarily attributable to additional
costs associated with the PHC health plans and Coventry's consolidation of
eighteen service centers to three regional service centers. In an effort to
control costs and improve customer service, Coventry is in the process of
transferring certain of its operating activities (e.g., customer service, claims
processing, billing and enrollment) to regional service centers. All activities
are expected to be fully transferred by the end of the fourth quarter of 1999.
Depreciation and amortization increased $3.4 million, or 32.0%,
compared to the corresponding period in the prior year primarily as a result of
the additional amortization related to the intangibles and goodwill recorded as
part of the PHC acquisition in April 1998.
Other income, net of interest expense, increased $5.5 million, or 74.9%, for
the six months ended June 30, 1999 from the corresponding period in 1998,
primarily due to the reduction of interest expense from the reduction of debt
and increased investment income resulting from the increase in invested assets
subsequent to the acquisition of PHC.
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<PAGE> 24
Earnings from operations increased $62.4 million, or 141.6% from the
corresponding period in 1998. Excluding charges related to AHERF and the
relocation of the corporate office, operating earnings decreased $0.4 million,
or 2.1%, attributable to the various factors as described above.
Coventry's net income was $17.5 million compared to a loss of $23.0
million for the six months ended June 30, 1998. Net income per share was $0.29
for the first half of 1999 compared to net loss per share of $0.50 in the first
half of 1998. Excluding the AHERF charge and merger costs, Coventry would have
reported earnings per share of $0.30 in the corresponding period in 1998. The
weighted average common shares outstanding were approximately 64,193,229 and
51,702,519 on a diluted basis for the six months ended June 30, 1999 and 1998,
respectively. The increase is primarily attributable to the issuance of shares
related to the acquisition of the PHC plans.
LIQUIDITY AND CAPITAL RESOURCES
Coventry's total cash and investments, excluding deposits of $24.5
million restricted under state regulations, decreased $99.0 million to $502.8
million at June 30, 1999 from $601.8 million at December 31, 1998. The decrease
is primarily attributable to $91.1 million of cash used in operations for the
six month period. A significant portion of the cash used in operations
(approximately $45.8 million) was used to pay 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 was also
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 Coventry's efforts to reduce medical claims
inventory in the first half of 1999.
Coventry's investment guidelines emphasize investment-grade
fixed-income instruments to provide short-term liquidity and minimize the risk
to principal. Coventry believes that as its long-term investments are available
for sale, the amount of such investments should be added to current assets when
assessing its working capital and liquidity; on such basis, current assets plus
long-term investments available for sale, less short-term liabilities,
increased to $228.3 million at June 30, 1999 from $187.8 million at December 31,
1998.
Coventry's health maintenance organizations and insurance company
subsidiary are required by state regulatory agencies to maintain minimum
surplus balances, thereby limiting the dividends Coventry may receive from its
HMOs and insurance company subsidiary. Including statutory reserve
requirements, Coventry's regulated subsidiaries had surpluses in excess of
requirements of approximately $80.9 million and $93.4 million at June 30, 1999
and December 31, 1998, respectively. Not including statutory reserves, Coventry
had cash and investments of approximately $87.3 million and $96.8 million at
June 30, 1999 and December 31, 1998, respectively. These funds are available
to pay intercompany balances to regulated subsidiaries and for general
corporate purposes. Coventry 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, Coventry entered into a
securities purchase agreement ("Warburg Agreement") with Warburg, Pincus
Ventures, L.P. ("Warburg") and Franklin Capital Associates III, L.P.
("Franklin") for the purchase of $40 million of Coventry's 8.3% Convertible
Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with
warrants to purchase 2.35 million shares of Coventry's common stock for $42.35
million. The original amount of the Coventry Notes, $36.0 million held by
Warburg and $4.0 million held by Franklin, are convertible into 3.6 million
shares and 0.4 million shares of Coventry's common stock, respectively, and
22
<PAGE> 25
are exchangeable at Coventry's or Warburg's option for shares of convertible
preferred stock. During the second quarter of 1999, Coventry converted all
Coventry Notes held by Franklin totaling $4.7 million, including interest, into
473,705 shares of Series A convertible preferred stock. The remaining Coventry
Notes are likely to be converted during the third quarter of 1999. In
accordance with the Warburg Agreement, effective May 28, 1999, the Coventry
Notes no longer bear interest. Interest on the Coventry Notes prior to May 28,
1999 is payable in additional Coventry Notes and, as a result, the accrued
interest at June 30, 1999 has been added to the outstanding indebtedness,
resulting in $42.4 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 $5.7 million, net has been expended for
the six months ended June 30, 1999.
Coventry 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 June 30, 2000.
IMPACT OF YEAR 2000
Coventry's business is significantly dependent on information systems
("IS"). Coventry 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. Coventry'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. As anticipated, the Year 2000 readiness program was
substantially completed by the second quarter of 1999. The total estimated
cost of the program is approximately $13.1 million, of which $11.9 million had
been incurred through June 30, 1999. No material impact on critical IS
development was caused by 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
Coventry's legal, compliance, finance, actuarial, medical and IS departments.
The steering committee reports the status of Coventry's Year 2000 readiness
program to senior management, who report to the board of directors.
While Coventry 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 Coventry's systems and operations rely
will be converted on a timely basis and will not have a material adverse effect
on Coventry.
The specific phases of the Year 2000 readiness program are as follows:
IS Hardware, Software and Networks
Coventry has historically purchased its core software applications
rather than build them. Coventry 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
23
<PAGE> 26
Coventry has converted its applications to that current release in a live
production environment. All operating system upgrades on above named systems
have been completed. Future Date Testing for the majority of plans has been
completed as scheduled, with two plans scheduled for completion in August 1999.
The former PHC health plans are using a different third party product, which
has been customized and is no longer supported by the vendor. That system
utilizes Julian dates for all internal processes and is Year 2000 compliant. As
part of Coventry's readiness program, the entire application has been reviewed
and necessary changes identified. Those programming modifications have been
completed, tested and are in production. The computer operating systems are
tested and are in production.
All internally developed systems have been inventoried and plans made
to upgrade, modify or replace them as necessary to make them Year 2000 ready.
All internally developed systems are in a Year 2000 ready state or are moving
to a legacy status. Coventry 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 Coventry'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 have also been completed.
Office Equipment
Coventry has requested its significant office equipment vendors to
submit Year 2000 readiness statements about their products. Coventry has
received the majority of such statements 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.
Second surveys received have been evaluated to assess potential risks and no
material risks have been found.
Business Partners and Customers
Coventry has communicated 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
Coventry's systems or otherwise impact its operations. Coventry is assessing
the extent to which its operations are vulnerable should those organizations
fail to remediate properly their computer systems. However, Coventry 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
24
<PAGE> 27
have a material adverse effect on Coventry's financial condition and results of
operations if these services or operations are not Year 2000 ready.
Risk Assessment and Contingency Planning
Coventry 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
Coventry is analyzing the most likely worst case scenario that could result
from Year 2000-related failures. Coventry'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. Coventry'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 Coventry's ability to
control medical costs, expose Coventry 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, Coventry's management 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, 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 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. Coventry does not believe this law will have a material adverse
effect on its operations.
RISK FACTORS
Coventry's business is subject to numerous risks and uncertainties
which may affect its 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. Some specific risks that could affect Coventry include
the following:
IF COVENTRY IS UNABLE TO INCREASE ITS REVENUES, IT MAY NOT BE PROFITABLE AND THE
VALUE OF YOUR INVESTMENT MAY DECLINE.
Increases in Coventry's revenues will be generally dependent upon its
ability to increase premiums and membership. Premium rates for managed care
plans generally have increased in recent months, but Coventry could experience
unforeseen decreases or severely limited increases in the future. Factors that
could affect Coventry's ability to maintain or increase revenues include (i)
loss of membership to competitors, (ii) failure to attract new members, (iii)
inability to increase premiums due to regulatory restrictions, (iv) loss of
membership due to increased premium rates, (v) withdrawal from unprofitable
markets, and (vi) consumer preferences for lower priced health care options.
Currently, the majority of Coventry's premium revenues come from commercial
employer contracts. Large customers, whose contracts are generally renewable
each year, represent a significant percentage of the membership of one or more
of Coventry's health plans and eighteen percent (18%) of the company's overall
membership is represented by large customers. The loss of one or more of such
customers could result in a material adverse effect with respect to future
revenues. Also, 25% of Coventry's 1999 premium revenues were derived from
governmental programs, such as Medicare and Medicaid, where premiums are
generally fixed by the government and cannot be adjusted by the company based on
its anticipated costs. Recent legislation has limited Medicare premium increases
substantially as compared to increases permitted in prior years. As a result,
the future costs of Coventry's government programs could exceed the future
premium revenues received. Such losses of premium revenues and membership could
adversely affect Coventry's financial position and profitability and cause a
decline in the value of your investment in the company.
LIMITATIONS ON ABILITY TO PROJECT ACTUAL HEALTH CARE COSTS COULD RESULT IN COSTS
BEING HIGHER THAN PREMIUM REVENUES, WHICH COULD ADVERSELY AFFECT YOUR
INVESTMENT IN COVENTRY.
Coventry expects to use a substantial portion of its revenues to pay
the costs of health care services and supplies delivered to its membership. The
total cost incurred is affected by the number of individual services rendered
and the cost of each services. A large part of the premium revenue is set on an
annual basis before the actual services are delivered and the related costs are
incurred. The number of individual services rendered and the cost of each
service affect Coventry's total health care costs. While the company attempts to
base the premiums it charges, at least in part on its estimate of expected
health care costs over the fixed premium period, other factors may limit its
ability to fully base premiums on estimated costs and could cause actual health
care costs to exceed estimates. Those factors could include (i) the occurrence
of catastrophes or epidemics, (ii) seasonality and trends, (iii) general
inflation, (iv) new mandated benefits or other regulatory changes that increase
our costs, (v) operational issues, (vi) insured population characteristics,
(vii) competitive pressures and (viii) other unforeseen occurrences. Coventry
sets up reserves based on estimates of the costs incurred for covered services
received by members but not yet reported. There may be discrepancies between the
reserves for incurred-but-not-reported liabilities and the actual amount of such
liabilities. Historically, increases in health care prices and higher than
expected use of health care services have caused health care costs to rise
faster than general inflation. While these increases have moderated recently,
Coventry cannot insure that health care prices or utilization will not again
increase at a more rapid pace. Such increases could significantly change results
of operations, affect profitability and adversely affect the value of your
investment.
FAILURE TO OBTAIN COST-EFFECTIVE AGREEMENTS WITH A SUFFICIENT NUMBER OF
PROVIDERS MAY RESULT IN HIGHER MEDICAL COSTS AND LOSS OF MEMBERSHIP, WHICH COULD
CAUSE YOUR INVESTMENT IN COVENTRY TO DECLINE IN VALUE.
Prior to 1997, Coventry's St. Louis and Pennsylvania health plans
offered members access to Coventry-owned and Coventry-staffed medical centers,
as well as to networks of contracting providers. During 1997, Coventry's medical
centers were sold to provider systems that contracted to provide care to its
members continuing to use such centers. Coventry expects that substantially
all of its members will be served by providers contracting with the company to
provide the requisite medical care. Coventry's ability to contract successfully
with a sufficiently large number of providers in a given geographic market will
impact the relative attractiveness of managed care products in those markets.
The terms of those provider contracts also have a material impact on Coventry's
medical costs and its ability to control such costs. In some of Coventry's
markets, certain provider systems have a major presence. If such provider
systems refuse to contract with the company, place Coventry at a competitive
disadvantage or use their market position to negotiate contracts unfavorable to
the company, product offerings or profitability in such markets could be
adversely affected.
Among the medical cost control techniques Coventry has utilized are
capitation agreements with providers pursuant to which the providers are paid a
fixed dollar amount per member per month, with the provider obligated to provide
all of a particular type of medical service required by the members, and global
capitation agreements pursuant to which a single integrated hospital-physician
provider system provides substantially all hospital and medical services to a
large number of members for a fixed percentage of the premium charged by
Coventry with respect to those members. While these systems may shift to the
contracting provider system the risk that medical costs will exceed the amounts
anticipated, Coventry will be exposed to the risks that the provider systems are
financially unable or unwilling to fulfill their payment or medical care
obligations under the capitation agreements or that members may prefer other
providers in the market.
OPERATING RESULTS MAY NOT CONTINUE TO IMPROVE IN 1999 AND 2000, WHICH COULD
NEGATIVELY AFFECT COVENTRY'S EARNINGS AND THE VALUE OF YOUR INVESTMENT IN
COVENTRY MAY DECLINE.
Coventry's operating loss in 1998 was primarily attributable to charges
related to the establishment of reserves related to the bankruptcy of Allegheny
Health, Education and Research Foundation, and to the relocation of the
company's corporate headquarters. Although Coventry has reached a global
settlement with Allegheny Health, Education and Research Foundation and the
company's operating results have improved, there can be no assurance that
operating results will continue to improve. If Coventry experiences operating
losses in 1999 and 2000, the value of your investment in the company may
decline.
RISK OF SUBSTANTIAL BENEFICIAL OWNERSHIP BY PRINCIPAL LIFE AND ITS AFFILIATES
As a result of Coventry's acquisition of the PHC health plans,
Principal Life owns approximately 40% of the company's common stock, on a fully
diluted basis. Although Principal Life has agreed to a limitation on acquiring
additional shares of Coventry's common stock and to refrain from taking certain
other actions, Principal Life will be permitted, under certain circumstances, to
acquire additional shares in order to maintain ownership of up to 40% of
Coventry's common stock, and has the right to elect at least one member of the
company's Board of Directors for each 6% ownership of common stock until April
2003. After April 2003, or after a third party acquires more voting securities
than those held by Principal Life, there will be no restrictions on the
acquisition of Coventry's common stock by Principal Life. Prior to September
1999, as long as Principal Life maintains ownership of 40% of Coventry's common
stock, it is highly unlikely that any matter involving a shareholder vote,
including the issuance of more than 20% of the company's common stock, or an
acquisition of Coventry by merger, consolidation, share exchange or other
transaction could be effectuated if Principal Life were opposed to it.
Thereafter, from September 1999 and until April 2003, Principal Life has agreed
to vote its shares in favor of an acquisition required to be approved by
shareholders that the Board has recommended and that has been approved by a
majority of shareholders other than Principal Life. After April 2003, there will
be no restrictions on the acquisition of additional shares of Coventry's common
stock by Principal Life, and as a result, Principal Life, in addition to having
an effective veto over transactions involving a shareholder vote (assuming it
were to continue to beneficially own 40% of Coventry's common stock), could
acquire over 50% of common stock and exercise actual control of Coventry without
a vote of our remaining shareholders. If Principal Life were to acquire over 50%
of common stock, it would have actual control of Coventry and would be the
majority shareholder and controlling vote in all actions involving a shareholder
vote. As the majority shareholder, Principal Life could block transactions that
were advantageous to the minority shareholders. There could be no assurance that
the value of your investment in Coventry would not decline because future
investors would not consider the company's stock to be an attractive Investment.
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" described above,
25
<PAGE> 28
and actual operations and results may differ materially from those expressed in
this Form 10-Q. Among the factors that may materially affect Coventry'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.
26
<PAGE> 29
Item 3: Quantitative and Qualitative Disclosures of Market Risk
Coventry's only material risk in investments in financial instruments
is in its debt securities portfolio. Coventry invests primarily in marketable
state and municipal, U.S. Government and agencies, corporate, and
mortgage-backed debt securities. Coventry does not invest in financial
instruments of a hedging or derivative nature.
Coventry has established policies and procedures to manage its
exposure to changes in the fair value of its investments. These policies
include emphasizing credit quality, managing portfolio duration, maintaining or
increasing investment income through high coupon rates, and actively managing
profile and security mix depending upon market conditions. Coventry has
classified all of its investments as available-for-sale. The fair value of the
Company's investments in debt securities at June 30, 1999 was $283.7 million.
Debt securities at June 30, 1999 mature according to their contractual terms,
as follows (actual maturities may differ because of call or prepayment rights):
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
---------------------------
(in thousands)
<S> <C> <C>
Maturities:
Within 1 year $73,072 $72,736
1 to 5 years 76,998 77,209
6 to 10 years 44,096 42,556
Over 10 years 90,964 91,196
Other securities without stated maturity - -
----------------------------
Total short-term and long-term securities $285,130 $283,697
========= ========
</TABLE>
Coventry believes its investment portfolio is diversified and expects
no material loss to result from defaults. The mortgage-backed securities are
insured by GNMA and FNMA.
Coventry's projections of hypothetical net losses in fair value of its
interest rate sensitive instruments, should potential changes in interest rates
occur, are presented below. While Coventry believes that the potential interest
rate change is reasonably possible, actual results may differ.
Based on Coventry's debt securities portfolio and interest rates at
June 30, 1999, a 100 basis point increase in interest rates would result in a
decrease of $7.7 million, or 2.7%, 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.
27
<PAGE> 30
PART II. OTHER INFORMATION
ITEM 1: Legal Proceedings
Settlement with AHERF related entities. The Company and certain affiliated
non-debtor hospitals of Allegheny Health, Education and Research Foundation
(AHERF) have been involved in litigation to determine who had the financial
responsibility for the medical services provided to the Company's members as a
consequence of the bankruptcy filed by AHERF which precluded it from
discharging its responsibilities for the payment of those medical services under
a global capitation agreement between the Company and AHERF covering
approximately 250,000 members in the western Pennsylvania market. AHERF filed
for bankruptcy protection on July 22, 1998, and shortly thereafter the Company
filed a lawsuit against certain non-debtor affiliated hospitals of AHERF seeking
a declaratory judgment that the company was not obligated to pay in excess of
$21.5 million to those hospitals for medical services provided by them to the
Company's members. The lawsuit also included additional claims for monetary
damages. In response to the lawsuit, the hospitals filed a counterclaim alleging
that the Company's subsidiary, HealthAmerica Pennsylvania, Inc. was liable to
the hospitals for the payment of those medical services. 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 global capitation agreement at
the time of the bankruptcy filing. Although AHERF has not formally rejected the
capitation agreement as of the date of this filing, the parties are no longer
operation under the terms of that agreement. On June 22, 1999, the Company
reached a settlement with the affiliated non-debtor hospitals whereby the
hospitals agreed that the Company would not be liable for the payment of the
medical services rendered by those hospitals to the Company's members prior to
July 21, 1998, the date of AHERF's bankruptcy filing. The hospitals agreed to
dismiss with prejudice their counterclaims against the Company and the Company
agreed to dismiss its lawsuit. The conditions to execute this settlement are
expected to be finalized over the next ninety days.
Unity Arbitration. 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 parties are proceeding with discovery and a date for
arbitration has been set. The Company intends to vigorously pursue this matter.
Other Legal Actions. 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 June 30, 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.
<PAGE> 31
ITEMS 2, 3, 4 and 5: Not Applicable
ITEM 6: Exhibits and Report on Form 8-K
(a) Exhibits required to be filed by Item 601 of Regulation S-K.
<TABLE>
<CAPTION>
Exhibit
No. Description of Exhibit
-------- ----------------------
<S> <C>
4.1 Specimen Series A Convertible Preferred Stock
Certificate
10.1 Separation Agreement and Release dated April 13, 1999
between Richard H. Jones and Coventry Health Care,
Inc.
10.2 Agreement dated May 19, 1999 between Coventry Health
Care, Inc. and Principal Life Insurance Company
10.3 Employment Agreement effective as of June 17, 1999,
executed by James E. McGarry and Coventry Health Care,
Inc.
11.1 Computation of Net Earnings Per Share
27 Financial Data Schedule (for SEC use only)
</TABLE>
(b) Reports on Form 8-K
On June 2, 1999, Registrant filed a current report on Form 8-K
disclosing that, on May 19, 1999, Registrant had entered into an agreement with
Principal Life pursuant to which Registrant waived its rights to reinsure and
renew Principal Life's health insurance indemnity business located in
Registrant's service area.
29
<PAGE> 32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C>
COVENTRY HEALTH CARE, INC.
(Registrant)
Date: August 16, 1999 By: /s/ Allen F. Wise
------------------- ----------------------------------
Allen F. Wise
President, Chief Executive
Officer and Director
Date: August 16, 1999 By: /s/ Dale B. Wolf
------------------- ----------------------------------
Dale B. Wolf
Executive Vice President,
Chief Financial Officer,
Treasurer and Principal
Accounting Officer
</TABLE>
30
<PAGE> 1
EXHIBIT 4.1
INCORPORATED UNDER THE LAWS OF THE
STATE OF DELAWARE
Number _____ COVENTRY HEALTH CARE, INC.
"_________" Shares
Series A Convertible Preferred Stock
THIS CERTIFIES THAT ________________________, is the registered holder
of ______ ( ) Shares of Series A Preferred Stock of the Corporation
transferable only on the books of the Corporation by the holder hereof in
person or by Attorney upon surrender of this Certificate properly endorsed.
SEE REVERSE SIDE
IN WITNESS WHEREOF, the said Corporation has caused this Certificate
to be signed by its duly authorized officers and its Corporate Seal to be
hereunto affixed this ___ day of ____________, 1999.
- ------------------------------- -----------------------------------
Secretary/Assistant Secretary President/Executive Vice President
<PAGE> 1
PLEASE READ THIS DOCUMENT CAREFULLY. IT WILL
RELEASE AND WAVE LEGAL CLAIMS AND RIGHTS
YOU MAY HAVE. YOU ARE ADVISED TO CONSULT WITH
AN ATTORNEY BEFORE SIGNING THIS DOCUMENT.
SEPARATION AGREEMENT AND RELEASE
1. Definitions. All words used by this Release have their plain meanings
in ordinary English. Specific terms used in this Release have the
following meanings.
A. "I," "me," and "my," mean both me and anyone who has or obtains
any legal rights or claims through me, including but not limited to, my
spouse, heirs, assigns, representatives, and executors.
B. "CHC" means Coventry Health Care, Inc., Coventry Corporation,
Coventry Health and Life Insurance Company, Group Health Plan, and any
of their present or past predecessors, successors, subsidiaries,
affiliates, divisions, committees, joint venture partners, or a new
entity created through merger or acquisition that includes any of the
preceding.
C. "Employer" means CHC; any present or past directors, officers,
employees, attorneys, agents, or representatives of CHC; any present or
past employee benefit plan sponsored by CHC and/or the directors,
officers, trustees, administrators, employees, attorneys, agents, or
representatives of that plan; any company providing insurance to CHC in
the present or past; and any person who acted on behalf of or on
instructions from CHC.
D. "My Employment Agreement" means the Employment Agreement
between CHC and myself entered into as of November 11, 1996.
E. "My Claims" means all of my existing rights, as of the date of
my execution of this agreement, to any relief of any kind from CHC,
whether or not I know about those rights, including but not limited to:
(1) all claims arising out of or relating to my past
employment with Employer, the termination of that employment,
or the statements or actions of Employer;
(2) all claims under any federal, state, or local statute,
ordinance, or regulation, including but not limited to, claims
for any alleged unlawful discrimination or any other alleged
unlawful employment practices under the Fair Labor Standards
Act, the Equal Pay Act, Title VII of the Civil Rights Act of
1964, as amended, Missouri Human Rights Law, as amended, the
Age Discrimination in Employment Act, the Older Workers Benefit
Protection Act, the Americans with Disabilities Act, the Civil
Rights Act of 1991, the Civil Rights Act of 1964, the National
Labor Relations Act, the Employment
<PAGE> 2
Page 2
Retirement Income Security Act, the Family and Medical Leave
Act, and the Worker Adjustment and Retraining Notification Act;
(3) all claims under any principle of common law, including
but not limited to, claims for alleged unpaid salary, overtime,
and bonuses, harassment, retaliation or reprisal, assault or
battery, defamation, intentional or negligent infliction of
emotional distress, invasion of privacy, false imprisonment,
fraud, intentional or negligent misrepresentation, interference
with contractual or business relationships, violation of public
policy, my conduct, if any, as a "whistleblower", negligence,
breach of contract, breach of fiduciary duty, breach of the
covenant of good faith and fair dealing, promissory or
equitable estoppel, and any other wrongful employment
practices;
(4) all claims for any type of relief from the Employer,
including but not limited to, claims for back pay, front pay,
lost benefits, reinstatement, liquidated damages, multiple
damages, punitive damages, and damages for any alleged breach
of contract, any tort claim, or any alleged personal injury or
emotional injury or damage, whether or not compensable under
any workers' compensation statutes; and
(5) all claims for attorneys' fees, costs, and
disbursements.
(6) "My Claims" do not include my vested rights, if any, in
CHC's Select Savings 401(k) Plan; in CHC's Stock Option Plan,
except as limited by paragraph 3, below; the CHC Supplemental
Executive Retirement Plan (SERP); or my rights under COBRA for
extended insurance coverage, all of which survive unaffected by
this Release.
2. My active services as an employee will end on April 23, 1999. I
will be granted consideration by CHC on the following basis:
CHC agrees to delete the requirement of paragraph 10 of My Employment
Agreement that I give sixty (60) days prior written notice of the
termination of my employment thereunder, with the understanding that
the remaining provisions of paragraph 10 of My Employment Agreement,
which are incorporated herein by reference, remain in effect.
CHC agrees that notwithstanding the provisions of paragraph 14(b) of My
Employment Agreement, I may 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 have a financial interest in, or aid and
assist anyone else in the conduct of, UnitedHealth Group, and its
affiliates and subsidiaries, so long as I do not participate in an
operating role with respect to any non-Medicare operations of
UnitedHealth Group, its affiliates and subsidiaries in the State of
Missouri for the period specified in paragraph 14(b). All
<PAGE> 3
Page 3
of the other provisions of paragraph 14 of My Employment Agreement,
which are incorporated herein by references, remain in effect.
As of my last day of active employment, I am no longer authorized to
incur any expenses, obligations or liabilities on behalf of Employer,
handle any Employer business, or direct employee activities. I agree to
repay any outstanding loans from the Employer to me within thirty days
of the effective date of this Separation Agreement and Release.
I may keep any copies or duplicates of reports or papers I now have
which are directly related to my personnel records or required for
preparation of my personal income tax return. I represent that I will
return all Employer property, including reports, files, records,
cellular telephones, pagers, MCI/Worldcom calling cards, American
Express cards, computers and/or peripheral equipment, leased vehicles,
if any, SecurID cards, software, security passcards, keys, computer
codes, manuals and other physical or personal property which I received
or prepared or helped prepare in connection with my employment with
Employer.
CHC, its present and past directors and officers, and I agree not to
make negative comments to current or future professional colleagues,
members of the health care community, or others about the other party
which could result in damage to the reputation of the other party,
recognizing that to do so will result in the use of allowable legal
recourse by the other party. I agree to resign from all positions as a
director or officer of Employer as of my last day of active employment.
I also agree, in addition to the provisions of paragraph 14(d) of My
Employment Agreement, as a condition of receiving the consideration
described in this agreement, to fully cooperate with and consult with
Employer, either by telephone or in person, with respect to any
administrative or judicial proceedings involving matters with which I
was involved during the term of my employment. Employer agrees that,
except as may be required by law or pursuant to legal proceedings, such
requests will be reasonable in number and will consider the time
required by me for other employment. Employer also agrees to reimburse
me for ordinary and necessary travel expenses incurred by me in
connection with such cooperation.
3. Agreement to Release My Claims. In exchange for the above
consideration, which is substantially more than Employer is required to
provide me under its standard policies and procedures, and which is
conditioned on and in consideration of my execution of this Release, I
agree to give up all My Claims against the Employer. I will not bring
any lawsuits or make any other demands or claims against the Employer
or allow or authorize any other person to do so on my behalf based on
My Claims. The consideration that I will receive is a full and fair
compromise payment for the release of My Claims and for the other
obligations I am assuming as specified in this Release. I also agree
that if I violate this Release by suing the Employer for any of My
Claims, I will pay all costs and expense of defending the lawsuit
incurred by
<PAGE> 4
Page 4
the Employer, including but not limited to, reasonable attorneys' fees,
costs, disbursements, awards, and judgments.
I also agree to give up (a) all claims to exercise, at any time more
than ninety days after my last day of active service, any stock options
granted to me, whether in My Employment Agreement or otherwise, which
are vested as of my last day of active service; and (b) all claims to
exercise, at any time whatsoever, any stock options granted to me,
whether in My Employment Agreement or otherwise, which were not vested
as of my last day of active service.
4. Vacation Payout. CHC agrees to pay me the unused vacation which I have
accrued as of my last day of employment. This payment will be made in a
lump-sum within 14 days of my last day of employment and is equivalent
to $109,230.28, less legal deductions. Since my active service as an
employee will end on April 23, 1999, this payment is not eligible for
deferrals to the Employer's 401(k) or SERP Plan.
5. Confidentiality. I understand that I may disclose the contents of this
Release to my spouse, my attorney, and my tax advisor. I agree that if
I do so, I will inform them of this confidentiality clause and tell
them that they are also bound by it. I agree that I will not disclose
the contents of this Release or any of its terms to any other
individual, corporation, or entity, except as required by law. I
acknowledge that disclosing the contents of this Release except to the
persons listed above would cause Employer injury and damage, the actual
amount of which would be difficult to determine; thus, I agree to pay
Employer $1,000.00 each time that I violate this confidentiality
clause, and also to pay all of CHC's attorneys' fees, costs, and
disbursements incurred in getting a court order to stop me from
violating this confidentiality clause or to seek damages from me
resulting from my violation. Employer also agrees that it will not
disclose the contents of this Release or any of its terms to any other
individual, corporation, or entity, except to its attorneys and tax
advisors, whom it will first inform are also bound by this
confidentiality clause, or as required by law.
6. Additional Agreements and Understandings. Even though the Employer is
granting me consideration to release My Claims, the Employer does not
admit that it is responsible or legally obligated to me for My Claims.
In, fact, I understand the Employer denies that it is responsible or
legally obligated for My Claims, or that it has engaged in any improper
or unlawful conduct or wrongdoing against me.
7. Advice to Consult With An Attorney. I understand and acknowledge that I
am being advised by the Employer to consult with an attorney prior to
signing this Release. My decision to sign or not to sign this Release
is my own voluntary decision made with full knowledge that the Employer
has advised me to consult with an attorney.
8. My Representations. I am old enough to sign this Release and to be
legally bound by the agreements that I am making. I have no physical or
mental impairment of any kind that has interfered with my ability to
understand the meaning or terms of this
<PAGE> 5
Page 5
Release and am not under the influence of any medication or
mind-altering chemical of any kind at the time I signed this Release. I
represent that I have not filed for personal bankruptcy or been
involved in any pending personal bankruptcy proceeding between any
accrual of My Claims and the date of my signature below. I am legally
able and entitled to receive the full consideration that will be given
to me by the Employer in settlement of My Claims. I have read this
Release carefully. I understand all its terms. In agreeing to sign this
Release I have not relied on any statements or explanations made by the
Employer or its attorneys, except as specifically set forth in this
Release. I am voluntarily releasing My Claims against the Employer. I
made the decision to sign this Release freely and without duress or
coercion. This Release shall be governed by the laws of the State of
Maryland.
9. My Rights to Review, Accept, or Rescind. The Employer has informed me
and I understand and acknowledge that I have a period of 21 days,
beginning on the day after the day this Release is delivered to me, to
consider whether I wish to enter into this Release and be bound by its
terms. The Employer has informed me and I understand and acknowledge
that if I do not accept the terms of this Release within that 21-day
review period, Employer may not extend the time in which its offer to
enter into the agreements contained in this Release is open to me. I
understand and acknowledge that if I sign this Release before the end
of the 21-day period, it will be my personal, voluntary decision to do
so.
If I decide to accept the terms of this Release, I must send the signed
and dated Release by first-class mail or deliver it by hand to the
address given below within the 21-day period that I have to consider
signing this Release.
The Employer has informed me and I also understand and acknowledge
that, after I sign this Release, I may change my mind within a 7-day
period, not counting the day on which I signed it, and revoke my
acceptance of it. In order for my revocation to be effective, I
understand and acknowledge that it must be in writing and mailed by
certified mail, return receipt requested, or hand delivered to Employer
at the following address and postmarked or received by Employer within
the 7-day period:
Coventry Health Care Inc.
Attention: Thomas P. McDonough
6705 Rockledge Drive
Bethesda, MD 20817
I understand and acknowledge that I will not receive any of the
consideration granted under this Release if I revoke it, and in any
event, I will not receive any consideration until after the 7-day
revocation period has expired.
10. Entire Agreement. This Release is the entire agreement between Employer
and me relating to the termination of my employment and this
settlement. If any portion of this Release is found to be invalid,
unlawful, or unenforceable, I desire that all other
<PAGE> 6
Page 6
portions of this Release that can be separated from it or
appropriately limited in scope will remain fully valid and enforceable.
11. NOTICE: MY SIGNATURE INDICATES THAT I HAVE CAREFULLY READ AND UNDERSTAND
THE TERMS OF THIS RELEASE AND WAIVER OF CLAIMS AND RIGHTS, THAT I HAVE
BEEN GIVEN TWENTY-ONE (21) DAYS TO CONSIDER THIS RELEASE AND THAT I WAS
ADVISED TO CONSULT AN ATTORNEY ABOUT THIS RELEASE AND WAIVER OF CLAIMS
AND RIGHTS, AND THAT I AM SIGNING THIS DOCUMENT VOLUNTARILY AND NOT AS
A RESULT OF COERCION, DURESS, OR UNDUE INFLUENCE.
I FURTHER UNDERSTAND THAT FOR A PERIOD OF SEVEN (7) DAYS FOLLOWING THE
SIGNING OF THIS RELEASE AND WAIVER OF CLAIMS AND RIGHTS, I MAY REVOKE
IT BY FOLLOWING THE DIRECTIONS IN PARAGRAPH 8 OF THIS DOCUMENT AND THE
RELEASE AND WAIVER OF RIGHTS AND CLAIMS WILL NOT BE EFFECTIVE UNTIL
SEVEN (7) DAYS AFTER I SIGN IT.
Dated: April 13, 1999
---------
Signature: /s/ RICHARD H. JONES
--------------------------------
Richard H. Jones
Social Security No: ###-##-####
COVENTRY HEALTH CARE, INC.
By: /s/ THOMAS P. MCDONOUGH
---------------------------------------------
Thomas P. McDonough
Executive Vice President and
Chief Operating Officer
April 15, 1999
--
<PAGE> 1
AGREEMENT
THIS AGREEMENT ("Agreement") is entered into as of the 19th day of May,
1999, by and between Principal Life Insurance Company, f/k/a Principal Mutual
Life Insurance Company ("Principal"), an Iowa corporation, and Coventry Health
Care, Inc. ("Coventry"), a Delaware corporation.
WHEREAS, Principal and Coventry are parties to certain agreements as
identified herein; and
WHEREAS, Principal and Coventry hereby desire, among other things, to
terminate certain agreements, provide for the purchase by Principal of a certain
preferred provider organization network from Coventry and provide for payment by
Principal to Coventry of certain monies in consideration for the termination of
the agreements, the purchase of the network and other matters as herein
addressed.
NOW, THEREFORE, for just and adequate consideration, the receipt and
sufficiency of which is hereby acknowledged, Principal and Coventry hereby agree
as follows:
1. On the Closing Date, Principal shall pay to Coventry Twenty Million
Dollars ($20,000,000.00).
2. Effective as of the Closing Date, that certain Renewal Rights Agreement
by and between Principal and Coventry's subsidiary Coventry Health and Life
Insurance Company dated as of April 1, 1998 (the "Renewal Rights Agreement"), is
terminated and shall be of no further force and effect and Coventry shall not
retain any liabilities or obligations of any kind whatsoever relating to the
business covered by the Renewal Rights Agreement.
<PAGE> 2
2
3. Effective as of the Closing Date, that certain Co-Insurance Agreement
between Principal and Coventry Health and Life Insurance Company dated as of
April 1, 1998 (the "Co-Insurance Agreement), is terminated and shall be of no
further force and effect and Coventry shall not retain any liabilities or
obligations of any kind whatsoever relating to the business covered by the
Co-Insurance Agreement.
4. Effective December 31, 1999, that certain License Agreement by and
between Principal and Coventry dated as of April 1, 1998, is terminated.
Effective June 30, 1999, Coventry will cease all references to it or its
affiliates being "A Principal Financial Group Partner in Health Care" or any
other similar reference.
5. Pursuant to that certain Asset Purchase Agreement (the "Purchase
Agreement") dated the date hereof by and between Principal's indirectly owned
subsidiary, Admar Corporation ("Admar"), and Coventry, Coventry hereby agrees to
sell, and Admar hereby agrees to buy, that certain preferred provider
organization ("PPO") network known as the "Chicago PPO Network." A copy of the
Purchase Agreement is attached hereto as Exhibit A.
6. The twenty million dollar ($20,000,000) payment referenced in paragraph
1 shall be allocated for GAAP purposes as follows:
<TABLE>
<S> <C>
Renewal Rights Agreement and Co-Insurance Agreement $19,750,000
Chicago PPO Network 250,000
-----------
$20,000,000
</TABLE>
7. Effective on the Closing Date, those two certain Administrative
Agreements between Principal and Principal Health Care, Inc. (a predecessor of
Coventry) dated February 1, 1996 regarding access to Coventry PPO networks ("the
Administrative Agreements") shall each be deemed amended to provide the
following:
<PAGE> 3
3
- - Principal shall receive most favored nation pricing on a market-by-market
basis as compared to Coventry's new business written after the Closing
Date.
- - There shall be an annual review period during which the parties will
negotiate rate increases, if any, in good faith on a market-by-market
basis, provided no increase shall be greater than an amount equal to 106%
of the fee then in effect for said market pursuant to such agreement.
8. Principal and Coventry shall on or before the date hereof have executed
those certain Principal Life Insurance Company Administrative Service Agreements
with Principal Health Care of Kansas City, Inc. and Principal Health Care of St.
Louis, Inc. for Point-of-Service Product (the "POS Agreements") for certain
areas of Illinois and Kansas. Copies of the POS Agreements are attached hereto
as Exhibits B-1 and B-2.
9. Nothing in this Agreement shall affect Principal's obligations under the
Management Services or Marketing Services Agreements dated as of April 1, 1998,
by and between Principal and Coventry, or the Administrative Agreements.
10. Coventry and its affiliates will cease marketing any Principal
indemnity products on or before May 1, 1999. Principal and its affiliates will
cease marketing any Coventry products on or before May 1, 1999.
11. Any defined terms not defined in this Agreement shall be defined as
provided in the Purchase Agreement.
12. This Agreement may be executed in one or more counterparts, each of
which shall be deemed an original but all of which together shall constitute one
and the same instrument.
<PAGE> 4
4
IN WITNESS WHEREOF, the parties hereby agree as set forth above as of the
date first set forth above.
PRINCIPAL LIFE INSURANCE COMPANY
By
-----------------------------------------
Its:
-------------------------------
COVENTRY HEALTH CARE, INC.
By
-----------------------------------------
Its:
-------------------------------
<PAGE> 1
AGREEMENT
This Agreement is entered into as of the 17th day of June, 1999, by and
between James E. McGarry ("Executive") and Coventry Health Care, Inc., a
Delaware corporation with its principal place of business at 6705 Rockledge
Drive, Suite 900, Bethesda, MD 20817 ("Employer").
WHEREAS, Executive and Employer have entered into an employment
relationship and desire to enter into a written agreement in which Executive
agrees to confidentiality, non-competition, non-solicitation and other
provisions during the term of his employment and during a severance period
thereafter in exchange for severance compensation in the event Executive is
terminated without cause by Employer.
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. 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 for any reason, to any person (other than a person
to whom disclosure is necessary in connection with the performance of his
duties as an employee 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 and for a period
of twelve months following termination of employment for any reason (the
"Severance Period"), 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 have any financial interest in, or aid or assist anyone else
in the conduct of, any business which is in competition with any business
conducted by Employer or any of its affiliates in any state in which Employer
or any of its affiliates is conducting business on the date of Executive's
termination of employment, 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 Executive's employment and
during the Severance Period, Executive will not (i) directly or indirectly
solicit from any entity, organization or person that is doing business with
Employer or any of its affiliates, or from which the Employer or any of its
affiliates was soliciting business at the time of the termination of employment
or of which Executive knew or had reason to know that Employer or any of its
affiliates was going to solicit business at the time of Executive's
termination, or (ii) employ, solicit for employment, or advise or recommend to
any other persons that they employ or solicit for employment, any employee of
Employer or any of its affiliates.
(d) Consultation. Executive shall, at Employer's written request
during the Severance Period, cooperate with Employer in concluding any matters
in which Executive was involved during the term of his employment and will make
himself available for consultation with Employer at reasonable times on matters
of importance to Employer.
2. TERMINATION OF EMPLOYMENT. Employer may terminate Executive,
with or without cause, at any time during the term of his employment. If
Executive's employment is terminated by Employer for any reason other than Good
Cause (as defined in Section 8 below):
<PAGE> 2
(a) Employer shall during the Severance Period, 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.
(b) During the Severance Period Executive and his spouse and family
will continue to be covered by all Welfare Plans (as defined in Section 8
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.
Executive's eligibility for, and the Employer match to, the 401(k) Plan (the
"401(k) Plan"), the Supplemental Executive Retirement Plan (the "SERP") and/or
any other retirement savings program in which the Employee participates shall
end at the date of termination of employment. Employee's balances in the SERP
shall be distributed to him as soon as practicable, less tax withholdings,
according to the terms of the SERP.
(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 any club memberships, and expenses for professional services.
Compensation under Section 2(a) and (b) is contingent upon Executive's
compliance with Section 1.
3. TERMINATION BY EXECUTIVE. Executive may terminate his
employment with Employer at any time upon sixty (60) days prior written notice.
Upon such termination by Executive, 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, except for
the payout of benefits already accrued under any Employee benefit plans or
other employee benefits.
4. SETOFF.
(a) With respect to Section 2, 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 2, 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
other professional services rendered. Employee shall notify
2
<PAGE> 3
Employer immediately in writing of the date upon which such services or other
work commenced and shall provide Employer with such documentation as Employer
shall require to determine the amount of any such setoff. Employee's failure to
provide such written notice and documentation as required herein shall
immediately release Employer from its obligations under this Agreement and
Employer shall have the right to recover all amounts payable hereunder.
5. 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 5 are in addition to any other benefit
due to Executive or his spouse or beneficiaries from Employer.
6. ENTIRE AGREEMENT. This instrument contains the entire agreement
of the parties and 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.
7. 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.
8. DEFINITIONS. For purposes of this Agreement:
(a) "Good Cause" shall be deemed to exist if, and only if:
(i) Executive engages in material acts or omissions constituting
dishonesty, breach of fiduciary obligation or intentional
wrongdoing, malfeasance or non-compliance with written
directives approved by the Board of Directors which are
demonstrably injurious to Employer;
(ii) Executive is convicted of a violation involving fraud or
dishonesty; or
(iii) Executive fails to satisfy the conditions and requirements of
his employment with Employer, and such failure by its nature is
incapable of being cured, or such failure remains uncured for
more than 30 days following receipt by Executive of written
notice from Employer specifying the nature of the failure and
demanding the cure thereof. For purposes of this paragraph
(iii), inattention by Executive to his duties shall be deemed a
failure of cure.
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
3
<PAGE> 4
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.
(b) "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.
IN WITNESS WHEREOF, the parties have executed this Agreement on the day
and year first written above.
/s/ JAMES E. MCGARRY
----------------------------------------
James E. McGarry
COVENTRY HEALTH CARE, INC.
By:/s/ THOMAS P. MCDONOUGH
----------------------------------------
Thomas P. McDonough
Executive Vice President and
Chief Operating Officer
McGarry
4
<PAGE> 1
Exhibit 11.1
<TABLE>
<CAPTION>
Coventry Health Care, Inc.
Computation of Net Earnings Per Share
Quarter ended June 30, 1999
------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net Income $9,157
-------------------
Basic EPS $9,157 58,952 $0.16
Effect of Dilutive Securities
Options and warrants 762
Convertible preferred stocks 78
Convertible notes 4,510
Interest on convertible notes 332
------------------------------------------------------------
Diluted EPS $9,489 64,302 $0.15
</TABLE>
<TABLE>
<CAPTION>
Quarter ended June 30, 1998
------------------------------------------------------------
Loss Shares Per Share
(Numerator) (Denominator) Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net loss ($27,756)
-------------------
Basic EPS ($27,756) 58,592 ($0.47)
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30, 1999
------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net Income $17,450
-------------------
Basic EPS $17,450 58,902 $0.30
Effect of Dilutive Securities
Options and warrants 737
Convertible preferred stocks 39
Convertible notes 4,515
Interest on convertible notes 848
------------------------------------------------------------
Diluted EPS $18,298 64,193 $0.29
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30, 1998
------------------------------------------------------------
Loss Shares Per Share
(Numerator) (Denominator) Amount
------------------------------------------------------------
<S> <C> <C> <C>
Net loss ($23,049)
-------------------
Basic EPS ($23,049) 45,970 ($0.50)
</TABLE>
1
<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
JUNE 30, 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> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 243,613
<SECURITIES> 283,697
<RECEIVABLES> 66,835
<ALLOWANCES> (17,129)
<INVENTORY> 0
<CURRENT-ASSETS> 458,494
<PP&E> 90,843
<DEPRECIATION> (52,734)
<TOTAL-ASSETS> 997,728
<CURRENT-LIABILITIES> 456,867
<BONDS> 42,358
0
5
<COMMON> 594
<OTHER-SE> 455,935
<TOTAL-LIABILITY-AND-EQUITY> 997,728
<SALES> 0
<TOTAL-REVENUES> 531,831
<CGS> 0
<TOTAL-COSTS> 522,205
<OTHER-EXPENSES> (7,480)
<LOSS-PROVISION> 782
<INTEREST-EXPENSE> 692
<INCOME-PRETAX> 16,414
<INCOME-TAX> 7,257
<INCOME-CONTINUING> 9,157
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,157
<EPS-BASIC> 0.16
<EPS-DILUTED> 0.15
</TABLE>
