<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 September 30, 1997 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 CORPORATION
(Exact name of registrant as specified in its charter)
TENNESSEE 62-1297579
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
53 CENTURY BOULEVARD, SUITE 250, NASHVILLE, TENNESSEE 37214
(Address of principal executive office)
(Zip Code)
(615) 391-2440
(Registrant's telephone number, including area code)
------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 6, 1997
- ----- -------------------------------
Common stock $.01 Par Value 33,620,871
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COVENTRY CORPORATION
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Balance Sheets at September 30,
1997 and December 31, 1996 1
Condensed Consolidated Statements of Operations for the
quarter and nine months ended September 30, 1997 and 1996 2
Condensed Consolidated Statements of Cash Flows for
the nine months ended September 30, 1997 and 1996 3
Notes to Condensed Consolidated Financial Statements 4
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3: Quantitative and Qualitative Disclosures about Market Risk 15
PART II. OTHER INFORMATION
Item 1: Legal Proceedings 16
Items 2, 3, 4 and 5 16
Item 6 16
Signatures 17
</TABLE>
<PAGE> 3
Part I:
Item 1:
COVENTRY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1997 1996
------------- ------------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 141,236 $ 85,646
Short-term investments 4,951 7,388
Accounts receivable, net 34,976 37,921
Other receivables 15,021 22,661
Assets held for sale -- 23,856
Deferred income taxes and other current assets 12,834 30,819
--------- ---------
Total current assets 209,018 208,291
Long-term investments 71,403 75,389
Property and equipment, net 22,856 24,979
Goodwill and intangible assets, net 112,281 118,346
Other assets 21,563 21,940
--------- ---------
Total assets $ 437,121 $ 448,945
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claim liabilities $ 116,743 $ 146,082
Accounts payable and other accrued liabilities 94,132 84,563
Deferred revenue 14,930 14,888
Current portion of long-term debt and notes payable 49,172 36,468
--------- ---------
Total current liabilities 274,977 282,001
Convertible exchangable subordinated notes 41,180 --
Long-term debt 1,286 57,291
Other long-term liabilities 6,448 9,226
Stockholders' equity:
Common Stock, $.01 par value; 50,000,000 shares
authorized; 33,589,464 issued (including 439,560 shares
owned by a subsidiary), 33,149,904 shares outstanding in
1997 and 33,001,296 shares issued and outstanding in 1996 336 330
Additional paid-in capital 145,498 136,142
Net unrealized investment gain 439 395
Accumulated deficit (28,043) (36,440)
Treasury stock, at cost, 439,560 shares (5,000) --
--------- ---------
Total stockholders' equity 113,230 100,427
--------- ---------
Total liabilities and stockholders' equity $ 437,121 $ 448,945
========= =========
</TABLE>
See notes to condensed consolidated financial statements
1
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COVENTRY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Quarter Ended Nine months ended
September 30, September 30,
------------------------ -------------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating revenues:
Managed care premiums $ 300,904 $ 269,602 $ 892,357 $ 757,277
Management services 5,790 3,301 14,763 10,300
--------- --------- --------- ---------
Total operating revenues 306,694 272,903 907,120 767,577
Operating expenses:
Health benefits 254,551 232,678 772,363 655,322
Selling, general and administrative 43,287 35,968 124,892 108,876
Depreciation and amortization 2,880 3,930 9,913 11,783
Other charges -- -- -- 8,243
(Gain) loss on sale of medical offices 643 -- (14,918) --
--------- --------- --------- ---------
Total operating expenses 301,361 272,576 892,250 784,224
--------- --------- --------- ---------
Operating earnings (loss) 5,333 327 14,870 (16,647)
Other income, net 1,933 2,403 7,435 6,546
Interest expense (2,832) (2,313) (8,278) (5,345)
--------- --------- --------- ---------
Earnings (loss) before income taxes
and minority interest 4,434 417 14,027 (15,446)
Provision for (benefit from) income taxes 1,774 167 5,611 (6,178)
Minority interest in (income) loss of consolidated
subsidiary, net of income tax 2 (98) 19 (120)
--------- --------- --------- ---------
Net earnings (loss) $ 2,658 $ 348 $ 8,397 $ (9,148)
========= ========= ========= =========
Net earnings (loss) per common and
common equivalent share $ 0.08 $ 0.01 $ 0.25 $ (0.28)
========= ========= ========= =========
Weighted average common and common
equivalent shares outstanding 34,609 33,021 33,505 32,839
========= ========= ========= =========
</TABLE>
See notes to condensed consolidated financial statements.
2
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COVENTRY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended September 30,
--------------------------------
1997 1996
---- ----
<S> <C> <C>
Net cash provided by operating activities $ 1,107 $ 8,982
--------- --------
Cash flows from investing activities:
Capital expenditures, net (4,902) (11,736)
Sale of investments 27,885 50,046
Purchase of investments (21,367) (35,770)
Proceeds from sale of subsidiary and medical offices 51,862 --
Payments for purchase of subsidiaries, net of cash acquired -- (28,132)
--------- --------
Net cash provided by (used in) investing activities 53,478 (25,592)
--------- --------
Cash flows from financing activities:
Issuance of long-term debt and notes payable 40,000 40,714
Payments of long-term debt and notes payable (43,217) (13,700)
Net proceeds from issuance of stock and warrants 4,222 5,589
--------- --------
Net cash provided by financing activities 1,005 32,603
--------- --------
Net increase in cash and cash equivalents 55,590 15,993
Cash and cash equivalents at beginning of the period 85,646 67,435
--------- --------
Cash and cash equivalents at end of the period $ 141,236 $ 83,428
========= ========
Supplemental disclosures of cash flow information
Cash paid (received) during the period was as follows:
Interest $ 6,119 $ 3,986
========= ========
Income taxes $ (6,508) $ 1,322
========= ========
</TABLE>
See notes to condensed consolidated financial statements.
3
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COVENTRY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of Coventry Corporation
and subsidiaries (the "Company") contained in this report are unaudited but
reflect all adjustments, consisting of normal recurring adjustments which, in
the opinion of management, are necessary for fair statement of the results of
the interim periods reflected. Certain information and footnote disclosures
normally included in the consolidated financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to applicable rules and regulations of the Securities and Exchange
Commission (the "SEC"). Certain reclassifications have been made to 1996 amounts
to conform to the 1997 presentation. The results of operations for the interim
periods reported herein are not necessarily indicative of results to be expected
for the full year. It is suggested that these condensed consolidated financial
statements be read in conjunction with the consolidated financial statements,
notes thereto and management's discussion and analysis included in the Company's
most recent Annual Report on Form 10-K/A, filed with the SEC in July 1997.
2. ACQUISITIONS
Effective March 22, 1996, the Company purchased 81% of the common stock
of PARTNERS Health Plan of Pennsylvania, Inc. and acquired the remaining 19% of
the common stock through the merger of a subsidiary of the Company with and into
PARTNERS, whose name was changed to Coventry Health Plan of Pennsylvania, Inc.
("CHP"). CHP is the holding company for Coventry Health Plan of Western
Pennsylvania, Inc., which, at the time of acquisition, was known as Aetna Health
Plan of Western Pennsylvania, Inc. and served approximately 16,000 HMO members
in the Pittsburgh area. Consideration for the transaction was approximately $35
million in cash, of which approximately $32.1 million was recorded as goodwill.
The acquisition has been accounted for under the purchase method of accounting
and, accordingly, the net assets have been included in the consolidated
financial statements from the effective date of acquisition. The acquisition
price included, among other typical business assets and goodwill, consideration
for non-compete agreements, the expectation of entering into a favorable joint
marketing agreement and the opportunity to acquire additional Aetna membership
at a favorable price. During the fourth quarter of 1996, the Company determined
that none of the opportunities were being realized, cash flows were short of
expectations (losses in 1996 versus projected positive cash flows) and that
Aetna had purchased U.S. Healthcare, which has operations in the Company's
service areas. In addition, the Company filed suit against Aetna and U.S.
Healthcare alleging breach of the acquisition agreement, seeking enforcement of
the non-compete agreement and requesting other forms of relief. Based on the
fair value estimates of the intangibles, on both a sales recovery and discounted
cash flow basis, the intangibles were written down to $10.0 million at December
31, 1996.
3. OTHER CHARGES
At the end of the second quarter of 1996, the Company established
reserves totaling $8.2 million for anticipated losses on multi-year contracts
with certain employer groups, primarily in the St. Louis market. The Company
expects to utilize these reserves over the remaining lives of the contracts and
then either discontinue these products or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at varying
dates through 1999 and cover approximately 30,000 members. The
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Company continually evaluates the underlying costs expected to be incurred in
servicing the contracts.
4. SALE OF MEDICAL OFFICES
Effective March 31, 1997, the Company completed its sale of the medical
offices associated with HealthAmerica Pennsylvania, Inc., its health plan in
Pittsburgh, Pennsylvania, to a major health care provider organization. The
sales price was $20 million and the transaction resulted in a pretax gain of
approximately $6.0 million. Coincident with the sale, the Company entered into a
long-term global capitation agreement with the purchaser which increased the
globally capitated membership in western Pennsylvania to approximately 226,000
members. Under the agreement, the provider organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive.
Effective May 1, 1997, the Company completed its sale of the medical
offices associated with Group Health Plan, its health plan in St. Louis,
Missouri, to a major health care provider organization. The sales price was
$26.9 million and the transaction resulted in a pretax gain of approximately
$9.6 million. Coincident with the sale, the Company entered into a long-term
global capitation agreement with the purchaser covering approximately 83,000
members, pursuant to which the provider organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive.
In August 1997, the Company entered into agreements to sell certain
medical offices associated with HealthAmerica, its health plan in Harrisburg,
Pennsylvania. The sales price was $2.1 million and the transaction resulted in a
pretax loss of $0.2 million. Additionally in the third quarter, the Company sold
its two remaining medical offices in Pittsburgh, Pennsylvania for $0.3 million
in cash and recorded a pretax loss of $0.4 million.
5. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES
On April 2, 1997, the Company announced that it entered into a
securities purchase agreement with Warburg, Pincus Ventures, L.P. ("Warburg")
and Franklin Capital Associates III L.P. ("Franklin" and collectively with
Warburg the "Investors") for the Investors' purchase of $40 million of the
Convertible Exchangeable Subordinated Notes of the Company (the "Convertible
Notes"), together with warrants to purchase 2.35 million shares of the Company's
common stock, for $42.35 million. The Convertible Notes are convertible into
four million shares of the Company's common stock. On May 9, 1997, the Investors
purchased $26.8 million of the Convertible Notes and 1.6 million warrants for an
aggregate purchase price of $28.4 million. Following approval from certain state
insurance regulators, the remaining investment by Warburg of approximately $13.9
million was completed on June 30, 1997. The Convertible Notes will be
exchangeable at the Company's option for shares of convertible preferred stock,
the authorization of which was approved by the Company's shareholders at the
1997 shareholders' meeting.
6. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is computed based upon the weighted average
shares of common stock and common stock equivalents during the period. Common
stock equivalents arising from dilutive stock options and warrants are computed
using the treasury stock method. In May and June of 1997, the Company issued
Convertible Notes which are not considered common stock equivalents. The fully
diluted earnings per share calculation assumes conversion of the Convertible
Notes and adjusts earnings for the interest that would not be paid in that
event. Fully diluted earnings per share are not
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presented, as the calculation does not materially affect earnings per share for
either period ending September 30, 1997.
7. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is
effective for both interim and annual reporting periods ending after December
15, 1997. The Company will adopt the new standard in its reporting for the
quarter and the year ended December 31, 1997. Management does not believe that
adoption of this standard will have a material impact on earnings per share.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive
Income," which is effective for fiscal years beginning after December 15, 1997
and requires restatement of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of certain items,
including gains and losses on certain securities, be shown in the financial
statements. Management has not yet determined the effect, if any, of SFAS No.
130 on the consolidated financial statements.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This standard requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS No. 131 also requires that
all public business enterprises report information about the revenues derived
from the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. This Statement is effective for financial
statements for periods beginning after December 15, 1997. Management has not yet
determined the effect, if any, of SFAS No. 131 on the consolidated financial
statements.
8. SUBSEQUENT EVENT
On November 3, 1997, a definitive Capital Contribution and Share
Exchange Agreement (the "Exchange Agreement") was entered into by and among
Coventry Corporation, a Tennessee corporation, Coventry Health Care, Inc., a
newly-formed Maryland corporation and wholly-owned subsidiary of Coventry
Corporation ("Coventry Health Care"), Principal Mutual Life Insurance Company,
an Iowa mutual insurance company ("Principal Mutual"), Principal Holding
Company, an Iowa corporation and wholly-owned subsidiary of Principal Mutual
("Holding"), and Principal Health Care, Inc., an Iowa corporation and
wholly-owned subsidiary of Holding ("PHC").
Pursuant to the Exchange Agreement, the Company's shareholders will
effect a 1:1 tax free share exchange (the "Exchange") with Coventry Health Care
and PHC will effect a capital contribution (the "Capital Contribution") to
Coventry Health Care of all of PHC's assets except for specified excluded
assets and PHC's liabilities except for specified excluded liabilities. Under
the Exchange, Coventry Health Care will issue to the Company's shareholders
approximately 33 million shares of its common stock, representing approximately
60% of Coventry Health Care's outstanding equity. Under the Capital
Contribution, Coventry Health Care will issue to PHC approximately 26 million
shares of its common stock, equal to approximately 40% of Coventry Health Care's
outstanding equity. Based on the stock price as of the close of business,
Monday, November 3, the value of the transaction is approximately $375 million.
The transaction will be treated as a purchase of PHC by Coventry Health Care,
Inc., the successor to the Company. PHC is a managed care company with
approximately $850 million in annualized 1997 revenues and 674,000 HMO members
in 18 markets throughout the Midwest and Southeastern United States.
In addition, Coventry Health Care will enter into an agreement to
manage that portion of Principal Mutual's health insurance indemnity book of
business in the Coventry Health Care markets. The management fee will be 3.3%
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of premium and will expire December 31, 1999, at which time Coventry Health Care
has agreed that it will either reinsure or renew the business on the books of
its subsidiary, Coventry Health and Life Insurance Company. The indemnity
premiums for this book of business are estimated to be approximately $550
million for 1997. The Coventry Health Care will also enter into a number of
other agreements to provide marketing and other services through December 1999
to Principal Mutual, for which Coventry Health Care will be compensated.
The transaction is subject to various conditions, including the
approval of various state regulatory agencies and approval of the Company's
shareholders and banks. The transaction is currently expected to be completed by
the end of the first quarter of 1998. When the transaction is completed,
Principal Mutual will have the right to nominate six directors on Coventry
Health Care, Inc.'s 15-person Board of Directors. Principal Mutual will enter
into a shareholders' agreement containing standstill provisions and limitations
on Principal Mutual's voting rights in certain circumstances.
7
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Item 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Quarter and nine months ended September 30, 1997 and 1996
GENERAL
Coventry Corporation, headquartered in Nashville, Tennessee, is a
managed health care company that provides managed care health benefits and
services to a broad cross section of employer and government-funded groups in
Pennsylvania, Ohio, West Virginia, Missouri, Illinois and Virginia.
The Company serves a membership of 753,201 full-risk members and
144,557 self-insured members as of September 30, 1997. The following tables show
the total number of enrollees as of September 30, 1997 and 1996 and the
percentage changes in enrollment.
<TABLE>
<CAPTION>
September 30,
------------------------- Percent
1997 1996 Change
------- ------- --------
<S> <C> <C> <C>
Western Pennsylvania 294,401 301,215 (2.3)%
Central Pennsylvania 256,022 238,567 7.3 %
St. Louis 275,315 238,704 15.3 %
Richmond 72,020 73,302 (1.7)%
Jacksonville -- 25,636 --
------- -------
Total 897,758 877,424 2.3 %
======= =======
</TABLE>
<TABLE>
<CAPTION>
September 30,
------------------------- Percent
1997 1996 Change
------- ------- -------
<S> <C> <C> <C>
Commercial HMO 392,272 424,032 (7.5)%
Commercial POS 224,070 174,901 28.1 %
Medicare Risk 34,588 16,873 105.0 %
Medicaid 102,271 110,624 (7.6)%
Non-Risk 144,557 150,994 (4.3)%
------- -------
Total 897,758 877,424 2.3 %
======= =======
</TABLE>
The Company's operating expenses are primarily medical costs, including
medical claims under contracted relationships with a wide variety of providers,
capitation payments and expenses relating to the operation of the Company's
health centers. Medical claims expense also includes an estimate of claims
incurred but not reported ("IBNR"). The Company believes that the estimates for
IBNR liabilities relating to its businesses are adequate to satisfy its ultimate
claims liability with respect thereto. In determining the Company's medical
claims reserves, the Company employs plan by plan standard actuarial reserve
methods (specific to the plan's membership, product characteristics, geographic
territories and provider network) which consider utilization frequency and unit
costs of inpatient, outpatient, pharmacy and other medical costs as well as
claim payment backlogs and the changing timing of provider reimbursement
practices. Calculated reserves are reviewed by underwriting, finance and
accounting, and other appropriate plan and corporate personnel and judgments are
then made as to the necessity for reserves in addition to the above calculated
amounts. Changes in assumptions for medical costs caused by changes in actual
experience, changes in the delivery system, changes in pricing due to ancillary
capitation and fluctuations in the claims backlog could cause these estimates to
change in
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the near term. The Company periodically monitors and reviews IBNR, and as actual
settlements are made or accruals adjusted, differences are reflected in current
operations. The Company continually refines its reserving practices to
incorporate new events and trends.
RESULTS OF OPERATIONS
QUARTERS ENDED SEPTEMBER 30, 1997 AND 1996
Managed care premiums increased $31.3 million, or 11.6%, from the prior
year quarter. This increase is a result of risk membership growth of 26,771, or
3.7%, from the prior year quarter. Growth in Medicare risk membership of 17,715
accounted for over 66% of the risk membership increase and, because of
significantly higher per member per month premiums compared to commercial
products, enhanced the growth in premium revenues. Premium revenues were also
enhanced in the period by increases in premium rates for renewing groups.
Management services revenue increased $2.5 million or 75.4% from the
prior year. This increase is primarily attributable to the increase in the
average per member per month administration fee and revenue from transition
services provided to the global capitation provider in St. Louis, Missouri to
whom the Company had previously sold its St. Louis medical offices.
Health benefits expense increased $21.9 million, or 9.4%, in 1997,
compared to 1996, as a result of the increase in risk enrollment. The Company's
medical loss ratio decreased to 84.6% from 86.3% in the corresponding prior year
quarter. The decline in the medical loss ratio is primarily attributable to the
global capitation contracts entered into in conjunction with the sales of the
Company's medical offices in Pittsburgh, Pennsylvania and St. Louis, Missouri.
The benefit from the global capitation agreements was partly offset as the
medical loss ratio increased in the central Pennsylvania region due to increases
in inpatient alternatives (such as outpatient surgery), referrals to
specialists, prescription drugs and increased health benefit expense associated
with the Medicaid membership.
The Company has undertaken initiatives to control its medical costs,
including global capitation arrangements, risk sharing with hospitals,
capitating specialists, national contracting of ancillary services and
divestiture of its health center operations. In March 1997, the Company entered
into agreements to sell the Company's medical offices in western Pennsylvania
and St. Louis, Missouri to major provider organizations in these markets. The
western Pennsylvania transaction closed effective March 31, 1997. The St. Louis,
Missouri agreement was completed effective May 1, 1997. Coincident with the sale
of the medical offices, the Company entered into long-term global capitation
arrangements with the purchasers of the medical offices, pursuant to which the
provider organizations will receive a fixed percentage of premium to cover all
of the costs of medical care the globally capitated members will receive. These
global capitation agreements covered approximately 226,000, or 91%, and 83,000,
or 45%, of the commercial, Medicaid and Medicare risk membership in western
Pennsylvania and St. Louis, respectively, on the respective signing dates. In
July 1997, regulatory approval was received to add approximately 11,000 Ohio
members to the western Pennsylvania contract. In August, the Company received
regulatory approval to add approximately 13,000 West Virginia members to the
western Pennsylvania contract. These arrangements in western Pennsylvania and
St. Louis, Missouri effectively reduce the Company's medical costs as a
percentage of premiums, enable the Company to reduce its administrative staff in
patient utilization and medical management and shift a significant portion of
the risk of medical costs fluctuations to the provider networks. As of September
30, 1997, the global capitation agreements covered 99% and 48% of the risk
membership in western Pennsylvania and St. Louis, Missouri, respectively.
However, since the global capitation
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arrangements are with single provider organizations and cover substantial
membership, the Company is exposed to substantial credit and operating risks
with respect to the financial strength of such organizations.
Selling, general and administrative ("SGA") expense increased $7.3
million, or 20.3%, from the prior year corresponding quarter. The increase in
SGA in 1997 is primarily attributable to the increase in full risk membership,
additional personnel cost relating to re-engineering of claims processing,
information systems and customer service, and the costs associated with the
growth of the Medicare risk product in certain markets.
Depreciation and amortization decreased $1.0 million, or 26.7%, from
1996. This decrease is primarily the result of the medical office sales.
As discussed in note 4, the Company completed its sale of its remaining
medical offices. The sales price totaled $2.4 million and the transactions
resulted in pretax losses of approximately $0.6 million.
Other income decreased $0.5 million from 1996. This decline is due to a
reserve resulting from a review of property and equipment which is currently in
process. This reserve offset increased earnings from cash and investments when
compared to the prior year quarter. Interest expense increased $0.5 million due
to the higher interest rate on the Company's term loan.
Earnings from operations were $5.3 million, or $5.0 million more than
the prior year quarter. Excluding the 1997 loss from the medical office sales
the operating earnings would have been $5.9 million, or $5.6 million greater
than the quarter ended September 30, 1996. This $5.6 million increase in
operating income is primarily attributable to the decrease in medical costs.
The Company's net earnings were $2.7 million, or $2.4 million greater
than the prior year quarter. Earnings per common and common equivalent share
were $0.08 per share in the third quarter of 1997 compared to $.01 in the third
quarter of 1996. The weighted average common and common equivalent shares
outstanding were approximately 34,609,000 and 33,021,000 for the quarters ended
September 30, 1997 and 1996, respectively.
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RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Managed care premiums increased $135.1 million, or 17.8%, from the
prior year nine months. This increase is a result of risk membership growth of
26,771, or 3.7%, from the prior period. The small growth in risk membership
reflects the closing of the Florida Medicaid plan effective June 30, 1997, which
had 21,747 members. The revenue increase in the first nine months was enhanced
by the growth in Medicare risk membership which has a significantly higher per
member per month premium when compared to the commercial products and increases
in premium rates as members renew.
Management services revenue increased $4.5 million or 43.3% from the
prior year. This increase is primarily attributable to the increase in the
average per member per month administration fee and revenues from transition
services provided to the global capitation provider in St. Louis, Missouri.
Health benefits expense increased $117.0 million, or 17.9%, in 1997,
compared to 1996, as a result of the increase in risk enrollment and increases
in medical costs. The Company's medical loss ratio increased to 86.6% from 86.5%
in the corresponding nine months. Medical loss ratios increased in the central
Pennsylvania region due to increases in inpatient alternatives (such as
outpatient surgery), referrals to specialists, pharmacy and increased health
benefit expense associated with the Medicaid membership. Significant medical
cost increases in the Medicare risk product in St. Louis, Missouri were a result
of increased Medicare risk membership and high utilization of inpatient
services.
The Company determined, at the end of 1996, that its Florida operations
were not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, the Company discontinued operations in the Florida HMO
market on June 30, 1997. The Company established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market and
the reserve is believed to be sufficient to cover the anticipated costs. During
the third quarter of 1997, the Company determined that it will exit its Medicaid
operations in Pennsylvania. On September 30, 1997 the Medicaid membership was
4,236 and 18,043 in western Pennsylvania and central Pennsylvania, respectively.
Selling, general and administrative ("SGA") expense increased $16.0
million, or 14.7%, from the prior year corresponding nine months. SGA in the
first half of 1996 included termination costs of $6.0 million related to
personnel reductions associated with streamlining the Company's administrative
processes and reducing staffing in its medical offices. The increase in SGA is
primarily attributable to the increase in full risk membership, additional
personnel costs relating to the re-engineering of administrative processes in
claims processing, information systems and customer services and costs
associated with the growth of the Company's Medicare risk product.
At the end of the second quarter of 1996, the Company established
reserves totaling $8.2 million for anticipated losses on multi-year contracts
with certain employer groups, primarily in the St. Louis market. The Company
expects to utilize these reserves over the remaining lives of the contracts and
then either discontinue these products or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at varying
dates through 1999 and cover approximately 30,000 members. The Company
continually evaluates the underlying costs expected to be incurred in servicing
the contracts.
11
<PAGE> 14
Depreciation and amortization decreased $1.9 million, or 15.9%, from
1996. This decrease is primarily the result of the medical office sales in 1997.
As discussed in note 4, effective March 31, 1997, the Company completed
the sale of its western Pennsylvania medical offices. The sales price was $20
million and the transaction resulted in a pretax gain of approximately $6.0
million. Also, effective May 1, 1997, the Company completed the sale of its St.
Louis, Missouri medical offices. The sales price was $26.9 million and the
transaction resulted in a pretax gain of approximately $9.6 million. During the
third quarter, the Company completed the sale of the remaining medical offices
in Pennsylvania. The sales price for the third quarter transactions was $2.4
million and resulted in a pretax loss of $0.6 million.
Other income increased $0.9 million primarily due to higher cash and
investments when compared to the prior year. Interest expense increased $2.9
million due primarily to a higher interest rate on the Company's term loan.
Earnings from operations were $14.9 million, or $31.5 million more than
the prior year nine months. Excluding the 1997 gain from the medical office
sales and the 1996 termination costs and contract loss provisions, the operating
loss would have been $48 thousand, or $2.4 million less than the loss for the
nine months ended September 30, 1996. This $2.4 million decrease in the
operating loss for the nine months ended September 30, 1997 is primarily
attributable to lower depreciation and amortization resulting from the medical
office sales.
The Company's net income was $8.4 million, or $17.5 million more than
the prior year nine months. Net income per common and common equivalent share
was $0.25 per share in the first nine months of 1997 compared to a $0.28 loss
per share in the first nine months of 1996. The weighted average common and
common equivalent shares outstanding were approximately 33,305,000 and
32,839,000 for the nine months ended September 30, 1997 and 1996, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total cash and investments, excluding deposits of $8.4
million restricted under state regulations, increased $49.2 million to $217.6
million at September 30, 1997 from $168.4 million at December 31, 1996. Cash and
cash equivalents increased $55.6 million to $141.2 million at September 30,
1997. Cash provided by operations of $1.1 million was primarily the result of
depreciation and amortization and income tax refunds offset by a reduction in
medical claims payable resulting from the Company's new global capitation
arrangements where the Company no longer has medical claims risk for certain
members. Cash flows provided by investing activities of $53.5 million were
primarily the result of the sales of medical offices and a subsidiary. Cash
flows provided by financing activities were the result of the sale of the
Convertible Notes and warrants, reduced by long-term debt repayments.
The Company's HMOs and insurance subsidiaries are required by state
regulatory agencies to maintain minimum surplus balances, thereby limiting the
dividends the Company may receive from its HMOs and insurance subsidiaries.
After giving effect to these statutory reserve requirements, the Company's
regulated subsidiaries had surplus in excess of statutory requirements of
approximately $45.9 million and $41.6 million at September 30, 1997 and December
31, 1996, respectively. Excluding funds subject to regulation, the Company had
cash and investments of approximately $34.2 million and $16.5 million at
September 30, 1997 and December 31, 1996, respectively, which are available to
pay intercompany balances to regulated companies and for general corporate
purposes.
12
<PAGE> 15
As a result of losses in the fourth quarter of 1996, the Company was
not in compliance with certain revised financial covenants in its Amended Credit
Facility ("Amended Credit Facility"). The Company entered into an amended and
restated agreement ("Restated Credit Facility") with the bank group effective
March 28, 1997, that, along with other changes, converted the amount outstanding
under the Restated Credit Facility to a term loan, revised certain financial
ratios the Company is required to maintain, effectively increased the interest
rate of the indebtedness by 2.7% (to the greater of prime plus 2% or the federal
funds rate plus 2.5%) and revised the amortization period of the loan. The
Restated Credit Facility required payments of $10 million on June 30, 1997, $7
million on September 30, 1997, $18 million on December 31, 1997 and $55 million
on April 1, 1998. The Company was in compliance with the covenants contained in
the Restated Credit Facility as of September 30, 1997.
The Restated Credit Facility contains covenants relating to investments
in non-admitted assets, operating margin, net worth levels and the creation or
assumption of debt or liens on the assets of the Company. The Restated Credit
Facility is collateralized by substantially all of the assets of the Company.
On September 30, 1997, the effective interest rate on the indebtedness
under the Restated Credit Facility was 10.5%.
The Restated Credit Facility required the Company apply 50% of the
net cash proceeds from the sale of the Convertible Notes and warrants to the
loan balance, with the payment being applied to reduce 1997 and 1998
amortization payments. The Restated Credit Facility also required the Company to
prepay loans upon receipt of $7.5 million of tax refunds resulting from the
carryback of operating losses to prior years, with the prepayment being applied
to reduce the December 1997 amortization payment. The Restated Credit Facility
requires the Company to apply 50% of the net cash proceeds of sales of the
Company's capital stock to reduce the scheduled amortization in the inverse
order of maturity, prohibits the sale of any substantial subsidiary and
restricts the Company's ability to declare and pay cash dividends on its common
stock.
On April 2, 1997, the Company announced that it entered into a
securities purchase agreement with Warburg, Pincus Ventures, L.P. ("Warburg")
and Franklin Capital Associates III L.P. ("Franklin" and collectively with
Warburg the "Investors") for the Investors' purchase of $40 million of the
Convertible Exchangeable Subordinated Notes of the Company (the "Convertible
Notes"), together with warrants to purchase 2.35 million shares of the Company's
common stock for $42.35 million. The Convertible Notes are convertible into 4
million shares of the Company's common stock. On May 9, 1997, the Investors
purchased $26.8 million of the Convertible Notes and 1.6 million warrants for an
aggregate purchase price of $28.4 million. Approximately $20 million of the
proceeds was utilized to prepay a portion of the outstanding indebtedness under
the Restated Credit Facility. Following approval from certain state insurance
regulators, the remaining investment by Warburg of approximately $13.9 million
was completed on June 30, 1997 and the total proceeds were used to retire $14
million of indebtedness under the Restated Credit Facility. The $14 million
payment was comprised of $7.0 million of mandatory prepayments from the Warburg
proceeds, $1.4 million for the required June 30 payment, $0.5 million of the
anticipated tax refund and $5.1 million of optional prepayment. During the third
quarter of 1997, the Company made payments of $7.8 million on the Restated
Credit Facility. The payments included $7.0 million of the income tax refund and
$0.8 million from the exercise of stock options.
The Convertible Notes will be exchangeable at the Company's option for
shares of convertible preferred stock.
13
<PAGE> 16
Interest is payable semi-annually and accrues at 8.3%. Interest is payable in
additional Convertible Notes and as a result, the accrued interest at September
30, 1997 has been added to the outstanding indebtedness.
As a result of the 1997 payments, at September 30, 1997, the payments
required on December 31, 1997 and April 1, 1998 under the Restated Credit
Facility were reduced to $5.2 million and $43.1 million, respectively.
Projected capital investments in 1997 of approximately $10 million
consist primarily of computer hardware, software and related equipment costs
associated with the development and implementation of improved operational and
communications systems.
The Company believes that cash flows generated from operations, cash on
hand and investments, excess funds in certain of its regulated subsidiaries, and
other financing alternatives will be sufficient to fund continuing operations
and debt service obligations through March 31, 1998. The Company believes that
completion of the Warburg transaction, strengthening its underwriting processes,
entering into global capitation arrangements, completing the medical office
sales and re-engineering its administrative processes will have a favorable
effect on liquidity in 1997 and future periods. The Company expects to refinance
a portion of the amount outstanding under the Restated Credit Facility before
April 1, 1998. The Company's investment guidelines emphasize investment grade
fixed income instruments in order to provide short-term liquidity and minimize
the risk to principal.
LEGISLATION AND REGULATION
Numerous proposals have been introduced in the United States Congress
and various state legislatures relating to health care reform. Some proposals,
if enacted, could among other things, restrict the Company's ability to raise
prices and to contract independently with employers and providers. Certain
reform proposals favor the growth of managed health care, while others would
adversely affect managed care. Although the provisions of any legislation
adopted at the state or federal level cannot be accurately predicted at this
time, management of the Company believes that the ultimate outcome of currently
proposed legislation would not have a material adverse effect on the Company and
its results of operations in the short run.
As a result of the introduction of Medicare and Medicaid risk products
in 1995, the Company is subject to regulatory and legislative changes in those
two government programs. On August 5, 1997, the President signed into law the
Balanced Budget Act of 1997. This law made revisions to the Medicare program,
including permitting provider-sponsored organizations to offer services to
Medicare beneficiaries, and requiring managed care plans serving Medicare
beneficiaries to make medically necessary care available 24 hours a day, to
provide coverage a "prudent lay person" would deem necessary and to provide
grievance and appeal procedures, and prohibiting such plans from restricting
providers' advice concerning medical care. The Company does not believe this
legislation will have a material adverse effect on its operations.
RISK FACTORS
The Company's business is subject to numerous risks and uncertainties
which may affect the Company's results of operations in the future and may cause
such future results of operations to differ materially and adversely from
projections included in or underlying any forward-looking statements made by or
on behalf of the Company. See "Business-Risk Factors" contained in Item
14
<PAGE> 17
1 of the Company's Annual Report on Form 10-K/A for the year ended December 31,
1996, which is incorporated herein by reference.
Item 3: Not Applicable
15
<PAGE> 18
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
In the normal course of business, the Company has been named as
defendant in various legal actions seeking payments for claims denied by the
Company, medical malpractice and other monetary damages. The Company also has
contingent litigation risks with certain discontinued operations. The claims are
in various stages of proceedings and some may ultimately be brought to trial.
Incidents occurring through September 30, 1997 may result in the assertion of
additional claims. With respect to medical malpractice, the Company carries
professional malpractice and general liability insurance for each of its
operations on a claims made basis with varying deductibles for which the Company
maintains reserves. In the opinion of management, the outcome of any of these
actions will not have a material adverse effect on the financial position or
results of operations of the Company.
Items 2, 3, 4 and 5: Not Applicable
Item 6: Exhibits and Reports on Form 8-K.
(27) Financial data schedule (for SEC use only).
16
<PAGE> 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVENTRY CORPORATION
(Registrant)
Date: November 14, 1997 By: /s/ Allen F. Wise
-------------------- -------------------------------------
Allen F. Wise
President and Chief Executive
Officer
Date: November 14, 1997 By: /s/ Dale B. Wolf
-------------------- -------------------------------------
Senior Vice President and
Chief Financial Officer
17
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<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 141,236
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