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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K/A
AMENDMENT NO. 4
to
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED,
EFFECTIVE OCTOBER 7, 1996]
For the Fiscal Year Ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-19147
Coventry Corporation
(Exact name of registrant as specified in its charter)
Tennessee 62-1297579
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
53 Century Boulevard, Suite 250
Nashville, Tennessee 37214
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (615) 391-2440
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the registrant's voting Common Stock
held by non-affiliates of the registrant as of March 14, 1997 (computed by
reference to the closing price of such stock on The Nasdaq Stock Market) was
$375,543,737.
As of March 14, 1997, there were 33,014,834 shares of the registrant's
voting Common Stock outstanding.
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COVENTRY CORPORATION
FORM 10-K/A
TABLE OF CONTENTS
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PART I Page
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Item 1: Business 1
Item 2: Description of Property 9
Item 3: Legal Proceedings 10
Item 4: Submission of Matters to a Vote of Security Holders 10
PART II
Item 5: Market for Registrant's Common Equity and Related Stockholder Matters 11
Item 6: Selected Consolidated Financial Data 12
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 8: Financial Statements and Supplementary Data 24
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 45
PART III Omitted
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 47
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PART I
ITEM 1: Business
(a) General Development of the Business
Coventry Corporation ("the Company") is a managed health care company
that provides comprehensive health benefits and services to 894,076 members in
Pennsylvania, Ohio, West Virginia, Missouri, Illinois, Virginia and Florida at
December 31, 1996. Health care services are provided to employer groups and
government funded groups through a variety of full-risk health care plans,
including health maintenance organization and preferred provider organization
products. Additionally, the Company administers self-insured health plans of
certain large employers. The Company's enrollment increased to 901,891 in
January 1997.
The Company was incorporated in 1986 in Delaware. Its principal
executive offices are located at 53 Century Boulevard, Suite 250, Nashville,
Tennessee 37214, and its telephone number is (615) 391-2440. Unless the
context indicates otherwise, references herein to "Coventry" and "the Company"
include Coventry Corporation and its subsidiaries.
(b) Financial Information about Industry Segments
The Company operates only in the managed care industry, and
accordingly, industry segment data is not applicable.
(c) Narrative Description of Business
Products
Commercial Health Maintenance Organizations
The Company's health maintenance organization ("HMO") products provide
comprehensive health care benefits to enrollees, including ambulatory and
inpatient physician services, hospitalization, pharmacy, dental, optical,
mental health, ancillary diagnostic and therapeutic services. In general, a
fixed monthly enrollment fee covers all HMO services, although some benefit
plans require co-payments or deductibles in addition to the basic enrollee
premium. A primary care physician assumes overall responsibility for the care
of an enrollee, including preventive and routine medical care and referrals to
specialists and consulting physicians. While an HMO enrollee's choice of
providers is limited to those within the health plan's HMO network, the HMO
enrollee is typically entitled to coverage of a broader range of healthcare
services than are covered by typical reimbursement or indemnity policies. At
December 31, 1996, the Company had approximately 416,000 commercial HMO
members.
The Pennsylvania Health Plans have licensed HMO service areas in
Pittsburgh and eight surrounding counties in western Pennsylvania, 21 counties
in central Pennsylvania, including the cities of Harrisburg, York, Lancaster,
State College, Lebanon and Scranton and five counties in eastern Ohio. Through
Coventry Health Plan of West Virginia, the Company serves Wheeling and 14
counties in West Virginia. The St. Louis Health Plan's service area includes
St. Louis and 23 adjacent counties in Missouri and 23 counties in central and
southern Illinois. The Richmond Health Plan services Richmond, Roanoke and 38
counties in central and southwestern Virginia. All of the commercial HMOs are
federally qualified.
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Preferred Provider Organizations and Point of Service
The Company, through its regional health plans, also offers
fully-insured flexible provider products, including preferred provider
organization ("PPO") and point of service ("POS") products, which permit
enrollees to participate in managed care but allow them to choose, at the time
services are required, to use providers not participating in the managed care
network. Deductibles and co-payments generally increase the out-of-pocket
costs to the enrollee if a non-participating provider is utilized. Fully
insured PPO/POS premiums are typically lower than HMO premiums due to these
increased out-of-pocket costs borne by enrollees. The Company's PPO and POS
products are underwritten by Coventry Health and Life Insurance Company
("CHLIC") a Texas insurance company. PPO/POS products are currently offered by
the western Pennsylvania, central Pennsylvania, St. Louis, and Richmond health
plans. At December 31, 1996, approximately 176,000 Coventry members were
enrolled in a flexible provider product.
Medicare
In late 1995, the Company introduced a Medicare risk product under the
name "Advantra" (R) in the St. Louis market. In 1996 the Company began
marketing this product in its western Pennsylvania and central Pennsylvania
markets.
Under a Medicare risk contract, the Company receives a fixed premium
per member, which reflects certain demographics of the Medicare population of
each region. At December 31, 1996, there were approximately 1.3 million
Medicare eligibles in the Company's current service areas. The Company
believes that the Medicare risk product represents substantial opportunity for
enrollment growth. However, the product also carries the risk of higher
utilization and related medical costs than commercial products, and the
possibility of regulatory or legislative changes which may reduce premiums or
increase mandated benefits in the future. The Company is also subject to
increased government regulation and reporting requirements related to the
product.
The Company also offers Medicare cost and supplement products. Under
a Medicare cost contract, the Company is reimbursed by the U.S. Health Care
Finance Administration ("HCFA") only for the cost of services rendered to
the plan members, including services provided at the health plan's medical
offices and a portion of administrative expenses. HCFA periodically audits the
cost of services and, as a result, the Company is at risk for less than full
reimbursement. Medicare supplement members enroll individually and pay a
monthly premium for comprehensive health services not covered under Medicare.
A majority of the Company's former Medicare cost and supplement members
converted to the Company's Advantra product during 1996. At December 31, 1996
the Company had approximately 28,000 Medicare members, including both risk and
cost based members.
Medicaid
The Company offers health care coverage to Medicaid recipients in the
north Florida, St. Louis and central Missouri, Richmond, Virginia,
Pittsburgh and central Pennsylvania markets. The Company's Medicaid products in
each region are generally similar to, and based upon, the products offered by
its HealthCare USA, Inc. ("HCUSA") subsidiary in Jacksonville, Florida, and
HCUSA generally administers the Company's Medicaid products in each of the
other regions. Medicaid recipients in north Florida, St. Louis and central
Missouri markets are generally required to choose a managed care provider. In
Pittsburgh, central Pennsylvania and Richmond, Virginia, enrollment in a
Medicaid HMO is voluntary. Under a Medicaid risk contract, the participating
state pays a monthly premium based on the age and sex of the recipients
enrolled in the Company's plans.
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Like the Medicare risk product, the Medicaid product makes the
Company's financial results more susceptible to government regulation and
legislative changes in premium levels and benefit structure. Under current
regulations, HMOs offering Medicaid products on a mandatory enrollment basis
must, within certain time frames, broaden their membership to include at least
25% commercial HMO members. The Company's Florida HMO has not achieved this
required percentage of commercial membership in Florida, but has received a
waiver of this requirement through June, 1998. Premium rates paid to the
Company's Medicaid operations in Florida were significantly reduced in 1995,
and future funding levels cannot be predicted with certainty. As a result of
premium rate reductions and the commercial membership requirements, the Company
has determined that its Florida Medicaid operations are not sufficiently
profitable on a long-term basis to justify a continued presence in the Florida
market and, as a result, the Company has decided to exit the Florida Medicaid
market. Accordingly, the Company has established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market. The
Company believes that its existing commercial membership in its St. Louis
Health Plan will satisfy the regulatory commercial membership requirements in
Missouri. At December 31, 1996, approximately 122,000 Coventry members were
enrolled in a Medicaid risk product, including approximately 28,000 in Florida,
77,000 in Missouri and 17,000 in other regions. See "Government Regulations."
Administrative Services Only
The Company's health plans offer an administrative services only
("ASO") product to large employers who self-insure their employee health
benefits. Under the ASO contracts, employers who fund their own health plans
receive the benefit of provider pricing arrangements from the health plan and
the health plan also provides a variety of administrative services such as
claims processing, utilization review and quality assurance for the employers.
The health plan receives an administrative fee for these services but does not
assume the health care cost underwriting risk. Certain of the Company's ASO
contracts include performance and utilization management standards which affect
the fees received for these services. Approximately 153,000 of the Company's
members were ASO members at December 31, 1996.
Delivery Systems
The health plans maintain provider networks which furnish health care
services through direct employment of or contractual arrangements with
physicians, hospitals and other health care providers, rather than providing
reimbursement to the enrollee for the charges of such providers. Because the
health plans receive the same amount of revenue from their enrollees
irrespective of the cost of health care services provided, they must manage
both the utilization of services and the unit cost of the services.
The Company's health plans' networks utilize a variety of physician
care delivery systems which differ primarily in the characterization of the
relationship between the Company and the participating physicians. The Company
utilizes staff models in western and central Pennsylvania and St. Louis,
Missouri to deliver primary care and certain specialist services through
physicians who are employed exclusively by the health plan. The exclusive
full-time employment of physicians in a staff model generally enables the
health plan to predict costs more effectively, maintain quality and respond
quickly to consumer issues. However, staff model operations also involves
substantial investment in certain costs, such as facilities and personnel, that
cannot be immediately adjusted to take into account changes in the membership
or third party provider pricing trends. During 1996, the Company initiated
efforts to reduce overhead in its staff models by reducing staff employment and
capitating certain specialist and ancillary functions. In addition to providing
health care to plan members, these staff models also accept non-member patients
on a fee-for-service basis, in an effort to help cover the costs associated
with the medical offices. The Company employed approximately 200 physicians at
December 31, 1996 in its staff model operations.
The Company's staff model operations, in recent years, have suffered
from over-capacity, and the Company has not been able to increase the number of
members or other patients utilizing such operations sufficiently to make such
operations profitable. As a result, the Company determined in late 1996 to
seek to dispose of the staff model operations in Pittsburgh, Pennsylvania and
St. Louis, Missouri. In March 1997, the Company entered into agreements to sell
its medical offices associated with its health plan in St. Louis, Missouri to
BJC Health Systems ("BJC"), a major provider organization in the St. Louis
market, and to sell its medical offices associated with its health plan in
Pittsburgh, Pennsylvania to Allegheny Health, Education and Research Foundation
("AHERF"), a major provider organization in the Pittsburgh market. The
agreements are subject to the satisfaction of various conditions, including
regulatory approval. After these sales, the Company's medical operations will
be limited to employing 22 physicians in eight offices in the central
Pennsylvania area.
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Coincident with the sale of the St. Louis and Pittsburgh medical
offices, the Company will enter into long-term global capitation arrangements
with BJC and AHERF, pursuant to which these provider organizations will receive
a fixed percentage of premiums to cover all the medical treatment the Company's
globally capitated members receive from the health care systems. These
arrangements are a continuation of the Company's efforts to enter into
capitation agreements with major providers whereby the providers will provide
all medical treatment for the Company's members in return for a fixed
percentage of premium. While these agreements limit the Company's exposure to
the risk of increasing medical costs, they expose the Company to risk as to the
adequacy of the financial and medical care resources of the provider
organization.
All of the Company's health plans also offer an open panel delivery
system. In an open panel structure, individual physicians or physician groups
contract with the health plans to provide services to enrollees but also
maintain independent practices in which they provide services to individuals
who are not Coventry health plan enrollees. The Company contracts with
approximately 18,000 physicians through the open panel model. Additionally,
the Company is aware that entering into global capitation contracts with
certain providers may cause disruption in its existing provider network.
Health Care Provider Compensation
The primary care physicians employed within the staff model
operations are compensated under salary and bonus arrangements. Under
most open panel contracts, each primary care physician is paid a monthly fixed
capitation fee for each enrollee selecting the physician and may receive
additional compensation from risk-sharing arrangements with the health plan to
the extent that pre-established utilization and quality goals are achieved.
Contracting specialist physicians are compensated under both discounted
fee-for-service arrangements and capitation arrangements. The majority of the
Company's contracts with hospitals provide for inpatient per diem or per case
hospital rates, while outpatient services are typically contracted on a
discounted fee-for-service basis. During 1996, the Company converted many of
its hospital and ancillary contracts from discounted fee-for-service to fixed
fee schedules or capitation arrangements.
Quality Assurance
The Company has established systems to monitor the availability,
appropriateness and effectiveness of the patient care it provides. Monitoring
the number of physicians and support personnel needed for the number of
enrollees served assists in maintaining the availability of care at appropriate
levels. Utilization data collected and disseminated in the context of
controlling costs are also a valuable indicator of over or under utilization of
necessary services and helps the Company's health plans provide optimal care to
their enrollees.
The Company's health plans also have internal quality assurance review
committees made up of physicians and other staff members whose responsibilities
include periodic review of medical records, development and implementation of
standards of care based on current medical literature and the collection of
data relating to results of treatment. Studies are regularly conducted to
discover possible adverse medical outcomes for both quality and risk management
purposes.
Appointment availability, member waiting times and environments are
monitored. A membership services department is responsible for ensuring
enrollee satisfaction, and the Company's health plans periodically conduct
membership surveys of both existing and former enrollees concerning services
furnished and suggestions for improvement.
The National Committee for Quality Assurance ("NCQA") is an
independent, nonprofit institution that evaluates and accredits the quality
assurance programs of managed care organizations and is recognized as the
national authority on quality. Both the Pennsylvania plans have earned full
accreditation. The Richmond and St. Louis plans received provisional
accreditation in 1995 and 1996, respectively.
In 1996, HCUSA met or exceeded all state standards in a Florida
Medicaid Contract compliance review conducted by the Florida Agency for
Healthcare Administration of 21 Medicaid HMOs. The Plan scored 100%, the
highest rating received, on the quality of care standards specified in its 1996
Medicaid contract and a 98% overall rating. See "Medicaid" and "Government
Regulation."
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Utilization Management and Review
A managed care company's profitability is dependent on maintaining
effective controls over utilization of health care services consistent with the
provision of high quality care. Each of the Company's health plans employs
physicians as Medical Directors who oversee the delivery of medical services
with respect to staff model and open panel operations. The Medical Director
supervises medical managers (physicians and nurses) who review and approve the
primary care physicians' referrals to specialists and hospitals. Medical
managers also continually review the status of hospitalized patients and
compare their medical progress with established clinical criteria. In
addition, nurses make hospital rounds to review patients' medical progress and
perform quality assurance and utilization functions.
Medical managers also monitor the utilization of diagnostic services
and encourage use of outpatient surgery and testing where appropriate. Data
showing each physician's utilization profile for diagnostic tests, specialty
referrals and hospitalization are collected by each health plan and provided to
the health plan's physicians. These results are monitored by medical managers
in an attempt to ensure the use of cost-effective, medically appropriate
services.
Marketing
The Company's commercial health plans are marketed primarily to
employer groups as alternatives to conventional fee-for-service health care and
indemnity health insurance programs. Employers generally pay all or part of
their employees' health care premiums, and many continue to offer their
employees a conventional insurance plan even if one or more of the Company's
products are offered.
Commercial marketing is generally a two-step process in which
presentations are made first to employers and then directly to employees. Once
selected by an employer, the Company solicits enrollees from the employee base
directly. During periodic "open enrollments", in which employees are permitted
to change health care programs, the Company uses direct mail, worksite
presentations, and radio and television advertisements to contact new
enrollees. The Company also markets through independent insurance brokers and
agents. Virtually all of the Company's employer group contracts are renewable
annually, and enrollment is continuously affected by employee turnover within
employer groups.
The Company's Medicaid products are marketed directly to individuals
while its Medicare products are marketed to both individuals, and, primarily in
the Pittsburgh market, employer group retirees. Individual marketing to
Medicare beneficiaries is conducted through use of a direct sales force and
advertising efforts that include television, radio, newspaper, billboards, and
direct mail. The Company also markets through independent insurance brokers and
agents. The Company's Medicaid and Medicare contracts are renewable annually,
and Medicare and Medicaid enrollees may disenroll monthly.
Each of the Company's health plans employs a full-time marketing
staff, totaling approximately 200 for the entire company. Each marketing
staff uses advertising and promotional material prepared by advertising firms
as well as market research programs.
No single employer group accounted for 10% or more of the Company's
consolidated revenues in 1996. As of December 31, 1996, the employer groups
which accounted for the ten highest amounts of managed care premiums for the
western and central Pennsylvania, St. Louis and Richmond health plans
represented approximately 26%, 28%, 28% and 62%, respectively, of each health
plan's premiums. HCUSA received approximately $32.0 million or 27% of its
revenue from the State of Florida and approximately $85.7 million or 73% from
the State of Missouri.
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Competition
As of December 31, 1996, the Company estimates that its share of the
commercial HMO market was approximately 50% in western Pennsylvania, 30% in
central Pennsylvania, 26% in St. Louis, and 24% in Richmond.
The Company's health plans operate in highly competitive environments
and compete with other HMOs, PPOs, indemnity insurance carriers and, most
recently, physician-hospital organizations. During 1996 the Company continued
to experience competitive pressures in its commercial products, most notably in
the Pennsylvania and Missouri markets, which adversely affected the premiums
that the Company has historically received from new and existing members, the
membership growth opportunities, and the mix of products sold. In some cases,
employer groups have moved from the traditional commercial HMO plans toward the
lower premium flexible provider products.
The Company believes that the principal factors influencing an
employer group's decision to choose among health care options are the price of
the benefit plans offered, locations of the health care providers, their
reputation for quality care, financial stability, comprehensiveness of
coverage, and diversity of product offerings.
The Company also competes with other managed care organizations and
indemnity insurance carriers in seeking to obtain and retain favorable
contracts with hospitals and other providers of services to the Company's
health plans. While the Company believes that the relatively large membership
in its health plans places them in a favorable position in negotiating
contracts, some of its competitors represent an equal or greater number of
potential patients for such contracting providers and therefore may be in an
equal or more favorable position to negotiate provider contracts.
Government Regulation
The Company's commercial HMOs are qualified under the federal Health
Maintenance Organization Act of 1973, which was enacted to promote the
development of HMOs. Only HMOs that continue to meet federal criteria for
sound fiscal operation may retain their qualified status. In order to maintain
such qualification, HMOs are required to set enrollment fees, or premiums,
pursuant to a "community rating system", which permits rating by class and
group specific rating on a prospective basis. The system can place an HMO at a
disadvantage when competing with conventional insurers for the business of
large employers; at the same time, it does not permit an established customer
to demand rate reductions based upon its group's favorable medical experience.
The Company's HMOs are required to file periodic reports with, and are
subject to periodic review by state and federal licensing authorities that
regulate them. The HMOs are required by state law to meet certain minimum
capital and deposit and/or reserve requirements and may be restricted from
paying dividends under certain circumstances. They are also required to
provide their enrollees with certain basic services based substantially on a
fixed, prepaid fee basis. Even under community rating, however, an HMO may
vary the type of non-fixed benefits offered. The HMOs are required to have
quality assurance and education programs for their professionals and enrollees.
State laws further require that representatives of the HMOs' enrollees have a
voice in policy making.
In 1996, HCFA promulgated regulations ("physician incentive
regulations") enforcing Sections 4204(a) and 4731 of the Omnibus Budget
Reconciliation Act of 1990 ("OBRA 90"). OBRA 90 and the physician incentive
regulations prohibit HMOs with Medicare risk contracts from knowingly making
incentive payments to physicians as an inducement to reduce or limit medically
necessary services to Medicare beneficiaries. Under the physician incentive
regulations, HMOs must, among other things, disclose to HCFA their physician
compensation plan in such detail as to allow HCFA to determine compliance with
the regulations, and provide assurance that stop-loss insurance is in place, if
the HMO places a physician or physician group at "substantial financial risk"
for services provided to Medicare beneficiaries. These regulations took effect
beginning January 1997.
On August 20, 1996, President Clinton signed into law the "Health
Insurance Portability and Accountability Act of 1996," which took effect
beginning January 1997. This legislation requires guaranteed issuance and
renewability of certain health coverage for individuals and small groups,
limits preexisting condition exclusions and provides for a demonstration
project for medical savings accounts. In addition, more recent federal
legislation, which will become effective beginning January 1998, requires
health plans to provide parity for mental health benefits and at least 48 hours
inpatient coverage for mothers and their newborns.
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All of the Company's Medicare and Medicaid plans are subject to HCFA
and state regulations. HCFA and the appropriate state agencies have the right
to audit any health plan operating under a Medicare or Medicaid contract to
determine the plan's compliance with HCFA and state regulations and quality of
care being rendered to the plan's members. Because the Company has Medicare
and Medicaid products, it also must comply with requirements established by
peer review organizations ("PRO"s), which are organizations under contract with
HCFA to monitor the quality of health care received by Medicare and Medicaid
beneficiaries. PRO requirements relate to quality assurance and utilization
review procedures. In addition, cost reimbursement reports are required with
respect to Medicare cost contracts and are subject to audit and revision.
The anti-kickback provisions of the Medicare and Medicaid laws
prohibit the payment or receipt of any remuneration in return for the referral
of a patient, the charges for which are subject to reimbursement by Medicare or
Medicaid. The Department of Health and Human Services has adopted safe harbor
regulations whereby, (i) HMOs' waivers of Medicare and Medicaid beneficiaries'
obligation to pay cost-sharing amounts or to provide other incentives in order
to attract Medicare and Medicaid enrollees and (ii) discounts offered to
prepaid health plans by contracting providers are not deemed to be violations
of the anti-kickback provisions. The Company believes that the incentives
offered by its HMOs to Medicare and Medicaid beneficiaries and the discounts
its plans receive from contracting health care providers satisfy the
requirements of the safe harbor regulations and do not in any event violate the
anti-kickback provisions.
The Company is subject to both federal and state regulations regarding
services to be provided to Medicaid enrollees, payment for those services and
other aspects of the Medicaid program.
The Company contracts with the United States Office of Personnel
Management ("OPM") to provide managed health care services under the Federal
Employees Health Benefits Program ("FEHBP"). These contracts with OPM and
applicable government regulations establish premium rating requirements for the
FEHBP. OPM conducts periodic audits of its contractors to, among other things,
verify that the premiums established under the OPM contracts are established in
compliance with the community rating and other requirements under FEHBP.
During 1996, managed care premiums were reduced by $1.7 million for the
settlement of OPM claims for 1995 and reserves for 1996 were established.
Numerous health care proposals have been introduced in the U.S.
Congress and in state legislatures. These include provisions which place
limitations on premium levels, increase minimum capital and reserves and other
financial viability requirements, prohibit or limit capitated arrangements or
provider financial incentives, mandate benefits (including mandatory length of
stay with surgery or emergency room coverage), limit the ability to manage care
and require contracting with all willing providers. If enacted, certain of
these proposals could have an adverse effect on the Company. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Health Care Reform" in Part II of this Report.
Risk Management
The HMOs maintain general liability and professional liability
(medical malpractice and managed care liability) insurance coverage in amounts
the Company believes to be adequate. Contracting physicians are also required
to maintain professional liability coverage. In addition to liability
coverage, the Company carries "stop-loss" insurance to reimburse its HMOs for
costs resulting from catastrophic illnesses. This insurance generally covers
costs in excess of $500,000 up to $1 million for any enrollee in any one year
for the St. Louis, Pennsylvania and Richmond Health Plans for commercial HMO
members, costs in excess of $150,000 up to $1 million for any Medicare enrollee
in any one year and costs in excess of $50,000 up to $1 million for any
Medicaid enrollee in any year. Some coinsurance contributions by the Company
are required. CHLIC maintains stop-loss insurance for the flexible provider
products that generally covers costs in excess of $150,000 for any enrollee in
any one year up to $1 million per enrollee per year. No assurance can be given
as to the future availability or costs of such insurance or that risks will not
exceed the limit of the insurance coverage.
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Employees
At December 31, 1996, the Company employed approximately 3,200
persons. None of the employees are covered by a collective bargaining
agreement.
Trademarks
The Company has the right to use the name "HealthAmerica" in Illinois,
Missouri, Pennsylvania and West Virginia. The Company has federal and/or state
registered service marks for "HealthAssurance," "GHP Access," "HealthCare USA,"
"Doc Bear," "CarePlus," "Coventry" and "Advantra."
Risk Factors
The Company's business is subject to numerous risks and uncertainties
which may affect the Company's results of operations in the future and may
cause such future results of operations to differ materially and adversely from
projections included in or underlying any forward-looking statements made by or
on behalf of the Company. Among the factors that may adversely affect the
Company's business are difficulties in increasing premiums to cover increasing
health care costs because of competitive pressures, regulatory restrictions and
consumer preference for lower-priced health care options. In addition, the
Company has exposure to risk pertaining to changes in delivery systems, pricing
arrangements and various ancillary and global capitation arrangements. The
Company may also experience difficulties in obtaining and maintaining favorable
contracts with health care providers and in predicting and controlling future
health care costs. Accordingly, there may be potential discrepancies between
reserves for incurred but not reported liabilities and the actual amount of
such liabilities. To the extent that the Company becomes a party to global
capitation agreements with a single provider organization, the Company becomes
exposed to credit risk with respect to such organization.
The nature of acquisitions gives rise to the possibility of incurred
but not reported medical costs and contingent liabilities that may be
undervalued at the time of acquisition. The Company may be required to write
off the cost of certain assets if the expected results of an acquisition are
not achieved. In selling assets, expected values may not be realized.
The Company's recent financial losses may make it more difficult to
obtain financing on as favorable terms in the future. In addition, operating
losses at a subsidiary may require the Company to make investments in, or to
refinance Company obligations to, such subsidiary in order to maintain required
capital levels.
The Company is also subject to risks associated with offering Medicaid
and Medicare risk products, including pricing and other regulatory
restrictions, potentially higher medical loss ratios and risks associated with
entering new markets. As discussed in "Government Regulation", the Company's
financial results are also susceptible to future state and federal regulatory
measures, including health care reform.
In addition, the health care industry in general is susceptible to
litigation and insurance risks, including medical malpractice liability,
disputes relating to the denial of coverage and the adequacy of "stop-loss"
reinsurance for costs resulting from catastrophic injuries or illnesses to the
Company's members. The Company has contingent litigation risk with certain
discontinued operations. Such litigation may result in losses to the Company.
This Annual Report on Form 10-K and other filings and statements made
on behalf of the Company include forward-looking information which is based on
current expectations at the time the filing or statement is made and is subject
to a number of risks and uncertainties. Forward-looking statements, which are
made in reliance on the safe harbor provided by the Private Securities
Litigation Reform Act of 1995, may be affected by a number of factors,
including the risk factors identified herein.
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Item 2: Description of Property
The Company leases in aggregate approximately 350,310 square feet of
office space primarily for administrative offices in western Pennsylvania,
central Pennsylvania, St. Louis, Missouri, Jacksonville, Florida and its
corporate office in Nashville, Tennessee. In addition, the Company has 33
medical centers, of which 28 are leased for terms of one to fifteen years and
summarized as follows:
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Number of Leased Medical Approximate Leased Square
Location Center Sites Footage
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Western Pennsylvania 11 179,181
Central Pennsylvania 8 43,230
St. Louis 9 108,884
Richmond - -
Jacksonville - -
------------------------ -------------------------
Total 28 331,295
======================== =========================
</TABLE>
The Company owns three medical centers in western Pennsylvania, two in
St. Louis and an administrative building in Richmond. Combined, these
properties have approximately 175,454 square feet.
The medical office sites in western Pennsylvania and St. Louis,
Missouri are included in the agreements to sell certain medical offices. See
"Delivery Systems."
In 1997, the Company plans to enter into a new lease agreement for the
administrative offices located in Harrisburg, Pennsylvania. Renovations of
other administrative offices will be completed as necessary.
9
<PAGE> 12
Item 3: Legal Proceedings
In the normal course of business, the Company has been named as
defendant in various other legal actions seeking payments for claims denied by
the Company, medical malpractice, and other monetary damages. The claims are
in various stages of proceedings and some may ultimately be brought to trial.
Incidents occurring through December 31, 1996 may result in the assertion of
additional claims. With respect to medical malpractice, the Company carries
professional malpractice and general liability insurance for each of its
operations on a claims made basis with varying deductibles for which the
Company maintains reserves. In the opinion of management, the outcome of any
of these actions will not have a material adverse effect on the financial
position or results of operations of the Company.
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year 1996.
10
<PAGE> 13
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder
Matters
Price Range of Common Stock
Coventry Corporation common stock is traded in the Nasdaq Stock
Market's National Market under the symbol "CVTY." The following tables show
the quarterly range of high and low closing sales prices of the common stock on
Nasdaq during the calendar period indicated:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------------------------
High Low High Low
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
First Quarter $20 7/8 $15 11/16 $30 $23 3/4
Second Quarter $20 15/16 $15 1/4 $29 1/2 $13 1/2
Third Quarter $15 5/8 $11 15/16 $21 1/4 $14 1/4
Fourth Quarter $11 1/2 $9 $22 1/8 $17 5/8
</TABLE>
<TABLE>
<CAPTION>
1997
- -------------------------------------------------------------
High Low
- -------------------------------------------------------------
<S> <C> <C>
Through March 14, 1997 $11 3/8 $6 7/8
</TABLE>
As of March 24, 1997, the Company had approximately 12,000
shareholders, including persons or entities holding common stock in nominee
name, and 583 shareholders of record.
Dividends
The Company has not paid any cash dividends on its common stock and
expects for the foreseeable future to retain all of its earnings to finance the
development of its business. The Company's ability to pay dividends is also
restricted by insurance regulations applicable to its subsidiaries and by the
terms of its credit facility. Subject to the terms of such insurance
regulations and the Company's credit facility, any future decision as to the
payment of dividends will be at the discretion of the Company's Board of
Directors and will depend on the Company's earnings, financial position,
capital requirements and other relevant factors. See Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" and Note G of the Notes to
Consolidated Financial Statements.
11
<PAGE> 14
Item 6: Selected Consolidated Financial Data
(in thousands, except per share data)
Operations Statement Data (1)
<TABLE>
<CAPTION>
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating revenues $1,057,129 $ 852,390 $ 776,643 $ 641,573 $ 475,454
- ---------------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss) $ (91,346) $ (1,275) $ 55,023 $ 43,177 $ 27,913
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from continuing
operations (2) $ (61,287) $ 18 $ 29,288 $ 22,005 $ 14,171
Loss on disposal of discontinued operations - - - - (3,846)
Extraordinary items - - - - 4,005
- ---------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (61,287) $ 18 $ 29,288 $ 22,005 $ 14,330
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share (3):
Continuing operations $ (1.86) $ 0.00 $ 0.93 $ 0.74 $ 0.51
Discontinued operations - - - - (0.14)
Extraordinary items - - - - 0.15
- ---------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) per share $ (1.86) $ 0.00 $ 0.93 $ 0.74 $ 0.52
- ---------------------------------------------------------------------------------------------------------------------------------
Weighted average common and common equivalent
shares outstanding (3) 33,011 32,164 31,425 29,585 27,547
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Balance Sheet Data (1)
December 31,
- ---------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash and investments (4) $ 173,396 $ 147,777 $ 133,975 $ 116,014 $ 65,488
Total assets $ 448,945 $ 385,675 $ 343,771 $ 266,971 $ 207,836
Notes payable and long-term debt (including
current maturities) $ 93,759 $ 67,907 $ 69,531 $ 44,185 $ 52,541
Stockholders' equity and partners' capital (5) $ 100,427 $ 153,851 $ 134,124 $ 96,906 $ 69,679
</TABLE>
(1) All periods presented have been restated for the merger with HCUSA in
1995, Southern Health Management Corporation ("SHMC") in 1994 and for
discontinued operations.
(2) Interest expense on all outstanding debt for all periods has been
attributed to continuing operations.
(3) Reflects the two-for-one split of the Company's common stock which
occurred in August, 1994.
(4) Certain reclassifications have been made to the 1994 and 1995
financial statements to conform to the 1996 presentation.
(5) Predecessor company of SHMC was an S Corporation.
12
<PAGE> 15
Supplementary Financial Information
The following is a summary of unaudited quarterly results of
operations (in thousands, except per share data) for the years ended December
31, 1996 and 1995.
<TABLE>
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1996(1) 1996(2) 1996 1996(3)
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $ 236,937 $ 257,737 $ 272,903 $ 289,552
Operating earnings (loss) $ (2,772) $ (14,346) $ 143 $ (74,371)
Net earnings (loss) $ (968) $ (8,528) $ 348 $ (52,139)
Net earnings (loss) per common and
common equivalent share $ (0.03) $ (0.26) $ 0.01 $ (1.58)
---------------------------------------------------------------
Weighted average common and common
equivalent shares outstanding 32,854 33,041 33,021 33,024
---------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1995 1995(4) 1995(5) 1995(6)
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $ 209,652 $ 208,868 $ 211,137 $ 222,733
Operating earnings (loss) $ 16,253 $ 4,764 $ 1,118 $ (23,410)
Net earnings (loss) $ 9,870 $ 2,177 $ 1,494 $ (13,523)
Net earnings (loss) per common and
common equivalent share $ 0.30 $ 0.07 $ 0.05 $ (0.42)
--------------------------------------------------------------
Weighted average common and common
equivalent shares outstanding 32,402 32,157 31,952 32,416
--------------------------------------------------------------
</TABLE>
(1) The first quarter operating results were affected by termination and
related costs to streamline the Company's administrative process and
reduce staffing in health centers, primarily in the Pennsylvania and St.
Louis plans, for total adjustments of $5.2 million.
(2) The second quarter operating results were affected by the establishment of
reserves relating to multi-year contracts with certain employer groups,
primarily in the St. Louis market. The Company expects to utilize these
reserves over the remaining lives of the contracts and then either
discontinue the contracts or significantly change the terms and conditions
of the contracts with these parties. The establishment of these reserves
resulted in total adjustments of $8.2 million.
(3) The fourth quarter operating results were affected by the increase of
reserves related to accounts receivable ($3.6 million), long-term
contracts ($1.6 million), medical claims ($25.6 million), termination costs
($2.1 million), write-offs of goodwill ($21.0 million), certain
capitalized expenses ($6.7 million) and other premium and sales tax,
advertising, legal and other expenses ($6.0 million).
(4) The second quarter operating results of 1995 were affected by merger costs
for the purchase of HCUSA ($2.3 million), severance and related costs
associated with staff restructuring in Pittsburgh and St. Louis ($2.0
million), additions to accruals for professional liability litigation
($1.2 million) and the settlement of certain Office of Personnel Management
negotiations ($1.5 million).
(5) The third quarter operating results of 1995 were affected by an increase in
medical claims liabilities for the western Pennsylvania market and start
up expenses associated with Medicaid and Medicare product development and
geographic expansion initiatives for total adjustments of approximately
$6.5 million.
(6) The fourth quarter operating results of 1995 were affected by the
elimination of several of its new market development areas ($5.1 million),
personnel reductions in its operations ($1.3 million), increases in legal
reserves ($1.5 million), medical and contingency reserves ($13.9 million)
for total adjustments of $21.8 million.
13
<PAGE> 16
Item 7: Management's Discussion and Analysis of Financial Condition and
Results of Operations
Coventry Corporation, headquartered in Nashville, Tennessee, is a managed
health care company that provides comprehensive health benefits and services to
a broad cross section of employer and government-funded groups in Pennsylvania,
Ohio, West Virginia, Missouri, Illinois, Virginia and Florida.
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking information which is based upon current
expectations and involves a number of risks and uncertainties. The forward-
looking statements, which are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995, may be affected by a
number of factors, including the risk factors set forth in the Company's Annual
Report on Form 10-K, and consequently, actual operations and results may differ
materially from those expressed in these forward-looking statements. Among the
factors that may materially affect the Company's business are potential
increases in medical costs, difficulties in increasing premiums due to
competitive pressures, imposition of regulatory restrictions, difficulties in
obtaining or maintaining favorable contracts with healthcare providers, credit
risks on certain global capitation arrangements, financing costs and
contingencies and litigation risk.
During the three year period ended December 31, 1996, the Company
experienced substantial growth in operating revenues due primarily to
membership growth. The Company achieved this membership growth through
marketing efforts, acquisitions, geographic expansion and increased product
offerings, including the introduction of Medicare and Medicaid risk products in
1995.
The acquisition of HealthCare USA in 1995 allowed the Company to enter the
Medicaid product market. Through HealthCare USA, the Company obtained a
presence in the Florida Medicaid market and entered the St. Louis and central
Missouri Medicaid markets during 1995, and continued to grow enrollment
throughout 1996. At December 31, 1996, approximately 120,000 Coventry members
were enrolled in a Medicaid risk product.
The Company began marketing its Medicare risk product in the St. Louis,
Missouri market in late 1995, and began marketing that product in the western
and central Pennsylvania markets in 1996. At December 31, 1996, the Company
had approximately 27,000 Medicare members, including both risk and cost based
members.
The Company's managed care premium revenues during the three year period
ended December 31, 1996 were comprised primarily of commercial premiums from
its HMO products and flexible provider products, including PPO and POS products
for which the Company assumes full underwriting risk. Fully insured PPO/POS
premiums are typically lower than HMO premiums due to the medical underwriting
and the deductibles and copayments required from the PPO/POS members.
Additional revenue is earned for other medical services provided on a
fee-for-service basis in Company-operated medical offices.
Premium rates for commercial HMO products are reviewed by various state
agencies based on rate filings. While the Company has not had such filings
modified, no assurance can be given that approvals for rate submissions will
continue. Premium rates for the Medicaid and Medicare risk products are
established by governmental regulatory agencies and may be reduced by
regulatory action. No assurance can be given that premium rates will not
decrease in the future.
The Company's management services revenues result from operations in which
the Company's health plans provide administrative and other services to
self-insured employers. The Company receives an administrative fee for these
services, but does not assume underwriting risk. A portion of these revenues,
however, are dependent upon the Company meeting specific performance criteria.
14
<PAGE> 17
The Company's operating expenses are primarily medical costs including
medical claims under contracted relationships with a wide variety of providers,
capitation payments and expenses relating to the operation of the Company's
health centers. Medical claims expense also includes an estimate of claims
incurred but not reported ("IBNR"). The Company believes that the estimates for
IBNR liabilities relating to its businesses are adequate in order to satisfy
its ultimate claims liability with respect thereto. 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 judgements are then made as to the necessity for reserves in
addition to the above calculated amounts. At the end of each year, and
occasionally within the fiscal year, the reserves are also reviewed by
actuarial consultants. Changes in assumptions for medical costs caused by
changes in actual experience, changes in the delivery system, changes
in pricing due to ancillary capitation and fluctuations in the claims backlog
could cause these estimates to change in the near term. The Company
periodically monitors and reviews IBNR, and as actual settlements are made or
accruals adjusted, differences are reflected in current operations.
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards Number 121 ("SFAS 121"), "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" and Statement of
Financial Accounting Standards Number 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation." The adoption of provisions of SFAS 121 and SFAS 123
had no material effect on the financial position or results of operations of
the Company.
The following discussion should be read in conjunction with the
accompanying consolidated financial statements and notes.
Results of Operations
The following table (in thousands, except percentages and membership data)
is provided to facilitate a more meaningful discussion regarding the results of
the Company's operations for the three years ended December 31, 1996.
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------- -------------------------------- -------------------
Percent Percent Percent
of Percent of Percent of
Operating Increase Operating Increase Operating
Amount Revenues (Decrease) Amount Revenues (Decrease) Amount Revenues
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums $1,035,778 98.00 % 22.7% $844,032 99.0 % 9.6 % $769,935 99.1 %
Management services 21,351 2.00 % 155.5% 8,358 1.0 % 24.6 % 6,708 0.9 %
- ----------------------------------------------------------------------------------------------------------------------------------
Total operating revenues 1,057,129 100.00 % 24.0% 852,390 100.0 % 9.8 % 776,643 100.0 %
- ----------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Health benefits (1) 930,739 88.00 % 30.5% 713,226 83.6 % 16.1 % 614,144 79.1 %
Selling, general and administrative 165,081 15.60 % 33.6% 123,523 14.5 % 30.5 % 94,684 12.2 %
Depreciation and amortization 42,862 4.10 % 192.3% 14,666 1.7 % 55.4 % 9,437 1.2 %
Other charges 9,793 0.90 % --
Merger costs 2,250 0.3 % (32.9)% 3,355 0.4 %
- ----------------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss) (91,346) (8.60)% NM (1,275) (0.1)% (102.3)% 55,023 7.1 %
Other income, net 13,379 1.20 % 73.6% 7,705 0.9 % 54.0 % 5,003 0.6 %
Interest expense (6,257) (0.60)% 28.2% (4,881) (0.6)% 78.7 % (2,731) (0.4)%
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before
income taxes and
minority interest (84,224) (8.00)% NM 1,549 0.2 % (97.3)% 57,295 7.4 %
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (61,287) $ 18 $ 29,288
==================================================================================================================================
Membership at December 31:
Commercial 592,001 510,815 468,743
Medicare (2) 27,507 18,890 19,068
Medicaid 121,599 73,550 26,143
Management services 152,969 92,232 67,003
- ----------------------------------------------------------------------------------------------------------------------------------
894,076 695,487 580,957
==================================================================================================================================
</TABLE>
(1) The medical loss ratio (health benefits as a percentage of managed care
premiums) was 89.9%, 84.5% and 79.8% in 1996, 1995 and 1994, respectively.
(2) Includes both full risk and cost-based members.
15
<PAGE> 18
Comparison of 1996 to 1995
Managed care premiums increased $191.7 million, or 22.7%, to $1,036 million
for the year ended 1996 compared to 1995. The increase was primarily
attributable to the 137,852 member, or 22.9%, increase in risk membership from
the prior year. Of this enrollment growth, 48,049 members, or 35%, were
related to the Medicaid product and 81,186 members or 59%, were commercial
members. The effect on revenues of the increased membership was partially
offset by changes in commercial membership mix, with an increased percentage of
that membership composed of the lower premium PPO and POS products compared to
the HMO products, and a 4.3% decline in average HMO premium yield. The decline
in average HMO premium yield of $5.57 on a per member per month basis equated
to a reduction in premiums of approximately $26.5 million in 1996 when compared
to 1995. Membership as of December 31, 1996 and 1995 was as follows:
<TABLE>
<CAPTION>
Commercial Medicare
HMO PPO/POS Cost Risk Medicaid Non-Risk Total
1996 -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Western PA 149,530 92,052 1,957 4,994 2,298 45,565 296,396
Central PA 115,780 44,704 466 365 11,836 71,900 245,051
St. Louis 92,895 39,579 4,794 14,931 76,829 24,574 253,602
Richmond 57,047 104 2,904 10,930 70,985
Jacksonville 310 27,732 28,042
-------------------------------------------------------------------------------------
Total 415,562 176,439 7,217 20,290 121,599 152,969 894,076
=====================================================================================
1995
Western PA 144,498 71,896 4,782 30,977 252,153
Central PA 102,772 17,154 443 38,391 158,760
St. Louis 87,973 28,726 13,234 431 47,388 11,895 189,647
Richmond 55,267 2,529 10,969 68,765
Jacksonville 26,162 26,162
-------------------------------------------------------------------------------------
Total 390,510 120,305 18,459 431 73,550 92,232 695,487
=====================================================================================
</TABLE>
The Company experienced competitive pressures in its commercial products,
which negatively affected the average premium the Company received and the mix
of commercial products sold during 1996. The Company anticipates continued
enrollment gains in 1997, although at a slower rate than seen in 1996.
Enrollment gains are expected to be lower than gains realized in prior years as
the Company focuses on profitability of current products and lines of business,
including efforts to increase the average premium yield. No assurances can be
given that increased yields are attainable. The Company believes that it may
lose certain of its existing commercial membership due to more stringent
underwriting practices and higher revenue requirements, but that the potential
loss in 1997 will be less than 5%.
Gains in Medicaid and Medicare enrollments increased the Company's exposure
to government regulation of premium levels and other requirements. The impact
of legislative or regulatory changes in the Medicaid and Medicare programs
could adversely affect enrollment, premiums and profitability of these
products.
Management services revenues increased approximately $13.0 million, or
155.5% from the prior year. The increase is attributable to the approximately
60,737 member increase in this product.
Health benefits expense increased $217.5 million, or 30.5%, in 1996
compared to 1995 as a result of the increase in full-risk enrollment and
increases in medical costs. As a result of the declining premium yields
discussed above and increases in medical costs, including the effects of a
decline in the proportion of risk membership utilizing staff medical facilities
in Pittsburgh, Pennsylvania and St. Louis, Missouri, the medical loss ratios
increased in all of the Company's markets as follows:
<TABLE>
<CAPTION>
1996 1995
----- -----
<S> <C> <C>
Western Pennsylvania 88.9% 87.3%
Central Pennsylvania 89.2% 80.0%
St. Louis 89.7% 86.2%
Richmond 87.6% 82.5%
Jacksonville 86.7% 80.0%
Total 89.9% 84.5%
</TABLE>
16
<PAGE> 19
Health benefits expense increased on a per member per month basis from 1995
in all markets. The increases in medical costs are attributable to increases
in the costs of inpatient services related to its Medicaid operations,
inpatient alternatives (such as outpatient surgery) and pharmacy.
Additionally, membership in the Company's western Pennsylvania medical office
operations, which declined during 1995 primarily as a result of the loss of two
significant accounts did not recover in 1996, continuing the excess capacity
problem for the medical office operations.
In March 1997, the Company entered into agreements to sell the Company's
medical offices in western Pennsylvania and St. Louis, Missouri to major
provider organizations in these respective markets for $27 million in cash for
the St. Louis medical offices and $20 million in cash for the Pittsburgh
offices. The agreements are subject to the satisfaction of various conditions,
including regulatory approval. Coincident with the sale of the medical
offices, the Company will enter into long-term global capitation arrangements
with the purchasers of the medical offices, pursuant to which the provider
organizations will receive a fixed percentage of premium to cover all of the
costs of medical treatment the Company's globally capitated members receive
from the health care systems. The Company anticipates these arrangements
in western Pennsylvania and St. Louis, Missouri will reduce its medical costs
as a percentage of premiums, enable the Company to reduce administrative staff
in patient utilization and medical management and effectively shift the risk of
medical costs fluctuations to the provider networks. To the extent that the
Company becomes a party to global capitation agreements with a single provider
organization serving substantial membership, the Company becomes exposed to
credit risk with respect to such organizations.
The Company has determined that its Florida Medicaid operations are
not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, the Company has decided to exit the Florida Medicaid
market. Accordingly, the Company has established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market.
Medical claim liability accruals are periodically monitored and reviewed
with differences for actual settlements reflected in current operations. In
addition to the Company's procedures for determining reserves as discussed on
page 15, the Company reviews the actual payout of claims relating to prior
period accruals, which may take up to six months to fully develop. Medical
costs are affected by a variety of factors, including the severity and
frequency of claims, that are difficult to predict and may not be entirely
within the Company's control. The Company continually refines its reserving
practices to incorporate new cost events and trends.
During 1996, the Company experienced certain fluctuations in claims backlogs
and changes in its underlying utilization and cost trends. At the end of each
quarter in 1996, the Company estimated the effects of these events in its
reserving methodologies and provided additional estimated expenses.
During the fourth quarter of 1996, the Company confirmed through claims
payment activity that the Company's costs had increased during 1996 at levels
slightly higher than estimated during the earlier quarters. These additional
costs were caused by both continued adverse utilization and cost severity
trends. As a result, the Company recorded additional provisions ($25.6
million) in the fourth quarter of 1996 to reflect additional expenses on prior
quarter claims ($4.3 million), to reflect additional expenses for current
quarter claims ($3.0 million) and to reflect increases in claims reserves in
order to provide reserves in excess of the actuarial determined midpoint
amounts. The Company decided to provide the additional reserves due to
possible unanticipated reserve needs, the growth of the Company's business and
the possible effects of changing provider contracting and reimbursement
methodologies. The Company expects to maintain the additional claim reserves
as a part of its ongoing reserve determinations.
Selling, general, and administrative expense ("SGA") increased $41.6
million, or 33.6%, from 1995. As a percentage of total operating revenues, SGA
increased from 14.5% in 1995 to 15.6% in 1996 due to increases in costs,
declines in commercial premiums and the items discussed below. The Company
decided to cease start-up development activities in certain markets in 1996.
As a result of narrowing the focus of new market development, certain
capitalized costs totaling $4.3 million were charged to SGA in 1996. During
1996, the Company also recorded approximately $8.1 million of charges related
to personnel terminations and related severance. These charges resulted from
administrative and medical office staff reductions due to excess capacity and
the outsourcing of certain ancillary services capabilities. Additionally,
due to an increase in the past due amounts of premium receivables provisions
for uncollectible accounts were increased by approximately $5.3 million during
the year. The additional expenses were incurred during each quarter of the
year as the past due amounts increased.
Depreciation and amortization increased $28.2 million, or 192.3%, from
1995. This increase was due primarily to the write-off of goodwill related to
the recently acquired PARTNERS Health Plan of Pennsylvania, Inc. of $20.1
million. In accordance with SFAS 121, the Company determined that the carrying
amounts of certain of its property and equipment (primarily data processing
equipment that will not be utilized in the future as a result of a change in
management information systems structure determined by the Company in the
fourth quarter) was not recoverable as of December 31, 1996. As a result,
approximately $4.3 million of property and equipment charge-offs were recorded
in the fourth quarter of 1996.
Other charges consisting of provisions for multi-year contracts of $9.8
million were recorded in 1996 to recognize anticipated losses on certain
multi-employer group contracts, primarily in the St. Louis market. The Company
expects to utilize these reserves over the remaining lives of the contracts and
then either discontinue these contracts or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at
varying dates through 1999 and cover approximately 30,000 members.
Operating earnings for the year 1996 decreased $90.1 million from 1995
operating earnings. The decrease is primarily attributable to the decline in
commercial yield, the increases in medical claims expense, the increase in
IBNR reserves, the asset write-downs and other charges noted above.
Other income, net increased $5.7 million, or 73.6%, from 1995. This
increase was primarily due to a $4.9 million gain on the sale of Champion
Dental Services, Inc. recorded in the fourth quarter of 1996.
17
<PAGE> 20
Interest expense increased $1.4 million in 1996 over the prior year
primarily due to a higher average outstanding debt balance for the year and an
increased interest rate on long-term debt. The majority of the approximately
$35 million purchase price of PARTNERS Health Plan of Pennsylvania, Inc. was
funded through borrowings on the Company's long-term credit agreement.
Provision for income taxes reflects a consolidated effective income tax
benefit rate of 27.1% for 1996 compared to a provision of 98.7% for 1995. The
increase in nondeductible goodwill amortization is the primary cause of the low
effective income tax benefit rate in 1996.
Loss for the year 1996 was $61.3 million. Loss per common and common
equivalent share was $1.86 in 1996 compared to $0.00 in the prior year. The
weighted average common and common equivalent shares outstanding increased to
33.0 million in 1996 compared to 32.2 million in 1995.
Comparison of 1995 to 1994
Managed care premiums increased $74.1 million, or 9.6%, to $844.0 million
for the year ended 1995 compared to 1994. The increase was primarily
attributable to the 89,301 members, or 17.4%, increase in risk membership from
the prior year. Of this enrollment growth, 47,047 members, or 53%, related to
the Medicaid product. The effect of the increased membership on revenues was
partially offset by changes in membership mix, with membership shifting from
HMO products to the PPO and POS products which have lower per member premiums.
During 1995, the Company introduced its Medicare risk product and expanded
the Medicaid product. The Company had limited experience with the Medicaid and
Medicare products, and as a result, with their underwriting, pricing, and
utilization patterns. Gains in Medicaid and Medicare enrollments increased the
Company's exposure to government regulation of premium levels and other
requirements. Premium rates paid to the Company's Medicaid operations in
Florida declined in the third quarter of 1995.
Furthermore, in 1995 the Company experienced competitive pressures in its
commercial products, which negatively affected the average premium that the
Company has historically received from new and existing members, the membership
growth opportunities and the mix of products sold. The average commercial
premium received by the Company declined in 1995 by 1.6%.
Management services revenues increased $1.7 million, or 24.6% from the
prior year. The increase is attributable to the approximately 25,200 members,
or 37.7%, increase in this product line. Approximately 10,600 of these new
non-risk members resulted from the acquisition of a Virginia third party
administrator in May 1995.
Health benefits expense increased $99.1 million, or 16.1%, in 1995 compared
to 1994 as a result of the increase in full-risk enrollment and increases in
medical costs. The medical loss ratios increased in all of the Company's
markets as follows:
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
Western Pennsylvania 87.3% 77.7%
Central Pennsylvania 80.0% 78.4%
St. Louis 86.2% 85.3%
Richmond 82.5% 80.6%
Jacksonville 80.0% 70.1%
Total 84.5% 79.8%
</TABLE>
18
<PAGE> 21
In the western Pennsylvania market, health benefits expense increased 15.5%
on a per member per month basis from 1994. The increase in medical costs in
the western Pennsylvania market was attributable to higher utilization of
inpatient alternatives and consultant services, and in general, each of the
markets experienced increases in the costs of inpatient services, inpatient
alternatives and consultant services relative to premium increases.
Additionally, membership in the western Pennsylvania's medical office
operations declined during 1995 primarily as a result of the loss of two
significant accounts. Because the operating costs of the medical offices were
not reduced, the loss of membership created excess capacity. The premium rate
reduction in the third quarter of 1995 in HealthCare USA's Jacksonville
Medicaid operations also contributed to the increase in the medical loss ratio.
Medical claim liability accruals are periodically monitored and reviewed
with differences for actual settlements reflected in current operations. In
addition to the Company's procedures for determining reserves as discussed on
page 15, the Company reviews the actual payout of claims relating to prior
period accruals, which may take up to six months to fully develop. Medical
costs are affected by a variety of factors, including the severity and
frequency of claims, that are difficult to predict and may not be entirely
within the Company's control. The Company continually refines its reserving
practices to incorporate new cost events and trends.
At the end of the second quarter of 1995, the Company identified adverse
trends that were occurring in western Pennsylvania in both the ultilization and
cost areas. The Company was also experiencing service delays in several of its
major plans, which created fluctations in its claim backlogs. The Company,
recognizing these factors as a part of its process, increased the medical
claims reserves from $66 million at December 1994 to $76 million at June 1995.
During the fourth quarter of 1995, the Company confirmed through claims payment
activity that the Company's costs had increased during 1995 at levels slightly
higher than estimated during the earlier quarters. These additional costs were
caused by both continued adverse utilization and costs severity trends.
As a result, the Company recorded additional provisions ($13.0 million) in the
fourth quarter of 1995 to reflect additional expenses on prior quarter claims
($2.5 million), to reflect additional expenses for current quarter claims ($4.0
million) and to reflect increases in claims reserves in order to provide
reserves in excess of the actuarial determined midpoint amounts. The Company
decided to provide the additional reserves due to possible unanticipated
reserve needs, the growth of the Company's business and the possible effects of
changing provider contracting and reimbursement methodologies.
Selling, general, and administrative expense increased $28.8 million, or
30.5%, from 1994. As a percentage of total operating revenues, SGA increased
from 12.2% in 1994 to 14.5% in 1995. During 1995, the Company recorded
approximately $3.0 million of charges related to personnel terminations and
related severance. In the fourth quarter of 1995, the Company decided to
narrow the focus of start-up development activities in 1996, while
concentrating development and growth efforts in existing and contiguous markets
and, as a result, previously capitalized costs incurred prior to and during
1995 of $5.1 million were expensed at year-end. Additionally, a reserve for
ongoing litigation and other contingencies of $2.2 million was established.
The increase in SGA represents primarily product introduction costs,
including additional personnel and systems support for government products
introduced in 1995. These costs also include other selling, general and
administrative costs associated with the geographic expansion of the western
Pennsylvania market to West Virginia and eastern Ohio and additional
administrative services capabilities.
Depreciation and amortization increased $5.2 million, or 55.4%, from 1994.
This increase was due primarily to the amortization of the goodwill resulting
from the purchase of the remaining 20% Penn Group Corporation minority interest
and increased depreciation expense corresponding to additions in net property
and equipment from 1994.
Merger costs of $2.3 million include all costs associated with the
HealthCare USA merger which was accounted for as a pooling of interests. The
1994 costs were associated with the acquisition of Southern Health Management
Corporation in Richmond, Virginia.
Operating earnings for the year 1995 decreased $56.3 million from 1994
operating earnings. The decrease is primarily attributable to the increase in
medical claims expense, SGA, and depreciation and amortization described above.
Other income, net, consists primarily of investment income and increased
$2.7 million, or 54%, from 1994. This increase was primarily due to the
increase in cash and investments during the year.
Interest expense increased $2.2 million in 1995 over the prior year due to
a higher average outstanding debt balance for the year. Effective October 31,
1994, the Company purchased the remaining 20% minority interest in Penn Group
Corporation for $50 million. The majority of the purchase price was funded
through borrowings on the credit facility.
19
<PAGE> 22
Provision for income taxes reflects a consolidated effective income tax
rate of 98.7% for 1995 compared to 42.6% for 1994. The increase was primarily
due to merger costs of $2.3 million, which are not deductible for tax purposes.
The ratio of these costs to pretax earnings was significantly higher in 1995
than in 1994.
Minority interest in earnings of consolidated subsidiary, net of income
taxes decreased $3.6 million in 1995 compared to 1994. The 1994 income
reflects ten months of the 20% minority interest in the Company's Pennsylvania
HMO which was held by a third party until its purchase in the fourth quarter of
1994. The 1995 minority interest amount reflects a minority shareholder's 30%
interest in Healthcare USA, LLC, the St. Louis-based Medicaid HMO.
Net earnings decreased $29.3 million, or 99.9%, for the year 1995 compared
to 1994. Earnings per common and common equivalent share was $0.00 compared to
$0.93 in the prior year. The weighted average common and common equivalent
shares outstanding increased to 32.2 million in 1995 compared to 31.4 million
in 1994.
Discontinued Operations
Effective January 1, 1995, the Company entered into an agreement with
United Insurance Companies, Inc. ("United"), whereby United assumption
reinsured a closed book of business comprised of traditional indemnity
insurance policies that were offered by the Company's insurance subsidiary
prior to 1993. United has managed these discontinued operations since December
1992. Under the terms of the agreement, United assumed substantially all of the
closed book of business claims, unearned premium reserves, and all other
statutory liabilities, except for certain litigation reserves that are retained
by the Company.
Litigation and Insurance
The Company may be subject to certain types of litigation, including
medical malpractice claims; claim disputes pertaining to contracts and other
arrangements with providers, employer groups and their employees and individual
members; and disputes relating to HMO denials of coverage for certain types of
medical procedures or treatments. In addition, the Company has contingent
litigation risk in connection with certain discontinued operations. Such
litigation may result in losses to the Company. The Company maintains
insurance coverage in amounts the Company believes to be adequate including
professional liability (medical malpractice) and general liability insurance.
Contracting physicians are required to maintain professional liability
insurance. In addition, the Company carries "stop-loss" reinsurance to
reimburse it for costs resulting from catastrophic injuries or illnesses to its
members. Nonetheless, no assurance can be given as to the future availability
or cost of such insurance and reinsurance or that litigation losses will not
exceed the limits of the insurance coverage and reserve. In the opinion of
management and based on the facts currently known, the outcome of these actions
will not have a material adverse effect on the financial position or results of
the operations of the Company.
New Accounting Standards
The Financial Accounting Standards Board has approved statements of
financial accounting standards effective for fiscal period ending after December
15, 1997, which establishes standards for computing and presenting earnings per
share and also establishes standards with respect to disclosure of information
about an entity's capital structure. The Company is required to adopt the
provisions in the fourth quarter of 1997 and does not expect the adoption
thereof to have a material effect on the Company's financial position or
results of operations.
20
<PAGE> 23
Inflation
Health care cost inflation has exceeded the general inflation rate and the
Company has implemented cost control measures and risk sharing arrangements
which seek to reduce the effect of health care cost inflation. During 1995 and
1996, the Company experienced downward pressure in premium rates, and as a
result has implemented further cost control measures to reduce both medical and
administrative expenses. An inability to successfully reduce expenses as a
percentage of premium adversely impacted the Company's results of operations in
1996.
Income Taxes
In its income tax returns, the Company is amortizing approximately $21
million of its intangible assets over periods ranging from three to eight
years. In the consolidated financial statements in the caption "Goodwill and
Intangible Assets" is an aggregate of $116.4 million of goodwill at December
31, 1996 which, for financial reporting purposes, is being amortized over
periods not exceeding 40 years. The different book and tax treatment arises
because the Company believes the methodologies and assumptions utilized in the
tax basis appraisal of these amounts are not appropriate for financial
reporting purposes. The Omnibus Reconciliation Act of 1993 ("OBRA") enacted
legislation, effective January 1, 1993, whereby all intangibles, including
goodwill, acquired in certain transactions can be amortized for income tax
purposes over 15 years. Although the provisions of the OBRA cannot be applied
to the $21 million of tax intangibles, the Company believes that the
legislation is indicative of the government's desire to minimize the costs of
intangibles controversies. The Company believes it will eventually sustain a
tax deduction for a substantial portion of the $21 million, but such a
deduction is likely to be determined on the basis of a compromise with the
government.
Pending a final determination of its tax position, the Company's income tax
provision has been adjusted to reflect no tax benefit in its financial
statements for the deduction of these amounts.
Quarterly Results of Operations
The quarterly consolidated results of operations of the Company are
summarized in Note T to Consolidated Financial Statements.
Liquidity and Capital Resources
The Company's total cash and investments, excluding restricted investments,
increased $25.6 million to $173.4 million as of December 31, 1996 compared to
$147.8 million at December 31, 1995. This increase is primarily attributable
to $37.3 million of cash provided by operating activities and $42.7 million of
cash from other activities including bank borrowings and net proceeds from the
issuance of common stock. The cash provided was offset by $54.4 million used
for capital expenditures, debt repayment and acquisitions. The Company invests
cash not needed to fund current liabilities primarily in liquid portfolios of
fixed income securities issued by the federal government and various states and
municipalities. Current assets plus these investments exceeded current
liabilities in 1996 by $19.7 million, compared to $49.1 million in 1995.
The Company's HMOs and insurance subsidiaries are required by state
regulatory agencies to maintain minimum surplus balances, thereby limiting the
dividends the Company may receive from its HMOs and insurance subsidiaries.
After giving effect to these statutory reserve requirements, the Company's
regulated subsidiaries had funds in excess of statutory requirements of
approximately $41.6 million and $43.0 million at December 31, 1996 and 1995,
respectively. Excluding funds subject to regulation, the Company had cash and
investments of approximately $16.5 million and $40.0 million in 1996 and 1995,
respectively, which are available to pay intercompany balances to regulated
companies and for general corporate purposes.
21
<PAGE> 24
In March 1997, the Company entered into a letter of intent to sell $40
million of Convertible Exchangeable Subordinated Notes (the "Convertible
Notes"), together with warrants to purchase 2.35 million shares of its common
stock to Warburg, Pincus Ventures, L.P. ("Warburg") for $42.35 million subject
to the negotiation of definitive documentation, the approval of state insurance
regulators in certain states and the approval of the lending banks under the
Company's credit facility. Proceeds from the sale are expected to be used to
repay outstanding indebtedness and provide working capital. The Convertible
Notes are expected to be convertible into 4 million shares of the Company's
common stock and will be exchangeable at the Company's option for shares of
convertible preferred stock, the authorization of which will require the
approval of the Company's shareholders at the 1997 shareholders' meeting.
Prior to June 30, 1996, the Company's long-term credit agreement (the
"Credit Facility") with a group of banks provided for borrowings up to $125
million. The Credit Facility called for scheduled semi-annual commitment
reductions of $20.83 million beginning February 18, 1997 with final reduction
of $20.85 million on August 18, 1999. As a result of losses in the second
quarter of 1996, the Company was not in compliance with certain financial
covenants in the Credit Facility as of June 30, 1996. Effective September 30,
1996 the Company reached an agreement ("Amended Credit Facility") with the bank
group amending the Credit Facility. Prior to the amendment, the Company
voluntarily reduced the availability under the Credit Facility to $100 million,
of which $90 million was outstanding at December 31, 1996. The Amended Credit
Facility, which revised certain financial ratios the Company was required to
maintain, increased the interest rate on the indebtedness by 0.8% and revised
the required reductions in availability. At December 31, 1996, the effective
interest rate on the indebtedness under the Amended Credit Facility was 7.56%.
As a result of continuing losses in the fourth quarter of 1996, the
Company was not in compliance with certain revised financial covenants in the
Amended Credit Facility and therefore was in default under the terms of the
Amended Credit Facility as of December 31, 1996. As a result, no further
borrowings under the Amended Credit Facility were available. Subsequent to
December 31, 1996, the Company entered into an amended and restated agreement
("Restated Credit Facility") with the bank group effective March 28, 1997 that,
along with other changes, converts the amount outstanding under the Restated
Credit Facility to a term loan, revises certain financial ratios the Company is
required to maintain, effectively increases the interest rate of the
indebtedness by 2.7% (to the greater of prime plus 2% or the federal funds rate
plus 2.5%) and revises the amortization period of the loan. The Restated Credit
Facility requires payments of $10 million on June 30, 1997, $7 million on
September 30, 1997, $18 million on December 31, 1997 and $55 million on April
1, 1998. The Restated Credit Facility eliminated the defaults that existed
under the Amended Credit Facility at December 31, 1996.
The amendment also requires the Company to apply 50% of the net cash
proceeds from the proposed Warburg, Pincus Ventures, L.P. transaction to the
loan balance, with the payment being applied to reduce 1997 and 1998
amortization payments. The Restated Credit Facility also requires the Company
to prepay loans upon receipt of an anticipated $9.5 million tax refund
resulting from the carryback of operating losses to prior years, with the
prepayment being applied to reduce the December 1997 amortization payment.
The Restated Credit Facility requires the Company to apply 50% of the net
cash proceeds of sales of the Company's capital stock to reduce the
scheduled amortization in the inverse order of maturity, prohibits the sale of
any substantial subsidiary and restricts the Company's ability to declare and
pay cash dividends on its common stock. Prior to the closing of the proposed
Warburg transaction, any event or condition which has or could reasonably be
expected to have a material adverse effect on the Company's business, financial
condition or results of operations will constitute an event of default under
the Restated Credit Facility. As of March 31, 1997, no such event or condition
has occurred.
The Restated Credit Facility contains covenants relating to investments in
non-admitted assets, operating margin, net worth levels and the creation or
assumption of debt or liens on the assets of the Company. The Restated Credit
Facility is collateralized by substantially all of the assets of the Company.
On March 31, 1997, the effective interest rate on the indebtedness under
the Restated Credit Facility was 10.5%.
22
<PAGE> 25
As of December 31, 1996, approximately 96% of the Company's long-term debt
was subject to fluctuations in interest rates.
During 1996, the Company's capital expenditures were $12.7 million and
included the costs of constructing a new health center in St. Louis, Missouri
and expanding and renovating other medical centers and administrative offices.
Other capital expenditures included the cost of acquiring and implementing new
operational software systems designed to enhance the Company's medical
management and information reporting capabilities.
Projected capital investments in 1997 of approximately $13 million consist
primarily of computer hardware, software and related equipment costs associated
with the development and implementation of improved operational and
communications systems and office equipment.
The Company believes that cash flows generated from operations, cash on
hand and investments, excess funds in certain of its regulated subsidiaries,
cash flows from the sale of certain medical offices and financing alternatives
will be sufficient to fund continuing operations and debt service obligations.
The Company believes that completion of the Warburg transaction, strengthening
its underwriting processes, entering into global capitation arrangements,
completing the proposed medical office sales and re-engineering its
administrative processes will have a favorable effect on liquidity in 1997 and
future periods. If the proposed Convertible Notes transaction is not
consummated, the Company will likely seek alternate financing in order to meet
scheduled debt service obligations. The Company's investment guidelines
emphasize investment grade fixed income instruments in order to provide
short-term liquidity and minimize the risk to principal.
Health Care Reform
Numerous proposals have been introduced in the United States Congress and
various state legislatures relating to health care reform. Some proposals, if
enacted, could among other things, restrict the Company's ability to raise
prices and to contract independently with employers and providers. Certain
reform proposals favor the growth of managed health care, while others would
adversely affect managed care. Although the provisions of any legislation
adopted at the state or federal level cannot be accurately predicted at this
time, management of the Company believes that the ultimate outcome of currently
proposed legislation would not have a material adverse effect on the Company
and its results of operations in the short run.
As a result of the introduction of Medicare and Medicaid risk products in
1995, the Company is subject to regulatory and legislative changes in those two
government programs.
1997 Outlook
The Company's enrollment in January 1997 increased to approximately 902,000
members, an increase of 15.5% over January 1996. Of the January 1997
enrollment, approximately 763,000 are members under the full-risk products and
approximately 139,000 members represent lives under management services plans.
The Company operates in highly competitive markets, but believes that the
pricing environment is improving in its existing markets, thus creating the
opportunity for reasonable price increases in the Company's market areas.
However, there is no assurance that the Company will be able to increase
premiums at rates equal to or in excess of increases in its health care costs.
For 1997, the Company has strengthened its underwriting processes and
oversight in both risk and non-risk products with the objective of increasing
premium yields and profitable growth. The Company will continue to pursue
global capitation arrangements as part of its delivery system with the
objectives of involving providers in medical cost management and stabilizing
operating margins. The completion of the medical office sales in St. Louis,
Missouri and Pittsburgh, Pennsylvania will improve liquidity and eliminate the
financial losses associated with excess capacity in the Company's delivery
system. Administrative processes in claims, information systems and customer
services are being re-engineered with emphasis on low costs and high quality.
The Company will focus on its existing markets for growth in commercial,
Medicare risk and Medicaid membership by leveraging the value of its franchises
and the volume of its membership base. The Company believes that these
objectives should result in progressive improvements in operations during 1997,
although realization of the benefit of these strategies is dependent upon a
variety of factors, some of which may be outside the control of the Company.
23
<PAGE> 26
Item 8: Financial Statements and Supplementary Data
Report of Independent Public Accountants
To the Board of Directors and Stockholders of Coventry Corporation:
We have audited the accompanying consolidated balance sheets of
Coventry Corporation and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Coventry Corporation and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996 in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
February 21, 1997 (except for
Notes G and S, as to which
the date is March 31, 1997)
24
<PAGE> 27
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
December 31,
- ------------------------------------------------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 90,619 $ 67,435
Short-term investments 7,388 18,408
Accounts receivable, net of allowance for doubtful 37,921 32,118
accounts of $8,000 and $2,700, respectively
Other receivables 22,661 10,909
Assets held for sale 23,856 -
Deferred income taxes 20,449 8,415
Prepaid expenses and other current assets 5,397 6,151
- -----------------------------------------------------------------------------------------------------------
Total current assets 208,291 143,436
Long-term investments 75,389 61,934
Property and equipment, net 24,979 51,253
Goodwill and intangible assets, net 118,346 111,879
Other assets 21,940 17,173
- -----------------------------------------------------------------------------------------------------------
Total assets $ 448,945 $ 385,675
===========================================================================================================
Liabilities and Stockholders' Equity
Medical claims liabilities $ 146,082 $ 92,160
Accounts payable 11,919 9,164
Accrued payroll and benefits 13,008 11,066
Other accrued liabilities 59,636 27,686
Deferred revenue 14,888 13,880
Current portion of long-term debt 36,468 2,307
- -----------------------------------------------------------------------------------------------------------
Total current liabilities 282,001 156,263
Long-term debt 57,291 65,600
Other long-term liabilities 9,226 7,994
Minority interest - 1,967
Stockholders' equity:
Common Stock, $.01 par value; 50,000,000 shares
authorized; issued and outstanding, 33,001,296
and 32,276,575 shares, respectively 330 323
Additional paid-in capital 136,142 128,119
Net unrealized investment gain 395 562
Retained earnings (accumulated deficit) (36,440) 24,847
- -----------------------------------------------------------------------------------------------------------
Total stockholders' equity 100,427 153,851
- -----------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 448,945 $ 385,675
===========================================================================================================
</TABLE>
See notes to consolidated financial statements.
25
<PAGE> 28
Consolidated Statements of Operations
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
- -----------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating revenues:
Managed care premiums $ 1,035,778 $ 844,032 $ 769,935
Management services 21,351 8,358 6,708
- -----------------------------------------------------------------------------------------------------------------------------
Total operating revenues 1,057,129 852,390 776,643
- -----------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Health benefits 930,739 713,226 614,144
Selling, general and administrative 165,081 123,523 94,684
Depreciation and amortization 42,862 14,666 9,437
Other charges 9,793 - -
Merger costs - 2,250 3,355
- -----------------------------------------------------------------------------------------------------------------------------
Total operating expenses 1,148,475 853,665 721,620
- -----------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss) (91,346) (1,275) 55,023
Other income, net 13,379 7,705 5,003
Interest expense (6,257) (4,881) (2,731)
- -----------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes and minority interest (84,224) 1,549 57,295
Provision for (benefit from) income taxes (22,860) 1,530 24,426
Minority interest in earnings (loss) of
consolidated subsidiary, net of income tax (77) 1 3,581
- -----------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (61,287) $ 18 $ 29,288
=============================================================================================================================
Net earnings (loss) per common and common equivalent share $ (1.86) $ 0.00 $ 0.93
=============================================================================================================================
Weighted average common and common equivalent
shares outstanding 33,011 32,164 31,425
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
26
<PAGE> 29
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1996, 1995 and 1994 (in thousands)
<TABLE>
<CAPTION>
Retained
Additional Net Unrealized Earnings Total
Common Paid-In Investment (Accumulated Stockholders'
Stock Capital Gain (Loss) Deficit) Equity
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1994 $ 293 $101,072 $ - $ (4,459) $ 96,906
Issuance of common stock,
including exercise of options 19 7,062 7,081
Tax benefit of stock options
exercised 1,653 1,653
Unrealized investment loss,
net of income tax (804) (804)
Net earnings 29,288 29,288
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 312 109,787 (804) 24,829 134,124
Issuance of common stock,
including exercise of options
and warrants 11 16,906 16,917
Tax benefit of stock options
exercised 1,426 1,426
Unrealized investment gain,
net of income tax 1,366 1,366
Net earnings 18 18
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 323 128,119 562 24,847 153,851
Issuance of common stock,
including exercise of options
and warrants 7 5,739 5,746
Tax benefit of stock options
exercised 2,284 2,284
Unrealized investment loss,
net of income tax (167) (167)
Net loss (61,287) (61,287)
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $ 330 $136,142 $ 395 $(36,440) $ 100,427
==========================================================================================================================
</TABLE>
See notes to consolidated financial statements.
27
<PAGE> 30
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
- --------------------------------------------------------------------------------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities of continuing operations:
Net earnings (loss) $ (61,287) $ 18 $ 29,288
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Depreciation and amortization 42,862 14,666 9,437
Benefit from deferred income taxes (15,989) (2,029) (657)
Increase in receivable due to sale of subsidiary (5,500) - -
Minority interest (19) 1 3,581
Other 103 (26) 386
Changes in assets and liabilities of continuing
operations, net of effects of the purchase of
subsidiaries:
Accounts receivable (5,285) (7,099) (2,091)
Other receivables (6,749) (4,913) (1,969)
Prepaid expenses and other current assets 758 (582) 2,959
Other assets (5,652) (6,458) (1,563)
Medical claims liabilities 49,350 21,736 4,849
Accounts payable 2,742 4,374 1,331
Other accrued liabilities 32,781 9,205 9,112
Income taxes payable 6,315 (15,173) 686
Deferred revenue 549 (3,756) (36)
Other long-term liabilities 1,251 3,882 1,084
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities of continuing operations 36,230 13,846 56,397
Net cash used in operating activities of discontinued operations - - (542)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 36,230 13,846 55,855
- --------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities of continuing operations:
Capital expenditures, net (12,688) (16,319) (22,466)
Sales of investments 75,511 53,224 41,109
Purchases of investments & other (80,049) (64,193) (55,841)
Payments for purchases of subsidiaries, net of cash acquired (27,256) (2,524) (54,279)
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities of continuing operations (44,482) (29,812) (91,477)
Net cash provided by investing activities of discontinued operations - - 8,809
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (44,482) (29,812) (82,668)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Borrowings of long-term debt 40,164 13,116 50,731
Payments on long-term debt (14,474) (14,740) (24,266)
Net proceeds from issuance of stock 5,746 16,917 5,831
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 31,436 15,293 32,296
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 23,184 (673) 5,483
Cash and cash equivalents at beginning of period 67,435 68,108 62,625
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 90,619 $ 67,435 $ 68,108
====================================================================================================================
====================================================================================================================
</TABLE>
See notes to consolidated financial statements.
28
<PAGE> 31
Notes to Consolidated Financial Statements
Years Ended December 31, 1996, 1995 and 1994
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Coventry Corporation ("the Company") is a managed health care company
that provides comprehensive health benefits and services to employer groups and
government-funded groups in Pennsylvania, Ohio, West Virginia, Missouri,
Illinois, Virginia and Florida.
The Company began operations in 1987 with the acquisition of the
American Service Companies ("ASC") entities. In 1988, the Company acquired
HealthAmerica Pennsylvania, Inc. ("HAPA"), a Pennsylvania HMO. In 1990, the
Company acquired Group Health Plan, Inc. ("GHP"), a St. Louis, Missouri HMO.
Southern Health Services, Inc. ("SHS"), a Richmond, Virginia, HMO was
acquired by the Company in 1994. In 1995, the Company acquired HealthCare USA
("HCUSA"), a Jacksonville, Florida-based Medicaid managed care company.
Principles of Consolidation - The consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant
intercompany transactions have been eliminated.
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Cash Equivalents - Cash equivalents consist principally of overnight
repurchase agreements, money market funds and certificates of deposit. The
Company considers all highly liquid securities purchased with an original
maturity of three months or less to be cash equivalents. The carrying amounts
of cash and cash equivalents reported in the accompanying consolidated balance
sheets approximate fair value.
Investments - Effective January 1, 1994, the Company adopted
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"). The Company considers
all of its investments as available for sale, and accordingly, records
unrealized gains and losses, net of deferred income taxes, as a separate
component of stockholders' equity. Realized gains and losses on the sale of
these investments are determined on the basis of specific cost. The adoption
of SFAS 115 did not have a material effect on the consolidated financial
statements.
Investments with original maturities in excess of three months and
less than one year are classified as short-term investments and generally
consist of time deposits, U.S. Treasury Notes, and obligations of various
states and municipalities. Long term investments have original maturities in
excess of one year and consist primarily of state and municipal debt securities
and obligations of the federal government and its agencies.
Other Receivables - Other receivables include interest receivable,
receivables from providers and suppliers and any other receivables that do not
relate to premiums.
Property and Equipment - Property and equipment are recorded at cost.
Depreciation is computed using the straight-line method over the estimated
lives of the related assets or, if shorter, over the terms of the respective
leases.
Long-Lived Assets - Effective January 1, 1996, the Company adopted
Statement of Financial Accounting Standards Number 121 ("SFAS 121"),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of." Following the criteria set forth in SFAS 121, long-lived
assets to be held are reviewed by the Company for events or changes in
circumstances which would indicate that the carrying value may not be
29
<PAGE> 32
recoverable. In making this determination, the Company considers a number of
factors, including estimated future cash flows prior to interest and non-cash
expenses associated with the long-lived asset. Assets held for sale are
recorded at the lower of the carrying amount or fair value, less any costs
associated with disposition.
Goodwill and Intangible Assets - Goodwill and intangible assets
consist primarily of costs in excess of the fair value of the net assets of
subsidiaries or operations acquired ($116.4 million) and non-compete agreements
($1.9 million). Goodwill is amortized over periods ranging from 15 to 40 years
and non-compete agreements are amortized over the respective lives of the
agreements. Accumulated amortization of goodwill and intangible assets was
approximately $40.3 million and $9.4 million at December 31, 1996 and 1995,
respectively. In accordance with SFAS 121 and APB 17, the Company periodically
evaluates the realizability of goodwill and intangible assets and the
reasonableness of the related lives in light of factors such as industry
changes, individual market competitive conditions, and operating income trends
(see Note B to Consolidated Financial Statements).
Other Assets - Other assets consist of loan acquisition costs, assets
related to the supplemental executive retirement plan (Note M of the Notes to
Consolidated Financial Statements), investment in a limited partnership,
deferred charges and certain costs incurred to develop new service areas and
new products prior to the initiation of revenues. Loan acquisition costs are
amortized over the term of the related debt while the other assets are
amortized over their expected periods of benefit, where applicable. The
preoperational new service area and new product costs are amortized over
expected benefit period up to eight years. Effective April 1, 1997, the
Company adopted a one-year period for amortization of new service area and
new product costs. Accumulated amortization of other assets was approximately
$3.6 million and $4.6 million at December 31, 1996 and 1995, respectively.
Medical Claims Liabilities - Medical claims liabilities consist of
actual claims reported but not paid and estimates of health care services
incurred but not reported. The estimated claims incurred but not reported are
based on historical data, current enrollment, health service utilization
statistics, and other related information. These accruals are continually
monitored and reviewed, and as settlements are made or accruals adjusted,
differences are reflected in current operations. Changes in assumptions for
medical costs caused by changes in actual experience could cause these
estimates to change in the near term.
Revenue Recognition - Managed care premiums are recorded as revenue in
the month in which members are entitled to service. Premiums collected in
advance are recorded as deferred revenue. Employer contracts are typically on
an annual basis, subject to cancellation by the employer group or the Company
upon thirty days written notice. Management services revenues are recognized
in the period in which the related services are performed.
Reinsurance - Premiums paid to reinsurers are reported as health
benefits expense and the related reinsurance recoveries are reported as
deductions from health benefits expense.
Income Taxes - The Company files a consolidated tax return for
Coventry and its wholly owned consolidated subsidiaries. The Company accounts
for income taxes in accordance with Statement of Financial Accounting Standards
No. 109 ("SFAS 109"). The deferred tax assets and/or liabilities are determined
by multiplying the differences between the financial reporting and tax
reporting bases for assets and liabilities by the enacted tax rates expected to
be in effect when such differences are recovered or settled. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date.
Minority Interest - For 1996, the minority interest represents a joint
venture interest of 51% in Pennsylvania HealthMate, Inc. ("HealthMate"). In
1995, the minority interest represents a minority shareholder's 30% interest in
HealthCare USA, Missouri LLC, a St. Louis-based Medicaid HMO. The Company
purchased the remaining 30% effective January 1, 1996. In 1994, the minority
interest represents a minority shareholder's 20% interest
30
<PAGE> 33
in Penn Group Corporation (Penn Group), which owns 100% of HAPA. On October
31, 1994, the Company purchased the Penn Group minority interest.
Earnings Per Share - Earnings per share is computed based on the
weighted average shares of common stock and common stock equivalents
outstanding during the period. Common stock equivalents arising from dilutive
stock options and warrants are computed using the treasury stock method. Fully
diluted earnings per share are not presented as the calculation is either
antidilutive or does not materially affect earnings per share.
SFAS no. 128, "Earnings per Share" has been issued effective for
fiscal years ending after December 15, 1997. SFAS no. 128 establishes a new
standard for computing and presenting earnings per share. The Company is
required to adopt the provisions of SFAS No. 128 in the fourth quarter of 1997
and does not expect adoption thereof to have a material effect on the Company's
financial position or results of operations.
Reclassifications - Certain 1994 and 1995 amounts have been
reclassified to conform to the 1996 presentation.
B. MERGERS AND ACQUISITIONS
Effective July 28, 1995, the Company acquired HCUSA, a Jacksonville,
Florida-based managed care company. Under the terms of the agreement,
2,849,691 shares of the Company's common stock, valued at approximately $45
million, were exchanged for all of HCUSA's capital stock in a nontaxable
transaction accounted for as a pooling of interests. HCUSA operates a 26,000
member HMO in Jacksonville and northeastern Florida, and through a subsidiary
provides managed care services to Missouri Medicaid recipients. At December
31, 1996, HCUSA's Missouri subsidiary had approximately 77,000 enrollees. The
Company's financial statements have been restated to include the results of
HCUSA for all periods presented.
Effective December 1, 1994, the Company acquired Southern Health
Management Corporation ("SHMC"), the parent company of SHS, a physician owned
HMO with approximately 45,000 members located in Richmond and central Virginia.
Under the terms of the agreement, common stock of the Company valued at
approximately $75 million was given as consideration in a nontaxable
transaction accounted for as a pooling of interests. Each of SHMC's 833,757
outstanding shares of common stock was converted into 3.436 shares of the
Company's common stock resulting in 2,864,789 shares being issued.
Additionally, 42,500 outstanding options to acquire SHMC's common stock were
converted to options to acquire 146,030 shares of the Company's common stock.
Accounting policies of the two companies were the same; therefore, no
conforming adjustments were needed. No intercompany transactions existed
between the companies for the periods presented, and certain reclassifications
were made to SHMC's and HCUSA's financial statements to agree with Coventry's
presentation.
In connection with the merger of SHMC, the Company recorded $3.4
million in the third and fourth quarters of 1994 for transaction costs. In
connection with the merger of HCUSA, the Company recorded $2.3 million of
merger costs in the second quarter of 1995. These costs include expenses for
investments bankers, SEC filing and shareholder reporting fees and professional
fees.
Effective March 22, 1996, the Company purchased 81% of the common
stock of PARTNERS Health Plan of Pennsylvania, Inc. ("PARTNERS") from a
subsidiary of Aetna Life & Casualty Company, now known as Aetna Services, Inc.
("Aetna") and acquired the remaining 19% of the common stock of PARTNERS
through the merger of a subsidiary of the Company with and into PARTNERS.
PARTNERS is the holding company for Coventry Health Plans of Western
Pennsylvania, Inc. ("CHP"), which at the time of acquisition served
approximately 16,000 HMO members in the Pittsburgh area. Consideration for the
transaction was approximately $35 million in cash, of which approximately $32.1
million was recorded as goodwill. The acquisition has been accounted for under
the purchase method of accounting and,
31
<PAGE> 34
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. As a result,
based on fair value estimates of the intangibles on both the sales recovery and
discounted cash flow basis, the intangibles were written down to an amount that
supported the estimated fair value ($10.0 million) of the assets.
Effective April 1, 1996 the Company entered into a Joint Venture
Agreement with Hamilton Health Center, Inc. ("Hamilton") to create HealthMate,
Inc., a company providing health care services to Medicaid recipients in
central Pennsylvania. As part of the agreement the Company made an initial
investment of $300,000 for ownership of 49% of HealthMate's common stock and is
obligated under certain circumstances to make additional contributions totaling
$550,000 over the next two and a half years. As of April 1, 1996 HealthMate
had approximately 6,500 members. Hamilton's rights are limited to the ability
to market the Company's product. HealthMate's only source of Medicaid
membership is through a government contract held by a wholly-owned subsidiary
of the Company, and as a result of the Company's contractual control rights,
the Company has accounted for this transaction under the purchase method of
accounting and, accordingly, the net assets have been included in the
consolidated financial statements from the effective date of acquisition.
Because the purchase price and the operations of the PARTNERS and
HealthMate acquisitions for the periods presented are not material to the
consolidated financial statements of the Company, pro forma financial
information has not been included herein.
Effective January 1, 1996, the Company purchased the 30% minority
interest in HealthCare USA, Missouri LLC, a St. Louis-based Medicaid HMO. The
purchase price was equal to the carrying value of the 30% ownership and as a
result, no goodwill was recorded.
The Company purchased two physician group practices in Pennsylvania in
January 1995, and a third party administrator in Richmond, Virginia in May
1995. The combined adjusted purchase price for these three acquisitions was
approximately $2.5 million, of which approximately $1.2 million was recorded as
goodwill. The purchase price included approximately $600,000 related to
noncompete agreements which have been recorded as intangible assets in the
consolidated balance sheet and which will be amortized between four and ten
years. In 1994, the Company purchased four physician group practices for which
the combined adjusted purchase price was $3.7 million. Approximately $2.0
million of the combined purchase price related to noncompete agreements which
have been recorded as intangible assets and which will be amortized over
five to ten years. Approximately $1.2 million of the combined purchase price
related to goodwill which will amortize over 25 years. These acquisitions have
been accounted for under the purchase method of accounting and, accordingly,
the net assets have been included in the consolidated financial statements from
the effective dates of acquisition. The transactions and operations of the
acquired entities are not significant in the consolidated financial statements
of the Company.
Effective October 31, 1994, the Company purchased the then remaining
20% minority interest in Penn Group Corporation, the parent company of
HealthAmerica Pennsylvania, Inc., the Company's Pennsylvania HMO operations.
The purchase price was approximately $50 million in cash, of which
approximately $38.6 million was recorded as goodwill.
32
<PAGE> 35
C. OTHER CHARGES
At the end of the second quarter of 1996, the Company established
reserves totaling $8.2 million for anticipated losses on multi-year contracts
with certain employer groups, primarily in the St. Louis market. The Company
expects to utilize these reserves over the remaining lives of the contracts and
then either discontinue these products or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at
varying dates through 1999 and cover approximately 30,000 members. In the
fourth quarter of 1996, the Company re-evaluated its cost structure in relation
to the contracts and recorded additional reserves of $1.6 million. The Company
continually evaluates the underlying costs expected to be incurred in servicing
the contracts. For the above contracts, increases in the underlying costs
during 1996 in the St. Louis provider network resulted in the provisions noted
above.
D. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
- --------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------
<S> <C> <C>
Land $ 481 $ 3,116
Buildings and leasehold improvements 8,427 25,507
Equipment 39,162 49,016
- --------------------------------------------------------------------------
48,070 77,639
Less accumulated depreciation (23,091) (26,386)
- --------------------------------------------------------------------------
$ 24,979 $ 51,253
==========================================================================
</TABLE>
During the fourth quarter of 1996, the Company authorized an extensive
review of its medical office operations and commenced discussions with several
parties related to the probable disposition of such operations. In February
1997, the Company announced the signing of agreements in principle for the sale
of its medical offices in St. Louis, Missouri and Pittsburgh, Pennsylvania and
definitive agreements for the sales of such offices were signed in March 1997,
subject to the satisfaction of various conditions, including regulatory
approval. Accordingly, property and equipment with a carrying value of
approximately $23.9 million has been classified as a current asset on the 1996
balance sheet. The Company expects the net proceeds from the sale will exceed
the carrying value.
In accordance with SFAS 121, the Company determined that the carrying
amounts of certain of its property and equipment (primarily data processing
equipment that will not be utilized in the future as a result of a change in
management information systems structure determined by the Company in the
fourth quarter) was not recoverable as of December 31, 1996. As a result,
approximately $4.3 million of property and equipment charge-offs were recorded
in the fourth quarter of 1996.
33
<PAGE> 36
E. INVESTMENTS IN DEBT AND EQUITY SECURITIES
The Company considers all of its investments as available for sale
securities, as defined within the Statement, and accordingly, records
unrealized gains and losses in the stockholders' equity section of its balance
sheet. As of December 31, 1996 and 1995, stockholders' equity was increased by
approximately $0.4 million and $0.6 million, respectively, net of a deferred
tax cost of $0.1 million and $0.3 million, respectively, to reflect the net
unrealized investment gain on securities. The amortized cost, gross unrealized
gain or loss and estimated fair value of short-term and long-term investments
by security type were as follows at December 31, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
1996 Cost Gain Loss Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
State and municipal bonds $50,926 $492 $ - $51,418
Asset-backed securities 9,407 - (31) 9,376
Mortgage-backed securities 13,740 - (85) 13,655
US Treasury securities 7,897 31 - 7,928
Other debt securities 329 - - 329
Equity securities 25 46 - 71
----------------------------------------------------------
$82,324 $569 $ (116) $82,777
==========================================================
</TABLE>
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
1995 Cost Gain Loss Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
State and municipal bonds $59,892 $788 $- $60,680
Asset-backed securities 7,654 - - 7,654
Mortgage-backed securities 526 - - 526
US Treasury securities 9,517 74 - 9,591
Other debt securities 1,815 - - 1,815
Equity securities 12 64 - 76
----------------------------------------------------------
$79,416 $926 $- $80,342
==========================================================
</TABLE>
34
<PAGE> 37
The amortized cost and estimated fair value of short-term and
long-term investments by contractual maturity were as follows at December 31,
1996 and December 31, 1995 (in thousands):
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
1996 ----------------------
<S> <C> <C>
Maturities:
Within 1 year $ 7,366 $ 7,388
1 to 5 years 26,140 26,229
6 to 10 years 7,383 7,494
Over 10 years 41,410 41,595
Other securities without stated maturity 25 71
----------------------
Total short-term and long-term securities $82,324 $82,777
======================
</TABLE>
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
1995 --------------------
<S> <C> <C>
Maturities:
Within 1 year $18,406 $18,408
1 to 5 years 24,477 24,762
6 to 10 years 6,344 6,424
Over 10 years 30,177 30,672
Other securities without stated maturity 12 76
---------------------
Total short-term and long-term securities $79,416 $80,342
=====================
</TABLE>
Proceeds from the sale of investments were approximately $76 million
and $53 million for the twelve months ending December 31, 1996 and 1995,
respectively. Gross investments gains of approximately $45,000 and gross
investments losses of $14,000 were realized on these sales for the twelve
months ended December 31, 1996 compared to $26,000 of gross investments gains
for the year ended December 31, 1995. Realized gains and losses from securities
sales are determined on the specific identification of the securities.
F. INCOME TAXES
The provision (benefit) for income taxes attributable to earnings
consisted of the following (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------------------------------------
1996 1995 1994
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current provision (benefit):
Federal $ (6,181) $ 3,125 $ 21,285
State (690) 434 3,798
Deferred provision (benefit):
Federal (15,565) (1,819) (558)
State (424) (210) (99)
- ---------------------------------------------------------------------------------------------------------------
$ (22,860) $ 1,530 $ 24,426
===============================================================================================================
</TABLE>
35
<PAGE> 38
The expected tax provision (benefit) based on the statutory rate of
35% differs from the Company's effective tax rate as a result of the following:
<TABLE>
<CAPTION>
Year Ended December 31,
- -----------------------------------------------------------------------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal tax rate (35.00)% 35.00 % 35.00 %
Effect of:
State income taxes, net of federal benefit (1.40)% 9.40 % 5.71 %
Amortization of goodwill 10.26 % 69.07 % 1.40 %
Tax exempt interest income (1.25)% (75.37)% (1.10)%
Change in valuation reserve - - (1.42)%
Merger costs - 49.71 % 2.02 %
Other 0.25 % 10.92 % 1.02 %
- -----------------------------------------------------------------------------------------------------------
Income tax provision (benefit) (27.14)% 98.73 % 42.63 %
===========================================================================================================
</TABLE>
The effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31, 1996 and 1995 are presented below (in thousands):
<TABLE>
<CAPTION>
December 31,
1996 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Medical liabilities $ 7,816 $ 984
Accounts receivable 2,897 904
Provision for long-term contracts 3,183 -
Other accruals and deferred revenue 10,943 6,234
Net operating loss carryforward 2,534 640
- ---------------------------------------------------------------------------------------------------------------
Gross deferred tax assets 27,373 8,762
Less valuation allowance (911) (640)
- ---------------------------------------------------------------------------------------------------------------
Deferred tax asset 26,462 8,122
- ---------------------------------------------------------------------------------------------------------------
Deferred tax liability:
Property and equipment (609) (1,031)
Capitalized development costs (1,806) -
Unrealized gain on securities available for sale (128) (363)
Other (332) (1,063)
- ---------------------------------------------------------------------------------------------------------------
Gross deferred tax liabilities (2,875) (2,457)
- ---------------------------------------------------------------------------------------------------------------
Net deferred tax asset $ 23,587 $ 5,665
===============================================================================================================
</TABLE>
The valuation allowance for deferred tax assets as of December 31,
1996 was $0.9 million due to the Company's belief that the realization of the
deferred tax asset resulting from federal and state net operating loss
carryforwards associated with certain acquisitions is doubtful. The valuation
allowance provided at December 31, 1996 will be allocated to reduce goodwill and
other intangible assets if the realization of the acquired net operating loss
carryforwards becomes more likely than not.
36
<PAGE> 39
G. NOTES PAYABLE AND LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1996 1995
<S> <C> <C>
Borrowings under the Credit Facility $90,000 $62,000
Note payable to U.S. DHHS 1,762 2,303
Other notes payable 1,997 3,604
----------------------
93,759 67,907
Less current portion of long-term debt (36,468) (2,307)
----------------------
Total long-term debt $57,291 $65,600
======================
</TABLE>
Prior to June 30, 1996, the Company's long-term credit agreement (the
"Credit Facility") with a group of banks provided a reducing revolving line of
credit of $125 million, collateralized by substantially all of the Company's
assets. The Credit Facility originally called for scheduled semi-annual
commitment reductions totaling $20.8 million beginning February 18, 1997 and
terminating availability on August 18, 1999. As of June 30, 1996, the Company
was not in compliance with certain financial covenants in the Credit Facility.
Effective September 30, 1996, the Company reached an agreement ("Amended Credit
Facility") with the bank group amending the Credit Facility. Prior to the
amendment, the Company voluntarily reduced the availability under the Credit
Facility to $100 million. The Amended Credit Facility, along with other
changes, revised certain financial ratios that the Company was required to
maintain, increased the interest rate on the indebtedness by 0.8% and revised
the required reductions in availability. At December 31, 1996, the effective
interest rate on indebtedness under the Amended Credit Facility was 7.56%.
As of December 31, 1996, the Company was not in compliance with
certain revised financial covenants in the Amended Credit Facility.
Subsequent to December 31, 1996, the Company entered into an amended and
restated agreement ("Restated Credit Facility") with the bank group effective
March 28, 1997, that along with other changes, converts the amount outstanding
under the Restated Credit Facility to a term loan, revises certain financial
ratios the Company is required to maintain, effectively increases the interest
rate on the indebtedness by 2.7% and revises the amortization period of the
loan. The Restated Credit Facility requires payments of $10 million on June
30, 1997, $7 million on September 30, 1997, $18 million on December 31, 1997
and $55 million on April 1, 1998. The Restated Credit Facility eliminated the
defaults that existed under the Amended Credit Facility at December 31, 1996.
Obligations under the Restated Credit Facility will bear interest at a rate
equal to the higher of the prime rate plus 2.0% or the federal funds rate plus
2.5%.
The Restated Credit Facility requires the Company to apply 50% of the
net cash proceeds of sales of the Company's equity securities to reduce the
scheduled amortizations, prohibits the sale of any substantial subsidiary and
restricts the Company's ability to declare and pay cash dividends on its
common stock.
The Restated Credit Facility contains covenants relating to net worth,
investments in non-admitted assets, operating margins and the creation or
assumption of debt or liens on the assets of the Company. Prior to the closing
of the proposed Warburg transactions described in Note S, any event or
condition which has or could reasonably be expected to have a material adverse
effect on the Company's business, financial condition or results of operations
will constitute an event of default under the Restated Credit Facility. As of
March 31, 1997, no such event or condition has occurred. The Restated Credit
Facility is collaterlized by substantially all of the assets of the Company.
On March 31, 1997 the effective interest rate on the indebtedness
under the Restated Credit Facility was 10.5%.
Notes payable to the U. S. Department of Health and Human Services
("U.S. DHHS") represents obligations which were assumed in the acquisition of
HAPA. Under the terms of the notes, principal is payable in various annual
installments through June 30, 2000 with interest payable semi-annually at rates
ranging from 7.75% to 9.125%. The notes are secured by certain assets of the
Company.
Other notes payable relate primarily to the acquisition of two
physician group practices in 1995 and four in 1994 (see Note D of the Notes to
Consolidated Financial Statements). Under the terms of these acquisitions, a
portion of the total purchase price is deferred for terms ranging between two
and four years. These deferred payments do not accrue interest.
37
<PAGE> 40
Maturities of long-term debt during each of the ensuing five years
ending December 31 and thereafter are as follows (in thousands):
<TABLE>
<S> <C>
1997 $ 36,468
1998 56,210
1999 687
2000 376
2001 18
Thereafter -
--------
$ 93,759
========
</TABLE>
H. STOCK DIVIDEND
On August 3, 1994, the Company's Board of Directors approved a
two-for-one stock split in the form of a stock dividend with one additional
share of common stock issued for every share held by shareholders of record as
of July 20, 1994. All share and per share amounts for 1994 have been adjusted
to reflect the stock split.
I. STOCK OPTIONS, WARRANTS AND EMPLOYEE STOCK PURCHASE PLAN
As of December 31, 1996, the Company had five stock option plans for
issuance of common stock to key employees, including physicians and directors.
Under these plans, the exercise provisions and prices of the options are
established on an individual basis with the exercise price of the options
generally being equal to 100% of the market value of the underlying stock at
the date of grant. Options generally become exercisable after one year in
20-25% increments per year and expire ten years from the date of grant. The
plans provide for incentive or nonqualified stock options to be issued at the
discretion of the Board of Directors.
With the merger of SHMC in December 1994, the Company assumed SHMC's
incentive stock option plan. The Company issued options for 146,030 shares of
common stock in exchange for 42,500 options to acquire shares of SHMC common
stock granted under SHMC's incentive stock option plan. These options were
exercisable upon the completion of the merger with SHMC and expire in 2003.
With the merger of HCUSA in July 1995, the Company exchanged 2,849,691
shares of the Company's common stock for all of HCUSA's common stock, preferred
stock and stock options.
Transactions with respect to the plans for the three years ended
December 31, 1996 were as follows and have been restated to reflect the
two-for-one stock split in the form of a stock dividend in August 1994:
<TABLE>
<CAPTION>
Number of Option Price
Shares Per Share
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding at January 1, 1994 1,732,430 $ 1.275 - $21.250
Granted 588,850 $16.875 - $25.000
Exercised (284,820) $ 1.275 - $13.563
Canceled (93,000) $ 4.750 - $21.250
- -----------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1994 1,943,460 $ 3.780 - $25.000
Granted 716,750 $15.875 - $24.500
Exercised (246,668) $ 3.780 - $21.250
Canceled (169,000) $ 5.000 - $24.250
- -----------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1995 2,244,542 $ 3.780 - $25.000
Granted 2,891,589 $ 9.625 - $20.625
Exercised (450,224) $ 3.780 - $18.125
Canceled (1,823,489) $ 5.000 - $25.000
- -----------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1996 2,862,418 $ 3.780 - $25.000
=================================================================================================================
</TABLE>
38
<PAGE> 41
Options vested and exercisable at December 31, 1996, 1995 and 1994
were 740,017, 888,573 and 664,266, respectively.
At December 31, 1996, the Company had outstanding warrants granting
holders the right to purchase 100,000 shares of common stock. The 100,000
warrants were issued in July 1995 at a price of $14.125 and expire July 2000.
Warrants were issued in December 1993 granting holders the right to purchase
800,000 shares at an exercise price of $21.00. Of the 800,000 shares, 550,300
were exercised before the expiration in December 1995. The remaining 249,700
warrants expired in December 1995. During the first half of 1996, 170,000
warrants were exercised at a price of $6.75.
At various dates in 1996, the Company repriced, canceled and reissued
approximately 1.3 million shares under option. The options canceled were at
prices ranging from a high of $25.00 to a low of $15.63. The shares were
reissued at market on the date of reissue and the prices ranged from a high of
$18.13 to a low of $12.75.
As of December 31, 1996, the Company had reserved an aggregate of
approximately 3.3 million common shares for options and warrants, approximately
0.4 million of which are available for future grants.
The Company implemented an Employee Stock Purchase Plan in 1994 which
allows substantially all employees who meet length of service requirements to
set aside a portion of their salary for the purchase of Company stock. At the
end of each plan year, the Company will issue the stock to participating
employees at an issue price equal to 85% of the lower of the stock price at the
end of the plan year or the average stock price, as defined. The Company has
reserved 1.0 million shares of stock for this plan and has issued 13,267 and
19,465 shares in 1995 and 1996, respectively, under this plan.
In 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards Number 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation." SFAS 123 establishes new financial accounting and
reporting standards for stock-based compensation plans. The Company has
adopted only the disclosure requirements of SFAS 123. As a result, no
compensation cost has been recorded for the Company's stock option plans. In
addition, based on the number of options outstanding and the historical and
extrapolated future trends of factors affecting valuation of those options,
management has determined that any compensation cost attributable to options
granted is immaterial.
J. REINSURANCE
The Company has reinsurance agreements, through its subsidiary CHLIC,
with a major insurance company for portions of the risk it has underwritten
through its products. These reinsurance agreements do not release the Company
of its primary obligations to its membership. In 1996, commercial HMO risk was
reinsured to $500,000 per member per year in excess of a maximum loss retention
of $500,000 per member per year and 20% coinsurance, subject to certain limits
on hospital costs per patient-day. PPO risk was reinsured to $850,000 per
member per year in excess of maximum loss retention of $150,000 per member per
year and 20% coinsurance. Medicaid in Florida and Pennsylvania was reinsured
to $950,000 per member per year in excess of a maximum loss retention of
$50,000 per member per year and 20% coinsurance.
Medicaid risk in Missouri was reinsured through the state of Missouri
mandated program with retention of $50,000 per member per year and 20%
coinsurance. Medicare risk was reinsured $850,000 per member per year in
excess of a maximum loss retention of $150,000 per member per year and 20%
coinsurance.
39
<PAGE> 42
Reinsurance premiums for the years ended December 31, 1996, 1995 and
1994, were approximately $1.8 million, $2.8 million and $3.3 million,
respectively. Reinsurance recoveries for the same periods were approximately
$1.5 million, $0.9 million and $1.3 million.
K. COMMITMENTS
The Company operates primarily in leased facilities with original lease
terms ranging from two to fifteen years. The Company also leases computer
equipment with lease terms of approximately three years. Leases that expire
generally are expected to be renewed or replaced by other leases.
The minimum rental commitments payable by the Company during each of the
next five years ended December 31 and thereafter for noncancellable operating
leases are as follows (in thousands):
<TABLE>
<CAPTION>
Year Amount
----- ------
<S> <C>
1997 $ 9,690
1998 7,859
1999 5,841
2000 4,368
2001 3,484
--------
Thereafter 12,750
--------
$ 43,992
========
</TABLE>
Total rent expense was approximately $11.7 million, $10.5 million and
$10.6 million for the years ended December 31, 1996, 1995, and 1994,
respectively.
During the first quarter of 1996, termination and related costs of
$5.2 million resulted from an initiative undertaken to streamline the Company's
administrative processes and reduce staffing in the Company's health centers,
primarily in the Pennsylvania and St. Louis plans. The costs relate to the
reduction of approximately 500 positions, 374 of which were health center
positions. Of the health center positions eliminated, 227 result from the
outsourcing of certain ancillary services to capitated vendors. At the end of
the second quarter, additional termination and related costs of $0.8 million
were recorded related to the curtailment of Medicaid operations in certain
markets. In the fourth quarter of 1996, $0.9 million of additional expenses
were recorded pertaining to the Pennsylvania, St. Louis and Medicaid staff
reductions.
Also, in the fourth quarter of 1996, as a result of premium rate
reductions in Florida in 1995 and the commercial membership requirements, the
Company has determined that its Florida Medicaid operations are not
sufficiently profitable to justify a continued presence in the Florida market
and, as a result, the Company has decided to exit the Florida Medicaid market.
Accordingly, the Company has established a reserve of $1.2 million at December
31, 1996 to reflect the anticipated costs of exiting this market. As of
December 31, 1996 approximately $6.0 million of these $8.1 million of accruals
had been paid.
L. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
investments in marketable securities and premiums receivable. The Company
invests its excess cash in interest bearing deposits with major banks,
commercial paper and money market funds. Investments in marketable securities
are managed within guidelines established by the Board of Directors which
emphasize investment-grade fixed income securities and limit the amount that
may be invested in any one issuer. The fair value of the Company's financial
instruments is substantially equivalent to their carrying value and, although
there is some credit risk associated with these instruments, the Company
believes this risk to be minimal.
As discussed in Note S to Consolidated Financial Statements, the
Company will enter into long-term global capitation arrangements with two
integrated provider organizations. To the extent that the Company becomes a
party to global capitation agreements with a single provider organization
serving substantial membership, the Company becomes exposed to credit risk with
respect to such organizations.
As of December 31, 1996, the western Pennsylvania, central
Pennsylvania, St. Louis, Richmond and HCUSA subsidiaries comprised 37%, 16%,
17%, 2% and 28% of accounts receivable, respectively. The Company's largest
employer group, the U.S. Office of Personnel Management, accounted for
approximately 5% of the Company's managed care
40
<PAGE> 43
premiums in 1996 and approximately 14% of the accounts receivable at December
31, 1996. The Company believes the allowance for doubtful collections
adequately provides for estimated losses as of December 31, 1996. The Company
has a risk of incurring loss if such allowances are not adequate.
M. BENEFIT PLANS
On July 1, 1994, the Company adopted an employee retirement plan
qualifying under IRC Section 401(k), the Coventry Corporation Retirement
Savings Plan (the "Plan"), which covers substantially all employees of the
Company and its subsidiaries who meet certain requirements as to age and length
of service and who elect to participate in the Plan. Similar retirements
savings plans offered by (1) both HAPA and GHP and (2) both CHMC and HCUSA
were merged into the Plan effective July 1, 1994 and January 1, 1996,
respectively. Under the Plan, employees may defer up to 15% of their
compensation, limited by the maximum compensation deferral amount permitted by
applicable law. The Company makes matching contributions equal to 100% of the
employee's contribution on the first 3% of the employee's compensation deferral
and equal to 50% of the employee's contribution on the second 3% of the
employee's compensation deferred. Employees vest in the Company's matching
contributions in 20% increments annually over a period of 5 years, based on
length of service with the Company and/or its subsidiaries. All costs of the
Plan are funded by the Company as they are incurred.
On July 1, 1994, the Company adopted a supplemental executive
retirement plan (the "SERP"), which covers employees of the Company and its
subsidiaries who (1) meet certain requirements as to age and management
responsibilities and/or salary, (2) are designated as being eligible to
participate in the SERP by the Compensation and Benefits Committee of the Board
of Directors of the Company, and (3) elect to participate in the SERP and the
Plan. A similar supplemental executive retirements plan offered by HAPA was
merged into the SERP effective July 1, 1994. Under the SERP, employees may
defer up to 15% of their base salary, and up to 100% of any bonus awarded, over
and beyond the compensation deferral limits of the Plan. The Company makes
matching contributions equal to 100% of the employee's contribution on the
first 3% of the employee's compensation deferred and 50% of the employee's
contribution on the second 3% of the employee's compensation deferred.
Employees vest in the Company's matching contributions in 20% increments
annually over a period of 5 years, based on length of service with the Company
and/or its subsidiaries. All costs of the SERP are funded by the Company as
they are incurred.
The cost, principally employer matching contributions, of the benefit
plans charged to operations for the years 1996, 1995 and 1994 was approximately
$2.4 million, $3.1 million and $3.5 million, respectively.
41
<PAGE> 44
N. STATUTORY INFORMATION
The Company's HMO subsidiaries are required by the respective domicile
states to maintain minimum statutory capital and surplus in the aggregate of
approximately $14.0 million at December 31, 1996. Combined statutory capital
and surplus of the Company's HMO was approximately $27.9 million. The states
in which the Company's HMOs operate require the HMOs to maintain deposits with
the Department of Insurance. At December 31, 1996, these deposits totaled $2.8
million and are included as other long-term assets in the financial statements.
CHLIC is required to maintain minimum statutory capital and surplus of
approximately $3.0 million. Statutory capital and surplus of CHLIC as of
December 31, 1996 was approximately $30.7 million. Statutory deposits for
CHLIC as of December 31, 1996 totaled approximately $3.7 million.
O. OTHER INCOME
Other income for the years ended December 31, 1996, 1995, and 1994
includes investment income of approximately $8.4 million, $7.4 million, and
$5.0 million, respectively. Additionally, in the fourth quarter of 1996, other
income includes a non-recurring gain of approximately $4.9 million as a result
of the sale of Champion Dental Service, Inc. for $5.5 million cash. The
transaction was effective December 31, 1996 and the proceeds were recorded in
other receivables at December 31, 1996. The cash proceeds were collected in
January 1997.
P. SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Cash paid during the periods for interest and income taxes is as
follows (in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
- ---------------------------------------------------------------------------
1996 1995 1994
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Interest $ 5,862 $ 4,517 $ 2,491
Income taxes $ 1,309 $16,410 $19,240
</TABLE>
Q. DISCONTINUED OPERATIONS
On March 30, 1992, the Company's Board of Directors approved a plan
pursuant to which the Company discontinued certain operations of ASC. ASC
provided individually underwritten health care benefits coverage to
self-employed individuals or small employers through CHLIC. The Company
retains CHLIC insurance licenses in 43 states and CHLIC continues to underwrite
the indemnity portion of certain flexible provider products offered by the
Company's HMOs.
Effective December 1, 1992, the Company entered into an agreement with
United Insurance Companies, Inc. ("United"), whereby United assumed management
responsibility for the discontinued operations; accordingly, the small-group
policies remaining in force comprised a closed book of business. Effective
January 1, 1995, United assumption reinsured the ASC closed book of business.
Under the terms of the agreement, United assumed substantially all of the
closed book of business claims, unearned premium reserves, and all other
statutory liabilities, except for certain litigation reserves that are retained
by the Company.
42
<PAGE> 45
R. LEGAL PROCEEDINGS
In the normal course of business, the Company has been named as
defendant in various legal actions seeking payments for claims denied by the
Company, medical malpractice, and other monetary damages. The claims are in
various stages of proceedings and some may ultimately be brought to trial.
Incidents occurring through December 31, 1996 may result in the assertion of
additional claims. With respect to medical malpractice, the Company carries
professional malpractice and general liability insurance for each of its
operations on a claims made basis with varying deductibles for which the
Company maintains reserves. In the opinion of management, the outcome of these
actions will not have a material adverse effect on the financial position or
results of operations of the Company.
S. SUBSEQUENT EVENTS
In March 1997, the Company entered into agreements to sell the medical
offices associated with Group Health Plan, its health plan in St. Louis,
Missouri and HealthAmerica, its health plan in Pittsburgh, Pennsylvania, to
major healthcare provider organizations in these markets. The purchase price
is $27 million in cash for the St. Louis medical offices and $20 million in
cash for the Pittsburgh offices. The initial agreements cover medical offices
serving 92,000 members at Group Health Plan and 80,000 members at
HealthAmerica. The agreements are subject to the satisfaction of various
conditions, including regulatory approval. Coincident with the sale of the
medical offices, the Company will enter into long-term global capitation
arrangements with the purchasers of the medical offices, pursuant to which the
provider organizations will receive a fixed percentage of premiums to cover all
the medical treatment the Company's globally capitated members receive from
the health care systems. The transactions are expected to occur in the first
half of 1997 and therefore, the assets of the respective medical offices have
been classified as current assets as of December 31, 1996. The anticipated
proceeds from the transactions are expected to exceed the current carrying
value of the medical offices.
On March 17, 1997, the Company announced that it entered into a
letter of intent with Warburg, Pincus Ventures, L.P. ("Warburg") for Warburg's
purchase of $40 million of Convertible Exchangeable Subordinated Notes of the
Company, together with warrants to purchase 2.35 million shares of the
Company's common stock. The notes are expected to be convertible into 4
million shares of the Company's common stock. The investment by Warburg is
subject to the negotiation of definitive terms, the approval of state
insurance regulators in certain states, and the approval of the lending banks
under the Credit Facility. The notes will be exchangeable at the Company's
option for shares of convertible preferred stock, the authorization of which
will require the approval of the Company's shareholders at the 1997
shareholders' meeting. If the proposed Convertible Notes transaction is not
consummated, the Company will likely seek alternative financing in order to
meet scheduled debt service obligations.
43
<PAGE> 46
T. QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of unaudited quarterly results of
operations (in thousands, except per share data) for the years ended December
31, 1996 and 1995.
<TABLE>
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1996(1) 1996(2) 1996 1996(3)
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $ 236,937 $ 257,737 $ 272,903 $ 289,552
Operating earnings (loss) $ (2,772) $ (14,346) $ 143 $ (74,371)
Net earnings (loss) $ (968) $ (8,528) $ 348 $ (52,139)
Net earnings (loss) per common
and common equivalent share $ (0.03) $ (0.26) $ 0.01 $ (1.58)
------------------------------------------------------------------
Weighted average common and common
equivalent shares outstanding 32,854 33,041 33,021 33,024
------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1995 1995(4) 1995(5) 1995(6)
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $ 209,652 $ 208,868 $ 211,137 $ 222,733
Operating earnings (loss) $ 16,253 $ 4,764 $ 1,118 $ (23,410)
Net earnings (loss) $ 9,870 $ 2,177 $ 1,494 $ (13,523)
Net earnings (loss) per common and common
equivalent share $ 0.30 $ 0.07 $ 0.05 $ (0.42)
-----------------------------------------------------------------
Weighted average common and common equivalent
shares outstanding 32,402 32,157 31,952 32,416
=================================================================
</TABLE>
(1) The first quarter operating results were affected by termination and
related costs to streamline the Company's administrative process and reduce
staffing in health centers, primarily in the Pennsylvania and St. Louis
plans for total adjustments of $5.2 million.
(2) The second quarter operating results were affected by the establishment
of reserves relating to multi-year contracts with certain employer groups,
primarily in the St. Louis market. The Company expects to utilize these
reserves over the remaining lives of the contracts and then either
discontinue the contracts or significantly change the terms and conditions
of the contracts with these parties. The establishment of these reserves
resulted in total adjustments of $8.2 million.
(3) The fourth quarter operating results were affected by the increase of
reserves related to accounts receivable ($3.6 million), long-term contracts
($1.6 million), medical claims ($25.6 million), termination costs
($2.1 million), write-offs of goodwill ($21.0 million), certain
capitalized expenses ($6.7 million) and other premium and sales taxes,
advertising, legal and other expenses ($6.0 million).
(4) The second quarter operating results of 1995 were affected by merger
costs for the purchase of HCUSA ($2.3 million), severance and related
costs associated with staff restructuring in Pittsburgh and St. Louis
($2.0 million), additions to accruals for professional liability
litigation ($1.2 million) and the settlement of certain Office of
Personnel Management negotiations ($1.5 million).
(5) The third quarter operating results of 1995 were affected by an increase
in medical claims liabilities for the western Pennsylvania market and
start up expenses associated with Medicaid and Medicare product
development and geographic expansion initiatives for total adjustments of
approximately $6.5 million.
(6) The fourth quarter operating results of 1995 were affected by the
elimination of several of its new market development areas ($5.1 million),
personnel reductions in the operations ($1.3 million), increases in
legal reserves ($1.5 million), medical and contingency reserves ($13.9
million) for total adjustments of $21.8 million.
44
<PAGE> 47
Item 9: Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
45
<PAGE> 48
PART III
Omitted From this Form 10K/A.
46
<PAGE> 49
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form
8-K
<TABLE>
<S> <C> <C>
(a) 1. FINANCIAL STATEMENTS
Form 10-K
Pages
----------
Report of Independent Public Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Consolidated Balance Sheets, December 31, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . 25
Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995
and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996,
1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Notes to Consolidated Financial Statements, December 31, 1996, 1995, and
1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 to 44
2. Financial statement schedules
Report of Independent Public Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . S-1
Schedule II - Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . . . . . . S-2
3. Exhibits required to be filed by Item 601 of Regulation S-K.
Exhibits required to be filed by Item 601 of Regulation S-K, whether filed herewith or incorporated
herein by reference, are listed on the Index to Exhibits of this filing.
(b) 1. Reports on Form 8-K
Form 8-K relating to February 24, 1997 press release was
filed on February 26, 1997.
</TABLE>
47
<PAGE> 50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Amendment to be signed
on its behalf by the undersigned, thereunto duly authorized.
COVENTRY CORPORATION
By: /s/ Allen F. Wise President, Chief Executive Officer and
------------------------- Director
Allen F. Wise
Dated: July 3, 1997
48
<PAGE> 51
ARTHUR ANDERSEN LLP
Nashville, Tennessee
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Coventry Corporation:
We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Coventry Corporation and subsidiaries for
the three years ended December 31, 1996 included in the Form 10-K and have
issued our report thereon dated February 21, 1997 (except for Notes G and S, as
to which the date is March 31, 1997). Our audits were made for the purpose of
forming an opinion on the basic consolidated financial statements taken as a
whole. The schedule listed under Item 14(a)(ii) is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth herein in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
February 21, 1997
S-1
<PAGE> 52
SCHEDULE II
COVENTRY CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Balance at Additions
Beginning of Charged to Costs Deductions Balance at
Period and Expenses (1) (Charge Offs) (1) End of Period
------------ ----------------- ----------------- -------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Allowance for doubtful accounts $ 2,700 $ 8,000 $(2,700) $ 8,000
======= ======= ======= =======
Year ended December 31, 1995:
Allowance for doubtful accounts $ 2,200 $ 3,100 $(2,600) $ 2,700
======= ======= ======= =======
Year ended December 31, 1994:
Allowance for doubtful accounts $ 1,240 $ 4,100 $(3,140) $ 2,200
======= ======= ======= =======
</TABLE>
(1) Additions to the allowance for doubtful accounts are included in selling,
general and administrative expense. All deductions or charge offs are
charged against the allowance for doubtful accounts.
S-2
<PAGE> 53
INDEX TO EXHIBITS
Reg. S-K
Item 601
Exhibit
No. Description of Exhibit
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or
Succession:
(i)
Agreement and Plan of Merger dated February 3, 1995 among the Company,
Coventry Acquisition Corporation and HealthCare USA, Inc.
(Incorporated by reference to Exhibit 2.1 to Form S-4 on Form S-3,
Registration Statement Nos. 33-90268 and 33-95084)
(ii)
Stock Purchase and Sale Agreement dated as of October 31, 1994 between
the Company and Presbyterian University Hospital. (Incorporated by
reference to Exhibit 2.1 to Form 8-K dated October 31, 1994 and filed
with the SEC on November 2, 1994)
(iii)
Stock Purchase and Merger Agreement by and among AHP Holdings, Inc.,
PARTNERS Health Plan of Pennsylvania, Inc., the Company and Coventry
Acquisition Corporation dated as of December 18, 1995 (Incorporated by
reference to Exhibit 2.2 to Annual Report on Form 10-K for the year
ended December 31, 1995) and Amendment No. 1 thereto dated March 20,
1996 (Incorporated by reference to Exhibit 2(ii) to the PARTNERS
Health Plan of Pennsylvania, Inc. Current Report on Form 8-K dated
March 20, 1996).
(3) Articles of Incorporation and Bylaws:
(i)
Fifth Restated Certificate of Incorporation of Coventry Corporation
(Incorporated by reference to Exhibit 3.1 attached to Annual Report on
Form 10-K for fiscal year ended December 31, 1994)
(ii)
Bylaws of Coventry Corporation (Incorporated by reference to Exhibit
3.2 to Form S-1, Registration Statement No. 33-36616), Amendment No. 1
(Incorporated by reference to Exhibit 3.2.1 attached to Annual Report
on Form 10-K for fiscal year ended December 31, 1994), and Amendment
No. 2 (See Exhibit 3.2.2 attached to the Annual Report on Form 10-K
for the year ended December 31, 1995).
(4) Instruments Defining the Rights of Security Holders, Including
Indentures:
(i)
Specimen Common Stock Certificate (See Exhibit 4.1 attached to the
Annual Report on Form 10-K for the year ended December 31, 1995 and
the Company's Certificate of Incorporation referenced at (3)(i) above)
(ii)
See Second Amended and Restated Credit Agreement referenced at 10(i)
below and the amendments thereto referenced at 10(i), 10(xx) and
10(xxi) below.
(iii)
Shareholder Rights Agreement dated February 7, 1996 between the
Company and Chemical Mellon Shareholder Services, L.L.C. (Incorporated
by reference to Exhibit 4 to Form 8-K, Current Report, dated February
7, 1996)
<PAGE> 54
(10) Material Contracts
(i)
Second Amended and Restated Credit Agreement dated as of November 20,
1992 among the Company, Morgan Guaranty Trust Company of New York,
Fleet National Bank, Third National Bank in Nashville, NationsBank of
Tennessee, N.A., Citicorp USA, Inc., Mellon Bank, N.A., First American
National Bank, and Morgan Guaranty Trust Company of New York as Agent
($125,000,000 Credit Facility) (See Exhibit 10.6 attached to the
Annual Report on Form 10-K for the year ended December 31, 1995) and
related documents (Incorporated by reference to Exhibit 10.6 attached
to Annual Report on Form 10-K for fiscal year ended December 31,
1994), Amendment No. 1 (See Exhibit 10.6.1 attached to the Annual
Report on Form 10-K for the year ended December 31, 1995) and
Amendment No. 2 (See Exhibit 10.6.2 attached to the Annual Report on
Form 10-K for the year ended December 31, 1995)
(ii)
Amended and Restated Employment Agreement dated December 1, 1994,
between Southern Health Management Corporation, the Company and James
L. Gore (Incorporated by reference to Exhibit 10.7.7 attached to
Annual Report on Form 10-K for fiscal year ended December 31, 1994)*
(iii)
Employment Agreement dated February 17, 1994 between HealthCare USA,
Inc. and Christopher T. Fey, as amended by Amendment to Employment
Agreement dated February 3, 1995 between HealthCare USA, Inc., the
Company and Mr. Fey (effective as to the Company on July 28, 1995)
(Incorporated by reference to Exhibit (xxv) to Form 10-Q, Quarterly
Report, for the quarter ended September 30, 1995)*
(iv)
Employment Agreement dated September 16, 1996 executed by
Allen F. Wise**
(v)
Employment Agreement dated December 30, 1996 executed by Dale B.
Wolf**
(vi)
Form of Company's Agreement (for Key Senior Executives) dated
September 12, 1995 (executed by Richard H. Jones and Frederick G.
Merkel) (Incorporated by reference to Exhibit (xxviii) to Form 10-Q,
Quarterly Report, for the quarter ended September 30, 1995)*
(vii)
Form of Company's Agreement (for Key Executives) dated September 12,
1995 (executed by James R. Hailey, Jan H. Hodges, Nancy I. Lorenz and
Shirley R. Smith) (Incorporated by reference to Exhibit (xxix) to Form
10-Q, Quarterly Report, for the quarter ended September 30, 1995)*
(viii)
Employment Agreement dated as of July 28, 1995, between Thomas Murray,
HealthAmerica Pennsylvania, Inc. and the Company (See Exhibit 10.7.1
attached to the Annual Report on Form 10-K for the year ended December
31, 1995)*
(ix)
Second Amended and Restated 1987 Statutory-Nonstatutory Stock Option
Plan (Incorporated by reference to Exhibit 10.8.1 attached to Annual
Report on Form 10-K for fiscal year ended December 31, 1993)*
<PAGE> 55
(x)
Third Amended and Restated 1989 Stock Option Plan (Incorporated by
reference to Exhibit 10.8.2 attached to Annual Report on Form 10-K for
fiscal year ended December 31, 1993)*
(xi)
1993 Outside Directors Stock Option Plan (as amended)(See Exhibit
10.8.3 attached to the Annual Report on Form 10-K for the year ended
December 31, 1995)*
(xii)
1993 Stock Option Plan (as amended)(See Exhibit 10.8.4 attached to the
Annual Report on Form 10-K for the year ended December 31, 1995)*
(xiii)
Coventry Corporation Supplemental Executive Retirement Plan effective
July 1, 1994 (Incorporated by reference to Exhibit 4.2 to Form S-8,
Registration Statement No. 33-81358)*
(xiv)
Coventry Share Plan (stock purchase plan) effective September 1, 1994
(Incorporated by reference to Exhibit 4.1 to Form S-8, Registration
Statement No. 33-82562)*
(xv)
Southern Health Management Corporation 1993 Stock Option Plan (See
Exhibit 10.8.5 attached to the Annual Report on Form 10-K for the year
ended December 31, 1995)*
(xvi)
Coinsurance Agreement effective January 1, 1995, between American
Service Life Insurance Company (now known as Coventry Health and Life
Insurance Company) and Mid-West National Life Insurance Company of
Tennessee (See Exhibit 10.9.1 attached to the Annual Report on Form
10-K for the year ended December 31, 1995)
(xvii)
Assumption Reinsurance Agreement between American Service Life
Insurance Company (now known as Coventry Health and Life Insurance
Company) and Mid-West National Life Insurance Company of Tennessee
(See Exhibit 10.9.2 attached to the Annual Report on Form 10-K for the
year ended December 31, 1995)
(xviii)
Subordinated Promissory Surplus Note dated May 12, 1995 in the amount
of $2,797,445 from HealthCare USA of Missouri, L.L.C. to the Company
(See Exhibit 10.9.3 attached to the Annual Report on Form 10-K for the
year ended December 31, 1995)
(xix)
License Agreement dated as of December 31, 1992 between Maxicare
Health Plans, Inc. and the Company (Incorporated by reference to
Exhibit 10.18.1 attached to Annual Report in Form 10-K for fiscal year
ended December 31, 1993) and Amendment No. 1 to License Agreement
between Maxicare Health Plans, Inc. and the Company (Incorporated by
reference to Exhibit 10.18.2 attached to Annual Report on Form 10-K
for fiscal year ended December 31, 1993)
(xx)
Amendment No. 3 to the Second Amended and Restated Credit
Agreement, dated as of September 30, 1996, among the Company, the Banks
listed on the signature pages thereof and Morgan Guaranty Trust Company
of New York as Agent (See Exhibit 10.6.3 attached to the Annual Report
on Form 10-K for the year ended December 31, 1996).**
(xxi)
Amendment No. 4 to the Second Amended and Restated Credit
Agreement, dated as of January 10, 1997, among the Company, the Banks
listed on the signature pages thereof and Morgan Guaranty Trust
Company of New York as Agent (See Exhibit 10.6.4 attached to the
Annual Report on Form 10-K for the year ended December 31, 1996).**
(xxii)
Employment Agreement dated October 14, 1996 executed by Joe Carroll**
(xxiii)
Employment Agreement dated January 1, 1997 executed by Jan H. Hodges**
(xxiv)
Employment Agreement dated November 11, 1996 executed by Richard H.
Jones**
(xxv)
Employment Agreement dated January 15, 1997 executed by Nancy I.
Lorenz**
(xxvi)
Employment Agreement dated January 27, 1997 executed by George R.
Mark**
(xxvii)
Employment Agreement dated January 24, 1997 executed by Robert A.
Mayer**
(xxviii)
Employment Agreement dated February 10, 1997 executed by Frederick G.
Merkel**
(xxix)
Employment Agreement dated January 15, 1997 executed by Shirley R.
Smith**
(xxx)
Retention Bonus Agreement dated December 31, 1996, executed by James
L. Gore**
(11) Statement re Computation of Per Share Earnings
(i)
Computation of Net Earnings Per Common and Common Equivalent Share**
(21) Subsidiaries of the Registrant
(i)
Subsidiaries of the Registrant**
(23) Consents of Experts and Counsel
(i)
Consent of Arthur Andersen LLP (See Exhibit 23 attached to this Report)
(27) **Financial Data Schedule (for SEC use only)
All other exhibits for which provision is made in Item 601 of
Regulation S-K promulgated by the Securities and Exchange Commission are either
not required by the instructions to Item 601 or are inapplicable and,
therefore, have been omitted.
* Management contract or compensatory plan.
** Previously filed as part of Annual Report on Form 10-K for fiscal year
ended December 31, 1996.
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion of our
reports dated February 21, 1997, included in this Amendment No. 4 to Form
10-K/A for the year ended December 31, 1996 and, in the Company's previous
filings as listed:
Form S-8 Registration Statement No. 33-71806
Form S-8 Registration Statement No. 33-57014
Form S-8 Registration Statement No. 33-81356
Form S-8 Registration Statement No. 33-81358
Form S-8 Registration Statement No. 33-82562
Form S-8 Registration Statement No. 33-87114
Form S-3 Registration Statement No. 33-95084
Form S-8 Registration Statement No. 33-97246
ARTHUR ANDERSEN LLP
Nashville, Tennessee
June 30, 1997