<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to __________________________
Commission file number 0-19147
COVENTRY CORPORATION
(Exact name of registrant as specified in its charter)
TENNESSEE 62-1297579
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
53 CENTURY BOULEVARD, SUITE 250, NASHVILLE, TENNESSEE 37214
(Address of principal executive office)
(Zip Code)
(615) 391-2440
(Registrant's telephone number, including area code)
------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 5, 1997
- ------ -----------------------------
Common stock $.01 Par Value 33,133,959
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COVENTRY CORPORATION
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Balance Sheets at June 30, 1997
and December 31, 1996 1
Condensed Consolidated Statements of Operations for
the quarter and six months ended June 30, 1997
and 1996 2
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 1997 and
1996 3
Notes to Condensed Consolidated Financial Statements 4
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1: Legal Proceedings 14
Items 2, 3, 4, and 5 14
Item 6 14
Signatures 15
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
COVENTRY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1997 1996
--------- ---------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 94,761 $ 85,646
Short-term investments 6,496 7,388
Accounts receivable, net 37,594 37,921
Other receivables 27,650 22,661
Assets held for sale -- 23,856
Deferred income taxes and other current assets 22,179 30,819
--------- ---------
Total current assets 188,680 208,291
Long-term investments 70,576 75,389
Property and equipment, net 23,096 24,979
Goodwill and intangible assets, net 114,930 118,346
Other assets 24,583 21,940
--------- ---------
Total assets $ 421,865 $ 448,945
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claims liabilities $ 109,837 $ 146,082
Accounts payable and other accrued liabilities 81,639 84,563
Deferred revenue 15,323 14,888
Current portion of long-term debt and notes payable 56,560 36,468
--------- ---------
Total current liabilities 263,359 282,001
Long-term debt 42,371 57,291
Other long-term liabilities 7,476 9,226
Stockholders' equity:
Common Stock, $.01 par value; 50,000,000 shares
authorized; 33,478,665 issued (including 439,560 shares
owned by a subsidiary), 33,039,105 shares outstanding in
1997 and 33,001,296 shares issued and outstanding in 1996 335 330
Additional paid-in capital 143,860 136,142
Net unrealized investment gain 165 395
Accumulated deficit (30,701) (36,440)
Treasury stock, at cost, 439,560 shares (5,000)
--------- ---------
Total stockholders' equity $ 108,659 $ 100,427
--------- ---------
Total liabilities and stockholders' equity $ 421,865 $ 448,945
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
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COVENTRY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Quarter ended Six months ended
June 30, June 30,
------------------------- -----------------------
1997 1996 1997 1996
------------ --------- ----------- ----------
<S> <C> <C> <C> <C>
Operating revenues:
Managed care premiums $ 295,934 $ 254,012 $ 591,453 $ 487,675
Management services 5,147 3,725 8,973 6,999
--------- --------- --------- ---------
Total operating revenues 301,081 257,737 600,426 494,674
Operating expenses:
Health benefits 253,536 223,343 517,812 422,644
Selling, general and administrative 42,284 36,351 81,605 72,908
Depreciation and amortization 3,787 4,146 8,102 7,997
Other charges -- 8,243 -- 8,243
Gain on sale of medical offices (9,607) -- (15,561) --
--------- --------- --------- ---------
Total operating expenses 290,000 272,083 591,958 511,792
--------- --------- --------- ---------
Operating earnings (loss) 11,081 (14,346) 8,468 (17,118)
Other income, net 2,434 1,869 5,502 4,143
Interest expense (2,536) (1,788) (4,377) (2,888)
--------- --------- --------- ---------
Earnings (loss) before income taxes 10,979 (14,265) 9,593 (15,863)
Provisions for (benefit from) income
taxes 4,391 (5,715) 3,837 (6,345)
Minority interest in earnings (loss)
of consolidated susidiary, net of
income tax (2) (22) 17 (22)
--------- --------- --------- ---------
Net earnings (loss) $ 6,590 $ (8,528) $ 5,739 $ (9,496)
========= ========= ========= =========
Net earnings (loss) per common and
common equivalent share $ 0.20 $ (0.26) $ 0.17 $ (0.29)
========= ========= ========= =========
Weighted average common and
common equivalent shares outstanding 33,390 33,041 33,112 32,947
========== ========= ========= =========
</TABLE>
See notes to condensed consolidated financial statements.
2
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COVENTRY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six months ended June 30,
1997 1996
-------- --------
<S> <C> <C>
Net cash provided by (used in) operating activities $(51,664) $ 2,968
-------- --------
Cash flows from investing activities:
Capital expenditures, net (2,674) (7,365)
Sale of investments 17,931 39,147
Purchase of investments (13,692) (27,489)
Proceeds from sale of subsidiary and
medical offices 51,566 --
Payments for purchase of subsidiaries,
net of cash acquired -- (27,983)
-------- --------
Net cash provided by (used in) investing activities 53,131 (23,690)
-------- --------
Cash flows from financing acitivities:
Issuance of long-term debt and notes payable 40,000 37,633
Payments of long-term debt and notes payable (35,075) (13,561)
Net proceeds from issuance of stock and warrants 2,723 5,001
-------- --------
Net cash provided by financing activities 7,648 29,073
-------- --------
Net increase in cash and cash equivalents 9,115 8,351
Cash and cash equivalents at beginning of the period 85,646 67,435
-------- --------
Cash and cash equivalents at end of the period $ 94,761 $ 75,786
======== ========
Supplemental disclosures of cash flow information
Cash paid (received) during the period was as follows:
Interest $ 4,722 $ 2,765
======== ========
Income taxes $ (2,018) $ (7,247)
======== ========
</TABLE>
See notes to condensed consolidated financial statements
3
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COVENTRY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of Coventry Corporation
and subsidiaries (the "Company") contained in this report are unaudited but
reflect all adjustments, consisting of normal recurring adjustments which, in
the opinion of management, are necessary for fair statement of the results of
the interim periods reflected. Certain information and footnote disclosures
normally included in the consolidated financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to applicable rules and regulations of the Securities and Exchange
Commission (the "SEC"). Certain reclassifications have been made to 1996 amounts
to conform to the 1997 presentation. The results of operations for the interim
periods reported herein are not necessarily indicative of results to be expected
for the full year. It is suggested that these condensed consolidated financial
statements be read in conjunction with the consolidated financial statements,
notes thereto and management's discussion and analysis included in the Company's
most recent Annual Report on Form 10-K/A, filed with the SEC in July 1997.
2. ACQUISITIONS
Effective March 22, 1996, the Company purchased 81% of the common stock
of PARTNERS Health Plan of Pennsylvania, Inc. and acquired the remaining 19% of
the common stock through the merger of a subsidiary of the Company with and into
PARTNERS, whose name was changed to Coventry Health Plan of Pennsylvania, Inc.
("CHP"). CHP is the holding company for Coventry Health Plan of Western
Pennsylvania, Inc., which, at the time of acquisition, was known as Aetna Health
Plan of Western Pennsylvania, Inc. and served approximately 16,000 HMO members
in the Pittsburgh area. Consideration for the transaction was approximately $35
million in cash, of which approximately $32.1 million was recorded as goodwill.
The acquisition has been accounted for under the purchase method of accounting
and, accordingly, the net assets have been included in the consolidated
financial statements from the effective date of acquisition. The acquisition
price included, among other typical business assets and goodwill, consideration
for non-compete agreements, the expectation of entering into a favorable joint
marketing agreement and the opportunity to acquire additional Aetna membership
at a favorable price. During the fourth quarter of 1996, the Company determined
that none of the opportunities were being realized, cash flows were short of
expectations (losses in 1996 versus projected positive cash flows) and that
Aetna had purchased U.S. Healthcare, which has operations in the Company's
service areas. In addition, the Company filed suit against Aetna and U.S.
Healthcare alleging breach of the acquisition agreement, seeking enforcement of
the non-compete agreement and requesting other forms of relief. Based on the
fair value estimates of the intangibles, on both a sales recovery and discounted
cash flow basis, the intangibles were written down to $10.0 million at December
31, 1996.
3. OTHER CHARGES
At the end of the second quarter of 1996, the Company established
reserves totaling $8.2 million for anticipated losses on multi-year contracts
with certain employer groups, primarily in the St. Louis market. The Company
expects to utilize these reserves over the remaining lives of the contracts and
then either discontinue these products or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at varying
dates through 1999 and cover approximately 30,000 members. The
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Company continually evaluates the underlying costs expected to be incurred in
servicing the contracts.
4. SALE OF MEDICAL OFFICES
Effective March 31, 1997, the Company completed its sale of the medical
offices associated with HealthAmerica Pennsylvania, Inc., its health plan in
Pittsburgh, Pennsylvania, to a major health care provider organization. The
sales price was $20 million and the transaction resulted in a pretax gain of
approximately $6.0 million. Coincident with the sale, the Company entered into a
long-term global capitation agreement with the purchaser which increased the
globally capitated membership in western Pennsylvania to approximately 226,000
members. Under the agreement, the provider organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive.
Effective May 1, 1997, the Company completed its sale of the medical
offices associated with Group Health Plan, its health plan in St. Louis,
Missouri, to a major health care provider organization. The sales price was
$26.9 million and the transaction resulted in a pretax gain of approximately
$9.6 million. Coincident with the sale, the Company entered into a long-term
global capitation agreement with the purchaser covering approximately 83,000
members, pursuant to which the provider organization will receive a fixed
percentage of premium to cover all of the medical treatment the globally
capitated members will receive.
5. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES
On April 2, 1997, the Company announced that it entered into a
securities purchase agreement with Warburg, Pincus Ventures, L.P. ("Warburg")
and Franklin Capital Associates III L.P. ("Franklin" and collectively with
Warburg the "Investors") for the Investors purchase of $40 million of the
Convertible Exchangeable Subordinated Notes of the Company (the "Convertible
Notes"), together with warrants to purchase 2.35 million shares of the Company's
common stock, for $42.35 million. The Convertible Notes are convertible into 4
million shares of the Company's common stock. On May 9, 1997, the Investors
purchased $26.8 million of the Convertible Notes and 1.6 million warrants for an
aggregate purchase price of $28.4 million. Following approval from certain state
insurance regulators, the remaining investment by Warburg of approximately $13.9
million was completed on June 30, 1997. The Convertible Notes will be
exchangeable at the Company's option for shares of convertible preferred stock,
the authorization of which will require the approval of the Company's
shareholders at the 1997 shareholders' meeting.
6. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is computed based upon the weighted average
shares of common stock and common stock equivalents during the period. Common
stock equivalents arising from dilutive stock options and warrants are computed
using the treasury stock method. In May and June of 1997, the Company issued
Convertible Notes which are not considered common stock equivalents. The fully
diluted earnings per share calculation assumes conversion of the Convertible
Notes and adjusts earnings for the interest that would not be paid in that
event. Fully diluted earnings per share are not presented, as the calculation
does not materially affect earnings per share for either period ending June 30,
1997.
7. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which
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is effective for both interim and annual reporting periods ending after December
15, 1997. The Company will adopt the new standard in its reporting for the
quarter and the year ended December 31, 1997. Management does not believe that
adoption of this standard will have a material impact on earnings per share.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive
Income," which is effective for fiscal years beginning after December 15, 1997
and requires restatement of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of certain items,
including gains and losses on certain securities, be shown in the financial
statements. Management has not yet determined the effect, if any, of SFAS No.
130 on the consolidated financial statements.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This standard requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS No. 131 also requires that
all public business enterprises report information about the revenues derived
from the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. This Statement is effective for financial
statements for periods beginning after December 15, 1997. Management has not yet
determined the effect, if any, of SFAS No. 131 on the consolidated financial
statements.
8. SUBSEQUENT EVENTS
In August 1997, the Company entered into an agreement to sell certain
medical officers associated with HealthAmerica Pennsylvania, Inc., its health
plan in Harrisburg, Pennsylvania. The agreement covers five medical offices and
21 physicians that serve approximately 12,000 members. Coincident with the sale
of the medical offices, the Company will enter into a long-term capitation
agreement with the purchaser of the medical offices, pursuant to which the
provider organization will receive a fixed percentage of premiums to cover the
medical treatment the Company's capitated members (approximately 7,000) receive
from the health care system. Proceeds from the sale are expected to approximate
the carrying value of the medical offices.
6
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Item 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Quarter and six months ended June 30, 1997 and 1996
GENERAL
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 and Virginia.
The Company serves a membership of 765,451 full-risk members and
146,630 self-insured members as of June 30, 1997. The following tables show the
total number of enrollees as of June 30, 1997 and 1996 and the percentage
increases in enrollment.
<TABLE>
<CAPTION>
June 30, Percent
1997 1996 Change
------------- --------------- ------------
<S> <C> <C> <C>
Western Pennsylvania 293,328 292,882 0.2%
Central Pennsylvania 259,586 224,297 15.7%
St. Louis 266,313 233,623 14.0%
Richmond 71,107 68,913 3.2%
Jacksonville (1) 21,747 25,234 (13.8%)
------------- ---------------
Total 912,081 844,949 7.9%
============= ===============
June 30, Percent
1997 1996 Change
------------- --------------- ------------
Commercial HMO 404,314 421,676 (4.1%)
Commercial PPO/POS 209,607 155,340 34.9%
Medicare risk 31,103 13,284 134.1%
Medicaid (1) 120,427 107,096 12.4%
Non-risk 146,630 147,553 (0.6%)
------------- ---------------
Total 912,081 844,949 7.9%
============= ===============
</TABLE>
(1) Effective June 30, 1997, the Company discontinued its Medicaid
operations in the Jacksonville, Florida area.
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
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changing timing of provider reimbursement practices. Calculated reserves are
reviewed by underwriting, finance and accounting, and other appropriate plan and
corporate personnel and judgments are then made as to the necessity for reserves
in addition to the above calculated amounts. Changes in assumptions for medical
costs caused by changes in actual experience, changes in the delivery system,
changes in pricing due to ancillary capitation and fluctuations in the claims
backlog could cause these estimates to change in the near term. The Company
periodically monitors and reviews IBNR, and as actual settlements are made or
accruals adjusted, differences are reflected in current operations. The Company
continually refines its reserving practices to incorporate new events and
trends.
RESULTS OF OPERATIONS
QUARTERS ENDED JUNE 30, 1997 AND 1996
Managed care premiums increased $41.9 million, or 16.5%, from the prior
year quarter. This increase is a result of risk membership growth of 68,055, or
9.8%, from the prior year quarter. Growth in Medicare risk membership of 17,819
accounted for over 26% of the membership increase. The revenue increase in the
second quarter was enhanced by the growth in Medicare risk membership which has
a significantly higher per member per month premium when compared to the
commercial products.
Management services revenue increased $1.4 million or 38.2% from the
prior year. This increase is primarily attributable to the increase in the
average per member per month administration fee and revenue from transition
services provided to the global capitation provider in St. Louis, Missouri.
Health benefits expense increased $30.2 million, or 13.5%, in 1997,
compared to 1996, as a result of the increase in risk enrollment. The Company's
medical loss ratio decreased to 85.7% from 87.9% in the corresponding prior year
quarter. The decline in the medical loss ratio is primarily attributable to the
global capitation contracts entered into in conjunction with the sales of the
Company's medical offices in Pittsburgh, Pennsylvania and St. Louis, Missouri.
The benefit from the global capitation agreements was reduced as the medical
loss ratio increased significantly in the central Pennsylvania region due to
increases in inpatient alternatives (such as outpatient surgery), referrals to
specialists and cost of prescription drugs.
The Company has undertaken initiatives to control its medical costs,
including global capitation arrangements, risk sharing with hospitals,
capitating specialists, national contracting of ancillary services and
rationalization of its health center operations. In March 1997, the Company
entered into agreements to sell the Company's medical offices in western
Pennsylvania and St. Louis, Missouri to major provider organizations in these
markets. The western Pennsylvania transaction closed effective March 31, 1997.
The St. Louis, Missouri agreement was completed effective May 1, 1997.
Coincident with the sale of the medical offices, the Company entered into
long-term global capitation arrangements with the purchasers of the medical
offices, pursuant to which the provider organizations will receive a fixed
percentage of premium to cover all of the costs of medical care the globally
capitated members will receive. These global capitation agreements covered
approximately 226,000, or 91%, and 83,000, or 45%, of the commercial, Medicaid
and Medicare risk membership in western Pennsylvania and St. Louis,
respectively, on the respective signing dates. In July 1997, regulatory approval
was received to add approximately 11,000 Ohio members to the western
Pennsylvania contract. The Company expects to add approximately 13,000 members
to the western Pennsylvania contract when regulatory approval is received from
West Virginia. These arrangements in western Pennsylvania and
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St. Louis, Missouri effectively reduce the Company's medical costs as a
percentage of premiums, enable the Company to reduce administrative staff in
patient utilization and medical management and shift the risk of medical costs
fluctuations to the provider networks. However, since the global capitation
arrangements are with single provider organizations covering substantial
membership, the Company is exposed to credit and operating risks with respect to
the financial strength of such organizations.
Selling, general and administrative ("SGA") expense increased $5.9
million, or 16.3%, from the prior year corresponding quarter. SGA in the second
quarter of 1996 included termination costs of $0.8 million related to personnel
reductions associated with streamlining the Company's administrative processes.
The 1997 amount includes $1.1 million of severance related to certain
executives. The increase in SGA in 1997 is primarily attributable to the
increase in full risk membership, additional personnel cost relating to
re-engineering of claims processing, information systems and customer service,
and the costs associated with the growth of the Medicare risk product in certain
markets which were not operational in the corresponding prior year quarter.
Depreciation and amortization decreased $0.4 million, or 8.7%, from
1996. This decrease is a result of the medical office sales.
At the end of the second quarter of 1996, the Company established
reserves totaling $8.2 million for anticipated losses on multi-year contracts
with certain employer groups, primarily in the St. Louis market. The Company
expects to utilize these reserves over the remaining lives of the contracts and
then either discontinue these products or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at varying
dates through 1999 and cover approximately 30,000 members. The Company
continually evaluates the underlying costs expected to be incurred in servicing
the contracts.
As discussed in note 4, effective May 1, 1997, the Company completed
its sale of its St. Louis, Missouri medical offices. The sales price was $26.9
million and the transaction resulted in a pretax gain of approximately $9.6
million.
Other income increased $0.6 million due to higher cash and investments
when compared to the prior year quarter. Interest expense increased $0.7 million
due to the higher interest rate on the Company's term loan.
Earnings from operations were $11.1 million, or $25.4 million more than
the prior year quarter. Excluding the 1997 gain from the medical office sale and
the 1996 termination cost and contract loss provisions, the operating earnings
would have been $1.5 million, or $6.8 million greater than the quarter ended
June 30, 1996. This $6.8 million increase in operating income is primarily
attributable to the decrease in medical cost.
The Company's net earnings were $6.6 million, or $15.1 million greater
than the prior year quarter. Earnings per common and common equivalent share
were $0.20 per share in the second quarter of 1997 compared to a $0.26 loss per
share in the second quarter of 1996. The weighted average common and common
equivalent shares outstanding were approximately 33,390,000 and 33,041,000 for
the quarters ended June 30, 1997 and 1996, respectively.
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RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1997 AND 1996
Managed care premiums increased $103.8 million, or 21.3%, from the
prior year six months. This increase is a result of risk membership growth of
68,055, or 9.8%, from the prior period. Growth in Medicare risk membership of
17,819 accounted for over 26% of the membership increase. The revenue increase
in the first six months was enhanced by the growth in Medicare risk membership
which has a significantly higher per member per month premium when compared to
the commercial products.
Management services revenue increased $2.0 million or 28.2% from the
prior year. This increase is primarily attributable to the increase in the
average per member per month administration fee and revenues from transition
services provided to the global capitation provider in St. Louis, Missouri.
Health benefits expense increased $95.2 million, or 22.5%, in 1997,
compared to 1996, as a result of the increase in risk enrollment and increases
in medical costs. The Company's medical loss ratio increased to 87.5% from 86.7%
in the corresponding six months. Medical loss ratios increased significantly in
the central Pennsylvania region due to increases in inpatient alternatives (such
as outpatient surgery), referrals to specialists and pharmacy. Significant
medical cost increases in the Medicare risk product in St. Louis, Missouri were
a result of increased Medicare risk membership and high utilization of inpatient
services.
The Company determined, at the end of 1996, that its Florida operations
are not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, the Company discontinued operations in the Florida HMO
market on June 30, 1997. The Company established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market and
the reserve is believed to be sufficient to cover the anticipated costs.
Selling, general and administrative ("SGA") expense increased $8.7
million, or 11.9%, from the prior year corresponding six months. SGA in the
first half of 1996 included termination costs of $6.0 million related to
personnel reductions associated with streamlining the Company's administrative
processes and reducing staffing in its medical offices. The increase in SGA is
primarily attributable to the increase in full risk membership, additional
personnel cost relating to the re-engineering of administrative processes in
claims processing, information systems and customer services, and the costs
associated with the growth of new products in certain markets which were not
operational in the corresponding prior year quarter.
Depreciation and amortization increased $0.1 million, or 1.3%, from
1996. This increase corresponds to additions in net property and equipment since
the corresponding prior year quarter which is offset by the effect of the
medical office sales in 1997.
As discussed in note 4, effective March 31, 1996, the Company completed
its sale of its western Pennsylvania medical offices. The sales price was $20
million and the transaction resulted in a pretax gain of approximately $6.0
million. Also, effective May 1, 1997, the Company completed its sale of its St.
Louis, Missouri medical offices. The sales price was $26.9 million and the
transaction resulted in a pretax gain of approximately $9.6 million.
Other income increased $1.4 million due to higher cash and investments
when compared to the prior year quarter. Interest expense increased $1.5 million
due to a higher interest rate on the Company's term loan.
Earnings from operations were $8.5 million, or $25.6 million more than
the prior year six months. Excluding the 1997 gain from the medical office sales
and the 1996 termination costs and contract loss provisions, the
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operating loss would have been $7.1 million, or $4.2 million greater than the
six months ended June 30, 1996. This $4.2 million increase in the operating loss
for the six months ended June 30, 1997 is primarily attributable to higher
medical cost in the first quarter of 1997, when compared to the first quarter of
1996, and the increase in SGA cost discussed above.
The Company's net income was $5.7 million, or $15.2 million more than
the prior year six months. Net income per common and common equivalent share was
$0.17 per share in the first half of 1997 compared to a $0.29 loss per share in
the first half of 1996. The weighted average common and common equivalent shares
outstanding were approximately 33,112,000 and 32,947,000 for the six months
ended June 30, 1997 and 1996, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total cash and investments, excluding deposits of $8.4
million restricted under state regulations, increased $3.4 million to $171.8
million at June 30, 1997 from $168.4 million at December 31, 1996. Cash and cash
equivalents increased $9.1 million to $94.8 million at June 30, 1997. Cash used
in operations of $51.7 million was primarily the result of a reduction in
medical claims payable resulting from the Company's new global capitation
arrangements where the Company no longer has medical claims risk for certain
members, and an increase in accounts receivable. Cash flows provided by
investing activities of $53.1 million were primarily the result of the sales of
medical offices and a subsidiary. Cash flows provided by financing activities
were the result of the sale of the Convertible Notes and warrants, reduced by
long-term debt repayments.
The Company's HMOs and insurance subsidiaries are required by state
regulatory agencies to maintain minimum surplus balances, thereby limiting the
dividends the Company may receive from its HMOs and insurance subsidiaries.
After giving effect to these statutory reserve requirements, the Company's
regulated subsidiaries had surplus in excess of statutory requirements of
approximately $43.7 million and $41.6 million at June 30, 1997 and December 31,
1996, respectively. Excluding funds subject to regulation, the Company had cash
and investments of approximately $20.0 million and $16.5 million at June 30,
1997 and December 31, 1996, respectively, which are available to pay
intercompany balances to regulated companies and for general corporate purposes.
As a result of losses in the fourth quarter of 1996, the Company was
not in compliance with certain revised financial covenants in its Amended Credit
Facility ("Amended Credit Facility"). The Company entered into an amended and
restated agreement ("Restated Credit Facility") with the bank group effective
March 28, 1997, that, along with other changes, converted the amount outstanding
under the Restated Credit Facility to a term loan, revised certain financial
ratios the Company is required to maintain, effectively increased the interest
rate of the indebtedness by 2.7% (to the greater of prime plus 2% or the federal
funds rate plus 2.5%) and revised the amortization period of the loan. The
Restated Credit Facility required payments of $10 million on June 30, 1997, $7
million on September 30, 1997, $18 million on December 31, 1997 and $55 million
on April 1, 1998. The Company was in compliance with the covenants contained in
the Restated Credit Facility as of June 30, 1997.
The Restated Credit Facility contains covenants relating to investments
in non-admitted assets, operating margin, net worth levels and the creation or
assumption of debt or liens on the assets of the Company. The Restated Credit
Facility is collateralized by substantially all of the assets of the Company.
On June 30, 1997, the effective interest rate on the indebtedness under
the Restated Credit Facility was 10.5%.
11
<PAGE> 14
The Restated Credit Facility requires the Company to apply 50% of the
net cash proceeds from the sale of the Convertible Notes and warrants to the
loan balance, with the payment being applied to reduce 1997 and 1998
amortization payments. The Restated Credit Facility also requires the Company to
prepay loans upon receipt of $7.5 million of tax refunds resulting from the
carryback of operating losses to prior years, with the prepayment being applied
to reduce the December 1997 amortization payment. The Restated Credit Facility
requires the Company to apply 50% of the net cash proceeds of sales of the
Company's capital stock to reduce the scheduled amortization in the inverse
order of maturity, prohibits the sale of any substantial subsidiary and
restricts the Company's ability to declare and pay cash dividends on its common
stock.
On April 2, 1997, the Company announced that it entered into a
securities purchase agreement with Warburg, Pincus Ventures, L.P. ("Warburg")
and Franklin Capital Associates III L.P. ("Franklin" and collectively with
Warburg the "Investors") for the Investors purchase of $40 million of the
Convertible Exchangeable Subordinated Notes of the Company (the "Convertible
Notes"), together with warrants to purchase 2.35 million shares of the Company's
common stock for $42.35 million. The Convertible Notes are convertible into 4
million shares of the Company's common stock. On May 9, 1997, the Investors
purchased $26.8 million of the Convertible Notes and 1.6 million warrants for an
aggregate purchase price of $28.4 million. Approximately $20 million of the
proceeds was utilized to prepay a portion of the outstanding indebtedness under
the Restated Credit Facility. Following approval from certain state insurance
regulators, the remaining investment by Warburg of approximately $13.9 million
was completed on June 30, 1997 and the total proceeds were used to retire $14
million of indebtedness under the Restated Credit Facility. The $14 million
payment was comprised of $7.0 million of mandatory prepayments from the Warburg
proceeds, $1.4 million for the required June 30 payment, $0.5 million of the
anticipated tax refund and $5.1 million of optional prepayment. The Convertible
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. Interest is payable
semi-annually and accrues at 8.3%. Interest is payable in additional Convertible
Notes and as a result, the accrued interest at June 30, 1997 has been added to
the outstanding indebtedness.
As a result of the 1997 payments, at June 30, 1997, the payments
required on December 31, 1997 and April 1, 1998 under the Restated Credit
Facility were reduced to $12.2 million and $43.8 million, respectively.
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.
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, the Convertible Notes
transaction and other financing alternatives will be sufficient to fund
continuing operations and debt service obligations through March 31, 1998. The
Company believes that completion of the Warburg transaction, strengthening its
underwriting processes, entering into global capitation arrangements, completing
the proposed medical office sales and re-engineering its administrative
processes will have a favorable effect on liquidity in 1997 and future periods.
The Company expects to refinance a portion of the amount outstanding under the
Restated Credit Facility before April 1, 1998. The Company's investment
guidelines emphasize investment grade fixed income
12
<PAGE> 15
instruments in order to provide short-term liquidity and minimize the risk to
principal.
LEGISLATION AND REGULATION
Numerous proposals have been introduced in the United States Congress
and various state legislatures relating to health care reform. Some proposals,
if enacted, could among other things, restrict the Company's ability to raise
prices and to contract independently with employers and providers. Certain
reform proposals favor the growth of managed health care, while others would
adversely affect managed care. Although the provisions of any legislation
adopted at the state or federal level cannot be accurately predicted at this
time, management of the Company believes that the ultimate outcome of currently
proposed legislation would not have a material adverse effect on the Company and
its results of operations in the short run.
As a result of the introduction of Medicare and Medicaid risk products
in 1995, the Company is subject to regulatory and legislative changes in those
two government programs. On August 5, 1997, the President signed into law the
Balanced Budget Act of 1997. This law made revisions to the Medicare program,
including permitting provider-sponsored organizations to offer services to
Medicare beneficiaries, and requiring managed care plans serving Medicare
beneficiaries to make medically necessary care available 24 hours a day, to
provide coverage a "prudent lay person" would deem necessary and to provide
grievance and appeal procedures, and prohibiting such plans from restricting
providers' advice concerning medical care. The Company does not believe this
legislation will have a material adverse effect on its operations.
RISK FACTORS
The Company's business is subject to numerous risks and uncertainties
which may affect the Company's results of operations in the future and may cause
such future results of operations to differ materially and adversely from
projections included in or underlying any forward-looking statements made by or
on behalf of the Company. See "Business-Risk Factors" contained in Item 1 of the
Company's Annual Report on Form 10-K/A for the year ended December 31, 1996,
which is incorporated herein by reference.
13
<PAGE> 16
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
In the normal course of business, the Company has been named as
defendant in various legal actions seeking payments for claims denied by the
Company, medical malpractice and other monetary damages. The Company also has
contingent litigation risks with certain discontinued operations. The claims are
in various stages of proceedings and some may ultimately be brought to trial.
Incidents occurring through June 30, 1997 may result in the assertion of
additional claims. With respect to medical malpractice, the Company carries
professional malpractice and general liability insurance for each of its
operations on a claims made basis with varying deductibles for which the Company
maintains reserves. In the opinion of management, the outcome of any of these
actions will not have a material adverse effect on the financial position or
results of operations of the Company.
Items 2, 3, 4, and 5: Not Applicable
Item 6: Exhibits and Reports on Form 8-K.
(a) Reports on Form 8-K:
(i) A report on Form 8-K relating to the Amended and Restated
Securities Purchase Agreement was filed on July 9, 1997.
(27) Financial data schedule (for SEC use only).
14
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVENTRY CORPORATION
(Registrant)
Date: August 14, 1997 By:/s/ Allen F. Wise
------------------------------ -----------------------------
Allen F. Wise
President and Chief Executive
Officer
Date: August 14, 1997 By:/s/ Dale B. Wolf
------------------------------ -----------------------------
Senior Vice President and
Chief Financial Officer
15
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