<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K/A
AMENDMENT NO. 6
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)
501 Corporate Centre Drive, Suite 400
Franklin, Tennessee 37067
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (615) 771-4141
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
<PAGE> 2
COVENTRY CORPORATION
FORM 10-K/A
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I Omitted
PART II
Item 8: Financial Statements and Supplementary Data
PART III Omitted
PART IV Omitted
</TABLE>
2
<PAGE> 3
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)
3
<PAGE> 4
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.
4
<PAGE> 5
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.
5
<PAGE> 6
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.
6
<PAGE> 7
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.
7
<PAGE> 8
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
8
<PAGE> 9
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. In the event such assets are
judged to be impaired, the fair value of the impaired asset is recorded based
on future discounted cash flows and sales recovery analysis. See Note B for
further discussion. 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
9
<PAGE> 10
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
investment 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,
10
<PAGE> 11
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.
11
<PAGE> 12
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, primarily as
a result of increases in medical costs for inpatient alternatives such as
outpatient surgery and prescriptions drugs. The Company continually evaluates
the underlying costs expected to be incurred in servicing the contracts.
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.
12
<PAGE> 13
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>
13
<PAGE> 14
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>
14
<PAGE> 15
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.
15
<PAGE> 16
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 transaction 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.
16
<PAGE> 17
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.
The Company follows APB No. 25, under which no compensation cost has been
recognized in connection with stock option grants. Had compensation cost been
determined consistent with FASB Statement No. 123, effective January 1, 1995,
the Company's net income and earnings per share would have been reduced to the
following pro forma amounts:
<TABLE>
<CAPTION>
1996 1995
-------- ------
<S> <C> <C>
Net Income:
As Reported........................................... $(61,287) $ 18
Pro Forma............................................. (64,081) (835)
Primary and Fully Diluted EPS:
As Reported........................................... $ (1.86) $ --
Pro Forma............................................. (1.95) (0.03)
</TABLE>
Because the Statement No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
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>
1996 1995 1994
--------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- -------------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year............... 2,244,542 $14.08 1,943,460 $14.60 1,732,430 $ 9.76
Granted................. 2,891,589 13.39 716,750 16.30 588,850 19.59
Exercised............... (450,224) 6.43 (246,668) 14.96 (284,820) 7.72
Canceled................ (1,823,489) 17.44 (169,000) 19.34 (93,000) 14.13
---------- ------ --------- ------ --------- ------
Outstanding at end of
year.................. 2,862,418 12.97 2,244,542 14.08 1,943,460 12.35
---------- ------ --------- ------ --------- ------
Exercisable at end of
year.................. 707,609 $15.28 1,052,873 $10.53 664,266 $ 7.41
---------- ------ --------- ------ --------- ------
</TABLE>
17
<PAGE> 18
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
RANGE OF EXERCISE PRICES AT 12/31/96 LIFE PRICES AT 12/31/96 PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 3.78 -$ 9.88................. 138,392 6.8 $ 7.53 74,226 $ 5.70
$10.00 - $11.00................ 698,000 9.8 $10.77 2,400 $11.00
$11.32 -$12.50................. 304,826 7.9 $11.79 103,572 $11.33
$12.75 - $12.75................ 1,155,414 8.3 $12.75 68,125 $12.75
$15.63 -$18.13................. 472,661 8.3 $17.11 366,411 $17.20
$18.75 - $25.00................ 93,125 7.4 $21.77 92,875 $21.78
--------- --- ------ ------- ------
$ 3.78 -$25.00................. 2,862,418 8.5 $12.93 707,609 $15.28
========= === ====== ======= ======
</TABLE>
The fair value of the stock options included in the pro forma amounts shown
above was estimated as of the grant date using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Dividend yield........................................... 0% 0%
Expected volatility...................................... 56% 74%
Risk-free interest rate.................................. 6% 6%
Expected life............................................ 5 years 3 years
</TABLE>
The weighted-average grant date fair values for options granted in 1996 and
1995 were $6.23 and $6.80, 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.
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.
18
<PAGE> 19
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
19
<PAGE> 20
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.
20
<PAGE> 21
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.
21
<PAGE> 22
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.
22
<PAGE> 23
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.
23
<PAGE> 24
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/ Dale B. Wolf Senior Vice President, Chief Financial
------------------------- Officer and Treasurer
Dale B. Wolf
Dated: March 10, 1998
24
<PAGE> 25
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------- ----------------------
23 Consent of Arthur Andersen LLP
<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. 6 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
March 9, 1998
