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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
to
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997
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
Common Stock purchase rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the registrant's voting Common Stock held
by non-affiliates of the registrant as of March 16, 1998 (computed by reference
to the closing price of such stock on The Nasdaq Stock Market) was $621,856,007.
As of March 16, 1998, there were 33,393,492 shares of the registrant's
voting Common Stock outstanding.
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COVENTRY CORPORATION
FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I Page
----
<S> <C> <C>
Item 1: Business 1
Item 2: Description of Property 9
Item 3: Legal Proceedings 9
Item 4: Submission of Matters to a Vote of Security Holders 9
PART II
Item 5: Market for Registrant's Common Equity and Related
Stockholder Matters 10
Item 6: Selected Consolidated Financial Data 11
Item 7: Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 8: Financial Statements and Supplementary Data 27
Item 9: Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 47
PART III 48
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 49
</TABLE>
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PART I
Item 1: Business
General
Coventry Corporation ("the Company") is a managed healthcare company
that at December 31, 1997, provides comprehensive health benefits and services
to 914,733 members in Pennsylvania, Ohio, West Virginia, Missouri, Illinois, and
Virginia of which 765,823 were full-risk members and 148,910 were self-insured
members. Healthcare services are provided to employer groups and government
funded groups through a variety of full-risk healthcare plans, including HMOs
and PPO products. Additionally, the Company administers self-insured health
plans of certain large employers.
Coventry was incorporated in 1986 in Delaware and changed its
jurisdiction of incorporation to Tennessee in April 1997. Its principal
executive offices are located at 501 Corporate Centre Drive, Suite 400,
Franklin, Tennessee 37067, and its telephone number is (615) 771-4141. Unless
the context indicates otherwise, references herein to "Coventry" and "the
Company" include Coventry Corporation and its subsidiaries.
The following tables show the total number of enrollees as of December
31, 1997 in the geographic markets in which Coventry conducts operations and the
products which Coventry offers:
<TABLE>
<CAPTION>
Geographic Market Dec. 31, 1997 Product Dec. 31, 1997
- ----------------- ------------- ------- -------------
<S> <C> <C> <C>
Western Pennsylvania 297,218 Commercial HMO 395,673
Central Pennsylvania 261,972 Commercial PPO/POS 227,269
St. Louis 282,165 Medicare Risk 38,314
Richmond 73,378 Medicaid (1) 104,567
Jacksonville (1) -- Non-Risk 148,910
Total: 914,733 Total: 914,733
</TABLE>
(1) Effective June 30, 1997, the Company discontinued its Medicaid operations in
Jacksonville, Florida.
Proposed Business Combination with Principal Health Care
A Capital Contribution and Merger Agreement (the "Combination
Agreement") has been entered into effective as of November 3, 1997 by and among
the Company, Principal Mutual Life Insurance Company, an Iowa mutual insurance
company ("Principal Mutual"), Principal Holding Company, an Iowa corporation and
wholly-owned subsidiary of Principal Mutual ("Holding"), Principal Health Care,
Inc., an Iowa corporation and wholly-owned subsidiary of Holding ("PHC") and
Coventry Health Care, Inc., a newly-formed Delaware corporation ("Coventry
Health Care"). PHC is a managed healthcare company, and the contributed
operations had approximately $802 million in 1997 revenues and 633,000 HMO
members in 18 markets throughout the Midwest and Southeastern United States.
Pursuant to the Combination Agreement, the Company will merge with a
wholly-owned subsidiary of Coventry Health Care (the "Merger") and PHC will
effect a capital contribution (the "Capital Contribution") to Coventry Health
Care by assigning it all of PHC's assets except for specified excluded assets
and by Coventry Health Care's assuming PHC's liabilities except for specified
excluded liabilities. Under the Merger, the Company will become a wholly-owned
subsidiary of Coventry Health Care, which will issue to the Company's
shareholders approximately 33 million shares of its common stock, representing
approximately 60% of Coventry Health Care's outstanding voting securities. Under
the Capital Contribution, Coventry Health Care will issue to PHC approximately
26 million shares of its common stock, equal to approximately 40% of Coventry
Health Care's outstanding voting securities. The transaction will be accounted
for as a purchase of the PHC assets and liabilities by Coventry Health Care, as
the successor to the Company.
In addition, Coventry Health Care will enter into an agreement to
manage certain of Principal Mutual's indemnity health insurance policies in the
Coventry Health Care markets. The management fee will be 3.3% of premium and
will expire December 31, 1999, at which time Coventry Health Care has agreed
that it will either reinsure or renew the business on the books of its
subsidiary, Coventry Health and Life Insurance Company ("CHLIC"). The indemnity
premiums for this book of business are estimated to be approximately $550
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million for 1997. Coventry Health Care will also enter into a number of other
agreements to provide marketing and other services through December 1999 to
Principal Mutual, for which Coventry Health Care will be compensated. Mutual
will receive a warrant that gives Principal Mutual the right to purchase from
Coventry Health Care that number of shares of Coventry Health Care's Common
Stock as shall equal 66 2/3% of the total number of shares of Coventry Health
Care's common stock as shall actually be issued by Coventry Health Care upon the
exercise or conversion of Company stock options, Company warrants and PHC
options outstanding as of the closing date.
The transaction is subject to various conditions, including the
approval of various state regulatory agencies and approval of the Company's
shareholders and banks. The transaction is currently expected to be completed by
the end of the first quarter or early in the second quarter of 1998. When the
transaction is completed, Principal Mutual will have the right to nominate six
directors on Coventry Health Care's 15-person Board of Directors. Principal
Mutual will enter into a shareholders' agreement containing standstill
provisions and limitations on Principal Mutual's voting rights in certain
circumstances.
Products
Commercial Health Maintenance Organizations
Coventry's HMO products provide comprehensive healthcare benefits to
enrollees, including ambulatory and inpatient physician services,
hospitalization, pharmacy, dental, optical, mental health, ancillary diagnostic
and therapeutic services. In general, a fixed monthly enrollment fee covers all
HMO services, although some benefit plans require copayments or deductibles in
addition to the basic enrollee premium. A primary care physician assumes overall
responsibility for the care of an enrollee, including preventive and routine
medical care and referrals to specialists and consulting physicians. While an
HMO enrollee's choice of providers is limited to those within the health plan's
HMO network, the HMO enrollee is typically entitled to coverage of a broader
range of healthcare services than are covered by typical reimbursement or
indemnity policies.
The Pennsylvania Health Plans have licensed HMO service areas in Pittsburgh
and eight surrounding counties in western Pennsylvania, 21 counties in central
Pennsylvania, including the cities of Harrisburg, York, Lancaster, State
College, Lebanon and Scranton and five counties in eastern Ohio. Through
Coventry Health Plan of West Virginia, Coventry serves Wheeling and 14 counties
in West Virginia. The St. Louis Health Plan service area includes St. Louis and
23 adjacent counties in Missouri and 23 counties in central and southern
Illinois. The Richmond Health Plans services Richmond, Roanoke and 38 counties
in central and southwestern Virginia.
Preferred Provider Organizations and Point of Service
Coventry, through its regional health plans, also offers fully-insured
flexible provider products, including PPO and POS products which permit
enrollees to participate in managed care but allow them to choose, at the time
services are required, to use providers not participating in the managed care
network. Deductibles and copayments generally increase the out-of-pocket costs
to the enrollee if a non-participating provider is utilized. Fully insured
PPO/POS premiums are typically lower than HMO premiums due to these increased
out-of-pocket costs borne by enrollees. Coventry's PPO and POS products are
underwritten by CHLIC. PPO/POS products are currently offered by the western
Pennsylvania, central Pennsylvania, St. Louis, and Richmond health plans.
Medicare
In late 1995, Coventry introduced a Medicare risk product under the name
"Advantra"(R) in the St. Louis market. In 1996 Coventry began marketing this
product in its western Pennsylvania and central Pennsylvania markets.
Under a Medicare risk contract, Coventry receives a fixed premium per
member, which reflects certain demographics of the Medicare population of each
region. At December 31, 1997, there were approximately 1.4 million Medicare
eligibles in Coventry's current service areas. Coventry believes that the
Medicare risk product represents substantial opportunity for enrollment growth.
However, the product also carries the risk of higher utilization and related
medical costs than commercial products, and the possibility of regulatory or
legislative changes which may reduce premiums or increase mandated benefits in
the future. Coventry is also subject to increased government regulation and
reporting requirements related to the product.
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Coventry also offers Medicare cost and supplement products. Under a Medicare
cost contract, Coventry is reimbursed by the U.S. Health Care Finance
Administration ("HCFA") only for the cost of services rendered to the plan
members, including a portion of administrative expenses. HCFA periodically
audits the cost of services and, as a result, Coventry is at risk for less than
full reimbursement. Medicare supplement members enroll individually and pay a
monthly premium for comprehensive health services not covered under Medicare. A
majority of Coventry's former Medicare cost and supplement members converted to
Coventry's Advantra product during 1996.
Medicaid
Coventry offers healthcare coverage to Medicaid recipients in the St. Louis
and central Missouri, Richmond, Virginia and central Pennsylvania markets.
Medicaid recipients in St. Louis and central Missouri markets are generally
required to choose a managed care provider. In central Pennsylvania and
Richmond, Virginia, enrollment in a Medicaid HMO is voluntary. Under a Medicaid
risk contract, the participating state pays a monthly premium based on the age
and sex of the recipients enrolled in Coventry's plans.
Coventry determined, at the end of 1996, that its Florida operations were
not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, Coventry discontinued operations in the Florida
Medicaid HMO market on June 30, 1997. Coventry established a reserve of $1.2
million at December 31, 1996 to reflect the anticipated costs of exiting this
market and the reserve is believed to be sufficient to cover the anticipated
costs. During the third quarter of 1997, Coventry determined that it will exit
its Medicaid operations in Pennsylvania. Coventry exited the Pittsburgh market
effective December 31, 1997. At December 31, 1997, the Medicaid membership was
20,028 in central Pennsylvania. Coventry anticipates exiting the central
Pennsylvania Medicaid market at the end of the first quarter of 1998.
Like the Medicare risk product, the Medicaid product makes Coventry's
financial results more susceptible to government regulation and legislative
changes in premium levels and benefit structure. Under current regulations, HMOs
offering Medicaid products on a mandatory enrollment basis must, within certain
time frames, broaden their membership to include at least 25% commercial HMO
members. Coventry believes that its existing commercial membership in its St.
Louis Health Plans satisfies the regulatory commercial membership requirements
in Missouri. See "Government Regulation."
Administrative Services Only
Coventry's health plans offer an administrative services only ("ASO")
product to large employers who self-insure their employee health benefits. Under
the ASO contracts, employers who fund their own health plans receive the benefit
of provider pricing arrangements from the health plan, and the health plan also
provides a variety of administrative services such as claims processing,
utilization review and quality assurance for the employers. The health plan
receives an administrative fee for these services but does not assume the
healthcare cost underwriting risk. Certain of Coventry's ASO contracts include
performance and utilization management standards which affect the fees received
for these services.
Delivery Systems
The health plans maintain provider networks which furnish healthcare
services through contractual arrangements with physicians, hospitals and other
healthcare providers, rather than providing reimbursement to the enrollee for
the charges of such providers. Because the health plans receive the same amount
of revenue from their enrollees irrespective of the cost of healthcare services
provided, they must manage both the utilization of services and the unit cost of
the services.
Coventry's health plans' networks historically have utilized a variety of
physician care delivery systems which differed primarily in the characterization
of the relationship between Coventry and the participating physicians. Prior to
1997, Coventry utilized staff models in western and central Pennsylvania and St.
Louis, Missouri to deliver primary care and certain specialist services through
physicians who were employed exclusively by the health plan. The exclusive
full-time employment of physicians in a staff model generally enabled the health
plan to predict costs more effectively, maintain quality and respond quickly to
consumer issues. However, staff model operations also involved substantial
investment in certain costs, such as facilities and personnel, that could not be
immediately adjusted to take into account changes in the membership or third
party provider pricing trends. In addition to providing healthcare to plan
members, these staff
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models also accepted non-member patients on a fee-for-service basis, in an
effort to help cover the costs associated with the medical offices.
Coventry's staff model operations, in recent years, suffered from
over-capacity, and Coventry was not able to increase the number of members or
other patients utilizing such operations sufficiently to make such operations
profitable. As a result, Coventry determined in late 1996 to seek to dispose of
the staff model operations in Pittsburgh, Pennsylvania and St. Louis, Missouri.
Effective March 31, 1997, Coventry completed its sale of the medical offices
associated with HealthAmerica Pennsylvania, Inc., its health plan in Pittsburgh,
Pennsylvania, to Allegheny Health, Education and Research Foundation ("AHERF"),
a major provider organization in the Pittsburgh market. The sales price was $20
million. Coincident with the sale, Coventry 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, or 91% of
the commercial, Medicaid and Medicare risk membership in western Pennsylvania.
Under the agreement, the 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, Coventry completed its sale of the medical
offices associated with Group Health Plan, Inc., its health plan in St. Louis,
Missouri, to BJC Health System ("BJC"), a major provider organization in the St.
Louis market. The sales price was $26.9 million. Coincident with the sale,
Coventry entered into a long-term capitation agreement with the purchaser
covering approximately 83,000 members, or 34.5% of the commercial, Medicaid and
Medicare risk membership in St. Louis. 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
September 30, 1997, Coventry completed its sale of its remaining five medical
offices associated with HealthAmerica Pennsylvania, Inc. to ProMedCo Management
Company. The agreement covered 21 physicians who serve approximately 12,000
members. The approximately $2.0 million proceeds from the sale approximate the
carrying value of the medical offices. These arrangements are a continuation of
Coventry's efforts to enter into capitation agreements with major providers
whereby the providers will provide all medical treatment for Coventry's members
in return for a fixed percentage of premium. While these agreements limit
Coventry's exposure to the risk of increasing medical costs, they expose
Coventry to risk as to the adequacy of the financial and medical care resources
of the provider organization. To the extent that the respective provider should
face financial difficulties or otherwise be unable to perform its obligations
under the global capitation agreements, Coventry, which is responsible for the
coverage of its members pursuant to its customer agreements, will be required to
perform such obligations, and may have to incur costs in doing so in excess of
the amounts it would otherwise have to pay under the global capitation
agreements.
In July 1997, regulatory approval was received to add approximately 11,000
Ohio members to the western Pennsylvania global capitalization contract. In
August, Coventry received regulatory approval to add approximately 13,000 West
Virginia members to the western Pennsylvania global capitalization contract.
These arrangements in western Pennsylvania and St. Louis, Missouri effectively
reduce Coventry's medical cost as a percentage of premiums, enable Coventry to
reduce administrative staff in patient utilization and medical management and
shift the risk of medical cost fluctuations to the provider networks. The
Company pays the provider a percentage of premium which ranges from 78% to 82%.
As of December 31, 1997, the global capitation agreements covered 99% and 31.8%
of the risk membership in western Pennsylvania and St. Louis, Missouri,
respectively. However, since the global capitation arrangements are with single
provider organizations, Coventry is exposed to credit and operating risks with
respect to the financial strength of such organizations. Additionally, there is
also a risk that entering into global capitation contracts with certain
providers will cause disruption in Coventry's existing provider network.
However, due to the large number of providers included in the original network,
the Company believes that the risk that an individual provider would not fulfill
their obligations is manageable.
All of Coventry's health plans offer an open panel delivery system. In an
open panel structure, individual physicians or physician groups contract with
the health plans to provide services to enrollees but also maintain independent
practices in which they provide services to individuals who are not Coventry
health plan enrollees. Coventry contracts with approximately 18,000 physicians
through the open panel model.
Health Care Provider Compensation
Under most open panel contracts, each primary care physician is paid a
monthly fixed capitation fee for each enrollee selecting the physician and may
receive additional compensation from risk-sharing arrangements with the health
plan to the extent that pre-established utilization and quality goals are
achieved. Contracting specialist physicians are compensated under both
discounted fee-for-service arrangements and capitation arrangements. The
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majority of Coventry's contracts with hospitals provide for inpatient per diem
or per case hospital rates, while outpatient services are typically contracted
on a discounted fee-for-service basis. During 1996, Coventry converted many of
its hospital and ancillary contracts from discounted fee-for-service to fixed
fee schedules or capitation agreements. During 1997, Coventry entered into
global capitation agreements in western Pennsylvania and St. Louis, Missouri,
pursuant to which the provider organizations will receive a fixed percentage of
premium to cover all of the costs of medical treatment Coventry's globally
capitated members receive from the health care systems. As of December 31, 1997
the global capitation agreements covered 99% and 31.8% of the risk membership
in western Pennsylvania and St. Louis, Missouri, respectively. However, since
the global capitation agreements are with single provider organizations and
cover substantial membership, Coventry is exposed to substantial credit and
operating risk with respect to such organizations.
Quality Assurance
Coventry has established systems to monitor the availability,
appropriateness and effectiveness of the patient care it provides. Monitoring
the number of physicians and support personnel needed for the number of
enrollees served assists in maintaining the availability of care at appropriate
levels. Utilization data collected and disseminated in the context of
controlling costs are also a valuable indicator of over or under utilization of
necessary services and helps Coventry's health plans provide optimal care to
their enrollees.
Coventry's health plans also have internal quality assurance review
committees made up of physicians and other staff members whose responsibilities
include periodic review of medical records, development and implementation of
standards of care based on current medical literature and the collection of data
relating to results of treatment. Studies are regularly conducted to discover
possible adverse medical outcomes for both quality and risk management purposes.
Appointment availability, member waiting times and environments are
monitored. A membership services department is responsible for monitoring and
maintaining enrollee satisfaction, and Coventry's health plans periodically
conduct membership surveys of both existing and former enrollees concerning
services furnished and suggestions for improvement.
The National Committee for Quality Assurance ("NCQA") is an independent,
nonprofit institution that evaluates and accredits the quality assurance
programs of managed care organizations and is recognized as the national
authority on quality. Each of the Company's plans have earned NCQA
accreditation.
Utilization Management and Review
A managed care company's profitability is dependent on maintaining effective
controls over utilization of health care services consistent with the provision
of high quality care. Each of Coventry's health plans employs physicians as
Medical Directors who oversee the delivery of medical services. The Medical
Director supervises medical managers (physicians and nurses) who review and
approve the primary care physicians' referrals to specialists and hospitals.
Medical managers also continually review the status of hospitalized patients and
compare their medical progress with established clinical criteria. In addition,
nurses make hospital rounds to review patients' medical progress and perform
quality assurance and utilization functions.
Medical managers also monitor the utilization of diagnostic services and
encourage use of outpatient surgery and testing where appropriate. Data showing
each physician's utilization profile for diagnostic tests, specialty referrals
and hospitalization are collected by each health plan and provided to the health
plan's physicians. These results are monitored by medical managers in an attempt
to ensure the use of cost-effective, medically appropriate services.
Marketing
Coventry's commercial health plans are marketed primarily to employer groups
as alternatives to conventional fee-for-service health care and indemnity health
insurance programs. Employers generally pay all or part of their employees'
health care premiums, and many continue to offer their employees a conventional
insurance plan even if one or more of Coventry's products are offered.
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Commercial marketing is generally a two-step process in which presentations
are made first to employers and then directly to employees. Once selected by an
employer, Coventry solicits enrollees from the employee base directly. During
periodic "open enrollments," in which employees are permitted to change health
care programs, Coventry uses direct mail, worksite presentations, and radio and
television advertisements to contact new enrollees. Coventry also markets
through independent insurance brokers and agents. Virtually all of Coventry's
employer group contracts are renewable annually, and enrollment is continuously
affected by employee turnover within employer groups.
Coventry's Medicaid products are marketed directly to individuals while its
Medicare products are marketed to both individuals and employer group retirees.
Individual marketing to Medicare beneficiaries is conducted through use of a
direct sales force and advertising efforts that include television, radio,
newspaper, billboards, and direct mail. Coventry also markets Medicare products
through independent insurance brokers and agents. Coventry's Medicaid and
Medicare contracts are renewable annually, and Medicare and Medicaid enrollees
may disenroll monthly.
Each of Coventry's health plans employs a full-time marketing staff,
totaling approximately 200 employees for the entire Company. The marketing staff
uses advertising and promotional material prepared by advertising firms as well
as market research programs.
No single employer group accounted for 10% or more of Coventry's
consolidated revenues in 1997. As of December 31, 1997, the employer groups
which accounted for the ten highest amounts of managed care premiums for the
western and central Pennsylvania, St. Louis and Richmond health plans
represented approximately 22.1%, 24.4%, 21.3% and 55.4%, respectively, of each
health plan's premiums. As of December 31, 1997, HealthCare USA, Inc. ("HCUSA")
received approximately $102.1 million or 86% of its revenues from the State of
Missouri. Since the closing of operations in Jacksonville, Florida, HCUSA has
received 100% of its revenues from the State of Missouri.
Competition
As of December 1997, Coventry estimated that it ranked number one in
the commercial HMO markets of western and central Pennsylvania, and number two
in the St. Louis, Missouri and Richmond, Virginia markets.
Coventry's health plans operate in highly competitive environments and
compete with other HMOs, PPOs, indemnity insurance carriers and, most recently,
physician-hospital organizations. During 1997 Coventry continued to experience
competitive pressures in its commercial products, most notably in the
Pennsylvania and Missouri markets, which adversely affected the premiums that
Coventry has historically received from new and existing members, the membership
growth opportunities, and the mix of products sold. In some cases, employer
groups have moved from the traditional commercial HMO plans toward the lower
premium flexible provider products.
Coventry believes that the principal factors influencing an employer group's
decision to choose among health care options are the price of the benefit plans
offered, locations of the health care providers, their reputation for quality
care, financial stability, comprehensiveness of coverage, and diversity of
product offerings.
Coventry also competes with other managed care organizations and indemnity
insurance carriers in seeking to obtain and retain favorable contracts with
hospitals and other providers of services to Coventry's health plans. While
Coventry believes that the relatively large membership in its health plans
places them in a favorable position in negotiating contracts, some of its
competitors represent an equal or greater number of potential patients for such
contracting providers and therefore may be in an equal or more favorable
position to negotiate provider contracts.
Government Regulation
Coventry's commercial HMOs are qualified under the federal Health
Maintenance Organization Act of 1973, as amended. Only HMOs that continue to
meet federal criteria including sound fiscal operation may retain their
qualified status. In order to maintain such qualification, HMOs are required to
set premiums pursuant to a "community rating system," which permits rating by
class ("community rating by class") and group specific rating on a prospective
basis ("adjusted community rating").
Coventry's HMOs are required to file periodic reports with, and are subject
to periodic review by, state and federal licensing authorities that regulate
them. The HMOs are required by state law to meet certain minimum
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capital and deposit and/or reserve requirements and may be restricted from
paying dividends under certain circumstances. They are also required to provide
their enrollees with certain mandated benefits. The HMOs are required to have
quality assurance and education programs for their professionals and enrollees.
Certain states' laws further require that representatives of the HMOs' enrollees
have a voice in policy making.
In 1996, the Healthcare Financing Administration ("HCFA") promulgated
regulations ("physician incentive regulations") enforcing Sections 4204(a) and
4731 of the Omnibus Budget Reconciliation Act of 1990 ("OBRA 90"). OBRA 90 and
the physician incentive regulations prohibit HMOs with Medicare, Medicaid or
CHAMPUS contracts from including any direct or indirect payment to physicians or
groups as an inducement to reduce or limit medically necessary services to
Medicare beneficiaries and Medicaid recipients. Under the physician incentive
regulations, HMOs must, among other things, disclose to HCFA their physician
compensation plan in such detail as to allow HCFA to determine compliance with
the regulations, and provide assurance that stop-loss insurance is in place, if
the HMO places a physician or physician group at "substantial financial risk"
for services provided to Medicare beneficiaries and Medicaid recipients. These
regulations took effect in 1996 and have a range of compliance dates which began
in January 1997.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
was signed into law on August 21, 1996. HIPAA amended Title I of the Employee
Retirement Income Security Act of 1974 ("ERISA"), the Code, and the Public
Health Service Act. HIPAA applies to both "group health plans" and "health
insurance issuers" and generally becomes effective for plan years beginning
after June 30, 1997. A "health insurance issuer" is defined under HIPAA to
include both insurance companies and HMOs subject to State laws that regulate
insurance. HIPAA limits the use of exclusions for preexisting conditions;
prohibits discrimination against both employees and dependents based on health
status; requires health insurance issuers to guarantee renewability and
availability of health coverage to certain employers and individuals; and
requires group health plans and health insurance issuers to issue certificates
of creditable coverage. With respect to health insurance issuers, states have
the primary responsibility for enforcement of HIPAA. (In some states, the U.S.
Department of Health and Human Services ("HHS") will be enforcing HIPAA's
requirements.) Coventry would be considered a health insurance issuer and
subject to HIPAA's requirements.
On April 1, 1997, the Departments of Labor, HHS and the Treasury issued
interim regulations that interpret many of the provisions of HIPAA. The states
are in the process of enacting implementing laws and regulations in this area.
The Newborns' and Mothers' Health Protection Act ("NMHPA") of 1996 was
signed into law on September 26, 1996. This law applies to group health plans
and health insurance issuers and becomes effective for plan years beginning on
or after January 1, 1998. NMHPA prohibits group health plans and health
insurance issuers from restricting benefits for a mother's or newborn child's
hospital stay in connection with childbirth to less than 48 hours for a vaginal
delivery or less than 96 hours for a cesarean section. Authorization or
precertification requirements cannot be imposed for these mandatory minimum
hospital stays. Coventry would be considered a health insurance issuer and
subject to NMHPA's requirements. Federal regulations implementing NMHPA have not
yet been promulgated.
The Mental Health Parity Act of 1996 ("MHPA") was signed into law on
September 26, 1996. This law applies to group health plans and health insurance
issuers and becomes effective for plan years beginning on or after January 1,
1998. MHPA prohibits group health plans and health insurance issuers providing
mental health benefits from imposing lower aggregate annual or lifetime
dollar-limits on mental health benefits than any such limits for medical and
surgical benefits. MHPA's requirements do not apply to small employers who have
between 2 and 50 employees or to any group health plan whose costs increase one
percent or more due to the application of these requirements. Coventry would be
considered a health insurance issuer and subject to NMHPA's requirements.
Federal regulations implementing MHPA have not yet been promulgated.
All of Coventry's HMOs that contract with HCFA to provide services to
Medicare beneficiaries pursuant to a Medicare risk contract are subject to
federal laws and regulations. These HMOs may also be subject to state laws
governing Medicare contracting. HCFA has the right to audit any health plan
operating under a Medicare risk contract to determine the plan's compliance with
federal law. Coventry HMOs with Medicare risk contracts must also comply with
the requirements established by peer review organizations ("PROs"), which are
organizations under contract with HCFA to monitor the quality of health care
received by Medicare beneficiaries and under contract with certain states to
monitor the quality of health care received by Medicaid recipients. In addition,
cost reimbursement reports are required with respect to Medicare cost contracts
and are subject to audit and revision.
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On August 5, 1997, the President signed into law the Balanced Budget
Act of 1997 ("BBA"). 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 BBA also revised the method of calculation of the
payments made to the Company's plan by Medicare and is expected to reduce the
annual increase in such payments from the amounts that would have been paid
under former calculation methods.
All of Coventry's HMOs that contract with states to provide services to
Medicaid recipients are subject to state and federal laws and regulations. HCFA
and the appropriate state regulatory agency have the right to audit any health
plan operating under a Medicaid managed care contract to determine the plan's
compliance with state and federal law. In some instances, states engage PROs to
perform quality assurance and utilization review oversight of Medicaid managed
care plans. Coventry HMOs would be required to abide by these PROs requirements.
The Social Security Act imposes criminal and civil penalties for paying or
receiving remuneration (which is deemed to include a kickback, bribe or rebate)
in connection with any federal health care program including, but not limited
to, the Medicare, Medicaid and CHAMPUS programs. The law and the related
regulations have been interpreted to prohibit the payment, solicitation,
offering or receipt of any form of remuneration in return for the referral of
federal health care program patients or any item or service that is reimbursed,
in whole or in part, by any federal health care program. Similar anti-kickback
provisions have been adopted by many states which apply regardless of the source
of reimbursement. The Department of Health and Human Services ("DHHS") has
adopted safe harbor regulations specifying certain relationships and activities
that are deemed not to violate the federal anti-kickback statute. Specifically,
DHHS has adopted safe harbor regulations whereby: (i) HMOs' waivers of Medicare
and Medicaid beneficiaries' obligation to pay cost-sharing amounts or to provide
other incentives in order to attract Medicare and Medicaid enrollees; and (ii)
certain discounts offered to prepaid health plans by contracting providers are
deemed not to be violations of the anti-kickback provisions. Coventry believes
that the incentives offered by its HMOs to Medicare and Medicaid beneficiaries
and the discounts its plans receive from contracting health care providers
should satisfy the requirements of the safe harbor regulations. However, failure
to satisfy each criterion of applicable safe harbor does not mean that the
arrangement constitutes a violation of the law; rather the safe harbor
regulations state that the arrangement must be analyzed on the basis of its
specific facts and circumstances. Accordingly, Coventry believes that its
arrangements do not violate the federal anti-kickback laws or similar state
anti-kickback laws.
Coventry contracts with the United States Office of Personnel Management
("OPM") to provide managed health care services under the Federal Employees
Health Benefits Program ("FEHBP"). These contracts with OPM and applicable
government regulations establish premium rating requirements for the FEHBP. OPM
conducts periodic audits of its contractors to, among other things, verify that
the premiums established under the OPM contracts are established in compliance
with the community rating and other requirements under FEHBP. During 1996,
managed care premiums were reduced by $1.7 million for the settlement with OPM
in St. Louis for 1995 and reserves for 1996 were established. The Company has
been notified by the OPM that premium audits will occur in 1998 for both the
Pennsylvania operations (years 1993 through 1997) and St. Louis operations
(years 1993 through 1997).
Numerous health care proposals have been introduced in the U.S. Congress and
in state legislatures. These include provisions which place limitations on
premium levels, increase minimum capital and reserves and other financial
viability requirements, prohibit or limit capitated arrangements or provider
financial incentives, mandate benefits (including mandatory length of stay with
surgery or emergency room coverage), limit the ability to manage care and
require contracting with all willing providers. If enacted, certain of these
proposals could have an adverse effect on Coventry. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Health Care Reform" in Part II of this Report.
Risk Management
The HMOs maintain general liability and professional liability (medical
malpractice and managed care liability) insurance coverage in amounts Coventry
believes to be adequate. Contracting physicians are also required to maintain
professional liability coverage. In addition to liability coverage, Coventry
carries "stop-loss" insurance to reimburse its HMOs for costs resulting from
catastrophic illnesses. This insurance generally covers costs in excess of
8
<PAGE> 11
$500,000 up to $1 million for any enrollee in any one year for the St. Louis,
Pennsylvania and Richmond Health Plans for commercial HMO members, costs in
excess of $150,000 up to $1 million for any Medicare enrollee in any one year
and costs in excess of $50,000 up to $1 million for any Medicaid enrollee in any
year. Some coinsurance contributions by Coventry are required. CHLIC maintains
stop-loss insurance for the flexible provider products that generally covers
costs in excess of $150,000 for any enrollee in any one year up to $1 million
per enrollee per year. No assurance can be given as to the future availability
or costs of such insurance or that risks will not exceed the limit of the
insurance coverage.
Employees
At December 31, 1997, Coventry employed approximately 2,100 persons.
None of the employees are covered by a collective bargaining agreement.
Trademarks
Coventry has the right to use the name "HealthAmerica" in Illinois,
Missouri, Pennsylvania and West Virginia. Coventry has federal and/or state
registered service marks for "HealthAssurance," "GHP Access," "Healthcare USA,"
"Doc Bear," "CarePlus," "Coventry" and "Advantra."
Item 2: Description of Property
Coventry leases in aggregate approximately 357,253 square feet of
office space primarily for administrative offices in western Pennsylvania,
central Pennsylvania, St. Louis, Missouri, Jacksonville, Florida and its
corporate office in Franklin, Tennessee. Coventry owns an administrative
building in Richmond, Virginia, which has approximately 45,000 square feet. The
Company believes that its facilities are appropriate for its operations.
Item 3: Legal Proceedings
In the normal course of business, Coventry has been named as defendant
in various other legal actions seeking payments for claims denied by Coventry,
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, 1997 may result in the assertion of additional
claims. With respect to medical malpractice, Coventry carries professional
malpractice and general liability insurance for each of its operations on a
claims-made basis with varying deductibles for which Coventry 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 Coventry.
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year 1997.
9
<PAGE> 12
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder
Matters
Price Range of Common Stock
Coventry Corporation common stock is traded in the Nasdaq Stock
Market's National Market under the symbol "CVTY." The following tables show the
quarterly range of high and low closing sales prices of the common stock on
Nasdaq during the calendar period indicated:
<TABLE>
<CAPTION>
1997 1996
- -------------------------------------------------------------------------------
High Low High Low
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------
First Quarter $12 1/2 $6 7/8 $20 7/8 $15 11/16
Second Quarter $16 $11 1/8 $20 15/16 $15 1/4
Third Quarter $19 7/8 $14 1/2 $15 5/8 $11 15/16
Fourth Quarter $18 3/8 $13 5/8 $11 1/2 $ 9
- -------------------------------------------------------------------------------
</TABLE>
As of February 2, 1998, the Company had approximately 7,500
shareholders, including persons or entities holding common stock in nominee
name, and 474 shareholders of record.
Dividends
The Company has not paid any cash dividends on its common stock and
expects for the foreseeable future to retain all of its earnings to finance the
development of its business. The Company's ability to pay dividends is also
restricted by insurance regulations applicable to its subsidiaries and by the
terms of its credit facility. Subject to the terms of such insurance regulations
and the Company's credit facility, any future decision as to the payment of
dividends will be at the discretion of the Company's Board of Directors and will
depend on the Company's earnings, financial position, capital requirements and
other relevant factors. See Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" and Note H of the Notes to Consolidated Financial Statements.
10
<PAGE> 13
Item 6: Selected Consolidated Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Operations Statement Data (1) (4) December 31,
1997 1996 1995 1994 1993
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating revenues $1,228,351 $1,057,129 $852,390 $776,643 $641,573
Operating earnings (loss) $ 5,739 $ (91,346) $ (1,275) $ 55,023 $ 43,177
Net earnings (loss) $ 11,903 $ (61,287) $ 18 $ 29,288 $ 22,005
Net earnings (loss) per share - basic (2) $ 0.36 $ (1.87) $ - $ 0.96 $ 0.77
Net earnings (loss) per share - diluted $ 0.36 $ (1.87) $ - $ 0.93 $ 0.74
Weighted average common shares outstanding - basic (4) 33,117 32,815 31,526 30,511 28,699
Weighted average shares outstanding - diluted 34,250 32,830 32,150 31,550 29,742
<CAPTION>
Balance Sheet Data (1) December 31,
1997 1996 1995 1994 1993
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash and investments $ 234,137 $ 168,423 $147,777 $133,975 $116,014
Total assets 469,331 448,945 385,675 343,771 266,971
Long-term obligations and notes
payable (including current maturities) 91,417 102,985 77,868 73,643 53,017
Stockholders' equity and
partners' capital (3) 117,818 100,427 153,851 134,124 96,906
</TABLE>
(1) All periods presented have been restated for the merger with HCUSA in
1995, Southern Health Management Corporation ("SHMC") in 1994 and for
discontinued operations.
(2) Reflects the two-for-one split of the Company's common stock which
occurred in August, 1994.
(3) Predecessor company of SHMC was an S Corporation.
(4) Restated to comply with SFAS 128, "Earnings per share."
Supplementary Financial Information
The following is a summary of unaudited quarterly results of operations
(in thousands, except per share data) for the years ended December 31, 1997 and
1996.
<TABLE>
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1997 (1) 1997 (2) 1997 (3) 1997
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $299,345 $301,081 $306,694 $321,231
Operating earnings (loss) $ (8,021) $ 1,997 $ 5,976 $ 5,787
Net earnings (loss) $ (851) $ 6,590 $ 2,658 $ 3,506
Net earnings (loss) per share - basic
and diluted $ (0.03) $ 0.20 $ 0.08 $ 0.11
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1996(4) 1996(5) 1996 1996(6)
------------------------------------------------------------------
<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 share - basic
and diluted $ (0.03) $ (0.26) $ 0.01 $ (1.58)
</TABLE>
(1) 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 sale price was $20 million and the transaction
resulted in a pretax gain of approximately $6.0 million.
(2) 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 sale
price was $26.9 million and the transaction resulted in a pretax gain
of approximately $9.6 million.
(3) In August, 1997, the Company entered into an agreement to sell the
medical offices associated with HealthAmerica, its health plan in
Harrisburg, Pennsylvania. The sale price was $2.1 million and the
transaction resulted in a pretax loss of $0.2 million. Also in the
third quarter, the Company sold its two remaining medical offices in
11
<PAGE> 14
Pittsburgh, Pennsylvania for $0.3 million in cash and recorded a pretax
loss of $0.4 million.
(4) The first quarter 1996 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.
(5) The second quarter 1996 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.
(6) The fourth quarter 1996 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).
12
<PAGE> 15
Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking information which is based upon current
expectations and involves a number of risks and uncertainties. The
forward-looking statements, which are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995, may be
affected by a number of factors, including the risk factors set forth below, and
consequently, actual operations and results may differ materially from those
expressed in these forward-looking statements. Among the factors that may
materially affect the Company's business are potential increases in medical
costs, difficulties in increasing premiums due to competitive pressures, price
restrictions under Medicaid and Medicare, imposition of regulatory restrictions,
issues relating to marketing of products, accreditation or certification by
private or governmental bodies, difficulties in obtaining or maintaining
favorable contracts with healthcare providers, credit risks on certain global
capitation arrangements, financing costs and contingencies and litigation risk.
There are also several risk factors relating to the proposed Business
Combination with PHC that may affect Coventry Health Care's business operations
after the Effective Time, including risks associated with the integration of
Coventry's and PHC's business operations and the lack of recent experience by
Coventry or PHC in the management or operation of a substantial indemnity health
insurance business.
During the three year period ended December 31, 1997, the Company
experienced substantial growth in operating revenues due primarily to membership
growth. The Company achieved this membership growth through marketing efforts,
acquisitions, geographic expansion and increased product offerings, including
the further introduction of Medicare and Medicaid risk products into its
markets.
The Company's managed care premium revenues during the three year
period ended December 31, 1997 were comprised primarily of commercial premiums
from its HMO products and flexible provider products, including PPO and POS
products for which the Company assumes full underwriting risk. Fully insured
PPO/POS premiums are typically lower than HMO premiums due to the medical
underwriting and the deductibles and copayments required from the PPO/POS
members. Prior to the sale of the Company's medical offices discussed below,
additional revenue was earned for other medical services provided on a
fee-for-service basis in those medical offices.
Premium rates for commercial HMO products are reviewed by various state
agencies based on rate filings. While the Company has not had such filings
modified, no assurance can be given that approvals for rate submissions will
continue. Premium rates for the Medicaid and Medicare risk products are
established by governmental regulatory agencies and may be reduced by regulatory
action. No assurance can be given that premium rates will not decrease in the
future.
The Company's management services revenues result from operations in
which the Company's health plans provide administrative and other services to
self-insured employers. The Company receives an administrative fee for these
services, but does not assume underwriting risk. A portion of these revenues,
however, are dependent upon the Company meeting specific performance criteria.
The Company's operating expenses are primarily medical costs including
medical claims under contracted relationships with a wide variety of providers,
capitation payments and, prior to their sale in 1997, expenses relating to the
operation of the Company's health centers. Medical claims expense also includes
an estimate of claims incurred but not reported ("IBNR"). The Company believes
that the estimates for IBNR liabilities relating to its businesses are adequate
in order to satisfy its ultimate claims liability with respect thereto. In
determining the Company's medical claims reserves, the Company employs plan by
plan standard actuarial reserve methods (specific to the plan's membership,
product characteristics, geographic territories and provider network) which
consider utilization frequency and unit costs of inpatient, outpatient,
pharmacy, and other medical costs as well as claim payment backlogs and the
changing timing of provider reimbursement practices. Calculated reserves are
reviewed by underwriting, finance and accounting, and other appropriate plan and
corporate personnel and 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.
13
<PAGE> 16
The following discussion should be read in conjunction with the
accompanying consolidated financial statements and notes.
Results of Operations
The following table (in thousands, except percentages and membership
data) is provided to facilitate a more meaningful discussion regarding the
results of the Company's operations for the three years ended December 31,
1997. (1)
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------------------------------------------------------------------
Percent of Percent Percent of Percent Percent of
Operating Increase Operating Increase Operating
Amount Revenues (Decrease) Amount Revenues (Decrease) Amount Revenues
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenues:
Managed care premiums $1,208,149 98.4 % 16.6 % $1,035,778 98.0 % 22.7 % $844,032 99.0 %
Management services 20,202 1.6 % (5.4)% 21,351 2.0 % 155.5 % 8,358 1.0 %
- -----------------------------------------------------------------------------------------------------------------------------------
Total operating revenues 1,228,351 100.0 % 16.2 1,057,129 100.0 % 24.0 % 852,390 100.0 %
- -----------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Health benefits (2) 1,039,860 84.7 % 11.7 % 930,739 88.0 % 30.5 % 713,226 83.7 %
Selling, general and
administrative 170,017 13.8 % 3.0 % 165,081 15.6 % 33.6 % 123,523 14.5 %
Depreciation and amortization 12,735 1.0 % (70.3)% 42,862 4.1 % 192.3 % 14,666 1.7 %
Provision for multi-year
contracts - - - 9,793 0.9 % - -
Merger costs - - - - - - 2,250 0.3 %
- ----------------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss) 5,739 0.5 % 106.3 % (91,346) (8.6)% NM (1,275) (0.1)%
Other income, net 24,880 2.0 % 86.0 % 13,379 1.3 % 73.6 % 7,705 0.9 %
Interest expense (10,275) (0.8)% 64.2 % (6,257) (0.6)% 28.2 % (4,881) (0.6)%
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income
taxes and minority interest 20,344 1.7 % 124.2 % (84,224) (8.0)% NM 1,549 0.2 %
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 11,903 $ (61,287) $ 18
===================================================================================================================================
Membership at December 31:
Commercial 622,942 599,218 510,815
Medicare 38,314 20,290 18,890
Medicaid 104,567 121,599 73,550
Management services 148,910 152,969 92,232
- -----------------------------------------------------------------------------------------------------------------------------------
914,733 894,076 695,487
===================================================================================================================================
</TABLE>
(1) Certain reclassifications have been made to the 1995 financial statement
and membership to conform to the 1996 presentation.
(2) The medical loss ratio (health benefits as a percentage of managed care
premiums) was 86.1%, 89.9% and 84.5% in 1997, 1996 and 1995, respectively.
Comparison of 1997 to 1996
Managed care premiums increased $172.4 million, or 16.6% to $1,208
million for 1997 compared to 1996. The revenue increase for the year was
enhanced by the growth in Medicare risk membership of 18,024 (which has a
significantly higher per member per month premium when compared to the
commercial and Medicaid products and represented an increase in premiums of
$98.2 million from $62.9 million in 1996 to $161.1 million in 1997) and
increases in premium rates as members renew. Premium yields on HMO, PPO/POS and
Medicaid members increased by 3.0%, 3.1% and 4.5% in 1997 compared to 1996,
respectively. The revenue increase is also a result of risk membership growth of
20,657, or 2.3%, from the prior year. The relatively small growth in risk
membership reflects the closing of the Florida Medicaid plan effective June 30,
1997, which had 21,747 members. Excluding the impact of exiting Florida, risk
membership grew by 52,758, or 7.4%. The Company has been notified by the OPM
that premium audits will occur in 1998 for both the Pennsylvania operations
(years 1993 through 1997) and St. Louis operations (years 1993 through 1997).
OPM accounted for approximately 4% of managed care premiums in 1997.
14
<PAGE> 17
<TABLE>
<CAPTION>
Membership
Commercial Medicare
HMO PPO/POS Risk Medicaid Non-Risk Total
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1997
Western PA 134,812 109,129 7,610 3,655 42,012 297,218
Central PA 103,310 65,028 4,531 20,028 69,075 261,972
St. Louis 103,456 52,932 26,173 78,323 21,281 282,165
Richmond 54,095 180 - 2,561 16,542 73,378
Jacksonville - - - - - -
- ---------------------------------------------------------------------------------
Total 395,673 227,269 38,314 104,567 148,910 914,733
=================================================================================
1996
Western PA 151,487 92,052 4,994 2,298 45,565 296,396
Central PA 116,246 44,704 365 11,836 71,900 245,051
St. Louis 97,689 39,579 14,931 76,829 24,574 253,602
Richmond 57,047 104 - 2,904 10,930 70,985
Jacksonville 310 - - 27,732 - 28,042
- ---------------------------------------------------------------------------------
Total 422,779 176,439 20,290 121,599 152,969 894,076
=================================================================================
</TABLE>
Health benefits expense increased $109.1 million, or 11.7%, in 1997,
compared to 1996, as a result of the increase in risk enrollment and increases
in medical costs. Coventry's medical loss ratio decreased to 86.1% from 89.9% in
the previous year. Medical loss ratios in western Pennsylvania and St. Louis
decreased due to the global capitation agreements signed in 1997. Approximately
$232.9 million and $70.8 million (22.4% and 6.8% of health benefit expense for
the 1997 period) represented amounts paid or accrued with respect to global
capitation agreements with Allegheny Health, Education and Research Foundation
("AHERF") and BJC Health System ("BJC"), respectively. See "Risk Factors --
Risks of Agreements with Providers" for a discussion of the credit and
operational risk associated with global capitation agreements with single
provider organizations. Medical loss ratios increased in the central
Pennsylvania region due to increases in inpatient alternatives (such as
outpatient surgery), referrals to specialists, pharmacy and increased health
benefit expense associated with the Medicaid membership. Significant medical
cost increases in the Medicare risk product in St. Louis, Missouri were a result
of increased Medicare risk membership and utilization of inpatient services.
Coventry determined, at the end of 1996, that its Florida operations
were not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, Coventry discontinued operations in the Florida HMO
market on June 30, 1997. Coventry established a reserve of $1.2 million at
December 31, 1996 to reflect the anticipated costs of exiting this market and
the reserve is believed to be sufficient to cover the anticipated costs. During
the third quarter of 1997, Coventry began to exit its Medicaid operations in
Pennsylvania. Coventry exited the Pittsburgh market effective December 31, 1997.
On December 31, 1997, the Medicaid membership was 20,028 in central
Pennsylvania. Coventry anticipates exiting the central Pennsylvania Medicaid
market in the first quarter of 1998.
Medical claim liability accruals are periodically monitored and
reviewed with differences for actual settlements reflected in current
operations. In addition to Coventry's procedures for determining reserves as
discussed above, Coventry reviews the actual payout of claims relating to prior
period accruals, which may take up to six months to fully develop. Medical costs
are affected by a variety of factors, including the severity and frequency of
claims, that are difficult to predict and may not be entirely within Coventry's
control. Coventry continually refines its reserving practices to incorporate new
cost events and trends.
Selling, general and administrative ("SGA") expense increased $4.9
million, or 3.0%, from the prior year, but as a percent of revenue decreased
from 15.6% in 1996 to 13.8% in 1997. SGA in 1996 included termination costs of
$8.1 million and charge-off of capitalized new market development costs of $4.3
million. The increase in SGA in 1997 is primarily attributable to the increase
in full risk membership, additional personnel costs relating to the
re-engineering of administrative processes in claims processing, information
systems and customer services and costs associated with the growth of Coventry's
Medicare risk product.
15
<PAGE> 18
Depreciation and amortization decreased $30.1 million, or 70.3%, from
1996. This decrease is primarily the result of the medical office sales in 1997,
write-off of $20.1 million of goodwill related to the PARTNERS acquisition due
to application of SFAS 121 and APB 17 in 1996 and charge-offs of $4.3 million of
property and equipment due to application of the impairment criteria of SFAS 121
in 1996.
During 1996, Coventry established reserves totaling $9.8 million for
anticipated losses on multi-year contracts with certain employer groups,
primarily in the St. Louis market. Coventry 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. Coventry continually evaluates the underlying
costs expected to be incurred in servicing the contracts.
Income from operations was $5.8 million, a $97.1 million improvement
over the prior year. Excluding the 1996 termination costs, contract loss
provisions, and capitalized costs, goodwill and other charge-offs, operating
income in 1997 was a $56.3 million improvement over the loss for 1996. This
$56.3 million improvement in operating income for 1997 is primarily attributable
to strong membership and revenue increases, a lower medical loss ratio, a lower
SGA expense ratio and lower depreciation and amortization resulting from the
medical office sales.
Other income increased $11.5 million. Effective March 31, 1997,
Coventry sold substantially all of its western Pennsylvania medical offices to
AHERF. The sales price was $20 million and the transaction resulted in a pretax
gain of approximately $6.0 million. Also, effective May 1, 1997, Coventry
completed the sale of its St. Louis, Missouri medical offices to BJC. The sales
price was $26.9 million and the transaction resulted in a pretax gain of
approximately $9.6 million. During the third quarter, Coventry completed the
sale of the remaining medical offices in Pennsylvania. The sales price for the
third quarter transactions was $2.4 million and resulted in a pretax loss of
$0.6 million. Other income for 1996 included a $4.9 million gain on sale of
Champion Dental Services, Inc.
Investment income increased $2.4 million primarily due to higher cash
and investments when compared to the prior year. Interest expense increased $4.0
million due primarily to a higher interest rate on Coventry's term loan.
Coventry's net income was $11.9 million, or $73.2 million more than the
prior year. Net income per common and common equivalent share was $0.36 per
share in 1997 compared to a $1.87 loss per share in 1996. The weighted average
number of common shares outstanding were approximately 33,117,000 and 32,815,000
for the year ended December 31, 1997 and 1996, respectively. Effective in the
fourth quarter, the Company adopted SFAS 128, "Earnings Per Share." Accordingly,
prior periods have been restated.
Comparison of 1996 to 1995
Managed care premiums increased $191.7 million, or 22.7%, to $1,036
million for the year ended 1996 compared to 1995. The increase was primarily
attributable to the 137,852 member, or 22.9%, increase in risk membership from
the prior year. Of this enrollment growth, 48,049 members, or 35%, were related
to the Medicaid product and 81,186 members, or 59%, were commercial members. The
effect on revenues of the increased membership was partially offset by changes
in commercial membership mix, with an increased percentage of that membership
composed of the lower premium PPO and POS products compared to the HMO products,
and a 4.3% decline in average HMO premium yield. The decline in average HMO
premium yield of $5.57 on a per member per month basis equated to a reduction in
premiums of approximately $26.5 million in 1996 when compared to 1995.
16
<PAGE> 19
Membership as of December 31, 1995 and 1996 was as follows:
<TABLE>
<CAPTION>
Commercial Medicare
HMO PPO/POS Risk Medicaid Non-Risk Total
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996
Western PA 151,487 92,052 4,994 2,298 45,565 296,396
Central PA 116,246 44,704 365 11,836 71,900 245,051
St. Louis 97,689 39,579 14,931 76,829 24,574 253,602
Richmond 57,047 104 - 2,904 10,930 70,985
Jacksonville 310 - - 27,732 - 28,042
----------------------------------------------------------------
Total 422,779 176,439 20,290 121,599 152,969 894,076
================================================================
1995
Western PA 149,280 71,896 - - 30,977 252,153
Central PA 103,215 17,154 - - 38,391 158,760
St. Louis 101,207 28,726 431 47,388 11,895 189,647
Richmond 55,267 2,529 - 10,969 68,765
Jacksonville - - - 26,162 - 26,162
----------------------------------------------------------------
Total 408,969 120,305 431 73,550 92,232 695,487
================================================================
</TABLE>
Coventry experienced competitive pressures in its commercial products,
which negatively affected the average premium Coventry received and the mix of
commercial products sold during 1996. As Coventry entered 1997, management
anticipated continued enrollment gains in 1997, although at a slower rate than
seen in 1996. Enrollment gains were expected to be lower than gains realized in
prior years as Coventry focused on profitability of current products and lines
of business, including efforts to increase the average premium yield. Coventry
believed that it would lose certain of its existing commercial membership due to
more stringent underwriting practices and higher revenue requirements. The
actual loss in 1997 was less than 5%.
Gains in Medicaid and Medicare enrollments increased Coventry's
exposure to government regulation of premium levels and other requirements. The
impact of legislative or regulatory changes in the Medicaid and Medicare
programs could adversely affect enrollment, premiums and profitability of these
products.
Management services revenues increased approximately $13.0 million, or
155.5% from the prior year. The increase is attributable to the approximately
60,737 member increase in this product.
Health benefits expense increased $217.5 million, or 30.5%, in 1996
compared to 1995 as a result of the increase in full-risk enrollment and
increases in medical costs. As a result of the declining premium yields
discussed above and increases in medical costs, including the effects of a
decline in the proportion of risk membership utilizing staff medical facilities
in Pittsburgh, Pennsylvania and St. Louis, Missouri, the medical loss ratios
increased in all of Coventry's markets.
Health benefits expense increased on a per member per month basis from 1995
in all markets. The increases in medical costs are attributable to increases in
the costs of inpatient services related to Coventry's Medicaid operations,
inpatient alternatives (such as outpatient surgery) and pharmacy. Additionally,
membership in Coventry's western Pennsylvania medical office operations, which
declined during 1995 primarily as a result of the loss of two significant
accounts, did not recover in 1996, continuing the excess capacity problem for
the medical office operations.
Coventry determined that its Florida Medicaid operations were not
sufficiently profitable to justify a continued presence in the Florida market
and, as a result, Coventry decided to exit the Florida Medicaid market.
Accordingly, Coventry established a reserve of $1.2 million at December 31, 1996
to reflect the anticipated costs of exiting this market.
During 1996, Coventry experienced certain fluctuations in claims
backlogs and changes in its underlying utilization and cost trends. At the end
of each quarter in 1996, Coventry estimated the effects of these events in its
reserving methodologies and provided additional estimated expenses.
17
<PAGE> 20
During the fourth quarter of 1996, Coventry confirmed through claims
payment activity that Coventry's costs had increased during 1996 at levels
slightly higher than estimated during the earlier quarters. These additional
costs were caused by both continued adverse utilization and cost severity
trends. As a result, Coventry recorded additional provisions ($25.6 million) in
the fourth quarter of 1996 to reflect additional expenses on prior quarter
claims ($4.3 million), to reflect additional expenses for current quarter claims
($3.0 million) and to provide reserves in excess of the actuarial determined
midpoint amounts. Coventry decided to provide the additional reserves due to
possible unanticipated reserve needs, the growth of Coventry's business and the
possible effects of changing provider contracting and reimbursement
methodologies. Coventry expects to maintain additional claim reserves as a part
of its ongoing reserve determinations.
SGA increased $41.6 million, or 33.6%, from 1995. As a percentage of
total operating revenues, SGA increased from 14.5% in 1995 to 15.6% in 1996 due
to increases in costs, declines in commercial premiums and the items discussed
below. Coventry decided to cease start-up development activities in certain
markets in 1996. As a result of narrowing the focus of new market development,
certain capitalized costs totaling $4.3 million were charged to SGA in 1996.
During 1996, Coventry also recorded approximately $8.1 million of charges
related to personnel terminations and related severance. These charges resulted
from administrative and medical office staff reductions due to excess capacity
and the outsourcing of certain ancillary services capabilities. Additionally,
due to an increase of 32% in premium receivables during 1996 and an increase in
the past due amounts due to delinquent collections, provisions for uncollectible
accounts were increased by approximately $5.3 million during the year. The
additional expenses were incurred during each quarter of the year as the past
due amounts increased.
Depreciation and amortization increased $28.2 million, or 192.3%, from
1995. This increase was due primarily to the write-off of goodwill related to
the recently acquired PARTNERS Health Plan of Pennsylvania, Inc. of $20.1
million. In accordance with SFAS 121, Coventry 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 Coventry 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.
Effective March 22, 1996, Coventry purchased the common stock of
PARTNERS Health Plan of Pennsylvania, Inc. ("PARTNERS") from Aetna Life &
Casualty Company ("Aetna"). At the time of acquisition PARTNERS 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 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, Coventry 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 Coventry's service areas. In addition,
Coventry 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 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. The litigation against Aetna and U.S.
Healthcare was settled recently without admission of liability by either party
and by each party releasing the other from all non-competition agreements. As of
the settlement date, the remaining intangible asset is realizable on a
discounted cash flow basis.
Other charges consisting of provisions for multi-year contracts of $9.8
million were recorded in 1996 to recognize anticipated losses on certain
multi-employer group contracts, primarily in the St. Louis market. Coventry is
utilizing these reserves over the remaining lives of the contracts and then will
either discontinue these contracts or significantly change the terms and
conditions of the contracts with these parties. The contracts expire at varying
dates through 1999 and cover approximately 30,000 members.
Operating earnings for the year 1996 decreased $90.1 million from 1995
operating earnings. The decrease is primarily attributable to the decline in
commercial yield, the increases in medical claims expense, the increase in IBNR
reserves, the asset write-downs and other charges noted above.
Other income, net increased $5.7 million, or 73.6%, from 1995. This
increase was primarily due to a $4.9 million gain on the sale of Champion Dental
Services, Inc. recorded in the fourth quarter of 1996.
18
<PAGE> 21
Interest expense increased $1.4 million in 1996 over the prior year
primarily due to a higher average outstanding debt balance for the year and an
increased interest rate on long-term debt. The majority of the approximately $35
million purchase price of PARTNERS Health Plan of Pennsylvania, Inc. was funded
through borrowings on Coventry's long-term credit agreement.
Provision for income taxes reflects a consolidated effective income tax
benefit rate of 27.1% for 1996 compared to a provision of 98.7% for 1995. The
increase in nondeductible goodwill amortization is the primary cause of the low
effective income tax benefit rate in 1996.
Loss for the year 1996 was $61.3 million. Loss per common share was
$1.87 in 1996 compared to $0.00 in the prior year. The weighted average common
shares outstanding increased to 32.8 million in 1996 compared to 31.5 million in
1995.
Liquidity and Capital Resources
Coventry's total cash and investments, excluding deposits of $6.5
million restricted under state regulations, increased $65.7 million to $234.1
million at December 31, 1997 from $168.4 million at December 31, 1996. Cash and
cash equivalents increased $68.3 million to $154.0 million at December 31, 1997.
Cash provided by operations of $22.3 million for the year was primarily the
result of operating earnings, depreciation and amortization, income tax refunds
and increases in deferred revenue and accrued liabilities offset by a reduction
in medical claims payable resulting from Coventry's new global capitation
arrangements where Coventry no longer has medical claims risk for certain
members. Cash flows provided by investing activities for the year of $50.0
million were primarily the result of the sales of medical offices and a
subsidiary. Cash flows used in financing activities were the result of long-term
debt repayments, offset by the sale of the Convertible Exchangeable Notes and
Warrants under the Warburg Agreement.
Coventry's HMOs and insurance subsidiaries are required by state
regulatory agencies to maintain minimum surplus balances, thereby limiting the
dividends Coventry may receive from its HMOs and insurance subsidiaries. After
giving effect to these statutory reserve requirements, Coventry's regulated
subsidiaries had surplus in excess of statutory requirements of approximately
$52.9 million and $41.6 million at December 31, 1997 and December 31, 1996,
respectively. Excluding funds subject to regulation, Coventry had cash and
investments of approximately $28.6 million and $16.5 million at December 31,
1997 and December 31, 1996, respectively, which are available to pay
intercompany balances to regulated companies and for general corporate purposes.
On December 29, 1997, the Company entered into a credit agreement with
a group of banks (the "Credit Facility"). The Credit Facility refinanced the
previous agreement and totaled $42.8 million. The Credit Facility bears interest
at LIBOR plus 1.75% and the entire outstanding balance is due on March 31, 1999.
The Credit Facility requires the Company to apply 50% of the net cash
proceeds of sales of the Company's equity securities to reduce the Credit
Facility, prohibits the sale of any substantial subsidiary and restricts the
Company's ability to declare and pay cash dividends on its common stock.
The Credit Facility contains covenants relating to net worth,
maintenance of statutory capital requirements, fixed charges coverage and the
creation or assumption of debt or liens on the assets of the Company. The Credit
Facility is collateralized by substantially all of the assets of the Company.
The Company is in compliance with all Credit Facility covenants.
On December 31, 1997, the effective interest rate on the indebtedness
under the Credit Facility was 7.6875%.
On April 2, 1997, Coventry announced that it entered into a securities
purchase agreement (" Warburg Agreement") with Warburg, Pincus Ventures, L.P.
("Warburg") and Franklin Capital Associates III, L.P. ("Franklin") for the
purchase of $40 million of Coventry's 8.3% Convertible Exchangeable Senior
Subordinated Notes ("Coventry Notes"), together with warrants to purchase 2.35
million shares of Coventry's common stock for $42.35 million. The Coventry
Convertible Notes are convertible into 4 million shares of Coventry Common
Stock. On May 9, 1997, Warburg and Franklin purchased $26.8 million of the
Coventry 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,
19
<PAGE> 22
$1.4 million for the required June 30 payment, $0.5 million of the anticipated
tax refund and $5.1 million of optional prepayment. During the third quarter of
1997, Coventry made payments of $7.8 million on the Restated Credit Facility.
The payments included $7.0 million of the income tax refund and $0.8 million
from the exercise of stock options.
The Coventry Convertible Notes will be exchangeable at Coventry's
option for shares of convertible preferred stock. Interest is payable
semi-annually for two years and accrues at 8.3%. Interest is payable in
additional Coventry Convertible Notes and as a result, the accrued interest at
December 31, 1997 has been added to the outstanding indebtedness.
Projected capital investments in 1998 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.
Coventry believes that cash flows generated from operations, cash on
hand and investments, excess funds in certain of its regulated subsidiaries and
other financing alternatives will be sufficient to fund continuing operations
and debt service obligations through March 31, 1999. Coventry believes that
completion of the Warburg transaction, strengthening its underwriting processes,
entering into global capitation arrangements, completing the medical office
sales and re-engineering its administrative processes will have a favorable
effect on liquidity in 1998 and future periods. Coventry's investment guidelines
emphasize investment grade fixed income instruments in order to provide
short-term liquidity and minimize the risk to principal. Coventry believes that
since its long-term investments are available for sale, the amount of such
investments should be added to short-term assets when assessing the Company's
working capital and liquidity and that short-term assets plus long-term
investments available for sale less short-term liabilities increased from $1.7
million at December 31, 1996 to $52.6 million at December 31, 1997.
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 Coventry'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 Coventry believes that the ultimate outcome of currently
proposed legislation would not have a material adverse effect on Coventry and
its results of operations in the short run.
Litigation and Insurance
The Company may be subject to certain types of litigation, including
medical malpractice claims; claim disputes pertaining to contracts and other
arrangements with providers, employer groups and their employees and individual
members; and disputes relating to HMO denials of coverage for certain types of
medical procedures or treatments. In addition, the Company has contingent
litigation risk in connection with certain discontinued operations. Such
litigation may result in losses to the Company. The Company maintains insurance
coverage in amounts the Company believes to be adequate including professional
liability (medical malpractice) and general liability insurance. Contracting
physicians are required to maintain professional liability insurance. In
addition, the Company carries "stop-loss" reinsurance to reimburse it for costs
resulting from catastrophic injuries or illnesses to its members. Nonetheless,
no assurance can be given as to the future availability or cost of such
insurance and reinsurance or that litigation losses will not exceed the limits
of the insurance coverage and reserve. In the opinion of management and based on
the facts currently known, the outcome of these actions will not have a material
adverse effect on the financial position or results of the operations of the
Company.
New Accounting Standards
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which is
effective for both interim and annual reporting periods ending after December
15, 1997. The Company adopted the new standard in its reporting for the quarter
and the year ended December 31, 1997 including required restatement of prior
periods. Adoption of this standard did not have a material impact on earnings
per share.
20
<PAGE> 23
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 does not believe that adoption of this standard will have a material
effect on its 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 does not
believe that adoption of this standard will have a material effect on its
consolidated financial statements.
Inflation
Health care cost inflation has exceeded the general inflation rate and
the Company has implemented cost control measures and risk sharing arrangements
which seek to reduce the effect of health care cost inflation. During 1997, the
Company implemented increases in premiums rates designed to offset at least a
portion of inflationary cost increases while maintaining competitive rates
within its markets. During 1996, the Company experienced downward pressure in
premium rates, and as a result implemented further cost control measures to
reduce both medical and administrative expenses.
Income Taxes
In its income tax returns, Coventry has amortized approximately $21
million of its intangible assets over periods ranging from three to eight years.
In the consolidated financial statements in the caption "Goodwill and Intangible
Assets" is an aggregate of $108.6 million of goodwill at December 31, 1997
which, for financial reporting purposes, is being amortized over periods not
exceeding 40 years. The different book and tax treatment arises because Coventry
believes the methodologies and assumptions utilized in the tax basis appraisal
of these amounts are not appropriate for financial reporting purposes. The
Omnibus Reconciliation Act of 1993 ("OBRA") enacted legislation, effective
January 1, 1993, whereby all intangibles, including goodwill, acquired in
certain transactions can be amortized for income tax purposes over 15 years.
Although the provisions of OBRA cannot be applied to the $21 million of tax
intangibles, Coventry believes that the legislation is indicative of the
government's desire to minimize the costs of intangibles controversies. Coventry
believes it will eventually sustain a tax deduction for a substantial portion of
the $21 million, but such a deduction is likely to be determined on the basis of
a compromise with the government.
Pending a final determination of its tax position, Coventry's income tax
provision has been adjusted to reflect no tax benefit in its financial
statements for the deduction of these amounts.
Quarterly Results of Operations
The quarterly consolidated results of operations of the Company are
summarized in Note U to Consolidated Financial Statements.
1998 Outlook
The Company's enrollment in January 1998 increased to approximately
916,000 members, an increase of 1.6% over January 1997. Of the January 1998
enrollment, approximately 774,000 are members under the full-risk products and
approximately 142,000 members represent lives under management services plans.
The Company and PHC operate in highly competitive markets, but the
Company generally believes that the pricing environment is improving in the
existing markets of Coventry and PHC, thus creating the opportunity for
reasonable price increases in the combined market areas. However, there is no
assurance that the Company or PHC will be able to increase premiums at rates
equal to or in excess of increases in their health care costs.
21
<PAGE> 24
For 1998, the completion of the combination with PHC will approximately
double the size of the Company and provide further profit growth opportunities.
The Company is continuing to seek to improve its underwriting processes and
oversight in both risk and non-risk products with the objective of increasing
premium yields and profitable growth in all its markets. The Company will
continue to pursue global capitation arrangements as part of its delivery system
with the objectives of involving its providers in medical cost management and
stabilizing operating margins. Administrative processes in claims, information
systems and customer services are being re-engineered to seek to lower cost and
provide high quality service. Management believes the existing Coventry and
acquired PHC markets have potential for growth in commercial, Medicare risk and,
in certain cases, Medicaid membership. Management believes that these objectives
should result in progressive improvements in operations during 1998, although
realization of the benefit of these strategies is dependent upon a variety of
factors, some of which may be outside the control of the Company.
Risk Factors
The foregoing "1998 Outlook" and other forward looking statements made
herein are based upon current expectations and involves a number of risks and
uncertainties. The forward-looking statements, which are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995,
may be affected by a number of factors, including the risk factors set forth
below, and consequently, actual operations and results may differ materially
from those expressed in these forward-looking statements.
Risks of Governmental Programs and Regulations
Coventry's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws and rules could force Coventry to
change how it does business and may restrict Coventry's revenue and/or
enrollment growth and/ or increase its health care and administrative costs.
Regulatory approvals must be obtained and maintained to market many of the
products and services of Coventry. Delays in obtaining or failure to obtain or
maintain such approvals could adversely affect Coventry's revenue or the number
of covered lives, or could increase costs.
Coventry is subject to risks associated with offering Medicaid and
Medicare risk products, including pricing and other regulatory restrictions,
potentially higher medical loss ratios and risks associated with entering new
markets. Coventry currently intends to continue to expand these products, and
its exposure to such risks will increase. Coventry's HMO subsidiaries which
provide managed health care services under the Federal Employees Health Benefits
Program are subject to audit, in the normal course of business, by the OPM, and
such audits could result in material adjustments. As discussed in "Government
Regulation," Coventry's financial results are also susceptible to future state
and federal regulatory measures, including health care reform. Recently, the
Clinton Administration and various leaders of the U.S. Congress have proposed
legislation which could result in increased costs to managed care providers.
Limitations on Ability to Increase Revenues
Increases in Coventry's revenues will be generally dependent upon its
ability to increase premiums and number of members, as well as the mix of the
products sold. Coventry's health care plan membership recently has shown only
moderate increases. Although premium rates for managed care plans generally have
increased recently, competitive pressures, regulatory restrictions and consumer
preference for lower-priced health care options may cause decreases or severely
limit increases in the future. The premiums from governmental programs such as
Medicare or Medicaid are generally not based on an individual company's
anticipated costs and cannot be adjusted by the Company, and recent legislation
has limited Medicare premium increases substantially compared to prior years.
Certain of the customers of Coventry represent a significant percentage of the
membership of one or more of their respective health plans, and the loss of one
or more of such customers could cause a material adverse effect on the revenues
of Coventry in the future.
Limits on Ability to Project Actual Health Care Costs
A substantial portion of the revenue received by Coventry is expected
to pay the costs of health care services or supplies delivered to persons
covered by its health plan and insurance products. The total health care costs
incurred by Coventry are affected by the number of individual services rendered
and the cost of each service. Much of the premium revenue is set in advance of
the actual delivery of services and the related incurring of the cost, usually
on a prospective annual basis. While Coventry attempts to base the premiums it
charges at least in part on its estimate of expected health care costs over the
fixed premium period, competition, regulations and other circumstances may limit
Coventry's ability to fully base premiums on estimated costs. In addition, many
factors may and often do cause actual health care costs to exceed those
estimated, including increased cost of individual
22
<PAGE> 25
services, catastrophes, epidemics, seasonality, general inflation, new mandated
benefits or other regulatory changes and insured population characteristics.
Accordingly, there may be discrepancies between reserves for
incurred-but-not-reported liabilities and the actual amount of such liabilities.
Historically, increases in health care prices and utilization have caused health
care costs to rise faster than general inflation. While these increases have
moderated recently, there can be no assurance that health care prices or
utilization will not again increase at a more rapid pace.
Risks of Agreements with Providers
Prior to 1997, Coventry's St. Louis and Pennsylvania health plans
offered members access to Company-owned and -staffed medical centers, as well as
to networks of contracting providers. During 1997, the Company's medical centers
were sold to provider systems which have contracted to provide care to the
Company's members continuing to use such centers. Coventry expects that
substantially all its membership will be served by providers contracting with
Coventry to provide the requisite medical care. The ability of Coventry to
contract successfully with a sufficiently large number of providers in a given
geographic market will impact the relative attractiveness of its managed care
products in those markets. The terms of such provider contracts also have a
material impact on Coventry's medical costs and its ability to control such
costs. In certain markets currently served by Coventry, certain provider systems
have significant market positions, and may compete with Coventry. If such
provider systems refuse to contract with Coventry, place Coventry at a
competitive disadvantage or use their market position to negotiate contracts
unfavorable to Coventry, Coventry's product offerings or profitability in such
market areas could be adversely affected.
Among the medical cost control techniques Coventry has utilized are
capitation agreements with providers pursuant to which providers are paid a
fixed dollar amount per member under the agreement, with the provider obligated
to provide all of a particular type of medical service required by the members,
and global capitation agreements, pursuant to which a single integrated
hospital-physician provider system provides substantially all hospital and
medical services to large number of members for a fixed percentage of the
premium charged by Coventry with respect to those members. While these systems
may shift to the contracting provider system the risk that medical costs will
exceed the amounts anticipated, Coventry will be exposed to the risk that the
provider systems will be financially unable or unwilling to fulfill their
payment or medical care obligations under the capitation agreements, and to the
risk that members may prefer other providers in the market.
Recent Operating Losses
Coventry experienced significant operating losses in 1996 and in the
first quarter of 1997 and has only recently returned to profitability. While
management of Coventry believes that its operating results will continue to
improve in 1998 and 1999, no assurance can be given that such profitability will
be achieved.
Information Systems and Administrative Expense Risks
The level of administrative expense is a significant factor in the
operating results of Coventry. While Coventry attempts to effectively manage
such expenses, increases in staff-related and other administrative expenses may
occur from time to time due to business or product start-ups or expansions,
growth or changes in business, acquisitions, regulatory requirements or other
reasons. Such expense increases are not clearly predictable, and increases in
administrative expenses may adversely affect results.
Coventry's business is significantly dependent on effective information
systems. Failure to maintain an effective and efficient information system could
result in loss of existing customers and difficulty in attracting new customers,
customer and provider disputes, regulatory problems, increases in administrative
expenses or other adverse consequences. In addition, Coventry, may, from time to
time, obtain significant portions of its systems-related or other services or
facilities from independent third parties which may make Coventry's operations
vulnerable to such third party's failure to perform adequately. Although
Coventry has undertaken programs designed to prevent material information system
disruption at January 1, 2000, such programs have not been completed and are
subject to the failure of third party vendors to comply with planned software
revisions.
23
<PAGE> 26
Financing Risk
Coventry's recent financial losses may make it more difficult to obtain
financing with similar terms to the current Credit Facility in the future. In
addition, operating losses by a subsidiary may require Coventry to make
investments in, or to refinance loans to, such subsidiary in order to maintain
required capital levels. Many of the state regulatory authorities in states in
which Coventry conducts business are expected to increase capital requirements
for managed care companies in the next two years. Coventry currently has a
credit facility with a group of banks, under which Coventry has $42.8 million of
outstanding indebtedness. The credit facility currently requires repayment in
full on April 1, 1999. Consummation of the transactions contemplated by the
Combination Agreement has received approval from Coventry's lending banks.
Risk of Competition
Coventry operates in a highly competitive industry. In many of its
geographic or product markets, Coventry will compete with a number of other
entities, some of which may have certain characteristics or capabilities that
give them an advantage in competing with Coventry. Coventry believes that there
are few barriers to entry in these markets, so that the addition of new
competitors can occur relatively easily. Certain of Coventry's existing
customers may decide to perform for themselves functions or services formerly
provided by Coventry resulting in a decrease of Coventry's projected revenue. In
addition, significant merger and acquisition activity has occurred in the
managed care industry as well as in other segments of the health care industry,
both nationally and in various local markets. This activity may create stronger
competitors and/or result in higher health care costs. To the extent that there
is strong competition or that competition intensifies in any market, Coventry's
ability to retain or increase customers, its revenue growth, its pricing
flexibility, its control over medical costs trends and its marketing expenses
may all be adversely affected.
Marketing Risk
Coventry markets its products and services through both employed sales
people and independent sales agents. Although Coventry has a number of such
sales employees and agents, if certain key sales employees or agents or a large
subset of such individuals were to leave, Coventry's ability to retain existing
customers and members could be impaired. In addition, certain of the customers
or potential customers of Coventry consider rating, accreditation or
certification of Coventry by various private or governmental bodies or rating
agencies necessary or important. Certain of Coventry's health plans or other
business units may not have obtained or may not desire or be able to obtain or
maintain such accreditation or certification which could adversely affect
Coventry's ability to obtain or retain business with such customers. The managed
care industry has recently received significant amounts of negative publicity.
Such general publicity, or any negative publicity regarding Coventry in
particular, could adversely affect Coventry's ability to sell its product or
services or could create regulatory problems for Coventry.
Litigation and Insurance Risk
The health care industry in general is susceptible to litigation and
insurance risks, including medical malpractice liability, disputes relating to
the denial of coverage and the adequacy of "stop-loss" reinsurance for costs
resulting from catastrophic injuries or illnesses. Coventry has contingent
litigation risk with certain discontinued operations. Such litigation may result
in losses to Coventry which could have a material adverse effect on the
operations, financial performance, cash flows or prospects of Coventry.
Stock Market Risk
Recently, the market prices of the securities of certain of the
publicly-held companies in the industry in which Coventry operates have shown
volatility and sensitivity in response to many factors, including public
communications regarding managed care, legislative or regulatory actions, health
care cost trends, pricing trends, competition, earnings or membership reports of
particular industry participants, and acquisition activity. There can be no
assurance regarding the level or stability of Coventry's share price at any time
or of the impact of these or any other factors on the share price.
Risk of the Combination
The Combination between Coventry and PHC involves the integration of
two companies that have previously been operated independently. Among the
factors
24
<PAGE> 27
considered by the Coventry Board of Directors in connection with its approval
of the Combination Agreement were the efficiencies that should result from such
integration. No assurance can be given that difficulties will not be encountered
in such integration, including, without limitation, difficulties relating to the
integration of the companies' management information, accounting, accrual and
control systems, executive management and culture, or that the benefits expected
from such operation and integration will be realized. Because of the demands
placed on the management information systems of the combined companies, the
integrated operations of Coventry are especially susceptible to risks associated
with a malfunction in these systems, including an impairment of the systems'
operations caused by the year 2000 problem. Any delays or unexpected costs
incurred in connection with such operation and integration could have a material
adverse effect on Coventry's business, results of operations or financial
condition. The previously discussed risk factors also apply to the operations
and assets of PHC included in the Combination. PHC has experienced operating
losses in 1995, 1996 and 1997. While Coventry management believes that the
Combination will increase the profitability of Coventry Health Care in 1998 and
1999, no assurance can be given that such profitability will be achieved.
Management of Indemnity Health Insurance Policies
Upon the closing of the Combination Agreement, Principal Mutual and
Coventry will enter into a management services agreement ("Management Services
Agreement") and a renewal rights agreement ("Renewal Rights Agreement") that
contemplate that Coventry Health Care will manage certain of Principal Mutual's
indemnity health insurance policies ("Indemnity Health Insurance Policies") in
the Coventry Health Care markets and offer to renew such policies as are in
force on December 31, 1999. Although Coventry believes that more than 50% of the
Indemnity Health Insurance Policies utilize preferred provider networks or other
elements of managed care similar to Coventry and Coventry Health Care's
business, a significant amount of the policies will be indemnity policies under
which the insurer is liable for all claims (subject to certain deductible
amounts or copayment percentages) regardless of whether the provider has an
agreement with the insurer. Neither Coventry nor PHC has any recent experience
in the management or operation of a substantial indemnity health insurance
business, and there can be no assurance that existing customers will renew their
existing indemnity health insurance policies with Mutual while the Management
Services Agreement is effective, or that such customers will agree to renew such
policies with CHLIC at the expiration of the Management Services Agreement, and
there can be no assurance that the benefits expected from the Management Service
Agreement, Renewal Rights Agreement and the agreement to reinsure the Indemnity
Health Insurance Policies ("Coinsurance Agreement") will be realized. In
addition, to the extent policy holders elect to renew the Indemnity Health
Insurance Policies with Mutual after December 31, 1999, CHLIC will be required
to reinsure such policies which will require that CHLIC increase its capital by
an amount estimated to be between $50 million to $100 million. There can be no
assurance that Coventry Health Care will be able to restructure its operations
to free up existing capital, generate sufficient funds from operations to
increase CHLIC's capital to required levels prior to December 31, 1999 or will
be able to raise such capital from external sources.
Risk of Substantial Beneficial ownership of Coventry Health Care by Mutual and
PHC
As a result of the Combination and the Capital Contribution, PHC will own
approximately 40% of the Coventry Health Care Common Stock and, although it has
agreed to a limitation on acquiring additional shares of the Coventry Health
Care Common Stock and from taking certain other actions, Mutual and its
affiliates will be permitted under certain circumstances to acquire additional
shares of Coventry Health Care Common Stock in order to maintain a collective
ownership of up to 40% of the Coventry Health Care Common Stock, and to elect
six of the fifteen members of Coventry Health Care's Board of Directors, until
the earlier of the fifth anniversary of the Effective Time or certain other
actions are taken by Coventry Health Care. After the fifth anniversary of the
Effective Time or after a third party acquires more voting securities than those
held by Mutual, there will be no restrictions on the acquisition of Coventry
Health Care Common Stock by Mutual and its affiliates. During the period from
the Effective Time until eighteen months thereafter, so long as Mutual maintains
ownership of 40% of the Coventry Health Care Common Stock, it is highly unlikely
that any matter involving a shareholder vote, including the issuance of more
than 20% of the Coventry Health Care Common Stock, or an acquisition of Coventry
Health Care by merger, consolidation, share exchange or other transaction could
be effectuated if Mutual were opposed thereto. During the period beginning
eighteen months after the Effective Time and ending on the fifth anniversary of
the Effective Time, Mutual has agreed to vote its shares in favor of an
acquisition required to be approved by shareholders that the Board has
recommended and has been approved by a majority of Coventry Health Care's
shareholders (other than Mutual and its affiliates). During the period after the
termination of the "standstill restrictions" contained in the Shareholders'
Agreement, and in any event after the fifth anniversary of the Effective Time,
there will be no restrictions on
25
<PAGE> 28
the acquisition of additional shares of Coventry Health Care Common Stock by
Mutual and its affiliates, and as a result, Mutual, in addition to having an
effective veto over transactions involving a shareholder vote (assuming it were
to continue to beneficially own 40% of Coventry Health Care's securities), could
acquire over 50% of the outstanding Coventry Health Care Common Stock and
exercise actual control of Coventry Health Care without a vote of the remaining
Coventry Health Care shareholders.
This Annual Report on Form 10-K and other filings and statements made
on behalf of the Company include forward-looking information which is based on
current expectations at the time the filing or statement is made and is subject
to a number of risks and uncertainties. Forward-looking statements, which are
made in reliance on the safe harbor provided by the Private Securities
Litigation Reform Act of 1995, may be affected by a number of factors, including
the risk factors identified herein.
26
<PAGE> 29
Item 8: Financial Statements and Supplementary Data
Report of Independent Public Accountants
To Coventry Corporation:
We have audited the accompanying consolidated balance sheets of
Coventry Corporation and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
February 23, 1998
27
<PAGE> 30
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
December 31,
- ----------------------------------------------------------------------------------
1997 1996
- ----------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $153,979 $ 85,646
Short-term investments 3,870 7,388
Accounts receivable, net of allowance for doubtful
accounts of $7,378 and $8,000, respectively 40,005 37,921
Other receivables 16,663 22,661
Assets held for sale - 23,856
Deferred income taxes 17,920 20,449
Prepaid expenses and other current assets 4,687 10,370
- ----------------------------------------------------------------------------------
Total current assets 237,124 208,291
Long-term investments 76,288 75,389
Property and equipment, net 21,937 24,979
Goodwill and intangible assets, net 108,637 118,346
Other assets 25,345 21,940
- ----------------------------------------------------------------------------------
Total assets $469,331 $448,945
==================================================================================
Liabilities and Stockholders' Equity
Medical claims liabilities $118,022 $146,082
Accounts payable 10,064 11,919
Accrued payroll and benefits 12,200 13,008
Other accrued liabilities 80,717 59,636
Deferred revenue 39,093 14,888
Current portion of long-term debt 765 36,468
- ----------------------------------------------------------------------------------
Total current liabilities 260,861 282,001
Convertible exchangeable subordinated notes 42,042 -
Long-term debt 43,677 57,291
Other long-term liabilities 4,933 9,226
Stockholders' equity:
Common stock, $.01 par value; 100,000,000 shares
authorized; 33,712,665 issued (including
439,560 shares owned by a subsidiary),
33,273,105 shares outstanding in 1997; and
33,001,296 shares issued and outstanding in 1996 337 330
Additional paid-in capital 146,426 136,142
Net unrealized investment gain 592 395
Accumulated deficit (24,537) (36,440)
Treasury stock, at cost, 439,560 shares (5,000) -
- ----------------------------------------------------------------------------------
Total stockholders' equity 117,818 100,427
- ----------------------------------------------------------------------------------
Total liabilities and stockholders' equity $469,331 $448,945
==================================================================================
</TABLE>
See notes to consolidated financial statements.
28
<PAGE> 31
Consolidated Statements of Operations
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating revenues:
Managed care premiums $1,208,149 $1,035,778 $844,032
Management services 20,202 21,351 8,358
- ---------------------------------------------------------------------------------------------------------
Total operating revenues 1,228,351 1,057,129 852,390
- ---------------------------------------------------------------------------------------------------------
Operating expenses:
Health benefits 1,039,860 930,739 713,226
Selling, general and administrative 170,017 165,081 123,523
Depreciation and amortization 12,735 42,862 14,666
Other charges - 9,793 -
Merger costs - - 2,250
- ---------------------------------------------------------------------------------------------------------
Total operating expenses 1,222,612 1,148,475 853,665
- ---------------------------------------------------------------------------------------------------------
Operating earnings (loss) 5,739 (91,346) (1,275)
Other income, net 24,880 13,379 7,705
Interest expense (10,275) (6,257) (4,881)
- ---------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes and minority interest 20,344 (84,224) 1,549
Provision for (benefit from) income taxes 8,422 (22,860) 1,530
Minority interest in earnings (loss) of
consolidated subsidiary, net of income tax 19 (77) 1
- ---------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 11,903 $ (61,287) $ 18
=========================================================================================================
Net earnings (loss) per share, basic and diluted $ 0.36 $ (1.87) $ -
=========================================================================================================
</TABLE>
See notes to consolidated financial statements.
29
<PAGE> 32
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1997, 1996 and 1995 (in thousands)
<TABLE>
<CAPTION>
Retained
Net Unrealized Earnings Total
Additional Investment Gain (Accumulated Treasury Stock Stockholders'
Common Stock Paid-In Capital (Loss) Deficit) at Cost Equity
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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
Issuance of common stock, including -
exercise of options and warrants 7 7,722 (5,000) 2,729
Issuance of warrants 2,353 2,353
Tax benefit of stock options exercised 209 209
Unrealized investment gain, -
net of income tax 197 197
Net earnings 11,903 11,903
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 $337 $146,426 $ 592 $(24,537) $(5,000) $117,818
===================================================================================================================================
</TABLE>
See notes to consolidated financial statements.
30
<PAGE> 33
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
- ----------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $ 11,903 $ (61,287) $ 18
Adjustments to reconcile net income (loss) to
cash provided by operating activities:
Depreciation and amortization 12,735 42,862 14,666
Deferred income tax benefit (11,701) (15,989) (2,029)
Gain on sales of medical offices & property disposals (13,338) - -
Increase in receivable due to sale of subsidiary - (5,500) -
Non-cash interest on convertible debt 2,042 - -
Other (383) 84 (25)
Changes in assets and liabilities of continuing operations,
net of effects of the purchase of subsidiaries:
Accounts receivable (2,432) (5,285) (7,099)
Other receivables 715 (6,749) (4,913)
Prepaid expenses and other current assets 2,013 (907) (3,890)
Other assets 2,874 (5,652) (11,332)
Medical claims liabilities (28,060) 49,350 21,736
Accounts payable (1,327) 2,742 4,374
Other accrued liabilities 14,438 32,781 9,205
Income taxes payable 12,889 6,315 (15,173)
Deferred revenue 24,205 549 (3,756)
Other long-term liabilities (4,312) 1,251 3,882
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 22,261 34,565 5,664
- ----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures, net (7,218) (12,688) (16,319)
Sales of investments 37,329 75,511 53,224
Purchases of investments & other (34,137) (80,049) (59,319)
Payments for purchases of subsidiaries,
net of cash acquired - (27,256) (2,524)
Proceeds from sale of subsidiary & medical offices 53,977 - -
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 49,951 (44,482) (24,938)
- ----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of convertible exchangeable notes 40,000 40,164 13,116
Payments on long-term debt (48,961) (14,474) (14,740)
Net proceeds from issuance of stock 2,729 5,746 16,917
Proceeds from issuance of stock warrants 2,353 - -
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (3,879) 31,436 15,293
- ----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 68,333 21,519 (3,981)
Cash and cash equivalents at beginning of period 85,646 64,127 68,108
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period 153,979 85,646 64,127
======================================================================================================================
</TABLE>
See notes to consolidated financial statements.
31
<PAGE> 34
Notes to Consolidated Financial Statements
Years Ended December 31, 1997, 1996 and 1995
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Coventry Corporation ("the Company" or "Coventry") is a managed health
care company that provides comprehensive health benefits and services to members
in Pennsylvania, Ohio, West Virginia, Missouri, Illinois and Virginia.
Healthcare services are provided to employer groups and government funded groups
through a variety of full-risk healthcare plans, including HMO, POS and PPO
products. Additionally, Coventry administers self-insured health plans of
certain large employers.
The Company began operations in 1987 with the acquisition of the
American Service Companies ("ASC") entities, including Coventry Health and Life
Insurance Company ("CHLIC"). 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, Inc. ("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. Interests of other investors in
the Company's majority-owned (or otherwise effectively-controlled) subsidiaries
are accounted for as minority interests and are included in other liabilities
for financial reporting purposes.
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, commercial paper 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 - The Company accounts for investments in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". 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 a specific identification basis.
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 primarily consist of debt securities.
Other Receivables - Other receivables include interest receivable,
reinsurance claims 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 No. 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 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. Assets held for sale are recorded at the lower of
the carrying amount or fair value, less any costs associated with disposition.
32
<PAGE> 35
Goodwill and Intangible Assets - Goodwill and intangible assets consist
of costs in excess of the fair value of the net assets of subsidiaries or
operations acquired ($108.6 million at December 31, 1997). Goodwill is amortized
over periods ranging from 15 to 40 years. Accumulated amortization of goodwill
and intangible assets was approximately $44.0 million and $40.3 million at
December 31, 1997 and 1996, 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.
Other Assets - Other assets consist of loan acquisition costs, assets
related to the supplemental executive retirement plan (Note N to consolidated
financial statements), restricted assets, 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 were amortized over their expected period of benefit 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. $2.7 million of expense was included
in SGA expense due to this change. These costs are fully amortized at December
31, 1997. Accumulated amortization of other assets was approximately $9.1
million and $3.6 million at December 31, 1997 and 1996, 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. Premiums for services to
federal employee groups are subject to audit and review by the OPM on a periodic
basis. Such audits are usually a number of years in arrears. The Company
provides reserves, on an estimated basis annually, based on the appropriate
guidelines. Any differences between actual results and estimates are recorded in
the year the audits are finalized. The adjustments have not been material to the
financial statements of the Company.
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 1997 and 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. See Note B for discussion
of HealthMate.
Stock-based Compensation - In 1995, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation." As permitted by SFAS 123, the
Company has elected to continue to account for stock-based compensation to
employees under APB Opinion No. 25, and complies with the disclosure
requirements for SFAS 123. See Note J.
Earnings per Share - In the fourth quarter of 1997, the Company adopted
Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share." SFAS 128 establishes new standards for computing and presenting earnings
per share ("EPS"), replacing primary EPS with "basic EPS." Basic EPS
33
<PAGE> 36
excludes dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS are not presented in these financial statements as the
calculation is either antidilutive or does not differ from basic EPS. The
adoption of SFAS 128 did not have a material effect on the Company's financial
position or results of operations. All prior periods have been restated to
comply with SFAS 128. See Note Q for calculation of EPS.
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 does not believe that adoption of this standard will have
a material effect on its 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 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 does not
believe that adoption of this standard will have a material effect on its
consolidated financial statements.
Reclassifications - Certain 1995 and 1996 amounts have been
reclassified to conform to the 1997 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. At July 28, 1995, HCUSA operated a 26,000 member
HMO in Jacksonville and northeastern Florida, and through a subsidiary provided
managed care services to Missouri Medicaid recipients. At December 31, 1997,
HCUSA's Missouri subsidiary had approximately 78,000 enrollees. The Company's
consolidated financial statements have been restated to include the results of
HCUSA for all periods presented. 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 HCUSA's financial statements to agree
with Coventry's presentation.
In connection with the merger, 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.
At the end of 1996, the Company determined that the HCUSA Florida
operations were not sufficiently profitable to justify a continued presence in
the Florida market and, as a result, the Company discontinued operations in the
Florida HMO market on June 30, 1997.
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
34
<PAGE> 37
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. The litigation against Aetna and U.S.
Healthcare was settled recently without admission of liability by either party.
Management believes the remaining intangible is realizable on a discounted cash
flow basis.
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. At 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.
During the third quarter of 1997, the Company determined that the
HealthMate operations were not sufficiently profitable to justify continuation
in the central Pennsylvania Medicaid market, and as a result, the Company
intends to discontinue such operations at the end of the first quarter of 1998.
Such discontinuance is subject to approval of the Commonwealth of Pennsylvania
and its various regulatory agencies.
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.
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 prescription drugs. During 1997, $7.8 million was
utilized over the lives of the respective contracts and offset against health
benefit expense. 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,
- -------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Land $ 481 $ 481
Buildings and leasehold improvements 9,583 8,427
Equipment 40,795 39,162
- -------------------------------------------------------------------------------
50,859 48,070
Less accumulated depreciation (28,922) (23,091)
- -------------------------------------------------------------------------------
$ 21,937 $ 24,979
===============================================================================
</TABLE>
E. SALE OF MEDICAL OFFICES
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,
35
<PAGE> 38
including regulatory approval. Accordingly, property and equipment with a
carrying value of approximately $23.9 million was classified as a current asset
on the 1996 balance sheet.
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 $20.0 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 premiums 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 premiums to cover all of the medical treatment the globally
capitated members will receive.
In August 1997, the Company entered into agreements to sell certain
medical offices associated with HealthAmerica, its health plan in Harrisburg,
Pennsylvania. The sales price was $2.1 million and the transaction resulted in a
pretax loss of $0.2 million. Additionally, in the third quarter, the Company
sold its two remaining medical offices in Pittsburgh, Pennsylvania for $0.3
million in cash and recorded a pretax loss of $0.4 million. All gains or losses
resulting from medical office sales are reflected in other income, net.
F. INVESTMENTS IN DEBT AND EQUITY SECURITIES
The Company considers all of its investments as available for sale
securities and accordingly, records unrealized gains and losses in the
stockholders' equity section of its consolidated balance sheet. As of December
31, 1997 and 1996, stockholders' equity was increased by approximately $0.6
million and $0.4 million, respectively, net of a deferred tax cost of $0.4
million and $0.1 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, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair
1997 Cost Gain Loss Value
--------------------------------------------------
<S> <C> <C> <C> <C>
State and municipal bonds $50,438 $769 $ - $51,207
Asset-backed securities 9,935 74 - 10,009
Mortgage-backed securities 11,621 37 - 11,658
US Treasury securities 4,900 81 - 4,981
Other debt securities 2,278 25 - 2,303
Equity securities - - - -
---------------------------------------------------
$79,172 $986 $ - $80,158
===================================================
<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>
36
<PAGE> 39
The amortized cost and estimated fair value of short-term and long-term
investments by contractual maturity were as follows at December 31, 1997 and
December 31, 1996 (in thousands):
<TABLE>
<CAPTION>
1997 Amortized Fair
Cost Value
-------------------------
<S> <C> <C>
Maturities:
Within 1 year $ 4,086 $ 4,055
1 to 5 years 29,073 29,396
6 to 10 years 12,707 12,879
Over 10 years 33,306 33,828
Other securities without stated maturity - -
-------------------------
Total short-term and long-term securities $79,172 $80,158
=========================
<CAPTION>
1996 Amortized Fair
Cost Value
-------------------------
<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>
Proceeds from the sale of investments were approximately $37 million
and $76 million for the twelve months ended December 31, 1997 and 1996,
respectively. Gross investment gains of approximately $275,000 and gross
investment losses of $194,000 were realized on these sales for the twelve months
ended December 31, 1997 compared to gross investment gains of $45,000 and gross
investment losses of $14,000 for the year ended December 31, 1996. Realized
gains and losses from securities sales are determined on the specific
identification of the securities.
G. INCOME TAXES
The provision (benefit) for income taxes consisted of the following (in
thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
- ---------------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Current provision (benefit):
Federal $16,439 $ (6,181) $ 3,125
State 3,684 (690) 434
Deferred provision (benefit):
Federal (9,943) (15,565) (1,819)
State (1,758) (424) (210)
- ---------------------------------------------------------------------------------
$ 8,422 $(22,860) $ 1,530
=================================================================================
</TABLE>
The expected tax provision 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,
1997 1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal tax rate 35.00% (35.00%) 35.00%
- ---------------------------------------------------------------------------------
Effect of:
State income taxes, net of federal benefit 6.15% (1.40%) 9.40%
Amortization of goodwill 5.98% 10.26% 69.07%
Tax exempt interest income (5.54%) (1.25%) (75.37%)
Merger costs - - 49.71%
Other (0.19%) 0.25% 10.92%
- ---------------------------------------------------------------------------------
Income tax provision (benefit) 41.40% (27.14%) 98.73%
=================================================================================
</TABLE>
37
<PAGE> 40
The effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997 and 1996 are presented below (in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
- ----------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Deferred revenue $ 3,123 $ 742
Medical liabilities 4,590 7,816
Accounts receivable 5,128 2,897
Deferred compensation 3,776 3,660
Accrued professional fees 622 3,571
Provision for long-term contracts 778 3,183
Accrued reorganization 604 1,126
Property and equipment 1,811 -
Other assets 4,966 -
Contingent liabilities 1,594 1,844
Net operating loss carryforward 1,433 2,534
- ----------------------------------------------------------------------------------
Gross deferred tax assets 28,425 27,373
Less valuation allowance (916) (911)
- ----------------------------------------------------------------------------------
Deferred tax asset $27,509 $26,462
- ----------------------------------------------------------------------------------
Deferred tax liability:
Property and equipment - (609)
Capitalized development costs - (1,806)
Other 11 (402)
Unrealized gain on securities available for sale (394) (58)
- ----------------------------------------------------------------------------------
Gross deferred tax liabilities (383) (2,875)
- ----------------------------------------------------------------------------------
Net deferred tax asset $27,126 $23,587
==================================================================================
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1997
is $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, 1997 will be allocated to reduce goodwill and other
intangible assets if the realization of the net operating loss carryforwards
becomes more likely than not.
H. 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 "Coventry Convertible
Notes"), together with warrants to purchase 2.35 million shares of the Company's
common stock, for $42.4 million. On May 9, 1997, the Investors purchased $26.8
million of the Coventry 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 ($13.2 million of the Coventry Convertible Notes and 0.75 million
warrants) was completed on June 30, 1997. The Coventry Convertible Notes will be
exchangeable at the Company's or Warburg's option for shares of Series A
Convertible Preferred Stock ("Preferred Stock"). The authorization of 6,000,000
shares of Preferred Stock was approved by the Company's shareholders at the 1997
shareholders' meeting.
The Coventry Convertible Notes accrue interest at 8.3% payable in
interest notes semiannually in arrears for the first two years and at 5.0%
payable in cash or in interest notes semiannually in arrears, thereafter. The
interest notes accrue interest from the point of issuance under the same terms
and conditions as the Coventry Convertible Notes. The Coventry Convertible Notes
and interest notes are subordinate to the Company's Credit Facility described in
Note I. Subject to repayment of the Company's Credit Facility, the Coventry
Convertible Notes are required to be repaid in an amount equal to 33%, 50% and
100%, respectively, of the aggregate principal amount outstanding as of the
fifth, sixth and seventh anniversaries of the respective Coventry Convertible
Note's issuance date. The Coventry Convertible Notes may be prepaid at the
option of the Company after the third anniversary date of issuance if the market
price of the Company's common stock exceeds certain targets.
38
<PAGE> 41
The Coventry Convertible Notes and interest notes are exchangeable for
Preferred Stock at a $10 per share conversion rate. The Preferred Stock accrues
dividends at 8.3% until May 29, 1999. Dividends are payable in additional shares
of Preferred Stock. The Preferred Stock may be called and is required to be
repaid with the same repayment terms as the Coventry Convertible Notes. The
Preferred Stock is convertible into common stock on a share for share basis.
The Coventry Convertible Notes and interest notes are convertible into
common stock at a $10 per share conversion rate.
I. NOTES PAYABLE AND LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
--------------------------
<S> <C> <C>
Borrowings under the Credit Facility $42,824 $ 90,000
Notes payable to U.S. DHHS 1,173 1,762
Other notes payable 445 1,997
--------------------------
44,442 93,759
Less current portion of long-term debt (765) (36,468)
--------------------------
Total long-term debt $43,677 $ 57,291
==========================
</TABLE>
On December 29, 1997, the Company entered into a credit agreement with
a group of banks (the "Credit Facility"). The Credit Facility refinanced the
previous agreement and totaled $42.8 million. The Credit Facility bears interest
at LIBOR plus 1.75% (7.69% at December 31, 1997) and the entire outstanding
balance is due on March 31, 1999.
The Credit Facility requires the Company to apply 50% of the net cash
proceeds of sales of the Company's equity securities to reduce the Credit
Facility, prohibits the sale of any substantial subsidiary and restricts the
Company's ability to declare and pay cash dividends on its common stock.
The Credit Facility contains covenants relating to net worth,
maintenance of statutory capital requirements, fixed charges coverage and the
creation or assumption of debt or liens on the assets of the Company, among
other restrictions. The Credit Facility is collateralized by substantially all
of the assets of the Company. The Company is in compliance with all Credit
Facility covenants.
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.
The fair value of the Company's long-term borrowings is based on quoted
market rates. The carrying amount of the Company's borrowings approximates fair
value.
Maturities of long-term debt during each of the ensuing five years
ending December 31 and thereafter are as follows (in thousands):
<TABLE>
<CAPTION>
Year Amount
---- ------
<C> <C>
1998 $ 765
1999 43,261
2000 416
Thereafter -
-------
$44,442
=======
</TABLE>
J. STOCK OPTIONS, WARRANTS AND EMPLOYEE STOCK PURCHASE PLAN
As of December 31, 1997, the Company had six 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.
39
<PAGE> 42
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.
During 1997, the Company adopted the 1997 Stock Incentive Plan (the
"1997 Plan"). Under the 1997 Plan, the Company may grant options and other
rights with respect to the Company's common stock to officers, other key
employees, consultants and outside directors of the Company. A total of
1,600,000 shares of common stock was reserved for this issuance.
With the merger of SHS in December 1994, the Company assumed SHS'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 SHS common
stock granted under SHS's incentive stock option plan. These options were
exercisable upon the completion of the merger with SHS 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.
In 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation." SFAS 123 establishes new financial accounting and
reporting standards for stock-based compensation plans. As allowed, the Company
has adopted only the disclosure requirements of SFAS 123. As a result, no
compensation cost has been recorded for the Company's stock option plans.
The Company follows APB No. 25, under which no compensation cost has
been recognized in connection with stock option grants. Had compensation cost
for these plans been determined consistent with SFAS 123, the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- ------
<S> <C> <C> <C> <C>
Net income (loss): As Reported $11,903 $(61,287) $ 18
Pro Forma 8,790 (63,949) (786)
EPS, basic
and diluted: As Reported $ 0.36 $ (1.87) $ -
Pro Forma 0.26 (1.95) (0.02)
</TABLE>
Because the SFAS 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, 1997 were as follows (shares in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
Weighted Weighted
Weighted Average Average
Average Exercise Exercise
Shares Exercise Price Shares Price Shares Price
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 2,858 $13 2,381 $14 2,276 $12
Granted 1,584 $15 2,898 $13 714 $16
Exercised (166) $12 (621) $ 6 (407) $ 7
Canceled (1,015) $14 (1,800) $17 (202) $17
- -----------------------------------------------------------------------------------------------------------------
Outstanding at end of year 3,261 $13 2,858 $13 2,381 $14
- -----------------------------------------------------------------------------------------------------------------
Exercisable at end of year 819 $13 708 $15 1,053 $11
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
40
<PAGE> 43
The following table summarizes information about stock options
outstanding at December 31, 1997 (shares in thousands):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices at 12/31/97 Life Prices at 12/31/97 Price
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 3 - $ 9 163 7.1 $ 7 63 $ 7
$ 9 - $11 664 8.8 $11 194 $11
$11 - $13 1,063 8.0 $12 320 $12
$13 - $16 826 9.4 $16 42 $16
$16 - $18 331 9.7 $17 1 $17
$18 - $25 214 7.2 $19 199 $19
--------------------------------------------- ------------------------
$ 3 - $25 3,261 8.6 $13 819 $13
============================================== ========================
</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>
1997 1996 1995
-----------------------------------------------------------------------
<S> <C> <C> <C>
Dividend yield 0% 0% 0%
Expected volatility 64% 56% 74%
Risk-free interest rate 6% 6% 6%
Expected life 5 years 5 years 6 years
-----------------------------------------------------------------------
</TABLE>
The weighted-average grant date fair values for options granted in
1997, 1996 and 1995 were $8.77, $6.61 and $10.09, respectively.
At December 31, 1997, 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.
On July 7, 1997, the Company finalized the sale of $40 million of
Convertible Exchangeable Subordinated Notes of the Company, together with
warrants to purchase 2.35 million shares at $10.625 per share of Coventry Common
Stock. The warrants were valued at $1.00 each by Coventry and the purchaser and
expire in seven years from purchase date. The Company has the right to force the
exercise of these warrants after three years if the market price of the
Company's common stock meets certain targets.
As of December 31, 1997, the Company had reserved an aggregate of
approximately 7.2 million common shares for options and warrants, approximately
1.4 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 7,144, 19,465
and 13,267 shares in 1997, 1996 and 1995, respectively, under this plan.
K. 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 1997, 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
41
<PAGE> 44
$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.
Reinsurance premiums for the years ended December 31, 1997, 1996 and
1995, were approximately $0.7 million, $1.8 million and $2.8 million,
respectively. Reinsurance recoveries for the same periods were approximately
$0.4 million, $1.5 million and $0.9 million.
L. COMMITMENTS
The Company operates primarily in leased facilities with original lease
terms of up to five years with options for renewal. 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 ending December 31 and thereafter for noncancellable
operating leases are as follows (in thousands):
<TABLE>
<CAPTION>
Year Amount
---- ------
<C> <C>
1998 $ 6,212
1999 3,327
2000 2,411
2001 1,951
2002 1,345
Thereafter 115
--------
$ 15,361
========
</TABLE>
Total rent expense was approximately $8.3 million, $11.7 million and
$10.5 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
M. 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 E to consolidated financial statements, the
Company entered 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. Coventry may utilize the following to manage such
risk: 1) contract with providers with significant net worth and cash reserves;
2) require letters of credit or cash to be reserved for claims payment and 3)
monitor the providers' financial condition in regard to the Coventry membership.
As of December 31, 1997, the western Pennsylvania, central
Pennsylvania, St. Louis, Richmond and HCUSA subsidiaries comprised 28%, 21%,
18%, 2% and 31% of accounts receivable, respectively. The Company's largest
employer group, the U.S. Office of Personnel Management, accounted for
approximately 4% of the Company's managed care premiums in 1997 and
approximately 2% of the accounts receivable at December 31, 1997. The Company
has been notified by the OPM that premium audits will occur in 1998 for both the
Pennsylvania operations (years 1993 through 1997) and St. Louis operations
(years 1993 through 1997). See Note A for additional information on accounting
policies.
42
<PAGE> 45
The Company believes the allowance for doubtful collections adequately
provides for estimated losses as of December 31, 1997. The Company has a risk of
incurring loss if such allowances are not adequate.
As discussed in Note K to consolidated financial statements, the
Company has reinsurance agreements with a major insurance company. The Company
monitors the insurance company's financial ratings to determine compliance with
standards set by state law and requirements of the Credit Facility. The Company
has a credit risk associated with these reinsurance agreements to the extent the
insurance company is unable to pay valid reinsurance claims of the Company.
N. 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 retirement 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
deferral. Prior to 1998, 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. Effective January 1, 1998, employees
vest in the Company's matching contributions ratably over two years, based on
length of service. All costs of the Plan are funded by the Company as they are
incurred.
Effective January 1, 1998, 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 will make matching contributions of the
Company's common stock 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 deferral. Employees
will vest in the Company's matching contributions in 50% increments annually
over a period of 2 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 retirement 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 deferral and 50% of the employee's contribution on
the second 3% of the employee's compensation deferral. 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 1997, 1996 and 1995 was approximately
$1.8 million, $2.4 million and $3.1 million, respectively.
O. 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 $13.8 million at December 31, 1997. Combined statutory capital and
surplus of the Company's HMOs was approximately $42.6 million. The states in
which the Company's HMOs operate require the HMOs to maintain deposits with the
Department of Insurance. At December 31, 1997, these deposits totaled $2.9
million and are included as other long-term assets in the consolidated balance
sheets.
CHLIC is required to maintain minimum statutory capital and surplus
of approximately $1.4 million. Statutory capital and surplus of CHLIC as of
43
<PAGE> 46
December 31, 1997 was approximately $25.5 million. Statutory deposits for CHLIC
as of December 31, 1997 totaled approximately $3.6 million.
P. OTHER INCOME
Other income for the years ended December 31, 1997, 1996, and 1995
includes investment income of approximately $10.8 million, $8.4 million and $7.4
million, respectively. As described in Note E, other income includes $15.0
million in 1997 from the sale of medical offices. 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.
Q. EARNINGS PER SHARE
Basic EPS is based on the weighted average number of common shares
outstanding during the year. Diluted earnings per share assumes the conversion
of convertible notes and the exercise of all options and warrants using the
treasury stock method. Net income is increased for interest expense on the
convertible notes.
The following table summarizes the earnings and the average number of
common shares used in the calculation of basic and diluted earnings per share
(in thousands, except for per share amounts):
<TABLE>
<CAPTION>
1997
---------------------------------------------------
Income Shares
(Numerator) (Denominator) Per Share Amount
---------------------------------------------------
<S> <C> <C> <C>
Net Income $ 11,903
-------------
Basic EPS $ 11,903 33,117 $ 0.36
Effect of Dilutive Securities
Options and warrants - 758
Convertible notes 427 375
---------------------------------------------------
Diluted EPS $ 12,330 34,250 $ 0.36
===================================================
<CAPTION>
1996
---------------------------------------------------
Income Shares
(Numerator) (Denominator) Per Share Amount
---------------------------------------------------
<S> <C> <C> <C>
Net Income $(61,287)
--------------
Basic EPS $(61,287) 32,815 $(1.87)
Effect of Dilutive Securities
Options and warrants - 15
---------------------------------------------------
Diluted EPS $(61,287) 32,830 $(1.87)
===================================================
<CAPTION>
1995
---------------------------------------------------
Income Shares
(Numerator) (Denominator) Per Share Amount
---------------------------------------------------
<S> <C> <C> <C>
Net Income $ 18
-------------
Basic EPS $ 18 31,526 $ 0.00
Effect of Dilutive Securities
Options and warrants - 624
-------------------------------------------------
Diluted EPS $ 18 32,150 $ 0.00
=================================================
</TABLE>
44
<PAGE> 47
R. SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Cash paid (received) during the periods for interest and income taxes
is as follows (in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
- ---------------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest $ 7,572 $ 5,862 $ 4,517
Income taxes (refunds) $ (4,456) $ 1,309 $ 16,410
</TABLE>
S. 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, 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 these actions
will not have a material adverse effect on the financial position or results of
operations of the Company.
T. SUBSEQUENT EVENT
A Capital Contribution and Merger Agreement (the "Combination
Agreement") has been entered into effective as of November 3, 1997 by and among
the Company, Principal Mutual Life Insurance Company, an Iowa mutual insurance
company ("Principal Mutual"), Principal Holding Company, an Iowa corporation and
wholly-owned subsidiary of Principal Mutual ("Holding"), Principal Health Care,
Inc., an Iowa corporation and wholly-owned subsidiary of Holding ("PHC") and
Coventry Health Care, Inc., a newly-formed Delaware corporation ("Coventry
Health Care"). PHC is a managed healthcare company, and the contributed
operations had approximately $802 million in 1997 revenues and 633,000 HMO
members in 18 markets throughout the Midwest and Southeastern United States.
Pursuant to the Combination Agreement, the Company will merge with a
wholly-owned subsidiary of Coventry Health Care (the "Merger") and PHC will
effect a capital contribution (the "Capital Contribution") to Coventry Health
Care by assigning it all of PHC's assets except for specified excluded assets
and by Coventry Health Care's assuming PHC's liabilities except for specified
excluded liabilities. Under the Merger, the Company will become a wholly-owned
subsidiary of Coventry Health Care, which will issue to the Company's
shareholders approximately 33 million shares of its common stock, representing
approximately 60% of Coventry Health Care's outstanding voting securities. Under
the Capital Contribution, Coventry Health Care will issue to PHC approximately
26 million shares of its common stock, equal to approximately 40% of Coventry
Health Care's outstanding voting securities. The transaction will be accounted
for as a purchase of the PHC assets and liabilities by Coventry Health Care, as
the successor to the Company.
In addition, Coventry Health Care will enter into an agreement to
manage certain of Principal Mutual's indemnity health insurance policies in the
Coventry Health Care markets. The management fee will be 3.3% of premium and
will expire December 31, 1999, at which time Coventry Health Care has agreed
that it will either reinsure or renew the business on the books of its
subsidiary, Coventry Health and Life Insurance Company. The indemnity premiums
for this book of business are estimated to be approximately $550 million for
1997. Coventry Health Care will also enter into a number of other agreements to
provide marketing and other services through December 1999 to Principal Mutual,
for which Coventry Health Care will be compensated. Mutual will receive a
warrant that gives Principal Mutual the right to purchase from Coventry Health
Care that number of shares of Coventry Health Care's Common Stock as shall equal
66 2/3% of the total number of shares of Coventry Health Care's common stock as
shall actually be issued by Coventry Health Care upon the exercise or conversion
of Company stock options, Company warrants and PHC options outstanding as of the
closing date.
The transaction is subject to various conditions, including the
approval of various state regulatory agencies and approval of the Company's
shareholders and banks. The transaction is currently expected to be completed by
the end of the first quarter or early in the second quarter of 1998. When the
transaction is completed, Principal Mutual will have the right to nominate six
directors on Coventry Health Care's 15-person Board of Directors. Principal
Mutual will enter into a shareholders' agreement containing standstill
provisions and limitations on Principal Mutual's voting rights in certain
circumstances.
45
<PAGE> 48
U. 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, 1997 and
1996.
<TABLE>
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1997 (1) 1997 (2) 1997 (3) 1997
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $299,345 $301,081 $306,694 $321,231
Operating earnings (loss) $ (8,021) $ 1,997 $ 5,976 $ 5,787
Net earnings (loss) $ (851) $ 6,590 $ 2,658 $ 3,506
Net earnings (loss) per share - basic
and diluted $ (0.03) $ 0.20 $ 0.08 $ 0.11
<CAPTION>
Quarter Ended
March 31, June 30, September 30, December 31,
1996(4) 1996(5) 1996 1996(6)
---------------------------------------------------------------------------------
<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 share - basic
and diluted $ (0.03) $ (0.26) $ 0.01 $ (1.58)
</TABLE>
(1) 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 sale price was $20 million and the transaction
resulted in a pretax gain of approximately $6.0 million.
(2) 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 sale
price was $26.9 million and the transaction resulted in a pretax gain
of approximately $9.6 million.
(3) In August, 1997, the Company entered into an agreement to sell the
medical offices associated with HealthAmerica, it health plan in
Harrisburg, Pennsylvania. The sale price was $2.1 million and the
transaction resulted in a pretax loss of $0.2 million. Also in the
third quarter, the Company sold its two remaining medical offices in
Pittsburgh, Pennsylvania for $0.3 million in cash and recorded a pretax
loss of $0.4 million.
(4) The first quarter 1996 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.
(5) The second quarter 1996 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.
(6) The fourth quarter 1996 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).
46
<PAGE> 49
Item 9: Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
47
<PAGE> 50
PART III
Pursuant to General Instruction G of Form 10-K, the Registrant will file the
information required by Part III on or before April 30, 1998 by an amendment to
this Form 10-K.
48
<PAGE> 51
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Form 10-K
Pages
---------
<S> <C>
Report of Independent Public Accountants 27
Consolidated Balance Sheets, December 31, 1997 and 1996 28
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995 29
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995 30
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995 31
Notes to Consolidated Financial Statements, December 31,
1997, 1996, and 1995 32 - 46
2. Financial statement schedules
Report of Independent Public Accountants S-1
Schedule II - Valuation and Qualifying Accounts S-2
3. Exhibits required to be filed by Item 601 of Regulation S-K.
Exhibit
No. Description of Exhibit
<S> <C>
2.1 Capital Contribution and Merger Agreement dated as of November 3,
1997 ("Combination Agreement") by and among Coventry Corporation,
Coventry Health Care, Inc., Principal Mutual Life Insurance
Company, Principal Holding Company and Principal Health Care,
Inc. (Incorporated by reference to Exhibit 2.1 to Form S-4,
Registration Statement No. 333-45821, of Coventry Health Care,
Inc.).
2.2 Agreement and Plan of Merger by and among Coventry Corporation,
Coventry Health Care, Inc. and Coventry Merger Corporation
(Incorporated by reference to Exhibit 2.2 to Form S-4,
Registration Statement No. 333-45821 of Coventry Health Care,
Inc.).
2.3 Agreement and Plan of Merger dated April 14, 1997 between
Coventry Corporation, a Tennessee corporation and Coventry
Corporation, a Delaware corporation.
3.1 Charter of Coventry Corporation (Incorporated by reference to
Exhibit 3(i) to the Coventry Corporation Current Report on Form
8-K dated April 14, 1997).
3.2 Articles of Amendment to Charter of Coventry Corporation dated
August 28, 1997.
3.3 Bylaws of Coventry Corporation (Incorporated by reference to
Exhibit 3(ii) to Coventry Corporation Current Report on Form 8-K
filed April 14, 1997).
4.1 Specimen Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 to Form 10-K for the year ended December 31, 1995).
4.2 Rights Agreement dated February 7, 1996 between Coventry
Corporation and Chemical Mellon Shareholder Services, L.L.C.
(Incorporated by reference to Exhibit 4 to Coventry Corporation
Form 8-K dated February 7, 1996).
4.3 First Amendment to Rights Agreement, dated May 7, 1997 by and
between Coventry Corporation and Chase Mellon Shareholder
Services, LLC. (Incorporated by reference to Exhibit 11, Coventry
Corporation Form 8-K dated May 7, 1997).
4.4 Amended and Restated Securities Purchase Agreement dated as of
April 2, 1997, by and among Coventry Corporation, Warburg, Pincus
Ventures, L.P. and Franklin Capital Associates III, L.P.,
together with Exhibit A (Form of Convertible Note), Exhibit B
(Form of warrant) and Exhibit C (Form of Certificate of
Designation of Series A Preferred Stock) (Incorporated by
reference to Exhibit 10 to Coventry Corporation Form 8-K dated
May 7, 1997).
4.5 Amended Form of Convertible Note.
4.6 Consent of Warburg, Pincus Ventures, L.P. dated November 3, 1997.
10.1 Form of warrant to be issued to Principal Mutual Life Insurance
Company pursuant to the Combination Agreement (Incorporated by
reference to Exhibit 10.1 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
10.2 Form of Coinsurance Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.2
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.3 Form of Renewal Rights Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.3
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.4 Form of Transition Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.4
to
</TABLE>
49
<PAGE> 52
<TABLE>
<S> <C>
Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.5 Form of Management Services Agreement to be executed pursuant
to the Combination Agreement (Incorporated by reference to
Exhibit 10.5 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.6 Form of Shareholders Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.6
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.7 Form of Tax Benefit Restitution Agreement to be executed pursuant
to the Combination Agreement (Incorporated by reference to
Exhibit 10.7 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.8 Form of License Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.8
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.9 Form of Marketing Service Agreement to be executed pursuant to
the Combination Agreement (Incorporated by reference to Exhibit
10.9 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.10 Employment Agreement dated September 16, 1996 executed by Allen
F. Wise (Incorporated by reference to Exhibit 10 (iv) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996 filed March 31, 1997)
10.11 Employment Agreement dated December 30, 1996 executed by Dale B.
Wolf (Incorporated by reference to Exhibit 10 (v) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996 filed March 31, 1997).
10.12 Form of Company's Agreement (for Key Senior Executives) dated
September 12, 1995 (executed by Richard H. Jones) (Incorporated
by reference to Exhibit (xxviii) to Form 10-Q, Quarterly Report,
for the quarter ended September 30, 1995).
10.13 Second Amended and Restated 1987 Statutory-Nonstatutory Stock
Option Plan (Incorporated by reference to Exhibit 10.8.1 attached
to Annual Report on Coventry Corporation's Form 10-K for fiscal
year ended December 31, 1993).
10.14 Third Amended and Restated 1989 Stock Option Plan (Incorporated
by reference to Exhibit 10.8.2 attached to Coventry Corporation's
Annual Report on Form 10-K for fiscal year ended December 31,
1993).
10.15 1993 Outside Directors Stock Option Plan (as amended) (See Exhibit
10.8.3 attached to the Coventry Corporation's Annual Report on
Form 10-K for the year ended December 31, 1995).
10.16 1993 Stock Option Plan (as amended) (See Exhibit 10.8.4 attached
to the Coventry Corporation's Annual Report on Form 10-K for the
year ended December 31, 1995).
10.17 Coventry Corporation 1997 Stock Incentive Plan, as amended.
10.18 Coventry Corporation Supplemental Executive Retirement Plan
("SERP") effective July 1, 1994 (Incorporated by reference to
Exhibit 4.2 to Coventry Corporation's Form S-8, Registration
Statement No. 33-81358).
10.19 First Amendment to SERP dated December 31, 1996.
10.20 Second Amendment to SERP dated July 15, 1997.
</TABLE>
50
<PAGE> 53
<TABLE>
<S> <C>
10.21 Southern Health Management Corporation 1993 Stock Option Plan
(Incorporated by reference to Exhibit 10.8.5 to Coventry
Corporation's Annual Report on Form 10-K for the year ended
December 31, 1995).
10.22 Employment Agreement dated October 14, 1996 executed by Joe
Carroll (Incorporated by reference to Exhibit 10 (xxii) to
Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.23 Employment Agreement dated November 11, 1996 executed by
Richard H. Jones (Incorporated by reference to Exhibit 10 (xxiv)
to Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.24 Employment Agreement dated January 24, 1997 executed by
Robert A. Mayer (Incorporated by reference to Exhibit 10 (xxvii)
to Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.25 Risk Sharing Agreement dated as of March 31, 1997 by and among
Health America Pennsylvania Inc., Coventry Corporation and
Allegheny Health, Education and Research Foundation.
(Incorporated by reference to Exhibit 10.1 to Coventry
Corporation's Form 8-K/A dated March 12, 1998)*
10.26 First Amendment to Risk Sharing Agreement, dated June 11, 1997,
by and between Coventry Corporation and Allegheny Health,
Education & Research Foundation. (Incorporated by reference to
Exhibit 10.2 to Coventry Corporation's Form 8-K/A dated March 12,
1998)*
10.27 Second Amendment to Risk Sharing Agreement, dated June 30, 1997,
by and between Coventry Corporation and Allegheny Health,
Education & Research Foundation. (Incorporated by reference to
Exhibit 10.3 to Coventry Corporation's Form 8-K/A dated March 12,
1998)*
10.28 Third Amendment to Risk Sharing Agreement, dated August 25, 1997,
by and between Coventry Corporation and Allegheny Health,
Education & Research Foundation.
10.29 Global Capitation Agreement, dated March 12, 1997, by and among
Group Health Plan, Inc., HealthCare USA of Missouri, LLC and BJC
Health Systems. (Incorporated by reference to Exhibit 10.5 to
Coventry Corporation's Form 8-K/A dated March 12, 1998)*
10.30 Credit Agreement dated as of December 29, 1997 among the Company,
Morgan Guaranty Trust Company of New York, NationsBank, N.A. and
Morgan Guaranty Trust Company of New York as agent ($42,823,577
Credit Facility) (Incorporated by reference to Exhibit 10 of
Coventry Corporation's Current Report on Form 8-K dated January
8, 1998).
11.1 Computation of Net Earnings Per Common and Common Equivalent Share
21.1 Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP (See Exhibit 23 attached to this
Report)
27 Financial Data Schedule (for SEC use only)
* Portions of this exhibit have been omitted and have been accorded
confidential treatment pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934, as amended.
</TABLE>
(b) Reports on Form 8-K
Registrant filed on November 11, 1997, a Current Report on
Form 8-K dated as of November 8, 1997 reporting under Item 5
that it had entered into a Capital Contribution and Share
Exchange Agreement dated as of November 3, 1997 with Coventry
Health Care, PHC, Principal Holding Company and Principal Mutual.
51
<PAGE> 54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
COVENTRY CORPORATION
By: /s/ Allen F. Wise President, Chief Executive Officer and Director
------------------------
Allen F. Wise
By: /s/ Dale B. Wolf Senior Vice President, Chief Financial Officer,
------------------------ Treasurer and Principal Accounting Officer
Dale B. Wolf
Dated: March 24, 1998
Pursuant to the requirements of the Securities and Exchange Act of
1934, this Report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE (PRINCIPAL FUNCTION) DATE
--------- -------------------------- ----
<S> <C> <C>
/s/ John H. Austin, M.D., M.P.H. Chairman of the Board and March 24, 1998
- -------------------------------- Director
John H. Austin, M.D., M.P.H.
/s/ Allen F. Wise President, Chief Executive March 24, 1998
- -------------------------------- Officer and Director
Allen F. Wise
/s/ Dale B. Wolf Senior Vice President, Chief March 24, 1998
- -------------------------------- Financial Officer, Treasurer
Dale B. Wolf and Principal Accounting
Officer
/s/ Lawrence N. Kugelman Director March 24, 1998
- --------------------------------
Lawrence N. Kugelman
/s/ Laurence DeFrance Director March 24, 1998
- --------------------------------
Laurence DeFrance
/s/ Emerson D. Farley, Jr., M.D. Director March 24, 1998
- --------------------------------
Emerson D. Farley, Jr., M.D.
/s/ Richard H. Jones Director March 24, 1998
- --------------------------------
Richard H. Jones
/s/ Phillip N. Bredesen Director March 24, 1998
- --------------------------------
Phillip N. Bredesen
/s/ Patrick T. Hackett Director March 24, 1998
- --------------------------------
Patrick T. Hackett
Director
- --------------------------------
Rodman W. Moorhead, III
</TABLE>
52
<PAGE> 55
ARTHUR ANDERSEN LLP
Nashville, Tennessee
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Coventry Corporation:
We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Coventry Corporation and subsidiaries for
the three years ended December 31, 1997 included in this Form 10-K and have
issued our report thereon dated February 23, 1998. Our audits were made for the
purpose of forming an opinion on the basic consolidated financial statements
taken as a whole. The schedule listed under Item 14(a)(2) is the responsibility
of the Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth herein in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
February 23, 1998
S-1
<PAGE> 56
SCHEDULE II
COVENTRY CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Balance at Additions Charged Balance
Beginning of to Costs and Deductions (Charge at End of
Period Expenses (1) (2) Offs) (1) (2) Period
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Allowance for doubtful accounts $8,000 $2,748 $(3,370) $7,378
Year ended December 31, 1996:
Allowance for doubtful accounts $2,700 $8,000 $(2,700) $8,000
Year ended December 31, 1995:
Allowance for doubtful accounts $2,200 $3,100 $(2,600) $2,700
</TABLE>
(1) Additions to the allowance for doubtful accounts are included in selling,
general and administrative expense. All deductions or charge offs are
charged against the allowance for doubtful accounts.
(2) Additions to the allowance for retroactive terminations are included in
revenue.
S-2
<PAGE> 57
INDEX TO EXHIBITS
Reg. S-K
Item 601
<TABLE>
<CAPTION>
Exhibit
No. Description of Exhibit
<S> <C>
2.1 Capital Contribution and Merger Agreement dated as of November 3,
1997 ("Combination Agreement") by and among Coventry Corporation,
Coventry Health Care, Inc., Principal Mutual Life Insurance
Company, Principal Holding Company and Principal Health Care,
Inc. (Incorporated by reference to Exhibit 2.1 to Form S-4,
Registration Statement No. 333-45821, of Coventry Health Care,
Inc.).
2.2 Agreement and Plan of Merger by and among Coventry Corporation,
Coventry Health Care, Inc. and Coventry Merger Corporation
(Incorporated by reference to Exhibit 2.2 to Form S-4,
Registration Statement No. 333-45821 of Coventry Health Care,
Inc.).
2.3 Agreement and Plan of Merger dated April 14, 1997 between
Coventry Corporation, a Tennessee corporation and Coventry
Corporation, a Delaware corporation.
3.1 Charter of Coventry Corporation (Incorporated by reference to
Exhibit 3(i) to the Coventry Corporation Current Report on Form
8-K dated April 14, 1997).
3.2 Articles of Amendment to Charter of Coventry Corporation dated
August 28, 1997.
3.3 Bylaws of Coventry Corporation (Incorporated by reference to
Exhibit 3(ii) to the Coventry Corporation Current Report on Form
8-K filed April 14, 1997).
4.1 Specimen Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 to Form 10-K for the year ended December 31, 1995).
4.2 Rights Agreement dated February 7, 1996 between Coventry
Corporation and Chemical Mellon Shareholder Services, L.L.C.
(Incorporated by reference to Exhibit 4 to Coventry Corporation
Form 8-K dated February 7, 1996).
4.3 First Amendment to Rights Agreement, dated May 7, 1997 by and
between Coventry Corporation and Chase Mellon Shareholder Services,
LLC (Incorporated by reference to Exhibit 11, Coventry
Corporation Form 8-K dated May 7, 1997)
4.4 Amended and Restated Securities Purchase Agreement dated as of
April 2, 1997, by and among Coventry Corporation, Warburg, Pincus
Ventures, L.P. and Franklin Capital Associates III, L.P.,
together with Exhibit A (Form of Convertible Note), Exhibit B
(Form of warrant) and Exhibit C (Form of Certificate of
Designation of Series A Preferred Stock) (Incorporated by
reference to Exhibit 10 to Coventry Corporation Form 8-K dated
May 7, 1997).
4.5 Amended Form of Convertible Note.
4.6 Consent of Warburg, Pincus Ventures, L.P. dated November 3, 1997.
10.1 Form of warrant to be issued to Principal Mutual Life Insurance
Company pursuant to the Combination Agreement (Incorporated by
reference to Exhibit 10.1 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
10.2 Form of Coinsurance Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.2
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.3 Form of Renewal Rights Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.3
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.4 Form of Transition Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.4
to
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Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.5 Form of Management Services Agreement to be executed pursuant
to the Combination Agreement (Incorporated by reference to
Exhibit 10.5 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.6 Form of Shareholders Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.6
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.7 Form of Tax Benefit Restitution Agreement to be executed pursuant
to the Combination Agreement (Incorporated by reference to
Exhibit 10.7 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.8 Form of License Agreement to be executed pursuant to the
Combination Agreement (Incorporated by reference to Exhibit 10.8
to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.9 Form of Marketing Service Agreement to be executed pursuant to
the Combination Agreement (Incorporated by reference to Exhibit
10.9 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
10.10 Employment Agreement dated September 16, 1996 executed by Allen
F. Wise (Incorporated by reference to Exhibit 10 (iv) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996 filed March 31, 1997)
10.11 Employment Agreement dated December 30, 1996 executed by Dale B.
Wolf (Incorporated by reference to Exhibit 10 (v) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996 filed March 31, 1997).
10.12 Form of Company's Agreement (for Key Senior Executives) dated
September 12, 1995 (executed by Richard H. Jones) (Incorporated
by reference to Exhibit (xxviii) to Form 10-Q, Quarterly Report,
for the quarter ended September 30, 1995).
10.13 Second Amended and Restated 1987 Statutory-Nonstatutory Stock
Option Plan (Incorporated by reference to Exhibit 10.8.1 attached
to Annual Report on Coventry Corporation's Form 10-K for fiscal
year ended December 31, 1993).
10.14 Third Amended and Restated 1989 Stock Option Plan (Incorporated
by reference to Exhibit 10.8.2 attached to Coventry Corporation's
Annual Report on Form 10-K for fiscal year ended December 31,
1993).
10.15 1993 Outside Directors Stock Option Plan (as amended) (See Exhibit
10.8.3 attached to the Coventry Corporation's Annual Report on
Form 10-K for the year ended December 31, 1995).
10.16 1993 Stock Option Plan (as amended) (See Exhibit 10.8.4 attached
to the Coventry Corporation's Annual Report on Form 10-K for the
year ended December 31, 1995).
10.17 Coventry Corporation 1997 Stock Incentive Plan, as amended.
10.18 Coventry Corporation Supplemental Executive Retirement Plan
("SERP") effective July 1, 1994 (Incorporated by reference to
Exhibit 4.2 to Coventry Corporation's Form S-8, Registration
Statement No. 33-81358).
10.19 First Amendment to SERP dated December 31, 1996.
10.20 Second Amendment to SERP dated July 15, 1997.
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10.21 Southern Health Management Corporation 1993 Stock Option Plan
(Incorporated by reference to Exhibit 10.8.5 to Coventry
Corporation's Annual Report on Form 10-K for the year ended
December 31, 1995).
10.22 Employment Agreement dated October 14, 1996 executed by Joe
Carroll (Incorporated by reference to Exhibit 10 (xxii) to
Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.23 Employment Agreement dated November 11, 1996 executed by
Richard H. Jones (Incorporated by reference to Exhibit 10 (xxiv)
to Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.24 Employment Agreement dated January 24, 1997 executed by
Robert A. Mayer (Incorporated by reference to Exhibit 10 (xxvii)
to Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.25 Risk Sharing Agreement dated as of March 31, 1997 by and among
Health America Pennsylvania Inc., Coventry Corporation and
Allegheny Health, Education and Research Foundation.
(Incorporated by reference to Exhibit 10.1 to Coventry
Corporation's Form 8-K/A dated March 12, 1998)*
10.26 First Amendment to Risk Sharing Agreement, dated June 11, 1997,
by and between Coventry Corporation and Allegheny Health,
Education & Research Foundation. (Incorporated by reference to
Exhibit 10.2 to Coventry Corporation's Form 8-K/A dated March 12,
1998)*
10.27 Second Amendment to Risk Sharing Agreement, dated June 30, 1997,
by and between Coventry Corporation and Allegheny Health,
Education & Research Foundation. (Incorporated by reference to
Exhibit 10.3 to Coventry Corporation's Form 8-K/A dated March 12,
1998)*
10.28 Third Amendment to Risk Sharing Agreement, dated August 25, 1997,
by and between Coventry Corporation and Allegheny Health,
Education & Research Foundation.
10.29 Global Capitation Agreement, dated March 12, 1997, by and among
Group Health Plan, Inc., HealthCare USA of Missouri, LLC and BJC
Health Systems. (Incorporated by reference to Exhibit 10.5 to
Coventry Corporation's Form 8-K/A dated March 12, 1998)*
10.30 Credit Agreement dated as of December 29, 1997 among the Company,
Morgan Guaranty Trust Company of New York, NationsBank, N.A. and
Morgan Guaranty Trust Company of New York as agent ($42,823,577
Credit Facility) (Incorporated by reference to Exhibit 10 of
Coventry Corporation's Current Report on Form 8-K dated January
8, 1998).
11.1 Computation of Net Earnings Per Common and Common Equivalent Share
21.1 Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP (See Exhibit 23 attached to this
Report)
27 Financial Data Schedule (for SEC use only)
* Portions of this exhibit have been omitted and have been accorded
confidential treatment pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934, as amended.
</TABLE>
<PAGE> 1
EXHIBIT 2.3
AGREEMENT AND PLAN OF MERGER
This AGREEMENT AND PLAN OF MERGER (the "Agreement") is made as of the
14th day of April, 1997 by and between Coventry Corporation, a Tennessee
corporation ("New Coventry"), and Coventry Corporation, a Delaware corporation
("Old Coventry") (collectively, the "Constituent Corporations").
RECITALS
WHEREAS, all of the issued and outstanding shares of capital stock of
New Coventry are owned beneficially and of record by Old Coventry;
WHEREAS, the sole purpose of the Plan of Merger embodied herein is to
effect a migratory merger within the meaning of Section 368(a)(1)(F) of the
Internal Revenue Code of 1986, as amended; and
WHEREAS, each of the Constituent Corporations has, subject to approval
by their respective shareholders, adopted the plan of merger embodied in this
Agreement, and the Constituent Corporations and their respective Boards of
Directors deem it advisable and in the best interest of each of the Constituent
Corporations that Old Coventry be merged with and into New Coventry pursuant to
the applicable corporation laws of Tennessee and Delaware.
AGREEMENT
NOW, THEREFORE, the Constituent Corporations do hereby agree to merge,
on the terms and conditions herein provided, as follows:
1. THE MERGER.
1.1 Governing Law. Old Coventry shall be merged into New
Coventry in accordance with the applicable laws of the States of
Tennessee and Delaware. New Coventry shall be the surviving corporation
and shall be governed by the laws of the State of Tennessee.
1.2 Effective Date. The "Effective Date" of the merger shall
be, and such term as used herein shall mean the date on which Articles
of Merger prepared in accordance herewith are filed in the office of
the Secretary of State of Tennessee and a Certificate of Merger
prepared in accordance herewith is filed in the office of the Secretary
of State of Delaware, all after satisfaction of the requirements of
applicable laws of the states prerequisite to such filings.
2. SHARE CONVERSION.
2.1 Stock of Old Coventry. On the Effective Date, each share
of Common Stock of Old Coventry issued and outstanding immediately
prior to the merger shall automatically be converted into and become,
without further action by the holder thereof, one share of Common Stock
of New Coventry. As of and after the Effective Date, each outstanding
certificate which, prior to the Effective Date represented shares of
Common Stock of Old Coventry shall be deemed for all purposes to
evidence ownership of, and to represent an equal number of shares of
Common Stock of New Coventry.
2.2 Stock of New Coventry. Upon the Effective Date, by virtue
of the merger and without any action on the part of the holder thereof,
each share of Common Stock of New Coventry outstanding immediately
prior thereto shall be cancelled and returned to the status of
authorized but unissued shares.
<PAGE> 2
3. EFFECT OF THE MERGER.
3.1 Rights, Privileges, Etc. On the Effective Date, New
Coventry, without further act, deed or other transfer, shall retain or
succeed to, as the case may be, and possess and be vested with all the
rights, privileges, immunities, powers, franchises and authority, of a
public as well as of a private nature, of the Constituent Corporations;
all property of every description and every interest therein and all
debts and other obligations of or belonging to or due to the
Constituent Corporations on whatever account shall thereafter be taken
and deemed to be held by or transferred to, as the case may be, or
vested in New Coventry without further act or deed; title to any real
estate, or any interest therein, vested in the Constituent Corporations
shall not revert or in any way be impaired by reason of this merger,
and all of the rights of creditors of the Constituent Corporations
shall be preserved unimpaired, and all liens upon the property of the
Constituent Corporations shall be preserved unimpaired, and such debts,
liabilities, obligations and duties of the Constituent Corporations
shall thenceforth remain with or attach to, as the case may be, New
Coventry and may be enforced against it to the same extent as if all of
such debts, liabilities, obligations and duties had been incurred or
contracted by it.
3.2 Employee Benefit Plans. On the Effective Date, New
Coventry will automatically assume all obligations of Old Coventry
under any and all employee benefit plans in effect as of the Effective
Date or with respect to which employee rights or accrued benefits are
outstanding as of the Effective Date.
3.3 Charter and Bylaws. The Charter of New Coventry as in
effect on the Effective Date shall, from and after the Effective Date,
be and continue to be the Charter of New Coventry without change or
amendment until thereafter amended in accordance with the provisions
thereof and applicable laws. The Bylaws of New Coventry as in effect on
the Effective Date shall, from and after the Effective Date, be and
continue to be the Bylaws of New Coventry without change or amendment
until thereafter amended in accordance with the provisions thereof, the
Charter of New Coventry and applicable laws.
3.4 Directors and Officers. The directors and officers of Old
Coventry shall be the directors and officers of New Coventry on the
Effective Date, and such directors and officers shall serve until they
are removed or replaced in accordance with the Charter and Bylaws of
New Coventry.
3.5 Options, Warrants and Rights. Each outstanding option,
warrant or right to acquire shares of Common Stock of Old Coventry
which are not exercised prior to the Effective Date shall, at the
Effective Date, be converted into the right to acquire the same number
of shares of Common Stock of New Coventry subject to the terms,
conditions and provisions for adjustment to which such options,
warrants or rights were previously subject.
3.6 Further Action. From time to time, as and when requested
by New Coventry, or by its successors or assigns, any party hereto
shall execute and deliver or cause to be executed and delivered all
such deeds and other instruments, and shall take or cause to be taken
all such further or other actions, as New Coventry, or its successors
or assigns, may deem necessary or desirable in order to vest in and
confirm to New Coventry, and its successors or assigns, title to and
possession of all the property, rights, privileges, powers and
franchises referred to herein and otherwise to carry out the intent and
purposes of this Agreement.
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<PAGE> 3
4. TERMINATION; AMENDMENT.
4.1 Termination Provision. Anything contained in this
Agreement to the contrary notwithstanding, this Agreement may be
terminated and the merger abandoned:
(a) Upon written notice at any time prior to the
Effective Date of the merger by either of the Constituent
Corporations; or
(b) If holders of at least a majority of the
outstanding shares of Common Stock of Old Coventry shall not
vote in favor of the merger.
4.2 Amendment Provisions. Anything contained in this Agreement
notwithstanding, this Agreement may be amended or modified in writing
at any time prior to the Effective Date; provided that, an amendment
made subsequent to the adoption of this Agreement by the shareholders
of the Constituent Corporations shall not (1) alter or change the
amount or kind of shares or other consideration to be received in
exchange for or on conversion of all or any of the shares of Common
Stock of the Constituent Corporations, (2) alter or change any term of
the Charter of New Coventry, or (3) alter or change any of the terms
and conditions of this Agreement if such alteration or change would
adversely affect the holders of any class or series thereof of the
Constituent Corporations; provided, however, the Constituent
Corporations may by agreement in writing extend the time for
performance of, or waive compliance with, the conditions or agreements
set forth herein.
4.3 Board Action. In exercising their rights under this
Section 4, each of the Constituent Corporations may act by its Board of
Directors, and such rights may be so exercised, notwithstanding the
prior approval of this Agreement by the shareholders of the Constituent
Corporations.
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<PAGE> 4
IN WITNESS WHEREOF, this Agreement, having first been duly approved by
resolutions of the Board of Directors of each of the Constituent Corporations,
is hereby executed on behalf of each of the Constituent Corporations by their
respective officers hereunto duly authorized.
COVENTRY CORPORATION,
a Delaware corporation
By: /s/ ALLEN F. WISE
--------------------------------------
Its: President and Chief Executive Officer
Attest: -------------------------------------
By: /s/ SHIRLEY R. SMITH
-------------------------------
Its: Secretary
------------------------------
COVENTRY CORPORATION,
a Tennessee corporation
By: /s/ ALLEN F. WISE
--------------------------------------
Its: President and Chief Executive Officer
-------------------------------------
Attest:
By: /s/ SHIRLEY R. SMITH
-------------------------------
Its: Secretary
------------------------------
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EXHIBIT 3.2
ARTICLES OF AMENDMENT
OF
COVENTRY CORPORATION
To the Secretary of State of the State of Tennessee:
Pursuant to the provisions of Section 48-20-106 of the Tennessee
Business Corporation Act (the "Act"), Coventry Corporation (the "Company")
submits these Articles of Amendment to its Articles of Incorporation (the
"Charter") for the purpose of amending Article IV to authorize the Company to
issue up to 6,000,000 shares of Series A Convertible Preferred Stock and up to
1,000,000 shares of Undesignated Preferred Stock.
FIRST: The name of the Company, a for profit corporation, is Coventry
Corporation.
SECOND: Article IV of the Charter is hereby amended and restated in its entirety
as follows:
ARTICLE IV
STOCK
The total number of shares of capital stock which the Company shall
have authority to issue is 107,000,000 shares, consisting of 100,000,000 shares
of Common Stock, par value of $0.01 per share ("Common Stock"), 6,000,000 shares
of Series A Convertible Preferred Stock, par value $0.01 per share ("Series A
Preferred Stock"), and 1,000,000 shares of undesignated preferred stock, par
value $0.01 per share ("Undesignated Preferred Stock").
1. SERIES A PREFERRED STOCK.
A. DESIGNATION AND AMOUNT. The number of shares constituting
the Series A Preferred Stock shall be 6,000,000.
B. DIVIDENDS.
(1) From the date of issuance hereof, until May 28, 1999 (the
"Dividend Payment Date"), the holders of Series A Preferred Stock shall be
entitled to receive, when and as declared, out
<PAGE> 2
of the net profits of the Company, dividends at the rate of $0.83 per annum,
payable in additional shares of Series A Preferred Stock, before any dividends
shall be set apart for or paid upon the Common Stock or any other stock ranking
on liquidation junior to the Series A Preferred Stock (such stock being referred
to hereinafter collectively as "Junior Stock") in any year. Dividends shall be
payable semi-annually on each November 28 and May 28, beginning November 28,
1997, through and including the Dividend Payment Date. The number of shares of
Series A Preferred Stock to be issued in payment of the dividend with respect to
each outstanding share of Series A Preferred Stock shall be determined by
dividing the amount of the dividend that would have been payable had such
dividend been paid in cash by $10.00. To the extent that any such dividend would
result in the issuance of a fractional share of Series A Preferred Stock (which
shall be determined with respect to the aggregate number of shares of Series A
Preferred Stock held of record by each holder) then the amount of such fraction
multiplied by $10.00 shall be paid in cash (unless there are no legally
available funds with which to make such cash payment, in which event such cash
payment shall be made as soon as possible). All dividends declared upon Series A
Preferred Stock shall be declared pro rata per share.
(2) Dividends on the Series A Preferred Stock through the
Dividend Payment Date shall be cumulative, whether or not in either fiscal year
there shall be net profits or surplus available for the payment of dividends in
such fiscal year, so that if in either fiscal year, dividends in whole or in
part are not paid upon the Series A Preferred Stock, unpaid dividends shall
accumulate as against the holders of the Junior Stock and no sums in that fiscal
year or any subsequent fiscal year shall be paid to the holders of Junior Stock
unless and until all dividends accrued and payable in respect of the Series A
Preferred Stock have been paid or a sum sufficient for such payment shall have
been set apart.
(3) At all times after the Dividend Payment Date, if, as and
when the Board of Directors of the Company declares any cash dividend on the
shares of Common Stock, the Board of Directors shall declare a cash dividend on
each share of Series A Preferred Stock equal to the dividend payable on each
share of Common Stock multiplied by the number of shares of Common Stock into
which such share of Series A Preferred Stock is convertible on the record date
for such dividend. Such dividend shall be payable at the same time and otherwise
on the same terms as any dividend paid on the Common Stock.
C. LIQUIDATION, DISSOLUTION OR WINDING UP.
(1) In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of shares of Series A
Preferred Stock then outstanding shall be entitled to be paid out of the assets
of the Company available for distribution to its stockholders, after and subject
to the payment in full of all amounts required to be distributed to the holders
of any other Preferred Stock of the Company ranking on liquidation prior and in
preference to the Series A hereinafter as "Senior Preferred Stock") upon such
liquidation, dissolution or winding up, but before any payment shall be made to
the holders of Junior Stock, an amount equal to $10.00 per share (subject to
adjustment in the event of any, dividend, stock split, stock distribution or
combination with respect to such shares), plus any accrued but unpaid dividends
as of the date of such liquidation, dissolution or winding-up. If upon any such
liquidation, dissolution or winding up of the Company the remaining assets of
the Company available for the distribution to its stockholders after payment in
full of amounts
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<PAGE> 3
required to be paid or distributed to holders of Senior Preferred Stock shall be
insufficient to pay the holders of shares of Series A Preferred Stock the full
amount to which they shall be entitled, the holders of shares of Series A
Preferred Stock, and any class of stock ranking on liquidation on a parity with
the Series A Preferred Stock, shall share ratably in any distribution of the
remaining assets and funds of the Company in proportion to the respective
amounts which would otherwise be payable in respect to the shares held by them
upon such distribution if all amounts payable on or with respect to said shares
were paid in full.
(2) After the payment of all preferential amounts required to
be paid to the holders of Senior Preferred Stock and Series A Preferred Stock
and any other series of Preferred Stock upon the dissolution, liquidation or
winding up of the Company, the holders of shares of Common Stock then
outstanding shall be entitled to receive the remaining assets and funds of the
Company available for distribution to its stockholders.
(3) The merger or consolidation of the Company into or with
another corporation, the merger or consolidation of any other corporation into
or with the Company, or the sale, conveyance, mortgage, pledge or lease of all
or substantially all the assets of the Company shall be deemed to be a
liquidation, dissolution or winding up of the Company for purposes of this
Paragraph C, unless waived by the holders of a majority of the then outstanding
shares of Series A Preferred Stock or unless, as of the date immediately
preceding such merger or consolidation, the Market Price is such that the
outstanding shares of Series A Preferred Stock would be otherwise redeemable
pursuant to Paragraph H(2) hereof, notwithstanding that such merger or
consolidation occurs prior to the third anniversary of the Second Closing Date
as defined in the Purchase Agreement referred to in Paragraph D(3)(b) hereof.
D. VOTING.
(1) Each issued and outstanding share of Series A Preferred
Stock shall be entitled to the number of votes equal to the number of shares of
Common Stock into which each such share of Series A Preferred Stock is
convertible (as adjusted from time to time pursuant to Paragraph E hereof), at
each meeting of stockholders of the Company with respect to any and all matters
presented to the stockholders of the Company for their action or consideration
other than the election of directors (as to which the Series A Preferred Stock
shall have rights voting separately as a class as set out in subparagraph (2)
below). Except as provided by law, by the provisions of subparagraphs (2), (3)
and (4) below, holders of Series A Preferred Stock and of any other outstanding
Preferred Stock shall vote together with the holders of Common Stock as a single
class.
(2) For so long as at least 1,000,000 shares of Series A
Preferred Stock remain outstanding (subject to adjustment in the event of any
stock dividend, stock split, stock distribution or combination with respect to
such shares), the holders of Series A Preferred Stock shall have the exclusive
right, voting separately as a class, to elect two directors (herein referred to
as the "Series A Directors"). In the event the Board of Directors is increased
to more than nine directors, for so long as any shares of Series A Preferred
Stock remain outstanding, the holders of record of a majority of the outstanding
shares of Series A Preferred Stock shall be entitled to select the whole number
of Series A Directors obtained by multiplying (a) the number of directors on the
Board of Directors (including
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<PAGE> 4
the Series A Directors) by (b) a fraction, the numerator of which is equal to
the number of shares of Series A Preferred Stock then outstanding and the
denominator of which is equal to the total number of shares of capital stock of
the Company then outstanding measured in each case on an as converted to Common
Stock basis. Each such Series A Director shall be (x)(i) a partner, officer or
employee of Warburg, Pincus Ventures, L.P. or any of its affiliates or (ii) a
person who is not a member of the board of directors or an employee or
consultant of any company which owns, manages or provides services to health
maintenance organizations ("HMOs") or preferred provider organizations ("PPOs")
in any of the geographic markets in which the Company, its subsidiaries, or the
HMOs and PPOs managed by the Company or its subsidiaries operate HMOs or PPOs as
of the date such person agrees to be designated to the Board of Directors of the
Company, and (y) elected by the affirmative vote of the holders of record of a
majority of the outstanding shares of Series A Preferred Stock either at
meetings of stockholders at which directors are elected, a special meeting of
holders of Series A Preferred Stock or by written consent without a meeting in
accordance with the Act. Each Series A Director so elected shall be in a
separate class from the other Series A Director, and each shall serve for the
term of that class. In addition to any other requirement herein, any vacancy in
the position of a Series A Director shall require the affirmative vote of the
holders of a majority of the Series A Preferred Stock in order to be filled. In
addition to any other requirement herein, the removal of a Series A Director
shall require the affirmative vote, at a special meeting of holders of Series A
Preferred Stock called for such purpose, or the written consent, of the holders
of record of a majority of the outstanding shares of Series A Preferred Stock.
Any vacancy created by such removal may also be filled at such meeting or by
such consent.
(3) In addition to any other rights provided by law, the
Company shall not, without first obtaining the affirmative vote or written
consent of a majority of the holders of Series A Preferred Stock:
(A) amend, alter or repeal any provision of the Company's
Certificate of Incorporation or amend, alter or repeal any provision of
the By-Laws that would adversely affect the rights of the holders of
Series A Preferred Stock, including, without limitation, any increase
in the number of shares of Series A Preferred Stock;
(B) issue any shares of Series A Preferred Stock other
than upon exchange of the Note (as defined in the Amended and Restated
Securities Purchase Agreement, dated as of April 2, 1997, by and among
the Company, Franklin Capital Associates III L.P. and Warburg, Pincus
Ventures, L.P. (the "Purchase Agreement")) or pursuant to Paragraph
B(1) hereof; or
(C) amend, alter or repeal the preferences, special rights
or other powers of the Series A Preferred Stock so as to affect
adversely the Series A Preferred Stock. For this purpose, the
authorization or issuance of any series of Preferred Stock with
preference or priority over, or being on a parity with the Series A
Preferred Stock as to the right to receive dividends or amounts
distributable upon liquidation, dissolution or winding up of the
Company shall be deemed so to affect adversely the Series A Preferred
Stock.
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<PAGE> 5
E. OPTIONAL CONVERSION. Each share of Series A Preferred Stock may
be converted at any time, at the option of the holder thereof, in the manner
hereinafter provided, into fully-paid and nonassessable shares of Common Stock,
provided, however, that on any redemption of any Series A Preferred Stock or any
liquidation of the Company, the right of conversion shall terminate at the close
of business on the full business day next preceding the date fixed for such
redemption or for the payment of any amounts distributable on liquidation to the
holders of Series A Preferred Stock.
(1) The initial conversion rate for the Series A Preferred
Stock shall be one share of Common stock for each one share of Series A
Preferred Stock surrendered for conversion, representing an initial Conversion
Price (for purposes of Paragraph F hereof) of $10.00 per share of the Company's
Common Stock plus a number of additional shares of Common Stock equal to the
amount of accrued but unpaid dividends (whether or not currently payable)
through the date of such conversion divided by the Conversion Price then in
effect. The applicable conversion rate and Conversion Price from time to time in
effect is subject to adjustment as hereinafter provided.
(2) The Company shall not issue fractions of shares of Common
Stock upon conversion of Series A Preferred Stock or scrip in lieu thereof. If
any fraction of a share of Common Stock would, except for the provisions of this
subparagraph (2), be issuable upon conversion of any Series A Preferred Stock,
the Company shall in lieu thereof pay to the person entitled thereto an amount
in cash equal to the average Market Price for the ten-day trading period
preceding such issuance and sale of such fraction, calculated to the nearest
one-hundredth (1/100) of a share. For purposes hereof, the term "Market Price"
shall mean (i) if the Common Stock is traded on a national securities exchange,
the last reported sale price of a share of Common Stock, regular way on such
date or, in case no such sale takes place on such date, the average of the
closing bid and asked prices thereof regular way on such date, in either case as
officially reported on the principal national securities exchange on which the
Common Stock is then listed or admitted for trading, or, (ii) if the Common
Stock is not then listed or admitted for trading on any national securities
exchange but is designated as a national market system security by the NASD, the
last reported trading price of the Common Stock on such date, or (iii) if not
listed or admitted to trading on any national securities exchange or designated
as a national market system security, the average of the reported bid and asked
price of the Common Stock on such date in the over-the-counter market as
furnished by the National Quotation Bureau, Inc., or, if such firm is not then
engaged in the business of reporting such prices, as furnished by any member of
the National Association of Securities Dealers, Inc. selected by the Company or,
(iv) if the shares of Common Stock are not so publicly traded, the fair market
value thereof, as determined in good faith by the Board of Directors of the
Company.
(3) Whenever the Conversion Price shall be adjusted as
provided in Paragraph F hereof, the Company shall forthwith file at each office
designated for the conversion of Series A Preferred Stock, a statement, signed
by the Chairman of the Board, the President, any Vice President or Treasurer of
the Company, showing in reasonable detail the facts requiring such adjustment.
The Company shall also cause a notice setting forth any such adjustments to be
sent by mail, first class, postage prepaid, to each record holder of Series A
Preferred Stock at his or its address appearing on the stock register. If such
notice relates to an adjustment resulting from an event referred to in Paragraph
5
<PAGE> 6
F(7), such notice shall be included as part of the notice required to be mailed
and published under the provisions of Paragraph F(7) hereof.
(4) In order to exercise the conversion right, the holder of
any Series A Preferred Stock to be converted shall surrender his or its
certificate or certificates therefore to the principal office of the transfer
agent for the Series A Preferred Stock (or if no transfer agent be at the time
appointed, then the Company at its principal office), and shall give written
notice to the Company at such office that the holder elects to convert the
Series A Preferred Stock represented by such certificates, or any number
thereof. Such notice shall also state the name or names (with address) in which
the certificate or certificates for shares of Common Stock which shall be
issuable on such conversion shall be issued, subject to any restrictions on
transfer relating to shares of the Series A Preferred Stock or shares of Common
Stock upon conversion thereof. If so required by the Company, certificates
surrendered for conversion shall be endorsed or accompanied by written
instrument or instruments of transfer, in form reasonably satisfactory to the
Company, duly authorized in writing. The date of receipt by the transfer agent
(or by the Company if the Company serves as its own transfer agent) of the
certificates and notice shall be the conversion date. As soon as practicable
after receipt of such notice and the surrender of the certificate or
certificates for Series A Preferred Stock as aforesaid, the Company shall cause
to be issued and delivered at such office to such holder, or on his or its
written order, a certificate or certificates for the number of full shares of
Common Stock issuable on such conversion in accordance with the provisions
hereof and cash as provided in Paragraph E(2) hereof in respect of any fraction
of a share of Common Stock otherwise issuable upon such conversion.
(5) The Company shall at all times when the Series A Preferred
Stock shall be outstanding reserve and keep available out of its authorized but
unissued stock, for the purposes of effecting the conversion of the Series A
Preferred Stock, such number of its duly authorized shares of Common Stock as
shall from time to time be sufficient to effect the conversion of all
outstanding Series A Preferred Stock. Before taking any action which would cause
an adjustment reducing the Conversion Price below the then par value of the
shares of Common Stock issuable upon conversion of the Series A Preferred Stock,
the Company will take any corporate action which may, in the opinion of its
counsel, be necessary in order that the Company may validly and legally issue
fully-paid and nonassessable shares of such Common Stock at such adjusted
Conversion Price.
(6) All shares of Series A Preferred Stock which shall have
been surrendered for conversion as herein provided shall no longer be deemed to
be outstanding and all rights with respect to such shares, including the rights,
if any, to receive notices and to vote, shall forthwith cease and terminate
except only the right of the holder thereof to receive shares of Common Stock in
exchange therefor. Any shares of Series A Preferred Stock so converted shall be
retired and canceled and shall not be reissued, and the Company may from time to
time take such appropriate action as may be necessary to reduce the authorized
Series A Preferred Stock accordingly.
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<PAGE> 7
F. ANTI-DILUTION PROVISIONS.
(1) In order to prevent dilution of the right granted
hereunder, the Conversion Price shall be subject to adjustment from time to time
in accordance with this Paragraph F(1). At any given time the Conversion Price
shall be that dollar (or part of a dollar) amount the payment of which shall be
sufficient at the given time to acquire one share of the Company's Common Stock
upon conversion of shares of Series A Preferred Stock. Upon each adjustment of
the Conversion Price pursuant to Paragraph F, the registered Holder of shares of
Series A Preferred Stock shall thereafter be entitled to acquire upon exercise,
at the Conversion Price resulting from such adjustment, the number of shares of
the Company's Common Stock obtainable by multiplying the Conversion Price in
effect immediately prior to such adjustment by the number of shares of the
Company's Common Stock acquirable immediately prior to such adjustment and
dividing the product thereof by the Conversion Price resulting from such
adjustment. For purposes of this Paragraph F, the term "Number of Common Shares
Deemed Outstanding" at any given time shall mean the sum of (x) the number of
shares of the Company's Common Stock outstanding at such time, (y) the number of
shares of the Company's Common Stock issuable assuming conversion at such time
of the Company's other series of convertible preferred stock, if any, and (z)
the number of shares of the Company's Common Stock deemed to be outstanding
under subparagraphs F(2)(i) to (ix), inclusive, at such time.
(2) Except as provided in Paragraph F(3) or F(5) below, if and
whenever on or after the date of initial issuance of the Series A Preferred
Stock (the "Initial Issuance Date"), the Company shall issue or sell, or shall
in accordance with Paragraphs F(2)(i) to (ix), inclusive, be deemed to have
issued or sold any shares of its Common Stock for a consideration per share less
than the average Market Price for the ten trading days immediately preceding
such issuance or sale, then forthwith upon such issue or sale (the "Triggering
Transaction"), the Conversion Price shall, subject to subparagraphs (i) to (ix)
of this Paragraph F(2), be reduced to the Conversion Price (calculated to the
nearest tenth of a cent) determined by multiplying the Conversion Price in
effect immediately prior to the time of such Triggering Transaction by a
fraction, the numerator of which shall be the sum of (x) the Number of Shares
Deemed Outstanding immediately prior to such Triggering Transaction and (y) the
number of shares of Common Stock which the aggregate consideration received by
the Company upon such Triggering Transaction would purchase at the average
Market Price for the ten-day period immediately preceding such Triggering
Transaction, and the denominator of which shall be the Number of Shares Deemed
Outstanding immediately after such Triggering Transaction.
For purposes of determining the adjusted Conversion Price
under this Paragraph F(2), the following subparagraphs (i) to (ix), inclusive,
shall be applicable:
(I) In case the Company at any time shall in any manner
grant (whether directly or by assumption in a merger or otherwise) any
rights to subscribe for or to purchase, or any options for the purchase
of, Common Stock or any stock or other securities convertible into or
exchangeable for Common Stock (such rights or options being herein
called "Options" and such convertible or exchangeable stock or
securities being herein called "Convertible Securities"), whether or
not such Options or the right to convert or exchange any such
Convertible Securities are immediately exercisable and the price per
share for which the Common Stock is issuable
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<PAGE> 8
upon exercise, conversion or exchange (determined by dividing (x) the
total amount, if any, received or receivable by the Company as
consideration for the granting of such Options, plus the aggregate
amount of additional consideration payable to the Company upon the
exercise of all such Options, plus, in the case of such Options which
relate to Convertible Securities, the aggregate amount of additional
consideration, if any, payable upon the issue or sale of such
Convertible Securities and upon the conversion or exchange thereof, by
(y) the total maximum number of shares of Common Stock issuable upon
the exercise of such Options or the conversion or exchange of such
Convertible Securities) shall be less than the average Market Price in
effect for the ten-day trading period immediately prior to the time of
the granting of such Option, then the total maximum amount of Common
Stock issuable upon the exercise of such Options or in the case of
Options for Convertible Securities, upon the conversion or exchange of
such Convertible Securities shall (as of the date of granting of such
Options) be deemed to be outstanding and to have been issued and sold
by the Company for such price per share. No adjustment of the
Conversion Price shall be made upon the actual issue of such shares of
Common Stock or such Convertible Securities upon the exercise of such
Options, except as otherwise provided in subparagraph (iii) below.
(II) In case the Company at any time shall in any manner issue
(whether directly or by assumption in a merger or otherwise) or sell
any Convertible Securities, whether or not the rights to exchange or
convert thereunder are immediately exercisable, and the price per share
for which Common Stock is issuable upon such conversion or exchange
(determined by dividing (x) the total amount received or receivable by
the Company as consideration for the issue or sale of such Convertible
Securities, plus the aggregate amount of additional consideration, if
any, payable to the Company upon the conversion or exchange thereof, by
(y) the total maximum number of shares of Common Stock issuable upon
the conversion or exchange of all such Convertible Securities) shall be
less than the average Market Price in effect for the ten-day trading
period immediately prior to the time of such issue or sale, then the
total maximum number of shares of Common Stock issuable upon conversion
or exchange of all such Convertible Securities shall (as of the date of
the issue or sale of such Convertible Securities) be deemed to be
outstanding and to have been issued and sold by the Company for such
price per share. No adjustment of the Conversion Price shall be made
upon the actual issue of such Common Stock upon exercise of the rights
to exchange or convert under such Convertible Securities, except as
otherwise provided in subparagraph (iii) below.
(III) If the purchase price provided for in any Options
referred to in subparagraph (i), the additional consideration, if any,
payable upon the conversion or exchange of any Convertible Securities
referred to in subparagraphs (i) or (ii), or the rate at which any
Convertible Securities referred to in subparagraph (i) or (ii) are
convertible into or exchangeable for Common Stock shall change at any
time (other than under or by reason of provisions designed to protect
against dilution of the type set forth in Paragraphs F(2) or F(4)), the
Conversion Price in effect at the time of such change shall forthwith
be readjusted to the Conversion Price which would have been in effect
at such time had such Options or Convertible Securities still
outstanding provided for such changed purchase price, additional
consideration at the time initially granted, issued or sold. If the
purchase price provided for in any Option referred to in subparagraph
(i) or the
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<PAGE> 9
rate at which any Convertible Securities referred to in subparagraphs
(i) or (ii) are convertible into or exchangeable for Common Stock,
shall be reduced at any time under or by reason of provisions with
respect thereto designed to protect against dilution, then in case of
the delivery of Common Stock upon the exercise of any such Option or
upon conversion or exchange of any such Convertible Security, the
Conversion Price then in effect hereunder shall forthwith be adjusted
to such respective amount as would have been obtained had such Option
or Convertible Security never been issued as to such Common Stock and
had adjustments been made upon the issuance of the shares of Common
Stock delivered as aforesaid, but only if as a result of such
adjustment the Conversion Price then in effect hereunder is hereby
reduced.
(IV) On the expiration of any Option or the termination of
any right to convert or exchange any Convertible Securities, the
Conversion Price then in effect hereunder shall forthwith be increased
to the Conversion Price which would have been in effect at the time of
such expiration or termination had such Option or Convertible
Securities, to the extent outstanding immediately prior to such
expiration or termination, never been issued.
(V) In case any Options shall be issued in connection with
the issue or sale of other securities of the Company, together
comprising one integral transaction in which no specific consideration
is allocated to such Options by the parties thereto, such Options shall
be deemed to have been issued without consideration.
(VI) In case any shares of Common Stock, Options or
Convertible Securities shall be issued or sold or deemed to have been
issued or sold for cash, the consideration received therefor shall be
deemed to be the amount received by the Company therefor (before
deduction for expenses or underwriters discounts or commissions related
to such issue or sale). In case any shares of Common Stock, Options or
Convertible Securities shall be issued or sold for a consideration
other than cash, the amount of the consideration other than cash
received by the Company shall be the fair value of such consideration
as determined in good faith by the Board of Directors of the Company.
In case any shares of Common Stock, Options or Convertible Securities
shall be issued in connection with any merger in which the Company is
the surviving corporation, the amount of consideration therefor shall
be deemed to be the fair value of such portion of the net assets and
business of the non-surviving corporation as shall be attributable to
such Common Stock, Options or Convertible Securities, as the case may
be as determined in good faith by the Board of Directors of the
Company.
(VII) The number of shares of Common Stock outstanding at
any given time shall not include shares owned or held by or for the
account of the Company and the disposition of any shares so owned or
held shall be considered an issue or sale of Common Stock for the
purpose of this Paragraph F(2).
(VIII) In case the Company shall declare a dividend or
make any other distribution upon the stock of the Company payable in
Common Stock, Options, or Convertible Securities, then in such case any
Common Stock, Options or Convertible Securities, as the case may be,
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<PAGE> 10
issuable in payment of such dividend or distribution shall be deemed to
have been issued or sold without consideration.
(IX) For purposes of this Paragraph F(2), in case the
Company shall take a record of the holders of its Common Stock for the
purpose of entitling them (x) to receive a dividend or other
distribution payable in Common Stock, Options or in Convertible
Securities, or (y) to subscribe for or purchase Common Stock, Options
or Convertible Securities, then such record date shall be deemed to be
the date of the issue or sale of the shares of Common Stock deemed to
have been issued or sold upon the declaration of such dividend or the
making of such other distribution or the date of the granting of such
right or subscription or purchase, as the case may be.
(3) In the event the Company shall declare a dividend upon the
Common Stock (other than a dividend payable in Common Stock covered by Paragraph
F(2)(viii)) payable otherwise than out of earnings or earned surplus, determined
in accordance with generally accepted accounting principles, including the
making of appropriate deductions for minority interests, if any, in subsidiaries
(herein referred to as "Liquidating Dividends"), then, as soon as possible after
the conversion of any Series A Preferred Stock, the Company shall pay to the
person converting such Series A Preferred Stock an amount equal to the aggregate
value at the time of such exercise of all Liquidating Dividends (including but
not limited to the Common Stock which would have been issued at the time of such
earlier exercise and all other securities which would have been issued with
respect to such Common Stock by reason of stock splits, stock dividends, mergers
or reorganizations, or for any other reason). For the purposes of this Paragraph
F(3), a dividend other than in cash shall be considered payable out of earnings
or earned surplus only to the extent that such earnings or earned surplus are
charged an amount equal to the fair value of such dividend as determined in good
faith by the Board of Directors of the Company.
(4) In case the Company shall at any time subdivide (other
than by means of a dividend payable in Common Stock covered by Paragraph
F(2)(viii)) its outstanding shares of Common Stock into a greater number of
shares, the Conversion Price in effect immediately prior to such subdivision
shall be proportionately reduced, and, conversely, in case the outstanding
shares of Common Stock of the Company shall be combined into a smaller number of
shares, the Conversion Price in effect immediately prior to such combination
shall be proportionately increased.
(5) If any capital reorganization or reclassification of the
capital stock of the Company, or consolidation or merger of the Company with
another corporation, or the sale of all or substantially all of its assets to
another corporation shall be effected in such a way that holders of Common Stock
shall be entitled to receive stock, securities, cash or other property with
respect to or in exchange for Common Stock, then, as a condition of such
reorganization, reclassification, consolidation,
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<PAGE> 11
merger or sale, lawful and adequate provision shall be made whereby the holders
of the Series A Preferred Stock shall have the right to acquire and receive upon
conversion of the Series A Preferred Stock, which right shall be prior to the
rights of the holders of Junior Stock (but after and subject to the rights of
holders of Senior Preferred Stock, if any), such shares of stock, securities,
cash or other property issuable or payable (as part of the reorganization,
reclassification, consolidation, merger or sale) with respect to or in exchange
for such number of outstanding shares of the Company's Common Stock as would
have been received upon conversion of the Series A Preferred Stock at the
Conversion Price then in effect. The Company will not effect any such
consolidation, merger or sale, unless prior to the consummation thereof the
successor corporation (if other than the Company) resulting from such
consolidation or merger or the corporation purchasing such assets shall assume
by written instrument mailed or delivered to the holders of the Series A
Preferred Stock at the last address of each such holder appearing on the books
of the Company, the obligation to deliver to each such holder such shares of
stock, securities or assets as, in accordance with the foregoing provisions,
such holder may be entitled to purchase. If a purchase, tender or exchange offer
is made to and accepted by the holders of more than fifty percent (50%) of the
outstanding shares of Common Stock of the Company, the Company shall not effect
any consolidation, merger or sale with the person having made such offer or with
any Affiliate of such person, unless prior to the consummation of such
consolidation, merger or sale the holders of the Series A Preferred Stock shall
have been given a reasonable opportunity to then elect to receive upon the
conversion of the Series A Preferred Stock either the stock, securities or
assets then issuable with respect to the Common Stock of the Company or the
stock, securities or assets, or the equivalent, issued to previous holders of
the Common Stock in accordance with such offer. For purposes hereof, the term
"Affiliate" with respect to any given person shall mean any person controlling,
controlled by or under common control with the given person.
(6) The provisions of this Paragraph F shall not apply to any
Common Stock issued, issuable or deemed outstanding under Paragraphs F(2)(i) to
(ix) inclusive: (i) to any person pursuant to any stock option, stock purchase
or similar plan or arrangement for the benefit of employees, consultants or
directors of the Company or its subsidiaries in effect on the Initial Issuance
Date or thereafter adopted by the Board of Directors of the Company (or
physicians or providers contracting with the Company or any of its Subsidiaries)
(ii) pursuant to options, warrants and conversion rights in existence on the
Initial Issuance Date, (iii) upon exercise of the Warrants issued to Franklin
Capital Associates, III L.P. ("Franklin") and Warburg, Pincus Ventures, L.P.
("Warburg") pursuant to the Purchase Agreement, (iv) on conversion of the Series
A Preferred Stock or the sale of any additional shares of Series A Preferred
Stock or the issuance of additional shares of Series A Preferred Stock as
dividends pursuant to Paragraph B(2) hereof, or (v) in connection with
underwritten public offerings for cash pursuant to a registration statement
filed under the Securities Act of Common Stock, Options or Convertible
Securities.
(7) In the event that:
(A) the Company shall declare any cash dividend upon its
Common Stock, or
(B) the Company shall declare any dividend upon its Common
Stock payable in stock or make any special dividend or other
distribution to the holders of its Common Stock, or
(C) the Company shall offer for subscription pro rata to
the holders of its Common Stock any additional shares of stock of any
class or other rights, or
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(D) there shall be any capital reorganization or
reclassification of the capital stock of the Company, including any
subdivision or combination of its outstanding shares of Common Stock,
or consolidation or merger of the Company with, or sale of all or
substantially all of its assets to, another corporation, or
(E) there shall be a voluntary or involuntary dissolution,
liquidation or winding up of the Company;
then, in connection with such event, the Company shall give to the holders of
the Series A Preferred Stock:
(I) at least 20 days prior written notice of the date on which the
books of the Company shall close or a record shall be taken
for such dividend, distribution or subscription rights or for
determining rights to vote in respect of any such
reorganization, reclassification, consolidation, merger, sale,
dissolution, liquidation or winding up; and
(II) in the case of any such reorganization, reclassification,
consolidation, merger, sale, dissolution, liquidation or
winding up, at least 20 days prior written notice of the date
when the same shall take place. Such notice in accordance with
the foregoing clause (i) shall also specify, in the case of
any such dividend, distribution or subscription rights, the
date on which the holders of Common Stock shall be entitled
thereto, and such notice in accordance with the foregoing
clause (ii) shall also specify the date on which the holders
of Common Stock shall be entitled to exchange their Common
Stock for securities or other property deliverable upon such
reorganization, reclassification consolidation, merger, sale,
dissolution, liquidation or winding up, as the case may be.
Each such written notice shall be given by first class mail,
postage prepaid, addressed to the holders of the Series A
Preferred Stock at the address of each such holder as shown on
the books of the Company.
(8) If at any time or from time to time on or after the
Initial Issuance Date, the Company shall grant, issue or sell any Options,
Convertible Securities or rights to purchase property (the "Purchase Rights")
pro rata to the record holders of any class of Common Stock of the Company and
such grants, issuances or sales do not result in an adjustment of the Conversion
Price under Paragraph F(2) hereof, then each holder of Series A Preferred Stock
shall be entitled to acquire (within 30 days after the later to occur of the
initial exercise date of such Purchase Rights or receipt by such holder of the
notice concerning Purchase Rights to which such holder shall be entitled under
Paragraph F(7)) and upon the terms applicable to such Purchase Rights either:
(A) the aggregate Purchase Rights which such holder could have
acquired if it had held the number of shares of Common Stock
acquirable upon conversion of the Series A Preferred Stock
immediately before the grant, issuance or sale of such
Purchase Rights; provided that if any Purchase Rights were
distributed to holders of Common Stock without the payment of
additional consideration by such holders, corresponding
Purchase Rights shall be distributed to the exercising holders
of the Series A Preferred
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<PAGE> 13
Stock as soon as possible after such exercise and it shall not
be necessary for the exercising holder of the Series A
Preferred Stock specifically to request delivery of such
rights; or
(B) in the event that any such Purchase Rights shall have expired
or shall expire prior to the end of said 30-day period, the
number of shares of Common Stock or the amount of property
which such holder could have acquired upon such exercise at
the time or times at which the Company granted, issued or sold
such expired Purchase Rights.
(9) If any event occurs as to which, in the opinion of the
Board of Directors of the Company, the provisions of this Paragraph F are not
strictly applicable or if strictly applicable would not fairly protect the
rights of the holders of the Series A Preferred Stock in accordance with the
essential intent and principles of such provisions, then the Board of Directors
shall make an adjustment in the application of such provisions, in accordance
with such essential intent and principles, so as to protect such rights as
aforesaid, but in no event shall any adjustment have the effect of increasing
the Conversion Price as otherwise determined pursuant to any of the provisions
of this Paragraph F except in the case of a combination of shares of a type
contemplated in Paragraph F(d) and then in no event to an amount larger than the
Conversion Price as adjusted pursuant to Paragraph F(d).
G. MANDATORY CONVERSION.
(1) Each share of Series A Preferred Stock shall automatically
be converted into shares of Common Stock at the then effective Conversion Price
for such shares upon the vote to so convert of the holders of at least a
majority of the shares of Series A Preferred Stock then outstanding.
(2) All holders of record of shares of Series A Preferred
Stock will be given at least ten days' prior written notice of the date fixed
and the place designated for mandatory conversion of all of such shares of
Series A Preferred Stock pursuant to this Paragraph G. Such notice will be sent
by mail, first class, postage prepaid, to each record holder of shares of Series
A Preferred Stock at such holder's address appearing on the stock register. On
or before the date fixed for conversion each holder of shares of Series A
Preferred Stock shall surrender his or its certificates or certificates for all
such shares to the Company at the place designated in such notice, and shall
thereafter receive certificates for the number of shares of Common Stock to
which such holder is entitled pursuant to this Paragraph G. On the date fixed
for conversion, all rights with respect to the Series A Preferred Stock so
converted will terminate, except only the right of the holders thereof, upon
surrender of their certificate or certificates therefore, to receive
certificates for the number of shares of Common Stock into which such Series A
Preferred Stock has been converted. If so required by the Company, certificates
surrendered for conversion shall be endorsed or accompanied by written
instrument or instruments of transfer, in form satisfactory to the Company, duly
executed by the registered holder or by his attorneys duly authorized in
writing. All certificates evidencing shares of Series A Preferred Stock which
are required to be surrendered for conversion in accordance with the provisions
hereof shall, from and after the date such certificates are so required to be
surrendered, be deemed to have been retired and canceled and the shares of
Series A Preferred Stock represented thereby converted into Common Stock for all
purposes, notwithstanding the failure of the holder or holders thereof to
surrender such certificates on or prior to
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<PAGE> 14
such date. As soon as practicable after the date of such mandatory conversion
and the surrender of the certificate or certificates for Series A Preferred
Stock as aforesaid, the Company shall cause to be issued and delivered to such
holder, or on his or its written order, a certificate or certificates for the
number of full shares of Common Stock issuable on such conversion in accordance
with the provisions hereof and cash as provided in Paragraph E(2) in respect of
any fraction of a share of Common Stock otherwise issuable upon such conversion.
H. REDEMPTION.
(1) The Company shall redeem (to the extent that such
redemption shall not violate any applicable provisions of the laws of the State
of Tennessee) at a price of $10.00 per share (subject to adjustment in the event
of any stock dividend, stock split, stock distribution or combination with
respect to such shares), plus an amount equal to any dividends accrued but
unpaid thereon (such amount is hereinafter referred to as the "Redemption
Price"), on May 15 (the "Redemption Date") of each of the years 2002 through
2004 thirty-three and one-third percent (33 1/3%) of the shares of Series A
Preferred Stock outstanding on the first Redemption Date or such lesser number
of shares as shall then be outstanding. If the Company is unable at any
Redemption Date to redeem any shares of Preferred Stock then to be redeemed
because such redemption would violate the applicable laws of the State of
Tennessee, then the Company shall redeem such shares as soon thereafter as
redemption would not violate such laws.
(2) The Series A Preferred Stock may not be redeemed before
the third anniversary of the Second Closing Date. Thereafter, the Series A
Preferred Stock shall be subject to redemption, in whole but not in part, at the
option of the Company, if the Market Price of the Common Stock on each of the 20
consecutive days on which there was a price for such shares during the period
ending within five days prior to the giving of written notice of redemption as
provided in subparagraph (4) below is at least $17.00 per share (appropriately
adjusted for any stock split, stock dividend or similar event) at a price in
cash equal to the Redemption Price then in effect.
(3) In the event of any redemption of only a part of the then
outstanding Series A Preferred Stock, the Company shall effect such redemption
pro rata among the holders thereof (based on the number of shares of Series A
Preferred Stock held on the date of notice of redemption).
(4) At least 30 days prior to each Redemption Date, written
notice shall be mailed, postage prepaid, to each holder of record of Series A
Preferred Stock to be redeemed, at his or its post office address last shown on
the records of the Company, notifying such holder of the number of shares so to
be redeemed, specifying the Redemption Date and the date on which such holder's
conversion rights (pursuant to Paragraph E hereof) as to such shares terminate
and calling upon such holder to surrender to the Company, in the manner and at
the place designated, his or its certificate or certificates representing the
shares to be redeemed (such notice is hereinafter referred to as the "Redemption
Notice"). On or prior to each Redemption Date, each holder of Series A Preferred
Stock to be redeemed shall surrender his or its certificate or certificates
representing such shares to the Company, in the manner and at the place
designated in the Redemption Notice, and thereupon the Redemption Price of such
shares shall be payable to the order of the person whose name appears on such
certificate or
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<PAGE> 15
certificates as the owner thereof and each surrendered certificate shall be
canceled. In the event less than all the shares represented by any such
certificate are redeemed, a new certificate shall be issued representing the
unredeemed shares. From and after the Redemption Date, unless there shall have
been a default in payment of the Redemption Price, all rights of the holders of
the Series A Preferred Stock designated for redemption in the Redemption Notice
as holders of Series A Preferred Stock of the Company (except the right to
receive the Redemption Price without interest upon surrender of their
certificate or certificates) shall cease with respect to such shares, and such
shares shall not thereafter be transferred on the books of the Company or be
deemed to be outstanding for any purpose whatsoever.
(5) Except as provided in subparagraph (1) above, the Company
shall have no right to redeem the shares of Series A Preferred Stock. Any shares
of Series A Preferred Stock so redeemed shall be permanently retired, shall no
longer be deemed outstanding and shall not under any circumstances be reissued,
and the Company may from time to time take such appropriate corporate action as
may be necessary to reduce the authorized Series A Preferred Stock accordingly.
Nothing herein contained shall prevent or restrict the purchase by the Company,
from time to time either at public or private sale, of the whole or any part of
the Series A Preferred Stock at such price or prices as the Company may
determine, subject to the provisions of applicable law.
2. UNDESIGNATED PREFERRED STOCK.
A. Except as set forth herein or otherwise required by law, the
Board of Directors is authorized to provide for the issuance of shares of
Undesignated Preferred Stock in one or more series and, by filing with the
Secretary of State an Articles of Amendment, which will be effective without
shareholder action in accordance with the provisions of Section 48-16-102(d) of
the Act, to establish from time to time the number of shares to be included in
each such series and to fix the designation, powers, preferences and rights of
the shares of each such series and the qualifications, limitations or
restrictions thereof.
B. The authority of the Board of Directors with respect to each
such series shall include, but not be limited to, the authority to provide that
the shares of any such series may:
(1) have special, confidential or limited voting rights or no
voting rights; provided, however, that the shares, if not convertible
into Common Stock, will not have more than one vote per share, except
as otherwise required by law, and if convertible into Common Stock will
not have more votes per share than they would have if they were so
converted, except as otherwise required by law;
(2) be redeemable or convertible: (a) at the option of the
Company, by the shareholder or another person on the occurrence of a
designated event; (b) for cash, indebtedness, securities, or other
property; or (c) in a designated amount or in an amount determined in
accordance with a designated formula or by reference to extrinsic data
or events;
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<PAGE> 16
(3) entitle the holders to distributions calculated in any
manner, including dividends that may be cumulative, noncumulative, or
partially cumulative; and
(4) have a preference over any other classes or series with
respect to distributions, including dividend and distributions upon the
dissolution of the Company, all as the Board of Directors may deem
advisable.
3. COMMON STOCK. The designation, powers, preferences and rights, and
the qualifications, limitations and restrictions thereof in respect to shares of
Common Stock are as follows:
A. VOTING RIGHTS. Except as set forth herein or otherwise required
by law, each outstanding share of Common Stock shall be entitled to vote on each
matter on which the shareholders of the Company shall be entitled to vote, and
each holder of Common Stock shall be entitled to one vote for each share of
Common Stock held by such holder.
B. DIVIDENDS. The Board of Directors of the Company may cause
dividends or other distributions to be paid to holders of Common Stock out of
funds legally available therefor.
4. PREEMPTIVE RIGHTS. The shareholders of the Company shall not have
preemptive rights.
THIRD: This amendment was duly authorized by the Board of Directors and was
adopted by the shareholders of the Company on August 20, 1997.
FOURTH: This amendment, which will constitute an amendment to the Charter, is to
be effective when filed with the Secretary of State.
IN WITNESS WHEREOF, COVENTRY CORPORATION has caused these Articles of
Amendment to be signed by Dale B. Wolf, its Senior Vice President and Chief
Financial Officer, this 28th day of August, 1997.
COVENTRY CORPORATION
/s/ DALE B. WOLF
------------------------------------
DALE B. WOLF, SENIOR VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
16
<PAGE> 1
Exhibit 4.5
CONVERTIBLE EXCHANGEABLE SENIOR SUBORDINATED NOTE
THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES
ACT OF 1933, AS AMENDED (THE "ACT")OR ANY STATE SECURITIES LAW, AND MAY NOT BE
SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE
REGISTRATION UNDER THE ACT OR IN A TRANSACTION WHICH, IN THE OPINION OF COUNSEL
REASONABLY ACCEPTABLE TO COVENTRY CORPORATION, IS EXEMPT FROM SUCH REGISTRATION.
THIS NOTE IS SUBORDINATED TO CERTAIN SENIOR
DEBT (AS DEFINED HEREIN) TO THE EXTENT PROVIDED HEREIN.
COVENTRY CORPORATION
8.3% CONVERTIBLE EXCHANGEABLE SENIOR SUBORDINATED NOTE
DUE MAY 28, 2004
R- Date: December 1, 1997
$___________ New York, New York
FOR VALUE RECEIVED, the undersigned, COVENTRY CORPORATION, a
corporation organized and existing under the laws of the State of Tennessee
(herein called the "Company"), hereby promises to pay to ________________
___________________________________________________ or registered assigns (the
"Holder"), the principal sum of ___________________________________________
_______ ($________) in scheduled payments as provided in the Agreement (as
hereinafter defined) until May 28, 2004, with interest on the unpaid balance
hereof at the rate of 8.3% per annum (computed on the basis of a 360-day year of
twelve 30-day months) until May 28, 1999 and at the rate of 5.0% per annum
(computed on the basis of a 360-day year of the twelve 30-day months)
thereafter, until the principal hereof shall become due and payable (whether at
maturity, upon notice of prepayment or otherwise). During the period from and
including the date hereof until but excluding May 28, 1999, interest shall
accrue (computed on the basis of a 360-day year of twelve 30-day months) and
shall compound on May 28, 1998 and November 28, 1998. On May 28, 1999, the
Company shall issue the Holder an Interest Note (an "Interest Note" and,
together with any other promissory notes issued hereunder in payment of interest
in lieu of cash, the "Interest Notes") in payment of such accrued interest,
which Interest Note shall bear interest on the principal amount thereof at the
rate of 5.0% per annum (computed on the basis of a 360-day year of twelve 30-day
months) until the principal thereof shall become due and payable (whether at
maturity, upon notice of prepayment or otherwise). After May 28, 1999, interest
on the principal amount hereof shall be payable semi-annually in arrears on each
November 28 and May 28 (or, if such date is not a Business Day, on the next
Business Day thereafter) until the principal amount hereof shall become due and
payable (whether at maturity, upon notice of prepayment or otherwise); provided,
however, the Company may, at its sole option, issue Interest Notes in lieu of a
<PAGE> 2
cash payment of any or all interest due hereunder after May 28, 1999, which
Interest Notes shall bear interest on the principal amount thereof from and
including the date of issuance thereof at the rate of 5.0% per annum (computed
on the basis of a 360-day year of twelve 30-day months) until the principal
thereof shall become due and payable (whether at maturity, upon notice of
prepayment or otherwise). Interest on the principal amount of the Interest Notes
shall be payable semi-annually in arrears on each November 28 and May 28 (or, if
such date is not a Business Day, on the next Business Day thereafter) until the
principal amount thereof shall become due and payable (whether at maturity, upon
notice of prepayment or otherwise); provided, however, the Company may, at its
sole option, issue Interest Notes in lieu of a cash payment of any or all
interest due and payable on such Interest Notes.
Payments of both principal and interest are to be made at the address
shown on the Company's registry or at such other place as the holder hereof
shall designate to the Company in writing, in lawful money of the United States
of America.
This Note is issued upon the surrender for cancellation of that certain
8.3% Convertible Exchangeable Senior Subordinated Note due May 9, 2004 (Number
R-___) in the original principal amount of $_________ issued to the Holder
pursuant to that certain Amended and Restated Securities Purchase Agreement
dated as of April 2, 1997 (the "Agreement"), by and among the Company, Warburg,
Pincus Ventures, L.P. and Franklin Capital Associates III L.P., and, in
addition, in lieu of the issuance of Interest Notes due under such note for the
period beginning May 9, 1997 and ending on the date hereof. This Note is
entitled to the benefits of the Agreement and, as provided in the Agreement, is
subject to prepayment in whole or in part in certain cases as specified in the
Agreement.
This Note is a registered Note and, as provided in the Agreement, upon
surrender of this Note for registration of transfer, duly endorsed, or
accompanied by a written instrument of transfer duly executed, by the registered
holder hereof or his attorney duly authorized in writing, a new Note for a like
principal amount will be issued to, and registered in the name of, the
transferee. Prior to due presentment for registration of transfer, the Company
may treat the person in whose name this Note is registered as the owner hereof
for the purpose of receiving payment and for all other purposes, and the Company
shall not be affected by any notice to the contrary.
The Company agrees to prepay this Note upon a Change of Control, as
specified in the Agreement.
This Note shall be subordinate and junior in right of payment to all
Senior Debt (as hereinafter defined) to the extent and in the manner provided in
this Note.
2
<PAGE> 3
Senior Debt means the principal amount of, and accrued interest
(including interest accruing or that would have accrued after the commencement
of bankruptcy proceedings involving the Company as debtor, whether or not such
interest is allowed) on, the loans outstanding under the Credit Agreement dated
as of December 29, 1997, among the Company, the Banks named therein and Morgan
Guaranty Trust Company of New York, as Agent, as the same shall be amended from
time to time (the "Credit Agreement"), and any fees or other amounts payable
pursuant to the Credit Agreement or any related agreement.
No payment or prepayment of any principal of or interest on this Note
shall be due and payable, or paid, unless and until all Senior Debt shall have
been paid in full in cash; provided, however, that the foregoing shall not limit
(x) the payment of interest through increases in the principal amount of this
Note in accordance with the provisions of Section 1.1 and Section 3 of the
Agreement, (y) the Company's right to cause the exchange of this Note for Series
A Preferred Stock pursuant to the provisions of Section 12.2 of the Agreement,
or (z) the Holder and the Majority Holders' (as defined in the Agreement) right
to convert this Note into Series A Preferred Stock or Common Stock pursuant to
the provisions of this Note and Section 9 of the Agreement. In furtherance of
the foregoing, the holders of Senior Debt shall be entitled to receive payments
or distributions of any kind or character (other than those permitted by the
proviso to the preceding sentence), whether in cash or property or securities,
which may be payable or deliverable (including in any insolvency or bankruptcy
proceedings, or any receivership, liquidation, reorganization or other similar
proceedings, relative to the Company or to its creditors, as such, or to its
property, or in the event of any proceedings for voluntary liquidation,
dissolution or other winding up of the Company, whether or not involving
insolvency or bankruptcy) in respect of this Note.
If, notwithstanding the provisions set forth above, any payment or
distribution of assets of the Company of any kind or character (other than as
permitted by the proviso to the first sentence of the preceding paragraph)
whether in cash, property or securities, shall be received by the holder of this
Note in respect of this Note before all Senior Debt is paid in full in cash,
such payment or distribution shall be held in trust for the benefit of, and
shall be paid over or delivered to the Agent under the Credit Agreement, for the
ratable account of the holders of such Senior Debt for application to the
payment of all Senior Debt remaining unpaid to the extent necessary to pay such
Senior Debt in full, in accordance with its terms, after giving effect to any
concurrent payment or distribution to the holders of such Senior Debt.
No holder of Senior Debt shall be prejudiced in its right to enforce
subordination of this Note by any act or failure to act on the part of the
Company. The provisions of this Note are solely
3
<PAGE> 4
for the purpose of defining the relative rights of the holders of Senior Debt,
on the one hand, and the Holder, on the other hand, and nothing herein shall
impair, as between the Company and the Holder, the obligation of the Company,
which (except as expressly stated above) is unconditional and absolute, to pay
to the Holder the principal thereof and interest thereon in accordance with its
terms and the terms of the Agreement, nor shall anything herein prevent the
Holder from exercising all remedies otherwise permitted by applicable law, the
Agreement or this Note upon default thereunder, subject to the rights under this
Note of holders of Senior Debt to receive cash, property or securities otherwise
payable or deliverable to the holder of this Note.
The holders of Senior Debt shall be intended third-party beneficiaries
of the foregoing terms of this Note and shall have the direct right to enforce
such terms including the right to intervene in any action or proceeding relating
to the payment of amounts under this Note and to enjoin any such payment.
Subject to the payment in full in cash of all Senior Debt, the Holder
shall be subrogated to the rights of the holders of Senior Debt to receive
payments or distribution of assets of the Company payable or distributable to
the holders of Senior Debt and, as among the Company, its creditors other than
the holders of Senior Debt, and the Holder, no payments or distributions
otherwise payable or deliverable in respect of this Note but, by virtue of the
provisions thereof and of this paragraph, paid or delivered to the holders of
Senior Debt shall be deemed to be a payment by the Company on account of Senior
Debt.
This Note may be exchanged at any time, at the option of the Company or
at the option of the Holder, into that number of shares of Series A Preferred
Stock (as defined in the Agreement) as shall equal (x) the aggregate unpaid
principal amount together with any accrued and unpaid interest thereon divided
by (y) $10.00. In addition, this Note may be converted at any time, at the
option of the Holder, into that number of shares of Common Stock issuable upon
the conversion of the number of shares of Series A Preferred Stock for which
this Note may then be exchanged. The exchange of this Note into shares of Series
A Preferred Stock or conversion of this Note into shares of Common Stock is
subject to the terms and conditions set forth in the Agreement.
Any voluntary or mandatory repayment of this Note shall be applied
first to the payment of interest accrued and unpaid on this Note and second to
the payment of installments of principal of this Note in the inverse order of
their maturity.
Upon the occurrence of an Event of Default (as defined in the
Agreement), (i) this Note shall become due and payable as set forth in the
Agreement and (ii) the aggregate principal amount of this Note then outstanding
and any overdue interest thereon, if any, shall bear interest (x) at the rate of
10.3% per annum if such Event of Default occurs on or prior to the second
anniversary of the date hereof and (y) at the rate of 8.0% if such Event of
Default occurs after the second anniversary of the date hereof
4
<PAGE> 5
until such outstanding amount and interest thereon has been paid in
full.
The Company agrees to pay the Holder all expenses incurred by such
holder, including reasonable attorneys' fees, in enforcing and collecting this
Note.
The Company hereby forever waives presentment, demand, presentment for
payment, protest, notice of protest, notice of dishonor of this Note and all
other demands and notices in connection with the delivery, acceptance,
performance and enforcement of this Note.
This Note shall be paid without deduction by reason of any set-off,
defense or counterclaim of the Company.
This Note shall be governed and construed in accordance with the laws
of the State of New York applicable to agreements made and to be performed
entirely in such state and shall be binding upon the heirs or legal
representatives of the Company and shall inure to the benefit of the successors
and registered assigns of the Holder.
COVENTRY CORPORATION
By:
-----------------------------------
Dale B. Wolf, Senior Vice President
and Chief Financial Officer
ATTEST:
- ---------------------------
Shirley R. Smith, Secretary
5
<PAGE> 1
EXHIBIT 4.6
CONSENT
Reference is made to the Amended and Restated Securities Purchase
Agreement dated as of April 2, 1997 (the "Securities Purchase Agreement") by and
among Warburg, Pincus Ventures, L.P., Franklin Capital Associates III L.P. and
Coventry Corporation; the capitalized terms herein shall have the meanings set
forth in the Securities Purchase Agreement, except as herein noted. The
undersigned, Warburg, Pincus & Co., as General Partner, on behalf of Warburg,
Pincus Ventures, L.P. hereby consents to the transactions contemplated by the
Capital Contribution and Share Exchange Agreement by and between Principal
Health Care, Inc., Principal Mutual Life Insurance Company, Principal Holding
Company, Coventry Health Care, Inc. and Coventry Corporation and dated as of
November 3, 1997 ("Exchange Agreement"), to waive any and all rights to which
Warburg, Pincus Ventures, L.P. would otherwise be entitled solely as a result of
the transactions contemplated by the Exchange Agreement, and in furtherance of
such waiver, to agree, as Majority Noteholder, to an amendment to the terms of
the Notes, the Warrant and the Series A Preferred Stock so as to provide that
the issuance of the consideration to Principal Health Care, Inc. ("PHC")
described in Section 1.5 of the Exchange Agreement, including the warrant
attached as Exhibit 2 thereto (the "PHC Warrant"), will not result in an
anti-dilution adjustment, as described in Section 10 of the Securities Purchase
Agreement (with respect to the Notes), Section 6 of the Certificate of
Designation and Section 3 of the Warrants.
It is acknowledged that the parties to the Exchange Agreement are
relying upon this Consent as a condition to entering into said Exchange
Agreement.
WARBURG, PINCUS VENTURES, L.P.
By: Warburg, Pincus & Co., General Partner
By: /s/ PATRICK T. HACKETT
---------------------------------------
(Signature)
PATRICK T. HACKETT
-------------------------------------------
(Print Name)
Title: Managing Director
------------------------------------
Dated: November 3, 1997
<PAGE> 1
Exhibit 10.17
COVENTRY CORPORATION
1997 STOCK INCENTIVE PLAN
SECTION 1. PURPOSE; DEFINITIONS.
The purpose of the Coventry Corporation 1997 Stock Incentive Plan (the
"Plan") is to enable Coventry Corporation (the "Company"), to attract, retain
and reward key employees of and consultants to the Company and its Subsidiaries
and Affiliates, and directors who are not also employees of the Company, and to
strengthen the mutuality of interests between such key employees, consultants,
and directors by awarding such key employees, consultants, and directors
performance-based stock incentives and/or other equity interests or equity-based
incentives in the Company, as well as performance-based incentives payable in
cash. The creation of the Plan shall not diminish or prejudice other
compensation programs approved from time to time by the Board.
For purposes of the Plan, the following terms shall be defined as set
forth below:
A. "Affiliate" means any entity other than the Company and its
Subsidiaries that is designated by the Board as a participating employer under
the Plan, provided that the Corporation directly or indirectly owns at least 20%
of the combined voting power of all classes of stock of such entity or at least
20% of the ownership interests in such entity.
B. "Board" means the Board of Directors of the Company.
C. "Cause" has the meaning provided in Section 5(j) of the Plan.
D. "Change in Control" has the meaning provided in Section 10(b) of the
Plan.
E. "Change in Control Price" has the meaning provided in Section 10(d)
of the Plan.
F. "Common Stock" means the Company's Common Stock, par value $.01
per share.
G. "Code" means the Internal Revenue Code of 1986, as amended from time
to time, and any successor thereto.
H. "Committee" means the Committee referred to in Section 2 of the
Plan.
I. "Corporation" means, a corporation organized under the laws of the
State of Tennessee or any successor corporation.
J. "Disability" means disability as determined under the Company's
Group Long Term Disability Insurance Plan.
<PAGE> 2
K. "Early Retirement" means retirement, for purposes of this Plan with
the express consent of the Company at or before the time of such retirement,
from active employment with the Company and any Subsidiary or Affiliate
prior to age 65, in accordance with any applicable early retirement policy of
the Company then in effect or as may be approved by the Committee.
L. "Effective Date" has the meaning provided in Section 14 of the Plan.
M. "Equity Issuance" means an issuance of Common Stock by the
Company following the Effective Date of this Plan in connection with a public or
private offering, including in connection with an acquisition, merger or similar
transaction, but excluding issuances of Common Stock under this Plan or in any
other compensatory transaction with an officer or employee of, or consultant to,
the Company or its Subsidiaries or Affiliates.
N. "Exchange Act" means the Securities Exchange Act of 1934, as amended
from time to time, and any successor thereto.
O. "Fair Market Value" means with respect to the Common Stock, as of
any given date or dates, unless otherwise determined by the Committee in good
faith, the reported closing price of a share of Common Stock on The Nasdaq
National Market or such other market or exchange as is the principal trading
market for the Common Stock, or, if no such sale of a share of Common Stock is
reported on The Nasdaq National Market or other exchange or principal trading
market on such date, the fair market value of a share of Common Stock as
determined by the Committee in good faith.
P. "Incentive Stock Option" means any Stock Option intended to be and
designated as an "Incentive Stock Option" within the meaning of Section 422 of
the Code.
Q. "Immediate Family" means any child, stepchild, grandchild, parent,
stepparent, grandparent, spouse, sibling, mother-in-law, father-in-law,
son-in-law, daughter-in-law, brother-in-law, or sister-in-law, and shall include
adoptive relationships.
R. "Non-Employee Director" means a member of the Board who is a
Non-Employee Director within the meaning of Rule 16b-3(b)(3) promulgated under
the Exchange Act and an outside director within the meaning of Treasury
Regulation Sec. 162-27(e)(3) promulgated under the Code.
S. "Non-Qualified Stock Option" means any Stock Option that is not an
Incentive Stock Option.
T. "Normal Retirement" means retirement from active employment with the
Company and any Subsidiary or Affiliate on or after age 65.
2
<PAGE> 3
U. "Other Stock-Based Award" means an award under Section 8 below that
is valued in whole or in part by reference to, or is otherwise based on, the
Common Stock.
V. "Outside Director" means a member of the Board who is not an officer
or employee of the Company or any Subsidiary or Affiliate of the
Company.
W. "Outside Director Option" means an award to an Outside Director
under Section 9 below.
X. "Plan" means this 1997 Stock Incentive Plan, as amended from time
to time.
Y. "Restricted Stock" means an award of shares of Common Stock that is
subject to restrictions under Section 7 of the Plan.
Z. "Restriction Period" has the meaning provided in Section 7 of the
Plan.
AA. "Retirement" means Normal or Early Retirement.
BB. "Section 162(m) Maximum" has the meaning provided in Section 3(a)
hereof.
CC. "Stock Appreciation Right" means the right pursuant to an award
granted under Section 6 below to surrender to the Company all (or a portion)
of a Stock Option in exchange for an amount equal to the difference between (i)
the Fair Market Value, as of the date such Stock Option (or such portion
thereof) is surrendered, of the shares of Common Stock covered by such Stock
Option (or such portion thereof), subject, where applicable, to the pricing
provisions in Section 6(b)(ii), and (ii) the aggregate exercise price of such
Stock Option (or such portion thereof).
DD. "Stock Option" or "Option" means any option to purchase shares of
Common Stock (including Restricted Stock, if the Committee so determines)
granted pursuant to Section 5 below.
EE. "Subsidiary" means any corporation (other than the Company) in
an unbroken chain of corporations beginning with the Company if each of the
corporations (other than the last corporation in the unbroken chain) owns stock
possessing 50% or more of the total combined voting power of all classes of
stock in one of the other corporations in the chain.
SECTION 2. ADMINISTRATION.
The Plan shall be administered by a Committee of not less than two
Non-Employee Directors, who shall be appointed by the Board and who shall serve
at the pleasure of the Board. The functions of the Committee specified in the
Plan may be exercised by an existing Committee of the Board composed exclusively
of Non-Employee Directors. The initial Committee shall be
3
<PAGE> 4
the Compensation Committee of the Board. In the event there are not at least two
Non-Employee Directors on the Board, the Plan shall be administered by the Board
and all references herein to the Committee shall refer to the Board.
The Committee shall have authority to grant, pursuant to the terms of
the Plan, to officers, other key employees, Outside Directors and consultants
eligible under Section 4: (i) Stock Options, (ii) Stock Appreciation Rights,
(iii) Restricted Stock, and/or (iv) Other Stock-Based Awards; provided, however,
that the power to grant and establish the terms and conditions of awards to
Outside Directors under the Plan other than pursuant to Section 9 shall be
reserved to the Board.
In particular, the Committee, or the Board, as the case may be, shall
have the authority, consistent with the terms of the Plan:
(a) to select the officers, key employees and Outside
Directors of and consultants to the Company and its Subsidiaries
and Affiliates to whom Stock Options, Stock Appreciation Rights,
Restricted Stock, and/or Other Stock-Based Awards may from time to time
be granted hereunder;
(b) to determine whether and to what extent Incentive Stock
Options, Non-Qualified Stock Options, Stock Appreciation Rights,
Restricted Stock, and/or Other Stock-Based Awards, or any combination
thereof, are to be granted hereunder to one or more eligible persons;
(c) to determine the number of shares to be covered by each
such award granted hereunder;
(d) to determine the terms and conditions, not inconsistent
with the terms of the Plan, of any award granted hereunder (including,
but not limited to, the share price and any restriction or limitation,
or any vesting acceleration or waiver of forfeiture restrictions
regarding any Stock Option or other award and/or the shares of Common
Stock relating thereto, based in each case on such factors as the
Committee shall determine, in its sole discretion); and to amend or
waive any such terms and conditions to the extent permitted by Section
11 hereof;
(e) to determine whether and under what circumstances a Stock
Option may be settled in cash or Restricted Stock under Section 5(m) or
(n), as applicable, instead of Common Stock;
(f) to determine whether, to what extent, and under what
circumstances Option grants and/or other awards under the Plan are to
be made, and operate, on a tandem basis vis-a-vis other awards under
the Plan and/or cash awards made outside of the Plan;
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<PAGE> 5
(g) to determine whether, to what extent, and under what
circumstances shares of Common Stock and other amounts payable with
respect to an award under this Plan shall be deferred either
automatically or at the election of the participant (including
providing for and determining the amount (if any) of any deemed
earnings on any deferred amount during any deferral period);
(h) to determine whether to require payment of tax withholding
requirements in shares of Common Stock subject to the award; and
(i) to impose any holding period required to satisfy Section
16 under the Exchange Act.
The Committee shall have the authority to adopt, alter, and repeal such
rules, guidelines, and practices governing the Plan as it shall, from time to
time, deem advisable; to interpret the terms and provisions of the Plan and any
award issued under the Plan (and any agreements relating thereto); and to
otherwise supervise the administration of the Plan.
All decisions made by the Committee pursuant to the provisions of the
Plan shall be made in the Committee's sole discretion and shall be final and
binding on all persons, including the Company and Plan participants.
SECTION 3. SHARES OF COMMON STOCK SUBJECT TO PLAN.
(a) As of the Effective Date, the aggregate number of shares of Common
Stock that may be issued under the Plan shall be 7,000,000 shares. The shares of
Common Stock issuable under the Plan may consist, in whole or in part, of
authorized and unissued shares or treasury shares. No officer of the Corporation
or other person whose compensation may be subject to the limitations on
deductibility under Section 162(m) of the Code shall be eligible to receive
awards pursuant to this Plan relating to in excess of 400,000 shares of Common
Stock in any fiscal year (the "Section 162(m) Maximum").
(b) If any shares of Common Stock that have been optioned cease to be
subject to a Stock Option, or if any shares of Common Stock that are subject to
any Restricted Stock or Other Stock-Based Award granted hereunder are forfeited
prior to the payment of any dividends, if applicable, with respect to such
shares of Common Stock, or any such award otherwise terminates without a payment
being made to the participant in the form of Common Stock, such shares shall
again be available for distribution in connection with future awards under the
Plan.
(c) In the event of any merger, reorganization, consolidation,
recapitalization, extraordinary cash dividend, stock dividend, stock split or
other change in corporate structure affecting the Common Stock, an appropriate
substitution or adjustment shall be made in the maximum number of shares that
may be awarded under the Plan, in the number and option price
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<PAGE> 6
of shares subject to outstanding Options granted under the Plan, in the number
of shares underlying Outside Director Options to be granted under Section 9
hereof, the Section 162(m) Maximum and in the number of shares subject to other
outstanding awards granted under the Plan as may be determined to be appropriate
by the Committee, in its sole discretion, provided that the number of shares
subject to any award shall always be a whole number. An adjusted option price
shall also be used to determine the amount payable by the Company upon the
exercise of any Stock Appreciation Right associated with any Stock Option.
SECTION 4. ELIGIBILITY.
Officers, other key employees and Outside Directors of and consultants
to the Company and its Subsidiaries and Affiliates who are responsible for
or contribute to the management, growth and/or profitability of the business of
the Company and/or its Subsidiaries and Affiliates are eligible to be granted
awards under the Plan. Outside Directors are eligible to receive awards pursuant
to Section 9 and as otherwise determined by the Board.
SECTION 5. STOCK OPTIONS.
Stock Options may be granted alone, in addition to, or in tandem with
other awards granted under the Plan and/or cash awards made outside of the Plan.
Any Stock Option granted under the Plan shall be in such form as the Committee
may from time to time approve.
Stock Options granted under the Plan may be of two types: (i) Incentive
Stock Options and (ii) Non-Qualified Stock Options. Incentive Stock Options may
be granted only to individuals who are employees of the Company or any
Subsidiary of the Company.
The Committee shall have the authority to grant to any optionee
Incentive Stock Options, Non-Qualified Stock Options, or both types of Stock
Options (in each case with or without Stock Appreciation Rights).
Options granted to officers, key employees, Outside Directors and
consultants under the Plan shall be subject to the following terms and
conditions and shall contain such additional terms and conditions, not
inconsistent with the terms of the Plan, as the Committee shall deem desirable.
(a) Option Price. The option price per share of Common Stock
purchasable under a Stock Option shall be determined by the Committee
at the time of grant but shall be not less than 100% (or, in the case
of any employee who owns stock possessing more than 10% of the total
combined voting power of all classes of stock of the Corporation or of
any of its Subsidiaries, not less than 110%) of the Fair Market Value
of the Common Stock at grant, in the case of Incentive Stock Options,
and not less than 50% of the Fair Market Value of the Common Stock at
grant, in the case of Non-Qualified Stock Options.
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<PAGE> 7
(b) Option Term. The term of each Stock Option shall be fixed
by the Committee, but no Incentive Stock Option shall be exercisable
more than ten years (or, in the case of an employee who owns stock
possessing more than 10% of the total combined voting power of all
classes of stock of the Company or any of its Subsidiaries or
parent corporations, more than five years) after the date the Option is
granted.
(c) Exercisability. Stock Options shall be exercisable at such
time or times and subject to such terms and conditions as shall be
determined by the Committee at or after grant; provided, however, that
except as provided in Section 5(g) and (h) and Section 10, unless
otherwise determined by the Committee at or after grant, no Stock
Option shall be exercisable prior to the first anniversary date of the
granting of the Option. The Committee may provide that a Stock Option
shall vest over a period of future service at a rate specified at the
time of grant, or that the Stock Option is exercisable only in
installments. If the Committee provides, in its sole discretion, that
any Stock Option is exercisable only in installments, the Committee may
waive such installment exercise provisions at any time at or after
grant, in whole or in part, based on such factors as the Committee
shall determine in its sole discretion.
(d) Method of Exercise. Subject to whatever installment
exercise restrictions apply under Section 5(c), Stock Options may be
exercised in whole or in part at any time during the option period, by
giving written notice of exercise to the Corporation specifying the
number of shares to be purchased. Such notice shall be accompanied by
payment in full of the purchase price, either by check, note, or such
other instrument as the Committee may accept. As determined by the
Committee, in its sole discretion, at or (except in the case of an
Incentive Stock Option) after grant, payment in full or in part may
also be made in the form of shares of Common Stock already owned by the
optionee or, in the case of a Non-Qualified Stock Option, shares of
Restricted Stock or shares subject to such Option or another award
hereunder (in each case valued at the Fair Market Value of the Common
Stock on the date the Option is exercised). If payment of the exercise
price is made in part or in full with Common Stock, the Committee may
award to the employee a new Stock Option to replace the Common Stock
which was surrendered. If payment of the option exercise price of a
Non-Qualified Stock Option is made in whole or in part in the form of
Restricted Stock, such Restricted Stock (and any replacement shares
relating thereto) shall remain (or be) restricted in accordance with
the original terms of the Restricted Stock award in question, and any
additional Common Stock received upon the exercise shall be subject to
the same forfeiture restrictions, unless otherwise determined by the
Committee, in its sole discretion, at or after grant. No shares of
Common Stock shall be issued until full payment therefor has been made.
An optionee shall generally have the rights to dividends or other
rights of a shareholder with respect to shares subject to the Option
when the optionee has given written notice of exercise, has paid in
full for such shares, and, if requested, has given the representation
described in Section 13(a).
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(e) Transferability of Options. No Non-Qualified Stock Option
shall be transferable by the optionee without the prior written consent
of the Committee other than (i) transfers by the Optionee to a member
of his or her Immediate Family or a trust for the benefit of the
optionee or a member of his or her Immediate Family, or (ii) transfers
by will or by the laws of descent and distribution. No Incentive Stock
Option shall be transferable by the optionee otherwise than by will or
by the laws of descent and distribution and all Incentive Stock Options
shall be exercisable, during the optionee's lifetime, only by the
optionee.
(f) Bonus for Taxes. In the case of a Non-Qualified Stock
Option or an optionee who elects to make a disqualifying disposition
(as defined in Section 422(a)(1) of the Code) of Common Stock acquired
pursuant to the exercise of an Incentive Stock Option, the Committee in
its discretion may award at the time of grant or thereafter the right
to receive upon exercise of such Stock Option a cash bonus calculated
to pay part or all of the federal and state, if any, income tax
incurred by the optionee upon such exercise.
(g) Termination by Death. Subject to Section 5(k), if an
optionee's employment by the Company and any Subsidiary or (except
in the case of an Incentive Stock Option) Affiliate terminates by
reason of death, any Stock Option held by such optionee may thereafter
be exercised, to the extent such option was exercisable at the time of
death or (except in the case of an Incentive Stock Option) on such
accelerated basis as the Committee may determine at or after grant (or
except in the case of an Incentive Stock Option, as may be determined
in accordance with procedures established by the Committee) by the
legal representative of the estate or by the legatee of the optionee
under the will of the optionee, for a period of one year (or such other
period as the Committee may specify at or after grant) from the date of
such death or until the expiration of the stated term of such Stock
Option, whichever period is the shorter.
(h) Termination by Reason of Disability. Subject to Section
5(k), if an optionee's employment by the Company and any Subsidiary
or (except in the case of an Incentive Stock Option) Affiliate
terminates by reason of Disability, any Stock Option held by such
optionee may thereafter be exercised by the optionee, to the extent it
was exercisable at the time of termination or (except in the case of an
Incentive Stock Option) on such accelerated basis as the Committee may
determine at or after grant (or, except in the case of an Incentive
Stock Option, as may be determined in accordance with procedures
established by the Committee), for a period of (i) three years (or such
other period as the Committee may specify at or after grant) from the
date of such termination of employment or until the expiration of the
stated term of such Stock Option, whichever period is the shorter, in
the case of a Non-Qualified Stock Option and (ii) one year from the
date of termination of employment or until the expiration of the stated
term of such Stock Option, whichever period is shorter, in the case of
an Incentive Stock Option; provided however, that, if the optionee dies
within the period specified in (i) above (or other such period as the
committee shall specify at or after grant), any unexercised Non-
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<PAGE> 9
Qualified Stock Option held by such optionee shall thereafter be
exercisable to the extent to which it was exercisable at the time of
death for a period of twelve months from the date of such death or
until the expiration of the stated term of such Stock Option, whichever
period is shorter. In the event of termination of employment by reason
of Disability, if an Incentive Stock Option is exercised after the
expiration of the exercise period applicable to Incentive Stock
Options, but before the expiration of any period that would apply if
such Stock Option were a Non-Qualified Stock Option, such Stock Option
will thereafter be treated as a Non-Qualified Stock Option.
(i) Termination by Reason of Retirement. Subject to Section
5(k), if an optionee's employment by the Company and any Subsidiary
or (except in the case of an Incentive Stock Option) Affiliate
terminates by reason of Normal or Early Retirement, any Stock Option
held by such optionee may thereafter be exercised by the optionee, to
the extent it was exercisable at the time of such Retirement or (except
in the case of an Incentive Stock Option) on such accelerated basis as
the Committee may determine at or after grant (or, except in the case
of an Incentive Stock Option, as may be determined in accordance with
procedures established by the Committee), for a period of (i) three
years (or such other period as the Committee may specify at or after
grant) from the date of such termination of employment or the
expiration of the stated term of such Stock Option, whichever period is
the shorter, in the case of a Non-Qualified Stock Option and (ii) three
months from the date of such termination of employment or the
expiration of the stated term of such Stock Option, whichever period is
the shorter, in the event of an Incentive Stock Option; provided
however, that, if the optionee dies within the period specified in (i)
above (or other such period as the Committee shall specify at or after
grant), any unexercised Non-Qualified Stock Option held by such
optionee shall thereafter be exercisable to the extent to which it was
exercisable at the time of death for a period of twelve months from the
date of such death or until the expiration of the stated term of such
Stock Option, whichever period is shorter. In the event of termination
of employment by reason of Retirement, if an Incentive Stock Option is
exercised after the expiration of the exercise period applicable to
Incentive Stock Options, but before the expiration of the period that
would apply if such Stock Option were a Non-Qualified Stock Option, the
option will thereafter be treated as a Non-Qualified Stock Option.
(j) Other Termination. Subject to Section 5(k), unless
otherwise determined by the Committee (or pursuant to procedures
established by the Committee) at or (except in the case of an Incentive
Stock Option) after grant, if an optionee's employment by the Company
and any Subsidiary or (except in the case of an Incentive Stock Option)
Affiliate is involuntarily terminated for any reason other than death,
Disability or Normal or Early Retirement, the Stock Option shall
thereupon terminate, except that such Stock Option may be exercised, to
the extent otherwise then exercisable, for the lesser of three months
or the balance of such Stock Option's term if the involuntary
termination is without Cause. For purposes of this Plan, "Cause" means
(i) a felony conviction of a participant or the failure of a
participant to contest prosecution for a
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felony, or (ii) a participant's willful misconduct or dishonesty, which
is directly and materially harmful to the business or reputation of the
Corporation or any Subsidiary or Affiliate. If an optionee voluntarily
terminates employment with the Company and any Subsidiary or
(except in the case of an Incentive Stock Option) Affiliate (except for
Disability, Normal or Early Retirement), the Stock Option shall
thereupon terminate; provided, however, that the Committee at grant or
(except in the case of an Incentive Stock Option) thereafter may extend
the exercise period in this situation for the lesser of three months or
the balance of such Stock Option's term.
(k) Incentive Stock Options. Anything in the Plan to the
contrary notwithstanding, no term of this Plan relating to Incentive
Stock Options shall be interpreted, amended, or altered, nor shall any
discretion or authority granted under the Plan be so exercised, so as
to disqualify the Plan under Section 422 of the Code, or, without the
consent of the optionee(s) affected, to disqualify any Incentive Stock
Option under such Section 422. No Incentive Stock Option shall be
granted to any participant under the Plan if such grant would cause the
aggregate Fair Market Value (as of the date the Incentive Stock Option
is granted) of the Common Stock with respect to which all Incentive
Stock Options are exercisable for the first time by such participant
during any calendar year (under all such plans of the Company and any
Subsidiary) to exceed $100,000. To the extent permitted under Section
422 of the Code or the applicable regulations thereunder or any
applicable Internal Revenue Service pronouncement:
(i) if (x) a participant's employment is
terminated by reason of death, Disability, or Retirement and
(y) the portion of any Incentive Stock Option that is
otherwise exercisable during the post-termination period
specified under Section 5(g), (h) or (i), applied without
regard to the $100,000 limitation contained in Section 422(d)
of the Code, is greater than the portion of such Option that
is immediately exercisable as an "Incentive Stock Option"
during such post-termination period under Section 422, such
excess shall be treated as a Non-Qualified Stock Option; and
(ii) if the exercise of an Incentive Stock Option
is accelerated by reason of a Change in Control, any portion
of such Option that is not exercisable as an Incentive Stock
Option by reason of the $100,000 limitation contained in
Section 422(d) of the Code shall be treated as a Non-Qualified
Stock Option.
(l) Buyout Provisions. The Committee may at any time offer to
buy out for a payment in cash, Common Stock, or Restricted Stock an
Option previously granted, based on such terms and conditions as the
Committee shall establish and communicate to the optionee at the time
that such offer is made.
(m) Settlement Provisions. If the option agreement so provides
at grant or (except in the case of an Incentive Stock Option) is
amended after grant and prior to
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exercise to so provide (with the optionee's consent), the Committee may
require that all or part of the shares to be issued with respect to the
spread value of an exercised Option take the form of Restricted Stock,
which shall be valued on the date of exercise on the basis of the Fair
Market Value (as determined by the Committee) of such Restricted Stock
determined without regards to the forfeiture restrictions involved.
(n) Performance and Other Conditions. The Committee may
condition the exercise of any Option upon the attainment of specified
performance goals or other factors as the Committee may determine, in
its sole discretion. Unless specifically provided in the option
agreement, any such conditional Option shall vest immediately prior to
its expiration if the conditions to exercise have not theretofore been
satisfied.
SECTION 6. STOCK APPRECIATION RIGHTS.
(a) Grant and Exercise. Stock Appreciation Rights may be
granted in conjunction with all or part of any Stock Option granted
under the Plan. In the case of a Non-Qualified Stock Option, such
rights may be granted either at or after the time of the grant of such
Stock Option. In the case of an Incentive Stock Option, such rights may
be granted only at the time of the grant of such Stock Option. A Stock
Appreciation Right or applicable portion thereof granted with respect
to a given Stock Option shall terminate and no longer be exercisable
upon the termination or exercise of the related Stock Option, subject
to such provisions as the Committee may specify at grant where a Stock
Appreciation Right is granted with respect to less than the full number
of shares covered by a related Stock Option. A Stock Appreciation Right
may be exercised by an optionee, subject to Section 6(b), in accordance
with the procedures established by the Committee for such purpose. Upon
such exercise, the optionee shall be entitled to receive an amount
determined in the manner prescribed in Section 6(b). Stock Options
relating to exercised Stock Appreciation Rights shall no longer be
exercisable to the extent that the related Stock Appreciation Rights
have been exercised.
(b) Terms and Conditions. Stock Appreciation Rights shall be
subject to such terms and conditions, not inconsistent with the
provisions of the Plan, as shall be determined from time to time by the
Committee, including the following:
(i) Stock Appreciation Rights shall be exercisable
only at such time or times and to the extent that the Stock
Options to which they relate shall be exercisable in
accordance with the provisions of Section 5 and this Section 6
of the Plan.
(ii) Upon the exercise of a Stock Appreciation Right,
an optionee shall be entitled to receive an amount in cash
and/or shares of Common Stock equal in value to the excess of
the Fair Market Value of one share of Common Stock over
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<PAGE> 12
the option price per share specified in the related Stock
Option multiplied by the number of shares in respect of which
the Stock Appreciation Right shall have been exercised, with
the Committee having the right to determine the form of
payment. When payment is to be made in shares, the number of
shares to be paid shall be calculated on the basis of the Fair
Market Value of the shares on the date of exercise. When
payment is to be made in cash, such amount shall be calculated
on the basis of the Fair Market Value of the Common Stock on
the date of exercise.
(iii) Stock Appreciation Rights shall be transferable
only when and to the extent that the underlying Stock Option
would be transferable under Section 5(e) of the Plan.
(iv) Upon the exercise of a Stock Appreciation Right,
the Stock Option or part thereof to which such Stock
Appreciation Right is related shall be deemed to have been
exercised for the purpose of the limitation set forth in
Section 3 of the Plan on the number of shares of Common Stock
to be issued under the Plan.
(v) The Committee, in its sole discretion, may also
provide that, in the event of a Change in Control and/or a
Potential Change in Control, the amount to be paid upon the
exercise of a Stock Appreciation Right shall be based on the
Change in Control Price, subject to such terms and conditions
as the Committee may specify at grant.
(vi) The Committee may condition the exercise of any
Stock Appreciation Right upon the attainment of specified
performance goals or other factors as the Committee may
determine, in its sole discretion.
SECTION 7. RESTRICTED STOCK.
(a) Administration. Shares of Restricted Stock may be issued
either alone, in addition to, or in tandem with other awards granted
under the Plan and/or cash awards made outside the Plan. The Committee
shall determine the eligible persons to whom, and the time or times at
which, grants of Restricted Stock will be made, the number of shares of
Restricted Stock to be awarded to any person, the price (if any) to be
paid by the recipient of Restricted Stock (subject to Section 7(b)),
the time or times within which such awards may be subject to
forfeiture, and the other terms, restrictions and conditions of the
awards in addition to those set forth in Section 7(c). The Committee
may condition the grant of Restricted Stock upon the attainment of
specified performance goals or such other factors as the Committee may
determine, in its sole discretion. The provisions of Restricted Stock
awards need not be the same with respect to each recipient.
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<PAGE> 13
(b) Awards and Certificates. The prospective recipient of a
Restricted Stock award shall not have any rights with respect to such
award, unless and until such recipient has executed an agreement
evidencing the award and has delivered a fully executed copy thereof to
the Company, and has otherwise complied with the applicable terms and
conditions of such award.
(i) The purchase price for shares of Restricted Stock
shall be established by the Committee and may be zero.
(ii) Awards of Restricted Stock must be accepted
within a period of 60 days (or such shorter period as the
Committee may specify at grant) after the award date, by
executing a Restricted Stock Award Agreement and paying
whatever price (if any) is required under Section 7(b)(i).
(iii) Each participant receiving a Restricted Stock
award shall be issued a stock certificate in respect of such
shares of Restricted Stock. Such certificate shall be
registered in the name of such participant, and shall bear an
appropriate legend referring to the terms, conditions, and
restrictions applicable to such award.
(iv) The Committee shall require that the stock
certificates evidencing such shares be held in custody by the
Company until the restrictions thereon shall have lapsed, and
that, as a condition of any Restricted Stock award, the
participant shall have delivered a stock power, endorsed in
blank, relating to the shares of Common Stock covered by such
award.
(c) Restrictions and Conditions. The shares of Restricted
Stock awarded pursuant to this Section 7 shall be subject to the
following restrictions and conditions:
(i) In accordance with the provisions of this Plan
and the award agreement, during a period set by the Committee
commencing with the date of such award (the "Restriction
Period"), the participant shall not be permitted to sell,
transfer, pledge, assign, or otherwise encumber shares of
Restricted Stock awarded under the Plan. Within these limits,
the Committee, in its sole discretion, may provide for the
lapse of such restrictions in installments and may accelerate
or waive such restrictions, in whole or in part, based on
service, performance, such other factors or criteria as the
Committee may determine in its sole discretion.
(ii) Except as provided in this paragraph (ii) and
Section 7(c)(i), the participant shall have, with respect to
the shares of Restricted Stock, all of the rights of a
shareholder of the Company, including the right to vote the
shares, and the right to receive any cash dividends. The
Committee, in its sole discretion, as determined at the time
of award, may permit or require the payment of cash dividends
to be deferred and, if the Committee so determines,
reinvested, subject
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to Section 14(e), in additional Restricted Stock to the extent
shares are available under Section 3, or otherwise reinvested.
Pursuant to Section 3 above, stock dividends issued with
respect to Restricted Stock shall be treated as additional
shares of Restricted Stock that are subject to the same
restrictions and other terms and conditions that apply to the
shares with respect to which such dividends are issued. If the
Committee so determines, the award agreement may also impose
restrictions on the right to vote and the right to receive
dividends.
(iii) Subject to the applicable provisions of the
award agreement and this Section 7, upon termination of a
participant's employment with the Company and any
Subsidiary or Affiliate for any reason during the Restriction
Period, all shares still subject to restriction will vest, or
be forfeited, in accordance with the terms and conditions
established by the Committee at or after grant.
(iv) If and when the Restriction Period expires
without a prior forfeiture of the Restricted Stock subject to
such Restriction Period, certificates for an appropriate
number of unrestricted shares shall be delivered to the
participant promptly.
(d) Minimum Value Provisions. In order to better ensure that
award payments actually reflect the performance of the Company and
service of the participant, the Committee may provide, in its sole
discretion, for a tandem performance-based or other award designed to
guarantee a minimum value, payable in cash or Common Stock to the
recipient of a restricted stock award, subject to such performance,
future service, deferral, and other terms and conditions as may be
specified by the Committee.
SECTION 8. OTHER STOCK-BASED AWARDS.
(a) Administration. Other Stock-Based Awards, including,
without limitation, performance shares, convertible preferred stock,
convertible debentures, exchangeable securities and Common Stock awards
or options valued by reference to earnings per share or Subsidiary
performance, may be granted either alone, in addition to, or in tandem
with Stock Options, Stock Appreciation Rights, or Restricted Stock
granted under the Plan and cash awards made outside of the Plan;
provided that no such Other Stock-Based Awards may be granted in tandem
with Incentive Stock Options if that would cause such Stock Options not
to qualify as Incentive Stock Options pursuant to Section 422 of the
Code. Subject to the provisions of the Plan, the Committee shall have
authority to determine the persons to whom and the time or times at
which such awards shall be made, the number of shares of Common Stock
to be awarded pursuant to such awards, and all other conditions of the
awards. The Committee may also provide for the grant of Common Stock
upon the completion of a specified performance period. The provisions
of Other Stock-Based Awards need not be the same with respect to each
recipient.
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(b) Terms and Conditions. Other Stock-Based Awards made
pursuant to this Section 8 shall be subject to the following terms and
conditions:
(i) Shares subject to awards under this Section 8 and
the award agreement referred to in Section 8(b)(v) below, may
not be sold, assigned, transferred, pledged, or otherwise
encumbered prior to the date on which the shares are issued,
or, if later, the date on which any applicable restriction,
performance, or deferral period lapses.
(ii) Subject to the provisions of this Plan and the
award agreement and unless otherwise determined by the
Committee at grant, the recipient of an award under this
Section 8 shall be entitled to receive, currently or on a
deferred basis, interest or dividends or interest or dividend
equivalents with respect to the number of shares covered by
the award, as determined at the time of the award by the
Committee, in its sole discretion, and the Committee may
provide that such amounts (if any) shall be deemed to have
been reinvested in additional shares of Common Stock or
otherwise reinvested.
(iii) Any award under Section 8 and any shares of
Common Stock covered by any such award shall vest or be
forfeited to the extent so provided in the award agreement, as
determined by the Committee in its sole discretion.
(iv) In the event of the participant's Retirement,
Disability, or death, or in cases of special circumstances,
the Committee may, in its sole discretion, waive in whole or
in part any or all of the remaining limitations imposed
hereunder (if any) with respect to any or all of an award
under this Section 8.
(v) Each award under this Section 8 shall be
confirmed by, and subject to the terms of, an agreement or
other instrument by the Corporation and the participant.
(vi) Common Stock (including securities convertible
into Common Stock) issued on a bonus basis under this Section
8 may be issued for no cash consideration. Common Stock
(including securities convertible into Common Stock) purchased
pursuant to a purchase right awarded under this Section 8
shall be priced at least 85% of the Fair Market Value of the
Common Stock on the date of grant.
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SECTION 9. CHANGE IN CONTROL PROVISIONS.
(a) Impact of Event. In the event of (1) a "Change in Control"
as defined in Section 9(b); or (2) a "Potential Change in Control" as
defined in Section 10(c), but only if and to the extent so determined
by the Committee or the Board at or after grant (subject to any right
of approval expressly reserved by the Committee or the Board at the
time of such determination),
(i) Subject to the limitations set forth below in
this Section 9(a), the following acceleration provisions shall
apply:
(a) Any Stock Appreciation Rights, any Stock
Option or Outside Director Option awarded under the
Plan not previously exercisable and vested shall
become fully exercisable and vested.
(b) The restrictions applicable to any
Restricted Stock and Other Stock-Based Awards, in
each case to the extent not already vested under the
Plan, shall lapse and such shares and awards shall be
deemed fully vested.
(ii) Subject to the limitations set forth below in
this Section 9(a), the value of all outstanding Stock Options,
Stock Appreciation Rights, Restricted Stock, Outside Director
Options and Other Stock-Based Awards, in each case to the
extent vested, shall, unless otherwise determined Board or by
the Committee
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in its sole discretion prior to any Change in Control, be
cashed out on the basis of the "Change in Control Price" as
defined in Section 9(d) as of the date such Change in Control
or such Potential Change in Control is determined to have
occurred or such other date as the Board or Committee may
determine prior to the Change in Control.
(iii) The Board or the Committee may impose
additional conditions on the acceleration or valuation of any
award in the award agreement.
(b) Definition of Change in Control. For purposes of Section
9(a), a "Change in Control" means the happening of any of the
following:
(i) any person or entity, including a "group" as
defined in Section 13(d)(3) of the Exchange Act, other than
the Company or a wholly-owned subsidiary thereof or any
employee benefit plan of the Company or any of its
Subsidiaries, becomes the beneficial owner of the Company's
securities having 35% or more of the combined voting power of
the then outstanding securities of the Company that may be
cast for the election of directors of the Company (other than
as a result of (A) an issuance of securities initiated by the
Company in the ordinary course of business or (B) a merger,
share exchange, sale of assets or other business combination
or combinations of the foregoing transactions approved by a
majority of the Board of Directors and in which a majority of
the combined voting power of the then outstanding securities
of the Company or any successor Company or entity entitled to
vote generally in the election of directors of the Company or
such other Company or entity after such transaction are held
in the aggregate by holders of the Company's securities
entitled to vote generally in the election of directors of the
Company immediately prior to such transaction); immediately
prior to the consummation of the transactions own more than
50% of the voting securities of the surviving corporation
immediately after the transaction); and in which the Company's
shareholders immediately prior to the consummation of the
transactions own more than 50% of the voting securities of the
surviving corporation immediately after the transaction); or
(ii) as the result of, or in connection with, any
cash tender or exchange offer, merger or other business
combination, sales of assets or contested election, or any
combination of the foregoing transactions, less than a
majority of the combined voting power of the then outstanding
securities of the Company or any successor corporation or
entity entitled to vote generally in the election of the
directors of the Company or such other corporation or entity
after such transaction are held in the aggregate by the
holders of the Company's securities entitled to vote generally
in the election of directors of the Company immediately prior
to such transaction; or
(iii) during any period of two consecutive years,
individuals who at the beginning of any such period constitute
the Board cease for any reason to constitute at least a
majority thereof, unless the election, or the nomination for
election by the Company's shareholders, of each director of
the Company first elected during such period was approved by a
vote of at least two-thirds of the directors of the Company
then still in office who were directors of the Company at the
beginning of any such period.
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(c) Definition of Potential Change in Control. For purposes of
Section 9(a), a "Potential Change in Control" means the happening of
any one of the following:
(i) The approval by shareholders of an agreement by
the Company, the consummation of which would result in a
Change in Control of the Company as defined in Section 9(b);
or
(ii) The acquisition of beneficial ownership,
directly or indirectly, by any entity, person or group (other
than the Company or a Subsidiary or any Company employee
benefit plan (including any trustee of such plan acting as
such trustee)) of securities of the Company representing 5% or
more of the combined voting power of the Company's outstanding
securities and the adoption by the Committee of a resolution
to the effect that a Potential Change in Control of the
Company has occurred for purposes of this Plan.
(d) Change in Control Price. For purposes of this Section 10,
"Change in Control Price" means the highest price per share paid in any
transaction reported on the The Nasdaq National Market or such other
exchange or market as is the principal trading market for the Common
Stock, or paid or offered in any bona fide transaction related to a
Potential or actual Change in Control of the Company at any time
during the 60 day period immediately preceding the occurrence of the
Change in Control (or, where applicable, the occurrence of the
Potential Change in Control event), in each case as determined by the
Committee except that, in the case of Incentive Stock Options and Stock
Appreciation Rights relating to Incentive Stock Options, such price
shall be based only on transactions reported for the date on which the
optionee exercises such Stock Appreciation Rights or, where applicable,
the date on which a cash out occurs under Section 10(a)(ii).
SECTION 10. AMENDMENTS AND TERMINATION.
The Board may at any time amend, alter or discontinue the Plan;
provided, however, that, without the approval of the Company's shareholders,
no amendment or alteration may be made which would (a) except as a result of the
provisions of Section 3(c) of the Plan, increase the maximum number of shares
that may be issued under the Plan or increase the Section 162(m) Maximum, (b)
change the provisions governing Incentive Stock Options except as required or
permitted under the provisions governing incentive stock options under the Code,
or (c) make any change for which applicable law or regulatory authority
(including the regulatory authority of the The Nasdaq National Market or any
other market or exchange on which the Common Stock is traded) would require
shareholder approval or for which shareholder approval would be required to
secure full deductibility of compensation received under the Plan under Section
162(m) of the Code. No amendment, alteration, or discontinuation shall be made
which would impair the rights of an optionee or participant under a Stock
Option, Stock Appreciation Right, Restricted Stock,
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Other Stock-Based Award or Outside Director Option theretofore granted, without
the participant's consent.
The Committee may amend the terms of any Stock Option or other award
theretofore granted, prospectively or retroactively, but, subject to Section 3
above, no such amendment shall impair the rights of any holder without the
holder's consent. The Committee may also substitute new Stock Options for
previously granted Stock Options (on a one for one or other basis), including
previously granted Stock Options having higher option exercise prices. Solely
for purposes of computing the Section 162(m) Maximum, if any Stock Options or
other awards previously granted to a participant are canceled and new Stock
Options or other awards having a lower exercise price or other more favorable
terms for the participant are substituted in their place, both the initial Stock
Options or other awards and the replacement Stock Options or other awards will
be deemed to be outstanding (although the canceled Stock Options or other awards
will not be exercisable or deemed outstanding for any other purposes).
SECTION 11. UNFUNDED STATUS OF PLAN.
The Plan is intended to constitute an "unfunded" plan for incentive and
deferred compensation. With respect to any payments not yet made to a
participant or optionee by the Company, nothing contained herein shall give
any such participant or optionee any rights that are greater than those of a
general creditor of the Company. In its sole discretion, the Committee may
authorize the creation of trusts or other arrangements to meet the obligations
created under the Plan to deliver Common Stock or payments in lieu of or with
respect to awards hereunder; provided, however, that, unless the Committee
otherwise determines with the consent of the affected participant, the existence
of such trusts or other arrangements is consistent with the "unfunded" status of
the Plan.
SECTION 12. GENERAL PROVISIONS.
(a) The Committee may require each person purchasing shares
pursuant to a Stock Option or other award under the Plan to represent
to and agree with the Corporation in writing that the optionee or
participant is acquiring the shares without a view to distribution
thereof. The certificates for such shares may include any legend which
the Committee deems appropriate to reflect any restrictions on
transfer. All certificates for shares of Common Stock or other
securities delivered under the Plan shall be subject to such
stock-transfer orders and other restrictions as the Committee may deem
advisable under the rules, regulations, and other requirements of the
Commission, any stock exchange upon which the Common Stock is then
listed, and any applicable Federal or state securities law, and the
Committee may cause a legend or legends to be put on any such
certificates to make appropriate reference to such restrictions.
19
<PAGE> 20
(b) Nothing contained in this Plan shall prevent the Board
from adopting other or additional compensation arrangements, subject to
shareholder approval if such approval is required; and such
arrangements may be either generally applicable or applicable only in
specific cases.
(c) The adoption of the Plan shall not confer upon any
employee of the Company or any Subsidiary or Affiliate any right to
continued employment with the Company or a Subsidiary or Affiliate,
as the case may be, nor shall it interfere in any way with the right of
the Company or a Subsidiary or Affiliate to terminate the
employment of any of its employees at any time.
(d) No later than the date as of which an amount first becomes
includible in the gross income of the participant for Federal income
tax purposes with respect to any award under the Plan, the participant
shall pay to the Company, or make arrangements satisfactory to the
Committee regarding the payment of, any Federal, state, or local taxes
of any kind required by law to be withheld with respect to such amount.
The Committee may require withholding obligations to be settled with
Common Stock, including Common Stock that is part of the award that
gives rise to the withholding requirement. The obligations of the
Company under the Plan shall be conditional on such payment or
arrangements and the Company and its Subsidiaries or Affiliates
shall, to the extent permitted by law, have the right to deduct any
such taxes from any payment of any kind otherwise due to the
participant.
(e) The actual or deemed reinvestment of dividends or dividend
equivalents in additional Restricted Stock (or other types of Plan
awards) at the time of any dividend payment shall only be permissible
if sufficient shares of Common Stock are available under Section 3 for
such reinvestment (taking into account then outstanding Stock Options
and other Plan awards).
(f) The Plan and all awards made and actions taken thereunder
shall be governed by and construed in accordance with the laws of the
State of Tennessee.
(g) The members of the Committee and the Board shall not be
liable to any employee or other person with respect to any
determination made hereunder in a manner that is not inconsistent with
their legal obligations as members of the Board. In addition to such
other rights of indemnification as they may have as directors or as
members of the Committee, the members of the Committee shall be
indemnified by the Corporation against the reasonable expenses,
including attorneys' fees actually and necessarily incurred in
connection with the defense of any action, suit or proceeding, or in
connection with any appeal therein, to which they or any of them may be
a party by reason of any action taken or failure to act under or in
connection with the Plan or any option granted thereunder, and against
all amounts paid by them in settlement thereof (provided such
settlement is approved by independent legal counsel selected by the
Company) or paid by them in
20
<PAGE> 21
satisfaction of a judgment in any such action, suit or proceeding,
except in relation to matters as to which it shall be adjudged in such
action, suit or proceeding that such Committee member is liable for
negligence or misconduct in the performance of his duties; provided
that within 60 days after institution of any such action, suit or
proceeding, the Committee member shall in writing offer the Company
the opportunity, at its own expense, to handle and defend the same.
(h) In addition to any other restrictions on transfer that may
be applicable under the terms of this Plan or the applicable award
agreement, no Stock Option, Stock Appreciation Right, Restricted Stock
award, or Other Stock-Based Award or other right issued under this Plan
is transferable by the participant without the prior written consent of
the Committee, or, in the case of an Outside Director, the Board, other
than (i) transfers by an optionee to a member of his or her Immediate
Family or a trust for the benefit of the optionee or a member of his or
her Immediate Family or (ii) transfers by will or by the laws of
descent and distribution. The designation of a beneficiary will not
constitute a transfer.
(i) The Committee may, at or after grant, condition the
receipt of any payment in respect of any award or the transfer of any
shares subject to an award on the satisfaction of a six-month holding
period, if such holding period is required for compliance with Section
16 under the Exchange Act.
SECTION 13. EFFECTIVE DATE OF PLAN.
The Plan shall be effective upon approval by the Board of the
Company and by a majority of the votes cast by the holders of the
Company's Common Stock.
SECTION 14. TERM OF PLAN.
No Stock Option, Stock Appreciation Right, Restricted Stock award,
Other Stock-Based Award or Outside Director Option award shall be granted
pursuant to the Plan on or after the tenth anniversary of the Effective Date of
the Plan, but awards granted prior to such tenth anniversary may be extended
beyond that date.
21
<PAGE> 1
Exhibit 10.19
FIRST AMENDMENT
TO THE
COVENTRY CORPORATION
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The Coventry Corporation Supplemental Executive Retirement Plan (the
"Plan") is hereby amended, effective as of the dates set forth below, as
follows:
1. Section 2.8 is amended to clarify its original meaning
and to provide as follows:
2.8 Deferred Compensation Account. "Deferred Compensation
Account" means the account maintained on the books of the Employer to
which Deferred Compensation and Employer Matching Contributions for
each Participant are credited, and to which deemed interest, dividends,
and investment gains are added to the account and the amount of any
distributions, deemed investment losses, and expenses are deducted from
the account.
2. Section 2.11 is deleted in its entirety.
3. Section 2.13 is amended, effective January 1, 1996, to
provide as follows:
2.13 Eligible Employee. "Eligible Employee" means an Employee
who the Compensation Committee of the Board determines is a highly
compensated employee or a select member of management who, by virtue of
his position with the Employer, is uniquely informed as to the
Employer's operations and has the ability to materially affect the
Employer's profitability and operations. The Compensation Committee may
determine at any time that an Employee no longer satisfies this
standard, in which case he shall cease to be an Eligible Employee.
4. Sections 2.24 is amended to clarify its original intent
and to provide as follows:
2.24 Trust. "Trust" means the grantor trust which
is intended to conform to the terms of the model trust
as described in Revenue Procedure 92-64. The Trust has
been established by the Employer for the purpose of
<PAGE> 2
accepting contributions which may be made under the Plan and to which
interest, dividends, and investment gains are added and from which the
amount of any distributions, investment losses, and expenses are
deducted.
5. Article III is amended to clarify its original intent and to
provide as follows:
ARTICLE III
ELIGIBILITY AND PARTICIPATION
3.1 Eligibility
(a) Eligibility. Eligibility to participate
in the Plan is limited to Eligible Employees.
3.2 Participation
(a) Form of Deferral. An Eligible Employee may become
a Participant by properly executing a Deferred Compensation
Agreement and filing such Agreement with the Committee. An
Eligible Employee may elect to defer, in whole percentages, 1%
to 15% of his base salary per pay period and 1% to 100% of his
bonus for a Plan Year. The Deferred Compensation Agreement
shall be executed before the first day of the Plan Year for
which the deferred compensation is otherwise payable and shall
be effective as of the first day of the first payroll period
beginning in such Plan Year; provided, however, that in the
first year that an Employee becomes an Eligible Employee, such
Eligible Employee may make an election within 30 days after
becoming an Eligible Employee to defer Compensation for
services to be performed after he becomes an Eligible Employee
and such Eligible Employee's Deferred Compensation Agreement
shall be effective as of the first day of the payroll period
beginning immediately following the execution of such
Agreement, or the effective date of such Agreement, if later.
(b) Modification of Deferral Compensation Agreements.
A Deferred Compensation Agreement will remain in effect until
a new Deferred Compensation Agreement is filed with the
Committee in accordance with the terms and conditions
specified herein or until the date a Participant ceases to be
an Eligible Employee. A Deferred Compensation Agreement may
only be amended or
2
<PAGE> 3
revoked for a subsequent Plan Year by filing a new Deferred
Compensation Agreement with the Committee at least 15 days
(or such shorter period as may be established by the
Committee) before the beginning of the subsequent Plan Year.
6. Section 4.2 is amended to clarify its original meaning
and to substitute the word "credit" for the word "contribute" in
the first sentence thereof.
7. Section 4.4 is amended to clarify its original meaning
and to provide as follows:
4.4 Participant Directed Investment Options. Each Participant
shall have the opportunity to direct the deemed investment of his
Deferred Compensation Account among the deemed investment options
selected by the Committee in multiples of 10% in accordance with which
deemed interest, dividends and investment gains and losses will be
added to or deducted from his Deferred Compensation Account. Transfers
among investment options may be made on a monthly basis throughout the
Plan Year, to be effective as of the last day of each calendar month.
8. Section 5.3 is amended to clarify its original meaning
by capitalizing the word "Beneficiary" in the first sentence
thereof.
9. Section 5.5 is amended to clarify its original meaning and to
substitute the reference to "paragraph 5.3(a)" for the reference to "paragraph
5.3(b)" in the last sentence thereof.
10. Section 9.3 is amended to clarify its original meaning
and to provide as follows:
9.3 Termination of Plan. The Board may at any time terminate
the Plan with respect to new deferral elections, as to any Eligible
Employee or in its entirety if, in its judgment, the tax, accounting,
or other effect of the continuance of the Plan, or any potential
payment thereunder would not be in the best
3
<PAGE> 4
interest of the Employer. If the Plan is terminated in its entirety or
as to any Eligible Employee, each affected Participant shall be 100%
vested in the value of his Deferred Compensation Account. Upon such
termination, each Participant will receive the value of his Deferred
Compensation Account in the form of a lump-sum payment to be made no
later than 120 days following the termination date.
11. Section 10.3 is amended to clarify its original meaning
and to provide as follows:
10.3 Nonassignability. Neither a Participant nor
any other person shall have any right to alienate, commute, sell,
assign, transfer, pledge, anticipate, mortgage or otherwise encumber,
transfer, hypothecate or convey in advance of actual receipt the
amounts, if any, payable hereunder, or any part thereof, which are,
and all right to which are, expressly declared to be unassignable and
non-transferrable. No part of the amounts payable shall, prior to
actual payment, be subject to seizure, attachment, garnishment by
creditors or separation for the payment of any other person, nor be
transferable by operation of law in the event of a Participant's or an
other person's bankruptcy or insolvency.
IN WITNESS WHEREOF, Coventry Corporation has caused this First
Amendment to the Coventry Corporation Supplemental Executive Retirement Plan to
be executed by its duly authorized officers this 31st day of December, 1996.
COVENTRY CORPORATION
By: /s/ Shirley R. Smith
-------------------------------
ATTEST:
/s/ J. H. Ockerman
- -------------------------
4
<PAGE> 1
Exhibit 10.20
SECOND AMENDMENT
TO THE
COVENTRY CORPORATION
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
WHEREAS, pursuant to an Asset Purchase Agreement made as of February
26, 1997, HealthAmerica Pennsylvania, Inc. ("HealthAmerica") sold to Allegheny
Health Education and Research Foundation ("AHERF") all the business, operations
and assets of certain medical centers (the "HealthAmerica Medical Operations")
and in connection with such sale, certain employees of HealthAmerica and Penn
Group Medical Associates, P.A. ("PGMA") became employees of AHERF but continued
to perform the same services for AHERF in connection with the HealthAmerica
Medical Operations purchased by AHERF that they provided for HealthAmerica and
PGMA prior to the sale and PGMA was no longer controlled by Coventry or its
subsidiaries; and
WHEREAS, pursuant to an Asset Purchase Agreement made as of March 12,
1997, Group Health Plan, Inc. ("GHP") sold to BJC Health System ("BJC") certain
assets relating to a staff model medical practice at various medical centers
(the "GHP Medical Operations") and in connection with such sale, certain
employees of GHP became employees of BJC but continued to perform the same
services for BJC in connection with the GHP Medical Operations purchased by BJC
that they provided for GHP prior to the sale; and
WHEREAS, Coventry and its subsidiaries and The Charles Schwab Trust
Company adopted a Revised Agreement of Adoption for the Trust under the Coventry
Corporation Supplemental Executive Retirement Plan (the "Trust") to confirm the
allocation of the assets held in the Trust subsequent to such sales and the
administration of the Coventry Supplemental
<PAGE> 2
Executive Retirement Plan (the "SERP") following such sales and pursuant to such
Agreement it was confirmed that, for purposes of determining the vesting
percentage under Section 4.3 of the SERP for the Participants described above,
service with AHERF following the AHERF sale or service with BJC following the
BJC sale, as applicable, were to be taken into account in determining Years of
Service under the Plan; and
WHEREAS, it is deemed appropriate to fully vest those Participants
described above as of the date of the AHERF sale or the BJC sale, as applicable,
regardless of the number of Years of Service at the time of the transfer of
employment and Section 9.1 of the SERP provides for its amendment with the
approval of the Board of Directors of Coventry Corporation;
NOW, THEREFORE, The Coventry Corporation Supplemental Executive
Retirement Plan is hereby amended, as follows:
Section 4.3 is amended to add a new sentence at the end thereof to
provide as follows:
Notwithstanding the foregoing, a Participant (i) who became an employee
of Allegheny Health, Education and Research Foundation in connection
with its purchase of all the business operations and assets of certain
medical offices of HealthAmerica Pennsylvania, Inc. pursuant to an
Asset Purchase Agreement made as of February 26, 1997 but continued to
perform the same services for the purchaser following such sale or (ii)
who became an employee of BJC Health System in connection with the sale
of certain assets relating to a staff model medical practice at various
medical centers pursuant to an Asset Purchase Agreement made as of
March __, 1997 and who continued to perform the same services for the
purchaser following such sale shall be 100% vested in the account
balance of his Deferred Compensation Account attributable to Employer
Matching Contributions upon his ceasing to be an Employee.
2
<PAGE> 3
IN WITNESS WHEREOF, Coventry Corporation has caused this Second
Amendment to the Coventry Corporation Supplemental Executive Retirement Plan to
be executed by its duly authorized officers this 15th day of July, 1997.
COVENTRY CORPORATION
By: /s/ Shirley R. Smith
--------------------------
ATTEST:
/s/ J. H. Ockerman
- -------------------------
3
<PAGE> 1
EXHIBIT 10.28
THIRD AMENDMENT
TO
RISK SHARING AGREEMENT
BY AND BETWEEN
ALLEGHENY HEALTH, EDUCATION & RESEARCH FOUNDATION
AND
COVENTRY CORPORATION
ON BEHALF OF MEMBER COMPANIES
THIS AGREEMENT is executed the 25th day of August 1997, by and between
HealthAmerica Pennsylvania, Inc., a Pennsylvania corporation licensed to operate
a health maintenance organization ("HealthAmerica"), Coventry Corporation, a
Delaware corporation ("Coventry") for and on behalf of the Member Companies (as
hereinafter defined) other than HealthAmerica, and Allegheny Health, Education
and Research Foundation, a Pennsylvania nonprofit corporation ("AHERF").
WHEREAS, HealthAmerica and Coventry entered into a Risk Sharing Agreement with
AHERF on March 31, 1997; and
WHEREAS, on June 11, 1997 HealthAmerica and Coventry entered into a First
Amendment to Risk Sharing Agreement with AHERF; and
WHEREAS, on June 30, 1997 HealthAmerica and Coventry and Coventry Health Plan of
West Virginia, Inc. d/b/a HealthAssurance HMO entered into a Second Amendment to
Risk Sharing Agreement with AHERF; and
WHEREAS, the parties to said Agreement desire to further amend said Agreement to
incorporate additional compliance language in order to comport with certain
regulatory requirements of the state of West Virginia.
NOW, THEREFORE, in consideration of the mutual covenants, premises and
undertakings herein and intending to be legally bound hereby, the parties agree
as follows:
1. Incorporation of Amendments. To the extent not modified by this Third
Amendment, the Second Amendment, First Amendment and Risk Sharing Agreement
are incorporated herein by reference.
2. Section 3, Duties of AHERF, shall be expanded, specifically for purposes of
compliance with West Virginia Code Section 114-43-1 et seq, as it relates
to West Virginia HMO, to add the following terms and conditions:
3.1.11 AHERF shall adhere to all quality and accessibility
standards to which West Virginia HMO is subject. Further,
to the extent AHERF subcontracts for the provision of
health care services it is agreed that all subcontractors
must adhere
1
<PAGE> 2
to the quality and accessibility standards to which West
Virginia HMO is subject.
3.1.12 AHERF shall maintain records which are adequate to
clearly differentiate the transactions which relate to the
provision of health care services on behalf of West
Virginia HMO.
3.1.13 AHERF and any Contracted Providers with which it
contracts for the provision of health care services shall
obtain and provide to West Virginia HMO no later than the
first day of June of each year an annual audited financial
report prepared by an independent certified public
accountant.
3.1.14 AHERF will only provide services on behalf of West
Virginia HMO in counties where West Virginia HMO is
authorized to operate by the West Virginia Department of
Insurance.
3.1.15 AHERF shall maintain working capital in the form of
cash or equivalent liquid assets at least equal to one
month's claims calculated by using the monthly average of
actual and estimated claims for the prior six months for
all health services provided under the Agreement.
3.1.16 AHERF shall create a segregated fund, which may be
aggregated, equal to the entire monthly IBNR as of the
first day of each month as actuarially determined by West
Virginia HMO.
3. Section 4 DUTIES OF HEALTHAMERICA/WEST VIRGINIA HMO, shall be expanded,
specifically for purposes of compliance with West Virginia Code Section
114-43-1 et. seq., as it relates to West Virginia HMO, to add the following
terms and conditions:
4.1.10 West Virginia HMO shall be responsible for maintaining
appropriate levels of capital, surplus, claims reserves and other financial
criteria as established pursuant to statute or rule.
4.1.11 All Covered Individuals or Covered Individual group
contracts will be entered into directly with West Virginia HMO and
specifically not with AHERF.
4. Section 5.9, NO BALANCE BILLING, shall be amended to read in its entirety
as follows:
"AHERF hereby agrees, on behalf of itself and its Affiliated
and Contracted Providers, that in no event, including but not
limited to, non-payment by a Member Company, a Member Company
insolvency or breach of the Agreement, shall AHERF bill,
charge or collect a deposit from, seek compensation,
remuneration or reimbursement from, or have any recourse
against, Covered Individuals or persons other than a Member
Company acting on their behalf for Covered Services. This
Section shall not prohibit collection of Copayments,
Coinsurance, Deductibles or Financial Penalties made in
2
<PAGE> 3
accordance with the terms of the applicable Covered
Individual's contract with a Member Company nor billing for
non-Covered Service for which Covered Individuals have had
prior notification and approved.
"AHERF further agrees that: (i) the no balance billing
provision herein shall survive the termination of the
Agreement regardless of the cause giving rise to termination
and shall be construed to be for the benefit of Covered
Individuals; and (ii) this no balance billing provision
supersedes any oral or written contrary Agreement now existing
or hereafter entered between AHERF and a Covered Individual or
a person acting on his/her behalf.
"Any modification, addition or deletion to the provisions of
this Section shall become effective on a date no earlier that
sixty (60) days after the Pennsylvania Secretary of Health and
the requisite governmental body of the State of Ohio and the
State of West Virginia, have received written notice of such
proposed change."
5. Section 5.11 of the Risk Sharing Agreement is intentionally deleted for
purposes of West Virginia HMO.
6. Section 22, GOVERNING LAW, shall be amended to read in its entirety as
follows:
"This Agreement shall be governed by the laws of the
Commonwealth of Pennsylvania as it in any way pertains to
HealthAmerica Pennsylvania, Inc., the State of Ohio as it in
any way pertains to HealthAmerica Pennsylvania, Inc. d/b/a
HealthAssurance HMO, and the State of West Virginia as the
Agreement in any way pertains to Coventry Health Plan of West
Virginia, Inc. Any actions, lawsuit or claim brought by either
party pertaining to breach, reformation or interpretation of
this Agreement as it relates to HealthAmerica Pennsylvania,
Inc. shall be exclusively brought in Pittsburgh,
Pennsylvania."
7. EFFECTIVE DATE. The effective date of this Agreement for purposes of West
Virginia HMO shall be July 1, 1997.
8. ALL OTHER TERMS. Notwithstanding anything contained herein, all other terms
of the Agreement and the First and Second Amendments shall remain unaltered
and in full force and effect.
[REST OF PAGE INTENTIONALLY BLANK]
3
<PAGE> 4
IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the day
and year first above written.
Allegheny Health, Education HealthAmerica Pennsylvania, Inc.
& Research Foundation
/s/ David W. McConnell /s/ ROBERT A. MAYER
- --------------------------- ------------------------------------------
David W. McConnell Robert A. Mayer
Executive Vice President and President and Chief Executive Officer
Chief Financial Officer
Coventry Corporation
/s/ ROBERT A. MAYER
-----------------------------------------
Robert A. Mayer
Senior Vice President
HealthAmerica Pennsylvania, Inc. d/b/a
HealthAssurance HMO
/s/ ROBERT A. MAYER
------------------------------------------
By: Robert A. Mayer
--------------------------------------
Title: President and Chief Executive
Officer
------------------------------------
Coventry Health Plan of West Virginia, Inc.
/s/ ROBERT A. MAYER
------------------------------------------
By: Robert A. Mayer
--------------------------------------
Title: President and Chief Executive
Officer
-----------------------------------
<PAGE> 1
Exhibit 11
Coventry Corporation
Computation of Net Earnings Per Share (1) (2)
<TABLE>
<CAPTION>
1997
---------------------------------------------------
Income Shares
(Numerator) (Denominator) Per Share Amount
---------------------------------------------------
<S> <C> <C> <C>
Net Income $11,903
----------
Basic EPS $11,903 33,117 $ 0.36
Effect of Dilutive Securities
Options and warrants - 758
Convertible notes 427 375
---------------------------------------------------
Diluted EPS $12,330 34,250 $ 0.36
===================================================
<CAPTION>
1996
---------------------------------------------------
Income Shares
(Numerator) (Denominator) Per Share Amount
---------------------------------------------------
<S> <C> <C> <C>
Net Income $(61,287)
-----------
Basic EPS $(61,287) 32,815 $ (1.87)
Effect of Dilutive Securities
Options and warrants - 15
---------------------------------------------------
Diluted EPS $(61,287) 32,830 $ (1.87)
===================================================
<CAPTION>
1995
---------------------------------------------------
Income Shares
(Numerator) (Denominator) Per Share Amount
---------------------------------------------------
<S> <C> <C> <C>
Net Income $ 18
-----------
Basic EPS $ 18 31,526 $ 0.00
Effect of Dilutive Securities
Options and warrants - 624
---------------------------------------------------
Diluted EPS $ 18 32,150 $ 0.00
===================================================
</TABLE>
(1) Restated for adoption of SFAS 128, "Earnings per Share."
(2) Restated for the purchase of HealthCare USA in 1995 accounted for as a
pooling of interests.
<PAGE> 1
Exhibit 21
COVENTRY CORPORATION SUBSIDIARIES
A. Coventry Health and Life Insurance Company - Texas insurance corporation
B. Pennsylvania HealthCare USA, Inc. - Pennsylvania
C. Coventry HealthCare Development Corporation - Delaware
C.1. Coventry Health Plan of West Virginia, Inc. - West Virginia
D. Healthpass, Inc. - Pennsylvania
E. HealthAmerica Pennsylvania, Inc. - Pennsylvania
E.1. The Medical Center HPJV, Inc. - Pennsylvania
E.1.a. Riverside Health Plan, Inc. - Pennsylvania
F. Group Health Plan, Inc. - Missouri
F.1. Specialty Services, Inc. - Missouri
G. Coventry HealthCare Management Corporation - Virginia
G.1. Southern Health Services, Inc. - Virginia
G.2. Southern Health Benefit Services, Inc. - Virginia
H. HealthCare USA, Inc. - Florida
H.1. HealthCare USA Midwest, Inc. - Delaware
H.1.a. HealthCare USA of Missouri LLC - Missouri LLC
I. Coventry Healthcare Management Corporation - Delaware
J. Coventry Health Care, Inc. - Delaware
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion
of our reports dated February 23, 1998, included in this Form 10-K for the year
ended December 31, 1997 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-8 Registration Statement No. 33-90268
Form S-3 Registration Statement No. 33-95084
Form S-8 Registration Statement No. 33-97246
Form S-8 Registration Statement No. 333-39581
Form S-8 Registration Statement No. 333-36735
Form S-3 Registration Statement No. 333-47239
and in the Coventry Health Care, Inc.
Form S-4 Registration Statement No. 333-45821
ARTHUR ANDERSEN LLP
Nashville, Tennessee
March 23, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF COVENTRY CORPORATION FOR THE YEAR ENDED DECEMBER 31,
1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 153,979
<SECURITIES> 3,870
<RECEIVABLES> 64,046
<ALLOWANCES> 7,378
<INVENTORY> 0
<CURRENT-ASSETS> 237,124
<PP&E> 50,859
<DEPRECIATION> 28,922
<TOTAL-ASSETS> 469,331
<CURRENT-LIABILITIES> 260,861
<BONDS> 85,719
0
0
<COMMON> 337
<OTHER-SE> 117,481
<TOTAL-LIABILITY-AND-EQUITY> 469,331
<SALES> 0
<TOTAL-REVENUES> 1,228,351
<CGS> 0
<TOTAL-COSTS> 1,222,612
<OTHER-EXPENSES> (24,880)
<LOSS-PROVISION> 2,748
<INTEREST-EXPENSE> 10,275
<INCOME-PRETAX> 20,344
<INCOME-TAX> 8,422
<INCOME-CONTINUING> 11,903
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,903
<EPS-PRIMARY> 0.36
<EPS-DILUTED> 0.36
</TABLE>
