-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q/LaQak+uBqn5WjZ1sIEv9S2/V/miWdclEYAq8gwqpWnv+Vzhwxv9Wtc8utEMg/Z GQ9yCTSDtdAqAhs0VoUAhg== 0000950133-00-001227.txt : 20000331 0000950133-00-001227.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950133-00-001227 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COVENTRY HEALTH CARE INC CENTRAL INDEX KEY: 0001054833 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 522073000 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-29676 FILM NUMBER: 584714 BUSINESS ADDRESS: STREET 1: 6705 ROCKLEDGE DR STE 100 CITY: BETHESDA STATE: MD ZIP: 20817 BUSINESS PHONE: 3015810600 MAIL ADDRESS: STREET 1: 6705 ROCKLEDGE DR SUITE 100 STREET 2: STE 250 CITY: BETHESDA STATE: MD ZIP: 20817 10-K 1 FORM 10-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-19147 COVENTRY HEALTH CARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-2073000 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number)
6705 ROCKLEDGE DRIVE, SUITE 900, BETHESDA, MARYLAND 20817 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (301) 581-0600 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 February 29, 2000 (computed by reference to the closing sales price of such stock on The Nasdaq Stock Market on such date) was $483,284,250. As of February 29, 2000, there were 59,027,084 shares of the registrant's voting Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Parts of the registrant's Proxy Statement for its 2000 Annual Meeting of Shareholders to be filed subsequent to the filing of this Form 10-K Report are incorporated by reference in items 10 through 13 of Part III hereof. ================================================================================ 2 COVENTRY HEALTH CARE, INC. FORM 10-K TABLE OF CONTENTS
PAGE --------- PART I Item 1: Business 3 Item 2: Properties 11 Item 3: Legal Proceedings 12 Item 4: Submission of Matters to a Vote of Security Holders 13 PART II Item 5: Market for Registrant's Common Equity and Related Stockholder Matters 14 Item 6: Selected Consolidated Financial Data 14 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 7A: Quantitative and Qualitative Disclosures About Market Risk 34 Item 8: Financial Statements and Supplementary Data 35 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 62 PART III Item 10: Directors and Executive Officers of the Registrant 63 Item 11: Executive Compensation 63 Item 12: Security Ownership of Certain Beneficial Owners and Management 63 Item 13: Certain Relationships and Related Transactions 63 PART IV Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 64
2 3 PART I The statements contained in this Form 10-K that are not historical are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which are subject to risks and uncertainties. These forward-looking statements may be affected by a number of factors, including the "Risk Factors" contained in Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K, and actual operations and results may differ materially from those expressed in this Form 10-K. 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 or accreditation or certification of the products by private or governmental bodies, difficulties in obtaining or maintaining favorable contracts with health care providers, credit risks on global capitation arrangements, financing costs and contingencies, litigation risk and substantial ownership of the Company's common stock by Principal Life Insurance Company ("Principal Life"). ITEM 1: BUSINESS GENERAL Coventry Health Care, Inc. (together with its subsidiaries, the "Company", "Coventry", "we", "our", or "us"), successor-in-interest to Coventry Corporation, is a managed health care company operating health plans under the names Coventry Health Care, HealthAmerica, HealthAssurance, HealthCare USA, Group Health Plan, Southern Health, SouthCare and Carelink Health Plans. The Company provides a full range of managed care products and services including health maintenance organization ("HMO"), point of service ("POS") and preferred provider organization ("PPO") products. The Company also administers self-insured plans for large employer groups. Coventry was incorporated under the laws of the state of Delaware on December 17, 1997. As of December 31, 1999, in continuing operations, the Company had 1,202,304 members for whom it assumes underwriting risk ("risk members") and 237,635 members of self-insured employers for whom it provides management services but does not assume underwriting risk. The following tables show the total number of members as of December 31, 1999 and 1998 and the percentage change in membership between these dates. The December 31, 1999 membership figures for continuing operations reflect the acquisitions of Carelink and Kaiser's North Carolina membership and the discontinuation of Coventry Health Care of Indiana, Inc., all of which occurred in 1999. 3 4
DECEMBER 31, PERCENTAGE 1999 1998 CHANGE ------------------- -------------------- -------------------- Membership by Market: At-risk membership in continuing operations Carolina 48,205 21,575 123.4% Delaware 56,700 54,329 4.4% Georgia 27,485 20,273 35.6% Iowa 76,205 79,306 (3.9%) Kansas City 66,753 51,993 28.4% Louisiana 37,837 39,730 (4.8%) Nebraska 26,927 34,598 (22.2%) Pennsylvania 376,416 402,178 (6.4%) Richmond 53,333 55,259 (3.5%) St. Louis 314,298 320,179 (1.8%) West Virginia 78,968 24,999 215.9% Wichita 39,177 35,342 10.9% ------ ------ ----- Total at-risk membership by market 1,202,304 1,139,761 5.5% Total non-risk membership 237,635 217,523 9.2% ------- ------- ---- Total membership in continuing operations 1,439,939 1,357,284 6.1% ========= ========= ==== Total membership in non-continuing operations Indiana 23,434 28,030 (16.4%) Total membership 1,463,373 1,385,314 5.6% ========= ========= ==== Membership by Product: At-risk membership in continuing operations Commercial 987,181 973,419 1.4% Medicare 68,632 63,599 7.9% Medicaid 146,491 102,743 42.6% ------- ------- ----- Total at-risk membership by product 1,202,304 1,139,761 5.5% Total non-risk membership 237,635 217,523 9.2% ------- ------- ---- Total membership in continuing operations 1,439,939 1,357,284 6.1% ========= ========= ==== Total membership in non-continuing operations Indiana 23,434 28,030 (16.4%) Total membership 1,463,373 1,385,314 5.6% ========= ========= ====
PRODUCTS Commercial HEALTH MAINTENANCE ORGANIZATIONS The Company's HMO products provide comprehensive health care benefits to members, including ambulatory and inpatient physician services, hospitalization, pharmacy, dental, optical, mental health, and 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 enrollment fee. A primary care physician assumes overall responsibility for the care of a member, including preventive and routine medical care and referrals to specialists and consulting physicians. While an HMO member's choice of providers is limited to those within the health plan's HMO network, the HMO member is typically entitled to coverage of a broader range of health care services than is covered by typical reimbursement or indemnity policies. 4 5 PREFERRED PROVIDER ORGANIZATIONS AND POINT OF SERVICE The Company, through its health plans, offers flexible provider products, including PPO and POS products. These products permit members 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. If a non-participating provider is utilized, deductibles and copayments are generally higher and increase the out-of-pocket costs to the member. PPO/POS premiums are typically lower than HMO premiums due to the increased out-of-pocket costs borne by the members. Governmental Programs MEDICARE In late 1995, the Company introduced a Medicare product, for which the Company assumes risk, under the name "Advantra", in the St. Louis market. In 1996, the Company began marketing this product in its western Pennsylvania and central Pennsylvania markets. The Company also marketed a Medicare risk product in the Chicago, Illinois and Jacksonville, Florida markets. The Company introduced a Medicare risk product in Kansas City and Delaware effective July 1, 1999 and January 1, 2000, respectively. In 1998, the Company exited the Medicare program in several counties, in which it had approximately 18,000 members, approximately 10,000 of whom were in the Illinois and Florida health plans that were sold effective November 30, 1998 and December 31, 1998, respectively. The remaining counties were exited because the reimbursement rates were not adequate and/or the Company was not successful in its efforts to increase reimbursement rates. Effective January 1, 2000, the Company exited three counties in central Pennsylvania for similar reasons, representing less than 900 members. Under a Medicare risk contract, the Company receives a county-specific fixed premium per member per month from the U.S. Health Care Financing Administration ("HCFA"), which reflects certain county-specific demographics of the Medicare population of each region. 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 that may reduce premiums or increase mandated benefits in the future. The Company is also subject to increased government regulation and reporting requirements related to the product. The Company also offers Medicare cost and supplement products. Under a Medicare cost contract, the Company is reimbursed by 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, the Company is at risk for less than full reimbursement. Medicare supplement members enroll individually and pay a monthly premium for comprehensive health services not covered under Medicare. A majority of the Company's former Medicare cost and supplement members converted to the Company's Advantra product during 1996. MEDICAID The Company offers health care coverage to Medicaid recipients in the St. Louis and central Missouri; Richmond, Virginia; Delaware; North Carolina; West Virginia and Iowa markets. Medicaid recipients in the St. Louis, central Missouri, North Carolina and Delaware markets are generally required to choose a managed care provider. In Richmond, Virginia, West Virginia and Iowa, enrollment in a Medicaid HMO is voluntary. Under a Medicaid risk contract, the participating state pays a monthly premium per member based on the age, sex, and eligibility category of the recipients enrolled in the Company's plans. The Company determined, at the end of 1996, that its Florida operations were not sufficiently profitable to justify a continued presence in the Florida market and, as a result, the Company discontinued operations in the Florida Medicaid HMO market on June 30, 1997. The Company also exited the western and central Pennsylvania Medicaid markets for similar reasons effective December 31, 1997 and March 31, 1998, respectively. 5 6 Management Services The Company's health plans offer management services to large employers who self-insure their employee health benefits. Under related contracts, employers who fund their own health plans receive the benefit of provider pricing arrangements from the health plan. 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 the Company's management services contracts include performance and utilization management standards which affect the fees received for these services. As a result of the acquisition of certain Principal Health Care Inc. ("PHC") health plans from Principal Life, the Company recognized revenue under a Marketing Services Agreement, Management Services Agreement and PPO access agreement with Principal Life. The Company also offers a PPO product to other third-party payors under which the Company provides rental of and access to the Company's PPO network, claims repricing and utilization review. The Company does not accept underwriting risk for this product. Non-risk membership in the tables above do not reflect membership attributable to this product. DELIVERY SYSTEMS The Company's health plans maintain provider networks that furnish health care services through contractual arrangements with physicians, hospitals and other health care providers, rather than providing reimbursement to the member for the charges of such providers. Because the health plans receive the same amount of revenue from their members irrespective of the cost of healthcare services provided, they must manage both the utilization of services and the unit cost of the services. The Company's health plans' networks historically have utilized a variety of physician care delivery systems that differed primarily in the characterization of the relationship between the Company and the participating physicians. Prior to 1997, the Company utilized staff models in the western and central Pennsylvania and St. Louis markets 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 facilities and personnel that could not be immediately adjusted to take into account changes in the membership or third party payor pricing trends. In addition to providing health care to plan members, these staff 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. The Company determined in late 1996 to dispose of the staff model operations in Pittsburgh, Pennsylvania and St. Louis, Missouri. Effective March 31, 1997, the Company completed its sale of a majority of the medical offices in Pittsburgh, Pennsylvania associated with Allegheny Health, Education and Research Foundation ("AHERF"), a major provider organization in the Pittsburgh market, for approximately $20 million. Upon the sale, the Company entered into a long-term global capitation agreement with AHERF that increased the Company's globally capitated membership in western Pennsylvania to approximately 250,000 members, which was 91% of the Company's commercial, Medicaid and Medicare membership in western Pennsylvania. Under the arrangement, AHERF received a fixed percentage of premium to cover all the medical costs provided to the globally capitated members. On July 21, 1998, AHERF filed for bankruptcy protection. As a result of the bankruptcy, AHERF failed to pay for medical services under its global capitation agreement with the Company covering approximately 250,000 Company members in the western Pennsylvania market. Shortly after AHERF filed for bankruptcy protection, the Company filed a lawsuit against AHERF's non-debtor, affiliated hospitals seeking monetary damages and a declaratory judgment that the Company was not obligated to pay in excess of $21.5 million to the hospitals for medical services provided by them to the Company's members and the hospitals filed a counterclaim for payment of these services. As a result, the Company, which was ultimately responsible for medical costs delivered to its members, notwithstanding the global capitation agreement, recorded a charge of $55.0 million in the second quarter of 1998 to establish a reserve for, among other things, the medical costs incurred by its members under the AHERF global capitation agreement at the time of the bankruptcy filing. On July 22, 1999, the Company reached a settlement with the hospitals, including Allegheny General Hospital, formerly owned by AHERF, and its new 6 7 owner, Western Pennsylvania Health Care System ("West Penn"), whereby the hospitals agreed that the Company would not be liable for the payment of certain medical services rendered by the hospitals to the Company's members prior to July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the settlement, the Company signed a new three-year provider contract with West Penn. The conditions to execute the settlement and the provider contract were finalized in October 1999 and, as a result, all liability issues surrounding AHERF's failure to fulfill its contractual obligations and the Company's remaining obligations have been determined and all AHERF-related litigation has been concluded. As of December 31, 1999, approximately $35.4 million of the $55.0 million reserve had been paid for medical claims. As a result of the settlement, the Company released $6.3 million from the reserve, which was reflected as a gain in the fourth quarter and year-end 1999 results. The balance of the reserve represents the Company's remaining obligations under the settlement and will be expended through August 2007. Effective May 1, 1997, the Company 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, for approximately $26.9 million. Upon the sale, the Company entered into a long-term global capitation agreement with BJC, since amended, that covered approximately 33.3% of the risk membership in St. Louis at December 31, 1998. Under the agreement, BJC receives a fixed percentage of premium to cover all of the medical treatment received by the globally capitated members. Global capitation agreements limit the Company's exposure to the risk of increasing medical costs, but expose the Company to risk as to the adequacy of the financial and medical care resources of the provider organization. To the extent that the respective provider organization faces financial difficulties or otherwise is unable to perform its obligations under the global capitation agreements, the Company, 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. Various disputes alleging breaches have arisen under the BJC global capitation agreement concerning the accuracy and timeliness of claims payments, and the accuracy of membership reconciliations that would affect the amount of premiums paid to BJC to provide its services under the agreement. BJC contends that these alleged breaches entitles it to terminate the agreement. Although the parties are obligated to arbitrate their disputes under the terms of the agreement, the parties have agreed to attempt to negotiate a resolution of the various disputed issues concurrent with arbitration. While the Company acknowledges certain claims payment inaccuracies, the Company denies the remaining allegations and vigorously disputes that any such claims constitute a material breach of the agreement. Management does not believe that the outcome of these disputes will have a material impact on the consolidated financial statements, although there can be no assurance in this regard. Effective September 30, 1997, the Company completed the sale of its remaining five medical offices associated with HealthAmerica Pennsylvania, Inc. ("HealthAmerica") to ProMedCo Management Company. The agreement covered 21 physicians who serve approximately 12,000 members. The approximate $2.0 million of proceeds from the sale roughly equaled the carrying value of the medical offices. All of the Company's health plans currently 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 members but also maintain independent practices in which they provide services to individuals who are not members of the Company's health plans. 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 and other incentive arrangements with the health plan to the extent that pre-established utilization and quality goals are achieved. Contracting specialist physicians are compensated under both discounted fee-for-service arrangements and capitation arrangements. The majority of the Company's contracts with hospitals provide for inpatient per diem or per case hospital rates, while outpatient services are typically contracted on a discounted fee-for-service basis. The Company pays many of its hospital and ancillary providers on a fixed fee schedule or a monthly fixed capitation fee. In the western Pennsylvania and St. Louis markets, the Company maintains risk sharing arrangements with integrated networks of physicians and providers. The Company has credit and operating risk associated with these arrangements. One of the risk sharing agreements in the St. Louis market remains in arbitration over amounts in 7 8 dispute. Additionally, the Company has significant membership covered by global capitation agreements in St. Louis, as discussed above. QUALITY ASSURANCE The Company has established systems to monitor the availability, appropriateness and effectiveness of the patient care it provides. Monitoring the quantity of physicians and support personnel needed for the number of enrollees served assists in determining and maintaining the availability of care at appropriate levels. Utilization data, collected and disseminated in the context of controlling costs, serves as a valuable indicator of over or under utilization of services, and helps the Company's health plans provide appropriate care for their members. The Company's health plans also have internal quality assurance review committees made up of practicing physicians and 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 member services department is responsible for monitoring and maintaining member satisfaction, and the Company's health plans periodically conduct membership surveys of both existing and former members concerning services furnished and suggestions for improvement. UTILIZATION MANAGEMENT AND REVIEW A managed care company's profitability is dependent on maintaining effective controls over utilization of health care services consistent with the provision of high quality care. Each of the Company's health plans either employs physicians or contracts with physicians as Medical Directors who oversee the delivery of medical services. The Medical Director supervises medical managers (nurses) who review and approve requests by physicians to perform certain diagnostic and therapeutic procedures, using nationally recognized clinical guidelines. Medical managers also continually review the status of hospitalized patients and compare their medical progress with established clinical criteria, make hospital rounds to review patients' medical progress, and perform quality assurance and utilization functions. Medical directors 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 presented to the health plan's physicians. These results are monitored by the medical directors in an attempt to ensure the use of cost-effective, medically appropriate services. MARKETING The Company's commercial health plans are marketed primarily to employer groups as alternatives to conventional fee-for-service health care and indemnity health insurance programs. Employers generally pay all or part of their employees' health care premiums, and many continue to offer their employees a conventional insurance plan even if one or more of the Company's products are offered. Commercial marketing is generally a two-step process in which presentations are made first to employers and then directly to employees. Once selected by an employer, the Company solicits members from the employee base directly. During periodic "open enrollments," in which employees are permitted to change health care programs, the Company uses direct mail, worksite presentations, and radio and television advertisements to contact prospective members. The Company also markets through independent insurance brokers, agents, and employee benefits consultants. Virtually all of the Company's employer group contracts are renewable annually, and enrollment is continuously affected by employee turnover within employer groups. 8 9 The Company'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. The Company also markets Medicare products through independent insurance brokers and agents. The Company's Medicaid and Medicare contracts are renewable annually. Medicare enrollees may disenroll monthly. Medicaid enrollees may disenroll, depending on the jurisdiction, either monthly or annually. Each of the Company's health plans employs a full-time marketing staff. The marketing staff uses advertising and promotional material prepared by advertising firms as well as market research programs. The Company received 16% of its consolidated revenues in 1999 from the Medicare program throughout its various markets. For the year ended December 31, 1999, HealthCare USA of Missouri, LLC ("HCUSA"), a subsidiary, received approximately $128 million or 100% of its revenues from the State of Missouri for Medicaid members. Also, the Company's health plan in Wichita received approximately $38.5 million, or 61% of its revenues from one employer group. COMPETITION The Company's health plans operate in highly competitive environments and compete with other HMOs, PPOs, indemnity insurance carriers and, most recently, physician-hospital organizations. While competitive pressures in 1998 had an adverse affect on premiums from the Company's commercial products, the environment has generally improved in 1999, allowing the Company to implement average rate increases of 10% in 1999 on commercial business. The favorable pricing environment is expected to continue in 2000. In some cases, employer groups have moved from the traditional commercial HMO plans toward the lower premium flexible provider products. The Company believes that the principal factors influencing an employer group's decision to choose among health care options are the price of the benefit plans offered, locations of the health care providers, reputation for quality care, financial stability, comprehensiveness of coverage, and diversity of product offerings. The Company also competes with other managed care organizations and indemnity insurance carriers in seeking to obtain and retain favorable contracts with hospitals and other providers of services to the Company's health plans. GOVERNMENT REGULATION The Company's HMOs are required to file periodic reports with, and are subject to periodic review by, state and federal licensing authorities that regulate them. The HMOs are required by state law to meet certain minimum capital and deposit and/or reserve requirements and may be restricted from paying dividends under certain circumstances. They are also required to provide their members 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' members have a voice in policy making. The Women's Health and Cancer Rights Act of 1998 ("WHCRA") was signed into law on October 21, 1998. This law applies to group health plans and health insurance issuers and became effective for plan years after October 21, 1998. WHCRA requires group health plans and health insurance issuers providing coverage for mastectomies to provide benefits for reconstructive surgery. Specifically, the law mandates that if an enrollee elects reconstructive surgery after a mastectomy, a group health plan or health insurance issuer must provide benefits for reconstruction of the affected breast, surgery and reconstruction of the other breast to produce a symmetrical appearance, prosthesis and treatment of physical complications at all stages of the mastectomy, including lymphedemas. This coverage may be subject to the same annual deductions and coinsurance provisions as established for other plan benefits. All of the Company's HMOs that contract with HCFA to provide services to Medicare beneficiaries pursuant to a Medicare+Choice contract are subject to federal laws and regulations. These HMOs may also be subject to state 9 10 laws governing Medicare contracting. HCFA has the right to audit any health plan operating under a Medicare+Choice contract to determine the plan's compliance with federal law. The Company's HMOs with Medicare+Choice 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. 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; 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. As a result of the Medicare+Choice and Medicaid products offered by Coventry, Coventry is subject to regulatory and legislative changes in those two government programs. The Balanced Budget Refinement Act of 1999 ("BBRA") was enacted into law on November 29, 1999. This law modifies the BBA, which had made the substantial revisions to the Medicare and Medicaid Programs. Specially, the BBRA revised the Medicare+Choice Program's enrollment rules and risk adjustment methodology. Additionally, the BBRA offers limited incentives to health plans to participate in the Medicare+Choice Program by offering increased monthly payments for Medicare+Choice plans in areas which currently do not have Medicare+Choice plans. The BBRA also allows Medicare+Choice plans greater flexibility in structuring benefit packages for enrollees in the same service area. At this time, the management of Coventry does not believe that the BBRA will have a material effect on the Company and its operations. All of the Company'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. The Company's HMOs are required to abide by these PRO 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. In 1996, as part of the Health Insurance Portability and Accountability Act of 1996, Congress adopted a statutory exception for certain risk-sharing arrangements which has not yet been interpreted by the Office of the Inspector General as no regulation, either proposed or final, has yet been published. Nevertheless, 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 addressing: (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. The Company believes that the incentives offered by its HMOs to Medicare and Medicaid beneficiaries and the discounts its plans receive from contracting health care providers should satisfy the requirements of the safe harbor regulations. However, failure to satisfy each criterion of the applicable safe harbor does not mean that the arrangement constitutes a violation of the law; rather the safe harbor regulations provide that the arrangement must be analyzed on the basis of its specific facts and circumstances. The Company believes that its arrangements do not violate the federal or similar state anti-kickback laws. 10 11 The Company contracts with the United States Office of Personnel Management ("OPM") to provide managed health care services under the Federal Employees Health Benefits Program ("FEHBP"). These contracts with OPM and applicable government regulations establish premium rating requirements for the FEHBP. OPM conducts periodic audits of its contractors to, among other things, verify that the premiums established under the OPM contracts are established in compliance with the community rating and other requirements under FEHBP. Such audits could result in material adjustments. Numerous proposals have been introduced in the United States Congress and various state legislatures relating to managed health care reform. Some proposals, if enacted, could, among other things, limit Coventry's ability to control medical costs, increase Coventry's exposure to liability to members for coverage denials or delays, require certain coverages and impose other requirements on managed care companies. Although the provisions of legislation that may be adopted at the state level cannot be accurately and completely predicated at this time, Coventry's management believes that the ultimate outcome of currently proposed legislation and state legislation enacted to date should not have a material effect on its operations. On the federal level, Coventry expects that some form of managed health care reform may be enacted. At this time, it is unclear when such legislation might be enacted as well as the content of any new provisions. Coventry's management believes that the ultimate outcome of such federal legislation should not have a material adverse effect on its operations. RISK MANAGEMENT The HMOs maintain general liability and professional liability (medical malpractice, managed care liability, and medical excess "stop loss") insurance coverage in amounts the Company believes to be adequate. Contracting physicians are also required to maintain professional liability coverage. No assurance can be given as to the future availability or costs of such insurance or that the liability will not exceed the limit of the insurance coverage. EMPLOYEES At March 3, 2000, the Company employed approximately 2,900 persons, none of whom are covered by a collective bargaining agreement. TRADEMARKS The Company has the right in perpetuity to use the federally registered name "HealthAmerica" in Illinois, Missouri, Pennsylvania and West Virginia. The Company has federal and/or state registered service marks for "HealthAssurance," "GHP Access," "Healthcare USA," "Doc Bear," "CarePlus," "Coventry", "Advantra," "SouthCare" and "CareNet." The Company has pending applications for federal registration of the service marks "Senior Life Management," "Southern Select," and "Neighborhood Housecall." Effective December 31, 1999, the Company ceased using the names "Principal Health Care," "The Principal," "The Principal Financial Group," "Principal Health Care 65," and "PrinChoice," pursuant to an agreement entered into with Principal Life on May 19, 1999. ITEM 2: PROPERTIES As of December 31, 1999, the Company leased approximately 171,000 square feet of space for its corporate office in Bethesda, Maryland, the majority of which is subleased. The Company also leased approximately 667,000 aggregate square feet for office space, subsidiary operations, and customer service centers in the various markets where the Company's health plans operate. The Company's leases expire at various dates from 2000 through 2009. The Company also owns a building in Richmond, Virginia with approximately 45,000 square feet, which is used for administrative services related to its health plan in that market. The Company believes that its facilities are adequate for its operations. 11 12 ITEM 3: LEGAL PROCEEDINGS SETTLEMENT WITH AHERF RELATED ENTITIES. The Company and certain affiliated hospitals of Allegheny Health, Education and Research Foundation ("AHERF") were involved in litigation to determine if the Company had the financial responsibility for medical services provided to the Company's members by the hospitals as a consequence of the bankruptcy filed by AHERF on July 21, 1998. As a result of the bankruptcy, AHERF failed to pay for medical services under its global capitation agreement with the Company covering approximately 250,000 Company members in the western Pennsylvania market. Shortly after AHERF filed for bankruptcy protection, the Company filed a lawsuit against AHERF's non-debtor, affiliated hospitals seeking monetary damages and a declaratory judgment that the Company was not obligated to pay in excess of $21.5 million to the hospitals for medical services provided by them to the Company's members and the hospitals filed a counterclaim for payment of these services. As a result, the Company, which was ultimately responsible for medical costs delivered to its members, notwithstanding the global capitation agreement, recorded a charge of $55.0 million in the second quarter of 1998 to establish a reserve for, among other things, the medical costs incurred by its members under the AHERF global capitation agreement at the time of the bankruptcy filing. On July 22, 1999, the Company reached a settlement with the hospitals, including Allegheny General Hospital, formerly owned by AHERF, and its new owner, Western Pennsylvania Health Care System ("West Penn"), whereby the hospitals agreed that the Company would not be liable for the payment of certain medical services rendered by the hospitals to the Company's members prior to July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the settlement, the Company signed a new three-year provider contract with West Penn. The conditions to execute the settlement and the provider contract were finalized in October 1999 and, as a result, all liability issues surrounding AHERF's failure to fulfill its contractual obligations and Coventry's remaining obligations have been determined and all AHERF-related litigation has been concluded. As of December 31, 1999, approximately $35.4 million of the $55.0 million reserve had been paid for medical claims. As a result of the settlement, Coventry released $6.3 million from the reserve, which was reflected as a gain in the fourth quarter and year-end 1999 results. The balance of the reserve represents Coventry's remaining obligations under the settlement and will be expended through August 2007. UNITY ARBITRATION. Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the Company, entered into an agreement, effective January 1, 1998, with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to provide health care services to GHP's members in the southern and western areas of St. Louis County, Missouri. The agreement contained risk sharing provisions. Disputes arose under the agreement and the matter was submitted to arbitration before the American Arbitration Association ("AAA"). GHP demanded payment from Unity of $7.6 million and specific performance under the agreement. Unity demanded payment from GHP of $14.5 million, specific performance of certain provisions of the agreement and suspension of its payment obligations. On December 23, 1999, the AAA tribunal of arbitrators awarded GHP the sum of $1.1 million for deficiencies in risk fund pools for 1998, and awarded Unity the sum of $1.8 million as liquidated damages for GHP's failure to meet certain administrative performance standards, and held Unity contractually liable for funding any deficits in the risk fund pools for 1999. The only remaining issue pending is the readjudication of certain disputed claims submitted subsequent to June 30, 1999. BJC. Effective May 1, 1997, the Company 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, for approximately $26.9 million. Upon the sale, the Company entered into a long-term global capitation agreement with BJC, since amended, that covered approximately 33.3% of the risk membership in St. Louis at December 31, 1998. Under the agreement, BJC receives a fixed percentage of premium to cover all of the medical treatment received by the globally capitated members. Global capitation agreements limit the Company's exposure to the risk of increasing medical costs, but expose the Company to risk as to the adequacy of the financial and medical care resources of the provider organization. To the extent that the respective provider 12 13 organization faces financial difficulties or otherwise is unable to perform its obligations under the global capitation agreements, the Company, 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. Various disputes alleging breaches have arisen under the BJC global capitation agreement concerning the accuracy and timeliness of claims payments, and the accuracy of membership reconciliations that would affect the amount of premiums paid to BJC to provide its services under the agreement. BJC contends that these alleged breaches entitles it to terminate the agreement. Although the parties are obligated to arbitrate their disputes under the terms of the agreement, the parties have agreed to attempt to negotiate a resolution of the various issues concurrent with arbitration. While the Company acknowledges certain claims payment inaccuracies, the Company denies the remaining allegations and vigorously disputes that any such claims constitute a material breach of the agreement. Management does not believe that the outcome of these disputes will have a material impact on the consolidated financial statements, although there can be no assurance in this regard. OTHER LEGAL ACTIONS. In the normal course of business, the Company has been named as a 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, 1999 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 for which the Company maintains reserves. In the opinion of management, the outcome of these actions should not have a material adverse effect on the financial position or results of operations of the Company. Other managed care companies have been sued recently in class action lawsuits claiming violations of the federal racketeering act (RICO) and federal employee benefits law (ERISA), and generally claiming that managed care companies overcharge consumers and misrepresent that they deliver quality health care. Although it is possible that the Company may be the target of a similar suit, the Company believes there is no valid basis for such a suit. The Company'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 could have significant impact on the Company's operations. 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 1999. 13 14 PART II ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK The Company's common stock is traded on the National Market of the Nasdaq Stock Market(R) under the symbol "CVTY." The following tables set forth the quarterly range of high and low closing sales prices of the common stock on Nasdaq during the calendar period indicated:
1999 1998 - ------------------------------------------------------------------------------------------------------------------ HIGH LOW HIGH LOW - ------------------------------------------------------------------------------------------------------------------ First Quarter $11.375 $7.500 $19.250 $12.375 Second Quarter 14.875 7.125 19.125 12.750 Third Quarter 11.500 9.500 16.000 3.875 Fourth Quarter 7.938 5.125 10.250 4.625
On March 17, 2000, the Company had approximately 487 shareholders of record, not including beneficial owners of shares held in nominee name. 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. Subject to the terms of such insurance regulations, 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." ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATIONS STATEMENT DATA (1) DECEMBER 31, --------------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------------------------------------------------------------------------- Operating revenues $2,162,372 $2,110,383 $1,228,351 $1,057,129 $ 852,390 Operating earnings (loss) 47,855 (36,195) 5,739 (91,346) (1,275) Net earnings (loss) 43,435 (11,741) 11,903 (61,287) 18 Net earnings (loss) per share - basic (3) 0.74 (0.22) 0.36 (1.87) - Net earnings (loss) per share - diluted (3) 0.69 (0.22) 0.35 (1.87) - Weighted average common shares outstanding - basic (3) 59,025 52,477 33,210 32,818 31,526 Weighted average common shares outstanding - diluted (3) 64,159 52,477 33,912 32,818 32,150 BALANCE SHEET DATA (1) DECEMBER 31, --------------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------------------------------------------------------------------------- Cash and investments $614,603 $614,583 $240,091 $168,423 $147,777 Total assets 1,081,583 1,091,228 487,182 448,945 385,675 Long-term obligations and notes payable (including current maturities) 31,217 88,737 109,268 102,985 77,868 Redeemable convertible preferred stock 47,095 - - - - Stockholders' equity and partners' capital (2) 480,385 436,539 117,818 100,427 153,851
14 15 (1) Balance Sheet Data for 1998 reflect the acquisition of the Principal Life Insurance Company health plans as of December 31, 1998 and Operations Statement Data for 1998 include the results of operations of the acquired PHC health plans beginning April 1, 1998, the date of acquisition. (2) Predecessor company of a wholly owned subsidiary of the Company was an S Corporation. (3) 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, 1999 and 1998.
QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1999 1999 1999 1999 (1) (2) -------------------- --------------------- ---------------------- ----------------------- Operating revenues $527,848 $531,831 $529,889 $572,804 Operating earnings 8,683 9,626 11,391 18,155 Net earnings 8,293 9,157 10,970 15,015 Net earnings per share - basic 0.14 0.16 0.19 0.25 Net earnings per share - diluted 0.14 0.15 0.17 0.24 QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1998 1998 (3)(4) 1998 1998 (5) -------------------- --------------------- ---------------------- ----------------------- Operating revenues $330,209 $583,804 $593,278 $603,092 Operating earnings (loss) 7,178 (51,238) 2,179 5,686 Net earnings (loss) 4,707 (27,756) 5,068 6,240 Net earnings (loss) per share - basic 0.14 (0.47) 0.09 0.11 Net earnings (loss) per share - diluted 0.13 (0.47) 0.09 0.11
(1) Coventry will close its subsidiary, Coventry Health Care of Indiana, Inc., by the end of the fourth quarter 2000. As a result of the cost associated with exiting the Indiana market, Coventry recorded a reserve for $2.0 million in the fourth quarter of 1999. (2) In October 1999, the Company reached a settlement with AHERF. As a result of the settlement, the Company released $6.3 million of its AHERF reserve, which was reflected as a gain in the fourth quarter. (3) Effective April 1, 1998, the Company completed its acquisition of certain assets of PHC from Principal Life. The acquisition was accounted for using the purchase method of accounting and, accordingly, the operations of PHC have been included in the Company's consolidated financial statements since the date of acquisition. As a result of the merger, an estimated reserve of $7.8 million was established for the costs related to the relocation of the corporate office from Nashville, Tennessee to Bethesda, Maryland and other merger related expenses. (4) The second quarter 1998 operating results were affected by the establishment of a reserve as a result of the bankruptcy filing by AHERF. The establishment of the reserves resulted in a charge to earnings of $55.0 million. (5) The merger costs were less than the reserve established in the second quarter of 1998, resulting in a credit to earnings of $1.3 million. 15 16 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the accompanying audited consolidated financial statements and notes thereto. 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 each of the three years in the period ended December 31, 1999.
1999 1998 ----------------------------------------------- ----------------------------------------------- PERCENT OF PERCENT PERCENT OF PERCENT OPERATING INCREASE OPERATING INCREASE AMOUNT REVENUE (DECREASE) AMOUNT REVENUE (DECREASE) ---------------- -------------- --------------- ---------------- -------------- --------------- Operating revenues: Managed care premiums $2,082,075 96.3% 2.4% $2,033,372 96.4% 68.3% Management services 80,297 3.7% 4.3% 77,011 3.6% 281.2% ------ ---- ---- ------ ---- ------ Total operating revenues 2,162,372 100.0% 2.5% 2,110,383 100.0% 71.8% ---------------- ---------------- Operating expenses: Health benefits (1) 1,792,652 82.9% 1.4% 1,767,374 83.7% 70.0% Selling, general and administrative 297,922 13.8% 2.1% 291,919 13.8% 71.7% Depreciation and amortization 28,205 1.3% 9.4% 25,793 1.2% 102.5% Plan shutdown expense 2,020 0.1% - - - - AHERF charge (6,282) (0.3%) (111.4%) 55,000 2.6% - Merger costs - - - 6,492 0.3% - Operating earnings (loss) 47,855 2.2% (232.2%) (36,195) (1.7%) (730.7%) Other income, net 29,906 1.4% 9.7% 27,251 1.3% 9.5% Interest expense (1,761) (0.1%) (79.4%) (8,566) (0.4%) (16.6%) ------- ------ ------- ------- ------ ------- Earnings (loss) before income taxes and minority interest 76,000 3.5% (534.0%) (17,510) (0.8%) (186.1%) ------ ---- -------- -------- ------ -------- Net earnings (loss) $43,435 $(11,741) ================ ================ Membership at December 31: Commercial 1,010,282 1,000,699 Governmental Programs 215,123 166,342 Non-risk 237,968 218,273 ---------------- ---------------- 1,463,373 1,385,314 ================ ================
17
1997 -------------------------------- PERCENT OF OPERATING AMOUNT REVENUE ---------------- --------------- Operating revenues: Managed care premiums $1,208,149 98.4% Management services 20,202 1.6% ------ ---- Total operating revenues 1,228,351 100.0% ---------------- Operating expenses: Health benefits (1) 1,039,860 84.7% Selling, general and administrative 170,017 13.8% Depreciation and amortization 12,735 1.0% Plan shutdown expense - - AHERF charge - - Merger costs - - Operating earnings 5,739 0.5% Other income, net 24,880 2.0% Interest expense (10,275) (0.8)% -------- ------ Earnings before income taxes and minority interest 20,344 1.7% ------ ---- Net earnings $11,903 ================ Membership at December 31: Commercial 622,942 Governmental Programs 142,881 Non-risk 148,910 ---------------- 914,733 ================
(1) The medical loss ratio (health benefits as a percentage of managed care premiums) was 86.1%, 86.9%, and 86.1% in 1999, 1998 and 1997, respectively. GENERAL OVERVIEW Coventry Health Care, Inc. (together with its subsidiaries, the "Company", "Coventry", "we", "our", or "us"), successor-in-interest to Coventry Corporation, is a managed health care company operating health plans under the names Coventry Health Care, HealthAmerica, HealthAssurance, HealthCare USA, Group Health Plan, Southern Health, SouthCare and Carelink Health Plans. The Company provides a full range of managed care products and services including health maintenance organization ("HMO"), point of service ("POS") and preferred provider organization ("PPO") products. The Company also administers self-insured plans for large employer groups. Coventry was incorporated under the laws of the state of Delaware on December 17, 1997. 16 18 During the three years ended December 31, 1999, the Company experienced substantial growth in operating revenues due primarily to membership increase. Much of the growth was in 1998 and was attributable to the acquisition of the Principal Health Care, Inc. ("PHC") plans effective April 1, 1998. Additional membership growth was achieved through marketing efforts, acquisitions, geographic expansion and increased product offerings. The Company's commercial managed care premium revenues during the three years in the period ended December 31, 1999 were comprised of premiums from its commercial HMO products and flexible provider products, including PPO and POS products for which the Company assumes full underwriting risk. Premiums for such commercial PPO and POS products are typically lower than HMO premiums due to medical underwriting and higher deductibles and copayments that are required from the PPO and POS members. 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. The public sector managed care premium revenues consists of premiums from the Company's Medicare risk, Medicare cost and Medicaid products. The Company provides comprehensive health benefits to members participating in government programs and receives premium payments from federal and state governments. Premium rates for the Medicaid and Medicare risk products are established by governmental regulatory agencies and may be reduced by regulatory action. 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 and to employer group beneficiaries that have elected HMO coverage. The Company receives an administrative fee for these services, but does not assume underwriting risk. In addition, the Company offers a PPO product to other third party payors, under which it provides rental of and access to the Company's PPO network, claims repricing and utilization review, and does not assume underwriting risk. A significant portion of the Company's management services revenue in 1999 and 1998 was a result of the acquisition of certain PHC health plans from Principal Life Insurance Company ("Principal Life"). The Company recognized revenue under a Marketing Services Agreement, Management Services Agreement and PPO access agreement with Principal Life. These agreements have either expired or have been terminated as of December 31, 1999. 17 19 17 20 As of December 31, 1999, Coventry had 1,202,304 members for whom it assumes underwriting risk ("risk members") and 237,635 members of self-insured employers for whom it provides management services but does not assume underwriting risk ("non-risk members") in continuing operations. The following tables show the total number of members in continuing operations as of December 31, 1999 and 1998.
COMMERCIAL RISK GOVERNMENTAL RISK ----------------------------------- ----------------------------------- HMO PPO/POS MEDICARE MEDICAID NON-RISK TOTAL - --------------------------------------- --------------- ----------------- -------------------------------------------------------- 1999 - -------------------- Pennsylvania 172,221 181,371 22,824 - 102,808 479,224 St. Louis 104,773 69,748 42,317 97,460 28,872 343,170 Delaware 35,529 139 - 21,032 59,978 116,678 West Virginia 44,937 19,291 990 13,750 13,636 92,604 Iowa 73,901 - 686 1,618 12,145 88,350 Kansas City 64,893 45 1,815 - 1,844 68,597 Richmond 37,650 7,268 - 8,415 14,345 67,678 Carolina 43,989 - - 4,216 - 48,205 Wichita 39,177 - - - 299 39,476 Louisiana 37,837 - - - 57 37,894 Nebraska 26,927 - - - 3,651 30,578 Georgia 27,485 - - - - 27,485 -------------------------------------------------------------------------------------------------------------- Total 709,319 277,862 68,632 146,491 237,635 1,439,939 ============================================================================================================== 1998 - -------------------- Pennsylvania 200,688 175,919 25,571 - 88,785 490,963 St. Louis 138,031 62,615 38,028 81,505 23,029 343,208 Delaware 37,500 - - 16,829 58,062 112,391 West Virginia 6,379 18,620 - - 14,503 39,502 Iowa 77,912 - - 1,394 10,778 90,084 Kansas City 51,993 - - - 5,526 57,519 Richmond 51,980 264 - 3,015 14,812 70,071 Carolina 21,575 - - - - 21,575 Wichita 35,342 - - - 399 35,741 Louisiana 39,730 - - - 161 39,891 Nebraska 34,598 - - - 720 35,318 Georgia 20,273 - - - 748 21,021 -------------------------------------------------------------------------------------------------------------- Total 716,001 257,418 63,599 102,743 217,523 1,357,284 ==============================================================================================================
The Company experienced strong sales and renewals for January 2000, adding about 30,000 members, excluding Indiana membership, to December 1999 results. Commercial membership grew by about 12,000 members despite pricing increases in most markets. Medicare membership was essentially flat, even though the Company exited three counties in Pennsylvania and reduced benefits and increased premiums in remaining service areas. Medicaid membership increased by about 17,000 members mainly due to the increase of membership in the Delaware plan, as a result of another carrier exiting the Medicaid program effective December 31, 1999. The remaining 1,000 member increase was a result of modest growth in non-risk membership. Coventry's operating expenses are primarily medical costs, including medical claims under contractual relationships with a wide variety of providers, and capitation payments. Medical claims expense also includes an estimate of claims incurred but not reported ("IBNR"). Coventry currently believes that the estimates for IBNR liabilities are adequate to satisfy its ultimate medical claims liability after all medical claims have been reported. In determining the Company's IBNR liabilities, Coventry employs plan by plan standard actuarial reserve methods (specific to the plan's membership, product characteristics, geographic territories and provider network) that consider utilization frequency and unit costs of inpatient, outpatient, pharmacy and other medical costs, as well as claim payment backlogs and the timing of provider reimbursements. Reserve estimates 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 estimated 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. Coventry 18 21 periodically monitors and reviews its IBNR reserves, and as actual settlements are made or accruals adjusted, reflects these differences in current operations. PHC Acquisitions and Dispositions Effective April 1, 1998, Coventry completed its acquisition of certain health plans of PHC from Principal Mutual Life Insurance Company, now known as Principal Life, for a total purchase price of approximately $330.2 million including transaction costs of approximately $5.7 million. The acquisition was accounted for using the purchase method of accounting and, accordingly, the operating results of PHC have been included in Coventry's consolidated financial statements since the date of acquisition. The purchase price consisted of 25,043,704 shares of Coventry's common stock at an assigned value of $11.96 per share. In addition, a warrant valued at $25.0 million ("the Warrant") was issued that grants Principal Life the right to acquire additional shares of Coventry's common stock in the event that its ownership percentage of such common stock is diluted below 40%. The Warrant is included as a component of additional paid-in capital in the accompanying consolidated financial statements. Through April 2003, Principal Life is restricted from buying additional shares of Coventry's common stock to increase its ownership percentage above 40%. As of December 31, 1999, Principal Life had exercised the Warrant to purchase 12,250 shares of the Company's common stock. Coincident with the closing of the transaction, Coventry entered into a Renewal Rights Agreement and a Coinsurance Agreement with Principal Life, to manage certain of Principal Life's indemnity health insurance policies in the markets where Coventry does business and, on December 31, 1999, to offer to renew such policies in force at that time. Effective June 1, 1999, Coventry amended these agreements with Principal Life and waived its rights to reinsure and renew Principal Life's health insurance indemnity business located in Coventry's service area. Coventry received $19.8 million in cash in exchange for waiving these rights. At the date of the amendment, the Renewal Rights and Coinsurance Agreements had a net book value of $19.7 million resulting in an after tax gain of $0.1 million. At the closing, Coventry also entered into a License Agreement, which was amended effective June 1, 1999, a Marketing Services Agreement and a Management Services Agreement with Principal Life. All three agreements expired on December 31, 1999. Pursuant to the latter two agreements, Coventry recognized revenue of approximately $25.5 million and $23.0 million for the years ended December 31, 1999 and 1998, respectively. Coventry no longer receives revenue under these agreements. In anticipation of the loss of these fees, Coventry commenced reducing selling, general and administrative ("SG&A") costs through cost savings from service center consolidation, headcount reductions and across-the-board reductions in administrative expenses. In addition to SG&A reductions, Coventry plans to increase its gross margin through acquisitions and by implementing rate increases. As a result of the acquisition, Coventry assumed an agreement with Principal Life, whereby Principal Life pays a fee for access to Coventry's PPO network based on a fixed rate per employee entitled to access the PPO network and a percentage of savings realized by Principal Life. Effective June 1, 1999, Coventry sold the Illinois portion of the PPO network back to Principal Life. Under this agreement, Coventry recognized revenue of approximately $8.0 million and $12.0 million for the years ended December 31, 1999 and 1998, respectively. Effective November 30, 1998, Coventry sold its subsidiary, Principal Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois health plan accounted for approximately 56,000 risk members and approximately 2,400 non-risk members as of November 30, 1998. On December 31, 1998, Coventry sold its subsidiary, Principal Health Care of Florida, Inc., for $95.0 million in cash. The Florida health plan accounted for approximately 156,000 risk members and approximately 5,500 non-risk members as of December 31, 1998. The proceeds from both sales were used to retire Coventry's credit facility, to assist in improving the capital position of its regulated subsidiaries, and for other general corporate purposes. Given the short time period between the respective acquisition and sale dates and the lack of events or other evidence which would indicate differing 19 22 values, no gain or loss was recognized on the sales of the Florida and Illinois health plans, as the sale prices were considered by management to be equivalent to the fair values allocable to these plans at the date of their acquisition from Principal Life in April 1998. In connection with the acquisition of certain PHC health plans and the sales of the Florida and Illinois plans, Coventry established reserves of approximately $33.0 million for the estimated transition costs of the PHC health plans. These reserves are primarily comprised of severance costs related to involuntary terminations of former PHC employees, relocation costs of former PHC personnel, lease termination costs and contract termination costs. Through December 31, 1999, Coventry has expended approximately $29.7 million related to these reserves and expects to make payments on the remaining reserves through July 2002. In the fourth quarter of 1999, Coventry notified the Indiana Department of Insurance of its intention to close its subsidiary, Coventry Health Care of Indiana, Inc. As of December 31, 1999, the health plan had approximately 23,000 members throughout the state. As a result of the cost associated with exiting the Indiana market, Coventry recorded a reserve of $2.0 million in the fourth quarter of 1999. Coventry has expended approximately $0.4 million as of December 31, 1999 and expects to close the plan by the end of the fourth quarter 2000. The Indiana health plan was not operating profitably or demonstrating good prospects for future growth. Although closing the plan will not have a substantial impact on consolidated earnings, it will allow Coventry to focus resources and management attention on its other markets. Coventry's transition plan gives employers and members ample time to obtain health care coverage through one of the many other companies operating in Indiana. In the fourth quarter of 1999, the Company's PHC subsidiaries changed the word Principal in their names to Coventry. All aspects of the health plans' operations, such as member coverage and access, remain unchanged. After the merger on April 1, 1998, the PHC plans continued to use the Principal brand name under the terms of the License Agreement as amended, between the parties, even though the Plans were no longer subsidiaries of Principal Life. Other Acquisitions Effective October 1, 1999, the Company acquired Carelink Health Plans ("Carelink"), the managed care subsidiary of Camcare, Inc., for a total purchase price of approximately $8.3 million including transaction costs of approximately $0.3 million. The acquisition was accounted for using the purchase method of accounting, and accordingly the operating results of Carelink have been included in the Company's consolidated financial statements since October 1, 1999, the date of the acquisition. The purchase price for Carelink was allocated to the assets, including the identifiable intangible assets, and liabilities based on estimated fair values. The $4.7 million excess of purchase price over the net identified tangible assets acquired was allocated to goodwill, which is being amortized over a useful life of 25 years. The final purchase price may be adjusted subject to the results of the final determination of the balance sheet of Carelink as of October 1, 1999. Carelink is the market leader and has a broad provider network in West Virginia with a service area covering the majority of the state's population. On November 1, 1999, the Company's subsidiary, Coventry Health Care of the Carolinas, Inc., acquired Kaiser Foundation Health Plan of North Carolina, Inc.'s (KFHPNC) commercial membership in Charlotte, North Carolina. The total purchase price was approximately $1.8 million including transaction costs. The transaction more than doubles Coventry's membership in the Charlotte market. Effective February 1, 2000, the Company completed its acquisition of The Anthem Company's West Virginia managed care subsidiary, PrimeONE, Inc., ("PrimeONE"), for the total purchase price of approximately $3.9 million including acquisition costs. The $1.5 million excess of purchase price over the net identifiable tangible assets acquired was allocated to goodwill. The acquisition expands Coventry's West Virginia service area and brings its total membership in the state to over 109,000 members. This transaction combined with the Carelink acquisition solidifies Coventry's market leadership position in West Virginia. 20 23 On February 3, 2000, Coventry completed the acquisition of Prudential Health Care Plan, Inc.'s 11,800-member Medicaid business in St. Louis, Missouri at approximately $100 per member. The acquisition brings Coventry's total Medicaid membership in St. Louis to more than 106,000 members, expanding Coventry's leading position in the market. Medical Office Dispositions Effective March 31, 1997, the Company completed the sale of the medical offices associated with HealthAmerica Pennsylvania, Inc., ("HealthAmerica"), in Pittsburgh, Pennsylvania, to a major health care provider organization. The sales price was $20.0 million, resulting in a pretax gain to the Company 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 Company's globally capitated membership in western Pennsylvania to approximately 250,000 members. Under the agreement, the provider organization received a fixed percentage of premiums to cover all of the medical treatment the globally capitated members received. The provider organization filed for bankruptcy protection on July 21, 1998 and, as a result, the Company is no longer operating under this agreement. See "Legal Proceedings - Settlement with AHERF Related Entities." Effective May 1, 1997, the Company completed the sale of the medical offices associated with GHP, its health plan in St. Louis, Missouri, to a major health care provider organization. The sales price was $26.9 million, resulting in a pretax gain to the Company 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 receives a fixed percentage of premiums to cover all of the medical treatment the globally capitated members receive. In August 1997, the Company entered into agreements to sell certain remaining medical offices associated with HealthAmerica in Harrisburg, Pennsylvania. The sales price was $2.4 million, resulting in a pretax loss to the Company of $0.6 million. All gains or losses resulting from medical office sales are reflected in other income, net, in the accompanying Consolidated Statement of Operations for the year ended December 31, 1997. Legal Proceedings SETTLEMENT WITH AHERF RELATED ENTITIES. The Company and certain affiliated hospitals of Allegheny Health, Education and Research Foundation (AHERF) were involved in litigation to determine if the Company had the financial responsibility for medical services provided to the Company's members by the hospitals as a consequence of the bankruptcy filed by AHERF on July 21, 1998. As a result of the bankruptcy, AHERF failed to pay for medical services under its global capitation agreement with the Company covering approximately 250,000 Company members in the western Pennsylvania market. Shortly after AHERF filed for bankruptcy protection, the Company filed a lawsuit against AHERF's non-debtor, affiliated hospitals seeking monetary damages and a declaratory judgment that the Company was not obligated to pay in excess of $21.5 million to the hospitals for medical services provided by them to the Company's members and the hospitals filed a counterclaim for payment of these services. As a result, the Company, which was ultimately responsible for medical costs delivered to its members, notwithstanding the global capitation agreement, recorded a charge of $55.0 million in the second quarter of 1998 to establish a reserve for, among other things, the medical costs incurred by its members under the AHERF global capitation agreement at the time of the bankruptcy filing. On July 22, 1999, the Company reached a settlement with the hospitals, including Allegheny General Hospital, formerly owned by AHERF, and its new owner, Western Pennsylvania Health Care System ("West Penn"), whereby the hospitals agreed that the Company would not be liable for the payment of certain medical services rendered by the hospitals to the Company's members prior to July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the settlement, the Company signed a new three-year provider contract with West Penn. The conditions to execute the settlement and the provider contract were finalized in October 1999 and, as a result, all liability issues surrounding AHERF's failure to fulfill its contractual obligations and Coventry's remaining obligations have been determined and all AHERF-related litigation has been concluded. As of December 31, 1999, approximately $35.4 million of the $55.0 million reserve had been paid for medical claims. As a result of the settlement, Coventry released $6.3 million from the reserve, which was reflected as a gain in the fourth quarter and year-end 1999 results. The balance of the reserve represents 21 24 Coventry's remaining obligations under the settlement and will be expended through August 2007. UNITY ARBITRATION. Group Health Plan, Inc. ("GHP"), a health plan subsidiary of the Company, entered into an agreement, effective January 1, 1998, with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to provide health care services to GHP's members in the southern and western areas of St. Louis County, Missouri. The agreement contained risk sharing provisions. Disputes arose under the agreement and the matter was submitted to arbitration before the American Arbitration Association ("AAA"). GHP demanded payment from Unity of $7.6 million and specific performance under the agreement. Unity demanded payment from GHP of $14.5 million, specific performance of certain provisions of the agreement and suspension of its payment obligations. On December 23, 1999, the AAA tribunal of arbitrators awarded GHP the sum of $1.1 million for deficiencies in risk fund pools for 1998, and awarded Unity the sum of $1.8 million as liquidated damages for GHP's failure to meet certain administrative performances standards, and held Unity contractually liable for funding any deficits in the risk fund pools for 1999. The only remaining issue pending is the readjudication of certain disputed claims submitted subsequent to June 30, 1999. BJC. Effective May 1, 1997, the Company 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, for approximately $26.9 million. Upon the sale, the Company entered into a long-term global capitation agreement with BJC, since amended, that covered approximately 33.3% of the risk membership in St. Louis at December 31, 1998. Under the agreement, BJC receives a fixed percentage of premium to cover all of the medical treatment received by the globally capitated members. Global capitation agreements limit the Company's exposure to the risk of increasing medical costs, but expose the Company to risk as to the adequacy of the financial and medical care resources of the provider organization. To the extent that the respective provider organization faces financial difficulties or otherwise is unable to perform its obligations under the global capitation agreements, the Company, 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. Various disputes alleging breaches have arisen under the BJC global capitation agreement concerning the accuracy and timeliness of claims payments, and the accuracy of membership reconciliations that would affect the amount of premiums paid to BJC to provide its services under the agreement. BJC contends that these alleged breaches entitles it to terminate the agreement. Although the parties are obligated to arbitrate their disputes under the terms of the agreement, the parties have agreed to attempt to negotiate a resolution of the various issues concurrent with arbitration. While the Company acknowledges certain claims payment inaccuracies, the Company denies the remaining allegations and vigorously disputes that any such claims constitute a material breach of the agreement. Management does not believe that the outcome of these disputes will have a material impact on the consolidated financial statements, although there can be no assurances in this regard. OTHER LEGAL ACTIONS. In the normal course of business, the Company has been named as a 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, 1999 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 for which the Company maintains reserves. In the opinion of management, the outcome of these actions should not have a material adverse effect on the financial position or results of operations of the Company. Other managed care companies have been sued recently in class action lawsuits claiming violations of the federal racketeering act (RICO) and federal employee benefits law (ERISA), and generally claiming that managed care companies overcharge consumers and misrepresent that they deliver quality health care. Although it is possible that the Company may be the target of a similar suit, the Company believes there is no valid basis for such a suit. The Company'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 could have significant impact on the Company's operations. 22 25 COMPARISON OF 1999 TO 1998 Managed care premiums increased $48.7 million in 1999, or 2.4%, over 1998. The increase is primarily attributable to the additional revenue associated with the acquisitions of Carelink and the KFHPNC membership in the fourth quarter of 1999 and also due to the increase in Medicare risk and Medicaid membership of 34,345, or 20.6%, in continuing markets. In addition to the increase in risk membership, premiums increased by an average of $9.0, or 6.3%, over 1998 on a per member per month ("PMPM") basis, to $150.8 PMPM, as a result of rate increases. The Medicare Risk and Medicaid programs continue to grow in existing markets through recently expanded programs. On a same store basis, the increase in Medicare risk and Medicaid membership was offset by a decrease in commercial membership of 57,321, or 5.7%. The decrease in commercial membership occurred primarily in the western Pennsylvania market, attributable to the disruption caused by the AHERF bankruptcy filing and the conversion of a large group from a commercial risk product to a self-funded product. Membership also decreased in other markets due to Coventry's efforts to adhere to a strict pricing discipline. Coventry will continue to be diligent in attempting to obtain adequate premium increases and expects premium rates to increase 8% to 10% for renewals in the first quarter of 2000. Management services revenue increased $3.3 million in 1999, or 4.3%, from the prior year. The increase in management service revenue is primarily attributable to an increase in self-funded membership of 19,695, or 9.0%, including the conversion of a large group from a commercial risk product to a self-funded product. Health benefits expense increased $25.3 million, or 1.4%, in 1999, compared to 1998 due primarily to the additional expenses associated with the acquisitions of Carelink and KFHPNC membership. Exclusive of the Carelink and KFHPNC transactions, health benefits expense decreased $4.0 million. Coventry's medical loss ratio decreased slightly to 86.1% from 86.9% in 1998 due to premium rate increases which were a result of Coventry's efforts to maintain a strict pricing discipline. Medical claim liability accruals are periodically monitored and reviewed with differences for actual settlements from reserves reflected in current operations. In addition to the procedures for determining reserves as discussed above, the Company reviews the actual payout of claims relating to prior period accruals, which may take up to six months to fully develop. Medical costs are affected by a variety of factors, including the severity and frequency of claims, that are difficult to predict and may not be entirely within the Company's control. The Company continually refines its reserving practices to incorporate new cost events and trends. SG&A expense increased $6.0 million, or 2.1%, from 1998. SG&A expense, as a percent of revenue, remained unchanged at 13.8% in 1999, compared to 1998. The increase in SG&A expense was primarily attributable to additional expense associated with the acquired Carelink health plan and Coventry's consolidation of eighteen service centers into three regional service centers. In an effort to control costs and improve customer service, Coventry is in the process of transferring certain of its operating activities (e.g., customer service, claims processing, billing and enrollment) to regional service centers. All activities are expected to be fully transferred by the end of the fourth quarter of 2000. Depreciation and amortization increased $2.4 million, or 9.4%, compared to the prior year primarily as a result of the depreciation related to the net capital expenditures of $14.7 million in 1999 and the additional amortization related to the intangibles recorded as part of the acquisition of the PHC health plans in April 1998. Other income, net of interest expense, increased $9.5 million, or 50.6%, in 1999 from 1998, primarily due to the reduction of interest expense from the reduction of debt and increased investment income resulting from the increase in invested assets subsequent to the acquisition of the PHC health plans. Earnings from operations increased $84.1 million, or 232.2% in 1999, compared to 1998. Excluding charges related to AHERF, plan shutdown expense and the relocation of the corporate office, operating earnings increased $18.3 million, or 72.3%, attributable to the various factors described above. 23 26 Coventry's net income was $43.4 million in 1999 compared to a loss of $11.7 million in 1998. Net income per diluted share was $0.69 in 1999 compared to a net loss per diluted share of $0.22 in 1998. Excluding the AHERF charge, plan shutdown expense and merger costs, Coventry would have reported earnings per diluted share of $0.65 and $0.49 in 1999 and 1998, respectively. The weighted average common shares outstanding were approximately 64,159,000 and 52,477,000 on a diluted basis for the years ended December 31, 1999 and 1998, respectively. COMPARISON OF 1998 TO 1997 Managed care premiums increased $825.2 million, or 68.3%, in 1998 compared to 1997. The PHC plans accounted for approximately $697.7 million, or 84.6%, of the increase. Exclusive of the PHC plans, the Medicare risk membership increased by 25,285 members, or 66.0%. Medicare risk membership has a significantly higher per member per month premium (approximately three times) when compared to commercial risk membership and represented an increase in premiums, exclusive of the PHC plans, of $117.9 million from $161.1 million in 1997 to $279.0 million in 1998. The increase in Medicare risk membership was offset by a 20,047 decrease in Medicaid risk membership primarily resulting from the Company's decision to exit the Medicaid market in Pennsylvania in the first quarter of 1998. In addition, revenues per member per month, exclusive of the PHC plans, increased by 3.3% for HMO members, 8.3% for PPO/POS members and 5.5% for Medicaid members in 1998 over 1997. Excluding Medicaid membership, risk membership grew by 25,885, or 3.9%. The Company implemented rate increases that averaged approximately 7.0% in the fourth quarter of 1998. The Company has exited the Medicare program in several counties representing approximately 18,000 members as of December 31, 1998. Approximately 10,000 of those members were in the Illinois and Florida health plans that were sold effective November 30, 1998 and December 31, 1998, respectively. Management services revenue increased $56.8 million for the year ended December 31, 1998, or 281.2%, from the prior year. Management services and marketing services agreements that were entered into coincident with the acquisition of the PHC plans accounted for approximately $23.0 million, or 40.5%, of the increase. Approximately $30.5 million, or 53.7%, of the increase is primarily attributable to the PHC Administrative Services Only ("ASO") operations and PPO access fees. Exclusive of the PHC plans and the related agreements with Principal Life, management services revenue increased approximately $3.3 million, or 5.8%, attributable to transition services related to global capitation agreements and rate increases to ASO customers. 24 27 MEMBERSHIP
COMMERCIAL RISK GOVERNMENTAL RISK ------------------------------------------------------------------ HMO PPO/POS MEDICARE MEDICAID NON-RISK TOTAL -------------------------------------------------------------------------------------------------------- 1998 - ---------------------- Pennsylvania (1) 207,067 194,539 25,571 - 103,288 530,465 St. Louis (2) 138,031 62,615 38,028 81,505 23,029 343,208 Richmond 51,980 264 - 3,015 14,812 70,071 Nebraska 34,598 - - - 720 35,318 Kansas City 51,993 - - - 5,526 57,519 Wichita 35,342 - - - 399 35,741 Louisiana 39,730 - - - 161 39,891 Delaware 37,500 - - 16,829 58,062 112,391 Iowa 77,912 - - 1,394 10,778 90,084 Indiana 27,280 - - - 750 28,030 Georgia 20,273 - - - 748 21,021 Carolina 21,575 - - - - 21,575 -------------------------------------------------------------------------------------------------------- Total 743,281 257,418 63,599 102,743 218,273 1,385,314 ======================================================================================================== 1997 - ---------------------- Pennsylvania (1) 238,122 174,157 12,141 23,683 111,087 559,190 St. Louis 103,456 52,932 26,173 78,323 21,281 282,165 Richmond 54,095 180 - 2,561 16,542 73,378 -------------------------------------------------------------------------------------------------------- Total 395,673 227,269 38,314 104,567 148,910 914,733 ========================================================================================================
(1) Pennsylvania includes West Virginia membership in 1998 and 1997. (2) St. Louis includes PHC of St. Louis membership in 1998. Health benefits expense increased $727.5 million for the year ended December 31, 1998, or 70.0%, compared to 1997. The PHC plans accounted for approximately $612.5 million, or 84.2%, of the increase. The Company's medical loss ratio increased slightly to 86.9% from 86.1% in the previous year, primarily as a result of increases in Medicare membership. As previously discussed, in July 1998, AHERF, the global capitation provider organization in western Pennsylvania, filed for bankruptcy protection under Chapter 11. On July 22, 1999, the Company reached a settlement with the non debtor, affiliated hospitals, including Allegheny General Hospital (AGH), formerly owned by AHERF, and its new owner, Western Pennsylvania Health Care System ("West Penn"), whereby the hospitals agreed that the Company would not be liable for the payment of certain medical services rendered by the hospitals to the Company's members prior to July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the settlement, the Company signed a new three-year provider contract with West Penn. The conditions to execute the settlement and the provider contract were finalized in October 1999 and, as a result, all liability issues surrounding AHERF's failure to fulfill its contractual obligations and Coventry's remaining obligations have been determined and all AHERF-related litigation has been concluded. SG&A expense for the year ended December 31, 1998 increased $121.9 million, or 71.7%, compared to 1997. The PHC plans accounted for approximately $92.8 million, or 76.1%, of the increase. The remainder of the increase in SG&A is primarily attributable to the increased costs relating to administrative processes, particularly in claims processing, associated with the growth of the Medicare product in certain markets. SG&A expense as a percent of revenue remained at 13.8% for the year ended 1998. In an effort to control costs and improve customer service, the Company started the process of migrating certain of its operating activities (e.g., customer service, claims processing, billing and enrollment) to regional service centers. 25 28 Depreciation and amortization for the year ended December 31, 1998 increased $13.1 million, or 102.5%, compared to 1997. Depreciation expense from the PHC plans accounted for approximately $2.3 million, or 17.6%, of the increase. The remainder of the increase is attributable to the amortization of intangibles and goodwill recorded in connection with the acquisition of the PHC plans. Loss from operations was $36.2 million for the year ended December 31, 1998. Excluding the $61.5 million of charges associated with the AHERF bankruptcy and the relocation of the corporate headquarters and other merger related costs, operating earnings were $25.3 million for the year ended December 31, 1998 compared to $5.7 million for the corresponding period in 1997. The increase in the operating earnings, exclusive of the $61.5 million of charges in 1998, is attributable to various factors as previously described. Other income, net of interest expense, increased $4.1 million for the year ended December 31, 1998, or 27.9%, from the corresponding period in the prior year. Other income, net of interest expense, related to the PHC plans accounted for approximately $10.1 million, or 246.3%, of the increase. Exclusive of the PHC plans, other income, net of interest expense, decreased by $6.0 million. This reduction was primarily attributable to a $15.0 million pre-tax gain related to the sale of medical offices that was recognized in the prior year, offset by increased investment income resulting from the increase in invested assets subsequent to the acquisition of the PHC plans. The Company's net loss was $11.7 million for the year ended December 31, 1998. Net loss per common and common equivalent share was $0.22 for the year ended December 31, 1998 compared to earnings per common and common equivalent share of $0.35 for the corresponding period in 1997. Excluding the $61.5 million of charges associated with the AHERF bankruptcy and the relocation of the corporate headquarters and other merger related costs, the Company reported basic earnings per common and common equivalent share of $0.50 in 1998. The weighted average number of common shares outstanding were approximately 52,477,000 and 33,912,000 for the years ended December 31, 1998 and 1997, respectively. The increase in the weighted average number of shares outstanding in 1998 was primarily attributable to the shares issued in April 1998 related to the acquisition of the PHC plans. Effective in the fourth quarter of 1997, the Company adopted SFAS 128, "Earnings Per Share." Accordingly, prior periods have been restated. LIQUIDITY AND CAPITAL RESOURCES The Company's total cash and investments, excluding deposits of $24.8 million restricted under state regulations, decreased $8.5 million to $589.8 million at December 31, 1999 from $598.3 million at December 31, 1998. This decrease was primarily a result of approximately $55.6 million that was used to pay the amount of medical claims for Principal Health Care of Florida, Inc. and Principal Health Care of Illinois, Inc., the two plans that were sold effective December 31, 1998 and November 30, 1998, respectively. The decrease is also attributable to the Company's efforts to reduce medical claims inventory in 1999. The Company's investment guidelines emphasize investment grade fixed income instruments in order to provide short-term liquidity and minimize the risk to principal. The Company believes that since its long-term investments are available-for-sale, the amount of such investments should be added to current assets when assessing the Company's working capital and liquidity; on such basis, current assets plus long-term investments available-for-sale less short-term liabilities increased to $246.7 million at December 31, 1999 from $187.8 million at December 31, 1998. The Company's HMOs and its insurance company subsidiary, Coventry Health and Life Insurance Company ("CHLIC"), are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the Company may receive from its HMOs and its insurance company subsidiary. After giving effect to these statutory reserve requirements, the Company's HMO subsidiaries had surplus in excess of statutory requirements of approximately $102.6 million and $93.4 million at December 31, 1999 and December 31, 1998, respectively. CHLIC had surplus in excess of statutory requirements of approximately $15.0 million and $7.8 million at December 31, 1999 and 1998, respectively. Excluding funds held by entities subject to regulation, the Company had cash and investments of approximately $61.1 million and $96.8 million at December 31, 1999 and 26 29 December 31, 1998, respectively, which are available to pay intercompany balances to regulated subsidiaries and for general corporate purposes. The Company also has entered into agreements with certain of its regulated subsidiaries to provide additional capital if necessary to prevent the subsidiary's insolvency. On December 29, 1997, the Company entered into a credit agreement with a group of banks (the "Credit Facility"), which replaced a prior credit agreement. Using a portion of the proceeds received from the sale of its Florida health plan, the Company retired the Credit Facility and the $42.2 million balance then outstanding effective December 31, 1998. On December 31, 1998, the effective interest rate on the indebtedness retired was 7.0625%. During the quarter ended June 30, 1997, the Company 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 $40.0 million of Coventry's 8.3% Convertible Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with warrants to purchase 2.35 million shares of the Company's common stock for $42.35 million. The original amount of the Coventry Notes, $36.0 million held by Warburg and $4.0 million held by Franklin, were exchangeable at Coventry's or Warburg's option for shares of redeemable convertible preferred stock. During the second and third quarters of 1999, Coventry converted all Coventry Notes held by Warburg and Franklin totaling $47.1 million, including interest, into 4,709,545 shares of Series A redeemable convertible preferred stock ("preferred stock") at a price of $10 per share. The preferred stock is subject to mandatory redemption at a price of $10 per share, plus accrued dividends, in an amount equal to one-third of the shares outstanding on May 15, 2002, 2003 and 2004. The stock is carried at its fair value, which equals both its redemption value and liquidation value as of December 31, 1999 and will accrue dividends only if the Board of Directors declares dividends on common stock. The dividends (per share) on the preferred stock would be equal to the dividends on the common stock. The preferred stock may be converted at any time at the holders' option into shares of common stock at a conversion price equal to the closing market price of the Company's common stock on the date of conversion, if the closing market price is less than $10 per share. If the closing market price of the Company's common stock is greater than $10 per share, the preferred stock is convertible to common stock on a share for share basis. The preferred stock is callable by the Company if the market price of the Company's common stock exceeds certain agreed upon targets. Projected capital investments in 2000 of approximately $15.0 million consist primarily of computer hardware, software and related equipment costs associated with the development and implementation of improved operational and communications systems. The Company believes that cash flows generated from operations, cash on hand and investments, and excess funds in certain of its regulated subsidiaries will be sufficient to fund continuing operations through December 31, 2000. SHARE REPURCHASE PROGRAM On December 20, 1999, the Company announced a program to purchase up to 5% of its outstanding common stock. Stock repurchases may be made from time to time at prevailing prices in the open market, by block purchase or in private transactions. Coventry had approximately 64.2 million diluted shares of common stock outstanding as of December 31, 1999. As part of a program previously authorized by the Board of Directors, as of March 23, 2000, the Company purchased approximately 826,200, 55,396 and 439,560 shares of its common stock in 2000, 1999 and 1997, respectively, for the treasury at an aggregate cost of $6.4 million, $0.4 million and $5.0 million in 2000, 1999 and 1997, respectively. LEGISLATION AND REGULATION Numerous proposals have been introduced in the United States Congress and various state legislatures relating to health care reform. Some proposals, if enacted, could among other things, restrict the Company's ability to raise prices and to contract independently with employers and providers. Certain reform proposals favor the growth of 27 30 managed health care, while others would adversely affect managed care. Although the provisions of any legislation adopted at the state or federal level cannot be accurately predicted at this time, management of the Company believes that the ultimate outcome of currently proposed legislation would not have a material adverse effect on the Company and its results of operations in the short-term. 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 it 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 reserves. In the opinion of management and based on the facts currently known, the outcome of these actions should not have a material adverse effect on the financial position or results of 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 became effective for both interim and annual reporting periods that ended 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. The adoption of this standard did not have a material impact on earnings per share. The FASB has also issued SFAS No. 130, "Reporting Comprehensive Income," which became effective for fiscal years that began after December 15, 1997. SFAS No. 130 requires that changes in the amounts of certain items, including unrealized gains and losses on certain securities, be reflected in the financial statements. The Company adopted SFAS 130 effective January 1, 1998. The adoption of this standard did not have a material effect on the Company's 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. Effective December 31, 1998, the Company adopted SFAS 131. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of the derivatives would be accounted for depending on the use of the derivatives and whether they qualify for hedge accounting. In June 1999, the FASB also issued SFAS No. 137 ("SFAS 137"), which defers the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. The Company does not believe that adoption of SFAS 133 (as amended by SFAS 137) will have a material effect on its future results of operations. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal 28 31 Use." SOP 98-1 provides authoritative guidance for the capitalization of certain costs related to computer software developed or obtained for internal applications, such as external direct costs of materials and services, payroll costs for employees and certain interest costs. Costs incurred during the preliminary project stage, as well as training and data conversion costs, are to be expensed as incurred. SOP 98-1 is effective for fiscal years that began after December 15, 1998. The Company adopted SOP 98-1 effective January 1, 1999. The adoption of SOP 98-1 did not have a material effect on the Company's consolidated financial statements. 29 32 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 1999, the Company implemented increases in premium rates which exceeded inflationary cost increases while maintaining competitive rates within its markets. QUARTERLY RESULTS OF OPERATIONS The unaudited quarterly consolidated results of operations of the Company are summarized in Item 6: Selected Consolidated Financial Data, Supplementary Financial Information. 2000 OUTLOOK The Company's membership in January 2000 was approximately 1,485,000 members, an increase of 6.3% over January 1999. The increase was primarily attributable to the acquisitions in North Carolina and West Virginia. Of the January 2000 membership, approximately 1,246,000 were risk members and approximately 239,000 were non-risk members. The Company operates in highly competitive markets, but generally believes that the pricing environment is improving in its existing markets, thus creating the opportunity for reasonable price increases. However, there is no assurance that the Company will be able to increase premiums at rates equal to or in excess of increases in its health care costs. For 2000, the Company continues to pursue ways to improve its underwriting processes and oversight in both risk and management services products with the objective of increasing premium yields and profitable growth in its markets. The Company's migration of certain of its operating activities (e.g., customer service, claims processing, billing and enrollment) to regional service centers is expected to be completed by the end of the fourth quarter of 2000. The Company expects that the regional service centers will allow it to provide improved levels of service in a more cost effective manner. The integration of the PHC health plans has allowed the Company to strengthen its balance sheet and gain entry into additional markets. Management believes that existing markets have potential for growth for the Company's commercial and governmental products. Management believes that the foregoing should result in progressive improvements in 2000, although realization is dependent upon a variety of factors, some of which may be outside the control of the Company. E-COMMERCE INITIATIVES The Company is launching several e-commerce initiatives. Each initiative is intended to reach a segment of our core business customers: providers, brokers, employers and members, and will have a distinct e-commerce solution. PROVIDER CHANNEL. In February 2000, the Company entered into a three-year agreement with Healtheon/WebMD, the first end-to-end Internet healthcare company connecting physicians and consumers to the entire healthcare industry. Initially, the Company will use Healtheon/WebMD's Internet services to manage the electronic submission and processing of eligibility determination, referrals and authorizations, claims submission, claim status, and reporting. Upon completion of the roll-out, Healtheon/WebMD will also provide administrative services to the providers in the Company's health plans' networks who have signed up for WebMD Practice. It is expected that this relationship will significantly improve service to our members and reduce administrative costs. BROKER/EMPLOYER CHANNEL. In February 2000, the Company entered into a two-year agreement with Workscape, Inc. ("Workscape"), which specializes in the development of Internet solutions for the insurance industry. Workscape will focus on automating the full broker/small employer relationship, including enrolling customers, providing benefits information, generating customized proposals, registering agents, processing applications, underwriting 30 33 risk, and calculating rates. The Company will initially implement this initiative in its Pittsburgh and Harrisburg, Pennsylvania markets, and then into its other markets. MEMBER CHANNEL. In March 2000, the Company announced a one-year agreement with GeoAccess to implement GeoAccess' online healthcare directory technology. This technology makes information about health plan providers available to members. The online directories will be available in all the Company's health plans. ProviderLookup Online uses GeoAccess' proprietary distance-calculation technology, which provides precise results about the providers located closest to an individual's address. The Company's members will be able to search for providers by name, geographic proximity or specific criteria. YEAR 2000 The Company has been aware of the "Year 2000" issue that has the potential to affect products and systems that were not designed to properly handle the transition between the twentieth and twenty-first centuries. The Company recognized the need to ensure that its business operations would not be adversely impacted by the Year 2000, and it implemented a Year 2000 readiness program to facilitate the necessary readiness preparations. Through December 31, 1999, the Company incurred approximately $13.1 million in its Year 2000 assessment and remediation program, and it does not expect to incur significant further costs in this program. Prior to the end of 1999, the Company completed its readiness assessment and its implementation of all plans for handling anticipated readiness risks. The Company's transition from 1999 to 2000 occurred without any major business disruption. With the transition into the Year 2000 complete, the Year 2000 issue has not had, and the Company believes it will not have, a material impact on the Company's business, financial condition or results of operations. RISK FACTORS The risks described below are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. Further, the trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. HEALTH CARE COSTS MAY RISE FASTER THAN OUR ABILITY TO INCREASE OUR PREMIUM RATES, CAUSING OUR PROFIT MARGINS TO SHRINK WHICH MAY IN TURN REDUCE OUR NET INCOME AND ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT IN COVENTRY. In the future, the costs of health care services and supplies that we provide to our membership may rise faster than our ability to increase premium rates. If costs rise and we are unable to increase premium rates, our profit margins will shrink. Shrinking profit margins may reduce our net income and adversely affect the value of your investment in Coventry. Premium rates for managed care plans generally have increased in recent months, but we could experience unforeseen decreases or severely limited increases in future premium rates. Also, 27.5% of our premium revenues through February 29, 2000 were derived from governmental programs, including Medicare and Medicaid. The government generally fixes these premium rates and we cannot adjust them based on our anticipated costs. Recent legislation has limited Medicare premium rate increases substantially as compared to increases permitted in prior years. As a result, in the future the total costs of our government programs could exceed the total premiums that we receive from these programs. IF WE ARE UNABLE TO INCREASE OUR REVENUES AND OUR PROFIT MARGINS SHRINK, OUR NET INCOME MAY DECREASE AND THE VALUE OF YOUR INVESTMENT IN COVENTRY MAY DECLINE. 31 34 In the future, we may not be able to increase or maintain our current revenues. Since we no longer receive revenues under our agreements with Principal Life, which expired on December 31, 1999, there is a risk that we may not be able to replace the revenues generated from these fees. We recognized revenues from these agreements of $25.5 million in 1999 and $23.0 million in 1998. We may also be unable to reduce our costs or increase our premium rates. If we are faced with shrinking profit margins and are unable to increase our revenues, we will have a decline in net income, which could adversely affect the value of your investment in Coventry. Increases in our revenues will be generally dependent upon our ability to increase premiums and membership. In addition to the loss of revenues generated from the Principal Life fees, there are several factors that may affect our ability to maintain or increase revenues including: - - rising costs - - loss of membership to our competitors - - failure to attract new members - - inability to increase premiums due to regulatory restrictions - - loss of membership due to increased premium rates - - withdrawal from unprofitable markets - - consumer preferences for lower priced health care options - - price competition OUR FAILURE TO ACCURATELY ESTIMATE FUTURE HEALTH CARE COSTS MAY RESULT IN PREMIUMS THAT ARE NOT SUFFICIENT TO COVER MEDICAL COSTS, WHICH MAY NEGATIVELY AFFECT OUR OPERATING RESULTS AND REDUCE THE VALUE OF YOUR INVESTMENT IN COVENTRY. If we underestimate the costs of health care services and supplies that we provide to our members, we may set our premium rates too low. Low premiums may result in an inability to generate revenues that are sufficient to pay future health care costs. This shortfall could significantly change our results of operations, affect profitability and adversely affect the value of your investment in Coventry. While we attempt to base the premiums we charge, at least in part on our estimate of expected health care costs over the fixed premium period, other factors may limit our ability to fully base premiums on estimated costs and could cause actual health care costs to exceed estimated health care costs. These factors could include: - - the increased cost of individual health care services - - the type and number of individual health care services delivered exceeding our expectations - - the occurrence of catastrophes or epidemics - - seasonality and trends - - general inflation - - new mandated benefits or other regulatory changes that increase our costs - - operational issues - - insured population characteristics - - competitive pressures - - other unforeseen occurrences FAILURE TO OBTAIN COST-EFFECTIVE AGREEMENTS WITH A SUFFICIENT NUMBER OF PROVIDERS MAY RESULT IN HIGHER MEDICAL COSTS AND LOSS OF MEMBERSHIP, WHICH COULD CAUSE A DECLINE IN THE VALUE OF YOUR INVESTMENT IN COVENTRY. We expect that substantially all of our members will be served by providers contracting with us to provide the requisite medical care. Our ability to contract successfully with a sufficiently large number of providers in a given geographic market will impact the relative attractiveness of managed care products in those markets. In addition, the terms of those provider contracts also have a material impact on our medical costs and our ability to control these costs. WE MAY NOT BE ABLE TO REACH COST-EFFECTIVE AGREEMENTS WITH CERTAIN MAJOR MARKET PROVIDERS WHICH COULD REDUCE COVENTRY'S NET INCOME AND CAUSE A DECLINE IN THE VALUE OF YOUR INVESTMENT IN COVENTRY. In some of our markets, there are provider systems that have a major presence. Our product offerings and profitability may be adversely affected if these provider systems refuse to contract with us, place us at a competitive disadvantage or use their market position to negotiate contracts that are unfavorable to us. THERE IS A RISK THAT PROVIDERS WITH WHOM WE HAVE CAPITATION CONTRACTS MAY BE FINANCIALLY UNABLE OR UNWILLING TO FULFILL THEIR PAYMENT OR MEDICAL CARE OBLIGATIONS UNDER CAPITATION AGREEMENTS AND THAT OUR MEMBERS MAY PREFER TO UTILIZE OTHER PROVIDERS WITH WHOM WE DO NOT HAVE CAPITATION CONTRACTS. 32 35 Among the medical cost control techniques we have utilized are capitation agreements with providers pursuant to which we pay providers a fixed dollar amount per member per month, 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 a large number of members for a fixed percentage of the premium we charge 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, we will be exposed to the risks that the provider systems are financially unable or unwilling to fulfill their payment or medical care obligations under the capitation agreements. In addition, it is possible that members may prefer other providers in the market with whom we do not have capitation agreements. If our members choose to utilize providers with whom we do not have capitation agreements, we may incur higher costs. These higher costs may reduce our net income and negatively impact the value of your investment in Coventry. PRINCIPAL LIFE AND ITS AFFILIATES' ABILITY TO EXERCISE CONTROL OVER COVENTRY COULD ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT IN COVENTRY. As a result of our acquisition of the Principal Health Care plans, Principal Life owns approximately 40% of our common stock, on a fully diluted basis. Due to previously agreed upon limitations that are effective through April 2003, Principal Life may purchase additional shares of our common stock, but only to maintain its 40% ownership of our fully diluted common stock. In addition to its ownership position, Principal Life has designated 4 members of our 10 member Board of Directors in correspondence with its percentage ownership of our common stock. As long as Principal Life owns at least 10% of our common stock, it can designate one member of our Board of Directors for each 6% ownership of our common stock. Accordingly, Principal Life has the right to designate up to six members of our Board. Principal Life's ownership position and its representation on our Board of Directors, allow it to exert significant influence over the direction and operations of Coventry. In some instances, this influence could be used in a manner that is contrary to the best interests of our other stockholders, and may accordingly decrease the value of your investment in Coventry. It should be noted, however, that prior to April 2003, Principal Life has agreed to vote its shares in favor of any acquisition required to be approved by our shareholders, that a Special Committee of our Board of Directors has recommended, and that a majority of our shareholders, other than Principal Life, have approved. The Special Committee will consist of members of our Board of Directors that are neither management, nor designees of Principal Life. Additionally, prior to April 2003, Principal Life has agreed to vote its shares for the election of directors nominated by the nominating committee of the Board of Directors, and not to oppose or seek removal of any person nominated by this nominating committee. Once the previously agreed upon limitations imposed on Principal Life expire in April 2003, Principal Life may acquire additional shares of our common stock to the point that it exercises complete control over the Company. If Principal Life were to acquire over 50% of our common stock, it would have actual control over us, and would have a controlling vote in all actions involving a shareholder vote. As the majority shareholder, Principal Life could block transactions that were advantageous to our minority shareholders. Accordingly, the value of your investment in Coventry could decline as future investors may not consider our common stock to be an attractive stock due to the percentage of our common stock held by Principal Life. FUTURE AND EXISTING LAWS AND RULES GOVERNING COVENTRY MAY IMPACT OUR BUSINESS AND NEGATIVELY AFFECT OUR PROFITABILITY. 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 could force us to change how we do business and may restrict our revenue and/or enrollment growth and/or increase our health care and administrative costs. Regulatory approvals must be obtained and maintained to market many of our products and services. Delays in obtaining or failing to obtain or maintain such approvals could adversely affect our revenue or the number of our covered lives, or could increase our costs. OUR CONTRACTS WITH FEDERAL AND STATE GOVERNMENT AGENCIES ARE SUBJECT TO PERIODIC AUDITS THAT COULD HAVE AN ADVERSE RESULT THAT MAY LEAD TO A DECLINE IN THE VALUE OF YOUR INVESTMENT IN COVENTRY. 33 36 Coventry contracts with various federal and state governmental agencies to provide managed health care services. These agencies include the United States Office of Personnel Management that contracts with us to provide managed health care services for federal employees under the Federal Employees Health Benefits Program; the U. S. Health Care Financing Administration that contracts with us to provide a Medicare product to eligible beneficiaries; and certain states that contract with us to provide a Medicaid product to eligible recipients. These contracts and applicable federal and state regulations, among other requirements, establish premium rating requirements or fixed premiums per member per month. These governmental agencies and states may periodically audit us to verify our compliance with their contracts and applicable federal and state laws and regulations. Such audits could result in material adjustments. An adverse audit of our contracts with governmental agencies could result in the loss of licensure, the loss of the right to participate in certain programs, the imposition of fines, penalties, and other sanctions and could negatively affect our reputation in various markets and make it more difficult for us to sell our products and services. IN THE FUTURE, WE MAY NOT BE ABLE TO MEET CERTAIN MINIMUM CAPITALIZATION LIMITS THAT MAY BE ADOPTED BY STATES IN WHICH WE DO BUSINESS. The National Association of Insurance Commissioners has proposed that states adopt risk-free capital standards that, if implemented, would generally require higher minimum capitalization limits for health care coverage provided by HMOs and other risk-bearing health care entities. To date, no state where Coventry has HMO operations has adopted those standards. We do not expect this legislation to have a material impact on our consolidated financial position in the near future. We believe that cash flows from operations will be sufficient to fund any additional regulatory risk-based capital. COSTS ASSOCIATED WITH LITIGATION MAY RESULT IN LOSSES TO US THAT COULD NEGATIVELY IMPACT THE VALUE OF YOUR INVESTMENT IN COVENTRY. We are 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 us that could have a material adverse effect on our operations, financial performance, cash flows or future prospects and adversely affect the value of your investment in Coventry. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK The Company's only material risk in investments in financial instruments is in its debt securities portfolio. The Company invests primarily in marketable state and municipal, U.S. Government and agencies, corporate, and mortgage-backed debt securities. As of December 31, 1999, the Company has not invested in financial instruments of a hedging or derivative nature. The Company has established policies and procedures to manage its exposure to changes in the fair value of its investments. These policies include an emphasis on credit quality, management of portfolio duration, maintaining or increasing investment income through high coupon rates and actively managing profile and security mix depending upon market conditions. The Company has classified all of its investments as available-for-sale. The fair value of the Company's investments in debt securities at December 31, 1999 was $374.5 million. Debt securities at December 31, 1999 mature according to their contractual terms, as follows (actual maturities may differ because of call or prepayment rights):
1999 AMORTIZED COST FAIR VALUE ---- -------------- ---------- Maturities: Within 1 year $102,126 $102,045 1 to 5 years 114,850 113,517 6 to 10 years 68,382 66,373 Over 10 years 93,726 92,592 ----------------- ----------------- Total short-term and long-term securities $379,084 $374,527 ================= =================
The Company believes its investment portfolio is diversified and expects no material loss to result from the failure to perform by the issuer of the debt securities it holds. The mortgage-backed securities are insured by GNMA and FNMA. The Company's projections of hypothetical net losses in fair value of the Company's market rate sensitive instruments, should potential changes in market rates occur, are presented below. While the Company believes that the potential market rate change is reasonably possible, actual results may differ. Based on the Company's debt securities portfolio and interest rates at December 31, 1999, a 100 basis point increase in interest rates would result in a decrease of $7.9 million or 2.1%, in the fair value of the portfolio. Changes in interest rates may affect the fair value of the debt securities portfolio and may result in unrealized gains or losses. Gains or losses would be realized upon the sale of the investments. 34 37 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE BOARD OF DIRECTORS OF COVENTRY HEALTH CARE, INC.: We have audited the accompanying consolidated balance sheets of Coventry Health Care, Inc. (a Delaware corporation and successor-in-interest to Coventry Corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Coventry Health Care, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. Baltimore, Maryland February 21, 2000 35 38 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
December 31, December 31, 1999 1998 ----------- ----------- ASSETS Cash and cash equivalents $ 240,076 $ 405,323 Short-term investments 88,365 46,714 Accounts receivable, net of allowance of $5,548 and $12,023 as of December 31, 1999 and 1998, respectively 53,173 43,466 Other receivables, net 42,304 23,126 Deferred income taxes 56,157 65,583 Other current assets 3,330 6,993 ----------- ----------- Total current assets 483,405 591,205 Long-term investments 286,162 162,546 Property and equipment, net 37,863 35,780 Goodwill and intangible assets, net 268,289 295,966 Other assets 5,864 5,731 ----------- ----------- Total assets $ 1,081,583 $ 1,091,228 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Medical claim liabilities $ 308,095 $ 330,743 Other medical liabilities 54,691 73,079 Accounts payable and other accrued liabilities 110,186 115,716 Deferred revenue 49,914 46,414 ----------- ----------- Total current liabilities 522,886 565,952 Convertible exchangeable subordinated notes - 45,538 Long-term debt - 781 Other long-term liabilities 31,217 42,418 ----------- ----------- Total liabilities 554,103 654,689 Redeemable convertible preferred stock, $.01 par value; Series A, 47,095 - 6,000,000 shares authorized; 4,709,545 shares issued and outstanding in 1999 Stockholders' equity: Common stock, $.01 par value; 200,000,000 shares authorized; 59,643,753 shares issued and 59,148,797 outstanding in 1999; and 59,274,370 shares issued and 58,834,810 outstanding in 1998 596 593 Additional paid-in capital 480,792 476,430 Accumulated other comprehensive (loss) income (2,780) 794 Retained earnings (accumulated deficit) 7,157 (36,278) Treasury stock, at cost, 494,956 and 439,560 shares as of December 31, 1999 and 1998, respectively (5,380) (5,000) ----------- ----------- Total stockholders' equity 480,385 436,539 ----------- ----------- Total liabilities and stockholders' equity $ 1,081,583 $ 1,091,228 =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 36 39 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, -------------------------------------------------- 1999 1998 1997 -------------- --------------- --------------- Operating revenues: Managed care premiums $ 2,082,075 $ 2,033,372 $ 1,208,149 Management services 80,297 77,011 20,202 -------------------------------------------------- Total operating revenues 2,162,372 2,110,383 1,228,351 -------------------------------------------------- Operating expenses: Health benefits 1,792,652 1,767,374 1,039,860 Selling, general and administrative 297,922 291,919 170,017 Depreciation and amortization 28,205 25,793 12,735 Plan shutdown expense 2,020 - - AHERF charge (6,282) 55,000 - Merger costs - 6,492 - -------------------------------------------------- Total operating expenses 2,114,517 2,146,578 1,222,612 -------------------------------------------------- Operating earnings (loss) 47,855 (36,195) 5,739 Other income, net 29,906 27,251 24,880 Interest expense (1,761) (8,566) (10,275) -------------------------------------------------- Earnings (loss) before income taxes and minority interest 76,000 (17,510) 20,344 Provision for (benefit from) income taxes 32,565 (5,769) 8,422 Minority interest in earnings of consolidated subsidiary, net of income tax - - 19 -------------------------------------------------- Net earnings (loss) $ 43,435 $ (11,741) $ 11,903 ================================================== Net earnings (loss) per share: Basic $ 0.74 $ (0.22) $ 0.36 ================================================== Diluted $ 0.69 $ (0.22) $ 0.35 ==================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 37 40 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (IN THOUSANDS)
ACCUMULATED RETAINED ADDITIONAL OTHER EARNINGS TOTAL COMMON PAID-IN COMPREHENSIVE (ACCUMULATED TREASURY STOCKHOLDERS' STOCK CAPITAL INCOME (LOSS) DEFICIT) STOCK, AT COST EQUITY ---------------------------------------------------------------------------------------- Balance, December 31, 1996 $330 $136,142 $395 $(36,440) $- $100,427 Comprehensive income: Net earnings 11,903 11,903 Unrealized gain on securities, net of reclassifications 197 197 ----------------- Comprehensive income: 12,100 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 - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 337 146,426 592 (24,537) (5,000) 117,818 Comprehensive (loss) income: Net loss (11,741) (11,741) Unrealized gain on securities, net of reclassifications 202 202 ----------------- Comprehensive loss: (11,539) Issuance of common stock, including exercise of options and warrants 256 304,888 305,144 Issuance of warrants 25,000 25,000 Tax benefit of stock options exercised 116 116 - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1998 593 476,430 794 (36,278) (5,000) 436,539 Comprehensive income (loss): Net earnings 43,435 43,435 Unrealized loss on securities, net of reclassifications (3,574) (3,574) ----------------- Comprehensive income: 39,861 Issuance of common stock, including exercise of options and warrants 3 3,931 (380) 3,554 Tax benefit of stock options exercised 431 431 - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1999 $596 $480,792 $(2,780) $7,157 $(5,380) $480,385 ===============================================================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 38 41 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, ----------------------------------------------------------- 1999 1998 1997 ---------------- ------------------ -------------------- Cash flows from operating activities: Net earnings (loss) $43,435 $(11,741) $11,903 Adjustments to reconcile net earnings (loss) to cash provided by operating activities: Depreciation and amortization 28,205 25,793 12,735 Deferred income tax provision (benefit) 14,038 (19,439) (11,701) Loss on sales of medical offices & property disposals 287 (399) (13,338) Non-cash interest on convertible debt 1,557 3,496 2,042 Other 100 3,631 (383) Changes in assets and liabilities, net of effects of the purchase of subsidiaries: Accounts receivable (7,357) 14,163 (2,432) Other receivables (17,265) 12,677 715 Prepaid expenses and other current assets 388 (424) 2,013 Other assets (133) 2,373 2,874 Medical claims liabilities (41,982) 36,184 (28,060) Other medical liabilities (20,007) 73,079 - Accounts payable and other accrued liabilities (7,139) (70,741) 26,000 Deferred revenue 3,012 516 24,205 Other long-term liabilities (8,269) (724) (4,312) ----------------------------------------------------------- Net cash (used in) provided by operating activities (11,130) 68,444 22,261 ----------------------------------------------------------- Cash flows from investing activities: Capital expenditures, net (14,717) (3,196) (7,218) Sales of investments 253,489 122,871 37,329 Purchases of investments & other (425,109) (141,577) (34,137) Payments for acquisitions (10,133) - - Proceeds from sales of subsidiaries & medical offices - 99,277 53,977 Proceeds from sale of Renewal Rights Agreement 19,850 - - Cash acquired in conjunction with acquisitions 19,730 148,600 - ----------------------------------------------------------- Net cash (used in) provided by investing activities (156,890) 225,975 49,951 ----------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of convertible exchangeable notes - - 40,000 Payments on long-term debt (781) (44,491) (48,961) Net proceeds from issuance of stock 3,554 1,416 2,729 Proceeds from issuance of stock warrants - - 2,353 ----------------------------------------------------------- Net cash provided by (used in) financing activities 2,773 (43,075) (3,879) ----------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (165,247) 251,344 68,333 Cash and cash equivalents at beginning of period 405,323 153,979 85,646 ----------------------------------------------------------- Cash and cash equivalents at end of period $240,076 $405,323 $153,979 =========================================================== Supplemental disclosure of cash flow information: Cash paid for interest $ - $3,386 $7,572 Income taxes paid (refunded), net $40,210 $9,487 $(4,456)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 39 42 Coventry Health Care, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Coventry Health Care, Inc. (together with its subsidiaries, the "Company", "we", "our", or "us"), successor-in-interest to Coventry Corporation, is a managed health care company operating health plans under the names Coventry Health Care, HealthAmerica, HealthAssurance, HealthCare USA, Group Health Plan, Southern Health, SouthCare and Carelink Health Plans. The Company provides a full range of managed care products and services including health maintenance organization ("HMO"), point of service ("POS") and preferred provider organization ("PPO") products. The Company also administers self-insured plans for large employer groups. The Company was incorporated under the laws of the state of Delaware on December 17, 1997. The Company began operations in 1987 with the acquisition of the American Service Companies ("ASC") entities, including the 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. In 1998, the Company acquired certain assets of Principal Health Care, Inc. ("PHC") from Principal Mutual Life Insurance Company, now known as Principal Life Insurance Company ("Principal Life"). On October 1, 1999, the Company acquired Carelink Health Plans ("Carelink") from Camcare, Inc. On November 1, 1999, the Company's subsidiary, Coventry Health Care of the Carolinas, Inc., acquired Kaiser Foundation Health Plan of North Carolina, Inc.'s commercial membership. See Notes B and C to consolidated financial statements. 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 long-term liabilities for financial reporting purposes. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 and Cash Equivalents - Cash and 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 ("SFAS 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. 40 43 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 - The Company has 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." In accordance with SFAS 121, the Company evaluates long-lived assets to be held for events or changes in circumstances that would indicate that the carrying value may not be recoverable. In making that determination, the Company considers a number of factors, including undiscounted future cash flows, prior to interest expense. The Company measures an impairment loss by comparing the fair value of the assets to their carrying value. Fair values are determined by using market prices for similar assets, if available, or discounted future estimated cash flows, prior to interest expense. Assets held for sale are recorded at the lower of the carrying amount or fair value, less any cost of disposition. 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. Goodwill is amortized using the straight-line method over periods ranging from 15 to 35 years. The remaining unamortized goodwill and intangible asset balances at December 31, 1999 are as follows (in thousands):
ESTIMATED ACCUMULATED DESCRIPTION USEFUL LIFE AMOUNT AMORTIZATION NET BOOK VALUE - ----------------------------------------------------------------------------------------------------------- Customer Lists 5 years $ 11,700 $ 8,450 $ 3,250 HMO Licenses 15-20 years 10,700 1,202 9,498 Goodwill 15-35 years 314,240 58,699 255,541 ------- ------ ------- Total $336,640 $68,351 $268,289 ======== ======= ========
Amortization expense for the years ended December 31, 1999, 1998 and 1997 was approximately $14.6 million, $13.6 million and $3.8 million, respectively. In accordance with SFAS 121 and Accounting Principles Board ("APB") Opinion No.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 (See Note P 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. Loan acquisition costs were fully amortized in 1999. 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 selling, general and administrative expense due to this change. These costs were fully amortized at December 31, 1997. Accumulated amortization of other assets was approximately $3.5 million and $3.4 million at December 31, 1999 and 1998, 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. Although considerable variability is inherent in such estimates, management believes that the liability is adequate. The Company also establishes reserves, if required, for the probability that anticipated future health care costs and contract maintenance costs under the group of existing contracts will exceed anticipated future premiums and reinsurance recoveries on those contracts. These accruals are continually monitored and reviewed, and as 41 44 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 Office of Personnel Management ("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. Significant Customers - For the years ended 1999, 1998, and 1997, the Company received 16.0%, 15.2%, and 14.0%, respectively, of its revenue from the Federal Medicare program throughout the Company's various markets. 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 the Company 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. See Note I for disclosures related to income taxes. Minority Interest - For 1997, the minority interest represents a joint venture interest of 51% in Pennsylvania HealthMate, Inc. ("HealthMate"). Stock-based Compensation - 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 L for disclosures related to stock-based compensation. 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 excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. The adoption of SFAS 128 did not have a material effect on the Company's earnings per share. All prior periods were previously restated to comply with SFAS 128. See Note S for calculation of EPS. Comprehensive Earnings - Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." SFAS 130 requires that changes in the amounts of certain items, including unrealized gains and losses on certain securities, be shown in the financial statements as part of comprehensive earnings. The adoption of this standard did not have a material effect on the Company's consolidated financial statements. Segment reporting - Effective December 31, 1998, the Company adopted Statement of Financial Accounting Standards No. 131 ("SFAS 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 42 45 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. The Company has two reportable segments: Commercial products and Government products. The products are provided to a cross section of employer groups through the Company's health plans in the Midwest, Mid-Atlantic, and Southeastern United States. Commercial products include HMO, PPO, and POS products. HMO products provide comprehensive health care benefits to enrollees through a primary care physician. PPO and POS products permit members to participate in managed care but allow them the flexibility to utilize out of network providers in exchange for an increase in out-of-pocket costs to the member. Governmental products include Medicare Risk, Medicare Cost, and Medicaid. The Company provides comprehensive health benefits to members participating in government programs and receives premium payments from federal and state governments. The Company evaluates the performance of its operating segments and allocates resources based on gross margin. Assets are not allocated to specific products and, accordingly, cannot be reported by segment. See Note U for disclosures on segment reporting. Derivative Instruments - In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of the derivatives would be accounted for depending on the use of the derivatives and whether they qualify for hedge accounting. In June 1999, the FASB also issued Statement of Financial Accounting Standards No. 137 ("SFAS 137"), which defers the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. The Company does not believe that adoption of SFAS 133 (as amended by SFAS 137) will have a material effect on its future results of operations. Computer Software - Effective January 1, 1999, the Company adopted Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use" issued by the American Institute of Certified Public Accountants ("AICPA"). SOP 98-1 provides authoritative guidance for the capitalization of certain costs related to computer software developed or obtained for internal applications, such as external direct costs of materials and services, payroll costs for employees and certain interest costs. Costs incurred during the preliminary project stage, as well as training and data conversion costs, are to be expensed as incurred. The adoption of SOP 98-1 did not have a material effect on the Company's consolidated financial statements. Reclassifications - Certain 1997 and 1998 amounts have been reclassified to conform to the 1999 presentation. B. PHC ACQUISITIONS AND DISPOSITIONS Effective April 1, 1998, the Company completed its acquisition of certain PHC health plans from Principal Life for a total purchase price of approximately $330.2 million including transaction costs of approximately $5.7 million. The acquisition was accounted for using the purchase method of accounting and, accordingly, the operating results of PHC have been included in the Company's consolidated financial statements since the date of acquisition. The purchase price consisted of 25,043,704 shares of the Company's common stock at an assigned value of $11.96 per share. In addition, a warrant valued at $25.0 million ("the Warrant") was issued that grants Principal Life the right to acquire additional shares of the Company's common stock in the event that its ownership percentage of such common stock is diluted below 40%. The Warrant is included as a component of additional paid-in capital in the accompanying consolidated financial statements. Through April 2003, Principal Life is restricted from buying additional shares of the Company's common stock to increase its ownership percentage above 40%. Coincident with the closing of the transaction, the Company entered into a Renewal Rights Agreement and a Coinsurance Agreement with Principal Life, to manage certain of Principal Life's indemnity health insurance policies in the markets where the Company does business and, on December 31, 1999, to offer to renew such policies in force at that time. Effective June 1, 1999, the Company amended these agreements with Principal Life 43 46 and waived its rights to reinsure and renew Principal Life's health insurance indemnity business located in the Company's service area. The Company received $19.8 million in cash in exchange for waiving these rights. At the date of the amendment, the Renewal Rights and Coinsurance Agreements had a net book value of $19.7 million resulting in an after tax gain of $0.1 million. At the closing, the Company also entered into a Marketing Services Agreement and a Management Services Agreement with Principal Life. Both agreements expired on December 31, 1999. Pursuant to the agreements, the Company recognized revenue of approximately $25.5 million and $23.0 million for the years ended December 31, 1999 and 1998, respectively. As a result of the acquisition, the Company assumed an agreement with Principal Life, whereby Principal Life paid a fee for access to the Company's PPO network based on a fixed rate per employee entitled to access the PPO network and a percentage of savings realized by Principal Life. Effective June 1, 1999, Coventry sold the Illinois portion of the PPO network back to Principal Life. Under this agreement, the Company recognized revenue of approximately $8.0 million and $12.0 million for the years ended December 31, 1999 and 1998, respectively. Effective November 30, 1998, the Company sold its subsidiary, Principal Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois health plan accounted for approximately 56,000 risk members and approximately 2,400 non-risk members as of November 30, 1998. On December 31, 1998, the Company sold its subsidiary, Principal Health Care of Florida, Inc., for $95.0 million in cash. The Florida health plan accounted for approximately 156,000 risk members and approximately 5,500 non-risk members as of December 31, 1998. The proceeds from both sales were used to retire the Company's credit facility, to assist in improving the capital position of its regulated subsidiaries, and for other general corporate purposes. Given the short time period between the respective acquisition and sale dates and the lack of events or other evidence which would indicate differing values, no gain or loss was recognized on the sales of the Florida and Illinois health plans, as the sale prices were considered by management to be equivalent to the fair values allocable to these plans at the date of their acquisition from Principal Life in April 1998. In connection with the acquisition of certain PHC health plans and the sales of the Florida and Illinois plans, the Company established reserves of approximately $33.0 million for the estimated transition costs of the PHC health plans. These reserves are primarily comprised of severance costs related to involuntary terminations of former PHC employees, relocation costs of former PHC personnel, lease termination costs and contract termination costs. Through December 31, 1999, the Company has expended approximately $29.7 million related to these reserves and expects to make payments on the remaining reserves through July 2002. In the fourth quarter of 1999, the Company notified the Indiana Department of Insurance of its intention to close its subsidiary, Coventry Health Care of Indiana, Inc. As of December 31, 1999, the health plan had approximately 23,000 members throughout the state. As a result of the cost associated with exiting the Indiana market, the Company recorded a reserve of $2.0 million in the fourth quarter of 1999. The Company plans to close the health plan by the end of the fourth quarter 2000 and has expended approximately $0.4 million as of December 31, 1999. 44 47 The purchase price for certain of the PHC plans was allocated to the assets, including the identifiable intangible assets, and liabilities based on estimated fair values. The $174.0 million excess of purchase price over the net identified tangible assets acquired was allocated to identifiable intangible assets and goodwill. The allocated amounts, net of the Florida and Illinois health plans and net of the impact of waiving the Renewal Rights and Coinsurance Agreements and the expiration of the Marketing Services Agreement, Management Services Agreement and PPO access agreement, and their related useful lives are as follows:
AMOUNT ESTIMATED DESCRIPTION (IN THOUSANDS) USEFUL LIFE ----------- -------------- ----------- Customer Lists 7,233 5 years HMO Licenses 10,000 20 years Goodwill 156,795 35 years ------- Total $174,028 ========
The following unaudited pro-forma condensed consolidated results of operations assumes the PHC acquisition and the sales of the Florida and Illinois health plans occurred on January 1, 1998 and 1997 and excludes the non-recurring charge to merger costs of $6.5 million, see Note F:
(IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, DECEMBER 31, 1998 1997 ---------------------------- --------------------------- (UNAUDITED) (UNAUDITED) Operating revenues $2,021,580 $1,875,411 Net loss (32,165) (22,694) Loss per share, basic (0.55) (0.39)
C. OTHER ACQUISITIONS Effective October 1, 1999, the Company acquired Carelink Health Plans ("Carelink"), the managed care subsidiary of Camcare, Inc., for a total purchase price of approximately $8.3 million including transaction costs of approximately $0.3 million. The acquisition was accounted for using the purchase method of accounting, and, accordingly, the operating results of Carelink have been included in the Company's consolidated financial statements since the date of the acquisition. The purchase price for Carelink was allocated to the assets, including the identifiable intangible assets, and liabilities based on estimated fair values. The $4.7 million excess of purchase price over the net identified tangible assets acquired was allocated to goodwill which is amortized over a useful life of 25 years. The final purchase price may be adjusted subject to the results of the final determination of the balance sheet of Carelink as of October 1, 1999. On November 1, 1999, the Company's subsidiary, Coventry Health Care of the Carolinas, Inc., acquired Kaiser Foundation Health Plan of North Carolina's ("KFHPNC") commercial membership in Charlotte, North Carolina. The total purchase price was approximately $1.8 million including transaction costs. D. MEDICAL OFFICE DISPOSITIONS Effective March 31, 1997, the Company completed its sale of the medical offices associated with HealthAmerica Pennsylvania, Inc., ("HealthAmerica"), in Pittsburgh, Pennsylvania, to a major health care provider organization. The sales price was $20.0 million resulting 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 250,000 members. Under the agreement, the provider organization receives a fixed percentage of premiums to cover all of the medical treatment 45 48 the globally capitated members receive. The provider organization filed for bankruptcy protection on July 21, 1998 and , as a result, the Company is no longer operating under this agreement. See Note E for AHERF Charge. Effective May 1, 1997, the Company completed its sale of the medical offices associated with GHP, its health plan in St. Louis, Missouri, to a major health care provider organization. The sales price was $26.9 million resulting 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 receives a fixed percentage of premiums to cover all of the medical treatment the globally capitated members receive. In August 1997, the Company entered into agreements to sell certain remaining medical offices associated with HealthAmerica in Harrisburg, Pennsylvania. The sales price was $2.4 million and the transaction resulted in a pretax loss of $0.6 million. All gains or losses resulting from medical office sales are reflected in other income, net, in the accompanying Consolidated Statement of Operations for the year ended December 31, 1997. E. AHERF CHARGE The Company and certain affiliated hospitals of Allegheny Health, Education and Research Foundation ("AHERF") were involved in litigation to determine if the Company had the financial responsibility for medical services provided to the Company's members by the hospitals as a consequence of the bankruptcy filed by AHERF on July 21, 1998. As a result of the bankruptcy, AHERF failed to pay for medical services under its global capitation agreement with the Company covering approximately 250,000 Company members in the western Pennsylvania market. Shortly after AHERF filed for bankruptcy protection, the Company filed a lawsuit against AHERF's non-debtor, affiliated hospitals seeking a declaratory judgment that the Company was not obligated to pay in excess of $21.5 million to the hospitals for medical services provided by them to the Company's members. The lawsuit also included additional claims for monetary damages. In response, the hospitals filed a counterclaim alleging that the Company's subsidiary, HealthAmerica Pennsylvania, Inc., was liable to the hospitals for payment of these medical services. As a result, the Company, which is ultimately responsible for medical costs delivered to its members, notwithstanding the global capitation agreement, recorded a charge of $55.0 million in the second quarter of 1998 to establish a reserve for, among other things, the medical costs incurred by its members under the AHERF global capitation agreement at the time of the bankruptcy filing. On July 22, 1999, the Company reached a settlement with the hospitals, including Allegheny General Hospital, formerly owned by AHERF, and its new owner, Western Pennsylvania Health Care System ("West Penn"), whereby the hospitals agreed that the Company would not be liable for the payment of certain medical services rendered by the hospitals to the Company's members prior to July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the settlement, the Company signed a new three-year provider contract with West Penn. The conditions to execute the settlement and the provider contract were finalized in October 1999 and, as a result, all liability issues surrounding AHERF's failure to fulfil its contractual obligations and the Company's remaining obligations have been determined and all AHERF-related litigation has been concluded. As of December 31, 1999, approximately $35.4 million of the $55.0 million reserve had been paid for medical claims. As a result of the settlement, the Company released $6.3 million of the reserve, which was reflected as a gain in the fourth quarter and year-end 1999 results. The balance of the reserve represents the Company's remaining obligations under the settlement and will be expended through August 2007. 46 49 F. MERGER COSTS In connection with the acquisition of the PHC health plans, the Company relocated its corporate headquarters from Nashville, Tennessee to Bethesda, Maryland. As a result, the Company established a one-time reserve in 1998 of approximately $6.5 million for the incurred and anticipated costs related to the relocation of the corporate office and other direct merger related costs. The reserve is primarily comprised of severance costs related to involuntary terminations, relocation costs for management personnel, and lease costs, net of sublease income, related to the unused space remaining at the old headquarters location. As of December 31, 1999, the Company expended approximately $6.0 million and expects to make payments through March 2003 related to these charges. G. PROPERTY AND EQUIPMENT Property and equipment is comprised of the following (in thousands):
DECEMBER 31, 1999 1998 -------------------- ----------------- Land $350 $481 Buildings and leasehold improvements 14,310 11,922 Equipment 62,567 54,313 ------ ------ 77,227 66,716 Less accumulated depreciation and amortization (39,364) (30,936) -------- -------- Property and equipment, net $37,863 $35,780 ======= =======
Depreciation expense for the years ended December 31, 1999, 1998, and 1997 was approximately $13.6 million, $12.2 million, and $8.9 million, respectively. 47 50 H. INVESTMENTS IN DEBT SECURITIES The Company considers all of its investments as available-for-sale securities and, accordingly, records unrealized gains and losses, as other comprehensive earnings, in the stockholders' equity section of its consolidated balance sheets. As of December 31, 1999 and 1998, stockholders' equity was decreased by approximately $5.9 million and increased by $0.3 million, respectively, netted by a deferred tax benefit of approximately $2.3 million and deferred tax cost of $0.1 million, respectively, to reflect the net unrealized investment loss/ 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, 1999 and 1998 (in thousands):
1999 AMORTIZED COST UNREALIZED GAIN UNREALIZED LOSS FAIR VALUE - --------------------------------------------- ----------------- ------------------- ------------------ ----------------- State and municipal bonds $107,821 $97 $(1,369) $106,549 Asset-backed securities 16,383 6 (172) 16,217 Mortgage-backed securities 63,577 424 (1,021) 62,980 US Treasury & agencies securities 34,046 23 (1,148) 32,921 Other debt securities 157,257 128 (1,525) 155,860 ================= =================== ================== ================= $379,084 $678 $(5,235) $374,527 ================= =================== ================== ================= 1998 AMORTIZED COST UNREALIZED GAIN UNREALIZED LOSS FAIR VALUE - --------------------------------------------- ----------------- ------------------- ------------------ ----------------- State and municipal bonds $55,355 $548 $(290) $55,613 Asset-backed securities 10,728 71 (174) 10,625 Mortgage-backed securities 50,626 455 (141) 50,940 US Treasury & agencies securities 51,246 661 (316) 51,591 Other debt securities 40,003 529 (41) 40,491 ================= =================== ================== ================= $207,958 $2,264 $(962) $209,260 ================= =================== ================== =================
48 51 The amortized cost and estimated fair value of short-term and long-term investments by contractual maturity were as follows at December 31, 1999 and December 31, 1998 (in thousands):
1999 AMORTIZED COST FAIR VALUE -------------------------------------------------------- Maturities: Within 1 year $102,126 $102,045 1 to 5 years 114,850 113,517 6 to 10 years 68,382 66,373 Over 10 years 93,726 92,592 -------------------------------------------------------- Total short-term and long-term securities $379,084 $374,527 ======================================================== 1998 AMORTIZED COST FAIR VALUE -------------------------------------------------------- Maturities: Within 1 year $50,773 $50,416 1 to 5 years 57,362 57,949 6 to 10 years 29,382 29,423 Over 10 years 70,441 71,472 -------------------------------------------------------- Total short-term and long-term securities $207,958 $209,260 ========================================================
Proceeds from the sale and maturities of investments were approximately $253.5 million and $122.9 million for the years ended December 31, 1999 and 1998, respectively. Gross investment gains of approximately $1.0 million and gross investment losses of approximately $1.2 million were realized on these sales for the year ended December 31, 1999 compared to gross investment gains of approximately $0.9 million and no gross investment losses on these sales for the year ended December 31, 1998. I. INCOME TAXES The provision (benefit) for income taxes consists of the following (in thousands):
YEAR ENDED DECEMBER 31, 1999 1998 1997 -------------------------------------------------------------- Current provision: Federal $15,606 $12,907 $16,439 State 2,921 763 3,684 Deferred provision (benefit): Federal 11,092 (14,695) (9,943) State 2,946 (4,744) (1,758) -------------------------------------------------------------- $32,565 $(5,769) $8,422 ==============================================================
49 52 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:
YEAR ENDED DECEMBER 31, ----------------------- 1999 1998 1997 -------------------------------------------------------------------- Statutory federal tax rate 35.00% (35.00%) 35.00% - -------------------------- -------------------------------------------------------------------- Effect of: State income taxes, net of federal benefit 4.00% (4.04%) 6.15% Amortization of goodwill 4.72% 18.60% 5.98% Tax exempt interest income (1.51%) (13.77%) (5.54%) Other 0.64% 1.27% (0.19%) -------------------------------------------------------------------- Income tax provision (benefit) 42.85% (32.94%) 41.40% ====================================================================
The effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998 are presented below (in thousands):
DECEMBER 31, 1999 1998 ----------------------------------------- Deferred tax assets: Deferred revenue $3,005 $2,804 Medical liabilities 4,748 5,799 Accounts receivable 4,749 7,921 Deferred compensation 4,525 4,211 Other accrued liabilities 3,254 6,487 Other assets 8,363 8,419 Contingent liabilities 29,289 31,173 Net operating loss carryforward 3,769 3,769 -------------------------------------------------------------------------------------------- Gross deferred tax assets 61,702 70,583 Less valuation allowance (3,252) (3,252) -------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------- Deferred tax asset 58,450 67,331 -------------------------------------------------------------------------------------------- Deferred tax liabilities: Property and equipment (5,000) (982) Intangibles (2,650) (12,562) Other - (508) -------------------------------------------------------------------------------------------- Gross deferred tax liabilities (7,650) (14,052) -------------------------------------------------------------------------------------------- Net deferred tax asset $50,800 $53,279 ============================================================================================
The valuation allowance for deferred tax assets as of December 31, 1999 and 1998 is $3.3 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. 50 53 J. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES AND REDEEMABLE CONVERTIBLE PREFERRED STOCK During the quarter ended June 30, 1997, the Company 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 $40.0 million of the Company's 8.3% Convertible Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with warrants to purchase 2.35 million shares of the Company's common stock for $42.35 million. The original amount of the Coventry Notes, $36.0 million held by Warburg and $4.0 million held by Franklin, were exchangeable at the Company's or Warburg's option for shares of redeemable convertible preferred stock. During the second and third quarters of 1999, the Company converted all Coventry Notes held by Warburg and Franklin totaling $47.1 million, including interest, into 4,709,545 shares of Series A redeemable convertible preferred stock ("preferred stock") at a price of $10 per share. The preferred stock is subject to mandatory redemption at a price of $10 per share, plus accrued dividends, in an amount equal to one-third of the shares outstanding on May 15, 2002, 2003 and 2004. The stock is carried at its fair value, which equals both its redemption value and liquidation value as of December 31, 1999 and will accrue dividends only if the Board of Directors declares dividends on common stock. The dividends (per share) on the preferred stock would be equal to the dividends on the common stock. The preferred stock may be converted at any time at the holders' option into shares of common stock at a conversion price equal to the closing market price of the Company's common stock on the date of conversion, if the closing market price is less than $10 per share. If the closing market price of the Company's common stock is greater than $10 per share, the preferred stock is convertible to common stock on a share for share basis. The preferred stock is callable by the Company if the market price of the Company's common stock exceeds certain agreed upon targets. K. LONG-TERM DEBT At December 31, 1998, long-term debt of $781,000, payable to the U. S. Department of Health and Human Services, represented obligations which were assumed in the acquisition of HAPA. Under the terms of the notes, principal was 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 were secured by certain assets of the Company. These notes were paid in full in May 1999. Interest expense for the year ended December 31, 1999 was $1.6 million, substantially all of which related to the Coventry Notes. 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. L. STOCK OPTIONS, WARRANTS AND EMPLOYEE STOCK PURCHASE PLAN As of December 31, 1999, the Company had one stock incentive plan, the Amended and Restated 1998 Stock Incentive Plan (the "1998 Plan"), with an aggregate of 7 million shares of common stock authorized for issuance thereunder to key employees, consultants and directors in the form of stock options, restricted stock and other stock-based awards. At April 1, 1998, the 1998 Plan assumed the obligations of six stock option plans of Coventry Corporation with total outstanding options representing 3,322,714 shares, and one stock option plan of Principal Health Care, Inc. with total outstanding options representing 750,000 shares, as a result of the acquisition of the PHC plans. Under the 1998 Plan, the terms and conditions of grants are established on an individual basis with the exercise price of the options being equal to not less than 100% of the market value of the underlying stock at the date of grant. Options generally become exercisable after one year in 20% to 25% increments per year and expire ten years from the date of grant. The 1998 Plan is authorized to grant either incentive stock options or nonqualified stock options at the discretion of the Compensation and Benefits Committee of the Board of Directors. 51 54 As of September 10, 1998, employees of the Company were offered an opportunity to exchange their existing options (issued at a higher exercise price) for a reduced number of new options (issued at a lower exercise price) equivalent to the same value as their existing options, based upon a Black-Scholes equal valuation model. Employees could choose to decline the offer of new options and keep their existing options. As a result, the Company canceled approximately 4,370,100 options, and reissued re-priced options equal to approximately 3,714,182 shares. The options canceled were at exercise prices ranging from a high of $22.750 to a low of $6.3750. The options were reissued in accordance with an exchange formula (using the Black-Scholes equal valuation model) that issued one-half of the new options at an exercise price of the then current market value ($5.00) and the remaining one-half at 150% of the then current market value ($7.50). The resulting value of the repriced options was the same as the exchanged options. 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. 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 (in thousands, except per share data):
FOR THE YEAR ENDED DECEMBER 31, 1999 1998 1997 ------------------------------------------------------ Net income (loss): As Reported $ 43,435 $(11,741) $11,903 Pro Forma 40,098 (14,224) 8,790 EPS, basic As Reported 0.74 (0.22) 0.36 EPS, diluted As Reported 0.69 (0.22) 0.35 EPS, basic Pro Forma 0.68 (0.27) 0.26 EPS, diluted Pro Forma 0.64 (0.27) 0.26
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, 1999 were as follows (shares in thousands):
1999 1998 1997 ------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ------------------------------------------------------------------------------------------- Outstanding at beginning of year 5,441 $8 3,261 $13 2,858 $13 Granted 2,339 9 7,627 8 1,584 $15 Exercised (344) 9 (110) 12 (166) $12 Canceled (1,259) 11 (5,337) 13 (1,015) $14 ------------------------------------------------------------------------------------------- Outstanding at end of year 6,177 $8 5,441 $8 3,261 $13 ------------------------------------------------------------------------------------------- Exercisable at end of year 1,655 $8 837 $11 819 $13 -------------------------------------------------------------------------------------------
52 55 The following table summarizes information about stock options outstanding at December 31, 1999 (shares in thousands):
OPTIONS OUTSTANDING OPTIONS EXCERCISABLE -------------------------------------------------------------------------------------------------- WEIGHTED NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED RANGE OF EXERCISE OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE EXERCISE PRICES 12/31/99 CONTRACTUAL LIFE EXERCISE PRICES 12/31/99 PRICE - ---------------------------------------------------------------------------------------------------------------------------- $ 5 - $ 7 2,910 8.6 $ 6 752 $ 5 $ 7 - $ 8 1,247 7.4 8 530 8 $ 8 - $ 11 1,449 9.4 10 43 9 $ 11 - $ 21 567 7.5 14 326 14 $ 21 - $ 25 4 5.0 25 4 25 ----- --- ---- ----- ---- $ 5 - $ 25 6,177 8.4 $ 8 1,655 $ 8 ===== === ==== ===== ====
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:
1999 1998 1997 ---- ---- ---- Dividend yield 0 % 0% 0% Expected volatility 74 % 73% 64% Risk-free interest rate 6 % 5% 6% Expected life 4 years 4 years 5 years
The weighted-average grant date fair values for options granted in 1999, 1998 and 1997 were $5.29, $4.53, and $8.77, respectively. At December 31, 1999, the Company had outstanding warrants granting holders the right to purchase 5,690,188 shares of common stock. In July 1995, 100,000 warrants were issued at a price of $14.125 and expire in July 2000. During the first half of 1996, warrants for 170,000 shares were exercised at a price of $6.75 per share. On July 7, 1997, the Company finalized the sale of $40 million of Coventry Convertible Exchangeable Subordinated Notes, together with warrants to purchase 2,352,941 shares at $10.625 per share of common stock. The purchase price for the warrants was $1.00 per share, valued by the Company and the purchaser. The warrants expire seven years from the purchase date. On April 1, 1998, the Company issued a warrant to PHC (the "Principal Warrant") to purchase that number of shares of common stock equal to 66-2/3% of the total number of shares of common stock actually issued upon the exercise or conversion of the Company's employee stock options and warrants issued and outstanding at March 31, 1998, on the same terms and conditions as set forth in the respective options and warrants. The subsequent repricing of outstanding employee stock options on September 10, 1998 (see above) did not affect the Principal Warrant. Options and warrants that terminated or expired and are not exercised, are also canceled in the Principal Warrant. At March 31, 1998, the Company had options and warrants outstanding for 5,800,480 shares of common stock, representing the right to purchase 3,866,986 shares under the Principal Warrant. On May 21, 1999 and November 11, 1999, PHC exercised a portion of the Principal Warrant pursuant to exercises of the underlying options and purchased 1,335 and 10,915 shares of common stock, respectively. At December 31, 1999, the Principal Warrant represented the right to purchase 3,017,183 shares, taking into account exercises and cancellations. 53 56 On May 1, 1997, the Company issued warrants to certain providers to purchase a total of 24,825 shares of common stock at an exercise price of $12.625 per share, expiring in 2002. On May 18, 1998, the Company issued warrants to four individual consultants to purchase a total of 40,000 shares of common stock at an exercise price of $13.625 per share, expiring in 2003. On October 22, 1998, the Company issued warrants to certain providers to purchase a total of 10,000 shares of common stock at an exercise price of $7.625 per share, expiring in 2003. On December 21, 1998, the Company issued a warrant to an individual in connection with the acquisition of a health plan to purchase 85,239 shares of common stock at an exercise price of $8.32 per share, expiring in 2003. On December 21, 1998, the Company issued a warrant to an individual in connection with legal services to purchase 50,000 shares of common stock at an exercise price of $7.625 per share, expiring in 2009. On April 19, 1999, the Company issued a warrant to an individual in recognition of years served on the Company's Board of Directors to purchase 10,000 shares of common stock at an exercise price of $7.625 per share, expiring in 2004. 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 the Company's common 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 11,416, 15,016, and 7,074, shares in 1999, 1998, and 1997 respectively. M. REINSURANCE Throughout 1997, 1998 and the first quarter of 1999, the Company had reinsurance agreements, through its subsidiary CHLIC, with American Continental Insurance Company and Continental Assurance Company for portions of the risk it has underwritten through its products. Beginning in April 1999, the Company entered into new reinsurance agreements with Continental Assurance Company and American Continental Insurance Company with greater coverages. Reinsurance premiums for the years ended December 31, 1999, 1998 and 1997 were approximately $9.9 million, $1.0 million and $0.7 million respectively. Reinsurance recoveries, including amounts receivable, for the same periods were approximately $5.9 million, $0.6 million and $0.4 million. These reinsurance agreements do not release the Company from its primary obligations to its membership. The Company remains liable to its membership if the reinsurers are unable to meet their contractual obligations under the reinsurance agreements. All reinsurance agreements are subject to certain limits on hospital costs per patient-day. To minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers on an annual basis. American Continental Insurance Company and Continental Assurance Company are both currently A rated by the A.M. Best Company. Medicaid risk exposures in Missouri are reinsured through the State of Missouri mandated program. Reinsurance recoveries for the years ended December 31, 1999, 1998 and 1997 were approximately $3.1 million, $2.1 million and $3.6 million, respectively. 54 57 N. COMMITMENTS The Company operates primarily in leased facilities with original lease terms of up to ten 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 and minimum sublease rentals to be received by the Company during each of the next five years ending December 31 and thereafter for noncancellable operating leases are as follows (in thousands):
RENTAL SUBLEASE YEAR COMMITMENTS INCOME ---------- ----------- ------------ 2000 $ 15,314 $ 4,491 2001 14,342 4,367 2002 12,727 3,878 2003 9,902 3,252 2004 8,657 3,216 Thereafter 7,795 3,157 ---------- ----------- $ 68,737 $ 22,361 ========== ===========
Total rent expense was approximately $14.5 million, $14.6 million and $8.3 million for the years ended December 31, 1999, 1998 and 1997, respectively. O. 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 accounts 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 Notes D and E to the consolidated financial statements, the Company entered into long-term global capitation arrangements with two integrated provider organizations. Global capitation agreements limit the Company's exposure to the risk of increasing medical costs, but expose the Company to risk as to the adequacy of the financial and medical care resources of the provider organization. To the extent that the respective provider organization faces financial difficulties or otherwise is unable to perform its obligations under the global capitation agreements, the Company, 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. To the extent that the Company becomes a party to global capitation agreements with a single provider organization serving substantial membership, the Company becomes exposed to credit risk with respect to such organizations. The Company 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 Company membership. Concentration of credit risk with respect to accounts receivable is limited due to the large number of customers comprising the Company's customer base and their breakdown among geographical locations. See Note A for additional information with respect to accounting policies for accounts receivable. The Company believes the allowance for doubtful collections adequately provides for estimated losses as of December 31, 1999. The Company has a risk of incurring loss if such allowances are not adequate. As discussed in Note M to consolidated financial statements, the Company has reinsurance agreements with major insurance companies. The Company monitors the insurance companies' financial ratings to determine compliance with standards set by state law. The Company has a credit risk associated with these reinsurance agreements to the extent the reinsurers are unable to pay valid reinsurance claims of the Company. 55 58 P. BENEFIT PLANS On July 1, 1994, Coventry Corporation adopted an employee defined contribution retirement plan qualifying under IRC Section 401(k), the Coventry Corporation Retirement Savings Plan (the "Plan"), which covered substantially all employees of Coventry Corporation 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 Coventry Healthcare Management Corporation ("CHMC") and HCUSA were merged into the Plan effective July 1, 1994 and January 1, 1996, respectively. Effective March 31, 1998, the Company was formed as the parent company of an affiliated group of companies that includes Coventry Corporation. The Company, with the approval of Coventry Corporation, adopted and became sponsor of the Plan effective April 1, 1998. On April 1, 1998, the Coventry Health Care, Inc. Retirement Savings Plan (the "New Plan") was adopted and any prior PHC and certain affiliated participant account balances included in the assets of the former PHC qualified retirement plan were rolled over into the New Plan at the election of the former PHC employees. Effective October 1, 1998, the Plan was merged with the New Plan. All employees that were participants under the Plan became participants in the New Plan. On October 1, 1998, the assets of the Plan were merged and transferred to: (1) Principal Life Insurance Company, as funding agent of the assets held under the terms of the Flexible Investment Annuity Contract with Coventry Health Care, Inc., (2) Delaware Charter Guarantee and Trust Company, as custodial trustee of the mutual funds and (3) Bankers Trust Company, as custodial trustee of the New Plan's participant loans and the Coventry Health Care, Inc. Common Stock. Effective October 1, 1999, pursuant to the merger of Coventry Health Plan of West Virginia, Inc. (CHC-WV), a wholly-owned subsidiary of the Company, and Carelink Health Plans, Inc. (Carelink) whereby Carelink was the surviving entity, Carelink became an adopting employer of the New Plan. Prior to 1998, under the Plan, participants were able to defer up to 15% of their compensation, limited by the maximum compensation deferral amount permitted by applicable law. The Company made matching contributions equal to 100% of the participant's contribution on the first 3% of the participant's compensation deferral and equal to 50% of the participant's contribution on the second 3% of the participant's compensation deferral. Prior to 1998, participants vested 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, under the Plan and the New Plan, participants may defer up to 15% of their compensation, limited by the maximum compensation deferral amount permitted by applicable law. The Company makes matching contributions in the Company's common stock equal to 100% of the participant's contribution on the first 3% of the participant's compensation deferral and equal to 50% of the participant's contribution on the second 3% of the participant's compensation deferral. Participants 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 and the New Plan are funded by the Company and participants as they are incurred. On July 1, 1994, Coventry Corporation adopted a supplemental executive retirement plan (the "SERP"), which covered employees of Coventry Corporation 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. The Company, with the approval of Coventry Corporation, adopted and became sponsor of the SERP effective April 1, 1998. Effective April 1, 1998, the SERP Plan name changed to the Coventry Health Care, Inc. Supplemental Executive Retirement Plan. Under the SERP, participants 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. Effective January 1, 1999, the Company amended the SERP's definition of compensation to exclude income or proceeds from the Company's Stock Incentive Plan and relocation payments. The Company makes matching contributions equal to 100% of the participant's contribution on the first 3% of the participant's compensation deferral and 50% of the participant's contribution on the second 3% of the participant's compensation deferral. Prior to January 1, 1998, participants vested 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, participants vest in the Company's matching contributions ratably over two years, based on length of service. All costs of the SERP are funded by the Company as they are incurred. 56 59 The cost, principally employer matching contributions, of the benefit plans charged to operations for 1999, 1998 and 1997 was approximately $3.6 million, $4.0 million and $1.8 million, respectively. Q. STATUTORY INFORMATION The Company's HMO subsidiaries are required by the respective domicile states to maintain minimum statutory capital and surplus in aggregate of approximately $80.7 million at December 31, 1999. Combined statutory capital and surplus of the Company's HMOs was approximately $159.8 million. The states in which the Company's HMOs operate require HMOs to maintain deposits with the Department of Insurance. These deposits totaled $24.8 million at December 31, 1999. The National Association of Insurance Commissioners has proposed that states adopt risk-free capital standards that, if implemented, would generally require higher minimum capitalization limits for health care coverage provided by HMOs and other risk-bearing health care entities. To date, no state where Coventry has HMO operations has adopted those standards. CHLIC's authorized control level risk-based capital is approximately $11.8 million. Total adjusted statutory capital and surplus of CHLIC as of December 31, 1999 was approximately $38.6 million. Statutory deposits for CHLIC as of December 31, 1999 totaled approximately $3.5 million. R. OTHER INCOME Other income for the years ended December 31, 1999, 1998, and 1997 includes investment income of approximately $30.3 million, $25.5 million, and $10.8 million, respectively. As described in Note D, other income includes $15.0 million in 1997 from the sale of medical offices. 57 60 S. EARNINGS PER SHARE Basic earnings per share ("EPS") is based on the weighted average number of common shares outstanding during the year. Diluted EPS, when applicable, assumes the conversion of convertible notes and the exercise of all options, warrants and redeemable convertible preferred stock using the treasury stock method. Net earnings is increased for the assumed elimination of interest expense on the convertible notes. In all cases, however, losses are not diluted. The following table summarizes the earnings and the average number of common shares used in the calculation of basic and diluted EPS (in thousands, except for per share amounts):
1999 --------------------------------------------------------- EARNINGS SHARES (NUMERATOR) (DENOMINATOR) PER SHARE AMOUNT --------------------------------------------------------- Basic EPS $43,435 59,025 $0.74 Effect of Dilutive Securities Options and warrants 498 Convertible notes 2,997 Redeemable convertible 1,639 preferred stock Interest on convertible notes $848 -------------------------------------------------------------- Diluted EPS $44,283 64,159 $0.69 ============================================================== 1998 -------------------------------------------------------------- LOSS SHARES (NUMERATOR) (DENOMINATOR) PER SHARE AMOUNT -------------------------------------------------------------- Basic EPS $(11,741) 52,477 $(0.22) Effect of Dilutive Securities Options and warrants Convertible notes -------------------------------------------------------------- Diluted EPS $(11,741) 52,477 $(0.22) ============================================================== 1997 -------------------------------------------------------------- LOSS SHARES (NUMERATOR) (DENOMINATOR) PER SHARE AMOUNT -------------------------------------------------------------- Basic EPS $11,903 33,210 $0.36 Effect of Dilutive Securities Options and warrants 702 Convertible notes -------------------------------------------------------------- Diluted EPS $11,903 33,912 $0.35 ==============================================================
58 61 T. LEGAL PROCEEDINGS In the normal course of business, the Company has been named as a 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, 1999 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 should not have a material adverse effect on the financial position or results of operations of the Company. Other managed care companies have been sued recently in class action lawsuits claiming violations of the federal racketeering act (RICO) and federal employee benefits law (ERISA), and generally claiming that managed care companies overcharge consumers and misrepresent that they deliver quality health care. Although it is possible that the Company may be the target of a similar suit, the Company believes there is no valid basis for such a suit. The Company'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 could have significant impact on the Company's operations. UNITY ARBITRATION. GHP, a health plan subsidiary of the Company, entered into an agreement, effective January 1, 1998, with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to provide health care services to GHP's members in the southern and western areas of St. Louis County, Missouri. The agreement contained risk sharing provisions. Disputes arose under the agreement and the matter was submitted to arbitration before the American Arbitration Association ("AAA"). GHP demanded payment from Unity of $7.6 million and specific performance under the agreement. Unity demanded payment from GHP of $14.5 million, specific performance of certain provisions of the agreement and suspension of its payment obligations. On December 23, 1999, the AAA tribunal of arbitrators awarded GHP the sum of $1.1 million for deficiencies in risk fund pools for 1998, and awarded Unity the sum of $1.8 million as liquidated damages for GHP's failure to meet certain administrative performance standards, and held Unity contractually liable for funding any deficits in the risk fund pools for 1999. The only remaining issue pending is the readjudication of certain disputed claims submitted subsequent to June 30, 1999. BJC. Effective May 1, 1997, the Company 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, for approximately $26.9 million. Upon the sale, the Company entered into a long-term global capitation agreement with BJC, since amended, that covered approximately 33.3% of the risk membership in St. Louis at December 31, 1998. Under the agreement, BJC receives a fixed percentage of premium to cover all of the medical treatment received by the globally capitated members. Various disputes alleging breaches have arisen under the BJC global capitation agreement concerning the accuracy and timeliness of claims payments, and the accuracy of membership reconciliations that would affect the amount of premiums paid to BJC to provide its services under the agreement. BJC contends that these alleged breaches entitles it to terminate the agreement. Although the parties are obligated to arbitrate their disputes under the terms of the agreement, the parties have agreed to attempt to negotiate a resolution of the various issues while concurrently proceeding with arbitration. While the Company acknowledges certain claims payment inaccuracies, the Company denies the remaining allegations and vigorously disputes that any such claims constitute a material breach of the agreement. Management does not believe that the outcome of these disputes will have a material impact on the consolidated financial statements, although there can no assurance in this regard. 59 62 U. SEGMENT INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1999 (IN $000S) COMMERCIAL GOVERNMENT PROGRAMS TOTAL --------------------------------------------------------------------------- Revenues $1,541,786 540,289 2,082,075 Gross Margin 235,084 60,621 295,705 FOR THE YEAR ENDED DECEMBER 31, 1998 (IN $000S) COMMERCIAL GOVERNMENT PROGRAMS TOTAL --------------------------------------------------------------------------- Revenues $1,561,640 471,732 2,033,372 Gross Margin 165,299 45,699 210,998 FOR THE YEAR ENDED DECEMBER 31, 1997 (IN $000S) COMMERCIAL GOVERNMENT PROGRAMS TOTAL --------------------------------------------------------------------------- Revenues $886,237 321,912 1,208,149 Gross Margin 132,340 35,949 168,289
Following are reconciliations of reportable segment information to financial statement amounts:
FOR THE YEARS ENDED DECEMBER 31, 1999 1998 1997 ------------------------------------------------------------------- Revenues Reportable Segments $2,082,075 $2,033,372 $1,208,149 Management services 80,297 77,011 20,202 ------------------------------------------------------------------- Total revenues $2,162,372 $2,110,383 $1,228,351 =================================================================== Earnings (Loss) Before Income Taxes: Gross margin from reportable segments $295,705 $210,998 $168,289 Management services 80,297 77,011 20,202 Selling, general and administrative (299,942) (291,919) (170,017) Depreciation and amortization (28,205) (25,793) (12,735) Merger costs - (6,492) - Other income, net 29,906 27,251 24,880 Interest expense (1,761) (8,566) (10,275) ------------------------------------------------------------------- Earnings (loss) before income taxes and minority interest $76,000 $(17,510) $20,344 ===================================================================
60 63 V. 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, 1999 and 1998.
QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1999 1999 1999 1999 (1)(2) ---------------------------------------------------------------------------------------- Operating revenues $527,848 $531,831 $529,889 $572,804 Operating earnings 8,683 9,626 11,391 18,155 Net earnings 8,293 9,157 10,970 15,015 Net earnings per share - basic 0.14 0.16 0.19 0.25 Net earnings per share - diluted 0.14 0.15 0.17 0.24 QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1998 1998 (3)(4) 1998 1998 (5) ---------------------------------------------------------------------------------------- Operating revenues $330,209 $583,804 $593,278 $603,092 Operating earnings (loss) 7,178 (51,238) 2,179 5,686 Net earnings (loss) 4,707 (27,756) 5,068 6,240 Net earnings (loss) per share - basic 0.14 (0.47) 0.09 0.11 Net earnings (loss) per share - diluted 0.13 (0.47) 0.09 0.11
(1) The Company will close its subsidiary, Coventry Health Care of Indiana, Inc., by the end of the fourth quarter 2000. As a result of the cost associated with exiting the Indiana market, the Company recorded a reserve for $2.0 million in the fourth quarter of 1999. (2) In October 1999, the Company reached a settlement with AHERF. As a result of the settlement, the Company released $6.3 million of its AHERF reserve, which was reflected as a gain in the fourth quarter. (3) Effective April 1, 1998, the Company completed its acquisition of certain assets of PHC from Principal Life. The acquisition was accounted for using the purchase method of accounting and, accordingly, the operations of PHC have been included in the Company's consolidated financial statements since the date of acquisition. As a result of the merger, an estimated reserve of $7.8 million was established for the costs related to the relocation of the corporate office from Nashville, Tennessee to Bethesda, Maryland and other merger related expenses. (4) The second quarter 1998 operating results were affected by the establishment of a reserve as a result of the bankruptcy filing by AHERF. The establishment of the reserves resulted in a charge to earnings of $55.0 million. (5) The merger costs were less than the reserve established in the second quarter of 1998, resulting in a credit to earnings of $1.3 million. 61 64 W. SUBSEQUENT EVENTS Effective February 1, 2000, the Company completed its acquisition of The Anthem Company's West Virginia managed care subsidiary, PrimeONE, Inc. ("PrimeONE"), for the total purchase price of approximately $3.9 million including acquisition costs. The $1.5 million excess of purchase price over the net identifiable tangible assets acquired was allocated to goodwill. PrimeONE has approximately 18,000 commercial members and annual premium revenue of $32.0 million. The acquisition expands the Company's West Virginia service area and brings its total membership in the state to over 109,000 members. On February 3, 2000, the Company completed the acquisition of Prudential Health Care Plan, Inc.'s 11,800-member Medicaid business in St. Louis, Missouri at approximately $100 per member. The acquisition brings the Company's total Medicaid membership in St. Louis to more than 106,000 members. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE. 62 65 PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information set forth under the captions "Directors and Executive Officers" and "Election of Directors" in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which the Company intends to file within 120 days after its fiscal year-end, is incorporated herein by reference. ITEM 11: EXECUTIVE COMPENSATION. The information set forth under the caption "Executive Compensation" in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which the Company intends to file within 120 days after its fiscal year-end, is incorporated herein by reference. ITEM 12: SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information set forth under the captions "Executive Compensation," "Voting Stock Outstanding and Shareholders," and "Voting Stock Ownership of Principal Shareholders and Management" in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which the Company intends to file within 120 days after its fiscal year-end, is incorporated by reference herein. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information set forth under the caption "Certain Transactions" in the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which the Company intends to file within 120 days after its fiscal year-end, is incorporated by reference herein. 63 66 PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements
FORM 10-K PAGES --------- Report of Independent Public Accountants 35 Consolidated Balance Sheets, December 31, 1999 and 1998 36 Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 37 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 38 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 39 Notes to Consolidated Financial Statements, December 31, 1999, 1998, and 1997 40 - 62
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 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.). 3.1 Certificate of Incorporation of Coventry Health Care, Inc. (Incorporated by reference to Exhibit 3.1 to Form S-4, Registration Statement No. 333-45821 of Coventry Health Care, Inc.). 3.2 Bylaws of Coventry Health Care, Inc. (Incorporated by reference to Exhibit 3.2 to Form S-4, Registration Statement No. 333-45821 of Coventry Health Care, Inc.). 4.1.1 Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated April 8, 1998). 64 67 4.1.2 Specimen Series A Convertible Preferred Stock Certificate (Incorporated by reference to Exhibit 4.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 4.2 Rights Agreement dated March 30, 1998 between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, L.L.C. as Rights Agent (Incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K dated April 8, 1998). 4.3 Amendment No. 1 to Rights Agreement, dated as of December 18, 1998 by and between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, LLC (Incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated December 21, 1998). 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's Form 8-K dated May 7, 1997). 4.5 Amendment No. 1 to Amended and Restated Securities Purchase Agreement dated August 1, 1998 between Coventry Health Care, Inc. (successor by merger to Coventry Corporation) and Warburg, Pincus Ventures, L.P. (Incorporated by reference to Exhibit 4.13 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998). 4.6 Amended Form of Convertible Note (Incorporated by reference to Exhibit 4.5 of Coventry Corporation's Annual Report on Form 10-K for the year ended December 31, 1997). 4.7 Consent to the Combination Agreement of Warburg, Pincus Ventures, L.P. dated December 18, 1998 (Incorporated by reference to Exhibit 4.7 to the Company's Form 8-K dated April 8, 1998). 4.8 Common Stock Purchase Warrant dated as of April 1, 1998 issued to Principal Health Care, Inc. pursuant to the Combination Agreement (Incorporated by reference to Exhibit 4.5 to the Company's Form 8-K dated April 8, 1998). 4.9 Amendment No. 1 to Common Stock Purchase Warrant effective as of October 29, 1998, issued to Principal Health Care, Inc. (Incorporated by reference to Exhibit 4.9 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 4.10 Form of Common Stock Purchase Warrant, as amended, of Coventry Corporation issued to Warburg, Pincus Ventures, L.P. (and also to Franklin Capital Associates III, L.P. for 235,294 shares of common stock) (assumed by the Company as of April 1, 1998) (Incorporated by reference to Exhibit 4.6 to the Company's Form 8-K dated April 8, 1998). 4.11 Form of Common Stock Purchase Warrant. 4.12 Common Stock Purchase Warrant issued as of January 4, 1999 to John W. Campbell (Incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q, Quarterly Report for the quarter ended June 30, 1999). 65 68 4.13 Shareholders' Agreement, dated as of April 1, 1998, by and among Coventry Health Care, Inc., Principal Mutual Life Insurance Company and Principal Health Care, Inc. (Incorporated by reference to Exhibit 4.8 to the Company's Form 8-K dated April 8, 1998). 10.0 Agreement dated May 19, 1999 between the Company and Principal Life Insurance Company (Incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q, Quarterly Report for the quarter ended June 30, 1999). 10.1 Form of Coinsurance Agreement executed as of April 1, 1998, 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.). 10.2 Form of Renewal Rights Agreement executed as of April 1, 1998, 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.). 10.3 Form of Transition Agreement executed as of April 1, 1998, pursuant to the Combination Agreement (Incorporated by reference to Exhibit 10.4 to Form S-4, Registration Statement No. 333-45821 of Coventry Health Care, Inc.). 10.4 Form of Management Services Agreement executed as of April 1, 1998, 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.). 10.5 Form of Tax Benefit Restitution Agreement executed as of April 1, 1998, 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.). 10.6 Form of License Agreement executed as of April 1, 1998, 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.). 10.7 Form of Marketing Service Agreement executed as of April 1, 1998, 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.). 10.8 Principal Health Care of Florida, Inc. Stock Purchase Agreement dated as of October 14, 1998, by and among Coventry Health Care, Inc., as Seller, Blue Cross and Blue Shield of Florida, Inc., Principal Health Care of Florida, Inc. and Health Options, Inc., as Buyer (Incorporated by reference to Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.9 Stock Purchase Agreement dated October 2, 1998, between Coventry Health Care, Inc., as Seller, and First American Group of Companies, Inc., as Buyer (Incorporated by reference to Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 66 69 10.10 Employment Agreement effective as of January 1, 1999, executed by Allen F. Wise and the Company. (Incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.11 Employment Agreement dated December 30, 1996 executed by Dale B. Wolf and Coventry Corporation (assumed by the Company as of April 1, 1998) (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). 10.12.1 Employment Agreement dated March 13, 1998 between Thomas McDonough and Coventry Corporation (assumed by the Company as of April 1, 1998) (Incorporated by reference to Exhibit 10.33 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.12.2 Amendment to Employment Agreement dated July 12, 1999 between Thomas McDonough and the Company (Incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the quarter ended September 30, 1999). 10.13.1 Employment Letter dated May 22, 1998 between James E. McGarry and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.34 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.13.2 Employment Agreement effective as of June 17, 1999, executed by James E. McGarry and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.3 to the Company's Form 10-Q Quarterly Report for the quarter ended June 30, 1999). 10.14 Form of Company's Employment Agreement executed by the following executives upon terms substantially similar, except as to compensation, dates of employment, position, and as otherwise noted: Claudia Bjerre, Janet M. Stallmeyer, Francis S. Soistman, Jr., Harvey Pollack, Ronald M. Chaffin, Bernard J. Mansheim, M. D., Thomas Davis (included executive's right to terminate and receive severance if he is required to relocate other than to Atlanta, Georgia or Bethesda, Maryland), J. Stewart Lavelle (includes executive's right to terminate and receive severance if there is a material reduction in position or compensation without consent, a change of control or a requirement to relocate), and Harvey C. DeMovick, Jr. (includes executive's right to terminate and receive severance if there is a significant change in his position or reporting relationship as a result of a change in control) (Incorporated by reference to Exhibit 10.32 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.15 Form of Company's Agreement (for Key Executives) dated September 12, 1995 (executed by James R. Hailey, Jan H. Hodges, and Shirley R. Smith) (Incorporated by reference to Exhibit (xxix) to Coventry Corporation's Form 10-Q, Quarterly Report, for the quarter ended September 30, 1995). 10.16 Separation Agreement and Release dated April 13, 1999 between Richard H. Jones and the Company (Incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the quarter ended June 30, 1999). 67 70 10.17 Agreement and Release dated May 29, 1998 between Robert A. Mayer, Coventry Corporation and HealthAmerica Pennsylvania, Inc. (Incorporated by reference to Exhibit 10.35 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.19 Agreement and Release dated June 30, 1998 between Kenneth J. Linde and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.36 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.20 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). 10.21 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 the fiscal year ended December 31, 1993). 10.22 1993 Outside Directors Stock Option Plan (as amended) (Incorporated by reference to Exhibit 10.8.3 attached to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.23 1993 Stock Option Plan (as amended) (Incorporated by reference to Exhibit 10.8.4 attached to the Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.24 Coventry Corporation 1997 Stock Incentive Plan, as amended. (Incorporated by reference to Exhibit 10.29 to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.25 Coventry Health Care, Inc. Amended and Restated 1998 Stock Incentive Plan (March 4, 1999) (Incorporated by reference to Exhibit 10.25 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.26 Coventry Health Care 1999 Management Incentive Plan (Incorporated by reference to Exhibit 10.26 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.27.1 Form of Coventry Health Care, Inc. Retirement Savings Plan, effective April 1, 1998. (Incorporated by reference to Exhibit 10.27 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998). 10.27.2 Amendment No. 1, Coventry Health Care, Inc. Retirement Savings Plan, effective October 1, 1998. 10.28.1 Coventry Corporation Supplemental Executive Retirement ("SERP") Plan effective July 1, 1994 (Incorporated by reference to Exhibit 4.2 to Coventry Corporation's Form S-8, Registration Statement No. 33-81358). 10.28.2 First Amendment to SERP dated December 31, 1996 (Incorporated by reference to Exhibit 10.19 to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 68 71 10.28.3 Second Amendment to SERP dated July 15, 1997 (Incorporated by reference to Exhibit 10.20 to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.28.4 Third Amendment to SERP dated April 30, 1998 (Incorporated by reference to Exhibit 10.32.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.28.5 Fourth Amendment to SERP dated November 4, 1999. 10.32 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). 10.33 Employment Agreement dated January 15, 1997 executed by Shirley R. Smith (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). 10.34 Employment Agreement dated January 1, 1997 executed by Jan H. Hodges (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). 10.35 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).* 10.36 Second Amendment to the Global Capitation Agreement by and between Group Health Plan, Inc., HealthCare USA of Missouri, LLC, and BJC Health System dated February 26, 1999 (Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 11 Computation of Net Earnings Per Common and Common Equivalent Share 21 Subsidiaries of the Registrant 23 Consent of Arthur Andersen LLP (See Exhibit 23 attached to this Report) 27 Financial Data Schedule (for SEC use only) (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended December 31, 1999. - ---------- * 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. 69 72 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 HEALTH CARE, INC. By: /s/ ALLEN F. WISE President, Chief Executive Officer and ---------------------------------- Director Allen F. Wise Executive Vice President, Chief Financial By: /s/ DALE B. WOLF Officer, Treasurer and Principal Accounting ---------------------------------- Officer Dale B. Wolf
DATED: MARCH 30, 2000 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.
Signature Title (Principal Function) Date /s/ JOHN H. AUSTIN, .M.D., M.P.H. ------------------------------------- Chairman of the Board and March 30, 2000 John H. Austin, M.D., M.P.H. Director /s/ ALLEN F. WISE ------------------------------------- President, Chief Executive March 30, 2000 Allen F. Wise Officer and Director /s/ DALE B. WOLF ------------------------------------- Executive Vice President, Chief Dale B. Wolf Financial Officer, Treasurer and March 30, 2000 Principal Accounting Officer /s/ LAWRENCE N. KUGELMAN ------------------------------------- Director March 30, 2000 Lawrence N. Kugelman /s/ EMERSON D. FARLEY, JR., M.D. ------------------------------------- Director March 30, 2000 Emerson D. Farley, Jr., M.D. /s/ JOEL ACKERMAN ------------------------------------- Director March 30, 2000 Joel Ackerman ------------------------------------- Director March 30, 2000 Elizabeth E. Tallett ------------------------------------- Director March 30, 2000 Thomas L. Blair /s/ THOMAS J. GRAF ------------------------------------- Director March 30, 2000 Thomas J. Graf /s/ DAVID J. DRURY ------------------------------------- Director March 30, 2000 David J. Drury /s/ RODMAN W. MOORHEAD, III ------------------------------------- Director March 30, 2000 Rodman W. Moorhead, III
70 73 ARTHUR ANDERSEN LLP REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE BOARD OF DIRECTORS OF COVENTRY HEALTH CARE, INC: We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements of Coventry Health Care, Inc. (a Delaware corporation and successor-in-interest to Coventry Corporation) and subsidiaries included in this Form 10-K and have issued our report thereon dated February 21, 2000. 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 BALTIMORE, MARYLAND FEBRUARY 21, 2000 71 74 SCHEDULE II COVENTRY HEALTH CARE INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
ADDITIONS CHARGED TO BALANCE AT COSTS AND EXPENSES DEDUCTIONS (CHARGE END OF BEGINNING OF PERIOD (1) (2) OFFS) (1)(2) PERIOD --------------------------------------------------------------------------------------- Year ended December 31, 1999: Allowance for doubtful accounts $ 12,023 $ 4,562 $ (11,037) $ 5,548 Year ended December 31, 1998: Allowance for doubtful accounts $ 7,378 $ 15,935 $ (11,290) $ 12,023 Year ended December 31, 1997: Allowance for doubtful accounts $ 8,000 $ 2,748 $ (3,370) $ 7,378
(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 as contra revenue. 72 75 INDEX TO EXHIBITS Reg. S-K Item 601 EXHIBIT NO. DESCRIPTION OF EXHIBIT 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.). 3.1 Certificate of Incorporation of Coventry Health Care, Inc. (Incorporated by reference to Exhibit 3.1 to Form S-4, Registration Statement No. 333-45821 of Coventry Health Care, Inc.). 3.2 Bylaws of Coventry Health Care, Inc. (Incorporated by reference to Exhibit 3.2 to Form S-4, Registration Statement No. 333-45821 of Coventry Health Care, Inc.). 4.1.1 Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated April 8, 1998). 4.1.2 Specimen Series A Convertible Preferred Stock Certificate (Incorporated by reference to Exhibit 4.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 4.2 Rights Agreement dated March 30, 1998 between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, L.L.C. as Rights Agent (Incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K dated April 8, 1998). 4.3 Amendment No. 1 to Rights Agreement, dated as of December 18, 1998 by and between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, LLC (Incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated December 21, 1998). 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's Form 8-K dated May 7, 1997). 4.5 Amendment No. 1 to Amended and Restated Securities Purchase Agreement dated August 1, 1998 between Coventry Health Care, Inc. (successor by merger to Coventry Corporation) and Warburg, Pincus Ventures, 73 76 L.P. (Incorporated by reference to Exhibit 4.13 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998). 4.6 Amended Form of Convertible Note (Incorporated by reference to Exhibit 4.5 of Coventry Corporation's Annual Report on Form 10-K for the year ended December 31, 1997). 4.7 Consent to the Combination Agreement of Warburg, Pincus Ventures, L.P. dated December 18, 1998 (Incorporated by reference to Exhibit 4.7 to the Company's Form 8-K dated April 8, 1998). 4.8 Common Stock Purchase Warrant dated as of April 1, 1998 issued to Principal Health Care, Inc. pursuant to the Combination Agreement (Incorporated by reference to Exhibit 4.5 to the Company's Form 8-K dated April 8, 1998). 4.9 Amendment No. 1 to Common Stock Purchase Warrant effective as of October 29, 1998, issued to Principal Health Care, Inc. (Incorporated by reference to Exhibit 4.9 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 4.10 Form of Common Stock Purchase Warrant, as amended, of Coventry Corporation issued to Warburg, Pincus Ventures, L.P. (and also to Franklin Capital Associates III, L.P. for 235,294 shares of common stock) (assumed by the Company as of April 1, 1998) (Incorporated by reference to Exhibit 4.6 to the Company's Form 8-K dated April 8, 1998). 4.11 Form of Common Stock Purchase Warrant. 4.12 Common Stock Purchase Warrant issued as of January 4, 1999 to John W. Campbell (Incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q, Quarterly Report for the quarter ended June 30, 1999). 4.13 Shareholders' Agreement, dated as of April 1, 1998, by and among Coventry Health Care, Inc., Principal Mutual Life Insurance Company and Principal Health Care, Inc. (Incorporated by reference to Exhibit 4.8 to the Company's Form 8-K dated April 8, 1998). 10.0 Agreement dated May 19, 1999 between the Company and Principal Life Insurance Company (Incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q, Quarterly Report for the quarter ended June 30, 1999). 10.1 Form of Coinsurance Agreement executed as of April 1, 1998, 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.). 10.2 Form of Renewal Rights Agreement executed as of April 1, 1998, 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.). 10.3 Form of Transition Agreement executed as of April 1, 1998, pursuant to the Combination Agreement (Incorporated by reference to Exhibit 10.4 to Form S-4, Registration Statement No. 333-45821 of Coventry Health Care, Inc.). 74 77 10.4 Form of Management Services Agreement executed as of April 1, 1998, 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.). 10.5 Form of Tax Benefit Restitution Agreement executed as of April 1, 1998, 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.). 10.6 Form of License Agreement executed as of April 1, 1998, 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.). 10.7 Form of Marketing Service Agreement executed as of April 1, 1998, 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.). 10.8 Principal Health Care of Florida, Inc. Stock Purchase Agreement dated as of October 14, 1998, by and among Coventry Health Care, Inc., as Seller, Blue Cross and Blue Shield of Florida, Inc., Principal Health Care of Florida, Inc. and Health Options, Inc., as Buyer (Incorporated by reference to Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.9 Stock Purchase Agreement dated October 2, 1998, between Coventry Health Care, Inc., as Seller, and First American Group of Companies, Inc., as Buyer (Incorporated by reference to Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.10 Employment Agreement effective as of January 1, 1999, executed by Allen F. Wise and the Company. (Incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.11 Employment Agreement dated December 30, 1996 executed by Dale B. Wolf and Coventry Corporation (assumed by the Company as of April 1, 1998) (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). 10.12.1 Employment Agreement dated March 13, 1998 between Thomas McDonough and Coventry Corporation (assumed by the Company as of April 1, 1998) (Incorporated by reference to Exhibit 10.33 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.12.2 Amendment to Employment Agreement dated July 12, 1999 between Thomas McDonough and the Company (Incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the quarter ended September 30, 1999). 10.13.1 Employment Letter dated May 22, 1998 between James E. McGarry and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.34 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 75 78 10.13.2 Employment Agreement effective as of June 17, 1999, executed by James E. McGarry and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.3 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1999). 10.14 Form of Company's Employment Agreement executed by the following executives upon terms substantially similar, except as to compensation, dates of employment, position, and as otherwise noted: Claudia Bjerre, Janet M. Stallmeyer, Francis S. Soistman, Jr., Harvey Pollack, Ronald M. Chaffin, Bernard J. Mansheim, M.D., Thomas Davis (included executive's right to terminate and receive severance if he is required to relocate other than to Atlanta, Georgia or Bethesda, Maryland), J. Stewart Lavelle (includes executive's right to terminate and receive severance if there is a material reduction in position or compensation without consent, a change of control or a requirement to relocate), and Harvey C. DeMovick, Jr. (includes executive's right to terminate and receive severance if there is a significant change in his position or reporting relationship as a result of a change in control) (Incorporated by reference to Exhibit 10.32 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.15 Form of Company's Agreement (for Key Executives) dated September 12, 1995 (executed by James R. Hailey, Jan H. Hodges, and Shirley R. Smith) (Incorporated by reference to Exhibit (xxix) to Coventry Corporation's Form 10-Q, Quarterly Report, for the quarter ended September 30, 1995) 10.16 Separation Agreement and Release dated April 13, 1999 between Richard H. Jones and the Company (Incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the quarter ended June 30, 1999). 10.17 Agreement and Release dated May 29, 1998 between Robert A. Mayer, Coventry Corporation and HealthAmerica Pennsylvania, Inc. (Incorporated by reference to Exhibit 10.35 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.19 Agreement and Release dated June 30, 1998 between Kenneth J. Linde and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.36 to the Company's Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998). 10.20 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). 10.21 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 the fiscal year ended December 31, 1993). 10.22 1993 Outside Directors Stock Option Plan (as amended) (Incorporated by reference to Exhibit 10.8.3 attached to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.23 1993 Stock Option Plan (as amended) (Incorporated by reference to Exhibit 10.8.4 attached to the Coventry 76 79 Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.24 Coventry Corporation 1997 Stock Incentive Plan, as amended. (Incorporated by reference to Exhibit 10.29 to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.25 Coventry Health Care, Inc. Amended and Restated 1998 Stock Incentive Plan (March 4, 1999) (Incorporated by reference to Exhibit 10.25 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.26 Coventry Health Care 1999 Management Incentive Plan - (Incorporated by reference to Exhibit 10.26 of the Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.27.1 Form of Coventry Health Care, Inc. Retirement Savings Plan, effective April 1, 1998. (Incorporated by reference to Exhibit 10.27 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998). 10.27.2 Amendment No. 1, Coventry Health Care, Inc. Retirement Savings Plan, effective October 1, 1998. 10.28.1 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). 10.28.2 First Amendment to SERP dated December 31, 1996 (Incorporated by reference to Exhibit 10.19 to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.28.3 Second Amendment to SERP dated July 15, 1997 (Incorporated by reference to Exhibit 10.20 to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.28.4 Third Amendment to SERP dated April 30, 1998 (Incorporated by reference to Exhibit 10.32.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.28.5 Fourth Amendment to SERP dated November 4, 1999. 10.32 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). 10.33 Employment Agreement dated January 15, 1997 executed by Shirley R. Smith (Incorporated by reference to Exhibit 10 (xxiv) to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 filed March 31, 1997). 10.34 Employment Agreement dated January 1, 1997 executed by Jan H. Hodges (Incorporated by reference to Exhibit 10 (xxvii) to Coventry Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 filed March 31, 1997). 10.35 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).* 10.36 Second Amendment to the Global Capitation Agreement by and between Group Health Plan, Inc., HealthCare USA of 77 80 Missouri, LLC, and BJC Health System dated February 26, 1999 (Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).* 11 Computation of Net Earnings Per Common and Common Equivalent Share 21 Subsidiaries of the Registrant 23 Consent of Arthur Andersen LLP (See Exhibit 23 attached to this Report) 27 Financial Data Schedule (for SEC use only) (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended December 31, 1999. - ---------- * 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. 78 EX-4.11 2 FORM OF COMMON STOCK PURCHASE WARRANT 1 EXHIBIT 4.11 THE SHARES UNDERLYING THIS WARRANT MAY NOT BE SOLD IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ANY APPLICABLE STATE SECURITIES OR BLUE SKY LAWS OR AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS THEREOF. THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR UNDER ANY STATE SECURITIES OR BLUE SKY LAWS. THIS WARRANT MAY NOT BE SOLD, ASSIGNED, TRANSFERRED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION UNDER SAID ACT AND UNDER APPLICABLE STATE SECURITIES OR BLUE SKY LAWS OR EXEMPTIONS FROM SUCH REGISTRATION. THIS WARRANT MAY NOT BE SOLD, ASSIGNED, TRANSFERRED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF EXCEPT UPON THE CONDITIONS SPECIFIED IN THIS WARRANT, AND NO SALE, ASSIGNMENT, TRANSFER, PLEDGE, HYPOTHECATION OR OTHER DISPOSITION OF THIS WARRANT SHALL BE VALID OR EFFECTIVE UNLESS AND UNTIL SUCH CONDITIONS SHALL HAVE BEEN COMPLIED WITH. NO. W________ Right to Purchase _______ Shares of Common Stock STOCK PURCHASE WARRANT THIS CERTIFIES THAT, for value received, _______________ is entitled to purchase from COVENTRY HEALTH CARE, INC., a Delaware corporation (the "Company"), at any time, in whole or in part, during the period specified in Paragraph 2 hereof, ____________________ (________) fully paid and nonassessable shares of the Company's Common Stock, par value $.01 per share (the "Warrant Shares"), at an exercise price of $________ per share (the "Exercise Price"). The Warrant Shares and the Exercise Price are subject to adjustment as provided in Paragraph 6 hereof. This Warrant is subject to the following terms, provisions, and conditions: 1. Manner of Exercise; Issuance of Certificates; Payment for Shares. Subject to the provisions hereof, including Section 2 hereof, this Warrant may be exercised by the holder hereof, in whole or in part, by the surrender of this Warrant, together with a completed Exercise Agreement in the form attached hereto, to the Company during normal business hours on any business day at the Company's principal executive offices (or such other office or agency of the Company as it may designate by notice to the holder hereof), and upon payment to the Company in cash or by certified or official bank check of the Exercise Price for the Warrant Shares specified in said Exercise Agreement. The Warrant Shares so purchased shall be deemed to be issued to the holder hereof or said holder's designee as the record owner of such shares as of the close of business on the date on which this Warrant shall have been surrendered, the completed Exercise Agreement delivered, and payment made for such shares as aforesaid. Certificates for the Warrant Shares so purchased, representing the aggregate number of shares specified in said Exercise Agreement, shall be delivered to the holder hereof within a reasonable time, not exceeding seven (7) business days, after this Warrant shall have been so exercised. The certificates so delivered shall be in such denominations as may be requested by the holder hereof and shall be registered in the name of said holder or such other name as shall be designated by said holder. If this Warrant shall have been exercised only in part, then, unless this Warrant has expired, the Company shall, at its expense, at the time of 2 delivery of said certificates, deliver to said holder a new Warrant representing the number of shares with respect to which this Warrant shall not then have been exercised. The holder shall pay all taxes and other expenses and charges payable in connection with the preparation, execution, and delivery of stock certificates (and any new Warrants) pursuant to this Paragraph 1. 2. Period of Exercise. This Warrant is exercisable at any time or from time to time after ____________, 20____ with respect to _____ shares, and after ________, 20____ with respect to the remaining ________ shares, and before the close of business on ________, 20____. This Warrant shall expire after the close of business on _________, 20____, and be of no further force and effect. 3. Certain Agreements of the Company. The Company hereby covenants and agrees as follows: (a) Shares to be Fully Paid. All Warrant Shares will, upon issuance, be validly issued, fully paid, and nonassessable and free from all taxes, liens, and charges with respect to the issue thereof. (b) Reservation of Shares. During the period within which this Warrant may be exercised, the Company will at all times have authorized, and reserved for the purpose of issuance upon exercise of this Warrant, a sufficient number of shares of Common Stock to provide for the exercise of this Warrant. (c) Successors and Assigns. This Warrant will be binding upon any entity succeeding to the Company by merger, consolidation, or acquisition of all or substantially all of the Company's assets. 4. No Rights or Liabilities as a Shareholder. This Warrant shall not entitle the holder hereof to any voting rights or other rights as a shareholder of the Company. No provision of this Warrant, in the absence of affirmative action by the holder hereof to purchase Warrant Shares, and no mere enumeration herein of the rights or privileges of the holder hereof, shall give rise to any liability of such holder for the Exercise Price or as a shareholder of the Company, whether such liability is asserted by the Company or by creditors of the Company. 5. Transfer, Exchange, and Replacement of Warrants and Shares. (a) Restriction on Transfer. Anything in this Warrant to the contrary notwithstanding, this Warrant (and any Warrant for which this Warrant may be exchanged or replaced) may not be transferred or assigned, except by will or pursuant to the laws of descent and distribution; provided, however, that any transfer or assignment shall be subject to the conditions set forth in Paragraph 5(f) hereof. Until due presentment for registration of transfer on the books of the Company, the Company may treat the registered holder hereof as the owner and holder hereof for all purposes, and the Company shall not be affected by any notice to the contrary. (b) Warrant Exchangeable for Different Denominations. Subject to Paragraph 5(a) hereof, this Warrant is exchangeable, upon the surrender hereof by the holder hereof at the office or agency of the Company referred to in Paragraph 5(e) hereof, for new Warrants of like tenor representing in the aggregate the right to purchase the number of shares of Common Stock which may be purchased hereunder, each of such new Warrants to represent 2 3 the right to purchase such number of shares as shall be designated by said holder hereof at the time of such surrender. (c) Replacement of Warrant. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction, or mutilation of this Warrant and, in the case of any such loss, theft, or destruction, upon delivery of an indemnity agreement reasonably satisfactory in form and amount to the Company, or, in the case of any such mutilation, upon surrender and cancellation of this Warrant, the Company, at its expense, will execute and deliver, in lieu thereof, a new Warrant of like tenor. (d) Cancellation; Payment of Expenses. Upon the surrender of this Warrant in connection with any transfer, exchange, or replacement as provided in this paragraph 5, this Warrant shall be promptly canceled by the Company. (e) Register. The Company shall maintain, at its principal executive offices (or such other office or agency of the Company as it may designate by notice to the holder hereof), a register for this Warrant, in which the Company shall record the name and address of the person in whose name this Warrant has been issued, as well as the name and address of each transferee and each prior owner of this Warrant. (f) Investment Representation. By acceptance of this Warrant, the holder hereof hereby represents that: (i) such holder understands that neither this Warrant nor the Warrant Shares payable hereunder have been registered under the Securities Act of 1933, as amended (the "Securities Act") or any state securities laws and, in addition to the other restrictions on transfer set forth in this Warrant, neither this Warrant nor the Warrant Shares payable hereunder may be transferred in the absence of an effective registration statement under the Securities Act and any applicable state securities laws or an exemption from the registration requirements thereof, and (ii) such holder is acquiring such Warrant for investment only, and not with a view to the resale or distribution of the Warrant or the Warrant Shares underlying such Warrant. Following the exercise of this Warrant, the holder shall not transfer the shares of Common Stock acquired upon the exercise hereof except pursuant to an effective registration statement under the Securities Act and any applicable state securities laws or unless the holder of this Warrant furnishes to the Company a written opinion of counsel, which opinion and counsel are acceptable to the Company, to the effect that such exercise, transfer, or exchange may be made without registration under said Act and under applicable state securities or blue sky laws and (iii) that the holder or transferee execute and deliver to the Company an investment letter in form and substance acceptable to the Company. 6. Adjustments Upon Changes in Common Stock. In the event the Company shall effect a split of the Common Stock or dividend payable in Common Stock, or in the event the outstanding Common Stock shall be combined into a smaller number of shares, the maximum number of shares for which this Warrant may be exercised hereunder shall be decreased or increased proportionately. In the event that the Company shall have effected such a split, dividend or combination before delivery by the Company of all of the Warrant Shares, the shares still subject to exercise under this Warrant shall be increased or decreased proportionately and the purchase price per share shall be decreased or increased proportionately so that the aggregate purchase price for all of the Warrant Shares shall remain the same as immediately prior to such split, dividend or combination. 3 4 In the event of a reclassification of Common Stock not covered by the foregoing, or in the event of a liquidation or reorganization (including a merger, consolidation, spin-off or sale of assets) of the Company or a parent or subsidiary of the Company, the Board of Directors of the Company shall make such adjustments, if any, as it may deem appropriate in the number, purchase price and kind of shares covered by the unexercised portions of this Warrant. The provisions of this Section shall only be applicable if, and only to the extent that, the application thereof does not conflict with a valid governmental statute, regulation or rule. 7. Notices. All notices, requests, and other communications required or permitted to be given or delivered hereunder to the holder of this Warrant shall be in writing, and shall be personally delivered, or shall be sent by certified or registered mail, postage prepaid and addressed to such holder at the address shown for such holder on the books of the Company, or at such other address as shall have been furnished to the Company by notice from such holder. All notices, requests, and other communications required or permitted to be given or delivered hereunder to the Company shall be in writing, and shall be personally delivered, or shall be sent by certified or registered mail, postage prepaid and addressed, to the office of the Company at 6705 Rockledge Drive, Suite 900, Bethesda, MD 20817, Attention: President (or Secretary) or at such other address as shall have been furnished to the holder of this Warrant by notice from the Company. Any such notice, request, or other communication may be sent by telegram, telex, or telecopy, but shall in such case be subsequently confirmed by a writing personally delivered or sent by certified or registered mail as provided above. All notices, requests, and other communications shall be deemed to have been given either at the time of the delivery thereof to (or the receipt by, in the case of a telegram, telex or telecopy) the person entitled to receive such notice at the address of such person for purposes of this Paragraph 7, or, if mailed, at the completion of the third (3rd) full day following the time of such mailing thereof to such address, as the case may be. 8. Governing Law. This Warrant shall be governed by and construed and enforced in accordance with the laws of the State of Delaware. 9. Miscellaneous. (a) Amendments. This Warrant and any provision hereof may not be changed, waived, discharged, or terminated, except by an instrument in writing signed by the party (or any predecessor interest thereof) against which enforcement of the same is sought. (b) Descriptive Headings. The descriptive headings of the several paragraphs of this Warrant are inserted for purposes of reference only, and shall not affect the meaning or construction of any of the provisions hereof. 4 5 IN WITNESS WHEREOF, the Company has caused this Warrant to be signed by its duly authorized officer under its corporate seal, attested by its duly authorized officer, as of the _____ day of ______, 20___. COVENTRY HEALTH CARE, INC. By: -------------------------------- [CORPORATE SEAL] Attest: - ---------------------------- Secretary 5 6 EXERCISE AGREEMENT Dated: , --------------- ------- To: ------------------------- The undersigned, pursuant to the provisions set forth in the within Warrant No. _______, hereby agrees to purchase _________ shares of Common Stock of Coventry Health Care, Inc. covered by such Warrant, and makes payment herewith in full therefor at the price per share provided by such Warrant in cash or by certified or official bank check in the amount of $_______________. Please issue a certificate or certificates for such shares of Common Stock in the name of (and pay cash for any fractional share(s)) to the following: Name: -------------------------------- SS No./ Tax ID No.: -------------------------------- Address: -------------------------------- -------------------------------- -------------------------------- Signature*: -------------------------------- --------- * The above signature should correspond exactly with the name on the face of the within Warrant. If the number of Warrant Shares exercised herein shall not be all of the shares purchasable under the within Warrant, a new Warrant is to be issued in the name of the above signatory covering the balance of the Warrant Shares purchasable under the within Warrant, less any fraction of a share paid to the holder in cash. 6 EX-10.27.2 3 AMENDED RETIREMENT SAVINGS PLAN 1 EXHIBIT 10.27.2 AMENDMENT NO. 1 COVENTRY HEALTH CARE, INC. RETIREMENT SAVINGS PLAN The Plan named above gives the Employer the right to amend it at any time. According to that right, the Plan is amended as provided below: Effective October 1, 1998, by striking the following: Page 5 Page 16 Page 17 Page 19 Page 20 Page 21 and substituting the following: Page 5 Page 16 Page 17 Page 19 Page 20 Page 21 Page 21a Attachment A The provisions and conditions set forth on any page of this amendment are a part of the Plan as fully as if recited over the signature(s) below. Unless otherwise stated on any page of this amendment, eligibility for any benefits and the amount of such benefits payable to or on behalf of an individual who is an Inactive Participant on the effective date(s) stated above, shall be determined according to the provisions of the Plan as in effect on the day before he became an Inactive Participant. By signing this amendment, the Employer acknowledges having counseled to the extent necessary with selected legal and tax advisors regarding the amendment's legal and tax implications. Signed this day of , 19 --------- ----------------- ----. COVENTRY HEALTH CARE, INC. By --------------------------------- --------------------------------- Title (4-32508)-1 2 INTRODUCTION The Primary Employer is establishing a defined contribution 401(k) savings plan for the exclusive benefit of certain of its employees. It is intended that the plan qualify as a profit sharing plan under the Internal Revenue Code of 1986, including any later amendments to the Code. The Employer agrees to operate the plan according to the terms, provisions and conditions set forth in this document. Participant loans were offered under the Principal Health Care, Inc. Select Savings Plan. This Plan will accept rollover loan notes from former employees of Principal Health Care, Inc. who participated under such plan. Coventry Corporation previously established the Coventry Corporation Retirement Savings Plan on July 1, 1994. The Primary Employer is of the opinion that this plan should be merged into the Coventry Health Care, Inc. Retirement Savings Plan. Effective October 1, 1998, the plan is merged and set forth in this document which is substituted in lieu of the prior document INTRODUCTION 5 (4-32508) 3 TRUST means an agreement of trust between the Primary Employer and Trustee established for the purpose of holding and distributing the Trust Fund under the provisions of the Plan. The Trust may provide for the investment of all or any portion of the Trust Fund in the Group Contract. TRUST FUND means the total funds held under the Trust for the purpose of providing benefits for Participants. These funds result from Contributions made under the Plan which are forwarded to the Trustee to be deposited in the Trust Fund. TRUSTEE means the trustee or trustees under the Trust. The term Trustee as it is used in this Plan is deemed to include the plural unless the context clearly indicates otherwise. VALUATION DATE means the date on which the value of the assets of the Trust is determined. The value of each Account which is maintained under this Plan shall be determined on the Valuation Date. In each Plan Year, the Valuation Date shall be the last day of the Plan Year. In addition, the Plan Administrator may designate from time to time, so long as the Trustee agrees, that another date or dates shall be Valuation Dates with respect to a specific Plan Year. VESTED ACCOUNT means the vested part of a Participant's Account. The Participant's Vested Account is determined as follows. If the Participant's Vesting Percentage is 100%, his Vested Account equals his Account. If the Participant's Vesting Percentage is less than 100%, his Vested Account equals the sum of (a) and (b) below: (a) The part of the Participant's Account that results from Employer Contributions made before a prior Forfeiture Date and all other Contributions which were 100% vested when made. (b) The balance of the Participant's Account in excess of the amount in (a) above multiplied by his Vesting Percentage. If the Participant has withdrawn any part of his Account resulting from Employer Contributions, other than the vested Employer Contributions included in (a) above, the amount determined under this subparagraph (b) shall be equal to P(AB + D) - D as defined below: P The Participant's Vesting Percentage. AB The balance of the Participant's Account in excess of the amount in (a) above. D The amount of withdrawal resulting from Employer Contributions,other than the vested Employer Contributions included in (a) above. The Participant's Vested Account is nonforfeitable. VESTING PERCENTAGE means the percentage used to determine the nonforfeitable portion of a Participant's Account attributable to Employer Contributions which were not 100% vested when made. For certain Participants who were covered under the Coventry Corporation Retirement Savings Plan prior to the October 1, 1998, merger, the applicable Vesting Percentage is outlined in Attachment A. ARTICLE I 16 (4-32508) 4 For all other Participants, the applicable Vesting Percentage is determined by his Employment Commencement Date as shown in the following schedules opposite the number of whole years of his Vesting Service. If his employment commencement date with Principal Health Care, Inc. occurred before July 1, 1997, his Vesting Percentage is 100%. If his employment commencement date with Principal Health Care, Inc. occurs on or after July 1, 1997, but before April 1, 1998:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0 1 or more 100
If his Employment Commencement Date with the Primary Employer or Adopting Employer occurs on or after April 1, 1998:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0 1 50 2 or more 100
However, the Vesting Percentage for a Participant who is an Employee on or after the earliest of (i) the date he reaches his Normal Retirement Age, (ii) the date of his death, or (iii) the date he becomes Totally and Permanently Disabled, shall be 100% on such date. If the schedule used to determine a Participant's Vesting Percentage is changed, the new schedule shall not apply to a Participant unless he is credited with an Hour-of-Service on or after the date of the change and the Participant's nonforfeitable percentage on the day before the date of the change is not reduced under this Plan. The amendment provisions of the AMENDMENT SECTION of Article IX regarding changes in the computation of the Vesting Percentage shall apply. VESTING SERVICE means an Employee's Period of Service. If he has more than one Period of Service or if all or a part of a Period of Service is not counted, his Vesting Service shall be determined by adjusting his Employment Commencement Date so that he has one continuous period of Vesting Service equal to the aggregate of all his countable Periods of Service. This period of Vesting Service shall be expressed as whole years and fractional parts of a year (to two decimal places) on the basis that 365 days equal one year. However, Vesting Service is modified as follows: Predecessor Employer Service included: An Employee's service with a Predecessor Employer shall be included as service with the Employer. This service includes service performed while a proprietor or partner. ARTICLE I 17 (4-32508) 5 ARTICLE II PARTICIPATION SECTION 2.01--ACTIVE PARTICIPANT. (a) An Employee shall first become an Active Participant (begin active participation in the Plan) on the earliest date on or after April 1, 1998, on which he is an Eligible Employee. This date is his Entry Date. Each Employee who was an Active Participant under the Coventry Corporation Retirement Savings Plan on September 30, 1998, shall be an Active Participant in this Plan if he is still an Eligible Employee on October 1, 1998, and his Entry Date shall not change. (b) An Inactive Participant shall again become an Active Participant (resume active participation in the Plan) on the date he again performs an Hour-of-Service as an Eligible Employee. This date is his Reentry Date. Upon again becoming an Active Participant, he shall cease to be an Inactive Participant. (c) A former Participant shall again become an Active Participant (resume active participation in the Plan) on the date he again performs an Hour-of-Service as an Eligible Employee. This date is his Reentry Date. An Active Participant or an Eligible Employee may elect not to be an Active Participant. The election may be for a specified or an indefinite period of time. The election shall be made by filing a written request with the Plan Administrator not to be an Active Participant. Employer Contributions shall not be allocated to the Eligible Employee for any period during which he is not an Active Participant. The Eligible Employee may at any time revoke such election and, a) if he has met all of the other eligibility requirements under this section and his Entry Date has occurred, he shall become an Active Participant as of the date of revocation, or b) if he has met all of the other eligibility requirements under this section and his Entry Date has not occurred, he shall become an Active Participant as provided in this section, or c) if he has not met all of the other eligibility requirements under this section, he shall become an Active Participant as provided in this section. There shall be no duplication of benefits for a Participant under this Plan because of more than one period as an Active Participant. SECTION 2.02--INACTIVE PARTICIPANT. An Active Participant shall become an Inactive Participant (stop accruing benefits under the Plan) on the earlier of the following: (a) The date on which he ceases to be an Eligible Employee (on his Retirement Date if the date he ceases to be an Eligible Employee occurs within one month of his Retirement Date). (b) The effective date of complete termination of the Plan. ARTICLE II 19 (4-32508)-1 6 An Employee or former Employee who was an Inactive Participant under the Coventry Corporation Retirement Savings Plan on September 30, 1998, shall be an Inactive Participant in this Plan on October 1, 1998. Eligibility for any benefits payable to him or on his behalf and the amount of the benefits shall be determined according to the provisions of the prior document, unless otherwise stated in this document. SECTION 2.03--CESSATION OF PARTICIPATION. A Participant shall cease to be a Participant on the date he is no longer an Eligible Employee and his Account is zero. SECTION 2.04--ADOPTING EMPLOYERS - SINGLE PLAN. Each of the employers controlled by or affiliated with the Employer and listed below is an Adopting Employer. Each Adopting Employer listed below participates with the Employer in this Plan. An Adopting Employer's agreement to participate in this Plan shall be in writing. If the Adopting Employer did not maintain its plan before its date of adoption specified below, its date of adoption shall be the Entry Date for any of its employees who have met the requirements in the ACTIVE PARTICIPANT SECTION of Article II as of that date. Service with and earnings from an Adopting Employer shall be included as service with and earnings from the Employer. Transfer of employment, without interruption, between an Adopting Employer and another Adopting Employer or the Employer shall not be considered an interruption of service. Contributions made by an Adopting Employer shall be treated as Contributions made by the Employer. Forfeitures arising from those Contributions shall be used for the benefit of all Participants. An employer shall not be an Adopting Employer if it ceases to be controlled by or affiliated with the Employer. Such an employer may continue a retirement plan for its employees in the form of a separate document. This Plan shall be amended to delete a former Adopting Employer from the list below. If an employer ceases to be an Adopting Employer and does not continue a retirement plan for the benefit of its employees, partial termination may result and the provisions of Article VII apply.
ADOPTING EMPLOYERS NAME FISCAL YEAR END DATE OF ADOPTION PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 IOWA, INC. PRINCIPAL HEALTH CARE December 31 April 1, 1998 MANAGEMENT CORPORATION PRINCIPAL HEALTH CARE OF THE December 31 April 1, 1998 CAROLINAS, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 DELAWARE, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 FLORIDA, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 GEORGIA, INC.
ARTICLE II 20 (4-32508)-1 7 PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 ILLINOIS, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 INDIANA, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 LOUISIANA, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 KANSAS CITY, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 NEBRASKA, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 PENNSYLVANIA, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 ST. LOUIS, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 SOUTH CAROLINA, INC. PRINCIPAL HEALTH CARE OF December 31 April 1, 1998 TENNESSEE, INC. UNITED HEALTH CARE SERVICES December 31 April 1, 1998 OF IOWA, INC. GROUP HEALTH PLAN, INC. December 31 October 1, 1998 HEALTH AMERICA PENNSYLVANIA, INC. December 31 October 1, 1998 COVENTRY HEALTH AND LIFE INSURANCE COMPANY December 31 October 1, 1998 COVENTRY HEALTH CARE December 31 October 1, 1998 MANAGEMENT CORPORATION HEALTH CARE USA - MIDWEST, INC. December 31 October 1, 1998 PENN GROUP MEDICAL ASSOCIATES, P.A. December 31 October 1, 1998 HEALTH CARE USA, INC. December 31 October 1, 1998 HEALTH CARE USA - ALABAMA, INC. December 31 October 1, 1998
ARTICLE II 21 (4-32508) 8 SOUTHERN HEALTH MANAGEMENT SERVICES, INC. December 31 October 1, 1998 HEALTH CARE USA OF MISSOURI LLC. December 31 October 1, 1998 COVENTRY HEALTH PLAN OF WEST VIRGINIA, INC. December 31 October 1, 1998
ARTICLE II 21a (4-32508) 9 ATTACHMENT A DETAIL OF COVENTRY CORPORATION RETIREMENT SAVINGS PLAN VESTING PRIOR TO 10-1-98 MERGER DIVISION 1 - HEALTHAMERICA-PITTSBURGH Prior to 1/1/98, the Company made matching contributions in cash to be invested according to the participants' elections. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 20% 2 40% 3 60% 4 80% 5 or more 100%
Subsequent to 1/1/98, the Company made matching contributions exclusively in Coventry Stock. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 50% 2 or more 100%
DIVISION 2 - GROUP HEALTH PLAN Prior to 1/1/98, the Company made matching contributions in cash to be invested according to the participants' elections. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 20% 2 40% 3 60% 4 80% 5 or more 100%
ATTACHMENT A 1 (4-32508)-1 10 Subsequent to 1/1/98, the Company made matching contributions exclusively in Coventry Stock. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 50% 2 or more 100%
DIVISION 3 - CORPORATE Prior to 1/1/98, the Company made matching contributions in cash to be invested according to the participants' elections. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 20% 2 40% 3 60% 4 80% 5 or more 100%
Subsequent to 1/1/98, the Company made matching contributions exclusively in Coventry Stock. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 50% 2 or more 100%
ATTACHMENT A 2 (4-32508)-1 11 DIVISION 4 - HEALTHAMERICA-HARRISBURG Prior to 1/1/98, the Company made matching contributions in cash to be invested according to the participants' elections. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 20% 2 40% 3 60% 4 80% 5 or more 100%
Subsequent to 1/1/98, the Company made matching contributions exclusively in Coventry Stock. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 50% 2 or more 100%
ATTACHMENT A 3 (4-32508)-1 12 DIVISION 5 - HEALTHCARE USA For employees hired subsequent to 12/31/95 the following applies: Prior to 1/1/98, the Company made matching contributions in cash to be invested according to the participants' elections. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 20% 2 40% 3 60% 4 80% 5 or more 100%
Subsequent to 1/1/98, the Company made matching contributions exclusively in Coventry Stock. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 50% 2 or more 100%
For employees in this division hired prior to 1/1/96 the following applies: The vesting for these individuals was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 25% 2 50% 3 75% 4 or more 100%
In addition to the above schedules for this division the Florida and Pittsburgh locations of this division were terminated. As a result of this, these individuals are 100% vested in all their balances based on the partial termination rules. ATTACHMENT A 4 (4-32508)-1 13 DIVISION 6 - SOUTHERN HEALTH MANAGEMENT CORP. For employees hired subsequent to 12/31/95 the following applies: Prior to 1/1/98, the Company made matching contributions in cash to be invested according to the participants' elections. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 20% 2 40% 3 60% 4 80% 5 or more 100%
Subsequent to 1/1/98, the Company made matching contributions exclusively in Coventry Stock. The vesting for this division was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 50% 2 or more 100%
For employees in this division hired prior to 1/1/96 the following applies: The vesting for these individuals was as follows:
VESTING SERVICE VESTING (whole years) PERCENTAGE Less than 1 0% 1 33.3% 2 66.7% 3 or more 100%
DIVISION 91 - TRANSFERRED DIVISION 1 EMPLOYEES These employees were treated as being transferred within the meaning of the "Same Desk Rule". By utilizing this rule, the participants were not actually treated as separating from service and as such are not allowed to take a termination distribution until the employment with the successor employer was ceased. These employees were also not allowed to take loans however they were still permitted to take hardship distributions. ATTACHMENT A 5 (4-32508)-1 14 DIVISION 92 - TRANSFERRED DIVISION 2 EMPLOYEES These employees were treated as being transferred within the meaning of the "Same Desk Rule". By utilizing this rule, the participants were not actually treated as separating from service and as such are not allowed to take a termination distribution until the employment with the successor employer was ceased. These employees were also not allowed to take loans however they were still permitted to take hardship distributions. DIVISION 94 - TRANSFERRED 4 EMPLOYEES These employees were treated as being transferred within the meaning of the "Same Desk Rule". By utilizing this rule, the participants were not actually treated as separating from service and as such are not allowed to take a termination distribution until the employment with the successor employer was ceased. These employees were also not allowed to take loans however they were still permitted to take hardship distributions. ATTACHMENT A 6 (4-32508)-1 EX-10.28.5 4 FOURTH AMENDMENT TO SERP 1 EXHIBIT 10.28.5 FOURTH AMENDMENT TO THE COVENTRY HEALTH CARE, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN WHEREAS, by resolution dated November 4, 1999, the Board of Directors of Coventry Health Care, Inc. (the "Company") authorized the amendment of the Coventry Health Care, Inc. Supplemental Executive Retirement Plan (the "SERP") to: (i) revise the definition of Compensation to exclude income or proceeds from the Company's Stock Incentive Plan and relocation payments; (ii) clarify the amounts that an Eligible Employee may defer to the SERP; (iii) revise the methodology used to calculate benefit payments to provide for annual recalculation of the monthly payments; and (iv) specifically delegate full power and discretionary authority to the 401(k) Plan Investment Committee to administer the SERP. NOW, THEREFORE, the Company hereby amends the SERP as follows: 1. Section 2.5 is amended, effective as of January 1, 1999, to provide as follows: 2.5 Committee. "Committee" means the Company's 401(k) Plan Investment Committee. 2. Section 2.6 is amended, effective January 1, 1999, to provide as follows: 2.6 Compensation. "Compensation" means the total compensation paid by the Employer to a Participant during the Plan Year, excluding income or proceeds from the Company's Stock Incentive Plan and relocation payments, but including base pay, annual management incentive pay, commissions, and amounts not included in income by reason of a Participant's agreement to defer Compensation under the terms of this Plan or a Participant's election under a cash or deferred arrangement under section 401(k) of the Code or a cafeteria plan described in Section 125 of the Code. 3. Section 2.7 is amended, effective January 1, 1999, to provide as follows: 2.7 Deferred Compensation. "Deferred Compensation" means the amount of Compensation not yet earned during the Plan Year that the Participant and the Employer mutually agree shall be deferred in accordance with the provisions of Section 3.2(a) of this Plan. 4. Section 3.2(a) is amended, effective January 1, 2000, to provide as follows: (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 (net of salary deferral contributions to a cash or deferred arrangement under section 401(k) of the Code) per pay period and 1% to 100% of his annual management incentive pay for a Plan Year. The Deferred Compensation Agreement shall be executed before the first day of the Plan Year (pursuant to Section 3.2(b) hereof) 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, 2 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 a portion of his base salary (net of salary deferral contributions to a cash or deferred arrangement under section 401(k) of the Code) and annual management incentive pay for a Plan Year, as otherwise set forth in this paragraph, 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. 5. Section 5.6(a) is amended, effective as of January 1, 2000, to provide as follows: (a) Monthly installments over a period of sixty (60) months paid each month. The monthly payment amount will be determined by dividing the balance in the Participant's Deferred Compensation Account by sixty (60), and adjusted each January 1 thereafter to reflect the then remaining number of months in the payment period. The last monthly payment will be equal to the remaining balance in the Participant's Deferred Compensation Account. 6. Section 7.1 is amended, effective as January 1, 1999, to provide as follows: 7.1 Committee. This Plan shall be administered by the Committee. Members of the Committee may be Participants under the Plan. The Committee shall have full power and discretionary authority to administer, interpret and construe this Plan, to determine and review claims for benefits under this Plan, to establish rules and regulations, to delegate responsibilities to others to assist it in administering this Plan, to establish investment guidelines, and to perform all other acts it believes reasonable and proper in connection with the administration of this Plan. The Committee shall rely on the records of the Company in determining benefits hereunder. The Plan shall be administered and interpreted consistent with the intention that the Plan shall constitute a plan which, for purposes of ERISA, is unfunded and maintained for a select group of management or highly compensated employees. IN WITNESS WHEREOF, the Company has caused this Fourth Amendment to the Coventry Health Care, Inc. Supplemental Executive Retirement Plan to be executed by its duly authorized officer this 4th day of November, 1999. Attest: COVENTRY HEALTH CARE, INC. /s/ Tim A. Silvera /s/ Shirley R. Smith - ---------------------- ---------------------- Vice President Senior Vice President 2 EX-11 5 COMPUTATION OF NET EARNINGS PER SHARE 1 Exhibit 11 Coventry Health Care, Inc. Computation of Net Earnings Per Share (1)
1999 ----------------------------------------------------------- EARNINGS SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------------------------------------------------------- Basic EPS $ 43,435 59,025 $ 0.74 Effect of Dilutive Securities Options and warrants 498 Convertible notes 2,997 Redeemable convertible 1,639 preferred stocks Interest on convertible notes $ 848 ----------- ------ ------ Diluted EPS $ 44,283 64,159 $ 0.69 =========== ====== ====== 1998 ----------------------------------------------------------- (LOSS) SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------------------------------------------------------- Basic EPS $ (11,741) 52,477 $(0.22) Effect of Dilutive Securities Options and warrants Convertible notes ------------ -------- ------ Diluted EPS $ (11,741) 52,477 $(0.22) ============ ======== ====== 1997 ----------------------------------------------------------- EARNINGS SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------------------------------------------------------- Basic EPS $ 11,903 33,210 $0.36 Effect of Dilutive Securities Options and warrants 702 Convertible Notes ---------- -------- ----- Diluted EPS $ 11,903 33,912 $0.35 ========== ======== =====
(1) Restated for adoption of SFAS 128, "Earnings Per Share". EX-21 6 SUBSIDIARIES OF THE REGISTRANT 1 Exhibit 21 COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES MARCH 15, 2000 NAME OF CORPORATION CURRENT CORPORATIONS: 1. COVENTRY HEALTH CARE, INC. (DELAWARE) 2. Coventry Corporation (Tennessee) 3. Coventry Health and Life Insurance Company(1) (Delaware) 4. Coventry Healthcare Management Corporation d/b/a HealthAssurance (Delaware) 5. Coventry HealthCare Management Corporation (Virginia) (i) Southern Health Services, Inc. (Virginia) (ii) Southern Health Benefit Services, Inc. (Virginia) 6. Coventry HealthCare Development Corporation (Delaware) (i) Carelink Health Plans, Inc.(2) (West Virginia) 7. Group Health Plan, Inc. (Missouri)(3) (i) Specialty Services of Missouri, Inc. (Missouri) 8. HealthAmerica Pennsylvania, Inc.(4) (Pennsylvania) - -------- (1) Redomesticated from Texas to Delaware on May 14, 1999 (2) Carelink Health Plans, Inc. ("Carelink") was acquired effective October 1, 1999 and, on the same date, Coventry Health Plan of West Virginia, Inc. was merged with and into Carelink, with Carelink as the surviving company. (3) Principal Health Care of St. Louis, Inc. was merged into Group Health Plan, Inc. effective December 21, 1999. (4) On April 5, 1999, Riverside Health Plan, Inc., a Pennsylvania corporation, was merged into its parent corporation, The Medical Center HPJV, Inc., a Pennsylvania corporation ("HPJV"), and HPJV was merged into its parent corporation, HealthAmerica Pennsylvania, Inc., a Pennsylvania corporation. 2 9. Healthcare America, Inc. (Kansas) (i) Coventry Health Care of Kansas City, Inc.(5) (Kansas) 10. HealthCare USA, Inc. (Florida) (i) HealthCare USA Midwest, Inc. (Delaware) (a) HealthCare USA of Missouri, L.L.C. (Missouri) 11. HealthPass, Inc. (Pennsylvania) 12. Pennsylvania HealthCare USA, Inc. (Pennsylvania) 13. Coventry Health Care of Iowa, Inc.(6) (Iowa) 14. Coventry Health Care Management Corporation of Iowa, Inc.(7) (Iowa) 15. Coventry Health Care of the Carolinas, Inc.(8) (North Carolina) 16. Coventry Health Care of Delaware, Inc.(9) (Delaware) 17. Coventry Health Care of Georgia, Inc.(10) (Georgia) 18. Coventry Health Care of Indiana, Inc.(11) (Delaware) 19. Coventry Health Care of Louisiana, Inc.(12) (Louisiana) 20. Coventry Health Care of Nebraska, Inc.(13) (Nebraska) - --------------------- (5) On December 21, 1998, Principal Health Care of Kansas City, Inc., a Missouri corporation, was merged with and into Healthcare America Plans, Inc., a Kansas corporation acquired by Coventry Health Care, Inc. on December 21, 1998, ("HAPI") with HAPI as the surviving company whose name was changed to Principal Health Care of Kansas City, Inc., a Kansas corporation. On November 10, 1999 in Kansas and on December 23, 1999 in Missouri, Principal Health Care of Kansas City, Inc. changed its name to Coventry Health Care of Kansas City, Inc. (6) On November 3, 1999, Principal Health Care of Iowa, Inc. changed its name to Coventry Health Care of Iowa, Inc. (7) On October 4, 1999, Principal Health Care Management Corporation changed its name to Coventry Health Care Management Corporation of Iowa, Inc. On February 2, 2000 the company was dissolved. (8) On October 4, 1999, Principal Health Care of the Carolinas, Inc. changed its name to Coventry Health Care of the Carolinas, Inc. (9) On the following dates and in the states indicated, Principal Health Care of Delaware, Inc. changed its name to Coventry Health Care of Delaware, Inc.: Delaware, October 4, 1999; Maryland, October 15, 1999; New Jersey, October 22, 1999 and Pennsylvania, November 12, 1999. (10) On November 1, 1999, Principal Health Care of Georgia, Inc. changed its name to Coventry Health Care of Georgia, Inc. (11) On October 4, 1999, Principal Health Care of Indiana, Inc. changed its name to Coventry Health Care of Indiana, Inc. (12) On December 17, 1999, Principal Health Care of Louisiana, Inc. changed its name to Coventry Health Care of Louisiana, Inc. (13) On October 4, 1999 in Nebraska and on October 22, 1999 in Iowa, Principal Health Care of Nebraska, Inc. changed its name to Coventry Health Care of Nebraska, Inc. 3 21. Coventry Health Care of Pennsylvania, Inc. (14) (Pennsylvania) 22. Principal Health Care of St. Louis, Inc.(15) (Delaware) 23. Coventry Health Care of South Carolina, Inc.(16) (South Carolina) 24. Coventry Health Care of Tennessee, Inc.(17) (Tennessee) 25. United HealthCare Services of Iowa, Inc.(18) (Iowa) FORMERLY OWNED SUBSIDIARIES WITH CONTINUING LIABILITIES: 1. Principal Health Care of Illinois, Inc.(19) (Illinois) 2. Principal Health Care of Florida, Inc.(20) (Florida) - -------------------------------------------------------------------------------- (14) On October 4, 1999, Principal Health Care of Pennsylvania, Inc. changed its name to Coventry Health Care of Pennsylvania, Inc. (15) Principal Health Care of St. Louis, Inc. was merged into Group Health Plan, Inc. effective December 21, 1999. (16) On October 4, 1999, Principal Health Care of South Carolina, Inc. changed its name to Coventry Health Care of South Carolina, Inc. On February 1, 2000, the company was dissolved. (17) On October 5, 1999, Principal Health Care of Tennessee, Inc. changed its name to Coventry Health Care of Tennessee, Inc. On February 3, 2000, the company was dissolved. (18) On February 2, 2000, the company was dissolved. (19) Sold to First American Group effective November 30, 1998. (20) Sold to Blue Cross Blue Shield of Florida, Inc. effective December 31, 1998. EX-23 7 CONSENT OF ARTHUR ANDERSEN LLP 1 Exhibit 23 ARTHUR ANDERSEN LLP CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports dated February 21, 2000, included in this Form 10-K for the year ended December 31, 1999, into previously filed registration statements 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-8 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-8 Registration Statement No. 333-47239 Form S-8 Registration Statement No. 333-75615 Form S-3 Registration Statement No. 333-75675 Form S-4 Registration Statement No. 333-45821. ARTHUR ANDERSEN LLP BALTIMORE, MARYLAND MARCH 27, 2000 EX-27 8 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF COVENTRY HEALTH CARE, INC. FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 240,076 374,527 58,721 (5,548) 0 483,405 96,414 (58,551) 1,081,583 522,886 0 47,095 0 596 479,789 1,081,583 0 2,162,372 0 2,114,517 (29,906) 4,562 1,761 76,000 32,565 43,435 0 0 0 43,435 0.74 0.69
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