UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________ to _________________

 

COMMISSION FILE NUMBER 1-16477

 

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

 

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 o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Large accelerated filer x

Accelerated filer o

 

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

Class

 

Outstanding at July 31, 2008

 

 

 

Common Stock $.01 Par Value

 

148,118,281

 

COVENTRY HEALTH CARE, INC.

FORM 10-Q

TABLE OF CONTENTS

 

 

PART I. FINANCIAL INFORMATION

 

 

ITEM 1: Financial Statements

 

 

 

Consolidated Balance Sheets

at June 30, 2008 and December 31, 2007

 

3

 

 

Consolidated Statements of Operations

for the quarters and six months ended June 30, 2008 and 2007

 

4

 

 

Condensed Consolidated Statements of Cash Flows

for the six months ended June 30, 2008 and 2007

 

5

 

 

Notes to the Condensed Consolidated Financial Statements

 

6

 

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

12

 

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

 

19

 

ITEM 4: Controls and Procedures

 

19

 

ITEM 4T: Not Applicable

 

19

PART II: OTHER INFORMATION

 

 

 

ITEM 1: Legal Proceedings

 

19

 

ITEM 1A: Risk Factors

 

19

 

ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds

 

19

 

ITEM 3: Not Applicable

 

19

 

ITEM 4: Submission of Matters to a Vote of Security Holders

 

20

 

ITEM 5: Not Applicable

 

20

 

ITEM 6: Exhibits

 

20

 

SIGNATURES

 

21

 

INDEX TO EXHIBITS

 

22

 

 

 

 

 

 

2

 

PART I. FINANCIAL INFORMATION

 

ITEM 1: Financial Statements

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

June 30,

 

December 31,

 

2008

 

2007

ASSETS

 

(unaudited)

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

$

894,093

 

$

945,535

Short-term investments

 

15,362

 

 

155,248

Accounts receivable, net

 

260,689

 

 

263,021

Other receivables, net

 

546,774

 

 

313,350

Other current assets

 

185,980

 

 

169,547

Total current assets

 

1,902,898

 

 

1,846,701

 

 

 

 

 

 

Long-term investments

 

1,584,535

 

 

1,758,454

Property and equipment, net

 

311,291

 

 

321,287

Goodwill

 

2,672,910

 

 

2,573,325

Other intangible assets, net

 

585,922

 

 

590,419

Other long-term assets

 

73,293

 

 

68,605

Total assets

$

7,130,849

 

$

7,158,791

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Medical liabilities

$

1,383,997

 

$

1,161,963

Accounts payable and other accrued liabilities

 

387,194

 

 

518,806

Deferred revenue

 

125,879

 

 

69,052

Total current liabilities

 

1,897,070

 

 

1,749,821

 

 

 

 

 

 

Long-term debt, net

 

1,472,337

 

 

1,662,021

Other long-term liabilities

 

444,763

 

 

445,470

Total liabilities

 

3,814,170

 

 

3,857,312

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $.01 par value; 570,000 authorized

 

1,902

 

 

1,899

190,155 issued and 151,679 outstanding in 2008

 

 

 

 

 

189,894 issued and 154,636 outstanding in 2007

 

 

 

 

 

Treasury stock, at cost; 38,860 in 2008; 35,258 in 2007

 

(1,184,935)

 

 

(987,132)

Additional paid-in capital

 

1,718,984

 

 

1,702,989

Accumulated other comprehensive (loss) income

 

(4,440)

 

 

6,735

Retained earnings

 

2,785,168

 

 

2,576,988

Total stockholders’ equity

 

3,316,679

 

 

3,301,479

Total liabilities and stockholders’ equity

$

7,130,849

 

$

7,158,791

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

 

3

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

 

 

 

 

 

Quarters Ended June 30,

Six Months Ended June 30,

 

 

 

 

 

2008

 

 

2007

 

 

2008

 

 

2007

Operating revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Managed care premiums

 

$

2,643,744

 

$

2,016,394

 

$

5,264,356

 

$

4,039,365

 

Management services

 

 

334,160

 

 

316,098

 

 

654,157

 

 

529,624

 

Total operating revenues

 

 

2,977,904

 

 

2,332,492

 

 

5,918,513

 

 

4,568,989

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Medical costs

 

 

2,268,819

 

 

1,605,437

 

 

4,430,545

 

 

3,261,977

 

Cost of sales

 

 

47,406

 

 

27,609

 

 

84,749

 

 

27,609

 

Selling, general and administrative

 

 

496,756

 

 

442,835

 

 

1,005,185

 

 

812,330

 

Depreciation and amortization

 

 

38,603

 

 

33,658

 

 

77,391

 

 

63,957

 

Total operating expenses

 

 

2,851,584

 

 

2,109,539

 

 

5,597,870

 

 

4,165,873

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating earnings

 

 

126,320

 

 

222,953

 

 

320,643

 

 

403,116

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

23,282

 

 

15,640

 

 

48,023

 

 

36,839

Other income, net

 

 

31,077

 

 

34,770

 

 

62,344

 

 

68,599

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

 

134,115

 

 

242,083

 

 

334,964

 

 

434,876

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

50,964

 

 

90,781

 

 

126,784

 

 

161,833

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

83,151

 

$

151,302

 

$

208,180

 

$

273,043

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.55

 

$

0.98

 

$

1.38

 

$

1.75

 

Diluted earnings per share

 

$

0.55

 

$

0.96

 

$

1.36

 

$

1.72

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

149,988

 

 

155,095

 

 

151,077

 

 

156,056

 

Effect of dilutive options and restricted stock

 

 

1,692

 

 

2,746

 

 

1,882

 

 

2,682

 

Diluted

 

 

151,680

 

 

157,841

 

 

152,959

 

 

158,738

 

 

See accompanying notes to the condensed consolidated financial statements.

 

 

4

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

 

Six Months Ended June 30,

 

 

 

 

2008

 

 

2007

Net cash from operating activities

$

219,784 

 

$

730,164 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Capital expenditures, net

 

(32,351)

 

 

(13,230)

 

Proceeds from sales of investments

 

562,047 

 

 

570,226 

 

Proceeds from maturities of investments

 

116,694 

 

 

198,270 

 

Purchases of investments

 

(382,129)

 

 

(648,829)

 

Payments for acquisitions, net of cash acquired

 

(131,982)

 

 

(411,318)

Net cash from investing activities

 

132,279 

 

 

(304,881)

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Proceeds from issuance of stock

 

5,173 

 

 

31,215 

 

Payments for repurchase of stock

 

(220,307)

 

 

(379,462)

 

Excess tax benefit from stock compensation

 

1,629 

 

 

23,705 

 

Proceeds from issuance of debt, net

 

30,000 

 

 

394,056 

 

Payments for retirement of debt

 

(220,000)

 

 

(180,500)

Net cash from financing activities

 

(403,505)

 

 

(110,986)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(51,442)

 

 

314,297 

Cash and cash equivalents at beginning of period

 

945,535 

 

 

1,370,836 

Cash and cash equivalents at end of period

$

894,093 

 

$

1,685,133 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

 

5

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

A.

BASIS OF PRESENTATION

The condensed consolidated financial statements of Coventry Health Care, Inc. and its subsidiaries (“Coventry” or the “Company”) contained in this report are unaudited but reflect all normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission. Therefore, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10–K for the year ended December 31, 2007. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. The year end balance sheet data included in this report was derived from audited financial statements but does not include all disclosures required by GAAP.

B.

    NEW ACCOUNTING STANDARDS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. The Company adopted the provisions of SFAS No. 157 as of January 1, 2008, for its financial instruments. The adoption of SFAS No. 157 did not have a material effect on the Company’s consolidated financial position or results of operations. The disclosures required by SFAS No. 157 are contained in Note J., Fair Value Measurements, herein.

C.

ACQUISITIONS

On May 14, 2008, the Company completed its acquisition of a majority ownership interest in Group Dental Services (“GDS”) in an all-cash transaction for approximately $36.7 million. GDS is a dental company based in Rockville, Maryland. The acquisition was accounted for using the purchase method of accounting and accordingly the Company’s ownership interest in GDS’ operating results have been included in its consolidated financial statements since the date of acquisition.

On February 13, 2008, the Company completed its acquisition of Mental Health Network Institutional Services, Inc. (“MHNet”) in an all-cash transaction for approximately $103.3 million, including working capital. MHNet, previously privately owned, is a mental-behavioral health company based in Austin, Texas. MHNet has served as a multi-year vendor to certain of the Company’s subsidiaries. The acquisition was accounted for using the purchase method of accounting and accordingly MHNet’s operating results have been included in the Company’s consolidated financial statements since the date of acquisition.

D.

DEBT

 

The Company’s outstanding debt as of June 30, 2008, and December 31, 2007, consisted of the following:

 

 

June 30, 2008

 

December 31, 2007

 

 

(in millions)

 

(in millions)

5.875% Senior notes due 1/15/12

 

250.0

 

250.0

6.125% Senior notes due 1/15/15

 

250.0

 

250.0

5.95% Senior notes due 3/15/17, net of unamortized discount

 

398.7

 

398.6

of $1,289 at June 30, 2008

 

 

 

 

6.30% Senior notes due 8/15/14, net of unamortized discount

 

398.6

 

398.4

of $1,494 at June 30, 2008

 

 

 

 

Revolving Credit Facility due 7/11/12, 3.20% weighted

 

175.0

 

365.0

average interest rate for the period ended June 30, 2008

 

 

 

 

Total debt

 

1,472.3

 

1,662.0

 

The Company’s senior notes and credit facility contain certain covenants and restrictions regarding additional debt, dividends or other restricted payments, transactions with affiliates, asset dispositions, and consolidations or mergers. Additionally, the Company’s credit facility requires compliance with a leverage ratio. As of June 30, 2008, the Company was in compliance with all applicable covenants and restrictions under its senior notes and credit facility.

 

6

 

E.

CONTINGENCIES

As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, the Company was a defendant in the provider track of the In Re: Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, Multi-District Litigation (“MDL”), No. 1334, in the action captioned, Charles B. Shane., et al., vs. Humana, Inc., et al. The trial court granted summary judgment in favor of the Company on all claims asserted in the litigation. The Eleventh Circuit Court of Appeals affirmed the trial court’s order granting summary judgment. The Shane lawsuit has triggered the filing of copycat class action complaints by other health care providers such as chiropractors, podiatrists, acupuncturists and other licensed health care professionals. Each of these actions has been transferred to the MDL and has been designated as “tag-along” actions. There are three tag-along actions currently filed against the Company. The trial court had entered an order which stayed all proceedings in these tag-along actions. Recently, the trial court requested the parties in the tag-along actions to refile all motions pending at the time of the stay and to file any new motions. On July 14, 2008, the trial court entered an order in the Harrison vs. Coventry Health Care of Georgia, Inc. (“CHCGA”) tag along action which dismissed all of the plaintiffs’ claims except their breach of contract claim which the court ordered to arbitration. In addition, the court deferred to the arbitrator for decision, the Company’s affirmative defenses that the plaintiffs waived their right to arbitration and/or their claim is barred by the doctrines of collateral estoppel and res judicata. The Harrison tag along action is a purported class action on behalf of all physicians in Georgia who had written provider contracts with CHCGA. The plaintiffs allege that CHCGA breached their contracts by not paying statutory interest on claims not adjudicated in compliance with Georgia’s prompt pay statute. CHCGA denies the allegation. Although the Company can not predict the outcome, it believes that the tag-along actions will not have a material adverse effect on its financial position or the results of operations. The Company also believes that the claims asserted in these lawsuits are without merit and intends to defend its position.

The Company has received a subpoena from the U.S. Attorney for the District of Maryland, Northern Division, requesting information regarding the operational process for confirming Medicare eligibility for the Workers Compensation set-aside product. The Company is fully cooperating and is providing the requested information. The Company can not predict what, if any, actions may be taken by the U.S. Attorney. However, based on the information known to date, the Company does not believe that the outcome of this inquiry will have a material adverse effect on its financial position or results of operations.

F.

    STOCK–BASED COMPENSATION

 

Stock Options

The Company granted 1.9 million stock options during the six months ended June 30, 2008. The Company recorded compensation expense related to stock options of approximately $8.6 million and $9.3 million for the quarters ended June 30, 2008 and 2007, respectively, and $18.1 million and $17.2 million for the six months ended June 30, 2008 and 2007, respectively. The total intrinsic value of options exercised was $0.4 million and $21.5 million for the quarters ended June 30, 2008 and 2007, respectively, and $8.7 million and $52.8 million for the six months ended June 30, 2008 and 2007, respectively. As of June 30, 2008, there was $73.9 million of total unrecognized compensation cost (net of expected forfeitures) related to nonvested stock option grants which is expected to be recognized over a weighted average period of 2.7 years.

The following table summarizes stock option activity for the six months ended June 30, 2008:

 

 

 

 

Weighted-

 

Aggregate

 

Weighted Average

 

 

Shares

 

Average

 

Intrinsic Value

 

Remaining

 

 

(in thousands)

 

Exercise Price

 

(in thousands)

 

Contractual Life

 

 

 

 

 

 

 

 

 

Outstanding at January 1, 2008

 

10,870 

 

$ 42.64

 

---

 

---

Granted

 

1,938 

 

$ 44.63

 

---

 

---

Exercised

 

(257)

 

$ 19.62

 

---

 

---

Cancelled and expired

 

(526)

 

$ 50.31

 

---

 

---

Outstanding at June 30, 2008

 

12,025 

 

$ 43.12

 

$ 16,789

 

7.1

Exercisable at June 30, 2008

 

6,748 

 

$ 37.40

 

$ 16,616

 

7.4

The Company continues to use the Black-Scholes-Merton option pricing model and amortizes compensation expense over the requisite service period of the grant. The methodology used in 2008 to derive the assumptions used in the valuation model is consistent with that used in 2007. The following average values and weighted-average assumptions for the quarters and six months ended June 30, 2008 and 2007 were used for option grants.

 

7

 

 

Quarters Ended

 

Six Months Ended

 

June 30, 2008

 

June 30, 2007

 

June 30, 2008

 

June 30, 2007

 

 

 

 

 

 

 

 

Black-Scholes-Merton Value

$ 13.34

 

$ 17.11

 

$ 13.36

 

$ 16.92

Dividend yield

0.0%

 

0.0%

 

0.0%

 

0.0%

Risk-free interest rate

3.0%

 

4.8%

 

2.9%

 

4.8%

Expected volatility

31.7%

 

25.4%

 

31.7%

 

25.3%

Expected life (in years)

4.2

 

4.1

 

4.2

 

4.1

 

 

Restricted Stock Awards

The Company awarded 0.8 million shares of restricted stock in the six months ended June 30, 2008. The value of the restricted shares is amortized over various vesting periods through 2012. The Company recorded compensation expense related to restricted stock grants, including restricted stock granted in prior periods, of approximately $6.4 million and $7.6 million for the quarters ended June 30, 2008 and 2007, respectively, and $13.6 million and $14.4 million for the six months ended June 30, 2008 and 2007, respectively. The total unrecognized compensation cost (net of expected forfeitures) related to the restricted stock was $33.5 million at June 30, 2008, and is expected to be recognized over a weighted average period of 2.2 years. The total fair value of shares vested during the six months ended June 30, 2008 and 2007 was $16.3 million and $35.8 million, respectively.

The following table summarizes restricted stock award activity for the six months ended June 30, 2008:

 

 

 

 

Weighted-Average

 

 

Shares

 

Grant-Date Fair

 

 

(in thousands)

 

Value Per Share

 

 

 

 

 

 

Nonvested, January 1, 2008

 

1,218 

 

$

53.38

Granted

 

793 

 

$

44.60

Vested

 

(395)

 

$

49.07

Forfeited

 

(80)

 

$

50.11

Nonvested, June 30, 2008

 

1,536 

 

$

50.13

 

G.

   SHARE REPURCHASE PROGRAM

In May 2008, the Company’s Board of Directors approved an increase to the share repurchase program in an amount equal to 5% of the Company’s then outstanding common stock, thus increasing the Company’s repurchase authorization by 7.5 million shares. Under the share repurchase program, the Company purchased 1.0 million shares and 4.2 million shares of its common stock during the three and six month periods ended June 30, 2008, respectively, at an aggregate cost of $44.7 million and $215.4 million, respectively. As of June 30, 2008, the total remaining number of common shares the Company is authorized to repurchase under this program is 9.9 million.

H.

COMPREHENSIVE INCOME

Comprehensive income was as follows (in thousands):

 

 

Quarters Ended June 30,

 

Six Months Ended June 30,

 

 

2008

 

2007

 

2008

 

2007

Net earnings

$ 83,151 

 

$ 151,302 

 

$ 208,180 

 

$ 273,043 

Other comprehensive losses:

 

 

 

 

 

 

 

 

Unrealized holding losses

(25,278)

 

(10,972)

 

(13,544)

 

(9,114)

 

Reclassification adjustments

(4,212)

 

(934)

 

(4,777)

 

(925)

 

Other comprehensive losses, before income taxes

(29,490)

 

(11,906)

 

(18,321)

 

(10,039)

 

Income tax benefit

11,501 

 

4,644 

 

7,146 

 

3,915 

 

Other comprehensive losses, net of income taxes

(17,989)

 

(7,262)

 

(11,175)

 

(6,124)

Comprehensive income

$ 65,162 

 

$ 144,040 

 

$ 197,005 

 

$ 266,919 

 

The Company’s unrealized holding loss on its investment portfolio during the quarters and six months ended June 30, 2008, primarily resulted from increases in interest rates during the periods.

 

8

 

I.

SEGMENT INFORMATION

The Company has three reportable segments: Commercial, Individual Consumer & Government, and Specialty. Each of these segments, which the Company also refers to as “Divisions,” is separately managed and provides separate operating results that are evaluated by the Company’s chief operating decision maker. Beginning in 2008, in order to reflect a change in the management of its operations, the Company reclassified its network rental business operating results from its Commercial Division to its Specialty Division. The network rental business operating results for the corresponding 2007 periods have been reclassified to conform to the 2008 segment presentation. The Commercial Division is comprised of all of the Company’s commercial employer-focused businesses, including the traditional health plan group risk and ASO products as well as the National Accounts and Federal Employees Health Benefit Plans (“FEHBP”). The Individual Consumer & Government Division contains the Company’s individual consumer products and all Medicare and Medicaid products. The Specialty Division includes the Company’s workers’ compensation services businesses, network rental business, mental-behavioral health benefits business and the newly acquired group dental services business.

The table below summarizes the operating results of the Company’s reportable segments (in thousands) through the gross margin level, as gross margin is the measure of profitability used by the Company’s chief operating decision maker to assess segment performance and make decisions regarding the allocation of resources. Additionally, the medical loss ratio (“MLR”) is presented for each applicable segment, as management believes that MLR is an important performance measure. The “other” column represents the elimination of premium and management service fees charged among segments. Total assets by reportable segment are not disclosed as these assets are not reported on a segment basis internally by the Company and therefore, are not reviewed separately by the Company’s chief operating decision maker.

 

Quarter Ended June 30, 2008

 

 

 

Individual Consumer

 

 

 

 

 

 

 

Commercial

 

& Government

 

Specialty

 

 

 

 

 

Division

 

Division

 

Division

 

Other

 

Total

Operating revenues

Managed care premiums

$ 1,291,560

 

$ 1,340,322

 

$   18,842

 

$ (6,980)

 

$ 2,643,744

Management services

82,323

 

43,191

 

210,454

 

(1,808)

 

334,160

Total operating revenues

1,373,883

 

1,383,513

 

229,296

 

(8,788)

 

2,977,904

Medical costs

1,067,297

 

1,196,072

 

12,048

 

(6,598)

 

2,268,819

Cost of sales

-

 

-

 

47,406

 

-

 

47,406

Gross margin

$   306,586

 

$   187,441

 

$ 169,842

 

$ (2,190)

 

$   661,679

MLR

82.6%

 

89.2%

 

63.9%

 

n/a

 

85.8%

 

 

 

 

 

 

 

 

 

 

 

Quarter Ended June 30, 2007

 

 

 

Individual Consumer

 

 

 

 

 

 

 

Commercial

 

& Government

 

Specialty

 

 

 

 

 

Division

 

Division

 

Division

 

Other

 

Total

Operating revenues

Managed care premiums

$ 1,134,278

 

$ 882,116

 

$             -

 

$             -

 

$ 2,016,394

Management services

94,628

 

46,716

 

176,172

 

(1,418)

 

316,098

Total operating revenues

1,228,906

 

928,832

 

176,172

 

(1,418)

 

2,332,492

Medical costs

881,283

 

724,432

 

-

 

(278)

 

1,605,437

Cost of sales

-

 

-

 

27,609

 

-

 

27,609

Gross margin

$   347,623

 

$ 204,400

 

$ 148,563

 

$ (1,140)

 

$   699,446

MLR

77.7%

 

82.1%

 

n/a

 

n/a

 

79.6%

 

 

 

9

 

 

Six Months Ended June 30, 2008

 

 

 

Individual Consumer

 

 

 

 

 

 

 

Commercial

 

& Government

 

Specialty

 

 

 

 

 

Division

 

Division

 

Division

 

Other

 

Total

Operating revenues

Managed care premiums

$ 2,579,699

 

$ 2,668,479

 

$   26,579

 

$ (10,401)

 

$ 5,264,356

Management services

168,467

 

86,803

 

402,185

 

(3,298)

 

654,157

Total operating revenues

2,748,166

 

2,755,282

 

428,764

 

(13,699)

 

5,918,513

Medical costs

2,079,571

 

2,344,110

 

16,473

 

(9,609)

 

4,430,545

Cost of sales

-

 

-

 

84,749

 

-

 

84,749

Gross margin

$   668,595

 

$   411,172

 

$ 327,542

 

$   (4,090)

 

$ 1,403,219

MLR

80.6%

 

87.8%

 

62.0%

 

n/a

 

84.2%

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2007

 

 

 

Individual Consumer

 

 

 

 

 

 

 

Commercial

 

& Government

 

Specialty

 

 

 

 

 

Division

 

Division

 

Division

 

Other

 

Total

Operating revenues

Managed care premiums

$ 2,267,804

 

$ 1,771,561

 

$             -

 

$             -

 

$ 4,039,365

Management services

193,243

 

96,321

 

242,783

 

(2,723)

 

529,624

Total operating revenues

2,461,047

 

1,867,882

 

242,783

 

(2,723)

 

4,568,989

Medical costs

1,768,415

 

1,494,121

 

-

 

(559)

 

3,261,977

Cost of sales

-

 

-

 

27,609

 

-

 

27,609

Gross margin

$   692,632

 

$   373,761

 

$ 215,174

 

$ (2,164)

 

$ 1,279,403

MLR

78.0%

 

84.3%

 

n/a

 

n/a

 

80.8%

 

J.

    FAIR VALUE MEASUREMENTS

SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1 - defined as observable inputs such as quoted prices in active markets; Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following table presents the fair value hierarchy for the Company’s financial assets measured at fair value on a recurring basis at June 30, 2008 (in thousands):

 

 

Quoted Prices in Active Markets for Identical Assets

Significant Other Observable Inputs

Significant Unobservable Inputs

 

Total

Level 1

Level 2

Level 3

 

Available-for-sale securities

$ 1,546,341

$ 53,903

$ 1,485,096

$ 7,342

Cash and cash equivalents

894,093

2,419

891,674

--

Total

$ 2,440,434

$ 56,322

$ 2,376,770

$ 7,342

 

The Company’s Level 1 securities primarily consist of US Treasury securities and cash. The Company determines the estimated fair value for its Level 1 securities using quoted (unadjusted) prices for identical assets or liabilities in active markets.

The Company’s Level 2 securities primarily consist of government-sponsored enterprise securities, state and municipal bonds, mortgage-backed securities, asset-backed securities, corporate debt, and money market funds. The Company determines the estimated fair value for its Level 2 securities using the following methods: quoted prices for similar assets/liabilities in active markets, quoted prices for identical or similar assets in non-active markets (few transactions, limited information, non-current prices, high variability over time), inputs other than quoted prices that are observable for the asset/liability (e.g. interest rates, yield curves volatilities, default rates, etc.), and inputs that are derived principally from or corroborated by other observable market data.

 

10

 

The Company’s Level 3 securities consist of three asset-backed securities and one corporate bond. The Company determines the estimated fair value for its Level 3 securities using unobservable inputs that cannot be corroborated by observable market data, such as broker quotes.

The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets for the quarter and six months ended June 30, 2008 (in thousands):

 

Quarter

 

Six Months

Beginning balances

$   9,585

 

$  10,797

Total gains or losses (realized / unrealized)

 

 

 

Included in earnings

-

 

(1)

Included in other comprehensive income (loss)

91

 

(254)

Purchases, issuances and settlements

(2,334)

 

(3,200)

Balance at June 30, 2008

$   7,342

 

$   7,342

 

Realized gains and losses are recorded in other income, net in the accompanying consolidated statement of operations.

K.

OTHER DISCLOSURES

Earnings Per Share: Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share assumes the exercise of all options and the vesting of all restricted stock using the treasury stock method. The Company excluded potential common stock equivalents to purchase 7.7 million and 3.3 million shares for the quarters ended June 30, 2008 and 2007, respectively, and 6.1 million and 3.2 million shares for the six months ended June 30, 2008 and 2007, respectively, from its computation of diluted earnings per share as these potential common stock equivalents were anti-dilutive.

Other Income: Other income includes interest income of $24.9 million and $33.0 million for the quarters ended June 30, 2008 and 2007, respectively and $54.6 million and $65.8 million for the six months ended June 30, 2008 and 2007, respectively.

 

 

 

 

 

 

 

 

 

 

 

11

 

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

General Information

This Form 10–Q contains forward-looking statements which are subject to risks and uncertainties in accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically include assumptions, estimates or descriptions of our future plans, strategies and expectations, and are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “intend,” “seek,” or other similar expressions. Examples of these include discussions regarding our operating and growth strategy, projections of revenue, income or loss and future operations. Unless this Form 10–Q indicates otherwise or the context otherwise requires, the terms “we,” “our,” “our Company,” “the Company” or “us” as used in this Form 10-Q refer to Coventry Health Care, Inc. and its subsidiaries.

These forward–looking statements may be affected by a number of factors, including, but not limited to, the “Risk Factors” contained in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10–K for the year ended December 31, 2007. Actual operations and results may differ materially from those forward-looking statements expressed in this Form 10–Q.

The following discussion and analysis relates to our financial condition and results of operations for the quarters and six months ended June 30, 2008 and 2007. This discussion should be read in conjunction with the condensed consolidated financial statements and other information presented herein as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10–K for the year ended December 31, 2007, including the critical accounting policies discussed therein.

Summary of Second Quarter 2008 Performance  

 

Revenue increased 27.7% over the prior year quarter.

 

Commercial Division membership increased 181,000 from the prior year quarter.

 

Individual Consumer & Government Division membership increased 500,000 from the prior year quarter.

 

Commercial health plan medical loss ratio (“MLR”) of 82.7%.

 

Medicare Advantage MLR of 93.2%.

 

Diluted earnings per share decreased 42.7% from the prior year quarter.

 

Repurchase of 1.0 million of our shares at a cost of $44.7 million.

New Accounting Standards

For this information, refer to Note B., New Accounting Standards, in the Notes to Condensed Consolidated Financial Statements, herein.

Acquisitions

For this information, refer to Note C., Acquisitions, in the Notes to Condensed Consolidated Financial Statements, herein.

Membership

The following table presents our membership as of June 30, 2008 and 2007 (amounts in thousands).

 

June 30,

Membership by Product

2008

2007

Commercial group risk

1,502

1,389

Health plan ASO

765

650

Other ASO

645

692

Total Commercial Division

2,912

2,731

 

 

 

Medicare Advantage

372

213

Medicare Part D

874

700

Total Medicare

1,246

913

 

 

 

Medicaid risk

493

396

Individual

111

41

Total Individual Consumer & Government Division

1,850

1,350

Total Membership

4,762

4,081

 

 

 

 

 

12

 

Commercial group risk membership increased 113,000 from the prior year, primarily due to members that were added through the acquisitions of Florida Health Plan Administrators, LLC (“Vista”) and of certain group health businesses from Mutual of Omaha (“Mutual”). Collectively, these resulted in an additional 166,000 members. Health plan ASO membership increased 115,000 from the prior year, primarily due to acquisitions, which contributed 99,000 members, and due to new sales and certain groups changing from a risk product to a non-risk product. Additionally, Other ASO membership decreased by 47,000 from the prior year.

Individual Consumer & Government Division membership increased 500,000 from the prior year, primarily due to organic growth in all products and expansion into new areas. Additionally, the acquisition of Vista added 142,000 members.

Results of Operations

Consolidated Financial Results

The following table is provided to facilitate a discussion regarding the comparison of our consolidated operating results for the quarters and six months ended June 30, 2008 and 2007 (dollars in thousands, except diluted earnings per share amounts).

 

 

 

 

 

Quarters Ended

 

 

 

Six Months Ended

 

 

 

 

 

June 30,

Increase

 

 

June 30,

Increase

 

 

 

 

2008

 

2007

(Decrease)

 

 

2008

 

2007

(Decrease)

Total operating revenues

 

$

2,977,904

$

2,332,492

27.7%

 

$

5,918,513

$

4,568,989

29.5%

Operating earnings

 

$

126,320

$

222,953

(43.3%)

 

$

320,643

$

403,116

(20.5%)

Operating earnings as a
      percentage of revenues

4.2%

 

9.6%

(5.4%)

 

 

5.4%

 

8.8%

(3.4%)

Net earnings

 

$

83,151

$

151,302

(45.0%)

 

$

208,180

$

273,043

(23.8%)

Diluted earnings per share

 

$

0.55

$

0.96

(42.7%)

 

$

1.36

$

1.72

(20.9%)

Selling, general and administrative

as a percentage of revenue

16.7%

 

19.0%

(2.3%)

 

 

17.0%

 

17.8%

(0.8%)

 

Quarters Ended June 30, 2008 and 2007

Managed care premium revenue increased in both our Individual Consumer & Government Division and Commercial Division. The increase is a result of growth in existing products as well as from our acquisitions described herein. Partially offsetting the increase was a decline in same store Commercial risk membership over the prior year quarter.

Management services revenue increased compared to the prior year quarter primarily as a result of continued growth in our workers’ compensation services business and the acquisition of Mutual, discussed herein. This increase was partially offset by the Other ASO membership decline described above.

Medical costs increased as a result of new business in both our Individual Consumer & Government Division and Commercial Division discussed above. Medical costs also increased due to increased Commercial medical cost trend as well as unfavorable IBNR reserve development on our Medicare Private-Fee-For-Service (“PFFS”) business. Total medical costs as a percentage of premium revenue (“medical loss ratio”) increased 6.2% from the prior year quarter as a result of our Commercial and Medicare businesses. The Commercial medical loss ratio increase is a result of higher than expected levels of inpatient and outpatient facility cost trends. To a lesser extent the increase is also due to the mix of business from the inclusion of Vista and Mutual. The increase in the Medicare PFFS medical loss ratio is a result of receiving a much higher than expected level of PFFS claims related to prior periods, as well as a resulting higher outlook for the current year. We expect the Medicare Advantage medical loss ratio to be in the mid 80’s for the last six months of 2008. The Medicare Part D medical loss ratio increase was a result of the premium rate changes from the annual competitive bid filings for our Medicare part D products as well as a widening of the risk corridors and growth in our low-income auto-assign population in 2008.

Selling, general and administrative expense increased primarily due to operating costs associated with our recent acquisitions of Mutual and Vista, as well as costs related to the growth of our Medicare business.

Depreciation and amortization expense increased as a result of the expense associated with the fixed assets and identifiable intangible assets acquired with the recent acquisitions.

Interest expense increased primarily as a result of the issuance of debt during the prior year third quarter.

Other income decreased primarily as a result of lower interest rates as well as a smaller portfolio balance.

The income tax provision decreased due to a decrease in earnings. The effective tax rate increased to 38.0%, as compared to 37.5% for the prior year quarter, primarily as a result of a change in the proportion of earnings in states with higher tax rates.

 

13

 

Six Months Ended June 30, 2008 and 2007

Managed care premium revenue increased in both our Individual Consumer & Government Division and Commercial Division. The increase is a result of growth in existing products as well as from the acquisitions described above. Partially offsetting the increase was a decline in same store Commercial risk membership over the prior year period.

Management services revenue increased compared to the prior year period primarily as a result of the acquisition of Concentra, described above, and continued organic growth in our workers’ compensation services business. This increase was partially offset by the Other ASO membership decline described above.

Medical costs increased as a result of new business in both our Individual Consumer & Government Division and Commercial Division discussed above. Medical cost also increased due to increased Commercial medical cost trend as well as unfavorable IBNR reserve development on our Medicare PFFS business. The Medicare Part D medical loss ratio increase over the prior year period was driven by a widening of the risk corridors and growth in our low-income auto-assign population in 2008.

 

Medical costs for the six months ended June 30, 2008 included approximately $34.2 million of favorable medical cost development related to prior calendar years. On a full year basis we expect favorable development related to prior calendar years to be slightly higher than that recorded for the first half of 2008. Comparatively, medical costs for the six months ended June 30, 2007, included approximately $111.8 million of favorable medical cost development related to prior calendar years. For the full year of 2007 we experienced favorable medical cost development of $135.1 million. The decline in favorable development during the 2008 six month period was primarily a result of receiving a higher than expected level of Medicare PFFS claims in 2008 related to the 2007 period, which was inconsistent with claims submission patterns of our network based Medicare Advantage products. In particular, the lag in claims submission on this product was longer than we had assumed at the end of 2007 and longer than what we experienced on our Medicare Advantage HMO business.

Selling, general and administrative expense increased primarily due to normal operating costs associated with our recent acquisitions of Concentra, Mutual and Vista, as well as costs related to growth of our Medicare business.

Depreciation and amortization expense increased as a result of the expense associated with the identifiable intangible assets acquired with the recent acquisitions.

Interest expense increased primarily as a result of the issuance of debt during the prior year. The increase is partially offset by the redemption during the first quarter of 2007 of our $170.5 million of outstanding 8.125% senior notes due February 15, 2012. Associated with this redemption, we recognized $9.1 million of interest expense in the prior year first quarter for both the premium paid on redemption as well as the write off of associated deferred financing costs.

Other income decreased primarily as a result of lower interest rates as well as a smaller portfolio balance.

The income tax provision decreased due to a decrease in earnings. The effective tax rate increased to 37.9%, as compared to 37.2% for the prior year six months, primarily as a result of a change in the proportion of earnings in states with higher tax rates.

Segment Results

We have three reportable segments: Commercial, Individual Consumer & Government, and Specialty. Each of these segments is separately managed and separate operating results are available that are evaluated by the chief operating decision maker. Beginning in 2008, in order to reflect a change in the manner in which we manage our operations, our network rental business operations were reclassified from our Commercial Division to our Specialty Division. Our network rental business results for the 2007 period have been reclassified to conform to the 2008 presentation. The Commercial Division is comprised of all of our commercial employer-focused businesses, including the traditional health plan group risk and ASO products as well as the National Accounts and FEHBP. The Individual Consumer & Government Division contains our individual consumer products and all Medicare and Medicaid products. The Specialty Division includes our workers’ compensation services businesses, network rental business and the newly acquired mental-behavioral health benefits business of Mental Health Network Institutional Services, Inc. (“MHNet”) and the dental benefits business of Group Dental Services (“GDS”).

 

14

 

 

Quarters Ended
June 30,

Increase

 

Six Months Ended
June 30,

Increase

 

2008

2007

(Decrease)

 

2008

2007

(Decrease)

Operating Revenues (in thousands)

 

 

 

 

 

 

 

 

Commercial group risk premiums

$ 1,291,560

$1,134,278

$ 157,282

 

$2,579,699

$2,267,804

$   311,895

Commercial ASO

82,323

94,628

(12,305)

 

168,467

193,243

(24,776)

Total Commercial Division 

1,373,883

1,228,906

144,977

 

2,748,166

2,461,047

287,119

Medicare risk premiums

997,406

657,652

339,754

 

1,989,829

1,326,107

663,722

Medicaid risk premiums

285,024

207,937

77,087

 

567,203

416,075

151,128

Individual risk premiums

57,892

16,527

41,365

 

111,447

29,379

82,068

Medicaid ASO

43,191

46,716

(3,525)

 

86,803

96,321

(9,518)

Total Individual Consumer & Gov't Division

1,383,513

928,832

454,681

 

2,755,282

1,867,882

887,400

Total Specialty Division 

229,296

176,172

53,124

 

428,764

242,783

185,981

Eliminations

(8,788)

(1,418)

(7,370)

 

(13,699)

(2,723)

(10,976)

 

Total Operating Revenues 

$ 2,977,904

$2,332,492

$ 645,412

 

$5,918,513

$4,568,989

$1,349,524

 

 

Gross Margin (in thousands)

 

Commercial Division

$ 306,586

$ 347,623

$ (41,037)

 

$   668,595

$   692,632

$ (24,037)

Individual Consumer & Gov't Division

187,441

204,400

(16,959)

 

411,172

373,761

37,411

Specialty Division

169,842

148,563

21,279

 

327,542

215,174

112,368

Eliminations

(2,190)

(1,140)

(1,050)

 

(4,090)

(2,164)

(1,926)

Total  

$ 661,679

$ 699,446

$ (37,767)

 

$1,403,219

$1,279,403

$ 123,816

 

Revenue and Medical Cost Statistics

 

Managed Care Premium Yields (per member per month):

 

Health plan commercial risk

$ 285.32

$ 271.39

5.1%

 

$ 284.41

$ 271.21

4.9%

 

Medicare Advantage risk (1)

$ 879.79

$ 836.17

5.2%

 

$ 865.68

$ 835.19

3.7%

 

Medicare Part D (2)

$   89.92

$ 101.49

(11.4%)

 

$   89.29

$   99.37

(10.1%)

 

Medicaid risk

$ 193.59

$ 174.48

11.0%

 

$ 193.87

$ 175.78

10.3%

Medical Loss Ratios:

 

Health plan commercial risk

82.7%

77.5%

5.2%

 

80.7%

78.0%

2.7%

 

Medicare Advantage risk

93.2%

79.3%

13.9%

 

88.3%

80.7%

7.6%

 

Medicare Part D

86.0%

80.3%

5.7%

 

96.1%

89.0%

7.1%

 

Medicaid risk

86.4%

91.7%

(5.3%)

 

85.4%

89.1%

(3.7%)

 

Total 

85.8%

79.6%

6.2%

 

84.2%

80.8%

3.4%

(1) Revenue PMPM excludes the impact of revenue ceded to external parties

(2) Revenue PMPM excludes the impact of CMS risk-share premium adjustments and revenue ceded to external parties

 

Commercial Division

Quarters and Six Months Ended June 30, 2008 and 2007

Commercial group risk premium revenue increased for the quarter and six months ended June 30, 2008 from the same periods in 2007 as a result of the acquisitions of Mutual and Vista, which accounted for $151 million in current quarter revenue and $302 million for the six months ended June 30, 2008. The increase was also a result of an increase in average realized premium yields per member per month in our commercial group risk business, resulting from renewal rate increases net of benefit buy downs on renewing groups and the mix of new group business net of terminated groups. This increase in revenue was partially offset by membership declines in our same store commercial group risk business. However, a portion of those members changed from our risk products to our non-risk products.

Commercial management services revenue declined from the prior year periods due to membership losses in our national accounts non-risk business as well as due to fee negotiations related to the long-term renewal of our contract as plan administrator to the Mail Handler’s Benefit Plan. These declines are partially offset by an increase in our commercial health plan ASO membership.

 

15

 

Gross margin decreased as a result of the increase in the Commercial health plan medical loss ratio in 2008 compared to 2007 and the decline in commercial management services revenue discussed above. The decrease is partially offset by the gross margin derived from the acquisitions discussed above.

Individual Consumer & Government Division

Quarters and Six Months Ended June 30, 2008 and 2007

Individual Consumer & Government Division revenue increased for the quarter and six months ended June 30, 2008 from the same periods in 2007 as a result of membership growth from our Medicare Advantage business, as well as increased Medicare Part D, Medicaid and Individual membership, both organic and acquired.

Medicare Advantage risk premium yields, excluding the effect of revenue ceded to external parties, per member per month increased as a result of the rate increases from the annual competitive bid filings for our Medicare Advantage products as well as from increases in risk factor adjustment scores for our Medicare Advantage products. With the effect of the ceded revenue being included in the premium yield, the Medicare Advantage risk premium yields per member per month for the six month period ending June 30 decreased to $747.36 in 2008 from $802.97 in 2007. The decrease is a result of a larger portion of our Medicare PFFS business in 2008 being ceded to external parties through quota share arrangements. This average premium yield decrease was partially offset by the annual competitive bid filings and risk factor scores noted above.

Part D premium yields for the six month period ending June 30, 2008 excluding the effect of CMS risk sharing premium adjustments and revenue ceded to external parties, have declined in 2008 compared to 2007 primarily due to the annual competitive bid filings for our Part D products as well as the mix of products sold. Including the effect of the CMS risk sharing premium adjustments as well as the ceded revenue, the yields were $92.60 in 2008 compared to $99.26 in 2007.

When reviewing the premium yield for Medicare Advantage and Part D business, adjusting for the ceded revenue is useful for comparisons to competitors that may not have similar ceding arrangements. When reviewing the Medicare Part D business, adjusting for the risk share amounts is useful to understand the results of the Part D business because of our expectation that the risk sharing revenue will eventually be insignificant on a full year basis.

Medicaid premium yields increased for the quarter and six month 2008 periods as a result of a rate increase in Missouri, our largest Medicaid market, effective July 1, 2007, as well as the inclusion in our results of Vista, which has a higher Medicaid premium yield.

The decrease in gross margin for the quarter ended June 30, 2008 was driven by increased medical costs associated with our Medicare PFFS business in 2008. This decrease is partially offset by higher gross margins for our Medicaid HMO and Individual businesses associated with the membership growth, both organic and acquired, as discussed above. Medicare Part D medical costs as a percentage of premium revenue have increased over the prior year quarter as a result of a widening of the risk corridors and growth in our low-income auto-assign population in 2008. Medicaid medical costs as a percentage of premium revenue decreased over the prior year quarter as a result of the premium yield increases discussed above.

Specialty Division

Quarters and Six Months Ended June 30, 2008 and 2007

Specialty Division revenue increased primarily as a result of the acquisition of Concentra during the second quarter of 2007, as well as continued organic growth in our workers’ compensation services business. The increase was also a result of the acquisition of MHNet in the first quarter of 2008 and to a lesser extent the acquisition of GDS in the second quarter of 2008.

Specialty Division gross margin increased during the quarter and six month 2008 periods as a result of the revenue increases discussed above partially offset by an increase in medical costs and costs of sales associated with the revenue growth.

Liquidity and Capital Resources

Liquidity

Our investment guidelines require our fixed income securities to be investment grade in order to provide liquidity to meet future payment obligations and minimize the risk to the principal. The fixed income portfolio includes government and corporate securities with an average quality rating of “AA+” and a modified duration of 3.8 years as of June 30, 2008. Typically, the amount and duration of our short-term assets are more than sufficient to pay for our short-term liabilities, and we do not anticipate that sales of our long-term investment portfolio will be necessary to fund our claims liabilities.

 

16

 

Our cash and investments, consisting of cash and cash equivalents and short-term and long-term investments, but excluding deposits of $63.0 million at June 30, 2008, and $64.4 million at December 31, 2007, that are restricted under state regulations, decreased $363.9 million to $2.4 billion at June 30, 2008, from $2.8 billion at December 31, 2007.

We have classified all of our investments as available–for–sale. Our investments at June 30, 2008, mature according to their contractual terms, as follows, in thousands (actual maturities may differ because of call or prepayment rights):

 

 

Amortized

 

Fair

 

 

Cost

 

Value

Maturities:

 

 

 

 

 

 

Within 1 year

$

88,246

 

$

88,521

 

1 to 5 years

 

498,260

 

 

499,024

 

5 to 10 years

 

355,141

 

 

353,759

 

Over 10 years

 

611,974

 

 

605,037

Total

$

1,553,621

 

 

1,546,341

Investments accounted for under the equity method

53,556

Total short-term & long-term investments

 

 

 

$

1,599,897

The demand for our products and services is subject to many economic fluctuations, risks and uncertainties that could materially affect the way we do business. Please refer to the section entitled “Risk Factors” in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10–K for the year ended December 31, 2007, for more information. Management believes that the combination of our ability to generate cash flows from operations, our cash and investments on hand and the excess funds held in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures, debt interest costs, debt principal repayments and other reasonably likely future cash requirements.

Cash Flows

Net cash from operating activities for the six months ended June 30, 2008, was an inflow primarily due to net earnings and an increase in medical liabilities, partially offset by federal tax payments during the period that exceeded the tax provision and CMS related accruals. The increase in medical liabilities during the current period primarily resulted from the increase in medical costs discussed herein as well as the growth in Medicare PFFS business during 2008.

Our net cash from operating activities for the six months ended June 30, 2007 was $510.4 million higher than the corresponding 2008 period, primarily because we received seven monthly CMS payments in the first six months of 2007 instead of the normal six. This additional CMS receipt totaled $311.8 million. Additionally, the increase in total medical liabilities during the six month 2007 period was $89.3 million greater than the increase during the 2008 period. This was primarily the result of the addition of the PFFS product in January 2007, which resulted in the addition of approximately 125,100 members during the 2007 period. The nature of our business is such that premium revenues are generally received up to two months prior to the expected cash payment for the related medical costs. This results in strong cash inflows upon the implementation of a benefit program. Additionally, $64.9 million in higher net earnings during the six month 2007 period contributed to the higher net cash from operating activities in the 2007 period.

Net cash from investing activities for the six months ended June 30, 2008, was an inflow primarily due to proceeds received from the sale and maturity of investments. This inflow was partially offset by investment purchases and cash paid for the MHNet acquisition in February 2008 and GDS acquisition in May 2008. The increase in cash from investing activities during the six month 2008 period primarily results from less purchases of investments and lower acquisition costs compared to the 2007 six month period.

Projected capital expenditures for 2008 of approximately $65 - $75 million consist primarily of computer hardware, software and other equipment.

Net cash from financing activities for the six months ended June 30, 2008, was an outflow primarily due to payments to repurchase our common stock and payments for the retirement of debt. The increase in the cash outflow from financing activities during the six month 2008 period primarily results from less debt issuance proceeds, partially offset by lower stock repurchase costs compared to the 2007 six month period.

Under our share repurchase program we purchased 1.0 million shares and 4.2 million shares of our common stock during the quarter and six months ended June 30, 2008, respectively, at an aggregate cost of $44.7 million and $215.4 million, respectively. As of June 30, 2008, the total remaining number of common shares that we are authorized to repurchase under this program is 9.9 million.

 

17

 

Health Plans

Our regulated Health Maintenance Organization (“HMO”) and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends our parent Company may receive from our regulated subsidiaries. During the quarter ended June 30, 2008, we received $288.6 million in dividends from our regulated subsidiaries, and we made $10.3 million in capital contributions to them.

The majority of states in which we operate health plans have adopted a risk-based capital (“RBC”) policy that recommends the health plans maintain statutory reserves at or above the “Company Action Level,” which is currently equal to 200% of their RBC. The State of Florida does not currently use RBC methodology in its regulation of HMOs. Some states in which our regulated subsidiaries operate require deposits to be maintained with the respective states’ departments of insurance. The table below summarizes our statutory reserve information, as of June 30, 2008 and December 31, 2007 (in millions, except percentage data):

 

 

June 30, 2008

 

December 31, 2007

 

 

 

(unaudited)

 

(unaudited)

 

Regulated capital and surplus

 

$ 1,028.5

 

$ 1,209.6

 

200% of RBC

 

$    562.2

(a)

$    562.2

(a)

Excess capital and surplus above 200% of RBC

$    466.3

(a)

$    647.4

(a)

Capital and surplus as percentage of RBC

 

366%

(a)

430%

(a)

Statutory deposits

 

$      63.0

 

$      64.4

 

 

 

 

 

 

 

(a) As mentioned above, the State of Florida does not have a RBC requirement for its regulated HMOs. Accordingly, the statutory reserve information provided for Vista is based on the actual statutory minimum capital required by the State of Florida.

 

The decrease in capital and surplus for our regulated subsidiaries primarily results from the timing of dividends paid to the parent company during the quarter.

We believe that all of our subsidiaries that incur medical claims maintain more than adequate liquidity and capital resources to meet these short-term obligations as a matter of both Company policy and state insurance regulations.

Excluding funds held by entities subject to regulation and excluding our equity method investments, we had cash and investments of approximately $199.9 million and $436.2 million at June 30, 2008 and December 31, 2007, respectively. The decrease during the six month 2008 period was due to payments for share repurchases, payments on debt, and payments for the acquisitions of MHNet and GDS. These payments were partially offset by dividends received from our regulated subsidiaries in the 2008 period.

Outlook

Within our suite of Medicaid products, as previously disclosed, we were notified of the termination of our Pennsylvania Medicaid behavioral health contract representing approximately 107,000 members, effective July 1, 2008. Given the nature of this globally capitated contract, we earned a low single digit operating margin. Our core Medicaid risk business performed well in the first half of 2008 and we expect that to continue throughout 2008.

Specialty Division – We continue to seek additional strategically related businesses for this division, most recently acquiring GDS, a dental service company, and the acquisition in the first quarter of MHNet, a mental-behavioral health company. These acquisitions are not expected to have a material effect on the Company’s full year 2008 results of operations.

Share Repurchases - The Company has already repurchased 3.1 million shares early in the third quarter of 2008 for a total year-to-date repurchase activity of 7.3 million shares. The Company expects to make additional share repurchases, as appropriate, through the remainder of the year.

Legal Proceedings

For this information, refer to Note E., Contingencies, in the Notes to Condensed Consolidated Financial Statements, herein.

 

18

 

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

These disclosures should be read in conjunction with the condensed consolidated financial statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and other information presented herein as well as in the “Quantitative and Qualitative Disclosures About Market Risk” section contained in our Annual Report on Form 10–K for the year ended December 31, 2007.

No material changes have occurred in our exposure to market risk since the date of our Annual Report on Form 10–K for the year ended December 31, 2007.

ITEM 4: Controls and Procedures

We have performed an evaluation as of the end of the period covered by this report of the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934), under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

There have been no significant changes in our internal control over financial reporting (as defined in Rule 13a–15(f) promulgated under the Securities and Exchange Act of 1934) during the quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 4T: Not Applicable

 

PART II. OTHER INFORMATION

 

ITEM 1: Legal Proceedings

For this information, refer to Note E., Contingencies, in the Notes to Condensed Consolidated Financial Statements, herein.

ITEM 1A: Risk Factors

There have been no material changes with respect to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents information about our purchases of our common stock during the quarter ended June 30, 2008 (in thousands, except average price paid per share information).

 

 

Total Number of Shares Purchased (1)

 

Average Price Paid per Share

Total Number of Shares Purchased as Part of Publicly Announced Plans

Maximum Number of Shares That May Yet Be Purchased Under The Plan or Program (2)

 

April 1-30, 2008

 

3

$

41.01

-

3,326

May 1-31, 2008

 

1,048

$

44.81

1,000

9,859

June 1-30, 2008

 

61

$

36.35

-

9,859

 

 

 

 

 

 

 

Totals

 

1,112

$

44.34

1,000

9,859

 

(1)     Includes shares purchased in connection with the vesting of restricted stock awards to satisfy employees’ minimum statutory tax withholding obligations.

(2)     These shares are under a stock repurchase program previously announced on December 20, 1999, as amended. In May 2008, our Board of Directors approved an increase to the repurchase authorization in an amount equal to 5% of our outstanding common stock, thus increasing our repurchase authorization by 7.5 million shares.

 

 

ITEM 3: Not Applicable

 

 

19

 

ITEM 4: Submission of Matters to a Vote of Security Holders

We held our Annual Meeting of Stockholders on May 15, 2008. An aggregate of 139,090,882 shares of Common Stock, or 91.7% of the Company’s outstanding shares, were represented at the meeting either in person or by proxy and accordingly, the meeting was duly constituted. The following proposals were adopted by a plurality (Proposal One) or majority (Proposal Two) of the shares voting for each proposal as follows:

Proposal One: To elect three Class II Directors to serve until the annual meeting of stockholders in 2011.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NUMBER OF SHARES/PERCENTAGE OF COMMON STOCK

 

 

 

NAME

FOR

%

WITHHELD

%

 

 

 

Joel Ackerman

130,628,441

93.92%

8,462,441

6.08%

 

 

Lawrence N. Kugelman

126,025,469

90.61%

13,065,413

9.39%

 

 

Dale B. Wolf

128,669,259

92.51%

10,421,623

7.49%

 

Proposal Two: To ratify the appointment of Ernst & Young LLP as the Company’s independent auditors for 2008.

 

 

 

 

 

 

 

 

 

FOR

137,837,283

99.10%

 

 

 

 

AGAINST

216,016

0.15%

 

 

 

 

ABSTAIN

1,037,583

0.75%

 

 

 

 

 

 

 

139,090,882

 

 

 

 

ITEM 5: Not Applicable

 

ITEM 6: Exhibits

Exhibit

 

 

No.

 

Description of Exhibit

 

 

 

31.1

 

Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Dale B. Wolf, President, Chief Executive Officer and Director.

 

 

 

31.2

 

Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Shawn M. Guertin, Executive Vice President, Chief Financial Officer and Treasurer.

 

 

 

32

 

Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 made by Dale B. Wolf, President, Chief Executive Officer and Director and Shawn M. Guertin, Executive Vice President, Chief Financial Officer and Treasurer.

 

 

20

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

 

 

 

 

 

 

 

COVENTRY HEALTH CARE, INC.

 

 

 

 

(Registrant)

 

 

 

 

 

 

 

 

 

 

 

Date:

August 7, 2008

 

By: /s/ Dale B. Wolf

 

 

 

 

Dale B. Wolf

 

 

 

 

President, Chief Executive Officer and Director

 

 

 

 

 

 

 

 

 

 

 

Date:

August 7, 2008

 

By: /s/ Shawn M. Guertin

 

 

 

 

Shawn M. Guertin

 

 

 

 

Executive Vice President, Chief Financial Officer and Treasurer

 

 

 

 

 

 

 

 

 

 

 

Date:

August 7, 2008

 

By: /s/ John J. Ruhlmann

 

 

 

 

John J. Ruhlmann

 

 

 

 

Senior Vice President and Corporate Controller

 

 

 

 

 

 

 

 

 

21

 

 

INDEX TO EXHIBITS

Reg. S-K: Item 601

 

Exhibit

 

 

No.

 

Description of Exhibit

 

 

 

31.1

 

Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Dale B. Wolf, President, Chief Executive Officer and Director.

 

 

 

31.2

 

Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Shawn M. Guertin, Executive Vice President, Chief Financial Officer and Treasurer.

 

 

 

32

 

Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 made by Dale B. Wolf, President, Chief Executive Officer and Director and Shawn M. Guertin, Executive Vice President, Chief Financial Officer and Treasurer.

 

 

 

 

22

 

 

 

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Dale B. Wolf, certify that:

  1. I have reviewed this quarterly report on Form 10-Q of Coventry Health Care, Inc.;

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

  3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

  4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

    1. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

    2. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

    3. evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

    4. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

  5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

    1. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

    2. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



By: /s/ Dale B. Wolf


Dale B. Wolf
President, Chief Executive Officer and Director
Date: August 7, 2008

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Shawn M. Guertin, certify that:

  1. I have reviewed this quarterly report on Form 10-Q of Coventry Health Care, Inc.;

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

  3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

  4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

    1. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

    2. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

    3. evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

    4. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

  5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

    1. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

    2. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By: /s/ Shawn M. Guertin


Shawn M. Guertin
Executive Vice President, Chief Financial Officer and Treasurer
Date: August 7, 2008

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Coventry Health Care, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2008, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned hereby certifies, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:

(1)  

The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and


(2)  

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


Date: August 7, 2008

By: /s/ Dale B. Wolf


Dale B. Wolf
President, Chief Executive Officer and Director
 
 

By: /s/ Shawn M. Guertin


Shawn M. Guertin
Executive Vice President, Chief Financial Officer and Treasurer