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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004

OR

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _________________

COMMISSION FILE NUMBER 1-16477

COVENTRY HEALTH CARE, INC.

(Exact name of registrant as specified in its charter)

6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817
(Address of principal executive offices) (Zip Code)

(301) 581-0600
(Registrant’s telephone number, including area code)

      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 þ No¨

     Indicate by check mark whether the registrant is an accelerated filer (as defined in the Securities Exchange Act of 1934 Rule 12b-2). Yes þ No¨

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

COVENTRY HEALTH CARE, INC.
FORM 10-Q
TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1: Financial Statements

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)

See accompanying notes to the condensed consolidated financial statements.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

See accompanying notes to the condensed consolidated financial statements.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See accompanying notes to the condensed consolidated financial statements.

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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 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 have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s most recent Annual Report on Form 10–K for the year ended December 31, 2003.

        On December 23, 2003, the Company’s Board of Directors approved a three–for–two stock split of the Company’s common stock. The stock split, in the form of a stock dividend, was distributed January 30, 2004 to stockholders of record on January 9, 2004. The stock split is reflected retroactively in the Company’s condensed consolidated financial statements and notes thereto for all periods presented.

B.     SIGNIFICANT ACCOUNTING POLICIES

        Stock–based Compensation – The Company accounts for stock–based compensation to employees under Accounting Principles Board (“APB”) No. 25 – “Accounting for Stock Issued to Employees,” and complies with the disclosure requirements for Statement of Financial Accounting Standards (“SFAS”) No. 123 – “Accounting for Stock–Based Compensation” and SFAS No. 148 – “Accounting for Stock–Based Compensation – Transition and Disclosure.” Unless the accounting rules change, the Company does not expect to transition to the fair value method of accounting for stock–based compensation. Had stock–based compensation cost been determined consistent with SFAS No. 123, the Company’s net earnings and earnings per share (“EPS”) would have been reduced to the following pro–forma amounts (in thousands, except per share data):

C.     ACQUISITION

        On May 17, 2004, the Company announced that its subsidiary, Coventry Health of Michigan, had entered into a definitive agreement with the OmniCare Health Plan and its rehabilitator to purchase certain assets of OmniCare including approximately 63,000 Medicaid members. The effective date of the acquisition is expected to be October 1, 2004 when the new Medicaid contract year commences, subject to closing conditions, regulatory and other customary approvals.

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D.     SENIOR NOTES

        The Company’s senior notes contain certain covenants and restrictions regarding incurring additional debt, limiting dividends or other restricted payments, and restricting transactions with affiliates, sales of assets and consolidations or mergers. The Company has complied with all covenants under the senior notes.

E.     CONTINGENCIES

        In the normal course of business, the Company has been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions, employment related claims and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through June 30, 2004 may result in the assertion of additional claims.

        The Company’s captive subsidiary provides up to $5 million in professional liability coverage for each single claim and up to $10 million in coverage for each class action claim. The captive professional liability policy has an aggregate limit of $20 million per year. The captive is also co–insured with a commercial carrier for an additional $10 million for professional liability claims made and reported prior to May 1, 2004. For claims made and reported after May 1, 2004, the Company has chosen to have no co–insurance coverage with a commercial carrier. Additionally, the captive employment practices liability policy provides up to $250,000 per single claim, $10 million per class action claim, and an aggregate policy limit of $10 million. Each year the Company will re–evaluate the most cost effective method for insuring these types of claims.

        Coventry Health Care, Inc. is a defendant in the provider track in the Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, Multi-District Litigation (“MDL”) No. 1334, styled in re: Humana, Inc., Charles B. Shane, MD, et al. vs. Humana, Inc., et al. This action was filed by a group of physicians as a class action against Coventry and twelve other companies in the managed care industry. In its fourth amended complaint, the plaintiffs have alleged violations of the federal racketeering act, Racketeer Influenced and Corrupt Organizations (“RICO”), conspiracy to violate RICO and aiding and abetting a scheme to violate RICO. In addition to these RICO claims, the complaint includes counts for breach of contract, violations of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. Coventry has filed a motion to dismiss each of these claims because they fail to state a cause of action or, in the alternative, to compel arbitration pursuant to the arbitration provisions which exist in the Company’s physician contracts. In response to the motion to dismiss, the trial court dismissed several of the claims and ordered that all physicians who have an arbitration provision in their provider contracts must submit all of their claims to arbitration. As a consequence of this ruling, all the plaintiffs who have arbitration provisions voluntarily dismissed all of their claims that are subject to arbitration. In response to the trial court’s order, the defendants filed demands to arbitrate the plaintiffs’ arbitrable claims. The trial court, however, in response to a motion filed by the plaintiffs, entered an order enjoining the defendants from arbitrating those claims. The defendants appealed the trial court’s order and were successful in having the 11th Circuit Court of Appeals overturn the order and dissolve the injunction barring arbitration of the plaintiffs’ arbitrable claims. As a result of the 11th Circuit dissolving the injunction, the defendants have filed a motion with the trial court to stay the Shane lawsuit pending arbitration of the plaintiffs’ arbitrable claims. The trial court has not yet ruled on the defendants’ motion to stay. The trial court however has made the determination that, the plaintiffs’ claims of conspiracy, conspiracy to violate RICO and aiding and abetting violations of RICO are not subject to arbitration. The defendants, including Coventry, have appealed the trial court’s decision to the 11th Circuit Court of Appeals. The appeal has been fully briefed and the parties are awaiting a date for oral argument. The trial court has certified various subclasses of physicians; however, Coventry is not subject to the class certification order because the motion to certify was filed before Coventry was joined as a defendant. The plaintiffs have now filed a motion to certify a class as to Coventry, and Coventry has filed their opposition to that motion. The trial court has not yet issued a ruling on the motion. The defendants who were subject to the certification order filed an appeal to the 11th Circuit which has been argued. The appeals court has not yet issued its decision. Subsequent to this appeal, two defendants have entered into settlement agreements with the plaintiffs. Both settlement agreements have been filed with the Court and have received final approval. 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 to Shane. The court has entered an order which stays all proceedings in the tag–along actions until all pre–trial proceedings in Shane have been concluded. Although the Company can not predict the outcome, management believes that the Shane lawsuit and tag–along actions will not have a material adverse effect on its financial position or its results of operations. Management also believes that the claims asserted in these lawsuits are without merit, and the Company intends to defend its position.

F.     RESTRICTED STOCK AWARDS

        In the second quarter of 2004, the Company awarded 518,500 shares of restricted stock subject to certain performance criteria and with varying vesting periods through May 2008. The fair value of the restricted shares, at the measurement date, is amortized over the vesting period. The fair value of the restricted shares is $48.90 per share. There were no restricted stock awards granted during the first quarter of 2004. The Company recorded compensation expense related to restricted stock grants, including restricted stock granted in prior periods of approximately $3.5 million and $2.2 million for the quarters ended June 30, 2004 and 2003, respectively, and $6.4 million and $4.0 million for the six months ended June 30, 2004 and 2003, respectively. The deferred portion of the restricted stock as reported in additional paid in capital is $42.3 million at June 30, 2004 and $23.4 million at December 31, 2003.

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G.    SHARE REPURCHASE PROGRAM

        Under a share repurchase program previously approved by the Board of Directors, the Company purchased 2.0 million shares of the Company’s common stock during the first quarter of 2004 at an aggregate cost of $84.6 million. There were no shares repurchased during the current quarter under this program. The program authorized 9.4 million shares to be repurchased and the total remaining common shares the Company is authorized to repurchase under this program is 1.8 million. Excluded from these amounts are shares purchased in exchange for employee payroll taxes on vesting of restricted stock awards as these purchases are not part of the program.

H.     SEGMENT INFORMATION

        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, can not be reported by segment. The following tables summarize the Company’s reportable segments through gross margin and include a medical loss ratio (“MLR”) calculation:

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I.     COMPREHENSIVE INCOME

        Comprehensive income for the quarters and six months ended June 30, 2004 and 2003 was as follows (in thousands):

        The unrealized loss on the Company’s investment portfolio for the second quarter of 2004 was a result of an increase in interest rates during the second quarter of 2004.

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

Quarters and Six Months Ended June 30, 2004 and 2003

        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 II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10–K for the year ended December 31, 2003. Actual operations and results may differ materially from those expressed in this Form 10–Q.

        The following discussion and analysis relates to our financial condition and results of operations for the quarters ended and six months ended June 30, 2004 and 2003. 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, 2003, including the critical accounting policies discussed therein.

Highlights of Second Quarter 2004 Performance
wMembership increased 14% over the prior year quarter.
wRevenue increased 19% over the prior year quarter.
wMedical loss ratio of 80.3% improved 60 basis points over the prior year quarter.
wSelling, general and administrative expenses were 11.6% of operating revenue, a 30 basis point improvement over the prior year quarter.
wOperating margin of 9.4% improved 110 basis points over the prior year quarter.
wDiluted earnings per share increased 33% over the prior year quarter.
wCash flows from operations was $118.2 million compared to net income of $84.0 million.

Stock split

        On December 23, 2003, our Board of Directors approved a three–for–two stock split of our common stock, effective January 30, 2004 for stockholders of record on January 9, 2004. The stock split is reflected retroactively in per share data for all periods presented.

Acquisition

        On May 17, 2004, we announced that its subsidiary, Coventry Health of Michigan, had entered into a definitive agreement with the OmniCare Health Plan and its rehabilitator to purchase certain assets of OmniCare including approximately 63,000 Medicaid members. The effective date of the acquisition is expected to be October 1, 2004 when the new Medicaid contract year commences, subject to closing conditions, regulatory and other customary approvals.

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Membership

        The following tables present our membership as of June 30, 2004 and 2003 (amounts in thousands).

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        Total membership, excluding network rental membership of 681,000, increased by 14% from the prior year second quarter. Risk membership has increased 11% and non–risk membership increased 29% from the prior year second quarter. The increases are both attributable to the acquisition of Altius (Utah) in the third quarter of 2003 and from additional organic membership. We expect organic membership growth to be 3–5% for the full year.

Results of Operations

        The following table is provided to facilitate a more meaningful discussion regarding the comparison of our operations for the quarters and six months ended June 30, 2004 and 2003.