The lease for our Virginia Beach call and data centers facility terminates in September 2004. We entered into a 15-year lease, dated as of September 15, 2003, for a new 106,000 square-foot building in Virginia Beach,
Virginia, construction for which is scheduled to be completed in September 2004. At this facility we will locate our Virginia Beach call center, our primary data center and other support functions.
The following selected consolidated financial data should be read in connection with the financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Form 10-K. Selected financial data as of and for each of the years in the five-year
We are a multi-state managed health care company focused on serving people who receive health care benefits through publicly sponsored programs, including Medicaid, SCHIP and FamilyCare. We were founded in December 1994 with the objective to become the leading managed care organization in the United States focused on serving people who receive these types of benefits. Calendar year 2003 was our second full-year as a public company and our first year trading on the New York Stock Exchange.
Expanding in existing service areas - Our 2003 same-store premium revenues increased 11.5% over 2002.
In 2003, our health benefits ratio was 80.2% versus 81.0% in the 2002. Through effective early case finding, disease management, reductions in membership related to less profitable products and continued improvement in our claims payment efficiencies, our medical costs remain stable and predictable.
In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates and the differences could be significant. We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Our results of operations depend on our ability to effectively manage expenses related to health benefits, as well as our ability to accurately predict costs incurred in recording the amounts in our consolidated financial statements. Expenses related to health benefits have two components: direct medical expenses and medically related administrative costs. Direct medical expenses include fees paid to hospitals, physicians and providers of ancillary medical services, such as pharmacy, laboratory, radiology, dental and vision. Medically related administrative costs include expenses related to services such as health promotion, quality assurance, case management, disease management and 24-hour on-call nurses. Direct medical expenses also include estimates of medical expenses incurred but not yet reported, or IBNR. For the year ended December 31, 2003, approximately 93% of our direct medical payments related to fees paid on a fee-for-service basis to our PCPs, specialist physicians and other providers, including fees paid to third-party vendors for ancillary services. The balance related to fees paid on a capitation, or per member, basis. Primary care and specialist physicians not paid on a capitated basis are paid on a maximum allowable fee schedule set forth in the contracts with our providers. We reimburse hospitals on a negotiated per diem, case rate or an agreed upon percent of their standard charges. In Maryland, the state sets the amount reimbursed to hospitals.
Changes in estimates of incurred claims for prior years recognized during 2003, 2002 and 2001 were attributable to lower than anticipated utilization and pricing of medical services.
Changes in estimates are primarily the result of obtaining more complete claims information that directly correlates with the claims and provider reimbursement trends. Since our estimates are based upon the blended per-member, per-month claims experience, changes cannot typically be explained by any single factor, but are the result of a number of interrelated variables, all influencing the resulting experience. These variables include fluctuations in claims payment patterns, changes in membership levels, number and mix of products, benefit structure, severity of illness and authorization trends. We believe there will be less volatility as we increase in size and gain more maturity in our markets.
As of December 31, 2003 and 2002, we had goodwill and other intangible assets of $144.4 million and $26.0 million, respectively, net of accumulated amortization. We review our intangible assets with defined lives for impairment whenever events or changes in circumstances indicate we might not recover their carrying value. We assess our goodwill for impairment at least annually. In assessing the recoverability of these assets, we must make assumptions regarding estimated future utility and cash flows and other internal and external factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets.
The following table sets forth selected operating ratios for the years ended December 31, 2003, 2002 and 2001. All ratios, with the exception of the health benefits ratio, are shown as a percentage of total revenues.
Expenses relating to health benefits for the year ended December 31, 2003 increased $362.3 million, or 38.8%, to $1,295.9 million from $933.6 million for the year ended December 31, 2002. The increase was primarily due to the increase in membership. The health benefits ratio, as a percentage of premium revenue, for the year ended December 31, 2003 was 80.2% compared to 81.0% in 2002.
Expenses relating to health benefits for the year ended December 31, 2002 increased $224.6 million, or 31.7%, to $933.6 million from $709.0 million for the year ended December 31, 2001. The increase was primarily due to the increase in membership. The health benefits ratio, as a percentage of premium revenue, for the year ended December 31, 2002 was 81.0% compared to 80.5% in 2001. The slight increase in the health benefits ratio is primarily due to variations in levels of seasonality from 2001 to 2002 and changes in the mix of members by product.
Income tax expense for 2002 was $32.7 million with an effective tax rate of 41.0% as compared to $26.1 million in 2001 and an effective tax rate of 42.0%. The effective tax rate decreased in 2002 due primarily to increased levels of investments in tax-advantaged securities.
Cash flows from operations was $128.4 million for the year ended December 31, 2003 compared to $117.9 million for the year ended December 31, 2002. The increase in cash from operations is primarily due to the impact of an early receipt of premium revenue received in 2003 attributable to operations in 2004 and increases in depreciation and amortization expense. As of December 31, 2003, we had working capital of $127.6 million.
Cash used in investing activities decreased to $27.8 million for the year ended December 31, 2003 from $143.5 million for the year ended December 31, 2002. The decrease in cash used in investing activities was primarily due to an escrow deposit made in connection with the acquisition of PHP and related costs of $124.1 million in 2002. We currently anticipate that our 2004 capital expenditures will be approximately $34 million.
Our investment policies are designed to provide liquidity, preserve capital and maximize total return on invested assets. As of December 31, 2003, our investment portfolio consisted primarily of fixed-income securities. The weighted average maturity is less than six months. We utilize investment vehicles such as municipal bonds, commercial paper, U.S. government backed agencies, auction rate securities and U.S. Treasury instruments. The states in which we operate prescribe the types of instruments in which our subsidiaries may invest their cash. The weighted average taxable equivalent yield on consolidated investments as of December 31, 2003 was approximately 1.56%.
Cash provided by financing activities was $98.6 million and $49.8 million for the year ended December 31, 2003 and December 31, 2002, respectively. Cash provided by financing activities in 2003 consisted primarily of net proceeds from our public offering of $138.8 million partially offset by $50.0 million in repayments of borrowings under our credit facility. Cash provided by financing activities in 2002 consisted primarily of proceeds from our credit facility of $50.0 million.
The following table summarizes our material contractual obligations, including both on- and off-balance sheet arrangements, and our commitments at December 31, 2003 (in thousands):
Capital Lease Obligations. Our capital lease obligations are primarily related to leased furniture, fixtures and equipment. The terms of these leases are normally between three and five years.
Credit Agreement. On October 22, 2003, we entered into a $95.0 million Amended and Restated Credit Agreement (Credit Agreement) with a syndicate of banks. The Credit Agreement contains a provision which allows us to obtain, subject to certain conditions, an increase in revolving commitments of up to an additional
Lease Guarantee. In connection with our acquisition of PHP, we agreed to guarantee a certain lease for office space operated by the former management of PHP. The lease term ends in March 2005.
The National Association of Insurance Commissioners, or NAIC, has adopted rules which, to the extent that they are implemented by the states, set new minimum net worth requirements for insurance companies, HMOs and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital rules. The change in rules for insurance companies became effective as of December 31, 1998. Illinois, Texas and the District of Columbia adopted various forms of the rules as of December 31, 1999, 2000 and 2003, respectively. Since our Maryland subsidiary is licensed in both the District of Columbia and Maryland, the highest risk-based capital requirement between the two will prevail. New Jersey and Florida have not yet adopted risk-based capital as their net worth requirements. The NAIC’s HMO rules, if adopted by these states in their proposed form, may increase the minimum capital required for our subsidiaries. Effective December 31, 2003, these plans are required to maintain a statutory capital level greater than the state regulations.
Although the general rate of inflation has remained relatively stable and health care cost inflation has stabilized in recent years, the national health care cost inflation rate still exceeds the general inflation rate. We use various strategies to mitigate the negative effects of health care cost inflation. Specifically, our health plans try to control medical and hospital costs through contracts with independent providers of health care services. Through these contracted care providers, our health plans emphasize preventive health care and appropriate use of specialty and hospital services.
The Company’s off-balance sheet arrangements include future minimum rental commitments of $62.8 million and a lease guarantee of $0.8 million, both of which are disclosed in Note 12(c) to the consolidated financial statements. The Company has no investments, loans or any other known contractual arrangements with special-purpose entities, variable interest entities or financial partnerships.
Effective January 1, 2003, we completed our acquisition of PHP Holdings, Inc. and its subsidiary, Physicians Healthcare Plans, Inc. The escrow deposit for pending acquisition and related costs of $124,133 was paid in 2003 and, as a result, we recorded the estimated fair values of the assets acquired and liabilities assumed (see note 5(d)).
On November 9, 2001, we completed our initial public offering of 4,985,000 shares of common stock, including an over-allotment issuance of 585,000 shares at a price per share of $17.00. We received net proceeds from the offering of $77,218. In conjunction with the offering, all Series A, B, C and D preferred stock in the aggregate was converted into 12,607,880 shares of common stock. The proceeds from the offering were used to repay the balance of our long-term debt facility of $4,352 and to redeem the Series E mandatorily redeemable preferred stock for $13,320. In addition, 1,123,823 shares of common stock were issued upon the exercise of all outstanding Series E warrants.
On October 16, 2003, we completed a public offering of 3,162,500 shares of common stock, including an over-allotment issuance of 412,500 shares at a price of $46.50 per share. We received net proceeds from the offering of $138,830. On October 21, 2003, we used $30,000 of proceeds from the offering to repay the outstanding balance of our credit facility.
The consolidated financial statements include the financial statements of AMERIGROUP Corporation and our five wholly owned subsidiaries: AMERIGROUP New Jersey, Inc., AMERIGROUP Illinois, Inc., AMERIGROUP Texas, Inc. and AMERIGROUP Florida, Inc., each a Health Maintenance Organization; AMERIGROUP Maryland, Inc., a Managed Care Organization and PHP Holdings, Inc., a holding company that is the parent company of AMERIGROUP Florida, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.
We consider all highly liquid temporary investments with original maturities of three months or less to be cash equivalents. We had cash equivalents of $323,190 and $107,978 at December 31, 2003 and 2002, respectively, which consist of money market funds, U.S. Treasury securities, certificates of deposit, asset-backed securities, auction rate securities and debt securities of government sponsored entities.
Other assets include deposits, debt issuance costs and cash surrender value of life insurance policies.
As permitted under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), we have chosen to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB Opinion No. 25), and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the estimated fair value of our stock at the date of grant over the amount an employee must pay to acquire the stock. In December 2002, Statement of Financial Accounting Standards No. 148, Stock-Based Compensation (SFAS No. 148), was issued which requires that we illustrate the effect on net income and net income per share if we had applied the fair value principles included in SFAS No. 123 for
both annual and interim financial statements. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition.
We record premium revenue based on membership and premium information from each state. Premiums are due monthly and are recognized as revenue during the period in which we are obligated to provide service to members. In all of our markets, except Florida, we receive payments under each state’s obstetric delivery supplements program. Upon delivery of a newborn, each state is notified according to our contract. We recognize revenue in the period that the newborn is delivered and related services were provided to our member. Additionally, in some states we receive supplemental payments for certain services such as high cost drugs and early childhood prevention screenings. Any amounts that have not been received from the state by the end of the period are recorded on our balance sheet as premium receivables.
Accrued medical expenses for inpatient, outpatient surgery, emergency room, specialist, pharmacy and ancillary medical claims include amounts billed and not paid and an estimate of cost incurred for unbilled services provided. These liabilities are principally based on historical payment patterns using actuarial techniques. In addition, claims processing costs are accrued based on an estimate of the costs necessary to process unpaid claims. Claims payable are reviewed and adjusted periodically and, as adjustments are made, differences are included in current operations. Claims payable also includes estimates of amounts due to or from contracted providers under risk-sharing arrangements. The arrangements are typically based upon quality measures as well as medical results. Estimates relating to risk-sharing arrangements are calculated as a
percentage, typically 25% to 50%, of the differences between actual results and specified targets of medical expense and may include a sharing of profits in excess of the targeted medical and administrative expenses, typically 7% to 10% of total premiums covered under the contract.
The amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for held-to-maturity short-term investments are as follows at December 31, 2003 and 2002:
The amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for held-to-maturity long-term investments are as follows at December 31, 2003 and 2002:
As a condition for licensure by various state governments to operate HMOs or MCOs, we are required to maintain certain funds on deposit with or under the control of the various departments of insurance. Accordingly, at December 31, 2003 and 2002, the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for these held-to-maturity securities are summarized as follows:
Property and equipment, net at December 31, 2003 and 2002 is summarized as follows:
Effective January 1, 2003, we completed our acquisition of PHP Holdings, Inc. and its subsidiary, Physicians Healthcare Plans, Inc. (together, PHP) pursuant to the terms of a merger agreement entered into on August 22, 2002 for $124,260, including acquisition costs of $1,260.
The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition.
consummated on January 1, 2002, and does not purport to be indicative of what would have occurred had the acquisition been made at that date or of the results which may occur in the future.
Effective July 1, 2003, we purchased the Medicaid contracts and related assets known as St. Augustine for $8,581. The assets purchased consisted primarily of St. Augustine’s rights to provide managed care services to its 26,000 Medicaid members who receive health care benefits under Florida’s Medicaid program in nine counties in the Miami/ Ft. Lauderdale, Orlando and Tampa markets. Goodwill and other intangibles totaling $8,581 includes $2,151 for identifiable intangibles allocated to a non-compete agreement and the rights to the membership. Intangible assets related to the non-compete agreement and the rights to the membership are being amortized based on the timing of related cash flows with an expected amortization of three to eight years.
Income tax expense (benefit) for the years ended December 31, 2003, 2002 and 2001 consists of the following:
The valuation allowance for deferred tax assets decreased by $785 in 2003 which decreased income tax expense by the same amount. The decrease in this allowance was due to the utilization of a state tax credit carryforward that we had previously established a valuation allowance for in 2002. The increase in the valuation allowance of $785 in 2002 increased income tax by the same amount. The allowance was established in 2002 as the state tax credit carryforward was only available for use to the extent our regular tax liability exceeded the alternative minimum tax liability for a given year. Future projections in 2002 did not show the regular tax liability exceeding the alternative minimum tax; however, the credit was utilized in 2003. In assessing the realizability of
Income taxes payable were $7,005 and $2,360 at December 31, 2003 and 2002 and were included in accrued expenses, capital leases and other current liabilities.
On October 22, 2003, we entered into a $95,000 Amended and Restated Credit Agreement (Credit Agreement) with a syndicate of banks. The Credit Agreement contains a provision which allows us to obtain, subject to certain conditions, an increase in revolving commitments of up to an additional $30,000. The proceeds of the Credit Agreement are available for general corporate purposes, including, without limitation, permitted acquisitions of businesses, assets and technologies. The borrowings under the Credit Agreement will accrue interest at one of the following rates, at our option: Eurodollar plus the applicable margin or an alternate base rate plus the applicable margin. The applicable margin for Eurodollar borrowings is between 2.00% and 2.50% and the applicable margin for alternate base rate borrowings is between 1.00% and 1.50%. The applicable margin will vary depending on our leverage ratio. The Credit Agreement is secured by substantially all of the assets of AMERIGROUP Corporation and its wholly owned subsidiary, PHP Holdings, Inc., including the stock of their respective wholly owned managed care subsidiaries. There is a commitment fee on the unused portion of the Credit Agreement that ranges from 0.375% to 0.50%, depending on the leverage ratio. The Credit Agreement terminates on October 22, 2006 and was undrawn as of December 31, 2003.
The Series A, B and C preferred stock was converted into 10,752,493 shares of common stock concurrent with our initial public offering.
The total of these dividends was charged to retained earnings on the interest method.
In May 2003, our shareholders approved and we adopted the 2003 Equity Incentive Plan (2003 Plan), which provides for the granting of stock options, restricted stock, phantom stock and stock bonuses to employees, directors and consultants. We reserved for issuance a maximum of 1,650,000 shares of common stock under the 2003 Plan. In addition, shares remaining available for issuance under our 2000 Stock Plan (described below) and our 1994 Stock Plan (described below) will be available for issuance under the 2003 Plan. Under all plans, an option’s maximum term is ten years. As of December 31, 2003, we had a total of 1,311,878 options available for issuance under our 2003 Plan, 2000 Plan and 1994 Plan.
In July 2000, we adopted the 2000 Equity Incentive Plan (2000 Plan), which provides for the granting of stock options, restricted stock, phantom stock and stock bonuses to employees, directors and consultants. We reserved for issuance a maximum of 2,064,000 shares of common stock under the 2000 Plan at inception. In addition, shares remaining available for issuance under our 1994 Stock Plan (described below) were available for issuance under the 2000 Plan. Twenty percent of the options vest upon grant date or at an employee’s hiring anniversary date, whichever is later, and five percent at the end of each three-month period thereafter.
A summary of stock plans at December 31, 2003, 2002, and 2001 and the changes during the years then ended follows:
The following table summarizes information related to the stock options outstanding at December 31, 2003:
We apply APB Opinion No. 25 and related interpretations in accounting for our stock plans. Accordingly, compensation cost related to stock options issued to employees would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. During 2000, we recorded deferred charges of $1,833, representing the difference between the exercise price and the deemed fair value of our common stock for the options granted in 2000. The deferred compensation is being amortized to expense over the period the options vest, generally four to five years. We recognized $360, $358 and $360 in non-cash compensation expense related to the amortization of deferred compensation during 2003, 2002 and 2001, respectively.
The fair value of each option grant is estimated on the date of grant using an option pricing model with the following assumptions: no dividend yield for all years, risk-free interest rate of 3.2%, 3.6% and 4.3%, expected life of 6.7, 4.0 and 3.5 years and volatility of 44.6%, 49.7% and 0.0%, for the years ended December 31, 2003, 2002 and 2001, respectively. Volatility is estimated to be zero in 2001 because our common stock was not publicly traded until November 6, 2001.
Long-term debt: The carrying amount of long-term debt approximates fair value as the interest rate of the outstanding debt fluctuates with market interest rates.
Regulations governing our managed care operations in New Jersey, Texas, Illinois, Maryland, Florida and the District of Columbia require the applicable subsidiary to meet certain minimum net worth requirements. Each subsidiary was in compliance with its requirements at December 31, 2003.
Amortization of assets held under capital leases is included with depreciation expense.
In connection with our acquisition of PHP effective January 1, 2003, AMERIGROUP Corporation agreed to guarantee a certain lease for office space occupied by a business operated by former management of PHP. Minimum lease payments under the guaranteed lease as of December 31, 2003 are $676 and $168 in 2004 and 2005, respectively. The fair value of the stand ready obligation under the guarantee is $34 and has been reflected
Total rent expense for all office space and office equipment under non-cancelable operating leases was approximately $8,187, $5,459 and $3,476 in 2003, 2002 and 2001, respectively, and is included in selling, general and administrative expenses in the accompanying Consolidated Income Statements.
On July 18, 2002, Texas Children’s Hospital (TCH) in Houston filed suit in State District Court against AMERIGROUP Texas, Inc., our Texas subsidiary, seeking to be paid full-billed charges for all services rendered to our Texas subsidiary’s Medicaid members since October 1999. Our Texas subsidiary does not have a contract with TCH to provide services to its Medicaid members. When TCH provides services to our members, it does so as a non-network provider. On January 17, 2003, the physicians of Baylor College of Medicine (Baylor), non-network providers who provide medical services at TCH, filed suit against our Texas subsidiary seeking full-billed charges for services provided since October 1999 to our Texas Medicaid members. On July 7, 2003, TCH and Baylor added AMERIGROUP Corporation as an additional defendant to the lawsuits, alleging that we are directly liable for the obligations of our Texas subsidiary. The trial court ruled in November 2003 to abate the lawsuit pending TCH’s exhaustion of its administrative remedies with the Texas Health and Human Services Commission (HHSC). To our knowledge TCH has not initiated an administrative complaint in accordance with the court’s order. However, in March 2004 we received notice that HHSC had commenced a review of certain claims payment issues raised by TCH in early 2002 and which are part of the subject matter of the lawsuit.