The following selected consolidated financial data should be read in connection with the consolidated 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 period ended December 31, 2005 are derived from our consolidated financial statements, which have been audited by KPMG LLP, independent registered public accounting firm. All share and per share amounts included in the following consolidated financial data have been retroactively adjusted to reflect the two-for-one stock split effective January 18, 2005.
Organic growth - Our premium revenues for 2005 grew 15.1% over the prior year from membership increases in existing service areas and new markets, including Ohio and Virginia, and premium rate increases received. Premium revenues benefited in 2005 from the reversal of a Maryland premium recoupment previously recorded, totaling $6.1 million, offset by $6.4 million of anticipated premium recoupments related to enrollment errors by the States of Florida and Texas due to eligibility issues related to prior periods.
Growth through acquisitions - Effective January 1, 2005, we completed our stock acquisition of CarePlus in New York City and Putnam County, New York, pursuant to the terms of the merger agreement. At the date of the acquisition, CarePlus served approximately 115,000 members covered by New York State’s Medicaid, Child Health Plus and Family Health Plus programs. CarePlus’ service areas include New York City (Brooklyn, Manhattan, Queens and Staten Island) and Putnam County, New York. CarePlus accounted for 45.1% of the premium revenue growth in 2005.
In 2005, our health benefits ratio (HBR) was 84.7% versus 81.0% in 2004. Our 2005 results have been impacted by an increase in health benefits expense trend as evidenced by changes in membership, higher incidence of illness, obstetric services and related costs such as neonatal intensive care unit and other services, higher utilization and unit costs for network changes and provider contract rates and terms, as well as higher costs associated with entry into new markets. In addition, due to the impact of the installation of our new claims processing system, FACETS, on October 1, 2005 in our Texas market, we enhanced our medical claims estimation process during the fourth quarter of 2005 and added $15.4 million to our claims payable balance to compensate for the reduction in the rate of claims processing. We also added a separate factor for uncertainty of $5.8 million to cover the impact of adverse changes in the level and nature of claims inventory associated with the conversion to FACETS.
Selling, general and administrative expenses (SG&A) were 11.1% of total revenues for the year ended December 31, 2005 compared to 10.5% in 2004. The increase in the SG&A ratio is primarily a result of increases in premium taxes, legal fees and experience rebate expenses.
We had an exclusive risk-sharing arrangement with Cook Children’s Health Care Network (CCHCN) and Cook Children’s Physician Network (CCPN), which includes Cook Children’s Medical Center (CCMC), that was terminated as of August 31, 2005. In its place, we entered into separate non-exclusive fee-for-service provider agreements with CCPN and CCMC. On December 27, 2005, CCPN and CCMC each sent notices indicating their intent to terminate these fee-for-service agreements as of March 31, 2006. We do not believe that such terminations are warranted under these agreements. It is our intent to take appropriate actions to persuade CCPN and CCMC to rescind their notices of termination. However, there is no assurance that our efforts will be successful. CCPN and CCMC control most of the inpatient and specialty pediatric services available in Fort Worth, Texas. If these agreements terminate, it would force us to make alternate arrangements for many services to our pediatric membership, which may adversely impact our costs and our membership. Therefore, our results from operations could be harmed as a result of the termination of these arrangements, and the impact could be material.
As part of the State of Texas re-bidding process, CCHCN obtained its own contract with the State of Texas to provide healthcare services to Medicaid recipients effective September 1, 2006. As a result, we may lose members based upon CCHCN’s contract with the State of Texas, and the impact could be material. In addition, under the risk-sharing arrangement with CCHCN that terminated as of August 31, 2005, the parties have an obligation to perform annual reconciliations and settlements of the risk pool for each contract year. We believe that CCHCN may owe us substantial payments for the 2004 and 2005 contract years, which we estimate at approximately $12.5 million as of December 31, 2005. As of this date, we have not reached an agreement with CCHCN as to the settlement amounts for the 2004 and 2005 contract years. If we are unable to agree on a settlement, our health benefits expenses attributable to these periods may be adversely affected, and we may incur significant costs in our efforts to reach a final resolution of this matter.
AMERIGROUP Virginia, Inc. signed a contract with the Commonwealth of Virginia on July 15, 2005, and began enrolling members in September 2005. AMERIGROUP Ohio, Inc. also received an HMO license in and signed a contract with the State of Ohio on July 25, 2005, and began enrolling members in September 2005.
On September 23, 2005, CMS designated AMERIGROUP Texas, Inc., as a Special Needs Plan. AMERIGROUP Texas, Inc. has entered into a contract with CMS to offer Medicare benefits to dual eligibles that live in and surrounding Harris County, Texas beginning January 1, 2006. AMERIGROUP Texas, Inc. already served these members through the Texas Medicaid STAR+PLUS program and will offer them the Medicare and Part D drug benefit under this new contract. As of January 1, 2006, we served approximately 8,800 members under this program.
In April 2004, the Maryland Legislature enacted a budget for the 2005 fiscal year beginning July 1, 2004 that included a provision to reduce the premium paid to managed care organizations (MCOs) that did not meet certain HEDIS scores and whose medical loss ratio was below 84% for the calendar year ended December 31, 2002. In May 2004, the Maryland Secretary of Health and Mental Hygiene, in consultation with Maryland’s legislative leadership, determined our premium recoupment to be $846,000. A liability for the recoupment was recorded with a corresponding charge to premium revenue during the year ended December 31, 2004. Additionally, the Maryland Legislature directed that the Department of Health and Mental Hygiene complete a study by September 2004 on the relevance of the medical loss ratio threshold as an indicator of quality. The results of this study, which were released in October 2004, did not directly address what would happen in the future if an MCO reported a medical loss ratio below 84%. As a result, we believed the Maryland Legislature could enact similar legislation in 2005 as part of its fiscal year 2006 budget, requiring premium recoupment. Accordingly, we recorded a reduction in premium of $6.1 million in our consolidated financial statements during the year ended December 31, 2004, which was our best estimate of the possible outcome of this issue.
We generate revenues primarily from premiums we receive from the states in which we operate to arrange for health benefit services for our members. In 2006, we will receive premiums from CMS for the SNP program. We recognize premium revenue during the period in which we are obligated to provide services to our members. A fixed premium per member per month is paid to us to arrange for healthcare benefit services for our members pursuant to our contracts in each of our markets. These premium payments are based upon eligibility determined
by the state governments with which we have contracted. Errors in this eligibility determination on which we rely can result in positive and negative premium adjustments to the extent this information is adjusted by the state. In all of our states, except Florida and Virginia, we are eligible to receive supplemental payments for newborn obstetric deliveries. Each state contract is specific as to what is required before payments are generated. Upon delivery of a newborn, each state is notified according to our contract. Revenue is recognized in the period that the delivery occurs and the related services are provided to our member based on our authorization system for these services. 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. We also generate income from investments.
We have used a consistent methodology for estimating our medical expenses and medical liabilities since our inception, and have refined our assumptions to take into account our maturing claims, product and market experience. As medical utilization patterns and cost trends change from year-to-year, our underlying claims payments reflect the variations in experience. Our estimates are revised based upon actual claims payments using historical per member per month claims cost, including provider settlements, changes in the age and gender of our membership, variations in the severity of medical conditions, high dollar claims and authorization data. Each of these factors may be considered in determining our current medical liabilities.
There are certain aspects of the managed care business that are not predictable with consistency. These aspects include the incidences of illness or disease state (e.g., cardiac heart failure cases, cases of upper respiratory illness, diabetes, the number of full-term versus premature births, and the number of neonatal intensive care babies) as well as non-medical aspects, such as changes in provider contracting and contractual benefits. Therefore, we must rely upon our historical experience, as continually monitored, to reflect the ever-changing mix and growth of members.
As part of our normal review, we also consider the costs to process medical claims, and estimates of amounts to cover uncertainties related to fluctuations in claims payment patterns, membership, products and authorization trends. These estimates are adjusted as more information becomes available and any adjustments are included in current operations. Due to the uncertainty associated with payment rates and inventory levels, associated with the FACETS conversion, we established a separate estimate for this uncertainty to cover the expected adverse claims development. We will maintain this additional estimate as long as this uncertainty related to the systems conversion remains.
Also included in claims payable are estimates for provider settlements due to clarification of contract terms, out-of-network reimbursement and claims payment differences, as well as amounts due to or from contracted providers under risk-sharing arrangements. During 2005, we reclassified certain provider receivables under our risk-sharing arrangement with CCHCN to prepaid expenses, provider receivables and other current assets as a result of the termination of the contract whereby no liabilities remained in claims payable to offset the risk-sharing receivable.
The Company’s methodology includes adding a factor to compensate for normal claims uncertainty. The more precisely we have been able to predict claims patterns, the lower the required factor for uncertainty as a percentage of our medical liability. Due to the changing mix of members, products and markets, this factor is a
necessary component of our medical liabilities. While our prior year development historically has been favorable, there is no guarantee this will continue and the factor for uncertainty mitigates the risk of emerging claims experience that is different from historical patterns. The health benefits expenses incurred during the period related to prior years relate almost entirely to revisions in estimates for the immediately preceding year. The application of our methodology has resulted in reversals of estimated incurred claims related to prior years in each of the years in the three-year period ended December 31, 2005. The resulting impact on operations is a function of the variation of the change in estimate from year-to-year. Included in the table above is the negative impact on earnings of the change in our factor for uncertainty of a total of $9.2 million in 2005. This change was largely due to increased uncertainty around the conversion to our new claims system, FACETS, for which we have added a specific factor for uncertainty of $5.8 million. We will maintain this specific factor for claims uncertainty as long as the uncertainty related to the systems conversion remains. We will review the progress of the systems conversion and will adjust the related factor for claims uncertainty as appropriate. Our 2005 unfavorable development of $9.2 million compares to a favorable development of $1.5 million in 2004, and an unfavorable development of $3.5 million in 2003.
As of December 31, 2005 and 2004, we had goodwill and other intangible assets of $255.1 million and $140.4 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.
for Stock Issued to Employees, and SFAS No. 148, Accounting for Stock Based Compensation, and amends FASB Statement of Financial Accounting Standard No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Proforma disclosure is no longer an alternative.
Effective January 1, 2006, we adopted SFAS No. 123(R) applying the modified prospective method.
an increase in premium taxes that the States of Texas, New Jersey and Maryland began assessing in September 2003, July 2004, and April 2005, respectively;
Interest expense was $0.6 million and $0.7 million for the years ended December 31, 2005 and 2004, respectively.
Premium revenue for the year ended December 31, 2004 increased $197.9 million, or 12.3%, to $1,813.4 million from $1,615.5 million in 2003. The increase was primarily due to internal growth in membership as well as premium rate increases. Total membership increased 9.2% to 936,000 as of December 31, 2004 from 857,000 as of December 31, 2003.
Investment income increased $3.6 million to $10.3 million for the year ended December 31, 2004. The increase in investment income is primarily due to increased levels of cash and investments that were a result of having the proceeds from the secondary offering that occurred in October 2003 available for a full year of investing in 2004 and cash generated from operations, as well as increases in market interest rates and a shift in our investment portfolio toward longer term investments with higher yields.
Expenses relating to health benefits for the year ended December 31, 2004 increased $173.2 million, or 13.4%, to $1,469.1 million from $1,295.9 million for the year ended December 31, 2003. The increase was primarily due to an increase in membership. The HBR for the year ended December 31, 2004 was 81.0% compared to 80.2% in 2003. The increase in HBR is driven by less favorable development than in the prior year due to a combination of more mature claims patterns in existing products and markets offset by increased leverage of premium revenue. This had the effect of increasing the current year HBR even though there was no increase in our core medical run rates. The underlying medical performance continues to be stable with trend patterns consistent with those of the prior year, except for more moderate seasonal respiratory disorders than in the prior year and continued elevated obstetric services.
a decrease in purchased services related to strategic initiatives in 2003 for operational improvements, including expenses related to the implementation of the HIPAA guidelines; and
Net income for 2004 rose $18.7 million to $86.0 million, or $1.66 per diluted share, compared to $67.3 million, or $1.48 per diluted share in 2003. Diluted earnings per share rose 12.2% as compared to an increase in net income of 27.8% due to the increase in shares outstanding primarily resulting from the issuance of 6,325,000 shares from our October 16, 2003 public offering.
Our primary sources of liquidity are cash and cash equivalents, short- and long-term investments, cash flows from operations and borrowings under our Amended and Restated Credit Agreement. As of December 31, 2005, we had cash and cash equivalents of $272.2 million, short and long-term investments of $314.9 million and restricted investments on deposit for licensure of $56.7 million. Unregulated cash, cash equivalents, and investments totaled $157.9 million at December 31, 2005.
Cash from operations was $113.1 million for the year ended December 31, 2005 compared to $102.1 million for the year ended December 31, 2004. The increase in cash from operations is primarily due to the following items:
a decrease in the effect of the change in unearned revenue of $18.4 million;
Cash provided by financing activities was $5.8 million and $3.1 million for the years ended December 31, 2005 and 2004, respectively. The increase in cash provided by financing activities primarily related to reductions in cash out flows from bank overdrafts offset by a decrease in proceeds from the exercise of stock options.
Credit Agreement. On May 10, 2005, we entered into an amendment (Amendment) to our Amended and Restated Credit Agreement (as amended, the Credit Agreement), which, among other things, provides for an increase in the commitments under our Credit Agreement then in existence to $150.0 million and a five-year extension of the term from the date of the Amendment. 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 $50.0 million. 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 0.875% and 1.625% and the applicable margin for alternate base rate borrowings is between 0.00% and 0.75%. The applicable margin will vary depending on our leverage ratio. The Credit Agreement is secured by substantially all of the assets of the Company 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 0.20% to 0.325%, depending on the leverage ratio. The Credit Agreement terminates on May 10, 2010. As of December 31, 2005, there were no borrowings outstanding under our Credit Agreement.
As of December 31, 2005, our subsidiaries had aggregate statutory capital and surplus of approximately $174.5 million, compared with the recommended minimum aggregate statutory capital and surplus of approximately $137.5 million.
The National Association of Insurance Commissioners (NAIC) utilizes risk-based capital (RBC) standards for HMOs and other entities bearing risk for healthcare coverage that are designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (RBC ratio). The RBC ratio is designed to reflect the risk profile of HMOs. Within certain ratio ranges, regulators have increasing authority to take action as the RBC ratio decreases. There are four levels of regulatory action, ranging from requiring insurers to submit a comprehensive plan to the state insurance commissioner to requiring the state insurance commissioner to place the insurer under regulatory control. At December 31, 2005, the RBC ratio of each of the Company’s health plans was at or above the level that would require regulatory action. Although not all states had adopted these rules at December 31, 2005, at that date, each of the Company’s active HMOs had a surplus that exceeded either the applicable state net worth requirements or, where adopted, the levels that would require regulatory action under the NAIC’s RBC rules.
While we currently believe our strategies to mitigate healthcare cost inflation are appropriate, competitive pressures, new healthcare and pharmaceutical product introductions, demands from healthcare providers and customers, applicable regulations or other factors may affect our ability to control the impact of healthcare cost increases. Our independent actuaries estimate our health benefits expense trend increase for the year ended December 31, 2005 compared to the same period in 2004, to be approximately 10% normalized for underlying membership and product changes. We anticipate our 2006 health benefits expense trend increase to be approximately 7.0%. Our inability to reduce the gap through operational improvements between expected rate increases of approximately 4.0% and this expected health benefits expense trend could significantly impact our results of operations in the future.
Our off-balance sheet arrangements at December 31, 2005 include future minimum rental commitments of $93.4 million and capital improvement obligations of $2.4 million. We have no investments, loans or any other known contractual arrangements with special-purpose entities, variable interest entities or financial partnerships.
On January 1, 2005, we completed our acquisition of CarePlus, LLC, which operates as CarePlus Health Plan (CarePlus). The following summarizes cash paid for this acquisition:
On October 16, 2003, we completed a public offering of 6,325,000 shares of common stock, including an over-allotment issuance of 825,000 shares at a price of $23.25 per share. We received net proceeds from the offering of $138,829. On October 21, 2003, we used $30,000 of proceeds from the offering to repay the outstanding balance of our credit facility.
On December 14, 2004, our Board of Directors approved a two-for-one split of our common stock effected in the form of a one hundred percent stock dividend. As a result of the stock split, our stockholders received one additional share of our common stock for each share of common stock held of record on December 31, 2004. The additional shares of our common stock were distributed on January 18, 2005. All share and per share amounts in these consolidated financial statements and related notes have been retroactively adjusted to reflect this stock split for all periods presented.
The consolidated financial statements include the financial statements of AMERIGROUP Corporation and our eleven wholly-owned subsidiaries: AMERIGROUP Florida, Inc., AMGP Georgia Managed Care Company, Inc. (d/b/a AMERIGROUP Georgia), AMERIGROUP Illinois, Inc., AMERIGROUP New Jersey, Inc., AMERIGROUP Ohio, Inc., AMERIGROUP New Mexico, Inc., AMERIGROUP Texas, Inc., and AMERIGROUP Virginia, Inc. each an HMO; AMERIGROUP Maryland, Inc., a Managed Care Organization, CarePlus LLC, a Prepaid Health Services Plan, 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 $126,404 and $2,513 at December 31, 2005 and 2004, respectively, which consist of commercial paper and municipal bonds.
(b) Short and Long-Term Investments and Investments on Deposit for Licensure
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expense on property and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Property and equipment held under capital leases and leasehold improvements are amortized on the straight-line method over the shorter of the lease term or estimated useful life of the asset.
Depreciation and amortization expense on property and equipment was $12,978, $12,495 and $14,389 for the years ended December 31, 2005, 2004 and 2003, respectively. The estimated useful lives are as follows:
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, Accounting for Stock-Based Compensation (SFAS No. 148), was issued which requires that we illustrate the effect on net income and net income per share as 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 as 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 services to members. In all of our states except Florida and Virginia, we are eligible to receive supplemental payments for newborns and/or obstetric deliveries. Each state contract is specific as to what is required before payments are generated. Upon delivery of a newborn, each state is notified according to our contract. Revenue is recognized in the period that the delivery occurs and the related services are 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 been earned and have not been received from the state by the end of the period are recorded on our balance sheet as premium receivables.
percentage of the contract profits as defined in the contract with the state. The profitability computation includes premium revenue earned from the state less actual medical and administrative costs incurred and paid and less estimated unpaid claims payable for the applicable membership. The unpaid claims payable estimates are based on historical payment patterns using actuarial techniques. A final settlement is generally made 334 days after the contract period ends using paid claims data and is subject to audit by the State any time thereafter. Any adjustment made to the experience rebate payable as a result of final settlement is included in current operations.
Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with SFAS No. 141, Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. No impairment of goodwill was recorded in 2005, 2004 or 2003.
Under SFAS No. 123(R), the modified prospective method permits compensation cost to be recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.
As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of the fair value method of SFAS No. 123(R) will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS No. 123(R) is estimated to be additional compensation cost of approximately $4,500, net of tax, or $0.09 per diluted share for the year ended December 31, 2006. This estimate could differ materially from actual compensation cost recognized as it depends on levels of share-based payments granted in the future. Had we adopted SFAS No. 123(R) in prior periods, the impact of the standard would have approximated the impact of SFAS No. 123 as described in the disclosure of proforma net income and earnings per share in Note 2(i) to our consolidated financial statements. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions were $8,571, $8,009 and $4,547 in 2005, 2004 and 2003, respectively.
Our profitability depends in large part on accurately predicting and effectively managing health benefits expense. We continually review our premium and benefit structure to reflect its underlying claims experience and revised actuarial data; however, several factors could adversely affect the health benefits expense. Certain of these
The carrying amount, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale and held-to-maturity short-term investments are as follows at December 31, 2005 and 2004:
The carrying amount, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale and held-to-maturity long-term investments are as follows at December 31, 2005 and 2004:
As a condition for licensure by various state governments to operate HMOs, MCOs, or PHSPs we are required to maintain certain funds on deposit with or under the control of the various departments of insurance. Accordingly, at December 31, 2005 and 2004, the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for these held-to-maturity securities are summarized as follows:
The following table shows the fair value of our held-to-maturity investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005:
Effective January 1, 2005, we completed our stock acquisition of CarePlus, LLC (CarePlus), in New York City, New York for $126,781 in cash, including acquisition costs, pursuant to the terms of the merger agreement entered into on October 26, 2004. On June 17, 2005, in accordance with the terms of the merger agreement, additional consideration was paid in the amount of $4,619 for meeting agreed upon revenue targets for the month ended December 31, 2004. On December 8, 2005, in accordance with the terms of the merger agreement, additional consideration was paid in the amount of $4,000 upon the approval from and execution of a contract with the State of New York to conduct a long-term care business in that state and enrollment of long-term care membership in December 2005. Both payments were accounted for as additional costs of the acquisition. In accordance with the terms of the merger agreement, additional consideration of up to $10,000 may be paid contingent upon the achievement of certain earnings thresholds by CarePlus during the twelve months ended December 31, 2005. The calculation of this earnings threshold is expected to be determined and agreed upon during 2006. If the earnings threshold is met and additional payment becomes due, it will be accounted for as an additional cost of the acquisition. Beginning January 1, 2005, the results of operations of CarePlus have been included in the accompanying Consolidated Income Statements.
The following table summarizes the fair values of the assets acquired and liabilities assumed of CarePlus at the date of the acquisition.
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 healthcare 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, all of which is deductible for income tax purposes. 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.
The following table summarizes intangible assets resulting from the St. Augustine transaction:
Of the $124,260 acquisition cost which includes transaction costs, approximately $50,000 was financed through our credit facility with the balance funded through unregulated cash. Goodwill and other intangibles totaling $116,075 includes $8,990 of identifiable intangibles allocated to the rights to membership and a non-compete agreement, none of which is deductible for tax purposes. Intangible assets related to the non-compete agreement and rights to membership are being amortized based on the timing of related cash flows. A portion of the purchase price remains in escrow pending various settlement provisions between us and the former shareholders of PHP Holdings, Inc. During 2004, $512 of the escrow was returned to us as part of an interim settlement provision and goodwill was reduced by the same amount. During 2003, as part of the finalization of our fair value analysis, purchase price adjustments totaling $127 were recorded and reflected as a reduction in goodwill in the period. Further, purchase price adjustments may arise in the future as a result of the settlement provisions.
Beginning January 1, 2003, all results of operations of PHP have been included in the accompanying Consolidated Income Statements.
Income tax expense (benefit) for the years ended December 31, 2005, 2004 and 2003 consists of the following:
Income tax expense differed from the amounts computed by applying the statutory U.S. federal income tax rate to income before income taxes as a result of the following:
The effective tax rate is based on expected taxable income, statutory tax rates, and estimated permanent book to tax differences. Income tax returns that we file are periodically audited by federal or state authorities for compliance with applicable federal and state tax laws. Our effective tax rate is computed taking into account changes in facts and circumstances, including progress of audits, developments in case law and other applicable authority, and emerging legislation.
of the assets of the Company 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 0.20% to 0.325%, depending on the leverage ratio. The Credit Agreement terminates on May 10, 2010. As of December 31, 2005, there were no borrowings outstanding under our Credit Agreement.
In May 2005, our shareholders adopted and approved our 2005 Equity Incentive Plan (2005 Plan), which provides for the granting of stock options, restricted stock, restricted stock units, stock appreciation rights, stock bonuses and other stock-based awards to employees and directors. We reserved for issuance a maximum of 3,750,000 shares of common stock under the 2005 Plan. In addition, shares remaining available for issuance under our 2003 Stock Plan (described below), our 2000 Stock Plan (described below) and our 1994 Stock Plan (described below) will be available for issuance under the 2005 Plan. Under all plans, an option’s maximum term is ten years. As of December 31, 2005, we had a total of 3,936,071 shares available for issuance under our 2005 Plan.
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 4.2%, 3.1% and 3.2%, expected life of 6.1, 5.4 and 6.7 years and volatility of 28.6%, 29.5% and 44.6%, for the years ended December 31, 2005, 2004 and 2003, respectively.
On August 10, 2005, the Compensation Committee approved the immediate and full acceleration of vesting of approximately 909,000 “out-of-the-money” stock options awarded on February 9, 2005 to employees, including its executive officers, under the Company’s annual bonus program pursuant to its 2003 Equity Incentive Plan (the “Grant”). No other option grants were affected. Each stock option issued as a part of the Grant has an exercise price which is greater than the closing price per share on the date of the Compensation Committee’s action. The purpose of the acceleration was to enable the Company to avoid recognizing compensation expense associated with these options in future periods in its consolidated income statements, as a result of SFAS No. 123(R). The pre-tax charge avoided totals approximately $8,900 which would have been recognized over the years 2006 and 2007. This amount has been reflected in the proforma disclosures of the 2005 consolidated year-end financial statements. Because the options that were accelerated had a per share exercise price in excess of the market value of a share of the Company’s common stock on the date of acceleration, the Compensation Committee determined that the expense savings outweighs the objective of incentive compensation and retention.
Our employees have the option to participate in a deferred compensation plan sponsored by the Company. All full-time and most part-time employees of AMERIGROUP Corporation and subsidiaries may elect to participate in this plan. This plan is exempt from income taxes under Section 401(k) of the Internal Revenue Code. Participants may contribute a certain percentage of their compensation subject to maximum federal and plan limits. We may elect to match a certain percentage of each employee’s contributions up to specified limits. For the years ended December 31, 2005, 2004 and 2003, the matching contributions under the plan were $1,700, $1,227, and $720, respectively.
In 2002, Cleveland A. Tyson, a former employee of our Illinois subsidiary, AMERIGROUP Illinois, Inc., filed a federal and state Qui Tam or whistleblower action against our Illinois subsidiary. The complaint was captioned the United States of America and the State of Illinois, ex rel., Cleveland A. Tyson v. AMERIGROUP Illinois, Inc. The complaint was filed in the U.S. District Court for the Northern District, Eastern Division. It alleges that AMERIGROUP Illinois, Inc. submitted false claims under the Medicaid program. Mr. Tyson’s first amended complaint was unsealed and served on AMERIGROUP Illinois, Inc., in June 2003. Therein, Mr. Tyson alleges that AMERIGROUP Illinois, Inc. maintained a scheme to discourage or avoid the enrollment into the health plan of pregnant women and other recipients with special needs. In his suit, Mr. Tyson seeks statutory penalties of no less than $5.5 and no more than $11.0 per violation and an unspecified amount of damages. Mr. Tyson’s complaint does not specify the number of alleged violations.
Plaintiffs have proposed a number of damage theories under which alleged damages range, after trebling, from $60,000 to $690,000; however, it is unclear which, if any, of these theories will be relied upon by plaintiff’s damage experts when expert discovery concludes. The damage experts retained by the Company for this litigation have not reached any conclusions as to estimates of potential damages, if any. Although it is possible that the outcome of this case will not be favorable to us, we cannot with any certainty give a reasonable estimate of any potential damages. Accordingly, we have not recorded any liability at December 31, 2005. There can be no assurance that the ultimate outcome of this matter will not have a material adverse effect on our financial position, results of operations or liquidity.
corresponding charge to premium revenue during the year ended December 31, 2004. Additionally, the Legislature directed that the Department of Health and Mental Hygiene complete a study by September 2004 on the relevance of the medical loss ratio threshold as an indicator of quality. The results of this, which were released in October 2004, did not directly address what would happen in the future if a managed care organization reported a medical loss ratio below 84%. As a result, we believed the Maryland Legislature could enact similar legislation in 2005 as part of its fiscal year 2006 budget, requiring premium recoupment. Accordingly, we recorded a reduction in premium of $6,100 in our consolidated financial statements during the year ended December 31, 2004.