(2) At December 31, 2008, the estimated tax benefit associated with the qui tam litigation settlement payment was approximately $34.6 million. In 2009, we recorded an additional $22.4 million tax benefit regarding the tax treatment of the qui tam litigation settlement through a pre-filing agreement with the Internal Revenue Service. We do not anticipate that there will be any further material changes to the tax benefit associated with this litigation settlement in future periods.
We are a multi-state managed healthcare company focused on serving people who receive healthcare benefits through publicly funded healthcare programs, including Medicaid, Children’s Health Insurance Program (“CHIP”), Medicaid expansion programs and Medicare Advantage. We operate in one business segment with a single line of business. We were founded in December 1994 with the objective of becoming the leading managed care organization in the U.S. focused on serving people who receive these types of benefits. We believe that we are better qualified and positioned than many of our competitors to meet the unique needs of our members and the government agencies with whom we contract because of our focus solely on recipients of publicly funded healthcare, medical management programs and community-based education and outreach programs. We design our programs to address the particular needs of our members, for whom we facilitate access to healthcare benefits pursuant to agreements with applicable state and federal government agencies. We combine medical, social and behavioral health services to help our members obtain quality healthcare in an efficient manner. Our success in establishing and maintaining strong relationships with government agencies, providers and members has enabled us to retain existing contracts, obtain new contracts and establish and maintain a leading market position in many of the markets we serve. We continue to believe that managed healthcare remains the only proven mechanism that improves health outcomes for our members while helping our government customers manage the fiscal viability of their healthcare programs. We are dedicated to offering real solutions that improve healthcare access and quality for our members, while proactively working to reduce the overall cost of care to taxpayers.
Membership increase of 93,000 members, or 4.8%, to 2,024,000 members as of December 31, 2011 compared to 1,931,000 members as of December 31, 2010;
Total revenues of $6.3 billion, an 8.8% increase over the year ended December 31, 2010;
Unregulated cash and investments of $724.8 million as of December 31, 2011;
On February 1, 2011 we began providing managed healthcare services to STAR+PLUS members under an expansion contract in the six-county service area surrounding Fort Worth, Texas;
On August 1, 2011, the Texas Health and Human Services Commission (“HHSC”) announced that we won our bid to expand our business in Texas through a state-wide competitive bidding process. Pending final contract negotiations, we anticipate beginning operations for the new business in early 2012;
On October 25, 2011, we signed an agreement to purchase substantially all of the operating assets and contract rights of Health Plus, a prepaid health services plan (“PHSP”) in New York, for $85.0 million;
On November 16, 2011, we issued $400.0 million in aggregate principal amount of 7.5% Senior Notes due on November 15, 2019. We completed a follow-on issuance of $75.0 million of aggregate principal amount of 7.5% Senior Notes at a premium of 103.75% on January 18, 2012; and
We have a disciplined approach to evaluating the operating performance of our existing markets to determine whether to exit or continue operating in each market. As a result, in the past we have and may in the future decide to exit certain markets if they do not meet our long-term business goals. We also periodically evaluate acquisition opportunities to determine if they align with our business strategy such as the planned acquisition of Health Plus in 2012. We continue to believe acquisitions can be an important part of our long-term growth strategy.
In June 2010, we received approval from CMS to add Fort Worth to our Medicare Advantage service area in Texas, and to add Rutherford County to our Medicare Advantage service area in Tennessee. In addition, CMS approved expansion of our Medicare Advantage plans to cover traditional Medicare beneficiaries in addition to the existing special needs beneficiaries already covered in Texas, Tennessee and New Mexico. These approvals allowed us to begin serving Medicare members in the expanded areas effective January 1, 2011.
We can give no assurance that our entry into these new service areas will be favorable to our financial position, results of operations or cash flows in future periods.
programs, as well as the federal Medicare Advantage program. We intend to fund the purchase price through available cash. In connection with this acquisition, we will also be required to fund certain minimum statutory capital levels commensurate with the anticipated increase in membership of our New York health plan. The transaction is subject to regulatory approvals and other closing conditions and is expected to close in the first half of 2012, although there can be no assurance as to the timing of consummation of this transaction or that this transaction will be consummated at all.
On January 18, 2012, we received an executed amendment to the Contractor Risk Agreement with the state of Tennessee TennCare Bureau. The amendment included a decrease of approximately 4.7% to the premium rates at which we provide Medicaid managed care services to eligible Medicaid members for the contract period July 1, 2011 through June 30, 2012. Additionally, the Tennessee contract employs an adjustment model to reflect the estimated risk profile of the participating managed care organizations’ membership, or a “risk adjustment factor”. This risk adjustment factor is determined annually subsequent to the determination of the premium rates established for the contract year. The risk adjustment factor resulted in a further reduction of 1.7% effective July 1, 2011. The revised premium rates, including the risk adjustment factor, have been recognized for the period from July 1, 2011 forward, in accordance with GAAP. We can provide no assurance that the decrease in premium rates will not have a material adverse effect on our financial position, results of operations or cash flows in future periods.
On August 1, 2011, HHSC announced that we were awarded a contract to continue to provide Medicaid managed care services to our existing service areas of Austin, Dallas/Fort Worth, Houston (including the September 1, 2011 expansion into the Beaumont service area) and San Antonio. We will no longer participate in the Corpus Christi area, for which we served approximately 10,000 members as of December 31, 2011 In addition to the existing service areas, on March 1, 2012, we will begin providing Medicaid managed care services in three new service areas: Lubbock, El Paso and in the 164 counties defined by HHSC as the rural service areas. Additionally, we will begin providing prescription drug benefits for all of our Texas members and inpatient hospital services for the STAR+PLUS program. Our new contracts with the state of Texas cover the period from March 1, 2012 through August 31, 2015.
On January 18, 2012, the Washington State Health Care Authority (“HCA”) announced that we were one of five managed care organizations selected through a competitive procurement to participate in the Healthy Options program and offer healthcare coverage to TANF, CHIP and Supplemental Security Income (“SSI”) eligibles who are not eligible for Medicare. The state indicated that the managed care organizations will enroll collectively approximately 700,000 members and HCA intends to add 100,000 Medicaid beneficiaries who are eligible for SSI but not Medicare. Additionally, we will participate in the state’s Basic Health program, which currently provides subsidized health coverage for approximately 41,000 low-income adults. We anticipate finalizing the contract with HCA in early 2012 and beginning operations in the second half of 2012.
In the ordinary course of business, we make a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our audited Consolidated Financial Statements in conformity with GAAP. 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.
Historically, the impact of adjustments from retroactivity, changes in authorizations and changes in claims data used to estimate supplemental revenues has represented less than 1.0% of annual revenue. This results in a negligible impact on annual earnings as changes in revenue are typically accompanied by corresponding changes in the related health benefits expense; however, these changes can and have been significant to quarterly operating results particularly where changes in retroactivity and health benefits expense are not recognized in the same period as a result of differences in the recognition criteria. We believe this historical experience represents what is reasonably likely to occur in future periods.
Additionally, delays in annual premium rate changes require that we defer the recognition of any increases to the period in which the premium rates become final. The time lag between the effective date of the premium rate increase and the final contract can and has been delayed one quarter or more. The value of the impact can be significant in the period in which it is recognized dependent on the magnitude of the premium rate change, the membership to which it applies and the length of the delay between the effective date and the final contract date. Premium rate decreases are recognized in the period the change in premium rate becomes effective and the change in the rate is known, which may be prior to the period when the related contract amendment becomes final.
insufficient, or such that the liabilities established for IBNR are sufficient to cover obligations under an assumption of moderately adverse conditions. Adverse conditions are situations in which the actual claims are expected to be higher than the otherwise estimated value of such claims at the time of the estimate. Therefore, in many situations, the claim amounts ultimately settled will be less than the estimate that satisfies the actuarial standards of practice.
Completion factors and medical cost trends are the most significant factors we use in developing our medical claims payable estimates. The following tables illustrate the sensitivity of these factors and the estimated potential impact on our medical claims payable estimates for those periods as of December 31, 2011:
(2) Reflects estimated potential changes in health benefits expense and medical claims payable caused by changes in medical costs trend data used in developing medical claims payable estimates for the most recent three months.
We continually monitor and adjust the medical claims payable and health benefits expense based on subsequent paid claims activity. If it is determined that our assumptions regarding medical cost trends and utilization are significantly different than actual results, our results of operations, financial position and liquidity could be impacted in future periods. Adjustments of prior year estimates may result in additional health benefits expense or a reduction of health benefits expense in the period an adjustment is made. Further, due to the considerable variability of healthcare costs, adjustments to medical claims payable occur each quarter and are sometimes significant as compared to the net income recorded in that quarter. Prior period development is recognized immediately upon the actuaries’ judgment that a portion of the prior period liability is no longer needed or that an additional liability should have been accrued.
We account for income taxes in accordance with current accounting guidance as prescribed under GAAP. On a quarterly basis, we estimate our required tax liability based on enacted tax rates, estimates of book-to-tax differences in income, and projections of income that will be earned in each taxing jurisdiction. Deferred tax assets and liabilities representing the tax effect of temporary differences between financial reporting net income and taxable income are measured at the tax rates enacted at the time the deferred tax asset or liability is recorded.
After tax returns for the applicable year are filed, the estimated tax liability is adjusted to the actual liability per the filed state and federal tax returns. Historically, we have not experienced significant differences between our estimates of tax liability and our actual tax liability.
Similar to other companies, we sometimes face challenges from tax authorities regarding the amount of taxes due. Positions taken on our tax returns are evaluated and benefits are recognized only if it is more likely than not that our position will be sustained on audit. Based on our evaluation of tax positions, we believe that we have appropriately accounted for potential tax exposures.
We manage our investment portfolio to limit our exposure to any one issuer or market sector, and largely limit our investments to U.S. government and agency securities; state and municipal securities; and corporate debt obligations, substantially all of investment grade quality. As of December 31, 2011, our investments included $11.6 million of securities with an auction reset feature (“auction rate securities”) issued by student loan corporations established by various state governments. Since early 2008, auctions for these auction rate securities have failed, significantly decreasing our ability to liquidate these securities prior to maturity. As we cannot predict the timing of future successful auctions, if any, our auction rate securities are classified as available-for-sale and are carried at fair value within long-term investments. The weighted average life of our auction rate security portfolio, based on the final maturity, is approximately 24 years. We currently believe that the $1.0 million net unrealized loss position that remains at December 31, 2011 on our auction rate securities portfolio is primarily due to liquidity concerns and not the creditworthiness of the underlying issuers. We currently have the intent and ability to hold our auction rate securities to maturity, if required, or if and when market stability is restored with respect to these investments. During 2011, certain investments in auction rate securities were called at par for net proceeds of $6.5 million. Additionally, we elected to tender an additional $3.6 million in auction rate securities at 95.5% of par resulting in a $0.2 million realized loss recognized in earnings.
(1) HBR is shown as a percentage of premium revenue because there is a direct relationship between the premium received and the health benefits provided.
Premium revenue increased 9.0% and 12.1% in the years ended December 31, 2011 and 2010, respectively, compared to the prior year. The increase in both periods was due in part to increases in full-risk membership across the majority of our existing products and markets. Additionally, both periods reflect increased premium revenue from premium rate increases and yield increases resulting from changes in membership mix and benefits across many of our markets.
The following table sets forth the approximate number of members we served in each state as of December 31, 2011, 2010 and 2009. Because we receive two premiums for members that are in both the Medicare Advantage and Medicaid products, these members have been counted twice in the states where we operate Medicare Advantage plans.
For the year ended December 31, 2011, our Texas contract represented approximately 22% of premium revenues and our Tennessee, Georgia and Maryland contracts represented approximately 14%, 12%, and 11% of premium revenues, respectively. Our state contracts have terms that are generally one-to-two years in length, some of which contain optional renewal periods at the discretion of the individual states. Some contracts also contain a termination clause with notification periods ranging from 30 to 180 days. At the termination of these contracts, re-negotiation of terms or the requirement to enter into a re-bidding or reprocurement process is required to execute a new contract. If these contracts were not renewed on favorable terms to us, our financial position, results of operations or cash flows could be materially adversely affected.
Other revenue for the year ended December 31, 2011 decreased $5.2 million to $0.4 million compared to $5.6 million for the year ended December 31, 2010. Other revenue for the year ended December 31, 2010, decreased $1.1 million from $6.7 million for the year ended December 31, 2009. Included in other revenue for the year ended December 31, 2010 is a $4.0 million gain on the sale of certain trademarks. Included in other revenue for the year ended December 31, 2009 is a $5.8 million gain on the sale of the South Carolina contract rights.
SG&A for the year ended December 31, 2010 increased 14.7% compared to the year ended December 31, 2009. The increase in SG&A is primarily a result of increased salary and benefits expenses due to increased variable compensation accruals as a result of our operating performance for 2010 as well as moderate wage, benefits and workforce increases over the prior year.
Premium taxes increased 13.7% for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in premium tax expense in 2011 compared to 2010 is due in part to growth in revenue in the majority of our markets where premium tax is levied, including growth from our Texas market expansions into the Fort Worth STAR+PLUS program in February 2011 and the Beaumont service area in September 2011 as well as premium revenue growth in the state of Tennessee relating to our entry into the TennCare CHOICES Program in March 2010. Additionally, premium tax increased due to the reinstatement of premium taxes in the state of Georgia in July 2010.
In the event of an equity offering at any time prior to November 15, 2014, we may redeem up to 35.0% of the aggregate principal amount of the 7.5% Senior Notes with the net cash proceeds of that equity offering and at a redemption price equal to 107.5% of the principal amount of the 7.5% Senior Notes redeemed, plus accrued and unpaid interest. Additionally, at any time prior to November 15, 2015, we may redeem all or a part of the 7.5% Senior Notes at par plus accrued and unpaid interest plus a “make-whole” premium as determined pursuant to the indenture governing the 7.5% Senior Notes dated November 16, 2011. On or after November 15, 2015, we may redeem all or a part of the 7.5% Senior Notes at the redemption prices set forth in the indenture and expressed as percentages of the principal amount, plus accrued and unpaid interest.
We intend to use a portion of the net proceeds from the initial offering to repay at or prior to maturity the outstanding aggregate principal amount of our 2.0% Convertible Senior Notes, discussed below. The remaining net proceeds will be used for general corporate purposes, including acquisitions and/or business development opportunities which may include the funding of statutory capital commensurate with growth and funding of our recently announced acquisition of the operating assets and contract rights of Health Plus.
The 7.5% Senior Notes contain certain covenants restricting our ability, among other things, to incur additional indebtedness, pay dividends or make other distributions or payments, repay junior indebtedness, sell assets, make investments, engage in transactions with affiliates, create certain liens and engage in certain types of mergers or acquisitions. These covenants are subject to certain exceptions, including exceptions that allow us to incur debt or make restricted payments if certain ratios are met. As of December 31, 2011, we believe we are in compliance with all covenants under the 7.5% Senior Notes.
Upon conversion of the 2.0% Convertible Senior Notes, we will pay cash up to the principal amount of the 2.0% Convertible Senior Notes converted. With respect to any conversion value in excess of the principal amount, we have the option to settle the excess with cash, shares of our common stock, or a combination thereof based on a daily conversion value, as defined in the indenture. The initial conversion rate for the 2.0% Convertible Senior Notes is 23.5114 shares of common stock per one thousand dollars of principal amount of 2.0% Convertible Senior Notes, which represents a 32.5% conversion premium based on the closing price of $32.10 per share of our common stock on March 22, 2007 and is equivalent to a conversion price of approximately $42.53 per share of common stock. Consequently, under the provisions of the 2.0% Convertible Senior Notes, if the market price of our common stock exceeds $42.53 we will be obligated to settle, in cash and/or shares of our common stock at our option, an amount equal to approximately $6.1 million for each dollar in share price that the market price of our common stock exceeds $42.53, or the conversion value in excess of the principal amount of the 2.0% Convertible Senior Notes. In periods prior to conversion, the 2.0% Convertible Senior Notes would also have a dilutive impact to earnings if the average market price of our common stock exceeds $42.53 for the period reported. At conversion, the dilutive impact would result if the conversion value in excess of the principal amount of the 2.0% Convertible Senior Notes, if any, is settled in shares of our common stock. The conversion rate is subject to adjustment in some events but will not be adjusted for accrued interest. In addition, if a “fundamental change” occurs prior to the maturity date, we will in some cases increase the conversion rate for a holder of 2.0% Convertible Senior Notes that elects to convert their 2.0% Convertible Senior Notes in connection with such fundamental change. As of December 31, 2011, the 2.0% Convertible Senior Notes had a dilutive impact to earnings per share as the average market price of our common stock of $56.67 for the year ended December 31, 2011 exceeded the conversion price of $42.53.
Also concurrent with the issuance of the 2.0% Convertible Senior Notes, we sold warrants to acquire, subject to customary anti-dilution adjustments, 6,112,964 shares of our common stock at an exercise price of $53.77 per share. If the average market price of our common stock during a defined period ending on or about the settlement date exceeds the exercise price of the warrants, the warrants will be settled in shares of our common stock. Consequently, under the provisions of the warrant instruments, if the market price of our common stock exceeds $53.77 at exercise we will be obligated to settle in shares of our common stock an amount equal to approximately $6.1 million for each dollar that the market price of our common stock exceeds $53.77 resulting in a dilutive impact to our earnings. As of December 31, 2011, the warrant instruments had a dilutive impact to earnings per share for the year ended December 31, 2011 as the average market price of our common stock for the year ended December 31, 2011 of $56.67 exceeded the $53.77 exercise price of the warrants.
During the year ended December 31, 2011, certain bondholders converted $120,000 in aggregate principal amount of the 2.0% Convertible Senior Notes with a conversion value in excess of the principal amount by $82,000. We paid the consideration for the conversion of the 2.0% Convertible Senior Notes using cash on hand and the conversion value in excess of the principal amount converted was recouped through cash received from the counterparty pursuant to the convertible note hedge instruments.
As of December 31, 2011, our common stock was last traded at a price of $59.08 per share. Based on this value, if the 2.0% Convertible Senior Notes had been converted or matured at December 31, 2011, we would be obligated to pay the principal of the 2.0% Convertible Senior Notes plus an amount in cash or shares equal to $101.1 million. An amount equal to $101.1 million would be owed to us in cash or in shares of our common stock through the provisions of the convertible note hedges resulting in a net cash outflow equal to the principal amount of the 2.0% Convertible Senior Notes. At this per share value, we would be required to deliver approximately $32.5 million in shares of our common stock under the warrant instruments or approximately 549,000 shares of our common stock at that price per share.
Under the authorization of our Board of Directors, we maintain an ongoing share repurchase program. On August 4, 2011, the Board of Directors authorized a $250.0 million increase to the share repurchase program,
Cash provided by operations was $208.0 million for the year ended December 31, 2011 compared to $401.9 million for the year ended December 31, 2010. The decrease in cash provided by operations primarily resulted from a decrease in cash flows generated from working capital changes of $140.9 million and a decrease in net income adjusted for non-cash items of $50.0 million, primarily as a result of an increase in health benefits expense that exceeded the growth in premium revenues. The decrease in cash provided by working capital changes was due, in part, to fluctuations in unearned revenues of $107.1 million as a result of variability in the timing of receipts of premium from government agencies. Additionally, the decrease in cash provided by working capital changes was due to a decrease in cash provided through changes in premium receivables of $45.0 million primarily as a result of the timing of receipts from government agencies for retroactive rate changes. The decrease in cash provided by working capital changes was further attributable to a net decrease in cash provided through changes in accounts payable, accrued expenses, contractual refunds payable and other current liabilities of $52.3 million primarily due to fluctuations in variable compensation and experience rebate accruals. The decrease in cash provided by working capital changes was partially offset by an increase in claims payable primarily associated with growth in the business.
Cash used in investing activities was $707.2 million for the year ended December 31, 2011 compared to $80.7 million for the year ended December 31, 2010. The increase in cash used in investing activities is due primarily to an increase in the net purchases of investments of $615.6 million, primarily due to investment of the net proceeds received from the issuance of $400.0 million in aggregate principal amount of 7.5% Senior Notes on November 16, 2011, a portion of which is intended to be used to repay at or prior to maturity the outstanding aggregate principal amount of our 2.0% Convertible Senior Notes. We currently anticipate total capital expenditures for 2012 to be between approximately $65.0 million and $75.0 million related primarily to technological infrastructure development and investment in our health plan and corporate support facilities.
The following table shows the types and percentages of our holdings within our investment portfolio, as well as the average Standard and Poor’s (“S&P”) ratings, if applicable, for our investment portfolio at December 31, 2011:
Cash provided by financing activities was $282.1 million for the year ended December 31, 2011 compared to cash used in financing activities of $63.3 million for the year ended December 31, 2010. The change in cash flows from financing activities primarily related to net proceeds received from the issuance of our 7.5% Senior Notes as well as an increase in proceeds and the related tax benefit from employee stock option exercises and stock purchases of $41.7 million. The increase in cash provided by financing activities was partially offset by changes in bank overdrafts of $51.6 million due to timing of check cycles and an increase in repurchases of our common stock of $37.2 million pursuant to our ongoing share repurchase program.
We believe that existing cash and investment balances and cash flow from operations will be sufficient to support continuing operations, capital expenditures and our growth strategy for at least the next 12 months. As a result of the issuance of our 7.5% Senior Notes, our debt-to-total capital ratio increased to 33.8% at December 31, 2011 from 17.4% at December 31, 2010. Giving effect to the follow on offering of $75.0 million in aggregate principal amount of our 7.5% Senior Notes on January 18, 2012, our resulting debt-to-capital ratio would have been 36.3%. We utilize the debt-to-total capital ratio as a measure, among others, of our leverage and financial flexibility. Our access to additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity, as well as the possibility that lenders could develop a negative perception of our long- or short-term financial prospects. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. If a combination of these factors were to occur, our internal sources of liquidity may prove to be insufficient, and in such case, we may not be able to successfully obtain additional financing on favorable terms.
Lastly, the government agencies with whom we contract can and have from time-to-time delayed the timing of payment of the premium revenue we are entitled to receive under our respective contracts by one month or more. This delay can be a result of cash management strategies on the part of the government agencies or other reasoning beyond our control. Despite any delays in premium payments, our contracts require that we pay claims for medical services within certain time frames which would require that we remit payments to providers for
services in advance of receipts from the government agencies if such receipts are delayed. In general, we believe we will be able to collect any delayed premiums; however, if these delays occur in a significant market for an extended period of time or in more than one market that in the aggregate are significant to our consolidated business, our liquidity could be materially adversely affected. For example, we anticipate a delay in the timing of premium payments to our Georgia health plan from GA DCH during the first quarter of 2012, or longer, that may impact a significant portion of the premium payments owed to us for the affected period. If this anticipated delay continues for an extended period, our liquidity could be materially adversely affected.
Our operations are conducted through our wholly-owned subsidiaries, which include Health Maintenance Organizations (“HMOs”), one health insuring corporation (“HIC”), one accident and health insurance company (“A&H”) and one prepaid health services plan (“PHSP”). HMOs, HICs, A&Hs and PHSPs are subject to state regulations that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and regulate the timing, payment and amount of dividends and other distributions that may be paid to their stockholders. Additionally, certain state regulatory agencies may require individual regulated entities to maintain statutory capital levels higher than the minimum capital and surplus levels under state regulations. As of December 31, 2011, we believe our subsidiaries are in compliance with all minimum statutory capital requirements. The parent company may be required to fund minimum net worth shortfalls or choose to increase capital at its subsidiary health plans during 2012 using unregulated cash, cash equivalents, investments or a combination thereof, particularly in light of expected growth in our Texas market and planned operations commencement in Louisiana and Washington. We believe, as a result, that we will continue to be in compliance with these requirements at least through the end of 2012. Additionally, in connection with our acquisition of the operating assets and contract rights of Health Plus, if consummated, we will also be required to fund certain minimum statutory capital levels commensurate with the anticipated increase in the membership of our New York health plan in 2012.
The National Association of Insurance Commissioners (“NAIC”) has defined risk-based capital (“RBC”) standards for HMOs, insurers and other entities bearing risk for healthcare coverage that are designed to measure capitalization levels 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 and insurers by establishing the minimum amount of capital appropriate for an HMO or insurer to support its overall business operations in consideration of its size, structure and risk profile. Within certain ratio ranges, regulators have increasing authority to take action as the RBC ratio decreases. There are four levels of regulatory action based on the HMO or insurer’s financial condition, ranging from (a) requiring insurers to submit a comprehensive RBC plan to the state insurance commissioner containing proposals for corrective action, to (b) requiring the state insurance commissioner to place the insurer under regulatory control (e.g., rehabilitation or liquidation) pursuant to the state insurer receivership statute. Eight of the eleven states in which we operated in at December 31, 2011 have adopted RBC as the measure of required surplus. At December 31, 2011, our consolidated RBC ratio for these states is estimated to be over 440% which compares to the required level of 200%, the level at which regulatory action would be initiated. In the remaining states, we have at least 120% of the state required surplus level.
Operating Lease Obligations. Our operating lease obligations at December 31, 2011 are primarily for payments under non-cancelable office space and office equipment leases.
The audited Consolidated Financial Statements include the financial statements of AMERIGROUP Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Additionally, certain reclassifications have been made to prior year amounts on the audited Consolidated Balance Sheets to conform to the current year presentation.
expenses and other current liabilities and deferred compensation (included in other long-term liabilities): The fair value of these financial instruments, except cash surrender value of life insurance and deferred compensation, approximates the historical cost because of the short maturity of these items. Cash surrender value of life insurance and deferred compensation are carried at the fair value of the underlying assets due to the nature of the life insurance policies and deferred compensation plan.
Short- and long-term investments and investments on deposit for licensure at December 31, 2011 and 2010 consisted of investment vehicles including auction rate securities, certificates of deposit, commercial paper, corporate bonds, debt securities of government sponsored entities, money market funds, municipal bonds and U.S. Treasury securities. Additionally, the Company held investments in equity index funds at December 31, 2011 and investments in federally insured corporate bonds at December 31, 2010. The Company considers all investments with original maturities greater than three months but less than or equal to twelve months to be short-term investments. At December 31, 2011, all of the Company’s securities are classified as available-for-sale. Available-for-sale securities are carried at fair value with changes in fair value reported in accumulated other comprehensive income until realized through the sale or maturity of the security or at the time at which an other-than-temporary-impairment is determined.
As a condition for licensure by various state governments to operate health maintenance organizations (“HMOs”), health insuring corporations (“HICs”), accident and health insurance companies (“A&Hs”) or prepaid health services plans (“PHSPs”), the Company is required to maintain certain funds on deposit, in specific dollar amounts based on either formulas or set amounts, with or under the control of the various departments of insurance. The Company purchases interest-bearing investments with a fair value equal to or greater than the required dollar amount. The interest that accrues on these investments is not restricted and is available for withdrawal.
Other assets include cash surrender value of life insurance policies, debt issuance costs net of accumulated amortization related to the 7.5% Senior Notes, deposits, amortizable intangible assets acquired in business combinations net of accumulated amortization and cash on deposit for payment of claims under administrative services only (“ASO”) arrangements. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
liabilities of a group classified as held for sale would be presented separately in the appropriate asset and liability sections of the audited Consolidated Balance Sheets. No impairment of long-lived assets was recorded in 2011, 2010 or 2009.
Accrued health benefits expenses for claims associated with the provision of services to the Company’s members (including hospital inpatient and outpatient services, physician services, pharmacy and other ancillary services) include amounts billed and not paid and an estimate of costs incurred for unbilled services provided. These estimates are principally based on historical payment patterns while taking into consideration variability in those 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.
Included in contractual refunds payable is a liability for contractual premium. The Company’s contracts in the states of Maryland, Florida, New Jersey and Virginia contain provisions relating to the amount of profit that can be earned. Depending on the contract, these profit collars are determined based on items such as minimum medical loss ratios or underwriting gain limitations and can be based on a calendar year or a state fiscal year basis. Medical loss ratio calculations typically limit the medical expenses as a percentage of revenue to a predetermined contractual percentage. Underwriting gain limitations limit the income before taxes and investment income to a predetermined percentage. Accruals for these refunds payable are reflected as reductions to premium revenue. Any adjustment made to the estimated liability as a result of final settlement is included in current operations.
Experience rebate payable, included in contractual refunds payable, consists of estimates of amounts due under contracts with the state of Texas. These amounts are computed based on a percentage of the contract profits as defined in the contract with the state. The profitability computation includes premium revenue earned from the state less paid medical and administrative costs incurred and 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 of Texas any time thereafter. Accruals for this rebate payable are reflected as a reduction in premium revenue. Any adjustment made to the experience rebate payable as a result of final settlement is included in current operations.
state contract is specific as to what is required before payments are generated. Upon delivery of a newborn, each state is notified according to the contract. Revenue is recognized in the period that the delivery occurs and the related services are provided to the Company’s member. Additionally, in some states, supplemental payments are received 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 the balance sheet as premium receivables.
Stop-loss premiums, net of recoveries, are included in health benefits expense in the accompanying audited Consolidated Statements of Income.
Stock-based compensation expense related to share-based payments is recorded using an estimate of the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The fair value of employee share options and similar instruments is estimated using option-pricing models. The fair value of employee stock awards is equal to the grant date closing price of the Company’s common stock as listed on the New York Stock Exchange. The fair value of performance-based employee stock awards subject to a market condition, if applicable, is calculated using a Monte Carlo valuation model. Expense associated with the performance-based restricted stock awards subject to the market condition, if and when the market condition is applicable, is recognized regardless of whether the market condition is met.
Stock-based compensation expense is recognized over the period during which an employee is required to provide service in exchange for the applicable awards, which is generally annually over four years. For grants awarded in 2010 and prior years, the service period is generally quarterly over four years.
financial reporting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when the Company realizes such amounts. On a quarterly basis, the Company’s tax liability is estimated based on enacted tax rates, estimates of book-to-tax differences in income, and projections of income that will be earned in each taxing jurisdiction.
In addition, the Company is periodically audited by state and federal tax authorities and these audits can result in proposed assessments. The Company believes that its tax positions comply with applicable tax law and, as such, will vigorously defend its positions on audit. The Company believes that it has adequately provided for any reasonable foreseeable outcome related to these matters. Although the ultimate resolution of these audits may require additional tax payments, it is not anticipated that any additional tax payments would have a material impact to earnings.
In December 2011, the Financial Accounting Standards Board (“FASB”) issued new guidance related to disclosures about offsetting assets and liabilities within the balance sheet. The new guidance requires entities to disclose quantitative and qualitative information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The new guidance is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013 and is to be applied retrospectively. The adoption of this new guidance in 2013 will not impact the Company’s financial position, results of operations or cash flows.
In September 2011, the FASB issued new guidance related to evaluating goodwill for impairment. The new guidance provides entities with the option to perform a qualitative assessment of whether it is more likely than
The Company’s profitability depends in large part on accurately predicting and effectively managing health benefits expense. The premium and benefit structure is continually reviewed to reflect the underlying claims experience and revised actuarial data; however, several factors could adversely affect the health benefits expense. Certain of these factors, which include changes in healthcare practices, cost trends, inflation, new technologies, major epidemics or pandemics, natural disasters and malpractice litigation, are beyond any health plan’s control and could adversely affect the Company’s ability to accurately predict and effectively control healthcare costs. Costs in excess of those anticipated could have a material adverse effect on the Company’s results of operations.
Level 1 - Observable inputs such as quoted prices in active markets: The Company’s Level 1 securities consist of debt securities of government sponsored entities, equity index funds, money market funds and U.S. Treasury securities. The Company’s Level 1 securities also consisted of federally insured corporate bonds at December 31, 2010. Level 1 securities are included in cash equivalents, short-term investments, long-term investments and investments on deposit for licensure in the accompanying audited
Level 3 - Unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions: The Company’s Level 3 securities consist of auction rate securities issued by student loan corporations established by various state governments. The auction events for these securities failed during early 2008 and have not resumed. Therefore, the estimated fair values of these securities have been determined utilizing an income approach, specifically discounted cash flow analyses. These analyses consider among other items, the creditworthiness of the issuer, the timing of the expected future cash flows, including the final maturity associated with the securities, and an assumption of when the next time the security is expected to have a successful auction. These securities were also compared, when possible, to other observable and relevant market data. As the timing of future successful auctions, if any, cannot be predicted, auction rate securities are classified as long-term investments in the accompanying audited Consolidated Balance Sheets.
The Company’s assets measured at fair value on a recurring basis at December 31, 2010 were as follows:
The following table presents the changes in the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), for the years ended December 31, 2011 and 2010:
quoted market price. As of December 31, 2011 and 2010, the fair value of the borrowings under the 2.0% Convertible Senior Notes was $371,005 and $303,550, respectively, compared to the face value of $259,880 and $260,000, respectively.
The amortized cost and fair value of investments in debt securities, by contractual maturity, for available-for-sale short- and long-term investments and investments on deposit for licensure held at December 31, 2011 were as follows:
Investments in equity index funds with a cost of $40,146 and a fair value of $40,843 are excluded from the table above because they do not have contractual maturities.
For the years ended December 31, 2011 and 2010, a net unrealized gain of $17,651 and a net unrealized loss of $1,201, respectively, was recorded to accumulated other comprehensive income as a result of changes in fair value for investments classified as available-for-sale.
As of December 31, 2011, the Company’s investments in debt securities in an unrealized loss position all hold investment grade ratings by various credit rating agencies. Additionally, the issuers have been current on all interest payments. The temporary declines in value at December 31, 2011 are primarily due to fluctuations in short-term market interest rates and the lack of liquidity of auction rate securities. Auction rate securities that have been in an unrealized loss position for greater than 12 months have experienced losses due to the lack of liquidity for these instruments, not as a result of impairment of the underlying debt securities. The unrealized loss positions on equity index funds as of December 31, 2011 are primarily due to recent market volatility in the corresponding equity indices that these funds are designed to replicate. These equity index funds have been trading below cost continuously for less than six months with the maximum decline of any equity holding below cost position of six percent which the Company believes is typical of the market volatility of these types of funds at any point in time but not representative of other-than-temporary impairment. Additionally, each equity index fund in an unrealized loss position at December 31, 2011 is actively traded and all received a dividend payment in the fourth quarter of 2011. The Company does not intend to sell the debt and equity securities in an unrealized loss position prior to maturity or recovery and it is not likely that the Company will be required to sell these securities prior to maturity or recovery; therefore, there is no indication of other-than-temporary impairment for these securities.
Property, equipment and software, net at December 31, 2011 and 2010 is summarized as follows:
Depreciation and amortization expense on property and equipment was $13,384, $12,795 and $15,506 for the years ended December 31, 2011, 2010 and 2009, respectively. Amortization expense on software was $22,182, $20,349 and $16,392 for the years ended December 31, 2011, 2010 and 2009, respectively.
incorporating all prior amendments and revising certain terms and conditions including, among other things, the addition of two one-year option terms to the contract, exercisable by GA DCH, which potentially extends the total term of the contract until June 30, 2014. The amended and restated contract also provides the Company’s Georgia health plan the option to expand statewide provided it is able to demonstrate compliance with the contract requirements in all service regions. The Company can give no assurance that its entry, if any, into additional service areas in Georgia will be favorable to its financial position, results of operations or cash flows in future periods. Additionally, on December 29, 2011, the Company received an amendment to the amended and restated contract that revised premium rates retroactive to July 1, 2011. Upon receipt of the final amendment, the revised premium rates were recognized for the period from July 1, 2011 forward, in accordance with GAAP. The contract, as renewed, will terminate on June 30, 2012 if an option to renew the contract for an additional one-year term is not exercised by GA DCH. Additionally, the state has indicated its intent to begin reprocurement of the contract through a competitive bidding process in 2012.
On July 25, 2011, the Louisiana Department of Health and Hospitals (“DHH”) announced that the Company was one of five managed care organizations selected through a competitive procurement to offer healthcare coverage to Medicaid recipients in Louisiana through its Louisiana health plan. The state indicated that the managed care organizations will enroll collectively approximately 900,000 members statewide, including children and families served by Medicaid’s TANF as well as people with disabilities. Of the five managed care organizations selected, the Company is one of three providers that began offering services on a full-risk basis on February 1, 2012 to approximately 45,000 members in the first of three regions to be covered under the contract. Two managed care organizations that bid in the procurement but were not selected have protested the award of the contract to the Company and the other successful bidders and have instituted legal proceedings regarding the contract awards. While the Company believes that the award of the contract was proper, the Company is unable to predict the outcome of the state court challenges that have been filed and can give no assurances that the award will be upheld or that the impact to the Company’s operations in Louisiana will not be significant if it is not upheld.
On October 6, 2011, one of the Company’s Texas health plans, AMERIGROUP Texas, Inc., received an executed amendment to the Texas Health and Human Services Commission (“HHSC”) Agreement for Health Services to the STAR, STAR+PLUS, CHIP and CHIP Perinatal programs for the contract period that began September 1, 2011. The amendment revised premium rates resulting in a net decrease of approximately 5.4%, effective September 1, 2011. The revised premium rates have been recognized since September 1, 2011, the effective date of the contract, in accordance with GAAP. The Company can provide no assurance that the impact of the decrease in premium rates will not have a material adverse effect on its financial position, results of operations or cash flows in future periods.
On March 1, 2009, the South Carolina health plan sold its rights to serve Medicaid members pursuant to the contract with the state of South Carolina for $5,810. As a result of this transaction, the Company’s South Carolina health plan does not currently serve any members. Costs recorded to discontinue operations in South Carolina were not material to the Company’s results of operations, financial position or cash flows.
There were no changes in the carrying amount of goodwill for the year ended December 31, 2011. The change in the carrying amount of goodwill for the year ended December 31, 2010 is as follows:
Other acquired intangible assets, included in other long-term assets in the audited Consolidated Balance Sheets, at December 31, 2011 and 2010 are as follows:
Amortization expense for the years ended December 31, 2011, 2010 and 2009 was $488, $589 and $404, respectively, and the estimated aggregate amortization expense for the five succeeding years is as follows:
Health benefits expense incurred during the year was reduced for amounts related to prior years by $92,988, $106,215 and $85,317 in the years ended December 31, 2011, 2010 and 2009, respectively. Actuarial standards of practice generally require that the liabilities established for accrued medical expenses be sufficient to cover obligations under an assumption of moderately adverse conditions. A portion of the reduction in health benefits expense incurred during the year related to prior years was attributable to releasing most of the provision for moderately adverse conditions for prior years. The amounts released were $28,749, $32,178 and $34,414 for the years ended December 31, 2011, 2010 and 2009, respectively.
The remaining reduction in health benefits expense incurred during the year, related to prior years, of $64,239, $74,037 and $50,903 for the years ended December 31, 2011, 2010 and 2009, respectively, primarily resulted from obtaining more complete claims information for claims incurred for dates of service in the prior years. These amounts are referred to as net reserve development. The Company experienced lower medical trend than originally estimated in addition to increased claim payment recoveries and coordination of benefits in 2011, 2010 and 2009 related to prior year dates of services for all periods. These factors also caused the actuarial estimates to include faster completion factors than were originally established. The lower medical trend, increased claim payment recoveries and faster completion factors each contributed to the net favorable reserve development in each respective period.
On January 18, 2012, the Company issued an additional $75,000 in aggregate principal amount of the 7.5% Senior Notes due November 15, 2019. The additional notes constitute a further issuance of, and are fungible with the $400,000 of 7.5% Senior Notes that the Company issued on November 16, 2011 and form a single series of debt securities with the initial notes. Following the issuance of the additional notes, the aggregate principal amount of the Company’s 7.5% Senior Notes outstanding was $475,000.
The 7.5% Senior Notes contain certain covenants restricting the Company’s ability, among other things, to incur additional indebtedness, pay dividends or make other distributions or payments, repay junior indebtedness, sell assets, make investments, engage in transactions with affiliates, create certain liens and engage in certain types of mergers or acquisitions. These covenants are subject to certain exceptions, including exceptions that allow the Company to incur debt or make restricted payments if certain ratios are met. As of December 31, 2011, the Company believes it was in compliance with all covenants under the 7.5% Senior Notes.
In May 2007, an automatic shelf registration statement was filed on Form S-3 with the Securities and Exchange Commission covering the resale of the 2.0% Convertible Senior Notes and common stock issuable upon conversion. The 2.0% Convertible Senior Notes are senior unsecured obligations of the Company and rank equal in right of payment with all of its existing and future senior debt and senior to all of its subordinated debt. The 2.0% Convertible Senior Notes are effectively subordinated to all existing and future liabilities of the Company’s subsidiaries and to any existing and future secured indebtedness. The 2.0% Convertible Senior Notes bear interest at a rate of 2.0% per year, payable semiannually in arrears in cash on May 15 and November 15 of each year, and mature on May 15, 2012, unless earlier repurchased or converted.
At conversion, the dilutive impact would result if the conversion value in excess of the principal amount of the 2.0% Convertible Senior Notes, if any, is settled in shares of the Company’s common stock. The conversion rate is subject to adjustment in some events but will not be adjusted for accrued interest. In addition, if a “fundamental change” occurs prior to the maturity date, the Company will in some cases increase the conversion rate for a holder of the 2.0% Convertible Senior Notes that elects to convert their 2.0% Convertible Senior Notes in connection with such fundamental change. During the year ended December 31, 2011, certain bondholders converted $120 in aggregate principal amount of the 2.0% Convertible Senior Notes with a conversion value in excess of the principal amount of $82. The Company paid the consideration for the conversion of the 2.0% Convertible Senior Notes using cash on hand and the conversion value in excess of the principal amount converted was recouped through cash received from the counterparty pursuant to the convertible note hedge instruments, discussed below.
Concurrent with the issuance of the 2.0% Convertible Senior Notes, the Company purchased convertible note hedges, subject to customary anti-dilution adjustments, covering 6,112,964 shares of its common stock. The convertible note hedges allow the Company to receive, at its option, shares of its common stock and/or cash equal to the amounts of common stock and/or cash related to the excess conversion value that the Company would pay to the holders of the 2.0% Convertible Senior Notes upon conversion. These convertible note hedges will generally terminate at the earlier of the maturity date of the 2.0% Convertible Senior Notes or the first day on which none of the 2.0% Convertible Senior Notes remain outstanding due to conversion or otherwise. The convertible note hedges are expected to offset the potential dilution upon conversion of the 2.0% Convertible Senior Notes in the event that the market value per share of the Company’s common stock, as measured under the convertible note hedges, at the time of exercise is greater than the strike price of the convertible note hedges, which corresponds to the initial conversion price of the 2.0% Convertible Senior Notes and is subject to certain customary adjustments. If, however, the market value per share of the Company’s common stock exceeds the strike price of the warrants (discussed below) when such warrants are exercised, the Company will be required to issue common stock. Both the convertible note hedges and warrants provide for net-share settlement at the time of any exercise for the amount that the market value of the common stock exceeds the applicable strike price.
Also concurrent with the issuance of the 2.0% Convertible Senior Notes, the Company sold warrants to acquire, subject to customary anti-dilution adjustments, 6,112,964 shares of its common stock at an exercise price of $53.77 per share. If the average market price of the Company’s common stock during a defined period ending on or about the settlement date exceeds the exercise price of the warrants, the warrants will be settled in shares of its common stock. Consequently, under the provisions of the warrant instruments, if the market price of the Company’s common stock exceeds $53.77 at exercise, the Company will be obligated to settle in shares of its common stock an amount equal to approximately $6,100 for each dollar that the market price of its common stock exceeds $53.77 resulting in a dilutive impact to its earnings. The warrant instruments had a dilutive impact to earnings per share for the year ended December 31, 2011 as the average market price of the Company’s common stock for the year ended December 31, 2011 of $56.67 exceeded the $53.77 exercise price of the
warrants. The warrant instruments did not have a dilutive impact to earnings per share for the years ended December 31, 2010 or 2009 as the average market price of the Company’s common stock for each of those years did not exceed the $53.77 exercise price of the warrants.
The convertible note hedges and warrants are separate instruments which will not affect holders’ rights under the 2.0% Convertible Senior Notes.
The Company maintains professional liability coverage for certain claims which is provided by independent carriers and is subject to annual coverage limits. Professional liability policies are on a claims-made basis and must be renewed or replaced with equivalent insurance if claims incurred during its term, but asserted after its expiration, are to be insured.
The Company leases office space and office equipment under operating leases which expire at various dates through 2021. Future minimum payments under operating leases that have initial or non-cancelable lease terms in excess of one year are as follows at December 31, 2011:
Company does not match any employee contributions; however, the Company’s obligation to the employee is equal to the employees’ deferrals plus or minus any return on investment the employee earns through self-selected investment allocations. Included in other long-term liabilities at December 31, 2011 and 2010, respectively was $6,688 and $6,612 related to this plan.
The Second Amended Class Action Complaint with respect to these consolidated cases alleges, inter alia, that the plaintiffs and certain other employees should have been classified as non-exempt employees under the Fair Labor Standards Act (“FLSA”) and during the course of their employment should have received overtime and other compensation under the FLSA from October 22, 2007 until the entry of judgment and under the New York Labor Law (“NYLL”) from October 22, 2004 until the entry of judgment. The Complaint requests certification of the NYLL claims as a class action under Rule 23, designation of the FLSA claims as a collective action, a declaratory judgment, injunctive relief, an award of unpaid overtime compensation, an award of liquidated damages under the FLSA and NYLL, pre-judgment interest, as well as costs, attorneys’ fees, and other relief.
The Company is involved in various other legal proceedings in the normal course of business. Based upon its evaluation of the information currently available, the Company believes that the ultimate resolution of any such proceedings will not have a material adverse effect, either individually or in the aggregate, on its financial position, results of operations or cash flows.
Stock option activity during the year ended December 31, 2011 was as follows:
i. the expected life of each award granted was calculated using historical exercise patterns;
Non-vested restricted stock for the twelve months ended December 31, 2011 is summarized below:
Prior to 2011, certain employees were eligible for a performance-based cash incentive award designed to retain key executives. Each eligible participant was assigned a cash target, the payment of which is deferred for three years. The amount of the target is dependent upon the participant’s performance against individual major job objectives in the first year of the program. The target award amount is funded over the three-year period, with the funding at the discretion of the Compensation and Organizational Management Committee of the Board of Directors. An executive is eligible for payment of a performance-based incentive award earned in any one year only if the executive remains employed with the Company and is in good standing on the date the payment is made following the third year of the three-year period. The expense recorded for the performance-based cash incentive awards for plan years prior to 2011 was $3,073, $7,051 and $3,192 in 2011, 2010 and 2009,
Performance-based cash awards are classified as liability awards because they are settled in cash. The fair value of the performance-based cash liability is re-evaluated using the Monte Carlo valuation model at each reporting date, if and when the market condition is in effect. A target of $4,448 performance-based cash awards were granted with the ability for participants to earn between $0 and $8,896.
The performance-based awards vest over a three-year performance period if certain performance and/or market conditions are achieved. Compensation costs for the performance-based awards are recognized by the Company over the requisite service period based on the probable outcome of the application of the performance and/or market conditions. The Company estimates the possible outcome of the performance and/or market conditions at each reporting period. The Company recognizes compensation costs based upon this estimate of the shares and cash that are expected to ultimately vest. For the year ended December 31, 2011, $3,145 was recognized related to grants of performance-based restricted stock units and performance-based cash and is included in selling, general and administrative expenses in the accompanying audited Consolidated Statements of Income. The related long-term cash liability of $1,853 at December 31, 2011 is included in other long-term liabilities and the balance of the expense is recorded to additional paid-in capital.
On May 12, 2011, the Company adopted, based on approval by the Board of Directors and stockholders, an employee stock purchase plan (the “2011 ESPP”). The 2011 ESPP was designed to replace the Company’s previous employee stock purchase plan which was adopted on February 15, 2001 (the “2001 ESPP”) and expired pursuant to its ten-year term. The terms and conditions of the 2011 ESPP are unchanged from the terms and conditions of the 2001 ESPP. All of the Company’s employees who have at least 90 days of service, customarily work at least 20 hours per week and customarily work more than five months per year are eligible to participate, except for employees who own shares possessing five percent or more of the total combined voting power or value of the Company or its subsidiaries. Eligible employees may join the plan every six months. Purchases of common stock are priced at the lower of the stock price less 15% on the first day or the last day of the six-month period. The Company has reserved for issuance 1,200,000 shares of common stock under the 2011 ESPP. During the year ended December 31, 2011, no shares were issued under the 2001 ESPP and 73,717 shares were issued under the 2011 ESPP. During the years ended December 31, 2010 and 2009, the Company had issued 88,343 and 97,332 shares, respectively, under the 2001 ESPP. As of December 31, 2011 a total of 1,126,283 shares were available for issuance under the 2011 ESPP.
To assess the recoverability of deferred tax assets, the Company considers whether it is more likely than not that deferred tax assets will be realized. In making this determination, the scheduled reversal of deferred tax liabilities and whether projected future taxable income is sufficient to permit deduction of the deferred tax assets are taken into account. Based on the reversal of deferred tax liabilities, the level of historical taxable income and projections for future taxable income, the Company believes it is more likely than not that it will fully realize the benefits of the gross deferred tax assets of $45,020.
The Company is subject to U.S. federal income tax, as well as income taxes in multiple state jurisdictions. Substantially all U.S. federal income tax matters have been concluded for years through 2007. Substantially all material state matters have been concluded for years through 2007.
Potential common stock equivalents representing 50,857 shares, 895,899 shares and 2,676,447 shares for the years ended December 31, 2011, 2010 and 2009, respectively, were not included in the computation of diluted net income per share because to do so would have been anti-dilutive.
The Company’s warrants to purchase shares of its common stock (see Note 9) were not included in the computation of diluted net income per share for the years ended December 31, 2010 and 2009 because to do so would have been anti-dilutive.