We are a multi-state managed healthcare company focused on serving people who receive healthcare benefits through publicly sponsored programs, including Medicaid, SCHIP, FamilyCare and Medicare Advantage programs. 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 continue to believe that managed healthcare remains the only proven mechanism that significantly reduces medical costs, helps our government partners control their costs, and improves health outcomes for those receiving these types of benefits.
In September 2007, we received approval from CMS to offer both Medicare Advantage Special Needs Plans and Medicare Advantage health plans in the following states: Florida, Maryland, New Jersey, New Mexico, New York, Tennessee and Texas. We had previously offered Medicare Advantage Special Needs Plans in Maryland and Texas. We expanded our service areas in these two states and added Medicare Advantage health plans. We are serving members in all seven states beginning in January 2008.
In August 2007, we concluded the contracting process with the State of South Carolina to begin serving Medicaid enrollees under the new South Carolina Healthy Connections Choices Program. The program will be implemented by region, with the Midlands Region, or the Columbia area, designated as the first area of service. We began enrollment in December 2007.
On April 1, 2007, AMERIGROUP Tennessee, Inc. began offering healthcare coverage to Medicaid members in the State of Tennessee for the Middle-Grand region. As of December 31, 2007, AMERIGROUP Tennessee, Inc. served approximately 186,000 members in the Middle-Grand region. On November 1, 2007, we acquired the contract rights and substantially all of the assets of MMCC, including substantially all of the assets of Midsouth Health Solutions, Inc., a subsidiary of MMCC. As of December 31, 2007, AMERIGROUP Tennessee, Inc. served approximately 170,000 members under an ASO arrangement in the West Tennessee region as a result of this acquisition. We believe this acquisition will strengthen our ability to respond to the West Tennessee request for proposal (“RFP”) that was released in January 2008. The State of Tennessee intends to convert the contracts in that region from an ASO arrangement to a risk arrangement.
We are in the process of establishing a contract with the State of New Mexico to serve the long-term care segment of the Medicaid population. Depending upon the pace of implementation established by the State, we may begin operations in 2008.
As of December 31, 2007, approximately 39% of our current membership has resulted from eleven acquisitions. We periodically evaluate acquisition opportunities to determine if they align with our business strategy. We continue to believe acquisitions can be an important part of our long-term growth strategy.
As described in Item 3 - Legal Proceedings of this Form 10-K, we have appealed the $334.0 million verdict against us in the Qui Tam Litigation to the United States Court of Appeals for the Seventh Circuit. On September 17, 2007, we filed our memorandum of law in support of our appeal with the Court of Appeals. On December 17, 2007, the United States of America and the State of Illinois filed a joint brief, and the Relator filed a brief, in response to our memorandum of law. We have until February 29, 2008 to file our reply to these briefs with the Court of Appeals, which we intend to do. Following filing this brief, we expect the Court of Appeals to set a date for oral arguments prior to rendering a decision. While we do not control this timeline it is possible the Court of Appeals could render a decision as early as summer 2008, but there is no assurance that the decision will not occur at an earlier or later date.
A Florida Statute (the “Statute”) gives the Florida Agency for Health Care Administration (“AHCA”) the right to contract with entities to provide comprehensive behavioral healthcare services, including mental health and substance abuse services. The Statute further requires the contractor to use at least 80% of the capitation for the provision of behavioral healthcare services, with any shortfall in the 80% expenditure being refunded to the State. In April 2007, our Florida subsidiary AMERIGROUP Florida Inc., and AHCA resolved the disagreement regarding this matter for the 2004 and 2005 contract years and AMERIGROUP Florida, Inc. paid approximately $5.3 million to AHCA.
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 consolidated financial statements in conformity with U.S. generally accepted accounting principles. 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.
In all of the states in which we operate, except Tennessee and Virginia, we are eligible to receive supplemental payments to offset the health benefits expenses associated with the birth of a baby. Each state contract is specific as to what is required before payments are collectible. Upon delivery of a baby, 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. Changes in authorization and claims data used to estimate supplemental revenues can occur as a result of changes in eligibility noted above or corrections of errors in the underlying data. Adjustments to revenue for corrections to authorization and claims data are recorded in the period in which the corrections become known. Historically, the impact of these adjustments has represented less than 1% of annual revenue which results in a negligible impact on annual earnings as changes in revenue are typically accompanied by corresponding changes in the related health benefits expense. We believe this historical experience represents what is reasonably likely to occur in future periods.
The most judgmental accounting estimate in our consolidated financial statements is our liability for medical claims payable. At December 31, 2007, this liability was $541.2 million and represented 46% of our total consolidated liabilities. Included in this liability and the corresponding health benefits expenses for incurred but not reported (IBNR) claims are the estimated costs of processing such claims. Health benefits expenses have two main components: direct medical expenses and medically-related administrative costs. Direct medical expenses include amounts paid to hospitals, physicians and providers of ancillary services, such as laboratories and pharmacies. Medically-related administrative costs include items such as case and disease management, utilization review services, quality assurance and on-call nurses.
We have used a consistent methodology for estimating our medical expenses and medical claims payable since inception, and have refined our assumptions to take into account our maturing claims, product and market experience. Our reserving practice is to consistently recognize the actuarial best point estimate within a level of confidence required by actuarial standards. Actuarial standards of practice generally require a level of confidence such that the liabilities established for IBNR have a greater probability of being adequate versus being 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.
We do not believe that completion factors are fully credible for estimating claims incurred for the most recent two to three months which constitute the majority of the amount of the medical claims payable. Accordingly, we estimate health benefits expenses incurred by applying observed medical cost trend factors to the average per member per month (PMPM) medical costs incurred in a more complete time period. Medical cost trend factors are developed through a comprehensive analysis of claims incurred in prior months for which more complete claim data is available. The average PMPM is also adjusted for known changes in hospital authorization data, provider contracting changes, changes in benefit levels, age and gender mix of members, and seasonality. The incurred estimates resulting from the analysis of completion factors, medical cost trend factors and other known changes are weighted together using actuarial judgment.
Many aspects of the managed care business are not predictable with consistency. These aspects include the incidences of illness or disease state (such as cardiac heart failure cases, cases of upper respiratory illness, the length and severity of the flu season, diabetes, the number of full-term versus premature births and the number of neonatal intensive care babies). Therefore, we must rely upon our historical experience, as continually monitored, to reflect the ever-changing mix, needs and growth of our members in our assumptions. Among the factors considered by management are changes in the level of benefits provided to members, seasonal variations in utilization, identified industry trends and changes in provider reimbursement arrangements, including changes in the percentage of reimbursements made on a capitated, as opposed to a fee-for-service, basis. These considerations are aggregated in the medical cost trend. Other external factors such as government-mandated benefits or other regulatory changes, catastrophes and epidemics may impact medical cost trends. Other internal factors such as system conversions and claims processing interruptions may impact our ability to accurately predict estimates of historical completion factors or medical cost trends. Medical cost trends potentially are more volatile than other segments of the economy. Management is required to use considerable judgment in the selection of health benefits expense trends and other actuarial model inputs.
Completion factors are the most significant factors we use in developing our medical claims payable estimates for older periods, generally periods prior to the most recent three months. The following table illustrates the sensitivity of these factors and the estimated potential impact on our medical claims payable estimates for those periods as of December 31, 2007:
Reflects estimated potential changes in health benefits expenses and medical claims payable caused by changes in medical costs PMPM trend data used in developing medical claims payable estimates for the most recent three months.
Changes in estimates of medical claims payable are primarily the result of obtaining more complete claims information that directly correlates with the claims and provider reimbursement trends. Volatility in members’ needs for medical services, provider claims submission and our payment processes results in identifiable patterns emerging several months after the causes of deviations from assumed trends occur. Since our estimates are based upon PMPM claims experience, changes cannot typically be explained by any single factor, but are the result of a number of interrelated variables, all influencing the resulting experienced medical cost trend. Deviations, whether positive or negative, between actual experience and estimates used to establish the liability are recorded in the period known.
Establishing the liabilities for IBNR, associated with health benefits expenses incurred during a year, related to that current year, at a level sufficient to cover obligations under an assumption of moderately adverse conditions will cause incurred health benefits expenses for that current year to be higher than if IBNR was established without sufficiency for moderately adverse conditions.
Also included in medical 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 contracted providers under risk-sharing arrangements.
In addition to incurred but not paid claims, the liability for medical claims payable includes reserves for premium deficiencies, if appropriate. Premium deficiencies are recognized when it is probable that expected claims and administrative expenses will exceed future premiums and investment income on existing medical insurance contracts. For purposes of premium deficiencies, contracts are grouped in a manner consistent with our method of acquiring, servicing and measuring the profitability of such contracts. We did not have any premium deficiency reserves at December 31, 2007.
After tax returns for the applicable year are filed, the estimated tax liability is trued up to the actual liability per the filed federal and state tax returns. Historically, we have not experienced significant differences between our estimates of tax liability and our actual tax liability.
In addition, we are periodically audited by federal and state taxing authorities and these audits can result in proposed assessments. We believe that our tax positions comply with applicable tax law and, as such, will vigorously defend these positions on audit. We believe that we have adequately provided for any reasonable foreseeable outcome related to these matters. Although the ultimate resolution of these audits may require additional tax payments, we do not anticipate any material impact to earnings.
In August 2007, the FASB proposed FASB Staff Position (“FSP”) APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). The proposed FSP would require the proceeds from the issuance of such convertible debt instruments to be allocated between a liability component and an equity component. The resulting debt discount would be amortized over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. The proposed change in accounting treatment would be effective for fiscal years beginning after December 15, 2008, and applied retrospectively to prior periods. If adopted, this FSP would change the accounting treatment for our $260.0 million 2.0% Convertible Senior Notes due May 15, 2012, which were issued effective March 28, 2007. If adopted in its current form, the impact of this new accounting treatment could be significant to our results of operations and result in an increase to non-cash interest expense beginning in fiscal year 2009 for financial statements covering past and future periods. We estimate earnings per diluted share could decrease by approximately $0.11 to $0.12 annually as a result of the adoption of this FSP. As the guidance is emerging and still under consideration regarding its effective date and scope, we can make no assurances that the actual impact upon adoption will not differ materially from our estimates.
Summarized comparative financial information for the years ending December 31, 2007, 2006 and 2005 are as follows ($ in millions, except per share data)
The following table sets forth the approximate number of our members in each state for the periods presented. 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 offer Medicare Advantage plans.
Included in the Texas membership are approximately 13,000, 14,000, and 10,000 members under an ASO contract in 2007, 2006 and 2005, respectively.
Included in the Tennessee membership are approximately 170,000 members under an ASO contract in 2007 commencing with the MMCC acquisition effective November 1, 2007.
As of December 31, 2007, we served approximately 1,711,000 members, which reflects an increase of approximately 395,000 members compared to December 31, 2006. Our entry into the Tennessee market in April 2007 resulted in approximately 186,000 members at year end. In addition, the acquisition of MMCC on November 1, 2007, increased our Tennessee membership by approximately 170,000 members. The ABD expansion markets in Texas and Ohio, which began enrollment in February 2007, increased membership by approximately 30,000 members. Texas membership has further increased as the State of Texas eliminated the primary care case management program, which expanded participation in health plans such as ours. These increases were offset by the contraction of the New York market whose membership decreased by 14,000 resulting from more stringent guidelines for eligibility re-determination implemented by the state in 2006 and a reduction in the size of our New York sales force in response to limits imposed by the State on marketing programs. Additionally, Georgia membership decreased by 16,000 resulting primarily from a decline in the overall eligible population as well as changes in our marketing programs during the year.
Investment income and other increased $34.1 million or 86.8% during the year ended December 31, 2007 and $21.0 million or 114.8% during the year ended December 31, 2006. These increases in investment income and other are primarily due to higher interest rates and increases in the average balance of invested assets. Additionally, 2007 benefited from approximately $14.2 million in income earned on restricted assets held as collateral. These assets were established in March and April 2007 from proceeds from borrowings under our Credit Agreement and the issuance of 2.0% Convertible Senior Notes due May 15, 2012, discussed below.
Expenses relating to health benefits for the year ended December 31, 2007 increased $950.1 million, or 41.9%. The HBR for the year ended December 31, 2007 was 83.1% compared to 81.1% in 2006. Our 2007 results compared to 2006 reflect an increase in HBR primarily as a result of a higher proportion of our business in developing markets. These developing markets (which include Georgia, Tennessee, Ohio ABD, and Texas ABD as well as Maryland Medicare Advantage, all as of December 31, 2007) generally have a higher HBR than our mature markets due to the
an increase in premium taxes as a result of our entry into the Georgia market, increased revenues in our Maryland and Ohio markets which bear premium tax and an increase in the premium tax rate in New Jersey;
an increase in legal expenses related to the Qui Tam Litigation; and
Premium taxes were $85.2 million, $47.1 million and $25.9 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Depreciation and amortization expense was $31.6 million, $25.5 million and $26.9 million for the years ended December 31, 2007, 2006 and 2005, respectively. The increase from 2006 to 2007 is a result of greater depreciable assets, the write-off of debt issuance costs related to the termination of the Company’s previous $150.0 million credit agreement and an increase in amortization of debt issuance costs as a result of the new Credit Agreement entered into in March 2007.
Interest expense was $12.3 million for the year ended December 31, 2007 and $0.6 million in each of the years ended December 31, 2006 and 2005. The increase in interest expense is a result of borrowings under our Credit Agreement and the issuance of the 2.0% Convertible Senior Notes due May 15, 2012, discussed below.
Our primary sources of liquidity are cash and cash equivalents, short- and long-term investments, cash flows from operations and borrowings under our Credit Agreement. As of December 31, 2007, we had cash and cash equivalents of $487.6 million, short and long-term investments of $579.7 million and restricted investments on deposit for licensure of $89.5 million. Cash, cash equivalents, and investments which are unrestricted and unregulated totaled $206.4 million at December 31, 2007.
Although the general rate of inflation has remained relatively stable and healthcare cost inflation has stabilized in recent years, the national healthcare cost inflation rate still significantly exceeds the general inflation rate. We use various strategies to reduce the negative effects of healthcare cost inflation. Specifically, our health plans try to control medical and hospital costs through contracts with independent providers of healthcare services. Through these contracted care providers, our health plans emphasize preventive healthcare and appropriate use of specialty and hospital services.
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 $16,372, $13,714 and $12,978 for the years ended December 31, 2007, 2006 and 2005, respectively. The estimated useful lives are as follows:
On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Shared-Based Payment (“FASB Statement No. 123(R)”), which is a revision of FASB Statement No. 123. FASB Statement No. 123(R) supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB Opinion No. 25), FASB Statement No. 148, Accounting for Stock-Based Compensation and amends FASB Statement No. 95, Statement of Cash Flows. FASB Statement No. 123(R) established the accounting for transactions in which an entity pays for employee services in share-based payment transactions. FASB Statement No. 123(R) requires companies to measure 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 adjusted for the unique characteristics of those instruments. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. The Company adopted FASB Statement No. 123(R) effective January 1, 2006, using the modified-prospective transition method. Under this method, compensation cost was recognized for awards granted and for awards modified, repurchased, or cancelled in the period after adoption. Compensation cost has also been recognized for the unvested portion of awards granted prior to adoption. Prior year financial statements were not restated.
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.
payments which increased at a more modest rate than estimated at the end of 2005. Claims payments for dates of service occurring in the early portion of 2005 increased significantly, based on available claims payment information as of December 31, 2005. We estimated health benefits expenses would continue to increase significantly through the remainder of 2005. As claims for medical services delivered in the second half of 2005 were paid during 2006, it became apparent that the elevated cost trends we anticipated did not continue throughout 2005.
Long-lived assets, such as property and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows and the assets could not be used within the Company, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the consolidated balance sheets and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a group classified as held for sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheet. No impairment of long-lived assets was recorded in 2007, 2006 or 2005.
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 FASB Statement 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 2007, 2006 or 2005.
Basic net income per share has been computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share reflects the potential dilution that could occur assuming the inclusion of dilutive potential common shares and has been computed by dividing net income by the weighted average number of common shares and dilutive potential common shares outstanding. Dilutive potential common shares include all outstanding stock options and convertible debt securities after applying the treasury stock method to the extent the potential common shares are dilutive.
The carrying amount, gross unrealized holding gains, gross unrealized holding losses and fair value for long-term investments are as follows at December 31, 2007 and 2006:
As a condition for licensure by various state governments to operate HMOs, health insuring corporations (“HICs”) or prepaid health services plans (“PHSPs”) we are 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. We purchase interest-based 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. The amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for these held-to-maturity securities are summarized as follows at December 31:
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, 2006:
On November 1, 2007, AMERIGROUP Corporation and AMERIGROUP Tennessee, Inc. acquired the contract rights and substantially all of the assets of Memphis Managed Care Corporation (“MMCC”) including substantially all of the assets of Midsouth Health Solutions, Inc., a subsidiary of MMCC, for approximately $11,733. An additional contingent payment of approximately $18,250 will be payable at such time if and when the State of Tennessee awards to AMERIGROUP Tennessee, Inc. a capitated contract through the TennCare program to provide full-risk managed care services to the Medicaid population in West Tennessee. The initial $11,733 payment is subject to post-closing adjustments based on the timing of the implementation of the full-risk program in West Tennessee and the $18,250 contingent payment is subject to adjustment based on the number of full-risk members assigned to AMERIGROUP Tennessee, Inc. should it bid successfully in West Tennessee. The purchase price was financed through available unregulated cash. The assets purchased consisted primarily of MMCC’s rights to provide administrative services to the State of Tennessee for its TennCare members in the West Tennessee region. As of December 31, 2007, total membership in the West Tennessee region equaled approximately 170,000. Goodwill and other intangibles total $10,039, which includes $1,819 of specifically identifiable intangibles allocated to the rights to the administrative services contract, the provider network and trademarks. Intangible assets related to the rights to membership and provider network are being amortized over ten years on a straight-line basis. Intangible assets related to the trademarks are being amortized over 14 months on a straight-line basis.
Effective January 1, 2005, we completed the 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. On August 16, 2006, in accordance with the terms of the merger agreement, additional consideration was paid in the amount of $4,766 for the achievement of an earnings threshold by CarePlus during the twelve months ended December 31, 2005. These payments were accounted for as additional costs of the acquisition. Beginning January 1, 2005, the results of operations of CarePlus have been included in the accompanying Consolidated Financial Statements.
This acquisition was funded with unregulated cash. Goodwill and other intangibles total $127,439, which includes $13,980 of specifically identifiable intangibles allocated to the rights to membership, the provider network, non-compete agreements and trademarks. Intangible assets related to the rights to membership are being amortized based on the timing of the related cash flows with an expected amortization of ten years. Intangible assets related to the provider network are being amortized over ten years on a straight-line basis. Intangible assets related to the trademarks and non-compete agreements are being amortized over 12 to 36 months on a straight-line basis.
Total income taxes for the years ended December 31, 2007, 2006 and 2005 were allocated as follows:
To assess the recoverability of deferred tax assets, we consider whether it is more likely than not that deferred tax assets will be realized. In making this determination, we take into account the scheduled reversal of deferred tax liabilities and whether projected future taxable income is sufficient to permit deduction of the deferred tax assets. Based on the level of historical taxable income and projections for future taxable income, we believe it is more likely than not that we will fully realize the benefits of the gross deferred tax assets of $54,717. State net operating loss carryforwards that expire in 2025 through 2027 comprise $1,322 of the gross deferred tax assets.
The Company is subject to U.S. federal income tax, as well as income taxes in multiple state jurisdictions. We have substantially concluded all U.S. federal income tax matters for years through 2003. Substantially all material state matters have been concluded for years through 2002.
We adopted the provisions of FIN 48 on January 1, 2007. As a result of the adoption of FIN 48, we recorded a $9,185 increase to retained earnings as of January 1, 2007. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Effective March 28, 2007, we issued an aggregate of $260,000 in principal amount of 2.0% Convertible Senior Notes due May 15, 2012 (the “Notes”). In May 2007, we filed an automatic shelf registration statement on Form S-3 with the SEC covering the resale of the Notes and common stock issuable upon conversion of the Notes. The total proceeds from the offering of the Notes, after deducting underwriting fees and estimated offering expenses, were approximately $253,100. We incurred offering expenses totaling approximately $6,900 in connection with the offering of the Notes which are included in other long-term assets in the accompanying Condensed Consolidated Financial Statements and are being amortized over the term of the Notes. As of December 31, 2007, approximately $221,300 of these proceeds plus $1,000 funded by the Company are held as restricted investments as the balance of the collateral required for the irrevocable letter of credit which totals $351,300, as discussed above. The remainder of the proceeds of the Notes were used in connection with the purchase of convertible note hedges and sold warrants that were established concurrent with the issuance of the Notes as discussed below.
The Notes are governed by an Indenture dated as of March 28, 2007 (the “Indenture”). The Notes are senior unsecured obligations of the Company and will rank equally with all of our existing and future senior debt and senior to all of our subordinated debt. The Notes will be effectively subordinated to all existing and future liabilities of our subsidiaries and to any existing and future secured indebtedness, including the obligations under our Credit Agreement.
The 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, beginning on May 15, 2007. The Notes mature on May 15, 2012, unless earlier repurchased or converted. Holders may convert their Notes at their option on any day prior to the close of business on the scheduled trading day immediately preceding March 15, 2012, only under the following circumstances: (1) during the five business-day period after any five consecutive trading-day period (the measurement period) in which the price per Note for each day of that measurement period was less than 98 percent of the product of the last reported sale price of our common stock and the conversion rate on each such day; (2) during any calendar quarter after the calendar quarter ending June 30, 2007, if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of our immediately preceding calendar quarter exceeds 130 percent of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (3) upon the occurrence of specified corporate events. The Notes will be convertible, regardless of the foregoing circumstances, at any time on or after March 15, 2012 through the third scheduled trading day immediately preceding the maturity date of the Notes, May 15, 2012.
The convertible note hedges and sold warrants are separate transactions which will not affect holders’ rights under the Notes.
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, 2007, we had a total 3,003,099 shares available for issuance under our 2005 Plan.
In May 2003, our shareholders approved and we adopted the 2003 Equity Incentive Plan (“2003 Plan”), which provides for the granting of stock options, restricted stock, phantom stock and stock bonuses to employees and directors. We reserved for issuance a maximum of 3,300,000 shares of common stock under the 2003 Plan.
In July 2000, we adopted the 2000 Equity Incentive Plan (“2000 Plan”), which provides for the granting of stock options, restricted stock, phantom stock and stock bonuses to employees, directors and consultants. We reserved for issuance a maximum of 4,128,000 shares of common stock under the 2000 Plan at inception.
The weighted-average fair value per share of options granted during the years ended December 31, 2007, 2006 and 2005 was $14.08, $11.08 and $14.64, respectively. The total fair value of options vested during the years December 31, 2007, 2006 and 2005 was $8,526, $6,706 and $30,084, respectively. The following table provides information related to options exercised during the years ended December 31, 2007, 2006, and 2005:
Total intrinsic value of options exercised was $12,561, $10,634 and $27,051, for the years ended December 31, 2007, 2006 and 2005, respectively.
As of December 31, 2007, there was $16,324 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2005, 2003, 2000 and 1994 Plans, which is expected to be recognized over a weighted-average period of 2.6 years.
Potential common stock equivalents representing 1,531,368 shares with a weighted-average exercise price of $37.59 for the year ended December 31, 2007, were not included in the computation of diluted net income per share because to do so would have been anti-dilutive for the periods presented. Potential common stock equivalents representing 1,666,560 shares with a weighted-average exercise price of $39.55 for the year ended December 31, 2006, were not included in the computation of diluted net income per share because to do so would have been anti-
The Company’s 2.0% Convertible Senior Notes due May 15, 2012 issued effective March 28, 2007 in an aggregate principle amount of $260,000, were not included as dilutive securities because the conversion price of $42.53 was greater than the average market price of shares of the Company’s common stock; therefore, to do so would have been anti-dilutive. The Company’s warrants sold on March 28, 2007 and April 9, 2007 were not included as dilutive securities because the warrants’ exercise price of $53.77 was greater than the average market price of the Company’s common shares; therefore, to do so would have been anti-dilutive.
Regulations governing our managed care operations in each of our licensed subsidiaries require the applicable subsidiaries to meet certain minimum net worth requirements. Each subsidiary was in compliance with its requirements at December 31, 2007.
We are obligated under capital leases covering certain office equipment that expire at various dates during the next year. At December 31, 2007 and 2006, the gross amount of office equipment and related accumulated amortization recorded under capital leases was as follows:
These leases have various escalations, abatements and tenant improvement allowances that have been included in the total cost of each lease and amortized on a straight-line basis. Total rent expense for all office space and office equipment under non-cancelable operating leases was $15,846, $12,576 and $11,362 in 2007, 2006 and 2005, respectively, and is included in selling, general and administrative expenses in the accompanying consolidated income statements.
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, 2007, 2006 and 2005, the matching contributions under the plan were $3,748, $2,785, and $1,700, respectively.
In 2002, Cleveland A. Tyson (the “Relator”), a former employee of our former Illinois subsidiary, AMERIGROUP Illinois, Inc., filed a federal and state Qui Tam or whistleblower action against our former 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 “Qui Tam Litigation”). The complaint was filed in the U.S. District Court for the Northern District of Illinois, Eastern Division (the “Court”). It alleged that AMERIGROUP Illinois, Inc. submitted false claims under the Medicaid program by maintaining a scheme to discourage or avoid the enrollment into the health plan of pregnant women and other recipients with special needs.
On March 13, 2007, the Court entered a judgment against AMERIGROUP Illinois, Inc., and AMERIGROUP Corporation in the amount of approximately $334,000, which includes the trebling of damages and false claim penalties. Under the Federal False Claims Act, the counsel for the Relator is entitled to collect their attorney’s fees, costs and expenses in the event the Relator’s claim is successful. On May 11, 2007 we filed a notice of appeal with the United States Court of Appeals for the Seventh Circuit. On September 17, 2007 we filed our memorandum of law in support of our appeal with the Court of Appeals. On December 17, 2007, the United States of America and the State of Illinois filed a joint brief, and the Relator filed a brief, in response to our memorandum of law. We have until February 29, 2008 to file our reply to these briefs with the Court of Appeals, which we intend to do. Following filing this brief, we expect the Court of Appeals to set a date for oral arguments prior to rendering a decision. While
In March 2005, Colleen Batty, a former employee of our former Illinois subsidiary, AMERIGROUP Illinois, Inc., has filed a federal and state Qui Tam or whistleblower complaint under seal against us and our former Illinois subsidiary AMERIGROUP Illinois, Inc. in District Court in the Northern District of Illinois. The action, which is styled United States of America ex. rel. Colleen Batty, State of Illinois ex. rel. Colleen Batty and Colleen Batty, individually v. AMERIGROUP Illinois, Inc. and AMERIGROUP Corporation, was unsealed in May 2007. Ms. Batty’s complaint alleged, among other things, that AMERIGROUP Illinois, Inc. submitted false claims under the Medicaid program by underpaying certain hospitals in connection with emergency services delivered in out-of-network settings. The federal government and the State of Illinois have declined to intervene in the suit. Ms. Batty’s complaint also alleged wrongful discharge of her employment in violation of the False Claims Act and the Illinois Whistleblower and Protection Act. The action seeks: (i) an unspecified amount of compensatory damages under the False Claims Act and Illinois Whistleblower and Protection Act, which damages, if any, would be trebled under applicable law; (ii) statutory penalties allowable under the False Claims Act which range between $5.5 and $11.0 per false claim and statutory penalties allowable under the Illinois Whistleblower Reward and Protection Act, which range between $5.0 and $10.0 per false claim; and (iii) reinstatement to her job, two years’ back pay and compensatory damages. On August 31, 2007 we filed a motion with the Court to dismiss Ms. Batty’s claims. On December 21, 2007, the Court entered an order (the “Order”) granting our motion to dismiss all claims brought by Ms. Batty. The Order dismissed with prejudice all of the federal and state Qui Tam claims asserted by Ms. Batty under the False Claims Act and the Illinois Whistleblower Reward and Protection Act. The Order also dismissed without prejudice the wrongful discharge claims asserted by Ms. Batty. On January 15, 2008, we reached a confidential final settlement of Ms. Batty’s wrongful discharge claims which did not have a material effect on our results of operations. On February 11, 2008, the Court entered an order dismissing the case with prejudice.
AMERIGROUP Texas, Inc. is required to pay an experience rebate to the State of Texas in the event profits exceed established levels. The experience rebate calculation reports that we filed for the state fiscal years (SFYs) 2000 through 2005 have been audited by a contracted auditing firm retained by the State of Texas. In their report, the auditor challenged the inclusion in the rebate calculation of certain expenses incurred by the Company in providing services to AMERIGROUP Texas, Inc. for services obtained from AMERIGROUP Corporation under an administrative services agreement. The audits of experience rebate calculation reports for SFYs 2006 and 2007 are in process.
In February 2008, we resolved all of the open audit issues with respect to the experience rebate calculation reports for SFYs 2005 and prior and those experience rebate reports are now final. With respect to the experience rebate calculation reports for SFYs 2006 and 2007, we also reached agreement on the nature and amount of the administrative expenses incurred by AMERIGROUP Texas, Inc., for services provided by AMERIGROUP Corporation under the administrative services agreement that can be included in the experience rebate calculation. The impact of this resolution has been fully recognized in our consolidated financial statements for the year ended December 31, 2007 which resulted in an increase to selling general and administrative expenses of approximately $7,400.
On February 15, 2001, the Board of Directors approved and we adopted an Employee Stock Purchase Plan. All employees are eligible to participate except those employees who have been employed by us less than 90 days, whose customary employment is less than 20 hours per week or any employee who owns five percent or more of our common stock. 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. We have reserved for issuance 1,200,000 shares of common stock. We issued 88,277, 81,152, and 80,340 shares under the Employee Stock Purchase Plan in 2007, 2006, and 2005, respectively. As of December 31, 2007 we had a total of 713,057 shares available for issuance under the Employee Stock Purchase Plan.
The fair value of the employees’ purchase rights granted in each of the six months offering periods during 2007, 2006 and 2005 was estimated on the date of grant using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions:
The per share fair value of those purchase rights granted in each of the six month offering periods during 2007, 2006 and 2005 were as follows:
The Company recognized $753 and $537 of compensation expense during the years ended December 31, 2007 and 2006, respectively, for the purchase rights granted during 2007 and 2006, respectively. Included in the pro forma effect on net income and earnings per share if the Company had applied fair value recognition in prior years was $791 for the year ended December 31, 2005.