We do not own any real property. We lease office space in Virginia Beach, Virginia, where our headquarters, call, claims and data centers are located. We also lease real property in each of the health plan locations. We are obligated by various insurance and Medicaid regulatory authorities to have offices in the service areas where we provide Medicaid benefits.
In 2003 we increased our total revenues by 39.8% over 2002. Our 2003 revenue growth came from a number of factors including:
Effective July 1, 2003, we acquired the Medicaid contract rights and related assets of St. Augustine which operates in nine counties in the Miami/ Fort Lauderdale, Orlando and Tampa markets and served approximately 26,000 members.
Obtaining rate increases from the states in which we operate - In a difficult state budgetary environment, we leveraged our partnerships with our states and received rate increases.
Successfully integrating members we received from a competitor exiting a market - During the third quarter of 2003, we successfully integrated approximately 28,000 members in Texas which came to us from a competitor exiting that market.
We successfully insourced our behavioral health benefits servicing approximately 463,000 members in four states and the District of Columbia. We believe this strategy optimizes member health status, and reinforces our mission to coordinate our members physical and behavioral health and positions us well for future growth in existing states.
The State of Florida oversubscribed its SCHIP or Florida Healthy Kids program and thus faced a state funding shortfall. The initial response from the State was to create a temporary waiting list. Florida recently announced a plan to possibly fund up to 90,000 additional SCHIP members.
The State of Texas has announced its intent to award AMERIGROUP a contract for the Travis Service Area, which includes Austin and 7 additional counties, bringing the number of counties that we serve in the State to 27. We are currently finalizing the terms with the State and expect operations to begin in summer 2004. While initial estimates of growth are modest, this service area complements our long-term growth strategy. Currently, these counties are served by only one other health plan.
Technological improvements during the last year helped us to maintain our SG&A ratio consistent with the prior year at 11.5%. An example of our technological improvements is the 52% increase in usage of our
Cash and investments totaled $535.1 million at the end of 2003. A portion of this cash is regulated by state capital requirements. However, $199.9 million of our cash and investments was unregulated and held at the parent level.
We expect acquisitions to continue to be an important part of our growth strategy. Over 45% of our membership has resulted from nine acquisitions and we are currently evaluating potential acquisition opportunities. We believe the proceeds from our recent public offering, our undrawn credit facility and our cash flows from operating activities position us to take advantage of acquisition opportunities.
We have used the same methodology for estimating our medical expenses and medical liabilities since our inception, and have refined our assumptions to take into account our maturing claims and market experience. As medical utilization patterns and cost trends change from year-to-year, our underlying claims payments reflect the variations in experience. Our estimates are revised based upon actual claims payments using historical per-member, per-month claims cost, including provider settlements, changes in the age and gender of our membership and variations in the severity of medical conditions. These variations are considered in determining our current medical liabilities and adjusted to reflect expected changes in cost or utilization patterns.
The following table shows the components of the change in medical claims payable for the years ended December 31, 2003, 2002 and 2001 (in thousands):
Due to the variable nature of claims, our methodology includes adding a factor to compensate for uncertainty. The more precisely we have been able to predict claims patterns, the lower the required factor for
uncertainty. The health benefits expenses incurred during the period related to prior years relate almost entirely to revisions in estimates for the immediately preceding year. The application of our methodology, even in a changing environment, has resulted in reversals of estimated incurred claims related to the prior year in each of the years in the three year period ended December 31, 2003. The resulting impact on operations is a function of the variation of the change in estimate from year-to-year. In certain circumstances we adjust claims for overpayments. A portion of these adjustments may not be collected, so we estimate a historical factor to offset the expected recoupment.
We believe that the amount of claims payable is adequate to cover our ultimate liability for unpaid claims as of December 31, 2003; however, actual claim payments and other items may differ from established estimates. Assuming a hypothetical 1% difference between our December 31, 2003 estimates of claims payable and actual claims payable, net income for the year ended December 31, 2003 would increase or decrease by approximately $1.4 million and diluted earnings per share would increase or decrease by approximately $0.06 per share.
Premium revenue for the year ended December 31, 2003 increased $462.9 million, or 40.2%, from $1,152.6 million in 2002. The increase was primarily due to the acquisition of PHP (193,000 members) and St. Augustine (26,000 members) as well as internal growth in overall membership. Total membership increased 45.0% to 857,000 as of December 31, 2003 from 591,000 as of December 31, 2002.
Investment income decreased $1.3 million to $6.7 million for the year ended December 31, 2003. The decrease in investment income is primarily due to the continued decline in market interest rates and increased levels of tax-advantaged securities partially offset by an increase in overall cash and investments levels throughout the year. Cash and investments levels have increased due to proceeds from our public offering and cash generated from operations.
Selling, general and administrative expenses increased $53.5 million to $186.9 million for the year ended December 31, 2003 compared to $133.4 million in 2002. The increase in selling, general and administrative expenses was primarily due to an increase in wages and related expenses for additional staff to support our increased membership, expenses related to implementation of the HIPAA guidelines, as well as expenses related to market development activities. Our selling, general and administrative expense ratio to revenue was 11.5% for both the years ended December 31, 2003 and 2002.
Interest expense was $1.9 million and $0.8 million for the years ended December 31, 2003 and 2002, respectively. The increase primarily relates to increased average borrowings under our revolving credit facility to partially finance the PHP acquisition. On October 21, 2003, we used a portion of the net proceeds from our October 16, 2003 public offering to repay the outstanding balance under our revolving credit facility.
Net income for 2003 rose $20.3 million to $67.3 million, or $2.95 per diluted share, compared to $47.0 million, or $2.19 per diluted share in 2002. Diluted earnings per share rose 34.7% as compared to an increase in net income of 43.2%, due to the increase in shares outstanding primarily resulting from the issuance of 3,162,500 shares from our October 16, 2003 public offering.
Premium revenue for the year ended December 31, 2002 increased $272.1 million, or 30.9%, to $1,152.6 million from $880.5 million for the year ended December 31, 2001. The increase was principally due to internal growth in overall membership and, to a lesser extent, the acquisition of the Medicaid contracts and related assets of Humana’s Houston, Texas business in August 2001 (15,000 members), MethodistCare’s Houston, Texas business in January 2002 (11,000 members) and the acquisition of the Medicaid line of business of CCHP of Washington, D.C. in July 2002 (23,000 members). Total membership increased 25.2% to 591,000 as of December 31, 2002 from 472,000 as of December 31, 2001.
Investment income decreased $2.6 million to $8.0 million for the year ended December 31, 2002. The decrease in investment income is primarily due to the continued decline in market interest rates and increased levels of tax-advantaged securities partially offset by an increase in overall cash and investments levels throughout the year. Cash and investment levels primarily increased due to proceeds from our initial public offering and cash generated from operations.
Interest expense was $0.8 million for each of the years ended December 31, 2002 and 2001.
Our primary sources of liquidity are cash and cash equivalents, short and long-term investments, cash flow from operations and borrowings under our credit facility. As of December 31, 2003, we had cash and cash equivalents of $407.2 million, short and long-term investments of $127.9 million and restricted investments on deposit for licensure of $35.3 million. As of December 31, 2003, there were no borrowings outstanding under our $95.0 million credit facility. Cash and investments totaled $535.1 million at December 31, 2003. A portion of this cash is regulated by state capital requirements. However, $199.9 million of our cash and investments were unregulated and held at the parent level.
On October 16, 2003, we completed a public offering of 3,162,500 shares of common stock at $46.50 per share, including an over-allotment issuance of 412,500 shares. Net proceeds from the offering, after fees and expenses, were approximately $138.8 million. On October 21, 2003, we used $30.0 million of proceeds from the offering to repay the outstanding balance under our credit facility.
On October 22, 2003, we entered into a $95.0 million Amended and Restated Credit Agreement with Bank of America, N.A., Wachovia Bank, National Association, Credit Suisse First Boston and CIBC World Markets Corp. The Credit Agreement contains a provision which allows us to obtain, subject to certain conditions, an increase in revolving commitments of up to an additional $30.0 million. The proceeds of the Credit Agreement are available for general corporate purposes, including, without limitation, permitted acquisitions of businesses, assets and technologies. The borrowings under the Credit Agreement will accrue interest at one of the following rates, at our option: Eurodollar plus the applicable margin or an alternate base rate plus the applicable margin. The applicable margin for Eurodollar borrowings is between 2.00% and 2.50% and the applicable margin for alternate base rate borrowings is between 1.00% and 1.50%. The applicable margin will vary depending on our leverage ratio. The Credit Agreement is secured by the assets of AMERIGROUP Corporation and by the commons stock of its direct, wholly owned subsidiaries. There is a commitment fee on the unused portion of the Credit Agreement that ranges from 0.375% to 0.50%, depending on the leverage ratio. The Credit Agreement terminates on October 22, 2006.
Our subsidiaries are required to maintain minimum statutory capital requirements prescribed by various jurisdictions, including the departments of insurance in each of the states in which we operate. As of December 31, 2003, our subsidiaries were in compliance with all minimum statutory capital requirements. We believe that we will continue to be in compliance with these requirements for the next twelve months.
Purchase Obligations. Under certain contracts, we are committed to spend approximately $8.6 million on software licensing and implementation expenses for our new claims payment system and leasehold improvements relating to a new building under construction in Virginia Beach, Virginia that we will begin leasing in 2004.
Our operations are conducted through our wholly owned subsidiaries, which include HMOs and one managed care organization, or MCO. HMOs and MCOs are subject to state regulations that, among other things, may require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment and amount of dividends and other distributions that may be paid to their stockholders. Additionally, state regulatory agencies may require individual HMO’s to maintain statutory capital levels higher than the state regulations. As of December 31, 2003, we believe our subsidiaries are in compliance with all minimum statutory capital requirements. We believe that we will continue to be in compliance with these requirements at least through the end of 2004.
As of December 31, 2003, our subsidiaries had aggregate statutory capital and surplus of approximately $106.9 million, compared with the required minimum aggregate statutory capital and surplus requirements of approximately $63.1 million.
The federal regulations promulgated under HIPAA relating to privacy, standard transactions and security were issued in proposed form in 1998. We met the compliance date of April 2003 for privacy rules and must comply by October 16, 2003 for transactions and April 2005 for security. The final security rule was issued in February 2003 and we have not fully assessed the cost of complying with these regulations. The fact that either state or federal rules may supersede the other, depending on the nature of the particular requirement, will require interpretations for which there is likely to be little precedent. We have implemented the programs and systems that were required for compliance with the new privacy regulations by April 2003 and continue work for transactions and security compliance. In order to comply with the requirements, we will have to employ additional or different programs and systems. We had expenses of approximately $2.5 million on HIPAA compliance in 2002. For 2003, we had expenses of approximately $2.6 million on HIPAA compliance. Additional costs will be incurred in 2004 in complying with the security regulations which require compliance by April 2005. We are in the process of interpreting the security regulations and cannot estimate the cost of compliance at this time. We expect to be fully compliant by the required dates. Further, compliance with these regulations are requiring changes to many of the procedures we currently use to conduct our business, which may lead to additional costs that we have not yet identified. We do not know whether, or the extent to which, we will be able to recover from the states our costs of complying with these new regulations.
During 1995, we incorporated wholly owned subsidiaries in New Jersey, Illinois and Texas to develop, own and operate health maintenance organizations (HMOs) in those states. During 1996, we began enrolling Medicaid members in HMOs: AMERIGROUP New Jersey, Inc., AMERIGROUP Illinois, Inc. and AMERIGROUP Texas, Inc. During 1999, we incorporated a wholly owned subsidiary in Delaware, AMERIGROUP Maryland, Inc., a Managed Care Organization, to develop, own and operate a managed care organization (MCO) in Maryland and an HMO in the District of Columbia. Effective January 1, 2003, AMERIGROUP Maryland Inc., a Managed Care Organization, changed its domicile of incorporation to the District of Columbia. During 2001, we incorporated a wholly owned subsidiary in Florida, AMERIGROUP Florida, Inc., an HMO, to develop, own and operate an HMO in Florida. Effective January 1, 2003, AMERIGROUP Corporation acquired PHP Holdings, Inc. and its subsidiary, Physicians Health Plans, Inc. (together, PHP) and merged it with AMERIGROUP Florida, Inc.
Short and long-term investments and investments on deposit for licensure at December 31, 2003 and 2002 consist of money market funds, U.S. Treasury securities, cash escrow accounts, asset-backed securities, debt securities of government sponsored entities, municipal bonds and auction rate securities. We consider all investments with original maturities greater than three months but less than twelve months to be short-term investments. We classify our debt and equity securities in one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities in which we have the ability and intent to hold the security until maturity. All other securities not included in trading or held-to-maturity are classified as available-for-sale. At December 31, 2003 and 2002, all of our securities are classified as held-to-maturity.
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation on property and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Property and equipment held under leasehold improvements are amortized on the straight-line method over the shorter of the lease term or estimated useful life of the asset. The estimated useful lives are as follows:
Goodwill represents the excess of aggregate purchase price over the estimated fair value of net assets acquired. Goodwill acquired prior to July 1, 2001, was amortized on a straight-line basis over 18 months to 20 years, the expected periods to be benefited. In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No. 142), goodwill acquired subsequent to July 1, 2001 is not amortized but instead is tested for impairment at least annually. In addition, all goodwill acquired prior to July 2001 is no longer amortized effective January 1, 2002 but instead is tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.
The following table presents net income and net income per share exclusive of goodwill amortization expense for 2003, 2002 and 2001.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
We adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not affect our financial statements.
In accordance with SFAS No. 144, 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, 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 balance sheet 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 balance sheet. No impairment of long-lived assets was recorded in 2003, 2002 or 2001.
Our management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
At December 31, 2003, we served members who received health care benefits through nine contracts with the regulatory entities in the jurisdictions in which we operate. Five of these contracts individually accounted for 10% or more of our revenues for the year ended December 31, 2003, with the largest of these contracts representing approximately 20% of our revenues.
The state governments in which we operate require us to maintain investments on deposit in specific dollar amounts based on either formulas or set amounts as determined by state regulations. 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.
One auction rate security and thirteen debt securities of government sponsored entities had temporary declines in value as of December 31, 2003. All temporary declines in value of held-to-maturity investments have experienced declines in value for less than twelve months. The temporary declines in value are primarily due to fluctuations in market interest rates.
Effective August 1, 2001, we purchased certain assets of Humana Inc.’s (Humana) Houston, Texas Medicaid line of business. The assets purchased consisted of Humana’s rights to provide managed care services to its Medicaid members. We utilized the purchase method of accounting. We paid $1,048 in cash including transaction costs, resulting in goodwill of the same amount. We operated as a Medicaid HMO in Houston, Texas prior to this acquisition.
Effective January 1, 2002, we purchased certain assets of MethodistCare, Inc.’s (MethodistCare) Houston, Texas Medicaid line of business. The assets purchased consisted of MethodistCare’s rights to provide managed care services to its Medicaid members. We paid $1,232 in cash including transaction costs, resulting in goodwill of the same amount.
Effective July 1, 2002, we purchased the Medicaid contracts and related assets of Capital Community Health Plan, or CCHP, in Washington, D.C. for $6,970, including acquisition costs. The assets purchased consisted primarily of CCHP’s rights to provide managed care services to its Medicaid members. During 2003, we settled on the final purchase price as provided under the asset purchase agreement and reduced goodwill by $963. Goodwill and other intangibles totaling $6,007 included $423 for identifiable intangibles allocated to the membership purchased. Identifiable intangibles with definite useful lives are being amortized based on the timing of related cash flows over eight years.
Established in 1992, PHP served 193,000 Medicaid and State Children’s Health Insurance Program (SCHIP) members at December 31, 2002 in twelve counties including the metropolitan areas of Orlando, Tampa and Ft. Lauderdale/Miami. PHP also served Medicare and commercial members which were spun off from PHP prior to December 31, 2002 and not acquired by us.
Of the $124,260 acquisition cost which includes transaction costs, approximately $50,000 was financed through our then-existing credit facility with the balance funded through unregulated cash. Goodwill and other intangibles totaling $116,587 includes $8,990 of identifiable intangibles allocated to the rights to membership and a non-compete agreement. Intangible assets related to the non-compete agreement and rights to membership are being amortized based on the timing of related cash flows with an expected amortization of five to eleven years. A portion of the purchase price remains in escrow pending various settlement provisions between us and the former shareholders of PHP Holdings, Inc. Purchase price adjustments may arise in the future as a result of these settlements.
The following unaudited pro forma summary information presents the consolidated income statement information for the twelve month period ended December 31, 2002 as if the PHP transaction had been
The unaudited pro forma summary information reflects adjustments made to our historical financial statements by including the applicable results of operations of PHP’s Medicaid and SCHIP lines of business in Florida prior to the acquisition.
deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, we will need to generate future taxable income of $1,780 prior to the expiration of a state net operating loss carryforward in 2022 and 2023. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of those deductible differences at December 31, 2003. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
The Series A, B and C preferred stock were convertible to common shares on a two-for-one basis, at the option of the preferred stockholder. The Series A, B and C preferred stock carried a noncumulative 10% dividend payable upon approval by the Board of Directors. We accreted dividends on Series A, B and C using the interest method and added the accrued dividends to the applicable redeemable preferred stock issue balance.
The Series E stock, with cumulative dividends, was redeemed concurrent with our initial public offering.
In 1994, we established the 1994 Stock Plan (1994 Plan), which provides for the granting of either incentive stock options or nonqualified options to purchase shares of our common stock by employees, directors and consultants of the Company for up to 2,099,500 shares of common stock as of December 31, 1999. On February 9, 2000, we increased the number of options available for grant to 2,249,500.
On February 11, 2004, we granted an additional 539,729 options at an exercise price of $37.07.
The following table sets forth the calculation of basic and diluted net income per share:
Cash and cash equivalents, premium receivables, prepaid expenses and other current assets, accounts payable, unearned revenue, accrued expenses and other current liabilities and claims payable: The carrying amounts approximate fair value because of the short maturity of these items.
We are obligated under capital leases covering certain office equipment that expires at various dates during the next five years. At December 31, 2003 and 2002, the gross amount of office equipment and related accumulated amortization recorded under capital leases was as follows:
We also lease office space under operating leases which expire at various dates through 2019. Future minimum payments by year and in the aggregate under all non-cancelable leases are as follows at December 31, 2003:
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, 2003, 2002 and 2001, the matching contribution under the plan in total was $720, $794 and $389, respectively.
In May 2002, Capital Health Systems (Capital) in New Jersey filed an action in the Superior Court of New Jersey (the Court) against AMERIGROUP New Jersey, Inc., our New Jersey subsidiary, seeking to be paid full-billed charges for all services rendered to our New Jersey subsidiary’s Medicaid members since January 1, 2002. Our New Jersey subsidiary has not had a contract with Capital to provide services to its Medicaid members since December 31, 2001. As a result, services provided by Capital to our members since January 1, 2002 have been provided as a non-network provider. Capital asserts that our New Jersey subsidiary agreed to pay full-billed charges upon the expiration of our contract with them on December 31, 2001. The Court ruled in favor of Capital on August 8, 2003, and determined that our New Jersey subsidiary entered into a new contract with Capital as of
December 31, 2001. Capital filed a notice of motion for summary judgment on damages on September 12, 2003, seeking approximately $8.5 million. Capital’s motion was denied on December 5, 2003. We have petitioned the Appeals Court of New Jersey for leave to file an appeal of the Court’s summary judgment on the issue of liability. The petition is currently pending before the appellate division. Once a determination of damages is made, we intend to appeal the ruling.
We believe in both cases that we have paid the providers in an appropriate manner. We have recorded in our financial statements amounts that represent our best estimates of outcomes that are reasonably probable. There can be no assurances that the ultimate outcome of either or both of these matters will not be materially different and could have a material effect on our consolidated financial position, results of operations, or liquidity.
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 600,000 shares of common stock. We issued 35,039 and 52,706 shares under the Employee Stock Purchase Plan in 2003 and 2002, respectively.