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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 2002, or
[ ] Transition report pursuant to Section 13 OR 15(d) of the Securities Exchange
Act of 1934
For the transition period from to
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COMMISSION FILE NUMBER 1-13340
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MID ATLANTIC MEDICAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of
incorporation or organization)
52-1481661
(IRS Employer Identification Number)
4 TAFT COURT, ROCKVILLE, MARYLAND
(Address of principal executive offices)
20850
(Zip code)
(301) 294-5140
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
The number of shares outstanding of each of the issuer's classes of common stock
was 46,525,822 shares of common stock, par value $.01, outstanding as of June
30, 2002.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS (Note 1)
(in thousands except share amounts)
(Unaudited) (Note)
June 30, 2002 December 31, 2001
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 5,436 $ 4,510
Investment securities 478,592 368,327
Accounts receivable, net of allowance of $6,921 and $6,647 124,658 105,343
Prepaid expenses, advances and other 30,988 27,194
Deferred income taxes 1,826 216
----------- -----------
Total current assets 641,500 505,590
Property and equipment, net of accumulated
depreciation of $64,778 and $59,426 60,239 57,329
Statutory deposits 17,610 17,690
Other assets 9,405 9,385
Deferred income taxes 6,647 4,219
---------- -----------
Total assets $ 735,401 $ 594,213
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ 3,228 $ 3,681
Accounts payable 63,263 49,397
Medical claims payable 307,894 212,010
Income taxes payable - 1,315
Deferred premium revenue 33,466 37,698
Deferred income taxes 6,789 8,641
----------- -----------
Total liabilities 414,640 312,742
----------- -----------
Stockholders' equity
Common stock, $.01 par, 100,000,000 shares authorized; 63,772,502 issued and
46,525,822 outstanding at June 30, 2002; 63,772,502 issued
and 47,884,422 outstanding at December 31, 2001 637 637
Additional paid-in capital 401,255 349,595
Stock compensation trust (common stock held in trust) 6,959,669 shares
outstanding at June 30, 2002;
9,019,450 shares outstanding at December 31, 2001 (218,186) (204,742)
Treasury stock, 17,246,680 shares at June 30, 2002; 15,888,080 shares at
December 31, 2001 (225,320) (185,110)
Accumulated other comprehensive income 6,536 2,528
Retained earnings 355,839 318,563
----------- -----------
Total stockholders' equity 320,761 281,471
----------- -----------
Total liabilities and stockholders' equity $ 735,401 $ 594,213
=========== ===========
Note: The balance sheet at December 31, 2001 has been extracted from the
audited financial statements at that date.
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands except share amounts)
(Unaudited)
Three Months Ended
June 30, June 30,
2002 2001
------------ ------------
Revenue
Health premium $ 558,615 $ 433,125
Fee and other 5,735 5,247
Life and short-term disability premium 2,250 2,007
Home health services 4,976 6,200
Investment 3,687 3,896
----------- -----------
Total revenue 575,263 450,475
----------- -----------
Expense
Medical 480,321 374,299
Life and short-term disability claims 966 652
Home health patient services 5,963 5,473
Administrative (including interest expense of $158 and $170) 60,749 52,232
----------- -----------
Total expense 547,999 432,656
----------- -----------
Income before income taxes 27,264 17,819
Income tax expense (8,841) (5,833)
----------- -----------
Net income $ 18,423 $ 11,986
=========== ===========
Basic earnings per common share $ .47 $ .31
=========== ===========
Diluted earnings per common share $ .44 $ .30
=========== ===========
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands except share amounts)
(Unaudited)
Six Months Ended
June 30, June 30,
2002 2001
------------ ------------
Revenue
Health premium $ 1,092,625 $ 839,872
Fee and other 11,290 10,866
Life and short-term disability premium 4,402 3,979
Home health services 10,220 12,971
Investment 6,889 7,448
----------- -----------
Total revenue 1,125,426 875,136
----------- -----------
Expense
Medical 935,765 722,110
Life and short-term disability claims 1,751 1,678
Home health patient services 10,737 10,850
Administrative (including interest expense of $317 and $317) 122,235 103,360
----------- -----------
Total expense 1,070,488 837,998
----------- -----------
Income before income taxes 54,938 37,138
Income tax expense (17,662) (12,270)
----------- -----------
Net income $ 37,276 $ 24,868
=========== ===========
Basic earnings per common share $ .95 $ .65
=========== ===========
Diluted earnings per common share $ .89 $ .62
=========== ===========
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months
Ended
June 30, 2002
------------
Cash flows provided by operating activities:
Net income $ 37,276
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization $ 5,710
Provision for bad debts 274
Credit for deferred income taxes (8,048)
Loss on sale and disposal of fixed assets 19
Stock option tax benefit 13,987
Increase in accounts receivable (19,589)
Increase in prepaid expenses, advances, and other (3,794)
Increase in accounts payable 13,866
Decrease in income taxes payable (1,315)
Increase in medical claims payable 95,884
Decrease in deferred premium revenue (4,232)
-----------
Total adjustments 92,762
-----------
Net cash provided by operating activities 130,038
Cash flows used in investing activities:
Purchases of investment securities (389,673)
Sales of investment securities 285,760
Purchases of property and equipment (8,547)
Purchases of statutory deposits (244)
Maturities of statutory deposits 100
Purchases of other assets (168)
Proceeds from sale of assets 94
-----------
Net cash used in investing activities (112,678)
Cash flows used in financing activities:
Decrease in short-term borrowings (453)
Exercise of stock options 24,229
Purchase of treasury stock (40,210)
-----------
Net cash used in financing activities (16,434)
-----------
Net increase in cash and cash equivalents 926
Cash and cash equivalents at beginning of period 4,510
-----------
Cash and cash equivalents at end of period $ 5,436
===========
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months
Ended
June 30, 2001
------------
Cash flows provided by operating activities:
Net income $ 24,868
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization $ 5,576
Provision for bad debts 441
Provision for deferred income taxes 4,418
Gain on sale and disposal of fixed assets (3)
Stock option tax benefit 2,395
Increase in accounts receivable (9,960)
Increase in prepaid expenses, advances, and other (1,750)
Increase in accounts payable 897
Increase in medical claims payable 14,110
Increase in deferred premium revenue 13,417
-----------
Total adjustments 29,541
-----------
Net cash provided by operating activities 54,409
Cash flows used in investing activities:
Purchases of investment securities (249,801)
Sales of investment securities 207,072
Purchases of property and equipment (4,782)
Purchases of statutory deposits (2,195)
Maturities of statutory deposits 2,150
Purchases of other assets (505)
Proceeds from sale of assets 101
-----------
Net cash used in investing activities (47,960)
Cash flows used in financing activities:
Increase in short-term borrowings 406
Exercise of stock options 19,742
Purchase of treasury stock (27,604)
-----------
Net cash used in financing activities (7,456)
-----------
Net decrease in cash and cash equivalents (1,007)
Cash and cash equivalents at beginning of period 5,047
-----------
Cash and cash equivalents at end of period $ 4,040
===========
See accompanying notes to these financial statements.
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MID ATLANTIC MEDICAL SERVICES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
INTRODUCTION
Mid Atlantic Medical Services, Inc. ("MAMSI") is a holding company whose
subsidiaries are active in managed health care and other life and health
insurance related activities. MAMSI's principal markets are currently in
Maryland, Virginia, the District of Columbia, Delaware, West Virginia, North
Carolina and Pennsylvania. MAMSI and its subsidiaries (collectively referred to
as the "Company") have developed a broad range of health care and related
ancillary products and deliver these services through health maintenance
organizations ("HMOs"), a preferred provider organization ("PPO"), a life and
health insurance company, home health care and home infusion services companies,
a hospice company, a coordination of benefits identification and collections
company and part ownership in an outpatient surgery center.
MAMSI delivers managed health care services principally through HMOs. The HMOs,
MD-Individual Practice Association, Inc. ("M.D. IPA"), Optimum Choice, Inc.
("OCI"), and Optimum Choice of the Carolinas, Inc. ("OCCI") arrange for health
care services to be provided to an enrolled population for a predetermined,
prepaid fee, regardless of the extent or nature of services provided to the
enrollees. The HMOs offer a full complement of health benefits, including
physician, hospital and prescription drug services.
Other MAMSI subsidiaries include Alliance PPO, LLC, which provides a delivery
network of physicians to employers and insurance companies in association with
various health plans, and provides psychiatric services principally to third
party payors or self-insured employer groups. MAMSI Life and Health Insurance
Company develops and markets indemnity health products, and group life,
accidental death and short-term disability insurance. HomeCall, Inc., FirstCall,
Inc., and HomeCall Pharmaceutical Services, Inc. provide in-home medical care
including skilled nursing, infusion and therapy to MAMSI's HMO members and other
payors. HomeCall Hospice Services, Inc. provides services to terminally ill
patients and their families. Beginning in January 2001, Alliance Recovery
Services, LLC provides coordination of benefit identification and collection
services to third party administrators and insurance companies
NOTE 1 - FINANCIAL STATEMENTS
The consolidated balance sheet of the Company as of June 30, 2002, the
consolidated statements of income for the three and six months ended June 30,
2002 and 2001, and the consolidated statements of cash flows for the six months
ended June 30, 2002 and 2001 have been prepared by MAMSI without audit. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included.
Certain information and disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. These financial statements should be read in conjunction
with the financial statements and notes thereto included in the Company's
December 31, 2001 audited consolidated financial statements included in its
annual report on Form 10-K for the year ended December 31, 2001 ("2001 Form
10-K"). The results of operations for the three and six month periods ended June
30, 2002 are not necessarily indicative of the operating results for the full
year.
In June 2001, the Financial Accounting Board issued Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement
No. 142"), which establishes standards for financial accounting and reporting
for intangible assets at acquisition and for goodwill and other intangible
assets subsequent to their acquisition. Statement No. 142 is applied to existing
goodwill and intangible assets for fiscal years beginning December 15, 2001. The
Company adopted this Statement January 1, 2002, at which time amortization of
the remaining book value of goodwill ceased. As the Company does not have a
material amount of goodwill, the adoption of Statement No. 142 had no
significant effect on the consolidated financial statements.
The Company has entered into certain long-term medical services related vendor
contracts, some of which include incentives or cost guarantees designed to
provide savings to the Company over several years. The Company typically
accounts for the benefit derived from these incentives or guarantees ratably
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over the contract period as a reduction to medical expense. Because of the
complexity of the Company's product offerings as well as obligations imposed
under the contracts, and the timing of settlement of various contractual
periods, disputes may arise as to the degree of satisfaction of the various
contractual obligations which could result in material adjustments to the
Company's financial statements. In the case of one of these contracts, a dispute
with the Company's pharmacy benefits manager, Merck-Medco Managed Care, LLC
("Merck"), had arisen which involved the approximately $41 million receivable
MAMSI had recorded related to the settlement of a cost guarantee for the year
2000. The Company is recording the benefit related to the 2000 guarantee over
the three year term of the contract which commenced in January 2000. From
inception through June 30, 2002, the Company has recognized approximately $34
million of the guarantee as a reduction of medical expense. On April 24, 2002
the Company reached a settlement of its dispute with Merck over its 2000 cost
guarantee. Under the terms of the settlement, the Company has received payment
of $41 million.
NOTE 2 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (in thousands except share amounts):
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Numerator:
Net income $ 18,423 $ 11,986 $ 37,276 $ 24,868
Denominator:
Denominator for basic earnings per share
- weighted average shares 39,229,386 38,511,079 39,143,705 38,385,990
Dilutive securities - employee stock options 2,962,123 1,472,524 2,771,493 1,701,429
Denominator for diluted earnings per share
- adjusted weighted average shares 42,191,509 39,983,603 41,915,198 40,087,419
Options to purchase approximately 7,000 shares of common stock at various prices
were outstanding at June 30, 2002, but were not included in the computation of
diluted earnings per share because the option proceeds would exceed the average
market price and, therefore, the effect would be antidilutive.
During the first six months of 2002 and 2001, total comprehensive income
amounted to $41,284,000 and $26,407,000, respectively.
The Company maintains a stock compensation trust (SCT") to fund its obligations
arising from its various stock option plans. Shares held by the SCT are excluded
from the denominator used in calculating basic and diluted earnings per common
share.
NOTE 3 - FEDERAL EMPLOYEES' HEALTH BENEFIT PROGRAM
M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or
arrange health services under the Federal Employees Health Benefits Program
("FEHBP"). The contract with OPM and applicable government regulations establish
premium rating requirements for the FEHBP. In the normal course of business, OPM
audits health plans with which it contracts to verify, among other things, that
the premiums calculated and charged to OPM are established in compliance with
the best price community rating guidelines established by OPM. OPM typically
audits plans once every five or six years, and each audit covers the prior five
or six year period. While the government's initial on-site audits are usually
followed by a post-audit briefing as well as a preliminary audit report in which
the government indicates its preliminary results, final resolution and
settlement of the audits can take two to three years. The results of these
audits could result in material adjustments to the Company's financial
statements. The Company has been audited through 1999. There were no significant
findings related to 1999.
9
NOTE 4 - REPORTABLE SEGMENTS
The Company's principal business is providing health insurance products. The
Company has two reportable segments: commercial risk products and preferred
provider organizations. The Company evaluates performance and allocates
resources based on profit or loss from operations before income taxes, not
including gains or losses on the Company's investment portfolio or investment
income. Management does not allocate assets in the measurement of segment profit
or loss. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies described in
the Company's 2001 Form 10-K.
Three Months Ending Six Months Ending
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
In 000's ------------ ------------ ------------ ------------
Revenues:
Commercial risk $ 558,615 $ 433,125 $ 1,092,625 $ 839,872
Preferred provider organizations 5,735 5,247 11,290 10,866
All other 7,226 8,207 14,622 16,950
----------- ----------- ----------- -----------
$ 571,576 $ 446,579 $ 1,118,537 $ 867,688
=========== =========== =========== ===========
Income before taxes:
Commercial risk $ 22,873 $ 10,972 $ 45,378 $ 23,740
Preferred provider organizations 2,868 2,624 5,646 5,434
All other (2,053) 483 (2,768) 814
----------- ----------- ----------- -----------
$ 23,688 $ 14,079 $ 48,256 $ 29,988
=========== =========== =========== ===========
Reconciliations of segment data to the Company's consolidated data is as
follows:
Three Months Ending Six Months Ending
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
In 000's ------------ ------------ ------------ ------------
Total profit from reportable segments $ 25,741 $ 13,596 $ 51,024 $ 29,174
Other (loss) profit (2,053) 483 (2,768) 814
Unallocated amounts:
Investment income 3,576 3,740 6,682 7,150
----------- ----------- ----------- -----------
Income before taxes $ 27,264 $ 17,819 $ 54,938 $ 37,138
=========== =========== =========== ===========
10
MID ATLANTIC MEDICAL SERVICES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
All forward-looking information contained in this Management's Discussion and
Analysis of Financial Condition and Results of Operations is based on
management's current knowledge of factors, all of which have inherent risks and
uncertainties, that affect MAMSI's business. MAMSI's actual results may differ
materially if these assumptions prove invalid. Significant risk factors, while
not all-inclusive, are:
1. The possibility of increasing price competition in the Company's service
area.
2. The effect on the Company due to a weak economy.
3. The effect on the Company due to the recent acts of terrorism and the threat
of future attacks.
4. The possibility that the Company is not able to increase its market share at
the anticipated premium rates.
5. The possibility of increased litigation, legislation or regulation (such as
the numerous class action lawsuits that have been filed against managed care
companies and the pending initiatives to increase health care regulation) that
might increase regulatory oversight which, in turn, would have the potential for
increased costs.
6. The inability to predict and control medical expenses due to: - Increased
utilization by the Company's membership. - Increased practitioner and
pharmaceutical costs. - Federal or state mandates that increase benefits or
limit the Company's oversight ability. - The potential for disputes under its
risk-sharing arrangements, and the Company's ability to maintain and renew these
arrangements.
7. The possibility that the Company is not able to negotiate new or renewal
contracts with appropriate physicians, other health care practitioners,
hospitals and facilities.
The list of significant risk factors is not intended to be exhaustive. There may
be other risk factors that would preclude the Company from realizing the
predictions made in the forward-looking statements. While the Company may
periodically update this discussion of risk factors, the Company does not
undertake to update any forward-looking statement that may be made by or on
behalf of the Company prior to its next required filing with the Securities and
Exchange Commission.
DISCUSSION OF MAMSI's BUSINESS AND IMPORTANT ACCOUNTING MATTERS
MAMSI, through its 100% owned subsidiary companies, is predominately in the
business of selling various forms of health insurance. In 2002, 97% of revenues
were earned from the sale of health insurance products, mostly to employers who
purchase health insurance for their employees. Since premium rates are generally
fixed for a one year period, it is critical to the Company's continued financial
success that its prices are set at levels that will at least cover the next
policy year's medical costs for members plus administrative costs to pay claims,
provide member services, pay taxes, and cover other related costs.
This means that we have to carefully evaluate data and estimate both future
utilization of medical services by our members and the cost of those services so
that we can set premiums at adequate levels. This is the single most important
factor in our business. Very simply, if our medical expenses are greater than
our premiums, we lose money.
While MAMSI's business is somewhat complex from an insurance regulatory
standpoint, its consolidated balance sheet and income statement are
straightforward and the accounting policies and procedures that we use to
produce them are reasonable and appropriate. MAMSI does not own any special
purpose entities, does not have any complex or extraordinarily risky investments
nor does it have any off balance sheet financing arrangements. In fact, MAMSI
has almost no debt outstanding.
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The buildings that the Company owns and uses in its operations do not have
mortgages; they are owned free and clear. The Company's funds are held in cash
or invested in money market accounts, tax exempt securities and other debt
securities. All of the bonds we own have investment ratings of "A" or better.
Certain of our accounting policies are extremely important to the fair
presentation of our results and financial position.
We think that the single most important accounting issue we have is the
recording, at the end of each reporting period, of an adequate liability and
corresponding expense for medical services that have been provided to our
members but for which we have not yet received a bill. This lag between date of
service and date of billing is normal in the insurance business and the
liability for these claims is called "liability for incurred, but not reported
claims" ("IBNR"). The IBNR liability is included with medical claims payable in
our balance sheet.
The determination of the Company's IBNR is a fairly complex process. The Company
employs its own actuary to aid in its determination. The primary method we use
to estimate IBNR is consistent from period to period and uses historical claims
data to develop the historical relationship of how many claims dollars have been
reported in any given month to what was received in total, once all claims were
received. This relationship gives us an indication of how much medical expense
has been incurred in months for which we have not yet received all claims. While
we use a consistent method in developing our IBNR estimate, considerable
judgment is required. To the extent that we over or under estimate our IBNR at
the end of any reporting period, the adjustment is included in the next period's
results.
Another important accounting policy relates to our risk sharing contracts.
Certain of the Company's larger medical services related vendors offer various
forms of "risk-sharing" or "guarantees" as a part of their contractual
relationship with us. These arrangements are not significant in relation to the
Company's financial statements with one exception; the Company's risk-sharing
arrangement with its Pharmacy Benefits Manager ("PBM"). The Company's PBM is
responsible for providing administrative and technical support as well as
providing the ability to process pharmacy transactions on a real time basis. The
Company's current PBM is Merck. As a part of its contract with us, Merck agreed
to a pharmacy cost guarantee related to fiscal year 2000. We are recording the
amount due under this guarantee over the contract term of three years, which
commenced January 2000. The total value of the guarantee we estimated for
financial statement purposes is approximately $41 million of which approximately
$34 million has been recorded in our financial statements as a reduction of
medical expense over the first two years and six months of the contract. At
December 31, 2001, approximately $28 million was also reported in the balance
sheet as a reduction of medical claims payable. In April 2002 the Company
received payment of $41 million from Merck. At June 30, 2002, the remaining $7
million of the guarantee yet to be recognized is reported in the balance sheet
in accounts payable.
Another accounting policy that is very important to the fair presentation of our
financial results is the proper valuation of the Company's accounts receivable.
The Company bills the majority of its health insurance customers on a monthly
basis. The premium bill is typically sent out 15 days in advance of the month
being billed for, so that the Company can receive the cash at the start of the
month for which the insurance is being provided. The vast majority of our
customers pay in a timely fashion but some do not. After some communication, we
generally receive payment but we do not always collect what we are due. This can
happen for a variety of reasons such as customers having financial difficulties,
disputes regarding the amount of the bill or a customer failing to notify us
that they have obtained other health insurance. To properly value the accounts
receivable at its net realizable value we must determine an allowance for
doubtful accounts.
The allowance for doubtful accounts reduces the gross amount of accounts
receivable that are recorded, based on the bills sent, to the net amount that we
actually think we will receive. The allowance also reduces premium revenue by
the same amount. To determine how much to record as a reduction of the gross
accounts receivable, we prepare an accounts receivable aging. This aging
segments the total accounts receivable balance by category as to when it was due
to the Company. This allows us to evaluate how old our accounts receivable are.
We then prepare an evaluation based on historical collection percentages applied
12
to various categories of accounts. We also identify individual accounts that are
unlikely to pay due to financial or other problems and analyze them
individually. The aforementioned analyses are then summarized and an allowance
is developed and recorded. The Company applies this methodology on a consistent
basis from period to period.
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE THREE MONTHS ENDED JUNE
30, 2001
Consolidated net income of the Company was $18,423,000 and $11,986,000 for the
second quarters of 2002 and 2001, respectively. Diluted earnings per share were
$.44 and $.30 in the second quarters of 2002 and 2001, respectively. This
increase in earnings is attributable to an increase in members, an increase in
premiums per member, a reduction in medical expenses as a percentage of health
premium revenue ("medical care ratio"), and a reduction in administrative
expenses as a percentage of total revenue ("administrative expense ratio"). The
Company has priced its health products competitively in order to increase its
membership base and thereby enhance its strategic position in its market place.
The Company currently has one of the largest HMO and managed care enrollments
and also the largest network of contract providers of medical care in its
service area (which includes the entire states of Maryland and Delaware, the
District of Columbia, most counties and cities in Virginia and certain areas of
West Virginia, North Carolina and Pennsylvania).
Health premium revenue for the three months ended June 30, 2002 increased
approximately $125.5 million or 29.0 percent over the three months ended June
30, 2001. A 17.6 percent increase in net average HMO and indemnity enrollment
resulted in an increase of approximately $76.3 million in health premium
revenue, while a 9.7 percent increase in average monthly premium per enrollee,
combined for all products, resulted in a $49.2 million increase in health
premium revenue. Management believes that commercial health premiums should
continue to increase during 2002 as the Company continues to increase its
commercial membership and as new and renewing groups are charged higher premium
rates due to legislatively mandated benefit enhancements and medical cost
inflation, both of which cause the Company to increase its premium rates. This
is a forward- looking statement. See "Forward Looking Information" above for a
description of the risk factors that may effect health premiums per member.
The Company has implemented increased premium rates across essentially all of
its products. As the Company's contracts are generally for a one year period,
increased pricing generally cannot be initiated until a contract reaches its
renewal date. Therefore, price increases are not implemented across the
Company's membership at the same time. Overall, commercial premium rate
increases are expected to continue in 2002 by approximately 12.0%. Management
believes that these rate increases may have the effect of slowing the Company's
future membership growth.
The Company's future membership growth depends on several factors such as
relative premium prices and product availability, future increases or decreases
in the Company's service area, and increased competition in the Company's
service area.
The Company's home health operations contributed approximately $5.0 million in
revenue in the second quarter of 2002 as compared with $6.2 million in the
second quarter of 2001 reflective of a decrease in services provided to
non-affiliated companies.
Life and short-term disability products contributed $2.3 million in revenue in
the second quarter of 2002 as compared with $2.0 million for the first quarter
of 2001.
Investment income decreased from $3.9 million in the second quarter of 2001 to
$3.7 million in the second quarter of 2002 primarily due to a decrease in
interest rates.
The medical care ratio decreased from 86.4% for the second quarter of 2001 to
86.0% for the second quarter of 2002. On a per member per month basis, medical
expenses increased 9.1 percent. The decrease in the medical care ratio is due to
a combination of factors including continuing efforts by the Company to
implement product specific cost containment controls, continued activity in
13
specialized subrogation areas and claims review for dual health coverage, and
also increased premiums per member. The ongoing initiatives should help to
control the Company's medical care ratio. The medical expense trend is expected
to be between 11.0% and 11.5% for 2002. The statements in this paragraph and the
preceding paragraphs regarding future utilization rates, cost containment
initiatives, total medical costs and trend and future increases in health
premiums per member, are forward-looking statements. See "Forward-Looking
Information" above for a description of risk factors that may affect medical
expenses per member and the medical care ratio.
Administrative expenses as a percentage of revenue ("administrative expense
ratio") decreased to 10.6 percent for the second quarter of 2002 as compared to
11.6 percent for the same period in 2001. The decrease in the administrative
expense ratio is principally due to increases in premium rates and membership,
and management's efforts to control costs as the business volume increases.
Management believes that the administrative expense ratio will be 11.0% for all
of 2002. Management's expectation concerning the administrative expense ratio is
a forward- looking statement. The administrative expense ratio is affected by
changes in health premiums and other revenues, development of the Company's
expansion areas, increased administrative activity related to business volume
and to price increases from the Company's vendors.
The net margin rate increased from 2.7 percent in the second quarter of 2001 to
3.2 percent in the current quarter. This increase is consistent with the factors
previously described.
THE SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THE SIX MONTHS ENDED JUNE 30,
2001
The Company's consolidated net income for the six months ended June 30, 2002
increased to $37,276,000 from $24,868,000 for the six months ended June 30,
2001. Diluted earnings per share on net income increased from $.62 in the first
six months of 2001 to $.89 for the same period in 2002. The increase in earnings
is primarily attributable to increased premiums per member and reduction in the
medical care and administrative expense ratios.
Health premium revenue for the six months ended June 30, 2002 increased
approximately $252.8 million or 30.1 percent over the six months ended June 30,
2001. An 11.5 percent increase in average premiums per HMO and indemnity
enrollee increased health premium revenue by approximately $112.5 million and a
16.7 percent increase in net average HMO and indemnity enrollment resulted in an
increase of approximately $140.2 million in health premium revenue.
The Company's home health operations contributed approximately $10.2 million in
revenue in the first six months of 2002 as compared with $13.0 million in the
first six months of 2001 reflective of a decrease in services provided to
non-affiliated companies.
Revenue from life and short-term disability products contributed $4.4 million in
revenue for the first six months of 2002 as compared to $4.0 million in the
first six months of 2001.
Investment income decreased from $7.4 million in the first six months of 2001 to
$6.9 million in the first six months of 2002 primarily due to a decrease in
interest rates.
The medical care ratio decreased to 85.6 percent for the six months ended June
30, 2002 as compared to 86.0 percent for the comparable period in 2001. The
reasons for this decrease are consistent with the items discussed in the
quarterly analysis.
The administrative expense ratio decreased to 10.9 percent for the first six
months of 2002 as compared to 11.8 percent for the comparable period in 2001.
The reasons for this decrease are consistent with the items discussed in the
quarterly analysis.
The net margin rate increased from 2.8 percent for the first six months of 2001
to 3.3 percent for the comparable period of 2002. This increase is consistent
with the factors previously described.
14
LIQUIDITY AND CAPITAL RESOURCES
The Company's business is not capital intensive and the majority of the
Company's expenses are payments to physicians and health care practitioners,
which generally vary in direct proportion to the health premium revenues
received by the Company. Although medical utilization rates vary by season, the
payments for such expenses lag behind cash inflow from premiums because of the
lag in provider billing procedures. In the past, the Company's cash requirements
have been met principally from operating cash flow, and it is anticipated that
this source, coupled with the Company's retained earnings and capital and
operating line-of- credit, will continue to be sufficient in the future.
The Company's cash and investment securities increased $111.2 million from
$372.8 million at December 31, 2001 to $484.0 million at June 30, 2002,
primarily due to the timing of medical expense payments which traditionally lag
behind the receipt of increased premiums per member, the $41.0 million payment
received from Merck in April 2002, cash received from exercise of stock options
and net income offset by the effect of treasury stock purchases. Accounts
receivable increased from $105.3 million at December 31, 2001 to $124.7 million
at June 30, 2002, due to significant new and renewal member activity. Prepaid
expenses, advances and other increased from $27.2 million at December 31, 2001
to $31.0 million at June 30, 2002 due to an increase in income tax amounts paid
in advance and an increase in working capital advances paid to Maryland
hospitals, offset by a reduction in the unamortized portion of prepayments for
maintenance and insurance policies which cover the Company's assets and business
operations.
Net property and equipment increased from $57.3 million at December 31, 2001 to
$60.2 million at June 30, 2002 primarily due to the purchase of furniture and
computer hardware necessitated by the Company's growth, in addition to the
purchase of a parcel of land adjacent to an existing Company owned facility.
Medical claims payable increased from $212.0 million at December 31, 2001 to
$307.9 million at June 30, 2002, primarily due to increased membership and an
increase in medical expenses per member, the timing of payments to physicians
and health care practitioners, and the receipt of the $41.0 million payment from
Merck which had been recorded as a reduction of medical claims payable. Deferred
premium revenue decreased from $37.7 million at December 31, 2001 to $33.5
million at June 30, 2002 due to a decrease in cash payments received in advance
of the premium coverage period.
Additional paid-in capital increased from $349.6 million at December 31, 2001 to
$401.3 million at June 30, 2002, principally due to the exercise of employee
stock options and a increase in the market value of the shares of the Company's
stock held in the stock compensation trust ("SCT").
The value of the SCT increased from $204.7 million at December 31, 2001 to
$218.2 million at June 30, 2002 primarily due to the increase in the market
value of the shares of the Company's stock held in the SCT offset by the
exercise of employee stock options. For financial reporting purposes, the SCT is
consolidated with MAMSI. The fair market value of the shares held by the SCT is
shown as a reduction to stockholders' equity in the Company's consolidated
balance sheets. All transactions between the SCT and MAMSI are eliminated. The
difference between the cost and the fair value of common stock held in the SCT
is included in the consolidated financial statements as additional paid-in
capital.
Treasury stock increased from $185.1 million at December 31, 2001 to $225.3
million at June 30, 2002 due to the purchase of 1,358,600 additional shares by
the Company at a total cost of $40.2 million.
The Company currently has access to total revolving credit facilities of $29.0
million which are subject to annual renewal and collateral requirements, and are
used to provide short-term capital resources for routine cash flow fluctuations.
At June 30, 2002, the Company's investment security balances used as collateral,
which are parent company only investments, fell below the minimum collateral
requirements thereby reducing the credit line availability to $25.6 million. In
addition, at June 30, 2002, approximately $3.2 million was drawn against these
facilities, and approximately $454,000 in letters of credit were outstanding.
While no amounts have been drawn against these letters of credit, they reduce
the Company's credit line availability.
15
Following is a schedule of the short-term capital resources available to the
Company (in thousands):
June 30, December 31,
2002 2001
------------ ------------
Cash and cash equivalents $ 5,436 $ 4,510
Investment securities 478,592 368,327
Working capital advances to Maryland hospitals 21,972 19,686
----------- -----------
Total available liquid assets 506,000 392,523
Credit line availability 21,953 20,184
----------- -----------
Total short-term capital resources $ 527,953 $ 412,707
=========== ===========
The Company believes that cash generated from operations along with its current
liquidity and borrowing capabilities are adequate for both current and planned
operations.
The Company's major business operations are principally conducted through its
HMOs and an insurance company. HMOs and insurance companies are subject to state
regulations that, among other things, may require those companies to maintain
certain levels of equity and risk based capital, and restrict the amount of
dividends and other distributions that may be paid to their parent corporations.
As of June 30, 2002, those subsidiaries of the Company were in compliance with
all minimum capital requirements and exceeded all risk based capital
requirements.
During the three months ended June 30, 2002, the Company repurchased an
additional 620,900 shares of its common stock for a total cost of approximately
$20.4 million. On May 8, 2002, the Board of Directors authorized a $30.0 million
stock repurchase program to begin immediately. This authorization included the
$8.5 million of unspent funds carried forward from the February 2002
authorization. At June 30, 2002, approximately $12.7 million of unspent
authorization was available for future purchases. During the month of July 2002,
the Company repurchased an additional 405,700 shares of its common stock for a
total cost of approximately $12.2 million. On August 7, 2002, the Board of
Directors authorized a $40.0 million stock repurchase program to begin
immediately. The authorization included the $.5 million of unspent funds carried
forward from the May 2002 authorization.
As previously described in Note 1 to these consolidated condensed financial
statements, in April 2002, the Company received payment of $41.0 million from
Merck in settlement of its dispute with Merck over its 2000 cost guarantee.
MARKET RISK
The Company is exposed to market risk through its investment in fixed and
variable rate debt securities that are interest rate sensitive. The Company does
not use derivative financial instruments. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer, or type of instrument. A hypothetical
ten percent change in market interest rates over the next year would not
materially impact the Company's financial position or cash flow. The Company has
no significant market risk with regard to liabilities and does not use special
purpose entities. There are no material changes in market risk exposure at June
30, 2002 when compared with December 31, 2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is contained in Item 2 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In September 2000, the Company and other HMOs operating in Maryland were served
with similar class action lawsuits challenging the constitutionality of the law
which allows the Company to subrogate against other insurance companies. The
action against the Company was filed in the Circuit Court for Montgomery County,
Maryland which recently ruled in another case which is now on appeal to the
Maryland Court of Appeals that the subrogation law was constitutional. The
Company believes that its operations with respect to the law are valid. However,
the Company is not able to predict, at this time, the ultimate outcome of this
action.
On April 24, 2002, the Company and Merck-Medco Managed Care, LLC ("Merck") and
related entities reached a settlement in the pending arbitration previously
disclosed by the Company concerning Merck's obligations under the Integrated
Drug Program Master Agreement for fiscal year ended 2000. Under the terms of the
settlement agreement, the Company has received payment of $41 million.
The Company is involved in other various legal actions arising in the normal
course of business, some of which seek substantial monetary damages. After
review, including consultation with legal counsel, management believes that any
ultimate liability that could arise from these other actions will not materially
effect the Company's consolidated financial position or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - None
(b) In a report on Form 8-K dated April 29, 2002, the Company reported under
Item 5 "Other Events" a settlement in the Demand for Arbitration filed against
Merck-Medco Managed Care, LLC and related entities.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
MID ATLANTIC MEDICAL SERVICES, INC.
--------------------------------------------
(Registrant)
Date: August 14, 2002 /s/ Robert E. Foss
-------------------------------------
Robert E. Foss
Senior Executive Vice President and
Chief Financial Officer (duly authorized officer
and principal financial officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Mid Atlantic Medical Services,
Inc. ("Company") on Form 10-Q for the period ended June 30, 2002 as filed with
the Securities and Exchange Commission on the date hereof ("Report"), each of
the undersigned, in the capacities and on the dates indicated below, hereby
certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that to his knowledge:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
August 14, 2002 /s/ Thomas P. Barbera
----------------------------------------------
Name: Thomas P. Barbera
Title: President and Chief Executive Officer
/s/ Robert E. Foss
----------------------------------------------
Name: Robert E. Foss
Title: Senior Executive Vice President and
Chief Financial Officer